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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 Quarter Ended December 28, 2002 Commission file number 0-4063

G&K SERVICES, INC.
(Exact name of registrant as specified in its charter)

5995 OPUS PARKWAY, SUITE 500
MINNETONKA, MINNESOTA 55343
(Address of principal executive offices and zip code)

(952) 912-5500
(Registrant’s 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 an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

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G&K Services, Inc.
Form 10-Q

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PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED CONDENSED BALANCE SHEETS
G&K Services, Inc. and Subsidiaries

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

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CONSOLIDATED STATEMENTS OF OPERATIONS
G&K Services, Inc. and Subsidiaries
(Unaudited)

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

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CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
G&K Services, Inc. and Subsidiaries
(Unaudited)

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

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G&K SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Amounts in thousands, except share and per share data)
Three and six month periods ended December 28, 2002 and December 29, 2001
(Unaudited)

		The consolidated condensed financial statements included herein, except for the June 29, 2002 balance sheet which was extracted from the audited consolidated financial statements for the fiscal year ended June 29, 2002, 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 December 28, 2002, and the results of its operations for the three and six months ended and its cash flows for the six months ended December 28, 2002 and December 29, 2001. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States 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 Company’s latest report on Form 10-K.
		The results of operations for the three and six month periods ended December 28, 2002 and December 29, 2001 are not necessarily indicative of the results to be expected for the full year.
1.		Summary of Significant Accounting Policies
		Accounting policies followed by the Company are set forth in Note 1 in the Company’s Annual Report on Form 10-K for the fiscal year ended June 29, 2002.
		Nature of Business
		G&K Services, Inc. is a market leader in providing corporate identity apparel and facility services programs to a wide variety of industrial, service and high-technology companies. The Company’s programs provide rental-lease or purchase options as well as non-apparel items such as floor mats, dustmops and cloths, 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.
		Principles of Consolidation
		The accompanying consolidated condensed financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. Intercompany balances and transactions have been eliminated in consolidation.
		Derivative Financial Instruments
		The Company uses derivative financial instruments principally 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 adjust 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 sheet and the related gains or losses on these contracts are deferred in stockholders’ equity (as a component of other comprehensive income). 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 may periodically hedge firm cash flow 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 second quarter of fiscal 2003. Notional amounts outstanding under foreign currency contracts at December 28, 2002 were $2,402, all of which will mature during fiscal 2003. No amounts were outstanding under such contracts at December 29, 2001. The fair values of the foreign currency contracts were not materially different as of December 28, 2002.
		Per Share Data
		Basic earnings per common share was 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 similar 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.

		Recent Accounting Pronouncements
		In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The Company adopted SFAS 143 effective June 30, 2002. The impact of adopting SFAS 143 was not material.
		In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 establishes a single accounting model, based on the framework established in SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” (SFAS 121), for long-lived assets to be disposed of by sale. SFAS 144 also resolves several significant implementation issues related to SFAS 121, such as eliminating the requirement to allocate goodwill to long-lived assets to be tested for impairment and establishing criteria to define whether a long-lived asset is held for sale. The Company adopted SFAS 144 effective June 30, 2002. The impact of adopting SFAS 144 was not material.
		In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. It nullifies Emerging Issues Task Force Issue

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		No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” SFAS 146 requires that a liability be recognized for costs associated with an exit or disposal activity only when the liability is incurred. SFAS 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company will apply the provisions of SFAS 146 for all exit or disposal activities initiated after December 31, 2002.
		In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148). SFAS 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosures in both annual and interim financial statements about the method used to account for stock-based employee compensation and the effect of the method used on reported results. The Company will continue to apply Accounting Principles Board Opinion No. 25 as the method used to account for stock-based compensation, where applicable, but will adopt the disclosure requirements of SFAS 148 beginning with the third quarter ending March 29, 2003.
2.		Comprehensive Income
		For the three and six month periods ended December 28, 2002 and December 29, 2001, the components of comprehensive income were as follows:

3.		Acquisitions
		During the current fiscal year, the Company has made several small acquisitions, including the acquisition of Rental Uniform Company at the beginning of the current quarter. All acquisitions were accounted for using the purchase method. The total purchase consideration, including related acquisition costs of these transactions, was approximately $60,713 for the three months ended December 28, 2002 and $71,186 for the six months ended December 28, 2002. The total purchase price exceeded the estimated fair values of assets acquired by approximately $34,522 for the three months ended December 28, 2002 and $42,226 for the six months ended December 28, 2002.
		The pro forma effects of these acquisitions, had they been acquired at the beginning of the fiscal year, were not material to the Company.

