<PAGE> 1
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
--------------------------------------
FORM 10-Q
/X/ QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
OR
/ / TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
FOR THE QUARTERLY PERIOD ENDED JUNE 30, 2000
Commission File Number: 000-21629
THE KROLL-O'GARA COMPANY
(EXACT NAME OF REGISTRANT AS SPECIFIED IN ITS CHARTER)
<TABLE>
<S> <C>
OHIO 31-1470817
(STATE OR OTHER JURISDICTION OF INCORPORATION OR ORGANIZATION) (IRS EMPLOYER IDENTIFICATION NO.)
</TABLE>
9113 LESAINT DRIVE
FAIRFIELD, OHIO 45014
(513) 874-2112
(ADDRESS, INCLUDING ZIP CODE, AND TELEPHONE NUMBER, INCLUDING AREA CODE
OF PRINCIPAL EXECUTIVE OFFICES)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months (or for such shorter period that the
registrant was required to file such reports), and (2) has been subject to such
filing requirements for the past 90 days. Yes X No
APPLICABLE ONLY TO CORPORATE ISSUERS:
Indicate the number of shares of each of the issuer's classes of common stock,
as of the latest practicable date.
22,309,610
(SHARES OF COMMON STOCK OUTSTANDING AS OF JULY 31, 2000)
<PAGE> 2
THE KROLL-O'GARA COMPANY
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED
JUNE 30, 2000
<TABLE>
<CAPTION>
PAGE
----
<S> <C>
PART I - FINANCIAL INFORMATION
ITEM 1: FINANCIAL STATEMENTS
Consolidated Balance Sheets (unaudited) as of
December 31, 1999 and June 30, 2000 .......................... 1
Consolidated Statements of Operations (unaudited) for
the three and six months ended June 30, 1999 and 2000 ........ 3
Consolidated Statements of Cash Flows (unaudited)
for the six months ended June 30, 1999 and 2000 .............. 4
Notes to Consolidated Unaudited Financial Statements ......... 5
ITEM 2: MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL
CONDITION AND RESULTS OF OPERATIONS .......................... 12
PART II - OTHER INFORMATION ............................................................. 23
ITEM 1: LEGAL PROCEEDINGS ..................................................... 23
ITEM 6: EXHIBITS .............................................................. 23
SIGNATURES ..................................................................... 24
</TABLE>
<PAGE> 3
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
AS OF DECEMBER 31, 1999 AND JUNE 30, 2000
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
------------ -----------
<S> <C> <C>
ASSETS
Current Assets:
Cash and equivalents (Note 7) $ 13,835 $ 6,260
Trade accounts receivable, net of allowance for doubtful accounts of $4,779
and $4,370 at December 31, 1999 and June 30, 2000, respectively 68,017 68,683
Unbilled revenues 18,034 22,548
Related party receivables 2,096 2,792
Costs and estimated earnings in excess of billings on uncompleted contracts 24,160 15,241
Inventories (Note 8) 26,264 30,587
Prepaid expenses and other 11,579 10,201
Deferred tax asset 824 824
------------ -----------
Total current assets 164,809 157,136
------------ -----------
Property, Plant and Equipment, at cost
Land 2,164 2,140
Buildings and improvements 8,587 8,379
Leasehold improvements 7,452 8,081
Furniture and fixtures 10,131 11,258
Machinery and equipment 36,769 39,699
------------ -----------
65,103 69,557
Less: accumulated depreciation (26,195) (29,735)
------------ -----------
38,908 39,822
------------ -----------
Databases, net of accumulated amortization of $26,187 and $27,853 at December 31,
1999 and June 30, 2000, respectively 9,696 10,083
Costs in Excess of Assets Acquired and Other Intangible Assets, net of accumulated
amortization of $9,028 and $10,798 at December 31, 1999 and June 30,
2000, respectively 81,676 79,077
Other Assets:
Other assets 4,304 4,553
------------ -----------
95,676 93,713
------------ -----------
$ 299,393 $ 290,671
============ ===========
</TABLE>
The accompanying notes are an integral part
of these consolidated balance sheets.
1
<PAGE> 4
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS (UNAUDITED)
AS OF DECEMBER 31, 1999 AND JUNE 30, 2000
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
DECEMBER 31, JUNE 30,
1999 2000
---------- ----------
<S> <C> <C>
LIABILITIES AND SHAREHOLDERS' EQUITY
Current Liabilities:
Bank lines of credit (Note 5) $ 26,583 $ 37,422
Current portion of long-term debt 3,737 1,806
Trade accounts payable 38,823 34,099
Billings in excess of costs and estimated earnings on uncompleted contracts 361 486
Accrued liabilities 28,299 23,137
Customer deposits 4,196 4,586
Income taxes currently payable 768 1,606
---------- ----------
Total current liabilities 102,767 103,142
---------- ----------
Other Long-Term Liabilities 2,673 1,894
Deferred Income Taxes 1,821 1,821
Long-Term Debt, net of current portion 36,264 36,580
---------- ----------
Total liabilities 143,525 143,437
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, 22,255,510 and
22,309,610 shares issued and outstanding at December 31, 1999 and June
30, 2000, respectively 223 223
Additional paid-in capital 170,102 170,026
Retained deficit (12,640) (17,300)
Deferred compensation (1,630) (1,218)
Accumulated other comprehensive loss (187) (4,497)
---------- ----------
Total shareholders' equity 155,868 147,234
---------- ----------
$ 299,393 $ 290,671
========== ==========
</TABLE>
The accompanying notes are an integral part
of these consolidated balance sheets.
