Page 1 of 245
Index to Exhibits on Page 19
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 2001.
OR
[ ] 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 1-3208.
NATIONAL SERVICE INDUSTRIES, INC.
(Exact name of registrant as specified in its charter)
Delaware 58-0364900
- -------------------------------- ----------------------------------------
(State or other jurisdiction of (I.R.S. Employer Identification Number)
incorporation or organization)
1420 Peachtree Street, N.E., Atlanta, Georgia 30309-3002
- --------------------------------------------------------------------------------
(Address of principal executive offices) (Zip Code)
(404) 853-1000
----------------------------------------------------------
(Registrant's telephone number, including area code)
None
--------------------------------------------------
(Former Name, Former Address and Former Fiscal
Year, if Changed Since Last Report)
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 the number of shares outstanding of each of the issuer's classes of
common stock, as of the latest practicable date.
Common Stock - $1.00 Par Value - 41,188,504 shares as of May 31, 2001.
Page 2
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
INDEX
Page No.
-----------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS (Unaudited) -
MAY 31, 2001 AND AUGUST 31, 2000 3
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) -
THREE AND NINE MONTHS ENDED MAY 31, 2001 AND 2000
4
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) -
NINE MONTHS ENDED MAY 31, 2001 AND 2000 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 6-12
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 13-15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 15
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 17
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 17
SIGNATURES 18
INDEX TO EXHIBITS 19
Page 3
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
--------------------------------------------------
CONSOLIDATED BALANCE SHEETS (Unaudited)
---------------------------------------
(In thousands, except share and per-share data)
May 31, August 31,
2001 2000
------------------ ---------------
Assets
- ------
Current Assets:
Cash and cash equivalents $ 9,018 $ 1,510
Receivables, less reserves for doubtful accounts of $8,435 at May 31,
2001 and $7,310 at August 31, 2000 (Note 8) 372,410 405,748
Inventories, at the lower of cost (on a first-in, first-out basis) or market 254,447 257,579
Linens in service, net of amortization 57,306 57,162
Deferred income taxes 4,094 10,285
Prepayments and other current assets 33,440 25,740
------------------ ---------------
Total Current Assets 730,715 758,024
------------------ ---------------
Property, Plant, and Equipment, at cost:
Land 28,561 28,697
Buildings and leasehold improvements 219,152 206,946
Machinery and equipment 587,291 559,483
------------------ ---------------
Total Property, Plant, and Equipment 835,004 795,126
Less-Accumulated depreciation and amortization 410,180 368,067
------------------ ---------------
Property, Plant, and Equipment-net 424,824 427,059
------------------ ---------------
Other Assets:
Goodwill and other intangibles 514,490 536,009
Other 92,762 95,347
------------------ ---------------
Total Other Assets 607,252 631,356
------------------ ---------------
Total Assets $1,762,791 $1,816,439
================== ===============
Liabilities and Stockholders' Equity
- ------------------------------------
Current Liabilities:
Current maturities of long-term debt $ 1,089 $ 201
Commercial paper 120,665 236,706
Short-term secured borrowings (Note 8) 118,900 -
Notes payable 18,690 20,285
Accounts payable 123,317 130,573
Accrued salaries, commissions, and bonuses 47,070 63,832
Current portion of self-insurance reserves 6,794 7,006
Accrued taxes payable - 1,924
Other accrued liabilities 76,472 76,425
------------------ ---------------
Total Current Liabilities 512,997 536,952
------------------ ---------------
Long-Term Debt, less current maturities 383,213 384,242
------------------ ---------------
Deferred Income Taxes 65,421 96,153
------------------ ---------------
Self-Insurance Reserves, less current portion 30,682 37,484
------------------ ---------------
Other Long-Term Liabilities 90,587 93,138
------------------ ---------------
Stockholders' Equity:
Series A participating preferred stock, $.05 stated value, 500,000 shares
Authorized, none issued
Preferred stock, no par value, 500,000 shares authorized, none issued
Common stock, $1 par value, 120,000,000 shares authorized, 57,918,978 shares issued 57,919 57,919
Paid-in capital 29,662 29,657
Retained earnings 1,027,232 1,022,974
Unearned compensation on restricted stock (Note 7) (1,020) -
Accumulated other comprehensive income (13,640) (12,777)
------------------ ---------------
1,100,153 1,097,773
Less-Treasury stock, at cost (16,730,474 shares at May 31, 2001 and
17,090,414 shares at August 31, 2000) 420,262 429,303
------------------ ---------------
Total Stockholders' Equity 679,891 668,470
------------------ ---------------
Total Liabilities and Stockholders' Equity $1,762,791 $1,816,439
================== ===============
The accompanying notes to consolidated financial statements are an integral part of these statements.
Page 4
National Service Industries, Inc. and Subsidiaries
--------------------------------------------------
Consolidated Statements of Income (Unaudited)
---------------------------------------------
(In thousands, except per-share data)
THREE MONTHS ENDED NINE MONTHS ENDED
MAY 31 MAY 31
------------------------------ -----------------------------
2001 2000 2001 2000
-------------- -------------- -------------- --------------
Sales and Service Revenues:
Net sales of products $560,957 $562,000 $1,651,430 $1,632,288
Service revenues 88,019 83,040 248,734 238,175
-------------- -------------- -------------- --------------
Total Revenues 648,976 645,040 1,900,164 1,870,463
-------------- -------------- -------------- --------------
Costs and Expenses:
Cost of products sold 331,354 337,771 978,821 978,648
Cost of services 49,300 46,070 141,934 136,009
Selling and administrative expenses 214,548 211,192 636,906 604,166
Amortization expense 5,316 5,287 15,635 15,650
Interest expense, net 12,392 11,678 39,028 32,191
(Gain) loss on sale of businesses 14,557 (170) 12,197 (356)
Other expense (income), net (447) (738) 2,319 (2,777)
-------------- -------------- -------------- --------------
Total Costs and Expenses 627,020 611,090 1,826,840 1,763,531
-------------- -------------- -------------- --------------
Income before Provision for Income Taxes 21,956 33,950 73,324 106,932
Provision for Income Taxes 9,385 13,174 28,391 41,490
-------------- -------------- -------------- --------------
Net Income $ 12,571 $ 20,776 $ 44,933 $ 65,442
============== ============== ============== ==============
Per Share:
Basic Earnings per Share $ 0.31 $ 0.51 $ 1.09 $ 1.61
============== ============== ============== ==============
Basic Weighted Average Number of Shares Outstanding 41,119 40,752 41,039 40,677
============== ============== ============== ==============
Diluted Earnings per Share $ 0.30 $ 0.51 $ 1.09 $ 1.61
============== ============== ============== ==============
Diluted Weighted Average Number of Shares Outstanding 41,532 40,756 41,280 40,711
============== ============== ============== ==============
The accompanying notes to consolidated financial statements are an integral part of these statements.
