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, 2012

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)

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

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 x 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		Smaller reporting company o
(Do not check if a smaller reporting company)

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 5, 2012, 14,503,874 shares of common stock of the registrant, par value $.01 per share, were outstanding.

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Item 1. Financial Statements

MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED BALANCE SHEETS (Unaudited)

(In thousands, except share data)

	December 31,			September 30,
	2011			2012
Assets
Current assets:
Cash and cash equivalents	$	13,881		$	14,244
Trade receivables, net of allowance for doubtful accounts	5,586			6,032
Inventory of finished goods, net	1,487			2,172
Deferred income taxes	1,044			1,044
Prepaid facilities management rent and other current assets	9,760			9,753
Total current assets	31,758			33,245
Property, plant and equipment, net	127,204			132,333
Goodwill	58,173			57,846
Intangible assets, net	181,609			172,675
Prepaid facilities management rent and other assets	10,955			11,627
Total assets	$	409,699		$	407,726

Liabilities and Stockholders’ Equity
Current liabilities:
Current portion of long-term debt and capital lease obligations	$	4,190		$	1,204
Trade accounts payable	8,528			8,915
Accrued facilities management rent	20,917			20,379
Accrued expenses and other current liabilities	17,885			15,675
Total current liabilities	51,520			46,173
Long-term debt and capital lease obligations	198,638			203,020
Deferred income taxes	43,804			42,380
Other liabilities	1,923			1,415
Total liabilities	295,885			292,988

Commitments and contingencies (Note 6)
Stockholders’ equity:
Preferred stock ($.01 par value, 5 million shares authorized, no shares issued or outstanding)	—			—
Common stock ($.01 par value, 30 million shares authorized, 14,335,290 issued and outstanding at December 31, 2011, and 14,503,056 issued and outstanding at September 30, 2012)	143			145
Additional paid in capital	86,217			88,987
Accumulated other comprehensive loss	(792		)	(299		)
Retained earnings	28,246			25,905
Total stockholders’ equity	113,814			114,738
Total liabilities and stockholders’ equity	$	409,699		$	407,726

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

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MAC-GRAY CORPORATION

CONDENSED CONSOLIDATED STATEMENTS OF INCOME AND COMPREHENSIVE INCOME

(Unaudited)

(In thousands, except per share data)

	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2011			2012			2011			2012
Revenue:
Laundry facilities management revenue	$	74,287		$	74,372		$	228,435		$	229,316
Commercial laundry equipment sales	4,205			3,501			10,939			10,620
Total revenue	78,492			77,873			239,374			239,936

Cost of revenue:
Cost of laundry facilities management revenue	52,004			52,600			157,560			160,840
Depreciation and amortization	10,568			10,706			32,512			31,536
Cost of commercial laundry equipment sales	3,144			2,827			8,722			8,675
Total cost of revenue	65,716			66,133			198,794			201,051

Gross margin	12,776			11,740			40,580			38,885

Operating expenses:
General and administration	4,759			4,303			14,190			15,506
Sales and marketing	3,023			2,772			10,186			8,435
Depreciation and amortization	206			216			564			626
Incremental costs of proxy contests	—			—			269			377
Gain on sale of assets, net	(13		)	(57		)	(170		)	(97		)
Total operating expenses	7,975			7,234			25,039			24,847
Income from operations	4,801			4,506			15,541			14,038
Interest expense, including the change in fair value of non-hedged interest rate derivative instruments and amortization of deferred financing costs	3,682			1,931			10,163			7,235
Loss on early extinguishment of debt	—			—			—			3,762
Income before provision for income taxes	1,119			2,575			5,378			3,041
Income tax expense	515			1,104			2,204			1,285
Net income	604			1,471			3,174			1,756
Other comprehensive gain, net of tax:
Unrealized gain on derivative instruments	202			173			540			493
Comprehensive income	$	806		$	1,644		$	3,714		$	2,249
Earnings per share – basic	$	0.04		$	0.10		$	0.22		$	0.12
Earnings per share – diluted	$	0.04		$	0.10		$	0.21		$	0.12
Weighted average common shares outstanding - basic	14,286			14,447			14,207			14,396
Weighted average common shares outstanding - diluted	15,000			15,134			14,953			15,078

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		Loss			Income		Earnings			of shares		Cost			Total
Balance, December 31, 2011	14,335,290	$	143	$	86,217	$	(792	)			$	28,246		—		$	—		$	113,814
Net income	—	—		—		—			$	1,756	1,756			—		—			$	1,756
Other comprehensive income:
Unrealized gain on derivative instrument and reclassification, net of tax of $314 (Note 4)	—	—		—		493			493		—			—		—			$	493
Comprehensive income									$	2,249
Repurchase of common stock	—	—		—		—					—			133,333		(2,000		)	$	(2,000	)
Options Exercised	32,671	—		229		—					(881		)	(82,649	)	1,240			$	588
Stock issuance - Employee Stock Purchase Plan	10,981	—		140		—					(25		)	(12,373	)	185			$	300
Stock compensation expense	—	—		2,024		—					—			—		—			$	2,024
Dividends paid, $.1815 per share	—	—		—		—					(2,629		)	—		—			$	(2,629	)
Stock grants	124,114	2		377		—					(562		)	(38,311	)	575			$	392
Balance, September 30, 2012	14,503,056	$	145	$	88,987	$	(299	)			$	25,905		—		$	—		$	114,738

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,
	2011			2012
Cash flows from operating activities:
Net income	$	3,174		$	1,756
Adjustments to reconcile net income to net cash flows provided by operating activities:
Depreciation and amortization	33,076			32,162
Amortization of deferred financing costs	657			356
Loss on early extinguishment of debt	—			1,220
Decrease in allowance for doubtful accounts and lease reserves	(3		)	(41		)
Gain on disposition of assets	(170		)	(97		)
Stock grants	475			392
Gain on change in fair value of interest rate derivatives	(487		)	(360		)
(Gain) loss on change in fair value of fuel commodity derivatives	133			(43		)
Proceeds from termination of derivative instrument	2,542			—
Increase (decrease) in deferred income taxes	138			(1,298		)
Non-cash stock compensation	2,290			2,024
Increase in accounts receivable	(235		)	(405		)
Increase in inventory	(350		)	(685		)
Increase in prepaid facilities management rent and other assets	(5,335		)	(3,232		)
Increase (decrease) in accounts payable, accrued facilities management rent, accrued expenses and other liabilities	196			(1,682		)
Net cash flows provided by operating activities	36,101			30,067

Cash flows from investing activities:
Capital expenditures	(22,026		)	(25,269		)
Proceeds from sale of assets	231			177
Net cash flows used in investing activities	(21,795		)	(25,092		)

Cash flows from financing activities:
Payments on capital lease obligations	(1,258		)	(1,010		)
Payment on senior notes	—			(100,000		)
Payments on secured revolving credit facility	(100,231		)	(169,592		)
Borrowings on secured revolving credit facility	90,651			289,978
Payments on secured term credit facility	(2,250		)	(18,750		)
Proceeds from exercise of stock options	739			588
Proceeds from issuance of common stock	316			300
Debt acquisition costs	—			(1,497		)
Cash dividend paid	(2,352		)	(2,629		)
Repurchase of common stock	—			(2,000		)
Net cash flows used in financing activities	(14,385		)	(4,612		)

Increase (decrease) in cash and cash equivalents	(79		)	363
Cash and cash equivalents, beginning of period	13,013			13,881
Cash and cash equivalents, end of period	$	12,934		$	14,244

Supplemental disclosure of non-cash investing and financing activities: during the nine months ended September 30, 2011 and 2012, the Company acquired various assets under capital lease agreements totaling $384 and $770, 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 2011 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, 2011. 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. The Company also sells and services commercial laundry equipment to commercial laundromats, multi-housing properties and institutions. The majority of the Company’s purchases of laundry equipment are from one supplier.

