<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, 2000
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 [X] No [_]
As of August 9, 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
-----
<TABLE>
<CAPTION>
Page No.
--------
<S> <C>
PART I FINANCIAL INFORMATION
ITEM 1 Financial Statements
Consolidated Balance Sheets
as of June 30, 2000 and March 31, 2000......................................... 2
Consolidated Statements of Operations and Comprehensive Loss
for the Three Months Ended June 30, 2000 and 1999.............................. 3
Consolidated Statements of Cash Flows
for the Three Months Ended June 30, 2000 and 1999.............................. 4
Notes to Consolidated Financial Statements.......................................... 5
ITEM 2 Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................................... 10
ITEM 3 Quantitative and Qualitative Disclosures About Market Risk.................................. 14
PART II OTHER INFORMATION
ITEM 6 Exhibits and Reports on Form 8-K............................................................ 15
</TABLE>
1
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INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
JUNE 30, 2000 MARCH 31, 2000
------------- --------------
(UNAUDITED)
ASSETS
<S> <C> <C>
CURRENT ASSETS
Cash and cash equivalents................................................... $ 814 $ 792
Accounts receivable - net of allowance for doubtful
accounts of $288 and $474, respectively................................. 29,973 27,675
Federal income tax refund receivable........................................ -- 3,020
Deferred taxes.............................................................. 640 640
Uniforms, net............................................................... 1,043 1,035
Other current assets........................................................ 1,427 2,018
--------- ---------
Total current assets.................................................... 33,897 35,180
PROPERTY AND EQUIPMENT
Security equipment.......................................................... 3,748 3,799
Service equipment........................................................... 2,212 2,206
Computer equipment.......................................................... 3,416 3,256
Furniture and fixtures...................................................... 1,106 1,100
Autos ................................................................... 907 936
Leasehold improvements...................................................... 70 70
--------- ---------
11,459 11,367
Less accumulated depreciation and amortization.............................. 6,773 6,470
--------- ---------
Property and equipment, net................................................. 4,686 4,897
INTANGIBLES, LESS ACCUMULATED AMORTIZATION OF
$6,854 and $6,254, respectively ............................................ 30,344 31,030
SECURITY DEPOSITS AND OTHER...................................................... 204 105
--------- ---------
TOTAL ASSETS............................................................ $ 69,131 $ 71,212
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES
Trade accounts payable...................................................... $ 4,704 $ 5,466
Accrued payroll and employee benefits....................................... 15,772 16,314
Other accrued expenses...................................................... 8,014 8,556
Current portion of Revolving Credit Facility................................ 23,320 --
Income taxes payable........................................................ 342 337
--------- ---------
Total current liabilities............................................... 52,152 30,673
DEFERRED TAXES................................................................... 640 640
REVOLVING CREDIT FACILITY........................................................ -- 22,103
WARRANTS......................................................................... 175 --
SHAREHOLDERS' EQUITY
Common shares, without par value, stated at $.01 per share -
authorized 20,000 shares, issued and outstanding
6,834 shares at June 30, 2000 and March 31, 2000....................... 68 68
Additional paid-in capital.................................................. 31,263 31,263
Accumulated other comprehensive loss........................................ (683) (470)
Retained deficit............................................................ (14,484) (13,065)
--------- ---------
16,164 17,796
--------- ---------
TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY.............................. $ 69,131 $ 71,212
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
2
<PAGE> 4
INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA)
(UNAUDITED)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30,
---------------------------
2000 1999
----------------------- ------------------------
<S> <C> <C> <C> <C>
Net operating revenues.................................... $ 51,136 100.0% $ 55,805 100.0%
Cost of revenues.......................................... 45,730 89.4% 50,442 90.4%
---------- ------ ---------- ------
GROSS MARGIN................................ 5,406 10.6% 5,363 9.6%
Selling, general and administrative expenses.............. 5,516 10.8% 5,905 10.6%
Amortization expense...................................... 600 1.2% 772 1.4%
---------- ------ ---------- ------
OPERATING LOSS.............................. (710) (1.4%) (1,314) (2.4%)
Interest expense-net..................................... 661 1.3% 320 0.5%
---------- ------ ---------- ------
LOSS BEFORE INCOME TAXES.................... (1,371) (2.7%) (1,634) (2.9%)
Provision for income taxes................................ 48 0.1% -- --
NET LOSS.................................... $ (1,419) (2.8%) $ (1,634) (2.9%)
========== ====== ========== ======
Other comprehensive loss
Foreign currency translation adjustment..... (213) (130)
---------- ----------
COMPREHENSIVE LOSS ......................... $ (1,632) $ (1,764)
========== =========
Net loss per share:
Basic ............................................ $ (0.21) $ (0.25)
========== =========
Diluted ............................................ $ (0.21) $ (0.25)
========== =========
