10-K405 1 e10-k405.txt 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, 2000 OR |_| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE TRANSITION PERIOD FROM _______ TO ______ COMMISSION FILE NUMBER 0-23073 INTERNATIONAL TOTAL SERVICES, INC. (Exact name of Registrant as Specified in 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 June 15, 2000, was approximately $3,558,800, (based on the closing price of the registrant's Common Stock on the Electronic Quotation System of the National Quotation Bureau LLC). As of June 15, 2000, the registrant had 6,837,494 shares of Common Stock issued and outstanding. 2
TABLE OF CONTENTS PART I PAGE 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...............................21 Item 11. Executive Compensation...........................................................22 Item 12. Security Ownership of Certain Beneficial Owners and Management...................25 Item 13. Certain Relationships and Related Transactions...................................27 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K.................27
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, among other things, 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, 2000 is referred to as "fiscal 2000." COMPANY OVERVIEW The Company is a significant domestic provider of aviation contract support services and is also a provider of commercial security staffing services. The Company provides services to customers in more than 300 cities in the United States and the United Kingdom. Aviation services offered by the Company include predeparture screening, 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 incurred a substantial operating loss in fiscal 1999, and fiscal 2000 results also reflect a substantial operating loss and negative cash flow from operations. The Company's current cash flow deficiency and forecasted negative cash flow from operations for at least the first half of fiscal 2001 raise substantial doubt about the Company's ability to continue as a going concern. The factors which raise such doubt, 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 continuation as a going concern will ultimately depend on its ability to (i) achieve profitable operations which generate positive cash flows and (ii) obtain new debt or equity financing. The financial statements do not include any adjustments relating to the recoverability of assets or the amount to settle liabilities that might be necessary should the Company be unable to continue as a going concern. The Company's strategy is to use its established business base as a platform for expanding the services that it provides. It is management's intention to seek higher overall margins by concentrating their marketing efforts on higher 1 4 margin opportunities, to formulate and implement business process improvement initiatives, evaluate past acquisitions, improve customer services and reduce and/or control costs with the goal of improving operating cash flow and profits. The Company intends to focus on the core businesses of aviation contract support services and commercial security staffing services and to eliminate under-performing contracts or locations and to dispose of non-core assets that provide no synergistic benefits to the Company. The Company believes that its best opportunity for increased profitability in the near term is growth in the higher margin commercial security business. 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 intends 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. 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, as part of its strategy to outsource the security product distribution business, the Company completed the disposition of Metroplex Control Systems Inc. ("MCS") 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 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. OTHER 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 which began on 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 2 5 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 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 the 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. Although the Company has filed its annual report on Form 10-K for the fiscal year ended March 31, 1999, as of June 15, 2000, the Company does not meet the requirements necessary to regain listing on the Nasdaq Stock Market. Internal Controls 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. The Company has addressed or implemented procedures to improve controls related to the identified material weakness and is in the process of improving internal controls with completion expected during fiscal 2001. The Company has been informed by Arthur Andersen LLP, that during the fiscal 2000 audit no material weaknesses in internal controls were identified. 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 3 6 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 and Other Airline Security Staffing Services. 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 30.3%, 32.3% and 36.7% of its revenues from predeparture screening services in fiscal 2000, 1999 and 1998, respectively. The Company also provides passenger profiling services and document verification agents, primarily in the United Kingdom, 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. 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 28.4%, 26.2% and 32.4% of its revenues from ramp and ground handling services in fiscal 2000, 1999, and 1998, respectively. 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 11.5%, 12.3% and 12.4% of its revenues from these services in fiscal 2000, 1999 and 1998, 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 22.1%, 22.4% and 12.0% of its net revenues from commercial security staffing services in fiscal 2000, 1999 and 1998, 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 4.0%, 1.9% and 2.1% of its net revenues from sales of security products in fiscal 2000, 1999 and 1998, respectively. The increased revenue in fiscal 2000 was due to the acquisition of MCS in May 1999, a company that primarily specialized in the sale and installation of security equipment for prisons. This security products 4 7 distribution company was sold in March 2000 as part of the Company's strategy to focus on its core businesses. See Company Overview and Acquisitions. GROWTH Prior to the Change in Control described above in "ITEM 1. BUSINESS - Other 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 accretive 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 reasonable margin contracts with new customers. ACQUISITIONS Historically, when making a domestic acquisition, the Company generally acquired only existing contracts and the equipment needed to fulfill the contracts. During fiscal 2000, the Company 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 and recognized a loss of approximately $800,000 in Fiscal 2000 related to this disposition. During fiscal 2000, MCS generated net operating revenues of $4.0 million and net income of $0.2 million, or $0.03 per share. 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. The Company's principal competitors in domestic predeparture screening include Globe Aviation Securities Corporation, AHL Services, Inc. and Huntleigh, Inc. In the United Kingdom Aviation 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 5 8 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 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. 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 Company's current plans are to outsource the implementation and service functions of this business segment during fiscal 2001. 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 United Kingdom. The Company's three regional directors in the United States and United Kingdom also have sales responsibilities and a portion of their incentive compensation is dependent on meeting established sales goals. Sales staff incentives are generally 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 requiring 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 6 9 sessions include presentation and customer service skills, database management and methods for cross-selling the Company's products and services. MANAGEMENT AND REPORTING SYSTEMS In fiscal 2000 and continuing into fiscal 2001, the Company has started a major project to develop the means to automate and coordinate both the collection of payroll data and the billing to customers. Management believes that these efforts will improve accuracy, provide for efficiencies and minimize billing disputes. 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 June 15, 2000, the Company had approximately 15,000 full- and part-time non-union employees engaged in performing its client services. The Company experiences annual turnover of almost 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 2000, Delta Air Lines, Inc. (22.8%), Continental Airlines, Inc. (12.2%), Trans World Airlines, Inc. (4.2%), U.S. Airways, Inc. (4.3%) and Northwest Airlines, Inc. (2.9%) accounted for 46.4% of the Company's net operating revenues. During fiscal 2000, 1999 and 1998, the Company's ten largest clients accounted for an aggregate of 56.5%, 59.0% and 66.3% 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 7 10 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 increased 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. 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 2000 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 the United Kingdom 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 of its headquarters space, 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 8 11 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. 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 June 25, 2000 are as follows:
NAME AGE POSITION ---- --- -------- Mark D. Thompson..................................... 42 President and Chief Executive Officer Terri M. Jones....................................... 43 Executive Vice President, Aviation 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 Security Staffing Services Scott E. Brewer...................................... 37 Senior Vice President and General Counsel John W. Demell....................................... 53 Senior Vice President, Aviation
The following are biographical summaries of the business experience of the executive officers of the Company. MARK D. THOMPSON is the President and Chief Executive Officer of the Company and was elected 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. 9 12 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. CHARLES P. LICATA is the President of the Commercial Security Staffing 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. 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. JOHN DEMELL is the Senior Vice President, Aviation of the Company since joining the Company in May 2000. Mr. Demell was the Vice president of regional operations of Lexford Residential Trust from 1988 to April 2000. From 1983 to 1987 Mr. Demell was with Fabri-Centers of America as a regional manager. * * * * * 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. 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 - Other Developments". As of June 15, 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 June 15, 2000 was $1.125. 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, 2000 -------------------------------- First Quarter........................................................................... $ 4.375 $ 3.313 Second Quarter (1)...................................................................... $ n/a $ n/a Third Quarter........................................................................... $ 1.563 $ 0.688 Fourth Quarter.......................................................................... $ 2.125 $ 1.00 (1) There was no trading of Company Common Stock from July 1, 1999 until October 26,1999. 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 June 15, 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. 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 2000, 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.