2
<PAGE> 5
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(DOLLARS IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, SIX MONTHS ENDED JUNE 30,
---------------------------- ------------------------------
1999 2000 1999 2000
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
NET SALES $ 80,542 $ 78,275 $ 152,041 $ 163,049
COST OF SALES 48,307 50,607 93,553 104,711
------------ ------------ ------------ ------------
Gross profit 32,235 27,668 58,488 58,338
OPERATING EXPENSES:
Selling and marketing expenses 7,027 7,298 13,302 14,624
General and administrative expenses 16,333 20,312 29,579 40,917
Separation expenses (Note 11) -- 676 -- 676
Failed merger expenses (Note 11) -- 680 -- 2,000
Merger expenses (Note 3) 2,886 348 3,094 438
Restructuring expense (Note 2) 3,856 -- 4,364 --
------------ ------------ ------------ ------------
Operating income (loss) 2,133 (1,646) 8,149 (317)
------------ ------------ ------------ ------------
OTHER INCOME (EXPENSE):
Interest expense (847) (1,498) (1,875) (2,872)
Other, net (245) (35) 70 (91)
------------ ------------ ------------ ------------
Income (loss) before provision for income taxes and
cumulative effect of change in accounting principle 1,041 (3,179) 6,344 (3,280)
Provision for income taxes 776 1,102 2,773 1,380
------------ ------------ ------------ ------------
Income (loss) before cumulative effect of change in
accounting principle 265 (4,281) 3,571 (4,660)
Cumulative effect of change in accounting principle,
net of applicable tax benefit of $408 (Note 6) -- -- (778) --
------------ ------------ ------------ ------------
Net income (loss) $ 265 $ (4,281) $ 2,793 $ (4,660)
------------ ------------ ------------ ------------
Other comprehensive income (loss), net of tax:
Foreign currency translation adjustment, net of $1,784
and $2,530 tax benefit, respectively (3,171) (4,497)
------------ ------------
Other comprehensive loss (3,171) (4,497)
------------ ------------
Comprehensive loss $ (378) $ (9,157)
============ ============
PER SHARE DATA:
BASIC EARNINGS (LOSS) PER SHARE (Note 4)
Earnings (loss) per share $ 0.01 $ (0.19) $ 0.13 $ (0.21)
============ ============ ============ ============
Weighted Average Shares Outstanding 21,891,216 22,278,378 21,815,388 22,267,065
============ ============ ============ ============
DILUTED EARNINGS (LOSS) PER SHARE (Note 4)
Earnings (loss) per share $ 0.01 $ (0 .19) $ 0.12 $ (0.21)
============ ============ ============ ============
Weighted Average Shares Outstanding 22,480,451 22,278,378 22,547,934 22,267,065
============ ============ ============ ============
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
3
<PAGE> 6
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 7)
(UNAUDITED)
FOR THE SIX MONTHS ENDED JUNE 30, 1999 AND 2000
(DOLLARS IN THOUSANDS)
<TABLE>
<CAPTION>
JUNE 30, JUNE 30,
1999 2000
-------- --------
<S> <C> <C>
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) $ 2,793 $ (4,660)
Adjustments to reconcile net income (loss) to net cash used in operating activities-
Depreciation and amortization 6,034 8,142
Bad debt expense 806 2,222
Noncash compensation expense 514 273
Change in assets and liabilities, net of effects of acquisitions and dispositions-
Receivables - trade and unbilled (12,098) (7,266)
Costs and estimated earnings in excess of billings on uncompleted contracts 2,976 8,919
Income tax receivable (327) --
Inventories, prepaid expenses and other assets 217 (2,528)
Accounts payable and income taxes currently payable (10,608) (3,886)
Billings in excess of costs and estimated earnings on uncompleted contracts (94) 125
Amounts due to/from related parties (1,027) (696)
Customer deposits (1,024) 390
Accrued liabilities 6,374 (5,177)
Long-term liabilities 1,862 (779)
-------- --------
Net cash used in operating activities (3,602) (4,921)
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net (9,325) (4,892)
Additions to databases (1,843) (2,249)
Acquisitions, net of cash acquired (12,015) (263)
Sale of marketable securities 12,007 --
-------- --------
Net cash used in investing activities (11,176) (7,404)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net borrowings under bank lines of credit 20,808 10,839
Payments of long-term debt (881) (1,840)
Proceeds from exercise of stock options 964 61
Foreign currency translation (2,719) (4,068)
-------- --------
Net cash provided by financing activities 18,172 4,992
-------- --------
NET INCREASE (DECREASE) IN CASH AND EQUIVALENTS 3,394 (7,333)
Effects of foreign currency exchange rates on cash (450) (242)
-------- --------
CASH AND EQUIVALENTS, BEGINNING OF PERIOD 14,041 13,835
-------- --------
CASH AND EQUIVALENTS, END OF PERIOD $ 16,985 $ 6,260
======== ========
</TABLE>
The accompanying notes are an integral part
of these consolidated financial statements.
4
<PAGE> 7
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
AS OF DECEMBER 31, 1999 AND JUNE 30, 2000
(1) GENERAL
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 Voice and Data Communications Group offers
secure satellite communication equipment and satellite navigation systems. The
Information Security Group offers information and computer security services,
including network and system security review and repair.
The consolidated financial statements include all majority-owned
subsidiaries. All material intercompany accounts and transactions are
eliminated. Investments in 20% to 50% owned entities are accounted for using the
equity method. Affiliated entities are not included in the accompanying
consolidated financial statements.
The accompanying unaudited consolidated financial statements have been
prepared in accordance with generally accepted accounting principles for interim
financial information and with the instructions to Form 10-Q and Article 10 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for fair presentation have
been included. Operating results for the three and six month periods ended June
30, 2000, are not necessarily indicative of the results that may be expected for
the year ended December 31, 2000. The accompanying financial statements should
be read in conjunction with the consolidated financial statements and notes
thereto included in Kroll-O'Gara's annual report on Form 10-K for the year ended
December 31, 1999.
(2) 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. Including the first quarter 1999 charge of $0.5 million, the
total non-recurring, pre-tax restructuring charge associated with the Plan was
$4.4 million. Total payments or writeoffs made pursuant to the Plan through June
30, 2000 were $3.5 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 are 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 June 30, 2000 are as follows:
5
<PAGE> 8
<TABLE>
<CAPTION>
DESCRIPTION EXPENSE ACCRUAL
----------------------------------------------------- ------- -------
(DOLLARS IN THOUSANDS)
<S> <C> <C>
Severance and related costs $ 3,116 $ 369
Writedown of property, plant and equipment 150 -
Lease termination costs 1,064 498
Other 34 -
------- -----
$ 4,364 867
=======
Less - Current portion 560
-----
$ 307
=====
</TABLE>
(3) ACQUISITIONS AND MERGERS
Kroll-O'Gara has completed several business combinations in the periods
presented. These transactions, accounted for as either purchase business
combinations or pooling of interests business combinations were as follows:
On June 16, 1999, Kroll-O'Gara acquired all of the outstanding capital
stock of Background America, Inc. for approximately 989,000 shares of
Kroll-O'Gara common stock, including approximately 90,000 shares reserved for
issuance for outstanding common stock equivalents. Background America provides
employment screening and compliance services to a variety of industries and is
included in Kroll-O'Gara's Investigations and Intelligence Group.
The merger with Background America constituted a tax-free
reorganization and has been accounted for as a pooling of interests transaction.
Accordingly, all prior period consolidated financial statements presented have
been restated to include the combined results of operations, financial position
and cash flows of Background America as though they had always been a part of
Kroll-O'Gara.
There were no transactions between Kroll-O'Gara and Background America
prior to the combination and immaterial adjustments were recorded to conform
Background America's accounting policies. Certain reclassifications were made to
Kroll-O'Gara's and Background America's financial statements to conform
presentation.
In 2000, Kroll-O'Gara recorded a charge to operating expenses of
approximately $0.4 million ($0.02 per diluted share) for integration related
costs. These costs relate primarily to mergers and acquisitions completed in
1999.
On May 16, 2000, Kroll-O'Gara acquired substantially all of the assets
and assumed certain liabilities of The Search Is On, Inc., a corporation doing
business in Nashville, Tennessee. The purchase price of $0.6 million was
satisfied with cash of $0.4 million and a note payable of $0.2 million to the
former owner. The acquisition has been accounted for as a purchase and was
effective on May 16, 2000. Goodwill related to this transaction was
approximately $0.4 million which is being amortized over 25 years. The Search Is
On specializes in obtaining public records information for utilization in
providing background investigation to clients. Its revenues are included in
Kroll-O'Gara's Investigations and Intelligence Group.
