XNYS:TUC Quarterly Report 10-Q Filing - 6/30/2012

Effective Date 6/30/2012

Table of Contents

 

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

FORM 10-Q

 

(Mark One)

 

x      QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the quarterly period ended June 30, 2012

 

OR

 

o         TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

 

For the transition period from                to              

 

COMMISSION FILE NUMBER 1-13495

 

MAC-GRAY CORPORATION

(Exact name of registrant as specified in its charter)

 

DELAWARE

 

04-3361982

(State or other jurisdiction incorporation or organization)

 

(I.R.S. Employer Identification No.)

 

 

 

404 WYMAN STREET, SUITE 400

 

 

WALTHAM, MASSACHUSETTS

 

02451-1212

(Address of principal executive offices)

 

(Zip Code)

 

Registrant’s telephone number, including area code: (781) 487-7600

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

Large Accelerated Filer o

 

Accelerated Filer x

 

 

 

Non-Accelerated Filer o
(Do not check if a smaller reporting company)

 

Smaller reporting company o

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes o  No x

 

As of August 1, 2012, 14,400,508 shares of common stock of the registrant, par value $.01 per share, were outstanding.

 

 

 



Table of Contents

 

INDEX

 

PART I

FINANCIAL INFORMATION

 

 

 

 

 

 

Item 1.

Financial Statements

3

 

 

 

 

 

 

Condensed Consolidated Balance Sheets at December 31, 2011 and June 30, 2012

3

 

 

 

 

 

 

Condensed Consolidated Statements of Income and Comprehensive Income for the Three and Six Months Ended June 30, 2011 and 2012

4

 

 

 

 

 

 

Condensed Consolidated Statement of Stockholders’ Equity for the Six Months Ended June 30, 2012

5

 

 

 

 

 

 

Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2011 and 2012

6

 

 

 

 

 

 

Notes to Condensed Consolidated Financial Statements

7

 

 

 

 

 

Item 2.

Management’s Discussion and Analysis of Financial Condition and Results of Operations

19

 

 

 

 

 

Item 3.

Quantitative and Qualitative Disclosures about Market Risk

27

 

 

 

 

 

Item 4.

Controls and Procedures

28

 

 

 

 

PART II

OTHER INFORMATION

 

 

 

 

 

 

Item 1A.

Risk Factors

28

 

 

 

 

 

Item 6.

Exhibits

29

 

 

 

 

 

Signature

30

 

2



Table of Contents

 

Item 1.                                 Financial Statements

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands, except share data)

 

 

 

December 31,

 

June 30,

 

 

 

2011

 

2012

 

Assets

 

 

 

 

 

Current assets:

 

 

 

 

 

Cash and cash equivalents

 

$

13,881

 

$

12,812

 

Trade receivables, net of allowance for doubtful accounts

 

5,586

 

3,474

 

Inventory of finished goods, net

 

1,487

 

2,607

 

Deferred income taxes

 

1,044

 

1,044

 

Prepaid facilities management rent and other current assets

 

9,760

 

10,017

 

Total current assets

 

31,758

 

29,954

 

Property, plant and equipment, net

 

127,204

 

129,254

 

Goodwill

 

58,173

 

57,955

 

Intangible assets, net

 

181,609

 

175,710

 

Prepaid facilities management rent and other assets

 

10,955

 

11,202

 

Total assets

 

$

409,699

 

$

404,075

 

 

 

 

 

 

 

Liabilities and Stockholders’ Equity

 

 

 

 

 

Current liabilities:

 

 

 

 

 

Current portion of long-term debt and capital lease obligations

 

$

4,190

 

$

1,155

 

Trade accounts payable

 

8,528

 

8,613

 

Accrued facilities management rent

 

20,917

 

20,020

 

Accrued expenses and other current liabilities

 

17,885

 

12,708

 

Total current liabilities

 

51,520

 

42,496

 

Long-term debt and capital lease obligations

 

198,638

 

204,200

 

Deferred income taxes

 

43,804

 

43,033

 

Other liabilities

 

1,923

 

1,559

 

Total liabilities

 

295,885

 

291,288

 

 

 

 

 

 

 

Commitments and contingencies (Note 6)

 

 

 

 

 

Stockholders’ equity:

 

 

 

 

 

Preferred stock ($.01 par value, 5 million shares authorized, no shares issued or outstanding)

 

 

 

Common stock ($.01 par value, 30 million shares authorized, 14,335,290 issued and outstanding at December 31, 2011, and 14,480,769 issued and 14,398,326 outstanding at June 30, 2012)

 

143

 

145

 

Additional paid in capital

 

86,217

 

88,229

 

Accumulated other comprehensive loss

 

(792

)

(472

)

Retained earnings

 

28,246

 

26,121

 

 

 

113,814

 

114,023

 

Less: common stock in treasury, at cost (82,443 shares at June 30, 2012)

 

 

(1,236

)

Total stockholders’ equity

 

113,814

 

112,787

 

Total liabilities and stockholders’ equity

 

$

409,699

 

$

404,075

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

3



Table of Contents

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share data)

 

 

 

Three Months Ended

 

Six Months Ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2012

 

2011

 

2012

 

Revenue:

 

 

 

 

 

 

 

 

 

Laundry facilities management revenue

 

$

74,959

 

$

74,639

 

$

154,148

 

$

154,944

 

Commercial laundry equipment sales

 

3,630

 

3,188

 

6,734

 

7,119

 

Total revenue

 

78,589

 

77,827

 

160,882

 

162,063

 

 

 

 

 

 

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

 

 

 

 

Cost of laundry facilities management revenue

 

52,760

 

53,274

 

105,556

 

108,240

 

Depreciation and amortization

 

10,913

 

10,393

 

21,944

 

20,830

 

Cost of commercial laundry equipment sales

 

3,001

 

2,651

 

5,578

 

5,848

 

Total cost of revenue

 

66,674

 

66,318

 

133,078

 

134,918

 

 

 

 

 

 

 

 

 

 

 

Gross margin

 

11,915

 

11,509

 

27,804

 

27,145

 

 

 

 

 

 

 

 

 

 

 

Operating expenses:

 

 

 

 

 

 

 

 

 

General and administration

 

4,669

 

4,511

 

9,431

 

11,203

 

Sales and marketing

 

3,435

 

2,785

 

7,163

 

5,663

 

Depreciation and amortization

 

187

 

209

 

358

 

410

 

Incremental costs of proxy contests

 

244

 

294

 

269

 

377

 

Gain on sale of assets, net

 

(65

)

(54

)

(157

)

(40

)

Total operating expenses

 

8,470

 

7,745

 

17,064

 

17,613

 

Income from operations

 

3,445

 

3,764

 

10,740

 

9,532

 

Interest expense, including the change in fair value of non-hedged interest rate derivative instruments and amortization of deferred financing costs

 

2,664

 

1,962

 

6,481

 

5,304

 

Loss on early extinguishment of debt

 

 

 

 

3,762

 

Income before provision for income taxes

 

781

 

1,802

 

4,259

 

466

 

Income tax expense

 

277

 

750

 

1,689

 

181

 

Net income

 

504

 

1,052

 

2,570

 

285

 

Other comprehensive gain, net of tax:

 

 

 

 

 

 

 

 

 

Unrealized gain on derivative instruments

 

84

 

182

 

338

 

320

 

Comprehensive income

 

$

588

 

$

1,234

 

$

2,908

 

$

605

 

Earnings per share — basic

 

$

0.04

 

$

0.07

 

$

0.18

 

$

0.02

 

Earnings per share — diluted

 

$

0.03

 

$

0.07

 

$

0.17

 

$

0.02

 

Weighted average common shares outstanding - basic

 

14,244

 

14,365

 

14,167

 

14,370

 

Weighted average common shares outstanding - diluted

 

15,033

 

15,055

 

14,923

 

15,050

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

4



Table of Contents

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)

(In thousands, except share data)

 

 

 

 

 

 

 

 

 

Accumulated

 

 

 

 

 

 

 

 

 

 

 

Common Stock

 

Additional

 

Other

 

 

 

 

 

Treasury Stock

 

 

 

 

 

Number

 

 

 

Paid In

 

Comprehensive

 

Comprehensive

 

Retained

 

Number

 

 

 

 

 

 

 

of shares

 

Value

 

Capital

 

Loss

 

Income

 

Earnings

 

of shares

 

Cost

 

Total

 

Balance, December 31, 2011

 

14,335,290

 

$

143

 

$

86,217

 

$

(792

)

 

 

$

28,246

 

 

$

 

$

113,814

 

Net income

 

 

 

 

 

$

285

 

285

 

 

 

$

285

 