Page 5
National Service Industries, Inc. and subsidiaries
--------------------------------------------------
Consolidated Statements of Cash Flows (Unaudited)
-------------------------------------------------
(In thousands)
NINE MONTHS ENDED
MAY 31
-------------------------------
2001 2000
-------------- --------------
Cash Provided by (Used for) Operating Activities
Net income $44,933 $65,442
Adjustments to reconcile net income to net cash provided by (used for) operating
activities:
Depreciation and amortization 69,380 63,875
Provision for losses on accounts receivable 3,499 3,520
(Gain) loss on the sale of property, plant, and equipment 1,359 (1,198)
(Gain) loss on the sale of businesses 12,197 (356)
Change in assets and liabilities net of effect of acquisitions and divestitures-
Receivables 27,875 (1,639)
Inventories and linens in service, net 923 (44,493)
Deferred income taxes (24,541) 1,818
Prepayments and other current assets (9,003) (5,265)
Accounts payable and accrued liabilities (23,672) (37,070)
Self-insurance reserves and other long-term liabilities (9,118) (2,883)
-------------- --------------
Net Cash Provided by Operating Activities 93,832 41,751
-------------- --------------
Cash Provided by (Used for) Investing Activities
Purchases of property, plant, and equipment (53,742) (78,793)
Sale of property, plant, and equipment 2,196 3,287
Acquisitions (2,598) (21,550)
Proceeds from the sale of businesses 4,085 -
Change in other assets 2,408 (3,660)
-------------- --------------
Net Cash Used for Investing Activities (47,651) (100,716)
-------------- --------------
Cash Provided by (Used for) Financing Activities
Net repayments of notes payable (1,595) (229)
Issuances (repayments) of commercial paper, net (less than 90 days) (107,188) 93,699
Issuances of commercial paper (greater than 90 days) 1,347 186,024
Repayments of commercial paper (greater than 90 days) (10,200) (182,750)
Proceeds from short-term secured borrowings 118,900 -
Repayments of long-term debt (826) (861)
Treasury stock transactions, net 2,260 3,039
Cash dividends paid (40,675) (39,884)
-------------- --------------
Net Cash Provided by (Used for) Financing Activities (37,977) 59,038
-------------- --------------
Effect of Exchange Rate Changes on Cash (696) (838)
-------------- --------------
Net Change in Cash and Cash Equivalents 7,508 (765)
Cash and Cash Equivalents at Beginning of Period 1,510 2,254
-------------- --------------
Cash and Cash Equivalents at End of Period $ 9,018 $ 1,489
============== ==============
Supplemental Cash Flow Information:
Income taxes paid during the period $55,678 $53,801
Interest paid during the period 35,169 28,309
Noncash Investing and Financing Activities:
Treasury shares issued under long-term incentive plan $ 6,784 $ 5,667
Noncash aspects of acquisitions--
Assets acquired $ 2,894 $ -
Liabilities assumed or incurred 296 1,219
The accompanying notes to consolidated financial statements are an integral part of these statements.
Page 6
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
--------------------------------------------------
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
------------------------------------------------------
(Dollar amounts in thousands, except share and
per-share data and as otherwise indicated)
1. BASIS OF PRESENTATION
The interim consolidated financial statements included herein have been prepared
by the company without audit and the condensed consolidated balance sheet as of
August 31, 2000 has been derived from audited statements. These statements
reflect all adjustments, all of which are of a normal, recurring nature, which
are, in the opinion of management, necessary to present fairly the consolidated
financial position as of May 31, 2001 and August 31, 2000, the consolidated
results of operations for the three and nine months ended May 31, 2001 and 2000,
and the consolidated cash flows for the nine months ended May 31, 2001 and 2000.
Certain reclassifications have been made to the prior year's financial
statements to conform to the current year's presentation. 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. The company believes that the disclosures are
adequate to make the information presented not misleading. It is suggested that
these financial statements be read in conjunction with the financial statements
and notes thereto included in the company's Annual Report on Form 10-K for the
fiscal year ended August 31, 2000.
The results of operations for the three and nine months ended May 31, 2001 are
not necessarily indicative of the results to be expected for the full fiscal
year because the company's revenues and income are generally higher in the
second half of its fiscal year and because of the uncertainty of general
business conditions.
2. Accounting Standards Yet to be Adopted
In September 2000, the Emerging Issues Task Force ("EITF") reached a final
consensus on EITF Issue 00-10, "Accounting for Shipping and Handling Fees and
Costs." Specifically, Issue 00-10 addresses how the seller of goods should
classify amounts billed to a customer for shipping and handling. The EITF
concluded that all amounts billed to a customer in a sale transaction related to
shipping and handling represent revenues earned for the goods provided and
should be classified as revenue. The company is required to and will adopt EITF
00-10 in the fourth quarter of fiscal year 2001. The company has historically
netted certain shipping and handling revenues charged to customers in costs and
expenses. The adoption of EITF 00-10 will result in an increase in sales and
service revenues and costs and expenses, with no impact on net income. The
company has not yet calculated the effect of this reclassification on its
reported revenues and costs.
Page 7
3. BUSINESS SEGMENT INFORMATION
Depreciation Capital
Sales and Operating and Expenditures
Service Profit Amortization and
Nine Months Ended May 31, 2001 Revenues (Loss) Expense Acquisitions
------------- ------------- ----------------- ----------------
Lighting Equipment $1,096,466 $ 93,670 $39,436 $31,031
Chemical 386,491 16,250 8,690 6,689
Textile Rental 248,734 16,033 12,345 13,729
Envelope 168,473 3,991 7,171 3,749
------------- ------------- ----------------- ----------------
1,900,164 129,944 67,642 55,198
Corporate (17,592) 1,738 1,142
Interest expense, net (39,028)
------------- ------------- ----------------- ----------------
Total $1,900,164 $ 73,324 $69,380 $56,340
============= ============= ================= ================
Depreciation Capital
Sales and Operating and Expenditures
Service Profit Amortization and
Nine Months Ended May 31, 2000 Revenues (Loss) Expense Acquisitions
------------- ------------- ----------------- ----------------
Lighting Equipment $1,093,469 $ 92,187 $36,630 $ 58,279
Chemical 373,153 34,644 8,290 4,254
Textile Rental 238,175 19,410 11,525 20,526
Envelope 165,666 6,185 5,714 15,240
------------- ------------- ----------------- ----------------
1,870,463 152,426 62,159 98,299
Corporate (13,303) 1,716 2,044
Interest expense, net (32,191)
------------- ------------- ----------------- ----------------
Total $1,870,463 $106,932 $63,875 $100,343
============= ============= ================= ================
Depreciation Capital
Sales and Operating and Expenditures
Service Profit Amortization and
Three Months Ended May 31, 2001 Revenues (Loss) Expense Acquisitions
------------- ------------- ----------------- ----------------
Lighting Equipment $368,821 $32,056 $13,304 $ 7,336
Chemical 136,763 (637) 2,924 2,192
Textile Rental 88,019 8,297 4,077 7,925
Envelope 55,373 1,416 2,415 1,407
------------- ------------- ----------------- ----------------
648,976 41,132 22,720 18,860
Corporate (6,784) 505 273
Interest expense, net (12,392)
------------- ------------- ----------------- ----------------
Total $648,976 $21,956 $23,225 $19,133
============= ============= ================= ================
Depreciation Capital
Sales and Operating and Expenditures
Service Profit Amortization and
Three Months Ended May 31, 2000 Revenues (Loss) Expense Acquisitions
------------- ------------- ----------------- ----------------
Lighting Equipment $371,778 $27,887 $11,984 $17,669
Chemical 133,645 14,550 2,780 2,003
Textile Rental 83,040 7,976 3,969 5,502
Envelope 56,577 662 2,066 6,026
------------- ------------- ----------------- ----------------
645,040 51,075 20,799 31,200
Corporate (5,447) 583 167
Interest expense, net (11,678)
------------- ------------- ----------------- ----------------
Total $645,040 $33,950 $21,382 $31,367
============= ============= ================= ================
Page 8
Total Assets
-------------------------------------------
May 31, 2001 August 31, 2000
------------------- ------------------
Lighting Equipment $1,107,141 $1,142,227
Chemical 235,083 241,645
Textile Rental 226,923 222,957
Envelope 147,278 151,003
------------------- ------------------
Subtotal 1,716,425 1,757,832
Corporate 46,366 58,607
------------------- ------------------
Total $1,762,791 $1,816,439
=================== ==================
4. INVENTORIES
Major classes of inventory as of May 31, 2001 and August 31, 2000 were as follows:
May 31, August 31,
2001 2000
----------------- -----------------
Raw Materials and Supplies $101,411 $104,566
Work-in-Process 18,987 20,262
Finished Goods 134,049 132,751
----------------- -----------------
Total $254,447 $257,579
================= =================
5. EARNINGS PER SHARE
The company accounts for earnings per share using Statement of Financial
Accounting Standards No. 128, "Earnings per Share." Under this statement, basic
earnings per share is computed by dividing net earnings available to common
stockholders by the weighted average number of common shares outstanding during
the period. Diluted earnings per share is computed similarly but reflects the
potential dilution that would occur if dilutive options were exercised and
restricted stock awards were vested. The following table calculates basic
earnings per common share and diluted earnings per common share at May 31, 2001
and May 31, 2000:
Three Months Ended Nine Months Ended
-------------------------------- -------------------------------
May 31, 2001 May 31, 2000 May 31, 2001 May 31, 2000
--------------- ------------- -------------- -------------
Basic earnings per common share:
Net income $12,571 $20,776 $44,933 $65,442
Basic weighted average shares outstanding (in thousands) 41,119 40,752 41,039 40,677
--------------- ------------- -------------- -------------
Basic earnings per common share $ 0.31 $ 0.51 $ 1.09 $ 1.61
=============== ============= ============== =============
Diluted earnings per common share:
Net income $12,571 $20,776 $44,933 $65,442
Basic weighted average shares outstanding (in thousands) 41,119 40,752 41,039 40,677
Add - Shares of common stock issuable upon assumed
exercise of dilutive stock options (in thousands) 362 4 216 34
Add - Unvested restricted stock (in thousands) 51 - 25 -
--------------- ------------- -------------- -------------
Diluted weighted average shares outstanding (in thousands) 41,532 40,756 41,280 40,711
--------------- ------------- -------------- -------------
Diluted earnings per common share $ 0.30 $ 0.51 $ 1.09 $ 1.61
=============== ============= ============== =============
Page 9
6. COMPREHENSIVE INCOME
Statement of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income," requires the reporting of a measure of all changes in equity of an
entity that result from recognized transactions and other economic events other
than transactions with owners in their capacity as owners. Other comprehensive
income (loss) for the three and nine months ended May 31, 2001 and May 31, 2000
includes only foreign currency translation adjustments. The calculation of
comprehensive income is as follows:
Three Months Ended Nine Months Ended
---------------------------------- ---------------------------------
May 31, 2001 May 31, 2000 May 31, 2001 May 31, 2000
--------------- --------------- -------------- ---------------
Net income $12,571 $20,776 $44,933 $65,442
Foreign currency translation adjustments 1,241 (2,615) (1,776) (2,375)
Reclassification adjustment for foreign currency
translation loss realized in net income as a result
of the sale of a foreign entity (Note 9) 913 - 913 -
--------------- --------------- -------------- ---------------
Comprehensive Income $14,725 $18,161 $44,070 $63,067
=============== =============== ============== ===============
7. RESTRICTED STOCK
In October 2000, the company awarded 256,800 shares of restricted stock to
officers and other key employees under the National Service Industries, Inc.
Long-Term Achievement Incentive Plan. The shares are granted in 20 percent
increments when the company's stock price equals or exceeds certain stock price
targets ranging from $22.14 to $38.50 for thirty consecutive calendar days. The
shares vest ratably in four equal annual installments beginning one year from
the date of grant. During the vesting period, the participants have voting
rights and receive dividends, but the shares may not be sold, assigned,
transferred, pledged or otherwise encumbered. If the stock price targets are not
reached on or before the fifth anniversary of the award date, the corresponding
shares are not granted. Additionally, granted but unvested shares are forfeited
upon termination of employment, unless certain retirement criteria are met.
The fair value of the restricted shares on the date of grant is amortized
ratably over the vesting period. In January 2001, the first stock price target
was achieved and 51,260 restricted shares were granted. Unearned compensation of
$1,281 on restricted stock was initially recorded based on the market value of
the shares on the date of grant and is generally being amortized over four
years. The unamortized balance of unearned compensation on restricted stock is
included as a separate component of stockholders' equity.
8. SECURED BORROWINGS
In May 2001, the company entered into a three-year agreement (the "Receivables
Facility") to borrow, on an ongoing basis, up to $150.0 million secured by
undivided interests in a defined pool of trade accounts receivable of the
lighting equipment and chemical segments. At May 31, 2001, net trade accounts
receivable pledged as security for borrowings under the Receivables Facility
totaled $220.4 million. Borrowings outstanding at May 31, 2001 of $118.9 million
were used to reduce borrowings under the company's commercial paper program.
Interest rates under the Receivables Facility are based on the LIBOR rate.
9. SALE OF BUSINESSES
As part of an initiative to refocus the overseas operations of the chemical
segment, the company sold its Australian subsidiary, NSI International Pty,
Ltd., resulting in a pretax loss of $5.6 million. In addition, the company
entered into a contract to sell its French operations, as well as certain
trademarks and formulas. The company recorded an estimated pretax loss on this
transaction of $9.0 million and finalized the sale on June 29, 2001. The
combined pretax loss of $14.6 million is included in "(Gain) loss on sale of
businesses" in the accompanying Consolidated Statements of Income.
Page 10
10. LEGAL PROCEEDINGS
The company is subject to various legal claims arising in the normal course of
business out of the conduct of its current and prior businesses, including
patent infringement and product liability claims. Based on information currently
available, it is the opinion of management that the ultimate resolution of
pending and threatened legal proceedings will not have a material adverse effect
on the company's financial condition or results of operations. However, in the
event of unexpected future developments, it is possible that the ultimate
resolution of such matters, if unfavorable, could have a material adverse effect
on the company's results of operations in a particular future period. The
company reserves for known legal claims when payments associated with the claims
become probable and the costs can be reasonably estimated. The actual costs of
resolving legal claims may be substantially lower or higher than that reserved.
The company does not believe that the amount of such costs below or in excess of
that reserved is reasonably estimable.
Among the product liability claims to which the company is subject are claims
arising from the installation and distribution of asbestos-containing
insulation, primarily in the southeastern United States, by a previously
divested business of the company. Most claims against the company seek both
substantial compensatory damages and punitive damages. The company believes that
many of the claims against it are without merit, and the company believes that
it has done nothing which should justify punitive damages. In addition, the
company believes that it has substantial legal defenses against many of these
claims, including that the company did not manufacture any asbestos-containing
building products and that statutes of repose in some states bar the claims.
However, there is no assurance that the company will be successful in asserting
defenses to these claims.
The company has reached settlement agreements with substantially all of its
relevant insurers providing for their payment of these claims up to the various
policy limits. Over the past two decades, through May 2001, approximately 38,500
such claims against the company have been resolved for an aggregate cost
(liability payments and other expenses) of approximately $47 million,
approximately $45 million of which has been paid or is expected to be paid by
insurers. The average per-claim liability payment made by the company and its
insurers was approximately nine hundred dollars over that period and has been
slightly more than twelve hundred dollars during the past eighteen months. As of
May 31, 2001, there were approximately 26,100 similar claims pending against the
company, including approximately 12,700 claims that have been settled in
principle (but not yet finalized) for amounts generally consistent with recent
historical per-claim settlement costs. The company anticipates that similar
claims will be made in the future.
Prior to February 1, 2001, the Center for Claims Resolution (the "CCR") handled
the processing and settlement of claims on behalf of the company and retained
local counsel for the defense of claims. Through February 1, 2001, the company
was responsible for varying percentages of CCR's defense and liability payments
on a claim-by-claim basis pursuant to predetermined sharing formulae, and
substantially all of the company's portion of those payments were paid directly
by the company's insurers. During the past eighteen months, several members have
left the CCR or declared bankruptcy. These members have failed to pay, or may
fail to pay, certain financial obligations in connection with settlements that
were reached while they were CCR members. The company has paid CCR approximately
five hundred thousand dollars for the company's allocated share of the amount
needed to cover defaulted obligations relating to paid settlements; the CCR may
request, and the company may be subject to claims that it has liability for,
further payments with respect to settlements reached in principle but not
finalized. Although the company will seek to recover the recent payment and any
future payments from insurance and other sources, there is no assurance that
such payments will be recoverable. In addition, several significant companies
that are traditional co-defendants in similar claims, but are not members of
CCR, sought bankruptcy protection during the past eighteen months. The absence
of these traditional defendants may increase the cost of resolving similar
claims for other defendants, including the company.
The ultimate asbestos-related liability of the company is difficult to estimate.
Based on the company's experience to date, and in light of the legal defenses
that the company believes should protect it and the increasing number of claims
by persons who are not impaired as a result of occupational exposure to asbestos
fibers, the company believes that substantially all of the costs it may incur in
defending and ultimately disposing of asbestos-related claims in the foreseeable
future will be paid by its insurers. The company is and will continue monitoring
and analyzing the trends, developments, and variables affecting or likely to
affect the resolution of pending and future claims against the company.
11. ENVIRONMENTAL MATTERS
The company's operations, as well as similar operations of other companies, are
subject to comprehensive laws and regulations relating to the generation,
storage, handling, transportation, and disposal of hazardous substances and
solid and hazardous wastes and to the remediation of contaminated sites. Permits
and environmental controls are required for certain of the company's operations
to limit air and water pollution, and these permits are subject to modification,
renewal, and revocation by issuing authorities. The company believes that it is
in substantial compliance with all material environmental laws, regulations, and
permits. On an ongoing basis, the company incurs capital and operating costs
relating to environmental compliance. Environmental laws and regulations have
generally become stricter in recent years, and the cost of responding to future
changes may be substantial.
Page 11
The company's environmental reserves, which are included in current liabilities,
totaled $7.5 million and $10.2 million at May 31, 2001 and August 31, 2000,
respectively. The actual cost of environmental issues may be substantially lower
or higher than that reserved due to the difficulty in estimating such costs,
potential changes in the status of government regulations, and the inability to
determine the extent to which contributions will be available from other
parties. The company does not believe that any amount of such costs below or in
excess of that accrued is reasonably estimable.
Certain environmental laws, such as Superfund, can impose liability for the
entire cost of site remediation upon each of the current or former owners or
operators of a site or parties who sent waste to a site where a release of a
hazardous substance has occurred regardless of fault or the lawfulness of the
original disposal activity. Generally, where there are a number of potentially
responsible parties ("PRPs") that are financially viable, liability has been
apportioned based on the type and amount of waste disposed of by each party at
such disposal site and the number of financially viable PRPs, although no
assurance as to the method of apportioning the liability can be given as to any
particular site.
The company is currently a party to, or otherwise involved in, legal proceedings
in connection with state and federal Superfund sites, two of which are located
on property owned by the company. Except for the Blydenburgh Landfill matter in
New York (which is discussed below), the company believes its liability is de
minimis at each of the currently active sites which it does not own where it has
been named as a PRP due to its limited involvement at the site and/or the number
of viable PRPs. Specifically, the preliminary allocation among 48 PRPs at the
Crymes Landfill site in Georgia indicates that the company's liability is not
significant, and there are more than 1,000 PRPs at the M&J Solvents site in
Georgia. For property which the company owns on Seaboard Industrial Boulevard in
Atlanta, Georgia, the company has conducted an investigation on its and
adjoining properties and submitted a Compliance Status Report ("CSR") to the
State of Georgia Environmental Protection Division ("EPD") pursuant to the
Georgia Hazardous Site Response Act. The CSR is currently pending, subject to
EPD's final approval. Until the CSR is finalized, the company will not be able
to determine if remediation will be required, if the company will be solely
responsible for the cost of such remediation, or whether such cost is likely to
result in a material adverse effect on the company. For property which the
company owns on East Paris Street in Tampa, Florida, the company was requested
by the State of Florida to clean up chlorinated solvent contamination in the
groundwater beneath the property and beneath surrounding property known as
Seminole Heights Solvent Site and to reimburse approximately $430 thousand of
costs already incurred by the State of Florida in connection with such
contamination. The company presented expert evidence to the State of Florida in
1998 that the company is not the source of the contamination, and the State has
not responded. On this matter, it is not possible to quantify the company's
potential exposure.
In connection with the sale of certain assets, including 29 of the company's
textile rental plants in 1997, the company has retained environmental
liabilities arising from events occurring prior to the closing, subject to
certain exceptions. The company has received notice from the buyer of the
textile rental plants of the alleged presence of perchloroethylene contamination
on one of the properties involved in the sale. Because the company is not the
source of contamination, the company asserted an indemnification claim against
the company from which it bought the property. The prior owner is currently
addressing the contamination at its expense, subject to a reservation of rights.
At this time, it is too early to quantify the company's potential exposure in
this matter, the likelihood of an adverse result, or the outcome of the
company's indemnification claim against the prior owner.
During the second quarter of 2001, management performed a review of the other
environmental liabilities recorded in connection with the textile rental
segment's 1997 uniform plants divestiture. Based on the advice of the company's
environmental experts, the company decreased its estimates for certain
environmental exposures and, as a result, reduced the related liability and
recorded a gain of approximately $2.0 million. The gain is included in
"(Gain)loss on sale of businesses" in the accompanying Consolidated Statements
of Income.
The State of New York has filed a lawsuit against the company alleging that the
company is responsible as a successor to Serv-All Uniform Rental Corp. for past
and future response costs in connection with the release or potential release of
hazardous substances at and from the Blydenburgh Landfill in Islip, New York.
The company believes that it is not a successor to Serv-All Uniform Rental Corp.
and therefore has no liability with respect to the Blydenburgh Landfill, and it
has responded to the lawsuit accordingly. The company has also asserted an
indemnification claim against the parent of Initial Services Investments, Inc.,
which the company acquired in 1992 and which had previously purchased and sold
certain assets of Serv-All Uniform Rental Corp. The federal district court in
the Eastern District of New York denied the company's motion for summary
judgment on the issue of successor liability and granted the State of New
York's motion for partial summary judgment and for a declaratory judgment that
the company is a successor to Serv-All Uniform Rental Corp. The company is
appealing this decision. At this stage, it is too early to quantify the
company's potential exposure, the likelihood of an adverse result, or the
outcome of the company's indemnification claim.
Page 12
12. SUBSEQUENT EVENT
On June 28, 2001, the company's Board of Directors approved a plan for the
company to consider the spin-off of the lighting equipment and chemical segments
to its stockholders in the form of a tax-free dividend. Separating the lighting
equipment and chemical segments from the rest of the company's operations would
create two companies, each with its own management and board of directors
focused on their respective businesses. Management believes the transaction will
enhance the ability of the respective companies to focus on strategic
initiatives and new business opportunities, improve cost structures and
operating efficiencies, and better align equity-based compensation to operating
performance. The company will receive opinions from counsel and from its tax
advisor that the spin-off will be tax-free for U.S. federal income tax purposes
to the company and its stockholders. At the effective time of the spin-off, each
holder of the company's common stock will receive a distribution of one share of
common stock of the newly formed entity comprised of the lighting equipment and
chemical segments for each share of company common stock. Assuming final
approvals are obtained, management expects to complete the transaction early in
fiscal 2002.
Page 13
MANAGEMENT'S DISCUSSION AND ANALYSIS
------------------------------------
OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
------------------------------------------------
The following discussion should be read in conjunction with the consolidated
financial statements and related notes.
National Service Industries is a diversified service and manufacturing company
operating in four segments: lighting equipment, chemicals, textile rental, and
envelopes. The company remained in solid financial condition at May 31, 2001.
Net working capital was $217.7 million, down from $221.1 million at August 31,
2000, and the current ratio remained constant at 1.4. The company's percentage
of debt to total capitalization improved from 49.0 percent at August 31, 2000 to
48.6 percent at May 31, 2001.
Results of Operations
National Service Industries generated revenue of $649.0 million and $1.9 billion
in the three and nine months ended May 31, 2001, respectively, compared to
revenue of $645.0 million and $1.9 billion, respectively, in the previous year.
Increased revenue in the chemical and textile rental segments was partially
offset by decreases in the lighting equipment and envelope segments during the
third quarter. Year-to-date revenue increased $29.7 million, primarily in the
chemical and textile rental segments.
Net income totaled $12.6 million, or $.30 per diluted share, for the three
months ended May 31, 2001 compared to net income of $20.8 million, or $.51 per
diluted share, for the three months ended May 31, 2000. On a year-to-date basis,
net income declined $20.5 million, from $65.4 million to $44.9 million. Net
income was negatively impacted by losses on the sale of the company's French and
Australian chemical businesses, weakened economic conditions, higher interest
expense and energy costs, and expenses associated with repositioning the company
for an economic slowdown. The company anticipates that its operations will
continue to be impacted by a softer economy. Although the company expects to
offset the effects of the economic slowdown with operational initiatives such as
the consolidation of the chemical businesses, a major sourcing initiative, other
cost reduction projects, and aggressive sales efforts, further deterioration in
economic conditions could negatively impact future earnings.
The lighting equipment segment reported revenue of $368.8 million for the third
quarter, representing a decrease of $3.0 million compared to the previous year.
The decrease in revenue during the quarter resulted primarily from a continued
softening in the non-residential construction market. The company expects the
non-residential construction market to remain flat or slightly down from current
levels over the remainder of calendar year 2001. Operating profit for the third
quarter increased $4.2 million to $32.1 million versus $27.9 million one year
ago as the decrease in revenue was offset by manufacturing efficiencies and
other cost reductions. On a year-to-date basis, revenue increased $3.0 million
to $1.1 billion, or less than 1 percent. Excluding a $1.0 million pretax charge
during the first quarter of fiscal 2000 for closing a manufacturing facility in
California, year-to-date operating profit remained relatively flat as profit
improvements during the third quarter were offset by increased spending for
sales, marketing and technology initiatives, and costs to establish a Texas
distribution center.
Revenue in the chemical segment of $136.8 million and $386.5 million for the
quarter and nine months ended May 31, 2001, respectively, increased $3.1 million
and $13.3 million, respectively, compared to the same prior-year periods. The
increase was due to sales volume growth in North America in the retail,
industrial, and institutional channels, offset somewhat by a decrease in revenue
in Europe and Australia. The decrease in international revenue was attributable,
in part, to unfavorable foreign currency fluctuations. The chemical segment
realized a slight loss for the quarter as the profit contribution from the
increase in revenue was more than offset by a loss on the sale of the segment's
French and Australian operations. In addition to these factors, operating profit
for the nine months ended May 31, 2001 decreased compared to a year ago as a
result of costs incurred to integrate the chemical operations, increased energy
costs, and up-front costs associated with developing new sales representatives.
As part of an initiative to refocus the overseas operations of the chemical
segment, the company sold its Australian subsidiary, NSI International Pty,
Ltd., resulting in a pretax loss of $5.6 million. In addition, the company
entered into a contract to sell its French operations, as well as certain
trademarks and formulas. The company recorded an estimated pretax loss on this
transaction of $9.0 million and finalized the sale on June 29, 2001. The
combined pretax loss of $14.6 million is included in "(Gain) loss on sale of
businesses" in the accompanying Consolidated Statements of Income.
Page 14
Textile rental segment revenue, representing all of the company's service
revenue, increased $5.0 million to $88.0 million during the third quarter and
increased $10.6 million to $248.7 million year-to-date primarily as a result of
additional volume associated with several new large customer accounts, price
increases, and revenues associated with acquired businesses. Operating margins
during the third quarter remained in line with the same period a year ago. The
year-to-date decrease in operating margins primarily resulted from higher
natural gas prices, costs incurred to close a facility in order to reduce the
segment's cost structure and improve customer service, increased retiree medical
and other insurance costs, and fewer gains associated with the sale of assets.
During the second quarter of 2001, management performed a review of the
liabilities recorded in connection with the textile rental segment's 1997
uniform plants divestiture. In 1997, the textile rental segment accrued for
items related to the sale of its uniform plants, including environmental
exposures. Based on the advice of the company's environmental experts, the
company decreased its estimates for certain environmental exposures and, as a
result, reduced the related liability and recorded a pretax gain of
approximately $2.0 million. The gain is included in "(Gain)loss on sale of
businesses" in the accompanying Consolidated Statements of Income.
Third quarter revenue in the envelope segment decreased $1.2 million compared to
the respective prior year period as a result of lower volumes in the courier and
direct mail markets. Revenue increased $2.8 million, or 1.7 percent, to $168.5
million for the nine months ended May 31, 2001 compared to a year ago primarily
because of higher sales volumes to strategic partners during the first quarter.
Operating profit for the quarter ended May 31, 2001 increased $.8 million
compared to the quarter ended May 31, 2000 primarily because of lower production
costs. Operating profit for the nine-month period decreased $2.2 million to $4.0
million principally as a result of higher costs for raw materials during the
first half of the year, power outages in California, and costs associated with
reorganizing the Miami, Florida manufacturing facility.
Corporate expenses for the third quarter of $6.8 million were $1.3 million
higher than the previous year. The increase for the quarter was primarily a
result of higher costs associated with strategic and operational initiatives.
For the nine months ended May 31, 2001, corporate expenses increased $4.3
million to $17.6 million. Higher year-to-date corporate expenses were primarily
caused by lower-than-normal long-term incentive compensation expense in the
prior-year first quarter and higher costs related to strategic and operational
initiatives. Net interest expense increased for the quarter and year-to-date as
a result of higher outstanding debt balances and higher interest rates.
Additionally, during the third quarter of fiscal 2001, the provision for income
taxes increased to 42.7 percent of pretax income as a result of nondeductible
losses associated with the chemical segment's divestiture of its French
operations. On a year-to-date basis, the provision for income taxes was 38.7
percent of pretax income compared to 38.8 percent in the prior year. The
year-to-date decrease is primarily attributable to the implementation of various
tax-saving strategies during the current year, offset by nondeductible losses
related to one of the chemical segment divestitures.
Liquidity and Capital Resources
Operating Activities
- --------------------
Operations provided cash of $93.8 million during the nine months ended May 31,
2001 compared with $41.8 million during the respective period of the prior year.
The improvement in operating cash flows was largely due to an increase in net
cash provided by receivables and inventory primarily as a result of the
implementation of working capital initiatives. Improvements in cash flow from
these items were partially offset by the decrease in net income.
Investing Activities
- --------------------
Investing activities used cash of $47.7 million versus $100.7 million in the
prior year. The change in investing cash flows related primarily to lower
capital expenditures and acquisition spending and an increase in cash provided
from the sale of businesses. Higher acquisition spending in fiscal 2000 was
primarily due to remaining payments associated with the 1999 acquisition of
Holophane.
Capital expenditures totaled $53.7 million for the nine months ended May 31,
2001 compared to $78.8 million in the prior period. In the lighting equipment
segment, investments were made primarily in manufacturing cost improvements, new
product tooling, and the completion of a new corporate headquarters. The
envelope segment invested in manufacturing process improvements and information
systems. In the chemical segment, capital expenditures were associated with
manufacturing equipment and facilities improvements. Capital investments in the
textile rental segment were primarily attributable to building improvements,
equipment upgrades, and information systems. In the same period last year,
capital spending was primarily attributable to the lighting equipment, envelope,
and textile rental segments. The lighting equipment segment invested in land,
buildings, and equipment for a new plant in Mexico, manufacturing cost
improvements, and new product tooling. Capital expenditures in the envelope
segment related primarily to new folding capacity, manufacturing process
improvements, and information systems. The textile rental segment's expenditures
related to replacing old equipment and delivery truck purchases and
refurbishments.
Page 15
Management believes current cash balances, anticipated cash flows from
operations, available funds from the commercial paper program, short-term
secured borrowings, and a committed credit facility, as well as the
complimentary lines of credit, are sufficient to meet the company's planned
level of capital spending and general operating cash requirements for at least
the next twelve months.
Financing Activities
- --------------------
Cash used for financing activities totaled $38.0 million during the nine-month
period compared to cash provided of $59.0 million one year ago, primarily as a
result of a reduction in cash provided by net borrowings. The decrease in cash
provided by net borrowings was primarily due to improved operating cash flows
and a decrease in capital expenditures and acquisition spending. Year-to-date
dividend payments totaled $40.7 million, or 99 cents per share, compared with
$39.9 million, or 98 cents per share, in the previous year.
In May 2001, the company entered into a three-year agreement (the "Receivables
Facility") to borrow, on an ongoing basis, up to $150.0 million secured by
undivided interests in a defined pool of trade accounts receivable of the
lighting equipment and chemical segments. At May 31, 2001, net trade accounts
receivable pledged as security for borrowings under the Receivables Facility
totaled $220.4 million. Borrowings outstanding at May 31, 2001 of $118.9 million
were used to reduce borrowings under the company's commercial paper program.
Interest rates under the Receivables Facility are based on the LIBOR rate.
In June 2001, the company renewed the $250.0 million, 364-day committed credit
facility (the "Revolving Credit Facility") with six domestic banks. The
Revolving Credit Facility supports the company's $250.0 million commercial paper
program. Interest rates under the Revolving Credit Facility are based on the
LIBOR rate or other rates, at the company's option. The company pays an annual
fee on the commitment based on the company's debt rating.
Legal Proceedings
- -----------------
For information concerning legal proceedings, including trends and developments
involving legal proceedings, see footnote 10 to the financial statements
included in this filing.
Environmental Matters
- ---------------------
For information concerning environmental matters, including trends and
developments involving environmental matters, see footnote 11 to the financial
statements included in this filing.
Quantitative and Qualitative Disclosures About Market Risk
- ----------------------------------------------------------
The company is exposed to market risks that may impact the Consolidated Balance
Sheets, Consolidated Statements of Income, and Consolidated Statements of Cash
Flows due to changing interest rates and foreign exchange rates. The company
does not currently participate in any significant hedging activities, nor does
it currently utilize any significant derivative financial instruments. The
following discussion provides additional information regarding the company's
market risks.
Interest Rates- Interest rate fluctuations expose the company's variable-rate
debt to changes in interest expense and cash flows. The company's variable-rate
debt, primarily commercial paper and short-term secured borrowings, amounted to
$269.4 million at May 31, 2001. Based on outstanding borrowings at quarter-end,
a 10 percent adverse change in market interest rates at May 31, 2001 would
result in additional annual after-tax interest expense of approximately $0.8
million. Although a fluctuation in interest rates would not affect interest
expense or cash flows related to the $360 million publicly traded notes, the
company's primary fixed-rate debt, a 10 percent increase in market interest
rates at May 31, 2001 would decrease the fair value of these notes to
approximately $345.7 million.
Foreign Exchange Rates-The majority of the company's revenue, expense, and
capital purchases are transacted in U.S. dollars. The company does not believe a
10 percent fluctuation in average foreign currency rates would have a material
effect on its consolidated financial position or results of operations. The
company does not engage in speculative transactions, nor does the company hold
or issue financial instruments for trading purposes. To the extent possible, the
company mitigates its exposure to unfavorable foreign currency translation
adjustments through the use of foreign-currency denominated debt agreements.
Page 16
Cautionary Statement Regarding Forward-Looking Information
- ----------------------------------------------------------
This filing contains forward-looking statements, within the meaning of the
Private Securities Litigation Reform Act of 1995, that involve risks and
uncertainties. Consequently, actual results may differ materially from those
indicated by the forward-looking statements. Statements made herein that may be
considered forward looking include statements concerning: (a) expectations
regarding a softer economy and the impact of the softer economy on the company's
operations and future earnings; (b) the ability of the company to offset the
effects of an economic slowdown with operational initiatives such as the
consolidation of the chemical businesses, a major sourcing initiative, other
cost reduction projects, and aggressive sales efforts; (c) expectations related
to growth in the non-residential construction market over the remainder of
calendar year 2001; (d) the ability of the company to meet its planned level of
capital spending and general operating cash requirements for the next twelve
months; (e) the potential impact on the company's consolidated financial
position or results of operations of an adverse fluctuation in average foreign
currency rates; (f) anticipated benefits of the spin-off of the company's
lighting and chemical segments such as the ability of management to focus on
strategic initiatives and new business opportunities, improved cost structures
and operating efficiencies, and a better alignment of equity-based compensation
to operating performance; (g) the timing of the completion of the spin-off; and
(h) expectations related to contingent liabilities involving environmental
matters and legal proceedings. A variety of risks and uncertainties could cause
the company's actual results to differ materially from the anticipated results
or other expectations expressed in the company's forward-looking statements. The
risks and uncertainties include without limitation the following: (a) the
uncertainty of general business and economic conditions, including the potential
for a more severe slowdown in non-residential construction awards, interest rate
changes, and fluctuations in commodity and raw material prices or foreign
currency rates; (b) unexpected developments and outcomes in the company's legal
and environmental proceedings; (c) underlying assumptions or expectations
related to the spin-off transaction prove to be inaccurate or unrealized; and
(d) the company's ability to realize the anticipated benefits of strategic and
operational initiatives related to increased productivity, new product
development, technological advances, cost synergies, the consolidation of the
company's chemical businesses, sourcing, decreases in net working capital, and
the achievement of sales growth across the business segments.
Page 17
PART II. OTHER INFORMATION
--------------------------
Item 1. Legal Proceedings
- --------------------------
For information concerning legal proceedings, including trends and developments
involving legal proceedings, see footnote 10 to the financial statements
included in this filing.
Item 6. Exhibits and Reports on Form 8-K
- ----------------------------------------
(a) Exhibits are listed on the Index to Exhibits (page 19).
(b) There were no reports on Form 8-K for the three months ended May 31, 2001.
Page 18
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
NATIONAL SERVICE INDUSTRIES, INC.
REGISTRANT
DATE July 3, 2001 /s/KENYON MURPHY
-------------------
KENYON MURPHY
SENIOR VICE PRESIDENT
AND GENERAL COUNSEL
DATE July 3, 2001 /s/BROCK HATTOX
-------------------
BROCK HATTOX
EXECUTIVE VICE PRESIDENT AND
CHIEF FINANCIAL OFFICER
Page 19
INDEX TO EXHIBITS
-----------------
Page No.
--------
EXHIBIT 10(i)A (1) Third Amendment to US$250,000,000 Credit Agreement, dated as of June
27, 2001, among National Service Industries, Inc., Certain of its 20
Subsidiaries, Certain Listed Banks, Bank One, NA, as Administrative
Agent, Wachovia Bank, N.A., as Syndication Agent, and SunTrust Bank,
as Documentation Agent.
(2) Receivables Sale Agreement between NSI Enterprises, Inc., as seller, 30
and National Service Industries, Inc., as purchaser, dated as of May
2, 2001.
(3) Receivables Sale and Contribution Agreement between National Service 66
Industries, Inc., as seller, and NSI Funding, Inc., as buyer, dated as
of May 2, 2001.
(4) Credit and Security Agreement, dated as of May 2, 2001, among NSI 120
Funding, Inc., National Service Industries, Inc., Blue Ridge Asset
Funding Corporation, Certain Liquidity Banks, and Wachovia Bank, N.A.,
as Agent.
(5) Amendment No. 1, dated May 24, 2001, to the Credit and Security 232
Agreement between NSI Funding, Inc., National Service Industries,
Inc., Blue Ridge Asset Funding Corporation, and Wachovia Bank, N.A.,
as Agent.
(6) Performance Undertaking, dated as of May 2, 2001, between National 237
Service Industries, Inc. and NSI Funding, Inc.
