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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D. C. 20549

FORM 10-Q

COMMISSION FILE NUMBER 1-13495

MAC-GRAY CORPORATION
(Exact name of registrant as specified in its charter)

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

        Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes o    No ý

The number of shares outstanding of each of the issuer's classes of
common stock as of the close of business on November 13, 2003:

INDEX

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Item 1. Financial Statements

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS

(In thousands, except share data)

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

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MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)

(In thousands, except per share data)

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

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MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS' EQUITY (Unaudited)

(In thousands, except share data)

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

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MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)

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

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Mac-Gray Corporation

Notes to Condensed Consolidated Financial Statements (unaudited)

(In thousands, except per share data)

1. Basis of Presentation

        The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-Q and rule 10-01 of Regulation S-X. The unaudited interim condensed consolidated financial statements do not include all information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America. In the opinion of the management of Mac-Gray Corporation (the "Company" or "Mac-Gray"), the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of only normal, recurring adjustments), which are necessary to present fairly the Company's financial position, the results of its operations, and its cash flows. These unaudited condensed consolidated financial statements should be read in conjunction with the Company's fiscal 2002 audited consolidated financial statements filed with the Securities and Exchange Commission in its Annual Report on Form 10-K. The results for interim periods are not necessarily indicative of the results to be expected for the full year.

        The Company generates the majority of its revenue from card/coin-operated laundry equipment located in the Northeastern, Midwestern and Southeastern United States. A significant portion of its revenue is also derived from the sale of the Company's MicroFridge® product lines. The Company's principal customer base is the multi-housing market, which consists of apartments, condominium units, colleges and universities, military bases, hotels and motels. The Company also sells, services and leases commercial laundry equipment to commercial laundromats and institutions. The majority of the Company's purchases of laundry equipment are from one supplier. The Company also derives a portion of its revenue from card/coin-operated reprographic equipment.

2. Long Term Debt

        On June 24, 2003, the Company refinanced its outstanding Senior Secured Credit Facility with a group of banks. This transaction retired both the June 2000 revolving line of credit and the June 2000 Senior Secured Term Loan Facility, which were due to expire in July 2004 and June 2005, respectively.

        This new Revolving Line of Credit and Term Loan Facility (the "2003 Senior Secured Credit Facility") provides for borrowings up to $80,000 with borrowings under a three-year revolving line of credit of up to $60,000 and a five-year $20,000 Senior Secured Term Loan Facility. In addition to the scheduled quarterly payments on the Senior Secured Term Loan Facility, the Company is required to pay an amount equal to 50% of the Excess Cash Flow, as defined, for each fiscal period provided that the funded debt ratio for each of the preceding four fiscal quarters is greater than 1.50 to 1. This payment is first used to reduce the Senior Secured Term Loan Facility with any remaining amounts used to reduce the revolving line of credit.

        Outstanding indebtedness under the 2003 Senior Secured Credit Facility bears interest, at the Company's option, at a rate equal to the i) prime rate plus 1.75% through September 30, 2003 and equal to the prime rate thereafter, or ii) LIBOR plus 1.75%. For periods after September 30, 2003, the applicable LIBOR margin may be adjusted quarterly based on certain financial ratios.

        The 2003 Senior Secured Credit Facility is collateralized by a blanket lien on the assets of the Company and each of its subsidiaries, as well as a pledge by the Company of all of the capital stock of its subsidiaries. The 2003 Senior Secured Credit Facility includes certain financial and operational

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covenants, including restrictions on paying dividends and other distributions, making certain acquisitions and incurring indebtedness, and requires that the Company maintain certain financial ratios. The most restrictive financial ratio is a minimum debt service coverage. The Company was in compliance with all financial covenants at September 30, 2003.

        The 2003 Senior Secured Credit Facility contains a commitment fee equal to 0.25% per annum of the average daily unused portion of the 2003 Senior Secured Credit Facility provided that the Funded Debt Ratio is less than 1.75 to 1.00. If the Funded Debt ratio is greater than or equal to 1.75 to 1.00, the commitment fee is equal to 0.375% per annum of the average daily unused portion of the 2003 Senior Secured Credit Facility. As of September 30, 2003, the Company's commitment fee was equal to 0.375%.

        Concurrent with the effective date of the 2003 Senior Secured Credit Facility, the Company wrote off approximately $381 in deferred financing costs associated with the 2000 Senior Secured Term Loan Facility.

