<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): DECEMBER 22, 1999
THE KROLL-O'GARA COMPANY
(Exact name of registrant as specified in its charter)
<TABLE>
<S> <C> <C>
Ohio 000-21629 31-1470817
(State or other jurisdiction of (Commission (I.R.S. Employer
Incorporation) file number) Identification No.)
</TABLE>
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 June 16, 1999, Kroll-O'Gara acquired all of the capital stock of
Background America, Inc. of Nashville, Tennessee, in exchange for approximately
899,243 shares of Kroll-O'Gara common stock. Background America provides
background investigation services to government, corporate, not-for-profit,
professional and other clients. The transaction was accounted for as a pooling
of interests. Background America's revenues are included in the Investigations
and Intelligence Group.
Because the acquisition of Background America was accounted for as a
pooling of interests, the consolidated balance sheets of The Kroll-O'Gara
Company and subsidiaries as of December 31, 1997 and 1998 and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998 have been restated to give effect to Background
America's financial information as if it had always been included in the
historical financial information of Kroll-O'Gara. In addition, Management's
Discussion and Analysis for the three years in the period ended December 31,
1998 and Selected Financial Data for the five fiscal years ended December 31,
1998 have been updated to include Background America's financial information.
<TABLE>
<CAPTION>
- ------------------------- -----------------------------------------------------------------------------------------------------
TABLE OF EXHIBITS DESCRIPTION
- ------------------------- -----------------------------------------------------------------------------------------------------
<S> <C>
1 Consolidated Balance Sheets of The Kroll-O'Gara Company and subsidiaries as of December 31, 1997 and
1998 and the related consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1998
- ------------------------- -----------------------------------------------------------------------------------------------------
2 Selected Financial Data for the five fiscal years ended December 31, 1998
- ------------------------- -----------------------------------------------------------------------------------------------------
3 Management's Discussion and Analysis for the three years in the period ended December 31, 1998
- ------------------------- -----------------------------------------------------------------------------------------------------
</TABLE>
1
<PAGE> 3
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: DECEMBER 22, 1999 THE KROLL-O'GARA COMPANY
By /s/Nicholas P. Carpinello
-----------------------------
Nicholas P. Carpinello
Controller and Treasurer
2
<PAGE> 1
Exhibit 1
Report of Independent Public Accountants
To The Kroll-O'Gara Company:
We have audited the accompanying consolidated balance sheets of The
KROLL-O'GARA COMPANY (Note 1) and subsidiaries as of December 31, 1997 and 1998
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits. We did not audit the 1996 financial statements of Kroll Holdings,
Inc., a company acquired during 1997 in a transaction accounted for as a pooling
of interests, as discussed in Notes 1 and 3. Such statements are included in the
consolidated financial statements of The Kroll-O'Gara Company and reflect total
revenues of 45 percent of the 1996 consolidated totals. We also did not audit
the 1996 or 1997 financial statements of Background America, Inc., a company
acquired during 1999 in a transaction accounted for as a pooling of interests,
as discussed in Note 3. Such statements are included in the consolidated
financial statements of The Kroll-O'Gara Company and reflect total revenues of 1
percent in 1996 and total assets and total revenues of 3 percent and 2 percent,
respectively, in 1997, of the consolidated totals. Those statements were audited
by other auditors whose reports have been furnished to us and our opinion,
insofar as it relates to amounts included for Kroll Holdings, Inc. and
Background America, Inc., respectively, is based solely upon the reports of the
other auditors.
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 and the reports of other auditors provide a
reasonable basis for our opinion.
In our opinion, based on our audits and the reports of the other
auditors, the consolidated financial statements referred to above present
fairly, in all material respects, the financial position of The Kroll-O'Gara
Company and subsidiaries as of December 31, 1997 and 1998 and the results of
their operations and their cash flows for each of the three years in the period
ended December 31, 1998, in conformity with generally accepted accounting
principles.
As explained in Note 2(s) to the consolidated financial statements,
effective in the fourth quarter of 1997, the Company changed its method of
accounting for costs incurred in connection with business process reengineering
activities.
Arthur Andersen LLP
Cincinnati, Ohio
November 15, 1999
<PAGE> 2
INDEPENDENT AUDITORS' REPORT
The Stockholders of
Kroll Holdings, Inc.
We have audited the consolidated statements of operations, changes in
stockholders' equity and cash flows (not presented separately herein) of Kroll
Holdings, Inc. (the "Company") and subsidiaries for the year ended December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit 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 financials statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly,
in all material respects, the results of the Company's and subsidiaries'
operations and their cash flows for the year ended December 31, 1996 in
conformity with generally accepted accounting principles.
/s/Deloitte & Touche LLP
New York, New York
March 13, 1997
(August 8, 1997 as to Notes 7 and 17)
<PAGE> 3
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Background America, Inc.
Nashville, Tennessee
We have audited the consolidated balance sheet of Background America, Inc. and
subsidiaries (the "Company") as of December 31, 1997, and the related
consolidated statements of operations, redeemable preferred stock and other
shareholders' equity (deficit) and cash flows for the years ended December 31,
1997 and 1996. These financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements (not presented separately
herein) present fairly, in all material respects, the financial position of
Background America, Inc. and subsidiaries as of December 31, 1997, and the
results of their operations and their cash flows for the years ended December
31, 1997 and 1996, in conformity with generally accepted accounting principles.
/s/Deloitte & Touche LLP
December 18, 1998
(January 21, 1999 as to
first paragraph of
Note 15)
<PAGE> 4
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
ASSETS (NOTE 7)
CURRENT ASSETS:
Cash and cash equivalents $ 12,370,463 $ 13,894,481
Marketable securities 22,969 13,285,322
Trade accounts receivable, net of allowance for doubtful accounts of
approximately $2,993,471 and $2,426,824 in 1997 and 1998, respectively
(Notes 2 and 4) 33,653,105 48,937,044
Unbilled revenues (Note 2) 3,081,481 7,766,015
Related party receivables (Note 6) 1,192,311 2,763,108
Costs and estimated earnings in excess of billings on uncompleted
contracts (Note 4) 11,897,801 26,408,097
Inventories (Note 4) 16,665,644 18,607,062
Prepaid expenses and other 5,367,244 7,748,236
Deferred tax asset (Note 5) 572,697 --
Net current assets of discontinued operations (Note 17) 6,026,768 6,836,920
------------- -------------
Total current assets 90,850,483 146,246,285
------------- -------------
PROPERTY, PLANT AND EQUIPMENT, at cost (Notes 2 and 8):
Land 1,827,507 1,856,003
Buildings and improvements 8,081,013 8,271,967
Leasehold improvements 5,212,513 6,330,363
Furniture and fixtures 4,717,170 6,007,570
Machinery and equipment 14,376,494 19,654,119
Construction-in-progress 1,050,451 2,915,135
------------- -------------
35,265,148 45,035,157
Less- accumulated depreciation (17,201,078) (20,462,991)
------------- -------------
18,064,070 24,572,166
------------- -------------
DATABASES, net of accumulated amortization of $19,505,625 and $22,788,857 in
1997 and 1998, respectively (Note 2) 8,335,211 9,238,903
COSTS IN EXCESS OF ASSETS ACQUIRED AND OTHER INTANGIBLE ASSETS, net of
accumulated amortization of $1,569,325 and $3,986,506 in 1997 and 1998,
respectively
(Notes 2 and 3) 24,130,294 59,152,915
OTHER ASSETS:
Other assets (Note 4) 2,985,629 4,882,416
Net non-current assets of discontinued operations (Note 17) 4,704,972 4,274,853
------------- -------------
40,156,106 77,549,087
------------- -------------
$ 149,070,659 $ 248,367,538
============= =============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
<PAGE> 5
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1998
<TABLE>
<CAPTION>
1997 1998
---- ----
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit (Note 7) $ 559,112 $ --
Current portion of long-term debt (Note 8) 4,038,080 2,000,299
Trade accounts payable 27,522,836 32,557,585
Related party payables (Note 6) 1,381,651 353,233
Billings in excess of costs and estimated earnings on uncompleted
contracts 250,870 182,656
Accrued liabilities (Note 4) 14,356,880 20,750,473
Income taxes currently payable 845,753 760,340
Deferred income taxes (Note 5) -- 781,575
Customer deposits 3,566,097 3,970,607
------------- -------------
Total current liabilities 52,521,279 61,356,768
OTHER LONG-TERM LIABILITIES 1,532,730 1,542,588
DEFERRED INCOME TAXES (Note 5) 2,514,606 1,625,363
LONG-TERM DEBT, net of current portion (Note 8) 49,641,484 39,346,555
------------- -------------
Total liabilities 106,210,099 103,871,274
------------- -------------
COMMITMENTS AND CONTINGENCIES (Notes 9, 12 and 17)
SHAREHOLDERS' EQUITY (Note 1):
Preferred stock, $.01 par value, 1,000,000 shares authorized; none issued -- --
Common stock, $.01 par value, 50,000,000 shares authorized, 15,679,545 and
21,584,872 shares issued and outstanding in 1997 and 1998, respectively 156,795 215,848
Additional paid-in-capital 65,837,989 157,229,936
Retained deficit (22,750,314) (10,964,249)
Deferred compensation -- (1,113,936)
Accumulated other comprehensive income (loss) (383,910) (871,335)
------------- -------------
Total shareholders' equity 42,860,560 144,496,264
------------- -------------
$ 149,070,659 $ 248,367,538
============= =============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
<PAGE> 6
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
NET SALES $ 158,924,026 $ 192,886,256 $ 254,542,779
COST OF SALES 113,264,162 128,900,762 164,290,540
------------- ------------- -------------
Gross profit 45,659,864 63,985,494 90,252,239
OPERATING EXPENSES:
Selling and marketing 10,032,952 13,349,843 19,473,085
General and administrative 27,341,791 33,417,926 41,821,029
Asset impairment (Note 2(i)) 124,531 -- --
Merger related costs -- 7,204,926 5,727,358
------------- ------------- -------------
Operating expenses 37,499,274 53,972,695 67,021,472
------------- ------------- -------------
Operating income 8,160,590 10,012,799 23,230,767
OTHER INCOME (EXPENSE):
Interest expense (3,049,397) (4,877,417) (4,382,010)
Interest income 6,167 173,079 1,273,218
Other, net 329,304 (278,164) 342,492
------------- ------------- -------------
Income from continuing operations before minority interest,
provision for income taxes, extraordinary item and
cumulative effect of change in accounting principle 5,446,664 5,030,297 20,464,467
Minority interest -- 156,223 --
------------- ------------- -------------
Income from continuing operations before provision for income
taxes, extraordinary item and cumulative effect of change in
accounting principle 5,446,664 4,874,074 20,464,467
Provision for income taxes 365,547 3,304,993 7,352,931
------------- ------------- -------------
Income from continuing operations before extraordinary item
and cumulative effect of change in accounting principle 5,081,117 1,569,081 13,111,536
Discontinued operations (Note 2(h) and 17(a)):
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) -- --
Income (loss) from operations of discontinued voice and data
communications group, net (Note 17(a)) 332,595 (305,207) (1,325,471)
------------- ------------- -------------
Income before extraordinary item and cumulative effect of
change in accounting principle 4,139,496 1,263,874 11,786,065
Extraordinary loss, net of applicable tax benefit of $129,250 (Note 7) -- (193,875) --
------------- ------------- -------------
Income before cumulative effect of change in accounting
principle 4,139,496 1,069,999 11,786,065
Cumulative effect of change in accounting principle, net of applicable tax
benefit of $240,000 (Note 2(s)) -- (360,000) --
------------- ------------- -------------
Net income $ 4,139,496 $ 709,999 $ 11,786,065
============= ============= =============
Earnings per share (Note 2(p)):
Basic $ 0.34 0.05 0.61
============= ============= =============
Diluted $ 0.31 0.05 0.59
============= ============= =============
Weighted average shares outstanding (Note 2(p)):
Basic 12,111,996 14,750,676 19,336,580
============= ============= =============
Diluted 12,670,478 15,560,050 19,908,206
============= ============= =============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
<PAGE> 7
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
COMPREHENSIVE ADDITIONAL
SHARES INCOME COMMON STOCK PAID-IN CAPITAL
------ ------ ------------ ---------------
<S> <C> <C> <C> <C>
BALANCE, December 31, 1995, as previously reported 10,020,277 $ 70,534 $ 22,040,722
Adjustment for pooling of interests (Note 3) 997,313 9,973 5,382,992
---------- --------- -------------
BALANCE, December 31, 1995, as restated 11,017,590 80,507 27,423,714
Distributions to shareholders, prior to the offering -- -- --
Sale of common stock between shareholders prior to the
offering -- -- 39,780
Issuances of stock under employee benefit plans (Note 11) 528,308 4,073 911,813
Public and private offerings of common stock, net of
issuance costs of approximately $3,550,000 2,451,444 55,393 15,477,924
Distribution of previously taxed S Corp earnings to S
Corp shareholders -- -- --
Issuance of stock in conjunction with acquisition of
business 37,809 378 290,193
Forgiveness of affiliate obligation (Note 6) -- -- --
Comprehensive income:
Net income -- $ 4,139,496 -- --
------------
Other comprehensive income, net of tax:
Foreign currency translation adjustment, net of
$237,000 tax benefit -- (355,534) -- --
Unrealized appreciation of marketable securities,
net of $9,000 tax provision -- 14,167 -- --
------------
Other comprehensive income (loss) -- (341,367) -- --
------------
Comprehensive income -- $ 3,798,129 -- --
---------- ============ --------- -------------
BALANCE, December 31, 1996 14,035,151 140,351 44,143,424
Issuances of stock under employee benefit plans,
including related tax benefit (Note 11) 750,725 7,507 6,301,276
Issuance of stock in conjunction with the acquisition of
businesses and minority interest (Note 3) 823,371 8,234 9,695,009
Issuance of stock in conjunction with the settlement of a
note payable 21,721 217 232,282
Private offering of common stock, net of issuance cost of
$36,373 307,613 3,076 5,964,976
Purchase and retirement of common stock (Note 11 (c)) (259,036) (2,590) (498,978)
Comprehensive income:
Net income -- $ 709,999 -- --
------------
Other comprehensive income, net of tax:
Foreign currency translation adjustment, net of
$157,000 tax benefit -- (236,393) -- --
Unrealized depreciation of marketable securities,
net of $2,400 tax benefit -- (3,698) -- --
------------
Other comprehensive income (loss) -- (240,091) -- --
------------
Comprehensive income -- $ 469,908 -- --
---------- ============ --------- -------------
BALANCE, December 31, 1997 15,679,545 156,795 65,837,989
Public and private offerings of common stock, net of
issuance costs of approximately $1,431,000 4,716,757 47,168 68,289,755
Net issuances of stock under employee benefit plans,
including related tax benefit (Note 11) 428,625 4,286 4,473,859
Issuance of stock in conjunction with the acquisition of
businesses (Note 3) 767,416 7,674 17,602,830
Exercise of stock put option (Note 3) (7,471) (75) (166,593)
Deferred compensation related to stock options -- -- 1,192,096
Comprehensive income:
Net income -- $ 11,786,065 -- --
------------
Other comprehensive income, net of tax:
Foreign currency translation adjustment, net of
$318,000 tax benefit -- (476,956) -- --
Reclassification adjustment for gain on securities
included in net income, net of $7,000 tax benefit -- (10,469) -- --
------------
Other comprehensive income (loss) -- (487,425) -- --
------------
Comprehensive income -- $ 11,298,640 -- --
---------- ============ --------- -------------
BALANCE, December 31, 1998 21,584,872 $ 215,848 $ 157,229,936
========== ========= =============
</TABLE>
<TABLE>
<CAPTION>
ACCUMULATED OTHER
RETAINED DEFERRED COMPREHENSIVE
DEFICIT COMPENSATION INCOME (LOSS) TOTAL
------- ------------ ------------- -----
<S> <C> <C> <C> <C>
BALANCE, December 31, 1995, as previously reported $(17,652,332) $ -- $ 197,548 $ 4,656,472
Adjustment for pooling of interests (Note 3) 1,354,779 -- -- 6,747,744
------------ ------------ --------- -------------
BALANCE, December 31, 1995, as restated (16,297,553) -- 197,548 11,404,216
Distributions to shareholders, prior to the offering (230,000) -- -- (230,000)
Sale of common stock between shareholders prior to the
offering -- -- -- 39,780
Issuances of stock under employee benefit plans (Note 11) -- -- -- 915,886
Public and private offerings of common stock, net of
issuance costs of approximately $3,550,000 -- 15,533,317
Distribution of previously taxed S Corp earnings to S
Corp shareholders (9,000,000) -- -- (9,000,000)
Issuance of stock in conjunction with acquisition of
business -- -- -- 290,571
Forgiveness of affiliate obligation (Note 6) 122,000 -- -- 122,000
Comprehensive income:
Net income 4,139,496 -- -- 4,139,496
Other comprehensive income, net of tax:
Foreign currency translation adjustment, net of
$237,000 tax benefit -- -- -- --
Unrealized appreciation of marketable securities,
net of $9,000 tax provision -- -- -- --
Other comprehensive income (loss) -- -- (341,367) (341,367)
Comprehensive income -- -- -- --
------------ ------------ --------- -------------
BALANCE, December 31, 1996 (21,266,057) -- (143,819) 22,873,899
Issuances of stock under employee benefit plans,
including related tax benefit (Note 11) -- -- -- 6,308,783
Issuance of stock in conjunction with the acquisition of
businesses and minority interest (Note 3) -- -- -- 9,703,243
Issuance of stock in conjunction with the settlement of a
note payable -- -- -- 232,499
Private offering of common stock, net of issuance cost of
$36,373 -- -- -- 5,968,052
Purchase and retirement of common stock (Note 11 (c)) (2,194,256) -- -- (2,695,824)
Comprehensive income:
Net income 709,999 -- -- 709,999
Other comprehensive income, net of tax:
Foreign currency translation adjustment, net of
$157,000 tax benefit -- -- -- --
Unrealized depreciation of marketable securities,
net of $2,400 tax benefit -- -- -- --
Other comprehensive income (loss) -- -- (240,091) (240,091)
Comprehensive income -- -- -- --
------------ ------------ --------- -------------
BALANCE, December 31, 1997 (22,750,314) -- (383,910) 42,860,560
Public and private offerings of common stock, net of
issuance costs of approximately $1,431,000 -- -- -- 68,336,923
Net issuances of stock under employee benefit plans,
including related tax benefit (Note 11) -- -- -- 4,478,145
Issuance of stock in conjunction with the acquisition of
businesses (Note 3) -- -- -- 17,610,504
Exercise of stock put option (Note 3) -- -- -- (166,668)
Deferred compensation related to stock options -- (1,113,936) -- 78,160
Comprehensive income:
Net income 11,786,065 -- -- 11,786,065
Other comprehensive income, net of tax:
Foreign currency translation adjustment, net of
$318,000 tax benefit -- --
Reclassification adjustment for gain on securities
included in net income, net of $7,000 tax benefit -- -- -- --
Other comprehensive income (loss) -- -- (487,425) (487,425)
Comprehensive income -- -- -- --
------------ ------------ --------- -------------
BALANCE, December 31, 1998 $(10,964,249) $ (1,113,936) $(871,335) $ 144,496,264
============ ============ ========= =============
</TABLE>
The accompanying notes to consolidated financial statements are an integral
part of these consolidated statements.
<PAGE> 8
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 15)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
<TABLE>
<CAPTION>
1996 1997 1998
---- ---- ----
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income $ 4,139,496 $ 709,999 $ 11,786,065
Adjustments to reconcile net income to net cash provided by (used in)
continuing operations-
Loss (income) from discontinued operations (332,595) 305,207 1,325,471
Depreciation and amortization 5,367,412 6,564,382 8,859,778
Bad debt expense 8,508,317 2,034,151 1,242,355
Shareholder stock compensation 930,846 1,356,280 --
Loss on write-off of notes receivable -- 35,434 --
Share in net income of joint ventures (19,224) (121,650) --
Gain on sale of marketable securities (108,646) (14,503) (10,469)
Asset impairment 174,531 -- --
Disposal of clinical business 1,263,000 -- --
Noncash compensation expense -- -- 226,074
Change in assets and liabilities, net of effects of acquisitions and
dispositions-
Receivables-trade and unbilled (6,283,517) (6,352,176) (12,083,029)
Costs and estimated earnings in excess of billings on uncompleted contracts (7,237,435) 3,290,709 (14,510,296)
Inventories, prepaid expenses and other assets (2,029,409) (6,001,920) (4,713,109)
Accounts payable and income taxes currently payable 1,627,688 8,389,338 2,324,655
Billings in excess of costs and estimated earnings on uncompleted contracts (653,807) (801,365) (68,214)
Amounts due to/from related parties (472,124) 412,999 (2,457,191)
Deferred taxes (1,150,316) (156,892) (838,668)
Accrued liabilities, long-term liabilities and customer deposits 4,760,140 81,167 (2,493,890)
------------ ------------ ------------
Net cash provided by (used in) continuing operations 8,484,357 9,731,160 (11,410,468)
------------ ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net (3,791,965) (5,970,849) (7,362,975)
Additions to databases (3,250,360) (3,856,914) (4,186,924)
Decrease in notes receivable - shareholder 233,253 -- --
Acquisitions, net of cash acquired (Note 3) (2,710,851) (10,710,128) (18,595,996)
Sale (purchases) of marketable securities, net 200,313 35,424 (13,262,353)
Other (216,711) 266,004 --
------------ ------------ ------------
Net cash used in investing activities of continuing operations (9,536,321) (20,236,463) (43,408,248)
------------ ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Loan financing fees -- (723,727) --
Net repayments under revolving lines of credit (252,818) (9,376,835) (559,112)
Proceeds from debt 179,569 44,902,987 284,877
Payments of long-term debt (3,245,524) (10,042,503) (13,662,425)
Proceeds from notes payable - shareholder 3,240,000 1,261,000 --
Repayment of notes payable - shareholder (803,745) (8,107,641) (176,057)
Net proceeds from issuance of common stock 15,533,317 4,914,317 68,336,923
Purchase and retirement of stock -- (2,695,824) (166,668)
Foreign currency translation (46,185) (189,497) (548,602)
Distributions to shareholders (9,230,000) -- --
Proceeds from exercise of stock options and warrants 445 2,780,966 4,478,145
------------ ------------ ------------
Net cash provided by financing activities of continuing operations 5,375,059 22,723,243 57,987,081
------------ ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS 4,323,095 12,217,940 3,168,365
Effects of foreign currency exchange rates on cash and cash equivalents 34,032 (75,931) 106,049
Net cash used in discontinued operations (3,817,805) (5,276,535) (1,750,396)
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, beginning of year 4,965,667 5,504,989 12,370,463
------------ ------------ ------------
CASH AND CASH EQUIVALENTS, end of year $ 5,504,989 $ 12,370,463 $ 13,894,481
============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
<PAGE> 9
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(1) Nature of Operations and Basis of Presentation-
The Kroll-O'Gara Company, an Ohio corporation, together with its
subsidiaries (collectively the "Company"), is a leading global provider
of a broad range of specialized products and services that are designed
to provide solutions to a variety of security needs. The Company's
Security Products and Services Group markets ballistic and blast
protected vehicles and security services. The Investigations and
Intelligence Group offers business intelligence and investigation
services. The Information Security Group offers information and computer
security services, including network and system security review and
repair. See Note 17(a) for a discussion of the discontinuance of the
Voice and Data Communications Group.
The Company was originally formed in 1996 for the purposes of becoming a
holding company, effecting a reorganization and a combination of certain
affiliated entities and carrying out an initial public offering of common
stock. On October 28, 1996, various O'Gara entities (primarily
O'Gara-Hess & Eisenhardt Armoring Company (OHE)) and their related
shareholders (primarily one shareholder who owned or controlled
approximately 86% to 88% of each entity) entered into the reorganization
plan. Accordingly, the accompanying consolidated financial statements
present, as a combination of entities under common control as if using
the pooling method of accounting, the financial position and related
results of operations of the O'Gara entities on a consolidated basis for
all periods presented.
In December 1997, a wholly owned subsidiary of The O'Gara Company
(O'Gara) was merged into Kroll Holdings, Inc. (Kroll). At the time of the
merger, the Company's name was changed from The O'Gara Company to The
Kroll-O'Gara Company. The consolidated financial statements include the
historical consolidated financial statements of the Company (and the
businesses it has acquired, since their respective dates of acquisition,
under the purchase method of accounting) and the financial position,
results of operations and cash flows of entities which were merged with
the Company in connection with pooling of interests business combinations
(See Note 3).
<PAGE> 10
-2-
(2) Summary of Significant Accounting Policies-
(a) Consolidation--The consolidated financial statements include the
accounts of all majority-owned subsidiaries. All material
intercompany accounts and transactions are eliminated. Investments in
20% to 50% owned entities are accounted for on the equity method and
investments in less than 20% owned entities are accounted for on the
cost method. Affiliated entities are not included in the accompanying
consolidated financial statements, and include entities that are
directly or indirectly owned by current shareholders or former
shareholders.
(b) Revenue Recognition--Revenue related to contracts for security
products (both government and commercial) results principally from
long-term fixed price contracts and is recognized on the
percentage-of-completion method calculated utilizing the cost-to-cost
approach. The percent deemed to be complete is calculated by
comparing the costs incurred to date to estimated total costs for
each contract. This method is used because management considers costs
incurred to be the best available measure of progress on these
contracts. However, adjustments to this measurement are made when
management believes that costs incurred materially exceed effort
expended. Contract costs include all direct material and labor costs,
along with certain direct overhead costs related to contract
production.
Provisions for any estimated total contract losses on uncompleted
contracts are recorded in the period in which it becomes known that
such losses will occur. Changes in estimated total contract costs
will result in revisions to contract revenue. These revisions are
recognized when determined.
Revenue from intelligence and investigation services and
information security services is recognized as the services are
performed. The Company records either billed or unbilled accounts
receivable based on case-by-case invoicing determination.
(c) 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 in
overnight 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.
(d) Marketable Securities--The Company adopted the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for
Certain Investments in Debt and Equity Securities," (SFAS 115) for
the year ended December 31, 1996. Under SFAS 115, the Company must
classify its debt and marketable securities as either trading,
available-for-sale or held-to-maturity. The Company's marketable
security investments consist largely of available-for-sale municipal
obligations. These securities are valued at current market value,
which approximates cost.
<PAGE> 11
-3-
Unrealized holding gains and losses, net of the related income tax
effect on the available-for-sale securities are excluded from
earnings and are reported as a separate component of shareholders'
equity until realized. The Company recorded an unrealized net loss of
$3,698 as of December 31, 1997. There were no such unrealized gains
(losses) as of December 31, 1998.
(e) Concentrations of Credit Risk--Financial instruments that subject the
Company to credit risk consist principally of trade receivables.
Concentrations of credit risk with respect to accounts receivable are
limited by the number of clients that comprise the Company's client
base, along with the different industries and geographic regions in
which the Company's clients operate. The Company does not generally
require collateral or other security to support client receivables,
although the Company does require retainers, up-front deposits or
irrevocable letters-of-credit in many situations. The Company has
established an allowance for doubtful accounts based upon facts
surrounding the credit risk of specific clients and past history.
Management does not anticipate incurring losses on its trade
receivables in excess of established allowances.
(f) Property, Plant and Equipment--Property, plant and equipment are
stated at cost. Depreciation is computed on both straight-line and
accelerated methods over the estimated useful lives of the related
assets as follows:
Buildings and improvements 5 - 40 years
Furniture and fixtures 5 - 10 years
Machinery and equipment 5 - 12 years
Leasehold improvements Life of lease
Vehicles 5 years
(g) Databases--Databases are capitalized costs incurred to obtain
information from third party providers. The Company relies on this
information to create and maintain its proprietary and
non-proprietary databases. Because of the continuing accessibility of
the information and its usefulness to future investigative
procedures, the cost of acquiring the information is capitalized and
amortized over a five year period. Amortization of databases for the
years ended December 31, 1996, 1997 and 1998 was $2,949,134,
$2,937,152 and $3,283,232, respectively.
(h) Discontinued Operation - Clinical Business--In connection with the
acquisition of a company specializing in forensic and clinical
testing and analysis, the Company shut down the clinical operations
effective in the fourth quarter of 1996. The Company had intended to
sell the clinical business, however, negotiations with three
potential buyers failed. 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 statements of operations as "loss from operations of
discontinued clinical business" and "loss on disposal of clinical
business," respectively.
<PAGE> 12
-4-
(i) 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" (SFAS 121). 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. In
accordance with this standard, the Company periodically reviews the
carrying value of these assets and impairments are recognized when
the expected undiscounted future cash flows are less than the
carrying amount of the asset. Based on its most recent analysis, the
Company believes no impairment exists at December 31, 1998. However,
it is possible, due to a change in circumstances, that carrying
values could become impaired in the future. Such impairment could
have a material effect on the results of operations in a particular
reporting period.
The adoption of SFAS 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. This impairment, in addition to an
approximate $13,000 laboratory equipment impairment, is included in
"asset impairment" in the accompanying consolidated statements of
operations.
(j) Costs in Excess of Assets Acquired--Costs in excess of assets
acquired represents the excess of the purchase cost over the fair
value of net assets acquired in a purchase business combination.
Costs in excess of assets acquired, net of accumulated amortization,
as of December 31, 1997 and December 31, 1998 were $17,521,721 and
$49,422,735, respectively. Amortization is recorded on a
straight-line basis over periods ranging from 15 to 40 years.
Amortization of costs in excess of assets acquired for the years
ended December 31, 1996, 1997 and 1998 was $162,288, $605,823 and
$1,471,975 respectively.
(k) Other Intangible Assets--Other intangible assets, comprised mainly of
customer lists and non-compete agreements, are amortized on a
straight-line basis. Customer lists are amortized over a fifteen year
period and the non-compete agreements are amortized over the lives of
the respective agreements, which range from six months to five years.
Other intangible assets, net of accumulated amortization, as of
December 31, 1997 and December 31, 1998 were $6,608,573 and
$9,730,180, respectively. Amortization of other intangible assets for
the years ended December 31, 1996, 1997 and 1998 was $147,396,
$348,898 and $945,202, respectively.
(l) Foreign Currency Translation--Assets and liabilities of foreign
operations are translated using year-end exchange rates and revenues
and expenses are translated using exchange rates prevailing during
the year, with gains or losses resulting from translation included in
a separate component of shareholders' equity.
<PAGE> 13
-5-
Gains or losses resulting from foreign currency transactions are
translated to local currency at the rates of exchange prevailing at
the dates of the transactions. Amounts receivable or payable in
foreign currencies, other than the subsidiary's local currency, are
translated at the rates of exchange prevailing at the balance sheet
date. The effect of transactional gains or losses is included in
other income (expense) in the accompanying consolidated statements of
operations.
(m) 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 and disclosure of contingent assets
and liabilities at the date of the financial statements and the
reported amounts of revenues and expenses during the reporting
period. Actual results could differ from those estimates.
(n) Research and Development--Research and development costs are expensed
as incurred. The Company incurred approximately $130,000, $121,000
and $537,000 for the years ended December 31, 1996, 1997 and 1998,
respectively, for research and development. These costs are included
in general and administrative expenses in the accompanying
consolidated statements of operations.
(o) Advertising--The Company expenses the cost of advertising as
incurred. Advertising expenses for the years ended December 31, 1996,
1997 and 1998 were approximately $757,028, $992,996 and $1,805,233,
respectively.
(p) Earnings Per Share--In 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS
128). In accordance with SFAS 128, basic earnings per share are
computed by dividing net income by the weighted average number of
shares of common stock outstanding during the year. Diluted earnings
per share are computed by dividing net income by the weighted average
number of shares of common stock and common stock equivalents
outstanding during the year. Dilutive common stock equivalents
represent shares issuable upon assumed exercise of stock options and
warrants, assumed issuance of restricted stock and assumed conversion
of the convertible note payable.
The following is a reconciliation of the numerator and denominator
for basic and diluted earnings per share for the years ended December
31, 1996, 1997 and 1998:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
Basic earnings per share $4,139,496 12,111,996 $0.34
=====
Effect of dilutive securities:
Options -- 136,505
Restricted stock (162,443) 287,482
Warrants -- 102,061
Convertible note payable -- 32,434
---------- ----------
Diluted earnings per share $3,977,053 12,670,478 $0.31
========== ========== =====
</TABLE>
<PAGE> 14
-6-
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
Basic earnings per share $709,999 14,750,676 $0.05
=====
Effect of dilutive securities:
Options -- 254,575
Restricted stock -- 443,152
Warrants -- 97,425
Convertible note payable -- 14,222
-------- ----------
Diluted earnings per share $709,999 15,560,050 $0.05
======== ========== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
------------------------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
Basic earnings per share $11,786,065 19,336,580 $0.61
=====
Effect of dilutive securities:
Options -- 568,849
Warrants -- 2,777
----------- ----------
Diluted earnings per share $11,786,065 19,908,206 $0.59
=========== ========== =====
</TABLE>
Basic and diluted earnings per share based on income from continuing
operations were $0.42 and $0.39, respectively, for the year ended
December 31, 1996. The basic and diluted per share impact of the
discontinued operations was $0.08.
Basic and diluted earnings per share based on income from continuing
operations before extraordinary item and cumulative effect of change
in accounting principle were $0.11 and $0.10, respectively, for the
year ended December 31, 1997. The basic and diluted per share impact
of the discontinued operation was $0.02, the extraordinary item was
$0.01 and the basic and diluted per share impact of the change in
accounting principle were $0.03 and $0.02, respectively.
<PAGE> 15
-7-
Basic and diluted earnings per share based on income from continuing
operations were $0.68 and $0.66, respectively, for the year ended
December 31, 1998. The basic and diluted per share impact of the
discontinued operation was $0.07.
During 1997, 66,000 warrants to purchase a total of 27,746 shares of
common stock of the Company at $7.20 per warrant were outstanding but
were not included in the computation of diluted earnings per share
because the warrants' exercise price was greater than the average
market price of the common shares.
During 1998, 11,666 warrants to purchase an equivalent amount of
shares of common stock of the Company at $25.69 per warrant were
outstanding but were not included in the computation of diluted
earnings per share because the warrants' exercise price was greater
than the average market price of the common shares.
(q) New Accounting Pronouncements--In 1998, the Company adopted Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive
Income" (SFAS 130), which established standards for reporting and
displaying comprehensive income and its components in a financial
statement that is displayed with the same prominence as other
financial statements. The Company has chosen to disclose
comprehensive income, which encompasses net income, foreign currency
translation adjustments and unrealized holding gains of marketable
securities, in the consolidated statements of shareholder's equity.
Prior years have been restated to conform to the SFAS 130
requirements. The accumulated other comprehensive income (loss)
balance of ($0.1) million at December 31, 1996 consisted of ($0.2)
million of foreign currency translation adjustments and $0.01 million
of unrealized appreciation of marketable securities. The accumulated
other comprehensive income (loss) balance of ($0.4) million at
December 31, 1997 consisted of ($0.4) million of foreign currency
translation adjustments and $0.01 million of unrealized appreciation
of marketable securities. The accumulated other comprehensive income
(loss) balance of ($0.9) million at December 31, 1998 consisted
entirely of foreign currency translation adjustments.
In June 1997, the FASB issued Statement of Financial Accounting
Standards No. 131, "Disclosures About Segments of an Enterprise and
Related Information" (SFAS 131), effective for fiscal years beginning
after December 15, 1997. This statement requires disclosure for each
segment into which a company is organized by the chief operating
decision maker for the purposes of making operating decisions and
assessing performance. Reportable segments are based on products and
services, geography, legal structure, management structure and any
manner in which management disaggregates a company. The Company
adopted SFAS 131 during fiscal 1998. This statement, which requires
expansion or modification to existing disclosures, had no impact on
the Company's reported consolidated financial position, results of
operations or cash flows.
<PAGE> 16
-8-
In April 1998, the American Institute of Certified Public Accountants
released Statement of Position (SOP) 98-5 "Reporting on the Cost of
Start-Up Activities." The SOP requires costs of start-up activities,
including preoperating costs, organization costs and other start-up
costs, to be expensed as incurred. The Company's current practice is
to capitalize certain of these expenses and amortize them over
periods ranging from one to five years. The Company is required to
adopt the provisions of this statement no later than the first
quarter of fiscal 1999. Included in the accompanying December 31,
1997 and 1998 consolidated balance sheets are approximately $1.0
million and $1.2 million, respectively, of preoperating, organization
and start-up costs which would have been expensed had this statement
already been implemented.
In June 1998, the Financial Accounting Standards Board issued
Statement of Financial Accounting Standards No. 133, "Accounting for
Derivative Instruments and Hedging Activities" (SFAS 133). SFAS 133
establishes accounting and reporting standards requiring that every
derivative instrument (including certain derivative instruments
embedded in other contracts) be recorded in the balance sheet as
either an asset or liability measured at its fair value. SFAS 133
requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are
met. SFAS 133, as amended, is effective for fiscal years beginning
after June 15, 2000. The Company has several forward contracts in
place in association with demand notes from certain subsidiaries.
These instruments qualify for hedge accounting. The Company has not
yet quantified the impact of adopting SFAS 133 on its financial
statements and has not determined the timing of or method of adoption
of SFAS 133. However, SFAS 133 could increase volatility in earnings
and other comprehensive income.
(r) Stock-Based Compensation--The Company has elected to account for the
cost of its employee stock options and other forms of employee
stock-based compensation plans utilizing the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25 (APB 25) as
allowed by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123). APB 25 requires
compensation cost for stock-based compensation plans to be recognized
based on the difference, if any, between the fair market value of the
stock on the date of grant and the option exercise price. SFAS 123
established a fair value-based method of accounting for compensation
cost related to stock options and other forms of stock-based
compensation plans. SFAS 123 allows an entity to continue to measure
compensation cost using the principles of APB 25 if certain pro forma
disclosures are made. The pro forma disclosures required by SFAS 123
are presented in Note 11(e).
(s) Change in Accounting Principle--In the fourth quarter of 1997, the
Company changed its method of accounting for costs incurred in
connection with business process reengineering activities relating to
information technology transformation. Consistent with a consensus
reached by the Emerging Issues Task Force (EITF) under Issue 97-13,
in late November 1997, the Company expensed costs previously
capitalized in earlier
<PAGE> 17
-9-
quarters of 1997 (approximately $360,000, net of tax benefit of
$240,000) as a cumulative effect of change in accounting principle.
(t) Derivative Financial Instruments--Financial instruments in the form
of foreign currency exchange contracts are utilized by the Company to
hedge its exposure to movements in foreign currency exchange rates.
The Company does not hold or issue derivative financial instruments
for trading purposes. Gains and losses on foreign exchange contracts
are deferred and amortized as an adjustment to the cumulative foreign
currency translation adjustment component of equity over the terms of
the agreements in accordance with hedge accounting standards. The
fair value of foreign currency exchange contracts is not recognized
in the consolidated financial statements since they are accounted for
as hedges.
(u) Reclassifications--Certain reclassifications have been reflected in
1996 and 1997 to conform with the current period presentation.
<PAGE> 18
-10-
(3) Mergers and Acquisitions-
The Company has completed numerous business combinations in the periods
presented. The Company has also completed several business combinations
during 1999. The transactions were accounted for as both purchase
business combinations and pooling of interests business combinations as
follows:
(a) Pooling of Interests Transactions--In December 1997, a wholly
owned subsidiary of the Company was merged with and into Kroll.
Effective upon the consummation of the merger with Kroll, each
then issued and outstanding share of Kroll common stock, including
shares subject to issuance under the Kroll restricted stock plan
(See Note 11), were converted into 62.52 shares of common stock of
the Company or 6,098,561 shares of Company common stock in total.
Outstanding employee stock options of Kroll were converted at the
same exchange factor into options to purchase 551,492 shares of
Company common stock (See Note 11).
The merger constituted a tax-free reorganization and has been
accounted for as a pooling of interests. Accordingly, all prior
period consolidated financial statements presented have been
restated to include the combined results of operations, financial
position and cash flows of Kroll as though it had always been a
part of the Company.
There were no transactions between O'Gara and Kroll prior to the
combination, and immaterial adjustments were recorded to conform
Kroll's accounting policies. Certain reclassifications were made
to the Kroll financial statements to conform to the Company's
presentations. The results of operations for the separate
companies and the combined amounts included in the consolidated
financial statements follow:
<TABLE>
<CAPTION>
O'GARA KROLL COMBINED
------ ----- --------
<S> <C> <C> <C>
Nine months ended
September 30, 1997 (unaudited)
Revenue $70,206,200 $53,823,958 $124,030,158
Loss from discontinued operation (197,000) -- (197,000)
Extraordinary item (193,875) -- (193,875)
Net income 4,181,387 1,796,124 5,977,511
Year ended December 31, 1996
Revenue $75,007,589 $70,883,058 $145,890,647
Income from discontinued operation 332,595 -- 332,595
Net income (loss) 6,658,962 (801,740) 5,857,222
</TABLE>
In connection with the Kroll merger in 1997, the Company recorded,
in the fourth quarter, a charge to operating expenses of
approximately $7.2 million ($5.7 million after taxes, or $0.37 per
diluted share) for direct and other merger-related costs
pertaining to the merger transaction. Merger transaction costs are
nonrecurring and
<PAGE> 19
-11-
include $0.8 million for stock based compensation costs triggered
by the change in control of Kroll, $1.8 million for stay bonuses
and severance and $4.6 million which consisted primarily of fees
for investment bankers, attorneys, accountants, financial
printing, travel and other related charges.
In December 1998, a wholly owned subsidiary of the Company was
merged with and into Laboratory Specialists of America, Inc.
(LSAI). Effective upon the consummation of the merger, each then
issued and outstanding share of LSAI common stock was converted
into .2102 shares of common stock of the Company or 1,209,053
shares of the Company's common stock in total. Outstanding stock
options and stock warrants of LSAI were converted at the same
exchange factor into options to purchase 39,094 and 24,386 shares,
respectively, of the Company's common stock (See Note 11). The
financial position and results of operations of LSAI are reported
as part of the Company's Investigations and Intelligence Group.
In December 1998, a wholly owned subsidiary of the Company was
merged with and into Schiff & Associates, Inc. (Schiff). Effective
upon the consummation of the merger, each then issued and
outstanding share of Schiff common stock was converted into
approximately 131.41 shares of common stock of the Company or
169,521 shares of the Company's common stock in total. The
financial position and results of operations of Schiff are
reported as part of the Company's Investigations and Intelligence
Group.
In December 1998, a wholly owned subsidiary of the Company was
merged with and into Securify Inc. (Securify). Effective upon the
consummation of the merger, all of the outstanding stock of
Securify was converted to shares of the Company's common stock at
a rate of .110793 for Series A Preferred, .118273 for Series B
Preferred and .0955252 for Securify common stock. In total, the
Company issued 1,430,936 shares of common stock. In addition,
outstanding employee stock options of Securify were converted at
the same exchange factor as Securify common stock into options to
purchase 179,877 shares of the Company's common stock. Effective
with the consummation of the merger, the Company created the
Information Security Group and Securify's results of operations
and financial position are reported in this group.
The mergers with LSAI, Schiff and Securify constituted tax-free
reorganizations and have been accounted for as pooling of
interests transactions. Accordingly, all prior period consolidated
financial statements presented have been restated to include the
combined results of operations, financial position and cash flows
of LSAI, Schiff and Securify as though they had always been a part
of the Company.
There were no transactions between the Company and LSAI, Schiff
and Securify prior to the combinations and immaterial adjustments
were recorded to conform LSAI's, Schiff's and Securify's
accounting policies. Certain reclassifications were made to the
Company's, LSAI's, Schiff's and Securify's financial statements to
conform presentation. The results of operations for the separate
companies and the combined amounts included in the consolidated
financial statements follow:
<PAGE> 20
-12-
<TABLE>
<CAPTION>
KROLL-
O'GARA
HISTORICAL LSAI SCHIFF SECURIFY COMBINED
---------- ---- ------ -------- --------
<S> <C> <C> <C> <C> <C>
Nine months ended September 30, 1998
(unaudited)
Revenue $ 164,146,336 $ 12,039,154 $ 3,531,062 $ 48,000 $ 179,764,552
Income from discontinued operation 287,000 -- -- -- 287,000
Net income (loss) 11,559,576 1,440,725 582,254 (944,196) 12,638,359
Year ended December 31, 1997
Revenue $ 172,975,941 $ 12,836,953 $ 2,852,303 $ -- $ 188,665,197
Loss from discontinued operation (305,207) -- -- -- (305,207)
Extraordinary item (193,875) -- -- -- (193,875)
Cumulative effect of change in
accounting principle (360,000) -- -- -- (360,000)
Net income 709,866 1,329,103 7,674 -- 2,046,643
Year ended December 31, 1996
Revenue $ 145,890,647 $ 8,726,799 $ 2,530,765 $ -- $ 157,148,211
Income (loss) from discontinued
operations 332,595 (1,274,216) -- -- (941,621)
Net income (loss) 5,857,222 (585,711) (3,096) -- 5,268,415
</TABLE>
In 1998, the Company recorded, in the fourth quarter, a charge to
operating expenses of approximately $5.3 million ($3.9 million
after taxes, or $0.20 per diluted share) for direct and other
merger and integration related costs. Merger transaction costs are
non-recurring and include $0.8 million for stay bonuses and $4.1
million which consisted primarily of fees for investment bankers,
attorneys, accountants, financial printing, travel and other
related charges. Integration costs relate primarily to the merger
with Kroll consummated in December 1997 and were approximately
$0.4 million.
In March 1999, a wholly owned subsidiary of the Company was merged
with and into Financial Research, Inc. (FRI). Effective upon the
consummation of the merger, each then issued and outstanding share
of FRI common stock was converted into 101.555 shares of common
stock of the Company or 101,555 shares of the Company's common
stock in total. The merger constituted a tax-free reorganization
and has been accounted for as a pooling of interests. The prior
period consolidated financial statements would not be materially
different from the reported results and accordingly have not been
restated.
In June 1999, a wholly owned subsidiary of the Company was merged
with and into Background America, Inc. (BAI). Effective upon the
consummation of the merger, each then issued and outstanding share
of BAI common and preferred stock was converted into .2689628
shares of common stock of the Company or 899,243 shares of the
Company's common stock in total. Outstanding stock options and
stock warrants of BAI were converted at the same exchange factor
into options to purchase 86,844 and 2,018 shares, respectively, of
the Company's common stock (see Note 11). The financial position
and results of operations of BAI are reported as part of the
Company's Investigations and Intelligence Group.
<PAGE> 21
-13-
The merger with BAI constituted a tax-free reorganization and has
been accounted for as a pooling of interests. Accordingly, all
prior period consolidated financial statements presented have been
restated to include the combined results of operations, financial
position and cash flows of BAI as though it had always been a part
of the Company.
There were no transactions between the Company and BAI prior to
the combination. Immaterial adjustments were recorded to conform
the accounting practices of the Company and BAI and certain
reclassifications were made to the BAI financial statements to
conform to the Company's presentation.
The combined companies have recorded an income tax benefit of
$113,533 in 1998 to reflect a reduction in a valuation allowance
applicable to certain domestic net operating loss carryforwards.
Included in the December 31, 1998 consolidated balance sheet is
approximately $573,000 of merger costs incurred by the Company
which, along with other merger costs subsequently incurred, will
be expensed immediately upon consummation of the transaction on a
pooling of interests basis in 1999. The results of operations for
the separate companies and the combined amounts presented in the
consolidated financial statements follow:
<TABLE>
<CAPTION>
Kroll-O'Gara
Historical BAI Adjustments Combined
---------- --- ----------- --------
<S> <C> <C> <C> <C>
Year ended December 31, 1998
Revenue $247,192,113 $ 7,350,666 $ -- $254,542,779
Loss from discontinued operation (1,325,471) -- -- (1,325,471)
Net income (loss) 13,088,906 (1,416,374) 113,533 11,786,065
Year ended December 31, 1997
Revenue $188,665,197 $ 4,221,059 $ -- $192,886,256
Loss from discontinued operation (305,207) -- -- (305,207)
Extraordinary item (193,875) -- -- (193,875)
Cumulative effect of change in accounting
principle (360,000) -- -- (360,000)
Net income (loss) 2,046,643 (1,336,644) -- 709,999
Year ended December 31, 1996
Revenue $157,148,211 $ 1,775,815 $ -- $158,924,026
Loss from discontinued operations (941,621) -- -- (941,621)
Net income (loss) 5,268,415 (1,128,919) -- 4,139,496
</TABLE>
<PAGE> 22
-14-
(b) Purchase Transactions--In addition to the merger with Kroll, the
Company completed five other acquisitions in 1997 which were
accounted for as purchase business combinations. Three of the 1997
purchase acquisitions have been included in the Company's Security
Products and Services Group and two in the Investigations and
Intelligence Group. The aggregate purchase price of these five
acquisitions amounted to approximately $22.5 million and consisted
of $13.4 million in cash, $2.5 million in seller-provided
financing and 583,572 shares of common stock (valued at
approximately $6.6 million or an average of $11.31 per share). In
connection with these acquisitions, the Company entered into
various employment and non-compete agreements with officers and
key employees of the acquired companies with varying terms and
conditions. The results of operations of the acquired businesses
are included in the consolidated financial statements from the
respective effective dates of acquisition. The resulting goodwill
from these transactions is being amortized over periods ranging
from fifteen to thirty years. In addition to these 1997
acquisitions, the Company also exercised its option to acquire the
minority interest in its O'Gara Brazilian subsidiary for
approximately 69,565 shares of common stock valued at
approximately $1.2 million.
The Company made one significant acquisition in 1997 which is
included above. In February 1997, Labbe, S.A. (Labbe), a company
located in France specializing in vehicle armoring systems, was
acquired for approximately $14.2 million, consisting of $10.7
million in cash and 376,597 shares of the Company's common stock
valued at approximately $3.5 million or $9.29 per share. For
accounting purposes, the acquisition was effective on January 1,
1997 and the results of operations of Labbe are included in the
consolidated results of operations of the Company from that date
forward. The following unaudited pro forma combined results of
operations for the year ended December 31, 1996 assumes the Labbe
acquisition occurred as of January 1, 1996 (in thousands, except
per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
----------------------------
<S> <C>
Sales $183,042
Income from continuing operations $ 5,276
Net income $ 4,334
Earnings per share:
Basic $ 0.35
Diluted $ 0.32
</TABLE>
In addition to the mergers with LSAI, Schiff and Securify, the
Company completed nine other acquisitions in 1998, all of which
were accounted for as purchase business combinations. Eight of the
1998 purchase acquisitions have been included in the Company's
Investigations and Intelligence Group and the ninth has been
included in the Security Products and Services Group. The
aggregate purchase price of these nine acquisitions amounted to
approximately $37.1 million and consisted of $19.5 million in
<PAGE> 23
-15-
cash and 767,416 shares of common stock (valued at approximately
$17.6 million or an average of $22.93 per share). The $37.1
million aggregate purchase price for the 1998 acquisitions
excludes a potential earnout of $3.25 million applicable to one of
the acquired companies, which is payable over three years and is
contingent upon the achievement of specified operating income
targets. In conjunction with one of the 1998 purchase
acquisitions, the shareholders of the acquired entity had the
option to put the shares of common stock received for cash of
$22.31 per share for a certain defined period. The put option
relating to 7,471 shares issued in connection with this
acquisition was exercised for $166,668 in cash with the remaining
put options expiring unexercised. In addition, in connection with
several of these acquisitions, the Company entered into various
employment and non-compete agreements with officers and key
employees of the acquired companies with varying terms and
conditions. The results of operations of the acquired businesses
are included in the consolidated financial statements from the
respective effective dates of acquisition. The allocation of
purchase price was based on estimates and may be revised at a
later date pending the completion of certain appraisals and other
analyses. The resulting goodwill from these transactions is being
amortized over periods ranging from twelve to twenty-five years.
The Company made one significant acquisition in 1998 which is
included above. In September 1998, Kizorek, Inc., now renamed In
Photo Surveillance, Inc. (In Photo), a company located in Illinois
specializing in video surveillance services, was acquired for
approximately $9.0 million, consisting of $0.8 million in cash and
352,381 shares of the Company's common stock valued at
approximately $8.2 million or $23.35 per share. For accounting
purposes, the acquisition was effective on July 1, 1998 and the
results of operations of In Photo are included in the consolidated
results of operations of the Company from that date forward. The
following unaudited pro forma combined results of operations for
the years ended December 31, 1997 and 1998 assumes the In Photo
acquisition occurred as of January 1, 1997 (in thousands, except
per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1997 1998
---- ----
<S> <C> <C>
Sales $207,362 $260,928
Income from continuing operations before extraordinary
item and cumulative effect of accounting change $ 2,063 $ 13,028
Net income $ 1,204 $ 11,702
Earnings per share:
Basic $ 0.08 $ 0.60
Diluted $ 0.08 $ 0.58
</TABLE>
In connection with the 1997 and 1998 purchase acquisitions, assets
were acquired and liabilities were assumed as follows (dollars in
thousands):
<PAGE> 24
-16-
<TABLE>
<CAPTION>
OTHER 1997 OTHER 1998
LABBE ACQUISITIONS IN PHOTO ACQUISITIONS
----- ------------ -------- ------------
<S> <C> <C> <C> <C>
FAIR VALUE OF ASSETS ACQUIRED
INCLUDING:
Cash $ 3,501 $ 125 $ 192 $ 701
Accounts Receivable 4,689 242 1,743 5,325
Inventories 3,392 553 -- --
Unbilled revenue -- -- 269 1,561
Other current assets 316 11 450 551
Property, plant and equipment 3,360 298 955 1,296
Other non-current assets 2,357 4 -- 271
Costs in excess of assets
acquired and other
intangible assets 7,802 8,268 8,995 28,147
-------- -------- -------- --------
25,417 9,501 12,604 37,852
Less: Cash paid for net assets (10,730) (2,700) (800) (18,689)
Fair value of debt issued -- (2,551) -- --
Fair value of stock issued (3,431) (3,178) (8,228) (9,381)
-------- -------- -------- --------
$ 11,256 $ 1,072 $ 3,576 $ 9,782
======== ======== ======== ========
LIABILITIES ASSUMED INCLUDING:
Liabilities assumed and
acquisition costs $ 9,287 $ 1,053 $ 3,376 $ 8,934
Debt 1,969 19 200 848
-------- -------- -------- --------
$ 11,256 $ 1,072 $ 3,576 $ 9,782
======== ======== ======== ========
</TABLE>
(4) Balance Sheet Accounts-
(a) Trade Accounts Receivable and Costs and Estimated Earnings in
Excess of Billings on Uncompleted Contracts--The following
summarizes the components of trade accounts receivable and costs
and estimated earnings in excess of billings on uncompleted
contracts:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
----------- -----------
<S> <C> <C>
United States Military:
Billed receivables $ 3,756,035 $ 3,225,664
Costs and estimated earnings in excess of billings on
uncompleted contracts 9,253,872 21,042,185
----------- -----------
Total United States Military $13,009,907 $24,267,849
=========== ===========
</TABLE>
<PAGE> 25
-17-
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
----------- -----------
<S> <C> <C>
Other contracts:
Billed receivables $29,897,070 $45,711,380
Costs and estimated earnings in excess of billings on
uncompleted contracts 2,643,929 5,365,912
Total other contracts $32,540,999 $51,077,292
Total trade accounts receivable $33,653,105 $48,937,044
----------- -----------
Total costs and estimated earnings in excess of billings on
uncompleted contracts $11,897,801 $26,408,097
=========== ===========
</TABLE>
Costs and estimated earnings in excess of billings on uncompleted contracts are
net of $89,875,813 and $107,374,834 of progress billings to the United States
Military at December 31, 1997 and 1998, respectively.
Costs and estimated earnings in excess of billings on uncompleted contracts
represent revenue recognized on long-term contracts in excess of billings
because amounts were not billable at the balance sheet date. It is anticipated
such unbilled amounts attributable to the United States Military will generally
be billed over the next 180 days as the contract is substantially completed.
Amounts receivable on other contracts are generally billed as shipments are
made. It is estimated that substantially all of such amounts will be billed
within one year, although contract extensions may delay certain collections
beyond one year.
The following summarizes activity in the allowance for doubtful accounts on
trade accounts receivable:
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO BALANCE
BEGINNING OF COSTS AND END OF
PERIOD EXPENSES DEDUCTIONS PERIOD
---------- ---------- ----------- ----------
<S> <C> <C> <C> <C>
Year ended
December 31, 1996 $2,685,171 $3,715,366 $(3,929,718) $2,470,819
Year ended
December 31, 1997 $2,470,819 $2,043,814 $(1,521,162) $2,993,471
Year ended
December 31, 1998 $2,993,471 $1,242,355 $(1,809,002) $2,426,824
</TABLE>
<PAGE> 26
-18-
(b) Inventories--Inventories are stated at the lower of cost or
market using the first-in, first-out (FIFO) method and include
the following:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1997 1998
----------- -----------
<S> <C> <C>
Raw materials $ 8,192,678 $ 7,102,009
Vehicle costs and work-in-process 8,472,966 11,505,053
----------- -----------
$16,665,644 $18,607,062
=========== ===========
</TABLE>
The following summarizes activity in valuation reserves for inventory
obsolescence:
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO BALANCE
BEGINNING OF COSTS AND END OF
PERIOD EXPENSES DEDUCTIONS PERIOD
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Year ended
December 31, 1996 $ -- $252,114 $ -- $252,114
Year ended
December 31, 1997 $252,114 $112,000 $(23,782) $340,332
Year ended
December 31, 1998 $340,332 $ 9,668 $ -- $350,000
</TABLE>
(c) Other Assets--Other assets are stated at cost less accumulated
amortization and are being amortized on a straight line basis
over their estimated useful lives, as applicable. Other assets
consist of the following:
<TABLE>
<CAPTION>
USEFUL DECEMBER 31,
LIFE --------------------------
DESCRIPTION (YEARS) 1997 1998
-------------------------------------------------------------- ----------- ----------- -----------
<S> <C> <C> <C>
Preoperating and start-up costs -- $1,029,784 $1,185,574
Security deposits -- 480,939 1,003,666
Pending acquisition costs -- -- 573,035
Long-term receivable -- 380,000 380,000
Non-refundable deposit on an equipment lease with a
related party 5 297,025 537,784
Deferred financing fees 7-30 876,667 906,667
Long-term investments -- 21,971 --
Other long-term assets -- 65,720 504,899
---------- ----------
3,152,106 5,091,625
(166,477) (209,209)
---------- ----------
$2,985,629 $4,882,416
========== ==========
</TABLE>
Preoperating and start-up costs include costs applicable to bids in
process which are deferred when management believes it is probable
that future contracts will be obtained. These costs are transferred
to contract costs when contracts are awarded or
<PAGE> 27
-19-
are expensed when the contract award is no longer considered
probable. Preopening and start-up costs also include certain
costs incurred in connection with establishing operations in
new locations. In accordance with SOP 98-5, all such costs
will be expensed in the first quarter of fiscal 1999 (see
Note 2(q)).
(d) Accrued Liabilities--Accrued liabilities consist of the
following at December 31, 1997 and 1998:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
DESCRIPTION 1997 1998
------------------------------------------------- ----------- -----------
<S> <C> <C>
Payroll and related benefits $ 8,364,863 $ 9,860,811
Property, sales and other taxes payable 773,846 2,160,417
Accrued professional fees 385,403 3,993,486
Accrued interest 564,168 460,923
Accrued hedge contract settlement -- 710,760
Accrued customer list installment payments 510,345 515,538
Other accruals 3,758,255 3,048,538
----------- -----------
$14,356,880 $20,750,473
=========== ===========
</TABLE>
(5) Income Taxes
Prior to October 28, 1996, OHE was an S Corporation and generally was not
responsible for payment of income taxes. Rather, the OHE shareholders were
taxed on OHE's taxable income at their respective individual federal and
state income tax rates. Therefore, the income generated by OHE was not
subject to federal, state or certain foreign income taxes prior to the date
of OHE's reorganization on October 28, 1996. Schiff was also an S
Corporation for all periods prior to December 31, 1998. Accordingly, the
accompanying consolidated financial statements only reflect a provision
(benefit) for income taxes for Kroll, BAI and LSAI, all of which were C
Corporations, for all periods prior to October 28, 1996.
The Company accounts for income taxes under the liability method pursuant
to Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes." Under the liability method, deferred tax liabilities and
assets are determined based on the differences between the financial
reporting and tax bases of assets and liabilities using enacted tax rates.
<PAGE> 28
-20-
The Company's provision (benefit) for income taxes on income (loss) from
continuing operations for all periods is summarized as follows:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- ----------
<S> <C> <C> <C>
Currently payable:
Federal $ 470,479 $ 2,800,720 $5,530,085
State and local 383,563 576,837 965,158
Foreign 83,000 1,364,873 1,834,143
----------- ----------- ----------
937,042 4,742,430 8,329,386
----------- ----------- ----------
Deferred:
Federal (425,558) (1,213,147) (847,018)
State and local (145,937) (224,290) (129,437)
Foreign -- -- --
----------- ----------- ----------
(571,495) (1,437,437) (976,455)
----------- ----------- ----------
$ 365,547 $ 3,304,993 $7,352,931
=========== =========== ==========
</TABLE>
A reconciliation between the statutory federal income tax rate and the
effective tax rate is summarized as follows:
<TABLE>
<CAPTION>
1996 1997 1998
---------------------- ---------------------- ----------------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
----------- -------- ----------- -------- ----------- --------
<S> <C> <C> <C> <C> <C> <C>
Provision for income taxes at the
federal statutory rate $ 1,851,866 34.0% $1,657,185 34.0% $7,039,777 34.4%
State and local income taxes, net
of federal benefit 156,912 2.9 295,119 6.1 637,004 3.1
Impact of S Corp income/loss,
prior to reorganization (2,087,529) (38.3) -- -- -- --
Impact of foreign income, prior to
reorganization (199,095) (3.7) -- -- -- --
Nondeductible expenses 43,348 0.8 1,357,517 27.9 197,446 1.0
Change in valuation allowance 484,553 8.9 (319,283) (6.6) (194,744) (1.0)
Effect of foreign income/loss 105,368 1.9 577,743 11.8 (47,924) (0.2)
Other 10,124 0.2 (263,288) (5.4) (278,628) (1.4)
Provision for income taxes $ 365,547 6.7% $3,304,993 67.8% $7,352,931 35.9%
=========== === ========== ==== ========== ====
</TABLE>
<PAGE> 29
-21-
The components of the Company's consolidated deferred income tax assets and
liabilities as of December 31 are summarized below:
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts $ 844,101 $ 432,027
Depreciation and amortization 564,262 244,693
Net operating loss carryforwards 2,793,873 3,580,761
Payroll and other benefits 594,401 1,721,081
Other accruals 336,817 707,708
Acquisition costs 440,000 1,697,885
Other 981,610 512,382
----------- -----------
6,555,064 8,896,537
Valuation allowance (3,080,165) (3,109,974)
----------- -----------
Net deferred tax assets 3,474,899 5,786,563
----------- -----------
Deferred tax liabilities:
Nonaccrual service fee receivable (212,079) (156,804)
Deferred revenue (1,908,823) (3,540,825)
Database capitalization (2,779,790) (2,951,351)
S to C conversion (5,223) (5,223)
Customer lists, net of amortization (344,000) (310,667)
Percentage of completion on foreign subsidiaries -- (381,917)
Foreign leasing transactions -- (125,827)
Other (166,893) (720,887)
----------- -----------
(5,416,808) (8,193,501)
----------- -----------
Net deferred tax liability $(1,941,909) $(2,406,938)
=========== ===========
</TABLE>
The Company has certain foreign and domestic net operating loss
carryforwards, which approximated $2.8 million and $3.6 million at
December 31, 1997 and 1998, respectively. The foreign net operating loss
carryforwards relate primarily to the United Kingdom, France and the
Philippines. The carryforwards expire beginning in 2001. A valuation
allowance for the majority of all existing foreign carryforwards has been
provided as it is not certain that the tax benefit will be realized in the
foreseeable future. Adjustments to the valuation allowance, if any, will be
recorded in the periods in which it is determined the asset is realizable.
<PAGE> 30
-22-
(6) Related Party Transactions
(a) Summary of Related Party Transactions--The following summarizes
transactions with related parties:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1996 1997 1998
---------- ---------- ----------
<S> <C> <C> <C>
Sales
to Shareholder $5,325,559 $6,412,244 $4,877,478
to affiliated entities 1,019,800 1,294,800 821,400
Purchases
from Shareholder 824,348 814,154 474,800
from affiliated entities 1,267,450 447,525 1,406,210
Lease expense to affiliated entities 1,196,500 856,300 916,600
Consulting, commission and legal services expense
provided by affiliated entities 348,000 -- --
provided by minority shareholders 118,000 -- --
provided by LSAI Director 30,000 170,000 190,000
Non-interest bearing advances to shareholders 288,829 525,996 568,213
Air charter fees included in costs of the offering
or merger costs 327,000 576,000 566,000
Interest on shareholder notes payable 66,600 78,950 1,100
Forgiveness of note payable to affiliated
entity/shareholder 122,000 1,053,735 --
Non-interest bearing advances to affiliates -- 282,346 615,851
</TABLE>
(b) Notes Payable-Shareholders--OHE had certain notes payable to
shareholders, which were repaid upon the completion of the Company's
initial public offering in 1996. Interest expense associated with
these obligations approximated $27,000 for the year ended
December 31, 1996.
BAI also had certain notes payable to shareholders. Interest expense
associated with these obligations approximated $78,950 and $1,100 in
1997 and 1998, respectively. In June 1997, approximately $1,053,735
of the principal and accrued interest payable by BAI to certain
shareholders was canceled in part consideration for the issuance of
stock. The remaining outstanding balance of $152,000 was paid in full
during 1998.
<PAGE> 31
-23-
The Company has certain amounts due to/from shareholders which
include the following amounts at December 31:
<TABLE>
<CAPTION>
1997 1998
--------- --------
<S> <C> <C>
Amounts due from certain shareholders $ 525,996 $568,213
--------- --------
Amounts due to certain shareholders (309,500) --
--------- --------
Net due from (due to) shareholders $ 216,496 $568,213
========= ========
</TABLE>
Balances included in amounts due to/from shareholders are classified
as open advance accounts or term loans. Substantially all amounts due
to and due from shareholders were paid off in connection with the
Kroll merger except for a loan payable of $309,500 which was paid off
during 1998.
(c) Sales-Shareholder--During 1996, 1997 and 1998, the Company rendered
services to a corporation which is also a shareholder of the Company.
Total revenue recognized for the years ended December 31, 1996, 1997
and 1998 was $5,325,559, $6,412,244 and $4,877,478, respectively.
Additionally, this corporation provided certain services to the
Company which have been included in cost of sales and operating
expenses in the accompanying consolidated statements of operations.
These costs were approximately $824,348, $814,154 and $474,800 for
the years ended December 31, 1996, 1997 and 1998, respectively.
The year end accounts receivable balance for this customer was
approximately $897,361 and $1,290,558 at December 31, 1997 and 1998,
respectively.
(d) Building and Equipment Leases - Affiliated Entities--Effective
June 1, 1998, the Company reached an agreement to terminate the
corporate aircraft lease which originated in February 1995 with an
affiliated entity. The terms of the aircraft lease addendum will
provide the Company with a future hourly discount from the normal
commercial hourly rate in order to amortize the remaining portion of
existing lease deposits from the original aircraft lease. Rental
expense, including amortization recognized, approximated $422,000,
$234,000 and $292,000 for the years ended December 31, 1996, 1997 and
1998, respectively. The Company also paid this affiliated entity
$327,000 in fiscal 1996 for usage of the aircraft during the roadshow
for the initial public stock offering and included such amount in
issuance costs. The Company paid $576,000 in fiscal 1997 for usage of
the aircraft to consummate the merger with Kroll and included such
amount in merger-related costs. The Company paid $296,000 in 1998 for
usage of the aircraft during the roadshow for a stock offering and
included such amount in stock issuance costs. The Company also paid
$270,000 in fiscal 1998 for usage of the aircraft to consummate the
merger with Securify and included such amount in merger related
costs. Management is of the opinion that the hourly rate paid by the
Company was equivalent to the rate charged by the affiliated entity
to other unrelated companies for similar services and it was
favorably comparable to rates charged by another unrelated charter
service for similar aircraft. As of December 31, 1997 and 1998, the
Company had approximately $297,025 and $484,371, respectively in
unamortized lease deposits with this affiliated entity.
<PAGE> 32
-24-
The Company is also currently leasing various equipment, a
manufacturing facility, and office space from several affiliated
entities under various three year and month-to-month lease
agreements. Rental expense, net of sub-lease income, approximated
$775,000, $622,000 and $625,000 for the years ended December 31,
1996, 1997 and 1998, respectively.
(7) Revolving Lines of Credit-
On October 30, 1998, the Company amended and restated its credit agreement
to provide for a revolving line of credit of $7.0 million and a letter of
credit facility of approximately $7.6 million which matures on May 31,
2000. The revolving credit facility bears interest at rates ranging from
prime less 1.75% to prime less .25%, or, at the Company's option, LIBOR
plus .75% to LIBOR plus 1.5%, dependent upon a defined financial ratio.
Average borrowings under the revolving line of credit and its predecessors
were $9,915,663, $4,568,994 and $1,659,131 during 1996, 1997 and 1998,
respectively, at approximate weighted average interest rates of 8.27%,
8.46% and 7.96%, respectively. The maximum borrowings outstanding during
1996, 1997, and 1998 were $12,145,000, $11,600,000 and $7,735,029,
respectively. Borrowings under this line of credit were $559,112 at
December 31, 1997. There were no outstanding borrowings under this line of
credit at December 31, 1998. On June 25, 1999 this credit agreement was
amended to provide for a revolving line of credit of $25.0 million.
In connection with a refinancing in 1997, the Company fully amortized the
remaining deferred financing costs from a previous agreement, resulting
in an extraordinary charge to the company's net income of $193,875, after
income tax benefits of $129,250, or $0.01 per diluted share.
This credit agreement includes financial covenants, which among other
restrictions, requires the maintenance of certain financial ratios and
other financial requirements, including a fixed charge coverage ratio and
net worth minimum, and imposes limitations on foreign investment, total
intangible assets, additional indebtedness and capital expenditures. The
Company was not in compliance with certain of these covenants as of
December 31, 1997 and 1998. These events of non-compliance were waived by
the lender. Had the lender not provided a waiver, all amounts outstanding
under the credit agreement would have been immediately payable.
BAI also has a credit agreement with a bank which provides for a maximum
working capital line of credit of $1,000,000. There were no borrowings
outstanding under the credit facility at December 31, 1997 and 1998. In
addition, there were no amounts drawn on the line of credit during 1998.
The credit facility bears interest at the bank's index rate, is due and
payable monthly and is guaranteed by certain shareholders of BAI. This
line of credit matured in April 1999.
(8) Long-Term Debt-
<PAGE> 33
-25-
The components of long-term debt are as follows at:
<TABLE>
<CAPTION>
DECEMBER 31,
---------------------------
1997 1998
----------- -----------
<S> <C> <C>
Senior unsecured notes payable to various institutions, interest at 8.56%
(9.56% prior to May 1998) payable semi-annually, principal payable at
maturity in May 2004, subject to prepayment penalties $35,000,000 $35,000,000
Economic Development Revenue Bonds, variable interest rate approximating
85% of the bond equivalent yield of 13 week U.S. Treasury bills (not to
exceed 12%), which approximated 4.52% at December 31, 1998, payable in
scheduled installments through September 2016, subject to optional
tender by the bondholders and a corresponding remarketing agreement,
secured by the property, plant and equipment of OHE and a bank letter
of credit (Note 12) 1,432,224 1,357,224
Notes payable to former shareholders of acquired companies, interest at
fixed rates ranging from 6% to 10%, payable in scheduled installments
through February 2000, certain notes secured by acquired assets 3,345,989 2,526,361
Notes payable to banks, variable interest rates at prime to prime plus
0.5% or LIBOR plus 2.5%, fixed rates ranging from 8.65% to 10.95%,
payable in scheduled installments through April 2003 with certain
instruments subject to prepayment penalties, collateralized by certain
real and personal property 9,801,780 1,001,204
Note payable to former shareholder of Kroll, non interest bearing, paid in
full in January 1998 1,255,402 --
Other notes payable, interest at 7% to 10.9%, payable in scheduled
installments through September 2007, certain notes secured by various
equipment 2,844,169 1,462,065
----------- -----------
53,679,564 41,346,854
Less- current portion (4,038,080) (2,000,299)
----------- -----------
$49,641,484 $39,346,555
=========== ===========
</TABLE>
The Company's $35 million of senior unsecured notes payable also contains
financial covenants, which among other restrictions, requires the
maintenance of a minimum level of net worth and a fixed charge coverage
ratio.
Scheduled maturities of long-term debt at December 31, 1998 are as
follows:
<TABLE>
<S> <C>
1999 $ 2,000,299
2000 2,454,193
2001 445,562
2002 236,765
2003 196,119
Thereafter 36,013,916
-----------
$41,346,854
===========
</TABLE>
<PAGE> 34
-26-
(9) Operating Leases-
The Company leases office space and certain equipment and supplies under
agreements with terms from one to ten years. The following is a schedule,
by year, of approximate future minimum rental or usage payments required
under operating leases that have initial or non-cancelable lease terms in
excess of one year as of December 31, 1998:
<TABLE>
<CAPTION>
TOTAL
-----------
<S> <C>
1999 $ 6,613,347
2000 5,673,899
2001 3,787,784
2002 2,872,836
2003 2,438,388
Thereafter 8,766,311
-----------
$30,152,565
===========
</TABLE>
Rental expense charged against current operations amounted to approximately
$4,632,000, $4,294,000 and $6,640,000, for the years ended December 31,
1996, 1997 and 1998, respectively.
(10) Defined Contribution and Bonus Plans-
As of December 31, 1998, the Company had the following employee benefit
plans in place:
(a) Defined Contribution Plans--The Company and its subsidiaries have
established various non-contributory profit sharing/401(k) plans
covering substantially all of the Company's employees. Contributions
to the plans are discretionary and are determined annually by the
Company's Board of Directors. Certain plans also offer a matching
contribution whereby the Company will contribute a percentage of the
amount a participant contributes, limited to certain maximum amounts.
Plan contribution expense charged against current operations for all
such plans amounted to approximately $1,258,492, $1,211,140 and
$797,003, for the years ended December 31, 1996, 1997 and 1998,
respectively.
(b) Profit and Revenue Sharing Plans--The Company and its subsidiaries
have established various profit and revenue sharing plans covering
substantially all of the Company's employees. The plans were
established to provide employees an annual cash incentive
<PAGE> 35
-27-
bonus based on various operating and non-operating criteria. The
Company may amend, modify or terminate these plans at any time.
The Company expensed approximately $2,288,000, $516,000 and $476,000
associated with the profit and revenue sharing plans in 1996, 1997
and 1998, respectively.
(11) Equity Arrangements-
(a) Stock Option Plans--In 1996, the Company adopted a stock option
plan (the 1996 Plan) for employee, non-employee directors and
consultants. The Company may grant options for up to 1,757,000 shares
under the 1996 Plan. Options for 180,000, 482,050 and 360,000 shares
were granted during 1996, 1997 and 1998, respectively. Options
granted under the plan are generally granted at fair market value at
the date of grant and are exercisable over periods not exceeding ten
years. Additionally, effective with the mergers with Kroll, LSAI,
Securify and BAI each outstanding stock option was converted at the
respective exchange factor into options to purchase Company common
stock. After conversion, total stock options granted under the
previously existing Kroll, LSAI, Securify and BAI stock option plans
in 1996, 1997 and 1998 were 225,754, 174,887 and 248,497,
respectively.
In connection with stock options granted by Securify during the year
ended December 31, 1998, the Company recorded deferred compensation
of $1,192,096, representing the difference between the deemed value
of the common stock for accounting purposes and the option exercise
price of such options at the date of grant. This amount is presented
as a reduction of shareholders' equity and will be amortized ratably
over the vesting periods of the applicable options. Approximately
$78,000 was expensed during the year ended December 31, 1998, and the
balance will be expensed ratably over the next four years as the
options vest.
(b) Restricted Stock Plan--Effective June 14, 1993, Kroll replaced a
previously existing long-term incentive plan with a restricted stock
plan. The restricted stock plan provided for cliff vesting after a
five-year period from the date the stock was awarded. Under the
provisions of the plan, a participant had the ability to put the
stock back to Kroll and receive cash for the then fair value of the
stock. In addition, the plan included a provision which resulted in
accelerated vesting of all shares in the event of a change in control
of Kroll. The Company has accounted for this plan as a fixed plan
and, accordingly, compensation expense was based on the fair market
value as determined by independent appraisal at the date of grant.
During 1996, 259,271 shares of restricted stock fully vested and were
issued. Based on a valuation of Kroll, the total value assigned to
these shares was $572,286.
Kroll also entered into other agreements with certain of its senior
executives which provided additional grants. During 1996, all 144,421
of these previously granted shares fully vested and were issued.
Based on a valuation of Kroll, the total value
<PAGE> 36
-28-
assigned to these shares on the vesting date was $318,780. As a
result of the Kroll merger in December 1997, all remaining shares
associated with the restricted stock plan vested and all restrictions
lapsed on the merger date. In connection with this accelerated
vesting the Company recognized compensation expense of approximately
$800,000 in 1997, which is included with merger related costs in the
accompanying consolidated statement of operations. In addition to the
regular tax benefits based on compensation expense recognized, the
Company also realized a tax benefit for the fair market value of all
restricted shares which became fully vested in 1997. This benefit of
approximately $2.2 million has been recognized as an increase to
additional paid in capital in the accompanying consolidated statement
of shareholders' equity. This balance represents the spread between
cumulative compensation expense recognized by the Company for
accounting purposes and the cumulative compensation expense
recognized for tax purposes based on the fair market value of the
shares. No shares were outstanding under the plan as of December 31,
1997 and effective January 2, 1998, further issuances under the plan
were ceased by a board resolution.
Effective August 12, 1998, the Company adopted a stock incentive plan
(the 1998 Stock Incentive Plan) for employees. The Company may grant
up to 500,000 shares under the 1998 Stock Incentive Plan. There were
no shares granted under the plan during 1998, however, during fiscal
1999, 47,500 shares were granted under the plan.
(c) Purchase and Retirement of Common Stock--In accordance with Kroll's
historical bylaws, restricted stock and stock option agreements,
Kroll acquired 259,036 shares (representing shares and shares under
options) of a former director for approximately $2.7 million upon his
leaving the employment of Kroll in January 1997.
(d) Common Stock Warrants--In connection with LSAI's initial public
offering on October 11, 1994, LSAI issued 660,000 warrants. No
warrants had been exercised at December 31, 1996. Until April 15,
1997, each warrant could be exercised to purchase .4204 shares of
common stock of the Company for $16.65 per share. After April 15,
1997, each warrant could be exercised to purchase .4204 shares of
common stock for $9.51 per share. On September 3, 1997, LSAI gave
notice to the holders of these warrants of LSAI's election to redeem
the outstanding warrants at $0.01 each on October 14, 1997, unless
extended, at the sole discretion of LSAI, 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, LSAI
also issued warrants to purchase 66,000 units at $7.32 per unit,
consisting of .4204 shares of common stock of the Company and one
warrant for .4204 additional shares of common stock of the Company,
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
<PAGE> 37
-29-
of these warrants were exercised for $0.12 per warrant plus $9.51 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 .4204 shares of common stock
of the Company comprising the unit for $7.20. In November 1997,
30,000 of the Underwriter Warrants were exercised with respect to the
.4204 shares of common stock of the Company comprising the unit for
$7.20. The remaining 36,000 of the Underwriter Warrants with respect
to the .4204 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 stock options and warrants in the accompanying consolidated
statement of cash flows and approximated $2.7 million, net of
commissions and other offering expenses.
In connection with the Warrant Redemption, LSAI issued warrants to
purchase 30,281 shares of common stock of the Company 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 $10.47 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 LSAI
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 shareholders' equity.
As of December 31, 1998, 24,386 warrants granted by LSAI were still
outstanding.
As of December 31, 1996 and 1997, BAI had outstanding warrants to
purchase 134 shares of common stock at $13.01 per share and 1,076
shares of common stock at $4.65 per share. These warrants were issued
in June and July of 1996 to certain consultants and other
non-employees of the Company with exercise prices equal to or greater
than the then fair value of BAI's common stock on those dates.
Additionally, as of December 31, 1998, BAI also had outstanding
warrants to purchase 807 shares of common stock at $19.52 per share
which were issued in January of 1998.
As of December 31, 1998, the Company had a total of 26,403 warrants
still outstanding.
(e) Stock Based Compensation Disclosure--SFAS 123 requires, at a minimum,
pro forma disclosures of expense for stock-based awards based on
their fair values. Had compensation cost for these plans been
determined consistent with SFAS 123, the Company's net income and
diluted earnings per share for the years ended December 31, 1996,
1997 and 1998 would have been as follows:
<PAGE> 38
-30-
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- -----------
<S> <C> <C> <C>
Net income:
As reported $4,139,496 $ 709,999 $11,786,065
Pro forma $4,023,548 $(403,461) $ 9,315,427
Diluted earnings per share:
As reported $ .31 $ .05 $ .59
Pro forma $ .30 $ (.03) $ .47
</TABLE>
<PAGE> 39
-31-
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following
weighted average assumptions used for grants in 1996, 1997 and 1998:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
--------------------------------------------------------------
1996 1997 1998
---------------- --------------------- ---------------------
<S> <C> <C> <C>
Dividend yield -- -- --
Expected volatility 0% - 39.3% 0% - 40.5% 40%-41.4%
Risk-free interest rate 5.7% - 6.5% 5.8% - 6.76% 4.2% - 5.7%
Expected lives 5 - 7.5 years 5 - 7.5 years 1.5 - 7.5 years
</TABLE>
Option grants by the Company during 1996 for 235,012 shares have a
weighted-average exercise price of $9.37, a weighted-average fair
value of $4.79 and remaining contractual lives, on a
weighted-average basis, of 7.5 years. The remaining 170,742
options granted by the Company during 1996 were determined to have
a fair value of $0. The 656,937 options granted by the Company
during 1997 have a weighted-average exercise price of $14.56, a
weighted-average fair value of $7.28 and remaining contractual
lives, on a weighted-average basis, of 9.4 years. The 608,497
options granted by the Company during 1998 have a weighted-average
exercise price of $12.78, a weighted-average fair value of $9.35
and remaining contractual lives, on a weighted-average basis, of
9.4 years.
A summary of the status of the Company's stock option plans at
December 31, 1996, 1997 and 1998, and the change during the years
then ended is presented in the table below:
<TABLE>
<CAPTION>
1996 1997 1998
--------------------- ---------------------- ----------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
---------- --------- ---------- --------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Outstanding, beginning of year 407,022 $6.91 812,749 $ 6.68 1,371,808 $10.11
Granted 405,754 6.44 656,937 14.56 608,497 12.78
Exercised -- -- (6,745) 8.50 (477,894) 8.52
Forfeited/Expired/ Cancelled (27) 4.65 (91,133) 11.74 (42,421) 17.05
------- ----- --------- ------ --------- ------
Outstanding, end of year 812,749 $6.68 1,371,808 $10.11 1,459,990 $11.54
======= ===== ========= ====== ========= ======
Exercisable, end of year 261,538 $6.14 761,825 $ 6.52 855,122 $ 8.31
======= ===== ========= ====== ========= ======
</TABLE>
Of the options outstanding at December 31, 1998, 314,944 options
are exercisable at prices per share ranging from $0.37 to $2.79
per share, 831,449 options are exercisable at prices per share
ranging from $4.65 to $18.59 per share and 313,598 options are
exercisable at prices per share ranging from $20.22 to $28.54 per
share.
(12) Commitments and Contingencies-
<PAGE> 40
-32-
(a) Letters of Credit--Under the terms of the Economic Development
Revenue Bonds Agreement, OHE is required to maintain a letter of
credit supporting the debt. As of December 31, 1998, the Company's
lender was committed to providing this letter of credit through
May 31, 2000. As of December 31, 1998, the Company had an
outstanding letter of credit in the amount of $1,681,750.
At December 31, 1998, the Company had standby and purchase letters
of credit, issued by the Company's lender, in the aggregate amount
of $3,263,081.
(b) Employment Agreements--The Company has employment agreements with
its executive officers and management level personnel with annual
compensation ranging in value from $57,000 to $400,000, over varying
periods extending to December 2003. The agreements generally provide
for salary continuation in the event of termination without cause for
the greater of the remainder of the agreement or one year. The
agreements also contain certain non-competition clauses and generally
provide for one year's salary if the agreement is not renewed.
As of December 31, 1998, the remaining aggregate commitment under
these employment agreements if all individuals were terminated
without cause was approximately $33.5 million.
(c) Legal Matters--The Company is party to various legal proceedings
arising from its operations. Management of the Company believes
that the outcome of these proceedings, individually and in the
aggregate, will have no material adverse effect on the Company's
financial position, results of operations or its cash flows.
(13) Fair Value of Financial Instruments-
The fair values of significant current assets, current liabilities and
long-term debt approximate their respective historical carrying amounts.
The Company has entered into eight foreign currency exchange contracts to
effectively hedge its exposure to certain foreign currency rate
fluctuations on demand loans to two subsidiaries which are denominated in
foreign currencies. By virtue of these contracts, the Company has fixed
the total dollar amount which they will receive under the aforementioned
subsidiary loans through the maturity dates of the contracts regardless
of the fluctuations in the exchange rate. As of December 31, 1998, the
total notional amount of the contracts, which mature between January 1999
and December 2000, was $18.3 million. The Company's cumulative foreign
currency translation adjustment component of shareholders' equity was
increased by $346,000 in 1997 and decreased by $702,000 in 1998 as a
result of these agreements.
The Company has estimated the fair value of their foreign exchange
contracts based on information obtained from the counterparty of the
amount the Company would receive at December 31, 1998 in order to
terminate the agreements. As of December 31, 1998, the Company would have
paid approximately $1,031,000 upon cancellation of all contracts.
<PAGE> 41
-33-
(14) Customer and Segment Data-
Segment Data--During 1996 and 1997, the Company operated in two business
segments, the Security Products and Services Group and the Investigations
and Intelligence Group. In addition, in 1998, the Company created the
information Security Group in connection with the merger with Securify.
The following summarizes information about the Company's business
segments:
<TABLE>
<CAPTION>
SECURITY INVESTIGATIONS
PRODUCTS AND INFORMATION
AND SERVICES INTELLIGENCE SECURITY
GROUP GROUP GROUP OTHER CONSOLIDATED
------------ -------------- ----------- --------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
1996
----
Net sales to unaffiliated customers $79,156 $79,768 $ -- $ -- $158,924
======== ======== ======= ======= ========
Gross profit $20,472 $25,188 $ -- $ -- $ 45,660
======== ======== ======= ======= ========
Operating income $ 6,954 $ 1,207 $ -- $ -- $ 8,161
======== ======== ======= ======= ========
Identifiable assets at year-end $39,343 $47,186 $ -- $ -- $ 86,529
======== ======== ======= =======
Corporate assets 1,357
Net assets of discontinued
operation 3,880
--------
Total assets at year-end $ 91,766
========
1997
----
Net sales to unaffiliated customers $105,557 $87,329 $ -- $ -- $192,886
======== ======== ======= ======= ========
Gross profit $ 30,006 $33,979 $ -- $ -- $ 63,985
======== ======== ======= ======= ========
Operating income $ 8,238 $ 1,775 $ -- $ -- $ 10,013
======== ======== ======= ======= ========
Identifiable assets at year-end $ 74,283 $58,670 $ -- $ -- $132,953
======== ======== ======= =======
Corporate assets 5,386
Net assets of discontinued
operation 10,732
--------
Total assets at year-end $149,071
========
1998
----
Net sales to unaffiliated customers $136,844 $117,583 $ 116 $ -- $254,543
======== ======== ======= ======= ========
Gross profit (loss) $ 39,345 $ 51,627 $ (395) $ (325) $ 90,252
======== ======== ======= ======= ========
Operating income (loss) $ 22,822 $ 11,748 $(2,194) $(9,145) $ 23,231
======== ======== ======= ======= ========
Identifiable assets at year-end $102,294 $108,303 $ 4,288 $ -- $214,885
======== ======== ======= =======
Corporate assets 22,371
Net assets of discontinued
operation 11,112
--------
Total assets at year-end $248,368
========
</TABLE>
Total net sales by segment includes sales to unaffiliated customers.
Intersegment sales are nominal. Operating income (loss) is total net sales
less operating expenses. Operating income (loss) does not include the
following items: interest expense, other expenses and income taxes. The
Other column includes the Company's corporate headquarters costs.
Depreciation expense and capital expenditures for each of the Company's
business segments for the years ended December 31, 1996, 1997 and 1998 are
as follows:
<PAGE> 42
-34-
<TABLE>
<CAPTION>
SECURITY INVESTIGATIONS
PRODUCTS AND INFORMATION
AND SERVICES INTELLIGENCE SECURITY
GROUP GROUP GROUP OTHER CONSOLIDATED
------------ -------------- ----------- --------- ------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
1996
----
Depreciation expense $ 841 $1,148 $ -- $ -- $1,989
====== ====== ==== ==== ======
Capital expenditures $2,627 $1,176 $ -- $ -- $3,803
====== ====== ==== ==== ======
1997
----
Depreciation expense $1,427 $1,373 $ -- $ -- $2,800
====== ====== ==== ==== ======
Capital expenditures $3,149 $3,263 $ -- $ -- $6,412
====== ====== ==== ==== ======
1998
----
Depreciation expense $1,282 $1,760 $ 24 $ 13 $3,079
====== ====== ==== ==== ======
Capital expenditures $3,427 $3,001 $186 $647 $7,261
====== ====== ==== ==== ======
</TABLE>
Identifiable assets by segment are those assets that are used in the
Company's operations in each segment. Corporate assets are principally
cash, marketable securities, computer software, certain intangible assets
and certain prepaid expenses.
The following summarizes information about the Company's different
geographic areas:
<TABLE>
<CAPTION>
UNITED OTHER
STATES FRANCE FOREIGN ELIMINATIONS CONSOLIDATED
---------- ---------- ----------- ------------ ------------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C>
1996
----
Net sales to unaffiliated customers $142,323 $ 2,142 $14,459 $ -- $158,924
Intercompany 3,584 316 2,804 (6,704) --
======== ======= ======= ======== ========
Total net sales $145,907 $ 2,458 $17,263 $(6,704) $158,924
======== ======= ======= ======== ========
Operating income (loss) $ 6,651 $ (118) $ 1,628 $ -- $ 8,161
======== ======= ======= ======== ========
Identifiable assets $ 78,207 $ 1,205 $ 7,117 $ -- $ 86,529
======== ======= ======= ========
Corporate assets 1,357
Net assets of discontinued
operation 3,880
--------
Total assets at yearend $ 91,766
========
1997
----
Net sales to unaffiliated customers $139,023 $24,004 $29,859 $ -- $192,886
Intercompany 7,413 208 4,170 (11,791) --
======== ======= ======= ======== ========
Total net sales $146,436 $24,212 $34,029 $(11,791) $192,886
======== ======= ======= ======== ========
Operating income $ 5,144 $ 1,382 $ 3,487 $ -- $ 10,013
======== ======= ======= ======== ========
Identifiable assets $ 91,325 $23,706 $17,922 $ -- $132,953
======== ======= ======= ========
Corporate assets 5,386
Net assets of discontinued
operation 10,732
--------
Total assets at yearend $149,071
========
1998
----
Net sales to unaffiliated customers $165,062 $28,458 $61,023 $ -- $254,543
Intercompany 2,960 199 3,318 (6,477) --
======== ======= ======= ======== ========
Total net sales $168,022 $28,657 $64,341 $(6,477) $254,543
======== ======= ======= ======== ========
Operating income $ 11,054 $ 2,251 $ 9,926 $ -- $ 23,231
======== ======= ======= ======== ========
Identifiable assets $139,759 $29,047 $46,079 $ -- $214,885
======== ======= ======= ========
Corporate assets 22,371
Net assets of discontinued
operation 11,112
--------
Total assets at yearend $248,368
========
</TABLE>
<PAGE> 43
-35-
The Company accounts for transfers between geographic areas at cost plus a
proportionate share of operating profit.
The following summarizes the Company's sales in the United States and
foreign locations:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------------------
1996 1997 1998
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Sales to unaffiliated customers:
U.S. Government $ 51,505 $ 43,719 $ 62,149
Other United States 74,113 78,069 97,204
Middle East 7,598 5,887 5,958
Europe 4,028 26,584 35,274
Asia 8,946 10,697 15,467
Central & South America 5,807 20,123 25,850
Other Foreign 6,927 7,807 12,641
-------- -------- --------
$158,924 $192,886 $254,543
======== ======== ========
</TABLE>
Export sales by the Company's domestic operations were approximately
15%, 16% and 18% of net sales for the years ended December 31, 1996,
1997 and 1998, respectively.
The Company is subject to audit and investigation by various agencies
which oversee contract performance in connection with the Company's
contracts with the U.S. Government. Additionally, the Company's
laboratory testing operations are certified and subject to frequent
inspections and proficiency tests by certain federal, state or local
jurisdictions. Management believes that potential claims from such
audits and investigations will not have a material adverse effect on
the consolidated financial statements. In addition, contracts with the
U.S. Government may contain cost or performance incentives or both
based on stated targets or other criteria. Cost or performance
incentives are recorded at the time there is sufficient information to
relate actual performance to targets or other criteria.
The Company has foreign operations and assets in Argentina, Australia,
Brazil, Canada, China, Colombia, France, Germany, India, Italy, Japan,
Mexico, Russia, Saudi Arabia, Singapore, Switzerland, the Philippines
and the United Kingdom. In addition, the Company sells its products and
services in other foreign countries and continues to increase its level
of international activity. Accordingly, the Company is subject to
various risks including, among others, foreign currency restrictions,
exchange rate fluctuations, government instability and complexities of
local laws and regulations.
<PAGE> 44
-36-
(b) Major Customers--During the years ended December 31, 1996, 1997
and 1998 sales in the Security Products and Services Group to the
U.S. Government approximated 32%, 23% and 24% of the Company's net
sales, respectively.
(15) Supplemental Cash Flows Disclosures-
The following is a summary of cash paid related to certain items:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- -----------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest $4,460,514 $4,960,504 $ 4,593,326
---------- ---------- -----------
Cash paid for taxes of continuing operations $ 729,193 $3,468,474 $ 3,952,951
---------- ---------- -----------
Cash paid for taxes of discontinued operation $ -- $ -- $ 142,398
---------- ---------- -----------
SUPPLEMENTAL DISCLOSURE OF NON-CASH ACTIVITIES:
Issuance of restricted stock $ 891,066 $1,356,280 $ --
---------- ---------- -----------
Affiliate obligation forgiven in connection with
the reorganization $ 122,000 $ -- $ --
---------- ---------- -----------
Fair value of stock issued in connection with
acquisition of businesses $ 290,571 $6,608,485 $17,610,504
---------- ---------- -----------
Fair value of stock issued in connection with
acquisition of minority interest $ -- $1,243,474 $ --
---------- ---------- -----------
Notes issued in connection with acquisition of
businesses $ 505,834 $2,906,513 $ --
---------- ---------- -----------
Tax benefit of restricted stock vesting $ -- $2,160,341 $ --
---------- ---------- -----------
Fair value of stock issued in connection with
acquisition of business of discontinued operation $ -- $1,851,284 $ --
---------- ---------- -----------
Cancellation of shareholder's note payable
obligation and issuance of stock $ -- $1,053,735 $ --
---------- ---------- -----------
Note issued in connection with consulting agreement
entered into with former shareholder of an
acquired business $ -- $ -- $ 147,914
---------- ---------- -----------
</TABLE>
<PAGE> 45
-37-
(16) Quarterly Financial Data (unaudited)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(in thousands, except per share amounts)
1998
- ----
<S> <C> <C> <C> <C>
Net sales $53,650 $60,605 $70,537 $69,751
Gross profit 18,621 21,496 25,276 24,858
Net income (loss) 2,792 3,955 5,292 (254)
Earnings (loss) per share:
Basic $ 0.18 $ 0.21 $ 0.25 $ (0.01)
Diluted $ 0.17 $ 0.21 $ 0.24 $ (0.01)
1997
- ----
Net sales $42,529 $47,799 $48,267 $54,291
Gross profit 14,318 16,891 16,064 16,712
Net income (loss) 1,251 2,312 2,387 (5,240)
Earnings (loss) per share:
Basic $ 0.09 $ 0.16 $ 0.16 $ (0.35)
Diluted $ 0.08 $ 0.15 $ 0.15 $ (0.35)
</TABLE>
(17) Subsequent Events
(a) Discontinued Operation - Voice and Data Communications Group--On
April 28, 1999, the Board of Directors approved a formal plan to
discontinue operations of the Voice and Data Communications Group,
which offered secure satellite communication equipment and satellite
navigation systems. The Company received an outside expression of
interest for this business in April, 1999 and intends to make the
assets of the segment available for sale immediately and expects to
complete the disposal of this segment within the next twelve months.
The results of operations of this Group have been classified as
discontinued operations and all prior periods have been restated
accordingly. The results of the discontinued Voice and Data
Communications Group reflect an allocation of interest expense based
on the Group's average net assets. The Group does not warrant any
material income tax expense or benefit for the periods presented.
Net sales, results of operations and net assets from this
discontinued operation are as follows (in thousands):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------
1996 1997 1998
------ ------- -------
<S> <C> <C> <C>
Net sales $7,770 $17,437 $17,653
Interest expense allocation $ -- $ 367 $ 288
Income (loss) from discontinued operations $ 333 $ (305) $(1,325)
</TABLE>
<PAGE> 46
-38-
<TABLE>
<CAPTION>
AS OF DECEMBER 31,
------------------
1997 1998
------- -------
<S> <C> <C>
Current assets, including $398 of advances on
purchase agreement $12,643 $12,071
Property, plant and equipment, net 125 68
Advances on purchase agreement 1,275 1,130
Other assets 3,305 3,077
Current liabilities (6,616) (5,234)
------- -------
Net assets of discontinued operations $10,732 $11,112
======= =======
</TABLE>
In June 1995, the Voice and Data Communications Group entered into a
firm purchase agreement with Glocom, Inc. ("Glocom"). The agreement
provided for an irrevocable purchase order for the purchase of 4,000
units of the Compact-M portable satellite telecommunication unit for
approximately $12,000,000. In October 1997, the agreement was amended
to provide certain pricing concessions to the Group for purchases by
the Group of products sold by Glocom and to provide a reduction in
the quantity of the original units that must be purchased. The
amendment also provided certain licensing rights to the Group. In
November 1998, the Group entered into a purchase agreement with
Glocom to acquire a new type of portable satellite telecommunication
terminal. This contract provided for approximately a $3,000,000
purchase commitment. The agreement restated that the pricing
concession provided on units purchased set forth in the above
referenced amendment, in order to continue to amortize the remaining
balance of the original advance, applies to the purchase of the new
terminals. At December 31, 1998, the Group was committed to purchase
approximately 240 INMARSAT B terminals at a total cost of
approximately $3.0 million. In accordance with the original
agreement, the Group advanced a total of $3,000,000 to Glocom for the
funding of the related production costs. As of December 31, 1997 and
1998, the Group had advances to the above vendor of $1,673,123 and
$1,130,361, respectively.
In February 1997, the Company completed an acquisition in the Voice
and Data Communications Group which was accounted for as a purchase
business combination. The purchase price of $3.5 million consisted of
approximately $1.6 million in seller-provided financing and 170,234
shares of common stock (valued at approximately $1.9 million or
$10.88 per share). The resulting goodwill of approximately $3.5
million from this transaction is being amortized over fifteen years.
One executive in the Voice and Data Communications Group has an
employment agreement subject to similar terms as discussed in Note
12(b). If terminated without cause, this commitment would approximate
$1.1 million as of December 31, 1998.
The Company will continue to monitor the potential for impairment of
the net assets of the discontinued Voice and Data Communications
Group, if any, and will record impairment reserves as facts and
circumstances warrant. Based on its most recent analysis, the Company
believes no impairment exists at December 31, 1998.
<PAGE> 47
-39-
(b) Acquisitions--In addition to the mergers during 1999 with BAI and
FRI discussed in Note 3, the Company completed an additional
acquisition in 1999 which was accounted for as a purchase business
combination. In June, 1999 the Company completed the acquisition of
substantially all of the assets and liabilities of The Buchler
Phillips Group (BP). BP provides financial recovery, restructuring,
insolvency and turnaround services throughout the United Kingdom and
Europe and will be included in the Investigations and Intelligence
Group. The purchase price amounted to approximately $20.0 million and
consisted of approximately $12.0 million in cash and 366,469 shares
of common stock (valued at approximately $8.0 million or an average
of $21.86 per share).
(c) Pending Purchase of Company Common Shares--On November, 15, 1999,
the Company announced that it had entered into a definitive agreement
with Blackstone Capital Partners III Merchant Banking Fund L.P.
(Blackstone) pursuant to which shares held by all Company
shareholders, other than certain members of management, will be
acquired by Blackstone for $18.00 per share in cash. Certain members
of management will retain ownership of approximately eight percent of
Company common stock. Additionally, certain significant shareholders
will exchange some of their shareholdings for preferred stock of the
Company. This transaction is subject to the approval of the Company's
shareholders.
<PAGE> 1
EXHIBIT 2. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected financial data reflects mergers during 1997, 1998
and 1999 which were accounted for as poolings of interest. The prior period
consolidated financial information has been restated as though the entities had
always been part of Kroll-O'Gara. The selected financial data also includes the
completion of other acquisitions in 1997 and 1998 that utilized the purchase
method of accounting, which requires including the reported results of each
acquired business from the effective date of its acquisition. The selected
historical financial data presented as of December 31, 1997 and 1998 and for
each of the three years ended December 31, 1998, have been derived from the
audited Consolidated Financial Statements of Kroll-O'Gara presented elsewhere in
this current report. The consolidated financial data as of December 31, 1994,
1995 and 1996 and for the years ended December 31, 1994 and 1995 are derived
from Kroll-O'Gara's unaudited consolidated financial statements not included in
this current report. The selected financial data should be read in conjunction
with the Consolidated Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
<S> <C> <C> <C> <C> <C>
Net sales............................. $91,338 $92,955 $158,924 $192,886 $254,543
Cost of sales......................... 57,990 65,106 113,264 128,901 164,291
------- ------- -------- -------- --------
Gross profit........................ 33,348 27,849 45,660 63,985 90,252
Selling, general and administrative
expenses, including amortization.... 32,227 30,912 37,375 46,768 61,294
Asset impairment...................... -- -- 125 -- --
Merger related expenses............... -- -- -- 7,205 5,727
------- ------- -------- -------- --------
Operating income (loss)............. 1,121 (3,063) 8,161 10,013 23,231
Interest expense...................... (2,599) (2,827) (3,049) (4,877) (4,382)
Other income (expense), net........... 533 36 335 (105) 1,615
------- ------- -------- -------- --------
Income (loss) from continuing
operations before minority interest,
provision (benefit) for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle......................... (945) (5,854) 5,447 5,030 20,464
Minority interest..................... -- -- -- (156) --
------- ------- -------- -------- --------
Income (loss) from continuing
operations before provision
(benefit) for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle......................... (945) (5,854) 5,447 4,874 20,464
Provision (benefit) for income
taxes............................... (1,540) (824) 366 3,305 7,353
------- ------- -------- -------- --------
Income (loss) from continuing
operations before extraordinary
item and cumulative effect of
change in accounting principle... 595 (5,030) 5,081 1,569 13,112
Income (loss) from operations of
discontinued Voice and Data
Communications Group, net (44) (676) 333 (305) (1,326)
Loss from operations and disposal of
discontinued clinical business,
net of tax....................... -- -- (1,274) -- --
------- ------- -------- -------- --------
Income (loss) before extraordinary
item and cumulative effect of
change in accounting principle... 551 (5,706) 4,139 1,264 11,786
</TABLE>
<PAGE> 2
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
Extraordinary item, net of tax benefit -- -- -- (194) --
------- ------- -------- -------- --------
Income (loss) before cumulative
effect of change in accounting
principle........................ 551 (5,706) 4,139 1,070 11,786
Cumulative effect of change in
accounting principle, net of tax benefit -- -- -- (360) --
------- ------- -------- -------- --------
Net income (loss)..................... $ 551 $(5,706) $ 4,139 $ 710 $11,786
======= ======= ======== ======== ========
Basic earnings (loss) per share from
continuing operations.............. $ 0.07 $ (0.46) $ 0.42 $ 0.11 $ 0.68
======= ======= ======== ======== ========
Basic weighted average shares
outstanding......................... 8,926 11,019 12,112 14,751 19,337
======= ======= ======== ======== ========
Diluted earnings (loss) per share from
continuing operations............... $ 0.02 $ (0.46) $ 0.39 $ 0.10 $ 0.66
======= ======= ======== ======== ========
Diluted weighted average shares
outstanding......................... 9,384 11,019 12,670 15,560 19,908
======= ======= ======== ======== ========
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
<S> <C> <C> <C> <C> <C>
BALANCE SHEET DATA:
Working capital....................... $17,261 $ 5,044 $10,626 $ 38,329 $ 84,890
Net property, plant, and equipment.... 7,752 8,325 11,106 18,064 24,572
Total assets.......................... 70,772 71,932 91,673 149,071 248,368
Long-term debt, including current
portion............................. 28,010 29,142 31,249 54,239 41,347
Shareholders' equity.................. 16,926 11,404 22,874 42,861 144,496
</TABLE>
<PAGE> 1
EXHIBIT 3. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
The following discussion of results of operations and financial condition
is based upon and should be read in conjunction with Kroll-O'Gara's Consolidated
Financial Statements and Notes. As a result of the acquisitions made by
Kroll-O'Gara in 1997 and 1998 (see below), financial results from
period-to-period may lack comparability. Additionally, effective December 31,
1998, Kroll-O'Gara established the Information Security Group and, on April 28,
1999, the Board of Directors approved a plan to discontinue operations of the
Voice and Data Communications Group. Historical revenue amounts have been
reclassified to conform to the current categories.
GENERAL
Kroll-O'Gara is a leading global provider of a broad range of specialized
products and services that are designed to provide solutions to a variety of
security needs. Kroll-O'Gara reports its revenue from continuing operations
through three groups. The Security Products and Services Group markets ballistic
and blast protected vehicles and security services and the Investigations and
Intelligence Group offers business intelligence and investigation services. With
the acquisition of Securify Inc., Kroll-O'Gara established a new Information
Security Group. The Information Security Group offers information and computer
security services, including network and system security review and repair. On
April 28, 1999, Kroll-O'Gara's Board of Directors approved a formal plan to
discontinue operations of the Voice and Data Communications Group. Accordingly,
these operations have been reclassified and reported as discontinued operations.
On May 5, 1998, Kroll-O'Gara completed a public offering ("the Offering")
of 3,200,000 shares of its common stock at $20.50 per share, resulting in net
proceeds to Kroll-O'Gara of $60.4 million. A portion of the net proceeds was
used to repay $14.8 million of indebtedness, with the balance available for
potential acquisitions, working capital and other general corporate purposes. In
addition to the shares sold by Kroll-O'Gara, certain shareholders sold 1,860,000
shares of Kroll-O'Gara common stock in conjunction with the Offering. The
Offering followed Kroll-O'Gara's initial public offering, which was completed on
November 15, 1996 and resulted in the issuance of 2,048,000 shares of common
stock.
Merger with Kroll Holdings. The merger with Kroll Holdings, Inc. was
completed on December 1, 1997. In the Kroll Holdings merger, 6,098,561 shares of
common stock were issued and an aggregate of $14.5 million in outstanding
indebtedness of Kroll Holdings was repaid. Approximately 550,000 additional
shares of Kroll-O'Gara common stock were reserved for issuance upon the exercise
of options held by Kroll Holdings employees, which were assumed by Kroll-O'Gara.
Other Acquisitions. Kroll-O'Gara has pursued a strategy of aggressive
growth and has completed numerous other acquisitions in 1997 and 1998, some of
which have been accounted for as poolings of interest and others of which have
been accounted for as purchases. These acquisitions are listed in the chart
which follows.
POOLINGS(1)
<TABLE>
<CAPTION>
COMPANY BUSINESS GROUP DATE ACQUIRED PRICE
------- -------- ----- ------------- -----
<S> <C> <C> <C> <C>
Laboratory Drug testing Investigations and December 7, 1998 1,209,053 shares
Specialists of Intelligence
America, Inc.(2)
Securify Inc. Information security Information Security December 31, 1998 1,430,936 shares
services
Schiff & Associates, Security architectural Investigations and December 31, 1998 169,521 shares
Inc. services Intelligence
</TABLE>
<PAGE> 2
PURCHASES(3)
<TABLE>
<CAPTION>
COMPANY BUSINESS GROUP DATE ACQUIRED PRICE
------- -------- ----- ------------- -----
<S> <C> <C> <C> <C>
Labbe, S.A. Armors commercial Security Products January 1, 1997 $10.7 million in cash
vehicles and builds and Services and 376,597 shares
truck bodies in France
Next Destination, Distributes high Voice and Data February 1, 1997 170,234 shares
Limited technology products for Communications $1.6 million in
the global positioning financing
satellite and satellite
communications markets
International Advanced security Security Products March 1, 1997 $0.5 million in cash,
Training, training and Services 68,086 shares and $1.2
Incorporated million in financing
ZAO IMEA Armors cash-in transit Security Products December 1, 1997 $0.6 million in cash
vehicles and distributes and Services and 138,889 shares
commercial bank
equipment in Russia
Corplex, Inc. Investigative and Investigations and March 1, 1998 29,207 shares
executive protection Intelligence
services
Lindquist Avey Forensic and Investigations and June 1, 1998 $4.7 million in cash
MacDonald investigative accounting Intelligence and 278,340 shares
Baskerville, Inc. services; headquartered
in Canada
Kizorek, Inc. Video surveillance Investigations and July 1, 1998 $0.8 million in cash
services Intelligence and 352,381 shares
Protec S.A. Armors cars in Colombia Security Products September 30, $3.2 million in cash
and Services 1998 and 38,788 shares
Holder Associates, Security services in Investigations and October 1, 1998 $4.5 million in cash
S.A. Argentina Intelligence and 46,287 shares
Fact Finders Limited Investigates Investigations and November 1, 1998 $3.2 million in cash,
intellectual property Intelligence plus a 3-year earn-
infringement cases in out based on profits
Hong Kong and the
Peoples Republic of
China
</TABLE>
(1) Pooling of interest accounting requires the restating of all prior period
consolidated financial information as though the acquired entity had always
been a part of Kroll-O'Gara.
(2) In 1997 and 1998 Laboratory Specialists paid a total of approximately $5.9
million to acquire customer lists and related assets from Pathology
Laboratories, Ltd., Harrison Laboratories, Inc., Accu-Path Medical
Laboratory, Inc., and TOXWORX Laboratories, Inc.
(3) Kroll-O'Gara's consolidated financial statements include the reported
results of each entity from its effective date of acquisition forward.
On June 16, 1999, Kroll-O'Gara acquired all of the capital stock of
Background America, Inc. of Nashville, Tennessee, in exchange for approximately
899,243 shares of Kroll-O'Gara common stock. Background America provides
background investigation services to government, corporate, not-for-profit,
professional and other clients. The transaction was accounted for as a pooling
of interests. Background America's revenues are included in the Investigations
and Intelligence Group.
On March 1, 1999, Kroll-O'Gara acquired all of the capital stock of
Financial Research, Inc. of Fort Washington, Pennsylvania, in exchange for
101,555 shares of Kroll-O'Gara common stock valued at approximately $3.3
million, or $32.49 per share. The acquisition has been accounted for as a
pooling of interests. Financial Research provides business valuation and
economic damage analysis services throughout the United States. It reports
revenue through the Investigation and Intelligence Group.
Revenue recognition. Kroll-O'Gara recognizes net sales from government and
most commercial armoring contracts using the percentage-of-completion method
calculated utilizing the cost-to-cost approach. Under this method, Kroll-O'Gara
accrues estimated contract revenues based generally on the percentage that costs
to date bear to total estimated costs and recognizes
<PAGE> 3
estimated contract losses in full when it becomes likely that a loss will occur.
Accordingly, Kroll-O'Gara periodically reviews and revises contract revenues and
total cost estimates as the work progresses and as change orders are approved.
It reflects adjustments in contract revenues, based upon the percentage of
completion, in the period when the estimates are revised. To the extent that
these adjustments result in an increase, a reduction or an elimination of
previously reported contract revenues, Kroll-O'Gara recognizes a credit or a
charge against current earnings, which could be material. Contract costs include
all direct material and labor costs, along with certain direct overhead costs
related to contract production. Kroll-O'Gara records provisions for any
estimated total contract losses on uncompleted contracts in the period in which
it concludes that the losses will occur. Changes in estimated total contract
costs result in revisions to contract revenue. The revisions are recognized when
determined.
Kroll-O'Gara recognizes revenue from investigative and intelligence
services as the services are performed. It records either billed or unbilled
accounts receivable based on case-by-case invoicing determinations.
Kroll-O'Gara recognizes information security service revenues, which
consist of consulting fees on information security projects, ratably over the
period of the agreement or according to the completed contract method of
accounting for contract revenues, depending on the nature of the agreement.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the items noted
as a percentage of net sales:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
-----------------------
1996 1997 1998
----- ----- -----
<S> <C> <C> <C>
Security products and services
Commercial................................................ 15.5% 32.1% 30.3%
Military.................................................. 34.4 22.7 23.5
Investigations and intelligence............................. 50.2 45.3 46.2
Information security........................................ -- -- --
----- ----- -----
Total net sales.................. ......................... 100.0% 100.0% 100.0%
Cost of sales............................................... 71.3 66.8 64.5
----- ----- -----
Gross profit.............................................. 28.7 33.2 35.5
Operating expenses:
Selling and marketing..................................... 6.3 6.9 7.7
General and administrative................................ 17.2 17.3 16.4
Asset impairment.......................................... 0.1 -- --
Merger related costs...................................... -- 3.7 2.3
----- ----- -----
Operating income............................................ 5.1 5.2 9.1
Other income (expense):
Interest expense.......................................... (1.9) (2.5) (1.7)
Interest income........................................... 0.0 0.1 0.5
Other, net................................................ 0.2 (0.2) 0.1
----- ----- -----
Income from continuing operations before provision for
income taxes, extraordinary item and cumulative effect
of accounting change...................................... 3.4 2.5 8.0
Provision for income taxes.................................. 0.2 1.7 2.9
----- ----- -----
Income from continuing operations before extraordinary item
and cumulative effect of accounting change................ 3.2 0.8 5.2
Income (loss) from operations of discontinued Voice and Data
Communications Group, net.... ........................ ... 0.2 (0.2) (0.5)
Loss from operations and disposal of discontinued clinical
business, net of tax...................................... (0.8) -- --
----- ----- -----
Income before extraordinary item and cumulative effect of
accounting change......................................... 2.6 0.7 4.6
Extraordinary item.......................................... -- (0.1) --
Cumulative effect of accounting change...................... -- (0.2) --
----- ----- -----
Net income.................................................. 2.6% 0.4% 4.6%
===== ===== =====
</TABLE>
<PAGE> 4
1998 COMPARED TO 1997
Net Sales. Net sales for the year ended December 31, 1998 increased
$61.7 million, or 32%, from $192.9 million in 1997 to $254.5 million in 1998.
Security Products and Services Group. For the year ended December 31, net
sales for the Security Products and Services Group increased $31.3 million, or
30%, from $105.6 million in 1997 to $136.8 million in 1998. The increase
includes net sales of commercial products and security services, which increased
$15.2 million, or 25%, from $61.8 million in 1997 to $77.0 million in 1998. The
increase in commercial net sales was primarily due to continued growth in
Kroll-O'Gara's international armoring divisions. During 1996, 1997 and 1998,
Kroll-O'Gara initiated start-up armoring operations in Mexico, Brazil and the
Philippines, and acquired Labbe, IMEA and the assets of Protec. Kroll-O'Gara
will continue its efforts to expand the operations of its existing foreign
subsidiaries along with evaluating new acquisition opportunities and
opportunities for entry into new markets.
Increases in net sales for security services also contributed to the
increase in commercial net sales for the Security Products and Services Group.
Net sales of these services increased $2.1 million, or 29%, for the year ended
December 31, 1998 in comparison with 1997.
Net sales for the Security Products and Services Group include sales of
military products and services, which increased $16.1 million, or 37%, from
$43.7 million in 1997 to $59.8 million in 1998. In April 1998, Kroll-O'Gara
began work on a new contract with the U.S. Military to supply 738 Up-Armored
HMMWVs to the U.S. Army and the U.S. Air Force (the "738 Contract"). Production
on Kroll-O'Gara's previous contract with the U.S. Military for 360 Up-Armored
HMMWVs continued through July 1998. The combination of production on the two
contracts was a factor in the increase in net sales. Currently, HMMWV production
is based only on the 738 Contract.
The U.S. Air Force has dictated an aggressive delivery schedule for the 738
Contract. This delivery schedule required Kroll-O'Gara to maintain an increased
level of production in 1998 for the Up-Armored HMMWV in comparison with
production levels in previous periods. Management expects the level of
production and net sales in 1999 to more nearly approximate those of 1997.
Investigations and Intelligence Group. For the year ended December 31, net
sales for the Investigations and Intelligence Group increased $30.3 million, or
35%, from $87.3 million in 1997 to $117.6 million in 1998. The increases in 1998
were primarily due to the inclusion of net sales from the acquisitions of
Lindquist Avey, InPhoto, Corplex, Fact Finders, and Holder. Excluding net sales
reported by these acquired entities, net sales for the Investigations and
Intelligence Group would have been $98.2 million for the year ended December 31,
1998, in comparison with $87.3 million for the year ended December 31, 1997, an
increase of 12%.
The increase in net sales without acquisitions in the Investigations and
Intelligence Group was the result of an internal growth plan carried out by the
Group in 1998. During the year, the Investigations and Intelligence Group opened
offices in Dallas, Boston, Houston and Mexico City. The internal growth plan
will continue in 1999, with the Group seeking additional markets for its
products, both domestic and foreign.
Information Security Group. The Information Security Group initiated
operations in 1998, recording net sales of $0.1 million. Management expects the
Information Security Group's product offerings to result in significantly higher
Group sales in 1999.
COST OF SALES AND GROSS PROFIT. For the year ended December 31, cost of
sales increased $35.4 million, or 28%, from $128.9 million in 1997 to $164.3
million in 1998. The increase in cost of sales was due to the increased level of
business activity experienced in 1998. Gross profit as a percentage of net sales
was 33.2% and 35.5% for 1997 and 1998, respectively. This increase is primarily
due to an increase in gross profit as a percent of net sales experienced in the
Investigations and Intelligence Group. This increase, approximately 5 percentage
points, was due to high margin engagements booked during the year which are
historically infrequent in nature.
The gross profit percents for the Security Products and Services Group
were 28.5% and 28.4% in 1998 and 1997, respectively.
Because the high margin engagements booked in 1998 are historically
infrequent, management does not expect to maintain the level of gross profit as
a percent of net sales reflected in the results of the Investigations and
Intelligence Group for the year ended December 31, 1998. As always, the gross
profit percent will vary on the mix of sales from the three groups. Kroll-O'Gara
historically has experienced its highest levels of gross profit as a percent of
net sales in the Investigations and Intelligence Group.
<PAGE> 5
As revenue from the Investigations and Intelligence Group increases as a percent
of total net sales, the gross profit percent should increase as well.
OPERATING EXPENSES. Operating expenses for the year ended December 31,
1998, increased $13.0 million, or 24%, to $67.0 million from $54.0 million for
the same period in 1997. Included in operating expenses in 1997 were
approximately $7.2 million in expenses related to the merger with Kroll
Holdings. In 1998, Kroll-O'Gara recorded approximately $5.7 million in merger
related expenses associated with the Laboratory Specialists, Schiff, Securify
and Background America mergers.
Before merger related expenses, operating expenses increased $14.5 million,
or 31%, from $46.8 million in 1997 to $61.3 million in 1998. The increase was
primarily attributable to an increase in the level of personnel and professional
services required to administer the growth experienced by Kroll-O'Gara in 1998.
As a percent of net sales, operating expenses, before merger related costs,
were 24.2% in 1997 and 24.1% in 1998. As a result of investments made by
Kroll-O'Gara in facilities and personnel in previous periods, Kroll-O'Gara did
not require additional commitments of fixed cost relative to the level of net
sales in 1998. As sales increase further, Kroll-O'Gara will be required to
commit additional amounts of fixed cost to secure increased incremental net
sales.
INTEREST EXPENSE. Interest expense for the year ended December 31, 1998
decreased $0.5 million, or 10%, to $4.4 million, compared to $4.9 million in
1997. With the completion of the Offering, a significant portion of
Kroll-O'Gara's indebtedness was repaid (approximately $14.8 million). As a
result, Kroll-O'Gara experienced lower interest expense starting in the third
quarter of 1998 and expects interest expense to be lower in comparison with
periods prior to that offering.
On May 30, 1997, Kroll-O'Gara entered into an agreement with institutional
investors to issue and sell $35.0 million worth of Senior Notes. This agreement
contained a provision for a reduction of the interest rate if specified criteria
were met. Kroll-O'Gara complied with the criteria and the step down of rates
commenced in the second quarter of 1998. The reduction, which changed the
interest rate from 9.56% to 8.56%, contributed to the decrease in interest
expense in 1998.
INTEREST INCOME. Interest income for the year ended December 31, 1998
increased $1.1 million, or 636%, to $1.3 million, compared to $0.2 million in
1997. Net proceeds of the Offering that were not used to repay debt were
invested in short-term instruments with maturities of three months or less. The
return on these investments was responsible for the increase in interest income
in 1998. Management anticipates that it will continue to have funds available
for investment in the foreseeable future. As a result, Kroll-O'Gara anticipates
it will continue to experience higher levels of interest income in 1999 in
comparison with periods prior to the Offering.
PROVISION FOR INCOME TAXES. The provision for income taxes was $7.4 million
for the year ended December 31, 1998 in comparison with $3.3 million for the
same period in 1997. The effective tax rates for the periods were 68% in 1997
and 36% in 1998. In 1997, Kroll-O'Gara booked taxes at an effective rate
significantly higher than it had previously experienced largely due to the
non-deductibility of some of the merger related expenses incurred in the period.
In 1998, Kroll-O'Gara determined that certain of the Kroll Holdings merger
expenses qualified for future deductibility which favorably impacted the
effective tax rate in 1998.
In addition, the 1998 tax provision also reflects the favorable impact of
foreign locations with statutory tax rates at levels below U.S. tax rates and
the reversal of the valuation allowance related to certain foreign net operating
loss carryforwards. Management expects the effective tax rate to be
approximately 40% in 1999.
DISCONTINUED OPERATIONS. The loss from operations of the discontinued Voice
and Data Communications Group increased $1.0 million from $0.3 million in 1997
to $1.3 million in 1998. This increase was due to increased operating expenses,
primarily selling expenses, to support expected revenue growth in 1998. Revenue
growth did not occur in 1998 and sales levels remained consistent with the 1997
levels. Due to the uncertainty surrounding the future realizability of the tax
benefit associated with the Voice and Data Communication Group's losses,
management concluded that a valuation allowance for the entire tax benefit was
required in both 1997 and 1998. No provision was made for a loss on disposal of
the business as management expects proceeds from the sale of this business to
cover Kroll-O'Gara's investment in net assets as well as any costs incurred to
sell the business.
NET INCOME. Net income increased $11.1 million, or 1,560%, from $0.7
million in 1997 to $11.8 million in 1998. The increase was due primarily to a
$26.3 million increase in gross profit, offset by $13.0 million in increased
operating expenses and an increased provision for income taxes, as discussed
above.
<PAGE> 6
1997 COMPARED TO 1996
NET SALES. Net sales increased $34.0 million, or 21%, from $158.9 million
in 1996 to $192.9 million in 1997. The primary reasons for this change were the
acquisitions made in Kroll-O'Gara's Security Products and Services Group in
1997.
Security Products and Services Group. Net sales for the Security Products
and Services Group increased $26.4 million, or 33%, from $79.2 million in 1996
to $105.6 million in 1997.
The Group's net sales for 1997 from commercial products and security
services were $61.8 million, an increase of $37.3 million, or 152%, over 1996.
This increase was due to several factors, including primarily the incorporation
of net sales from Labbe and International Training in the Groups' results.
Excluding acquisitions, net sales from commercial products and services
increased $12.7 million, or 52%. Kroll-O'Gara experienced significant growth in
its Brazilian and Mexican armoring subsidiaries. With the purchase of IMEA and
the initiation of a start-up armoring operation in the Philippines, the Security
Products and Services Group continued its expansion in existing and new markets.
In 1996, the U.S. Military requested accelerated production of Up-Armored
HMMWV's. This resulted in net sales of $54.6 million in 1996. Military net sales
returned to a non-accelerated level in 1997, resulting in net sales from
military products decreasing by $10.9 million, or 20%, to $43.7 million in 1997.
Investigations and Intelligence Group. Net sales for the Investigations and
Intelligence Group increased $7.6 million, or 9%, from $79.8 million in 1996 to
$87.3 million in 1997. This increase was primarily due to an increase in
specimens analyzed by Laboratory Specialists, Kroll-O'Gara's drug testing
subsidiary. The increase in specimens analyzed was due to asset purchases made
in early 1997, along with additional accounts obtained through normal sales and
marketing efforts.
Most of the revenue reported by the Investigations and Intelligence Group
is generated by Kroll Holdings. Throughout 1997, Kroll Holdings was actively
involved in various strategic discussions that contemplated the sale of the
company. Pending the outcome of the discussions, Kroll Holdings delayed
implementation of its internal growth plans. In addition, uncertainties
surrounding the outcome of the discussions resulted in the departure of some
managers at Kroll Holdings prior to the Kroll Holdings merger. Finally, in
connection with the Kroll Holdings merger and in an effort to improve its cost
structure, Kroll-O'Gara reduced personnel in some markets. As a result, revenue
growth at Kroll Holdings was flat in comparison with 1996.
COST OF SALES AND GROSS PROFIT. Cost of sales increased $15.6 million, or
14%, from $113.3 million in 1996 to $128.9 million in 1997. The increase in cost
of sales was due to increases in Kroll-O'Gara's level of business activity as a
result of the acquisitions made in 1997.
Security Products and Services Group. Gross profit as a percentage of net
sales for the Security Products and Services Group improved from 25.8% in 1996
to 28.4% in 1997. As revenues and costs are recognized using the
percentage-of-completion method of accounting, actual cost and gross profit may
be revised from previously estimated amounts. Historically Kroll-O'Gara has
experienced a higher gross profit percent related to net sales of commercial
armoring products in comparison with those of military armoring products. In the
future, Kroll-O'Gara expects to increase its percentage of sales from commercial
armoring products.
Investigations and Intelligence Group. Gross profit as a percent of net
sales for the Investigations and Intelligence Group increased from 31.6% in 1996
to 38.9% in 1997. Gross profit percent in 1996 was unfavorably affected by a
write-off of $5.0 million in uncollectible accounts receivable relating to
services provided in earlier periods. Without the write-off, the gross profit
percentages would have been comparable between periods.
OPERATING EXPENSES. Excluding expenses of $7.2 million related to the Kroll
Holdings merger, operating expenses increased $9.3 million, or 25%, from $37.5
million in 1996 to $46.8 million in 1997. The $7.2 million in expenses related
to the Kroll Holdings merger consisted of approximately $4.6 million in
professional fees and expenses and approximately $2.6 million relating to the
integration of the operations of the two companies. Included in the integration
expenses were bonuses paid to key employees as incentives to remain with
Kroll-O'Gara and severance payments made to employees who left Kroll-O'Gara in
connection with the merger. Also included was a charge made as a result of the
acceleration of the vesting of shares of restricted Kroll Holdings stock
immediately prior to the merger. All of the costs related to the Kroll Holdings
merger were recognized in 1997 and will have no effect on the earnings of
Kroll-O'Gara in future periods.
Of the $9.3 million increase in operating expenses, exclusive of expenses
related to the Kroll Holdings merger, $2.9 million was attributable to the
inclusion of operations from the acquisitions made in 1997. The remaining
increase in operating expenses
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reflects Kroll-O'Gara's efforts to expand into new markets, both in the Security
Products and Services Group and the Investigations and Intelligence Group.
Excluding expenses related to the Kroll Holdings merger, operating expenses as a
percent of net sales stayed essentially consistent between the periods at 24.2%
in 1997 and 23.6% in 1996.
Prior to the Kroll Holdings merger, Kroll Holdings was involved in merger
discussions with Choicepoint, Inc., then a subsidiary of Equifax, Inc.
Choicepoint and Kroll Holdings did not reach a final agreement, and as result
did not consummate the transaction. Approximately $0.5 million of professional
fees associated with the Choicepoint transaction are included in Kroll-O'Gara's
operating expenses in 1997.
INTEREST EXPENSE. Interest expense for 1997 increased $1.9 million, or 63%,
to $4.9 million, compared to $3.0 million in 1996. The increase in 1997 was the
result of increased borrowing to finance Kroll-O'Gara's 1997 acquisitions.
Kroll-O'Gara retired a portion of its debt with proceeds from the Offering.
OTHER, NET. Other income (expense), net decreased from $0.3 million of
income in 1996 to ($0.3) million in expense in 1997. The change was primarily
due to an increase in foreign currency translation losses recognized in 1997.
PROVISION FOR INCOME TAXES. The provision for income taxes increased from
$0.4 million in 1996 to $3.3 million in 1997. Kroll-O'Gara's O'Gara-Hess &
Eisenhardt Armoring Company ("OHE") subsidiary did not book a tax provision for
the first ten months of 1996 due to OHE's S Corporation status, which was
terminated on October 28, 1996 in conjunction with a reorganization in advance
of Kroll-O'Gara's initial public offering.
Kroll-O'Gara incurred taxes at the effective rate of 68% in 1997 due to the
non-deductibility of expenses related to the Kroll Holdings merger in the period
and the impact of foreign and some domestic losses for which no benefit can be
provided.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Kroll-O'Gara had
previously capitalized costs related to the reengineering of some of its
information systems. The capitalized amount, approximately $0.6 million before
tax, was expensed in 1997 in accordance with Emerging Issues Task Force No.
97-13 "Accounting for Costs Incurred in Connection with a Consulting Contract
that Combines Business Process Reengineering and Information Technology
Transformation." The amount expensed is shown net of applicable tax benefit of
$0.2 million.
DISCONTINUED OPERATIONS. In connection with the acquisition of National
Psychopharmacology Laboratory, Inc. Kroll-O'Gara's Laboratory Specialists
subsidiary attempted to sell the clinical testing and analysis lines of business
of National Psychopharmacology without success. In the fourth quarter of 1996,
Laboratory Specialists discontinued these operations resulting in a loss from
the discontinued operation of $0.5 million and a loss on the disposal of $0.8
million, after giving effect to tax benefits of $0.3 million and $0.5 million,
respectively.
In 1997, the loss from operations related to the discontinued Voice and
Data Communications Group was $0.3 million compared to income from operations of
this business in 1996 of $0.3 million. The $0.6 million decrease was directly
related to an increase in interest and amortization expense as a result of the
acquisition of Next Destination in February 1997. No tax provision was provided
for in 1996 due to the S corporation status of OHE described above. Due to the
uncertainty surrounding the future realizability of the tax benefit associated
with the Voice and Data Communications Group's loss in 1997, management
concluded that a valuation allowance for the entire tax benefit was required.
NET INCOME. Net income decreased $3.4 million, or 83%, from $4.1
million in 1996 to $0.7 million in 1997. This decrease was due primarily to
increased operating expenses of $9.3 million, $7.2 million in merger expenses,
$1.9 million in interest expense and an increased provision for income taxes of
$2.9 million, offset in part by increased gross profit of $18.3 million, as
discussed above.
LIQUIDITY AND CAPITAL RESOURCES
General. Kroll-O'Gara historically has met its operating cash needs by
utilizing borrowings under its credit arrangements and net proceeds from public
offerings to supplement cash provided by operations, excluding non-cash charges
such as depreciation and amortization.
Credit Facility. On June 25, 1999, Kroll-O'Gara amended and restated its
credit agreement with KeyBank National Association to provide for a revolving
line of credit of $25 million and a letter of credit facility of approximately
$7.6 million which matures on May 31, 2000. Advances under the revolving credit
facility bear interest at rates ranging from prime less 1.75% to prime, or, at
Kroll-O'Gara's option, LIBOR plus .75% to LIBOR plus 1.75%, dependent upon a
defined financial ratio. The credit agreement includes financial covenants
which, among other restrictions, require the maintenance of certain financial
ratios,
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including interest coverage and net worth, and impose limitations on goodwill,
additional indebtedness and capital expenditures. Kroll-O'Gara was in compliance
with these financial covenants as of September 30, 1999. Borrowings under this
line of credit were approximately $18.9 million at September 30, 1999.
The remaining proceeds from the Offering along with the unused capacity on
the revolving line of credit will be sufficient to fund the working capital
needs of Kroll-O'Gara for the next twelve months. In addition, Kroll-O'Gara
expects to have proceeds available upon the sale of its Voice and Data
Communications Group.
Cash flows from operating activities. Operating activities used $11.4
million in net cash for the year ended December 31, 1998 in comparison with $9.7
million in net cash provided by operating activities in 1997. Since the
inception of Kroll-O'Gara's contract with the U.S. Government to armor the HMMWV
through the time of the merger with Kroll Holdings and the acquisitions
completed in 1997 and the first quarter of 1998, Kroll-O'Gara was designated a
Small Business according to U.S. Government procurement regulations. Thereafter,
Kroll-O'Gara's designation was changed to Large Business for government
procurement purposes.
The change in designation affects progress payments made by the government
to Kroll-O'Gara over the course of a contract, and Kroll-O'Gara's cash flow, in
two ways. First, the progress payments are determined using a smaller percentage
of total cost committed than before. Second, Kroll-O'Gara is reimbursed for
vendor invoices paid instead of expenses incurred. Although these changes will
not affect the total amount ultimately collected, they defer some of the amounts
previously included as part of a progress payment until the vehicles are
delivered.
The majority of these adjustments to the way Kroll-O'Gara is reimbursed for
its military business were applied to the HMMWV contracts in 1998. This resulted
in a significant increase in the balance of Cost and Estimated Earnings in
Excess of Billings on Uncompleted Contracts and its related effect on cash flows
from operating activities.
Kroll-O'Gara will continue to absorb the effect of the change in
procurement designation throughout the life of the HMMWV contract. Although
there will be no effect on Cash Flows from Operating Activities on a cumulative
basis, the change in payment terms will impact accounts receivable and Cost and
Estimated Earnings in Excess of Billings on Uncompleted Contracts from
period-to-period.
Also, Kroll-O'Gara's level of accounts receivable was higher in 1998
compared to 1997 due to the increased level of business activity experienced in
1998. Additionally, due to provisions of the purchase agreement, Kroll-O'Gara
did not record any accounts receivable on the opening balance sheet in
connection with the acquisition of Lindquist Avey. As of December 31, 1998,
Lindquist Avey had approximately $2.8 million recorded in accounts receivable,
helping to explain the significant amount of cash used by changes in accounts
receivable.
Cash flows from investing activities. Historically, Kroll-O'Gara has
limited its capital expenditure requirements by leasing certain assets. Capital
expenditures totaled $7.4 million for the year ended December 31, 1998, and $6.0
million for the same period in 1997. Additions to databases totaled $4.2 million
and $3.9 million for the years ended December 31, 1998 and 1997, respectively.
The levels of capital expenditures are in excess of the amounts permitted
by the credit agreement between Kroll-O'Gara and KeyBank, due mainly to
Kroll-O'Gara's mergers and acquisitions in 1998. KeyBank has provided
Kroll-O'Gara a waiver from the requirements of this covenant.
In addition to capital expenditures, 1997 investing activities included the
acquisitions of Labbe, IMEA and International Training, which required a total
cash outlay of $10.7 million, net of cash acquired. In 1998, the acquisitions of
Lindquist Avey, InPhoto, Holder and Fact Finders as well as the assets of
Protec, Pathology Laboratories, Accu-Path, Harrison Laboratories and TOXWORX
Laboratories required cash of approximately $18.6 million, net of cash acquired.
Management anticipates that, as Kroll-O'Gara continues to pursue strategic
acquisitions, additional cash outlays will be required.
Cash flows from financing activities. Net cash provided by financing
activities was $58.0 million and $22.7 million for the years ended December 31,
1998 and 1997, respectively. Cash from financing activities in 1998 includes
approximately $60.4 million in net proceeds from the Offering. In addition,
Laboratory Specialists completed a private offering of its stock in June 1998
with proceeds of approximately $2.3 million. Approximately $14.8 million of the
proceeds from these transactions was used to repay indebtedness of Kroll-O'Gara.
The amounts not used to repay debt were invested in short-term instruments and
are being used as necessary for acquisitions, working capital and other general
corporate purposes.
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Cash flows from Financing Activities also include convertible preferred
stock issued by Securify in 1998, which was converted to Kroll-O'Gara common
stock in Kroll-O'Gara's acquisition of Securify. The net proceeds to Securify
associated with these shares were approximately $5.5 million.
Net cash provided by financing activities in 1997 largely reflects
borrowing under the Senior Notes that was used to finance certain acquisitions
and working capital requirements.
Net cash used in discontinued operations was $5.3 million in 1997 compared
with $1.8 million in 1998. Cash used in 1997 reflects increased working capital
investments due to the acquisition of Next Destination in February 1997. Cash
was used in 1998 primarily to fund the Voice and Data Communications Group's net
loss.
Foreign operations. Kroll-O'Gara attempts to mitigate the risks of doing
business in foreign countries by separately incorporating its operations in
those countries, maintaining reserves for credit losses, maintaining insurance
on equipment to protect against losses related to political risks and terrorism,
and using financial instruments to hedge Kroll-O'Gara's risk from translation
gains and losses.
Kroll-O'Gara utilizes derivative financial instruments, in the form of
forward contracts, to hedge some of its exposure to foreign currency rate
fluctuations. At December 31, 1998 eight such contracts, maturing between
January 1999 and December 2000, were outstanding in connection with intercompany
demand notes with Labbe and Lindquist Avey. These contracts are intended to
hedge Kroll-O'Gara's exposure to deterioration in the amount outstanding due to
changes in currency translation rates. The notional amount, together with
amortized premium, and the fair market value associated with these forward
contracts were $18.3 million and $0.9 million, respectively. Gains or losses on
existing forward instruments are offset against the translation effects
reflected in shareholders' equity. The fair value of forward contracts is not
recognized in the consolidated financial statements since they are accounted for
as hedges. Kroll-O'Gara does not hold or issue derivative financial instruments
for trading purposes.
Year 2000 Issues. Kroll-O'Gara has initiated a program to prepare for the
year 2000. During 1997, Kroll-O'Gara began the process of replacing the
enterprise systems at its two largest subsidiaries, both for the purpose of
making the systems Year 2000 compliant and to enhance the information systems
capabilities of these subsidiaries. One of the new systems became operational
early in the third quarter of 1999 and the other is scheduled to be operational
by the end of the fourth quarter of 1999.
Additionally, Kroll-O'Gara is implementing a plan to prepare its remaining
systems for Year 2000. Kroll-O'Gara has completed an inventory of all its
computer software and embedded technology and has prepared a master database of
all technology potentially impacted by the Year 2000 issue. In conjunction with
outside consultants, Kroll-O'Gara now is in the process of acting to resolve any
potential problems which were previously identified. Kroll-O'Gara anticipates
that it will have taken all the necessary steps to ensure no interruption of
services as a result of the Year 2000 issue by the end of the fourth quarter of
1999.
Total Year 2000 compliance cost is estimated to be approximately $6.2
million, of which approximately $5.6 million relates to the acquisition of new
enterprise systems and will be capitalized. The remaining approximately $0.6
million will be charged to expense over several reporting periods in accordance
with established accounting pronouncements, and is not expected to be material
to Kroll-O'Gara's results of operations or cash flows. Total costs paid relating
to this plan as of September 30, 1999 were $6.0 million. There can be no
assurance that the final costs of the Year 2000 program will not exceed current
management estimates.
Many of the operations of Kroll-O'Gara's largest revenue groups are
manual. The manufacture of bullet resistant vehicles and some of the
investigation and intelligence services provided by Kroll-O'Gara are not largely
dependent on embedded technology. If, however, the databases of public records
relied upon by the Investigations and Intelligence Group are not available due
to lack of compliance with Year 2000, manual searches would be required, which
would increase the cost and length of time as well as negatively affect the
quality of investigations. Kroll-O'Gara is actively engaged in evaluating and
confirming compliance in this area. Kroll-O'Gara has attempted to contact all of
its key vendors to ascertain the state of their Year 2000 compliance. The
majority of these vendors have responded and indicated that they are or on a
timely basis will be compliant. Kroll-O'Gara is continuing its efforts to obtain
assurances from those who have not yet responded.
Kroll-O'Gara believes that its internal computer software and systems will
not experience significant disruption in connection with Year 2000. However,
there can be no assurance that third-party failures to resolve the Year 2000
issue will not have an adverse effect on Kroll-O'Gara. In particular, if
Kroll-O'Gara's internal computer software and systems or those of one or more
third parties experience any significant disruption in connection with the Year
2000 issue, the disruption could affect Kroll-O'Gara's ability to conduct
business and may have a material adverse effect on operations and results.
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Quarterly fluctuations. Kroll-O'Gara's operations may fluctuate on a
quarterly basis as a result of the timing of contract costs and revenues of its
Security Products and Services Group, particularly from its military and
governmental contracts which are generally awarded on a periodic and/or sporadic
basis. Kroll-O'Gara generally does not have long-term contracts with its clients
in its Investigations and Intelligence Group and its ability to generate net
sales is dependant upon obtaining many new projects each year, most of which are
of a relatively short duration. Period-to-period comparisons within a given year
or between years may not be meaningful or indicative of operating results over a
full fiscal year.
Forward-looking Statements. This current report contains statements which
Kroll-O'Gara believes are forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. These statements are made
particularly in this Management's Discussion and Analysis of Financial Condition
and Results of Operations, but also appear elsewhere in this document.
Forward-looking statements can be identified by the use of language such as
"may," "will," "expect," "anticipate," "estimate," "continue" or other similar
words. Kroll-O'Gara's results may differ materially from those in the
forward-looking statements. Forward-looking statements are based on management's
current views and assumptions, and involve risks and uncertainties that could
significantly affect expected results. For example, operating results may be
affected by a number of external factors such as actions of competitors, changes
in laws and regulations, customer demand, effectiveness of programs, strategic
relations, fluctuations in the cost and availability of resources, and foreign
economic conditions, including currency rate fluctuations.
