10-Q 1 l86455ae10-q.txt INTERNATIONAL TOTAL SERVICES, INC. FORM 10-Q 1 UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 FORM 10-Q (MARK ONE) [X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 FOR THE QUARTERLY PERIOD ENDED DECEMBER 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 ITS CHARTER) OHIO 34-1264201 ---- ---------- (State of Incorporation) (I.R.S. Employer Identification No.) CROWN CENTRE 5005 ROCKSIDE ROAD, SUITE 1200 INDEPENDENCE, OHIO 44131 ------------------ ----- (Address of Principal Executive Offices) (Zip Code) Registrant's telephone number, including area code: (216) 642-4522 Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No ----- ----- As of February 9, 2001, the Registrant had 6,837,494 Common Shares issued and outstanding. 2 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES FORM 10-Q INDEX
PAGE NO. PART I FINANCIAL INFORMATION ITEM 1 Financial Statements Consolidated Balance Sheets as of December 31, 2000 and March 31, 2000............................................. 2 Consolidated Statements of Operations and Comprehensive Loss for the: Three Months Ended December 31, 2000 and 1999........................................... 3 Nine Months Ended December 31, 2000 and 1999............................................ 4 Consolidated Statements of Cash Flows for the Nine Months Ended December 31, 2000 and 1999.................................... 5 Notes to the Consolidated Financial Statements.............................................. 6 ITEM 2 Management's Discussion and Analysis of Financial Condition and Results of Operations....................................................................... 12 ITEM 3 Quantitative and Qualitative Disclosures About Market Risk....................................... 18 PART II OTHER INFORMATION ITEM 6 Exhibits and Reports on Form 8 - K............................................................... 20
1 3 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA)
DECEMBER 31, MARCH 31, 2000 2000 ---- ---- (UNAUDITED) ASSETS CURRENT ASSETS Cash and cash equivalents................................................ $ 362 $ 792 Accounts receivable - net of allowance for doubtful accounts of $1,384 and $474 respectively............................... 27,189 27,675 Federal income tax refund receivable..................................... -- 3,020 Deferred taxes........................................................... 640 640 Uniforms, net............................................................ 1,036 1,035 Other current assets..................................................... 1,108 2,018 ------------- ---------- Total current assets................................................... 30,335 35,180 PROPERTY AND EQUIPMENT Security equipment....................................................... 3,275 3,799 Service equipment........................................................ 2,093 2,206 Computer equipment....................................................... 3,685 3,256 Furniture and fixtures................................................... 1,078 1,100 Autos .............................................................. 872 936 Leasehold improvements.................................................. 71 70 ------------- ---------- 11,074 11,367 Less accumulated depreciation and amortization........................... 7,082 6,470 ------------ --------- Property and equipment, net........................................... 3,992 4,897 INTANGIBLES, less accumulated amortization of $8,045 and $6,254, respectively................................................. 29,123 31,030 SECURITY DEPOSITS AND OTHER.................................................... 150 105 ------------- ---------- TOTAL ASSETS............................................................. $ 63,600 $ 71,212 ============= ========== LIABILITIES AND SHAREHOLDERS' EQUITY CURRENT LIABILITIES Trade accounts payable................................................... $ 3,882 $ 5,466 Current portion of Revolving Credit Facility............................. 24,903 -- Accrued payroll and employee benefits.................................... 14,281 16,314 Other accrued expenses................................................... 7,083 8,556 Income taxes payable..................................................... 356 337 ------------- ---------- Total current liabilities.............................................. 50,505 30,673 DEFERRED TAXES .............................................................. 640 640 REVOLVING CREDIT FACILITY...................................................... -- 22,103 WARRANTS .............................................................. 258 -- SHAREHOLDERS' EQUITY Common shares, without par value, stated at $.01 per share, authorized 20,000 shares, issued and outstanding 6,837 shares at December 31, 2000 and March 31, 2000................... 68 68 Additional paid-in capital............................................... 31,263 31,263 Accumulated other comprehensive loss..................................... (747) (470) Retained deficit......................................................... (18,387) (13,065) -------------- ----------- 12,197 17,796 ------------- ---------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY............................... $ 63,600 $ 71,212 ============= ==========
The accompanying notes are an integral part of these consolidated financial statements. 2 4 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA) (UNAUDITED)
THREE MONTHS ENDED DECEMBER 31, ------------------------------- 2000 1999 ---------------------- ----------------------- Net operating revenues....................................... $ 45,003 100.0% $ 49,926 100.0% Cost of revenues............................................. 38,928 86.5% 45,253 90.6% ---------- ------- ---------- -------- GROSS MARGIN................................. 6,075 13.5% 4,673 9.4% Selling, general and administrative expenses................. 5,287 11.6% 7,692 15.4% Specific bad debt reserve (Note C)........................... 1,100 2.6% -- -- Amortization expense......................................... 595 1.3% 819 1.6% ---------- ------- ---------- -------- OPERATING LOSS............................. (907) (2.0)% (3,838) (7.6)% Interest expense-net......................................... 767 1.7% 517 1.0% ---------- ------- ---------- -------- LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES (1,674) (3.7)% (4,355) (8.6)% Provision for income taxes................................... 44 0.1% -- -- ---------- ------- ---------- -------- NET LOSS FROM CONTINUING OPERATIONS........... $ (1,718) (3.8)% $ (4,355) (8.6)% Discontinued operations...................................... (957) (2.1)% 458 .9% ---------- ------- ---------- -------- NET LOSS...................................... $ (2,675) (5.9)% $ (3,897) (7.7)% ========== ======= ========== ======== Other comprehensive income Foreign currency translation adjustment................... 66 (73) ---------- ---------- COMPREHENSIVE LOSS............................ $ (2,609) $ (3,970) ========== ========== Net loss per share from continuing operations: Basic .................................................... $ (0.25) $ (0.65) ========== ========== Diluted................................................... $ (0.25) $ (0.65) ========== ========== Net income/(loss) per share from discontinued operations: Basic .................................................... $ (0.14) $ 0.07 ========== ========== Diluted................................................... $ (0.14) $ 0.07 ========== ========== Net loss per share: Basic .................................................... $ (0.39) $ (0.58) ========== ========== Diluted................................................... $ (0.39) $ (0.58) ========== ========== Weighted average number of shares outstanding: Basic .................................................... 6,747 6,662 ========== ========== Diluted................................................... 6,747 6,662 ========== ==========
The accompanying notes are an integral part of these consolidated financial statements. 3 5 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF OPERATIONS AND COMPREHENSIVE LOSS (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA) (UNAUDITED)
