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**UNITEDSTATES**

**SECURITIESAND EXCHANGE COMMISSION**

**WASHINGTON, D.C. 20549**

 

**FORM 10-K/A**

**(AmendmentNo. 1)**

** **
| **x** | ** ** | **ANNUAL  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|-------|------------|-------------------------------------------------------------------------------------------|------------|

 

**For the fiscal year ended December 31, 2007**

** **

**OR**

 
| **o** | ** ** | **TRANSITION  REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934** | ** ** |
|-------|------------|-----------------------------------------------------------------------------------------------|------------|

 

**For the transition period from                    to**

 

**COMMISSION FILE NUMBER 1-13495**

 

**MAC-GRAYCORPORATION**

 (Exact name of registrant asspecified in its charter)

 

| **DELAWARE** (State or other jurisdiction incorporation or organization) | ** ** | **04-3361982** (I.R.S. Employer Identification No.) |
|--------------------------------------------------------------------------|------------|-----------------------------------------------------|

 

| **404 WYMAN STREET, SUITE 400  WALTHAM, MASSACHUSETTS** | ** ** | **02451-1212** |
|---------------------------------------------------------|------------|----------------|
| (Address of principal executive offices)                |       | (Zip Code)     |

 

Registrant’s telephone number, including area code: **(781) 487-7600**

 

Securities Registered Pursuant to Section 12(b) of the Act:

 

| **Title of Each Class**                | ** ** | **Name of Each Exchange  On Which Registered** |
|----------------------------------------|------------|------------------------------------------------|
| Common Stock, par value $.01 per share |       | New York Stock Exchange                        |
| Preferred Stock Purchase Rights        |       | New York Stock Exchange                        |

 

Securities Registered Pursuant to Section 12(g) of the Act: **None**

 

Indicateby check mark if the registrant is a well-known seasoned issuer, as defined in Rule405 of the Securities Act. Yes o    No x

 

Indicateby check mark whether the registrant is not required to file reports pursuantto Section 13 or Section 15(d) of the Act. Yes o    No x

 

Indicateby check mark whether the registrant (1) has filed all reports required to befiled by Section 13 or 15(d) of the Securities Exchange Act of 1934 during thepreceding 12 months (or for such shorter period that the registrant wasrequired to file such reports), and (2) has been subject to such filingrequirements for the past 90 days. Yes x    No o

 

Indicateby check mark if disclosure of delinquent filers pursuant to Item 405 ofRegulation S-K is not contained herein, and will not be contained, to the bestof the registrant’s knowledge, in definitive proxy or information statementsincorporated by reference in Part III of this Form 10-K or any amendment tothis Form 10-K.     o

 

Indicateby check mark whether the registrant is a large accelerated filer, anaccelerated filer, a non-accelerated filer, or a smaller reporting company. Seedefinitions of “large accelerated filer,” “accelerated filer” and “smallerreporting company” in Rule 12b-2 of the Exchange Act (Check one):

 

| Large accelerated filer o |   | Accelerated filer x |   | Non-accelerated filer o (Do not check if a smaller  reporting company) |   | Smaller reporting company o |
|--------------------------------|--------|--------------------------|--------|-----------------------------------------------------------------------------|--------|----------------------------------|

 

Indicateby check mark whether the registrant is a shell company (as defined in Rule 12b-2of the Act). Yes o    No x

 

Theaggregate market value of the voting and non-voting stock of the registrantheld by non-affiliates of the registrant as of June 30, 2007 was $131,033,989.

 

Asof March 3, 2008, 13,310,163 shares of common stock of the registrant, parvalue $.01 per share, were outstanding.

 

**DOCUMENTS INCORPORATED BY REFERENCE**

 

Portionsof the Registrants’ Proxy Statement for the Annual Meeting of Stockholders tobe held on May 22, 2008, are incorporated by reference into Items 10, 11, 12,13 and 14 of Part III of this report. Such Proxy Statement shall not be deemedto be “filed” as part of this Annual Report on Form 10-K, except for thoseparts therein which have been specifically incorporated by reference herein.

 

 

 

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**EXPLANATORY NOTE**

 

Mac-GrayCorporation (the “Company”) is filing this Amendment to its Annual Report on Form10-K for the fiscal year ended December 31, 2007, originally filed with theSecurities and Exchange Commission (“SEC”) on March 14, 2008 (the “Original Form10-K”), to (i) amend “Part II — Item 7 — Management’s Discussion and Analysisof Financial Condition and Results of Operations” to expand our disclosureregarding certain non-GAAP measures and (ii) amend “Part II — Item 9A —Controls and Procedures” to add disclosure regarding management’s conclusion onthe effectiveness of our disclosure controls and procedures at December 31,2007.

 

ThisForm 10-K/A also includes new certifications as exhibits 31.1, 31.2 and 32.1 byour principal executive officer and principal financial officer as required by Rules12b-15 and 13a-14 promulgated under the Securities Exchange Act of 1934, asamended.  Except for the amendeddisclosure described above, the information in this Form 10-K/A has not beenupdated to reflect events that occurred after March 14, 2008, the filing dateof the Original Form 10-K.  Accordingly,this Form 10-K/A should be read in conjunction with our filings made with theSEC subsequent to the filing of the Original Form 10-K, including anyamendments to those filings.

 

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**MAC-GRAY CORPORATION**

 

**Annual Report on Form 10-K/A**

 

**Table of Contents**

 
| ** **        | ** **                                                                                                          | **Page**   |
|-------------------|---------------------------------------------------------------------------------------------------------------------|------------|
| ** **        | ** **                                                                                                          | ** ** |
| **Part I**        |                                                                                                                |       |
|              |                                                                                                                |       |
| Item 1.      | Business                                                                                                            | 1          |
|              |                                                                                                                |       |
| Item 1A.     | Risk Factors                                                                                                        | 6          |
|              |                                                                                                                |       |
| Item 1B.     | Unresolved  SEC Staff Comments                                                                                      | 12         |
|              |                                                                                                                |       |
| Item 2.      | Properties                                                                                                          | 12         |
|              |                                                                                                                |       |
| Item 3.      | Legal Proceedings                                                                                                   | 13         |
|              |                                                                                                                |       |
| Item 4.      | Submission  of Matters to a Vote of Security Holders                                                                | 13         |
|              |                                                                                                                |       |
| **Part II**  |                                                                                                                |       |
|              |                                                                                                                |       |
| Item 5.      | Market for  Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases  of Equity Securities | 14         |
|              |                                                                                                                |       |
| Item 6.      | Selected  Financial Data                                                                                            | 15         |
|              |                                                                                                                |       |
| Item 7.      | Management’s  Discussion and Analysis of Financial Condition and Results of Operations                         | 18         |
|              |                                                                                                                |       |
| Item 7A.     | Quantitative  and Qualitative Disclosures About Market Risk                                                         | 38         |
|              |                                                                                                                |       |
| Item 8.      | Financial  Statements and Supplementary Data                                                                        | 40         |
|              |                                                                                                                |       |
| Item 9.      | Changes in  and Disagreements With Accountants on Accounting and Financial Disclosure                               | 40         |
|              |                                                                                                                |       |
| Item 9A.     | Controls and  Procedures                                                                                            | 40         |
|              |                                                                                                                |       |
| Item 9B.     | Other Information                                                                                                   | 41         |
|              |                                                                                                                |       |
| **Part III** |                                                                                                                |       |
|              |                                                                                                                |       |
| Item 10.     | Directors  and Executive Officers of the Registrant                                                                 | 41         |
|              |                                                                                                                |       |
| Item 11.     | Executive  Compensation                                                                                             | 41         |
|              |                                                                                                                |       |
| Item 12.     | Security  Ownership of Certain Beneficial Owners and Management and Related Stockholder  Matters                    | 41         |
|              |                                                                                                                |       |
| Item 13.     | Certain  Relationships and Related Transactions                                                                     | 42         |
|              |                                                                                                                |       |
| Item 14.     | Principal  Accounting Fees and Services                                                                             | 42         |
|              |                                                                                                                |       |
| **Part IV**  |                                                                                                                |       |
|              |                                                                                                                |       |
| Item 15.     | Exhibits,  Financial Statements and Notes to Financial Statements                                                   | 42         |

 

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** **

**PART I**

 

**Forward-Looking Statements**

 

Someof the statements made in this report under the captions “Risk Factors,” “Business,”and “Management’s Discussion and Analysis of Financial Condition and Results ofOperations” and elsewhere in this report or in documents incorporated herein byreference are “forward-looking statements” within the meaning of the PrivateSecurities Litigation Reform Act of 1995. In some cases you can identify thesestatements by forward-looking words such as “anticipate,” “assume,” “believe,” “estimate,”“expect,” “intend,” and other similar expressions. Investors should not rely onforward-looking statements since they involve known and unknown risks,uncertainties and other factors, which are, in some cases, beyond the Company’scontrol and which could materially affect actual results, performance orachievements. Factors that could cause actual results, performance orachievements to differ materially from those expressed or implied by theseforward-looking statements include, without limitation, the factors describedunder Item 1A, “Risk Factors.” Investors should carefully review all of thefactors described therein, which may not be an exhaustive list of the factorsthat could cause these differences.

 

**Item 1.    Business**

 

**Overview**

 

Unlessthe context requires otherwise, all references in this report to “we,” “our,” “Mac-Gray,”the “Company,” or “us” means Mac-Gray Corporation and its subsidiaries andpredecessors.

 

Sinceits founding in 1927, Mac-Gray Corporation has grown to become the secondlargest laundry facilities management contractor in the United States. Throughour portfolio of card- and coin-operated laundry equipment located in laundryfacilities across the country, we provide laundry convenience to residents ofmulti-unit housing such as apartment buildings, condominiums, colleges anduniversity residence halls, and hotels and motels. Based on our ongoing surveyof colleges and universities, we believe that we are the largest provider ofsuch services to the college and university market in the United States.Mac-Gray Corporation was re-incorporated in Delaware in 1997.

 

Wederive our revenue principally as a laundry facilities management contractorfor the multi-unit housing industry. We manage laundry rooms under long-termleases with property owners, colleges and universities and governmentalagencies. We refer to these leases as “laundry leases” or “management contracts”and this business as “laundry facilities management.” In 2007, 81% of ourconsolidated revenue was derived from laundry facilities management. As of December31, 2007, our laundry facilities management business had revenue-generatinglaundry equipment operating in 43 states and the District of Columbia.

 

IntirionCorporation (“Intirion”), which operates our MicroFridge® branded product salesbusiness, derives revenue through the sale and rental of a family of patentedcombination refrigerator/freezer/microwave ovens, or “Units,” and other householdappliances to colleges and universities, military bases, the hotel and motelmarket, and assisted living facilities. Intirion also derives revenue throughthe sale of commercial laundry equipment to the United States military and isalso a national distributor of Whirlpool Corporation’s Maytag®, Amana®, MagicChef®, KitchenAid®, Estate® and Whirlpool® brands of appliances using the brandname “Maytag Direct®.”

 

Ourlaundry equipment sales unit sells and services commercial laundry equipmentmanufactured by Whirlpool Corporation, Dexter Laundry Company, American DryerCorporation and Primus Laundry Company. This business unit sells commerciallaundry equipment to retail laundromats, restaurants, hotels, health clubs andsimilar institutional users that operate their own on-premise laundryfacilities. We refer to this business as our “commercial laundry equipmentsales business.”

 

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Ourreprographics business unit (“Copico”) derives its revenue principally throughmanaging college and municipal libraries’ vended reprographic equipment, withoperations concentrated in the Northeast United States. In the fourth quarterof 2006, the Company incurred an impairment charge for the write-off of asignificant portion of the assets associated with the operations of thisbusiness unit.

 

***Segment Information***

 

Thefollowing is a discussion of each of our reportable business segments: (i) FacilitiesManagement and (ii) Product Sales. Financial information with regard to eachbusiness segment is reported in Note 15 to the Company’s consolidated financialstatements included in this report.

 

**Facilities Management Segment**

 

Mac-Gray’sfacilities management segment includes both our laundry facilities managementbusiness and reprographics facilities management business. For the years ended December31, 2006 and 2007, our facilities management segment accounted forapproximately 83% and 82% of our total revenue, respectively, and 82% and 77%of our gross margin, respectively for each year.

 

***Laundry Facilities Management Business***

 

Throughour facilities management segment, we act as a laundry facilities managementcontractor with property owners or managers. Mac-Gray leases space within aproperty, in some instances improves the leased space with flooring, ceilingsand other improvements (“betterments”) and then installs and services thelaundry equipment and collects the payments. The property owner or manager isusually responsible for maintaining, cleaning, and securing of the premises andpayment of utilities. Under our long-term leases, we typically receive theexclusive right to provide and service laundry equipment within a multi-unit housingproperty in exchange for a negotiated percentage of the total revenuecollected. We refer to this percentage as “facilities management rent.” Duringthe past five years, we have retained approximately 97% of our equipment baseper year. Our gross additions to our equipment base for each of the years endedDecember 31, 2006 and 2007 through internally generated growth has equaled 4%.Our additions, net of lost business, has equaled 1% for each of the years endedDecember 31, 2006 and 2007. The machine base not retained is attributable tocontracts lost to competitors, contracts the Company has chosen not to renewdue to unacceptable margins, including some acquired contracts that did notmeet our performance criteria and condominium conversions. Mac-Gray believesthat its ability to retain its existing equipment base and grow it throughinternally generated growth in equipment installations is indicative of itsservice of, and attention to, property owners and managers. The Company alsoprovides its customers with proprietary technologies such as LaundryViewTM andLaundryLinxTM and continues to invest in research and development of suchtechnologies. We generally have the ability to set and adjust the vend pricingfor our equipment based upon local market conditions.

 

Mac-Grayhas centralized its administrative and marketing operations at its corporateheadquarters in Waltham, Massachusetts. Mac-Gray also operates sales and/orservice centers in Arizona (two locations), Colorado, Connecticut, Florida (twolocations), Georgia, Illinois, Louisiana, Maine, Maryland, Massachusetts (twolocations), New Jersey, New Mexico, New York (two locations), North Carolina,Oregon, Tennessee, Texas (three locations), Utah, Virginia, and Washington.

 

Mac-Grayalso generates revenue by leasing equipment to commercial laundry customers whochoose neither to purchase equipment nor to become a laundry facilitiesmanagement customer, but instead wish to maintain their own laundry rooms. Thisleasing business generated revenue of $4.0 million and $4.5 million for theyears ended December 31, 2006 and 2007, respectively, and is included in thelaundry facilities management business unit.

 

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Mac-Gray’slaundry facilities management business has certain intrinsic characteristics inboth its industry and its customer base, including the following:

 

*Revenue.    *Mac-Gray operates as a laundry facilitiesmanagement contractor under long-term leases and other arrangements withproperty owners or managers. Mac-Gray’s efforts are designed to maintain thesecustomer relationships over the long-term. Our typical leases have an originalaverage term of approximately seven years, with an option to renew if mutuallyagreed upon by us and the owner or manager. In each of the past five years, wehave retained contracts representing approximately 97% of our equipment baseper year.

 

*Customers.*    As of February 1, 2008, Mac-Gray providedlaundry equipment and related services to approximately 69,000 laundry roomslocated in 43 states throughout the continental United States and The Districtof Columbia. As of February 1, 2008, no customer contract accounted for morethan 1% of Mac-Gray’s laundry facilities management revenue. Mac-Gray servescustomers in multi-unit housing facilities, including apartment buildings,college and university residence halls, condominiums and public-housingcomplexes.

 

*Seasonality.*    The Company experiences moderate seasonality asa result of its operations in the college and university market. Revenuesderived from the college and university market represented approximately 15% ofthe laundry facilities management revenue for 2007. Academic facilitiesmanagement revenues are derived substantially during the school year in thefirst, second and fourth calendar quarters. Conversely, during the thirdcalendar quarter when most colleges and universities are not in session, theCompany increases its operating and capital expenditures when it has itsgreatest product installation activities. Product sales, principally ofMicroFridge® branded products, to this market are typically higher during thethird calendar quarter as compared to the rest of the calendar year, somewhatoffsetting the seasonality effect of the laundry facilities management businessunit.

 

*Competition.*    The laundry facilities management industry ishighly competitive, capital intensive and requires the delivery of reliable andprompt services to customers. Mac-Gray believes that customers consider anumber of factors in selecting a laundry facilities management contractor, suchas customer service, reputation, facilities management rent rates (includingincentives), advance rents, range of products and services, and technology.Mac-Gray believes that different types of customers assign varied weight toeach of these factors and that no one factor alone determines a customer’sselection of a laundry facilities management contractor. Within any givengeographic area, Mac-Gray may compete with local independent operators,regional and multi-regional operators. The industry is highly fragmented;consequently, Mac-Gray has grown by acquisitions, as well as through newequipment placement. Mac-Gray believes that it is the second largest laundryfacilities management contractor in North America.

 

*Impact of Occupancy Rates.*    The Company’s laundryfacilities management revenue is affected by multi-unit housing occupancyrates. Occupancy rates in the multi-unit housing industry are affected byseveral factors. These factors include local economic conditions, localemployment levels, mortgage interest rates as they relate to first-timehomebuyers, and the supply of apartments in specific markets. The Company issomewhat protected from revenue decreases caused by declining occupancy ratesdue to the variation of markets served, the various types of multi-unit housingfacilities therein, and the percentage of revenue derived from colleges anduniversities. The Company monitors independent market research data regardingtrends in occupancy rates in its markets to better understand laundryfacilities revenue trends and variations.

 

*Suppliers.*    The Company currently purchases substantially allof the equipment that it uses in its laundry facilities management businessfrom Whirlpool Corporation (“Whirlpool”). In addition, the Company derives aportion of its revenue, as well as certain competitive advantages, from itsposition as a distributor of Whirlpool manufactured appliances. The Company hasmaintained a relationship

 

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withWhirlpool and its predecessor, Maytag Corporation, since 1927. Either partyupon written notice may terminate the purchase and distribution agreementsbetween the Company and Whirlpool. A termination of, or substantial revision ofthe terms of, the contractual arrangements or business relationships withWhirlpool could have a material adverse effect on the Company’s business,results of operations, financial condition and prospects.

 

***Reprographics Facilities ManagementBusiness***

 

Ourreprographics facilities management business unit, operating as Copico, is aprovider of card- and coin-operated reprographics equipment and services to theacademic and public library markets in the Northeast, and to a lesser extent inthe Mid-Atlantic and the Midwest regions of the United States. Copico providesand services copiers and laser printers for the libraries of colleges,universities, graduate schools and public libraries. Copico represented lessthan 1% of the Company’s consolidated revenue in 2007.

 

Copico’srevenue and corresponding operating income have been declining since 1999 whencollege libraries, followed by public libraries, began to make referencematerial available to patrons electronically. Electronic availability,widespread conversion to laser printers (free of charge in many schoollibraries) and other technical advancements have led to reduced use of vendedcopy machines resulting in reduced revenue at several accounts. As a result, in2006 the Company recorded a pre-tax impairment charge of $2.5 million to writedown the value of the reprographics business unit to its net realizable value.Copico continues to serve its customer base but is not actively seeking toexpand the business.

 

**Product Sales Segment**

 

Mac-Gray’sproduct sales segment includes both Intirion and commercial laundry equipmentsales. For the years ended December 31, 2006 and 2007, our product salessegment accounted for approximately 17% and 18% of our total revenue,respectively, and 18% and 23% of our gross margin, respectively.

 

***Intirion Sales Business***

 

*Revenue.*    Our Intirion business unit consists of supplyingcombination refrigerator/ freezer/microwave ovens (“Units”) to multi-unithousing facilities such as military bases, hotels, motels, colleges anduniversities and assisted living facilities under the brand names MicroFridge®and SnackMateTM. The Intirion business unit revenue also includes sales ofcommercial laundry equipment to military installations. The Intirion businessunit is a national distributor of Whirlpool’s Maytag®, Amana® Magic Chef®, KitchenAid®,Estate® and Whirlpool® brands of appliances using Maytag Direct® as our brandname. For the years ended December 31, 2006 and 2007, our Intirion businessunit accounted for approximately 11% of our total revenue for each year.

 

*Products.*    The MicroFridge® branded product line with SafePlugTM is a family of combination refrigerator/freezer/microwave ovens. TheUnits’ circuitry has proven to be an important feature for those customers whohave concerns about electrical capacity and seek a safer alternative to hotplates and other cooking or heating appliances. Sales efforts behind theMicroFridge® branded product have been focused on such “home-away-from-home”markets as military bases, hotels, motels, colleges and universities andassisted living facilities.

 

Mac-Graybelieves that the product line carrying the MicroFridge® brand enhances theCompany’s ability to provide multiple amenities to both its current customerbase as well as future customers seeking one source to fill multiple needs.

 

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*Customers.*    The Intirion business unit revenue is derivedfrom both the sale and rental of products carrying the MicroFridge® andSnackMateTM brands. In 2007, the largest market was government living,consisting principally of military bases. In this market, the MicroFridge®branded product line is available through government contracts with variousgovernmental agencies. MicroFridge® branded units have been installed at morethan 200 United States government facilities throughout the world. The secondlargest market was the hospitality lodging industry and assisted living marketthroughout the United States, to which we sell both directly and through anindependent dealer network. MicroFridge® branded units are also sold and leasedto the academic living market. The academic living market is composed of morethan 1,800 colleges and universities across the United States that haveon-campus residence halls. The MicroFridge® brands’ presence in this marketprovides our sales staff with the opportunity to cross sell the Company’slaundry facility management services and refrigerator/microwave product line.

 

*Competition.*    In addition to large direct sellers, theIntirion business unit also competes with major retail stores and local andregional distributors who sell various brand-name compact refrigerators as wellas microwave ovens to the markets where the MicroFridge® brand has a presence.Although we jointly hold a patent on combination units utilizing internalcircuitry, there has been continuing competition from “similar look” productsutilizing an external circuitry control mechanism. There also exists local andregional competition in the combination appliance rental business. Managementbelieves that its brand equity gained from being the first entrant in themarket enables it to compete effectively against new entrants in thecombination appliance business. Principal competitors for MicroFridge® brandedproducts include Absocold, Avanti, General Electric, Sears, Tatung, Home Depot,Lowe’s, Wal-Mart, and several companies focused on the college rentalmarketplace.

 

*Suppliers.*    The Intirion business unit maintains originalequipment manufacturer, or “OEM,” arrangements with two primary manufacturers:Sanyo E&E Corporation (“Sanyo”), and Nisshin Industry Co. Ltd. Theprincipal patent underlying the MicroFridge® branded product is held jointly bySanyo and us. The patented circuitry of the MicroFridge® branded units ismarketed under the trade name Safe Plug®.

 

***Commercial Laundry Equipment Sales andServices Business***

 

Throughits commercial equipment sales and services business, Mac-Gray is a significantdistributor for several commercial laundry equipment manufacturers, primarilyWhirlpool. Mac-Gray does not manufacture any of the commercial laundryequipment that it sells. As an equipment distributor, Mac-Gray sells commerciallaundry equipment to public retail laundromats, as well as to the multi-unithousing industry. In addition, Mac-Gray sells commercial laundry equipmentdirectly to institutional purchasers, including hospitals, restaurants, andhotels, for use in their own on-premise laundry facilities. Mac-Gray iscertified by the manufacturers to service the commercial laundry equipment thatit sells. Installation and repair services are provided on an occurrence basis,not on a contractual basis. Related revenue is recognized at the time theinstallation service, or other service, is provided to the customer. For theyears ended December 31, 2006 and 2007, our laundry equipment sales businessunit accounted for approximately 6% and 7%, respectively, of our total revenue.

 

**Employee Base**

 

Asof February 1, 2008, the Company employed 831 full-time employees. No employeeis covered by a collective bargaining agreement and the Company believes thatits relationship with its employees is good.

 

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**Operating Characteristics**

 

TheCompany maintains a corporate staff as well as centralized finance, humanresources, legal services, information technology and marketing departments.Regionally, the Company maintains service centers and warehouses staffed bylocal management, service technicians, collectors, customer servicerepresentatives and inventory handlers. These facilities service the FacilitiesManagement segment as well as commercial laundry equipment sales.

 

TheFacilities Management segment’s sales and marketing efforts are conductedprimarily by employees of the Company. Outside service providers are usedperiodically for various matters, including equipment installation. The ProductSales segment uses an internal sales force and independent distributors inparts of the United States where business opportunities do not warrant a directsales force.

 

**Backlog**

 

Dueto the nature of the Company’s laundry facilities management business, backlogsdo not exist. There is no significant backlog of orders in the Company’s twosales businesses.

 

**Contact Information**

 

TheCompany files its annual report on Form 10-K, quarterly reports on Form 10-Q,and current reports on Form 8-K with the Securities and Exchange Commission, or“SEC.” Company reports filed with the SEC are available at the SEC’s website atwww.sec.gov and the Company’s website at www.macgray.com. The informationcontained on our website is not included as a part of, or incorporated byreference into, this annual report on Form 10-K/A.

 

TheCompany’s corporate offices are located at 404 Wyman Street, Suite 400,Waltham, Massachusetts, 02451-1212. The Company’s telephone number is (781) 487-7600,its fax number is (781) 487-7606, and its email address for investor relationsis ir@macgray.com.

 

**Item 1A.    Risk Factors**

 

Thisannual report on Form 10-K/A contains statements which are not historical factsand are considered forward-looking within the meaning of the Private SecuritiesLitigation Reform Act of 1995. These forward-looking statements containprojections of the Company’s future results of operations or financial positionor state other forward-looking information. In some cases you can identify thesestatements by forward-looking words such as “anticipate,” “believe,” “could,”“estimate,” “expect,” “intend,” “may,” “should,” “will” and “would” or similarwords. You should not rely on forward-looking statements, because they involveknown and unknown risks, uncertainties and other factors, some of which arebeyond the Company’s control. These risks, uncertainties and other factors maycause the Company’s actual results, performance or achievements to differmaterially from the anticipated future results, performance or achievementsexpressed or implied by the forward-looking statements. Some of the factorsthat might cause these differences are as follows:

 

**If we are unable to establish new laundry facility leases,renew our existing laundry facility leases or retain relationships with ourcustomers who are not subject to leases, our business, results of operations,cash flows and financial condition could be adversely affected.**

 

Ourlaundry facilities management business unit, which provided 81% of our totalrevenue for the year ended December 31, 2007, is highly dependent upon therenewal of leases with property owners and property management companies.Leases that we have entered into or renewed since 2001 provide for an averageinitial term of seven years. Approximately 10% to 15% of our leases are up forrenewal each year. We have traditionally relied upon exclusive, long-termleases with our customers, as well as

 

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frequentcustomer interaction and an emphasis on customer service, to assure continuityof financial and operating results. We cannot guarantee that in the future wewill be able to establish long-term leases with new customers or renew existinglong-term leases as they expire on favorable terms, or at all.

 

Failureby us to continue to establish long-term leases with new customers, or tosuccessfully renew existing long-term leases as they expire, could have amaterial adverse effect on our business, results of operations, cash flows andfinancial condition. Further, approximately 10% of our customers are notsubject to leases, are subject to short-term leases of less than one yearremaining, or have the right to terminate their lease with us at their option.Failure to retain these customers could have a material adverse effect on ourbusiness, results of operations, cash flows and financial condition.

 

**We face strong competition in the outsourced laundryfacilities management industry.**

 

Theoutsourced laundry facilities management industry is highly competitive, and wecompete for long-term leases, both locally and nationally, with property ownersand other operators in the industry. We compete based on customer service,reputation, facilities management rent rates, incentive payments and a range ofproducts and services. Smaller local and regional operators typically havelong-standing relationships with property owners and managers in their specificgeographic market. As such, we may have difficulty penetrating such markets, asproperty owners and managers may be resistant to terminating such long-standingrelationships. We also compete with property owners, as there is no guaranteethat property owners will continue to outsource their laundry facilitiesmanagement to operators. There is one competitor in the industry, CoinmachCorporation, with a larger installed equipment base than us. Competition in theindustry may make it more difficult and more expensive to consummateacquisitions in the future and to maintain and expand our installed equipmentbase. In addition, some of our competitors may have less indebtedness than wedo, and therefore more of their cash is potentially available for business purposesother than debt service. We cannot assure you that our results of operations,cash flows or financial condition will not be materially and adversely affectedby competition, or that we will be able to maintain our profitability if thecompetitive environment changes.

 

**Our cash flows may not be sufficient to finance thesignificant capital expenditures required to replace equipment, implement newtechnology, or make incentive payments to property managers.**

 

Wemust continue to make capital expenditures in order to maintain and replace ourinstalled equipment base and implement new technology in our equipment. We mustalso make incentive payments to some property managers in order to secure newlaundry leases and renew existing laundry leases. We cannot assure you that ourresources or cash flows will be sufficient to finance anticipated capitalexpenditures and incentive payments for at least the next year. To the extentthat available resources are insufficient to fund our capital needs, we may needto raise additional funds through public or private financings or curtailcertain expenditures. These financings may not be available on favorable terms,or at all, and, in the case of equity financings, could result in dilution tostockholders. If we cannot maintain or replace our equipment as we require orimplement our new technologies, our results of operations, cash flows andfinancial condition could be materially and adversely affected.

 

**If we are unable to continue our relationships with WhirlpoolCorporation and other equipment suppliers, our revenues could be reduced, andour ability to meet customer requirements could be materially and adverselyaffected.**

 

Wepurchase substantially all of the equipment that we use in our laundryfacilities management business unit from Whirlpool. In addition, we derive asignificant amount of our product sales revenue from our position as adistributor of Whirlpool commercial laundry products. We cannot assure you thatWhirlpool will continue its relationship with us. If Whirlpool terminates itsrelationship with us,

 

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ourresults of operations, cash flows and financial condition could be materiallyand adversely affected, and further, we may be unable to replace ourrelationship with Whirlpool with a comparable company on favorable terms, or atall. Whirlpool became our largest supplier of laundry equipment following itsacquisition of Maytag Corporation in March 2006. There have been no significantchanges in our relationship with Whirlpool as a result of the acquisition.

 

Inaddition, we currently obtain the products used by our MicroFridge® brandedbusiness from two suppliers. If either of these suppliers terminates or demandsa substantial revision of the contracts or business relationships currently inplace, we may be unable to find a replacement in a timely manner, on favorableterms, or at all, which could have a material adverse affect on our results ofoperations and our ability to meet customer demands.

 

**A decrease in multi-unit housing sector occupancy rates inthe markets in which we conduct business could adversely affect our facilitiesmanagement revenue.**

 

Ourfacilities management revenue from our operation of card- and coin-operatedlaundry equipment, particularly in the multi-unit housing sector, dependspartially upon the level of tenant occupancy. The number of apartments occupiedin an apartment building with a vended laundry facility directly affects ourrevenue. Extended periods of reduced occupancy in our clients’ buildings couldadversely affect our operations. The level of occupancy can be adverselyaffected by many market and general economic conditions, all of which arebeyond our control, including:

 

·**local economicrecessions and increases in the unemployment rate;

 

·**mortgage interestrates as they apply to first-time homebuyers;

 

·**oversupply ofapartments; and

 

·**conversion ofapartment units to condominiums with in-unit laundry hookups.

 

**If we are unable to comply with our debt service requirementsunder existing or future indebtedness, our indebtedness could become payableimmediately.**

 

Ourcurrent financing agreements require us to meet certain financial covenants. Ifwe are unable to meet those requirements, our indebtedness could becomeimmediately due and payable. If our debt were accelerated we would need torefinance or restructure our debt agreement as our current cash flow would beinadequate to retire our debt, which we may not be able to consummate oncommercially reasonable terms, or at all.

 

**If we are unable to access capital on acceptable financialterms, our ability to consummate acquisitions will be limited.**

 

Thesuccess of our long-term growth strategy is partially dependent upon ourability to identify, finance and consummate acquisitions on acceptablefinancial terms. Access to capital is subject to the following risks:

 

·**use of common stockas acquisition consideration may result in dilution to stockholders;

 

·**if our common stockdoes not maintain a sufficient valuation or if potential acquisition candidatesare unwilling to accept shares of our common stock, then we would be requiredto increase our use of cash resources or other consideration to consummateacquisitions;

 

·**if we are unable togenerate sufficient cash for acquisitions from existing operations, we will notbe able to consummate acquisitions unless we are able to obtain additionalcapital through external financings, which we may not be able to consummate oncommercially reasonable terms, or at all;

 

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·**funding futureacquisitions through debt financings would result in additional leverage; and

 

·**the agreementsgoverning our indebtedness include significant limitations on our ability toborrow money for acquisitions and other purposes and, as a result, we may notbe able to take advantage of acquisition opportunities.

 

**We may have difficulties integrating future acquisitions intoour business.**

 

Wehave in the past, and intend to in the future, engage in acquisitions tocontinue the expansion of our laundry facilities management business unit. Thefailure to successfully complete the integration of any acquisition wouldadversely affect our business and results of operations.

