e10vq
UNITED STATES SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended April 1, 2006
Commission file number 0-4063
G&K SERVICES, INC.
(Exact name of registrant as specified in its charter)
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MINNESOTA
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41-0449530 |
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(State or other jurisdiction of
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(I.R.S. Employer |
incorporation or organization)
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Identification No.) |
5995 OPUS PARKWAY
MINNETONKA, MINNESOTA 55343
(Address of principal executive offices and zip code)
(952) 912-5500
(Registrants telephone number, including area code)
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.
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated
filer, or a non-accelerated filer. See definition of accelerated filer and large accelerated
filer in Rule 12b-2 of the Exchange Act (Check one):
Large Accelerated Filer þ Accelerated Filer o Non-Accelerated Filer o
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of
the Exchange Act).
Indicate the number of shares outstanding of each of the issuers classes of common stock as
of the latest practicable date.
Common Stock, par value $0.50 per share, outstanding
May 1, 2006 was 21,271,489 shares.
G&K Services, Inc.
Form 10-Q
Table of Contents
2
PART I
FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED CONDENSED BALANCE SHEETS
G&K Services, Inc. and Subsidiaries
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April 1, |
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July 2, |
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2006 |
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2005 |
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(In thousands) |
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(Unaudited) |
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(Restated) |
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ASSETS |
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Current Assets |
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Cash and cash equivalents |
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$ |
21,960 |
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$ |
15,345 |
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Accounts receivable, less allowance for doubtful
accounts of $3,146 and $2,890 |
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95,426 |
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83,459 |
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Inventories |
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137,290 |
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121,120 |
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Prepaid expenses |
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14,630 |
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16,587 |
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Total current assets |
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269,306 |
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236,511 |
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Property, Plant and Equipment, net |
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249,896 |
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243,307 |
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Goodwill |
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344,642 |
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338,701 |
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Other Assets |
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84,336 |
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84,650 |
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$ |
948,180 |
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$ |
903,169 |
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LIABILITIES AND STOCKHOLDERS EQUITY |
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Current Liabilities |
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Accounts payable |
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$ |
32,874 |
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$ |
25,695 |
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Accrued expenses |
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66,877 |
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71,483 |
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Deferred income taxes |
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9,201 |
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8,971 |
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Current maturities of long-term debt |
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17,925 |
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26,537 |
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Total current liabilities |
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126,877 |
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132,686 |
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Long-Term Debt, net of Current Maturities |
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212,066 |
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210,462 |
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Deferred Income Taxes |
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30,756 |
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30,887 |
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Other Noncurrent Liabilities |
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54,427 |
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47,691 |
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Stockholders Equity |
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524,054 |
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481,443 |
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$ |
948,180 |
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$ |
903,169 |
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The accompanying notes are an integral part of these consolidated condensed financial statements.
3
CONSOLIDATED STATEMENTS OF OPERATIONS
G&K Services, Inc. and Subsidiaries
(Unaudited)
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For the Three Months Ended |
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For the Nine Months Ended |
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April 2, |
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April 2, |
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April 1, |
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2005 |
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April 1, |
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2005 |
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(In thousands, except per share data) |
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2006 |
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(Restated) |
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2006 |
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(Restated) |
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Revenues |
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Rental operations |
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$ |
201,562 |
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$ |
188,064 |
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$ |
594,985 |
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$ |
547,465 |
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Direct sales |
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24,579 |
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15,746 |
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58,452 |
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33,912 |
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Total revenues |
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226,141 |
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203,810 |
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653,437 |
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581,377 |
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Operating Expenses |
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Cost of rental operations |
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131,387 |
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119,139 |
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383,565 |
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346,563 |
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Cost of direct sales |
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17,659 |
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12,011 |
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42,015 |
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25,348 |
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Selling and administrative |
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49,619 |
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43,283 |
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141,219 |
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124,577 |
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Depreciation and amortization |
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10,883 |
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10,407 |
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32,126 |
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30,726 |
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Total operating expenses |
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209,548 |
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184,840 |
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598,925 |
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527,214 |
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Income from Operations |
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16,593 |
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18,970 |
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54,512 |
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54,163 |
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Interest expense |
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3,395 |
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2,891 |
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9,712 |
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8,080 |
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Income before Income Taxes |
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13,198 |
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16,079 |
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44,800 |
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46,083 |
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Provision for income taxes |
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2,840 |
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6,129 |
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13,837 |
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17,338 |
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Net Income |
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$ |
10,358 |
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$ |
9,950 |
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$ |
30,963 |
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$ |
28,745 |
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Basic weighted average number
of shares outstanding |
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21,132 |
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20,994 |
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21,069 |
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20,910 |
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Basic Earnings per Common Share |
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$ |
0.49 |
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$ |
0.47 |
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$ |
1.47 |
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$ |
1.37 |
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Diluted weighted average number
of shares outstanding |
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21,311 |
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21,322 |
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21,228 |
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21,362 |
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Diluted Earnings per Common Share |
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$ |
0.49 |
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$ |
0.47 |
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$ |
1.46 |
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$ |
1.35 |
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Dividends per share |
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$ |
0.0175 |
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$ |
0.0175 |
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$ |
0.0525 |
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$ |
0.0525 |
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The accompanying notes are an integral part of these consolidated condensed financial statements.
4
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
G&K Services, Inc. and Subsidiaries
(Unaudited)
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For the Nine Months Ended |
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April 2, |
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April 1, |
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2005 |
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(In thousands) |
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2006 |
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(Restated) |
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Operating Activities: |
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Net income |
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$ |
30,963 |
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$ |
28,745 |
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Adjustments to reconcile net income to net cash
provided by operating activities |
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Depreciation and amortization |
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32,126 |
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30,726 |
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Stock-based compensation |
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3,060 |
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2,891 |
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Deferred income taxes |
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354 |
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1,095 |
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Changes in current operating items, exclusive of acquisitions |
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(17,320 |
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(20,253 |
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Other assets and liabilities |
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829 |
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1,159 |
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Net cash provided by operating activities |
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50,012 |
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44,363 |
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Investing Activities: |
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Property, plant and equipment additions, net |
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(26,414 |
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(10,194 |
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Acquisitions of business assets and other |
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(13,020 |
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(74,895 |
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Net cash used for investing activities |
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(39,434 |
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(85,089 |
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Financing Activities: |
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Repayments of long-term debt |
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(7,661 |
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(21,317 |
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Proceeds from short-term borrowings, net |
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2,050 |
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41,200 |
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Cash dividends paid |
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(1,112 |
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(1,100 |
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Sale of common stock |
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2,395 |
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4,268 |
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Net cash (used for) provided by financing activities |
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(4,328 |
) |
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23,051 |
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Increase (Decrease) in Cash and Cash Equivalents |
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6,250 |
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(17,675 |
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Effect of Exchange Rates on Cash |
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365 |
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1,608 |
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Cash and Cash Equivalents: |
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Beginning of period |
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15,345 |
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26,931 |
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End of period |
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$ |
21,960 |
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$ |
10,864 |
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Supplemental Cash Flow Information: |
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Non-Cash Transactions |
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Debt issued in connection with business acquisitions |
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$ |
(1,419 |
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$ |
11,890 |
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The accompanying notes are an integral part of these consolidated condensed financial statements.