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND EMPLOYEE DATA) YEARS ENDED MARCH 31, --------------------- 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- STATEMENTS OF OPERATIONS DATA: Net operating revenues.............................. $ 214,640 $226,872 $ 172,367 $ 115,242 $ 95,467 Income (loss) before income taxes .................. (13,965) (6,501) 8,357 2,725 1,815 Net income (loss)................................. (13,015) (7,295) 4,857 1,569 930 Net income (loss) per share:........................... Basic............................................... $ (1.95) $ (1.10) $ 0.93 $ 0.31 $ 0.16 Diluted............................................. (1.95) (1.10) 0.92 0.31 0.16 Weighted average common shares outstanding (1): Basic .............................................. 6,683 6,662 5,215 5,089 5,776 Diluted............................................. 6,683 6,662 5,265 5,089 5,776 AS OF MARCH 31, --------------- 2000 1999 1998 1997 1996 ---- ---- ---- ---- ---- OPERATING DATA: Number of employees.................................... 15,000 16,000 15,000 10,700 9,900 BALANCE SHEET DATA: Cash and cash equivalents........................... $ 792 $ 672 $ 3,542 $ 3,018 $ 2,693 Working capital (deficit)........................... 4,507 3,318 11,491 1,496 (2,398) Total assets........................................ 71,212 70,634 61,631 28,865 21,929 Long-term obligations............................... 22,103 10,859 3,682 11,641 5,790 Shareholders' equity................................ 17,796 30,841 38,319 2,800 3,710
(1) 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'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 2000, the Company completed two acquisitions 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. 12 15 Operations generated negative cash flow for fiscal 2000. Although the Company obtained a one year extension of its credit facility through April 2001 (See Note G of "Notes to the Consolidated Financial Statements") the negative cash generated during fiscal 2000 and forecast to continue at least through the first half of fiscal 2001 are factors that raise doubts about the Company's ability to continue as a going concern. The audit report of Arthur Andersen LLP for fiscal 2000 contains an explanatory paragraph with respect to this matter. RESULTS OF OPERATIONS YEAR ENDED MARCH 31, 2000 COMPARED WITH YEAR ENDED MARCH 31, 1999 The following discussion of operating results for fiscal 2000 as compared to fiscal 1999 focuses on the core business segments of the Company. This presentation is intended to facilitate shareholders' and prospective investors' evaluation of the Company's performance in relation to its strategy of focusing on internal growth by improving margins and reducing expenses of its core business segments. The following are the Net Operating Revenues, Cost of Revenues and Gross Margin for fiscal 2000 as compared to fiscal 1999, by segment (in thousands).
2000 % of Rev 1999 % of Rev Inc/(Dec) % Inc/(Dec) ------------------------- ------------------------------------------------- Net Revenues: Aviation $ 158,603 73.9% $171,726 75.7% $ (13,123) -7.6% Commercial Security 47,406 22.1% 50,849 22.4% (3,443) -6.8% Security Products 8,631 4.0% 4,297 1.9% 4,334 100.9% ------------------------- ----------------------- ------------------------- 214,640 100.0% 226,872 100.0% (12,232) -5.4% ------------------------- ----------------------- ------------------------- Cost of Revenues: Aviation 149,636 94.3% 158,558 92.3% (8,922) -5.6% Commercial Security 39,268 82.8% 43,282 85.1% (4,014) -9.3% Security Products 6,467 74.9% 3,384 78.8% 3,083 91.1% ------------------------- ----------------------- ------------------------- 195,371 91.0% 205,224 90.5% (9,853) -4.8% ------------------------- ----------------------- ------------------------- Gross Margin: Aviation 8,967 5.7% 13,168 7.7% (4,201) -31.9% Commercial Security 8,138 17.2% 7,567 14.9% 571 7.6% Security Products 2,164 25.1% 913 21.2% 1,251 137.0% ------------------------- ----------------------- ------------------------- $ 19,269 9.0% $ 21,648 9.5% $ (2,379) -11.0% ========================= ======================= =========================
Net Operating Revenues. Net operating revenues in fiscal 2000 decreased by $12.2 million, or 5.4%, as compared with fiscal 1999. The decrease is attributable to the loss of aviation and commercial security staffing contracts that was partially offset by an increase in revenues from the sale of Security Products. The increase in Security Products net revenues was primarily related to the acquisition of MCS in May 1999, a company that was primarily devoted to the sale and installation of security equipment for prisons and fire safety equipment. The increase in net operating revenues for Security Products is not expected to continue. The Company has decided to focus on its core businesses of Aviation staffing services and Commercial Security services. In conjunction with this strategy the Company sold MCS in March 2000 and intends to outsource the implementation and service functions of this business segment during fiscal 2001. (See Item 1.BUSINESS "Company Overview"). The decrease in aviation revenues relates to lost service contracts at several sites. The contracts were generally lost in competitive bidding processes. The Company has been at a disadvantage in these bids due to competitors taking advantage of the Company's uncertain financial situation. This decline may continue as management focuses on higher margin business and intends to give notice on contracts that do not meet profit criteria. The Company believes it has mitigated the uncertainty of its financial position with the extension of the Company's credit facility. The decrease in Commercial Security net revenues was related to the Company's strategy, commencing in the third quarter of fiscal 2000, to eliminate contracts that did not meet profit criteria. Although commercial security net revenues decreased by 13 16 $3.4 million, or 6.8%, gross margin actually increased approximately $0.6 million from 14.9% of revenue to 17.2% of revenue. Cost of Revenues. Cost of revenues includes primarily the cost of field personnel (wages, payroll taxes, vacation, workers' compensation and uniforms) and related equipment costs. Fiscal 2000 total cost of revenues decreased $9.9 million, or 4.8%, from fiscal 1999. Most of this decrease was due to costs associated with the service contracts lost or discontinued in fiscal 2000. However, cost of revenues as a percent of net operating revenues for Commercial Security services decreased from 85.1% in fiscal 1999 to 82.8% in fiscal 2000 primarily as a result of focusing on higher margin contracts and eliminating lower margin contracts. The cost of revenues for security products increased $3.1 million primarily due to the acquisition previously discussed. See "Net Operating Revenues". The improved margin performance in the Commercial Security staffing services and the Security Products businesses were offset by the increased costs of revenues as a percent of net operating revenues for the Aviation staffing services business. The Aviation Staffing Services cost of revenues increased from 92.3% in fiscal 1999 to 94.3% in fiscal 2000 primarily due to the increase in labor costs. The Company is working to eliminate low margin contracts and improve controls over labor costs to improve margins in the Aviation Staffing services segment 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, primarily in the Aviation Staffing Services segment. These factors continue to exert downward pressure on the Company's margins. Management is currently implementing 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 ("S G & A"). Selling, general and administrative expenses include corporate governance costs, support services for field personnel, bad debt expense and professional services (legal, audit and consulting). The following table breaks down S,G & A by business segment and corporate administrative costs (in thousands): 2000 1999 -------------- --------------- Aviation Staffing Services $ 7,463 $ 8,308 Commercial Security Staffing Services 6,024 4,904 Security Products 1,314 403 Corporate Administration 12,933 11,035 -------------- --------------- $ 27,734 $ 24,650 ============== =============== These expenses increased $3.1 million, or 12.5%, in fiscal 2000 as compared to fiscal 1999. S, G & A expenses were 12.9% and 10.9% of net operating revenues for fiscal 2000 and 1999, respectively. The following discusses the change in S, G & A expenses by business segment for fiscal 2000 as compared to fiscal 1999. Aviation Staffing Services S, G & A expenses decreased $0.8 million for fiscal 2000 as compared to fiscal 1999. The decrease was due to aviation contracts that have been lost which reduced administrative costs, primarily salary and payroll taxes and benefits. The Company has initiated a reorganization of the administrative structure of the aviation business segment which is anticipated to further reduce the S, G & A related to Aviation Staffing Services. Commercial Security Staffing Services S, G & A expenses increased $1.1 million, or 22.8%, in fiscal 2000 as compared to fiscal 1999. Approximately $0.6 million of the increase related to payroll, payroll taxes and benefits. This increase was attributable to the numerous acquisitions during fiscal 1999 and fiscal 2000, which added significant overhead. The Company has completed the reorganization of the Commercial Security administrative support structure. The actual 14 17 Commercial Security S, G & A for the month of April 2000, if maintained for all of fiscal 2001, would result in Commercial Security S, G & A for fiscal 2001 of $5.2 million. Security Products S, G & A increased $0.9 million in fiscal 2000 as compared to fiscal 1999. The increase was primarily due to the acquisition of MCS in May 1999. In connection with the Company's current strategy to focus on its core business segments, the Company sold MCS in March 2000 and is currently planning to outsource the implementation and service functions of this business segment during fiscal 2001. The S, G & A expenses associated with the Security Products Distribution business segment should decrease significantly during fiscal 2001 as the Company implements its strategy. Corporate Administration S, G & A costs increased $1.9 million in fiscal 2000 as compared to fiscal 1999. Professional, consulting and settlement expenses increased $2.3 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. Contributing to this increase was a $1.0 million charge related to the retirement and consulting agreement with the former chairman. In addition, bank charges increase $0.3 million related to the loan modifications completed in fiscal 2000.This increase was offset by costs incurred in fiscal 1999 that did not reoccur in fiscal 2000. 