-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, LLlOpcGiqO4WIH+GxSmcuSls9C3VwfvT+Jxl2R8IDVrjwpC8knqpvyQwtgIfGl7C wEbG5Gvxb0V6cuWi7TeNHw== 0000950152-98-005961.txt : 19980720 0000950152-98-005961.hdr.sgml : 19980720 ACCESSION NUMBER: 0000950152-98-005961 CONFORMED SUBMISSION TYPE: 10-K PUBLIC DOCUMENT COUNT: 5 CONFORMED PERIOD OF REPORT: 19980331 FILED AS OF DATE: 19980714 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: INTERNATIONAL TOTAL SERVICES INC CENTRAL INDEX KEY: 0001040993 STANDARD INDUSTRIAL CLASSIFICATION: AIRPORTS, FLYING FIELDS & AIRPORT TERMINAL SERVICES [4581] IRS NUMBER: 341264201 STATE OF INCORPORATION: OH FISCAL YEAR END: 0331 FILING VALUES: FORM TYPE: 10-K SEC ACT: SEC FILE NUMBER: 333-29463 FILM NUMBER: 98666075 BUSINESS ADDRESS: STREET 1: CROWN CENTRE STREET 2: 5005 ROCKSIDE RD CITY: CLEVELAND STATE: OH ZIP: 44131 BUSINESS PHONE: 2166424522 MAIL ADDRESS: STREET 1: CROWN CENTRE STREET 2: 5005 ROCKSIDE RD CITY: INDEPENDENCE STATE: OH ZIP: 44131 10-K 1 INTERNATIONAL TOTAL SERVICES, INC FORM 10-K 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, DC 20549 ---------- FORM 10-K FOR ANNUAL AND TRANSITION REPORTS PURSUANT TO SECTIONS 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 (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, 1998 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 or Other Jurisdiction (I.R.S. Employer of Incorporation or Organization) Identification No.) Crown Centre 5005 Rockside Road 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: Common Shares, without par value Indicated by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ---- --- 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. --- 2 The aggregate market value of the common shares held by non-affiliates of the registrant, based upon the closing market price on July 10, 1998, was approximately $26,538,023. As of July 10, 1998, the registrant had 6,662,494 Common Shares issued and outstanding. DOCUMENTS INCORPORATED BY REFERENCE Definitive Proxy Statement for the Annual Meeting of Shareholders to be held September 18, 1998, into Part III, Items 10, 11, 12 and 13. TABLE OF CONTENTS
PAGE ---- PART I Item 1. Business............................................................................................1 Item 2. Properties.........................................................................................10 Item 3. Legal Proceedings..................................................................................10 Item 4. Submission of Matters to a Vote of Security Holders................................................11 PART II .............................................................................................................12 Item 5. Market for Registrant's Common Shares and Related Shareholder Matters..............................12 Item 6. Selected Financial Data............................................................................13 Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations..............13 Item 7A. Quantitative and Qualitative Disclosures about Market Risk........................................17 Item 8. Consolidated Financial Statements and Supplementary Data...........................................17 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure...............17 PART III ............................................................................................................18 Item 10. Directors and Executive Officers of the Registrant................................................18 Item 11. Executive Compensation............................................................................18 Item 12. Security Ownership of Certain Beneficial Owners and Management....................................18 Item 13. Certain Relationship and Related Transactions.....................................................18 PART IV .............................................................................................................19 Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K..................................19
3 FORWARD LOOKING STATEMENTS - -------------------------------------------------------------------------------- This Annual Report on Form 10-K (this "Form 10-K") contains statements that constitute forward looking statements. Those statements appear in a number of places in this Form 10-K and in the documents incorporated by reference herein and include statements regarding the intent, belief or current expectations of International Total Services, Inc., an Ohio corporation (the "Company" or "ITS"), its directors or its officers with respect to (i) potential acquisitions by the Company; (ii) the Company's financing plans; and (iii) trends affecting the Company's financial condition or results of operations. Prospective investors 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 unanticipated losses of service contracts, conditions in the aviation industry, and negative publicity regarding the airline security and services and commercial security industries. Readers are cautioned not to place undue reliance on forward looking statements. 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, 1998 is referred to as "fiscal 1998." COMPANY OVERVIEW General. The Company is a leading domestic provider of aviation contract support services and is establishing a growing presence in the security services market. The Company provides services to customers in more than 329 cities in the United States and Europe. The Company has used its predeparture screening business to establish a growing presence in the broader aviation services market. Aviation services offered by the Company include skycap, baggage handling and aircraft appearance services, and wheelchair and electric cart operations. The Company's security services extend beyond aviation security, and include the provision of commercial security 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 repay indebtedness and for general corporate purposes, including working capital and to fund acquisitions. The Company has experienced significant revenue growth driven by the expansion of the aviation staffing support service industry and as a result of acquisitions and a trend toward consolidation in the market. The Company's growth strategy is premised on using its experience in recruiting, training, motivating and managing the large numbers of personnel needed to perform the labor-intensive, task-repetitive functions that its services require. The Company intends to continue to grow internally and through acquisitions. This growth will be generated by using the Company's established business base as a platform for expanding the services that it provides at existing locations and for developing new service locations. The Company targets acquisition candidates that add geographic scope to its existing businesses, broaden its service offerings and expand its client base. Since the Initial Offering and through June 30, 1998, the Company has used this strategy to complete 13 acquisitions. -1- 4 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 gross margins. In early fiscal 1999, the Company began implementing operational strategies that it believes will improve gross margins, however, there can be no assurance that these strategies will be successful or that, in the event of further improvements in the United States economy, the Company's margins will not decrease further. See "Management's Discussion and Analysis of Financial Condition and Results of Operations." Recent Developments. The Company has completed three acquisitions since the end of fiscal 1998. These acquisitions are described below. GIBRALTAR PROTECTION, INC. In April 1998, the Company acquired the commercial security contracts and goodwill of Gibraltar Protection, Inc., headquartered in Torrance, California, for $1.3 million in cash. The acquired contracts cover commercial security staffing throughout Los Angeles and Orange county California. VERSATILE SERVICES, INC. In May 1998, the Company acquired the contracts and goodwill of Versatile Services, Inc., headquartered in Honolulu, Hawaii, for $0.1 million in cash. The acquired contracts cover skycap service in Hawaii. SECURITY COORDINATORS, INC. In June 1998, the Company acquired the commercial security contracts and related goodwill of Security Coordinators, Inc., headquartered in San Antonio, Texas, for $1.5 million in cash. The acquired contracts cover commercial security staffing throughout Texas. AVIATION SERVICES Industry Overview 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 imposed substantial administrative burdens, most airlines opted to contract out predeparture screening and other security services to third party contractors. Certain other airline services, such as food service and fueling, historically have also been contracted out by the airlines. In the past several years, market forces have driven airlines to outsource a number of other labor-intensive aviation services in order to permit airline management to focus on the essential aspects of its business and to reduce labor, benefit costs and administrative overhead. As the costs of labor have increased, airlines now frequently outsource baggage claim and check services, skycap, baggage handling, aircraft appearance and wheelchair assistance services, and inter-gate cart services. Ticketing and check-in services are also beginning to be outsourced. Many small, regional carriers still provide their own ground handling and cleaning services, offering additional growth opportunities for contractors such as the Company. Ramp and ground handling services have been the fastest growing part of the Company's aviation services business, followed by predeparture screening services and other aviation services, based on annual revenues. -2- 5 Aviation Services. Ramp and Ground Handling Services. The ramp and ground handling services provided by the Company are described in the chart below.
Service Description - ------- ----------- Baggage Handling................................ Conveyance of checked baggage from terminal to baggage compartment of plane and from plane to baggage carousel. Aircraft Appearance............................. Interior: cleaning interior parts of the aircraft between flights and at end of the aircraft's flight day. Exterior: washing exterior of aircraft. Lavatory and Water Services..................... Use of equipment to empty lavatory and replace the water source with potable water. De-icing........................................ Spraying ice-melting substance on aircraft prior to departure from gate, in accordance with customer specifications.
The Company derived approximately 32.4%, 14.2% and 12.7% of its revenues from ramp and ground handling services in fiscal 1998, 1997 and 1996, respectively. Airline Security Services. The Company is a leading provider of domestic airline predeparture screening services. The Company currently employs approximately 4,400 predeparture screeners in more than 127 U.S. airports in 38 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 also provides passenger profiling services and document verification agents, primarily in Europe and Asia, where airlines and airports have been obliged 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 enter or leave a country via an international flight. In the domestic market, the Company also provides parked aircraft and employee parking lot security, and the checking of employee identification cards and baggage. The Company derived approximately 36.7%, 50.0% and 50.0% of its revenues from airline security services in fiscal 1998, 1997 and 1996, respectively. Other Aviation 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 transport for passengers who need to board flights at distant gates. The Company derived approximately 12.4%, 19.6% and 22.7% of its revenues from these services in fiscal 1998, 1997 and 1996, respectively. COMMERCIAL SECURITY 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, office and government buildings, airports, hospitals, malls, distribution centers, sports arenas, museums and other facilities. The Company entered the commercial security market in the early 1990s to further capitalize on its aviation security experience. Industrial security is a $100 billion per year industry that employed approximately 2 million people in 1996, according to the American Society for Industrial Security in Arlington, Virginia ("ASIS"). ASIS data indicates that the industry is highly fragmented, with approximately 160,000 companies registered as protection companies. Commercial security accounted for approximately 16.3%, 11.7% and 11.0% of the Company's revenue in fiscal 1998, 1997, and 1996, respectively. -3- 6 SECURITY PRODUCTS DISTRIBUTION In addition to service offerings to the airline industry, the Company distributes a line of security products through its subsidiary, Crown Technical Systems, Inc. ("CTS"), including airport and commercial security checkpoint products and hand-held metal detectors. In 1992, CTS introduced the High Efficiency Screening System ("HESS"), which replaces the standard checkpoint configuration currently found in most U.S. airports. CTS also offers, either with the entire HESS system or alone, an exit lane motion detector that replaces the exit lane guard currently found at most checkpoints. CTS also offers a separate line of hand-held and walk-through metal detectors that it sells to banks, schools, governmental entities and large businesses. CTS also markets control access 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 2.1%, 3.0% and 2.2% of its revenues from sales of security products in fiscal 1998, 1997 and 1996, respectively. GROWTH The Company expects to grow internally and through acquisitions. The Company focuses on using its experience in recruiting, training, motivating and managing the large numbers of personnel needed to handle labor-intensive, task-repetitive jobs to capitalize on the trend toward outsourcing labor-intensive services. The Company believes that its airline security business provides an effective platform from which to take advantage of opportunities in other elements of the airline services business. The Company also believes that its experience in managing the personnel requirements of its airline security business provides opportunities to expand into related labor-intensive service businesses, such as commercial security services. Growth Through Expansion of Existing Businesses. The Company believes that the management and administrative resources it has developed to manage its operations in 329 cities provide it with the capacity to expand in a number of geographic areas without significant additional overhead costs. By leveraging its existing administrative base, the Company seeks to increase its share of the highly fragmented aviation and commercial security market. The Company's use of its "installed base" of airline security business to increase the range of other services that it provides to its airline customers is an equally important element of its growth strategy. The Company believes that the administrative base supporting the Company's airline security services at an airport can be used to support other services without significant additional costs, which can give the Company an important advantage in competing with other providers of airline services on the basis of price. The Company's division and field management teams actively seek these opportunities and are experienced in exploiting them. The Company has experienced recent growth in the demand for its ramp and ground handling and cabin appearance services and expects these services to provide opportunities for continued growth. The Company intends to identify new business opportunities and to use its existing marketing, management and administrative systems, as well as its existing airline relationships, to expand its reach in these areas. Because all carriers, regardless of location, need aircraft appearance, baggage handling and passenger related services, the Company believes the potential market for these services is as large as, if not larger than, the airline security market. Outside of the airline industry, the Company provides uniformed security officers in a wide range of commercial settings. The Company, with an administrative infrastructure in 41 states, believes that it has the ability to expand in this market without significant additional overhead costs. Growth Through Acquisitions. When making a domestic acquisition, the Company acquires only the existing contracts and equipment needed to fulfill the contracts. When making a European acquisition, the Company acquires all of the outstanding capital stock of a business. The Company is willing to retain members of an acquired company's management team that it -4- 7 believes can contribute expertise. Management believes the Company has certain advantages resulting from the Company's size and administrative infrastructure that may enable it to implement its acquisition strategy more successfully than its competitors. Specifically, management believes that its self-insurance and risk management practices and its centralized administration of payroll and billing functions have resulted in a lower cost structure than many of its competitors. Aviation Services Acquisitions. In fiscal 1998, the Company completed seven aviation services acquisitions, six of which were completed after the Initial Offering. These acquisitions are described below. INTEX AVIATION SERVICES, INC. In April 1997, the Company acquired the ground handling service contracts and goodwill of Intex Aviation Services, Inc. ("Intex"), headquartered in Greenville, South Carolina, for $4.8 million in cash. The contracts acquired from Intex cover ramp and ground handling services, including baggage handling, lavatory and water services, aircraft appearance, and ground support and facility services, in 30 locations across the United States. ARC SECURITY, INC. In October 1997, the Company acquired the aviation service contracts and goodwill of ARC Security, Inc., headquartered in Atlanta, Georgia, for $9.0 million in cash. The acquired contracts cover airline security, pre-board passenger screening, and aircraft appearance services in the eastern and southern United States for all 12 major airlines. WHITE LION AVIATION SECURITY, LTD. In October 1997, the Company purchased White Lion Aviation Security, Ltd. ("White Lion"), headquartered in London, England, for $0.7 million in cash. White Lion offers aviation security, expedited baggage and cargo delivery services at the Stanstead Airport, a growing hub airport located outside of London, and has service contracts with a number of international air carriers. ASI, INC. In October 1997, the Company purchased the contracts and goodwill of ASI, Inc., headquartered in Providence, Rhode Island, for $0.1 million in cash. The acquired contracts cover aircraft appearance and baggage handling services. NEPTUNE EQUIPMENT AND FACILITIES, INC. In December 1997 and February 1998, the Company acquired six aviation service contracts and goodwill from Neptune Equipment and Facilities, Inc. ("Neptune") for $0.4 million in cash. Neptune provided ground equipment maintenance, aircraft appearance, janitorial and Crown Room staffing services. All of the acquired contracts are for facilities located where the Company had existing operations. OS SECURITY SERVICE GMBH. In December 1997, the Company purchased OS Security Services GMBH ("OS Security"), located in Frankfurt, Germany, for $0.3 million in cash. OS Security provides aviation security for eight major European and international airlines and has stations at four major German airports: Dusseldorf, Berlin, Hamburg and Stuttgart. OS Security performs aircraft guarding, passenger profiling, and baggage and cargo screening services, as well as VIP escorting and collection services SKY VALET, INC. In February 1998, the Company acquired the aviation staffing contracts and goodwill of Sky Valet, Inc., headquartered in West Palm Beach, Florida, for $0.8 million in cash. The acquired contracts cover services in Florida, Massachusetts, Mississippi, Pennsylvania, South Carolina, Tennessee and Texas. Commercial Security Acquisitions. The Company completed three commercial security acquisitions in fiscal 1998. CURTIS SECURITY SERVICES, INC. In October 1997, the Company acquired the contracts and goodwill of Curtis Security Services, Inc., headquartered in San Francisco, California, for $0.7 million in cash. The acquired contracts cover commercial security services to approximately 50 Fortune 500 clients located in California, Nevada and several other western states. STOREHIRE UK LTD. In January 1998, the Company purchased Storehire UK Ltd. ("Storehire"), headquartered in London, England, for $0.7 million in cash. Storehire provides secure lockable storage units for -5- 8 commercial, professional and personal use, and operates in Stanstead Airport. This acquisition complemented the Company's acquisition of White Lion. SECUREX, INC. In February 1998, the Company acquired the contracts and goodwill of Securex, Inc., headquartered in Tampa, Florida, for $5.4 million in cash. The acquired contracts cover commercial security staffing, credential checkers, ticket checkers, ticket setters and other outsourcing services. COMPETITION Ramp and Ground Handling Services. Airlines have found it cost-effective to outsource ramp and ground handling services because these services often require an investment in hard equipment, which can be expensive for carriers with few flights. The Company has taken advantage of the opportunity to offer a package of new or refurbished equipment, maintenance and manpower, all for a per-hour labor charge. In addition, the Company considers potential revenue gains from ground handling and passenger business when negotiating new security business, and is sometimes able to package combinations of services to clients at a lower overall cost than it could offer for one type of service alone. The Company has typically offered ground handling or passenger services as "add on" services to its screening business. It also offers these services on a stand-alone basis at certain locations. In this area, the Company competes with the airlines, 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 and using advanced cleaning equipment. The Company conducts an Aircraft Appearance and Facility Audit Program through which it continually monitors its own performance. Under this program, the Company's supervisors and managers conduct a predetermined number of audits based on the number of planes serviced for a particular client. The Company provides the results of the audit to the client regularly, emphasizing areas requiring improvement. The Company believes that its clients appreciate the continuous and honest feedback the audit program provides and that this approach enables the Company to correct problems that might not otherwise come to its attention until the client became dissatisfied. The Company believes, based on discussions with its customers, that it is the only cleaning service provider that has such a program. The Company's competitors in aircraft appearance are the airlines, Signature Flight Support Services, AMR Services, Ogden Allied Support Services, Hudson General, and Service Master Co. Airline Security Services. 