Other comprehensive income:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Unrealized gain on derivative instrument and reclassification, net of tax of $207 (Note 4)

 

 

 

 

320

 

320

 

 

 

 

$

320

 

Comprehensive income

 

 

 

 

 

 

 

 

 

$

605

 

 

 

 

 

 

 

 

 

Repurchase of common stock

 

 

 

 

 

 

 

 

133,333

 

(2,000

)

$

(2,000

)

Options Exercised

 

10,384

 

 

139

 

 

 

 

(112

)

(13,761

)

207

 

$

234

 

Stock issuance - Employee

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Stock Purchase Plan

 

10,981

 

 

140

 

 

 

 

 

 

 

$

140

 

Stock compensation expense

 

 

 

1,365

 

 

 

 

 

 

 

$

1,365

 

Dividends paid, $.121 per share

 

 

 

 

 

 

 

 

(1,752

)

 

 

$

(1,752

)

Stock grants

 

124,114

 

2

 

368

 

 

 

 

(546

)

(37,129

)

557

 

$

381

 

Balance, June 30, 2012

 

14,480,769

 

$

145

 

$

88,229

 

$

(472

)

 

 

$

26,121

 

82,443

 

$

(1,236

)

$

112,787

 

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

5



Table of Contents

 

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)

 

 

 

Six months ended
June 30,

 

 

 

2011

 

2012

 

Cash flows from operating activities:

 

 

 

 

 

Net income

 

$

2,570

 

$

285

 

Adjustments to reconcile net income to net cash flows provided by operating activities:

 

 

 

 

 

Depreciation and amortization

 

22,302

 

21,240

 

Amortization of deferred financing costs

 

438

 

266

 

Loss on early extinguishment of debt

 

 

1,220

 

Increase (decrease) in allowance for doubtful accounts and lease reserves

 

4

 

(43

)

Gain on disposition of assets

 

(157

)

(40

)

Stock grants

 

414

 

381

 

Gain on change in fair value of interest rate derivatives

 

(442

)

(235

)

(Gain) loss on change in fair value of fuel commodity derivatives

 

(122

)

24

 

Increase (decrease) in deferred income taxes

 

481

 

(687

)

Non-cash stock compensation

 

1,526

 

1,365

 

Decrease in accounts receivable

 

2,106

 

2,155

 

Increase in inventory

 

(532

)

(1,120

)

Increase in prepaid facilities management rent and other assets

 

(2,268

)

(2,211

)

Decrease in accounts payable, accrued facilities management rent, accrued expenses and other liabilities

 

(1,259

)

(5,628

)

Net cash flows provided by operating activities

 

25,061

 

16,972

 

 

 

 

 

 

 

Cash flows from investing activities:

 

 

 

 

 

Capital expenditures

 

(15,526

)

(15,460

)

Proceeds from sale of assets

 

206

 

92

 

Net cash flows used in investing activities

 

(15,320

)

(15,368

)

 

 

 

 

 

 

Cash flows from financing activities:

 

 

 

 

 

Payments on capital lease obligations

 

(881

)

(690

)

Payment on senior notes

 

 

(100,000

)

Payments on secured revolving credit facility

 

(61,212

)

(137,490

)

Borrowings on secured revolving credit facility

 

54,373

 

259,132

 

Payments on secured term credit facility

 

(1,500

)

(18,750

)

Proceeds from exercise of stock options

 

683

 

234

 

Proceeds from issuance of common stock

 

97

 

140

 

Debt acquisition costs

 

 

(1,497

)

Cash dividend paid

 

(1,566

)

(1,752

)

Repurchase of common stock

 

 

(2,000

)

Net cash flows used in financing activities

 

(10,006

)

(2,673

)

 

 

 

 

 

 

Decrease in cash and cash equivalents

 

(265

)

(1,069

)

Cash and cash equivalents, beginning of period

 

13,013

 

13,881

 

Cash and cash equivalents, end of period

 

$

12,748

 

$

12,812

 

 

Supplemental disclosure of non-cash investing and financing activities: during the six months ended June 30, 2011 and 2012, the Company acquired various assets under capital lease agreements totaling $350 and $325, respectively.

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

6



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

1.  Basis of Presentation

 

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The unaudited interim condensed consolidated financial statements do not include all information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America. In the opinion of the management of Mac-Gray Corporation (the “Company” or “Mac-Gray,”) the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal, recurring adjustments), which are necessary to present fairly the Company’s financial position, the results of its operations, and its cash flows. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s 2011 audited consolidated financial statements filed with the Securities and Exchange Commission in its Annual Report on Form 10-K for the year ended December 31, 2011. The results for interim periods are not necessarily indicative of the results to be expected for the full year.

 

The Company generates the majority of its revenue from card and coin-operated laundry equipment located in 43 states throughout the United States, as well as the District of Columbia. The Company’s principal customer base is the multi-unit housing market, which consists of apartments, condominium units, colleges and universities. The Company also sells and services commercial laundry equipment to commercial laundromats, multi-housing properties and institutions. The majority of the Company’s purchases of laundry equipment are from one supplier.

 

2.  Revisions to Income Statement Presentation

 

The Company has determined that the amortization of deferred financing costs which was included in depreciation and amortization within operating expenses for the three and six months ended June 30, 2011 should have been included in interest expense.  Accordingly, the Company has corrected the presentation of the amortization of deferred financing costs and included it as part of interest expense on the condensed consolidated statements of income and comprehensive income.  The Company has revised its condensed consolidated statements of income and comprehensive income by decreasing depreciation and amortization within operating expenses and increasing interest by $219 and $438 for the three and six months ended June 30, 2011, respectively.  Accordingly, income from operations increased from $3,226 to $3,445 for the three months ended June 30, 2011 and from $10,302 to $10,740 for the six months ended June 30, 2011.  This change in presentation does not impact income before income tax expense or net income; nor does it impact the condensed consolidated balance sheets or the condensed consolidated statements of cash flows.

 

3.  Long-Term Debt

 

On February 29, 2012, the Company entered into an Amended and Restated Senior Secured Credit Agreement (the “2012 Credit Agreement”).  The 2012 Credit Agreement provides for borrowings up to $250,000 under a revolving credit facility (the “Revolver”).  The 2012 Credit Agreement matures on February 28, 2017. The 2012 Credit Agreement is collateralized by a blanket lien on the assets of the Company and each of its subsidiaries as well as a pledge by the Company of all the capital stock of its subsidiaries.  Outstanding indebtedness under the 2012 Credit Agreement bears interest at a fluctuating rate equal to (i) in the case of Eurodollar rate loans, the LIBOR rate plus an applicable percentage, ranging from 1.75% to 2.75% per annum (currently 2.50%), determined by reference to our consolidated total leverage ratio, and (ii) in the case of base rate loans and swingline loans, the higher of (a) the federal funds rate plus 0.50%, (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate,” or (c) for each day, the floating rate of interest equal to LIBOR for a one month term quoted for such date (the highest of which is defined as the “Base Rate”), plus, in each case, an applicable percentage, ranging from 0.75% to 1.75% per annum (currently 1.50%), determined by reference to our consolidated total leverage ratio.

 

7



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

3.  Long-Term Debt (continued)

 

The Company pays a commitment fee equal to a percentage of the actual daily-unused portion of the Revolver under the 2012 Credit Agreement. This percentage is determined quarterly by reference to the Company’s consolidated total leverage ratio and ranges between 0.250% per annum and 0.500% per annum (currently 0.350%).  For purposes of the calculation of the commitment fee, letters of credit are considered usage under the Revolver, but swingline loans are not considered usage under the Revolver.

 

The 2012 Credit Agreement includes certain financial and operational covenants, including restrictions on paying dividends and other distributions, making certain acquisitions and incurring indebtedness, and requires that the Company maintain certain financial ratios.  The most significant financial ratios that the Company is required to maintain include a consolidated total leverage ratio of not greater than 3.75 to 1.00 (3.50 to 1.00 as of December 31, 2013 and thereafter) and a consolidated cash flow coverage ratio of not less than 1.20 to 1.00.  The Company was in compliance with all financial covenants at June 30, 2012.

 

The Company incurred deferred financing costs of $1,497 associated with the 2012 Credit Agreement and wrote off unamortized deferred financing costs of $133 associated with the Company’s 2008 credit facility.

 

As of June 30, 2012, there was $203,061 outstanding under the Revolver and $1,380 in outstanding letters of credit. The available balance under the Revolver was $45,559 at June 30, 2012. The average interest rates on the borrowings outstanding under the prior credit agreement and the 2012 Credit Agreement at June 30, 2011 and 2012 were 5.58% and 3.67%, respectively, including the applicable spread paid to the banks and the effect of the interest rate swap agreements tied to the debt (see Note 4 for discussion on Fair Value Measurements).

 

On August 16, 2005, the Company issued senior unsecured notes in the amount of $150,000 with the fixed interest rate of 7.625%. On October 21, 2011, the Company redeemed $50,000 of the senior notes by utilizing $51,271 of availability under its 2008 credit facility. The Company paid a premium of $1,271 as well as interest accrued through the date of redemption and wrote off unamortized deferred financing costs of $623 associated with this redemption.  On March 30, 2012, the Company redeemed the remaining $100,000 of the senior notes by utilizing $103,495 of availability under the 2012 Credit Agreement and paying a premium of $2,542 as well as interest accrued through the date of redemption.  The Company wrote off the remaining $1,087 of unamortized deferred financing costs associated with this redemption.

 

Interest expense associated with the Company’s long term debt for the three and six months ended June 30, 2011 and 2012 is comprised of the following:

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2012

 

2011

 

2012

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

$

3,252

 

$

2,018

 

$

6,485

 

$

5,273

 

Change in the fair value of non-hedged interest rate derivative instruments

 

(807

)

(146

)

(442

)

(235

)

Amortization of deferred financing costs

 

219

 

90

 

438

 

266

 

Interest expense, including change in fair value of non-hedged interest rate derivative instruments and amortization of deferred financing costs

 

$

2,664

 

$

1,962

 

$

6,481

 

$

5,304

 

 

Capital lease obligations comprised primarily of Company’s fleet of vehicles totaled $2,659 and $2,294 at December 31, 2011 and June 30, 2012, respectively.

 

8



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

3.  Long-Term Debt (continued)

 

Required payments under the Company’s long-term debt and capital lease obligations are as follows:

 

 

 

Amount

 

2012(six months)

 

$

591

 

2013

 

1,006

 

2014

 

585

 

2015

 

88

 

2016

 

24

 

Thereafter

 

203,061

 

 

 

$

205,355

 

 

The Company historically has not needed sources of financing other than its internally generated cash flow and revolving credit facilities to fund its working capital, capital expenditures, and smaller acquisitions. As a result, the Company anticipates that its cash flow from operations and revolving credit facilities will be sufficient to meet its anticipated cash requirements for at least the next twelve months.

 

4.  Fair Value Measurements

 

The Company has adopted accounting guidance regarding fair value measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

 

Level 1:  Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

Level 2:  Inputs, other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

 

Level 3:  Unobservable inputs that reflect the reporting entity’s own assumptions.

 

The following table summarizes the basis used to measure certain financial assets and financial liabilities at fair value on a recurring basis in the balance sheet:

 

9



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

4.  Fair Value Measurements (continued)

 

 

 

 

 

Basis of Fair Value Measurments

 

 

 

Balance at
June 30,
2012

 

Quoted
Prices In
Active
Markets
for
Identical
Items
(Level 1)

 

Significant
Other
Observable
Inputs
(Level 2)

 

Significant
Unobservable
Inputs
(Level 3)

 

Interest rate swap derivative financial instruments (included in accrued expenses and other current liabilities)

 

$

1,278

 

$

 

$

1,278

 

$

 

 

 

 

 

 

 

 

 

 

 

Fuel commodity derivatives (included in accrued expenses and other current liabilities)

 

$

58

 

$

 

$

 

$

58

 

 

The Company has entered into standard International Swaps and Derivatives Association (“ISDA”) interest rate swap agreements (“Swap Agreements”) to manage the interest rate associated with its debt. The interest rate Swap Agreements effectively convert $53,000 of the Company’s variable rate debt to a long-term fixed rate. Under these agreements the Company receives a variable rate of LIBOR plus a markup and pays a fixed rate.  The Company recognized a non-cash unrealized gain of $440 and $930 for the three months ended June 30, 2012 and 2011, respectively, and a non-cash unrealized gain of $830 and $713 for the six months ended June 30, 2012 and 2011, respectively, on the interest rate Swap Agreements as a result of the change in the fair value.

 

In December 2010, the Company entered into a fuel commodity derivative to manage the fuel cost on its fleet of vehicles. The derivative was effective April 1, 2011 and expired December 31, 2011.  On September 23, 2011 the Company entered into an additional fuel commodity derivative. The derivative was effective January 1, 2012 and expires December 31, 2012.  The derivative has a monthly notional amount of 85 thousand gallons from January 1, 2012 through December 31, 2012 for a total notional amount of 1.02 million gallons. The Company has a put price of $3.205 per gallon and a strike price of $3.70 per gallon. The Company recognized a non-cash unrealized loss of $274 and $157 for the three months ended June 30, 2012 and 2011, respectively, and a loss of $24 and a gain of $122 for the six months ended June 30, 2012 and 2011, respectively, on the fuel commodity derivatives as a result of the change in the fair value.

 

The fair value of these interest rate derivatives are based on quoted prices for similar instruments from a commercial bank and are considered a Level 2 item. The fuel commodity derivative is based on market assumptions and a quoted price from the counter party and is considered a Level 3 item.

 

10



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

 

4.  Fair Value Measurements (continued)

 

The fuel commodity derivative activity for the six months ended June 30, 2012 is as follows:

 

Balance, December 31, 2011

 

$

(34

)

Realized gains

 

33

 

Unrealized losses

 

(24

)

Settlements

 

(33

)

Balance, June 30, 2012

 

$

(58

)

 

The Company determines the fair value of the amount outstanding under its 2012 Credit Facility using Level 2 inputs. The fair value of the 2012 Credit Agreement at June 30, 2012 approximates carrying value.

 

During the first quarter of 2012, as a result of the senior note redemption (Note 3), the Company no longer qualified for hedge accounting treatment on its interest rate swap agreements.  Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost is being reclassified as an earnings charge through the maturity date of the derivative.  This charge to interest expense, when combined with an interest rate swap agreement that previously lost hedge accounting treatment, amounted to $294 and $595 for the three and six months ended June 30, 2012 compared to $123 and $271 for the three and six months ended June 30, 2011, respectively. The remaining balance of $763 associated with these interest rate swap agreements and included in Accumulated Other Comprehensive Loss will be charged to interest expense through the maturity date of the interest rate swap agreements on April 1, 2013.

 

The table below outlines the details of each remaining interest rate Swap Agreement:

 

 

 

 

 

Notional

 

Notional

 

 

 

 

 

 

 

Original

 

Amount

 

Amount

 

 

 

 

 

Date of

 

Notional

 

Fixed/

 

June 30,

 

Expiration

 

Fixed

 

Origin

 

Amount

 

Amortizing

 

2012

 

Date

 

Rate

 

 

 

 

 

 

 

 

 

 

 

 

 

May 8, 2008

 

$

45,000

 

Amortizing

 

$

30,000

 

Apr 1, 2013

 

3.78

%

May 8, 2008

 

$

40,000

 

Amortizing

 

$

23,000

 

Apr 1, 2013

 

3.78

%

 

In accordance with the interest rate Swap Agreements and on a quarterly basis, interest expense is calculated based on the floating 90-day LIBOR and the fixed rate.  If interest expense, as calculated, is greater based on the 90-day LIBOR, the financial institution pays the difference to the Company.  If interest expense, as calculated, is greater based on the fixed rate, the Company pays the difference to the financial institution.

 

11



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

4.  Fair Value Measurements (continued)

 

Depending on fluctuations in the LIBOR, the Company’s interest rate exposure and its related impact on interest expense and net cash flow may increase or decrease. The counterparty to the interest rate Swap Agreements expose the Company to credit loss in the event of non-performance; however, nonperformance is not anticipated given the counterparty’s creditworthiness.

 

The tables below display the impact the Company’s derivative instruments had on the Condensed Consolidated Balance Sheets as of December 31, 2011 and June 30, 2012 and the Condensed Consolidated Statements of Income and Comprehensive Income for the three and six months ended June 30, 2011 and 2012.

