form10q-3q2010.htm


UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

FORM 10-Q

x
 
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
   
SECURITIES EXCHANGE ACT OF 1934
     
   
For the quarterly period ended May 29, 2010
     
   
OR
     
o
 
TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
   
SECURITIES EXCHANGE ACT OF 1934
     
   
For the transition period from ________________ to ________________

Commission file number:  1-8504

UNIFIRST CORPORATION
(Exact name of Registrant as Specified in Its Charter)

Massachusetts
 
04-2103460
(State or Other Jurisdiction of
 
(I.R.S. Employer
Incorporation or Organization)
 
Identification No.)
     
68 Jonspin Road, Wilmington, MA
 
01887
(Address of Principal Executive Offices)
 
(Zip Code)

 (978) 658-8888
(Registrant’s Telephone Number, Including Area Code)

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

Yes  x       No  o

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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.

Large accelerated filer o
Accelerated filer  x
   
Non-accelerated filer  o
Smaller reporting company  o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes  o       No  x

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

The number of outstanding shares of UniFirst Corporation Common Stock and Class B Common Stock at July 2, 2010 were 14,911,879 and 4,913,369, respectively.

 
 
 

 
UniFirst Corporation
Quarterly Report on Form 10-Q
For the Quarter ended May 29, 2010

Table of Contents
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
     
   
   
   
   
   


 
 

 
PART I – FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS

UniFirst Corporation and Subsidiaries
Consolidated Statements of Income
(Unaudited)

     
Thirteen weeks ended
     
Thirty-nine weeks ended
 
     
May 29,
     
May 30,
     
May 29,
     
May 30,
 
(In thousands, except per share data)
   
2010
     
2009
     
2010
     
2009
 
                                 
Revenues
 
$
261,248
   
$
252,105
   
$
770,989
   
$
771,944
 
                                 
Operating expenses:
                               
   Cost of revenues (1)
   
158,563
     
148,597
     
464,812
     
464,632
 
   Selling and administrative expenses (1)
   
54,798
     
52,152
     
158,693
     
159,752
 
   Depreciation and amortization
   
15,814
     
14,641
     
45,903
     
42,683
 
     Total operating expenses
   
229,175
     
215,390
     
669,408
     
667,067
 
                                 
Income from operations
   
32,073
     
36,715
     
101,581
     
104,877
 
                                 
Other expense (income):
                               
   Interest expense
   
2,210
     
2,226
     
6,579
     
7,141
 
   Interest income
   
(499
)
   
(441
)
   
(1,568
)
   
(1,492
)
   Exchange rate loss (gain)
   
639
     
(789
)
   
1,221
     
340
 
     
2,350
     
996
     
6,232
     
5,989
 
                                 
Income before income taxes
   
29,723
     
35,719
     
95,349
     
98,888
 
Provision for income taxes
   
10,409
     
14,030
     
36,233
     
40,057
 
                                 
Net income
 
 $
19,314
   
$
21,689
   
$
59,116
   
$
58,831
 
                                 
Income per share – Basic
                               
   Common Stock
 
 $
1.03
   
1.18
   
$
3.20
   
$
3.21
 
   Class B Common Stock
 
 $
0.83
   
0.95
   
$
2.56
   
$
2.57
 
                                 
Income per share – Diluted
                               
   Common Stock
 
 $
0.98
   
$
1.12
   
$
3.03
   
$
3.04
 
                                 
Income allocated to: – Basic
                               
   Common Stock
 
$
15,145
   
$
17,021
   
$
46,388
   
$
46,165
 
   Class B Common Stock
 
$
3,949
   
$
4,668
   
$
12,479
   
$
12,666
 
                                 
Income allocated to: – Diluted
                               
   Common Stock
 
 $
19,106
   
$
21,689
   
$
58,880
   
$
58,831
 
                                 
Weighted average number of shares outstanding – Basic
                               
   Common Stock
   
14,645
     
14,394
     
14,510
     
14,389
 
   Class B Common Stock
   
4,766
     
4,935
     
4,877
     
4,935
 
                                 
Weighted average number of shares outstanding – Diluted
                               
   Common Stock
   
19,490
     
19,376
     
19,455
     
19,371
 

(1) Exclusive of depreciation on the Company’s property, plant and equipment and amortization of its intangible assets.


The accompanying notes are an integral part of these
Consolidated Financial Statements.


 
 

 
UniFirst Corporation and Subsidiaries
Consolidated Balance Sheets
(Unaudited)

(In thousands, except share data)
 
May 29,
2010
   
August 29,
2009 (a)
 
Assets
           
Cash and cash equivalents
  $ 104,463     $ 60,151  
Receivables, less reserves of $6,479 and $5,567, respectively
    106,223       97,784  
Inventories
    37,934       43,586  
Rental merchandise in service
    82,897       73,063  
Prepaid and deferred income taxes
    24,789       24,901  
Prepaid expenses
    4,276       2,889  
                 
Total current assets
    360,582       302,374  
                 
Property, plant and equipment:
               
Land, buildings and leasehold improvements
    329,022       325,034  
Machinery and equipment
    365,997       352,511  
Motor vehicles
    121,647       113,048  
                 
      816,666       790,593  
Less -- accumulated depreciation
    435,616       407,823  
                 
      381,050       382,770  
                 
Goodwill
    270,272       261,171  
Customer contracts, net
    56,644       56,616  
Other intangible assets, net
    2,748       3,438  
Other assets
    2,763       2,416  
    $ 1,074,059     $ 1,008,785  
                 
Liabilities and shareholders' equity
               
Current liabilities:
               
Current maturities of long-term obligations
  $ 5,759     $ 6,447  
Accounts payable
    42,205       41,180  
Accrued liabilities
    105,256       104,003  
Accrued income taxes
    3,259       2,437  
                 
Total current liabilities
    156,479       154,067  
                 
Long-term obligations, net of current maturities
    175,358       175,568  
Deferred income taxes
    52,343       52,115  
                 
Commitments and contingencies (Note 9)
               
Shareholders' equity:
               
Preferred stock, $1.00 par value; 2,000,000 shares authorized; no shares issued and outstanding
           
Common Stock, $0.10 par value; 30,000,000 shares authorized; 14,911,879 and 14,435,254 issued and outstanding, respectively
    1,491       1,443  
Class B Common Stock, $0.10 par value; 20,000,000 shares authorized; 4,913,369 and 4,933,369 issued and outstanding, respectively
    491       493  
Capital surplus
    23,301       20,137  
Retained earnings
    662,291       605,262  
Accumulated other comprehensive income (loss)
    2,305       (300
                 
Total shareholders' equity
    689,879       627,035  
                 
    $ 1,074,059     $ 1,008,785  

(a) Derived from audited financial statements
 

The accompanying notes are an integral part of these
Consolidated Financial Statements.


 
 

 
UniFirst Corporation and Subsidiaries
Consolidated Statements of Cash Flows
(Unaudited)

   
Thirty-nine weeks ended
 
 (In thousands)
 
May 29,
2010
   
May 30,
2009
 
Cash flows from operating activities:
           
Net income
  $ 59,116     $ 58,831  
Adjustments to reconcile net income to cash provided by operating activities:
               
  Depreciation
    38,989       36,072  
  Amortization of intangible assets
    6,914       6,611  
  Amortization of deferred financing costs
    200       200  
  Deferred income taxes
    (314 )     (246 )
  Stock-based compensation
    2,070       761  
  Accretion on environmental contingencies
    595       501  
  Accretion on asset retirement obligations
    426       380  
  Changes in assets and liabilities, net of acquisitions:
               
     Receivables
    (7,716 )     (1,612 )
     Inventories
    5,171       (1,277 )
     Rental merchandise in service
    (8,005 )     15,821  
     Prepaid expenses
    (1,369 )     (1,820 )
     Accounts payable
    1,148       (18,119 )
     Accrued liabilities
    1,739       6,197  
     Accrued income taxes
    808       7,108  
Net cash provided by operating activities
    99,772       109,408  
                 
Cash flows from investing activities:
               
  Acquisition of businesses, net of cash acquired
    (17,801 )     (3,434 )
  Capital expenditures
    (37,289 )     (55,457 )
  Other
    (1,331 )     2  
Net cash used in investing activities
    (56,421 )     (58,889 )
                 
Cash flows from financing activities:
               
  Proceeds from long-term obligations
    8,850       138,987  
  Payments on long-term obligations
    (9,060 )     (180,638 )
  Proceeds from exercise of Common Stock options
    1,140       109  
  Payment of cash dividends
    (2,071 )     (2,064 )
Net cash used in financing activities
    (1,141 )     (43,606 )
                 
Effect of exchange rate changes on cash and cash equivalents
    2,102       (187 )
                 
Net increase in cash and cash equivalents
    44,312       6,726  
Cash and cash equivalents at beginning of period
    60,151       25,655  
                 
Cash and cash equivalents at end of period
  $ 104,463     $ 32,381  


The accompanying notes are an integral part of these
Consolidated Financial Statements.


