<PAGE> 1
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UNITED STATES SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
----------
FORM 8-K
Current Report
PURSUANT TO SECTION 13 OR 15(d) OF
THE SECURITIES EXCHANGE ACT OF 1934
DATE OF THE REPORT (DATE OF EARLIEST EVENT REPORTED): OCTOBER 22, 1998
THE KROLL-O'GARA COMPANY
(Exact name of registrant as specified in its charter)
Ohio 000-21629 31-1470817
(State or other jurisdiction of (Commission (I.R.S. Employer
Incorporation) file number) Identification No.)
9113 LeSaint Drive
Fairfield, Ohio 45014
(513) 874-2112
(Address, including zip code, and telephone number, including area
code, of registrant's principal executive offices)
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<PAGE> 2
INFORMATION TO BE INCLUDED IN THE REPORT
Items 1, 2, 3, 4, 6, 7, 8 and 9 are not applicable and are omitted from this
Current Report.
ITEM 5. OTHER INFORMATION.
On October 22, 1998, The Kroll-O'Gara Company (the "Company" or
"Kroll-O'Gara") announced that it had executed a definitive purchase agreement
to acquire all the shares of Laboratory Specialists of America, Inc.
("Laboratory Specialists"). The transaction will be effected by means of the
merger of a wholly owned subsidiary of Kroll-O'Gara with and into Laboratory
Specialists (the "Merger"), and is expected to qualify for "pooling of
interests" accounting treatment. The Merger is subject to the approval of the
shareholders of Laboratory Specialists. Closing is expected in December 1998.
Laboratory Specialists owns and operates a laboratory in New Orleans
and provides drug-testing services to corporate and institutional clients
seeking to deter the use of illegal drugs. The laboratory is certified by the
federal Substance Abuse and Mental Health Services Administration. In addition
to drug testing, Laboratory Specialists offers a range of services, which are
customized to assist clients in implementing cost-effective drug testing
programs.
This Current Report on Form 8-K is being filed to furnish the financial
statements listed and presented below. The Unaudited Pro Forma Condensed
Consolidated Financial Statements should be read in conjunction with the
historical consolidated Financial Statements and related notes of the Company
contained in its annual report on Form 10-K for the year ended December 31,
1997.
<TABLE>
<CAPTION>
(a) THE KROLL-O'GARA COMPANY PRO FORMA FINANCIAL STATEMENTS (UNAUDITED)
(1) Kroll-O'Gara and Laboratory Specialists Unaudited Pro Forma
Combining Financial Statements
------------------------------------------------------------------------
<S> <C>
Unaudited Pro Forma Combining Condensed Balance Sheets
as of September 30, 1998..................................................3
Unaudited Pro Forma Combining Statements of Operations for
the Year Ended December 31, 1995..........................................4
Unaudited Pro Forma Combining Statements of Operations for
the Year Ended December 31, 1996..........................................5
Unaudited Pro Forma Combining Statements of Operations for
the Year Ended December 31, 1997..........................................6
Unaudited Pro Forma Combining Statements of Operations for
the Nine Months Ended September 30, 1997..................................7
Unaudited Pro Forma Combining Statements of Operations for
the Nine Months Ended September 30, 1998..................................8
(2) Kroll-O'Gara Pro Forma and Laboratory Specialists Unaudited Pro Forma
Combining Financial Statements
--------------------------------------------------------------------------------
Unaudited Pro Forma Combining Statements of Operations for
the Year Ended December 31, 1997.........................................10
Unaudited Pro Forma Combining Statements of Operations for
the Nine Months Ended September 30, 1998.................................12
(b) FINANCIAL STATEMENTS OF LABORATORY SPECIALISTS OF AMERICA, INC.
Report of Independent Public Accountants.....................................13
</TABLE>
1
<PAGE> 3
<TABLE>
<S> <C>
Consolidated Balance Sheets as of December 31, 1996 and 1997.................14
Consolidated Statements of Income for the Years Ended
December 31, 1995, 1996, and 1997...................................15
Consolidated Statements of Stockholders' Equity for the Years
Ended December 31, 1995, 1996, and 1997.............................16
Consolidated Statements of Cash Flows for the Years
Ended December 31, 1995, 1996, 1997.................................17
Notes to Consolidated Financial Statements...................................18
Consolidated Balance Sheet as of September 30, 1998 (unaudited)..............31
Consolidated Statements of Income for the Nine Months
Ended September 30, 1997 and 1998 (unaudited).......................32
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1997 and 1998 (unaudited).......................33
Notes to Consolidated Unaudited Financial Statements ........................34
</TABLE>
2
<PAGE> 4
KROLL-O'GARA AND LABORATORY SPECIALISTS UNAUDITED PRO FORMA
COMBINING FINANCIAL STATEMENTS
The unaudited pro forma combining financial data gives effect to the Merger
as a pooling of interests, and should be read in conjunction with, and is
qualified by reference to the audited consolidated financial statements of
Kroll-O'Gara and Laboratory Specialists and the notes thereto. For purposes of
the unaudited pro forma operating data, Kroll-O'Gara's consolidated financial
statements for the three fiscal years ended December 31, 1997 and for the nine
months ended September 30, 1997 and 1998 have been combined with the
consolidated financial statements of Laboratory Specialists for the three fiscal
years ended December 31, 1997 and for the nine months ended September 30, 1997
and 1998, respectively. For purposes of the unaudited pro forma combined balance
sheet data, Kroll-O'Gara's consolidated financial data at September 30, 1998 has
been combined with Laboratory Specialist's consolidated financial data at
September 30, 1998.
The pro forma data is presented for illustrative purposes only and is not
necessarily indicative of the operating results or financial position that would
have been achieved if the Merger had been consummated as of the beginning of the
periods indicated, nor is it indicative of future financial position or results
of operations.
KROLL-O'GARA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING CONDENSED BALANCE SHEETS
<TABLE>
<CAPTION>
AS OF SEPTEMBER 30, 1998
----------------------------------------
LABORATORY
KROLL-O'GARA SPECIALISTS PRO FORMA
------------ ----------- ---------
(IN THOUSANDS)
<S> <C> <C> <C>
Current Assets:
Cash and equivalents................................... $ 32,859 $ 2,513 $ 35,372
Accounts receivable, net............................... 54,806 3,203 58,009
Costs and estimated earnings in excess of billings on
uncompleted contracts............................... 21,625 -- 21,625
Inventories............................................ 19,094 64 19,158
Other current assets................................... 14,901 260 15,161
-------- ------- --------
Total current assets.............................. 143,285 6,040 149,325
Property, plant and equipment, net....................... 18,389 2,555 20,944
Databases................................................ 9,012 -- 9,012
Costs in excess of assets acquired and other intangible
assets, net............................................ 41,833 9,746 51,579
Other assets............................................. 5,743 36 5,779
-------- ------- --------
Total assets...................................... $218,262 $18,377 $236,639
======== ======= ========
Current Liabilities:
Accounts payable....................................... $ 27,022 $ 962 $ 27,984
Accrued liabilities.................................... 18,111 613 18,724
Other current liabilities.............................. 905 1,104
Current debt obligations............................... 8,726 302 9,028
-------- ------- --------
Total current liabilities......................... 54,764 2,981 57,745
Long-term debt, net of current portion................... 39,339 1,595 40,934
Other long-term liabilities.............................. 5,235 360 5,595
Shareholders' equity..................................... 118,924 13,441 132,365
-------- ------- --------
Total liabilities and shareholders' equity........ $218,262 $18,377 $236,639
======== ======= ========
</TABLE>
3
<PAGE> 5
KROLL-O'GARA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
----------------------------------------------------------
LABORATORY PRO FORMA
KROLL-O'GARA SPECIALISTS ADJUSTMENTS PRO FORMA
------------ ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net sales............................ $85,841 $6,926 $92,767
Cost of sales........................ 62,114 3,247 56(1) 65,417
------- ------ -------
Gross profit.................... 23,727 3,679 27,350
Selling and marketing expenses....... 9,448 561 10,009
General and administrative expenses,
including amortization............. 18,916 2,390 (56)(1) 21,250
------- ------ -------
Operating income (loss)......... (4,637) 728 (3,909)
Interest expense..................... (2,813) (30) (2,843)
Interest income...................... -- 127 127
Other income (expense), net.......... (384) 324 (60)
------- ------ -------
Income (loss) before provision
for income taxes.............. (7,834) 1,149 (6,685)
Provision (benefit) for income
taxes.............................. (1,298) 475 (823)
------- ------ -------
Net income...................... (6,536) 674 (5,862)
Dividends on preferred stock......... -- (13) (13)
------- ------ -------
Net income available to common
shareholders.................. $(6,536) $ 661 $ 5,875
======= ====== =======
Basic earnings per share............. $ (0.65) $ 0.20 $ (0.54)
======= ====== =======
Basic weighted average shares
outstanding........................ 10,021 3,298 (2,513)(2) 10,806(3)
======= ====== =======
Diluted earnings per share........... $ (0.65) $ 0.17 $ (0.54)
======= ====== =======
Diluted weighted average shares
outstanding........................ 10,021 3,843 (3,058)(2) 10,806(3)
======= ====== =======
</TABLE>
- ---------------
(1) Reflects reclassifications necessary to conform the accounting practices of
the combined companies.
(2) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Laboratory Specialists common stock and
equivalents into Kroll-O'Gara common stock and equivalents based on the
estimated exchange ratio. For purposes of the pro forma basic and diluted
earnings per share computations, we have assumed an exchange ratio of .2381
Kroll-O'Gara share for every outstanding share of Laboratory Specialists
common stock on a weighted average basis. The above exchange ratio is based
upon a Kroll-O'Gara stock price of $21.
(3) On a pro forma basis for the year ended December 31, 1995, Kroll-O'Gara and
Laboratory Specialists had a combined net loss. As such, there is no further
dilution of earnings per share by the common stock equivalents of
Kroll-O'Gara and Laboratory Specialists and basic and diluted weighted
average shares outstanding are the same.