2. Revisions to Income Statement Presentation

The Company has determined that the amortization of deferred financing costs which was included in depreciation and amortization within operating expenses for the three and nine months ended September 30, 2011 should have been included in interest expense. Accordingly, the Company has corrected the presentation of the amortization of deferred financing costs and included it as part of interest expense on the condensed consolidated statements of income and comprehensive income. The Company has revised its condensed consolidated statements of income and comprehensive income by decreasing depreciation and amortization within operating expenses and increasing interest by $219 and $657 for the three and nine months ended September 30, 2011, respectively. Accordingly, income from operations increased from $4,582 to $4,801 for the three months ended September 30, 2011 and from $14,884 to $15,541 for the nine months ended September 30, 2011. This change in presentation does not impact income before income tax expense or net income; nor does it impact the condensed consolidated balance sheets or the condensed consolidated statements of cash flows.

3. Long-Term Debt

On February 29, 2012, the Company entered into an Amended and Restated Senior Secured Credit Agreement (the “2012 Credit Agreement”). The 2012 Credit Agreement provides for borrowings up to $250,000 under a revolving credit facility (the “Revolver”). The 2012 Credit Agreement matures on February 28, 2017. The 2012 Credit Agreement is collateralized by a blanket lien on the assets of the Company and each of its subsidiaries as well as a pledge by the Company of all the capital stock of its subsidiaries. Outstanding indebtedness under the 2012 Credit Agreement bears interest at a fluctuating rate equal to (i) in the case of Eurodollar rate loans, the LIBOR rate plus an applicable percentage, ranging from 1.75% to 2.75% per annum (currently 2.50%), determined by reference to our consolidated total leverage ratio, and (ii) in the case of base rate loans and swingline loans, the higher of (a) the federal funds rate plus 0.50%, (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate,” or (c) for each day, the floating rate of interest equal to LIBOR for a one month term quoted for such date (the highest of which is defined as the “Base Rate”), plus, in each case, an applicable percentage, ranging from 0.75% to 1.75% per annum (currently 1.50%), determined by reference to our consolidated total leverage ratio.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

3. Long-Term Debt (continued)

The Company pays a commitment fee equal to a percentage of the actual daily-unused portion of the Revolver under the 2012 Credit Agreement. This percentage is determined quarterly by reference to the Company’s consolidated total leverage ratio and ranges between 0.25% per annum and 0.50% per annum (currently 0.35%). For purposes of the calculation of the commitment fee, letters of credit are considered usage under the Revolver, but swingline loans are not considered usage under the Revolver.

The 2012 Credit Agreement includes certain financial and operational covenants, including restrictions on paying dividends and other distributions, making certain acquisitions and incurring indebtedness, and requires that the Company maintain certain financial ratios. The most significant financial ratios that the Company is required to maintain include a consolidated total leverage ratio of not greater than 3.75 to 1.00 (3.50 to 1.00 as of December 31, 2013 and thereafter) and a consolidated cash flow coverage ratio of not less than 1.20 to 1.00. The Company was in compliance with all financial covenants at September 30, 2012.

The Company incurred deferred financing costs of $1,497 associated with the 2012 Credit Agreement and wrote off unamortized deferred financing costs of $133 associated with the Company’s 2008 credit facility.

As of September 30, 2012, there was $201,805 outstanding under the Revolver and $1,380 in outstanding letters of credit. The available balance under the Revolver was $46,815 at September 30, 2012. The average interest rates on the borrowings outstanding under the prior credit agreement and the 2012 Credit Agreement at September 30, 2011 and 2012 were 5.71% and 3.65%, respectively, including the applicable spread paid to the banks and the effect of the interest rate swap agreements tied to the debt (see Note 4 for discussion on Fair Value Measurements).

On August 16, 2005, the Company issued senior unsecured notes in the amount of $150,000 with the fixed interest rate of 7.625%. On October 21, 2011, the Company redeemed $50,000 of the senior notes by utilizing $51,271 of availability under its 2008 credit facility. The Company paid a premium of $1,271 as well as interest accrued through the date of redemption and wrote off unamortized deferred financing costs of $623 associated with this redemption. On March 30, 2012, the Company redeemed the remaining $100,000 of the senior notes by utilizing $103,495 of availability under the 2012 Credit Agreement and paying a premium of $2,542 as well as interest accrued through the date of redemption. The Company wrote off the remaining $1,087 of unamortized deferred financing costs associated with this redemption.

Interest expense associated with the Company’s long term debt for the three and nine months ended September 30, 2011 and 2012 is comprised of the following:

	Three months ended						Nine months ended
	September 30,						September 30,
	2011			2012			2011			2012

Interest expense	$	3,508		$	1,966		$	9,993		$	7,239
Change in the fair value of non-hedged interest rate derivative instruments	(45		)	(125		)	(487		)	(360		)
Amortization of deferred financing costs	219			90			657			356
Interest expense, including change in fair value of non-hedged interest rate derivative instruments and amortization of deferred financing costs	$	3,682		$	1,931		$	10,163		$	7,235

Capital lease obligations comprised primarily of Company’s fleet of vehicles totaled $2,659 and $2,419 at December 31, 2011 and September 30, 2012, respectively.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

3. Long-Term Debt (continued)

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

	Amount
2012 (three months)	$	321
2013	1,121
2014	702
2015	191
2016	84
Thereafter	201,805
	$	204,224

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.

4. Fair Value Measurements

The Company has adopted 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.

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:

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

4. Fair Value Measurements (continued)

			Basis of Fair Value Measurments
	Balance at September 30, 2012		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 accrued expenses)	$	872	$	—	$	872	$	—

Fuel commodity derivatives (included in current aseets)	$	41	$	—	$	—	$	41

Fuel commodity derivatives (included in other liabilities)	$	32	$	—	$	—	$	32

The Company has entered into standard International Swaps and Derivatives Association (“ISDA”) interest rate swap agreements (“Swap Agreements”) to manage the interest rate associated with its debt. The interest rate Swap Agreements effectively convert $52,000 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 Company recognized a non-cash unrealized gain of $405 and $145 for the three months ended September 30, 2012 and 2011, respectively, and a non-cash unrealized gain of $1,235 and $858 for the nine months ended September 30, 2012 and 2011, respectively, on the interest rate Swap Agreements as a result of the change in the fair value.

