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 February 28, 2002.
-----------------
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 10,963,172 shares as of March 31, 2002.
Page 2
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
INDEX
Page No.
--------
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
CONSOLIDATED BALANCE SHEETS (Unaudited) -
FEBRUARY 28, 2002 AND AUGUST 31, 2001 3
CONSOLIDATED STATEMENTS OF INCOME (Unaudited) -
THREE AND SIX MONTHS ENDED FEBRUARY 28, 2002 AND 2001 4
CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) -
SIX MONTHS ENDED FEBRUARY 28, 2002 AND 2001 5
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 6-16
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS 17-21
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT
MARKET RISK 21
PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS 22
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 22
SIGNATURES 22
INDEX TO EXHIBITS 22
Page 3
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
(In thousands, except share data)
February 28, August 31,
2002 2001
----------- -----------
ASSETS
Current Assets:
Receivables, less reserves for doubtful accounts of $1,649
at February 28, 2002, and
$1,798 at August 31, 2001 $ 59,839 $ 60,406
Inventories, at the lower of cost (on a first-in,
first-out basis) or market 17,451 19,195
Linens in service, net of amortization 51,712 56,910
Deferred income taxes 11,490 9,138
Prepayments 3,194 11,300
Insurance receivable (Note 8) 30,193 28,616
Other current assets 2,582 804
----------- -----------
Total Current Assets 176,461 186,369
Property, Plant, and Equipment, at cost:
Land 12,845 12,775
Buildings and leasehold improvements 55,854 57,433
Machinery and equipment 259,861 258,344
----------- -----------
Total Property, Plant, and Equipment 328,560 328,552
Less: Accumulated depreciation and amortization 163,309 157,507
----------- -----------
165,251 171,045
Other Assets:
Goodwill -- 28,432
Other intangibles 7,755 8,629
Insurance receivable (Note 8) 63,639 66,574
Other 37,117 37,049
----------- -----------
Total Other Assets 108,511 140,684
Net assets of discontinued operations (Note 5) -- 400,296
----------- -----------
Total Assets $ 450,223 $ 898,394
=========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
Current Liabilities:
Current maturities of long-term debt (Note 7) $ 962 $ 1,011
Notes payable (Note 7) 11,000 1,999
Accounts payable 18,415 28,164
Accrued salaries, commissions, and bonuses 9,600 7,050
Current portion of self-insurance reserves 4,212 3,119
Environmental reserve (Note 9) 6,789 7,291
Current portion of litigation reserve (Note 8) 29,160 30,453
Other accrued liabilities 20,048 19,561
----------- -----------
Total Current Liabilities 100,186 98,648
Long-Term Debt, less current maturities (Note 7) 1,628 1,990
----------- -----------
Deferred Income Taxes 24,079 32,431
----------- -----------
Self-Insurance Reserves, less current portion 10,969 12,477
----------- -----------
Litigation Reserve, less current portion (Note 8) 72,740 82,917
----------- -----------
Other Long-Term Liabilities 6,485 7,303
----------- -----------
Commitments and Contingencies (Notes 8 and 9)
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, 14,478,578
shares issued (Note 11) 14,479 14,480
Paid-in capital 14,313 72,860
Retained earnings 564,300 995,537
Unearned compensation on restricted stock (4,771) (880)
Accumulated other comprehensive income (43) (43)
----------- -----------
588,278 1,081,954
Less: Treasury stock, at cost (3,532,106 shares at February 28, 2002
and 4,173,299 shares at August 31, 2001) 354,142 419,326
----------- -----------
Total Stockholders' Equity 234,136 662,628
----------- -----------
Total Liabilities and Stockholders' Equity $ 450,223 $ 898,394
=========== ===========
The accompanying notes to consolidated financial statements are an integral part
of these balance sheets.
Page 4
CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED)
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
(In thousands, except per-share data)
THREE MONTHS ENDED SIX MONTHS ENDED
---------------------------- ----------------------------
February 28, February 28, February 28, February 28,
2002 2001 2002 2001
------------ ------------ ------------ ------------
Sales and Service Revenues:
Service revenues $ 77,335 $ 79,608 $ 156,171 $ 160,715
Net sales of products 54,703 55,534 110,256 115,114
--------- --------- --------- ---------
Total Revenues 132,038 135,142 266,427 275,829
Costs and Expenses:
Cost of services 46,398 46,201 94,162 92,634
Cost of products sold 42,012 44,022 84,028 90,058
Selling and administrative expenses 44,033 42,579 88,791 83,982
Restructuring expense and other charges (Note 10) (381) -- 5,439 --
Gain on sale of business (379) (2,359) (379) (2,359)
Amortization expense 432 716 913 1,431
Interest expense 168 439 279 889
Other (income) expense, net (176) 227 (657) 2,139
--------- --------- --------- ---------
Total Costs and Expenses 132,107 131,825 272,576 268,774
--------- --------- --------- ---------
(Loss) income from continuing operations before income taxes and
cumulative effect of a change in accounting principle (69) 3,317 (6,149) 7,055
Income tax (benefit) expense (28) 1,227 (2,460) 2,610
--------- --------- --------- ---------
(Loss) income from continuing operations before cumulative
effect of a change in accounting principle (41) 2,090 (3,689) 4,445
--------- --------- --------- ---------
Discontinued Operations (Note 5):
Income from discontinued operations, net of tax of $7,066
in 2002, and $8,067 and $16,396 for the three and six
months ended February 28, 2001, respectively -- 13,735 11,534 27,917
Costs associated with effecting the spin-off, net of tax
benefit of $717 -- -- (19,069) --
--------- --------- --------- ---------
Total Discontinued Operations -- 13,735 (7,535) 27,917
Cumulative effect of a change in accounting principle, net
of tax benefit of $10,830 -- -- (17,602) --
--------- --------- --------- ---------
Net (Loss) Income $ (41) $ 15,825 $ (28,826) $ 32,362
========= ========= ========= =========
Basic earning per share (split adjusted):
(Loss) earnings per share from continuing operations before
cumulative effect of a change in accounting principle $ -- $ 0.20 $ (0.36) $ 0.43
Discontinued operations:
Income from discontinued operations, net of tax -- 1.34 1.12 2.73
Costs associated with effecting the spin-off, net of
tax benefit -- -- (1.85) --
--------- --------- --------- ---------
Total Discontinued Operations -- 1.34 (0.73) 2.73
--------- --------- --------- ---------
Cumulative effect of a change in accounting principle, net of
tax benefit -- -- (1.71) --
--------- --------- --------- ---------
Net (Loss) Income $ -- $ 1.54 $ (2.80) $ 3.16
========= ========= ========= =========
Diluted earning per share (split adjusted):
(Loss) earnings per share from continuing operations before
cumulative effect of a change in accounting principle $ -- $ 0.20 $ (0.36) $ 0.43
Discontinued operations:
Income from discontinued operations, net of tax -- 1.33 1.12 2.71
Costs associated with effecting the spin-off, net of
tax benefit -- -- (1.85) --
--------- --------- --------- ---------
Total Discontinued Operations -- 1.33 (0.73) 2.71
--------- --------- --------- ---------
Cumulative effect of a change in accounting principle,
net of tax benefit -- -- (1.71) --
--------- --------- --------- ---------
Net (Loss) Income $ -- $ 1.53 $ (2.80) $ 3.14
========= ========= ========= =========
Basic Weighted Average Number of Shares Outstanding 10,317 10,269 10,310 10,251
========= ========= ========= =========
Diluted Weighted Average Number of Shares Outstanding 10,317 10,374 10,310 10,296
========= ========= ========= =========
The accompanying notes to consolidated financial statements are an integral
part of these statements.
