Borg-Warner Security Corporation
Innovation
"Wells Fargo Alarm Services provides electronic security services at more than
30 Caterpillar facilities nationwide. We chose Wells Fargo Alarm because they
offered innovative service options and advanced technology solutions on a
national level. Each of our locations presents a unique challenge and Wells
Fargo Alarm was able to customize each installation to meet those challenges." .
In 1997 we accelerated our investment in developing new products and services
that offer customers more complete and more reliable protection of life and
property. . Wells Fargo Alarm's newest product, SecurVision/R/, represents a
break-through in the electronic security industry. SecurVision is a video
recognition system that uses neural net technology to distinguish between human
and non-human movement. Confirmed intrusions are then encrypted and transmitted
as live video to a control center for evaluation and response, thereby reducing
the incidence of costly false alarms. . At Borg-Warner Protective Services, our
major investments in technology have provided us with the most modern and
efficient physical security services available. Touch-ToCo/R/, a security
officer tour-confirmation system; and PoCo/R/, a security officer post-
confirmation system are only two examples of technology that are adding value
and reliability to our physical security services. . Our customers depend on
Borg-Warner Security to provide them with the latest advances available in the
area of security technology and we remain committed to meeting this challenge.
[PHOTO]
Ron Smith, Corporate Security Services Systems Administrator, Caterpillar Inc.
13
The following table sets forth selected financial information for Borg-Warner
Security Corporation (the "Company"). The information is derived from the
audited financial statements of the Company. Previously reported results have
been restated to reflect the discontinued operations of the Company's courier
services unit in September 1996. In addition, the Company's armored security
services unit entered into a business combination with Loomis Armored in January
1997. The combined company, known as Loomis, Fargo & Co. ("Loomis, Fargo"), is
accounted for under the equity method. The business combination impacts the
comparison of the Company's 1997 results to prior periods because the armored
services unit was included in the Company's results of operations for only 23
days in 1997. The selected financial data should be read in connection with the
1997 Consolidated Financial Statements and accompanying notes.
Statement of Operations Data Year Ended December 31,
(millions of dollars, except per share) 1997 1996 1995 1994 1993
- ---------------------------------------------------------------------------------------------------------------------------
Net service revenues $1,548.0 $1,711.2 $1,708.5 $1,626.8 $1,592.1
Earnings before interest and income taxes 72.0 80.0 71.2 59.4 (148.8)
Earnings (loss) before income taxes 30.0 23.4 15.3 10.6 (198.7)
Provision (benefit) for income taxes (1) 11.0 9.5 6.9 (3.2) 19.5
Earnings (loss) from continuing operations (2) 19.0 13.9 8.4 13.8 (218.2)
Earnings (loss) from continuing operations per share - basic(3) 0.81 0.60 0.36 0.60 (9.80)
Earnings (loss) from continuing operations per share - diluted(3) $ 0.79 $ 0.59 $ 0.36 $ 0.59 $ (9.54)
Average common shares - basic (in thousands)(4) 23,475 23,266 23,097 22,893 22,272
Average common shares and equivalents outstanding - diluted
(in thousands)(4) 24,075 23,517 23,399 23,170 22,858
Balance Sheet Data (at end of year)
- ---------------------------------------------------------------------------------------------------------------------------
Total assets $ 659.6 $ 760.8 $ 838.5 $ 811.6 $ 773.5
Total debt 344.9 442.6 484.5 459.9 450.3
Shareholders' equity 65.0 41.2 49.7 43.8 27.5
Net assets of discontinued operations $ 15.4 $ 12.6 $ 36.8 $ 32.5 $ 35.1
Stock Prices First Second Third Fourth
- ---------------------------------------------------------------------------------------------------------------------------
1997 Quarters
High $ 15 1/8 $18 $19 9/16 $19 3/4
Low $ 10 1/8 $13 3/4 $16 1/8 $15 1/4
1996 Quarters
High $ 12 3/4 $13 1/8 $ 9 7/8 $11 3/8
Low $ 10 1/4 $ 9 5/8 $ 8 1/4 $ 9 3/8
(1) Income taxes for the year ended December 31, 1994 reflect certain
adjustments related to changes in tax bases.
(2) $250 million of excess purchase price over net assets acquired not directly
attributed to the protective services business was written off as a charge
to earnings in the first quarter of 1993.
(3) Earnings (loss) from continuing operations per share have been restated for
adoption of Statement of Financial Accounting Standards No. 128.
(4) The average common shares outstanding include 3,795,000 shares sold through
an initial public offering on January 27, 1993.
14
Management's Responsibility for Consolidated Financial Statements Borg-Warner
Security Corporation
The information in this report is the responsibility of management. Borg-Warner
Security Corporation has in place reporting guidelines and policies designed to
ensure that the statements and other information contained in this report
present a fair and accurate financial picture of the Company. In fulfilling this
management responsibility, we make informed judgments and estimates conforming
with generally accepted accounting principles.
The accompanying financial statements have been audited by Deloitte &
Touche LLP, independent auditors. Management has made available all of the
Company's financial records and related information deemed necessary by Deloitte
& Touche LLP. Furthermore, management believes that all representations made by
it to Deloitte & Touche LLP during their audit were valid and appropriate.
Management is responsible for maintaining a comprehensive system of
internal control through its operations that provides reasonable assurance that
assets are protected from improper use, that material errors are prevented or
detected within a timely period and that records are sufficient to produce
reliable financial reports. The system of internal control is supported by
written policies and procedures that are updated by management as necessary.
The system is reviewed and evaluated regularly by the Company's internal
auditors, as well as by the independent auditors in connection with their annual
audit of the financial statements.
The independent auditors conduct their audit in accordance with generally
accepted auditing standards and perform such tests of transactions and balances
as they deem necessary. Management considers the recommendations of its internal
auditors and independent auditors concerning the Company's system of internal
control and takes the necessary actions that are cost-effective in the
circumstances. Management believes that, as of December 31, 1997, the Company's
system of internal control was adequate to accomplish the objectives set forth
in the previous paragraph.
An audit committee composed entirely of directors of the Company, who are
not employees, meets periodically with the Company's management and independent
auditors to review financial results and procedures, internal financial
controls, and internal and external audit plans and recommendations. To
guarantee independence, the audit committee and the independent auditors have
unrestricted access to each other with or without the presence of management
representatives.
/s/ J. Joe Adorjan
J. Joe Adorjan
Chairman, President and Chief Executive Officer
/s/ Timothy M. Wood
Timothy M. Wood
Vice President and Chief Financial Officer
15
Results of Operations
Net Revenues
1997 vs. 1996
(millions of dollars) 1997 1996 1995 Percent Change
- -------------------------------------------------------------------------------
Physical Security Services $1,289.3 $1,223.8 $1,222.8 5.4%
Electronic Security Services 243.4 241.1 254.7 1.0%
Armored Security Services 15.3 246.3 231.0 (93.8%)
- -------------------------------------------------------------------------------
Total Revenues $1,548.0 $1,711.2 $1,708.5 (9.5%)
===============================================================================
The Company's physical security services unit is the world's largest provider of
contract security personnel and related services with approximately 73,000
employees serving 14,000 customers in the United States, Canada, the United
Kingdom and Colombia. Revenue increased in 1997 principally due to new business
growth, higher billing rates and improved customer retention. Physical security
1996 revenues were essentially flat compared to 1995 primarily due to
management's decision to prune higher risk, low margin business during the year.
The Company's electronic security services unit is a leading full service
provider of integrated electronic security systems in the United States and
Canada, including intrusion and fire detection, closed circuit television and
access control. The unit has approximately 126,000 customers and 2,200
employees. The unit's revenues in 1997 increased modestly compared to 1996 as
higher direct sales of commercial installations and higher service revenue on
residential operations were principally offset by the negative impact of bank
consolidations. The electronic security services unit primarily recognizes
leased equipment under sales-type leases for certain contracts dated after
January 1, 1995 and as operating leases for prior periods. At December 31, 1997,
sales-type leases represented 46.4 percent of the lease base, compared to 25.0
percent and 15.6 percent at December 31, 1996 and 1995, respectively. The annual
aggregate retention rate, excluding the impact of bank consolidations, for all
subscriber installation leases was 90 percent in 1997 versus 89 percent in 1996
and 88 percent in 1995.