5
G&K SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)
Three and nine month periods ended April 1, 2006 and April 2, 2005
(Unaudited)
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The consolidated condensed financial statements included herein, except for the July 2, 2005
balance sheet which was derived from the audited consolidated financial statements for the
fiscal year ended July 2, 2005, have been prepared by G&K Services, Inc. (the Company),
without audit, pursuant to the rules and regulations of the Securities and Exchange
Commission. In the opinion of the Company, the accompanying unaudited consolidated condensed
financial statements contain all adjustments (consisting of only normal recurring
adjustments) necessary to present fairly the financial position of the Company as of April
1, 2006, and the results of its operations for the three and nine months ended and its cash
flows for the nine months ended April 1, 2006 and April 2, 2005. Certain information and
footnote disclosures normally included in financial statements prepared in accordance with
U.S. generally accepted accounting principles have been condensed or omitted pursuant to
such rules and regulations, although the Company believes that the disclosures herein are
adequate to make the information presented not misleading. It is suggested that these
consolidated condensed financial statements be read in conjunction with the consolidated
financial statements and the notes thereto included in the Companys latest report on Form
10-K. |
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The results of operations for the three and nine month periods ended April 1, 2006 and April
2, 2005 are not necessarily indicative of the results to be expected for the full year. |
1. |
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Summary of Significant Accounting Policies |
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Accounting policies followed by the Company are set forth in Note 1 in the Companys Annual
Report on Form 10-K for the fiscal year ended July 2, 2005. |
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Nature of Business |
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G&K Services, Inc. (the Company) is a market leader in providing branded identity apparel
and facility services programs that enhance image and safety in the workplace. The Company
serves a wide variety of industrial, service and high-technology companies providing them
with rented uniforms or purchase options as well as facility services products such as floor
mats, dust mops, wiping towels, selected linen items and several restroom products. The
Company also manufactures certain uniform garments that it uses to support its garment
rental programs. The Company has two operating segments, United States and Canada, which
have been identified as components of the Company that are reviewed by the Companys Chief
Executive Officer to determine resource allocation and evaluate performance. |
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Principles of Consolidation |
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The accompanying consolidated condensed financial statements include the accounts of the
Company and its subsidiaries, all of which are wholly owned. Significant intercompany
balances and transactions have been eliminated in consolidation. |
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Revenue Recognition |
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The Companys rental operations business is largely based on written service agreements
whereby it agrees to collect, launder and deliver uniforms and other related products. The
service agreements provide for weekly billing upon completion of the laundering process and
delivery to the customer. Accordingly, the Company recognizes revenue from rental
operations in the period in which the services are provided. Revenue from rental operations
also includes billings to customers for lost or abused merchandise. Direct sale revenue is
recognized in the period in which the product is shipped. |
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Derivative Financial Instruments |
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The Company uses derivative financial instruments to manage the risk that changes in
interest rates will affect the amount of its future interest payments. Interest rate swap
contracts are used to balance the proportion of total debt that is subject to variable and
fixed interest rates. The interest rate swap contracts are reflected at fair value in the
consolidated condensed balance sheets and the related gains or losses on these contracts are
recorded in other comprehensive income, which is a component of stockholders equity.
Amounts to be paid or received under the contracts are accrued as interest rates change and
are recognized over the life of the contracts as an adjustment to interest expense. The net
effect of this accounting is that interest expense on the portion of variable rate debt
being hedged is generally recorded based on fixed interest rates. |
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The Company also uses derivative financial instruments to manage the risk that changes in
gasoline cost will affect the future financial results of the Company. The Company
purchases futures contracts to effectively hedge a portion of anticipated actual gasoline
purchases. The futures contracts are reflected at fair value in the consolidated condensed
balance sheet and the related gains or losses on these contracts are recorded in other
comprehensive income, which is a component of stockholders equity or in the statements of
operations depending on the effectiveness of the hedge. Upon settlement of each contract,
the actual gain or loss is reflected in gasoline expense. |
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The Company may periodically hedge firm commitments with its foreign subsidiary, generally
with foreign currency contracts. These agreements are recorded at current market values and
the gains and losses are included in earnings. Gains and losses on such transactions were
not significant in the third quarter of fiscal 2006 or 2005. |
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Per Share Data |
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Basic earnings per common share were computed by dividing net income by the weighted average
number of shares of common stock outstanding during the period. Diluted earnings per common
share was computed similarly to the computation of basic earnings per share, except that the
denominator is increased for the assumed exercise of dilutive options and other dilutive
securities, including nonvested restricted stock, using the treasury stock method. |
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Three Months Ended |
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Nine Months Ended |
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April 1, |
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April 2, |
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April 1, |
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April 2, |
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2006 |
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2005 |
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2006 |
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2005 |
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Weighted average number of common
shares outstanding used in computation
of basic earnings per share |
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21,132 |
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|
20,994 |
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|
21,069 |
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20,910 |
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Weighted average effect of nonvested
restricted stock grants and assumed
exercise of options |
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|
179 |
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|
328 |
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|
159 |
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|
452 |
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Shares used in computation of
diluted earnings per share |
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21,311 |
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|
21,322 |
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21,228 |
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|
21,362 |
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Potential common shares related to the Companys outstanding stock options and
restricted stock grants of 492,000 and 84,000 for the three month periods, and 487,000 and
210,000 for the nine month periods ended April 1, 2006 and April 2, 2005, respectively, were
excluded from the computation of diluted earnings per share. Inclusion of these shares
would have been anti-dilutive as the exercise price of these shares exceeded market value. |
7
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Reclassifications |
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Certain prior period amounts have been reclassified to conform with current year
presentation. These reclassifications did not impact current or historical net income or
stockholders equity. |
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2. |
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Comprehensive Income |
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For the three and nine month periods ended April 1, 2006 and April 2, 2005, the components
of comprehensive income were as follows: |
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Three Months Ended |
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Nine Months Ended |
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April 1, |
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April 2, |
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April 1, |
|
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April 2, |
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|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
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Net income |
|
$ |
10,358 |
|
|
$ |
9,950 |
|
|
$ |
30,963 |
|
|
$ |
28,745 |
|
Other comprehensive income
|
|
|
|
|
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|
|
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|
|
|
|
|
|
|
|
Foreign currency translation
adjustments, net of tax |
|
|
(405 |
) |
|
|
(1,205 |
) |
|
|
6,331 |
|
|
|
9,233 |
|
Net unrealized holding gain on
derivative financial
instruments, net of tax |
|
|
457 |
|
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|
575 |
|
|
|
975 |
|
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|
804 |
|
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|
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Comprehensive income |
|
$ |
10,410 |
|
|
$ |
9,320 |
|
|
$ |
38,269 |
|
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$ |
38,782 |
|
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|
3. |
|
Goodwill and Intangible Assets |
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|
The changes in the carrying amount of goodwill for the nine months ended April 1, 2006, by
operating segment, are as follows: |
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United States |
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Canada |
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Total |
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|
|
|
Balance as of July 2, 2005 |
|
$ |
286,313 |
|
|
$ |
52,388 |
|
|
$ |
338,701 |
|
Goodwill acquired during
the period, net of
purchase price adjustments |
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|
(229 |
) |
|
|
3,388 |
|
|
|
3,159 |
|
Other, primarily foreign
currency translation |
|
|
|
|
|
|
2,782 |
|
|
|
2,782 |
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|
Balance as of April 1, 2006 |
|
$ |
286,084 |
|
|
$ |
58,558 |
|
|
$ |
344,642 |
|
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8
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|
Information regarding the Companys other intangible assets, which are included in
other assets on the consolidated condensed balance sheet, are as follows: |
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As of April 1, 2006 |
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Carrying |
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Accumulated |
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Amount |
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Amortization |
|
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Net |
|
|
|
|
Customer contracts |
|
|
$105,683 |
|
|
|
$55,344 |
|
|
|
$50,339 |
|
Non-competition agreements |
|
|
10,879 |
|
|
|
8,142 |
|
|
|
2,737 |
|
|
|
|
Total |
|
|
$116,562 |
|
|
|
$63,486 |
|
|
|
$53,076 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
As of July 2, 2005 |
|
|
|
Carrying |
|
|
Accumulated |
|
|
|
|
|
|
Amount |
|
|
Amortization |
|
|
Net |
|
|
|
|
Customer contracts |
|
|
$102,021 |
|
|
|
$47,821 |
|
|
|
$54,200 |
|
Non-competition agreements |
|
|
10,829 |
|
|
|
7,239 |
|
|
|
3,590 |
|
|
|
|
Total |
|
|
$112,850 |
|
|
|
$55,060 |
|
|
|
$57,790 |
|
|
|
|
|
|
The customer contracts include the combined value of the written service agreements and
the related customer relationship. It has been determined that there is no significant
separate value in any customer relationships. |
|
|
|
Amortization expense was $8,056 and $6,803 for the nine months ended April 1, 2006 and April
2, 2005, respectively. Estimated amortization expense for each of the five succeeding
fiscal years based on the intangible assets as of April 1, 2006 is as follows: |
|
|
|
|
|
|
2006 remaining |
|
$ |
2,770 |
|
2007 |
|
|
10,610 |
|
2008 |
|
|
10,048 |
|
2009 |
|
|
6,329 |
|
2010 |
|
|
6,152 |
|
2011 |
|
|
5,482 |
|
|
4. |
|
Long-Term Debt |
|
|
|
On August 31, 2005, the Company amended and restated its revolving credit facility. The
amended and restated revolving credit facility of $325,000 expires on August 31, 2010. As
of April 1, 2006, borrowings outstanding under the revolving credit facility were $58,300.