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. Amortization Expense. Amortization expense was $2.8 million in fiscal 2000 compared to $2.3 million in fiscal 1999, an increase of $0.5 million, or 21.4%. The increase was the result of the additional charges to amortization for the fiscal 2000 acquisitions and a full year's charge for fiscal 1999 acquisitions. Interest Expense. Interest expense increased by $0.8 million to $1.8 million for fiscal 2000, principally as a result of the increase in the Company's level of outstanding debt obligations to an average of $21.5 million from $10.4 million for fiscal 2000 and 1999, respectively. In addition, the Company's weighted average borrowing rate increased to 8.6% for fiscal 2000 from 7.9% for fiscal 1999. Income Taxes. The Company recorded an income tax benefit of $0.9 million in fiscal 2000 as compared to an income tax expense of $0.8 million for fiscal 1999. The income tax benefit recorded in fiscal 2000 was a result of the realized tax benefit of the carry back of the fiscal 2000 net operating tax loss to prior years. 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 fiscal 1999 loss net of a provision to provide a deferred tax valuation allowance on net deferred tax assets where there is uncertainty of their future realization. Loss on Disposal Assets. The Company recorded a $0.8 million loss in fiscal 2000 related to the disposal of MCS which it had acquired in May 1999. The Company completed the disposition in March 2000. The disposition was part of the Company's strategy to focus on its core businesses of Aviation Staffing Services and Commercial Security staffing services. 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 did not 15 18 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' compensation - $1.5 million; aircraft damages and fines - $.8 million; and wages and overtime - $5.7 million. 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 debt expense increased (approximately $1.2 million in fiscal 1999 compared to $0.3 million in 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 $0.3 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 $0.8 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 $0.8 million was incurred. This expense is the tax 16 19 benefit for the year's loss net of a provision to provide a deferred tax valuation allowance on net deferred tax assets where there is uncertainty of their future realization. LIQUIDITY AND CAPITAL RESOURCES The Company's business is labor intensive. Consequently, it has substantial needs for cash throughout its fiscal year. During fiscal 2000, the Company's cash requirements were heightened by its increased payroll and professional and consulting costs. Operating activities used net cash of approximately $8.0 million, investing activities used net cash of $3.1 million primarily related to the two acquisitions completed in early fiscal 2000 and financing activities generated net cash of $11.2 million during fiscal 2000. During fiscal 2000, principal uses of funds, in addition to working capital requirements, included expenditures associated with the Company's acquisitions. These included $4.0 million in acquisitions of service contracts, related goodwill and non-compete agreements, $1.5 million of net working capital acquired and $0.3 million for related property and equipment. In addition, the Company used funds amounting to $0.8 million related to additions to property and equipment. The Company financed its investing and operating activities with borrowings under its credit facility and proceeds from the sale of assets and the sale of MCS which it had acquired in May 1999. As a result of the net loss incurred in fiscal 1999 and fiscal 2000, 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 lenders granted the Company waivers for all non-compliant loan covenants as of March 31, 1999, in addition to granting waivers for the non-compliance with loan covenants through April 1, 2000. On August 27, 1999, the lender agreed to modify the credit facility. The modifications included an extension to the maturity date of the facility to April 1, 2000, a $5.0 million reduction in the maximum available borrowings under the credit facility to $25.0 million, and a $3.0 million reduction in the annual capital asset acquisition allowance to $1.0 million. Subsequent to year end, 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, a minimum debt coverage ratio, and standard financial reporting requirements. As of June 15, 2000 the Company was in compliance with all covenants and the outstanding obligation under this facility was $22.1 million. In consideration for the amendment and extension of the credit facility the Company granted the banks warrants for the purchase of 300,000 shares of the Company's Common Stock at an exercise price of $1.41, which the Board determined was the fair market value of the Company's Common Stock as of the date of the grant. The warrants expire on March 31, 2007. As part of the transaction, the banks were granted a "put" option commencing April 1, 2001 which would, if exercised, require the Company to purchase 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 anticipates negative cash flow from operations for at least the first half of fiscal 2001, but believes that the Company will generate positive cash flow from operations in the second half of fiscal 2001 when the benefits of programs to improve the margins and expense reductions are expected to start to be realized. Although there can be no assurance, the Company believes that amounts available under its credit facility combined with the receipt of an income tax refund of $3.0 million in May 2000 will be sufficient to meet its cash requirements, including monthly debt service, until operations begin to generate positive cash flow. The Company will seek to refinance its outstanding borrowings under the credit facility on or prior to December 31, 2000, but there can be no assurance as to the Company's ability to obtain a replacement credit facility or otherwise refinance its debt or obtain equity financing. 17 20 As previously discussed, the Company's lack of external financing sources will limit its ability to grow by acquisitions and cause it to rely on net cash generated by operations to pay expenses and existing liabilities. Such limitations may have an adverse impact on the Company's liquidity and results of operations. 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. 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 (2.6% of total revenues for the year ended March 31, 2000) are received, and operating costs are incurred, in foreign currencies. The denomination of foreign subsidiaries' account balances in their local currency exposes the Company to certain foreign exchange rate risks which the Company believes are not 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, 2000, 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, 2000 of $22.1 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, 2000 balance of this debt is considered to be at fair value. Based upon the Company's June 15, 2000 outstanding balance on the variable rate credit facility, a hypothetical increase of 100 basis points in the prime rate of interest would adversely affect future earnings and cash flows by approximately $220,000 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 19 22 See Index to Consolidated Financial Statements on page F-1. ITEM 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure None. 20 23 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. DIRECTORS OF THE REGISTRANT
DIRECTOR TERM TO NAME OF DIRECTOR AGE PRINCIPAL OCCUPATION AND OTHER INFORMATION SINCE EXPIRE ---------------- --- ------------------------------------------ ----- ------ John P. O'Brien 59 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. (NASDAQ: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, 2000, 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, 2000 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, 2000, 1999 and 1998 ("Named Executive Officers").