4
<PAGE> 6
KROLL-O'GARA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
-------------------------------------------------------
LABORATORY PRO FORMA
KROLL-O'GARA SPECIALISTS ADJUSTMENTS PRO FORMA
------------ ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net sales............................ $153,661 $8,727 $162,388
Cost of sales........................ 111,459 3,816 168(1) 115,443
-------- ------ --------
Gross profit.................... 42,202 4,911 46,945
Selling and marketing expenses....... 9,763 602 10,365
General and administrative expenses,
including amortization............. 23,940 2,947 (168)(1) 26,719
Asset impairment..................... -- 124 124
-------- ------ --------
Operating income................ 8,499 1,238 9,737
Interest expense..................... (3,140) (67) (3,207)
Interest income...................... -- 41 41
Other income, net.................... 336 4 340
-------- ------ --------
Income from continuing
operations before provision
(benefit) for income taxes.... 5,695 1,216 6,911
Provision (benefit) for income
taxes.............................. (162) 527 365
-------- ------ --------
Income from continuing
operations (4)
$ 5,857 $ 689 $ 6,546
======== ====== ========
Basic earnings per share from
continuing operations (4).......... $ 0.55 $ 0.21 $ 0.57
======== ====== ========
Basic weighted average shares
outstanding........................ 10,742 3,310 (2,522)(2) 11,530(3)
======== ====== ========
Diluted earnings per share from
continuing operations (4).......... $ 0.51 $ 0.17 $ 0.53
======== ====== ========
Diluted weighted average shares
outstanding........................ 11,160 3,955 (3,013)(2) 12,102(3)
======== ====== ========
</TABLE>
- ---------------
(1) Reflects reclassifications necessary to conform the accounting practices of
the combined companies.
(2) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Laboratory Specialists common stock and
equivalents into Kroll-O'Gara common stock and equivalents based on the
estimated exchange ratio. For purposes of the pro forma basic and diluted
earnings per share computations, we have assumed an exchange ratio of .2381
Kroll-O'Gara share for every outstanding share of Laboratory Specialists
common stock on a weighted average basis. The above exchange ratio is based
upon a Kroll-O'Gara stock price of $21.
(3) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the year ended December 31, 1996:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share........................... $6,546 11,530
Effect of dilutive securities:
Options.......................................... -- 133
Restricted stock................................. (162) 287
Warrants......................................... -- 115
Convertible note payable......................... -- 37
------ ------
Diluted earnings per share......................... $6,384 12,102
====== ======
</TABLE>
(4) During the fourth quarter of 1996, Laboratory Specialists discontinued its
clinical operations. The related operating loss and shut down expenses of
$1,274, net of a benefit for income taxes of $747, were reported as
discontinued operations by Laboratory Specialists in its income statement
for the year ended December 31, 1996. The basic and diluted earnings per
share impact of the discontinued operations for the year ended December 31,
1996 was $0.11.
5
<PAGE> 7
KROLL-O'GARA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-------------------------------------------------------
LABORATORY PRO FORMA
KROLL-O'GARA SPECIALISTS ADJUSTMENTS PRO FORMA
------------ ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net sales............................... $190,413 $12,837 $203,250
Cost of sales........................... 131,644 5,829 187(1) 137,660
-------- ------- --------
Gross profit....................... 58,769 7,008 65,590
Selling and marketing expenses.......... 14,371 654 15,025
General and administrative expenses,
including amortization................ 28,222 3,920 (187)(1) 31,955
Merger related costs.................... 7,205 -- 7,205
-------- ------- --------
Operating income................... 8,971 2,434 11,405
Interest expense........................ (4,806) (231) (5,037)
Interest income......................... -- 78 78
Other income (expense), net............. (393) 1 (392)
-------- ------- --------
Income from continuing operations
before minority interest,
provision for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle........................ 3,772 2,282 6,054
Minority interest....................... (156) -- (156)
-------- ------- --------
Income from continuing operations
before provision for income
taxes, extraordinary item and
cumulative effect of change in
accounting principle............. 3,616 2,282 5,898
Provision for income taxes.............. 2,352 953 3,305
-------- ------- --------
Income from continuing operations
before extraordinary item and
cumulative effect of change in
accounting principle (4)......... $ 1,264 $ 1,329 $ 2,593
======== ======= ========
Basic earnings per share from continuing
operations (4)........................ $ 0.10 $ 0.36 $ 0.19
======== ======= ========
Basic weighted average shares
outstanding........................... 13,061 3,693 (2,814)(2) 13,940(3)
======== ======= ========
Diluted earnings per share from
continuing operations (4)............. $ 0.09 $ 0.31 $ 0.18
======== ======= ========
Diluted weighted average shares
outstanding........................... 13,721 4,326 (3,295)(2) 14,751(3)
======== ======= ========
</TABLE>
- ---------------
(1) Reflects reclassifications necessary to conform the accounting practices of
the combined companies.
(2) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Laboratory Specialists common stock and
equivalents into Kroll-O'Gara common stock and equivalents based on the
estimated exchange ratio. For purposes of the pro forma basic and diluted
earnings per share computations, we have assumed an exchange ratio of .2381
Kroll-O'Gara share for every outstanding share of Laboratory Specialists
common stock on a weighted average basis. The above exchange ratio is based
upon a Kroll-O'Gara stock price of $21.
(3) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the year ended December 31, 1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share........................... $2,593 13,940
Effect of dilutive securities:
Options.......................................... -- 242
Restricted stock................................. -- 443
Warrants......................................... -- 110
Convertible note payable......................... -- 16
------ ------
Diluted earnings per share......................... $2,593 14,751
====== ======
</TABLE>
(4) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. In addition, during the
fourth quarter of 1997, Kroll-O'Gara changed its method of accounting for
costs incurred in connection with business process reengineering activities
relating to information technology transformation and recorded a cumulative
effect of change in accounting principle of $360, net of a benefit for
income taxes of $240. The basic and diluted earnings per share impact of the
extraordinary item was $0.01 and the basic and diluted earnings per share
impact of the change in accounting principle was $0.03 and $0.02,
respectively, for the year ended December 31, 1997.
6
<PAGE> 8
KROLL-O'GARA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1997
-------------------------------------------------------
LABORATORY PRO FORMA
KROLL-O'GARA SPECIALISTS ADJUSTMENTS PRO FORMA
------------ ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net sales............................... $136,390 $9,549 $145,939
Cost of sales........................... 92,919 4,246 138 (1) 97,303
------- ------ -------
Gross profit....................... 43,471 5,303 48,636
Selling and marketing expenses.......... 9,739 458 10,197
General and administrative expenses,
including amortization................ 20,054 2,873 (138)(1) 22,789
------- ------ -------
Operating income................... 13,678 1,972 15,650
Interest expense........................ (3,387) (152) (3,539)
Interest income......................... 259 37 296
Other expense, net...................... (226) 1 (225)
------- ------ -------
Income from continuing operations
before minority interest,
provision for income taxes and
extraordinary item............... 10,324 1,858 12,182
Minority interest....................... (118) -- (118)
------- ------ -------
Income from continuing operations
before provision for income taxes
and extraordinary item........... 10,206 1,858 12,064
Provision for income taxes.............. 4,035 774 4,809
------- ------ -------
Income from continuing operations
before extraordinary item (4).... $ 6,171 $1,084 $ 7,255
======= ====== =======
Basic earnings per share from continuing
operations (4)........................ $ 0.46 $ 0.33 $ 0.52
======= ====== =======
Basic weighted average shares
outstanding........................... 13,058 3,333 (2,539)(2) 13,852(3)
======= ====== =======
Diluted earnings per share from
continuing operations (4)............. $ 0.42 $ 0.28 $ 0.48
======= ====== =======
Diluted weighted average shares
outstanding........................... 13,825 3,866 (2,945)(2) 14,746(3)
======= ====== =======
</TABLE>
- ---------------
(1) Reflects reclassifications necessary to conform the accounting policies of
the combined companies.
(2) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Laboratory Specialists common stock and
equivalents into Kroll-O'Gara common stock and equivalents based on the
estimated exchange ratio. For purposes of the pro forma basic and diluted
earnings per share computations, we have assumed an exchange ratio of .2381
Kroll-O'Gara share for every outstanding share of Laboratory Specialists
common stock on a weighted average basis. The above exchange ratio is based
upon a Kroll-O'Gara stock price of $21.
(3) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share........................... $7,255 13,852
Effect of dilutive securities:
Options.......................................... -- 199
Restricted stock................................. (227) 585
Warrants......................................... -- 89
Convertible note payable......................... -- 21
------ ------
Diluted earnings per share......................... $7,028 14,746
====== ======
</TABLE>
(4) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. The basic and diluted
earnings per share impact of the extraordinary item for the nine months
ended September 30, 1997 was $0.01.
7
<PAGE> 9
KROLL-O'GARA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
--------------------------------------------------------
LABORATORY PRO FORMA
KROLL-O'GARA SPECIALISTS ADJUSTMENTS PRO FORMA
------------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net sales............................ $178,943 $12,039 $190,982
Cost of sales........................ 120,100 5,438 158(1) 125,696
-------- ------ --------
Gross profit.................... 58,843 6,601 65,286
Selling and marketing expenses....... 12,092 721 12,813
General and administrative expenses,
including amortization............. 24,768 3,464 (158)(1) 28,074
-------- ------ --------
Operating income................ 21,983 2,416 24,399
Interest expense..................... (3,322) (148) (3,470)
Interest income...................... 759 107 866
Other income (expense), net.......... (219) 77 (142)
-------- ------ --------
Income before provision for
income taxes.................. 19,201 2,452 21,653
Provision for income taxes........... 7,641 1,011 8,652
-------- ------ --------
Net income...................... $ 11,560 $1,441 $ 13,001
======== ====== ========
Basic earnings per share............. $ 0.74 $ 0.28 $ 0.77
======== ====== ========
Basic weighted average shares
outstanding........................ 15,580 5,237 (3,990)(2) 16,827(3)
======== ====== ========
Diluted earnings per share........... $ 0.72 $ 0.26 $ 0.75
======== ====== ========
Diluted weighted average shares
outstanding........................ 15,955 5,503 (4,193)(2) 17,265(3)
======== ====== ========
</TABLE>
- ---------------
(1) Reflects reclassifications necessary to conform the accounting practices of
the combined companies.
(2) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Laboratory Specialists common stock and
equivalents into Kroll-O'Gara common stock and equivalents based on the
estimated exchange ratio. For purposes of the pro forma basic and diluted
earnings per share computations, we have assumed an exchange ratio of .2381
Kroll-O'Gara share for every outstanding share of Laboratory Specialists
common stock on a weighted average basis. The above exchange ratio is based
upon a Kroll-O'Gara stock price of $21.
(3) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1998:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share........................... $13,001 16,827
Effect of dilutive securities:
Options.......................................... -- 420
Warrants......................................... -- 18
------- ------
Diluted earnings per share......................... $13,001 17,265
======= ======
</TABLE>
8
<PAGE> 10
KROLL-O'GARA PRO FORMA AND LABORATORY SPECIALISTS UNAUDITED PRO FORMA
COMBINING FINANCIAL STATEMENTS
The following unaudited pro forma combining statements of operations for
the year ended December 31, 1997 and the nine months ended September 30, 1998
are derived from the unaudited pro forma combined condensed financial statements
which give effect to the Merger as a pooling of interests, after giving effect
to Kroll-O'Gara's acquisition of Kizorek, Inc. on September 1, 1998. The
financial statements of Kizorek, Inc. and certain pro forma financial
information for Kroll-O'Gara and Kizorek, Inc. were filed as part of
Kroll-O'Gara's Current Report on Form 8-K/A on October 23, 1998. For purposes of
the unaudited operating data, Kroll-O'Gara's pro forma consolidated statement of
operations for the year ended December 31, 1997 and the nine months ended
September 30, 1998 have been combined with the consolidated statement of
operations of Laboratory Specialists for the year ended December 31, 1997 and
the nine months ended September 30, 1998.