        Required payments under the 2003 Senior Secured Credit Facility are as follows:

        Long-term debt also includes various notes payable totaling $1,161 at December 31, 2002, and $321 at September 30, 2003.

3. Derivative Instruments

        On June 24, 2003, the Company terminated its two $20,000 interest rate swap agreements, which had been in effect since February 2000 and January 2002, respectively. The January 2002 interest rate swap agreement was due to expire in February 2004 while the February 2000 interest rate swap agreement was due to expire in February 2005. The Company paid $3,037 to terminate both the February 2000 and January 2002 swap agreements. The accumulated other comprehensive losses related to the terminated interest rate swap agreements are reclassified against current period earnings in the same period the forecasted interest payments affect earnings. Upon termination, there was $1,419, net of taxes of $946, included in accumulated other comprehensive loss. The $88 associated with the January 2002 interest rate swap agreement will be reclassified as an earnings charge through February 2004 and the $1,331 associated with the February 2000 interest rate swap agreement will be reclassified as an earnings charge through February 2005.

        On June 24, 2003, as required by the 2003 Senior Secured Credit Facility, the Company entered into two standard International Swaps and Derivatives Association ("ISDA") interest rate swap agreements (the "2003 Swap Agreements") to manage the interest rate risk associated with its 2003

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Senior Secured Credit Facility. The Company has designated its interest rate swap agreements as cash flow hedges. Each agreement has a notional amount of $20,000 and a maturity date in June 2008. The first interest rate swap agreement has a fixed notional amount throughout its term and a fixed rate of 2.34%. The second interest rate swap agreement contains an amortization provision and a fixed rate of 2.69%. The notional amount of this agreement at September 30, 2003 was $19,286. In accordance with the 2003 Swap Agreements and on a quarterly basis, interest expense is calculated based on the floating 90-day LIBOR and the fixed rate. If interest expense as calculated is greater based on the 90-day LIBOR, the financial institution pays the difference to the Company; if interest expense as calculated is greater based on the fixed rate, the Company pays the difference to the financial institution. Depending on fluctuations in the LIBOR, the Company's interest rate exposure and its related impact on interest expense and net cash flow may increase or decrease. The Company is exposed to credit loss in the event of non-performance by the other party to the swap agreement; however, nonperformance is not anticipated.

        The fair value of the 2003 Swap Agreements is the estimated amount that the Company would receive or pay to terminate the agreement at the reporting date, taking into account current interest rates and the credit worthiness of the counter party. At September 30, 2003, the fair value of the 2003 Swap Agreements, net of related taxes, was an unrealized gain of $335. This amount has been included in other assets on the consolidated balance sheet.

        Prior to its termination in June 2003, the ineffective portion of the January 2002 interest rate swap agreement resulted in income, after the effect of related income taxes, for the three and nine months ended September 30, 2003 of $0 and $152, respectively. The ineffective portion of the January 2002 interest rate swap agreement resulted in income, after the effect of related income taxes, for the three and nine months ended September 30, 2002 was $0 and $137, respectively.

        The changes in accumulated other comprehensive loss relate entirely to the Company's interest rate swap agreements. The components of other comprehensive income (loss) are as follows:

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4. Adoption of FAS 142

        On January 1, 2002, the Company adopted the provisions of Statement of Financial Accounting Standards No. 142 ("FAS 142")—"Goodwill and Other Intangible Assets." The Company engaged an independent third-party business appraisal firm to assist in this process. After their review of information provided by the Company and obtained from public sources, the outside firm performed a fair market valuation of the Company's Laundry and Reprographics, and MicroFridge® segments. These segments represent the Company's reporting units under FAS 142. Upon the completion of this evaluation it was determined that the fair value of the Laundry and MicroFridge® reporting units exceeded their book value, therefore no impairment of goodwill occurred in these reporting units. However, due to the continued decline in the services of the Reprographics reporting unit as a result of expanding use of the Internet in college and public libraries, and access to free laser printers, the book value of the Reprographics reporting unit exceeded the fair value, resulting in a non-cash write-off of the remaining book value of the reporting unit's goodwill in the period ended March 31, 2002, of $906, or $0.07 per share. In accordance with FAS 142, this was recorded as the effect of a change in accounting principle.

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        Goodwill, which will not be further amortized, and intangible assets to be amortized consist of the following:

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

        Amortization of intangible assets for the nine months ended September 30, 2002 and 2003 was $1,020 and $1,044, respectively.