On June 3, 1999, Kroll-O'Gara acquired substantially all of the assets
and assumed certain liabilities of The Buchler Phillips Group, a partnership
headquartered in London, England. The purchase price of $20.0 million was
satisfied with cash of $12.0 million and 366,469 shares of stock valued at $8.0
million, or $21.86 per share. The acquisition has been accounted for as a
purchase and was effective on April 1, 1999. Goodwill related to this
transaction was approximately $20.7 million which is being amortized over 25
years. Buchler Phillips specializes in corporate advisory practices which
includes
6
<PAGE> 9
work related to corporate rescue, insolvency, financial consulting and corporate
finance. Buchler Phillips' revenues are included in the Investigations and
Intelligence Group.
On March 1, 1999, Kroll-O'Gara acquired all of the capital stock of
Financial Research, Inc. for approximately $3.3 million, consisting of 101,555
shares of common stock. Financial Research provides business valuation and
economic damage analysis services and is included in Kroll-O'Gara's
Investigations and Intelligence Group. The acquisition has been accounted for as
a pooling of interests.
(4) EARNINGS PER SHARE
In accordance with Statement of Financial Accounting Standards No. 128,
"Earnings Per Share", basic earnings per share are computed by dividing net
income by the weighted average number of shares of common stock outstanding
during the period. 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 period. Dilutive common stock equivalents
represent shares issuable upon assumed exercise of stock options and warrants
and upon assumed issuance of restricted stock. The following is a reconciliation
of the numerator and denominator for basic and diluted earnings per share for
the three and six months ended June 30, 1999 (in thousands, except per share
data):
<TABLE>
<CAPTION>
THREE MONTHS ENDED JUNE 30, 1999
-------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Basic EPS $ 265 21,891 $ 0.01
=======
Effect of dilutive securities:
Options -- 570
Warrants -- 1
Restricted Stock -- 18
------- ------
Diluted EPS $ 265 22,480 $ 0.01
======= ====== =======
</TABLE>
<TABLE>
<CAPTION>
SIX MONTHS ENDED JUNE 30, 1999
-------------------------------------------
INCOME SHARES PER-SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
<S> <C> <C> <C>
Basic EPS $ 2,793 21,815 $ 0.13
=======
Effect of dilutive securities:
Options -- 708
Warrants -- 3
Restricted Stock -- 22
--------- ------
Diluted EPS $ 2,793 22,548 $ 0.12
========= ====== =======
</TABLE>
As a result of the net loss recorded for the three and six months ended
June 30, 2000, 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 cumulative
effect of change in accounting principle were $0.16 for the six months ended
June 30, 1999. The basic and diluted per share impact of the change in
accounting principle was $0.03 and $0.04, respectively.
7
<PAGE> 10
(5) DEBT
(a) Amendment of Credit Facility
On May 12, 2000, Kroll-O'Gara amended its credit agreement to provide
for a 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 September 30, 2000, at which time
all borrowings in excess of $25.0 million must be repaid. 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 line of credit mature on May
31, 2001. Advances under the revolving line of credit during the period of the
temporary increase bear interest at prime, or, at Kroll-O'Gara's option, LIBOR
plus 0.75% to LIBOR plus 1.75%, dependent upon a defined financial ratio.
Borrowings under this line of credit were approximately $22.8 million and $34.3
million at December 31, 1999 and June 30, 2000, respectively.
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. Pursuant to the amended credit agreement,
certain of these financial ratios were revised. Kroll-O'Gara was not in
compliance with certain of these covenants at June 30, 2000. All such events of
non-compliance were subsequently waived by the lender.
(b) Senior unsecured notes payable
Kroll-O'Gara's $35.0 million of senior unsecured notes payable also
contains financial covenants, which among other restrictions, require the
maintenance of a minimum level of net worth and a fixed charge coverage ratio.
Kroll-O'Gara was not in compliance with the fixed charge coverage ratio at June
30, 2000. This event of non-compliance was subsequently waived by the lenders.
(6) NEW PRONOUNCEMENTS
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
pre-operating costs, organization costs and start-up costs to be expensed as
incurred. Kroll-O'Gara's practice was to capitalize these expenses and amortize
them over periods ranging from one to five years. Kroll-O'Gara adopted SOP 98-5
in the first quarter of 1999 and recorded a cumulative effect of an accounting
change of $0.8 million, net of a tax benefit of $0.4 million.
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 nine forward contracts in place in association with demand
notes from two 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
8
<PAGE> 11
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 financial position or the results of operations.
(7) SUPPLEMENTAL CASH FLOW DISCLOSURE
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.
<TABLE>
<CAPTION>
1999 2000
------- -------
(DOLLARS IN
THOUSANDS)
<S> <C> <C>
Cash paid for taxes $ 3,680 $ 991
Cash paid for interest $ 1,949 $ 2,708
Non-cash activity:
Fair value of stock issued in connection with acquisition of Buchler
Phillips $ 8,011 $ -
Deferred compensation related to options and restricted stock $ 1,572 $ -
</TABLE>
(8) 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, JUNE 30,
INVENTORY CATEGORY 1999 2000
------------------ ------------ --------
(dollars in thousands)
<S> <C> <C>
Raw materials $ 14,495 $ 19,437
Vehicle costs and work-in-process 11,769 11,150
-------- ---------
Total inventory $ 26,264 $ 30,587
======== =========
</TABLE>
(9) 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.
9
<PAGE> 12
Kroll-O'Gara has entered into nine foreign currency exchange contracts
to hedge its exposure to certain foreign currency rate fluctuations on demand
loans to two subsidiaries that are denominated in the foreign currencies. By
virtue of these contracts, Kroll-O'Gara has fixed the total dollar amount that
they will receive under the aforementioned subsidiary loans through the maturity
dates of the contracts regardless of the fluctuations in the exchange rate. At
June 30, 2000, the total notional amount of the contracts, which mature between
July 2000 and January 2002, is $17.9 million. Kroll-O'Gara's foreign currency
translation adjustment component of shareholder's equity was increased by $0.9
million in the six months ended June 30, 2000 as a result of these agreements.
Kroll-O'Gara has estimated the fair value of the foreign exchange
contracts based on information obtained from the counterparty of the amount
Kroll-O'Gara would receive at June 30, 2000 in order to terminate the
agreements. As of June 30, 2000, Kroll-O'Gara would have received approximately
$1.8 million upon cancellation of all contracts.
(10) SEGMENT DATA
During 1999 and 2000, Kroll-O'Gara operated in four business segments,
the Security Products and Services Group, the Investigations and Intelligence
Group, the Voice and Data Communications Group and the Information Security
Group.