 

Fair Values of Derivative Instruments

 

 

 

 

 

Liability Derivatives

 

 

 

December 31, 2011

 

June 30, 2012

 

 

 

Balance Sheet
Location

 

Fair Value

 

Balance Sheet
Location

 

Fair Value

 

 

 

 

 

 

 

 

 

 

 

Derivatives designated as hedging instruments:

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Accrued expenses

 

$

949

 

Accrued expenses

 

$

 

Interest rate contracts

 

Other liabilites

 

190

 

Other liabilites

 

 

 

 

 

 

 

 

 

 

 

 

Derivatives not designated as hedging instruments:

 

 

 

 

 

 

 

 

 

Interest rate contracts

 

Accrued expenses

 

743

 

Accrued expenses

 

1,278

 

Interest rate contracts

 

Other liabilites

 

159

 

Other liabilities

 

 

Fuel commodity derivatives

 

Accrued expenses

 

34

 

Accrued expenses

 

58

 

 

 

 

 

 

 

 

 

 

 

Total derivatives

 

 

 

$

2,075

 

 

 

$

1,336

 

 

12



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

4.  Fair Value Measurements (continued)

 

The Effect of Derivative Instruments on the Condensed Consolidated Income Statements

for the three months ended June 30, 2011 and 2012

 

Derivatives in
Net Investment

 

Amount of Gain or (Loss)
Recognized in OCI on
Derivative (Effective
Portion)

 

Location of Loss
Reclassified from
Accumulated OCI

 

Amount of Loss
Reclassified from
Accumulated OCI into
Income (Effective Portion)

 

Derivatives Not
Designated as

 

Location of
Gain
Recognized in

 

Amount of Gain
Recognized in Income on
Derivative

 

Hedging

 

June 30,

 

June 30,

 

into Income (Effective

 

June 30,

 

June 30,

 

Hedging

 

Income on

 

June 30,

 

June 30,

 

Relationships

 

2011

 

2012

 

Portion)

 

2011

 

2012

 

Instruments

 

Derivative

 

2011

 

2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts:

 

 

 

 

 

Interest expense, including the change in the fair value of non-hedged derivative instruments:

 

 

 

 

 

Interest rate contracts:

 

Interest expense, including the change in the fair value of non-hedged derivative instruments:

 

 

 

 

 

Unrealized

 

$

14

 

$

 

Unrealized

 

$

(123

)

$

(294

)

 

 

Unrealized

 

$

930

 

$

440

 

Realized

 

(263

)

 

Realized

 

(263

)

 

 

 

Realized

 

425

 

(442

)

Total

 

$

(249

)

$

 

Total

 

$

(386

)

$

(294

)

 

 

Total

 

$

1,355

 

$

(2

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel commodity derivatives:

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

Fuel commodity derivatives:

 

Cost of revenue:

 

 

 

 

 

Unrealized

 

$

 

$

 

Unrealized

 

$

 

$

 

 

 

Unrealized

 

$

(157

)

$

(274

)

Realized

 

 

 

Realized

 

 

 

 

 

Realized

 

70

 

20

 

Total

 

$

 

$

 

Total

 

$

 

$

 

 

 

Total

 

$

(87

)

$

(254

)

 

13



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

4.  Fair Value Measurements (continued)

 

The Effect of Derivative Instruments on the Condensed Consolidated Income Statements

for the six months ended June 30, 2011 and 2012

 

Derivatives in
Net Investment

 

Amount of Gain or (Loss)
Recognized in OCI on
Derivative (Effective
Portion)

 

Location of Loss
Reclassified from
Accumulated OCI

 

Amount of Loss
Reclassified from
Accumulated OCI into
Income (Effective Portion)

 

Derivatives Not
Designated as

 

Location of
Gain
Recognized in

 

Amount of Gain
Recognized in Income on
Derivative

 

Hedging

 

June 30,

 

June 30,

 

into Income (Effective

 

June 30,

 

June 30,

 

Hedging

 

Income on

 

June 30,

 

June 30,

 

Relationships

 

2011

 

2012

 

Portion)

 

2011

 

2012

 

Instruments

 

 Derivative

 

2011

 

2012

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Interest rate contracts:

 

 

 

 

 

Interest expense, including the change in the fair value of non-hedged derivative instruments:

 

 

 

 

 

Interest rate contracts:

 

Interest expense, including the change in the fair value of non-hedged derivative instruments:

 

 

 

 

 

Unrealized

 

$

280

 

$

(67

)

Unrealized

 

$

(271

)

$

(595

)

 

 

Unrealized

 

$

713

 

$

830

 

Realized

 

(524

)

(162

)

Realized

 

(524

)

(162

)

 

 

Realized

 

855

 

(734

)

Total

 

$

(244

)

$

(229

)

Total

 

$

(795

)

$

(757

)

 

 

Total

 

$

1,568

 

$

96

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Fuel commodity derivatives:

 

 

 

 

 

Cost of revenue:

 

 

 

 

 

Fuel commodity derivatives:

 

Cost of revenue:

 

 

 

 

 

Unrealized

 

$

 

$

 

Unrealized

 

$

 

$

 

 

 

Unrealized

 

$

122

 

$

(24

)

Realized

 

 

 

Realized

 

 

 

 

 

Realized

 

70

 

33

 

Total

 

$

 

$

 

Total

 

$

 

$

 

 

 

Total

 

$

192

 

$

9

 

 

5.  Goodwill and Intangible Assets

 

Goodwill and intangible assets consist of the following:

 

 

 

As of December 31, 2011

 

 

 

Cost

 

Accumulated
Amortization

 

Net Book Value

 

 

 

 

 

 

 

 

 

Goodwill

 

$

58,173

 

 

 

$

58,173

 

 

 

$

58,173

 

 

 

$

58,173

 

Intangible assets:

 

 

 

 

 

 

 

Trade Name

 

$

14,050

 

$

 

$

14,050

 

Non-compete agreements

 

3,187

 

3,170

 

17

 

Contract rights

 

237,768

 

72,730

 

165,038

 

Distribution rights

 

1,623

 

784

 

839

 

Deferred financing costs

 

5,207

 

3,542

 

1,665

 

 

 

$

261,835

 

$

80,226

 

$

181,609

 

 

14



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

5.  Goodwill and Intangible Assets (continued)

 

 

 

As of June 30, 2012

 

 

 

Cost

 

Accumulated
Amortization

 

Net Book Value

 

 

 

 

 

 

 

 

 

Goodwill

 

$

57,955

 

 

 

$

57,955

 

 

 

$

57,955

 

 

 

$

57,955

 

Intangible assets:

 

 

 

 

 

 

 

Trade Name

 

$

14,050

 

$

 

$

14,050

 

Non-compete agreements

 

2,277

 

2,269

 

8

 

Contract rights

 

228,843

 

69,625

 

159,218

 

Distribution rights

 

1,623

 

865

 

758

 

Deferred financing costs

 

1,796

 

120

 

1,676

 

 

 

$

248,589

 

$

72,879

 

$

175,710

 

 

Estimated future amortization expense of intangible assets consists of the following:

 

2012 (six months)

 

$

6,010

 

2013

 

12,019

 

2014

 

12,013

 

2015

 

12,004

 

2016

 

12,004

 

Thereafter

 

106,746

 

 

 

$

160,796

 

 

Amortization expense of intangible assets for the six months ended June 30, 2011 and 2012 was $6,515 and $6,116, respectively.

 

Intangible assets primarily consist of various non-compete agreements, and contract rights recorded in connection with acquisitions. The deferred financing costs were incurred in connection with our senior secured credit facility and our senior notes and are amortized from five to ten years. The non-compete agreements are amortized using the straight-line method over the life of the agreements, which range from five to fifteen years. Contract rights are amortized using the straight-line method over fifteen to twenty years. The life assigned to acquired contracts is based on several factors, including:  (i) the historical renewal rate of the contract portfolio for the most recent years prior to the acquisition, (ii) the number of years the average contract has been in the contract portfolio, (iii) the overall level of customer satisfaction within the contract portfolio, and (iv) our ability to maintain comparable renewal rates in the future. The contract rights acquired are aggregated for purposes of calculating their fair value upon acquisition due to the fact that there are thousands of individual contracts in each market. No single contract accounts for more than 2% of the revenue of any acquired portfolio and the contracts are homogeneous. The fair values of acquired portfolios are established based upon discounted cash flows generated by the acquired contracts.  The fair values of the contracts are allocated to asset groups, comprised of the Company’s geographic markets, based on an estimate of relative fair value.

 

15



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

6.  Commitments and Contingencies

 

The Company is involved in various litigation proceedings arising in the normal course of business.  In the opinion of management, the Company’s ultimate liability, if any, under pending litigation would not materially affect its financial condition or the results of its operations or cash flows.

 

7.  Earnings Per Share

 

A reconciliation of the weighted average number of common shares outstanding is as follows:

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2012

 

2011

 

2012

 

 

 

 

 

 

 

 

 

 

 

Net income

 

$

504

 

$

1,052

 

$

2,570

 

$

285

 

 

 

 

 

 

 

 

 

 

 

Weighted average number of common shares outstanding - basic

 

14,244

 

14,365

 

14,167

 

14,370

 

Effect of dilutive securities:

 

 

 

 

 

 

 

 

 

Stock options and restricted stock units

 

789

 

690

 

756

 

680

 

Weighted average number of common shares outstanding - diluted

 

15,033

 

15,055

 

14,923

 

15,050

 

 

 

 

 

 

 

 

 

 

 

Net income per share - basic

 

$

0.04

 

$

0.07

 

$

0.18

 

$

0.02

 

Net income per share - diluted

 

$

0.03

 

$

0.07

 

$

0.17

 

$

0.02

 

 

There were 256 and 587 shares under option plans that were excluded from the computation of diluted earnings per share for the three months ended June 30, 2011 and 2012, respectively, and 288 and 530 shares under option plans that were excluded from the computation of diluted earnings per share for the six months ended June 30, 2011 and 2012, respectively, due to their anti-dilutive effects.

 

8.  Stock Compensation

 

During the three months ended June 30, 2012, grants of options for 5 shares were issued by the Company.  The grant-date fair values of employee share options and similar instruments are estimated using the Black-Scholes option-pricing model.  The fair values of the stock options granted were estimated using the following components:

 

Weighted average fair value of options at grant date

 

$5.06

Risk free interest rates

 

0.93% - 1.43%

Pre-vest forfeiture rates

 

0.00% - 19.00%

Expected life

 

6 years - 7 years

Expected volatility

 

42.103% - 44.067%

Dividend Yield

 

1.73% - 1.88%

 

During the three months ended June 30, 2012, the Company granted restricted stock units covering 33 shares of stock with a fair market value on date of grant of $12.90 per share.  The restricted stock units vest over three years.

 

16



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

8.  Stock Compensation (continued)

 

For the three and six months ended June 30, 2012, the Company incurred stock compensation expense of $856 and $1,676, respectively. The allocation of stock compensation expense is consistent with the allocation of the participants’ salaries and other compensation expenses.

 

At June 30, 2012, options for 542 shares and 191 restricted shares have been granted but have not yet vested.

 

Compensation expense related to unvested options and restricted shares will be recognized in the following years:

 

2012 (six months)

 

$

1,589

 

2013

 

1,341

 

2014

 

687

 

2015

 

109

 

 

 

$

3,726

 

 

9.  Income Taxes

 

The following table presents the income tax expense and the effective income tax rates for the three and six months ended June 30, 2011 and 2012:

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2012

 

2011

 

2012

 

 

 

 

 

 

 

 

 

 

 

Income tax expense

 

$

277

 

$

750

 

$

1,689

 

$

181

 

Effective tax rate

 

35

%

42

%

40

%

39

%

 

The effective income tax rate on operations is based upon the estimated income for the year and adjustments, if any, resulting from tax audits or other tax contingencies.

 

The changes in the effective tax rates for the three and six months ended June 30, 2011 and 2012 are the result of the relative impact of permanent differences due to changes in estimated pretax annual profits.

 

As June 30, 2012, the uncertain tax positions recognized by the Company in the consolidated financial statements were not material.

 

10.  New Accounting Pronouncements

 

In May 2011, the FASB issued an amendment to the accounting guidance for fair value measurement and disclosure.  Among other things, the guidance expands the disclosure requirements around fair value measurements categorized in Level 3 of the fair value hierarchy and requires disclosure of the level in the fair value hierarchy of items that are not measured at fair value in the statement of financial position but whose fair value must be disclosed.  It also clarifies and expands upon existing requirements for measurement of the fair value of financial assets and liabilities as well as instruments classified in stockholders’ equity.  The guidance

 

17



Table of Contents

 

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

 

is effective for interim and annual periods beginning after December 15, 2011.  The adoption of this guidance did not have a material impact on our financial statements.

 

In June 2011, the FASB issued accounting guidance which improves the comparability, consistency and transparency of financial reporting and increases the prominence of items reported in other comprehensive income. This guidance is effective for fiscal years beginning on or after December 15, 2011 and early adoption is permitted. The Company adopted this guidance in the first quarter of 2012 with no impact on financial results.

 

In December 2011, the FASB issued updated guidance that provides amendments for disclosures about offsetting assets and liabilities. The amendments require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The amendments are effective for annual reporting periods beginning on or after January 1, 2013.  Disclosures required by the amendments should be provided retrospectively for all comparative periods presented.  The adoption of this guidance will not impact the Company’s financial results.

 

No other new accounting pronouncement issued or effective during the fiscal year has had or is expected to have a material impact on the Consolidated Financial Statements.

 

11.  Payment of dividends

 

The Company’s Board of Directors declared quarterly dividends of $0.0605 per share which were paid on March 30, 2012 and June 29, 2012 to stockholders of record at the close of business on March 15, 2012 and June 15, 2012, respectively.

 

12.  Repurchase of Common Stock

 

On December 31, 2011, the Company’s Board of Directors authorized a share repurchase program under which the Company is authorized to purchase up to an aggregate of $2,000 of its common stock. The Company repurchased 133,333 shares through June 30, 2012 under the plan for a total cash outlay of $2,000, thereby completing the repurchase program.

 

13. Subsequent Events

 

The Company has reviewed subsequent events and concluded that no material subsequent events have occurred that are not accounted for in the accompanying financial statements or disclosed in the accompanying notes.

 

18



Table of Contents

 

Item 2

 

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

 

This report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties.  Additional statements identified by words such as “will,” “likely,” “may,” “believe,” “expect,” “anticipate,” “intend,” “seek,” “designed,” “develop,” “would,” “future,” “can,” “could,” “outlook” and other expressions that are predictions of or indicate future events and trends and which do not relate to historical matters, also identify forward-looking statements.  These forward-looking statements reflect our current views about future events and financial performance.  Investors should not rely on forward-looking statements because they are subject to a variety of factors that could cause actual results to differ materially from our expectations.  Factors that could cause or contribute to such differences include, but are not limited to, the following:

 

·            debt service requirements under our existing and future indebtedness;

 

·            availability of cash flow to finance capital expenditures;

 

·            our ability to renew laundry leases with our customers;

 

·            competition in the laundry facilities management industry;

 

·                                    our ability to maintain relationships with our suppliers;

 

·                                    our ability to maintain adequate internal controls over financial reporting;

 

·                                    our ability to consummate acquisitions and successfully integrate the businesses we acquire;

 

·            increases in multi-unit housing sector apartment vacancy rates and condominium conversions;

 

·            our ability to protect our intellectual property and proprietary rights and create new technology;

 

·            our ability to retain our key personnel and attract and retain other highly skilled employees;

 

·            decreases in the value of our intangible assets;

 

·            our ability to comply with current and future environmental regulations;

 

·            actions of our controlling stockholders;

 

·            provisions of our charter and bylaws that could discourage takeovers; and

 

·                                    those factors discussed under Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2011 and our other filings with the Securities and Exchange Commission (“SEC”).

 

Our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations or financial condition.  In view of these uncertainties, investors are cautioned not to place undue reliance on these forward-looking statements. We assume no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

 

In this Quarterly Report on Form 10-Q, unless the context suggests otherwise, references to the “Company,” “Mac-Gray,” “we,” “us,” “our” and similar terms refer to Mac-Gray Corporation and its subsidiaries.  We have registered, applied to register or are using the following trademarks: Mac-Gray®, Web®, Hof, Automatic Laundry Company, LaundryView®, PrecisionWashÔ, Intelligent Laundry®, LaundryLinxÔ, TechLinxÔ,

 

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VentSnakeÔ, LaundryAuditÔ, e-issuesÔ Life Just Got Easier® , The Laundry Room Experts®, Change Point®, The Campus Clothes Line®, and Digital Laundry is here®.

 

Overview

 

Mac-Gray Corporation was founded in 1927 and re-incorporated in Delaware in 1997. Since its founding, Mac-Gray has grown to become the second largest laundry facilities management business in the United States.  Through our portfolio of card and coin-operated laundry equipment located in laundry facilities across the country, we provide laundry convenience to residents of multi-unit housing, such as apartment buildings, condominiums, colleges and universities, public housing complexes, and hotels and motels in 43 states and the District of Columbia.  Based on our ongoing survey of colleges and universities, we believe we are the largest provider of such services to the college and university market in the United States.

 

Our business model is built on a stable demand for laundry services, combined with long-term leases, strong customer relationships, a broad customer base, and predictable capital needs.  For the three and six months ended June 30, 2012, our total revenue was $77,827 and $162,063, respectively. Approximately 96% of our total revenue for the three and six month period was generated by our facilities management business.  We generate facilities management revenue primarily by entering into long-term leases with property owners or property management companies for the exclusive right to install and maintain laundry equipment in common area laundry rooms within their properties in exchange for a negotiated portion of the revenue we collect.  As of June 30, 2012, approximately 84% of our installed equipment base was located in laundry facilities subject to long-term leases, which have a weighted average remaining term of approximately four years.  Our capital costs are typically incurred in connection with new or renewed leases, and include investments in laundry equipment and card and coin-operated systems, incentive payments to property owners or property management companies, and expenses to refurbish laundry facilities.  Our capital costs consist primarily of a large number of relatively small amounts, which are associated with our entry into or renewal of leases. Our capital needs other than for laundry leases are not significant.  Accordingly, our capital needs are predictable and largely within our control.  For the three and six months ended June 30, 2012, we incurred $7,726 and $15,460 of capital expenditures, respectively. In addition, we made incentive payments of approximately $858 and $2,007 in the three and six months ended June 30, 2012 to property owners and property management companies in connection with obtaining our lease arrangements.

