-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, Gl5SOeboe0rqf3toFmtUSBZUDrJANUDtWfzUg/Ov5Wy6K8GDWOCqrvoVr5EnDaoi v4FR1t4xvIY2zcsTKplb5g== 0000950152-00-003664.txt : 20000505 0000950152-00-003664.hdr.sgml : 20000505 ACCESSION NUMBER: 0000950152-00-003664 CONFORMED SUBMISSION TYPE: 10-K405 PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 19990331 FILED AS OF DATE: 20000504 FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERNATIONAL TOTAL SERVICES INC CENTRAL INDEX KEY: 0001040993 STANDARD INDUSTRIAL CLASSIFICATION: AIRPORTS, FLYING FIELDS & AIRPORT TERMINAL SERVICES [4581] IRS NUMBER: 341264201 STATE OF INCORPORATION: OH FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K405 SEC ACT: SEC FILE NUMBER: 333-29463 FILM NUMBER: 619581 BUSINESS ADDRESS: STREET 1: CROWN CENTRE STREET 2: 5005 ROCKSIDE RD CITY: CLEVELAND STATE: OH ZIP: 44131 BUSINESS PHONE: 2166424522 MAIL ADDRESS: STREET 1: CROWN CENTRE STREET 2: 5005 ROCKSIDE RD CITY: INDEPENDENCE STATE: OH ZIP: 44131 10-K405 1 INTERNATIONAL TOTAL SERVICES, INC. 10-K405 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-K (Mark One) [X] Annual Report Pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the fiscal year ended March 31, 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 Charter) OHIO 34-1264201 ---- ---------- (State of Incorporation) (I.R.S. Employer Identification No.) 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 SECURITIES REGISTERED PURSUANT TO SECTION 12(b) OF THE ACT: TITLE OF EACH CLASS NAME OF EACH EXCHANGE ON WHICH REGISTERED ------------------- ----------------------------------------- None N/A SECURITIES REGISTERED PURSUANT TO SECTION 12(g) OF THE ACT: TITLE OF EACH CLASS ------------------- Common Shares, without par value Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [ ] No [X] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X] The aggregate market value of the common shares held by non-affiliates of the registrant, based upon the closing market price on April 7, 2000, was approximately $5,491,213, (based on the closing price of the registrant's Common Stock on the Electronic Quotation System of the National Quotation Bureau LLC). As of April 7, 2000, the registrant had 6,837,494 shares of Common Stock issued and outstanding. 2 TABLE OF CONTENTS
PAGE ---- PART I - ------ Item 1. Business......................................................................................... 1 Item 2. Properties....................................................................................... 8 Item 3. Legal Proceedings................................................................................ 8 Item 4. Submission of Matters to a Vote of Security Holders.............................................. 9 Executive Officers............................................................................... 9 PART II - ------- Item 5. Market for Registrant's Common Shares and Related Shareholder Matters............................ 11 Item 6. Selected Financial Data.......................................................................... 12 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations........................................................................ 12 Item 7A. Quantitative and Qualitative Disclosures about Market Risk....................................... 19 Item 8. Consolidated Financial Statements and Supplementary Data......................................... 19 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure......................................................................... 20 PART III - -------- Item 10. Directors and Executive Officers of the Registrant............................................... 20 Item 11. Executive Compensation........................................................................... 22 Item 12. Security Ownership of Certain Beneficial Owners and Management................................... 26 Item 13. Certain Relationships and Related Transactions................................................... 28 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K................................. 28
3 FORWARD LOOKING STATEMENTS This Annual Report on Form 10-K (this "Form 10-K") contains statements that constitute forward looking statements. Those statements appear in a number of places in this Form 10-K and in the documents incorporated by reference herein and include statements regarding the intent, belief or current expectations of International Total Services, Inc., an Ohio corporation (the "Company" or "ITS"), its directors or its officers with respect to (i) potential acquisitions by the Company; (ii) the Company's financing plans; and (iii) trends affecting the Company's financial condition or results of operations. Readers are cautioned that any forward looking statements in this Form 10-K are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. Forward looking statements are subject to certain risks and uncertainties that could cause actual results to differ materially from projected results, including the Company's ability to payoff or refinance its bank 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. Readers are cautioned not to place undue reliance on forward looking statements. Other factors that could cause actual results to differ materially from projected results include, but are not limited to, those factors discussed in the "Risk Factors" section of the prospectus contained in the Company's Registration Statement on Form S-1 (Registration No. 333-29463), as amended. PART I ITEM 1. BUSINESS The Company's fiscal year ends on March 31, and its fiscal years are identified by reference to the calendar year in which they end. For example, the fiscal year ended March 31, 1999 is referred to as "fiscal 1999." RECENT DEVELOPMENTS 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 beginning February 1, 2000. The Company is obligated to pay Weitzel the $500,000 consulting fee whether or not any 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 the date of the filing of this Form 10-K. 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, ("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 Common Stock beneficially owned or acquired by Weitzel are placed 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 Common Stock held in the Voting Trust, by the action of a majority of the Voting Trustees. In addition, 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 1 4 transfer shares of the 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. In October 1999, the Company's Board of Directors named Mark D. Thompson, President and Interim Chief Executive Officer. Delisting of Common Shares In June 1999, the Company announced that its Annual Report on Form 10-K for the fiscal year ended March 31, 1999 would not be filed with the Securities and Exchange Commission by the prescribed due date. On July 1, 1999, the Company was informed by the Nasdaq Stock Market that trading of the Common Stock on that market, 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 halt was the Company's failure to timely file its 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 Common Stock was delisted from the Nasdaq Stock Market. On October 26, 1999 price quotes for the Common Stock began appearing in the Electronic Quotation System of the National Quotation Bureau LLC. Other Developments The Company received a letter dated August 20, 1999 from Arthur Andersen LLP, the Company's independent public accountants, 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 issues of the identified material weakness and is in the process of addressing the remaining issues with completion expected during fiscal 2001. In February 2000, the Company announced that as a result of facts uncovered during the audit of its financial statements for fiscal 1999, the fiscal 1999 quarters and the prior year financial statements required restatement. The restated financial statements are included elsewhere herein. The Company incurred a substantial operating loss in fiscal 1999 and fiscal 2000 results will also reflect a substantial operating loss and negative cash flow from operations. The Company's current cash flow and forecasted cash flow raise substantial doubts about the Company's ability to continue as a going concern. The factors which raise such doubts, and management's plans to address them, are discussed further in ITEM 7 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS, and NOTE B OF NOTES TO CONSOLIDATED FINANCIAL STATEMENTS, contained elsewhere herein. The Company's strategy is to use its established business base as a platform for expanding its services and currently will not pursue any further acquisitions (other than the two 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. COMPANY OVERVIEW The Company is a significant domestic provider of aviation contract support services and is 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 services offered by the Company include skycap, baggage handling and aircraft appearance services, and 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. In September 1997, the Company completed its initial public offering (the "Initial Offering"). The Company used the proceeds from the Initial Offering to fund acquisitions, repay indebtedness and for general corporate purposes, including funding of working capital. The Company's strategy is to use the Company's established business base as a platform for expanding the services that it provides. 2 5 From the Initial Offering through June 30, 1999, the Company completed 18 acquisitions. Management intends to assess the impact and strategic benefits of past acquisitions and, when appropriate, make strategic recommendations to the Board of Directors concerning acquired companies and/or business segments. In March 2000, the Company completed the disposition of Metroplex Control Systems Inc. which was acquired in May 1999. See Acquisitions. The Company is not presently pursuing acquisitions, and does not anticipate that acquisitions will materially contribute to growth in the foreseeable future. The Company's new management team has initiated a thorough operational audit of each of the Company's business segments. Working with selected consultants, management hopes to effectively evaluate the performance of each segment and the profitability of each significant customer relationship. It is management's intention to formulate and implement business process improvement initiatives which will improve customer service, control costs and facilitate timely and accurate public reporting. However, there can be no assurance that the Company will be able to obtain and successfully deploy the necessary technical, operational, financial, human and other resources necessary to implement these initiatives or that these initiatives will achieve their desired results. The current strength of the United States economy, which has driven unemployment to low levels, has adversely affected the Company's ability to attract and retain the workforce needed to provide the services required under its service contracts. The difficulty in attracting these workers has resulted in the Company's payment of increased overtime 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. These factors have resulted in downward pressure on the Company's margins. The Company operates in a rapidly changing and dynamic market, and the Company's strategies and plans are designed to adapt to changing market conditions where and when possible. However, there can be no assurance that the Company's management will identify the risks (especially those newly emerging from time to time) affecting, and their impact on, the Company and its business. Further, there is no assurance that the Company's strategies and plans will take into account all market conditions or that such strategies and plans will be successfully implemented. Accordingly, neither the historical results presented in the Company's consolidated financial statements and discussed herein, nor any forward-looking statements in this Form 10-K, are necessarily indicative of the Company's future results. INDUSTRY OVERVIEW Aviation Staffing Services GENERAL. In 1973, the Federal Aviation Administration (the "FAA") mandated that airlines conduct predeparture screening of all passengers at most airports in the U.S. Because the labor-intensive nature of predeparture screening imposes substantial administrative burdens, most airlines have opted to contract out predeparture screening and other security services to third party contractors. Certain other airline services, such as food service and fueling, historically have also been contracted out by the airlines. In the past several years, market forces have driven airlines to outsource a number of additional labor-intensive aviation services in order to permit airline management to focus on the essential aspects of the airline business and to reduce labor, benefit costs and administrative overhead. As the costs of labor have increased, airlines have frequently outsourced baggage claim services, skycap, baggage handling, aircraft appearance, wheelchair assistance services and inter-gate cart services. Ticketing and check-in services are also beginning to be outsourced. PREDEPARTURE SCREENING. The Company is a leading provider of domestic airline predeparture screening services. The Company currently employs predeparture screeners at 129 U.S. airports in 41 states. The Company's predeparture screening services include conducting x-ray or electromagnetic inspection of all carry-on baggage, manual searches of suspicious baggage and metal-detector searches of all passengers. The Company derived approximately 32.3%, 36.7% and 50.0% of its revenues from predeparture screening services in fiscal 1999, 1998 and 1997, respectively. 3 6 RAMP AND GROUND HANDLING SERVICES. The ramp and ground handling services provided by the Company include: conveyance of checked baggage from terminal to baggage compartment of plane and from plane to baggage carousel; cleaning interior sections of the aircraft between flights and at the end of the aircraft's flight day; washing the exterior of aircraft; emptying on-board lavatories and replacing the water source with potable water; and spraying ice-melting substance on aircraft in accordance with customer specifications. The Company derived approximately 26.2%, 32.4% and 14.2% of its revenues from ramp and ground handling services in fiscal 1999, 1998, and 1997, respectively. AIRLINE SECURITY STAFFING SERVICES. The Company provides passenger profiling services and document verification agents, primarily in Europe, where airlines and airports have been required by regulatory agencies and the political climate to devote significant resources to the prevention of terrorist activity. Airlines contract with the Company to provide document verification (customs) agents who interview passengers as they embark or disembark a country via an international flight. In the domestic market, the Company also provides security for parked aircraft and employee parking lots, and the checking of employee identification cards and baggage. Airline security services other than predeparture screening did not represent a significant percentage of the Company's revenues in any of the last three fiscal years. OTHER AVIATION STAFFING SERVICES. The Company's other aviation services include providing skycaps for curbside check-in, baggage assistance and help with routine passenger problems, wheelchair operators to transport disabled or elderly passengers to and from the check-in area and the plane, and electric cart drivers to provide inter-gate transportation for passengers who need to board flights at distant gates. The Company derived approximately 12.3%, 12.4% and 19.6% of its revenues from these services in fiscal 1999, 1998 and 1997, respectively. Commercial Security Staffing Services The Company provides uniformed security officer services, business and facility access control, security consulting, special event security and security assessment to a broad range of commercial clients and owners or managers of commercial offices, government buildings, airports, hospitals, malls, distribution centers, sports arenas, museums and other facilities. The Company entered the commercial security market in the early 1990's to further capitalize on its staffing services experience. The Company derived approximately 22.4%, 12.0% and 7.6% of its net revenues from commercial security staffing services in fiscal 1999, 1998 and 1997, respectively. Security Products Distribution In addition to service offerings to the airline industry, the Company distributes a line of security products through its wholly-owned subsidiary, Crown Technical Systems, Inc. ("CTS"), including airport and commercial security checkpoint products and hand-held metal detectors. CTS markets access control equipment, including swipe card and other products to control access to secured areas, and closed circuit television monitoring equipment to domestic and international customers. The Company derived approximately 1.9%, 2.1% and 2.9% of its net revenues from sales of security products in fiscal 1999, 1998 and 1997, respectively. GROWTH Prior to the Change in Control described above in "ITEM 1. BUSINESS - Recent Developments", the Company had aggressively pursued acquisitions since the Initial Offering in 1997. It is the view of the Company's current management team that the Company's cost of capital makes it extremely difficult to find attractive acquisitions at this time, given historical and prevailing operating margins in the Company's lines of business which limit the effective yield of capital invested in such acquisitions. The Company's credit facility also prohibits any further acquisitions at this time. As a result, management intends to instead focus on a renewed emphasis on sales and service, seeking an expansion of services provided to existing customers and actively pursuing contracts with new customers. 4 7 ACQUISITIONS Historically, when making a domestic acquisition, the Company generally acquired only existing contracts and the equipment needed to fulfill the contracts. During fiscal 1999, the Company acquired the contracts and related property and equipment from six companies for aggregate cash payments of $9.7 million. Two of these acquisitions were in the aviation staffing services segment and four were in commercial security staffing services. Since the end of fiscal 1999, the Company has completed two acquisitions: (1) American Investigative Services, Inc., a commercial security staffing business based in Houston, Texas, was acquired in April 1999 for $1.5 million in cash; and (2) Metroplex Control Systems, Inc. ("MCS"), which sells, installs and services fire detectors, detention control and other security systems from its Dallas, Texas headquarters, was acquired in June 1999 for $5.0 million in cash. The Company completed the disposition of MCS on March 10, 2000 for cash in an amount approximately equal to its net cash investment in MCS. The Company is not presently pursuing further acquisitions, and does not anticipate that acquisitions will materially contribute to growth in the foreseeable future. COMPETITION Aviation Staffing Services PREDEPARTURE SCREENING. Contracts for predeparture screening services tend to be highly competitive among a handful of experienced providers and are generally awarded to the low-cost provider. At the same time, the airlines are sensitive about security lapses and may cancel a contract based on even minor security breaches. Currently, the Company faces the same challenge as its competitors do--finding qualified employees to provide consistent service at the wage rates offered by the airlines for screeners in the current economic environment. See "Company Overview - General". The Company's principal competitors in domestic predeparture screening include Globe Aviation Securities Corporation, AHL Services, Inc. and Huntleigh, Inc. In the international security market the Company strives to distinguish itself by developing training programs and screening methods that meet the demands of its customers. The Company's passenger profilers are trained in questioning techniques that are designed to elicit cooperation and to avoid offense to innocent travelers. The Company's main competitors for international profiling and screening services are ICTS International, N.V., AHL Services, Inc. and International Aviation Security, Inc. RAMP AND GROUND HANDLING SERVICES. Airlines frequently outsource ramp and ground handling services because these services often require a considerable investment in support equipment, which can be expensive for carriers with few flights at a particular location. The Company has the ability to offer a package of services which include new or refurbished equipment, maintenance and manpower, for a fully inclusive per-hour charge. The Company has typically offered ground handling or passenger services as "add on" services to its base airline security business. It also offers these services on a stand-alone basis at certain locations. In this area, the Company competes with the airlines themselves, Signature Flight Support Services, AMR Services, Ogden Allied Support Services, Hudson General, and Service Master Co. The Company has sought to increase the volume of its aircraft appearance business by focusing on providing service in accordance with detailed specifications. The Company conducts an Aircraft Appearance and Facility Audit Program through which it continually monitors its own performance. The Company believes that this approach enables the Company to correct problems that might not otherwise come to its attention until client dissatisfaction has occurred. To complement the Quality Assurance Programs, the Company introduced a comprehensive health and safety program system-wide to establish responsibilities and procedures for safety awareness programs. The Company's competitors in aircraft appearance include airlines themselves, Signature Flight Support Services, AMR Services, Ogden Allied Support Services, Hudson General, and Service Master Co. OTHER AVIATION SERVICES. The Company believes that customer service is as important as cost in the competition for domestic passenger service contracts. Because passenger service providers such as skycaps, wheelchair operators and cart 5 8 drivers have a high level of interaction with passengers, the Company has developed specialized training programs that emphasize customer service and empathy. The Company's main competitors for passenger services include the airlines, AHL Services, Inc., Globe Aviation Securities Corporation, and Huntleigh, Inc. Commercial Security Staffing Services The commercial security staffing industry is highly fragmented. Management believes there are in excess of 100,000 separate providers of commercial and industrial security services, and the Company does not believe that any single participant has a significant share of the market. While the Company has made only minor inroads into this market, the Company's competitive strength in this area comes from its low overhead costs and its ability to assimilate acquired commercial staffing businesses into its existing administrative structure. In the commercial staffing field, the major providers include Borg-Warner Security Corporation, Guardsmark, Inc. and The Wackenhut Corporation. Security Products Distribution The Company, through its wholly-owned subsidiary, Crown Technical Systems, focuses on Technical security applications and their integration into existing security arrangements. The chief competitors in the integrated checkpoint and automated exit lane fields are Ross Technologies and ADT Systems. In each of the segments where the Company operates, most of the Company's competitors are larger and may have greater financial resources than the Company. SALES AND MARKETING The Company believes that strengthening and maintaining relationships with personnel at various levels of its customer organizations are an integral element of its sales and marketing efforts. There are four sales executives servicing the Company's three operating regions throughout the United States and Europe. The Company's three regional directors in the United States and Europe also have sales responsibilities and a portion