-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, KqC/+MeP0m8f7HPxpEp+cHywRaoJpHIVB8shEBcRGhIC+n/T3cbBppH4zLi05EE+ bQvYkrMymCN6kudX06JWow== 0000950144-02-000302.txt : 20020413 0000950144-02-000302.hdr.sgml : 20020413 ACCESSION NUMBER: 0000950144-02-000302 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 4 CONFORMED PERIOD OF REPORT: 20011130 FILED AS OF DATE: 20020111 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NATIONAL SERVICE INDUSTRIES INC CENTRAL INDEX KEY: 0000070538 STANDARD INDUSTRIAL CLASSIFICATION: ELECTRIC LIGHTING & WIRING EQUIPMENT [3640] IRS NUMBER: 580364900 STATE OF INCORPORATION: DE FISCAL YEAR END: 0831 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 001-03208 FILM NUMBER: 2507963 BUSINESS ADDRESS: STREET 1: 1420 PEACHTREE ST NE CITY: ATLANTA STATE: GA ZIP: 30309-3002 BUSINESS PHONE: 4048531000 MAIL ADDRESS: STREET 1: 1420 PEACHTREE ST NE CITY: ATLANTA STATE: GA ZIP: 30309 10-Q 1 g73683e10-q.txt NATIONAL SERVICE INDUSTRIES, INC. 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 November 30, 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 10,327,867* shares as of December 31, 2001. * Outstanding shares as of December 31, 2001 have been adjusted to reflect the impact of the Company's one-for-four reverse stock split effected on January 7, 2001 Page 2 NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES INDEX
Page No. -------- PART I. FINANCIAL INFORMATION ITEM 1. FINANCIAL STATEMENTS CONSOLIDATED BALANCE SHEETS (Unaudited) - NOVEMBER 30, 2001 AND AUGUST 31, 2001 3 CONSOLIDATED STATEMENTS OF INCOME (Unaudited) - THREE MONTHS ENDED NOVEMBER 30, 2001 AND 2000 4 CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) - THREE MONTHS ENDED NOVEMBER 30, 2001 AND 2000 5 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) 6-14 ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15-17 ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 17 PART II. OTHER INFORMATION ITEM 1. LEGAL PROCEEDINGS 18 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS 18 ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K 18 SIGNATURES 18 INDEX TO EXHIBITS 19
Page 3 CONSOLIDATED BALANCE SHEETS (UNAUDITED) NATIONAL SERVICE INDUSTRIES, INC. (In thousands, except share data)
November 30, August 31, 2001 2001 ------------ ----------- ASSETS Current Assets: Receivables, less reserves for doubtful accounts of $1,922 at November 30, 2001 and $1,798 at August 31, 2001 $ 62,202 $ 60,406 Inventories, at the lower of cost (on a first-in, first-out basis) or market 18,791 19,195 Linens in service, net of amortization 54,063 56,910 Deferred income taxes 13,789 9,138 Prepayments 4,239 11,300 Insurance receivable (Note 8) 27,269 28,616 Other current assets 3,257 804 ----------- ----------- Total Current Assets 183,610 186,369 Property, Plant, and Equipment, at cost: Land 12,898 12,775 Buildings and leasehold improvements 55,635 57,433 Machinery and equipment 258,806 258,344 ----------- ----------- Total Property, Plant, and Equipment 327,339 328,552 Less - Accumulated depreciation and amortization 161,785 157,507 ----------- ----------- Property, Plant, and Equipment - net 165,554 171,045 Other Assets: Goodwill -- 28,432 Other intangibles 8,148 8,629 Insurance receivable (Note 8) 66,585 66,574 Other 37,203 37,049 ----------- ----------- Total Other Assets 111,936 140,684 Net assets of discontinued operations (Note 5) -- 400,296 ----------- ----------- Total Assets $ 461,100 $ 898,394 =========== =========== LIABILITIES AND STOCKHOLDERS' EQUITY Current Liabilities: Current maturities of long-term debt (Note 7) $ 1,033 $ 1,011 Notes payable (Note 7) 2,240 1,999 Accounts payable 23,319 28,164 Accrued salaries, commissions, and bonuses 7,274 7,050 Current portion of self-insurance reserves 3,269 3,119 Environmental reserve (Note 9) 6,967 7,291 Current portion of litigation reserve (Note 8) 27,439 30,453 Other accrued liabilities 26,578 19,561 ----------- ----------- Total Current Liabilities 98,119 98,648 Long-Term Debt, less current maturities (Note 7) 1,723 1,990 ----------- ----------- Deferred Income Taxes 23,098 32,431 ----------- ----------- Self-Insurance Reserves, less current portion 13,100 12,477 ----------- ----------- Litigation Reserve, less current portion (Note 8) 83,091 82,917 ----------- ----------- Other Long-Term Liabilities 7,164 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, 14,479,745 shares issued (Note 11) 14,480 14,480 Paid-in capital 72,495 72,860 Retained earnings 565,183 995,537 Unearned compensation on restricted stock (137) (880) Accumulated other comprehensive income (43) (43) ----------- ----------- 651,978 1,081,954 Less - Treasury stock, at cost (4,151,878 shares at November 30, 2001 and 4,173,299 shares at August 31, 2001) 417,173 419,326 ----------- ----------- Total Stockholders' Equity 234,805 662,628 ----------- ----------- Total Liabilities and Stockholders' Equity $ 461,100 $ 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 NOVEMBER 30 ------------------------------ 2001 2000 --------- -------- Sales and Service Revenues: Service revenues $ 78,836 $ 81,107 Net sales of products 55,553 59,580 --------- -------- Total Revenues 134,389 140,687 --------- -------- Costs and Expenses: Cost of services 47,764 46,433 Cost of products sold 42,016 46,036 Selling and administrative expenses 44,758 41,403 Restructuring expense and other charges (Note 10) 5,820 -- Amortization expense 481 715 Interest expense 111 439 Other (income) expense, net (481) 1,924 --------- -------- Total Costs and Expenses 140,469 136,950 --------- -------- (Loss) income from continuing operations before income taxes and cumulative effect of a change in accounting principle (6,080) 3,737 Income tax (benefit) expense (2,432) 1,383 --------- -------- (Loss) income from continuing operations before cumulative effect of a change in accounting principle (3,648) 2,354 --------- -------- Discontinued Operations (Note 5): Income from discontinued operations, net of tax of $7,066 in 2001 and $8,329 in 2000 11,534 14,183 Costs associated with effecting the spin-off, net of tax benefit of $717 (19,069) -- --------- -------- Total Discontinued Operations (7,535) 14,183 --------- -------- Cumulative effect of a change in accounting principle, net of tax benefit of $10,830 (17,602) -- --------- -------- Net (Loss) Income $ (28,785) $ 16,537 ========= ======== Basic and diluted earnings per share (split adjusted): (Loss) earnings per share from continuing operations before cumulative effect of a change in accounting principle $ (0.35) $ 0.23 Discontinued operations: Income from discontinued operations, net of tax 1.12 1.39 Costs associated with effecting the spin-off, net of tax benefit (1.85) -- --------- -------- Total Discontinued Operations (0.73) 1.39 --------- -------- Cumulative effect of a change in accounting principle, net of tax benefit (1.71) -- --------- -------- Net (Loss) Income $ (2.79) $ 1.62 ========= ======== Basic Weighted Average Number of Shares Outstanding 10,305 10,235 ========= ======== Diluted Weighted Average Number of Shares Outstanding 10,305 10,239 ========= ========
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)
THREE MONTHS ENDED NOVEMBER 30 ------------------------- 2001 2000 -------- -------- Cash Provided by (Used for) Operating Activities: Net (loss) income from continuing operations $ (3,648) $ 2,354 Adjustments to reconcile net income to net cash provided by (used for) operating activities: Depreciation and amortization 6,534 6,929 Provision for losses on accounts receivable 495 590 (Gain) loss on the sale of property, plant, and equipment (78) 1,707 Restructuring expense and other charges 5,820 -- Change in assets and liabilities, net of effect of acquisitions and divestitures- Receivables (2,291) (3,468) Inventories and linens in service, net 2,975 1,943 Deferred income taxes (2,437) 4,928 Prepayments and other current assets (2,043) (2,194) Accounts payable and accrued liabilities (2,199) 155 Self-insurance reserves and other long-term liabilities 663 (3,290) -------- -------- Net Cash Provided by Continuing Operations 3,791 9,654 Net Cash Provided by Discontinued Operations 6,935 7,312 -------- -------- Net Cash Provided by Operating Activities 10,726 16,966 -------- -------- Cash Provided by (Used for) Investing Activities: Purchases of property, plant, and equipment (4,996) (3,312) Sale of property, plant, and equipment 354 183 Acquisitions -- (200) Change in other assets (149) (844) -------- -------- Net Cash Used for Investing Activities (4,791) (4,173) -------- -------- Cash Provided by (Used for) Financing Activities: Borrowings of notes payable, net 241 -- Repayments of long-term debt (245) -- Treasury stock transactions, net 679 754 Cash dividends paid (6,610) (13,547) -------- -------- Net Cash Used for Financing Activities (5,935) (12,793) -------- -------- 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 $ 3,443 $ 3,308 Interest paid during the period 12,888 9,674 Noncash Activities: Treasury shares issued under long-term incentive plan $ 1,109 $ 4,551 Cumulative effect of a change in accounting principle 28,432 --
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 November 30, 2001, the consolidated results of operations for the three months ended November 30, 2001 and 2000, and the consolidated cash flows for the three months ended November 30, 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 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 months ended November 30, 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. 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
November 30, 2001 August 31, 2001 -------------------------------- ------------------------------- Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization -------------- ------------ -------------- ------------ Amortized intangible assets Customer contracts $10,215 $(2,707) $10,215 $(2,348) Other 1,428 (788) 1,428 (666) ------- ------- ------- ------- Total $11,643 $(3,495) $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 $481 and $417 related to intangible assets in the first three months of fiscal 2002 and fiscal 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 November 30, 2001 $ -- $ -- $ -- ======= ======== ========
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 three months ended November 30, 2001. 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 November 30, ---------------------------- 2001 2000 -------- ------- Reported (loss) income from continuing operations $ (3,648) $ 2,354 Add back: Goodwill amortization -- 188 -------- ------- Adjusted (loss) income from continuing operations $ (3,648) $ 2,542 ======== ======= Adjusted net (loss) income $(28,785) $16,725 ======== ======= Basic and diluted earnings per share: Reported (loss) income from continuing operations $ (0.35) $ 0.23 Add back: Goodwill amortization -- -- -------- ------- Adjusted (loss) income from continuing operations $ (0.35) $ 0.23 ======== ======= Adjusted net (loss) income $ (2.79) $ 1.62 ======== =======
Page 8 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 NOVEMBER 30, 2001 REVENUES (LOSS) EXPENSE ACQUISITIONS --------- -------- ------------ ------------ Textile Rental $ 78,836 $(5,379) $4,117 $4,105 Envelope 55,553 2,154 2,204 838 --------- ------- ------ ------ 134,389 (3,225) 6,321 4,943 Corporate -- (2,744) 213 53 Interest expense -- (111) -- -- --------- ------- ------ ------ Total $ 134,389 $(6,080) $6,534 $4,996 ========= ======= ====== ======
DEPRECIATION CAPITAL SALES AND OPERATING AND EXPENDITURES SERVICE PROFIT AMORTIZATION INCLUDING THREE MONTHS ENDED NOVEMBER 30, 2000 REVENUES (LOSS) EXPENSE ACQUISITIONS --------- -------- ------------ ------------ Textile Rental $ 81,107 $ 3,727 $4,147 $2,071 Envelope 59,580 1,712 2,325 1,084 -------- ------- ------ ------ 140,687 5,439 6,472 3,155 Corporate -- (1,263) 457 357 Interest expense -- (439) -- -- -------- ------- ------ ------ Total $140,687 $ 3,737 $6,929 $3,512 ======== ======= ====== ======
Total Assets ------------------------------- November 30, August 31, 2001 2001 ------------ ---------- Textile Rental $215,486 $231,422 Envelope 114,414 141,945 -------- -------- Subtotal 329,900 373,367 Corporate 131,200 124,731 -------- -------- Total $461,100 $498,098 ======== ========
4. INVENTORIES Major classes of inventory as of November 30, 2001 and August 31, 2001 were as follows:
November 30, August 31, 2001 2001 ------------ --------- Raw Materials and Supplies $ 7,666 $ 6,716 Work-in-Process 1,398 817 Finished Goods 9,727 11,662 ------- ------- Total $18,791 $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. Page 9 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 =========
A summary of the operating results of the discontinued operations is as follows:
Three Months Ended November 30, ------------------------------- 2001 2000 -------- -------- Sales $481,691 $502,646 ======== ======== Income before provision for income taxes $ 18,600 $ 22,512 Provision for income taxes 7,066 8,329 -------- -------- Income from discontinued operations $ 11,534 $ 14,183 ======== ========
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 potential dilution that would occur if dilutive options were exercised. Page 10 The following table calculates basic earnings per common share and diluted earnings per common share at November 30, and reflects the January 7, 2002 one-for-four reverse stock split further described in note 11:
Three Months Ended November 30 --------------------------------- 2001 2000 ---------- ---------- Basic weighted average shares outstanding 10,305 10,235 Add: Shares of common stock assumed issued upon exercise of dilutive stock options -- 4 ---------- ---------- Diluted weighted average shares outstanding 10,305 10,239 ========== ========== Basic earnings per common share: (Loss) income from continuing operations before cumulative effect of a change in accounting principle $ (0.35) $ 0.23 ---------- ---------- Income from discontinued operations, net of tax 1.12 1.39 Costs associated with effecting the spin-off, net of tax (1.85) -- ---------- ---------- Total discontinued operations (0.73) 1.39 ---------- ---------- Cumulative effect of a change in accounting principle, net of tax (1.71) -- ---------- ---------- Net (loss) income $ (2.79) $ 1.62 ========== ========== Diluted earnings per common share: (Loss) income from continuing operations before cumulative effect of a change in accounting principle $ (0.35) $ 0.23 ---------- ---------- Income from discontinued operations, net of tax 1.12 1.39 Costs associated with effecting the spin-off, net of tax (1.85) -- ---------- ---------- Total discontinued operations (0.73) 1.39 ---------- ---------- Cumulative effect of a change in accounting principle, net of tax (1.71) -- ---------- ---------- Net (loss) income $ (2.79) $ 1.62 ========== ==========
7. LONG-TERM DEBT Outstanding borrowings at November 30, 2001 included approximately $2,756 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 $2,240 was outstanding under this facility at November 30, 2001. 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 11 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 begun to retain 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, some members or former members of the CCR have failed, by reason of bankruptcy or otherwise, to make payments to the CCR 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 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 December 31, 2001, 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 members to recover amounts due under these settlement agreements. The Company believes that it should not be liable for settlement payments attributable to other members or former members of the CCR, and the Company has joined a joint defense group with other 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 CCR members or former 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 CCR members. Several significant companies that are traditional co-defendants in asbestos claims, both 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 quarter ended November 30, 2001, the Company was served with approximately 2,300 asbestos-related claims and resolved approximately 13,600 claims for an average of approximately $785 per claim (including approximately 11,300 claims that were dismissed with no payment as previously disclosed). As of November 30, 2001, there were approximately 23,700 open claims pending against the Company (including approximately 2,900 claims that were settled in principle after February 1, 2001 but not finalized) and approximately 11,200 additional claims that were settled in principle prior to February 1, 2001 but not finalized. As of November 30, 2001 and August 31, 2001, an estimated accrual of $110.5 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 12 indemnity payments and defense costs associated with pending and future asbestos-related claims to be paid through 2004; settlements agreed to but not paid as of November 30, 2001; 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. 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 $93.9 million and $95.2 million has been reflected in the accompanying financial statements as of November 30, 2001 and August 31, 2001, respectively, with respect to previously paid claims and pending and future claims estimated to be paid through 2004 and the other items included in the accrual of asbestos-related liabilities. Approximately $27.3 million and $28.6 million of the aggregate insurance recovery and $27.4 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 November 30, 2001 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 August 31, 2001 the resolution of asbestos-related uncertainties and the incurrence of asbestos-related costs net to 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. 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 $6,967 and $7,291 at November 30, 2001 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. Page 13 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. 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. 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 recognizing that the issues presented by this case were appropriate for judicial review, ordered that judgment against the Company be entered but that execution of the judgment be stayed pending appeal to the Second Circuit Court of Appeals. The Company will immediately appeal this order. Among other things, the Company will argue that the trial court erred in declaring the Company is a successor to Serv-All and in its verbal finding that the State's claims were not barred by the statute of limitations. Furthermore, even if the Company were eventually found liable for the total amount claimed by the State, the Company would have a right to seek recovery of these 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. 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 Page 14 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. The major components of the fiscal 2001 and 2002 restructuring charges and related activity are as follows:
Reserve, Cash Reserve, August 31, 2001 Payments Expense November 30, 2001 --------------- -------- ------- ----------------- Severance costs $2,969 $(1,479) $ 11 $1,501 Exit costs $1,582 $ (776) $1,396 $2,202
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. SUBSEQUENT EVENT 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 15 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 November 30, 2001. Net working capital was $85.5 million, down slightly from $87.7 million at August 31, 2001, and the current ratio remained constant at 1.9. 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 three months ended November 30, 2001 (see note 2). On November 7, 2001, the Company's board of directors approved the spin-off 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). 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 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 RESULTS OF OPERATIONS NSI generated revenue of $134.4 million in the three months ended November 30, 2001, compared to revenue of $140.7 million 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 $3.6 million, or $0.35 per diluted share, for the three months ended November 30, 2001, compared to income from continuing operations of $2.4 million, or $0.23 per diluted share, for the three months ended November 30, 2000. Income from continuing operations declined $6.0 million primarily as a result of lower overall revenues and costs associated with restructuring activities in the Company's textile rental segment. Textile rental segment first quarter revenues of $78.8 million decreased 2.8 percent compared to last year's $81.1 million. The operating loss was $5.4 million compared to last year's operating profit of $3.7 million. Reported operating profit reflects severance and restructuring charges of $5.8 million for the first quarter related to the closure of two facilities. Excluding these charges, the decline in operating profit reflects the impact of lower revenues, primarily as a result of the soft economy and increases in labor and benefits costs. The restructuring charge included severance costs of $11 thousand for four employees, all of whom were terminated prior to the end of the first quarter, and $1.4 million in exit expenses to close and consolidate facilities. Exit expenses primarily include costs of lease terminations and costs to dispose of closed facilities. 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 first quarter revenues of $55.6 million decreased 6.8 percent from last year's results of $59.6 million. Operating profit was $2.2 million, up $442,000 from the prior year. Last year's results included $880,000 of costs associated with the reorganization of the Miami, Florida facility and approximately $240,000 of goodwill amortization. The revenue decline reflects lower volumes from the courier market and the impact of the closure of two non-performing plants during the last half of fiscal 2001. Excluding the prior year reorganization costs and goodwill amortization, which ceased upon the adoption of SFAS No. 142, profits decreased approximately $678,000 as a result of the lower overall revenue and increased benefits costs. Corporate expenses were $2.7 million for the first quarter compared to last year's $1.3 million. The planned increase is representative of on-going, stand-alone corporate costs. First quarter net interest expense of $111,000 decreased from last year's $439,000 due to lower overall rates. Additionally, the provision for income taxes increased to 40 percent of income from continuing operations for the first quarter 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 provided cash of $3.8 million during the first quarter of fiscal 2002 compared with $9.7 million during the respective period of the prior year. Fiscal 2002 operating cash flow was lower primarily because of a decrease in net income. Investing Activities Investing activities used cash of $4.8 million versus $4.2 million in the prior year. The increase in spending was due mainly to increased capital spending in the textile rental segment. Capital expenditures totaled $5.0 million compared to $3.3 million in the first quarter of last year. In the first quarter of fiscal 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 purchases and information systems. In the first quarter of fiscal 2001, capital expenditures in the envelope segment related primarily to manufacturing process improvements and information systems. The textile rental segment's expenditures were mainly attributable to building improvements, replacing old equipment and information systems. Page 17 Financing Activities Cash used by financing activities totaled $5.9 million in the current-year first quarter compared to cash used of $12.8 million in fiscal 2001 primarily as a result of lower dividends. First quarter dividend payments totaled $6.6 million, or $0.64 per share, compared with $13.5 million, or $1.32 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 $2.2 million was outstanding under this facility at November 30, 2001. 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. 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. 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 $2.2 million at November 30, 2001. Based on outstanding borrowings at November 30, 2001, 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. 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." 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. Page 18 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 4. Submission of Matters to a Vote of Security Holders At the annual meeting of stockholders held January 3, 2002, all nominees for director were elected to the board without opposition and Arthur Andersen LLP's appointment as independent auditor for the current fiscal year was ratified. The elected board members are as follows: Brock A. Hattox, Chairman Joia M. Johnson Dennis R. Beresford Michael Z. Kay John E. Cay, III Betty L. Seigel Don L. Chapman In addition, stockholders voted on the following:
Votes Cast ----------------------------------------------- Affirmative Negative Abstentions ----------- -------- ----------- National Service Industries, Inc. 2001 Nonemployee Directors' Stock Incentive Plan 6,889,750 1,622,016 114,883 Amendment of the Corporation's Restated Certificate of Incorporation to effect a reverse stock split 5,861,876 2,662,016 102,758
Item 6. Exhibits and Reports on Form 8-K (a) Exhibits are listed on the Index to Exhibits (page 19). (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 January 11, 2002 /s/ CAROL ELLIS MORGAN ------------------------------------------- CAROL ELLIS MORGAN SENIOR VICE PRESIDENT, GENERAL COUNSEL AND SECRETARY DATE January 11, 2002 /s/ CHESTER J. POPKOWSKI ------------------------------------------- CHESTER J. POPKOWSKI SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND TREASURER Page 19 INDEX TO EXHIBITS EXHIBIT 10(iii)A (1) Restricted Stock Award Agreement under the National Service Filed with the Securities and Industries, Inc. Long-Term Achievement Incentive Plan Exchange Commission as part of this Form 10-Q (2) Amendment No. 1 to the National Service Industries, Inc. Long-Term Filed with the Securities and Achievement Incentive Plan (As amended and restated as of January Exchange Commission as part of 5, 2000) effective January 7, 2002 this Form 10-Q (3) National Service Industries, Inc. 2001 Nonemployee Directors' Filed with the Securities and Stock Incentive Plan effective November 27, 2001 Exchange Commission as part of this Form 10-Q
EX-10.(III)(A)(1) 3 g73683ex10-iiia1.txt RESTRICTED STOCK AWARD AGREEMENT Exhibit 10(iii)A (1) RESTRICTED STOCK AWARD AGREEMENT under the NATIONAL SERVICE INDUSTRIES, INC. LONG-TERM ACHIEVEMENT INCENTIVE PLAN THIS AGREEMENT, made and entered into as of the ____ day of January, 2002, by and between NATIONAL SERVICE INDUSTRIES, INC. (the "Company") and ________________ ("Grantee"). WITNESSETH THAT: WHEREAS, the Company maintains the National Service Industries, Inc. Long-Term Achievement Incentive Plan (the "Plan"), and the Grantee has been selected by the Committee to receive a Restricted Stock Award under the Plan; NOW, THEREFORE, IT IS AGREED, by and between the Company and the Grantee, as follows: 1. AWARD OF RESTRICTED STOCK 1.1 The Company hereby grants to the Grantee an award of ___________ Shares of restricted stock ("Restricted Stock"), subject to, and in accordance with, the restrictions, terms and conditions set forth in this Agreement. The grant date of this award of Restricted Stock is January __, 2002 ("Grant Date"). 1.2 This Agreement shall be construed in accordance with, and subject to, the provisions of the Plan (the provisions of which are incorporated herein by reference) and, except as otherwise expressly set forth herein, the capitalized terms used in this Agreement shall have the same definitions as set forth in the Plan. 2. RESTRICTIONS 2.1 Subject to Sections 2.2 and 2.3 below, if the Grantee remains employed by the Company, the Grantee shall become vested in the Restricted Stock as set forth below on each anniversary of the Grant Date (each such date shall be a "Vesting Date"), such that on January __, 2006 ("Final Vesting Date") all of the Shares of Restricted Stock shall be fully vested:
Date Number of Shares Vested January __, 2003 25% (________ Shares) January __, 2004 25% (________ Shares) January __, 2005 25% (________ Shares) January __, 2006 25% (________ Shares)
On each Vesting Date, Grantee shall own the Vested Shares of Restricted Stock free and clear of all restrictions imposed by this Agreement (except those imposed by Section 3.4 below). The Company shall deliver a certificate(s) for the Vested Shares of Restricted Stock to Grantee as soon as practical after each Vesting Date. For purposes of this Agreement, employment with a Subsidiary of the Company shall be considered employment with the Company. 2.2 In the event, prior to the Final Vesting Date, (i) Grantee dies while actively employed by the Company, or (ii) Grantee has his employment terminated by reason of Disability, the Restricted Stock shall become fully vested and nonforfeitable as of the date of Grantee's death or Disability. The Company shall deliver certificate(s) for the Restricted Stock, free and clear of any restrictions imposed by this Agreement (except for Section 3.4) to Grantee (or, in the event of death, his surviving spouse or, if none, to his estate) as soon as practical after his date of death or termination for Disability. Except for death or Disability or as provided in Section 2.3 if Grantee terminates his employment or if the Company terminates Grantee prior to the Final Vesting Date, the Restricted Stock shall cease to vest further and Grantee shall only be entitled to the Restricted Stock that is vested as of his date of termination. 2.3 Notwithstanding the other provisions of this Agreement, in the event of a Change in Control prior to Grantee's Final Vesting Date, the Restricted Stock shall become fully vested and nonforfeitable as of the date of the Change in Control. On the date of the Change in Control, the Company shall deliver to Grantee a certificate(s) for the Restricted Stock, free and clear of any restrictions imposed by this Agreement. 2.4 The Restricted Stock may not be sold, assigned, transferred, pledged or otherwise encumbered prior to the date Grantee becomes vested in the Restricted Stock. 3. STOCK; DIVIDENDS; VOTING 3.1 The stock certificate(s) evidencing the Restricted Stock shall be registered on the Company's books in the name of the Grantee as of the Grant Date. The Company may issue stock certificates or evidence the Grantee's interest by using a book entry account. Physical possession or custody of such stock certificates shall be retained by the Company until such time as the Shares are vested in accordance with Section 2. The Company reserves the right to place a legend on the stock certificate(s) restricting the transferability of such certificates and referring to the terms and conditions (including forfeiture) of this Agreement and the Plan. 3.2 During the period the Restricted Stock is not vested, the Grantee shall be entitled to receive dividends and/or other distributions declared on such Restricted Stock and Grantee shall be entitled to vote such Restricted Stock. 3.3 In the event of a Change in Capitalization, the number and class of Shares or other securities that Grantee shall be entitled to, and shall hold, pursuant to this Agreement shall be appropriately adjusted or changed to reflect the Change in Capitalization, provided that any such 2 additional Shares or additional or different shares or securities shall remain subject to the restrictions in this Agreement. 3.4 The Grantee represents and warrants that he is acquiring the Restricted Stock for investment purposes only, and not with a view to distribution thereof. The Grantee is aware that the Restricted Stock may not be registered under the federal or any state securities laws and that, in addition to the other restrictions on the Shares, they will not be able to be transferred unless an exemption from registration is available or the Shares are registered. By making this award of Restricted Stock, the Company is not undertaking any obligation to register the Restricted Stock under any federal or state securities laws. 4. NO RIGHT TO CONTINUED EMPLOYMENT Nothing in this Agreement or the Plan shall be interpreted or construed to confer upon the Grantee any right with respect to continuance of employment by the Company or a subsidiary, nor shall this Agreement or the Plan interfere in any way with the right of the Company or a Subsidiary to terminate the Grantee's employment at any time. 5. TAXES AND WITHHOLDING The Grantee shall be responsible for all federal, state and local income taxes payable with respect to this award of Restricted Stock. The Grantee shall have the right to make such elections under the Internal Revenue Code of 1986, as amended, as are available in connection with this award of Restricted Stock. The Company and Grantee agree to report the value of the Restricted Stock in a consistent manner for federal income tax purposes. The Company shall have the right to retain and withhold from any payment of Restricted Stock the amount of taxes required by any government to be withheld or otherwise deducted and paid with respect to such payment. At its discretion, the Company may require Grantee to reimburse the Company for any such taxes required to be withheld and may withhold any distribution in whole or in part until the Company is so reimbursed. In lieu thereof, the Company shall have the right to withhold from any other cash amounts due to Grantee an amount equal to such taxes required to be withheld or withhold and cancel (in whole or in part) a number of shares of Restricted Stock having a market value not less than the amount of such taxes. 6. GRANTEE BOUND BY THE PLAN The Grantee hereby acknowledges receipt of a copy of the Plan and the prospectus for the Plan, and agrees to be bound by all the terms and provisions thereof. 7. MODIFICATION OF AGREEMENT This Agreement may be modified, amended, suspended or terminated, and any terms or conditions may be waived, but only by a written instrument executed by the parties hereto. 3 8. SEVERABILITY Should any provision of this Agreement be held by a court of competent jurisdiction to be unenforceable or invalid for any reason, the remaining provisions of this Agreement shall not be affected by such holding and shall continue in full force in accordance with their terms. 9. GOVERNING LAW The validity, interpretation, construction and performance of this Agreement shall be governed by the laws of the State of Delaware without giving effect to the conflicts of laws principles thereof. 10. SUCCESSORS IN INTEREST This Agreement shall inure to the benefit of, and be binding upon, the Company and its successors and assigns, whether by merger, consolidation, reorganization, sale of assets or otherwise. This Agreement shall inure to the benefit of the Grantee's legal representatives. All obligations imposed upon the Grantee and all rights granted to the Company under this Agreement shall be final, binding and conclusive upon the Grantee's heirs, executors, administrators and successors. 11. RESOLUTION OF DISPUTES Any dispute or disagreement which may arise under, or as a result of, or in any way relate to the interpretation, construction or application of this Agreement shall be determined by the Committee. Any determination made hereunder shall be final, binding and conclusive on the Grantee and the Company for all purposes. IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first above written. NATIONAL SERVICE INDUSTRIES, INC. By: ------------------------------- ---------------------------------- Name of Grantee: 4 EX-10.(III)(A)(2) 4 g73683ex10-iiia2.txt AMENDMENT NO. 1 Exhibit 10(iii)A (2) AMENDMENT NO. 1 TO THE NATIONAL SERVICE INDUSTRIES, INC. LONG-TERM ACHIEVEMENT INCENTIVE PLAN (As amended and restated as of January 5, 2000) THIS AMENDMENT made as of the 3rd day of January, 2002, by National Service Industries, Inc., a Delaware corporation (the "Company"); WITNESSETH: WHEREAS, the Company has previously established the National Service Industries, Inc. Long-Term Achievement Incentive Plan (the "Plan") for the benefit of its eligible employees and their beneficiaries; and WHEREAS, the Company now desires to amend the Plan in the manner provided below; and NOW, THEREFORE, the Plan is hereby amended effective as of January 7, 2002, as follows: 1. Section 8 of the Plan is hereby amended by deleting the fourth sentence of such section and substituting the following therefor: "The aggregate maximum number of Shares that may be awarded under a Restricted Stock Award and an Award of Performance Shares and Performance Units to a Participant during any fiscal year of the Company is 200,000 Shares and Units." 2. Section 9(a) of the Plan is hereby amended by deleting the last paragraph of such subsection and substituting the following therefor: "The aggregate maximum number of Performance Units and Performance Shares and Shares of Restricted Stock a Participant may be awarded for any fiscal year of the Company shall be 200,000 Units and Shares." 3. This Amendment shall be effective as of January 7, 2002 (after the effectiveness of the Company's reverse stock split, such that the 200,000 Units and Shares referred to above will not be further adjusted for the Company's reverse stock split). 4. Except as provided herein, the provisions of the Plan shall remain in full force and effect. IN WITNESS WHEREOF, the Company has caused this Amendment No. 1 to be executed by its duly authorized corporate officers as of the date and year first written above. ATTEST: NATIONAL SERVICE INDUSTRIES, INC. By: /s/ Carol Ellis Morgan By: /s/ Brock A. Hattox -------------------------------- -------------------------------- 2 EX-10.(III)(A)(3) 5 g73683ex10-iiia3.txt NONEMPLOYEE DIRECTORS' STOCK INCENTIVE PLAN Exhibit 10(iii)A (3) NATIONAL SERVICE INDUSTRIES, INC. 2001 NONEMPLOYEE DIRECTORS' STOCK INCENTIVE PLAN 1. PURPOSE (a) The purpose of this Plan is to provide a means by which nonemployee directors of National Service Industries, Inc. (the "Company") may be given an opportunity to receive or purchase stock of the Company. (b) The Company, by means of the Plan, seeks to secure and retain the services of persons best qualified to serve as directors of the Company and to provide incentives for such persons to exert maximum efforts for the success of the Company. (c) The Company intends that the options issued under the Plan shall be options which do not qualify as incentive stock options for purposes of Section 422 of the Code. 2. DEFINITIONS For purposes of the Plan: 2.1 "Adjusted Fair Market Value" means, in the event of a Change in Control, the greater of (i) the highest price per Share paid to holders of the Shares in any transaction (or series of transactions) constituting or resulting in a Change in Control or (ii) the highest Fair Market Value of a Share during the ninety (90) day period ending on the date of a Change in Control. 2.2 "Agreement" means the written agreement between the Company and an Optionee or Grantee evidencing the grant of an Option or Award and setting forth the terms and conditions thereof. 2.3 "Award" means a grant of Restricted Stock or Stock. 2.4 "Board" means the Board of Directors of the Company. 2.5 "Cause" means the commission of an act of fraud or intentional misrepresentation or an act of embezzlement, misappropriation, or conversion of assets or opportunities of the Company or any Subsidiary. 2.6 "Change in Capitalization" means any increase or reduction in the number of Shares, or any change (including, but not limited to, a change in value) in the Shares or exchange of Shares for a different number or kind of shares or other securities of the Company, by reason of a reclassification, recapitalization, merger, consolidation, reorganization, spin-off, split-up, issuance of warrants or rights or debentures, stock dividend, stock split or reverse stock split, cash dividend, property dividend, combination or exchange of shares, repurchase of shares, change in corporate structure, or otherwise. 1 2.7 A "Change in Control" means any of the following events: (a) The acquisition (other than from the Company) by any "Person" (as the term is used for purposes of Sections 13(d) or 14(d) of the Exchange Act) of beneficial ownership (within the meaning of Rule 13d-3 promulgated under the Exchange Act) of twenty percent (20%) or more of the combined voting power of the Company's then outstanding voting securities; or (b) The individuals who, as of the Effective Date were members of the Board (the "Incumbent Board"), cease for any reason to constitute at least two-thirds of the Board; provided, however, that if the election, or nomination for election by the Company's stockholders, of any new director was approved by a vote of at least two-thirds of the Incumbent Board, such new director shall, for purposes of this Plan, be considered as a member of the Incumbent Board; or (c) A merger or consolidation involving the Company if the stockholders of the Company immediately before such merger or consolidation do not, as a result of such merger or consolidation, own, directly or indirectly, more than seventy percent (70%) of the combined voting power of the then outstanding voting securities of the corporation resulting from such merger or consolidation in substantially the same proportion as their ownership of the combined voting power of the voting securities of the Company outstanding immediately before such merger or consolidation; or (d) A complete liquidation or dissolution of the Company or an agreement for the sale or other disposition of all or substantially all of the assets of the Company. Notwithstanding the foregoing, a Change in Control shall not be deemed to occur pursuant to Section 2.7(a), solely because twenty percent (20%) or more of the combined voting power of the Company's then outstanding securities is acquired by (i) a trustee or other fiduciary holding securities under one or more employee benefit plans maintained by the Company or any of its subsidiaries or (ii) any corporation which, immediately prior to such acquisition, is owned directly or indirectly by the stockholders of the Company in the same proportion as their ownership of stock in the Company immediately prior to such acquisition. 2.8 "Code" means the Internal Revenue Code of 1986, as amended. 2.9 "Company" means National Service Industries, Inc. 2.10 "Director" means a director of the Company. 2.11 "Disability" means a physical or mental infirmity which impairs the Optionee's or Grantee's ability to perform substantially his or her duties for a period of one hundred eighty (180) consecutive days, as determined by the Board. 2.12 "Exchange Act" means the Securities Exchange Act of 1934, as amended. 2 2.13 "Fair Market Value" on any date means (A) if the Shares are admitted to trading on a national securities exchange, the last sale price reported for the Shares on such exchange on such date or, if no sale was reported on such date, on the last date preceding such date on which a sale was reported, (B) if the Shares are admitted to quotation on the National Association of Securities Dealers Automated Quotation System ("NASDAQ") or other comparable quotation system and have been designated as a National Market System ("NMS") security, the last sale price reported for the Shares on such system on such date or on the last day preceding such date on which a sale was reported, (C) if the Shares are admitted to quotation on NASDAQ and have not been designated a NMS security, the average of the highest bid and lowest asked prices of the Shares on such system on such date, or (D) if there have been no published bid or asked quotations with respect to Shares on such date, the value established by the Board in good faith and in accordance with Section 422 of the Code. 2.14 "Grantee" means a person to whom an Award has been granted under the Plan. 2.15 "Nonemployee Director" means a Director who is not an officer or employee of the Company or any subsidiary. 2.16 "Option" means an option granted under this Plan to purchase Shares. 2.17 "Optionee" means a person to whom an Option has been granted under the Plan. 2.18 "Parent" means any corporation which is a parent corporation (within the meaning of Section 424(e) of the Code) with respect to the Company. 2.19 "Plan" means the National Service Industries, Inc. 2001 Nonemployee Directors' Stock Incentive Plan. 2.20 "Restricted Stock" means Shares issued or transferred to a Nonemployee Director which are subject to restrictions. 2.21 "Shares" means the common stock, par value $1.00 per share, of the Company. 2.22 "Stock Award" means a grant of Shares that is not generally subject to restrictions and pursuant to which a certificate for the Shares is transferred to the Nonemployee Director. 2.23 "Subsidiary" means any corporation in an unbroken chain of corporations, beginning with the Company, if each of the corporations other than the last corporation in the unbroken chain owns stock possessing 50% or more of the total combined voting power of all classes of stock in one of the other corporations in such chain. The term "Subsidiary" shall also include a partnership in which the Company or a Subsidiary owns 50% or more of the profits interest or capital interest in the partnership. 3 3. ADMINISTRATION 3.1 The Plan shall be administered by the Board. 3.2 The Board shall have the power, subject to, and within the limitations of, the express provisions of the Plan: (a) to determine those Nonemployee Directors to whom Options shall be granted under the Plan and the number of Options to be granted to each Nonemployee Director and to prescribe the terms and conditions of each Option, including the purchase price per Share subject to each Option, and to make any amendment or modification to any Agreement consistent with the terms of the Plan; (b) to select those Nonemployee Directors to whom Awards shall be granted under the Plan and to determine the number of Shares and/or shares of Restricted Stock to be granted pursuant to each Award, the terms and conditions of each Award, including the restrictions or performance criteria relating to such Award, the maximum value of each Award, and to make any amendment or modification to any Agreement consistent with the terms of the Plan; (c) to exercise its discretion with respect to the powers and rights granted to it as set forth in the Plan; (d) to construe and interpret the Plan and the Options and Awards granted hereunder and any condition or restrictions imposed on Shares acquired pursuant to the exercise of an Option, to define the terms used herein and to establish, amend, and revoke rules and regulations for administration of the Plan. The Board in the exercise of this power, may correct any defect, omission, or inconsistency in the Plan or in any Agreement, in a manner and to the extent it shall deem necessary or expedient to make the Plan fully effective. All decisions and determinations by the Board in the exercise of this power shall be final, binding and conclusive upon the Company and the Optionees and Grantees, as the case may be; (e) to amend, modify, suspend, or terminate the Plan in accordance with Section 10; and (f) generally, to exercise such powers and to perform such acts as the Board deems necessary or expedient to promote the best interests of the Company in connection with the Plan. 4. STOCK SUBJECT TO THE PLAN 4.1 The maximum number of Shares that may be issued or transferred pursuant to Options and Awards under the Plan is 300,000 Shares (or the number and kind of shares of stock or other securities to which such Shares are adjusted upon a Change in Capitalization pursuant to Section 8) and the Company shall reserve for the purposes of the Plan, out of its 4 authorized but unissued Shares or out of Shares held in the Company's treasury, or partly out of each, such number of Shares as shall be determined by the Board. 4.2 Whenever any outstanding Option or Award or portion thereof expires, is forfeited, is cancelled or is otherwise terminated for any reason (other than upon the exercise of the Option or upon the surrender of the Option pursuant to Section 7), the Shares allocable to the cancelled or otherwise terminated Option or Award or portion thereof may again be the subject of Options and Awards granted hereunder. 5. OPTION GRANTS FOR NONEMPLOYEE DIRECTORS 5.1 Discretionary Grant. The Board may grant Options in accordance with the Plan and the terms and conditions of each Option shall be set forth in an Agreement. The Board shall have sole discretion in determining the number of Shares underlying each Option to grant a Nonemployee Director. 5.2 Purchase Price. The purchase price for Shares under each Option shall be equal to 100% of the Fair Market Value of a Share on the date the Option is granted. 5.3 Duration. Unless otherwise provided in the Agreement, Options shall be for a term of ten (10) years, except an Option may terminate earlier as follows: (a) if an Optionee's service as a Director terminates for Cause, the Options granted to the Optionee hereunder shall immediately terminate in full and no rights thereunder may be exercised; (b) if an Optionee's service as a Director terminates for any reason other than Cause, the Optionee (or any guardian, legal representative, heir or successor of the Optionee) may for a period of three (3) years after such termination exercise his or her Options to the extent, and only to the extent, that such Options or portions thereof were vested and exercisable as of the date the Optionee's service as a Director terminated, after which time the Options shall automatically terminate in full. This Section 5.3 shall not be construed to extend the term of any Option or to permit anyone to exercise any Option after expiration of its term, nor shall it be construed to increase the number of Shares as to which any Option is exercisable from the amount exercisable on the date of termination of the Optionee's service as a Director. 5.4 Vesting. Unless provided otherwise in the Agreement, and subject to Section 7, each Option shall be exercisable in whole or in part at any time after one (1) year from the date of grant of the Option. 5.5 Non-transferability. No Option granted hereunder shall be transferable by the Optionee to whom granted otherwise than (i) by will or the laws of descent and distribution and (ii) upon such terms and conditions as the Company may establish, to immediate family members of the Optionee or to a trust, partnership or similar vehicle for the benefit of such immediate family members (collectively, the "Permitted Transferees"). For purposes of this 5 Section 5.5, "immediate family" means an Optionee's spouse, parents, children, grandchildren and spouse of children and grandchildren (including adopted children and grandchildren, as the case may be). A Permitted Transferee may not further transfer the Option. An Option transferred pursuant to this Section 5.5 shall remain subject to all of the provisions of the Plan and any Agreement with respect to such Option and may not be exercised by a Permitted Transferee unless and until all legal or regulatory approvals, listings, registrations, qualifications or other clearances as determined by the Company to be required or appropriate have been obtained. An Option may be exercised during the lifetime of such Optionee only by the Optionee or his beneficiary or guardian or legal representative or, if applicable, by Permitted Transferees. The terms of such Option shall be final, binding and conclusive upon the beneficiaries, executors, administrators, heirs, successors, and Permitted Transferees of the Optionee. 5.6 Method of Exercise. The exercise of an Option shall be made only by a written notice delivered in person or by mail to the Secretary of the Company at the Company's principal executive office, specifying the number of Shares to be purchased and accompanied by payment therefor and otherwise in accordance with the Agreement pursuant to which the Option was granted. The purchase price for any Shares purchased pursuant to the exercise of an Option shall be paid in full upon such exercise in cash, by check or by transferring Shares to the Company upon such terms and conditions as determined by the Board. The written notice pursuant to this Section 5.6 may also provide instructions from the Optionee to the Company that upon receipt of the purchase price in cash from the Optionee's broker or dealer, designated as such on the written notice, in payment for any Shares purchased pursuant to the exercise of an Option, the Company shall issue such Shares directly to the designated broker or dealer. Any Shares transferred to the Company as payment of the purchase price under an Option shall be valued at their Fair Market Value on the day preceding the date of exercise of such Option. If requested by the Board, the Optionee shall deliver the Agreement evidencing the Option to the Secretary of the Company who shall endorse thereon a notation of such exercise and return such Agreement to the Optionee. No fractional Shares (or cash in lieu thereof) shall be issued upon exercise of an Option and the number of Shares that may be purchased upon exercise shall be rounded to the nearest number of whole Shares. 5.7 Rights of Optionees. No Optionee shall be deemed for any purpose to be the owner of any Shares subject to any Option unless and until (i) the Option shall have been exercised pursuant to the terms thereof, (ii) the Company shall have issued and delivered the Shares to the Optionee, and (iii) the Optionee's name shall have been entered as a stockholder of record on the books of the Company. Thereupon, the Optionee shall have full voting, dividend, and other ownership rights with respect to such Shares. 6. RESTRICTED STOCK; STOCK AWARDS 6.1 Grants. The Board may from time to time in its discretion grant Restricted Stock and Stock Awards to Nonemployee Directors and may determine the number of Shares of Restricted Stock or Stock Awards to be granted. The Board shall determine the terms and 6 conditions of, and the amount of payment, if any, to be made by the Nonemployee Director for such Shares or Restricted Stock. A grant of Restricted Stock may, in addition to other conditions, require the Nonemployee Director to pay for such Shares of Restricted Stock, but the Board may establish a price below Fair Market Value at which the Nonemployee Director can purchase the Shares of Restricted Stock. Each grant of Restricted Stock shall be evidenced by an Agreement containing terms and conditions not inconsistent with the Plan as the Board shall determine to be appropriate in its sole discretion. 6.2 Restricted Period; Lapse of Restrictions. At the time a grant of Restricted Stock is made, the Board shall establish a period or periods of time applicable to such grant over which the Restricted Stock will vest or may establish performance requirements for the vesting of the Restricted Stock. Subject to the other provisions of this Article 6, when the restrictions lapse, the Restricted Stock shall vest in the Nonemployee Director. At the time a grant is made, the Board may, in its discretion, prescribe conditions for the incremental lapse of restrictions during the restricted period and for the lapse or termination of restrictions upon the occurrence of other conditions in addition to or other than the expiration of the restricted period or satisfaction of performance measures with respect to all or any portion of the Restricted Stock. Such conditions may, but need not, include the following: (a) The death or Disability of the Nonemployee Director to whom Restricted Stock is granted, or (b) The occurrence of a Change in Control. The Board may also, in its discretion, shorten or terminate the restricted period, or waive any conditions for the lapse or termination of restrictions with respect to all or any portion of the Restricted Stock at any time after the date the grant is made. 6.3 Rights of Holder; Limitations Thereon. Upon a grant of Restricted Stock, a stock certificate (or certificates) representing the number of Shares of Restricted Stock granted to the Nonemployee Director shall be registered in the Nonemployee Director's name and shall be held in custody by the Company or a bank selected by the Board for the Nonemployee Director's account. Unless provided otherwise in the Agreement, following such registration, the Nonemployee Director shall have the rights and privileges of a shareholder as to such Restricted Stock, including the right to vote such Restricted Stock, except that the Nonemployee Director shall not have the right to dividends and except further that, the following restrictions shall apply: (a) The Nonemployee Director shall not be entitled to delivery of a certificate until the expiration or termination of the restricted period for the Shares represented by such certificate and the satisfaction of any and all other conditions prescribed by the Board; (b) None of the Shares of Restricted Stock may be sold, transferred, assigned, pledged, or otherwise encumbered or disposed of during the restricted period and until the satisfaction of any and all other conditions prescribed by the Board; and 7 (c) Unless provided otherwise in the Agreement, all of the Shares of Restricted Stock that have not vested shall be forfeited and all rights of the Nonemployee Director to such Shares of Restricted Stock shall terminate without further obligation on the part of the Company, unless the Nonemployee Director has remained a Nonemployee Director of the Company or any of its Subsidiaries, until the expiration or termination of the restricted period and the satisfaction of any and all other conditions prescribed by the Board applicable to such Shares of Restricted Stock. Upon the forfeiture of any Shares of Restricted Stock, such forfeited Shares shall be transferred to the Company without further action by the Nonemployee Director and shall, in accordance with Section 4.2, again be available for grant under the Plan. If the Nonemployee Director paid any amount for the Shares of Restricted Stock that are forfeited, the Company shall pay the Nonemployee Director the lesser of the Fair Market Value of the Shares on the date they are forfeited or the amount paid by the Nonemployee Director. With respect to any Shares received as a result of adjustments under Section 8 or 9 hereof and any Shares received with respect to cash dividends declared on Restricted Stock, the Nonemployee Director shall have the same rights and privileges, and be subject to the same restrictions, as are set forth in this Article 6. 6.4 Delivery of Unrestricted Shares. Upon the expiration or termination of the restricted period for any Shares of Restricted Stock and the satisfaction of any and all other conditions prescribed by the Board, the restrictions applicable to such Shares of Restricted Stock shall lapse and a stock certificate for the number of Shares of Restricted Stock with respect to which the restrictions have lapsed shall be delivered, free of all such restrictions except any that may be imposed by law, to the holder of the Restricted Stock. The Company shall not be required to deliver any fractional Share but will pay, in lieu thereof, the Fair Market Value (determined as of the date the restrictions lapse) of such fractional Share to the holder thereof. 6.5 Nonassignability of Restricted Stock. Unless the Board provides otherwise in the Agreement, the Restricted Stock may not be sold, assigned, transferred, pledged or otherwise encumbered prior to the date Grantee becomes vested in the Restricted Stock, and following such date, shall be sold, assigned, transferred, pledged or otherwise encumbered only in accordance with any Shareholders Agreement in effect from time to time. 7. EFFECT OF CHANGE IN CONTROL Unless the Agreement provides otherwise, in the event of a Change in Control, (i) all conditions and restrictions on Shares of Restricted Stock shall immediately lapse on the date of such Change in Control, (ii) all Options outstanding on the date of such Change in Control shall become immediately and fully exercisable; (iii) an Optionee will be permitted to surrender for cancellation within sixty (60) days after such Change in Control, any Option or portion of an Option to the extent not yet exercised and the Optionee will be entitled to receive a cash payment in an amount equal to the excess, if any, of (x) the greater of (1) the Fair Market Value, on the date preceding the date of surrender, of the Shares subject to the 8 Option or portion thereof surrendered or (2) the Adjusted Fair Market Value of the Shares subject to the Option or portion thereof surrendered, over (y) the aggregate purchase price for such Shares under the Option or portion thereof surrendered; provided, however, that in the case of an Option granted within six (6) months prior to the Change in Control, the Optionee shall be entitled to surrender for cancellation his or her Option during the sixty (60) day period commencing upon the expiration of six (6) months from the date of grant of any such Option. 8. ADJUSTMENT UPON CHANGES IN CAPITALIZATION 8.1 Subject to Section 9, in the event of a Change in Capitalization, the Board shall conclusively determine the appropriate adjustments, if any, to the (i) maximum number and class of Shares or other stock or securities with respect to which Options and Awards may be granted under the Plan, (ii) the number and class of Shares or other stock or securities which are to be subject to Options and Awards to be granted under Sections 5 and 6; and (iii) the number and class of Shares or other stock or securities which are subject to outstanding Options and Awards granted under the Plan, and the purchase price therefor, if applicable; provided, however, that any stock adjustment in the Shares or other stock or securities subject to an outstanding Award or Option (including any adjustments in the purchase price) shall be made only to the extent necessary to maintain the proportionate interest of the Optionee or Grantee and preserve, without exceeding, the value of such Option or Award. 8.2 If, by reason of a Change in Capitalization, an Optionee shall be entitled to exercise an Option with respect to new, additional or different shares of stock or securities, such new, additional or different shares shall thereupon be subject to all of the conditions which were applicable to the Shares subject to the Option, as the case may be, prior to such Change in Capitalization. 9. EFFECT OF CERTAIN TRANSACTIONS Subject to Section 7, in the event of (i) the liquidation or dissolution of the Company or (ii) a merger or consolidation of the Company (a "Transaction"), the Plan and the Options and Awards issued hereunder shall continue in effect in accordance with their respective terms and each Optionee or Grantee shall be entitled to receive in respect of each Share subject to any outstanding Option or Award, upon exercise of such Option or lapse or restrictions on such Award, the same number and kind of stock, securities, cash, property, or other consideration that each holder of a Share was entitled to receive in the Transaction in respect of a Share. In the event that, after a Transaction, there occurs any change of a type described in Section 2.6 with respect to the shares of the surviving or resulting corporation, then adjustments similar to, and subject to the same conditions as, those in Section 8 shall be made by the Board. 10. TERMINATION AND AMENDMENT OF THE PLAN The Plan shall terminate on the day prior to the tenth anniversary of the effective date of the Plan, and no Option may be granted thereafter. The Board may sooner terminate the 9 Plan and the Board may from time to time amend, modify, or suspend the Plan; provided, however that: (a) Except as provided in Sections 7 and 8, no such amendment, modification, suspension, or termination shall impair or adversely alter any Options, Awards, or rights theretofore granted under the Plan, except with the consent of the Optionee or Grantee, nor shall any amendment, modification, suspension, or termination deprive any Optionee or Grantee of any Shares which he or she may have acquired through or as a result of the Plan; (b) To the extent required by applicable law, regulation or rule, no amendment shall be effective unless approved by the stockholders of the Company in accordance with applicable law and regulations at an annual or special meeting held within twelve (12) months before or after the date of adoption of such amendment. 11. NON-EXCLUSIVITY OF THE PLAN (a) The adoption of the Plan by the Board shall not be construed as amending, modifying or rescinding any previously approved compensation arrangement or as creating any limitations on the power of the Board to adopt such other compensation arrangements as it may deem desirable, including, without limitation, the granting of stock options otherwise than under the Plan, and such arrangements may be either applicable generally or only in specific cases. (b) Nothing contained in this Plan prohibits a Nonemployee Director from being appointed as an officer or employee of the Company at any time; nor does anything contained in this Plan specifically require a Nonemployee Director to surrender or forfeit an Option solely because he or she accepts an appointment as an officer or employee of the Company at any time after election or appointment to the Board. However, during such time as a Nonemployee Director serves an an officer or employee, he or she shall not be eligible to receive any additional awards under this Plan. 12. LIMITATION OF LIABILITY As illustrative of the limitations of liability of the Company, but not intended to be exhaustive thereof, nothing in the Plan shall be construed to: (i) give any person any right to be granted an Option or Award other than as specifically provided by the Plan; (ii) give any person any rights whatsoever with respect to Shares except as specifically provided in the Plan; (iii) limit in any way the right of the Company to terminate the service of any person as a Director pursuant to the Company's bylaws and articles of incorporation; or nominate or appoint any person as a Director. 10 13. REGULATIONS AND OTHER APPROVALS; GOVERNING LAW 13.1 This Plan and the rights of all persons claiming hereunder shall be construed and determined in accordance with the laws of the State of Delaware without giving effect to the conflicts of laws principles thereof, except to the extent that such law is preempted by federal law. 13.2 The obligation of the Company to sell or deliver Shares with respect to Options or Awards granted under the Plan shall be subject to all applicable laws, rules and regulations, including all applicable federal and state securities laws, and the obtaining of all such approvals by governmental agencies as may be deemed necessary or appropriate by the Board. 13.3 The Plan is intended to comply with Rule 16b-3 promulgated under the Exchange Act and the Board shall interpret and administer the provisions of the Plan or any Agreement in a manner consistent therewith. Any provisions inconsistent with such Rule shall be inoperative and shall not affect the validity of the Plan. 13.4 Each Option and Award is subject to the requirement that, if at any time the Board determines, in its discretion, that the listing, registration, or qualification of Shares issuable pursuant to the Plan is required by any securities exchange or under any state or federal law, or the consent or approval of any governmental regulatory body is necessary or desirable as a condition of, or in connection with, the grant of an Option or Award or the issuance of Shares, no Options or Awards shall be granted or payment made or Shares issued, in whole or in part, unless listing, registration, qualification, consent, or approval has been effected or obtained free of any conditions as acceptable to the Board. 13.5 Notwithstanding anything contained in the Plan to the contrary, in the event that the disposition of Shares acquired pursuant to the Plan is not covered by a then-current registration statement under the Securities Act of 1933, as amended, and is not otherwise exempt from such registration, such Shares shall be restricted against transfer to the extent required by the Securities Act of 1933, as amended, and Rule 144 or other regulations thereunder. The Board may require any individual receiving Shares pursuant to the Plan, as a condition precedent to receipt of such Shares upon exercise of an Option, to represent and warrant to the Company in writing that the Shares acquired by such individual are acquired without a view to any distribution thereof and will not be sold or transferred other than pursuant to an effective registration thereof under said Act or pursuant to an exemption applicable under the Securities Act of 1933, as amended, or the rules and regulations promulgated thereunder. The certificates evidencing any of such Shares shall be appropriately inscribed with a legend reflecting their status as restricted securities as aforesaid. 11 14. DESIGNATION OF BENEFICIARY Each Optionee and Grantee may designate a person or persons to receive in the event of his or her death, any Option or Award or any amount payable pursuant thereto, to which he or she would then be entitled. Such designation will be made upon forms supplied by and delivered to the Company and may be revoked in writing. If an Optionee or Grantee fails effectively to designate a beneficiary, then his or her estate will be deemed to be the beneficiary. 15. EFFECTIVE DATE The Plan is effective as of November 27, 2001, the date the Plan was approved by the Company's Board of Directors, subject to approval by the Company's stockholders. IN WITNESS WHEREOF, the Plan has been executed by the Company on this 28th day of November, 2001, to be effective on the Effective Date. NATIONAL SERVICE INDUSTRIES, INC. By: /s/ Brock A. Hattox ------------------------------- 12 -----END PRIVACY-ENHANCED MESSAGE-----