5. Commitments and Contingencies

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

6. New Accounting Pronouncements

        In November 2002, the Financial Accounting Standards Board ("FASB") issued FASB Interpretation No. 45, "Guarantor's Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others" ("FIN 45"). FIN 45 elaborates on the disclosures to be made by a guarantor in its interim and annual financial statements about its obligations under certain guarantees that it has issued. It also clarifies that a guarantor is required to recognize, at the inception of the guarantee, a liability for the fair value of the obligation undertaken in issuing the guarantee. FIN 45 does not prescribe a specific approach for subsequently measuring the guarantor's recognized liability over the term of the related guarantee. This Interpretation also incorporates, without change, the guidance in FASB Interpretation No. 34, "Disclosure of Indirect Guarantees of Indebtedness of Others", which is being superseded. The Company has adopted the disclosure provisions of this pronouncement as of December 31, 2002. The adoption of the financial provisions of FIN 45 on January 1, 2003 had no material effect on the Company's financial position or results of operations.

        In January 2003, the FASB issued FASB Interpretation No. 46, "Consolidation of Variable Interest Entities" ("FIN 46"). This interpretation of Accounting Research Bulletin No. 51, "Consolidated Financial Statements," addresses consolidation by business enterprises of variable interest entities, which possess certain characteristics. FIN 46 requires that if a business enterprise has a controlling financial interest in a variable interest entity, the assets, liabilities, and results of the activities of the variable interest entity must be included in the consolidated financial statements with those of the business enterprise. FIN 46 applies immediately to variable interest entities created after January 31, 2003 and to variable interest entities in which an enterprise obtains an interest after that date. The Company does not have any ownership in any variable interest entities as of September 30, 2003. The

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Company will apply the consolidation requirement of FIN 46 in future periods if the Company should own any interest in any variable interest entity.

        In April 2003, the FASB issued Statement of Financial Accounting Standard No. 149, "Amendment of Statement 133 on Derivative Instruments and Hedging Activities" ("FAS 149"), which amends and clarifies financial accounting and reporting for derivative instruments, including certain derivative instruments embedded in other contracts and for hedging activities under FAS 133. FAS 149 is effective for contracts entered into or modified after June 30, 2003 except for the provisions that were cleared by the FASB in prior pronouncements. The adoption of FAS 149 on July 1, 2003 had no material effect on the Company's financial position or results of operations.

        In May 2003, the FASB issued Statement of Financial Accounting Standards No. 150, "Accounting for Certain Financial Instruments with Characteristics of Both Liabilities and Equity" ("FAS 150"). FAS 150 establishes standards for how an issuer classifies and measures certain financial instruments with characteristics of both liabilities and equity. It requires that an issuer classify a financial instrument that is within its scope as a liability (or an asset in some circumstances). Many of those instruments were previously classified as equity. FAS 150 is effective for financial instruments entered into or modified after May 31, 2003, and otherwise is effective at the beginning of the first interim period beginning after June 15, 2003, except for mandatorily redeemable financial instruments of nonpublic entities. It is to be implemented by reporting the cumulative effect of a change in an accounting principle for financial instruments created before the issuance date of the FAS 150 and still existing at the beginning of the interim period of adoption. Restatement is not permitted. The adoption of FAS 150 on July 1, 2003 had no material effect on the Company s financial position or results of operations.

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7. Earnings Per Share

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

        There were 773 and 57 shares under option plans that were excluded from the computation of diluted earnings per share at September 30, 2002 and 2003, respectively, due to their anti-dilutive effects.

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8. Segment Information

        The Company operates three business units which are based on the Company's different product and service categories: Laundry, MicroFridge® and Reprographics. These three business units have been aggregated into two reportable segments ("Laundry and Reprographics" and "MicroFridge®"). The Laundry and Reprographics business units have been aggregated into one reportable segment since many operating functions of the laundry and reprographics operations are integrated. The Laundry business unit provides coin and card-operated laundry equipment to multiple housing facilities such as apartment buildings, colleges and universities and public housing complexes. The Laundry business unit also operates as a distributor of and provides service to commercial laundry equipment in public laundromats, as well as institutional purchasers, including hospitals, restaurants and hotels, for use in their own on-premise laundry facilities. The MicroFridge® segment sells its own patented and proprietary line of refrigerator/freezer/microwave oven combinations to a customer base which includes colleges and universities, government, hotel, motel and assisted living facilities. The Reprographics business unit provides coin and card-operated reprographics equipment to academic and public libraries.