ANNUAL COMPENSATION (2) ----------------------- NAME AND FISCAL SALARY OTHER PRINCIPAL POSITION YEAR (1) ($) BONUS ($) COMPENSATION ($) Mark D. Thompson (4)............................. 2000 50,000 -- 140,625(4) President and Chief ............................. 1999 -- -- -- Executive Officer................................ 1998 -- -- -- Robert A. Weitzel (5)............................ 2000 270,833 -- 550,000(5) Former Chairman and Chief........................ 1999 300,000 100,000 Executive Officer................................ 1998 309,288 211,025 1,897(3) Charles P. Licata ............................... 2000 108,332 -- (7) President ....................................... 1999 23,754 -- -- Commercial Security Staffing Services............ 1998 -- -- -- Thomas M. Vaiden (6)............................. 2000 108,333 -- -- President ....................................... 1999 -- -- -- Aviation Staffing Services....................... 1998 -- -- -- Charles S. Deutchman............................. 2000 -- -- 344,658(7 & 8) Vice President - Finance and .................... 1999 -- -- -- Chief Financial Officer.......................... 1998 -- -- --
(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. Mark D. Thompson joined the Company in October 1999. Other compensation includes $87,500 paid to Mr Thompson as consulting fees prior to becoming an employee of the Company. In addition, Mr. Thompson received an award of 175,000 shares of Common Stock on January 13, 2000, 75,000 of which vested immediately with the remaining 100,000 shares vesting over a four year period or upon the achievement of specified average share prices over 10-day trading periods. In January 2000, 10,000 of the 100,000 shares vested. Other compensation includes $53,125 related to the value of the 85,000 shares of Common Stock that vested in fiscal 2000. The value of this award was determined by multiplying the number of shares subject to this grant by the estimated fair market value of the shares on the vesting date. The value of this award at the end of fiscal 2000 was $280,000 based on the March 31, 2000 price of $1.60 per share. (See "Employment Agreement") 22 25 (5) 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 - Other Developments. Other compensation reflects payments made related to Mr. Weitzel's retirement and consulting agreement. (6) Mr. Vaiden joined the Company in June 1999 and resigned in June 2000. (7) Mr. Licata and Mr. Deutchman were granted Common Stock options of 25,000 and 100,000 shares, respectively, during fiscal 2000 at exercise price based on the fair market value on the grant date. The exercise price for Mr. Licata is $0.625 per share and $0.9375 per share for Mr. Deutchman. (8) Mr. Deutchman served as the Company's Vice President-Finance and Chief Financial Officer from October 15, 1999 until February 29, 2000. Mr. Deutchman was employed as an independent contractor and received $182,158 in fees and $162,500 as a lump severance payment upon the termination of his contract. OPTIONS
OPTION GRANTS IN FISCAL YEAR 2000 INDIVIDUAL GRANTS ----------------- POTENTIAL REALIZABLE PERCENTAGE OF VALUE AT ASSUMED TOTAL OPTIONS ANNUAL RATES OF STOCK GRANTED TO PRICE APPRECIATION FOR OPTIONS EMPLOYEES IN EXERCISE OPTION TERM(4) GRANTED (#) FISCAL PRICE EXPIRATION ------------------------ NAME (1) YEAR(2) ($/SHARE)(3) DATE 5%($) 10%($) ---- --- ------- ------------ ---- ----- ------ Charles P. Licata........ 25,000 12.5% 0.625 1/13/2010 9,800 24,975 Charles S. Deutchman (5). 100,000 50% 0.9375 10/15/2009 58,950 149,350
(1) Options are fully vested. (2) Based on 200,000 options granted to all employees during fiscal year 2000. (3) Options were granted at the fair market value of the Common Stock on the day of the grant. (4) These amounts are based on hypothetical appreciation rates of 5% and 10%, as required by the Securities and Exchange Commission 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. (5) Mr. Deutchman left the Company on February 29, 2000, however his options will not lapse until October 2009. 23 26
AGGREGATED OPTION EXERCISES IN FISCAL 2000 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 ---- ------------ --- ------------- ------------- Charles P. Licata.................. -- -- 25,000/-0- 24,375/-0- Charles S. Deutchman............... -- -- 100,000/-0- 66,250/-0-
(1) Mr. Licata's exercise price is $0.625 per share. Mr. Deutchman's exercise price is $0.9375 per share. (2) Using the March 31, 2000 Common Stock closing price of $1.60. 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 share 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 Agreement. 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 2000 were H. Jeffrey Schwartz, John P. O'Brien and J. Jeffrey Eakin. No member of the Compensation Committee has served as an executive officer or employee of the Company or served during fiscal 2000 as an executive officer of another entity of which any executive officer of the Company was a director or member of the Compensation Committee. 24 27 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 June 15, 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 (2) ................................................................ -- * H. Jeffrey Schwartz (2) ............................................................ -- * J. Jeffrey Eakin (2&3)............................................................. 7,000 * Mark D. Thompson (6)................................................................ 175,000 2.6% Terri M. Jones (3).................................................................. 26,000 * Ronald P. Koegler (3)............................................................... 25,000 * Michael F. Sosh (3)................................................................. 25,000 * Charles P. Licata. (3).............................................................. 25,000 * Scott E. Brewer (3)................................................................. 41,151 * John W. Demell (3).................................................................. 25,000 * Charles S. Deutchman (3)............................................................ 100,000 1.4% All directors, the Voting Trust, and executive officers as a group (12 people as a group)............................................................ 3,774,131 53.2%
* 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 - Other Developments". In addition, Mr. Weitzel is contractually obligated to transfer the voting rights of any stock options he may exercise to this Voting Trust. All of Mr. Weitzel`s stock options have 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 - Other Developments". (3) Includes Common Stock which may be acquired within 60 days of June 15, 2000 pursuant to the Company's September 1997 Long-Term Incentive Plan as follows: 25 28 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 John W. Demell............................................................................... 25,000 Scott E. Brewer.............................................................................. 25,035 Charles S. Deutchman......................................................................... 100,000 All directors and executive officers as a group.............................................. 255,035
(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 Common Stock which vests over a four year period. Mr. Thompson holds voting rights over the entire 175,000 shares of Common Stock. 26 29 ITEM 13. Certain Relationships and Related Transactions See "ITEM 1 BUSINESS - Other 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 (c) EXHIBIT NO. REF: 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. 10.17 Fourth amendment to Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement. 10.18 Common Stock Warrant Agreement 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. *** Incorporated by reference from the Company's Form 10-K for fiscal 1999 filed on May 4, 2000. (d) Financial Statement Schedules See Index to Consolidated Financial Statements and Schedule on Page F-1 27 30 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. INTERNATIONAL TOTAL SERVICES, INC. JUNE 29, 2000 By: /s/ MARK D. THOMPSON ------------- -------------------- Mark D. Thompson President and 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. JUNE 29, 2000 /s/ MARK D. THOMPSON ------------- -------------------- Mark D. Thompson President and Chief Executive Officer (Principal Executive Officer) JUNE 29, 2000 /s/ RONALD P. KOEGLER ------------- --------------------- Ronald P. Koegler Executive Vice President and Controller (Principal Accounting Officer) JUNE 29, 2000 /s/ MICHAEL F. SOSH ------------- ------------------- Michael F. Sosh Executive Vice President and Treasurer (Principal Financial Officer) JUNE 29, 2000 /s/ JOHN P. O'BRIEN ------------- ------------------- John P. O'Brien Director, Co-Chairman of the Board of Directors JUNE 29, 2000 /s/ H. JEFFREY SCHWARTZ ------------- ----------------------- H. Jeffrey Schwartz Director, Co-Chairman of the Board of Directors JUNE 29, 2000 /s/ J. JEFFREY EAKIN ------------- -------------------- J. Jeffrey Eakin Director 28 31 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 Years Ended March 31, 2000 and 1999........................ F-2 Report of Independent Public Accountants - For the Year Ended March 31, 1998 ................................. F-3 Consolidated Balance Sheets as of March 31, 2000 and 1999..................................................... F-4 Consolidated Statements of Operations and Comprehensive Income (Loss) for the years ended March 31, 2000, 1999 and 1998......................................................... F-6 Consolidated Statements of Shareholders' Equity for the years ended March 31, 2000, 1999 and 1998............................................................................................. F-7 Consolidated Statements of Cash Flows for the years ended March 31, 2000, 1999 and 1998.................................................................................................. F-8 Notes to Consolidated Financial Statements as of March 31, 2000, 1999 and 1998................................ F-9 Schedule II Valuation and Qualifying Accounts................................................................. F-23