NINE MONTHS ENDED DECEMBER 31, ------------------------------ 2000 1999 ---------------------- ----------------------- Net operating revenues....................................... $ 142,293 100.0% $ 157,451 100.0% Cost of revenues ............................................ 125,945 88.5% 142,154 90.3% ---------- -------- ---------- --------- GROSS MARGIN........................................ 16,348 11.5% 15,297 9.7% Selling, general and administrative expenses................. 15,698 11.0% 19,355 12.3% Specific bad debt reserve (Note C)........................... 1,100 0.8% -- -- Amortization expense......................................... 1,791 1.3% 2,243 1.4% ---------- -------- ---------- --------- OPERATING LOSS...................................... (2,241) (1.6)% (6,301) (4.0)% Interest expense-net......................................... 2,098 1.5% 1,274 0.8% ---------- -------- --------- --------- LOSS FROM CONTINUING OPERATIONS BEFORE INCOME TAXES. (4,339) (3.1)% (7,575) (4.8)% Provision for income taxes................................... 114 0.1% -- --% ---------- -------- ---------- --------- NET LOSS FROM CONTINUING OPERATIONS................. $ (4,453) (3.2)% $ (7,575) (4.8)% Discontinued operations...................................... (869) (.6)% 816 0.5% ---------- -------- ---------- --------- NET LOSS............................................ $ (5,322) (3.8)% $ (6,759) (4.3)% ========== ======== ========== ========= Other comprehensive income Foreign currency translation adjustment................... (277) (35) ---------- ---------- COMPREHENSIVE LOSS.................................. $ (5,599) $ (6,794) ========== ========== Net loss per share from continuing operations: Basic .................................................... $ (0.66) $ (1.14) ========== ========== Diluted................................................... $ (0.66) $ (1.14) ========== ========== Net income/(loss) per share from discontinued operations: Basic .................................................... $ (0.13) $ 0.12 ========== ========== Diluted................................................... $ (0.13) $ 0.12 ========== ========== Net loss per share: Basic .................................................... $ (0.79) $ (1.02) ========== ========== Diluted................................................... $ (0.79) $ (1.02) ========== ========== Weighted average number of shares outstanding: Basic .................................................... 6,747 6,662 ========== ========== Diluted................................................... 6,747 6,662 ========== ===========
The accompanying notes are an integral part of these consolidated financial statements. 4 6 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS (AMOUNTS IN THOUSANDS) (UNAUDITED)
NINE MONTHS ENDED DECEMBER 31, ------------------------------ 2000 1999 ---------------------- ----------------------- OPERATING ACTIVITIES: Net loss.................................................. $ (5,322) $ (6,759) Adjustments to reconcile net loss to net cash (used for) provided by operating activities: Depreciation.......................................... 1,079 1,170 Amortization.......................................... 1,791 2,243 Loss/(Gain) on disposal of fixed assets............... 296 (62) Changes in working capital: Accounts receivable................................. (614) (335) Specific bad debt reserve (Note C).................. 1,100 -- Other assets........................................ 3,851 696 Trade accounts payable.............................. (1,584) 662 Accrued expenses.................................... (3,487) 1,029 -------------- ----------- Net cash used for operating activities............ (2,890) (1,356) INVESTING ACTIVITIES: Additions to property and equipment....................... (641) (740) Proceeds received from deposits and sale of equipment..... 18 904 Property and equipment of acquired businesses............. -- (302) Working capital acquired, net of cash..................... -- (1,470) Intangibles from acquisitions of businesses............... -- (4,026) ------------- ------------ Net cash used for investing activities............ (623) (5,634) FINANCING ACTIVITIES: Net borrowings on note payable to bank.................... 2,800 8,055 ------------- ----------- Net cash provided by financing activities......... 2,800 8,055 Effect of exchange rates on cash............................. 283 (35) ------------- ------------ Net increase (decrease) in cash and cash equivalents...... (430) 1,030 Cash and cash equivalents at beginning of period............. 792 672 ------------- ----------- Cash and cash equivalents at end of period................... $ 362 $ 1,702 ============= =========== SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION: Cash paid for: Interest.............................................. $ 1,878 $ 1,218 ============= =========== Income taxes.......................................... $ 109 $ 68 ============= ===========
The accompanying notes are an integral part of these consolidated financial statements. 5 7 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS THREE AND NINE MONTHS ENDED DECEMBER 31, 2000 (TABULAR AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AND PERCENTAGE DATA) (UNAUDITED) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES BASIS OF PRESENTATION The accompanying unaudited financial statements include the accounts of International Total Services, Inc. and its wholly-owned subsidiaries (the "Company"). These financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of normal recurring accruals) considered necessary for a fair presentation of the financial position of the Company as of December 31, 2000 and the results of its operations for the three and nine month periods ended December 31, 2000 and 1999 and cash flows for the nine month periods ended December 31, 2000 and 1999 have been included. The accompanying unaudited consolidated financial statements should be read in conjunction with the Company's consolidated financial statements, including the notes thereto, appearing in the Company's Annual Report on Form 10-K for the year ended March 31, 2000. The preparation of financial statements and the accompanying notes thereto, in conformity with generally accepted accounting principles, requires management to make estimates and assumptions that affect reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and reported amounts of revenues and expenses during the respective reporting periods. Actual results could differ from those estimates. Operating results for the three and nine month periods ended December 31, 2000 are not necessarily indicative of the results that may be expected for the year ended March 31, 2001. The Company's fiscal year ends on March 31. All references to fiscal years in this Quarterly Report on Form 10-Q represent the year in which the fiscal period ends (i.e. fiscal 2001 is the fiscal year ended March 31, 2001) unless otherwise noted. REVENUE RECOGNITION Revenues are recognized at the time aviation and commercial security services are provided. Commencing in the first quarter of fiscal 2000, as a result of an acquisition, revenues generated from the sales of security products were recognized on the percentage-of-completion basis. This was the policy of the newly acquired company which was involved in numerous long term installation contracts. The percentage-of-completion method was based on estimates by project managers. Prior to that time, revenues generated from the sales of security products were recognized when the products had been delivered and installed. In the third quarter of fiscal 2001, the Company discontinued its distribution and installation of security products operations, see Note E. COST RECOGNITION Cost of revenues include all labor costs and direct costs relating to aviation and commercial security and the material costs related to security products. Indirect costs are charged to selling, general and administrative expenses as incurred. Provisions for estimated losses on uncompleted contracts are made in the period in which such losses are determined. Changes in job performance, job conditions and estimated profitability, including those arising from contract penalty provisions, and final contract settlements may result in revisions to costs and income and are recognized in the period in which the revisions are determined. 6 8 CHANGE IN ESTIMATE - AMORTIZATION OF UNIFORMS IN SERVICE Effective April 1, 2000, the Company changed the estimated useful life of uniforms in service from 18 months to 15 months. The change was based on an analysis of the current usage and life of uniforms after placed in service. The estimated impact of this change on the net loss for the nine months of fiscal 2001 is not significant. RECLASSIFICATIONS Certain reclassifications have been made to the prior periods' consolidated financial statements and the accompanying notes due to the Company discontinuing its Security Products operations. NET LOSS PER SHARE Net loss per share - basic is based on the weighted average number of shares outstanding during each period. Net loss per share - diluted gives effect to the net additional shares that would have been issued had all dilutive stock options been exercised. The Company had no other potentially dilutive common share obligations outstanding. For purposes of calculating the basic and diluted net loss per share, no adjustments have been made to the reported amounts of net loss. NOTE B - GOING CONCERN The accompanying consolidated financial statements have been prepared on a going concern basis, which contemplates the realization of assets and the settlement of liabilities, including any commitments and/or contingent liabilities, in the normal course of business. The Company incurred a loss from operations for fiscal 2001, fiscal 2000 and fiscal 1999, and has negative tangible net worth. In addition, operations generated negative cash flow for fiscal 2001, the Company is not in compliance with certain loan covenants as of February 9, 2001, and the revolving credit facility is due on April 1, 2001. Further, in the third quarter of fiscal 2001 a major customer filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court. The