 

Through our commercial equipment sales and services business, we generate revenue by selling commercial laundry equipment.  For the three and six months ended June 30, 2012, our commercial laundry equipment sales business generated approximately 4% of our total revenue, and 5% of our gross margin. We anticipate that tight credit markets for our customers will continue to challenge our ability to maintain and grow our revenue from laundry equipment sales.

 

Our current priorities include: (i) continuing to reduce funded debt, thereby improving debt leverage ratios and reducing interest expense, (ii) maintaining capital expenditures at the levels needed to sustain and grow the business, (iii) increasing facilities management operating efficiencies in all markets, (iv) improving the profitability of individual laundry facilities management accounts that come up for contract renewal, and (v) continuing to look for acquisitions that complement our current footprint.  One of the key challenges we face is maintaining and expanding our customer base in a competitive industry. Approximately 8% to 10% of our laundry room leases are up for renewal each year.  Within any given geographic area, Mac-Gray may compete with local independent operators, regional operators and multi-region operators as well as property owners and property management companies who self-operate their laundry facilities. We devote substantial resources to our sales efforts and are focused on continued innovation in order to distinguish us from our competitors.

 

On February 29, 2012, we entered into an Amended and Restated Senior Secured Credit Agreement (“2012 Credit Agreement”) with a lending syndicate, including Bank of America, N.A., as Administrative Agent and Collateral Agent , Wells Fargo Bank, National Association, as Syndication Agent, and RBS Citizens, N.A. and TD Banknorth, NA, as Co-Documentation Agents.  See “Liquidity and Capital Resources” below.

 

On March 30, 2012, we redeemed the remaining $100,000 of our senior notes utilizing $103,495 of availability under the 2012 Credit Agreement.  The redemption price for the notes was 102.542%. Under the terms of the 2012 Credit Agreement, we will pay an interest rate of LIBOR plus a spread of between 1.75% and 2.75%. If there is not a significant change in LIBOR, we expect the cash payback on this strategy to be approximately six to eight months.

 

Our Board of Directors declared quarterly dividends of $0.0605 per share which were paid on March 30, 2012

 

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and June 29, 2012 to stockholders of record at the close of business on March 15, 2012 and June 15, 2012, respectively.

 

On December 31, 2011, our Board of Directors authorized a share repurchase program under which we are authorized to purchase up to an aggregate of $2,000 of our common stock. We repurchased 133,333 shares through March 31, 2012 under the plan for a total cash outlay of $2,000, thereby completing the repurchase program.

 

Results of Operations (Dollars in thousands)

 

Three and six months ended June 30, 2012 compared to three and six months ended June 30, 2011.

 

The information presented below for the three and six months ended June 30, 2012 and 2011 is derived from our unaudited condensed consolidated financial statements and related notes included elsewhere in this report:

 

 

 

For the three months ended June 30,

 

 

 

 

 

 

 

Increase

 

%

 

 

 

2011

 

2012

 

(Decrease)

 

Change

 

Laundry facilities management revenue

 

$

74,959

 

$

74,639

 

$

(320

)

0

%

Commercial laundry equipment sales revenue

 

3,630

 

3,188

 

(442

)

-12

%

Total revenue

 

$

78,589

 

$

77,827

 

$

(762

)

-1

%

 

 

 

For the six months ended June 30,

 

 

 

 

 

 

 

Increase

 

%

 

 

 

2011

 

2012

 

(Decrease)

 

Change

 

Laundry facilities management revenue

 

$

154,148

 

$

154,944

 

$

796

 

1

%

Commercial laundry equipment sales revenue

 

6,734

 

7,119

 

385

 

6

%

Total revenue from continuing operations

 

$

160,882

 

$

162,063

 

$

1,181

 

1

%

 

Revenue

 

Total revenue decreased by $762, or 1%, to $77,827 for the three months ended June 30, 2012 compared to $78,589 for the three months ended June 30, 2011. Total revenue increased by $1,181, or 1%, to $162,063 for the six months ended June 30, 2012 compared to $160,882 for the six months ended June 30, 2011.

 

Laundry facilities management revenue.  Laundry facilities management revenue decreased by $320, or less than 1%, to $74,639 for the three months ended June 30, 2012 compared to $74,959 for the three months ended June 30, 2011. Laundry facilities management revenue increased by $796, or 1%, to $154,944 for the six months ended June 30, 2012 compared to $154,148 for the six months ended June 30, 2011. The slight decrease in revenue in the three months ended June 30, 2012 and the increase in revenue for the six months ended June 30, 2012 compared to the same periods in the prior year reflect the cumulative impact of our vend price management initiatives, equipment usage, and general economic uncertainty implied in the apparent decline in consumer spending.  We expect that these factors are likely to continue to influence revenue in the near term.  We expect that the improving apartment occupancy rates will mitigate some of the pressure on revenue; however, industry data shows that the occupancy rates in the type of multi-family apartments in which we operate are improving at a slower rate than the premium type properties where we do not have a large presence. We continue to analyze economic trends in connection with expense controls and to optimize our capital spending.

 

Commercial laundry equipment sales.  Revenue in the commercial laundry equipment sales business decreased by $442, or 12%, to $3,188 for the three months ended June 30, 2012 compared to $3,630 for the three months ended June 30, 2011. Revenue in the commercial laundry equipment sales business increased by $385, or 6%, to $7,119 for the six months ended June 30, 2012 compared to $6,734 for the six months ended June 30, 2011.  Sales in the commercial laundry equipment sales business are sensitive to the strength of the local economy,

 

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the availability and cost of financing to small businesses, consumer confidence, and local permitting and therefore, tend to fluctuate significantly from period to period.

 

Cost of revenue

 

Cost of laundry facilities management revenue.  Cost of laundry facilities management revenue includes rent paid to customers as well as those costs associated with installing and servicing equipment and costs of collecting, counting, and depositing facilities management revenue. Cost of laundry facilities management revenue increased by $514, or 1%, to $53,274 for the three months ended June 30, 2012 as compared to $52,760 for the three months ended June 30, 2011. Cost of laundry facilities management revenue increased by $2,684, or 3%, to $108,240 for the six months ended June 30, 2012 as compared to $105,556 for the six months ended June 30, 2011.  As a percentage of laundry facilities management revenue, cost of laundry facilities management revenue was 71% and 70% for the three months ended June 30, 2012 and 2011, respectively, and 70% and 68% for the six months ended June 30, 2012 and 2011, respectively. Laundry facilities management rent varied approximately 1% for the three and six months ended June 30, 2012 compared to the corresponding periods in 2011, directly attributable to the changes in facilities management revenue. Laundry facilities management rent as a percentage of laundry facilities management revenue was 49.8 % for each of the three months ended June 30, 2012 and 2011 and 49.2% and 48.7% for the six months ended June 30, 2012 and 2011, respectively. Laundry facilities management rent can be affected by new and renewed laundry leases and by other factors such as the amount of incentive payments and laundry room betterments invested in new or renewed laundry leases. As we vary the amount invested in a facility, the laundry facilities management rent, as a function of laundry facilities management revenue, can vary. Other costs of laundry facilities management revenue increased by $672, or 4%, to $16,084 for the three months ended June 30, 2012 compared to $15,412 for the three months ended June 30, 2011. Other costs of laundry facilities management revenue increased by $1,564, or 5%, to $32,018 for the six months ended June 30, 2012 compared to $30,454 for the six months ended June 30, 2011. The increase in operating expenses for the three and six months ended June 30, 2012 compared to the same periods in 2011 is attributable to cost increases associated with our fleet of vehicles as well as increased credit card fees.

 

Depreciation and amortization related to operations.  Depreciation and amortization related to operations decreased by $520, or 5%, to $10,393 for the three months ended June 30, 2012 as compared to $10,913 for the three months ended June 30, 2011. Depreciation and amortization related to operations decreased by $1,114, or 5%, to $20,830 for the six months ended June 30, 2012 as compared to $21,944 for the six months ended June 30, 2011.The decrease in depreciation and amortization for the three and six months ended June 30, 2012 as compared to the same period in 2011 is attributable to the Company’s decision, in the past two years, to closely manage capital investment in light of the uncertain economy. We have begun to increase our capital spending and expect depreciation expense to begin to increase.