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. While the Company believes it has an advantage because of its size and overhead in underbidding other companies, the Company faces the same challenge as its competitors do--finding qualified employees to provide consistent service at the minimum wage rates offered by the airlines for screeners in the current economic environment. See "Growth." The Company's principal competitors in domestic predeparture screening include Globe Aviation Securities Corporation, AHL Services, Inc. and Huntleigh, Inc. In the international security arena, where training and service generally are more important, 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. In addition, because the Company's method of profiling is less intrusive than other security methods, the Company considers it to be more cost-effective and passenger-friendly than other systems. Currently, the Company has a small number of contracts to provide these services in Europe and Asia. The Company's main competitors for international profiling and screening services are, ICTS International, N.V., AHL Services, Inc. and International Aviation Security, Inc. Passenger Services. Customer service is as important as cost in the awarding of 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 -6- 9 service and empathy. In 1996, the Company was awarded a contract to provide Continental Airlines, Inc. skycaps nationwide. The Company's main competitors for passenger services include the airlines, AHL, Globe Aviation Securities Corporation, and Huntleigh, Inc. Commercial Security. The commercial security field is highly fragmented. There are as many as 160,000 separate providers of commercial and industrial security services, and the Company does not believe that any participant has a significant share of the market. While the Company has made only minor inroads into this market, the Company's competitive strength in this area comes from its low overhead costs and its ability to assimilate acquired commercial security businesses into its existing administrative structure. In the commercial security field, the major providers include Borg-Warner Security Corporation, Guardsmark, Inc. and The Wackenhut Corporation. The Company competes in international, national, regional and local markets with specialized contract service providers, outsourcing companies, and its clients' and potential clients' internal service staffs. While substantial consolidation is occurring in the Company's markets, portions of these markets remain extremely competitive and highly fragmented, with limited barriers to entry. Industry participants compete on the quality of service provided, their ability to provide national and international services, and the range of services offered. The Company believes its primary competitive advantage is its low administrative overhead, which enables it to offer competitive costs for large contracts. The Company has been successful in minimizing its workers' compensation and liability insurance costs and in leveraging its administrative base to add new contracts with minimal increase in overhead cost. In addition, the Company believes that it offers a broader range of services than many of its competitors. SALES AND MARKETING The Company believes that strengthening and maintaining relationships with personnel at various levels of its clients' organizations will continue to be an integral element of its sales and marketing efforts. There are eight sales executives servicing the Company's four operating divisions throughout the United States and Europe. The Company's four division vice presidents in the United States and Europe also have sales responsibilities and a portion of their incentive compensation is dependent on meeting established sales goals. The Company expects to continue its internal growth through 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's broad, long-term global presence provides a strong foundation from which to expand into additional international markets. In November 1997, the Company hired a Vice President of Marketing to lead the Company's marketing initiatives. These initiatives include the development of branded services, direct mail marketing, creation of local, regional and national marketing plans, strategic positioning for preferred provider partnerships, integration of high technology components, and coordination of the Company's participation in trade shows and other sales activities. Additionally, the corporate marketing department conducts quarterly training sessions for sales executives. These training sessions include presentation and customer service skills, database management and methods for cross-selling the Company's products and services. MANAGEMENT AND REPORTING SYSTEMS In fiscal 1996, the Company implemented measures to improve its cost structure and competitive position in preparation for more aggressive growth. These changes included reductions in corporate headquarters staff and executive compensation, the development of divisional budgeting systems and the implementation of compensation programs tied to the achievement of expected performance levels. In addition, the Company enhanced its management and control systems in order to improve accounts receivable collection and streamline its purchasing arrangements. Consequently, operating profit has improved from 3.1% in fiscal 1996 to 6.1% in fiscal 1998. Chairman and Chief Executive Officer Robert Weitzel, who co-founded the Company in 1978, has substantial experience in the airline services and commercial security industries. Mr. Weitzel has been the Company's -7- 10 strategic leader since 1987 and has directed over 40 acquisitions. President and Chief Operating Officer James Singer, who joined the Company in April 1997, was formerly President-Airline Services Division of AMR Services, and brings to the Company broad experience in ground handling and passenger services operations. Vice President, Finance Brian Kenyon joined the Company in April 1998 and will be instrumental in improving financial reporting systems and the Company's management information systems. Mr. Kenyon most recently was Director of Financial Analysis at Signature Brands USA, Inc. Scott Brewer is the Vice President, General Counsel of the Company. He has served as Vice President since April 1995 and General Counsel since 1993. Mr. Brewer was in a private law practice from October 1988 to August 1993. The Company's business organization include, four regional divisions--Eastern, Central, Western and International, as well as CTS. Each division has its own controller, human resource manger and sales executive, as well as quality control and training functions. In July 1998, the Company disbanded its industrial security division and transferred its industrial security operations to its regional divisions. The Company is currently installing an updated version, that the Company has been informed by its vendors is fully year 2000 compliant, of the system that processes the majority of its transactions. This new version will replace the Company's current version and the Company believes that this version will be fully operational before year 2000 issues begin to impact the Company. In addition, the Company will have an outside consultant perform a review of its other information systems to determine if any other areas of exposure exist. The cost of this new version, and of any other new information systems, will be capitalized and depreciated over their estimated useful lives for financial reporting purposes. WORKFORCE MANAGEMENT As of July 8, 1998, the Company had approximately 15,000 full and part-time employees engaged in performing its client services. The Company experiences annual turnover of approximately 100%, and believes that maximizing employee retention is important to reducing operating costs and providing high quality service to its clients. Accordingly, the Company places significant emphasis on motivating its employees and reducing turnover. In January 1997, the Company instituted an employee medical benefit plan that provides medical benefits to its eligible hourly employees. In addition, 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. The Company also provides a 401(k) program for all employees who have been with the Company at least one year. 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. In addition, 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. The Company's policy is not to hire applicants whose criminal background verification checks reveal prior criminal convictions. CUSTOMERS AND CONTRACT TERMS The Company derives a significant portion of its revenues from a few clients. In fiscal 1998, Delta Air Lines, Inc. (26.0%), Continental Airlines, Inc. (14.7%), Trans World Airlines, Inc. (4.6%), U.S. Airways, Inc. (4.2%), Southwest Airlines Co. (4.0%), and United Airlines, Inc. (3.8%) accounted for 57.3% of the Company's revenues. During fiscal 1998, 1997 and 1996, the Company's ten largest clients accounted for an aggregate of 66.5%, 68.6% and 71.2% respectively, of the Company's revenues. The Company's contracts with clients, including those that it obtains 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 clients weekly, which is typical in -8- 11 that field. In addition, the Company's contracts with airlines typically provide that the Company will indemnify the client against claims for property damage, or death of or personal injury to any person, arising out of the negligent acts or omissions of ITS, unless the claim results from a negligent act of the client. The services provided by the Company require it to train and manage effectively 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. These reimbursements have not had a material impact on the Company. The risk of contract termination as a result of actual or perceived service failures is enhanced by the substantial publicity that, because of public concern over airline security issues, often attends errors in the provision of screening services. Failure to meet test 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. The Company does not believe that any test failure, or series of test failures, without other performance deficiencies, has resulted in the loss of a contract or service location. GOVERNMENT REGULATION Certain of the Company's 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, and maintenance and flight crews. The FAA has promulgated regulations requiring air carriers to conduct predeparture screening of all passengers and property that will be carried in an aircraft cabin. These regulations also provide basic standards for the screeners, and equipment and procedures to be used in predeparture screening activities. FAA regulations also mandate pre-employment background checks of persons hired to serve as screeners. Although an air carrier is permitted to outsource its screening function, FAA regulations require the air carrier to provide oversight in order to assure that all requirements are met. For example, FAA regulations require an air carrier's ground security coordinator to review security-related functions and initiate corrective action for noncompliance, and to conduct an annual evaluation of each person assigned screening duties. In addition to the oversight responsibilities imposed on air carriers, 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. In addition, certain initiatives reviewing airport security are currently underway. The Company cannot predict the outcome of these initiatives. The Company's aviation and commercial security services are subject to regulation by various state and local authorities. The Company is also required to obtain and maintain various licenses and permits from state and local authorities to provide aviation and commercial security services, as well as certain other services. -9- 12 ITEM 2. PROPERTIES The Company leases approximately 20,548 square feet in Independence, Ohio for its corporate headquarters. The initial term of the lease expires in 2001 and may be extended, at the option of the Company, until 2006. The Company leases space in numerous facilities in the United States and Europe to contain local offices. None of these local office leases are material to the Company's operations. ITEM 3. LEGAL PROCEEDINGS Because the Company's employees function in public facilities and in the workplaces of other businesses, the Company is exposed to possible claims by its clients' customers and employees of discrimination, harassment and negligence, and similar claims. The Company is subject to liability for the acts or negligence of its employees while on assignment that cause personal injury or damages, and to claims of misuse of client proprietary information or theft of client property. As a provider of security services, the Company faces potential liability for claims that may arise from any terrorist activity occurring in circumstances associated with the Company. Although the Company maintains insurance coverage against such potential liabilities, any such claim against the Company might exceed the amount of such insurance coverage or fall outside the type of activities covered by such insurance. In May 1997, a United States District Court in Philadelphia, Pennsylvania, rendered a judgment in the amount of $900,000 against the Company in connection with an employment discrimination lawsuit. The Company believes that it has accrued adequate reserves to cover the ultimate cost of this action and is contesting the judgment on appeal. The Company is also 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. 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. -10- 13 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 are as follows: Name Age Position ---- --- -------- Robert A. Weitzel ......................................... 63 Chairman of the Board of Directors and Chief Executive Officer James O. Singer ........................................... 53 Director, President and Chief Operating Officer Scott E. Brewer ........................................... 36 Vice President and General Counsel Brian S. Kenyon ........................................... 34 Vice President, Finance Peter J. Collins .......................................... 58 Vice President of Eastern Division Stephen P. Metzler ........................................ 40 Vice President of Central Division Gene R. Empey ............................................. 53 Vice President of Western Division Dillard D. Woodson ........................................ 49 Vice President of International Division
The following is a biographical summary of the business experience of the executive officers of the Company. Robert A. Weitzel, a Director since 1987, is the Chairman of the Board and Chief Executive Officer of the Company. He has served as the Chief Executive Officer of the Company since 1987 and was President from 1987 to April 1997. He served as Senior Vice President from 1982 to 1987 and Vice President from 1978 to 1982. James O. Singer, a Director since June 1997, has been President and Chief Operating Officer since joining the Company in April 1997. Mr. Singer was employed by AMR Services Corporation, an aviation services company, as President-Airline Services Division and later served in Business Development for Europe from May 1989 to March 1995. From April 1995 until April 1997, Mr. Singer worked as a consultant in the aviation industry. Brian S. Kenyon is Vice President, Finance. He has served in this capacity since April 1998. From December 1996 to April 1998 he served as Director, Financial Analysis for Signature Brands USA, Inc., a publicly traded consumer products company. From October 1990 to December 1996 he was employed by NACCO Industries, Inc., a publicly traded holding company, where he last served as Manager of Shareholder Relations and External Reporting. From December 1986 to October 1990 he was employed by Coopers & Lybrand, where he last served as a Senior Associate Auditor. Scott E. Brewer is the Vice President and General Counsel of the Company. He has served as 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. Peter J. Collins is the Eastern Division President. He has served in this position since October 1997. From August 1995 to October 1997 he served as a District Manager for the Southern District for the Company. From July -11- 14 1991 to August 1995 he was employed by Pennzoil Corporation, where he last served as a multi-store manager in their retail operations. Prior to July 1995, he was employed by Eastern Airlines for 30 years where he held a number of positions. Stephen Metzler is the Central Division President of the Company. He has served in this capacity since April 1996. He served as Vice President Eastern Division from May 1995 to April 1996 and District Manager from May 1994 to May 1995. He served as Aircraft Appearance Manager from December 1991 to May 1994. Gene Empey is the Western Division President of the Company. He has served in this capacity since December 1988. Dillard Woodson is the International Division President of the Company. He has served in this capacity since February 1997. He served as the Vice President of Systems and Training from February 1996 to February 1997. He served as the Technical Management Consultant to CSA Airlines in Prague from January 1994 to February 1996. He served as the General Manager for Liberia for Intercon Security Ltd., a commercial security company, from April 1993 to June 1993. Mr. Woodson was an artillery officer in the United States Marine Corps from 1968 to June 1993. 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. PART II ITEM 5. MARKET FOR REGISTRANT'S COMMON SHARES AND RELATED SHAREHOLDER MATTERS (a) MARKET INFORMATION The Company's Common Shares are traded in the Nasdaq National Market under the symbol "ITSW." The following table sets forth for the indicated periods the high and low market prices for the Common Shares:
Price Range ----------- Fiscal Year ended March 31, 1998 High Low ---- --- Third Quarter (beginning September 19, 1997) $18.75 $13.00 Fourth Quarter $24.13 $15.75
(b) SHAREHOLDER INFORMATION As of June 30, 1998, there were 17 record holders of Common Shares and approximately 650 beneficial owners. (c) DIVIDEND INFORMATION The Company has never paid, and does not anticipate paying in the foreseeable future, cash dividends on the Common Shares because it intends to retain its earnings to finance the expansion of its business and for general corporate purposes. In addition, the Company's ability to pay cash dividends is limited by the terms of its revolving line of credit from its senior lender. (d) SALES OF UNREGISTERED SECURITIES In March 1997, prior to the Initial Offering, the Company issued 4,125.64 Common Shares, to Robert A. Weitzel, the Company's Chairman of the Board and Chief Executive Officer, in exchange for his interest in a former -12- 15 provider of leasing services to the Company. This issuance was valued at $9.08 per Common Share and was made in reliance on the exemption from registration set forth in Section 4(2) of the Securities Act of 1933. ITEM 6. SELECTED FINANCIAL DATA The selected financial data of the Company for the years ended March 31, 1995, 1996, 1997 and 1998 are derived from audited financial statements. The selected financial data of the Company for the year ended March 31, 1994 has been derived from unaudited financial statements. Those unaudited financial statements include all adjustments, consisting only of normal recurring accruals, which the Company considers necessary for a fair presentation of its financial position and results of operations for those periods.