Company has a receivable from this customer of approximately $1.1 million which has been fully reserved as uncollectible due to the bankruptcy filing. These factors raise substantial doubt about the Company's ability to continue as a going concern. The Company's strategy is to use its established business base as a platform for expanding services and currently will not pursue any further acquisitions due to the unavailability of funds. It is management's intention to seek higher overall margins by concentrating its marketing efforts on higher margin opportunities, to formulate and implement business process improvement initiatives, evaluate past acquisitions, improve customer services and reduce and/or control costs with the goal of improving operating cash flow and profits. The Company's continuation as a going concern will ultimately depend on its ability to (i) achieve profitable operations which generate positive cash flows and (ii) obtain new debt or equity financing. The financial statements do not include any adjustments relating to the recoverability of assets or the amount to settle liabilities that might be necessary should the Company be unable to continue as a going concern. NOTE C - REPORTABLE SEGMENTS The Company has two segments: Aviation Staffing Services and Commercial Security Staffing Services. The aviation services offered by the Company include pre-board screening, skycap, baggage handling, aircraft appearance, wheelchair and electric cart operations. The Company's Commercial Security Staffing Services extend beyond aviation security, and include the provision of uniformed security officers, facility access control, security consulting, special event security and security assessment to a broad range of clients. In the third quarter, the Company discontinued the operations of its Security Products Distribution segment, see Note E. The Company's reportable segments are strategic business units that offer different products and services to different markets. Aviation Staffing Services is treated as a separate business because of its unique marketing focus and the specialized 7 9 needs of its customer base, the airline industry. Commercial Security Staffing Services is treated as a separate business due to its focus on security services and its wide range of clients. The following table provides selected information about the Company's two business units. The Company makes operating decisions based on segment revenues, costs of revenues, gross margins, and net income (loss). It does not make operating decisions based on the level of assets held by a segment. SEGMENT DISCLOSURE DATA -----------------------
AVIATION COMMERCIAL STAFFING SECURITY STAFFING FOR THE NINE MONTHS ENDED DECEMBER 31, 2000 SERVICES SERVICES TOTALS ------------------------------------------- --------- -------- ------ Net operating revenues.................................... $ 111,545 $ 30,748 $ 142,293 Cost of revenues.......................................... $ 101,280 $ 24,665 $ 125,945 Gross margin ............................................ $ 10,265 $ 6,083 $ 16,348 Net loss ............................................ $ (2,807) $ (1,646) $ (4,453) FOR THE NINE MONTHS ENDED DECEMBER 31, 1999 ------------------------------------------- Net operating revenues.................................... $ 121,038 $ 36,413 $ 157,451 Cost of revenues.......................................... $ 112,005 $ 30,149 $ 142,154 Gross margin ............................................ $ 9,033 $ 6,264 $ 15,297 Net loss ............................................ $ (5,945) $ (1,630) $ (7,575)
DISCLOSURE OF GEOGRAPHIC INFORMATION ------------------------------------
NET OPERATING REVENUES FOR THE NINE MONTHS ENDED DECEMBER 31, 2000 AND ASSETS AT DECEMBER 31, 2000 -------------------------------------------------------------------------------------------------- REVENUES ASSETS United States ................................................................... $ 139,770 $ 62,936 United Kingdom................................................................... 2,523 664 -------------- -------------- Total ................................................................... $ 142,293 $ 63,600 ============== ============== NET OPERATING REVENUES FOR THE NINE MONTHS ENDED DECEMBER 31, 1999 AND ASSETS AT MARCH 31, 2000 ----------------------------------------------------------------------------------------------- REVENUES ASSETS United States ................................................................... $ 152,766 $ 70,450 Other countries.................................................................. 4,685 762 -------------- -------------- Total ................................................................... $ 157,451 $ 71,212 ============== ==============
DISCLOSURE ABOUT MAJOR CUSTOMERS During the nine months ended December 31, 2000 and 1999, revenues from one major customer amounted to $22.5 million and $37.6 million or 15.8% and 23.9%, respectively, of net operating revenues. Services provided to another major customer generated revenues for the Company of $17.0 million or 12.0% of net operating revenues for the nine months ended December 31, 2000 and 12.7% of total revenues during the same period in the prior year. Five airline customers, including the two noted above, accounted for approximately 41.6% and 48.2% of net operating revenue for the nine months ended December 31, 2000 and 1999, respectively, and accounted for 28.0% and 28.6% of net accounts receivable at December 31, 2000 and March 31, 2000 respectively. In the third quarter of fiscal 2001 a major customer filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court. The Company has a receivable from this customer of approximately $1.1 million which has been fully reserved as uncollectible due to the bankruptcy filing. 8 10 NOTE D - FINANCING ARRANGEMENTS In April 2000 management secured, from the Company's banks, certain amendments to the Company's existing $25.0 million credit facility. Among the amendments were an extension of the term to April 1, 2001 with a reduction of the interest rate to be charged on borrowings to prime plus 0.75%, if the loan was repaid by December 31, 2000. The amendments also contained a provision that if the loan was not repaid by December 31, 2000, the interest rate charged on borrowings equals prime plus 1.25%, retroactive to April 2000. As the loan was not repaid, the Company recorded a one-time retroactive interest rate adjustment charge in third quarter of fiscal 2001 of approximately $86,000, of which approximately $29,000 was applicable to both the first and second quarter of fiscal 2001. Effective January 1, 2001 the interest rate charged on borrowings was increased to prime plus 1.50%. The amendments also included an increase to the percentage advance rate of eligible receivables as well as more relaxed financial covenants. The financial covenants included certain net worth covenants and a minimum debt coverage ratio and standard financial reporting requirements. As of February 9, 2001, the Company was not in compliance with certain covenants and the outstanding obligation under this facility was $23.9 million. In consideration for the amendments and extension of the credit facility, the Company granted the lenders warrants for the purchase of 300,000 shares of the Company's Common Stock at an exercise price of $1.41, which the Company's Board of Directors determined was the fair market value of the Company's Common Stock as of the date of the grant. The warrants expire on March 31, 2007. As part of the transaction, the banks were granted a "put" option commencing April 1, 2001 which would, if exercised, require the Company to purchase the warrants at $1.00 per warrant, and the Company retained a "call" option commencing immediately at an initial price of $4.50 per warrant. The call price increases by $1.00 per warrant per year commencing April 1, 2001. In the first nine months of fiscal 2001, the Company recorded a warrant liability amounting to $225,000 related to the put option associated with warrants granted to the banks. Interest expense was charged for the accretion of the put option feature from the grant date to the end of the third quarter of fiscal 2001. The Company will record an additional $75,000 over the balance of fiscal 2001 related to the contingent put option liability. Guarantee of Debt On July 7, 1999, the Company entered into a First Demand Guarantee with a German bank to guarantee overdrafts of the German operations up to 500,000 Deutsche Marks (approximately $270,000 at that date). In February 2000 the Company received notice for a claim amounting to approximately $122,000 related to this guarantee. The Company ceased operations in Germany during fiscal 2000. NOTE E-DISCONTINUED OPERATIONS In the third quarter of fiscal 2001, the Company discontinued its Security Products Distribution segment operations. The Company completed the remaining open projects and abandoned or liquidated the remaining assets for nominal proceeds. The Company recorded a loss on the disposal and abandonment of fixed assets and obsolete inventory of approximately $292,000. At the end of fiscal 2000 the Company began evaluating the possibility of exiting the Security Products Distribution segment to focus on its core businesses of Aviation Staffing Services and Commercial Security Staffing Services. In March 2000, in conjunction with this strategy, the Company completed the disposition of a subsidiary, which had been acquired in the first quarter of fiscal 2000. The revenue of this subsidiary represented a major portion of the Security Products Distribution segment. The Company reported a $0.8 million loss on the sale of this subsidiary in the fourth quarter of fiscal 2000. The Company's strategy also included a decision to outsource the balance of this function, which resulted in an agreement to act as a sales representative for an independent third party security product distributor and installer. The estimated commission revenue related to this agreement is not anticipated to be material. 9 11 The summarized results of discontinued operations and related effect per common share are as follows:
THREE MONTHS ENDED NINE MONTHS ENDED DECEMBER 31, DECEMBER 31, 2000 1999 2000 1999 ------------------------------------------------- Net operating revenues....................................... $ 34 $ 2,879 $ 2,116 $ 6,768 Cost of revenues............................................. 240 2,037 2,197 4,903 ---------- -------- ---------- --------- GROSS MARGIN................................. (206) 842 (81) 1,865 Selling, general and administrative expenses................. 18 385 55 1,061 ---------- -------- ---------- --------- OPERATING INCOME/(LOSS).................... (224) 457 (136) 804 Interest expense-net......................................... -- (1) -- (12) Loss on disposal of assets-net............................... 733 -- 733 -- ---------- -------- ---------- --------- INCOME/(LOSS) BEFORE INCOME TAXES................. (957) 458 (136) 816 Provision for income taxes................................... -- -- -- -- ---------- -------- ---------- --------- NET INCOME/(LOSS)............................. $ (957) $ 458 $ (869) $ 816 ========== ======== ========== ========= Net income/(loss) per share: Basic .................................................... (.14) .07 (.13) .12 ========== ======== ========== ========= Diluted................................................... (.14) .07 (.13) .12 ========== ======== ========== =========
At December 31, 2000 the Company's Consolidated Balance Sheet contained liabilities of approximately $0.5 million and no material assets for the Security Products Distribution segment. At March 31, 2000 the Company's Consolidated Balance Sheet contained liabilities of approximately $0.5 million and assets of approximately $1.5 million for the Security Products Distribution segment. NOTE F-CAPITAL STOCK Change in Control On October 19, 1999, Robert A. Weitzel ("Weitzel") resigned as the chairman, chief executive officer and director of the Company and entered into certain additional arrangements. As of November 1, 1999, Weitzel entered into a retirement and consulting agreement (the "Retirement and Consulting Agreement") with the Company. This agreement required the Company to pay Weitzel $300,000 on November 1, 1999 and $200,000 on January 3, 2000, and provide certain other standard employment benefits through September 30, 2001. In addition, the Company will pay Weitzel an aggregate of $500,000 under a 20 month consulting agreement which began February 1, 2000. The Retirement and Consulting Agreement also provided that Weitzel enter into a voting trust agreement (the "Voting Trust Agreement") among the Company, Weitzel, and H. Jeffrey Schwartz, J. Jeffrey Eakin and John P. O'Brien, as voting trustees (the "Trustees"), and a stock restriction agreement between Weitzel and the Company (the "Stock Restriction Agreement"). The three Trustees constitute the entire Board of Directors of the Company. Pursuant to the Voting Trust Agreement, Weitzel transferred record ownership, and thereby voting control, of 3,324,979 shares of the Company's Common Stock, representing approximately 48.6% of the issued and outstanding shares of the Company's Common Stock, held by Weitzel individually and by The Weitzel Family Limited Partnership to the voting trust (the "Voting Trust") created by the Voting Trust Agreement. Pursuant to the Voting Trust Agreement, a voting trust certificate was issued and delivered to Weitzel. The Voting Trust Agreement provides that all shares of the Company's Common Stock transferred to the Trust are held in trust until the earlier of September 30, 2001 or a payment default by the Company under certain provisions of the Retirement and Consulting Agreement. Pursuant to the Voting Trust Agreement, the Trustees exercise voting power with respect to the shares of the Company's Common Stock held in the Voting Trust, by the action of a majority of the Voting Trustees. In addition, any transfer of the voting trust certificate is only permitted in accordance with the Stock Restriction Agreement. Pursuant to the Stock Restriction Agreement, other than transfers to his spouse, children, or grandchildren, or entities of which those people are the beneficiaries or hold controlling interests, Weitzel is not permitted to transfer shares of the Company's Common Stock, or voting trust certificates, without first offering those shares on identical terms to the Company, and the Company has a specified period of time during which it may exercise its option to purchase those shares. 10 12 Delisting of Common Shares On July 1, 1999, the Company was informed by the Nasdaq Stock Market that trading of the Company's Common Stock on that market would be halted pending the receipt and review of additional information in accordance with Marketplace Rules of the Nasdaq Stock Market. The primary cause for the halt was the Company's failure to timely file the Company's Form 10-K for the fiscal year ended March 31, 1999, which was originally due on or before July 1, 1999. On September 15, 1999, after an oral hearing on September 9, 1999, the Company's Common Stock was delisted from the Nasdaq Stock Market. On October 26, 1999 price quotes for the Company's Common Stock began appearing in the Electronic Quotation System of the National Quotation Bureau LLC. Although the Company is now current for all Securities and Exchange Commission filings, the Company does not meet the requirements necessary to regain listing on the Nasdaq Stock Market. NOTE G-SUBSEQUENT EVENT On February 7, 2001 the Company signed a Letter of Intent with Brantley Partners IV, L.P. and Brantley Capital Corporation (Collectively "Brantley") whereby Brantley would invest $10 million to acquire a controlling equity interest in the Company. Closing is currently scheduled to occur on or about April 2, 2001 but is subject to several conditions including the completion of Brantley's due diligence, negotiation of a satisfactory credit facility, negotiation of a definitive share purchase agreement and obtaining requisite approvals. The Board of Directors of the Company has set a record date of March 1, 2001 for purposes of the meeting of shareholders which will be called to approve the transaction. 11 13 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS THREE AND NINE MONTHS ENDED DECEMBER 31, 2000 OVERVIEW The Company's continuing operations consist of being a leading provider of aviation contract support services and also a significant provider of commercial security staffing services. The Company provides services to customers in the United States and United Kingdom. Aviation support services offered by the Company include pre-board screening, skycap, baggage handling and aircraft appearance services, wheelchair and electric cart operations. The Company's security services extend beyond aviation security, and include the provision of commercial security staffing services to government and business clients, hospitals, arenas, and museums. The Company's services are provided under contracts that generally have terms of one to three years, but are cancelable by either party on 30 to 90 days notice. Although contract terms vary significantly, clients generally pay an hourly rate for services provided. Certain services, such as aircraft cleaning, are billed on a flat fee-for-service basis, and certain others are billed at a fixed monthly rate. The Company recognizes revenues as the related services are performed. Operations generated negative cash flow for fiscal 2000 and for the first nine months of fiscal 2001. Although the Company obtained a one year extension of its credit facility through April 2001 (See Note D of "Notes to the Consolidated Financial Statements") the negative cash flow generated during fiscal 2000 and 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 contained an explanatory paragraph with respect to this matter. RESULTS OF OPERATIONS COMPARISON OF RESULTS OF OPERATIONS FOR THE THREE MONTHS ENDED DECEMBER 31, 2000 AND 1999 The following are the Net Operating Revenues, Cost of Revenues and Gross Margin for the third quarter of fiscal 2001 as compared to the same period in fiscal 2000, by segment (dollars in thousands). Certain reclassifications have been made to the prior period due to the discontinued operation of the Security Products segment (See Note E of "Notes to the Consolidated Financial Statements").
