ItTable is the Company’s policy to self insure for certain insurable risks consisting primarily of physical loss to property; business interruptions resulting from such loss; and workers’ compensation, employee medical, comprehensive general, and auto liability. Insurance coverage is obtained for catastrophic property and casualty exposures as well as those risks required to be insured by law or contract. Based on an independent actuary’s estimate of the aggregate liability for claims incurred, a provision for claims under the self-insured program is recorded and revised annually. The actuarial estimates are subject to uncertainty from various sources, including changes in claim reporting patterns, claim settlement patterns, judicial decisions, legislation, and economic conditions. Contents

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

(Mark One)

x		QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended May 31, 2002 .
For the quarterly period ended November 30, 2002
OR
o		TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to

~~For~~Commission ~~the~~file ~~transition~~number ~~period from ______________________________________ to ________________________________________~~1-3208.

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 incorporation or organization)		(I.R.S. Employer Identification Number)

1420 Peachtree Street, N.E., Atlanta, Georgia		30309–3002
(Address of principal executive offices)		(Zip Code)

1420 Peachtree Street, N.E., Suite 200, 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 o

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 1011,~~968~~179,~~089~~169 shares as of ~~June~~December 3031, 2002.

Page 2

TABLE OF CONTENTS

	CONSOLIDATED BALANCE SHEETS (Unaudited)
		CONSOLIDATED BALANCE SHEETS (UNAUDITED)
	~~CONSOLIDATED STATEMENTS OF INCOME (Unaudited)~~	CONSOLIDATED STATEMENTS OF INCOME (Unaudited)
	~~CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)~~	CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)
	~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)~~	NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS
	Quantitative and Qualitative Disclosures About Market Risk
	Item 3. Quantitative and Qualitative Disclosures About Market Risk
	Item 4. Controls and Procedures
PART II. OTHER INFORMATION
	Item 1. Legal Proceedings
	Item 4. Submission of Matters to a Vote of Security Holders
	Item 5. Other Information
	Item 6. Exhibits and Reports on Form 8-K
SIGNATURES
CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER
CERTIFICATION OF THE CHIEF FINANCIAL OFFICER
INDEX TO EXHIBITS
EX-10.(III)(A)(2) FORM OF RESTRICTED STOCK AWARD
EX-10.(III)(A)(3) RESTRICTED STOCK AWARD AGREEMENT
EX-10.(III)(A)(4) AMENDMENT NO. 1 TO RESTRICTED
EX-99.1 CERTIFICATION OF THE P.E.O.
EX-99.2 CERTIFICATION OF THE P.F.O.

NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES

INDEX

			Page No.		~~Page No.~~
PART I		FINANCIAL INFORMATION
PART I. FINANCIAL INFORMATION
		ITEM 1	FINANCIAL STATEMENTS
	ITEM 1. FINANCIAL STATEMENTS
			CONSOLIDATED BALANCE SHEETS (Unaudited) – MAY 31, 2002 AND AUGUST 31, 2001			3
		CONSOLIDATED BALANCE SHEETS (Unaudited) – NOVEMBER 30, 2002 AND AUGUST 31, 2002		3
			CONSOLIDATED STATEMENTS OF INCOME (Unaudited) – THREE AND NINE MONTHS ENDED MAY 31, 2002 AND 2001			4
		CONSOLIDATED STATEMENTS OF INCOME (Unaudited) – THREE MONTHS ENDED NOVEMBER 30, 2002 AND 2001		4
			CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) – NINE MONTHS ENDED MAY 31, 2002 AND 2001			5
		CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited) – THREE MONTHS ENDED NOVEMBER 30, 2002 AND 2001		5
		NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)	~~NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)~~	6-14		~~6-16~~
		ITEM 2	MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			17-21
	ITEM 2. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS			15-19
		ITEM 3	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			21
	ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK			19
PART II		OTHER INFORMATION
	ITEM 4. CONTROLS AND PROCEDURES			20
		ITEM 1	LEGAL PROCEEDINGS			22
PART II. OTHER INFORMATION
		ITEM 6	EXHIBITS AND REPORTS ON FORM 8-K			22
	ITEM 1. LEGAL PROCEEDINGS			21
SIGNATURES						22
	ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS			21
INDEX TO EXHIBITS						22
	ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K			21
SIGNATURES				21
CERTIFICATION OF CHIEF EXECUTIVE OFFICER				22
CERTIFICATION OF CHIEF FINANCIAL OFFICER				23
INDEX TO EXHIBITS				24

~~Page~~CONSOLIDATED 3BALANCE SHEETS (UNAUDITED) NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES (In thousands, except share data)

CONSOLIDATED BALANCE SHEETS (Unaudited)


					November 30,			August 31,
					2002			2002

Assets
Current Assets:
	Cash and cash equivalents				$	16,602		$	20,969
	Receivables, less reserves for doubtful accounts of $1,210 at November 30, 2002, and $1,173 at August 31, 2002					49,653			52,198
	Inventories, at the lower of cost (on a first-in, first-out basis) or market					16,902			16,037
	Linens in service, net of amortization					49,901			51,806
	Prepayments					4,737			5,086
	Insurance receivable (Note 8)					48,347			42,024
	Other current assets					1,997			693

			Total Current Assets			188,139			188,813
Property, Plant and Equipment, at cost:
	Land					5,715			5,715
	Buildings and leasehold improvements					50,105			49,867
	Machinery and equipment					259,227			259,730

			Total Property, Plant and Equipment			315,047			315,312
	Less: Accumulated depreciation and amortization					170,982			167,356

						144,065			147,956
Other Assets:
	Intangibles					8,118			8,357
	Insurance receivable (Note 8)					128,940			140,831
	Prepaid benefit cost					31,483			30,644
	Other assets					2,405			2,497

			Total Other Assets			170,946			182,329

				Total Assets	$	503,150		$	519,098

Liabilities and Stockholders’ Equity
Current Liabilities:
	Current maturities of long-term debt (Note 7)				$	1,116		$	1,093
	Accounts payable					16,535			16,569
	Accrued salaries, commissions, and bonuses					5,357			7,007
	Current portion of self-insurance reserves					3,706			5,785
	Environmental reserve (Note 9)					5,751			5,777
	Current portion of litigation reserve (Note 8)					47,857			41,288
	Deferred income taxes					5,170			8,811
	Other accrued liabilities					19,144			19,506

		Total Current Liabilities				104,636			105,836
Long-Term Debt, less current maturities (Note 7)						696			984

Deferred Income Taxes						10,064			7,853

Self-Insurance Reserves, less current portion						8,875			9,258

Litigation Reserve, less current portion (Note 8)						152,600			166,844

Other Long-Term Liabilities						7,559			7,690

Commitments and Contingencies (Notes 8 and 9)
Stockholders’ Equity:
	Series A participating preferred stock, $.05 stated value, 500,000 shares authorized, none issued					—			—
	Preferred stock, no par value, 500,000 shares authorized, none issued					—			—
	Common stock, $1 par value, 120,000,000 shares authorized, 14,478,500 shares issued (Note 11)					14,479			14,479
	Paid-in capital					—			11,570
	Retained earnings					542,827			552,302
	Unearned compensation on restricted stock					(4,768	)		(4,092	)
	Accumulated other comprehensive income					(2,350	)		(2,350	)

						550,188			571,909
	Less: Treasury stock, at cost (3,312,784 shares at November 30, 2002 and 3,510,515 shares at August 31, 2002)					331,468			351,276

			Total Stockholders’ Equity			218,720			220,633

				Total Liabilities and Stockholders’ Equity	$	503,150		$	519,098

~~NATIONAL~~The ~~SERVICE~~accompanying ~~INDUSTRIES,~~notes ~~INC.~~to ~~AND~~consolidated ~~SUBSIDIARIES~~financial statements are an ~~(In~~integral ~~thousands,~~part ~~except~~of ~~share~~these ~~data)~~statements.

					May 31,			August 31,
					2002			2001
Assets
Current Assets:
	Cash and cash equivalents				$	18,416		$	—
	Receivables, less reserves for doubtful accounts of $1,491 at May 31, 2002, and $1,798 at August 31, 2001					54,539			60,406
	Inventories, at the lower of cost (on a first-in, first-out basis) or market					17,351			19,195
	Linens in service, net of amortization					50,568			56,910
	Deferred income taxes					9,148			9,138
	Prepayments					4,041			11,300
	Insurance receivable (Note 8)					30,316			28,616
	Other current assets					1,307			804
			Total Current Assets			185,686			186,369
Property, Plant, and Equipment, at cost:
	Land					6,320			12,775
	Buildings and leasehold improvements					50,816			57,433
	Machinery and equipment					260,464			258,344
			Total Property, Plant, and Equipment			317,600			328,552
	Less: Accumulated depreciation and amortization					164,342			157,507
						153,258			171,045
Other Assets:
	Goodwill					—			28,432
	Other intangibles					7,438			8,629
	Insurance receivable (Note 8)					72,460			66,574
	Other					37,284			37,049
			Total Other Assets			117,182			140,684
	Net assets of discontinued operations (Note 5)					—			400,296
				Total Assets	$	456,126		$	898,394
Liabilities and Stockholders’ Equity
Current Liabilities:
	Current maturities of long-term debt (Note 7)				$	1,070		$	1,011
	Credit facility borrowings (Note 7)					—			1,999
	Accounts payable					15,281			28,164
	Accrued salaries, commissions, and bonuses					7,054			7,050
	Current portion of self-insurance reserves					4,402			3,119
	Environmental reserve (Note 9)					6,690			7,291
	Current portion of litigation reserve (Note 8)					28,655			30,453
	Other accrued liabilities					22,578			19,561
		Total Current Liabilities				85,730			98,648
Long-Term Debt, less current maturities (Note 7)						1,266			1,990
Deferred Income Taxes						30,862			32,431
Self-Insurance Reserves, less current portion						11,550			12,477
Litigation Reserve, less current portion (Note 8)						81,900			82,917
Other Long-Term Liabilities						8,923			7,303
Commitments and Contingencies (Notes 8 and 9)
Stockholders’ Equity:
	Series A participating preferred stock, $.05 stated value, 500,000 shares authorized, none issued					—			—
	Preferred stock, no par value, 500,000 shares authorized, none issued					—			—
	Common stock, $1 par value, 120,000,000 shares authorized, 14,478,500 shares issued (Note 11)					14,479			14,480
	Paid-in capital					12,738			72,860
	Retained earnings					565,653			995,537
	Unearned compensation on restricted stock					(4,406	)		(880	)
	Accumulated other comprehensive income					(43	)		(43	)
						588,421			1,081,954
	Less: Treasury stock, at cost (3,522,905 shares at May 31, 2002 and 4,173,299 shares at August 31, 2001)					352,526			419,326
			Total Stockholders’ Equity			235,895			662,628
				Total Liabilities and Stockholders’ Equity	$	456,126		$	898,394

The accompanying notes to consolidated financial statements are an integral part of these balance sheets.

~~Page~~CONSOLIDATED 4STATEMENTS OF INCOME (Unaudited) NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES (In thousands, except per-share data)

CONSOLIDATED STATEMENTS OF INCOME (Unaudited)


				THREE MONTHS ENDED

				November 30,			November 30,
				2002			2001

Sales and Service Revenues:
	Service revenues			$	76,092		$	78,836
	Net sales of products				43,971			55,553

			Total Revenues		120,063			134,389
Costs and Expenses:
	Cost of services				47,318			47,764
	Cost of products sold				34,093			42,016
	Selling and administrative expenses				44,124			44,758
	Restructuring expense and other charges (Note 10)				—			5,820
	Gain on sale of business				(2,161	)		—
	Amortization expense				465			481
	Interest expense				1			111
	Other income, net				(682	)		(481	)

			Total Costs and Expenses		123,158			140,469

Loss from continuing operations before income taxes and cumulative effect of a change in accounting principle					(3,095	)		(6,080	)
Income tax benefit					(1,171	)		(2,432	)

Loss from continuing operations before cumulative effect of a change in accounting principle					(1,924	)		(3,648	)

Discontinued Operations (Note 5):
	Income from discontinued operations, net of tax of $7,066 in 2001				—			11,534
	Costs associated with effecting the spin-off, net of tax benefit of $717				—			(19,069	)

			Total Discontinued Operations		—			(7,535	)
Cumulative effect of a change in accounting principle, net of tax benefit of $10,830					—			(17,602	)

Net Loss				$	(1,924	)	$	(28,785	)

Basic and diluted earnings per share (split adjusted):
	Earnings per share from continuing operations before cumulative effect of a change in accounting principle			$	(0.19	)	$	(0.35	)
	Discontinued operations:
		Income from discontinued operations, net of tax			—			1.12
		Costs associated with effecting the spin-off, net of tax benefit			—			(1.85	)

			Total Discontinued Operations		—			(0.73	)

	Cumulative effect of a change in accounting principle, net of tax benefit				—			(1.71	)

			Net Loss	$	(0.19	)	$	(2.79	)

Basic Weighted Average Number of Shares Outstanding					10,357			10,305

Diluted Weighted Average Number of Shares Outstanding					10,357			10,305

NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES (In thousands, except per-share data)

				THREE MONTHS ENDED						NINE MONTHS ENDED
				May 31,			May 31,			May 31,			May 31,
				2002			2001			2002			2001
Sales and Service Revenues:
	Service revenues			$	83,738		$	88,019		$	239,909		$	248,734
	Net sales of products				52,341			56,309			162,597			171,423
			Total Revenues		136,079			144,328			402,506			420,157
Costs and Expenses:
	Cost of services				48,205			49,300			142,367			141,934
	Cost of products sold				40,913			43,699			124,941			133,757
	Selling and administrative expenses				44,081			43,082			132,872			127,064
	Restructuring expense and other charges (Note 10)				—			—			5,439			—
	Gain on sale of business				—			—			(379	)		(2,359	)
	Gain on sale of corporate headquarters building (Note 12)				(7,966	)		—			(7,966	)		—
	Amortization expense				435			683			1,348			2,114
	Interest expense				90			439			369			1,328
	Other (income) expense, net				(812	)		(656	)		(1,469	)		1,483
			Total Costs and Expenses		124,946			136,547			397,522			405,321
Income from continuing operations before income taxes and cumulative effect of a change in accounting principle					11,133			7,781			4,984			14,836
Income tax expense					4,342			2,879			1,882			5,489
Income from continuing operations before cumulative effect of a change in accounting principle					6,791			4,902			3,102			9,347
Discontinued Operations (Note 5):
	Income from discontinued operations, net of tax of $7,066 in 2002, and $6,506 and $22,902 for the three and nine months ended May 31, 2001, respectively				—			7,669			11,534			35,586
	Costs associated with effecting the spin-off, net of tax benefit of $717				—			—			(19,069	)		—
			Total Discontinued Operations		—			7,669			(7,535	)		35,586
Cumulative effect of a change in accounting principle, net of tax benefit of $10,830					—			—			(17,602	)		—
Net Income (Loss)				$	6,791		$	12,571		$	(22,035	)	$	44,933
Basic earnings per share (split adjusted):
	Earnings per share from continuing operations before cumulative effect of a change in accounting principle			$	0.66		$	0.48		$	0.30		$	0.91
	Discontinued operations:
		Income from discontinued operations, net of tax			—			0.74			1.12			3.47
		Costs associated with effecting the spin-off, net of tax benefit			—			—			(1.85	)		—
			Total Discontinued Operations		—			0.74			(0.73	)		3.47
	Cumulative effect of a change in accounting principle, net of tax benefit				—			—			(1.71	)		—
			Net Income (Loss)	$	0.66		$	1.22		$	(2.14	)	$	4.38
Diluted earnings per share (split adjusted):
	Earnings per share from continuing operations before cumulative effect of a change in accounting principle			$	0.65		$	0.47		$	0.30		$	0.91
	Discontinued operations:
		Income from discontinued operations, net of tax			—			0.74			1.12			3.44
		Costs associated with effecting the spin-off, net of tax benefit			—			—			(1.84	)		—
			Total Discontinued Operations		—			0.74			(0.72	)		3.44
	Cumulative effect of a change in accounting principle, net of tax benefit							—			(1.70	)		—
			Net Income (Loss)	$	0.65		$	1.21		$	(2.12	)	$	4.35
Basic Weighted Average Number of Shares Outstanding					10,330			10,280			10,317			10,260
Diluted Weighted Average Number of Shares Outstanding					10,467			10,383			10,371			10,320

