10-Q

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

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

For Quarter Ended December 28, 2002 Commission file number 0-4063

G&K SERVICES, INC.
(Exact name of registrant as specified in its charter)

MINNESOTA	41-0449530
(State or other jurisdiction of incorporation or organization)	(I.R.S. Employer Identification No.)

5995 OPUS PARKWAY, SUITE 500
MINNETONKA, MINNESOTA 55343
(Address of principal executive offices and zip code)

(952) 912-5500
(Registrant’s telephone number, including area code)

     Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES X NO

     Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

YES X NO

     Indicate the number of shares outstanding of each of the issuer’s classes of common stock as of the latest practicable date.

CLASS A	Outstanding February 6, 2003
Common Stock, par value $0.50 per share	19,257,585
CLASS B	Outstanding February 6, 2003
Common Stock, par value $0.50 per share	1,474,996

TABLE OF CONTENTS

PART I
	ITEM 1. FINANCIAL STATEMENTS
		CONSOLIDATED CONDENSED BALANCE SHEETS
		CONSOLIDATED STATEMENTS OF OPERATIONS
		CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
		NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
	ITEM 4. CONTROLS AND PROCEDURES
PART II
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
SIGNATURES
CERTIFICATION
CERTIFICATION
EX-99.1 Certification Pursuant to Section 1350

G&K Services, Inc.
Form 10-Q

Table of Contents

PART I		PAGE
Item 1.	Financial Statements
	Consolidated Condensed Balance Sheets as of December 28, 2002 and June 29, 2002		3
	Consolidated Statements of Operations for the three and six months ended December 28, 2002 and December 29, 2001		4
	Consolidated Condensed Statements of Cash Flows for the six months ended December 28, 2002 and December 29, 2001		5
	Notes to Consolidated Condensed Financial Statements		6
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		11
Item 3.	Quantitative and Qualitative Disclosure About Market Risk		17
Item 4.	Controls and Procedures		18
PART II
Item 4.	Submission of Matters to a Vote of Security Holders		19
Item 6.	Exhibits and Reports on Form 8-K		19
Signatures			20
Certifications			21

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PART I

FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

CONSOLIDATED CONDENSED BALANCE SHEETS
G&K Services, Inc. and Subsidiaries

			December 28,
			2002		June 29,
(In thousands)			(Unaudited)		2002
ASSETS
Current Assets
	Cash and cash equivalents		$	17,573	$	9,986
	Accounts receivable, less allowance for doubtful accounts of $4,155 and $3,326			74,297		66,555
	Inventories			94,617		91,733
	Prepaid expenses			11,251		17,536
		Total current assets		197,738		185,810
Property, Plant and Equipment, net				249,095		230,530
Goodwill, net				241,661		200,140
Other Assets				71,520		65,219
			$	760,014	$	681,699
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
	Accounts payable		$	18,814	$	17,361
	Accrued expenses			59,059		52,026
	Deferred income taxes			11,111		11,157
	Current maturities of long-term debt			10,257		9,443
		Total current liabilities		99,241		89,987
Long-Term Debt, net of Current Maturities				264,581		214,977
Deferred Income Taxes				23,547		21,570
Other Noncurrent Liabilities				14,633		15,007
Stockholders’ Equity				358,012		340,158
			$	760,014	$	681,699

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

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CONSOLIDATED STATEMENTS OF OPERATIONS
G&K Services, Inc. and Subsidiaries
(Unaudited)

			For the Three Months Ended				For the Six Months Ended
			Dec 28,		Dec 29,		Dec 28,		Dec 29,
(In thousands, except per share data)			2002		2001		2002		2001
Revenues
	Rental operations		$	158,030	$	149,660	$	309,936	$	301,423
	Direct sales			8,020		6,001		12,367		11,336
		Total revenues		166,050		155,661		322,303		312,759
Operating Expenses
	Cost of rental operations			92,487		87,232		180,412		176,102
	Cost of direct sales			5,427		4,226		8,928		8,079
	Selling and administrative			38,827		36,314		75,482		72,858
	Depreciation and amortization			9,454		8,832		18,473		17,601
		Total operating expenses		146,195		136,604		283,295		274,640
Income from Operations				19,855		19,057		39,008		38,119
	Interest expense			3,531		3,292		6,792		7,122
Income before Income Taxes				16,324		15,765		32,216		30,997
	Provision for income taxes			6,366		6,227		12,564		12,244
Net Income			$	9,958	$	9,538	$	19,652	$	18,753
	Basic weighted average number of shares outstanding			20,567		20,483		20,556		20,482
Basic Earnings per Common Share			$	0.48	$	0.47	$	0.96	$	0.92
	Diluted weighted average number of shares outstanding			20,759		20,566		20,722		20,535
Diluted Earnings per Common Share			$	0.48	$	0.46	$	0.95	$	0.91
Dividends per share			$	0.0175	$	0.0175	$	0.0350	$	0.0350

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

4

CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS
G&K Services, Inc. and Subsidiaries
(Unaudited)