        There are no intersegment revenues.

        The tables below present information about the operations of the reportable segments of Mac-Gray for the three and nine months ended September 30, 2002 and 2003. The information

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presented represents the key financial metrics that are utilized by the Company's senior management in assessing the performance of each of the Company's reportable segments.

(1)

Principally cash, prepaid expenses and property, plant & equipment.

9. Stock Compensation

        The Company's stock option plans are accounted for in accordance with Accounting Principles Board Opinion No. 25, "Accounting for Stock Issued to Employees" ("APB No. 25"). The Company uses the disclosure requirements of Statement of Financial Accounting Standard No. 123, "Accounting for Stock-Based Compensation" ("FAS 123"). Under APB No. 25, the Company does not recognize compensation expense on stock options granted to employees, because the exercise price of each option is equal to the market price of the underlying stock on the date of the grant.

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        If the company had elected to recognize compensation cost based on the fair value of the options granted at grant date as prescribed by FAS 123, the Company's net income and earnings per share would have been reduced to the following pro forma amounts:

        Because the determination of the fair value of all options granted includes vesting periods over several years and additional option grants are expected to be made each year, the above pro forma disclosures are not representative of pro forma effects of reported net income for future periods.

10. Repurchase of Common Stock

        On December 2, 2002, the Board of Directors authorized a $2,000 stock repurchase program. The authorization expires on December 2, 2003. As of September 30, 2003, 144,800 shares had been purchased since the authorization was granted at a total cost of $563.

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11. Product Warranties

        The Company offers limited-duration warranties on MicroFridge® products and, at the time of sale, provides reserves for all estimated warranty costs based upon historical warranty costs. Actual costs have not exceeded the Company's estimates.

        The activity for the nine months ended September 30, 2003 is as follows:

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Item 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

        This report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. These forward-looking statements reflect the Company's current views about future events and financial performance. Investors should not rely on forward-looking statements because they are subject to a variety of factors that could cause actual results to differ materially from the Company's expectations. Factors that could cause or contribute to such differences include, but are not limited to: ability to meet future capital requirements to replace equipment and implement new technology; compliance with financial and operational covenants included in the 2003 Senior Secured Credit Facility; dependence upon certain suppliers, such as Maytag Corporation; lease renewals; retention of senior executives; market acceptance of new products and services; implementation of acquisition strategy; integration of acquired businesses; and those factors discussed under Item 7 "Management's Discussion and Analysis of Financial Condition and Results of Operations-Risk Factors" in Mac-Gray's Form 10-K for the year ended December 31, 2002, and Mac-Gray's other filings with the Securities and Exchange Commission ("SEC"). The historical financial information presented herein represents the consolidated results of Mac-Gray. The following discussion and analysis should be read in conjunction with the financial statements and related notes thereto presented elsewhere in this report and with the annual financial statements and related notes previously filed by Mac-Gray with the SEC on its Annual Report on Form 10-K for the year ended December 31, 2002.

Overview

        Mac-Gray derives its revenue principally as a laundry facilities contractor for the multi-housing industry. Mac-Gray also sells and services commercial laundry equipment and MicroFridge® equipment. Mac-Gray also operates card/coin-operated reprographics equipment in academic and public libraries. Mac-Gray operates laundry rooms, reprographics equipment and MicroFridge® equipment under long-term leases with property owners, colleges and universities, and governmental agencies. Mac-Gray's laundry services segment is comprised of revenue-generating laundry machines, operated in approximately 30,000 multi-housing laundry rooms located in 27 states and the District of Columbia. Mac-Gray's reprographics segment is concentrated in the northeastern United States, with smaller operations in the Mid-Atlantic, Florida, and the Midwest.

        Mac-Gray also derives revenue as a distributor and service provider of commercial laundry equipment manufactured by The Maytag Corporation, and sells laundry equipment manufactured by American Dryer Corp., The Dexter Company, and Whirlpool Corporation. Additionally, the Company sells or rents laundry equipment to restaurants, hotels, health clubs, and similar institutional users that operate their own on-premise laundry facilities.

        The MicroFridge® segment derives revenue through the sale of its MicroFridge® products to colleges and universities, military bases, the hotel and motel market, and assisted living facilities.

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Results of Operations (Dollars in thousands)

        Three and nine months ended September 30, 2003 compared to three and nine months ended September 30, 2002.