In December 2010, the Company entered into a fuel commodity derivative to manage the fuel cost on its fleet of vehicles. The derivative was effective April 1, 2011 and expired December 31, 2011. On September 23, 2011 the Company entered into an additional fuel commodity derivative. The derivative was effective January 1, 2012 and expires December 31, 2012. The derivative has a monthly notional amount of 85 thousand gallons from January 1, 2012 through December 31, 2012 for a total notional amount of 1.02 million gallons. The Company has a put price of $3.205 per gallon and a strike price of $3.70 per gallon. On September 19, 2012 the Company entered into an additional fuel commodity derivative. The derivative is effective January 1, 2013 and expires December 31, 2013. The derivative has a monthly notional amount of 80 thousand gallons from January 1, 2013 through December 31, 2013 for a total notional amount of 960 thousand gallons. The Company has a put price of $3.26 per gallon and a strike price of $3.90 per gallon. The Company recognized a non-cash unrealized gain of $67 and a non-cash unrealized loss $255 for the three months ended September 30, 2012 and 2011, respectively, and a non-cash unrealized gain of $43 and a non-cash unrealized loss $133 for the nine months ended September 30, 2012 and 2011, respectively, on these fuel commodity derivatives as a result of the change in the fair value.

The fair value of these interest rate derivatives are based on quoted prices for similar instruments from a commercial bank and are considered a Level 2 item. The fuel commodity derivative is based on market assumptions and a quoted price from the counter party and is considered a Level 3 item.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (unaudited)

(In thousands, except per share data)

4. Fair Value Measurements (continued)

The fuel commodity derivative activity for the nine months ended September 30, 2012 is as follows:

Balance, December 31, 2011	$	(34	)
Realized gains	47
Unrealized gains	43
Settlements	(47		)
Balance, September 30, 2012	$	9

The Company determines the fair value of the amount outstanding under its 2012 Credit Facility using Level 2 inputs. The fair value of the 2012 Credit Agreement at September 30, 2012 approximates carrying value.

During the first quarter of 2012, as a result of the senior note redemption (Note 3), the Company no longer qualified for hedge accounting treatment on its only effective interest rate swap agreement. Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost is being reclassified as an earnings charge through the maturity date of the derivative. This charge to interest expense, when combined with an interest rate swap agreement that previously lost hedge accounting treatment, amounted to $280 and $875 for the three and nine months ended September 30, 2012 compared to $100 and $371 for the three and nine months ended September 30, 2011, respectively. The remaining balance of $483 associated with these interest rate swap agreements and included in Accumulated Other Comprehensive Loss will be charged to interest expense through the maturity date of the interest rate swap agreements on April 1, 2013.

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

Notional

Original

Amount

Date of

Notional

Fixed/

September 30,

Expiration

Fixed

Origin

Amount

Amortizing

2012

Date

Rate

May 8, 2008

45,000

Amortizing

30,000

Apr 1, 2013

3.78

May 8, 2008

40,000

Amortizing

22,000

Apr 1, 2013

3.78

In accordance with the interest rate 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.

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

4. Fair Value Measurements (continued)

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 counterparty to the interest rate Swap Agreements exposes the Company to credit loss in the event of non-performance; however, non-performance is not anticipated given the counterparty’s creditworthiness.

The tables below display the impact the Company’s derivative instruments had on the Condensed Consolidated Balance Sheets as of December 31, 2011 and September 30, 2012 and the Condensed Consolidated Statements of Income and Comprehensive Income for the three and nine months ended September 30, 2011 and 2012.

Fair Values of Derivative Instruments

	Liability Derivatives
	December 31, 2011			September 30, 2012
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value

Derivatives designated as hedging instruments:
Interest rate contracts	Accrued expenses	$	949	Accrued expenses	$	—
Interest rate contracts	Other liabilites	190		Other liabilites	—

Derivatives not designated as hedging instruments:
Interest rate contracts	Accrued expenses	743		Accrued expenses	872
Interest rate contracts	Other liabilites	159		Other liabilities	—
Fuel commodity derivatives	Accrued expenses	34		Current Assets	(41		)
Fuel commodity derivatives	Other liabilities	—		Other liabilities	32

Total derivatives		$	2,075		$	863

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

4. Fair Value Measurements (continued)

The Effect of Derivative Instruments on the Condensed Consolidated Income Statements

for the three months ended September 30, 2011 and 2012

Derivatives in Net Investment	Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)					Location of Loss Reclassified from Accumulated OCI into Income	Amount of Loss Reclassified from Accumulated OCI into Income (Effective Portion)						Derivatives Not Designated as	Location of Gain or (Loss) Recognized in	Amount of Gain or (Loss) Recognized in Income on Derivative
Hedging	September 30,					(Effective	September 30,						Hedging	Income on	September 30,
Relationships	2011			2012		Portion)	2011			2012			Instruments	Derivative	2011			2012

Interest rate contracts:						Interest expense, including the change in the fair value of non-hedged derivative instruments:							Interest rate contracts:	Interest expense, including the change in the fair value of non-hedged derivative instruments:
Unrealized	$	230		$	—	Unrealized	$	(100	)	$	(280	)		Unrealized	$	145		$	405
Realized	(271		)	—		Realized	(271		)	—				Realized	134			(444		)
Total	$	(41	)	$	—	Total	$	(371	)	$	(280	)		Total	$	279		$	(39	)

Fuel commodity derivatives:						Cost of revenue:							Fuel commodity derivatives:	Cost of revenue:
Unrealized	$	—		$	—	Unrealized	$	—		$	—			Unrealized	$	(255	)	$	67
Realized	—			—		Realized	—			—				Realized	32			14
Total	$	—		$	—	Total	$	—		$	—			Total	$	(223	)	$	81

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

4. Fair Value Measurements (continued)

The Effect of Derivative Instruments on the Condensed Consolidated Income Statements

for the nine months ended September 30, 2011 and 2012

Derivatives in Net Investment	Amount of Gain or (Loss) Recognized in OCI on Derivative (Effective Portion)						Location of Loss Reclassified from Accumulated OCI	Amount of Loss Reclassified from Accumulated OCI into Income (Effective Portion)						Derivatives Not Designated as	Location of Gain or (Loss) Recognized in	Amount of Gain or (Loss) Recognized in Income on Derivative
Hedging	September 30,						into Income (Effective	September 30,						Hedging	Income on	September 30,
Relationships	2011			2012			Portion)	2011			2012			Instruments	Derivative	2011			2012