			For the Six Months Ended
			December 28,			December 29,
(In thousands)			2002			2001
Operating Activities:
	Net income		$	19,652		$	18,753
	Adjustments to reconcile net income to net cash provided by operating activities -
		Depreciation and amortization		18,473			17,601
		Deferred income taxes		(331	)		(1,294	)
		Amortization of deferred compensation — restricted stock		544			447
		Changes in current operating items, exclusive of acquisitions		8,782			5,556
	Other, net			240			1,268
Net cash provided by operating activities				47,360			42,331
Investing Activities:
	Property, plant and equipment additions, net			(18,074	)		(13,657	)
	Acquisitions of business assets and other			(71,797	)		(33,719	)
Net cash used for investing activities				(89,871	)		(47,376	)
Financing Activities:
	Proceeds from debt financing			163,209			48,709
	Repayments of debt financing			(112,839	)		(41,913	)
	Cash dividends paid			(725	)		(722	)
	Sale of common stock			384			187
Net cash provided by financing activities				50,029			6,261
Increase in Cash and Cash Equivalents				7,518			1,216
Effect of Exchange Rates on Cash				69			(510	)
Cash and Cash Equivalents:
	Beginning of period			9,986			15,317
	End of period		$	17,573		$	16,023

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

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G&K SERVICES, INC. AND SUBSIDIARIES

NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(Amounts in thousands, except share and per share data)
Three and six month periods ended December 28, 2002 and December 29, 2001
(Unaudited)

	The consolidated condensed financial statements included herein, except for the June 29, 2002 balance sheet which was extracted from the audited consolidated financial statements for the fiscal year ended June 29, 2002, have been prepared by G&K Services, Inc. (the “Company”), without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. In the opinion of the Company, the accompanying unaudited consolidated condensed financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary to present fairly the financial position of the Company as of December 28, 2002, and the results of its operations for the three and six months ended and its cash flows for the six months ended December 28, 2002 and December 29, 2001. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States have been condensed or omitted pursuant to such rules and regulations, although the Company believes that the disclosures herein are adequate to make the information presented not misleading. It is suggested that these consolidated condensed financial statements be read in conjunction with the consolidated financial statements and the notes thereto included in the Company’s latest report on Form 10-K.
	The results of operations for the three and six month periods ended December 28, 2002 and December 29, 2001 are not necessarily indicative of the results to be expected for the full year.
1.	Summary of Significant Accounting Policies
	Accounting policies followed by the Company are set forth in Note 1 in the Company’s Annual Report on Form 10-K for the fiscal year ended June 29, 2002.
	Nature of Business
	G&K Services, Inc. is a market leader in providing corporate identity apparel and facility services programs to a wide variety of industrial, service and high-technology companies. The Company’s programs provide rental-lease or purchase options as well as non-apparel items such as floor mats, dustmops and cloths, wiping towels, selected linen items and several restroom products. The Company also manufactures certain uniform garments that it uses to support its garment rental programs.
	Principles of Consolidation
	The accompanying consolidated condensed financial statements include the accounts of the Company and its subsidiaries, all of which are wholly owned. Intercompany balances and transactions have been eliminated in consolidation.
	Derivative Financial Instruments
	The Company uses derivative financial instruments principally to manage the risk that changes in interest rates will affect the amount of its future interest payments. Interest rate swap contracts are used to adjust the proportion of total debt that is subject to variable and fixed interest rates. The interest rate swap contracts are reflected at fair value in the consolidated condensed balance sheet and the related gains or losses on these contracts are deferred in stockholders’ equity (as a component of other comprehensive income). Amounts to be paid or received under the contracts are accrued as interest rates change and are recognized over the life of the contracts as an adjustment to interest expense. The net effect of this accounting is that interest expense on the portion of variable rate debt being hedged is generally recorded based on fixed interest rates.

6

The Company may periodically hedge firm cash flow commitments with its foreign subsidiary, generally with foreign currency contracts. These agreements are recorded at current market values and the gains and losses are included in earnings. Gains and losses on such transactions were not significant in the second quarter of fiscal 2003. Notional amounts outstanding under foreign currency contracts at December 28, 2002 were $2,402, all of which will mature during fiscal 2003. No amounts were outstanding under such contracts at December 29, 2001. The fair values of the foreign currency contracts were not materially different as of December 28, 2002.

Per Share Data

Basic earnings per common share was computed by dividing net income by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per common share was computed similar to the computation of basic earnings per share, except that the denominator is increased for the assumed exercise of dilutive options and other dilutive securities, including nonvested restricted stock, using the treasury stock method.

	Three Months Ended				Six Months Ended
	Dec 28,		Dec 29,		Dec 28,		Dec 29,
	2002		2001		2002		2001
Weighted average number of common shares outstanding		20,567,000		20,483,000		20,556,000		20,482,000
Shares used in computation of basic earnings per share		20,567,000		20,483,000		20,556,000		20,482,000
Weighted average effect of nonvested restricted stock grants and assumed exercise of options		192,000		83,000		166,000		53,000
Shares used in computation of diluted earnings per share		20,759,000		20,566,000		20,722,000		20,535,000

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. The Company adopted SFAS 143 effective June 30, 2002. The impact of adopting SFAS 143 was not material.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 establishes a single accounting model, based on the framework established in SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” (SFAS 121), for long-lived assets to be disposed of by sale. SFAS 144 also resolves several significant implementation issues related to SFAS 121, such as eliminating the requirement to allocate goodwill to long-lived assets to be tested for impairment and establishing criteria to define whether a long-lived asset is held for sale. The Company adopted SFAS 144 effective June 30, 2002. The impact of adopting SFAS 144 was not material.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. It nullifies Emerging Issues Task Force Issue

7

	No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” SFAS 146 requires that a liability be recognized for costs associated with an exit or disposal activity only when the liability is incurred. SFAS 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. The Company will apply the provisions of SFAS 146 for all exit or disposal activities initiated after December 31, 2002.
	In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148). SFAS 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosures in both annual and interim financial statements about the method used to account for stock-based employee compensation and the effect of the method used on reported results. The Company will continue to apply Accounting Principles Board Opinion No. 25 as the method used to account for stock-based compensation, where applicable, but will adopt the disclosure requirements of SFAS 148 beginning with the third quarter ending March 29, 2003.
2.	Comprehensive Income
	For the three and six month periods ended December 28, 2002 and December 29, 2001, the components of comprehensive income were as follows:

		Three Months Ended					Six Months Ended
		Dec 28,		Dec 29,			Dec 28,			Dec 29,
		2002		2001			2002			2001
Net income		$	9,958	$	9,538		$	19,652		$	18,753
Other comprehensive income
	Foreign currency translation adjustments, net of tax		581		(767	)		(1,971	)		(3,608	)
	Net unrealized holding gain (loss), net of tax		34		293			(30	)		(481	)
Comprehensive income		$	10,573	$	9,064		$	17,651		$	14,664

3.	Acquisitions
	During the current fiscal year, the Company has made several small acquisitions, including the acquisition of Rental Uniform Company at the beginning of the current quarter. All acquisitions were accounted for using the purchase method. The total purchase consideration, including related acquisition costs of these transactions, was approximately $60,713 for the three months ended December 28, 2002 and $71,186 for the six months ended December 28, 2002. The total purchase price exceeded the estimated fair values of assets acquired by approximately $34,522 for the three months ended December 28, 2002 and $42,226 for the six months ended December 28, 2002.
	The pro forma effects of these acquisitions, had they been acquired at the beginning of the fiscal year, were not material to the Company.

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4.	Goodwill and Intangible Assets
	In July 2001, the Company adopted the provisions of SFAS No. 141, “Business Combinations” and SFAS No. 142, “Goodwill and Other Intangible Assets.” The changes in the carrying amount of goodwill for the six months ended December 28, 2002, by operating segment, are as follows:

	United States		Canada			Total
Balance as of June 29, 2002	$	173,707	$	26,433		$	200,140
Goodwill acquired during the period		42,226		—			42,226
Other, primarily foreign currency translation		—		(705	)		(705	)
Balance as of December 28, 2002	$	215,933	$	25,728		$	241,661

Information regarding the Company’s other intangible assets are as follows:

	As of December 28, 2002
	Carrying		Accumulated
	Amount		Amortization		Net
Customer Lists	$	74,586	$	27,892	$	46,694
Restrictive Covenants		9,556		4,565		4,991
Total	$	84,142	$	32,457	$	51,685

	As of June 29, 2002
	Carrying		Accumulated
	Amount		Amortization		Net
Customer Lists	$	66,470	$	24,914	$	41,556
Restrictive Covenants		7,979		4,184		3,795
Total	$	74,449	$	29,098	$	45,351

Amortization expense for the six months ended December 28, 2002 was $3,495. Estimated amortization expense for each of the five succeeding fiscal years based on the intangible assets as of December 28, 2002 is as follows:

2003 remaining	$	3,790
2004		7,495
2005		7,427
2006		7,123
2007		7,001
2008		6,699

5.

Segment Information

The Company has two operating segments under the guidelines of SFAS No. 131: United States and Canada, which have been identified as components of the Company that are reviewed by the Company’s Chief Executive Officer to determine resource allocation and evaluate performance. Each operating segment derives revenues from the corporate identity apparel and facility services industry, which includes garment rental and non-apparel items such as floor mats, dust mops and cloths, wiping

9

towels, selected linen items and several restroom products. No one customer’s transactions account for 1.0% or more of the Company’s revenues.

The accounting policies of the segments are the same as those described in the summary of significant accounting policies (see Note 1). Corporate expenses are allocated to the segments based on segment revenue. The Company evaluates performance based on income from operations. Financial information by geographic location for the three and six month periods ended December 28, 2002 and December 29, 2001 is as follows:

		United
For the Three Months Ended		States		Canada		Total
Second Quarter Fiscal Year 2003:
	Revenues	$	146,476	$	19,574	$	166,050
	Income from operations		15,388		4,467		19,855
	Capital expenditures		6,158		2,940		9,098
	Depreciation and amortization expense		8,635		819		9,454
Second Quarter Fiscal Year 2002:
	Revenues	$	136,674	$	18,987	$	155,661
	Income from operations		14,391		4,666		19,057
	Capital expenditures		7,827		266		8,093
	Depreciation and amortization expense		7,985		847		8,832