 

Anyfuture acquisitions could involve numerous risks, including:

 

·**potential disruptionof our ongoing business and distraction of management;

 

·**difficultyintegrating the operations of the acquired businesses;

 

·**unanticipatedexpenses related to equipment, maintenance and technology integration;

 

·**exposure to unknownliabilities, including litigation against the companies that we may acquire;

 

·**additional costs dueto entering new geographic locations and duplication of key talent;

 

·**potential loss ofkey employees or customers of the acquired businesses;

 

·**the inability toachieve anticipated synergies or increase the revenue and profit of theacquired business; and

 

·**the expenditure of adisproportionate amount of money and time integrating acquired businesses,particularly operations located in new geographic regions and operationsinvolving new lines of business.

 

Wemay not be successful in addressing these risks or any other problemsencountered in connection with any acquisitions.

 

**Our internal controls over financial reporting may not beadequate and our independent auditors may not be able to certify as to theiradequacy, which could have a significant and adverse effect on our business andreputation.**

 

Section404 of the Sarbanes-Oxley Act of 2002 requires a reporting company such as oursto, among other things, annually review and disclose its internal controls overfinancial reporting, and evaluate and disclose changes in its internal controlsover financial reporting quarterly. If we are not able to achieve and maintainadequate compliance, or our independent auditors are not able to certify as tothe effectiveness of our internal control over financial reporting, we may besubject to sanctions or investigation by regulatory authorities, such as theSEC. As a result, there could be an adverse reaction in the financial marketsdue to a loss of confidence in the reliability of our financial statements. Inaddition, we may be required to incur costs in improving our internal controlsystem and the hiring of additional personnel. Any such action could adverselyaffect our results of operations and financial condition.

 

**Our Intirion products may be susceptible to product liabilityclaims for which our current levels of insurance coverage may not be adequate.**

 

Throughour Intirion business, we market and distribute combinationrefrigerator/freezer/ microwave oven units under the brand names MicroFridge®,SnackMateTM and Intelli-VaultTM. The sale and distribution of Intirion products,as well as other products, entails a risk of product liability claims. AlthoughMicroFridge®, SnackMateTM and Intelli-VaultTM branded units are manufactured bythird

 

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partiesunder contract with us, we may still be subject to risks of product liabilityclaims related to these units. Potential product liability claims may exceedthe amount of our product liability insurance coverage or may be excluded fromthat coverage. We cannot assure you that we will be able to renew our existingproduct liability insurance at a cost and level of coverage comparable to thatcurrently in place, if at all. In the event that our Intirion business is heldliable for a claim for which it is not indemnified or for damages exceeding thelimits of available product liability insurance coverage, the claim could havea material adverse effect on our business, results of operations and financialcondition.

 

**Inability to protect our trademarks and other proprietaryrights could adversely impact our competitive position.**

 

Werely on patents, copyrights, trademarks, trade secrets, confidentialityprovisions and employee and third party non-disclosure and non-solicitationagreements to establish and protect our intellectual property and proprietaryrights. We cannot be certain that steps we have taken to protect ourintellectual property and proprietary rights will be adequate or that thirdparties will not infringe or misappropriate any of our intellectual property orproprietary rights. While we have periodically made filings with the U.S.Patent and Trademark Office, we have traditionally relied upon the protectionsafforded by contract rights and common law ownership rights, and we cannotassure you that these contract rights and common law ownership rights willadequately protect our intellectual property and proprietary rights. Anyinfringement or misappropriation of our intellectual property and proprietaryrights could damage their value and could have a material adverse effect on ourbusiness, results of operations and financial condition. We may have to engagein litigation to protect our rights to our intellectual property andproprietary rights, which could result in significant litigation expenses andrequire a significant amount of management’s time.

 

Weown or license several registered and unregistered trademarks, includingMac-Gray®, Web®, Hof®, MicroFridge®, Intelligent LaundryTM, LaundryViewTM,LaundryLinxTM, PrecisionWashTM, TechLinxTM, VentSnakeTM, Intelli-VaultTM, SnackMateTM,LaundryAuditTM and e-issuesTM that we use in the marketing and sale of ourproducts. However, the degree of protection that these trademarks afford us isunknown and these trademarks may expire or be terminated. In the event thatsomeone infringes on or misappropriates our trademarks, the brand images andreputation that we have developed could be damaged, which could have a materialadverse effect on our business, results of operations and financial condition.

 

**We are dependent on key personnel, and the loss of any of ourkey personnel could have a material adverse effect on our business, results ofoperations and financial condition.**

 

Ourcontinued success will depend largely on the efforts and abilities of ourexecutive officers, management teams and other key employees. The loss of anyof these officers or other key employees could result in inefficiencies in ouroperations, lost business opportunities or the loss of one or more customers.

 

**Our financial results have been and could further be negativelyimpacted by impairments of goodwill or other intangible assets required by SFAS142 and the application of future accounting policies or interpretations ofexisting accounting policies.**

 

Inaccordance with Statement of Financial Accounting Standards No. 142,*Goodwill and Other Intangible Assets*referred to as “SFAS 142,” we perform an annual assessment on goodwill andother intangible assets for impairment and also an assessment if an eventoccurs or circumstances change that would more likely than not reduce the fairvalue of a reporting unit below it’s carrying amount. See Note 2 to theconsolidated financial statements and Item 7, “Management’s Discussion andAnalysis of Financial Condition and Results of Operations—Critical AccountingPolicies and Estimates” in this Form 10-K/A.

 

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Adownward revision in the fair value of one of our reporting units could resultin additional impairments of goodwill under SFAS 142 and additional non-cashcharges. Any charge resulting from the application of SFAS 142 could have asignificant negative effect on our reported net loss. In addition, ourfinancial results could be negatively impacted by the application of existingand future accounting policies or interpretations of existing accountingpolicies, any continuing impact of SFAS 142 or any negative impact relating tothe application of Statement of Financial Accounting Standards No. 144,*Accounting for the Improvement and Disposal ofLong-Lived Assets* .

 

**We face risks associated with environmental regulation.**

 

Ourbusinesses and operations are subject to federal, state and local environmentallaws and regulations, including those governing the discharge of pollutants,the handling, generation, storage and disposal of hazardous materials,substances and wastes and the cleanup of contaminated sites. In connection withcurrent or historical operations by us or at our sites, we could incursubstantial costs, including clean-up costs, fines and civil or criminalsanctions, and third-party claims for property damage or personal injury, as aresult of violations of, or liabilities under, environmental laws andregulations. While we are not aware of any existing or potential environmentalclaims against us that are likely to have a material adverse effect on ourbusiness or financial condition, we cannot guarantee you that we will not inthe future incur liability or other costs under environmental laws andregulations that could have a material adverse effect on our business orfinancial condition.

 

**We are controlled by a concentrated group of stockholders,whose interests could be in conflict with yours.**

 

Asof December 31, 2007, our directors, executive officers, and certain of ourstockholders related to such persons and their affiliates beneficially owned inthe aggregate approximately 33.2% of the outstanding shares of our common stock(See Item 12, “Security Ownership of Certain Beneficial Owners and Managementand Related Stockholders Matters” below). This percentage ownership does notinclude options to purchase 691,654 shares of our common stock held by some ofthese persons, which options were exercisable at, or within 60 days subsequentto, December 31, 2007. If all of these options had been exercised as of December31, 2007, then these stockholders and their affiliates would have beneficiallyowned 38.4% of the outstanding shares of our common stock. Additionally, wehave entered into a stockholders’ agreement, dated June 26, 1997, with some ofthese stockholders that gives them rights of first offer to purchase shares ofour common stock offered for sale by another stockholder party thereto (SeeItem 13, “Certain Relationships and Related Transactions below). As a result ofthis concentration in ownership, these stockholders, acting together, have theability to significantly influence the outcome of the election of directors andall other matters requiring approval by a majority of stockholders.Circumstances may arise in which the interests of this group of stockholderscould be in conflict with interests of other stockholders.

 

**Provisions in our charter and bylaws, Delaware law, and theshareholders agreement could have the effect of discouraging takeovers.**

 

Specificprovisions of our charter and bylaws, as described below and in Footnote 14 tothe Consolidated Financial Statements; sections of the corporate law ofDelaware; the shareholder agreement, and powers of our Board of Directors maydiscourage takeover attempts not first approved by the Board of Directors,including takeovers which some stockholders may deem to be in their bestinterests. These provisions and powers of the Board of Directors could delay orprevent the removal of incumbent directors or the assumption of control bystockholders, even if the particular removal or assumption of control would bebeneficial to stockholders. These provisions and powers of the Board ofDirectors could also discourage or make more difficult a merger, tender offeror proxy contest, even

 

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ifthese events would be beneficial, in the short term, to the interests of someshareholders. The anti-takeover provisions and powers of the Board of Directorsinclude, among other things:

 

·**the ability of ourBoard of Directors to issue shares of preferred stock and to establish thevoting rights, preferences and other terms of such preferred stock;

 

·**a classified Boardof Directors serving staggered three-year terms;

 

·**the elimination ofstockholder voting by written consent;

 

·**the absence ofcumulative voting for directors;

 

·**the removal ofdirectors only for cause;

 

·**the vesting ofexclusive authority in our Board of Directors to determine the size of theBoard of Directors and, subject to the rights of holders of any series ofpreferred stock, if issued, to fill vacancies thereon;

 

·**the vesting ofexclusive authority in our Board of Directors, except as otherwise required bylaw, to call special meetings of stockholders;

 

·**advance noticerequirements for stockholder proposals and nominations for election to theBoard of Directors;

 

·**ownership restrictions,under the corporate law of Delaware, with limited exceptions, upon acquirersincluding their affiliates and associates of 15% or more of its common stock;and

 

·**our entry into ashareholder rights agreement providing for the issuance of rights that willcause substantial dilution to a person or group of persons that acquires 15% ormore of the common shares unless the rights are redeemed.

 

**Item 1B.    Unresolved SECStaff Comments**

 

None.

 

**Item 2.    Properties**

 

Mac-Grayrents approximately 32,000 square feet in Waltham, Massachusetts that it usesas its corporate headquarters and which houses the Company’s administrative andcentral services. Mac-Gray owns a sales and service facility in Tampa, Floridaconsisting of approximately 12,000 square feet. At December 31, 2007, Mac-Grayleased the following regional facilities, which are largely operated as salesand service facilities, although limited administrative functions are alsoperformed at many of them:

 
| **Location**                | ** ** | **Approximate  Square  Footage** | ** ** | **Annual  Rental  Rate** | ** ** | **Expiration  Date** | ** ** |
|-----------------------------|------------|----------------------------------|------------|--------------------------|------------|----------------------|------------|
| Albuquerque, New  Mexico    |       | 6,600                            |       | $                        | 48,392     |                 | 4/2009     |   |
| Auburn,  Washington         |       | 7,253                            |       | 53,400                   |       | 4/2009               |       |
| Beltsville,  Maryland       |       | 22,432                           |       | 179,456                  |       | 8/2012               |       |
| Buda, Texas                 |       | 7,000                            |       | 46,200                   |       | 1/2009               |       |
| Buffalo, New  York          |       | 10,000                           |       | 37,800                   |       | 9/2008               |       |
| Charlotte, North  Carolina  |       | 10,640                           |       | 52,348                   |       | 3/2008               |       |
| College Station,  Texas     |       | 1,250                            |       | 6,900                    |       | 12/2008              |       |
| Deerfield Beach,  Florida   |       | 8,300                            |       | 97,147                   |       | 5/2010               |       |
| Denver, Colorado            |       | 5,000                            |       | 30,521                   |       | 9/2010               |       |
| East Brunswick,  New Jersey |       | 9,600                            |       | 63,168                   |       | 7/2010               |       |
|                             |            |                                  |            |                          |            |                      |            |  |

 

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| East Hartford,  Connecticut |   | 14,900 |   | 66,992  |   | 5/2013  |   |
|-----------------------------|--------|--------|--------|---------|--------|---------|--------|
| Eugene, Oregon              |   | 2,500  |   | 24,800  |   | 6/2008  |   |
| Euless, Texas               |   | 10,000 |   | 47,740  |   | 4/2009  |   |
| Gurnee, Illinois            |   | 22,521 |   | 138,536 |   | 4/2011  |   |
| Gurnee, Illinois            |   | 12,000 |   | 67,870  |   | 7/2011  |   |
| Hendersonville,  Tennessee  |   | 11,000 |   | 52,536  |   | 4/2008  |   |
| Houston, Texas              |   | 10,687 |   | 43,603  |   | 10/2010 |   |
| Jessup, Maryland            |   | 10,361 |   | 65,580  |   | 3/2012  |   |
| Lake City,  Florida         |   | 1,125  |   | 9,000   |   | 4/2010  |   |
| Lithia Springs,  Georgia    |   | 10,675 |   | 59,606  |   | 2/2011  |   |
| Metairie,  Louisiana        |   | 4,000  |   | 48,392  |   | 4/2009  |   |
| Oklahoma City,  Oklahoma    |   | 2,250  |   | 11,700  |   | 11/2010 |   |
| Orlando, Florida            |   | 2,100  |   | 21,600  |   | 12/2008 |   |
| Phoenix, Arizona            |   | 25,920 |   | 112,704 |   | 4/2009  |   |
| Portland, Oregon            |   | 10,000 |   | 64,950  |   | 3/2011  |   |
| Salt Lake City,  Utah       |   | 4,750  |   | 25,380  |   | 6/2008  |   |
| Syracuse, New  York         |   | 8,400  |   | 46,200  |   | 10/2008 |   |
| Tucson, Arizona             |   | 4,676  |   | 39,648  |   | 4/2009  |   |
| Virginia Beach,  Virginia   |   | 3,800  |   | 25,800  |   | 7/2008  |   |
| Walpole,  Massachusetts     |   | 19,000 |   | 151,920 |   | 5/2011  |   |
| Waltham,  Massachusetts     |   | 32,000 |   | 941,952 |   | 11/2015 |   |
| Westbrook, Maine            |   | 5,625  |   | 39,375  |   | 7/2011  |   |
| Woburn,  Massachusetts      |   | 40,000 |   | 206,667 |   | 2/2016  |   |

 

Allproperties are primarily utilized for the laundry facilities managementbusiness except for the Walpole, Massachusetts facility, which is utilized byboth the Product Sales segment and Copico. The Product Sales segment alsoleases space at public warehouses, where rent is based on handling and thenumber of Units stored.

 

Mac-Graybelieves that its properties are generally well maintained and in goodcondition. Mac-Gray believes that its properties are adequate for present needsand that suitable additional or replacement space will be available asrequired.

 

**Item 3.    Legal Proceedings**

 

Fromtime to time, Mac-Gray is a party to litigation arising in the ordinary courseof business. There can be no assurance that Mac-Gray’s insurance coverage willbe adequate to cover any liabilities resulting from such litigation. In theopinion of management, any liability that Mac-Gray might incur upon theresolution of currently pending litigation will not, individually or in theaggregate, have a material adverse effect on our business, financial condition,results of operations or cash flows.

 

Ourbusiness and operations are subject to federal, state and local environmentallaws and regulations, including those governing the discharge of pollutants,the handling, generation, disposal and storage of hazardous materials andwastes, and the cleanup of contaminated sites. In connection with current orhistorical operations by us or at our sites, we could incur substantial costs,including clean-up costs, fines and civil or criminal sanctions, andthird-party claims for property damage or personal injury, as a result ofviolations of, or liabilities under, environmental laws and regulations. Webelieve that our operations are in material compliance with applicable environmentallaws and regulations.

 

**Item 4.    Submission ofMatters to a Vote of Security Holders**

 

Nomatters were submitted to vote of security holders during the fourth quarter of2007.

 

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**PART II**

 

**Item 5.    Market forRegistrant’s Common Equity, Related Stockholder Matters and Issuer Purchases ofEquity Securities**

 

Mac-Graycommon stock is traded on the New York Stock Exchange, or NYSE, under thesymbol “TUC.”

 

Thefollowing table sets forth the high and low sales prices for Mac-Gray commonstock on the NYSE for the periods indicated.

 
| ** **     | ** ** | **December 31, 2006** | ** ** | **December 31, 2007** | ** ** |
|----------------|------------|---------------------------------|------------|---------------------------------|------------|
| ** **     | ** ** | **High**                        | ** ** | **Low**                         | ** ** | **High** | ** ** | **Low** | ** ** |
| First Quarter  |       | $                               | 12.70      |                            | $          | 10.95 |   | $ | 16.14 |   | $ | 11.52 |   |
| Second Quarter |       | $                               | 13.10      |                            | $          | 11.51 |   | $ | 16.55 |   | $ | 14.36 |   |
| Third Quarter  |       | $                               | 12.35      |                            | $          | 10.91 |   | $ | 17.25 |   | $ | 11.95 |   |
| Fourth Quarter |       | $                               | 11.98      |                            | $          | 10.53 |   | $ | 14.26 |   | $ | 9.90 |   |

 

Asof March 6, 2008 there were 137 shareholders of record of Mac-Gray commonstock.

 

TheCompany does not currently pay dividends to the holders of Mac-Gray commonstock. The Company currently intends to retain future earnings, if any, for thedevelopment of its businesses and does not anticipate paying cash dividends onits common stock in the foreseeable future. Future determinations by the Boardof Directors to pay dividends on the Company’s common stock would be basedprimarily upon the financial condition, results of operations, and businessrequirements of the Company. Dividends, if any, would be payable at the solediscretion of the Board of Directors out of the funds legally availabletherefor. In addition, the payment of dividends is restricted under theCompany’s senior credit facilities.

 

Forinformation related to our stock option plans and employee stock purchaseplans, see Item 12, “Security Ownership of Certain Beneficial Owners andManagement and Related Stockholder Matters” below.

 

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**Item 6.    Selected FinancialData (Dollars in thousands, except per share data)**

 

Setforth below are selected historical financial data as of the dates and for theperiods indicated. The selected financial data set forth below should be readin conjunction with, and are qualified by reference to, “Management’sDiscussion and Analysis of Financial Condition and Results of Operations” andthe consolidated financial statements of Mac-Gray and the notes theretoincluded elsewhere in this report.

 
| ** **                                                               | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                               | ** ** | **2003**                                    | ** ** | **2004(1)** | ** ** | **2005(2)** | ** ** | **2006** | ** ** | **2007(3)** | ** ** |
| Statement of  Income Data:                                               |       |                                        |       |   |   |   |   |   |   |   |   |
| Revenue                                                                  |       | $                                           | 149,656    |   | $ | 182,694 |   | $ | 260,623 |   | $ | 279,327 |   | $ | 295,902 |   |
| Cost of revenue:                                                         |       |                                        |       |   |   |   |   |   |   |   |   |
| Cost of  facilities management revenues                                  |       | 72,823                                      |       | 93,512 |   | 142,052 |   | 153,861 |   | 162,839 |   |
| Depreciation and  amortization                                           |       | 16,723                                      |       | 20,747 |   | 31,337 |   | 35,156 |   | 37,410 |   |
| Cost of product  sales                                                   |       | 28,803                                      |       | 30,821 |   | 36,173 |   | 37,352 |   | 40,347 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Total cost of  revenue                                                   |       | 118,349                                     |       | 145,080 |   | 209,562 |   | 226,369 |   | 240,596 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Operating  expenses:                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| General and  administration                                              |       | 9,519                                       |       | 11,078 |   | 14,164 |   | 17,826 |   | 18,075 |   |
| Sales and  marketing                                                     |       | 11,341                                      |       | 13,005 |   | 16,097 |   | 16,248 |   | 16,364 |   |
| Depreciation and  amortization                                           |       | 1,100                                       |       | 1,047 |   | 1,189 |   | 1,589 |   | 1,611 |   |
| Gain on sale of  assets                                                  |       | (145                                        | )          | (1,208 | ) | (10,735 | ) | (32 | ) | (254 | ) |
| Loss on early  extinguishment of debt                                    |       | 381                                         |       | 183 |   | 668 |   | 73 |   | — |   |
| Impairment of  assets                                                    |       | —                                      |       | — |   | — |   | 2,502 |   | — |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Total operating  expenses                                                |       | 22,196                                      |       | 24,105 |   | 21,383 |   | 38,206 |   | 35,796 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Income from  operations                                                  |       | 9,111                                       |       | 13,509 |   | 29,678 |   | 14,752 |   | 19,510 |   |
| Interest expense,  net                                                   |       | (2,807                                      | )          | (4,312 | ) | (10,939 | ) | (13,653 | ) | (13,745 | ) |
| Gain (loss)  related to derivative instruments                           |       | —                                      |       | — |   | 1,876 |   | (96 | ) | (1,737 | ) |
| Gain on sale of  lease receivables                                       |       | 836                                         |       | — |   | — |   | — |   | — |   |
| Other expense,  net                                                      |       | —                                      |       | — |   | — |   | — |   | — |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Income before  provision for income taxes                                |       | 7,140                                       |       | 9,197 |   | 20,615 |   | 1,003 |   | 4,028 |   |
| Provision for  income taxes                                              |       | (3,036                                      | )          | (3,934 | ) | (8,563 | ) | (147 | ) | (1,509 | ) |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Net income  available to common stockholders                             |       | $                                           | 4,104      |   | $ | 5,263 |   | $ | 12,052 |   | $ | 856 |   | $ | 2,519 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Net income per  common share—basic                                  |       | $                                           | 0.32       |   | $ | 0.41 |   | $ | 0.94 |   | $ | 0.07 |   | $ | 0.19 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Net income per  common share—diluted                                |       | $                                           | 0.32       |   | $ | 0.40 |   | $ | 0.91 |   | $ | 0.06 |   | $ | 0.18 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Weighted average  common shares outstanding—basic                   |       | 12,635                                      |       | 12,702 |   | 12,864 |   | 13,008 |   | 13,209 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Weighted average  common shares outstanding—diluted                 |       | 12,741                                      |       | 13,028 |   | 13,283 |   | 13,448 |   | 13,680 |   |
|                                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Other Financial  Data:                                                   |       |                                        |       |   |   |   |   |   |   |   |   |
| EBITDA(4)                                                                |       | 27,770                                      |       | 35,303 |   | 64,080 |   | 51,401 |   | 56,794 |   |
| Depreciation and  amortization                                           |       | 17,823                                      |       | 21,794 |   | 32,526 |   | 36,745 |   | 39,021 |   |
| Capital  expenditures(5)                                                 |       | 15,372                                      |       | 17,826 |   | 26,380 |   | 25,911 |   | 27,154 |   |
| Cash flows  provided by operating activities                             |       | 24,480                                      |       | 37,108 |   | 37,798 |   | 36,403 |   | 43,645 |   |
| Cash flows used  in investing activates                                  |       | (12,802                                     | )          | (57,101 | ) | (120,251 | ) | (44,975 | ) | (73,387 | ) |
| Cash flows (used  in) provided by financing activities                   |       | (11,398                                     | )          | 21,188 |   | 87,008 |   | 9,520 |   | 31,073 |   |
| Balance Sheet  Data (at end of period):                                  |       |                                        |       |   |   |   |   |   |   |   |   |
| Working capital                                                          |       | 5,247                                       |       | (2,737 | ) | (1,673 | ) | 2,064 |   | 2,551 |   |
| Long-term debt  and capital lease obligations, including current portion |       | 50,873                                      |       | 73,328 |   | 166,678 |   | 177,068 |   | 208,521 |   |
| Long-term debt  and capital lease obligations, net of current portion    |       | 47,254                                      |       | 67,225 |   | 165,493 |   | 175,823 |   | 207,169 |   |
| Total assets                                                             |       | 162,005                                     |       | 202,330 |   | 324,917 |   | 339,004 |   | 383,537 |   |
| Stockholders’  equity                                               |       | 68,729                                      |       | 75,936 |   | 88,601 |   | 91,640 |   | 97,844 |   |

 

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*(1)*

Includes the results of operations of theeastern region laundry facilities management assets acquired onJanuary 16, 2004 from Web Service Company, Inc. for approximately$42,000.

 

*(2)*

Includes the results of operations of thewestern region laundry facilities management assets acquired onJanuary 10, 2005 from Web Service Company, Inc. for approximately$113,000.

 

*(3)*

Includes the results of operations of theMaryland laundry facilities management assets acquired on August 8, 2007from Hof Service Company, Inc. for approximately $43,000.

 

*(4)*

EBITDA is defined as net income beforeprovision for income taxes, depreciation and amortization expense, and interestexpense. Adjusted EBITDA is EBITDA further adjusted to exclude the itemsdescribed in the table below. We have excluded these items because we believethey are not reflective of our ongoing operating performance. EBITDA andAdjusted EBIDTA are included in this report because they are a basis upon whichour management and board of directors assess our operating performance. EBITDAand Adjusted EBITDA are not measures of our liquidity or financial performanceunder GAAP and should not be considered as alternatives to net income or anyother performance measure derived in accordance with GAAP, or as an alternativeto cash flows from operating activities as a measure of our liquidity. The useof EBITDA and Adjusted EBITDA instead of net income has limitations as an analyticaltool, including the exclusion of interest expense and depreciation andamortization expense, which represent significant and unavoidable operatingcosts given the level of indebtedness and the capital expenditures needed tomaintain our business. Management compensates for these limitations by relyingprimarily on our GAAP results and by using EBITDA and Adjusted EBITDA onlysupplementally. Our management believes EBITDA and Adjusted EBITDA are usefulto investors because they help enable investors to evaluate our business in thesame manner as our management and because they are frequently used bysecurities analysts, investors and other interested parties in the evaluationof companies with substantial financial leverage. Our measures of EBITDA andAdjusted EBITDA are not necessarily comparable to other similarly titledcaptions of other companies due to potential inconsistencies in the methods ofcalculation.

 

*(5)*

Excludes $1,380, $1,579, $1,499, $1,776and $2,003 in 2003, 2004, 2005, 2006 and 2007, respectively, of capital leasesassociated with vehicles acquired and used in the operation of the Company.

 

The followingis a reconciliation of net income to EBITDA and Adjusted EBITDA:

 
| ** **                                               | ** ** | **Years Ended December 31,** | ** ** |
|----------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                               | ** ** | **2003**                                    | ** ** | **2004(1)** | ** ** | **2005(2)** | ** ** | **2006** | ** ** | **2007(3)** | ** ** |
| Net income                                               |       | $                                           | 4,104      |   | $ | 5,263 |   | $ | 12,052 |   | $ | 856 |   | $ | 2,519 |   |
| Add:                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Provision for  income taxes                              |       | 3,036                                       |       | 3,934 |   | 8,563 |   | 147 |   | 1,509 |   |
|                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Cost of revenue  depreciation and amortization expense   |       | 16,723                                      |       | 20,747 |   | 31,337 |   | 35,156 |   | 37,410 |   |
|                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Operating  expense depreciation and amortization expense |       | 1,100                                       |       | 1,047 |   | 1,189 |   | 1,589 |   | 1,611 |   |
| Interest  expense, net                                   |       | 2,807                                       |       | 4,312 |   | 10,939 |   | 13,653 |   | 13,745 |   |
|                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| EBITDA(4)                                                |       | 27,770                                      |       | 35,303 |   | 64,080 |   | 51,401 |   | 56,794 |   |
| Add (Subtract):                                          |       |                                        |       |   |   |   |   |   |   |   |   |
| Gain on sale of  certain assets, net                     |       | —                                      |       | (1,218) | (7) | (10,767) | (8) | — |   | — |   |
| Stock  compensation expense                              |       | —                                      |       | — |   | — |   | 1,147 |   | 1,814 |   |
| Impairment of  assets                                    |       | —                                      |       | — |   | — |   | 2,502 |   | — |   |
| (Gain) loss  related to derivative instruments (5)       |       | —                                      |       | — |   | (1,876 | ) | 96 |   | 1,737 |   |
| Loss related to  2005 hurricanes                         |       | —                                      |       | — |   | 316 |   | — |   | — |   |
| Loss on early  extinguishment of debt (6)                |       | 381                                         |       | 183 |   | 668 |   | 73 |   | — |   |
|                                                     |       |                                        |       |   |   |   |   |   |   |   |   |
| Adjusted EBITDA  (4)                                     |       | $                                           | 28,151     |   | $ | 34,268 |   | $ | 52,421 |   | $ | 55,219 |   | $ | 60,345 |   |

 

----

*(1)*

Includes the results of operations of theeastern region laundry facilities management assets acquired onJanuary 16, 2004 from Web Service Company, Inc. for approximately$42,000.

 

*(2)*

Includes the results of operations of thewestern region laundry facilities management assets acquired onJanuary 10, 2005 from Web Service Company, Inc. for approximately$113,000.

 

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*(3)*

Includes the results of operations of theMaryland laundry facilities management assets acquired on August 8, 2007from Hof Service Company, Inc. for approximately $43,000.

 

*(4)*

EBITDA is defined as net income beforeprovision for income taxes, depreciation and amortization expense, and interestexpense. Adjusted EBITDA is EBITDA further adjusted to exclude the itemsdescribed in the table below. We have excluded these items because we believethey are not reflective of our ongoing operating performance. EBITDA andAdjusted EBIDTA are included in this report because they are a basis upon whichour management and board of directors assess our operating performance. EBITDAand Adjusted EBITDA are not measures of our liquidity or financial performanceunder GAAP and should not be considered as alternatives to net income or anyother performance measure derived in accordance with GAAP, or as an alternativeto cash flows from operating activities as a measure of our liquidity. The useof EBITDA and Adjusted EBITDA instead of net income has limitations as ananalytical tool, including the exclusion of interest expense and depreciationand amortization expense, which represent significant and unavoidable operatingcosts given the level of indebtedness and the capital expenditures needed tomaintain our business. Management compensates for these limitations by relyingprimarily on our GAAP results and by using EBITDA and Adjusted EBITDA onlysupplementally. Our management believes EBITDA and Adjusted EBITDA are usefulto investors because they help enable investors to evaluate our business in thesame manner as our management and because they are frequently used bysecurities analysts, investors and other interested parties in the evaluationof companies with substantial financial leverage. Our measures of EBITDA andAdjusted EBITDA are not necessarily comparable to other similarly titledcaptions of other companies due to potential inconsistencies in the methods ofcalculation.

 

*(5)*

The (gain) loss related to derivative instruments is the consequence ofinterest rate swaps which had previously qualified for hedge accounting nolonger qualifying for such treatment as a result of separate and distinctrefinancings of our credit facility in 2005 and 2006. Management does notexpect its other interest rate swaps to fail to qualify for hedge accountingtreatment in future periods because the Company does not currently expectfurther refinancings of the facility prior to its maturity in 2013.  Forinterest rate swaps that do qualify as hedged instruments, changes in mark tomarket will continue to be recorded in Other Comprehensive Income and not inthe income statement.  Including the fluctuation in the fair value of thederivative instruments in the reconciliation of net income as reported to netincome as adjusted allows for a more consistent comparison of the operatingresults of the Company.  The fair value of the derivatives is ultimatelyzero at the time of settlement.  Thus, over the life of the derivative instrumentsthe net impact to the Company's operating results will be zero as any income orloss recorded in prior periods will be reversed in subsequent periods.

 

*(6)*

Each of the losses on early extinguishment of debt resulted fromseparate and distinct refinancings of our senior credit facility in 2003, 2004,2005 and  2006 and is not related to theperformance of the Company’s business. Each of the losses reflects only the unamortized cost of the prior bankfinancing which had been allocated to banks which did not participate in thereplacement financing agreement.  Becausethe losses were triggered by refinancings of our senior credit facility and theCompany does not currently expect further refinancings of the facility prior toits maturity in 2011, management believes that the impact of this item on theCompany’s financial results will not continue.

 

*(7)*

Represents a pretax gain recognized inconnection with the sale of certain laundry facilities management assets andrelated contracts.

 

*(8)*

Represents a pretax gain recognized inconnection with the sale of a facility in Cambridge, Massachusetts onJune 30, 2005.

 

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**Item 7.    Management’sDiscussion and Analysis of Financial Condition and Results of Operations.(Dollars in Thousands)**

 

Thefollowing discussion and analysis should be read in conjunction with theconsolidated financial statements and related notes thereto presented elsewherein this report.

 

Thisreport contains, in addition to historical information, forward-lookingstatements that involve risks and uncertainties. These forward-lookingstatements reflect our current views about future events and financialperformance. Investors should not rely on forward-looking statements becausethey are subject to a variety of factors that could cause actual results todiffer materially from our expectations. Factors that could cause, orcontribute to such differences include, without limitation, the factorsdescribed under Item 1A “Risk Factors.”