Interest rate contracts:							Interest expense, including the change in the fair value of non-hedged derivative instruments:							Interest rate contracts:	Interest expense, including the change in the fair value of non-hedged derivative instruments:
Unrealized	$	509		$	(67	)	Unrealized	$	(371	)	$	(875	)		Unrealized	$	858		$	1,235
Realized	(795		)	(162		)	Realized	(795		)	(162		)		Realized	989			(1,178		)
Total	$	(286	)	$	(229	)	Total	$	(1,166	)	$	(1,037	)		Total	$	1,847		$	57

Fuel commodity derivatives:							Cost of revenue:							Fuel commodity derivatives:	Cost of revenue:
Unrealized	$	—		$	—		Unrealized	$	—		$	—			Unrealized	$	(133	)	$	43
Realized	—			—			Realized	—			—				Realized	103			47
Total	$	—		$	—		Total	$	—		$	—			Total	$	(30	)	$	90

5. Goodwill and Intangible Assets

Goodwill and intangible assets consist of the following:

	As of December 31, 2011
	Cost		Accumulated Amortization		Net Book Value

Goodwill	$	58,173			$	58,173
	$	58,173			$	58,173
Intangible assets:
Trade Name	$	14,050	$	—	$	14,050
Non-compete agreements	3,187		3,170		17
Contract rights	237,768		72,730		165,038
Distribution rights	1,623		784		839
Deferred financing costs	5,207		3,542		1,665
	$	261,835	$	80,226	$	181,609

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

5. Goodwill and Intangible Assets (continued)

	As of September 30, 2012
	Cost		Accumulated Amortization		Net Book Value

Goodwill	$	57,846			$	57,846
	$	57,846			$	57,846
Intangible assets:
Trade Name	$	14,050	$	—	$	14,050
Non-compete agreements	2,277		2,270		7
Contract rights	228,813		72,498		156,315
Distribution rights	1,623		906		717
Deferred financing costs	1,796		210		1,586
	$	248,559	$	75,884	$	172,675

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

2012 (three months)	$	3,005
2013	12,019
2014	12,013
2015	12,004
2016	12,004
Thereafter	106,746
	$	157,791

Amortization expense of intangible assets for the nine months ended September 30, 2011 and 2012 was $9,676 and $9,121, respectively.

Intangible assets primarily consist of various non-compete agreements, and contract rights recorded in connection with acquisitions. The deferred financing costs were incurred in connection with our senior secured credit facility and our senior notes and are amortized from five to ten years. The non-compete agreements are amortized using the straight-line method over the life of the agreements, which range from five to 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)

6. 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.

7. 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,
	2011		2012		2011		2012

Net income	$	604	$	1,471	$	3,174	$	1,756

Weighted average number of common shares outstanding - basic	14,286		14,447		14,207		14,396
Effect of dilutive securities:
Stock options and restricted stock units	714		687		746		682
Weighted average number of common shares outstanding - diluted	15,000		15,134		14,953		15,078

Net income per share - basic	$	0.04	$	0.10	$	0.22	$	0.12
Net income per share - diluted	$	0.04	$	0.10	$	0.21	$	0.12

There were 306 and 587 shares under option plans that were excluded from the computation of diluted earnings per share for the three months ended September 30, 2011 and 2012, respectively, and 294 and 548 shares under option plans that were excluded from the computation of diluted earnings per share for the nine months ended September 30, 2011 and 2012, respectively, due to their anti-dilutive effects.

8. Stock Compensation

For the three and nine months ended September 30, 2012, the Company incurred stock compensation expense of $799 and $2,475, respectively. The allocation of stock compensation expense is consistent with the allocation of the participants’ salaries and other compensation expenses.

At September 30, 2012, options for 542 shares and 172 restricted shares have been granted but have not yet vested.

Compensation expense related to unvested options and restricted shares will be recognized in the following years:

2012 (three months)	$	793
2013	1,348
2014	681
2015	106
	$	2,928

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MAC-GRAY CORPORATION

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

(In thousands, except per share data)

9. Income Taxes

The following table presents the income tax expense and the effective income tax rates for the three and nine months ended September 30, 2011 and 2012:

	Three months ended						Nine months ended
	September 30,						September 30,
	2011			2012			2011			2012

Income tax expense	$	515		$	1,104		$	2,204		$	1,285
Effective tax rate	46		%	43		%	41		%	42		%

The effective income tax rate on operations is based upon the estimated income for the year and adjustments, if any, resulting from tax audits or other tax contingencies.

The changes in the effective tax rates for the three and nine months ended September 30, 2011 and 2012 are the result of the relative impact of permanent differences due to changes in estimated pretax annual profits.

At September 30, 2012, the uncertain tax positions recognized by the Company in the consolidated financial statements were not material.

10. New Accounting Pronouncements

In December 2011, the FASB issued updated guidance that provides amendments for disclosures about offsetting assets and liabilities. The amendments require an entity to disclose information about offsetting and related arrangements to enable users of its financial statements to understand the effect of those arrangements on its financial position. Entities are required to disclose both gross information and net information about both instruments and transactions eligible for offset in the statement of financial position and instruments and transactions subject to an agreement similar to a master netting arrangement. This scope would include derivatives, sale and repurchase agreements and reverse sale and repurchase agreements, and securities borrowing and securities lending arrangements. The amendments are effective for annual reporting periods beginning on or after January 1, 2013. Disclosures required by the amendments should be provided retrospectively for all comparative periods presented. The adoption of this guidance will not impact the Company’s financial results.

In July 2012, the FASB issued updated guidance which simplifies how an entity is required to test indefinite lived-intangible assets for impairment. The amendment allows an entity to first assess qualitative factors to determine whether it is necessary to perform a quantitative indefinite-lived asset impairment test. Current guidance requires an entity to test indefinite-lived intangible assets for impairment, on at least an annual basis, by first comparing the fair value of the indefinite-lived asset with its carrying amount. If the carrying amount of the intangible asset exceeds its fair value, an entity should recognize an impairment loss in the amount of that excess. In accordance with the amendment, an entity will have an option not to calculate annually the fair value of an indefinite-lived intangible asset if the entity determines that it is not more likely than not that the asset is impaired. The amendment includes a number of factors to be considered in conducting the qualitative assessment. The amendment is effective for annual and interim indefinite-lived intangible impairment tests performed for fiscal years beginning after September 15, 2012. The adoption of this guidance is not expected to have a material impact on the Company’s financial results.

No other new accounting pronouncement issued or effective during the fiscal year has had or is expected to have a material impact on the Consolidated Financial Statements.

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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 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, 2011 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 suggests otherwise, references to the “Company,” “Mac-Gray,” “we,” “us,” “our” and similar terms refer to Mac-Gray Corporation and its subsidiaries. We have registered, applied to register or are using the following trademarks: Mac-Gray®, Web®, Hof™, Automatic Laundry Company™, LaundryView®, PrecisionWashÔ, Intelligent Laundry®, LaundryLinxÔ, TechLinxÔ,

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VentSnakeÔ, LaundryAuditÔ, e-issuesÔ Life Just Got Easier® , The Laundry Room Experts®, Change Point®, The Campus Clothes Line®, and Digital Laundry is here®.