		United
For the Six Months Ended		States		Canada		Total
Fiscal Year 2003:
	Revenues	$	283,752	$	38,551	$	322,303
	Income from operations		30,227		8,781		39,008
	Capital expenditures		12,841		5,233		18,074
	Depreciation and amortization expense		16,751		1,722		18,473
Fiscal Year 2002:
	Revenues	$	274,688	$	38,071	$	312,759
	Income from operations		28,576		9,543		38,119
	Capital expenditures		13,235		422		13,657
	Depreciation and amortization expense		15,865		1,736		17,601

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ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
(Unaudited)

Overview

G&K Services, Inc., founded in 1902 and headquartered in Minnetonka, Minnesota, is a market leader in providing corporate identity apparel and facility services programs to a wide variety of North American industrial, service and high-technology companies. We rent uniforms and other related products such as floor mats, dust mops, wiping towels, restroom supplies and selected linen items. We also sell uniforms and other apparel items to customers in our direct sale programs. The North American rental market is approximately $6.3 billion, while the direct sales market, targeted by us, is approximately $4.5-$5.0 billion in size.

During the current fiscal year, we have made several small acquisitions, including the acquisition of Rental Uniform Company at the beginning of the current quarter. All acquisitions were accounted for using the purchase method. The pro forma effects of these acquisitions, had they been acquired at the beginning of the fiscal year, were not material. The total purchase consideration, including related acquisition costs of these transactions, was approximately $60.7 million for the three months ended December 28, 2002 and $71.2 million for the six months ended December 28, 2002. The total purchase price exceeded the estimated fair values of assets acquired by approximately $34.5 million for the three months ended December 28, 2002 and $42.2 million for the six months ended December 28, 2002.

Critical Accounting Policies

The discussion of the financial condition and results of operations are based upon the consolidated condensed financial statements, which have been prepared in conformity with accounting principles generally accepted in the United States. As such, management is required to make certain estimates, judgments and assumptions that are believed to be reasonable based on the information available. These estimates and assumptions affect the reported amount of assets and liabilities, revenues and expenses, and disclosure of contingent assets and liabilities at the date of the financial statements. Actual results may differ from these estimates under different assumptions or conditions.

Critical accounting policies are defined as those that are reflective of significant judgments and uncertainties, and potentially result in materially different results under different assumptions and conditions. See Note 1 to the consolidated condensed financial statements for additional discussion of the application of these and other accounting policies.

Revenue Recognition and Allowance for Doubtful Accounts

We recognize revenue from rental operations in the period in which the services are provided. Direct sale revenue is recognized in the period in which the product is shipped. Estimates are used in determining the collectability of billed accounts receivable. Management analyzes specific accounts receivable and historical bad debt experience, customer credit worthiness, current economic trends and the age of outstanding balances when evaluating the adequacy of the allowance for doubtful accounts. Significant management judgments and estimates are used in connection with establishing the allowance in any accounting period. Material differences may result in the amount and timing of bad debt expense recognition for any given period if management makes different judgments or utilizes different estimates.

Inventories

Our inventories consist of new goods and rental merchandise in service. Estimates are used in determining the likelihood that new goods on hand can be sold to customers or used in rental operations. Historical inventory usage and current revenue trends are considered in estimating both obsolete and excess inventories. New goods are stated at lower of cost or market, net of any reserve for obsolete or excess inventory. Merchandise placed in service to support rental operations is amortized into cost of rental operations over the estimated useful lives of the underlying inventory items, primarily on a straight-line basis. Estimated lives of rental merchandise in service range from nine months to three years. In establishing estimated lives for merchandise in service, management considers

11

manufacturer expectations, historical experience and the intended use of the merchandise. Material differences may result in the amount and timing of operating profit for any period if management makes different judgments or utilizes different estimates.

Goodwill, Intangibles and Other Long-Lived Assets

We adopted SFAS 142 at the beginning of fiscal 2002 and as a result no longer amortize goodwill. SFAS 142 also requires that companies test goodwill for impairment on an annual basis and when events occur or circumstances change that would more likely than not reduce the fair value of the reporting unit to which goodwill is assigned below its carrying amount. There have been no impairments of goodwill in fiscal 2003 or 2002. Our evaluation considers changes in the operating environment, competitive information, market trends, operating performance and cash flow modeling. Future events could cause management to conclude that impairment indicators exist and that goodwill and other intangibles associated with acquired businesses are impaired. Any resulting impairment loss could have a material impact on our financial condition and results of operations.

Property, plant and equipment and definite-lived intangible assets are depreciated or amortized over their useful lives. Useful lives are based on management estimates of the period that the assets will generate revenue. Long-lived assets are evaluated for impairment whenever events and circumstances indicate an asset may be impaired. There have been no write-downs of any long-lived assets in fiscal 2003 or 2002.

Insurance

We self-insure for certain obligations related to health and workers’ compensation programs. We purchase stop-loss insurance policies to protect us from catastrophic losses. Estimates are used in determining the potential value associated with reported claims and for losses that have occurred, but have not been reported. Management estimates consider historical claims experience, escalating medical cost trends, expected timing of claim payments and actuarial analysis provided by a third party. Changes in the cost of medical care, our ability to settle claims or the estimates and judgment used by management could have a material impact on the amount and timing of expense for any period.