 

Ouractual results, performance or achievement could differ materially from thoseexpressed in, or implied by, these forward-looking statements, and accordingly,we can give no assurances that any of the events anticipated by theforward-looking statements will occur or, if any of them do, what impact theywill have on our results of operations or financial condition. In view of theseuncertainties, investors are cautioned not to place undue reliance on theseforward-looking statements. We assume no obligation to update or revisepublicly any forward-looking statements, whether as a result of newinformation, future events or otherwise.

 

**Overview**

 

Mac-Graywas founded in 1927 and re-incorporated in Delaware in 1997. We conduct ourbusiness in the following four business units: (1) the laundry facilitiesmanagement business unit, through which we manage laundry facilities inmulti-unit housing; (2) the Intirion business unit, through which we sella line of combination refrigerator/freezer/microwave oven units and Whirlpoolappliances under the MicroFridge®, SnackmateTM and Maytag Direct® brands tomulti-unit housing facilities such as hospitality and assisted livingfacilities, military housing, and colleges and universities; (3) thecommercial laundry equipment sales business unit, through which we sellcommercial laundry equipment; and (4) the reprographics business unit,through which we provide reprographics equipment and services to the academicand public library markets. We report our business in two segments: facilitiesmanagement and product sales. Facilities management consists of our laundryfacilities management and reprographics business units. Product sales consistof our commercial laundry equipment sales and Intirion business units.

 

Ourcore business model is built on a stable demand for laundry services, combinedwith long-term leases, strong customer relationships, a broad customer base andpredictable capital needs. For the years ended December 31, 2006 and 2007,our total revenue was $279,300 and $295,900, respectively. Approximately 82%and 81% of our total revenue for these periods, respectively, was generated byour laundry facilities management business unit. We generate laundry facilitiesmanagement revenue primarily through long-term leases with property owners orproperty management companies granting us the exclusive right to install andmaintain laundry equipment in common area laundry rooms within theirproperties, in exchange for a negotiated portion of the revenue we collect. Asof December 31, 2007, approximately 90% of our installed machine base waslocated in laundry facilities subject to long-term leases, with a weightedaverage remaining term of approximately five years. Our capital costs aretypically incurred in connection with new or renewed leases, and include investmentsin laundry equipment and card- and coin-operated systems, incentive payments toproperty owners or property management companies and/or expenses to refurbishlaundry facilities. Our capital costs consist of a large number of relativelysmall amounts associated with our entry into or renewal of leases. Accordingly,our capital needs are predictable and largely within our control. For the yearsended December 31, 2006 and 2007, we incurred approximately $25,900 and$27,200 of capital expenditures, respectively. In addition, we make incentivepayments to property owners and property management

 

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companiesto secure our lease arrangements. We paid approximately $4,500 and $3,800 ofincentive payments in the years ended December 31, 2006 and 2007,respectively.

 

Inaddition, through our product sales segment, we generate revenue by sellingcommercial laundry equipment, our line of combinationrefrigerator/freezer/microwave oven units under the MicroFridge® and SnackMateTMbrands and the full lines of Maytag®, Amana® Magic Chef®, KitchenAid®, Estate®,and Whirlpool® domestic laundry and kitchen appliances under our Maytag Direct®program. For the years ended December 31, 2006 and 2007, our product salessegment accounted for approximately 17% and 18% of our total revenue,respectively, and 18% and 23% of our gross margin, respectively.

 

Ourfinancial objective is to maintain and enhance profitability by retainingexisting customers, adding customers in areas in which we currently operate,selectively expanding our geographic footprint and density throughacquisitions, and controlling costs. One of the key challenges we face ismaintaining and expanding our customer base in a competitive industry. Weexperience competition from other industry participants, including national,regional and local laundry facilities management operators and from propertyowners and property management companies who self-operate their laundryfacilities. We devote substantial resources to our marketing and sales effortsand we focused on continued innovation in order to distinguish us fromcompetitors. Approximately 10% to 15% of our laundry room leases are up forrenewal each year. Over the past five calendar years, we have been able toretain, on average, approximately 97% of our total installed equipment baseeach year. For each of the years ended December 31, 2006 and 2007, we havebeen able to add 4% to our equipment base through internally generated growth.The machine base that has not been retained is attributable to contracts lostto competitors, contracts the Company has chosen not to renew due tounacceptable margins and condominium conversions.

 

TheIntirion business unit derives revenue through the sale and rental of itsMicroFridge®, SnackMateTM and Maytag Direct® branded appliances to thehospitality industry and assisted living market, military bases and collegesand universities. The Intirion business unit also derives revenue through thesales of laundry equipment to the United States government and sales of kitchenappliances to the multi-housing market.

 

**Recent Developments**

 

OnFebruary 28, 2007, we acquired the laundry facilities management assetsand commercial laundry equipment distribution rights of a regional operator inthe Southeast United States. On April 26, 2007, we acquired the laundryfacilities management assets of a regional operator in New York. The combinedcost of these acquisitions was approximately $5,200 and was funded byborrowings under our senior credit facilities. We estimate that the combinedacquisitions will add approximately $4,700 of annual revenue.

 

OnAugust 8, 2007, we acquired the laundry facilities management assets ofHof Service Company, Inc. and Bobb Corp. in Maryland (the “HofAcquisition”). The cost of this acquisition was approximately $43,000, whichincludes a contingent payment of $2,000, subject to the achievement of certainfinancial results. The Hof acquisition was funded using the accordion featureincluded in the Company’s senior credit facilities, which increased the totalcredit line to $85,000. We estimate that the Hof Acquisition will addapproximately $25,000 of annual revenue.

 

**Results of Operations (Dollars in thousands, except per sharedata)**

 

Theinformation presented below for the years ended December 31, 2006 and 2007is derived from Mac-Gray’s consolidated financial statements and related notesincluded in this report.

 

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***Revenue***

 
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | **2007 to 2006** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **2006**   | ** ** | **2007**   | ** ** | **Increase  (Decrease)**   | ** ** | **%  Change** | ** ** |
| Laundry  facilities management              |       | $          | 229,719    |       | $          | 240,944                    |       | $ | 11,225 |   | 5 | % |
| Reprographics  revenue                      |       | 2,462      |       | 1,859      |       | (603                       | )          | (24 | )% |
|                                        |       |       |       |       |       |                       |       |   |   |
| Total facilities  management revenue        |       | 232,181    |       | 242,803    |       | 10,622                     |       | 5 | % |
|                                        |       |       |       |       |       |                       |       |   |   |
| Intirion sales  revenue                     |       | 30,410     |       | 33,418     |       | 3,008                      |       | 10 | % |
| Commercial  laundry equipment sales revenue |       | 16,736     |       | 19,681     |       | 2,945                      |       | 18 | % |
|                                        |       |       |       |       |       |                       |       |   |   |
| Total product  sales revenue                |       | 47,146     |       | 53,099     |       | 5,953                      |       | 13 | % |
|                                        |       |       |       |       |       |                       |       |   |   |
| Total revenue                               |       | $          | 279,327    |       | $          | 295,902                    |       | $ | 16,575 |   | 6 | % |

 

**Fiscal year ended December 31, 2007 compared to fiscalyear ended December 31, 2006**

 

Totalrevenue increased by $16,575, or 6%, to $295,902 for the year ended December 31,2007 compared to $279,327 for the year ended December 31, 2006. Thisgrowth in revenue is primarily attributable to an increase in laundryfacilities management revenue associated with several acquisitions in 2007.

 

*Facilities management revenue.*    Total facilitiesmanagement revenue increased $10,622, or 5%, to $242,803 for the year ended December 31,2007 compared to $232,181 for the year ended December 31, 2006. Thisincrease is attributable to increases in revenue in the laundry facilitiesmanagement business unit, due to the impact of several acquisitions during 2007and an increase in the number of laundry leases through organic growth, offsetto a small extent by decreases in revenue in the reprographics business unit.

 

Withinthe facilities management segment, revenue in the laundry facilities managementbusiness unit increased $11,225, or 5%, to $240,944 for the year ended December 31,2007 compared to $229,719 for the year ended December 31, 2006. Therevenue generated by the acquired assets during 2007 accounted for virtuallyall of the increase in revenue in 2007 over 2006. Higher vacancy rates, andconsequently reduced usage of our equipment in some of our markets, eclipsedsome of the growth in a majority of our markets. The Company was able tomaintain revenue from its core business that was consistent with 2006.

 

Revenuein the reprographics business unit decreased $603, or 24%, to $1,859 for theyear ended December 31, 2007 compared to $2,462 for the year ended December 31,2006. In the years ended December 31, 2006 and 2007, the reprographicsbusiness unit accounted for less than 1% of consolidated revenue for each year.Due to the continued decline in the use of vended copiers in libraries andsimilar facilities, the reduction in the number of locations we operate, thedifficulty of servicing fewer accounts over a wider territory, and thedifficulty of predicting future income generation, the Company decided not torenew expiring contracts in selected geographic markets. This decision, inaddition to the Company’s inability to predict success at negotiatingprofitable contracts going forward for this business in any of its presentmarkets, resulted in the Company taking a non-cash impairment charge of $1,639,net of tax, in the fourth quarter of 2006.

 

*Product sales revenue.*    Product sales revenueincreased $5,953, or 13%, to $53,099 for the year ended December 31, 2007compared to $47,146 for the year ended December 31, 2006. The increase inrevenue for the year ended December 31, 2007 as compared to the sameperiod in 2006 is attributable to increases in revenue in the Intirion businessunit and the laundry equipment sales business unit.

 

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Revenuein the Intirion business unit increased $3,008, or 10%, to $33,418 for the yearended December 31, 2007 compared to $30,410 for the year ended December 31,2006. The increase is primarily attributable to an increase in sales to thegovernment market. Sales in the academic sector also increased. Sales declinedin the hospitality, retail and property management sectors. Our sales to thegovernment will continue to fluctuate based on shifting budget priorities aswell as the timing of the release of funds for military housing initiatives.Sales in the hospitality sector have benefited in recent years from an increasein capital spending by that industry. The level of spending by the hospitalityindustry began to level off in 2007.

 

Revenuein the commercial laundry equipment sales business unit increased $2,945, or18%, to $19,681 for the year ended December 31, 2007 compared to $16,736for the year ended December 31, 2006. Sales in the commercial laundryequipment sales business unit are sensitive to the strength of the localeconomy, consumer confidence, local permitting and the availability and cost offinancing to small businesses, and therefore, tend to fluctuate from period toperiod. The combination of these factors, coupled with the Company’s marketingefforts focused towards new store developments, contributed to the increase in sales.

 

***Cost of revenue***

 

*Cost of facilities management revenue.*    Cost of facilitiesmanagement revenue includes rent paid to customers as well as costs associatedwith installing and servicing machines, costs of collecting, counting, anddepositing facilities management revenue and the costs of delivering andservicing rented facilities management equipment. Cost of facilities managementrevenue increased $8,978, or 6%, to $162,839 for the year ended December 31,2007, as compared to $153,861 for the year ended December 31, 2006. Thisincrease is attributable primarily to the cost of facilities management rentassociated with the increase in facilities management revenue of $10,622. Costof facilities management revenue as a percentage of facilities managementrevenue was 67% for the year ended December 31, 2007 compared to 66% forthe year ended December 31, 2006. Changes in facilities management rent asa percentage of facilities management revenue can be caused by new and renewedlaundry leases and by other factors such as the amount of incentive paymentsand laundry room betterments invested in new or renewed laundry leases. As wevary the amount invested in a facility, the facilities management rent as afunction of facilities management revenue can vary. Also affecting the rent canbe the rate associated with acquired portfolios. Incentive payments and roombetterments are amortized over the life of the laundry lease.

 

*Depreciation and amortization.*    Depreciation andamortization increased by $2,254, or 6%, to $37,410 for the year ended December 31,2007 as compared to $35,156 for the year ended December 31, 2006. Laundryfacilities management equipment and contract rights are depreciated andamortized using the straight-line method. The increased depreciation andamortization expense is attributable to the amortization of acquired contracts,new equipment placed in laundry facilities at new locations, and replacement ofolder equipment with new equipment as contracts were renegotiated. In addition,due to management’s decision not to recondition and redeploy equipment that isnot as energy efficient as newer equipment, we disposed of certain laundryequipment in 2007 and 2006 that had a remaining net book value of $542 and$847, respectively. These costs are included in depreciation expense.

 

*Cost of product sales.*    Cost of product salesconsists primarily of the cost of laundry equipment, MicroFridge® brandedequipment and parts and supplies sold, as well as salaries and relatedwarehousing expenses as part of the product sales segment. Cost of productsales increased by $2,995, or 8%, to $40,347 for the year ended December 31,2007 as compared to $37,352 for the year ended December 31, 2006. As apercentage of sales, cost of product sold was 76% for the year ended December 31,2007 compared to 79% in 2006. The gross margin on product sales includes thegross margins from the commercial laundry equipment sales and Intirion businessunits. The gross margin in

 

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thecommercial laundry equipment sales business unit increased to 25% for the yearended December 31, 2007 as compared to 20% for the same period in 2006. Theincrease in margin is attributable to an increase in pricing and favorableproduct mix. The gross margin in the Intirion business unit increased to 23%for the year ended December 31, 2007 as compared to 20% for the sameperiod in 2006. The increase in margin is attributable to some increases inpricing, the favorable mix of products sold as well as the Company’s ability toachieve some efficiency in freight and warehousing costs.

 

***Operating expenses***

 

*General, administration, sales, marketing and depreciationand amortization expense.*    General, administration, sales, marketing anddepreciation and amortization expense increased by $387, or 1%, to $36,050 forthe year ended December 31, 2007 as compared to $35,663 for the year endedDecember 31, 2006. As a percentage of total revenue, general,administration, sales, marketing and depreciation expense decreased to 12% forthe year ended December 31, 2007 compared to 13% for the year ended December 31,2006.

 

*Loss on early extinguishment of debt.*    Effective December 29,2006, the Company amended its bank credit facilities. As a result of thisamendment, a portion of the unamortized financing costs amounting to $73, whichhad been incurred as part of the prior credit facility, were expensed in 2006.

 

*Gain on sale of assets.*    Gain on sale of assetsrepresents the gain from the sale of vehicles and other non-inventory assets inthe ordinary course of business.

 

*Impairment of assets.*    The revenue andcorresponding operating income in our reprographics business unit have beendeclining since 1999 when college libraries, followed by public libraries,began to make reference material available to patrons electronically.Electronic availability, widespread conversion to laser printers (free ofcharge in many school libraries) and other technical advancements have led toreduced use of vended copy machines, resulting in reduced revenue at severalaccounts. During the fourth quarter of 2006, the Company performed anevaluation of the reprographics business unit and its long-term prospects. As aresult of this evaluation, management determined that the carrying amount ofthe business unit’s long lived assets exceeded the estimated undiscounted cashflows expected to result from operating this business unit, and recognized anon-cash, non-recurring impairment charge of $2,502, or $0.19 per diluted sharebefore taxes ($1,639, or $0.12 per diluted share net of taxes.) This charge wascalculated in accordance with SFAS No. 144, “Accounting for the Impairmentor disposal of Long-Lived Assets” (“FAS 144”). Accordingly, the Companyused a discounted cash flow model to calculate the amount of the impairmentcharge after it was determined that, pre-write-down, the carrying amount of thebusiness unit’s long lived assets exceeded the estimated undiscounted futurecash flows expected to result from operating this business unit.

 

***Income from operations***

 

Incomefrom operations increased by $4,758, or 32%, to $19,510 for the year ended December 31,2007 as compared to $14,752 for the year ended December 31, 2006.Excluding the cost of impairment of assets and loss on early extinguishment ofdebt, income from operations, as adjusted, would have been $19,510 for the yearended December 31, 2007, compared to $17,327 for the year ended 2006, oran increase of 13%. This increase is due primarily to the reasons discussedabove. We have supplemented the consolidated financial statements presentedaccording to generally accepted accounting principles (GAAP), using a non-GAAPfinancial measure of adjusted income from operations. Management believespresentation of this measure is useful to investors to enhance an overallunderstanding of our historical financial performance and future prospects.Adjusted income from operations, which is adjusted to exclude certain gains andlosses from the comparable GAAP income from operations, is an indication of ourbaseline performance before gains, losses or other

 

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chargesthat are considered by management to be outside of our core operating results.The presentation of this additional information is not meant to be consideredin isolation or as a substitute for income from operations or other measuresprepared in accordance with GAAP.

 

Areconciliation of income from operations in accordance with GAAP to income fromoperations, as adjusted, is provided below:

 
| ** **                               | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2006**                                    | ** ** | **2007** | ** ** |
| Income from operations                   |       | $                                           | 14,752     |   | $ | 19,510 |   |
| Impairment of  assets(1)                 |       | 2,502                                       |       | — |   |
| Loss on early  extinguishment of debt(2) |       | 73                                          |       | — |   |
|                                     |       |                                        |       |   |   |
| Income from  operations, as adjusted     |       | $                                           | 17,327     |   | $ | 19,510 |   |

 

----

*(1)*

Representsa pre-tax charge associated with the reprographics business unit.

 

*(2)*

Theloss on early extinguishment of debt resulted from a refinancing of our seniorcredit facility and is not related to the performance of the Company’sbusiness.  The loss reflects only theunamortized cost of the prior bank financing which had been allocated to bankswhich did not participate in the replacement financing agreement. Because theloss was triggered by a refinancing of the Company’s senior credit facility andthe Company does not currently expect further refinancings of the facilityprior to its maturity in 2011, management believes that the impact of this itemon the Company’s financial results will not continue.

 

***Interest expense, net***

 

Interestexpense, net of interest income, increased by $92, or less than 1%, to $13,745for the year ended December 31, 2007 as compared to $13,653 for the yearended December 31, 2006. The increase is primarily attributable to anincrease in the average borrowing in 2007 compared to 2006. The increase in ourborrowing in 2007 is attributable to our 2007 acquisitions. The averageborrowing rate was 7.1% for the year ended December 31, 2007 as comparedto 7.2% for the year ended December 31, 2006.

 

***Gain or loss related to derivativeinstruments***

 

TheCompany is party to interest rate swap agreements which it entered into toprotect the interest rates on its debt. Certain of these swap agreements do not qualify as cash flowhedges.  In accordance with the guidelinesfor accounting for derivatives, a non-cash expense of $1,737 and $96 has beencharged to the income statement for the years ended December 31, 2007 and2006, respectively.

 

***Provision for income taxes***

 

Theprovision for income taxes increased by $1,362 to $1,509 for the year ended December 31,2007 compared to $147 for the year ended December 31, 2006. The increaseis the combination of an increase in taxable income, a decrease in theeffective tax rate and a reduction in the reserve for uncertain tax positions.The effective tax rate, without considering the impact of the reduction in thereserve in 2006 and 2007, decreased to 41.9% from 54.5% for the year ended December 31,2007 compared to the same period in 2006. The decrease in the effective taxrate is due to a change in the estimated rate at which the deferred state taxassets will be realized and the impact of permanent book/tax differences on theincreased taxable income in 2007 compared to 2006. The reduction in the reservefor uncertain tax provisions further reduced the effective tax rate to 37.5%for the year ended 2007 and 14.7% for the year ended December 31, 2006.The reductions to the rates relate to the expiration of the statute oflimitations for certain tax exposures.

 

***Net income***

 

Asa result of the foregoing, net income increased $1,663, or 194%, to $2,519 forthe year ended December 31, 2007 as compared to $856 for the year ended December 31,2006. Net income, as

 

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adjustedfor the items in the table below, increased $471, or 15%, to $3,605 for theyear ended December 31, 2007 as compared to $3,134 for the year ended December 31,2006.

 

Areconciliation of net income, as reported to net income, as adjusted isprovided below:

 
| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2006**                                    | ** ** | **2007** | ** ** |
| Net income, as  reported                               |       | $                                           | 856        |   | $ | 2,519 |   |
|                                                   |       |                                        |       |   |   |
| Income before  provision for income taxes, as reported |       | $                                           | 1,003      |   | $ | 4,028 |   |
| Impairment of  assets(1)                               |       | 2,502                                       |       | — |   |
| Loss related to  derivative instruments(2)             |       | 96                                          |       | 1,737 |   |
| Loss on early  extinguishment of debt(3)               |       | 73                                          |       | — |   |
|                                                   |       |                                        |       |   |   |
| Income before  provision for income taxes, as adjusted |       | 3,674                                       |       | 5,765 |   |
| Provision for  income taxes, as adjusted               |       | 540                                         |       | 2,160 |   |
|                                                   |       |                                        |       |   |   |
| Net income, as  adjusted                               |       | $                                           | 3,134      |   | $ | 3,605 |   |
|                                                   |       |                                        |       |   |   |
| Diluted earnings  per share, as adjusted               |       | $                                           | 0.23       |   | $ | 0.26 |   |

 

----

*(1)*

Representsa pre-tax charge associated with the reprographics business unit.

 

*(2)*

Thelosses related to derivative instruments are the consequence of interest rateswaps which had previously qualified for hedge accounting no longer qualifyingfor such treatment as a result of separate and distinct refinancings of ourcredit facility in 2005 and 2006. Management does not expect its other interestrate swaps to fail to qualify for hedge accounting treatment in future periodsbecause the Company does not currently expect further refinancings of thefacility prior to its maturity in 2011.  For interest rate swaps that doqualify as hedged instruments, changes in mark to market will continue to berecorded in Other Comprehensive Income and not in the income statement. Including the fluctuation in the fair value of the derivative instruments inthe reconciliation of net income as reported to net income as adjusted allowsfor a more consistent comparison of the operating results of the Company. The fair value of the derivatives is ultimately zero at the time ofsettlement.  Thus, over the life of the derivative instruments the netimpact to the Company’s operating results will be zero as any income or lossrecorded in prior periods will be reversed in subsequent periods.

 

*(3)*

Theloss on early extinguishment of debt resulted from a refinancing of our seniorcredit facility and is not related to the performance of the Company’sbusiness.  The loss reflects only theunamortized cost of the prior bank financing which had been allocated to bankswhich did not participate in the replacement financing agreement. Because theloss was triggered by a refinancing of the Company’s senior credit facility andthe Company does not currently expect further refinancings of the facilityprior to its maturity in 2011, management believes that the impact of this itemon the Company’s financial results will not continue.

 

Tosupplement the Company’s consolidated financial statements presented on agenerally accepted accounting principles (GAAP) basis, management has used anon-GAAP measure of net income. Management believes presentation of thismeasure is appropriate to enhance an overall understanding of our historicalfinancial performance and future prospects. Adjusted net income, which isadjusted to exclude certain gains and losses from the comparable GAAP netincome, is an indication of our baseline performance before gains, losses orother charges that are considered by management to be outside of our coreoperating results. These non-GAAP results are among the primary indicatorsmanagement uses as a basis for evaluating the Company’s financial performanceas well as for forecasting future periods. For these reasons, management believesthese non-GAAP measures can be useful to investors, potential investors andothers.

 

Non-GAAPfinancial measures are not in accordance with, or an alternative for, generallyaccepted accounting principles in the United States. The Company’s non-GAAP financialmeasures are not meant to be considered in isolation or as a substitute forcomparable GAAP financial measures, and should be read only in conjunction withthe Company’s consolidated financial statements prepared in accordance withGAAP.

 

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**Fiscal year ended December 31, 2006 compared to fiscalyear ended December 31, 2005**

 

Theinformation presented below for the years ended December 31, 2005 and 2006is derived from Mac-Gray’s consolidated financial statements and related notesincluded in this report.

 

***Revenue***

 
| ** **                                  | ** ** | ** ** | ** ** | ** ** | ** ** | **2006 to 2005** | ** ** |
|---------------------------------------------|------------|------------|------------|------------|------------|----------------------------|------------|
| ** **                                  | ** ** | **2005**   | ** ** | **2006**   | ** ** | **Increase  (Decrease)**   | ** ** | **%  Change** | ** ** |
| Laundry  facilities management              |       | $          | 211,892    |       | $          | 229,719                    |       | $ | 17,827 |   | 8 | % |
| Reprographics  revenue                      |       | 2,924      |       | 2,462      |       | (462                       | )          | (16 | )% |
|                                        |       |       |       |       |       |                       |       |   |   |
| Total facilities  management revenue        |       | 214,816    |       | 232,181    |       | 17,365                     |       | 8 | % |
|                                        |       |       |       |       |       |                       |       |   |   |
| Intirion sales  revenue                     |       | 30,513     |       | 30,410     |       | (103                       | )          | 0 | % |
| Commercial  laundry equipment sales revenue |       | 15,294     |       | 16,736     |       | 1,442                      |       | 9 | % |
|                                        |       |       |       |       |       |                       |       |   |   |
| Total product  sales revenue                |       | 45,807     |       | 47,146     |       | 1,339                      |       | 3 | % |
|                                        |       |       |       |       |       |                       |       |   |   |
| Total revenue                               |       | $          | 260,623    |       | $          | 279,327                    |       | $ | 18,704 |   | 7 | % |

 

Totalrevenue increased by $18,704, or 7%, to $279,327 for the year ended December 31,2006 compared to $260,623 for the year ended December 31, 2005. Thisgrowth in revenue is primarily attributable to an increase in laundryfacilities management revenue associated with several acquisitions in 2006,additional laundry leases through organic growth, and vend increases.

 

*Facilities management revenue.*    Total facilitiesmanagement revenue increased $17,365, or 8%, to $232,181 for the year ended December 31,2006 compared to $214,816 for the year ended December 31, 2005. Thisincrease is attributable to increases in revenue in the laundry facilitiesmanagement business unit, primarily due to the impact of several acquisitionsduring 2006, organic growth in the number of management contracts and vendincreases partially offset to a small extent by decreases in revenue in thereprographics business unit.

 

Withinthe facilities management segment, revenue in the laundry facilities managementbusiness unit increased $17,827, or 8%, to $229,719 for the year ended December 31,2006 compared to $211,892 for the year ended December 31, 2005. Theincrease is attributable primarily to the revenue generated by the assetsacquired during 2006, which accounted for approximately 50% of the 2006increase over 2005. The remaining 50% is attributable to organic growth in thenumber of management contracts signed, increases in the vend prices charged foruse of the equipment and an increase in revenue associated with the conversionof coin-operated locations to card-operated locations. Due to the convenience ofcard-operated systems, usage, and therefore revenue, typically increases uponthe conversion from a coin-operated system.

 

Revenuein the reprographics business unit decreased $462, or 16%, to $2,462 for theyear ended December 31, 2006 compared to $2,924 for the year ended December 31,2005. In the year ended December 31, 2006, the reprographics business unitaccounted for less than 1% of consolidated revenue. Due to the continueddecline in the use of vended copiers in libraries and similar facilities, thereduction in the number of locations we operate, the difficulty of servicingfewer accounts over a wider territory, and the difficulty of predicting futureincome generation, in the fourth quarter of 2006 the Company decided not torenew contracts which will expire in the next twelve months in selectedgeographic markets. This decision, in addition to the Company’s inability topredict success at negotiating profitable contracts going forward for thisbusiness in any of its present markets, resulted in the Company taking anon-cash impairment charge of $1,639, net of tax, in the fourth quarter of2006.

 

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* *

*Product sales revenue.*    Product sales revenueincreased $1,339, or 3%, to $47,146 for the year ended December 31, 2006compared to $45,807 for the year ended December 31, 2005. The increase inrevenue for the year ended December 31, 2006 as compared to the sameperiod in 2005 is attributable to increases in revenue in the laundry equipmentsales business unit.

 

Revenuein the Intirion business unit decreased $103, or less than 1%, to $30,410 forthe year ended December 31, 2006 compared to $30,513 for the year ended December 31,2005. The decrease is primarily attributable to a decrease in sales to theacademic market and government market, partially offset by an increase inhospitality and assisted living sales. The hospitality sales increase isattributable to an increase in capital spending by the industry and a full yearof sales to several new distributors added by our Company in 2005. We believethe decrease in academic sales can be attributed to constraints by academicinstitutions on capital spending on amenity items. Our sales to the governmentare continually affected by changes in government spending priorities. Webelieve current spending on military housing improvements has been delayed as aresult of current military efforts in the Middle East.

 

Revenuein the commercial laundry equipment sales business unit increased $1,442, or9%, to $16,736 for the year ended December 31, 2006 compared to $15,294for the year ended December 31, 2005. Sales in the commercial laundryequipment sales business unit are sensitive to the strength of the localeconomy, consumer confidence, local permitting and the availability and cost offinancing to small businesses, and therefore, tend to fluctuate from period toperiod. The combination of these factors, coupled with the Company’s marketingefforts, contributed to the increase in sales.

*** ***

***Cost of revenue***

 

*Cost of facilities management revenue.*    Cost of facilitiesmanagement revenue includes rent paid to customers as well as costs associatedwith installing and servicing machines and costs of collecting, counting, anddepositing facilities management revenue, and the costs of purchasing,delivering and servicing rented facilities management equipment. Salaries,warehousing and other operating expenses include $1,104 which had been includedin facilities management costs in 2005 have been reclassified to cost of salesfor the product sales segment to conform to 2006’s presentation. The followingreferences to 2005 give effect to the reclassification. Cost of facilities managementrevenue increased $11,809, or 8%, to $153,861 for the year ended December 31,2006, as compared to $142,052 for the year ended December 31, 2005. Thisincrease is attributable primarily to the cost, primarily facilities managementrent, associated with the increase in facilities management revenue of $17,365,partially offset by the costs associated with the 2005 hurricanes which did notrecur in 2006. Included in the cost for the year ended December 31, 2005are costs associated with the 2005 hurricanes. Adjusting 2005 total costs toexclude the hurricane costs, cost of facilities management as a percentage offacilities management revenue remained consistent at 66% for the years ended December 31,2006 and 2005. Changes in facilities management rent as a percentage offacilities management revenue can be affected by new and renewed laundry leasesand by other factors such as the amount of incentive payments and laundry roombetterments invested in new or renewed laundry leases. As we vary the amount investedin a facility, the facilities management rent as a function of facilitiesmanagement revenue can vary. Incentive payments and room betterments areamortized over the life of the laundry lease.

 

*Depreciation and amortization.*    Depreciation and amortizationincreased by $3,819, or 12%, to $35,156 for the year ended December 31,2006 as compared to $31,337 for the year ended December 31, 2005. Laundryfacilities management equipment and contract rights are depreciated andamortized using the straight-line method. The increased depreciation expense isattributable to new equipment placed in laundry facilities at new locations andreplacement of older equipment as contracts were renegotiated. In addition, dueto management’s decision not to recondition and redeploy equipment which is notas energy efficient as newer equipment, we disposed of certain laundry

 

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equipmentin 2006 that had a remaining net book value of $847. This cost is included indepreciation expense.

 

*Cost of product sales.*    Cost of product salesconsists primarily of the cost of laundry equipment, MicroFridge® brandedequipment and parts and supplies sold, as well as salaries and relatedwarehousing expenses as part of the product sales segment. Costs of $1,104consisting of salaries and other operating expenses, which were included in thecost of facilities management revenue in 2005, have been reclassified to theproduct sales segment to conform to 2006’s presentation. The followingreferences to 2005 give effect to the reclassification. Cost of product salesincreased by $1,179, or 3%, to $37,352 for the year ended December 31,2006 as compared to $36,173 for the year ended December 31, 2005. As apercentage of sales, cost of product sold was consistent at 79% for the yearsended December 31, 2006 and 2005. The gross margin on product salesincludes the gross margins from the laundry equipment sales and Intirionbusiness units. The gross margin in the laundry equipment sales business unitdecreased to 20% for the year ended December 31, 2006 as compared to 24%for the same period in 2005. The decrease in margin is attributable to productmix and increased costs from our suppliers. The gross margin in the Intirionbusiness unit increased to 20% for the year ended December 31, 2006 ascompared to 18% for the same period in 2005. The slight increase in margin isattributable to the mix of products sold as well as the Company’s ability topass on some increased fuel costs.

 

***Operating expenses***

 

*General, administration, sales, marketing anddepreciation expense.*    General,administration, sales, marketing and depreciation expense increased by $4,213, or13%, to $35,663 for the year ended December 31, 2006 as compared to$31,450 for the year ended December 31, 2005. As a percentage of totalrevenue, general, administration, sales, marketing and depreciation expenseincreased from 12% for the year ended December 31, 2005 to 13% for theyear ended December 31, 2006. The increase in total expenses is primarilyattributable to the costs incurred to comply with the requirements of Section 404of the Sarbanes-Oxley Act of 2002 and the non-cash expense related to stockcompensation, which was required to be recorded in 2006 in accordance withStatement of Financial Accounting Standards No. 123 (revised 2004), “Share-BasedPayments” (“FAS123(R)”).

 

*Loss on early extinguishment of debt.*    Unamortized financingcosts of $461 related to the term loan were expensed in 2005. In connectionwith the senior credit facilities, we repaid them in full and terminated our2003 senior credit facilities. Unamortized financing costs of $207 associatedwith our 2003 senior credit facilities were also expensed in 2005. Effective December 29,2006, the Company amended its bank credit facilities. As a result of thisamendment, a portion of the unamortized financing costs amounting to $73, whichhad been incurred as part of the prior credit facility, were expensed.

