<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): MARCH 9, 1999
THE KROLL-O'GARA COMPANY
(Exact name of registrant as specified in its charter)
Ohio 000-21629 31-1470817
(State or other jurisdiction of (Commission (I.R.S. Employer
Incorporation) file number) Identification No.)
9113 LeSaint Drive
Fairfield, Ohio 45014
(513) 874-2112
(Address, including zip code, and telephone
number, including area code, of registrant's principal executive offices)
===============================================================================
<PAGE> 2
INFORMATION TO BE INCLUDED IN THE REPORT
Items 1, 2, 3, 4, 6, 8 and 9 are not applicable and are omitted from this
Current Report. This Report is filed to provide the following information
pursuant to Items 5 and 7.
Item 5. On January 21, 1999, The Kroll-O'Gara Company announced that it
had executed a definitive purchase agreement to acquire all of
the shares of Background America, Inc. The transaction will be
affected by means of the merger of a wholly owned subsidiary of
Kroll-O'Gara with and into Background America, and is expected to
qualify for "pooling of interests" accounting treatment. The
Merger is subject to the approval of the shareholders of
Background America. The Merger may be terminated by either
Kroll-O'Gara or Background America if it is not completed by
June 30, 1999.
Also, since December 31, 1997, Kroll-O'Gara has acquired
several other companies. This Report on Form 8-K is being filed
to report certain historical, supplemental and pro forma
information relating to these transactions. The financial
statements and the exhibit identified in Item 7 and attached
hereto are incorporated herein by reference.
The Unaudited Pro Forma Combining Condensed Financial Statements
should be read in conjunction with the historical consolidated
financial statements and related notes of Kroll-O'Gara contained
in its annual report on Form 10-K for the year ended December 31,
1997 and the supplemental consolidated financial statements and
related notes of Kroll-O'Gara as of December 31, 1996 and 1997
and for the three years ended December 31, 1997 included herein.
Item 7. FINANCIAL STATEMENTS AND EXHIBITS
Page
----
(a) BACKGROUND AMERICA, INC.
Independent Auditors' Report................................ F-1
Consolidated Balance Sheets as of December 31, 1996 and
1997..................................................... F-2
Consolidated Statements of Operations for the Years Ended
December 31, 1996 and 1997............................... F-3
Consolidated Statements of Common Shareholders' Deficit for
the Years Ended December 31, 1996 and 1997............... F-4
Consolidated Statements of Cash Flows for the Years Ended
December 31, 1996 and 1997............................... F-5
Notes to Consolidated Financial Statements.................. F-6
Consolidated Balance Sheet as of September 30, 1998
(unaudited).............................................. F-13
Consolidated Statements of Operations for the Nine Months
Ended September 30, 1997 and 1998 (unaudited)............ F-14
Consolidated Statements of Cash Flows for the Nine Months
Ended September 30, 1997 and 1998 (unaudited)............ F-15
Notes to Consolidated Financial Statements (unaudited)...... F-16
SUPPLEMENTAL FINANCIAL STATEMENTS -- THE KROLL-O'GARA COMPANY
Report of Independent Public Accountants.................... F-17
Supplemental Consolidated Balance Sheets as of December 31,
1996 and 1997............................................ F-19
Supplemental Consolidated Statements of Operations for the
Years Ended December 31, 1995, 1996 and 1997............. F-21
Supplemental Consolidated Statements of Shareholders' Equity
for the Years Ended December 31, 1995, 1996 and 1997..... F-22
Supplemental Consolidated Statements of Cash Flows for the
Years Ended December 31, 1995, 1996 and 1997............. F-23
Notes to Supplemental Consolidated Financial Statements..... F-24
Supplemental Consolidated Balance Sheet as of September 30,
1998 (unaudited)......................................... F-53
Supplemental Consolidated Statements of Operations for the
Nine Months Ended September 30, 1997 and 1998
(unaudited).............................................. F-55
Supplemental Consolidated Statement of Shareholders' Equity
for the Nine Months Ended September 30, 1998
(unaudited).............................................. F-56
Supplemental Consolidated Statements of Cash Flows for the
Nine Months Ended September 30, 1997 and 1998
(unaudited).............................................. F-57
Notes to Supplemental Consolidated Unaudited Financial
Statements............................................... F-58
2
<PAGE> 3
(b) Kroll-O'Gara and Background America Unaudited Pro Forma
Combining Condensed Financial Statements................. F-65
Kroll-O'Gara and Background America Unaudited Pro Forma
Combining Condensed Balance Sheets as of September 30,
1998..................................................... F-66
Kroll-O'Gara and Background America Unaudited Pro Forma
Combining Condensed Statements of Operations for the
Years Ended December 31, 1995, 1996 and 1997 and the
Nine Months Ended September 30, 1997 and 1998............ F-67
Kroll-O'Gara and Background America Unaudited Pro Forma
Combining Condensed Financial Statements................. F-73
Kroll-O'Gara and Kizorek Unaudited Pro Forma and
Background America Unaudited Pro Forma Combining
Condensed Statements of Operations for the Year Ended
December 31, 1997 and the Nine Months Ended September
30, 1998................................................. F-75
Kroll-O'Gara Supplemental and Background America Unaudited
Pro Forma Combining Condensed Balance Sheets as of
September 30, 1998....................................... F-77
Kroll-O'Gara Supplemental and Background America Unaudited
Pro Forma Combining Condensed Statements of Operations
for the Years Ended December 31, 1995, 1996 and 1997
and the Nine Months Ended September 30, 1997 and
1998..................................................... F-78
Kroll-O'Gara Supplemental and Background America Unaudited
Pro Forma Combining Condensed Financial Statements of
Operations............................................... F-82
Kroll-O'Gara Supplemental and Kizorek Unaudited Pro Forma
and Background America Unaudited Pro Forma Combining
Condensed Statements of Operations for the Year Ended
December 31, 1997 and the Nine Months Ended September
30, 1998................................................. F-84
(c) Exhibit 99.1
The Kroll-O'Gara Company Management's Discussions and Analyses of
Financial Condition and Results of Operations - Historical and
Supplemental
3
<PAGE> 4
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: March 10, 1999 THE KROLL-O'GARA COMPANY
By /s/ Nicholas P. Carpinello
-----------------------------
Nicholas P. Carpinello
Controller and Treasurer
4
<PAGE> 5
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Background America, Inc.
Nashville, Tennessee
We have audited the accompanying consolidated balance sheets of Background
America, Inc. and subsidiaries (the "Company") as of December 31, 1996 and 1997,
and the related consolidated statements of operations, common shareholders'
deficit and cash flows for the years then ended. These financial statements are
the responsibility of the Company's management. Our responsibility is to express
an opinion on these financial statements based on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the financial position of Background America, Inc. and
subsidiaries as of December 31, 1996 and 1997, and the results of their
operations and their cash flows for the years then ended, in conformity with
generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
Nashville, Tennessee
December 18, 1998
(January 21, 1999 as to
second paragraph of
Note 15)
F-1
<PAGE> 6
BACKGROUND AMERICA, INC.
CONSOLIDATED BALANCE SHEETS
DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents (Note 2)........................ $ 92,412 $ 2,925,547
Accounts receivable --
Trade, net of allowance for doubtful accounts of $8,682
for 1996 and 1997 (Note 14).......................... 357,579 608,569
Related party (Note 13)................................ 87,079 272,244
Prepaid expenses and other current assets................. 15,831 53,302
----------- -----------
Total current assets.............................. 552,901 3,859,662
PROPERTY AND EQUIPMENT (Notes 2, 3 and 14).................. 431,892 925,641
Less accumulated depreciation and amortization............ (89,000) (296,248)
----------- -----------
342,892 629,393
GOODWILL, NET (Notes 2 and 14).............................. 633,225 577,558
OTHER ASSETS (Note 2)....................................... 145,955 135,330
----------- -----------
$ 1,674,973 $ 5,201,943
=========== ===========
LIABILITIES, REDEEMABLE PREFERRED STOCK
AND COMMON SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable -- trade................................. $ 222,332 $ 201,013
Accounts payable -- related party (Note 13)............... 139,459 231,499
Accrued expenses and other current liabilities (Note 6)... 245,960 224,301
Notes payable to shareholders (Notes 11 and 13)........... 1,310,000 152,000
----------- -----------
Total current liabilities......................... 1,917,751 808,813
COMMITMENTS (Note 5)
Series A redeemable and convertible cumulative preferred
stock ($1 par value; authorized, 5,000,000 shares; issued
and outstanding, -0- and 1,143,700, respectively;
aggregate liquidation preference of $6,324,660) (Note
11)....................................................... -- 5,968,052
COMMON SHAREHOLDERS' DEFICIT: (Notes 2, 9, 10, 12 and 13)
Common stock (no par value; authorized, 20,000,000 shares;
issued and outstanding, 2,140,572 and 2,144,172,
respectively).......................................... 962,071 966,571
Retained deficit.......................................... (1,204,849) (2,541,493)
----------- -----------
Common shareholders' deficit...................... (242,778) (1,574,922)
----------- -----------
$ 1,674,973 $ 5,201,943
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-2
<PAGE> 7
BACKGROUND AMERICA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
REVENUES (Note 2)........................................... $ 1,775,815 $ 4,221,059
COSTS OF SALES.............................................. 1,624,319 3,447,569
----------- -----------
Gross operating profit................................. 151,496 773,490
OPERATING EXPENSES:
Selling, general and administrative expenses.............. 1,118,116 1,899,086
Depreciation and amortization (Notes 2 and 3)............. 118,624 279,214
----------- -----------
Operating loss......................................... (1,085,244) (1,404,810)
OTHER INCOME (EXPENSE):
Interest expense (Notes 4 and 13)......................... (41,801) (84,463)
Interest income........................................... -- 93,106
Other, net................................................ (1,874) 59,523
----------- -----------
NET LOSS.................................................... $(1,128,919) $(1,336,644)
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-3
<PAGE> 8
BACKGROUND AMERICA, INC.
CONSOLIDATED STATEMENTS OF COMMON SHAREHOLDERS' DEFICIT
YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
COMMON STOCK COMMON
-------------------- RETAINED SHAREHOLDERS'
SHARES AMOUNT DEFICIT DEFICIT
--------- -------- ----------- -------------
<S> <C> <C> <C> <C>
BALANCE, DECEMBER 31, 1995................ 10,000 $ 10,000 $ (75,930) $ (65,930)
Fifty-for-one stock split, effective
January 30, 1996 (Note 12)........... 490,000 -- -- --
Issuance of common stock in acquisitions
(Note 14)............................ 140,572 290,571 -- 290,571
Issuance of common stock................ 1,500,000 661,500 -- 661,500
Net loss................................ -- -- (1,128,919) (1,128,919)
--------- -------- ----------- -----------
BALANCE, DECEMBER 31, 1996................ 2,140,572 962,071 (1,204,849) (242,778)
Exercise of stock options (Note 10)..... 3,600 4,500 -- 4,500
Net loss................................ -- -- (1,336,644) (1,336,644)
--------- -------- ----------- -----------
BALANCE, DECEMBER 31, 1997................ 2,144,172 $966,571 $(2,541,493) $(1,574,922)
========= ======== =========== ===========
</TABLE>
See notes to consolidated financial statements.
F-4
<PAGE> 9
BACKGROUND AMERICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
YEARS ENDED DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(1,128,919) $(1,336,644)
Adjustments to reconcile net loss to net cash used in
operating activities:
Depreciation and amortization.......................... 118,624 279,214
Changes in assets and liabilities, net of effects of
acquisitions:
Increase in accounts receivable........................ (188,524) (436,155)
Increase in prepaid expenses........................... (10,129) (37,471)
Increase in other assets............................... (4,705) (4,375)
Increase in accounts payable and accrued expenses...... 442,162 53,112
----------- -----------
Net cash used in operating activities................ (771,491) (1,482,319)
----------- -----------
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (317,986) (495,488)
Cash paid for acquisitions, net of cash received.......... (571,728) --
Cash paid for non-compete agreements...................... (150,000) --
----------- -----------
Net cash used in investing activities................ (1,039,714) (495,488)
----------- -----------
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from issuance of preferred stock, net of issuance
costs.................................................. -- 4,914,317
Proceeds from issuance of common stock.................... 661,500 --
Proceeds from issuance of notes payable to shareholders... 1,240,000 761,000
Repayment of notes payable to shareholders................ -- (868,875)
Advances under line-of-credit facility.................... -- 232,000
Payments under line-of-credit facility.................... -- (232,000)
Exercise of stock options................................. -- 4,500
----------- -----------
Net cash provided by financing activities............ 1,901,500 4,810,942
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS................... 90,295 2,833,135
CASH AND CASH EQUIVALENTS AT BEGINNING OF YEAR.............. 2,117 92,412
----------- -----------
CASH AND CASH EQUIVALENTS AT END OF YEAR.................... $ 92,412 $ 2,925,547
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid during the year for interest.................... $ -- $ 107,042
=========== ===========
SUPPLEMENTAL DISCLOSURES OF NONCASH TRANSACTIONS:
Retirement of shareholders' notes payable and accrued
interest............................................... $ -- $ 1,053,735
=========== ===========
Issuance of preferred stock............................... $ -- $ 1,053,735
=========== ===========
Common stock issued in acquisitions....................... $ 290,571 $ --
=========== ===========
Fair value of net assets acquired......................... $ 218,140 $ --
=========== ===========
Escrow liability from acquisitions........................ $ 20,000 $ --
=========== ===========
</TABLE>
See notes to consolidated financial statements.
F-5
<PAGE> 10
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
YEARS ENDED DECEMBER 31, 1996 AND 1997
1. ORGANIZATION
Background America, Inc. (the "Company") was formed in September of 1995 to
deliver high-quality background investigation services to government, corporate
and other professional clients. The consolidated financial statements include
the amounts of the Company and its inactive subsidiaries, all of which are
wholly owned. All significant intercompany balances and transactions have been
eliminated.
2. SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
ACCOUNTING 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 reported amounts of revenues and expenses during
the reporting period. Actual results could differ from those estimates.
CASH AND CASH EQUIVALENTS include highly liquid investments with original
maturities of three months or less.
PROPERTY AND EQUIPMENT is carried at cost and is depreciated using an
accelerated method over the estimated useful lives of the assets. Asset lives
are generally three to five years. Significant improvements are capitalized
while maintenance and repairs are expensed as incurred.
SOFTWARE POLICY. External direct costs of materials and services and
payroll-related costs of employees working solely on development of the software
system portion of the project are capitalized. Capitalized costs of the project
will be amortized over the estimated useful life of the software, generally
three to five years. Training costs and costs to reengineer business processes
are expensed as incurred.
GOODWILL arising from the accounting for acquired businesses is amortized
using the straight-line method over twelve years which represents the estimated
useful life. The Company reviews its long-lived and intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable. As of December 31, 1997, in the opinion
of management, there has been no such impairment.
At December 31, 1996 and 1997, cost in excess of net assets acquired
totaled $666,112 and accumulated amortization totaled $32,887 and $88,554,
respectively.
OTHER ASSETS as of December 31, 1996 and 1997, include deposits of $4,075
and $9,080, respectively, and non-compete agreements in the amount of $150,000.
The non-compete agreements are amortized using the straight-line method over the
life of each agreement. Accumulated amortization of the non-compete agreements
totaled $8,750 and $23,750 as of December 31, 1996 and 1997, respectively.
INCOME TAXES. The Company accounts for income taxes under the provisions
of Statement of Financial Accounting Standards ("SFAS") No. 109, Accounting for
Income Taxes. Under such statement, the tax benefits of tax operating loss
carryforwards are recorded to the extent available less a valuation allowance if
it is more likely than not that some portion of the deferred tax asset will not
be realized.
REVENUES from operations are recognized at the time that service is
completed using the accrual method of accounting.
STOCK-BASED COMPENSATION. SFAS No. 123, Accounting for Stock-Based
Compensation, encourages, but does not require, companies to adopt the fair
value method of accounting for stock-based compensation. The Company has chosen
to continue to account for stock-based employee compensation in accordance with
Accounting Principles Board Opinion No. 25, Accounting for Stock Issued to
Employees, and related interpretations. (See Note 10)
F-6
<PAGE> 11
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
CONCENTRATIONS OF CREDIT RISK. Financial instruments which potentially
subject the Company to concentrations of credit risk consist principally of cash
investments and trade receivables. The Company places its cash investments in
high credit quality commercial paper, federal government agencies and FDIC
insured financial institutions thus reducing potential risk. Concentrations of
credit risk with respect to trade receivables are limited due to the Company's
large number of customers and their dispersion across many geographic areas.
3. PROPERTY AND EQUIPMENT:
<TABLE>
<CAPTION>
1996 1997
-------- ---------
<S> <C> <C>
Furniture and fixtures.................................... $ 21,188 $ 36,471
Equipment................................................. 92,777 158,673
Computers, copiers and software........................... 317,259 717,574
Leasehold improvements.................................... 668 12,923
-------- ---------
431,892 925,641
Less accumulated depreciation and amortization............ (89,000) (296,248)
-------- ---------
$342,892 $ 629,393
======== =========
</TABLE>
4. LINE OF CREDIT
On April 4, 1997, the Company entered into a credit agreement with a bank
which provides for a working capital line of $1,000,000 in maximum principal.
There were no borrowings outstanding under the credit facility at December 31,
1997. The credit facility bears interest at the bank's index rate, is due and
payable monthly, matures on April 4, 1999 and is guaranteed by certain
shareholders of the Company.
5. COMMITMENTS
The Company leases certain office space under noncancelable operating lease
agreements. Total rent expense under operating leases for the years ended
December 31, 1996 and 1997 was $113,633 and $214,009, respectively. (See Note
13.)
The following is a schedule of the future minimum rental payments required
under noncancelable operating leases as of December 31, 1997:
<TABLE>
<CAPTION>
1997
--------
<S> <C>
1998.................................................. $158,957
1999.................................................. 159,495
2000.................................................. 125,288
2001.................................................. 56,875
2002.................................................. 28,875
--------
Total....................................... $529,490
========
</TABLE>
6. SELF-INSURED RISK
The Company maintains a self-insured health benefits program on behalf of
its employees, covering major medical and hospitalization costs. The Company has
limited its exposure to claims costs by securing an insurance policy on the
plan. The insurance policy reimburses the Company for accumulated costs incurred
and paid during a calendar year related to any covered individual which exceeds
$10,000. Additionally, the insurance limits the maximum amount of costs the
Company will be responsible for, based on the number of employees and families
covered by the plan during the year.
F-7
<PAGE> 12
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
As of December 31, 1996 and 1997, the Company accrued for claims which had
occurred, but had not been paid of $19,980 and $27,306, respectively. Claims
expense, net of insurance reimbursements relative to the health benefit program
for the years ended December 31, 1996 and 1997 was $62,616 and $105,168,
respectively.
7. RETIREMENT PLAN
The Company offers a retirement plan which is available to all full-time
employees for the Company with one year of service. Participants in the plan can
contribute up to 14% of annual earnings as defined by the plan and the Company
will contribute a discretionary matching amount. The Company contributed $15,492
and $0 to the plan in 1996 and 1997, respectively.
8. INCOME TAXES
At December 31, 1996 and 1997, the Company has federal and state net
operating loss carryforwards available to offset future taxable income. The
differences between financial and tax losses are attributable to differences
between reported amounts of assets and liabilities and their tax bases provided
for in accordance with SFAS No. 109. At December 31, 1997, the Company has
approximately $2,400,000 of net operating loss carryforwards for federal tax
purposes which begin to expire in the years 2011 through 2012. The carryforwards
represent a deferred tax asset of the Company which is offset fully by a
valuation allowance due to the uncertainty as to the amount, if any, of the
carryforwards which will ultimately be realized.
9. STOCK WARRANTS
As of December 31, 1996 and 1997, the Company had outstanding warrants to
purchase 500 shares of common stock at $3.50 per share and 4,000 shares of
common stock at $1.25 per share. These warrants were issued in June and July of
1996 with exercise prices equal to or greater than the fair value of the
Company's common stock on those dates to certain consultants and other
non-employees of the Company. Warrants totaling 4,000 and 500 vest and become
exercisable on June 30, 1999 and July 15, 2001, respectively. Warrants totaling
4,000 expire on June 30, 2001 or earlier with the occurrence of a merger, sale
or initial public offering of the Company unless exercised. The remaining
warrants do not expire unless there is a breach of certain contractual terms as
defined by the Stock Purchase Warrant Agreement.
10. STOCK OPTION PLANS
The Company has two stock option plans, the 1996 and 1997 stock option
plans, which provide for the granting of either incentive stock options or
nonqualified stock options to purchase shares of the Company's common stock to
officers, directors and other key employees who have substantial responsibility
for the direction and management of the Company. At December 31, 1997, 100,000
and 240,000 shares of common stock were reserved for issuance under the 1996 and
1997 plans, respectively. Approximately 45,000 and 52,000 of such reserved
shares are available for future grants under the 1996 and 1997 plans,
respectively.
Substantially all outstanding options under such plans are incentive stock
options with vesting periods of three years and maximum option terms of five
years. Vesting is accelerated in the event of the Company's shares being sold in
an initial public offering or ten days preceding the date on which the Company
enters into a merger in which the Company is not the surviving corporation. No
compensation expense related to stock option grants under the 1996 and 1997
plans was recorded in 1996 or 1997 as the option exercise prices were equal to
fair market value on the date of grant. Fair market value is the per share value
of the Company's common stock determined by the board of directors in their sole
discretion, taking into consideration those factors affecting or reflecting
value that they deem appropriate including but not limited to the Company's net
worth, prospective earning power and dividend paying capacities, the goodwill of
the business, the economic outlook in the industry, the values of securities of
corporations engaged in the same or similar lines of business that are listed on
a stock
F-8
<PAGE> 13
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
exchange or are traded in the over-the-counter market or for which there is
other information regarding value, the importance and presence of nonoperating
assets and the economic environment.
A summary of the status of the Company's two fixed stock option plans for
fiscal 1996 and 1997 and changes during those years are presented below:
<TABLE>
<CAPTION>
WEIGHTED
NUMBER AVERAGE
OF EXERCISE
SHARES PRICE
------- --------
<S> <C> <C>
Balance at December 31, 1995................................ -- $ --
Options granted............................................. 59,952 1.23
Options forfeited........................................... (100) 1.25
-------
Balance at December 31, 1996................................ 59,852 1.23
Options granted............................................. 189,125 2.68
Options forfeited........................................... (2,350) 2.21
Options exercised........................................... (3,600) 1.25
-------
Balance at December 31, 1997................................ 243,027 2.34
=======
</TABLE>
Information relating to options under the Company's two fixed stock option
plans at December 31, 1997 summarized by exercise price is as follows:
<TABLE>
<CAPTION>
WEIGHTED
AVERAGE WEIGHTED
RANGE OF REMAINING VESTED AVERAGE
EXERCISE OPTIONS CONTRACTUAL OPTIONS EXERCISE
PRICES OUTSTANDING LIFE IN YEARS OUTSTANDING PRICE
- ------------ ----------- ------------- ----------- --------
<S> <C> <C> <C> <C>
$ .75 - 1.25 58,452 3.49 -- $1.22
2.70 - 5.00 184,575 4.46 -- 2.70
-------
243,027 4.22 -- 2.34
=======
</TABLE>
In accordance with accounting for such options utilizing the intrinsic
value method, there is no related compensation expense recorded in the Company's
financial statements for the years ended December 31, 1996 and 1997 related to
the option activity summarized above.
If compensation cost for stock-based compensation had been determined based
on the fair value of the options at the grant dates consistent with the method
of SFAS No. 123, the Company's net loss for the years ended December 31, 1996
and 1997 would have been increased to the pro forma amounts presented below:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Net loss
As reported......................................... $(1,128,919) $(1,336,644)
Pro forma........................................... (1,134,412) (1,383,360)
</TABLE>
The fair value of each option grant is estimated as of the date of grant
utilizing the minimum value option-pricing model with the following weighted
average assumptions applied to the options granted:
<TABLE>
<CAPTION>
1996 1997
---- ----
<S> <C> <C>
Expected dividend yield..................................... 0.0% 0.0%
Expected volatility......................................... 0.0% 0.0%
Risk-free interest rate..................................... 5.7% 5.8%
Expected life of options (years)............................ 5 5
</TABLE>
F-9
<PAGE> 14
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The weighted average fair value at the date of grant for all options
granted during 1996 and 1997 using the minimum value method approximated $.30
and $.66, respectively.
11. REDEEMABLE PREFERRED STOCK
On June 16, 1997, the Company's charter was amended and restated to
authorize 5,000,000 shares of preferred stock having a par value of $1.00 per
share. Concurrently, the Company issued 1,143,700 shares of Series A Preferred
Stock ("Preferred Stock") for $5.25 per share. Cash proceeds from this investor
financing totaled $4,914,317, net of issuance costs totaling $36,373, with the
remaining proceeds received in the form of cancellation of the principal and
accrued interest amounts due under certain notes payable previously issued by
the Company to certain shareholders totaling $1,053,735.
The holders of Preferred Stock shall be entitled to vote on an "as
converted" basis with the common shares and have a right to elect a certain
number of representatives to the Company's Board of Directors as defined by the
amended and restated corporate charter. At the holders' option, the Preferred
Stock may be converted into the Company's common stock on a share for share
basis, subject to certain anti-dilution conversion adjustments. The holders of
Preferred Stock will be entitled to accrued dividends beginning in June 2000 at
a rate of $.2625 per share, which are payable quarterly in arrears. Beginning in
March 2002, the dividend rate will be increased to $.5250 per outstanding share.
Such dividends are cumulative and are paid in preference to any declared
dividends on common stock. In the event of a sale, merger, liquidation,
dissolution or winding up the Company, the holders of Preferred Stock are
entitled to receive from the proceeds of such an event an amount not less than
the initial issuance price of the stock, $5.25 per share, plus a ten percent
(10%) per annum compounded return on investment, net of dividends paid in
preference to holders of common stock or any other class or series of stock.
Additionally, the holders of Preferred Stock, as a group, may elect to redeem
their shares on or after March 2002 at the greater of the fair market value or
the initial issuance price, plus a ten percent (10%) per annum compounded return
on investment from the date of issuance, net of dividends paid. Preferred Stock
redeemed will be retired in four quarterly installments beginning June 19, 2002.
Should redemption as to any shares of Preferred Stock not occur when required
based on the terms described above, interest will accrue on the unpaid
redemption price at a bank's prime rate plus 1% per annum during the first year
of such delay and at a bank's prime rate plus 3% per annum thereafter.
12. COMMON STOCK
On January 30, 1996, the Company, by action of its shareholders and
directors, amended the corporate charter to increase the maximum number of
authorized common stock shares from 10,000 to 2,000,000. Concurrently, the Board
of Directors approved a fifty-for-one stock split which was effective January
30, 1996. In October 1996, the Company, by action of its shareholders and
directors, amended the corporate charter to increase the maximum number of
authorized common stock shares to 20,000,000.
In connection with the common and preferred stock issuances, certain
shareholders entered into shareholder agreements whereby the Company maintains
the first right of refusal in future transfers of such stock.
13. RELATED PARTIES
LEASES -- In July 1996, the Company entered into a month to month lease
agreement with a company controlled by the Chief Executive Officer of the
Company. The lease involves the use of a 7,500 square foot office building
located near the corporate offices and certain furniture and equipment. The
lease calls for monthly rentals in the amount of $8,050 and may be terminated by
either party with ninety days notice. The Company owed $48,300 and $64,400 under
the lease agreements as of December 31, 1996 and 1997, respectively and reported
rent expense of $48,300 and $96,600 for the years ended December 31, 1996 and
1997, respectively.
F-10
<PAGE> 15
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company subleases approximately 2,500 square feet of its corporate
office space to a company with common ownership as that of the Company,
including certain officers and directors of the Company. In May 1997, the
affiliated company was sold to a publicly traded company, however, a portion of
the sales price is contingent on the affiliate's results of operations for a
period of three years following the date of sale. The lease continues on a month
to month basis. Monthly rental charged by the Company is at cost, allocated
based on the percentage of space used by the affiliate. The monthly rental
amount has ranged from $2,775 to $4,450. This sublease income has been reflected
as a reduction of rental expense totaling $30,800 and $53,300 for the years
ended December 31, 1996 and 1997, respectively.
ACCOUNTING AND OTHER SERVICES -- The Company has provided a company with
common ownership as that of the Company with certain accounting services for a
fee which totaled $152,800 and $127,000 for the years ended December 31, 1996
and 1997, respectively. The affiliated company also provided the Company with
temporary personnel on a per hour basis and was paid a fee for employee
recruiting services based on successful efforts. Total expense incurred for
temporary employees and recruiting services were $91,450 and $36,525 for the
years ended December 31, 1996 and 1997, respectively. Receivables from the
affiliate were $21,100 and $17,000, and payables to the affiliate were $11,100
and $1,200 as of December 31, 1996 and 1997, respectively.
The Company provided administrative payroll and personnel benefit services
on behalf of certain companies controlled by certain shareholders, officers and
directors of the Company. Charges for these services are based on cost plus an
administrative fee. Total billings for these services were $631,000 and
$1,146,800 for the years ended December 31, 1996 and 1997, respectively and
receivables due to the Company resulting from such services were $53,700 and
$216,700 as of December 31, 1996 and 1997, respectively.
NOTES PAYABLE TO SHAREHOLDERS -- During 1996 and 1997 certain officers of
the Company issued loans to the Company due on demand, bearing interest at
annual rates ranging from 8.50% to 8.75%. Interest expense recognized by the
Company on these loans totaled $39,600 and $78,950 for the years ended December
31, 1996 and 1997, respectively. In June 1997, $1,050,000 and $3,735 in
principal and accrued interest amounts due, respectively, were canceled in part
consideration for the purchase of Series A Preferred Stock shares (See Note 11).
The outstanding balance due under these loans as of December 31, 1996 and 1997
was $1,310,000 and $152,000, respectively.
14. ACQUISITIONS
In February 1996, the Company acquired all of the outstanding stock of
Quality Facts, Inc. ("Quality"), an Alabama corporation, in exchange for
$300,000 plus 12,000 shares of common stock valued at $9,000. Quality was in the
business of providing traditional background verification reports for its
clients and maintained operations in Birmingham, Alabama and Goodlettsville,
Tennessee.
In conjunction with the acquisition of Quality, the Company entered into
employment agreements with each of the three shareholders of Quality,
guaranteeing employment to each shareholder for a period of two years at annual
salary of $36,000. Additionally, the Company committed to issue to the Quality
shareholders stock options to purchase a total of 10,200 shares at a weighted
average exercise price of $1.55.
In June 1996, the Company purchased all of the outstanding stock of Concord
Security Services, Inc. ("Concord"), a Maryland corporation, in exchange for
128,572 shares of common stock valued at $281,571. Concord was in the business
of providing traditional background verification services for its clients and
operated in Hamstead, Maryland.
As additional consideration to the shareholders of Concord, the Company
granted the shareholders of Concord put options which were exercisable in May
1997 at an exercise price of $3.85 per share. None of the put options were
exercised and therefore expired in May 1997.
F-11
<PAGE> 16
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Additionally, in June 1996, the Company purchased the assets and assumed
certain liabilities of Background Source, Inc. ("Background"), a Tennessee
corporation, for a total of $110,000. Background maintained a computerized
database of criminal records which provided its clients direct inquiry for a
fee. Additionally, Background provided traditional background verification
services to its clients.
In December 1996, the Company purchased the assets and assumed certain
liabilities of Tennessee Criminal Investigation Center, a Tennessee general
partnership, ("TCIC") for cash of $183,678. TCIC maintained a computerized
database of criminal records which provided its clients direct inquiry for a
fee.
The above acquisitions were accounted for using the purchase method.
Accordingly, the purchase prices have been allocated to the assets purchased and
liabilities assumed of the acquired entities based upon their estimated fair
values at the date of acquisition. The excess of the purchase price over the
estimated fair value of all net assets acquired ("goodwill") is being amortized
on a straight-line basis over 12 years. The purchase prices have been allocated
as follows:
<TABLE>
<CAPTION>
CONCORD
QUALITY SECURITY BACKGROUND
FACTS, INC. SERVICES, INC. SOURCE, INC. TCIC
----------- -------------- ------------ --------
<S> <C> <C> <C> <C>
Receivables and other current assets............ $ 40,807 $154,108 $ 26,104 $ --
Property, plant and equipment................... 7,540 3,398 16,801 45,315
Goodwill........................................ 307,049 132,332 72,043 154,685
Liabilities assumed............................. (46,396) (8,267) (4,948) (16,322)
-------- -------- -------- --------
$309,000 $281,571 $110,000 $183,678
======== ======== ======== ========
</TABLE>
15. SUBSEQUENT EVENTS
The Company entered into an Agreement and Plan of Merger in March 1998 to
acquire the outstanding stock of Profiles Plus, Inc. for 83,334 shares of common
stock of the Company and the option to put such shares to the Company for cash
of $6.00 per share any time during the period beginning June 1, 1998 and ending
June 30, 1998. The put option relating to 27,778 shares issued in connection
with this acquisition was exercised with the remaining put options expiring
unexercised. Additionally, the Company entered into a non-compete agreement with
a shareholder of Profiles Plus, Inc.
In January 1999, the Company entered into an agreement to sell all of the
Company's outstanding capital stock in exchange for approximately 989,000 shares
of the acquiring company, Kroll-O'Gara Co., of Fairfield, Ohio. The Company will
continue to operate as an independent subsidiary of Kroll-O'Gara Co.
* * * * * *
F-12
<PAGE> 17
BACKGROUND AMERICA, INC.
CONSOLIDATED BALANCE SHEET
SEPTEMBER 30, 1998
(UNAUDITED)
<TABLE>
<CAPTION>
1998
-----------
<S> <C>
ASSETS
CURRENT ASSETS:
Cash and cash equivalents................................. $ 1,058,328
Accounts receivable-
Trade, net of allowance for doubtful accounts of $8,682
for 1998.............................................. 1,377,340
Related party.......................................... 212,676
Prepaid expenses and other current assets................. 90,079
-----------
Total current assets.............................. 2,738,423
PROPERTY AND EQUIPMENT...................................... 1,450,329
Less-accumulated depreciation and amortization............ (703,752)
-----------
746,577
GOODWILL, NET............................................... 1,066,916
OTHER ASSETS................................................ 248,769
-----------
$ 4,800,685
===========
LIABILITIES, REDEEMABLE PREFERRED STOCK AND COMMON
SHAREHOLDERS' DEFICIT
CURRENT LIABILITIES:
Accounts payable -- trade................................. $ 323,750
Accounts payable -- related party......................... 9,622
Accrued expenses and other current liabilities............ 348,248
Current portion of long-term debt......................... 33,824
-----------
Total current liabilities......................... 715,444
Long-term debt............................................ 98,223
Series A redeemable and convertible cumulative preferred
stock ($1 par value; authorized, 5,000,000 shares;
issued and outstanding, 1,143,700; aggregate
liquidation preference of $6,324,660).................. 5,968,052
COMMON SHAREHOLDERS' DEFICIT:
Common stock (no par value; authorized, 20,000,000 shares;
issued and outstanding, 2,199,728)..................... 1,243,783
Common stock, 5,556 shares held in escrow for Profiles'
acquisition............................................ 33,324
Retained deficit.......................................... (3,258,141)
-----------
Common shareholders' deficit...................... (1,981,034)
-----------
$ 4,800,685
===========
</TABLE>
The accompanying notes to the unaudited financial statements
are an integral part of these financial statements.
F-13
<PAGE> 18
BACKGROUND AMERICA, INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
1997 1998
----------- ----------
<S> <C> <C>
REVENUES.................................................... $ 3,075,604 $5,027,994
COSTS OF SALES.............................................. 2,554,981 3,359,594
----------- ----------
Gross operating profit................................. 520,623 1,668,400
OPERATING EXPENSES:
Selling, general and administrative expenses.............. 1,362,891 2,150,348
Depreciation and amortization............................. 204,810 318,947
----------- ----------
Operating loss......................................... (1,047,078) (800,895)
OTHER INCOME (EXPENSE):
Interest expense.......................................... (79,189) (9,139)
Interest income........................................... 51,919 76,694
Other, net................................................ 14,307 16,692
----------- ----------
NET LOSS.................................................... $(1,060,041) $ (716,648)
=========== ==========
</TABLE>
The accompanying notes to the unaudited financial statements
are an integral part of these financial statements.
F-14
<PAGE> 19
BACKGROUND AMERICA, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1997 AND 1998
(UNAUDITED)
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net loss.................................................. $(1,060,041) $ (716,648)
Adjustments to reconcile net loss to net cash used in
operating activities-
Depreciation and amortization.......................... 204,811 318,946
Changes in assets and liabilities, net of effects of
acquisitions-
Increase in accounts receivable........................ (482,886) (709,202)
Increase in prepaid expenses........................... (41,017) (36,777)
Increase in other assets............................... (4,375) (5,378)
Increase in accounts payable and accrued expenses...... 89,497 9,173
----------- -----------
Net cash used in operating activities................ (1,294,011) (1,139,886)
CASH FLOWS FROM INVESTING ACTIVITIES:
Capital expenditures...................................... (415,111) (441,337)
Cash paid for non-compete agreements...................... -- (133,996)
----------- -----------
Net cash used in investing activities................ (415,111) (575,333)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from the issuance of preferred stock, net........ 4,914,317 --
Proceeds from the issuance of notes payable to
shareholders........................................... 761,000 --
Repayment of notes payable to shareholders................ (868,875) (152,000)
Advances under line-of-credit facility.................... 232,000 --
Payments under line-of-credit facility.................... (232,000) --
Exercise of stock options and stock puts.................. 4,500 --
----------- -----------
Net cash provided by (used in) financing
activities........................................ 4,810,942 (152,000)
----------- -----------
NET INCREASE IN CASH AND CASH EQUIVALENTS................... 3,101,820 (1,867,219)
CASH AND CASH EQUIVALENTS, beginning of period.............. 92,412 2,925,547
----------- -----------
CASH AND CASH EQUIVALENTS, end of period.................... $ 3,194,232 $ 1,058,328
=========== ===========
SUPPLEMENTAL DISCLOSURES OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ (79,189) $ (9,139)
=========== ===========
SUPPLEMENTAL DISCLOSURE OF NONCASH TRANSACTIONS:
Retirement of shareholder notes payable and accrued
interest............................................... $ 1,053,735 $ --
=========== ===========
Issuance of preferred stock............................... $ 1,053,735 $ --
=========== ===========
Common stock issued in acquisitions....................... $ -- $ 477,504
=========== ===========
Fair value of net assets acquired......................... $ -- $ 88,352
=========== ===========
Escrow liability from acquisitions........................ $ -- $ 48,500
=========== ===========
</TABLE>
The accompanying notes to the unaudited financial statements
are an integral part of these financial statements.
F-15
<PAGE> 20
BACKGROUND AMERICA, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
SEPTEMBER 30, 1997 AND 1998
(1) ORGANIZATION
Background America, Inc. (the Company) was formed in September of 1995 to
deliver high-quality background investigation services to government, corporate
and other professional clients. The consolidated financial statements include
the amounts of the Company and its inactive subsidiaries, all of which are
wholly owned. All significant intercompany balances and transactions have been
eliminated.
The accompanying unaudited financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements.
In the opinion of management, the accompanying interim audited financial
statements contain all adjustments (consisting of normal recurring accruals)
necessary to present fairly the financial position of the Company as of
September 30, 1998 and 1997.
(2) REVENUE RECOGNITION
Revenues from operations are recognized at the time the service is
completed using the accrual method of accounting.
(3) SOFTWARE POLICY
External direct costs of materials and services and payroll-related costs
of employees working solely on the development of the software system portion of
the project are capitalized. Capitalized costs of the project will be amortized
over the estimated useful life of the software, generally three to five years.
Training costs and costs to reengineer business processes are expensed as
incurred.
(4) GOODWILL
Goodwill arising from the accounting for acquired businesses is amortized
using the straight-line method over twelve years which represents the estimated
useful life. The Company reviews its long-lived and intangible assets for
impairment whenever events or changes in circumstances indicate that the
carrying amount may not be recoverable.
(5) BUSINESS COMBINATION
The Company entered into an Agreement and Plan of Merger in March 1998 to
acquire the outstanding stock of Profiles Plus, Inc. for 83,334 shares of common
stock of the Company and the option to put such shares to the Company for cash
of $6.00 per share any time during the period beginning June 1, 1998 and ending
June 30, 1998. The put option relating to 27,778 shares issued in connection
with this acquisition was exercised with the remaining put options expiring
unexercised. Additionally, the Company entered into a non-compete agreement with
a shareholder of Profiles Plus, Inc.
(6) SUBSEQUENT EVENTS
In January 1999, the Company entered into an agreement to sell all of the
Company's outstanding capital stock in exchange for approximately 989,000 shares
of the acquiring company, The Kroll-O'Gara Company of Fairfield, Ohio. The
Company will continue to operate as an independent subsidiary of The
Kroll-O'Gara Company.
F-16
<PAGE> 21
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The Kroll-O'Gara Company:
We have audited the consolidated balance sheets of THE KROLL-O'GARA COMPANY
(Note 1) and subsidiaries as of December 31, 1996 and 1997 and the related
consolidated statements of operations, shareholders' equity and cash flows for
each of the three years in the period ended December 31, 1997 included elsewhere
in this document. 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 1995 or 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 Note 1.
Such statements are included in the consolidated financial statements of The
Kroll-O'Gara Company and reflect total assets and total revenues of 46 percent
and 46 percent, respectively, in 1996 and total revenues of 62 percent in 1995,
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 the amounts included for Kroll Holdings, Inc. for those years, is based
solely on 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 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, 1996 and 1997 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1997, in conformity with generally accepted accounting principles.
We have also made a similar audit of the accompanying supplemental
consolidated balance sheets of The Kroll-O'Gara Company and subsidiaries as of
December 31, 1996 and 1997, and the related supplemental consolidated statements
of income, shareholders' equity and cash flows for each of the three years in
the period ended December 31, 1997. The supplemental consolidated statements
give retroactive effect to the mergers with Laboratory Specialists of America,
Inc. on December 7, 1998, Schiff & Associates, Inc. on December 31, 1998 and
Securify Inc. on December 31, 1998 which have been accounted for as pooling of
interests transactions as described in Note 1. These supplemental financial
statements are the responsibility of the Company's management. Our
responsibility is to express an opinion on these supplemental financial
statements based on our audits.
We did not audit the 1995 or 1996 financial statements of Kroll Holdings,
Inc. included in the supplemental consolidated financial statements of The
Kroll-O'Gara Company, which statements reflect total assets and total revenues
constituting 41 percent and 43 percent, respectively, in 1996 and total revenues
of 56 percent in 1995 of the related supplemental consolidated totals. Those
statements were audited by other auditors whose reports thereon have been
furnished to us, and our opinion expressed herein, insofar as it relates to the
amounts included for Kroll Holdings, Inc., is based solely on 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 audit and the reports of other auditors, the
supplemental consolidated financial statements referred to above present fairly,
in all material respects, the financial position of The Kroll-O'Gara
F-17
<PAGE> 22
Company and its subsidiaries as of December 31, 1996 and 1997, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1997, after giving retroactive effect to the mergers
with Laboratory Specialists of America, Inc., Schiff & Associates, Inc. and
Securify Inc. as described in Note 1, all in conformity with generally accepted
accounting principles.
As explained in Note 2(r) to the supplemental 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
February 25, 1999
F-18
<PAGE> 23
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
ASSETS (NOTE 7)
CURRENT ASSETS:
Cash and cash equivalents................................. $ 5,491,944 $ 9,765,422
Marketable securities..................................... 47,500 22,969
Trade accounts receivable, net of allowance for doubtful
accounts of approximately $2,523,884 and $3,100,064 in
1996 and 1997, respectively (Notes 2 and 4)............ 25,422,774 40,796,471
Unbilled revenues (Note 2)................................ 4,150,307 3,081,481
Related party receivables (Note 6)........................ 1,071,661 939,894
Costs and estimated earnings in excess of billings on
uncompleted contracts (Note 4)......................... 15,326,548 12,078,464
Inventories (Note 4)...................................... 8,833,394 19,562,899
Prepaid expenses and other................................ 3,340,465 6,786,288
Deferred tax asset (Note 5)............................... 211,078 572,697
------------ ------------
Total current assets.............................. 63,895,671 93,606,585
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, at cost (Notes 2 and 8):
Land...................................................... 955,182 1,831,042
Buildings and improvements................................ 5,059,512 8,100,454
Leasehold improvements.................................... 5,186,648 5,242,607
Furniture and fixtures.................................... 3,850,933 4,752,974
Machinery and equipment................................... 10,418,786 13,500,247
Construction-in-progress.................................. -- 1,037,528
------------ ------------
25,471,061 34,464,852
Less -- accumulated depreciation............................ (14,707,659) (16,904,830)
------------ ------------
10,763,402 17,560,022
------------ ------------
DATABASES, net of accumulated amortization of $16,568,473
and $19,505,625 in 1996 and 1997, respectively (Note 2)... 7,415,449 8,335,211
COSTS IN EXCESS OF ASSETS ACQUIRED AND OTHER INTANGIBLE
ASSETS, net of accumulated amortization of $678,885 and
$1,691,307 in 1996 and 1997, respectively (Notes 2 and
3)........................................................ 6,884,313 26,651,017
OTHER ASSETS (Note 4)....................................... 3,104,953 4,331,645
------------ ------------
17,404,715 39,317,873
------------ ------------
$ 92,063,788 $150,484,480
============ ============
</TABLE>
The accompanying notes to supplemental consolidated financial statements
are an integral part of these supplemental consolidated balance sheets.
F-19
<PAGE> 24
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1996 AND 1997
<TABLE>
<CAPTION>
1996 1997
------------ ------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit (Note 7)........................ $ 9,935,947 $ 559,112
Current portion of long-term debt (Note 8)................ 5,327,641 4,038,080
Related party payables (Note 6)........................... 2,532,998 1,184,439
Obligations related to discontinued operation............. 784,272 126,813
Trade accounts payable.................................... 16,519,488 32,328,154
Billings in excess of costs and estimated earnings on
uncompleted contracts (Note 4)......................... 1,330,402 320,662
Accrued liabilities....................................... 10,072,388 15,085,447
Income taxes currently payable............................ 514,871 845,753
Deferred income taxes (Note 5)............................ 1,703,377 --
Customer deposits......................................... 3,183,564 3,839,770
------------ ------------
Total current liabilities......................... 51,904,948 58,328,230
OTHER LONG-TERM LIABILITIES................................. 2,057,197 1,532,730
SHAREHOLDER PAYABLE......................................... 5,048,266 --
DEFERRED INCOME TAXES (Note 5).............................. 2,309,879 2,514,606
LONG-TERM DEBT, net of current portion (Note 8)............. 7,626,821 49,641,484
------------ ------------
Total liabilities................................. 68,947,111 112,017,050
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 9 and 12)
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, 13,459,431 and 14,795,244 shares issued and
outstanding in 1996 and 1997, respectively............. 134,594 147,952
Additional paid-in-capital................................ 43,187,110 58,912,209
Retained deficit.......................................... (20,061,208) (20,208,821)
Accumulated other comprehensive income (loss)............. (143,819) (383,910)
------------ ------------
Total shareholders' equity........................ 23,116,677 38,467,430
------------ ------------
$ 92,063,788 $150,484,480
============ ============
</TABLE>
The accompanying notes to supplemental consolidated financial statements
are an integral part of these supplemental consolidated balance sheets.
F-20
<PAGE> 25
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
1995 1996 1997
----------- ------------ ------------
<S> <C> <C> <C>
NET SALES.............................................. $94,998,407 $164,918,313 $206,102,605
COST OF SALES.......................................... 66,763,734 117,298,266 139,765,613
----------- ------------ ------------
Gross profit (Note 14)............................. 28,234,673 47,620,047 66,336,992
OPERATING EXPENSES:
Selling and marketing................................ 10,042,762 10,401,530 15,054,990
General and administrative........................... 21,766,460 27,310,521 32,590,832
Asset impairment (Note 2(h))......................... -- 124,531 --
Merger related costs................................. -- -- 7,204,926
----------- ------------ ------------
Operating expenses................................. 31,809,222 37,836,582 54,850,748
----------- ------------ ------------
Operating income (loss)............................ (3,574,549) 9,783,465 11,486,244
OTHER INCOME (EXPENSES):
Interest expense..................................... (2,896,979) (3,260,945) (5,092,372)
Interest income...................................... 127,006 41,260 79,438
Other, net........................................... (108,701) 344,398 (411,576)
----------- ------------ ------------
Income (loss) from continuing operations before
minority interest, provision (benefit) for
income taxes, extraordinary item and cumulative
effect of change in accounting principle........ (6,453,223) 6,908,178 6,061,734
Minority interest...................................... -- -- (156,223)
----------- ------------ ------------
Income (loss) from continuing operations before
provision (benefit) for income taxes,
extraordinary item and cumulative effect of
change in accounting principle.................. (6,453,223) 6,908,178 5,905,511
Provision (benefit) for income taxes................... (823,432) 365,547 3,304,993
----------- ------------ ------------
Income (loss) from continuing operations before
extraordinary item and cumulative effect of
change in accounting principle.................. (5,629,791) 6,542,631 2,600,518
Discontinued operations (Note 3(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) before extraordinary item and
cumulative effect of change in accounting
principle....................................... (5,629,791) 5,268,415 2,600,518
Extraordinary loss, net of applicable tax benefit of
$129,250 (Note 7).................................... -- -- (193,875)
----------- ------------ ------------
Income (loss) before cumulative effect of change in
accounting principle............................ (5,629,791) 5,268,415 2,406,643
Cumulative effect of change in accounting principle,
net of applicable tax benefit of $240,000 (Note
2(r))................................................ -- -- (360,000)
----------- ------------ ------------
Net income (loss).................................. (5,629,791) 5,268,415 2,046,643
Dividends on preferred stock........................... 13,344 -- --
----------- ------------ ------------
Net income (loss) available to common
shareholders.................................... $(5,643,135) $ 5,268,415 $ 2,046,643
=========== ============ ============
Earnings (loss) per share (Note 2(o)):
Basic................................................ $ (0.52) $ 0.45 $ 0.15
=========== ============ ============
Diluted.............................................. $ (0.52) $ 0.42 $ 0.14
=========== ============ ============
Weighted average shares outstanding (Note 2(o)):
Basic................................................ 10,883,123 11,607,329 14,006,638
=========== ============ ============
Diluted.............................................. 10,883,123 12,160,974 14,799,322
=========== ============ ============
</TABLE>
The accompanying notes to supplemental consolidated financial statements
are an integral part of these supplemental consolidated statements.
F-21
<PAGE> 26
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
ADDITIONAL
COMPREHENSIVE COMMON PREFERRED PAID-IN RETAINED
SHARES INCOME STOCK STOCK CAPITAL DEFICIT
---------- ------------- -------- --------- ----------- ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1994, as
previously reported................. 9,097,902 $ 69,371 $ -- $21,791,885 $(10,953,793)
Adjustment for pooling of interests... 862,846 8,628 300,000 5,374,337 538,105
---------- -------- --------- ----------- ------------
BALANCE, December 31, 1994, as
restated............................ 9,960,748 77,999 300,000 27,166,222 (10,415,688)
Incorporation of OSN.................. 922,375 1,163 -- 248,837 --
Distributions to shareholders......... -- -- -- -- (162,800)
Redemption of preferred stock (Note
6).................................. -- -- (300,000) -- --
Comprehensive income:
Net loss available to common
shareholders...................... -- $(5,643,135) -- -- -- (5,643,135)
-----------
Other comprehensive income, net of
tax:
Foreign currency translation
adjustment, net of $20,000 tax
provision....................... -- 29,735 -- -- -- --
-----------
Other comprehensive income........ -- 29,735 -- -- -- --
-----------
Comprehensive income (loss)..... -- $(5,613,400) -- -- -- --
---------- ----------- -------- --------- ----------- ------------
BALANCE, December 31, 1995............ 10,883,123 79,162 -- 27,415,059 (16,221,623)
Distributions to shareholders, prior
to the offering..................... -- -- -- -- (230,000)
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 --
Initial public offering of common
stock, net of issuance costs of
approximately $3,550,000 (Note 1)... 2,048,000 51,359 -- 14,820,458 --
Distribution of previously taxed S
Corp earnings to S Corp shareholders
(Note 1)............................ -- -- -- -- (9,000,000)
Forgiveness of affiliate obligation
(Note 6)............................ -- -- -- -- 122,000
Comprehensive income:
Net income.......................... -- $ 5,268,415 -- -- -- 5,268,415
-----------
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............ -- $ 4,927,048 -- -- -- --
---------- ----------- -------- --------- ----------- ------------
BALANCE, December 31, 1996............ 13,459,431 134,594 -- 43,187,110 (20,061,208)
Issuances of stock under employee
benefit plans, including related tax
benefit (Note 11)................... 749,757 7,497 -- 6,296,786 --
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 --
Purchase and retirement of common
stock (Note 11(d)).................. (259,036) (2,590) -- (498,978) (2,194,256)
Comprehensive income:
Net income.......................... -- $ 2,046,643 -- -- -- 2,046,643
-----------
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............ -- $ 1,806,552 -- -- -- --
---------- =========== -------- --------- ----------- ------------
BALANCE, December 31, 1997............ 14,795,244 $147,952 $ -- $58,912,209 $(20,208,821)
========== ======== ========= =========== ============
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME (LOSS) TOTAL
------------- -----------
<S> <C> <C>
BALANCE, December 31, 1994, as
previously reported................. $ 167,813 $11,075,276
Adjustment for pooling of interests... -- 6,221,070
--------- -----------
BALANCE, December 31, 1994, as
restated............................ 167,813 17,296,346
Incorporation of OSN.................. -- 250,000
Distributions to shareholders......... -- (162,800)
Redemption of preferred stock (Note
6).................................. -- (300,000)
Comprehensive income:
Net loss available to common
shareholders...................... -- (5,643,135)
Other comprehensive income, net of
tax:
Foreign currency translation
adjustment, net of $20,000 tax
provision....................... -- --
Other comprehensive income........ 29,735 29,735
Comprehensive income (loss)..... -- --
--------- -----------
BALANCE, December 31, 1995............ 197,548 11,470,146
Distributions to shareholders, prior
to the offering..................... -- (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
Initial public offering of common
stock, net of issuance costs of
approximately $3,550,000 (Note 1)... -- 14,871,817
Distribution of previously taxed S
Corp earnings to S Corp shareholders
(Note 1)............................ -- (9,000,000)
Forgiveness of affiliate obligation
(Note 6)............................ -- 122,000
Comprehensive income:
Net income.......................... -- 5,268,415
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............ (143,819) 23,116,677
Issuances of stock under employee
benefit plans, including related tax
benefit (Note 11)................... -- 6,304,283
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
Purchase and retirement of common
stock (Note 11(d)).................. -- (2,695,824)
Comprehensive income:
Net income.......................... -- 2,046,643
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............ $(383,910) $38,467,430
========= ===========
</TABLE>
The accompanying notes to supplemental consolidated financial statements
are an integral part of these supplemental consolidated statements.
F-22
<PAGE> 27
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 15)
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
<TABLE>
<CAPTION>
1995 1996 1997
----------- ----------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $(5,629,791) $ 5,268,415 $ 2,046,643
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operating activities:
Depreciation and amortization........................... 4,138,531 5,248,788 6,519,454
Bad debt expense........................................ 3,134,556 8,555,063 2,083,080
Shareholder stock compensation.......................... -- 930,846 1,356,280
Loss on write-off of notes receivable................... 55,966 -- 35,434
Share in net (income) loss of joint ventures............ 224,789 (19,224) (121,650)
Gain on sale of marketable securities................... -- (108,646) (14,503)
Asset impairment........................................ -- 174,531 --
Disposal of clinical business........................... -- 1,263,000 --
Change in assets and liabilities, net of effects of
acquisitions:
Receivables -- trade and unbilled....................... (510,378) (7,191,858) (9,974,669)
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. (3,957,287) (7,626,473) 3,499,084
Inventories, prepaid expenses and other assets.......... (4,619,118) (3,274,443) (7,184,407)
Accounts payable and income taxes currently payable..... 5,747,515 1,539,236 8,101,505
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. (43,150) (375,640) (1,009,740)
Amounts due to/from employees........................... 19,820 (294,471) 443,290
Deferred taxes.......................................... (894,006) (1,150,316) (156,892)
Accrued liabilities, long-term liabilities and customer
deposits.............................................. 796,993 5,016,351 571,909
----------- ----------- ------------
Net cash provided by (used in) operating activities... (1,535,560) 7,955,159 6,194,818
----------- ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net........... (1,699,685) (3,473,979) (5,521,131)
Additions to databases.................................... (2,985,409) (3,250,360) (3,856,914)
Decrease (increase) in notes receivable -- shareholder.... (233,253) 233,253 --
Acquisitions, net of cash acquired (Note 3)............... (101,826) (2,139,123) (10,710,128)
Sale of marketable securities............................. -- 200,313 35,424
Other..................................................... (27,600) (66,711) 266,004
----------- ----------- ------------
Net cash used in investing activities................. (5,047,773) (8,496,607) (19,786,745)
----------- ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Loan financing fees....................................... (13,825) -- (723,727)
Net borrowings (repayments) under revolving lines of
credit.................................................. 4,551,025 (252,818) (9,376,835)
Proceeds from debt........................................ 415,011 179,569 44,902,987
Payments of long-term debt................................ (3,827,330) (5,832,603) (10,042,503)
Proceeds from notes payable -- shareholder................ 2,600,000 2,000,000 500,000
Repayment of notes payable -- shareholder................. (106,500) (803,745) (7,238,766)
Net proceeds from issuance of common stock................ 250,000 14,871,817 --
Purchase and retirement of stock.......................... -- -- (2,695,824)
Redemption of preferred stock............................. (300,000) -- --
Warrant offering cost..................................... (38,821) -- --
Foreign currency translation.............................. 922 (46,187) (160,462)
Distributions to shareholders, including preferred
dividends............................................... (187,548) (9,230,000) --
Proceeds from exercise of stock options and warrants...... -- 445 2,776,466
----------- ----------- ------------
Net cash provided by financing activities............. 3,342,934 886,478 17,941,336
----------- ----------- ------------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS........ (3,240,399) 345,030 4,349,409
Effects of foreign currency exchange rates on cash and cash
equivalents............................................... -- 34,032 (75,931)
----------- ----------- ------------
CASH AND CASH EQUIVALENTS, beginning of year................ 8,353,281 5,112,882 5,491,944
----------- ----------- ------------
CASH AND CASH EQUIVALENTS, end of year...................... $ 5,112,882 $ 5,491,944 $ 9,765,422
=========== =========== ============
</TABLE>
The accompanying notes to supplemental consolidated financial statements
are an integral part of these supplemental consolidated statements.
F-23
<PAGE> 28
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
(1) NATURE OF OPERATIONS AND BASIS OF PRESENTATION
(a) HISTORY AND NATURE OF OPERATIONS -- 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 to businesses, individuals and governments. It also offers
security services such as training, risk and crisis management services, and
site security systems. The Investigations and Intelligence Group offers business
intelligence and investigation services to clients worldwide. The Voice and Data
Communications Group offers secure satellite communication equipment, satellite
navigation systems and computer hardware and software security.
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 supplemental
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.
The Company completed its initial public offering of common stock in 1996.
The $14.9 million in net proceeds from the sale of 2,048,000 shares of common
stock were used by the Company for retirement of bank debt, payment of $9
million in undistributed previously taxed income of OHE as an S corporation,
purchase of a manufacturing facility in Mexico, acquisition of Palmer net assets
(Note 3) and transaction costs associated with the offering.
(b) BASIS OF PRESENTATION -- 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 (see Note 3). The supplemental consolidated
financial statements include the historical consolidated financial statements of
the Company and the financial position, results of operations and cash flows of
three entities which were merged with the Company in December 1998.
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 will be 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 will be 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
F-24
<PAGE> 29
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 will be reported in this group. The Information Security
Group offers information and computer security services, including network and
system security review and repair.
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 on a supplemental basis to include the combined
results of operations, financial position and cash flows of LSAI and Schiff as
though they had always been a part of the Company. Securify was not formed until
1998 and therefore no results of operations, financial position or cash flows
are included in the supplemental consolidated financial statements of the
Company.
There were no transactions between the Company and LSAI, Schiff and
Securify prior to the combination and immaterial adjustments were recorded to
conform LSAI's and Schiff's accounting policies. Certain reclassifications were
made to both the Company's, LSAI's and Schiff's financial statements to conform
presentation. The results of operations for the separate companies and the
combined amounts presented in the supplemental consolidated financial statements
follow:
<TABLE>
<CAPTION>
KROLL-O'GARA
HISTORICAL LSAI SCHIFF COMBINED
------------ ----------- ---------- ------------
<S> <C> <C> <C> <C>
Year ended December 31, 1997
Revenue....................... $190,413,349 $12,836,953 $2,852,303 $206,102,605
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....................... 153,660,749 8,726,799 2,530,765 164,918,313
Discontinued operations....... -- (1,274,216) -- (1,274,216)
Net income (loss).......... 5,857,222 (585,711) (3,096) 5,268,415
Year ended December 31, 1995
Revenue....................... 85,841,300 6,925,716 2,231,391 94,998,407
Net income (loss)............. (6,535,739) 661,216 231,388 (5,643,135)
</TABLE>
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) CONSOLIDATION -- The supplemental 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 supplemental 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
F-25
<PAGE> 30
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 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.
Revenue related to voice and data communications equipment and services is
recognized as equipment is shipped or as services are provided. Revenue and
related direct costs of brokered satellite time are recorded when payments are
received from customers.
(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 (SFAS 115), "Accounting for
Certain Investments in Debt and Equity Securities," 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 has classified marketable securities as available-for-sale.
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 gain (loss) of $14,167 and $(3,698) as of December 31,
1996 and 1997, respectively.
(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 the straight-line method over the
estimated useful lives of the related assets as follows:
<TABLE>
<S> <C>
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
</TABLE>
(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
F-26
<PAGE> 31
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
databases for the years ended December 31, 1995, 1996 and 1997 was $2,470,696,
$2,949,134 and $2,937,152, respectively.
(h) IMPAIRMENT OF LONG-LIVED ASSETS -- Effective January 1, 1996, the
Company adopted the provisions of SFAS No. 121 (SFAS 121), "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of."
This standard requires that long-lived assets, certain identifiable intangibles
and goodwill related to those assets be reviewed for impairment by asset group
for which the lowest level of independent cash flows can be identified. 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, 1997. However, it is possible, due to a change in circumstances,
that the carrying value could become impaired in the future. Such impairment
could have a material effect on the results of operations in a particular
reporting period.
The adoption of SFAS 121 in 1996 resulted in no adjustment to the
supplemental consolidated financial statements of the Company. However, during
the fourth quarter of 1996, LSAI 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 supplemental
consolidated statements of operations.
(i) 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. 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, 1995, 1996
and 1997 was $26,939, $26,992 and $683,649, respectively.
(j) 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 being amortized over the life of the agreement, which
ranges from six months to five years.
(k) 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.
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 supplemental
consolidated statements of operations.
(l) 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.
(m) RESEARCH AND DEVELOPMENT -- Research and development costs are
expensed as incurred. The Company incurred approximately $91,000, $130,000 and
$136,000 for the years ended December 31, 1995, 1996 and 1997, respectively, for
research and development. These costs are included in general and administrative
expenses in the accompanying supplemental consolidated statements of operations.
F-27
<PAGE> 32
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(n) ADVERTISING -- The Company expenses the cost of advertising as
incurred. Advertising expenses for the years ended December 31, 1995, 1996 and
1997 were $381,000, $782,000 and $1,534,000, respectively.
(o) 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, 1995,
1996 and 1997:
Since there were no dilutive securities, basic and diluted loss per share
in 1995 are identical, thus a reconciliation of the numerator and denominator is
not necessary.
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------------------------
INCOME (NUMERATOR) SHARES (DENOMINATOR) PER SHARE AMOUNT
------------------ -------------------- ----------------
<S> <C> <C> <C>
Basic earnings per share..... $5,268,415 11,607,329 $0.45
-----
Effect of dilutive
securities:
Options.................... -- 131,932
Restricted stock........... (162,443) 287,482
Warrants................... -- 101,797
Convertible note payable... -- 32,434
---------- ----------
Diluted earnings per share... $5,105,972 12,160,974 $0.42
========== ========== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
--------------------------------------------------------------
INCOME (NUMERATOR) SHARES (DENOMINATOR) PER SHARE AMOUNT
------------------ -------------------- ----------------
<S> <C> <C> <C>
Basic earnings per share..... $2,046,643 14,006,638 $0.15
-----
Effect of dilutive
securities:
Options.................... -- 238,570
Restricted stock........... -- 443,152
Warrants................... -- 96,740
Convertible note payable... -- 14,222
---------- ----------
Diluted earnings per share... $2,046,643 14,799,322 $0.14
========== ========== =====
</TABLE>
Basic and diluted earnings per share based on income from continuing
operations were $0.56 and $0.52, respectively, for the year ended December 31,
1996. The basic and diluted per share impact of the discontinued operations were
$0.11 and $0.10, respectively.
Basic and diluted earnings per share based on income from continuing
operations before extraordinary item and cumulative effect of change in
accounting principle were $0.19 and $0.18, respectively, for the year ended
December 31, 1997. The basic and diluted per share impact of 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.
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.
F-28
<PAGE> 33
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(p) 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 supplemental consolidated statement of
shareholder's equity. Prior years have been restated to conform to the SFAS 130
requirements. The accumulated other comprehensive income (loss) balance of $0.2
million at December 31, 1995 consisted entirely of foreign currency translation
adjustments. 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.
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, has no impact on the Company's reported supplemental
consolidated financial position, results of operations or cash flows.
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
supplemental consolidated balance sheet are approximately $1.0 million 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 is
effective for fiscal years beginning after June 15, 1999. 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.
(q) 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
F-29
<PAGE> 34
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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(g).
(r) 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 quarters of 1997 (approximately
$360,000, net of tax benefit of $240,000) as a cumulative effect of change in
accounting principle.
(s) 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
supplemental consolidated financial statements since they are accounted for as
hedges.
(t) RECLASSIFICATIONS -- Certain reclassifications have been reflected in
1995 and 1996 to conform with the current period presentation.
(3) MERGER AND ACQUISITIONS
The Company has completed the following transactions during 1996 and 1997.
All were accounted for as purchase business combinations except for the merger
with Kroll which was accounted for as a pooling of interests business
combination.
(a) NATIONAL PSYCHOPHARMACOLOGY LABORATORY, INC. -- On January 2, 1996,
the Company acquired all of the shares of National Psychopharmacology
Laboratory, Inc. (NPLI), a company engaged in forensic drug testing and clinical
testing and analysis.
The total purchase price of approximately $3,400,000, substantially all of
which was recorded as intangible assets, consisted of $1,075,000 in cash,
$650,000 in unsecured promissory notes and assumption of net liabilities of
approximately $1,675,000, including $800,000 in deferred income taxes. For
accounting purposes, the acquisition of NPLI was effective on January 1, 1996
and the results of operations of NPLI are included in the supplemental
consolidated results of operations of the Company from that date forward.
The forensic portion of NPLI's business was merged into the operations of a
subsidiary of the Company effective February 1996. The Company intended to sell
the clinical business during 1996, but after negotiations with three potential
buyers failed, the Company shut down the clinical operations effective in the
fourth quarter of 1996. The revenues related to the discontinued clinical
operation for the year ended December 31, 1996, were approximately $3,413,000.
The related operating loss and shut down expenses of the clinical business are
included in the accompanying supplemental consolidated statements of operations
as "discontinued operation" and "disposition of discontinued operation,"
respectively.
(b) PALMER ASSOCIATES, S.C. -- In October 1996, the Company purchased
substantially all of the assets and certain liabilities of Palmer Associates,
S.C., (Palmer) a security services provider, for approximately $1,000,000, which
resulted in goodwill (amortized over fifteen years) and intangible assets equal
to the purchase price. The purchase was payable $500,000 at the closing of the
Company's initial public offering and $250,000 each in November 1997 and 1998.
The former owner also entered into a four year non-competition agreement,
payable in annual installments of $50,000, and a two year employment agreement.
F-30
<PAGE> 35
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(c) PATHOLOGY LABORATORIES, LTD. -- On January 31, 1997, the Company
acquired certain intangible assets from Pathology Laboratories, Ltd. (PLL), a
Company engaged in providing drug testing services. The total purchase price of
approximately $2.6 million, which was allocated entirely to customer lists to be
amortized over fifteen years, consisted of $1.6 million in cash and quarterly
payments beginning on July 31, 1997 and ending on March 31, 1998 totaling
approximately $1.0 million based on a prescribed level of revenues generated
form the purchased customer list. In the accompanying supplemental consolidated
balance sheet at December 31, 1997, the Company has approximately $250,000
accrued for the remainder of the total purchase price. For accounting purposes,
the acquisition of PLL was effective on January 31, 1997 and the results of
operations of PLL are included in the supplemental consolidated results of
operations of the Company from that date forward.
(d) NEXT DESTINATION LIMITED -- On February 5, 1997, the Company acquired
all of the shares of Next Destination Limited (Next), consisting of
approximately $1.9 million in shares of the Company's common stock (170,234
shares) and approximately $1.6 million in seller-provided financing in the form
of secured three-year 6% notes. Next, headquartered in Salisbury, United Kingdom
(UK), is a distributor of high technology communication equipment for the
consumer electronic, marine, aviation, professional and leisure markets in both
the UK and Europe. The former managing director and founder of Next agreed to
continue to manage the business and enter into a three year non-competition
agreement. For accounting purposes, the acquisition was effective on February 1,
1997 and the results of operations of Next are included in the supplemental
consolidated results of operations of the Company from that date forward. The
resulting goodwill from this transaction is being amortized over fifteen years.
(e) LABBE, S.A. -- On February 12, 1997, the Company acquired all shares
of Labbe, S.A. (Labbe) 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. Labbe, headquartered in Lamballe, France, provides
vehicle armoring systems for commercial customers located mainly in Western
Europe. The former shareholders are subject to certain non-competition
agreements upon their leaving the employment of the Company. For accounting
purposes, the acquisition was effective on January 1, 1997 and the results of
operations of Labbe are included in the supplemental consolidated results of
operations of the Company from that date forward. The resulting goodwill from
this transaction is being amortized over thirty years.
The following unaudited proforma 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....................................................... $189,036
Net income.................................................. $ 5,463
Earnings per share:
Basic..................................................... $ 0.46
Diluted................................................... $ 0.42
</TABLE>
(f) INTERNATIONAL TRAINING, INCORPORATED -- On March 24, 1997, the Company
acquired all of the shares of International Training, Incorporated (ITI) for
approximately $2.5 million, consisting of approximately $800,000 in shares of
the Company's common stock (68,086 shares), $500,000 in cash and approximately
$1.2 million in seller-provided financing in the form of unsecured two-year 10%
notes. ITI, headquartered near Washington D.C., provides advanced security
training. For accounting purposes, the acquisition was effective on March 1,
1997 and the results of operations of ITI are included in the supplemental
consolidated results of operations of the Company from that date forward. The
resulting goodwill from this transaction is being amortized over fifteen years.
(g) ACCU-PATH MEDICAL LABORATORIES, INC. -- On December 1, 1997, the
Company acquired certain intangible assets from Accu-Path Medical Laboratories,
Inc. (Accu-Path) a Company engaged in providing drug
F-31
<PAGE> 36
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
testing services. The total purchase price of approximately $360,000, which was
allocated entirely to customer lists to be amortized over fifteen years,
consisted of $100,000 in cash and quarterly payments beginning on approximately
March 31, 1998 and ending on September 30, 1999 totaling $260,000 based on a
prescribed level of revenues generated from the purchased customer list. In the
accompanying supplemental consolidated balance sheet at December 31, 1997, the
Company has $260,000 accrued for the remainder of the total purchase price. For
accounting purposes, the acquisition of Accu-Path was effective on December 1,
1997 and the results of operations of Accu-Path are included in the supplemental
consolidated results of operations of the Company from that date forward.
(h) ZAO IMEA -- On December 2, 1997, the Company acquired all of the
shares of ZAO IMEA, a Russian corporation, and certain assets, liabilities and a
twenty year non-compete agreement in Russia from Acorn Communication Group, Inc.
(Acorn) for approximately $3.1 million, consisting of $600,000 in cash and
138,889 shares of the Company's common stock valued at approximately $2.4
million. IMEA provides vehicle armoring systems and other equipment for
commercial customers located in Russia. IMEA and Acorn had substantially common
ownership prior to the acquisition. The former shareholders also entered into
employment agreements, which include non-competition clauses, for periods of six
months to three years. For accounting purposes, the acquisition was effective on
December 1, 1997 and the results of operations of IMEA are included in the
supplemental consolidated results of operations of the Company from that date
forward. The resulting goodwill from this transaction is being amortized over
fifteen years.
In connection with the acquisitions in 1997 of PLL, Next, Labbe, ITI,
Accu-Path and IMEA, assets were acquired and liabilities were assumed as follows
(in thousands):
<TABLE>
<CAPTION>
ACCU-
PLL NEXT LABBE ITI PATH IMEA
------- ------- -------- ------- ----- -------
<S> <C> <C> <C> <C> <C> <C>
FAIR VALUE OF ASSETS ACQUIRED
INCLUDING:
Cash................................. $ -- $ -- $ 3,501 $ 123 $ -- $ 2
Accounts receivable.................. -- 1,830 4,689 231 -- 11
Inventories.......................... -- 1,276 3,392 -- -- 553
Prepaid expenses and other........... -- -- 316 4 -- 7
Property, plant & equipment.......... -- 80 3,360 216 -- 82
Costs in excess of assets acquired
and other intangible assets....... 2,560 3,459 7,802 2,061 360 3,287
Other non-current assets............. -- -- 2,357 -- -- 4
------- ------- -------- ------- ----- -------
2,560 6,645 25,417 2,635 360 3,946
Less: Cash paid for net assets....... (1,600) -- (10,730) (500) (100) (500)
Fair value of debt issued......... (960) (1,575) -- (1,231) (260) (100)
Fair value of stock issued........ -- (1,851) (3,431) (800) -- (2,378)
------- ------- -------- ------- ----- -------
$ -- $ 3,219 $ 11,256 $ 104 $ -- $ 968
======= ======= ======== ======= ===== =======
LIABILITIES ASSUMED INCLUDING:
Liabilities assumed and acquisition
costs............................. $ -- $ 3,219 $ 9,287 $ 85 $ -- $ 968
Debt................................. -- -- 1,969 19 -- --
------- ------- -------- ------- ----- -------
$ -- $ 3,219 $ 11,256 $ 104 $ -- $ 968
======= ======= ======== ======= ===== =======
</TABLE>
(i) MERGER WITH 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
F-32
<PAGE> 37
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 presented in the
supplemental consolidated financial statements follow:
<TABLE>
<CAPTION>
O'GARA KROLL COMBINED
----------- ----------- ------------
<S> <C> <C> <C>
Nine months ended
September 30, 1997 (unaudited)
Revenue............................. $82,567,200 $53,823,958 $136,391,158
Extraordinary item.................. (193,875) -- (193,875)
Net income.......................... 4,181,387 1,796,124 5,977,511
Year ended December 31, 1996
Revenue............................. 82,777,691 70,883,058 153,660,749
Net income (loss)................... 6,658,962 (801,740) 5,857,222
Year ended December 31, 1995
Revenue............................. 32,816,996 53,024,304 85,841,300
Net income (loss)................... (1,122,052) (5,413,687) (6,535,739)
</TABLE>
In connection with the Kroll merger, the Company recorded, in the fourth
quarter, a charge to operating expenses of approximately $7.2 million ($5.7
million after taxes, or $0.39 per diluted share) for direct and other
merger-related costs pertaining to the merger transaction. Merger transaction
costs are nonrecurring and 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.
(j) PURCHASE OF MINORITY INTEREST -- During 1997, the Company exercised
their 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.
(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,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
United States Military:
Billed receivables................................. $ 1,461,491 $ 3,756,035
Costs and estimated earnings in excess of billings
on uncompleted contracts........................ 10,189,891 9,253,872
----------- -----------
Total United States Military.................... $11,651,382 $13,009,907
=========== ===========
</TABLE>
F-33
<PAGE> 38
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
Other contracts:
Billed receivables................................. $23,961,283 $37,040,436
Costs and estimated earnings in excess of billings
on uncompleted contracts........................ 5,136,657 2,824,592
----------- -----------
Total other contracts........................... $29,097,940 $39,865,028
=========== ===========
Total trade accounts receivable................. $25,422,774 $40,796,471
=========== ===========
Total costs and estimated earnings in excess of
billings on uncompleted contracts............. $15,326,548 $12,078,464
=========== ===========
</TABLE>
Costs and estimated earnings in excess of billings on uncompleted contracts
are net of $66,180,434 and $89,875,813 of progress billings to the United States
Military at December 31, 1996 and 1997, 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,
1995....................... $3,282,518 $3,149,467 $(3,731,814) $2,700,171
Year ended December 31,
1996....................... $2,700,171 $3,778,583 $(3,954,870) $2,523,884
Year ended December 31,
1997....................... $2,523,884 $2,097,342 $(1,521,162) $3,100,064
</TABLE>
(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,
-------------------------
1996 1997
---------- -----------
<S> <C> <C>
Raw materials......................................... $4,882,075 $ 9,551,152
Vehicle costs and work-in-process..................... 3,951,319 10,011,747
---------- -----------
$8,833,394 $19,562,899
========== ===========
</TABLE>
F-34
<PAGE> 39
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following summarizes activity in valuation reserves for inventory
obsolescence:
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO BALANCE
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
--------- ---------- ---------- --------
<S> <C> <C> <C> <C>
Year ended December 31, 1995........ $ -- $ -- $ -- $ --
Year ended December 31, 1996........ $ -- $264,114 $ -- $264,114
Year ended December 31, 1997........ $264,114 $113,567 $(23,782) $353,899
</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>
DECEMBER 31,
USEFUL LIFE ------------------------
DESCRIPTION (YEARS) 1996 1997
- ----------- ----------- ---------- ----------
<S> <C> <C> <C>
Advance to vendor........................... -- $1,825,207 $1,275,437
Deferred costs.............................. -- 80,818 642,971
Security deposits........................... -- 326,376 471,859
Long-term receivable........................ -- -- 380,000
Non-refundable deposit on an equipment lease
with a related party...................... 10 503,858 297,025
Deferred financing fees..................... 7 - 30 152,940 876,667
Long-term investments....................... -- 180,998 101,630
Other long-term assets...................... -- 137,003 452,533
---------- ----------
3,207,200 4,498,122
(102,247) (166,477)
---------- ----------
$3,104,953 $4,331,645
========== ==========
</TABLE>
Costs applicable to bids in process 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 are expensed when
the contract award is no longer considered probable.
(d) ACCRUED LIABILITIES -- Accrued liabilities consist of the following at
December 31, 1996 and 1997:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
DESCRIPTION 1996 1997
- ----------- ----------- -----------
<S> <C> <C>
Payroll and related benefits......................... $ 5,874,724 $ 8,205,962
Property, sales and other taxes payable.............. 590,648 773,846
Accrued interest..................................... 268,605 564,168
Accrued satellite time............................... 680,835 1,009,162
Accrued customer list installment payments........... -- 510,345
Other accruals....................................... 2,657,576 4,021,964
----------- -----------
$10,072,388 $15,085,447
=========== ===========
</TABLE>
F-35
<PAGE> 40
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(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 respective OHE shareholders
were taxed on OHE's taxable income at the respective individual federal and
state income tax rates. Therefore, the income generated by OHE has not been
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 presented in the supplemental consolidated financial statements.
Accordingly, the accompanying supplemental consolidated financial statements
only reflect a provision (benefit) for income taxes for Kroll and LSAI, both 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.
The Company's provision (benefit) for income taxes on income (loss) from
continuing operations for all periods is summarized as follows:
<TABLE>
<CAPTION>
1995 1996 1997
--------- --------- -----------
<S> <C> <C> <C>
Currently payable:
Federal.................................. $ 230,439 $ 470,479 $ 2,800,720
State and local.......................... (169,824) 383,563 576,837
Foreign.................................. -- 83,000 1,364,873
--------- --------- -----------
60,615 937,042 4,742,430
--------- --------- -----------
Deferred:
Federal.................................. (585,645) (425,558) (1,213,147)
State and local.......................... (298,402) (145,937) (224,290)
Foreign.................................. -- -- --
--------- --------- -----------
(884,047) (571,495) (1,437,437)
--------- --------- -----------
$(823,432) $ 365,547 $ 3,304,993
========= ========= ===========
</TABLE>
F-36
<PAGE> 41
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A reconciliation between the statutory federal income tax rate and the
effective tax rate is summarized as follows:
<TABLE>
<CAPTION>
1995 1996 1997
------------------- ------------------- ------------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
----------- ----- ----------- ----- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Provision (benefit) for income
taxes at the federal
statutory rate............... $(2,194,096) (34.0)% $ 2,349,834 34.0% $2,005,265 34.0%
State and local income taxes,
net of federal benefit....... (308,682) (4.8) 156,912 2.3 295,119 5.0
Impact of S Corp income/loss,
prior to reorganization...... 381,498 5.9 (2,087,529) (30.2) -- --
Impact of foreign income, prior
to reorganization............ -- -- (199,095) (2.9) -- --
Nondeductible expenses......... 13,446 0.3 34,766 0.5 1,424,333 24.1
Change in valuation
allowance.................... 1,338,113 20.7 109,303 1.6 (755,044) (12.8)
Effect of foreign
income/loss.................. 105,693 1.6 (8,768) (0.1) 577,743 9.8
Other.......................... (159,404) (2.5) 10,124 0.1 (242,423) (4.1)
----------- ----- ----------- ----- ---------- -----
Provision (benefit) for
income taxes............ $ (823,432) (12.8)% $ 365,547 5.3% $3,304,993 56.0%
=========== ===== =========== ===== ========== =====
</TABLE>
The components of the Company's consolidated deferred income tax assets and
liabilities as of December 31 are summarized below:
<TABLE>
<CAPTION>
1996 1997
----------- -----------
<S> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts........................... $ 783,046 $ 844,101
Fixed assets, depreciation and amortization differences... 646,744 564,262
Accrual for restricted stock plan......................... 164,794 --
Net operating loss carryforwards.......................... 1,423,336 1,839,743
Payroll and other benefits................................ 220,000 594,401
Other accruals............................................ 311,180 336,817
Acquisition costs......................................... -- 440,000
Other..................................................... 422,000 981,610
----------- -----------
3,971,100 5,600,934
Valuation allowance....................................... (2,303,336) (2,126,035)
----------- -----------
Net deferred tax assets................................ 1,667,764 3,474,899
----------- -----------
Deferred tax liabilities:
Nonaccrual service fee receivable......................... (219,560) (212,079)
Deferred revenue.......................................... (2,105,813) (1,908,823)
Database capitalization................................... (2,738,824) (2,779,790)
S to C conversion......................................... (5,745) (5,223)
Customer lists, net of amortization....................... (400,000) (344,000)
Other..................................................... -- (166,893)
----------- -----------
(5,469,942) (5,416,808)
----------- -----------
Net deferred tax liability.................................. $(3,802,178) $(1,941,909)
=========== ===========
</TABLE>
F-37
<PAGE> 42
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company has certain foreign net operating loss carryforwards, primarily
in the United Kingdom and France, which approximate $1.4 million and $1.8
million at December 31, 1996 and 1997, respectively. The carryforwards expire
beginning in 2001. A valuation allowance for the full amount 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.
(6) RELATED PARTY TRANSACTIONS
(a) SUMMARY OF RELATED PARTY TRANSACTIONS -- The following summarizes
transactions with related parties:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------------
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
Sales
to Shareholder.................................. $3,868,967 $5,325,559 $6,412,244
to affiliated entities.......................... 208,000 236,000 21,000
Purchases
from Shareholder................................ 485,807 824,348 814,154
from affiliated entities........................ 557,000 1,176,000 411,000
Lease expense to affiliated entities.............. 431,000 1,179,000 813,000
Consulting, commission and legal services expense
provided by affiliated entities................. 377,000 348,000 --
provided by minority shareholders............... 284,000 118,000 --
provided by LSAI Director....................... 130,000 30,000 170,000
Receivables sale to shareholder................... 4,507,800 -- --
Non-interest bearing advances to shareholders..... -- 288,829 525,996
Charter fee included in costs of the offering or
merger costs.................................... -- 327,000 576,000
Interest on shareholder notes payable............. 33,000 27,000 --
Forgiveness of note payable to affiliated
entity.......................................... -- 122,000 --
</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 $33,000 and $27,000 for the years ended December 31, 1995 and 1996,
respectively.
Kroll has certain amounts due to/from shareholders of the Company which
include the following amounts at December 31:
<TABLE>
<CAPTION>
1996 1997
----------- ---------
<S> <C> <C>
Amounts due from a certain shareholder................ $ 1,345,499 $ --
----------- ---------
Amounts due to certain shareholders................... (8,393,765) (309,500)
----------- ---------
Net due to shareholders.......................... $(7,048,266) $(309,500)
=========== =========
</TABLE>
Balances included in amounts due to/from shareholders are classified as
open advance accounts or term loans. The net due to shareholders under the term
loans was $2,309,500 at December 31, 1996. Substantially all amounts due to and
due from shareholders were paid off in connection with the merger except for a
loan payable of $309,500 which is due on demand and bears interest at prime less
0.5%.
F-38
<PAGE> 43
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(c) SALES -- SHAREHOLDER -- During 1995, 1996 and 1997, the Company
rendered services to a corporation which is also a shareholder of the Company.
Total revenue recognized for the years ended December 31, 1995, 1996 and 1997
was $3,868,967, $5,325,559 and $6,412,244, respectively. Additionally, this
corporation provided certain services to the Company which have been included in
cost of sales and operating expenses in the accompanying supplemental
consolidated statements of operations. These costs were approximately $485,807,
$824,348 and $814,154 for the years ended December 31, 1995, 1996 and 1997,
respectively. The year end accounts receivable balance for this customer was
approximately $857,820 and $897,361 at December 31, 1996 and 1997, respectively.
(d) BUILDING AND EQUIPMENT LEASES -- AFFILIATED ENTITIES -- The Company
currently leases a corporate aircraft from an affiliated entity under a ten year
lease agreement which began in February 1995. The lease stipulates minimum
monthly payments of $35,200, with additional charges accruing for usage in
excess of established base limits. The terms of the lease required a
non-refundable deposit. The original deposit of approximately $504,000 is being
amortized as rental expense over the existing lease period. Rental expense,
including amortization recognized, approximated $414,000, $422,000 and $234,000
for the years ended December 31, 1995, 1996 and 1997, 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. Additionally, 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. 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. Also, the Company has recorded $152,000 in prepaid expenses
related to payments for the future use of the aircraft at December 31, 1997.
The Company is also currently leasing equipment and a manufacturing
facility from two affiliated entities under various three year and
month-to-month lease agreements which began in July 1995. Rental expense
approximated $17,000, $757,000 and $579,000 for the years ended December 31,
1995, 1996 and 1997, respectively.
(e) NOTE PAYABLE -- In 1994, Laboratory Specialists, Inc. (LSI), a
wholly-owned subsidiary of LSAI, issued a note payable in the amount of $353,123
to an affiliated entity in connection with LSI's then president and former
owner's acquisition of LSI's common stock. This individual later exchanged all
of the outstanding common stock of LSI for 1,000,000 shares of common stock and
300,000 shares of Series I Cumulative Redeemable Preferred Stock (the Series I
Preferred Stock) of LSAI. LSAI redeemed the Series I Preferred Stock in July
1995 at $1.00 per share totaling $300,000.
(7) REVOLVING LINES OF CREDIT
The Company had a $12,000,000 revolving line of credit with a bank at
December 31, 1996, which was replaced during 1997. Borrowings under this line of
credit were $9,935,947 at December 31, 1996.
On December 1, 1997 the Company amended and restated its credit agreement
which provides for a revolving line of credit of $7.0 million maturing on May
31, 1999, a letter of credit facility of approximately $7.7 million and a term
note of $7.0 million which matures on January 4, 1999. The revolving credit
facility bears interest at rates ranging from prime less 0.5% to prime or, at
the Company's option, at LIBOR plus 2.0% to LIBOR plus 2.5%, dependent upon
amounts outstanding. Average borrowings under the revolving line of credit and
its predecessors were $6,530,260, $9,915,663 and $4,568,994 during 1995, 1996
and 1997, respectively, at an approximate weighted average interest rate of
8.82%, 8.27% and 8.46%, respectively. The maximum borrowings outstanding during
1995, 1996 and 1997 were $8,216,000, $12,145,000 and $11,600,000, respectively.
Borrowings under this line of credit were $559,112 at December 31, 1997. On
October 30, 1998 this credit
F-39
<PAGE> 44
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
agreement was amended and restated 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.
In connection with a refinancing in 1997, the Company fully amortized the
remaining deferred financing costs from a previous agreement, resulting in a one
time 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 certain financial covenants, which among
other restrictions, requires the maintenance of certain financial ratios,
including fixed charge coverage and net worth 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. These events of non compliance have been waived by the
lender.
In December 1995, LSI entered into a $1 million line of credit arrangement,
which matured in December 1996. The line of credit was renewed for $250,000 in
January 1997 with an interest rate equal to the CitiBank N.A. rate, which was
8.25% at the date of renewal. This line of credit matured in January 1998. This
line of credit was collateralized by LSI's accounts receivable, intangibles,
inventories, equipment and furniture and fixtures. No borrowings were made
against the line of credit during 1997, and no balance was outstanding as of
December 31, 1997.
F-40
<PAGE> 45
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) LONG-TERM DEBT
The components of long-term debt are as follows at:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1996 1997
----------- -----------
<S> <C> <C>
Senior unsecured notes payable to various
institutions, interest at 9.56% (amended to 8.56%
in May 1998) payable semi-annually, principal
payable at maturity in May 2004, subject to
prepayment penalties............................... $ -- $35,000,000
Development Bonds, variable interest rate
approximating 85% of the bond equivalent yield of
13 week U.S. Treasury bills (not to exceed 12%),
which approximated 3.9% at December 31, 1997,
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).................... 1,525,000 1,432,224
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............................................. 961,127 3,345,989
Notes payable to banks and insurance company,
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 with certain notes
collateralized by substantially all assets of
LSI................................................ 8,927,666 9,801,780
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 or
substantially all assets of LSI.................... 1,540,669 2,844,169
----------- -----------
12,954,462 53,679,564
Less-current portion................................. (5,327,641) (4,038,080)
----------- -----------
$ 7,626,821 $49,641,484
=========== ===========
</TABLE>
The Company's $35 million of senior unsecured notes payable also contains
financial covenants, which among other restrictions, require the maintenance of
net worth and fixed charge coverage ratios.
Scheduled maturities of long-term debt at December 31, 1997 are as follows:
<TABLE>
<S> <C>
1998............................................... $ 4,038,080
1999............................................... 9,108,484
2000............................................... 2,490,701
2001............................................... 603,093
2002............................................... 687,671
Thereafter......................................... 36,751,535
-----------
$53,679,564
===========
</TABLE>
F-41
<PAGE> 46
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(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, 1997:
<TABLE>
<CAPTION>
AFFILIATED
COMPANIES OTHER TOTAL
---------- ----------- -----------
<S> <C> <C> <C>
1998......................................... $ 703,265 $ 4,574,331 $ 5,277,596
1999......................................... 439,600 3,571,406 4,011,006
2000......................................... 422,400 2,711,017 3,133,417
2001......................................... 422,400 2,166,347 2,588,747
2002......................................... 422,400 1,834,362 2,256,762
Thereafter................................... 1,126,400 8,508,128 9,634,528
---------- ----------- -----------
$3,536,465 $23,365,591 $26,902,056
========== =========== ===========
</TABLE>
Rental expense charged against current operations amounted to approximately
$3,317,000, $4,595,000 and $4,115,000, for the years ended December 31, 1995,
1996 and 1997, respectively.
(10) DEFINED CONTRIBUTION AND BONUS PLANS
As of December 31, 1997, 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 $1,083,000, $1,243,000
and $1,211,140 for the years ended December 31, 1995, 1996 and 1997,
respectively.
(b) PROFIT AND REVENUE SHARING PLANS -- In 1991, Kroll adopted a Profit
and Revenue Sharing Plan to give Kroll employees an annual cash incentive bonus
based on Kroll's performance. The plan made a portion of most employees'
compensation (except administrative personnel, who have a guaranteed bonus)
contingent upon the achievement of certain performance incentives. There were
two plans under the Profit and Revenue Sharing Plan umbrella -- the Profit and
Revenue Sharing Plan for Managing Directors and the Bonus Plan for Professionals
and Senior Administrative Employees.
PROFIT AND REVENUE SHARING PLAN FOR MANAGING DIRECTORS
The managing directors' bonus plan is based on a matrix of Kroll revenue
and a percentage of operating profit. The maximum bonus opportunity for managing
directors was 50%, 15% and 35% of salary in 1995, 1996 and 1997, respectively.
The administrator may amend, modify or terminate the plan at any time.
BONUS PLAN FOR PROFESSIONAL AND SENIOR ADMINISTRATIVE STAFF
Similar to the managing directors' bonus plan, the plan for the
professional staff is based on a matrix of Kroll revenue and a percentage of
operating profit. The maximum bonus opportunity for this group ranged from 18%
to 26% of salary in 1995, from 15% of salary in 1996, and from 15% of salary in
1997, depending on the employee's level in Kroll. The administrator may amend,
modify or terminate the plan at any time.
The Company expensed approximately $314,000, $2,288,000 and $516,000
associated with the profit and revenue sharing plans in 1995, 1996 and 1997,
respectively.
F-42
<PAGE> 47
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(11) EQUITY ARRANGEMENTS
(a) STOCK OPTION PLANS -- In 1996, the Company adopted a stock option plan
(the 1996 Plan) for employees and non-employee directors. The Company may grant
options for up to 1,757,000 shares under the 1996 Plan. Options for 180,000 and
482,050 shares were granted during 1996 and 1997, 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.
In January 1995, Kroll established the Kroll Holdings, Inc., Management
Stock Option Plan (the "Management Stock Option Plan"). Options granted under
the Management Stock Option Plan are nonqualified stock options. Options to
purchase 380,747 and 33,448 shares of common stock of the Company were granted
under the Management Stock Option Plan in 1995 and 1996, respectively. In
addition, during 1996, options to purchase 137,294 shares of common stock of the
Company were granted to two key employees with an exercise price above market
price. There were no option grants under the Management Stock Option Plan during
1997.
In May 1994, LSAI established the 1994 Stock Option Plan (the "1994 Plan").
The 1994 Plan provides for the issuance of both incentive stock options ("ISO
Options") and nonqualified stock options with or without stock appreciation
rights ("SARs") to directors, executive officers, key employees and independent
contractors and consultants. ISO Options may be granted only to employees of
LSAI and its subsidiaries. Options to purchase 26,275, 38,887 and 52,550 shares
of common stock were granted under the 1994 Plan in 1995, 1996 and 1997,
respectively.
In October 1997, LSAI established the 1997 Non-Qualified Stock Option Plan
(the "1997 Plan"). The 1997 Plan provides for the issuance of nonqualified stock
options, with SARs attached, to directors, executive officers, key employees and
independent contractors and consultants. Options to purchase 71,468 shares of
common stock were granted under the 1997 Plan in 1997.
Options granted under the 1994 and 1997 Plans are fixed-price options
generally granted at the fair market value of the underlying common stock on the
date of the grant. Generally, these options vest and become exercisable six
months from the grant date and expire five to ten years after the grant date.
(b) RESTRICTED STOCK PLAN -- Kroll adopted a long-term incentive plan
designed to give managing directors and other key employees of the Kroll
division a stake in the long-term success of Kroll through grants of phantom
stock options. Each option gave the right to receive a payment equal to the
appreciation in the price of the option at the payment determination date.
Effective June 14, 1993, Kroll replaced the 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 is 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. 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 supplemental
consolidated statement of operations. In addition to the regular tax benefits
based on compensation expense recognized, the Company will also realize 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 supplemental
consolidated statement of shareholders' equity. This balance represents
F-43
<PAGE> 48
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 are 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.
(c) KROLL SUPPLEMENTAL EXECUTIVE AWARD AGREEMENTS -- The Company entered
into agreements with certain senior Kroll executives which provided additional
benefits to the participants. During 1996, all 144,421 previously granted shares
fully vested and were issued. Based on a valuation of the Company, the total
value assigned to the shares on the vesting date equaled $318,780.
(d) 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.
(e) OHE EXECUTIVE BONUS PLAN -- During 1993, OHE adopted an executive
bonus plan, which covered four individuals. The plan awarded a bonus based on
the attainment of goals stipulated in the five year business plan, ranging from
50% to 120% of the executives' base compensation. The bonus amounts were
distributed 50% in cash and 50% in non-qualified stock options to purchase stock
of OHE. Subject to the executives' ability to elect a decrease in the percentage
of cash payments and to increase the percentage of stock options, 50% of the
bonus amount was payable in cash, and the remainder in stock options. OHE issued
121,463 options in 1994 based on 1993's operating results. No options were
issued in 1995 or 1996. In August 1996, the 121,463 options were exercised for
121,463 shares of common stock of the Company for $445 and the executive bonus
plan was terminated.
(f) 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 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 supplemental consolidated statement of cash
flows and was approximately $2.7 million, net of commissions and other offering
expenses.
In connection with the Warrant Redemption, LSAI issued warrants to purchase
30,281 shares of common stock of the Company to various investment bankers as a
portion of their compensation for serving as managers
F-44
<PAGE> 49
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
(g) 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 (loss) and diluted earnings (loss) per
share for the years ended December 31, 1995, 1996 and 1997 would have been as
follows:
<TABLE>
<CAPTION>
1995 1996 1997
----------- ---------- ----------
<S> <C> <C> <C>
Net income (loss):
As reported............................. $(5,643,135) $5,268,415 $2,046,643
Pro forma............................... $(5,689,580) $5,157,960 $ 979,899
Diluted earnings (loss) per share:
As reported............................. $ (0.52) $ 0.42 $ 0.14
Pro forma............................... $ (0.52) $ 0.42 $ 0.07
</TABLE>
Had compensation cost for the Company's stock options issued in 1995 and
1996 under the Management Stock Option Plan been determined consistent with SFAS
123, there would have been no effect on the Company's net loss or diluted loss
per share as these options were determined to have a fair value of $0.
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 1995, 1996 and 1997:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
---------------------------------------
1995 1996 1997
------- ----------- -------------
<S> <C> <C> <C>
Dividend yield.......................... -- -- --
Expected volatility..................... 35% 35% - 39.3% 38% - 40.5%
Risk-free interest rate................. 6% 6% - 6.5% 5.96% - 6.76%
Expected lives.......................... 5 years 5 - 7.5 years 5 - 7.5 years
</TABLE>
The 26,275 options granted by the Company during 1995 to employees and
non-employee directors, excluding options issued under the Management Stock
Option Plan, have a weighted average exercise price of $14.27 per option, a
weighted-average fair value of $5.85 per option and remaining contractual lives,
on a weighted average basis, of 2.9 years. The 218,887 options granted by the
Company during 1996 to employee and non-employee directors, excluding options
issued under the Management Stock Option Plan, have a weighted average exercise
price of $9.72, a weighted-average fair value of $5.06 and remaining contractual
lives, on a weighted-average basis, of 7.9 years. The 606,068 options granted by
the Company during 1997 to employees and non-employee directors have a
weighted-average exercise price of $14.95 per option, a weighted-average fair
value of $7.68 per option and remaining contractual lives, on a weighted-average
basis, of 9.9 years.
F-45
<PAGE> 50
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
A summary of the status of the Company's stock option plans at December 31,
1995, 1996 and 1997, and the change during the years then ended is presented in
the table below:
<TABLE>
<CAPTION>
1995 1996 1997
------------------- ------------------- ---------------------
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 $6.91 796,651 $6.72
Granted................. 407,022 6.91 389,629 6.52 606,068 14.95
Exercised............... -- -- -- -- (5,777) 9.14
Forfeited/Expired/
Cancelled............ -- -- -- -- (90,500) 11.76
------- ----- ------- ----- --------- -----
Outstanding, end of
year.................... 407,022 $6.91 796,651 $6.72 1,306,443 $9.47
======= ===== ======= ===== ========= =====
Exercisable, end of
year.................... 97,320 $6.57 261,538 $6.14 761,825 $6.52
======= ===== ======= ===== ========= =====
</TABLE>
(12) COMMITMENTS AND CONTINGENCIES
(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, 1997, the Company's lender was committed
to providing this letter of credit through September 1, 1999. During 1998, this
commitment was extended through May 31, 2000. As of December 31, 1997, the
Company had an outstanding letter of credit in the amount of $1,681,750.
At December 31, 1997, the Company had standby and purchase letters of
credit, issued by two financial institutions, in the aggregate amount of
$4,776,502.
(b) PURCHASE AGREEMENTS -- In June 1995, the Company 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 Company and to provide a reduction in the quantity of units that must be
purchased. The amendment also provided certain licensing rights to the Company.
At December 31, 1997, the Company was committed to purchase approximately 250
units at a total cost of approximately $0.7 million. In accordance with the
original agreement, the Company advanced a total of $3,000,000 to Glocom for the
funding of the related production costs. As of December 31, 1996 and 1997, the
Company had advances to the above vendor of $2,320,307 and $1,673,123,
respectively.
(c) EMPLOYMENT AGREEMENTS -- On December 1, 1997, the Company entered into
employment agreements with seven key officers and five key employees with annual
compensation ranging in value from $65,000 to $375,000, ending on November 30,
2000. Each of these officers is also eligible for an annual bonus plan. These
agreements also granted options to five of the officers to purchase shares of
the Company's common stock at the then existing market value with the number of
shares ranging from 10,000 to 75,000 (see Note 11(g)). In the event of
termination without cause, the terminated individual shall continue to receive
his salary for the greater of the remainder of the agreement or one year. If the
agreement is not renewed, the officer shall receive one year's salary. Each
officer has also agreed to certain non-competition clauses.
LSAI also has written employment agreements with a few of its key officers
which provide, among other things, a term of four years from April 16, 1996,
with automatic one year extensions after each year of service, annual
compensation ranging from $112,500 to $125,000 and eligibility for an annual
bonus. Subsequent to December 31, 1997, these agreements were verbally amended
to increase the range of annual compensation. The
F-46
<PAGE> 51
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
agreements also provide for certain non-competition clauses. Additionally, LSI
has a written employment severance agreement with one of its key employees
providing for salary continuation for a period of twelve months upon termination
for any reason other than cause.
As of December 31, 1997, the remaining aggregate commitment under these
employment agreements if all individuals were terminated without cause was
approximately $8.0 million.
(d) 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 four foreign currency exchange contracts to
effectively hedge its exposure to certain foreign currency rate fluctuations on
a demand loan to a subsidiary which is denominated in the foreign currency. By
virtue of these contracts, the Company has fixed the total dollar amount which
they will receive under the aforementioned subsidiary loan through the maturity
dates of the contracts regardless of the fluctuations in the exchange rate. The
total notional amount of the contracts, which mature between January 1998 and
July 1999, is $15.5 million. The Company's cumulative foreign currency
translation adjustment component of shareholders' equity was increased by
$346,000 in 1997 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, 1997 in order to terminate the agreements.
As of December 31, 1997, the Company would have received approximately $534,000
upon cancellation of all contracts.
(14) CUSTOMER AND SEGMENT DATA
SEGMENT DATA -- During 1995, 1996 and 1997, the Company operated in three
business segments, the Security Products and Services Group, the Investigations
and Intelligence Group and the Voice and Data Communications Group. In addition,
as was discussed in Note 1, 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
PRODUCTS INVESTIGATIONS VOICE AND
AND AND DATA
SERVICES INTELLIGENCE COMMUNICATIONS
GROUP GROUP GROUP CONSOLIDATED
-------- -------------- -------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
1995
Net sales to unaffiliated
customers.......................... $ 34,883 $58,071 $ 2,044 $ 94,998
======== ======= ======= ========
Gross profit......................... $ 8,113 $19,713 $ 409 $ 28,235
======== ======= ======= ========
Operating income (loss).............. $ (430) $(2,556) $ (589) $ (3,575)
======== ======= ======= ========
Identifiable assets at year-end...... $ 26,490 $44,351 $ 3,324 $ 74,165
-------- ------- -------
Corporate assets..................... 1,275
--------
Total assets at year end... $ 75,440
========
</TABLE>
F-47
<PAGE> 52
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SECURITY
PRODUCTS INVESTIGATIONS VOICE AND
AND AND DATA
SERVICES INTELLIGENCE COMMUNICATIONS
GROUP GROUP GROUP CONSOLIDATED
-------- -------------- -------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
1996
Net sales to unaffiliated
customers.......................... $ 79,156 $77,992 $ 7,770 $164,918
======== ======= ======= ========
Gross profit......................... $ 20,438 $25,036 $ 2,146 $ 47,620
======== ======= ======= ========
Operating income..................... $ 6,953 $ 2,292 $ 538 $ 9,783
======== ======= ======= ========
Identifiable assets at year-end...... $ 38,380 $45,511 $ 6,816 $ 90,707
======== ======= =======
Corporate assets..................... 1,357
--------
Total assets at year-end... $ 92,064
========
1997
Net sales to unaffiliated
customers.......................... $105,557 $83,109 $17,437 $206,103
======== ======= ======= ========
Gross profit......................... $ 30,017 $33,206 $ 3,114 $ 66,337
======== ======= ======= ========
Operating income..................... $ 8,014 $ 3,180 $ 292 $ 11,486
======== ======= ======= ========
Identifiable assets at year-end...... $ 74,283 $53,468 $13,449 $141,200
======== ======= =======
Corporate assets..................... 9,284
--------
Total assets at year-end... $150,484
========
</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. Depreciation expense
and capital expenditures for each of the Company's business segments for the
years ended December 31, 1995, 1996 and 1997 are as follows:
<TABLE>
<CAPTION>
SECURITY
PRODUCTS INVESTIGATIONS
AND AND VOICE AND DATA
SERVICES INTELLIGENCE COMMUNICATIONS
GROUP GROUP GROUP CONSOLIDATED
-------- -------------- -------------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C>
1995
Depreciation expense.................. $ 462 $ 985 $ -- $ 1,447
======= ======= ====== =======
Capital expenditures.................. $ 755 $ 956 $ -- $ 1,711
======= ======= ====== =======
1996
Depreciation expense.................. $ 841 $ 1,071 $ -- $ 1,912
======= ======= ====== =======
Capital expenditures.................. $ 2,627 $ 858 $ -- $ 3,485
======= ======= ====== =======
1997
Depreciation expense.................. $ 1,427 $ 1,164 $ 16 $ 2,607
======= ======= ====== =======
Capital expenditures.................. $ 3,149 $ 2,767 $ 43 $ 5,959
======= ======= ====== =======
</TABLE>
F-48
<PAGE> 53
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Identifiable assets by segment are those assets that are used in the
Company's operations in each segment. Corporate assets are principally cash,
certain intangible assets and certain prepaid expenses.
The following summarizes information about the Company's different
geographic areas:
<TABLE>
<CAPTION>
UNITED OTHER ELIMI- CONSOLI-
STATES FRANCE FOREIGN NATIONS DATED
-------- ------- ------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1995
Net sales to unaffiliated
customers....................... $ 79,666 $ 1,708 $13,624 $ -- $ 94,998
Intercompany...................... 908 276 1,542 (2,726) --
-------- ------- ------- -------- --------
Total net sales......... $ 80,574 $ 1,984 $15,166 $ (2,726) $ 94,998
======== ======= ======= ======== ========
Operating income (loss)........... $ (2,367) $ (860) $ (348) $ -- $ (3,575)
======== ======= ======= ======== ========
Identifiable assets............... $ 66,123 $ 1,338 $ 6,704 $ -- $ 74,165
======== ======= ======= ========
Corporate assets.................. 1,275
--------
Total assets at
year-end............. $ 75,440
========
1996
Net sales to unaffiliated
customers....................... $140,547 $ 2,142 $22,229 $ -- $164,918
Intercompany...................... 3,584 316 2,804 (6,704) --
-------- ------- ------- -------- --------
Total net sales......... $144,131 $ 2,458 $25,033 $ (6,704) $164,918
======== ======= ======= ======== ========
Operating income (loss)........... $ 7,735 $ (118) $ 2,166 $ -- $ 9,783
======== ======= ======= ======== ========
Identifiable assets............... $ 75,569 $ 1,205 $13,933 $ -- $ 90,707
======== ======= ======= ========
Corporate assets.................. 1,357
--------
Total assets at
year-end............. $ 92,064
========
1997
Net sales to unaffiliated
customers....................... $134,802 $24,004 $47,297 $ -- $206,103
Intercompany...................... 7,413 208 5,624 (13,245) --
-------- ------- ------- -------- --------
Total net sales......... $142,215 $24,212 $52,921 $(13,245) $206,103
======== ======= ======= ======== ========
Operating income.................. $ 6,325 $ 1,382 $ 3,779 $ -- $ 11,486
======== ======= ======= ======== ========
Identifiable assets............... $ 86,123 $23,706 $31,371 $ -- $141,200
======== ======= ======= ========
Corporate assets.................. 9,284
--------
Total assets at
year-end............. $150,484
========
</TABLE>
The Company accounts for transfers between geographic areas at cost plus a
proportionate share of operating profit.
F-49
<PAGE> 54
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following summarizes the Company's sales in the United States and
foreign locations:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
-------------------------------
1995 1996 1997
------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Sales to unaffiliated customers:
U.S. Government............................... $11,514 $ 51,505 $ 43,719
Other United States........................... 54,281 72,337 73,848
Middle East................................... 8,582 7,598 5,887
Europe........................................ 8,831 11,798 44,022
Asia.......................................... 6,729 8,946 10,697
Central & South America....................... 1,050 5,807 20,123
Other Foreign................................. 4,011 6,927 7,807
------- -------- --------
$94,998 $164,918 $206,103
======= ======== ========
</TABLE>
Export sales by the Company's domestic operations were approximately 10%,
14% and 15% of net sales for the years ended December 31, 1995, 1996 and 1997,
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 supplemental 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 France, The United
Kingdom, China, Brazil, Mexico, The Philippines, Russia, India, Australia,
Japan, Saudi Arabia, Singapore, Switzerland, Canada, Colombia and Italy. 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.
(b) MAJOR CUSTOMERS -- During the years ended December 31, 1995, 1996 and 1997
sales to the U.S. Government approximated 12%, 31% and 21% of the Company's net
sales, respectively. In addition, the year-end accounts receivable balance of
the U.S. Government approximated 6% and 9% of the Company's accounts receivable
balance as of December 31, 1996 and 1997, respectively.
F-50
<PAGE> 55
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) SUPPLEMENTAL CASH FLOWS DISCLOSURES
The following is a summary of cash paid related to certain items:
<TABLE>
<CAPTION>
1995 1996 1997
---------- ---------- ----------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.......................... $2,720,585 $4,460,514 $4,853,462
---------- ---------- ----------
Cash paid for taxes............................. $ 604,091 $ 729,193 $3,468,474
---------- ---------- ----------
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 $ --
---------- ---------- ----------
Exchange of note receivable for trade
receivables.................................. $ 60,000 $ -- $ --
---------- ---------- ----------
Exchange of stock in an unaffiliated company for
trade receivables............................ $ 125,000 $ -- $ --
---------- ---------- ----------
Fair value of stock issued in connection with
acquisition of businesses.................... $ -- $ -- $8,459,769
---------- ---------- ----------
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
---------- ---------- ----------
</TABLE>
(16) QUARTERLY FINANCIAL DATA (UNAUDITED)
<TABLE>
<CAPTION>
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<S> <C> <C> <C> <C>
1997
Net sales.................................... $44,369 $51,441 $52,071 $58,222
Gross profit................................. 14,818 17,623 16,633 17,263
Net income (loss)............................ 1,665 2,640 2,701 (4,959)
Earnings (loss) per share:
Basic..................................... $ 0.12 $ 0.19 $ 0.19 $ (0.35)
Diluted................................... $ 0.09 $ 0.16 $ 0.17 $ (0.35)
1996
Net sales.................................... $38,764 $41,629 $39,880 $44,645
Gross profit................................. 12,450 11,129 15,690 8,351
Net income (loss)............................ 3,449 1,157 4,300 (3,638)
Earnings (loss) per share:
Basic..................................... $ 0.31 $ 0.10 $ 0.38 $ (0.29)
Diluted................................... $ 0.27 $ 0.08 $ 0.35 $ (0.29)
</TABLE>
F-51
<PAGE> 56
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(17) SUBSEQUENT EVENTS
(a) ACQUISITIONS -- In addition to the mergers with LSAI, Schiff and
Securify during 1998 discussed in Note 1, the Company completed eight
acquisitions which were accounted for as purchases. Seven of the 1998
acquisitions will be included in the Company's Investigations and Intelligence
Group. The eighth acquisition will be included in the Company's Security
Products and Services Group. The aggregate purchase price of these eight
acquisitions amounted to approximately $36.4 million and consisted of $19.3
million in cash and 745,003 shares of common stock (valued at approximately
$17.1 million or an average of $22.95 per share). In addition, in connection
with the acquisitions discussed above and the mergers discussed in Note 1, the
Company entered into various employment agreements with officers and key
employees of the acquired companies with varying terms and conditions with an
aggregate future commitment of approximately $33.2 million as of December 31,
1998.
(b) STOCK OFFERINGS -- On May 5, 1998, the Company completed a public
stock offering of 3,200,000 shares of its common stock at $20.50 per share which
resulted in net proceeds to the Company of $60.4 million. A portion of the net
proceeds was used to pay off $14.8 million of indebtedness of the Company, with
the balance invested in short-term instruments and available for potential
acquisitions, working capital and other general corporate purposes. In addition
to the shares sold by the Company, certain shareholders sold 1,860,000 shares of
common stock in conjunction with the Offering.
In addition, on June 4, 1998, LSAI completed a private stock offering of
116,708 shares of its common stock which resulted in net proceeds of
approximately $2.3 million. In addition to underwriting fees, LSAI also issued
to a certain securities corporation and its designees 55,522 warrants. The net
proceeds were used to pay a portion of the purchase price for a customer list
acquired by LSAI in June 1998.
F-52
<PAGE> 57
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED BALANCE SHEET
ASSETS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
<S> <C>
CURRENT ASSETS:
Cash and equivalents...................................... $ 40,208
Marketable securities..................................... --
Trade accounts receivable, net of allowance for doubtful
accounts of $3,295 at September 30, 1998............... 59,527
Unbilled revenues......................................... 7,753
Related party receivables................................. 1,065
Costs and estimated earnings in excess of billings on
uncompleted contracts.................................. 21,625
Inventories............................................... 19,158
Prepaid expenses and other................................ 5,687
Deferred tax asset........................................ 754
--------
Total current assets.............................. 155,777
--------
PROPERTY, PLANT, AND EQUIPMENT, at cost
Land...................................................... 1,831
Buildings and improvements................................ 8,291
Leasehold improvements.................................... 5,832
Furniture and fixtures.................................... 6,422
Machinery and equipment................................... 19,754
Construction-in-progress.................................. 1,936
--------
44,066
Less: accumulated depreciation............................ (22,352)
--------
21,714
--------
DATABASES, net of accumulated amortization of $21,987 at
September 30, 1998........................................ 9,012
COSTS IN EXCESS OF ASSETS ACQUIRED AND OTHER INTANGIBLE
ASSETS, net of accumulated amortization of $3,057 at
September 30, 1998........................................ 49,375
OTHER ASSETS................................................ 7,995
--------
66,382
--------
$243,873
========
</TABLE>
The accompanying notes are an integral part of this supplemental consolidated
balance sheet.
F-53
<PAGE> 58
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED BALANCE SHEET
LIABILITIES AND SHAREHOLDERS' EQUITY
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
<S> <C>
CURRENT LIABILITIES:
Revolving lines of credit................................. $ --
Current portion of long-term debt......................... 1,445
Shareholder payable....................................... 263
Accounts payable --
Trade.................................................. 27,975
Affiliates............................................. 131
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. 155
Accrued liabilities....................................... 20,352
Income taxes currently payable............................ 4,359
Customer deposits......................................... 3,949
--------
Total current liabilities......................... 58,629
OTHER LONG-TERM LIABILITIES................................. 4,553
DEFERRED INCOME TAXES....................................... 2,637
LONG-TERM DEBT, net of current portion...................... 39,735
--------
Total liabilities................................. 105,554
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 1,000,000 shares
authorized, none issued................................ --
Common stock, $.01 par value, 50,000,000 shares
authorized, 20,525,395 shares issued and outstanding in
1998................................................... 6,261
Additional paid-in-capital................................ 140,261
Retained deficit.......................................... (7,571)
Deferred compensation..................................... (365)
Accumulated other comprehensive income (loss)............. (267)
--------
Total shareholders' equity........................ 138,319
--------
$243,873
========
</TABLE>
The accompanying notes are an integral part of this supplemental consolidated
balance sheet.
F-54
<PAGE> 59
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF OPERATIONS
(UNAUDITED)
(IN THOUSANDS, EXCEPT PER SHARE DATA)
<TABLE>
<CAPTION>
FOR THE
NINE MONTHS ENDED
SEPTEMBER 30,
--------------------
1997 1998
-------- --------
<S> <C> <C>
NET SALES
Security Products & Services.............................. $ 72,970 $100,808
Investigations & Intelligence............................. 61,711 78,909
Information Security...................................... -- 48
Voice & Data Communications............................... 13,199 14,797
-------- --------
147,880 194,562
COST OF SALES
Security Products & Services.............................. 51,434 72,457
Investigations & Intelligence............................. 36,501 43,285
Information Security...................................... -- 268
Voice & Data Communications............................... 10,868 12,113
-------- --------
98,803 128,123
GROSS PROFIT
Security Products & Services.............................. 21,536 28,351
Investigations & Intelligence............................. 25,210 35,624
Information Security...................................... -- (220)
Voice & Data Communications............................... 2,331 2,684
-------- --------
49,077 66,439
OPERATING EXPENSES
Selling and marketing..................................... 10,217 12,849
General and administrative................................ 23,242 29,585
-------- --------
Operating income..................................... 15,618 24,005
OTHER INCOME (EXPENSE):
Interest expense.......................................... (3,563) (3,512)
Interest income........................................... 297 930
Other, net................................................ (225) (133)
-------- --------
Income before minority interest, provision for income
taxes and extraordinary item........................ 12,127 21,290
Minority interest........................................... (118) --
-------- --------
Income before provision for income taxes and
extraordinary item.................................. 12,009 21,290
Provision for income taxes.................................. 4,809 8,652
-------- --------
Income before extraordinary item, net................ 7,200 12,638
Extraordinary item, net..................................... (194) --
-------- --------
Net income........................................... $ 7,006 $ 12,638
======== ========
Basic earnings per share.................................... $ 0.50 $ 0.71
======== ========
Basic weighted average shares outstanding................... 13,929 17,845
======== ========
Diluted earnings per share.................................. $ 0.46 $ 0.69
======== ========
Diluted weighted average shares outstanding................. 14,808 18,371
======== ========
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
F-55
<PAGE> 60
THE KROLL-O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED STATEMENT OF SHAREHOLDERS' EQUITY
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(UNAUDITED)
(IN THOUSANDS)
<TABLE>
<CAPTION>
ACCUMULATED
ADDITIONAL OTHER
COMPREHENSIVE COMMON PAID-IN RETAINED DEFERRED COMPREHENSIVE
SHARES INCOME STOCK CAPITAL DEFICIT COMPENSATION INCOME (LOSS) TOTAL
------ ------------- ------ ---------- -------- ------------ ------------- --------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1997.... 14,795 $ 148 $ 58,912 $(20,209) $ -- $(384) $ 38,467
Issuance of stock in
conjunction with the
acquisition of businesses... 699 7 15,625 -- -- -- 15,632
Public offering of common
stock, net of issuance costs
of approximately $1,325..... 3,316 38 62,502 -- -- -- 62,540
Issuance of Securify common
stock....................... 1,400 6,063 -- -- -- -- 6,063
Issuance of stock bonus to
certain employees........... 2 -- 48 -- -- -- 48
Exercise of stock options, and
related income tax
benefit..................... 287 4 3,219 -- -- -- 3,223
Redemption of warrants........ 28 1 -- -- -- -- 1
Purchase and retirement of
treasury stock.............. (2) -- (45) -- -- -- (45)
Deferred compensation related
to stock options............ -- -- -- (365) -- (365)
Comprehensive income:
Net income................ $12,638 -- -- 12,638 -- -- 12,638
-------
Other comprehensive income,
net of tax:
Foreign currency
translation
adjustments, net of
$85 tax provision.... -- 127 -- -- -- -- -- --
Reclassification adjustment
for gain on securities
included in net income,
net of $4 tax benefit..... -- (10) -- -- -- -- -- --
-------
Other comprehensive income.... -- 117 -- -- -- -- 117 117
-------
Comprehensive income.......... $12,755 -- -- -- -- -- --
======= ------ -------- -------- ----- ----- --------
BALANCE, September 30, 1998... 20,525 $6,261 $140,261 $ (7,571) $(365) $(267) $138,319
====== ====== ======== ======== ===== ===== ========
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
F-56
<PAGE> 61
THE KROLL O'GARA COMPANY
SUPPLEMENTAL CONSOLIDATED STATEMENTS OF CASH FLOWS
(UNAUDITED)
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
FOR THE NINE MONTHS
ENDED SEPTEMBER 30,
--------------------
1997 1998
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income................................................ $ 7,006 $ 12,638
Adjustments to reconcile net income to net cash provided
by (used in) operating activities --
Depreciation and amortization.......................... 2,087 2,513
Amortization of databases.............................. 2,245 2,397
Amortization of costs in excess of assets acquired..... 667 1,112
Bad debt expense....................................... 965 1,210
Gain from extinguishment of long-term debt............. -- (38)
Gain on sale of marketable securities.................. -- (7)
Minority Interest...................................... 44 --
Non-cash compensation expense.......................... -- 33
Share in net income of joint ventures.................. (149) --
Change in assets and liabilities, net of effects of
acquisitions --
Receivables............................................ (7,591) (17,997)
Related party receivables.............................. 477 473
Unbilled revenues...................................... (118) (4,264)
Costs in excess of billings on uncompleted contracts... 794 (9,546)
Inventories............................................ (4,046) 749
Prepaid expenses and other assets...................... (2,844) (382)
Accounts payable and income and other taxes currently
payable............................................... (1,719) (1,724)
Affiliate payable...................................... -- (744)
Notes payable -- shareholders.......................... 107 (58)
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. (199) (165)
Customer deposits...................................... (788) 110
Deferred income taxes payable.......................... 811 (45)
Accrued liabilities.................................... (857) 1,704
Long term liabilities.................................. 106 1,427
-------- --------
Net cash used in operating activities................ (3,002) (10,604)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net........... (6,462) (4,198)
Additions to databases.................................... (3,036) (3,074)
Acquisitions, net of cash acquired........................ (7,606) (11,414)
Sale (purchase) of marketable securities.................. (3,768) 20
Other..................................................... (15) 9
-------- --------
Net cash used in investing activities.................. (20,887) (18,657)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings (repayments) under revolving lines of
credit................................................. (8,220) (1,101)
Proceeds from long-term debt.............................. 37,067 --
Payments of long-term debt................................ -- (10,706)
Repayment of shareholder notes............................ (186) --
Net proceeds from public offering of common stock......... -- 62,850
Issuance of preferred stock............................... -- 5,508
Warrant offering costs.................................... (110) --
Proceeds from exercise of stock options including related
tax benefits........................................... 140 3,071
Purchase and retirement of common stock................... (2,693) (45)
Foreign currency translation.............................. (529) 50
-------- --------
Net cash provided by financing activities.............. 25,469 59,627
-------- --------
NET INCREASE IN CASH AND EQUIVALENTS........................ 1,580 30,366
Effects of foreign currency exchange rates on cash.......... (64) 77
-------- --------
CASH AND EQUIVALENTS, beginning of period................... 5,491 9,765
-------- --------
CASH AND EQUIVALENTS, end of period......................... $ 7,007 $ 40,208
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid for interest.................................... $ 2,171 $ 2,626
======== ========
Cash paid for taxes....................................... $ 2,907 $ 2,252
======== ========
</TABLE>
The accompanying notes are an integral part of these supplemental consolidated
financial statements.
F-57
<PAGE> 62
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
(1) 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 to businesses,
individuals and governments. It also offers security services such as training,
risk and crisis management services, and site security systems. The
Investigations and Intelligence Group offers business intelligence and
investigation services to clients worldwide. The Voice and Data Communications
Group offers secure satellite communication equipment, satellite navigation
systems and computer hardware and software security.
In December 1997, a wholly owned subsidiary of The O'Gara Company
("O'Gara") was merged (the "Merger") 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.
Effective upon the consummation of the Merger, each then issued and
outstanding share of Kroll common stock (including those issued under the Kroll
restricted stock plan) was 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 were converted at the same exchange factor into options
to purchase 551,492 shares of Company Common Stock.
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 the Company or 1,209,053 shares
of the Company's common stock in total. Outstanding stock option 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.
The financial position and results of operations of LSAI will be 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 will be 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 into 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 will be reported in this group. The Information Security
Group offers information and computer security services, including network and
system review and repair.
The Mergers constitute tax-free reorganizations and have been accounted for
as pooling of interests. Accordingly, all prior period supplemental consolidated
financial statements presented have been restated to include the combined
results of operations, financial position and cash flows of Kroll, LSAI, Schiff,
and Securify as though they had always been a part of the Company.
On May 5, 1998, the Company completed a public offering of 3,200,000 shares
of its Common Stock at $20.50 per share (the "Offering"), resulting in net
proceeds to the Company of $60.4 million. A portion of the net proceeds was used
to pay off $14.8 million of indebtedness of the Company, with the balance
invested in short-term instruments and available for potential acquisitions,
working capital and other general corporate
F-58
<PAGE> 63
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED UNAUDITED
FINANCIAL STATEMENTS -- (CONTINUED)
purposes. In addition to the shares sold by the Company, certain shareholders
sold 1,860,000 shares of Common Stock in conjunction with the Offering. The
Offering followed the Company's initial public offering, which was completed on
November 15, 1996 and resulted in the issuance of 2,048,000 shares of Common
Stock.
In addition, on June 4, 1998, LSAI completed a private stock offering of
116,708 shares of its common stock which resulted in net proceeds of
approximately $2.3 million. In addition to the underwriting fees, LSAI also
issued to a certain securities corporation and its designees 55,522 warrants.
The net proceeds were used to pay a portion of the purchase price for a customer
list acquired by LSAI in June 1998.
The supplemental consolidated financial statements include the accounts of
the Company and its majority-owned subsidiaries. All material intercompany
accounts and transactions have been eliminated. Investments in 20% to 50% owned
entities are accounted for on the cost method. Affiliated entities are not
included in the accompanying supplemental consolidated financial statements.
The accompanying unaudited supplemental consolidated financial statements
have been prepared in accordance with generally accepted accounting principles
for interim financial information and with the instructions to Form 10-Q and
Article 10 of Regulation S-X. Accordingly, they do not include all of the
information and footnotes required by generally accepted accounting principles
for complete financial statements. In the opinion of management, all adjustments
(consisting of normal recurring adjustments) considered necessary for fair
presentation have been included. Operating results for the three and nine month
periods ended September 30, 1998, are not necessarily indicative of the results
that may be expected for the year ended December 31, 1998. The accompanying
supplemental consolidated financial statements should be read in conjunction
with the supplemental consolidated financial statements and notes thereto
included elsewhere in this document for the year ended December 31, 1997.
(2) REVENUE RECOGNITION
Revenue related to contracts for security products (both government and
commercial) results principally from long-term, fixed price contracts and is
recognized using the percentage-of-completion method calculated utilizing the
cost-to-cost approach. The percent deemed to be complete is determined by
comparing the costs incurred to date with 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 investigations, intelligence and security services is
recognized as the services are performed. The Company records either billed or
unbilled accounts receivable based on a case-by-case invoice determination.
Revenue related to voice and data security equipment are recognized as
equipment is shipped. Revenue and related direct costs of brokered satellite
time are recorded when payments are received from customers.
(3) ACQUISITIONS
The Company completed the following acquisitions during the first nine
months of 1998, all of which were accounted for as purchases. 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.
F-59
<PAGE> 64
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED UNAUDITED
FINANCIAL STATEMENTS -- (CONTINUED)
(a) On March 16, 1998, the Company acquired all of the shares of
Corplex, Inc. ("Corplex"), a provider of investigative and executive
protection services based in New York, New York. The purchase price
consisted of 29,207 shares of Common Stock (valued at approximately $0.5
million or $17.98 per share). For accounting purposes, the acquisition was
effective March 1, 1998, and the results of operations of Corplex are
included in the consolidated results of the Company from that date forward.
The former shareholder of Corplex, who was employed by Corplex prior to the
acquisition, continues in his formerly held capacity. Cost in excess of
assets acquired is expected to be $0.4 million and will be amortized over
15 years.
(b) On May 1, 1998, the Company acquired from Harrison Laboratories,
Inc. (HLI) a customer list pursuant to an Asset Purchase Agreement, dated
April 13, 1998 (the HLI Asset Purchase). In connection with the HLI Asset
Purchase, the Company paid $500,000 at closing and agreed to pay on or
before May 30, 1999, an amount equal to the revenues attributable to the
customer list, during the one-year period ending April 30, 1999, in excess
of $500,000. In addition, the Company assumed HLI's obligations under a
five-year lease and acquired the related equipment and entered into a
three-year employment agreement with the principal shareholder of HLI which
provides for a base salary of $50,000 per year, monthly bonuses and other
benefits. The purchase price of the customer list was recorded as an
intangible asset and is being amortized over 15 years.
(c) On June 15, 1998, the Company completed the acquisition of
Lindquist Avey MacDonald Baskerville Inc. ("Lindquist Avey"), a provider of
forensic and investigative accounting services headquartered in Toronto,
Canada. The purchase price for the acquisition was $10.7 million consisting
of $4.7 million in cash and 278,340 shares of Common Stock (valued at
approximately $6.0 million or $21.52 per share). For accounting purposes,
the acquisition was effective June 1, 1998, and the results of operations
of Lindquist Avey are included in the consolidated results of the Company
from that date forward. Cost in excess of assets acquired is expected to be
$10.7 million and will be amortized over 25 years.
(d) On July 1, 1998, the Company acquired from Toxworx Laboratories,
Inc. (TLI), a California corporation, a customer list pursuant to an Asset
Purchase Agreement, dated June 8, 1998 (TLI Asset Purchase). In connection
with the TLI Asset Purchase Agreement, the Company paid $2,400,000 at
closing. The purchase price of the customer list was recorded as an
intangible asset which is being amortized over 15 years.
(e) On September 1, 1998, the Company completed the acquisition of all
of the capital stock of Kizorek, Inc., now renamed InPhoto Surveillance,
Inc. ("InPhoto"). InPhoto, headquartered in Naperville, Illinois, is a
leading claims investigation agency which primarily provides video
surveillance services to insurance companies, corporations and government
agencies in connection with investigating exaggerated disability claims and
other fraud. The purchase price consisted of $0.8 million in cash and
352,381 shares of Common Stock (valued at approximately $8.2 million or
$23.35 per share). For accounting purposes, the acquisition was effective
July 1, 1998, and the results of operations of InPhoto are included in the
consolidated results of the Company from that date forward. Cost in excess
of assets is expected to be $8.1 million and will be amortized over 25
years.
(f) On September 22, 1998, the Company completed, through its wholly
owned subsidiary, O'Gara-Hess & Eisenhardt de Colombia, Inc. ("OHE
Colombia"), the acquisition of the assets and technology of Protec S.A.
("Protec") of Bogota, Colombia. Protec was a leading manufacturer of
armored vehicles and bullet-and smash- resistant glass for the Colombian
market. The purchase price consisted of $3.2 million in cash and 38,788
shares of Common Stock (valued at approximately $0.9 million or $22.95 per
share). For accounting purposes, the acquisition was effective September
30, 1998, and the results of operations of OHE
F-60
<PAGE> 65
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED UNAUDITED
FINANCIAL STATEMENTS -- (CONTINUED)
Colombia are included in the consolidated results of the Company from that
date forward. Cost in excess of assets acquired is expected to be $3.6
million and will be amortized over 20 years.
In connection with the 1998 acquisitions, assets were acquired and
liabilities were assumed as follows (dollars in thousands):
<TABLE>
<CAPTION>
LINDQUIST
PROTEC INPHOTO AVEY CORPLEX HLI TLI
------- ------- --------- ------- ----- -------
<S> <C> <C> <C> <C> <C> <C>
FAIR VALUE OF ASSETS ACQUIRED INCLUDING:
Cash...................................... $ -- $ 192 $ 257 $ 16 $ -- $ --
Accounts receivable....................... -- 1,743 -- 96 -- --
Unbilled revenue.......................... -- 269 339 69 -- --
Other current assets...................... 75 448 577 -- -- --
Property, plant and equipment............. 311 955 628 4 -- --
Other non-current assets.................. -- -- 116 15 -- --
Intangible assets......................... 200 700 -- -- 500 2,400
Goodwill.................................. 3,602 8,076 10,716 384 -- --
------- ------- ------- ----- ----- -------
$ 4,188 $12,383 $12,633 $ 584 $ 500 $ 2,400
Less: Cash paid for net assets........... (3,200) (800) (4,727) -- (500) (2,400)
Fair value of stock issued......... (890) (8,228) (5,989) (525) -- --
------- ------- ------- ----- ----- -------
$ 98 $ 3,355 $ 1,917 $ 59 $ -- $ --
======= ======= ======= ===== ===== =======
LIABILITIES ASSUMED INCLUDING:
Liabilities assumed and acquisition
costs.................................. $ 98 $ 3,155 $ 1,917 $ 46 $ -- $ --
Debt...................................... -- 200 -- 13 -- --
------- ------- ------- ----- ----- -------
$ 98 $ 3,355 $ 1,917 $ 59 $ -- $ --
======= ======= ======= ===== ===== =======
</TABLE>
(4) EARNINGS PER SHARE
In 1997, the Company adopted Statement of Financial Accounting Standards
No. 128, "Earnings Per Share" ("SFAS No. 128"). In accordance with SFAS No. 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 equivalents outstanding during the year.
Dilutive common stock equivalents represent shares issuable upon assumed
exercise of stock options and upon assumed issuance of restricted stock. The
following is a
F-61
<PAGE> 66
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED UNAUDITED
FINANCIAL STATEMENTS -- (CONTINUED)
reconciliation of the numerator and denominator for basic and diluted earnings
per share for the nine months ended September 30, 1997 and 1998 (in thousands
except per share data):
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
--------------------------------------
PER
INCOME SHARES SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
Basic EPS................................................ $7,006 13,929 $0.50
=====
Effect of dilutive securities:
Options................................................ -- 197
Restricted stock....................................... (227) 585
Warrants............................................... -- 78
Convertible note taxable............................... -- 19
------ ------
Diluted EPS.............................................. $6,779 14,808 $0.46
====== ====== =====
</TABLE>
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1997
--------------------------------------
PER
INCOME SHARES SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ------
<S> <C> <C> <C>
Basic EPS......................................... $12,638 17,845 $0.71
=====
Effect of dilutive securities:
Options......................................... -- 510
Warrants........................................ -- 16
------- ------
Diluted EPS....................................... $12,638 18,371 $0.69
======= ====== =====
</TABLE>
(5) NEW PRONOUNCEMENTS
In 1998, the Company adopted Statement of Financial Accounting Standards
No. 130, "Reporting Comprehensive Income" ("SFAS No. 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 Statement
of Shareholder's Equity. Prior years have been restated to conform to the SFAS
No. 130 requirements. The Accumulated Other Comprehensive Income balance of $0.1
million at September 30, 1998 consists entirely of foreign currency translation
adjustments.
Total comprehensive income for the nine-month period ended September 30,
1997 is as follows (in thousands):
<TABLE>
<S> <C>
Net income.................................................. $7,006
------
Other comprehensive income, net of tax:
Foreign currency translation adjustments, net of $390 tax
benefit................................................ (585)
------
Other comprehensive income.................................. (585)
------
Comprehensive income...................................... $6,421
======
</TABLE>
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
("SFAS No. 131"), effective for fiscal years beginning after
F-62
<PAGE> 67
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED UNAUDITED
FINANCIAL STATEMENTS -- (CONTINUED)
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 intends to adopt SFAS No. 131 during fiscal 1998. This statement,
which requires expansion or modification to existing disclosures, will have no
impact on the Company's reported financial position, results of operations or
cash flows.
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 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 September 30, 1998
Consolidated Balance Sheet are approximately $0.7 million 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 No. 133"). SFAS No. 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
No. 133 requires that changes in the derivative's fair value be recognized
currently in earnings unless specific hedge accounting criteria are met. SFAS
No. 133 is effective for fiscal years beginning after June 15, 1999. The Company
currently 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 No. 133 on its
financial statements and has not determined the timing of or method of adoption
of SFAS No. 133. However, SFAS No. 133 could increase volatility in earnings and
other comprehensive income.
(6) SUPPLEMENTAL CASH FLOW DISCLOSURE
Cash and equivalents consist of all operating cash accounts and investments
with an original maturity of three months or less. Marketable securities consist
of available-for-sale commercial paper obligations which mature in 1998. These
securities are valued at current market value, which approximates cost. Non-cash
activity for the nine months ended September 30, 1998 is as follows (dollars in
thousands):
<TABLE>
<CAPTION>
1998
------
<S> <C>
Fair value of stock issued in connection with acquisition of
ITI....................................................... --
Notes issued in connection with acquisition of ITI.......... --
Fair value of stock issued in connection with acquisition of
Next Destination.......................................... --
Notes issued in connection with acquisition of Next
Destination............................................... --
Fair value of stock issued in connection with acquisition of
Labbe..................................................... --
Fair value of stock issued in connection with acquisition of
Corplex................................................... $ 525
Fair value of stock issued in connection with acquisition of
Lindquist Avey............................................ $5,989
Fair value of stock issued in connection with acquisition of
InPhoto................................................... $8,228
Fair value of stock issued in connection with acquisition of
Protec.................................................... $ 890
Fair value of stock issued in connection with employee stock
bonus paid................................................ $ 48
</TABLE>
F-63
<PAGE> 68
THE KROLL-O'GARA COMPANY
NOTES TO SUPPLEMENTAL CONSOLIDATED UNAUDITED
FINANCIAL STATEMENTS -- (CONTINUED)
(7) INVENTORIES
Inventories are stated at the lower of cost or market using the first-in,
first-out (FIFO) method and include the following (dollars in thousands):
<TABLE>
<CAPTION>
SEPTEMBER 30,
1998
-------------
(UNAUDITED)
<S> <C>
Raw materials......................................... $10,792
Vehicle costs and work-in-process..................... 8,366
-------
$19,158
=======
</TABLE>
(8) 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.
The Company has entered into five foreign currency exchange contracts to
effectively hedge its exposure to certain foreign currency rate fluctuations on
demand loans to subsidiaries which are denominated in the foreign currency. By
virtue of these contracts, the Company has fixed the total dollar amount which
it will receive under the aforementioned subsidiary loans through the maturity
dates of the contracts regardless of the fluctuations in the exchange rate. The
total notional amount and fair market value of the contracts, which mature
between January 1999 and September 2000, are $17.9 million and $0.5 million,
respectively. The Company's foreign currency translation adjustment component of
accumulated other comprehensive income (loss) was increased by $0.1 million in
the first three quarters of 1998 as a result of these agreements.
F-64
<PAGE> 69
KROLL-O'GARA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING FINANCIAL STATEMENTS
The unaudited pro forma combining financial statements give effect to the
merger as a pooling of interests, and should be read in conjunction with, and is
qualified by reference to, the audited consolidated financial statements of
Kroll-O'Gara and Background America and the notes thereto and the audited
supplemental consolidated financial statements of Kroll-O'Gara and notes thereto
included elsewhere in this Proxy Statement / Prospectus. For purposes of the
unaudited pro forma operating data, Kroll-O'Gara's historical and supplemental
consolidated financial statements for the three fiscal years ended December 31,
1997 and the nine months ended September 30, 1997 and 1998 have been combined
with the consolidated financial statements of Background America for the three
fiscal years ended December 31, 1997 and the nine months ended September 30,
1997 and 1998, respectively. For purposes of the unaudited pro forma combined
condensed balance sheets, Kroll-O'Gara's consolidated financial statements and
supplemental consolidated financial statements at September 30, 1998 have been
combined with Background America's consolidated financial statements at
September 30, 1998.
The pro forma financial statements are presented for illustrative purposes
only and are not necessarily indicative of the operating results or financial
position that would have been achieved if the merger had been consummated as of
the beginning of the periods indicated, nor are they indicative of future
financial position or results of operations.
F-65
<PAGE> 70
KROLL-O'GARA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED BALANCE SHEETS
AS OF SEPTEMBER 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
BACKGROUND
KROLL-O'GARA AMERICA PRO FORMA
------------- ---------- ---------
<S> <C> <C> <C>
Current Assets:
Cash and cash equivalents........................... $ 32,859 $1,058 $ 33,917
Accounts receivable billed and unbilled, net........ 63,624 1,590 65,214
Costs and estimated earnings in excess of billings
on uncompleted contracts......................... 21,625 -- 21,625
Inventories......................................... 19,094 -- 19,094
Other current assets................................ 6,083 90 6,173
-------- ------ --------
Total current assets............................. 143,285 2,738 146,023
Property, plant and equipment, net.................... 18,389 747 19,136
Databases, net........................................ 9,012 -- 9,012
Costs in excess of assets acquired and other
intangible assets, net.............................. 39,629 1,067 40,696
Other assets, net..................................... 7,947 249 8,196
-------- ------ --------
Total assets..................................... $218,262 $4,801 $223,063
======== ====== ========
Current liabilities:
Accounts payable.................................... $ 27,022 $ 334 $ 27,356
Accrued liabilities................................. 18,111 348 18,459
Other current liabilities........................... 9,631 34 9,665
-------- ------ --------
Total current liabilities........................ 54,764 716 55,480
Long-term debt, net of current portion................ 39,339 98 39,437
Other long-term liabilities........................... 5,235 -- 5,235
Shareholders' equity.................................. 118,924 3,987(1) 122,911
-------- ------ --------
Total liabilities and shareholders' equity....... $218,262 $4,801 $223,063
======== ====== ========
</TABLE>
(1) This amount includes a reclass of approximately $6.0 million for mandatorily
redeemable preferred stock that was historically reflected as a long-term
liability but is treated as essentially the same as common stock in the
merger transaction.
F-66
<PAGE> 71
KROLL-O'GARA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
----------------------------------------------------
BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales..................................... $85,841 $ -- $85,841
Cost of sales................................. 62,114 -- 62,114
------- ---- -------
Gross profit............................. 23,727 -- 23,727
Selling, general and administrative expenses,
including amortization...................... 28,364 76 28,440
------- ---- -------
Operating loss........................... (4,637) (76) (4,713)
Interest expense.............................. (2,813) -- (2,813)
Other expense, net............................ (384) -- (384)
------- ---- -------
Loss before benefit for income taxes..... (7,834) (76) (7,910)
Benefit for income taxes...................... (1,298) -- (1,298)
------- ---- -------
Net loss................................. $(6,536) $(76) $(6,612)
======= ==== =======
Basic loss per share from continuing
operations.................................. $ (0.65) $ (0.66)(2)
======= =======
Basic weighted average shares outstanding..... 10,021 29(1) 10,050(2)
======= =======
Diluted loss per share from continuing
operations.................................. $ (0.65) $ (0.66)(2)
======= =======
Diluted weighted average shares outstanding... 10,021 29(1) 10,050(2)
======= =======
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(2) On a pro forma basis for the year ended December 31, 1995, Kroll-O'Gara and
Background America had a combined net loss. As such, there is no further
dilution of earnings per share by the common stock equivalents of
Kroll-O'Gara and Background America and basic and diluted earnings per
share are the same.
F-67
<PAGE> 72
KROLL-O'GARA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
------------------------------------------------------
BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------ ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales................................ $153,661 $ 1,776 $155,437
Cost of sales............................ 111,459 1,624 113,083
-------- ------- --------
Gross profit........................ 42,202 152 42,354
Selling, general and administrative
expenses, including amortization....... 33,703 1,237 34,940
-------- ------- --------
Operating income (loss)............. 8,499 (1,085) 7,414
Interest expense......................... (3,140) (42) (3,182)
Other income, net........................ 336 (2) 334
-------- ------- --------
Income (loss) before benefit for
income taxes...................... 5,695 (1,129) 4,566
Benefit for income taxes................. (162) -- (162)
-------- ------- --------
Net income (loss)................... $ 5,857 $(1,129) $ 4,728
======== ======= ========
Basic earnings per share from continuing
operations............................. $ 0.55 $ 0.42
======== ========
Basic weighted average shares
outstanding............................ 10,742 505(1) 11,247(2)
======== ========
Diluted earnings per share from
continuing operations.................. $ 0.51 $ 0.39
======== ========
Diluted weighted average shares
outstanding............................ 11,160 510(1) 11,670(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(2) The following is a reconciliation of the numerator and denominator for
basic and diluted earnings per share for the year ended December 31, 1996:
<TABLE>
<CAPTION>
INCOME SHARES
------ -------
<S> <C> <C>
Basic earnings per share.................................... $4,728 11,247
Effect of dilutive securities:
Options................................................... -- 135
Restricted stock.......................................... (162) 287
Warrants.................................................. -- 1
------ -------
Diluted earnings per share.................................. $4,566 11,670
====== =======
</TABLE>
F-68
<PAGE> 73
KROLL-O'GARA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-------------------------------------------------------
BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales................................ $190,413 $ 4,221 $194,634
Cost of sales............................ 131,644 3,448 135,092
-------- ------- --------
Gross profit........................ 58,769 773 59,542
Selling, general and administrative
expenses, including amortization....... 42,593 2,178 44,771
Merger related costs..................... 7,205 -- 7,205
-------- ------- --------
Operating income (loss)............. 8,971 (1,405) 7,566
Interest expense......................... (4,806) (84) (4,890)
Interest income.......................... -- 93 93
Other income (expense), net.............. (393) 59 (334)
-------- ------- --------
Income (loss) before minority interest,
provision for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle........................... 3,772 (1,337) 2,435
Minority interest........................ (156) -- (156)
-------- ------- --------
Income (loss) before provision for
income taxes, extraordinary item and
cumulative effect of change in
accounting principle................ 3,616 (1,337) 2,279
Provision for income taxes............... 2,352 -- 2,352
-------- ------- --------
Income (loss) from continuing
operations(3)..................... $ 1,264 $(1,337) $ (73)
======== ======= ========
Basic earnings per share from continuing
operations(3).......................... $ 0.10 $ (0.01)(2)
======== ========
Basic weighted average shares
outstanding............................ 13,061 744(1) 13,805(2)
======== ========
Diluted earnings per share from
continuing operations(3)............... $ 0.09 $ (0.01)(2)
======== ========
Diluted weighted average shares
outstanding............................ 13,721 84(1) 13,805(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(2) On a pro forma basis for the year ended December 31, 1997, Kroll-O'Gara and
Background America had a combined net loss. As such, there is no further
dilution of earnings per share by the common stock equivalents of
Kroll-O'Gara and Background America and basic and diluted earnings per share
are the same.
(3) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. In addition, during the
fourth quarter of 1997, Kroll-O'Gara changed its method of accounting for
costs incurred in connection with business process reengineering activities
relating to information technology transformation and recorded a cumulative
effect of change in accounting principle of $360, net of a benefit for
income taxes of $240. The pro forma basic and diluted earnings per share
impact of the extraordinary item was $0.01 and the pro forma basic and
diluted earnings per share impact of the cumulative effect of change in
accounting principle was $0.03 for the year ended December 31, 1997.
F-69
<PAGE> 74
KROLL-O'GARA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1997
-------------------------------------------------------
BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales................................ $136,390 $ 3,076 $139,466
Cost of sales............................ 92,919 2,555 95,474
-------- ------- --------
Gross profit........................ 43,471 521 43,992
Selling, general and administrative
expenses, including amortization....... 29,793 1,568 31,361
-------- ------- --------
Operating income (loss)............. 13,678 (1,047) 12,631
Interest expense......................... (3,387) (79) (3,466)
Interest income.......................... 259 52 311
Other expense, net....................... (226) 14 (212)
-------- ------- --------
Income (loss) before minority interest,
provision for income taxes and
extraordinary item.................. 10,324 (1,060) 9,264
Minority interest........................ (118) -- (118)
-------- ------- --------
Income (loss) before provision for
income taxes and extraordinary
item.............................. 10,206 (1,060) 9,146
Provision for income taxes............... 4,035 -- 4,035
-------- ------- --------
Income (loss) from continuing
operations(3)..................... $ 6,171 $(1,060) $ 5,111
======== ======= ========
Basic earnings per share from continuing
operations (3)......................... $ 0.47 $ 0.37
======== ========
Basic weighted average shares
outstanding............................ 13,058 697(1) 13,755(2)
======== ========
Diluted earnings per share from
continuing operations (3).............. $ 0.43 $ 0.34
======== ========
Diluted weighted average shares
outstanding............................ 13,825 708(1) 14,533(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
F-70
<PAGE> 75
(2) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share.................................... $5,111 13,755
Effect of dilutive securities:
Options................................................... -- 192
Restricted stock.......................................... (227) 585
Warrants.................................................. -- 1
------ ------
Diluted earnings per share.................................. $4,884 14,533
====== ======
</TABLE>
(3) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. The pro forma basic and
diluted earnings per share impact of the extraordinary item was $0.01 for
the nine months ended September 30, 1997.
F-71
<PAGE> 76
KROLL-O'GARA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
----------------------------------------------------
BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales..................................... $178,943 $5,028 $183,971
Cost of sales................................. 120,100 3,360 123,460
-------- ------ --------
Gross profit............................. 58,843 1,668 60,511
Selling, general and administrative expenses,
including amortization...................... 36,860 2,469 39,329
-------- ------ --------
Operating income (loss).................. 21,983 (801) 21,182
Interest expense.............................. (3,322) (9) (3,331)
Interest income............................... 759 76 835
Other expense, net............................ (219) 17 (202)
-------- ------ --------
Income (loss) before provision for income
taxes.................................. 19,201 (717) 18,484
Provision for income taxes.................... 7,641 -- 7,641
-------- ------ --------
Net income (loss) from continuing
operations............................. $ 11,560 $ (717) $ 10,843
======== ====== ========
Basic earnings per share from continuing
operations.................................. $ 0.74 $ 0.66
======== ========
Basic weighted average shares outstanding..... 15,580 898(1) 16,478(2)
======== ========
Diluted earnings per share from continuing
operations.................................. $ 0.72 $ 0.64
======== ========
Diluted weighted average shares outstanding... 15,955 940(1) 16,895(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(2) The following is a reconciliation of the numerator and denominator for
basic and diluted earnings per share for the nine months ended September
30, 1998:
<TABLE>
<CAPTION>
INCOME SHARES
------- -------
<S> <C> <C>
Basic earnings per share.................................... $10,843 16,478
Effect of dilutive securities:
Options................................................... -- 416
Warrants.................................................. -- 1
------- -------
Diluted earnings per share.................................. $10,843 16,895
======= =======
</TABLE>
F-72
<PAGE> 77
KROLL-O'GARA AND KIZOREK UNAUDITED PRO FORMA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PRO FORMA KROLL-O'GARA BACKGROUND PRO FORMA
KROLL-O'GARA KIZOREK(1) ADJUSTMENTS(2) PRO FORMA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- -------------- ------------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales.................... $190,413 $14,476 $204,889 $ 4,221 $209,110
Cost of sales................ 131,644 8,113 139,757 3,448 143,205
-------- ------- ----- -------- ------- --------
Gross profit............. 58,769 6,363 65,132 773 65,905
Selling, general and
administrative expenses,
including amortization..... 42,593 5,111 340(3) 48,044 2,178 50,222
Merger related costs......... 7,205 -- 7,205 -- 7,205
-------- ------- ----- -------- ------- --------
Operating income
(loss)................. 8,971 1,252 (340) 9,883 (1,405) 8,478
Interest expense............. (4,806) (20) (69)(4) (4,895) (84) (4,979)
Interest income.............. -- -- -- 93 93
Other income (expense),
net........................ (393) -- (393) 59 (334)
-------- ------- ----- -------- ------- --------
Income (loss) before
minority interest,
provision for income
taxes, extraordinary item
and cumulative effect of
change in accounting
principle................ 3,772 1,232 (409) 4,595 (1,337) 3,258
Minority Interest............ (156) -- (156) -- (156)
-------- ------- ----- -------- ------- --------
Income (loss) before
provision for income
taxes, extraordinary item
and cumulative effect of
change in accounting
principle................ 3,616 1,232 (409) 4,439 (1,337) 3,102
Provision for income taxes... 2,352 -- 329(5) 2,681 -- 2,681
-------- ------- ----- -------- ------- --------
Income (loss) from
continuing
operations(9)............ $ 1,264 $ 1,232 $(738) $ 1,758 $(1,337) $ 421
======== ======= ===== ======== ======= ========
Basic earnings per share from
continuing operations(9)... $ 0.10 $ 0.13 $ 0.03
======== ======== ========
Basic weighted average shares
outstanding................ 13,061 352(6) 13,413 744(7) 14,157(8)
======== ======== ========
Diluted earnings per share
from continuing
operations(9).............. $ 0.09 $ 0.12 $ 0.03
======== ======== ========
Diluted weighted average
shares outstanding......... 13,721 352(6) 14,073 761(7) 14,834(8)
======== ======== ========
</TABLE>
- ---------------
(1) To include historical results of operations for Kizorek for the year ended
October 31, 1997. Kizorek's operating costs have been allocated into
categories consistent with the Company's statement of operations
presentation policies.
(2) Pro forma adjustments exclude the impact of compensation expense for a
non-recurring charge under the Kizorek deferred compensation plan associated
with the accelerated vesting of benefits resulting from a change in control
of the company.
(3) Pro forma adjustments are comprised of the following components:
amortization of goodwill resulting from the acquisition of Kizorek (gross
cost of $6,772 over 25 years), amortization of capitalized acquisition costs
associated with Kizorek ($545 over 25 years) and amortization of customer
lists and detective licenses identified in conjunction with the acquisition
($700 over 15 years).
(4) To record interest expense under Kizorek deferred compensation plan ($1,350
at 5.125%).
(5) To recognize the benefit for income taxes on pro forma adjustments and the
provision for income taxes on the historical results of Kizorek, which had
been previously treated as an S Corporation for income tax purposes. An
effective rate of 40% was used to determine the pro forma income tax impact.
F-73
<PAGE> 78
(6) These amounts represent the number of Kroll-O'Gara common shares issued to
Kizorek shareholders for the purchase of Kizorek. Kizorek does not have any
common stock equivalents which would cause further dilution to earnings per
share.
(7) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(8) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the year ended December 31,1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share.................................... $421 14,157
Effect of dilutive securities:
Options................................................... -- 233
Restricted stock.......................................... -- 443
Warrants.................................................. -- 1
---- ------
Diluted earnings per share.................................. $421 14,834
==== ======
</TABLE>
(9) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. The pro forma basic and
diluted earnings per share impact of the extraordinary item was $0.01 for
the year ended December 31, 1997.
F-74
<PAGE> 79
KROLL-O'GARA AND KIZOREK UNAUDITED PRO FORMA AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
PRO FORMA KROLL-O'GARA BACKGROUND PRO FORMA
KROLL-O'GARA KIZOREK (1) ADJUSTMENTS (2) PRO FORMA AMERICA ADJUSTMENTS PRO FORMA
------------- ----------- --------------- ------------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales.................. $178,943 $6,385 $185,328 $5,028 $190,356
Cost of sales.............. 120,100 3,911 124,011 3,360 127,371
-------- ------ -------- -------- ------ --------
Gross profit........... 58,843 2,474 61,317 1,668 62,985
Selling, general and
administrative expenses,
including amortization... 36,860 2,411 169(3) 39,440 2,469 41,909
-------- ------ -------- -------- ------ --------
Operating income
(loss)............... 21,983 63 (169) 21,877 (801) 21,076
Interest expense........... (3,322) -- (35)(4) (3,357) (9) (3,366)
Interest income............ 759 -- 759 76 835
Other income (expense),
net...................... (219) -- (219) 17 (202)
-------- ------ -------- -------- ------ --------
Income (loss) before
provision for income
taxes.................. 19,201 63 (204) 19,060 (717) 18,343
Provision (benefit) for
income taxes............. 7,641 -- (57)(5) 7,584 -- 7,584
-------- ------ -------- -------- ------ --------
Net income (loss) from
continuing
operations........... $ 11,560 $ 63 $ (147) $ 11,476 $ (717) $ 10,759
======== ====== ======== ======== ====== ========
Basic earnings per share
from continuing
operations............... $ 0.74 $ 0.74 $ 0.65
======== ======== ========
Basic weighted average
shares outstanding....... 15,580 15,580 898(6) 16,478(7)
======== ======== ========
Diluted earnings per share
from continuing
operations............... $ 0.72 $ 0.72 $ 0.64
======== ======== ========
Diluted weighted average
shares outstanding....... 15,955 15,955 940(6) 16,895(7)
======== ======== ========
</TABLE>
- ---------------
(1) To include historical results of operations for Kizorek for the six months
ended April 30, 1998. Kizorek's operating costs have been allocated into
categories consistent with the Company's statement of operations
presentation policies. Kizorek's results of operations from July 1, 1998
through September 30, 1998 are included in the consolidated results of
operations of Kroll-O'Gara.
(2) Pro forma adjustments exclude the impact of compensation expense for a
non-recurring charge under the Kizorek deferred compensation plan associated
with the accelerated vesting of benefits resulting from a change in control
of the company.
(3) Pro forma adjustments are comprised of the following components:
amortization of goodwill resulting from the acquisition of Kizorek (gross
cost of $6,772 over 25 years), amortization of capitalized acquisition costs
associated with Kizorek ($545 over 25 years) and amortization of customer
lists and detective licenses identified in conjunction with the acquisition
($700 over 15 years).
(4) To record interest expense under Kizorek deferred compensation plan ($1,350
at 5.125%).
(5) To recognize the benefit for income taxes on pro forma adjustments and the
provision for income taxes on the historical results of Kizorek, which had
been previously treated as an S Corporation for income tax purposes. An
effective rate of 40% was used to determine the pro forma income tax impact.
(6) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
F-75
<PAGE> 80
(7) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1998:
<TABLE>
<CAPTION>
INCOME SHARES
------- ------
<S> <C> <C>
Basic earnings per share.................................... $10,759 16,478
Effect of dilutive securities:
Options................................................... -- 416
Warrants.................................................. -- 1
------- ------
Diluted earnings per share.................................. $10,759 16,895
======= ======
</TABLE>
F-76
<PAGE> 81
KROLL-O'GARA SUPPLEMENTAL AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED BALANCE SHEETS
AS OF SEPTEMBER 30, 1998
(IN THOUSANDS)
<TABLE>
<CAPTION>
SUPPLEMENTAL BACKGROUND
KROLL-O'GARA AMERICA PRO FORMA
------------ ---------- ---------
<S> <C> <C> <C>
Current Assets:
Cash and equivalents................................ $ 40,208 $1,058 $ 41,266
Accounts receivable, net............................ 68,345 1,590 69,935
Costs and estimated earnings in excess of billings
on uncompleted contracts......................... 21,625 -- 21,625
Inventories......................................... 19,158 -- 19,158
Other current assets................................ 6,441 90 6,531
-------- ------ --------
Total current assets............................. 155,777 2,738 158,515
Property, plant and equipment, net.................... 21,714 747 22,461
Databases, net........................................ 9,012 -- 9,012
Costs in excess of assets acquired and other
intangible assets, net.............................. 49,387 1,067 50,454
Other assets, net..................................... 7,983 249 8,232
-------- ------ --------
Total assets..................................... $243,873 $4,801 $248,674
======== ====== ========
Current liabilities:
Accounts payable.................................... $ 28,106 $ 334 $ 28,440
Accrued liabilities................................. 19,809 348 20,157
Other current liabilities........................... 10,714 34 10,748
-------- ------ --------
Total current liabilities........................ 58,629 716 59,345
Long-term debt, net of current portion................ 41,330 98 41,428
Other long-term liabilities........................... 5,595 -- 5,595
Shareholders' equity.................................. 138,319 3,987(1) 142,306
-------- ------ --------
Total liabilities and shareholders' equity....... $243,873 $4,801 $248,674
======== ====== ========
</TABLE>
(1) This amount includes a reclass of approximately $6.0 million for mandatorily
redeemable preferred stock that was historically reflected as a long-term
liability but is treated as essentially the same as common stock in the
merger transaction.
F-77
<PAGE> 82
KROLL-O'GARA SUPPLEMENTAL AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1995
------------------------------------------------------
SUPPLEMENTAL BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------ ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales................................. $94,998 $ -- $94,998
Cost of sales............................. 66,764 -- 66,764
------- ---- -------
Gross profit......................... 28,234 -- 28,234
Selling, general and administrative
expenses, including amortization........ 31,809 76 31,885
------- ---- -------
Operating loss.......................... (3,575) (76) (3,651)
Interest expense.......................... (2,897) -- (2,897)
Interest income........................... 127 -- 127
Other expense, net........................ (109) -- (109)
------- ---- -------
Loss before benefit for income taxes.... (6,454) (76) (6,530)
Benefit for income taxes.................. (824) -- (824)
------- ---- -------
Net loss............................. (5,630) (76) (5,706)
Dividends on preferred stock.............. 13 -- 13
------- ---- -------
Net loss available to common
shareholders....................... $(5,643) $(76) $(5,719)
======= ==== =======
Basic loss per share from continuing
operations.............................. $ (0.52) $ (0.52)(2)
======= =======
Basic weighted average shares
outstanding............................. 10,884 29(1) 10,913(2)
======= =======
Diluted loss per share from continuing
operations.............................. $ (0.52) $ (0.52)(2)
======= =======
Diluted weighted average shares
outstanding............................. 10,884 29(1) 10,913(2)
======= =======
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(2) On a pro forma basis for the year ended December 31, 1995, Kroll-O'Gara
supplemental and Background America had a combined net loss. As such, there
is no further dilution of earnings per share by the common stock
equivalents of Kroll-O'Gara and Background America and basic and diluted
earnings per share are the same.
F-78
<PAGE> 83
KROLL-O'GARA SUPPLEMENTAL AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1996
--------------------------------------------------------
SUPPLEMENTAL BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
-------------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales............................... $164,918 $ 1,776 $166,694
Cost of sales........................... 117,298 1,624 118,922
-------- ------- --------
Gross profit....................... 47,620 152 47,772
Selling, general and administrative
expenses, including amortization...... 37,712 1,237 38,949
Asset impairment........................ 125 -- 125
-------- ------- --------
Operating income (loss)............ 9,783 (1,085) 8,698
Interest expense........................ (3,261) (42) (3,303)
Interest income......................... 41 -- 41
Other income (loss), net................ 345 (2) 343
-------- ------- --------
Income (loss) from continuing
operations before provision for
income taxes....................... 6,908 (1,129) 5,779
Provision for income taxes.............. 365 -- 365
-------- ------- --------
Income (loss) from continuing
operations (3)..................... $ 6,543 $(1,129) $ 5,414
======== ======= ========
Basic earnings per share from continuing
operations (3)........................ $ 0.56 $ 0.45
======== ========
Basic weighted average shares
outstanding........................... 11,607 505(1) 12,112(2)
======== ========
Diluted earnings per share from
continuing operations (3)............. $ 0.52 $ 0.41
======== ========
Diluted weighted average shares
outstanding........................... 12,161 510(1) 12,671(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(2) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the year ended December 31, 1996:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share.................................... $5,414 12,112
Effect of dilutive securities:
Options................................................... -- 137
Restricted stock.......................................... (162) 288
Warrants.................................................. -- 102
Convertible note payable.................................. -- 32
------ ------
Diluted earnings per share.................................. $5,252 12,671
====== ======
</TABLE>
(3) During the fourth quarter of 1996, a subsidiary of Kroll-O'Gara discontinued
its clinical operations. The related operating loss and shut down expenses
of $1,274, net of a benefit for income taxes of $747, were reported as
discontinued operations by Kroll-O'Gara in its supplemental statement of
operations for the year ended December 31, 1996. The pro forma basic and
diluted earnings per share impact of the discontinued operations for the
year ended December 31, 1996 were $0.11 and $0.10, respectively.
F-79
<PAGE> 84
KROLL-O'GARA SUPPLEMENTAL AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
------------------------------------------------------
SUPPLEMENTAL BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------ ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales................................. $206,103 $ 4,221 $210,324
Cost of sales............................. 139,766 3,448 143,214
-------- ------- --------
Gross profit......................... 66,337 773 67,110
Selling, general and administrative
expenses, including amortization........ 47,646 2,178 49,824
Merger related costs...................... 7,205 -- 7,205
-------- ------- --------
Operating income (loss).............. 11,486 (1,405) 10,081
Interest expense.......................... (5,092) (84) (5,176)
Interest income........................... 79 93 172
Other income (expense), net............... (411) 59 (352)
-------- ------- --------
Income (loss) before minority interest,
provision for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle............................ 6,062 (1,337) 4,725
Minority interest......................... (156) -- (156)
-------- ------- --------
Income (loss) before provision for
income taxes, extraordinary item and
cumulative effect of change in
accounting principle................. 5,906 (1,337) 4,569
Provision for income taxes................ 3,305 -- 3,305
-------- ------- --------
Income (loss) from continuing
operations(3)........................ $ 2,601 $(1,337) $ 1,264
======== ======= ========
Basic earnings per share from continuing
operations(3)........................... $ 0.19 $ 0.09
======== ========
Basic weighted average shares
outstanding............................. 14,007 744(1) 14,751(2)
======== ========
Diluted earnings per share from continuing
operations(3)........................... $ 0.18 $ 0.08
======== ========
Diluted weighted average shares
outstanding............................. 14,799 761(1) 15,560(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
F-80
<PAGE> 85
(2) The following is a reconciliation of the numerator and denominator for
basic and diluted earnings per share for the year ended December 31, 1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ -------
<S> <C> <C>
Basic earnings per share.................................... $1,264 14,751
Effect of dilutive securities:
Options................................................... -- 255
Restricted stock.......................................... -- 443
Warrants.................................................. -- 97
Convertible note payable.................................. -- 14
------ -------
Diluted earnings per share.................................. $1,264 15,560
====== =======
</TABLE>
(3) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. In addition, during the
fourth quarter of 1997, Kroll-O'Gara changed its method of accounting for
costs incurred in connection with business process reengineering activities
relating to information technology transformation and recorded a cumulative
effect of change in accounting principle of $360, net of a benefit for
income taxes of $240. The pro forma basic and diluted earnings per share
impact of the extraordinary item was $0.01 and the pro forma basic and
diluted earnings per share impact of the cumulative effect of change in
accounting principle was $0.02 for the year ended December 31, 1997.
F-81
<PAGE> 86
KROLL-O'GARA SUPPLEMENTAL AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1997
-------------------------------------------------------
SUPPLEMENTAL BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales................................ $147,880 $ 3,076 $150,956
Cost of sales............................ 98,803 2,555 101,358
-------- --------- --------
Gross profit........................ 49,077 521 49,598
Selling, general and administrative
expenses, including amortization....... 33,459 1,568 35,027
-------- --------- --------
Operating income (loss)............. 15,618 (1,047) 14,571
Interest expense......................... (3,563) (79) (3,642)
Interest income.......................... 297 52 349
Other income (expense), net.............. (225) 14 (211)
-------- --------- --------
Income (loss) before minority interest,
provision for income taxes and
extraordinary item.................. 12,127 (1,060) 11,067
Minority interest........................ (118) -- (118)
-------- --------- --------
Income (loss) before provision for
income taxes and extraordinary
item................................ 12,009 (1,060) 10,949
Provision for income taxes............... 4,809 -- 4,809
-------- --------- --------
Income (loss) from continuing
operations(3)....................... $ 7,200 $ (1,060) $ 6,140
======== ========= ========
Basic earnings per share from continuing
operations(3).......................... $ 0.52 $ 0.42
======== ========
Basic weighted average shares
outstanding............................ 13,929 697(1) 14,626(2)
======== ========
Diluted earnings per share from
continuing operations(3)............... $ 0.47 $ 0.38
======== ========
Diluted weighted average shares
outstanding............................ 14,808 708(1) 15,516(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
F-82
<PAGE> 87
(2) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share.................................... $6,140 14,626
Effect of dilutive securities:
Options................................................... -- 207
Restricted stock.......................................... (227) 585
Warrants.................................................. -- 79
Convertible note payable.................................. -- 19
------ ------
Diluted earnings per share................................ $5,913 15,516
====== ======
</TABLE>
(3) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. The pro forma basic and
diluted earnings per share impact of the extraordinary item was $0.01 for
the nine months ended September 30, 1997.
F-83
<PAGE> 88
KROLL-O'GARA SUPPLEMENTAL AND BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
NINE MONTHS ENDED SEPTEMBER 30, 1998
-------------------------------------------------------
SUPPLEMENTAL BACKGROUND PRO FORMA
KROLL-O'GARA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- ----------- ---------
<S> <C> <C> <C> <C>
Net sales................................ $194,562 $5,028 $199,590
Cost of sales............................ 128,123 3,360 131,483
-------- ------ --------
Gross profit........................ 66,439 1,668 68,107
Selling, general and administrative
expenses, including amortization....... 42,434 2,469 44,903
-------- ------ --------
Operating income (loss)............. 24,005 (801) 23,204
Interest expense......................... (3,512) (9) (3,521)
Interest income.......................... 930 76 1,006
Other income (expense), net.............. (133) 17 (116)
-------- ------ --------
Income (loss) before provision for
income taxes........................ 21,290 (717) 20,573
Provision for income taxes............... 8,652 -- 8,652
-------- ------ --------
Net income (loss) from continuing
operations.......................... $ 12,638 $ (717) $ 11,921
======== ====== ========
Basic earnings per share from continuing
operations............................. $ 0.71 $ 0.64
======== ========
Basic weighted average shares
outstanding............................ 17,845 898(1) 18,743(2)
======== ========
Diluted earnings per share from
continuing operations.................. $ 0.69 $ 0.62
======== ========
Diluted weighted average shares
outstanding............................ 18,371 940(1) 19,311(2)
======== ========
</TABLE>
- ---------------
(1) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(2) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1998:
<TABLE>
<CAPTION>
INCOME SHARES
------- ------
<S> <C> <C>
Basic earnings per share.................................... $11,921 18,743
Effect of dilutive securities:
Options................................................... -- 551
Warrants.................................................. -- 17
Convertible note payable.................................. -- --
------- ------
Diluted earnings per share.................................. $11,921 19,311
======= ======
</TABLE>
F-84
<PAGE> 89
KROLL-O'GARA SUPPLEMENTAL AND KIZOREK UNAUDITED PRO FORMA AND
BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
FOR THE YEAR ENDED DECEMBER 31, 1997
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SUPPLEMENTAL
SUPPLEMENTAL PRO FORMA KROLL-O'GARA BACKGROUND PRO FORMA
KROLL-O'GARA KIZOREK(1) ADJUSTMENTS(2) PRO FORMA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- -------------- ------------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales.................... $206,103 $14,476 $220,579 $ 4,221 $224,800
Cost of sales................ 139,766 8,113 147,879 3,448 151,327
-------- ------- ------ -------- ------- --------
Gross profit............. 66,337 6,363 72,700 773 73,473
Selling, general and
administrative expenses,
including amortization..... 47,646 5,111 340(3) 53,097 2,178 55,275
Merger related costs......... 7,205 -- 7,205 -- 7,205
-------- ------- ------ -------- ------- --------
Operating income
(loss)................. 11,486 1,252 (340) 12,398 (1,405) 10,993
Interest expense............. (5,092) (20) (69)(4) (5,181) (84) (5,265)
Interest income.............. 79 -- 79 93 172
Other income (expense),
net........................ (411) -- (411) 59 (352)
-------- ------- ------ -------- ------- --------
Income (loss) before
minority interest,
provision for income
taxes, extraordinary item
and cumulative effect of
change in accounting
principle................ 6,062 1,232 (409) 6,885 (1,337) 5,548
Minority interest............ (156) -- (156) -- (156)
-------- ------- ------ -------- ------- --------
Income (loss) before
provision for income
taxes, extraordinary item
and cumulative effect of
change in accounting
principle................ 5,906 1,232 (409) 6,729 (1,337) 5,392
Provision for income taxes... 3,305 -- 329(5) 3,634 -- 3,634
-------- ------- ------ -------- ------- --------
Income (loss) from
continuing
operations(9)............ $ 2,601 $ 1,232 $ (738) $ 3,095 $(1,337) $ 1,758
======== ======= ====== ======== ======= ========
Basic earnings per share from
continuing operations(9)... $ 0.19 $ 0.22 $ 0.12
======== ======== ========
Basic weighted average shares
outstanding................ 14,007 352(6) 14,359 744(7) 15,103(8)
======== ======== ========
Diluted earnings per share
from continuing
operations(9).............. $ 0.18 $ 0.20 $ 0.11
======== ======== ========
Diluted weighted average
shares outstanding......... 14,799 352(6) 15,151 761(7) 15,912(8)
======== ======== ========
</TABLE>
- ---------------
(1) To include historical results of operations for Kizorek for the year ended
October 31, 1997. Kizorek's operating costs have been allocated into
categories consistent with the Company's statement of operations
presentation policies.
(2) Pro forma adjustments exclude the impact of compensation expense for a
non-recurring charge under the Kizorek deferred compensation plan
associated with the accelerated vesting of benefits resulting from a change
in control of the company.
(3) Pro forma adjustments are comprised of the following components:
amortization of goodwill resulting from the acquisition of Kizorek (gross
cost of $6,772 over 25 years), amortization of capitalized acquisition
costs associated with Kizorek ($545 over 25 years) and amortization of
customer lists and detective licenses identified in conjunction with the
acquisition ($700 over 15 years).
(4) To record interest expense under Kizorek deferred compensation plan ($1,350
at 5.125%).
F-85
<PAGE> 90
(5) To recognize the benefit for income taxes on pro forma adjustments and the
provision for income taxes on the historical results of Kizorek, which had
been previously treated as an S Corporation for income tax purposes. An
effective rate of 40% was used to determine the pro forma income tax
impact.
(6) These amounts represent the number of Kroll-O'Gara common shares issued to
Kizorek shareholders for the purchase of Kizorek. Kizorek does not have any
common stock equivalents which would cause further dilution to earnings per
share.
(7) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(8) The following is a reconciliation of the numerator and denominator for
basic and diluted earnings per share for the year ended December 31, 1997:
<TABLE>
<CAPTION>
INCOME SHARES
------ ------
<S> <C> <C>
Basic earnings per share.................................... $1,758 15,103
Effect of dilutive securities:
Options................................................... -- 255
Restricted stock.......................................... -- 443
Warrants.................................................. -- 97
Convertible note payable.................................. -- 14
------ ------
Diluted earnings per share.................................. $1,758 15,912
====== ======
</TABLE>
(9) During the second quarter of 1997, Kroll-O'Gara recorded an extraordinary
charge of $194, net of a benefit for income taxes of $129, related to the
refinancing of certain debt obligations in 1997. In addition, during the
fourth quarter of 1997, Kroll-O'Gara changed its method of accounting for
costs incurred in connection with business process reengineering activities
relating to information technology transformation and recorded a cumulative
effect of change in accounting principle of $360, net of a benefit for
income taxes of $240. The pro forma basic and diluted earnings per share
impact of the extraordinary item was $0.01 and the pro forma basic and
diluted earnings per share impact of the cumulative effect of change in
accounting principle was $0.02 for the year ended December 31, 1997.
F-86
<PAGE> 91
KROLL-O'GARA SUPPLEMENTAL AND KIZOREK UNAUDITED PRO FORMA AND
BACKGROUND AMERICA
UNAUDITED PRO FORMA COMBINING CONDENSED STATEMENTS OF OPERATIONS
FOR THE NINE MONTHS ENDED SEPTEMBER 30, 1998
(AMOUNTS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
SUPPLEMENTAL
SUPPLEMENTAL PRO FORMA KROLL-O'GARA BACKGROUND PRO FORMA
KROLL-O'GARA KIZOREK(1) ADJUSTMENTS(2) PRO FORMA AMERICA ADJUSTMENTS PRO FORMA
------------- ---------- -------------- ------------- ---------- ----------- ---------
<S> <C> <C> <C> <C> <C> <C> <C>
Net sales................ $194,562 $ 6,385 $200,947 $5,028 $205,975
Cost of sales............ 128,123 3,911 132,034 3,360 135,394
-------- --------- -------- -------- ------ --------
Gross profit......... 66,439 2,474 68,913 1,668 70,581
Selling, general and
administrative
expenses, including
amortization........... 42,434 2,411 169(3) 45,014 2,469 47,483
-------- --------- -------- -------- ------ --------
Operating income
(loss)............. 24,005 63 (169) 23,899 (801) 23,098
Interest expense......... (3,512) -- (35)(4) (3,547) (9) (3,556)
Interest income.......... 930 -- 930 76 1,006
Other income (expense),
net.................... (133) -- (133) 17 (116)
-------- --------- -------- -------- ------ --------
Income (loss) before
provision (benefit)
for income taxes..... 21,290 63 (204) 21,149 (717) 20,432
Provision (benefit) for
income taxes........... 8,652 -- (57)(5) 8,595 -- 8,595
-------- --------- -------- -------- ------ --------
Net income (loss)
from continuing
operations......... $ 12,638 $ 63 $ (147) $ 12,554 $ (717) $ 11,837
======== ========= ======== ======== ====== ========
Basic earnings per share
from continuing
operations............. $ 0.71 $ 0.70 $ 0.63
======== ======== ========
Basic weighted average
shares outstanding..... 17,845 17,845 898(6) 18,743(7)
======== ======== ========
Diluted earnings per
share from continuing
operations............. $ 0.69 $ 0.68 $ 0.61
======== ======== ========
Diluted weighted average
shares outstanding..... 18,371 18,371 940(6) 19,311(7)
======== ======== ========
</TABLE>
- ---------------
(1) To include historical results of operations for Kizorek for the six months
ended April 30, 1998. Kizorek's operating costs have been allocated into
categories consistent with the Company's statement of operations
presentation policies. Kizorek's results of operations from July 1, 1998
through September 30, 1998 are included in the consolidated results of
operations of Kroll-O'Gara.
(2) Pro forma adjustments exclude the impact of compensation expense for a
non-recurring charge under the Kizorek deferred compensation plan associated
with the accelerated vesting of benefits resulting from a change in control
of the company.
(3) Pro forma adjustments are comprised of the following components:
amortization of goodwill resulting from the acquisition of Kizorek (gross
cost of $6,772 over 25 years), amortization of capitalized acquisition costs
associated with Kizorek ($545 over 25 years) and amortization of customer
lists and detective licenses identified in conjunction with the acquisition
($700 over 15 years).
(4) To record interest expense under Kizorek deferred compensation plan ($1,350
at 5.125%).
F-87
<PAGE> 92
(5) To recognize the benefit for income taxes on pro forma adjustments and the
provision for income taxes on the historical results of Kizorek, which had
been previously treated as an S Corporation for income tax purposes. An
effective rate of 40% was used to determine the pro forma income tax impact.
(6) These amounts adjust the historical weighted average shares outstanding to
reflect the conversion of Background America common stock and equivalents
into Kroll-O'Gara common stock and equivalents based on the fixed exchange
ratio of .2689628 Kroll-O'Gara shares for every outstanding share of
Background America common and preferred stock on a weighted average basis.
(7) The following is a reconciliation of the numerator and denominator for basic
and diluted earnings per share for the nine months ended September 30, 1998:
<TABLE>
<CAPTION>
INCOME SHARES
------- ------
<S> <C> <C>
Basic earnings per share.................................... $11,837 18,743
Effect of dilutive securities:
Options................................................... -- 550
Warrants.................................................. -- 18
------- ------
Diluted earnings per share.................................. $11,837 19,311
======= ======
</TABLE>
F-88
<PAGE> 1
Exhibit 99.1
THE KROLL-O'GARA COMPANY
MANAGEMENT'S DISCUSSIONS AND ANALYSES OF FINANCIAL CONDITION AND RESULTS OF
OPERATIONS
Two Management's Discussions and Analyses are set forth in this section.
The first, beginning on this page, is based upon Kroll-O'Gara's historical
Consolidated Financial Statements and Notes. This information has not been
restated or adjusted to give effect to transactions which occurred after it was
prepared. The second is based upon Kroll-O'Gara's Supplemental Consolidated
Financial Statements. During 1998, Kroll-O'Gara acquired several companies in
transactions which were accounted for as poolings of interests. The Supplemental
Consolidated Financial Statements restate Kroll-O'Gara's historical Consolidated
Financial Statements to present financial information as if these acquired
companies had been a part of Kroll-O'Gara for the periods covered.
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. Historically, Kroll-O'Gara reported its revenue through three
groups. The Security Products and Services Group markets ballistic and blast
protected vehicles to businesses, individuals, and governments. It also offers
security services such as training, risk and crisis management services, and
site security systems. The Investigations and Intelligence Group offers business
intelligence and investigation services to clients worldwide. The Voice and Data
Communications Group offers secure satellite communication equipment and
satellite navigation systems. With the acquisition of Securify Inc.,
Kroll-O'Gara established a new Information Security Group.
On May 5, 1998, Kroll-O'Gara completed a public 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 pay off
$14.8 million of the indebtedness of Kroll-O'Gara, 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. ("KHI")
was completed on December 1, 1997. In the KHI merger, 6,098,561 shares of Common
Stock were issued and an aggregate of $14.5 million in outstanding indebtedness
of KHI was repaid. Approximately 550,000 additional shares of Kroll-O'Gara
common stock were reserved for issuance upon the exercise of options held by KHI
employees, which were assumed by Kroll-O'Gara. Revenues of KHI comprise all of
those reported by the Investigations and Intelligence Group as well as certain
revenues in the other two Groups.
Acquisitions -- 1997. On February 5, 1997, Kroll-O'Gara completed the
acquisition of all of the shares of Next Destination, Ltd of Salisbury, the
United Kingdom, a distributor of high technology products for the global
positioning satellite and satellite communication markets. The purchase price
consisted of 170,234 shares of Kroll-O'Gara common stock (valued at
approximately $1.9 million or $10.88 per share) and $1.6 million in
seller-provided financing, in the form of secured, three-year 6% notes. Next
Destination, which had been selling the portable satellite terminal offered by
Kroll-O'Gara, reports revenue through the Voice and Data Communications Group.
For accounting purposes, the acquisition was effective February 1, 1997, and the
results of operations of Next Destination are included in the consolidated
results of operations of Kroll-O'Gara from that date forward.
On February 12, 1997, Kroll-O'Gara completed the acquisition of all of the
shares of Labbe, S.A. a leading armorer of commercial and private vehicles
headquartered in Lamballe, France. The purchase price consisted of $10.7 million
in cash and 376,597 shares of Kroll-O'Gara common stock (valued at approximately
$3.5 million or $9.29 per share). The acquisition of Labbe increased
substantially the level of commercial revenue generated by the Security Products
and Services Group and enhanced Kroll-O'Gara's competitive position due to an
expanded product line, which includes cash-in-transit vehicles, and penetration
into new markets, such as Europe
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and Africa. For accounting purposes, the acquisition was effective January 1,
1997, and the results of operations of Labbe are included in the consolidated
results of operations of Kroll-O'Gara from that date forward.
On March 24, 1997, Kroll-O'Gara completed the acquisition of all the shares
of International Training, Inc., a provider of advanced security training
headquartered near Washington, D.C. The purchase price consisted of $0.5 million
in cash, 68,086 shares of Kroll-O'Gara common stock (valued at approximately
$0.8 million or $11.89 per share) and $1.2 million in seller-provided financing
in the form of unsecured, two-year 10% notes. ITI, which reports revenue through
the Security Products and Services Group, added a number of new services, such
as evasive and defensive driver training, terrorist surveillance training, force
protection consulting and advanced weapons training, not previously available
from Kroll-O'Gara. For accounting purposes, the acquisition was effective March
1, 1997, and the results of operations of ITI are included in the consolidated
results of operations of Kroll-O'Gara from that date forward.
Effective December 2, 1997, Kroll-O'Gara acquired all of the shares of ZAO
IMEA, as well as certain work in process of, and an agreement not to compete in
Russia by, Acorn Communications Group, Inc. IMEA and Acorn had substantially
common ownership prior to the acquisition. The purchase price of $3.0 million
consisted of $0.6 million in cash and 138,889 shares of Kroll-O'Gara common
stock (valued at approximately $2.4 million or $18.00 per share). IMEA is
engaged in the business of selling cash-in-transit vehicles and other commercial
bank equipment, such as safes, money counters and counterfeit detectors,
throughout Russia; it reports revenue through the Security Products and Services
Group. For accounting purposes, the acquisition was effective December 1, 1997,
and the results of operations of IMEA are included in the consolidated results
of operations of Kroll-O'Gara from that date forward.
Acquisitions -- 1998. On March 16, 1998, Kroll-O'Gara acquired all of the
shares of Corplex, Inc., a provider of investigative and executive protection
services based in New York, New York. The purchase price consisted of 29,207
shares of Kroll-O'Gara common stock (valued at approximately $0.5 million or
$17.98 per share). Corplex, which reports revenue through the Investigations and
Intelligence Group, allows Kroll-O'Gara to streamline its use of subcontract
investigators in the New York metropolitan area and to offer certain new
products, such as executive protection and electronic countermeasure expertise,
that are natural extensions of existing service areas. For accounting purposes,
the acquisition was effective March 1, 1998, and the results of operations of
Corplex are included in the consolidated results of operations of Kroll-O'Gara
from that date forward.
On June 15, 1998, Kroll-O'Gara acquired all of the capital stock of
Lindquist Avey MacDonald Baskerville, Inc., a provider of forensic and
investigative accounting services headquartered in Toronto, Canada. The purchase
price consisted of $4.7 million in cash and 278,340 shares of Kroll-O'Gara
common stock (valued at approximately $6.0 million or $21.52 per share). The
acquisition of Lindquist Avey expands Kroll-O'Gara's forensic and investigative
accounting service product line and establishes Kroll-O'Gara in a new geographic
market. For accounting purposes, the acquisition was effective June 1, 1998, and
the results of operations of Lindquist Avey are included in the consolidated
results of operations of Kroll-O'Gara from that date forward. Lindquist Avey
reports revenue through the Investigations and Intelligence Group.
On September 1, 1998, Kroll-O'Gara acquired all of the capital stock of
Kizorek, Inc. of Naperville, Illinois, now renamed InPhoto Surveillance, Inc.
The purchase price consisted of $0.8 million in cash and 352,381 shares of
Kroll-O'Gara common stock (valued at approximately $8.2 million or $23.35 per
share). InPhoto is a leading claims investigation agency which primarily
provides video surveillance services to insurance companies, corporations and
government agencies in connection with investigating exaggerated disability
claims and other fraud. It reports revenue through the Investigations and
Intelligence Group. For accounting purposes, the acquisition was effective July
1, 1998, and the results of operations of InPhoto are included in the
consolidated results of operations of Kroll-O'Gara from that date forward.
On September 22, 1998, O'Gara-Hess & Eisenhardt de Colombia, a wholly owned
subsidiary of Kroll-O'Gara, acquired all of the assets of Protec S.A. of Bogota,
Colombia. Protec was engaged in the business of armoring cars in Colombia, South
America, and also operated a facility for the manufacture of bullet-and smash-
resistant glass for its own use and for sale to third parties. The purchase
price consisted of $3.2 million in cash and 38,788 shares of Kroll-O'Gara common
stock (valued at approximately $0.9 million or $22.95 per share).
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<PAGE> 3
OHE de Colombia will report revenue through the Security Products and Services
Group. For accounting purposes, the acquisition was effective September 30,
1998, and the results of operations of OHE de Colombia will be included in the
consolidated results of operations of Kroll-O'Gara from that date forward.
On November 18, 1998, Kroll-O'Gara entered into a definitive agreement to
acquire all of the capital stock of Holder Associates, S.A. of Buenos Aires,
Argentina, for a purchase price of $6.0 million, payable $4.5 million in cash
and $1.5 million in Kroll-O'Gara common stock. Holder Associates provides
investigative, security consulting and litigation support services, as well as
special escort and general protective services, primarily in Argentina. The
transaction has been completed, pending receipt of approval from the Argentine
Federal Police and the City of Buenos Aires, and was deemed effective October 1,
1998. Holder Associates reports revenue through Kroll-O'Gara's Investigations
and Intelligence Group.
On December 7, 1998, Kroll-O'Gara acquired all of the capital stock of
Laboratory Specialists of America, Inc. Laboratory Specialists owns and operates
an independent drug testing laboratory which is certified by the federal
Substance Abuse and Mental Health Services Administration and provides pre- and
post-employment drug testing services to corporate and institutional customers.
Kroll-O'Gara issued approximately 1,209,000 shares of Kroll-O'Gara common stock
(valued at approximately $35.7 million or $29.54 per share) in the transaction
and assumed options and warrants to issue an additional 63,480 shares of
Kroll-O'Gara common stock. The transaction has been accounted for as a pooling
of interests. Laboratory Specialists reports revenue through the Investigations
and Intelligence Group.
Laboratory Specialists completed several acquisitions prior to its
acquisition by Kroll-O'Gara. On January 2, 1996, Laboratory Specialists
completed the acquisition of National Psychopharmacology Laboratory, Inc. for
$3.4 million in common stock, cash, promissory notes and real estate. National
Psychopharmacology was engaged in forensic drug testing and clinical testing and
analysis. Laboratory Specialists consolidated and assimilated the forensic drug
testing operations of National Psychopharmacology with its own during the first
quarter of 1996. Laboratory Specialists discontinued the clinical testing and
analysis operations of National Psychopharmacology during the fourth quarter of
1996 after several attempts to dispose of the clinical testing and analysis
operations.
On January 31, 1997, Laboratory Specialists paid approximately $2.4 million
to Pathology Laboratories, Ltd. for its customer list and all related assets,
and all assets owned by Pathology Laboratories in connection with its
Greenville, South Carolina laboratory. The purchase price consisted of cash,
debt and the assumption of certain obligations of Pathology Laboratories.
In addition, in 1997 and 1998 Laboratory Specialists paid approximately
$3.3 million to acquire customer lists and intangible assets from Harrison
Laboratories, Inc., Accu-Path Medical Laboratory, Inc. and TOXWORX Laboratories,
Inc. The purchase price for all customer lists and intangible assets were
recorded as intangible assets by Laboratory Specialists and will be amortized
over 15 years.
On December 18, 1998, Kroll-O'Gara acquired Fact Finders Limited of Hong
Kong and an affiliated company for a purchase price, payable in cash, of
approximately $3.2 million, plus an earn-out over three years based upon
attaining specified profits. Fact Finders' primary line of business is
investigating intellectual property cases in Hong Kong and the Peoples Republic
of China. Fact Finders will report revenue through the Investigations and
Intelligence Group. For accounting purposes, the acquisition was effective
November 1, 1998, and the results of operations of Fact Finders will be included
in the consolidated results of operations of Kroll-O'Gara from that date
forward.
On December 31, 1998, Kroll-O'Gara acquired all of the capital stock of
Securify Inc. of Mountain View, California. Securify provides comprehensive
security services in the areas of e-commerce and business and government
applications. Kroll-O'Gara issued 1,430,936 shares of Kroll-O'Gara common stock
(valued at approximately $52.7 million or $36.85 per share) in the transaction
and assumed options to purchase an additional 179,877 shares of Kroll-O'Gara
common stock. The transaction has been accounted for as a pooling of interests.
Securify reports revenue through Kroll-O'Gara's new Information Security Group.
Also on December 31, 1998, Kroll-O'Gara acquired all of the capital stock
of Schiff & Associates, Inc. of Austin, Texas, in exchange for 169,521 shares of
Kroll-O'Gara common stock (valued at approximately
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<PAGE> 4
$6.2 million or $36.85 per share). This acquisition also has been accounted for
as a pooling of interests. Schiff & Associates provides integrated security
consulting and engineering solutions to corporations, governments, architects,
owners and developers for projects in North America, Europe and Asia. It reports
revenue through the Investigations and Intelligence Group.
Acquisitions -- 1999. 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 $ million or $ 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 Kroll-O'Gara's Investigations 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 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 would recognize a credit or a charge against current
earnings, which could be material. Contract costs include all direct material
and labor costs, along with certain overhead costs allocated 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 such
losses will occur. Changes in estimated total contract costs will 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.
Kroll-O'Gara recognizes revenue related to telecommunications equipment and
services as equipment is shipped or as services are provided. It records revenue
and related direct costs of brokered satellite time when payments are received
from customers.
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<PAGE> 5
RESULTS OF OPERATIONS -- HISTORICAL
The following discussion of results of operations and financial condition
is based upon and should be read in conjunction with Kroll-O'Gara's historical
Consolidated Financial Statements and Notes. As a result of acquisitions made by
Kroll-O'Gara in 1996, 1997 and 1998, which were accounted for as purchases,
financial results from period-to-period may lack comparability.
The following table sets forth, for the periods indicated, the items noted
as a percentage of net sales:
<TABLE>
<CAPTION>
FOR THE NINE
MONTHS ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- --------------
1995 1996 1997 1997 1998
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Security products and services
Military......................................... 17.4% 35.5% 23.0% 21.8% 24.7%
Commercial....................................... 23.2 16.0 32.5 31.7 31.6
Intelligence and investigations.................... 57.0 43.4 35.4 36.8 35.4
Voice and data communications...................... 2.4 5.1 9.1 9.7 8.3
----- ----- ----- ----- -----
Total net sales............................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales...................................... 72.4 72.5 69.1 68.1 67.1
----- ----- ----- ----- -----
Gross profit.................................. 27.6 27.5 30.9 31.9 32.9
Operating expenses
Selling and marketing............................ 11.0 6.4 7.5 7.1 6.8
General and administrative and amortization...... 22.0 15.6 14.8 14.7 13.8
Merger related costs............................. -- -- 3.8 -- --
----- ----- ----- ----- -----
Operating income (loss)............................ (5.4) 5.5 4.7 10.0 12.3
Other income (expense)
Interest expense................................. (3.3) (2.0) (2.5) (2.5) (1.9)
Other, net....................................... (0.4) 0.2 (0.2) (0.0) 0.3
----- ----- ----- ----- -----
Income (loss) before minority interest, provision
(benefit) for income taxes, extraordinary item
and cumulative effect of change in accounting
principle........................................ (9.1) 3.7 2.0 7.6 10.7
Minority interest.................................. -- -- 0.1 0.1 --
----- ----- ----- ----- -----
Income (loss) before provision (benefit) for income
taxes, extraordinary item and cumulative effect
of change in accounting principle................ (9.1) 3.7 1.9 7.5 10.7
Provision (benefit) for income taxes............. (1.5) (0.1) 1.2 3.0 4.3
----- ----- ----- ----- -----
Income (loss) before extraordinary item and
cumulative effect of change in accounting
principle........................................ (7.6) 3.8 0.7 4.5 6.5
Extraordinary item, net............................ -- -- (0.1) (0.1) --
----- ----- ----- ----- -----
Income (loss) before cumulative effect of change in
accounting principle............................. (7.6) 3.8 0.6 4.4 6.5
----- ----- ----- ----- -----
Cumulative effect of change in accounting
principle........................................ -- -- (0.2) -- --
----- ----- ----- ----- -----
Net income (loss).................................. (7.6)% 3.8% 0.4% 4.4% 6.5%
===== ===== ===== ===== =====
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1997 COMPARED TO NINE MONTHS ENDED SEPTEMBER 30,
1998
NET SALES. Net sales for the nine months ended September 30 increased
$42.6 million, or 31%, to $178.9 million in 1998 from $136.4 million in the same
period in 1997.
Security Products and Services Group. For the nine months ended September
30, net sales for the Security Products and Services Group increased $27.8
million, or 38%, from $73.0 million in 1997 to $100.8 million in 1998. The
increase included net sales of commercial armoring products and services, which
increased $13.5 million, or 31%, from $43.2 million for the nine months ended
September 30, 1997 to $56.6 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
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<PAGE> 6
and the Philippines, and acquired Labbe and IMEA and the assets of Protec.
Kroll-O'Gara will continue in its efforts to expand the operations of its
existing foreign subsidiaries along with evaluating new acquisition
opportunities and additional new markets.
Increases in net sales for security services contributed to the increase in
net sales for commercial products and services contained within the Security
Products and Services Group. Net sales increased $1.0 million, or 18%, for the
nine months ended September 30, 1998 in comparison with 1997.
Also included in net sales for the Security Products and Services Group are
sales of military products and services, which increased $14.4 million, or 48%,
from $29.8 million for the nine months ended September 30, 1997 to $44.2 million
in 1998. In April 1998, Kroll-O'Gara began work on a new contract with the U.S.
Military to supply 738 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 HMMWV's (the "360 CONTRACT") continued through
July 1998. The combination of production on the two contracts was a factor in
the increase in net sales. In future periods, HMMWV production will be based
solely on the 738 Contract.
Based on certain internal requirements, the U.S. Air Force has dictated an
aggressive delivery schedule for the 738 Contract. This delivery schedule will
require Kroll-O'Gara to maintain an increased level of production for the
Up-Armored HMMWV in comparison with production levels in previous periods. This
increase in production will result in an increase in net sales of military
products over levels experienced in 1997 and the first quarter of 1998.
Management expects to maintain the increased level of production throughout the
balance of 1998, with decreases in production and net sales as the 738 Contract
nears completion in 1999.
Investigations and Intelligence Group. For the nine months ended September
30, net sales for the Investigations and Intelligence Group increased $13.1
million, or 26%, from $50.2 million in 1997 to $63.3 million in 1998. The
increases in 1998 were primarily due to the inclusion of net sales from the
acquisition of Lindquist Avey, InPhoto and Corplex. Excluding net sales reported
by these acquired entities, net sales for the Investigations and Intelligence
Group would have been $54.3 million for the nine months ended September 30,
1998, in comparison with $50.2 million for the nine months ended September 30,
1997, an increase of 8%.
Voice and Data Communications Group. For the nine months ended September
30, net sales for the Voice and Data Communications Group increased $1.6
million, or 12%, from $13.2 million in 1997 to $14.8 million in 1998. Late in
the second quarter of 1998 and throughout a majority of the third quarter,
Kroll-O'Gara was approached by a third party interested in purchasing the Voice
and Data Communications Group. The Group's management during this time period
was focused on negotiations, due diligence requests, and related demands on
their time. The diversion resulted in a decrease in net sales in the third
quarter of 1998. Due to several factors, the potential buyer decided not to
complete the transaction, and all discussions have been abandoned. Kroll-O'Gara
does not expect to incur any material charges associated with these discussions.
Management expects that the fourth quarter results from the Voice and Data
Communications Group will return to the levels experienced in the first half of
1998.
COST OF SALES. For the nine months ended September 30, cost of sales
increased $27.2 million, or 29%, from $92.9 million in 1997 to $120.1 million in
1998. The increase in cost of sales was due to the increased level of business
activity experienced in 1998. For the nine months ended September 30, gross
profit as a percent of net sales was 32.9% and 31.9% for 1998 and 1997,
respectively.
Kroll-O'Gara has historically experienced its highest level of gross profit
as a percent of net sales in the Investigations and Intelligence Group and its
lowest level in the Voice and Data Communications Group. Gross profit as a
percentage of net sales for the Investigations and Intelligence Group increased
approximately 5% (from approximately 39% in 1997 to 44% in 1998) for the nine
months ended September 30, 1998. This increase was primarily due to a more
efficient use of subcontract services and certain high margin engagements booked
in the third quarter which are historically infrequent in nature.
Because these engagements 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. As always, the
gross profit percent will vary on the mix of sales from the three groups. As
revenue from the
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<PAGE> 7
Investigations and Intelligence Group increases as a percent of total net sales,
the gross profit percent should increase as well.
OPERATING EXPENSES. For the nine months ended September 30, 1998,
operating expenses increased $7.1 million, or 24%, to $36.9 million from $29.8
million for the same period in 1997. The increase was attributable primarily to
an increase in the level of personnel and professional services required to
administer the growth experienced by Kroll-O'Gara in 1997 and 1998.
As a percent of net sales, operating expenses for the nine months ended
September 30 decreased from 22% in 1997 to 21% 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 an additional commitment of fixed cost to
achieve growth in 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. For the nine months ended September 30, interest expense
decreased from $3.4 million in 1997 to $3.3 million in 1998, a decrease of 2%.
With the completion of the May 1998 offering, a significant portion of
Kroll-O'Gara's indebtedness was paid off (approximately $14.8 million). As a
result, Kroll-O'Gara experienced lower interest expense in the third quarter of
1998 and expects interest expense to be lower in comparison with 1997 for the
remainder of 1998.
Additionally, the agreement governing Kroll-O'Gara's Senior Notes (see
"Liquidity and Capital Resources") contained a provision for a reduction of the
interest rate if certain criteria were met. Kroll-O'Gara complied with the
specified criteria and the reduction 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. For the nine months ended September 30, interest income
increased from $0.3 million in 1997 to $0.8 million in 1998, an increase of
193%. Net proceeds of the May 1998 offering that were not used to pay down 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
1998 in comparison with 1997.
PROVISION FOR INCOME TAXES. For the nine months ended September 30, the
provision for taxes was $7.6 million and $4.0 million in 1998 and 1997,
respectively. The effective tax rate for the first three quarters of 1998 and
1997 was 40%.
YEARS ENDED DECEMBER 31, 1995, 1996 AND 1997
1997 COMPARED TO 1996
NET SALES. Net sales increased $36.7 million, or 24%, from $153.7 million
in 1996 to $190.4 million in 1997. The primary reasons for this increase were
the acquisitions made in Kroll-O'Gara's Security Products and Services Group and
Voice and Data Communications 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 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 ITI in the Group's 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, a trend management believes will continue for the
foreseeable future. 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. Kroll-O'Gara will continue
to seek out new acquisition opportunities and additional new markets for its
security products and services.
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<PAGE> 8
In 1996, the U.S. Military requested accelerated production of Up-Armored
HMMWVs. 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.
Management expects net sales from military products to remain at a level
comparable to 1997 for the foreseeable future.
Investigations and Intelligence Group. Net sales of the Investigations and
Intelligence Group in 1997 were derived from the activities of KHI. Throughout
1997, KHI was actively involved in various strategic discussions that
contemplated a sale of the company. Pending the outcome of such discussions, KHI
delayed implementation of its internal growth plans. Furthermore, uncertainties
regarding the outcome of the discussions resulted in the departure of certain
KHI managers prior to the merger with The O'Gara Company. Finally, in connection
with the KHI merger and in an effort to improve its cost structure, Kroll-O'Gara
reduced personnel in certain markets. As a result of these factors, net sales
for the Investigations and Intelligence Group increased only $0.7 million, or
1%, from $66.7 million in 1996 to $67.4 million in 1997. The change in 1997 was
attributable primarily to an increase in net sales from business intelligence
services, which includes due diligence work and services related to corporate
mergers and acquisitions, offset by a decline in net sales from investigations.
During the fourth quarter, the Investigations and Intelligence Group
reactivated its growth plan to open offices in Boston, Mexico City and Dallas
and to pursue related acquisitions. Kroll-O'Gara expects these initiatives will
have a favorable impact on growth of net sales in 1998.
Voice and Data Communications Group. During 1997, Kroll-O'Gara replaced
its primary wholesale distributor, acquired Next Destination, a subdistributor,
and reconfigured its distribution product mix to focus on the sale of satellite
communications equipment in addition to satellite navigation equipment. As a
result, Kroll-O'Gara experienced a growth rate in 1997 approximately five to six
times higher than normal. Net sales for the Voice and Data Communications Group
were $17.4 million in 1997, an increase of $9.7 million, or 124%, from $7.8
million in 1996. Kroll-O'Gara expects growth in this segment to return to a more
normal rate in 1998.
COST OF SALES AND GROSS PROFIT. Cost of sales for 1997 increased $20.2
million, or 18%, from $111.5 million in 1996 to $131.6 million in 1997. The
increase in cost of sales was due to increases in Kroll-O'Gara's level of
business activity as result of the acquisitions made in 1997.
Security Products and Services Group. Gross profit as a percent of net
sales for the Security Products and Services Group increased 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. However, because
Kroll-O'Gara's gross profit percentage was affected favorably by adjustments
resulting from performance on certain contracts in 1997, Kroll-O'Gara does not
expect to maintain the 1997 gross profit percentage level in 1998.
Investigations and Intelligence Group. Gross profit as a percent of net
sales for the Investigations and Intelligence Group increased from 29.4% in 1996
to 38.0% 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.
Voice and Data Communications Group. Prior to the acquisition of Next
Destination, Kroll-O'Gara's Voice and Data Communications Group realized a
higher gross profit percentage due to a higher mix of integrated products versus
distributed products. As a distributor, Next Destination's gross profit
percentages were relatively lower. Gross profit as a percent of net sales for
the Voice and Data Communications Group decreased from 27.6% in 1996 to 17.9% in
1997. Management expects the level of gross profit percentage experienced in
1997 to be maintained in future periods.
OPERATING EXPENSES. Excluding expenses of $7.2 million related to the KHI
merger, operating expenses increased $8.9 million, or 26%, from $33.7 million in
1996 to $42.6 million in 1997. The $7.2 million in expenses related to the KHI
merger consisted of approximately $4.6 million in professional fees and expenses
8
<PAGE> 9
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
certain key employees as incentives to remain with Kroll-O'Gara and severance
payments made to employees who left employment of Kroll-O'Gara in connection
with the merger. Also included was a charge made as result of the acceleration
of the vesting of certain shares of restricted KHI stock immediately prior to
that merger. All of the costs related to the KHI merger were recognized in 1997
and will have no effect on the earnings of Kroll-O'Gara in future periods.
The primary reason for the increase in operating expenses, exclusive of
expenses related to the KHI merger, was the inclusion of operations from the
acquisitions made in 1997. In addition, the increase in operating expenses
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 KHI merger, operating expenses as a percent of
net sales stayed constant at 22% in both 1996 and 1997.
Prior to the KHI merger, KHI was involved in merger discussions with
Choicepoint, Inc., a subsidiary of Equifax, Inc. Choicepoint and KHI did not
reach a final agreement and, as a result, did not consummate the transaction.
Certain professional fees, which totaled approximately $0.5 million, associated
with the Choicepoint transaction are included in Kroll-O'Gara's operating
expenses in 1997.
INTEREST EXPENSE. Interest expense for 1997 increased $1.7 million, or
53%, to $4.8 million, compared to $3.1 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 of the May 1998
offering. As a result, interest expense is expected to be lower in 1998 than in
1997.
OTHER, NET. Other income (expense), net decreased from $0.3 million of
income in 1996 to $0.4 million in expense in 1997. The change was due primarily
to an increase in foreign currency translation losses recognized in 1997.
PROVISION (BENEFIT) FOR INCOME TAXES. The provision (benefit) for income
taxes increased from a benefit of $(0.2) million in 1996 to a provision of $2.4
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 65% in 1997 due to the
non-deductibility of certain expenses related to the KHI merger in the period
and the impact of foreign losses for which no benefit can be provided.
Management believes that the rate is substantially higher than Kroll-O'Gara will
experience in 1998 and for future periods.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Kroll-O'Gara had
previously capitalized costs related to the reengineering of certain information
systems. The capitalized amount, approximately $0.6 million before tax, was
expensed in 1997 in accordance with Emerging Issues Task Force Issue 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.
1996 COMPARED TO 1995
NET SALES. Net sales increased $67.8 million, or 79%, from $85.8 million
in 1995 to $153.7 million in 1996. The primary reasons for this change were the
acceleration of the HMMWV contract and increases in the level of business
activity in the Investigations and Intelligence Group and Voice and Data
Communications Group discussed below.
Security Products and Services Group. Net sales for the Security Products
and Services Group increased $44.3 million, or 127%, from $34.9 million in 1995
to $79.2 million in 1996. 1996 net sales reflect the U.S. Government's request
to accelerate the production of Up-Armored HMMWVs and HMMWV armor kits. In
addition, the level of military net sales in 1995 was significantly impacted by
an unanticipated six-month delay in
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<PAGE> 10
the delivery of HMMWV chassis from a supplier, leading to production of
substantially fewer Up-Armored HMMWVs.
Commercial revenue for 1996 was $24.6 million, an increase of $4.6 million,
or 23% over 1995. This increase was primarily due to the inclusion of net sales
from start-up operations in Russia, Mexico and Brazil.
Investigations and Intelligence Group. Net sales for the Investigations
and Intelligence Group increased $17.8 million, or 36%, from $48.9 million in
1995 to $66.7 million in 1996. The increase in 1996 was attributable primarily
to an increase in net sales from corporate investigation and business
intelligence services, which increased $12.3 million and $4.0 million,
respectively. These increases were the result of expansion into new geographic
areas and an enhanced marketing program, including a Vendor Integrity Program,
which accounted for approximately $1.0 million of the increase in net sales.
Voice and Data Communications Group. Net sales for the Voice and Data
Communications Group increased $5.7 million, or 280%, from $2.0 million in 1995
to $7.8 million in 1996. The increase in net sales was attributable primarily to
the addition of the Compact-M portable satellite terminal, initially marketed by
Kroll-O'Gara in 1996.
COST OF SALES AND GROSS PROFIT. Cost of sales for 1996 increased $49.3
million, or 79%, from $62.1 million in 1995 to $111.5 million in 1996. The
increase in cost of sales was due to increases in Kroll-O'Gara's level of
business activity.
Security Products and Services Group. Gross profit as a percent of net
sales for the Security Products and Services Group increased from 23.3% in 1995
to 25.8% in 1996. This increase was due to revenue recognized on new military
contracts, both U.S. and foreign, with a higher gross profit percent than
previously experienced. Also contributing to the increase in gross profit as a
percent of sales was the effect of the start-up operations in Brazil, Mexico and
Russia, which experienced higher gross margins for their products than
Kroll-O'Gara had experienced previously. These higher margins were the result of
lower direct costs and less developed competition in the markets where these
start-up operations exist.
Investigations and Intelligence Group. Gross profit as a percent of net
sales decreased from 31.1% in 1995 to 29.4% in 1996. Cost of sales in 1996
included a write-off of $5.0 million in uncollectible accounts receivable
relating to services provided in earlier periods. Without the effect of the
write-off, gross margin as a percent of net sales would have increased 5.8% over
1995 to 36.9%.
Voice and Data Communications Group. Gross profit as a percent of net
sales increased from 20.0% in 1995 to 27.6% in 1996. This increase was due
primarily to new products marketed by Kroll-O'Gara in 1996, that were sold at a
higher gross margin than Kroll-O'Gara had experienced with other products.
OPERATING EXPENSES. Operating expenses in 1996 increased $5.3 million, or
19%, from $28.4 million in 1995 to $33.7 million in 1996. As a percent of net
sales, operating expenses decreased from 33% in 1995 to 22% in 1996, as result
of increases in net sales which did not require a commitment of additional
marketing and administrative resources.
Selling and marketing expenses increased approximately $0.3 million, or 3%,
from $9.4 million in 1995 to $9.7 million in 1996. Certain costs, primarily
personnel and advertising, increased $1.2 million due to Kroll-O'Gara's growth
into its new Brazilian, Mexican and Russian markets. This increase was offset by
a $0.9 million reduction primarily attributable to the use of lower cost
information services for pre-marketing purposes in the Investigations and
Intelligence Group.
General and administrative expenses increased $5.0 million, or 27%, from
$18.9 million in 1995 to $23.9 million in 1996. This increase was attributable
primarily to the addition of professional employees and associated
infrastructure to support Kroll-O'Gara's increased level of business activity.
These increases included the addition of personnel and facilities to support
expansion into new product lines, such as risk and crisis management services,
and new geographic regions, such as Asia and Latin America.
INTEREST EXPENSE. Interest expense increased $0.3 million, or 12%, from
$2.8 million in 1995 to $3.1 million in 1996. The increase was due primarily to
increased borrowings necessary to finance increased
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<PAGE> 11
production levels and new operations in Kroll-O'Gara's Security Products and
Services Group. This increase was offset partially by a reduction in interest
expense paid on long-term debt outstanding to certain shareholders. The amount
outstanding to those shareholders was reduced due to principal payments made in
1996.
OTHER, NET. Other income (expense), net increased $0.7 million, from
$(0.4) million in 1995 to $0.3 million in 1996. This increase was due primarily
to a gain on the sale of marketable securities and a realized foreign currency
transaction gain.
PROVISION (BENEFIT) FOR INCOME TAXES. The provision (benefit) decreased
from a benefit of $1.3 million in 1995 to a benefit of $0.2 million in 1996. The
lower benefit for income taxes in 1996 in comparison with 1995 was related to
KHI's losses before taxes, which were lower in 1996. OHE booked no provision for
income taxes prior to the termination of its S Corporation status in October
1996.
LIQUIDITY AND CAPITAL RESOURCES -- HISTORICAL
General. Kroll-O'Gara historically has met its operating cash needs by
utilizing borrowings under its credit arrangements to supplement cash provided
by operations, excluding non-cash charges such as depreciation and amortization.
Public Offering. A portion of the net proceeds of the May 1998 offering
(approximately $60.4 million) was used to pay off certain indebtedness of
Kroll-O'Gara ($14.8 million). The remaining amounts were invested in short-term
instruments and are being used as necessary for acquisitions, working capital
and other general corporate purposes.
Senior Notes. On May 30, 1997, Kroll-O'Gara issued and sold $35.0 million
worth of Senior Notes, maturing on May 30, 2004, to certain institutional
investors. The Senior Notes bear interest at 8.56% and impose covenant
restrictions on Kroll-O'Gara's operations. These restrictions include
limitations on dividends and priority debt, and constraints on specific
investments, as well as requirements relating to Kroll-O'Gara's net worth, fixed
charge coverage ratio and level of outstanding debt.
Credit Facility. Kroll-O'Gara has a revolving credit facility with KeyBank
National Association, which was entered into in May 1997 and amended in October
1998. This agreement provides for a revolving line of credit of $7.0 million and
a letter of credit facility of approximately $7.7 million. The revolving credit
facility bears interest which fluctuates between the prime rate less 1.75% and
prime less 2.25%, or, at Kroll-O'Gara's option, between the LIBOR rate plus
0.75% and LIBOR plus 1.50%. The Credit Agreement imposes requirements on
Kroll-O'Gara's reported fixed charge coverage ratio, net worth and debt
capitalization, along with certain restrictions on investments, acquisitions,
intangibles and capital expenditures.
As of March 1, 1999, there were no borrowings under the revolving line of
credit. The remaining proceeds from the May 1998 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 foreseeable future.
Kroll-O'Gara will continue to pursue its strategy of acquiring security
related companies in an effort to consolidate its position in the risk
mitigation industry. To that end, Kroll-O'Gara will continue to review
additional sources of working capital as they become necessary.
Cash flows from operating activities. Net cash used in operating
activities was $11.7 million and $4.9 million for the nine months ended
September 30, 1998 and 1997, respectively. Since the inception of Kroll-
O'Gara's contract with the U.S. Government to armor the HMMWV through the second
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 will be determined using a smaller
percentage of total cost committed than they have in the past. Second,
Kroll-O'Gara will only be reimbursed for vendor invoices paid instead of
expenses incurred. Although these changes will not affect the total amount
ultimately collected, they will defer certain amounts previously included as
part of a progress payment until the vehicles are delivered.
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<PAGE> 12
The majority of these adjustments to the way Kroll-O'Gara is reimbursed for
its military business were applied to the HMMWV contracts on a cumulative basis
in the second quarter of 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 initiated discussions with the government in the third quarter of
1998 in an attempt to alleviate the significant negative cash flow position
Kroll-O'Gara had been put in due to the change in designation. The result of
these discussions was an agreement that the new payment guidelines would be
applied to Kroll-O'Gara on a prospective basis (effective in the second quarter
of 1998) only. As a result, Kroll-O'Gara received a payment for approximately
$11.0 million in the third quarter and had approximately $8.0 million of
outstanding receivables with the government as of September 30, 1998.
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.
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 September 30, 1998, Lindquist Avey
had approximately $2.7 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 $3.5 million for the nine months ended September 30, 1998,
and $3.1 million for the same period in 1997. Additions to databases totaled
$3.1 million and $3.0 million for the nine months ended September 30, 1998 and
1997, respectively.
In addition to capital expenditures, 1997 investing activities included the
acquisitions of Labbe and ITI, which required a total cash outlay of $7.6
million, net of cash acquired. In 1998, the acquisitions of Lindquist Avey and
InPhoto and the assets of Protec required cash of approximately $8.3 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 $52.4 million and $24.1 million for nine months ended September
30, 1998 and 1997, respectively. Cash from financing activities in 1998 includes
the net proceeds from the May 1998 offering (approximately $60.4 million). The
amount in 1997 reflects borrowing under the Senior Notes that was used to
finance certain acquisitions and working capital requirements.
Foreign operations. Kroll-O'Gara attempts to mitigate the risks of doing
business in foreign countries by separately incorporating its operations in such
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 its exposure to foreign currency rate fluctuations.
At September 30, 1998 five such contracts 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 $17.9 million and $0.5 million, respectively. These
contracts mature between January 1999 and September 2000. 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
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<PAGE> 13
of making the systems Year 2000 compliant and to enhance the information systems
capabilities of these subsidiaries. The new systems are scheduled to be
operational by mid-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 evaluating the
findings from its inventory and formulating plans of action. Kroll-O'Gara
anticipates that it will have taken all the necessary steps to ensure no
interruption in services as a result of the Year 2000 issue by the third quarter
of 1999. Total Year 2000 compliance cost is estimated to be approximately $4.0
million, of which approximately $3.6 relates to the new enterprise systems and
will be capitalized. The remaining approximately $0.4 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.
If systems are not in place or if all appropriate actions have not been
taken, Kroll-O'Gara's ability to administer and report revenue will be greatly
compromised. Both of Kroll-O'Gara's largest revenue groups are, for the most
part, manual operations. The manufacture of bullet resistant vehicles and the
investigation and intelligence services provided by Kroll-O'Gara are not largely
dependent on embedded technology. Barring a catastrophic collapse from third
party sources, such as a lack of electrical power, Kroll-O'Gara should be able
to maintain production in its main revenue producing groups, although at a
reduced level.
Many operations Kroll-O'Gara maintains, especially in the Voice and Data
Communications and the Investigations and Intelligence Groups, rely on third
party compliance with the Year 2000 issue to ensure Kroll-O'Gara can continue to
operate in these areas. Limited services in Kroll-O'Gara's Investigations and
Intelligence Group, including certain intelligence gathering services, rely
solely on third party sources, such as Lexis-Nexis, for their continued
operation. The satellite and global positioning equipment marketed by the Voice
and Data Communications Group is exclusively dependent on the compliance of the
manufacturers of the equipment and the agencies that maintain the satellites for
its revenue. Lack of compliance by third parties would significantly impact
Kroll-O'Gara in these areas.
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 in 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. Forward-looking statements, within the meaning
of Section 21E of the Securities and Exchange Act of 1934, are made throughout
this Management's Discussion and Analysis of Financial Condition and Results of
Operations. 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 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.
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<PAGE> 14
RESULTS OF OPERATIONS -- SUPPLEMENTAL
The following discussion of results of operations and financial condition
is based upon and should be read in conjunction with Kroll-O'Gara's Supplemental
Consolidated Financial Statements and Notes. As a result of acquisitions made by
Kroll-O'Gara in 1996, 1997 and 1998, which were accounted for as purchases,
financial results from period-to-period may lack comparability.
The following table sets forth, for the periods indicated, the items noted
as a percentage of net sales:
<TABLE>
<CAPTION>
NINE MONTHS
ENDED
YEAR ENDED DECEMBER 31, SEPTEMBER 30,
----------------------- --------------
1995 1996 1997 1997 1998
----- ----- ----- ----- -----
<S> <C> <C> <C> <C> <C>
Security Products and Services
Military......................................... 15.7% 33.1% 21.2% 20.1% 22.7%
Commercial....................................... 21.0 14.9 30.0 29.3 29.1
Investigations and intelligence.................... 61.1 47.3 40.3 41.7 40.6
Information security............................... -- -- -- -- 0.0
Voice and data communications...................... 2.2 4.7 8.5 8.9 7.6
----- ----- ----- ----- -----
Total net sales............................... 100.0% 100.0% 100.0% 100.0% 100.0%
Cost of sales...................................... 70.3 71.1 67.8 66.7 65.8
----- ----- ----- ----- -----
Gross profit.................................. 29.7 28.9 32.2 33.3 34.2
Operating expenses:
Selling and marketing............................ 10.6 6.3 7.3 6.9 6.6
General and administrative....................... 22.9 16.6 15.8 15.8 15.3
Merger related costs............................. -- -- 3.5 -- --
Asset impairment................................. -- 0.1 -- -- --
----- ----- ----- ----- -----
Operating income (loss)............................ (3.8) 5.9 5.6 10.6 12.3
Other income (expense):
Interest expense................................. (3.0) (1.9) (2.5) (2.4) (1.8)
Interest income.................................. 0.1 0.0 0.0 0.2 0.5
Other, net....................................... (0.1) 0.2 (0.2) (0.2) (0.1)
----- ----- ----- ----- -----
Income (loss) from continuing operations before
provision (benefit) for income taxes,
extraordinary item and cumulative effect of
accounting change................................ (6.8) 4.2 2.9 8.1 10.9
Provision for income taxes....................... 0.9 0.2 1.6 3.3 4.4
----- ----- ----- ----- -----
Income (loss) from continuing operations before
extraordinary item and cumulative effect of
accounting change................................ (5.9) 4.0 1.3 4.8 6.5
Loss from operations of discontinued clinical
business......................................... -- (0.3) -- -- --
Loss on disposal of clinical business.............. -- (0.5) -- -- --
----- ----- ----- ----- -----
Income (loss) before extraordinary item and
cumulative effect of accounting change........... (5.9) 3.2 1.3 4.8 6.5
Cumulative effect of accounting change............. -- -- (0.2) -- --
Extraordinary item................................. -- -- (0.1) (0.1) --
----- ----- ----- ----- -----
Net income (loss).................................. (5.9)% 3.2% 1.0% 4.7% 6.5%
===== ===== ===== ===== =====
</TABLE>
NINE MONTHS ENDED SEPTEMBER 30, 1998 COMPARED TO NINE MONTHS ENDED
SEPTEMBER 30, 1997
NET SALES. Net sales for the nine months ended September 30, 1998 increased
$46.7 million, or 32%, to $194.6 million from $147.9 million for the nine months
ended September 30, 1997.
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<PAGE> 15
Security Products and Services Group. For the nine months ended September
30, net sales for the Security Products and Services Group increased $27.8
million, or 38%, from $73.0 million in 1997 to $100.8 million in 1998. The
increase included net sales of commercial armoring products and services, which
increased $13.5 million, or 31%, from $43.2 million for the nine months ended
September 30, 1997 to $56.6 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
and IMEA and the assets of Protec. Kroll-O'Gara will continue in its efforts to
expand the operations of its existing foreign subsidiaries along with evaluating
new acquisition opportunities and additional new markets.
Increases in net sales for security services contributed to the increase in
net sales for commercial products and services contained within the Security
Products and Services Group. Net sales increased $1.0 million, or 18%, for the
nine months ended September 30, 1998 in comparison with 1997.
Also included in net sales for the Security Products and Services Group are
sales of military products and services, which increased $14.4 million, or 48%,
from $29.8 million in 1997 to $44.2 million in 1998. In April 1998, Kroll-O'Gara
began work on a new contract with the U.S. Military to supply 738 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
HMMWV's (the "360 CONTRACT") continued through July 1998. The combination of
production on the two contracts was a factor in the increase in net sales. In
future periods, HMMWV production will be solely based on the 738 Contract.
Based on certain internal requirements, the U.S. Air Force has dictated an
aggressive delivery schedule for the 738 Contract. This delivery schedule will
require Kroll-O'Gara to maintain an increased level of production for the
Up-Armored HMMWV in comparison with production levels in previous periods. This
increase in production will result in an increase in net sales of military
products over levels experienced in 1997 and the first quarter of 1998.
Management expects to maintain the increased level of production throughout the
balance of 1998, with decreases in production and net sales as the 738 Contract
nears completion in 1999.
Investigations and Intelligence Group. For the nine months ended September
30, net sales for the Investigations and Intelligence Group increased $17.2
million, or 28%, from $61.7 million in 1997 to $78.9 million in 1998. The
increases in 1998 were primarily due to the inclusion of net sales from the
acquisitions of Lindquist Avey, InPhoto, and Corplex. Excluding net sales
reported by these acquired entities, net sales for the Investigations and
Intelligence Group would have been $69.9 million for the nine months ended
September 30, 1998, in comparison with $61.7 million for the nine months ended
September 30, 1997, an increase of 13%.
Voice and Data Communications Group. For the nine months ended September
30, net sales for the Voice and Data Communications Group increased $1.6
million, or 12%, from $13.2 million in 1997 to $14.8 million in 1998. Late in
the second quarter of 1998, and throughout a majority of the third quarter,
Kroll-O'Gara was approached by a third party interested in purchasing the Voice
and Data Communications Group. The Group's management during this time period
was focused on negotiations, due diligence requests, and related demands on
their time. The diversion resulted in a decrease in net sales in the third
quarter of 1998. Due to several factors, the potential buyer decided not to
complete the transaction, and all discussions have been abandoned. Kroll-O'Gara
does not expect to incur any material charges associated with these discussions.
Management expects that the fourth quarter results from the Voice and Data
Communications Group will return to the levels experienced in the first half of
1998.
COST OF SALES. For the nine months ended September 30, cost of sales
increased $29.3 million, or 30%, from $98.7 million in 1997 to $128.0 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 for the
nine months ended September 30 was 34.2% and 33.3% for 1998 and 1997,
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 4%, was due to a more efficient use of subcontract
services and certain high margin engagements booked during the year which are
historically infrequent in nature.
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<PAGE> 16
Because these engagements 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 nine months
ended September 30, 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 and its lowest in the Voice and Data
Security Group. 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. For the nine months ended September 30, 1998, operating
expenses increased $9.0 million, or 27%, to $42.6 million from $33.6 million for
the same period in 1997. 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 for the nine months ended
September 30 decreased from 23% in 1997 to 22% 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 an additional commitment of fixed cost to
achieve growth in 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 nine months ended September 30,
1998 decreased $0.1 million, or 3%, to $3.5 million, compared to $3.6 million
for the same period in 1997. With the completion of the May 1998 offering, a
significant portion of Kroll-O'Gara's indebtedness was paid off (approximately
$14.8 million). As a result, Kroll-O'Gara experienced lower interest expense in
the third quarter of 1998 and expects interest expense to be lower in comparison
with 1997 for the remainder of 1998.
Additionally, the agreement governing Kroll-O'Gara's Senior Notes (see
"Liquidity and Capital Resources") contained a provision for a reduction of the
interest rate if certain criteria were met. Kroll-O'Gara complied with the
specified 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 nine months ended September 30,
1998 increased $0.6 million, or 213%, to $0.9 million, compared to $0.3 million
in the same period in 1997. Net proceeds of the May 1998 offering that were not
used to pay down 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 1998 in comparison with 1997.
Provision for income taxes. The provision for income taxes was $8.7 million
for the nine months ended September 30, 1998 in comparison with $4.8 million for
the same period in 1997. The effective tax rate for the first three quarters of
1998 and 1997 was 40%.
1997 COMPARED TO 1996
NET SALES. Net sales increased $41.2 million, or 25%, from $164.9 million
in 1996 to $206.1 million in 1997. The primary reasons for this change were the
acquisitions made in Kroll-O'Gara's Security Products and Services Group and
Voice and Data Communications 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 in 1997.
The Group's net sales for 1997 from commercial products and 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 ITI in the Group's 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, a trend management believes will continue for the
foreseeable
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future. 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. Kroll-O'Gara will continue to seek
out new acquisition opportunities and additional new markets for its security
products and services.
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.
Management expects net sales from military products to remain at a level
comparable to 1997 for the forseeable future.
Investigations and Intelligence Group. Net sales for the Investigations
and Intelligence Group increased $5.1 million, or 7%, from $78.0 million in 1996
to $83.1 million in 1997. This increase was primarily due to an increase in
specimens analyzed by Laboratory Specialists, Kroll-O'Gara's drug testing
division. This increase in specimens analyzed was due to certain asset purchases
made by Kroll-O'Gara 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 KHI. Throughout 1997, KHI was actively involved in various
strategic discussions that contemplated the sale of the company. Pending the
outcome of such discussions, KHI delayed implementation of its internal growth
plans. In addition, uncertainties surrounding the outcome of the discussions
resulted in the departure of certain KHI managers prior to the merger with The
O'Gara Company. Finally, in connection with the KHI merger and in an effort to
improve its cost structure, Kroll-O'Gara reduced personnel in certain markets.
As result, revenue growth at KHI was flat in comparison with 1996.
During the fourth quarter of 1997, the Investigations and Intelligence
Group reactivated its growth plan to open offices in Boston, Mexico City, and
Dallas and to pursue related acquisitions. Kroll-O'Gara expects these
initiatives will have a favorable impact on growth of net sales in future
periods.
Voice and Data Communications Group. During 1997, Kroll-O'Gara replaced
its primary wholesale distributor, acquired Next Destination, a subdistributor,
and reconfigured its distribution product mix to focus on the sale of satellite
communications equipment in addition to satellite navigation equipment. As a
result, Kroll-O'Gara experienced a higher than normal growth rate in 1997. Net
sales for the Voice and Data Communications Group were $17.4 million in 1997, an
increase of $9.7 million, or 124%, from $7.8 million in 1996. Kroll-O'Gara
expects growth in this segment to return to a more normal rate in 1998.
COST OF SALES AND GROSS PROFIT. Cost of sales for 1997 increased $22.5
million, or 19%, to $139.8 million from $117.3 million in 1996. The increase in
cost of sales was due to increases in Kroll-O'Gara's level of business activity
as 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. However, because Kroll-O'Gara's gross profit percentage was
affected favorably by adjustments resulting from performance on certain
contracts in 1997, Kroll-O'Gara does not expect to maintain the 1997 gross
profit percentage level in 1998.
Investigations and Intelligence Group. Gross profit as a percent of net
sales for the Investigations and Intelligence Group increased from 32.1% in 1996
to 40.0% 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.
Voice and Data Communications Group. Prior to the acquisition of Next
Destination, Kroll-O'Gara's Voice and Data Communications Group realized a
higher gross profit percentage due to its mix of integrated products versus
distributed products. As a distributor, Next Destination's gross profit
percentages were relatively lower. As result, the inclusion of revenue from Next
Destination caused a decrease in gross profit as a percent of
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net sales for the Voice and Data Communications Group from 27.6% in 1996 to
17.9% in 1997. Management expects the level of gross profit percentage
experienced in 1997 to be maintained in future periods.
OPERATING EXPENSES. Excluding expenses of $7.2 million related to the KHI
merger, operating expenses increased $9.8 million, or 26%, from $37.8 million in
1996 to $47.6 million in 1997. The $7.2 million in expenses related to the KHI
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
certain 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 is a charge made as a result of the acceleration of the vesting of
certain shares of restricted KHI stock immediately prior to that merger. All of
the costs related to the KHI merger were recognized in 1997 and will have no
effect on the earnings of Kroll-O'Gara in future periods.
The primary reason for the increase in operating expenses, exclusive of
expenses related to the KHI merger, was the inclusion of operations from the
acquisitions made in 1997. In addition, the increase in operating expenses
reflects Kroll-O'Gara's efforts to expand into new markets, both in the Security
Products and Service Group and the Investigations and Intelligence Group.
Excluding expenses related to the KHI merger, operating expenses as a percent of
net sales stayed essentially constant between the periods at 23.1% in 1997 and
22.9% in 1996.
Prior to the KHI merger, KHI was involved in merger discussions with
Choicepoint, Inc., a subsidiary of Equifax, Inc. Choicepoint and KHI did not
reach a final agreement and, as a result, did not consummate the transaction.
Certain professional fees, which totaled approximately $0.5 million, associated
with the Choicepoint transaction are included in Kroll-O'Gara's operating
expenses in 1997.
INTEREST EXPENSE. Interest expense for 1997 increased $1.8 million, or
56%, to $5.1 million, compared to $3.3 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 May 1998
offering. As a result, interest expense is expected to be lower in 1998 than in
1997.
OTHER, NET. Other income (expense), net decreased from $0.3 million of
income in 1996 to $0.4 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 was 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 56% in 1997 due to the
non-deductibility of certain expenses related to the KHI merger in the period
and the impact of foreign losses for which no benefit can be provided.
Management believes that the rate is substantially higher than Kroll-O'Gara will
experience in 1998 and for future periods.
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 benefit of $0.3 million and $0.5 million,
respectively.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Kroll-O'Gara had
previously capitalized costs related to the reengineering of certain 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 Reegineering and
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Information Technology Transformation." The amount expensed is shown net of
applicable tax benefit of $0.2 million.
1996 COMPARED TO 1995
NET SALES. Net sales increased $69.9 million, or 74%, from $95.0 million
in 1995 to $164.9 million in 1996. The primary reasons for this change were the
acceleration of the HMMWV contract and increases in the level of business
activity in the Intelligence and Investigation Group and Voice and Data
Communications Group discussed below.
Security Products and Services Group. Net sales for the Security Products
and Services Group increased $44.3 million, or 127%, from $34.9 million in 1995
to $79.2 million in 1996. 1996 net sales reflect the U.S. Government's request
to accelerate the production of Up-Armored HMMWVs and HMMWV armor kits. In
addition, the level of military revenue in 1995 was significantly impacted by an
unanticipated six-month delay in the delivery of HMMWV chassis from a supplier,
leading to production of substantially fewer Up-Armored HMMWVs.
Commercial revenue for 1996 was $24.6 million, an increase of $4.6 million,
or 23%, over 1995. This increase was primarily due to the inclusion of revenue
from start-up operations in Russia, Mexico and Brazil.
Investigations and Intelligence Group. Net sales for the Investigations
and Intelligence Group increased $19.9 million, or 34%, from $58.1 million in
1995 to $78.0 million in 1996. The increase in 1996 was attributable primarily
to an increase in net sales from corporate investigation and business
intelligence services, which increased $12.3 million and $4.0 million,
respectively. These increases were the result of expansion into new geographic
areas and an enhanced marketing program, including a Vendor Integrity Program,
which accounted for approximately $1.0 million of the increase in net sales.
Voice and Data Communications Group. Net sales for the Voice and Data
Communications Group increased $5.7 million, or 280%, from $2.0 million in 1995
to $7.8 million in 1996. The increase in net sales was attributable primarily to
the addition of the Compact-M portable satellite terminal, initially marketed by
Kroll-O'Gara in 1996.
COST OF SALES AND GROSS PROFIT. Cost of sales for 1996 increased $50.5
million, or 76%, to $117.3 million from $66.8 million in 1995. The increase in
cost of sales was due to increases in Kroll-O'Gara's level of business activity.
Security Products and Services Group. Gross profit as a percentage of net
sales for the Security Products and Services Group increased from 23.3% in 1995
to 25.8% in 1996. This increase was due to revenue recognized on new military
contracts, both U.S. and foreign, with a higher gross profit percentage than
previously experienced. Also contributing to the increase in gross profit as a
percent of sales was the effect of the start-up operations in Brazil, Mexico and
Russia, which experienced higher gross margins for their products than Kroll-
O'Gara had experienced previously. These higher margins were the result of lower
direct costs and less developed competition in the markets where these start-up
operations exist.
Investigations and Intelligence Group. As a percent of net sales, gross
profit decreased from 33.9% in 1995 to 32.1% in 1996. Cost of sales in 1996
included a write-off of $5.0 million in uncollectible accounts receivable
relating to services provided in earlier periods. Without the effect of the
write-off, gross margin as a percent of net sales would have increased 4.6% over
1995 to 38.5%.
Voice and Data Communications Group. Gross profit as a percent of net
sales increased from 20.0% in 1995 to 27.6% in 1996. This increase was primarily
due to new products marketed by Kroll-O'Gara in 1996, that were sold at a higher
gross margin than Kroll-O'Gara had experienced with other products.
OPERATING EXPENSES. Operating expenses in 1996 increased $6.0 million, or
19%, from $31.8 million in 1995 to $37.8 million in 1996. As a percent of net
sales, operating expenses decreased from 33% in 1995 to 23% in 1996, as a result
of increases in net sales which did not require a commitment of additional
marketing and administrative resources.
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Selling and marketing expenses increased approximately $0.4 million, or 4%,
from $10.0 million in 1995 to $10.4 million in 1996. Certain costs, primarily
personnel and advertising, increased $1.2 million due to Kroll-O'Gara's growth
into its new Brazilian, Mexican and Russian markets. This increase was offset by
a $0.8 million reduction primarily attributable to the use of lower cost
information services for pre-marketing purposes in the Investigations and
Intelligence Group.
General and administrative expenses increased $5.5 million, or 25%, from
$21.8 million in 1995 to $27.3 million in 1996. This increase was attributable
primarily to the addition of professional employees and associated
infrastructure to support Kroll-O'Gara's increased level of business activity.
These increases included the addition of personnel and facilities to support
expansion into new product lines, such as risk and crisis management services,
and new geographic regions, such as Asia and Latin America.
INTEREST EXPENSE. Interest expense increased $0.4 million, or 13%, from
$2.9 million in 1995 to $3.3 million in 1996. The increase was primarily due to
increased borrowings necessary to finance increased production levels and new
operations in Kroll-O'Gara's Security Products and Services Group. This increase
was partially offset by a reduction in interest expense paid on long-term debt
outstanding to certain shareholders. The amount outstanding with those
shareholders was reduced due by principal payments made in 1996.
OTHER, NET. Other income (expense), net increased $0.4 million, or 417%,
from $(0.1) million in 1995 to $0.3 million in 1996. This increase was primarily
due to a gain on the sale of marketable securities and a realized foreign
currency translation gain.
PROVISION (BENEFIT) FOR INCOME TAXES. The provision (benefit) increased
from a benefit of $0.8 million in 1995 to a provision of $0.4 million in 1996.
The lower benefit for income taxes in 1996 in comparison with 1995 was related
to KHI's losses before taxes, which were lower in 1996. OHE booked no provision
for income taxes prior to the termination of its S Corporation status which
terminated in October 1996.
LIQUIDITY AND CAPITAL RESOURCES -- SUPPLEMENTAL
General. Kroll-O'Gara historically has met its operating cash needs by
utilizing borrowings under its credit arrangements to supplement cash provided
by operations, excluding non-cash charges such as depreciation and amortization.
Public Offering. A portion of the net proceeds of the May 1998 offering
(approximately $60.4 million) was used to pay off certain indebtedness of
Kroll-O'Gara ($14.8 million). The remaining amounts were invested in short-term
instruments and are being used as necessary for acquisitions, working capital
and other general corporate purposes.
Senior Notes. On May 30, 1997, Kroll-O'Gara issued and sold $35.0 million
worth of Senior Notes, maturing on May 30, 2004, to certain institutional
investors. The Senior Notes bear interest at 8.56% and impose covenant
restrictions on Kroll-O'Gara's operations. These restrictions include
limitations on dividends and priority debt, and constraints on specific
investments, as well as requirements relating to Kroll-O'Gara's net worth, fixed
charge coverage ratio and level of outstanding debt.
Credit Facility. Kroll-O'Gara has a revolving credit facility with KeyBank
National Association, which was entered into in May 1997 and amended in October
1998. This agreement provides for a revolving line of credit of $7.0 million and
a letter of credit facility of approximately $7.7 million. The revolving credit
facility bears interest which fluctuates between the prime rate less 1.75% and
prime less 2.25%, or, at Kroll-O'Gara's option, between the LIBOR rate plus
0.75% and LIBOR plus 1.50%. The Credit Agreement imposes requirements on
Kroll-O'Gara's reported fixed charge coverage ratio, net worth and debt
capitalization, along with certain restrictions on investments, acquisitions,
intangibles and capital expenditures.
As of March 1, 1999, there were no borrowings under the revolving line of
credit. The remaining proceeds from the May 1998 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 foreseeable future.
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Kroll-O'Gara will continue to pursue its strategy of acquiring security
related companies in an effort to consolidate its position in the risk
mitigation industry. To that end, Kroll-O'Gara will continue to review
additional sources of working capital as they become necessary.
Cash flows from operating activities. Net cash used in operating
activities was $10.6 million and $3.0 million for the nine months ended
September 30, 1998 and 1997, respectively. Since the inception of Kroll-
O'Gara's contract with the U.S. Government to armor the HMMWV through the second
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 will be determined using a smaller
percentage of total cost committed than they have in the past. Second,
Kroll-O'Gara will only be reimbursed for vendor invoices paid instead of
expenses incurred. Although these changes will not affect the total amount
ultimately collected, they will defer certain 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 on a cumulative basis
in the second quarter of 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 initiated discussions with the government in the third quarter of
1998 in an attempt to alleviate the significant negative cash flow position
Kroll-O'Gara had been put in due to the change in designation. The result of
these discussions was an agreement that the new payment guidelines would be
applied to Kroll-O'Gara on a prospective basis (effective in the second quarter
of 1998) only. As a result, Kroll-O'Gara received a payment for approximately
$11.0 million in the third quarter and had approximately $8.0 million of
outstanding receivables with the government as of September 30, 1998.
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.
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 September 30, 1998, Lindquist Avey
had approximately $2.7 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 $4.2 million for the nine months ended September 30, 1998,
and $6.5 million for the same period in 1997. Additions to databases totaled
$3.1 million and $3.0 million for the nine months ended September 30, 1998 and
1997, respectively.
In addition to capital expenditures, 1997 investing activities included the
acquisitions of Labbe and ITI, which required a total cash outlay of $7.6
million, net of cash acquired. In 1998, the acquisitions of Lindquist Avey,
InPhoto, the assets of Protec, Pathology Laboratories, Harrison Laboratories,
Accu-Path and TOXWORX Laboratories required cash of approximately $11.4 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 $59.6 million and $25.5 million for the nine months ended
September 30, 1998 and 1997, respectively. Cash from financing activities in
1998 includes the net proceeds from the May 1998 offering (approximately $60.4
million) completed in the second quarter. In addition, Laboratory Specialists
completed a private offering of its stock in June 1998 with proceeds of
approximately $2.3 million. A portion of the proceeds from these transactions
was used to pay off certain indebtedness of Kroll-O'Gara (approximately $14.8
million). The amounts not used to pay off 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 into Kroll-O'Gara common
stock in Kroll-O'Gara's acquisition of Securify). The net proceeds to Securify
associated with the sale of these shares were approximately $5.5 million.
The amount in 1997 reflects borrowing under the Senior Notes that was used
to finance certain acquisitions and working capital requirements.
Foreign operations. Kroll-O'Gara attempts to mitigate the risks of doing
business in foreign countries by separately incorporating its operations in such
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 its exposure to foreign currency rate fluctuations.
At September 30, 1998 five such contracts 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 $17.9 million and $0.5 million, respectively. These
contracts mature between January 1999 and September 2000. 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. The new systems are scheduled to be
operational by mid-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 evaluating the
findings from its inventory and formulating plans of action. Kroll-O'Gara
anticipates that it will have taken all the necessary steps to ensure no
interruption in services as result of the Year 2000 issue by the third quarter
of 1999. Total Year 2000 compliance cost is estimated to be approximately $4.0
million, of which approximately $3.6 million relates to the new enterprise
systems and will be capitalized. The remaining approximately $0.4 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.
If systems are not in place or if all appropriate actions have not been
taken, Kroll-O'Gara's ability to administer and report revenue will be greatly
compromised. Both of Kroll-O'Gara's largest revenue Groups are, for the most
part, manual operations. The manufacture of bullet resistant vehicles and the
investigation and intelligence services provided by Kroll-O'Gara are not largely
dependent on embedded technology. Barring a catastrophic collapse from third
party sources, such as a lack of electrical power, Kroll-O'Gara should be able
to maintain production in its main revenue producing groups, although at a
reduced level.
Many operations Kroll-O'Gara maintains, especially in the Voice and Data
Communications and Investigations and Intelligence Groups, rely on third party
compliance with the Year 2000 issue to ensure Kroll-O'Gara can continue to
operate in these areas. Limited services in Kroll-O'Gara's Investigations and
Intelligence Group, including certain intelligence gathering services, rely
solely on third party sources, such as Lexis-Nexis, for their continued
operation. The satellite and global positioning equipment marketed by the Voice
and Data Communications Group is exclusively dependent on the compliance of the
manufacturers of the equipment and the agencies that maintain the satellites for
its revenue. Lack of compliance by third parties would significantly impact
Kroll-O'Gara in these areas.
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
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and governmental contracts which are generally awarded in a periodic and/or
sporadic basis. Kroll-O'Gara generally does not have long-term contracts with
its clients in its Investigations and Intelligence and Information Security
Groups 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. Forward-looking statements, within the meaning
of Section 21E of the Securities and Exchange Act of 1934, are made throughout
this Management's Discussion and Analysis of Financial Conditions and Results of
Operations. 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 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.
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