Page 5
CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
(In thousands)
SIX MONTHS ENDED
-------------------------------
February 28, February 28,
2002 2001
------------ ------------
Cash Provided by (Used for) Operating Activities:
Net (loss) income $ (3,689) $ 4,445
Adjustments to reconcile net income to net cash provided by (used for)
operating activities:
Depreciation and amortization 12,530 13,956
Provision for losses on accounts receivable 643 894
(Gain) loss on the sale of property, plant, and equipment (81) 1,697
Restructuring expense and other charges 5,439 --
Gain on the sale of business (379) (2,359)
Change in assets and liabilities, net of effect of acquisitions
and divestitures:
Receivables (354) (42)
Inventories and linens in service, net 6,011 (1,008)
Deferred income taxes 842 (1,156)
Prepayments and other assets (299) (1,819)
Accounts payable and accrued liabilities (8,553) 10,777
Self-insurance reserves and other long-term liabilities (12,217) (5,516)
-------- --------
Net Cash (Used for) Provided by Continuing Operations (107) 19,869
Net Cash Provided by Discontinued Operations 6,935 13,090
-------- --------
Net Cash Provided by Operating Activities 6,828 32,959
-------- --------
Cash Provided by (Used for) Investing Activities:
Purchases of property, plant, and equipment (10,607) (8,361)
Sale of property, plant, and equipment 705 437
Acquisitions (60) (223)
Divestitures 1,062 2,286
Change in other assets (149) (1,085)
-------- --------
Net Cash Used for Investing Activities (9,049) (6,946)
-------- --------
Cash Provided by (Used for) Financing Activities:
Borrowing of notes payable, net 9,001 --
Repayments of long-term debt (411) (450)
Treasury stock transactions, net 679 1,532
Cash dividends paid (7,048) (27,095)
-------- --------
Net Cash Provided by (Used for) Financing Activities 2,221 (26,013)
-------- --------
Net Change in Cash and Cash Equivalents -- --
Cash and Cash Equivalents at Beginning of Period -- --
-------- --------
Cash and Cash Equivalents at End of Period $ -- $ --
======== ========
Supplemental Cash Flow Information:
Income taxes paid during the period $ 3,501 $ 29,168
Interest paid during the period 12,987 21,800
Noncash Activities:
Treasury shares issued under long-term incentive plan $ -- $ 3,637
Cumulative effect of a change in accounting principle 28,432 --
Noncash aspects of sale of business:
Reduction of liabilities recorded in conjunction with the
1997 sale of business 379 2,069
The accompanying notes to consolidated financial statements are an integral part
of these statements.
Page 6
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES
(Dollar amounts in thousands, except per-share data and information contained
in Note 8)
1. BASIS OF PRESENTATION
On November 7, 2001, management of National Service Industries, Inc. ("NSI" or
the "Company") approved the spin-off of its lighting equipment and chemicals
businesses into a separate publicly-traded company with its own management and
board of directors. The spin-off was effected on November 30, 2001 through a
tax-free distribution ("Distribution") of 100% of the outstanding shares of
common stock of Acuity Brands, Inc. ("Acuity"), a wholly-owned subsidiary of NSI
owning and operating the lighting equipment and chemicals businesses. Each NSI
stockholder of record as of November 16, 2001, the record date for the
distribution, received one share of Acuity common stock for each share of NSI
common stock held at that date.
Certain NSI corporate assets, liabilities, and expenses have been allocated to
Acuity based on an estimate of the proportion of corporate amounts allocable to
Acuity, utilizing such factors as revenues, number of employees, and other
relevant factors. As a result of the spin-off, the Company's financial
statements have been prepared with Acuity's net assets, results of operations,
and cash flows presented as discontinued operations. All historical statements
have been restated to conform with this presentation. In the opinion of
management, the allocations have been made on a reasonable basis.
The interim consolidated financial statements included herein have been prepared
by the Company without audit and the consolidated balance sheet as of August 31,
2001 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 February 28, 2002, the consolidated results of operations for the
three and six months ended February 28, 2002 and 2001, and the consolidated cash
flows for the six months ended February 28, 2002 and 2001. 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 generally accepted accounting principles 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,
2001.
The results of operations for the three and six months ended February 28, 2002
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. RECENT ACCOUNTING STANDARDS
NEWLY ADOPTED ACCOUNTING STANDARDS
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 141 ("SFAS 141") "Business Combinations," and Statement No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets." SFAS 141 prospectively prohibits
the pooling of interests method of accounting for business combinations
initiated after June 30, 2001. SFAS 142 requires companies to cease amortizing
goodwill that existed at June 30, 2001 and establishes a new method for testing
goodwill for impairment on an annual basis (or an interim basis if an event
occurs that might reduce the fair value of a reporting unit below its carrying
value.) Any goodwill resulting from acquisitions completed after June 30, 2001
will not be amortized. SFAS 142 also requires that an identifiable intangible
asset that is determined to have an indefinite useful economic life not be
amortized, but separately tested for impairment using a fair value based
approach.
Page 7
The Company adopted SFAS 142 as of September 1, 2001. Summarized information for
the Company's acquired intangible assets is as follows:
Acquired Intangible Assets
February 28, 2002 August 31, 2001
--------------------------------- -------------------------------
Gross Carrying Accumulated Gross Carrying Accumulated
Amount Amortization Amount Amortization
-------------- ------------ -------------- ------------
Amortized intangible assets
Customer contracts $10,249 $(3,065) $10,215 $(2,348)
Other 1,433 (862) 1,428 (666)
------- ------- ------- -------
Total $11,682 $(3,927) $11,643 $(3,014)
======= ======= ======= =======
The Company amortizes customer contracts over estimated useful lives of seven
years. Other acquired intangible assets, consisting primarily of restrictive
covenant agreements, are amortized over the lives of the agreements, which
average approximately four years. The Company recorded amortization expense of
$432 and $913 related to intangible assets for the three and six months ended
February 28, 2002, and $417 and $834 for the three and six months ended February
28, 2001, respectively.
The changes in the carrying amount of goodwill during the period are summarized
as follows:
Textile
Rental Envelope Total
------ -------- -----
Balance as of August 31, 2001 $ 4,162 $ 24,270 $ 28,432
Goodwill acquired during the quarter -- -- --
Transitional impairment losses (4,162) (24,270) (28,432)
------- -------- --------
Balance as of February 28, 2002 $ -- $ -- $ --
======= ======== ========
The textile rental and envelope segments each tested goodwill for impairment
during the first quarter of 2002 as required by SFAS 142 upon adoption,
utilizing a combination of valuation techniques including the expected present
value of future cash flows, a market multiple approach and a comparable
transaction approach. As a result of this valuation process as well as the
application of the remaining provisions of SFAS 142, the Company recorded a
pre-tax transitional impairment loss of $28,432, representing the write-off of
all of the Company's existing goodwill. This write-off was reported as a
cumulative effect of a change in accounting principle, on a net of tax basis, in
the Company's Consolidated Statement of Income for the six months ended February
28, 2002.
Page 8
Prior to the adoption of SFAS 142 in September 2001, the Company amortized
goodwill over estimated useful lives ranging from 10 years to 30 years. Had the
Company accounted for goodwill consistent with the provisions of SFAS 142 in
prior periods, the Company's income from continuing operations and net income
would have been affected as follows:
Three Months Ended Six Months Ended
February 28, February 28,
----------------------------- ---------------------------
2002 2001 2002 2001
------------- ---------- ---------- ----------
Reported (loss) income from
continuing operations $ (41) $ 2,090 $ (3,689) $ 4,445
Add back: Goodwill amortization -- 188 -- 376
------------- ---------- ---------- ----------
Adjusted (loss) income from
continuing operations $ (41) $ 2,278 $ (3,689) $ 4,821
============= ========== ========== ==========
Adjusted net (loss) income $ (41) $ 16,013 $ (28,826) $ 32,738
============= ========== ========== ==========
Basic earning per share:
Reported (loss) income from
continuing operations $ -- $ 0.20 $ (0.36) $ 0.43
Add back: Goodwill amortization -- 0.02 -- 0.04
------------- ---------- ---------- ----------
Adjusted (loss) income from
continuing operations $ -- $ 0.22 $ (0.36) $ 0.47
============= ========== ========== ==========
Adjusted net (loss) income $ -- $ 1.56 $ (2.80) $ 3.19
============= ========== ========== ==========
Diluted earning per share:
Reported (loss) income from
continuing operations $ -- $ 0.20 $ (0.36) $ 0.43
Add back: Goodwill amortization -- 0.02 -- 0.04
------------- ---------- ---------- ----------
Adjusted (loss) income from
continuing operations $ -- $ 0.22 $ (0.36) $ 0.47
============= ========== ========== ==========
Adjusted net (loss) income $ -- $ 1.54 $ (2.80) $ 3.18
============= ========== ========== ==========
Page 9
3. BUSINESS SEGMENT INFORMATION
The following tables summarize the Company's business segment information from
continuing operations:
DEPRECIATION CAPITAL
SALES AND OPERATING AND EXPENDITURES
SERVICE PROFIT AMORTIZATION INCLUDING
THREE MONTHS ENDED FEBRUARY 28, 2002 REVENUES (LOSS) EXPENSE ACQUISITIONS
------------------------------------------------------------
Textile Rental $ 77,335 $ 1,342 $4,071 $3,155
Envelope 54,703 649 1,800 2,381
----------------------------------------------------------
132,038 1,991 5,871 5,536
Corporate -- (1,892) 125 135
Interest expense -- (168) -- --
----------------------------------------------------------
Total $132,038 $ (69) $5,996 $5,671
==========================================================
DEPRECIATION CAPITAL
SALES AND OPERATING AND EXPENDITURES
SERVICE PROFIT AMORTIZATION INCLUDING
THREE MONTHS ENDED FEBRUARY 28, 2001 REVENUES (LOSS) EXPENSE ACQUISITIONS
------------------------------------------------------------
Textile Rental $ 79,608 $ 4,009 $4,121 $3,733
Envelope 55,534 863 2,431 1,258
----------------------------------------------------------
135,142 4,872 6,552 4,991
Corporate -- (1,116) 475 81
Interest expense -- (439) -- --
----------------------------------------------------------
Total $135,142 $ 3,317 $7,027 $5,072
==========================================================
DEPRECIATION CAPITAL
SALES AND OPERATING AND EXPENDITURES
SERVICE PROFIT AMORTIZATION INCLUDING
SIX MONTHS ENDED FEBRUARY 28, 2002 REVENUES (LOSS) EXPENSE ACQUISITIONS
------------------------------------------------------------
Textile Rental $156,171 $(4,037) $8,188 $7,260
Envelope 110,256 2,803 4,004 3,219
----------------------------------------------------------
266,427 (1,234) 12,192 10,479
Corporate -- (4,636) 338 188
Interest expense -- (279) -- --
----------------------------------------------------------
Total $266,427 $(6,149) $12,530 $10,667
==========================================================
DEPRECIATION CAPITAL
SALES AND OPERATING AND EXPENDITURES
SERVICE PROFIT AMORTIZATION INCLUDING
SIX MONTHS ENDED FEBRUARY 28, 2001 REVENUES (LOSS) EXPENSE ACQUISITIONS
------------------------------------------------------------
Textile Rental $160,715 $ 7,736 $8,268 $5,804
Envelope 115,114 2,575 4,756 2,342
----------------------------------------------------------
275,829 10,311 13,024 8,146
Corporate -- (2,367) 932 438
Interest expense -- (889) -- --
----------------------------------------------------------
Total $275,829 $ 7,055 $13,956 $8,584
==========================================================
Total Assets
-------------------------------------
February 28, August 31,
2002 2001
---------------- ----------------
Textile Rental $212,979 $231,422
Envelope 112,689 141,945
---------------- ----------------
Subtotal 325,668 373,367
Corporate 124,555 124,731
---------------- ----------------
Total $450,223 $498,098
================ ================
Page 10
4. INVENTORIES
Major classes of inventory as of February 28, 2002 and August 31, 2001 were as
follows:
February 28, August 31,
2002 2001
------------ ----------
Raw Materials and Supplies $ 6,979 $ 6,716
Work-in-Process 2,261 817
Finished Goods 8,211 11,662
------- -------
Total $17,451 $19,195
======= =======
5. DISCONTINUED OPERATIONS
On November 7, 2001, the Company's board of directors approved the spin-off of
its lighting equipment and chemicals businesses into a separate publicly-traded
company with its own management and board of directors. The spin-off was
effected on November 30, 2001 through a tax-free distribution of 100% of the
outstanding shares of common stock of Acuity, a wholly-owned subsidiary of the
Company owning and operating the lighting equipment and chemicals businesses.
Each NSI stockholder of record as of November 16, 2001, the record date for the
Distribution, received one share of the Acuity common stock for each share of
NSI common stock held at that date.
As a result of the November 2001 spin-off, the Company's financial statements
have been prepared with these businesses' net assets, results of operations, and
cash flows presented as discontinued operations through the effective date of
the Distribution, November 30, 2001. All historical statements have been
restated to conform with this presentation.
Summarized financial information for discontinued operations is as follows:
August 31,
2001
---------
Current Assets $ 559,116
Property, Plant, and Equipment - net 248,423
Goodwill and Other Intangibles 468,944
Other Long-Term Assets 54,092
Current Liabilities (442,067)
Long-Term Debt, less current maturities (373,707)
Other Long-Term Liabilities (131,503)
Accumulated Other Comprehensive Income Items 16,998
---------
Net Assets of Discontinued Operations $ 400,296
=========
In conjunction with the spin-off, the Company and Acuity entered into various
agreements that address the allocation of assets and liabilities between them
and that define their relationship after the separation, including a
distribution agreement, a tax disaffiliation agreement, an employee benefits
agreement, and a transition services agreement.
In addition, Acuity and NSI entered into a put option agreement, whereby NSI has
the option to require Acuity to purchase the property where NSI's corporate
headquarters are located for a purchase price equal to 85 percent of the
agreed-upon fair market value of the property. This put option will commence on
June 1, 2002 and expire on May 31, 2003.
6. 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
dilutive effect of potential common shares, including options and restricted
stock.
Page 11
The following table calculates basic earnings per common share and diluted
earnings per common share at February 28, and reflects the January 7, 2002
one-for-four reverse stock split further described in note 11:
Three Months Ended Six Months Ended
February 28, February 28,
--------------------- ---------------------
2002 2001 2002 2001
-------- ------- -------- -------
Basic earnings per common share:
(Loss) income from continuing operations before
cumulative effect of a change in accounting principle $ (41) $ 2,090 $ (3,689) $ 4,445
Basic weighted average shares outstanding 10,317 10,269 10,310 10,251
-------- ------- -------- -------
Basic earnings per common share $ -- $ 0.20 $ (0.36) $ 0.43
======== ======= ======== =======
Diluted earnings per common share:
(Loss) income from continuing operations before
cumulative effect of a change in accounting principle $ (41) $ 2,090 $ (3,689) $ 4,445
-------- ------- -------- -------
Basic weighted average shares outstanding 10,317 10,269 10,310 10,251
Add: Shares of common stock assumed issued
upon exercise of dilutive stock options -- 96 -- 41
Add: Unvested restricted stock -- 9 -- 4
-------- ------- -------- -------
Diluted weighted average shares outstanding 10,317 10,374 10,310 10,296
-------- ------- -------- -------
Diluted earnings per common share $ -- $ 0.20 $ (0.36) $ 0.43
======== ======= ======== =======
Stock options to purchase 1,485 and 1,305 shares of common stock for the three
and six months ended February 28, 2002, respectively, and 744 and 759 shares of
common stock for the three and six months ended February 28, 2001, respectively,
were not included in the computation of diluted earnings per share because their
effect would have been antidilutive.
7. LONG-TERM DEBT
Outstanding borrowings at February 28, 2002 included approximately $2,590 in
notes payable at 8.5%.
In October 2001, the Company negotiated a $40,000, three-year committed credit
facility with a single major US bank that became effective at the time of the
spin-off. The facility contains financial covenants including a leverage ratio,
a ratio of income available for fixed charges to fixed charges, and a minimum
net worth. Interest rates under the facility are based on the LIBOR rate or
other rates, at the Company's option. The Company will pay an annual fee on the
commitment based on the Company's leverage ratio. Approximately $11,000 was
outstanding under this facility at February 28, 2002.
8. 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
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 legal claims when payments associated with the claims become
probable and the costs can be reasonably estimated for financial statement
purposes. While management believes that its reserves are appropriate based on
information currently available, the actual costs of resolving pending and
future legal claims against the Company may differ substantially from the
amounts reserved.
Among the product liability claims to which the Company is subject are claims
for personal injury or wrongful death 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. The Company believes its conduct with respect to asbestos-containing
insulation was consistent with recognized safety standards at the relevant
times, and the Company believes there is no basis for imposing punitive damages
against it in connection with asbestos claims. 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,
that the Company did not distribute or install products at certain sites where
exposure is
Page 12
alleged, 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.
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. Pursuant to a written agreement among
CCR members, the Company was responsible for varying percentages of defense and
liability payments on a claim-by-claim basis for each claim in which it was
named in accordance with predetermined sharing formulae. Substantially all of
the Company's portion of those payments were paid directly by the Company's
insurers. Since February 1, 2001, the Company has retained trial counsel
directly, rather than through the CCR, to defend asbestos-related claims against
the Company and has engaged another outside consultant to provide claims
processing and administration services for asbestos-related claims. Now that it
is no longer a member of the CCR, the Company intends to be more vigorous in
defending asbestos-related claims and will seek to dismiss without any
settlement payment claims arising in jurisdictions or involving worksites where
the Company did not distribute or install asbestos-containing products.
During the past two years, certain former members of the CCR have failed to make
payments to the CCR, by reason of bankruptcy or otherwise, for their shares of
certain settlement agreements the CCR had reached on behalf of its members with
plaintiffs. Consequently, with respect to some settlement agreements, the CCR
has been unable to make the full payments contemplated by those agreements. In
some circumstances, the Company and other former members of the CCR have
contributed additional funds to the CCR to permit it to make certain payments
contemplated by the settlement agreements. As of February 28, 2002, the Company
has contributed approximately $5.3 million to the CCR for this purpose, and it
may make further such payments in the future. Payments made since August 31,
2001 have been applied against the Company's accrual for asbestos liabilities
established as of August 31, 2001. Some plaintiffs who are parties to settlement
agreements with the CCR that contemplate payments that the CCR has been unable
to make have commenced litigation against the CCR, the Company, and other former
members to recover amounts due under these settlement agreements. The Company
believes that it should not be liable for settlement payments attributable to
former members of the CCR, and the Company has joined a joint defense group with
other former CCR members to defend these claims.
The Company believes that any amount it pays, including the $5.3 million it has
already contributed to the CCR, on account of payments contemplated by
settlement agreements entered into by the CCR on behalf of its members, should
be covered either by the Company's insurance or by surety bonds and collateral
provided by those former members who failed to meet their obligations. There can
be no assurance, however, that the Company can actually recover any of these
amounts. Accordingly, no insurance or other recovery with respect to these
amounts has been recorded as an asset in the Company's financial statements.
The amount of the Company's liability on account of payments contemplated by
settlement agreements entered into by the CCR is uncertain. The Company has
included in its reserves its estimate of the Company's potential liability in
this respect, but the Company's ultimate liability for these matters could be
greater than estimated if more former CCR members fail to meet their
obligations or if the courts determine that the Company could be liable for
settlement payments that were attributable to other former CCR members.
Several significant companies that are traditional co-defendants in asbestos
claims, both former members of the CCR and non-members, have sought protection
under Chapter 11 of the federal bankruptcy code during the past two years.
Litigation against such co-defendants generally is stayed or restricted as a
result of their bankruptcy filings. The absence of these traditional defendants
may increase the number of claims filed against other defendants, including the
Company, and may increase the cost of resolving such claims. Due to the
uncertainties surrounding the ultimate effect of these bankruptcies on remaining
asbestos defendants, the effect on the amount of the Company's liabilities
cannot be determined.
During the fiscal year ended August 31, 2001, the Company was served with
approximately 30,000 asbestos-related claims and settled approximately 16,000
claims for an average of approximately $1,035 per claim (including approximately
200 claims that were dismissed with no payment). As of August 31, 2001, there
were approximately 35,000 open claims pending against the Company (including
approximately 1,000 claims that were settled in principle after February 1, 2001
but not finalized) and approximately 12,000 additional claims that were settled
in principle prior to February 1, 2001 but not finalized.
During the six months ended February 28, 2002, the Company was served with
approximately 4,900 asbestos-related claims and resolved approximately 14,100
claims for an average of approximately $880 per claim (including approximately
11,300 claims that were dismissed with no payment). As of February 28, 2002,
there were approximately 25,800 open claims pending against the Company
(including approximately 2,800 claims that were settled in principle after
February 1, 2001 but not finalized) and approximately 7,900 additional claims
that were settled in principle prior to February 1, 2001 but not finalized.
As of February 28, 2002 and August 31, 2001, an estimated accrual of $101.9
million and $113.4 million, respectively, for asbestos-related liabilities,
before consideration of insurance recoveries, has been reflected in the
accompanying financial statements, primarily in long-term liabilities. The
amount of the accrual is based on the following: the Company's estimate of
Page 13
indemnity payments and defense costs associated with pending and future
asbestos-related claims to be paid through mid-2005; settlements agreed to but
not paid as of February 28, 2002; the Company's expected payment on account of
settlement obligations of defaulting CCR members; interest on settlement
payments that are subject to ongoing dispute resolution with certain insurance
providers; and other legal fees and expenses. The Company's estimates of
indemnity payments and defense costs associated with pending and future asbestos
claims are based on the Company's estimate of the number of future
asbestos-related claims and the type of disease, if any, alleged or expected to
be alleged in such claims, assumptions regarding the timing and amounts of
settlement payments, the status of ongoing litigation and settlement
initiatives, and the advice of outside counsel with respect to the current state
of the law related to asbestos claims. The ultimate liability for all pending
and future claims cannot be determined with certainty due to the difficulty of
forecasting the numerous variables that can affect the amount of liability.
There are inherent uncertainties involved in estimating these amounts, and the
Company's actual costs in future periods could exceed the Company's estimates
due to changes in facts and circumstances after the date of each estimate.