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

~~Page~~CONSOLIDATED 5STATEMENTS OF CASH FLOWS (Unaudited) NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES (In thousands)

CONSOLIDATED STATEMENTS OF CASH FLOWS (Unaudited)


					THREE MONTHS ENDED

					November 30,			November 30,
					2002			2001

Cash Provided by (Used for) Operating Activities:
	Net loss from continuing operations				$	(1,924	)	$	(3,648	)
	Adjustments to reconcile net income to net cash provided by (used for) operating activities:
		Depreciation and amortization				6,491			6,534
		Provision for losses on accounts receivable				275			495
		Gain on the sale of property, plant and equipment				(73	)		(78	)
		Restructuring expense and other charges				—			5,820
		Gain on the sale of business				(2,161	)		—
		Change in assets and liabilities, net of effect of acquisitions and divestitures:
			Receivables			1,925			(2,291	)
			Inventories and linens in service, net			(147	)		2,975
			Deferred income taxes			(1,430	)		(2,437	)
			Prepayments and other assets			(1,060	)		(3,379	)
			Accounts payable			(258	)		(4,186	)
			Accrued liabilities			(2,190	)		5,001
			Self-insurance reserves and other long-term liabilities			(4,451	)		(1,015	)

				Net Cash (Used for) Provided by Continuing Operations		(5,003	)		3,791
				Net Cash Provided by Discontinued Operations		—			6,935

				Net Cash (Used for) Provided by Operating Activities		(5,003	)		10,726

Cash Provided by (Used for) Investing Activities:
	Purchases of property, plant and equipment					(2,848	)		(4,996	)
	Sale of property, plant and equipment					271			354
	Acquisitions					(240	)		—
	Divestitures					4,075			—
	Change in other assets					—			(149	)

		Net Cash Provided by (Used for) Investing Activities				1,258			(4,791	)

Cash Provided by (Used for) Financing Activities:
	Repayments of notes payable, net					—			241
	Repayments of long-term debt					(265	)		(245	)
	Treasury stock transactions, net					82			679
	Cash dividends paid					(439	)		(6,610	)

		Net Cash Used for Financing Activities				(622	)		(5,935	)

Net Change in Cash and Cash Equivalents						(4,367	)		—
Cash and Cash Equivalents at Beginning of Period						20,969			—

Cash and Cash Equivalents at End of Period					$	16,602		$	—

Supplemental Cash Flow Information:
	Income taxes paid during the period				$	124		$	3,443
	Interest paid during the period					43			12,888
Noncash Activities:
	Treasury shares issued under long-term incentive plan				$	—		$	1,109
	Cumulative effect of a change in accounting principle					—			28,432

NATIONAL SERVICE INDUSTRIES, INC. AND SUBSIDIARIES (In thousands)

					NINE MONTHS ENDED
					May 31,			May 31,
					2002			2001
Cash Provided by (Used for) Operating Activities:
	Net income from continuing operations				$	3,102		$	9,347
	Adjustments to reconcile net income to net cash provided by (used for) operating activities:
		Depreciation and amortization				19,079			20,795
		Provision for losses on accounts receivable				900			1,028
		(Gain) loss on the sale of property, plant, and equipment				(8,064	)		1,595
		Restructuring expense and other charges				5,439			—
		Gain on the sale of business				(379	)		(2,359	)
		Change in assets and liabilities, net of effect of acquisitions and divestitures:
			Receivables			4,688			(30	)
			Inventories and linens in service, net			6,994			(1,860	)
			Deferred income taxes			842			(20,674	)
			Prepayments and other assets			11,465			(4,185	)
			Accounts payable and accrued liabilities			(18,985	)		(223	)
			Self-insurance reserves and other long-term liabilities			(11,159	)		(4,716	)
				Net Cash Provided by (Used for) Continuing Operations		13,922			(1,282	)
				Net Cash Provided by Discontinued Operations		6,935			57,177
				Net Cash Provided by Operating Activities		20,857			55,895
Cash Provided by (Used for) Investing Activities:
	Purchases of property, plant, and equipment					(14,992	)		(15,416	)
	Sale of property, plant, and equipment					22,645			834
	Acquisitions					(1,535	)		(2,598	)
	Divestitures					1,062			2,286
	Change in other assets					(149	)		(1,900	)
		Net Cash Provided by (Used for) Investing Activities				7,031			(16,794	)
Cash Provided by (Used for) Financing Activities:
	Repayments of notes payable, net					(1,999	)		—
	Repayments of long-term debt					(665	)		(685	)
	Treasury stock transactions, net					679			2,260
	Cash dividends paid					(7,487	)		(40,676	)
		Net Cash Used for Financing Activities				(9,472	)		(39,101	)
Net Change in Cash and Cash Equivalents						18,416			—
Cash and Cash Equivalents at Beginning of Period						—			—
Cash and Cash Equivalents at End of Period					$	18,416		$	—
Supplemental Cash Flow Information:
	Income taxes paid during the period				$	3,619		$	55,678
	Interest paid during the period					13,131			35,169
Noncash Activities:
	Treasury shares issued under long-term incentive plan				$	—		$	3,637
	Cumulative effect of a change in accounting principle					28,432			—
	Noncash aspects of acquisitions:
		Assets acquired			$	1,560		$	2,894
		Liabilities assumed				25			296

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, subject to certain conditions, of its lighting equipment and chemicals businesses into a separate publicly-traded company with its own management and board of directors. The spin-off conditions were met November 29, 2001 and 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~~2002 has been derived from audited statements. These statements reflect all adjustments, all of which are of a normal, recurring nature, which are, in the opinion of management, necessary to present fairly the consolidated financial position as of ~~May~~November 3130, 2002, the consolidated results of ~~operations~~ operations for the three ~~and nine~~ months ended ~~May~~November 3130, 2002 and 2001, and the ~~consolidated~~ consolidated cash flows for the ~~nine~~three months ended ~~May~~November 3130, 2002 and 2001. ~~Certain~~ 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~~ accordance with generally accepted accounting principles have been condensed or omitted. The Company believes that the disclosures are adequate to make the ~~information~~ 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~~ 2002.

The results of operations for the three ~~and nine~~ months ended ~~May~~November 3130, 2002 are ~~not~~ 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.

In accordance with the Temporary Final Rule relating to “Requirements for Arthur Andersen LLP Auditing Clients” dated March 18, 2002, the unaudited financial statements contained in this report have not been reviewed by an independent accountant in accordance with Rule 10-01(d). As disclosed in a Form 8-K filed May 21, 2002, NSI elected not to retain the services of Arthur Andersen LLP and has recently engaged PricewaterhouseCoopers LLP as its independent accountants. PricewaterhouseCoopers LLP has not completed its review of the Company’s financial statements as of and for the three and nine months ended May 31, 2002. Under the terms of this Temporary Final Rule, if upon completion of this review there is a change to these financial statements, NSI will amend this filing. Otherwise, NSI will disclose in its 10-K filing for the fiscal year ended August 31, 2002, that these financial statements have been reviewed by PricewaterhouseCoopers LLP.

2. RECENT ACCOUNTING STANDARDS

Accounting Standards Yet to be Adopted

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No. 143 (“SFAS 143”) “Accounting for Asset Retirement Obligations.” SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes a cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The Company will adopt SFAS 143 effective September 1, 2002. The Company has not completed its evaluation of the effect of the adoption of SFAS 143, but does not expect the adoption to have a material adverse impact on the Company’s financial statements.

Page 7

In August 2001, the FASB issued Statement of Financial Accounting Standards No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of”, and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” for a disposal of a segment of a business. The Company will adopt SFAS 144 effective September 1, 2002. The Company does not expect the adoption to have a material effect on the Company’s financial statements.

Newly Adopted Accounting Standards

In June 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No. 143 (“SFAS 143”) “Accounting for Asset Retirement Obligations.” SFAS 143 addresses financial accounting and reporting obligations associated with the retirement of tangible long-lived assets and the associated asset retirement costs. It requires entities to record the fair value of a liability for an asset retirement obligation in the period in which it is incurred. When the liability is initially recorded, the entity capitalizes the cost by increasing the carrying amount of the related long-lived asset. Over time, the liability is accreted to its present value each period, and the capitalized cost is depreciated over the useful life of the related asset. Upon settlement of the liability, an entity either settles the obligation for its recorded amount or incurs a gain or loss upon settlement. The Company adopted SFAS 143 effective September 1, 2002. The adoption of SFAS 143 did not have a material impact on the Company’s financial statements.

In August 2001, the FASB issued Statement No. 144, “Accounting for the Impairment or Disposal of Long-Lived Assets” which addresses financial accounting and reporting for the impairment or disposal of long-lived assets. This statement supersedes FASB Statement No. 121, “Accounting for the Impairment of Long-Lived Assets and Long-Lived Assets to be Disposed Of”, and the accounting and reporting provisions of APB Opinion No. 30, “Reporting the Results of Operations – Reporting the Effects of Disposal of a Segment of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions” for a disposal of a segment of a business. The Company adopted SFAS 144 effective September 1, 2002. The adoption of SFAS 144 did not have a material impact on the Company’s financial statements.

In July 2001, the 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 Company adopted SFAS 142 as of September 1, 2001. Summarized information for the Company’s acquired intangible assets is as follows:

Acquired Intangible Assets

				May 31, 2002							August 31, 2001
			November 30, 2002							August 31, 2002
			Gross Carrying	~~Gross Carrying~~		Accumulated	~~Accumulated~~			Gross Carrying	~~Gross Carrying~~		Accumulated	~~Accumulated~~
			Amount	~~Amount~~		Amortization	~~Amortization~~			Amount	~~Amount~~		Amortization	~~Amortization~~
Amortized intangible assets:
	Customer contracts		$	$11,783	~~10,361~~	$	$(4,214	~~(3,427~~)	)	$	$11,589	~~10,215~~	$	$(3,851	~~(2,348~~)	)
	Other			1,639	~~1,439~~		(1,090	~~(935~~)	)		1,635	~~1,428~~		(1,016	~~(666~~)	)
	Total	~~Total~~	$	$13,422	~~11,800~~	$	$(5,304	~~(4,362~~)	)	$	$13,224	~~11,643~~	$	$(4,867	~~(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 $~~435~~465 and $~~1,348~~481 related to intangible assets for the three ~~and nine~~ months ended ~~May 31~~November 30, 2002, and ~~$381 and $1,215 for the three and nine months ended May 31,~~ 2001, respectively.

The ~~changes~~textile inrental ~~the~~and ~~carrying~~envelope ~~amount~~segments ofeach tested goodwill for impairment during the ~~period~~first ~~are~~quarter ~~summarized~~of fiscal 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 ~~follows:~~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.

	Textile
	Rental			Envelope			Total
Balance as of August 31, 2001	$	4,162		$	24,270		$	28,432
Transitional impairment losses		(4,162	)		(24,270	)		(28,432	)
Balance as of May 31, 2002	$	—		$	—		$	—

The textile rental and envelope segments each tested goodwill for impairment during the first quarter of 2002 as required by SFAS 142 upon adoption, utilizing a combination of valuation techniques including the expected present value of future cash flows, a market multiple approach and a comparable transaction approach. As a result of this valuation process as well as the application of the remaining provisions of SFAS 142, the Company recorded a pre-tax transitional impairment loss of $28,432, representing the write-off of all of the Company’s existing goodwill. This write-off was reported as a cumulative effect of a change in accounting principle, on a net of tax basis, in the Company’s Consolidated Statement of Income for the nine months ended May 31, 2002.

Page 8

Prior to the adoption of SFAS 142 in September 2001, the Company amortized goodwill over estimated useful lives ranging from 10 years to 30 years. Had the Company accounted for goodwill consistent with the provisions of SFAS 142 in prior periods, the Company’s income from continuing operations and net income would have been affected as follows:

	Three Months Ended				Nine Months Ended
	May 31,				May 31,
	2002		2001		2002			2001
Reported income from continuing operations	$	6,791	$	4,902	$	3,102		$	9,347
Add back: Goodwill amortization		—		190		—			566
Adjusted income from continuing operations	$	6,791	$	5,092	$	3,102		$	9,913
Adjusted net income (loss)	$	6,791	$	12,761	$	(22,035	)	$	45,499
Basic earning per share:
Reported income from continuing operations	$	0.66	$	0.48	$	0.30		$	0.91
Add back: Goodwill amortization		—		0.02		—			0.06
Adjusted income from continuing operations	$	0.66	$	0.50	$	0.30		$	0.97
Adjusted net (loss) income	$	0.66	$	1.24	$	(2.14	)	$	4.43
Diluted earning per share:
Reported income from continuing operations	$	0.65	$	0.47	$	0.30		$	0.91
Add back: Goodwill amortization		—		0.02		—			0.05
Adjusted income from continuing operations	$	0.65	$	0.49	$	0.30		$	0.96
Adjusted net income (loss)	$	0.65	$	1.23	$	(2.12	)	$	4.41

Page 9

3. BUSINESS SEGMENT INFORMATION

The following tables summarize the Company’s business segment information from continuing operations:

						Depreciation		Capital
	Sales and		Operating			and		Expenditures
	Service		Profit			Amortization		Including
Three Months Ended May 31, 2002	Revenues		(Loss)			Expense		Acquisitions
Three Months Ended November 30, 2002	Revenues		(Loss)			Expense		Acquisitions
Textile Rental	$	8376,~~738~~092	$	5(2,~~696~~106	)	$	4,~~281~~256	$	41,~~439~~882
Envelope		5243,~~341~~971		24(939	)		2,~~043~~114		1,~~421~~042
		136,079		5,720			6,324		5,860
		120,063		(3,045	)		6,370		2,924
Corporate		—		~~5,503~~(49	)		~~225~~121		—164
Interest expense		—		(901	)		—		—
Total	$	~~136~~120,~~079~~063	$	11(3,~~133~~095	)	$	6,~~549~~491	$	53,~~860~~088

Depreciation

Capital

Sales and

Operating

and

Expenditures

Service

Profit

Amortization

Including

Three Months Ended May 31, 2001

Revenues

(Loss)

Expense

Acquisitions

Three Months Ended November 30, 2001

Revenues

(Loss)

Expense

Acquisitions

Textile Rental

8878,~~019~~836

8(5,~~297~~379

)

4,~~077~~117

74,~~925~~105

Envelope

5655,~~309~~553

12,~~416~~154

2,~~415~~204

~~1,407~~838

144,328

9,713

6,492

9,332

134,389

(3,225

)

6,321

4,943

Corporate

—

(12,~~493~~744

)

~~347~~213

9853

Interest expense

—

(~~439~~111

)

—

Total

~~144~~134,~~328~~389

7(6,~~781~~080

)

6,~~839~~534

94,~~430~~996

						Depreciation		Capital
	Sales and		Operating			and		Expenditures
	Service		Profit			Amortization		Including
Nine Months Ended May 31, 2002	Revenues		(Loss)			Expense		Acquisitions
Textile Rental	$	239,909	$	1,659		$	12,469	$	11,699
Envelope		162,597		2,827			6,047		4,640
		402,506		4,486			18,516		16,339
Corporate		—		867			563		188
Interest expense		—		(369	)		—		—
Total	$	402,506	$	4,984		$	19,079	$	16,527

						Depreciation		Capital
	Sales and		Operating			and		Expenditures
	Service		Profit			Amortization		Including
Nine Months Ended May 31, 2001	Revenues		(Loss)			Expense		Acquisitions
Textile Rental	$	248,734	$	16,033		$	12,345	$	13,729
Envelope		171,423		3,991			7,171		3,749
		420,157		20,024			19,516		17,478
Corporate		—		(3,860	)		1,279		536
Interest expense		—		(1,328	)		—		—
Total	$	420,157	$	14,836		$	20,795	$	18,014

	Total Assets, Excluding Discontinued Operations
	May 31,		August 31,
	2002		2001
Textile Rental	$	211,680	$	231,422
Envelope		106,963		141,945
Subtotal		318,643		373,367
Corporate		137,483		124,731
Total	$	456,126	$	498,098

Page 10


	Total Assets

	November 30,		August 31,
	2002		2002

Textile Rental	$	205,143	$	207,886
Envelope		96,601		99,391

Subtotal		301,744		307,277
Corporate		201,406		211,821

Total	$	503,150	$	519,098

4. INVENTORIES

Major classes of inventory as of ~~May~~November 3130, 2002 and August 31, ~~2001~~2002 were as follows:

	May 31,		August 31,
	November 30,		August 31,
	2002		~~2001~~2002
Raw Materials and Supplies	$	65,~~096~~940	$	65,716
Work-in-Process		23,~~697~~324		~~817~~2,493
Finished Goods		87,~~558~~638		117,~~662~~828
Total	$	1716,~~351~~902	$	1916,~~195~~037

5. DISCONTINUED OPERATIONS

On November 7, 2001, the Company’s board of directors approved the spin-off of its lighting equipment and chemicals businesses into a separate publicly-traded company with its own management and board of directors. The spin-off was effected on November 30, 2001 through a tax-free distribution of 100% of the outstanding shares of common stock of Acuity, a wholly-owned subsidiary of the Company owning and operating the lighting equipment and chemicals businesses. Each NSI stockholder of record as of November 16, 2001, the record date for the Distribution, received one share of the Acuity common stock for each share of NSI common stock held at that date.

As a result of the November 2001 spin-off, the Company’s financial statements have been prepared with these businesses’ net assets, results of operations, and cash flows presented as discontinued operations through the effective date of the Distribution, November 30, 2001. All historical statements have been restated to conform with this presentation.

~~Summarized~~In ~~financial~~conjunction ~~information~~with ~~for~~the ~~discontinued~~spin-off, ~~operations~~the isCompany asand ~~follows:~~Acuity entered into various agreements that addressed the allocation of assets and liabilities between them and that defined their relationship after the separation, including a distribution agreement, a tax disaffiliation agreement, an employee benefits agreement, a transition services agreement and a lease agreement. Management believes the amounts paid or received associated with these services are representative of the fair value of the services provided.

	August 31,
	2001
Current Assets	$	559,116
Property, Plant, and Equipment – net		248,423
Goodwill and Other Intangibles		468,944
Other Long-Term Assets		54,092
Current Liabilities		(442,067	)
Long-Term Debt, less current maturities		(373,707	)
Other Long-Term Liabilities		(131,503	)
Accumulated Other Comprehensive Income Items		16,998
Net Assets of Discontinued Operations	$	400,296

In addition, Acuity and NSI entered into a put option agreement, whereby NSI had 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. On May 23, 2002 the Company completed the cash sale of the property to an unrelated third party. Subsequent to the sale, NSI executed a release of the put option agreement, thereby extinguishing any rights that NSI had under the agreement.

6. EARNINGS PER SHARE

The Company accounts for earnings per share using Statement of Financial Accounting Standards No. 128, “Earnings per Share.” Under this statement, basic earnings per share is computed by dividing net earnings available to common stockholders by the weighted average number of common shares outstanding during the period. Diluted earnings per share is computed similarly but reflects the dilutive effect of potential common shares, including options and restricted stock.

~~Page~~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:

The following table calculates basic earnings per common share and diluted earnings per common share at May 31, and reflects the January 7, 2002 one-for-four reverse stock split further described in note 11:


	Three Months Ended
	November 30,

	2002			2001

Basic and diluted earnings per common share:
Income from continuing operations before cumulative effect of a change in accounting principle	$	(1,924	)	$	(3,648	)
Basic and diluted weighted average shares outstanding		10,357			10,305

Basic earnings from continuing operations before cumulative effect of a change in accounting principle per share	$	(0.19	)	$	(0.35	)

	Three Months Ended				Nine Months Ended
	May 31,				May 31,
	2002		2001		2002		2001
Basic earnings per common share:
Income from continuing operations before cumulative effect of a change in accounting principle	$	6,791	$	4,902	$	3,102	$	9,347
Basic weighted average shares outstanding		10,330		10,280		10,317		10,260
Basic earnings from continuing operations before cumulative effect of a change in accounting principle per share	$	0.66	$	0.48	$	0.30	$	0.91
Diluted earnings per common share:
Income from continuing operations before cumulative effect of a change in accounting principle	$	6,791	$	4,902	$	3,102	$	9,347
Basic weighted average shares outstanding		10,330		10,280		10,317		10,260
Add: Shares of common stock assumed issued upon exercise of dilutive stock options		19		90		7		54
Add: Unvested restricted stock		118		13		47		6
Diluted weighted average shares outstanding		10,467		10,383		10,371		10,320
Diluted earnings from continuing operations before cumulative effect of a change in accounting principle per share	$	0.65	$	0.47	$	0.30	$	0.91

Stock options to purchase 1,237 and 1,074 shares of common stock for the three months ended November 30, 2002 and 2001, respectively, and unvested restricted shares of 805 and 12 for the three months ended November 30, 2002 and 2001, respectively, were not included in the computation of diluted earnings per share because their effect would have been antidilutive.

Stock options to purchase 1,401 and 1,338 shares of common stock for the three and nine months ended May 31, 2002, respectively, and 744 and 754 shares of common stock for the three and nine months ended May 31, 2001, respectively, were not included in the computation of diluted earnings per share because their effect would have been antidilutive.

7. LONG-TERM DEBT

Outstanding borrowings at ~~May~~November 3130, 2002 included $21,~~336~~812 in notes payable at an interest rate of 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. No amounts were outstanding under this facility at ~~May~~November 3130, 2002.

8. LEGAL PROCEEDINGS

The Company is subject to various legal claims arising in the normal course of business out of the conduct of its current and prior businesses, including product liability claims. Based on information currently available, it is the opinion of management that the ultimate resolution of pending and threatened legal proceedings will not have a material adverse effect on the Company’s financial condition or results of operations. beyond its current estimates. 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 financial condition and results of operations in a particular future period. The Company ~~reserves~~ accrues 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 accruals ~~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~~accrued.

Among the product liability claims to which the Company is subject are claims for personal injury or wrongful death arising from the installation and distribution of asbestos-containing insulation, primarily in the southeastern United States, by a previously divested business of the Company. Most claims against the Company seek both substantial compensatory damages and punitive damages. The Company believes that many of the claims against it are without merit. The Company believes its conduct with respect to asbestos-containing insulation was consistent with recognized safety standards at the relevant times, and the Company believes there is no basis for imposing punitive damages against it in connection with asbestos claims. In addition, the Company believes that it has substantial legal defenses against many of these claims, including that the Company did not manufacture any asbestos-containing building products, that the Company did not distribute or install products at certain sites where exposure is alleged, and that statutes of repose in some states bar the claims. However, there is no assurance that the Company will be successful in asserting defenses to these claims.

Prior to February 1, 2001, the Center for Claims Resolution (the “CCR”), a membership organization for asbestos defendants, 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 was paid directly by the Company’s insurers. Since February 1, 2001, the Company has retained trial counsel directly, rather than through the CCR, to defend asbestos-related claims against the Company and has engaged another outside consultant to provide claims processing and administration services for asbestos-related claims. The Company is more vigorously 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.

~~Page~~During 12the past two years, certain former members of the CCR have failed to make payments to the CCR, by reason of bankruptcy or otherwise, for their shares of certain settlement agreements the CCR had reached on behalf of its members with plaintiffs. Consequently, with respect to some settlement agreements, the CCR has been unable to make the full payments contemplated by those agreements. In some circumstances, the Company and other members and former members of the CCR have contributed additional funds to the CCR to permit it to make certain payments contemplated by the settlement agreements, though the Company does not believe it is liable for such additional funds. As of November 30, 2002, the Company has contributed approximately $5.8 million to the CCR for this purpose, and it may make further such payments in the future. 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 and former 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 itany ~~has~~amount ~~substantial~~it ~~legal~~pays, ~~defenses~~including ~~against~~the ~~many~~$5.8 million ofit ~~these claims,~~has ~~including~~already ~~that~~contributed to the ~~Company~~CCR, ~~did~~on ~~not~~account ~~manufacture~~of ~~any~~payments ~~asbestos-containing~~contemplated ~~building~~by ~~products,~~settlement ~~that~~agreements ~~the~~entered ~~Company~~into ~~did~~by ~~not~~the ~~distribute~~CCR oron ~~install~~behalf ~~products~~of atits ~~certain~~members, should ~~sites~~be ~~where~~covered ~~exposure~~either isby ~~alleged,~~the Company’s insurance or by surety bonds and ~~that~~collateral provided ~~statutes~~by ofthose ~~repose~~former inmembers ~~some~~who ~~states~~failed ~~bar~~to ~~the~~meet ~~claims~~their obligations. ~~However,~~There ~~there~~can isbe no assurance, however, that the Company ~~will~~can beactually ~~successful~~recover inany ~~asserting defenses~~of tothese amounts. Accordingly, no insurance or other recovery with respect to these ~~claims~~amounts has been recorded as an asset in the Company’s financial statements.

~~Prior~~The toamount ~~February 1, 2001, the Center for Claims Resolution (the “CCR”) handled the processing and settlement~~ of ~~claims on behalf of~~ the Company’s ~~and~~liability ~~retained local~~on ~~counsel~~account ~~for the defense~~ of ~~claims.~~payments ~~Pursuant~~contemplated ~~to a written agreement among~~by ~~CCR~~settlement ~~members,~~agreements ~~the~~entered ~~Company~~into ~~was responsible for varying percentages of defense and liability payments on a claim-~~by~~-claim~~ ~~basis~~the ~~for~~CCR ~~each~~is ~~claim~~uncertain. inThe ~~which~~Company ~~it was~~has ~~named~~included in ~~accordance~~its ~~with~~accruals ~~predetermined~~its ~~sharing~~estimate ~~formulae. Substantially all~~ of the Company’s ~~portion~~potential ofliability ~~those~~in this ~~payments~~respect, ~~were~~but ~~paid directly by~~ the Company’s ~~insurers.~~ ~~Since~~ultimate ~~February 1,~~liability ~~2001,~~for ~~the~~these ~~Company~~matters ~~has~~could ~~retained trial counsel~~be ~~directly,~~greater ~~rather~~ than ~~through~~estimated ~~the~~if more CCR, tomembers ~~defend~~or ~~asbestos-related~~former ~~claims against~~members ~~the~~fail ~~Company and has engaged another outside consultant~~ to ~~provide~~meet their ~~claims~~obligations ~~processing~~or ~~and~~if ~~administration~~the ~~services~~courts ~~for~~determine ~~asbestos-related~~that ~~claims.~~the ~~The~~ Company ~~intends~~could to be ~~more~~liable ~~vigorous in defending asbestos-related claims and~~for ~~will seek to dismiss without any~~ settlement ~~payment~~payments ~~claims~~that ~~arising~~were ~~in jurisdictions~~attributable orto ~~involving~~other ~~worksites~~CCR ~~where the Company did not distribute or install asbestos-containing products~~members.

~~During~~Several ~~the~~significant ~~past~~companies ~~two~~that ~~years,~~are ~~certain~~traditional ~~former~~co-defendants ~~members~~in ~~of the CCR have failed to~~asbestos ~~make payments to the CCR~~claims, byboth ~~reason~~former ofmembers ~~bankruptcy or otherwise, for their shares~~ of ~~certain settlement agreements~~ the CCR ~~had~~and ~~reached on behalf of its~~ non-members ~~with plaintiffs. Consequently~~, ~~with~~have ~~respect~~sought toprotection under ~~some~~Chapter 11 ~~settlement agreements,~~of the ~~CCR~~federal ~~has~~bankruptcy ~~been~~code ~~unable~~during ~~to make~~ the ~~full~~past ~~payments~~three ~~contemplated by~~years. ~~those~~Litigation ~~agreements.~~against Insuch ~~some~~co-defendants ~~circumstances,~~generally ~~the~~is ~~Company~~stayed ~~and~~or ~~other~~restricted ~~members~~as ~~and~~a ~~former~~result ~~members~~ of ~~the~~their ~~CCR~~bankruptcy ~~have~~filings. ~~contributed~~The ~~additional~~absence ~~funds~~of tothese ~~the CCR to~~traditional ~~permit~~defendants itmay toincrease ~~make certain payments contemplated by~~ the ~~settlement~~number ~~agreements. As~~ of ~~May 31,~~claims ~~2002,~~filed ~~the~~against ~~Company~~other ~~has contributed approximately $5.3 million to~~defendants, including the ~~CCR for this purpose~~Company, and it may ~~make~~increase ~~further such payments in~~ the ~~future. Payments~~cost ~~made since August 31, 2001 have been applied against the Company’s accrual for asbestos liabilities established as~~ of ~~August 31,~~resolving ~~2001~~such claims. ~~Some~~Due ~~plaintiffs who are parties~~ to ~~settlement agreements with~~ the ~~CCR~~uncertainties ~~that contemplate~~surrounding ~~payments that~~ the ~~CCR~~ultimate ~~has~~effect ~~been~~of ~~unable~~these tobankruptcies ~~make have commenced~~on ~~litigation~~remaining ~~against~~asbestos ~~the CCR~~defendants, the ~~Company,~~effect ~~and~~on ~~other~~the ~~members~~amount ~~and former 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~~’s ~~defense~~liabilities ~~group~~cannot ~~with~~be ~~other CCR members to defend these claims~~determined.

The ~~Company~~claims ~~believes~~activity ~~that~~for ~~any~~each ~~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~~three onmonth ~~behalf~~periods ofended ~~its~~November 30 ~~members, should~~was 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~~follows: ~~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.


		2002			2001

Open claims, beginning of period			35,300			35,000
	Served		16,000			2,300
	Dismissed		(100	)		(11,300	)
	Settled		(1,200	)		(2,300	)

			50,000			23,700
Settled in principle after February 1, 2001 but not finalized			(13,700	)		(2,900	)

Open claims pending, end of period			36,300			20,800

Average resolution indemnity cost per claim for the three months ended November 30*		$	916		$	785

Total claims resolved since February 1, 2001			32,300

Average resolution indemnity cost per claim for claims resolved since February 1, 2001*		$	815

~~Several~~ * Average ~~significant~~resolution ~~companies~~indemnity ~~that~~cost ~~are~~is ~~traditional~~based ~~co-defendants~~on inindemnity ~~asbestos~~costs for 1,300 ~~claims~~and 13,600 ~~both~~claims ~~former~~dismissed ~~members~~and ofsettled during the ~~CCR~~three months ended November 30, 2002 and ~~non-members~~2001, ~~have~~respectively. ~~sought~~During ~~protection under~~the ~~Chapter~~three months ended November 1130, 2002, ofa ~~the~~significant ~~federal~~number ~~bankruptcy~~of ~~code~~claims ~~during~~reflected ~~the~~as ~~past~~pending ~~two~~as ~~years.~~of August 31, 2002 ~~Litigation~~were ~~against~~settled ~~such~~in ~~co-defendants~~principle ~~generally~~but ishave ~~stayed~~not orbeen ~~restricted~~finalized asfor aan average indemnity ~~result~~cost ofsubstantially ~~their~~higher ~~bankruptcy~~than ~~filings.~~the ~~The~~Company’s ~~absence~~historical ofaverages. ~~these~~If ~~traditional~~these ~~defendants~~claims ~~may~~were ~~increase~~included in the ~~number~~average ofresolution ~~claims~~indemnity ~~filed~~cost ~~against~~per ~~other~~claim ~~defendants, including~~for the three ~~Company~~months ended November 30, ~~and~~2002, ~~may~~the cost would increase from $916 to $14,192 per claim. If these claims were included in the average resolution indemnity cost ofper ~~resolving~~claim ~~such~~for claims. ~~Due~~resolved since February 1, 2001, the cost would increase from $815 to ~~the~~$2,657 ~~uncertainties~~per ~~surrounding~~claim. ~~the~~These ~~ultimate~~cases ~~effect~~were ofpending ~~these~~against ~~bankruptcies~~the onCompany ~~remaining~~in ~~asbestos~~Jefferson ~~defendants~~County (Beaumont) and Orange County, Texas, and the ~~effect~~Company onelected to settle these claims for amounts significantly greater than its historical averages in order to avoid the ~~amount~~risk of ~~the~~potentially ~~Company’s liabilities~~higher ~~cannot~~jury beawards ~~determined~~in these unfavorable jurisdictions.

~~During~~As ~~the~~of ~~fiscal year ended August~~November ~~31, 2001, the Company was served with approximately~~ 30,~~000~~ ~~asbestos-related~~2002 ~~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 357,~~000~~800 ~~open~~and ~~claims pending against the~~11,200 ~~Company~~additional ~~(including~~claims, ~~approximately 1~~respectively,~~000~~ ~~claims~~ that were ~~settled in principle after February 1~~, ~~2001~~as ~~but~~part ~~not~~of ~~finalized)~~CCR ~~and approximately 12~~settlements,~~000~~ ~~additional claims that were~~ settled in principle prior to February 1, 2001 but not finalized.

~~The claim activity for the nine~~10 ~~months ended May 31, 2002 was as follows:~~

Open claims pending as of August 31, 2001			35,000
	Served		10,400
	Dismissed		(11,900	)
	Settled		(2,900	)
			30,600
	Settled in principle after February 1, 2001 but not finalized		(2,700	)
Open claims pending as of May 31, 2002			27,900
Average resolution indemnity cost per claim for the nine months ended May 31, 2002		$	634

As of May 31, 2002, there were approximately 12,700 additional claims that were settled in principal prior to February 1, 2001 but not finalized.

~~Page~~As 13of November 30, 2002 and August 31, 2002, an estimated accrual of $200.4 million and $208.1 million, respectively, for asbestos-related liabilities, before consideration of insurance recoveries, has been reflected in the accompanying financial statements, primarily in long-term liabilities. During the year ended August 31, 2002, as part of its ongoing estimating process, consultation with outside experts, the nature of pending claims, the jurisdiction in which claims have been filed, and in light of its gained experience in administration of its defense strategy and recent settlement activity, the Company reviewed its asbestos claims liabilities and adjusted the balances in these accounts from its prior three year outlook to an estimate of the total probable liabilities from pending and expected future asbestos claims over an approximate fifty year period, which takes into consideration the life expectancy of individuals potentially exposed. As a result of such review, the Company concluded that a reasonable estimate of its expected future claims for approximately fifty years would require an increase in its liabilities ranging from approximately $94 million to $139 million over the amounts recorded as of August 31, 2001. Additionally, the Company believes it has insurance coverage available to recover most of its asbestos-related costs; however, out-of-pocket costs associated with the range of additional liabilities could be from $17 million to $31 million, representing the costs that would be paid by the Company due primarily to the insolvency of certain foreign insurance carriers. Management does not believe that any amount in the range is more accurate than any other. Therefore, as of August 31, 2002, the Company increased its liabilities for asbestos related costs by approximately $94 million, the low end of the range and recorded an additional insurance recovery amount of $77 million. 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 differ materially from the Company’s estimates due to changes in facts and circumstances after the date of each estimate.

AsThe ofCompany ~~May 31,~~believes ~~2002~~that ~~and~~it ~~August 31,~~has ~~2001,~~insurance ancoverage ~~estimated~~available ~~accrual~~to ofrecover ~~$110.6 million~~most ~~and~~of ~~$113.4 million,~~its ~~respectively, for~~ asbestos-related ~~liabilities,~~costs. ~~before~~With the exception of the Company’s payments on ~~consideration~~account of ~~insurance~~settlement ~~recoveries~~obligations of defaulting CCR members as discussed above, the Company has ~~been~~reached ~~reflected~~settlement inagreements ~~the~~with ~~accompanying~~substantially all of its ~~financial~~relevant ~~statements,~~insurers ~~primarily~~providing infor ~~long~~payment of substantially all asbestos-~~term~~related claims ~~liabilities~~(subject to retentions) up to the various policy limits. The timing and amount of future recoveries from insurance carriers will depend on the pace of ~~accrual~~claims isreview ~~based~~and processing by such carriers and on the ~~following:~~resolution of any remaining disputes regarding coverage under such policies. In the event the Company’s ~~estimate~~insurers ofdispute ~~indemnity~~amounts ~~payments~~billed ~~and~~to ~~defense~~them ~~costs~~or ~~associated~~pay ~~with~~on ~~pending~~an ~~and~~untimely ~~future~~basis, ~~asbestos-related~~the ~~claims~~Company totakes beall ~~paid~~practicable ~~through~~steps ~~mid-2005;~~to ~~settlements~~secure ~~agreed~~payment, ~~to but~~including ~~not~~alternative ~~paid~~dispute asresolution ofprocedures ~~May 31,~~and ~~2002;~~litigation to resolve the issues. The Company’s ~~expected~~has ~~payment~~initiated onalternative ~~account~~dispute ofresolution proceedings with two ~~settlement~~insurers ~~obligations~~to ofresolve ~~defaulting~~outstanding ~~CCR~~insurance ~~members;~~policy ~~interest~~interpretation onissues, ~~settlement~~and, ~~payments~~with ~~that~~respect ~~are~~to ~~subject~~one of the insurers, to ~~ongoing~~secure ~~dispute~~payment ~~resolution~~of ~~with~~past ~~certain~~due ~~insurance providers;~~amounts and to ~~other~~ensure ~~legal~~that ~~fees~~the ~~and~~insurer’s ~~expenses~~future obligations will be met in a timely fashion. The Company’s ~~estimates~~believes ofits recorded receivables, which includes both ~~indemnity~~billed ~~payments~~amounts and ~~defense~~estimates ~~costs~~of ~~associated~~future ~~with~~recoveries, ~~pending~~from ~~and~~insurance ~~future~~carriers are ~~asbestos~~collectible. ~~claims~~The ~~are~~Company ~~based~~reached onthis ~~the~~conclusion ~~Company’s~~after ~~estimate~~considering ofvarious factors ~~the~~including ~~number~~its ofprior ~~future~~insurance-related recoveries in respect of asbestos-related claims, ~~and~~existing insurance policies, settlement agreements with insurers, the ~~type~~apparent viability of ~~disease~~its insurers, ifthe ~~any,~~advice ~~alleged~~of oroutside counsel ~~expected~~with respect to the applicable insurance coverage law relating to terms beand ~~alleged~~conditions inof ~~such~~those ~~claims~~policies, ~~assumptions~~and ~~regarding~~a general assessment by the ~~timing~~Company and its ~~amounts~~advisors of ~~settlement~~ ~~payments,~~ the ~~status~~financial condition of ~~ongoing~~the ~~litigation~~relevant ~~and~~insurers. ~~settlement initiatives~~Accordingly, an ~~and~~estimated ~~the~~aggregate ~~advice~~insurance recovery of ~~outside~~$177.3 million ~~counsel~~and ~~with~~$182.9 million has ~~respect~~been toreflected in the ~~current state~~accompanying financial statements as of ~~the~~November 30, 2002 ~~law~~and ~~related~~August 31, to2002, ~~asbestos~~respectively, ~~claims.~~with ~~The~~respect ~~ultimate~~to ~~liability~~previously ~~for~~paid ~~all~~claims, pending and future claims ~~cannot~~and bethe ~~determined~~other ~~with~~items ~~certainty~~included ~~due~~in to the ~~difficulty~~ accrual of asbestos-related ~~forecasting~~liabilities. Approximately $48.3 million and $42.0 million of the ~~numerous~~aggregate ~~variables~~insurance ~~that~~recovery ~~can~~and ~~affect~~$47.9 million ~~the~~and ~~amount~~$41.3 million of the ~~liability.~~asbestos-related ~~There~~accrual ~~are~~have ~~inherent~~been ~~uncertainties~~classified ~~involved~~as incurrent ~~estimating~~assets ~~these amounts,~~ and liabilities in the ~~Company’s~~accompanying ~~actual~~balance ~~costs~~sheet inas ~~future~~of ~~periods~~November 30, ~~could~~2002 ~~exceed~~and ~~the~~August 31, 2002, ~~Company’s~~respectively. ~~estimates~~Approximately ~~due~~$5.7 million toof ~~changes~~insurance inrecovery ~~facts~~was ~~and~~under alternative ~~circumstances~~dispute ~~after~~resolution ~~the~~proceedings ~~date~~at ~~of each~~November 30, ~~estimate~~2002.

~~The~~Management ~~Company~~continues ~~believes~~to ~~that~~monitor itclaims ~~has~~activity, ~~insurance~~the ~~coverage~~status ~~available~~of ~~to recover most~~lawsuits of(including ~~its~~settlement ~~asbestos-related~~initiatives), ~~costs.~~legislative ~~The~~developments, ~~Company~~and ~~has reached settlement agreements~~costs ~~with~~incurred ~~substantially~~in ~~all~~order ofto ~~its~~ascertain ~~relevant~~whether ~~insurers~~an ~~providing~~adjustment ~~for~~to ~~payment~~the ofexisting accruals ~~substantially~~should ~~all~~be ~~asbestos-related~~made ~~claims (subject~~ to ~~retentions)~~the extent upthat tohistorical ~~the various~~experience ~~policy~~may ~~limits,~~differ ~~except~~significantly ~~for~~from the Company’s ~~payments on account of~~ ~~settlement~~underlying ~~obligations~~assumptions. ofAs ~~defaulting~~additional ~~CCR~~information ~~members~~becomes available, ~~as discussed above. The~~the ~~timing~~Company ~~and~~will ~~amount~~reassess ofits ~~future~~liability ~~recoveries~~and ~~from~~revise ~~insurance~~its ~~carriers~~estimates ~~will~~as ~~depend on~~appropriate. ~~the~~Management ~~pace~~currently ofbelieves ~~claims~~that, ~~review~~based ~~and processing by such carriers and~~ on the ~~resolution of~~factors ~~any~~discussed ~~remaining~~in ~~disputes regarding coverage under such policies. In~~ the ~~event~~ ~~the~~preceding ~~Company’s~~paragraphs ~~insurers~~and ~~dispute~~taking ~~amounts~~into ~~billed~~account tothe ~~them~~accruals orreflected ~~pay~~as ~~on an untimely~~of ~~basis~~November 30, ~~the Company takes all practicable steps to secure payment~~2002, ~~including alternative~~the ~~dispute~~ resolution ~~procedures~~of ~~and~~asbestos-related ~~litigation~~uncertainties toand ~~resolve~~ the ~~issues.~~ ~~The~~incurrence ~~Company~~of ~~has~~asbestos-related ~~initiated~~costs ~~alternative~~net ~~dispute~~of ~~resolution~~related ~~proceedings with two insurers to resolve outstanding~~ insurance ~~policy~~recoveries ~~interpretation issues, and,~~should ~~with~~not ~~respect~~have toa ~~one~~material ofadverse ~~the~~effect ~~insurers,~~on ~~to secure payment of past due amounts and to ensure that~~ the ~~insurer~~Company’s ~~future~~long-term ~~obligations~~consolidated financial ~~will~~position beor ~~met~~results inof ~~a timely fashion~~operations. ~~The~~However, ~~Company~~as ~~believes that substantial recoveries from~~ the ~~insurance~~Company’s ~~carriers~~estimates are ~~probable.~~periodically ~~The~~re-evaluated, ~~Company~~additional ~~reached~~accruals ~~this~~to ~~conclusion~~the ~~after considering~~liabilities ~~its~~reflected ~~prior~~in ~~insurance-related~~the ~~recoveries~~Company’s infinancial ~~respect~~statements ofmay ~~asbestos-related~~be ~~claims~~necessary, ~~existing~~ ~~insurance~~and ~~policies,~~such accruals ~~settlement~~could ~~agreements~~be ~~with~~material ~~insurers,~~to the ~~apparent viability~~results of ~~its insurers,~~ the ~~advice~~period ofin ~~outside~~which ~~counsel~~they ~~with~~are recorded. ~~respect~~Given to the ~~applicable~~ ~~insurance~~number ~~coverage law relating to terms~~ and ~~conditions~~complexity of ~~those policies,~~factors ~~and~~that aaffect ~~general assessment by~~ the Company’s liability and its ~~advisors~~available ofinsurance, the ~~financial~~ ~~condition~~actual ofliability ~~the~~and ~~relevant~~insurance recovery ~~insurers.~~may ~~Accordingly,~~differ ansubstantially ~~estimated aggregate~~from ~~insurance~~the ~~recovery~~Company’s ~~of $102~~estimates.~~8 million~~ ~~and~~No ~~$95.2 million~~assurance can ~~has~~be ~~been reflected~~given inthat the ~~accompanying~~Company ~~financial~~will ~~statements~~not asbe ofsubject ~~May 31,~~to ~~2002~~significant ~~and~~additional ~~August 31,~~asbestos ~~2001,~~litigation ~~respectively,~~and ~~with~~material ~~respect~~additional toliabilities. ~~previously~~If ~~paid~~actual ~~claims and~~liabilities ~~pending~~significantly ~~and~~exceed ~~future~~the ~~claims~~Company’s ~~estimated~~estimates toor beif ~~paid~~expected ~~through mid-2005 and the other~~insurance ~~items~~recoveries ~~included~~become inunavailable, ~~the~~due ~~accrual~~to ofadditional ~~asbestos-related~~insolvencies ~~liabilities.~~among ~~Approximately~~the ~~$30.3 million~~Company’s ~~and~~primary ~~$28.6 million~~or ofexcess ~~the~~insurance ~~aggregate~~carriers, ~~insurance~~disputes ~~recovery~~with ~~and~~carriers ~~$28.7~~or ~~million~~otherwise, ~~and $30.5 million of~~ the ~~asbestos-related~~Company’s ~~accrual~~results ~~have~~of ~~been~~operations, ~~classified as~~liquidity ~~current assets~~ and ~~liabilities in the accompanying balance sheet as of May~~financial ~~31,~~condition ~~2002~~could ~~and~~be ~~August 31,~~materially ~~2001,~~adversely ~~respectively~~affected.

~~Management continues to monitor claims activity, the status of lawsuits~~11 ~~(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 May 31, 2002, the resolution of asbestos-related uncertainties and the incurrence of asbestos-related costs net of related insurance recoveries should not have a material adverse effect on the Company’s consolidated financial position or results of operations. However, as the Company’s estimates are periodically re-evaluated, additional accruals to the liabilities reflected in the Company’s financial statements may be necessary, and such accruals could be material to the results of the period in which they are recorded. Given the number and complexity of factors that affect the Company’s liability and its available insurance, the actual liability and insurance recovery may differ substantially from the Company’s estimates. No assurance can be given that the Company will not be subject to significant additional asbestos litigation and material additional liabilities. If actual liabilities significantly exceed the Company’s estimates or if expected insurance recoveries become unavailable, due to insolvencies among the Company’s primary or excess insurance carriers, disputes with carriers or otherwise, the Company’s results of operations, liquidity and financial condition could be materially adversely affected.

The Company has been sued in three putative class actions and a case brought “on behalf of the general public” in California relating to the collection by National Linen Service of energy surcharges, environmental charges and, in two of the cases, sales taxes. The first case was filed in the Circuit Court of Barbour County, Alabama in May 2001 and was removed to the United States District Court for the Middle District of Alabama. The federal court denied the plaintiff’s motion to remand the case to state court. The second case was filed in the Court of Common Pleas, Fifteenth Judicial Circuit, County of Horry, South Carolina in October 2001. That case was removed to the United States District Court for South Carolina, Florence Division. The South Carolina federal court also denied plaintiff’s motion to remand. The third case was filed in Superior Court, Napa County, California in May 2002. This case alleges that National Linen Service and numerous other linen and uniform suppliers have violated Sections 17200 and 17500 of the California Business and Professions Code. The fourth case was filed in the United States District Court in the Southern District of Illinois in June 2002. This case alleges that National Linen Service and numerous other linen and uniform

~~Page~~The 14Company has been sued in four putative class actions, including a case brought “on behalf of the general public” in California, relating to the collection by National Linen Service of energy surcharges, environmental charges and, in two of the cases, sales taxes. The first case was filed in the Circuit Court of Barbour County, Alabama in May 2001 and was removed to the United States District Court for the Middle District of Alabama. The federal court denied the plaintiff’s motion to remand the case to state court. The second case was filed in the Court of Common Pleas, Fifteenth Judicial Circuit, County of Horry, South Carolina in October 2001. That case was removed to the United States District Court for South Carolina, Florence Division. The South Carolina federal court also denied plaintiff’s motion to remand. The third case was filed in Superior Court of Napa County, California in May 2002. This case alleges that National Linen Service and numerous other linen and uniform suppliers have violated Sections 17200 and 17500 of the California Business and Professions Code. The fourth case was filed in the United States District Court in the Southern District of Illinois in June 2002. This case alleges that National Linen Service and numerous other linen and uniform suppliers and the Textile Rental Services Association violated federal antitrust laws and state statutes in setting and charging the fees described above. As of January 1, 2003, no substantive discovery had occurred in any case. Based on information currently available, it is the opinion of management that the claims in these cases are without merit and that the ultimate resolution of these legal proceedings will not have a material adverse effect on the Company’s financial condition or results of operations.

suppliers and the Textile Rental Service Association violated federal antitrust laws and state statutes in setting and charging the fees described above. As of July 15, 2002, no substantive discovery had occurred in any case. Based on information currently available, it is the opinion of management that these claims are without merit and that the ultimate resolution of these legal proceedings will not have a material adverse effect on the Company’s financial condition or results of operations.

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.

~~Environmental~~The ~~laws~~Company’s ~~and~~environmental ~~regulations~~accruals, ~~have~~which ~~generally~~are ~~become~~included ~~stricter~~ in ~~recent~~current ~~years~~liabilities, totaled $5,751 and ~~the~~$5,777 at November 30, 2002 and August 31, 2002, respectively. The actual cost of ~~responding~~environmental issues may be lower or higher than that accrued due to ~~future~~the difficulty in estimating such costs and potential changes ~~may~~in bethe ~~substantial~~status of government regulations.

The Company’s environmental reserves, which are included in current liabilities, totaled $6,690 and $7,291 at May 31, 2002 and August 31, 2001, respectively. The actual cost of environmental issues may be lower or higher than that reserved due to the difficulty in estimating such costs and potential changes in the status of government regulations.

Certain environmental laws can impose liability regardless of fault. The federal Superfund law is an example of such an environmental law. However, liability under Superfund is mitigated by the presence of other parties who will share in the costs associated with clean-up of sites. The extent of liability is determined on a case-by-case basis taking into account many factors, including the number of other parties whose status or activities also subjects them to liability regardless of fault.

The Company is currently a party to, or otherwise involved in, legal proceedings in connection with state and federal Superfund sites, one of which is located on property owned by the Company. Except for the Blydenburgh Landfill matter in New York (which is discussed below), the Company believes its liability is de minimis at each of the currently active sites which it does not own where it has been named as a potentially responsible party (“PRP”) due to its limited involvement at the site and/or the number of viable PRPs. For property which the Company owns on East Paris Street in Tampa, Florida, the Company was requested by the State of Florida to clean up chlorinated solvent contamination in the groundwater beneath the property and beneath surrounding property known as Seminole Heights Solvent Site and to reimburse approximately $430 of costs already incurred by the State of Florida in connection with such contamination. The Company presented expert evidence to the State of Florida in 1998 that the Company is not the source of the contamination, and the State has referred this matter to the Environmental Protection Agency for review. At this point in time, it is not possible to quantify the extent, if any, of the Company’s exposure.

In connection with the sale of certain assets, including 29 of the Company’s textile rental plants in 1997, the Company has retained environmental liabilities arising from events occurring prior to the closing, subject to certain exceptions. The Company has received notice from the buyer of the textile rental plants of the alleged presence of perchloroethylene contamination on two of the properties in Texas involved in the sale. Because the Company is not the source of contamination, the Company asserted indemnification claims against the company from which it bought the properties. The prior owner is currently addressing the contamination at its expense at ~~one of~~ the properties, subject to a reservation of rights~~, and is currently reviewing the Company’s claim regarding the other property~~. At this time, it is too early to quantify the Company’s potential exposure in these matters, the likelihood of an adverse result, or the outcome of the Company’s indemnification claims against the prior owner.

During the second quarter of 2001, management performed a review of the other environmental liabilities recorded in connection with the textile rental segment’s 1997 uniform plants divestiture. Based on the advice of the Company’s environmental experts, the Company decreased its estimates for certain environmental exposures and, as a result, reduced the related liability and recorded a gain of approximately $2,000. The gain is included in “Gain on sale of business” in the accompanying consolidated statements of income.

In May 1999, the State of New York 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.

In February 2001, the federal district court in the Eastern District of New York denied the Company’s motion for summary judgment on the issue of successor liability and granted the State of New York’s motion for partial summary judgment, issuing a declaratory judgment that the Company is a successor to Serv-All. Subsequently, the Company and the State of New York each ~~filed a~~ ~~cross-motion for summary judgment on the Company’s liability under the~~ ~~Comprehensive Environmental Response, Compensation, and Liability Act.~~

~~Page~~filed 15a 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 noted that the issues presented by this case were appropriate for judicial review. The Court reiterated its denial of the Company’s motion in a written order on January 10, 2002. Final judgment in the amount of $12,477 was entered against the Company on February 1, 2002. Execution of the judgment was stayed pending appeal to the Second Circuit Court of Appeals.

The Company filed a notice of appeal to the Second Circuit Court of Appeals on March 1, 2002. InAs ~~its~~a ~~appeal,~~result ~~the~~of ~~Company~~a ~~asserted~~technical ~~that~~error made by the ~~trial~~District ~~court~~Court ~~erred~~ in the ~~declaring~~language ~~that~~of the ~~Company~~final isjudgment, athe ~~successor~~judgment was remanded to ~~Serv-All,~~the inEastern District ~~finding~~of ~~that~~New York to be corrected. This correction was made, and the final ~~State’s~~judgment ~~claims~~was ~~were~~re-entered ~~not~~on ~~barred~~September 17, by2002, in the ~~statute~~amount of ~~limitations~~$12,499. ~~and~~A second innotice ~~holding that~~of ~~the~~appeal ~~Company~~was isfiled ~~jointly~~on October 10, 2002. Briefing will be completed by March 28, 2003, and ~~severally~~oral ~~liable~~argument ~~for~~will ~~response~~be ~~costs~~scheduled no earlier than April 15, 2003.

OnIn ~~May 22,~~its ~~2002~~appeal, the Company ~~filed~~asserted that the trial court erred in declaring that the Company is a ~~lawsuit~~successor ~~against~~to Serv-All, in finding that the ~~parent~~State’s ~~(“Initial~~claims ~~Parent”)~~were ofnot ~~Initial~~barred ~~Services~~by ~~Investments~~the statute of limitations, ~~Inc~~and in holding that the Company is jointly and severally liable for response costs., ~~which~~Even if the Company ~~acquired~~were unsuccessful in its appeal to the Second Circuit Court of Appeals, the Company ~~1992~~would ~~and~~have ~~which~~a ~~had~~right ~~previously~~to ~~purchased~~seek ~~and~~recovery ~~sold~~of ~~certain~~response ~~assets~~costs from the many other parties whose wastes were disposed of ~~Serv-All~~at the Blydenburgh Landfill. In fact, the Company has initiated the process of seeking torecovery ~~enforce~~in ana ~~indemnification~~related ~~provided~~case filed by ~~Initial~~the ~~Parent~~State toof New York against Hickey’s Carting Co. (“Hickey’s”) in the ~~Company~~Eastern District of New York (the “Hickey’s Case”).

~~Even~~In if the ~~Company~~Hickey’s ~~were~~Case, ~~unsuccessful~~the inState ~~its~~of ~~appeal~~New toYork ~~the~~sued ~~Second Court of Appeals~~Hickey’s, the ~~Company~~company ~~would~~Serv-All retained ~~have~~to atransport ~~right~~its towaste, ~~seek~~for ~~recovery~~past ofand future response costs ~~from~~in ~~the~~connection ~~many~~with ~~other~~the ~~parties~~release ~~whose~~or ~~wastes~~potential ~~were~~release ~~disposed~~ of hazardous substances at and from the Blydenburgh Landfill. Atin ~~this point~~Islip, itNew isYork. ~~too~~On ~~early~~September 3, ~~to quantify the Company~~2002, Hickey’s ~~potential~~then ~~exposure,~~sued the ~~likelihood~~ ~~of an adverse result~~Company, oralong ~~the~~with ~~outcome~~several ofother ~~the~~parties, ~~Company’s~~for ~~indemnification~~contribution ~~claim,~~to ~~and~~any ~~thus,~~judgment noultimately ~~accrual~~awarded ~~has~~against ~~been recorded related to this matter~~Hickey’s.

The Company has all of the same defenses in the Hickey’s Case as in the case brought against the Company by the State of 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 (either to the State of New York or to Hickey’s) and has responded to the lawsuit accordingly. The Company has also counterclaimed against Hickey’s and cross-claimed against the other named parties, seeking contribution toward the judgment entered in the case brought against the Company by the State of New York.

If the Company prevails in the Second Circuit with its argument that it is not a successor to Serv-All, the Company will then file a motion to dismiss it from the Hickey’s Case. Even if the Company does not prevail, any liability to the State of New York will be reduced by the contributions the Company will receive from the many other parties, including Hickey’s, whose wastes were disposed of at the Blydenburgh Landfill, and the Company will have no additional liability to Hickey’s or any other party in the Hickey’s Case.

The Company also believes it is entitled to indemnification for all costs associated with the Blydenburgh Landfill by the parent (“Initial Parent”) of Initial Services Investments, Inc., which the Company acquired in 1992 and which had previously purchased and sold certain assets of Serv-All. On May 22, 2002, the Company filed a lawsuit against Initial Parent, seeking to enforce an indemnification provided by Initial Parent to the Company. The lawsuit seeks full indemnification by Initial Parent for all costs and expenses of litigating the Blydenburgh Landfill action, as well as a declaration that Initial Parent is obligated to indemnify the Company for any judgment which ultimately is assessed against the Company. On July 15, 2002, Initial Parent filed a motion to dismiss the lawsuit, followed by a motion for summary judgment on July 25, 2002. The Company has filed briefs in opposition to these motions. Discovery in the indemnity lawsuit is progressing, but is not complete.

At this point, it is too early to quantify the Company’s potential exposure, the likelihood of an adverse result, or the outcome of the Company’s indemnification claim, and thus, no accrual has been recorded related to any of the above-described matters relating to the Blydenburgh Landfill.

10. RESTRUCTURING EXPENSE AND OTHER CHARGES

During 2001, management conducted reviews of its continuing operations as part of ~~management’s~~a strategic initiative to examine under-performing operations and to to position the Company for an economic slowdown. As a result of these reviews, the Company approved a significant restructuring program and recorded a related charge of $5,014 during the fourth quarter of fiscal 2001. The ~~accrual~~ 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~~ the envelope segment, and $345 in losses related to the sale of two textile ~~rental~~ rental businesses. As of August 31, 2001, approximately $118 of the severance ~~accrual~~ accrual had been paid to employees.

~~During the first quarter of fiscal 2002, the Company closed two facilities in~~13 ~~the textile rental segment and recorded a related charge of $5,820. The~~ charge included severance costs of $11 for four employees, all of whom were terminated prior to the end of the first quarter, and $1,396 in exit expenses to close and consolidate facilities. Exit expenses primarily include costs of lease terminations and costs to dispose of facilities. Additionally, as a further result of the closure of the two textile rental facilities, the Company recognized long-lived asset impairments totaling $4,413. Textile rental assets to be disposed of were reduced to state them at their estimated fair value less costs to sell. Assets to be disposed of primarily related to equipment located in the facilities included in the restructuring program noted above. After the charge, the remaining net book value of these assets was immaterial. Estimated fair market values were established based on an analysis of expected future cash flows.

During the second quarter of fiscal 2002, the Company recorded a reduction of restructuring and other charges of $381. Reserves of $413 were reduced primarily due to lower than originally estimated costs to prepare a facility closed in a prior year for sale. This amount was offset by additional expense of $32 related to reserves which were established during the fourth quarter of fiscal 2001 and the first quarter of fiscal 2002. The $32 of expense included a reduction of the reserve for severance costs of $159, and an increase in the reserve for exit costs of $191.

The major components of the fiscal 2001 and 2002 restructuring charges and related activity are as follows:

	Reserve,		Cash			Expense			Reserve,
	August 31, 2001		Payments			(Gain)			May 31, 2002
Severance costs	$	2,969	$	(2,303	)	$	(148	)	$	518
Exit costs	$	1,582	$	(2,126	)	$	1,587		$	1,043

The losses resulting from the restructuring activities and asset impairments are included in “Restructuring expense and other charges” in the Consolidated Statements of Income.

~~Page~~During 16the first quarter of fiscal 2002, the Company closed two under-performing 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 2003 and 2002 restructuring charges and related activity are as follows:


	Reserve,		Cash					Reserve,
	Beginning of Year		Payments			Expense		November 30

2003
Severance costs	$	527	$	—		$	—	$	527
Exit costs		557		(181	)		—		376
2002
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. REVERSE STOCK SPLIT

On January 3, 2002, the Company’s ~~shareholders~~stockholders 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.

12. ~~SALE~~ OFRESTRICTED ~~CORPORATE HEADQUARTERS BUILDING~~STOCK

OnIn ~~May 23,~~October 2002, the Company ~~completed~~awarded ~~the~~183,927 ~~cash~~shares ~~sale~~ of ~~the~~restricted ~~property~~stock ~~where NSI’s~~to ~~corporate~~officers ~~headquarters~~and isother ~~located~~key ~~for $22,500~~employees. The ~~sale~~shares ~~transaction resulted~~vest ratably in athree ~~gain~~equal annual ofinstallments ~~$7,966~~beginning ~~and~~one ayear ~~deferred~~from ~~gain~~the date of ~~$3,376~~the grant. ~~In conjunction~~During ~~with~~ the vesting ~~sale~~period, the ~~Company~~participants ~~entered~~have ~~into~~voting anrights ~~agreement~~and toreceive ~~lease~~dividends, ~~up to~~but ~~four~~the ~~floors,~~shares ormay ~~approximately~~not 79be sold,~~000~~ ~~square feet~~assigned, ~~of the 155~~transferred,~~000~~ ~~square~~pledged ~~foot building~~or ~~for up to 42 months~~otherwise encumbered. ~~The~~Additionally, ~~deferred~~granted ~~gain~~but ofunvested ~~approximately~~shares ~~$80~~are ~~per~~forfeited ~~month will be amortized as a~~upon ~~reduction~~termination ~~to lease expense over the term~~ of ~~the lease~~employment.

13The fair value of the restricted shares on the date of the grant is amortized ratably over the vesting period. ~~STOCKHOLDERS~~ Unearned compensation on the October 2002 grant of restricted stock of $1,044 was recorded based on the market value of the shares on the date of grant and is generally being amortized over three years. The unamortized balance of unearned compensation on restricted stock is included as a separate component of stockholders’ ~~EQUITY~~equity. Additionally, as a result of the grant, the cost of the treasury stock in excess of the unearned compensation reduced additional paid in capital to zero; the remaining amount reduced retained earnings.

~~The changes in stockholders’ equity for the nine months ended May 31, 2002 are~~14 ~~as follows:~~

											Unearned
											Compensation			Accumulated
											on			Other
		Common			Paid-in			Retained			Restricted			Comprehensive			Treasury
		Stock			Capital			Earnings			Stock			Income			Stock			Total
Balance, August 31, 2001		$	14,480		$	72,860		$	995,537		$	(880	)	$	(43	)	$	(419,326	)	$	662,628
	Net loss		—			—			(22,035	)		—			—			—			(22,035	)
	Treasury stock issued in connection with long-term incentive program		—			(71	)		—			—			—			1,180			1,109
	Employee stock purchase plan issuances		—			(1,857	)		—			—			—			2,647			790
	Restricted stock issued in connection with long-term incentive program		—			(58,179	)		—			(4,910	)		—			63,089			—
	Amortization and forfeitures of restricted stock grants		—			(6	)		—			707			—			(116	)		585
	Transfer of restricted stock in connection with spin-off		—			—			—			677			—			—			677
	Dividend of common equity interest in Acuity (see Note 5)		—			—			(400,362	)		—			—			—			(400,362	)
	Cash dividends paid on common stock		—			—			(7,487	)		—			—			—			(7,487	)
	Cash in lieu of fractional shares		(1	)		(9	)		—			—			—			—			(10	)
Balance, May 31, 2002		$	14,479		$	12,738		$	565,653		$	(4,406	)	$	(43	)	$	(352,526	)	$	235,895

~~Page~~ITEM 172. MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS

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, Inc. (the “~~NSI~~Company” or ~~the~~ “~~Company~~NSI”) isoperates ain ~~diversified service~~two business segments — textile rental and envelope manufacturing. ~~company~~NSI ~~operating~~is headquartered in ~~two~~Atlanta, ~~segments:~~Georgia, ~~textile~~and ~~rental~~provides products and services ~~envelopes~~throughout the United States. The Company remained in solid financial condition at ~~May~~November 3130, 2002. Net working capital was $~~100~~83.05 million, up from $8783.7 0 million at August 31, ~~2001~~ 2002, and the current ratio ~~was~~remained ~~2.2,~~constant upat ~~from~~ 1.~~9 at August 31, 2001~~8.

In July 2001, the Financial Accounting Standards Board (“FASB”) issued Statement No. ~~141~~142 (“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 fiscal 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 ~~nine~~three months ended ~~May~~November 3130, ~~2002~~2001 (see Note 2 to the financial statements included in in this filing).

On November 7, 2001, the ~~Company’s~~ ~~board~~Board of ~~directors~~Directors of NSI approved the spin-off, subject to certain conditions, of its lighting equipment and chemicals businesses into a separate publicly-traded company with its own management and board of directors. The spin-off conditions were met November 29, 2001 and 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 ~~the~~NSI ~~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~~Distribution, received one share of Acuity common stock for each share of NSI common stock held aton that date. The historical financial statements of NSI have been restated to reflect Acuity as a discontinued operation (see Note 5 to the financial statements included in this filing).

In conjunction with the spin-off, the Company and Acuity entered into various agreements that address the allocation of assets and liabilities between them and that define their relationship after the separation, including a distribution agreement, a tax disaffiliation agreement, an employee benefits agreement, ~~and~~ a transition services agreement. ~~The~~and ~~Company~~a ~~expects to~~lease ~~finalize the amount of the dividend of common equity interest in Acuity by August 31, 2002~~agreement. Under the tax ~~disaffiliation~~ 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~~In ~~believes~~addition ~~the~~to ~~amounts~~other ~~paid~~services ordescribed ~~received~~in ~~associated~~the ~~with~~agreement, ~~these~~the transition services agreement ~~are~~provides that Acuity will, for a fee, provide collateral associated ~~representative~~with ofvarious ~~the~~property ~~fair~~and ~~value~~casualty insurance programs of ~~the~~NSI ~~services~~as ~~provided.~~follows:


Period

Beginning	Ending	Letters of Credit

September 1, 2002	October 31, 2002	$10.4 million
November 1, 2002	October 31, 2003	$8.0 million
November 1, 2003	October 31, 2004	$5.0 million
November 1, 2004	October 31, 2005	$2.0 million

Management believes the amounts paid or received associated with these services are representative of the fair value of the services provided.

~~As a result of the November 2001 spin-off, the Company’s financial statements~~15 ~~have been prepared with these businesses’ net assets, results of operations,~~ and cash flows presented as discontinued operations. Accordingly, the results of operations and liquidity and capital resources information presented below reflect only the continuing operations of the Company.

On January 3, 2002, the Company’s shareholders approved a one-for-four reverse stock split of NSI common stock, which began trading on a reverse split basis on January 7, 2002. As a result of the stock split, every four shares of NSI common stock were replaced with one share of NSI common stock. The reverse split did not change the number of authorized shares of NSI common stock or the par value per share of NSI common stock. All references to common stock, common shares outstanding, average numbers of common stock shares outstanding and per share amounts in these Consolidated Financial Statements, Notes to Consolidated Financial Statements and Management’s Discussion and Analysis of Financial Condition and Results of Operations

~~Page~~As 18a result of the spin-off, the net assets and results of operations of the lighting equipment and chemicals businesses have been reflected as discontinued operations for all periods presented herein. The Company’s continuing operations consist of its textile rental and envelope segments.

On January 3, 2002, the Company’s stockholders 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.

Critical Accounting Policies

NSI’s financial statements have been prepared in accordance with accounting principles generally accepted in the United States. The preparation of the financial statements requires the Company to make estimates and assumptions that affect the reported amounts of assets, liabilities, revenues and expenses, and the disclosure of contingent assets and liabilities. The Company reviews its estimates on a regular basis including those related to litigation, insurance receivable, and environmental matters ~~and self-insurance~~. The Company’s estimates are based on historical experience and other assumptions management believes are reasonable under current circumstances. Actual results may differ from these estimates under different assumptions or circumstances.

In December 2001, the Securities and Exchange Commission (“SEC”) requested that all registrants include their “critical accounting policies” in ~~MD&A~~Management’s Discussion and Analysis. The SEC indicated that a “critical accounting policy” is one which is both important to the portrayal of the company’s financial condition and results of operations and requires management’s most difficult, subjective or complex judgments, often as a result of the need to ~~make~~ make estimates about the effect of matters that are inherently uncertain. NSI believes the following represent its critical accounting policies:

Litigation

The Company is subject to various legal claims arising in the normal course of business out of the conduct of its current and prior businesses, including product liability claims. Based on information currently available, it is the opinion of management that the ultimate resolution of pending and threatened legal proceedings will not have a material adverse effect on the Company’s financial condition or results of operations. However, in the event of unexpected future developments, it is possible that the ultimate resolution of such matters, if unfavorable, could have a material adverse effect on the Company’s results of operations in future periods. The Company ~~reserves~~accrues 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~~accruals are appropriate based on information currently available, the actual costs of resolving legal claims may be substantially different from the amounts ~~reserved~~accrued.

~~The~~Prior ~~accrual~~to ~~for~~February 1, ~~asbestos-related liabilities~~2001, ~~before~~the ~~consideration~~Center offor ~~insurance recoveries~~Claims isResolution ~~based on~~ (the ~~following:~~“CCR”) handled the ~~Company’s~~processing ~~estimate~~and settlement of ~~indemnity payments~~claims ~~and~~on ~~defense~~behalf ~~costs~~of ~~associated~~the ~~with~~Company ~~pending~~ and ~~future asbestos-related~~retained ~~claims~~local tocounsel befor ~~paid~~the ~~through~~defense ~~mid-2005;~~of ~~settlements~~claims. ~~agreed~~Pursuant to ~~but~~a ~~not~~written ~~paid~~agreement ~~as of~~among ~~May 31~~CCR members, ~~2002;~~ the Company’s ~~expected~~was ~~payment~~responsible onfor ~~account~~varying ofpercentages ~~settlement obligations~~ of ~~defaulting~~defense ~~CCR~~and liability ~~members;~~payments ~~interest~~ on ~~settlement~~a ~~payments~~claim-by-claim ~~that~~basis ~~are subject~~for toeach ~~ongoing~~claim ~~dispute~~in ~~resolution~~which ~~with~~it ~~certain~~was named ~~insurance~~in ~~providers;~~accordance ~~and other~~with ~~legal~~predetermined ~~fees~~sharing ~~and expenses~~formulae. ~~The~~Substantially all of the Company’s ~~estimates~~portion of ~~indemnity~~those payments ~~and~~ ~~defense~~was ~~costs~~paid ~~associated~~directly ~~with~~by ~~pending and future asbestos claims are based on~~ the Company’s insurers. ~~estimate~~Since ofFebruary 1, 2001, the ~~number~~Company ofhas ~~future~~retained ~~asbestos-related~~trial ~~claims and~~counsel ~~the~~directly, ~~type~~rather ofthan ~~disease,~~through ifthe ~~any~~CCR, ~~alleged or expected~~ to bedefend ~~alleged~~asbestos-related ~~in such~~ claims, ~~assumptions~~against ~~regarding~~ the ~~timing~~Company and ~~amounts~~has ofengaged ~~settlement~~another ~~payments, the status of ongoing litigation and settlement initiatives, and the advice of~~ outside ~~counsel~~ ~~with~~consultant ~~respect~~ to ~~the~~provide claims ~~current~~processing ~~state~~and ofadministration ~~the~~services ~~law~~for asbestos-related ~~to asbestos~~ claims. The Company ~~ultimate~~is ~~liability~~more ~~for~~vigorously ~~all~~defending ~~pending~~asbestos-related ~~and future~~ claims ~~cannot~~and ~~be determined~~will ~~with~~seek ~~certainty due~~ to ~~the difficulty of forecasting the numerous~~ ~~variables~~dismiss ~~that~~without ~~can~~any ~~affect~~settlement ~~the~~payment ~~amount~~claims ofarising ~~liability. There are inherent uncertainties involved~~ in ~~estimating~~jurisdictions ~~these amounts, and the Company’s actual~~or ~~costs~~involving inworksites ~~future~~where ~~periods could exceed~~ the Company’s ~~estimates~~did ~~due~~not todistribute ~~changes~~or ininstall ~~facts~~asbestos-containing ~~and circumstances after the date of each estimate~~products. ~~For additional~~ ~~information, see Note 8 to the financial statements included in this filing.~~

~~Insurance~~At ~~Receivable~~August 31, 2001, the accrual for asbestos-related liabilities, before consideration of insurance recoveries, was based on the following: the Company’s estimate of indemnity payments and defense costs associated with pending and future asbestos-related claims; settlements agreed to but not paid; 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. During 2002, as part of its ongoing estimating process, consultation with outside experts, the nature

~~Among the product liability claims to which the Company is subject are claims~~16 ~~for personal injury or wrongful death arising from the installation and~~ distribution of asbestos-containing insulation, primarily in the southeastern United States, by a previously divested business of the Company. The Company believes that it has insurance coverage available to recover most of its asbestos-related costs. The Company has reached settlement agreements with substantially all of its relevant insurers providing for payment of substantially all asbestos-related claims (subject to retentions) up to the various policy limits, except for the Company’s payments on account of settlement obligations of defaulting CCR members, as discussed in Note 8 to the financial statements

~~Page~~of 19pending claims, the jurisdictions in which claims have been filed, and in light of its gained experience in administration of its defense strategy and recent settlement activity, the Company reviewed its asbestos claims liabilities and adjusted the balances in these accounts from its prior three year outlook to its estimate of the total probable liabilities from pending and expected future asbestos claims over an approximate fifty year period, which takes into consideration the life expectancy of individuals potentially exposed. As a result of such review, the Company concluded that a reasonable estimate of its expected future claims for approximately fifty years would require an increase in its liabilities ranging from approximately $94 million to $139 million over the amounts recorded as of August 31, 2001. Management does not believe that any amount in the range is more accurate than any other. Therefore, as of August 31, 2002, the Company increased its liabilities for asbestos-related costs by $94 million, the low end of the range and recorded an additional insurance recovery of $77 million. 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 differ materially from the Company’s estimates due to changes in facts and circumstances after the date of each estimate. For additional information, see Note 8, Legal Proceedings, in the Notes to the Consolidated Financial Statements included in this filing.

~~included~~Insurance ~~in this filing. The timing and amount of future recoveries from~~Receivable ~~insurance carriers will depend on the pace of claims review and processing by~~ such carriers and on the resolution of any remaining disputes regarding coverage under such policies. In the event the Company’s insurers dispute amounts billed to them or pay on an untimely basis, the Company takes all practicable steps to secure payment, including alternative dispute resolution procedures and litigation to resolve the issues. The Company has initiated alternative dispute resolution proceedings with two insurers to resolve outstanding insurance policy interpretation issues, and, with respect to one of the insurers, to secure payment of past due amounts and to ensure that the insurer’s future obligations will be met in a timely fashion. The Company believes that substantial recoveries from the insurance carriers are probable. The Company reached this conclusion after considering its prior insurance-related recoveries in respect of asbestos-related claims, existing insurance policies, settlement agreements with insurers, the apparent viability of its insurers, the advice of outside counsel with respect to the applicable insurance coverage law relating to terms and conditions of those policies, and a general assessment by the Company and its advisors of the financial condition of the relevant insurers. If expected insurance recoveries become unavailable, due to insolvencies among the Company’s primary or excess insurance carriers, disputes with carriers or otherwise, the Company’s results of operations, liquidity and financial condition could be materially adversely affected.

The Company believes that it has insurance coverage available to recover most of its asbestos-related costs. With the exception of the Company’s payments on account of settlement obligations of defaulting CCR members, 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, as discussed in Note 8, Legal Proceedings, in the Notes to the Consolidated Financial Statements included in this filing. The timing and amount of future recoveries from insurance carriers will depend on the pace of claims review and processing by such carriers and on the resolution of any remaining disputes regarding coverage under such policies. In the event the Company’s insurers dispute amounts billed to them or pay on an untimely basis, the Company takes all practicable steps to secure payment, including alternative dispute resolution procedures and litigation to resolve the issues. The Company has initiated alternative dispute resolution proceedings with two insurers to resolve outstanding insurance policy interpretation issues, and, with respect to one of the insurers, to secure payment of past due amounts and to ensure that the insurer’s future obligations will be met in a timely fashion. Approximately $5.7 million of insurance recovery was under alternative dispute resolution proceedings at November 30, 2002. The Company believes its recorded receivables, which includes both billed amounts and estimates of future recoveries, from insurance carriers are collectible. The Company reached this conclusion after considering various factors including 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. Although the Company believes these assumptions are reasonable, other assumptions could have been used that would result in substantially lower recoveries. If expected insurance recoveries become unavailable, due to insolvencies among the Company’s primary or excess insurance carriers, disputes with carriers or otherwise, the Company’s results of operations, liquidity and financial condition could be materially adversely affected.

Environmental Matters

The Company’s operations, as well as similar operations of other companies, are subject to comprehensive laws and regulations relating to the generation, storage, handling, transportation, and disposal of hazardous substances and solid and hazardous wastes and to the remediation of contaminated sites. Permits and environmental controls are required for certain of the Company’s operations to limit air and water pollution, and these permits are subject to modification, renewal, and revocation by issuing authorities. The Company believes that it is in substantial compliance with all material environmental laws, regulations, and permits. On an ongoing basis, the Company incurs ~~capital~~ capital and operating costs relating to environmental compliance. Environmental laws and regulations have generally become stricter in recent years, and the cost of responding to future changes may be substantial.

The Company ~~reserves~~accrues for known environmental claims when payments associated with the claims become probable and the costs can be reasonably estimated. The actual cost of environmental issues may be higher than that ~~reserved~~accrued due to difficulty in estimating such costs and potential changes in the status of government regulations.

~~Self-Insurance~~17

Results of Operations

NSI generated revenue of $~~136~~120.1 million ~~and $402.5 million~~ for the three ~~and nine~~ months ended ~~May~~November 3130, 2002, ~~respectively,~~ compared to revenue of $~~144~~134.~~3 million and $420.2~~4 million, ~~respectively,~~ in the previous year. The decrease was primarily related to the overall softer economy, ~~and~~which ~~lost~~has ~~revenues~~resulted ~~from the closure of~~in ~~two~~lower ~~envelope~~volumes ~~manufacturing~~per ~~facilities~~customer in the ~~fourth~~textile ~~quarter~~rental ofsegment ~~fiscal~~and ~~2001~~decreases in pricing in the envelope segment.

~~Income~~During ~~from~~the ~~continuing~~first ~~operations~~quarter ~~was~~of ~~$6.8 million,~~fiscal ~~or $0.65 per diluted share~~2003, ~~for~~ the ~~three~~Company ~~months~~completed ~~ended~~the ~~May 31,~~sale ~~2002,~~of ~~compared~~its linen tobusiness ~~income~~in ~~from~~San ~~continuing operations~~Diego offor $4.98 million, orand recorded a gain of $02.472 million. ~~per~~In ~~diluted share~~addition, ~~for~~ the ~~three~~Company ~~months ended~~reached ~~May 31,~~a ~~2001.~~settlement Onin aprinciple ~~year-to-date~~with ~~basis,~~one of ~~net~~its ~~income~~asbestos-related ~~from~~insurance ~~continuing operations~~carriers ~~for~~regarding ~~the~~several ~~first~~coverage ~~nine~~issues, including ~~months~~an ofagreement ~~the~~as ~~current~~to ~~fiscal~~the ~~year~~amount ~~was~~of ~~$3.1 million,~~compensation or(interest ~~$0.30~~charge) ~~per~~owed by ~~diluted~~the ~~share,~~Company ~~compared~~ to the carrier for covering prior ~~year’s~~period ~~income~~asbestos ~~from~~related ~~continuing~~settlements ~~operations~~in place of ~~$9.3 million,~~other ornonpaying $0carriers.91 ~~per~~As ~~diluted~~a ~~share.~~result, ~~The~~the ~~decline~~Company inrecognized ~~income~~a ~~from~~gain ~~continuing~~of ~~operations~~$2.5 million, ~~resulted~~which ~~primarily~~was ~~from~~reflected ~~lower~~as ~~revenues~~a reduction in corporate expense.

~~Textile~~Losses ~~rental~~from ~~segment~~continuing ~~third~~operations ~~quarter~~were ~~revenues of~~ $831.~~7 million decreased 4.~~9 ~~percent compared to last year’s $88.0~~ million~~. On a year-to-date basis~~, ~~revenues~~ ~~decreased~~or $80.~~8 million,~~19 orper ~~3.5 percent compared to the same prior year~~diluted ~~period. The revenue decline reflects continued soft economic conditions~~share, ~~particularly~~ ~~in those segments dependent on corporate travel and entertainment such as lodging and fine dining. Operating profit~~ for the ~~third~~three ~~quarter~~months ~~was $5.7~~ended November ~~million~~30, 2002, compared to ~~last~~losses ~~year’s~~from continuing ~~operating~~operations ~~profit~~ of $8.3.6 million~~. On a year-to- date basis~~, ~~the~~or ~~textile rental segment had an operating profit of~~ $~~1.7 million for the first nine months of fiscal 2002 versus operating profit of $16.~~0 ~~million for the first nine months of fiscal 2001~~.35 ~~Year-to-date~~per ~~operating~~diluted ~~profit includes restructuring expense and other charges of $5.4 million relating to the closure of two facilities and $304 thousand of gains related to previously divested businesses~~share, ~~whereas the operating profit~~ for the ~~same~~three ~~prior~~months ~~year~~ended ~~period included $2.4~~November ~~million~~30, ~~of gains on sales of businesses~~2001. ~~The decline in operating profit is primarily a result of lower revenues.~~ ~~Increased costs associated with labor and benefit plans have been largely offset by improvements in overall production efficiency and improved merchandise control.~~

Textile rental segment first quarter revenues of $76.1 million decreased 3.5 percent compared to last year’s $78.8 million. Overall volumes per customer continue to be negatively impacted by soft economic conditions, particularly in those segments dependent on corporate travel and entertainment such as lodging and fine dining. These conditions, combined with the revenue loss as a result of the sale of the San Diego business, account for the lower revenue. Operating losses for the quarter were $2.1 million compared to last year’s operating loss of $5.4 million. Operating results in the current year include $2.2 million of pretax gains from the sale of the San Diego business. Fiscal 2002 results included charges of $5.8 million for severance and restructuring activities. The following table presents information that management believes will provide the reader more consistent, comparable trend information:


	Three Months Ended November 30,

	2002			2001

	(Dollar amounts in millions)
Loss from continuing operations	$	(2.1	)	$	(5.4	)
Gain on sale of business		(2.2	)		—
Restructuring and severance charge		—			5.8

Adjusted operating (loss) profit	$	(4.3	)	$	0.4

Revenue shortfalls and increased costs related to employee benefits, casualty insurance, legal defense and plant efficiency programs resulted in the reduction in profitability.

The fiscal 2002 restructuring charge included severance costs of $11 thousand for four employees, 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 $44.0 million decreased 20.8 percent from last year’s results of $55.6 million. Lower direct mail and courier volumes, increased competitive pricing pressures in both the direct mail and transactional segments, and the closure of the segment’s Los Angeles facility in fiscal 2002 account for the revenue decline. Operating losses of $0.9 million compared to operating profit in the prior year of $2.2 million are the result of lower revenues and increased benefit costs partially offset by improvements in operational efficiencies.

Corporate expenses, which included the $2.5 million benefit of the insurance settlement, were approximately $0.1 million for the quarter. Excluding the settlement, corporate costs were $2.6 million for the first quarter compared to last year’s $2.7 million.

Net interest expense of $1 thousand for the three months ended November 30, 2002 decreased from last year’s $111 thousand due to lower interest bearing obligations and interest earned on cash and cash equivalents. Additionally, the income tax benefit decreased to approximately 38 percent of income from continuing operations compared to 40 percent in the prior year as a result of fluctuations in two federal income tax credits.

Page 20

The restructuring charge included a reduction of severance costs of $148 thousand, and $1.6 million in exit expenses to close and consolidate facilities. Exit expenses primarily include costs of lease terminations and costs to dispose of closed facilities. Reserve reductions of $413 thousand were also recorded primarily due to lower than originally estimated costs to prepare a facility closed in a prior year for sale.

Additionally, as a further result of the closure of the two textile rental facilities, the Company recognized long-lived asset impairments totaling $4.4 million. Textile rental assets to be disposed of were reduced to state them at their estimated fair value less costs to sell. Assets to be disposed of primarily related to equipment located in the facilities included in the restructuring program noted above. After the charge, the remaining net book value of these assets was immaterial. Estimated fair market values were established based on an analysis of expected future cash flows.

The envelope segment third quarter revenues of $52.3 million decreased 7.0 percent from last year’s results of $56.3 million. Lower volumes attributable to the closing of two unprofitable plants announced in the fourth quarter of fiscal 2001 and lower courier volumes account for the revenue decline. Operating profit was $24 thousand, a decrease of almost $1.4 million from last year’s $1.4 million profit. Excluding approximately $254 thousand of goodwill amortization that has been discontinued with the adoption of SFAS 142, profits decreased approximately $1.6 million. The decline in operating profits is the result of the decrease in revenues. On a year-to-date basis, the envelope segment revenues of $162.6 million decreased 5.1 percent from last year’s results of $171.4 million, and operating profit of $2.8 million decreased $1.2 million from last year’s results of $4.0 million. Last year’s results included $880 thousand of costs associated with the reorganization of the Miami, Florida facility. Excluding the current year gain of $75 thousand, which was recognized in the second quarter for the sale of the Lyon Folder unit, the prior year reorganization costs and approximately $734 thousand of prior year goodwill amortization, which ceased upon the adoption of SFAS No. 142, profits decreased approximately $2.9 million primarily as a result of the lower overall revenues.

Corporate expenses, excluding the gain of $8.0 million on the sale of the headquarters building, were $2.5 million for the third quarter compared to last year’s $1.5 million. For the nine months ended May 31, 2002, corporate expenses, excluding the sale of the headquarters building, increased from $3.9 million to $7.1 million. The planned increase is representative of on-going, stand-alone corporate costs.

Net interest expense of $90 thousand and $369 thousand for the three and nine months ended May 31, 2002, respectively, decreased from $439 thousand and $1.3 million for the same prior year periods, respectively, due to lower overall rates, lower interest bearing obligations and the allocation of interest expense performed in conjunction with the spin-off. Additionally, the provision for income taxes increased to 39 percent of income from continuing operations compared to 37 percent in the prior year as a result of the loss of certain state tax benefits associated with the spin-off.

Liquidity and Capital Resources

Operating Activities

Continuing operations ~~provided~~used cash of $135.90 million during the ~~nine~~three months ~~ended~~ ~~May~~ended November 3130, 2002 compared with cash ~~used~~provided of $1.3.8 million during the respective period of the prior year. Fiscal ~~2002~~2003 ~~operating~~ cash ~~flow~~used ~~was higher because of an increase in cash provided~~ by ~~current assets, inventory and~~continuing ~~linens~~operations ~~in service which~~ was ~~partially~~impacted ~~offset~~ by ansegment ~~increase~~bonus inpayments, ~~cash~~payout ~~used~~of ~~for both~~a ~~current and long-term liabilities. The increase in cash used for current~~deferred ~~and~~compensation ~~long-term~~program ~~liabilities resulted primarily from lower days in accounts payable due to utilization of recently negotiated vendor payment terms~~ and ~~payments~~ ~~related~~annual toinsurance ~~asbestos~~premium ~~settlements~~payments.

Investing Activities

Investing activities provided cash of $71.03 million versus cash used of $164.8 million in the prior year. The increase in cash provided was primarily due to the sale of the ~~headquarters~~linen ~~building~~business in San Diego as well as reductions in purchases of property, plant and equipment.

~~During~~Capital ~~the~~expenditures ~~third~~totaled ~~quarter,~~$2.8 million for the ~~Company~~three ~~completed~~month ~~the~~period ~~cash~~compared to ~~sale~~$5.0 million ofin the ~~property where~~prior ~~NSI’s~~year. ~~corporate~~During ~~headquarters~~the isthree ~~located~~months ~~for~~ended ~~$22.5~~November ~~million. The sale~~30, ~~transaction~~2002, ~~resulted~~the intextile arental ~~gain~~segment ofinvested ~~$8.0 million~~primarily ~~and~~in aequipment ~~deferred gain of $3~~replacements.4 ~~million.~~Capital Inexpenditures ~~conjunction~~in ~~with~~ the ~~sale,~~envelope ~~the~~segment ~~Company~~were ~~entered~~primarily ~~into~~related ~~an agreement~~ to manufacturing ~~lease~~equipment uppurchases toand ~~four~~replacements. ~~floors,~~Equipment orpurchases ~~approximately~~in ~~79,000~~the envelope ~~square~~segment ~~feet,~~provided ofnewer ~~the~~technology ~~155,000~~that produces a higher quality ~~square~~product ~~foot~~more ~~building~~efficiently ~~for~~and upat toa ~~42 months~~lower cost. ~~The~~During ~~deferred~~the ~~gain~~three ofmonths ended ~~approximately~~November 30, ~~$80~~2001, ~~thousand~~capital ~~per~~expenditures ~~month~~in ~~will~~the beenvelope ~~amortized~~segment related asprimarily ~~a reduction~~ to ~~lease~~manufacturing ~~expense~~equipment ~~over~~purchases ~~the~~and ~~term~~information ~~of the lease~~systems. The textile ~~proceeds~~rental ~~from~~segment’s ~~the~~expenditures ~~sale~~were ~~are~~primarily ~~being~~attributable ~~used~~ to replacement ~~reduce~~of ~~the~~old ~~Company’s~~equipment, ~~debt~~ and ~~for~~delivery ~~general~~truck ~~corporate~~purchases ~~purposes~~and refurbishments.

Capital expenditures totaled $15.0 million for the nine month period compared to $15.4 million in the prior year. During the nine months ended May 31, 2002, the textile rental segment invested primarily in replacing old equipment and delivery trucks. Capital expenditures in the envelope segment were primarily related to manufacturing equipment and information systems. During the nine months ended May 31, 2001, capital expenditures in the envelope segment related primarily to manufacturing process improvements and information systems. The textile rental segment’s expenditures were primarily attributable to building improvements, equipment upgrades and information systems.

Page 21

Financing Activities

Cash used for financing activities totaled $90.56 million during the ~~nine~~three months ended ~~May~~November 3130, 2002 compared to cash used of $395.19 million in fiscal 2001. ~~The~~ The decrease in cash used is primarily due to lower dividends ~~offset by repayment of debt~~. Dividend payments totaled $70.54 million, or $0.7204 per share, compared with $406.76 million, or $30.9664 per share, for the prior-year period.

~~Upon~~In ~~completion~~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. onThe ~~November 30~~facility contains financial covenants including a leverage ratio, ~~2001~~a ratio of income available for fixed charges to fixed charges, and ~~approximately~~a ~~$371~~minimum net worth.~~3 million~~ ofInterest ~~long-term~~rates ~~debt~~under ~~was~~the ~~assumed~~facility byare ~~Acuity~~based on the LIBOR rate or other rates, ~~leaving~~at ~~approximately~~the $2Company’s option.8 The Company will pay an ~~million~~annual ~~outstanding~~fee ~~for~~on the commitment based on the Company’s leverage ratio. No amounts were outstanding under this facility at November 30, 2002.

InThe ~~October~~Company ~~2001,~~has ~~the~~settlement ~~Company~~agreements ~~negotiated~~for acertain ~~$40 million,~~asbestos ~~three-year~~related ~~committed~~liabilities. ~~credit~~The ~~facility~~timing ~~with~~of asome ~~single~~of ~~major~~these USpayments ~~bank~~is ~~that~~contingent ~~became~~on ~~effective~~several atfactors, including the ~~time~~ Company’s receipt of ~~the~~legal ~~spin-off~~documentation from claimants and plaintiff attorneys. The ~~facility~~Company ~~contains~~estimates ~~financial~~that ~~covenants~~its ~~including~~asbestos arelated ~~leverage~~obligations ~~ratio,~~due aover ~~ratio~~the ofnext ~~income~~twelve ~~available~~months ~~for~~are ~~fixed~~$37.3 million. ~~charges~~However, tothe Company ~~fixed~~anticipates ~~charges,~~that substantially all of the settled asbestos liabilities ~~and~~will abe ~~minimum~~reimbursed ~~net~~by ~~worth~~insurance. ~~Interest~~Management ~~rates~~believes ~~under~~its ~~the~~current ~~facility~~cash balances, ~~are~~anticipated ~~based~~cash onflows ~~the LIBOR~~from ~~rate~~operations orand ~~other~~insurance ~~rates~~reimbursements, and atthe committed credit facilities are sufficient to meet the Company’s planned ~~option.~~level ~~The~~of ~~Company~~capital ~~will~~spending ~~pay~~and ~~an annual~~general ~~fee~~operating oncash ~~the~~requirements, including ~~commitment~~but ~~based~~not onlimited ~~the~~to ~~Company’s~~cash ~~leverage~~requirements ~~ratio.~~related Noto ~~amounts~~litigation as ~~were~~discussed ~~outstanding~~above ~~under~~and ~~this~~as ~~facility~~further atdescribed ~~May 31~~in Note 8 to the financial statements, for ~~2002~~the next twelve months.

~~Management~~At ~~believes~~November 30, ~~its~~2002 ~~current~~and ~~cash~~August 31, ~~balances~~2002, ~~anticipated~~the ~~cash~~Company ~~flows~~did ~~from operations~~not ~~and~~have ~~the~~any relationships ~~committed~~with ~~credit~~unconsolidated ~~facilities~~entities ~~are~~or ~~sufficient~~financial topartnerships, ~~meet~~such ~~the~~as ~~Company’s~~entities ~~planned~~often ~~level~~referred ofto ~~capital~~as ~~spending~~structured ~~and~~finance ~~general~~or ~~operating~~special ~~cash requirements~~purpose entities, which ~~including~~would ~~but~~have ~~not~~been ~~limited~~established tofor ~~cash~~the ~~requirements~~purpose ~~related~~of tofacilitating off-balance ~~litigation~~sheet asarrangements ~~further~~or ~~described~~other incontractually ~~Note~~narrow 8or tolimited ~~the financial statements, for the next twelve months~~purposes.

At May 31, 2002 and August 31, 2001, the Company did not have any relationships with unconsolidated entities or financial partnerships, such as entities often referred to as structured finance or special purpose entities, which would have been established for the purpose of facilitating off-balance sheet arrangements or other contractually narrow or limited purposes.

Legal Proceedings

For information concerning legal proceedings, including trends and developments involving legal proceedings, see Note 8 to the financial statements included in this filing.

Environmental Matters

For information concerning environmental matters, see Note 9 to the financial statements included in this filing.

Item 3. 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~~19 ~~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 did not have any variable-rate debt outstanding at May 31, 2002.~~

Commodity Price Risk From time to time, the Company’s textile rental segment enters into arrangements locking in for specified periods the prices the Company will pay for the volume of natural gas or other commodities to which the contract relates. The contracts are structured to reduce the segment’s exposure to changes in the price of natural gas and relate only to portions of the Company’s normal expected usage. However, these contracts also limit the benefit the segment might have otherwise received from decreases in the price of natural gas. The Company does not believe a 10 percent adverse change in market rates of natural gas would have a material impact on its “Consolidated Balance Sheets” or “Consolidated Statements of Income.”

~~Page~~Interest 22Rates 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 did not have any variable-rate debt outstanding at November 30, 2002.

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 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.” At November 30, 2002, there were no outstanding contracts for natural gas.

The Company’s envelope segment uses paper as its primary raw material. Generally, the Company passes fluctuations in the price of paper through to its customers. The Company does not believe that a 10 percent change in market rates of paper would have a material impact on its “Consolidated Balance Sheets” or “Consolidated Statements of Income”.

Item 4. Controls and Procedures

Within 90 days of the filing of this report, an evaluation was performed under the supervision and with the participation of the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures. Based on that evaluation, management, including the Chief Executive Officer and the Chief Financial Officer, concluded that the Company’s disclosure controls and procedures were effective as of November 30, 2002. No significant changes in the Company’s internal controls or in other factors have occurred that could significantly affect controls subsequent to November 30, 2002.

Disclosure controls and procedures are designed to ensure that information required to be disclosed in the Company’s periodic filings with the Commission is (i) recorded, processed, summarized and reported within the time periods specified by the Commission’s rules and forms, and (ii) accumulated and communicated to the Company’s management, including the Chief Executive Officer and the Chief Financial Officer, as appropriate to allow timely decisions regarding required disclosure.

Internal controls are part of the Company’s disclosure controls and procedures and, in accordance with Exchange Act rules, are designed to provide reasonable assurances that (i) transactions are executed in accordance with management’s general or specific authorization, (ii) transactions are recorded as necessary to permit preparation of financial statements in conformity with accounting principles generally accepted in the United States and to maintain accountability for assets, (iii) access to assets is permitted only in accordance with management’s general or specific authorization, and (iv) the recorded accountability for assets is compared with the existing assets at reasonable intervals and appropriate action is taken with respect to any differences.

Cautionary Statement Regarding Forward-Looking Information

This ~~filing~~report contains forward-looking statements, within the meaning of the ~~Private~~federal ~~Securities~~securities ~~Litigation~~laws. ~~Reform~~Statements ~~Act of 1995,~~ that ~~involve~~are ~~risks~~not ~~and uncertainties.~~historical ~~Consequently~~facts, ~~actual~~including statements ~~results~~about ~~may~~management’s ~~differ~~and ~~materially~~the ~~from~~Company’s ~~those indicated~~beliefs byand ~~the~~expectations, are forward-looking statements. AForward-looking ~~variety~~statements ofinclude ~~risks and~~statements ~~uncertainties~~preceded ~~could~~by, ~~cause~~followed ~~the~~by ~~Company’s~~or ~~actual~~that ~~results~~include tothe ~~differ~~words ~~materially~~“believes,” “expects,” ~~from~~“anticipates,” ~~the~~“plans,” ~~anticipated~~“estimates” ~~results~~ or ~~other~~similar ~~expectations~~expressions. ~~expressed~~These instatements include, ~~the~~among ~~Company’s forward-looking~~others, statements. ~~The~~regarding ~~risks~~our ~~and~~expected ~~uncertainties~~business ~~include without~~outlook, ~~limitation~~pricing ~~the~~levels, ~~following:~~raw ~~(a) the~~materials ~~uncertainty~~costs, ofanticipated ~~general~~financial ~~business~~ and ~~economic~~operating ~~conditions~~results, ~~interest~~strategies, ~~rate changes~~contingencies, financing and ~~fluctuations~~working incapital ~~commodity~~requirements, sources of liquidity, capital expenditures, amounts and ~~raw~~timing of expenditures ~~material~~with ~~prices;~~respect to asbestos litigation and ~~(b) unexpected~~environmental ~~developments~~matters, amounts and timing ~~outcomes~~of ininsurance recoveries covering those expenses, the resolution of allocation and coverage issues with the Company’s insurers, the solvency of the ~~legal~~Company’s insurers, competitive conditions and ~~environmental~~general ~~proceedings~~economic conditions.

Forward-looking statements are only predictions and are not guarantees of performance. These statements are based on management’s beliefs and assumptions, which in turn are based on currently available information. These assumptions could prove inaccurate. Forward-looking statements also involve risks and uncertainties, which could cause actual results to differ materially from those contained in any forward-looking statement. Many of these factors are beyond the Company’s ability to control or predict. Such factors include, but are not limited to:

	•		changes in general business and economic conditions;

	•		fluctuations in raw material prices;

	•		unexpected developments or outcomes in the Company’s legal or environmental proceedings;

	•		the risk of additional insolvencies among the Company’s insurance carriers;

	•		the risk of an increase or acceleration in the number of asbestos-related claims filed against the Company;

	•		the risk of adverse judgments and damage awards against the Company in pending or future litigation;

	•		the risk that the number of future asbestos claims or the settlement costs of such claims will exceed the Company’s forecasts;

	•		changes in competitive conditions in the Company’s markets;

	•		foreign currency fluctuations relative to the U.S. dollar; and

	•		increases in labor and other significant operating expenses.

Investors should not place undue reliance on any forward-looking statements, which are based on current expectations. Further, forward-looking statements speak only as of the date they are made, and the Company undertakes no obligation to update publicly any of them in light of new information or future events.

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 Company’s annual meeting of stockholders held on December 19, 2002, all nominees for director were elected to the board of directors without opposition. The vote on the election of directors was as follows:


	For	Against

Brock A. Hattox, Chairman	8,330,977	125,340
Dennis R. Beresford	8,272,044	184,273
John E. Cay, III	8,281,380	174,937
Don L. Chapman	8,325,427	130,890
Joia M. Johnson	8,289,607	166,710
Michael Z. Kay	8,326,061	130,256
Betty L. Seigel	8,327,992	128,325
John T. Sweetwood	8,290,055	166,262

At the annual meeting of stockholders, the stockholders also approved a proposal to ratify the appointment of PricewaterhouseCoopers LLP as the Company’s independent auditors for the fiscal year ended August 31, 2003. The vote on this proposal was:


For	Against	Abstain

8,307,784	126,075	22,458

Item 5. Other Information

On December 19, 2002, Brock A. Hattox, Chairman of the Board, President and Chief Executive Officer of the Company announced his decision to retire from the Company. Mr. Hattox’s retirement is expected to be effective upon his reaching age 55 on March 23, 2003. However, he will remain in his position until a successor is appointed and will stay with the Company through an appropriate transition period. Upon his retirement, Mr. Hattox will also resign as a director.

Item 6. Exhibits and Reports on Form 8-K

(a)		Exhibits —are ~~None~~listed on the Index to Exhibits (page 24)
(b)		AnThe Company filed a Form 8-K ~~was filed~~ on ~~May~~November 2114, 2002 ~~for~~relating ato ~~change in~~ the ~~Company’s~~settlement ~~independent~~of ~~public~~certain ~~accountant~~legal ~~for~~claims against the ~~fiscal year ended August 31, 2002~~Company.

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.

CERTIFICATION OF THE CHIEF EXECUTIVE OFFICER

I, Brock A. Hattox, President and Chief Executive Officer of National Service Industries, Inc., certify that:


1.	I have reviewed this quarterly report on Form 10-Q of National Service Industries, Inc. (the “registrant”);

2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

	a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

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

	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


		/s/ Brock A. Hattox

		Brock A. Hattox President and Chief Executive Officer

Date: January 14, 2003

CERTIFICATION OF THE CHIEF FINANCIAL OFFICER

I, Chester J. Popkowski, Senior Vice President, Chief Financial Officer and Secretary of National Service Industries, Inc., certify that:


1.	I have reviewed this quarterly report on Form 10-Q of National Service Industries, Inc. (the “registrant”);

2.	Based on my knowledge, this quarterly report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this quarterly report;

3.	Based on my knowledge, the financial statements, and other financial information included in this quarterly report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this quarterly report;

4.	The registrant’s other certifying officers and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and have:

	a)	designed such disclosure controls and procedures to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this quarterly report is being prepared;

	b)	evaluated the effectiveness of the registrant’s disclosure controls and procedures as of a date within 90 days prior to the filing date of this quarterly report (the “Evaluation Date”); and

	c)	presented in this quarterly report our conclusions about the effectiveness of the disclosure controls and procedures based on our evaluation as of the Evaluation Date;

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

	a)	all significant deficiencies in the design or operation of internal controls which could adversely affect the registrant’s ability to record, process, summarize and report financial data and have identified for the registrant’s auditors any material weaknesses in internal controls; and

	b)	any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal controls; and

6.	The registrant’s other certifying officers and I have indicated in this quarterly report whether there were significant changes in internal controls or in other factors that could significantly affect internal controls subsequent to the date of our most recent evaluation, including any corrective actions with regard to significant deficiencies and material weaknesses.


		/s/ Chester J. Popkowski

		Chester J. Popkowski Senior Vice President, Chief Financial Officer and Treasurer

Date: January 14, 2003

INDEX TO EXHIBITS


Exhibit 3	(a) Restated Certificate of Incorporation	Reference is made to Exhibit 3(a) of registrant's Form 10-K for the fiscal year ended August 31, 2001, which is incorporated herein by reference.
	(b) By-Laws as Amended and Restated October 16, 2001	Reference is made to Exhibit 3(b) of registrant's Form 10-K for the fiscal year ended August 31, 2001, which is incorporated herein by reference.
Exhibit 4	(a) Amended and Restated Rights Agreement dated as of December 17, 1997 between National Service Industries, Inc. and Wachovia Bank, N.A. (replacing Wachovia Bank, N.A. with First Chicago Trust Company).	Reference is made to Exhibit 4.1 of registrant's Form 8-A/A as filed with the Commission on December 17, 1997, which is incorporated herein by reference.
	(b) First Amendment dated as of April 30, 1998 between National Service Industries, Inc. and First Chicago Trust Company of New York, to the Amended and Restated Rights Agreement, dated as of December 17, 1997 between National Service Industries, Inc. and Wachovia Bank, N.A.	Reference is made to Exhibit 1 of registrant's Form 8-A/A-3 as filed with the Commission on June 22, 1998, which is incorporated herein by reference.
	(c) Second Amendment dated as of January 6, 1999 between National Service Industries, Inc. and First Chicago Trust Company of New York, to the Amended and Restated Rights Agreement, dated as of December 17, 1997 between National Service Industries, Inc. and First Chicago Trust Company of New York, as Rights Agent, as amended.	Reference is made to Exhibit 1 of registrant's Form 8-A/A-4 as filed with the Commission on January 12, 1999, which is incorporated herein by reference.
Exhibit 10(iii)(A)	(1) Amendment No. 1 to Employment Agreement, made as of the 4th day of October, 2002, by and between National Service Industries, Inc. and Brock A. Hattox.	Reference is made to Exhibit 10(iii)(A)(97) of registrant's Annual Report on Form 10-K filed with the Commission on November 15, 2002, which is incorporated herein by reference.
	(2) Form of Restricted Stock Award Agreement under the National Service Industries, Inc. Long-Term Achievement Plan.	Filed with the Securities and Exchange Commission as part of this Form 10-Q.
	(3) Restricted Stock Award Agreement between National Service Industries, Inc. and Brock A. Hattox under the National Service Industries, Inc. Long-Term Achievement Plan.	Filed with the Securities and Exchange Commission as part of this Form 10-Q.
	(4) Amendment No. 1 to Restricted Stock Award Agreement between National Service Industries, Inc. and Brock A. Hattox under the National Service Industries, Inc. Long-Term Achievement Incentive Plan.	Filed with the Securities and Exchange Commission as part of this Form 10-Q.
Exhibit 99.1	Certification of Principal Executive Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed with the Securities and Exchange Commission as part of this Form 10-Q.
Exhibit 99.2	Certification of Principal Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.	Filed with the Securities and Exchange Commission as part of this Form 10-Q.

NATIONAL SERVICE INDUSTRIES, INC.

REGISTRANT

~~July~~January 1514, ~~2002~~2003

/s/ BROCK A. HATTOX

BROCK A. HATTOX CHAIRMAN, CHIEF EXECUTIVE OFFICER AND PRESIDENT

~~July~~January 1514, ~~2002~~2003

/s/ CHESTER J. POPKOWSKI

CHESTER J. POPKOWSKI SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND TREASURER

~~CHESTER J. POPKOWSKI SENIOR VICE PRESIDENT, CHIEF FINANCIAL OFFICER AND TREASURER~~

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