Weighted average number of shares outstanding: (000's)
Basic ............................................ 6,747 6,662
========== =========
Diluted ............................................ 6,747 6,662
========== =========
</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,
----------------------------
2000 1999
--------- ---------
OPERATING ACTIVITIES:
<S> <C> <C>
Net loss ................................................................... $ (1,419) $ (1,634)
Adjustments to reconcile net loss to net cash used for operating activities:
Depreciation............................................................ 335 421
Amortization............................................................ 600 772
Loss on disposal of fixed assets........................................ (6) 24
Changes in working capital:
Accounts receivable................................................ (2,298) (80)
Other assets....................................................... 3,603 (13)
Trade accounts payable............................................. (762) (608)
Accrued expenses and other......................................... (1,004) 785
--------- ---------
Net cash used for operating activities........................ (951) (333)
INVESTING ACTIVITIES:
Additions to property and equipment......................................... (172) (470)
Proceeds received from sale of equipment.................................... 15 127
Property and equipment of acquired businesses............................... - (302)
Working capital acquired, net of cash ...................................... - (1,470)
Intangibles from acquisitions of businesses................................. - (3,843)
--------- ---------
Net cash used for investing activities........................ (157) (5,958)
FINANCING ACTIVITIES:
Net borrowings on note payable to bank...................................... 1,217 7,120
--------- ---------
Net cash provided by financing activities..................... 1,217 7,120
Effect of exchange rates on cash................................................. (87) (130)
--------- ---------
Net increase (decrease) in cash and cash equivalents........................ 22 699
Cash and cash equivalents, at beginning of period................................ 792 672
--------- ---------
Cash and cash equivalents, at end of period...................................... $ 814 $ 1,371
========= =========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for:
Interest ................................................................... $ 582 $ 301
========= =========
Income taxes................................................................ $ 43 $ 64
========= =========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
4
<PAGE> 6
INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
THREE MONTHS ENDED JUNE 30, 2000
(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
accounting principles generally accepted in the United States 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, 2000 and the results of its
operations and cash flows for the three month periods ended June 30, 2000 and
1999 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, 2000.
The preparation of financial statements and the accompanying notes
thereto, in conformity with accounting principles generally accepted in the
United States, 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, 2000 are not necessarily indicative of the results that may be
expected for the year ended March 31, 2001.
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 2001 is the year ended March 31, 2001) 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.
Commencing in the first quarter of fiscal 2000, as a result of an
acquisition, see note E, revenues generated from the sales of security products
were recognized on the percentage-of-completion basis. This was the policy of
the newly acquired company which was involved in numerous long term installation
contracts. The percentage-of-completion method is based on estimates by the
project manager. Commencing in fiscal 2001, the Company outsources the
distribution and installation of security products.
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 contract settlements may result in
revisions to costs and income and are recognized in the period in which the
revisions are determined.
5
<PAGE> 7
CHANGE IN ESTIMATE - AMORTIZATION OF UNIFORMS IN SERVICE
Effective April 1, 2000, the Company changed the estimated useful life
of uniforms in service from 18 months to 15 months. The change was based on an
analysis of the current usage and life of uniforms after placed in service. The
estimated impact of this change on the net loss for the first quarter of fiscal
2001 is not significant.
NET LOSS PER SHARE
Net loss per share - basic is based on the weighted average number of
shares outstanding during each period.
Net 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 loss per share,
no adjustments have been made to the reported amounts of net loss.
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 2000 and fiscal 1999, and has negative tangible net worth.
In addition, operations generated negative cash flow for fiscal 2000 and the
revolving credit facility is due in less than one year. These factors raise
substantial doubt about the Company's ability to continue as a going concern.
The Company's strategy is to use its established business base as a
platform for expanding services and currently will not pursue any further
acquisitions 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.
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 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 - 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 pre-board screening, skycap, baggage
handling, aircraft appearance, 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 Distribution segment offers a
line of security products including airport and commercial security 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 Staffing
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
Security Staffing Services is treated as a separate business due to its focus on
security services and its wide range of clients. Security Products Distribution
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).
6
<PAGE> 8
The following table provides selected information about the Company's
three business units. The Company makes operating decisions based on segment
revenues, costs of operating revenues, gross margins, and net income. 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, 2000 SERVICES SERVICES DISTRIBUTION TOTALS
---------------------------------------- -------- -------- ------------ ------
<S> <C> <C> <C> <C>
Net operating revenues.................................... $ 39,042 $ 10,749 $1,345 $51,136
Cost of revenues.......................................... $ 35,724 $ 8,608 $1,398 $45,730
Gross margin ............................................ $ 3,318 $ 2,141 $ (53) $ 5,406
Net loss ............................................ $ (868) $ (371) $ (180) $(1,419)
FOR THE THREE MONTHS ENDED JUNE 30, 1999
----------------------------------------
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)
</TABLE>
<TABLE>
<CAPTION>
DISCLOSURE OF GEOGRAPHIC INFORMATION
------------------------------------
NET OPERATING REVENUES FOR THE THREE MONTHS ENDED JUNE 30, 2000 AND ASSETS AT JUNE 30, 2000 REVENUES ASSETS
------------------------------------------------------------------------------------------- -------- ------
<S> <C> <C>
United States ................................................................... $50,315 $68,595
United Kingdom................................................................... 821 536
Total ................................................................... $51,136 $69,131
NET OPERATING REVENUES FOR THE THREE MONTHS ENDED JUNE 30, 1999 AND ASSETS AT MARCH 31, 2000 REVENUES ASSETS
-------------------------------------------------------------------------------------------- -------- ------
United States ................................................................... $54,009 $70,450
Other Countries.................................................................. 1,796 762
Total ................................................................... $55,805 $71,212
</TABLE>
DISCLOSURE ABOUT MAJOR CUSTOMERS
During the three months ended June 30, 2000 and 1999, revenues from one
major customer amounted to $10.4 million and $13.5 million or 20.3% and 24.2% of
net operating revenues, respectively. Services provided to another major
customer generated revenues for the Company of $5.9 million or 11.5% of net
operating revenues for the quarter ended June 30, 2000 and 12.2% of total
revenues during the same period in the prior year.
Five airline customers, including the two noted above, accounted for
approximately 44.0% and 47.4% of net operating revenue for the quarters ended
June 30, 2000 and 1999, respectively, and accounted for 35.9% and 34.5% of net
accounts receivable at June 30, 2000 and March 31, 2000 respectively.
NOTE D-FINANCING ARRANGEMENTS
----------------------
In April 2000 management secured, from its lenders, certain amendments
to its existing $25.0 million credit facility. Among them were 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
7
<PAGE> 9
covenants and a minimum debt coverage ratio and standard financial reporting
requirements. As of August 9, 2000, the Company was in compliance with all
covenants and the outstanding obligations under this facility were $23.3
million.
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.
In the first quarter of fiscal 2001, the Company recorded a warrant
liability amounting to $175,000 related to the put option associated with
warrants granted to the Bank. Interest expense was charged for the accretion of
the put option feature from the grant date to the end of the first quarter of
fiscal 2001. The Company will record an additional $125,000 over the balance of
fiscal 2001 related to the contingent put option liability.
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. The Company ceased operations in Germany during fiscal 2000.
NOTE E-DISPOSITION
In the first quarter of fiscal 2000, the Company acquired the
outstanding stock of Metroplex Control Systems, Inc. ("Metroplex") headquartered
in Dallas, Texas for approximately $5.0 million in cash. The purchase price
allocation resulted in goodwill of approximately $2.5 million which was charged
to operations in fiscal 2000 due to the subsequent disposition of Metroplex. In
March 2000, the Company completed the disposition of Metroplex in conjunction
with the Company's strategy to focus on its core businesses and outsource the
security products distribution and installation business. The Company reported a
$0.8 million loss on the sale in the fourth quarter of fiscal 2000. During the
first quarter of fiscal 2000, Metroplex generated net operating revenues of $0.6
million and net income of approximately $11,000.
NOTE F-CAPITAL STOCK
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 the Company to pay Weitzel $300,000 on
November 1, 1999 and $200,000 on January 3, 2000, and provide 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 which began February 1, 2000. 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 August 9, 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
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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.