The Company believes that it has insurance coverage available to recover most of
its asbestos-related costs. The Company has reached settlement agreements with
substantially all of its relevant insurers providing for payment of
substantially all asbestos-related claims (subject to retentions) up to the
various policy limits, except for the Company's payments on account of
settlement obligations of defaulting CCR members, as discussed above. The timing
and amount of future recoveries from insurance carriers will depend on the pace
of claims review and processing by such carriers and on the resolution of any
remaining disputes regarding coverage under such policies. In the event the
Company's insurers dispute amounts billed to them or pay on an untimely basis,
the Company takes all practicable steps to secure payment, including alternative
dispute resolution procedures and litigation to resolve the issues. The Company
has initiated an alternative dispute resolution proceeding with one insurer to
resolve outstanding insurance policy interpretation issues, to secure payment of
past due amounts and to ensure that the insurer's future obligations will be met
in a timely fashion. The Company believes that substantial recoveries from the
insurance carriers are probable. The Company reached this conclusion after
considering its prior insurance-related recoveries in respect of
asbestos-related claims, existing insurance policies, settlement agreements with
insurers, the apparent viability of its insurers, the advice of outside counsel
with respect to the applicable insurance coverage law relating to terms and
conditions of those policies, and a general assessment by the Company and its
advisors of the financial condition of the relevant insurers. Accordingly, an
estimated aggregate insurance recovery of $93.8 million and $95.2 million has
been reflected in the accompanying financial statements as of February 28, 2002
and August 31, 2001, respectively, with respect to previously paid claims and
pending and future claims estimated to be paid through mid-2005 and the other
items included in the accrual of asbestos-related liabilities. Approximately
$30.2 million and $28.6 million of the aggregate insurance recovery and $29.2
million and $30.5 million of the asbestos-related accrual have been classified
as current assets and liabilities in the accompanying balance sheet as of
February 28, 2002 and August 31, 2001, respectively.
Management continues to monitor claims activity, the status of lawsuits
(including settlement initiatives), legislative developments, and costs incurred
in order to ascertain whether an adjustment to the existing accruals should be
made to the extent that historical experience may differ significantly from the
Company's underlying assumptions. As additional information becomes available,
the Company will reassess its liability and revise its estimates as appropriate.
Management currently believes that, based on the factors discussed in the
preceding paragraphs and taking into account the accruals reflected as of
February 28, 2002, the resolution of asbestos-related uncertainties and the
incurrence of asbestos-related costs net of related insurance recoveries should
not have a material adverse effect on the Company's consolidated financial
position or results of operations. However, as the Company's estimates are
periodically re-evaluated, additional accruals to the liabilities reflected in
the Company's financial statements may be necessary, and such accruals could be
material to the results of the period in which they are recorded. Given the
number and complexity of factors that affect the Company's liability and its
available insurance, the actual liability and insurance recovery may differ
substantially from the Company's estimates. No assurance can be given that the
Company will not be subject to significant additional asbestos litigation and
material additional liabilities. If actual liabilities significantly exceed the
Company's estimates or if expected insurance recoveries become unavailable, due
to insolvencies among the Company's primary or excess insurance carriers,
disputes with carriers or otherwise, the Company's results of operations,
liquidity and financial condition could be materially adversely affected.
The Company has been sued in two putative class actions relating to the
collection from customers of National Linen Service of energy surcharges,
environmental charges and sales taxes. One case was filed in the Circuit Court
of Barbour County, Alabama and subsequently has been removed to the United
States District Court for the Middle District of Alabama. The federal court
denied the plaintiff's motion to remand the case to state court. The second case
was filed in the Court of Common Pleas, Fifteenth Judicial Circuit, County of
Horry, South Carolina. That case has been removed to the United States District
Court for South Carolina, Florence Division. The plaintiff has filed a motion to
remand which, as of April 11, 2002, had not been ruled on by the court. As of
April 11, 2002, no substantive discovery has occurred in either case. Based on
information currently available, it is the opinion of management that these
claims are without merit and that the ultimate resolution of these legal
proceedings will not have a material adverse effect on the Company's financial
condition or results of operations.
Page 14
9. 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.
The Company's environmental reserves, which are included in current liabilities,
totaled $6,789 and $7,291 at February 28, 2002 and August 31, 2001,
respectively. The actual cost of environmental issues may be lower or higher
than that reserved due to the difficulty in estimating such costs and potential
changes in the status of government regulations.
Certain environmental laws can impose liability regardless of fault. The federal
Superfund law is an example of such an environmental law. However, liability
under Superfund is mitigated by the presence of other parties who will share in
the costs associated with clean-up of sites. The extent of liability is
determined on a case-by-case basis taking into account many factors, including
the number of other parties whose status or activities also subjects them to
liability regardless of fault.
The Company is currently a party to, or otherwise involved in, legal proceedings
in connection with state and federal Superfund sites, one of which is 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 potentially responsible party ("PRP") due to its limited
involvement at the site and/or the number of viable PRPs. 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 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 referred this
matter to the Environmental Protection Agency for review. At this point in time,
it is not possible to quantify the extent, if any, of the Company's 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 two of the properties in Texas involved in the sale. Because the Company is
not the source of contamination, the Company asserted indemnification claims
against the company from which it bought the properties. The prior owner is
currently addressing the contamination at its expense at one of the properties,
subject to a reservation of rights, and is currently reviewing the Company's
claim regarding the other property. At this time, it is too early to quantify
the Company's potential exposure in these matters, the likelihood of an adverse
result, or the outcome of the Company's indemnification claims 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 $2,000. The gain is included in "Gain on sale
of business" 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.
("Serv-All") 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 and therefore has no liability with respect to the Blydenburgh Landfill
and 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.
In February 2001, 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, issuing a declaratory judgment that the Company is a successor to
Serv-All. Subsequently, the Company and the State of New York each filed a
cross-motion for summary judgment on the Company's liability under the
Comprehensive Environmental Response, Compensation, and Liability Act.
Page 15
On December 12, 2001, the Court granted summary judgment for the State. At a
January 9, 2002 status conference, the Court verbally denied the Company's
motion for summary judgment and explicitly noted that the issues presented by
this case were appropriate for judicial review. The Court reiterated its denial
of the Company's motion in a written order on January 10, 2002. Final judgment
in the amount of $12,477 was entered against the Company on February 1, 2002.
Execution of the judgment was stayed pending appeal to the Second Circuit Court
of Appeals.
The Company filed a notice of appeal to the Second Circuit Court of Appeals on
March 1, 2002. In its appeal, the Company asserted that the trial court erred in
declaring that the Company is a successor to Serv-All, in finding that the
State's claims were not barred by the statute of limitations, and in holding
that the Company is jointly and severally liable for response costs.
Even if the Company were unsuccessful in its appeal to the Second Court of
Appeals, the Company would have a right to seek recovery of response costs from
the many other parties whose wastes were disposed of at the Landfill. At this
point, 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, and thus, no accrual has been recorded related to this matter.
10. RESTRUCTURING EXPENSE AND OTHER CHARGES
During 2001, management conducted reviews of its continuing operations as part
of management's strategic initiative to examine under-performing operations and
to position the Company for an economic slowdown. As a result of these reviews,
the Company approved a significant restructuring program and recorded a related
charge of $5,014 during the fourth quarter of fiscal 2001. The accrual included
severance costs of $3,087 for 367 employees of the textile rental and envelope
segments, all of whom were terminated prior to the end of the fiscal year,
$1,582 in exit expenses to close and consolidate facilities in the envelope
segment, and $345 in losses related to the sale of two textile rental
businesses. As of August 31, 2001, approximately $118 of the severance accrual
had been paid to employees.
During the first quarter of fiscal 2002, the Company closed two facilities in
the textile rental segment and recorded a related charge of $5,820. The charge
included severance costs of $11 for four employees, all of whom were terminated
prior to the end of the first quarter, and $1,396 in exit expenses to close and
consolidate facilities. Exit expenses primarily include costs of lease
terminations and costs to dispose of facilities. Additionally, as a further
result of the closure of the two textile rental facilities, the Company
recognized long-lived asset impairments totaling $4,413. Textile rental assets
to be disposed of were reduced to state them at their estimated fair value less
costs to sell. Assets to be disposed of primarily related to equipment located
in the facilities included in the restructuring program noted above. After the
charge, the remaining net book value of these assets was immaterial. Estimated
fair market values were established based on an analysis of expected future cash
flows.
During the second quarter of fiscal 2002, the Company recorded a reduction of
restructuring and other charges of $381. Reserves of $413 were reduced primarily
due to lower than originally estimated costs to prepare a facility closed in a
prior year for sale. This amount was offset by additional expense of $32 related
to reserves which were established during the fourth quarter of fiscal 2001 and
the first quarter of fiscal 2002. The $32 of expense included a reduction of the
reserve for severance costs of $159, and an increase in the reserve for exit
costs of $191.
The major components of the fiscal 2001 and 2002 restructuring charges and
related activity are as follows:
Reserve, Cash Expense Reserve,
August 31, 2001 Payments (Gain) February 28, 2002
-------------------------------------------------------------------------
Severance costs $2,969 $(2,187) $ (148) $ 634
Exit costs $1,582 $(1,951) $ 1,587 $1,218
The losses resulting from the restructuring activities and asset impairments are
included in "Restructuring expense and other charges" in the Consolidated
Statements of Income.
11. REVERSE STOCK SPLIT
On January 3, 2002, the Company's shareholders approved a one-for-four reverse
stock split of NSI common stock, which began trading on a reverse split basis on
January 7, 2002. As a result of the stock split, every four shares of NSI common
stock were replaced with one share of NSI common stock. The reverse split did
not change the number of authorized shares of NSI common stock or the par value
per share of NSI common stock. All references to common stock, common shares
outstanding, average numbers of common stock shares outstanding and per share
amounts in these Consolidated Financial Statements and Notes to Consolidated
Financial Statements prior to the effective date of the reverse stock split have
been restated to reflect the one-for-four common stock reverse split on a
retroactive basis.
Page 16
12. RESTRICTED STOCK
In January 2002, the Company awarded 627,880 shares of restricted stock to
officers, other key employees and members of the Board of Directors. The shares
vest ratably in four equal annual installments beginning one year from the date
of the 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. Additionally, granted but unvested shares are
forfeited upon termination of employment.
The fair value of the restricted shares on the date of the grant is amortized
ratably over the vesting period. Unearned compensation on the January 2002 grant
of restricted stock of $4,910 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.
Page 17
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 ("NSI" or the "Company") is a diversified service
and manufacturing company operating in two segments: textile rental and
envelopes. The Company remained in solid financial condition at February 28,
2002. Net working capital was $76.3 million, down from $87.7 million at August
31, 2001, and the current ratio was 1.8, down slightly from 1.9 at August 31,
2001.
In July 2001, the Financial Accounting Standards Board ("FASB") issued Statement
No. 141 ("SFAS 141") "Business Combinations," and Statement No. 142 ("SFAS
142"), "Goodwill and Other Intangible Assets." SFAS 141 prospectively prohibits
the pooling of interests method of accounting for business combinations
initiated after June 30, 2001. SFAS 142 requires companies to cease amortizing
goodwill that existed at June 30, 2001 and establishes a new method for testing
goodwill for impairment on an annual basis (or an interim basis if an event
occurs that might reduce the fair value of a reporting unit below its carrying
value). Any goodwill resulting from acquisitions completed after June 30, 2001
will not be amortized. SFAS 142 also requires that an identifiable intangible
asset that is determined to have an indefinite useful economic life not be
amortized, but separately tested for impairment using a fair value based
approach.
The textile rental and envelope segments each tested goodwill for impairment
during the first quarter of 2002 as required by SFAS 142 upon adoption,
utilizing a combination of valuation techniques including the expected present
value of future cash flows, a market multiple approach and a comparable
transaction approach. As a result of this valuation process, as well as the
application of the remaining provisions of SFAS 142, the Company recorded a
pre-tax transitional impairment loss of $28.4 million, representing the
write-off of all of the Company's existing goodwill. This write-off was reported
as a cumulative effect of a change in accounting principle, on a net of tax
basis, in the Company's Consolidated Statement of Income for the six months
ended February 28, 2002 (see Note 2 to the financial statements included in this
filing).
On November 7, 2001, the Company's board of directors approved the spin-off of
its lighting equipment and chemicals businesses into a separate publicly-traded
company with its own management and board of directors. The spin-off was
effected on November 30, 2001 through a tax-free distribution of 100% of the
outstanding shares of common stock of Acuity Brands, Inc. ("Acuity"), a
wholly-owned subsidiary of the Company owning and operating the lighting
equipment and chemicals businesses. Each NSI stockholder of record as of
November 16, 2001, the record date for the distribution, received one share of
Acuity common stock for each share of NSI common stock held at that date (see
Note 5 to the financial statements included in this filing).
In conjunction with the spin-off, the Company and Acuity entered into various
agreements that address the allocation of assets and liabilities between them
and that define their relationship after the separation, including a
distribution agreement, a tax disaffiliation agreement, an employee benefits
agreement, and a transition services agreement. Under the tax disaffiliation
agreement, Acuity will indemnify NSI for certain taxes and liabilities that may
arise related to the Distribution. The agreement also sets out each party's
rights and obligations with respect to deficiencies and refunds, if any, of
federal, state, local, or foreign taxes for periods before and after the
Distribution. The transition services agreement provides that NSI and Acuity
will provide each other services in such areas as information management and
technology, employee benefits administration, payroll, financial accounting and
reporting, claims administration and reporting, legal, and other areas where NSI
and Acuity may need transitional assistance and support. Management believes the
amounts paid or received associated with these services are representative of
the fair value of the services provided.
In addition, Acuity and NSI entered into a put option agreement, whereby NSI has
the option to require Acuity to purchase the property where NSI's corporate
headquarters are located for a purchase price equal to 85 percent of the
agreed-upon fair market value of the property. This put option will commence on
June 1, 2002 and expire on May 31, 2003.
As a result of the November 2001 spin-off, the Company's financial statements
have been prepared with these businesses' net assets, results of operations, and
cash flows presented as discontinued operations. Accordingly, the results of
operations and liquidity and capital resources information presented below
reflect only the continuing operations of the Company.
On January 3, 2002, the Company's shareholders approved a one-for-four reverse
stock split of NSI common stock, which began trading on a reverse split basis on
January 7, 2002. As a result of the stock split, every four shares of NSI common
stock were replaced with one share of NSI common stock. The reverse split did
not change the number of authorized shares of NSI common stock or the par value
per share of NSI common stock. All references to common stock, common shares
outstanding, average numbers of common stock shares outstanding and per share
amounts in these Consolidated Financial Statements, Notes to Consolidated
Financial Statements and Management's Discussion and Analysis of Financial
Condition and Results of Operations
Page 18
prior to the effective date of the reverse stock split have been restated to
reflect the one-for-four common stock reverse split on a retroactive basis.
CRITICAL ACCOUNTING POLICIES
NSI's financial statements have been prepared in accordance with accounting
principles generally accepted in the United States. The preparation of the
financial statements requires the Company to make estimates and assumptions that
affect the reported amounts of assets, liabilities, revenues and expenses, and
the disclosure of contingent assets and liabilities. The Company reviews its
estimates on a regular basis including those related to litigation, insurance
receivable, environmental matters and self-insurance. The Company's estimates
are based on historical experience and other assumptions management believes are
reasonable under current circumstances. Actual results may differ from these
estimates under different assumptions or circumstances.
In December 2001, the SEC requested that all registrants include their "critical
accounting policies" in MD&A. The SEC indicated that a "critical accounting
policy" is one which is both important to the portrayal of the company's
financial condition and results and requires management's most difficult,
subjective or complex judgments, often as a result of the need to make estimates
about the effect of matters that are inherently uncertain. NSI believes the
following represent its critical accounting policies:
Litigation
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
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 future periods. The Company reserves for
legal claims when payments associated with the claims become probable and the
costs can be reasonably estimated for financial statement purposes. While
management believes that its reserves are appropriate based on information
currently available, the actual costs of resolving legal claims may be
substantially different from the amounts reserved.
Among the product liability claims to which the Company is subject are claims
for personal injury or wrongful death 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. The Company believes its conduct with respect to asbestos-containing
insulation was consistent with recognized safety standards at the relevant
times, and the Company believes there is no basis for imposing punitive damages
against it in connection with asbestos claims. 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,
that the Company did not distribute or install products at certain sites where
exposure is alleged, 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 accrual for asbestos-related liabilities, before consideration of insurance
recoveries is based on the following: the Company's estimate of indemnity
payments and defense costs associated with pending and future asbestos-related
claims to be paid through mid-2005; settlements agreed to but not paid as of
February 28, 2002; the Company's expected payment on account of settlement
obligations of defaulting CCR members; interest on settlement payments that are
subject to ongoing dispute resolution with certain insurance providers; and
other legal fees and expenses. The Company's estimates of indemnity payments and
defense costs associated with pending and future asbestos claims are based on
the Company's estimate of the number of future asbestos-related claims and the
type of disease, if any, alleged or expected to be alleged in such claims,
assumptions regarding the timing and amounts of settlement payments, the status
of ongoing litigation and settlement initiatives, and the advice of outside
counsel with respect to the current state of the law related to asbestos claims.
The ultimate liability for all pending and future claims cannot be determined
with certainty due to the difficulty of forecasting the numerous variables that
can affect the amount of liability. There are inherent uncertainties involved in
estimating these amounts, and the Company's actual costs in future periods could
exceed the Company's estimates due to changes in facts and circumstances after
the date of each estimate. For additional information, see Note 8 to the
financial statements included in this filing.
Insurance Receivable
Among the product liability claims to which the Company is subject are claims
for personal injury or wrongful death arising from the installation and
distribution of asbestos-containing insulation, primarily in the southeastern
United States, by a previously divested business of the Company. The Company
believes that it has insurance coverage available to recover most of its
asbestos-related costs. The Company has reached settlement agreements with
substantially all of its relevant insurers providing for payment of
substantially all asbestos-related claims (subject to retentions) up to the
various policy limits, except for the Company's payments on account of
settlement obligations of defaulting CCR members, as discussed in Note 8 to the
financial statements
Page 19
included in this filing. The timing and amount of future recoveries from
insurance carriers will depend on the pace of claims review and processing by
such carriers and on the resolution of any remaining disputes regarding coverage
under such policies. In the event the Company's insurers dispute amounts billed
to them or pay on an untimely basis, the Company takes all practicable steps to
secure payment, including alternative dispute resolution procedures and
litigation to resolve the issues. The Company has initiated an alternative
dispute resolution proceeding with one insurer to resolve outstanding insurance
policy interpretation issues, to secure payment of past due amounts and to
ensure that the insurer's future obligations will be met in a timely fashion.
The Company believes that substantial recoveries from the insurance carriers are
probable. The Company reached this conclusion after considering its prior
insurance-related recoveries in respect of asbestos-related claims, existing
insurance policies, settlement agreements with insurers, the apparent viability
of its insurers, the advice of outside counsel with respect to the applicable
insurance coverage law relating to terms and conditions of those policies, and a
general assessment by the Company and its advisors of the financial condition of
the relevant insurers. If expected insurance recoveries become unavailable, due
to insolvencies among the Company's primary or excess insurance carriers,
disputes with carriers or otherwise, the Company's results of operations,
liquidity and financial condition could be materially adversely affected.
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.
The Company reserves for known environmental claims when payments associated
with the claims become probable and the costs can be reasonably estimated. The
actual cost of environmental issues may be higher than that reserved due to
difficulty in estimating such costs and potential changes in the status of
government regulations.
Self-Insurance
It is the Company's policy to self insure for certain insurable risks consisting
primarily of physical loss to property; business interruptions resulting from
such loss; and workers' compensation, employee medical, comprehensive general,
and auto liability. Insurance coverage is obtained for catastrophic property and
casualty exposures as well as those risks required to be insured by law or
contract. Based on an independent actuary's estimate of the aggregate liability
for claims incurred, a provision for claims under the self-insured program is
recorded and revised annually. The actuarial estimates are subject to
uncertainty from various sources, including changes in claim reporting patterns,
claim settlement patterns, judicial decisions, legislation, and economic
conditions.
RESULTS OF OPERATIONS
NSI generated revenue of $132.0 million and $266.4 million for the three and six
months ended February 28, 2002, respectively, compared to revenue of $135.1
million and $275.8 million, respectively, in the previous year. The decrease was
related to the overall softer economy and lost revenues from the closure of two
envelope manufacturing facilities in the fourth quarter of fiscal 2001.
Losses from continuing operations totaled $41 thousand, or $0.00 per diluted
share, for the three months ended February 28, 2002, compared to income from
continuing operations of $2.1 million, or $0.20 per diluted share, for the three
months ended February 28, 2001. On a year-to-date basis, net losses from
continuing operations for the first six months of the current fiscal year were
$3.7 million, or $0.36 per diluted share, compared to the prior year's income
from continuing operations of $4.4 million, or $0.43 per diluted share. The
decline in income from continuing operations primarily resulted from lower
revenues, restructuring charges and higher overall labor and benefits.
Textile rental segment second quarter revenues of $77.3 million decreased 2.9
percent compared to last year's $79.6 million. On a year-to-date basis, revenues
decreased $4.5 million, or 2.8 percent compared to the same prior year period.
Operating profit for the second quarter was $1.3 million compared to last year's
operating profit of $4.0 million. Operating profit for the second quarter
included $304 thousand of gains related to previously divested businesses and a
$381 thousand reduction of expense associated with ongoing restructuring plans.
Last year's operating profit included $2.4 million of gains on sales of
businesses. On a year-to-date basis, the textile rental segment had an
operating loss of $4.0 million for the first six months of fiscal 2002 versus
operating profit of $7.7 million for the first six months of fiscal 2001.
Year-to-date operating profit includes restructuring expense and other charges
of $5.4 million relating to the closure of two facilities and $304 thousand of
gains related to previously divested businesses, whereas the operating profit
for the same prior year period included $2.4 million of gains on sales of
businesses. Excluding these
Page 20
items, the decline in operating profit is largely due to the impact of business
travel and entertainment, increases in labor and benefit costs, and costs
associated with overhead reduction programs within the business.
The restructuring charge included a reduction of severance costs of $148
thousand, and $1.6 million in exit expenses to close and consolidate facilities.
Exit expenses primarily include costs of lease terminations and costs to dispose
of closed facilities. Reserve reductions of $413 thousand were also recorded
during the second quarter of fiscal 2002 primarily due to lower than originally
estimated costs to prepare a facility closed in a prior year for sale.
Additionally, as a further result of the closure of the two textile rental
facilities, the Company recognized long-lived asset impairments totaling $4.4
million. Textile rental assets to be disposed of were reduced to state them at
their estimated fair value less costs to sell. Assets to be disposed of
primarily related to equipment located in the facilities included in the
restructuring program noted above. After the charge, the remaining net book
value of these assets was immaterial. Estimated fair market values were
established based on an analysis of expected future cash flows.
The envelope segment second quarter revenues of $54.7 million decreased 1.5
percent from last year's results of $55.5 million. Operating profit was $649
thousand, a decrease of $214 thousand from last year's $863 thousand profit.
During the quarter, the envelope segment sold its Lyon Folder unit, recognizing
a gain of approximately $75 thousand. Excluding the current year gain, and
approximately $245 thousand of goodwill amortization that has been discontinued
with the adoption of SFAS 142, profits decreased approximately $534 thousand.
The decline in operating profits is the result of the decrease in revenue,
primarily from lower courier volumes. On a year-to-date basis, the envelope
segment revenues of $110.3 million decreased 4.2 percent from last year's
results of $115.1 million, and operating profit of $2.8 million increased $228
thousand from last year's results of $2.6 million. Last year's results included
$880 thousand of costs associated with the reorganization of the Miami, Florida
facility. Excluding the current year gain of $75 thousand, the prior year
reorganization costs and approximately $485 thousand of prior year goodwill
amortization, which ceased upon the adoption of SFAS No. 142, profits decreased
approximately $1.2 million as a result of the lower overall revenue and
increased benefits costs.
Corporate expenses were $1.9 million for the first quarter compared to last
year's $1.1 million. For the six months ended February 28, 2002, corporate
expenses increased from $2.4 million to $4.6 million. The planned increase is
representative of on-going, stand-alone corporate costs.
Net interest expense of $168 thousand and $279 thousand for the three and six
months ended February 28, 2002, respectively, decreased from $439 thousand and
$889 thousand for the same prior year periods, respectively, due to lower
overall rates and lower interest bearing obligations. Additionally, the
provision for income taxes increased to 40 percent of income from continuing
operations compared to 37 percent in the prior year as a result of the loss of
certain state tax benefits associated with the spin-off.
LIQUIDITY AND CAPITAL RESOURCES
Operating Activities
Continuing operations used cash of $107 thousand during the six months ended
February 28, 2002 compared with cash provided of $19.9 million during the
respective period of the prior year. Fiscal 2002 operating cash flow was lower
because of a decrease in net income and an increase in cash used for both
current and long-term liabilities, which was partially offset by an increase in
cash provided by inventory and linens in service. The increase in cash used for
current and long-term liabilities resulted primarily from lower days in accounts
payable due to utilization of recently negotiated vendor payment terms and
payments related to asbestos settlements.
Investing Activities
Investing activities used cash of $9.0 million versus $6.9 million in the prior
year. The increase in spending was due mainly to increased capital spending and
less cash provided by divestitures.
Capital expenditures totaled $10.6 million for the six month period compared to
$8.4 million in the prior year. During the six months ended February 28, 2002,
the textile rental segment invested primarily in replacing old equipment and
delivery truck purchases and refurbishment. Capital expenditures in the envelope
segment were primarily related to manufacturing equipment and information
systems. During the six months ended February 28, 2001, capital expenditures in
the envelope segment related primarily to manufacturing process improvements and
information systems. The textile rental segment's expenditures were primarily
attributable to building improvements, replacing old equipment and information
systems.
Page 21
Financing Activities
Cash provided by financing activities totaled $2.2 million during the six months
ended February 28, 2002 compared to cash used of $26.0 million in fiscal 2001
primarily due to borrowing of notes payable and lower dividends. Dividend
payments totaled $7.0 million, or $0.68 per share, compared with $27.1 million,
or $2.64 per share, for the prior-year period.
Upon completion of the spin-off on November 30, 2001, approximately $371.3
million of long-term debt was assumed by Acuity, leaving approximately $2.8
million outstanding for the Company.
In October 2001, the Company negotiated a $40 million, three-year committed
credit facility with a single major US bank that became effective at the time of
the spin-off. The facility contains financial covenants including a leverage
ratio, a ratio of income available for fixed charges to fixed charges, and a
minimum net worth. Interest rates under the facility are based on the LIBOR rate
or other rates, at the Company's option. The Company will pay an annual fee on
the commitment based on the Company's leverage ratio. Approximately $11.0
million was outstanding under this facility at February 28, 2002.
Management believes anticipated cash flows from operations and the committed
credit facilities are sufficient to meet the Company's planned level of capital
spending and general operating cash requirements, including but not limited to
cash requirements related to litigation as further described in Note 8 to the
financial statements, for the next twelve months.
Subsequent to the end of the second quarter, the Company entered into an
agreement to sell the property where NSI's corporate headquarters is located.
The agreement provides a due diligence period through April 26, 2002, during
which time the purchaser has the right to terminate the agreement without any
material financial obligation. Management anticipates that the sale will occur
by the end of the third quarter of fiscal 2002 and that the proceeds from the
sale will be used to repay outstanding debt and to fund general corporate
purposes.
Legal Proceedings
For information concerning legal proceedings, including trends and developments
involving legal proceedings, see Note 8 to the financial statements included in
this filing.
Environmental Matters
For information concerning environmental matters, see Note 9 to the financial
statements included in this filing.
Quantitative and Qualitative Disclosures About Market Risk
Disclosures about Market Risk
The Company believes that its exposure to market risks that may impact the
"Consolidated Balance Sheets," "Consolidated Statements of Income," and
"Consolidated Statements of Cash Flows" primarily relate to changing interest
rates and commodity prices. The Company does not enter into derivative
arrangements for trading or speculative purposes.
Interest Rates
The Company's credit line is subject to interest rate fluctuations. These
fluctuations expose the Company to changes in interest expense and cash flows.
The Company's variable-rate debt amounted to $11.0 million at February 28, 2002.
Based on outstanding borrowings at February 28, 2002, a 10 percent adverse
change in effective market interest rates would result in an immaterial amount
of additional interest expense.
Commodity Price Risk
From time to time, the Company's textile rental segment enters into arrangements
locking in for specified periods the prices the Company will pay for the volume
of natural gas or other commodities to which the contract relates. The contracts
are structured to reduce the segment's exposure to changes in the price of
natural gas and relate only to portions of the Company's normal expected usage.
However, these contracts also limit the benefit the segment might have otherwise
received from decreases in the price of natural gas. The Company does not
believe a 10 percent adverse change in market rates of natural gas would have a
material impact on its "Consolidated Balance Sheets" or "Consolidated Statements
of Income."
Page 22
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. 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, interest rate changes, and fluctuations in commodity and raw
material prices and; (b) unexpected developments and outcomes in the Company's
legal and environmental proceedings.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
For information concerning legal proceedings, including trends and developments
involving legal proceedings, see Note 8 to the financial statements included in
this filing.
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits - None
(b) A Form 8-K was filed on December 14, 2001 related to the completion of the
distribution of the common stock of Acuity Brands, Inc. A Form 8-K was filed on
January 7, 2002 related to the completion of a one-for-four reverse stock split
of its common stock.
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 April 15, 2002 /s/ CAROL MORGAN
-------------- ------------------------------------------
CAROL MORGAN
SENIOR VICE PRESIDENT,
GENERAL COUNSEL AND SECRETARY
DATE April 15, 2002 /s/ CHESTER J. POPKOWSKI
-------------- ------------------------------------------
CHESTER J. POPKOWSKI
SENIOR VICE PRESIDENT,
CHIEF FINANCIAL OFFICER AND
TREASURER