 
 

 
UniFirst Corporation and Subsidiaries
Notes to Consolidated Financial Statements

1. Basis of Presentation

These Consolidated Financial Statements of UniFirst Corporation (the “Company”) have been prepared, without audit, pursuant to the rules and regulations of the Securities and Exchange Commission. Certain information and footnote disclosures normally included in financial statements prepared in accordance with accounting principles generally accepted in the United States (“US GAAP”) have been condensed or omitted pursuant to such rules and regulations; however, the Company believes that the information furnished reflects all adjustments (consisting only of normal recurring adjustments) which are, in the opinion of management, necessary for a fair statement of results for the interim period.

It is suggested that these Consolidated Financial Statements be read in conjunction with the financial statements and the notes thereto included in the Company’s Annual Report on Form 10-K for the fiscal year ended August 29, 2009. There have been no material changes in the accounting policies followed by the Company during the current fiscal year. Results for an interim period are not indicative of any future interim periods or for an entire fiscal year.

2. Recent Accounting Pronouncements

In June 2008, the Financial Accounting Standards Board (the "FASB") issued revised guidance which clarifies whether instruments granted in share-based payment transactions are participating securities prior to vesting and therefore, need to be included in the earnings allocation in computing earnings per share (“EPS”). The Company adopted the revised guidance on August 30, 2009.  See Note 7 to the Consolidated Financial Statements for more discussion on this revised guidance and the Company’s EPS calculations.

In June 2009, the FASB approved its Accounting Standards Codification, (the “Codification”), as the single source of authoritative United States accounting and reporting standards applicable for all non-governmental entities, with the exception of the SEC and its staff. The Codification, which changes the referencing of financial standards, was effective for interim or annual financial periods ending after September 15, 2009. Therefore, starting in the Company’s first quarter of fiscal 2010, any references made to US GAAP use the new Codification numbering system prescribed by the FASB. The Codification was not intended to change or alter existing US GAAP and, as a result, it did not have any impact on the Company’s Consolidated Financial Statements.

In January 2010, the FASB issued revised guidance which requires additional disclosures about items transferring into and out of Levels 1 and 2 measurements in the fair value hierarchy.  The revised guidance also requires additional separate disclosures about purchases, sales, issuances, and settlements relative to Level 3 measurements, and clarifies, among other things, the existing fair value disclosures about the level of disaggregation. This pronouncement is effective for interim and annual financial periods beginning after December 15, 2009, except for the disclosures about purchases, sales, issuances, and settlements relative to Level 3 measurements, which are effective for interim and annual financial periods beginning after December 15, 2010.  The Company expects the adoption of this guidance will not have a material impact on its Consolidated Financial Statements.  See Note 4 to the Consolidated Financial Statements for more discussion on this revised guidance.

3. Acquisitions
 
During the thirty-nine weeks ended May 29, 2010, the Company completed five acquisitions with an aggregate purchase price of approximately $17.8 million. The results of operations of these acquisitions have been included in the Company’s consolidated financial results since their respective acquisition dates. None of these acquisitions was significant in relation to the Company’s consolidated financial results and, therefore, pro forma financial information has not been presented.

4. Fair Value Measurements

US GAAP establishes a framework for measuring fair value and establishes disclosure requirements about fair value measurements. Fair value is defined as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date. We considered non-performance risk when determining fair value of our derivative financial instruments. The fair value hierarchy prescribed under US GAAP contains three levels as follows:

  Level 1 –  
Quoted prices in active markets for identical assets or liabilities.

  Level 2 –  
Observable inputs other than quoted prices included in Level 1, such as quoted prices for similar assets and liabilities in active markets; quoted prices for identical or similar assets and liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

  Level 3 –  
Unobservable inputs that are supported by little or no market activity and that are significant to the fair value of the assets or liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

All financial assets or liabilities that are measured at fair value on a recurring basis (at least annually) have been segregated into the most appropriate level within the fair value hierarchy based on the inputs used to determine the fair value at the measurement date.  The assets or liabilities measured at fair value on a recurring basis are summarized in the table below (in thousands):

   
As of May 29, 2010
 
   
Level 1
   
Level 2
   
Level 3
   
Fair Value
 
Assets:
                       
Cash Equivalents
  $ 28,616                 $ 28,616  
     Total
  $ 28,616                 $ 28,616  
                                 
Liabilities:
                               
Derivative Instruments
  $       2,066           $ 2,066  
     Total
  $       2,066           $ 2,066  

5. Derivative Instruments and Hedging Activities

All derivative financial instruments are recognized at fair value and are recorded in the accrued liabilities line item in the Company’s Consolidated Balance Sheets. In January 2008, the Company entered into an interest rate swap agreement to manage its exposure to interest rate movements and the related effect on its variable rate debt. The Company concluded that the interest rate swap met the criteria to qualify as a cash flow hedge under US GAAP. Accordingly, the Company has reflected all changes in the fair value of the swap agreement in accumulated other comprehensive income (loss), a component of shareholders’ equity. The swap agreement, with a notional amount of $100.0 million, matures on March 14, 2011. The Company pays a fixed rate of 3.51% and receives a variable rate tied to the three month LIBOR rate.
 
As of May 29, 2010, the Company had recorded the fair value of the interest rate swap of $2.1 million in accrued liabilities and a corresponding loss of $1.3 million in accumulated other comprehensive income (loss), which was net of the associated tax benefit. As of August 29, 2009, the amounts recorded in accrued liabilities and other comprehensive income were $3.6 million and $2.2 million, respectively. The $1.3 million loss deferred in accumulated other comprehensive income (loss) as of May 29, 2010 is expected to be reclassified to interest expense prior to its maturity on March 14, 2011.
 
The Company has recorded any realized gains or losses from its interest rate swap as an adjustment to interest expense in its Consolidated Statements of Income.  For the thirteen weeks ended May 29, 2010 and May 30, 2009, the Company reclassified a loss from accumulated other comprehensive income (loss) into interest expense totaling $0.8 million and $0.5 million, respectively.  For the thirty-nine weeks ended May 29, 2010 and May 30, 2009, the Company reclassified a loss from accumulated other comprehensive income (loss) into interest expense totaling $2.4 million and $1.0 million, respectively.

6. Employee Benefit Plans

Defined Contribution Retirement Savings Plan

The Company has a defined contribution retirement savings plan with a 401(k) feature for all eligible employees not under collective bargaining agreements. The Company matches a portion of the employee’s contribution and can make an additional contribution at its discretion. Contributions charged to expense under the plan for the thirteen weeks ended May 29, 2010 and May 30, 2009 were $2.7 million and $4.6 million, respectively. Contributions charged to expense under the plan for the thirty-nine weeks ended May 29, 2010 and May 30, 2009 were $8.1 million and $10.3 million, respectively.

Pension Plans and Supplemental Executive Retirement Plans

The Company maintains an unfunded Supplemental Executive Retirement Plan for certain eligible employees of the Company, a non-contributory defined benefit pension plan covering union employees at one of its locations, and a frozen pension plan the Company assumed in connection with its acquisition of Textilease Corporation in fiscal 2004. The amounts charged to expense related to these plans for the thirteen weeks ended May 29, 2010 and May 30, 2009 were $0.5 million and $0.4 million, respectively. The amounts charged to expense related to these plans for the thirty-nine weeks ended May 29, 2010 and May 30, 2009 were $1.4 million and $1.3 million, respectively.