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 in 43 states and the District of Columbia. 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.

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, 2012, our total revenue was $77,873 and $239,936, respectively. Approximately 96% of our total revenue for the three and nine month period was generated by our facilities management business. 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, 2012, approximately 84% of our installed equipment base was located in laundry facilities subject to long-term leases, which have a weighted average remaining term of approximately four 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 primarily of a large number of relatively small amounts, which are associated with our entry into or renewal of leases. Our capital needs other than for laundry leases are not significant. Accordingly, our capital needs are predictable and largely within our control. For the three and nine months ended September 30, 2012, we incurred $9,809 and $25,269 of capital expenditures, respectively. In addition, we made incentive payments of approximately $1,300 and $3,307 in the three and nine months ended September 30, 2012 to property owners and property management companies in connection with obtaining our lease arrangements.

Through our commercial equipment sales and services business, we generate revenue by selling commercial laundry equipment. For the three and nine months ended September 30, 2012, our commercial laundry equipment sales business generated approximately 4% of our total revenue, and 5% of our gross margin. We anticipate that tight credit markets for our customers will continue to challenge our ability to maintain and grow our revenue from laundry equipment sales.

Our current priorities include: (i) continuing to reduce funded debt, thereby improving debt leverage ratios and reducing interest expense, (ii) increase revenue, (iii) maintaining capital expenditures at the levels needed to sustain and grow the business, (iv) increasing facilities management operating efficiencies in all markets, (v) improving the profitability of individual laundry facilities management accounts that come up for contract renewal, and (vi) continuing to look for acquisitions that complement our current footprint. One of the key challenges we face is maintaining and expanding our customer base in a competitive industry. Approximately 8% to 10% 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.

On December 21, 2011, our Board of Directors authorized a share repurchase program under which we are authorized to purchase up to an aggregate of $2,000 of our common stock. We repurchased 133,333 shares through March 31, 2012 under the plan for a total cash outlay of $2,000, thereby completing the repurchase program.

On February 29, 2012, we entered into an Amended and Restated Senior Secured Credit Agreement (“2012 Credit Agreement”) with a lending syndicate, including Bank of America, N.A., as Administrative Agent and Collateral Agent , Wells Fargo Bank, National Association, as Syndication Agent, and RBS Citizens, N.A. and TD Banknorth, NA, as Co-Documentation Agents. See “Liquidity and Capital Resources” below.

On March 30, 2012, we redeemed the remaining $100,000 of our senior notes utilizing $103,495 of availability

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under the 2012 Credit Agreement. The redemption price for the notes was 102.542%. Under the terms of the 2012 Credit Agreement, we will pay an interest rate of LIBOR plus a spread of between 1.75% and 2.75%. If there is not a significant change in LIBOR, we expect the cash payback on this strategy to be approximately six to eight months.

Our Board of Directors declared quarterly dividends of $0.0605 per share which were paid on March 30, 2012, June 29, 2012, and October 1, 2012 to stockholders of record at the close of business on March 15, 2012, June 15, 2012, and September 17, 2012, respectively.

We will realize some loss of revenue and some loss of equipment resulting from the impact of hurricane Sandy. Operations at our New Jersey branch were the most severely affected. We expect that the majority of the disruption will be temporary. While we cannot yet determine the total losses or the extent to which the losses will be offset by insurance, we believe it will have an adverse impact on our financial results for the fourth quarter of 2012, however we believe such impact will be immaterial.

Results of Operations (Dollars in thousands)

Three and nine months ended September 30, 2012 compared to three and nine months ended September 30, 2011.

The information presented below for the three and nine months ended September 30, 2012 and 2011 is derived from our unaudited condensed consolidated financial statements and related notes included elsewhere in this report:

	For the three months ended September 30,
					Increase			%
	2011		2012		(Decrease)			Change
Laundry facilities management revenue	$	74,287	$	74,372	$	85		0	%
Commercial laundry equipment sales revenue	4,205		3,501		(704		)	-17	%
Total revenue	$	78,492	$	77,873	$	(619	)	-1	%

	For the nine months ended September 30,
					Increase			%
	2011		2012		(Decrease)			Change
Laundry facilities management revenue	$	228,435	$	229,316	$	881		0	%
Commercial laundry equipment sales revenue	10,939		10,620		(319		)	-3	%
Total revenue	$	239,374	$	239,936	$	562		0	%

Revenue

Total revenue decreased by $619, or 1%, to $77,873 for the three months ended September 30, 2012 compared to $78,492 for the three months ended September 30, 2011. Total revenue increased by $562 or less than 1%, to $239,936 for the nine months ended September 30, 2012 compared to $239,374 for the nine months ended September 30, 2011.

Laundry facilities management revenue. Laundry facilities management revenue increased by $85, or less than 1%, to $74,372 for the three months ended September 30, 2012 compared to $74,287 for the three months ended September 30, 2011. Laundry facilities management revenue increased by $881, or less than 1%, to $229,316 for the nine months ended September 30, 2012 compared to $228,435 for the nine months ended September 30, 2011. The slight increase in revenue in the three and nine months ended September 30, 2012 compared to the same periods in the prior year reflect the cumulative impact of our vend price management initiatives, equipment usage, and general economic uncertainty implied by the decline in consumer spending. We expect that these factors are likely to continue to influence revenue in the near term. We expect that the improving apartment occupancy rates will mitigate some of the negative factors which are restricting revenue growth; however, industry data shows that the occupancy rates in the type of multi-family apartments in which we operate are improving at a slower rate than the premium type properties where we do not have a large presence. We continue to analyze economic trends in connection with expense controls and to optimize our capital spending.

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Commercial laundry equipment sales. Revenue in the commercial laundry equipment sales business decreased by $704, or 17%, to $3,501 for the three months ended September 30, 2012 compared to $4,205 for the three months ended September 30, 2011. Revenue in the commercial laundry equipment sales business decreased by $319, or 3%, to $10,620 for the nine months ended September 30, 2012 compared to $10,939 for the nine months ended September 30, 2011. Sales in the commercial laundry equipment sales business are sensitive to the strength of the local economy, the availability and cost of financing to small businesses, consumer confidence, and local permitting and therefore, tend to fluctuate significantly from period to period.