The unused portion of the revolver may be used for general corporate purposes, acquisitions,
working capital needs and to provide up to $50,000 in letters of credit. As of April 1,
2006, letters of credit outstanding against the revolver were $33,140. |
|
|
|
Borrowings under the revolving credit facility bear interest at 0.55% to 1.50% over the
London Interbank Offered Rate (LIBOR), or the Canadian prime rate for Canadian borrowings,
based on a leverage ratio calculated on a quarterly basis. Advances outstanding as of April
1, 2006 bear interest at LIBOR plus 0.875%. The Company also pays a fee on the unused daily
balance of the revolver based on a leverage ratio calculated each quarter. |
9
5. |
|
Stock-Based Compensation |
|
|
|
The Company maintains Stock Option and Compensation Plans (the Employee Plans) to grant
certain stock awards, including stock options at fair market value and restricted shares, to
key employees of the Company. Exercise periods for stock options are limited to a maximum
of 10 years and a minimum of one year. A maximum of 3,000,000 stock awards can be granted
under the Employee Plans and 1,039,194 awards were available for grant as of April 1, 2006. |
|
|
|
The Company also maintains the 1996 Director Stock Option Plan (the Directors Plan). The
Directors Plan provides for automatic grant of 3,000 nonqualified stock options (initial
grants) to nonemployee directors of the Company as of the later of August 1996 or the date
such individuals became directors of the Company and 1,500 nonqualified stock options on
each subsequent annual shareholder meeting date and 500 stock grants on the first business
day of each calendar year that each nonemployee director is serving. The Company has
reserved 100,000 shares of Class A common stock for issuance under the Directors Plan.
These options expire within 10 years of grant and are exercisable one year from the date of
grant, except for the initial grants, of which, one-third of the total options are
exercisable each year beginning with the first anniversary of the date of grant. The option
price will be the average market price of the Class A common stock during the 10 business
days preceding the date of grant. |
|
|
|
The Company has adopted the provisions of the Statement of Financial Accounting Standards
No. 123 (revised 2004) Share-Based Payment (SFAS 123(r)) in the first quarter of fiscal
2006 under the modified retrospective transition method. SFAS 123(r) eliminates accounting
for share-based compensation transactions using the intrinsic value method prescribed in APB
Opinion No. 25, Accounting for Stock Issued to Employees, and requires instead that the
fair value of all share-based transactions, including grants of employee stock options, be
recognized in the income statement. Under the modified retrospective transition method, all
prior period financial statements were restated to recognize compensation cost in the
amounts previously reported in the Notes to Consolidated Financial Statements. |
|
|
|
As a result of adopting SFAS 123(r) on July 3, 2005, income before income taxes and net
income have been restated by $765 and $476 for the three month period, and $2,214 and $1,378
for the nine month period ended April 2, 2005, respectively. Basic and diluted earnings per
share have been restated by $0.03 and $0.02 per share for the three month period, and $0.07
and $0.07 per share for the nine month period ended April 2, 2005, respectively. The
beginning balances of deferred taxes, paid in capital and retained earnings have been
restated by $6,013, $18,496 and $12,483, respectively, to recognize compensation cost for
fiscal years 1996 through 2005 in the amounts previously reported in the Notes to
Consolidated Financial Statements under provisions of SFAS No.123, Accounting for
Stock-Based Compensation. |
10
|
|
The following schedule summarizes activity in the plans for the three and nine month periods
ended April 1, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Stock Options |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Weighted |
|
|
|
Employee |
|
|
Directors |
|
|
|
|
|
|
Average |
|
|
|
Plans |
|
|
Plan |
|
|
Grant Price |
|
|
Exercise Price |
|
Three months: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at December 31,
2005 |
|
|
1,358,744 |
|
|
|
60,500 |
|
|
$ |
25.00 53.34 |
|
|
$ |
35.81 |
|
Granted |
|
|
2,350 |
|
|
|
1,500 |
|
|
|
38.09 38.34 |
|
|
|
38.25 |
|
Exercised |
|
|
(32,349 |
) |
|
|
|
|
|
|
27.95 36.41 |
|
|
|
31.55 |
|
Canceled |
|
|
(5,662 |
) |
|
|
|
|
|
|
27.95 46.00 |
|
|
|
39.33 |
|
|
|
Outstanding at April 1, 2006 |
|
|
1,323,083 |
|
|
|
62,000 |
|
|
$ |
25.00 53.34 |
|
|
$ |
35.87 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Nine months: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Outstanding at July 2, 2005 |
|
|
1,161,547 |
|
|
|
55,000 |
|
|
$ |
25.00 53.34 |
|
|
$ |
34.21 |
|
Granted |
|
|
260,015 |
|
|
|
15,000 |
|
|
|
38.09 42.97 |
|
|
|
42.08 |
|
Exercised |
|
|
(66,026 |
) |
|
|
(8,000 |
) |
|
|
25.00 41.56 |
|
|
|
31.38 |
|
Canceled |
|
|
(32,453 |
) |
|
|
|
|
|
|
27.95 46.00 |
|
|
|
38.28 |
|
|
|
Outstanding at April 1, 2006 |
|
|
1,323,083 |
|
|
|
62,000 |
|
|
$ |
25.00 53.34 |
|
|
$ |
35.87 |
|
|
|
Exercisable at April 1, 2006 |
|
|
849,555 |
|
|
|
43,000 |
|
|
$ |
25.00 53.34 |
|
|
$ |
34.12 |
|
|
|
|
The following schedule summarizes the information related to stock options outstanding at
April 1, 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Options Outstanding |
|
|
Options Exercisable |
|
|
|
|
|
|
|
Average |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Remaining |
|
|
Weighted |
|
|
|
|
|
|
Weighted |
|
Range of |
|
Number |
|
|
Option Life |
|
|
Average |
|
|
Number |
|
|
Average |
|
Exercise Price |
|
Outstanding |
|
|
(Years) |
|
|
Exercise Price |
|
|
Exercisable |
|
|
Exercise Price |
|
|
$16.50 25.00 |
|
|
42,300 |
|
|
|
4.2 |
|
|
$ |
25.00 |
|
|
|
42,300 |
|
|
$ |
25.00 |
|
25.01 37.00 |
|
|
860,794 |
|
|
|
7.0 |
|
|
|
32.57 |
|
|
|
647,682 |
|
|
|
31.76 |
|
37.01 53.34 |
|
|
481,989 |
|
|
|
5.9 |
|
|
|
42.71 |
|
|
|
202,573 |
|
|
|
43.58 |
|
|
|
|
|
1,385,083 |
|
|
|
6.5 |
|
|
$ |
35.87 |
|
|
|
892,555 |
|
|
$ |
34.12 |
|
|
|
|
The weighted average fair value of options granted was $11.47 and $12.76 for the three month
periods, and $10.90 and $10.96 for the nine month periods ended April 1, 2006 and April 2,
2005, respectively. The weighted average exercise price was $31.55 and $30.26 for the three
month periods, and $31.38 and $29.37 for the nine month periods ended April 1, 2006 and
April 2, 2005, respectively. |
|
|
|
The fair value of each option grant is estimated on the date of grant using the
Black-Scholes option pricing model with the following weighted average assumptions used:
risk-free interest rates of 4.40% and 3.88% for the three month periods, and 3.91% and 3.37%
for the nine month periods ended April 1, 2006 and April 2, 2005, respectively; expected
annual dividends of $0.07 per share; expected lives of 4 years and 5 years for the three and
nine months ended April 1, 2006 and April 2, 2005, respectively; and expected volatility of
24.52% and 25.85% for the three month periods, and 24.46% and 26.41% for the nine month
periods ended April 1, 2006 and April 2, 2005, respectively. |
11
|
|
Compensation cost for stock options is recognized on a straight-line basis over the
requisite service period of the award (or to an employees eligible retirement date, if
earlier). Total compensation expense related to stock options was $600 and $765 for the
three month periods, and $2,205 and $2,214 for the nine month periods ended April 1, 2006
and April 2, 2005, respectively. |
|
|
|
Under the Employee Plans, the Company grants restricted stock to key employees for nominal
consideration. The restrictions lapse over periods up to seven years. The Company granted
450 shares of restricted stock in the three month period ended April 1, 2006 and 80,185 and
12,250 shares of restricted stock in the nine month periods ended April 1, 2006 and April 2,
2005, respectively. The weighted average grant date fair value per share of restricted
stock granted during the three month period ended April 1, 2006 was $39.09, and for the nine
month periods ended April 1, 2006 and April 2, 2005 was $42.57 and $36.41, respectively.