7. Net Income Per Share
 
As described in Note 2, Recent Accounting Pronouncements, to the Consolidated Financial Statements, the Company adopted revised guidance on August 30, 2009 which clarifies whether instruments granted in share-based payment transactions are participating securities prior to vesting, as well as requires the Company to allocate income to its unvested participating securities as part of its EPS calculations.

The following table sets forth the computation of basic earnings per share using the two-class method for amounts attributable to the Company’s shares of Common Stock and Class B Common Stock (in thousands, except per share data):

   
Thirteen weeks ended
   
Thirty-nine weeks ended
 
   
May 29,
   
May 30,
   
May 29,
   
May 30,
 
   
2010
   
2009
   
2010
   
2009
 
                         
Net income available to shareholders
  $ 19,314     $ 21,689     $ 59,116     $ 58,831  
                                 
Allocation of net income for Basic:
                               
Common Stock
  $ 15,145     $ 17,021     $ 46,388     $ 46,165  
Class B Common Stock
    3,949       4,668       12,479       12,666  
Unvested participating shares
    220             249        
     $ 19,314      $ 21,689      $ 59,116      $ 58,831  
                                 
Weighted average number of shares for Basic:
                               
Common Stock
    14,645       14,394       14,510       14,389  
Class B Common Stock
    4,766       4,935       4,877       4,935  
Unvested participating shares
    249             90        
      19,660       19,329       19,477       19,324  
                                 
Earnings per share for Basic:
                               
Common Stock
  $ 1.03     $ 1.18     $ 3.20     $ 3.21  
Class B Common Stock
    0.83       0.95       2.56       2.57  
                                 

For diluted EPS, the revised guidance requires the Company to calculate diluted EPS for Common Stock using the more dilutive of the following two methods:

 
 
The treasury stock method; or
 
 
 
The two-class method assuming a participating security is not exercised or converted.
 
For the thirteen and thirty-nine weeks ended May 29, 2010, the Company’s diluted EPS was calculated using the two-class method as follows (in thousands, except per share data):

   
Thirteen weeks
   
Thirty-nine weeks
 
   
ended May 29, 2010
   
ended May 29, 2010
 
   
Earnings
               
Earnings
             
   
to Common
   
Common
         
to Common
   
Common
       
   
shareholders
   
Shares
   
EPS
   
shareholders
   
Shares
   
EPS
 
                                     
As reported - Basic
  $ 15,145       14,645     $ 1.03     $ 46,388       14,510     $ 3.20  
                                                 
Add: effect of dilutive potential common shares
                                               
Common Stock options
          79                     68          
Class B Common Stock
    3,949       4,766               12,479       4,877          
                                                 
Add: Undistributed earnings allocated to
                                               
unvested participating shares
    220                     249                
                                                 
Less: Undistributed earnings reallocated to
                                               
unvested participating shares
    (208 )                   (236 )              
                                                 
Diluted EPS – Common Stock
  $ 19,106       19,490     $ 0.98     $ 58,880       19,455     $ 3.03  

Stock options to purchase 10,689 and 17,017 shares of Common Stock were excluded from the calculation of diluted earnings per share for both the thirteen and thirty-nine weeks ended May 29, 2010, respectively, because they were anti-dilutive.

For the thirteen and thirty-nine weeks ended May 30, 2009, the Company’s diluted EPS was calculated using the treasury stock method as follows (in thousands, except per share data):

   
Thirteen weeks
   
Thirty-nine weeks
 
   
ended May 30, 2009
   
ended May 30, 2009
 
   
Earnings
               
Earnings
             
   
to Common
   
Common
         
to Common
   
Common
       
   
shareholders
   
Shares
   
EPS
   
shareholders
   
Shares
   
EPS
 
                                     
As reported - Basic
  $ 17,021       14,394     $ 1.18     $ 46,165       14,389     $ 3.21  
                                                 
Add: effect of dilutive potential common shares
                                               
Common Stock options
          47                     47          
Class B Common Stock
    4,668       4,935               12,666       4,935          
                                                 
Diluted EPS – Common Stock
  $ 21,689       19,376     $ 1.12     $ 58,831       19,371     $ 3.04  

Stock options to purchase 274,100 shares of Common Stock were excluded from the calculation of diluted earnings per share for both the thirteen and thirty-nine weeks ended May 30, 2009 because they were anti-dilutive.

The diluted earnings per share calculations assume the conversion of all of the Company’s Class B Common Stock into Common Stock; therefore, no allocation of earnings to Class B Common Stock is required.

8. Asset Retirement Obligations

The Company recognizes asset retirement obligations in the period in which they are incurred if a reasonable estimate of fair value can be made. The associated asset retirement costs are capitalized as part of the carrying amount of the long-lived asset. The Company continues to depreciate, on a straight-line basis, the amount added to property, plant and equipment and recognizes accretion expense in connection with the discounted liability over the various remaining lives which range from approximately one to thirty-four years.

A reconciliation of the Company’s asset retirement liability is as follows (in thousands):

     
May 29,
2010
 
Beginning balance as of August 29, 2009
 
$
8,584
 
Accretion expense
   
426
 
Ending balance as of May 29, 2010
 
$
9,010
 

As of May 29, 2010, the $9.0 million asset retirement obligation is included in accrued liabilities in the accompanying Consolidated Balance Sheet.

9. Commitments and Contingencies

The Company and its operations are subject to various federal, state and local laws and regulations governing, among other things, the generation, handling, storage, transportation, treatment and disposal of hazardous waste and other substances. In particular, industrial laundries use and must dispose of detergent waste water and other residues, and, in the past used perchloroethylene and other dry cleaning solvents.  The Company is attentive to the environmental concerns surrounding the disposal of these materials and has, through the years, taken measures to avoid their improper disposal. In the past, the Company has settled, or contributed to the settlement of, actions or claims brought against the Company relating to the disposal of hazardous materials and there can be no assurance that the Company will not have to expend material amounts to remediate the consequences of any such disposal in the future.

US GAAP requires that a liability for contingencies be recorded when it is probable that a liability has occurred and the amount of the liability can be reasonably estimated. Significant judgment is required to determine the existence of a liability, as well as the amount to be recorded. The Company regularly consults with attorneys and outside consultants in its consideration of the relevant facts and circumstances before recording a contingent liability. Changes in enacted laws, regulatory orders or decrees, management’s estimates of costs, insurance proceeds, participation by other parties, the timing of payments and the input of outside consultants and attorneys based on changing legal or factual circumstances could have a material impact on the amounts recorded for environmental and other contingent liabilities.

Under environmental laws, an owner or lessee of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances located on, or in, or emanating from, such property, as well as related costs of investigation and property damage. Such laws often impose liability without regard to whether the owner or lessee knew of, or was responsible for the presence of such hazardous or toxic substances. There can be no assurances that acquired or leased locations have been operated in compliance with environmental laws and regulations or that future uses or conditions will not result in the imposition of liability upon the Company under such laws or expose the Company to third-party actions such as tort suits. The Company continues to address environmental conditions under terms of consent orders negotiated with the applicable environmental authorities or otherwise with respect to sites located in or related to Woburn, Massachusetts, Somerville, Massachusetts, Springfield, Massachusetts, Uvalde, Texas, Stockton, California, three sites related to former operations in Williamstown, Vermont, as well as a number of additional locations that it acquired as part of its acquisition of Textilease Corporation in September 2003.  In addition, the Company recently received a notice from the Maryland Department of Environment directing the Company to investigate potential contamination at its Landover, Maryland facility.

The Company has accrued certain costs related to the sites described above as it has been determined that the costs are probable and can be reasonably estimated. The Company continues to implement mitigation measures and to monitor environmental conditions at the Somerville, Massachusetts site. The Company also has potential exposure related to an additional parcel of land (the "Central Area") related to the Woburn, Massachusetts site discussed above. Currently, the consent decree for the Woburn site does not define or require any remediation work in the Central Area. The United States Environmental Protection Agency (the "EPA") has provided the Company and other signatories to the consent decree with comments on the design and implementation of groundwater and soil remedies at the Woburn site and investigation of environmental conditions in the Central Area.  The Company met with EPA to discuss its comments, and the Company and another signatory to the consent decree subsequently submitted work plans to perform additional environmental investigations.  Such work pursuant to these work plans has been initiated.  The Company has accrued costs to perform certain work responsive to EPA's comments.