The following summarizes information about the Company's business
segments:
<TABLE>
<CAPTION>
SECURITY INVESTIGATIONS
PRODUCTS AND AND VOICE AND DATA INFORMATION
SERVICES INTELLIGENCE COMMUNICATIONS SECURITY
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
--------- --------- --------- --------- --------- ---------
(DOLLARS IN THOUSANDS)
<S> <C> <C> <C> <C> <C> <C>
THREE MONTHS ENDED JUNE 30, 1999
Net sales to unaffiliated customers $ 28,755 $ 46,487 $ 4,029 $ 1,271 $ -- $ 80,542
========= ========= ========= ========= ========= =========
Gross profit $ 10,001 $ 21,319 $ 268 $ 647 $ -- $ 32,235
========= ========= ========= ========= ========= =========
Operating income (loss) $ 5,799 $ 1,572 $ (435) $ (41) $ (4,762) $ 2,133
========= ========= ========= ========= ========= =========
THREE MONTHS ENDED JUNE 30, 2000
Net sales to unaffiliated customers $ 24,298 $ 48,991 $ 4,039 $ 947 $ -- $ 78,275
========= ========= ========= ========= ========= =========
Gross profit $ 5,585 $ 21,204 $ 746 $ 133 $ -- $ 27,668
========= ========= ========= ========= ========= =========
Operating income (loss) $ 1,640 $ 3,857 $ 56 $ (2,321) $ (4,878) $ (1,646)
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED JUNE 30, 1999
Net sales to unaffiliated customers $ 57,475 $ 84,623 $ 7,463 $ 2,480 $ -- $ 152,041
========= ========= ========= ========= ========= =========
Gross profit $ 18,576 $ 37,822 $ 823 $ 1,267 $ -- $ 58,488
========= ========= ========= ========= ========= =========
Operating income (loss) $ 9,544 $ 5,818 $ (633) $ 123 $ (6,703) $ 8,149
========= ========= ========= ========= ========= =========
SIX MONTHS ENDED JUNE 30, 2000
Net sales to unaffiliated customers $ 54,650 $ 98,001 $ 8,588 $ 1,810 $ -- $ 163,049
========= ========= ========= ========= ========= =========
Gross profit $ 14,184 $ 43,023 $ 1,372 $ (241) $ -- $ 58,338
========= ========= ========= ========= ========= =========
Operating income (loss) $ 5,191 $ 8,925 $ (122) $ (4,704) $ (9,607) $ (317)
========= ========= ========= ========= ========= =========
Identifiable assets at June 30, 2000 $ 99,783 $ 159,300 $ 10,762 $ 4,907 $ -- $ 274,752
========= ========= ========= ========= =========
Corporate assets 15,919
---------
Total assets at June 30, 2000 $ 290,671
=========
</TABLE>
(11) FAILED MERGER AND PROPOSED SEPARATION OF BUSINESS
On November 15, 1999, Kroll-O'Gara announced that it had entered into a
definitive agreement with Blackstone Capital Partners III Merchant Banking Fund
L.P. (Blackstone) pursuant to
10
<PAGE> 13
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
recapitalization merger in the six months ended June 30, 2000 were approximately
$2.0 million ($0.09 per diluted share) and consisted primarily of fees for
attorneys, accountants, travel and other related charges.
On July 26, 2000, Kroll-O'Gara announced tentative plans to separate
its two principal operating segments, the Security Products and Services Group
and the Investigations and Intelligence Group, into two distinct companies.
Completion of the transaction, which is expected in the fourth quarter of 2000
or first quarter of 2001, is pending receipt of favorable tax rulings and
relevant stockholder approvals. When the separation is completed, Kroll-O'Gara's
stockholders will own shares in two publicly-traded companies. Costs associated
with this separation in the six months ended June 30, 2000 were approximately
$0.7 million ($0.03 per diluted share) and consisted primarily of fees for
attorneys, accountants and other related charges. Kroll-O'Gara anticipates
additional expenses will be incurred in the second half of 2000.
(12) 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 due
to an inability to agree to terms of a sale with 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.
Kroll-O'Gara had not anticipated a loss on disposal of the Voice and
Data Communications Group and, accordingly, had not recorded any estimated loss
on disposal. Kroll-O'Gara continues to monitor the potential for impairment of
the net assets of this Group and will record impairment reserves as facts and
circumstances warrant. Based on its most recent analysis, Kroll-O'Gara believes
that no impairment existed at June 30, 2000.
11
<PAGE> 14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of results of operations and financial
condition is based upon and should be read in conjunction with Kroll-O'Gara's
Consolidated Financial Statements and Notes. As a result of the acquisitions
made by Kroll-O'Gara in 1999, financial results from period-to-period may lack
comparability. In May 2000, Kroll-O'Gara decided to retain the Voice and Data
Communications Group which had been classified as discontinued operations.
Historical amounts have been reclassified to conform to the current categories.
RECENT DEVELOPMENTS
Failed Merger and Proposed Separation of Business
On November 15, 1999, Kroll-O'Gara announced that it had entered into a
definitive agreement with Blackstone Capital Partners III Merchant Banking Fund
L.P. (Blackstone) pursuant to which shares held by all 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.
On July 26, 2000, Kroll-O'Gara announced tentative plans to separate
its two principal operating segments, the Security Products and Services Group
and the Investigations and Intelligence Group, into two distinct companies.
Completion of the transaction, which is expected in the fourth quarter of 2000
or first quarter of 2001, is pending receipt of favorable tax rulings and
relevant stockholder approvals. When the separation is completed, Kroll-O'Gara's
stockholders will own shares in two publicly-traded companies. Each of these
companies will continue to hold an equity interest in the Information Security
Group, Securify, Inc., which will operate as a private company under separate
management. This will result in each of Kroll-O'Gara's Groups, other than the
Voice and Data Communications Group being stand-alone companies. Costs
associated with this separation in the six months ended June 30, 2000 were
approximately $0.7 million ($0.03 per diluted share) and consisted primarily of
fees for attorneys, accountants and other related charges. Kroll-O'Gara
anticipates additional expenses will be incurred in the second half of 2000. The
possible effects of this transaction on Kroll-O'Gara's future business,
financial condition, results of operations and cash flow currently are unknown.
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. See Note 12 to the Notes to
Consolidated Unaudited Financial Statements for more information.
Restructuring of Security Products and Services Group Operations
In the third quarter of 2000, Kroll-O'Gara's Security Products and
Services Group began implementation of a plan to reduce costs on a post
separation basis and estimates a total non-recurring pre-tax restructuring
charge of less than $1.0 million. The primary component of the restructuring
charge is severance related to the termination of employees.
GENERAL
Kroll-O'Gara is a leading global provider of a broad range of
specialized products and services that are designed to provide solutions to a
variety of security needs. Kroll-O'Gara reports its revenue through four groups.
The 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 Voice and Data
Communications Group offers secure satellite communication equipment and
satellite navigation systems. The Information Security Group offers information
and computer security services.
12
<PAGE> 15
Other Acquisitions. Kroll-O'Gara completed several acquisitions in 1999
and 2000, some of which were accounted for as pooling of interests and others
which were accounted for as purchases.
On May 16, 2000, Kroll-O'Gara acquired substantially all of the assets
and assumed certain liabilities of The Search Is On, Inc., a corporation doing
business in Nashville, Tennessee. The purchase price of $0.6 million was
satisfied with cash of $0.4 million and a note payable of $0.2 million to the
former owner. The acquisition has been accounted for as a purchase and was
effective on May 16, 2000. Goodwill related to this transaction was
approximately $0.4 million which is being amortized over 25 years. The Search Is
On specializes in obtaining public records information for utilization in
providing background investigation to clients. Its revenues are included in
Kroll-O'Gara's Investigations and Intelligence Group.