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Results of Operations

The percentage relationships to net sales of certain income and expense items for the three and six month periods ended December 28, 2002 and December 29, 2001, and the percentage changes in these income and expense items between periods are presented in the following table:

			Three Months						Six Months						Percentage
			Ended						Ended						Change
															Three Months			Six Months
			Dec 28,			Dec 29,			Dec 28,			Dec 29,			FY 2003			FY 2003
			2002			2001			2002			2001			vs. FY 2002			vs. FY 2002
Revenues:
	Rental			95.2	%		96.1	%		96.2	%		96.4	%		5.6	%		2.8	%
	Direct			4.8			3.9			3.8			3.6			33.6			9.1
		Total revenues		100.0			100.0			100.0			100.0			6.7			3.1
Expenses:
	Cost of rental sales			58.5			58.3			58.2			58.4			6.0			2.4
	Cost of direct sales			67.7			70.4			72.2			71.3			28.4			10.5
		Total cost of sales		58.9			58.8			58.8			58.9			7.1			2.8
	Selling and administrative			23.4			23.3			23.4			23.3			6.9			3.6
	Depreciation and amortization			5.7			5.7			5.7			5.6			7.0			5.0
Income from operations				12.0			12.2			12.1			12.2			4.2			2.3
Interest expense				2.2			2.1			2.1			2.3			7.3			(4.6	)
Income before income taxes				9.8			10.1			10.0			9.9			3.5			3.9
Provision for income taxes				3.8			4.0			3.9			3.9			2.2			2.6
Net income				6.0	%		6.1	%		6.1	%		6.0	%		4.4	%		4.8	%

Three months ended December 28, 2002 compared to three months ended December 29, 2001

Revenues. Total revenues in the second quarter of fiscal 2003 increased 6.7% to $166.1 million from $155.7 million in the second quarter of fiscal 2002. Rental revenue increased $8.4 million in the second quarter, or 5.6%. If the net impact of acquisitions and changes in foreign currency exchange rates is removed, the internal growth rate of the industrial rental business was approximately (3.0)%.

Direct sale revenue increased 33.6% to $8.0 million in the second quarter of fiscal 2003 compared to $6.0 million in the same period of fiscal 2002. Direct sale revenue is up due to the success of our annual winter outerwear promotion.

Cost of Rental and Direct Sale. Cost of rental operations increased 6.0% to $92.5 million in the second quarter of fiscal 2003 from $87.2 million in the same period of fiscal 2002. Gross margin from rental sales decreased to 41.5% in the second quarter of fiscal 2003 from 41.7% in the second quarter of fiscal 2002. The decrease in rental gross margin is due to higher costs for energy, acquisition integration and plant consolidation, partially offset by improved operational productivity.

Cost of direct sales increased 28.4% to $5.4 million in the second quarter of fiscal 2003 from $4.2 million in the same period of fiscal 2002. Gross margin from direct sales increased to 32.3% in the second quarter of fiscal 2003 from 29.6% in the second quarter of fiscal 2002. The increase in gross margin is due to leveraging fixed costs over the higher sales volume.

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Selling and Administrative. Selling and administrative expenses increased 6.9% to $38.8 million in the second quarter of fiscal 2003 from $36.3 million in the same period of fiscal 2002. As a percentage of total revenues, selling and administrative expenses increased to 23.4% in the second quarter of fiscal 2003 from 23.3% in the same period of fiscal 2002.

Depreciation and Amortization. Depreciation and amortization expense increased 7.0% to $9.5 million in the second quarter of fiscal 2003 from $8.8 million in the same period of fiscal 2002. As a percentage of total revenues, depreciation and amortization expense was 5.7% in the second quarter of both fiscal 2003 and fiscal 2002. Capital expenditures, excluding acquisition of businesses, were $9.1 million in the second quarter of fiscal 2003 compared to $8.1 million in the prior year’s quarter.

Interest Expense. Interest expense was $3.5 million in the second quarter of fiscal 2003, up from $3.3 million in the same period of fiscal 2002. The increase in interest expense is due primarily to higher debt levels in conjunction with our acquisition activities, partially offset by lower effective interest rates.

Provision for Income Taxes. Our effective tax rate decreased to 39.0% in the second quarter of fiscal 2003 from 39.5% in the same period of fiscal 2002 due largely to decreases in Canadian statutory income tax rates.

Six months ended December 28, 2002 compared to six months ended December 29, 2001

Revenues. Total revenues for the first six months of fiscal 2003 increased 3.1% to $322.3 million from $312.8 million for the same period of fiscal 2002. Rental revenue increased $8.5 million in the first six months or 2.8%. If the net impact of acquisitions and changes in foreign currency exchange rates is removed, the internal growth rate of the industrial rental business was approximately (4.0)%.

Direct sale revenue increased 9.1% to $12.4 million in the first six months of fiscal 2003 compared to $11.3 million in the same period of fiscal 2002. Direct sale revenue is up due to the success of our annual winter outerwear promotion in the second quarter, partially offset by the continued postponement of customer direct sale orders.

Cost of Rental and Direct Sale. Cost of rental operations increased 2.4% to $180.4 million in the first six months of fiscal 2003 from $176.1 million in the same period of fiscal 2002. Gross margin from rental sales increased to 41.8% in the first six months of fiscal 2003 from 41.6% in the same period of fiscal 2002. Improved operational productivity and lower merchandise expense, partially offset by higher costs of energy, acquisition integration and plant consolidation, contributed to the improved rental gross margin.