In January 1997, Wells Fargo Armored entered into a business combination
with Loomis Armored. The combined company, known as Loomis, Fargo & Co., is
owned 51 percent by the former Loomis shareholders and 49 percent by the
Company. The combination created a leading armored transportation and ATM
services company with broad geographic coverage. This transaction also allowed
the Company to reduce its debt by approximately $93 million through December 31,
1997. The excess of proceeds received over carrying value of net assets
contributed in the combination was substantially deferred and offset by purchase
price adjustments and provisions for other contingent liabilities related to the
contributed assets and liabilities of the armored services unit. The Company
accounts for its investment in the new company under the equity method. The
business combination impacts the comparison of the Company's 1997 results to
prior periods because the armored services unit was included in the Company's
results of operations for only 23 days in 1997. Armored security 1996 revenues
increased versus 1995 mainly due to higher volume in ATM services.
Costs and Expenses
Cost of services as a percent of revenue was 79.6 percent, 79.5 percent and 79.6
percent in 1997, 1996 and 1995, respectively. Gross profit margins remained
constant despite increased labor costs, as a result of the Company's commitment
to improve account profitability and internal productivity programs.
Depreciation expense was $39.1 million in 1997, down from $47.0 million in
1996 and $52.1 million in 1995. The 1997 decrease resulted principally from the
Loomis, Fargo combination, while the 1996 decrease resulted primarily from the
change to sales-type lease accounting for subscriber installations.
Selling, general and administrative (SG&A) expenses were $194.6 million,
$210.6 million and $212.5 million in 1997, 1996 and 1995, respectively. As a
percent of net sales, SG&A costs were 12.6 percent, 12.3 percent and 12.4
percent in 1997, 1996 and 1995, respectively. The 1997 increase as a percentage
of sales was principally due to investments in new product development,
information systems and marketing programs. The 1997 decreased spending
primarily reflects the Loomis, Fargo combination. The Company also received cash
proceeds of approximately $3.0 million from the sale of non-operating assets.
This sale resulted in a gain that was more than offset by the increases noted
above.
Operating Profit
Operating profit decreased to $80.3 million in 1997 from $93.1 million in 1996
and $85.9 million in 1995. Operating profit margin decreased to 5.2 percent in
1997 from 5.4 percent in 1996 and 5.0 percent in 1995. Operating profit from
physical security services increased to $64.9 million in 1997 from $62.1 million
in 1996 and $56.4 million in 1995. Physical security services operating profit
margins were 5.0 percent, 5.1 percent and 4.6 percent in 1997, 1996 and 1995,
respectively. Electronic security services
16
Borg-Warner Security Corporation
operating profit decreased to $14.5 million in 1997 from $18.9 million in 1996
and $15.8 million in 1995. Electronic security services operating profit margins
were 6.0 percent, 7.8 percent and 6.2 percent in 1997, 1996 and 1995,
respectively. The decrease reflects the up-front cost of increased investment in
systems, sales and marketing and new product development. It also reflects the
lapse of certain purchase accounting credits related to the acquisition of Borg-
Warner in 1987. Armored security services operating profit was $0.9 million in
1997 compared with $12.1 million in 1996 and $13.7 million in 1995. The decrease
resulted from the Loomis, Fargo combination.
During 1997, the Company took several steps toward its long-term objective
of shifting from defined benefit to defined contribution retirement plans. The
Company recorded pre-tax income of approximately $3.7 million resulting from
defined pension benefit plan changes.
Other Income/Expense
Other expense in 1997 was $10.0 million versus $13.4 million in 1996 and 1995.
The 1997 decrease principally reflects a net gain of $2.2 million and reduced
amortization resulting from the Loomis, Fargo combination.
Interest Expense and Finance Charges
Interest expense, including the amortization of financing costs, decreased to
$42.0 million in 1997 from $56.6 million in 1996 and $55.9 million in 1995. The
1997 decrease from 1996 is principally due to the lower borrowing levels
resulting from the proceeds from the Loomis, Fargo combination and improved
terms under the subsequent refinancing of bank borrowings. The increase in 1996
from 1995 resulted from higher costs associated with the issuance and
renegotiation of certain bank lines of credit and borrowing facilities. This was
partially offset by the benefits of lower short-term market rates of interest
and lower average debt levels outstanding.
Income Taxes
Income taxes were $11.0 million, $9.5 million and $6.9 million in 1997, 1996 and
1995, respectively. The Company's effective tax rate in 1997 was 36.7 percent,
down from 40.6 percent in 1996 and 45.1 percent in 1995. The effective tax rate
generally exceeds the statutory rate because of non-deductible excess purchase
price amortization. The decreased 1997 effective tax rate principally relates to
Loomis, Fargo income which is included in the Company's financial statements
after-tax.
Net Earnings
Earnings from continuing operations for 1997 were $19.0 million, versus $13.9
million in 1996 and $8.4 million in 1995. Net earnings for 1997 were $19.0
million compared with a net loss of $14.6 million in 1996, which included the
impact of treating the courier services unit as a discontinued operation. Net
earnings of $1.2 million in 1995 included a charge of $4.7 million, net of tax,
from the early extinguishment of debt in connection with the amendment of the
Company's credit facilities.
International Operations
Revenues for 1997 were $122.7 million compared with $116.7 million in 1996 and
$109.4 million in 1995. Operations are primarily in Canada, the United Kingdom
and Colombia and principally involve the employment of contract guard personnel.
Discontinued Operations
As of September 30, 1996, the Company's courier services unit has been treated
as a discontinued operation. The Company incurred an after-tax charge of $25
million, $1.06 per share, in 1996 to reflect the future realizable value of this
business.
Cash Flow
The Company generated cash flow from continuing operations of $47.4 million in
1997, compared to $57.7 million and $66.3 million in 1996 and 1995,
respectively. The decreased cash flow in 1997 was due primarily to increased
working capital requirements. Capital expenditures and investments in sales-type
leases totaled $47.9 million, $47.4 million and $52.7 million in 1997, 1996 and
1995, respectively. Core security services capital expenditures and investments
in sales-type leases totaled $47.7 million, $39.3 million and $49.0 million in
1997, 1996 and 1995, respectively. Increased 1997 spending, despite improved
spending controls, is due to higher electronic security installations. In March
1996, the Company began selling equipment payment rights due under customer
leases of certain electronic security installations. Net proceeds received by
the Company were approximately $2 million in 1997 and $10 million in 1996. For
cost and administrative reasons, the Company has suspended such sales and is
investigating alternative methods of financing its sales-type leases.
Liquidity
Total debt declined to $344.9 million at December 31, 1997 from $442.6 million
at December 31, 1996, a reduction of $97.7 million. This reduction resulted
primarily from the proceeds realized from the Loomis, Fargo combination.
17
On March 24, 1997, the Company completed a refinancing pursuant to which it
issued $125 million principal amount of 9 5/8% senior subordinated notes due in
2007 and replaced its existing term loan, revolving credit and letter of credit
facilities with a new credit facility consisting of up to a $155 million
revolving credit facility and up to a $155 million letter of credit facility
subject to an overall limit on the aggregate amount outstanding under both
facilities of $285 million. The new credit facility matures on March 31, 2002
with mandatory semiannual reductions in the total commitments totaling $10
million in 1999, $20 million in 2000 and $30 million in 2001. At year-end 1997,
$63.9 million was outstanding under the revolving credit facility and letters of
credit totaling $110.8 million were issued and outstanding.
The Company has an accounts receivable facility providing for the sale of a
$120 million undivided interest in a revolving pool of customer receivables.
Other current assets at December 31, 1997 and December 31, 1996 included
interest bearing cash deposits of $17.6 million and $9.8 million, respectively,
that were held in trust under the terms of the accounts receivable facility.
These deposits represent collections held back based on the amount of eligible
receivables in the revolving receivables pool. The Company presently intends to
replace this facility with a similar facility.
The Company believes that cash generated from future operations and capital
resources will enable it to maintain its current level of operations and its
planned operations, including capital expenditures and investment in sales-type
leases, for the foreseeable future. Additionally, the Company has initiated
programs to review its computer systems and applications for compatibility with
the year 2000. Expenditures specifically related to modifications for year 2000
compatibility are not expected to be material.
As discussed more fully in Note 8 of the Notes to Consolidated Financial
Statements, various complaints seeking substantial dollar amounts have been
filed against the Company. The Company believes that it has established adequate
provisions for litigation liabilities in its financial statements in accordance
with generally accepted accounting principles. The Company believes that none of
these matters individually or in the aggregate will have a material adverse
effect on its financial position or future operating results, although no
assurance can be given with respect to the ultimate outcome of any such
proceeding.