The Company routinely reviews and evaluates sites that may require remediation and monitoring and determines its estimated costs based on various estimates and assumptions. These estimates are developed using its internal sources or by third party environmental engineers or other service providers. Internally developed estimates are based on:

 
 
Management’s judgment and experience in remediating and monitoring the Company’s sites;
 
 
 
Information available from regulatory agencies as to costs of remediation and monitoring;
 
 
 
The number, financial resources and relative degree of responsibility of other potentially responsible parties (PRPs) who may be liable for remediation and monitoring of a specific site; and
 
 
 
The typical allocation of costs among PRPs.

There is usually a range of reasonable estimates of the costs associated with each site. The Company’s accruals reflect the amount within the range that constitutes its best estimate. Where it believes that both the amount of a particular liability and the timing of the payments are reliably determinable, the Company adjusts the cost in current dollars using a rate of 3% for inflation until the time of expected payment and discounts the cost to present value using risk-free rates of interest ranging from 3.5% to 4.2%.

For environmental liabilities that have been discounted, the Company includes interest accretion, based on the effective interest method, in selling and administrative expenses on the Consolidated Statements of Income. The changes to the Company’s environmental liabilities for the thirty-nine weeks ended May 29, 2010 are as follows (in thousands):

     
May 29,
2010
 
Beginning balance as of August 29, 2009
 
$
19,384
 
Costs incurred for which reserves have been provided
   
(1,717
)
Insurance proceeds received
   
181
 
Interest accretion
   
595
 
Change in estimate of liability
   
(303
)
Balance as of May 29, 2010
 
$
18,140
 

Anticipated payments and insurance proceeds of currently identified environmental remediation liabilities as of May 29, 2010, for the next five fiscal years and thereafter, as measured in current dollars, are reflected below (in thousands).

Fiscal year ended August
 
2010
 
2011
 
2012
 
2013
 
2014
 
Thereafter
   
Total
 
Estimated costs – current dollars
$
3,161
 
2,616
 
2,027
 
963
 
920
 
13,636
 
$
23,323
 
                                 
Estimated insurance proceeds
 
(148
)
(158
)
(180
)
(150
)
(180
)
(2,175
)
 
(2,991
)
                                 
Net anticipated costs
$
3,013
 
2,458
 
1,847
 
813
 
740
 
11,461
 
$
20,332
 
                                 
Effect of Inflation
                           
8,175
 
Effect of Discounting
                           
(10,367
)
                                 
Balance as of May 29, 2010
                         
$
18,140
 

Estimated insurance proceeds are primarily received from an annuity received as part of a legal settlement with an insurance company. Annual proceeds of approximately $0.3 million are deposited into an escrow account which funds remediation and monitoring costs for three sites related to former operations in Williamstown, Vermont. Annual proceeds received but not expended in the current year accumulate in this account and may be used in future years for costs related to this site through the year 2027. As of May 29, 2010, the balance in this escrow account, which is held in a trust and is not recorded on the Company’s Consolidated Balance Sheets, was approximately $3.0 million. Also included in estimated insurance proceeds are amounts the Company is entitled to receive pursuant to legal settlements as reimbursements from three insurance companies for estimated costs at the site in Uvalde, Texas.

The Company’s nuclear garment decontamination facilities are licensed by the Nuclear Regulatory Commission (“NRC”), or, in certain cases, by the applicable state agency, and are subject to regulation by federal, state and local authorities. There can be no assurance that such regulation will not lead to material disruptions in the Company’s garment decontamination business.

From time to time, the Company is also subject to legal proceedings and claims arising from the conduct of its business operations, including litigation related to charges for certain ancillary services on invoices, personal injury claims, customer contract matters, employment claims and environmental matters as described above.

While it is impossible to ascertain the ultimate legal and financial liability with respect to contingent liabilities, including lawsuits and environmental contingencies, the Company believes that the aggregate amount of such liabilities, if any, in excess of amounts accrued or covered by insurance, will not have a material adverse effect on the consolidated financial position and/or results of operations of the Company. It is possible, however, that future financial position or results of operations for any particular period could be materially affected by changes in the Company’s assumptions or strategies related to these contingencies or changes out of the Company’s control.

10. Income Taxes

The Company’s effective income tax rate was 35.0% and 38.0% for the thirteen and thirty-nine weeks ended May 29, 2010, respectively, as compared to 39.3% and 40.5% for the thirteen and thirty-nine weeks ended May 30, 2009, respectively.  The decrease in the effective income tax rate for both the thirteen and thirty-nine week periods of fiscal 2010 was the result of reductions in tax contingency reserves due to certain statute expirations during the thirteen weeks ended May 29, 2010.  The Company recognizes interest and penalties related to uncertain tax positions as a component of income tax expense which is consistent with the recognition of these items in prior reporting periods.  During the thirty-nine weeks ended May 29, 2010, there were no material changes in the amount of unrecognized tax benefits or the amount accrued for interest and penalties.

All U.S. and Canadian federal income tax examinations have substantially concluded through fiscal years 2004 and 2001, respectively. With a few exceptions, the Company is no longer subject to state and local income tax examinations for periods prior to fiscal 2003.  The Company is not aware of any tax positions for which it is reasonably possible that the total amounts of unrecognized tax benefits will change significantly in the next 12 months.

11. Long-Term Obligations

The Company has a $225.0 million unsecured revolving credit agreement (“Credit Agreement”) with a syndicate of banks, which matures on September 13, 2011.  Under the Credit Agreement, the Company is able to borrow funds at variable interest rates based on the Eurodollar rate or the bank’s prime rate, as selected by the Company. Availability of credit requires compliance with certain financial and other covenants, including a maximum funded debt ratio and minimum interest coverage as defined in the Credit Agreement.  The Company generally tests its compliance with these financial covenants on a fiscal quarterly basis. At May 29, 2010, the interest rates applicable to the Company’s borrowings under the Credit Agreement would be calculated as LIBOR plus 50 basis points at the time of the respective borrowing.  As of May 29, 2010, the Company had no outstanding borrowings, letters of credit of $36.5 million and $188.5 million available for borrowing under the Credit Agreement.

On June 14, 2004, the Company issued $75.0 million of fixed rate notes pursuant to a Note Purchase Agreement (“2004 Note Agreement”) with a seven year term (June 2011) and bearing interest at 5.27%.  The Company also issued $90.0 million of floating rate notes which were repaid in September 2005 and September 2006.

On September 14, 2006, the Company issued $100.0 million of floating rates notes (“Floating Rate Notes”) pursuant to a Note Purchase Agreement (“2006 Note Agreement”).  The Floating Rate Notes mature on September 14, 2013, bear interest at LIBOR plus 50 basis points and may be repaid at face value two years from the date of issuance.  The proceeds from the issuance of the Floating Rate Notes were used to first repay the outstanding floating rate notes under the 2004 Note Agreement in the amount of $75.0 million and then to pay down outstanding amounts under the Credit Agreement.

As of May 29, 2010, the Company was in compliance with all covenants under the 2004 Note Agreement, 2006 Note Agreement and the Credit Agreement.

12. Comprehensive Income

The components of comprehensive income are as follows (in thousands):

     
Thirteen weeks ended
     
Thirty-nine weeks ended
 
     
May 29,
     
May 30,
     
May 29,
     
May 30,
 
     
2010
     
2009
     
2010
     
2009
 
                                 
Net income
 
$
19,314
   
$
21,689
   
$
59,116
   
$
58,831
 
Other comprehensive income (loss):
                               
Foreign currency translation adjustments
   
(693
)    
10,258
     
1,664
     
(2,674
)
Pension-related
   
     
     
     
(473
)
Change in value of interest rate swap, net
   
580
     
(261
)
   
941
     
(2,161
)
                                 
Comprehensive income
 
$
19,201
   
$
31,686
   
$
61,721
   
$
53,523
 

13. Segment Reporting

Operating segments are identified as components of an enterprise for which separate discrete financial information is available for evaluation by the chief operating decision-maker, or decision-making group, in making decisions on how to allocate resources and assess performance. The Company’s chief operating decision maker is the Company’s chief executive officer. The Company has six operating segments based on the information reviewed by its chief executive officer; US Rental and Cleaning, Canadian Rental and Cleaning, Manufacturing (MFG), Corporate, Specialty Garments Rental and Cleaning (Specialty Garments) and First Aid. The US Rental and Cleaning and Canadian Rental and Cleaning operating segments have been combined to form the US and Canadian Rental and Cleaning reporting segment, and as a result, the Company has five reporting segments.

The US and Canadian Rental and Cleaning reporting segment purchases, rents, cleans, delivers and sells, uniforms and protective clothing and non-garment items in the United States and Canada.  The laundry locations of the US and Canadian Rental and Cleaning reporting segment are referred to by the Company as “industrial laundries” or “industrial laundry locations.”

The MFG operating segment designs and manufactures uniforms and non-garment items solely for the purpose of providing these goods to the US and Canadian Rental and Cleaning reporting segment. MFG revenues are generated when goods are shipped from the Company’s manufacturing facilities to other Company locations. These revenues are recorded at a transfer price which is typically in excess of the actual manufacturing cost. The transfer price is determined by management and may not necessarily represent the fair value of the products manufactured. Products are carried in inventory and subsequently placed in service and amortized at this transfer price. On a consolidated basis, intercompany revenues and income are eliminated and the carrying value of inventories and rental merchandise in service is reduced to the manufacturing cost.  Income before income taxes from MFG net of the intercompany MFG elimination offsets the merchandise amortization costs incurred by the US and Canadian Rental and Cleaning reporting segment as the merchandise costs of this reporting segment are amortized and recognized based on inventories purchased from MFG at the transfer price which is above the Company’s manufacturing cost.
 
The Corporate operating segment consists of costs associated with the Company’s distribution center, sales and marketing, information systems, engineering, materials management, manufacturing planning, finance, budgeting, human resources, other general and administrative costs and interest expense. The revenues generated from the Corporate operating segment represent certain direct sales made by the Company directly from its distribution center. The products sold by this operating segment are the same products rented and sold by the US and Canadian Rental and Cleaning reporting segment. In the table below, no assets or capital expenditures are presented for the Corporate operating segment because no assets are allocated to this operating segment in the information reviewed by the chief executive officer. However, depreciation and amortization expense related to certain assets are reflected in income from operations and income before income taxes for the Corporate operating segment. The assets that give rise to this depreciation and amortization are included in the total assets of the US and Canadian Rental and Cleaning reporting segment as this is how they are tracked and reviewed by the Company.  The majority of expenses accounted for within the Corporate segment relate to costs of the US and Canadian Rental and Cleaning segment, with the remainder of the costs relating to the Specialty Garment and First Aid segments.

The Specialty Garments operating segment purchases, rents, cleans, delivers and sells, specialty garments and non-garment items primarily for nuclear and cleanroom applications. The First Aid operating segment sells first aid cabinet services and other safety supplies.

The Company refers to the US and Canadian Rental and Cleaning, MFG, and Corporate reporting segments combined as its “core laundry operations,” which is included as a subtotal in the following table (in thousands):
 
 
US and
             
 
Canadian
     
Subtotal
     
 
Rental and
 
Net Interco
 
Core Laundry
Specialty
   
 
Cleaning
MFG
MFG Elim
Corporate
Operations
Garments
First Aid
Total
Thirteen weeks ended
                                               
May 29, 2010
                                               
Revenues
$
225,264
 
$
26,295
 
$
(26,295
)
$
2,542
 
$
227,806
 
$
25,672
 
$
7,770
 
$
261,248
 
                                                 
Income (loss) from operations
$
36,123
 
$
9,214
 
$
(1,979
)
$
(17,148
)
$
26,210
 
$
5,159
 
$
704
 
$
32,073
 
                                                 
Interest (income)  expense, net
$
(441
)
$
 
$
 
$
2,152
 
$
1,711
 
$
 
$
 
$
1,711
 
                                                 
Income (loss) before taxes
$
36,585
 
$
9,217
 
$
(1,979
)
$
(19,302
)
$
24,521
 
$
4,498
 
$
704
 
$
29,723
 
                                                 
Thirteen weeks ended
                                               
May 30, 2009
                                               
Revenues
$
221,780
 
$
15,687
 
$
(15,687
)
$
1,997
 
$
223,777
 
$
21,040
 
$
7,288
 
$
252,105
 
                                                 
Income (loss) from operations
$
41,764
 
$
5,909
 
$
441
 
$
(14,854
)
$
33,260
 
$
3,014
 
$
441
 
$
36,715
 
                                                 
Interest (income)  expense, net
$
(445
)
$
 
$
 
$
2,230
 
$
1,785
 
$
 
$
 
$
1,785
 
                                                 
Income (loss) before taxes
$
42,224
 
$
5,675
 
$
441
 
$
(17,044
)
$
31,296
 
$
3,982
 
$
441
 
$
35,719
 
                                                 
Thirty-nine weeks ended
                                               
May 29, 2010
                                               
Revenues
$
674,814
 
$
68,757
   
(68,757
)
$
6,060
 
$
680,874
 
$
67,977
 
$
22,138
 
$
770,989
 
                                                 
Income (loss) from operations
$
112,844
 
$
25,560
   
(3,978
)
$
(46,034
)
$
88,392
 
$
11,894
 
$
1,295
 
$
101,581
 
                                                 
Interest (income)  expense, net
$
(1,426
)
$
   
 
$
6,437
 
$
5,011
 
$
 
$
 
$
5,011
 
                                                 
Income (loss) before taxes
$
114,299
 
$
25,507
   
(3,978
)
$
(52,470
)
$
83,358
 
$
10,696
 
$
1,295
 
$
95,349
 
                                                 
Thirty-nine weeks ended
                                               
May 30, 2009
                                               
Revenues
$
689,064
 
$
61,625
   
(61,625
)
$
5,930
 
$
694,994
 
$
55,720
 
$
21,230
 
$
771,944
 
                                                 
Income (loss) from operations
$
124,940
 
$
21,609
   
(770
)
$
(47,848
)
$
97,931
 
$
6,411
 
$
535
 
$
104,877
 
                                                 
Interest (income)  expense, net
$
(1,515
)
$
   
 
$
7,164
 
$
5,649
 
$
 
$
 
$
5,649
 
                                                 
Income (loss) before taxes
$
126,482
 
$
21,849
   
(770
)
$
(55,198
)
$
92,363
 
$
5,990
 
$
535
 
$
98,888
 


 
 

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

SAFE HARBOR FOR FORWARD LOOKING STATEMENTS

This Quarterly Report on Form 10-Q and any documents incorporated by reference contain forward looking statements within the meaning of the federal securities laws.  Forward looking statements contained in this Quarterly Report on Form 10-Q and any documents incorporated by reference are subject to the safe harbor created by the Private Securities Litigation Reform Act of 1995.  Forward looking statements may be identified by words such as “estimates,” “anticipates,” “projects,” “plans,” “expects,” “intends,” “believes,” “seeks,” “could,” “should,” “may,” “will,” or the negative versions thereof, and similar expressions and by the context in which they are used.  Such forward looking statements are based upon our current expectations and speak only as of the date made.  Such statements are highly dependent upon a variety of risks, uncertainties and other important factors that could cause actual results to differ materially from those reflected in such forward looking statements.  Such factors include, but are not limited to, uncertainties regarding our ability to consummate and successfully integrate acquired businesses, uncertainties regarding any existing or newly-discovered expenses and liabilities related to environmental compliance and remediation, our ability to compete successfully without any significant degradation in our margin rates, seasonal fluctuations in business levels, uncertainties regarding the price levels of natural gas, electricity, fuel and labor, the impact of negative economic conditions on our customers and such customers’ workforce, the continuing increase in domestic healthcare costs, demand and prices for our products and services, additional professional and internal costs necessary for compliance with recent and proposed future changes in Securities and Exchange Commission (including the Sarbanes-Oxley Act of 2002), New York Stock Exchange and accounting rules, strikes and unemployment levels, our efforts to evaluate and potentially reduce internal costs, economic and other developments associated with the war on terrorism and its impact on the economy, general economic conditions and other factors described under “Item 1A. Risk Factors” in our Annual Report on Form 10-K for the year ended August 29, 2009 and in other filings with the Securities and Exchange Commission.  We undertake no obligation to update any forward looking statements to reflect events or circumstances arising after the date on which such statements are made.
 
Business Overview

UniFirst Corporation, together with its subsidiaries, hereunder referred to as “we”, “our”, the “Company”, or “UniFirst”, is one of the largest providers of workplace uniforms and protective clothing in the United States.  We design, manufacture, personalize, rent, clean, deliver, and sell a wide range of uniforms and protective clothing, including shirts, pants, jackets, coveralls, lab coats, smocks, aprons and specialized protective wear, such as flame resistant and high visibility garments.  We also rent industrial wiping products, floor mats, facility service products and other non-garment items, and provide first aid cabinet services and other safety supplies, to a variety of manufacturers, retailers and service companies.

We serve businesses of all sizes in numerous industry categories. Typical customers include automobile service centers and dealers, delivery services, food and general merchandise retailers, food processors and service operations, light manufacturers, maintenance facilities, restaurants, service companies, soft and durable goods wholesalers, transportation companies, and others who require employee clothing for image, identification, protection or utility purposes. We also provide our customers with restroom supplies, including air fresheners, paper products and hand soaps.

At certain specialized facilities, we also decontaminate and clean work clothes that may have been exposed to radioactive materials and service special cleanroom protective wear. Typical customers for these specialized services include government agencies, research and development laboratories, high technology companies and utilities operating nuclear reactors.
 
We continue to expand into additional geographic markets through acquisitions and organic growth.  We currently service over 225,000 customer locations in the United States, Canada and Europe from approximately 200 customer service, distribution and manufacturing facilities.
 
As discussed and described in Note 13 to the Consolidated Financial Statements, we have five reporting segments: US and Canadian Rental and Cleaning, Manufacturing (“MFG”), Corporate, Specialty Garments Rental and Cleaning (“Specialty Garments”) and First Aid. We refer to the laundry locations of the US and Canadian Rental and Cleaning reporting segment as “industrial laundries” or “industrial laundry locations”, and to the US and Canadian Rental and Cleaning, MFG, and Corporate reporting segments combined as our “core laundry operations.”

Critical Accounting Policies and Estimates

The discussion of the financial condition and results of operations is based upon the Consolidated Financial Statements, which have been prepared in conformity with United States generally accepted accounting principles (“US GAAP”). 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, the most important and pervasive accounting policies used and areas most sensitive to material changes from external factors. See Note 1 to the Consolidated Financial Statements in our Annual Report on Form 10-K for the fiscal year ended August 29, 2009 for additional discussion of the application of these and other accounting policies.

Results of Operations

The amounts of revenues and certain expense items for the thirteen and thirty-nine weeks ended May 29, 2010 and May 30, 2009, and the percentage changes in revenues and certain expense items as a percentage of total revenues between these periods, are presented in the following table.  Cost of revenues presented in the table below include merchandise costs related to the amortization of rental merchandise in service and direct sales as well as labor and other production, service and delivery costs associated with operating our industrial laundries, Specialty Garments facilities, First Aid locations and our distribution center. Selling and administrative expenses include costs related to our sales and marketing functions, as well as general and administrative costs associated with our corporate offices and operating locations, including information systems, engineering, materials management, manufacturing planning, finance, budgeting, and human resources.

   
Thirteen weeks ended
     
Thirty-nine weeks ended
 
(In thousands, except percentages)
May 29, 2010
% of Rev.
   
May 30, 2009
% of Rev.
 
% Change
     
May 29, 2010
% of Rev.
   
May 30, 2009
% of Rev.
 
% Change
 
                                           
Revenues
$
261,248
100.0
%
$
252,105
100.0
%
3.6
%
 
$
770,989
100.0
%
$
771,944
100.0
%
-0.1
%
                                           
Operating expenses:
                                         
Cost of revenues (1)
 
158,563
60.7
   
148,597
58.9
 
6.7
     
464,812
60.3
   
464,632
60.2
 
0.0
 
Selling and administrative expenses (1)
 
54,798
21.0
   
52,152
20.7
 
5.1
     
158,693
20.6
   
159,752
20.7
 
-0.7
 
Depreciation and amortization
 
15,814
6.1
   
14,641
5.8
 
8.0
     
45,903
6.0
   
42,683
5.5
 
7.5
 
   
229,175
87.7
   
215,390
85.4
 
6.4
     
669,408
86.8
   
667,067
86.4
 
0.4
 
                                           
Income from operations
 
32,073
12.3
   
36,715
14.6
 
-12.6
     
101,581
13.2
   
104,877
13.6
 
-3.1
 
                                           
Other expense (income)
 
2,350
0.9
   
996
0.4
 
135.9
     
6,232
0.8
   
5,989
0.8
 
4.1
 
                                           
Income before income taxes
 
29,723
11.4
   
35,719
14.2
 
-16.8
     
95,349
12.4
   
98,888
12.8
 
-3.6
 
Provision for income taxes
 
10,409
4.0
   
14,030
5.6
 
-25.8
     
36,233
4.7
   
40,057
5.2
 
-9.5
 
                                           
Net income
$
19,314
7.4
%
$
21,689
8.6
%
-11.0
%
 
$
59,116
7.7
%
$
58,831
7.6
%
0.5
%

 (1) Exclusive of depreciation on our property, plant and equipment and amortization on our intangible assets.

General

We derive our revenues through the design, manufacture, personalization, rental, cleaning, delivering, and selling of a wide range of uniforms and protective clothing, including shirts, pants, jackets, coveralls, lab coats, smocks and aprons and specialized protective wear, such as flame resistant and high visibility garments. We also rent industrial wiping products, floor mats, facility service products, other non-garment items, and provide first aid cabinet services and other safety supplies, to a variety of manufacturers, retailers and service companies.  The current challenging economic conditions continue to affect employment levels in the United States and Canada, which has a negative effect on wearer levels and, as a result, on our business.

Thirteen weeks ended May 29, 2010 compared with thirteen weeks ended May 30, 2009

Revenues

   
May 29,
   
May 30,
   
Dollar
   
Percent
 
(In thousands, except percentages)
 
2010
   
2009
   
Change
   
Change
 
                         
   Core Laundry Operations
  $ 227,806     $ 223,777     $ 4,029       1.8 %
   Specialty Garments
    25,672       21,040       4,632       22.0  
   First Aid
    7,770       7,288       482       6.6  
Consolidated total
  $ 261,248     $ 252,105     $ 9,143       3.6 %

For the thirteen weeks ended May 29, 2010, our consolidated revenues increased by $9.1 million from the comparable period in fiscal 2009, or 3.6%. The consolidated increase was primarily the result of increases in revenues during the third quarter of fiscal 2010 as compared to the third quarter of fiscal 2009 in core laundry operations and Specialty Garments. Core laundry operations’ revenues increased to $227.8 million for the thirteen weeks ended May 29, 2010 from $223.8 million for the comparable period of fiscal 2009, or 1.8%. This increase was attributable to acquisition related growth of 1.4% and the effect of foreign exchange rate fluctuations on our Canadian revenues of 1.4%, which was partially offset by negative organic growth of 1.0%.  Organic growth is comprised of new sales, price increases and net additions to our customer base, offset by lost accounts.  The negative organic growth rate of 1.0% for the third quarter of fiscal 2010 was primarily due to the high rate of wearer reductions that we experienced in our existing customer base throughout fiscal 2009 and into fiscal 2010.  Throughout fiscal 2009, the deteriorating worldwide economic conditions resulted in increased domestic layoffs in the United States, which were reflected in the reduction of wearers throughout our broad customer base. Lost accounts also increased in 2009 as we saw a larger number of accounts either go out of business or in financial distress.  Although the economy has improved somewhat in fiscal 2010, economic conditions remain challenging.

Specialty Garments revenues increased to $25.7 million in the third quarter of 2010 from $21.0 million in the comparable period of 2009, an increase of 22.0%.  The increase in quarterly revenues was primarily the result of higher than expected revenues from certain U.S. and Canadian reactor projects.