Revenue.

        Total revenue for the three months ended September 30, 2003 was $37,296 as compared to $35,947 for the same period in 2002, for an increase of $1,349, or 4%. Total revenue for the nine months ended September 30, 2003 was $109,298 as compared to $110,793 for the same period in 2002, for a decrease of $1,495, or 1%. The increase in revenue for the three months ended September 30, 2003 as compared to the three months ended September 30, 2002 was primarily attributable to a 68% increase in Laundry equipment sales and an increase in laundry facility management revenue partially offset by a decrease in MicroFridge® academic sales and rental revenue. The decrease in revenue for the nine months ended September 30, 2003 as compared to the same period last year was primarily attributable to a decrease in MicroFridge® academic sales and rental revenue.

        Laundry revenue for the three months ended September 30, 2003 was comprised of laundry facility management revenue of $24,931 and the sale of laundry equipment of $4,993 as compared to the three months ended September 30, 2002 when laundry facility management revenue was $24,430 and the sale of laundry equipment was $2,980. Laundry revenue for the nine months ended September 30, 2003 was comprised of laundry facility management revenue of $76,922 and the sale of laundry equipment of $12,285 as compared to the nine months ended September 30, 2002 when laundry facility management revenue was $75,981 and the sale of laundry equipment was $12,236.

        Although laundry facility management revenue increased $501, or 2% for the third quarter, and $941, or 1% for the first nine months of 2003, as compared to the same periods in 2002, the Company's laundry facility management business has been adversely affected by the increase in apartment vacancy rates, with its southeastern markets being affected the most. Management believes that this increase in vacancy rates has led to a decrease of approximately 2% in laundry facility management revenue for the nine months ended September 30, 2003. The Company derives a significant portion of its laundry facility management business on college campuses and in the Northeast markets, which has mitigated the impact of the higher apartment vacancy rates. In the first nine months of 2003, the Company compensated for this loss in revenue in several ways, including the installation of additional laundry equipment to its facility management operation and continuing a program of vending price increases.

        Laundry equipment sales increased $2,013, or 68%, for the three months ended September 30, 2003 as compared to the three months ended September 30, 2002 and by $49, or less than 1% for the nine months ended September 30, 2003 as compared to the nine months ended September 30, 2002.

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This increase in the third quarter of 2003 as compared to the same period in 2002 is primarily attributable to the release of several laundromat customer orders which had been delayed for several months. Management believes that these customers have found it easier to obtain financing than in prior months. Also accounting for some of the increase is the improved coverage of key markets by additional sales representatives.

        MicroFridge® equipment sales and rental revenue decreased by $1,175, or 16% for the three months ended September 30, 2003 as compared to the three months ended September 30, 2002 and by $2,073, or 11% for the nine months ended September 30, 2003 as compared to the nine months ended September 30, 2002. These decreases were caused primarily by decreases in the academic sales and rental business of $721, or 23%, and $2,461, or 39%, for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002, as well as decreases in the government division of $652, or 27%, and $136, or 2%, for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. These decreases were partially offset by increases in the hotel and assisted living division of $198, or 10%, and $524, or 9%, for the three and nine months ended September 30, 2003, respectively, as compared to the same periods in 2002. We believe the decrease in sales in the Academic market remains primarily attributable to an increase in retail competition as well as colleges and universities continuing to delay or cancel capital spending. The increase in sales to the hotel and assisted living markets is due primarily to expansion of hotel and assisted living sales and marketing efforts into new regions of the country. Government sales remain unpredictable due to the interruption of spending on military living accommodations as a result of heavy military spending in Iraq.

        Reprographics revenue totaled $1,036 for the three months ended September 30, 2003 as compared to $1,026 for the same period in 2002, for an increase of $10, or 1%. Reprographics revenue totaled $3,697 and $4,109 for the nine months ended September 30, 2003 and 2002, respectively, for a decrease of $412, or 10%. Although reprographics revenue has decreased for the last several quarters as compared to the same period in prior years, the third quarter of 2003 represented a slight increase as compared to the same period in 2002. This increase is due primarily to several accounts being converted from a variable rate structure based on volume to a fixed monthly fee arrangement. The decline in reprographic revenue for the nine months ended September 30, 2003 as compare to the nine months ended September 30, 2002 is primarily attributable to the continued decline in volume at public and private libraries due to the increased use of the internet and a program the Company started in 2002 to terminate certain customer contracts that did not provide the level of business to justify continued investment.