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 Common Stock on that market would be halted
pending the receipt and review of additional information in accordance with
Marketplace Rules of the Nasdaq Stock Market. The primary cause for the halt was
the Company's failure to timely file the Company's Form 10-K for the 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
Common Stock was delisted from the Nasdaq Stock Market. On October 26, 1999
price quotes for the Company's Common Stock began appearing in the Electronic
Quotation System of the National Quotation Bureau LLC. Although the Company is
now current for all Securities and Exchange Commission filings, as of August 4,
2000 the Company does not meet the requirements necessary to regain listing on
the Nasdaq Stock Market.
NOTE G-SUBSEQUENT EVENT
In July 2000, the Company received notice that its aviation service
contracts at the Dallas Fort Worth airport ("DFW") would be terminated effective
August 2000. In fiscal 2000, the DFW location generated net revenues of $7.4
million and gross margin of $1.0 million.
9
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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, 2000
OVERVIEW
The Company is a leading provider of aviation contract support services
and is also a significant provider of commercial security staffing services. The
Company provides services to customers in more than 300 cities in the United
States and United Kingdom. Aviation support services offered by the Company
include pre-board screening, 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.
Operations generated negative cash flow for fiscal 2000 and for the
first quarter of fiscal 2001. Although the Company obtained a one year extension
of its credit facility through April 2001 (See Note D of "Notes to the
Consolidated Financial Statements") the negative cash flow generated during
fiscal 2000 and forecast to continue at least through the first half of fiscal
2001 are factors that raise doubts about the Company's ability to continue as a
going concern. The audit report of Arthur Andersen LLP for fiscal 2000 contains
an explanatory paragraph with respect to this matter.
RESULTS OF OPERATIONS
The following are the Net Operating Revenues, Cost of Revenues and
Gross Margin for the first quarter of fiscal 2001 as compared to the same period
in fiscal 2000, by segment (in thousands).
<TABLE>
<CAPTION>
For the Three Months Ended June 30,
2000 % of Rev 1999 % of Rev Inc/(Dec) % Inc/(Dec)
-------------------- -------------------- ----------------------
<S> <C> <C> <C> <C> <C> <C>
Net Revenues:
Aviation $ 39,042 76.4% $ 42,000 75.3% $(2,958) -7.0%
Commercial Security 10,749 21.0% 12,348 22.1% (1,599) -13.0%
Security Products 1,345 2.6% 1,457 2.6% (112) -7.7%
-------------------- -------------------- ----------------------
51,136 100.0% 55,805 100.0% (4,669) -8.4%
-------------------- -------------------- ----------------------
Cost of Revenues:
Aviation 35,724 91.5% 38,925 92.7% (3,201) -8.2%
Commercial Security 8,608 80.1% 10,337 83.7% (1,729) -16.7%
Security Products 1,398 103.9% 1,180 81.0% 218 18.5%
-------------------- -------------------- ----------------------
45,730 89.4% 50,442 90.4% (4,712) -9.3%
-------------------- -------------------- ----------------------
Gross Margin:
Aviation 3,318 8.5% 3,075 7.3% 243 7.9%
Commercial Security 2,141 19.9% 2,011 16.3% 130 6.5%
Security Products (53) -3.9% 277 19.0% (330) -119.1%
-------------------- -------------------- ----------------------
$ 5,406 10.6% $ 5,363 9.6% $ 43 0.8%
==================== ==================== ======================
</TABLE>
NET OPERATING REVENUES. Net operating revenues in the first quarter of
fiscal 2001 decreased by $4.7 million, or 8.4%, as compared with the first
quarter of fiscal 2000. The decrease is attributable to the loss of aviation and
commercial security staffing contracts. The decrease in Security Products
10
<PAGE> 12
Distribution net revenues was primarily related to the Company's decision to
phase out of the direct sale and installation of security systems and to
outsource the implementation and service functions of this business segment
during fiscal 2001. The decrease in aviation revenues relates to lost service
contracts at several sites. The contracts were generally lost in competitive
bidding processes. This decline may continue as management focuses on higher
margin business and intends to terminate contracts that do not meet profit
criteria. The initial impact of this strategy is reflected in the improved
margin in aviation services which increased $0.2 million despite a $3.0
million decrease in net revenue. Gross margin as a percent of revenue increased
from 7.3% in the first quarter of fiscal 2000 to 8.5% in the first quarter of
fiscal 2001. Although the Company intends to retain profitable contracts there
can be no assurance that the Company will be successful (See Note G of "Notes to
the Consolidated Financial Statements"). The decrease in Commercial Security
Staffing Services net revenues was related to the Company's strategy, commencing
in the third quarter of fiscal 2000, to eliminate contracts that did not meet
profit criteria. Although Commercial Security Staffing Services net revenues
decreased by $1.6 million, or 13.0%, gross margin actually increased
approximately $0.1 million from 16.3% of revenue to 19.9% of revenue.