Cost of direct sales increased 10.5% to $8.9 million in the six months of fiscal 2003 from $8.1 million in the same period of fiscal 2002. Gross margin from direct sales decreased to 27.8% in the first six months of fiscal 2003 from 28.7% in the same period of fiscal 2002. The decrease in gross margin is due primarily to large initial stocking orders in the first quarter of fiscal 2002 and the continued postponement of customer direct sale orders in the current year, partially offset by the successful winter outerwear promotion.

Selling and Administrative. Selling and administrative expenses increased 3.6% to $75.5 million in the first six months of fiscal 2003 from $72.9 million in the same period of fiscal 2002. As a percentage of total revenues, selling and administrative expenses increased to 23.4% in the first six months of fiscal 2003 from 23.3% in the same period of fiscal 2002.

Depreciation and Amortization. Depreciation and amortization expense increased 5.0% to $18.5 million in the first six months of fiscal 2003 from $17.6 million in the same period of fiscal 2002. As a percentage of total revenues, depreciation and amortization expense increased to 5.7% in the first six months of fiscal 2003 from 5.6% in the same period of fiscal 2002. Capital expenditures, excluding acquisition of businesses, were $18.1 million in the first six months of fiscal 2003 compared to $13.7 million in the same period of fiscal 2002.

Interest Expense. Interest expense was $6.8 million in the first six months of fiscal 2003, down from $7.1 million in the same period of fiscal 2002. The decrease in interest expense is due primarily to lower effective interest rates, partially offset by higher debt levels in conjunction with our acquisition activities.

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Provision for Income Taxes. Our effective tax rate decreased to 39.0% in the first six months of fiscal 2003 from 39.5% in the same period of fiscal 2002 due largely to decreases in Canadian statutory income tax rates.

Liquidity, Capital Resources and Financial Condition

Our primary sources of cash are net cash flows from operations and borrowings under the term loan and revolving credit facilities. Primary uses of this cash are interest payments on indebtedness, capital expenditures, acquisition of business assets and general corporate purposes.

Operating Activities. Net cash provided by operating activities was $47.4 million in the first six months of fiscal 2003 and $42.3 million in the same period of fiscal 2002.

Working capital at December 28, 2002 was $98.5 million, up 2.8% from $95.8 million at June 29, 2002. The increase was largely due to acquisitions during the current year, partially offset by an increase in current maturities of long-term debt associated with debt amortization.

Investing Activities. Net cash used in investing activities was $89.9 million in the first six months of fiscal 2003 and $47.4 million in the same period of fiscal 2002. In both fiscal years 2003 and 2002, cash was largely used for acquisition of business assets and property, plant and equipment additions.

Financing Activities. Cash provided by financing activities was $50.0 million in the first six months of fiscal 2003 and $6.3 million in the same period of fiscal 2002. Cash provided in both fiscal years 2003 and 2002 was used primarily in acquisitions of businesses. We paid dividends of $0.7 million during the first six months of fiscal 2003.

Cash Obligations. Under various agreements, we are obligated to make future cash payments in fixed amounts. These include payments under the variable rate term loan and revolving credit facility, the fixed rate term loan, capital lease obligations and rent payments required under
non-cancelable operating leases with initial or remaining terms in excess of one year.

The following table summarizes our fixed cash obligations as of December 28, 2002 for the fiscal years ending June (in thousands):

	2003 Remaining		2004		2005		2006		2007		2008 and Thereafter		Total
Variable rate term loan and revolving credit facility	$	1,875	$	13,125	$	15,000	$	18,750	$	22,500	$	147,900	$	219,150
Fixed rate term loan		—		—		7,143		7,143		7,143		28,571		50,000
Other debt arrangements, including capital leases		1,026		1,183		1,286		66		29		—		3,590
Operating leases		5,849		9,260		7,676		5,486		4,441		4,292		37,004
Total contractual cash obligations	$	8,750	$	23,568	$	31,105	$	31,445	$	34,113	$	180,763	$	309,744

Also, at December 28, 2002, we had stand-by letters of credit totaling $10.9 million that have been issued and are outstanding, primarily in connection with our property and casualty insurance programs. No amounts have been drawn upon these letters of credit.

At December 28, 2002, we had available cash on hand of $17.6 million and approximately $91.2 million of available capacity under our revolving credit facility. We anticipate that we will generate sufficient cash flows from operations to satisfy our cash commitments and capital requirements for fiscal 2003; however, we may utilize borrowings under the revolving credit facility to supplement our cash requirements from time to time. We estimate that capital expenditures in fiscal 2003 will be approximately $30.0 million to $35.0 million.

15

The amount of cash flow generated from operations is subject to a number of risks and uncertainties. In fiscal 2003, we may actively seek and consider acquisitions of business assets, the consummation of any acquisition could affect our liquidity profile and level of outstanding debt. We believe that available capacity under our revolving credit facility will be adequate to finance any such acquisitions and planned capital expenditures in fiscal 2003.