On June 16, 1999, Kroll-O'Gara acquired all of the capital stock of
Background America, Inc. of Nashville, Tennessee, in exchange for 899,243 shares
of Kroll-O'Gara common stock. Background America provides background
investigation services to a variety of industries. The transaction was accounted
for as a pooling of interests. Background America's revenues are included in the
Investigations and Intelligence Group.
On June 3, 1999, Kroll-O'Gara acquired substantially all of the assets
and assumed certain liabilities of The Buchler Phillips Group, a partnership
headquartered in London, England. The purchase price of $20.0 million was
satisfied with cash of $12.0 million and 366,469 shares of stock valued at $8.0
million, or $21.86 per share. The acquisition has been accounted for as a
purchase and was effective on April 1, 1999. Goodwill related to this
transaction was approximately $20.8 million, which will be amortized over 25
years. Buchler Phillips specializes in corporate advisory practices which
includes work related to corporate rescue, insolvency, financial consulting and
corporate finance. Buchler Phillips' revenues are included in the Investigations
and Intelligence Group.
On March 1, 1999, Kroll-O'Gara acquired all of the capital stock of
Financial Research, Inc. of Fort Washington, Pennsylvania, in exchange for
101,555 shares of Kroll-O'Gara common stock valued at approximately $3.3
million, or $32.49 per share. The acquisition has been accounted for as a
pooling of interests. Financial Research provides business valuation and
economic damage analysis services throughout the United States. Its revenues are
included in the Investigations and Intelligence Group.
Revenue recognition. Kroll-O'Gara recognizes net sales from military
and most commercial armoring contracts using the percentage-of-completion method
calculated utilizing the cost-to-cost approach. Under this method, Kroll-O'Gara
recognizes estimated contract revenues based generally on the percentage that
costs to date bear to total estimated costs and recognizes estimated contract
losses in full when it becomes likely that a loss will occur. Accordingly,
Kroll-O'Gara periodically reviews and revises contract revenues and total cost
estimates as the work progresses and as change orders are approved. It reflects
adjustments in contract revenues, based upon the percentage of completion, in
the period when the estimates are revised. To the extent that these adjustments
result in an increase, a reduction or an elimination of previously reported
contract revenues, Kroll-O'Gara recognizes a credit or a charge against current
earnings, which could be material. Contract costs include all direct material
and labor costs, along with certain direct overhead costs related to contract
production. Kroll-O'Gara records provisions for any estimated total contract
losses on uncompleted contracts in the period in which it concludes that the
losses will occur. Changes in estimated total contract costs result in revisions
to contract revenue. The revisions are recognized when determined.
Kroll-O'Gara recognizes revenue from investigative and intelligence
services as the services are performed. It records either billed or unbilled
accounts receivable based on case-by-case invoicing determinations.
13
<PAGE> 16
Kroll-O'Gara recognizes revenue from telecommunications equipment and
services 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.
Kroll-O'Gara recognizes information security service revenues, which
consist of consulting fees on information security projects, ratably over the
period of the agreement or according to the completed contract method of
accounting for contract revenues, depending on the nature of the agreement.
RESTRUCTURING OF OPERATIONS
Due to the large number of acquisitions Kroll-O'Gara completed in 1997
and 1998, integration of the operations of the acquired companies with existing
operations was a strategic initiative for Kroll-O'Gara's management in 1999. As
part of this initiative, management evaluated its business segments to ensure
that its core businesses within the segments are operating efficiently. In 1998,
most of the businesses were acquired as part of the Investigations and
Intelligence Group. As a result of management's evaluation of this Group, the
decision was made to close several less profitable operating facilities so that
the Group could focus on integration of existing facilities with the newly
acquired businesses. In 1997, the Security Products and Services Group completed
several acquisitions as well. In evaluating the operations of this Group,
management concluded that a cost savings initiative was required and would be
achieved largely through operating process improvements and a corresponding
decrease in personnel.
In the first quarter of 1999, Kroll-O'Gara began implementation of such
a plan to reduce costs and improve operating efficiencies and recorded a
non-recurring pre-tax restructuring charge of approximately $0.5 million. In the
second quarter of 1999, Kroll-O'Gara completed the restructuring plan with an
additional non-recurring pre-tax restructuring charge of $3.9 million. The
principal elements of the restructuring plan are the closure of two
Investigations and Intelligence Group offices and the elimination of
approximately 82 employees. The primary components of the restructuring charge
were severance costs and lease termination costs. See Note 2 to the Notes to
Consolidated Unaudited Financial Statements for more information.
RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the items
noted as a percentage of net sales:
14
<PAGE> 17
<TABLE>
<CAPTION>
FOR THE THREE MONTHS ENDED FOR THE SIX MONTHS ENDED
JUNE 30, JUNE 30,
-------------------------- ------------------------
1999 2000 1999 2000
------ ------ ------ ------
<S> <C> <C> <C> <C>
Security Products and Services
Military 8.8% 8.9% 11.7% 9.4%
Commercial 26.9% 22.1% 26.1% 24.1%
Investigations and Intelligence 57.7% 62.6% 55.7% 60.1%
Voice and Data Communications 5.0% 5.2% 4.9% 5.3%
Information Security 1.6% 1.2% 1.6% 1.1%
------ ------ ------ ------
Total net sales 100.0% 100.0% 100.0% 100.0%
Cost of sales 60.0 64.7 61.5 64.2
------ ------ ------ ------
Gross profit 40.0 35.3 38.5 35.8
Operating expenses:
Selling and marketing 8.7 9.3 8.7 9.0
General and administrative 20.3 25.9 19.5 25.1
Separation expenses -- 0.9 -- 0.4
Failed merger expenses -- 0.9 -- 1.2
Merger expenses 3.6 0.4 2.0 0.3
Restructuring charge 4.8 -- 2.9 --
------ ------ ------ ------
Operating income (loss) 2.6 (2.1) 5.4 (0.2)
Other income (expense):
Interest expense (1.1) (1.9) (1.2) (1.8)
Other, net (0.3) -- -- (0.1)
------ ------ ------ ------
Income (loss) before provision for income
taxes and cumulative effect of
accounting change 1.3 (4.1) 4.2 (2.0)
Provision for income taxes 1.0 1.4 1.8 0.8
------ ------ ------ ------
Income (loss) before cumulative effect of
accounting change 0.3 (5.5) 2.3 (2.9)
Cumulative effect of accounting change, net
of tax benefit -- -- (0.5) --
------ ------ ------ ------
Net income (loss) 0.3% (5.5)% 1.8% (2.9)%
====== ======= ====== =======
</TABLE>
Three Months Ended June 30, 2000 Compared to Three Months Ended June 30, 1999
NET SALES. Net sales for the three months ended June 30, 2000 decreased
$2.3 million, or 3%, from $80.5 million in 1999 to $78.3 million in 2000.
