##### Table of Contents



(G&K SERVICES LOGO) 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 October 2, 2004 Commission file number 0-4063 G&K SERVICES, INC.  MINNESOTA
    
    41-0449530(State or other jurisdiction of
incorporation or organization)
    
    (I.R.S. Employer
Identification No.)
 5995 OPUS PARKWAY
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. YES [X]
    
    NO [  ]
 Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act). YES [X]
    
    NO [  ]
 Indicate the number of shares outstanding of each of the issuers classes
of common stock as of the latest practicable date. CLASS A
Common Stock, par value $0.50 per share
    
    Outstanding November 1, 2004
19,514,274
 CLASS B
Common Stock, par value $0.50 per share
    
    Outstanding November 1, 2004
1,474,996




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G&K Services, Inc.
Form 10-Q Table of Contents  
 PAGEPART IItem 1.
    
    Financial StatementsConsolidated Condensed Balance Sheets as of
October 2, 2004 and July 3, 2004
    
    
    3Consolidated Statements of Operations for the three months ended
October 2, 2004 and September 27, 2003
    
    
    4Consolidated Condensed Statements of Cash Flows for the three
months ended October 2, 2004 and September 27, 2003
    
    
    5Notes to Consolidated Condensed Financial Statements
    
    
    6Item 2.
    
    Managements Discussion and Analysis of Financial Condition and
Results of Operations
    
    
    11Item 3.
    
    Quantitative and Qualitative Disclosure About Market Risk
    
    
    16Item 4.
    
    Controls and Procedures
    
    
    17PART IIItem 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    18Item 6.
    
    Exhibits and Reports on Form 8-K
    
    
    18Signatures
    
    
    
    
    19Certification of Chief Executive OfficerCertification of Chief Financial OfficerCertification of Chief Executive OfficerCertification of Chief Financial Officer
  2




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PART I
FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS 
 CONSOLIDATED CONDENSED BALANCE SHEETS
G&K Services, Inc. and Subsidiaries October 2,2004
    
    July 3,(In thousands)
    
    (Unaudited)
    
    2004ASSETSCurrent AssetsCash and cash equivalents
    
    $
    11,789
    
    
    $
    26,931Accounts receivable, less allowance for doubtful
accounts of $2,692 and $2,603
    
    
    74,550
    
    
    
    71,058Inventories
    
    
    96,766
    
    
    
    94,476Prepaid expenses
    
    
    9,999
    
    
    
    14,902Total current assets
    
    
    193,104
    
    
    
    207,367Property, Plant and Equipment, net
    
    
    238,309
    
    
    
    240,609Goodwill, net
    
    
    299,467
    
    
    
    285,892Other Assets
    
    
    71,381
    
    
    
    68,879$
    802,261
    
    
    $
    802,747LIABILITIES AND STOCKHOLDERS EQUITYCurrent LiabilitiesAccounts payable
    
    $
    19,833
    
    
    $
    20,511Accrued expenses
    
    
    70,214
    
    
    
    76,470Deferred income taxes
    
    
    7,537
    
    
    
    7,395Current maturities of long-term debt
    
    
    24,662
    
    
    
    24,018Total current liabilities
    
    
    122,246
    
    
    
    128,394Long-Term Debt, net of Current Maturities
    
    
    173,468
    
    
    
    184,305Deferred Income Taxes
    
    
    38,581
    
    
    
    38,256Other Noncurrent Liabilities
    
    
    26,952
    
    
    
    26,369Stockholders Equity
    
    
    441,014
    
    
    
    425,423$
    802,261
    
    
    $
    802,747
 The accompanying notes are an integral part of these consolidated condensed
financial statements. 3




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CONSOLIDATED STATEMENTS OF OPERATIONS
G&K Services, Inc. and Subsidiaries
(Unaudited) For the Three Months EndedOctober 2,
    
    September 27,(In thousands, except per share data)
    
    2004
    
    2003RevenuesRental operations
    
    $
    176,291
    
    
    $
    173,280Direct sales
    
    
    6,141
    
    
    
    5,323Total revenues
    
    
    182,432
    
    
    
    178,603Operating ExpensesCost of rental operations
    
    
    111,009
    
    
    
    109,845Cost of direct sales
    
    
    4,896
    
    
    
    4,301Selling and administrative
    
    
    38,619
    
    
    
    38,533Depreciation and amortization
    
    
    10,158
    
    
    
    9,690Total operating expenses
    
    
    164,682
    
    
    
    162,369Income from Operations
    
    
    17,750
    
    
    
    16,234Interest expense
    
    
    2,548
    
    
    
    3,155Income before Income Taxes
    
    
    15,202
    
    
    
    13,079Provision for income taxes
    
    
    5,702
    
    
    
    4,970Net Income
    
    $
    9,500
    
    
    $
    8,109Basic weighted average number
of shares outstanding
    
    
    20,825
    
    
    
    20,610Basic Earnings per Common Share
    
    $
    0.46
    
    
    $
    0.39Diluted weighted average number
of shares outstanding
    
    
    21,066
    
    
    
    20,728Diluted Earnings per Common Share
    
    $
    0.45
    
    
    $
    0.39Dividends per share
    
    $
    0.0175
    
    
    $
    0.0175
 The accompanying notes are an integral part of these consolidated condensed
financial statements. 4




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CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
G&K Services, Inc. and Subsidiaries
(Unaudited) For the Three Months EndedOctober 2,
    
    September 27,(In thousands)
    
    2004
    
    2003Operating Activities:Net income
    
    $
    9,500
    
    
    $
    8,109Adjustments to reconcile net income to net cash
provided by operating activities -Depreciation and amortization
    
    
    10,158
    
    
    
    9,690Deferred income taxes
    
    
    101
    
    
    
    465Amortization
of deferred compensation  restricted stock
    
    
    277
    
    
    
    232Changes in current operating items, exclusive of
acquisitions
    
    
    (6,045
    )
    
    
    9,385Other, net
    
    
    490
    
    
    
    (272
    )Net cash provided by operating activities
    
    
    14,481
    
    
    
    27,609Investing Activities:Property, plant and equipment additions, net
    
    
    586
    
    
    
    (3,621
    )Acquisitions of business assets and other
    
    
    (19,864
    )
    
    
    (539
    )Net cash used for investing activities
    
    
    (19,278
    )
    
    
    (4,160
    )Financing Activities:Proceeds from issuance of long-term debt
    
    
    
    
    
    
    1,345Repayments of long-term debt
    
    
    (12,877
    )
    
    
    (3,205
    )Proceeds from (repayments of) short-term borrowings, net
    
    
    1,100
    
    
    
    (19,300
    )Cash dividends paid
    
    
    (365
    )
    
    
    (363
    )Sale of common stock
    
    
    1,219
    
    
    
    423Net cash used for financing activities
    
    
    (10,923
    )
    
    
    (21,100
    )(Decrease) Increase in Cash and Cash Equivalents
    
    
    (15,720
    )
    
    
    2,349Effect of Exchange Rates on Cash
    
    
    578
    
    
    
    174Cash and Cash Equivalents:Beginning of period
    
    
    26,931
    
    
    
    11,504End of period
    
    $
    11,789
    
    
    $
    14,027
 The accompanying notes are an integral part of these consolidated condensed
financial statements. 5




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G&K SERVICES, INC. AND SUBSIDIARIES 
 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Amounts in thousands, except per share data)
Three-month period ended October 2, 2004 and September 27, 2003
(Unaudited)  The consolidated condensed financial statements included herein, except
for the July 3, 2004 balance sheet which was derived from the audited
consolidated financial statements for the fiscal year ended July 3, 2004,
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 October 2, 2004, and
the results of its operations and its cash flows for the three months
ended October 2, 2004 and September 27, 2003. 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-month periods ended October 2,
2004 and September 27, 2003 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 July
3, 2004.Nature of BusinessG&K Services, Inc. (the Company) is a market leader in providing
branded identity apparel and facility services programs that enhance
image and safety in the workplace. The Company serves a wide variety of
industrial, service and high-technology companies providing them with
rented uniforms or purchase options as well as facility services products
such as floor mats, dust mops, wiping towels, selected linen items and
several restroom products. The Company also manufactures certain uniform
garments that it uses to support its garment rental programs. The
Company has two operating segments, United States and Canada, which have
been identified as components of the Company that are reviewed by the
Companys Chief Executive Officer to determine resource allocation and
evaluate performance.Principles of ConsolidationThe 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 RecognitionThe Companys rental operations business is largely based on written
service agreements whereby it agrees to collect, launder and deliver
uniforms and other related products. The service agreements provide for
weekly billing upon completion of the laundering process and delivery to
the customer. Accordingly, the Company recognizes revenue from rental
operations in the period in which the services are provided. Revenue
from rental operations also includes billings to customers for lost or
abused merchandise. Direct sale revenue is recognized in the period in
which the product is shipped. 6