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 32 REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS FOR THE YEARS ENDED MARCH 31, 2000 AND 1999 To the Shareholders and Board of Directors of INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES: We have audited the accompanying consolidated balance sheets of International Total Services, Inc. and Subsidiaries, (an Ohio corporation), as of March 31, 2000 and 1999, and the related consolidated statements of operations and comprehensive loss, shareholders' equity, and cash flows for each of the two years in the period ended March 31, 2000. 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 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 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 audits provide 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, 2000 and 1999 and the results of their operations and their cash flows for each of the two years in the period ended March 31, 2000 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 losses from operations in fiscal 2000 and fiscal 1999 and has negative tangible net worth. In addition, the Company generated negative cash flow from operations in fiscal 2000. 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, June 23, 2000. F-2 33 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS FOR THE YEAR ENDED MARCH 31, 1998 Shareholders and Board of Directors INTERNATIONAL TOTAL SERVICES, INC. We have audited the accompanying consolidated statements of operations and comprehensive income (loss), shareholders' equity, and cash flows of International Total Services, Inc. and Subsidiaries for the year 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 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 consolidated financial statements referred to above present fairly, in all material respects, the consolidated results of operations and the consolidated cash flows of International Total Services, Inc. and Subsidiaries for the year ended March 31, 1998 in conformity with accounting principles generally accepted in the United States. 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 for the year ended March 31, 1998 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 34 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2000 AND 1999 (AMOUNTS IN THOUSANDS)
2000 1999 ---- ---- ASSETS CURRENT ASSETS Cash and cash equivalents ................................................. $ 792 $ 672 Accounts receivable--net of allowance for doubtful accounts of $474 and $513, respectively ................................ 27,675 23,811 Federal income tax refund receivable ...................................... 3,020 -- Deferred taxes ............................................................ 640 3,033 Uniforms, net ............................................................. 1,035 2,691 Other current assets ...................................................... 2,018 1,422 ------- ------- Total current assets ................................................... 35,180 31,629 PROPERTY AND EQUIPMENT Security equipment ........................................................ 3,799 4,729 Service equipment ......................................................... 2,206 2,636 Computer equipment ........................................................ 3,256 2,882 Furniture and fixtures .................................................... 1,100 1,136 Autos ..................................................................... 936 974 Leasehold improvements .................................................... 70 63 ------- ------- 11,367 12,420 Less accumulated depreciation and amortization ............................ 6,470 5,773 ------- ------- Property and equipment, net ......................................... 4,897 6,647 INTANGIBLES, less accumulated amortization of $6,254 and $3,932, respectively ........................................... 31,030 32,254 SECURITY DEPOSITS AND OTHER .................................................. 105 104 ------- ------- TOTAL ASSETS ........................................................ $71,212 $70,634 ======= =======
The accompanying notes are an integral part of these Consolidated Financial Statements. F-4 35 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS AS OF MARCH 31, 2000 AND 1999 (AMOUNTS IN THOUSANDS) LIABILITIES AND SHAREHOLDERS' EQUITY
2000 1999 ---- ---- CURRENT LIABILITIES Trade accounts payable .......................................................... $ 5,466 $ 1,871 Accrued payroll and employee benefits ........................................... 16,314 17,832 Other accrued expenses .......................................................... 8,556 8,554 Income taxes payable ............................................................ 337 54 -------- -------- Total current liabilities ....................................................... 30,673 28,311 DEFERRED TAXES ..................................................................... 640 623 LONG-TERM DEBT OBLIGATIONS ......................................................... 22,103 10,859 SHAREHOLDERS' EQUITY Common shares, without par value, stated at $.01 per share -authorized 20,000 shares, 6,837 and 6,662 shares issued and outstanding at March 31, 2000 and 1999, respectively .............. 68 67 Additional paid-in capital ...................................................... 31,263 31,211 Accumulated other comprehensive loss: Foreign currency translation adjustment ......................................... (470) (387) Retained deficit ............................................................... (13,065) (50) -------- -------- Total shareholders' equity ...................................................... 17,796 30,841 -------- -------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY ......................................... $ 71,212 $ 70,634 ======== ========
The accompanying notes are an integral part of these Consolidated Financial Statements. F-5 36 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE INCOME (LOSS) FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
2000 1999 1998 ---- ---- ---- Net operating revenues........................................... $ 214,640 $ 226,872 $ 172,367 Cost of revenues................................................. 195,371 205,224 147,311 -------------- ------------- -------------- GROSS MARGIN............................................. 19,269 21,648 25,056 Selling, general and administrative expenses..................... 27,734 24,650 15,015 Amortization expense............................................. 2,833 2,334 988 -------------- ------------- -------------- OPERATING PROFIT (LOSS).................................. (11,298) (5,336) 9,053 Interest expense, net............................................ 1,791 994 719 Loss on disposal of assets, net.................................. 876 171 (23) -------------- ------------- -------------- 2,667 1,165 696 -------------- ------------- -------------- INCOME (LOSS) BEFORE INCOME TAXES........................ (13,965) (6,501) 8,357 Provision (Benefit) for Income taxes............................. (950) 794 3,500 NET INCOME (LOSS)........................................ (13,015) (7,295) 4,857 ============== ============= ============== Other comprehensive income (loss) Foreign currency translation adjustment....................... (83) (183) (105) -------------- ------------- -------------- COMPREHENSIVE INCOME (LOSS).............................. $ (13,098) $ (7,478) $ 4,752 ============== ============= ============== Net income (loss) per share: Basic........................................................ $ (1.95) $ (1.10) $ 0.93 ============== ============= ============== Diluted....................................................... $ (1.95) $ (1.10) $ 0.92 ============== ============= ============== Weighted average number of shares outstanding: Basic......................................................... 6,683 6,662 5,215 ============== ============= ============== Diluted....................................................... 6,683 6,662 5,265 ============== ============= ============== The accompanying notes are an integral part of these Consolidated Financial Statements.