For the Three Months Ended Dec 31, 2000 % of Rev 1999 % of Rev Inc/(Dec) % Inc/(Dec) ------------------------- ------------------------- ------------------------ Net Operating Revenues: Aviation $ 35,308 78.5% $ 38,015 76.1% $ (2,707) -7.1% Commercial Security 9,695 21.5% 11,911 23.9% (2,216) -18.6% ------------------------- ------------------------- ------------------------ 45,003 100.0% 49,926 100.0% (4,923) -9.9% ------------------------- ------------------------- ------------------------ Cost of Revenues: Aviation 31,145 88.2% 35,441 93.2% (4,296) -12.1% Commercial Security 7,783 80.3% 9,812 82.4% (2,029) -20.7% ------------------------- ------------------------- ------------------------ 38,928 86.5% 45,253 90.6% (6,325) -14.0% ------------------------- ------------------------- ------------------------ Gross Margin: Aviation 4,163 11.8% 2,574 6.8% 1,589 61.7% Commercial Security 1,912 19.7% 2,099 17.6% (187) -8.9% ------------------------- ------------------------- ------------------------ $ 6,075 13.5% $ 4,673 9.4% $ 1,402 30.0% ========================= ========================= ========================
NET OPERATING REVENUES. Net operating revenues in the third quarter of fiscal 2001 decreased by $4.9 million, or 9.9%, as compared with the third quarter of fiscal 2000. The decrease is attributable to the loss of aviation and commercial security staffing contracts. 12 14 The decrease in aviation revenues relates to lost service contracts at several sites which has been partially offset by price increases obtained from airlines and new service contracts obtained since the beginning of the fiscal 2001. The Company's contracts with clients generally have one to three year terms but are cancelable by either party on 30 to 90 days' notice. In the normal course of business, the competitive bidding process and other factors, the Company has lost certain profitable contracts. In the second quarter of fiscal 2001, the Company lost a contract at the Dallas/Fort Worth airport that generated net revenues of $7.4 million and gross margin of $1.0 million in fiscal 2000. The loss of this and other business with the same customer contributed to the decrease in net operating revenues when compared to last year and the prior quarter. The Company's strategy to focus on higher margins has resulted in price increases and approximately 45 new contracts at targeted margin percentages. The benefit of this strategy is reflected in gross margin as a percent of revenue, which increased from 6.8% in the third quarter of fiscal 2000 to 11.8% for the same period in fiscal 2001. Commencing in the third quarter of fiscal 2001 the Company has obtained significant price increases and a major new contract. This new contract is projected to generate net revenues of $4.0 million and gross margin of approximately $0.4 million per year. Additionally, the Company benefits from price increases by reducing employee turnover and lowering non-reimbursed overtime expenditures due to increased wages for employees (See "Cost of Revenues"). Although the Company will seek to retain profitable contracts, obtain price increases, and generate new business, there can be no assurance that the Company will be successful in its efforts. The decrease in Commercial Security Staffing Services net revenues was related to the Company's strategy, commencing in the third quarter of fiscal 2000, to eliminate contracts that did not meet the Company's profit criteria. Although Commercial Security Staffing Services net revenues decreased by $2.2 million, or 18.6%, gross margin only decreased approximately $0.2 million, with gross margin as a percent of revenue increasing from 17.6% in the third quarter of fiscal 2000 to 19.7% for the same period in fiscal 2001. Commencing in the fourth quarter of fiscal 2001, Commercial Security Staffing Services has obtained two new contracts that are projected to generate combined net revenues of $4.0 million and gross margins of $0.8 million annually. COST OF REVENUES. Cost of revenues includes primarily the cost of field personnel (wages, payroll taxes, vacation, workers' compensation and uniforms) and related equipment costs. In the third quarter of fiscal 2001, total cost of revenues decreased $6.3 million, or 14.0%, as compared to the same period in fiscal 2000. Most of this decrease was due to costs associated with the service contracts lost or discontinued. As a percent to net operating revenues, cost of net operating revenues decreased from 90.6% in fiscal 2000 to 86.5% in fiscal 2001. This is attributed to the Company's strategy which includes the implementation of process improvement initiatives and cost cutting measures within both the Aviation Staffing Services and the Commercial Security Staffing Services segments. Aviation Services gross margin increased from 6.8% in the third quarter of fiscal 2000 to 11.8% for the same period in fiscal 2001. The gross margin of 11.8% for Aviation Staffing Services in the third quarter of fiscal 2001 is an improvement from the gross margin of 7.5% for the second quarter of fiscal 2001. The Company is continuing efforts to eliminate negative and low margin contracts and improve controls over labor costs, especially non-reimbursed overtime costs, to improve margins in the Aviation Staffing Services and Commercial Security Staffing Services segments. The strength of the United States economy during this period has driven unemployment to low levels and has forced the Company to increase the wages paid to employees in advance of increases in the rates paid by the Company's customers. The low unemployment rates have resulted in higher overtime pay than in prior years which has been incurred in order to provide the services required per the contracts with the customers. In addition, low unemployment rates have increased employee turnover, which increases recruiting and training costs. The Company's ability to obtain price increases for aviation services is dependent, in part, upon the economic strength of the airline industry, which may be impacted by rising fuel prices and competition. SELLING, GENERAL AND ADMINISTRATIVE EXPENSES. ("S, G & A"). Selling, general and administrative expenses include corporate governance costs, support services for field personnel, bad debt expense and professional services (legal, audit and consulting). The following table breaks down S, G & A by business segment and corporate administrative costs (in thousands): Three Months ended Dec 31, -------------------------------- 2000 1999 ------------- -------------- Aviation $ 1,719 $ 2,126 Commercial Security 1,438 1,525 Corporate Administration 2,130 4,041 ------------- -------------- $ 5,287 $ 7,692 ============= ============== 13 15 Total S, G & A expenses decreased $2.4 million, or 31.3%, in the third quarter of fiscal 2001 as compared to the same period in fiscal 2000. S, G & A expenses were 11.7% and 15.4% of net operating revenues for the third quarter of fiscal 2001 and 2000, respectively. The following discusses the changes in S, G & A expenses by business segment for the third quarter of fiscal 2001 as compared to the same period in fiscal 2000. Aviation Staffing Services S, G & A expenses decreased $0.4 million for the third quarter of fiscal 2001 as compared to the same period in fiscal 2000. The decrease was due to aviation contracts that have been lost combined with expense savings generated from the reorganization of aviation administration which reduced administrative costs, primarily salary and payroll taxes and benefits. Commercial Security Staffing Services S, G & A expenses decreased approximately $87,000 in the third quarter of fiscal 2001 as compared to the same period in fiscal 2000, primarily related to salary and payroll taxes and benefits. The Company has completed the reorganization of the Commercial Security administrative support structure. Corporate Administration S, G & A decreased $1.9 million in the third quarter of fiscal 2001 as compared to the same period in fiscal 2000. The decrease is due to the Company's strategy to reduce annual Corporate Administrative costs in fiscal 2001 as compared to fiscal 2000. S, G & A expense in the third quarter of fiscal 2000 included a $1.0 million charge related to the Retirement