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SECURITIES AND EXCHANGE COMMISSION

FORM 10-Q

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

For Quarter Ended March 29, 2003 Commission file number 0-4063

G&K SERVICES, INC.

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 per share data)
Three and nine month periods ended March 29, 2003 and March 30, 2002
(Unaudited)

The consolidated condensed financial statements included herein, except for the June 29, 2002 balance sheet which was derived 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 March 29, 2003, and the results of its operations for the three and nine months ended and its cash flows for the nine months ended March 29, 2003 and March 30, 2002. 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 nine month periods ended March 29, 2003 and March 30, 2002 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.
		Revenue Recognition
		The Company recognizes 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. Beginning in the third quarter of fiscal 2003, the Company made a change in the classification of billings to customers for lost or abused merchandise to a preferred classification of including such billings in revenue. Accordingly, all prior period billings for lost or abused garments have been reclassified from a reduction of cost of rental operations to rental operations revenue. Billings reclassified totaled $13,471 in the third quarter of fiscal 2003 and $12,542 in the same period of fiscal 2002. For the nine months of fiscal 2003 billings reclassified were $40,619 and were $38,770 for the nine months of fiscal 2002. This reclassification did not impact current or historical net income or stockholders’ equity.

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		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 at a fixed rate during the interest rate swap contract period.
		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 third quarter of fiscal 2003. Notional amounts outstanding under foreign currency contracts at March 29, 2003 were $2,524, all of which will mature during fiscal 2003. No amounts were outstanding under such contracts at March 30, 2002. Foreign currency contracts were recorded at fair value as of March 29, 2003.
		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.

		Stock-Based Compensation
		The Company maintains Stock Option and Compensation Plans (the Employee Plans), which are more fully described in Note 6 in the Company’s Annual Report on Form 10-K for the fiscal year ended June 29, 2002. The Company applies Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees,” and related interpretations in accounting for its stock option plans. Accordingly, only compensation cost related to restricted stock issued under the Employee Plans has been recognized in the accompanying consolidated statements of operations. Compensation cost related to the restricted shares was $224 and $248 for the three month periods and $768 and $695 for the nine month periods ended March 29, 2003 and March 30, 2002, respectively. Had compensation cost been recognized based on the fair values of options at the grant dates consistent with the provisions of Statement of Financial Accounting Standards No. 123,

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“Accounting for Stock-Based Compensation” (SFAS 123), the Company’s net income and net income per common share would have been adjusted as follows:

		Recent Accounting Pronouncements
		In June 2001, the Financial Accounting Standards Board issued SFAS 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 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 adopted the provisions of SFAS 146 effective January 1, 2003. The impact of adopting SFAS 146 was not material.
		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

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		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. The Company adopted the disclosure requirements of SFAS 148 beginning with the third quarter ended March 29, 2003.
2.		Comprehensive Income
		For the three and nine month periods ended March 29, 2003 and March 30, 2002, the components of comprehensive income were as follows:

3.		Acquisitions
		During fiscal year 2003, the Company has made several insignificant acquisitions, including the acquisition of Rental Uniform Company at the beginning of the second quarter. All acquisitions were accounted for using the purchase method. The total purchase consideration, including related acquisition costs of these transactions, was approximately $3,621 for the three months ended March 29, 2003 and $74,807 for the nine months ended March 29, 2003. The total purchase price exceeded the estimated fair values of assets acquired by approximately $7,910 for the three months ended March 29, 2003 and $50,136 for the nine months ended March 29, 2003.
		The pro forma effects of these acquisitions, had they been acquired at the beginning of the fiscal year, were not material to the Company.
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 nine months ended March 29, 2003, by operating segment, are as follows:

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

Amortization expense for the nine months ended March 29, 2003 was $5,362. Estimated amortization expense for each of the five succeeding fiscal years based on the intangible assets as of March 29, 2003 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 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 nine month periods ended March 29, 2003 and March 30, 2002 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 and cloths, 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 fiscal year 2003, we have made several insignificant acquisitions, including the acquisition of Rental Uniform Company at the beginning of the second 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 $3.6 million for the three months ended March 29, 2003 and $74.8 million for the nine months ended March 29, 2003. The total purchase price exceeded the estimated fair values of assets acquired by approximately $7.9 million for the three months ended March 29, 2003 and $50.1 million for the nine months ended March 29, 2003.

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. Beginning in the third quarter of fiscal 2003, we made a change in the classification of billings to customers for lost or abused merchandise to a preferred classification of including such billings in revenue. Accordingly, all prior period billings for lost or abused garments have been reclassified from a reduction of cost of rental operations to rental operations revenue. Billings reclassified totaled $13.5 million in the third quarter of fiscal 2003 and $12.5 million in the same period of fiscal 2002. For the nine months of fiscal 2003 billings reclassified were $40.6 million and were $38.8 million for the nine months of fiscal 2002. This reclassification did not impact current or historical net income or stockholders’ equity.

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.

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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 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 nine month periods ended March 29, 2003 and March 30, 2002, and the percentage changes in these income and expense items between periods are presented in the following table: