<PAGE> 1
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 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 JUNE 30, 1999
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE TRANSITION PERIOD FROM ____________ TO ____________
COMMISSION FILE NUMBER 0-23073
INTERNATIONAL TOTAL SERVICES, INC.
(Exact name of registrant as specified in its charter)
OHIO 34-1264201
---- ----------
(State of Incorporation) (I.R.S. Employer
Identification No.)
CROWN CENTRE
5005 ROCKSIDE ROAD, SUITE 1200
INDEPENDENCE, OHIO 44131
------------------ -----
(Address of Principal Executive Offices) (Zip Code)
Registrant's telephone number, including area code: (216) 642-4522
Indicated 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 [ ] No [X]
As of April 30, 2000, the Registrant had 6,837,494 Common Shares issued and
outstanding.
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INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
10-Q
INDEX
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<TABLE>
<CAPTION>
PAGE NO.
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<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements
Consolidated Balance Sheets
as of June 30, 1999 and March 31, 1999......................................... 2
Consolidated Statements of Operations and Comprehensive Income (Loss)
for the Three Months Ended June 30, 1999 and 1998.............................. 3
Consolidated Statements of Cash Flows
for the Three Months Ended June 30, 1999 and 1998.............................. 4
Notes to Consolidated Financial Statements.......................................... 5
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................... 11
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk.................................. 16
PART II OTHER INFORMATION
ITEM 6 Exhibits and Reports on Form 8-K............................................................ 17
</TABLE>
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INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, 1999 MARCH 31, 1999
------------- --------------
(UNAUDITED)
<S> <C> <C>
ASSETS
CURRENT ASSETS
Cash and cash equivalents................................................... $ 1,371 $ 672
Accounts receivable - net of allowance for doubtful
accounts of $677 and $513, respectively................................. 25,445 23,811
Costs and estimated earnings in excess of billings.......................... 299 --
Deferred taxes.............................................................. 3,033 3,033
Uniforms, net............................................................... 2,443 2,691
Other current assets........................................................ 1,642 1,422
-------------- --------------
Total current assets.................................................... 34,233 31,629
PROPERTY AND EQUIPMENT
Security equipment.......................................................... 4,888 4,729
Service equipment........................................................... 2,324 2,636
Computer equipment.......................................................... 3,048 2,882
Furniture and fixtures...................................................... 1,545 1,136
Autos ................................................................... 1,089 974
Leasehold improvements...................................................... 68 63
-------------- --------------
12,962 12,420
Less accumulated depreciation and amortization.............................. 6,116 5,773
-------------- --------------
Property and equipment, net................................................. 6,846 6,647
INTANGIBLES, LESS ACCUMULATED AMORTIZATION OF
$4,704 and $3,932, respectively ............................................ 35,326 32,254
SECURITY DEPOSITS AND OTHER...................................................... 141 104
-------------- --------------
TOTAL ASSETS............................................................ $ 76,546 $ 70,634
============== ==============
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable...................................................... $ 1,295 $ 1,871
Billings in excess of costs and estimated earnings.......................... 158 --
Accrued payroll and employee benefits....................................... 17,911 17,832
Other accrued expenses...................................................... 9,450 8,554
Income taxes payable........................................................ 54 54
-------------- --------------
Total current liabilities............................................... 28,868 28,311
DEFERRED TAXES................................................................... 623 623
LONG-TERM OBLIGATIONS............................................................ 17,978 10,859
SHAREHOLDERS' EQUITY
Common shares, without par value, stated at $.01 per share - authorized
20,000 shares, issued and outstanding
6,662 shares at June 30, 1999 and March 31, 1999....................... 67 67
Additional paid-in capital.................................................. 31,211 31,211
Accumulated other comprehensive loss........................................ (517) (387)
Retained deficit............................................................ (1,684) (50)
--------------- ---------------
29,077 30,841
-------------- --------------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............................. $ 76,546 $ 70,634
============== ==============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
2
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INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS)
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
--------------------------------------------------------
(RESTATED)
1999 1998
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<S> <C> <C> <C> <C>
Net operating revenues.................................... $ 55,805 100.0% $ 56,121 100.0%
Cost of revenues.......................................... 50,442 90.4% 50,288 89.6%
----------- ------------ ---------- -----------
GROSS MARGIN................................ 5,363 9.6% 5,833 10.4%
Selling, general and administrative expenses.............. 5,905 10.6% 5,060 9.0%
Amortization expense...................................... 772 1.4% 502 0.9%
----------- ------------ ---------- -----------
OPERATING PROFIT (LOSS)..................... (1,314) (2.4%) 271 0.5%
Interest expense-net..................................... 320 0.5% 90 0.2%
----------- ------------ ---------- -----------
INCOME (LOSS) BEFORE INCOME TAXES........... (1,634) (2.9%) 181 0.3%
Provision for income taxes................................ -- -- 75 0.1%
----------- ------------ ---------- -----------
NET INCOME (LOSS)........................... $ (1,634) (2.9%) $ 106 0.2%
========== ============ ========= ===========
Other comprehensive income (loss)
Foreign currency translation adjustment..... (130) (125)
----------- ----------
COMPREHENSIVE LOSS ......................... $ (1,764) $ (19)
=========== ==========
Net income (loss) per share:
Basic ............................................ $ (0.25) $ 0.02
=========== ==========
Diluted ............................................ $ (0.25) $ 0.02
=========== ==========
Weighted average number of shares outstanding: (000's)
Basic ............................................ 6,662 6,662
=========== ==========
Diluted ............................................ 6,662 6,747
=========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
3
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INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
(AMOUNTS IN THOUSANDS)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
-------------------------------------------
RESTATED
1999 1998
-------------------- ----------------
<S> <C> <C>
OPERATING ACTIVITIES:
Net income (loss)........................................................... $ (1,634) $ 106
Adjustments to reconcile net income (loss) to net cash (used for) provided
by operating activities:
Depreciation............................................................ 421 295
Amortization............................................................ 772 502
Loss on disposal of fixed assets........................................ 24 -
Deferred Taxes.......................................................... - (529)
Changes in working capital:
Accounts receivable................................................ (80) (605)
Other assets....................................................... (13) (987)
Trade accounts payable............................................. (608) 1,115
Accrued expenses................................................... 785 1,884
-------------- --------------
Net cash (used for) provided by operating activities.......... (333) 1,781
INVESTING ACTIVITIES:
Additions to property and equipment......................................... (470) (895)
Proceeds received from sale of equipment.................................... 127 18
Property and equipment of acquired businesses............................... (302) --
Working capital acquired, net of cash ...................................... (1,470) --
Intangibles from acquisitions of businesses................................. (3,843) (4,215)
--------------- ---------------
Net cash used for investing activities........................ (5,958) (5,092)
FINANCING ACTIVITIES:
Net borrowings on note payable to bank...................................... 7,120 2,897
-------------- --------------
Net cash provided by financing activities..................... 7,120 2,897
Effect of exchange rates on cash................................................. (130) (125)
--------------- ---------------
Net increase (decrease) in cash and cash equivalents........................ 699 (539)
Cash and cash equivalents, at beginning of period................................ 672 3,542
-------------- --------------
Cash and cash equivalents, at end of period...................................... $ 1,371 $ 3,003
============== ==============
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest ................................................................... $ 301 $ 68
============== ==============
Income taxes................................................................ $ 64 $ 101
============== ==============
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
4
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INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 1999
(TABULAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
(UNAUDITED)
NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
------------------------------------------
BASIS OF PRESENTATION
The accompanying unaudited financial statements include the accounts of
International Total Services, Inc. and its wholly-owned subsidiaries (the
"Company"). These financial statements have been prepared in accordance with
generally accepted accounting principles for interim financial information and
with the instructions to Form 10-Q and Article 10 of Regulation S-X.
Accordingly, they do not include all of the information and footnotes required
by generally accepted accounting principles for complete financial statements.
In the opinion of management, all adjustments (consisting of normal recurring
accruals) considered necessary for a fair presentation of the financial position
of the Company as of June 30, 1999 and the results of its operations and cash
flows for the three month periods ended June 30, 1999 and 1998 have been
included. The accompanying unaudited consolidated financial statements should be
read in conjunction with the Company's consolidated financial statements,
including the notes thereto, appearing in the Company's Annual Report on Form
10-K for the year ended March 31, 1999.
The preparation of financial statements and the accompanying notes
thereto, in conformity with generally accepted accounting principles, requires
management to make estimates and assumptions that affect reported amounts of
assets and liabilities and disclosure of contingent assets and liabilities at
the date of the financial statements and reported amounts of revenues and
expenses during the respective reporting periods. Actual results could differ
from those estimates. Operating results for the three month period ended June
30, 1999 are not necessarily indicative of the results that may be expected for
the year ended March 31, 2000.
The Company's fiscal year ends on March 31. All references to fiscal
years in this Quarterly Report on Form 10-Q represent the year in which the
fiscal period ends (i.e. fiscal 1999 is the year ended March 31, 1999) unless
otherwise noted.
REVENUE RECOGNITION
Revenues are recognized at the time aviation and commercial security
services are provided. Revenues generated from the sales of security products
are recognized when the products have been delivered and installed if the
duration of the contract is five (5) working days or less and the contract terms
require payment only after installation has been completed. This has been the
policy prior to fiscal 2000.
Commencing in the first quarter of fiscal 2000, as a result of an
acquisition (see Note D), revenues generated from the sales of security products
are recognized on the percentage of completion basis, if the duration of the
contract is greater than five (5) working days and the contract payment terms
allow for related progress billings. This change was necessary since the newly
acquired company is involved in numerous long term installation contracts. This
change did not have a material impact on the results previously reported for the
sale of security products. The percentage-of-completion method is based on
estimates by the project manager.
COST RECOGNITION
Cost of revenues include all labor costs and direct costs relating to
aviation and commercial security and the material costs related to security
products. Indirect costs are charged to selling, general and administrative
expenses as incurred. Provisions for estimated losses on uncompleted contracts
are made in the period in which such losses are determined. Changes in job
performance, job conditions and estimated profitability, including those arising
from contract penalty provisions, and final
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contract settlements may result in revisions to costs and income and are
recognized in the period in which the revisions are determined.
CONTRACTS IN PROCESS
Contracts in process are stated at costs incurred plus estimated profit
(percentage of completion) less than or in excess of related progress billings.
The percentage of completion is based on estimates by the project manager,
consistent with billings to the customer. Management considers this estimate to
be the best available measure of progress on the contracts. All contracts in
process at period-end are scheduled to be completed and billed during the
current fiscal year. The asset, "Costs and estimated earnings in excess of
billings" represents revenues recognized or costs incurred in excess of amounts
billed. The liability, "Billings in excess of costs and estimated earnings on
uncompleted contracts", represents amounts billed in excess of revenues
recognized.
NET INCOME (LOSS) PER SHARE
Net income (loss) per share - basic is based on the weighted average
number of shares outstanding during each period.
Net income (loss) per share - diluted gives effect to the net
additional shares that would have been issued had all dilutive stock options
been exercised. The Company had no other potentially dilutive common share
obligations outstanding.
For purposes of calculating the basic and diluted net income (loss) per
share, no adjustments have been made to the reported amounts of net income
(loss).
RECLASSIFICATIONS
Certain reclassifications have been made to the prior periods' consolidated
financial statements to conform with the fiscal 2000 presentation.
NOTE B - GOING CONCERN
-------------
The accompanying consolidated financial statements have been prepared on a
going concern basis, which contemplates the realization of assets and the
settlement of liabilities, including any commitments and/or contingent
liabilities, in the normal course of business. The Company incurred a loss from
operations for fiscal 1999, incurred a loss for the three months ended June 30,
1999 and for Fiscal 2000, and has negative tangible net worth. Operations have
generated negative cash flow for fiscal 2000. These factors raise doubts about
the Company's ability to continue as a going concern.
The Company's strategy is to use the established business base as a
platform for expanding its services and currently will not pursue any further
acquisitions (other than the two (2) already consummated during the first
quarter of fiscal 2000) due to the unavailability of funds. It is management's
intention to seek higher overall margins by concentrating its marketing efforts
on higher margin opportunities, to formulate and implement business process
improvement initiatives, evaluate past acquisitions, improve customer services
and reduce and/or control costs with the goal of improving operating cash flow
and profits. There can be no assurance that capital will be obtained from any
sources or that this plan will be successful.
The Company's continuation as a going concern will ultimately depend on its
ability to (i) achieve profitable operations which generate positive cash flows
and (ii) obtain other sources of capital with new debt or equity financing. The
financial statements do not include any adjustments relating to the
recoverability of assets or the amount to settle liabilities that might be
necessary should the Company be unable to continue as a going concern.
NOTE C - RESTATEMENT
-----------
Subsequent to March 31, 1999, management determined that its previously
issued fiscal 1998, 1997, 1996 and 1995 financial statements and the unaudited
results for the first, second and third quarters of fiscal 1999 required
restatement. The restatement is to correct accounting that resulted from the
failure of the Company to properly consider information available at the time
those financial statements were prepared, including information that may not
have been considered due to errors and omissions in accounting or corporate
records.
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The following is a summary of the restated unaudited quarterly results
of operations for the year ended March 31, 1999.
<TABLE>
<CAPTION>
JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31
------- ------------ ----------- --------
<S> <C> <C> <C> <C>
FISCAL 1999
Net operating revenues $56,121 $58,407 $58,858 $ 53,486
======= ======= ======= ========
Gross margin, as previously reported $ 7,125 $ 7,586 $ 7,552 $(1,884)
Restatement (1,292) (1,287) (1,100) 4,948
------- ------- ------- --------
Gross margin, as restated $ 5,833 $ 6,299 $ 6,452 $ 3,064
======= ======= ======= =======
Net income, as previously reported $ 448 $ 425 $ 490 $(9,442)
Restatement (342) (262) (276) 1,664
------- ------- ------- --------
Net income/(loss) as restated $ 106 $ 163 $ 214 $(7,778)
======= ======= ======= ========
Net income/(loss) per share
Basic and Diluted
As reported 0.07 0.06 0.07 (1.41)
Restatement $(0.05) $(0.04) $(0.04) $ 0.24
------- ------- ------- --------
As restated $ 0.02 $ 0.02 $ 0.03 $(1.17)
======= ======= ======= ========
</TABLE>
NOTE D - ACQUISITIONS
------------
In the first quarter of fiscal 2000, the Company made two acquisitions.
The Company acquired commercial security contracts from an entity for an
aggregate purchase price of approximately $1.6 million, which included $98,000
for equipment. Approximately $1.3 million of the purchase price was allocated to
the contracts and approximately $148,000 was allocated to goodwill.
Also during the first quarter of fiscal 2000, the Company acquired the
outstanding stock of a security products distribution entity for approximately
$5.0 million in cash. The purchased net assets included cash of $826,000, net
receivables of $1,555,000, inventories of $249,000, equipment of $204,000,
accounts payable and other liabilities of $334,000 and $2,500,000 attributable
to goodwill. See Note G - Subsequent Events.
These acquisitions have been accounted for under the purchase method of
accounting and goodwill is being charged to operations on a straight-line basis
over 20 years.
The operating results related to the acquired contracts and the
acquired security products distribution entity have been included in the
Company's results of operations from the respective dates of acquisitions.
The following unaudited pro forma results of operations give effect to
the above acquisitions as if the two acquisitions, made during the first quarter
of fiscal 2000, had been made at April 1, 1998.
THREE MONTHS ENDED JUNE 30
---------------------------
1999 1998
---- ----
RESTATED
Net operating revenues..................... $ 56,824 $ 58,524
Net income (loss).......................... $ (1,533) $ 288
Net income (loss) per share:
Basic ............................. $ (0.23) $ 0.04
Diluted ............................. $ (0.23) $ 0.04
The pro forma results of operations have been prepared for comparative
purposes only and do not purport to present actual operating results had the
acquisitions been made at the beginning of each year, or results which may occur
in the future.
NOTE E - REPORTABLE SEGMENTS
-------------------
The Company has three segments: Aviation Staffing Services, Commercial
Security Staffing Services and Security Products Distribution. The aviation
services offered by the Company include skycap, baggage handling, aircraft
appearance,
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wheelchair and electric cart operations. The Company's commercial security
staffing services extend beyond aviation security, and include the provision of
uniformed security officers, facility access control, security consulting,
special event security and security assessment to a broad range of clients. The
security products segment offers a line of security products including airport
and commercial staffing checkpoint products and hand-held metal detectors.
The Company's reportable segments are strategic business units that
offer different products and services to different markets. Aviation services is
treated as a separate business because of its unique marketing focus and the
specialized needs of its customer base, the airline industry. Commercial
staffing services is treated as a separate business due to its focus on security
services and its wide range of clients. Security products is treated as a
separate business because it markets tangible security goods.
The accounting policies of the segments are the same as those described
in the summary of significant accounting policies (see Note A).
The following table provides selected information about the Company's
three business units. The Company makes operating decisions based on segment
revenues, costs of revenues, gross margins, and net income (loss). It does not
make operating decisions based on the level of assets held by a segment.
SEGMENT DISCLOSURE DATA
-----------------------
<TABLE>
<CAPTION>
AVIATION COMMERCIAL SECURITY
STAFFING SECURITY STAFFING PRODUCTS
FOR THE THREE MONTHS ENDED JUNE 30, 1999 SERVICES SERVICES DISTRIBUTION TOTALS
- ---------------------------------------- -------- -------- ------------ ------
<S> <C> <C> <C> <C>
Net operating revenues.................................... $42,000 $12,348 $1,457 $55,805
Cost of revenues.......................................... $38,925 $10,337 $1,180 $50,442
Gross margin ............................................ $ 3,075 $ 2,011 $ 277 $ 5,363
Net loss ............................................ $(1,084) $ (509) $( 41) $(1,634)
FOR THE THREE MONTHS ENDED JUNE 30, 1998 (RESTATED)
Net operating revenues.................................... $43,511 $11,454 $1,156 $56,121
Cost of revenues......................................... $39,423 $ 9,927 $ 938 $50,288
Gross margin ............................................ $ 4,088 $ 1,527 $ 218 $ 5,833
Net income (loss)......................................... $ 295 $ 102 $( 87) $ 106
</TABLE>
DISCLOSURE OF GEOGRAPHIC INFORMATION
------------------------------------
<TABLE>
<CAPTION>
NET OPERATING REVENUES FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND ASSETS AT REVENUES ASSETS
- ----------------------------------------------------------------------------- -------------- --------------
JUNE 30, 1999
- -------------
<S> <C> <C>
United States ................................................................... $54,009 $75,926
Other Countries.................................................................. 1,796 620
-------------- --------------
Total ................................................................... $55,805 $76,546
============== ==============
NET OPERATING REVENUES FOR THE THREE MONTHS ENDED JUNE 30, 1998 AND ASSETS AT REVENUES ASSETS
- ----------------------------------------------------------------------------- -------------- --------------
MARCH 31, 1999
- --------------
United States ................................................................... $54,133 $70,010
Other Countries.................................................................. 1,988 624
-------------- --------------
Total ................................................................... $56,121 $70,634
============== ==============
</TABLE>
DISCLOSURE ABOUT MAJOR CUSTOMERS
During the three month periods ended June 30, 1999 and 1998, revenues
from one major customer amounted to $13.5 million and $16.0 million or 24.2% and
28.5% of net operating revenues, respectively. Services provided to another
major
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customer generated revenues for the Company of $6.8 million or 12.2% of net
operating revenues for the quarter ended June 30, 1999 and 12.1% of total
revenues during the same period in the prior year.
Five airline customers, including the two noted above, accounted for
approximately 47.4% and 51.3% of net operating revenue for the quarters ended
June 30, 1999 and 1998, respectively, and accounted for 37.0% and 42.6% of net
accounts receivable at June 30, 1999 and March 31, 1999, respectively.
NOTE F- FINANCING ARRANGEMENTS
----------------------
Prior to August 27, 1999, the Company had a credit facility secured by
substantially all accounts receivable, equipment, and other assets. The credit
facility provided for borrowings under a revolving promissory note of up to $30
million through September 30, 1999, limited to a percentage of eligible
receivables. The revolving promissory note bears interest at a variable rate
based on the Company's total debt to tangible net worth ranging from LIBOR plus
1.50% to the bank's prime rate plus 3.0%. The Company had approximately
$17,978,000 and $10,859,000 outstanding under the facility at June 30, 1999 and
March 31, 1999, respectively, with weighted average interest rates of 7.57% at
both period ends.
On August 27, 1999, the lender agreed to modify the credit facility.
The modifications included a six month extension of the maturity date of the
facility to April 1, 2000, a $5,000,000 reduction in the maximum available
borrowings to $25,000,000, and a $3,000,000 reduction in the annual capital
asset acquisition allowance to $1,000,000. In April 2000 the credit facility was
amended and extended to April 1, 2001. See Note G Subsequent Events. At April
30, 2000, outstanding obligations under this facility were $23.9 million.
The credit facility limits the Company's ability to incur additional
indebtedness and pay dividends, requires the Company to maintain prescribed
debt-to-equity and fixed charge coverage ratios, minimum net worth levels, and
to satisfy other financial covenants. At June 30, 1999, the Company was not in
compliance with certain of these covenants. Waivers were obtained for these
covenant violations and waivers were obtained through March 31, 2000 for those
covenants which the Company did not meet through the end of fiscal 2000.
NOTE G- SUBSEQUENT EVENTS
-----------------
CHANGE IN CONTROL
On October 19, 1999, Robert A. Weitzel ("Weitzel") resigned as the
chairman, chief executive officer and director of the Company and entered into
certain additional arrangements. As of November 1, 1999, Weitzel entered into a
retirement and consulting agreement (the "Retirement and Consulting Agreement")
with the Company. This agreement required payments to Weitzel of $300,000 on
November 1, 1999 and $200,000 on January 3, 2000, which have been made, and
provides certain other standard employment benefits through September 30, 2001.
In addition, the Company will pay Weitzel an aggregate of $500,000 under a 20
month consulting agreement beginning February 1, 2000. The Company is obligated
to pay Weitzel the $500,000 consulting fee whether or not services are provided.
The Retirement and Consulting Agreement also provided that Weitzel enter into a
voting trust agreement (the "Voting Trust Agreement") among the Company,
Weitzel, and H. Jeffrey Schwartz, J. Jeffrey Eakin and John P. O'Brien, as
voting trustees (the "Trustees"), and a stock restriction agreement between
Weitzel and the Company (the "Stock Restriction Agreement."). The three Trustees
constitute the entire Board of Directors of the Company as of April 30, 2000.
Pursuant to the Voting Trust Agreement, Weitzel transferred record ownership,
and thereby voting control, of 3,324,979 shares of the Company's common stock,
representing approximately 48.6% of the issued and outstanding shares of the
Company's Common Stock, held by Weitzel individually and by The Weitzel Family
Limited Partnership to the voting trust (the "Voting Trust") created by the
Voting Trust Agreement. Pursuant to the Voting Trust Agreement, a voting trust
certificate was issued and delivered to Weitzel.
The Voting Trust Agreement provides that all shares of the Company's
Common Stock transferred to the Trust are held in trust until the earlier of
September 30, 2001 or a payment default by the Company under certain provisions
of the Retirement and Consulting Agreement. Pursuant to the Voting Trust
Agreement, the Trustees exercise voting power with respect to the shares of the
Company's Common Stock held in the Voting Trust, by the action of a majority of
the Voting Trustees. In addition, any transfer of the voting trust certificate
is only permitted in accordance with the Stock Restriction Agreement.
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Pursuant to the Stock Restriction Agreement, other than transfers to
his spouse, children, or grandchildren, or entities of which those people are
the beneficiaries or hold controlling interests, Weitzel is not permitted to
transfer shares of the Company's Common Stock, or voting trust certificates,
without first offering those shares on identical terms to the Company, and the
Company has a specified period of time during which it may exercise its option
to purchase those shares.
DELISTING OF COMMON SHARES
On July 1, 1999, the Company was informed by The Nasdaq Stock Market
that trading of the Company's shares would be halted pending the receipt and
review of additional information in accordance with Rule 4330 (c) of Marketplace
Rules of the Nasdaq Stock Market. The primary cause for the extended halt is a
result of the non-timely filing of the Company's Form 10-K for fiscal year ended
March 31, 1999, which was originally due on or before July 1, 1999. On September
15, 1999, after an oral hearing on September 9, 1999, the Company's stock was
delisted from the Nasdaq Stock Market. On October 26, 1999 the Company's stock
began being quoted on the Electronic Quotation System of National Quotation
Bureau LLC.
GUARANTEE OF DEBT
On July 7, 1999, the Company entered into a First Demand Guarantee with
a German bank to guarantee overdrafts of the German operations up to 500,000
Deutsche Marks (approximately $270,000 at that date). In February 2000 the
Company received notice for a claim amounting to approximately $122,000 related
to this guarantee.
EMPLOYMENT AGREEMENTS
In October 1999, the Company entered into an employment agreement with
Mr. Mark D. Thompson, President and Interim Chief Executive Officer. In addition
to setting a base salary of $300,000 effective January 13, 2000, Mr. Thompson
was granted 75,000 shares of Company common stock as well as an additional
100,000 shares of restricted Company common stock which vest either over a set
period of time or upon attainment of specified goals. Upon termination of
employment other than for "cause", Mr. Thompson's 100,000 shares of restricted
Company common stock would fully vest.
EXTENSION OF BANK CREDIT FACILITY
In April 2000 management secured, from the Company's lenders, certain
amendments to its existing credit facility. Among them are an extension of the
term to April 1, 2001 with a reduction of the interest rate to be charged on
borrowings to prime plus 0.75%, if the loan is repaid by December 31, 2000. The
amended agreement also includes an increase to the percentage advance rate of
eligible receivables as well as more relaxed financial covenants. The financial
covenants include certain net worth covenants and a minimum debt coverage ratio
and standard financial reporting requirements. As of April 30, 2000, the Company
was in compliance with all covenants.
In consideration for the amendment and extension of the credit facility
the Company granted the banks warrants for the purchase of 300,000 shares of the
Company's Common Stock at an exercise price of $1.41, which the Board determined
was the fair market value of the Company's Common Stock as of the date of the
grant. The warrants expire on March 31, 2007. As part of the transaction, the
banks were granted a "put" option commencing April 1, 2001 which would, if
exercised, require the Company to purchase the warrants at $1.00 per warrant and
the Company retained a "call" option commencing immediately at an initial price
of $4.50 per warrant. The call price increases by $1.00 per warrant per year
commencing April 1, 2001.
DISPOSITIONS
In March 2000, the Company completed the disposition of the security
products distribution company that it had acquired in the first quarter of
fiscal 2000. See Note D - Acquisitions. The sale proceeds combined with the cash
flow distributions received during the period owned was approximately equal to
its net cash investment.
10
<PAGE> 12
INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
THREE MONTHS ENDED JUNE 30, 1999
OVERVIEW
The Company is a significant domestic provider of aviation contract
support services and is also a provider of commercial security staffing
services. The Company provides services to customers in more than 300 cities in
the United States and Europe. Aviation support services offered by the Company
include skycap, baggage handling and aircraft appearance services, wheelchair
and electric cart operations. The Company's security services extend beyond
aviation security, and include the provision of commercial security staffing
services to government and business clients, hospitals, arenas, and museums.
The Company's services are provided under contracts that generally have
terms of one to three years, but are cancelable by either party on 30 to 90 days
notice. Although contract terms vary significantly, clients generally pay an
hourly rate for services provided. Certain services, such as aircraft cleaning,
are billed on a flat fee-for-service basis, and certain others are billed at a
fixed monthly rate. The Company recognizes revenues as the related services are
performed.
Acquisitions had played an important role in the Company's net
operating revenue growth during fiscal 1999 and 1998. During the first quarter
of fiscal 2000 the Company completed two acquisitions, both of which were
accounted for under the purchase method, and accordingly their operating results
are included in the Company's consolidated financial statements for all periods
subsequent to the date of acquisition. The Company is not presently pursuing
further acquisitions, and does not anticipate that acquisitions will materially
contribute to growth in the foreseeable future.
On March 1, 1999 the Company announced the engagement of Arthur
Andersen LLP as its new independent public accountants. The Company received a
letter dated August 20, 1999 from Arthur Andersen LLP, addressed to the Audit
Committee of the Board of Directors. The letter indicated that Arthur Andersen
had noted certain matters related to the accounting systems and internal
controls of the Company that they considered to be a "material weakness" and
recommended that the Company take steps to improve internal accounting control
procedures. A special committee of the Board of Directors was established to,
among other things, monitor the Company's progress in addressing this weakness.
The Company has addressed or implemented procedures to improve controls related
to certain of the identified material weaknesses and is in the process of
addressing the remaining issues with completion expected during fiscal 2001.
Following the Change in Control during October 1999, as described in
Note G of Notes to Consolidated Financial Statements, the Company hired a new
chief executive officer and began an extensive review of internal processes,
organizational structure and business practices to identify methods of improving
the quality of its delivered services.
On November 2, 1999, the Company announced that it would revise
downward its previously announced results for the fiscal year ended March 31,
1999, and for the quarter ended June 30, 1999. These revisions were based upon
additional information identified and the completion of a review of judgmental
accounting matters by the Company's management which were reviewed with the
Audit Committee of the Board of Directors. On February 3, 2000, the Company
announced a $6.3 million downward adjustment to the fiscal 1999 results and a
$2.0 million downward adjustment to the first quarter of fiscal 2000 results. In
addition, the Company announced that it would be restating its previously issued
financial statements. This restatement is to correct accounting that resulted
from the failure of the Company to properly consider information available at
the time these financial statements were prepared, including information that
may not have been considered due to errors and omissions in accounting or
corporate records. Accordingly, the fiscal 1998, 1997, 1996 and 1995 financial
statements were restated, as reported in the consolidated financial statements
appearing in the Company's Annual Report on Form 10-K for the year ended March
31, 1999.
The Company will incur an operating loss in fiscal 2000. The Company's
new management team continues its review of all aspects of its operations with
the goal of improving profitability. Management actions taken to increase the
efficiency of the Company's operations may result in additional charges in
fiscal 2000.
11
<PAGE> 13
The accompanying unaudited consolidated financial statements have been
prepared on a going concern basis, which contemplates the realization of assets
and the settlement of liabilities, including commitments and/or contingent
liabilities, in the normal course of business. The Company incurred a loss from
operations in the fiscal year ended March 31, 1999 and continues to incur losses
and negative cash flow in fiscal 2000 and has negative tangible net worth.
Although the Company obtained a one year extension of its credit facility in
April 2000 (See Note G of Notes to the Consolidated Financial Statements) the
negative cash generated during fiscal 2000 and forecast to continue into the
first half of fiscal 2001 are factors that raise doubts about the Company's
ability to continue as a going concern.
The Company obtained an extension of its credit facility through April
1, 2001 for use in funding operations. In addition, the Company will use its
established business base as a platform for expanding its services and currently
will not pursue any further acquisitions (other than the two (2) already
consummated during the first quarter of this year) due to the unavailability of
funds. It is management's intention to seek higher overall margins by
concentrating its marketing efforts on higher margin opportunities, to formulate
and implement business process improvement initiatives, evaluate past
acquisitions, improve customer services and reduce and/or control costs with the
goal of improving operating cash flow and profits. There can be no assurance
that capital will be obtained from any sources or that this plan will be
successful.
RESULTS OF OPERATIONS
NET OPERATING REVENUES. Revenues for the first quarter of fiscal 2000
decreased by $0.3 million, or 0.5%, to $55.8 million as compared with $56.1
million in the first quarter of fiscal 1999. The major factor affecting revenues
during the first quarter was the loss of four large aviation service contracts
worth an estimated $2.6 million in quarterly revenues which was partially offset
by the impact of the acquisitions in late fiscal 1999 and early fiscal 2000.
Since the Company has decided not to pursue acquisitions at the present time due
to the Company's cost of capital and lack of availability of funds under its
current credit facility, this revenue decline is expected to continue.
COST OF REVENUES. Cost of revenues was $50.4 million in fiscal 2000
compared with $50.3 million in fiscal 1999, an increase of $.1 million, or .3%.
As a percentage of revenues, cost of revenues was 90.4% in fiscal 2000, compared
with 89.6% in fiscal 1999. The strength of the United States economy during this
period has driven unemployment to low levels and has forced the Company to
increase the wages paid to employees in advance of increases in the rates paid
by the Company's customers and to pay more overtime than in the prior years.
These factors have resulted in downward pressure on the Company's gross margins.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and
administrative expenses were $ 5.9 million in the first quarter of fiscal 2000
compared to $ 5.1 million in the first quarter of fiscal 1999, an increase of
$0.8 million, or 15.7%. Measured as a percentage of operating revenues, these
expenses were 10.6% and 9.0% respectively. This increase related specifically to
increased corporate expenses for consulting and professional (legal and
accounting) fees and wages incurred. The Company has hired new management and
consultants to assist in evaluating organizational structure, identify
inefficiencies and improve controls over field operations. Management is
evaluating the performance and profitability of each business segment and the
contract relationship with each significant customer. These costs are expected
to continue throughout fiscal 2000 as management formulates and implements a
business improvement plan. There is no assurance that this plan will achieve its
desired results of increased profitability.
AMORTIZATION EXPENSE. Contract and goodwill amortization expense
increased $0.3 million, or 53.8%, to $0.8 million in the first quarter of fiscal
2000 from $0.5 million in the first quarter of fiscal 1999. The increase is a
result of the amortization of the contract values and goodwill for the six
acquisitions completed in fiscal 1999 and the two acquisitions completed in the
first quarter of fiscal 2000.
INTEREST EXPENSE. Interest expense increased in the first quarter of
fiscal 2000 to $0.3 million from $0.1 million in the first quarter of the prior
year. Average outstanding debt increased from $4.7 million during the first
quarter of fiscal 1999 to $18.2 million during the first quarter of fiscal 2000.
This increase in debt, primarily incurred to fund acquisitions, was partially
offset by a decrease in the Company's effective borrowing rate from 7.71% to
7.57% for the quarters ended June 30, 1998 and 1999, respectively.
INCOME TAXES. Due to the loss incurred, and the uncertainty of the
Company's ability to realize any carry forward tax benefits, no tax benefit was
recorded in the first quarter of fiscal 2000. The Company's effective income tax
rate was 41.4% for the first quarter of fiscal year 1999.
12
<PAGE> 14
LIQUIDITY AND CAPITAL RESOURCES
The Company's business is labor intensive. Consequently, it has
substantial needs for cash throughout its fiscal year. During the first quarter
of fiscal 2000, the Company's cash requirements were heightened by its increased
payroll and by its acquisition program and the need to support the activities
resulting from those acquisitions as well as those completed after first quarter
of fiscal 1999. Operating activities used net cash of approximately $0.3 million
and financing activities generated net cash of $7.1 million during the quarter
ended June 30, 1999.
During the first quarter of fiscal 2000, principal uses of funds, in
addition to working capital requirements, included expenditures associated with
the Company's acquisition program. These included $6.1 million in gross
acquisitions ($5.3 million, net of cash received) of service contracts, related
goodwill, non-compete arrangements and net working capital items as part of a
stock acquisition and $0.3 million for related property and equipment.
The Company had capital expenditures during the balance of fiscal 2000
(exclusive of the $6.5 million gross cash outlay for the two acquisitions
completed during the first quarter of fiscal 2000) of approximately $.4 million,
primarily related to leasehold improvements, computer software and systems and
equipment used in operations.
During fiscal 2000, the Company had a revolving credit facility
providing maximum borrowing availability of $30 million, subject to certain
borrowing base limitations. That facility was secured by substantially all of
the Company's assets. The interest rate on that credit facility was based on
either LIBOR or the bank's base lending rate, plus a margin depending on the
Company's ratio of its debt to tangible net worth. Borrowings under that credit
facility bore interest at a rate between LIBOR plus 1.5% and a prime rate plus
3.0%. The credit facility contained customary restrictions and covenants, which
limited the Company's ability to incur additional indebtedness and pay
dividends, required the Company to maintain prescribed debt-to-equity and fixed
charge coverage ratios, minimum net worth levels, and to satisfy certain other
financial covenants.
As a result of the net loss incurred in fiscal 1999, the Company was
not in compliance with several covenants under its credit facility. Those
covenants included maintenance of a specified minimum shareholders' equity, debt
service coverage ratio, and a specified minimum earnings before interest, taxes,
depreciation and amortization level. The lender granted the Company waivers for
all non-compliant loan covenants as of March 31, 1999, in addition to granting
waivers for the non-compliance with loan covenants during the first and second
quarters of fiscal 2000. Since the Company expected to be in violation of these
loan covenants through the remainder of fiscal 2000, the bank extended the
waivers until March 31, 2000. On August 27, 1999, the lender agreed to modify
the credit facility. The modifications included a six-month extension to the
maturity date of the facility to April 1, 2000, a $5,000,000 reduction in the
maximum available borrowings under the credit facility to $25,000,000, and a
$3,000,000 reduction in the annual capital asset acquisition allowance to
$1,000,000. As of April 30, 2000 the outstanding obligation under this facility
was $23.9 million. In April 2000, management secured, from the Company's
lenders, certain amendments to its credit facility. Among them are an extension
of the term to April 1, 2001 with a reduction of the interest rate to be charged
on borrowings to prime rate plus 0.75%, if the loan is repaid by December 31,
2000. The amended agreement also includes an increase to the percentage advance
rate of eligible receivables as well as more relaxed financial covenants. The
financial covenants include certain net worth covenants and a minimum debt
coverage ratio, and standard financial reporting requirements. As of April 30,
2000 the Company was in compliance with all covenants.
In consideration for the amendment and extension of the credit facility
the Company granted the banks warrants for the purchase of 300,000 shares of the
Company's Common Stock at an exercise price of $1.41, which the Board determined
was the fair market value of the Company's Common Stock as of the date of the
grant. The warrants expire on March 31, 2007. As part of the transaction, the
banks were granted a "put" option commencing April 1, 2001 which would, if
exercised, require the Company to purchase the warrants at $1.00 per warrant and
the Company retained a "call" option commencing immediately at an initial price
of $4.50 per warrant. The call price increases by $1.00 per warrant per year
commencing April 1, 2001.
The Company anticipates negative cash flow from operations for the
first half of fiscal 2001 but believes that the Company will generate positive
cash flow from operations in the second half of fiscal 2001 when the benefits of
improved margins and expense reductions are expected to be realized. Although
there can be no assurance, the Company believes that amounts available under its
credit facility will be sufficient to meet its cash requirements until
operations begin to generate positive cash flow. The entire credit facility will
become due and payable on April 1, 2001. The Company will seek to refinance
13
<PAGE> 15
its outstanding borrowings under the credit facility on or prior to December 31,
2000, but there can be no assurance as to the Company's ability to obtain a
replacement credit facility or otherwise refinance its debt.
As previously discussed, the Company's lack of external financing
sources will limit its ability to grow by acquisitions and rely on net cash
generated by operations to pay expenses and existing liabilities. Such
limitations may have an adverse impact on the Company's liquidity and results of
operations.
YEAR 2000 BUSINESS MATTERS
STATE OF READINESS
The information set forth under this caption is hereby designated to be
a "Year 2000 Readiness Disclosure" under The Year 2000 Information Readiness
Disclosure Act (The "Year 2000 Act"), Public Law 105-271, and the statements
below and the Company, as the maker thereof, shall be entitled to the
protections provided by The Year 2000 Act.