        Cost of Route Revenues.    Cost of route revenues include rent paid to route clients as well as those costs associated with installing and servicing machines and the costs of collecting, counting, and depositing route revenue. Cost of route revenues increased $335, or 2%, to $17,714 for the three months ended September 30, 2003 from the three months ended September 30, 2002 and increased $335, or 1% to $54,601 for the nine months ended September 30, 2003 as compared to the same period in 2002. As a percentage of route revenue, cost of route revenues was 70% and 69% for the three and nine months ended September 30, 2003, respectively, essentially flat as compared to the same periods in 2002.

        Depreciation and Amortization.    Depreciation and amortization increased by $25, or 1%, to $3,931 for the three months ended September 30, 2003 from the three months ended September 30, 2002 and by $106, or 1%, to $12,480 for the nine months ended September 30, 2003 from the nine months ended September 30, 2002. This increase was primarily attributable to the placement of new equipment on the laundry route as the Company generates new business and the replacement of older equipment as contracts are renegotiated.

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        Cost of Product Sold.    Cost of product sold consists primarily of the cost of laundry equipment, MicroFridge® equipment, parts, and supplies sold. Cost of product sold increased by $1,224, or 18%, to $8,087 for the three months ended September 30, 2003 from the three months ended September 30, 2002 and by $82, or less than 1% to $20,190 for the nine months ended September 30, 2003 from the nine months ended September 30, 2002. As a percentage of sales, cost of product sold increased from 66% for the three months ended September 30, 2002 to 72% for the three months ended September 30, 2003 and increased from 68% for the nine months ended September 30, 2002 to 72% for the nine months ended September 30, 2003. This increase in percentage for the three and nine months ended September 30, 2003 is caused primarily by the decrease in higher margin MicroFridge® academic sales. The hotel and assisted living margin also decreased for the three and nine months ended September 30, 2003 as a result of offering free shipping, and other pricing concessions, in reaction to competitive pressure. The margin in the Laundry equipment sales division increased, both in the third quarter and for the nine months ended September 30, 2003 as compared to the same periods in 2002. This increase in margin was primarily a result of sales mix within this division.

        Selling, General and Administration Expenses.    Selling, general and administration expenses increased by $15, or less than 1%, to $5,501 for the three months ended September 30, 2003 from the three months ended September 30, 2002 and decreased by $325, or 2%, to $16,121 for the nine months ended September 30, 2003 from the nine months ended September 30, 2002. The decrease for the nine month period is due to the Company's successful efforts to implement administrative cost-cutting measures, particularly in the use of outside services, and a reduction in the amount provided for doubtful accounts receivable due to improved collection experience.

        Loss on early extinguishment of debt.    In connection with the June 24, 2003 refinancing of the Company's Senior Secured Credit Facility, $381 of unamortized financing costs were expensed during the nine months ended September 30, 2003 to reflect the early extinguishment of the Company's 2000 Senior Secured Credit Facility.

        Income from operations.    Income from operations was $2,063 for the three months ended September 30, 2003 as compared to $2,313 for the same period in 2002, for a decrease of $250, or 11%. Income from operations for the nine months ended September 30, 2003 was $5,525 as compared to $7,599, for a decrease of $2,074, or 27%. As a percentage of total revenue, income from operations remained constant at 6% for the three months ended September 30, 2003 as compared to the three months ended September 30, 2002 and decreased to 5% for the nine months ended September 30, 2003 from 7% for the nine months ended September 30, 2002. These decreases are due primarily to the reasons discussed above.

        Interest and Other Expense.    Interest and other expense, net of interest and other income, decreased by $524, or 41%, to $752 for the three months ended September 30, 2003 from the three months ended September 30, 2002 and by $1,213, or 38%, to $2,008 for the nine months ended September 30, 2003 from the nine months ended September 30, 2002. The decrease in interest expense for both the third quarter of 2003 and the first nine months of 2003, as compared to the same periods in 2002, is attributable, in part, to lower average borrowing levels, lower interest rates, and the accounting treatment associated with the Company's interest rate swap agreements. Total interest-bearing borrowings have decreased from $65,165 on September 30, 2002 to $56,305 on September 30, 2003. Interest rates have also fallen from an average of 5.8% as of September 30, 2002 to 4.0% as of September 30, 2003. Non-cash interest expense associated with the accounting treatment of the Company's interest rate swap agreements has had a favorable impact of $405 for the nine months ended September 30, 2003.