COST OF REVENUES. Cost of revenues includes primarily the cost of field
personnel (wages, payroll taxes, vacation, workers' compensation and uniforms)
and related equipment costs. In the first quarter of fiscal 2001 total cost of
revenues decreased $4.7 million, or 9.3%, as compared to the same period in
fiscal 2000. Most of this decrease was due to costs associated with the service
contracts lost or discontinued. However, cost of revenues as a percent of net
operating revenues for Commercial Security Staffing Services and Aviation
Staffing Services decreased from 83.1% and 92.7% in the first quarter of fiscal
2000 to 80.1% and 91.5%, respectively, in the first quarter of fiscal 2001. The
decrease was primarily as a result of focusing on higher margin contracts and
eliminating lower margin contracts. The cost of revenues for Security Products
distribution increased $0.2 million primarily due to the Company's strategy
related to security products as previously discussed. See "Net Operating
Revenues". The Company is continuing efforts to eliminate low margin contracts
and improve controls over labor costs to improve margins in the Aviation
Staffing Services and Commercial Security Staffing Services segments. 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. The low
unemployment rates have resulted in higher overtime pay than in prior years
which has been incurred in order to provide the services required per the
contracts with the customers. These factors have resulted in downward pressure
on the Company's gross margins.
SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. ("S G & A"). Selling,
general and administrative expenses include corporate governance costs, support
services for field personnel, bad debt expense and professional services (legal,
audit and consulting). The following table breaks down S,G & A by business
segment and corporate administrative costs (in thousands):
Three Months ended June 30,
---------------------------------
2000 1999
--------------- ---------------
Aviation Staffing Services $ 1,633 $ 1,806
Commercial Security Staffing Services 1,408 1,472
Security Products Distribution 21 279
Corporate Administration 2,454 2,348
--------------- ---------------
$ 5,516 $ 5,905
=============== ===============
Total S, G & A expenses decreased $0.4 million, or 6.6%, in the first
quarter of fiscal 2001 as compared to the same period in fiscal 2000. S, G & A
expenses were 10.8% and 10.6% of net operating revenues for the first quarter of
fiscal 2001 and 2000, respectively. The following discusses the change in S, G &
A expenses by business segment for the first quarter of fiscal 2001 as compared
to the same period in fiscal 2000.
Aviation Staffing Services S, G & A expenses decreased $0.2 million for
the first quarter of fiscal 2001 as compared to the same period in fiscal 2000.
The decrease was due to aviation contracts that have been lost combined with
expense savings generated from the reorganization of aviation administration
which reduced administrative costs, primarily salary and payroll taxes and
benefits.
Commercial Security Staffing Services S, G & A expenses decreased
approximately $64,000 in the first quarter of fiscal 2001 as compared to the
same period in fiscal 2000, primarily related to salary and payroll taxes and
benefits. The Company has completed the reorganization of the Commercial
Security administrative support structure.
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Security Products Distribution S, G & A decreased $0.3 million in the
first quarter of fiscal 2001 as compared to the same period in fiscal 2000. The
decrease is due to the Company's intention to outsource the implementation and
service functions of this business segment during fiscal 2001. The S, G & A
associated with the Security Products Distribution business segment should be
minimal during fiscal 2001 as the Company continues to implement its strategy.
Corporate Administration S, G & A increased $0.1 million in the first
quarter of fiscal 2001 as compared to the same period in fiscal 2000. The slight
increase in Corporate Administrative costs is not related to any single category
of expense. However, the Company's efforts to reduce these costs should result
in an overall reduction of annual Corporate Administrative costs in fiscal 2001
as compared to fiscal 2000.
AMORTIZATION EXPENSE. Contract and goodwill amortization expense
decreased $0.2 million, or 22.3%, to $0.6 million in the first quarter of fiscal
2001 from $0.8 million in the first quarter of fiscal 2000. The decrease relates
to a decrease in goodwill amortization due to a disposition and its related
goodwill in March 2000. (See Note E of "Notes to the Consolidated Financial
Statements")
INTEREST EXPENSE. In the first quarter of fiscal 2001, interest expense
increased to $0.7 million from $0.3 million in the first quarter of fiscal 2000.