At the end of the twentieth century, there was a worldwide concern
regarding the use by many existing computer programs of only the last two digits
rather than four to identify the year in the date field. If not corrected, many
computer applications may have failed to treat year dates intended to represent
years in the twenty-first century as such but instead treat them as still in the
twentieth century, potentially resulting in system failure or miscalculations,
disruption of business operations, including among other things, an inability to
initiate, receive, process, invoice or otherwise complete normal business
activities. These Year 2000 issues affected virtually all companies and
organizations.
The Company completed its assessment of its most significant systems
and updated them to be Year 2000 compliant.
HISTORICAL AND REMAINING COSTS TO BECOME YEAR 2000 COMPLIANT
As of March 31, 1999, the Company had expended approximately $1.2
million on its Year 2000 compliance efforts. The Company spent an additional
$0.1 million after March 31, 1999 to complete its Year 2000 preparations.
STATUS OF YEAR 2000 ISSUE
The Company's significant operations are based on manual labor, such as
airline baggage handling and security services and rely heavily on third parties
like airlines, air traffic control systems and airport authorities. As of April
30, 2000 the Company has not encountered any Year 2000 failure problems and is
unable to determine if there will be any failure problems in the future. The
Company has not adopted a formal contingency plan and is unable to determine if
any failure will occur and whether it will have a material impact on the
Company's results of operations, liquidity and financial condition.
NEW ACCOUNTING PRONOUNCEMENTS
In June 1998, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standard No. 133, (SFAS No. 133) "Accounting
for Derivative Instruments and Hedging Activities" (as amended by SFAS No. 137).
SFAS No. 133 must be applied in the first quarter of fiscal years that begin
after June 15, 2000 (the first quarter of fiscal 2002 for the Company) and in
general requires that entities recognize all derivative financial instruments as
assets and liabilities, measured at fair value, and include in earnings the
changes in the fair value of such assets and liabilities in either operations or
comprehensive income (loss). The Company does not presently utilize derivative
instruments, either for hedging or other purposes, and therefore it is expected
that the adoption of the requirements of SFAS No. 133 will not have a material
affect on its financial statements.
FORWARD LOOKING STATEMENTS
Forward-looking statements in this Form 10-Q including, without
limitation, statements relating to the Company's plans, strategies, objectives,
expectations, intentions, and adequacy of resources, are made pursuant to the
safe harbor provisions of the Private Securities Litigation Reform Act of 1995.
These forward-looking statements involve known and unknown risks, uncertainties,
and other factors that may cause the actual results, performance, or
achievements of the company to be materially different from any future results,
performance or achievements expressed or implied by such forward-looking
statements.
14
<PAGE> 16
Statements in this quarterly report, including the notes to the consolidated
financial statements, describe factors, among others, that could contribute to
or cause such differences. These factors include, among others, the Company's
ability to pay off or refinance its credit facility, unanticipated losses of
service contracts, economic and labor conditions in the aviation industry and
commercial security industry, the transition to new management, and negative
publicity regarding the airline security and services and commercial staffing
services industries. The Company undertakes no obligation to publicly update or
revise any forward-looking statements, whether as a result of new information,
future events or otherwise.
15
<PAGE> 17
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of business, the Company is subject to foreign
currency and interest rate risks. The risks primarily relate to the sale of the
Company's services to foreign customers through its foreign subsidiaries and
changes in interest rates on the Company's short-term financing.
Foreign Currency Risk. A portion of the Company's revenues (3.2%
through June 30, 1999) are received, and operating costs are incurred, in
foreign currencies. The denomination of foreign subsidiaries' account balances
in their local currency exposes the Company to certain foreign exchange rate
risks which the Company believes are not significant. The Company does not
engage in hedging transactions to reduce exposure to fluctuations in foreign
currency exchange rates.
Interest Rate Risk. The Company maintains a revolving line of credit
which subjects the Company to the risk of loss associated with movements in
market interest rates. This line of credit had a balance at June 30, 1999 of
$18.0 million which was at a variable rate of interest based on prime. Since
revolving payments and borrowing are made on this line of credit on a daily
basis subject to a market variable rate of interest, the June 30, 1999 balance
of this debt is considered to be at fair value. Based upon the Company's current
outstanding balance on its variable rate credit facility, a hypothetical
increase of approximately 100 basis points in the prime rate of interest would
adversely affect future earnings and cash flows by approximately $181,000 on an
annual basis. The Company does not use interest rate derivative instruments to
manage exposure to interest rate changes.
16
<PAGE> 18
INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
PART II - OTHER INFORMATION AND SIGNATURES
ITEM 6 - EXHIBITS AND REPORTS ON FORM 8 - K
----------------------------------
(a) Exhibits:
EXHIBIT NUMBER DESCRIPTION
-------------- -----------
27 Financial Data Schedule (For SEC Filing Purposes Only)
(b) Reports on Form 8 - K
No reports on Form 8-K have been filed during the quarter for which this
report is filed.
17
<PAGE> 19
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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.
MAY 9, 2000 INTERNATIONAL TOTAL SERVICES, INC.
- -----------
By: /S/ MARK D. THOMPSON
---------------------------------------------
Mark D. Thompson
President and Interim Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this report has been signed below by the following persons on behalf of the
registrant and in the capacities and on the dates indicated.
MAY 9, 2000 /S/ MARK D. THOMPSON
- ----------- --------------------
Mark D. Thompson
President and Interim Chief Executive Officer
(Principal Executive Officer)
MAY 9, 2000 /S/ RONALD P. KOEGLER
- ----------- ---------------------
Ronald P. Koegler
Executive Vice President and Controller
(Principal Accounting Officer)
MAY 9, 2000 /S/ MICHAEL F. SOSH
- ----------- -------------------
Michael F. Sosh
Executive Vice President and Treasurer
(Principal Financial Officer)
18
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<FISCAL-YEAR-END> MAR-31-2000
<PERIOD-START> APR-01-1999
<PERIOD-END> JUN-30-1999
<CASH> 1,371,000
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