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Derivative Financial InstrumentsThe 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 first quarter of fiscal 2005 or fiscal 2004. Notional
amounts outstanding under foreign currency contracts at October 2, 2004
were $440, all of which will mature during fiscal 2005. Notional amounts
outstanding under foreign currency contracts at September 27, 2003 were
$393, all of which matured during fiscal 2004. Foreign currency contracts
were recorded at fair value as of October 2, 2004.Per Share DataBasic 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. Three Months EndedOctober 2,
    
    September 27,2004
    
    2003Weighted average number of common
shares outstanding used in computation
of basic earning per share
    
    
    20,825
    
    
    
    20,610Weighted average effect of nonvested
restricted stock grants and assumed
exercise of options
    
    
    241
    
    
    
    118Shares used in computation of
diluted earnings per share
    
    
    21,066
    
    
    
    20,728
  Stock-Based CompensationThe 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 July 3, 2004. 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 $277 and $232 for the
three-month periods ended October 2, 2004 and September 27, 2003,
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, Accounting for 7




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Stock-Based Compensation (SFAS 123),
the Companys net income and net income per common share would have been
adjusted as follows: Three Months EndedOctober 2,
    
    September 27,2004
    
    2003Net income, as reported
    
    $
    9,500
    
    
    $
    8,109Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects
    
    
    (433
    )
    
    
    (444
    )Pro forma net income
    
    $
    9,067
    
    
    $
    7,665Basic net income per share:As reported
    
    $
    0.46
    
    
    $
    0.39Pro forma
    
    
    0.44
    
    
    
    0.37Diluted net income per share:As reported
    
    $
    0.45
    
    
    $
    0.39Pro forma
    
    
    0.43
    
    
    
    0.37
 2. Comprehensive Income  For the three-month periods ended October 2, 2004 and September 27, 2003,
the components of comprehensive income were as follows: Three Months EndedOctober 2,
    
    September 27,2004
    
    2003Net income
    
    $
    9,500
    
    
    $
    8,109Other comprehensive incomeForeign currency translation
adjustments, net of tax
    
    
    4,958
    
    
    
    (343
    )Net unrealized gain on derivative
financial instruments, net of tax
    
    
    2
    
    
    
    371Comprehensive income
    
    $
    14,460
    
    
    $
    8,137
 8




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3. Goodwill and Intangible Assets  The changes in the carrying amount of goodwill for the three months ended
October 2, 2004, by operating segment, are as follows: United States
    
    Canada
    
    TotalBalance as of July 3, 2004
    
    $
    254,998
    
    
    $
    30,894
    
    
    $
    285,892Goodwill acquired during the period
    
    
    348
    
    
    
    11,910
    
    
    
    12,258Other, primarily foreign currency
translation
    
    
    
    
    
    
    1,317
    
    
    
    1,317Balance as of October 2, 2004
    
    $
    255,346
    
    
    $
    44,121
    
    
    $
    299,467
  Information regarding the Companys other intangible assets, which are
included in other assets on the balance sheet, are as follows: As of October 2, 2004Carrying
    
    AccumulatedAmount
    
    Amortization
    
    NetCustomer contracts and
related customer
relationships
    
    $
    84,290
    
    
    $
    41,063
    
    
    $
    43,227Non-competition agreements
    
    
    9,922
    
    
    
    6,272
    
    
    
    3,650Total
    
    $
    94,212
    
    
    $
    47,335
    
    
    $
    46,877
 As of July 3, 2004Carrying
    
    AccumulatedAmount
    
    Amortization
    
    NetCustomer contracts and
related customer
relationships
    
    $
    80,142
    
    
    $
    38,991
    
    
    $
    41,151Non-competition agreements
    
    
    9,822
    
    
    
    6,013
    
    
    
    3,809Total
    
    $
    89,964
    
    
    $
    45,004
    
    
    $
    44,960
  Amortization expense was $2,036 and $1,945 for the three months ended
October 2, 2004 and September 27, 2003, respectively. Estimated
amortization expense for each of the five succeeding fiscal years based
on the intangible assets as of October 2, 2004 is as follows: 2005 remaining
    
    $
    6,3062006
    
    
    8,1672007
    
    
    7,9642008
    
    
    7,5952009
    
    
    3,9182010
    
    
    3,893
 9




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4. Employee Benefit Plans  The components of net periodic pension cost are as follows for the three
months ended October 2, 2004 and September 27, 2003: Supplemental ExecutivePension Plan
    
    Retirement PlanThree Months Ended
    
    Three Months EndedOct 2,
    
    Sept 27,
    
    Oct 2,
    
    Sept 27,2004
    
    2003
    
    2004
    
    2003Service cost
    
    $
    1,154
    
    
    $
    991
    
    
    $
    226
    
    
    $
    182Interest cost
    
    
    829
    
    
    
    630
    
    
    
    196
    
    
    
    143Expected return on assets
    
    
    (663
    )
    
    
    (380
    )
    
    
    
    
    
    
    Prior service cost
    
    
    17
    
    
    
    14
    
    
    
    12
    
    
    
    9Loss
    
    
    157
    
    
    
    264
    
    
    
    66
    
    
    
    78Net periodic pension cost
    
    $
    1,494
    
    
    $
    1,519
    
    
    $
    500
    
    
    $
    412
 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 branded
identity apparel and facility services industry, which includes
garment rental and facility services products such as floor mats,
dust mops, 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-month periods ended October 2, 2004 and September 27, 2003
is as follows: UnitedFor the Three Months Ended
    
    States
    
    Canada
    
    TotalFirst Quarter Fiscal Year 2005:Revenues
    
    $
    155,870
    
    
    $
    26,562
    
    
    $
    182,432Income from operations
    
    
    12,853
    
    
    
    4,897
    
    
    
    17,750Property, plant and equipment
additions, net
    
    
    (1,120
    )
    
    
    534
    
    
    
    (586
    )Depreciation and amortization
expense
    
    
    8,901
    
    
    
    1,257
    
    
    
    10,158First Quarter Fiscal Year 2004:Revenues
    
    $
    155,758
    
    
    $
    22,845
    
    
    $
    178,603Income from operations
    
    
    12,297
    
    
    
    3,937
    
    
    
    16,234Property, plant and equipment
additions, net
    
    
    3,677
    
    
    
    (56
    )
    
    
    3,621Depreciation and amortization
expense
    
    
    8,627
    
    
    
    1,063
    
    
    
    9,690
 10




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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 branded identity apparel and facility services
programs that enhance image and safety in the workplace. We serve a wide
variety of North American industrial, service and high-technology companies
providing them with rented uniforms and facility services products such as
floor mats, dust mops, wiping towels, restroom supplies and selected linen
items. We also sell uniforms and other apparel items to customers in our
direct sale programs. The North American rental market is approximately
$6.5-$7.0 billion, while the portion of the direct sale market targeted by us
is approximately $4.5-$5.0 billion in size. 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 Our rental operations business is largely based on written service agreements
whereby we agree to collect, launder and deliver uniforms and other related
products. The service agreements provide for weekly billing upon completion of
the laundering process and delivery to the customer. Accordingly, we recognize
revenue from rental operations in the period in which the services are
provided. Revenue from rental operations also includes billings to customers
for lost or abused merchandise. Direct sale revenue is recognized in the
period in which the product is shipped. Estimates are used in determining the collectibility of billed accounts
receivable. Management analyzes specific accounts receivable and historical
bad debt experience, customer credit worthiness, current economic trends and
the age of outstanding balances when evaluating the adequacy of the allowance
for doubtful accounts. Significant management judgments and estimates are used
in connection with establishing the allowance in any accounting period.
Material differences may result in the amount and timing of bad debt expense
recognition for any given period if management makes different judgments or
utilizes different estimates. Inventories Our inventories consist of new goods and rental merchandise in service.
Estimates are used in determining the likelihood that new goods on hand can be
sold to customers or used in rental operations. Historical inventory usage and
current revenue trends are considered in estimating both obsolete and excess
inventories. New goods are stated at lower of cost or market, net of any
reserve for obsolete or excess inventory. Merchandise placed in service to
support rental operations is amortized into cost of rental operations over the
estimated useful lives of the underlying inventory items, primarily on a straight-line basis, which results
in a matching of the cost of the merchandise with the weekly rental revenue
generated by merchandise. Estimated lives of rental merchandise in service
range from nine months to three years. In establishing estimated lives for
merchandise in service, management considers historical 11




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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 Statement of Financial Accounting Standards No. 142, Goodwill and
Other Intangible Assets (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.
Our evaluation considers changes in the operating environment, competitive
information, market trends, operating performance and cash flow modeling.
Management completes its annual impairment test in the fourth quarter of each
fiscal year and there have been no impairments of goodwill or definite-lived
intangible assets in fiscal 2004 or through the first three months of fiscal
2005. 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 2004 or through the first three
months of fiscal 2005. 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
liability associated with reported claims and for losses that have occurred,
but have not been reported. Management estimates consider historical claims
experience, escalating medical cost trends, expected timing of claim payments
and an actuarial analysis provided by a third party. Changes in the cost of
medical care, our ability to settle claims and the estimates and judgments used
by management could have a material impact on the amount and timing of expense
for any period. Income Taxes In the normal course of business, we are subject to audits from federal, state,
Canadian provincial and other tax authorities regarding various tax
liabilities. These audits may alter the timing or amount of taxable income or
deductions, or the allocation of income among tax jurisdictions. The amount
ultimately paid upon resolution of issues raised may differ from the amount
accrued. We believe that taxes accrued on our consolidated balance sheets
fairly represent the amount of future tax liability due. We utilize income tax planning to reduce our overall cost of income taxes.
Upon audit, it is possible that certain strategies might be disallowed
resulting in an increased liability for income taxes. We believe that the
provision for liabilities resulting from the implementation of income tax
planning is appropriate. To date, we have not experienced an examination by
governmental revenue authorities that would lead management to believe that our
past provisions for exposures related to income tax planning are not
appropriate. Deferred income taxes are determined in accordance with SFAS No. 109,
Accounting for Income Taxes. Deferred tax assets and liabilities are
recorded for temporary differences between the tax basis of assets and
liabilities and their reported amounts in the financial statements, using
statutory rates in effect for the year in which the differences are expected to
reverse. The effect on deferred tax assets and liabilities of a change in tax
rates is recognized in the results of operations in the period that includes
the enactment date. We record valuation allowances to reduce deferred tax
assets when it is more likely than not that some portion of the asset may not
be realized. As such, we have established a valuation allowance for all
foreign tax credit carryforwards due to the uncertainty of the use of the 12




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tax
benefit in future periods. We evaluate our deferred tax assets and liabilities
on a periodic basis. We believe that we have adequately provided for our
future tax consequences based upon current facts and circumstances. Results of Operations The percentage relationships to net sales of certain income and expense items
for the three-month periods ended October 2, 2004 and September 27, 2003, and
the percentage changes in these income and expense items between periods are
presented in the following table: Three Months
    
    PercentageEnded
    
    ChangeThree MonthsOct 2,
    
    Sept 27,
    
    FY 20052004
    
    2003
    
    vs. FY 2004Revenues:Rental
    
    
    96.6
    %
    
    
    97.0
    %
    
    
    1.7
    %Direct
    
    
    3.4
    
    
    
    3.0
    
    
    
    15.4Total revenues
    
    
    100.0
    
    
    
    100.0
    
    
    
    2.1Expenses:Cost of rental sales
    
    
    63.0
    
    
    
    63.4
    
    
    
    1.1Cost of direct sales
    
    
    79.7
    
    
    
    80.8
    
    
    
    13.8Total cost of sales
    
    
    63.5
    
    
    
    63.9
    
    
    
    1.5Selling and administrative
    
    
    21.2
    
    
    
    21.6
    
    
    
    0.2Depreciation and amortization
    
    
    5.6
    
    
    
    5.4
    
    
    
    4.8Income from operations
    
    
    9.7
    
    
    
    9.1
    
    
    
    9.3Interest expense
    
    
    1.4
    
    
    
    1.8
    
    
    
    (19.2
    )Income before income taxes
    
    
    8.3
    
    
    
    7.3
    
    
    
    16.2Provision for income taxes
    
    
    3.1
    
    
    
    2.8
    
    
    
    14.7Net income
    
    
    5.2
    %
    
    
    4.5
    %
    
    
    17.2
    %
 Three months ended October 2, 2004 compared to three months ended September 27,
2003 Revenues.Total revenues in the first quarter of fiscal 2005 increased 2.1% to
$182.4 million from $178.6 million in the first quarter of fiscal 2004. Rental
revenue increased $3.0 million in the first quarter, or 1.7%. The organic
industrial rental growth rate, which is calculated using industrial rental
revenue adjusted for foreign currency exchange rate differences and revenue
from newly acquired business compared to prior-period results, was
approximately negative 2.0%. We believe that the organic industrial rental
growth rate better reflects the growth of our existing industrial business and
is therefore useful in analyzing our financial condition and results of
operations. Organic industrial rental revenue continues to be negatively
impacted by lost uniform wearers due to reduced employment levels within our
existing customer base and more competitive pricing on both new accounts and
account renewals. Direct sale revenue increased 15.4% to $6.1 million in the first quarter of
fiscal 2005 compared to $5.3 million in the same period of fiscal 2004. The
increase in revenue was driven by garment sales through our rental operations
including the initial impact of our annual winter outerwear promotion. Cost of Rental and Direct Sale.Cost of rental operations increased 1.1% to
$111.0 million in the first quarter of fiscal 2005 from $109.8 million in the
same period of fiscal 2004. Gross margin from rental sales increased to 37.0%
in the first quarter of fiscal 2005 from 36.6% in the first quarter of fiscal
2004. The increase in rental gross 13




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margins reflects the benefit of numerous
operational initiatives that resulted in lower merchandise and processing
costs, partially offset by higher energy costs. Cost of direct sales increased 13.8% to $4.9 million in the first quarter of
fiscal 2005 from $4.3 million in the same period of fiscal 2004. Gross margin
from direct sales increased to 20.3% in the first quarter of fiscal 2005 from
19.2% in the first quarter of fiscal 2004. The increase in margins was
primarily due to the increase in sales volume. Selling and Administrative.Selling and administrative expenses increased 0.2%
to $38.6 million in the first quarter of fiscal 2005 from $38.5 million in the
same period of fiscal 2004. As a percentage of total revenues, selling and
administrative expenses decreased to 21.2% in the first quarter of fiscal 2005
from 21.6% in the first quarter of fiscal 2004. The decrease as a percent of
revenue was due to lower administrative costs and a $0.3 million gain on sale
of property, partially offset by increased selling costs in connection with the
expansion of our new account sales team. Depreciation and Amortization. Depreciation and amortization expense increased
4.8% to $10.2 million in the first quarter of fiscal 2005 from $9.7 million in
the same period of fiscal 2004. As a percentage of total revenues,
depreciation and amortization expense increased to 5.6% in the first quarter of
fiscal 2005 from 5.4% in the first quarter of fiscal 2004. Interest Expense. Interest expense was $2.5 million in the first quarter of
fiscal 2005, down from $3.2 million in the same period of fiscal 2004. The
decrease was due to lower debt levels associated with significant levels of
cash flow and slightly lower interest rates. Provision for Income Taxes. Our effective tax rate decreased to 37.5% in the
first quarter of fiscal 2005 from 38.0% in the same period of fiscal 2004 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 our credit facilities. Primary uses of cash are interest payments on
indebtedness, capital expenditures, acquisitions and general corporate
purposes. Operating Activities.Net cash provided by operating activities was $14.5
million in the first three months of fiscal 2005 and $27.6 million in the same
period of fiscal 2004. Operating cash flow was down from the prior year
primarily due to the timing of cash payments for income taxes and an increase
in new goods inventory in connection with our expansion of our manufacturing
operations. Working capital at October 2, 2004 was $70.9 million, down 10.3% from $79.0
million at July 3, 2004. The decrease was due to the use of cash for
acquisitions of business assets. Investing Activities.Net cash used in investing activities was $19.3 million
in the first three months of fiscal 2005 and $4.2 million in the same period of
fiscal 2004. In fiscal 2005, cash was largely used for acquisitions of
business assets with capital expenditures being largely offset by proceeds from
the sale of selected plant assets. The sale of these assets is the result of
our continued focus on improving asset utilization. Proceeds on these sales
totaled $5.6 million. In fiscal 2004, cash was primarily used for property,
plant and equipment additions. Financing Activities.Cash used for financing activities was $10.9 million in
the first three months of fiscal 2005 and $21.1 million in the same period of
fiscal 2004. Cash used in both fiscal 2005 and fiscal 2004 was primarily
related to the repayment of debt. The Company paid dividends of $0.4
million during the first three months of fiscal 2005. 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. 14




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##### Table of Contents



The following table summarizes our fixed cash obligations as of October 2, 2004
for the fiscal years ending June (in thousands): 2010 and2005
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    There-Remaining
    
    2006
    
    2007
    
    2008
    
    2009
    
    after
    
    TotalVariable rate term loan and
revolving
credit facility
    
    $
    11,250
    
    
    $
    18,750
    
    
    $
    22,500
    
    
    $
    100,700
    
    
    $
    
    
    
    $
    
    
    
    $
    153,200Fixed rate term loan
    
    
    
    
    
    
    7,143
    
    
    
    7,143
    
    
    
    7,143
    
    
    
    7,143
    
    
    
    14,285
    
    
    
    42,857Other debt arrangements, including
capital leases
    
    
    1,475
    
    
    
    530
    
    
    
    68
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    2,073Operating leases
    
    
    10,864
    
    
    
    12,338
    
    
    
    10,062
    
    
    
    7,823
    
    
    
    4,976
    
    
    
    4,690
    
    
    
    50,753Total contractual cash obligations
    
    $
    23,589
    
    
    $
    38,761
    
    
    $
    39,773
    
    
    $
    115,666
    
    
    $
    12,119
    
    
    $
    18,975
    
    
    $
    248,883
 Also, at October 2, 2004, we had stand-by letters of credit totaling $16.7
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. At October 2, 2004, we had available cash on hand of $11.8 million and over
$130.0 million of available capacity under our revolving credit facility. We
anticipate that we will generate sufficient cash flows from operations to
satisfy our cash commitments and capital requirements for fiscal 2005; however,
we may utilize borrowings under the revolving credit facility to supplement our
cash requirements from time to time. The amount of cash flow generated from operations is subject to a number of
risks and uncertainties. In fiscal 2005, we may actively seek and consider
acquisitions of business assets, the consummation of any acquisition could
affect our liquidity profile and level of outstanding debt. We believe that
available capacity under our revolving credit facility will be adequate to
finance any such acquisitions and planned capital expenditures in fiscal 2005. Pension Obligations We account for our defined benefit pension plan using Statement of Financial
Accounting Standards No. 87 Employers Accounting for Pensions (SFAS 87).
Under SFAS 87, pension expense is recognized on an accrual basis over
employees approximate service periods. Pension expense calculated under SFAS
87 is generally independent of funding decisions or requirements. We recognized
expense for our defined benefit pension plan of $1.5 million in the first
quarter of fiscal 2005 and $1.5 million in the same period of fiscal 2004. At
July 3, 2004, the fair value of our pension plan assets totaled $26.7 million. The calculation of pension expense and the corresponding liability requires the
use of a number of critical assumptions, including the expected long-term rate
of return on plan assets and the assumed discount rate. Changes in these
assumptions can result in different expense and liability amounts, and future
actual experience can differ from these assumptions. Pension expense increases
as the expected rate of return on pension plan assets decreases. At July 3,
2004, we estimated that the pension plan assets will generate a long-term rate
of return of 8.0%. This rate was developed by evaluating input from our actuary
as well as long-term inflation assumptions. The expected long-term rate of
return on plan assets at July 3, 2004 is based on an allocation of U.S.
equities and U.S. fixed income securities. Decreasing the expected long-term
rate of return by 0.5% (from 8.0% to 7.5%) would increase our estimated fiscal
2005 pension expense by approximately $0.1 million. Pension liability and
future pension expense increase as the discount rate is reduced. We discounted
future pension obligations using a rate of 6.25% at July 3, 2004. The discount
rate is determined based on the current rates earned on high quality long-term
bonds. Decreasing the discount rate by 0.5% (from 6.25% to 5.75%) would have
increased our accumulated benefit obligation at July 3, 2004 by approximately $3.8 million and increased the
estimated fiscal 2005 pension expense by approximately $0.9 million. 15




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Future changes in plan asset returns, assumed discount rates and various other
factors related to the participants in our pension plan will impact our future
pension expense and liabilities. We cannot predict with certainty what these
factors will be in the future. Impact of Inflation In general, management believes that our results of operations are not
dependent on moderate changes in the inflation rate. Historically, we have been
able to manage the impact of more significant changes in inflation rates
through our customer relationships, customer agreements that generally provide
for price increases consistent with the rate of inflation or 5.0%, whichever is
greater, and continued focus on improvements of operational productivity. Significant increases in energy costs, specifically natural gas and gasoline,
can materially affect our results of operations and financial condition.
Currently, energy costs represent between 3-4% of our total revenue. Litigation We are involved in a variety of legal actions relating to personal injury,
customer contracts, employment, trade practices, environmental and other legal
matters that arise in the normal course of business. These legal actions
include lawsuits that challenge the practice of charging for certain
environmental services on invoices, and being named, along with other
defendants, as a potentially responsible party at certain waste disposal sites
where ground water contamination has been detected or is suspected. None of
these legal actions are expected to have a material adverse effect on our
results of operations or financial position. Cautionary Statements Regarding Forward-Looking Statements The Private Securities Litigation Reform Act of 1995 (the Act) provides
companies with a safe harbor when making forward-looking statements as a way
of encouraging them to furnish their shareholders with information regarding
expected trends in their operating results, anticipated business developments
and other prospective information. Statements made in this report concerning
our intentions, expectations or predictions about future results or events are
forward-looking statements within the meaning of the Act. These statements
reflect our current expectations or beliefs, and are subject to risks and
uncertainties that could cause actual results or events to vary from stated
expectations, which could be material and adverse. Given that circumstances
may change, and new risks to the business may emerge from time to time, having
the potential to negatively impact our business in ways we could not anticipate
at the time of making a forward-looking statement, you are cautioned not to
place undue reliance on these statements, and we undertake no obligation to
publicly update or revise any forward-looking statements, whether as a result
of new information, future events or otherwise. Some of the factors that could cause actual results or events to vary from
stated expectations include, but are not limited to, the following: unforeseen
operating risks; the effects of overall economic conditions; fluctuations in
costs of insurance and energy; acquisition integration costs; the performance
of acquired businesses; preservation of positive labor relationships;
competition, including pricing, within the corporate identity apparel and
facility services industry; and the availability of capital to finance planned
growth. Additional information concerning potential factors that could effect
future financial results is included in the Companys Annual Report on Form
10-K for the fiscal year ended July 3, 2004. 
 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Interest Rate Risk We are subject to market risk exposure related to changes in interest rates.
We use financial instruments, including fixed and variable rate debt, as well
as interest rate swaps to manage interest rate risk. Interest rate swap
agreements are entered into for periods consistent with related underlying
exposures and do not constitute positions independent of those exposures.
Assuming the current level of borrowings, a one percentage point increase in
interest rates under these borrowings would have increased our interest expense
for the first quarter of fiscal 2005 by approximately $0.2 16




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##### Table of Contents



million. This estimated exposure considers the mitigating effects of interest rate swap
agreements outstanding at October 2, 2004 on the change in the cost of variable
rate debt. Foreign Currency Exchange Risk We have a significant foreign subsidiary located in Canada. The assets and
liabilities of this subsidiary are denominated in the Canadian dollar and as
such are translated into U.S. dollars at the exchange rate in effect at the
balance sheet date. Results of operations are translated using the average
exchange rates throughout the period. The effect of exchange rate fluctuations
on translation of assets and liabilities are recorded as a component of
stockholders equity. Gains and losses from foreign currency transactions are
included in results of operations. 
 ITEM 4. CONTROLS AND PROCEDURES Under the supervision and with the participation of our management, including
our chief executive officer and chief financial officer, we conducted an
evaluation of our disclosure controls and procedures, as such term is defined
under Rule 13a-15(e) or Rule 15d-15(e) promulgated under the Securities
Exchange Act of 1934, as amended, as of the end of the period covered by this
Form 10-Q. Based on their evaluation, our chief executive officer and chief
financial officer concluded that the Companys disclosure controls and
procedures are effective. There have been no significant changes (including corrective actions with
regard to significant deficiencies or material weaknesses) in our internal
controls or in other factors that could significantly affect these controls
subsequent to the date of the evaluation referenced above. 17




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##### Table of Contents



PART II OTHER INFORMATION 
 ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES The following table includes information about our share repurchases for the
quarter ended October 2, 2004. Maximum Number(or ApproximateTotal Number of
    
    Dollar Value) ofShares (or Units)
    
    Shares (or Units) thatTotal Number of
    
    Average Price
    
    Purchased as Part of
    
    May Yet beShares (or Units)
    
    Paid per Share
    
    Publicly Announced
    
    Purchased Under thePeriod
    
    Purchased (1)
    
    (or Unit)
    
    Plans or Programs
    
    Plans or ProgramsMonth #2
(Fiscal month
ending September 4,
2004)
    
    
    3,934
    
    
    $
    0.50
    
    
    
    
    
    
    
    
  (1)
    
    All repurchased shares were initially issued under the Employee
Plans as restricted stock grants subject to forfeiture upon termination
of employment. All repurchases were made upon forfeiture of shares by
the recipient of such restricted stock grants. Pursuant to the
Restricted Stock Agreements governing such grants, the repurchase price
for all shares was $0.50, which represents the per share amount paid by
the restricted stock grant recipient on the date of grant. 
 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K  a.
    
    Exhibits  31.1 Certification of Chief Executive Officer pursuant to
Securities Exchange Act Rule 13a-15(e)/15d-15(e) as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.31.2 Certification of Chief Financial Officer pursuant to
Securities Exchange Act Rule 13a-15(e)/15d-15(e) as adopted pursuant
to Section 302 of the Sarbanes-Oxley Act of 2002.32.1 Certification of Chief Executive Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.32.2 Certification of Chief Financial Officer pursuant to 18 U.S.C.
Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002.  b.
    
    Reports filed on Form 8-K  None 18




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SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has caused this report to be signed on its behalf by the
undersigned thereunto duly authorized. G&K SERVICES, INC.
(Registrant)Date: November 5, 2004
    
    
    By:
    
    /s/ Jeffrey L. WrightJeffrey L. WrightSenior Vice President and ChiefFinancial Officer(Principal Financial Officer)By:
    
    /s/ Michael F. WoodardMichael F. WoodardVice President and Controller(Principal Accounting Officer)
 19