 

*Gain on sale of assets.*    Gain on sale of assetsrepresents the gain from the sale of vehicles and other non-inventory assets inthe ordinary course of business. In the year ended December 31, 2005, thegain included $10,588 from the sale of our corporate headquarters.

 

*Impairment of assets.*    The revenue andcorresponding operating income in our reprographics business unit have beendeclining since 1999 when college libraries, followed by public libraries,began to make reference material electronically available to patrons.Electronic availability, widespread conversion to laser printers (free ofcharge in many school libraries) and other technical advancements have led toreduced use of vended copy machines resulting in reduced revenue at severalaccounts. During the fourth quarter of 2006, the Company performed anevaluation of the reprographics business unit and its long-term prospects. As aresult of this evaluation, management determined that the carrying amount of thebusiness unit’s long lived assets exceeded the estimated undiscounted cashflows expected to result from operating this business unit, and recognized anon-cash, non-recurring

 

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impairmentcharge of $2,502, or $0.19 per diluted share before taxes ($1,639, or $0.12 perdiluted share net of taxes). This charge was calculated in accordance with SFASNo. 144, “Accounting for the Impairment or disposal of Long-Lived Assets”(“FAS 144”). Accordingly, the Company used a discounted cash flow model tocalculate the amount of the impairment charge after it was determined that,pre-write-down, the carrying amount of the business unit’s long lived assetsexceeded the estimated undiscounted future cash flows expected to result fromoperating this business unit.

 

***Income from operations***

 

Incomefrom operations decreased by $14,926, or 50%, to $14,752 for the year ended December 31,2006 as compared to $29,678 for the year ended December 31, 2005.Excluding the cost of non-cash compensation recorded in 2006, impairment ofassets, loss on early extinguishment of debt and the gain on sale of certainassets, income from operations, as adjusted, would have been $18,474 for theyear ended December 31, 2006, compared to $19,758 for the year ended 2005,or a decrease of 6%. This decrease is due primarily to the reasons discussedabove. To supplement the consolidated financial statements presented accordingto generally accepted accounting principles (GAAP), we have used a non-GAAPfinancial measure of adjusted income from operations. Management believespresentation of this measure is useful to investors to enhance an overallunderstanding of our historical financial performance and future prospects.Adjusted income from operations, which is adjusted to exclude certain gains andlosses from the comparable GAAP income from operations, is an indication of ourbaseline performance before gains, losses or other charges that are consideredby management to be outside of our core operating results. The presentation ofthis additional information is not meant to be considered in isolation or as asubstitute for income from operations or other measures prepared in accordancewith GAAP.

 

Areconciliation of income from operations in accordance with GAAP to income fromoperations, as adjusted, is provided below:

 
| ** **                               | ** ** | **Years ended December 31,** | ** ** |
|------------------------------------------|------------|---------------------------------------------|------------|
| ** **                               | ** ** | **2005**                                    | ** ** | **2006** | ** ** |
| Income from  operations                  |       | $                                           | 29,678     |   | $ | 14,752 |   |
| Non-cash  compensation(1)                |       | —                                      |       | 1,147 |   |
| Impairment of  assets(2)                 |       | —                                      |       | 2,502 |   |
| Loss on early  extinguishment of debt(3) |       | 668                                         |       | 73 |   |
| Gain on sale of  certain fixed assets(4) |       | (10,588                                     | )          | — |   |
|                                     |       |                                        |       |   |   |
| Income from  operations, as adjusted     |       | $                                           | 19,758     |   | $ | 18,474 |   |

 

----

*(1)*

OnJanuary 1, 2006, the Company adopted FAS123(R). These amounts representexpenses relating to issuances of equity awards in the periods presented.

 

*(2)*

Representsa pre-tax charge associated with the reprographics business unit.

 

*(3)*

Eachof the losses on early extinguishment of debt resulted from separate anddistinct refinancings of our senior credit facility in 2005 and 2006 and is notrelated to the performance of the Company’s business. Each of the lossesreflects only the unamortized cost of the prior bank financing which had beenallocated to banks which did not participate in the replacement financingagreement. Because the losses were triggered by refinancings of our seniorcredit facility and the Company does not currently expect further refinancingsof the facility prior to its maturity in 2011, management believes that theimpact of this item on the Company’s financial results will not continue.

 

*(4)*

Representsa pre-tax gain recognized in connection with the sale of the Company’s officeand warehouse facility in Cambridge, Massachusetts on June 30, 2005.

 

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***Interest expense, net***

 

Interestexpense, net of interest income, increased by $2,714, or 25%, to $13,653 forthe year ended December 31, 2006 as compared to $10,939 for the year endedDecember 31, 2005. The increase is primarily attributable to an increasein the average borrowing rates to 7.2% for the year ended December 31,2006 as compared to 5.9% for the year ended December 31, 2005. Theincrease in average borrowing rates is due, in large part, to the $150,000 ofsenior notes that we issued on August 16, 2005 and which bear interest atthe rate of 7.625% per annum for which we recognized a full year’s expense in2006. Also contributing to the increase is our increased borrowing in 2006 ofapproximately $19,000 attributable to our 2006 acquisitions.

 

***Gain or loss related to derivativeinstruments***

 

TheCompany is party to interest rate swap agreements that it had accounted for ascash flow hedges. The fair value of these swaps has been included in othercomprehensive income in the equity section of the balance sheet.  As a result of the reduction in the amountoutstanding under our senior credit facilities, certain swap agreements nolonger qualified for cash flow hedge accounting treatment.  The revised accounting treatment resulted inan expense of $96 and a gain of $1,876 in the income statement for the yearsended December 31, 2006 and 2005, respectively.

 

***Provision for income taxes***

 

Theprovision for income taxes decreased by $8,416, or 98%, to $147 for the yearended December 31, 2006 compared to $8,563 for the year ended December 31,2005. The decrease is the combination of a decrease in taxable income, anincrease in the effective tax rate and a reduction in the reserve for uncertaintax positions. The effective tax rate, without considering the impact of thereduction in the reserve, increased to 54.5% from 41.5% for the year ended December 31,2006 compared to the same period in 2005. The increase in the effective taxrate is due primarily to the impact of permanent book/tax differences on thedecreased taxable income in 2006 compared to 2005. The reduction in the reservefor uncertain tax provisions further reduced the effective tax rate to 14.7%for the year ended December 31, 2006. This reduction relates to theexpiration of the statute of limitations as of September 15, 2006 forcertain state tax exposures.

 

***Net income***

 

Asa result of the foregoing, net income decreased $11,196, or 93%, to $856 forthe year ended December 31, 2006 as compared to $12,052 for the year endedDecember 31, 2005. Net income, as adjusted for the items in the tablebelow, decreased $1,125, or 21%, to $4,114 for the year ended

 

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December 31,2006 as compared to $5,239 for the year ended December 31, 2005.  A reconciliation of net income, as reportedto net income, as adjusted is provided below:

 
| ** **                                             | ** ** | **Years Ended December 31,** | ** ** |
|--------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                             | ** ** | **2005**                                    | ** ** | **2006** | ** ** |
| Net income, as  reported                               |       | $                                           | 12,052     |   | $ | 856 |   |
|                                                   |       |                                        |       |   |   |
| Income before  provision for income taxes, as reported |       | $                                           | 20,615     |   | $ | 1,003 |   |
| Non-cash  compensation expense(1)                      |       | —                                      |       | 1,147 |   |
| Gain on  non-recurring sale of assets(2)               |       | (10,767                                     | )          | — |   |
| Impairment of  assets(3)                               |       | —                                      |       | 2,502 |   |
| (Gain) loss  related to derivative instruments(4)      |       | (1,876                                      | )          | 96 |   |
| Loss related to  2005 hurricanes                       |       | 316                                         |       | — |   |
| Loss on early  extinguishment of debt(5)               |       | 668                                         |       | 73 |   |
|                                                   |       |                                        |       |   |   |
| Income before  provision for income taxes, as adjusted |       | 8,956                                       |       | 4,821 |   |
| Provision for  income taxes, as adjusted               |       | 3,717                                       |       | 707 |   |
|                                                   |       |                                        |       |   |   |
| Net income, as  adjusted                               |       | $                                           | 5,239      |   | $ | 4,114 |   |
|                                                   |       |                                        |       |   |   |
| Diluted earnings  per share, as adjusted               |       | $                                           | 0.39       |   | $ | 0.31 |   |

 

----

*(1)*

OnJanuary 1, 2006, the Company adopted FAS 123(R). These amountsrepresent expenses relating to issuances of equity awards in the periodspresented.

 

*(2)*

Representsa pre-tax gain recognized in connection with the sale of the Company’s officeand warehouse facility in Cambridge, Massachusetts on June 30, 2005.

 

*(3)*

Representsa pre-tax charge associated with the reprographics business unit.

 

*(4)*

The(gain) loss related to derivative instruments is the consequence of interestrate swaps which had previously qualified for hedge accounting no longerqualifying for such treatment as a result of separate and distinct refinancingsof our credit facility in 2005 and 2006. Management does not expect its otherinterest rate swaps to fail to qualify for hedge accounting treatment in futureperiods because the Company does not currently expect further refinancings ofthe facility prior to its maturity in 2011.  For interest rate swaps thatdo qualify as hedged instruments, changes in mark to market will continue to berecorded in Other Comprehensive Income and not in the income statement. Including the fluctuation in the fair value of the derivative instruments inthe reconciliation of net income as reported to net income as adjusted allowsfor a more consistent comparison of the operating results of the Company. The fair value of the derivatives is ultimately zero at the time ofsettlement.  Thus, over the life of the derivative instruments the netimpact to the Company’s operating results will be zero as any income or lossrecorded in prior periods will be reversed in subsequent periods.

 

*(5)*

Eachof the losses on early extinguishment of debt resulted from separate anddistinct refinancings of our senior credit facility in 2005 and 2006 and is notrelated to the performance of the Company’s business. Each of the lossesreflects only the unamortized cost of the prior bank financing which had beenallocated to banks which did not participate in the replacement financingagreement. Because the losses were triggered by refinancings of our seniorcredit facility and the Company does not currently expect further refinancingsof the facility prior to its maturity in 2011, management believes that theimpact of this item on the Company’s financial results will not continue.

 

Tosupplement the Company’s consolidated financial statements presented on agenerally accepted accounting principles (GAAP) basis, management has used anon-GAAP measure of net income. Management believes presentation of thismeasure is appropriate to enhance an overall understanding of our historicalfinancial performance and future prospects. Adjusted net income, which isadjusted to exclude certain gains and losses from the comparable GAAP netincome, is an indication of our baseline performance before gains, losses orother charges that are considered by management to be outside of our coreoperating results. These non-GAAP results are among the primary indicatorsmanagement uses as a basis for evaluating the Company’s financial performanceas well as for forecasting future periods. For these reasons, managementbelieves these non-GAAP measures can be useful to investors, potentialinvestors and others.

 

Non-GAAPfinancial measures are not in accordance with, or an alternative for, generallyaccepted accounting principles in the United States. The Company’s non-GAAPfinancial measures are not meant to be considered in isolation or as asubstitute for comparable GAAP financial measures, and should be read only inconjunction with the Company’s consolidated financial statements prepared inaccordance with GAAP.

 

**Liquidity and Capital Resources (Dollars in thousands)**

 

Webelieve that we can satisfy our working capital requirements and funding ofcapital needs with internally generated cash flow and, as necessary, borrowingsunder our revolving loan facility described

 

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below.Included in the capital requirements that we expect to be able to fund during2008 is approximately $30,000 of laundry equipment, laundry room betterments,and contract incentives incurred in connection with new customer leases and therenewal of existing leases.

 

Wehistorically have not needed sources of financing other than our internallygenerated cash flow and our revolving credit facilities to fund our workingcapital, capital expenditures and smaller acquisitions. As a result, weanticipate that our cash flow from operations and revolving credit facilitieswill be sufficient to meet our anticipated cash requirements for at least thenext twelve months.

 

Fromtime to time, we consider potential acquisitions. We believe that any futureacquisitions of significant size would likely require us to obtain additionaldebt or equity financing. In the past, we have been able to obtain suchfinancing for other material transactions on terms that we believed to bereasonable. However, it is possible that we may not be able to find acquisitionfinancing on favorable terms in the future.

 

Ourcurrent long-term liquidity needs are principally the repayment of theoutstanding principal amounts of our long-term indebtedness, includingborrowings under our senior credit facilities. We are unable to project withcertainty whether our long-term cash flow from operations will be sufficient torepay our long-term debt when it comes due. If this cash flow were insufficient,then we would need to refinance such indebtedness or otherwise amend its termsto extend the maturity dates. We cannot make any assurances that suchrefinancing or amendments, if necessary, would be available on reasonableterms, if at all.

 

**Operating Activities**

 

Forthe years ended December 31, 2005, 2006 and 2007, cash flows provided byoperating activities were $37,798, $36,403 and $43,645, respectively. Cashflows from operations consist primarily of facilities management revenue andequipment sales, offset by the cost of facilities management revenues, cost ofproduct sold, and selling, general and administration expenses. The increasefor the year ended December 31, 2007 as compared to the year ended December 31,2006 is primarily attributable to ordinary changes in working capital. The mostsignificant increases in cash flows provided by operating activities weredepreciation and amortization expense, non-cash compensation expense, non-cashexpense related to derivative instruments, and an increase in accounts payable,accrued facilities management rent and accrued expenses. The increase indepreciation and amortization expense is primarily attributable to the contractrights and equipment we acquired in 2007. The increase in accounts payable, accruedfacilities management rent and accrued expenses was also attributable to theacquisitions in 2007. The most significant decrease in cash flows provided byoperating activities was caused by an increase in accounts receivable.

 

**Investing Activities**

 

Forthe years ended December 31, 2005, 2006 and 2007, cash flows used ininvesting activities were $120,251, $44,975 and $73,387, respectively. Theincrease for the year ended December 31, 2007 as compared to the yearended December 31, 2006 is attributable to the payment for certainacquisitions of laundry facilities management assets during 2007 of $46,626.Other capital expenditures for the years ended December 31, 2007 and 2006totaled $27,154 and $25,911, respectively.

 

**Financing Activities**

 

Forthe years ended December 31, 2005, 2006 and 2007, cash flows provided byfinancing activities were $87,008, $9,520 and $31,073, respectively. Cash flowsprovided by financing activities consist primarily of proceeds from andrepayments of bank borrowings, which increased in 2007 due to borrowings tofund acquisitions.

 

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EffectiveDecember 29, 2006, we amended our senior bank credit facilities, reducingthe credit line to $65,000 (with the option, subject to customary terms andconditions, to increase the line up to $100,000, in increments of not less than$10,000, over the life of the facility), reducing the interest rate on outstandingborrowings, modifying certain covenants and extending the maturity date to December 29,2011. Concurrent with the Hof Acquisition, we increased the credit line to$85,000. The senior credit facilities are collateralized by a blanket lien onall of our assets and our two subsidiaries, Mac-Gray Services, Inc. andIntirion Corporation, as well as a pledge by the Company of all of the capitalstock of its two subsidiaries. Borrowings outstanding under the revolving lineof credit bear interest at a fluctuating rate equal to (i) in the case ofEurodollar rate loans, the LIBOR rate (adjusted for statutory reserves) plus anapplicable percentage, ranging from 1.00% to 1.50% (1.50% as of December 31,2007) determined quarterly by reference to the funded debt ratio, or (ii) inthe case of alternate base rate loans and swing line loans, the higher of (a) thefederal funds rate plus 0.50% or (b) the annual rate of interest announcedby JPMorgan Chase Bank, N.A. as its “prime rate,” in each case, plus an applicablepercentage, ranging from 0.00% to 0.50% (0.50% as of December 31, 2007),determined and payable quarterly by reference to the funded debt ratio. Underthe senior credit facilities, we pay a commitment fee equal to a percentage,ranging from 0.25% to 0.30%, determined and payable quarterly by reference tothe funded debt ratio, of the average daily-unused portion of the revolverunder the senior credit facility. This commitment fee percentage was 0.30% asof December 31, 2007.

 

Asof December 31, 2007, there was $55,000 outstanding under the revolvingline of credit and $860 in outstanding letters of credit under the seniorcredit facilities. The available balance under the revolving line of credit was$29,140 at December 31, 2007. The average interest rate on the borrowingsoutstanding under the senior credit facilities at December 31, 2006 and2007 were 5.94% and 6.20%, respectively, including the applicable spread paidto the banks.

 

Thecredit agreement for the senior credit facilities includes customary covenants,including, but not limited to, restrictions pertaining to: (i) theincurrence of additional indebtedness, (ii) limitations on liens, (iii) makingdistributions, dividends and other payments, (iv) the making of certaininvestments and loans, (v) mergers, consolidations and acquisitions, (vi) dispositionsof assets, (vii) the maintenance of minimum consolidated net worth,maximum funded debt ratios, minimum consolidated cash flow coverage ratios, andmaximum senior secured leverage ratios, (viii) transactions withaffiliates, (ix) sale and leaseback transactions, (x) entering intoswap agreements, and (xi) changes to governing documents, in each casesubject to numerous baskets, exceptions and thresholds. The funded debt ratio,consolidated cash flow coverage ratio and senior secured leverage ratio that wewere required to meet as of December 31, 2007 were 4.25 to 1.00, 1.10 to1.00, and 2.50 to 1.00, respectively. We were in compliance with these and allother financial covenants at December 31, 2007.

 

Thecredit agreement for the senior credit facilities provides for customary eventsof default, including, but not limited to: (i) failure to pay anyprincipal or interest when due, (ii) failure to comply with covenants, (iii) anymaterial representation or warranty made by the Company proving to be incorrectin any material respect, (iv) defaults relating to or acceleration ofother material indebtedness, (v) certain insolvency or receivership eventsaffecting the Company or any of its subsidiaries, (vi) a change incontrol, (vii) material judgments, claims or liabilities against theCompany or (viii) a material defect in the lenders’ lien against thecollateral securing the obligations under the credit agreement. There were noevents of default under the senior credit facilities at December 31, 2007.

 

OnAugust 16, 2005, we issued senior unsecured notes in the amount of$150,000. These notes bear interest at 7.625% payable semi-annually each February andAugust. The maturity date of the notes is August 15, 2015. The seniorcredit facilities were amended to permit the offering of the notes and modifycertain of the covenants applicable to the senior credit facilities. Theproceeds from the

 

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seniornotes, less financing costs, were used to retire the term loan and pay down therevolver under the senior credit facilities.

 

Onand after August 15, 2010, we will be entitled, at our option, to redeemall or a portion of these notes at the redemption prices (expressed inpercentages of principal amount on the redemption date,) plus accrued interestto the redemption date, if redeemed, during the 12-month period commencing on August 15of the years set forth below:

 
| **Period**           | ** ** | **Redemption  Price** | ** ** |
|----------------------|------------|-----------------------|------------|
| 2010                 |       | 103.813               | %          |
| 2011                 |       | 102.542               | %          |
| 2012                 |       | 101.271               | %          |
| 2013 and  thereafter |       | 100.000               | %          |

 

Subjectto certain conditions, we will be entitled, at our option, on one or moreoccasions prior to August 15, 2008 to redeem notes in an aggregateprincipal amount not to exceed 35% of the aggregate principal amount of thenotes originally issued at a redemption price (expressed as a percentage ofprincipal amount on the redemption date) of 107.625%, plus accrued and unpaidinterest to the redemption date, with the net cash proceeds from one or moreequity offerings.

 

Theterms of the senior notes include customary covenants, including, but notlimited to, restrictions pertaining to: (i) incurrence of additionalindebtedness and issuance of preferred stock, (ii) payment of dividends onor making of distributions in respect of capital stock or making certain otherrestricted payments or investments, (iii) entering into agreements thatrestrict distributions from restricted subsidiaries, (iv) sale or otherdisposition of assets, including capital stock of restricted subsidiaries, (v) transactionswith affiliates, (vi) incurrence of liens, (vii) sale/leasebacktransactions, and (viii) merger, consolidation or sale of substantiallyall of our assets, in each case subject to numerous baskets, exceptions andthresholds. We were in compliance with these and all other financial covenantsat December 31, 2007.

 

Theterms of the senior notes provide for customary events of default, including,but not limited to: (i) failure to pay any principal or interest when due,(ii) failure to comply with covenants and limitations, (iii) certaininsolvency or receivership events affecting us or any of our subsidiaries and (iv) unsatisfiedmaterial judgments, claims or liabilities against us. There were no events ofdefault under the senior notes at December 31, 2007.

 

Unamortizedfinancing costs of $668 and $73, related to our senior credit facilities, wereexpensed during the years ended December 31, 2005 and 2006, respectively.

 

Capitallease obligations on our fleet of vehicles totaled $3,068 and $3,521 at December 31,2006 and 2007, respectively.

 

Wehave entered into standard International Swaps and Derivatives Association, orISDA, interest rate swap agreements to manage the interest rate risk associatedwith our senior credit facilities. For a description of our interest rate swapagreements see Item 3, “Quantitative and Qualitative Disclosures AboutMarket Risk.”

 

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**Contractual Obligations**

 

Asummary of the Company’s contractual obligations and commitments related to itsoutstanding long-term debt and future minimum lease payments related to ourvehicle fleet, corporate headquarters and warehouse rent and minimum facilitiesmanagement rent as of December 31, 2007 is as follows:

 
| **Fiscal Year** | ** ** | **Long Term  Debt** | ** ** | **Facilities Rent  Commitments** | ** ** | **Capital Lease  Commitments** | ** ** | **Operating Lease  Commitments** | ** ** | **Total** | ** ** |
|----------------------|------------|--------------------------|------------|---------------------------------------|------------|-------------------------------------|------------|---------------------------------------|------------|-----------|------------|
| **2008**             |       | $                        | —     |                                  | $          | 16,734                              |       | $                                     | 1,352      |      | $          | 2,905 |   | $ | 20,991 |   |
| **2009**             |       | —                   |       | 14,763                                |       | 1,058                               |       | 2,485                                 |       | 18,306    |       |
| **2010**             |       | —                   |       | 12,174                                |       | 823                                 |       | 2,280                                 |       | 15,277    |       |
| **2011**             |       | 55,000                   |       | 8,003                                 |       | 288                                 |       | 1,884                                 |       | 65,175    |       |
| **2012**             |       | —                   |       | 6,008                                 |       | —                              |       | 1,529                                 |       | 7,537     |       |
| **Thereafter**       |       | 150,000                  |       | 9,345                                 |       | —                              |       | 4,044                                 |       | 163,389   |       |
|                 |       |                     |       |                                  |       |                                |       |                                  |       |      |       |
| **Total**            |       | $                        | 205,000    |                                  | $          | 67,027                              |       | $                                     | 3,521      |      | $          | 15,127 |   | $ | 290,675 |   |

 

Weanticipate that available funds from current operations, existing cash andother sources of liquidity will be sufficient to meet current operatingrequirements and anticipated capital expenditures. However, we may requireexternal sources of financing for any significant future acquisitions. Further,our senior credit facility matures on December 29, 2011. The repayment ofthis facility may require external financing.

 

**Off Balance Sheet Arrangements**

 

Atthe years ended December 31, 2005, 2006 and 2007, the Company had norelationships with unconsolidated entities or financial partnerships, such asentities often referred to as structured finance or special purpose entities,which would have been established for the purpose of facilitating off balancesheet arrangements, or other contractually narrow or limited purposes.

 

**Seasonality**

 

Weexperience moderate seasonality as a result of our operations in the collegeand university market. Revenues derived from the college and university marketrepresented approximately 15%, or $36,000, of our total facilities managementrevenue in 2007. Academic facilities management and rental revenues are derivedsubstantially during the school year in the first, second and fourth calendarquarters. Conversely, our operating and capital expenditures have historicallybeen higher during the third calendar quarter when we install a large amount ofequipment while colleges and universities are generally on summer break.Product sales, principally of MicroFridge® branded products, to this market aretypically higher during the third calendar quarter as compared to the rest ofthe calendar year, somewhat offsetting the seasonality effect of the laundryfacilities management business unit.

 

**Inflation**

 

TheCompany does not believe that its financial performance has been materiallyaffected by inflation.

 

**Critical Accounting Policies and Estimates**

 

Thepreparation of our consolidated financial statements in accordance with GAAPrequires management to make judgments, assumptions and estimates that affectthe amounts reported. A critical accounting estimate is an assumption abouthighly uncertain matters and could have a material effect on the consolidatedfinancial statements if another, also reasonable, amount was used or a changein the estimate is reasonably likely from period to period. We base ourassumptions on historical

 

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experienceand on other estimates that we believe are reasonable under the circumstances.Actual results could differ significantly from these estimates.

 

Ourcritical accounting policies, as described in Note 2 to the Mac-Grayaudited consolidated financial statements included elsewhere in this report, “SignificantAccounting Policies,” state our policies as they relate to significant matters:cash and cash equivalents, revenue recognition, provision for doubtfulaccounts, inventories, provision for inventory reserves, goodwill andintangible assets, impairment of long-lived assets, financial instruments andfair value of financial instruments.

 

*Cash and cash equivalents.*    We consider all highlyliquid investments with original maturities of three months or less to be cashequivalents. Included in cash and cash equivalents is an estimate of cash notyet collected at period-end that remains at laundry facilities management andreprographics customer locations. At December 31, 2007 and 2006, thistotaled $9,646 and $9,027, respectively. We record the estimated cash not yetcollected as cash and cash equivalents and facilities management revenue. Wealso record the estimated related facilities management rent expense. Theseestimates are based upon historical collection trends, so that total cash atthe end of each period will be reasonably stated.

 

*Revenue recognition.*    We recognize laundry facilitiesmanagement and reprographics revenue on the accrual basis. Rental revenue onMicroFridge® branded products is recognized ratably over the relatedcontractual period. Included in deferred revenue and deposits is an estimate ofrefunds due to customers. We recognize revenue from product sales upon shipmentof the products unless otherwise specified. We offer limited durationwarranties on MicroFridge® branded products and, at the time of sale, providereserves for all estimated warranty costs based upon historical warranty costs.Actual costs have not exceeded our estimates. Shipping and handling feescharged to customers are recognized upon shipment of the products and areincluded in revenue with related cost included in cost of sales.

 

Wehave entered into long-term lease transactions that meet the qualifications ofa sales-type lease for certain equipment. For these transactions, the amount ofrevenue recognized upon product shipment is the present value of the minimumlease payments, excluding executory costs and excluding profits on executorycosts, discounted at the interest rate implicit in the lease. Interest revenueis recognized over the life of the rental agreement. At December 31, 2007and 2006, we had $3,017 and $1,758, respectively, in receivables related tosales-type leases. These receivables have been recorded net of unearnedinterest income of $555 and $324 at December 31, 2007 and 2006,respectively. These receivables are primarily due ratably over the next sevenyears and have been classified as other current assets and other long-termassets, as appropriate, on the balance sheet. The related reserve foruncollectible lease receivables at December 31, 2007 and 2006 was $17 and$26, respectively. All installation and repair services are provided on anoccurrence basis, not on a contractual basis. Related revenue is recognized atthe time the installation service, or other service, is provided to thecustomer.

 

Webelieve our accounting for facilities management revenue, rental revenue,service fees and long-term lease transactions are appropriate for us, properlymatching the earnings process with the proper reporting period.

 

*Provision for doubtful accounts.*    On a regular basis, wereview the adequacy of our provision for doubtful accounts for trade accountsreceivable and lease receivables based on historical collection results andcurrent economic conditions, using factors based on the aging of our tradeaccounts receivable and lease receivables. In addition, we estimate specific additionalallowances based on indications that a specific customer may be experiencingfinancial difficulties.

 

*Inventories.*    Inventories are stated at the lower of cost (asdetermined using the average cost method) or market and primarily consist offinished goods. Based on the nature of our inventory, being laundry andMicroFridge® branded equipment, and our inventory handling practices, webelieve the lower of cost or market is the most appropriate valuation methodfor us.

 

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*Provision for inventory reserves.*    On a regular basis, wereview the adequacy of our reserve for inventory obsolescence based onhistorical experience, product knowledge and frequency of shipments.

 

*Goodwill and intangible assets.*    Intangible assetsprimarily consist of various non-compete agreements, customer lists, goodwilland contract rights recorded in connection with acquisitions. The non-competeagreements are amortized using the straight-line method over the life of theagreements, which range from five to fifteen years. Customer lists areamortized using the straight-line method over fifteen years. Contract rightsare amortized using the straight-line method over fifteen or twenty years. Thelife assigned to acquired contracts is based on several factors, including: (i) theseller’s renewal rate of the contract portfolio for the most recent years priorto the acquisition, (ii) the number of years the average contract has beenin the seller’s contract portfolio, (iii) the overall level of customersatisfaction within the contract portfolio and (iv) our ability tomaintain or exceed the level of customer satisfaction maintained by the sellerprior to the acquisition by us. We are accounting for acquired contract rightson a pool-basis based on the fact that, in general, no single contract accountsfor more than 2% of the revenue of any acquired portfolio and the fact that fewof the contracts are predicted to be terminated, either prior to or at the endof the contract term. Based on our experience, we believe that these costsassociated with various acquisitions are properly recognized and amortized overa reasonable length of time.

 

*Impairment of long-lived assets.*    We review long-livedassets, including fixed assets, acquired contract rights and intangible assetswith definitive lives, for impairment whenever events or changes in businesscircumstances indicate that the carrying amount of the assets may not be fullyrecoverable or that the useful lives of these assets are no longer appropriate.Our annual impairment test for contract rights assigned a 15-year amortizationperiod consists of comparing the current number of machines under contract andthe current cash flow of all our contracts in the market where the portfolioswere acquired to the original number of machines acquired and the cash flow aspredicted by us at the time of the acquisition. For those contract rightsassigned a 20-year amortization period, our annual impairment test consistsprimarily of identifying the accumulated retention rate of the specificcontract portfolio in order to assess the appropriateness of the net book valueof the related contract rights. If impairment is indicated, the asset iswritten down to its estimated fair value on a discounted cash flow basis.

 

Inaccordance with FAS 142, we test our goodwill annually for impairment andwhenever events or changes in business circumstances indicate that the carryingamount of the assets may not be fully recoverable. The goodwill impairmentreview consists of a two-step process of first comparing the fair value of thereporting unit with its carrying value. If this fair value exceeds the carryingvalue, no further analysis or goodwill impairment charge is required. If thefair value is below the carrying value, the Company would proceed to the nextstep, which is to measure the amount of the impairment loss. Any suchimpairment loss would be recognized in the Company’s results of operations inthe period the impairment loss arose.

 

Inmeasuring whether goodwill is impaired, the Company uses an estimate of itsfuture undiscounted cash flows of the business over the estimated remaininglife. If the Company’s expectation of future undiscounted net cash flowsindicates an impairment, the Company would write down the appropriate assets totheir estimated realizable values based on discounted cash flows. In estimatingexpected future cash flows for determining whether an asset is impaired, assetsare grouped at the lowest level for which there is identifiable cash flows.

 

*Financial instruments.*    We account forderivative instruments in accordance with Statement of Financial AccountingStandard No. 133, “Accounting for Derivative Instruments and HedgingActivities” (“FAS 133”), and Statement of Financial Accounting Standard No. 138,“Accounting for Certain Derivative Instruments and Certain HedgingActivities-an amendment of FASB No. 133” (“FAS 138”). These statementsrequire us to recognize derivatives on our balance sheet at fair value.

 

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Derivativesthat are not hedges must be adjusted to fair value through earnings. If thederivative is a hedge, changes in the fair value of derivatives will either beoffset against the change in fair value of the hedged assets, liabilities orfirm commitments through earnings or recognized in other comprehensive incomeuntil the hedged item is recognized in earnings, depending on the intended useof the derivative. The ineffective portion of a derivative’s change in fairvalue will be immediately recognized in earnings. We have designated some ofour interest rate swap agreements as cash flow hedges. Accordingly, the changein fair value of the agreements is recognized in other comprehensive income andthe ineffective portion of the change is recognized in earnings immediately.

 

*Fair value of financial instruments.*    For purposes offinancial reporting, we have determined that the fair value of financialinstruments approximates book value at December 31, 2007 and 2006, basedupon terms currently available to us in financial markets. The fair value ofthe interest rate swaps is the estimated amount that we would receive or pay toterminate the agreement at the reporting date, taking into account currentinterest rates and the credit worthiness of the counter party.

 

**New Accounting Pronouncements**

 

InSeptember 2006, the FASB issued SFAS No. 157, “Fair ValueMeasurements” (“FAS 157”). FAS 157 clarifies the principle that fairvalue should be based on the assumptions market participants would use whenpricing an asset or liability and establishes a fair value hierarchy thatprioritizes the information used to develop those assumptions. Under thestandard, fair value measurements would be separately disclosed by level withinthe fair value hierarchy. FAS 157 is effective for fiscal years beginningafter November 15, 2007, with early adoption permitted. The Company iscurrently reviewing this new accounting standard but does not expect it to havea material impact on its financial statements.

 

InFebruary 2007, the FASB issued SFAS No. 159, “The Fair Value Optionfor Financial Assets and Financial Liabilities, including an amendment of No. 115”(“FAS 159”), which is effective for fiscal years beginning after November 15,2007, with early adoption permitted. FAS 159 expands opportunities to usefair value measurements in financial reporting and permits entities to chooseto measure many financial instruments and certain other items at fair value.The Company is currently reviewing this new accounting standard but does notexpect it to have a material impact on its financial statements.

 

InDecember 2007, the FASB issued SFAS No. 141(R), “BusinessCombinations” (“SFAS No. 141(R)”). SFAS 141(R) requires theacquiring entity in a business combination to recognize the full fair value ofassets acquired and liabilities assumed in the transaction (whether a full orpartial acquisition); establishes the acquisition-date fair value as themeasurement objective for all assets acquired and liabilities assumed; requiresexpensing of most transaction and restructuring costs; and requires theacquirer to disclose to investors and other users all of the information neededto evaluate and understand the nature and financial effect of the businesscombination. SFAS No. 141(R) applies to all transactions or otherevents in which the Company obtains control of one or more businesses,including those sometimes referred to as “true mergers” or “mergers of equals”and combinations achieved without the transfer of consideration, for example,by contract alone or through the lapse of minority veto rights. SFAS No. 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter January 1, 2009.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements—an amendment of AccountingResearch Bulletin No. 51” (“SFAS No. 160”). SFAS No. 160requires reporting entities to present noncontrolling (minority) interests asequity (as opposed to as a liability or mezzanine equity) and provides guidanceon the accounting for transactions between an entity and noncontrollinginterests. SFAS No. 160 applies prospectively as of January 1,

 

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2009,except for the presentation and disclosure requirements which will be appliedretrospectively for all periods presented.

 

**Item 7A.    Quantitative andQualitative Disclosures About Market Risk**

 

TheCompany is exposed to a variety of risks, including changes in interest rateson its borrowings. In the normal course of its business, the Company managesits exposure to these risks as described below. The Company does not engage intrading market-risk sensitive instruments for speculative purposes.

 

*Interest Rates—*

 

Thetable below provides information about the Company’s debt obligations includingdebt obligations that are sensitive to changes in interest rates. For debtobligations, the table presents principal cash flows and related weightedaverage interest rates by expected maturity dates. The fair market value oflong-term debt approximates book value at December 31, 2007.

 
| ** **             | ** ** | **December 31, 2007**                               | ** ** |
|------------------------|------------|---------------------------------------------------------------|------------|
| ** **             | ** ** | **Expected Maturity Date (In Thousands)** | ** ** |
| ** **             | ** ** | **2008**                                                      | ** ** | **2009** | ** ** | **2010** | ** ** | **2011** | ** ** | **2012** | ** ** | **Thereafter** | ** ** | **Total** | ** ** |
| Long-term Debt:        |       |                                                          |       |   |   |   |   |   |   |   |   |   |   |   |   |
| Fixed Rate             |       | $                                                             | —     |   | $ | — |   | $ | — |   | $ | — |   | $ | — |   | $ | 150,000 |   | $ | 150,000 |   |
| Average interest  rate |       |                                                          |       |   |   |   |   |   |   |   |   | 7.625 | % |   |   |
| Variable rate          |       | $                                                             | —     |   | $ | — |   | $ | — |   | $ | 55,000 |   | $ | — |   | $ | — |   | $ | 55,000 |   |
| Average interest  rate |       |                                                          |       |   |   |   |   | 6.20 | % |   |   |   |   |   |   |

 

TheCompany entered into standard International Swaps and Derivatives Association (“ISDA”)interest rate swap agreements (the “Swap Agreements”) to manage the interestrate risk associated with its debt. Concurrent with the reduction of theamounts due under the senior credit facilities, certain Swap Agreementspreviously designated as cash flow hedges ceased to qualify as such. The changein the fair value of the Swap Agreements that do not qualify for hedgeaccounting is recognized in the income statement in the period in which thechange occurs. The change in the fair value of these contracts resulted in aloss of $1,737 and $96 for the years ended December 31, 2007 and 2006,respectively.

 

Thetable below outlines the details of each remaining Swap Agreement:

 
| **Date of Origin** | ** ** | **Original  Notional  Amount** | ** ** | **Fixed/  Amortizing** | ** ** | **Notional  Amount  December 31,  2007** | ** ** | **Expiration  Date** | ** ** | **Fixed  Rate** | ** ** |
|------------------------------|------------|--------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|----------------------|------------|-----------------|------------|
| June 24,  2003          |       | $                              | 20,000     |                   | Amortizing |                                          | $          | 7,143                |       | Jun 30, 2008    |       | 2.34 | % |
| June 24,  2003          |       | $                              | 20,000     |                   | Fixed      |                                          | $          | 20,000               |       | Jun 30, 2008    |       | 2.69 | % |
| May 2, 2005             |       | $                              | 17,000     |                   | Fixed      |                                          | $          | 17,000               |       | Dec 31, 2011    |       | 4.69 | % |
| May 2, 2005             |       | $                              | 12,000     |                   | Fixed(1)   |                                          | $          | —               |       | Sep 30, 2009    |       | 4.66 | % |
| May 2, 2005             |       | $                              | 10,000     |                   | Fixed(1)   |                                          | $          | —               |       | Dec 31, 2011    |       | 4.77 | % |

 

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*(1)*

EffectiveDate is June 30, 2008

 

Inaccordance with the Swap Agreements and on a quarterly basis, interest expenseis calculated based on the floating 90-day LIBOR and the fixed rate. Ifinterest expense as calculated is greater based on the 90-day LIBOR, thefinancial institution pays the difference to the Company; if interest expenseas calculated is greater based on the fixed rate, the Company pays thedifference to the financial institution. Depending on fluctuations in theLIBOR, the Company’s interest rate exposure

 

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andits related impact on interest expense and net cash flow may increase ordecrease. The counter party to the swap agreement exposes the Company to creditloss in the event of non-performance; however, nonperformance is notanticipated.

 

Thefair value of the Swap Agreements is the estimated amount that the Companywould receive or (pay) to terminate the agreement at the reporting date, takinginto account current interest rates and the credit worthiness of the counterparty. At December 31, 2006 and 2007, the fair values of the SwapAgreements were $1,335 and $(665), respectively. These amounts have beenincluded in other assets and other liabilities on the consolidated balancesheets.

 

Asof December 31, 2007, there was $55,000 outstanding under the revolvingline of credit and $860 in outstanding letters of credit. The available balanceunder the revolving line of credit was $29,140 at December 31, 2007. Theaverage interest rate on the borrowings outstanding at December 31, 2007was approximately 6.20%, including the applicable spread paid to the banks.

 

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**Item 8.    FinancialStatements and Supplementary Data**

 

Financialstatements and supplementary data are contained in pages F-1 through F-35hereto.

 

**Item 9.    Changes in andDisagreements With Accountants on Accounting and Financial Disclosure**

 

None.

 

**Item 9A.    Controls andProcedures**

 

*(a)  Disclosure Controls and Procedures*

 

Asof the end of the period covered by this report, an evaluation was carried outby our management, with the participation of our chief executive officer andchief financial officer, of the effectiveness of our disclosure controls andprocedures (as defined in Rule 13a and 15(d)-15(e) under theSecurities Exchange Act of 1934, as amended (the “Exchange Act”)). Based uponthat evaluation, our chief executive officer and chief financial officerconcluded that these disclosure controls and procedures were effective as of December 31,2007 in providing reasonable assurance that information required to bedisclosed by us in the reports that we file or submit under the Exchange Act isrecorded, processed, summarized and reported within the time periods specifiedin the SEC’s rules and forms. In response to a comment from the staff ofthe Securities and Exchange Commission, the Company amended this Item 9A toremove certain language. The language had been included due to an inadvertent,administrative error and management does not believe this error reflects on theoverall effectiveness of the Company’s disclosure controls and procedures.  Accordingly, our principal executive officerand principal financial officer continue to conclude that the Company’sdisclosure controls and procedures were effective at December 31, 2007. Indesigning and evaluating the disclosure controls and procedures, our managementrecognized that any controls and procedures, no matter how well designed andoperated, can provide only reasonable assurances of achieving the desiredcontrol objectives and management necessarily was required to apply itsjudgment in designing and evaluating the controls and procedures. On anon-going basis, we review and document our disclosure controls and proceduresand our internal control over financial reporting and may from time to timemake changes aimed at enhancing their effectiveness and to ensure that oursystems evolve with our business. There were no changes in our internal controlover financial reporting (as defined in Rule 13a-15(f) or Rule 15(d)-15(f) underthe Exchange Act) that occurred during the fourth quarter of our fiscal yearended December 31, 2007 that has materially affected, or is reasonablylikely to materially affect, our internal control over financial reporting.

 

*(b)  Management’s Annual Report on InternalControl over Financial Reporting*

 

Themanagement of the Company is responsible for establishing and maintainingadequate internal control over financial reporting for the Company. The Company’sinternal control over financial reporting is a process designed under thesupervision of the Company’s principal executive and principal financialofficers to provide reasonable assurance regarding the reliability of financialreporting and the preparation of the Company’s financial statements forexternal reporting purposes in accordance with accounting principles generallyaccepted in the United States. Because of its inherent limitations, internalcontrol over financial reporting may not prevent or detect misstatements andeven when determined to be effective, can only provide reasonable assurancewith respect to financial statement preparation and presentation. Also,projections of any evaluation of effectiveness to future periods are subject tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

Wehave excluded the acquisition of Hof Service Company, Inc. and Bobb Corp.(collectively “Hof”) from our assessment of internal controls over financialreporting as of December 31, 2007, because we acquired Hof in a purchasebusiness combination during 2007. The Hof business is a component of ourFacilities Management reporting segment and represents approximately 11% of ourtotal consolidated assets as of December 31, 2007 and approximately 5% ofour total consolidated revenue for the year ended December 31, 2007.

 

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* *

*(c)  Changes in Internal Control over FinancialReporting*

 

Asof the end of the Company’s 2007 fiscal year, management conducted assessmentsof the effectiveness of the Company’s internal control over financial reportingbased on the criteria set forth by the Committee of Sponsoring Organizations ofthe Treadway Commission in*InternalControl—Integrated Framework* . Based on these assessments,management has determined that the Company’s internal control over financialreporting as of December 31, 2007 was effective. Our internal control overfinancial reporting includes policies and procedures that (1) pertain tothe maintenance of records that, in reasonable detail, accurately and fairlyreflect transactions and dispositions of our assets; (2) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with accounting principlesgenerally accepted in the United States, and that receipts and expenditures arebeing made only in accordance with authorizations of management and thedirectors of the Company; and (3) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use or dispositionof the Company’s assets that could have a material effect on our financialstatements.

 

*NYSE Annual CEO Certification.*    On May 30, 2007,Stewart Gray MacDonald, Jr., Chief Executive Officer of the Company,submitted to the New York Stock Exchange (the “NYSE”) the Annual CEOCertification required by Section 303A of the Corporate Governance Rules ofthe NYSE certifying that he was not aware of any violation by the Company ofNYSE corporate governance listing standards.

 

**Item 9B.    Other Information**

 

None.

 

**PART III**

 

**Item 10.    Directors andExecutive Officers of the Registrant**

 

Wewill furnish to the SEC a definitive Proxy Statement no later 120 daysafter the close of the fiscal year ended December 31, 2007. Certaininformation required by this Item 10 is incorporated herein by referenceto the Proxy Statement.

 

**Item 11.    Executive Compensation**

 

Theinformation required by this Item 11 is incorporated herein by referenceto the Proxy Statement.

 

**Item 12.    Security Ownershipof Certain Beneficial Owners and Management and Related Stockholder Matters**

 

Theinformation required by this Item 12 is incorporated herein by referenceto the Proxy Statement.

 

41

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**Stock Option Plan Information and Employee StockPurchase Plan Information**

 

The following tables provide information as of December 31, 2007regarding shares of our common stock that may be issued under the existingequity compensation plans, including our 1997 Stock Option and Incentive Plan(the “1997 Plan”), 2001 Employee Stock Purchase Plan (the “ESPP”) and 2005Stock Option and Incentive Plan (the “2005 Plan”). There are no equitycompensation plans that have not been approved by the shareholders.

 
| **Plan category**                                      | ** ** | **Number of securities to  be issued upon exercise  of outstanding options,  warrants and rights** | ** ** | **Weighted average  exercise price of  outstanding options,  warrants and rights** | ** ** | **Number of securities  remaining available for  future issuance under  equity compensation plans  (excluding securities  referenced in column (a))** | ** ** |
|-------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------------------------------------------|------------|------------------------------------------------------------------------------------------------------------------|------------|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|
| ** **                                                  | ** ** | **(a)**                                                                                                                                              | ** ** | **(b)**                                                                                                          | ** ** | **(c)**                                                                                                                                                                                                           | ** ** |
| Equity  compensation plans approved by security holders(1)  |       | 1,493,388                                                                                                                                            |       | $                                                                                                                | 8.71       |                                                                                                                                                                                                              | 1,921,559  | (2) |
| Equity  compensation plans not approved by security holders |       | —                                                                                                                                               |       | —                                                                                                           |       | —                                                                                                                                                                                                            |       |
|                                                        |       |                                                                                                                                                 |       |                                                                                                             |       |                                                                                                                                                                                                              |       |
| Total                                                       |       | 1,493,388                                                                                                                                            |       | $                                                                                                                | 8.71       |                                                                                                                                                                                                              | 1,921,559  | (2) |

 

----

*(1)*

Represents outstanding options and restricted shares granted but not yetissued under the 1997 Plan and 2005 Plan. There are no options, warrants orrights outstanding under the ESPP (does not include the purchase rightsaccruing under the ESPP because the purchase price, and therefore the number ofshares to be purchased, is not determinable until the end of the purchaseperiod).

 

*(2)*

Includes680,600 shares available for future issuance under the 1997 Plan, 1,214,834shares available for future issuance under the 2005 Plan, and 26,125 sharesavailable for future issuance under the ESPP. No new share options may begranted under the 1997 Plan. The number of shares reserved for issuance underthe 2005 Plan is 1,300,000.

 

**Item 13.    CertainRelationships and Related Transactions, and Director Independence**

 

The information required by this Item 13 is incorporated herein byreference to the Proxy Statement.

 

**Item 14.    PrincipalAccounting Fees and Services**

 

The information required by this Item 14 is incorporated herein byreference to the Proxy Statement.

 

**PART IV**

 

**Item 15.    Exhibits andFinancial Statement Schedules**

 

(a)   1. and 2. An Index to Consolidated FinancialStatements and Financial Statement Schedules is on Page F-1 of thisReport.

 

(b)   3. Exhibits:

 

Exhibits required by Item 601 of Regulation S-K and AdditionalExhibits. Unless otherwise indicated, all exhibits are part of Commission FileNumber 1-13495. Certain exhibits indicated below are incorporated byreference to documents of Mac-Gray on file with the Commission.

 

Each exhibit marked by a cross (+) was previously filed as an exhibit toMac-Gray’s Registration Statement on Form S-1 filed on August 14,1997 (No. 333-33669) and the number in parentheses following thedescription of the exhibit refers to the exhibit number in the Form S-1.

 

Each exhibit marked by a number sign (#) was previously filed as anexhibit to Amendment No. 1 to Mac-Gray’s Registration Statement on Form S-1,filed on September 25, 1997 (No. 333-33669) and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form S-1.

 

Each exhibit marked by a (z) was previously filed as an exhibit toAmendment No. 1 of Mac-Gray’s Registration Statement on Form S-1,filed on April 17, 1998 (No. 333-49795) and the number in parenthesesfollowing the description of the exhibit refers to the exhibit number in the Form S-1.

 

Each exhibit marked by a (x) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on June 18, 1999 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (v) was previously filed as an exhibit toMac-Gray’s Form 10-K filed on March 29, 2002 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 10-K.

 

Each exhibit marked by a (t) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on January 28, 2004 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by an (s) was previously filed as an exhibit toMac-Gray’s Form 10-K/A filed on April 11, 2002 and the number inparenthesis following the description of the exhibit refers to the exhibitnumber in the Form 10-K/A.

 

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Each exhibit marked by an (r) was previously filed as an exhibit toMac-Gray’s Form 10-K filed on March 31, 2005, and the number inparenthesis following the description of the exhibit refers to the exhibitnumber in the Form 10-K.

 

Each exhibit marked by a (p) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on May 31, 2005 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (o) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on July 28, 2005 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (n) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on August 18, 2005 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (l) was previously filed as an exhibit toMac-Gray’s Form 10-Q filed on November 14, 2005 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 10-Q.

 

Each exhibit marked by a (k) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on November 13, 2006 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (j) was previously filed as an exhibit to Mac-Gray’sForm 8-K filed on December 28, 2006 and the number in parenthesesfollowing the description of the exhibit refers to the exhibit number in the Form 8-K.

 

Each exhibit marked by a (i) was previously filed as an exhibit toMac-Gray’s Form 10-Q filed on May 15, 2006 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 10-Q.

 

Each exhibit marked by a (h) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on March 13, 2007 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (g) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on August 13, 2007 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (f) was previously filed as an exhibit toMac-Gray’s Form 10-Q filed on November 9, 2007 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 10-Q.

 

Each exhibit marked by a (e) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on January 24, 2008 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (d) was previously filed as an exhibit toMac-Gray’s Definite Proxy Statement, filed on April 19, 2001 and thenumber in parentheses following the description of the exhibit refers to theexhibit number in the Proxy Statement.

 

Each exhibit marked by a (c) was previously filed as an exhibit toMac-Gray’s Form 8-K filed on March 7, 2008 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 8-K.

 

Each exhibit marked by a (b) was previously filed as an exhibit toMac-Gray’s Form 10-K filed on March 14, 2008 and the number inparentheses following the description of the exhibit refers to the exhibitnumber in the Form 10-K.

 

The following is a complete list of exhibits filed or incorporated byreference as part of this Annual Report on Form 10-K/A.

 
| 3.10   | Amended  and Restated Certificate of Incorporation (3.1)+                                                                                                                    |
|--------|------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                         |
| 3.20   | Amended  and Restated By-laws (3.1)c                                                                                                                                         |
|   |                                                                                                                                                                         |
| 4.10   | Specimen  certificate for shares of Common Stock, $.01 par value, of the  Registrant (4.1)#                                                                             |
|   |                                                                                                                                                                         |
| 4.20   | Shareholder  Rights Agreement, dated as of June 15, 1999, by and between the  Registrant and State Street Bank and Trust Company (4.1)x                            |
|   |                                                                                                                                                                         |
| 4.30   | Indenture,  dated August 16, 2005, among Mac-Gray Corporation, Mac-Gray  Services, Inc., Intirion Corporation and Wachovia Bank, National  Association (4.1)n |
|   |                                                                                                                                                                         |
| 10.01  | Stockholders’  Agreement, dated as of June 26, 1997, by and among the Registrant and  certain stockholders of the Registrant (10.2)+                          |
|   |                                                                                                                                                                         |
| 10.02  | Form of  Maytag Distributorship Agreements (10.13)+                                                                                                                     |
|   |                                                                                                                                                                         |
| 10.03  | The  Registrant’s 1997 Stock Option and Incentive Plan (with form of option  agreements attached as exhibits) (10.16)+***                                          |
|   |                                                                                                                                                                         |
| 10.09  | Form of  Noncompetition Agreement between the Registrant and its executive  officers (10.15)v***                                                                   |

 

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| 10.10  | Form of  Director Indemnification Agreement between the Registrant and each of its  Directors (10.16)v***                                                                                                                          |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                         |
| 10.11  | April 2001  Amendment to the Mac-Gray Corporation 1997 Stock Option and Incentive  Plan (10.17)v***                                                                                                                                |
|   |                                                                                                                                                                                                                                         |
| 10.12  | 2005  Directors Compensation Arrangements (10.11)l***                                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                         |
| 10.14  | Form of  executive severance agreement between the Registrant and each of its chief  financial officer and chief operating officer (10.18)s***                                                                                     |
|   |                                                                                                                                                                                                                                         |
| 10.15  | Form of  executive severance agreement between the Registrant and its chief executive  officer (10.19)s***                                                                                                                         |
|   |                                                                                                                                                                                                                                         |
| 10.16  | Asset  Purchase Agreement, dated as of January 16, 2004, between Mac-Gray  Services, Inc. and Web Service Company (2.1)t                                                                                                      |
|   |                                                                                                                                                                                                                                         |
| 10.17  | Asset  Purchase Agreement, dated as of January 10, 2005, between Mac-Gray  Services, Inc. and Web Service Company (10.18)r                                                                                                    |
|   |                                                                                                                                                                                                                                         |
| 10.18  | Trademark  License Agreement dated January 10, 2005 by and between Web Service  Company, Inc. (“Licensor”) and Mac-Gray Services, Inc.  (“Licensee”) (10.19)r                                        |
|   |                                                                                                                                                                                                                                         |
| 10.19  | Mac-Gray  Corporation 2005 Stock Option and Incentive Plan (10.1)p***                                                                                                                                                                   |
|   |                                                                                                                                                                                                                                         |
| 10.20  | Form of  Incentive Stock Option Agreement under the Mac-Gray Corporation 2005 Stock  Option and Incentive Plan (10.2)p***                                                                                                          |
|   |                                                                                                                                                                                                                                         |
| 10.21  | Form of  Non-Qualified Stock Option Agreement for Company Employees under the Mac-Gray  Corporation 2005 Stock Option and Incentive Plan (10.3)p***                                                                                |
|   |                                                                                                                                                                                                                                         |
| 10.23  | Form of  Restricted Stock Award Agreement for awards under the Mac-Gray Corporation  2005 Stock Option and Incentive Plan (10.5)p***                                                                                               |
|   |                                                                                                                                                                                                                                         |
| 10.24  | Lease  Agreement, dated July 22, 2005, between Mac-Gray Services, Inc.,  and 404 Wyman LLC (99.1)o                                                                                                                       |
|   |                                                                                                                                                                                                                                         |
| 10.25  | Registration  Rights Agreement, dated August 16, 2005, by and among Mac-Gray  Corporation, Mac-Gray Services, Inc., Intirion Corporation and J.P.  Morgan Securities Inc. (99.1)n                                        |
|   |                                                                                                                                                                                                                                         |
| 10.26  | Form of  Mac-Gray Corporation 7 (5) / 8% Senior Notes  due 2015 (4.2)n                                                                                                                                                        |
|   |                                                                                                                                                                                                                                         |
| 10.28  | Form of  executive severance agreement between the Registrant and its executive vice  president, operations (99.1)k***                                                                                                             |
|   |                                                                                                                                                                                                                                         |
| 10.29  | Amended  and Restated Credit Agreement, dated December 21, 2006, by and among the  Registrant, the other Borrowers (as defined therein), the lenders named  therein and JPMorgan Chase Bank, N.A., as administrative agent (10.1)j |
|   |                                                                                                                                                                                                                                         |
| 10.30  | Form of  Restricted Stock Award Agreement for awards under the Mac-Gray Corporation  Long Term Incentive Plan (10.1)i***                                                                                                                |
|   |                                                                                                                                                                                                                                         |
| 10.31  | Form of  Employment Agreement between the Company and certain executive  officers (10.1)h***                                                                                                                                       |

 

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| 10.32  | Asset  Purchase Agreement, dated as of August 8, 2007, by and among Mac-Gray  Services, Inc., Hof Service Company, Inc., and the stockholders of  Hof Service Company, Inc. (2.1)g                                                                                                          |
|--------|----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.33  | Asset  Purchase Agreement, dated as of August 8, 2007, by and among Mac-Gray  Services, Inc., Bobb Corp., and the stockholders of Bobb  Corp. (2.2)g                                                                                                                                                  |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.34  | Incremental  Facility Amendment and Amendment No. 1, dated August 8, 2007, to  Amended and Restated Credit Agreement, dated December 21, 2006, by and  among the Company, the other Borrowers therein, the lenders named therein and  JPMorgan Chase Bank, N.A., as administrative agent (10.1)f |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.35  | Mac-Gray  Corporation Long Term Incentive Plan (10.1)e***                                                                                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.36  | Form of  Restricted Stock Unit Agreement for cash settled awards under the Long Term  Incentive Plan (10.2)e***                                                                                                                                                                                            |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.37  | Form of  Restricted Stock Unit Agreement for stock settled awards under the Long Term  Incentive Plan (10.3)e***                                                                                                                                                                                           |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.38  | Mac-Gray  Senior Executive Incentive Plan (10.4)e***                                                                                                                                                                                                                                                                 |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.39  | Form of  Non-Qualified Stock Option Agreement for Non-Employee Directors under the  Mac-Gray Corporation 2005 Stock Option and Incentive Plan (10.5)e***                                                                                                                                                   |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.40  | Mac-Gray  Corporation 2001 Employee Stock Purchase Plan (Ex. A)d***                                                                                                                                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.41  | Form of  executive severance agreement, dated March 3, 2008, between the Registrant  and each of Linda Serafini, Robert Tuttle and Phil Emma (10.1)c***                                                                                                                                               |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.42  | Form of  first amendment to executive severance agreement, dated March 3, 2008,  between the Registrant and each of Stewart MacDonald, Michael Shea and Neil  MacLellan III (10.42)b***                                                                                                                    |
|   |                                                                                                                                                                                                                                                                                                                 |
| 10.43  | Form of  first amendment to employment agreement, dated March 3, 2008, between  the Registrant and each of Stewart MacDonald, Michael Shea and Neil MacLellan  III (10.43)b***                                                                                                                             |
|   |                                                                                                                                                                                                                                                                                                                 |
| 21.1   | Subsidiaries  of the Registrant (21.1)z                                                                                                                                                                                                                                                                         |
|   |                                                                                                                                                                                                                                                                                                                 |
| 23.1   | Consent  of PricewaterhouseCoopers LLP b                                                                                                                                                                                                                                                                        |
|   |                                                                                                                                                                                                                                                                                                                 |
| 31.1   | Certification  of Principal Executive Officer pursuant to Section 302 of the  Sarbanes-Oxley Act of 2002 (filed herewith)                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                 |
| 31.2   | Certification  of Principal Financial Officer pursuant to Section 302 of the Sarbanes  Oxley Act of 2002 (filed herewith)                                                                                                                                                                                       |
|   |                                                                                                                                                                                                                                                                                                                 |
| 32.1   | Certification  of Principal Executive Officer and Principal Financial Officer pursuant to  Section 906 of the Sarbanes-Oxley Act of 2002 (filed herewith)                                                                                                                                                       |

 

----

*****

Management compensatory plan or arrangement

 

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** **

**SIGNATURES**

 

PURSUANTTO THE REQUIREMENTS OF SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGEACT OF 1934, THE REGISTRANT HAS DULY CAUSED THIS REPORT TO BE SIGNED ONITS BEHALF BY THE UNDERSIGNED, THEREUNTO DULY AUTHORIZED, THIS 13TH  DAYOF MARCH, 2009.

 
|   | MAC-GRAY  CORPORATION |
|--------|-----------------------|
|   |                  |   |
|   |                  |   |
|   | By:                   | /s/  Linda A. Serafini |
|   |                  | Linda A. Serafini*Vice President, General Counsel and Secretary**(Duly Authorized Representative)* |
|   |                  |   |
|   |                  |   |

 

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**Items 15(a)(1) and (2)**

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND**

**FINANCIAL STATEMENT SCHEDULE**

 

**Item 15(a)(1)**

 

Thefollowing consolidated financial statements of the registrant and itssubsidiaries required to be included in Item 8 are listed below.

 
| **MAC-GRAY CORPORATION** |                                                                                                             |   |
|--------------------------|------------------------------------------------------------------------------------------------------------------|--------|
| ** **               |                                                                                                             |   |
|                     | Report  of Independent Registered Public Accounting Firm                                                         |   | F-2 |
|                     | Consolidated Balance Sheets at  December 31, 2006 and 2007                                                  |   | F-4 |
|                     | Consolidated Income Statements  for the Years Ended December 31, 2005, 2006 and 2007                        |   | F-5 |
|                     | Consolidated  Statements of Stockholders’ Equity for the Years Ended December 31,  2005, 2006 and 2007 |   | F-6 |
|                     | Consolidated Statements of  Cash Flows for the Years Ended December 31, 2005, 2006 and 2007                 |   | F-7 |
|                     | Notes to  Consolidated Financial Statements                                                                      |   | F-8 |

 

**Item 15(a)(2)**

 

Thefollowing consolidated financial statement schedule of Mac-Gray Corporationshould be read in conjunction with the financial statements included herein.

 
|   | Schedule II  Valuation and Qualifying Accounts |   | F-34 |
|--------|-----------------------------------------------------|--------|------|

 

Allother schedules for which provision is made in the applicable accountingregulations of the Securities and Exchange Commission are not required underthe related instructions or are not material, and therefore have been omitted.

 

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----

Table of Contents

 

**Report ofIndependent Registered Public Accounting Firm**

 

Tothe Board of Directors and Stockholders of Mac-Gray Corporation:

 

Inour opinion, the consolidated financial statements listed in the indexappearing under Item 15(a)(1) on page F-1 present fairly, in allmaterial respects, the financial position of Mac-Gray Corporation (the“Company”) and its subsidiaries at December 31, 2007 and December 31,2006, and the results of their operations and their cash flows for each of thethree years in the period ended December 31, 2007 in conformity withaccounting principles generally accepted in the United States of America. Inaddition, in our opinion, the financial statement schedule listed in the indexappearing under 15(a)(2) on page F-1 presents fairly, in all materialrespects, the information set forth therein when read in conjunction with therelated consolidated financial statements. Also in our opinion, the Companymaintained, in all material respects, effective internal control over financialreporting as of December 31, 2007, based on criteria established in*Internal Control—Integrated Framework* issuedby the Committee of Sponsoring Organizations of the Treadway Commission (COSO).The Company’s management is responsible for these financial statements andfinancial statement schedule, for maintaining effective internal control overfinancial reporting and for its assessment of the effectiveness of internalcontrol over financial reporting, included in “Management’s Annual Report onInternal Control Over Financial Reporting” appearing under Item 9A. Ourresponsibility is to express opinions on these financial statements, on thefinancial statement schedule, and on the Company’s internal control overfinancial reporting based on our audits (which were integrated audits in 2007and 2006). We conducted our audits in accordance with the standards of thePublic Company Accounting Oversight Board (United States). Those standardsrequire that we plan and perform the audits to obtain reasonable assuranceabout whether the financial statements are free of material misstatement andwhether effective internal control over financial reporting was maintained inall material respects. Our audits of the financial statements includedexamining, on a test basis, evidence supporting the amounts and disclosures inthe financial statements, assessing the accounting principles used andsignificant estimates made by management, and evaluating the overall financialstatement presentation. Our audit of internal control over financial reportingincluded obtaining an understanding of internal control over financialreporting, assessing the risk that a material weakness exists, and testing andevaluating the design and operating effectiveness of internal control based onthe assessed risk. Our audits also included performing such other procedures aswe considered necessary in the circumstances. We believe that our auditsprovide a reasonable basis for our opinions.

 

Asdiscussed in Note 2 to the consolidated financial statements, effective January 1,2006, the Company adopted Statement of Financial Accounting Standards No. 123(R),*Share-Based Payment* and effective January 1,2007, the Company adopted FASB Interpretation No. 48,*Accounting for Uncertainty in Income Taxes.*

 

Acompany’s internal control over financial reporting is a process designed toprovide reasonable assurance regarding the reliability of financial reportingand the preparation of financial statements for external purposes in accordancewith generally accepted accounting principles. A company’s internal controlover financial reporting includes those policies and procedures that (i) pertainto the maintenance of records that, in reasonable detail, accurately and fairlyreflect the transactions and dispositions of the assets of the company; (ii) providereasonable assurance that transactions are recorded as necessary to permitpreparation of financial statements in accordance with generally acceptedaccounting principles, and that receipts and expenditures of the company arebeing made only in accordance with authorizations of management and directorsof the company; and (iii) provide reasonable assurance regardingprevention or timely detection of unauthorized acquisition, use, or dispositionof the company’s assets that could have a material effect on the financialstatements.

 

Becauseof its inherent limitations, internal control over financial reporting may notprevent or detect misstatements. Also, projections of any evaluation ofeffectiveness to future periods are subject

 

F-2

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Table of Contents

 

tothe risk that controls may become inadequate because of changes in conditions,or that the degree of compliance with the policies or procedures maydeteriorate.

 

Asdescribed in “Management’s Annual Report on Internal Control over FinancialReporting” appearing under Item 9A, management has excluded theacquisition of Hof Service Company, Inc. and Bobb Corp. (collectively“Hof”) from its assessment of internal control over financial reporting as of December 31,2007 because it was acquired by the Company in a purchase business combinationduring 2007. We have also excluded Hof from our audit of internal control overfinancial reporting. The Hof business is a component of the Company’sFacilities Management reporting segment whose total consolidated assets andtotal consolidated revenues represent 11% and 5%, respectively, of the relatedconsolidated financial statement amounts as of and for the year ended December 31,2007.

 

/s/PricewaterhouseCoopers LLP

 

Boston,Massachusetts

 March 12, 2008

 

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**MAC-GRAY CORPORATION**

 

** CONSOLIDATED BALANCE SHEETS**

 

** (In thousands,except share data)**

 
| ** **                                                                                                                                                                                                                                      | ** ** | **December 31, 2006** | ** ** | **December 31, 2007** | ** ** |
|-------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------|------------|---------------------------------|------------|
| **Assets**                                                                                                                                                                                                                                      |       |                            |       |                            |       |
| Current assets:                                                                                                                                                                                                                                 |       |                            |       |                            |       |
| Cash and cash  equivalents                                                                                                                                                                                                                      |       | $                               | 11,994     |                            | $          | 13,325 |   |
| Trade  receivables, net of allowance for doubtful accounts                                                                                                                                                                                      |       | 9,176                           |       | 10,106                          |       |
| Inventory of  finished goods, net                                                                                                                                                                                                               |       | 7,237                           |       | 7,400                           |       |
| Deferred income  taxes                                                                                                                                                                                                                          |       | 961                             |       | 943                             |       |
| Prepaid  facilities management rent and other current assets                                                                                                                                                                                    |       | 12,951                          |       | 15,160                          |       |
|                                                                                                                                                                                                                                            |       |                            |       |                            |       |
| Total current  assets                                                                                                                                                                                                                           |       | 42,319                          |       | 46,934                          |       |
| Property, plant  and equipment, net                                                                                                                                                                                                             |       | 118,654                         |       | 126,321                         |       |
| Goodwill                                                                                                                                                                                                                                        |       | 38,454                          |       | 42,229                          |       |
| Intangible  assets, net                                                                                                                                                                                                                         |       | 125,543                         |       | 153,341                         |       |
| Prepaid  facilities management rent and other assets                                                                                                                                                                                            |       | 14,034                          |       | 14,712                          |       |
|                                                                                                                                                                                                                                            |       |                            |       |                            |       |
| Total assets                                                                                                                                                                                                                                    |       | $                               | 339,004    |                            | $          | 383,537 |   |
| ** **                                                                                                                                                                                                                                      |       |                            |       |                            |       |
| **Liabilities  and Stockholders’ Equity**                                                                                                                                                                                                  |       |                            |       |                            |       |
| Current  liabilities:                                                                                                                                                                                                                           |       |                            |       |                            |       |
| Current portion  of capital lease obligations                                                                                                                                                                                                   |       | $                               | 1,245      |                            | $          | 1,352 |   |
| Trade accounts  payable                                                                                                                                                                                                                         |       | 10,447                          |       | 11,595                          |       |
| Accrued  facilities management rent                                                                                                                                                                                                             |       | 16,527                          |       | 18,309                          |       |
| Accrued expenses                                                                                                                                                                                                                                |       | 11,445                          |       | 12,350                          |       |
| Deferred  revenues and deposits                                                                                                                                                                                                                 |       | 591                             |       | 777                             |       |
|                                                                                                                                                                                                                                            |       |                            |       |                            |       |
| Total current  liabilities                                                                                                                                                                                                                      |       | 40,255                          |       | 44,383                          |       |
| Long-term debt                                                                                                                                                                                                                                  |       | 174,000                         |       | 205,000                         |       |
| Long-term  capital lease obligations                                                                                                                                                                                                            |       | 1,823                           |       | 2,169                           |       |
| Deferred income  taxes                                                                                                                                                                                                                          |       | 29,620                          |       | 30,907                          |       |
| Other  liabilities                                                                                                                                                                                                                              |       | 1,666                           |       | 3,234                           |       |
| Commitments and  contingencies (Note 16)                                                                                                                                                                                                   |       |                            |       |                            |       |
| Stockholders’  equity:                                                                                                                                                                                                                     |       |                            |       |                            |       |
| Preferred stock  of Mac-Gray Corporation ($.01 par value, 5 million shares authorized, no  shares outstanding)                                                                                                                             |       | —                          |       | —                          |       |
| Common stock of  Mac-Gray Corporation ($.01 par value, 30 million shares authorized,  13,443,754 issued and 13,077,694 outstanding at December 31, 2006, and  13,443,754 issued and 13,276,864 outstanding at December 31, 2007) |       | 134                             |       | 134                             |       |
| Additional paid  in capital                                                                                                                                                                                                                     |       | 70,553                          |       | 72,586                          |       |
| Accumulated  other comprehensive income                                                                                                                                                                                                         |       | 183                             |       | 45                              |       |
| Retained  earnings                                                                                                                                                                                                                              |       | 24,571                          |       | 26,812                          |       |
|                                                                                                                                                                                                                                            |       |                            |       |                            |       |
|                                                                                                                                                                                                                                            |       | 95,441                          |       | 99,577                          |       |
| Less common  stock in treasury, at cost (366,060 shares at December 31, 2006 and  166,890 shares at December 31, 2007)                                                                                                                |       | (3,801                          | )          | (1,733                          | )          |
|                                                                                                                                                                                                                                            |       |                            |       |                            |       |
| Total  stockholders’ equity                                                                                                                                                                                                                |       | 91,640                          |       | 97,844                          |       |
|                                                                                                                                                                                                                                            |       |                            |       |                            |       |
| Total  liabilities and stockholders’ equity                                                                                                                                                                                                |       | $                               | 339,004    |                            | $          | 383,537 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-4

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

** CONSOLIDATED INCOME STATEMENTS**

 

** (In thousands,except share data)**

 
| ** **                                                | ** ** | **Years Ended December 31,** | ** ** |
|-----------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenue:                                                  |       |                                        |       |   |   |   |   |
| Facilities  management revenue                            |       | $                                           | 214,816    |   | $ | 232,181 |   | $ | 242,803 |   |
| Product sales                                             |       | 45,807                                      |       | 47,146 |   | 53,099 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Total revenue                                             |       | 260,623                                     |       | 279,327 |   | 295,902 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Cost of revenue:                                |       |                                        |       |   |   |   |   |
|                                                      |       |                                        |       |   |   |   |   |
| Cost of facilities management revenue |       | 142,052                                     |       | 153,861 |   | 162,839 |   |
| Depreciation and  amortization                            |       | 31,337                                      |       | 35,156 |   | 37,410 |   |
| Cost of product  sales                                    |       | 36,173                                      |       | 37,352 |   | 40,347 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Total cost of  revenue                                    |       | 209,562                                     |       | 226,369 |   | 240,596 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Gross margin                                              |       | 51,061                                      |       | 52,958 |   | 55,306 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Operating  expenses:                                      |       |                                        |       |   |   |   |   |
|                                                      |       |                                        |       |   |   |   |   |
| General and  administration                               |       | 14,164                                      |       | 17,826 |   | 18,075 |   |
| Sales and  marketing                                      |       | 16,097                                      |       | 16,248 |   | 16,364 |   |
| Depreciation and  amortization                            |       | 1,189                                       |       | 1,589 |   | 1,611 |   |
| Gain on sale of  assets, net                              |       | (10,735                                     | )          | (32 | ) | (254 | ) |
| Loss on early  extinguishment of debt                     |       | 668                                         |       | 73 |   | — |   |
| Impairment of  assets                                     |       | —                                      |       | 2,502 |   | — |   |
|                                                      |       |                                        |       |   |   |   |   |
| Total operating  expenses                                 |       | 21,383                                      |       | 38,206 |   | 35,796 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Income from  operations                                   |       | 29,678                                      |       | 14,752 |   | 19,510 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Interest  expense, net                                    |       | (10,939                                     | )          | (13,653 | ) | (13,745 | ) |
| Gain (loss)  related to derivative instruments            |       | 1,876                                       |       | (96 | ) | (1,737 | ) |
|                                                      |       |                                        |       |   |   |   |   |
| Income before  provision for income taxes                 |       | 20,615                                      |       | 1,003 |   | 4,028 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Provision for  income taxes                               |       | (8,563                                      | )          | (147 | ) | (1,509 | ) |
|                                                      |       |                                        |       |   |   |   |   |
| Net income                                                |       | $                                           | 12,052     |   | $ | 856 |   | $ | 2,519 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Net income per  common share—basic                   |       | $                                           | 0.94       |   | $ | 0.07 |   | $ | 0.19 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Net income per  common share—diluted                 |       | $                                           | 0.91       |   | $ | 0.06 |   | $ | 0.18 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Weighted average  common shares outstanding—basic    |       | 12,864                                      |       | 13,008 |   | 13,209 |   |
|                                                      |       |                                        |       |   |   |   |   |
| Weighted average  common shares outstanding—diluted  |       | 13,283                                      |       | 13,448 |   | 13,680 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-5

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**CONSOLIDATEDSTATEMENTS OF STOCKHOLDERS’ EQUITY**

 

**(In thousands, except share data)**

 
| ** **                                                                                                            | ** ** | **Common stock**      | ** ** | ** ** | ** ** | **Accumulated Other**                | ** ** | ** **                          | ** ** | ** **                | ** ** | **Treasury Stock** | ** ** | ** **                 | ** ** |
|-----------------------------------------------------------------------------------------------------------------------|------------|----------------------------|------------|------------|------------|-------------------------------------------|------------|-------------------------------------|------------|---------------------------|------------|-------------------------|------------|----------------------------|------------|
| ** **                                                                                                            | ** ** | **Number of  shares** | ** ** | **Value**  | ** ** | **Additional  Paid in Capital** | ** ** | **Comprehensive  (Loss) Gain** | ** ** | **Comprehensive  Income** | ** ** | **Retained  Earnings**  | ** ** | **Number  of shares** | ** ** | **Cost** | ** ** | **Total** | ** ** |
| Balance,  December 31, 2004                                                                                      |       | 13,443,754                 |       | $          | 134        |                                      | $          | 68,568                              |       | $                         | 822        |                    |       |                       | $          | 13,283 |   | 661,665 |   | $ | (6,871 | ) | $ | 75,936 |   |
| Net income                                                                                                            |       | —                     |       | —     |       | —                                    |       | —                              |       | $                         | 12,052     |                    | 12,052     |                       | —     |   | — |   | 12,052 |   |
| Other  comprehensive income:                                                                                          |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Unrealized loss  on derivative instruments and reclassification adjustment, net of tax benefit  of $338 (Note 7) |       | —                     |       | —     |       | —                                    |       | (507                                | )          | (507                      | )          | —                  |       | —                     |       | — |   | (507 | ) |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Comprehensive  income                                                                                                 |       | —                     |       | —     |       | —                                    |       | —                              |       | $                         | 11,545     |                    | —     |                       | —     |   | — |   | — |   |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Stock  issuance—Employee Stock Purchase Plan                                                                     |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | (127                    | )          | (31,610                    | )          | 328 |   | 201 |   |
| Options exercised                                                                                                     |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | (693                    | )          | (104,583                   | )          | 1,086 |   | 393 |   |
| Windfall tax  benefit                                                                                                 |       | —                     |       | —     |       | 464                                       |       | —                              |       |                      |       | —                  |       | —                     |       | — |   | 464 |   |
| Stock granted                                                                                                         |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | (2                      | )          | (6,058                     | )          | 64 |   | 62 |   |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Balance,  December 31, 2005                                                                                      |       | 13,443,754                 |       | 134        |       | 69,032                                    |       | 315                                 |       |                      |       | 24,513                  |       | 519,414                    |       | (5,393 | ) | 88,601 |   |
| Net income                                                                                                            |       | —                     |       | —     |       | —                                    |       | —                              |       | $                         | 856        |                    | 856        |                       | —     |   | — |   | 856 |   |
| Other  comprehensive income:                                                                                          |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Unrealized loss  on derivative instruments, net of tax benefit of $84 (Note 7)                                   |       | —                     |       | —     |       | —                                    |       | (132                                | )          | (132                      | )          | —                  |       | —                     |       | — |   | (132 | ) |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Comprehensive  income                                                                                                 |       | —                     |       | —     |       | —                                    |       | —                              |       | $                         | 724        |                    | —     |                       | —     |   | — |   | — |   |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Options exercised                                                                                                     |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | (754                    | )          | (129,967                   | )          | 1,350 |   | 596 |   |
| Stock compensation  expense                                                                                           |       | —                     |       | —     |       | 1,147                                     |       | —                              |       |                      |       | —                  |       | —                     |       | — |   | 1,147 |   |
| Windfall tax  benefit                                                                                                 |       | —                     |       | —     |       | 365                                       |       | —                              |       |                      |       | —                  |       | —                     |       | — |   | 365 |   |
| Stock  issuance—Employee Stock Purchase Plan                                                                     |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | (44                     | )          | (17,534                    | )          | 182 |   | 138 |   |
| Stock granted                                                                                                         |       | —                     |       | —     |       | 9                                         |       | —                              |       |                      |       | —                  |       | (5,853                     | )          | 60 |   | 69 |   |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Balance,  December 31, 2006                                                                                      |       | 13,443,754                 |       | 134        |       | 70,553                                    |       | 183                                 |       |                      |       | 24,571                  |       | 366,060                    |       | (3,801 | ) | 91,640 |   |
| Cumulative change  related to the adoption of FIN 48                                                             |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | 500                     |       | —                     |       | — |   | 500 |   |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
|                                                                                                                  |       | 13,443,754                 |       | 134        |       | 70,553                                    |       | 183                                 |       |                      |       | 25,071                  |       | 366,060                    |       | (3,801 | ) | 92,140 |   |
| Net income                                                                                                            |       | —                     |       | —     |       | —                                    |       | —                              |       | $                         | 2,519      |                    | 2,519      |                       | —     |   | — |   | 2,519 |   |
| Other  comprehensive income:                                                                                          |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Unrealized loss  on derivative instruments, net of tax benefit of $124 (Note 7)                                  |       | —                     |       | —     |       | —                                    |       | (138                                | )          | (138                      | )          | —                  |       | —                     |       | — |   | (138 | ) |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Comprehensive  income                                                                                                 |       | —                     |       | —     |       | —                                    |       | —                              |       | $                         | 2,381      |                    | —     |                       | —     |   | — |   | — |   |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Options exercised                                                                                                     |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | (527                    | )          | (128,955                   | )          | 1,340 |   | 813 |   |
| Stock  compensation expense                                                                                           |       | —                     |       | —     |       | 1,679                                     |       | —                              |       |                      |       | —                  |       | —                     |       | — |   | 1,679 |   |
| Windfall tax  benefit                                                                                                 |       | —                     |       | —     |       | 338                                       |       | —                              |       |                      |       | —                  |       | —                     |       | — |   | 338 |   |
| Stock  issuance—Employee Stock Purchase Plan                                                                     |       | —                     |       | —     |       | —                                    |       | —                              |       |                      |       | (22                     | )          | (49,446                    | )          | 514 |   | 492 |   |
| Stock granted                                                                                                         |       | —                     |       | —     |       | 16                                        |       | —                              |       |                      |       | (229                    | )          | (20,769                    | )          | 214 |   | 1 |   |
|                                                                                                                  |       |                       |       |       |       |                                      |       |                                |       |                      |       |                    |       |                       |       |   |   |   |   |
| Balance,  December 31, 2007                                                                                      |       | 13,443,754                 |       | $          | 134        |                                      | $          | 72,586                              |       | $                         | 45         |                    |       |                       | $          | 26,812 |   | 166,890 |   | $ | (1,733 | ) | $ | 97,844 |   |

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-6

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Table of Contents

 

**MAC-GRAY CORPORATION**

** **

**CONSOLIDATEDSTATEMENTS OF CASH FLOWS**

 

** (In thousands)**

 
| ** **                                                                                                                | ** ** | **Years ended December 31,** | ** ** |
|---------------------------------------------------------------------------------------------------------------------------|------------|---------------------------------------------|------------|
| ** **                                                                                                                | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2007** | ** ** |
| Cash flows from  operating activities:                                                                                    |       |                                        |       |   |   |   |   |
| Net income                                                                                                                |       | $                                           | 12,052     |   | $ | 856 |   | $ | 2,519 |   |
| Adjustments to  reconcile net income to net cash flows provided by operating activities, net  of effects of acquisitions: |       |                                        |       |   |   |   |   |
| Depreciation and  amortization                                                                                            |       | 32,526                                      |       | 36,745 |   | 39,021 |   |
| Impairment of  assets                                                                                                     |       | —                                      |       | 2,502 |   | — |   |
| Loss on early  extinguishment of debt                                                                                     |       | 668                                         |       | 73 |   | — |   |
| (Decrease)  increase in allowance for doubtful accounts and lease reserves                                                |       | 206                                         |       | (154 | ) | (50 | ) |
| Gain on  disposition of assets                                                                                            |       | (10,735                                     | )          | (33 | ) | (254 | ) |
| Stock grants                                                                                                              |       | 62                                          |       | 69 |   | 1 |   |
| Non-cash  derivative interest (income) expense                                                                            |       | (1,680                                      | )          | 96 |   | 1,737 |   |
| Deferred income  taxes                                                                                                    |       | 2,188                                       |       | 944 |   | 1,305 |   |
| Non cash stock  compensation                                                                                              |       | —                                      |       | 1,147 |   | 1,679 |   |
| Windfall tax  benefit                                                                                                     |       | 464                                         |       | — |   | — |   |
| Decrease  (increase) in accounts receivable                                                                               |       | (2,077                                      | )          | 1,294 |   | (888 | ) |
| Decrease  (increase) in inventory                                                                                         |       | (300                                        | )          | (714 | ) | 784 |   |
| Increase in  prepaid facilities management rent and other assets                                                          |       | (5,888                                      | )          | (7,519 | ) | (6,628 | ) |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Increase in  accounts payable, accrued facilities management rent, accrued expenses and  other liabilities                |       | 10,433                                      |       | 1,188 |   | 4,233 |   |
| Increase  (decrease) in deferred revenues and customer deposits                                                           |       | (121                                        | )          | (91 | ) | 186 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Net cash flows  provided by operating activities                                                                          |       | 37,798                                      |       | 36,403 |   | 43,645 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Cash flows from  investing activities:                                                                                    |       |                                        |       |   |   |   |   |
| Capital  expenditures                                                                                                     |       | (26,380                                     | )          | (25,911 | ) | (27,154 | ) |
| Payments for  acquisitions                                                                                                |       | (106,244                                    | )          | (19,356 | ) | (46,626 | ) |
| Proceeds from  sale of assets                                                                                             |       | 12,373                                      |       | 292 |   | 393 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Net cash flows  used in investing activities                                                                              |       | (120,251                                    | )          | (44,975 | ) | (73,387 | ) |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Cash flows from  financing activities:                                                                                    |       |                                        |       |   |   |   |   |
| Payments on  capital lease obligations                                                                                    |       | (1,286                                      | )          | (1,386 | ) | (1,550 | ) |
| Borrowings on  2005 Senior Notes                                                                                          |       | 150,000                                     |       | — |   | — |   |
| Borrowings on  2005 term credit facility                                                                                  |       | 80,000                                      |       | — |   | — |   |
| Payments on 2005  term credit facility                                                                                    |       | (80,000                                     | )          | — |   | — |   |
| Payments on 2003  term credit facility and mortgage note payable                                                          |       | (33,880                                     | )          | — |   | — |   |
| Payments on  revolving credit facility                                                                                    |       | (142,758                                    | )          | (34,000 | ) | (32,000 | ) |
| Borrowings on  revolving credit facility                                                                                  |       | 119,774                                     |       | 44,000 |   | 63,000 |   |
| Financing costs                                                                                                           |       | (6,218                                      | )          | (193 | ) | (20 | ) |
| Windfall tax  benefit                                                                                                     |       | —                                      |       | 365 |   | 338 |   |
| Proceeds from  termination of derivative instruments                                                                      |       | 782                                         |       | — |   | — |   |
| Proceeds from  exercise of stock options                                                                                  |       | 393                                         |       | 596 |   | 813 |   |
| Proceeds from  issuance of common stock                                                                                   |       | 201                                         |       | 138 |   | 492 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Net cash flows  provided by financing activities                                                                          |       | 87,008                                      |       | 9,520 |   | 31,073 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Increase in cash  and cash equivalents                                                                                    |       | 4,555                                       |       | 948 |   | 1,331 |   |
| Cash and cash  equivalents, beginning of period                                                                           |       | 6,491                                       |       | 11,046 |   | 11,994 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Cash and cash  equivalents, end of period                                                                                 |       | $                                           | 11,046     |   | $ | 11,994 |   | $ | 13,325 |   |
|                                                                                                                      |       |                                        |       |   |   |   |   |
| Supplemental  cash flow information:                                                                                      |       |                                        |       |   |   |   |   |
| Interest paid                                                                                                             |       | $                                           | 6,553      |   | $ | 14,015 |   | $ | 13,637 |   |
| Income taxes  paid                                                                                                        |       | $                                           | 6,622      |   | $ | 1,301 |   | $ | 78 |   |

 

Supplementaldisclosure of non-cash investing activities:

 

Duringthe years ended December 31, 2005, 2006 and 2007, the Company acquiredvarious vehicles under capital lease agreements totaling $1,499, $1,776 and$2,003 respectively.

 

Duringthe year ended December 31, 2007, the company incurred a liability in theamount of $1,670 in the form of a future cash payment related to anacquisition.

 

The accompanying notes are an integral part of these consolidatedfinancial statements.

 

F-7

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Tableof Contents

 

**MAC-GRAY CORPORATION**

 

** NOTES TO CONSOLIDATED FINANCIAL STATEMENTS**

 

** (In thousands,except per share data)**

 

**1. Description of the Business and Basis of Presentation**

 

*Description of the Business.*    Mac-Gray Corporation(“Mac-Gray” or the “Company”) generates the majority of its revenue from card-and coin-operated laundry rooms located in 43 states and the District ofColumbia. A portion of its revenue is also derived from the sale and lease ofthe Company’s MicroFridge® branded product lines. The Company’s principalcustomer base is the multi-unit housing market, which includes apartments,condominium units, colleges and universities, and military bases. The Companyalso sells, services and leases commercial laundry equipment to commerciallaundromats, multi-unit housing properties and institutions. The majority ofthe Company’s purchases of laundry equipment is from one supplier.

 

*Basis of Presentation.*    The consolidatedfinancial statements include the accounts of the Company and its wholly-ownedsubsidiaries. All significant intercompany transactions and balances have beeneliminated in consolidation.

 

**2. Significant Accounting Policies**

 

*Cash and Cash Equivalents.*    The Company considersall highly liquid investments with original maturities of three months or lessto be cash equivalents. The Company has cash deposited with financialinstitutions in excess of the $100 insured limit of the Federal DepositInsurance Corporation. Included in cash and cash equivalents is an estimate ofcash not yet collected which remains at laundry customer locations. At December 31,2006 and 2007, this estimate was $9,027 and $9,646, respectively.

 

*Revenue Recognition.*    The Company recognizesfacilities management revenue on the accrual basis. Rental revenue isrecognized ratably over the related contractual period. The Company recognizesrevenue from product sales upon shipment of the products, unless otherwisespecified. Shipping and handling fees charged to customers are recognized uponshipment of the products and are included in revenue with the related costincluded in cost of sales. Installation and repair services are provided on anoccurrence basis, not on a contractual basis. Related revenue is recognized atthe time the installation service, or other service, is provided to thecustomer.

 

TheCompany has entered into long-term lease transactions that meet thequalifications of a sales-type lease for certain equipment. For thesetransactions, the amount of revenue recognized upon product shipment is thepresent value of the minimum lease payments, excluding executory costs andexcluding profits on executory costs, discounted at the interest rate implicitin the lease. Interest revenue is recognized over the life of the rentalagreement. At December 31, 2006 and 2007, the Company had $1,758 and$3,017, respectively, in receivables related to sales-type leases. Thesereceivables have been recorded net of unearned interest income of $324 and $555at December 31, 2006 and 2007, respectively. These receivables areprimarily due ratably over the next seven years and have been classified asother current assets and other long-term assets, as appropriate, in theconsolidated balance sheet. The related reserve for lease receivables was $26and $17 at December 31, 2006 and 2007, respectively.

 

*Allowance for Doubtful Accounts.*    On a regular basis,the Company reviews the adequacy of its provision for doubtful accounts fortrade accounts receivable and lease receivables based on historical collectionresults and current economic conditions using factors based on the aging of itstrade accounts and lease receivables. In addition, the Company estimatesspecific additional allowances based on indications that a specific customermay be experiencing financial difficulties. The Company maintains

 

F-8

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Table of Contents

** **

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**2. Significant Accounting Policies (Continued)**

 

anallowance for doubtful trade accounts receivable of $408 and $366 at December 31,2006 and 2007, respectively.

 

*Concentration of Credit Risk.*    Financial instrumentswhich potentially expose the Company to concentration of credit risk includetrade and lease receivables generated by the Company as a result of the sellingand leasing of laundry equipment and MicroFridge® branded products. To minimizethis risk, ongoing credit evaluations of customers’ financial condition areperformed and reserves are maintained. The Company typically does not requirecollateral. No individual Product Sales customer accounted for more than 10% ofrevenues or accounts receivable for any period presented.

 

*Fair Value of Financial Instruments.*    For purposes offinancial reporting, the Company has determined that the fair value offinancial instruments approximates book value at December 31, 2006 and2007, based upon terms currently available to the Company in financial markets.The fair value of the interest rate swaps is the estimated amount that theCompany would receive or pay to terminate the agreement at the reporting date,taking into account current interest rates and the credit worthiness of thecounter party.

 

*Inventories.*    Inventoriesare stated at the lower of cost (as determined using the average cost method)or market, and consist primarily of finished goods.

 

*Provision for Inventory Reserves.*    On a regular basis,the Company reviews the adequacy of its reserve for inventory obsolescencebased on historical experience,product knowledge and frequency of shipments.

 

*Prepaid Facilities Management Rent.*    Prepaid facilitiesmanagement rent consists of cash advances paid to property owners and managers under laundry service contracts. Theprepaid amount is amortized ratably over the life of the contract.

 

*Property, Plant and Equipment.*    Property, Plant andEquipment are stated at cost and depreciated using the straight-line methodover the estimated useful livesof the respective assets. Expenditures for maintenance and repairs are chargedto operations as incurred; acquisitions, major renewals, and betterments arecapitalized. Upon retirement or sale, the cost of assets disposed of and theirrelated accumulated depreciation or amortization are removed from the accounts,with the resulting gain or loss reflected in income.

 

*Facilities Management Equipment—Not Yet Placed inService.*    Theseassets represent laundry machines that management estimates will be installedin facilities management laundry rooms over the next twelve months and have notbeen purchased for commercial sale. These assets are grouped in Property, Plantand Equipment and are not depreciated until placed in service under afacilities management lease agreement.

 

*Advertising Costs.*    Advertising costs areexpensed as incurred. These costs were $1,347, $953 and $1,185 for the yearsended December 31, 2005, 2006 and 2007, respectively.

 

*Goodwill and Intangible Assets.*    Intangible assetsprimarily consist of various non-compete agreements, customer lists, goodwill,trade name and contract rights recorded in connection with acquisitions. Thenon-compete agreements are amortized using the straight-line method over thelife of the agreements, which range from five to fifteen years. Customer listsare amortized using the

 

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**2. Significant Accounting Policies (Continued)**

 

straight-linemethod over fifteen years. The majority of contract rights are amortized usingthe straight-line method over twenty years, with the balance amortized on astraight-line method over fifteen years. The life assigned to acquiredcontracts is based on several factors, including: the seller’s renewal rate ofthe contract portfolio for the most recent years prior to the acquisition, thenumber of years the average contract has been in the seller’s contractportfolio, the overall level of customer satisfaction within the contractportfolio and the ability of the Company to maintain or exceed the level ofcustomer satisfaction maintained by the seller prior to the acquisition by theCompany. The Company is accounting for acquired contract rights on a pool-basisbased on the fact that, in general, no single contract accounts for more than2% of the revenue of any acquired portfolio and the fact that few of thecontracts are predicted to be terminated, either prior to or at the end of thecontract term.

 

*Impairment of Long-Lived Assets.*    The Company reviewslong-lived assets, including fixed assets and intangible assets with definitivelives, for impairment whenever events or changes in business circumstancesindicate that the carrying amount of the assets may not be fully recoverable orthat the useful lives of these assets are no longer appropriate. The Company’sannual impairment test for laundry facilities management contract rightsassigned a 15-year amortization period consists of comparing the current numberof machines under contract and the current cash flow of all the Company’scontracts in the market where the portfolios were acquired to the originalnumber of machines acquired and the cash flow as predicted by the Company atthe time of the acquisition. For those contract rights assigned a 20-yearamortization period, the Company’s annual impairment test consists primarily ofidentifying the accumulated retention rate of the specific acquired contractportfolio in order to assess the appropriateness of the net book value of therelated contract rights. If an impairment is indicated, the asset is writtendown to its estimated fair value on a discounted cash flow basis.

 

TheCompany tests its goodwill annually for impairment. The goodwill impairmentreview consists of a two-step process of first comparing the fair value of thereporting unit with its carrying value. If this fair value exceeds the carryingvalue, no further analysis or goodwill impairment charge is required. If thefair value is below the carrying value, the Company would proceed to the nextstep, which is to measure the amount of the impairment loss. Any suchimpairment loss would be recognized in the Company’s results of operations inthe period the impairment loss arose.

 

Inmeasuring whether goodwill is impaired, the Company uses an estimate of itsfuture undiscounted cash flows of the business over the estimated remaininglife. If the Company’s expectation of future undiscounted net cash flowsindicates an impairment, the Company would write down the appropriate assets totheir estimated realizable values based on discounted cash flows. In estimatingexpected future cash flows for determining whether an asset is impaired, assetsare grouped at the lowest level for which there is identifiable cash flows.

 

TheCompany evaluates its trade name annually for impairment. If the trademark isstill actively used by the Company and continues to be a recognized brand inthe industry, there is deemed to be no impairment.

 

*Income Taxes.*    The Company utilizes the asset and liabilitymethod of accounting for income taxes, as set forth in Statement of FinancialAccounting Standards No. 109, “Accounting for Income Taxes”(“FAS 109”). FAS 109 requires the recognition of deferred tax assetsand liabilities for the

 

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**2. Significant Accounting Policies (Continued)**

 

expectedfuture tax consequences of temporary differences between the financialstatement carrying amounts of the existing assets and liabilities, and theirrespective tax bases. Deferred tax assets and liabilities are measured usingenacted tax rates in effect for the year in which those temporary differencesare expected to be recovered or settled.

 

*Stock Compensation.*    The Company adoptedSFAS No. 123 (revised 2004), “Share-Based Payments”, (“FAS 123(R)”)as of January 1, 2006. FAS 123(R) establishes standards for theaccounting for transactions in which an entity exchanges its equity instrumentsfor goods or services. FAS 123(R) requires the Company to measure thecost of employee services received in exchange for an award of equityinstruments (usually stock options) based on the grant-date fair value of theaward. That cost is recognized on a straight-line basis over the period duringwhich an employee is required to provide service in exchange for the award—therequisite service period (usually the vesting period).

 

Thegrant-date fair value of employee share options and similar instruments isestimated using the Black-Scholes option-pricing model. The expected life ofoptions and the expected forfeiture rates are estimated based on historicalexperience. The historical volatility is used to estimate the expectedvolatility at the measurement date.

 

*Use of Estimates.*    The preparation offinancial statements in conformity with accounting principles generallyaccepted in the United States of America requires management to make estimatesand assumptions that affect the reported amounts of assets and liabilities anddisclosure of contingent assets and liabilities at the date of the financialstatements and the reported amounts of revenues and expenses during thereporting period. Actual results could differ from those estimates.

 

*Earnings Per Share.*    The Company accountsfor earnings per share in accordance with SFAS No. 128, “Earnings PerShare” (“FAS 128”). FAS 128 requires the presentation of basicearnings per share (“EPS”) and diluted earnings per share. Basic EPS includesno dilution and is computed by dividing net income available to commonstockholders by the weighted-average number of common shares outstanding forthe period. Diluted EPS reflects the potential dilution of securities thatcould share in the earnings of an entity. Diluted EPS has been calculated usingthe treasury stock method.

 

*Other Comprehensive Income.*    The Company accountsfor comprehensive income in accordance with SFAS No. 130, “ReportingComprehensive Income” (“FAS 130”). This statement requires disclosure ofcomprehensive income and its components in interim and annual reports.Comprehensive income includes all changes in stockholders’ equity during aperiod except those resulting from investments by stockholders anddistributions to stockholders.

 

*Financial Instruments.*    The Company accountsfor derivative instruments in accordance with the provisions of SFAS No. 133,“Accounting for Derivative Instruments and Hedging Activities”(“FAS 133”), and Statement of Financial Accounting Standard No. 138,“Accounting for Certain Derivative Instruments and Certain HedgingActivities—an amendment of FAS No. 133” (“FAS 138”). These statementsrequire the Company to recognize derivatives on its balance sheet at fairvalue. Derivatives that are not hedges must be adjusted to fair value throughearnings. If the derivative is a hedge, changes in the fair value ofderivatives will either be offset against the change in fair value of thehedged assets, liabilities or firm commitments through earnings or recognizedin other comprehensive income until the hedged item is recognized in earnings,depending on the intended use

 

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Table of Contents

** **

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**2. Significant Accounting Policies (Continued)**

 

ofthe derivative. The ineffective portion of a derivative’s change in fair valuewill be immediately recognized in earnings.

 

*Product Warranties.*    The Company offerslimited-duration warranties on MicroFridge® branded products and, at the timeof sale, provides reserves for all estimated warranty costs based upon historical experience.These amounts are included in accrued expenses and other liabilities on theCompany’s balance sheets.

 

Theactivity for the year ended December 31, 2007 is as follows:

 
| ** **                             | ** ** | **Accrued Warranty** | ** ** |
|----------------------------------------|------------|---------------------------|------------|
| Balance,  December 31, 2005       |       | $                         | 567        |   |
| Accruals for  warranties issued        |       | 193                       |       |
| Settlements made  (in cash or in kind) |       | (304                      | )          |
|                                   |       |                      |       |
| Balance,  December 31, 2006       |       | 456                       |       |
| Accruals for  warranties issued        |       | 242                       |       |
| Settlements made  (in cash or in kind) |       | (340                      | )          |
|                                   |       |                      |       |
| Balance,  December 31, 2007       |       | $                         | 358        |   |

 

*New Accounting Pronouncements.*    In September 2006,the FASB issued SFAS No. 157, “Fair Value Measurements” (“FAS 157”). FAS 157clarifies the principle that fair value should be based on the assumptionsmarket participants would use when pricing an asset or liability andestablishes a fair value hierarchy that prioritizes the information used todevelop those assumptions. Under the standard, fair value measurements would beseparately disclosed by level within the fair value hierarchy. FAS 157 iseffective for fiscal years beginning after November 15, 2007, with earlyadoption permitted. The Company is currently reviewing this new accountingstandard but does not expect it to have a material impact on its financialstatements.

 

InFebruary 2007, the FASBissued SFAS No. 159, “The Fair Value Option for Financial Assets andFinancial Liabilities, including an amendment of No. 115”(“FAS 159”), which is effective for fiscal years beginning after November 15,2007, with early adoption permitted. FAS 159 expands opportunities to usefair value measurements in financial reporting and permits entities to chooseto measure many financial instruments and certain other items at fair value.The Company is currently reviewing this new accounting standard but does notexpect it to have a material impact on its financial statements.

 

InDecember 2007, the FASBissued SFAS No. 141(R), “Business Combinations” (“SFAS No. 141(R)”).SFAS 141(R) requires the acquiring entity in a business combinationto recognize the full fair value of assets acquired and liabilities assumed inthe transaction (whether a full or partial acquisition); establishes theacquisition-date fair value as the measurement objective for all assetsacquired and liabilities assumed; requires expensing of most transaction andrestructuring costs; and requires the acquirer to disclose to investors andother users all of the information needed to evaluate and understand the natureand financial effect of the business combination. SFAS No. 141(R) appliesto all transactions or other events in which the Company obtains control of oneor more businesses, including those sometimes referred to as “true mergers” or“mergers of equals” and combinations

 

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**2. Significant Accounting Policies (Continued)**

 

achievedwithout the transfer of consideration, for example, by contract alone orthrough the lapse of minority veto rights. SFAS No. 141(R) appliesprospectively to business combinations for which the acquisition date is on orafter January 1, 2009.

 

InDecember 2007, the FASB issued SFAS No. 160, “NoncontrollingInterests in Consolidated Financial Statements—an amendment of AccountingResearch Bulletin No. 51” (“SFAS No. 160”). SFAS No. 160requires reporting entities to present noncontrolling (minority) interests asequity (as opposed to as a liability or mezzanine equity) and provides guidanceon the accounting for transactions between an entity and noncontrolling interests.SFAS No. 160 applies prospectively as of January 1, 2009, except forthe presentation and disclosure requirements which will be appliedretrospectively for all periods presented.

 

*Reclassifications.*    Certain amounts fromprior years have been reclassified to conform to current year presentation.

 

**3. Impairment of Assets**

 

Therevenue and corresponding operating income from the Company’s reprographicsbusiness unit have been declining since 1999 when college libraries, followedby public libraries, began to make reference material available to patronselectronically. Electronic availability, widespread conversion to laserprinters (free of charge in many school libraries) and other technicaladvancements have led to reduced use of vended copy machines resulting inreduced revenue at several accounts. During the fourth quarter of 2006, theCompany performed an evaluation of the reprographics business unit and itslong-range prospects. As a result of this evaluation, management determinedthat the carrying amount of the business unit’s long lived assets exceeded theestimated undiscounted cash flows expected to result from operating thisbusiness unit, and recognized a non-cash, non-recurring, pre-tax impairmentcharge of $2,502. This charge was calculated in accordance with SFAS No. 144,“Accounting for the Impairment or Disposal of Long Lived Assets”,(“FAS 144”).

 

**4. Acquisitions**

 

OnAugust 8, 2007, the Company acquired the laundry facilities managementassets of Hof Service Company, Inc. and Bob Corp. in Maryland (the “HofAcquisition”). On April 26, 2007, the Company acquired the laundryfacilities management assets of a regional operator in New York. On February 28,2007, the Company acquired the laundry facilities management assets anddistribution rights of a regional operator in the Southeast United States.These acquisitions have been reflected in the accompanying consolidatedfinancial statements from the dates of the acquisition, and have been accountedfor as purchase business combinations in accordance with Statement of FinancialAccounting Standards No. 141, “Business Combinations” (“FAS 141”).The total purchase price of each of these acquisitions has been allocated tothe acquired assets and liabilities, based on estimates of their related fairvalue. A twenty-year amortization period has been assigned to the acquiredcontract rights, a ten-year amortization period for the acquired distributionrights, and the acquired used laundry equipment has been assigned an averagelife of two to seven years based upon physical evaluation of the equipment.

 

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Table of Contents

** **

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**4. Acquisitions (Continued)**

 

Thetotal purchase price for eachof these acquisitions was allocated as follows:

 
| ** **            | ** ** | **February 28,  2007** | ** ** | **April 26,  2007** | ** ** | **August 8,  2007** | ** ** |
|-----------------------|------------|-----------------------------|------------|--------------------------|------------|--------------------------|------------|
| Contract rights       |       | $                           | 546        |                     | $          | 2,134                    |       | $ | 30,900 |   |
| Goodwill              |       | —                      |       | —                   |       | 3,775                    |       |
| Trade name            |       | —                      |       | —                   |       | 1,400                    |       |
| Distribution  rights  |       | 1,623                       |       | —                   |       | —                   |       |
| Equipment             |       | 170                         |       | 526                      |       | 5,934                    |       |
| Inventory             |       | 239                         |       | —                   |       | 708                      |       |
|                  |       |                        |       |                     |       |                     |       |
| Total Purchase  Price |       | $                           | 2,578      |                     | $          | 2,660                    |       | $ | 42,717 |   |

 

Thepurchase price of the HofAcquisition includes a discounted future payment in the amount of $1,670. Thispayment is due upon the third anniversary of the acquisition date and iscontingent upon the acquired business achieving certain financial conditions.The Company believes the financial conditions set forth will be achieved andexpects to make this payment on the due date.

 

Thefollowing unaudited pro formaoperating results of the Company assume the 2007 acquisitions took place on January 1,2006. Such information includes adjustments to reflect additional depreciation,amortization and interest expense, and is not necessarily indicative of whatthe results of operations would have been or the results of operations infuture periods.

 
| ** **             | ** ** | **Year Ended  December 31,  2006** | ** ** | **Year Ended  December 31,  2007** | ** ** |
|------------------------|------------|----------------------------------------------|------------|----------------------------------------------|------------|
| Net revenue            |       | $                                            | 309,558    |                                         | $          | 312,239 |   |
| Net income             |       | $                                            | (160       | )                                            | $          | 1,895 |   |
| Net income per  share: |       |                                         |       |                                         |       |
| Basic                  |       | $                                            | (0.01      | )                                            | $          | 0.14 |   |
| Diluted                |       | $                                            | (0.01      | )                                            | $          | 0.14 |   |

 

Throughoutthe year the Company made certain other acquisitions for a combined purchaseprice of $341, which was allocated to contract rights. These acquisitions arebeing amortized over a period of four to seven years.

 

**5. Sale of Corporate Headquarters**

 

OnJune 30, 2005, wecompleted the sale of our corporate headquarters in Cambridge, Massachusettsfor $11,800 in cash. We used the net proceeds from the sale to repay the $3,800balance of the mortgage loan on the property and repay $2,000 under the 2005senior credit facilities. Concurrently with the closing of the sale, we leasedthe property back from the purchaser until March 31, 2006 while werelocated our corporate, warehouse and branch operations to new facilities. Inconnection with this sale, in the second quarter of 2005, we recorded a gain ofapproximately $6,100, net of taxes.

 

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**6. Long-Term Debt**

 

EffectiveDecember 29, 2006, the Company amended its senior bank credit facilities,reducing the credit line to $65,000 (with the option, subject to customaryterms and conditions, to increase the line up to $100,000, in increments of notless than $10,000, over the life of the facility), reducing the interest rateon outstanding borrowings, modifying certain covenants and extending thematurity date to December 29, 2011. Concurrent with the Hof Acquisition inAugust 2007, the Company increased its credit line to $85,000. The seniorcredit facilities are collateralized by a blanket lien on all of our assets andour two main subsidiaries, Mac-Gray Services, Inc. and IntirionCorporation, as well as a pledge by the Company of all of the capital stock ofits two subsidiaries. Borrowings outstanding under the revolving line of creditbear interest at a fluctuating rate equal to (i) in the case of Eurodollarrate loans, the LIBOR rate (adjusted for statutory reserves) plus an applicablepercentage, ranging from 1.00% to 1.50% (1.50% as of December 31, 2007)determined quarterly by reference to the funded debt ratio, or (ii) in thecase of alternate base rate loans and swing line loans, the higher of (a) thefederal funds rate plus 0.50% or (b) the annual rate of interest announcedby JPMorgan Chase Bank, N.A. as its “prime rate,” in each case, plus anapplicable percentage, ranging from 0.00% to 0.50% (0.50% as of December 31,2007), determined and payable quarterly by reference to the funded debt ratio.Under the senior credit facilities, the Company pays a commitment fee equal toa percentage, ranging from 0.25% to 0.30%, determined and payable quarterly byreference to the funded debt ratio, of the average daily-unused portion of therevolver under the senior credit facility. This commitment fee percentage was0.30% as of December 31, 2007.

 

Asof December 31, 2007, there was $55,000 outstanding under the revolvingline of credit and $860 in outstanding letters of credit under the seniorcredit facilities. The available balance under the revolving line of credit was$29,140 at December 31, 2007. The average interest rate on the borrowingsoutstanding under the senior credit facilities at December 31, 2006 and2007 were 5.94% and 6.20%, respectively, including the applicable spread paidto the banks.

 

Thecredit agreement for the senior credit facilities includes customary covenants,including, but not limited to, restrictions pertaining to: (i) theincurrence of additional indebtedness, (ii) limitations on liens, (iii) makingdistributions, dividends and other payments, (iv) the making of certaininvestments and loans, (v) mergers, consolidations and acquisitions, (vi) dispositionsof assets, (vii) the maintenance of minimum consolidated net worth,maximum funded debt ratios, minimum consolidated cash flow coverage ratios, andmaximum senior secured leverage ratios, (viii) transactions withaffiliates, (ix) sale and leaseback transactions, (x) entering intoswap agreements, and (xi) changes to governing documents, in each casesubject to numerous baskets, exceptions and thresholds. The funded debt ratio,consolidated cash flow coverage ratio and senior secured leverage ratio thatthe Company was required to meet as of December 31, 2007 were 4.25 to1.00, 1.10 to 1.00, and 2.50 to 1.00, respectively. The Company was incompliance with these and all other financial covenants at December 31,2007.

 

Thecredit agreement for the senior credit facilities provides for customary eventsof default, including, but not limited to: (i) failure to pay anyprincipal or interest when due, (ii) failure to comply with covenants, (iii) anymaterial representation or warranty made by the Company proving to be incorrectin any material respect, (iv) defaults relating to or acceleration ofother material indebtedness, (v) certain insolvency or receivership eventsaffecting the Company or any of its subsidiaries, (vi) a change incontrol, (vii) material judgments, claims or liabilities against the Companyor (viii) a material defect in the lenders’ lien against the collateralsecuring the obligations under the

 

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**6. Long-Term Debt (Continued)**

 

creditagreement. There were no events of default under the senior credit facilitiesat December 31, 2007.

 

OnAugust 16, 2005, the Company issued senior unsecured notes in the amountof $150,000. These notes bear interest at 7.625% payable semi-annually each February andAugust. The maturity date of the notes is August 15, 2015. The seniorcredit facilities were amended to permit the offering of the notes and modifycertain of the covenants applicable to the senior credit facilities. Theproceeds from the senior notes, less financing costs, were used to retire theterm loan and pay down the revolver under the senior credit facilities.

 

Onand after August 15, 2010, the Company will be entitled, at its option, toredeem all or a portion of these notes at the redemption prices (expressed in percentages ofprincipal amount on the redemption date), plus accrued interest to theredemption date, if redeemed, during the 12-month period commencing on August 15of the years set forth below:

 
| **Period**           | ** ** | **Redemption Price** | ** ** |
|----------------------|------------|---------------------------|------------|
| 2010                 |       | 103.813                   | %          |
| 2011                 |       | 102.542                   | %          |
| 2012                 |       | 101.271                   | %          |
| 2013 and  thereafter |       | 100.000                   | %          |

 

Subjectto certain conditions, the Company will be entitled, at its option, on one ormore occasions prior to August 15, 2008, to redeem notes in an aggregateprincipal amount not to exceed 35% of the aggregate principal amount of thenotes originally issued at a redemption price (expressed as a percentage ofprincipal amount on the redemption date) of 107.625%, plus accrued and unpaidinterest to the redemption date, with the net cash proceeds from one or moreequity offerings.

 

Theterms of the senior notes include customary covenants, including, but notlimited to, restrictions pertaining to: (i) incurrence of additionalindebtedness and issuance of preferred stock, (ii) payment of dividends onor making of distributions in respect of capital stock or making certain otherrestricted payments or investments, (iii) entering into agreements thatrestrict distributions from restricted subsidiaries, (iv) sale or otherdisposition of assets, including capital stock of restricted subsidiaries, (v) transactionswith affiliates, (vi) incurrence of liens, (vii) sale/leasebacktransactions, and (viii) merger, consolidation or sale of substantiallyall of our assets, in each case subject to numerous baskets, exceptions andthresholds. The Company was in compliance with these and all other financialcovenants at December 31, 2007.

 

Theterms of the senior notes provide for customary events of default, including,but not limited to: (i) failure to pay any principal or interest when due,(ii) failure to comply with covenants and limitations, (iii) certaininsolvency or receivership events affecting us or any of our subsidiaries and (iv) unsatisfiedmaterial judgments, claims or liabilities against us. There were no events ofdefault under the senior notes at December 31, 2007.

 

Financingcosts of $668 and $73, related to the prior financing agreement that hadn’tpreviously been written off, were expensed during the years ended December 31,2005 and 2006, respectively.

 

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**6. Long-Term Debt (Continued)**

 

Capitallease obligations on the Company’s fleet of vehicles totaled $3,068 and $3,521at December 31, 2006 and 2007, respectively.

 

Requiredpayments under the Company’s long-term debt and capital lease obligations areas follows:

 
| ** ** | ** ** | **Amount** | ** ** |
|------------|------------|------------|------------|
| 2008       |       | $          | 1,324      |   |
| 2009       |       | 1,086      |       |
| 2010       |       | 823        |       |
| 2011       |       | 55,288     |       |
| 2012       |       | —     |       |
| Thereafter |       | 150,000    |       |
|       |       |       |       |
|       |       | $          | 208,521    |   |

 

**7. Derivative Instruments**

 

TheCompany entered into standard International Swaps and Derivatives Association (“ISDA”)interest rate swap agreements (the “Swap Agreements”) to manage the interestrate risk associated with its debt. Concurrent with the reduction of theamounts due under the senior credit facilities, certain Swap Agreementspreviously designated as cash flow hedges ceased to qualify as such. The changein the fair value of the Swap Agreements that do not qualify for hedgeaccounting is recognized in the income statement in the period in which thechange occurs. The change in the fair value of these contracts resulted in again (loss) of $1,876, $(96) and $(1,737) for the years ended December 31,2005, 2006 and 2007, respectively. One Swap Agreement continues to bedesignated as a cash flow hedge.

 

Thetable below outlines the details of each remaining Swap Agreement:

 
| **Date of Origin** | ** ** | **Original  Notional  Amount** | ** ** | **Fixed/  Amortizing** | ** ** | **Notional  Amount  December 31,  2007** | ** ** | **Expiration  Date** | ** ** | **Fixed  Rate** | ** ** |
|------------------------------|------------|--------------------------------|------------|------------------------|------------|-----------------------------------------------|------------|----------------------|------------|-----------------|------------|
| June 24,  2003          |       | $                              | 20,000     |                   | Amortizing |                                          | $          | 7,143                |       | Jun 30, 2008    |       | 2.34 | % |
| June 24,  2003          |       | $                              | 20,000     |                   | Fixed      |                                          | $          | 20,000               |       | Jun 30, 2008    |       | 2.69 | % |
| May 2, 2005             |       | $                              | 17,000     |                   | Fixed      |                                          | $          | 17,000               |       | Dec 31, 2011    |       | 4.69 | % |
| May 2, 2005             |       | $                              | 12,000     |                   | Fixed(1)   |                                          | $          | —               |       | Sep 30, 2009    |       | 4.66 | % |
| May 2, 2005             |       | $                              | 10,000     |                   | Fixed(1)   |                                          | $          | —               |       | Dec 31, 2011    |       | 4.77 | % |

 

----

*(1)*

EffectiveDate is June 30, 2008.

 

Inaccordance with the Swap Agreements and on a quarterly basis, interest expenseis calculated based on the floating 90-day LIBOR and the fixed rate. Ifinterest expense as calculated is greater based on the 90-day LIBOR, thefinancial institution pays the difference to the Company. If interest expense ascalculated is greater based on the fixed rate, the Company pays the differenceto the financial institution. Depending on fluctuations in the LIBOR, theCompany’s interest rate exposure and its related impact on interest expense andnet cash flow may increase or decrease. The counter

 

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**7. Derivative Instruments (Continued)**

 

partyto the Swap Agreements exposes the Company to credit loss in the event ofnon-performance; however, nonperformance is not anticipated.

 

Thefair value of a Swap Agreement is the estimated amount that the Company wouldreceive or (pay) to terminate the agreement at the reporting date, taking intoaccount current interest rates and the credit worthiness of the counter party.At December 31, 2006 and 2007, the fair value of the Swap Agreements was$1,335 and $(665), respectively. These amounts have been included in otherassets and other liabilities, respectively, on the consolidated balance sheets.

 

Thechanges in accumulated other comprehensive income relate entirely to theCompany’s interest rate Swap Agreement, which is accounted for as a cash flowhedge. If the Company were to change its hedging strategy, it would recognize again of approximately $73 based on the fair value of this Swap Agreement at December 31,2007.

 

Theactivity included in other comprehensive income is as follows:

 
| ** **                                          | ** ** | **For the years ended December 31,** | ** ** |
|-----------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                          | ** ** | **2005**                                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
| Unrealized gain  (loss) on derivative instruments   |       | $                                                             | 835        |   | $ | (216 | ) | $ | (262 | ) |
| Reclassification  adjustment                        |       | (1,680                                                        | )          | — |   | — |   |
|                                                |       |                                                          |       |   |   |   |   |
| Total other  comprehensive loss before income taxes |       | (845                                                          | )          | (216 | ) | (262 | ) |
| Income tax  benefit                                 |       | 338                                                           |       | 84 |   | 124 |   |
|                                                |       |                                                          |       |   |   |   |   |
| Total other  comprehensive loss                     |       | $                                                             | (507       | ) | $ | (132 | ) | $ | (138 | ) |

 

**8. Prepaid Facilities Management Rent and Other CurrentAssets**

 

Prepaidfacilities management rent and other current assets consist of the following:

 
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**              | ** ** | **2007** | ** ** |
| Prepaid  facilities management rent |       | $                     | 3,852      |   | $ | 4,104 |   |
| Supplies                            |       | 2,749                 |       | 4,177 |   |
| Leases  receivable                  |       | 727                   |       | 820 |   |
| Interest  receivable                |       | 90                    |       | — |   |
| Due from vendor                     |       | 604                   |       | 786 |   |
| Sales tax  reimbursement            |       | 107                   |       | — |   |
| Income tax  receivable              |       | 3,406                 |       | 4,039 |   |
| Prepaid  insurance                  |       | 641                   |       | 443 |   |
| Other                               |       | 775                   |       | 791 |   |
|                                |       |                  |       |   |   |
|                                |       | $                     | 12,951     |   | $ | 15,160 |   |

 

F-18

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**9. Prepaid Facilities Management Rent and Other Assets**

 

Prepaidfacilities management rent and other assets consist of the following:

 
| ** **                          | ** ** | **December 31,** | ** ** |
|-------------------------------------|------------|-----------------------|------------|
| ** **                          | ** ** | **2006**              | ** ** | **2007** | ** ** |
| Prepaid  facilities management rent |       | $                     | 10,032     |   | $ | 10,768 |   |
| Leases  receivable                  |       | 1,005                 |       | 2,180 |   |
| Notes receivable                    |       | 303                   |       | 127 |   |
| Deposits                            |       | 851                   |       | 1,294 |   |
| Derivative  instruments             |       | 1,335                 |       | — |   |
| Other                               |       | 508                   |       | 343 |   |
|                                |       |                  |       |   |   |
|                                |       | $                     | 14,034     |   | $ | 14,712 |   |

 

**10. Property, Plant and Equipment**

 

Property,plant and equipment consist of the following:

 
| ** **                                                  | ** ** | **Estimated**        | ** ** | **December 31** | ** ** |
|-------------------------------------------------------------|------------|----------------------|------------|----------------------|------------|
| ** **                                                  | ** ** | **Useful Life** | ** ** | **2006**             | ** ** | **2007** | ** ** |
| Facilities  management equipment                            |       | 2-10 years      |       | $                    | 211,750    |   | $ | 237,647 |   |
| Facilities  management improvements                         |       | 7-10 years      |       | 12,110               |       | 13,036 |   |
| Buildings and  improvements                                 |       | 15-39 years     |       | 1,607                |       | 1,680 |   |
| Furniture,  fixtures and computer equipment                 |       | 2-7 years       |       | 13,362               |       | 13,861 |   |
| Trucks and autos                                            |       | 3-5 years       |       | 7,525                |       | 8,590 |   |
| Tooling costs                                               |       | 3 years         |       | 422                  |       | 422 |   |
| Land and  improvements                                      |       | —               |       | 77                   |       | 77 |   |
|                                                        |       |                 |       |                 |       |   |   |
|                                                        |       |                 |       | 246,853              |       | 275,313 |   |
| Less:  accumulated depreciation                             |       |                 |       | 131,463              |       | 153,408 |   |
|                                                        |       |                 |       |                 |       |   |   |
|                                                        |       |                 |       | 115,390              |       | 121,905 |   |
| Facilities  management equipment, not yet placed in service |       |                 |       | 3,264                |       | 4,416 |   |
|                                                        |       |                 |       |                 |       |   |   |
| Property, plant  and equipment, net                         |       |                 |       | $                    | 118,654    |   | $ | 126,321 |   |

 

Depreciationof property, plant and equipment totaled $26,409, $29,615 and $30,765 for theyears ended December 31, 2005, 2006 and 2007, respectively.

 

AtDecember 31, 2006 and 2007, trucks and autos included $7,463 and $8,170,respectively, of equipment under capital lease with an accumulated amortizationbalance of $4,395 and $4,649, respectively.

 

F-19

----

Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**11. Goodwill and Intangible Assets**

 

Goodwilland intangible assets consist of the following:

 
| ** **                | ** ** | **As of December 31, 2006** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|
| ** **                | ** ** | **Cost**                                        | ** ** | **Accumulated  Amortization** | ** ** | **Net Book Value** | ** ** |
| Goodwill:                 |       |                                            |       |   |   |   |   |
| Facilities  Management    |       | $                                               | 38,231     |   |   |   | $ | 38,231 |   |
| Product Sales             |       | 223                                             |       |   |   | 223 |   |
|                      |       |                                            |       |   |   |   |   |
|                      |       | $                                               | 38,454     |   |   |   | $ | 38,454 |   |
|                      |       |                                            |       |   |   |   |   |
| Intangible  assets:       |       |                                            |       |   |   |   |   |
| Facilities  Management:   |       |                                            |       |   |   |   |   |
| Trade Name                |       | $                                               | 12,650     |   | $ | — |   | $ | 12,650 |   |
| Non-compete  agreements   |       | 4,041                                           |       | 3,861 |   | 180 |   |
| Contract rights           |       | 125,437                                         |       | 18,290 |   | 107,147 |   |
| Product Sales:            |       |                                            |       |   |   |   |   |
| Customer lists            |       | 1,451                                           |       | 830 |   | 621 |   |
| Deferred  financing costs |       | 5,996                                           |       | 1,051 |   | 4,945 |   |
|                      |       |                                            |       |   |   |   |   |
|                      |       | $                                               | 149,575    |   | $ | 24,032 |   | $ | 125,543 |   |

 
| ** **                | ** ** | **As of December 31, 2007** | ** ** |
|---------------------------|------------|-------------------------------------------------|------------|
| ** **                | ** ** | **Cost**                                        | ** ** | **Accumulated  Amortization** | ** ** | **Net Book Value** | ** ** |
| Goodwill:                 |       |                                            |       |   |   |   |   |
| Facilities  Management    |       | $                                               | 42,006     |   |   |   | $ | 42,006 |   |
| Product Sales             |       | 223                                             |       |   |   | 223 |   |
|                      |       |                                            |       |   |   |   |   |
|                      |       | $                                               | 42,229     |   |   |   | $ | 42,229 |   |
|                      |       |                                            |       |   |   |   |   |
| Intangible  assets:       |       |                                            |       |   |   |   |   |
| Facilities  Management:   |       |                                            |       |   |   |   |   |
| Trade Name                |       | $                                               | 14,050     |   | $ | — |   | $ | 14,050 |   |
| Non-compete  agreements   |       | 4,041                                           |       | 3,901 |   | 140 |   |
| Contract rights           |       | 158,448                                         |       | 25,555 |   | 132,893 |   |
| Product Sales:            |       |                                            |       |   |   |   |   |
| Customer lists            |       | 1,451                                           |       | 927 |   | 524 |   |
| Distribution  rights      |       | 1,623                                           |       | 134 |   | 1,489 |   |
| Deferred  financing costs |       | 6,016                                           |       | 1,771 |   | 4,245 |   |
|                      |       |                                            |       |   |   |   |   |
|                      |       | $                                               | 185,629    |   | $ | 32,288 |   | $ | 153,341 |   |

 

F-20

----

Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**11. Goodwill and Intangible Assets (Continued)**

 

Estimatedfuture amortization expense of intangible assets consists of the following:

 
| 2008       |   | $      | 9,202   |   |
|------------|--------|--------|---------|--------|
| 2009       |   | 9,093  |    |
| 2010       |   | 8,872  |    |
| 2011       |   | 8,465  |    |
| 2012       |   | 8,159  |    |
| Thereafter |   | 94,097 |    |
|       |   |   |    |
|       |   | $      | 137,888 |   |

 

Amortizationexpense of intangible assets for the years ended December 31, 2005, 2006and 2007 was $6,117, $7,130 and $8,256, respectively.

 

**12. Accrued Expenses**

 

Accruedexpenses consist of the following:

 
| ** **                                         | ** ** | **December 31,** | ** ** |
|----------------------------------------------------|------------|-----------------------|------------|
| ** **                                         | ** ** | **2006**              | ** ** | **2007** | ** ** |
| Accrued interest                                   |       | $                     | 4,448      |   | $ | 4,705 |   |
| Accrued  salaries/benefits                         |       | 248                   |       | 759 |   |
| Accrued  commission/bonuses                        |       | 2,514                 |       | 2,738 |   |
| Accrued stock  compensation                        |       | —                |       | 135 |   |
| Accrued warranty                                   |       | 216                   |       | 358 |   |
| Reserve for refunds                                |       | 456                   |       | 352 |   |
| Accrued rent                                       |       | 446                   |       | 517 |   |
| Current portion  of deferred retirement obligation |       | 104                   |       | 104 |   |
| Accrued  professional fees                         |       | 498                   |       | 384 |   |
| Accrued personal  property taxes                   |       | 816                   |       | 628 |   |
| Accrued sales  tax                                 |       | 417                   |       | 355 |   |
| Accrued benefit  insurance                         |       | 941                   |       | 928 |   |
| Other accrued  expenses                            |       | 341                   |       | 387 |   |
|                                               |       |                  |       |   |   |
|                                               |       | $                     | 11,445     |   | $ | 12,350 |   |

 

F-21

----

Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**13. Income Taxes**

 

Theprovision for state and federal income taxes consists of the following:

 
| ** **          | ** ** | **Years Ended December 31,** | ** ** |
|---------------------|------------|---------------------------------------------|------------|
| ** **          | ** ** | **2005**                                    | ** ** | **2006** | ** ** | **2007** | ** ** |
| Current state       |       | $                                           | 1,074      |   | $ | (223 | ) | $ | (110 | ) |
| Deferred state      |       | 623                                         |       | 340 |   | 225 |   |
| Current federal     |       | 5,368                                       |       | (380 | ) | 81 |   |
| Deferred federal    |       | 1,498                                       |       | 410 |   | 1,313 |   |
|                |       |                                        |       |   |   |   |   |
| Total income  taxes |       | $                                           | 8,563      |   | $ | 147 |   | $ | 1,509 |   |

 

Thenet deferred tax liability in the accompanying balance sheets includes thefollowing amounts of deferred tax assets and liabilities at December 31:

 
| ** **                                                   | ** ** | **2006** | ** ** | **2007** | ** ** |
|--------------------------------------------------------------|------------|----------|------------|----------|------------|
| Current deferred  tax assets (liabilities):                  |       |     |       |     |       |
| Accounts  receivable                                         |       | $        | 161        |     | $          | 141 |   |
| Inventory                                                    |       | 161      |       | 185      |       |
| Accrued bonus                                                |       | 574      |       | 375      |       |
| Accrued rent                                                 |       | —   |       | 200      |       |
| Deferred  compensation                                       |       | 41       |       | 40       |       |
| Warranty Reserve                                             |       | —   |       | 138      |       |
| Other                                                        |       | 24       |       | (136     | )          |
|                                                         |       |     |       |     |       |
|                                                         |       | 961      |       | 943      |       |
|                                                         |       |     |       |     |       |
| Non-current  deferred tax (liabilities) assets:              |       |     |       |     |       |
| Depreciation                                                 |       | (22,077  | )          | (21,733  | )          |
| Amortization                                                 |       | (6,874   | )          | (9,746   | )          |
| Sales-type  leases                                           |       | (481     | )          | (1,044   | )          |
| Stock  compensation                                          |       | —   |       | 853      |       |
| Derivative  instrument interest                              |       | (392     | )          | 285      |       |
| Net operating  loss carryforwards                            |       | —   |       | 550      |       |
| Other                                                        |       | 204      |       | 159      |       |
|                                                         |       |     |       |     |       |
|                                                         |       | (29,620  | )          | (30,676  | )          |
| Valuation  allowance against non-current deferred tax assets |       | —   |       | (231     | )          |
|                                                         |       |     |       |     |       |
|                                                         |       | (29,620  | )          | (30,907  | )          |
|                                                         |       |     |       |     |       |
| Net deferred tax  liabilities                                |       | $        | (28,659    | )        | $          | (29,964 | ) |

 

F-22

----

Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**13. Income Taxes (Continued)**

 

Forthe years ended December 31, 2005, 2006 and 2007, the statutory income taxrate differed from the effective rate primarily as a result of the followingdifferences:

 
| ** **                                  | ** ** | **2005** | ** ** | **2006** | ** ** | **2007** | ** ** |
|---------------------------------------------|------------|----------|------------|----------|------------|----------|------------|
| Taxes computed  at federal statutory rate   |       | 35.0     | %          | 34.0     | %          | 34.0     | %          |
| State income  taxes, net of federal benefit |       | 5.3      |       | 7.8      |       | 6.3      |       |
| Change in state  deferred rate              |       | —   |       | —   |       | (12.5    | )          |
| Change in  valuation allowance              |       | —   |       | —   |       | 5.7      |       |
| Tax settlement  adjustments                 |       | —   |       | (40.0    | )          | (4.2     | )          |
| Meals &  entertainment             |       | 0.5      |       | 10.1     |       | 2.6      |       |
| Non-deductible  stock options               |       | —   |       | —   |       | 2.7      |       |
| Other                                       |       | 0.7      |       | 2.8      |       | 2.9      |       |
|                                        |       |     |       |     |       |     |       |
| Income tax provision                        |       | 41.5     | %          | 14.7     | %          | 37.5     | %          |

 

AtDecember 31, 2007, the Company had state net operating loss carryforwardsof $550, which expire at various times through the year 2027. The Company hasevaluated the positive and negative evidence bearing upon the realization ofthe Net Operating Losses and has established a valuation allowance of $231 forthe corresponding deferred tax asset, which is comprised principally of statenet operating loss carryovers incurred in various jurisdictions.

 

TheCompany adopted FASB Interpretation No. 48,*Accounting for Uncertainty in Income Taxes* (“FIN 48”),as of January 1, 2007. FIN 48 establishes a single model to addressaccounting for uncertain tax positions. FIN 48 clarifies the accountingfor income taxes by prescribing a minimum recognition threshold a tax positionis required to meet before being recognized in the financial statements.FIN 48 also provides guidance on derecognition, measurementclassification, interest and penalties, accounting in interim periods, disclosureand transition. FIN 48 requires a company to evaluate whether the taxposition taken by a company will more likely than not be sustained uponexamination by the appropriate taxing authority. Upon adoption, the liabilityfor income taxes associated with uncertain tax positions was $893. As a resultof the implementation of FIN 48, the change to the Company’s reserve foruncertain tax positions was accounted for as a $500 adjustment to increase theCompany’s beginning retained earnings. The Company had estimated potentialexposure related to all tax years open for review by the relevant taxingauthorities. As of September 15, 2007, the statute of limitations for the2003 tax year had expired and a reserve of $163 was no longer necessary.

 

Areconciliation of the beginning and ending amount of unrecognized tax benefitsis as follows:

 
| Balance at  January 1, 2007                              |   | $      | 504    |   |
|---------------------------------------------------------------|--------|--------|--------|--------|
| Additions based  on tax positions related to the current year |   | 10     |   |
| Additions for  tax positions of prior years                   |   | — |   |
| Reductions for  tax positions of prior years                  |   | — |   |
| Lapse of statute  of limitations                              |   | (181   | )      |
|                                                          |   |   |   |
| Balance at  December 31, 2007                            |   | $      | 333    |   |

 

F-23

----

Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**13. Income Taxes (Continued)**

 

Includedin the balance at January 1, 2007 and December 31, 2007, are taxpositions in the amount of $231, which would impact the Company’s effective taxrate if recognized. The Company’s continuing practice is to recognize interestand/or penalties related to income tax matters in income tax expense. Duringthe year ended December 31, 2007, the Company recognized $25 in interestexpense and $30 of interest income. The Company had $63 accrued for the paymentof interest and no accrual for penalties at the end of fiscal year December 31,2007. Accrued interest included in the reserve at January 1, 2007 was $68.

 

TheCompany and its subsidiaries are subject to U.S. federal income tax as well asto income tax of multiple state jurisdictions. The Company has concluded allU.S. federal income tax matters for years through 2003. All material state andlocal income tax matters have been concluded for years through 2002. Subsequentto year end the Internal Revenue Service concluded its audit of the 2004 taxreturn. The results of the audit indicate that the Company is entitled to asmall refund. In 2008, the Company expects to reverse an uncertain tax positionin the amount of $138 in conjunction with the completion of tax audits. Also in2008, the Company has been notified that the Internal Revenue Service willaudit the year ended December 31, 2005.

 

**14. Preferred Stock Purchase Rights**

 

Pursuantto the terms of a Shareholder Rights Agreement (the “Rights Agreement”), theBoard of Directors declared a distribution on June 15, 1999 of onePreferred Stock Purchase Right (a “Right”) for each outstanding share of CommonStock of the Company (the “Common Stock”). Under certain circumstances, eachRight entitles the holder thereof to purchase from the Company a unitconsisting of one ten thousandth of a share (a “Unit”) of Series A JuniorParticipating Cumulative Preferred Stock, par value $.01 per share (the “PreferredStock”), at a cash exercise price of $80.00 per Unit, subject to adjustment.The Rights are not exercisable and are attached to and trade with all shares ofCommon Stock until the earlier to occur of (i) 10 days following thefirst public announcement that a person or group of affiliated or associatedpersons has acquired beneficial ownership of 15% or more of the outstandingshares of Common Stock (an “Acquiring Person”) (the date of said announcementbeing referred to as the “Stock Acquisition Date”), (ii) 10 business daysfollowing the commencement of a tender offer or exchange offer that couldresult upon its consummation in a person or group becoming the beneficial ownerof 15% or more of the outstanding shares of Common Stock or (iii) thedetermination by the Board of Directors that any person is an “Adverse Person”as defined in the Rights Agreement. The Rights will expire at the close ofbusiness on June 15, 2009 (the “Expiration Date”), unless previouslyredeemed or exchanged by the Company as described below. The Rights are notentitled to vote or to receive dividends.

 

F-24

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**14. Preferred Stock Purchase Rights (Continued)**

 

Inthe event that a Stock Acquisition Date occurs or the Board of Directorsdetermines that a person is an Adverse Person, each Right will be entitled toreceive upon exercise that number of Units of Preferred Stock of the Companyhaving a market value of two times the exercise price of the Right. In theevent that, at any time following the Stock Acquisition Date, (i) theCompany merges with and into any other person, and the Company is not thecontinuing or surviving corporation, (ii) any person merges with and intothe Company and the Company is the continuing or surviving corporation of suchmerger and, in connection with such merger, all or part of the shares of CommonStock are changed into or exchanged for securities of any other person or cashor any other property, or (iii) 50% or more of the Company’s assets orearning power is sold, each Right will be entitled to receive, upon exercise,common stock of the acquiring company having a market value equal to two timesthe exercise price of the Right. Rights that are or were beneficially owned byan Acquiring Person or an Adverse Person may (under certain circumstancesspecified in the Rights Agreement) become null and void.

 

TheRights may be redeemed in whole, but not in part, at a price of $0.01 per Rightby the Board of Directors only until the earliest of (i) the time at whicha person is declared to be an Adverse Person, (ii) the time at which anyperson becomes an Acquiring Person, or (iii) the Expiration Date.

 

**15. Segment Information**

 

TheCompany operates four business units which are based on the Company’s differentproduct and service categories: Laundry Facilities Management, CommercialLaundry Equipment Sales, MicroFridge® branded product sales and Reprographics.These four business units constitute two reportable segments (“FacilitiesManagement” and “Product Sales”). The Facilities Management segment includestwo business units: Laundry Facilities Management and Reprographics. TheLaundry Facilities Management business unit provides card- and coin-operatedlaundry equipment to multi-unit housing facilities such as apartment buildings,colleges and universities and public housing complexes. The Reprographicsbusiness unit provides card- and coin-operated copiers to academic and publiclibraries. The Product Sales segment includes two business units: MicroFridge®branded product sales and Commercial Laundry Equipment Sales. The Intirionbusiness unit revenue includes sales of its own patented and proprietary lineof refrigerator/freezer/microwave oven combinations to a customer base whichincludes hospitality and assisted living facilities, military housing andcolleges and universities. The Commercial Laundry Equipment Sales business unitoperates as a distributor of, and provides service to, commercial laundryequipment in public laundromats, as well as for institutional purchasers,including hospitals, hotels and the United States military for use in their ownon-premise laundry facilities.

 

Thereare no intersegment revenues.

 

Thetables below present information about the operations of the reportablesegments of Mac-Gray for the years ended December 31, 2005, 2006 and 2007.The information presented

 

F-25

----

Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**15. Segment Information (Continued)**

 

representsthe key financial metrics that are utilized by the Company’s senior managementin assessing the performance of each of the Company’s reportable segments.

 
| ** **                                     | ** ** | **For the years ended December 31,** | ** ** |
|------------------------------------------------|------------|---------------------------------------------------------------|------------|
| ** **                                     | ** ** | **2005**                                                      | ** ** | **2006** | ** ** | **2007** | ** ** |
| Revenue:                                       |       |                                                          |       |   |   |   |   |
| Facilities  management                         |       | $                                                             | 214,816    |   | $ | 232,181 |   | $ | 242,803 |   |
| Product sales                                  |       | 45,807                                                        |       | 47,146 |   | 53,099 |   |
|                                           |       |                                                          |       |   |   |   |   |
| Total                                          |       | 260,623                                                       |       | 279,327 |   | 295,902 |   |
| Gross margin:                                  |       |                                                          |       |   |   |   |   |
| Facilities  management                         |       | 41,818                                                        |       | 43,533 |   | 42,800 |   |
| Product sales                                  |       | 9,243                                                         |       | 9,425 |   | 12,506 |   |
|                                           |       |                                                          |       |   |   |   |   |
| Total                                          |       | 51,061                                                        |       | 52,958 |   | 55,306 |   |
| Selling, general  and administration expenses  |       | 31,450                                                        |       | 35,663 |   | 36,050 |   |
| Impairment of  assets                          |       | —                                                        |       | 2,502 |   | — |   |
| Loss on early  extinguishment of debt          |       | 668                                                           |       | 73 |   | — |   |
| Gain on sale of  assets                        |       | (10,735                                                       | )          | (32 | ) | (254 | ) |
| (Gain) loss  related to derivative instruments |       | (1,876                                                        | )          | 96 |   | 1,737 |   |
| Interest and  other expenses, net              |       | 10,939                                                        |       | 13,653 |   | 13,745 |   |
|                                           |       |                                                          |       |   |   |   |   |
| Income before  provision for income taxes      |       | $                                                             | 20,615     |   | $ | 1,003 |   | $ | 4,028 |   |

 
| ** **                     | ** ** | **December 31,** | ** ** |
|--------------------------------|------------|-----------------------|------------|
| ** **                     | ** ** | **2006**              | ** ** | **2007** | ** ** |
| Assets                         |       |                  |       |   |   |
| Facilities management          |       | $                     | 293,749    |   | $ | 332,810 |   |
| Product sales                  |       | 25,973                |       | 28,105 |   |
|                           |       |                  |       |   |   |
| Total for  reportable segments |       | 319,722               |       | 360,915 |   |
| Corporate(1)                   |       | 18,321                |       | 21,679 |   |
| Deferred income  taxes         |       | 961                   |       | 943 |   |
|                           |       |                  |       |   |   |
| Total assets                   |       | $                     | 339,004    |   | $ | 383,537 |   |
|                           |       |                  |       |   |   |

----

*(1)*

Principallycash and cash equivalents, prepaid expenses and property, plant and equipmentnot included elsewhere.

 

**16. Commitments and Contingencies**

 

TheCompany is involved in various litigation proceedings arising in the normalcourse of business. In the opinion of management, the Company’s ultimateliability, if any, under pending litigation would not materially affect itsfinancial condition, results of its operations, or its cash flow.

 

F-26

----

Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**16. Commitments and Contingencies (Continued)**

 

*Leases.*    The Company leases certain equipment andfacilities under non-cancelable operating leases. The Company also leasescertain vehicles under capital leases.

 

Futureminimum lease payments under non-cancelable operating and capital leasesconsist of the following:

 
| ** **                                                                     | ** ** | **Capital  Leases** | ** ** | **Operating  Leases** | ** ** |
|--------------------------------------------------------------------------------|------------|---------------------|------------|-----------------------|------------|
| Year ended  December 31,                                                  |       |                |       |                  |       |
| 2008                                                                           |       | $                   | 1,559      |                  | $          | 2,905 |   |
| 2009                                                                           |       | 1,279               |       | 2,485                 |       |
| 2010                                                                           |       | 970                 |       | 2,280                 |       |
| 2011                                                                           |       | 339                 |       | 1,884                 |       |
| 2012                                                                           |       | —              |       | 1,529                 |       |
| Thereafter                                                                     |       | —              |       | 4,044                 |       |
|                                                                           |       |                |       |                  |       |
|                                                                           |       | 4,147               |       | $                     | 15,127     |   |
|                                                                           |       |                |       |                  |       |
| Less: amount  representing interest (LIBOR of 4.78% at December 31, 2007) |       | 626                 |       |                  |       |
|                                                                           |       |                |       |                  |       |
|                                                                           |       | 3,521               |       |                  |       |
| Less: future  minimum lease payments due within one year                       |       | 1,352               |       |                  |       |
|                                                                           |       |                |       |                  |       |
| Amounts due  after one year                                                    |       | $                   | 2,169      |                  |       |   |

 

Rentexpense incurred by the Company under non-cancelable operating leases totaled$2,439, $3,221 and $3,361 for the years ended December 31, 2005, 2006 and2007, respectively.

 

*Guaranteed Facilities Management Rent Payments.*    The Company operatescard- and coin-operated facilities management laundry rooms under various leaseagreements in which the Company is required to make minimum guaranteed rentpayments to the respective lessors. The following is a schedule by years offuture minimum guaranteed rent payments required under these lease agreementsthat have initial or remaining non-cancelable contract terms in excess of oneyear as of December 31, 2007:

 
| 2008       |   | $      | 16,734 |   |
|------------|--------|--------|--------|--------|
| 2009       |   | 14,763 |   |
| 2010       |   | 12,174 |   |
| 2011       |   | 8,003  |   |
| 2012       |   | 6,008  |   |
| Thereafter |   | 9,345  |   |
|       |   |   |   |
|       |   | $      | 67,027 |   |

 

F-27

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**17. Employee Benefit and Stock Plans**

 

*Retirement Plans.*    The Company maintainsa qualified profit-sharing/401(k) plan (the “Plan”) covering substantiallyall employees. The Company’s contributions to the Plan are at the discretion ofthe Board of Directors. Costs under the Plan amounted to $1,046, $1,122 and$1,144 for the years ended December 31, 2005, 2006 and 2007, respectively.

 

*Stock Option and Incentive Plans.*    On April 7, 1997,the Company’s stockholders approved the 1997 Stock Option and Incentive Planfor the Company (the “1997 Stock Plan”). On May 26, 2005, the Company’sstockholders approved the 2005 Stock Option and Incentive Plan for the Company(the “2005 Stock Plan” and together with the 1997 Stock Plan the “Stock Plans”).The Stock Plans are designed and intended as a performance incentive forofficers, employees, and independent directors to promote the financial successand progress of the Company. All officers, employees and independent directorsare eligible to participate in the Stock Plans. Awards, when made, may be inthe form of stock options, restricted stock, restricted stock units,unrestricted stock options, and dividend equivalent rights. The Stock Plansrequire the maximum term of options to be ten years.

 

Employeeoptions generally vest such that one-third of the options will becomeexercisable on each of the first through third anniversaries of the date ofgrant of the options; however, the administrator of the Stock Plans maydetermine, at its discretion, the vesting schedule for any option award. In theevent of termination of the optionee’s relationship with the Company, vestedoptions not yet exercised terminate within 90 days. The non-qualifiedoptions granted to independent directors are exercisable immediately and terminateten years from the date of the grant. Directors have one year after leaving theboard to exercise their options. The exercise prices are the fair market valueof the shares underlying the options on the respective dates of the grants. TheCompany issues shares upon exercise of options from its treasury shares, ifavailable. The grant-date fair value of employee share options and similarinstruments is estimated using the Black-Scholes option-pricing model. The fairvalues of the stock options granted in 2007 and 2006 were estimated using thefollowing components:

 
| ** **                           | ** ** | **2007**                       | ** ** | **2006**                       | ** ** |
|--------------------------------------|------------|--------------------------------|------------|--------------------------------|------------|
| Fair value of  options at grant date |       | $1.91 - $5.65                  |       | $3.44 - $5.41                  |       |
| Risk free  interest rate             |       | 4.25% - 4.98%                  |       | 4.60% - 4.91%                  |       |
| Estimated  forfeiture rate           |       | 0.00% - 4.00%                  |       | 0.00% - 1.65%                  |       |
| Estimated option  term               |       | 1.0 - 8.0 years |       | 5.0 - 9.0 years |       |
| Expected  volatility                 |       | 23.82% - 26.36%                |       | 24.40% - 27.30%                |       |

 

Theexpected volatility of the Company’s stock price was based on historicalperformance over the prior number of years equal to the expected term.

 

F-28

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**17. Employee Benefit and Stock Plans (Continued)**

 

Thefollowing is a summary of stock option plan activity under the Plans as of December 31,2007, and changes during the year then ended:

 
| ** **                                                  | ** ** | **Options** | ** ** | **Weighted  Average  Exercise  Price** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|-------------------------------------------------------------|------------|-------------|------------|----------------------------------------|------------|---------------------------------------------------------|------------|
| Outstanding at  January 1, 2007                        |       | 1,210,640   |       | $                                      | 6.93       |                                                    | $          | 3.06 |   |
| Granted                                                     |       | 309,547     |       | 13.58                                  |       | 4.36                                                    |       |
| Exercised                                                   |       | (128,955    | )          | 6.29                                   |       | 3.08                                                    |       |
| Forfeited                                                   |       | (13,499     | )          | 12.35                                  |       | 4.45                                                    |       |
|                                                        |       |        |       |                                   |       |                                                    |       |
| Outstanding at  December 31, 2007                      |       | 1,377,733   |       | $                                      | 8.44       |                                                    | $          | 3.34 |   |
|                                                        |       |        |       |                                   |       |                                                    |       |
| Exercisable at  December 31, 2007                      |       | 912,475     |       | $                                      | 6.73       |                                                    | $          | 2.85 |   |
|                                                        |       |        |       |                                   |       |                                                    |       |
| Options vested  during the year                             |       | 232,070     |       |                                   |       |                                                    |       |
|                                                        |       |        |       |                                   |       |                                                    |       |
| Weighted average  remaining life of the outstanding options |       | 6.42        |       |                                   |       |                                                    |       |
|                                                        |       |        |       |                                   |       |                                                    |       |
| Weighted average  remaining life of the exercisable options |       | 5.32        |       |                                   |       |                                                    |       |
|                                                        |       |        |       |                                   |       |                                                    |       |
| Total intrinsic  value of the outstanding options           |       | $           | 4,757,643  |                                   |       |                                                    |       |   |
|                                                        |       |        |       |                                   |       |                                                    |       |
| Total intrinsic  value of the exercisable options           |       | $           | 4,512,035  |                                   |       |                                                    |       |   |

 
| ** **                                      | ** ** | **December 31,** | ** ** |
|-------------------------------------------------|------------|-----------------------|------------|
| ** **                                      | ** ** | **2007**              | ** ** | **2006** | ** ** |
| Weighted average  fair value of options granted |       | $                     | 4.36       |   | $ | 4.79 |   |
| Intrinsic value  of options exercised           |       | 1,018,046             |       | 963,211 |   |
| Fair value of  shares vested                    |       | 2,600,554             |       | 2,011,936 |   |
|                                                 |            |                       |            |  |  |  |  |

 

Asummary of the status of the Company’s nonvested shares as of December 31,2007 and changes during the year then ended is presented below:

 
| ** **                           | ** ** | ** ** | ** ** | **Grant Date  Fair Value** | ** ** |
|--------------------------------------|------------|------------|------------|--------------------------------------|------------|
| Nonvested at  January 1, 2007   |       | 392,780    |       | $                                    | 4.32       |   |
| Granted                              |       | 309,547    |       | 4.36                                 |       |
| Vested                               |       | (232,070   | )          | 4.42                                 |       |
| Forfeited                            |       | (4,999     | )          | 4.32                                 |       |
|                                 |       |       |       |                                 |       |
| Nonvested at  December 31, 2007 |       | 465,258    |       | $                                    | 4.30       |   |

 

Inthe year ended December 31, 2007, the Company granted 69,288 shares ofrestricted stock with an average fair market value of $11.86 per share. Thestock vests evenly over three years upon the achievement of certain performanceobjectives to be determined by the Board of Directors at the beginning of eachfiscal year. The Company also granted 6,792 shares of restricted stock with an

 

F-29

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**17. Employee Benefit and Stock Plans (Continued)**

 

averagefair market value of $14.59 per share that vest over three years which do nothave a performance requirement. Restricted stock activity for fiscal 2007 ispresented below:

 
| ** **                                                           | ** ** | **Restricted  Stock** | ** ** | **Weighted  Average  Grant Date  Fair Value** | ** ** |
|----------------------------------------------------------------------|------------|-----------------------|------------|---------------------------------------------------------|------------|
| Outstanding at  January 1, 2007                                 |       | 59,674                |       | $                                                       | 11.86      |   |
| Restricted Stock  Granted                                            |       | 76,080                |       | 12.19                                                   |       |
| Restricted Stock  Issued                                             |       | (20,098               | )          | 11.86                                                   |       |
|                                                                 |       |                  |       |                                                    |       |
| Outstanding at  December 31, 2007                               |       | 115,656               |       | $                                                       | 12.08      |   |
|                                                                 |       |                  |       |                                                    |       |
| Exercisable at  December 31, 2007                               |       | —                |       | —                                                  |       |
|                                                                 |       |                  |       |                                                    |       |
| Restricted stock  earned during the year                             |       | 19,960                |       | $                                                       | 11.86      |   |
| Weighted average  remaining life of the outstanding restricted stock |       | 1.11                  |       |                                                    |       |
| Weighted average  remaining life of the exercisable restricted stock |       | —                |       |                                                    |       |
| Total intrinsic  value of the outstanding restricted stock           |       | $                     | (74,000    | )                                                       |       |   |
| Total intrinsic  value of the exercisable restricted stock           |       | —                |       |                                                    |       |
|                                                                      |            |                       |            |                                                         |            |  |  |

 

Compensationexpense related to nonvested options and restricted shares will be recognizedin the following years:

 
| 2008   |   | $      | 1,343  |   |
|--------|--------|--------|--------|--------|
| 2009   |   | 765    |   |
| 2010   |   | 93     |   |
|   |   |   |   |
|   |   | $      | 2,201  |   |

 

AtDecember 31, 2007, the stock plans provide for the issuance of up to2,481,470 shares of Common Stock of which 586,036 shares have been issuedpursuant to the exercise of option agreements or restricted stock awards. At December 31,2007 1,377,733 shares are subject to outstanding options, 115,656 shares havebeen granted subject to certain performance criteria and 402,045 remainavailable for issuance. Subsequent to April 6, 2007, no additional grantsmay be made from the 1997 Plan.

 

*Mac-Gray Corporation 2001 Employee Stock PurchasePlan.*    TheCompany established the Mac-Gray Corporation 2001 Employee Stock Purchase Plan(the “ESPP”) in May 2001. Under the terms of the ESPP, eligible employeesmay have between 1% and 15% of eligible compensation deducted from their pay topurchase Company Common Stock. The per share purchase price is 85% of the fairmarket value of the stock on, the lower of, the first day or the last day ofeach six month interval. Up to 200,000 shares may be offered pursuant to theESPP. The plan includes certain restrictions, such as the holding period of thestock by employees. Currently there are 131 participants in the ESPP. Thenumber of shares of Common Stock purchased through the ESPP was 17,534 and49,446 for the years ended December 31, 2006 and 2007, respectively. Therehave been 173,875 shares purchased since the inception of the ESPP. At December 31,2006 and 2007, the Company had

 

F-30

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**17. Employee Benefit and Stock Plans (Continued)**

 

accumulatedemployee withholdings associated with this plan of $330 and $151 foracquisition of stock in 2007 and 2008, respectively.

 

**18. Earnings Per Share**

 
| ** **                                                         | ** ** | **Year Ended December 31,** | ** ** |
|--------------------------------------------------------------------|------------|--------------------------------------------|------------|
| ** **                                                         | ** ** | **2005**                                   | ** ** | **2006** | ** ** | **2007** | ** ** |
| Net income                                                         |       | $                                          | 12,052     |   | $ | 856 |   | $ | 2,519 |   |
|                                                               |       |                                       |       |   |   |   |   |
| Weighted average  number of common shares outstanding—basic   |       | 12,864                                     |       | 13,008 |   | 13,209 |   |
| Effect of  dilutive securities:                                    |       |                                       |       |   |   |   |   |
| Stock options                                                      |       | 419                                        |       | 440 |   | 471 |   |
|                                                               |       |                                       |       |   |   |   |   |
| Weighted average  number of common shares outstanding—diluted |       | 13,283                                     |       | 13,448 |   | 13,680 |   |
|                                                               |       |                                       |       |   |   |   |   |
| Net income per  share—basic                                   |       | $                                          | 0.94       |   | $ | 0.07 |   | $ | 0.19 |   |
|                                                               |       |                                       |       |   |   |   |   |
| Net income per  share—diluted                                 |       | $                                          | 0.91       |   | $ | 0.06 |   | $ | 0.18 |   |

 

Therewere 1, 253, and 552 shares under option plans that were excluded from thecomputation of diluted earnings per share at December 31, 2005, 2006 and2007, respectively, due to their anti-dilutive effects.

 

F-31

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**19. Summary of Quarterly Financial Information (unaudited)**

 
| ** **                                               | ** ** | **Year Ended December 31, 2006** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                               | ** ** | **1st Qtr**                                     | ** ** | **2nd Qtr** | ** ** | **3rd Qtr** | ** ** | **4th Qtr** | ** ** | **Total** | ** ** |
| Revenue                                                  |       | $                                                    | 67,698     |   | $ | 69,019 |   | $ | 70,003 |   | $ | 72,607 |   | $ | 279,327 |   |
| Cost of revenue                                          |       | 53,447                                               |       | 56,214 |   | 58,057 |   | 58,651 |   | 226,369 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Gross margin                                             |       | 14,251                                               |       | 12,805 |   | 11,946 |   | 13,956 |   | 52,958 |   |
| Operating expenses                                       |       | 8,674                                                |       | 9,107 |   | 8,105 |   | 12,320 |   | 38,206 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Income from operations                                   |       | 5,577                                                |       | 3,698 |   | 3,841 |   | 1,636 |   | 14,752 |   |
| Interest and other expense, net                          |       | (3,184                                               | )          | (3,397 | ) | (3,666 | ) | (3,406 | ) | (13,653 | ) |
| Gain related to derivative instruments                   |       | 542                                                  |       | 383 |   | (965 | ) | (56 | ) | (96 | ) |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Income before provision for income taxes                 |       | 2,935                                                |       | 684 |   | (790 | ) | (1,826 | ) | 1,003 |   |
| Provision for income taxes                               |       | 1,181                                                |       | 275 |   | (523 | ) | (786 | ) | 147 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Net income                                               |       | $                                                    | 1,754      |   | $ | 409 |   | $ | (267 | ) | $ | (1,040 | ) | $ | 856 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Net income per common share—basic                   |       | $                                                    | 0.14       |   | $ | 0.03 |   | $ | (0.02 | ) | $ | (0.08 | ) | $ | 0.07 | (a) |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Net income per common share—diluted                 |       | $                                                    | 0.13       |   | $ | 0.03 |   | $ | (0.02 | ) | $ | (0.08 | ) | $ | 0.06 | (a) |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Weighted average common shares  outstanding—basic   |       | 12,944                                               |       | 12,984 |   | 13,034 |   | 13,070 |   | 13,008 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Weighted average common shares  outstanding—diluted |       | 13,352                                               |       | 13,444 |   | 13,034 |   | 13,070 |   | 13,448 |   |

 

----

*(a)*

Thesum of the quarterly earnings per share amounts may not equal the full yearamount since the computations of the weighted average shares outstanding foreach quarter and the full year are computed independently of each other.

 

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Table of Contents

** **

**MAC-GRAY CORPORATION**

 

**NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Continued)**

 

**(In thousands, except per share data)**

 

**19. Summary of Quarterly Financial Information (unaudited)(Continued)**

 
| ** **                                               | ** ** | **Year Ended December 31, 2007** | ** ** |
|----------------------------------------------------------|------------|------------------------------------------------------|------------|
| ** **                                               | ** ** | **1st Qtr**                                     | ** ** | **2nd Qtr** | ** ** | **3rd Qtr** | ** ** | **4th Qtr** | ** ** | **Total** | ** ** |
| Revenue                                                  |       | $                                                    | 71,474     |   | $ | 69,215 |   | $ | 76,525 |   | $ | 78,688 |   | $ | 295,902 |   |
| Cost of revenue                                          |       | 56,651                                               |       | 56,705 |   | 63,730 |   | 63,510 |   | 240,596 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Gross margin                                             |       | 14,823                                               |       | 12,510 |   | 12,795 |   | 15,178 |   | 55,306 |   |
| Operating expenses                                       |       | 9,303                                                |       | 8,597 |   | 8,288 |   | 9,608 |   | 35,796 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Income from operations                                   |       | 5,520                                                |       | 3,913 |   | 4,507 |   | 5,570 |   | 19,510 |   |
| Interest and other expense, net                          |       | (3,136                                               | )          | (3,122 | ) | (3,586 | ) | (3,901 | ) | (13,745 | ) |
| Gain (loss) related to derivative  instruments           |       | (264                                                 | )          | 516 |   | (986 | ) | (1,003 | ) | (1,737 | ) |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Income before provision for income taxes                 |       | 2,120                                                |       | 1,307 |   | (65 | ) | 666 |   | 4,028 |   |
| Provision for income taxes                               |       | 866                                                  |       | 539 |   | (190 | ) | 294 |   | 1,509 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Net income                                               |       | $                                                    | 1,254      |   | $ | 768 |   | $ | 125 |   | $ | 372 |   | $ | 2,519 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |   |   |   |   |   |
| Net income per common share—basic                   |       | $                                                    | 0.10       |   | $ | 0.06 |   | $ | 0.01 |   | $ | 0.03 |   | $ | 0.19 | (a) |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Net income per common share—diluted                 |       | $                                                    | 0.09       |   | $ | 0.06 |   | $ | 0.01 |   | $ | 0.03 |   | $ | 0.18 | (a) |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Weighted average common shares  outstanding—basic   |       | 13,132                                               |       | 13,185 |   | 13,245 |   | 13,272 |   | 13,209 |   |
|                                                     |       |                                                 |       |   |   |   |   |   |   |   |   |
| Weighted average common shares  outstanding—diluted |       | 13,557                                               |       | 13,668 |   | 13,670 |   | 13,700 |   | 13,680 |   |
|                                                          |            |                                                      |            |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |  |

 

----

*(a)*

Thesum of the quarterly earnings per share amounts may not equal the full yearamount since the computations of the weighted average shares outstanding foreach quarter and the full year are computed independently of each other.

 

F-33

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Table of Contents

 

**MAC-GRAY CORPORATION**

 

**SCHEDULE II**

 

**VALUATION AND QUALIFYING ACCOUNTS**

 

**YEARS ENDED DECEMBER 31, 2005, 2006, AND 2007**

 
| ** **                                          | ** ** | **Balance  Beginning  of Year** | ** ** | **Charged to  Cost and  Expenses** | ** ** | **Deductions** | ** ** | **Balance  at End  of Year** | ** ** |
|-----------------------------------------------------|------------|--------------------------------------|------------|----------------------------------------------|------------|----------------|------------|----------------------------------------|------------|
| Year Ended December 31, 2005:                  |       |                                 |       |                                         |       |           |       |                                   |       |
| Allowance for doubtful accounts and lease  reserves |       | $                                    | 382        |                                         | $          | 329            |       | $                                      | (123       | ) | $ | 588 |   |
| Year Ended December 31, 2006:                  |       |                                 |       |                                         |       |           |       |                                   |       |
| Allowance for doubtful accounts and lease  reserves |       | $                                    | 588        |                                         | $          | 126            |       | $                                      | (280       | ) | $ | 434 |   |
| Year Ended December 31, 2007:                  |       |                                 |       |                                         |       |           |       |                                   |       |
| Allowance for doubtful accounts and lease  reserves |       | $                                    | 434        |                                         | $          | 195            |       | $                                      | (246       | ) | $ | 383 |   |

 

F-34

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