<PAGE> 1
Exhibit 1
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
TO THE KROLL-O'GARA COMPANY:
We have audited the accompanying consolidated balance sheets of THE
KROLL-O'GARA COMPANY and subsidiaries as of December 31, 1998 and 1999 and the
related consolidated statements of operations, shareholders' equity and cash
flows for each of the three years in the period ended December 31, 1999. 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 1997 financial statements of Background
America, Inc., a company acquired during 1999 in a transaction accounted for as
a pooling of interests, as discussed in Note 3. Such statements are included in
the consolidated financial statements of The Kroll-O'Gara Company and reflect
total revenues of 2 percent of the consolidated totals. Those statements were
audited by other auditors whose report has been furnished to us and our opinion,
insofar as it relates to amounts included for Background America, Inc., is based
solely upon the report of the other auditors.
We conducted our audits in accordance with auditing standards generally
accepted in the United States. 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 report of other
auditors provide a reasonable basis for our opinion.
In our opinion, based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of The Kroll-O'Gara Company and
subsidiaries as of December 31, 1998 and 1999 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1999, in conformity with accounting principles generally accepted
in the United States.
As explained in Note 2(r) to the consolidated financial statements,
effective in the fourth quarter of 1997, the Company changed its method of
accounting for costs incurred in connection with business process reengineering
activities and, effective in the first quarter of 1999, the Company changed its
method of accounting for costs of start-up activities.
Arthur Andersen LLP
Cincinnati, Ohio
September 14, 2000
<PAGE> 2
INDEPENDENT AUDITORS' REPORT
Board of Directors and Shareholders
Background America, Inc.
Nashville, Tennessee
We have audited the consolidated statements of operations, redeemable
preferred stock and other shareholders' equity (deficit) and cash flows for the
year ended December 31, 1997 of Background America, Inc. and subsidiaries (the
"Company"). 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 audit.
We conducted our audit in accordance with auditing standards generally
accepted in the United States of America. 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 audit provides a
reasonable basis for our opinion.
In our opinion, such consolidated financial statements (not presented
separately herein) present fairly, in all material respects, the results of
operations of Background America, Inc. and subsidiaries and their cash flows for
the year ended December 31, 1997, in conformity with accounting principles
generally accepted in the United States of America.
Deloitte & Touche LLP
Nashville, Tennessee
December 18, 1998
(January 21, 1999 as to
first paragraph of Note 15)
<PAGE> 3
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
------------ ------------
<S> <C> <C>
ASSETS (NOTE 7)
CURRENT ASSETS:
Cash and cash equivalents................................. $ 14,040,700 $ 13,834,560
Marketable securities..................................... 13,285,322 --
Trade accounts receivable, net of allowance for doubtful
accounts of approximately $3,821,306 and $4,778,906 in
1998 and 1999, respectively (Notes 2 and 4)............ 56,960,753 68,017,062
Unbilled revenues (Note 2)................................ 7,766,015 18,033,811
Related party receivables (Note 6)........................ 2,763,108 2,095,810
Costs and estimated earnings in excess of billings on
uncompleted contracts (Note 4)......................... 26,408,097 24,159,724
Inventories (Note 4)...................................... 22,397,939 26,264,388
Prepaid expenses and other................................ 8,001,102 11,579,522
Deferred tax asset (Note 5)............................... -- 823,831
------------ ------------
Total current assets.............................. 151,623,036 164,808,708
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, at cost (Notes 2 and 8):
Land...................................................... 1,856,003 2,164,197
Buildings and improvements................................ 8,271,967 8,586,985
Leasehold improvements.................................... 6,344,398 7,451,655
Furniture and fixtures.................................... 6,013,679 10,131,191
Machinery and equipment................................... 19,702,242 36,768,571
Construction-in-progress.................................. 2,915,135 --
------------ ------------
45,103,424 65,102,599
Less-accumulated depreciation............................. (20,462,991) (26,194,953)
------------ ------------
24,640,433 38,907,646
------------ ------------
DATABASES, net of accumulated amortization of $22,788,857
and $26,187,348 in 1998 and 1999, respectively (Note 2)... 9,238,903 9,696,162
COSTS IN EXCESS OF ASSETS ACQUIRED AND OTHER INTANGIBLE
ASSETS, net of accumulated amortization of $4,449,752 and
$9,028,471 in 1998 and 1999, respectively (Notes 2 and
3)........................................................ 62,148,482 81,676,083
OTHER ASSETS:
Other assets (Note 4)..................................... 6,093,435 4,304,000
------------ ------------
77,480,820 95,676,245
------------ ------------
$253,744,289 $299,392,599
============ ============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
<PAGE> 4
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1998 AND 1999
<TABLE>
<CAPTION>
1998 1999
------------ ------------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit (Note 7)........................ $ -- $ 26,582,688
Current portion of long-term debt (Note 8)................ 2,000,299 3,737,227
Trade accounts payable.................................... 35,989,761 38,822,977
Related party payables (Note 6)........................... 353,233 --
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. 182,656 360,725
Accrued liabilities (Note 4).............................. 22,800,436 28,299,006
Income taxes currently payable............................ 760,340 768,105
Deferred income taxes (Note 5)............................ 781,575 --
Customer deposits......................................... 3,865,219 4,195,762
------------ ------------
Total current liabilities......................... 66,733,519 102,766,490
OTHER LONG-TERM LIABILITIES................................. 1,542,588 2,673,092
DEFERRED INCOME TAXES (Note 5).............................. 1,625,363 1,820,815
LONG-TERM DEBT, net of current portion (Note 8)............. 39,346,555 36,264,163
------------ ------------
Total liabilities................................. 109,248,025 143,524,560
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 9, 12 and 17)
SHAREHOLDERS' EQUITY (Note 1):
Preferred stock, $.01 par value, 1,000,000 shares
authorized; none issued................................ -- --
Common stock, $.01 par value, 50,000,000 shares
authorized, 21,584,872 and 22,255,510 shares issued and
outstanding in 1998 and 1999, respectively............. 215,848 222,555
Additional paid-in-capital................................ 157,229,936 170,101,929
Retained deficit.......................................... (10,964,249) (12,639,574)
Deferred compensation..................................... (1,113,936) (1,629,893)
Accumulated other comprehensive loss...................... (871,335) (186,978)
------------ ------------
Total shareholders' equity........................ 144,496,264 155,868,039
------------ ------------
$253,744,289 $299,392,599
============ ============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
<PAGE> 5
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
<TABLE>
<CAPTION>
1997 1998 1999
------------ ------------ ------------
<S> <C> <C> <C>
NET SALES....................................... $210,323,664 $272,195,513 $321,937,532
COST OF SALES................................... 143,213,182 178,421,433 203,456,962
------------ ------------ ------------
Gross profit............................. 67,110,482 93,774,080 118,480,570
OPERATING EXPENSES:
Selling and marketing......................... 15,532,029 22,332,090 27,470,879
General and administrative.................... 34,292,093 42,834,565 74,861,467
Restructuring charge (Note 4)................. -- -- 4,363,566
Failed merger related costs (Note 17)......... -- -- 1,562,331
Merger related costs (Note 3)................. 7,204,926 5,727,358 4,069,089
------------ ------------ ------------
Operating expenses....................... 57,029,048 70,894,013 112,327,332
------------ ------------ ------------
Operating income......................... 10,081,434 22,880,067 6,153,238
OTHER INCOME (EXPENSE):
Interest expense.............................. (5,244,249) (4,670,010) (4,965,597)
Interest income............................... 172,544 1,273,218 409,892
Other, net.................................... (284,639) (344,279) (311,901)
------------ ------------ ------------
Income before minority interest,
provision for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle............................. 4,725,090 19,138,996 1,285,632
Minority interest............................. 156,223 -- --
------------ ------------ ------------
Income before provision for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle............................. 4,568,867 19,138,996 1,285,632
Provision for income taxes.................... 3,304,993 7,352,931 2,429,410
------------ ------------ ------------
Income (loss) before extraordinary item
and cumulative effect of change in
accounting principle.................. 1,263,874 11,786,065 (1,143,778)
Extraordinary loss, net of applicable tax
benefit of $129,250 (Note 7)............... (193,875) -- --
------------ ------------ ------------
Income (loss) before cumulative effect of
change in accounting principle........ 1,069,999 11,786,065 (1,143,778)
Cumulative effect of change in accounting
principle, net of applicable tax benefit of
$240,000 in 1997 and $408,000 in 1999 (Note
2(r))...................................... (360,000) -- (778,041)
------------ ------------ ------------
Net income (loss)........................ $ 709,999 $ 11,786,065 $ (1,921,819)
============ ============ ============
Earnings (loss) per share (Note 2(o)):
Basic...................................... $ 0.05 $ 0.61 $ (0.09)
============ ============ ============
Diluted.................................... $ 0.05 $ 0.59 $ (0.09)
============ ============ ============
Weighted average shares outstanding (Note
2(o)):
Basic...................................... 14,750,676 19,336,580 22,005,632
============ ============ ============
Diluted.................................... 15,560,050 19,908,206 22,005,632
============ ============ ============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
<PAGE> 6
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
<TABLE>
<CAPTION>
COMPREHENSIVE COMMON ADDITIONAL RETAINED DEFERRED
SHARES INCOME (LOSS) STOCK PAID-IN CAPITAL DEFICIT COMPENSATION
---------- ------------- -------- --------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1996......... 14,035,151 $140,351 $ 44,143,424 $(21,266,057) $ --
Issuances of stock under employee
benefit plans, including related
tax benefit (Note 11)............ 750,725 7,507 6,301,276 -- --
Issuance of stock in conjunction
with the acquisition of
businesses and minority interest
(Note 3)......................... 823,371 8,234 9,695,009 -- --
Issuance of stock in conjunction
with the settlement of a note
payable.......................... 21,721 217 232,282 -- --
Private offering of common stock,
net of issuance cost of
$36,373.......................... 307,613 3,076 5,964,976 -- --
Purchase and retirement of common
stock (Note 11 (c)).............. (259,036) (2,590) (498,978) (2,194,256) --
Comprehensive income:
Net income....................... -- $ 709,999 -- -- 709,999 --
-----------
Other comprehensive income
(loss), 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 loss....... -- (240,091) -- -- -- --
-----------
Comprehensive income......... -- $ 469,908 -- -- -- --
---------- =========== -------- ------------ ------------ -----------
BALANCE, December 31, 1997......... 15,679,545 156,795 65,837,989 (22,750,314) --
Public and private offerings of
common stock, net of issuance
costs of approximately
$1,431,000....................... 4,716,757 47,168 68,289,755 -- --
Net issuances of stock under
employee benefit plans, including
related tax benefit (Note 11).... 428,625 4,286 4,473,859 -- --
Issuance of stock in conjunction
with the acquisition of
businesses (Note 3).............. 767,416 7,674 17,602,830 -- --
Exercise of stock put option (Note
3)............................... (7,471) (75) (166,593) -- --
Deferred compensation related to
stock options.................... -- -- 1,192,096 -- (1,113,936)
Comprehensive income:
Net income....................... -- $11,786,065 -- -- 11,786,065 --
-----------
Other comprehensive income
(loss), net of tax:
Foreign currency translation
adjustment, net of $318,000
tax benefit.................. -- (476,956) -- -- -- --
Reclassification adjustment for
gain on securities included
in net income, net of $7,000
tax benefit.................. -- (10,469) -- -- -- --
-----------
Other comprehensive loss....... -- (487,425) -- -- -- --
-----------
Comprehensive income......... -- $11,298,640 -- -- -- --
---------- =========== -------- ------------ ------------ -----------
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME (LOSS) TOTAL
------------- ------------
<S> <C> <C>
BALANCE, December 31, 1996......... $(143,819) $ 22,873,899
Issuances of stock under employee
benefit plans, including related
tax benefit (Note 11)............ -- 6,308,783
Issuance of stock in conjunction
with the acquisition of
businesses and minority interest
(Note 3)......................... -- 9,703,243
Issuance of stock in conjunction
with the settlement of a note
payable.......................... -- 232,499
Private offering of common stock,
net of issuance cost of
$36,373.......................... -- 5,968,052
Purchase and retirement of common
stock (Note 11 (c)).............. -- (2,695,824)
Comprehensive income:
Net income....................... -- 709,999
Other comprehensive income
(loss), 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 loss....... (240,091) (240,091)
Comprehensive income......... -- --
--------- ------------
BALANCE, December 31, 1997......... (383,910) 42,860,560
Public and private offerings of
common stock, net of issuance
costs of approximately
$1,431,000....................... -- 68,336,923
Net issuances of stock under
employee benefit plans, including
related tax benefit (Note 11).... -- 4,478,145
Issuance of stock in conjunction
with the acquisition of
businesses (Note 3).............. -- 17,610,504
Exercise of stock put option (Note
3)............................... -- (166,668)
Deferred compensation related to
stock options.................... -- 78,160
Comprehensive income:
Net income....................... -- 11,786,065
Other comprehensive income
(loss), net of tax:
Foreign currency translation
adjustment, net of $318,000
tax benefit.................. -- --
Reclassification adjustment for
gain on securities included
in net income, net of $7,000
tax benefit.................. -- --
Other comprehensive loss....... (487,425) (487,425)
Comprehensive income......... -- --
--------- ------------
</TABLE>
<PAGE> 7
<TABLE>
<CAPTION>
COMPREHENSIVE COMMON ADDITIONAL RETAINED DEFERRED
SHARES INCOME (LOSS) STOCK PAID-IN CAPITAL DEFICIT COMPENSATION
---------- ------------- -------- --------------- ------------ ------------
<S> <C> <C> <C> <C> <C> <C>
BALANCE, December 31, 1998......... 21,584,872 $215,848 $157,229,936 $(10,964,249) $(1,113,936)
Net issuances of stock under
employee benefit plans, including
related tax benefit (Note 11).... 202,614 2,026 3,293,084 -- --
Issuance of stock in conjunction
with acquisition of businesses
(Note 3)......................... 468,024 4,681 8,007,248 246,494 --
Deferred compensation related to
restricted stock and stock
options (Note 11)................ -- -- 1,571,661 -- (515,957)
Comprehensive income (loss):
Net loss......................... -- $(1,921,819) -- -- (1,921,819) --
-----------
Other comprehensive income
(loss), net of tax:
Foreign currency translation
adjustment, net of $456,000
tax provision................ -- 684,357 -- -- -- --
-----------
Other comprehensive income..... -- 684,357 -- -- -- --
-----------
Comprehensive income
(loss)..................... -- $(1,237,462) -- -- -- --
---------- =========== -------- ------------ ------------ -----------
BALANCE, December 31, 1999......... 22,255,510 $222,555 $170,101,929 $(12,639,574) $(1,629,893)
========== ======== ============ ============ ===========
<CAPTION>
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME (LOSS) TOTAL
------------- ------------
<S> <C> <C>
BALANCE, December 31, 1998......... $(871,335) $144,496,264
Net issuances of stock under
employee benefit plans, including
related tax benefit (Note 11).... -- 3,295,110
Issuance of stock in conjunction
with acquisition of businesses
(Note 3)......................... -- 8,258,423
Deferred compensation related to
restricted stock and stock
options (Note 11)................ -- 1,055,704
Comprehensive income (loss):
Net loss......................... -- (1,921,819)
Other comprehensive income
(loss), net of tax:
Foreign currency translation
adjustment, net of $456,000
tax provision................ -- --
Other comprehensive income..... 684,357 684,357
Comprehensive income
(loss)..................... -- --
--------- ------------
BALANCE, December 31, 1999......... $(186,978) $155,868,039
========= ============
</TABLE>
The accompanying notes to consolidated financial statements are an integral part
of these consolidated statements.
<PAGE> 8
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 15)
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
<TABLE>
<CAPTION>
1997 1998 1999
------------ ----------- ------------
<S> <C> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss)......................................... $ 709,999 $11,786,065 $ (1,921,819)
Adjustments to reconcile net income (loss) to net cash
provided by (used in) operations --
Depreciation and amortization......................... 6,798,668 9,112,221 14,088,149
Bad debt expense...................................... 2,083,080 2,556,506 4,360,227
Shareholder stock compensation........................ 1,356,280 -- --
Loss on write-off of notes receivable................. 35,434 -- --
Share in net income of joint ventures................. (121,650) -- --
Gain on sale of marketable securities................. (14,503) (10,469) --
Noncash compensation expense.......................... -- 226,074 1,055,704
Change in assets and liabilities, net of effects of
acquisitions --
Receivables -- trade and unbilled....................... (10,410,824) (13,668,954) (19,094,085)
Costs and estimated earnings in excess of billings on
uncompleted contracts................................. 3,499,084 (14,329,633) 2,248,373
Inventories, prepaid expenses and other assets.......... (7,226,253) (4,100,776) (5,189,742)
Accounts payable and income taxes currently payable..... 8,058,527 608,102 966,965
Billings in excess of costs and estimated earnings on
uncompleted contracts................................. (1,009,740) (138,006) 178,069
Amounts due to/from related parties..................... 443,290 (2,623,651) 731,612
Deferred taxes.......................................... (156,892) (838,668) (1,409,954)
Accrued liabilities, long-term liabilities and customer
deposits.............................................. 667,999 (1,902,669) (1,333,001)
------------ ----------- ------------
Net cash provided by (used in) operating
activities....................................... 4,712,499 (13,323,858) (5,319,502)
------------ ----------- ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net........... (6,016,619) (7,329,376) (19,198,147)
Additions to databases.................................... (3,856,914) (4,186,924) (3,855,750)
Acquisitions, net of cash acquired (Note 3)............... (10,710,128) (18,595,996) (12,014,287)
Sale (purchases) of marketable securities, net............ 35,424 (13,262,353) 13,285,322
Other..................................................... 266,004 -- --
------------ ----------- ------------
Net cash used in investing activities.............. (20,282,233) (43,374,649) (21,782,862)
------------ ----------- ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Loan financing fees....................................... (723,727) -- --
Net borrowings (repayments) under revolving lines of
credit.................................................. (9,376,835) (559,112) 24,262,221
Proceeds from debt........................................ 44,902,987 284,877 --
Payments of long-term debt................................ (10,042,503) (13,662,425) (1,345,464)
Proceeds from notes payable -- shareholder................ 1,261,000 -- --
Repayment of notes payable -- shareholder................. (8,107,641) (176,057) --
Net proceeds from issuance of common stock................ 4,914,317 68,336,923 --
Purchase and retirement of stock.......................... (2,695,824) (166,668) --
Foreign currency translation.............................. (160,462) (593,494) 1,096,137
Proceeds from exercise of stock options and warrants...... 2,780,966 4,478,145 3,295,110
------------ ----------- ------------
Net cash provided by financing activities.......... 22,752,278 57,942,189 27,308,004
------------ ----------- ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS................... 7,182,544 1,243,682 205,640
Effects of foreign currency exchange rates on cash and cash
equivalents............................................... (75,931) 106,049 (411,780)
CASH AND CASH EQUIVALENTS, beginning of year................ 5,584,356 12,690,969 14,040,700
------------ ----------- ------------
CASH AND CASH EQUIVALENTS, end of year...................... $ 12,690,969 $14,040,700 $ 13,834,560
============ =========== ============
</TABLE>
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
<PAGE> 9
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1997, 1998 AND 1999
(1) NATURE OF OPERATIONS AND BASIS OF PRESENTATION --
The Kroll-O'Gara Company, an Ohio corporation, together with its
subsidiaries (collectively "Kroll-O'Gara"), is a leading global provider of
a broad range of specialized products and services that are designed to
provide solutions to a variety of security needs. Kroll-O'Gara's Security
Products and Services Group markets ballistic and blast protected vehicles
and security services. The Investigations and Intelligence Group offers
business intelligence and investigation services. The Information Security
Group offers information and computer security services, including network
and system security review and repair. The Voice and Data Communications
Group offers secure satellite communication equipment and satellite
navigation systems.
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 O'Gara Company's name was changed to The Kroll-O'Gara Company. The
consolidated financial statements include the historical consolidated
financial statements of Kroll-O'Gara (and the businesses it has acquired,
since their respective dates of acquisition, under the purchase method of
accounting) and the financial position, results of operations and cash
flows of entities which were merged with Kroll-O'Gara in connection with
pooling of interests business combinations (See Note 3).
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES --
(a) CONSOLIDATION -- The consolidated financial statements include the
accounts of all majority-owned subsidiaries. All material intercompany
accounts and transactions are eliminated. Investments in 20% to 50%
owned entities are accounted for on the equity method and investments
in less than 20% owned entities are accounted for on the cost method.
Affiliated entities are not included in the accompanying consolidated
financial statements, and include entities that are directly or
indirectly owned by current shareholders or former shareholders.
(b) REVENUE RECOGNITION -- Revenue related to contracts for security
products (both government and commercial) results principally from
long-term fixed price contracts and is recognized on the
percentage-of-completion method calculated utilizing the cost-to-cost
approach. The percent deemed to be complete is calculated by comparing
the costs incurred to date to estimated total costs for each contract.
This method is used because management considers costs incurred to be
the best available measure of progress on these contracts. However,
adjustments to this measurement are made when management believes that
costs incurred materially exceed effort expended. Contract costs
include all direct material and labor costs, along with certain direct
overhead costs related to contract production.
Provisions for any estimated total contract losses on uncompleted
contracts are recorded in the period in which it becomes known that
such losses will occur. Changes in estimated total contract costs will
result in revisions to contract revenue. These revisions are recognized
when determined.
Revenue from intelligence and investigation services and information
security services is recognized as the services are performed.
Kroll-O'Gara records either billed or unbilled accounts receivable
based on case-by-case invoicing determinations.
<PAGE> 10
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Kroll-O'Gara 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 -- Pursuant to the provisions of Statement of
Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," (SFAS 115), Kroll-O'Gara
must classify its debt and marketable securities as either trading,
available-for-sale or held-to-maturity. Kroll-O'Gara's marketable
security investments consist largely of available-for-sale municipal
obligations. These securities are valued at current market value, which
approximates cost.
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. Kroll-O'Gara recorded an unrealized net loss of $3,698 as of
December 31, 1997. There were no such unrealized gains or losses as of
December 31, 1998 and 1999.
(e) CONCENTRATIONS OF CREDIT RISK -- Financial instruments that subject
Kroll-O'Gara 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 Kroll-O'Gara's client
base, along with the different industries and geographic regions in
which Kroll-O'Gara's clients operate. Kroll-O'Gara does not generally
require collateral or other security to support client receivables,
although Kroll-O'Gara does require retainers, up-front deposits or
irrevocable letters-of-credit in many situations. Kroll-O'Gara has
established an allowance for doubtful accounts based upon facts
surrounding the credit risk of specific clients and past history.
Management does not anticipate incurring losses on its trade
receivables in excess of established allowances.
(f) PROPERTY, PLANT AND EQUIPMENT -- Property, plant and equipment are
stated at cost. Depreciation is computed on both straight-line and
accelerated methods over the estimated useful lives of the related
assets as follows:
<TABLE>
<S> <C>
Buildings and improvements............................... 5-40 years
Furniture and fixtures................................... 4-10 years
Machinery and equipment.................................. 3-12 years
Leasehold improvements................................... Life of lease
</TABLE>
(g) DATABASES -- Databases are capitalized costs incurred to obtain
information from third party providers. Kroll-O'Gara 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
<PAGE> 11
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
and amortized over a five year period. Amortization of databases for the
years ended December 31, 1997, 1998 and 1999 was $2,937,152, $3,283,232
and $3,520,624, respectively.
(h) IMPAIRMENT OF LONG-LIVED ASSETS -- Pursuant to the provisions of SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for
Long-Lived Assets to Be Disposed Of" (SFAS 121), long-lived assets,
certain identifiable intangibles and goodwill related to those assets
must be reviewed for impairment by asset group for which the lowest
level of independent cash flows can be identified. In accordance with
this standard, Kroll-O'Gara 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, Kroll-O'Gara believes no
impairment existed at December 31, 1999. However, it is possible, due
to a change in circumstances, that carrying values could become
impaired in the future. Such impairment could have a material effect on
the results of operations in a particular reporting period.
(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. Costs in
excess of assets acquired, net of accumulated amortization, as of
December 31, 1998 and 1999 were $52,418,302 and $72,269,993,
respectively. Amortization is recorded on a straight-line basis over
periods ranging from 12 to 40 years. Amortization of costs in excess of
assets acquired for the years ended December 31, 1997, 1998 and 1999
were $828,913, $1,636,013 and $3,431,058, 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 amortized over the lives of
the respective agreements, which range from 6 months to fifteen years.
Other intangible assets, net of accumulated amortization, as of
December 31, 1998 and 1999 were $9,730,180 and $9,406,090,
respectively. Amortization of other intangible assets for the years
ended December 31, 1997, 1998 and 1999 was $350,309, $972,489 and
$1,147,660, respectively.
(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 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.
<PAGE> 12
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(m) RESEARCH AND DEVELOPMENT -- Research and development costs are expensed
as incurred. Kroll-O'Gara incurred approximately $136,000, $537,000 and
$297,000 for the years ended December 31, 1997, 1998 and 1999,
respectively, for research and development. These costs are included in
general and administrative expenses in the accompanying consolidated
statements of operations.
(n) ADVERTISING -- Kroll-O'Gara expenses the cost of advertising as
incurred. Advertising expenses for the years ended December 31, 1997,
1998 and 1999 were approximately $1,542,996, $2,027,233 and $2,374,096,
respectively.
(o) EARNINGS PER SHARE -- In 1997, Kroll-O'Gara 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 a 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,
1997, 1998 and 1999:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1997
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Basic earnings per share............ $709,999 14,750,676 $0.05
=====
Effect of dilutive securities:
Options........................... -- 254,575
Restricted stock.................. -- 443,152
Warrants.......................... -- 97,425
Convertible note payable.......... -- 14,222
-------- ----------
Diluted earnings per share.......... $709,999 15,560,050 $0.05
======== ========== =====
</TABLE>
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1998
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Basic earnings per share........... $11,786,065 19,336,580 $0.61
=====
Effect of dilutive securities:
Options.......................... -- 568,849
Warrants......................... -- 2,777
----------- ----------
Diluted earnings per share......... $11,786,065 19,908,206 $0.59
=========== ========== =====
</TABLE>
<PAGE> 13
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31, 1999
-----------------------------------------
LOSS SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Basic and diluted loss per share... $(1,921,819) 22,005,632 $(0.09)
=========== ======
Effect of anti-dilutive securities:
Options.......................... 546,614
Restricted stock................. 42,974
Warrants......................... 1,188
----------
Diluted shares..................... 22,596,408
==========
</TABLE>
As a result of the net loss recorded in 1999, basic and diluted
earnings per share are identical as all options and warrants are
anti-dilutive.
Basic and diluted earnings per share based on income before
extraordinary item and cumulative effect of change in accounting
principle were $0.09 and $0.08, respectively, for the year ended
December 31, 1997. The basic and diluted per share impact of the
extraordinary item were $0.01 and the basic and diluted per share
impact of the change in accounting principle were $0.03 and $0.02,
respectively.
Basic and diluted loss per share based on loss before cumulative effect
of change in accounting principle were $0.05 for the year ended
December 31, 1999. The basic and diluted per share impact of the change
in accounting principle was $0.04.
During 1997, 66,000 warrants to purchase a total of 27,746 shares of
common stock of Kroll-O'Gara at $7.20 per warrant were outstanding but
were not included in the computation of diluted earnings per share
because the warrants' exercise price was greater than the average
market price of the common shares.
During 1998, 11,666 warrants to purchase an equivalent amount of shares
of common stock of Kroll-O'Gara at $25.69 per warrant were outstanding
but were not included in the computation of diluted earnings per share
because the warrants' exercise price was greater than the average
market price of the common shares.
During 1999, 8,719 warrants and 597,155 options to purchase an
equivalent amount of shares of common stock of Kroll-O'Gara at $25.69
per warrant and from $26.94 to $34.88 per option were outstanding but
were not included in the computation of diluted weighted average shares
because the warrants' and options' exercise prices were greater than
the average market price of the common shares.
(p) NEW ACCOUNTING PRONOUNCEMENTS -- In 1998, Kroll-O'Gara 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. Kroll-O'Gara has chosen to disclose comprehensive
income, which encompasses net income, foreign currency translation
adjustments and unrealized holding gains of marketable securities, in
the consolidated statements of shareholders' equity. Prior years have
been restated to conform to the SFAS 130 requirements. 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.
<PAGE> 14
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The accumulated other comprehensive income (loss) balance of ($0.9)
million and ($0.2) million at December 31, 1998 and 1999, respectively,
consisted entirely of foreign currency translation adjustments.
In June 1998, the Financial Accounting Standards Board issued Statement
of Financial Accounting Standards No. 133, "Accounting for Derivative
Instruments and Hedging Activities" (SFAS 133). SFAS 133 establishes
accounting and reporting standards requiring that every derivative
instrument (including certain derivative instruments embedded in other
contracts) be recorded in the balance sheet as either an asset or
liability measured at its fair value. SFAS 133 requires that changes in
the derivative's fair value be recognized currently in earnings unless
specific hedge accounting criteria are met. SFAS 133, as amended, is
effective for fiscal years beginning after June 15, 2000. Kroll-O'Gara
has several forward contracts in place in association with demand notes
from certain subsidiaries. These instruments qualify for hedge
accounting. Kroll-O'Gara 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.
In March 2000, the FASB issued Financial Accounting Standards Board
Interpretation No. 44 ("Interpretation No. 44"), "Accounting for
Certain Transactions Involving Stock Compensation -- an interpretation
of APB Opinion 25." Interpretation No. 44 is effective July 1, 2000.
Interpretation No. 44 clarifies the application of APB Opinion 25 for
certain matters, specifically (a) the definition of an employee for
purposes of applying APB Opinion 25, (b) the criteria for determining
whether a plan qualifies as a noncompensatory plan, (c) the accounting
consequence of various modifications to the terms of a previously fixed
stock option or award, and (d) the accounting for an exchange of stock
compensation awards in a business combination. Management does not
anticipate that the adoption of Interpretation No. 44 will have a
material impact on Kroll-O'Gara's financial position or results of
operations.
(q) STOCK-BASED COMPENSATION -- Kroll-O'Gara has elected to account for the
cost of its employee stock options and other forms of employee
stock-based compensation plans utilizing the intrinsic value method
prescribed in Accounting Principles Board Opinion No. 25 (APB 25) as
allowed by Statement of Financial Accounting Standards No. 123,
"Accounting for Stock-Based Compensation" (SFAS 123). APB 25 requires
compensation cost for stock-based compensation plans to be recognized
based on the difference, if any, between the fair market value of the
stock on the date of grant and the option exercise price. SFAS 123
established a fair value-based method of accounting for compensation
cost related to stock options and other forms of stock-based
compensation plans. SFAS 123 allows an entity to continue to measure
compensation cost using the principles of APB 25 if certain pro forma
disclosures are made. The pro forma disclosures required by SFAS 123
are presented in Note 11(e).
(r) CHANGES IN ACCOUNTING PRINCIPLE -- In 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. Consistent with a consensus
reached by the Emerging Issues Task Force (EITF) under Issue 97-13, in
late November 1997, Kroll-O'Gara expensed costs previously capitalized
in earlier quarters of 1997 (approximately $0.4 million, net of tax
benefit of $0.2 million) as a cumulative effect of change in accounting
principle.
<PAGE> 15
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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. Kroll-O'Gara's former practice was
to capitalize certain of these expenses and amortize them over periods
ranging from one to five years. Included in the accompanying December
31, 1998 consolidated balance sheet is approximately $1.2 million of
preoperating, organization and start-up costs which would have been
expensed had this statement already been implemented. Kroll-O'Gara
adopted the provisions of this statement in the first quarter of fiscal
1999 and recorded a cumulative effect of a change in accounting
principle of $0.8 million, net of a tax benefit of $0.4 million.
(s) DERIVATIVE FINANCIAL INSTRUMENTS -- Financial instruments in the form
of foreign currency exchange contracts are utilized by Kroll-O'Gara to
hedge its exposure to movements in foreign currency exchange rates.
Kroll-O'Gara 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.
(t) RECLASSIFICATIONS -- Certain reclassifications have been reflected in
1997 and 1998 to conform with the current period presentation.
(3) MERGERS AND ACQUISITIONS --
Kroll-O'Gara has completed numerous business combinations in the periods
presented. The transactions were accounted for as both purchase business
combinations and pooling of interests business combinations as follows:
(a) POOLING OF INTERESTS TRANSACTIONS -- In December 1997, a wholly owned
subsidiary of O'Gara was merged with and into Kroll. Effective upon the
consummation of the merger with Kroll, each then issued and outstanding
share of Kroll common stock, including shares subject to issuance under
the Kroll restricted stock plan (See Note 11), were converted into
62.52 shares of common stock of Kroll-O'Gara or 6,098,561 shares of
Kroll-O'Gara's 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 Kroll-O'Gara common stock (See
Note 11).
The merger constituted a tax-free reorganization and was 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 Kroll-O'Gara.
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 Kroll-O'Gara's presentations.
The results
<PAGE> 16
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of operations for the separate companies and the combined amounts
included in the consolidated financial statements follow:
<TABLE>
<CAPTION>
O'GARA KROLL COMBINED
----------- ----------- ------------
<S> <C> <C> <C>
Nine months ended
September 30, 1997
(unaudited)
Revenue...................... $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
</TABLE>
In connection with the Kroll merger, Kroll-O'Gara recorded, in the
fourth quarter in 1997, a charge to operating expenses of approximately
$7.2 million ($5.7 million after taxes, or $0.37 per diluted share) for
direct and other merger-related costs pertaining to the transaction.
Merger transaction costs are nonrecurring and included $0.8 million for
stock based compensation costs triggered by the change in control of
Kroll, $1.8 million for stay bonuses and severance and $4.6 million
which consisted primarily of fees for investment bankers, attorneys,
accountants, financial printing, travel and other related charges.
In December 1998, a wholly owned subsidiary of Kroll-O'Gara 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 Kroll-O'Gara or 1,209,053 shares of Kroll-O'Gara'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 Kroll-O'Gara's common stock
(See Note 11). The financial position and results of operations of LSAI
are reported as part of Kroll-O'Gara's Investigations and Intelligence
Group.
In December 1998, a wholly owned subsidiary of Kroll-O'Gara 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 Kroll-O'Gara or 169,521 shares of Kroll-O'Gara's common
stock in total. The financial position and results of operations of
Schiff are reported as part of Kroll-O'Gara's Investigations and
Intelligence Group.
In December 1998, a wholly owned subsidiary of Kroll-O'Gara 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 Kroll-O'Gara's common stock at a rate of .110793 per share
of Series A Preferred, .118273 per share of Series B Preferred and
.0955252 per share of Securify common stock. In total, Kroll-O'Gara
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 Kroll-O'Gara's common stock. Effective with the consummation of the
merger, Kroll-O'Gara created the Information Security Group and
Securify's results of operations and financial position are reported in
this group.
The mergers with LSAI, Schiff and Securify constituted tax-free
reorganizations and have been accounted for as pooling of interests
transactions. Accordingly, all prior period consolidated financial
statements presented have been restated to include the combined results
of operations,
<PAGE> 17
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
financial position and cash flows of LSAI, Schiff and Securify as
though they had always been a part of Kroll-O'Gara.
There were no transactions between Kroll-O'Gara and LSAI, Schiff and
Securify prior to the combinations and immaterial adjustments were
recorded to conform LSAI's, Schiff's and Securify's accounting
policies. Certain reclassifications were made to Kroll-O'Gara's,
LSAI's, Schiff's and Securify's financial statements to conform
presentation. The results of operations for the separate companies and
the combined amounts included in the consolidated financial statements
follow:
<TABLE>
<CAPTION>
KROLL-O'GARA
HISTORICAL LSAI SCHIFF SECURIFY COMBINED
------------ ----------- ---------- --------- ------------
<S> <C> <C> <C> <C> <C>
Nine months ended
September 30, 1998
(unaudited)
Revenue.............. $178,943,336 $12,039,154 $3,531,062 $ 48,000 $194,561,552
Net income (loss).... 11,559,576 1,440,725 582,254 (944,196) 12,638,359
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
</TABLE>
In 1998, Kroll-O'Gara recorded, in the fourth quarter, a charge to
operating expenses of approximately $5.7 million ($4.1 million after
taxes, or $0.21 per diluted share) for direct and other merger and
integration related costs. Merger transaction costs are non-recurring
and included $0.8 million for stay bonuses and $4.5 million, which
consisted primarily of fees for investment bankers, attorneys,
accountants, financial printing, travel and other related charges.
Integration costs related primarily to the merger with Kroll
consummated in December 1997 and were approximately $0.4 million.
In March 1999, a wholly owned subsidiary of Kroll-O'Gara was merged
with and into Financial Research, Inc. (FRI). Effective upon the
consummation of the merger, each then issued and outstanding share of
FRI common stock was converted into 101.555 shares of common stock of
Kroll-O'Gara or 101,555 shares of Kroll-O'Gara's common stock in total.
The merger constituted a tax-free reorganization and has been accounted
for as a pooling of interests. The prior period consolidated financial
statements would not have been materially different from the reported
results and accordingly have not been restated.
In June 1999, a wholly owned subsidiary of Kroll-O'Gara was merged with
and into Background America, Inc. (BAI). Effective upon the
consummation of the merger, each then issued and outstanding share of
BAI common and preferred stock was converted into .2689628 shares of
common stock of Kroll-O'Gara or 899,243 shares of Kroll-O'Gara's common
stock in total. Outstanding stock options and stock warrants of BAI
were converted at the same exchange factor into options to purchase
86,844 and 2,018 shares, respectively, of Kroll-
<PAGE> 18
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
O'Gara's common stock (see Note 11). The financial position and results
of operations of BAI are reported as part of Kroll-O'Gara's
Investigations and Intelligence Group.
The merger with BAI constituted a tax-free reorganization and has been
accounted for as a pooling of interests. Accordingly, all prior period
consolidated financial statements presented have been restated to
include the combined results of operations, financial position and cash
flows of BAI as though it had always been a part of Kroll-O'Gara.
There were no transactions between Kroll-O'Gara and BAI prior to the
combination. Immaterial adjustments were recorded to conform the
accounting practices of Kroll-O'Gara and BAI and certain
reclassifications were made to the BAI financial statements to conform
to Kroll-O'Gara's presentation.
The combined companies have recorded an income tax benefit of $113,533
in 1998 to reflect a reduction in a valuation allowance applicable to
certain domestic net operating loss carryforwards. Included in the
December 31, 1998 consolidated balance sheet is approximately $573,000
of merger costs incurred by Kroll-O'Gara which, along with other merger
costs subsequently incurred, were expensed immediately upon
consummation of the transaction on a pooling of interests basis in
1999. The results of operations for the separate companies and the
combined amounts presented in the consolidated financial statements
follow:
<TABLE>
<CAPTION>
KROLL-O'GARA
HISTORICAL BAI ADJUSTMENTS COMBINED
------------ ----------- ----------- ------------
<S> <C> <C> <C> <C>
Three months ended
March 31, 1999 (unaudited)
Revenue......................... $ 69,007,000 $ 2,492,000 $ -- $ 71,499,000
Cumulative effect of change in
accounting principle......... (778,041) -- -- (778,041)
Net income...................... 2,418,000 110,000 -- 2,528,000
Year ended December 31, 1998
Revenue......................... 264,844,847 7,350,666 -- 272,195,513
Net income (loss)............... 13,088,906 (1,416,374) 113,533 11,786,065
Year ended December 31, 1997
Revenue......................... 206,102,605 4,221,059 -- 210,323,664
Extraordinary item.............. (193,875) -- -- (193,875)
Cumulative effect of change in
accounting principle......... (360,000) -- -- (360,000)
Net income (loss)............... 2,046,643 (1,336,644) -- 709,999
</TABLE>
In 1999, Kroll-O'Gara recorded a charge to operating expenses of
approximately $4.1 million ($3.2 million after taxes, or $0.14 per
diluted share) for direct and other merger and integration related
costs. Merger transaction costs are non-recurring and included $0.3
million for stay bonuses, $0.4 million for stock based compensation
costs triggered by the change in control of BAI and $2.4 million which
consisted primarily of fees for investment bankers, attorneys,
accountants, financial printing, travel and other related charges.
Integration costs related primarily to the mergers and acquisitions
completed in the fourth quarter of 1998 and were approximately $1.0
million.
<PAGE> 19
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(b) PURCHASE TRANSACTIONS -- In addition to the merger with Kroll,
Kroll-O'Gara completed six other acquisitions in 1997 which were
accounted for as purchase business combinations. Three of the 1997
purchase acquisitions have been included in Kroll-O'Gara's Security
Products and Services Group, two in the Investigations and Intelligence
Group and one in the Voice and Data Communications Group. The aggregate
purchase price of these six acquisitions amounted to approximately
$26.0 million and consisted of $13.4 million in cash, $4.1 million in
seller-provided financing and 753,806 shares of common stock (valued at
approximately $8.5 million or an average of $11.28 per share). In
connection with these acquisitions, Kroll-O'Gara entered into various
employment and non-compete agreements with officers and key employees
of the acquired companies with varying terms and conditions. The
results of operations of the acquired businesses are included in the
consolidated financial statements from the respective effective dates
of acquisition. The resulting goodwill from these transactions is being
amortized over periods ranging from fifteen to thirty years. In
addition to these 1997 acquisitions, Kroll-O'Gara also exercised its
option to acquire the minority interest in its O'Gara Brazilian
subsidiary for approximately 69,565 shares of common stock valued at
approximately $1.2 million.
Kroll-O'Gara made one significant acquisition in 1997 which is included
above. In February 1997, Labbe, S.A. (Labbe), a company located in
France specializing in vehicle armoring systems, was acquired for
approximately $14.2 million, consisting of $10.7 million in cash and
376,597 shares of Kroll-O'Gara's common stock valued at approximately
$3.5 million or $9.29 per share. For accounting purposes, the
acquisition was effective on January 1, 1997 and the results of
operations of Labbe are included in the consolidated results of
operations of Kroll-O'Gara from that date forward.
In addition to the mergers with LSAI, Schiff and Securify, Kroll-O'Gara
completed nine other acquisitions in 1998, all of which were accounted
for as purchase business combinations. Eight of the 1998 purchase
acquisitions have been included in Kroll-O'Gara's Investigations and
Intelligence Group and the ninth has been included in the Security
Products and Services Group. The aggregate purchase price of these nine
acquisitions amounted to approximately $37.1 million and consisted of
$19.5 million in cash and 767,416 shares of common stock (valued at
approximately $17.6 million or an average of $22.93 per share). The
$37.1 million aggregate purchase price for the 1998 acquisitions
excludes a potential earnout of $3.25 million applicable to one of the
acquired companies, which is payable over three years and is contingent
upon the achievement of specified operating income targets.
Approximately $1.1 million was earned and accrued at December 31, 1999
pursuant to this earnout agreement. In conjunction with one of the 1998
purchase acquisitions, the shareholders of the acquired entity had the
option to put the shares of common stock received for cash of $22.31
per share for a certain defined period. The put option relating to
7,471 shares issued in connection with this acquisition was exercised
for $166,668 in cash with the remaining put options expiring
unexercised. In addition, in connection with several of these
acquisitions, Kroll-O'Gara entered into various employment and
non-compete agreements with officers and key employees of the acquired
companies with varying terms and conditions. The results of operations
of the acquired businesses are included in the consolidated financial
statements from the respective effective dates of acquisition. The
resulting goodwill from these transactions is being amortized over
periods ranging from twelve to twenty-five years.
<PAGE> 20
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Kroll-O'Gara made one significant acquisition in 1998 which is included
above. In September 1998, Kizorek, Inc., now renamed InPhoto
Surveillance, Inc. (InPhoto), a company located in Illinois specializing
in video surveillance services, was acquired for approximately $9.1
million, consisting of $0.9 million in cash and 352,381 shares of
Kroll-O'Gara's common stock valued at approximately $8.2 million or
$23.35 per share. For accounting purposes, the acquisition was effective
on July 1, 1998 and the results of operations of InPhoto are included in
the consolidated results of operations of Kroll-O'Gara from that date
forward. The following unaudited pro forma combined results of
operations for the years ended December 31, 1997 and 1998 assumes the
InPhoto acquisition occurred as of January 1, 1997 (in thousands, except
per share data):
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
------------------------
1997 1998
---------- ----------
<S> <C> <C>
Sales.............................................. $224,800 $278,581
Income before extraordinary item and cumulative
effect of accounting change...................... 1,716 11,680
Net income......................................... 1,162 11,680
Earnings per share:
Basic............................................ $ 0.08 $ 0.60
Diluted.......................................... $ 0.07 $ 0.58
</TABLE>
In addition to the mergers with BAI and FRI during 1999, Kroll-O'Gara
completed an additional acquisition in 1999 which was accounted for as
a purchase business combination. In June 1999 Kroll-O'Gara completed
the acquisition of substantially all of the assets and liabilities of
The Buchler Phillips Group (BP). BP provides financial recovery,
restructuring, insolvency and turnaround services throughout the United
Kingdom and Europe and has been included in the Investigations and
Intelligence Group. The purchase price amounted to approximately $20.0
million and consisted of approximately $12.0 million in cash and
366,469 shares of Kroll-O'Gara's common stock (valued at approximately
$8.0 million or an average of $21.86 per share). For accounting
purposes, the acquisition was effective on April 1, 1999 and the
results of operations of BP are included in the consolidated results of
operations of Kroll-O'Gara from that date forward. The resulting
goodwill from this acquisition is being amortized over 25 years.
<PAGE> 21
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the 1997, 1998 and 1999 purchase acquisitions,
assets were acquired and liabilities assumed were as follows (dollars
in thousands):
<TABLE>
<CAPTION>
OTHER 1997 OTHER 1998 1999
LABBE ACQUISITIONS INPHOTO ACQUISITIONS ACQUISITION
-------- ------------ ------- ------------ -----------
<S> <C> <C> <C> <C> <C>
FAIR VALUE OF ASSETS
ACQUIRED INCLUDING:
Cash................... $ 3,501 $ 125 $ 192 $ 701 $ 4
Accounts receivable.... 4,689 2,072 1,743 5,300 1,174
Inventories............ 3,392 1,829 -- -- --
Unbilled revenue....... -- -- 269 1,561 5,441
Other current assets... 316 11 450 551 852
Property, plant and
equipment........... 3,360 378 955 1,243 1,233
Other non-current
assets.............. 2,357 4 -- 271 319
Costs in excess of
assets acquired and
other intangible
assets.............. 7,802 11,727 9,790 28,874 20,835
-------- ------- ------- -------- --------
25,417 16,146 13,399 38,501 29,858
Less: Cash paid for net
assets.............. (10,730) (2,700) (854) (18,689) (12,018)
Fair value of debt
issued.............. -- (4,126) -- -- --
Fair value of stock
issued.............. (3,431) (5,029) (8,228) (9,381) (8,012)
-------- ------- ------- -------- --------
$ 11,256 $ 4,291 $ 4,317 $ 10,431 $ 9,828
======== ======= ======= ======== ========
LIABILITIES ASSUMED
INCLUDING:
Liabilities assumed and
acquisition costs... $ 9,287 $ 4,272 $ 4,117 $ 9,583 $ 7,508
Debt................... 1,969 19 200 848 2,320
-------- ------- ------- -------- --------
$ 11,256 $ 4,291 $ 4,317 $ 10,431 $ 9,828
======== ======= ======= ======== ========
</TABLE>
(4) BALANCE SHEET ACCOUNTS --
(a) TRADE ACCOUNTS RECEIVABLE AND COSTS AND ESTIMATED EARNINGS IN EXCESS OF
BILLINGS ON UNCOMPLETED CONTRACTS -- The following summarizes the
components of trade accounts receivable and costs and estimated
earnings in excess of billings on uncompleted contracts:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1999
----------- -----------
<S> <C> <C>
United States Military:
Billed receivables.......................... $ 3,225,664 $ 4,877,570
Costs and estimated earnings in excess of
billings on uncompleted contracts........ 21,042,185 13,827,929
----------- -----------
Total United States Military........ $24,267,849 $18,705,499
=========== ===========
</TABLE>
<PAGE> 22
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
1998 1999
----------- -----------
<S> <C> <C>
Other contracts and receivables:
Billed receivables.......................... $53,735,089 $63,139,492
Costs and estimated earnings in excess of
billings on uncompleted contracts........ 5,365,912 10,331,795
----------- -----------
Total other contracts and
receivables....................... $59,101,001 $73,471,287
=========== ===========
Total trade accounts receivable, net.......... $56,960,753 $68,017,062
=========== ===========
Total costs and estimated earnings in excess
of billings on uncompleted contracts........ $26,408,097 $24,159,724
=========== ===========
</TABLE>
Costs and estimated earnings in excess of billings on uncompleted
contracts are net of $107,374,834 and $131,582,751 of progress billings
to the United States Military at December 31, 1998 and 1999,
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
from the balance sheet date 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
BEGINNING OF COSTS AND BALANCE END
PERIOD EXPENSES DEDUCTIONS OF PERIOD
------------ ---------- ----------- -----------
<S> <C> <C> <C> <C>
Year ended December 31, 1997....... $2,532,566 $2,083,080 $(1,506,900) $3,108,746
Year ended December 31, 1998....... 3,108,746 2,556,506 (1,843,946) 3,821,306
Year ended December 31, 1999....... 3,821,306 4,360,227 (3,402,627) 4,778,906
</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,
--------------------------
1998 1999
----------- -----------
<S> <C> <C>
Raw materials................................. $ 8,148,000 $15,347,831
Vehicle costs and work-in-process............. 14,249,939 10,916,557
----------- -----------
$22,397,939 $26,264,388
=========== ===========
</TABLE>
<PAGE> 23
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The following summarizes activity in valuation reserves for inventory
obsolescence:
<TABLE>
<CAPTION>
ADDITIONS
BALANCE CHARGED TO BALANCE
BEGINNING OF COSTS AND END OF
PERIOD EXPENSES DEDUCTIONS PERIOD
------------ ---------- ---------- ----------
<S> <C> <C> <C> <C>
Year ended December 31,
1997...................... $264,114 $113,567 $(23,782) $ 353,899
Year ended December 31,
1998...................... 353,899 7,971 -- 361,870
Year ended December 31,
1999...................... 361,870 804,960 -- 1,166,830
</TABLE>
(c) OTHER ASSETS -- Other assets are stated at cost less accumulated
amortization and are being amortized on a straight line basis over
their estimated useful lives, as applicable. Other assets consist of
the following:
<TABLE>
<CAPTION>
USEFUL DECEMBER 31,
LIFE -----------------------
DESCRIPTION (YEARS) 1998 1999
----------- ----------- ---------- ----------
<S> <C> <C> <C>
Advance to vendor..................... -- $1,130,361 $ --
Preoperating and start-up costs....... -- 1,185,574 --
Security deposits..................... -- 1,003,666 971,405
Pending acquisition costs............. -- 573,035 --
Long-term receivable.................. -- 380,000 1,112,681
Non-refundable deposit on an equipment
lease with a related party.......... 5 537,784 537,784
Deferred financing fees............... 7-30 906,667 920,492
Investment in unconsolidated
subsidiary.......................... -- -- 520,695
Other long-term assets................ -- 585,557 653,935
---------- ----------
6,302,644 4,716,992
Less- accumulated amortization........ (209,209) (412,992)
---------- ----------
$6,093,435 $4,304,000
========== ==========
</TABLE>
Preoperating and start-up costs in 1998 included costs applicable to
bids in process which were deferred when management believed it was
probable that future contracts would be obtained. These costs were
transferred to contract costs when contracts were awarded or were
expensed when the contract award was no longer considered probable.
Preopening and start-up costs also included certain costs incurred in
connection with establishing operations in new locations. In accordance
with SOP 98-5, all such costs were expensed in the first quarter of
fiscal 1999 (see Note 2(r)).
<PAGE> 24
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) ACCRUED LIABILITIES -- Accrued liabilities consist of the following at
December 31, 1998 and 1999:
<TABLE>
<CAPTION>
DECEMBER 31,
--------------------------
DESCRIPTION 1998 1999
----------- ----------- -----------
<S> <C> <C>
Payroll and related benefits.................. $ 9,860,811 $11,019,288
Accrued professional fees..................... 3,993,486 2,113,264
Property, sales and other taxes payable....... 2,160,417 2,636,732
Accrued satellite time........................ 1,948,557 1,619,204
Accrued hedge contract settlement............. 710,760 --
Accrued medical costs......................... 483,038 645,132
Accrued interest.............................. 460,923 497,576
Accrued warranty reserve...................... 451,773 442,597
Accrued payments to former owners of acquired
businesses.................................. 515,538 2,868,569
Accrued restructuring costs................... -- 664,900
Other accruals................................ 2,215,133 5,791,744
----------- -----------
$22,800,436 $28,299,006
=========== ===========
</TABLE>
(e) RESTRUCTURING OF OPERATIONS -- In the first quarter of 1999,
Kroll-O'Gara began implementation of a restructuring plan (the "Plan")
to reduce costs and improve operating efficiencies. The Plan was
substantially completed by the end of the second quarter of 1999. The
total non-recurring pre-tax restructuring charge recorded pursuant to
the Plan was approximately $4.4 million. Total payments or writeoffs
made pursuant to the Plan through December 31, 1999 were $3.1 million.
Kroll-O'Gara does not expect to incur any other significant
restructuring charges in future periods related to this Plan. The
principal elements of the restructuring plan were the closure of two
Investigations and Intelligence Group offices and the elimination of
approximately 82 employees. The primary components of the restructuring
charge, including accrued balances as of December 31, 1999, were as
follows:
<TABLE>
<CAPTION>
DESCRIPTION EXPENSE ACCRUAL
----------- ---------- ----------
<S> <C> <C>
Severance and related costs..................... $3,116,303 $ 540,667
Writedown of property, plant and equipment...... 150,166 --
Lease termination costs......................... 1,064,270 686,301
Other........................................... 32,827 --
---------- ----------
$4,363,566 1,226,968
==========
Less -- Current portion......................... (664,900)
----------
$ 562,068
==========
</TABLE>
(5) INCOME TAXES --
Kroll-O'Gara accounts for income taxes under the liability method pursuant
to Statement of Financial Accounting Standards No. 109, "Accounting for
Income Taxes." Under the liability
<PAGE> 25
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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.
Kroll-O'Gara's provision (benefit) for income taxes, excluding extraordinary
item and the cumulative effect of a change in accounting principle, for all
periods is summarized as follows:
<TABLE>
<CAPTION>
1997 1998 1999
----------- ---------- -----------
<S> <C> <C> <C>
Currently payable:
Federal........................ $ 2,800,720 $5,530,085 $ 1,887,333
State and local................ 576,837 965,158 333,059
Foreign........................ 1,364,873 1,834,143 2,235,172
----------- ---------- -----------
4,742,430 8,329,386 4,455,564
----------- ---------- -----------
Deferred:
Federal........................ (1,213,147) (847,018) (1,352,885)
State and local................ (224,290) (129,437) (238,745)
Foreign........................ -- -- (434,524)
----------- ---------- -----------
(1,437,437) (976,455) (2,026,154)
----------- ---------- -----------
$ 3,304,993 $7,352,931 $ 2,429,410
=========== ========== ===========
</TABLE>
A reconciliation between the statutory federal income tax rate and the
effective tax rate is summarized as follows:
<TABLE>
<CAPTION>
1997 1998 1999
----------------- ----------------- ------------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
---------- ---- ---------- ---- ---------- -----
<S> <C> <C> <C> <C> <C> <C>
Provision for income
taxes at the
federal statutory
rate............... $1,553,415 34.0% $6,583,815 34.4% $ 437,115 34.0%
State and local
income taxes, net
of federal
benefit............ 295,119 6.5 637,004 3.3 47,750 3.7
Nondeductible
expenses........... 1,437,174 31.4 275,294 1.4 2,010,619 156.4
Change in valuation
allowance.......... (319,283) (7.0) (1,035) -- (119,704) (9.3)
Effect of foreign
(income) loss...... 577,743 12.6 (47,924) (0.2) (187,783) (14.6)
Other................ (239,175) (5.2) (94,223) (0.5) 241,413 18.8
---------- ---- ---------- ---- ---------- -----
Provision for
income taxes.... $3,304,993 72.3% $7,352,931 38.4% $2,429,410 189.0%
========== ==== ========== ==== ========== =====
</TABLE>
<PAGE> 26
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of Kroll-O'Gara's consolidated deferred income tax assets and
liabilities as of December 31 are summarized below:
<TABLE>
<CAPTION>
1998 1999
----------- -----------
<S> <C> <C>
Deferred tax assets:
Allowance for doubtful accounts............. $ 432,027 $ 1,051,436
Depreciation and amortization............... 244,693 320,653
Net operating loss carryforwards............ 3,774,470 3,847,371
Payroll and other benefits.................. 1,721,081 1,452,718
Restructuring............................... -- 658,246
Other accruals.............................. 707,708 961,809
Acquisition costs........................... 1,697,885 1,694,866
Other....................................... 512,382 779,765
----------- -----------
9,090,246 10,766,864
Valuation allowance......................... (3,303,683) (3,183,979)
----------- -----------
Net deferred tax assets.................. 5,786,563 7,582,885
----------- -----------
Deferred tax liabilities:
Nonaccrual service fee receivable........... (156,804) (181,579)
Deferred revenue............................ (3,540,825) (4,220,953)
Database capitalization..................... (2,951,351) (3,107,610)
Customer lists, net of amortization......... (310,667) (121,399)
Percentage of completion on foreign
subsidiaries............................. (381,917) (201,148)
Foreign leasing transactions................ (125,827) (147,146)
Other....................................... (726,110) (600,034)
----------- -----------
(8,193,501) (8,579,869)
----------- -----------
Net deferred tax liability.................... $(2,406,938) $ (996,984)
=========== ===========
</TABLE>
Kroll-O'Gara has certain foreign and domestic net operating loss
carryforwards, which approximated $3.8 million at December 31, 1998 and
1999, respectively. The foreign net operating loss carryforwards relate
primarily to the United Kingdom, Mexico and the Philippines. The
carryforwards expire beginning in 2001. A valuation allowance for the
majority of all existing foreign carryforwards has been provided as it is
not more likely than not that the tax benefit will be realized in the
foreseeable future. Adjustments to the valuation allowance, if any, will be
recorded in the periods in which it is determined the asset is realizable.
<PAGE> 27
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(6) RELATED PARTY TRANSACTIONS --
(a) SUMMARY OF RELATED PARTY TRANSACTIONS -- The following summarizes
transactions with related parties:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
------------------------------------
1997 1998 1999
---------- ---------- ----------
<S> <C> <C> <C>
Sales
to Shareholder..................... $6,412,244 $4,877,478 $4,779,449
to affiliated entities............. 1,294,800 821,400 70,595
Purchases
from Shareholder................... 814,154 474,800 361,320
from affiliated entities........... 447,525 1,406,210 382,100
Lease expense to affiliated
entities........................... 856,300 916,600 792,979
Legal services expense provided by
former Director.................... 170,000 190,000 --
Non-interest bearing advances to
shareholders....................... 525,996 568,213 581,779
Air charter fees included in offering
or merger costs.................... 576,000 566,000 --
Interest on shareholder notes
payable............................ 78,950 1,100 --
Forgiveness of note payable to
affiliated entity/shareholder...... 1,053,735 -- --
Non-interest bearing advances to
affiliates......................... 282,346 615,851 282,346
Trade accounts receivable due from
shareholder........................ 897,361 1,290,558 1,231,685
</TABLE>
(b) NOTES PAYABLE -- SHAREHOLDERS -- BAI had certain notes payable to
shareholders. Interest expense associated with these obligations
approximated $78,950 and $1,100 in 1997 and 1998, respectively. In June
1997, approximately $1,053,735 of the principal and accrued interest
payable by BAI to certain shareholders was canceled in partial
consideration for the issuance of stock. The remaining outstanding
balance of $152,000 was paid in full during 1998.
(c) SALES -- SHAREHOLDER -- During 1997, 1998 and 1999, Kroll-O'Gara
rendered services to American International Group, Inc. and its
subsidiaries (AIG) which is also a shareholder of Kroll-O'Gara. Total
revenue recognized for the years ended December 31, 1997, 1998 and 1999
was $6,412,244, $4,877,478 and $4,779,449, respectively. Additionally,
AIG provides certain services to Kroll-O'Gara which have been included
in cost of sales and operating expenses in the accompanying
consolidated statements of operations. These costs were approximately
$814,154, $474,800 and $361,320 for the years ended December 31, 1997,
1998 and 1999, respectively. The yearend accounts receivable balance
for AIG was approximately $1,290,558 and $1,231,685 at December 31,
1998 and 1999, respectively.
(d) BUILDING AND EQUIPMENT LEASES -- AFFILIATED ENTITIES -- Effective June
1, 1998, Kroll-O'Gara reached an agreement to terminate the corporate
aircraft lease which originated in February 1995 with an affiliated
entity. The terms of the aircraft lease addendum provide Kroll-O'Gara
with a future hourly discount from the normal commercial hourly rate in
order to
<PAGE> 28
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
amortize the remaining portion of existing lease deposits from the
original aircraft lease. Rental expense, including amortization
recognized, approximated $234,000, $292,000 and $82,000 for the years
ended December 31, 1997, 1998 and 1999, respectively. Kroll-O'Gara also
paid this affiliated entity $576,000 in fiscal 1997 for usage of the
aircraft to consummate the merger with Kroll and included such amount in
merger-related costs. Kroll-O'Gara paid $296,000 in 1998 for usage of
the aircraft during the roadshow for a stock offering and included such
amount in stock issuance costs. Kroll-O'Gara also paid $270,000 in
fiscal 1998 for usage of the aircraft to consummate the merger with
Securify and included such amount in merger related costs. Management is
of the opinion that the hourly rate paid by Kroll-O'Gara was equivalent
to the rate charged by the affiliated entity to other unrelated
companies for similar services and it was favorably comparable to rates
charged by another unrelated charter service for similar aircraft. As of
December 31, 1998 and 1999, Kroll-O'Gara had approximately $484,371 and
$402,801, respectively in unamortized lease deposits with this
affiliated entity.
Kroll-O'Gara is also currently leasing various equipment and office
space from several affiliated entities under various three year
and month-to-month lease agreements. Rental expense, net of sub-lease
income, approximated $622,000, $625,000 and $711,000 for the years ended
December 31, 1997, 1998 and 1999, respectively.
(7) REVOLVING LINES OF CREDIT --
On September 14, 2000, Kroll-O'Gara amended its existing credit agreement
to extend its temporary increase in its revolving line of credit from $25.0
million to $40.0 million. Pursuant to the amended credit agreement, the
increase in the revolving line of credit is effective until January 1,
2001, at which time all borrowings in excess of $25.0 million must be
repaid. See Note 17 for additional discussion. The credit facility
continues to provide for a letter of credit facility of approximately $7.6
million. Both the letter of credit facility and the revolving line of
credit mature on May 31, 2001. Advances under the revolving line of credit
bear interest at rates ranging from prime to prime plus 0.75%, or, at
Kroll-O'Gara's option, LIBOR plus 1.50% to LIBOR plus 2.50%, dependent upon
a defined financial ratio. Average borrowings under the revolving line of
credit and its predecessors were $4,568,994, $1,659,131 and $10,838,273
during 1997, 1998 and 1999, respectively, at approximate weighted average
interest rates of 8.46%, 7.96% and 7.02%, respectively. The maximum
borrowings outstanding during 1997, 1998, and 1999 were $11,600,000,
$7,735,029 and $22,822,706, respectively. Borrowings under this line of
credit were approximately $22.8 million at December 31, 1999. There were no
outstanding borrowings pursuant to line of credit agreements at December
31, 1998.
This credit agreement includes financial covenants which, among other
restrictions, require the maintenance of certain financial ratios and other
financial requirements, including an interest coverage ratio and net worth
minimum, and impose limitations on foreign investment, goodwill, additional
indebtedness and capital expenditures. Kroll-O'Gara was not in compliance
with certain of these covenants as of December 31, 1999. All such events of
non-compliance were subsequently waived or amended by the lender. Had the
lender not provided a waiver or amendment, all amounts outstanding under
the credit agreement would have been subject to acceleration by the lender.
Effective June 3, 1999, with the acquisition of BP, Kroll-O'Gara acquired a
demand note with maximum borrowings of L2.5 million. The demand note bears
interest at the Bank of England's
<PAGE> 29
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
base rate plus 1.5%. Average borrowings during 1999 under the demand note
were $2,836,905, as translated, at an approximate weighted average interest
rate of 6.71%. The maximum borrowings outstanding during 1999 were
$3,675,097, as translated. Maximum borrowings permitted and borrowings
outstanding pursuant to this demand note were approximately $4.0 million
and $3.4 million, respectively, as translated at December 31, 1999.
Kroll-O'Gara also had borrowings of approximately $0.4 million outstanding
as of December 31, 1999, pursuant to various overdraft facilities of
certain subsidiaries.
In connection with a refinancing in 1997, Kroll-O'Gara fully amortized the
remaining deferred financing costs from a previous agreement, resulting in
an extraordinary charge to Kroll-O'Gara's net income of $193,875, after
income tax benefits of $129,250, or $0.01 per diluted share.
(8) LONG-TERM DEBT --
The components of long-term debt are as follows at:
<TABLE>
<CAPTION>
DECEMBER 31,
-------------------------
1998 1999
----------- -----------
<S> <C> <C>
Senior unsecured notes payable to various institutions,
interest at 8.56% (9.56% prior to May 1998) payable
semi-annually, principal payable at maturity in May 2004,
subject to prepayment penalties........................... $35,000,000 $35,000,000
Economic Development Revenue Bonds, variable interest rate
approximating 85% of the bond equivalent yield of 13 week
U.S. Treasury bills (not to exceed 12%), which
approximated 5.17% at December 31, 1999, payable in
scheduled installments through September 2016, subject to
optional tender by the bondholders and a corresponding
remarketing agreement, secured by certain property, plant
and equipment and a bank letter of credit (Note 12)....... 1,357,224 1,275,974
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.......................... 2,526,361 1,994,414
Notes payable to banks, variable interest rate at prime plus
1.5%, fixed rates ranging from 6.39% to 20.66%, payable in
scheduled installments through December, 2010 with certain
instruments subject to prepayment penalties,
collateralized by certain real and personal property...... 1,001,204 452,806
Other notes payable, interest at 7% to 10.9%, payable in
scheduled installments through September 2007, certain
notes secured by various equipment........................ 1,462,065 1,278,196
----------- -----------
Less -- current portion..................................... 41,346,854) 40,001,390)
(2,000,299 (3,737,227
----------- -----------
$39,346,555 $36,264,163
=========== ===========
</TABLE>
<PAGE> 30
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Kroll-O'Gara's $35.0 million of senior unsecured notes payable also
contains financial covenants, which among other restrictions, requires the
maintenance of a minimum level of net worth and a fixed charge coverage
ratio.
Scheduled maturities of long-term debt at December 31, 1999 are as follows:
<TABLE>
<S> <C>
2000...................................................... $ 3,737,227
2001...................................................... 355,759
2002...................................................... 180,031
2003...................................................... 128,775
2004...................................................... 35,134,848
Thereafter................................................ 464,750
-----------
$40,001,390
===========
</TABLE>
(9) OPERATING LEASES --
Kroll-O'Gara leases office space and certain equipment and supplies under
agreements with terms from one to fifteen 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, 1999:
Rental expense charged against current operations amounted to approximately
$4,329,000, $6,691,000 and $10,204,000, for the years ended December 31,
1997, 1998 and 1999, respectively.
<TABLE>
<S> <C>
2000...................................................... $ 9,250,804
2001...................................................... 8,606,454
2002...................................................... 6,029,952
2003...................................................... 5,191,308
2004...................................................... 4,057,019
Thereafter................................................ 13,434,484
-----------
$46,570,021
===========
</TABLE>
(10) DEFINED CONTRIBUTION AND BONUS PLANS --
As of December 31, 1999, Kroll-O'Gara had the following employee benefit
plans in place:
(a) DEFINED CONTRIBUTION PLANS -- Kroll-O'Gara and its subsidiaries have
established various profit sharing/401(k) plans covering substantially
all of Kroll-O'Gara's employees. Contributions to the plans are
discretionary and are determined annually by Kroll-O'Gara's Board of
Directors. Certain plans also offer a matching contribution whereby
Kroll-O'Gara 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 $1,211,140, $797,003 and $1,189,841, for the years
ended December 31, 1997, 1998 and 1999, respectively.
(b) PROFIT AND REVENUE SHARING PLANS -- Kroll-O'Gara and its subsidiaries
have established various profit and revenue sharing plans covering
substantially all of Kroll-O'Gara's employees.
<PAGE> 31
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The plans were established to provide employees an annual cash
incentive bonus based on various operating and non-operating criteria.
Kroll-O'Gara may amend, modify or terminate these plans at any time.
Kroll-O'Gara expensed approximately $516,000, $476,000 and $1,235,000
associated with the profit and revenue sharing plans in 1997, 1998 and
1999, respectively.
(11) EQUITY ARRANGEMENTS --
(a) STOCK OPTION PLANS -- In 1996, Kroll-O'Gara adopted a stock option plan
(the 1996 Plan) for employees, non-employee directors and consultants.
Kroll-O'Gara may grant options for up to 1,757,000 shares under the
1996 Plan. Options for 482,050, 360,000 and 647,195 shares were granted
during 1997, 1998 and 1999, respectively. Options granted under the
plan have been granted at fair market value at the date of grant and
are exercisable over periods not exceeding ten years. Additionally,
effective with the mergers with Kroll, LSAI, Securify and BAI each
outstanding stock option was converted at the respective exchange
factor into options to purchase Kroll-O'Gara common stock. After
conversion, total stock options granted under the previously existing
Kroll, LSAI, Securify and BAI stock option plans in 1997 and 1998 were
174,887 and 248,497, respectively. No options were granted under
previously existing stock option plans in 1999.
In connection with stock options granted by Securify during the year
ended December 31, 1998, Kroll-O'Gara recorded deferred compensation of
$1,192,096, representing the difference between the deemed value of the
common stock for accounting purposes and the option exercise price of
such options at the date of grant. This amount is presented as a
reduction of shareholders' equity, to be expensed ratably over the
vesting periods of the applicable options. Approximately $78,000 and
$298,000 was expensed in 1998 and 1999, respectively, with the balance
to be expensed ratably over the next three years as the options vest.
Effective May 12, 2000, Kroll-O'Gara established a new stock option
plan (the 2000 Plan). Pursuant to this plan, employees were granted
879,400 stock options on May 12, 2000. Additionally, effective May 12,
2000, Kroll-O'Gara amended the 1996 Plan and granted options to certain
employees for 118,000 shares of common stock under that plan.
(b) RESTRICTED STOCK PLAN -- Effective June 14, 1993, Kroll replaced a
previously existing long-term incentive plan with a restricted stock
plan. The restricted stock plan provided for cliff vesting after a
five-year period from the date the stock was awarded. Under the
provisions of the plan, a participant had the ability to put the stock
back to Kroll and receive cash for the then fair value of the stock. In
addition, the plan included a provision which resulted in accelerated
vesting of all shares in the event of a change in control of Kroll.
Kroll-O'Gara 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.
Kroll also entered into other agreements with certain of its senior
executives which provided additional grants. 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 Kroll-O'Gara
recognized compensation expense of approximately $800,000 in 1997,
which is included with merger related costs in the
<PAGE> 32
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
accompanying consolidated statement of operations. In addition to the
regular tax benefits based on compensation expense recognized,
Kroll-O'Gara also realized a tax benefit for the fair market value of
all restricted shares which became fully vested in 1997. This benefit
of approximately $2.2 million has been recognized as an increase to
additional paid in capital in the accompanying consolidated statement
of shareholders' equity. This balance represents the spread between
cumulative compensation expense recognized by Kroll-O'Gara for
accounting purposes and the cumulative compensation expense recognized
for tax purposes based on the fair market value of the shares. No
shares were outstanding under the plan as of December 31, 1997 and
effective January 2, 1998, further issuances under the plan were ceased
by a board resolution.
Effective August 12, 1998, Kroll-O'Gara adopted a stock incentive plan
(the 1998 Stock Incentive Plan) for employees. Kroll-O'Gara may grant
up to 500,000 shares under the 1998 Stock Incentive Plan. There were no
shares granted under the plan during 1998; however, during fiscal 1999,
47,500 shares were granted under the plan. In connection with the
shares granted under the Stock Incentive Plan in 1999, Kroll-O'Gara
recorded deferred compensation of $1,571,661, representing the
difference between the fair market value of Kroll-O'Gara common stock
on the date of grant and the purchase price of the shares. This amount
is presented as a reduction of shareholders' equity, to be expensed
ratably over the vesting periods of the applicable grants.
Approximately $758,000 was expensed in 1999 and the balance will be
expensed ratably over the next two years as the grants vest.
(c) PURCHASE AND RETIREMENT OF COMMON STOCK -- In accordance with Kroll's
historical bylaws, restricted stock and stock option agreements, Kroll
acquired 259,036 shares (representing shares and shares under options)
of a former director for approximately $2.7 million upon his leaving
the employment of Kroll in January 1997.
(d) COMMON STOCK WARRANTS -- In connection with LSAI's initial public
offering on October 11, 1994, LSAI issued 660,000 warrants. No warrants
had been exercised at December 31, 1996. Until April 15, 1997, each
warrant could be exercised to purchase .4204 shares of common stock 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 Kroll-O'Gara and one
warrant for .4204 additional shares of common stock of Kroll-O'Gara,
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
<PAGE> 33
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Kroll-O'Gara 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 Kroll-O'Gara comprising the unit for $7.20.
The remaining 36,000 of the Underwriter Warrants with respect to the
.4204 shares of common stock had not been exercised and were
outstanding at December 31, 1997. The proceeds from the exercise of all
warrants during 1997 are included in net proceeds from exercise of
stock options and warrants in the accompanying consolidated statement
of cash flows and approximated $2.7 million, net of commissions and
other offering expenses.
In connection with the Warrant Redemption, LSAI issued warrants to
purchase 30,281 shares of common stock of Kroll-O'Gara to various
investment bankers as a portion of their compensation for serving as
managers of the Warrant Redemption and certain other services. These
warrants have an exercise price per share of $10.47 and expire on
October 14, 2000. Both the number of shares and the exercise price per
share are subject to adjustment under certain circumstances. The value
of these warrants, recognized as compensation paid to the investment
bankers for services provided, was treated as a reduction in the
recognized net proceeds to LSAI from the Warrant Redemption. The value
of the outstanding warrants is included in paid in capital in excess of
par and entirely offsets the recognized compensatory value of the
warrants, resulting in no net effect on shareholders' equity.
As of December 31, 1999, 8,775 warrants granted by LSAI were still
outstanding.
As of December 31, 1999, BAI had outstanding warrants to purchase 135
shares of Kroll-O'Gara's common stock at $13.01 per share and 1,076
shares of Kroll-O'Gara's common stock at $4.65 per share. These
warrants were issued in June and July of 1996 to certain consultants
and other non-employees of BAI with exercise prices equal to or greater
than the then fair value of BAI's common stock on those dates.
Additionally, as of December 31, 1999, BAI also had outstanding
warrants to purchase 807 shares of Kroll-O'Gara's common stock at
$19.52 per share which were issued in January 1998.
As of December 31, 1999, Kroll-O'Gara had a total of 10,793 warrants
still outstanding.
(e) STOCK BASED COMPENSATION DISCLOSURE -- SFAS 123 requires, at a minimum,
pro forma disclosures of expense for stock-based awards based on their
fair values. Had compensation cost for these plans been determined
consistent with SFAS 123, Kroll-O'Gara's net income (loss) and diluted
earnings (loss) per share for the years ended December 31, 1997, 1998
and 1999 would have been as follows:
<TABLE>
<CAPTION>
1997 1998 1999
--------- ----------- -----------
<S> <C> <C> <C>
Net income (loss):
As reported..................... $ 709,999 $11,786,065 $(1,921,819)
Pro forma....................... $(403,461) $ 9,315,427 $(4,844,407)
Diluted earnings (loss) per share:
As reported..................... $ .05 $ .59 $ (.09)
Pro forma....................... $ (.03) $ .47 $ (.22)
</TABLE>
<PAGE> 34
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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 1997, 1998 and 1999:
<TABLE>
<CAPTION>
YEAR ENDED DECEMBER 31,
----------------------------------------------------------
1997 1998 1999
----------------- --------------- ------------------
<S> <C> <C> <C>
Dividend yield....... -- -- --
Expected
volatility......... 0% - 40.5% 40% - 41.4% 41.4%
Risk-free interest
rate............... 5.8% - 6.76% 4.2% - 5.7% 5.29% - 5.44%
Expected lives....... 5 - 7.5 years 1.5 - 7.5 years 7.5 years
</TABLE>
Option grants by Kroll-O'Gara during 1997 have a weighted-average
exercise price of $14.56, a weighted-average fair value of $7.28 and
contractual lives, on a weighted-average basis, of 9.4 years. The
608,497 options granted by Kroll-O'Gara during 1998 have a
weighted-average exercise price of $12.78, a weighted-average fair value
of $9.35 and contractual lives, on a weighted-average basis, of 9.4
years. The 647,195 options granted by Kroll-O'Gara during 1999 have a
weighted-average exercise price of $27.31, a weighted-average fair value
of $15.49 and contractual lives, on a weighted-average basis, of 9.2
years.
A summary of the status of Kroll-O'Gara's stock option plans at December
31, 1997, 1998 and 1999, and the change during the years then ended is
presented in the table below:
<TABLE>
<CAPTION>
1997 1998 1999
-------------------- -------------------- --------------------
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............. 812,749 $ 6.68 1,371,808 $10.11 1,459,990 $11.54
Granted............. 656,937 14.56 608,497 12.78 647,195 27.31
Exercised........... (6,745) 8.50 (477,894) 8.52 (194,371) 9.11
Forfeited/Expired/
Cancelled........ (91,133) 11.74 (42,421) 17.05 (82,775) 23.06
--------- ------ --------- ------ --------- ------
Outstanding, end of
year................ 1,371,808 $10.11 1,459,990 $11.54 1,830,039 $17.06
========= ====== ========= ====== ========= ======
Exercisable, end of
year................ 761,825 $ 6.52 855,122 $ 8.31 983,510 $10.53
========= ====== ========= ====== ========= ======
</TABLE>
Of the options outstanding at December 31, 1999, 274,173 options are
exercisable at prices per share ranging from $0.52 to $2.79 per share,
673,898 options are exercisable at prices per share ranging from $4.65
to $18.59 per share and 881,968 options are exercisable at prices per
share ranging from $20.22 to $34.88 per share.
(12) COMMITMENTS AND CONTINGENCIES --
(a) LETTERS OF CREDIT -- Under the terms of the Economic Development
Revenue Bonds Agreement, Kroll-O'Gara is required to maintain a letter
of credit supporting the debt. As of December 31, 1999, Kroll-O'Gara's
lender was committed to providing this letter of credit through May 31,
2001. As of December 31, 1999, Kroll-O'Gara had an outstanding letter
of credit in the amount of $1,437,625.
<PAGE> 35
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
At December 31, 1999, Kroll-O'Gara had standby and purchase letters of
credit, issued by Kroll-O'Gara's lender, in the aggregate amount of
$1,678,241.
(b) EMPLOYMENT AGREEMENTS -- Kroll-O'Gara has employment agreements with
its executive officers and management level personnel with annual
compensation ranging in value from $55,000 to $486,000, over varying
periods extending to April 2005. The agreements generally provide for
salary continuation in the event of termination without cause for the
greater of the remainder of the agreement or one year. The agreements
also contain certain non-competition clauses and generally provide for
one year's salary if the agreement is not renewed.
As of December 31, 1999, the remaining aggregate commitment under these
employment agreements if all individuals were terminated without cause
was approximately $22.9 million.
(c) LEGAL MATTERS -- Kroll-O'Gara has been named as a defendant in eight
lawsuits alleging that its officers and directors breached their
fiduciary duties in connection with the now terminated proposed
acquisition of a majority of Kroll-O'Gara's shares by a company formed
by Blackstone Capital Partners III Merchant Banking Fund L.P.
(Blackstone). Five of the lawsuits were filed in the Court of Common
Pleas, Butler County, Ohio, and were consolidated on November 29, 1999.
The remaining three lawsuits were filed in the United States District
Court for the Southern District of New York and were consolidated on
November 30, 1999. In amended complaints, plaintiffs allege that
Kroll-O'Gara's officers and directors breached their fiduciary duties
by deferring acquisitions, by negotiating an inadequate acquisition
price, by failing to engage in arms-length negotiations and by failing
to seek redress from Blackstone after Blackstone terminated the
proposed transaction. The plaintiffs also allege that Blackstone and
AIG aided and abetted the directors' and officers' alleged breaches of
fiduciary duties. The plaintiffs seek to bring their claims
derivatively on behalf of Kroll-O'Gara and also seek class
certification. On behalf of Kroll-O'Gara and putative plaintiff classes
of shareholders, they seek a declaration that the individual defendants
breached their fiduciary duty and seek damages and attorneys' fees in
an unspecified amount. The defendants believe that the allegations in
the complaints are wholly meritless and will defend the suits
vigorously.
Kroll-O'Gara has learned that an individual has filed a qui tam suit,
which is under seal, against Kroll-O'Gara under the Civil False Claims
Act, 31 U.S.C. sec. 3729, alleging that Kroll-O'Gara and three of its
vendors knowingly violated their contractual requirements with the
Army. On January 18, 2000, an attorney for the U.S. Department of
Justice stated that it was his intention to recommend that the
Government intervene and take over the suit and estimated
Kroll-O'Gara's liability to be as high as $16,000,000 stemming from its
vendors' alleged failure to have certified welders. Though Kroll-O'Gara
strongly disputes the Government's contention and will vigorously
contest the Government's claims, in September 2000, the Company began
settlement negotiations with the U.S. Department of Justice. Management
currently believes a settlement of this matter is possible for
approximately $1.1 million and the Company will accrue this expense in
the third quarter of fiscal 2000.
In addition to the matters discussed above, Kroll-O'Gara is involved in
litigation from time to time in the ordinary course of its business;
however, Kroll-O'Gara does not believe that there is
<PAGE> 36
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
any currently pending or threatened litigation, individually or in the
aggregate, that is likely to have a material adverse effect on its 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.
Kroll-O'Gara has entered into nine foreign currency exchange contracts to
effectively hedge its exposure to certain foreign currency rate
fluctuations on demand loans to two subsidiaries which are denominated in
foreign currencies. By virtue of these contracts, Kroll-O'Gara 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. As of December 31, 1999, the total
notional amount of the contracts, which mature between January 2000 and
July 2001, was $18.1 million. Kroll-O'Gara's cumulative foreign currency
translation adjustment component of shareholders' equity was decreased by
$0.7 million in 1998 and increased by $1.9 million in 1999 as a result of
these agreements.
Kroll-O'Gara has estimated the fair value of their foreign exchange
contracts based on information obtained from the counterparty of the amount
Kroll-O'Gara would receive at December 31, 1999 in order to terminate the
agreements. As of December 31, 1999, Kroll-O'Gara would have received
approximately $1.1 million upon cancellation of all contracts.
(14) CUSTOMER AND SEGMENT DATA --
(a) SEGMENT DATA -- During 1997, Kroll-O'Gara operated in three business
segments, the Security Products and Services Group, the Investigations
and Intelligence Group, and the Voice and Data Communications Group. In
1998, Kroll-O'Gara created the Information Security Group in connection
with the merger with Securify.
The following summarizes information about Kroll-O'Gara's business
segments:
<TABLE>
<CAPTION>
SECURITY VOICE AND
PRODUCTS INVESTIGATIONS DATA
AND AND INFORMATION COMMUNI-
SERVICES INTELLIGENCE SECURITY CATIONS
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
-------- -------------- ----------- --------- -------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1997
Net sales to
unaffiliated
customers............. $105,557 $ 87,329 $ -- $17,438 $ -- $210,324
======== ======== ======= ======= ======== ========
Gross profit............ $ 30,006 $ 33,979 $ -- $ 3,125 $ -- $ 67,110
======== ======== ======= ======= ======== ========
Operating income........ $ 8,238 $ 1,775 $ -- $ 68 $ -- $ 10,081
======== ======== ======= ======= ======== ========
Identifiable assets at
year-end.............. $ 74,283 $ 58,670 $ -- $13,449 $ -- $146,402
======== ======== ======= ======= ========
Corporate assets........ 9,284
--------
Total assets at
year-end.............. $155,686
========
</TABLE>
<PAGE> 37
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SECURITY VOICE AND
PRODUCTS INVESTIGATIONS DATA
AND AND INFORMATION COMMUNI-
SERVICES INTELLIGENCE SECURITY CATIONS
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
-------- -------------- ----------- --------- -------- ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
1998
Net sales to
unaffiliated
customers............. $136,844 $117,583 $ 116 $17,653 $ -- $272,196
======== ======== ======= ======= ======== ========
Gross profit (loss)..... $ 39,345 $ 51,627 $ (395) $ 3,522 $ (325) $ 93,774
======== ======== ======= ======= ======== ========
Operating income
(loss)................ $ 22,822 $ 11,748 $(2,194) $ (351) $ (9,145) $ 22,880
======== ======== ======= ======= ======== ========
Identifiable assets at
year-end.............. $102,294 $108,303 $ 4,288 $16,488 $ -- $231,373
======== ======== ======= ======= ========
Corporate assets........ 22,371
--------
Total assets at
year-end.............. $253,744
========
1999
Net sales to
unaffiliated
customers............. $120,824 $176,837 $ 4,345 $19,932 $ -- $321,938
======== ======== ======= ======= ======== ========
Gross profit............ $ 35,004 $ 78,762 $ 2,300 $ 2,415 $ -- $118,481
======== ======== ======= ======= ======== ========
Operating income
(loss)................ $ 12,786 $ 13,167 $(1,764) $(1,534) $(16,502) $ 6,153
======== ======== ======= ======= ======== ========
Identifiable assets at
year-end.............. $107,786 $155,534 $ 3,359 $17,791 $ -- $284,470
======== ======== ======= ======= ========
Corporate assets........ 14,923
--------
Total assets at
year-end.............. $299,393
========
</TABLE>
Total net sales by segment includes sales to unaffiliated customers.
Intersegment sales are nominal. Operating income (loss) is total net
sales less operating expenses. Operating income (loss) does not include
the following items: interest expense, other expenses and income taxes.
The Other column includes Kroll-O'Gara's corporate headquarters costs.
Depreciation expense and capital expenditures for each of
Kroll-O'Gara's business segments for the years ended December 31, 1997,
1998 and 1999 are as follows:
<TABLE>
<CAPTION>
SECURITY VOICE AND
PRODUCTS DATA
AND INVESTIGATIONS AND INFORMATION COMMUNI-
SERVICES INTELLIGENCE SECURITY CATIONS
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
-------- ------------------ ----------- --------- ------ ------------
<S> <C> <C> <C> <C> <C> <C>
1997
Depreciation expense... $1,427 $1,373 $ -- $ 16 $ -- $ 2,816
====== ====== ====== ==== ====== =======
Capital expenditures... $3,149 $3,263 $ -- $ 43 $ -- $ 6,455
====== ====== ====== ==== ====== =======
</TABLE>
<PAGE> 38
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
SECURITY VOICE AND
PRODUCTS DATA
AND INVESTIGATIONS AND INFORMATION COMMUNI-
SERVICES INTELLIGENCE SECURITY CATIONS
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
-------- ------------------ ----------- --------- ------ ------------
<S> <C> <C> <C> <C> <C> <C>
1998
Depreciation expense... $1,282 $1,760 $ 24 $ 24 $ 13 $ 3,103
====== ====== ====== ==== ====== =======
Capital expenditures... $3,427 $3,001 $ 186 $ 68 $ 647 $ 7,329
====== ====== ====== ==== ====== =======
1999
Depreciation expense... $2,188 $3,400 $ 93 $ 36 $ 400 $ 6,117
====== ====== ====== ==== ====== =======
Capital expenditures... $5,969 $9,687 $1,673 $117 $1,752 $19,198
====== ====== ====== ==== ====== =======
</TABLE>
Identifiable assets by segment are those assets that are used in
Kroll-O'Gara's operations in each segment. Corporate assets are
principally cash, marketable securities, computer software, certain
intangible assets and certain prepaid expenses.
The following summarizes information about Kroll-O'Gara's different
geographic areas:
<TABLE>
<CAPTION>
UNITED OTHER
STATES FRANCE FOREIGN ELIMINATIONS CONSOLIDATED
-------- ------- -------- ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1997
Net sales to unaffiliated
customers........................ $139,023 $24,004 $ 47,297 $ -- $210,324
Intercompany....................... 7,413 208 5,624 (13,245) --
-------- ------- -------- -------- --------
Total net sales.......... $146,436 $24,212 $ 52,921 $(13,245) $210,324
======== ======= ======== ======== ========
Operating income................... $ 4,920 $ 1,382 $ 3,779 $ -- $ 10,081
======== ======= ======== ======== ========
Identifiable assets................ $ 91,325 $23,706 $ 31,371 $ -- $146,402
======== ======= ======== ========
Corporate assets................... 9,284
--------
Total assets at
year-end............... $155,686
========
1998
Net sales to unaffiliated
customers........................ $165,062 $28,458 $ 78,676 $ -- $272,196
Intercompany....................... 2,960 199 4,548 (7,707) --
-------- ------- -------- -------- --------
Total net sales.......... $168,022 $28,657 $ 83,224 $ (7,707) $272,196
======== ======= ======== ======== ========
Operating income................... $ 10,825 $ 2,251 $ 9,804 $ -- $ 22,880
======== ======= ======== ======== ========
Identifiable assets................ $139,759 $29,047 $ 62,567 $ -- $231,373
======== ======= ======== ========
Corporate assets................... 22,371
--------
Total assets at
year-end............... $253,744
========
</TABLE>
<PAGE> 39
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
<TABLE>
<CAPTION>
UNITED OTHER
STATES FRANCE FOREIGN ELIMINATIONS CONSOLIDATED
-------- ------- -------- ------------ ------------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C>
1999
Net sales to unaffiliated
customers........................ $183,904 $27,483 $110,551 $ -- $321,938
Intercompany....................... 6,683 1,858 5,746 (14,287) --
-------- ------- -------- -------- --------
Total net sales.......... $190,587 $29,341 $116,297 $(14,287) $321,938
======== ======= ======== ======== ========
Operating income (loss)............ $ (4,654) $ 2,245 $ 8,562 $ -- $ 6,153
======== ======= ======== ======== ========
Identifiable assets................ $160,952 $26,784 $ 96,734 $ -- $284,470
======== ======= ======== ========
Corporate assets................... 14,923
--------
Total assets at
year-end............... $299,393
========
</TABLE>
Kroll-O'Gara accounts for transfers between geographic areas at cost
plus a proportionate share of operating profit.
The following summarizes Kroll-O'Gara's sales in the United States and
foreign locations:
<TABLE>
<CAPTION>
YEARS ENDED DECEMBER 31,
--------------------------------
1997 1998 1999
-------- -------- --------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C>
Sales to unaffiliated customers:
U.S. Government...................... $ 43,719 $ 62,149 $ 54,953
Other United States.................. 78,068 97,204 126,212
Middle East.......................... 5,887 5,958 4,917
Europe............................... 44,022 52,927 66,057
Asia................................. 10,697 15,467 22,763
Central & South America.............. 20,123 25,850 33,428
Other Foreign........................ 7,808 12,641 13,608
-------- -------- --------
$210,324 $272,196 $321,938
======== ======== ========
</TABLE>
Export sales by Kroll-O'Gara's domestic operations were approximately
15%, 17% and 3% of net sales for the years ended December 31, 1997,
1998 and 1999, respectively.
Kroll-O'Gara is subject to audit and investigation by various agencies
which oversee contract performance in connection with Kroll-O'Gara's
contracts with the U.S. Government. Additionally, Kroll-O'Gara's
laboratory testing operations are certified and subject to frequent
inspections and proficiency tests by certain federal, state or local
jurisdictions. Management believes that potential claims from such
audits and investigations will not have a material adverse effect on
the consolidated financial statements. In addition, contracts with the
U.S. Government may contain cost or performance incentives or both
based on stated targets or other criteria. Cost or performance
incentives are recorded at the time there is sufficient information to
relate actual performance to targets or other criteria.
Kroll-O'Gara has foreign operations and assets in Argentina, Australia,
Brazil, Canada, Chile, China, Colombia, France, Germany, India, Italy,
Japan, Mexico, Russia, Singapore, South Africa, Switzerland, the
Philippines and the United Kingdom. In addition, Kroll-O'Gara sells its
products and services in other foreign countries and has continued to
increase its level of international activity. Accordingly, Kroll-O'Gara
is subject to various risks including, among
<PAGE> 40
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
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, 1997, 1998 and
1999 sales in the Security Products and Services Group to the U.S.
Government approximated 21%, 23% and 17% of Kroll-O'Gara's net sales,
respectively.
(15) SUPPLEMENTAL CASH FLOWS DISCLOSURES --
The following is a summary of cash paid related to certain items:
<TABLE>
<CAPTION>
1997 1998 1999
---------- ----------- ----------
<S> <C> <C> <C>
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest................. $4,960,504 $ 4,593,326 $4,581,720
========== =========== ==========
Cash paid for taxes.................... $3,468,474 $ 4,095,349 $6,055,244
========== =========== ==========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
ACTIVITIES:
Issuance of restricted stock........... $1,356,280 $ -- $ --
========== =========== ==========
Deferred compensation related to
options and restricted stock......... $ -- $ 1,192,096 $1,571,661
========== =========== ==========
Accrued contingent consideration
incurred in connection with
acquisition of business.............. $ -- $ -- $1,071,688
========== =========== ==========
Fair value of stock issued in
connection with acquisition of
businesses........................... $8,459,769 $17,610,504 $8,011,929
========== =========== ==========
Fair value of stock issued in
connection with acquisition of
minority interest.................... $1,243,474 $ -- $ --
========== =========== ==========
Notes issued in connection with
acquisition of businesses............ $2,906,513 $ -- $ --
========== =========== ==========
Tax benefit of restricted stock
vesting.............................. $2,160,341 $ -- $ --
========== =========== ==========
Cancellation of shareholder's note
payable obligation and issuance of
stock................................ $1,053,735 $ -- $ --
========== =========== ==========
Note issued in connection with
consulting agreement entered into
with former shareholder of an
acquired business.................... $ -- $ 147,914 $ --
========== =========== ==========
</TABLE>
<PAGE> 41
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(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>
1999
Net sales............................. $ 71,499 $ 80,542 $ 87,547 $ 82,350
Gross profit.......................... 26,253 32,235 31,994 27,999
Net income (loss)..................... 2,528 265 3,654 (8,369)
Earnings (loss) per share:
Basic.............................. $ 0.12 $ 0.01 $ 0.16 $ (0.38)
Diluted............................ $ 0.11 $ 0.01 $ 0.16 $ (0.38)
1998
Net sales............................. $ 58,476 $ 66,319 $ 74,794 $ 72,607
Gross profit.......................... 19,547 22,503 26,027 25,697
Net income (loss)..................... 2,792 3,955 5,293 (254)
Earnings (loss) per share:
Basic.............................. $ 0.18 $ 0.21 $ 0.25 $ (0.01)
Diluted............................ $ 0.17 $ 0.21 $ 0.24 $ (0.01)
</TABLE>
(17) SUBSEQUENT EVENTS --
(a) FAILED MERGER WITH BLACKSTONE -- On November, 15, 1999, Kroll-O'Gara
announced that it had entered into a definitive agreement with
Blackstone pursuant to which shares held by all Kroll-O'Gara
shareholders, other than certain members of management, would be
acquired by Blackstone for $18.00 per share in cash. On April 12, 2000,
Kroll-O'Gara announced that Blackstone had withdrawn its offer to
acquire Kroll-O'Gara shares. Costs associated with the failed merger
through December 31, 1999 were approximately $1.6 million ($0.9 million
after taxes, or $0.04 per diluted share) and consisted primarily of
fees for attorneys, accountants, travel and other related charges.
Kroll-O'Gara anticipates additional expenses will be incurred in fiscal
2000.
(b) PROPOSED PLAN OF REORGANIZATION AND DISSOLUTION -- In April 2000,
subsequent to the terminated Blackstone transaction, Kroll-O'Gara
decided to explore the split-up of its principal businesses into two
independent public companies. On August 30, 2000, Kroll-O'Gara's Board
of Directors approved an agreement and plan of reorganization and
dissolution of Kroll-O'Gara (which was executed effective September 8,
2000), the completion of which is subject to a number of conditions
including the receipt of a favorable tax ruling and the approval by
Kroll-O'Gara's shareholders. Under this agreement, The O'Gara Company
(O'Gara), a newly incorporated company, will receive substantially all
of the assets and liabilities of Kroll-O'Gara's Security Products and
Services Group, and 60% of Kroll-O'Gara's ownership interest in the
common stock of the entity comprising its Information Security Group,
as well as a portion of Kroll-O'Gara's assets and liabilities that are
not attributable to a particular business group. The remaining business
of Kroll-O'Gara, primarily the Investigations and Intelligence Group,
the Voice and Data Communications Group and 40% of Kroll-O'Gara's
ownership interest in the common stock of the entity comprising the
Information Security Group, as well as the other assets and liabilities
that are not attributable to a particular business group, will be
transferred to and assumed by another newly incorporated company, Kroll
Risk Consulting Services, Inc. (KRCS). After these transfers, certain
management shareholders of Kroll-O'Gara will exchange all of their
shares of Kroll-O'Gara common stock for shares of O'Gara common
<PAGE> 42
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
stock and other management shareholders of Kroll-O'Gara will exchange
all their shares of Kroll-O'Gara common stock for shares of KRCS
common stock. Kroll-O'Gara then will distribute, on a pro rata basis,
all remaining shares of O'Gara common stock and KRCS common stock held
by it to the remaining holders of Kroll-O'Gara common stock. The
exchanging management shareholders will not participate in this
distribution. Concurrent with the completion of these transactions,
O'Gara and KRCS will become separate publicly-traded companies.
Subsequent to the reorganization and split-up, Kroll-O'Gara will be
dissolved.
As part of the reorganization and split-up, Kroll-O'Gara will incur
approximately $2.8 million (net of tax benefit of $1.9 million) of
charges for the write-off of certain intangibles and unamortized
financing fees, debt prepayment fees and compensation costs related to
accelerated vesting of stock option plans. KRCS and O'Gara have agreed
to split these charges on an agreed-upon basis. Also, as soon as
possible following completion of this transaction, KRCS plans to sell
the Voice and Data Communications Group.
(c) FINANCING ARRANGEMENTS
As described above, Kroll-O'Gara has entered into an agreement for the
separation of its principal business groups into two public companies.
Management of each of O'Gara and KRCS is currently in discussions with
banks to provide financing for each company subsequent to the
separation. Pending the separation, Kroll-O'Gara will require
additional sources of capital to supplement operating cash flow, either
through amending and increasing its credit facilities, through an
equity offering of one of its subsidiaries or both. In the absence of
the separation of the businesses, management is of the opinion that
there will be sufficient liquidity available from existing operations
and credit facilities, which can be supplemented, if necessary, with
additional secured or unsecured financing, to finance the continuing
operations of Kroll-O'Gara.
(d) DISCONTINUED OPERATIONS SUBSEQUENTLY RETAINED
On April 28, 1999, the Board of Directors approved a formal plan to
discontinue operations of the Voice and Data Communications Group
pursuant to several outside expressions of interest to purchase this
business. In May 2000, Kroll-O'Gara terminated all then pending
negotiations to sell this business to outside third parties.
Accordingly, the results of operations of the Voice and Data
Communications Group for all prior periods have been reclassified from
discontinued operations to continuing operations.
(e) ACQUISITIONS -- During fiscal 2000, Kroll-O'Gara has completed two
acquisitions in the Investigations and Intelligence Group. The
aggregate purchase price of these acquisitions amounted to $1.2 million
and consisted of $0.7 million of cash and $0.5 million in seller
provided financing. These acquisitions have been accounted for as
purchase business acquisitions and the related goodwill from these
acquisitions (approximately $1.0 million) is being amortized over
twenty-five years.