and Consulting Agreement with the former Chairman. (See Note F of "Notes to the Consolidated Financial Statements"). SPECIFIC BAD DEBT RESERVE. In the third quarter of fiscal 2001 a major customer filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court. The Company has a receivable from this customer of approximately $1.1 million which has been fully reserved as uncollectible and expensed to S, G & A during the third quarter of fiscal 2001 due to the bankruptcy filing. AMORTIZATION EXPENSE. Contract and goodwill amortization expense decreased $0.2 million, or 27.4%, to $0.6 million in the third quarter of fiscal 2001 from $0.8 million in the third quarter of fiscal 2000. The decrease relates to a decrease in goodwill amortization due to a disposition and its related goodwill in March 2000. (See Note E of "Notes to the Consolidated Financial Statements"). INTEREST EXPENSE. In the third quarter of fiscal 2001, interest expense increased to $0.8 million from $0.5 million in the third quarter of fiscal 2000. Average outstanding debt increased from $21.3 million during the third quarter of fiscal 2000 to $23.1 million during the third quarter of fiscal 2001. This increase in debt was primarily incurred during fiscal 2000 to fund the negative cash flow from operations. In addition, the Company's effective borrowing rate increased from 9.09% to 10.75% for the third quarter of fiscal 2000 as compared to the third quarter of fiscal 2001. The increase in the effective borrowing rate was due to the increase in the prime rate of interest as well as provisions contained within the April 2000 amended credit facility agreement, see Liquidity and Capital Resources. Interest expense in the third quarter of fiscal 2001 also includes a $75,000 non-cash charge related to the put option associated with the warrants to purchase stock granted to the Bank. (See Note D of "Notes to the Consolidated Financial Statements"). Additionally, a one-time retroactive interest rate adjustment resulted in the Company recognizing in the third quarter of fiscal 2001 a charge of approximately $86,000, of which approximately $29,000 was applicable to both the first and second quarter of fiscal 2001. (See Note D of "Notes to the Consolidated Financial Statements"). INCOME TAXES. Due to the loss incurred, and the uncertainty of the Company's ability to realize any carry forward tax benefits, no tax benefit was recorded in the third quarter of fiscal 2001 or fiscal 2000. The tax provision for the third quarter of fiscal 2001 relates to United Kingdom tax obligations in addition to certain domestic state and local taxes. DISCONTINUED OPERATIONS. In the third quarter of fiscal 2001, the Company discontinued its Security Products Distribution business segment operations. The Company recorded a loss on the disposal and abandonment of fixed assets and obsolete inventory of approximately $292,000. Discontinued operations generated a net loss for the three months ended December 31, 2000 of $957,000. The loss primarily related to the wrap up of incompleted projects. (See Note E of "Notes to the Consolidated Financial Statements"). 14 16 COMPARISON OF RESULTS OF OPERATIONS FOR THE NINE MONTHS ENDED DECEMBER 31, 2000 AND 1999 The following are the Net Operating Revenues, Cost of Revenues and Gross Margin for the nine months ended December 31, 2000 of fiscal 2001 as compared to the same period in fiscal 2000, by segment (dollars in thousands). Certain reclassifications have been made due to the discontinued operation of the Security Products segment (See Note E of "Notes to the Consolidated Financial Statements").
For the Nine Months Ended Dec 31, 2000 2000 % of Rev 1999 % of Rev Inc/(Dec) % Inc/(Dec) ------------------------- ------------------------- -------------------------- Net Operating Revenues: Aviation $ 111,545 78.4% $ 121,038 76.9% $ (9,493) -7.8% Commercial Security 30,748 21.6% 36,413 23.1% (5,665) -15.6% ------------------------- ------------------------- -------------------------- 142,293 100.0% 157,451 100.0% (15,158) -9.6% ------------------------- ------------------------- -------------------------- Cost of Revenues: Aviation 101,280 90.8% 112,005 92.5% (10,725) -9.6% Commercial Security 24,665 80.2% 30,149 82.8% (5,484) -18.2% ------------------------- ------------------------- -------------------------- 125,945 88.5% 142,154 90.3% (16,209) -11.4% ------------------------- ------------------------- -------------------------- Gross Margin: Aviation 10,265 9.2% 9,033 7.5% 1,232 13.6% Commercial Security 6,083 19.8% 6,264 17.2% (181) -2.9% ------------------------- ------------------------- -------------------------- $ 16,348 11.5% $ 15,297 9.7% $ 1,051 6.9% ========================= ========================= ==========================
NET OPERATING REVENUES. Net operating revenues in the first nine months of fiscal 2001 decreased by $15.2 million, or 9.6%, as compared with the same period of fiscal 2000. The decrease is attributable to the loss of aviation and commercial security staffing contracts. The decrease in aviation revenues relates to lost service contracts at several sites which has been partially offset by price increases obtained from airlines and new service contracts obtained since the beginning of the fiscal 2001. The Company's contracts with clients generally have one to three year terms but are cancelable by either party on 30 to 90 days' notice. In the normal course of business, the competitive bidding process and other factors, the Company has lost certain profitable contracts. In the second quarter of fiscal 2001, the Company lost a contract at the Dallas/Fort Worth airport that generated net revenues of $7.4 million and gross margin of $1.0 million in fiscal 2000. The loss of this and other business with the same customer contributed to the decrease in net operating revenue when compared to last year. The Company's strategy to focus on higher margins has resulted in price increases and approximately 45 new contracts at targeted margin percentages. The benefit of this strategy is reflected in gross margin as a percent of revenue, which increased from 7.5% for the first nine months of fiscal 2000 to 9.2% for the same period in fiscal 2001. Commencing in the third quarter of fiscal 2001 the Company has obtained significant price increases and a major new contract. This new contract is projected to generate net revenues of $4.0 million and gross margin of approximately $0.4 million per year. Additionally, the Company benefits from price increases by reducing employee turnover and lowering non-reimbursed overtime expenditures due to increased wages for employees (See "Cost of Revenues"). The effects of this strategy may result in improved margins for the fourth quarter of fiscal 2001 as compared to the prior fiscal year. Although the Company will seek to retain profitable contracts, obtain price increases, and generate new business, there can be no assurance that the Company will be successful in its efforts. The decrease in Commercial Security Staffing Services net revenues was related to the Company's strategy, commencing in the third quarter of fiscal 2000, to eliminate contracts that did not meet the Company's profit criteria. Although Commercial Security Staffing Services net revenues decreased by $5.7 million, or 15.6%, gross margin only decreased approximately $0.2 million, with gross margin as a percent of revenue increasing from 17.2% for the nine months of fiscal 2000 to 19.8% for the same period in fiscal 2001. Commencing in the fourth quarter of fiscal 2001, Commercial Security Staffing Services has obtained two new contracts that are projected to generate combined net revenues of $4.0 million and gross margins of $0.8 million annually. 15 17 COST OF REVENUES. Cost of revenues includes primarily the cost of field personnel (wages, payroll taxes, vacation, workers' compensation and uniforms) and related equipment costs. In the first nine months of fiscal 2001, total cost of revenues decreased $16.2 million, or 11.4%, as compared to the same period in fiscal 2000. Most of this decrease was due to costs associated with the service contracts lost or discontinued. The decrease in total cost of revenues resulted in the company increasing gross margin from 9.7% in the first nine months of fiscal 2000 to 11.5% for the same period of fiscal 2001. The gross margin of 11.5% for the Company in the first nine months of fiscal 2001 is an improvement from the gross margin of 10.6% for the first six months of fiscal 2001. These results are attributed to the Company's strategy, which includes the implementation of process improvement initiatives and cost cutting measures within both the Aviation Staffing Services and the Commercial Security Staffing Services segments. The Company is continuing efforts to eliminate negative and low margin contracts and improve controls over labor costs, especially non-reimbursed overtime costs, to improve margins in the Aviation Staffing Services and Commercial Security Staffing Services segments. The strength of the United States economy during this period has driven unemployment to low levels and has forced the Company to increase the wages paid to employees in advance of increases in the rates paid by the Company's customers. The low unemployment rates have resulted in higher overtime pay than in prior years which has been incurred in order to provide the services required per the contracts with the customers. In addition, low unemployment rates have increased employee turnover, which increases recruiting and training costs. The Company's ability to obtain price increases for aviation services is dependent, in part, upon the economic strength of the airline industry, which may be impacted by rising fuel prices and competition. 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): Nine Months ended Dec 31 ------------------------------ 2000 1999 ------------ ------------ Aviation $ 5,329 $ 6,977 Commercial Security 4,270 4,390 Corporate Administration 6,099 7,988 ------------ ------------ $ 15,698 $ 19,355 ============ ============ Total S, G & A expenses decreased $3.7 million, or 18.9%, in the first nine months of fiscal 2001 as compared to the same period in fiscal 2000. S, G & A expenses were 11.0% and 12.3% of net operating revenues for the first nine months of fiscal 2001 and 2000, respectively. The following discusses the change in S, G & A expenses by business segment for the first nine months of fiscal 2001 as compared to the same period in fiscal 2000. Aviation Staffing Services S, G & A expenses decreased $1.6 million for the first nine months of fiscal 2001 as compared to the same period in fiscal 2000. The decrease was due to aviation contracts that have been lost combined with expense savings generated from the reorganization of aviation administration which reduced administrative costs, primarily salary and payroll taxes and benefits. Commercial Security Staffing Services S, G & A expenses decreased approximately $120,000 in the first nine months of fiscal 2001 as compared to the same period in fiscal 2000, primarily related to salary and payroll taxes and benefits. The Company has completed the reorganization of the Commercial Security administrative support structure. Corporate Administration S, G & A decreased $1.9 million in the first nine months of fiscal 2001 as compared to the same period in fiscal 2000. The decrease is due to the Company's strategy to reduce annual Corporate Administrative costs in fiscal 2001 as compared to fiscal 2000. S, G & A expense in fiscal 2000 included a $1.0 million charge related to the Retirement and Consulting Agreement with the former Chairman. (See Note F of "Notes to the Consolidated Financial Statements") SPECIFIC BAD DEBT RESERVE. In the third quarter of fiscal 2001 a major customer filed a voluntary petition for relief under Chapter 11 of the United States Bankruptcy Code in the United States Bankruptcy Court. The Company has a receivable from this customer of approximately $1.1 million which has been fully reserved as uncollectible and expensed to S, G & A during fiscal 2001 due to the bankruptcy filing. 16 18 AMORTIZATION EXPENSE. Contract and goodwill amortization expense decreased $0.5 million, or 20.2%, to $1.8 million in the first nine months of fiscal 2001 from $2.2 million in the same period of fiscal 2000. The decrease relates to a decrease in goodwill amortization due to a disposition and its related goodwill in March 2000. (See Note E of "Notes to the Consolidated Financial Statements"). INTEREST EXPENSE. In the first nine months of fiscal 2001, interest expense increased to $2.1 million from $1.3 million in the same period of fiscal 2000. Average outstanding debt increased from $20.6 million during the first nine months of fiscal 2000 to $23.1 million during the same period of fiscal 2001. This increase in debt was primarily incurred during fiscal 2000 to fund the negative cash flow from operations. In addition, the Company's effective borrowing rate increased from 8.27% to 10.64% for the first nine months of fiscal 2000 as compared to the same period of fiscal 2001. The increase in the effective borrowing rate was due to the increase in the prime rate of interest as well as provisions contained within the April 2000 amended credit facility agreement, see Liquidity and Capital Resources. Interest expense in the first nine months of fiscal 2001 also includes a $225,000 charge related to the put option associated with the warrants to purchase stock granted to the Bank. (See Note D of "Notes to the Consolidated Financial Statements"). INCOME TAXES. Due to the loss incurred, and the uncertainty of the Company's ability to realize any carry forward tax benefits, no tax benefit was recorded in the first nine months of fiscal 2001 or fiscal 2000. The tax provision for the nine months of fiscal 2001 relates to United Kingdom tax obligations in addition to certain domestic state and local taxes. DISCONTINUED OPERATIONS. In the third quarter of fiscal 2001, the Company discontinued its Security Products Distribution business segment operations. The Company recorded a loss on the disposal and abandonment of fixed assets and obsolete inventory of approximately $292,000. Discontinued operations generated a net loss for the nine months ended December 31, 2000 of $869,000. The loss primarily related to the wrap up of incompleted projects (See Note E of "Notes to the Consolidated Financial Statements"). LIQUIDITY AND CAPITAL RESOURCES The Company's business is labor intensive. Consequently, it has substantial needs for cash throughout its fiscal year. Operating activities used net cash of approximately $2.9 million and financing activities generated net cash of $2.8 million during the nine months ended December 31, 2000. The primary use of funds in the first nine months of fiscal 2001 was to fund accrued expenses, principally worker's compensation and other prior year obligations. During the first nine months of fiscal 2001, principal uses of funds, in addition to working capital requirements, included expenditures associated with capital expenditures. The Company anticipates capital expenditures during the balance of fiscal 2001 of approximately $0.2 million, primarily related to computer software and systems and equipment used in operations. In April 2000 management secured, from the Company's banks, certain amendments to the Company's existing $25.0 million credit facility. Among the amendments were an extension of the term to April 1, 2001 with a reduction of the interest rate to be charged on borrowings to prime plus 0.75%, if the loan was repaid by December 31, 2000. The amendments also contained a provision that if the loan was not repaid by December 31, 2000, the interest rate charged on borrowings equals prime plus 1.25%, retroactive to April 2000. The one-time retroactive interest rate adjustment resulted in the Company recognizing in the third quarter of fiscal 2001 a charge of approximately $86,000, of which approximately $29,000 was applicable to both the first and second quarter of fiscal 2001. Effective January 1, 2001 the interest rate charged on borrowings was increased to prime plus 1.50%. The amendments also included an increase to the percentage advance rate of eligible receivables as well as more relaxed financial covenants. The financial covenants included certain net worth covenants and a minimum debt coverage ratio and standard financial reporting requirements. As of February 9, 2001, the Company was not in compliance with certain covenants and the outstanding obligation under this facility was $23.9 million. In consideration for the amendments and extension of the credit facility, the Company granted the lenders warrants for the purchase of 300,000 shares of the Company's Common Stock at an exercise price of $1.41, which the Company's Board of Directors 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. (See Note D of "Notes to the Consolidated Financial Statements"). 17 19 The Company has generated negative cash flow from operations for the first nine months of fiscal 2001, but believes that the Company will generate positive cash flow from operations in the fourth quarter of fiscal 2001 when the benefits of programs to improve margins and reduce expenses are expected to begin to generate positive cash flow. However, positive cash flow from operations will be significantly impacted by the Chapter 11 bankruptcy filing of a major customer. The Company has a receivable from this customer of approximately $1.1 million which was reserved as uncollectible in the third quarter of fiscal 2001. (See Note B of "Notes to the Consolidated Financial Statements"). 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, may be sufficient to meet its cash requirements, including monthly debt service, until operations begin to generate sufficient positive cash flow. The Company will seek to refinance its outstanding borrowings under the credit facility on or prior to March 31, 2001, but there can be no assurance as to the Company's ability to obtain a replacement credit facility or otherwise refinance its debt, if necessary, or obtain other equity financing. The Company's lack of external financing sources will limit its ability to grow and cause it to rely on 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. In conjunction with the Company's efforts to obtain external financing, the Company signed a Letter of Intent with Brantley Partners IV, L.P. and Brantley Capital Corporation that would provide a capital infusion of $10 million (See Note G of "Notes to the Consolidated Financial Statements"), in exchange for a controlling equity interest in the Company. Although this letter of intent has been signed, it is subject to satisfaction of several conditions and no assurance can be given that Brantley Partners IV, L.P., Brantley Capital Corporation, or any other entity will close on a transaction that will provide the Company with equity financing. FORWARD LOOKING STATEMENTS Forward-looking statements in this Form 10-Q including, without limitation, statements relating to the Company's plans, strategies, objectives, expectations, intentions, and adequacy of resources, are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These forward-looking statements involve known and unknown risks, uncertainties, and other factors that may cause the actual results, performance, or achievements of the company to be materially different from any future results, performance or achievements expressed or implied by such forward-looking statements. Statements in this quarterly report, including the notes to the consolidated financial statements, describe factors that could contribute to or cause such differences. These factors include, among others, the Company's ability to pay off or refinance its credit facility, unanticipated losses of service contracts, economic and labor conditions in the aviation industry and commercial security industry, the transition to new management, and negative publicity regarding the airline security and services and commercial staffing services industries. The Company undertakes no obligation to publicly update or revise any forward-looking statements, whether as a result of new information, future events or otherwise. Readers are referred to the Company's Annual Report on Form 10K as filed with the Securities and Exchange Commission which identifies certain risk factors. ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK In the ordinary course of business, the Company is subject to foreign currency, interest rate and labor market risks. The risks primarily relate to the sale of the Company's services to foreign customers through its foreign subsidiaries, changes in interest rates on the Company's short-term financing and the availability and cost of labor. Foreign Currency Risk. A portion of the Company's revenues, (1.8% through December 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 significant. The Company does not engage in hedging transactions to reduce exposure to fluctuations in foreign currency exchange rates. Interest Rate Risk. The Company maintains a revolving line of credit which subjects the Company to the risk of loss associated with movements in market interest rates. This line of credit had a balance at December 31, 2000 of $24.0 million, which was at a variable rate of interest based on prime. Since revolving payments and borrowing are made on this line of credit on a daily basis subject to a market variable rate of interest, the December 31, 2000 balance of this debt is considered to be at fair value. Based upon the Company's current outstanding balance on its revolving line of credit, a hypothetical increase of approximately 100 basis points in the prime rate of interest would adversely affect future earnings and cash flows by approximately $240,000 on an annual basis. The Company does not use interest rate derivative instruments to manage exposure to interest rate changes. 18 20 Labor Market Risk. The Company's profitability can be significantly impacted by the availability of qualified personnel and the cost of labor. Direct labor costs comprise approximately 83.2% of the Company's net operating revenues. Changes in the labor market may increase direct labor costs through higher wages and increased amounts of overtime that can not be recovered from customers. The Company anticipates managing such risk by entering contracts that permit increases based on the labor market and attempt to reduce turnover to reduce recruiting and training costs to mitigate increases in wages. However, there can be no assurance that the Company will be able to obtain increased billing rates to offset increases in labor costs or to successfully reduce employee turnover. 19 21 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES PART II - OTHER INFORMATION ITEM 3 - DEFAULTS UPON SENIOR SECURITIES At December 31, 2000, the Company was not in compliance with the interest coverage, net worth, and accounts receivable coverage covenants included in its $24.0 million outstanding obligation under the Company's revolving credit facility. ITEM 6 - EXHIBITS AND REPORTS ON FORM 8 - K (a) Exhibits: EXHIBIT NUMBER DESCRIPTION -------------- ----------- 10.19 Employment Agreement Between the Company and Mark D. Thompson executed in November 2000. 10.20 Retention and Severance Agreement Between The Company and Ronald P. Koegler Executed in November 2000. 10.21 Retention and Severance Agreement Between The Company and Michael F. Sosh Executed in November 2000. 10.22 Retention and Severance Agreement Between The Company and Scott E. Brewer executed in November 2000. 10.23 Retention and Severance Agreement Between The Company and Charles P. Licata executed in November 2000. 10.24 Retention and Severance Agreement Between The Company and John W. Demell executed in November 2000. 27 Financial Data Schedule (For SEC Filing Purposes Only) (b) Reports on Form 8 - K No reports on Form 8-K have been filed during the quarter for which this report is filed. 20 22 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. FEBRUARY 13, 2001 International Total Services, Inc. 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. FEBRUARY 13, 2001 /s/ Mark D. Thompson ----------------------------------------- Mark D. Thompson President and Chief Executive Officer (Principal Executive Officer) FEBRUARY 13, 2001 /s/ Ronald P. Koegler ----------------------------------------- Ronald P. Koegler Executive Vice President and Controller (Principal Accounting Officer) FEBRUARY 13, 2001 /s/ Michael F. Sosh ----------------------------------------- Michael F. Sosh Executive Vice President, Treasurer and Chief Financial Officer (Principal Financial Officer) 21