        Gain on sale of lease receivables.    During the three months ended September 30, 2003, the Company sold certain lease receivables associated with the MicroFridge® division. The $836 gain

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associated with this sale is primarily attributable to the interest income that would have been recognized throughout the life of the lease had it not been sold.

        Provision for Income Taxes.    The provision for income taxes increased by $476, to $920 for the three months ended September 30, 2003 from the three months ended September 30, 2002 and by $21, to $1,847 for the nine months ended September 30, 2003 from the nine months ended September 30, 2002. This increase is due primarily to the corresponding increase in taxable income for the three and nine months ended September 30, 2003 as compared to the three and nine months ended September 30, 2002. As a percentage of income before the provision for income taxes, the effective tax rate was constant at 43% for the three months ended September 30, 2002 and 2003, and was constant at 42% for the nine months ended September 30, 2002 and 2003. Increases in the effective tax rate are due primarily to an increase in certain expenses that are deductible for financial reporting purposes, which are not deductible for federal and state tax purposes.

Seasonality

        The Company experiences moderate seasonality as a result of its significant operations in the college and university market. Revenues derived from the college and university market typically represent approximately 25% of the Company's total annual revenue. Academic route and rental revenues are derived substantially during the school year in the first, second and fourth calendar quarters. Conversely, the Company's operating and capital expenditures have historically been higher during the third calendar quarter, when the Company installs a large number of machines while colleges and universities are generally on summer break. Product sales, principally of MicroFridge® products, to this market are also typically higher during the third calendar quarter as compared to the rest of the calendar year.

Liquidity and Capital Resources (Dollars in thousands)

        For the nine months ended September 30, 2003, Mac-Gray's source of cash has been primarily from operating activities and proceeds from the sale of lease receivables. The Company's primary uses of cash have been the purchase of new laundry machines and reduction of debt. The Company anticipates that it will continue to use cash flow from its operating activities to finance working capital needs, including interest payments on outstanding indebtedness, capital expenditures, and other purposes.

        For the nine months ended September 30, 2003 and 2002, cash flows provided by operations were $14,951 and $14,943, respectively. Cash flow from operations consists primarily of facility management revenue, product sales, laundry equipment service revenue, and rental revenue, offset by facility management rent and expenditures, cost of product sales, cost of rental revenue, general and administration expenses, and sales and marketing expenses. The slight increase for the nine months ended September 30, 2003 as compared to the nine months ended September 30, 2002 is attributable to ordinary changes in working capital. Included is a larger increase in accounts receivable since January 1, 2003 as compared to the increase during the same period last year. This trade receivable increase is due to an increase in laundry equipment sales during September of 2003 as compared to the same period last year. Also contributing to this increase in cash flows from operations is an increase in prepaid expenses since January 1, 2003 as compared to a decrease during the same period last year. These increases were largely offset by a decrease in inventory and an increase in trade accounts payable and accrued expenses.

        For the nine months ended September 30, 2003 and 2002, cash used in investing activities was $8,978 and $9,455, respectively. Capital expenditures were $11,520 and $10,156 for the nine months ended September 30, 2003 and 2002, respectively. The increase in capital expenditures was due to more laundry equipment being placed in service in the nine-month period ended September 30, 2003 as

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compared to the same period a year ago as well as $1,015 spent on the acquisition of three minor business during the second quarter of 2003. The overall decrease in cash used in investing activities was primarily attributable to the proceeds from the sale of lease receivables, which amounted to $3,284.

        For the nine months ended September 30, 2003 and 2002, cash flows used in financing activities were $5,849 and $6,025, respectively. Cash flows used in financing activities consist primarily of proceeds from and repayments of bank borrowing, capital lease obligations, and other long-term debt. The decrease in cash used for financing activities is attributable to a decrease in net payments on the Senior Secured Credit Facility, offset by payments for the termination of the swap agreements, the additional financing costs associated with the new credit facility and payments for the repurchase of the Company's common stock.

        On June 24, 2003, the Company refinanced its outstanding Senior Secured Credit Facility with a group of banks. This transaction retired both the June 2000 revolving line of credit and the June 2000 Senior Secured Term Loan Facility, which were due to expire in July 2004 and June 2005, respectively.