Impact of Inflation

In general, management believes that our results of operations are not dependent on moderate changes in the inflation rate. Historically, we have been able to manage the impacts of more significant changes in inflation rates through our customer relationships, and continued focus on improvements of operational productivity. Customer agreements generally provide for price increases consistent with the rate of inflation or 5.0%, whichever is greater.

Litigation

We are involved in a variety of legal actions relating to personal injury, customer contracts, employment, trade practices, environmental and other legal matters that arise in the normal course of business. These legal actions include lawsuits that challenge the practice of charging for certain environmental services on invoices, and being named, along with other defendants, as a potentially responsible party at certain waste disposal sites where ground water contamination has been detected or is suspected. While we are unable to predict the ultimate outcome of these legal actions, it is the opinion of management that the disposition of these matters will not have a material adverse effect on our consolidated financial statements taken as a whole.

Recent Accounting Pronouncements

In June 2001, the Financial Accounting Standards Board issued SFAS No. 143, “Accounting for Asset Retirement Obligations” (SFAS 143). SFAS 143 addresses financial accounting and reporting for obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. SFAS 143 requires that the fair value of a liability for an asset retirement obligation be recognized in the period in which it is incurred if a reasonable estimate of fair value can be made. We adopted SFAS 143 effective June 30, 2002. The impact of adopting SFAS 143 was not material.

In August 2001, the Financial Accounting Standards Board issued SFAS No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” (SFAS 144). SFAS 144 establishes a single accounting model, based on the framework established in SFAS No. 121, “Accounting for the Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of” (SFAS 121), for long-lived assets to be disposed of by sale. SFAS 144 also resolves several significant implementation issues related to SFAS 121, such as eliminating the requirement to allocate goodwill to long-lived assets to be tested for impairment and establishing criteria to define whether a long-lived asset is held for sale. We adopted SFAS 144 effective June 30, 2002. The impact of adopting SFAS 144 was not material.

In June 2002, the Financial Accounting Standards Board issued SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (SFAS 146). SFAS 146 addresses financial accounting and reporting for costs associated with exit or disposal activities. It nullifies Emerging Issues Task Force Issue No. 94-3, “Liability Recognition for Certain Employee Termination Benefits and Other Costs to Exit an Activity.” SFAS 146 requires that a liability be recognized for costs associated with an exit or disposal activity only when the liability is incurred. SFAS 146 also establishes fair value as the objective for initial measurement of liabilities related to exit or disposal activities. SFAS 146 is effective for exit or disposal activities that are initiated after December 31, 2002. We will apply the provisions of SFAS 146 for all exit or disposal activities initiated after December 31, 2002.

In December 2002, the Financial Accounting Standards Board issued SFAS No. 148, “Accounting for Stock-Based Compensation — Transition and Disclosure” (SFAS 148). SFAS 148 amends SFAS No. 123, “Accounting for Stock-Based Compensation,” to provide alternative methods of transition for a voluntary change to the fair value method of accounting for stock-based employee compensation. SFAS 148 also amends the disclosures in both annual and interim financial statements about the method used to account for stock-based employee compensation and the effect of the method used on reported results. We will continue to apply Accounting Principles Board

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Opinion No. 25 as the method used to account for stock-based compensation, where applicable, but will adopt the disclosure requirements of SFAS 148 beginning with the third quarter ending March 29, 2003.

Cautionary Statements Regarding Forward-Looking Statements

The Private Securities Litigation Reform Act of 1995 (the “Act”) provides companies with a “safe harbor” when making forward-looking statements as a way of encouraging them to furnish their shareholders with information regarding expected trends in their operating results, anticipated business developments and other prospective information. Statements made in this report concerning our intentions, expectations or predictions about future results or events are “forward-looking statements” within the meaning of the Act. These statements reflect our current expectations or beliefs, and are subject to risks and uncertainties that could cause actual results or events to vary from stated expectations, which could be material and adverse. Given that circumstances may change, and new risks to the business may emerge from time to time, having the potential to negatively impact our business in ways we could not anticipate at the time of making a forward-looking statement, you are cautioned not to place undue reliance on these statements, and we undertake no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise.

Some of the factors that could cause actual results or events to vary from stated expectations include, but are not limited to, the following: unforeseen operating risks; the effects of overall economic conditions; fluctuations in costs of insurance and energy; acquisition integration costs; the performance of acquired businesses; preservation of positive labor relationships; competition, including pricing, within the corporate identity apparel and facility services industry; and the availability of capital to finance planned growth. Additional information concerning potential factors that could effect future financial results is included in the Company’s Annual Report on Form 10-K for the Fiscal Year Ended June 29, 2002.

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK

Interest Rate Risk

We are subject to market risk exposure related to changes in interest rates. We use financial instruments, including fixed and variable rate debt, as well as interest rate swaps to manage interest rate risk. Interest rate swap agreements are entered into for periods consistent with related underlying exposures and do not constitute positions independent of those exposures. Assuming the current level of borrowings, a 100 basis point increase in interest rates under these borrowings would have increased our interest expense for the second quarter of fiscal 2003 by approximately $0.4 million. This estimated exposure considers the mitigating effects of interest rate swap agreements outstanding at December 28, 2002 on the change in the cost of variable rate debt.