of their incentive compensation is dependent on meeting established sales goals. Sales staff are generally incentivized based on margins derived from their respective annual revenues. The Company seeks internal growth through, among other things, a focused marketing approach based on expanding the services provided to existing customers and increasing the volume of services provided in targeted markets. The Company is further developing national sales and marketing strategies aimed at improving the consistency of its sales approach. The Company has implemented a digitally integrated contract administration function that automatically tracks contracts, identifying in a timely manner contracts for pricing adjustments. The Company's marketing initiatives include the development of branded services, direct mail marketing, creation of local, regional and national marketing plans, strategic positioning for preferred provider partnerships, integration of high technology components, and coordination of the Company's participation in trade shows and other sales activities. Additionally, the corporate marketing department conducts quarterly training sessions for sales executives. These training sessions include presentation and customer service skills, database management and methods for cross-selling the Company's products and services. MANAGEMENT AND REPORTING SYSTEMS As a result of the strength of the United States economy, which has resulted in the need to increase wage rates, the Company has experienced downward pressure on its gross margins. In fiscal 1999, the Company implemented certain strategies in an attempt to counter these pressures. These strategies include time and motion studies and increased use of technology designed to accomplish more services with less manpower, and an improved labor hours monitoring system. In late fiscal 1999, the Company installed an improved version of portions of its Management Information System. While the prior system allowed management to assess the results of the field operations at the end of every month, the new 6 9 system allows an assessment of field operations at any time. The Company has hired consultants to assist it in evaluating organizational structure, identifying inefficient practices, and has begun improving control over field operations. WORKFORCE MANAGEMENT As of April 7, 2000, the Company had approximately 16,000 full- and part-time non union employees engaged in performing its client services. The Company experiences annual turnover of over 100%, and believes that improving employee retention is important to reducing operating costs and providing high quality service to its clients. Because employee turnover is inherent in the nature of its business, the Company allocates significant resources to recruiting potential employees. Each applicant must complete an interview and a written application that includes inquiry concerning prior criminal convictions. The Company grants various bonuses and awards to exceptional employees, in part to further enhance retention. These include bonuses for detecting weapons and other illegal objects, including those detected during FAA-mandated tests. Currently, the Company faces the same challenge as its competitors do - finding qualified employees to provide consistent service at the wage rate allowed by clients. For certain aviation services employees, FAA regulations require that each applicant provide proof of citizenship or resident alien status, and each applicant is subject to a five- or ten-year background verification, depending upon the position, and a pre-employment drug screen. For persons with unescorted access to secured areas, a criminal background verification procedure, which is conducted by the Federal Bureau of Investigation, is triggered by any 12-month gap in employment history that cannot be explained through independent verification. CUSTOMERS AND CONTRACT TERMS The Company derives a significant portion of its revenues from a few clients. In fiscal 1999, Delta Air Lines, Inc. (26.0%), Continental Airlines, Inc. (11.7%), Trans World Airlines, Inc. (3.8%), U.S. Airways, Inc. (3.8%) and Northwest Airlines, Inc. (2.9%) accounted for 48.0% of the Company's net operating revenues. During fiscal 1999, 1998 and 1997, the Company's ten largest clients accounted for an aggregate of 59.0%, 66.3% and 68.5% respectively, of the Company's net operating revenues. The Company's contracts with clients, including those that it has obtained through acquisitions, generally have one- to three-year terms but are cancelable by either party on 30 to 90 days' notice. The Company invoices its aviation services clients weekly or biweekly. The Company invoices its commercial security staffing services clients weekly, which is typical in that field. The services provided by the Company require it to train and manage low wage workforces with high turnover rates. From time to time, the Company has failed to meet test standards or a client's service expectations at a particular location, and, like its competitors, has had contracts terminated because of customer dissatisfaction with various aspects of its performance. The Company's predeparture screening services are tested daily at numerous locations, both internally and by the FAA, to determine the Company's ability to detect weapons passing through checkpoints. Failure to pass FAA tests may result in fines to the airline responsible for the checkpoint, which the Company reimburses pursuant to its contracts in amounts up to $11,000 per test failure. In addition, the Company's contracts with airlines typically provide that the Company will indemnify the client against claims for property damage, or death of or personal injury to any person, arising out of the negligent acts or omissions of the Company, unless the claim results from a negligent act of the customer. The Company is self-insured for the first $250,000 per incident. The risk of contract termination as a result of actual or perceived service failures is enhanced by the substantial publicity that often accompanies errors in the provision of screening services, because of public concern over airline security issues. Failure to meet tests or other performance standards may result in fines, or the loss of a contract or service location or the Company's license to perform services, and any such loss could have a material adverse effect on the Company's reputation, business, results of operations and financial condition. 7 10 GOVERNMENT REGULATION The Company's aviation services' clients are subject to various regulations and directives issued by the FAA. Under current regulations, independent contractors, such as the Company, that perform services for air carriers and airport authorities share responsibility for aviation security with air carriers, airport authorities, the FAA and various other federal, state and local agencies. At airports throughout the United States, the FAA tests security systems and conducts threat and vulnerability assessments. Through the use of its regulatory powers, the FAA directs the aviation industry to implement measures that address existing and anticipated threat situations. FAA regulations require each air carrier and airport authority to implement an FAA-approved security program. Airport authorities are responsible for maintaining a secure environment on airport grounds and for providing law enforcement support and training. Air carriers are responsible for the security of all people and items connected to their aircraft, including passengers, baggage, maintenance equipment and flight crews. Although an air carrier is permitted to outsource certain security functions, FAA regulations require the air carrier to provide oversight in order to assure that all requirements are met. The FAA itself regularly conducts tests of predeparture screening checkpoints at U.S. airports. Failure to meet requirements imposed by the FAA or the air carrier or the failure of various tests administered by the FAA can result in fines and other penalties to the responsible air carrier, which are in turn passed on to the screening company under the terms of the contract between the provider and the carrier. Regulatory compliance problems and test failures may also result in the termination of a security contract or of services at the affected site. The Company's aviation and commercial security staffing services are also subject to regulation by various state and local authorities. The Company is required to obtain and maintain various licenses and permits from state and local authorities to provide aviation and commercial security staffing services, as well as certain other services. ITEM 2. PROPERTIES During fiscal 1999 the Company leased approximately 20,600 square feet in Independence, Ohio, for its corporate headquarters. The initial term of the lease expires in 2001 and may be extended, at the option of the Company, until 2006. The Company leases space in numerous facilities in the United States and Europe to house local offices. None of these local office leases are material to the Company's operations. The Company does not own any real estate. In April 2000, the Company signed a partial lease termination related to 6,496 square feet leaving approximately 14,100 square feet for its corporate headquarters. The Company believes its current facilities are adequate for its needs. ITEM 3. LEGAL PROCEEDINGS Because the Company's employees function in public facilities and in the workplaces of other businesses, the Company is exposed to possible claims by its clients' customers and employees of discrimination, harassment and negligence, and similar claims. The Company is subject to liability for the acts or negligence of its employees while on assignment that cause personal injury or damages, and to claims of misuse of client proprietary information or theft of client property. As a provider of security services, the Company faces potential liability for claims that may arise from any terrorist activity occurring in circumstances associated with the Company. Although the Company maintains insurance coverage against such potential liabilities, any such claim against the Company might exceed the amount of such insurance coverage or fall outside the type of activities covered by such insurance. The Company is involved in various legal proceedings, including routine civil actions instituted by the FAA with respect to test failures, background checks and recordkeeping matters that arise in the ordinary course of its business and litigation relating to its acquisitions. The Company does not believe that the ultimate outcome of these proceedings will have a material adverse effect on the Company's business, assets, financial condition or results of operations, however, in the event any of the foregoing litigation results in an award of money damages against the Company, given the Company's current liquidity situation, that award could adversely affect the financial condition of the Company. 8 11 ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS There were no matters submitted to a vote of security holders during the fourth quarter of the fiscal year covered by this report. EXECUTIVE OFFICERS Pursuant to Instruction 3 to Item 401(b) of Regulation S-K, the following information is reported below. Executive officers of the Company are elected by, and serve at the discretion of, the Board of Directors until their successors are duly chosen and qualified. The executive officers of the Company at April 7, 2000 are as follows:
NAME AGE POSITION - ---- --- -------- Mark D. Thompson............................ 42 President and Interim Chief Executive Officer Terri M. Jones.............................. 43 Executive Vice President Ronald P. Koegler........................... 47 Executive Vice President and Controller Michael F. Sosh............................. 38 Executive Vice President, Treasurer and Chief Financial Officer Charles P. Licata........................... 55 President, Commercial Staffing Services Thomas M. Vaiden............................ 55 President, Aviation Services Scott E. Brewer............................. 37 Senior Vice President and General Counsel Neal B. Davis............................... 47 Vice President, Aviation-Western Region Operations Stephen P. Metzler.......................... 41 Vice President, Aviation-Customer Service
The following are biographical summaries of the business experience of the executive officers of the Company. MARK D. THOMPSON is the President and Interim Chief Executive Officer of the Company and was named to this position in October 1999. Mr. Thompson was the Executive Vice President and Chief Financial Officer of Lexford Residential Trust from April 1996 until September 1999, when Lexford was acquired by Equity Residential Properties Trust. Lexford Residential Trust was a publicly traded real estate investment trust which specialized in the ownership and management of multi-family housing. From January 1995 to March 1996, Mr. Thompson was a partner with the law firm of McDonald, Hopkins, Burke & Haber. From September 1985 to December 1994, Mr. Thompson was an associate and partner with the law firm of Benesch, Friedlander, Coplan & Aronoff, LLP. TERRI M. JONES is the Executive Vice President - Aviation since January 2000. Ms. Jones joined the Company in November 1997 as Vice President, Marketing and was named Senior Vice President, Sales and Marketing in June 1999. For the seven years prior to joining the Company, Ms. Jones was with the American Heart Association, as Director of Communications and Marketing. RONALD P. KOEGLER has been the Executive Vice President and Controller since joining the Company in February 2000. From 1989 until joining the Company, Mr. Koegler held various positions with Lexford Residential Trust, most recently as Senior Vice President and Controller since December 1996, as Vice President and Treasurer from January 1996 to December 1996 and Controller from April 1992 to January 1996. MICHAEL F. SOSH is the Executive Vice President, Treasurer and Chief Financial Officer of the Company since January 2000. Mr. Sosh joined the Company in November 1999 as a consultant. Mr. Sosh was the Senior Vice President and Treasurer of Lexford Residential Trust from January 1997 to September 1999. From 1987 to 1997 Mr. Sosh was with the retail department store chain of Bon-Ton Stores, Inc. (NASDAQ:BONT), as Manager of Financial Planning and Financial Analyst from 1987 to 1995 and Divisional Vice President and Assistant Treasurer from March 1995 to January 1997. 9 12 CHARLES P. LICATA is the President of the Commercial Staffing Security business since June 1999. Mr. Licata joined the Company in December 1998 as Vice President of Commercial Services. Prior to joining the Company, Mr. Licata was a Vice President at Borg-Warner Protective Services for 16 years. THOMAS M. VAIDEN is the President of the Aviation Staffing Services business since June 1999. Prior to June 1999, Mr. Vaiden was employed by Delta Air Lines, Inc. for the past 34 years in various capacities. His last position for Delta was Station Manager in Omaha, Nebraska. SCOTT E. BREWER is the Senior Vice President and General Counsel of the Company since June 1999. He has served as a Vice President since April 1995 and General Counsel since September 1993. Mr. Brewer was in the private practice of law from October 1988 to August 1993. NEAL B. DAVIS is the Vice President, Aviation-Western Region Operations. He has served in this position since August 1999. Prior to this position, Mr. Davis served in an executive role with Win West Jet, LC., an airline charter operation, since April 1998, as a founder of Professional Travel Services, Inc., a consulting firm to the airline industry, since June 1995, and as a Vice President for Morris Air, an airline staffing organization, from November 1992. STEPHEN P. METZLER is the Vice President, Aviation-Central Region since March 2000. Prior to this position, Mr. Metzler served as a Vice President-Customer Service from June 1999 to March 2000, as a Divisional President from May 1995 to June 1999, as District Manager from May 1994 to May 1995 and as Aircraft Appearance Manager from December 1991 to May 1994. * * * * * There are no arrangements or understandings known to the Company between any executive officer and any other person pursuant to which any executive officer was elected to office. There is no family relationship between any director or executive officer and any other director or executive officer of the Company. The following officers and directors left their positions with the Company since March 31, 1998 and through April 7, 2000: President James O. Singer resigned from his position in October 1998; Vice President, Finance Brian Kenyon resigned from his position in April 1999; President Steven S. Johnston resigned from his position in May 1999; Robert A. Weitzel, Chairman and Chief Executive Officer, retired from his position in October 1999; Vice President, Aviation-Eastern Region Operations, Douglas J. Robinson resigned from his position in February 2000; and Vice President and Chief Financial Officer Charles S. Deutchman's October 15, 1999 employment agreement ended on March 1, 2000; President of Crown Technical Systems, Inc. Robert P. Weitzel (son of Robert A. Weitzel) resigned from his position in March 2000; Director Ivan J. Winfield resigned in April 1999; and Director Lee Howley resigned in May 1999. 10 13 PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDER MATTERS (a) Market Information During the year ended March 31, 1999, the Common Stock was traded on the Nasdaq Market under the symbol "ITSW". On July 1, 1999, trading of the Common Stock was halted. On September 15, 1999, the Common Stock was delisted from the Nasdaq Stock Market. On October 26, 1999, price quotes for the Common Stock began appearing on the Electronic Quotation System of the National Quotation Bureau LLC ("Pink Sheets"). See "ITEM 1. BUSINESS - Recent Developments". As of April 7, 2000 the Common Stock is still being quoted on the Pink Sheets and therefore there is no established public trading market for the Common Stock. The reported closing price on the Pink Sheets on April 7, 2000 was $1.75. The following table sets forth for the indicated periods the high and low market prices for the Common Stock:
PRICE RANGE ----------- HIGH LOW ---- --- FISCAL YEAR ENDED MARCH 31, 1999 - -------------------------------- First Quarter........................................................................... $ 22.00 $ 5.625 Second Quarter.......................................................................... $ 8.125 $ 3.875 Third Quarter........................................................................... $ 6.375 $ 3.50 Fourth Quarter.......................................................................... $ 5.375 $ 3.50 FISCAL YEAR ENDED MARCH 31, 1998 - -------------------------------- Third Quarter (beginning September 19, 1997)............................................ $ 18.75 $ 13.00 Fourth Quarter.......................................................................... $ 24.13 $ 15.75
(b) Shareholder Information As of April 7, 2000, there were 54 record holders of Common Stock and approximately 860 beneficial owners. (c) Dividend Information The Company has never paid, and does not anticipate paying in the foreseeable future, cash dividends on the Common Stock. In, addition, the Company's ability to pay cash dividends is limited by the terms of its revolving line of credit from its lender. 11 14 ITEM 6. SELECTED FINANCIAL DATA The following sets forth certain selected financial data appearing in or derived from the Company's historical audited financial statements. The selected financial data should be read in conjunction with the consolidated financial statements and notes thereto appearing elsewhere herein, and with Item 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS. During fiscal 1999, 1998 and 1997, the Company paid cash for the acquisitions of service contracts and the related equipment. These acquisitions were accounted for under the purchase method and accordingly their operating results are included in the consolidated financial statements for all periods subsequent to the date of acquisition. Certain reclassifications have been made to the prior periods' consolidated financial statements to conform with the 1999 presentation.
(amounts in thousands, except per share and employee data) YEARS ENDED MARCH 31, --------------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (1) (1) (1) (1) STATEMENTS OF OPERATIONS DATA: Net operating revenues................... $ 226,872 $ 172,367 $ 115,242 $ 95,467 $ 92,156 Income (loss) before income taxes........ (6,501) 8,357 2,725 1,815 (293) Net income (loss)........................ (7,295) 4,857 1,569 930 (783) Net income (loss) per share: Basic............................... $ (1.10) $ 0.93 $ 0.31 $ 0.16 $ (0.12) Diluted............................. (1.10) 0.92 0.31 0.16 (0.12) Weighted average common shares outstanding (2): Basic............................... 6,662 5,215 5,089 5,776 6,293 Diluted............................. 6,662 5,265 5,089 5,776 6,293 AS OF MARCH 31, --------------- 1999 1998 1997 1996 1995 ---- ---- ---- ---- ---- (1) (1) OPERATING DATA: Number of employees...................... 16,000 15,000 10,700 9,900 9,900 BALANCE SHEET DATA: Cash and cash equivalents................ $ 672 $ 3,542 $ 3,018 $ 2,693 $ 1,267 Working capital (deficit)................ 3,318 11,491 1,496 (2,398) (5,343) Total assets............................. 70,634 61,631 28,865 21,929 20,438 Long-term obligations.................... 10,859 3,682 11,641 5,790 5,810 Shareholders' equity..................... 30,841 38,319 2,800 3,710 2,979
(1) Data for the years ended and as of March 31, 1998, 1997, 1996 and 1995 has been restated to correct certain accounting errors reflected in the Company's previously issued financial statements for those periods. See ITEM 7 - MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS AND NOTE C OF THE NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS. (2) The weighted average number of shares outstanding has been adjusted to reflect the 12,892.62 for 1 stock split declared June 17, 1997. ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 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 12 15 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 includes 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 played an important role in the Company's net operating revenue growth during fiscal 1999 and 1998. In fiscal 1999, the Company completed six acquisitions of service contracts, all 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 the acquisition. The Company is not presently pursuing 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, 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 certain judgmental accounting estimates by the Company's management which were then 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 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 have been restated, as described in Note C of Notes to Consolidated Financial Statements. All amounts and percentages in the following discussions reflect the effects of such restatements. 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 also result in additional charges in fiscal 2000. Operations have generated negative cash flow for fiscal 2000. Although the Company obtained a one year extension of its credit facility through April 2001 (See Notes G and T of Notes to the Consolidated Financial Statements) the negative cash generated during fiscal 2000 and forecast to continue into the first quarter of fiscal 2001 are factors that raise doubts about the Company's ability to continue as a going concern and the audit report of Arthur Andersen LLP for fiscal 1999 contains an explanatory paragraph with respect to this matter. The Company obtained an extension of its credit facility through April 1, 2001 for use in funding operations. See "Liquidity and Capital Resources" below. In addition, the Company will seek to grow internally by using the established business base as a platform for expanding its 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 13 16 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 this plan will be successful. RESULTS OF OPERATIONS - --------------------- The following table sets forth the Company's results of operations in both dollars and as a percentage of revenues for the years ended March 31: (Dollars in Thousands)
1998 1997 1999 (Restated) (Restated) ----- ----------- ---------- Net operating revenues $226,872 100.0% $172,367 100.0% $115,242 100.00% Cost of revenues 205,224 90.5% 147,311 85.5% 99,037 85.9% ---------- --------- ----------- ------------ ------------ ---------- Gross margin 21,648 9.5% 25,056 14.5% 16,205 14.1% Selling, general and administrative expenses 24,650 10.9% 15,015 8.7% 12,627 11.0% Amortization expense 2,334 1.0% 988 0.6% 208 0.2% ---------- --------- ----------- ------------ ------------ ---------- Operating profit (loss) (5,336) (2.4%) 9,053 5.2% 3,370 2.9% Interest expense, net 994 0.4% 719 0.4% 637 0.5% Other (income) expense, net 171 0.1% (23) 0.0% 8 0.0% ---------- --------- ----------- ------------ ------------ ---------- Income (loss) before income taxes (6,501) (2.9%) 8,357 4.8% 2,725 2.4% Provision for income taxes 794 .3% 3,500 2.0% 1,156 1.0% ---------- --------- ----------- ------------ ------------ ---------- Net income (loss) $ (7,295) (3.2%) $ 4,857 2.8% $ 1,569 1.4% ========== ========= =========== ============ ============ ==========
YEAR ENDED MARCH 31, 1999 COMPARED WITH YEAR ENDED MARCH 31, 1998 - ----------------------------------------------------------------- NET OPERATING REVENUES. Net operating revenues in fiscal 1999 increased by $54.5 million, or 31.6%, as compared with fiscal 1998. The increase is mostly attributable to revenues from the six acquisitions completed during the year, and the inclusion of a full year of revenues from the eleven acquisitions completed in fiscal 1998. This rate of growth is not expected to continue into fiscal 2000 as the Company completed only two acquisitions during fiscal 2000 and has determined not to pursue further acquisitions at the present time. See "ITEM 1-BUSINESS-Growth". Internal growth accounted for only a nominal portion of the revenue increases in fiscal 1999. Revenues from Aviation Services increased $23.6 million or 16.0%, Commercial Staffing Services increased $30.2 million or 145.8%, and Security Products increased $0.7 million, or 19.5%. These growth rates did not continue into fiscal 2000. The fourth quarter of fiscal 1999 showed a 9.1% decrease in net operating revenue from the prior quarter. 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. Fiscal 1999 cost of revenues increased $57.9 million, or 39.3%, over fiscal 1998. Most of this increase (approximately $56.0 million) was due to expenses associated with fiscal 1999 acquisitions and inclusion of a full year of expenses for fiscal 1998 acquisitions. Marginally, cost of revenues were 90.5% and 85.5% of net operating revenues for fiscal 1999 and 1998, respectively. This deterioration of margin was largely due to: increased workers compensation expense, increased aircraft damages and fines; and a greater proportionate increase in wages and overtime. The approximate impact on fiscal 1999 cost of revenues for each of these items was as follows: Workers' compen- sation - $1.5 million; aircraft damages and fines - $.8 million; and wages and overtime - $5.7 million. The current strength of the United States economy, which has driven unemployment to low levels, has adversely impacted the Company's ability to attract and retain the workforce needed to provide the services required under its service contracts. The difficulty in attracting these workers has resulted in the Company's payment of increased overtime 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. These factors continue to exert downward pressure on the Company's margins. Management is currently implementing 14 17 operational strategies that it believes will improve margins, however, there can be no assurance that these strategies will be successful. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses include support services for field personnel, bad debt expense, charges for cessation of certain operations and professional services (legal, audit and consulting). These expenses increased $9.7 million, or 64.2%, to $24.7 million in fiscal 1999 from $15.0 million in fiscal 1998. Selling, general and administrative expenses were 10.9% and 8.7% of net operating revenues for fiscal 1999 and 1998, respectively. During fiscal 1999, management decided to cease operations in the Czech Republic and Italy. The Company also adjusted the carrying value of its investment in the United Kingdom and Germany to net realizable value due to the filing for insolvency by its joint venture partner in the United Kingdom (which was also its largest customer in Germany). Charges of $1.8 million for the unrealized loss on the carrying value of these assets identified for disposition are included in fiscal 1999 results. Bad in debt expense increased (approximately $1.2 million in fiscal 1999 compared to $.3 million fiscal 1998) primarily due to increased revenue and information that came to the Company's attention regarding the realizability of certain accounts receivable balances. Professional and consulting expenses increased $1.7 million due to settlement of certain outstanding litigation and related legal fees and additional costs incurred for accounting and consulting due to the material weakness identified by the Company's independent public accountants. The balance of the increase in Selling, General and Administrative expenses primarily relates to increased expenditures to expand the corporate infrastructure to support the numerous acquisitions completed in fiscal 1999 and 1998. This was the primary factor for the increase in selling, general and administrative payroll, taxes and benefits which increased $3.5 million in fiscal 1999 as compared to 1998. AMORTIZATION EXPENSE. Amortization expense was $2.3 million in fiscal 1999 compared to $1.0 million in fiscal 1998, an increase of $1.3 million, or 130%. The increase was the result of the additional charges to amortization for the fiscal 1999 acquisitions and a full year's charge for fiscal 1998 acquisitions. INTEREST EXPENSE. Interest expense increased by $.3 million to $1.0 million for fiscal 1999 from fiscal 1998, principally as a result of the increase in the Company's level of outstanding debt obligations to an average of $ 10.4 million from $6.1 million for fiscal 1999 and 1998, respectively, partially offset by the decrease in the Company's effective borrowing rate to 7.9 % for fiscal 1999 from 13.2% for fiscal 1998. INCOME TAXES. Income tax expense decreased to $.8 million for fiscal 1999 from $3.5 million for fiscal 1998. Despite recording a pre-tax book loss for fiscal 1999, a net tax expense of $.8 million was incurred. This expense is the tax benefit for the year's loss net of a provision to provide a deferred tax valuation allowance to reserve for net deferred tax assets where there is uncertainty of their future realization. YEAR ENDED MARCH 31, 1998 COMPARED WITH YEAR ENDED MARCH 31, 1997 (RESTATED) - ----------------------------------------------------------------- NET OPERATING REVENUES. Net operating revenues in fiscal 1998 increased by $57.1 million, or 49.6%, as compared to fiscal 1997. This increase is attributable to an increase in revenues from the eleven acquisitions that were completed during the year, the inclusion of a full year of revenues from the six acquisitions completed in fiscal 1997 and internal growth. The eleven acquisitions completed in fiscal 1998 contributed $46.3 million to the total increase in net operating revenues for the year, with $42.3 million in aviation services and $4.0 million in commercial staffing services. The inclusion of a full year of operating results from the six acquisitions completed in fiscal 1997 contributed $6.8 million to net operating revenues. Internal growth contributed the remainder of the increase in net operating revenues in fiscal 1998 compared with fiscal 1997. COST OF REVENUES. Fiscal 1998 cost of revenues increased $48.3 million or 48.7% over fiscal 1997, primarily due to acquisitions. The decrease in cost of revenues as a percent of sales is attributable to the shift in the Company's sales mix to 15 18 higher margin services such as ground handling, passenger services and commercial staffing services and away from lower margin preboard screening services. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. Selling, general and administrative expenses in fiscal 1998 were $15.0 million compared with $12.6 million in the prior year, an increase of $2.4 million, or 18.9%. The increase primarily reflects expenses associated with the operations of acquired businesses. Measured as a percentage of net operating revenues, these expenses were 8.7% in fiscal 1998 and 11.0% in fiscal 1997. This decrease is attributable to improved overhead absorption resulting from the growth of revenues over the prior year. AMORTIZATION EXPENSE. Amortization expense was $1.0 million in fiscal 1998 compared to $.2 million in the fiscal 1997. The increase was the result of the partial year (pro-rata) charges to amortization for the fiscal 1998 acquisitions in addition to a full year's charge for fiscal 1997 acquisitions. INTEREST EXPENSE. Interest expense increased in fiscal 1998 to $0.7 million from $0.6 million in fiscal 1997 because of an increase in average borrowings, primarily incurred to fund acquisitions. INCOME TAXES. The Company's consolidated effective income tax rate in fiscal 1998 was 41.9% as compared to 42.4% in fiscal 1997. The decrease in the Company's effective tax rate in fiscal 1998 was due to reduced overall tax rates on foreign earnings taxed at rates different than the U. S. statutory tax rate. In addition, the amount of non-tax deductible expenses decreased causing a reduction in the Company's effective tax rate. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- The Company's business is labor intensive. Consequently, it has substantial needs for cash throughout its fiscal year. During fiscal 1999, 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. Operating activities generated net cash of approximately $1.8 million. Financing activities generated net cash of $7.2 million during fiscal 1999. During fiscal 1999, principal uses of funds, in addition to working capital requirements, included expenditures associated with the Company's acquisition program. These included $9.5 million in acquisitions of service contracts, related goodwill and noncompete agreements and $0.2 million for related property and equipment. The Company financed its acquisitions with cash from the proceeds of the Initial Public Offering completed in September 1997, borrowings under its credit facility and internally generated cash. In addition, the Company spent $2.4 million on purchases of property and equipment in fiscal 1999, and received $0.4 million from the sale of equipment utilized in operations. During fiscal 1999, 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 percent and prime rate plus 3.0 percent. 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 at 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 April 1, 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 7, 2000 the outstanding obligation under this facility was $22.9 million. In April 2000, 16 19 Management secured, from its 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 1, 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 all 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 made capital expenditures in fiscal 2000 (exclusive of the $6.5 million cash outlay for the two acquisitions completed during the first quarter of fiscal 2000) of approximately $1.0 million, primarily related to leasehold improvements, computer software and systems and equipment used in operations. 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 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 worldwide concern regarding the use by many existing computer programs of only the last two digits rather than four to identify the year in a date field. If not corrected, many computer applications would fail 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. All costs were expensed as incurred. CONTINGENCY PLAN 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 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 17 20 future. The Company has not adopted a formal contingency plan and is unable to determine if any failure will occur, whether it will have a material impact on the Company's results of operations, liquidity and financial condition. EURO CONVERSION - --------------- On January 1, 1999, 11 of the 15 countries that are members of the European Union introduced a new currency unit called the "Euro," which will ultimately replace the national currencies of these 11 countries. The conversion rates between the Euro and the participating nations' currencies were fixed irrevocably as of January 1, 1999, with the participating national currencies being removed from circulation between January 1, 2002 and June 30, 2002, and replaced by Euro notes and coinage. During the "transition period" from January 1, 1999 through December 31, 2001, public and private entities as well as individuals may pay for goods and services using either checks, drafts or wire transfers denominated in Euro or the participating country's national currency. Under the regulations governing the transition to a single currency, there is a "no compulsion, no prohibition" rule, which states that no one is obligated to use the Euro until the notes and coinage have been introduced on January 1, 2002. In keeping with this rule, as of January 1, 1999, the Company is now also able to (i) receive Euro-denominated payments, (ii) invoice in Euro as requested by vendors and suppliers and (iii) perform appropriate conversion and rounding calculations. Full conversion of all affected country operations to the Euro is expected to be completed by the time national currencies are removed from circulation. The cost of software and business process conversion required to achieve such abilities is not expected to be material. The Company does not anticipate that the introduction and use of the Euro will materially affect the Company's foreign exchange, or will have a material adverse effect on operating results or cash flows due to the immateriality of European operations to the Company's financial statements. However, the ultimate effect of the Euro on competition due to foreign currency risk cannot yet be determined and may have an adverse effect, on the Company's operations, financial position or cash flows. Conversely, introduction of the Euro may also have positive effects, such as lower foreign currency risk. NEW ACCOUNTING PRONOUNCEMENTS - ----------------------------- In June 1998, the Financial Accounting Standards Board (FASB) issued Statement of Financial Accounting Standards (SFAS) No. 133, "Accounting for Derivative Instruments and Hedging Activities" (as amended by SFAS No. 137). SFAS No. 133 must first 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 or 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 effect on its financial statements. During fiscal 1998, the FASB issued SFAS No. 131, "Disclosures About Segments of an Enterprise and Related Information" ("SFAS No. 131"). SFAS No. 131 revises the manner in which an entity determines the operating segments it must report and requires the disclosure of additional segment information. The Company adopted the provisions of SFAS No. 131 for the fiscal year ended March 31, 1999. As the adoption of this pronouncement only modified disclosures, there was no effect on the Company's consolidated financial position, results of operations or cash flows. In fiscal 1998, the AICPA issued Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 requires the capitalization of certain costs incurred in the development of software used by a company for its own internal operations. The Company adopted the provisions of SOP 98-1 for the fiscal year ended March 31, 1999. The adoption of this pronouncement did not have a material effect on the Company's consolidated financial position, results of operations or cash flows. 18 21 FORWARD LOOKING STATEMENTS - -------------------------- In addition to discussing and analyzing the Company's recent historical financial results and condition, the preceding management's discussion and analysis of financial condition and results of operations includes statements regarding certain trends or of other forward-looking information concerning the Company's anticipated revenues, costs, financial resources or otherwise affecting or relating to the Company which are intended to qualify for the protections afforded "forward-looking statements" under the Private Securities Litigation Reform Act of 1995. The forward-looking statements made herein and elsewhere in this Form 10-K are inherently subject to risks and uncertainties, which could cause the Company's actual results or other future events pertaining to the Company to differ materially from the forward-looking statements. ITEM 7A. 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 (3.5% of total revenues for the year ended March 31, 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 material. The Company does not engage in hedging transactions to reduce exposure to fluctuations in foreign currency exchange rates. The financial results of the Company's foreign subsidiaries are measured in their local currencies. Assets and liabilities are translated into U.S. dollars at the rates of exchange at the end of each year and revenues and expenses are translated at average rates of exchange during the year. Resulting translation adjustments are reported as a component of comprehensive income (loss). Historically, the Company has not experienced any significant foreign currency gains or losses involving U.S. dollars and other currencies. This is primarily due to natural hedges of revenues and expenses in the functional currencies of the countries in which subsidiaries are located. Although the Company did not have any forward foreign currency exchange contracts in place at March 31, 1999, it does monitor its foreign currency exposure and does not anticipate any material impact on financial statements in the near future. INTEREST RATE RISK - ------------------ The Company maintains a revolving line of credit which subjects the Company to the risk associated with movements in market interest rates. This line of credit had a balance at March 31, 1999 of $10.9 million, which was at a variable rate of interest based on prime. Since revolving payments and borrowings are made on this line of credit on a daily basis with a variable market interest rate, the March 31, 1999 balance of this debt is considered to be at fair value. Based upon the Company's April 7, 2000 outstanding balance on the variable rate credit facility, a hypothetical increase of 100 basis points in the prime rate of interest would adversely effect future earnings and cash flows by approximately $229,000 on an annual basis. The Company monitors its interest rate risk, but does not engage in any hedging activities using derivative financial instruments to mitigate such risk. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Index to Consolidated Financial Statements on page F-1. 19 22 ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE The information required by Item 9, which relates to the change in the Company's accounting firm, is incorporated herein by reference to the information set forth under the Company's Form 8-K Securities and Exchange Commission filing dated March 1, 1999. PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT A portion of the information required by this Item 10 is incorporated by reference to the information under the heading "Executive Officers", in Part I of this Annual Report on Form 10-K. 20 23
DIRECTORS OF THE REGISTRANT - --------------------------- - -------------------------------------------------------------------------------------------------------------------------------- Director Term to Name of Director Age Principal Occupation and Other Information Since Expire - -------------------------------------------------------------------------------------------------------------------------------- John P. O'Brien 58 Co-Chairman of the Board of International Total Services, Inc. August 1999 Next since October 1999. Currently, Mr. O'Brien is Managing Director Annual of Inglewood Associates, a firm specializing in consulting and Meeting investing in financial turnarounds, since 1990; Chairman of the Board of Allied Construction Products, Inc., a majority owned subsidiary of PUBCO, Inc., since 1993; and is a Director of American Italian Pasta Company (NYSE:PLB) since 1997. From 1995 to 1999 Mr. O'Brien was Chairman of the Board and Chief Executive Officer of Jeffrey Mining Products LP, a distributor of underground mining products. Prior to 1990, Mr. O'Brien was with the public accounting firm of PriceWaterhouse, LLP, most recently as the firm's Southeast Regional Managing Partner. - -------------------------------------------------------------------------------------------------------------------------------- H. Jeffrey Schwartz 45 Co-Chairman of the Board of International Total Services, Inc. April 1999 Next since October 1999. Mr. Schwartz is an attorney engaged as a Annual partner with the law firm of Benesch, Friedlander, Coplan & Meeting Aronoff, LLP. Mr. Schwartz has been with this firm since 1983 and currently heads his firm's Business Reorganization Department and serves on its Executive Committee. Mr. Schwartz is also a Director of Driveoff.com, Inc a full service internet automobile purchasing solution, and a subsidiary of Navidec Inc. (NASDQ:NVDC) - -------------------------------------------------------------------------------------------------------------------------------- J. Jeffrey Eakin 53 Currently Mr. Eakin is Senior Vice President and a founder of September 1998 Next Preferred Capital Inc., a general equipment finance company, Annual since 1997. From 1994 to 1997 Mr. Eakin was a founder of and Meeting served as Vice President and Division Credit Officer for DVI Capital Company, a wholly owned wholesale finance company subsidiary of DVI, Inc. (NYSE:DVI) From 1992 to 1994 Mr. Eakin was Director of Credit and Funding for Picker Financial Group, a joint venture lease financing company between Picker International and LDI Corporation. - --------------------------------------------------------------------------------------------------------------------------------
SECTION 16(a) BENEFICIAL OWNERSHIP REPORTING COMPLIANCE - ------------------------------------------------------- Section 16(a) of the Securities Exchange Act of 1934, as amended, requires the Company's directors and executive officers, and owners of more than 10% of the Company's Common Shares, to file with the Securities and Exchange Commission (the "SEC") initial reports of ownership and reports of changes in ownership of Common Shares and other equity securities of the Company. Executive officers, directors and owners of more than 10% of the Common Shares are required by SEC regulations to furnish the Company with copies of all forms they file pursuant to Section 16(a). To the Company's knowledge, based solely on its review of the copies of such reports furnished to the Company and written representations that no other reports were required, during the fiscal year ended March 31, 1999, all Section 16(a) filing requirements applicable to its executive officers, directors and greater-than-10% beneficial owners were complied with. 21 24 ITEM 11. EXECUTIVE COMPENSATION SUMMARY COMPENSATION TABLE - -------------------------- The following table sets forth a summary of the compensation earned for services rendered by the Company's Chief Executive Officer, three other most highly compensated executive officers who were serving as an executive officer of the registrant at March 31, 1999 and any other individual that would have been among the three most highly compensated executives but for the fact that the individual was not serving as an Executive Officer at the end of the last completed fiscal year for the fiscal years ended March 31, 1999, 1998 and 1997 ("Named Executive Officers").
ANNUAL COMPENSATION (2) ---------------------- NAME AND FISCAL SALARY OTHER ANNUAL PRINCIPAL POSITION YEAR (1) ($) BONUS ($) COMPENSATION ($) Robert A. Weitzel (4) 1999 300,000 100,000 Chairman and Chief 1998 309,288 211,025 1,897(3) Executive Officer 1997 312,250 200,244 447(3) James O. Singer (5) 1999 164,744 25,000 President and Chief 1998 135,000 50,000 Operating Officer 1997 -- -- Scott E. Brewer 1999 81,154 61,933 Senior Vice President and 1998 55,770 77,065 General Counsel 1997 50,000 38,239 43,402(8) Steven S. Johnston (6) 1999 128,194 -- (9) President and Chief 1998 -- -- Operating Officer 1997 -- -- Brian Kenyon (7) 1999 84,569 47,781 (9) Vice President, Finance 1998 -- -- 1997 -- -- - -------------------------------------------------------------------------------------------------------------------------
(1) The Company's fiscal year ends on March 31, and its fiscal years are identified by reference to the calendar year in which they end. Amounts shown include compensation earned or awarded for each fiscal year. (2) No named executive officer received perquisites or other personal benefits in excess of the lesser of $50,000 or 10% of that individual's salary plus annual bonus. (3) Represents amounts contributed by the Company to the Company's 401(k) Plan as matching contributions relating to before-tax contributions made by that individual. (4) Mr. Robert A. Weitzel joined the Company in September 1978, and resigned in October 1999. Mr. Weitzel was under a two-year employment contract, which would have expired on December 31, 2000. The Company and Mr. Weitzel came to an agreement on his resignation, effective October 19, 1999. See "ITEM 1 BUSINESS - Recent Developments". (5) Mr. Singer joined the Company in April 1997 and resigned in November 1998. Mr. Singer was under a two-year employment contract, which would have expired December 24, 1999. Both parties to the contract came to an agreement on the termination, effective November 12, 1998 to pay Mr. Singer $100,000 severance, payable over a period of six months. Fiscal 1999 compensation includes $75,000 of this amount. 22 25 (6) Mr. Johnston joined the Company in October 1998 and resigned in May 1999. (7) Mr. Kenyon joined the Company in April 1998 and resigned in April 1999. Mr. Kenyon was under a one-year employment contract, which would have expired April 20, 1999. (8) Amount reflects the fair market value of Common Stock awarded on November 1, 1996, as determined by an independent appraisal. (9) Mr. Johnston and Mr. Kenyon were granted Common Stock options of 25,000 and 50,070 shares respectively during fiscal 1999 at an exercise price of the closing market price on the day of the grant. The exercise price on Mr. Kenyon's options were re-priced to a lower price on September 18, 1998. Both Mr. Johnston's and Mr. Kenyon's options expired 90 days after their employment with the Company terminated. OPTIONS - -------
OPTION GRANTS IN FISCAL YEAR 1999 INDIVIDUAL GRANTS ----------------- POTENTIAL REALIZABLE PERCENTAGE OF VALUE AT ASSUMED TOTAL OPTIONS ANNUAL RATES OF STOCK GRANTED TO PRICE APPRECIATION FOR OPTIONS EMPLOYEES IN EXERCISE OPTION TERM(4) GRANTED (#) FISCAL PRICE EXPIRATION ---------------- NAME (1) YEAR(2) ($/SHARE)(3) DATE(3) 5%($) 10%($) ---- ------- ----------- ------------ ----------- ----- ------ Robert A. Weitzel -- -- -- -- -- -- James O. Singer -- -- -- -- -- -- Scott E. Brewer -- -- -- -- -- -- Steven S. Johnston 25,000 25.8% 4.50 10/26/08 70,750 179,295 Brian Kenyon 50,070 51.7% 5.00 4/20/08 157,440 398,993 - ------------------------------------------------------------------------------------------------------------------
(1) Options vest in annual 25% increments. (2) Based on 96,756 options granted to all employees during fiscal year 1999. (3) Options were granted at the closing price for the Common Stock on the day of the grant. Mr. Johnston and Mr. Kenyon were granted Common Stock options of 25,000 and 50,070 shares respectively during fiscal 1999 at an exercise price of the closing market price on the day of the grant. The exercise price on Mr. Kenyon's options were re-priced to a lower price on September 18, 1998. Both Mr. Johnston's and Mr. Kenyon's options expired 90 days after their employment with the Company terminated. (4) These amounts are based on hypothetical appreciation rates of 5% and 10%, as required by the SEC and are not intended to forecast the actual future appreciation of the Common Stock. No gain to optionees is possible without an actual increase in the price of the Common Stock, which would benefit all of the Company's shareholders. All calculations are based on a ten-year option period. 23 26 AGGREGATED OPTION EXERCISES IN FISCAL 1999 AND FISCAL YEAR-END OPTION VALUES
NUMBER OF VALUE OF UNEXERCISED UNEXERCISED OPTIONS AT IN-THE-MONEY FISCAL YEAR-END (1) OPTIONS AT FISCAL SHARES VALUE (#) YEAR-END ($)(2) ACQUIRED ON REALIZED EXERCISABLE/ EXERCISABLE/ NAME EXERCISE (#) ($) UNEXERCISABLE UNEXERCISABLE ---- ------------ ------ ------------- ------------- Robert A. Weitzel -- -- 16,667/50,003 -0-/-0- James O. Singer -- -- -0-/-0- -0-/-0- Scott E. Brewer -- -- 12,517/37,553 -0-/-0- Steven S. Johnston -- -- -0-/25,000 -0-/-0- Brian Kenyon -- -- -0-/50,070 -0-/-0- - -------------------------------------------------------------------------------------------------------------------
(1) Includes options with exercise price ranging from $4.50 to $11.25. (2) Using the March 31, 1999 Common Stock closing price of $3.50, none of these options were in-the-money. OPTION REPRICING - ---------------- In September 1998 the Board of Directors approved the repricing of Brian Kenyon's stock options. Mr. Kenyon's then existing share options were repriced so the exercise price equaled the fair market value of the Company's Common Stock as of the close of business on the day of the repricing. The exercise price at the time of repricing was changed from $20 per share to $5 per share. The Board took this action based on the fact that Mr. Kenyon joined the Company in April 1998 and was provided the share options in April 1998 as incentive to improve Company performance and shareholder value. Subsequent to April 1998, based upon financial results for the year ended March 31, 1998 the market value of the shares decreased to prices ranging between $6 and $7 per share by the end of July 1998. The price continued to decline to $5 per share in September 1998 based on the disappointing financial results for the first quarter of fiscal 1999. The Board determined that since the decline in the share price related to factors occurring prior to the time Mr. Kenyon joined the Company, maintaining his option strike at $20 per share unfairly penalized Mr. Kenyon for factors beyond his control. The Board of Directors believed that the repricing of the options provided Mr. Kenyon a fairer opportunity to benefit from his contributions to the Company. Mr. Kenyon subsequently resigned from the Company in April 1999 and his options lapsed. J. Jeffrey Eakin, Director 24 27
TEN YEAR OPTIONS/SAR REPRICINGS Number of Market Price of Exercise Price Securities Stock at Time at Time of New Length of Original Underlying of Repricing or Repricing or Exercise Option Term Options/SAas Amendment Amendment Price Remaining at Date Repriced or of Repricing or Name Date Amended $ $ $ Amendment - ----------------------------- ---------- -------------- ----------------- ----------------- ------------- --------------------- Brian Kenyon 9/18/98 50,070 $5.00 $20.00 $5.00 9.58 years
Vice President, Finance DIRECTOR'S COMPENSATION. Each director who is not an employee of the Company is compensated at the rate of $12,000 per year and also receives $1,000 for attendance at each meeting of the Board of Directors and for each meeting of any committee. Upon joining the Board in September 1998, Mr. Eakin received an option to purchase 5,000 shares of Common Stock at the exercise price of $5.00 per share. In addition, the Directors participate in the Non-Employee Director Compensation Plan which provided a one-time grant of 50,000 phantom shares of the Company's common stock to each Director, 20% of which vested at grant and the remainder of which vests in 10% increments upon the attainment of certain target shares prices. Vesting is accelerated as a result of a change in control of the Company and the plan provides that non-employee directors may have a portion of their fees that would otherwise be paid to them deferred into phantom shares. EMPLOYMENT AGREEMENTS. The Company entered into an employment agreement (the "Thompson Agreement') effective October 28, 1999 with Mark D. Thompson pursuant to which Mr. Thompson serves as the Company's President and Interim Chief Executive Officer. Under the terms of the Thompson Agreement, Mr. Thompson is employed indefinitely on a month-to-month basis, subject to termination by the Board of Directors with at least ninety (90) days advance notice. Mr. Thompson receives a base salary of $300,000 per year. Mr. Thompson was granted 75,000 fully vested shares of Common Stock on January 13, 2000, the date Mr. Thompson's agreement was approved by the Board. In addition, Mr. Thompson was granted a restricted stock award of 100,000 shares of Common Stock which vest over a four year period or upon the achievement of specified average share prices over 10-day trading periods, and which vesting is subject to acceleration upon the occurrence of a change in control or termination of Mr. Thompson's employment other than for "cause" (as defined in the Thompson Agreement). The Company entered into an employment agreement with Scott E. Brewer effective September 1997 for an initial term to December 31, 1999, which was automatically extended through December 31, 2000. Mr. Brewer's base annual salary was $110,000 as of September 1, 1999. Mr. Brewer is also entitled to a bonus keyed to the Company's profits, if any. COMPENSATION COMMITTEE INTERLOCKS AND INSIDER PARTICIPATION. The members of the Compensation Committee during fiscal 1999 were J. Jeffrey Eakin, Ivan J. Winfield and Lee Howley. No member of the Compensation Committee has served as an executive officer or employee of the Company or served during fiscal 1999 as an executive officer of another entity of which any executive officer of the Company was a director or member of the Compensation Committee. 25 28 ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The following table sets forth information with respect to each person or group known to the Company to be beneficial owners, as of April 7, 2000 of more than 5% of the Common Stock and by all directors of the Company, the Chief Executive Officer of the Company and the Named Executive Officers and by all officers and directors of the Company as a group:
NUMBER OF SHARES PERCENT BENEFICIALLY OF CLASS NAME AND BENEFICIAL OWNER OWNED (3) OUTSTANDING - ------------------------- --------- ----------- Robert A. Weitzel (1)................................................................... 3,324,979 48.6% Wanger Asset Management, L.P. (4)....................................................... 500,000 7.3% Brantley Partners IV, LP (5)............................................................ 417,000 6.1% John P. O'Brien ........................................................................ 0(2) * H. Jeffrey Schwartz .................................................................... 0(2) * J. Jeffrey Eakin ....................................................................... 7,000(2) * Mark D. Thompson (6).................................................................... 175,000 2.6% Terri M. Jones.......................................................................... 26,000 * Ronald P. Koegler....................................................................... 25,000 * Michael F. Sosh......................................................................... 25,000 * Charles P. Licata....................................................................... 25,000 * Thomas M. Vaiden........................................................................ 0 * Scott E. Brewer......................................................................... 41,151 * Neal B. Davis........................................................................... 0 * Stephen P. Metzler...................................................................... 8,545 * Peter J. Collins........................................................................ 5,008 * Steven S. Johnston (7).................................................................. 0 * Brian Kenyon (8)........................................................................ 0 * James O. Singer (9)..................................................................... 300 * All directors, the Voting Trust, and executive officers as a group (14 people as a group) 3,662,685 52.5%
* Less than one percent (1%). (1) Mr. Robert A. Weitzel resigned from the Company in October 1999. On November 5, 1999, Mr. Weitzel entered into a Voting Trust Agreement among the Company, Mr. Weitzel, H. Jeffrey Schwartz, J. Jeffrey Eakin, and John P. O'Brien, as Voting Trustees. Pursuant to the Voting Trust Agreement, Mr. Weitzel and the Weitzel Family Limited Partnership transferred record ownership, and thereby voting control, of 3,324,979 shares of Common Stock to the Voting Trust. Pursuant to the Voting Trust, the Trustees, constituting the entire Board of Directors of the Company, exercise voting power with respect to Mr. Weitzel's shares while Mr. Weitzel exercises dispositive and investment control, subject to the stock retention agreement. See "ITEM 1 BUSINESS - Recent Developments". In addition, Mr. Weitzel is contractually obligated to transfer the voting rights of any stock options he may exercise to this Voting Trust. At April 7, 2000, all of Mr. Weitzel stock options had lapsed. (2) The Trustees reported beneficial ownership of 3,324,979 Common Shares pursuant to a Voting Trust Agreement between the Company, Trustees and Mr. Weitzel. Pursuant to the Voting Trust Agreement, Mr. Weitzel transferred record ownership, and thereby voting control, of 3,324,979 shares of Common Stock to the Voting Trust. The Trustees reported shared voting power with respect to all of Mr. Weitzel's Shares. See "ITEM 1 BUSINESS - Recent Developments". 26 29 (3) Includes Common Stock which may be acquired within 60 days pursuant to the Company's September 1997 Long-Term Incentive Plan as follows: Mr. J. Jeffrey Eakin 5,000 Terri M. Jones 25,000 Ronald P. Koegler 25,000 Michael F. Sosh 25,000 Charles P. Licata 25,000 Mr. Scott E. Brewer 25,035 Mr. Stephen P. Metzler 8,345 Mr. Peter Collins 5,008 All directors and executive officers as a group 140,388 (4) Based solely on information set forth in a Schedule 13G filed with the Securities and Exchange Commission on February 11, 2000; Wanger Asset Management, L.P. ("WAM"), Wanger Asset Management Ltd ("WAM Limited"). and Acorn Investment Trust ("Acorn") (collectively "WAM Parties"), reported the beneficial ownership of 500,000 Common Shares. The principal business address of the WAM Parties is 227 West Monroe Street, Suite 3000, Chicago, Illinois 60606. The WAM Parties reported shared voting and dispositive power with respect to all such shares of Common Stock. According to the Schedule 13G, Acorn is the only person known to be entitled to receive all dividends from, and all proceeds from the sale of, shares of Common Stock to the extent of more than 5% of the class. (5) Based solely on information set forth in a Schedule 13D filed with the Securities and Exchange Commission on November 15, 1999. Brantley Capital Corporation reports beneficial ownership of 104,250 Common Shares. Brantley Partners IV, L.P. reports beneficial ownership of 312,750 shares of Common Stock. Each entity disclaims beneficial ownership of all shares of Common Stock owned by the other entity. The Company is unable to determine from the Schedule 13D the exact relationship between the entities. The principal address listed for Brantley Capital Corporation and Brantley Partners IV L.P. is 20600 Chagrin Blvd., Suite 1150, Cleveland, Ohio 44122. (6) Mr. Thompson was granted 75,000 fully vested shares of Common Stock effective January 13, 2000. In addition, Mr. Thompson was granted 100,000 shares of restricted stock which vests over a four year period. Mr. Thompson holds voting rights over the entire 175,000 shares of Common Stock. (7) Mr. Johnston resigned from the Company in May 1999. (8) Mr. Kenyon resigned from the Company in April 1999. (9) Mr. Singer resigned from the Company in November 1998 27 30 ITEM 13. CERTAIN RELATIONSHIPS AND RELATED TRANSACTIONS See "ITEM 1 BUSINESS - Recent Developments". ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a) (1) and (2) FINANCIAL STATEMENTS See Index to Consolidated Financial Statements on page F-1. (a) (3) Exhibits - See Item 14(c). (b) REPORTS ON FORM 8-K On March 1, 1999, a Current Report on Form 8-K was filed announcing the engagement of Arthur Andersen LLP as its new independent auditors and the dismissal of its prior auditors, Grant Thornton LLP. (c) Exhibit No. Description ----------- ----------- 3.1 Amended and Restated Articles of Incorporation* 3.2 Amended and Restated Code of Regulations* 4.1 Specimen Common Share Certificate* 10.3 Employment Agreement between the Company and Scott E. Brewer* 10.9 Directors' Deferred Compensation Plan* 10.10 Long-Term Incentive Plan* 10.11 Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement, dated as of March 31, 1997, between Bank One, Cleveland, NA, and the Company* 10.12 First Amendment to Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement, dated as of October 10, 1997, between Bank One, Cleveland, NA and the Company** 10.13 Amended and Restated Replacement Promissory Note executed by the Company in favor of Bank One, NA, successor by merger to Bank One, Cleveland, NA** 10.14 Second Amendment to Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement, dated as of December 16, 1998, between Bank One, Cleveland, NA and the Company 10.15 Employment Agreement between the Company and Mark D. Thompson 10.16 Non-Employee Director Compensation Plan 21.1 Subsidiaries of International Total Services, Inc. 27 Financial Data Schedule. * Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No. 333-29463), as amended. ** Incorporated by reference from the Company's Form 10-K for fiscal 1998 filed on July 14, 1998. (d) FINANCIAL STATEMENT SCHEDULES See Index to Consolidated Financial Statements and Schedule on Page F-1 28 31 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. APRIL 28, 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. April 28, 2000 /s/ Mark D. Thompson - -------------- ------------------------------------- Mark D. Thompson President and Interim Chief Executive Officer (Principal Executive Officer) April 28, 2000 /s/ Ronald P. Koegler - -------------- ------------------------------------- Ronald P. Koegler Executive Vice President and Controller (Principal Accounting O Officer) April 28, 2000 /s/ Michael F. Sosh - -------------- ------------------------------------- Michael F. Sosh Executive Vice President and Treasurer (Principal Financial Officer) April 28, 2000 /s/ John P. O'Brien - -------------- ------------------------------------- John P. O'Brien Director, Co-Chairman of the Board of Directors April 28, 2000 /s/ H. Jeffrey Schwartz - -------------- ------------------------------------- H. Jeffrey Schwartz Director, Co-Chairman of the Board of Directors April 28, 2000 /s/ J. Jeffrey Eakin - -------------- ------------------------------------- J. Jeffrey Eakin Director 29 32 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- The following consolidated financial statements of International Total Services, Inc. and Subsidiaries are included in Item 8: Report of Independent Public Accountants - For the Year Ended March 31, 1999................................ F-2 Report of Independent Public Accountants - For the Years Ended March 31, 1998 and 1997...................... F-3 Consolidated Balance Sheets as of March 31, 1999 and 1998................................................... F-4 Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended March 31, 1999, 1998 and 1997...................................................... F-6 Consolidated Statements of Shareholders' Equity for the years ended March 31, 1999, 1998 and 1997........... F-7 Consolidated Statements of Cash Flows for the years ended March 31, 1999, 1998 and 1997..................... F-8 Notes to Consolidated Financial Statements as of March 31, 1999, 1998 and 1997.............................. F-9 The following consolidated financial statement schedule of International Total Services, Inc. and Subsidiaries is included in Item 14(d): Schedule II - Valuation and Qualifying Accounts for the years ended March 31, 1999, 1998 and 1997............................................................................... F-25
All other schedules for which provision is made in the applicable accounting regulation of the Securities and Exchange Commission are not required under the related instructions or are inapplicable, and therefore have been omitted. F-1 33 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS FOR THE YEAR ENDED MARCH 31, 1999 --------------------------------- To the Shareholders and Board of Directors of INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES: We have audited the accompanying consolidated balance sheet of International Total Services, Inc. and Subsidiaries, (an Ohio corporation), as of March 31, 1999, and the related consolidated statements of operations and comprehensive loss, shareholders' equity, and cash flows for the year then ended. These consolidated financial statements and the schedule referred to below are the responsibility of the company's management. Our responsibility is to express an opinion on these consolidated financial statements and schedule based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audit provides a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of International Total Services, Inc. and Subsidiaries as of March 31, 1999 and the results of their operations and their cash flows for the year then ended in conformity with accounting principles generally accepted in the United States. The accompanying consolidated financial statements have been prepared assuming that the Company will continue as a going concern. As discussed in Note B, the Company incurred a loss from operations in fiscal 1999 and fiscal 2000 (based on unaudited information) and has negative tangible net worth. In addition, the Company generated negative cash flow from operations in fiscal 2000 (based on unaudited information). These matters raise substantial doubt about the Company's ability to continue as a going concern. The consolidated financial statements do not include any adjustments relating to the recoverability and classification of asset carrying amounts or the amount and classification of liabilities that might result should the Company be unable to continue as a going concern. Our audit was made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index to consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects, the financial data required to be set forth therein in relation to the basic consolidated financial statements taken as a whole. /s/ ARTHUR ANDERSEN LLP Cleveland, Ohio, April 14, 2000. F-2 34 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Shareholders and Board of Directors INTERNATIONAL TOTAL SERVICES, INC. We have audited the accompanying consolidated balance sheet of International Total Services, Inc. and subsidiaries as of March 31, 1998, and the related consolidated statements of operations and comprehensive income (loss), shareholders' equity, and cash flows for each of the two years in the period ended March 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of International Total Services, Inc. and subsidiaries as of March 31, 1998, and the consolidated results of their operations and their consolidated cash flows for each of the two years in the period ended March 31, 1998 in conformity with accounting principles generally accepted in the United States. Our audits were made for the purpose of forming an opinion on the basic consolidated financial statements taken as a whole. The schedule listed in the index to consolidated financial statements is presented for purposes of complying with the Securities and Exchange Commission's rules and is not part of the basic consolidated financial statements. This schedule has been subjected to the auditing procedures applied in the audit of the basic consolidated financial statements and, in our opinion, fairly states in all material respects, the financial data required to be set forth therein for the years ended March 31, 1998 and 1997 in relation to the basic consolidated financial statements taken as a whole. /S/ GRANT THORNTON LLP Cleveland, Ohio May 15, 1998, except for Note C as to which the date is April 14, 2000 F-3 35 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS MARCH 31 (AMOUNTS IN THOUSANDS)
1999 1998 ---- ---- (RESTATED) ASSETS CURRENT ASSETS Cash and cash equivalents......................................................... $ 672 $ 3,542 Accounts receivable--net of allowance for doubtful accounts of $513 and $100, respectively....................................... 23,811 20,768 Deferred taxes.................................................................... 3,033 2,007 Uniforms, net..................................................................... 2,691 2,686 Other current assets.............................................................. 1,422 1,684 ----------- ----------- Total current assets........................................................ 31,629 30,687 PROPERTY AND EQUIPMENT Security equipment................................................................ 4,729 3,682 Service equipment................................................................. 2,636 2,362 Computer equipment................................................................ 2,882 2,049 Furniture and fixtures............................................................ 1,136 994 Autos ............................................................................ 974 1,607 Leasehold improvements............................................................ 63 56 ----------- ----------- 12,420 10,750 Less accumulated depreciation and amortization.................................... 5,773 5,255 ----------- ----------- Property and equipment, net................................................. 6,647 5,495 INTANGIBLES, less accumulated amortization of $3,932 and $1,636, respectively................................................... 32,254 25,295 SECURITY DEPOSITS AND OTHER.......................................................... 104 154 ----------- ----------- TOTAL ASSETS................................................................ $ 70,634 $ 61,631 =========== ===========
The accompanying notes are an integral part of these Consolidated Financial Statements. F-4 36 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS--CONTINUED MARCH 31 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
1999 1998 ---- ---- (RESTATED) LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Trade accounts payable......................................................... $ 1,871 $ 1,226 Accrued payroll and employee benefits.......................................... 17,832 12,530 Other accrued expenses......................................................... 8,554 5,342 Income taxes payable........................................................... 54 98 ------------- ----------- Total current liabilities................................................ 28,311 19,196 DEFERRED TAXES.................................................................... 623 434 LONG-TERM DEBT OBLIGATIONS........................................................ 10,859 3,682 SHAREHOLDERS' EQUITY Common shares, without par value, stated at $.01 per share -authorized 20,000 shares, 6,662 shares issued and outstanding at March 31, 1999 and 1998........................... 67 67 Additional paid-in capital..................................................... 31,211 31,211 Accumulated other comprehensive loss: Foreign currency translation adjustment.................................... (387) (204) Retained earnings (deficit).................................................... (50) 7,245 -------------- ----------- Total shareholders' equity............................................... 30,841 38,319 ------------- ----------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................... $ 70,634 $ 61,631 ============= ===========
F-5 The accompanying notes are an integral part of these Consolidated Financial Statements. 37 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED MARCH 31 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
1999 1998 1997 ---- ---- ---- (RESTATED) (RESTATED) Net operating revenues....................................... $ 226,872 $ 172,367 $ 115,242 Cost of revenues............................................. 205,224 147,311 99,037 -------------- ------------ ------------- GROSS MARGIN........................................... 21,648 25,056 16,205 Selling, general and administrative expenses................. 24,650 15,015 12,627 Amortization expense......................................... 2,334 988 208 -------------- ------------ ------------- OPERATING PROFIT (LOSS)................................ (5,336) 9,053 3,370 Interest expense, net........................................ 994 719 637 Other (income) expense, net.................................. 171 (23) 8 -------------- ------------ ------------- 1,165 696 645 -------------- ------------ ------------- INCOME (LOSS) BEFORE INCOME TAXES...................... (6,501) 8,357 2,725 Provision for income taxes................................... 794 3,500 1,156 -------------- ------------ ------------- NET INCOME (LOSS)...................................... (7,295) 4,857 1,569 ============== ============ ============= Other comprehensive income (loss) Foreign currency translation adjustment............... (183) (105) (21) -------------- ------------ ------------- COMPREHENSIVE INCOME (LOSS).......................... $ (7,478) $ 4,752 $ 1,548 ============== ============ ============= Net income (loss) per share: Basic..................................................... $ (1.10) $ 0.93 $ 0.31 ============== ============ ============= Diluted................................................... $ (1.10) $ 0.92 $ 0.31 ============== ============ ============= Weighted average number of shares outstanding: Basic..................................................... 6,662 5,215 5,089 ============== ============ ============= Diluted................................................... 6,662 5,265 5,089 ============== ============ =============
The accompanying notes are an integral part of these Consolidated Financial Statements. F-6 38 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997 (AMOUNTS IN THOUSANDS)
ACCUMULATED ADDITIONAL OTHER RETAINED TOTAL PREFERRED COMMON PAID-IN COMPREHENSIVE EARNINGS TREASURY SHAREHOLDERS' SHARES SHARES CAPITAL LOSS (DEFICIT) STOCK EQUITY ------ ------ ------- ---- --------- ----- ------ BALANCE AT APRIL 1, 1996, AS PREVIOUSLY REPORTED......... $ 220 $ 64 $ 362 $ (78) $ 3,998 $ (588) $ 3,978 Prior period adjustments........ -- -- -- -- (269) -- (269) --------- -------- --------- -------- -------- --------- ---------- BALANCE AT APRIL 1, 1996, AS RESTATED.................... 220 64 362 (78) 3,729 (588) 3,709 --------- -------- --------- -------- -------- --------- ---------- Purchase of common shares for treasury.................. -- -- -- -- -- (1,226) (1,226) Issuance of common shares from treasury................. -- -- 171 -- -- 31 202 Foreign currency translation adjustment -- -- -- (21) -- -- (21) Dividends declared--Class E preferred stock............... -- -- -- -- (52) -- (52) Redeem Class E Preferred Stock.. (200) -- -- -- -- -- (200) Acquisition and merger of affiliate..................... -- -- 35 -- (1,219) 2 (1,182) Retirement of treasury stock.... (20) (27) (95) -- (1,639) 1,781 -- Net income, as restated......... -- -- -- -- 1,569 -- 1,569 --------- -------- --------- -------- -------- --------- ---------- BALANCE AT MARCH 31, 1997, AS RESTATED.................... -- 37 473 (99) 2,388 -- 2,799 Purchase of common shares....... -- -- (165) -- -- -- (165) Contribution of common shares by shareholder................ -- -- 805 -- -- -- 805 Initial Public Offering-- issuance of common shares..... -- 30 29,963 -- -- -- 29,993 Foreign currency translation adjustment -- -- (105) -- -- (105) Other........................... -- -- 135 -- -- -- 135 Net income, as restated......... -- -- -- -- 4,857 -- 4,857 --------- -------- --------- -------- -------- --------- ---------- BALANCE AT MARCH 31, 1998, AS RESTATED.................... -- 67 31,211 (204) 7,245 -- 38,319 Foreign currency translation adjustment -- -- -- (183) -- -- (183) Net loss........................ -- -- -- -- (7,295) -- (7,295) --------- -------- --------- -------- --------- --------- ----------- BALANCE AT MARCH 31, 1999....... $ -- $ 67 $ 31,211 $ (387) $ (50) $ -- $ 30,841 ========= ======== ========= ======== ========= ========= ===========
The accompanying notes are an integral part of these Consolidated Financial Statements. F-7 39 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MARCH 31 (AMOUNTS IN THOUSANDS)
1999 1998 1997 ---- ---- ---- (RESTATED) (RESTATED) OPERATING ACTIVITIES: Net income (loss) ........................................... $ (7,295) $ 4,857 $ 1,569 Adjustments to reconcile net income (loss) to net cash provided by operating activities: Depreciation............................................... 1,240 948 837 Amortization............................................... 2,334 988 208 Other...................................................... (104) 334 1,498 Deferred income taxes...................................... (837) (73) (390) Changes in working capital: Accounts receivable...................................... (3,043) (8,984) (2,709) Other assets............................................. 307 147 (1,144) Trade accounts payable................................... 645 (57) (161) Accrued expenses......................................... 8,513 5,594 2,084 ----------- ------------ ------------- Net cash provided by operating activities.............. 1,760 3,754 1,792 INVESTING ACTIVITIES: Purchases of property and equipment........................... (2,373) (1,508) (1,052) Proceeds received from sale of equipment...................... 446 -- 160 Purchased property and equipment of acquired businesses....... (187) (1,699) -- Payments for acquisitions of businesses, primarily by purchase of service contracts............................ (9,510) (19,042) (2,760) Deposit on acquisition of business............................ -- -- (2,571) ----------- ------------ ------------- Net cash used in investing activities.................... (11,624) (22,249) (6,223) FINANCING ACTIVITIES: Net proceeds from Initial Public Offering..................... -- 29,993 -- Net borrowings (payments) on note payable to bank............. 7,177 (2,400) 2,850 (Payments) borrowings on subordinated debt.................... -- (3,000) 3,000 Principal payments on long-term debt.......................... -- (5,439) -- Purchase of Company common shares............................. -- (165) (1,226) Other......................................................... -- 135 153 ----------- ------------ ------------- Net cash provided by financing activities.................. 7,177 19,124 4,777 Effect of exchange rates on cash................................. (183) (105) (21) ----------- ------------ ------------- Net (decrease) increase in cash and cash equivalents....... (2,870) 524 325 Cash and cash equivalents at beginning of year................... 3,542 3,018 2,693 ----------- ------------ ------------- Cash and cash equivalents at end of year......................... $ 672 $ 3,542 $ 3,018 =========== ============ ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Interest................................................... $ 771 $ 841 $ 782 =========== ============ ============= Income taxes............................................... $ 1,412 $ 3,943 $ 1,231 =========== ============ =============
The accompanying notes are an integral part of these Consolidated Financial Statements. F-8 40 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 1999, 1998 AND 1997 (TABULAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES ------------------------------------------ BUSINESS International Total Services, Inc. and Subsidiaries (the "Company"), an Ohio corporation, is a provider of aviation security and other aviation services, providing personnel and management support to airlines at airports primarily in the United States and Europe. The Company also provides commercial staffing services and security products to various businesses in the United States. FISCAL YEAR The Company's fiscal year ends on March 31. All references to fiscal years in these notes to the consolidated financial statements represent the year in which the fiscal period ends (i.e. fiscal 1999 is the year ended March 31, 1999) unless otherwise noted. PRINCIPLES OF CONSOLIDATION The consolidated financial statements include the accounts of the Company and its wholly-owned foreign and domestic subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. REVENUE RECOGNITION Revenues are recognized at the time that aviation and commercial security services are provided. Revenues generated from sales of security products are recognized when the products are delivered and installed. TRANSLATION OF FOREIGN CURRENCIES All balance sheet accounts of foreign operations are translated into U.S. dollars at the fiscal year-end rate of exchange, and statement of operations items are translated at the weighted average exchange rate for the fiscal year. The resulting translation adjustments are reflected in comprehensive income (loss) and displayed as a separate component of shareholders' equity. STATEMENTS OF CASH FLOWS During fiscal 1998 and 1997, the Company entered into the following noncash transactions (during fiscal 1999, there were no such noncash transactions): (1) During fiscal 1998, the Company's principal shareholder, who was also, at the time, the Company's Chairman and Chief Executive Officer, contributed 73,101 common shares, valued at approximately $805,000, to a former employee to settle the Company's previously recorded liability to him. (2) During fiscal 1997, the Company redeemed 200 shares of Class E preferred shares from its principal shareholder in settlement of a $200,000 note receivable from him. In addition, the Company declared $52,000 in F-9 41 dividends, including all dividend arrearages, on the preferred shares and paid the dividends by reducing the accrued interest receivable due on the note. (3) During fiscal 1997, the Company acquired an affiliated entity in a transaction accounted for in a manner similar to a pooling. The acquisition was completed by issuing 4,126 common shares from treasury to the Company's (and the affiliate's) principal shareholder, paying $12,500 to the other shareholders of the affiliate and by offsetting $1.7 million in notes and accrued interest receivable due to the Company from the shareholders of the affiliate against corresponding obligations of the affiliate to such shareholders. The notes and interest receivable included $1.3 million due from the Company's principal shareholder. The shareholders of the affiliate were also officers of the Company. FINANCIAL INSTRUMENTS The Company considers all highly liquid investments with original maturities of three months or less to be cash and cash equivalents. Other financial instruments consisting of trade and other receivables, and long-term debt, are considered to have a fair value which approximates their carrying value at March 31, 1999 and 1998, due to the short term duration of receivables and the fact that the debt instruments have variable rate interest features and a relatively short-term duration. UNIFORMS Uniforms consist of uniforms on hand that have not been issued to employees and uniforms in service. Uniforms in service are recorded at cost and amortized over their expected useful lives of 18 months. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the respective assets, principally five or seven years, using the straight-line method. INTANGIBLES Intangibles consist primarily of goodwill, representing the excess purchase price paid over the fair value of net assets acquired from the acquisitions of various aviation service and commercial security businesses, primarily through the assumption of security service contracts. Intangibles include the fair value of those service contracts acquired in the acquisitions. Goodwill is being amortized on a straight-line basis over the life of the contracts, including anticipated renewals (generally 20 years), based on the Company's historical retention rate, giving consideration to additional business obtained or obtainable as a result of entering new markets through the acquisition of existing contracts. The service contracts are being amortized on a straight-line basis over their remaining lives, up to a maximum of five years. Accumulated amortization of intangibles was $3,932,000 and $1,636,000 at March 31, 1999 and 1998, respectively. Management of the Company regularly evaluates the recoverability of its goodwill and long-lived assets under APB Opinion No. 17 "Intangible Assets" and Statement of Financial Accounting Standards ("SFAS") No. 121, "Accounting for the Impairment of Long-Lived Assets To Be Disposed Of." The Company uses projected undiscounted future cash flows to determine whether the carrying amount of the asset can be recovered over its remaining life. Based on the assessments made, management believes that there has been no impairment of the Company's domestic goodwill and long-lived assets. The Company recorded a $472,000 write-down of contracts and goodwill at two of its foreign locations. See Note F for a discussion of the foreign operations. SELF-INSURANCE RESERVES The Company is self-insured up to a stop loss of $250,000 per claim for general liability and workers' compensation claims. An estimated provision for claims under the self-insurance programs is recorded and revised annually based on industry trends, historical experience and management judgment. Changes in assumptions for such matters as legal actions, medical costs and actual experience could cause estimates to change in the near term. F-10 42 USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Since actual results could differ from those estimates, management revises estimates as better information becomes available. ACCOUNTING STANDARDS NOT YET ADOPTED In June 1998, the Financial Accounting Standards Board ("FASB") issued SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities." This Statement establishes accounting and reporting standards for derivative instruments and hedging activities. It requires companies to recognize all derivatives on the balance sheet as assets and liabilities, measured at fair value. Gains or losses resulting from changes in the values of those derivatives would be accounted for depending on the use of the derivative and whether it qualifies for hedge accounting. This Statement is effective for fiscal years beginning after June 15, 2000. The Company will adopt this Statement on April 1, 2001, and it is expected not to have a material effect on its financial statements. RECLASSIFICATIONS All 1997 share and per share amounts have been adjusted for the 12,892.62 for 1 stock split declared on June 17, 1997. Certain reclassifications have been made to the prior periods' consolidated financial statements to conform with the 1999 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 and 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. See Note U. This restatement is to correct accounting that resulted from the failure of the Company to properly consider F-11 43 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. The Company's fiscal 1998 and 1997 financial statements have been restated to (i) increase Workers' Compensation expense, (ii) charge to expense in fiscal 1998 and 1997 vacation costs incurred for those years but not accrued (iii) record various liabilities relating to corporate rent that should have been accrued in fiscal 1998 (iv) adjust the 1998 and 1997 income tax provisions for the tax effects of the adjustments described above. The total and per share effects of each of these adjustments on the previously reported results of operations for 1998 and 1997 and the restated amounts are as follows:
Years Ended March 31, --------------------- 1998 1997 ---- ---- Earnings Per Earnings Per Net Income Share* Net Income Share* ---------- ------ ---------- ------ Amounts previously reported $5,245 $1.01 $1,696 $0.33 ------ ----- ------ ----- Restatement Adjustments: Increase in Worker's Compensation (272) (.05) (66) (.01) Increase in Vacation Expense (304) (.06) (142) (.03) Increase in miscellaneous operating expenses (70) (.02) Related income tax adjustments 258 .05 81 .02 ------ --- ------ ------ Total restated adjustments (388) (.08) (127) (.02) ------- ----- ----- ----- Restated Amount $4,857 $0.93 $1,569 $0.31 ====== ===== ====== =====
*Calculated using the weighted average number of basic shares outstanding. The diluted per share amounts for these periods would be approximately the same as the basic per share amounts presented above. The accompanying financial statements also reflect adjustments to the April 1, 1996 balance of retained earnings for the effects as of that date of changes to the Company's previously reported fiscal 1996, 1995 and prior financial statements as follows: Retained Earnings as of April 1, 1996, as previously reported $ 3,998 ------ Prior period adjustments (net of tax): Increase in Workers Compensation expense 1996 (26) 1995 (5) Increase in Vacation expense 1996 (82) 1995 (60) Prior (96) ------- (269) Retained Earnings at April 1, 1996, as restated $3,729 ------ Impact on Earnings per share:* Decrease to 1996 Net Income per Share $(0.02) ======= Increase to 1995 Net Loss per Share $ 0.01 ======= F-12 44 *Calculated using the weighted average number of basic shares outstanding. The diluted per share amount for these periods would be the same as the basic per share amounts presented above. NOTE D - COMPREHENSIVE INCOME (LOSS) -------------------------- Effective April 1, 1998 the Company adopted SFAS No. 130, "Reporting Comprehensive Income" which requires disclosure of comprehensive income (loss). Comprehensive income (loss) is defined as changes in shareholders' equity from non-owner sources and for the Company, includes net income (loss) and changes in the foreign currency translation adjustment. The adoption of this statement had no impact on the Company's net income (loss) or shareholders' equity. Prior year financial statements have been reclassified to conform to the requirements of this statement. NOTE E - ACQUISITIONS OF OPERATING CONTRACTS ----------------------------------- During fiscal year 1999, the Company acquired aviation services and commercial staffing contracts and related property and equipment from six companies for an aggregate purchase price of approximately $9.7 million. During the fiscal year ended March 31, 1998, the Company acquired aviation service and commercial security contracts and related property and equipment from eleven entities for an aggregate purchase price of approximately $23.3 million. The acquisitions have been accounted for under the purchase method of accounting with the purchase price allocated to the contracts based upon their estimated fair market values. The purchase price allocation for the 1999 acquisitions resulted in goodwill of approximately $7.4 million, which is being amortized to operations on a straight-line basis over 20 years. The purchase price allocation for the 1998 acquisitions resulted in goodwill of approximately $19.8 million. The operating results related to the acquired contracts have been included in the Company's results of operations from the respective dates of acquisition. The following unaudited pro forma results of operations give effect to the above acquisitions as if the acquisitions had occurred at April 1, 1997:
Years Ended March 31 -------------------------- 1999 1998 ---- ---- Net operating revenues.............................. $ 232,536 $ 232,446 Net income (loss)................................... $ (7,030) $ 7,088 Net income (loss) per share: Basic ..................................... $ (1.06) $ 1.36 Diluted ..................................... (1.06) $ 1.35