Year Ended March 31, ---------------------------------------------------------------- 1994 1995 1996 1997 1998 ------------ ----------- ----------- ---------- ------------ (Amounts in Thousands, except per share and employee data) STATEMENTS OF OPERATIONS DATA: Revenues............................. $ 78,173 $ 92,654 $ 95,900 $ 115,745 $ 173,235 Cost of Revenues .................... 66,103 79,981 81,341 98,338 145,968 --------- --------- --------- ---------- --------- Gross profit......................... 12,070 12,673 14,559 17,407 27,267 General and administrative expenses.. 11,075 12,655 11,603 13,334 16,677 --------- --------- --------- ---------- --------- Operating income..................... 995 18 2,956 4,073 10,590 Interest expense-net................. 34 188 523 637 719 Other expense........................ 0 0 437 503 868 --------- --------- --------- ---------- --------- Income (loss) before income taxes..................... 961 (170) 1,996 2,933 9,003 Income taxes......................... 1,035 548 958 1,237 3,758 --------- --------- --------- ---------- --------- Net income (loss)................ $ (74) $ 718 $ 1,038 $ 1,696 $ 5,245 ========= ========= ========= ========== ========= Net income (loss) per share: Basic............................ $ (0.01) $ (0.11) $ 0.18 $ 0.33 $ 1.01 Diluted.......................... $ (0.01) $ (0.11) $ 0.18 $ 0.33 $ 1.00 Weighted average common shares: Basic............................ 6,446 6,293 5,776 5,089 5,215 Diluted.......................... 6,446 6,293 5,776 5,089 5,265 OPERATING DATA (AT PERIOD END): Number of employees.................. 9,000 9,900 9,900 10,700 15,000 BALANCE SHEET DATA (AT PERIOD END): Cash and cash equivalents............ 769 1,267 1,873 1,452 1,032 Working capital (deficit)............ (1,351) (4,425) (2,951) 324 9,137 Total assets......................... 14,843 20,295 20,892 27,001 58,567 Short-term bank debt and current maturities of long-term debt....... 875 5,658 4,806 2,520 0 Long-term obligations, net of current maturities......................... 0 152 164 7,555 544 Retained earnings.................... 3,678 2,961 3,998 2,784 8,029 shareholders' equity................. 4,273 3,139 3,978 3,195 39,103
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS The Company is a leading domestic provider of aviation contract support services and is establishing a growing presence in the security services market. The Company provides services to customers in more than 329 cities in the United States and Europe. The Company has used its predeparture screening business to establish a growing presence in the broader aviation services market. Aviation services offered by the Company include skycap, baggage handling and aircraft appearance services, and wheelchair and electric cart operations. The Company's security services extend beyond aviation security, and include the provision of commercial security services to government and business clients, hospitals, arenas and museums. The Company's revenues have grown from $95.9 million in fiscal 1996 to $173.2 million in fiscal 1998, reflecting a compound annual growth rate of 40 percent. The revenue growth for fiscal 1998 and 1997 was 50 percent and 21 percent, respectively. Gross margins associated with airline security services are typically lower than gross margins on other airlines services, reflecting the maturity of the market for airline security services and the intensity of price competition in that market. While airline security services have long been outsourced, airlines have only recently begun to outsource many other services. Consequently, the market for these other services is more fragmented and less mature than the market for airline security services. The Company anticipates that, as the airlines services market matures, gross margins will experience compression as a result of increasing competition in the market and the increasing importance of cost considerations to the airlines that outsource these services. Gross margins associated with commercial security services typically exceed those achieved for airline security services. 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 lavatory 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. Prior to fiscal 1996, ITS's strategy included using technological innovation to drive the growth of its business, and the Company made research and development expenditures of approximately $500,000 in support of this strategy. In recognition of the importance of cost considerations in customer purchasing decisions, in fiscal 1996 the Company decided to reduce its cost structure in order to enhance its competitive position. As a consequence of this decision, ITS made several important operational changes that contributed to a significant improvement in its financial results. These changes included reductions in corporate headquarters staff and executive compensation, which aggregated approximately $500,000, the development of divisional budgeting systems and the implementation of compensation programs tied to the achievement of budgeted performance levels. The Company also made efforts to enhance its management and control systems in order to improve accounts receivable collection and streamline its purchasing arrangements. Acquisitions played an important role in the Company's revenue and earnings growth during fiscal 1998 and 1997, and they are expected to remain an important component of ITS's growth strategy during future periods. ITS seeks acquisition candidates that will add geographic coverage to the Company's existing businesses, broaden its service offerings and expand its customer base. The Company's recent domestic acquisitions have involved the purchase of service contracts and property and equipment related to those contracts, but not the liabilities associated with the sellers' businesses. Management believes that the acquisition of service contracts, rather than of stock or of assets unrelated to those contracts, significantly reduces the risks associated with and the costs of integrating acquired operations. -13- 16 In fiscal 1998, ITS completed eleven acquisitions of service contracts, all of which were accounted for under the purchase method, and accordingly their operating results are included in ITS's consolidated financial statements for all periods subsequent to the date of the acquisition. All of these acquisitions were in the Company's core operations of aviation staffing and support services and commercial security. These acquisitions contributed approximately $46.3 million in total revenues during fiscal 1998. During fiscal 1997, the Company completed six acquisitions of service contracts, all of which were accounted for under the purchase method. All of the acquisitions completed in fiscal 1997 involved providers of airline security and commercial security services. These acquisitions contributed approximately $5.9 million in total revenues during fiscal 1997. The Company has financed its acquisitions with borrowings under its credit facility, cash from the proceeds of the Initial Public Offering completed in September 1997, and internally generated cash. RESULTS OF OPERATIONS The following table sets forth ITS' results of operations in both dollars and as a percentage of revenues for the years ended March 31:
1998* 1997* 1996* ----------------------- ----------------------- ------------------------ Revenues ......................... $ 173,235 100.0% $ 115,745 100.0% $ 95,900 100.0% Cost of operating revenues ....... 145,968 84.3% 98,338 85.0% 81,341 84.8% --------- --------- --------- --------- --------- --------- Gross profit ................. 27,267 15.7% 17,407 15.0% 14,559 15.2% Selling, general & admin. expenses 16,677 9.6% 13,334 11.5% 11,603 12.1% --------- --------- --------- --------- --------- --------- Operating profit ............. 10,590 6.1% 4,073 3.5% 2,956 3.1% Other expense .................... (868) (0.5)% (503) (0.4)% (437) (0.5)% Interest expense ................. (719) (0.4)% (637) (0.6)% (523) (0.5)% --------- --------- --------- --------- --------- --------- Income before income taxes ... 9,003 5.2% 2,933 2.5% 1,996 2.1% Income taxes ..................... 3,758 2.2% 1,237 1.1% 958 1.0% --------- --------- --------- --------- --------- --------- Net income ................... $ 5,245 3.0% $ 1,696 1.4% $ 1,038 1.1% ========= ========= ========= ========= ========= =========
* (dollars in thousands) YEAR ENDED MARCH 31, 1998 COMPARED WITH YEAR ENDED MARCH 31, 1997 Revenues. Revenues in fiscal 1998 increased by $57.5 million, or 49.7 percent as compared with fiscal 1997. The increase is attributable to an increase in revenues from the eleven acquisitions completed during the year, the inclusion of a full year of revenues from the six acquisitions completed in fiscal 1997, and internal growth. The eleven acquisitions completed in fiscal 1998 contributed $46.3 million to the total increase in revenues for the year, with $42.3 million in aviation services and $4.0 million in industrial security services. The inclusion of a full year of operating results from the six acquisitions completed in fiscal 1997 contributed $6.8 million to revenues. Internal growth contributed the remainder of the increase in revenues in fiscal 1998 compared with fiscal 1997. Gross Profit. Gross profit was $27.3 million in fiscal 1998 compared with $17.4 million fiscal 1997, an increase of $9.9 million, or 56.9 percent. The eleven acquisitions completed in fiscal 1998, and the inclusion of a full year of operating results from the six acquisitions completed in fiscal 1997, contributed $6.2 million and $0.7 million, respectively to the increased gross profit. As a percentage of revenues, gross profit was 15.7 percent in fiscal 1998, compared with 15.0 percent in fiscal 1997. The increase in gross profit as a percent of sales is attributable to the shift in the Company's sales mix to higher margin services such as ground handling, passenger services and industrial security and away from lower margin preboard screening services. The current strength of the United States economy, which has driven unemployment to low levels has adversely impacted the Company's ability to attract and retain the workforce needed to provide the services required under its service contracts. The difficulty in attracting these workers has resulted in the Company's payment of increased overtime and has forced the Company to increase the wages paid to employees in advance of increases in the rates paid by the Company's customers. These factors have resulted in downward pressure on -14- 17 the Company's gross margins. In early fiscal 1999, the Company began implementing operational strategies that the Company believes will improve its gross margins, however, there can be no assurance that these strategies will be successful. Selling, General and Administrative Expenses. Selling, general and administrative expenses in fiscal 1998 were $16.7 million compared with $13.3 million in the prior year, an increase of $3.4 million, or 25.6 percent. The increase primarily reflects expenses associated with the operations of acquired businesses. Measured as a percentage of net sales, these expenses were 9.6 percent in fiscal 1998 and 11.5 percent in fiscal 1997. This decrease is attributable to improved overhead absorption resulting from the growth of revenues over the prior year. Interest Expense. Interest expense increased in fiscal 1998 to $0.7 million from $0.6 million in fiscal 1997 because of an increase in average borrowings, primarily incurred to fund acquisitions. Income Taxes. The Company's consolidated effective income tax rate in fiscal 1998 was 41.7 percent compared with 42.2 percent in fiscal 1997. The decrease in the Company's effective tax rate in fiscal 1998 is due to reduced overall tax rates on foreign earnings taxed at rates in excess of the U.S. statutory tax rate. In addition, a decrease in expenses that are not deductible for tax purposes lowered the Company's effective tax rate. Net Income. As a result of the increased revenues and reduction in selling, general and administrative expenses as a percentage of revenues, the Company's net income increased to $5.2 million in fiscal 1998 from $1.7 million in fiscal 1997, an increase of 206 percent. YEAR ENDED MARCH 31, 1997 COMPARED WITH YEAR ENDED MARCH 31, 1996 Revenues. Revenues in fiscal 1997 increased by $19.8 million, or 20.7 percent, as compared to fiscal 1996. This increase is attributable to an increase in revenues from the six acquisitions that were completed during the year, and from the addition of continuous bag search services that were required by the FAA during the year, as well as increased revenues from passing along to customers the U.S. minimum wage increase commencing October 1, 1996 and an increase in revenues from existing customers for aircraft cleaning and ground handling. Of the $19.8 million increase in revenues, $5.9 million was attributable to the acquisitions ($3.2 million in predeparture screening and $2.7 million in industrial security), $4.2 million to continuous bag search, $2.3 million to the minimum wage increase, $1.4 million to aircraft cleaning and ground handling and the remainder due to internal growth. Gross Profit. Gross profit was $17.4 million in fiscal 1997 compared with $14.6 million in fiscal 1996, an increase of $2.8 million, or 19.6 percent. Approximately $1.4 million of the increase resulted from higher margin contracts of acquired businesses. Approximately $1.0 million of the increase resulted from an increase in hourly rates under certain contracts and higher utilization of personnel and improved operating efficiencies. Company-wide cost reduction measures, including decreases in worker's compensation and liability insurance rates contributed approximately $400,000 to the increase in gross profit. Selling, General and Administrative Expenses. Selling, general and administrative expenses in fiscal 1997 were $13.3 million compared with $11.6 million in the prior year, an increase of $1.7 million, or 14.7 percent. The increase primarily reflects expenses associated with the operations of acquired businesses. Measured as a percentage of net sales, these expenses were 11.5 percent in fiscal 1997 and 12.1 percent in fiscal 1996. The decrease in these expenses as a percentage of sales was attributable to improved overhead absorption resulting from the growth of revenues over the prior year. On a pro forma basis, after giving effect to the Intex acquisition, the Company's selling, general and administrative -15- 18 expenses for fiscal 1997 would have been 11.3 percent of total revenues, primarily as a result of improved overhead absorption resulting from the larger pro forma revenue base. Interest Expense. Interest expense increased in fiscal 1997 to $0.6 million from $0.5 million in fiscal 1996 because of an increase in the amount of debt outstanding. The debt was incurred primarily in connection with the acquisitions. Income Taxes. The Company's consolidated effective income tax rate in fiscal 1997 was 42.2 percent as compared to 48.0 percent in fiscal 1996. The Company's effective tax rate will vary from period to period depending on the breakdown of earnings among the various operating subsidiaries and the treatment of earnings items by the relevant tax authorities and income tax effects deferred from prior periods. Net Income. As a result of the foregoing, the Company's net income increased to $1.7 million in fiscal 1997 from $1.0 million in fiscal 1996, an increase of 70.0 percent. LIQUIDITY AND CAPITAL RESOURCES - ------------------------------- The Company's business is labor intensive. Consequently, it has substantial needs for cash throughout its fiscal year. During fiscal 1998, the Company's cash requirements were heightened by its acquisition program and the need to support the higher levels of revenue resulting from those acquisitions. Operating activities generated cash of approximately $1.5 million. Financing activities generated net cash of $20.4 million during fiscal 1998 primarily as a result of the $30 million of net proceeds from the Company's Initial Offering, offset by the repayment of $7.1 million of long-term debt and the net repayment of $2.4 million of short-term borrowings. Principal uses of funds, in addition to working capital requirements, included expenditures associated with the Company's acquisition program. During fiscal 1998, these included $19.0 million in acquisitions of service contracts, related goodwill and noncompete agreements and $1.7 million for related property and equipment. In addition, the Company spent $1.5 million on purchases of property and equipment. In April 1997, the Company acquired substantially all of the aviation services business of Intex by purchasing various existing contracts. Under the terms of the purchase agreement, the Company's $2.6 million deposit was credited toward the purchase price. The total purchase price, payable to the former owner of Intex, was determined on the basis of a multiple of monthly revenues on the acquired contracts for the period from April 1, 1997 to June 30, 1997. The balance of the purchase price was paid on July 15, 1997. After the acquisition, the Company lost contracts worth $2.5 million in annual revenue, which was deducted from the purchase price based on a multiple of monthly revenue. The Company has a two-year revolving credit facility providing maximum availability of $30 million, subject to certain borrowing base limitations. This facility expires in September 1999 and is secured by substantially all of the Company's assets. The interest rate on this credit facility is based on either LIBOR or the bank's base lending rate, plus a margin depending on the Company's ratio of its debt to tangible net-worth. Borrowings under this credit facility currently bear interest at LIBOR plus 1.5 percent. The credit facility contains customary restrictions and covenants, which limit the Company's ability to incur additional indebtedness and pay dividends, and require the Company to maintain prescribed debt-to-equity and fixed charge coverage ratios, and minimum net worth levels, and to satisfy certain other financial covenants. The Company anticipates making capital expenditures in fiscal 1999 of approximately $1.6 million primarily related to office space and equipment improvements and computer software and systems. In addition, the Company anticipates that it will continue making significant expenditures to fund its ongoing acquisition program. The Company believes that operating cash flows and amounts available under its credit facility will be sufficient to meet its anticipated cash requirements through the end of fiscal 1999. -16- 19 RECENTLY ISSUED BUT NOT YET ADOPTED ACCOUNTING STANDARDS During the first quarter of 1998, the AICPA's Accounting Standards Executive Committee issued SOP 98-5, Reporting on the Costs of Start-Up Activities. This SOP requires that costs of start-up activities be expensed as incurred. SOP 98-5 is required to be adopted for financial statements with fiscal years beginning after December 15, 1998 and requires the cumulative effect of the accounting change to be reported in net income in the year of adoption. The Company believes adoption of this standard will not have a material impact on the Company's financial position or results of operations. During the first quarter of 1998, the Financial Accounting Standards Board issued SFAS No. 130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. These standards are effective for fiscal years beginning after December 15, 1997. The Company believes adoption of these standards will not have a material impact on the Company's financial disclosures. YEAR 2000 BUSINESS MATTERS The Company is currently installing an updated version, that the Company has been informed by its vendors is fully year 2000 compliant, of the system that processes the majority of its transactions. This new version will replace the Company's current version and the Company believes that this version will be fully operational before year 2000 issues begin to impact the Company. In addition, the Company will have an outside consultant perform a review of its other information systems to determine if any other areas of exposure exist. The cost of this new version, and of any other new information systems, will be capitalized and depreciated over their estimated useful lives for financial reporting purposes. FORWARD LOOKING STATEMENTS This Management's Discussion and Analysis of Financial Condition and Results of Operations ("MD&A") contains statements that constitute forward looking statements. Those statements appear in a number of places in this MD&A Section and include statements regarding the intent, belief or current expectations of International Total Services, Inc., 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. Prospective investors are cautioned that any forward looking statements in this MD&A Section 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 unanticipated losses of service contracts, conditions in the aviation industry, and negative publicity regarding the airline security and services and commercial security industries. Readers are cautioned not to place undue reliance on forward looking statements. 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. ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Not applicable. ITEM 8. CONSOLIDATED FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA See Index to Consolidated Financial Statements on page F-1. ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND FINANCIAL DISCLOSURE Not applicable. -17- 20 PART III ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT The information required by this Item 10 is incorporated by reference to the information under the headings "Election of Directors" and "Section 16(a) Beneficial Ownership Reporting Compliance" contained in the Company's Proxy Statement in connection with its Annual Meeting of Shareholders to be held on September 18, 1998, and the information under the heading "Executive Officers" in Part I of this Annual Report on Form 10-K. ITEM 11. EXECUTIVE COMPENSATION The information required by this Item 11 is incorporated by reference to the information under the heading "Executive Compensation" contained in the Company's Proxy Statement in connection with its Annual Meeting of Shareholders to be held on September 18, 1998. ITEM 12. SECURITY OWNERSHIP OF CERTAIN BENEFICIAL OWNERS AND MANAGEMENT The information required by this Item 12 is incorporated by reference to the information under the heading "Security Ownership of Certain Beneficial Owners and Management" contained in the Company's Proxy Statement in connection with its Annual Meeting of Shareholders to be held on September 18, 1998. ITEM 13. CERTAIN RELATIONSHIP AND RELATED TRANSACTIONS The information required by Item 13 is incorporated herein by reference to the information set forth under the heading "Certain Relationships and Related Transactions" contained in the Company's Proxy Statement in connection with its Annual Meeting of Shareholders to be held on September 18, 1998. -18- 21 PART IV ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES, AND REPORTS ON FORM 8-K (a)(1) FINANCIAL STATEMENTS See Index to Consolidated Financial Statements on page F-1. (a)(2) FINANCIAL STATEMENT SCHEDULES Schedule II -- Valuation and Qualifying Accounts (a)(3) EXHIBITS
Exhibit No. Description ----------- ----------- 3.1 Amended and Restated Articles of Incorporation* 3.2 Amended and Restated Code of Regulations* 4.1 Specimen Common Share Certificate* 10.1 Employment Agreement between the Company and Robert A. Weitzel* 10.2 Employment Agreement between the Company and James O. Singer* 10.3 Employment Agreement between the Company and Scott E. Brewer* 10.4 Employment Agreement between the Company and Brian S. Kenyon 10.5 Employment Agreement between the Company and Robert A. Swartz* 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 Registrant* 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 Registrant 10.13 Amended and Restated Replacement Promissory Note executed by the Registrant in favor of Bank One, NA, successor by merger to Bank One, Cleveland, NA 21.1 Subsidiaries* 27.1 Financial Data Schedule * Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No. 333-29463), as amended. (b) REPORTS ON FORM 8-K Current Report on Form 8-K dated February 20, 1998, as amended by the Current Report on Form 8-K/A filed with the Commission on May 6, 1998.