Compensation expense is recognized as the restrictions are removed from the stock for the
difference between the par value and fair market value as of the grant date. Total
compensation expense related to restricted stock was $342 and $154 for the three month
periods, and $855 and $677 for the nine month periods ended April 1, 2006 and April 2, 2005,
respectively. |
|
6. |
|
Employee Benefit Plans |
|
|
|
The components of net periodic pension cost are as follows for the three months ended April
1, 2006 and April 2, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Executive |
|
|
|
Pension Plan |
|
|
Retirement Plan |
|
|
|
Three Months Ended |
|
|
Three Months Ended |
|
|
|
April 1, |
|
|
April 2, |
|
|
April 1, |
|
|
April 2, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
|
Service cost |
|
$ |
1,190 |
|
|
$ |
948 |
|
|
$ |
234 |
|
|
$ |
198 |
|
Interest cost |
|
|
809 |
|
|
|
681 |
|
|
|
188 |
|
|
|
171 |
|
Expected return on assets |
|
|
(617 |
) |
|
|
(545 |
) |
|
|
|
|
|
|
|
|
Prior service cost |
|
|
13 |
|
|
|
14 |
|
|
|
11 |
|
|
|
11 |
|
Loss |
|
|
341 |
|
|
|
129 |
|
|
|
76 |
|
|
|
47 |
|
|
|
|
Net periodic pension cost |
|
$ |
1,736 |
|
|
$ |
1,227 |
|
|
$ |
509 |
|
|
$ |
427 |
|
|
|
|
|
|
The components of net periodic pension cost are as follows for the nine months ended
April 1, 2006 and April 2, 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Supplemental Executive |
|
|
|
Pension Plan |
|
|
Retirement Plan |
|
|
|
Nine Months Ended |
|
|
Nine Months Ended |
|
|
|
April 1, |
|
|
April 2, |
|
|
April 1, |
|
|
April 2, |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
|
|
Service cost |
|
$ |
3,571 |
|
|
$ |
2,843 |
|
|
$ |
702 |
|
|
$ |
588 |
|
Interest cost |
|
|
2,427 |
|
|
|
2,042 |
|
|
|
565 |
|
|
|
509 |
|
Expected return on assets |
|
|
(1,850 |
) |
|
|
(1,634 |
) |
|
|
|
|
|
|
|
|
Prior service cost |
|
|
39 |
|
|
|
42 |
|
|
|
32 |
|
|
|
32 |
|
Loss |
|
|
1,021 |
|
|
|
387 |
|
|
|
228 |
|
|
|
151 |
|
|
|
|
Net periodic pension cost |
|
$ |
5,208 |
|
|
$ |
3,680 |
|
|
$ |
1,527 |
|
|
$ |
1,280 |
|
|
|
|
12
7. |
|
Segment Information |
|
|
|
The Company has two operating segments, United States and Canada, which have been
identified as components of the Company that are reviewed by the Companys Chief
Executive Officer to determine resource allocation and evaluate performance. Each
operating segment derives revenues from the branded identity apparel and facility
services industry, which includes garment rental and non-apparel items such as floor
mats, dust mops, wiping towels, selected linen items and several restroom products. No
one customers transactions account for 1.0% or more of the Companys revenues. |
|
|
|
The accounting policies of the segments are the same as those described in the summary
of significant accounting policies (see Note 1). Corporate expenses are allocated to
the segments based on segment revenue. Income from operations for the three and nine
months ended April 1, 2006, for United States operating segment, includes a provision of
$2,050 related to the pending resolution of two specific legal matters. The Company
evaluates performance based on income from operations. Financial information by
geographic location for the three and nine month periods ended April 1, 2006 and April
2, 2005 is as follows: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United |
|
|
|
|
|
|
|
For the Three Months Ended |
|
States |
|
|
Canada |
|
|
Total |
|
|
Third Quarter Fiscal Year 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
186,965 |
|
|
$ |
39,176 |
|
|
$ |
226,141 |
|
Income from operations |
|
|
10,254 |
|
|
|
6,339 |
|
|
|
16,593 |
|
Property, plant and equipment
additions, net |
|
|
9,144 |
|
|
|
788 |
|
|
|
9,932 |
|
Depreciation and amortization
expense |
|
|
9,389 |
|
|
|
1,494 |
|
|
|
10,883 |
|
Third Quarter Fiscal Year 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
170,069 |
|
|
$ |
33,741 |
|
|
$ |
203,810 |
|
Income from operations |
|
|
12,510 |
|
|
|
6,460 |
|
|
|
18,970 |
|
Property, plant and equipment
additions, net |
|
|
4,884 |
|
|
|
1,215 |
|
|
|
6,099 |
|
Depreciation and amortization
expense |
|
|
8,976 |
|
|
|
1,431 |
|
|
|
10,407 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
United |
|
|
|
|
|
|
|
For the Nine Months Ended |
|
States |
|
|
Canada |
|
|
Total |
|
|
Fiscal Year 2006: |
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
541,459 |
|
|
$ |
111,978 |
|
|
$ |
653,437 |
|
Income from operations |
|
|
35,419 |
|
|
|
19,093 |
|
|
|
54,512 |
|
Property, plant and equipment
additions, net |
|
|
24,320 |
|
|
|
2,094 |
|
|
|
26,414 |
|
Depreciation and amortization
expense |
|
|
27,653 |
|
|
|
4,473 |
|
|
|
32,126 |
|
Fiscal Year 2005: |
|
|
|
|
|
|
|
|
|
|
|
|
Revenues |
|
$ |
489,113 |
|
|
$ |
92,264 |
|
|
$ |
581,377 |
|
Income from operations |
|
|
36,263 |
|
|
|
17,900 |
|
|
|
54,163 |
|
Property, plant and equipment
additions, net |
|
|
7,119 |
|
|
|
3,075 |
|
|
|
10,194 |
|
Depreciation and amortization
expense |
|
|
26,683 |
|
|
|
4,043 |
|
|
|
30,726 |
|
|
13
ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(Unaudited)
Overview
G&K Services, Inc., founded in 1902 and headquartered in Minnetonka, Minnesota, is a market leader
in providing branded identity apparel and facility services programs that enhance image and safety
in the workplace. We serve a wide variety of North American industrial, service and
high-technology companies providing them with rented uniforms and facility services products such
as floor mats, dust mops, wiping towels, restroom supplies and selected
linen items. We also sell uniforms and other apparel items to customers in our direct sale
programs. Industry-wide North American rental market revenues are approximately $6.5-$7.0 billion
annually, while the portion of the industry-wide revenues targeted by us is approximately $4.5-$5.0
billion in size.
In the third quarter of fiscal year 2006 our rental business increased to $201.6 million, up 7.2
percent over the prior-year quarter. Direct sale revenue increased to $24.6 million, up 56.1
percent over the prior-year quarter, driven almost entirely by organic growth. The growth of
direct sale revenue for the quarter was driven primarily by revenue from Lion Uniform Group.
Earnings per diluted share totaled $0.49 for the quarter, up 4.3 percent from $0.47 during the
prior-year quarter. The increase in earnings were due to higher sales and a lower effective tax
rate, partially offset by the impact of higher costs, continued investment in strategic
initiatives, costs associated with the accelerated new account growth, reserves established for the
pending resolution of two specific legal matters and increased employee benefit costs which
includes healthcare and workers compensation costs.
Our industry is consolidating from many family owned and small local providers to several large
providers. We are participating in this industry consolidation. Our goal is to build a national
footprint and, we accordingly, place strategic value on acquisitions which expand our geographic
presence.
We made
two small acquisitions during the first nine months of fiscal 2006. In October, 2005, we
acquired certain assets from an organization in Ontario, Canada, a uniform and textile service
company serving customers in Sarnia, Ontario, Detroit, Michigan and St. Louis, Missouri. This
purchase expands and enhances our uniform and textile rental business in North America. Also in
October, 2005, we acquired certain customer contracts from an organization, serving customers in
the southeast United States. This purchase enhances our geographic coverage in North America.
The pro forma effect of these acquisitions, had they been acquired at the beginning of each fiscal
year, were not material, either individually or in aggregate. The total purchase price
consideration, including related acquisition costs of the transaction was $11.3 million. The total
purchase price exceeded the estimated fair values of assets acquired and liabilities assumed by
$3.2 million.
Critical Accounting Policies
The discussion of the financial condition and results of operations are based upon the consolidated
condensed financial statements, which have been prepared in conformity with U.S. generally accepted
accounting principles. As such, management is required to make certain estimates, judgments and
assumptions that are believed to be reasonable based on the information available. These estimates
and assumptions affect the reported amount of assets and liabilities, revenues and expenses, and
disclosure of contingent assets and liabilities at the date of the financial statements. Actual
results may differ from these estimates under different assumptions or conditions.