Foreign Currency Exchange Risk

We have a significant foreign subsidiary located in Canada. The assets and liabilities of this subsidiary are denominated in the Canadian dollar and as such are translated into U.S. dollars at the exchange rate in effect at the balance sheet date. Results of operations are translated using the average exchange rates throughout the period. The effect of exchange rate fluctuations on translation of assets and liabilities are recorded as a component of stockholders’ equity. Gains and losses from foreign currency transactions are included in results of operations.

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ITEM 4. CONTROLS AND PROCEDURES

Under the supervision and with the participation of management, including our Chief Executive Officer and Chief Financial Officer, we performed an evaluation of disclosure controls and procedures within 90 days of filing this quarterly report (the “Evaluation Date”). After evaluating the effectiveness of disclosure controls and procedures, the Chief Executive Officer and Chief Financial Officer, along with other key management, have determined that disclosure controls and procedures were effective and designed to ensure that material information relating to G&K Services and its consolidated subsidiaries would be made known to them on a timely basis. There were no significant changes in internal controls or other factors that could significantly affect these controls subsequent to the Evaluation Date.

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PART II

OTHER INFORMATION

ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS

a.	The Company held its Annual Meeting of Stockholders on November 7, 2002.
b.	The following three persons were elected as Class I directors: Michael G. Allen, Richard Fink and M. Lenny Pippin. The following six persons comprise the other directors whose terms of office continued after the Annual Meeting of Shareholders: Paul Baszucki, Wayne M. Fortun, Donald W. Goldfus, Thomas Moberly, William M. Hope and D.R. Verdoorn.
c.	1.	Each director nominee received the following votes:

	Shares
	In Favor		Withhold Authority
Mr. Allen		31,202,860		1,357,164
Mr. Fink		28,261,283		4,298,741
Mr. Pippin		30,720,716		1,839,308

2.	Stockholders approved an amendment to the Company’s 1998 Stock Option and Compensation Plan to increase the number of shares of Common Stock reserved for issuance thereunder from 1,500,000 to 3,000,000 shares with 22,077,733 shares in favor, 6,824,526 shares voting against, 73,096 shares abstaining and 3,584,669 broker non-vote.
3.	Stockholders ratified the appointment of Ernst & Young LLP, Certified Public Accountants, as independent auditors of the Company for 2003: 32,021,853 shares in favor, 502,788 shares voting against and 35,383 shares abstaining.

ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K

a.	Exhibits
	99.1 Certification of the Company’s Chief Executive Officer, Thomas R. Moberly, and Chief Financial Officer, Jeffrey L. Wright, pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
b.	Reports on Form 8-K
	None

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SIGNATURES

Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has caused this report to be signed on its behalf by the undersigned thereunto duly authorized.

Date: February 11, 2003	G&K SERVICES, INC. (Registrant)
	By:	/s/ Jeffrey L. Wright
		Jeffrey L. Wright Chief Financial Officer and Secretary (Principal Financial Officer)
	By:	/s/ Michael F. Woodard
		Michael F. Woodard Controller (Principal Accounting Officer)

20

CERTIFICATION

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Thomas R. Moberly, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of G&K Services, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 11, 2003
	By:	/s/ Thomas R. Moberly Thomas R. Moberly Chief Executive Officer (Principal Executive Officer)

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CERTIFICATION

Pursuant to Section 302 of the Sarbanes-Oxley Act of 2002

I, Jeffrey L. Wright, certify that:

1.	I have reviewed this quarterly report on Form 10-Q of G&K Services, Inc.;
2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;
3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;
4.	The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and we have;

a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;
b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and
c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

5. The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation, to the registrant’s auditors and the audit committee of registrant’s board of directors (or persons performing the equivalent function):

a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and
b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6. The registrant’s other certifying officer and I have indicated in this quarterly report whether or not there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation including any corrective actions with regard to significant deficiencies and material weaknesses.

Date: February 11, 2003
	By:	/s/ Jeffrey L. Wright Jeffrey L. Wright Chief Financial Officer and Secretary (Principal Financial Officer)

22 EX-99.1 3 c74568exv99w1.htm EX-99.1 CERTIFICATION PURSUANT TO SECTION 1350

EXHIBIT 99.1

G&K Services, Inc.
Certification of CEO and CFO Pursuant to
18 U.S.C. Section 1350, as Adopted Pursuant to
Section 906 of the Sarbanes-Oxley Act of 2002

In connection with the Quarterly Report on Form 10-Q of G&K Services, Inc. (the “Company”) for the quarterly period ended December 28, 2002 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), Thomas R. Moberly, as Chief Executive Officer of the Company, and Jeffrey L. Wright, as Chief Financial Officer of the Company, each hereby certifies, that, to the best of his knowledge:

1.	The Report fully complies with the requirements of Section 13(a) of the Securities Exchange Act of 1934; and
2.	The information contained in the Report fairly presents, in all material respects, the financial condition of the Company as of December 28, 2002 and the results of its operations for such period.

Date: February 11, 2003
	By:	/s/ Thomas R. Moberly Thomas R. Moberly Chief Executive Officer (Principal Executive Officer)
	By:	/s/ Jeffrey L. Wright Jeffrey L. Wright Chief Financial Officer and Secretary (Principal Financial Officer)

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EX-99.1

G&K Services, Inc.