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4.		Goodwill and Intangible Assets
		In July 2001, the Company adopted the provisions of SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” The changes in the carrying amount of goodwill for the six months ended December 28, 2002, by operating segment, are as follows:

Information regarding the Company’s other intangible assets are as follows:

Amortization expense for the six months ended December 28, 2002 was $3,495. Estimated amortization expense for each of the five succeeding fiscal years based on the intangible assets as of December 28, 2002 is as follows:

5.		Segment Information
		The Company has two operating segments under the guidelines of SFAS No. 131: United States and Canada, which have been identified as components of the Company that are reviewed by the Company’s Chief Executive Officer to determine resource allocation and evaluate performance. Each operating segment derives revenues from the corporate identity apparel and facility services industry, which includes garment rental and non-apparel items such as floor mats, dust mops and cloths, wiping

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		towels, selected linen items and several restroom products. No one customer’s transactions account for 1.0% or more of the Company’s 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. The Company evaluates performance based on income from operations. Financial information by geographic location for the three and six month periods ended December 28, 2002 and December 29, 2001 is as follows:

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ITEM 2. MANAGEMENT’S 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 corporate identity apparel and facility services programs to a wide variety of North American industrial, service and high-technology companies. We rent uniforms and other related 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. The North American rental market is approximately $6.3 billion, while the direct sales market, targeted by us, is approximately $4.5-$5.0 billion in size.

During the current fiscal year, we have made several small acquisitions, including the acquisition of Rental Uniform Company at the beginning of the current quarter. All acquisitions were accounted for using the purchase method. The pro forma effects of these acquisitions, had they been acquired at the beginning of the fiscal year, were not material. The total purchase consideration, including related acquisition costs of these transactions, was approximately $60.7 million for the three months ended December 28, 2002 and $71.2 million for the six months ended December 28, 2002. The total purchase price exceeded the estimated fair values of assets acquired by approximately $34.5 million for the three months ended December 28, 2002 and $42.2 million for the six months ended December 28, 2002.

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 accounting principles generally accepted in the United States. 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 uncertainties, and potentially result in materially different results under different assumptions and conditions. See Note 1 to the consolidated condensed financial statements for additional discussion of the application of these and other accounting policies.

Revenue Recognition and Allowance for Doubtful Accounts

We recognize revenue from rental operations in the period in which the services are provided. Direct sale revenue is recognized in the period in which the product is shipped. Estimates are used in determining the collectability 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. 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. Estimated lives of rental merchandise in service range from nine months to three years. In establishing estimated lives for merchandise in service, management considers

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manufacturer expectations, 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

We adopted SFAS 142 at the beginning of fiscal 2002 and as a result no longer amortize goodwill. 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. There have been no impairments of goodwill in fiscal 2003 or 2002. Our evaluation considers changes in the operating environment, competitive information, market trends, operating performance and cash flow modeling. 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 generate revenue. Long-lived assets are evaluated for impairment whenever events and circumstances indicate an asset may be impaired. There have been no write-downs of any long-lived assets in fiscal 2003 or 2002.

Insurance

We self-insure for certain obligations related to health and workers’ compensation programs. We purchase stop-loss insurance policies to protect us from catastrophic losses. Estimates are used in determining the potential value 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 actuarial analysis provided by a third party. Changes in the cost of medical care, our ability to settle claims or the estimates and judgment used by management could have a material impact on the amount and timing of expense for any period.

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Results of Operations

The percentage relationships to net sales of certain income and expense items for the three and six month periods ended December 28, 2002 and December 29, 2001, and the percentage changes in these income and expense items between periods are presented in the following table:

Three months ended December 28, 2002 compared to three months ended December 29, 2001

Revenues. Total revenues in the second quarter of fiscal 2003 increased 6.7% to $166.1 million from $155.7 million in the second quarter of fiscal 2002. Rental revenue increased $8.4 million in the second quarter, or 5.6%. If the net impact of acquisitions and changes in foreign currency exchange rates is removed, the internal growth rate of the industrial rental business was approximately (3.0)%.

Direct sale revenue increased 33.6% to $8.0 million in the second quarter of fiscal 2003 compared to $6.0 million in the same period of fiscal 2002. Direct sale revenue is up due to the success of our annual winter outerwear promotion.

Cost of Rental and Direct Sale. Cost of rental operations increased 6.0% to $92.5 million in the second quarter of fiscal 2003 from $87.2 million in the same period of fiscal 2002. Gross margin from rental sales decreased to 41.5% in the second quarter of fiscal 2003 from 41.7% in the second quarter of fiscal 2002. The decrease in rental gross margin is due to higher costs for energy, acquisition integration and plant consolidation, partially offset by improved operational productivity.

Cost of direct sales increased 28.4% to $5.4 million in the second quarter of fiscal 2003 from $4.2 million in the same period of fiscal 2002. Gross margin from direct sales increased to 32.3% in the second quarter of fiscal 2003 from 29.6% in the second quarter of fiscal 2002. The increase in gross margin is due to leveraging fixed costs over the higher sales volume.

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Selling and Administrative. Selling and administrative expenses increased 6.9% to $38.8 million in the second quarter of fiscal 2003 from $36.3 million in the same period of fiscal 2002. As a percentage of total revenues, selling and administrative expenses increased to 23.4% in the second quarter of fiscal 2003 from 23.3% in the same period of fiscal 2002.

Depreciation and Amortization. Depreciation and amortization expense increased 7.0% to $9.5 million in the second quarter of fiscal 2003 from $8.8 million in the same period of fiscal 2002. As a percentage of total revenues, depreciation and amortization expense was 5.7% in the second quarter of both fiscal 2003 and fiscal 2002. Capital expenditures, excluding acquisition of businesses, were $9.1 million in the second quarter of fiscal 2003 compared to $8.1 million in the prior year’s quarter.