Cost of Revenues

Cost of revenues increased as a percentage of revenues from 58.9%, or $148.6 million, for the thirteen weeks ended May 30, 2009 to 60.7%, or $158.6 million, for the thirteen weeks ended May 29, 2010.  This increase was primarily due to higher energy, payroll and merchandise costs.

Selling and Administrative Expense

Our selling and administrative expenses increased from $52.2 million, or 20.7% of revenues, for the thirteen weeks ended May 30, 2009 to $54.8 million, or 21.0% of revenues, for the thirteen weeks ended May 29, 2010.  Increased sales force headcount, as well as annual salary increases contributed to higher selling and administrative costs during the quarter.  In addition, stock compensation expense was higher as a result of stock awards granted to our Chief Executive Officer in April 2010.  Approximately $0.8 million was recognized in the quarter related to these grants.  These items were partially offset by lower costs associated with our environmental contingencies in the third quarter of fiscal 2010 compared to the third quarter of fiscal 2009.

Depreciation and Amortization

Our depreciation and amortization expense increased to $15.8 million for the thirteen weeks ended May 29, 2010 from $14.6 million for the thirteen weeks ended May 30, 2009.  The increase in depreciation and amortization expense was due to capital expenditures and acquisition activity.

Income from Operations

For the thirteen weeks ended May 29, 2010 and May 30, 2009, changes in our revenues and costs as discussed above resulted in the following changes in our income from operations:

   
May 29,
   
May 30,
   
Dollar
   
Percent
 
(In thousands, except percentages)
 
2010
   
2009
   
Change
   
Change
 
                         
   Core Laundry Operations
  $ 26,210     $ 33,260     $ (7,050 )     -21.2 %
   Specialty Garments
    5,159       3,014       2,145       71.2  
   First Aid
    704       441       263       59.3  
Consolidated total
  $ 32,073     $ 36,715     $ (4,642 )     -12.6 %

Other Expense (income)

Other expense (income), which includes interest expense, interest income and foreign currency exchange (gain) loss, increased by $1.4 million to $2.4 million for the thirteen weeks ended May 29, 2010 as compared with $1.0 million for the thirteen weeks ended May 30, 2009.  This increase was primarily due to unfavorable foreign currency fluctuations during the thirteen weeks ended May 29, 2010, resulting in a loss of $0.6 million, as compared to a foreign currency exchange gain of $0.8 million in the comparable period of fiscal 2009.

Provision for Income Taxes

Our effective income tax rate was 35.0% for the thirteen weeks ended May 29, 2010, as compared to 39.3% for the thirteen weeks ended May 30, 2009.  The Company’s effective income tax rate for the current quarter was lower than the prior year as a result of reductions in tax contingency reserves due to certain statute expirations.

Thirty-nine weeks ended May 29, 2010 compared with thirty-nine weeks ended May 30, 2009

Revenues

   
May 29,
   
May 30,
   
Dollar
   
Percent
 
(In thousands, except percentages)
 
2010
   
2009
   
Change
   
Change
 
                         
   Core Laundry Operations
  $ 680,874     $ 694,994     $ (14,120 )     -2.0 %
   Specialty Garments
    67,977       55,720       12,257       22.0  
   First Aid
    22,138       21,230       908       4.3  
Consolidated total
  $ 770,989     $ 771,944     $ (955 )     -0.1 %

For the thirty-nine weeks ended May 29, 2010, our consolidated revenues decreased by $1.0 million from the comparable period in fiscal 2009, or 0.1%.  The consolidated decrease was the result of a decrease in revenues in our core laundry operations.  Core laundry operations’ revenues decreased to $680.9 million for the thirty-nine weeks ended May 29, 2010 from $695.0 million for the comparable period of fiscal 2009, or 2.0%.  This decrease was attributable to negative organic growth of 4.0%, which was partially offset by an increase from the effect of foreign exchange rate fluctuations on our Canadian revenues of 1.0% and acquisition-related growth of 1.0%.  Organic growth is comprised of new sales, price increases and net additions to our existing customer base, offset by lost accounts.  The negative organic growth rate of 4.0% for the first nine months of fiscal 2010 is primarily due to the high rate of wearer reductions that we experienced in our existing customer base throughout fiscal 2009.  Throughout fiscal 2009, the deteriorating worldwide economic conditions resulted in increased domestic layoffs in the United States, which were reflected in the reduction of wearers throughout our broad customer base.  Lost accounts also increased in 2009 as we saw a larger number of accounts either go out of business or in financial distress.  Although the economy has improved somewhat in fiscal 2010, economic conditions remain challenging.

Specialty Garments revenues increased to $68.0 million for the thirty-nine weeks ended May 29, 2010 from $55.7 million in the comparable period of fiscal 2009, an increase of 22.0%.  The increase in the revenues was primarily the result of higher than expected revenues from certain U.S. and Canadian reactor projects.

Cost of Revenues

Cost of revenues increased from $464.6 million, or 60.2% of revenues, for the thirty-nine weeks ended May 30, 2009 to $464.8 million, or 60.3% of revenues, for the thirty-nine weeks ended May 29, 2010.  This increase was primarily the result an increase in production costs as a percentage of revenues, as well as higher payroll related costs, including healthcare.  These increases were offset by slightly lower merchandise and payroll costs as a percentage of revenues as a result of head count reductions in fiscal 2009.

Selling and Administrative Expense

Our selling and administrative expenses decreased from $159.8 million, or 20.7% of revenues, for the thirty-nine weeks ended May 30, 2009 to $158.7 million, or 20.6% of revenues, for the thirty-nine weeks ended May 29, 2010.  This decrease was primarily due to a $3.2 million charge related to environmental contingencies we recorded in the thirty-nine weeks ended May 30, 2009.  The favorable comparison was partially offset by slightly higher payroll and payroll related costs as a percentage of revenues.

Depreciation and Amortization

Our depreciation and amortization expense increased to $45.9 million for the thirty-nine weeks ended May 29, 2010 from $42.7 million for the thirty-nine weeks ended May 30, 2009. The increase in depreciation and amortization expense was due to capital expenditures and acquisition activity.

Income from Operations

For the thirty-nine weeks ended May 29, 2010 and the thirty-nine weeks ended May 30, 2009, the revenue growth in our operations, as well as the change in our costs, discussed above, resulted in the following changes in our income from operations:

   
May 29,
   
May 30,
   
Dollar
   
Percent
 
(In thousands, except percentages)
 
2010
   
2009
   
Change
   
Change
 
                         
   Core Laundry Operations
  $ 88,392     $ 97,931     $ (9,539 )     -9.7 %
   Specialty Garments
    11,894       6,411       5,483       85.5  
   First Aid
    1,295       535       760       142.0  
Consolidated total
  $ 101,581     $ 104,877     $ (3,296 )     -3.1 %

Other Expense (income)

Other expense (income), which includes interest expense, interest income and foreign currency exchange (gain) loss, was $6.2 million for the thirty-nine weeks ended May 29, 2010 as compared with $6.0 million for the thirty-nine weeks ended May 30, 2009. This increase was due to unfavorable foreign currency fluctuations during the thirty-nine weeks ended May 29, 2010, resulting in a loss of $1.2 million, as compared to a loss of $0.3 million in the comparable period of fiscal 2009.  Interest expense decreased to $6.6 million for the thirty-nine weeks ended May 29, 2010 from $7.1 million for the thirty-nine weeks ended May 30, 2009.   The decrease in interest expense was primarily attributable to lower average debt outstanding. For the thirty-nine weeks ended May 29, 2010, the average debt outstanding was $181.6 million, as compared to $214.5 million during the thirty-nine weeks ended May 30, 2009.

Provision for Income Taxes

Our effective income tax rate was 38.0% for the thirty-nine weeks ended May 29, 2010, as compared to 40.5% for the thirty-nine weeks ended May 30, 2009.  The Company’s effective income tax rate was negatively impacted in fiscal 2009 by increases to our reserves for tax contingencies while fiscal 2010’s rate benefitted from reductions to our tax contingency reserves due to certain statute expirations.

Liquidity and Capital Resources

General

As of May 29, 2010, we had cash and cash equivalents of $104.5 million and working capital of $204.1 million. We believe that current cash and cash equivalent balances, cash generated from operations and amounts available under our Credit Agreement (defined below) will be sufficient to meet our currently anticipated working capital and capital expenditure requirements for at least the next 12 months.

Sources and Uses of Cash

During the thirty-nine weeks ended May 29, 2010, we generated cash from operating activities of $99.8 million, resulting primarily from net income of $59.1 million, net of non-cash amounts charged for depreciation and amortization of $45.9 million and stock-based compensation of $2.1 million. We also generated cash as a result of decreases in inventories of $5.2 million and increases in accounts payable and accruals of $2.9 million.  These inflows were partially offset by increases in rental merchandise in-service of $8.0 million, accounts receivable of $7.7 million and prepaid expenses of $1.4 million. We used our cash to, among other things, invest $37.3 million in capital expenditures and fund the acquisitions of businesses in the amount of approximately $17.8 million.

Long-Term Debt and Borrowing Capacity

We have a $225.0 million unsecured revolving credit agreement (“Credit Agreement”) with a syndicate of banks, which matures on September 13, 2011.  Under the Credit Agreement, we can borrow funds at variable interest rates based on the Eurodollar rate or the bank’s prime rate, as selected by us. Availability of credit requires our compliance with certain financial and other covenants, including a maximum funded debt ratio and minimum interest coverage as defined in the Credit Agreement.  We generally test our compliance with these financial covenants on a fiscal quarterly basis. At May 29, 2010, the interest rates applicable to our borrowings under the Credit Agreement would be calculated as LIBOR plus 50 basis points at the time of the respective borrowing.  As of May 29, 2010, we had no outstanding borrowings, letters of credit of $36.5 million and $188.5 million available for borrowing under the Credit Agreement.

On June 14, 2004, we issued $75.0 million of fixed rate notes pursuant to a Note Purchase Agreement (“2004 Note Agreement”) with a seven year term (June 2011) and bearing interest at 5.27%.  We also issued $90.0 million of floating rate notes which were repaid in September 2005 and September 2006.

On September 14, 2006, we issued $100.0 million of floating rates notes (“Floating Rate Notes”) pursuant to a Note Purchase Agreement (“2006 Note Agreement”).  The Floating Rate Notes mature on September 14, 2013, bear interest at LIBOR plus 50 basis points and may be repaid at face value two years from the date of issuance.  The proceeds from the issuance of the 2006 Floating Rate Notes were used to first repay the $75.0 million of outstanding Floating Rate Notes and then to pay down outstanding amounts under the Credit Agreement.

As of May 29, 2010, we were in compliance with all covenants under the 2004 Note Agreement, 2006 Note Agreement and the Credit Agreement.

In January 2008, we entered into an interest rate swap agreement to manage our exposure to interest rate movements and the related effect on our variable rate debt.  The swap agreement, with a notional amount of $100.0 million, matures on March 14, 2011. We pay a fixed rate of 3.51% and receive a variable rate tied to the three month LIBOR rate. We have accounted for this instrument as a cash flow hedge under US GAAP and, as a result, have recorded all changes in the fair value of the swap agreement in accumulated other comprehensive income, a component of shareholders’ equity.  For additional information regarding the interest rate swap, see Note 5 to the Consolidated Financial Statements.

Commitments and Contingencies

We are subject to various federal, state and local laws and regulations governing, among other things, the generation, handling, storage, transportation, treatment and disposal of hazardous wastes and other substances. In particular, industrial laundries currently use and must dispose of detergent waste water and other residues, and, in the past, used perchloroethylene and other dry cleaning solvents. We are attentive to the environmental concerns surrounding the disposal of these materials and have, through the years, taken measures to avoid their improper disposal. Over the years, we have settled, or contributed to the settlement of, actions or claims brought against us relating to the disposal of hazardous materials and there can be no assurance that we will not have to expend material amounts to remediate the consequences of any such disposal in the future.

US GAAP requires that a liability for contingencies be recorded when it is probable that a liability has occurred and the amount of the liability can be reasonably estimated. Significant judgment is required to determine the existence of a liability, as well as the amount to be recorded. We regularly consult with attorneys and outside consultants in our consideration of the relevant facts and circumstances before recording a contingent liability. Changes in enacted laws, regulatory orders or decrees, management’s estimates of costs, insurance proceeds, participation by other parties, the timing of payments and the input of outside consultants and attorneys based on changing legal or factual circumstances could have a material impact on the amounts recorded for environmental and other contingent liabilities.

Under environmental laws, an owner or lessee of real estate may be liable for the costs of removal or remediation of certain hazardous or toxic substances located on, or in, or emanating from such property, as well as related costs of investigation and property damage. Such laws often impose liability without regard to whether the owner or lessee knew of, or was responsible for, the presence of such hazardous or toxic substances. There can be no assurances that acquired or leased locations have been operated in compliance with environmental laws and regulations or that future uses or conditions will not result in the imposition of liability upon our Company under such laws or expose our Company to third party actions such as tort suits. We continue to address environmental conditions under terms of consent orders negotiated with the applicable environmental authorities or otherwise with respect to sites located in or related to Woburn, Massachusetts, Somerville, Massachusetts, Springfield, Massachusetts, Uvalde, Texas, Stockton, California, three sites in Williamstown, Vermont, as well as a number of additional locations that we acquired as part of our acquisition of Textilease Corporation in September 2003.  In addition, we recently received notice from the Maryland Department of Environment directing us to investigate potential contamination at our Landover, Maryland facility.

We have accrued certain costs related to the sites described above as it has been determined that the costs are probable and can be reasonably estimated. We continue to implement mitigation measures and to monitor environmental conditions at the Somerville, Massachusetts site. We also have potential exposure related to an additional parcel of land (the “Central Area”) related to the Woburn, Massachusetts site discussed above. Currently, the consent decree for the Woburn site does not define or require any remediation work in the Central Area. The United States Environmental Protection Agency (the “EPA”) has provided us and other signatories to the consent decree with comments on the design and implementation of groundwater and soil remedies at the Woburn site and investigation of environmental conditions in the Central Area.  We met with EPA to discuss its comments, and we and another signatory to the consent decree subsequently submitted work plans to perform additional environmental investigations.  Such work pursuant to these work plans has been initiated.  We have accrued costs to perform certain work responsive to EPA's comments.

We routinely review and evaluate sites that may require remediation and monitoring and determine our estimated costs based on various estimates and assumptions. These estimates are developed using our internal sources or by third-party environmental engineers or other service providers. Internally developed estimates are based on:

 
 
Management’s judgment and experience in remediating and monitoring our sites;
 
 
 
Information available from regulatory agencies as to costs of remediation and monitoring;
 
 
 
The number, financial resources and relative degree of responsibility of other potentially responsible parties (PRPs) who may be liable for remediation and monitoring of a specific site; and
 
 
 
The typical allocation of costs among PRPs.

There is usually a range of reasonable estimates of the costs associated with each site. We generally use the amount within the range that constitutes our best estimate. When we believe that both the amount of a particular liability and the timing of the payments are reliably determinable, we adjust the cost in current dollars using a rate of 3% for inflation until the time of expected payment and discount the cost to present value using risk-free interest rates ranging from 3.5% to 4.2%.

For environmental liabilities that have been discounted, we include interest accretion, based on the effective interest method, in selling and administrative expenses on the Consolidated Statements of Income. The changes to the amounts of our environmental liabilities for the thirty-nine weeks ended May 29, 2010 are as follows (in thousands):

     
May 29,
2010
 
Beginning balance as of August 29, 2009
 
$
19,384
 
Costs incurred for which reserves have been provided
   
(1,717
)
Insurance proceeds received
   
181
 
Interest accretion
   
595
 
Change in estimate of liability
   
(303
)
Balance as of May 29, 2010
 
$
18,140
 

Anticipated payments and insurance proceeds relating to currently identified environmental remediation liabilities as of May 29, 2010, for the next five fiscal years and thereafter, as measured in current dollars, are reflected below (in thousands).

Fiscal year ended August
 
2010
 
2011
 
2012
 
2013
 
2014
 
Thereafter
   
Total
 
Estimated costs – current dollars
$
3,161
 
2,616