 

Cost of laundry equipment sales.  Cost of commercial laundry equipment sales consists primarily of the cost of laundry equipment, and parts and supplies sold, as well as salaries, warehousing and distribution expenses.  Cost of commercial laundry equipment sales decreased by $350, or 12%, to $2,651 for the three months ended June 30, 2012 as compared to $3,001 for the three months ended June 30, 2011. Cost of commercial laundry equipment sales increased by $270, or 5%, to $5,848 for the six months ended June 30, 2012 as compared to 5,578 for the six months ended June 30, 2011. As a percentage of sales, cost of product sold was 83% for the three months ended June 30, 2012 and 2011, and 82% and 83% for the six months ended June 30, 2012 and 2011, respectively. The changes in cost of sales for the three and six months ended June 30, 2012 compared to the same periods ending June 30, 2011 is a direct result of the changes in sales revenue.  Operating expenses were essentially unchanged in total. The gross margin in the commercial laundry equipment sales business unit was 17% for the three months ended June 30, 2012 and 2011, and 18% and17% for the six months ended June 30, 2012 and 2011, respectively.

 

Operating expenses

 

General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs.  General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs decreased by $736, or 9%, to $7,799 for the three months ended June 30, 2012 as compared to $8,535 for the three months ended June 30, 2011. General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs increased by $432, or 3%, to $17,653 for the six months ended June 30, 2012 as compared to $17,221 for the six months ended June 30, 2011. As a percentage of total revenue, these expenses were 10% and 11% for the three months ended June 30,

 

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2012 and 2011, respectively, and 11% for the six months ended June 30, 2012 and 2011. The decrease in expenses for the three months ended June 30, 2012 as compared to the same period in 2011 is primarily related to a decrease in personnel related expenses and advertising costs.  The increase in expenses for the six months ended June 30, 2012 is primarily attributable to legal fees relating to a dispute that was concluded in the first quarter and accounted for a $2,200 increase.  This increase was partially offset by a decrease in personnel related expenses and advertising costs.

 

Gain on sale of assets

 

The gains of $54 and $65 for the three months ended June 30, 2012 and 2011, respectively, and the gains of $40 and $157 in the six months ended June 30, 2012 and 2011, respectively, are from the sale of vehicles and other fixed assets in the normal course of business.

 

Loss on early extinguishment of debt

 

Loss on early extinguishment of debt amounted to $3,762 for the six months ended June 30, 2012 and includes the premium of $2,542 we incurred for the early redemption of our senior unsecured notes and $1,087 of unamortized deferred financing costs associated with the redemption. We also wrote off $133 of unamortized deferred financing costs associated with our 2008 credit facility.

 

Income from operations

 

Income from operations increased by $319, or 9%, to $3,764 for the three months ended June 30, 2012 compared to $3,445 for the three months ended June 30, 2011 and decreased by $1,208, or 11%, to $9,532 for the six months ended June 30, 2012 compared to $10,740 for the six months ended June 30, 2011 due primarily to the cumulative effect of the reasons discussed above.

 

Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs

 

Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs, decreased by $702, or 26%, to $1,962 for the three months ended June 30, 2012, as compared to $2,664 for the three months ended June 30, 2011. Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs, decreased by $1,177, or 18%, to $5,304 for the six months ended June 30, 2012, as compared to $6,481 for the six months ended June 30, 2011. This decrease for the three and six months ended June 30, 2012 were primary attributable to interest savings as a result of retiring our 7.625% fixed rate senior notes by utilizing our 2012 Credit Agreement at lower interest rates.  This decrease was partially offset by decreases in the unrealized gains on our interest rate contracts that do not qualify for hedge accounting.  Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, was $2,018 and $3,252 for the three months ended June 30, 2012 and 2011, respectively, a decrease of $1,234, or 38%.  Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, was $5,273 and $6,485 for the six months ended June 30, 2012 and 2011, respectively, a decrease of $1,212, or 19%.

 

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Interest expense associated with the company’s long term debt is comprised of the following:

 

 

 

Three months ended

 

Six months ended

 

 

 

June 30,

 

June 30,

 

 

 

2011

 

2012

 

2011

 

2012

 

 

 

 

 

 

 

 

 

 

 

Interest expense

 

$

3,252

 

$

2,018

 

$

6,485

 

$

5,273

 

Change in the fair value of non-hedged interest rate derivative instruments

 

(807

)

(146

)

(442

)

(235

)

Amortization of deferred financing costs

 

219

 

90

 

438

 

266

 

Interest expense, including change in fair value of non-hedged interest rate derivative instruments and amortization of deferred financing costs

 

$

2,664

 

$

1,962

 

$

6,481

 

$

5,304

 

 

During the first quarter of 2012, the Company no longer qualified for hedge accounting treatment for one of its interest rate swap agreements.  Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost is being reclassified as an earnings charge through the maturity date of the derivative.  This charge to interest expense, when combined with an interest rate swap agreement that previously lost hedge accounting treatment, amounted to $294 and $595 for the three and six months ended June 30, 2012 compared to $123 and $271 for the three and six months ended June 30, 2011, respectively. The remaining balance of $763 associated with these interest rate swap agreements and included in Accumulated Other Comprehensive Loss will be charged to interest expense through the maturity date of the interest rate swap agreements on April 1, 2013.

 

Income tax expense

 

Income tax expense increased by $473 to $750 for the three months ended June 30, 2012 compared to the income tax expense of $277 for the three months ended June 30, 2011. Income tax expense decreased by $1,508 to $181 for the six months ended June 30, 2012 compared to income tax expense of $1,689 for the six months ended June 30, 2011. The increase in the three months is the result of the increase in pre-tax income to $1,802 for the three months ended June 30, 2012, compared to the pre-tax income of $781 for the three months ended June 30, 2011, respectively. The decrease in the six months is the result of the decrease in pre-tax income to $466 for the six months ended June 30, 2012, compared to the pre-tax income of $4,259 for the six months ended June 30, 2011.  The effective tax rate decreased to 38.8% for the six months ended June 30, 2012, compared to 39.7% for the same period in 2011. The changes in the effective rate for the three and six months ended June 30, 2012 are the result of the relative impact of permanent differences due to changes in estimated pretax annual profits.

 

Net Income

 

As a result of the foregoing, net income increased by $548 to $1,052 for the three months ended June 30, 2012 compared to $504 for the same period ended June 30, 2011. Net income decreased by $2,285 to $285 for the six months ended June 30, 2012 compared to $2,570 for the same period in 2011.

 

Seasonality

 

We experience moderate seasonality as a result of our operations in the college and university market. Revenues derived from the college and university market represented approximately 14% of our total laundry facilities management revenue. Academic facilities management and rental revenues are derived substantially during the school year in the first, second and fourth calendar quarters. Conversely, our operating and capital expenditures have historically been higher during the third calendar quarter when we install a large amount of equipment while colleges and universities are generally on summer break.

 

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Table of Contents

 

Liquidity and Capital Resources (Dollars in thousands)

 

We believe that we can satisfy our working capital requirements and funding of capital needs with internally generated cash flow and, as necessary, borrowings from our revolving credit facility described below. Capital requirements for the year ending December 31, 2012, including contract incentive payments, are currently expected to be between $35,000 and $38,000.  In the six months ended June 30, 2012, spending on capital expenditures was $15,460 and spending on contract incentives was $2,007. The capital expenditures for 2012 are primarily composed of laundry equipment installed in connection with new customer leases and the renewal of existing leases.

 

We historically have not needed sources of financing other than our internally generated cash flow and revolving credit facilities to fund our working capital, capital expenditures and smaller acquisitions. As a result, we anticipate that our cash flow from operations and revolving credit facilities will be sufficient to meet our anticipated cash requirements for at least the next twelve months.

 

Our current long-term liquidity needs are principally the repayment of borrowings under our 2012 Credit Agreement. We are unable to project with certainty whether our long-term cash flow from operations will be sufficient to repay our long-term debt when it comes due. We anticipate that we will need to refinance some portion of this indebtedness when it reaches maturity.  We cannot make any assurances that such financing would be available on reasonable terms, if at all.

 

For the six months ended June 30, 2012, our source of cash was primarily from operating activities. Our primary uses of cash for the six months ended June 30, 2012 were the purchase of new laundry equipment, the premium paid to redeem our senior notes, the repurchase of our common stock, fees paid in connection with our 2012 Credit Agreement, and the payments of dividends. We anticipate that we will continue to use cash flows provided by operating activities to finance working capital needs, debt service, and capital expenditures.