Cost of revenue

Cost of laundry facilities management revenue. Cost of laundry 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 laundry facilities management revenue increased by $596, or 1%, to $52,600 for the three months ended September 30, 2012 as compared to $52,004 for the three months ended September 30, 2011. Cost of laundry facilities management revenue increased by $3,280, or 2%, to $160,840 for the nine months ended September 30, 2012 as compared to $157,560 for the nine months ended September 30, 2011. As a percentage of laundry facilities management revenue, cost of laundry facilities management revenue was 71% and 70% for the three months ended September 30, 2012 and 2011, respectively, and 70% and 69% for the nine months ended September 30, 2012 and 2011, respectively. Laundry facilities management rent increased by less than 1% for the three and nine months ended September 30, 2012 compared to the corresponding periods in 2011, directly attributable to the changes in facilities management revenue. Laundry facilities management rent as a percentage of laundry facilities management revenue was 49.1 % and 49.0 % for the three months ended September 30, 2012 and 2011, respectively, and 49.2% and 48.8% for the nine months ended September 30, 2012 and 2011, respectively. Laundry facilities management rent can be affected by new and renewed laundry leases 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 laundry facilities management rent, as a function of laundry facilities management revenue, can vary. Other costs of laundry facilities management revenue increased by $477, or 3%, to $16,068 for the three months ended September 30, 2012 compared to $15,591 for the three months ended September 30, 2011. Other costs of laundry facilities management revenue increased by $2,041, or 4%, to $48,086 for the nine months ended September 30, 2012 compared to $46,045 for the nine months ended September 30, 2011. The increase in operating expenses for the three and nine months ended September 30, 2012 compared to the same periods in 2011 is attributable to an increase in personnel and fleet costs, as well as increased credit card fees.

Depreciation and amortization related to operations. Depreciation and amortization related to operations increased by $138, or 1%, to $10,706 for the three months ended September 30, 2012 as compared to $10,568 for the three months ended September 30, 2011. Depreciation and amortization related to operations decreased by $976, or 3%, to $31,536 for the nine months ended September 30, 2012 as compared to $32,512 for the nine months ended September 30, 2011.The increase in depreciation and amortization for the three months ended September 30, 2012 as compared to the three months ended September 30, 2011 is attributable to an increase in our capital spending on new and renegotiated accounts during this quarter. The decrease in depreciation and amortization for the nine months ended September 30, 2012 as compared to the same period in 2011 is attributable to the Company’s decision, in the past two years, to closely manage capital investment in light of the uncertain economy. We have begun to increase our capital spending and expect depreciation expense to continue to increase.

Cost of laundry equipment sales. Cost of commercial laundry equipment sales consists primarily of the cost of laundry equipment, and parts and supplies sold, as well as salaries, warehousing and distribution expenses. Cost of commercial laundry equipment sales decreased by $317, or 10%, to $2,827 for the three months ended September 30, 2012 as compared to $3,144 for the three months ended September 30, 2011. Cost of commercial laundry equipment sales decreased by $47, or less than 1%, to $8,675 for the nine months ended September 30, 2012 as compared to 8,722 for the nine months ended September 30, 2011. As a percentage of sales, cost of product sold was 81% and 75%for the three months ended September 30, 2012 and 2011, and 82% and 80% for the nine months ended September 30, 2012 and 2011, respectively. The changes in cost of sales for the three and nine months ended September 30, 2012 compared to the same periods ending September 30, 2011 are a direct result of the changes in sales revenue and product mix. Operating expenses were essentially unchanged in total. The gross margin in the commercial laundry equipment sales business unit was 19% and 25% for the three months ended September 30, 2012 and 2011, and 18% and 20% for the nine months ended September 30, 2012 and 2011, respectively. The lower margins in 2012 compared to 2011 are the result of price increases by the manufacturer which we were unable to fully pass on to our customers.

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Operating expenses

General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs. General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs decreased by $697, or 9%, to $7,291 for the three months ended September 30, 2012 as compared to $7,988 for the three months ended September 30, 2011. General and administration, sales and marketing, related depreciation and amortization, and incremental proxy costs decreased by $265, or 1%, to $24,944 for the nine months ended September 30, 2012 as compared to $25,209 for the nine months ended September 30, 2011. As a percentage of total revenue, these expenses were 9% and 10% for the three months ended September 30, 2012 and 2011, respectively, and 10% and 11% for the nine months ended September 30, 2012 and 2011. The decrease in expenses for the three months ended September 30, 2012 as compared to the same period in 2011 is primarily related to a decrease in personnel related expenses and advertising costs. The decrease in expenses for the nine months ended September 30, 2012 is also attributable to decreases in personnel related expenses and advertising costs, partially offset by $2,300 in legal fees relating to a dispute that was concluded in the first quarter.

Gain on sale of assets

The gains of $57 and $13 for the three months ended September 30, 2012 and 2011, respectively, and the gains of $97 and $170 in the nine months ended September 30, 2012 and 2011, respectively, are from the sale of vehicles and other fixed assets in the normal course of business.

Income from operations

Income from operations decreased by $295, or 6%, to $4,506 for the three months ended September 30, 2012 compared to $4,801 for the three months ended September 30, 2011 and decreased by $1,503, or 10%, to $14,038 for the nine months ended September 30, 2012 compared to $15,541 for the nine months ended September 30, 2011 due primarily to the cumulative effect of the reasons discussed above.

Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs

Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs, decreased by $1,751, or 48%, to $1,931 for the three months ended September 30, 2012, as compared to $3,682 for the three months ended September 30, 2011. Interest expense, including the change in the fair value of non-hedged derivative instruments and amortization of deferred financing costs, decreased by $2,928, or 29%, to $7,235 for the nine months ended September 30, 2012, as compared to $10,163 for the nine months ended September 30, 2011. This decrease for the three and nine months ended September 30, 2012 were primary attributable to interest savings as a result of retiring our 7.625% fixed rate senior notes by utilizing our 2012 Credit Agreement at lower interest rates. Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, was $1,966 and $3,508 for the three months ended September 30, 2012 and 2011, respectively, a decrease of $1,542, or 44%. Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, was $7,239 and $9,993 for the nine months ended September 30, 2012 and 2011, respectively, a decrease of $2,754, or 28%. Interest expense, excluding the change in fair value of non-hedged derivative instruments and amortization of deferred financing costs, includes interest paid or (received) in connection with our derivative instruments. This amounted to $444 and $137 for the three months ended September 30, 2012 and 2011, respectively, and $1,340 and $(194) for the nine months ended September 30, 2012 and 2011, respectively.

Interest expense associated with the company’s long term debt is comprised of the following:

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	Three months ended						Nine months ended
	September 30,						September 30,
	2011			2012			2011			2012

Interest expense	$	3,508		$	1,966		$	9,993		$	7,239
Change in the fair value of non-hedged interest rate derivative instruments	(45		)	(125		)	(487		)	(360		)
Amortization of deferred financing costs	219			90			657			356
Interest expense, including change in fair value of non-hedged interest rate derivative instruments and amortization of deferred financing costs	$	3,682		$	1,931		$	10,163		$	7,235

During the first quarter of 2012, the Company no longer qualified for hedge accounting treatment for its only effective interest rate swap agreement. Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost is being reclassified as an earnings charge through the maturity date of the derivative. This charge to interest expense, when combined with an interest rate swap agreement that previously lost hedge accounting treatment, amounted to $280 and $875 for the three and nine months ended September 30, 2012 compared to $100 and $371 for the three and nine months ended September 30, 2011, respectively. The remaining balance of $483 associated with these interest rate swap agreements and included in Accumulated Other Comprehensive Loss will be charged to interest expense through the maturity date of the interest rate swap agreements on April 1, 2013.

Loss on early extinguishment of debt

Loss on early extinguishment of debt amounted to $3,762 for the nine months ended September 30, 2012 and includes the premium of $2,542 we incurred for the early redemption of our senior unsecured notes and $1,087 of unamortized deferred financing costs associated with the redemption. We also wrote off $133 of unamortized deferred financing costs associated with our 2008 credit facility.

Income tax expense

Income tax expense increased by $589 to $1,104 for the three months ended September 30, 2012 compared to the income tax expense of $515 for the three months ended September 30, 2011. Income tax expense decreased by $919 to $1,285 for the nine months ended September 30, 2012 compared to income tax expense of $2,204 for the nine months ended September 30, 2011. The increase in the three months is the result of the increase in pre-tax income to $2,575 for the three months ended September 30, 2012, compared to the pre-tax income of $1,119 for the three months ended September 30, 2011, respectively. The decrease in the nine months is the result of the decrease in pre-tax income to $3,041 for the nine months ended September 30, 2012, compared to the pre-tax income of $5,378 for the nine months ended September 30, 2011. The effective tax rate increased to 42% for the nine months ended September 30, 2012, compared to 41% for the same period in 2011. The changes in the effective rate for the nine months ended September 30, 2012 are the result of the relative impact of permanent differences due to changes in estimated pretax annual profits.

Net Income

As a result of the foregoing, net income increased by $867 to $1,471 for the three months ended September 30, 2012 compared to $604 for the same period ended September 30, 2011. Net income decreased by $1,418 to $1,756 for the nine months ended September 30, 2012 compared to $3,174 for the same period in 2011.

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 14% of our total laundry 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

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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.

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, 2012, including contract incentive payments, are currently expected to be between $35,000 and $38,000. In the nine months ended September 30, 2012, spending on capital expenditures was $25,269 and spending on contract incentives was $3,307. The capital expenditures for 2012 are primarily composed of laundry equipment installed in connection with new customer leases and the renewal of existing leases.

We historically have not needed sources of financing other than our internally generated cash flow and revolving credit facilities to fund our working capital, capital expenditures and smaller acquisitions. As a result, we anticipate that our cash flow from operations and revolving credit facilities will be sufficient to meet our anticipated cash requirements for at least the next twelve months.

Our current long-term liquidity needs are principally the repayment of borrowings under our 2012 Credit Agreement. 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. We anticipate that we will need to refinance some portion of this indebtedness when it reaches maturity. We cannot make any assurances that such financing would be available on reasonable terms, if at all.

For the nine months ended September 30, 2012, our source of cash was primarily from operating activities. Our primary uses of cash for the nine months ended September 30, 2012 were the purchase of new laundry equipment, the repurchase of our common stock and the payments of dividends. We anticipate that we will continue to use cash flows provided by operating activities to finance working capital needs, debt service, and capital expenditures.

On February 29, 2012, we entered into an Amended and Restated Senior Secured Credit Agreement (the “2012 Credit Agreement”). The 2012 Credit Agreement provides for borrowings up to $250,000 under a revolving credit facility (the “Revolver”) and matures on February 28, 2017. Borrowings under the 2012 Credit Agreement are collateralized by a blanket lien on the assets of the Company and each of its subsidiaries as well as a pledge by the Company of all the capital stock of its subsidiaries. Outstanding indebtedness under the 2012 Credit Agreement bears interest at a fluctuating rate equal to (i) in the case of Eurodollar rate loans, the LIBOR rate plus an applicable percentage, ranging from 1.75% to 2.75% per annum (currently 2.50%), determined by reference to our consolidated total leverage ratio, and (ii) in the case of base rate loans and swingline loans, the higher of (a) the federal funds rate plus 0.50%, (b) the annual rate of interest announced by Bank of America, N.A. as its “prime rate,” or (c) for each day, the floating rate of interest equal to LIBOR for a one month term quoted for such date (the highest of which is defined as the “Base Rate”), plus, in each case, an applicable percentage, ranging from 0.75% to 1.75% per annum (currently 1.50%), determined by reference to our consolidated total leverage ratio.

We pay a commitment fee equal to a percentage of the actual daily-unused portion of the Revolver under the 2012 Credit Agreement. This percentage is determined quarterly by reference to our consolidated total leverage ratio and will range between 0.25% per annum and 0.50% per annum (currently 0.35%). For purposes of the calculation of the commitment fee, letters of credit are considered usage under the Revolver, but swingline loans are not considered usage under the Revolver.

The 2012 Credit Agreement includes certain financial and operational covenants, including restrictions on paying dividends and other distributions, making certain acquisitions and incurring indebtedness, and requires that the Company maintain certain financial ratios. The most significant financial ratios that we are required to maintain include a consolidated total leverage ratio of not greater than 3.75 to 1.00 (3.50 to 1.00 as of December 31, 2013 and thereafter) and a consolidated cash flow coverage ratio of not less than 1.20 to 1.00. We were in compliance with all financial covenants at September 30, 2012.

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banks and the effect of the interest rate swap agreements tied to the debt (see Note 4 for discussion on Fair Value Measurements).

On October 21, 2011, we redeemed $50,000 of our 7.625% senior notes by utilizing $51,271 of availability under our prior credit facility. On March 30, 2012, we redeemed the remaining $100,000 of our senior notes by utilizing $103,495 of availability under the 2012 Credit Agreement.

Operating Activities

For the nine months ended September 30, 2012 and 2011, net cash flows provided by operating activities were $30,067 and $36,101, respectively. Cash flows from operations consists primarily of facilities management revenue and equipment sales, offset by the cost of facilities management revenues, cost of product sold, and general, administration, sales and marketing expenses. The most significant changes to cash flows for the nine months ended September 30, 2012 as compared to the nine months ended September 30, 2011 are a decrease in net income in 2012 compared to 2011, proceeds from the termination of a derivative instrument in 2011, a decrease in deferred taxes in 2012 compared to a slight increase in 2011, a larger increase in prepaid facilities management rent and other assets in 2011 compared to 2012 and a decrease in accounts payable, accrued facilities management rent, accrued expenses and other liabilities compared to a slight increase in 2011. These accounts are subject to normal fluctuations from period to period.

Investing Activities

For the nine months ended September 30, 2012 and 2011, net cash flows used in investing activities were $25,092 and $21,795, respectively. Capital expenditures for the nine months ended September 30, 2012 and 2011 were $25,269 and $22,026, respectively, primarily for the acquisition of laundry equipment for new and renewed lease locations.