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 fiscal 1998, or of results which may occur in the future. NOTE F - FOREIGN OPERATIONS ------------------ In the fourth quarter of fiscal 1999, management decided to abandon all operating activities, consisting of aviation services, in Italy and the Czech Republic due to poor operating performance (total operating losses of approximately $269,000). This resulted in a charge of $190,000 in fiscal 1999 to operations to write-off all of the remaining assets, consisting primarily of accounts receivable and other net assets associated with these entities. The Company also decided to cease all of its operating activities, consisting of aviation services, in Germany based on unfavorable past performance and the insolvency of its largest customer. A charge of $457,000 to operations was incurred in fiscal 1999 to recognize the write-off of the related net assets, exclusive of intangibles. These assets primarily consisted of accounts receivable and other assets. For the fiscal year ending March 31, 1999, prior to the charges discussed above, the German affiliate recorded a loss from operations of approximately $353,000. F-13 45 Also as a result of the customer's insolvency mentioned above, the Company wrote off its $409,000 investment in the United Kingdom joint venture with this customer. In conjunction with the above, the Company recognized an impairment charge of approximately $472,000; which is equal to the value of unamortized contracts and goodwill associated with the Italian and German entities, as all operations within these countries were ceased. This charge is included as a component of selling, general and administrative expenses in the accompanying statement of operations. The Company reviewed the realizability of its contracts and related goodwill based on historical and future profitability and concluded it does not expect to receive any future benefit from these assets. Management also evaluated the receivables associated with its Philippine operations. Based on management's analysis of the realizabilty of the Philippine operations receivables, the Company recorded an additional allowance for doubtful accounts of approximately $247,000 at March 31, 1999. The above charges were recorded during the fourth quarter of fiscal 1999. NOTE G - 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 3.00%. The Company had approximately $10,859,000 and $3,682,000 outstanding under the facility at March 31, 1999 and 1998, respectively with weighted average interest rates of 7.57% and 7.13%, respectively. The credit facility 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. At March 31, 1999, the Company was not in compliance with certain of these covenants. Waivers were obtained for these covenant violations as of March 31, 1999 and waivers were obtained through March 31, 2000 for those covenants which the Company does not anticipate meeting through the end of fiscal 2000. On August 27, 1999, the lender agreed to modify the credit facility. The modifications included a six-month extension of the maturity date 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 Bank Credit Facility was amended and extended to April 1, 2001. See Note T Subsequent Events. At April 7, 2000, outstanding obligations under this facility were $22.9 million. NOTE H - LEASE OBLIGATIONS ----------------- The Company leases certain equipment and facilities under operating leases that expire at various dates. The future minimum lease commitments under these operating leases are as follows: YEARS ENDED MARCH 31, --------------------- 2000................................................. $ 1,231 2001................................................. 1,032 2002................................................. 692 2003................................................. 458 2004................................................. 296 Thereafter........................................... 29 ---------- Total Future Minimum Lease Commitments............... $ 3,738 ========== Rent expense incurred under operating leases was $3.3 million, $2.2 million and $1.4 million for the years ended March 31, 1999, 1998 and 1997, respectively. F-14 46 NOTE I - LITIGATION ---------- The Company is subject to on-going legal proceedings and claims which arise in the ordinary course of its business. While the ultimate outcome of these matters cannot be reasonably estimated at this time, these actions, when ultimately settled or adjudicated, will not, in the opinion of management, have a material adverse effect on the financial condition or results of operations of the Company. The Company has accrued for matters where management has determined that it is probable a liability for which a loss or range of loss can be reasonably estimated has been incurred. The Company does not believe that the ultimate outcome of these proceedings will have a material adverse effect on the Company's business, assets, financial condition or results of operations, however, in the event any of the foregoing litigation results in an award of money damages against the Company, given the Company's liquidity situation, any award could adversely affect the financial condition of the Company. NOTE J - RELATED PARTY TRANSACTIONS -------------------------- The Company had notes receivable due from the Company's principal shareholder, approximately $325,000, which were fully repaid in September 1997. Interest income on shareholder notes amounted to $14,000 and $119,000 in the years ended March 31, 1998 and 1997, respectively. See discussions of other Related Party Transactions in Notes A and T. NOTE K - SELF INSURANCE RESERVE ---------------------- The Company carries insurance for workers' compensation and general liability matters. The Company self insures all employees except for those in states that require coverage under the state's workers' compensation funds. The insurance coverages have deductibles of $250,000 per occurrence. Under the terms of the insurance agreement, the Company has $210,000 in cash on deposit with insurance carriers, which is included in other current assets in the accompanying consolidated balance sheets, and an outstanding letters of credit in the amount of $990,000 at March 31, 1999. These funds and letter of credit serve as collateral for any claims incurred but not reported. The Company has an accrued liability for unpaid workers' compensation claims and claims incurred but not reported (IBNR) of approximately $3.8 million and $1.8 million at March 31, 1999 and 1998, respectively which is included in accrued payroll and employee benefits in the accompanying consolidated balance sheets. The Company has accrued liability for litigation matters that have arisen in the normal operation of the Company of approximately $1.5 million and $1.2 million, respectively at March 31, 1999 and 1998, which is included in other accrued expenses in the accompanying consolidated balance sheets. NOTE L - OTHER ACCRUED EXPENSES ---------------------- Other accrued expenses includes the following at March 31:
1999 1998 ---- ---- Legal and professional (including litigation reserve) $ 1,856 $ 1,226 FAA fines and aircraft damages 1,329 512 Other accrued accounts (all individually below $500) 5,369 3,604 -------- -------- Total other accrued expenses $ 8,554 $ 5,342 ======= =======
NOTE M - INCOME TAXES The components of income (loss) before income taxes and provision for income taxes consist of the following:
YEARS ENDED MARCH 31, ------------------------------------ 1999 1998 1997 ---- ---- ---- (Restated) (Restated) INCOME (LOSS) BEFORE INCOME TAXES Domestic....................................................... $ (4,718) $ 7,914 $ 2,289 Foreign........................................................ (1,783) 443 436 ------------- ------------ ----------
F-15 47 Total..................................................... $ (6,501) $ 8,357 $ 2,725 ============= ============ ========== PROVISION FOR INCOME TAXES CURRENT TAX EXPENSE: Federal..................................................... $ 1,270 $ 2,650 $ 1,095 State....................................................... 145 700 253 Foreign..................................................... 215 223 199 ------------ ------------ ---------- Total current............................................. 1,630 3,573 1,547 DEFERRED TAX EXPENSE (BENEFIT): Federal..................................................... (2,187) (78) (331) State....................................................... (366) 5 (60) ------------ ------------ ---------- Total deferred............................................ (2,553) (73) (391) ------------ ------------ ---------- Total provision before valuation allowance on net deferred tax assets.................. (923) 3,500 1,156 Valuation allowance on net deferred tax assets............ 1,717 - - Total provision for income taxes.................................. $ 794 $ 3,500 $ 1,156 ============= ============ ===========
A reconciliation of the provision for income taxes computed at the United States federal statutory tax rate to the Company's effective tax rate is as follows:
YEARS ENDED MARCH 31, 1999 1998 1997 ---- ---- ---- (Restated) (Restated) Tax at U.S. federal income tax rate (34%)......................... $ (2,210) $ 2,841 $ 926 Valuation allowance............................................... 1,717 -- -- State income taxes--net of U.S. federal tax benefit............... 195 452 118 Difference between foreign and U.S. federal tax rates............. 101 72 51 Nondeductible items............................................... 718 57 60 Other--net........................................................ 273 78 1 ------------ ------------ ---------- $ 794 $ 3,500 $ 1,156 ============ ============ ========== Effective tax rates.......................................... (12.20%) 41.9% 42.4% ============ ============ ==========
The Company does not provide deferred income taxes on unremitted earnings of foreign subsidiaries, as such funds are deemed indefinitely reinvested in those operations. F-16 48 Deferred income taxes reflect the tax effect of temporary differences between the carrying amounts of assets and liabilities for financial reporting purposes and for income tax purposes. Significant components of deferred tax assets and liabilities relate to the following at March 31:
1999 1998 ---- ---- DEFERRED TAX ASSETS: (Restated) Accrued workers' compensation............................................ $ 1,538 $ 785 Accrued legal expenses................................................... 904 571 Deferred compensation.................................................... 81 81 Amortization of intangibles.............................................. 101 35 Allowance for doubtful accounts.......................................... 235 40 State income taxes....................................................... -- 63 Other accruals not currently deductible.................................. 928 554 Other.................................................................... 963 132 ---------- ------- Total Deferred Tax Assets................................................ 4,750 2,261 ---------- ------- DEFERRED TAX LIABILITIES: Depreciation............................................................. 610 620 Other.................................................................... 13 68 ---------- ------- Total Deferred Tax Liabilities........................................... 623 688 ---------- ------- Net Deferred Tax Asset before Valuation Allowance........................ 4,127 1,573 Less: Valuation Allowance............................................ ( 1,717) - ---------- ------- Net Deferred Tax Assets............................................... $ 2,410 $ 1,573 ============ =======
The Company periodically reviews the need for a valuation allowance against certain deferred tax assets and recognizes these assets to the extent that realization is more likely than not. Based upon a review of earnings history, taxes paid, and tax losses for fiscal 2000, the Company recognized to the extent expected to be realized, the tax benefit of $2.4 million. The Company provided a valuation allowance of $1.7 million in 1999, primarily against the net deferred tax assets relating to significant accruals for which utilization is uncertain, since the Company is unable to determine, at this time, that the generation of future taxable income can be predicted to be more likely than not. The net change in the valuation allowance for the year ended March 31, 1999 was $1.7 million and $0 for the two prior years. The net deferred tax assets are classified in the balance sheet as follows at March 31:
1999 1998 ---- ---- (Restated) Current deferred income taxes..................................... $ 3,033 $ 2,007 Noncurrent deferred income taxes.................................. (623) (434) -------------- -------------- Net deferred tax assets......................................... $ 2,410 $ 1,573 ============= ==============
NOTE N - INITIAL PUBLIC OFFERING ----------------------- On September 24, 1997, the Company completed a public offering of 3,021,477 shares of its Common Stock and received net proceeds of approximately $30 million. The Company used the proceeds from the Initial Offering to repay indebtedness and for general corporate purposes, including working capital, and mostly to fund acquisitions. NOTE O - CAPITAL STOCK ------------- The Company has authorized Common Stock at March 31, 1999 of 20,000,000 shares. The Common Stock has one vote per share. The Company had authorized 5 million preferred shares. The Company had issued ten shares of Class A preferred stock for $20,000 and 200 shares of Class E preferred stock for $200,000. All preferred shares were redeemed and retired in 1997. Prior to their redemption, in March 1997, the Company declared and paid dividends on the Class E preferred shares in the amount of $52,000, which included all dividends in arrears, at that date. F-17 49 NOTE P - 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 net income (loss). The share amounts used for the years ended March 31 are as follows:
1999 1998 1997 ---- ---- ---- Basic common shares (weighted average) 6,662 5,215 5,089 Dilutive stock options - 50 - ----- ----- ----- Diluted common shares 6,662 5,265 5,089 ===== ===== =====
There were no dilutive stock options outstanding at March 31, 1999. NOTE Q - LONG-TERM INCENTIVE PLAN ------------------------ In September 1997, the Company adopted the Long-Term Incentive Plan (the "Plan") for its officers and directors. The Company accounts for the Plan under APB Opinion No. 25 and related interpretations. The Plan allows the Company to grant options to officers and directors for up to 500,000 common shares. Options currently outstanding become exercisable one to five years from the grant date and expire 10 years after the grant date. The options are exercisable at the market price of the Company's common shares on the date of grant. Accordingly, no compensation cost has been recognized for the Plan. Had compensation cost for the Plan been determined based on the fair value of the options at the grant date consistent with the method of SFAS No. 123, "Accounting for Stock-Based Compensation", the Company's net income (loss) and earnings (loss) per share for the years ended March 31, 1999 and 1998 would have been reduced (increased) to the proforma amounts indicated below. There were no outstanding options at March 31, 1997.
YEARS ENDED MARCH 31, --------------------------- 1999 1998 ---- ---- NET INCOME (LOSS) (Restated) As reported ........................................................ $ (7,295) $ 4,857 Proforma ........................................................ $ (7,636) $ 4,561 NET INCOME (LOSS) PER SHARE--BASIC As reported ........................................................ $ (1.10) $ 0.93 Proforma ........................................................ $ (1.15) $ 0.87 NET INCOME (LOSS) PER SHARE--DILUTED As reported ........................................................ $ (1.10) $ 0.92 Proforma ........................................................ $ (1.15) $ 0.87
The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions: expected volatility of 45%; risk-free interest rate of 6.24%; and expected lives of 10 years. The effect of applying SFAS 123 for the pro forma disclosures are not representative of the effect expected on reported net income (loss) per share in future years, since the valuations are based on highly subjective assumptions about the future, including stock price volatility and exercise patterns. F-18 50 A summary of the status of the Company's plan as of and for the years ended March 31 are as follows:
1999 1998 ---------------------------------- ----------------------------------- Weighted Average Weighted Average Exercise price Exercise price Shares per share Shares per share ------------ --------------------- ------------ ---------------------- Outstanding at beginning of year... 265 $ 11.25 - - Granted................................ 97 5.95 265 $ 11.25 Forfeited.............................. (115) 11.25 - - ---------- ---------- ---------- -------- Outstanding at end of year......... 247 $ 9.17 265 $ 11.25 ========== ========== ========== ======== Options exercisable at end of year.. 38 0 ========== ========== Weighted average fair value of options granted during the year... $ 13.78 $ 7.43 ========== ========== Weighted average remaining contractual life (years)............. 8.78 9.49 ========== ==========
On September 18, 1998, the Company reset the price of 50,070 stock options to $5.00 per share. On that same day, the Company reset the price of 16,690 stock options to $11.25 per share. There were no options exercised during fiscal 1998 or 1999. The exercise prices of outstanding options on March 31, 1999 range from $4.50 to $11.25. The outstanding options expire at various dates through the year 2008. A summary of stock options outstanding and exercisable as of March 31, 1999 is as follows:
OPTIONS OUTSTANDING OPTIONS EXERCISABLE - ---------------------------------------------------------- ------------------------------------------ Weighted Average Remaining Weighted Average Number Contractual Life Per Share Exercise Number Weighted Average Outstanding (years) Price Exercisable Per Share Exercise Price - --------------- -------------------- ------------------- ------------- -------------------------- 25 9.58 $ 4.50 - - 55 9.06 $ 5.00 - - 167 8.56 $11.25 38 $11.25 --- -- 247 38 === ==
As of March, 31, 1998 there were approximately 265,000 stock options outstanding with a weighted average remaining contractual life of 9.49 years and a weighted average exercise price or $11.25 per share. None of the options were exercisable as of March 31, 1998. NOTE R - DEFINED CONTRIBUTION PLANS -------------------------- The Company and its subsidiaries have a defined contribution (401k) plan for substantially all employees. Employees may contribute up to 15% of their pay. Currently, the Company contributes, in cash, amounts equal to 5% of the employee's contributions, up to the first 8% of the employee's pay. The employee vests in the Company match over a five year period on a pro rata basis. The amount expensed for the Company's matching contribution to the plan was $95,000 and $14,000 in fiscal 1999 and 1998, respectively. NOTE S - REPORTABLE SEGMENTS ------------------- In 1999, the Company adopted SFAS No. 131 "Disclosures about Segments of an Enterprise and Related Information" This statement requires companies to identify segments consistent with the manner in which management makes decisions about allocating resources to segments and measuring their performance. It also requires disclosures of products and services, geographic areas and major customers. The following disclosures have been made in accordance with this new statement. 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, wheelchair and electric cart operations. The Company's commercial staffing services extend beyond aviation security, and include the provision of uniformed security officers, facility access control, security consulting, special event security and F-19 51 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 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 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 -----------------------
COMMERCIAL AVIATION SECURITY SECURITY STAFFING STAFFING PRODUCTS FOR THE YEAR ENDED MARCH 31, 1999 SERVICES SERVICES DISTRIBUTION TOTALS - --------------------------------- -------- -------- ------------ ------ Net operating revenues........................... $171,726 $ 50,849 $ 4,297 $ 226,872 Cost of revenues................................. $158,558 $ 43,282 $ 3,384 $ 205,224 Gross margin..................................... $ 13,168 $ 7,567 $ 913 $ 21,648 Net income (loss)................................ $ (6,005) $ (1,484) $ 194 $ (7,295) FOR THE YEAR ENDED MARCH 31, 1998 (Restated) - ---------------------------------- Net operating revenues........................... $148,082 $ 20,688 $ 3,597 $ 172,367 Cost of revenues................................. $127,856 $ 16,681 $ 2,774 $ 147,311 Gross margin..................................... $ 20,226 $ 4,007 $ 823 $ 25,056 Net income ...................................... $ 4,458 $ 169 $ 230 $ 4,857 FOR THE YEAR ENDED MARCH 31, 1997 (Restated) - --------------------------------- Net operating revenues........................... $103,181 $ 8,740 $ 3,321 $115,242 Cost of revenues................................. $ 89,616 $ 6,937 $ 2,484 $ 99,037 Gross margin..................................... $ 13,565 $ 1,803 $ 837 $ 16,205 Net income (loss)................................ $ 1,500 $ (109) $ 178 $ 1,569
F-20 52
DISCLOSURE OF GEOGRAPHIC INFORMATION ------------------------------------ NET OPERATING REVENUES FOR THE YEAR ENDED MARCH 31, 1999 AND ASSETS AT MARCH 31, 1999 ------------------------------------------------------------------------------------- REVENUES ASSETS ---------------- --------------- United States........................................................ $ 218,889 $ 70,010 Other Countries...................................................... 7,983 624 ---------------- --------------- Total................................................................ $ 226,872 $ 70,634 ================ =============== NET OPERATING REVENUES FOR THE YEAR ENDED MARCH 31, 1998 AND ASSETS AT MARCH 31, 1998 (Restated) ------------------------------------------------------------------------------------- REVENUES ASSETS ---------------- --------------- United States........................................................ $ 166,996 $ 60,135 Other Countries...................................................... 5,371 1,496 ---------------- --------------- Total................................................................ $ 172,367 $ 61,631 ================ =============== NET OPERATING REVENUES FOR THE YEAR ENDED MARCH 31, 1997 AND ASSETS AT MARCH 31, 1997 (Restated) ------------------------------------------------------------------------------------- REVENUES ASSETS ---------------- --------------- United States........................................................ $ 111,635 $ 27,770 Other Countries...................................................... 3,607 1,095 ---------------- --------------- Total................................................................ $ 115,242 $ 28,865 ================ ===============
DISCLOSURE ABOUT MAJOR CUSTOMERS Revenues from the Company's largest customer were approximately 26.0%, 25.6% and 6.6% of net operating revenues for the years ended March 31, 1999, 1998 and 1997, respectively. Accounts receivable from this customer were 32.7% and 19.7% of net accounts receivable at March 31, 1999 and 1998, respectively. Services provided to another major customer represented approximately 11.7%, 14.8% and 19.0% of net operating revenues for the years ended March 31, 1999, 1998 and 1997 respectively. Accounts receivable from this customer were 2.4% and 2.6% of net accounts receivable at March 31, 1999 and 1998, respectively. Furthermore, five airline customers, including the two noted above, accounted for approximately 48%, 54% and 44% of net operating revenues for the years ended March 31, 1999, 1998 and 1997, respectively, and accounted for 42.6% and 30.7% of net accounts receivable at March 31, 1999 and 1998, respectively. NOTE T - 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 the Company to pay Weitzel $300,000 on November 1, 1999 and $200,000 on January 3, 2000, which has been made, 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 beginning February 1, 2000. The Company is obligated to pay Weitzel the $500,000 consulting fee whether or not any services are performed. The Retirement and Consulting Agreement also provided that Weitzel enter into a voting trust agreement (the "Voting Trust Agreement") among F-21 53 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 February 15, 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. 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 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 Common Stock was delisted from the Nasdaq Stock Market. On October 26, 1999 the Company's Common Stock began being quoted on the Electronic Quotation System of the 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. ACQUISITIONS In April, 1999, the Company acquired the commercial security contracts and goodwill of American Investigative and Security Services, Inc. headquartered in Houston, Texas for approximately $1.5 million in cash. The acquired contracts cover commercial staffing services throughout Texas. The transaction will be accounted for as a purchase. In June, 1999, the Company acquired the outstanding stock of Metroplex Control Systems, Inc. ("Metroplex") headquartered in Dallas, Texas for approximately $5.0 million in cash. Metroplex sells, installs and services fire detectors, detention control and other security systems throughout the United States. The transaction was accounted for as a purchase. In March 2000, the Company completed the disposition of Metroplex. The sale proceeds combined with the cash flow distributions received during the period Metroplex was owned was approximately equivalent to the Company's net cash investment. 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 F-22 54 was granted 75,000 shares of common stock as well as an additional 100,000 shares of restricted common stock which vest either over a set period of time or upon attainment of specified goals. Upon termination of employment, Mr. Thompson's 100,000 common shares fully vest. EXTENSION OF BANK CREDIT FACILITY In April 2000 management secured, with its 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 1, 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. NOTE U - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED AND RESTATED) ------------------------------------------------------- The following is a summary of the unaudited restated quarterly results of operations for the years ended March 31, 1999 and 1998.
JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31 ------- ------------ ----------- -------- FISCAL 1999 Net operating revenues (1).................... $ 56,121 $ 58,407 $ 58,858 $ 53,486 ============ ============ ============ ============== Gross margin, as previously reported(1)....... $ 7,125 $ 7,586 $ 7,552 $ (1,884) Restatement(2)............................ $ (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 (2)........................... $ (342) $ (262) $ (276) $ 1,664 ------------ ------------ ------------ -------------- Net income/(loss) as restated................. $ 106 $ 163 $ 214 $ (7,778) ============ ============ ============ =============== Net income/(loss) per share Basic 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) ============ ============ ============ ============== 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) ============ ============ ============ ============== FISCAL 1998 Net operating revenues (1).................... $ 38,205 $ 38,442 $ 46,056 $ 49,664 ============ ============ ============ ============== Gross margin, as previously reported (1)...... $ 6,151 $ 5,990 $ 7,028 $ 6,463 Restatement (2)........................... $ (144) $ (185) $ (164) $ (83) ------------ ------------ ------------ -------------- Gross margin, as restated..................... $ 6,007 $ 5,805 $ 6,864 $ 6,380 ============ ============ ============ ============== Net income, as previously reported............ $ 853 $ 1,125 $ 1,826 $ 1,441 Restatement (2)........................... $ (98) $ (122) $ (109) $ (59) ------------ ------------ ------------ --------------
F-23 55 Net income, as restated....................... $ 755 $ 1,003 $ 1,717 $ 1,382 ============ ============ ============ ============== Net income/(loss) per share Basic As reported........................... $ 0.23 $ 0.29 $ 0.27 $ 0.22 Restatement........................... $ (0.02) $ (0.03) $ (0.01) $ (0.02) ------------ ------------ ------------ -------------- As restated........................... $ 0.21 $ 0.26 $ 0.26 $ 0.20 ============ ============ ============ ============== Diluted As reported........................... $ 0.23 $ 0.29 $ 0.27 $ 0.21 Restatement .......................... $ (0.02) $ (0.03) $ (0.01) $ (0.02) ------------ ------------ ------------ -------------- As restated........................... $ 0.21 $ 0.26 $ 0.26 $ 0.19 ============ ============ ============ ==============
(1) Amounts for the first three quarters of fiscal 1999 and each quarter of fiscal 1998 reflect certain reclassifications to the amounts previously reported to be consistent with the fiscal 1999 presentation. There was no impact on net income (loss). (2) Represents the effect on amounts previously reported for the first three quarters of fiscal 1999 and each quarter of fiscal 1998 (see Note C). RESULTS OF THE THREE MONTHS ENDED MARCH 31, 1999 ------------------------------------------------ Reported earnings for the fourth quarter of fiscal 1999 were impacted materially by several non-recurring items and the results of an in depth review by the Company's management which led to changes in the Company's reserves and accruals. The following is a summary of these adjustments: Write down of assets of foreign operations 1,775(1) Increase in legal and professional accrual 1,277(2) Increase in allowance for customer incentive programs and allowance for doubtful accounts 1,048(3) Write off of fixed assets 575(4)
(1) Represents charges to operations relative to cessation of business and/or adjustments to assets in Italy, Czech Republic, Germany, United Kingdom and Philippines. (See Note F) (2) Charges for legal settlements, changes in case status, legal fees and additional accounting and consulting services incurred as a result of the material weakness in internal controls identified by the Company's independent public accountants. (3) Represents charges for a customer incentive program and adjustment in reserve for bad debts based on a Company review of accounts receivable collected after fiscal year end. (4) During the fourth quarter, the Company identified specific fixed assets that were no longer being utilized in operations. These assets were directly owned or were covered by non-cancelable operating leases. The Company wrote-off those assets no longer utilized in operations and provided for all future monthly obligations for those assets abandoned or covered by non-cancelable operating leases. F-24 56 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES FOR THE YEARS ENDED MARCH 31, 1999, 1998 AND 1997 (AMOUNTS IN THOUSANDS)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------- -------- -------- -------- -------- ADDITIONS BALANCE AT CHARGED TO: BALANCE AT BEGINNING ----------- END OF DESCRIPTION OF PERIOD EXPENSES OTHER DEDUCTIONS PERIOD ----------- --------- -------- ----- ---------- ------ (Restated) (d) Year Ended March 31, 1999 - ------------------------- Self Insurance Reserve $2,996 $5,402 - $3,063 (a) $5,335 Reserve for FAA Fines and Aircraft Damage 512 1,821 - 1,004 (b) 1,329 Allowance for Doubtful Accounts 100 1,248 - 835 (c) 513 Year Ended March 31, 1998 (Restated) (d) - ------------------------- Self Insurance Reserve $1,556 $4,723 - $3,283 (a) $2,996 Reserve for FAA Fines and Aircraft Damage 397 1,280 - 1,165 (b) 512 Allowance for Doubtful Accounts 100 319 - 319 (c) 100 Year Ended March 31, 1997 (Restated) (d) - ------------------------- Self Insurance Reserve $225 $2,358 - $1,027 (a) $1,556 Reserve for FAA Fines and Aircraft Damage 37 574 - 214 (b) 397 Allowance for Doubtful Accounts 100 57 - 57 (c) 100
(a) Cash payments of insurance premiums and claims. (b) Cash payments made for fines and reduction of claims. (c) Trade receivables written off. (d) Amounts have been restated. (See Note C of Notes to Consolidated Financial Statements) F-25 EX-10.14 2 EXHIBIT 10.14 1 EXHIBIT 10.14 SECOND AMENDMENT TO THIRD AMENDED AND RESTATED CONSOLIDATED REPLACEMENT CREDIT FACILITY AND SECURITY AGREEMENT -------------------------------------------------- THIS SECOND AMENDMENT TO THIRD AMENDED AND RESTATED CONSOLIDATED REPLACEMENT CREDIT FACILITY AND SECURITY AGREEMENT (this "Agreement") dated as of December 16, 1998, is entered into by and between INTERNATIONAL TOTAL SERVICES, INC., an Ohio corporation ("Borrower"), and BANK ONE, NA, successor by merger to BANK ONE, CLEVELAND, NA, a national bank (the "Bank"). WITNESSETH ---------- WHEREAS, the Borrower and the Bank are parties to that certain Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement dated as of March 31, 1997, as amended by that certain First Amendment dated as of October 10, 1997 (the "Loan Agreement", all terms defined in said Loan Agreement being used herein with the same meaning), pursuant to which the Bank has agreed to make a $30,000,000 Revolving Loan to the Borrower until September 30, 1999, evidenced by a Note dated October 10, 1997 and payable to the Bank, such Note being payable on demand; and WHEREAS, the Borrower and the Bank have agreed to amend the Loan Agreement (i) to provide for a new form of Borrowing Base Certificate; and (ii) to modify certain definitions in Section 1 of the Loan Agreement, to modify certain provisions of Section 2 of the Loan Agreement and to modify certain convents in Section 8 of the Loan Agreement; NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Borrower and the Bank agree as follows: AGREEMENT Section 1. AMENDMENT OF LOAN AGREEMENT. A. The definition of "Commitment" set forth in Section 1 of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: COMMITMENT - Lender's letter to Borrower dated March 21, 1997, as accepted by Borrower on March 25, 1997; Lender's letter to Borrower dated June 11, 1997, containing 2 Option A and B as accepted by Borrower on June 11, 1997 as to Option B; and Lender's letter to Borrower dated December 3, 1998, as accepted by Borrower on December 9, 1998. B. Subsection 2.3(A) of the Agreement is, effective the Effective Date, amended and restated to read in its entirety as follows: 2.3 REVOLVING LOAN. (A) REVOLVING LOAN. Subject at all times to the terms hereof, the Lender will, from and after December 16, 1998 until September 30, 1999 make such loans to the Borrower as from time to time the Borrower requests (the "Revolving Loan") consisting of advances made by Lender against the value of Eligible Accounts-Domestic and Eligible Accounts-Foreign. Subject to the provisions of Subsection (B) of this Section 2.3, the aggregate unpaid principal of the Revolving Loan outstanding at any one time shall not exceed the lesser of (a) the line of credit approved for Borrower, which is currently Thirty Million Dollars ($30,000,000), less the face amount of all outstanding Letters of Credit issued by Lender for the account of Borrower or (b) the sum of (i) eighty percent (80%) of the unpaid face amount of Eligible Accounts-Domestic (or such other percentages of Eligible Accounts-Domestic as may from time to time be fixed by the Lender upon notice to the Borrower) and (ii) the lesser of fifty percent (50%) of the unpaid face amount of Eligible Accounts-Foreign (or such other percentages of Eligible Accounts- Foreign as may from time to time be fixed by the Lender upon notice to the Borrower) or Three Hundred Fifteen Thousand Dollars ($315,000) (or such other dollar amount as may from time to time be fixed by the Lender upon notice to the Borrower) less a reserve equal to twenty-five percent (25%) of the Borrower's accrued payroll and related expenses account calculated at the most recent calendar month-end plus the difference between seventy-five percent (75%) of the accrued payroll and related expense account and forty percent (40%) of the qualified accounts receivable value (Line 8 of the Borrowing Base Certificate); provided, however, that if this figure is zero or negative, a zero value will be added to the reserve for payroll and related expenses account, otherwise the difference will be added to the reserve for payroll and related expenses account; and further provided, however, the reserve is limited to a maximum of fifty percent (50%) of the Borrower's accrued payroll and related expenses account. C. Subsection 8.1(O) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: (O) Maintain at all times a Tangible Net Worth equal to or greater than Five Hundred Thousand Dollars ($500,000) commencing September 30, 1998 and thereafter, and maintain at all times Stockholder's Equity equal to or greater than Thirty-Eight Million Dollars ($38,000,000) commencing September 30, 1998 and thereafter, such covenants to be calculated monthly in accordance with GAAP based on Borrower's internally prepared interim financial statements. D. Subsection 8.2(K) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: 2 3 (K) Make Capital Expenditures during any fiscal year of Borrower which, in the aggregate, exceed Four Million Dollars ($4,000,000). E. EXHIBIT A attached to the Loan Agreement is, effective the Effective Date, hereby deleted and the form of Borrowing Base Certificate attached to this Agreement as EXHIBIT A is hereby substituted therefor. Section 2. EFFECTIVE DATE OF THE AGREEMENT. The effective date of this Agreement ("Effective Date") shall be the date on which all conditions precedent have been satisfied, or waived by the Bank in writing. Section 3. CONDITIONS PRECEDENT. Borrower hereby acknowledges and agrees that the effectiveness of this Agreement is conditioned upon the receipt by the Bank, on or prior to the date hereof, in form and substance satisfactory to the Bank and its counsel, of the following: A. A certificate, dated as of the date hereof, signed by the Chief Executive Officer of Borrower and to the effect that: 1) As of said date, no Event of Default has occurred and is continuing, and no event has occurred and is continuing that, with the giving of notice or passage of time, or both, would be an Event of Default; and 2) The representations and warranties of Borrower set forth in Section 7 of the Loan Agreement are true and correct as of such date; and 3) Borrower is in compliance with all of the terms and conditions set forth in the Loan Agreement on and as of said date. B. A certificate, dated as of the date hereof, signed by the Secretary of Borrower certifying as follows: 1) Borrower's Articles of Incorporation and Code of Regulations have not been modified or amended since June 17, 1997 (or certifying that true, correct and complete copies of all such modifications and amendments are attached thereto); and 2) Copies of resolutions of Borrower's Board of Directors are attached thereto with respect to the approval of this Agreement and of the matters contemplated hereby and authorizing the execution, delivery and performance of this Agreement and each other document, instrument, agreement or note to be delivered pursuant hereto; and 3 4 3) As to the incumbency and signatures of the officers of Borrower signing this Agreement and each other document, instrument, agreement or note to be delivered pursuant hereto. C. An Acknowledgement, Consent and Agreement in the form of EXHIBIT B attached hereto, with all blanks completed, duly executed and delivered by Transport, NBC, and the Guarantors to Bank. D. The written opinion of counsel for Borrower as to the enforceability of this Agreement, the Loan Agreement, Note, and each of the other Credit Documents and covering such other issues thereunder as requested by Bank and its counsel. E. Such other documents, instruments, agreements and notes as the Bank may reasonably request to implement this Agreement and the transactions contemplated hereby and by the Loan Agreement. SECTION 4. FEES AND EXPENSES. Borrower shall pay all out-of-pocket fees and expenses incurred by the Bank in connection with the preparation, negotiation, execution and delivery of this Agreement, the promissory notes, guaranty, participation agreement, and all the other agreements, documents or certificates required or contemplated hereby, including, without limitation, legal fees and expenses of the Bank. SECTION 5. REFERENCES. On and after the effective date of this Agreement, each reference in the Loan Agreement to "this Agreement", "hereunder", "hereof", or words of like import referring to the Loan Agreement, and in the Note to the "Loan Agreement", "thereof", or words of like import referring to the Loan Agreement shall mean and refer to the Loan Agreement as previously amended and as amended hereby. References to EXHIBIT A in the Loan Agreement shall be deemed to refer to the form of Borrowing Base Certificate attached hereto as EXHIBIT A. The Loan Agreement, as previously amended and as amended by this Agreement, and all Credit Documents are and shall continue to be in full force and effect and are hereby and in all respects ratified and confirmed. References to the Loan Agreement in the Note shall be deemed to include all amendments to the Loan Agreement whether specified in the Note or not. SECTION 6. APPLICABLE LAW. This Agreement shall be deemed to be a contract under the laws of the State of Ohio, and for all purposes shall be construed in accordance with the laws of the State of Ohio. 4 5 SECTION 7. COUNTERPARTS. This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument, and any one of the parties hereto may execute this Agreement by signing any such counterpart. IN WITNESS WHEREOF, the Borrower and the Bank have caused this Agreement to be executed by their duly authorized officers as of the date and year first above written. BANK ONE, NA INTERNATIONAL TOTAL SERVICES, INC. By /s/Louis G. Johnston By /s/Robert A. Weitzel -------------------- -------------------- Name: Louis G. Johnston Name: Robert A. Weitzel Title: Senior Vice President Title: Chief Executive Officer 5 6 SCHEDULE 1 List of Guarantors ------------------ DOMESTIC Crown Technical Systems, Inc. (Ohio) T.I.S. Incorporated (Texas) Certified Investigative Services, Inc. (Texas) I.T.S. of New York, Inc. (New York) Selective Detective Services, Inc. (New Jersey) FOREIGN International Total Services, Ltd. (United Kingdom) International Transport Security, s.r.o. (Czech Republic) International Transport Services, Ltd. (Thailand) EXHIBIT A --------- FORM OF BORROWING BASE CERTIFICATE 7 EXHIBIT B --------- FORM OF ACKNOWLEDGMENT, CONSENT AND AGREEMENT (GUARANTORS) ACKNOWLEDGEMENT, CONSENT AND AGREEMENT -------------------------------------- The undersigned each hereby acknowledges receipt of a copy of the Second Amendment to Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement dated as of December 16, 1998, by and between International Total Services, Inc. ("Borrower") and Bank One, NA, successor by merger to Bank One, Cleveland, NA ("Bank One") and by executing this Acknowledgment, Consent and Agreement the undersigned each hereby agrees to remain bound by the terms and conditions of its respective Amended and Restated Replacement Guaranty Agreement, Guaranty Agreement, Amended and Restated Replacement Guarantor Security Agreement and Guarantor Security Agreement, as applicable, each dated as of August 11, 1995, executed and delivered to Bank One in connection with the Second Amended and Restated Replacement Credit Agreement dated as of August 11, 1995, as subsequently amended, and each other document hereafter executed in connection herewith or therewith by the undersigned. Dated: December 16, 1998 CROWN TECHNICAL SYSTEMS, INC. By: /s/Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chairman of the Board T.I.S. INCORPORATED By: /s/Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chief Executive Officer CERTIFIED INVESTIGATIVE SERVICES, INC. By: /s/ Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chief Executive Officer 8 I.T.S. OF NEW YORK, INC. By: /s/Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chief Executive Officer SELECTIVE DETECTIVE SERVICES, INC. By: /s/Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chief Executive Officer INTERNATIONAL TOTAL SERVICES, LTD. By: /s/Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chief Executive Officer INTERNATIONAL TRANSPORT SECURITY, s.r.o. By: /s/Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chief Executive Officer INTERNATIONAL TRANSPORT SERVICES, LTD. By: /s/Robert A. Weitzel -------------------------------- Name: Robert A. Weitzel Title: Chief Executive Officer EX-10.15 3 EXHIBIT 10.15 1 EXHIBIT 10.15 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT is made as of the 28th day of October, 1999, by and between INTERNATIONAL TOTAL SERVICES, INC., an Ohio corporation (the "Corporation"), and MARK D. THOMPSON, an Ohio resident ("Thompson"). RECITALS WHEREAS, the Corporation desires to employ Thompson and Thompson desires to enter into the employ of the Corporation, all on the terms and subject to the conditions set forth in this Agreement; and WHEREAS, Thompson has requested, and the Corporation has agreed, that Thompson be indemnified for all liabilities arising out of or relating to his services to the Corporation whether as a consultant, employee or officer of the Corporation or otherwise; NOW, THEREFORE, in consideration of the recitals and of the mutual covenants and agreements set forth herein and for other good and valuable consideration, the receipt and sufficiency of which are hereby acknowledged, the Corporation and Thompson hereby agree as follows: 1. Employment, Contract Period. During the period specified in this Section 1, the Corporation shall employ Thompson, and Thompson shall serve the Corporation, on the terms and subject to the conditions set forth herein. The term of Thompson's employment hereunder shall commence as of the date hereof (the "Effective Date"), and, subject to prior termination as provided in Section 8 hereof, shall continue indefinitely on a month-to-month basis. The term of Thompson's employment hereunder shall be automatically renewed on the first of each following month for an additional term of one month, unless the Corporation shall have given at least ninety (90) days advance notice of its intention not to renew the term of Thompson's employment hereunder. The term of Thompson's employment hereunder is sometimes hereinafter referred to as the "Contract Period". 2. Position; Duties; Responsibilities. (a) At all times during the Contract Period, Thompson shall have the titles of "President" and "Interim Chief Executive Officer" and shall have and perform duties and responsibilities as may be assigned by the Board of Directors of the Corporation, which duties and responsibilities will be those customarily performed by a chief executive officer of a publicly-held company of comparable size in the same or related industries. (b) Thompson shall devote such professional time, energy and talent to the business of and to the furtherance of the purposes and objectives of the Corporation as he deems appropriate to carry out his duties hereunder. (c) Thompson shall report directly to the Board of Directors of the Corporation. 3. Compensation. The Corporation shall pay to Thompson a base salary at the rate specified in Paragraph (a), below, and a bonus, if any, as provided in Paragraph (b), below. 2 (a) The rate of Thompson's base salary shall be $300,000 per year, payable in accordance with the Corporation's usual pay practices (and in any event no less frequently than monthly), as the same may be increased (but not decreased) from time to time (based upon the performance of the Corporation and Thompson) as determined by the Board of Directors of the Corporation in its sole discretion. (b) For each calendar year or portion thereof that Thompson is employed under this Agreement, the Corporation may pay to Thompson a bonus, which will be based upon the performance of the Corporation and Thompson, at such times and in such amounts as the Board of Directors of the Corporation, in its sole discretion, may determine. (c) Upon adoption of this Agreement, the Corporation shall grant to Thompson 75,000 of the Corporation's common shares on a fully vested and unrestricted basis. In addition, the Corporation shall grant Thompson 100,000 of the Corporation's common shares as a restricted stock award subject to the vesting, forfeiture and other provisions set forth in the Restricted Stock Award Agreement attached hereto as Exhibit "A." The Corporation shall use its reasonable best efforts consistent with fiscal responsibility to register such common shares with the Securities and Exchange Commission for resale by Thompson as soon as practicable after the Effective Date. 4. Reimbursement for Expenses. The Corporation shall reimburse Thompson for all reasonable, ordinary and necessary expenses incurred by him in the performance of his duties hereunder, provided that Thompson accounts to the Corporation therefor in a manner sufficient to substantiate deductions with respect to those expenses by the Corporation for federal income tax purposes. 5. Vacations. During the Contract Period, Thompson shall be entitled to up to four (4) weeks (twenty (20) days) of vacation each year to be taken at such time or times as Thompson may determine in such a manner as to avoid undue disruption to the business of the Corporation. 6. Benefits. During the Contract Period, Thompson and his family shall be entitled to participate in such pension, retirement, medical reimbursement, insurance and similar plans, if any, enjoyed by executive officers of the Corporation generally. Thompson shall also be entitled to participate in any option or other employee benefit compensation plan that is enjoyed by executive officers of the Corporation generally. Thompson's participation in and benefits under any such plan shall be on the terms and subject to the conditions specified in the governing document of that plan. 7. Effect of Disability While in Employ of the Corporation. If while Thompson is employed by the Corporation, he becomes disabled, by reason of physical or mental impairment, to such an extent that he is unable to substantially perform his duties under this Agreement: (a) the Corporation may relieve Thompson of his duties under this Agreement for as long as Thompson is so disabled. (b) the Corporation shall pay to Thompson, net of the offset referred to in the last sentence of this Paragraph (b), all base salary to which he would have been entitled under 2 3 this Agreement had he continued to be actively employed by the Corporation to the earliest of (i) the first date on which he is no longer so disabled, (ii) the date on which he has been so disabled for an aggregate of 120 business days (whether or not consecutive) during any period of twelve consecutive calendar months, (iii) the date of his death, or (iv) the 90th day of his disability. Any payment referred to in this Paragraph (b) shall be made at the same time as that payment would have been made if Thompson were not disabled. Payments under this Paragraph (b) for any period shall be offset, dollar for dollar, by any disability benefits (other than benefits payable pursuant to any disability income policy all of the premiums for which were paid by Thompson) for that period that are received by Thompson. (c) Except as provided in this Section 7, the Corporation shall have no further obligations to Thompson for base salary for any period during which Thompson is so disabled to such an extent that he is unable to substantially perform his duties under this Agreement. 