The pro forma data is presented for illustrative purposes only, and is not
indicative of the financial position or operating results that would have been
achieved if the acquisition of Kizorek, Inc. or the Merger had been consummated
as of the beginning of the periods indicated, nor is it indicative of future
financial position or results of operations.
9
<PAGE> 11
KROLL-O'GARA PRO FORMA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------
KROLL-O'GARA LABORATORY PRO FORMA
PRO FORMA SPECIALISTS ADJUSTMENTS PRO FORMA
------------- ----------- ----------- ---------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net sales.................................... $204,889 $12,837 $217,726
Cost of sales................................ 139,757 5,829 187(1) 145,773
-------- ------- --------
Gross profit............................ 65,132 7,008 71,953
Selling and marketing expenses............... 15,703 654 16,357
General and administrative expenses,
including amortization..................... 32,341 3,920 (187)(1) 36,074
Merger related costs......................... 7,205 -- 7,205
-------- ------- --------
Operating income........................ 9,883 2,434 12,317
Interest expense............................. (4,895) (231) (5,126)
Interest income.............................. -- 78 78
Other income (expense), net.................. (393) 1 (392)
-------- ------- --------
Income from continuing operations before
minority interest, provision for
income taxes, extraordinary item and
cumulative effect of change in
accounting principle.................. 4,595 2,282 6,877
Minority interest............................ (156) -- (156)
-------- ------- --------
Income from continuing operations before
provision for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle............................. 4,439 2,282 6,721
Provision for income taxes................... 2,681 953 3,634
-------- ------- --------
Income from continuing operations before
extraordinary item and cumulative
effect of change in accounting
principle (4)......................... $ 1,758 $ 1,329 $ 3,087
======== ======= ========
Basic earnings per share from continuing
operations (4)............................. $ 0.13 $ 0.36 $ 0.22
======== ======= ========
Basic weighted average shares outstanding.... 13,413 3,693 (2,814)(2) 14,292(3)
======== ======= ========
Diluted earnings per share from continuing
operations (4)............................. $ 0.12 $ 0.31 $ 0.20
======== ======= ========
Diluted weighted average shares
outstanding................................ 14,073 4,325 (3,295)(2) 15,103(3)
======== ======= ========
</TABLE>
- ---------------
(1) Reflects reclassifications necessary to conform the accounting practices of
the combined companies.
(2) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Laboratory Specialists common stock and
equivalents into Kroll-O'Gara common stock and equivalents based on the
estimated exchange ratio. For purposes of the pro forma basic and diluted
earnings per share computations, we have assumed an exchange ratio of .2381
Kroll-O'Gara share for every outstanding share of Laboratory Specialists
stock on a weighted average basis. The above exchange ratio is based upon a
Kroll-O'Gara stock price of $21.
10
<PAGE> 12
(3) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the year ended December 31, 1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share........................... $3,087 14,292
Effect of dilutive securities:
Options.......................................... -- 242
Restricted stock................................. -- 443
Warrants......................................... -- 110
Convertible note payable......................... -- 16
------ ------
Diluted earnings per share......................... $3,087 15,103
====== ======
</TABLE>
(4) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. In addition, during the
fourth quarter of 1997, Kroll-O'Gara changed its method of accounting for
costs incurred in connection with business process reengineering activities
relating to information technology transformation and recorded a cumulative
effect of change in accounting principle of $360, net of a benefit for
income taxes of $240. The basic and diluted earnings per share impact of the
extraordinary item was $0.01 and the basic and diluted earnings per share
impact of the change in accounting principle was $0.03 and $0.02,
respectively, for the year ended December 31, 1997.
11
<PAGE> 13
KROLL-O'GARA PRO FORMA AND LABORATORY SPECIALISTS
UNAUDITED PRO FORMA COMBINING
STATEMENTS OF OPERATIONS
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
--------------------------------------------------------
KROLL-O'GARA LABORATORY PRO FORMA
PRO FORMA SPECIALISTS ADJUSTMENTS PRO FORMA
------------- ----------- ----------- ---------
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
Net sales................................ $185,328 $12,039 $197,367
Cost of sales............................ 124,011 5,438 158(1) 129,607
-------- ------ --------
Gross profit........................ 61,317 6,601 67,760
Selling and marketing expenses........... 12,710 721 13,431
General and administrative expenses,
including amortization................. 26,730 3,464 (158)(1) 30,036
-------- ------ --------
Operating income.................... 21,877 2,416 24,293
Interest expense......................... (3,357) (148) (3,505)
Interest income.......................... 759 107 866
Other income (expense), net.............. (219) 77 (142)
-------- ------ --------
Income before provision for income
taxes............................. 19,060 2,452 21,512
Provision for income taxes............... 7,584 1,011 8,595
-------- ------ --------
Net income............................. $ 11,476 $1,441 $ 12,917
======== ====== ========
Basic earnings per share................. $ 0.72 $ 0.28 $ 0.75
======== ====== ========
Basic weighted average shares
outstanding............................ 15,894 5,237 (3,990)(2) 17,141(3)
======== ====== ========
Diluted earnings per share............... $ 0.71 $ 0.26 $ 0.73
======== ====== ========
Diluted weighted average shares
outstanding............................ 16,269 5,503 (4,193)(2) 17,579(3)
======== ====== ========
</TABLE>
- ---------------
(1) Reflects reclassifications necessary to conform the accounting practices of
the combined companies.
(2) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Laboratory Specialists common stock and
equivalents into Kroll-O'Gara common stock and equivalents based on the
estimated exchange ratio. For purposes of the pro forma basic and diluted
earnings per share computations, we have assumed an exchange ratio of .2381
Kroll-O'Gara share for every outstanding share of Laboratory Specialists
stock on a weighted average basis. The above exchange ratio is based upon a
Kroll-O'Gara stock price of $21.
(3) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1998:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share........................... $12,917 17,141
Effect of dilutive securities:
Options....................................... -- 420
Warrants...................................... -- 18
------- ------
Diluted earnings per share......................... $12,917 17,579
======= ======
</TABLE>
12
<PAGE> 14
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To the Board of Directors of
Laboratory Specialists of America, Inc.:
We have audited the accompanying consolidated balance sheets of Laboratory
Specialists of America, Inc. (an Oklahoma corporation) and subsidiaries as of
December 31, 1997 and 1996, and the related consolidated statements of income,
stockholders' 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, the financial statements referred to above present fairly,
in all material respects, the financial position of Laboratory Specialists of
America, Inc. and subsidiaries as of 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.
ARTHUR ANDERSEN LLP
Oklahoma City, Oklahoma,
March 6, 1998
13
<PAGE> 15
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
---------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents.............................. $ 727,381 $ 2,863,639
Accounts receivable, net of allowance of $597,499 in
1996 and $568,237 in 1997............................. 1,696,744 2,262,990
Income tax refund receivable........................... 312,664 190,498
Inventories............................................ 99,754 109,929
Prepaid expenses and other............................. 146,859 115,219
Deferred tax asset..................................... 211,078 160,709
---------- -----------
Total current assets.............................. 3,194,480 5,702,984
---------- -----------
PROPERTY, PLANT AND EQUIPMENT, net of accumulated
depreciation of
$900,948 in 1996 and $1,123,909 in 1997.............. 1,592,599 2,376,885
---------- -----------
OTHER ASSETS:
Goodwill, net of accumulated amortization of $171,355
in 1996 and $272,148 in 1997.......................... 2,663,850 2,316,302
Customer lists, net of accumulated amortization of
$216,429 in 1996 and $518,105 in 1997................. 1,863,061 4,587,814
Deferred costs......................................... 80,818 32,595
---------- -----------
Total other assets................................ 4,607,729 6,936,711
---------- -----------
Total assets...................................... $9,394,808 $15,016,580
========== ===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable....................................... $ 521,705 $ 742,292
Accrued payroll expenses............................... 300,103 411,364
Accrued customer list installment payments............. -- 510,345
Other accrued expenses................................. 57,310 78,491
Short-term debt........................................ 410,293 --
Current portion of long-term debt...................... 118,085 527,696
Obligations related to discontinued operation.......... 784,272 126,813
---------- -----------
Total current liabilities......................... 2,191,768 2,397,001
---------- -----------
LONG-TERM DEBT, net of current portion...................... 1,245,690 2,353,428
---------- -----------
DEFERRED INCOME TAXES....................................... 307,100 359,848
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 20,000,000 shares
authorized, 3,313,405 shares issued and outstanding in
1996 and 4,924,818 shares issued and outstanding in
1997.................................................. 3,313 4,925
Paid in capital in excess of par....................... 5,366,027 8,291,365
Retained earnings...................................... 280,910 1,610,013
---------- -----------
Total stockholders' equity........................ 5,650,250 9,906,303
---------- -----------
Total liabilities and stockholders' equity........ $9,394,808 $15,016,580
========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated balance
sheets.