-19- 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. July 13, 1998 INTERNATIONAL TOTAL SERVICES, INC. By: /s/ Robert A. Weitzel ------------------------------------------- Robert A. Weitzel Director, Chairman of the Board of Directors 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. July 13, 1998 /s/ Robert A. Weitzel ------------------------------------------- Robert A. Weitzel Director, Chairman of the Board of Directors and Chief Executive Officer July 13, 1998 /s/ Brian S. Kenyon ------------------------------------------- Brian S. Kenyon Vice President, Finance (Principal Accounting Officer) July 13, 1998 /s/ Ivan J. Winfield ------------------------------------------- Ivan J. Winfield Director July 13, 1998 ------------------------------------------- Lee C. Howley, Jr. Director July 13, 1998 /s/ James O. Singer ------------------------------------------- James O. Singer Director July 13, 1998 /s/ Jerry V. Jarret ------------------------------------------- Jerry V. Jarrett Director
-20- 23 INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
PAGE ---- International Total Services, Inc. and Subsidiaries Report of Independent Certified Public Accountants........................................... F-2 Consolidated Balance Sheets as of March 31, 1998 and 1997.................................... F-3 Consolidated Statements of Income for the years ended March 31, 1998, 1997 and 1996............................................................ F-5 Consolidated Statements of Shareholders' Equity for the years ended March 31, 1998, 1997 and 1996............................................................ F-6 Consolidated Statements of Cash Flows for the years ended March 31, 1998, 1997 and 1996............................................................ F-7 Notes to Consolidated Financial Statements................................................... F-8
F-1 24 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS Shareholders and Board of Directors INTERNATIONAL TOTAL SERVICES, INC. We have audited the accompanying consolidated balance sheets of International Total Services, Inc. and subsidiaries as of March 31, 1998 and 1997, and the related consolidated statements of income, shareholders' equity, and cash flows for each of the three years in the period ended March 31, 1998. These financial statements are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements based on our audits. We conducted our audits in accordance with generally accepted auditing standards. Those standards require that we plan and perform the audits to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the consolidated financial position of International Total Services, Inc. and subsidiaries as of March 31, 1998 and 1997, and the consolidated results of their operations and their consolidated cash flows for each of the three years in the period ended March 31, 1998 in conformity with generally accepted accounting principles. GRANT THORNTON LLP Cleveland, Ohio May 15, 1998 F-2 25 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS March 31 (Amounts in thousands) ASSETS
1998 1997 -------------- ------------- Current Assets Cash and cash equivalents $ 1,032 $ 1,452 Accounts receivable - net of allowance for doubtful accounts of $100 in each year 20,768 11,784 Deferred taxes 1,453 1,494 Uniforms 2,686 770 Other current assets 1,684 786 -------------- ------------- Total current assets 27,623 16,286 Notes receivable from Officers -- 445 Property and Equipment Security equipment 3,682 2,759 Service equipment 2,362 1,657 Computer equipment 2,049 1,758 Furniture and fixtures 994 860 Leasehold improvements 56 56 Autos 1,607 500 -------------- ------------- 10,750 7,590 Less accumulated depreciation and amortization 5,255 4,336 -------------- ------------- Property and equipment - net 5,495 3,254 Intangibles, less accumulated amortization of $1,636 and $648 in 1998 and 1997, respectively 25,295 4,346 Security Deposits and Other 154 2,670 -------------- ------------- 25,449 7,016 -------------- ------------- TOTAL ASSETS $ 58,567 $ 27,001 ============== =============
The accompanying notes are an integral part of these statements. F-3 26 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED BALANCE SHEETS - CONTINUED March 31 (Amounts in thousands, except per share data) LIABILITIES AND SHAREHOLDERS' EQUITY
1998 1997 ------------- --------------- Current Liabilities Trade accounts payable $ 4,590 $ 2,748 Notes payable to bank - 2,400 Current maturities of long-term obligations - 120 Accrued payroll and payroll taxes 11,938 8,703 Other accrued expenses 1,860 1,418 Income taxes payable 98 573 ------------- --------------- Total current liabilities 18,486 15,962 Deferred Taxes 434 289 Long-Term Obligations 544 7,555 Shareholders' Equity Common shares, without par value, stated at $.01 per share - authorized 20,000 shares, issued and outstanding 6,662 and 3,660 shares in 1998 and 1997, respectively 67 37 Additional paid-in capital 31,211 473 Cumulative translation adjustment (204) (99) Retained earnings 8,029 2,784 ------------- --------------- Total shareholders' equity 39,103 3,195 ------------- --------------- TOTAL LIABILITIES AND SHAREHOLDERS' EQUITY $ 58,567 $ 27,001 ============= ===============
The accompanying notes are an integral part of these statements. F-4 27 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF INCOME For the years ended March 31 (Amounts in thousands, except per share data)
1998 1997 1996 -------------- -------------- -------------- Operating revenues $ 173,235 $ 115,745 $ 95,900 -------------- -------------- -------------- Cost of operating revenues 145,968 98,338 81,341 -------------- -------------- -------------- Gross profit 27,267 17,407 14,559 Selling, general and administrative expenses 16,677 13,334 11,603 -------------- -------------- -------------- Operating profit 10,590 4,073 2,956 Interest expense - net 719 637 523 Other expense 868 503 437 -------------- -------------- -------------- 1,587 1,140 960 -------------- -------------- -------------- Income before income taxes 9,003 2,933 1,996 Income taxes 3,758 1,237 958 -------------- -------------- -------------- NET INCOME $ 5,245 $ 1,696 $ 1,038 ============== ============== ============== NET INCOME PER SHARE Basic $ 1.01 $ 0.33 $ 0.18 ============== ============== ============== Diluted $ 1.00 $ 0.33 $ 0.18 ============== ============== ============== WEIGHTED AVERAGE NUMBER OF SHARES Basic 5,215 5,089 5,776 ============== ============== ============== Diluted 5,265 5,089 5,776 ============== ============== ==============
The accompanying notes are an integral part of these statements. F-5 28 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY For the years ended March 31, 1998, 1997 and 1996 (Amounts in thousands)
CUMULATIVE ADDITIONAL TRANSLATION PREFERRED COMMON PAID-IN ADJUSTMENT RETAINED STOCK SHARES CAPITAL AND OTHER EARNINGS -------- ------- ----------- ----------- --------- BALANCE AT MARCH 31, 1995 $ 220 $ 64 $ 362 $ (60) $ 2,960 Translation adjustment - - - (69) - Sale of marketable securities - - - 51 - Purchase of common shares for treasury - - - - - Issuance of common shares from treasury - - - - - Net income - - - - 1,038 ------- ---- -------- ------ -------- BALANCE AT MARCH 31, 1996 220 64 362 (78) 3,998 Purchase of common shares for treasury - - - - - Issuance of common shares from treasury - - 171 - - Translation adjustment - - - (21) - Dividends declared - Class E Preferred Stock - - - - (52) Redeem Class E Preferred Stock (200) - - - - Acquisition and merger of affiliate - - 35 - (1,219) Retirement of Treasury Stock (20) (27) (95) - (1,639) Net income - - - - 1,696 ------- ---- -------- ------ -------- BALANCE AT MARCH 31, 1997 - 37 473 (99) 2,784 Purchase of common shares - - (165) - - Contribution of common shares by shareholder - - 805 - - Initial Public Offering - issuance of common shares - 30 29,963 - - Translation adjustment - - - (105) - Other - - 135 - - Net income - - - - 5,245 ------- ---- -------- ------ -------- BALANCE AT MARCH 31, 1998 $ - $ 67 $ 31,211 $ (204) $ 8,029 ======= ==== ======== ====== ========
TOTAL TREASURY SHAREHOLDERS' STOCK EQUITY -------- ------------ BALANCE AT MARCH 31, 1995 $ (406) $ 3,140 Translation adjustment - (69) Sale of marketable securities - 51 Purchase of common shares for treasury (200) (200) Issuance of common shares from treasury 18 18 Net income - 1,038 -------- -------- BALANCE AT MARCH 31, 1996 (588) 3,978 Purchase of common shares for treasury (1,226) (1,226) Issuance of common shares from treasury 31 202 Translation adjustment - (21) Dividends declared - Class E Preferred Stock - (52) Redeem Class E Preferred Stock - (200) Acquisition and merger of affiliate 2 (1,182) Retirement of Treasury Stock 1,781 - Net income - 1,696 -------- -------- BALANCE AT MARCH 31, 1997 - 3,195 Purchase of common shares - (165) Contribution of common shares by shareholder - 805 Initial Public Offering - issuance of common shares - 29,993 Translation adjustment - (105) Other - 135 Net income - 5,245 -------- -------- BALANCE AT MARCH 31, 1998 $ - $ 39,103 ======== ========
The accompanying notes are an integral part of these statements. F-6 29 INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES CONSOLIDATED STATEMENTS OF CASH FLOWS For the years ended March 31 (Amounts in thousands)
1998 1997 1996 --------------- ---------------- ---------------- OPERATING ACTIVITIES: Net income $ 5,245 $ 1,696 $ 1,038 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 948 837 897 Amortization 988 208 268 Other 18 500 (123) Deferred income taxes 185 (310) (295) Changes in working capital: Accounts receivable (8,984) (2,709) (501) Other current and noncurrent assets (2,747) (518) 12 Trade accounts payable 1,842 315 404 Accrued expenses 4,007 1,924 264 --------------- ---------------- ---------------- Net cash provided by operating activities 1,502 1,943 1,964 INVESTING ACTIVITIES: Additions to property and equipment (1,508) (1,052) (900) Proceeds received from sale of equipment - 160 543 Proceeds from sale of marketable securities - - 109 Property and equipment of acquired businesses (1,699) - - Payments for acquisitions of businesses, primarily by purchase of security contracts (19,042) (2,760) - Deposit on acquisition of business of Intex Aviation Services, Inc. - (2,571) - --------------- ---------------- ---------------- Net cash used in investing activities (22,249) (6,223) (248) FINANCING ACTIVITIES: Net proceeds from Initial Public Offering 29,993 - - Net borrowings (payments) on note payable to bank (2,400) 2,005 (819) (Payments) borrowings on subordinated debt (3,000) 3,000 - Principal payments on long-term debt (4,131) (52) (99) Purchase of Company common shares (165) (1,227) (200) Other 135 154 77 --------------- ---------------- ---------------- Net cash provided by (used in) financing activities 20,432 3,880 (1,041) Effect of exchange rates on cash (105) (21) (69) --------------- ---------------- ---------------- NET (DECREASE) INCREASE IN CASH (420) (421) 606 Cash and cash equivalents at beginning of year 1,452 1,873 1,267 --------------- ---------------- ---------------- Cash and cash equivalents at end of year $ 1,032 $ 1,452 $ 1,873 =============== ================ ================ - ------------------------------------------------------------------ SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION - ------------------------------------------------------------------ Cash paid for: Interest $ 841 $ 782 $ 610 =============== ================ ================ Income taxes $ 3,943 $ 1,231 $ 1,138 =============== ================ ================
The accompanying notes are an integral part of these statements. F-7 30 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES A summary of the significant accounting policies consistently applied in the preparation of the combined financial statements follows. All 1997 and 1996 share and per share amounts have been adjusted for the 12,892.62 for 1 stock split declared on June 17, 1997. Certain reclassifications have been made to the 1997 and 1996 consolidated financial statements to conform with the 1998 presentation. The Company's fiscal year ends on March 31. All references to fiscal years in these notes to the consolidated financial statements represent the year in which the fiscal period ends (i.e. fiscal 1998 is the year ended March 31, 1998) unless otherwise noted. BUSINESS International Total Services, Inc. (the Company) is a provider of aviation security and other aviation services, providing personnel and management support to airlines at airports primarily in the United States and Europe. The Company also provides commercial security services to various businesses in the United States. One airline customer accounted for 26.0%, 7.0% and 5.9% of operating revenues for the years ended March 31, 1998, 1997 and 1996, respectively. Another airline customer accounted for 14.7%, 18.9% and 18.3% of operating revenues for the same periods. Furthermore, five airline customers, including the two noted above, accounted for approximately 54%, 44% and 39% of operating revenues for the years ended March 31, 1998, 1997 and 1996, respectively, and 43%, 35% and 39%, respectively of accounts receivable at those dates. 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. TRANSLATION OF FOREIGN CURRENCIES All balance sheet accounts of foreign operations are translated into U.S. dollars at the year-end rate of exchange, and statement of earnings items are translated at the weighted average exchange rate for the year. The resulting translation adjustments are made directly to a separate component of stockholders' equity. Certain foreign activities are considered to be an extension of the U.S. operations, and the gain or loss resulting from remeasuring these transactions into U.S. dollars are included in income. Gains or losses from other foreign currency transactions, such as those resulting from the settlement of foreign receivables or payables, are also included in the statement of earnings. F-8 31 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED CASH FLOW STATEMENT For purposes of the Statement of Cash Flows, the Company considers all short-term, highly liquid debt instruments purchased with a maturity of three months or less to be cash equivalents. During fiscal 1998 and 1997, the Company entered into the following noncash transactions: (1) During fiscal 1998, the Company's principal shareholder, who is also the Company's chairman and chief executive officer, contributed 73,101 common shares, valued at approximately $805,000, to a former employee to settle the Company's previously recorded liability to him. (2) During fiscal 1997, the Company redeemed 200 shares of Class E preferred shares from its principal shareholder in settlement of a $200,000 note receivable from him. In addition, the Company declared $52,000 in dividends, including all dividend arrearages, on the preferred shares and paid the dividends by reducing the accrued interest receivable due on the note. (3) During fiscal 1997, the Company acquired an affiliated entity in a transaction accounted for in a manner similar to a pooling. The acquisition was completed by issuing 4,126 common shares from treasury to the Company's (and the affiliate's) principal shareholder, paying $12,500 to the other shareholders of the affiliate and by offsetting $1.7 million in notes and accrued interest receivable due to the Company from the shareholders of the affiliate against corresponding obligations of the affiliate to such shareholders. The notes and interest receivable included $1.3 million due from the Company's principal shareholder. The shareholders of the affiliate were also officers of the Company. FAIR VALUE OF FINANCIAL INSTRUMENTS Management has determined that at March 31, 1998 and 1997, the fair value of financial instruments included in the balance sheets approximated their carrying values. With respect to cash and cash equivalents, net trade receivables and payables, this determination was based on the relatively short period to maturity of these instruments. With respect to long-term debt, the assessment was based on borrowing rates currently available to the Company for debt with comparable maturities. F-9 32 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED UNIFORMS Uniforms consists of uniforms on hand that have not been issued to employees and uniforms in service. Uniforms in service are recorded at cost and amortized over their expected useful lives of 18 months. PROPERTY AND EQUIPMENT Property and equipment are stated at cost. Depreciation is provided over the estimated useful lives of the respective assets, principally five or seven years, using the straight-line method. INTANGIBLES Intangibles primarily consist of goodwill resulting from the acquisition by the Company of various aviation service and commercial security businesses, primarily through the assumption of security service contracts. Intangibles additionally include the fair value of the service contracts and, as applicable, covenants not to compete also acquired in those acquisitions. Goodwill, resulting from the acquisition of service contracts, is being amortized over the estimated life of the contracts, including 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 by the acquisition of existing contracts. The service contracts and covenants not to compete are being amortized over their remaining lives of up to five years. Amortization of intangibles was $988,000, $208,000 and $268,000 for the fiscal years ended March 31, 1998, 1997 and 1996, respectively. Management of the Company assesses the recoverability of its long-lived assets by using projected undiscounted future cash flows to determine whether the carrying amount of the asset can be recovered over its remaining life. The evaluation of long-lived assets also takes into consideration operating results and trends and prospects of the Company. Based on the assessments made, management believes that there has been no impairment of the Company's long-lived assets. USE OF ESTIMATES The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amount of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. F-10 33 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE A - SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES - CONTINUED ACCOUNTING STANDARDS During the first quarter of 1998, the AICPA's Accounting Standards Executive Committee issued SOP 98-5, Reporting on the Costs of Start-Up Activities. This SOP requires that costs of start-up activities be expensed as incurred. SOP 98-5 is required to be adopted for financial statements with fiscal years beginning after December 15, 1998 and requires the cumulative effect of the accounting change to be reported in net income in the year of adoption. The Company believes adoption of this standard will not have a material impact on the Company's financial position or results of operations. During the first quarter of 1998, the Financial Accounting Standards Board issued SFAS No. 130, Reporting Comprehensive Income, and SFAS No. 131, Disclosures About Segments of an Enterprise and Related Information. These standards are effective for fiscal years beginning after December 15, 1997. The Company believes adoption of these standards will not have a material impact on the Company's financial disclosures. NOTE B - INITIAL PUBLIC OFFERING On September 24, 1997, the Company completed a public offering of 3,021,477 common shares and received net proceeds of approximately $30 million. A portion of the proceeds were used to repay outstanding debt and the balance was used for general corporate purposes, including the acquisition of service contracts. NOTE C - CAPITAL STOCK The Company has authorized 5 million preferred shares. The Company had issued ten shares of Class A preferred stock for $20,000 and 200 shares of Class E preferred stock for $200,000. All preferred shares were redeemed and retired in 1997. Prior to their redemption, in March 1997, the Company declared and paid dividends on the Class E preferred shares in the amount of $52,000, which amount included all dividends in arrears at that date. During the fiscal years ended March 31, 1998, 1997 and 1996, the Company reacquired 19,339 common shares, 2,028,477 common shares and 286,099 common shares, respectively. During the 1997 and 1996 fiscal years, the Company reissued 70,909 of those shares, including 45,124 common shares valued at $203,000 that were granted to certain officers in November 1996. F-11 34 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE D - FINANCING ARRANGEMENTS The Company has a committed credit facility secured by all domestic accounts receivable, equipment, and other assets. The facility originally consisted of a revolving promissory note of $10,500,000, a $2,000,000 term loan and a $900,000 term loan. The credit facility was amended and restated effective October 10, 1997. The restated credit facility provides borrowings under a revolving promissory note up to $30 million through September 30, 1999, limited to a formula percentage of eligible receivables. The revolving promissory note bears interest at a variable rate based on the Company's total debt to tangible net worth ranging from LIBOR plus 1.50% to the bank's prime rate plus 3%. The interest rate on borrowings outstanding at March 31, 1998 was LIBOR (5.625% at March 31, 1998) plus 1.5%. The credit facility is collateralized by substantially all accounts receivable and property and equipment, and contains various covenants, the most restrictive of which limit capital expenditures and require the Company to maintain certain financial ratios. NOTES PAYABLE TO BANK Notes payable to bank consisted of the $2,000,000 term loan and the $900,000 term loan (with a balance of $400,000 at March 31, 1997) which were paid in full in September 1997 from the proceeds of the initial public offering. The term loans had maturity dates in 1997 and, accordingly, were classified as current liabilities at March 31, 1997. LONG-TERM OBLIGATIONS Long-term obligations consist of the following at March 31:
=============================== 1998 1997 ------------- ----------------- Revolving promissory note $544 $4,358 Subordinated debt - 3,000 Other - 317 ------------- ----------------- 544 7,675 Less current portion - 120 ------------- ----------------- $544 $7,555 ============= =================
The subordinated debt consisted of a promissory note payable, bearing interest at 20%, due in twelve quarterly principal installments of $250,000 each, beginning in February 1999. The note, which was subordinated to all borrowings provided under the bank credit facility, was fully repaid from the proceeds of the initial public offering. F-12 35 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE E - INCOME TAXES The provision for income taxes consists of the following for the years ended March 31:
1998 1997 1996 ----------------- ----------------- ------------------ PRETAX INCOME Domestic $ 8,560 $ 2,497 $ 1,635 Foreign 443 436 361 ----------------- ----------------- ------------------ TOTAL $ 9,003 $ 2,933 $ 1,996 ================= ================= ================== CURRENT Federal $ 2,650 $ 1,095 $ 884 State 700 253 233 Foreign 223 199 136 ----------------- ----------------- ------------------ Total current 3,573 1,547 1,253 DEFERRED Federal 143 (260) (251) State 42 (50) (44) ----------------- ----------------- ------------------ Total deferred 185 (310) (295) ----------------- ----------------- ------------------ TOTAL PROVISION $ 3,758 $ 1,237 $ 958 ================= ================= ==================
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:
1998 1997 1996 ----------------- ----------------- ------------------ Tax at U.S. federal income tax rate (34%) $ 3,061 $ 997 $ 679 State income taxes - net of U.S. federal tax benefit 490 128 124 Difference between foreign and U.S. federal tax rates 72 51 14 Nondeductible items 57 60 154 Other - net 78 1 (13) ----------------- ----------------- ------------------ $ 3,758 $ 1,237 $ 958 ================= ================= ================== Effective tax rates 41.7% 42.2% 48.0% ================= ================= ==================
F-13 36 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE E - INCOME TAXES - CONTINUED 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:
1998 1997 1996 --------------- --------------- --------------- DEFERRED TAX ASSETS: Deferred compensation $ 81 $ 428 $ 360 Accrued workers' compensation 545 360 400 Accrued legal expenses 571 536 324 Other accruals not currently deductible 240 180 164 Amortization of intangibles 35 51 22 Allowance for doubtful accounts 40 40 40 State income taxes 63 46 30 Other 132 50 55 --------------- --------------- --------------- TOTAL DEFERRED TAX ASSETS $ 1,707 $ 1,691 $ 1,395 =============== =============== =============== DEFERRED TAX LIABILITIES: Depreciation $ 620 $ 340 $ 412 Deferred expenses 34 112 57 Other 34 34 31 --------------- --------------- --------------- TOTAL DEFERRED TAX LIABILITIES $ 688 $ 486 $ 500 =============== =============== =============== NET DEFERRED TAX ASSETS $ 1,019 $ 1,205 $ 895 =============== =============== ===============
The net deferred tax assets are classified in the balance sheet as follows at March 31:
1998 1997 --------------- --------------- Current deferred income taxes $ 1,453 $ 1,494 Noncurrent deferred income taxes (434) (289) --------------- --------------- Net deferred tax assets $ 1,019 $ 1,205 =============== ===============
F-14 37 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE F - LEASE OBLIGATIONS The Company leases certain equipment and facilities under operating leases that expire at various dates through December 31, 2004. The future minimum lease commitments under these operating leases are as follows:
YEARS ENDED MARCH 31, - --------------------------------------- 1999 $1,696 2000 1,300 2001 1,199 2002 873 2003 304 Thereafter 376 --------------- $5,748 ===============
Rent expense incurred under operating leases was $2.2 million, $1.4 million and $1.7 million for the years ended March 31, 1998, 1997 and 1996, respectively. NOTE G - RELATED PARTY TRANSACTIONS Notes receivable from officers at March 31, 1997 consisted of two notes due from the Company's principal shareholder, plus accrued interest thereon. The notes, which aggregated approximately $325,000, were fully repaid in September 1997. Interest income on shareholder notes amounted to $14,000, $119,000 and $137,000 in the years ended March 31, 1998, 1997 and 1996, respectively. NOTE H - 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. F-15 38 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE I - WORKERS' COMPENSATION INSURANCE The Company carries workers' compensation insurance that provides coverage to all employees except for those in states that require coverage under the state's workers' compensation funds. The insurance coverage has a deductible of $250,000 per occurrence and an aggregate deductible of $950,000 per policy. Under the terms of the insurance agreements, the Company has $130,000 in cash on deposit with insurance carriers and an outstanding letter of credit in the amount of $1,022,000 at March 31, 1998. These funds and letter of credit serve as collateral for any claims incurred but not reported. The Company has an accrued liability for unpaid claims and claims incurred but not reported of $1.4 million, $900,000 and $714,000 at March 31, 1998, 1997 and 1996, respectively. NOTE J - NET INCOME PER SHARE Net income per share - basic is based on the weighted average number of shares outstanding during each period. Net income 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 potential common stock outstanding. The table below presents the information used to compute net income per share, with and without dilution:
================================================================== FOR THE YEAR ENDED MARCH 31, 1998 ------------------------------------------------------------------ INCOME SHARES PER SHARE (NUMERATOR) (DENOMINATOR) AMOUNT ------------------------------------------------------------------ Net income $5,245 5,215 $1.01 Basic ======================= Effect of dilutive securities: Stock options - 50 ------------------------------------------ $5,245 5,265 $1.00 Diluted ==================================================================
F-16 39 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE K - 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 267,015 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 Statement of Financial Accounting Standards No. 123, Accounting for Stock-Based Compensation (SFAS 123), the Company's net income and earnings per share would have been reduced to the proforma amounts indicated below.
======================== MARCH 31, 1998 ------------------------ NET INCOME As reported $5,245 Proforma $4,949 NET INCOME PER SHARE - BASIC As reported $1.01 Proforma $ .95 NET INCOME PER SHARE - DILUTED As reported $1.00 Proforma $ .94
The fair value of each option grant is estimated on the date of grant using the Black-Scholes options-pricing model with the following weighted-average assumptions: expected volatility of 45 percent; risk-free interest rate of 6.24%; and expected lives of 10 years. F-17 40 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE K - LONG-TERM INCENTIVE PLAN - CONTINUED A summary of the status of the Company's plan as of and for the year ended March 31, 1998 is as follows:
WEIGHTED AVERAGE SHARES EXERCISE PRICE --------------------------------------------- Outstanding at beginning of year - $ - Granted 265 11.25 --------------------------------------------- Outstanding at end of year 265 $11.25 ============================================= Options exercisable at end of year 0 ============== Weighted average fair value of options granted during the year $7.43 ============== Weighted average remaining contractual life (years) 9.49 ==============
F-18 41 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE L - ACQUISITIONS OF OPERATING CONTRACTS During the fiscal year ended March 31, 1998, the Company acquired aviation service and commercial security contracts and related property and equipment of $1.7 million from ten entities for an aggregate purchase price of approximately $23.3 million. During the fiscal year ended March 31, 1997, the Company acquired security operating contracts from six entities for an aggregate purchase price of approximately $2.8 million. The Company believes the purchase of these contracts to be substantially equivalent to the purchase of businesses. Accordingly, the acquisitions have been accounted for under the purchase method of accounting. The purchase prices have been allocated to the contracts and, where applicable, covenants not to compete, based upon their estimated fair market values; the excess of the purchase prices over those values have been allocated to goodwill, which is being charged to operations on a straight-line basis over 20 years (see Note A). 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 1997 acquisitions had been made at April 1, 1995 and the 1998 acquisitions had been made at April 1, 1996:
================================================= YEARS ENDED MARCH 31, ------------------------------------------------- 1998 1997 1996 ------------------------------------------------- Operating revenues $214,297 $203,515 $116,246 Net income $6,607 $5,550 $2,341 Net income per share: Basic $1.27 $1.09 $0.41 Diluted $1.25 $1.09 $0.41
The pro forma results of operations have been prepared for comparative purposes only and do not purport to present actual operating results had the acquisitions been made at the beginning of each year, or of results which may occur in the future. F-19 42 International Total Services, Inc. and Subsidiaries NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - CONTINUED March 31, 1998, 1997 and 1996 (Tabular amounts in thousands, except per share and percentage data) NOTE M - QUARTERLY RESULTS OF OPERATIONS (UNAUDITED) The following is a summary of the unaudited quarterly results of operations for the years ended March 31, 1998 and 1997:
- ------------------------------------------------------------------------------------------------------ JUNE 30 SEPTEMBER 30 DECEMBER 31 MARCH 31 - ------------------------------------------------------------------------------------------------------ FISCAL 1998 - --------------------------------- Operating revenues $38,364 $38,604 $46,240 $50,027 Gross profit 6,540 6,312 7,418 6,997 Net income 853 1,125 1,826 1,441 Net income per share - basic $0.23 $0.29 $0.27 $0.22 Net income per share - diluted $0.23 $0.29 $0.27 $0.21 - ------------------------------------------------------------------------------------------------------ FISCAL 1997 (1) - --------------------------------- Operating revenues $24,082 $29,195 $31,885 $30,583 Gross profit 3,663 4,599 4,952 4,193 Net income 442 549 552 153 Net income per share - basic $0.08 $0.10 $0.10 $0.04 Net income per share - diluted $0.08 $0.10 $0.10 $0.04
(1) The amounts reported above have been restated from those that were previously reported in the Company's quarterly reports on Form 10-Q to reflect the reclassification from revenue to other expense of discounts given to customers. F-20 43 REPORT OF INDEPENDENT CERTIFIED PUBLIC ACCOUNTANTS ON SCHEDULES Shareholders and Board of Directors INTERNATIONAL TOTAL SERVICES, INC. In connection with our audit of the consolidated financial statements of International Total Services, Inc. and Subsidiaries referred to in our report dated May 15, 1998, we have also audited Schedule II for each of the three years in the period ended March 31, 1998. In our opinion, this schedule presents fairly, in all material respects, the information required to be set forth therein. GRANT THORNTON LLP Cleveland, Ohio May 15, 1998 S-1 44 SCHEDULE II - VALUATION AND QUALIFYING ACCOUNTS INTERNATIONAL TOTAL SERVICES, INC. AND SUBSIDIARIES For the years ended March 31, 1998, 1997 and 1996 (Amounts in thousands)
COLUMN A COLUMN B COLUMN C COLUMN D COLUMN E -------------------------------- ADDITIONS -------------------------------- BALANCE AT CHARGED TO BALANCE AT BEGINNING COSTS AND CHARGED TO END OF YEAR DESCRIPTION OF PERIOD EXPENSES OTHER ACCOUNTS DEDUCTIONS PERIOD - ---------- ------------------------------- --------------- ---------- ---------------- ------------- ---------- 1996 Allowance for doubtful accounts $ 100 $ 111 $ 111 $ 100 1997 Allowance for doubtful accounts $ 100 $ 57 $ 57 $ 100 1998 Allowance for doubtful accounts $ 100 $ 319 $ 319 $ 100
S-2 45 EXHIBIT INDEX ------------- Exhibit No. Description - ----------- ----------- 3.1 Amended and Restated Articles of Incorporation* 3.2 Amended and Restated Code of Regulations* 4.1 Specimen Common Share Certificate* 10.1 Employment Agreement between the Company and Robert A. Weitzel* 10.2 Employment Agreement between the Company and James O. Singer* 10.3 Employment Agreement between the Company and Scott E. Brewer* 10.4 Employment Agreement between the Company and Brian S. Kenyon 10.5 Employment Agreement between the Company and Robert A. Swartz* 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 Registrant* 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 Registrant 10.13 Amended and Restated Replacement Promissory Note executed by the Registrant in favor of Bank One, NA, successor by merger to Bank One, Cleveland, NA 21.1 Subsidiaries* 27.1 Financial Data Schedule * Incorporated by reference from the Company's Registration Statement on Form S-1 (Registration No. 333-29463), as amended. EX-10.4 2 EXHIBIT 10.4 1 EXHIBIT 10.4 EMPLOYMENT AGREEMENT THIS EMPLOYMENT AGREEMENT is entered into as of the 20th day of April, 1998, between International Total Services, Inc., an Ohio corporation (the "Company"), and Brian S. Kenyon (the "Executive"). W I T N E S S E T H: WHEREAS, the Company desires to employ the Executive, and the Executive desires to be employed by the Company, on the terms and subject to the conditions set forth herein; NOW, THEREFORE, in consideration of the mutual promises herein contained, the parties agree as follows: 1. Employment. (a) The Company hereby employs the Executive as its Vice President of Finance for the Corporate Headquarters, and the Executive hereby accepts such employment, on the terms and subject to the conditions hereinafter set forth. (b) During the term of this Employment Agreement and any renewal hereof (all references herein to the term of this Employment Agreement shall include references to the period of renewal hereof, if any), the Executive shall be and have the title of Vice President of Finance for the Corporate Headquarters, subject to becoming Vice President and Chief Financial Officer upon the first anniversary of this Employment Agreement (as described in Section 2), and shall devote such business time and all reasonable efforts to his employment as the Executive deems appropriate and perform diligently such duties as are customarily performed by officers holding such titles with publicly-held companies of comparable size in the same or related industries, together with such other duties as may be reasonably requested from time to time by the Board of Directors of the Company (the "Board"), which duties shall be consistent with his positions as set forth above and as provided in Paragraph 2. 2. Term and Positions. (a) Subject to the provisions for renewal and termination hereinafter provided, the term of this Employment Agreement shall begin on the date hereof and shall continue until the second anniversary of this Employment Agreement. Such term automatically shall be extended for one (1) additional calendar year, unless: (i) this Employment Agreement is terminated as provided in Paragraph 4(a)(i) or 4(a)(ii) or (ii) either the Company or the Executive shall give at least 180 days written notice of non-extension of this Employment Agreement to the other on or before the second anniversary of this Employment Agreement or on or before any subsequent anniversary of this Employment Agreement. (b) Until the first anniversary of this Employment Agreement, the Executive shall 2 be entitled to serve as Vice President of Finance for the Corporate Headquarters of the Company. Upon the first anniversary of this Employment Agreement, the Executive shall be entitled to serve as Vice President and Chief Financial Officer of the Company. Without limiting the generality of any of the foregoing, except as hereafter expressly agreed in writing by the Executive: (i) the Executive shall be required to report only to the Chief Executive Officer, and (ii) no other individual shall be elected or appointed as Chief Financial Officer of the Company. For service as an officer and employee of the Company, the Executive shall be entitled to the full protection of applicable indemnification provisions of the articles of incorporation and code of regulations of the Company, as the same may be amended from time to time. (c) If: (i) the Company materially changes the Executive's duties and responsibilities as set forth in Paragraph 1(b) or 2(b) without his consent (including, without limitation, by violating any of the provisions of clause (i) or (ii) of Paragraph 2 (b)); (ii) the Executive's place of employment or the principal executive offices of the Company are moved to a location more than fifty (50) miles from the geographical center of Cleveland, Ohio; (iii) there occurs a material breach by the Company of any of its obligations under this Employment Agreement (other than those specified in this Section 2(c)), which breach has not been cured in all material respects within ten (10) days after the Executive gives notice thereof to the Company; or (iv) there occurs a "change in control" (as hereinafter defined) of the Company, then the Executive shall have the right to terminate his employment with the Company, but such termination shall not be considered a voluntary resignation or termination of such employment or of this Employment Agreement by the Executive but rather a discharge of the Executive by the Company without "cause" (as defined in Paragraph 4(a)(ii)). (d) The Executive shall be considered not to have consented to any written proposal calling for a material change in his duties and responsibilities unless he shall give written notice of his consent thereto to the Board within fifteen (15) days after receipt of such written proposal. If the Executive shall not have given such consent, the Company shall have the opportunity to withdraw such proposed material change by written notice to the Executive given within ten (10) days after the end of said fifteen (15) day period. (e) The term "change in control" means the first to occur of the following events: (i) any person or group of commonly controlled persons, other than Robert A. Weitzel or any such group of which Robert A. Weitzel is a member, owns or controls, directly or indirectly, fifty percent (50%) or more of the voting control or value of the 3 equity interests in the Company following consummation of the initial public offering of the Company's Common Shares, without par value (the "IPO"); or (ii) any person or group of commonly controlled persons who own less than five percent (5%) of the voting control or value of the equity interests in the Company during the first 30 days following the consummation of the IPO acquire ownership or control, directly or indirectly, of more than twenty percent (20%) of the voting control or value of the equity interests in the Company; or (iii) the shareholders of the Company approve an agreement to merge or consolidate with another corporation or other entity resulting (whether separately or in connection with a series of transactions) in a change in ownership of twenty percent (20%) or more of the voting control or value of the equity interests in the Company, or an agreement to sell or otherwise dispose of all or substantially all of the Company's assets (including, without limitation, a plan of liquidation or dissolution), or otherwise approve of a fundamental alteration in the nature of the Company's business. 3. Compensation. During the term of this Employment Agreement the Company shall pay or provide, as the case may be, to the Executive the compensation and other benefits and rights set forth in this Paragraph 3. (a) The Company shall pay to the Executive a base salary payable in accordance with the Company's usual pay practices (and in any event no less frequently than monthly) at the rate of Ninety-Two Thousand Dollars ($92,000) per annum, to be increased (but not decreased) from time to time (based upon the performance of the Company and the Executive) as determined by the Board in its sole discretion. (b) The Company shall pay to the Executive a signing bonus of Ten Thousand Two Hundred Eighty-One Dollars and Fifteen Cents ($10,281.15), payable in three equal monthly installments of Three Thousand Four Hundred Twenty-Seven Dollars and Five Cents ($3,427.05) beginning thirty (30) days after the date of this Employment Agreement; provided, however, such bonus payments shall be prorated on a per diem basis in the event of the termination of the Executive's employment before the third and final payment is due. (c) The Company shall pay to the Executive bonus compensation for each fiscal quarter of the Company, not later than sixty (60) days following the end of such fiscal quarter or the termination of his employment, as the case may be, prorated on a per diem basis for partial fiscal quarters, of 0.162% of the Company's net operating profit for that fiscal quarter if the Company achieves its operating budget goals for that fiscal quarter to be increased or decreased from time to time as determined by the Board in its sole discretion; provided, however, this bonus shall be increased by 0.10% of the Company's net operating profit for that fiscal quarter if the Company exceeds its operating budget goals for that fiscal quarter by 2.00% or more. (d) The Company shall provide to the Executive and his family all the medical, 4 dental, and all other group insurance benefits which the Company provides generally to employees of the Company during active employment. In the event of disability or death of the Executive, these benefits shall be continued by the Company for life for the Executive and his spouse. (e) The Executive shall have the right to participate in all retirement and other benefit plans of the Company generally available from time to time to employees of the Company and for which the Executive qualifies under their terms (and nothing in this Employment Agreement shall or shall be considered to in any way affect the Executive's rights and benefits thereunder except as expressly provided herein). (f) Until the fifth anniversary of this Employment Agreement, the Executive shall be entitled to three weeks of vacation per year. Upon the fifth anniversary of this Employment Agreement, the Executive shall be entitled to four weeks of vacation. The Executive shall be entitled to sick leave allowance each year as determined by the Executive in his reasonable and good faith discretion, which in any event shall be not less than as provided generally under the Company's sick leave policy for executive officers. (g) The Executive shall be entitled to participate in any option or other employee benefit compensation plan that is generally available to senior executive officers, as distinguished from general management, of the Company. The Executive's participation in and benefits under any such plan shall be on the terms and subject to the conditions specified in the governing document of that plan. (h) The Company shall reimburse the Executive or provide him with an expense allowance during the term of this Employment Agreement for travel, entertainment and other expenses reasonably and necessarily incurred by the Executive in connection with the Company's business. The Executive shall furnish such documentation with respect to reimbursement to be paid hereunder as the Company shall reasonably request. (i) The Company shall reimburse the Executive during the term of this Employment Agreement for all expenses, including continuing education expenses and licensing fees, reasonably and necessarily incurred by the Executive in connection with maintaining the Executive's status as a certified public accountant. The Executive shall furnish such documentation with respect to reimbursement to be paid hereunder as the Company shall reasonably request. 4. Termination. (a) The employment of the Executive under this Employment Agreement, and the term hereof, may be terminated by the Company: (i) on the death or permanent disability (as defined below) of the Executive; (ii) for cause at any time by action of the Board. For purposes hereof, the 5 term "cause" shall mean: (A) The Executive's fraud, commission of a felony or of an act or series of acts which result in material injury to the business or reputation of the Company, commission of an act or series of repeated acts of dishonesty which are materially inimical to the best interests of the Company, or the Executive's willful and repeated failure to perform his duties under this Employment Agreement, which failure has not been cured within fifteen (15) days after the Company gives notice thereof to the Executive; or (B) The Executive's material breach of any other material provision of this Employment Agreement, which breach has not been cured in all substantial respects within ten (10) days after the Company gives notice thereof to the Executive; or (iii) other than for cause at any time by action of the Board, subject to the operation of Paragraph 4(d). The exercise by the Company of its rights of termination under this Paragraph 4 shall be the Company's sole remedy in the event of the occurrence of the event as a result of which such right to terminate arises. Upon any termination of this Employment Agreement, the Executive shall be deemed to have resigned from all offices and directorships held by the Executive in the Company. (b) For purposes of this Employment Agreement, the Executive's "permanent disability" shall be deemed to have occurred after one hundred twenty (120) days in the aggregate during any consecutive twelve (12) month period, or after ninety (90) consecutive days, during which one hundred twenty (120) or ninety (90) days, as the case may be, the Executive, by reason of his physical or mental disability or illness, shall have been unable to discharge his duties under this Employment Agreement. The date of permanent disability shall be such one hundred twentieth (120th) or ninetieth (90th) day, as the case may be. In the event either the Company or the Executive, after receipt of notice of the Executive's permanent disability from the other, dispute that the Executive's permanent disability shall have occurred, the Executive shall promptly submit to a physical examination by the chief of medicine of any major accredited hospital in the Cleveland, Ohio, area and, unless such physician shall issue his written statement to the effect that in his opinion, based on his diagnosis, the Executive is capable of resuming his employment and devoting his full time and energy to discharging his duties within thirty (30) days after the date of such statement, such permanent disability shall be deemed to have occurred. (c) In the event of a termination claimed by the Company to be for "cause" pursuant to Paragraph 4(a)(ii), the Executive shall have the right to have the justification for said termination determined by arbitration in Cleveland, Ohio. In order to exercise such right, the Executive shall serve on the Company within thirty (30) days after termination a written request for arbitration. The Company immediately shall request the appointment of an arbitrator by the American Arbitration Association and thereafter the question of "cause" shall be determined under the rules of the American Arbitration Association, and the decision of the arbitrator shall be final 6 and binding on both parties. The parties shall use all reasonable efforts to facilitate and expedite the arbitration and shall act to cause the arbitration to be completed as promptly as possible. During the pendency of the arbitration, the Executive shall continue to receive all compensation and benefits to which he is entitled hereunder, and if at any time during the pendency of such arbitration the Company fails to pay and provide all compensation and benefits to the Executive in a timely manner, the Company shall be deemed to have automatically waived whatever rights it then may have had to terminate the Executive's employment for cause. Expenses of the arbitration shall be borne equally by the parties. (d) In the event of termination for any of the reasons set forth in Paragraph 2(a) or subparagraph (a)(i) or (a)(ii) of this Paragraph 4, except as otherwise provided in Paragraph 3(c), the Executive shall be entitled to no further compensation or other benefits under this Employment Agreement, except as to that portion of any unpaid salary and other benefits accrued and earned by him hereunder up to and including the effective date of such termination. If the Company terminates the Executive's employment other than pursuant to Paragraph 2(a) or subparagraph 4(a)(i) or 4(a)(ii) or the Executive terminates his employment pursuant to subparagraph 2(c), all of the compensation and benefits payable to the Executive pursuant to this Employment Agreement shall be paid to the Executive for the remainder of the term of this Employment Agreement (as that term is defined in subparagraph 2(a)). 5. Covenants and Confidential Information. (a) The Executive acknowledges the Company's reliance and expectation of the Executive's continued commitment to performance of his duties and responsibilities during the term of this Employment Agreement. In light of such reliance and expectation on the part of the Company, during the term of this Employment Agreement and for a period of two (2) years thereafter (and, as to clause (ii) of this subparagraph (a), at any time during and after the term of this Employment Agreement), the Executive shall not, directly or indirectly, do or suffer either of the following: (i) Own, manage, control or participate in the ownership, management, or control of, or be employed or engaged by or otherwise affiliated or associated as a consultant, independent contractor or otherwise with, any other corporation, partnership, proprietorship, limited liability company, firm, association or other business entity engaged in the business of, or otherwise engage in the business of, aviation services or commercial security; except that the Executive may own not more than one percent (1%) of any class of publicly traded securities of any entity, and own interests in the Company subject only to any restriction imposed by any agreement or instrument other than this Employment Agreement; or (ii) Disclose, divulge, discuss, copy or otherwise use or suffer to be used in any manner, in competition with, or contrary to the interests of, the Company, any confidential information relating to the Company's operations, properties or otherwise to its particular business or other trade secrets of the Company, it being acknowledged by the Executive that all such information regarding the business of the Company compiled or obtained by, or furnished to, the Executive while the Executive shall have been 7 employed by or associated with the Company is confidential information and the Company's exclusive property; provided, however, that the foregoing restrictions shall not apply to the extent that such information: (A) is clearly obtainable in the public domain, (B) becomes obtainable in the public domain, except by reason of the breach by the Executive of the terms hereof, (C) was not acquired by the Executive in connection with his employment or affiliation with the Company, (D) was not acquired by the Executive from the Company or its representatives, or (E) is required to be disclosed by rule of law or by order of a court or governmental body or agency. (b) The Executive agrees and understands that the remedy at law for any breach by him of this Paragraph 5 will be inadequate and that the damages flowing from such breach are not readily susceptible to being measured in monetary terms. Accordingly, it is acknowledged that, upon adequate proof of the Executive's violation of any legally enforceable provision of this Paragraph 5, the Company shall be entitled to immediate injunctive relief and may obtain a temporary order restraining any threatened or further breach. Nothing in this Paragraph 5 shall be deemed to limit the Company's remedies at law or in equity for any breach by the Executive of any of the provisions of this Paragraph 5 which may be pursued or availed of by the Company. (c) The Executive has carefully considered the nature and extent of the restrictions upon him and the rights and remedies conferred upon the Company under this Paragraph 5, and hereby acknowledges and agrees that the same are reasonable in time and territory, are designed to eliminate competition which otherwise would be unfair to the Company, do not stifle the inherent skill and experience of the Executive, would not operate as a bar to the Executive's sole means of support, are fully required to protect the legitimate interests of the Company and do not confer a benefit upon the Company disproportionate to the detriment to the Executive. 6. Tax Adjustment Payments. If all or any portion of the amounts payable to the Executive under this Employment Agreement (together with all other payments of cash or property, whether pursuant to this Employment Agreement or otherwise, including, without limitation, the issuance of common shares of the Company, or the granting, exercise or termination of options therefor) constitutes "excess parachute payments" within the meaning of Section 280G of the Internal Revenue Code of 1986, as amended (the "Code") that are subject to the excise tax imposed by Section 4999 of the Code (or any similar tax or assessment), the amounts payable hereunder shall be increased to the extent necessary to place the Executive in the same after-tax position as he would have been in had no such tax assessment been imposed on any such payment paid or payable to the Executive under this Employment Agreement or any other payment that the Executive may receive in connection therewith. The determination of the amount of any such tax or assessment and the incremental payment required hereby in connection therewith shall be made by the accounting firm employed by the Executive within thirty (30) calendar days after such payment and said incremental payment shall be made within five (5) calendar days after determination has been made. If, after the date upon which the payment required by this Paragraph 6 has been made, it is determined (pursuant to final regulations or published rulings of the Internal Revenue Service, final judgment of a court of competent jurisdiction, Internal Revenue Service audit assessment, or otherwise) that the amount of excise or other similar taxes or assessments payable by the Executive is greater than the amount initially 8 so determined, then the Company shall pay the Executive an amount equal to the sum of: (i) such additional excise or other taxes, PLUS (ii) any interest, fines and penalties resulting from such underpayment, PLUS (iii) an amount necessary to reimburse the Executive for any income, excise or other tax assessment payable by the Executive with respect to the amounts specified in (i) and (ii) above, and the reimbursement provided by this clause (iii), in the manner described above in this Paragraph 6. Payment thereof shall be made within five (5) calendar days after the date upon which such subsequent determination is made. 7. Representations and Warranties of the Company. (a) The Company is a corporation duly organized, validly existing and in good standing under the laws of the State of Ohio, and has all requisite corporate power and authority to enter into, execute and deliver this Employment Agreement, fulfill its obligations hereunder and consummate the transactions contemplated hereby. (b) The execution and delivery of, performance of obligations under, and consummation of the transactions contemplated by, this Employment Agreement have been duly authorized and approved by all requisite corporate action by or in respect of the Company, and this Employment Agreement constitutes the legally valid and binding obligation of the Company, enforceable by the Executive in accordance with its terms. (c) No provision of the Company's governing documents or any agreement to which it is a party or by which it is bound or of any material law or regulation of the kind usually applicable to and binding upon the Company prohibits or limits its ability to enter into, execute and deliver this Employment Agreement, fulfill its obligations hereunder and consummate the transactions contemplated hereby. 8. Miscellaneous. (a) The Executive represents and warrants that he is not a party to any agreement, contract or understanding, whether employment or otherwise, which would restrict or prohibit him from undertaking or performing employment in accordance with the terms and conditions of this Employment Agreement. (b) The provisions of this Employment Agreement are severable and if any provision may be determined to be illegal or otherwise unenforceable, in whole or in part, the remaining provisions and any partially unenforceable provision, to the extent enforceable in any jurisdiction, nevertheless shall be binding and enforceable. (c) The rights and obligations of the Company under this Employment Agreement shall inure to the benefit of, and shall be binding on, the Company and its successors and assigns, and the rights and obligations (other than obligations to perform services) of the Executive under this Employment Agreement shall inure to the benefit of, and shall be binding upon, the Executive and his heirs, personal representatives and assigns. (d) Any controversy or claim arising out of or relating to this Employment 9 Agreement, or the breach thereof, shall be settled by arbitration in accordance with the Rules of the American Arbitration Association then pertaining in the City of Cleveland, Ohio, and judgment upon the award rendered by the arbitrator or arbitrators may be entered in any court having jurisdiction thereof. The arbitrator or arbitrators shall be deemed to possess the powers to issue mandatory orders and restraining orders in connection with such arbitration; provided, however, that nothing in this Paragraph 8(d) shall be construed so as to deny the Company the right and power to seek and obtain any remedy available in a court for any breach or threatened breach by the Executive of any of his covenants contained in Paragraph 5 hereof. (e) Any notice to be given under this Employment Agreement shall be personally delivered in writing or shall have been deemed duly given when received after it is posted in the United States mail, postage prepaid, registered or certified, return receipt requested, and if mailed to the Company, shall be addressed to its principal place of business, attention: General Counsel, and if mailed to the Executive, shall be addressed to him at his home address last known on the records of the Company, or at such other address or addresses as either the Company or the Executive, as addressee, may hereafter designate in writing to the other. (f) The failure of either party to enforce any provision of this Employment Agreement shall not in any way be construed as a waiver of any such provision as to any future violation thereof, or prevent that party thereafter from enforcing each and every other provision of this Employment Agreement. The rights granted the parties herein are cumulative and the waiver of any single remedy shall not constitute a waiver of such party's right to assert all other remedies available to it under the circumstances. (g) This Employment Agreement supersedes all prior agreements and understandings between the parties and may not be modified or terminated orally. No modification, termination or attempted waiver shall be valid unless in writing and signed by the party against whom the same is sought to be enforced. (h) This Employment Agreement shall be governed by and construed according to the laws of the State of Ohio. (i) This Agreement may be executed in two or more counterparts, each of which will constitute one and the same instrument. (j) Where necessary or appropriate to the meaning hereof, the singular and plural shall be deemed to include each other, and the masculine, feminine and neuter shall be deemed to include each other. 10 IN WITNESS WHEREOF, the parties hereto have executed or caused this Employment Agreement to be duly executed as of the date first above written. INTERNATIONAL TOTAL SERVICES, INC. By:/s/ Robert A. Weitzel ------------------------------------ Title: Chief Executive Officer --------------------------------- And By: /s/ Scott E. Brewer ------------------------------- Title: Secretary -------------------------------- /s/ Brian S. Kenyon --------------------------------------- BRIAN S. KENYON EX-10.12 3 EXHIBIT 10.12 1 Exhibit 10.12 FIRST AMENDMENT TO THIRD AMENDED AND RESTATED CONSOLIDATED REPLACEMENT CREDIT FACILITY AND SECURITY AGREEMENT -------------------------------------------------- THIS FIRST AMENDMENT TO THIRD AMENDED AND RESTATED CONSOLIDATED REPLACEMENT CREDIT FACILITY AND SECURITY AGREEMENT (this "Agreement") dated as of October 10, 1997, is entered into by and between INTERNATIONAL TOTAL SERVICES, INC., an Ohio corporation ("Borrower"), and BANK ONE, NA, successor by merger to BANK ONE, CLEVELAND, NA, a national bank (the "Bank"). WITNESSETH WHEREAS, the Borrower and the Bank are parties to that certain Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement dated as of March 31, 1997 (the "Loan Agreement", all terms defined in said Loan Agreement being used herein with the same meaning), pursuant to which the Bank has made a $2,000,000 Term Loan to the Borrower evidenced by a Note dated March 31, 1997 and payable to the Bank, the final installment of principal thereunder being due on November 1, 1997; and also pursuant to which the Bank has made a $900,000 Domestic Term Loan to the Borrower evidenced by a Note dated February 1, 1996 and payable to the Bank, the final installment of principal thereunder originally being due on June 30, 1996, but now due on December 31, 1997; and also pursuant to which the Bank has agreed to make a $10,5000,000 Revolving Loan to the Borrower until March 31, 1999 evidenced by a Note dated March 31, 1997 and payable to the Bank, such Note being payable on demand; and WHEREAS, the Borrower and the Bank have agreed to amend the Loan Agreement (i) to extend the maturity date of the Revolving Loan to September 30, 1999; (ii) to modify certain definitions in Section 1 of the Loan Agreement, to modify certain provisions of Section 2 of the Loan Agreement and to modify certain convents in Section 8 of the Loan Agreement; and (iii) to increase the Revolving Loan to an aggregate of $30,000,000; NOW, THEREFORE, in consideration of the foregoing and the mutual covenants and agreements contained herein, and for other good and valuable consideration, the receipt and sufficiency of which is hereby acknowledged, the Borrower and the Bank agree as follows: 2 AGREEMENT Section 1. AMENDMENT OF LOAN AGREEMENT. ---------------------------- A. The definitions of "Commitment", "Contract Rate", and "Notes" set forth in Section 1 of the Agreement are, effective the Effective Date, hereby amended and restated to read in their entirety as follows: COMMITMENT - Lender's letter to Borrower dated March 21, 1997, as accepted by Borrower on March 25, 1997 and Lender's letter to Borrower dated June 11, 1997, containing Option A and B as accepted by Borrower on June 11, 1997 as to Option B. CONTRACT RATE - A fluctuating rate established as follows:
BORROWER'S TOTAL DEBT TO TANGIBLE NET WORTH CONTRACT RATE - ------------------------------------------- ------------- greater than 17.0 to 1.0 Default Rate greater than 14.0 to 1.0 and less than or equal to 17.0 to 1.0 Base Rate plus 3.00% per annum greater than 11.0 to 1.0 and less than or equal to 14.0 to 1.0 Base Rate plus 2.50% per annum greater than 8.0 to 1.0 and less than or equal to 11.0 to 1.0 Base Rate plus 2.00% per annum greater than 6.0 to 1.0 and less than or equal to 8.0 to 1.0 Base Rate plus 1.50% per annum greater than 4.0 to 1.0 and less than or equal to 6.0 to 1.0 Base Rate plus 1.00% per annum greater than 3.0 to 1.0 and less than or equal to 4.0 to 1.0 Base Rate plus 0.75% per annum greater than 2.0 to 1.0 and less than or equal to 3.0 to 1.0 Base Rate greater than 1.0 to 1.0 and less than or equal to 2.0 to 1.0 LIBOR Rate plus 2.50% per annum greater than 0.5 to 1.0 and less than or equal to 1.0 to 1.0 LIBOR Rate plus 2.00% per annum less than 0.50 to 1.0 LIBOR Rate plus 1.50% per annum
For the purposes of this definition, Borrower's Total Debt shall be defined as all accruals and payables for payroll and payroll related liabilities, plus all Lender financing and Borrower's Tangible Net Worth shall be defined as net worth less all or any capitalized value of contracts acquired after the completion of Borrower's Initial Public Offering, and any other intangible asset which may arise after the completion of Borrower's Initial Public Offering. NOTES - The Amended and Restated Replacement Promissory Note (Revolving Loan) and any other promissory note or other instrument evidencing the Borrower's obligation to repay any Obligations. B. The following definitions of "Initial Public Offering" and "LIBOR Rate" are, effective the Effective Date, hereby added to Section 1 of the Agreement to read in their entirety as follows: -2- 3 INITIAL PUBLIC OFFERING - Borrower's initial offering of stock to the public pursuant to the prospectus dated September 19, 1997 and filed with the SEC on September 19, 1997, the proceeds of which were, in part, used to satisfy all indebtedness of Borrower to Seidler. LIBOR RATE - The rate of interest determined on the basis of the offered rate of deposits in U.S. dollars in the London interbank market, commonly referred to as the London Interbank Offered Rate ("LIBOR"), for one and three month periods, as elected by Borrower at the time of any advance under the Revolving Loan as provided in Section 2.3 (A) of this Agreement; provided, however, that Borrower shall not elect a period extending beyond the maturity date of the Revolving Loan. C. Subsections 2.3(A), (B) and (C) of the Agreement are, effective the Effective Date, amended and restated to read in their entirety as follows: 2.3 Revolving Loan. --------------- (A) REVOLVING LOAN. Subject at all times to the terms hereof, the Lender will, from and after October 10, 1997 until September 30, 1999 make such loans to the Borrower as from time to time the Borrower requests (the "Revolving Loan") consisting of advances made by Lender against the value of Eligible Accounts-Domestic and Eligible Accounts-Foreign. Subject to the provisions of Subsection (B) of this Section 2.3, the aggregate unpaid principal of the Revolving Loan outstanding at any one time shall not exceed the lesser of (a) the line of credit approved for Borrower, which is currently Thirty Million Dollars ($30,000,000), less the face amount of all outstanding Letters of Credit issued by Lender for the account of Borrower or (b) the sum of (i) eighty percent (80%) of the unpaid face amount of Eligible Accounts-Domestic (or such other percentages of Eligible Accounts-Domestic as may from time to time be fixed by the Lender upon notice to the Borrower) and (ii) the lesser of fifty percent (50%) of the unpaid face amount of Eligible Accounts-Foreign (or such other percentages of Eligible Accounts- Foreign as may from time to time be fixed by the Lender upon notice to the Borrower) or Three Hundred Fifteen Thousand Dollars ($315,000) less fifty percent (50%) of the Borrower's accrued payroll and related expenses account calculated at the most recent calendar month-end (or such other dollar amount as may from time to time be fixed by the Lender upon notice to the Borrower). (B) MAXIMUM BORROWINGS AVAILABLE UNDER REVOLVING LOAN. Notwithstanding anything to the contrary contained in this Section 2.3, at no time shall the loans outstanding at any time under the Revolving Loan exceed the sum of Thirty Million Dollars ($30,000,000), less the face amount of all outstanding Letters of Credit issued by Lender for the account of Borrower. -3- 4 (C) PAYMENT. The Revolving Loan shall be payable on September 30, 1999 and bear interest as provided in Section 2.3(D) of this Agreement and shall otherwise be evidenced by, and repayable in accordance with, the Revolving Note, but in the absence of such revolving promissory note shall be evidenced by the Lender's record of disbursements and repayments. D. Section 2.12 of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: 2.12 COMMITMENT FEE. Borrower shall pay to Lender annually, in advance, on the date of this Agreement and on October 10, 1998, and, if the Revolving Loan is hereafter renewed, on the date of renewal and annually thereafter if renewed for a period of more than one (1) year, a commitment fee (the "Commitment Fee") of forty-five hundredths of one percentage point (0.45%) of the maximum borrowings available under the Revolving Loan pursuant to Section 2.3(B) of this Agreement, whether the Borrower shall be entitled to request such amount pursuant to Section 2.3(A) of this Agreement or not. E. Subsection 8.1(H) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: (H) Keep adequate records and books of account with respect to its business activities in which proper entries are made in accordance with GAAP reflecting all its financial transactions and permit the Lender annually, in its discretion, to conduct two (2) or three (3) field examinations and an audit as set forth in the Commitment, at Borrower's expense. F. Subparagraph (v) of Subsection 8.1(I) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: 8.1(I)(v) Concurrently with each request for an advance under the Revolving Loan, and monthly, weekly or daily according to the schedule below on the last day of each month, week or day according to the schedule below, a certificate prepared by the chief financial officer or president of Borrower in the form attached hereto as EXHIBIT A, which certificate may be delivered to Lender by telecopy and on the first business day of each week Borrower shall submit to Lender a certificate (certified by the President or Chief Financial Officer of Borrower as of the last lay of the preceding week) that payroll taxes for which Borrower is obligated through and as of the date of the certificate have been paid in full or remitted when due. The Borrower shall also provide to Lender on or before the 10th day of each month, a monthly reconciliation of unbilled Accounts Receivable for the preceding month and, on or before the 30th day of each month, a monthly reconciliation between Accounts Receivable as shown on its -4- 5 CLEVELAND/0041673.03 General Ledger and Borrowing Certificates for the preceding month, each in form acceptable to Lender and including such detail as the Lender shall require.
Borrowing Certificate Frequency Leverage Ratio ------------------------------- -------------- Monthly less than or equal to 2.0 to 1.0 Weekly greater than 2.0 to 1.0 and less than or equal to 4.0 to 1.0 Daily greater than 4.0 to 1.0
G. Subsection 8.1(O) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: (O) Maintain at all times a Tangible Net Worth equal to or greater than Five Hundred Thousand Dollars ($500,000) commencing September 30 1997 and thereafter, and maintain at all times Stockholder's Equity as set forth below commencing September 30, 1997 and thereafter, such covenants to be calculated monthly in accordance with GAAP based on Borrower's internally prepared interim financial statements.
NET PROCEEDS OF INITIAL PUBLIC OFFERING STOCKHOLDER'S EQUITY --------------------------------------- -------------------- greater than $18,000,000 and less than or equal to $19,000,000 $20,500,000 greater than $19,000,000 and less than or equal to $20,000,000 $21,500,000 greater than $20,000,000 and less than or equal to $21,000,000 $22,500,000 greater than $21,000,000 and less than or equal to $22,000,000 $23,500,000 greater than $22,000,000 $24,000,000
H. Subsection 8.1(P) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: (P) Maintain Debt Coverage (as defined herein) not less than 2.5 to 1.0 at September 30, 1997 and thereafter. "Debt Coverage" as used in this Section 8.1(P) means the ratio of Borrower's net income, plus depreciation and amortization and net interest paid to Lender, less dividends, purchases of treasury stock and capital expenditures, to the amount of all principal and interest payable to Lender calculated quarterly in accordance with GAAP based upon Borrower's quarterly and fiscal year-end financial statements. I. Subsection 8.1(Q) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: -5- 6 (Q) Maintain at all times a ratio of total unsubordinated liabilities (including deferred liabilities and/or deferred income), computed in accordance with GAAP, to Tangible Net Worth equal to or less than 17.0 to 1.0 commencing September 30, 1997 and thereafter, and a ratio of funded bank debt to EBITDA of not more than 3.0 to 1.0 commencing September 30, 1997 thereafter, to be tested quarterly beginning September 30, 1997, such covenants to be calculated in accordance with GAAP based on Borrower's fiscal year-end financial statements. J. Subsection 8.2(A) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: (A) Merge or consolidate with, or acquire all or any substantial portion of the assets or capital stock of, any Person. K. Subsection 8.2(K) of the Agreement is, effective the Effective Date, hereby amended and restated to read in its entirety as follows: (K) Make Capital Expenditures during any fiscal year of Borrower which, in the aggregate, exceed Two Million Dollars ($2,000,000). L. EXHIBIT I attached to the Agreement is, effective the Effective Date, hereby amended to delete item number 3 contained therein. M. EXHIBIT J attached to the Agreement is, effective the Effective Date, hereby amended to delete item number 5 contained therein. Section 2. EFFECTIVE DATE OF THE AGREEMENT. -------------------------------- The effective date of this Agreement ("Effective Date") shall be the date on which all conditions precedent and all conditions subsequent have been satisfied, or waived by the Bank in writing. Section 3. CONDITIONS PRECEDENT. --------------------- Borrower hereby acknowledges and agrees that the effectiveness of this Agreement is conditioned upon the receipt by the Bank, on or prior to the date hereof, in form and substance satisfactory to the Bank and its counsel, of the following: -6- 7 A. A certificate, dated as of the date hereof, signed by the President of Borrower and to the effect that: 1) As of said date, no Event of Default has occurred and is continuing, and no event has occurred and is continuing that, with the giving of notice or passage of time, or both, would be an Event of Default; and 2) The representations and warranties of Borrower set forth in Section 7 of the Loan Agreement are true and correct as of such date; and 3) Borrower is in compliance with all of the terms and conditions set forth in the Loan Agreement on and as of said date. B. A certificate, dated as of the date hereof, signed by the Secretary of Borrower certifying as follows: 1) Borrower's Articles of Incorporation and Code of Regulations have not been modified or amended since August 11, 1995 (or certifying that true, correct and complete copies of all such modifications and amendments are attached thereto); and 2) Copies of resolutions of Borrower's Board of Directors are attached thereto with respect to the approval of this Agreement and of the matters contemplated hereby and authorizing the execution, delivery and performance of this Agreement and each other document, instrument, agreement or note to be delivered pursuant hereto; and 3) As to the incumbency and signatures of the officers of Borrower signing this Agreement and each other document, instrument, agreement or note to be delivered pursuant hereto. C. The Amended and Restated Replacement Promissory Note (Revolving Loan) in the form of EXHIBIT A attached hereto, with all blanks completed, duly executed and delivered by Borrower to Bank. D. An Acknowledgement, Consent and Agreement in the form of EXHIBIT B attached hereto, with all blanks completed, duly executed and delivered by Transport, NBC, and the Guarantors to Bank. E. Evidence that Borrower has completed its Initial Public Offering, including receipt by Borrower of at least Eighteen Million Dollars ($18,000,000) as a result of the sale of -7- 8 stock of Borrower pursuant to the Initial Public Offering, net of all costs and expenses whatsoever incurred by Borrower in connection with the Initial Public Offering. F. Evidence of repayment in full of all indebtedness of Borrower to Seidler, including receipt by Borrower from Seidler of fully executed UCC-3 Termination Statements for all outstanding UCC filings and the original promissory note of Borrower and all guarantys of the indebtedness of Borrower to Seidler marked "Paid in Full" or written acknowledgment from Seidler that Borrower's indebtedness to Seidler has been fully satisfied and all security interests and liens discharged or terminated. G. Evidence of repayment in full of all indebtedness of Robert A. Weitzel to Borrower. H. A fully executed Participation Agreement between the Bank and IBJ Schroder Business Credit Corporation ("IBJ Schroder"), pursuant to which IBJ Schroder agrees to participate $10,000,000 of the Revolving Loan, together with receipt by the Bank from IBJ Schroder of all funds necessary to consummate such participation. I. The written opinion of counsel for Borrower as to the enforceability of this Agreement, the Loan Agreement, the Note, and each of the other Credit Documents and covering such other issues thereunder as requested by the Bank and its counsel. J. Such other documents, instruments, agreements and notes as the Bank may reasonably request to implement this Agreement and the transactions contemplated hereby and by the Loan Agreement. SECTION 4. FEES AND EXPENSES. ------------------ Borrower shall pay all out-of-pocket fees and expenses incurred by the Bank in connection with the preparation, negotiation, execution and delivery of this Agreement, the promissory notes, guaranty, participation agreement, and all the other agreements, documents or certificates required or contemplated hereby, including, without limitation, legal fees and expenses of the Bank. Borrower shall pay a closing fee to IBJ Schroder of $25,000 and shall also pay all out-of-pocket fees and expenses incurred by IBJ Schroder in connection with the preparation, negotiation, execution and delivery of the Participation Agreement, including, without limitation, legal fees and expenses of IBJ Schroder. SECTION 5. REFERENCES. ----------- On and after the effective date of this Agreement, each reference in the Loan Agreement to "this Agreement", "hereunder", "hereof", or words of like import referring to the Loan -8- 9 Agreement, and in the Note to the "Loan Agreement", "thereof", or words of like import referring to the Loan Agreement shall mean and refer to the Loan Agreement as previously amended and as amended hereby. References to Exhibit C-1 in the definition of "Revolving Note" in the Loan Agreement shall be deemed to refer to the Promissory Note, a copy of which is attached hereto as EXHIBIT A. References in the Loan Agreement, Note and other Credit Documents to Bank One, Cleveland, NA shall mean and refer to Bank One, NA as successor to Bank One, Cleveland, NA. The Loan Agreement, as previously amended and as amended by this Agreement, and all Credit Documents are and shall continue to be in full force and effect and are hereby and in all respects ratified and confirmed. References to the Loan Agreement in the Note shall be deemed to include all amendments to the Loan Agreement whether specified in the Note or not. SECTION 6. Applicable Law. --------------- This Agreement shall be deemed to be a contract under the laws of the State of Ohio, and for all purposes shall be construed in accordance with the laws of the State of Ohio. SECTION 7. Counterparts. ------------- This Agreement may be executed in any number of counterparts, all of which taken together shall constitute one and the same instrument, and any one of the parties hereto may execute this Agreement by signing any such counterpart. IN WITNESS WHEREOF, the Borrower and the Bank have caused this Agreement to be executed by their duly authorized officers as of the date and year first above written. BANK ONE, NA INTERNATIONAL TOTAL SERVICES, INC. By /s/ James G. Zamborsky By /s/ Robert A. Weitzel ----------------------------- --------------------------------- Name: James G. Zamborsky Name: Robert A. Weitzel Title: Relationship Manager Title: Chief Executive Officer -9- 10 SCHEDULE 1 ---------- List of Guarantors ------------------ Domestic - -------- Crown Technical Systems, Inc. (Ohio) T.I.S. Incorporated (Texas) Certified Investigative Services, Inc. (Texas) I.T.S. of New York, Inc. (New York) Selective Detective Services, Inc. (New Jersey) Foreign - ------- International Total Services, Ltd. (United Kingdom) International Transport Security, s.r.o. (Czech Republic) International Transport Services, Ltd. (Thailand) -10- EX-10.13 4 EXHIBIT 10.13 1 Exhibit 10.13 AMENDED AND RESTATED -------------------- REPLACEMENT PROMISSORY NOTE --------------------------- (Revolving Loan) $ 30,000,000 Cleveland, Ohio October 10, 1997 FOR VALUE RECEIVED, INTERNATIONAL TOTAL SERVICES, INC., a corporation organized under the laws of the State of Ohio (hereinafter referred to as the "Company"), promises to pay to the order of BANK ONE, NA, successor by merger to BANK ONE, CLEVELAND, NA (hereinafter referred to as the "Bank"), the principal amount of Thirty Million Dollars ($30,000,000), or such lesser amount as shall have from time to time been borrowed by the Company, on September 30, 1999, or sooner as hereinafter provided, with interest on the unpaid balance of said principal amount from the date hereof at the Contract Rate, as defined in the Agreement hereinafter referred to, which definition is hereby accepted by the Company, as the same may from time to time be established. If any installment of principal, interest or other amounts due and payable hereunder are not paid when due, or within any applicable grace periods, the Company shall pay interest thereon at the rate per annum of six percent (6.0%) in excess of the Contract Rate, as the same may from time to time be established. The Company agrees to pay interest on the unpaid principal amount outstanding of this Note in monthly installments, commencing on the 1st day of November, 1997 and continuing on the 1st day of each month thereafter. The unpaid balance of the principal amount outstanding and all accrued interest thereon shall be due and payable on September 30, 1999. Payments of both principal of and interest on this Note shall be made in lawful money of the United States of America, at 600 Superior Avenue, Cleveland, Ohio 44114, or at such other place as the Bank or any subsequent holder hereof shall have designated to the Company in writing. Interest payable on this Note shall be computed on a three hundred sixty (360) day per year basis counting the actual number of days elapsed. This Note, in part, evidences, but does not extinguish or satisfy, a pre-existing indebtedness of the Company to the Bank heretofore evidenced by a $10,500,000 Replacement Promissory Note (Revolving Loan) dated March 31, 1997 to the Bank and is issued pursuant to and is entitled to the benefits of a Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement dated as of March 31, 1997, as amended by that certain First Amendment to Third Amended and Restated Consolidated Replacement Credit Facility and Security Agreement dated as of October 10, 1997, each by and between the Company and the Bank (collectively, the "Agreement"), to which Agreement reference is hereby made for a statement of the rights and obligations of the Bank and the duties and obligations of the Company in relation thereto; but neither 2 this reference to said Agreement nor any provisions thereof shall affect or impair the absolute and unconditional obligation of the Company to pay the principal of or interest on this Note when due. The Company may prepay all or any portion of this Note at any time or times and in any amount only as provided in the Agreement. In case an Event of Default, as defined in said Agreement, shall occur and be continuing beyond any applicable grace period, the principal of this Note may be declared immediately due and payable at the option of the Bank. The Company hereby authorizes any attorney-at-law to appear in any court of record in the State of Ohio, or in any other state or territory of the United States, at any time or times after the above sum becomes due, and waive the issuance and service of process and confess judgment against it, in favor of any holder of this Note, for the amount then appearing due, together with the costs of suit, and thereupon to release all errors and waive all rights of appeal and stay of execution. The foregoing warrant of attorney shall survive any judgment, it being understood that should any judgment be vacated for any reason, the foregoing warrant of attorney nevertheless may thereafter be used for obtaining an additional judgment or judgments. No delay on the part of any holder hereof in exercising any power or rights hereunder shall operate as a waiver of any power or rights. Any demand or notice hereunder to the Company may be made by delivering the same to the address last known to the Bank, or by mailing the same to such address, with the same effect as if delivered to the Company in person. This Note is executed at Cleveland, Cuyahoga County, Ohio. "WARNING. BY SIGNING THIS PAPER YOU GIVE UP YOUR RIGHT TO NOTICE AND COURT TRIAL. IF YOU DO NOT PAY ON TIME, A COURT JUDGMENT MAY BE TAKEN AGAINST YOU WITHOUT YOUR PRIOR KNOWLEDGE AND THE POWERS OF A COURT CAN BE USED TO COLLECT FROM YOU REGARDLESS OF ANY CLAIMS YOU MAY HAVE AGAINST THE CREDITOR WHETHER FOR RETURNED GOODS, FAULTY GOODS, FAILURE ON HIS PART TO COMPLY WITH THE AGREEMENT OR ANY OTHER CAUSE." INTERNATIONAL TOTAL SERVICES, INC. By /s/ Robert A. Weitzel -------------------------------------- Name: Robert A. Weitzel Its: Chief Executive Officer EX-27.1 5 EXHIBIT 27.1
5 YEAR MAR-31-1998 APR-01-1997 MAR-31-1998 1,032,000 0 20,868,000 100,000 0 27,623,000 10,750,000 5,255,000 58,567,000 18,486,000 0 0 0 67,000 39,036,000 39,103,000 173,235,000 173,235,000 145,968,000 162,645,000 868,000 318,651 719,000 9,003,000 3,758,000 0 0 0 0 5,245,000 1.01 1.00
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