Security Products and Services Group. Net sales for the Security
Products and Services Group for the three months ended June 30, 2000 decreased
$4.5 million, or 16%, from $28.8 million in 1999 to $24.3 million in 2000. The
decrease results from a decrease in net sales of commercial products and
services of $4.4 million, or 20%, from $21.7 million in 1999 to $17.3 million in
2000. In the second quarter of 2000, production and net sales for commercial
armoring decreased due to a lag between completing one U.S. government contract
at the end of the first quarter of 2000 and beginning a new contract in the
third quarter of 2000. In addition, in a certain foreign location, net sales in
the second quarter of 2000 decreased because base units needed to start
production on signed contracts were not available due to recalls by the
original equipment manufacturer in order to fix certain safety defects.
Also included in net sales for the Security Products and Services Group
are sales of military products and services, which decreased $0.1 million, or
1%, from $7.1 million in 1999 to $7.0 million in 2000.
15
<PAGE> 18
Investigations and Intelligence Group. Net sales for the Investigations
and Intelligence Group increased $2.5 million, or 5%, from $46.5 million in the
second quarter of 1999 to $49.0 million in 2000. This increase primarily stems
from internal growth in the Group's Business Investigations and Intelligence
and Corporate Services practices.
Voice and Data Communications Group. Net sales for the Voice and Data
Communications Group remained approximately the same at $4.0 million in the
second quarter of 2000 compared to the second quarter of 1999.
Information Security Group. Net sales for the Information Security
Group decreased $0.3 million, or 26%, from $1.3 million in 1999 to $0.9 million
in 2000. Net sales decreased due to a continuing focus on development of this
Group's service capabilities and the related inability to establish a firm
customer base until the development of the business is complete.
COST OF SALES. Cost of sales for the three months ended June 30, 2000
increased $2.3 million, or 5%, from $48.3 million in 1999 to $50.6 million in
2000. The increase in cost of sales was primarily due to increased employee
compensation costs and subcontractor fees associated with generating
professional fee revenue in the Investigations and Intelligence Group. Gross
margin was 35.3%, as compared with 40.0% for the same period in 1999.
Gross margin for the Security Products and Services Group decreased
approximately 11.8 percentage points from 34.8% in 1999 to 23.0% in 2000. This
decrease is a result of increased fixed costs as a percentage of total net
sales. In the second quarter of 2000, production and net sales for commercial
armoring decreased due to a lag between completing one U.S. government contract
at the end of the first quarter of 2000 and beginning a new contract in the
third quarter of 2000. In addition, new vehicle models caused additional costs
as prototypes for the new models had to be completed before full production
could begin. All prototype costs were expensed as incurred. In the second
quarter of 1999, there were no prototype expenses. In addition, commercial
armoring margins were impacted by the previously mentioned original equipment
manufacturer recalls as well as competitive pricing pressures and pricing
concessions necessitated by poor foreign economic conditions in certain
locations.
Gross margin decreased approximately 2.6 percentage points from 45.9%
in 1999 to 43.3% in 2000 for the Investigations and Intelligence Group. The
decrease in gross margin was due to increased fixed costs associated with
increased employee compensation and benefits as well as increased subcontractor
fees associated with generating professional fee revenue.
Gross margin for the Voice and Data Communications Group increased 11.7
percentage points from 6.7% in 1999 to 18.4% in 2000. This increase relates to a
change in sales mix from 1999 to 2000. In 1999, sales were based exclusively on
sales of the Group's navigation and satellite communication products. Due to
softness in the market at the time, these sales were at much lower margins than
had previously been achieved. In 2000, the Group continued work on a large
foreign satellite communications integration contract received in the fourth
quarter of 1999. Because the contract involved integration services as well as
equipment, sales and gross margin were higher than product sales alone.
OPERATING EXPENSES. Operating expenses for the three months ended June
30, 2000 decreased $0.8 million, or 3%, from $30.1 million in 1999 to $29.3
million in 2000. The decrease is due to a decrease in non-recurring expenses of
$5.0 million, from $6.7 million in 1999 to $1.7 million in 2000. Non-recurring
charges in 2000 consist of approximately $0.7 million of costs associated with
the failed recapitalization merger with Blackstone as well as $0.7 million of
costs associated with the separation of Kroll-O'Gara's Security Products and
Services Group and Investigations and Intelligence Group. In addition, $0.3
million of costs relate to additional merger integration costs associated with
the acquisitions completed in 1999. In 1999, non-recurring expenses included
$2.9
16
<PAGE> 19
million of merger-related expenses primarily for the Background America merger
as well as a restructuring charge of $3.9 million.
Excluding non-recurring expenses, operating expenses increased $4.2
million. Included in this increase were $0.5 million for depreciation and
amortization of fixed and intangible assets, including goodwill, and $0.6
million for bad debt expense. In the second quarter of 2000, slow customer
payments prompted Kroll-O'Gara's Investigations and Intelligence Group to
increase its reserve for uncollectible accounts receivable. In addition,
operating expenses in the Information Security Group increased $1.6 million as a
result of the continuing focus on development of this Group's software products
capabilities including an increase in professional support personnel to support
the increased development. The remaining increase relates to an increase in
expenses related to the additional legal, accounting, insurance and information
system costs required to administer the growth experienced by Kroll-O'Gara due
to the acquisitions completed in December 1998 and throughout 1999.
As a percent of net sales, operating expenses, before non-recurring
charges, increased from 29.0% in 1999 to 35.2% in 2000. As mentioned previously,
the increase in operating expenses as a percentage of net sales is primarily a
result of increased fixed costs to develop the Information Security Group's
software products capabilities and to administer the growth experienced by
Kroll-O'Gara due to the acquisitions completed in December 1998 and throughout
1999.
INTEREST EXPENSE. Interest expense for the three months ended June 30,
2000 increased $0.7 million, or 77%, from $0.8 million in 1999 to $1.5 million
in 2000. This increase was the result of increased borrowings on Kroll-O'Gara's
revolving credit facility. For most of the second quarter of 1999, Kroll-O'Gara
had excess funds as a result of a public offering of stock completed in May 1998
and no additional borrowings were required on the revolving credit facility
until the purchase of Buchler Phillips on June 3, 1999.
PROVISION FOR INCOME TAXES. The provision for income taxes for the
three months ended June 30, 2000 was $1.1 million compared to $0.8 million in
1999. Despite a pre-tax loss in the second quarter of 2000, Kroll-O'Gara
recorded a provision for income taxes for certain foreign subsidiaries which
generated income in the period. In addition, certain foreign jurisdictions
realized losses in the second quarter of 2000 from which Kroll-O'Gara was not
able to benefit for tax purposes due to the uncertainty relating to the future
realizability of the net operating loss carryforward.
Six Months Ended June 30, 2000 Compared to Six Months Ended June 30, 1999
NET SALES. Net sales for the six months ended June 30, 2000 increased
$11.0 million, or 7%, from $152.0 million in 1999 to $163.0 million in 2000.
Security Products and Services Group. Net sales for the Security
Products and Services Group for the six months ended June 30, 2000 decreased
$2.8 million, or 5%, from $57.5 million in 1999 to $54.7 million in 2000. The
decrease results from a decrease in net sales of military products and services
of $2.6 million, or 14%, from $17.9 million in 1999 to $15.3 million in 2000.