Average outstanding debt increased from $18.2 million during the first quarter
of fiscal 2000 to $23.1 million during the first quarter of fiscal 2001. This
increase in debt was primarily incurred during fiscal 2000 to fund the negative
cash flow from operations. In addition, the Company's effective borrowing rate
increased from 7.57% to 9.94% for the first quarter of fiscal 2000 as compared
to the first quarter of fiscal 2001. The increase in the effective borrowing
rate was due to the increase in the prime rate of interest. Interest expense in
the first quarter of fiscal 2001 also includes a $75,000 charge related to the
put option associated with the warrants to purchase stock granted to the Bank.
(See Note D of "Notes to the Consolidated Financial Statements")
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 2001 or fiscal 2000. The tax provision
for the first quarter of fiscal 2001 relates to United Kingdom tax obligations
in addition to certain domestic state and local taxes.
LIQUIDITY AND CAPITAL RESOURCES
The Company's business is labor intensive. Consequently, it has
substantial needs for cash throughout its fiscal year. Operating activities used
net cash of approximately $1.0 million and financing activities generated net
cash of $1.2 million during the quarter ended June 30, 2000.
During the first quarter of fiscal 2001, principal uses of funds, in
addition to working capital requirements, included expenditures associated with
capital expenditures. The Company anticipates capital expenditures during the
balance of fiscal 2001 of approximately $0.5 million, primarily related to
leasehold improvements, computer software and systems and equipment used in
operations.
In April 2000, management secured, from the Company's lenders, certain
amendments to its existing $25.0 million 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 require-
ments. As of August 9, 2000 the Company was in compliance with all covenants and
the outstanding obligation under this facility was $23.3 million.
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 at least
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 programs to improve margins and reduce expenses are expected to
generate positive cash flow.
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<PAGE> 14
Although there can be no assurance, the Company believes that amounts
available under its credit facility, combined with the receipt of an income tax
refund of $3.0 million in May 2000, will be sufficient to meet its cash
requirements, including monthly debt service, until operations begin to generate
positive cash flow. The Company will seek to refinance 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 or obtain equity financing.
The Company's lack of external financing sources will limit its ability
to grow and cause it to 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.
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. 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. Readers are referred to the Company's
Annual Report on Form 10K as filed with the Securities and Exchange Commission
which identifies certain risk factors.
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<PAGE> 15
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
In the ordinary course of business, the Company is subject to foreign
currency, interest rate and labor market risks. The risks primarily relate to
the sale of the Company's services to foreign customers through its foreign
subsidiaries, changes in interest rates on the Company's short-term financing
and the availability and cost of labor.
Foreign Currency Risk. A portion of the Company's revenues, (1.6%
through June 30, 2000), 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, 2000 of
$23.3 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, 2000 balance
of this debt is considered to be at fair value. Based upon the Company's current
outstanding balance on its revolving line of credit, a hypothetical increase of
approximately 100 basis points in the prime rate of interest would adversely
affect future earnings and cash flows by approximately $233,000 on an annual
basis. The Company does not use interest rate derivative instruments to manage
exposure to interest rate changes.
Labor Market Risk. The Company's profitability can be significantly
impacted by the availability of qualified personnel and the cost of labor.
Direct labor costs comprise approximately 81% of the Company's net operating
revenues. Changes in the labor market may increase direct labor costs through
higher wages and increased amounts of overtime that can not be recovered from
customers. The Company anticipates managing such risk by entering contracts that
permit increases based on the labor market and attempt to reduce turnover to
reduce recruiting and training costs to mitigate increases in wages. However,
there can be no assurance that the Company will be able to obtain increased
billing rates to offset increases in labor costs or to successfully reduce
employee turnover.
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<PAGE> 16
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.
15
<PAGE> 17
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.
August 11, 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.
August 11, 2000 /s/ Mark D. Thompson
--------------- ------------------------------
Mark D. Thompson
President and Interim Chief
Executive Officer (Principal
Executive Officer)
August 11, 2000 /s/ Ronald P. Koegler
--------------- ------------------------------
Ronald P. Koegler
Executive Vice President and
Controller (Principal
Accounting Officer)
August 11, 2000 /s/ Michael F. Sosh
--------------- ------------------------------
Michael F. Sosh
Executive Vice President Chief
Financial Officer
Treasurer (Principal Financial
Officer)
16