F-6 37 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (AMOUNTS IN THOUSANDS)
Accumulated Additional Other Retained Total Common Paid-in Comprehensive Earnings Shareholders' Shares Capital Loss (Deficit) Equity BALANCE AT MARCH 31, 1997 ................ $ 37 $ 473 $ (99) $ 2,388 $ 2,799 -------- -------- -------- -------- -------- Purchase of common shares for treasury ....................... -- (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............. ............... -- -- -- 4,857 4,857 -------- -------- -------- -------- -------- BALANCE AT MARCH 31, 1998 ................ 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 Foreign currency translation adjustment -- -- (83) -- (83) Stock Compensation .................... 1 52 -- -- 53 Net loss .............................. -- -- -- (13,015) (13,015) -------- -------- -------- -------- -------- BALANCE AT MARCH 31, 2000 ................ $ 68 $ 31,263 $ (470) $(13,065) $ 17,796 ======== ======== ======== ======== ======== The accompanying notes are an integral part of these Consolidated Financial Statements.
F-7 38 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (AMOUNTS IN THOUSANDS)
2000 1999 1998 ---- ---- ---- OPERATING ACTIVITIES: Net income (loss).................................................. $ (13,015) $ (7,295) $ 4,857 Adjustments to reconcile net income (loss) to net cash (used in)/provided by operating activities: Depreciation.................................................... 1,543 1,240 948 Amortization.................................................... 2,833 2,334 988 Loss on Disposal of Assets...................................... 876 (104) 334 Deferred income taxes........................................... 2,392 (837) (73) Changes in working capital: Accounts receivable.......................................... (3,226) (3,043) (8,984) Other assets................................................. (1,914) 307 147 Trade accounts payable....................................... 3,741 645 (57) Accrued expenses............................................. (1,257) 8,513 5,594 ------------ ----------- ------------- Net cash (used in)/provided by operating activities........ (8,027) 1,760 3,754 INVESTING ACTIVITIES: Purchases of property and equipment................................ (826) (2,373) (1,508) Proceeds received from sale of assets.............................. 3,592 446 -- Purchased property and equipment of acquired businesses............ (302) (187) (1,699) Working capital acquired, net of cash.............................. (1,471) -- -- Payments for acquisitions of businesses, primarily by purchase of service contracts................................ (4,008) (9,510) (19,042) ------------ ----------- ------------- Net cash used in investing activities...................... (3,015) (11,624) (22,249) FINANCING ACTIVITIES: Net proceeds from Initial Public Offering.......................... -- -- 29,993 Net borrowings (payments) on note payable to bank.................. 11,245 7,177 (2,400) Payments on subordinated debt...................................... -- -- (3,000) Principal payments on long-term debt............................... -- -- (5,439) Purchase of Company common shares.................................. -- -- (165) Other ............................................................. -- -- 135 ------------ ----------- ------------- Net cash provided by financing activities.................. 11,245 7,177 19,124 Effect of exchange rates on cash...................................... (83) (183) (105) ------------ ----------- ------------- Net (decrease) increase in cash and cash equivalents.............................................. 120 (2,870) 524 Cash and cash equivalents at beginning of year........................ 672 3,542 3,018 ------------ ----------- ------------- Cash and cash equivalents at end of year.............................. $ 792 $ 672 $ 3,542 ============ =========== ============= SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Interest........................................................ $ 1,677 $ 771 $ 841 ============ =========== ============= Income taxes.................................................... $ 412 $ 1,412 $ 3,943 ============ =========== ============= The accompanying notes are an integral part of these Consolidated Financial Statements.
F-8 39 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES NOTES TO CONSOLIDATED FINANCIAL STATEMENTS MARCH 31, 2000, 1999 AND 1998 (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 United Kingdom. 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 year ends (i.e. fiscal 2000 is the year ended March 31, 2000) 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 aviation and commercial security services are provided. Revenues generated from the sales of security products are recognized when the products have been delivered and installed. Commencing in the first quarter of fiscal 2000, as a result of an acquisition (see Note E), revenues generated from the sales of security products are recognized on the percentage of completion basis. This was the policy of the newly acquired company which was involved in numerous long term installation contracts. The percentage-of-completion method is based on estimates by the project manager. 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, the Company entered into the following non-cash transaction. 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. There were no such non-cash transactions in fiscal 2000 or 1999. F-9 40 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, 2000 and 1999, 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 an expected useful life 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 also include the fair value of those service contracts acquired in the acquisitions. Goodwill is being amortized on a straight-line basis over the expected 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 $6.2 million and $3.9 million at March 31, 2000 and 1999, 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. During fiscal 1999, 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. Use of Estimates The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and F-10 41 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. NOTE B - GOING CONCERN The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities, including any commitments and/or contingent liabilities, in the normal course of business. The Company incurred a loss from operations for fiscal 2000 and fiscal 1999, and has negative tangible net worth. In addition, operations generated negative cash flow for fiscal 2000. These factors raise substantial doubt about the Company's ability to continue as a going concern. The Company's strategy is to use its established business base as a platform for expanding services and currently will not pursue any further acquisitions due to the unavailability of funds. It is management's intention to seek higher overall margins by concentrating its marketing efforts on higher margin opportunities, to formulate and implement business process improvement initiatives, evaluate past acquisitions, improve customer services and reduce and/or control costs with the goal of improving operating cash flow and profits. 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 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 Prior to the issuance of the fiscal 1999 financial statements, 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. This restatement is to correct accounting that resulted from the failure of the Company to properly consider information available at the time those financial statements were prepared, including information that may not have been considered due to errors and omissions in accounting or corporate records. The Company's restated fiscal 1998 financial statements in the fiscal 1999 10K included changes to (i) increase Workers' Compensation expense, (ii) charge to expense vacation costs incurred but not accrued (iii) record various liabilities relating to corporate rent (iv) adjust the income tax provisions for the tax effects of the adjustments described above. See the Company's Form 10K for fiscal 1999 as filed with the Securities and Exchange Commission. F-11 42 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 were reclassified to conform to the requirements of this statement. NOTE E - 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 was accounted for as a purchase. The purchase price allocation resulted in goodwill of approximately $1.5 million which is being amortized to operations on a straight line basis over 20 years. 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. The purchase price allocation resulted in goodwill of approximately $2.5 million which amount was charged to operations in fiscal 2000 due to the subsequent disposition. In March 2000, the Company completed the disposition of Metroplex in conjunction with the Company's strategy to focus on its core businesses and reported an $800,000 loss on the sale. During fiscal 2000, MCS generated net operating revenues of $4.0 million and net income of $0.2 million, or $0.03 per share. 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 During the third quarter of fiscal 2000, management decided to abandon all operating activities, consisting of aviation services, in the Philippines and fully reserved all 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 $130,000 and $247,000 at March 31, 2000 and 1999, respectively. 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. F-12 43 Also during fiscal 1999, 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. 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, during fiscal 1999 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. NOTE G - FINANCING ARRANGEMENTS Prior to August 27, 1999, the Company's credit facility which was secured by substantially all accounts receivable, equipment, and other assets, 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 bore 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 $22.1 million and $10.8 million outstanding under the facility at March 31, 2000 and 1999, respectively with weighted average interest rates of 8.64% and 7.57%, respectively. At June 15, 2000, outstanding obligations under this facility were $22.1 million. 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. 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 did not meet 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 $5.0 million reduction in the maximum available borrowings to $25.0 million, and a $3.0 million reduction in the annual capital asset acquisition allowance to $1.0 million. Subsequent to year end 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 June 15, 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. F-13 44 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. 