The decrease in net sales of military products and services was a result of the
completion in the fourth quarter of 1999 of a contract with the U.S. Military to
supply 738 armored High Mobility Multi-Purpose Wheeled Vehicles ("HMMWVs") to
the U.S. Army and the U.S. Air Force (the "738 Contract"). The 738 Contract
which began in 1998 resulted in higher levels of production and net sales as a
result of an aggressive delivery schedule required by the U.S. Air Force. In
2000, Kroll-O'Gara's military product sales were based solely on a newer
contract for 245 Up-Armored HMMWVs, which does not provide for an aggressive
delivery schedule.
Also included in net sales for the Security Products and Services Group
are sales of commercial armoring products and services, which decreased $0.3
million, or 1%, from $39.6 million
17
<PAGE> 20
in 1999 to $39.4 million in 2000. In a certain foreign location, net sales in
the second quarter of 2000 decreased because base units needed to start
production on signed contracts were not available due to recalls by the
original equipment manufacturer in order to fix certain safety defects.
Investigations and Intelligence Group. Net sales for the Investigations
and Intelligence Group increased $13.4 million, or 16%, from $84.6 million in
1999 to $98.0 million in 2000. A portion of this increase is a
result of the Buchler Phillips acquisition completed for the Group in the second
quarter of 1999. Excluding purchase acquisitions, sales increased $8.4 million.
This increase primarily stems from internal growth in the Group's Business
Investigations and Intelligence and Corporate Services practices.
Voice and Data Communications Group. Net sales for the Voice and Data
Communications Group increased $1.1 million, or 15%, from $7.5 million in 1999
to $8.6 million in 2000. The increase in net sales is a result of a large
foreign satellite communications integration contract received in the fourth
quarter of 1999. In addition, the Group focused efforts on reducing its
inventory of satellite communications equipment in order to improve cash flow
and offered slightly discounted prices in order to move certain inventory.
Information Security Group. Net sales for the Information Security
Group decreased $0.7 million, or 27%, from $2.5 million in 1999 to $1.8 million
in 2000. Net sales decreased due to a continuing focus on development of this
Group's service capabilities and the related inability to establish a firm
customer base until the development of the business is complete.
COST OF SALES. Cost of sales for the six months ended June 30, 2000
increased $11.2 million, or 12%, from $93.6 million in 1999 to $104.7 million in
2000. The increase in cost of sales was partially due to the Buchler Phillips
acquisition completed in the second quarter of 1999. Excluding this acquisition,
cost of sales increased $8.2 million. This increase in cost of sales was
primarily due to increased employee compensation costs and subcontractor fees
associated with generating professional fee revenue in the Investigations and
Intelligence Group. Gross margin for the six months ended June 30, 2000 was
35.8%, as compared with 38.5% for the same period in 1999.
Gross margin for the Security Products and Services Group decreased
approximately 6.3 percentage points from 32.3% in 1999 to 26.0% in 2000. In the
second quarter of 2000, new vehicle models caused additional costs as prototypes
for the new models had to be completed before full production could begin. All
prototype costs were expensed as incurred. In 1999, there were no prototype
expenses. In addition, commercial armoring margins were impacted by the
previously mentioned original equipment manufacturer recalls as well as
competitive pricing pressures and pricing concessions necessitated by poor
foreign economic conditions in certain locations.
Gross margin decreased approximately 0.8 percentage points from 44.7%
in 1999 to 43.9% in 2000 for the Investigations and Intelligence Group. The
decrease in gross margin was due to increased fixed costs associated with
increased employee compensation and benefits as well as increased subcontractor
fees associated with generating professional fee revenue.
Gross margin for the Voice and Data Communications Group increased 5.0
percentage points from 11.0% in 1999 to 16.0% in 2000. This increase relates to
a change in sales mix from 1999 to 2000. In 1999, sales were based exclusively
on sales of the Group's navigation and satellite communication products. Due to
softness in the market at the time, these sales were at much lower margins than
had previously been achieved. In 2000, the Group continued work on a large
foreign satellite communications integration contract received in the fourth
quarter of 1999. Because the contract involved integration services as well as
equipment, sales and gross margin were higher than product sales alone.
18
<PAGE> 21
OPERATING EXPENSES. Operating expenses for the six months ended June
30, 2000 increased $8.3 million, or 17%, from $50.3 million in 1999 to $58.7
million in 2000. This increase is despite a decrease in non-recurring expenses
of $4.3 million, from $7.5 million in 1999 to $3.1 million in 2000.
Non-recurring charges in 2000 consist of approximately $2.0 million of costs
associated with the failed recapitalization merger with Blackstone as well as
$0.7 million of costs associated with the separation of Kroll-O'Gara's Security
Products and Services Group and Investigations and Intelligence Group. In
addition, $0.4 million of costs relate to additional merger integration costs
associated with the acquisitions completed in 1999. In 1999, non-recurring
expenses included $3.1 million of merger-related expenses primarily for the
Background America merger as well as a restructuring charge of $4.4 million.
Excluding non-recurring expenses, operating expenses increased $12.7
million. Approximately $1.6 million of this increase is due to operating
expenses incurred by Buchler Phillips in the first quarter of 2000. The Buchler
Phillips acquisition was not completed until the second quarter of 1999 and its
operating expenses are not included in Kroll-O'Gara's historical financial
information until the effective date of the acquisition, April 1, 2000. Also
included in this increase were $2.1 million for depreciation and amortization of
fixed and intangible assets, including goodwill, and $1.4 million for bad debt
expense. In the first six months of 2000, slow customer payments as well as
several customer bankruptcies prompted Kroll-O'Gara's Investigations and
Intelligence Group to increase its reserve for uncollectible accounts
receivable. In addition, operating expenses in the Information Security Group
increased $3.3 million as a result of the continuing focus on development of
this Group's software products capabilities including an increase in
professional and support personnel to support the increased development. The
remaining increase relates to an increase in expenses related to the additional
legal, accounting, insurance and information system costs required to administer
the growth experienced by Kroll-O'Gara due to the acquisitions completed in
December 1998 and throughout 1999.
As a percent of net sales, operating expenses, before non-recurring
charges, increased from 28.2% in 1999 to 34.1% in 2000. As mentioned previously,
the increase in operating expenses as a percentage of net sales is primarily a
result of increased fixed costs to develop the Information Security Group's
software products capabilities and to administer the growth experienced by
Kroll-O'Gara due to the acquisitions completed in December 1998 and throughout
1999.
INTEREST EXPENSE. Interest expense for the six months ended June 30,
2000 increased $1.0 million, or 53%, from $1.9 million in 1999 to $2.9 million
in 2000. This increase was the result of increased borrowings on Kroll-O'Gara's
revolving credit facility. For most of the first six months of 1999,
Kroll-O'Gara had excess funds as a result of a public offering of stock
completed in May 1998 and no additional borrowings were required on the
revolving credit facility until the purchase of Buchler Phillips on June 3,
1999.
PROVISION FOR INCOME TAXES. The provision for income taxes for the six
months ended June 30, 2000 was $1.4 million compared to $2.8 million in 1999.
Despite a pre-tax loss in the first six months of 2000, Kroll-O'Gara recorded a
provision for income taxes for certain foreign subsidiaries which generated
income in the period. In addition, certain foreign jurisdictions realized
losses during the first six months of 2000 from which Kroll-O'Gara was not able
to benefit for tax purposes due to the uncertainty relating to the future
realizability of the net operating loss carryforward.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Kroll-O'Gara had
previously capitalized costs associated with the start-up of activities,
including pre-operating costs, organization costs and other start-up costs.