14
<PAGE> 16
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF INCOME
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
-------------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
REVENUES................................................. $6,925,716 $8,726,799 $12,836,953
COST OF LABORATORY SERVICES.............................. 3,246,470 3,816,114 5,828,665
---------- ---------- -----------
Gross profit........................................... 3,679,246 4,910,685 7,008,288
---------- ---------- -----------
OPERATING EXPENSES:
Selling................................................ 561,470 601,945 654,284
General and administrative............................. 2,157,410 2,442,602 3,230,117
Depreciation and amortization.......................... 232,535 504,123 690,268
Asset impairment....................................... -- 124,531 --
---------- ---------- -----------
Total operating expenses....................... 2,951,415 3,673,201 4,574,669
---------- ---------- -----------
OTHER (EXPENSE) INCOME:
Interest expense....................................... (29,651) (67,185) (230,433)
Interest income........................................ 126,939 41,208 78,035
Other income........................................... 323,846 4,169 1,146
---------- ---------- -----------
Total other (expense) income................... 421,134 (21,808) (151,252)
---------- ---------- -----------
Income from continuing operations before income
taxes........................................ 1,148,965 1,215,676 2,282,367
INCOME TAX EXPENSE....................................... 474,405 527,171 953,264
---------- ---------- -----------
Income from continuing operations...................... 674,560 688,505 1,329,103
DISCONTINUED OPERATION:
Loss from operations of discontinued clinical business,
net of tax benefit of $257,904...................... -- (500,636) --
Loss on disposal of clinical business, net of tax
benefit of $489,420................................. -- (773,580) --
---------- ---------- -----------
Net income (loss)................................... 674,560 (585,711) 1,329,103
DIVIDENDS ON PREFERRED STOCK............................. 13,344 -- --
---------- ---------- -----------
Net income (loss) available to common
stockholders........................................ $ 661,216 $ (585,711) $ 1,329,103
========== ========== ===========
BASIC EARNINGS PER COMMON SHARE:
Weighted average number of common stock shares
outstanding......................................... 3,298,405 3,309,594 3,693,146
========== ========== ===========
Continuing operations.................................. $ 0.20 $ 0.21 $ 0.36
Discontinued operation................................. -- (0.39) --
---------- ---------- -----------
Total............................................... $ 0.20 $ (0.18) $ 0.36
========== ========== ===========
DILUTED EARNINGS PER COMMON SHARE:
Weighted average number of common stock shares and
common stock equivalents outstanding................ 3,843,391 3,954,787 4,325,618
========== ========== ===========
Continuing operations.................................. $ 0.17 $ 0.17 $ 0.31
Discontinued operation................................. -- (0.32) --
---------- ---------- -----------
Total............................................... $ 0.17 $ (0.15) $ 0.31
========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
15
<PAGE> 17
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF STOCKHOLDERS' EQUITY
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
--------------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Preferred stock, $0.001 par value, $1 stated value:
Balance, beginning of period......................... $ 300,000 $ -- $ --
Redemption of stock (Note 5)......................... (300,000) -- --
---------- ---------- ----------
Balance, end of period............................ -- -- --
---------- ---------- ----------
Common stock, $0.001 par value:
Balance, beginning of period......................... 3,298 3,298 3,313
Exercise of common stock warrants
(Note 11)......................................... -- -- 1,501
Issuance of stock in connection with the settlement
of a note payable (Note 7)........................ -- -- 103
Other issuance of stock.............................. -- 15 8
---------- ---------- ----------
Balance, end of period............................ 3,298 3,313 4,925
---------- ---------- ----------
Paid in capital in excess of par:
Balance, beginning of period......................... 5,341,667 5,341,667 5,366,027
Exercise of common stock warrants
(Note 11)......................................... -- -- 2,677,950
Issuance of stock in connection with the settlement
of a note payable (Note 7)........................ -- -- 232,396
Other issuance of stock.............................. -- 24,360 14,992
---------- ---------- ----------
Balance, end of period............................ 5,341,667 5,366,027 8,291,365
---------- ---------- ----------
Retained earnings:
Balance, beginning of period......................... 205,405 866,621 280,910
Net income (loss).................................... 674,560 (585,711) 1,329,103
Preferred stock dividends............................ (13,344) -- --
---------- ---------- ----------
Balance, end of period............................ 866,621 280,910 1,610,013
---------- ---------- ----------
Total stockholders' equity................... $6,211,586 $5,650,250 $9,906,303
========== ========== ==========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
16
<PAGE> 18
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE YEARS ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997
---------- ---------- -----------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)........................................ $ 674,560 $ (585,711) $ 1,329,103
Adjustments to reconcile net income (loss) to net cash
provided by operating activities --
Depreciation and amortization.................... 232,535 550,933 690,268
Provision for bad debts and other................ 84,246 446,087 40,000
Gain on sales of assets.......................... -- (50,000) --
Deferred income taxes............................ (18,694) (744,936) 103,117
Asset impairment................................. -- 174,531 --
Disposal of clinical business.................... -- 1,263,000 --
Impact of changes in assets and liabilities --
Accounts receivable............................ (222,300) (411,079) (606,246)
Income tax refund receivable................... 8,600 (54,939) 275,139
Inventories.................................... (3,745) 43,582 (10,175)
Prepaid expenses and other..................... (13,045) 64,182 17,342
Accounts payable and accrued expenses.......... (7,682) (222,849) (183,742)
---------- ---------- -----------
Net cash provided by operating activities... 734,475 472,801 1,654,806
---------- ---------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures.................................. (211,886) (127,915) (1,038,561)
Proceeds from sales of assets......................... -- 50,000 --
Purchase of PLL customer list......................... -- -- (2,406,593)
Purchase of Accu-Path customer list................... -- -- (101,018)
Purchase of NPLI stock, net of cash acquired.......... -- (1,022,597) --
Acquisition costs..................................... (101,826) (301,816) (98,569)
---------- ---------- -----------
Net cash used in investing activities....... (313,712) (1,402,328) (3,644,741)
---------- ---------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Dividends paid........................................ (24,748) -- --
Redemption of preferred stock......................... (300,000) -- --
Warrant offering costs................................ (38,821) -- --
Net proceeds from exercise of warrants and stock
options............................................. -- -- 2,733,272
Payments on short-term debt........................... -- (598,515) (91,833)
Payments on long-term debt............................ (90,585) (155,628) (902,651)
Proceeds from long-term borrowings, net of loan
origination fees.................................... -- -- 2,387,405
---------- ---------- -----------
Net cash provided by (used in) financing
activities................................ (454,154) (754,143) 4,126,193
---------- ---------- -----------
INCREASE (DECREASE) IN CASH AND CASH
EQUIVALENTS.............................................. (33,391) (1,683,670) 2,136,258
CASH AND CASH EQUIVALENTS, beginning of period............. 2,444,442 2,411,051 727,381
---------- ---------- -----------
CASH AND CASH EQUIVALENTS, end of period................... $2,411,051 $ 727,381 $ 2,863,639
========== ========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest.............. $ 29,651 $ 112,698 $ 218,298
========== ========== ===========
Cash paid during the period for income taxes.......... $ 480,405 $ 631,564 $ 823,000
========== ========== ===========
</TABLE>
The accompanying notes are an integral part of these consolidated financial
statements.
17
<PAGE> 19
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
DECEMBER 31, 1996 AND 1997
1. GENERAL:
Laboratory Specialists of America, Inc. (the "Company" or "LSAI"), an
Oklahoma corporation, was organized in March 1994. Effective July 8, 1994, and
January 2, 1996, respectively, LSAI acquired all of the capital stock of
Laboratory Specialists, Inc. ("LSI"), a Louisiana corporation, and National
Psychopharmacology Laboratory, Inc. ("NPLI"), a Tennessee corporation, and LSI
and NPLI became wholly owned subsidiaries of the Company.
Through LSI, the Company operates an independent forensic drug testing
laboratory providing integrated drug testing services to corporations and
governmental bodies, by negotiated contract, for detection of illegal drug use
by employees and prospective employees. The Company's customers are primarily in
the construction, transportation, service, mining and manufacturing industries,
principally located in the southeast and southwest United States. See Note 3 for
a discussion of NPLI.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES:
Principles of Consolidation
The consolidated financial statements include the accounts of all
subsidiary companies. All material intercompany transactions have been
eliminated.
Earnings Per Common Share
The Company adopted the disclosure requirements of Statement of Financial
Accounting Standards ("SFAS") No. 128, "Earnings per Share," during 1997 and
restated all previously presented amounts in conformity with SFAS No. 128. Basic
earnings per common share includes no dilution and is computed by dividing
income available to common stockholders by the weighted-average number of common
stock shares outstanding for the period. Diluted earnings per common share is
computed by dividing income available to common stockholders by the
weighted-average number of common stock shares and common stock equivalents
outstanding which includes the dilutive impact of a convertible note payable and
outstanding warrants and options using the treasury stock method.
18
<PAGE> 20
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following table summarizes the calculation of basic earnings per common
share and diluted earnings per common share:
<TABLE>
<CAPTION>
FOR THE YEAR ENDED DECEMBER 31,
--------------------------------------------------------------------
1995 1996 1997
-------------------- -------------------- ----------------------
INCOME SHARES INCOME SHARES INCOME SHARES
(NUMER- (DENOMI- (NUMER- (DENOMI- (NUMER- (DENOMI-
ATOR) NATOR) ATOR) NATOR) ATOR) NATOR)
-------- --------- -------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Income from continuing
operations.................. $674,560 $688,505 $1,329,103
Less -- Preferred stock
dividends................... 13,344 -- --
-------- --------- -------- --------- ---------- ---------
Basic Earnings Per Common
Share
Income from continuing
operations available to
common stockholders......... 661,216 3,298,405 688,505 3,309,594 1,329,103 3,693,146
Per Common Share Amount....... $0.20 $0.21 $0.36
----- ----- -----
----- ----- -----
Diluted Earnings Per Common
Share Effect of dilutive
securities:
Convertible note payable...... -- -- -- 154,303 -- 67,662
Warrants...................... -- 541,809 -- 484,286 -- 460,226
Options....................... -- 3,177 -- 6,604 -- 104,584
-------- --------- -------- --------- ---------- ---------
Income from continuing
operations available to
common stockholders plus
assumed
conversions................. $661,216 3,843,391 $688,505 3,954,787 $1,329,103 4,325,618
======== ========= ======== ========= ========== =========
Per Common Share Amount....... $0.17 $0.17 $0.31
----- ----- -----
----- ----- -----
</TABLE>
During 1997, 66,000 warrants to purchase two shares of common stock at
$7.20 per warrant were outstanding but were not included in the computation of
diluted earnings per common share because the warrants' exercise price was
greater than the average market price of the common shares. Of these warrants,
30,000 were exercised to purchase 60,000 shares of common stock in November
1997, and the common shares issued are included as outstanding for the period
from exercise through December 31, 1997, in both the basic earnings per common
share and diluted earnings per common share calculations. The remaining 36,000
warrants, which expire on October 10, 1999, were outstanding at the end of 1997
(see Note 11).
Cash and Cash Equivalents
Cash equivalents consist of all highly liquid debt instruments with an
initial maturity of three months or less at the date of purchase. The Company
invests excess cash overnight in repurchase agreements, which are government
collateralized securities. The carrying amount of cash and cash equivalents
approximates fair value of those instruments due to their short maturity.
Inventories
Inventories consist of supplies of laboratory chemicals and specimen
collection materials. Inventories are valued at the lower of cost or market,
using the first-in, first-out method.
19
<PAGE> 21
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Property, Plant and Equipment
Property, plant and equipment are recorded at cost, and are depreciated
over the estimated useful lives of the assets using the straight-line method as
follows:
<TABLE>
<CAPTION>
ESTIMATED
USEFUL LIVES 1996 1997
------------ ---------- -----------
<S> <C> <C> <C>
Land................................................... N/A $ 29,353 $ 169,353
Building and improvements.............................. 7 - 40 Years 867,110 1,457,097
Equipment.............................................. 5 - 12 Years 1,492,633 1,765,377
Vehicles............................................... 5 Years 32,419 32,419
Furniture and fixtures................................. 5 - 10 Years 72,032 76,548
---------- -----------
2,493,547 3,500,794
Less- Accumulated depreciation and amortization........ (900,948) (1,123,909)
---------- -----------
$1,592,599 $ 2,376,885
========== ===========
</TABLE>
Impairment of Long-Lived Assets
Effective January 1, 1996, the Company adopted the provisions of SFAS No.
121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed Of." This standard requires that long-lived assets,
certain identifiable intangibles and goodwill related to those assets be
reviewed for impairment by asset group for which the lowest level of independent
cash flows can be identified. The adoption of SFAS No. 121 in 1996 resulted in
no adjustment to the consolidated financial statements of the Company. However,
during the fourth quarter of 1996, the Company made a decision to hold for sale
a former laboratory building, which resulted in an impairment of approximately
$111,000 being recorded, which reduced the net book value of the building to
$225,000. The impairment is included in "Asset Impairment" in the accompanying
consolidated income statement.
Goodwill and Customer Lists
Goodwill is amortized on a straight-line basis over 20 or 40 years and the
customer lists are amortized on a straight-line basis over fifteen years. The
Company continually evaluates whether events and circumstances have occurred
that indicate the remaining estimated useful life of goodwill or the customer
lists may warrant revision or that the remaining unamortized balance of goodwill
or the customer lists may not be recoverable. When factors, such as operating
losses, loss of customers, loss or suspension of laboratory certification for an
extended period, or changes in the drug testing industry, if present, indicate
that goodwill or the customer lists should be evaluated for possible impairment,
the Company uses an estimate of the related undiscounted net cash flows over the
remaining life of the goodwill or the customer lists in measuring whether they
are recoverable. Although management believes that goodwill and the customer
lists are currently recoverable over the respective remaining amortization
periods, it is possible, due to a change in circumstances, that the carrying
value could become impaired in the future. Such impairment could have a material
effect on the results of operations in a particular reporting period.
Deferred Costs
At December 31, 1997, deferred costs of $32,595 related to loan origination
fees for two notes payable to a bank which were issued during 1997. These costs
are being amortized over the related lives of the associated notes payable.
Deferred costs at December 31, 1996, included $38,821 of legal and accounting
expenses incurred in connection with the registration of the Company's
outstanding warrants (see Note 11), $33,523 related to
20
<PAGE> 22
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
construction in progress, and $8,474 other. In 1997, the deferred registration
costs were recorded as a reduction of the proceeds from the exercise of the
warrants. Also in 1997, the Company transferred the construction in progress to
property, plant and equipment and began depreciating the costs when the related
building was placed in use.
Employee Stock Option Plan
The Company accounts for its employee stock option plan using the intrinsic
value method in accordance with Accounting Principles Board Opinion No. 25,
"Accounting for Stock Issued to Employees" (see Note 10).
Income Taxes
Deferred income taxes are provided to reflect the future tax consequences
of differences between the tax bases of assets and liabilities and their
reported amounts in the financial statements.
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 amounts of assets and liabilities, the
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 as additional
information becomes known.
3. BUSINESS ACQUISITIONS:
National Psychopharmacology Laboratory, Inc.
On January 2, 1996, the Company acquired all of the issued and outstanding
capital stock (the "NPLI Stock") of NPLI, and purchased goodwill (the "NPLI
Goodwill"), pursuant to a Stock Purchase Agreement dated January 1, 1996 (the
"NPLI Purchase Agreement"), and NPLI became a wholly owned subsidiary of the
Company (the "NPLI Acquisition"). NPLI was engaged in forensic drug testing
(urine drug screening with chain of custody) and clinical testing and analysis.
Pursuant to the Purchase Agreement and in connection with the NPLI
Acquisition, the Company (i) agreed to pay $1,585,000 for the NPLI Stock of
which $1,075,000 was paid at closing to the shareholders of NPLI (the "NPLI
Shareholders"), and two unsecured promissory notes, with an aggregate adjusted
face value of $510,000, were issued and delivered to the NPLI Shareholders, (ii)
agreed to pay $140,000 for the NPLI Goodwill payable in 24 monthly installments
commencing on February 1, 1996, (iii) assumed net liabilities of NPLI of
approximately $875,000, and (iv) incurred deferred income taxes of approximately
$800,000 as a result of NPLI's tax basis being significantly less than the
purchase price of the NPLI Stock. All of the above resulted in a total purchase
price of approximately $3,400,000, substantially all of which was recorded as
intangible assets.
The forensic portion of NPLI's business was merged into LSI's operation
effective February 1996. The Company intended to sell the clinical business
during 1996, but after negotiations with three potential buyers failed, the
Company shut down the clinical operations effective in the fourth quarter of
1996. The revenues related to the discontinued clinical operation for the year
ended December 31, 1996, were approximately $3,413,000. The related operating
loss and shut down expenses of the clinical business are included in the
accompanying consolidated income statement as "Discontinued Operation" and
"Disposition of Discontinued Operation," respectively. Assuming the acquisition
had occurred at the beginning of 1995, the unaudited
21
<PAGE> 23
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
consolidated pro forma results of operations (excluding the clinical business)
for the year ended December 31, 1995, are as follows (in thousands of dollars,
except per-share amounts):
<TABLE>
<CAPTION>
(UNAUDITED)
-----------
<S> <C>
Revenues.................................................... $8,626
Net income from continuing operations....................... $ 851
Basic earnings per common share from continuing
operations................................................ $ 0.26
Diluted Earnings per common share from continuing
operations................................................ $ 0.22
</TABLE>
Pathology Laboratories, Ltd.
On January 31, 1997, the Company acquired from Pathology Laboratories, Ltd.
("PLL") certain intangible assets pursuant to an Asset Purchase Agreement dated
January 31, 1997. PLL is a privately held corporation. The assets purchased
included the forensic drug testing customer list of PLL and all contracts,
contract rights and agreements, correspondence with the customers for which PLL
has provided forensic drug testing services, and all assets owned by PLL used in
connection with the PLL office in Greenville, South Carolina. Pursuant to the
Purchase Agreement, the Company (i) paid $1,600,000 at closing and (ii) assumed
the obligations of PLL under a certain lease, dated September 16, 1996, which
requires monthly base rental payments of $2,083 and which expires on September
16, 1999. Furthermore, the Company agreed to make four additional quarterly
installment payments to PLL within 60 days following the end of each three-month
period during the twelve months ending January 31, 1998. These quarterly
payments are based on ninety percent of gross revenues directly attributable to
each customer comprising the customer base of PLL for the year ending January
31, 1998, exceeding $1,600,000. Excluding the obligations assumed under the
lease, the Company has estimated the total purchase price will be $2,560,000,
which was allocated entirely to the customer list to be amortized over 15 years.
In the accompanying consolidated balance sheet at December 31, 1997, the Company
has $250,345 accrued for the remainder of the estimated purchase price as
"accrued customer list installment payments." The initial purchase price of
$1,600,000 was financed with additional long-term bank indebtedness. The Company
consolidated the drug testing services with LSI's laboratory in March 1997.
Assuming the acquisition had occurred at the beginning of 1996, the
unaudited consolidated pro forma results of operations for the year ended
December 31, 1996, are as follows (in thousands of dollars, except per-share
amounts):
<TABLE>
<CAPTION>
(UNAUDITED)
-----------
<S> <C>
Revenues.................................................... $11,287
Net income from continuing operations....................... $ 1,093
Basic earnings per common share from continuing
operations................................................ $ 0.33
Diluted earnings per common share from continuing
operations................................................ $ 0.28
</TABLE>
Accu-Path Medical Laboratories, Inc.
On December 1, 1997, the Company acquired from Accu-Path Medical
Laboratories, Inc. ("Accu-Path") certain intangible assets pursuant to an Asset
Purchase Agreement dated December 1, 1997. Accu-Path is a privately held
corporation. The assets purchased included the forensic drug testing customer
list of Accu-Path, all contracts and contract rights for the providing of drug
testing services, and certain of the assets owned by Accu-Path used in
connection with the Accu-Path office in Ruston, Louisiana. The purchase price
for these assets was established as 180% of the collected and collectible
forensic drug testing customer list revenues during the period from June 1998
through November 1998. The Company paid $100,000 at closing and will pay within
30 days following the end of each three-month period after closing, 50% of the
forensic testing revenue for each of the first three quarters. The remaining
purchase price balance will be paid through four quarterly installment
22
<PAGE> 24
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
payments with the first of such payments due 30 days following the end of the
first twelve-month anniversary date of the acquisition. The Company has
estimated the total purchase price will be $360,000, which was allocated
entirely to the customer list to be amortized over 15 years. In the accompanying
consolidated balance sheet at December 31, 1997, the Company has $260,000
accrued for the remainder of the estimated purchase price as "accrued customer
list installment payments." The Company consolidated the drug testing services
with LSI's laboratory in December 1997. Had the acquisition occurred at the
beginning of 1997, the Company's results of operations for the year ended
December 31, 1997, would not have been materially different from those presented
in the accompanying consolidated statement of income.
4. OTHER INCOME:
Other income, as reflected in the consolidated statement of income for the
year ended December 31, 1995, includes proceeds of $320,000 received from the
settlement of litigation brought by LSI.
5. TRANSACTIONS WITH RELATED PARTIES:
During the years 1995, 1996 and 1997, the Company incurred approximately
$130,000, $30,000 and $170,000, respectively, for legal services rendered by a
director of the Company who also serves as legal counsel for the Company.
Management believes that the amounts incurred approximate those which would have
been paid to unrelated parties for the same services.
In 1994, LSI issued a note payable in the amount of $353,123 to MBf USA,
Inc. ("MBf") in connection with LSI's President and former owner, Arthur R.
Peterson, Jr.'s acquisition of LSI's common stock. Peterson later exchanged all
of the outstanding common stock of LSI for 1,000,000 shares of common stock and
300,000 shares of Series I Cumulative Redeemable Convertible Preferred Stock
(the "Series I Preferred Stock") of LSAI. The Series I Preferred Stock was
entitled to annual cumulative dividends based upon the national prime rate which
initially was 6.75% subject to a maximum 2% rate increase or decrease
adjustment. LSAI redeemed the Series I Preferred Stock in July 1995 at $1.00 per
share totaling $300,000.
6. LINE OF CREDIT:
In December 1995, LSI entered into a $1 million line of credit arrangement,
which matured in December 1996. The line of credit was renewed for $250,000 in
January 1997, maturing in January 1998, with an interest rate equal to the
Citibank N.A. rate, which was 8.25% at the date of renewal. LSAI is a guarantor
of any balances outstanding under the line of credit, which is collateralized by
LSI's accounts receivable, intangibles, inventories, equipment, and furniture
and fixtures. No borrowings were made against the line of credit during 1997,
and no balance was outstanding as of December 31, 1997.
7. DEBT:
Short-term debt at December 31, 1996, consisted of notes payable to the
former shareholders of NPLI with a recorded amount of $334,460, representing the
discounted value of approximately 153,282 shares reserved for issuance pursuant
to the NPLI Purchase Agreement. The Company did not issue and deliver these
shares to the former shareholders during 1996, based upon certain
representations made by the NPLI Shareholders which the Company believed to have
been misleading and false at the closing of the NPLI Acquisition. In August
1997, 103,333 shares of stock were issued to the NPLI shareholders to settle the
note payable. The issuance of these shares of common stock has been excluded
from the accompanying consolidated statement of cash flows as it is a non-cash
transaction. The remaining short-term debt at December 31, 1996, of $75,833
related to the note payable for NPLI Goodwill (see Note 3), was paid in 1997.
23
<PAGE> 25
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Long-term debt consists of the following at December 31, 1996 and 1997:
<TABLE>
<CAPTION>
1996 1997
---------- ----------
<S> <C> <C>
Note payable to MBf, due February 1999, interest rate 7%,
collateralized by substantially all of the assets of LSI
(see Note 5).............................................. $ 353,123 $ 353,123
Note payable for purchase of laboratory building............ 450,000 --
Capital lease agreement with Boehringer-Mannheim
Corporation............................................... 560,652 442,567
Note payable to a bank bearing interest at 8.65%, with
principal and interest payable monthly through June 2002
and the balance of principal and interest due in a balloon
payment in July 2002, collateralized by substantially all
of the assets of LSI...................................... -- 697,101
Term loan with a bank bearing interest at the prime rate
plus 0.5% (9.0% at December 31, 1997), with principal and
interest payable monthly through January 2002,
collateralized by substantially all of the assets of
LSI....................................................... -- 1,388,333
---------- ----------
Total long-term debt.............................. 1,363,775 2,881,124
Less-Current portion.............................. (118,085) (527,696)
---------- ----------
$1,245,690 $2,353,428
========== ==========
</TABLE>
In late 1996, the Company purchased a building to be renovated for its new
laboratory. The purchase was financed by a note payable to the seller due in
June 1997, with no stated interest rate. This was a noncash transaction and was
excluded from the accompanying 1996 consolidated statement of cash flows. In
1996, this note payable to the seller was classified as long-term based on a
written commitment from a bank to refinance the purchase and construction costs
up to the lesser of 80% of appraised value or cost, not to exceed $720,000. Upon
maturity in 1997, the note was refinanced through a note payable to a bank.
During February 1996, LSI entered into an agreement with
Boehringer-Mannheim Corporation through February 2001, to purchase equipment and
certain lab supplies at a fixed price, per drug screen performed. The agreement
resulted in the Company recording approximately $650,000 in additional
equipment, with an equal amount recorded as a capital lease obligation payable
over five years. The amortization of the capital lease assets is included in
depreciation expense in the accompanying consolidated statements of income. The
total monthly payment through November 1996 was $46,740. The agreement was
amended during December 1996, due to increased drug testing volumes and the new
monthly payment became $59,750, with $13,223 allocated to the principal and
interest of the capital lease obligation, and the remaining cost allocated to
the cost of laboratory supplies. In July 1997, due to further increases in drug
testing volumes, the original lease term was extended from five years to six
years and additional equipment was added. The total monthly payment and capital
lease obligation did not change as a result of this amendment, and the portion
of the monthly payment which is allocated to the principal and interest of the
capital lease obligation during the first five years of the agreement
24
<PAGE> 26
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
will be treated as equipment rental expense during the sixth year. The future
minimum lease payments related to this obligation are as follows:
<TABLE>
<CAPTION>
CAPITAL OPERATING
-------- ----------
<S> <C> <C>
1998........................................................ $158,670 $ 558,330
1999........................................................ 158,670 558,330
2000........................................................ 158,670 558,330
2001........................................................ 26,446 690,555
2002........................................................ -- 119,500
-------- ----------
502,456 2,485,045
Less -- Interest on capital lease obligation................ 59,889 --
-------- ----------
Total future minimum lease payments............... $442,567 $2,485,045
======== ==========
</TABLE>
8. INCOME TAXES:
Prior to 1995, the Company had no material differences between the tax
bases of assets and liabilities and their reported amounts in the financial
statements, except for certain goodwill which is not deductible for tax
purposes, and treated as a permanent difference.
The 1995, 1996 and 1997 provision (benefit) for income taxes on income from
continuing operations is summarized below:
<TABLE>
<CAPTION>
1995 1996 1997
-------- -------- --------
<S> <C> <C> <C>
U.S. Federal--
Current................................................... $390,008 $581,467 $690,916
Deferred.................................................. (8,735) (166,115) 57,829
-------- -------- --------
381,273 415,352 748,745
State....................................................... 93,132 111,819 204,519
-------- -------- --------
Total............................................. $474,405 $527,171 $953,264
======== ======== ========
</TABLE>
The results of the discontinued operation for the year ended December 31,
1996, include a tax benefit of $747,324.
25
<PAGE> 27
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Deferred tax liabilities (assets) at December 31, 1996 and 1997, are
composed of the following:
<TABLE>
<CAPTION>
1996 1997
--------- ---------
<S> <C> <C>
Net current deferred tax asset:
Allowance for doubtful accounts........................ $(134,273) $(133,660)
Accrued liabilities.................................... (105,180) (58,564)
Deferred taxable revenue, short-term................... 28,375 4,848
Customer list, net of amortization, short-term......... -- 26,667
--------- ---------
(211,078) (160,709)
--------- ---------
Net non-current deferred tax liability:
Accelerated depreciation............................... (69,748) 42,515
Customer list, net of amortization, long-term.......... 372,000 317,333
Deferred taxable revenue, long-term.................... 4,848 --
--------- ---------
307,100 359,848
--------- ---------
Total deferred taxes.............................. $ 96,022 $ 199,139
========= =========
</TABLE>
In the following table, the U.S. Federal income tax rate is reconciled to
the Company's 1995, 1996 and 1997 effective tax rates from continuing operations
for income as reflected in the consolidated statements of income.
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
U.S. statutory rate......................................... 34.0% 34.0% 34.0%
Increases resulting from --
State income taxes..................................... 5.4 6.1 6.1
Goodwill amortization.................................. 1.2 2.9 1.5
Other.................................................. 0.7 0.4 0.2
---- ---- ----
41.3% 43.4% 41.8%
==== ==== ====
</TABLE>
9. COMMITMENTS AND CONTINGENCIES:
Contingent Liabilities
Incidental to its business, the Company from time to time is sued by
individuals who have tested positive for drugs of abuse, generally arising from
LSI's alleged failure to properly administer drug urinalysis tests. LSI is
currently a defendant in several such lawsuits. Based upon prior successful
defense of similar-type lawsuits, the Company believes it has valid defenses to
each of such lawsuits, and intends to vigorously defend itself in such actions.
Although LSI maintains insurance to protect itself against such liability, and
LSI's insurance carriers have assumed the defense of LSI in connection with
certain actions, the extent of such insurance coverage is limited, both in terms
of types of risks covered by the policies and the amount of coverage. In the
opinion of the Company's management and its legal counsel, these suits and
claims should not result in judgments or settlements which would have a material
adverse effect on the Company's results of operations or financial position.
Although LSI has not experienced any material liability related to such claims,
there can be no assurance that LSI, and possibly the Company, will not at some
time in the future experience significant liability in connection with such
claims and such liability may exceed the extent of such insurance coverage, both
in terms of risks covered by the policies and the amount of coverage, which
could have a material effect on the results of operations and financial
condition of the Company.
26
<PAGE> 28
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Certification
The Company's laboratory is certified by the Substance Abuse and Mental
Health Services Administration ("SAMHSA"), the successor to the National
Institute on Drug Abuse, as well as certain state and local jurisdictions.
Certification by SAMHSA is essential to the Company's business, as certain
clients are required to use certified laboratories, and many of its clients look
to certification as an indication of reliability and accuracy of tests. In order
to remain certified, the Company is subject to frequent inspections and
proficiency tests. Failure to meet any of the numerous certification
requirements could result in suspension or loss of certification. Such
suspension or loss of certification could have a material adverse effect on the
Company.
Employment Agreements
LSAI has written employment agreements with its President and its Chief
Executive Officer which provide, among other things, the following: (i) a term
of four years from April 16, 1996, which automatically extends one additional
year after each year of service; (ii) a base salary of $112,500 each; (iii)
bonuses at the discretion of the Board of Directors not to exceed 10 percent of
the net income of the Company; (iv) eligibility for stock options under LSAI's
stock option plans (see Note 10); and (v) health and disability insurance
benefits and life insurance of $500,000. Subsequent to December 31, 1997, these
agreements were verbally amended to increase the base salary to $114,750 each.
The agreements also restrict the right to participate in other activities
outside of LSAI to the extent such activities conflict with the ability to
perform duties and that would violate duty and loyalty to LSAI.
LSI has a written employment agreement with its President which provides,
among other things, the following: (i) a term of four years from April 16, 1996,
which automatically extends one additional year after each year of service; (ii)
a base salary of $125,000, (iii) a bonus equal to 10 percent of the pre-tax
income of LSAI, not to exceed $50,000; (iv) eligibility for stock options under
LSAI's stock option plans (see Note 10); and (v) health and disability insurance
benefits and life insurance of $1,000,000. Subsequent to December 31, 1997, this
agreement was verbally amended to increase the base salary to $127,500. The
agreement requires the President to devote his full time and attention to the
business of LSI.
LSI has verbal employment agreements with five key employees which provide,
among other things, the following: (i) bonuses equal to one percent of the
pre-tax income of LSI or equal to one percent of the net income of LSAI; (ii)
other bonuses at the discretion of the Board of Directors; (iii) eligibility for
stock options under LSAI's stock option plans (see Note 10); and (iv)
eligibility for health, disability and life insurance benefits on the same terms
as other employees. Additionally, LSI has a written employment severance
agreement with one of these employees providing for salary continuation for a
period of twelve months upon termination for any reason other than cause. The
agreements require the five key employees to devote their full time and
attention to the business of LSI.
Judicial Decisions and Government Policy
Employee drug testing by federal agencies and certain private employers is
subject to regulation by certain federal agencies. Legislation currently exists
in a number of states regulating the circumstances under which employers may
test employees and the procedures under which such tests must be conducted. In
addition, the circumstances under which drug testing can legally be required by
employers is subject to court precedent and judicial review.
Hazardous Materials
Certain testing procedures employed by the Company require the use of
hazardous materials. Failure to comply with current or future federal, state or
local environmental laws or regulations could have a material adverse effect on
the Company.
27
<PAGE> 29
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
10. STOCK OPTION PLANS:
LSAI established the 1994 Stock Option Plan (the "1994 Plan") on May 10,
1994. On October 30, 1996, the 1994 Plan was amended, and the total number of
shares of common stock authorized and reserved for issuance was increased from
225,000 to 425,000. The 1994 Plan provides for the issuance of both incentive
stock options ("ISO Options") and nonqualified stock options with or without
stock appreciation rights ("SARs") to directors, executive officers, key
employees and independent contractors and consultants of the Company and its
subsidiaries. ISO Options may be granted only to employees of the Company and
its subsidiaries.
On October 1, 1997, LSAI established the 1997 Non-Qualified Stock Option
Plan (the "1997 Plan"), with 400,000 shares of common stock authorized to be
granted. The 1997 Plan provides for the issuance of non-qualified stock options,
with stock appreciation rights attached, to directors, executive officers, key
employees and independent contractors and consultants of the Company and its
subsidiaries.
The Board of Directors interprets both Plans and establishes certain
committees to administer the Plans. These committees or the Board of Directors
have authority to grant options to all eligible employees and determine the
types of options granted, with or without SARs, the terms, restrictions and
conditions of the options at the time of grant, and whether SARs, if granted,
are exercisable at the time of the exercise of the option to which the SAR is
attached. Under both Plans, the option price of the common stock is determined
by the Board of Directors or the various committees. The price may not be less
than 85% of the fair market value of the shares on the date of the grant of the
option, with the exception of ISO options, which may not be less than the fair
market value of the shares on the date of grant. The Company's stock options are
fixed-price options generally granted at the fair market value of the underlying
common stock on the date of grant. Generally, the options vest and become
exercisable six months from the grant date and expire five to ten years after
the grant date.
The following table shows the activity for options issued under the Plans
as well as other options issued:
<TABLE>
<CAPTION>
1994 PLAN AND
OTHER OPTIONS ISSUED 1997 PLAN
-------------------------- -------------------------
WEIGHTED WEIGHTED
AVERAGE AVERAGE
EXERCISE PRICE EXERCISE PRICE
OPTIONS PER OPTION OPTIONS PER OPTION
-------- -------------- ------- --------------
<S> <C> <C> <C> <C>
Balance outstanding December 31, 1994..... -- -- -- --
Options granted...................... 125,000 3.00 -- --
-------- -------
Balance outstanding December 31, 1995..... 125,000 3.00 -- --
Options granted...................... 185,000 2.75 -- --
-------- -------
Balance outstanding December 31, 1996..... 310,000 2.85 -- --
Options cancelled.................... (250,000) 2.82 -- --
Options granted...................... 250,000 2.00 340,000 3.18
Options exercised.................... (7,500) 2.00 -- --
-------- -------
Balance outstanding December 31, 1997..... 302,500 2.20 340,000 3.18
======== =======
Options exercisable--
December 31, 1995.................. 10,000 3.00 -- --
December 31, 1996.................. 125,000 3.00 -- --
December 31, 1997.................. 302,500 2.20 -- --
</TABLE>
Following is the range of exercise prices, the weighted-average remaining
life of all stock options outstanding at December 31, 1997, and the
weighted-average price within each price range of those options outstanding and
those options exercisable at December 31, 1997.
28
<PAGE> 30
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
OPTIONS EXERCISABLE AT
OPTIONS OUTSTANDING AT DECEMBER 31, 1997 DECEMBER 31, 1997
- ------------------------------------------------------ ------------------------
WEIGHTED-
AVERAGE WEIGHTED- WEIGHTED-
EXERCISE REMAINING AVERAGE AVERAGE
PRICE CONTRACTUAL EXERCISE PRICE EXERCISE PRICE
OPTIONS PER OPTION LIFE (YEARS) PER OPTION OPTIONS PER OPTION
- --------- ---------- ------------ -------------- ------- --------------
<S> <C> <C> <C> <C> <C>
242,500 $ 2.00 9.3 $2.00 242,500 $2.00
60,000 3.00 2.9 3.00 60,000 3.00
340,000 3.18 9.8 3.18 -- --
------- -------
642,500 2.00-3.18 8.9 2.72 302,500 2.20
======= =======
</TABLE>
SFAS No. 123, "Accounting for Stock-Based Compensation," prescribes a
fair-value method of accounting for employee stock options under which
compensation expense is measured based on the estimated fair value of stock
options at the grant date and recognized over the period that the options vest.
The Company will continue to account for its stock option plans under the
optional intrinsic value method of APB No. 25, whereby no compensation expense
is recognized for fixed-price stock options with a grant price equal to or in
excess of the fair market value of the underlying stock at the grant date. Had
compensation expense been determined in accordance with SFAS No. 123, the
estimated weighted-average, grant-date fair value would have been $1.23, $1.14
and $0.94 per option for those options granted in 1995, 1996 and 1997,
respectively, and the resulting compensation expense would have reduced net
income and earnings per share as shown in the following pro forma amounts. These
amounts may not be representative of compensation expense that might be expected
to result in future years using the fair-value method of accounting for employee
stock options, as the number of options granted in a particular year may not be
indicative of the number of options granted in future years.
<TABLE>
<CAPTION>
1995 1996 1997
-------- --------- ----------
<S> <C> <C> <C>
Net income (loss) available for common stockholders:
As reported............................................ $661,216 $(585,711) $1,329,103
Pro forma.............................................. 614,771 (673,516) 1,053,706
Earnings (loss) per share:
Basic, as reported..................................... $ 0.20 $ (0.18) $ 0.36
Diluted, as reported................................... 0.17 (0.15) 0.31
Basic, pro forma....................................... 0.19 (0.20) 0.29
Diluted, pro forma..................................... 0.16 (0.17) 0.24
</TABLE>
The fair value of each option granted in 1995, 1996 and 1997 was estimated
as of the grant date using the Black-Scholes option pricing model with the
following weighted-average assumptions:
<TABLE>
<CAPTION>
1995 1996 1997
---- ---- ----
<S> <C> <C> <C>
Expected life (years)....................................... 5 5 5
Risk-free interest rate..................................... 6% 6% 6%
Expected dividend yield..................................... -- -- --
Expected volatility......................................... 35% 35% 38%
</TABLE>
11. COMMON STOCK WARRANTS:
In connection with the Company's public offering on October 11, 1994, the
Company issued 660,000 warrants. No warrants had been exercised at December 31,
1996. Until April 15, 1997, each warrant could be exercised to purchase two
shares of common stock for $3.50 per share. After April 15, 1997, each warrant
could be exercised to purchase two shares of common stock for $2.00 per share.
On September 3, 1997, LSAI gave notice to the holders of these warrants of the
Company's election to redeem the outstanding warrants at $0.01
29
<PAGE> 31
LABORATORY SPECIALISTS OF AMERICA, INC. AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
each on October 14, 1997, unless extended, at the sole discretion of the
Company, to a date not later than November 7, 1997 (the "Warrant Redemption").
As a result, 658,290 of the warrants were exercised in September and October
1997, and the remaining 1,710 warrants were redeemed.
As a portion of the public offering underwriting compensation, the Company
also issued warrants to purchase 66,000 units at $7.32 per unit, consisting of
two shares of common stock and one warrant for two additional shares of common
stock, exercisable during a four-year period commencing on October 11, 1995 (the
"Underwriter Warrants"). The warrants included within each unit were exercisable
under the same terms as the warrants issued in connection with the public
offering as described above. As a result of the Warrant Redemption, 62,000 of
these warrants were exercised for $0.12 per warrant plus $2.00 per share in
September and October 1997, and the remaining 4,000 warrants were redeemed.
After the Warrant Redemption, the holders of the Underwriter Warrants continue
to have the right to exercise the Underwriter Warrants with respect to the two
shares of common stock comprising the unit for $7.20. In November 1997, 30,000
of the Underwriter Warrants were exercised with respect to the two shares of
common stock comprising the unit for $7.20. The remaining 36,000 of the
Underwriter Warrants with respect to the two shares of common stock had not been
exercised and were outstanding at December 31, 1997. The proceeds from the
exercise of all warrants during 1997 are included in "net proceeds from exercise
of warrants and stock options" in the accompanying consolidated statement of
cash flows and was approximately $2.7 million, net of commissions and other
offering expenses.
In connection with the Warrant Redemption, LSAI issued warrants to purchase
144,058 shares of common stock to various investment bankers as a portion of
their compensation for serving as managers of the Warrant Redemption and certain
other services. These warrants have an exercise price per share of $2.20 and
expire on October 14, 2000. Both the number of shares and the exercise price per
share are subject to adjustment under certain circumstances. The value of these
warrants, recognized as compensation paid to the investment bankers for services
provided, was treated as a reduction in the recognized net proceeds to the
Company from the Warrant Redemption. The value of the outstanding warrants is
included in paid in capital in excess of par and entirely offsets the recognized
compensatory value of the warrants, resulting in no net effect on stockholders'
equity.
30
<PAGE> 32
LABORATORY SPECIALISTS OF AMERICA, INC.
CONSOLIDATED BALANCE SHEETS
<TABLE>
<CAPTION>
9/30/98
-----------
(UNAUDITED)
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents $ 2,512,843
Accounts receivable, net of allowances of $521,880 in 1998 3,203,077
Inventories 64,284
Prepaid expenses and other 98,599
Deferred tax asset 160,709
-----------
Total current assets 6,039,512
-----------
PROPERTY, PLANT AND EQUIPMENT, net of accumulated
depreciation of $1,379,859 in 1998 2,555,202
-----------
OTHER ASSETS:
Goodwill, net of accumulated amortization of $338,813 in 1998 2,249,638
Customer list, net of accumulated amortization of $834,507 in 1998 7,496,412
Deferred costs 36,400
-----------
Total other assets 9,782,450
-----------
Total assets $18,377,164
===========
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Accounts payable $ 962,316
Accrued income tax 302,477
Accrued payroll 436,149
Accrued expenses 176,538
Accrued customer list installment payments 549,539
Obligations from discontinued operations 14,730
Current portion of long-term debt. 539,570
-----------
Total current liabilities 2,981,319
-----------
LONG-TERM DEBT, net of current portion 1,594,820
-----------
DEFERRED INCOME TAXES 359,848
-----------
COMMITMENTS AND CONTINGENCIES
STOCKHOLDERS' EQUITY:
Common stock, $0.001 par value, 20,000,000 shares authorized,
5,729,091 shares issues and outstanding at 9/30/98 5,729
Paid in capital in excess of par, common stock 10,384,710
Retained earnings 3,050,738
-----------
Total stockholders' equity 13,441,177
-----------
Total liabilities and stockholders' equity $18,377,164
===========
</TABLE>
The accompanying notes are an integral part of this consolidated balance sheet.
31
<PAGE> 33
LABORATORY SPECIALISTS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF INCOME
UNAUDITED
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
-----------------------------
9/30/97 9/30/98
---------- -----------
<S> <C> <C>
REVENUES $9,549,032 $12,039,154
COST OF LABORATORY SERVICES 4,246,113 5,438,352
---------- -----------
Gross profit 5,302,919 6,600,802
---------- -----------
OPERATING EXPENSES:
Selling 458,221 720,619
General and administrative 2,371,735 2,811,881
Depreciation and amortization 501,230 651,765
---------- -----------
Total operating expenses 3,331,186 4,184,265
---------- -----------
Income from operations 1,971,733 2,416,537
---------- -----------
OTHER INCOME (EXPENSE):
Interest expense (152,467) (147,993)
Interest income 37,112 106,636
Other income 1,130 77,055
---------- -----------
Total other income (expense) (114,225) 35,698
---------- -----------
Income before income taxes 1,857,508 2,452,235
INCOME TAX EXPENSE 773,923 1,011,510
---------- -----------
Net income $1,083,585 $ 1,440,725
========== ===========
BASIC EARNINGS PER SHARE:
Weighted Average Number Of Common
Stock Shares Outstanding 3,332,904 5,237,332
========== ===========
Net Income Per Common Stock Share $ 0.33 $ 0.28
========== ===========
DILUTED EARNINGS PER SHARE:
Weighted Average Number Of Common
Stock Shares And Common Stock
Equivalents Outstanding 3,866,119 5,502,783
========== ===========
Net Income Per Common Stock And
Common Stock Equivalents $ 0.28 $ 0.26
========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
32
<PAGE> 34
LABORATORY SPECIALISTS OF AMERICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
<TABLE>
<CAPTION>
FOR THE NINE MONTHS ENDED
-------------------------------------
9/30/97 9/30/98
---------- ----------
(UNAUDITED)
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $1,083,585 $1,440,725
Adjustments to reconcile net income to net cash
provided by operating activities -
Depreciation and amortization 501,230 651,765
Provision for bad debts and other 17,175 30,000
Gain from extinguishment of long-term debt -- (38,123)
Impact of changes in assets and liabilities:
Accounts receivable (916,292) (1,003,942)
Income tax refund receivable 500,914 190,498
Inventories (11,159) 45,645
Prepaid expenses and other 47,356 12,815
Income tax payable -- 302,477
Accounts payable and accrued expenses 373,918 230,774
---------- ----------
Net cash provided by operating activities 1,596,727 1,862,634
---------- ----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures (913,498) (447,017)
Purchase of PLL Customer List (2,215,210) (42,033)
Purchase of Accu-Path Customer List -- (139,147)
Purchase of Harrison Customer List -- (553,515)
Purchase of Toxworx Customer List -- (2,417,256)
Acquisition costs (99,587) --
----------- -----------
Net cash used in investing activities (3,228,295) (3,598,968)
CASH FLOWS FROM FINANCING ACTIVITIES:
Payments on short-term borrowings (452,554) --
Payments on long-term borrowings (323,261) (708,610)
Proceeds from long-term borrowings 2,385,485 --
Proceeds (payments) from exercise of warrants and
stock options, net of related taxes paid -- (150,941)
Proceeds from private offering -- 2,245,090
Warrant offering costs (110,288) --
----------- -----------
Net cash provided by financing activities 1,499,382 1,385,539
----------- -----------
(DECREASE) IN CASH AND CASH EQUIVALENTS (132,186) (350,795)
----------- -----------
CASH AND CASH EQUIVALENTS, beginning of period 727,381 2,863,639
----------- -----------
CASH AND CASH EQUIVALENTS, end of period $ 595,195 $ 2,512,844
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the period for interest $ 152,467 $ 160,129
=========== ===========
Cash paid during the period for income taxes $ 521,000 $ 518,535
=========== ===========
</TABLE>
The accompanying notes are an integral part of these statements.
33
<PAGE> 35
LABORATORY SPECIALISTS OF AMERICA, INC.
NOTES TO FINANCIAL STATEMENTS
(INFORMATION FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998, IS UNAUDITED.)
1. GENERAL
The consolidated financial statements included in this report have been prepared
by the Company pursuant to the rules and regulations of the Securities and
Exchange Commission for interim reporting and include all adjustments which are,
in the opinion of management, necessary for a fair presentation. These financial
statements have not been audited by an independent accountant. The consolidated
balance sheet at December 31, 1997, has been derived from the audited balance
sheet of the Company.
Certain information and footnote disclosures normally included in financial
statements prepared in accordance with generally accepted accounting principles
have been condensed or omitted pursuant to such rules and regulations for
interim reporting. The Company believes that the disclosures are adequate to
make the information presented not misleading. However, these financial
statements should be read in conjunction with the audited financial statements
and notes thereto included in the Annual Report on Form 10-KSB filed by the
Company with the Securities and Exchange Commission on March 27, 1998. The
financial data for the interim periods presented may not necessarily reflect the
results to be expected for the full year.
2. EARNINGS PER COMMON SHARE
Both basic and diluted earnings per common share were computed using the
weighted average number of common shares outstanding. Diluted earnings per share
also reflect the dilutive effect, if any, of the conversion of stock options
(with the exception of the 525,000 stock options issued on July 20, 1998 and
rescinded effective with the date of grant), outstanding warrants and contingent
shares. In the diluted earnings per share calculation the outstanding warrants
were calculated using the weighted average market price during the term of the
warrants.
Income from continuing operations for purposes of computing both basic earnings
per share and diluted earnings per share was $1,440,725 and $1,083,585 for the
nine months ended September 30, 1998 and 1997, respectively. A reconciliation of
the average shares outstanding used to compute basic earnings per share to the
shares used to compute diluted earnings per share for both periods is presented
below:
<TABLE>
<CAPTION>
Nine Months Ended
-----------------------
9/30/98 9/30/97
--------- ----------
<S> <C> <C>
Average shares outstanding-basic 5,237,332 3,332,904
Dilutive effect of stock options 187,872 70,789
Dilutive effect of warrants 77,579 371,962
Dilutive effect of contingent shares related to
NPL purchase -- 90,464
--------- ---------
Average shares outstanding assuming dilution 5,502,783 3,866,119
========= =========
</TABLE>
34
<PAGE> 36
3. GOODWILL AND CUSTOMER LIST
Goodwill and customer lists are being amortized on a straight-line basis over
twenty to forty years and fifteen years, respectively. The Company continually
evaluates whether events and circumstances have occurred that indicate the
remaining estimated useful life of goodwill and customer lists may warrant
revision or that the remaining unamortized balance of goodwill or customer lists
may not be recoverable. When factors, such as operating losses, loss of
customers, loss or suspension for an extended period of laboratory
certification, or changes in the drug testing industry, if present, indicate
that goodwill or customer lists should be evaluated for possible impairment, the
Company uses an estimate of the related undiscounted cash flows over the
remaining life of the goodwill or customer lists in measuring whether the
goodwill and the customer lists are recoverable. Although management believes
that goodwill and the customer lists are currently recoverable over the
respective remaining amortization periods, it is possible, due to a change in
circumstances, that the carrying value could become impaired in the future. Such
impairment could have a material effect on the results of operations in a
particular reporting period.
4. CONTINGENT LIABILITIES
Incidental to its business, the Company from time to time is sued by individuals
who have tested positive for drugs of abuse or who allege that improper analysis
has been performed, generally arising from Laboratory Specialists, Inc.'s, the
company's wholly owned subsidiary ("LSI"), alleged failure to properly
administer drug urinalysis tests. LSI is currently a defendant in several such
lawsuits. Based upon prior successful defense of similar-type lawsuits, the
Company believes it has valid defenses to each of such lawsuits, and intends to
vigorously defend in such actions. Although LSI maintains insurance to protect
itself against such liability, and LSI's insurance carriers have assumed the
defense of LSI in connection with certain actions, the extent of such insurance
coverage is limited, both in terms of types of risks covered by the policies and
the amount of coverage. In the opinion of the Company's management and it's
legal counsel, these suits and claims should not result in judgments or
settlements which would have a material adverse effect on the Company's results
of operations or financial position. Although LSI has not experienced any
material liability related to such claims, there can be no assurance that LSI,
and possibly LSAI, will not at some time in the future experience significant
liability in connection with such claims and such liability may exceed the
extent of such insurance coverage, both in terms of risks covered by the
policies and the amount of coverage, which could have a material adverse effect
upon the results of operations and financial condition of the Company.
5. SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES
In connection with the purchase of assets from Pathology Laboratories, Ltd.
("PLL"), a liability of $960,000 was recorded based upon estimated future
quarterly installment payments to be made to PLL. As of September 30, 1998, all
installment payments, totaling $751,688 had been made and the remaining balance
of the liability of $208,312, was treated as a reduction in the carrying value
of the PLL customer list since it will not be paid pursuant to the purchase
agreement.
In connection with the purchase of assets from Accu-Path Medical Laboratory,
Inc. ("Accu-Path"), a liability of $260,000 was recorded based upon estimated
future quarterly installment payments to be made to Accu-Path. As of September
30, 1998, the first three installment payments, totaling approximately $136,606,
had been made, with one quarterly installment payment remaining to be paid.
In connection with the purchase of assets from Harrison Laboratories, Inc.
("HLI"), a liability of $460,000 was recorded based upon the estimated future
payment obligation. As of September 30, 1998, no payments have been made on this
liability; however, a $33,855 reduction was recorded as a result of the offset
of amounts owed to Laboratory Specialists, Inc. by HLI.
35
<PAGE> 37
The above transactions, except the reductions in the liabilities owed to PLL,
Accu-Path and HLI, are non-cash transactions and have been excluded from the
accompanying statements of cash flows.
6. SUBSEQUENT EVENTS
On October 15, 1998, the Company issued 1,500 shares of common stock to James
Cassel in connection with the exercise of certain warrants.
On October 20, 1998, the Company rescinded 525,000 stock options that had been
issued on July 20, 1998, effective with the date of grant.
On October 21, 1998, the Company entered into a definitive agreement to be
acquired by The Kroll-O'Gara Company (NASDAQ : KROG) for a purchase price of
approximately $5 per share, subject to certain conditions and payable in
Kroll-O'Gara common stock. Closing of the transaction is anticipated in
December, 1998 and is subject to the approval of the shareholders of the
Company.
On October 23, 1998, the Company issued 15,373 shares of common stock to James
Cassel in connection with the exercise of certain warrants.
36
<PAGE> 38
SIGNATURES
----------
Pursuant to the requirements of the Securities Exchange Act of 1934, the
Registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
DATE: NOVEMBER 23, 1998 THE KROLL-O'GARA COMPANY
By /s/ Nicholas P. Carpinello
---------------------------------
Nicholas P. Carpinello
Controller and Treasurer
37