Critical accounting policies are defined as those that are reflective of significant judgments and
estimates, the most important and pervasive accounting policies used and the areas most sensitive
to material changes from external factors. See Note 1 to the consolidated condensed financial
statements for additional discussion of the application of these and other accounting policies.
14
Revenue Recognition and Allowance for Doubtful Accounts
Our rental operations business is largely based on written service agreements whereby we agree to
collect, launder and deliver uniforms and other related products. The service agreements provide
for weekly billing upon completion
of the laundering process and delivery to the customer. Accordingly, we recognize revenue from
rental operations in the period in which the services are provided. Revenue from rental operations
also includes billings to customers for lost or abused merchandise. Direct sale revenue is
recognized in the period in which the product is shipped. Estimates are used in determining the
collectibility of billed accounts receivable. Management analyzes specific accounts receivable and
historical bad debt experience, customer credit worthiness, current economic trends and the age of
outstanding balances when evaluating the adequacy of the allowance for doubtful accounts.
Significant management judgments and estimates are used in connection with establishing the
allowance in any accounting period. While we have been consistent in applying our judgments and in
making our estimates over relevant periods, material differences may result in the amount and
timing of bad debt expense recognition for any given period if management makes different judgments
or utilizes different estimates.
Inventories
Our inventories consist of new goods and rental merchandise in service. Estimates are used in
determining the likelihood that new goods on hand can be sold to customers or used in rental
operations. Historical inventory usage and current revenue trends are considered in estimating
both obsolete and excess inventories. New goods are stated at lower of cost or market, net of any
reserve for obsolete or excess inventory. Merchandise placed in service to support rental
operations is amortized into cost of rental operations over the estimated useful lives of the
underlying inventory items, primarily on a straight-line basis, which results in a matching of the
cost of the merchandise with the weekly rental revenue generated by
the merchandise. Estimated lives
of rental merchandise in service range from nine months to three years. In establishing estimated
lives for merchandise in service, management considers historical experience and the intended use
of the merchandise. Material differences may result in the amount and timing of operating profit
for any period if management makes different judgments or utilizes different estimates.
Goodwill, Intangibles and Other Long-Lived Assets
As required under Statement of Financial Accounting Standards No. 142, Goodwill and Other
Intangible Assets (SFAS 142), goodwill is separately disclosed from other intangible assets on
the balance sheet and no longer amortized. SFAS 142 also requires that companies test goodwill for
impairment on an annual basis and when events occur or circumstances change that would more likely
than not reduce the fair value of the reporting unit to which goodwill is assigned below its
carrying amount. Our evaluation follows the two step impairment test prescribed by SFAS 142.
First we assess whether the fair value of the reporting units exceeds the carrying amount of the
unit including goodwill. Our evaluation considers changes in the operating environment,
competitive position, market trends, operating performance, quoted market prices for our equity
securities and fair value models and research prepared by independent analysts. If the carrying
amount of a reporting unit exceeded its fair value, we would perform a second test to measure the
amount of impairment loss, if any. Management completes its annual impairment tests in the fourth
quarter of each fiscal year. There have been no impairments of goodwill or definite-lived
intangible assets in fiscal 2005 and we believe there have been no events or circumstances through
the first nine months of fiscal 2006 that would indicate that there may have been any impairment of
goodwill or definite-lived assets. Future events could cause management to conclude that
impairment indicators exist and that goodwill and other intangibles associated with acquired
businesses are impaired. Any resulting impairment loss could have a material impact on our
financial condition and results of operations.
Property, plant and equipment and definite-lived intangible assets are depreciated or amortized
over their useful lives. Useful lives are based on management estimates of the period that the
assets will add value. Long-lived assets and definite-lived intangible assets are evaluated for
impairment whenever events and circumstances indicate an asset may be impaired. There have been no
material write-downs of long-lived assets or definite-lived intangible assets in fiscal 2005 or
through the first nine months of fiscal 2006.
15
Insurance
We self-insure for certain obligations related to health, workers compensation and auto and
general liability programs. We purchase stop-loss insurance policies to protect us from
catastrophic losses. Estimates are used in determining the potential liability associated with
reported claims and for losses that have occurred, but have not been reported. Management estimates
consider historical claims experience, escalating medical cost trends, expected timing of claim
payments and an actuarial analysis provided by a third party. Changes in the cost of medical care,
our ability to settle claims and the estimates and judgments used by management could have a
material impact on the amount and timing of expense for any period.
Income Taxes
In the normal course of business, we are subject to audits from federal, state, Canadian provincial
and other tax authorities regarding various tax liabilities. These audits may alter the timing or
amount of taxable income or deductions, or the allocation of income among tax jurisdictions. The
amount ultimately paid upon resolution of issues raised may differ from the amount accrued. We
believe that taxes accrued on our consolidated balance sheets fairly represent the amount of future
tax liability due.
We utilize income tax planning to reduce our overall cost of income taxes. Upon audit, it is
possible that certain strategies might be disallowed resulting in an increased liability for income
taxes. We believe that the provision for liabilities resulting from the implementation of income
tax planning is appropriate. To date, we have not experienced an examination by governmental
revenue authorities that would lead management to believe that our past provisions for exposures
related to income tax planning are not appropriate.
Deferred income taxes are determined in accordance with SFAS No. 109, Accounting for Income
Taxes. Deferred tax assets and liabilities are recorded for temporary differences between the tax
basis of assets and liabilities and their reported amounts in the financial statements, using
statutory rates in effect for the year in which the differences are expected to reverse. The
effect on deferred tax assets and liabilities of a change in tax rates is recognized in the results
of operations in the period that includes the enactment date. We record valuation allowances to
reduce deferred tax assets when it is more likely than not that some portion of the asset may not
be realized. We evaluate our deferred tax assets and liabilities on a periodic basis. We believe
that we have adequately provided for our future tax consequences based upon current facts and
circumstances.
Results of Operations
The percentage relationships to net sales of certain income and expense items for the three and
nine month periods ended April 1, 2006 and April 2, 2005, and the percentage changes in these
income and expense items between periods are presented in the following table:
|
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|
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|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Nine Months |
|
|
Percentage |
|
|
|
Ended |
|
|
Ended |
|
|
Change |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Three Months |
|
|
Nine Months |
|
|
|
April 1, |
|
|
April 2, |
|
|
April 1, |
|
|
April 2, |
|
|
FY 2006 |
|
|
FY 2006 |
|
|
|
2006 |
|
|
2005 |
|
|
2006 |
|
|
2005 |
|
|
vs. FY 2005 |
|
|
vs. FY 2005 |
|
Revenues: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Rental |
|
|
89.1 |
% |
|
|
92.3 |
% |
|
|
91.1 |
% |
|
|
94.2 |
% |
|
|
7.2 |
% |
|
|
8.7 |
% |
Direct |
|
|
10.9 |
|
|
|
7.7 |
|
|
|
8.9 |
|
|
|
5.8 |
|
|
|
56.1 |
|
|
|
72.4 |
|
|
|
|
|
|
|
|
|
|
|
|
Total revenues |
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
100.0 |
|
|
|
11.0 |
|
|
|
12.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Expenses: |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Cost of rental sales |
|
|
65.2 |
|
|
|
63.4 |
|
|
|
64.5 |
|
|
|
63.3 |
|
|
|
10.3 |
|
|
|
10.7 |
|
Cost of direct sales |
|
|
71.8 |
|
|
|
76.3 |
|
|
|
71.9 |
|
|
|
74.7 |
|
|
|
47.0 |
|
|
|
65.8 |
|
|
|
|
|
|
|
|
|
|
|
|
Total cost of sales |
|
|
65.9 |
|
|
|
64.3 |
|
|
|
65.1 |
|
|
|
64.0 |
|
|
|
13.6 |
|
|
|
14.4 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Selling and administrative |
|
|
22.0 |
|
|
|
21.3 |
|
|
|
21.7 |
|
|
|
21.4 |
|
|
|
14.6 |
|
|
|
13.4 |
|
Depreciation and
amortization |
|
|
4.8 |
|
|
|
5.1 |
|
|
|
4.9 |
|
|
|
5.3 |
|
|
|
4.6 |
|
|
|
4.6 |
|
|
|
|
|
|
|
|
|
|
|
|
Income from operations |
|
|
7.3 |
|
|
|
9.3 |
|
|
|
8.3 |
|
|
|
9.3 |
|
|
|
(12.5 |
) |
|
|
0.6 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Interest expense |
|
|
1.5 |
|
|
|
1.4 |
|
|
|
1.4 |
|
|
|
1.4 |
|
|
|
17.4 |
|
|
|
20.2 |
|
|
|
|
|
|
|
|
|
|
|
|
Income before income taxes |
|
|
5.8 |
|
|
|
7.9 |
|
|
|
6.9 |
|
|
|
7.9 |
|
|
|
(17.9 |
) |
|
|
(2.8 |
) |
Provision for income taxes |
|
|
1.2 |
|
|
|
3.0 |
|
|
|
2.2 |
|
|
|
3.0 |
|
|
|
(53.7 |
) |
|
|
(20.2 |
) |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
Net income |
|
|
4.6 |
% |
|
|
4.9 |
% |
|
|
4.7 |
% |
|
|
4.9 |
% |
|
|
4.1 |
% |
|
|
7.7 |
% |
|
|
|
|
|
|
|
|
|
|
|
16
Three months ended April 1, 2006 compared to three months ended April 2, 2005
Revenues. Total revenues in the third quarter of fiscal 2006 increased 11.0% to $226.1 million
from $203.8 million in the third quarter of fiscal 2005. Rental revenue increased $13.5 million in
the third quarter, or 7.2%. The organic industrial rental growth rate was approximately 3.5%, an
improvement from 1.5% in the same period of fiscal 2005. Organic industrial rental revenue has
improved due to growth initiatives and in particular, accelerated new account growth. These
improvements were slightly offset by lost revenues related to hurricanes.