        This new Revolving Line of Credit and Term Loan Facility (the "2003 Senior Secured Credit Facility") provides for borrowings up to $80,000 with borrowings under a three-year revolving line of credit of up to $60,000 and a five-year $20,000 Senior Secured Term Loan Facility. In addition to the scheduled quarterly payments on the Senior Secured Term Loan Facility, the Company is required to pay an amount equal to 50% of the Excess Cash Flow, as defined, for each fiscal period provided that the funded debt ratio for each of the preceding four fiscal quarters is greater than 1.50 to 1. This payment is first used to reduce the Senior Secured Term Loan Facility with any remaining amounts used to reduce the revolving line of credit. As of September 30, 2003, there was $19,286 outstanding under the term loan and $34,715 outstanding under the revolving line of credit, and the available balance under the revolving line of credit was $24,903. At September 30, 2003 outstanding letters of credit amounted to $382. The average interest rate was approximately 4.0% as of September 30, 2003, compared with approximately 5.8% as of September 30, 2002.

        Outstanding indebtedness under the 2003 Senior Secured Credit Facility bears interest, at the Company's option, at a rate equal to the i) prime rate plus 1.75% through September 30, 2003 and equal to the prime rate thereafter, or ii) LIBOR plus 1.75%. For the periods ending after September 30, 2003, the applicable LIBOR margin may be adjusted quarterly based on certain financial ratios.

        The 2003 Senior Secured Credit Facility is collateralized by a blanket lien on the assets of the Company and each of its subsidiaries, as well as a pledge by the Company of all of the capital stock of its subsidiaries. The 2003 Senior Secured Credit Facility includes certain financial and operational covenants, including restrictions on paying dividends and other distributions, making certain acquisitions and incurring indebtedness, and require that the Company maintain certain financial ratios. The most restrictive financial ratio is a minimum debt service coverage. On September 30, 2003 the Company was in compliance with all financial covenants.

        The 2003 Senior Secured Credit Facility contains a commitment fee equal to 0.25% per annum of the average daily-unused portion of the 2003 Senior Secured Credit Facility provided that the Funded Debt Ratio is less than 1.75 to 1.00. If the Funded Debt ratio is greater than or equal to 1.75 to 1.00, the commitment fee is equal to 0.375% per annum of the average daily unused portion of the 2003 Senior Secured Credit Facility. As of September 30, 2003, the Company's commitment fee was equal to 0.375%.

        On June 24, 2003, the Company terminated its two $20,000 interest rate swap agreements, which had been in effect since February 2000 and January 2002, respectively. The January 2002 interest rate swap agreement was due to expire in February 2004 while the February 2000 interest rate swap

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agreement was due to expire in February 2005. The Company paid $3,037 to terminate both the February 2000 and January 2002 swap agreements.

        On June 24, 2003, as required by the 2003 Senior Secured Credit Facility, the Company entered into two standard International Swaps and Derivatives Association ("ISDA") interest rate swap agreements (the "2003 Swap Agreements") to manage the interest rate risk associated with its 2003 Senior Secured Credit Facility. The Company has designated its interest rate swap agreements as cash flow hedges. Each agreement has a notional amount of $20,000 and a maturity date in June 2008. The first interest rate swap agreement has a fixed notional amount throughout its term and a fixed rate of 2.34%. The second interest rate swap agreement contains an amortization provision and a fixed rate of 2.69%. The notional amount of this agreement at September 30, 2003 was $19,286. In accordance with the 2003 Swap Agreements and on a quarterly basis, interest expense is calculated based on the floating 90-day LIBOR and the fixed rate. If interest expense as calculated is greater based on the 90-day LIBOR, the financial institution pays the difference to the Company; if interest expense as calculated is greater based on the fixed rate, the Company pays the difference to the financial institution. Depending on fluctuations in the LIBOR, the Company's interest rate exposure and its related impact on interest expense and net cash flow may increase or decrease. The Company is exposed to credit loss in the event of non-performance by the other party to the swap agreement; however, nonperformance is not anticipated.

        The fair value of the 2003 Swap Agreements is the estimated amount that the Company would receive or pay to terminate the agreement at the reporting date, taking into account current interest rates and the credit worthiness of the counter party. At September 30, 2003, the fair value of the 2003 Swap Agreements, net of related taxes, was an unrealized gain of $335. This amount has been included in other assets on the consolidated balance sheet.

        A summary of the Company's contractual obligations and commitments related to its outstanding long term debt and future minimum lease payments is as follows: