UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

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

For the quarterly period ended September 30, 2009

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-GRAY CORPORATION

(Exact name of registrant as specified in its charter)

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

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

(781) 487-7600

Registrant’s telephone number, including area code:

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes o No o

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting 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

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

As of November 6, 2009, 13,616,684 shares of common stock of the registrant, par value $.01 per share, were outstanding.

Table of Contents

Item 1. Financial Statements

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands, except share data)

	December 31,			September 30,
	2008			2009

Assets
Current assets:
Cash and cash equivalents	$	18,836		$	16,171
Trade receivables, net of allowance for doubtful accounts	9,793			8,701
Inventory of finished goods, net	6,047			6,703
Deferred income taxes	869			840
Prepaid facilities management rent and other current assets	13,918			12,633
Total current assets	49,463			45,048
Property, plant and equipment, net	143,494			136,017
Goodwill	59,701			59,375
Intangible assets, net	222,285			212,265
Prepaid facilities management rent and other assets	15,061			14,372
Total assets	$	490,004		$	467,077

Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt and capital lease obligations	$	5,471		$	5,595
Trade accounts payable	4,841			8,655
Accrued facilities management rent	22,211			20,351
Accrued expenses	16,139			14,412
Deferred revenues and deposits	791			989
Total current liabilities	49,453			50,002
Long-term debt and capital lease obligations	295,821			267,856
Other liabilities	11,385			9,895
Deferred income taxes	35,381			36,932
Commitments and contingencies (Note 5)	—			—
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 13,381,387 outstanding at December 31, 2008, and 13,610,860 issued and 13,610,684 outstanding at September 30, 2009)	134			136
Additional paid in capital	74,669			77,329
Accumulated other comprehensive loss	(3,117		)	(2,360		)
Retained earnings	26,925			27,289
	98,611			102,394
Less: common stock in treasury, at cost (62,367 shares at December 31, 2008 and 176 shares at September 30, 2009)	(647		)	(2		)
Total stockholders’ equity	97,964			102,392
Total liabilities and stockholders’ equity	$	490,004		$	467,077

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

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MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED INCOME STATEMENTS (Unaudited)

(In thousands, except per share data)

	Three months ended September 30,					Nine months ended September 30,
	2008		2009			2008			2009

Revenue:
Facilities management revenue	$	78,508	$	74,816		$	224,392		$	232,022
Product sales	19,533		12,579			44,191			37,314
Total revenue	98,041		87,395			268,583			269,336

Cost of revenue:
Cost of facilities management revenue	53,418		51,757			151,852			157,680
Depreciation and amortization	12,768		12,291			34,854			36,858
Cost of product sales	15,379		9,779			34,591			28,769
Total cost of revenue	81,565		73,827			221,297			223,307

Gross margin	16,476		13,568			47,286			46,029

General and administration expenses	4,731		4,806			14,639			14,476
Sales and marketing expenses	4,648		4,548			13,710			13,658
Incremental costs of 2009 proxy contest	—		—			—			971
Depreciation and amortization	443		439			1,284			1,311
(Gain) loss on sale or disposal of assets, net	8		(59		)	(41		)	(552		)
Loss on early extinguishment of debt	—		—			207			—
Total operating expenses	9,830		9,734			29,799			29,864

Income from operations	6,646		3,834			17,487			16,165

Interest expense, net	5,654		4,828			15,064			14,825
Loss (gain) related to derivative instruments	122		(57		)	159			(558		)
Income (loss) before provision for income taxes	870		(937		)	2,264			1,898

Provision (benefit) for income taxes	217		(551		)	639			911

Net income (loss)	$	653	$	(386	)	$	1,625		$	987

Net income (loss) per common share - basic	$	0.05	$	(0.03	)	$	0.12		$	0.07
Net income (loss) per common share — diluted	$	0.05	$	(0.03	)	$	0.12		$	0.07
Weighted average common shares outstanding - basic	13,366		13,587			13,335			13,498
Weighted average common shares outstanding — diluted	13,729		13,587			13,690			13,895

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

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MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENT OF STOCKHOLDERS’ EQUITY (Unaudited)

(In thousands, except share data)

							Accumulated
	Common Stock			Additional			Other								Treasury Stock
	Number			Paid In			Comprehensive			Comprehensive		Retained			Number
	of shares	Value		Capital			Income (Loss)			Income		Earnings			of shares		Cost			Total

Balance, December 31, 2008	13,443,754	$	134	$	74,669		$	(3,117	)			$	26,925		62,367		$	(647	)	$	97,964
Net income	—	—		—			—			$	987	987			—		—			$	987
Other comprehensive income:
Unrealized gain on derivative instrument, net of tax of $476 (Note 3)	—	—		—			757			757		—			—		—			$	757
Comprehensive income										$	1,744
Repurchase of common stock	—	—		—								—			9,597		(113		)	$	(113	)
Option Exercised	87,746	1		596			—					(14		)	(9,597	)	113			$	696
Stock issuance - Employee Stock Purchase Plan	67,372	1		363			—					—			—		—			$	364
Stock compensation expense	—	—		1,628			—					—			—		—			$	1,628
Net tax benefit (shortfall) from share based payment arrangements	—	—		(22		)	—					—			—		—			$	(22	)
Stock grants	11,988	—		95			—					(609		)	(62,191	)	645			$	131
Balance, September 30, 2009	13,610,860	$	136	$	77,329		$	(2,360	)			$	27,289		176		$	(2	)	$	102,392

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

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MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)

(In thousands)

	Nine months ended September 30,
	2008			2009
Cash flows from operating activities:
Net income	$	1,625		$	987
Adjustments to reconcile net income to net cash flows provided by operating activities:
Depreciation and amortization	36,138			38,169
Increase in allowance for doubtful accounts and lease reserves	105			3
Gain on sale of assets	(41		)	(552		)
Stock grants	79			131
Loss (gain) related to derivative instruments	159			(558		)
Loss on early extinguishment of the debt	207			—
Deferred income taxes	6,910			1,706
Excess tax benefits from share based payment arrangements	(19		)	(131		)
Non cash stock compensation	1,723			1,628
(Increase) decrease in accounts receivable	(4,540		)	1,089
Decrease (increase) in inventory	925			(656		)
Increase in prepaid facilities management rent and other assets	(2,710		)	(482		)
(Decrease) increase in accounts payable, accrued facilities management rent, accrued expenses and other liabilities	(3,841		)	321
Increase in deferred revenues and customer deposits	12			198
Net cash flows provided by operating activities	36,732			41,853

Cash flows from investing activities:
Capital expenditures	(22,611		)	(17,372		)
Payments for acquisitions	(106,213		)	—
Proceeds from sale of assets	394			1,111
Net cash flows used in investing activities	(128,430		)	(16,261		)

Cash flows from financing activities:
Payments on capital lease obligations	(1,536		)	(1,268		)
Borrowings on 2005 revolving credit facility	8,000			—
Payments on 2005 revolving credit facility	(63,000		)	—
Payments on acquisition note	—			(10,000		)
Borrowings on 2008 revolving credit facility	135,971			77,540
Payments on 2008 revolving credit facility	(22,431		)	(92,607		)
Borrowings on 2008 term loan	40,000			—
Payments on 2008 term loan	(2,000		)	(3,000		)
Debt acquisition costs	(1,680		)	—
Excess tax benefits from share based payment arrangements	19			131
Proceeds from exercise of stock options	204			696
Repurchase of common stock	—			(113		)
Proceeds from issuance of common stock under ESPP program	346			364
Net cash flows provided by (used in) financing activities	93,893			(28,257		)

Increase (decrease) in cash and cash equivalents	2,195			(2,665		)
Cash and cash equivalents, beginning of period	13,325			18,836
Cash and cash equivalents, end of period	$	15,520		$	16,171

Supplemental disclosure of non-cash investing and financing activities: During the nine months ended September 30, 2008 and 2009, the Company acquired various vehicles under capital lease agreements totaling $1,668 and $1,495, respectively.

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

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

1. Basis of Presentation

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States of America for interim financial reporting and the instructions to Form 10-Q and Rule 10-01 of Regulation S-X. The unaudited interim condensed consolidated financial statements do not include all information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States of America. In the opinion of the management of Mac-Gray Corporation (the “Company” or “Mac-Gray”), the accompanying unaudited condensed consolidated financial statements contain all adjustments (consisting of normal, recurring adjustments), which are necessary to present fairly the Company’s financial position, the results of its operations, and its cash flows. These unaudited condensed consolidated financial statements should be read in conjunction with the Company’s 2008 audited consolidated financial statements filed with the Securities and Exchange Commission in its Annual Report on Form 10-K for the year ended December 31, 2008. The results for interim periods are not necessarily indicative of the results to be expected for the full year.

The Company generates the majority of its revenue from card and coin-operated laundry equipment located in 43 states throughout the United States, as well as the District of Columbia. The Company’s principal customer base is the multi-unit housing market, which consists of apartments, condominium units, colleges and universities, military bases, hotels and motels. The Company also sells the MicroFridge® branded product lines, kitchen appliances and sells, services and leases commercial laundry equipment to commercial laundromats and institutions. The majority of the Company’s purchases of laundry equipment are from one supplier.

2. Long Term Debt

The Company has a senior secured credit agreement (the “Secured Credit Agreement”) pursuant to which the Company may borrow up to $164,000 in the aggregate, including $34,000 pursuant to a Term Loan and up to $130,000 pursuant to a Revolver. The Term Loan requires quarterly principal payments of $1,000 at the end of each calendar quarter through December 31, 2012, with the remaining principal balance of $21,000 due on April 1, 2013. The Secured Credit Agreement also provides for Bank of America, N. A. to make swingline loans to us of up to $10,000 (the “Swingline Loans”) and any Swingline Loans will reduce the borrowings available under the Revolver. Subject to certain terms and conditions, the Secured Credit Agreement gives the company the option to establish additional term and/or revolving credit facilities there under, provided that the aggregate commitments under the Secured Credit Agreement cannot exceed $220,000.

Borrowings outstanding under the Secured Credit Agreement bear interest at a fluctuating rate equal to (i) in the case of Eurodollar rate loans, the LIBOR rate (adjusted for statutory reserves) plus an applicable percentage, ranging from 2.00% to 2.50% per annum (currently 2.25%), determined by reference to our senior secured leverage ratio, and (ii) in the case of base rate loans and Swingline Loans, the higher of (a) the federal funds rate plus 0.5% or (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate,” in each case, plus an applicable percentage, ranging from 1.00% to 1.50% per annum (currently 1.25%), determined by reference to the Company’s senior secured leverage ratio.

The obligations under the Secured Credit Agreement are guaranteed by the Company’s subsidiaries and secured by (i) a pledge of 100% of the ownership interests in the subsidiaries, and (ii) a first-priority security interest in substantially all our tangible and intangible assets.

Under the Secured Credit Agreement, the Company is subject to customary lending covenants, including restrictions pertaining to, among other things: (i) the incurrence of additional indebtedness, (ii) limitations on liens, (iii) making distributions, dividends and other payments, (iv) the making of certain investments and loans, (v) mergers, consolidations and acquisitions, (vi) dispositions of assets, (vii) the maintenance of a maximum total leverage ratio of not greater than 4.25 to 1.00, a maximum senior secured leverage ratio of not greater than 2.50 to 1.00, and a minimum consolidated cash flow coverage ratio of not less than 1.20 to 1.00, (viii) transactions with affiliates, and (ix) changes to governing documents and subordinate debt documents, in

Table of Contents

MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

2. Long-Term Debt (continued)

each case subject to baskets, exceptions and thresholds. The Company was in compliance with these and all other financial covenants at September 30, 2009.

The Secured Credit Agreement provides for customary events of default with, in some cases, corresponding grace periods, including (i) failure to pay any principal or interest when due, (ii) failure to comply with covenants, (iii) any representation or warranty made by us proving to be incorrect in any material respect, (iv) payment defaults relating to, or acceleration of, other material indebtedness, (v) certain bankruptcy, insolvency or receivership events affecting us, (vi) a change in our control, (vii) the Company or its subsidiaries becoming subject to certain material judgments, claims or liabilities, or (viii) a material defect in the lenders’ lien against the collateral securing the obligations under the Secured Credit Agreement.

In the event of an event of default, the Administrative Agent may, and at the request of the requisite number of lenders under the Secured Credit Agreement must, terminate the lenders’ commitments to make loans under the Secured Credit Agreement and declare all obligations under the Secured Credit Agreement immediately due and payable. For certain events of default related to bankruptcy, insolvency and receivership, the commitments of the lenders will be automatically terminated and all outstanding obligations of the Company under the Secured Credit Agreement will become immediately due and payable.

The Company pays a commitment fee equal to a percentage of the actual daily-unused portion of the Secured Revolver under the Secured Credit Agreement. This percentage, currently 0.375% per annum, will be determined quarterly by reference to the senior secured leverage ratio and will range between 0.300% per annum and 0.500% per annum.

As of September 30, 2009, there was $85,873 outstanding under the Revolver, $34,000 outstanding under the Term Loan and $1,380 in outstanding letters of credit. The available balance under the Revolver was $42,747 at September 30, 2009. The average interest rates on the borrowings outstanding under the Secured Credit Agreement at December 31, 2008 and September 30, 2009 were 5.28% and 4.45%, respectively, including the applicable spread paid to the banks.

On April 1, 2008, the Company issued a $10,000 unsecured note to the seller in the Automatic Laundry Company, Ltd., (“ALC”), acquisition. This note bore interest at 9% and was to mature on April 1, 2010 with interest payments due quarterly on the first day of July, October, January and April each year until maturity. The Company paid this note in full on June 16, 2009.

On August 16, 2005, the Company issued senior unsecured notes in the amount of $150,000. These notes bear interest at 7.625% payable semi-annually each February and August. The maturity date of the notes is August 15, 2015. The proceeds from the senior notes, less financing costs, were used to pay down senior bank debt.

On and after August 15, 2010, the Company has the option to redeem all or a portion of the senior notes at the redemption prices (expressed in percentages of principal amount on the redemption date), plus accrued interest to the redemption date, if redeemed, during the 12-month period commencing on August 15 of the years set forth below:

	Remdemption
Period	Price
2010	103.813	%
2011	102.542	%
2012	101.271	%
2013 and thereafter	100.000	%

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

2. Long-Term Debt (continued)

The terms of the senior notes include customary covenants, including, but not limited to, restrictions pertaining to: (i) incurrence of additional indebtedness and issuance of preferred stock, (ii) payment of dividends on or making of distributions in respect of capital stock or making certain other restricted payments or investments, (iii) entering into agreements that restrict distributions from restricted subsidiaries, (iv) sale or other disposition of assets, including capital stock of restricted subsidiaries, (v) transactions with affiliates, (vi) incurrence of liens, (vii) sale/leaseback transactions, and (viii) merger, consolidation or sale of substantially all of our assets, in each case subject to numerous baskets, exceptions and thresholds. The Company was in compliance with these and all other financial covenants at September 30, 2009.

The terms 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) certain insolvency or receivership events affecting us or any of our subsidiaries and (iv) unsatisfied material judgments, claims or liabilities against us. There were no events of default under the senior notes at September 30, 2009.

Capital lease obligations on the Company’s fleet of vehicles totaled $3,352 and $3,578 at December 31, 2008 and September 30, 2009, respectively.

Required payments under the Company’s long-term debt and capital lease obligations are as follows:

	Amount
2009 (three months)	$	1,412
2010	5,517
2011	4,931
2012	4,501
2013	107,090
Thereafter	150,000
	$	273,451

3. Fair Value Measurements

Effective January 1, 2008, the Company adopted new accounting guidance regarding fair value measurements, which defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The guidance utilizes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value into three broad levels. The following is a brief description of those three levels:

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2: Inputs, other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

3. Fair Value Measurements (continued)

The following table summarizes the basis used to measure certain financial assets and financial liabilities at fair value on a recurring basis in the balance sheet:

			Basis of Fair Value Measurments
	Balance at September 30, 2009		Quoted Prices In Active Markets for Identical Items (Level 1)	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)

Interest rate swap derivative financial instruments (included in other liabilities)	$	5,984	—	$	5,984	—

The Company has entered into standard International Swaps and Derivatives Association (“ISDA”) interest rate swap agreements (the “Swap Agreements”) to manage the interest rate risk associated with its debt. The Swap Agreements effectively convert a portion of the Company’s variable rate debt to a long-term fixed rate. Under these agreements, the Company receives a variable rate of LIBOR plus a markup and pays a fixed rate. The fair value of these interest rate derivatives are based on quoted prices for similar instruments from a commercial bank and, therefore, the interest rate derivatives are considered a Level 2 item.

Certain of the Company’s Swap Agreements qualify as cash flow hedges while others do not. The change in the fair value of the Swap Agreements that do not qualify for hedge accounting treatment is recognized in the income statement in the period in which the change occurs. The effective portion of the Swap Agreements that qualify for hedge accounting are included in Other Comprehensive Income in the period in which the change occurs while the ineffective portion, if any, is recognized in income in the period in which the change occurs.

The table below outlines the details of each remaining Swap Agreement:

				Notional
	Original			Amount
Date of	Notional		Fixed/	September 30,		Expiration	Fixed
Origin	Amount		Amortizing	2009		Date	Rate

May 8, 2008	$	45,000	Amortizing	$	40,000	Apr 1, 2013	3.78	%
May 8, 2008	$	40,000	Amortizing	$	34,000	Apr 1, 2013	3.78	%
May 2, 2005	$	17,000	Fixed	$	17,000	Dec 31, 2011	4.69	%
May 2, 2005	$	12,000	Fixed	$	12,000	Dec 31, 2009	4.66	%
May 2, 2005	$	10,000	Fixed	$	10,000	Dec 31, 2011	4.77	%

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

3. Fair Value Measurements (continued)

net cash flow may increase or decrease. The counterparty to the Swap Agreements exposes the Company to credit loss in the event of non-performance; however, nonperformance is not anticipated.

The Company has also adopted new accounting guidance on disclosures about derivative instruments and hedging activities. The tables below display the impact the Company’s derivative instruments had on the Condensed Consolidated Balance Sheets as of December 31, 2008 and September 30, 2009 and the Condensed Consolidated Income Statements for the three and nine months ended September 30, 2008 and 2009.

Fair Values of Derivative Instruments

	Liability Derivatives
	December 31, 2008			September 30, 2009
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value

Derivatives designated as hedging instruments under Statement 133:
Interest rate contracts	Other liabilites	$	5,078	Other liabilites	$	3,845

Derivatives not designated as hedging instruments under Statement 133:
Interest rate contracts	Other liabilites	2,697		Other liabilites	2,139

Total derivatives		$	7,775		$	5,984

The Effect of Derivative Instruments on the Condensed Consolidated Income Statements

For the three months ended September 30, 2008 and 2009

Derivatives in
Net Investment

Amount of Loss Recognized in
OCI on Derivative (Effective
Portion)

Location of Gain
or
(Loss)Reclassified
from
Accumulated
OCI into Income

Amount of Gain Reclassified
from Accumulated OCI into
Income (Effective Portion)

Derivatives
Not
Designated as

Location of
Gain or
(Loss)
Recognized

Amount of (Loss) Gain
Recognized in Income on
Derivative

Hedging

September 30,

(Effective

September 30,

Hedging

in Income on

September 30,

Relationships

2008

2009

Portion)

2008

2009

Instruments

Derivative

2008

2009

Interest rate contracts

(332

)

(292

)

Gain (loss) related to derivative instruments

—

Interest rate contracts

Gain (loss) related to derivative instruments

(122

)

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

3. Fair Value Measurements (continued)

The Effect of Derivative Instruments on the Consensed Consolidated Income Statements

For the nine months ended September 30, 2008 and 2009

Derivatives in
Net Investment

Amount of Gain Recognized in
OCI on Derivative (Effective
Portion)

Location of Gain
or
(Loss)Reclassified
from Accumulated

Amount of Loss Reclassified
from Accumulated OCI into
Income (Effective Portion)

Derivatives
Not
Designated as

Location of
Gain or
(Loss)
Recognized
in Income

Amount of Gain or (Loss)
Recognized in Income on
Derivative

Hedging

September 30,

OCI into Income

September 30,

Hedging

September 30,

Relationships

2008

2009

(Effective Portion)

2008

2009

Instruments

Derivative

2008

2009

Interest rate contracts

136

757

Gain (loss) related to derivative instruments

(45

)

—

Interest rate contracts

Gain (loss) related to derivative instruments

(159

)

558

4. Goodwill and Intangible Assets

Goodwill and intangible assets consist of the following:

	As of December 31, 2008
	Cost		Accumulated Amortization		Net Book Value
Goodwill:
Facilities Management	$	59,478			$	59,478
Product Sales	223				223
	$	59,701			$	59,701
Intangible assets:
Facilities Management:
Trade Name	$	14,050			$	14,050
Non-compete agreements	4,041		$	3,936	105
Contract rights	238,128		36,729		201,399
Product Sales:
Customer lists	1,451		1,024		427
Distribution rights	1,623		297		1,326
Patents	99		—		99
Deferred financing costs	6,798		1,919		4,879
	$	266,190	$	43,905	$	222,285

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

4. Goodwill and Intangible Assets (continued)

	As of September 30, 2009
	Cost		Accumulated Amortization		Net Book Value
Goodwill:
Facilities Management	$	59,152			$	59,152
Product Sales	223				223
	$	59,375			$	59,375
Intangible assets:
Facilities Management:
Trade Name	$	14,050			$	14,050
Non-compete agreements	4,041		$	3,958	83
Contract rights	238,038		45,785		192,253
Product Sales:
Customer lists	1,451		1,097		354
Distribution rights	1,623		418		1,205
Patents	99		1		98
Deferred financing costs	6,798		2,576		4,222
	$	266,100	$	53,835	$	212,265

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

2009 (three months)	$	3,309
2010	13,222
2011	12,817
2012	12,544
2013	12,167
Thereafter	142,963
	$	197,022

Amortization expense of intangible assets for the nine months ended September 30, 2008 and 2009 was $8,994 and $9,929, respectively.

Intangible assets primarily consist of various non-compete agreements, customer lists and contract rights recorded in connection with acquisitions. The non-compete agreements are amortized using the straight-line method over the life of the agreements, which range from five to fifteen years. Customer lists are amortized using the straight-line method over fifteen years. Contract rights are amortized using the straight-line method over fifteen to twenty years. The life assigned to acquired contracts is based on several factors, including: (i) the historical renewal rate of the contract portfolio for the most recent years prior to the acquisition, (ii) the number of years the average contract has been in the contract portfolio, (iii) the overall level of customer satisfaction within the contract portfolio and (iv) our ability to maintain comparable renewal rates in the future. The contract rights acquired are aggregated for purposes of calculating their fair value upon acquisition due to the fact that there are thousands of individual contracts in each market. No single contract accounts for more than 2% of the revenue of any acquired portfolio and the contracts are homogeneous. The fair values of acquired portfolios are established based upon discounted cash flows generated by the acquired contracts. The fair values of the contracts are allocated to asset groups, comprised of the Company’s geographic markets, based on an estimate of relative fair value.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

4. Goodwill and Intangible Assets (continued)

Impairment of Goodwill. The Company assesses goodwill for impairment at least annually and whenever events or circumstances indicate that the carrying amount of the goodwill may be impaired. Important factors that could trigger an impairment review include significant under-performance relative to historical or projected future operating results, significant negative industry or economic trends, or a significant decline in the Company’s market capitalization relative to its book value. The Company evaluated its goodwill for impairment as of December 31, 2008 and determined that there were no impairments. The goodwill impairment review consists of a two-step process of first assessing the fair value and comparing to the carrying value of its reporting units. The Company has determined that it’s business units, laundry facilities management and Intirion, are the appropriate reporting units for goodwill impairment testing. If this fair value exceeds the carrying value, no further analysis or goodwill impairment charge is required. If the fair value is below the carrying value, the Company would proceed to the next step, which is to measure the amount of the impairment loss. The impairment loss is measured as the difference between the carrying value and implied fair value of goodwill. Any such impairment loss would be recognized in the Company’s results of operations in the period the impairment loss arose. The fair value of the Company’s reporting units at December 31, 2008 was significantly in excess of their carrying values.

Impairment of Long-Lived Assets. The Company reviews long-lived assets, including fixed assets (primarily laundry equipment) and intangible assets with definite lives (primarily laundry facilities management contract rights (“contract rights”)) for impairment whenever triggering events or changes in business circumstances indicate that the carrying amount of the assets may not be fully recoverable or that the useful lives of these assets are no longer appropriate. Triggering events that could indicate that the carrying value of these long-lived assets is not fully recoverable are identified primarily via the assessment of the useful lives of the contract rights described below. Other triggering events include, but are not limited to, the loss of significant customers, adverse changes to volumes and/or profitability in specific geographic markets and changes in the Company’s business strategy that result in a significant reduction in cash flows generated in a specific market.

Accounting guidance prescribes that, for the purposes of recognition and measurement of impairment loss, a long-lived asset or assets shall be grouped with other assets and liabilities at the lowest level for which identifiable cash flows are largely independent of the cash flows of other assets and liabilities. For the Company’s long-lived assets, the Company has determined that the lowest level for which identifiable cash flows are largely independent is at the geographic market level. The Company has identified nine geographic markets to which contract rights and other long-lived assets can reasonably be allocated. The assets within each geographic market have common characteristics and share support services and management. Within each of these geographic markets, the Company has the ability to economically reallocate assets and supporting services as needed. If a triggering event has occurred, the recoverability of the carrying amount of the contract rights and fixed assets for that market is calculated by comparing the carrying amount of the asset group to the projected future undiscounted cash flows from the operation and disposition of the assets, taking into consideration the remaining useful life of the assets. The cash flow period is based upon the remaining life of the acquired contract rights which are generally considered the primary asset of the asset group. If the undiscounted cash flow is less than the carrying amount of the asset group, the Company would then determine the fair value of the contract rights and the fixed assets and record an impairment provision, if any. The fair value of the contract rights would be estimated utilizing a discounted cash flow in the same manner that the values were established at the time of acquisitions. The fair value of the fixed assets would be determined based upon the fair market value of similar equipment.

Management also performs an annual assessment of the useful lives of the contract rights and accelerates amortization, if necessary. The results of this analysis may also indicate potential impairment triggering events. For contract rights, the useful life assessment consists primarily of comparing the percent of revenue declines for acquired contracts by acquisition to the percent of amortization recorded on the contract rights for that acquisition. If the rate of revenue decline exceeds the rate of amortization, the remaining useful life is adjusted prospectively.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

4. Goodwill and Intangible Assets (continued)

We also evaluate our trade names annually for impairment using the relief from royalty method, which considers the discounted present value of future tax effected royalty payments, to estimate fair value. If the fair value is less than the carrying value, the trade name would be written down to its implied fair value. Our evaluation in 2008 did not result in an impairment. However, a 1% increase in the discount rate would have resulted in an impairment of $100 for one of our trade names.

5. Commitments and Contingencies

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

6. Earnings Per Share

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

	Three months ended					Nine months ended
	September 30,					September 30,
	2008		2009			2008		2009

Net income (loss)	$	653	$	(386	)	$	1,625	$	987

Weighted average number of common shares outstanding - basic	13,366		13,587			13,335		13,498
Effect of dilutive securites:
Stock options	363		—			355		397
Weighted average number of common shares outstanding - diluted	13,729		13,587			13,690		13,895

Net income (loss) per share - basic	$	0.05	$	(0.03	)	$	0.12	$	0.07
Net income (loss) per share - diluted	$	0.05	$	(0.03	)	$	0.12	$	0.07

There were 923 and 873 shares under option plans that were excluded from the computation of diluted earnings per share at September 30, 2008 and 2009, respectively, due to their anti-dilutive effects.

7. Segment Information

The Company operates four business units which are based on the Company’s different product and service categories: Laundry Facilities Management Business, Commercial Laundry Equipment Sales and Service Business, Intirion Sales Business and Reprographics Facilities Management Business. These four business units have been aggregated into two reportable segments (“Facilities Management” and “Product Sales”). The Facilities Management segment includes two business units: Laundry Facilities Management and Reprographics Facilities Management. The Laundry Facilities Management business unit provides coin and debit card-operated laundry equipment to multi-unit housing facilities such as apartment buildings, colleges and universities and public housing complexes. The Reprographics Facilities Management business unit provides coin and debit-card-operated copiers to academic and public libraries. The Product Sales segment includes two business units: Intirion Sales and Commercial Laundry Equipment Sales. The Intirion Sales business unit revenue includes sales of its own proprietary line of refrigerator/freezer/microwave oven combinations under the brand name MicroFridge® to a customer base which includes hospitality and assisted living facilities, military housing and colleges and universities. The Intirion Sales business unit also

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

7. Segment Information (continued)

sells a full range of kitchen and laundry appliances. The Commercial Laundry Equipment Sales business unit operates as a distributor of, and provides service to, commercial laundry equipment in public laundromats, as well as for institutional purchasers, including hospitals, hotels and the United States military for use in their own on-premise laundry facilities.

There are no intersegment revenues.

The tables below present information about the operations of the Company’s reportable segments for the three and nine months ended September 30, 2008 and 2009. The information presented represents the key financial metrics that are utilized by the Company’s senior management in assessing the performance of each of the Company’s reportable segments.

	For the three months ended					For the nine months ended
	September 30,					September 30,
	2008		2009			2008			2009

Revenue:
Facilities management	$	78,508	$	74,816		$	224,392		$	232,022
Product sales	19,533		12,579			44,191			37,314
Total	98,041		87,395			268,583			269,336
Gross margin:
Facilities management	12,410		10,849			37,942			37,712
Product sales	4,066		2,719			9,344			8,317
Total	16,476		13,568			47,286			46,029
Selling, general, depreciation and amortization expenses	9,822		9,793			29,633			30,416
(Gain) loss on sale of assets	8		(59		)	(41		)	(552		)
Loss on early extinguishment of debt	—		—			207			—
Interest expense, net	5,654		4,828			15,064			14,825
Loss (gain) related to derivative instruments	122		(57		)	159			(558		)
Income (loss) before provision for income taxes	$	870	$	(937	)	$	2,264		$	1,898

	December 31, 2008		September 30, 2009
Assets:
Facilities management	$	442,214	$	420,444
Product sales	29,432		32,029
Total for reportable segments	471,646		452,473
Corporate (1)	17,489		13,764
Deferred income taxes	869		840
Total	$	490,004	$	467,077

(1) Principally cash and cash equivalents, prepaid expenses and property, plant and equipment not included elsewhere.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

8. Stock Compensation

For the three and nine months ended September 30, 2009, the Company incurred stock compensation expense of $650 and $1,924, respectively. The allocation of stock compensation expense is consistent with the allocation of the participants’ salary and other compensation expenses.

At September 30, 2009, options for 916 shares and 138 restricted shares have been granted but have not yet vested.

9. Product Warranties

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

The activity for the nine months ended September 30, 2009 is as follows:

	Accrued
	Warranty

Balance, December 31, 2008	$	390
Accruals for warranties issued	300
Settlements made (in cash or in kind)	(327		)
Balance, September 30, 2009	$	363

10. New Accounting Pronouncements

In June 2009, the FASB issued the FASB Accounting Standards Codification (Codification). The Codification is the single source for all authoritative GAAP recognized by the FASB and applies to financial statements issued for periods ending after September 15, 2009. The Codification does not change GAAP and will not have an affect on our financial position, results of operations or liquidity.

On January 1, 2009, we adopted new accounting guidance on disclosures about derivative instruments and hedging activities. The new guidance impacts disclosures only and requires additional qualitative and quantitative information on the use of derivatives and their impact on an entity’s financial position, results of operations and cash flows. Refer to Note 3 for additional information regarding our risk management activities, including derivative instruments and hedging activities.

On January 1, 2008, we adopted new accounting guidance on fair value measurements. This new guidance defines fair value, establishes a framework for measuring fair value in generally accepted accounting principles and expands disclosures about fair value measurements. Refer to Note 3 for additional information regarding our fair value measurements for financial assets and liabilities. The new guidance is effective for non-financial assets and liabilities recognized or disclosed at fair value on a non-recurring basis beginning January 1, 2009.

In June 2009, we adopted new accounting guidance on subsequent events. This new guidance establishes a new financial statement disclosure requirement to disclose the date in which subsequent events that are considered for disclosure occur after the balance sheet date but before the report is issued or available to be issued (See Note 12).

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Item 2.

MANAGEMENT’S DISCUSSION AND ANALYSIS OF

FINANCIAL CONDITION AND RESULTS OF OPERATIONS

This report contains, in addition to historical information, forward-looking statements that involve risks and uncertainties. Additional statements identified by words such as “will,” “likely,” “may,” “believe,” “expect,” “anticipate,” “intend,” “seek,” “designed,” “develop,” “would,” “future,” “can,” “could,” “outlook” and other expressions that are predictions of or indicate future events and trends and which do not relate to historical matters, also identify forward-looking statements. These forward-looking statements reflect our current views about future events and financial performance. Investors should not rely on forward-looking statements because they are subject to a variety of factors that could cause actual results to differ materially from our expectations. Factors that could cause or contribute to such differences include, but are not limited to, the following:

· debt service requirements under our existing and future indebtedness;

· availability of cash flow to finance capital expenditures;

· our ability to renew laundry leases with our customers;

· competition in the laundry facilities management industry;

· our ability to maintain relationships with our suppliers;

· our ability to maintain adequate internal controls over financial reporting;

· our ability to consummate acquisitions and successfully integrate the businesses we acquire;

· increases in multi-unit housing sector apartment vacancy rates and condominium conversions;

· our susceptibility to product liability claims;

· our ability to protect our intellectual property and proprietary rights and create new technology;

· our ability to retain our key personnel and attract and retain other highly skilled employees;

· decreases in the value of our intangible assets;

· our ability to comply with current and future environmental regulations;

· actions of our controlling stockholders;

· provisions of our charter and bylaws that could discourage takeovers; and

· those factors discussed under Item 1A “Risk Factors” in our Annual Report on Form 10-K for the year ended December 31, 2008 and our other filings with the Securities and Exchange Commission (“SEC”).

Our actual results, performance or achievements could differ materially from those expressed in, or implied by, these forward-looking statements, and accordingly, we can give no assurances that any of the events anticipated by the forward-looking statements will occur or, if any of them do, what impact they will have on our results of operations or financial condition. In view of these uncertainties, investors are cautioned not to place undue reliance on these forward-looking statements. We assume no obligation to update or revise publicly any forward-looking statements, whether as a result of new information, future events or otherwise.

In this Quarterly Report on Form 10-Q, unless the context suggest otherwise, references to the “Company,” “Mac-Gray,” “we,” “us,” “our” and similar terms refer to Mac-Gray Corporation and its subsidiaries. We have

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registered, applied to register or are using the following trademarks: Mac-Gray®, Web®, Hof™, Automatic Laundry Company™, MicroFridge®, SnackMate®, LaundryView®, PrecisionWashÔ, Intelligent Laundry® Systems, LaundryLinxÔ, TechLinxÔ, VentSnakeÔ, Intelli-Vault®, Safe Plug®, LaundryAuditÔ, e-issuesÔ and Life Just Got Easier®. The following are trademarks of parties other than us: Maytag®, Whirlpool®, Amana®, Magic Chef®, KitchenAid®, and Estate®.

Overview

Mac-Gray Corporation was founded in 1927 and re-incorporated in Delaware in 1997. Since its founding, Mac-Gray has grown to become the second largest laundry facilities management business in the United States. Through our portfolio of card and coin-operated laundry equipment located in laundry facilities across the country, we provide laundry convenience to residents of multi-unit housing, such as apartment buildings, condominiums, colleges and universities, public housing complexes and hotels and motels. Based on our ongoing survey of colleges and universities, we believe we are the largest provider of such services to the college and university market in the United States. We report our business in two segments, facilities management and product sales. Facilities management consists of our laundry facilities management and reprographics business units. Product sales consist of our commercial laundry equipment sales and Intirion Corporation (“Intirion”), which operates our MicroFridge® branded product sales business.

Our business model is built on a stable demand for laundry services, combined with long-term leases, strong customer relationships, a broad customer base, and predictable capital needs. For the three and nine months ended September 30, 2009, our total revenue was $87,395 and $269,336, respectively. Approximately 86% of our total revenue for the three and nine month period was generated by our facilities management segment. We generate facilities management revenue primarily by entering into long-term leases with property owners or property management companies for the exclusive right to install and maintain laundry equipment in common area laundry rooms within their properties in exchange for a negotiated portion of the revenue we collect. As of September 30, 2009, approximately 90% of our installed equipment base was located in laundry facilities subject to long-term leases, which have a weighted average remaining term of approximately five years. Our capital costs are typically incurred in connection with new or renewed leases, and include investments in laundry equipment and card and coin-operated systems, incentive payments to property owners or property management companies, and expenses to refurbish laundry facilities. Our capital costs consist of a large number of relatively small amounts, which are associated with our entry into or renewal of leases. Accordingly, our capital needs are predictable and largely within our control. For the three and nine months ended September 30, 2009, we incurred $4,922 and $17,372 of capital expenditures, respectively. In addition, we made incentive payments of approximately $348 and $1,547 in the three and nine months ended September 30, 2009 to property owners and property management companies in connection with obtaining our lease arrangements.

In addition, through our product sales segment, we generate revenue by selling commercial laundry equipment and our line of combination refrigerator/freezer/microwave oven units under the MicroFridge® and SnackMateTM brands. Intirion is also a national distributor of Maytag®, Whirlpool®, Amana®, Magic Chef®, KitchenAid®, and Estate® brands of appliances. For the three and nine months ended September 30, 2009, our product sales segment generated approximately 14% of our total revenue and 20% and 18% of our gross margin, respectively.

Our current priorities include 1) continuing to reduce funded debt, thereby improving debt leverage ratios and reducing interest expense, 2) maintaining capital expenditures at the irreducible levels needed to sustain the business, 3) increasing facilities management operating efficiencies in all markets, particularly the ones that have been influenced by acquisition activity in the past three years, and 4) improving the profitability of individual laundry facilities management accounts that come up for contract renewal. One of the key challenges we face is maintaining and expanding our customer base in a competitive industry. Approximately 10% to 15% of our laundry room leases are up for renewal each year. Within any given geographic area, Mac-Gray may compete with local independent operators, regional operators and multi-region operators as well as property owners and property management companies who self-operate their laundry facilities. We devote substantial resources to our sales efforts and are focused on continued innovation in order to distinguish us from our competitors.

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Results of Operations (Dollars in thousands)

Three and nine months ended September 30, 2009 compared to three and nine months ended September 30, 2008.

The information presented below for the three and nine months ended September 30, 2009 and 2008 is derived from our unaudited condensed consolidated financial statements and related notes included elsewhere in this report:

	For the three months ended September 30,									For the nine months ended September 30,
					Increase			%						Increase			%
	2008		2009		(Decrease)			Change		2008		2009		(Decrease)			Change
Laundry facilities management	$	78,279	$	74,712	$	(3,567	)	-5	%	$	223,520	$	231,294	$	7,774		3	%
Reprographics revenue	229		104		(125		)	-55	%	872		728		(144		)	-17	%
Total facilities management revenue	78,508		74,816		(3,692		)	-5	%	224,392		232,022		7,630			3	%
Intirion sales revenue	12,639		9,031		(3,608		)	-29	%	28,318		24,856		(3,462		)	-12	%
Laundry equipment sales revenue	6,894		3,548		(3,346		)	-49	%	15,873		12,458		(3,415		)	-22	%
Total product sales revenue	19,533		12,579		(6,954		)	-36	%	44,191		37,314		(6,877		)	-16	%
Total revenue	$	98,041	$	87,395	$	(10,646	)	-11	%	$	268,583	$	269,336	$	753		0	%

Revenue

Total revenue decreased by $10,646, or 11%, to $87,395 for the three months ended September 30, 2009 compared to $98,041 for the three months ended September 30, 2008. Total revenue increased by $753, or less than 1%, to $269,336 for the nine months ended September 30, 2009 compared to $268,583 for the nine months ended September 30, 2008.

Facilities management revenue. Facilities management revenue decreased by $3,692, or 5%, to $74,816 for the three months ended September 30, 2009 compared to $78,508 for the three months ended September 30, 2008. The decrease in revenue is primarily the result of reduced usage of the Company’s equipment in apartment building laundry rooms as a result of increased apartment vacancy rates in most markets, particularly in the Southwest. To a lesser extent, the decrease in revenue is attributable to the termination of contracts we have chosen not to renew, partially offset by the Company’s vend increase program. Facilities management revenue increased by $7,630, or 3%, to $232,022 for the nine months ended September 30, 2009 compared to $224,392 for the nine months ended September 30, 2008. The increase in revenue is the net of an increase of $12,078 attributable to the laundry facilities management businesses acquired in 2008, offset by a decline of $4,448 resulting from increased apartment vacancy rates and the termination of contracts we have chosen not to renew. We expect continued and increasing vacancy rates to continue to have a negative impact on our facilities management business in the near term. We track the change in revenue month over month and quarter over quarter for certain large accounts to better understand the revenue trend for our multi-family housing customers. This analysis does not include all revenue and is not adjusted for variances such as number of collection days in one quarter vs. another. This analysis is used to enable us to respond to changing trends in different geographic markets and to enable us to better allocate capital spending.

Product sales revenue. Revenue from our product sales segment decreased by $6,954, or 36%, to $12,579 for the three months ended September 30, 2009 compared to $19,533 for the three months ended September 30, 2008. Revenue from our product sales segment decreased by $6,877, or 16%, to $37,314 for the nine months ended September 30, 2009 compared to $44,191 for the nine months ended September 30, 2008.

Revenue in the Intirion business unit decreased by $3,608, or 29%, to $9,031 for the three months ended September 30, 2009 compared to $12,639 for the three months ended September 30, 2008. Revenue in the Intirion business unit decreased by $3,462, or 12%, to $24,856 for the nine months ended September 30, 2009 compared to $28,318 for the nine months ended September 30, 2008. The decrease in revenue for the three months ended September 30, 2009 compared to the same period in 2008 is attributable to a decrease in sales to all markets, particularly the academic and government markets. The decrease in revenue for the nine months ended September 30, 2009 compared to the nine months ended September 30, 2008 is attributable primarily to a decrease in sales to the academic and hospitality markets. Sales to the other markets were essentially flat year over year. We expect sales to the hospitality and academic markets will continue to be impacted by the widespread scaling back of capital projects by the hospitality industry and academic institutions. Our sales to

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the government will fluctuate based on the government’s shifting budget priorities as well as the timing of the release of funds for military housing initiatives.

Revenue in the laundry equipment sales business unit decreased by $3,346, or 49%, to $3,548 for the three months ended September 30, 2009 compared to $6,894 for the three months ended September 30, 2008. Revenue in the laundry equipment sales business unit decreased by $3,415, or 22%, to $12,458 for the nine months ended September 30, 2009 compared to $15,873 for the nine months ended September 30, 2008. Sales in the laundry equipment sales business unit are sensitive to the strength of the economy, local economic factors, local permitting and the availability of financing to small businesses, and therefore have the potential to fluctuate significantly from quarter to quarter. We expect that the current economic environment will continue to negatively impact sales in the laundry equipment business unit.

Cost of revenue

Cost of facilities management revenue. Cost of facilities management revenue includes rent paid to customers as well as those costs associated with installing and servicing equipment and costs of collecting, counting, and depositing facilities management revenue. Cost of facilities management revenue decreased by $1,661, or 3%, to $51,757 for the three months ended September 30, 2009 as compared to $53,418 for the three months ended September 30, 2008. The decrease in cost is the net of a decrease of $2,466 in facilities management rent offset by an increase of $805 in other operating expenses. The decrease in facilities management rent is directly attributable to the decline in facility management revenue. The increase in other operating expenses is the net of an increase of $1,055 in employee health insurance costs and a decrease of $250 in other expenses. Cost of facilities management revenue increased by $5,828, or 4%, to $157,680 for the nine months ended September 30, 2009 as compared to $151,852 for the nine months ended September 30, 2008. The increase is due primarily to the $3,550 increased rent associated with the increase in facility management revenue resulting from the facilities management business we acquired on April 1, 2008. Increased employee health insurance costs of $2,128 and additional operating expenses related to the acquisition offset by cost control measures implemented by the Company accounted for the remaining increase of $2,278. As a percentage of facilities management revenue, cost of facilities management revenue was 69% and 68%, respectively, for the three months ended September 30, 2009 and 2008 and 68% for both the nine months ended September 30, 2009 and 2008. Facilities management rent as a percentage of facilities management revenue was 48% and 49% for the three months ended September 30, 2009 and 2008, respectively. Facilities management rent was 49% for both the nine months ended September 30, 2009 and September 30, 2008. Facilities management rent can be affected by new and renewed laundry leases, lease portfolios acquired and by other factors such as the amount of incentive payments and laundry room betterments invested in new or renewed laundry leases. As we vary the amount invested in a facility, the facilities management rent as a function of facilities management revenue can vary. Incentive payments and betterments are amortized over the life of the related lease.

Depreciation and amortization related to operations. Depreciation and amortization related to operations decreased by $477, or 4%, to $12,291 for the three months ended September 30, 2009 as compared to $12,768 for the three months ended September 30, 2008. Depreciation and amortization related to operations increased by $2,004, or 6%, to $36,858 for the nine months ended September 30, 2009 as compared to $34,854 for the nine months ended September 30, 2008. The increase in depreciation and amortization for the nine months ended September 30, 2009 as compared to the same period in 2008 is primarily attributable to having nine full months of depreciation and amortization associated with the contract rights and equipment we acquired as part of our acquisition of a facilities management business on April 1, 2008 compared to only six months of such depreciation and amortization in the comparable period in 2008.

Cost of product sales. Cost of product sales consists primarily of the cost of laundry equipment, MicroFridge® branded equipment and parts sold, as well as salaries, warehousing and distribution expenses and other costs included in the product sales segment. Cost of product sales decreased by $5,600, or 36%, to $9,779 for the three months ended September 30, 2009 as compared to $15,379 for the three months ended September 30, 2008. Cost of product sales decreased by $5,822, or 17%, to $28,769 for the nine months ended September 30, 2009 as compared to $34,591 for the nine months ended September 30, 2008. As a percentage of sales, cost of product sales was 78% for the three months ended September 30, 2009, as compared to 79% for the three months ended September 30, 2008 and 77% for the nine months ended September 30, 2009, as compared to 78% for the nine months ended September 30, 2008. The gross margin in the Intirion® business unit increased to 22% for the three months ended September 30, 2009 as compared to 21% for the same period in 2008 and increased to 23% for the nine months ended September 30, 2009 as compared to 22% for the corresponding period in 2008. The gross margin in the Intirion® business unit is impacted by the mix of products and markets into which we sell. Typically direct sales, such as sales to the government, achieve a higher margin than sales

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into distribution channels. The gross margin in the laundry equipment sales business unit decreased to 20% for the three-month period ended September 30, 2009 as compared to 21% for the same period in 2008 and stayed at 20% for both the nine month period ended September 30, 2009 and September 30, 2008. The gross margin is primarily a function of the mix of products sold.

Operating expenses

General, administration, sales and marketing, and related depreciation and amortization expense. General, administration, sales and marketing, and related depreciation and amortization expense decreased by $29, or less than 1%, to $9,793 for the three months ended September 30, 2009 as compared to $9,822 for the three months ended September 30, 2008. Medical claims and related expenses increased by $207 in the three months ended September 30, 2009 compared to the three months ended September 30, 2008. General, administration, sales and marketing, and related depreciation and amortization expense increased by $783, or 3%, to $30,416 for the nine months ended September 30, 2009 as compared to $29,633 for the nine months ended September 30, 2008. As a percentage of total revenue, general, administration, sales and marketing and related depreciation expenses were 11% and 10% for the three months ended September 30, 2009 and 2008, respectively, and 11% for both the nine months ended September 30, 2009 and September 30, 2008. The increase in expenses in the nine months ended September 30, 2009 compared to the same periods in 2008 is primarily attributable to proxy contest related expenses of $971 incurred in 2009 and an increase in medical claim related expenses of $318.

Gain on sale of assets

The gain on sale of assets is primarily attributable to the gain on the sale of our facility in Tampa, Florida during the first quarter of 2009. It has been our objective to sell all operating facilities and property, thus increasing our flexibility relating to facility costs and locations. The sale of the Tampa facility completes the disposal of Company owned properties.

Income from operations

Income from operations decreased by $2,812, or 42%, to $3,834 for the three months ended September 30, 2009 compared to $6,646 for the three months ended September 30, 2008 and decreased by $1,322, or 8%, to $16,165 for the nine months ended September 30, 2009 compared to $17,487 for the nine months ended September 30, 2008 due primarily to the cumulative effect of the reasons discussed above.

Interest expense, net

Interest expense, net of interest income, decreased by $826, or 15%, to $4,828 for the three months ended September 30, 2009, as compared to $5,654 for the three months ended September 30, 2008. The decrease is due to lower outstanding debt balances resulting from our concerted effort to reduce interest-bearing debt. For the nine months ended September 30, 2009 interest expense decreased by $239, or 2%, to $14,825 compared to $15,064 for the nine months ended September 30, 2008. Included in interest expense for the nine months ended September 30, 2008 is six months interest on our debt resulting from our April, 2008 acquisition. Included in the nine months ended September 30, 2009 is nine months interest on our debt resulting from our April, 2008 acquisition. Our average effective interest rates are not significantly affected by fluctuations in the market as a significant amount of our debt has been assigned fixed rates through our derivative instruments.

Gain/Loss related to derivative instruments

Certain of the Company’s Swap Agreements qualify as cash flow hedges while others do not. The change in the fair value of the Swap Agreements that do not qualify for hedge accounting treatment is recognized in the income statement in the period in which the change occurs. The change in the fair value of these contracts resulted in a gain of $57 for the three months ended September 30, 2009, compared to a loss of $122 for the same period in 2008. For the nine months ended September 30, 2009, we recorded a gain of $558 compared to a loss of $159 for the nine months ended September 30, 2008.

Provision for income taxes

The provision for income taxes decreased by $768 to a benefit of $551 for the three months ended September 30, 2009 compared to an expense of $217 for the three months ended September 30, 2008. The decrease is the result of the pre-tax loss of $937 for the three months ended September 30, 2009 compared to the pre-tax

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income of $870 for the three months ended September 30, 2008. The provision for income taxes increased by $272 to $911 for the nine months ended September 30, 2009 compared to $639 for the nine months ended September 30, 2008. The effective tax rate increased to 48% from 28% for the nine months ended September 30, 2009, compared to the same period in 2008. The effective tax rate for the nine months ended September 30, 2008 was reduced by the benefit of a reduction of the reserve for uncertain tax positions of $204 and an amendment to Massachusetts tax law which will reduce payment on timing items that become taxable after January 1, 2009. The effective tax rate for the nine months ended September 30, 2008 without considering the effect of the reduction to the reserve was 44%. The increase in the effective rate from 44% to 48% is primarily a function of permanent tax differences as a percent of income before taxes.

Net income (loss)

As a result of the foregoing, net income decreased by $1,039 to a loss of $386 for the three months ended September 30, 2009 compared to net income of $653 for the same period ending September 30, 2008. Net income decreased by $638, or 39%, to $987 for the nine months ended September 30, 2009 as compared to net income of $1,625 for the nine months ended September 30, 2008.

Seasonality

We experience moderate seasonality as a result of our operations in the college and university market. Revenues derived from the college and university market represented approximately 13% of our total facilities management revenue. Academic facilities management and rental revenues are derived substantially during the school year in the first, second and fourth calendar quarters. Conversely, our operating and capital expenditures have historically been higher during the third calendar quarter when we install a large amount of equipment while colleges and universities are generally on summer break. Product sales, principally of Intirion® products, to this market are typically higher during the third calendar quarter as compared to the rest of the calendar year, somewhat offsetting the seasonality effect of the laundry facilities management business unit.

Liquidity and Capital Resources (Dollars in thousands)

We believe that we can satisfy our working capital requirements and funding of capital needs with internally generated cash flow and, as necessary, borrowings from our revolving credit facility described below. Capital requirements for the year ending December 31, 2009, including contract incentive payments, are currently expected to be between $27,000 and $30,000. In the nine months ended September 30, 2009, spending on capital expenditures and contract incentives totaled $17,372 and $1,547, respectively. The capital expenditures for 2009 are primarily composed of laundry equipment installed in connection with new customer leases and the renewal of existing leases.

Our current long-term liquidity needs are principally the repayment of the outstanding principal amounts of our long-term indebtedness, including borrowings under our senior credit facility and our senior notes. We are unable to project with certainty whether our long-term cash flow from operations will be sufficient to repay 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 terms to extend the maturity dates. We cannot make any assurances that such refinancings or amendments, if necessary, would be available on reasonable terms, if at all.

For the nine months ended September 30, 2009, our source of cash was from operating activities. Our primary uses of cash for the nine months ended September 30, 2009 were the reduction of debt, the purchase of new laundry equipment and the semi-annual interest payment on our senior notes. We anticipate that we will continue to use cash flows provided by operating activities to finance working capital needs, debt service, and capital expenditures.

Our senior secured credit agreement (the “Secured Credit Agreement”) provides that we may borrow up to $164,000 in the aggregate, including $34,000 pursuant to a Term Loan and up to $130,000 pursuant to a Revolver. The Term Loan requires quarterly principal payments of $1,000 at the end of each calendar quarter through December 31, 2012, with the remaining principal balance of $21,000 due on April 1, 2013. The Revolver also matures on April 1, 2013. The Secured Credit Agreement also provides for Bank of America, N. A. to make swingline loans to us of up to $10,000 (the “Swingline Loans”) and any Swingline Loans will reduce the borrowings available under the Revolver. Subject to certain terms and conditions, the Secured Credit Agreement gives us the option to establish additional term and/or revolving credit facilities thereunder, provided that the aggregate commitments under the Secured Credit Agreement cannot exceed $220,000.

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The obligations under the Secured Credit Agreement are guaranteed by our subsidiaries and secured by (i) a pledge of 100% of the ownership interests in the subsidiaries, and (ii) a first-priority security interest in substantially all our tangible and intangible assets.

Under the Secured Credit Agreement, we are subject to customary lending covenants, including restrictions pertaining to, among other things: (i) the incurrence of additional indebtedness, (ii) limitations on liens, (iii) making distributions, dividends and other payments, (iv) the making of certain investments and loans, (v) mergers, consolidations and acquisitions, (vi) dispositions of assets, (vii) the maintenance of a maximum total leverage ratio of not greater than 4.25 to 1.00, a maximum senior secured leverage ratio of not greater than 2.50 to 1.00, and a minimum consolidated cash flow coverage ratio of not less than 1.20 to 1.00, (viii) transactions with affiliates, and (ix) changes to governing documents and subordinate debt documents, in each case subject to baskets, exceptions and thresholds. We were in compliance with these and all other financial covenants at September 30, 2009.

The Secured Credit Agreement provides for customary events of default with, in some cases, corresponding grace periods, including (i) failure to pay any principal or interest when due, (ii) failure to comply with covenants, (iii) any representation or warranty made by us proving to be incorrect in any material respect, (iv) payment defaults relating to, or acceleration of, other material indebtedness, (v) certain bankruptcy, insolvency or receivership events affecting us, (vi) a change in our control, (vii) our or our subsidiaries becoming subject to certain material judgments, claims or liabilities, or (viii) a material defect in the lenders’ lien against the collateral securing the obligations under the Secured Credit Agreement.

In the event of an event of default, the Administrative Agent may, and at the request of the requisite number of lenders under the Secured Credit Agreement must, terminate the lenders’ commitments to make loans under the Secured Credit Agreement and declare all obligations under the Secured Credit Agreement immediately due and payable. For certain events of default related to bankruptcy, insolvency and receivership, the commitments of the lenders will be automatically terminated and all of our outstanding obligations under the Secured Credit Agreement will become immediately due and payable.

We pay a commitment fee equal to a percentage of the actual daily-unused portion of the Revolver under the Secured Credit Agreement. This percentage, currently 0.375% per annum, will be determined quarterly by reference to the senior secured leverage ratio and will range between 0.300% per annum and 0.500% per annum.

On April 1, 2008, we issued a $10,000 unsecured note to the seller in the ALC acquisition. This note bore interest at 9% and was to mature on April 1, 2010 with interest payments due quarterly on the first day of July, October, January and April each year until maturity. We paid this note in full on June 16, 2009.

On August 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 and August. The maturity date of the notes is August 15, 2015. The proceeds from the senior notes, less financing costs, were used to pay down senior bank debt.

On and after August 15, 2010, we have the option to redeem all or a portion of the senior notes at the redemption prices (expressed in percentages of principal amount on the redemption date), plus accrued interest to the redemption date, if redeemed, during the 12-month period commencing on August 15 of the years set forth below:

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	Remdemption
Period	Price
2010	103.813	%
2011	102.542	%
2012	101.271	%
2013 and thereafter	100.000	%

The Company historically has not needed sources of financing other than its internally generated cash flow and revolving credit facilities to fund its working capital, capital expenditures and smaller acquisitions. As a result, the Company anticipates that its cash flow from operations and revolving credit facilities will be sufficient to meet its anticipated cash requirements for at least the next twelve months. However, we may require external sources of financing for any significant future acquisitions. Further, our senior credit facilities mature in April 2013. The repayment of these facilities may require external financing.

Operating Activities

For the nine months ended September 30, 2009 and 2008, net cash flows provided by operating activities were $41,853 and $36,732 respectively. Cash flows from operations consists primarily of facilities management revenue and product sales, offset by the cost of facilities management revenues, cost of product sales, and general, administration, sales and marketing expenses. The change in working capital is primarily due to the timing of purchases of inventory and services, and when such expenditures are due to be paid. The increase for the nine months ended September 30, 2009 as compared to the nine months ended September 30, 2008 is primarily attributable to an increase in depreciation and amortization expense, a decrease in accounts receivable and an increase in accounts payable and accrued expenses in the nine months ended September 30, 2009 compared to an increase in accounts receivable and prepaid facilities management rent and other assets and a decrease in accounts payable and accrued expenses, offset in part by an increase in deferred taxes in the nine months ended September 30, 2008.

Investing Activities

For the nine months ended September 30, 2009 and 2008, net cash flows used in investing activities were $16,261 and $128,430 respectively. Of the 2008 total, $106,213 was used for acquisitions. Capital expenditures for the nine months ended September 30, 2009 and 2008, primarily laundry equipment for new and renewed lease locations, were $17,372 and $22,611, respectively.

Financing Activities

For the nine months ended September 30, 2009, net cash flows used in financing activities were $28,257. For the same period in 2008, net cash flows provided by financing activities were $93,893. Cash flows used in financing activities consist of net reductions in bank borrowings. Cash flows provided by financing activities consist primarily of net proceeds from bank borrowings and proceeds from the exercise of options and the issuance of stock through the employee stock purchase program. The increase in borrowings in 2008 was related to our acquisition on April 1, 2008.

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We have entered into standard International Swaps and Derivatives Association, or ISDA, interest rate Swap Agreements to manage the interest rate risk associated with our senior credit facilities. For a description of our interest rate Swap Agreements see “Item 3. Quantitative and Qualitative Disclosures About Market Risk.”

Contractual Obligations

A summary of our contractual obligations and commitments related to our outstanding long-term debt and future minimum lease payments related to our vehicle fleet, warehouse rent and facilities management rent as of September 30, 2009 is as follows:

Fiscal	Long-term		Interest on		Facilites rent		Capital lease		Operating lease
Year	debt		senior notes		commitments		commitments		commitments		Total
2009 (3 mos.)	$	1,000	$	—	$	4,489	$	412	$	879	$	6,780
2010	4,000		11,438		15,947		1,517		3,116		$	36,018
2011	4,000		11,438		11,957		931		2,629		$	30,955
2012	4,000		11,438		9,887		501		2,152		$	27,978
2013	106,873		11,438		7,707		217		1,796		$	128,031
Thereafter	150,000		22,876		17,264		—		3,045		$	193,185
Total	$	269,873	$	68,628	$	67,251	$	3,578	$	13,617	$	422,947

Item 3.

QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT

MARKET RISK

We are exposed to a variety of risks, including changes in interest rates on some of our borrowings. In the normal course of our business, we manage our exposure to these risks as described below. We do not engage in trading market-risk sensitive instruments for speculative purposes.

Interest rates

The table below provides information about our debt obligations that are sensitive to changes in interest rates. For debt obligations, the table presents principal cash flows and related weighted average interest rates by expected maturity dates. The fair market value of long-term debt approximates book value at September 30, 2009.

(in thousands)	2009			2010			2011			2012			2013			Thereafter		Total
Variable rate	$	1,000		$	4,000		$	4,000		$	4,000		$	106,873		$	—	$	119,873
Average interest rate	4.45		%	4.45		%	4.45		%	4.45		%	4.45		%	—		4.45		%

The Company has entered into standard International Swaps and Derivatives Association (“ISDA”) interest rate swap agreements (the “Swap Agreements”) to manage the interest rate risk associated with its debt. The Swap Agreements effectively convert a portion of our variable rate debt to a long-term fixed rate. Under these agreements, we receive a variable rate of LIBOR plus a markup and pay a fixed rate. The fair value of these interest rate derivatives are based on quoted prices for similar instruments from a commercial bank and, therefore, the interest rate derivatives are considered a Level 2 item.

Certain of the Company’s Swap Agreements qualify as cash flow hedges while others do not. The change in the fair value of the Swap Agreements that do not qualify for hedge accounting treatment is recognized in the income statement in the period in which the change occurs. The change in the fair value of these contracts resulted in a gain of $57 and a loss of $122 for the three months ended September 30, 2009 and 2008, respectively, and a gain of $558 and a loss of $159 for the nine months ended September 30, 2009 and 2008.

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The table below outlines the details of each remaining Swap Agreement:

				Notional
	Original			Amount
Date of	Notional		Fixed/	September 30,		Expiration	Fixed
Origin	Amount		Amortizing	2009		Date	Rate

May 8, 2008	$	45,000	Amortizing	$	40,000	Apr 1, 2013	3.78	%
May 8, 2008	$	40,000	Amortizing	$	34,000	Apr 1, 2013	3.78	%
May 2, 2005	$	17,000	Fixed	$	17,000	Dec 31, 2011	4.69	%
May 2, 2005	$	12,000	Fixed	$	12,000	Dec 31, 2009	4.66	%
May 2, 2005	$	10,000	Fixed	$	10,000	Dec 31, 2011	4.77	%

In accordance with the Swap Agreements and on a quarterly basis, interest expense is calculated based on the floating 90-day LIBOR and the fixed rate. If interest expense as calculated is greater based on the 90-day LIBOR, the financial institution pays the difference to the Company. If interest expense as calculated is greater based on the fixed rate, the Company pays the difference to the financial institution. Depending on fluctuations in the LIBOR, the Company’s interest rate exposure and its related impact on interest expense and net cash flow may increase or decrease. The counter party to the Swap Agreements exposes the Company to credit loss in the event of non-performance; however, nonperformance is not anticipated. The fair value of a Swap Agreement is the estimated amount that the Company would receive or pay to terminate the agreement at the reporting date, taking into account current interest rates and the credit worthiness of the counter party. At September 30, 2009, the fair value of the Swap Agreements was a liability of $5,984. This amount has been included in other liabilities on the condensed consolidated balance sheets.

Item 4.

CONTROLS AND PROCEDURES

Evaluation of disclosure controls and procedures. As of the end of the period covered by this report, an evaluation was carried out by our management, with the participation of our chief executive officer and chief financial officer, of the effectiveness of our disclosure controls and procedures (as defined in Rule 13a-15(e) under the Securities Exchange Act of 1934, as amended (the “Exchange Act”)). Based upon that evaluation, our chief executive officer and chief financial officer concluded that these disclosure controls and procedures were effective as of September 30, 2009 in providing reasonable assurance that information required to be disclosed by us in the reports that we file or submit under the Exchange Act is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms.

Changes in internal controls. In addition, no change in our internal control over financial reporting (as defined in Rule 13a-15(f) under the Exchange Act) occurred during the quarter ending September 30, 2009 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART I	FINANCIAL INFORMATION

	Item 1.	Financial Statements	3

		Condensed Consolidated Balance Sheets at December 31, 2008 and September 30, 2009	3

		Condensed Consolidated Income Statements for the Three and Nine Months Ended September 30, 2008 and 2009	4

		Condensed Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2009	5

		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2008 and 2009	6

		Notes to Condensed Consolidated Financial Statements	7

	Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	19

	Item 3.	Quantitative and Qualitative Disclosures about Market Risk	27

	Item 4.	Controls and Procedures	28

PART II	OTHER INFORMATION

	Item 1A.	Risk Factors	29

	Item 6.	Exhibits	29

	Signature		30

31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (5)
31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (5)
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (6)

		MAC-GRAY CORPORATION
November 6, 2009		/s/ Michael J. Shea
		Michael J. Shea
		Executive Vice President, Chief Financial Officer and Treasurer
		(On behalf of registrant and as principal financial officer)

Date: November 6, 2009
		/s/ Stewart G. MacDonald, Jr.
		Stewart G. MacDonald, Jr.
		Chief Executive Officer
		(Principal Executive Officer)

Date: November 6, 2009
		/s/ Michael J. Shea
		Michael J. Shea
		Chief Financial Officer and Treasurer
		(Principal Financial Officer)

INDEX

MAC-GRAY CORPORATION

Cost of revenue

Item 6. Exhibits

CERTIFICATION PURSUANT TO

Dated:	November 6, 2009	/s/ Stewart G. MacDonald, Jr.
		Name: Stewart G. MacDonald, Jr.
		Title: Chief Executive Officer

Dated:	November 6, 2009	/s/ Michael J. Shea
		Name: Michael J. Shea
		Title: Chief Financial Officer