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, 2001................................................ $ 1,196 2002................................................ 780 2003................................................ 460 2004................................................ 232 2005................................................ 105 Thereafter.......................................... 161 ---------- Total Future Minimum Lease Commitments.............. $ 2,934 ========== Rent expense incurred under operating leases was $3.8 million, $3.3 million and $2.2 million for the years ended March 31, 2000, 1999 and 1998, respectively. 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 in the year ended March 31, 1998. See discussions of other Related Party Transactions in Notes A and O. 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 outstanding letters of credit in the amount of $838,000 at March 31, 2000. These letters 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) and premiums due of approximately $2.5 million and $3.8 million at March 31, 2000 and 1999, respectively which is F-14 45 included in accrued payroll and employee benefits in the accompanying consolidated balance sheets. The Company has an accrued liability for litigation matters that have arisen in the normal operation of the Company of approximately $1.4 million and $1.5 million, respectively at March 31, 2000 and 1999, 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:
2000 1999 ---- ---- Legal and professional (including litigation reserve)........................................ $ 1,638 $ 1,856 FAA fines and aircraft damages............................................................... 1,760 1,329 Other accrued accounts individually below $1.5 million....................................... 5,158 5,369 --------- --------- Total other accrued expenses......................................................... $ 8,556 $ 8,554 ========= =========
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, --------------------- 2000 1999 1998 ---- ---- ---- INCOME (LOSS) BEFORE INCOME TAXES Domestic............................................................ $ (14,359) $ (4,718) $ 7,914 Foreign............................................................. 394 (1,783) 443 ------------- ------------ ---------- Total......................................................... $ (13,965) $ (6,501) $ 8,357 ============= ============ ========== PROVISION FOR INCOME TAXES CURRENT TAX (BENEFIT)/EXPENSE: Federal............................................................. $ (3,437) $ 1,270 $ 2,650 State .............................................................. 100 145 700 Foreign............................................................. (24) 215 223 ------------- ------------ ---------- Total current.......................................................... (3,361) 1,630 3,573 DEFERRED TAX EXPENSE (BENEFIT): Federal............................................................. (228) (2,187) (78) State .............................................................. (200) (366) 5 ------------- ------------ ---------- Total deferred................................................... (428) (2,553) (73) ------------- ------------ ---------- Total provision before valuation allowance on net deferred tax assets.................................... (3,789) (923) 3,500 Valuation allowance on net deferred tax assets................... 2,839 1,717 - ------------- ------------ ---------- Total (benefit)/provision for income taxes............................. $ (950) $ 794 $ 3,500 ============= ============ ==========
As a result of the taxable loss incurred in the year ended March 31, 2000, the Company was able to carry back a significant portion of these losses to prior years to obtain a refund of taxes paid. The Company recorded a receivable of $3.0 million as of March 31, 2000 related to the carry back of these losses. The income tax refund was received in May 2000. F-15 46 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, --------------------- 2000 1999 1998 ---- ---- ---- Tax at U.S. federal income tax rate (34%).......................... $ (4,748) $ (2,210) $ 2,841 Valuation allowance................................................ 2,839 1,717 -- State income taxes--net of U.S. federal tax benefit................ (134) 195 452 Difference between foreign and U.S. federal tax rates.............. (158) 101 72 Nondeductible items................................................ 427 718 57 Other--net......................................................... 824 273 78 ------------- ------------- ------------- $ (950) $ 794 $ 3,500 ============= ============= ============= Effective tax rates................................................ (6.8%) (12.2%) 41.9% ============= ============= =============
The Company does not provide deferred income taxes on unremitted earnings of foreign subsidiaries, as such funds are deemed indefinitely reinvested in those operations. 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:
2000 1999 ---- ---- DEFERRED TAX ASSETS: Accrued workers' compensation........................................................ $ 1,149 $ 1,538 Accrued legal expenses............................................................... 562 904 Deferred compensation................................................................ 81 81 Amortization of intangibles.......................................................... 211 101 Allowance for doubtful accounts...................................................... 382 235 State income taxes................................................................... 86 -- Net Operating Loss carry forward..................................................... 249 -- Other accruals not currently deductible.............................................. 1,537 928 Other ............................................................................... 939 963 -------------- ----------- Total Deferred Tax Asset............................................................. 5,196 4,750 -------------- ----------- DEFERRED TAX LIABILITIES: Depreciation......................................................................... 627 610 Other ............................................................................... 13 13 -------------- ----------- Total Deferred Tax Liabilities....................................................... 640 623 -------------- ----------- Net Deferred Tax Asset before Valuation Allowance.................................... 4,556 4,127 Less: Valuation Allowance ........................................................ (4,556) (1,717) -------------- ----------- Net Deferred Tax Assets........................................................... $ -- $ 2,410 ============== ===========
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 projected tax losses for fiscal 2001, the Company provided a valuation allowance of $2.8 million and $1.7 million in fiscal 2000 and 1999, respectively. The valuation allowance was provided 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 was $2.8 million and $1.7 million for the years ended March 31, 2000 and 1999, respectively. There was no change in the reserve for the year ended March 31, 1998. At March 31, 2000, the Company has an estimated net operating loss carry forward for tax purposes of approximately $0.6 million which expires if not utilized prior to fiscal 2007. F-16 47 The net deferred tax assets are classified in the balance sheet as follows at March 31:
2000 1999 ---- ---- Current deferred income taxes........................................................ $ 640 $ 3,033 Noncurrent deferred income taxes..................................................... (640) (623) ----------- ------------ Net deferred tax assets........................................................... $ -- $ 2,410 =========== ============
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, 2000 of 20,000,000 shares. The Common Stock has one vote per share. Delisting of Common Shares On July 1, 1999, the Company was informed by the Nasdaq Stock Market that trading of the Company's Common Stock on that market would be halted pending the receipt and review of additional information in accordance with Marketplace Rules of the Nasdaq Stock Market. The primary cause for the halt was the Company's failure to timely file the Company's Form 10-K for the fiscal year ended March 31, 1999, which was originally due on or before July 1, 1999. On September 15, 1999, after an oral hearing on September 9, 1999, the Company's Common Stock was delisted from the Nasdaq Stock Market. On October 26, 1999 price quotes for the Company's Common Stock began appearing in the Electronic Quotation System of the National Quotation Bureau LLC. Although the Company filed its annual report on Form 10K for the fiscal year ended March 31, 1999, as of June 15, 2000 the Company does not meet the requirements necessary to regain listing on the Nasdaq Stock Market. Change in Control On October 19, 1999, Robert A. Weitzel ("Weitzel") resigned as the chairman, chief executive officer and director of the Company and entered into certain additional arrangements. As of November 1, 1999, Weitzel entered into a retirement and consulting agreement (the "Retirement and Consulting Agreement") with the Company. This agreement required the Company to pay Weitzel $300,000 on November 1, 1999 and $200,000 on January 3, 2000, and provide certain other standard employment benefits through September 30, 2001. In addition, the Company will pay Weitzel an aggregate of $500,000 under a 20 month consulting agreement which began February 1, 2000. The 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 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 June 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. F-17 48 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 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: (in thousands)
2000 1999 1998 ---- ---- ---- Basic common shares (weighted average)...................................... 6,683 6,662 5,215 Dilutive stock options...................................................... - - 50 ------ ------ ------ Diluted common shares....................................................... 6,683 6,662 5,265 ====== ====== ======
There were no dilutive stock options outstanding at March 31, 2000 and 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, 2000, 1999 and 1998 would have been reduced (increased) to the proforma amounts indicated below.
Years Ended March 31, ----------------------------- 2000 1999 1998 ---- ---- ---- NET INCOME (LOSS) As reported ............................................................. $ (13,015) $ (7,295) $ 4,857 Proforma ................................................................. $ (12,840) $ (7,636) $ 4,561 NET INCOME (LOSS) PER SHARE--BASIC As reported .............................................................. $ (1.95) $ (1.10) $ 0.93 Proforma ................................................................. $ (1.92) $ (1.15) $ 0.87
F-18 49 NET INCOME (LOSS) PER SHARE--DILUTED As reported ............................................................. $ (1.95) $ (1.10) $ 0.92 Proforma ................................................................. $ (1.92) $ (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 40% to 45%; and risk-free interest rate of 6.24% to 6.54%; and expected lives of 8 to 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. A summary of the status of the Company's plan as of and for the years ended March 31 are as follows:
2000 1999 1998 ---- ---- ---- Weighted Weighted Weighted Ave. Ave. Ave. Exercise Exercise Exercise Price Price Price Shares per share Shares per share Shares per share ------ --------- ------ --------- ------ --------- Options outstanding at beginning of year 247 $ 9.17 265 $ 11.25 - $ - ------ ------- ------- ------- ------ ------- Granted 200 0.78 97 5.95 265 11.25 Forfeited (158) 7.95 (115) 11.25 - - ------ ------- ------- ------- ------ ------- Options outstanding at end of year 289 $ 3.88 247 $ 9.17 265 $ 11.25 ====== ======= ======= ======= ====== ======= Options exercisable at end of year 238 38 - ====== ======= ====== Weighted average fair value of options Granted during the year $ 0.44 $ 13.78 $ 7.43 ====== ======= ====== Weighted average remaining contractual Life (Years) 9.30 8.78 9.49 ====== ======= ======
On September 18, 1998, the Company reset the price of 16,690 stock options to $11.25 per share. There were no options exercised during fiscal 2000, 1999 or 1998. The exercise prices of outstanding options on March 31, 2000 range from $0.625 to $11.25. The outstanding options expire at various dates through the year 2010. As of March 31, 2000 the following stock options were outstanding, 100,000 stock options with an exercise price of $0.625 per share, 100,000 stock options with an exercise price of $0.9375, approximately 83,000 stock options with an exercise price of $11.25 per share and 5,000 stock options with an exercise price of $5.00 per share. As of March 31, 2000 there were approximately 238,000 options exercisable at a weighted average exercise price of $2.33 per share. In Fiscal 2000, the Company granted 75,000 fully vested shares of Common Stock and 100,000 shares of restricted shares of Common Stock which vests over a four year period or upon the achievement of specified share prices over 10-day trading periods. The shares were granted in connection with an employment contract for an executive officer of the Company. In fiscal 2000, the Company recorded compensation expense of approximately $53,000 related to the fully vested share award and 10,000 shares of the 100,000 restricted share award which vested in fiscal 2000. The expense was recorded based on the per share value at the grant date of $0.625. F-19 50 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 $34,000 and $95,000 in fiscal 2000 and 1999, 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 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, 2000 Services Services Distribution Totals --------------------------------- -------- -------- ------------ ------ Net operating revenues .............................. $ 158,603 $ 47,406 $ 8,631 $ 214,640 Cost of revenues..................................... $ 149,636 $ 39,268 $ 6,467 $ 195,371 Gross margin ........................................ $ 8,967 $ 8,138 $ 2,164 $ 19,269 Net (loss)........................................... $ (9,703) $ (2,777) $ (535) $ (13,015) For the Year Ended March 31, 1999 --------------------------------- 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)
F-20 51
For the Year Ended March 31, 1998 --------------------------------- 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
DISCLOSURE OF GEOGRAPHIC INFORMATION NET OPERATING REVENUES FOR THE YEAR ENDED MARCH 31, 2000 AND ASSETS AT MARCH 31, 2000
Revenues Assets -------- ------ United States................................................... $ 208,978 $ 70,450 Other Countries................................................. 5,662 762 ------------- --------------- Total........................................................... $ 214,640 $ 71,212 ============= ===============
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
Revenues Assets -------- ------ United States................................................... $ 166,996 $ 60,135 Other Countries................................................. 5,371 1,496 ------------- ------------- Total........................................................... $ 172,367 $ 61,631 ============= =============
Disclosure About Major Customers Revenues from the Company's largest customer were approximately 22.8%, 26.0% and 25.6% of net operating revenues for the years ended March 31, 2000, 1999 and 1998, respectively. Accounts receivable from this customer were 19.9% and 32.7% of net accounts receivable at March 31, 2000 and 1999, respectively. Services provided to another major customer represented approximately 12.2%, 11.7% and 14.8% of net operating revenues for the years ended March 31, 2000, 1999 and 1998 respectively. Accounts receivable from this customer were 1.1% and 2.4% of net accounts receivable at March 31, 2000 and 1999, respectively. Furthermore, five airline customers, including the two noted above, accounted for approximately 46.4%, 48% and 54% of net operating revenues for the years ended March 31, 2000, 1999 and 1998, respectively, and accounted for 34.5% and 42.6% of net accounts receivable at March 31, 2000 and 1999, respectively. F-21 52 NOTE T - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of the unaudited quarterly results of operations for the years ended March 31, 2000 and 1999.
June 30 September 30 December 31 March 31 ------- ------------ ----------- -------- FISCAL 2000 Net operating revenues ............................ $ 55,805 $ 55,609 $ 52,805 $ 50,421 ============== ============ ============ ============ Gross margin....................................... $ 5,363 $ 6,284 $ 5,515 $ 2,107 ============== ============ ============ ============ Net (loss)......................................... $ (1,634) $ (1,228) $ (3,897) $ (6,256) ============== ============ ============ ============ Net (loss) per share: Basic....................................... $ (0.25) $ (0.18) $ (0.58) $ (0.94) ============== ============ ============ ============ Diluted..................................... $ (0.25) $ (0.18) $ (0.58) $ (0.94) ============== ============ ============ ============
June 30 September 30 December 31 March 31 ------- ------------ ----------- -------- FISCAL 1999 Net operating revenues............................. $ 56,121 $ 58,407 $ 58,858 $ 53,486 ============== ============ ============ ============ Gross margin....................................... $ 5,833 $ 6,299 $ 6,452 $ 3,064 ============== ============ ============ ============ Net income/(loss) ................................. $ 106 $ 163 $ 214 $ (7,778) ============== ============ ============ ============ Net income/(loss) per share Basic........................................... $ 0.02 $ 0.02 $ 0.03 $ (1.17) ============== ============ ============ ============ Diluted......................................... $ 0.02 $ 0.02 $ 0.03 $ (1.17) ============== ============ ============ ============
F-22 53 SCHEDULE II--VALUATION AND QUALIFYING ACCOUNTS INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES FOR THE YEARS ENDED MARCH 31, 2000, 1999 AND 1998 (AMOUNTS IN THOUSANDS)
Column A Column B Column C Column D Column E -------- -------- -------- -------- -------- Balance at Additions Balance At Beginning Charged to: End of Description of Period Expenses Other Deductions Period ----------- --------- -------- ----- ---------- ------ Year Ended March 31, 2000 ------------------------- Self Insurance Reserve........................ $5,335 $6,490 - $7,990 (a) $3,835 Reserve for FAA Fines and Aircraft Damage..... 1,329 1,426 - 995 (b) 1,760 Allowance for Doubtful Accounts............... 513 989 - 1,028 (c) 474 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 ------------------------- 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
(a) Cash payments of insurance premiums and claims. (b) Cash payments made for fines and reduction of claims. (c) Trade receivables written off. F-23