Direct sale revenue increased 56.1% to $24.6 million in the third quarter of fiscal 2006 compared
to $15.7 million in the same period of fiscal 2005. The organic direct sale growth rate during the
same period was approximately 54.0%. The increase in organic direct sale revenue was due primarily
to the installation of a new uniform program with a major customer in our Lion Uniform Group, along
with increased revenue from a number of other customers.
Organic growth rates are calculated using industrial rental and direct sale revenue, respectively,
adjusted for foreign currency exchange rate differences and revenue from newly acquired business
compared to prior-period results with comparable adjustments. We believe that the organic growth
rates better reflect the growth of our existing industrial rental and direct sale business and are
therefore useful in analyzing our financial condition and results of operations.
Cost of Rental and Direct Sale. Cost of rental operations increased 10.3% to $131.4 million in the
third quarter of fiscal 2006 from $119.1 million in the same period of fiscal 2005. Gross margin
from rental sales decreased to 34.8% in the third quarter of fiscal 2006 from 36.6% in the same
period of fiscal 2005. Rental gross margins declined due to higher energy costs and costs
associated with new customer growth. These costs were partially offset by operational initiatives
focused on lower merchandise and production costs as well as the impact of higher pricing.
Cost of direct sales increased 47.0% to $17.7 million in the third quarter of fiscal 2006 from
$12.0 million in the same period of fiscal 2005. Gross margin from direct sales increased to 28.2%
in the third quarter of fiscal 2006 from 23.7% in the third quarter of fiscal 2005. The increase
in gross margin was primarily due to improved efficiencies from higher volume.
Selling and Administrative. Selling and administrative expenses increased to $49.6 million in the
third quarter of fiscal 2006 from $43.3 million in the same period of fiscal 2005. As a percentage
of total revenues, selling and administrative expenses increased to 22.0% in the third quarter of
fiscal 2006 from 21.3% in the third quarter of fiscal 2005. Total selling and administrative
expenses increased due to the establishment of $2.1 million of reserves for two specific legal
matters, the continued investment in growth oriented initiatives, information technology and
productivity improvements and sales expenses associated with new account growth.
Depreciation and Amortization. Depreciation and amortization expense increased 4.6% to $10.9
million in the third quarter of fiscal 2006 from $10.4 million in the same period of fiscal 2005.
As a percentage of total revenues, depreciation and amortization expense decreased to 4.8% in the
third quarter of fiscal 2006 from 5.1% in the third quarter of fiscal 2005. Capital expenditures,
excluding acquisition of businesses, were $9.9 million in the third quarter of fiscal 2006 compared
to $6.1 million in the prior years quarter with similar adjustments.
Interest Expense. Interest expense was $3.4 million in the third quarter of fiscal 2006, up from
$2.9 million in the same period of fiscal 2005. The increase was due to increased debt levels in
conjunction with the acquisition of business assets in the previous twelve months and an increase
in interest rates.
Provision for Income Taxes. Our effective tax rate decreased to 21.5% in the third quarter of
fiscal 2006 from 38.1% in the same period of fiscal 2005 due to a reduction in taxes previously
provided for as a result of the expiration of
certain tax statutes and adjustments resulting from
the final calculation and filing of the Companys fiscal 2005 tax returns.
17
Nine months ended April 1, 2006 compared to nine months ended April 2, 2005
Revenues. Total revenues for the first nine months of fiscal 2006 increased 12.4% to $653.4
million from $581.4 million for the same period of fiscal 2005. Rental revenue increased $47.5
million in the first nine months, or 8.7%. The organic industrial rental growth rate was
approximately 3.5%. Organic industrial rental revenue has improved due to growth initiatives and
in particular, accelerated new account growth and improved customer retention. These improvements
were slightly offset by lost revenues associated with hurricanes.
Direct sale revenue increased 72.4% to $58.5 million in the first nine months of fiscal 2006
compared to $33.9 million in the same period of fiscal 2005. The organic direct sale growth rate
was approximately 29.5%. The increase in organic direct sale revenue is largely due to garment
sales through our rental operations including our annual outerwear promotion and growth in our Lion
Uniform Group which was due primarily to the installation of a new uniform program with a major
customer.
Cost of Rental and Direct Sale. Cost of rental operations increased 10.7% to $383.6 million in the
first nine months of fiscal 2006 from $346.6 million in the same period of fiscal 2005. Gross
margin from rental sales decreased to 35.5% in the first nine months of fiscal 2006 from 36.7% in
the same period of fiscal 2005. Higher energy costs, costs associated with new customer growth,
the impact of hurricanes on the operations and costs related to acquisitions, primarily in Canada
were partially offset by numerous operational initiatives as well as the impact of higher pricing.
Cost of direct sales increased 65.8% to $42.0 million in the first nine months of fiscal 2006 from
$25.3 million in the same period of fiscal 2005. Gross margin from direct sales increased to 28.1%
in the first nine months of fiscal 2006 from 25.3% in the same period of fiscal 2005. The increase
in margins was primarily due to improved cost leverage resulting from greater sales volume.
Selling and Administrative. Selling and administrative expenses increased 13.4% to $141.2 million
in the first nine months of fiscal 2006 from $124.6 million in the same period of fiscal 2005. As
a percentage of total revenues, selling and administrative expenses increased to 21.7% in the first
nine months of fiscal 2006 from 21.4% in the same period of fiscal 2005. The increase as a percent
of revenue was due to the establishment of a reserve of $2.1 million for two specific legal
matters, continued investment in growth initiatives and increased staffing to support long-term
growth and strategic initiatives. These costs were partially offset as a percent of revenue by
additional leverage provided by incremental revenue growth.
Depreciation and Amortization. Depreciation and amortization expense increased 4.6% to $32.1
million in the first nine months of fiscal 2006 from $30.7 million in the same period of fiscal
2005. As a percentage of total revenues, depreciation and amortization expense decreased to 4.9%
in the first nine months of fiscal 2006 from 5.3% in the same period of fiscal 2005. Capital
expenditures, excluding acquisition of businesses, were $26.4 million in the first nine months of
fiscal 2006 compared to $10.2 million in the same period of fiscal 2005. The increase in capital
expenditures was driven primarily by the addition of a new facility and improvements to existing
facilities. These additions were partially offset by disposals of fixed assets.
Income from Operations. Hurricanes in the first nine months of fiscal 2006 had a negative impact
on net operating margins of approximately 0.3%.
Interest Expense. Interest expense was $9.7 million in the first nine months of fiscal 2006, up
from $8.1 million in the same period of fiscal 2005. The increase was due to increased debt levels
in conjunction with the acquisition of business assets in the previous twelve months and an
increase in interest rates.
18
Provision for Income Taxes. Our effective tax rate decreased to 30.9% in the first nine months of
fiscal 2006 from 37.6% in the same period of fiscal 2005 due to a reduction in taxes previously
provided for as a result of the expiration of certain tax statutes and adjustments resulting from a
favorable mix of income earned in various taxing jurisdictions and the final calculation and filing
of the Companys fiscal 2005 tax returns.
Liquidity, Capital Resources and Financial Condition
Our primary sources of cash are net cash flows from operations and borrowings under our debt
arrangements. Primary uses of cash are interest payments on indebtedness, capital expenditures,
acquisitions and general corporate purposes.
Operating Activities. Net cash provided by operating activities was $50.0 million in the first
nine months of fiscal 2006 and $44.4 million in the same period of fiscal 2005. This increase is
due primarily to cash provided from net income and changes in operating items.
Working capital at April 1, 2006 was $142.4 million, up 37.2% from $103.8 million at July 2, 2005.
The increase in working capital is largely due to the increases in our accounts receivable and
inventory in connection with the overall growth of the Company.
Investing Activities. Net cash used in investing activities was $39.4 million in the first nine
months of fiscal 2006 and $85.1 million in the same period of fiscal 2005. In fiscal 2006, cash
was primarily used for acquisition of property plant and equipment additions and business assets.
In fiscal 2005, cash was largely used for acquisition of business assets and property plant and
equipment additions, partially offset by proceeds from the sale of selected plant assets. Proceeds
on these sales totaled $5.6 million.
Financing Activities. Cash used for financing activities was $4.3 million in the first nine months
of fiscal 2006 and cash provided by financing activities was $23.1 million in the same period of
fiscal 2005. Cash used in fiscal 2006 was for repayments of long-term debt. Cash provided in
fiscal 2005 was primarily related to the short-term borrowings in connection with the acquisition
of business assets. The Company paid dividends of $1.1 million during the first nine months of
fiscal 2006.
As of April 1, 2006, borrowings outstanding under the revolving credit facility were $58.3 million.
The unused portion of the revolver may be used for general corporate purposes, acquisitions,
working capital needs and to provide up to $50 million in letters of credit. As of April 1, 2006,
letters of credit outstanding against the revolver were $33.1 million.
Borrowings under the revolving credit facility bear interest at 0.55% to 1.50% over the London
Interbank Offered Rate (LIBOR), or the Canadian prime rate for Canadian borrowings, based on a
leverage ratio calculated on a quarterly basis. Advances outstanding as of April 1, 2006 bear
interest at LIBOR plus 0.875%. We also pay a fee on the unused daily balance of the revolver based
on a leverage ratio calculated each quarter.
Cash Obligations. Under various agreements, we are obligated to make future cash payments in fixed
amounts. These include payments under the variable rate term loan and revolving credit facility,
the fixed rate term loan, capital lease obligations and rent payments required under non-cancelable
operating leases with initial or remaining terms in excess of one year.
19
The following table summarizes our fixed cash obligations as of April 1, 2006 for the fiscal years
ending June (in thousands):
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
2011 and |
|
|
|
|
|
|
2006 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
There- |
|
|
|
|
|
|
Remaining |
|
|
2007 |
|
|
2008 |
|
|
2009 |
|
|
2010 |
|
|
after |
|
|
Total |
|
Variable rate revolving
credit facility |
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
|
|
|
$ |
58,300 |
|
|
$ |
|
|
|
$ |
58,300 |
|
Variable rate senior notes |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
75,000 |
|
|
|
75,000 |
|
Variable rate senior loan |
|
|
|
|
|
|
|
|
|
|
50,000 |
|
|
|
|
|
|
|
|
|
|
|
|
|
|
|
50,000 |
|
Fixed rate notes |
|
|
|
|
|
|
7,143 |
|
|
|
7,143 |
|
|
|
7,143 |
|
|
|
7,143 |
|
|
|
7,142 |
|
|
|
35,714 |
|
Other debt arrangements, including
capital leases |
|
|
38 |
|
|
|
10,777 |
|
|
|
120 |
|
|
|
42 |
|
|
|
|
|
|
|
|
|
|
|
10,977 |
|
Operating leases |
|
|
4,546 |
|
|
|
16,387 |
|
|
|
13,404 |
|
|
|
9,070 |
|
|
|
6,541 |
|
|
|
6,014 |
|
|
|
55,962 |
|
|
Total contractual cash obligations |
|
$ |
4,584 |
|
|
$ |
34,307 |
|
|
$ |
70,667 |
|
|
$ |
16,255 |
|
|
$ |
71,984 |
|
|
$ |
88,156 |
|
|
$ |
285,953 |
|
|
Also, at April 1, 2006, we had stand-by letters of credit totaling $33.1 million issued and
outstanding, primarily in connection with our property and casualty insurance programs and to
provide security in connection with a promissory note. No amounts have been drawn upon these
letters of credit.
At April 1, 2006, we had available cash on hand of $22.0 million and approximately $234 million of
available capacity under our revolving credit facility when considering current outstanding
borrowings and letters of credit. We anticipate that we will generate sufficient cash flows from
operations to satisfy our cash commitments and capital requirements for fiscal 2006 and to reduce
the amounts outstanding under the revolving credit facility; however, we may utilize borrowings
under the revolving credit facility to supplement our cash requirements from time to time. We
estimate that capital expenditures in fiscal 2006 will be approximately $30 million to $35 million.
The amount of cash flow generated from operations is subject to a number of risks and
uncertainties. In fiscal 2006, we may actively seek and consider acquisitions of business assets;
the consummation of any acquisition could affect our liquidity profile and level of outstanding
debt. We believe that our earnings and cash flow from operations, existing credit facilities and
our ability to obtain additional debt or equity capital, if necessary, will be adequate to finance
acquisition opportunities.
Pension Obligations
We account for our defined benefit pension plan using Statement of Financial Accounting Standards
No. 87 Employers Accounting for Pensions (SFAS 87). Under SFAS 87, pension expense is
recognized on an accrual basis over employees approximate service periods. Pension expense
calculated under SFAS 87 is generally independent of funding decisions or requirements. We
recognized expense for our defined benefit pension plan of $1.7 million in the third quarter of
fiscal 2006 and $1.2 million in the same period of fiscal 2005. At July 2, 2005, the fair value of
our pension plan assets totaled $29.1 million.
The calculation of pension expense and the corresponding liability requires the use of a number of
assumptions, including the expected long-term rate of return on plan assets and the assumed
discount rate. Changes in these assumptions can result in different expense and liability amounts,
and future actual experience can differ from these assumptions. Pension expense increases as the
expected rate of return on pension plan assets decreases. At July 2, 2005, we estimated that the
pension plan assets will generate a long-term rate of return of 8.0%. This rate was
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developed by
evaluating input from our actuary as well as long-term inflation assumptions. The expected
long-term rate of return on plan assets at July 2, 2005 is based on an allocation of U.S. equities
and U.S. fixed income securities. Decreasing the expected long-term rate of return by 0.5% (from
8.0% to 7.5%) would increase our estimated fiscal 2006 pension expense by approximately $0.1
million. Pension liability and future pension expense increase as the discount rate is reduced. We
discounted future pension obligations using a rate of 5.50% at July 2, 2005. The discount rate is
determined based on the current rates earned on high quality long-term bonds. Decreasing the
discount rate by 0.5% (from 5.50% to 5.00%) would have increased our accumulated benefit obligation
at July 2, 2005 by approximately $4.1 million and increased the estimated fiscal 2006 pension
expense by approximately $1.1 million.
Future changes in plan asset returns, assumed discount rates and various other factors related to
the participants in our pension plan will impact our future pension expense and liabilities. We
cannot predict with certainty what these factors will be in the future.
Impact of Inflation
In general, management believes that our results of operations are not dependent on moderate
changes in the inflation rate. Historically, we have been able to manage the impact of more
significant changes in inflation rates through our customer relationships, customer agreements that
generally provide for price increases consistent with the rate of inflation or 5.0%, whichever is
greater, and continued focus on improvements of operational productivity.
Significant increases in energy costs, specifically natural gas and gasoline, can materially affect
our results of operations and financial condition. Currently, energy costs represent approximately
5% of our total revenue.
Litigation
We are involved in a variety of legal actions relating to personal injury, employment,
environmental and other legal matters that arise in the normal course of business. These legal
actions include lawsuits that challenge the practice of charging for certain environmental services
on invoices and certain contract disputes. During the three months ended April 1, 2006, the
Company recorded a provision of $2.1 million related to the pending resolution of two specific
legal matters. None of these legal actions are expected to have a material adverse effect on our
results of operations or financial position.
Stock-Based Compensation
We have adopted the provisions of the Statement of Financial Accounting Standards No. 123 (revised
2004) Share-Based Payment (SFAS 123(r)) in the first quarter of fiscal 2006 under the modified
retrospective transition method. SFAS 123(r) eliminates accounting for share-based compensation
transactions using the intrinsic value method prescribed in APB Opinion No. 25, Accounting for
Stock Issued to Employees, and requires instead that the fair value of all share-based
transactions, including grants of employee stock options, be recognized in the income statement.
Under the modified retrospective transition method, all prior period financial statements were
restated to recognize compensation cost in the amounts previously reported in the Notes to
Consolidated Financial Statements.
As a
result of our adopting SFAS 123(r) on July 3, 2005, income before income taxes and net income have been
restated by $0.8 million and $0.5 million for the three month period, and $2.2 million and $1.4
million for the nine month period ended April 2, 2005, respectively. Basic and diluted earnings
per share have been restated by $0.03 and $0.02 per share for the three month period, and $0.07 and
$0.07 per share for the nine month period ended April 1, 2006, respectively. The beginning
balances of deferred taxes, paid in capital and retained earnings have been restated by $6.0
million, $18.5 million and $12.5 million, respectively, to recognize compensation cost for fiscal
years 1996 through 2005 in the amounts previously reported in the Notes to Consolidated Financial
Statements under provisions of SFAS No.123, Accounting for Stock-Based Compensation.
We estimate the fair value of each option grant on the date of grant using the Black-Scholes option
pricing model with the following weighted average assumptions used: risk-free interest rates of
4.40% and 3.88% for the three month periods, and 3.91% and 3.37% for the nine month periods ended
April 1, 2006 and April 2, 2005,
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respectively; expected annual dividends of $0.07 per share;
expected lives of 4 years and 5 years for the three and nine months ended April 2, 2006 and April
2, 2005, respectively; and expected volatility of 24.52% and 25.85% for the three month periods,
and 24.46% and 26.41% for the nine month periods ended April 1, 2006 and April 2, 2005,
respectively.
We recognize compensation cost for stock options on a straight-line basis over the requisite
service period of the award (or to an employees eligible retirement date, if earlier). Total
compensation expense related to stock options was $0.6 million and $0.8 million for the three month
periods, and $2.2 million and $2.2 million for the nine month periods ended April 1, 2006 and April
2, 2005, respectively.
Under the Employee Plans, we grant restricted stock to key employees for nominal consideration.
The restrictions lapse over periods up to seven years. We granted 450 shares of restricted stock
in the three month period ended April 1, 2006 and 80,185 and 12,250 shares of restricted stock in
the nine month periods ended April 1, 2006 and April 2, 2005, respectively. The weighted average
grant date fair value per share of restricted stock granted during the three month period ended
April 1, 2006 was $39.09, and for the nine month periods ended April 1, 2006 and April 2, 2005 was
$42.57 and $36.41, respectively. We recognize compensation expense as the restrictions are removed
from the stock for the difference between the par value and fair market value as of the grant date.
Total compensation expense related to restricted stock was $0.3 million and $0.2 million for the
three month periods, and $0.9 million and $0.7 million for the nine month periods ended April 1,
2006 and April 2, 2005, respectively.
Cautionary Statements Regarding Forward-Looking Statements
The Private Securities Litigation Reform Act of 1995 (the Act) provides companies with a safe
harbor when making forward-looking statements as a way of encouraging them to furnish their
shareholders with information regarding expected trends in their operating results, anticipated
business developments and other prospective information. Statements made in this report concerning
our intentions, expectations or predictions about future results or events are forward-looking
statements within the meaning of the Act. These statements reflect our current expectations or
beliefs, and are subject to risks and uncertainties that could cause actual results or events to
vary from stated expectations, which could be material and adverse. Given that circumstances may
change, and new risks to the business may emerge from time to time, having the potential to
negatively impact our business in ways we could not anticipate at the time of making a
forward-looking statement, you are cautioned not to place undue reliance on these statements, and
we undertake no obligation to publicly update or revise any forward-looking statements, whether as
a result of new information, future events or otherwise.
Some of the factors that could cause actual results or events to vary from stated expectations
include, but are not limited to, the following: unforeseen operating risks; the effects of overall
economic conditions and employment levels; fluctuations in costs of insurance and energy;
acquisition integration costs; the performance of acquired businesses; preservation of positive
labor relationships; competition, including pricing, within the branded identity apparel and
facility services industry; unplanned litigation or regulatory proceedings; and the availability of
capital to finance planned growth. Additional information concerning potential factors that could
effect future financial results is included in the Companys Annual Report on Form 10-K for the
fiscal year ended July 2, 2005.
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ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Interest Rate Risk
We are subject to market risk exposure related to changes in interest rates. We use financial
instruments, including fixed and variable rate debt, as well as interest rate swaps to manage
interest rate risk. Interest rate swap agreements are entered into for periods consistent with
related underlying exposures and do not constitute positions independent of those exposures.
Assuming the current level of borrowings, a one percentage point increase in interest rates under
these borrowings would have increased our interest expense for the third quarter of fiscal 2006 by
approximately $0.3 million. This estimated exposure considers the mitigating effects of interest
rate swap agreements outstanding at April 1, 2006 on the change in the cost of variable rate debt.
Energy Cost Risk
We use derivative financial instruments to manage the risk that changes in gasoline cost will
affect the future financial results of the Company. We purchase gasoline futures contracts to
effectively hedge a portion of anticipated actual gasoline purchases. The gasoline futures
contracts are reflected at fair value in the consolidated condensed balance sheet and the related
gains or losses on these contracts are deferred in stockholders equity (as a component of other
comprehensive income) or in the statements of operations depending on the effectiveness of the
hedge. Upon settlement of each contract, the actual gain or loss is reflected in gasoline expense.
The current fair market value of all outstanding contracts at April 1, 2006 is a negative $0.1
million.
Foreign Currency Exchange Risk
We have a significant foreign subsidiary located in Canada. The assets and liabilities of this
subsidiary are denominated in the Canadian dollar and as such are translated into U.S. dollars at
the exchange rate in effect at the balance sheet date. Results of operations are translated using
the average exchange rates throughout the period. The effect of exchange rate fluctuations on
translation of assets and liabilities are recorded as a component of stockholders equity. Gains
and losses from foreign currency transactions are included in results of operations.
ITEM 4. CONTROLS AND PROCEDURES
Based on our managements evaluation (with the participation of our principal executive officer and
principal financial officer), as of the end of the period covered by this report, our principal
executive officer and principal financial officer have concluded that our disclosure controls and
procedures (as defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934,
as amended (the Exchange Act)), are effective to ensure that information required to be disclosed
by us in reports that we file or submit under the Exchange Act is recorded, processed, summarized
and reported within the time periods specified in Securities and Exchange Commission rules and
forms.
There have been no significant changes (including corrective actions with regard to significant
deficiencies or material weaknesses) in our internal controls or in other factors that could
significantly affect theses controls subsequent to the date of the evaluation referenced above.
There was no change in our internal control over financial reporting during the period covered by
this Form 10-Q that has materially affected, or is reasonably likely to materially affect, our
internal control over financial reporting.
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PART II
OTHER INFORMATION
ITEM 2. UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
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At the beginning of the third quarter, the Company had two classes of voting securities
outstanding: Class A Common Stock, $0.50 par value per share, and Class B Common Stock,
$0.50 par value per share. Each share of Class A Common Stock is entitled to one vote, and
each share of Class B Common Stock was entitled to 10 votes, in each case, on matters
submitted to a vote of the Companys shareholders. Class A Common Stock may be acquired by
holders of Class B Common Stock upon conversion of their shares of Class B Common Stock, at
any time, on the basis of one share of Class A Common Stock for each share of Class B Common
Stock converted. On February 3, 2006 and March 23, 2006 the Company issued 1,208,256 and
67,573 shares of Class A Common Stock, respectively, to three of its shareholders upon the
conversion by such shareholders of a like number of shares of Class B Common Stock. The
Company received no proceeds from such issuance. The Company relied on available exemptions
from registration to complete this transaction. |
ITEM 6. EXHIBITS
a. Exhibits
31.1 Certification of Chief Executive Officer pursuant to Securities Exchange Act
Rule 13a-15(e)/15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
31.2 Certification of Chief Financial Officer pursuant to Securities Exchange Act
Rule 13a-15(e)/15d-15(e) as adopted pursuant to Section 302 of the Sarbanes-Oxley Act
of 2002.
32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as
adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has
caused this report to be signed on its behalf by the undersigned thereunto duly authorized.
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G&K SERVICES, INC.
(Registrant)
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Date: May 5, 2006 |
By: |
/s/ Jeffrey L. Wright
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Jeffrey L. Wright |
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Senior Vice President
and Chief Financial Officer
(Principal Financial Officer) |
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By: |
/s/ Michael F. Woodard
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Michael F. Woodard |
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Vice President and Controller
(Principal Accounting Officer) |
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