Interest Expense. Interest expense was $3.5 million in the second quarter of fiscal 2003, up from $3.3 million in the same period of fiscal 2002. The increase in interest expense is due primarily to higher debt levels in conjunction with our acquisition activities, partially offset by lower effective interest rates.

Provision for Income Taxes. Our effective tax rate decreased to 39.0% in the second quarter of fiscal 2003 from 39.5% in the same period of fiscal 2002 due largely to decreases in Canadian statutory income tax rates.

Six months ended December 28, 2002 compared to six months ended December 29, 2001

Revenues. Total revenues for the first six months of fiscal 2003 increased 3.1% to $322.3 million from $312.8 million for the same period of fiscal 2002. Rental revenue increased $8.5 million in the first six months or 2.8%. If the net impact of acquisitions and changes in foreign currency exchange rates is removed, the internal growth rate of the industrial rental business was approximately (4.0)%.

Direct sale revenue increased 9.1% to $12.4 million in the first six months of fiscal 2003 compared to $11.3 million in the same period of fiscal 2002. Direct sale revenue is up due to the success of our annual winter outerwear promotion in the second quarter, partially offset by the continued postponement of customer direct sale orders.

Cost of Rental and Direct Sale. Cost of rental operations increased 2.4% to $180.4 million in the first six months of fiscal 2003 from $176.1 million in the same period of fiscal 2002. Gross margin from rental sales increased to 41.8% in the first six months of fiscal 2003 from 41.6% in the same period of fiscal 2002. Improved operational productivity and lower merchandise expense, partially offset by higher costs of energy, acquisition integration and plant consolidation, contributed to the improved rental gross margin.

Cost of direct sales increased 10.5% to $8.9 million in the six months of fiscal 2003 from $8.1 million in the same period of fiscal 2002. Gross margin from direct sales decreased to 27.8% in the first six months of fiscal 2003 from 28.7% in the same period of fiscal 2002. The decrease in gross margin is due primarily to large initial stocking orders in the first quarter of fiscal 2002 and the continued postponement of customer direct sale orders in the current year, partially offset by the successful winter outerwear promotion.

Selling and Administrative. Selling and administrative expenses increased 3.6% to $75.5 million in the first six months of fiscal 2003 from $72.9 million in the same period of fiscal 2002. As a percentage of total revenues, selling and administrative expenses increased to 23.4% in the first six months of fiscal 2003 from 23.3% in the same period of fiscal 2002.

Depreciation and Amortization. Depreciation and amortization expense increased 5.0% to $18.5 million in the first six months of fiscal 2003 from $17.6 million in the same period of fiscal 2002. As a percentage of total revenues, depreciation and amortization expense increased to 5.7% in the first six months of fiscal 2003 from 5.6% in the same period of fiscal 2002. Capital expenditures, excluding acquisition of businesses, were $18.1 million in the first six months of fiscal 2003 compared to $13.7 million in the same period of fiscal 2002.

Interest Expense. Interest expense was $6.8 million in the first six months of fiscal 2003, down from $7.1 million in the same period of fiscal 2002. The decrease in interest expense is due primarily to lower effective interest rates, partially offset by higher debt levels in conjunction with our acquisition activities.

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Provision for Income Taxes. Our effective tax rate decreased to 39.0% in the first six months of fiscal 2003 from 39.5% in the same period of fiscal 2002 due largely to decreases in Canadian statutory income tax rates.

Liquidity, Capital Resources and Financial Condition

Our primary sources of cash are net cash flows from operations and borrowings under the term loan and revolving credit facilities. Primary uses of this cash are interest payments on indebtedness, capital expenditures, acquisition of business assets and general corporate purposes.

Operating Activities. Net cash provided by operating activities was $47.4 million in the first six months of fiscal 2003 and $42.3 million in the same period of fiscal 2002.

Working capital at December 28, 2002 was $98.5 million, up 2.8% from $95.8 million at June 29, 2002. The increase was largely due to acquisitions during the current year, partially offset by an increase in current maturities of long-term debt associated with debt amortization.

Investing Activities. Net cash used in investing activities was $89.9 million in the first six months of fiscal 2003 and $47.4 million in the same period of fiscal 2002. In both fiscal years 2003 and 2002, cash was largely used for acquisition of business assets and property, plant and equipment additions.

Financing Activities. Cash provided by financing activities was $50.0 million in the first six months of fiscal 2003 and $6.3 million in the same period of fiscal 2002. Cash provided in both fiscal years 2003 and 2002 was used primarily in acquisitions of businesses. We paid dividends of $0.7 million during the first six months of fiscal 2003.

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.

The following table summarizes our fixed cash obligations as of December 28, 2002 for the fiscal years ending June (in thousands):

Also, at December 28, 2002, we had stand-by letters of credit totaling $10.9 million that have been issued and are outstanding, primarily in connection with our property and casualty insurance programs. No amounts have been drawn upon these letters of credit.