18
Consolidated Statement of Operations Borg-Warner Security Corporation
Year Ended December 31,
(millions of dollars, except per share) 1997 1996 1995
- --------------------------------------------------------------------------------------------------------------
Net service revenues $1,548.0 $1,711.2 $1,708.5
Cost of services 1,232.3 1,360.2 1,359.3
Selling, general and administrative expenses 194.6 210.6 212.5
Depreciation 39.1 47.0 52.1
Other expense, net 10.0 13.4 13.4
Interest expense and finance charges 42.0 56.6 55.9
- --------------------------------------------------------------------------------------------------------------
Earnings before income taxes 30.0 23.4 15.3
Provision for income taxes-Note 12 11.0 9.5 6.9
- --------------------------------------------------------------------------------------------------------------
Earnings from continuing operations 19.0 13.9 8.4
Loss from discontinued operations, net of income taxes-Note 4 -- (28.5) (2.5)
- --------------------------------------------------------------------------------------------------------------
Earnings (loss) before extraordinary item 19.0 (14.6) 5.9
Extraordinary item:
Loss from early extinguishment of debt, net of $3.2 tax benefit-Note 5 -- -- (4.7)
- --------------------------------------------------------------------------------------------------------------
Net earnings (loss) $19.0 $(14.6) $ 1.2
==============================================================================================================
Earnings (loss) per common share - basic:
Continuing operations $0.81 $ 0.60 $ 0.36
Discontinued operations -- (1.23) (0.11)
Extraordinary item -- -- (0.20)
- --------------------------------------------------------------------------------------------------------------
Net earnings (loss) per share $0.81 $(0.63) $ 0.05
==============================================================================================================
Earnings (loss) per common share - diluted:
Continuing operations $0.79 $ 0.59 $ 0.36
Discontinued operations -- (1.21) (0.11)
Extraordinary item -- -- (0.20)
- --------------------------------------------------------------------------------------------------------------
Net earnings (loss) per share $0.79 $(0.62) $ 0.05
==============================================================================================================
(See accompanying notes to consolidated financial statements)
19
Consolidated Balance Sheet
December 31,
(millions of dollars, except share data) 1997 1996
- ---------------------------------------------------------------------------------------------------------------------
Assets
Cash and cash equivalents $ 8.7 $ 17.8
Receivables, net 52.2 63.7
Inventories 11.0 12.1
Other current assets 72.3 73.5
- ---------------------------------------------------------------------------------------------------------------------
Total current assets 144.2 167.1
Property, plant and equipment
Land and buildings 30.4 46.9
Machinery and equipment 39.9 67.6
Subscribers' installations 278.5 312.8
Capital leases 2.8 14.3
Construction in progress 0.6 1.0
- ---------------------------------------------------------------------------------------------------------------------
352.2 442.6
Less accumulated depreciation 210.9 239.5
- ---------------------------------------------------------------------------------------------------------------------
Net property, plant and equipment 141.3 203.1
Net excess purchase price over net assets acquired 198.9 237.2
Deferred tax asset, net 39.1 46.8
Net assets of discontinued operations 15.4 12.6
Other assets 120.7 94.0
- ---------------------------------------------------------------------------------------------------------------------
Total other assets 374.1 390.6
- ---------------------------------------------------------------------------------------------------------------------
$659.6 $760.8
=====================================================================================================================
Liabilities and Shareholders' Equity
Notes payable $ 2.4 $ 4.4
Accounts payable and accrued expenses 145.5 173.7
- ---------------------------------------------------------------------------------------------------------------------
Total current liabilities 147.9 178.1
Long-term debt 342.5 438.2
Other long-term liabilities 104.2 103.3
Capital stock:
Common stock, issued 23,362,806 shares in 1997 and 22,446,100 shares in 1996 0.2 0.2
Series I non-voting common stock, issued 2,720,000 shares in 1997 and 1996 -- --
Capital in excess of par value 30.8 29.0
Retained earnings 41.7 20.6
Notes receivable-management stock purchase -- (0.3)
Cumulative translation adjustment -- 0.5
- ---------------------------------------------------------------------------------------------------------------------
72.7 50.0
Treasury common stock, at cost, 2,506,400 shares in 1997 and 1,862,311 shares in 1996 (7.7) (8.8)
- ---------------------------------------------------------------------------------------------------------------------
Total shareholders' equity 65.0 41.2
- ---------------------------------------------------------------------------------------------------------------------
$659.6 $760.8
=====================================================================================================================
(See accompanying notes to consolidated financial statements)
20
Consolidated Statement of Cash Flows Borg-Warner Security Corporation
Year ended December 31,
(millions of dollars) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------------------
Operating:
Continuing operations:
Earnings from continuing operations $ 19.0 $ 13.9 $ 8.4
Adjustments to reconcile net earnings to net cash
provided by continuing operations:
Non-cash charges to earnings:
Depreciation and amortization 50.2 60.4 65.5
Provision for losses on receivables 1.8 2.7 4.4
Deferred income taxes 7.7 6.0 (2.0)
Amortization of debt discount -- 0.6 2.1
Principal reduction in sales-type leases 13.0 9.9 4.6
Changes in assets and liabilities:
(Increase) decrease in receivables (20.9) 7.3 10.9
(Increase) decrease in other current assets 4.1 (17.7) (21.7)
(Decrease) increase in accounts payable and accrued expenses (9.8) (11.9) 13.8
Net change in other long-term assets and liabilities (15.5) (13.5) (19.7)
Gain on sale of assets of armored services unit (2.2) -- --
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by continuing operations 47.4 57.7 66.3
Discontinued operations:
Net loss -- (28.5) (2.5)
Other cash related to discontinued operations (2.8) 24.2 (4.3)
- -------------------------------------------------------------------------------------------------------------------
Net cash used in discontinued operations (2.8) (4.3) (6.8)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by operating activities 44.6 53.4 59.5
Investing:
Capital expenditures, excluding sales-type leases (8.9) (14.5) (10.9)
Investment in sales-type leases (39.0) (32.9) (41.8)
Net outsourcing of sales-type leases 1.7 9.6 --
Proceeds from sale of assets of armored services unit 92.9 -- --
Other, net 0.9 1.9 (1.1)
- -------------------------------------------------------------------------------------------------------------------
Net cash provided by (used in) investing activities 47.6 (35.9) (53.8)
Financing:
(Decrease) increase in notes payable (1.5) 0.8 (6.1)
(Decrease) increase in debt outstanding under revolving credit facility (22.9) (37.8) 19.4
(Decrease) increase in receivables sold (7.8) 21.3 (23.1)
Issuance of long-term debt 125.0 100.0 100.0
Retirement of long-term debt (196.8) (105.5) (90.8)
Sales of treasury common stock 1.1 0.3 1.0
Other, net 1.6 1.8 (2.0)
- -------------------------------------------------------------------------------------------------------------------
Net cash used in financing activities (101.3) (19.1) (1.6)
- -------------------------------------------------------------------------------------------------------------------
Net (decrease) increase in cash and cash equivalents (9.1) (1.6) 4.1
Cash and cash equivalents at beginning of year 17.8 19.4 15.3
- -------------------------------------------------------------------------------------------------------------------
Cash and cash equivalents at end of year $ 8.7 $ 17.8 $ 19.4
===================================================================================================================
Supplemental cash flow information:
Interest paid $ 40.8 $ 57.7 $ 54.2
Income taxes paid 9.4 2.8 0.7
(See accompanying notes to consolidated financial statements)
21
Year Ended December 31, 1997 1996 1995
(millions of dollars, except share data) Shares Amount Shares Amount Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Common Stock Issued
Beginning balance 25,166,100 $ 0.2 25,166,100 $ 0.2 25,155,700 $ 0.2
Shares issued under stock option and
related plans 16,706 -- -- -- -- --
Conversion of Series I non-voting shares
to common shares 900,000 -- -- -- 10,400 --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31 26,082,806 0.2 25,166,100 0.2 25,166,100 0.2
- ------------------------------------------------------------------------------------------------------------------------------------
Capital in Excess of Par Value
Beginning balance 29.0 28.1 30.9
Shares issued under stock option and
related plans 1.0 0.4 (5.4)
Tax benefit from trust distribution and exercise of
stock options 0.8 0.5 2.6
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31 30.8 29.0 28.1
- ------------------------------------------------------------------------------------------------------------------------------------
Retained Earnings
Beginning balance 20.6 31.2 29.7
Net earnings (loss) 19.0 (14.6) 1.2
Adjustment for deferred pension experience loss 2.1 4.0 0.3
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31 41.7 20.6 31.2
- ------------------------------------------------------------------------------------------------------------------------------------
Notes Receivable-Management Stock Purchase
Beginning balance (0.3) (0.3) (1.0)
Net activity 0.3 -- 0.7
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31 -- (0.3) (0.3)
- ------------------------------------------------------------------------------------------------------------------------------------
Cumulative Translation Adjustment
Beginning balance 0.5 (0.4) (0.5)
Current year adjustment (0.5) 0.9 0.1
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31 -- 0.5 (0.4)
- ------------------------------------------------------------------------------------------------------------------------------------
Treasury Stock
Beginning balance 1,862,311 (8.8) 1,928,861 (9.1) 2,237,344 (15.5)
Shares issued under stock option and
related plans (255,911) 1.1 (66,550) 0.3 (318,883) 6.4
Conversion of Series I non-voting shares
to common shares 900,000 -- -- -- 10,400 --
- ------------------------------------------------------------------------------------------------------------------------------------
Balance at December 31 2,506,400 (7.7) 1,862,311 (8.8) 1,928,861 (9.1)
====================================================================================================================================
Total Shareholders' Equity $65.0 $ 41.2 $49.7
====================================================================================================================================
(See accompanying notes to consolidated financial statements)
22
Notes to Consolidated Financial Statements Borg-Warner Security Corporation
Note 1 -- Summary of Significant Accounting Policies
The following paragraphs briefly describe significant accounting policies.
Certain 1996 and 1995 amounts have been reclassified to conform with the 1997
presentation.
Principles of Consolidation
The consolidated financial statements include all significant subsidiaries. As
of September 30, 1996, the Company's courier services unit has been treated as a
discontinued operation. The assets, liabilities, results of operations and
adjustments to carrying values of net assets and cash flows of the courier unit
have been segregated and reported as discontinued operations for all periods
presented, and previously reported results have been restated (see Note 4). On
January 24, 1997, the Company's armored services unit entered into a business
combination with Loomis Armored. The combined company, known as Loomis, Fargo &
Co., is owned 51 percent by the former Loomis shareholders and 49 percent by the
Company. The Company accounts for its investment in Loomis, Fargo under the
equity method. The business combination impacts the comparison of the Company's
1997 results to prior periods because the armored unit was included in the
Company's results of operations for only 23 days in 1997 (see Note 3).
Use of Estimates
The preparation of the consolidated financial statements in conformity with
generally accepted accounting principles requires management to make estimates
and assumptions that affect the reported amounts and related disclosures. Actual
results may differ from those estimates.
Cash and Cash Equivalents
Cash and cash equivalents consists primarily of cash and certificates of deposit
with original maturities of three months or less.
Inventories
Inventories are valued at the lower of cost or market. Cost of substantially all
inventories is determined by the first-in, first-out method.
Property, Plant and Equipment and Depreciation
Property, plant and equipment is carried at cost less accumulated depreciation.
Expenditures for maintenance, repairs and renewals of relatively minor items are
generally charged to expense as incurred. Renewals of significant items are
capitalized. Depreciation is computed generally on the straight-line method over
the following estimated useful lives:
Buildings and improvements 15 to 50 years
Machinery and equipment 3 to 12 years
Subscribers' installations 8 to 15 years
Property under capital leases 3 to 7 years
Amortization of Excess Purchase Price Over Net Assets Acquired
Excess of purchase price over net assets acquired is being amortized on a
straight-line basis over 5 to 40 years, with the majority being amortized over
40 years. The Company periodically reviews its operations to determine whether
there has been a diminution in value of its excess purchase price over net
assets acquired.
Derivative Financial Instruments
The Company uses interest rate swap agreements to manage exposure to interest
rate fluctuations. The Company does not use derivative instruments for
speculative purposes. The differential paid or received on interest rate swap
agreements is recognized as an adjustment to interest expense in the period
incurred or earned. The Company has no interest rate swap agreements outstanding
(see Note 6).
Casualty Insurance Liabilities
The Company has accrued a discounted liability for the retained portion of
insurance costs related to its various deductible policies. This insurance
liability is determined by the Company based on claims filed and an estimate of
claims incurred but not yet reported (see Note 2).
Revenue Recognition
Revenue is recognized at the time services are provided. In certain
circumstances this can result in revenue recognition prior to customer billing
and revenue deferral from advance billings.
Transactions with Borg-Warner Automotive
Under a tax-sharing agreement with the Company, for periods prior to January
1993, Borg-Warner Automotive is required to pay the Company for any operating
loss carryforward apportioned to it at such time as the benefits related to such
carry-forward are realized by Borg-Warner Automotive. Also, certain costs
incurred at corporate headquarters are charged to Borg-Warner Automotive based
on a service agreement with the Company.
Retirement Benefit Plans
A number of eligible salaried and hourly employees participate in contributory
or noncontributory defined benefit or defined contribution plans. Funding policy
is based upon independent actuarial valuations and is within the limits required
by ERISA for U.S. defined benefit plans.
The benefits provided to certain salaried employees covered under various
defined benefit plans are based on years of service and final average pay and
utilize the projected unit credit method for cost allocation. The benefits
provided to certain hourly employees under various defined benefit plans are
based on years of service and utilize the unit credit method for cost
allocation.
Under the defined contribution plans, contributions by the Company or its
subsidiaries sponsoring the plans are based on the employees' salary, age, years
of service, and/or a fixed schedule.
23
These contributions are charged to earnings as they are made to the various
plans (see Note 9).
Stock Options
The Company uses the intrinsic value method for expense recognition for stock
options and discloses additional information, including the impact under the
fair value method, in the notes to the financial statements (see Note 10).
Income Taxes
Income taxes are determined using the liability method, under which deferred tax
assets and liabilities are determined based on the differences between the
financial accounting and tax bases of assets and liabilities. Deferred tax
assets or liabilities at the end of each period are determined using the
currently enacted tax rate expected to apply to taxable income in the periods in
which the deferred tax asset or liability is expected to be settled or realized
(see Note 12).
Earnings Per Common Share (EPS)
In 1997, the Company adopted Statement of Financial Accounting Standards No.
128, "Earnings Per Share." This statement replaced the presentation and
calculation of primary EPS and fully diluted EPS with basic EPS and diluted EPS.
The statement requires disclosure of basic and diluted EPS on the face of the
financial statements. Basic EPS is based on average outstanding common shares.
Diluted EPS is based on average outstanding common shares and common share
equivalents. Common share equivalents recognize the dilutive effects of common
shares which may be issued in the future upon exercise of certain stock options.
Prior years EPS have been restated under the new method (see Note 14).
New Accounting Pronouncements
In January 1997, the Company adopted Statement of Financial Accounting Standards
No. 125, "Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities". The adoption of this standard did not have a
material effect on the financial statements.
Note 2 -- Balance Sheet Information
Detailed balance sheet data are as follows:
December 31,
(millions of dollars) 1997 1996
- -----------------------------------------------------------------------------
Receivables
Customers $ 55.8 $ 66.1
Other 1.3 3.9
- -----------------------------------------------------------------------------
57.1 70.0
Less allowance for losses 4.9 6.3
- -----------------------------------------------------------------------------
Net receivables $ 52.2 $ 63.7
=============================================================================
Other current assets
Retained interest in receivables $ 30.8 $ 36.7
Restricted interest-bearing
cash deposits 17.6 9.8
Other 23.9 27.0
- -----------------------------------------------------------------------------
Total other current assets $ 72.3 $ 73.5
=============================================================================
Other assets
Net investment in sales-type leases $ 78.2 $ 54.4
Debt issuance costs 8.0 10.4
Deferred pension asset 12.1 9.1
Deferred subscribers' installation costs 6.3 5.4
Other 16.1 14.7
- -----------------------------------------------------------------------------
Total other assets $120.7 $ 94.0
=============================================================================
Accounts payable and accrued expenses
Trade payables $ 36.5 $ 42.5
Payroll and related 38.6 41.6
Casualty insurance 27.6 44.4
Interest 6.7 5.2
Liabilities to former shareholders 7.7 8.7
Deferred income 10.1 10.3
Other 18.3 21.0
- -----------------------------------------------------------------------------
Total accounts payable and
accrued expenses $145.5 $173.7
=============================================================================
The Company has an agreement under which it sells a revolving pool of trade
accounts receivable to a special purpose subsidiary of the Company. At December
31, 1997 and 1996 the subsidiary had purchased $150.8 million and $156.7 million
of such accounts receivable. The subsidiary sells up to $120 million of
undivided interests in such accounts receivable. The difference represents the
interest retained by the Company which is considered as an interest in a
security and has been included in "Other current assets". The fair value of the
retained interest approximates its carrying value
24
Borg-Warner Security Corporation
due to the short-term nature of the receivables. Also included in "Other current
assets" is $17.6 million and $9.8 million at December 31, 1997 and 1996,
respectively, representing interest-bearing cash deposits held in trust under
the terms of the agreement. These deposits represent proceeds of collections
held back based on the amount of eligible receivables in the pool. The Company's
retained interest in the receivables and cash deposits are generally restricted.
Selling, general and administrative expenses include provisions for losses
on receivables of $1.8 million, $2.7 million and $4.4 million in 1997, 1996 and
1995, respectively.
Accumulated depreciation related to capital leases amounted to $0.2 million
and $8.8 million at December 31, 1997 and 1996, respectively. Accumulated
amortization related to excess purchase price over net assets acquired amounted
to $74.9 million and $74.2 million at December 31, 1997 and 1996, respectively.
Trade payables include checks outstanding in excess of bank deposits in the
Company's central disbursement accounts, since arrangements with the banks do
not call for reimbursement until checks are presented for payment. Such amounts
were $25.6 million and $32.7 million at December 31, 1997 and 1996,
respectively.
The non-current portion of the casualty insurance liability, included in
other long-term liabilities, was $58.6 million and $44.2 million at December 31,
1997 and 1996, respectively. The total discounted insurance accrual, including
the portion reflected in accounts payable and accrued liabilities, was $86.2
million and $88.6 million at December 31, 1997 and 1996, respectively. The
estimated aggregate undiscounted insurance liability was $101.1 million and
$101.9 million at December 31, 1997 and 1996, respectively. The discount rate
used to value the future obligation at December 31, 1997 and 1996 was 6.0
percent and 5.5 percent, respectively.
Note 3 -- Investment in Affiliates
On January 24, 1997, the Company's armored security services unit entered into a
business combination with Loomis Armored. The combined company, known as Loomis,
Fargo & Co., is owned 51 percent by the former Loomis shareholders and 49
percent by the Company. The Company's armored services unit contributed
substantially all of its assets and assigned certain of its liabilities to
Loomis, Fargo in exchange for (i) 4,900,000 shares of Loomis, Fargo common stock
and (ii) a cash payment of approximately $105 million which includes amounts
paid to satisfy intercompany indebtedness assumed by Loomis, Fargo. The cash
proceeds received were net of transaction costs and subject to certain
adjustments. At December 31, 1997, $3.5 million has been expended to settle
working capital adjustments and $8.7 million for payments of retained casualty
insurance liabilities.
The business combination impacts the comparison of the Company's 1997
results to prior periods because the armored services unit was included in the
Company's results of operations for only 23 days in 1997. Armored security
revenues were $15.3 million, $246.3 million and $231.0 million in 1997, 1996 and
1995, respectively. Armored security operating profit was $0.9 million in 1997,
compared with $12.1 million in 1996 and $13.7 million in 1995. Total assets at
December 31, 1996 were $87.4 million.
The Company accounts for its interest in Loomis, Fargo as a 49% owned
equity investment. The excess of proceeds received over carrying value of net
assets contributed in the Loomis, Fargo combination was substantially deferred
and offset by purchase price adjustments and provisions for other contingent
liabilities related to the contributed assets and liabilities of the armored
services unit. In 1997, the net gain recognized by the Company on the
combination was $2.2 million. The net loss recognized under the equity method
for the year was $1.1 million. The Company does not guarantee the indebtedness
of Loomis, Fargo nor is it required to fund Loomis, Fargo's future operations.
Note 4 -- Discontinued Operations
As of September 30, 1996, the Company's courier services unit has been treated
as a discontinued operation. The assets, liabilities, results of operations and
adjustments to carrying values of net assets and cash flows of the courier unit
have been segregated and reported as discontinued operations for all periods
presented, and previously reported results have been restated. The Company
incurred an after-tax charge of $25 million, $1.06 per share, in 1996 to reflect
the future realizable value of this business.
At December 31, 1997, the net assets of the discontinued operation consist
mainly of customer receivables, property, plant and equipment and accounts
payable. Net service revenues were $142.2 million, $140.0 million and $154.0
million in 1997, 1996 and 1995, respectively. Net loss was $7.2 million (net of
$3.9 million tax benefit), $5.4 million (net of $2.8 million tax benefit) and
$2.5 million (net of $1.0 million tax benefit) in 1997, 1996 and 1995,
respectively. Management believes that the estimated loss for the disposal of
the unit recorded in 1996 continues to be adequate to cover the ultimate
disposition of the operation. The Company has an active program in place to find
a buyer for the unit and expects that the unit will be sold in the near future.
25
Note 5 - Notes Payable and Long-Term Debt
The following is a summary of notes payable and long-term debt which reflects
all borrowings of the Company and its consolidated subsidiaries:
December 31, 1997 December 31, 1996
(millions of dollars) Current Long-Term Current Long-Term
- -------------------------------------------------------------------------------------------------------------------
9 1/8% senior subordinated notes (face amount $150 million due 2003) $ -- $149.2 $ -- $149.2
9 5/8% senior subordinated notes (face amount $125 million due 2007) -- 124.2 -- --
Bank revolving credit loan due through 1999
(at an average rate of 7.9% in 1997 and 8.5% in 1996) -- 63.9 -- 86.8
Bank term loan due 1998 (at an average of 8.9% in 1996) -- -- -- 196.8
Capital lease liability (at an average rate of 9.2% in 1997
and 10.2% in 1996) 1.3 5.0 2.4 5.3
Unsecured notes (at an average rate of 7.6% in 1997
and 7.3% in 1996) 1.1 0.2 2.0 0.1
- -------------------------------------------------------------------------------------------------------------------
Total notes payable and long-term debt $2.4 $342.5 $4.4 $438.2
- -------------------------------------------------------------------------------------------------------------------
Maturities of long-term debt, including unamortized discount of $1.6 million,
are as follows: 1999, $11.5 million; 2000, $21.3 million; 2001, $31.2 million;
2002, $4.6 million; and after 2002, $275.5 million.
Included in long-term debt at December 31, 1997 and 1996 were obligations
of $278.6 million and $154.5 million, respectively, with fixed interest rates
and $63.9 million and $283.7 million, respectively, with variable interest rates
(generally based on LIBOR or prime rate).
In 1997, the Company completed a refinancing which included a new $285
million bank facility and the issuance of $125 million principal amount of
9 5/8% senior subordinated notes due in 2007. The bank facility includes a
revolving credit commitment of $155 million and the capacity to issue up to $155
million letters of credit. The bank facility is available through March 31,
2002. The committed amount under the bank facility reduces semi-annually
beginning September 30, 1999. Available future commitments at December 31 are as
follows: 1998, $285 million; 1999, $275 million; 2000, $255 million; and 2001,
$225 million. At December 31, 1997, unused revolving credit commitments were
$91.1 million, and letters of credit totalling $110.8 million were issued and
outstanding.
The credit facilities contain numerous financial and operating covenants
including, among others, covenants requiring the Company to maintain certain
financial ratios and restricting its ability to incur additional indebtedness,
to create or permit to exist certain liens, or to pay dividends. To secure its
obligations under these facilities, the Company pledged the stock of certain of
its subsidiaries.
In 1995, an extraordinary loss of $4.7 million, net of tax, was realized
related to the extinguishment of debt in connection with the amendment of the
Company's credit facilities.
Note 6 - Fair Value of Financial Instruments
The methods and assumptions used to estimate the fair value of each class of
financial instrument are as follows:
Cash and cash equivalents, receivables, notes payable
and accounts payable
The carrying amounts approximate fair value because of the short maturity of
these instruments.
Long-term debt
The carrying amounts of the Company's bank borrowings under its short-term bank
lines and revolving credit agreement approximate fair value because the interest
rates are based on floating rates identified by reference to market rates. The
fair values of the Company's other long-term debt either approximate carrying
value or are estimated based on quoted market prices for the same or similar
issues or on the current rates offered to the Company for debt of the same
remaining maturities.
The carrying amounts and fair values of long-term debt at December 31, 1997
and 1996 were as follows:
December 31,
(millions of dollars) 1997 1996
- -------------------------------------------------------------------------------
Carrying amount $342.5 $438.2
Fair value 347.1 437.7
Interest rate swaps
The Company uses interest rate swap agreements to manage exposure to interest
rate fluctuations. The Company does not use derivative instruments for
speculative purposes. The differential paid or received on interest rate swap
agreements is recognized as an adjustment to interest expense in the period
incurred or earned. The Company has no interest rate swap agreements
outstanding.
26
Borg-Warner Security Corporation
Letters of credit
The Company utilizes third-party letters of credit to guarantee certain casualty
insurance activities. The letters of credit reflect fair value as a condition of
their underlying purpose and are subject to fees competitively determined in the
marketplace. The contract value/fair value of the letters of credit at December
31, 1997 and 1996 were $110.8 million and $136.3 million, respectively. To
monitor the counter parties' ability to perform, these letters of credit are
only executed with major financial institutions.
Note 7 - Commitments
The Company is committed to pay rents on non-cancelable operating leases with
terms exceeding one year. Rental amounts committed in future years are
summarized at December 31, 1997 as follows:
Fiscal year (millions of dollars)
- ----------------------------------------------------------------
1998 $12.6
1999 9.2
2000 5.8
2001 2.8
2002 1.9
2003 and after 6.4
- ----------------------------------------------------------------
Total $38.7
================================================================
Total rental expense amounted to $17.9 million, $26.7 million and $26.1 million
in 1997, 1996 and 1995, respectively.
Note 8 - Contingent Liabilities
The Company's discontinued property and casualty insurance subsidiary
("Centaur") ceased writing insurance in 1984 and has been operating under
rehabilitation since September 1987. Rehabilitation is a process supervised by
the Illinois Director of Insurance to attempt to compromise claim liabilities at
an aggregate level that is not in excess of Centaur's assets. In rehabilitation,
Centaur's assets are being used to satisfy claim liabilities under direct
insurance policies written by Centaur. Any remaining assets will be applied to
Centaur's obligations to other insurance companies under reinsurance contracts.
If all of Centaur's obligations are not satisfied through rehabilitation, it is
possible that satisfaction could be sought from the Company for Centaur's
liabilities.
The foregoing has resulted in one pending lawsuit against the Company,
certain of its current and former subsidiaries, and directors and officers of
certain current and former subsidiaries for recovery of alleged damages incurred
because of Centaur's failure to satisfy its reinsurance obligations. The lawsuit
seeks in excess of $100 million for current losses, future losses and other
damages and also seeks punitive damages. While the Company has recognized
provisions in its financial statements for potential claims related to the
Centaur litigation, it believes that any damages for failure to satisfy
reinsurance obligations are solely the responsibility of Centaur and that the
resolution of the lawsuit relating to Centaur, including the Company's
indemnification obligations to certain former officers and directors, will not
have a material adverse effect on its financial position or future operating
results; however, no assurance can be given as to the ultimate outcome with
respect to such lawsuit.
The Company and certain of its current and former subsidiaries have been
identified by the U.S. Environmental Protection Agency and certain state
environmental agencies as potentially responsible parties ("PRPs") at several
hazardous waste disposal sites under the Comprehensive Environmental Response,
Compensation and Liability Act ("Superfund") and equivalent state laws and, as
such, may be liable for the cost of cleanup and other remedial activities at
these sites. Responsibility for cleanup and other remedial activities at a
Superfund site is typically shared among PRPs based on an allocation formula.
The Company believes that none of these matters individually or in the aggregate
will have a material adverse effect on its financial position or future
operating results, generally either because the maximum potential liability at a
site is not large or because liability will be shared with other PRPs, although
no assurance can be given with respect to the ultimate outcome of any such
liability. Based on its estimate of allocations of liability among PRPs, the
probability that other PRPs, many of whom are large, solvent public companies,
will fully pay the costs allocated to them, currently available information
concerning the scope of contamination at such sites, estimated remediation costs
at such sites, indemnification obligations in favor of the Company from the
current owners of certain sold or discontinued operations, estimated legal fees
and other factors, the Company has made provisions for indicated environmental
liabilities in the aggregate amount of approximately $7 million (relating to
environmental matters with respect to discontinued operations of the Company).
The Company has requested that its discontinued automotive subsidiary,
Borg-Warner Automotive, indemnify it against certain past and future costs
relating to environmental and financing liabilities associated with certain
former automotive operations. At December 31, 1997 such past costs were
approximately $3.5 million. Borg-Warner Automotive has contested its
indemnification obligation with respect to such liabilities. The parties
submitted the dispute to binding arbitration. In November 1997, the arbitrator
found in favor of the Company. In February 1998, an appellate panel upheld the
arbitration award. Separately, in January 1998, Borg-Warner Automotive filed
suit against the Company raising the same issues asserted in the arbitration and
other issues related to the 1993 spin-off of Borg-Warner Automotive. The lawsuit
seeks specific performance, equitable relief and unspecified compensatory and
punitive damages.
The Company believes that the various asserted claims and litigation in
which it is involved will not materially affect its financial position, future
operating results or cash flows, although no assurance can be given with respect
to the ultimate outcome of any such claim or litigation.
27
Note 9 - Retirement Benefits
The Company has various defined benefit and contribution plans which cover
eligible employees.
Retirement benefit expense (income) amounted to ($0.8) million, $4.5
million and $4.7 million in 1997, 1996 and 1995, respectively. This expense
includes post-retirement life insurance and medical benefits of $0.3 million for
1997, 1996 and 1995, respectively, as well as defined contribution plan expenses
of $1.5 million, $1.5 million and $1.7 million in 1997, 1996 and 1995,
respectively. Also, under the provisions of SFAS No. 88, "Accounting for
Settlements and Curtailments of Defined Benefit Pension Plans and for
Termination Benefits," benefit freezes resulted in the recognition of $3.7
million of net curtailment gains in 1997. This gain resulted from the net
decrease in the Company's benefit obligation for employees affected by the
armored services unit combination with Loomis Armored Inc., the treatment of the
courier services unit as a discontinued operation and other benefit freezes.
The following table sets forth the funded status of the defined benefit
plans:
Funded Status December 31, 1997 December 31, 1996
(millions of dollars) Over Over Under
- ------------------------------------------------------------------------------------------------------
Actuarial present value of benefit obligations:
Vested benefits $102.0 $60.6 $ 25.7
Non-vested benefits 2.6 2.6 0.1
- ------------------------------------------------------------------------------------------------------
Accumulated benefit obligations 104.6 63.2 25.8
Effect of projected future compensation levels 2.0 5.0 --
- ------------------------------------------------------------------------------------------------------
Projected benefit obligation 106.6 68.2 25.8
Plan assets at fair value 124.4 81.4 20.5
- ------------------------------------------------------------------------------------------------------
Assets in excess of (less than) projected benefit obligation 17.8 13.2 (5.3)
Unrecognized net loss (gain) (6.5) (4.9) 3.1
Unrecognized prior service cost 0.8 0.8 --
- ------------------------------------------------------------------------------------------------------
Net asset (liability) before minimum liability 12.1 9.1 (2.2)
Adjustment required to recognize minimum liability -- -- (3.1)
- ------------------------------------------------------------------------------------------------------
Net asset (liability) on balance sheet $ 12.1 $ 9.1 ($5.3)
======================================================================================================
Assets held in trust for the defined benefit plans are comprised primarily of
marketable equity and fixed income securities.
Provisions of FASB Statement No. 87 require the Company, under certain
circumstances, to record a minimum pension liability relating to unfunded
accumulated benefit obligations and reduce shareholders' equity, net of future
tax benefits. During 1997, minimum pension liability recorded in prior years was
eliminated as a result of the merger of several plans and performance of
invested assets.
Net periodic pension expense for the defined benefit plans was comprised as
follows:
Year ended December 31,
(millions of dollars) 1997 1996 1995
- --------------------------------------------------------------
Service cost $ 2.4 $ 3.3 $ 2.4
Interest cost 7.6 7.0 6.9
Actual return on assets (25.7) (12.5) (20.4)
Net amortization and deferrals 16.8 4.9 13.8
- --------------------------------------------------------------
Net periodic pension cost $ 1.1 $ 2.7 $ 2.7
==============================================================
The Company's assumptions used as of December 31, 1997, 1996 and 1995 in
determining the pension cost and pension liability shown above were as follows:
(percent) 1997 1996 1995
- --------------------------------------------------------------
Discount rate 7.5 8.0 7.5
Rate of salary progression 4.0 4.0 4.0
Long-term rate of return on assets 10.0 10.0 9.5
The Company also has post-employment benefits covering certain existing and
former employees, including employees of businesses which have been divested by
the Company. The liabilities on the Company's balance sheet for these benefits
as of December 31, 1997 and 1996 were $10.7 million and $11.5 million,
respectively, and are included in "Other long-term liabilities". The discount
rate used in determining this liability was 7.5% in 1997 and 8.0% in 1996.
Medical expense increases are projected to be 6.25% in 1998 grading to 5.25% in
1999.
28
Borg-Warner Security Corporation
Note 10 - Stock Options
The Company has stock incentive plans that authorize the grant of options to
purchase shares of the Company's common stock. All options granted to date carry
exercise prices ranging from $5.00 to $20.75 per share. These prices correspond
to the fair market value (as defined in the plans) of the Company's common stock
at the time of grant with a graded vesting schedule between two to three years.
In 1997, 1996 and 1995 there were no options canceled or converted.
Common shares under option for the years ended December 31, 1997, 1996 and
1995 are summarized as follows:
Number of Shares (thousands of shares) Weighted-Average Exercise Price
1997 1996 1995 1997 1996 1995
- ---------------------------------------------------------------------------------------------------------------------------
Shares under option at January 1 1,545 1,810 1,843 $12.20 $13.34 $14.49
Granted 843 159 390 11.30 10.98 8.50
Exercised (273) (66) (141) 6.12 5.00 5.00
Forfeited (143) (358) (282) 16.03 18.76 18.36
- ---------------------------------------------------------------------------------------------------------------------------
Shares under option at end of year 1,972 1,545 1,810 $12.38 $12.20 $13.34
===========================================================================================================================
Options exercisable 917 985 800
===================================================================================
Shares available for future grant 664 1,177 78
===================================================================================
Weighted-average fair value of options
granted during the year $ 4.39 $ 4.00 $ 3.57
===================================================================================
Additional information regarding options outstanding as of December 31, 1997 is
as follows (thousands of shares):
Options Outstanding Options Exercisable
-------------------------------------------------------------- ---------------------------------
Weighted-Average
Range of Number Remaining Weighted-Average Number Weighted-Average
Exercise Prices Outstanding Contractual Life (yrs) Exercise Price Exercisable Exercise Price
- ------------------------------------------------------------------------------------------------------------------------
$ 5.00- 8.75 426 6.8 $ 8.20 281 $ 8.05
10.56-15.94 1,251 8.1 12.38 368 15.33
16.03-18.83 233 3.8 17.98 217 17.99
19.06-20.75 62 5.8 20.04 51 20.11
- ------------------------------------------------------------------------------------------------------------------------
$ 5.00-20.75 1,972 7.2 $12.38 917 $14.00
========================================================================================================================
The 1,055 thousand options outstanding at December 31, 1997 that are not
presently exercisable will vest according to various schedules between two to
three years.
The Company has retained the "intrinsic value" method of accounting for
stock-based compensation expense under APB 25. Had compensation cost been
determined based on the "fair value" method under SFAS 123, the Company's pro
forma net income and earnings per share would have been as follows:
Year Ended December 31,
(millions of dollars, except per share) 1997 1996
- ------------------------------------------------------------------------
Net income (loss) As reported $19.0 $(14.6)
Pro forma 18.2 (14.9)
Earnings (loss) per share-basic As reported $0.81 $(0.63)
Pro forma 0.78 (0.64)
Earnings (loss) per share-diluted As reported $0.79 $(0.62)
Pro forma 0.76 (0.63)
The fair value of each option granted is estimated on the date of grant using
the Black-Scholes option-pricing model with the following weighted-average
assumptions used for grants in 1997 and 1996, respectively: expected volatility
of 41% and 41%; risk-free interest rates of 5.28-5.30% and 6.15-6.22%; and
expected lives of four and three to four years.
29
Note 11 - Business Segment Information
The Company's continuing operations have been classified into three business
segments: physical, electronic and armored security services. The physical
security segment provides contract security officers to patrol client
facilities, monitor electronic systems and control public and employee access.
The electronic security segment primarily designs, installs, monitors and
services sophisticated electronic security systems and fire and intrusion
detection systems. The armored security segment transported currency, securities
and other valuables. Additionally, this segment provided full-service automated
teller machine operations and cash management services such as deposit
verification and currency processing.
As discussed in Note 3, the Company combined its armored security business
with Loomis Armored Inc. to form a new company, Loomis, Fargo & Co. The Company
accounts for its investment in Loomis, Fargo under the equity method. The
business combination impacts the comparison of the Company's 1997 results to
prior periods because the armored security segment was included in the Company's
results of operations for only 23 days in 1997.
Intersegment sales are not significant. Operating profit by business
segment represents total revenues less operating expenses, depreciation and
amortization, and excludes interest income, interest expense, income taxes and
net unallocated corporate expenses. Certain interim reported information has
been reclassified to conform with the full year presentation.
Identifiable assets are those assets employed in each segment's operations,
including an allocated value to each segment of cost in excess of net assets
acquired. Corporate assets consist principally of cash and cash equivalents,
certain corporate receivables and other assets.
30
Borg-Warner Security Corporation
Summarized financial information by business segment for 1997, 1996 and 1995 is
as follows:
Year Ended December 31,
(millions of dollars) 1997 1996 1995
- ------------------------------------------------------------------------------------------------------
Net service revenues:
Physical security services $1,289.3 $1,223.8 $1,222.8
Electronic security services 243.4 241.1 254.7
Armored security services 15.3 246.3 231.0
- ------------------------------------------------------------------------------------------------------
Total net service revenues $1,548.0 $1,711.2 $1,708.5
======================================================================================================
Operating profit:
Physical security services $ 64.9 $ 62.1 $ 56.4
Electronic security services 14.5 18.9 15.8
Armored security services 0.9 12.1 13.7
- ------------------------------------------------------------------------------------------------------
Total operating profit 80.3 93.1 85.9
Other expense, net 8.3 13.1 14.7
Interest expense 42.0 56.6 55.9
- ------------------------------------------------------------------------------------------------------
Earnings before taxes 30.0 23.4 15.3
Provision for income taxes 11.0 9.5 6.9
- ------------------------------------------------------------------------------------------------------
Earnings from continuing operations $ 19.0 $ 13.9 $ 8.4
======================================================================================================
Depreciation:
Physical security services $ 4.3 $ 5.7 $ 7.3
Electronic security services/(a)/ 34.2 34.2 37.4
Armored security services 0.4 7.0 7.1
Corporate 0.2 0.1 0.3
- ------------------------------------------------------------------------------------------------------
Total depreciation $ 39.1 $ 47.0 $ 52.1
======================================================================================================
Amortization of excess purchase price over net assets acquired:
Physical security services $ 7.8 $ 8.9 $ 8.9
Electronic security services 3.0 2.9 2.8
Armored security services 0.1 1.4 1.5
Corporate 0.2 0.2 0.2
- ------------------------------------------------------------------------------------------------------
Total amortization $ 11.1 $ 13.4 $ 13.4
======================================================================================================
Capital expenditures and investment in sales-type leases:
Physical security services $ 4.1 $ 3.1 $ 3.6
Electronic security services 43.6 36.2 45.4
Armored security services 0.2 8.1 3.7
- ------------------------------------------------------------------------------------------------------
Total capital expenditures and investment in sales-type leases $ 47.9 $ 47.4 $ 52.7
======================================================================================================
Identifiable assets:
Physical security services $ 206.4 $ 231.1
Electronic security services 346.7 348.2
Armored security services -- 87.4
Discontinued operations 15.4 12.6
Corporate 91.1 81.5
- ------------------------------------------------------------------------------------------
Total identifiable assets $ 659.6 $ 760.8
==========================================================================================
/(a)/ Excludes principal repayments of sales-type leases totalling $13.0
million, $9.9 million and $4.6 million in 1997, 1996 and 1995, respectively.
31
Note 12 -- Income Taxes
Earnings before income taxes from continuing operations and provision for income
taxes consist of:
Non- 1997 Non- 1996 Non- 1995
(millions of dollars) U.S. U.S. Total U.S. U.S. Total U.S. U.S. Total
- ---------------------------------------------------------------------------------------------------------------------
Earnings before income taxes $26.7 $3.3 $30.0 $19.1 $4.3 $23.4 $11.9 $3.4 $15.3
=====================================================================================================================
Income taxes:
Current:
Federal/Foreign $ 0.5 $1.3 $ 1.8 $ 0.7 $1.3 $ 2.0 $ 6.4 $1.5 $ 7.9
State 1.5 -- 1.5 1.5 -- 1.5 1.0 -- 1.0
- ---------------------------------------------------------------------------------------------------------------------
2.0 1.3 3.3 2.2 1.3 3.5 7.4 1.5 8.9
Deferred 7.7 -- 7.7 6.0 -- 6.0 (2.0) -- (2.0)
- ---------------------------------------------------------------------------------------------------------------------
Provision for income taxes $ 9.7 $1.3 $11.0 $ 8.2 $1.3 $ 9.5 $ 5.4 $1.5 $ 6.9
=====================================================================================================================
The analysis of the variance of income taxes as reported from income taxes
computed at the U.S. statutory federal income tax rate for continuing operations
is as follows:
(millions of dollars) 1997 1996 1995
- ----------------------------------------------------------------------------------------
Income taxes at U.S. statutory rate of 35% $10.5 $ 8.2 $ 5.3
Increases (decreases) resulting from:
State income taxes 1.0 0.8 0.8
Non-temporary differences 0.1 0.7 0.7
Other, net (0.6) (0.2) 0.1
- ----------------------------------------------------------------------------------------
Income taxes reported $11.0 $ 9.5 $ 6.9
========================================================================================
Following are the components of the net deferred tax asset as of December 31,
1997 and 1996:
(millions of dollars) 1997 1996
- ----------------------------------------------------------------------------------------
Deferred tax assets:
Liabilities for casualty insurance $ 35.9 $ 35.6
Liabilities related to discontinued operations 7.9 9.6
Liabilities for pension benefits -- 0.4
Liabilities for other post-retirement benefits 4.2 4.6
Other, net 1.1 2.8
Net operating loss carry-forward -- 10.9
General business credit 24.8 26.3
Minimum tax credit 26.6 26.6
Foreign tax credit 0.4 1.3
- ----------------------------------------------------------------------------------------
Total deferred tax assets 100.9 118.1
Valuation allowance (5.3) (6.8)
- ----------------------------------------------------------------------------------------
95.6 111.3
Deferred tax liabilities:
Fixed assets (37.7) (43.9)
Investments (13.1) (13.1)
Net excess purchase price over net assets acquired (5.7) (7.5)
- ----------------------------------------------------------------------------------------
Total deferred tax liabilities (56.5) (64.5)
- ----------------------------------------------------------------------------------------
Net deferred tax asset $ 39.1 $ 46.8
========================================================================================
32
The foreign tax credit carry-forward has been fully considered in the valuation
allowance at both December 31, 1997 and 1996 while an additional allowance of
$4.8 million and $5.5 million at December 31, 1997 and 1996, respectively, has
been established against the other credits. The general business credit carry-
forward will expire in years 2004-2009 while the minimum tax credit can be
carried forward indefinitely.
Note 13 - Capital Stock
The following table summarizes the Company's capital stock at December 31, 1997
and 1996:
December 31,
(thousands of shares) 1997 1996
- ------------------------------------------------------------------------------------------------------------------------------------
Common stock, $.01 par value:
Authorized 50,000.0 50,000.0
Issued 23,362.8 22,446.1
Outstanding 23,326.8 22,154.2
Series I non-voting common stock, $.01 par value:
Authorized 25,000.0 25,000.0
Issued 2,720.0 2,720.0
Outstanding 249.6 1,149.6
Preferred stock, $.01 par value:
Authorized 5,000.0 5,000.0
Issued and Outstanding --- ---
Note 14 - Earnings Per Share
1997 1996 1995
Per Share Per Share Per Share
(millions of dollars, except per share) Earnings Shares Amount Earnings Shares Amount Earnings Shares Amount
- ------------------------------------------------------------------------------------------------------------------------------------
Earnings from
continuing operations $ 19.0 $13.9 $8.4
Basic EPS
Earnings available to
common shareholders 19.0 23.5 $0.81 13.9 23.3 $0.60 8.4 23.1 $ 0.36
====================================================================================================================================
Effect of Dilutive Securities
Outstanding stock options - 0.6 - 0.2 - 0.3
Diluted EPS
Earnings available to
common shareholders +
assumed conversions $ 19.0 24.1 $0.79 $13.9 23.5 $0.59 $8.4 23.4 $ 0.36
====================================================================================================================================
33
Note 15 - Interim Financial Information (Unaudited)
1997 Quarter Ended 1996 Quarter Ended
(millions of dollars, except per share)
Mar. 31 June 30 Sept. 30 Dec. 31 Year 1997 Mar. 31 June 30 Sept. 30 Dec. 31 Year 1996
- ----------------------------------------------------------------------------------------------------------------------------------
Net service revenues $382.4 $378.6 $390.8 $396.2 $1,548.0 $414.1 $418.3 $434.9 $443.9 $1,711.2
Cost of services 304.4 300.4 313.8 313.7 1,232.3 329.6 332.2 348.2 350.2 1,360.2
Selling, general and
administrative expenses 51.8 48.7 45.8 48.3 194.6 52.7 52.2 51.8 53.9 210.6
Depreciation 9.8 9.8 9.9 9.6 39.1 12.1 11.8 11.7 11.4 47.0
Other expense, net 0.6 2.5 3.3 3.6 10.0 3.3 3.4 3.4 3.3 13.4
Interest expense and finance
charges 10.6 10.2 10.6 10.6 42.0 14.5 14.1 14.1 13.9 56.6
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings before income taxes 5.2 7.0 7.4 10.4 30.0 1.9 4.6 5.7 11.2 23.4
Provision for income taxes 1.2 2.9 2.7 4.2 11.0 0.3 1.7 2.5 5.0 9.5
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings from continuing
operations 4.0 4.1 4.7 6.2 19.0 1.6 2.9 3.2 6.2 13.9
Loss from discontinued operations,
net of income taxes - - - - - (1.1) (1.0) (26.4) - (28.5)
- ----------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) $ 4.0 $ 4.1 $ 4.7 $ 6.2 $ 19.0 $ 0.5 $ 1.9 $(23.2) $ 6.2 $ (14.6)
==================================================================================================================================
Earnings (loss) per common share - basic:
Continuing operations $ 0.17 $ 0.18 $ 0.20 $ 0.26 $ 0.81 $ 0.07 $ 0.12 $ 0.14 $ 0.27 $ 0.60
Discontinued operations - - - - - (0.05) (0.04) (1.14) - (1.23)
- ----------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) per
share $ 0.17 $ 0.18 $ 0.20 $ 0.26 $ 0.81 $ 0.02 $ 0.08 $(1.00) $ 0.27 $ (0.63)
- ----------------------------------------------------------------------------------------------------------------------------------
Earnings (loss) per common share - diluted:
Continuing operations $ 0.17 $ 0.17 $ 0.19 $ 0.26 $ 0.79 $ 0.07 $ 0.12 $ 0.14 $ 0.26 $ 0.59
Discontinued operations - - - - - (0.05) (0.04) (1.13) - (1.21)
- ----------------------------------------------------------------------------------------------------------------------------------
Net earnings (loss) per share
$ 0.17 $ 0.17 $ 0.19 $ 0.26 $ 0.79 $ 0.02 $ 0.08 $(0.99) $ 0.26 $ (0.62)
==================================================================================================================================
34
To the Board of Directors and Shareholders,
Borg-Warner Security Corporation
We have audited the consolidated balance sheets of Borg-Warner Security
Corporation and subsidiaries as of December 31, 1997 and 1996, and the related
consolidated statements of operations, shareholders' equity, and cash flows for
each of the three years in the period ended December 31, 1997. 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 audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Borg-Warner Security
Corporation and subsidiaries at December 31, 1997 and 1996, and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ Deloitte & Touche LLP
----------------------
Deloitte & Touche LLP
Chicago, Illinois
February 3, 1998
35