8. Termination. (a) AT EXPIRATION OF A TERM. If the Corporation gives Thompson 90 days' advance notice of its intention not to renew the term of Thompson's employment hereunder (as permitted by Section 1), Thompson's employment hereunder shall terminate at the close of business on the last day of the month next preceding the first day of the month as to which such 90 days' advance notice was given. (b) DEATH OR DISABILITY. Thompson's employment hereunder will terminate immediately upon Thompson's death. The Corporation may terminate Thompson's employment hereunder immediately upon giving notice of termination if Thompson is disabled, by reason of physical or mental impairment, to such an extent that he has been unable to substantially perform his duties under this Agreement for an aggregate of 120 business days (whether or not consecutive) during any period of twelve consecutive calendar months. (c) FOR CAUSE. The Board of Directors of the Corporation, by action of three-quarters of all of its duly elected members, may terminate Thompson's employment under this Agreement if it determines in good faith that Thompson has, by action or failure to act, given the Corporation Cause for that termination and delivers written notice of that termination, describing the facts constituting Cause, to Thompson. For purposes hereof, the term "Cause" shall mean Thompson's fraud or commission of a felony which results in material injury to the business or reputation of the Corporation, or Thompson's willful breach of this Agreement, which breach has not been cured within thirty (30) days after the Corporation gives notice thereof to Thompson. (d) WITHOUT CAUSE. The Board of Directors of the Corporation may terminate Thompson's employment hereunder at any time without Cause upon notice to Thompson. (e) BY THOMPSON FOR GOOD REASON. Thompson may terminate his employment hereunder for "Good Reason" at any time upon thirty (30) days' advance notice from 3 4 Thompson to the Board of Directors of the Corporation. Thompson shall be deemed to have "Good Reason" to terminate his employment under this Agreement if, at any time during the Contract Period, (i) the Corporation materially changes Thompson's duties and responsibilities without his consent; (ii) Thompson's place of employment or the principal executive offices of the Corporation are moved to a location more than fifty (50) miles from Public Square in the City of Cleveland, Ohio; (iii) there occurs a material breach by the Corporation of any of its obligations under this Agreement (other than those specified in this Section 8(e)); or (iv) there occurs a "Change in Control" (as hereinafter defined) of the Corporation. The term "Change in Control" means the first to occur of the following events (i) any person or group of commonly controlled persons, other than the voting trust established and maintained pursuant to the Voting Trust Agreement made and entered into as of November 1, 1998 by and among the Corporation, Robert A. Weitzel, H. Jeffrey Schwartz, John P. O'Brien and J. Jeffrey Eakin (the "Voting Trust"), acquire ownership or control, directly or indirectly, of more than twenty percent (20%) of the voting control or value of the equity interests in the Corporation; (ii) the shareholders of the Corporation approve an agreement to merge or consolidate with another corporation or other entity resulting (whether separately or in connection with a series of transactions) in a change in ownership of twenty percent (20%) or more of the voting control or value of the equity interests in the Corporation, or an agreement to sell or otherwise dispose of all or substantially all of the Corporation's assets (including, without limitation, a plan of liquidation or dissolution), or otherwise approve of a fundamental alteration in the nature of the Corporation's business; (iii) at any time during any period of twenty-four (24) consecutive months, individuals who were directors at the beginning of the 24-month period no longer constitute a majority of the members of the Board of Directors of the Corporation, unless the election, or the nomination for election by the Corporation's shareholders, of each director who was not a director at the beginning of the period is approved by at least a majority of the directors who (x) are in office at the time of the election or nomination and (y) were directors at the beginning of the period (the "Continuing Directors"); (iv) the election of any director to the Board of Directors of the Corporation who was not nominated by the Continuing Directors; or (v) termination of the Voting Trust. Thompson may exercise his right to terminate under this Section 8(e) only if Thompson gives the Corporation written notice thereof within thirty (30) days after he first knew of the existence of the events constituting "Good Reason" and, with respect to the events specified in clauses (i) and (iii) of the definition of "Good Reason" above, the Corporation fails to eliminate or cure the events constituting "Good Reason" within ten (10) days after receiving that notice. (f) BY THOMPSON WITHOUT GOOD REASON. Thompson may terminate his employment hereunder at any time upon notice from Thompson to the Board of Directors of the Corporation. The exercise by the Corporation of its rights of termination under this Section 8 shall be the Corporation's sole remedy in the event of the occurrence of the event as a result of which such right 4 5 to terminate arises. Upon any termination of this Agreement, Thompson shall be deemed to have resigned from all offices and directorships held by Thompson in the Corporation. In the event of a termination claimed by the Corporation to be for "Cause" pursuant to Section 8(c) or by Thompson to be for "Good Reason" pursuant to Section 8(e), Thompson or the Corporation shall have the right to have the justification for said termination determined by arbitration in Cleveland, Ohio. In order to exercise such right, Thompson or the Corporation shall serve on the other party hereto, within thirty (30) days after termination, a written request for arbitration. The Corporation immediately shall request the appointment of an arbitrator by the American Arbitration Association and thereafter the question of "Cause" or "Good Reason," as the case may be, shall be determined under the rules of the American Arbitration Association, and the decision of the arbitrator shall be final and binding on both parties. The parties shall use all reasonable efforts to facilitate and expedite the arbitration and shall act to Cause the arbitration to be completed as promptly as possible. During the pendency of the arbitration, Thompson shall continue to receive all compensation and benefits to which he is entitled hereunder, and if at any time during the pendency of such arbitration the Corporation fails to pay and provide all compensation and benefits to Thompson in a timely manner, the Corporation shall be deemed to have automatically waived whatever rights it then may have had to terminate Thompson's employment for Cause. Expenses of the arbitration shall be borne by the parties in the proportion determined by the arbitrator based upon the reasonableness of the positions of the parties. 9. Payments Upon Termination. Upon any termination of Thompson's employment, the Corporation shall pay to Thompson all accrued, unpaid base salary and other benefits accrued through the date of termination. Upon any termination pursuant to Sections 8(a), 8(d) or 8(e), the Corporation shall pay to Thompson all of the compensation and benefits payable hereunder for the remainder of the Contract Period. 10. Tax Adjustment Payments. If all or any portion of the amounts payable to Thompson under this Agreement (together with all other payments of cash or property, whether pursuant to this Agreement or otherwise, including, without limitation, the issuance of common shares of the Corporation, or the granting, exercise or termination of options therefor) constitutes "excess parachute payments" within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code"), that are subject to the excise tax imposed by Section 4999 of the Code (or any similar tax or assessment), the amounts payable hereunder shall be increased to the extent necessary to place Thompson in the same after-tax position as he would have been in had no such tax assessment been imposed on any such payment paid or payable to Thompson under this Agreement or any other payment that Thompson may receive in connection therewith. The determination of the amount of any such tax or assessment and the incremental payment required hereby in connection therewith shall be made by the accounting firm employed by Thompson and said incremental payment shall be made within five (5) days after that determination has been made. If, after the date upon which the payment required by this Section 10 has been made, it is determined (pursuant to final regulations or published rulings of the Internal Revenue Service, final judgment of a court of competent jurisdiction, Internal Revenue Service audit assessment, or otherwise) that the amount of excise or other similar taxes or assessments payable by Thompson is greater than the amount initially so determined, then the Corporation shall pay Thompson an amount equal to the sum of (i) such additional excise or other taxes, plus (ii) any interest, fines and penalties resulting 5 6 from such underpayment, plus (iii) an amount necessary to reimburse Thompson for any income, excise or other tax assessment payable by Thompson with respect to the amounts specified in (i) and (ii) above and the reimbursement provided by this clause (iii), in the manner described above in this Section 10. Payment thereof shall be made within five (5) days after the date upon which such subsequent determination is made. 11. Indemnification. (a) INDEMNIFICATION IN NON-DERIVATIVE ACTIONS. The Corporation shall indemnify Thompson against any and all losses, claims, damages, liabilities, costs and expenses other than attorneys' fees (including any and all losses, claims, damages, liabilities, costs and expenses arising out of events occurring prior to the Effective Date) with respect to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative, other than an action by or in the right of the Corporation, by reason of the fact that he is or was a consultant to or agent or officer of the Corporation, or is or was serving at the request of the Corporation as a consultant to or a director, trustee, officer, employee or agent of another corporation, domestic or foreign, nonprofit or for profit, partnership, limited liability company, joint venture, trust or other enterprise, including judgments, fines and amounts paid in settlement, actually and reasonably incurred by him in connection with such action, suit or proceeding if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, and with respect to any criminal action or proceeding, had no reasonable Cause to believe his conduct was unlawful. The termination of any action, suit or proceeding by judgment, order, settlement, conviction or upon a plea of nolo contendere or its equivalent, shall not, of itself, create a presumption that Thompson did not act in good faith and in a manner which he reasonably believed to be in or not opposed to the best interests of the Corporation, and with respect to any criminal action or proceeding, that he had reasonable Cause to believe that his conduct was unlawful. (b) INDEMNIFICATION IN DERIVATIVE ACTIONS. The Corporation shall indemnify Thompson against any and all losses, claims, damages, liabilities, costs and expenses other than attorneys' fees (including any and all losses, claims, damages, liabilities, costs and expenses arising out of events occurring prior to the Effective Date) with respect to any threatened, pending or completed action or suit by or in the right of the Corporation to procure a judgment in its favor by reason of the fact that he is or was a consultant to or agent or officer of the Corporation, or is or was serving at the request of the Corporation as a consultant to or a director, trustee, officer, employee or agent of another corporation, domestic or foreign, nonprofit or for profit, partnership, limited liability company, joint venture, trust or other enterprise, actually and reasonably incurred by him in connection with the defense or settlement of such action or suit if he acted in good faith and in a manner he reasonably believed to be in or not opposed to the best interests of the Corporation, except that no indemnification shall be made in respect of any claim, issue or matter as to which Thompson shall have been adjudged to be liable for gross negligence or gross misconduct in the performance of his duty to the Corporation unless, and only to the extent that the court in which such action or suit was brought shall determine upon application that, despite the 6 7 adjudication of liability, but in view of all the circumstances of the case, Thompson is fairly and reasonably entitled to indemnity for such expenses as such court shall deem proper. (c) COUNSEL. Thompson shall, at his own expense, have the right to retain counsel of his own choosing to represent him in connection with any matters as to which the provisions of this Section 11 apply. (d) ADVANCE PAYMENT OF EXPENSES. Expenses, excluding attorneys' fees, incurred in defending any action, suit or proceeding referred to in this Section 11, shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of Thompson to repay such amount, unless it shall ultimately be determined that he is entitled to be indemnified by the Corporation as provided herein. Such fees and expenses shall be paid from time to time as incurred upon request by Thompson. (e) NONEXCLUSIVITY. The parties agree that nothing in this Agreement shall be construed to limit or negate any rights of Thompson under the Corporation's Articles of Incorporation or Code of Regulations, as the same may be amended from time to time, or any other agreement, vote of shareholders or directors, or provision of applicable law, whether statutory or common law, or otherwise, which provides Thompson with broader protection than that provided herein. (f) SURVIVAL. The provisions of this Section 11 shall survive the termination of this Agreement. 12. Liability Insurance. The Corporation will maintain officer's acts and omissions liability insurance for Thompson in amounts comparable to that maintained for other executive officers employed by the Corporation. In the event that Thompson is subject to a liability in excess of the coverage limits of such insurance, the Corporation will be responsible for any such uninsured liabilities to the extent provided herein. 13. Assignment and Binding Effect. The obligations of the parties hereto may not be assigned or transferred, except upon the merger, consolidation or sale of the Corporation, or the sale of all or substantially all the assets of the Corporation, with or to another person or entity. This Agreement shall be binding upon and inure to the benefit of Thompson and the Corporation; provided, however, that this Agreement shall also inure to the benefit of Thompson's heirs, personal representatives, executors and administrators. 14. Notices. All notices under this Agreement shall be in writing and shall be deemed effective when delivered in person, or three days after deposit thereof in the official U.S. mail, postage prepaid, for delivery as registered or certified mail, or its delivery by a courier service, such as, for example, FedEx or UPS, addressed: 7 8 if to Thompson, to Mark D. Thompson 682 Laurel Ridge Drive Gahanna, Ohio 43230 Telephone: (614) 337-1917 and if to the Corporation, to International Total Services, Inc. 1200 Crown Centre 5005 Rockside Road Cleveland, Ohio 44131 Attention, Chairman, Board of Directors Telephone: (216) 642-4522 Telecopier: (216) 642-4539 In lieu of personal notice or notice by deposit in the official U.S. mail, or delivery by courier service, a party may give notice by confirmed telegram, telex or facsimile. Either party may change the address to which notice to that party may be mailed by notifying the other party of the change in the manner contemplated in this Section. 15. Severability. Any provision of this Agreement that is prohibited or unenforceable shall be ineffective to the extent, but only to the extent, of such prohibition or unenforceability without invalidating the remaining portions hereof and such remaining portions of this Agreement shall continue to be in full force and effect. 16. Governing Law. The provisions of this Agreement shall be governed by and construed in accordance with the laws of the State of Ohio applicable to contracts made in and to be performed within the State of Ohio. 17. Entire Agreement. This Agreement embodies the entire agreement and understanding between the parties hereto and, except as provided herein, supersedes all prior understandings, whether written or oral, with respect to the employment of Thompson by the Corporation. This Agreement was adopted by the Compensation Committee of the Corporation's Board of Directors on January 13, 2000. 18. Counterparts. This Agreement may be executed in two or more counterparts, each of which will be deemed an original, but all of which together shall constitute but one and the same instrument. 8 9 IN WITNESS WHEREOF, the parties have executed this Agreement as of the date first written above. INTERNATIONAL TOTAL SERVICES, INC. By: /s/ H. Jeffrey Schwartz ----------------------------------- Name: ----------------------------- Title: CO-CHAIRMAN OF THE BOARD ---------------------------- MARK D. THOMPSON /s/ Mark D. Thompson -------------------------------------- 9 EX-10.16 4 EXHIBIT 10.16 1 EXHIBIT 10.16 INTERNATIONAL TOTAL SERVICES, INC. NON-EMPLOYEE DIRECTOR COMPENSATION PLAN This International Total Services, Inc. Non-Employee Director Compensation Plan ("Plan") was adopted by the Compensation Committee of the Board on January 5, 2000. ARTICLE I DEFINITIONS 1.1 "Board" means the Company's Board of Directors. 1.2 "Change in Control" means the first to occur of the following events (i) any person or group of commonly controlled persons, other than the voting trust established and maintained pursuant to the Voting Trust Agreement made and entered into as of November 1, 1998 by and among the Corporation, Robert A. Weitzel, H. Jeffrey Schwartz, John P. O'Brien and J. Jeffrey Eakin (the "Voting Trust"), acquire ownership or control, directly or indirectly, of more than twenty percent (20%) of the voting control or value of the equity interests in the Corporation excluding from this clause (i), however, a transfer of voting control to Robert A. Weitzel resulting solely and directly from the termination of the Voting Trust pursuant to its terms; (ii) the shareholders of the Corporation approve an agreement to merge or consolidate with another corporation or other entity resulting (whether separately or in connection with a series of transactions) in a change in ownership of twenty percent (20%) or more of the voting control or value of the equity interests in the Corporation, or an agreement to sell or otherwise dispose of all or substantially all of the Corporation's assets (including, without limitation, a plan of liquidation or dissolution), or otherwise approve of a fundamental alteration in the nature of the Corporation's business; or (iii) at any time during any period of twenty-four (24) consecutive months, individuals who were directors at the beginning of the 24-month period no longer constitute a majority of the members of the Board of Directors of the Corporation, unless the election, or the nomination for election by the Corporation's shareholders, of each director who was not a director at the beginning of the period is approved by at least a majority of the directors who (x) are in office at the time of the election or nomination and (y) were directors at the beginning of the period. 1.3 "Closing Price" means the closing price of a share of the Company's common stock on a national securities exchange or inter-dealer quotation system on the last business day prior to the date on which the value is determined, as reported in the Wall Street Journal or such other source of quotations for or report of trading of such shares as the Compensation Committee of the Board may select from time to time; provided, however, that if such shares are not traded on such an exchange, or inter-dealer quotation system, Closing Price means the mean between the high and the low bid and asked prices (to the extent such information is available) for such shares on the over-the-counter market on the last business day prior to the date on which value is determined (or the next preceding day on which sales occurred if there were no sales on such date). In the event of a Change in Control, the Closing Price shall be determined pursuant to the foregoing or as is otherwise determined in good faith by the Compensation Committee of the Board. 2 1.4 "Company" means International Total Services, Inc., an Ohio corporation. 1.5 "Director Fees" means the fees that would otherwise be paid to the Eligible Director for service on the Board and/or any of its committees, including any annual fees and meeting fees. 1.6 "Eligible Director" means a non-employee director on the Board on or after January 1, 2000. 1.7 "Phantom Share" means an economic interest that is equivalent in value to the value of one share of the Company's common stock. 1.8 "Share Price Target" means for any vesting percentage on the Schedule in Section 2.1(b) that the Closing Price on each of the trading days (determined without regard to whether any trades are actually made) during twenty (20) consecutive trading days equals or exceeds the relevant Share Price Target amount listed opposite such percentage on such Schedule. ARTICLE II PHANTOM SHARE AWARD 2.1 AWARD. Each person who is an Eligible Director on January 5, 2000 shall receive an award of 50,000 Phantom Shares. 2.2 VESTING. (a) 20% of the Phantom Shares awarded to an Eligible Director under Section 2.1 shall be immediately fully vested and nonforfeitable. (b) The remaining Phantom Shares awarded to an Eligible Director under Section 2.1 that are not vested under Section 2.2(a) shall vest upon the attainment of Share Price Targets as follows: Additional Vesting (expressed as a percentage of the total Award) Share Price Target ---------------------------------------------- ------------------ 10% $ 2.00 10% $ 3.00 10% $ 4.00 10% $ 5.00 10% $ 6.00 10% $ 8.00 10% $10.00 10% $12.00 3 (c) Notwithstanding Section 2.2(b) all Phantom Shares Awarded under Section 2.1 shall immediately become fully vested and nonforfeitable in the event of a Change in Control. 2.3 DISTRIBUTION. The Company shall pay a person receiving an award under Section 2.1 an amount, in cash, equal to the number of the Person's vested Phantom Shares multiplied by the Closing Price measured on the first to occur of the following dates (the "Article II Measurement Date"): (a) the date the award becomes fully vested; or (b) the date the director ceases to be a Board member. Actual payment under the preceding sentence shall be made as soon as practicable, but in no event more than ten (10) business days after the person's Article II Measurement Date. ARTICLE III DIRECTOR FEE DEFERRAL 3.1 DEFERRAL. Each Eligible Director may at any time prospectively elect to have all or some portion of the Director Fees that would otherwise be paid to the Director for future service be deferred under this Plan. Amounts deferred under the preceding sentence shall be converted into Phantom Shares in a manner such that the number of Phantom Shares awarded equals one hundred twenty percent (120%) of the fee so deferred, based upon the Closing Price on the date the fee would otherwise be paid to the Eligible Director. 3.2 VESTING. The Phantom Shares awarded under Section 3.1 shall be fully vested and nonforfeitable at all times. 3.3 DISTRIBUTION. The Company shall pay a person awarded Phantom Shares pursuant to Section 3.1 an amount, in cash, equal to the number of such Phantom Shares multiplied by the Closing price on the first to occur of the following dates (the "Article III Measurement Date"): (a) the date the director ceases to be a Board member; (b) the date of a Change in Control; or (c) the date specified in the deferral election form making the deferral under Section 3.1, provided such date is at least one year following the date the Director Fee would otherwise be paid to the Eligible Director. Actual payment under the preceding sentence shall be made as soon as practicable, but in no event more than ten (10) business days after the person's Article III Measurement Date. ARTICLE IV MISCELLANEOUS 4.1 AMENDMENT AND TERMINATION. The Board, in its sole discretion, may amend or terminate this Plan at any time; provided, however, that any amendment or termination that could adversely affect an Eligible Director's rights and interests hereunder (other than to the right to continued deferral under Article III) will be effective as to such Eligible Director only if he consents in writing to the amendment or termination. 4 4.2 NO BENEFICIAL INTEREST OR FUNDING. No person or entity shall acquire any beneficial interest in an amount under this Plan prior to the date on which the amount becomes payable. The amounts payable hereunder shall not be funded in any way and, prior to payment, the rights of an Eligible Director hereunder shall be no greater than that of a general creditor of the Company. 4.3 ADJUSTMENTS UPON CHANGES IN CAPITALIZATION. In the event of changes in the outstanding shares of Company stock by reason of stock dividends, stock splits, reclassifications, recapitalizations, mergers, consolidations, combinations, exchanges of shares, separations, reorganizations, liquidation or similar events or in the event of extraordinary non-cash dividends or distributions being declared with respect to such shares or similar transactions or events, the number and class or Phantom Shares hereunder shall be equitably adjusted by the Compensation Committee of the Board. 4.4 GOVERNING LAW. This Plan shall be governed and construed in accordance with the laws of the State of Ohio, without giving effect to principles of conflicts of laws thereof. EX-21.1 5 EXHIBIT 21.1 1 EXHIBIT 21.1 SUBSIDIARIES OF INTERNATIONAL TOTAL SERVICES, INC. Crown Technical Systems, Inc., an Ohio Corporation I.T.S. of New York Security, Inc., a New York Corporation Selective Detective Services, Inc., a New Jersey Corporation T.I.S., Incorporated, a Texas Corporation Certified Investigative Services, Inc., a Texas Corporation International Total Services, Limited, a United Kingdom Company OS Security Services, GMBH, a German company ITS Security Services, GMBH, a German company Texas International Services Corp., a Texas Corporation (fka Metroplex Control Systems, Inc.) EX-27 6 EXHIBIT 27
5 12-MOS MAR-31-1999 APR-01-1998 MAR-31-1999 672,000 0 24,324,000 (513,000) 2,691,000 31,629,000 12,420,000 (5,773,000) 70,634,000 28,311,000 0 0 0 67,000 31,211,000 70,634,000 226,872,000 226,872,000 205,224,000 232,379,000 0 0 994,000 (6,501,000) 794,000 0 0 0 0 (7,295,000) (1.10) (1.10)
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