 

On February 29, 2012, we entered into an Amended and Restated Senior Secured Credit Agreement (the “2012 Credit Agreement”).  The 2012 Credit Agreement provides for borrowings up to $250,000 under a revolving credit facility (the “Revolver”) and matures on February 28, 2017.  Borrowings under the 2012 Credit Agreement are collateralized by a blanket lien on the assets of the Company and each of its subsidiaries as well as a pledge by the Company of all the capital stock of its subsidiaries. Outstanding indebtedness under the 2012 Credit Agreement bears interest at a fluctuating rate equal to (i) in the case of Eurodollar rate loans, the LIBOR rate plus an applicable percentage, ranging from 1.75% to 2.75% per annum (currently 2.50%), determined by reference to our consolidated total leverage ratio, and (ii) in the case of base rate loans and swingline loans, the higher of (a) the federal funds rate plus 0.50%, (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate,” or (c) for each day, the floating rate of interest equal to LIBOR for a one month term quoted for such date (the highest of which is defined as the “Base Rate”), plus, in each case, an applicable percentage, ranging from 0.75% to 1.75% per annum (currently, 1.50%), determined by reference to our consolidated total leverage ratio.

 

We pay a commitment fee equal to a percentage of the actual daily-unused portion of the Revolver under the 2012 Credit Agreement. This percentage is determined quarterly by reference to our consolidated total leverage ratio and will range between 0.250% per annum and 0.500% per annum (currently 0.350%).  For purposes of the calculation of the commitment fee, letters of credit are considered usage under the Revolver, but swingline loans are not considered usage under the Revolver.

 

The 2012 Credit Agreement includes certain financial and operational covenants, including restrictions on paying dividends and other distributions, making certain acquisitions and incurring indebtedness, and requires that the Company maintain certain financial ratios.  The most significant financial ratios that we are required to maintain include a consolidated total leverage ratio of not greater than 3.75 to 1.00 (3.50 to 1.00 as of December 31, 2013 and thereafter) and a consolidated cash flow coverage ratio of not less than 1.20 to 1.00.  We were in compliance with all financial covenants at June 30, 2012.

 

As of June 30, 2012, there was $203,061 outstanding under the Revolver and $1,380 in outstanding letters of credit. The available balance under the Revolver was $45,559 at March 31, 2012. The average interest rates on the borrowings outstanding under the prior credit agreement and the 2012 Credit Agreement at June 30, 2011 and 2012 were 5.58% and 3.67%, respectively, including the applicable spread paid to the banks and the effect of the interest rate swap agreements tied to the debt (see Note 4 for discussion on Fair Value Measurements).

 

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On October 21, 2011, we redeemed $50,000 of our 7.625% senior notes by utilizing $51,271 of availability under our prior credit facility. On March 30, 2012, we redeemed the remaining $100,000 of our senior notes by utilizing $103,495 of availability under the 2012 Credit Agreement.

 

Operating Activities

 

For the six months ended June 30, 2012 and 2011, net cash flows provided by operating activities were $16,972 and $25,061, respectively. Cash flows from operations consists primarily of facilities management revenue and equipment sales, offset by the cost of facilities management revenues, cost of product sold, and general, administration, sales and marketing expenses. The most significant changes to cash flows for the six months ended June 30, 2012 as compared to the six months ended June 30, 2011 are decreases in net income, a larger decrease in accounts payable, accrued facilities management rent, accrued expenses and other liabilities in 2012 as compared to 2011, a larger increase in inventory, and a decrease in depreciation and amortization. These accounts are subject to normal fluctuations from period to period.

 

Investing Activities

 

For the six months ended June 30, 2012 and 2011, net cash flows used in investing activities were $15,368 and $15,320, respectively.  Capital expenditures for the six months ended June 30, 2012 and 2011 were $15,460 and $15,526, respectively, primarily for the acquisition of laundry equipment for new and renewed lease locations.

 

Financing Activities

 

For the six months ended June 30, 2012 and 2011, net cash flows used in financing activities were $2,673 and $10,006, respectively. Cash flows used in financing activities consist of changes in long term debt, principally resulting from the redemption of our senior notes, entry into the 2012 Credit Agreement, repurchase of common stock, and the payments of dividends.

 

Contractual Obligations

 

A summary of our contractual obligations and commitments related to our outstanding long-term debt and future minimum lease payments related to our vehicle fleet, warehouse rent and facilities management rent as of June 30, 2012 is as follows:

 

 

 

 

 

Interest on

 

 

 

 

 

 

 

 

 

Fiscal

 

Long-term

 

variable rate

 

Facilites rent

 

Capital lease

 

Operating lease

 

 

 

Year

 

debt

 

debt (1)

 

commitments

 

commitments

 

commitments

 

Total

 

2012(six months)

 

$

 

$

7,452

 

$

7,231

 

$

591

 

$

1,748

 

$

17,022

 

2013

 

 

7,452

 

11,198

 

1,006

 

3,000

 

$

22,656

 

2014

 

 

7,452

 

9,067

 

585

 

2,586

 

$

19,690

 

2015

 

 

7,452

 

6,429

 

88

 

2,255

 

$

16,224

 

2016

 

 

7,452

 

5,115

 

24

 

607

 

$

13,198

 

Thereafter

 

203,061

 

1,244

 

13,402

 

 

494

 

$

218,201

 

Total

 

$

203,061

 

$

38,504

 

$

52,442

 

$

2,294

 

$

10,690

 

$

306,991

 

 


(1)   Interest is calculated using the Company’s average interest rate at June 30, 2012.

 

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Table of Contents

 

Item 3.

 

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT

MARKET RISK

 

We are exposed to a variety of risks, including changes in interest rates on some of our borrowings and the change in fuel prices. In the normal course of our business, we manage our exposure to these risks as described below. We do not engage in trading market-risk sensitive instruments for speculative purposes.

 

Interest rates

 

The table below provides information about our debt obligations that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. The fair market value of long-term debt approximates book value at June 30, 2012.

 

(in thousands)

 

2012

 

2013

 

2014

 

2015

 

2016

 

Thereafter

 

Total

 

Variable rate

 

 

 

 

 

 

 

$

 

$

 

$

203,061

 

$

203,061

 

Average interest rate

 

 

 

 

 

 

 

 

3.67

%

3.67

%

 

We have entered into standard International Swaps and Derivatives Association interest rate swap agreements to manage the interest rate associated with our debt. The interest rate Swap Agreements effectively convert $53,000 of our variable rate debt to a long-term fixed rate. Under these agreements, we receive a variable rate of LIBOR plus a markup and pay a fixed rate. We recognized a non-cash unrealized gain of $440 and $931 for the three months ended June 30, 2012 and 2011, respectively, and a non-cash unrealized gain of $830 and $713 for the six months ended June 30, 2012 and 2011, respectively, on the interest rate swap agreements as a result of the change in the fair value.

 

On September 23, 2011, we entered into a fuel commodity derivative to manage the fuel cost on our fleet of vehicles. The derivative was effective January 1, 2012 and expires December 31, 2012.  The derivative has a monthly notional amount of 85 thousand gallons from January 1, 2012 through December 31, 2012 for a total notional amount of 1.02 million gallons. We have a put price of $3.205 per gallon and a strike price of $3.70 per gallon. We recognized a non-cash unrealized loss of $274 and $157 for the three months ended June 30, 2012 and 2011, respectively, and a loss of $24 and a gain $122 for the six months ended June 30, 2012 and 2011, respectively, on the fuel commodity derivative as a result of the change in the fair value.

 

The fair values of these interest rate derivatives are based on quoted prices for similar instruments from a commercial bank and are considered to be Level 2 items.  The fuel commodity derivative is based on market assumptions and a quoted price from the counter party and is considered a Level 3 item.

 

During the first quarter of 2012, as a result of our senior note redemption, we no longer qualified for hedge accounting treatment on our interest rate swap agreements.  Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost is being reclassified as an earnings charge through the maturity date of the derivative.  This charge to interest expense, when combined with an interest rate swap agreement that previously lost hedge accounting treatment, amounted to $294 and $595 for the three and six months ended June 30, 2012 compared to $123 and $271 for the three and six months ended June 30, 2011, respectively. The remaining balance of $763 associated with these interest rate swap agreements and included in Accumulated Other Comprehensive Loss will be charged to interest expense through the maturity date of the interest rate swap agreements on April 1, 2013.

 

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The table below outlines the details of each remaining interest rate Swap Agreement:

 

 

 

 

 

Notional

 

Notional

 

 

 

 

 

 

 

Original

 

Amount

 

Amount

 

 

 

 

 

Date of

 

Notional

 

Fixed/

 

June 30,

 

Expiration

 

Fixed