Financing Activities

For the nine months ended September 30, 2012 and 2011, net cash flows used in financing activities were $4,612 and $14,385, respectively. Cash flows used in financing activities consist of changes in long term debt, principally resulting from the redemption of our senior notes, entry into the 2012 Credit Agreement, repurchase of common stock, and the payments of dividends.

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, 2012 is as follows:

			Interest on
Fiscal	Long-term		variable rate		Facilites rent		Capital lease		Operating lease
Year	debt		debt (1)		commitments		commitments		commitments		Total
2012(three months)	$	—	$	1,841	$	3,039	$	321	$	841	$	6,042
2013	—		7,366		11,141		1,121		3,055		$	22,683
2014	—		7,366		9,065		702		2,666		$	19,799
2015	—		7,366		6,694		191		2,336		$	16,587
2016	—		7,366		5,340		84		688		$	13,478
Thereafter	201,805		1,228		13,244		—		575		$	216,852
Total	$	201,805	$	32,533	$	48,523	$	2,419	$	10,161	$	295,441

(1) Interest is calculated using the Company’s average interest rate at September 30, 2012.

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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 and the change in fuel prices. 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, 2012.

(in thousands)	2012		2013		2014		2015		2016		Thereafter			Total
Variable rate	$	—	$	—	$	—	$	—	$	—	$	201,805		$	201,805
Average interest rate	—		—		—		—		—		3.65		%	3.65		%

We have entered into standard International Swaps and Derivatives Association interest rate swap agreements to manage the interest rate associated with our debt. The interest rate Swap Agreements effectively convert $52,000 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. We recognized a non-cash unrealized gain of $405 and $145 for the three months ended September 30, 2012 and 2011, respectively, and a non-cash unrealized gain of $1,235 and $858 for the nine months ended September 30, 2012 and 2011, respectively, on the interest rate swap agreements as a result of the change in the fair value.

On September 23, 2011, we entered into a fuel commodity derivative to manage the fuel cost on our fleet of vehicles. The derivative was effective January 1, 2012 and expires December 31, 2012. The derivative has a monthly notional amount of 85 thousand gallons from January 1, 2012 through December 31, 2012 for a total notional amount of 1.02 million gallons. We have a put price of $3.205 per gallon and a strike price of $3.70 per gallon. On September 19, 2012 we entered into an additional fuel commodity derivative. The derivative is effective January 1, 2013 and expires December 31, 2013. The derivative has a monthly notional amount of 80 thousand gallons from January 1, 2013 through December 31, 2013 for a total notional amount of 960 thousand gallons. We have a put price of $3.26 per gallon and a strike price of $3.90 per gallon. We recognized a non-cash unrealized gain of $67 and a non-cash unrealized loss $255 for the three months ended September 30, 2012 and 2011, respectively, and a non-cash unrealized gain of $43 and a non-cash unrealized loss $133 for the nine months ended September 30, 2012 and 2011, respectively, on these fuel commodity derivatives as a result of the change in the fair value.

The fair values of these interest rate derivatives are based on quoted prices for similar instruments from a commercial bank and are considered to be Level 2 items. The fuel commodity derivative is based on market assumptions and a quoted price from the counter party and is considered a Level 3 item.

During the first quarter of 2012, as a result of our senior note redemption, we no longer qualified for hedge accounting treatment on our only effective interest rate swap agreement. Accordingly, the amount included in Accumulated Other Comprehensive Loss at the time hedge accounting was lost is being reclassified as an earnings charge through the maturity date of the derivative. This charge to interest expense, when combined with an interest rate swap agreement that previously lost hedge accounting treatment, amounted to $280 and $875 for the three and nine months ended September 30, 2012 compared to $100 and $371 for the three and nine months ended September 30, 2011, respectively. The remaining balance of $483 associated with these interest rate swap agreements and included in Accumulated Other Comprehensive Loss will be charged to interest expense through the maturity date of the interest rate swap agreements on April 1, 2013.

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

Notional

Original

Amount

Date of

Notional

Fixed/

September 30,

Expiration

Fixed

Origin

Amount

Amortizing

2012

Date

Rate

May 8, 2008

45,000

Amortizing

30,000

Apr 1, 2013

3.78

May 8, 2008

40,000

Amortizing

22,000

Apr 1, 2013

3.78

In accordance with the interest rate Swap Agreements and on a quarterly basis, interest expense is calculated based on the floating 90-day LIBOR and the fixed rate. With regard to our floating to fixed rate interest rate swap agreements, if interest expense, as calculated, is greater based on the 90-day LIBOR, the financial institution pays the difference to us. If interest expense, as calculated, is greater based on the fixed rate we pay the difference to the financial institution.

Depending on fluctuations in the LIBOR, our interest rate exposure and the related impact on interest expense and net cash flow may increase or decrease. The counter party to the interest rate Swap Agreements exposes us to credit loss in the event of non-performance; however, nonperformance is not anticipated. The fair value of an interest rate Swap Agreement is the estimated amount that we 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, 2012, the fair value of the interest rate Swap Agreements was a liability of $872. This amount has been included in accrued expenses 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, 2012 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 ended September 30, 2012 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

PART II – OTHER INFORMATION

Item 1A. Risk Factors

There have been no material changes in our risk factors from those disclosed in Part 1, Item 1A (“Risk Factors”) of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011, except to the extent previously updated or to the extent additional factual information disclosed elsewhere in this Quarterly Report on Form 10-Q relates to such risk factors. The risks described in our annual report on Form 10-K are not the only risks facing our Company. Additional risks and uncertainties not currently known to us or that we currently deem to be immaterial also may materially adversely affect our business, financial condition and/or operating results.

31.1		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
31.2		Certification pursuant to Section 302 of the Sarbanes-Oxley Act of 2002 (1)
32.1		Certification pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (2)
101		The following financial statements from the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2012 formatted in eXtensible Business Reporting Language (XBRL): (i) the Condensed Consolidated Balance Sheets, (ii) the Condensed Consolidated Statements of Income and Comprehensive Income, (iii) the Condensed Consolidated Statements of Stockholders’ Equity, (iv) the Condensed Consolidated Statements of Cash Flows and (v) related notes, tagged as blocks of text. (2)

		MAC-GRAY CORPORATION
November 9, 2012		/s/ Michael J. Shea
		Michael J. Shea
		Executive Vice President, Chief Financial Officer and Treasurer
		(On behalf of registrant and as principal financial officer)

PART I	FINANCIAL INFORMATION

	Item 1.	Financial Statements	3

		Condensed Consolidated Balance Sheets at December 31, 2011 and September 30, 2012	3

		Condensed Consolidated Statements of Income and Comprehensive Income for the Three and Nine Months Ended September 30, 2011 and 2012	4

		Condensed Consolidated Statement of Stockholders’ Equity for the Nine Months Ended September 30, 2012	5

		Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2012	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	28

	Item 6.	Exhibits	29

	Signature		30