These capitalized costs were amortized over periods ranging from one to five
years. The capitalized amount, $1.2 million before tax, was expensed in 1999 in
accordance with the American Institute of Certified Public Accountants Statement
of Position 98-5, "Reporting on the Cost of Start-Up Activities". The amount
expensed is shown net of applicable tax benefit of $0.4 million.
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LIQUIDITY AND CAPITAL RESOURCES
General. Kroll-O'Gara historically has met its operating cash needs by
utilizing borrowings under its credit arrangements to supplement cash provided
by operations and other financing activities, excluding non-cash charges such as
depreciation and amortization.
Credit Facility. On May 12, 2000, Kroll-O'Gara amended its credit
agreement to provide for a 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 September 30,
2000, at which time all borrowings in excess of $25.0 million must be repaid.
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 line of
credit mature on May 31, 2001. Advances under the revolving line of credit
during the period of the temporary increase bear interest at prime, or, at
Kroll-O'Gara's option, LIBOR plus 1.75%. On September 30, 2000, advances under
the revolving line of credit will bear interest at rates ranging from prime less
1.75% to prime, or, at Kroll-O'Gara's option, LIBOR plus 0.75% to LIBOR plus
1.75%, dependent upon a defined financial ratio. Borrowings under this line of
credit were approximately $22.8 million and $34.3 million at December 31, 1999
and June 30, 2000, respectively.
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. Pursuant to the amended credit agreement,
certain of these financial ratios were revised. Kroll-O'Gara was not in
compliance with certain of these covenants at June 30, 2000. The lender
subsequently waived all such events of non-compliance.
Effective June 3, 1999, with the acquisition of Buchler Phillips,
Kroll-O'Gara acquired a demand note with maximum borrowings of pound sterling
2.5 million. The demand note bears interest at the Bank of England's base rate
plus 1.5%. Maximum borrowings permitted pursuant to this demand note were
approximately $4.0 million. Borrowings outstanding pursuant to this demand note
were $3.4 million and $2.9 million, respectively, as translated at December 31,
1999 and June 30, 2000.
Kroll-O'Gara's $35.0 million of senior unsecured notes payable also
contains financial covenants, which among other restrictions, require the
maintenance of a minimum level of net worth and a fixed charge coverage ratio.
Kroll-O'Gara was not in compliance with the fixed charge coverage ratio at June
30, 2000. The lenders subsequently waived this event of non-compliance.
As described above, Kroll-O'Gara will explore structuring a series of
transactions that would result in a separation into two public companies of its
principal business groups. Kroll-O'Gara cannot predict at this time what the
effect of such a transaction would be on its funding requirements. However,
without giving effect to any such transaction, additional sources of capital
will be required to supplement operating cash flow for the next twelve months
either through amending and increasing Kroll-O'Gara's credit facilities or
through an equity offering of one of its subsidiaries. Management is currently
in discussions with its banks to provide financing subsequent to the separation.
Cash flows from operating activities. Cash used in operating activities
increased from $3.6 million in the first six months of 1999 to $4.9 million in
2000. In 1999, cash was used primarily to fund working capital investments
offset by net income. In 2000, cash was used primarily to fund Kroll-O'Gara's
net loss which resulted from the net loss incurred by the Information Security
Group.
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Cash flows from investing activities. In the six months ended June 30,
2000, Kroll-O'Gara incurred $4.9 million of capital expenditures primarily for
upgrades of general information systems as well as additional leasehold
improvements and office furniture and fixtures related to new office space in
the Investigations on Intelligence Group. In the six months ended June 30, 1999,
Kroll-O'Gara incurred capital expenditures of $9.3 million primarily related to
the acquisition and implementation of two new enterprise systems, one at its
Security Products and Services Group and one at its Investigations and
Intelligence Group. In 1999, Kroll-O'Gara sold $12.0 million of its marketable
securities in order to fund its increased capital expenditure requirements.
Additions to databases totaled $1.8 million and $2.2 million for the six months
ended June 30, 1999 and 2000, respectively.
Cash flows from financing activities. Cash provided by financing
activities for the first six months of 1999 was $18.2 million. In 2000, cash
provided by financing activities was $5.0 million. In both periods, cash was
provided by borrowings under bank lines of credit, net of repayments of long
term debt.
Foreign operations. Kroll-O'Gara attempts to mitigate the risks of
doing business in foreign countries by separately incorporating its operations
in those countries; maintaining reserves for credit losses; maintaining
insurance on equipment to protect against losses related to political risks and
terrorism, and using financial instruments to hedge Kroll-O'Gara's risk from
translation gains and losses.
Kroll-O'Gara utilizes derivative financial instruments, in the form of
forward contracts, to hedge some of its exposure to foreign currency rate
fluctuations. At June 30, 2000, nine such contracts, maturing between July 2000
and January 2002, were outstanding in connection with intercompany demand notes
with certain subsidiaries. These contracts are intended to hedge Kroll-O'Gara's
exposure to deterioration in the amount outstanding due to changes in currency
translation rates. The notional amount, together with amortized premium, and the
fair market value associated with these forward contracts was $17.9 and $1.8
million, respectively. Gains or losses on existing forward instruments are
offset against the translation effects reflected in shareholders' equity. The
fair value of forward contracts is not recognized in the consolidated financial
statements since they are accounted for as hedges. Kroll-O'Gara does not hold or
issue derivative financial instruments for trading purposes.
Quarterly fluctuations. Kroll-O'Gara's operations may fluctuate on a
quarterly basis as a result of the timing of contract costs and revenues of its
Security Products and Services Group, particularly from its military and
governmental contracts which are generally awarded in a periodic and/or sporadic
basis. Kroll-O'Gara generally does not have long-term contracts with its clients
in its Investigations and Intelligence Group and its ability to generate net
sales is dependant upon obtaining many new projects each year, most of which are
of a relatively short duration. Period-to-period comparisons within a given year
or between years may not be meaningful or indicative of operating results over a
full fiscal year.
Forward-Looking Statements. This quarterly report contains statements
which Kroll-O'Gara believes are forward-looking statements within the meaning of
Section 21E of the Securities Exchange Act of 1934. These statements are made
particularly in this Management's Discussion and Analysis of Financial Condition
and Results of Operations, but also appear elsewhere in this document.
Forward-looking statements can be identified by the use of language such as
"may," "will," "expect," "anticipate," "estimate," "continue" or other similar
words. Such statements are based upon management's estimates, assumptions and
projections and are subject to substantial risks and uncertainties that could
cause actual results to differ materially from those set forth in the
forward-looking statements. Factors that could cause actual results to differ
materially from those in the forward-looking statements include, among other
things: contract delays, reductions or cancellations; cost overruns with regard
to fixed price contracts; problems and costs associated with integrating past
and future business combinations; various political and economic risks of
conducting business
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outside the United States, including foreign economic conditions and currency
rate fluctuations; changes in laws and regulations; adjustments associated with
percentage-of-completion accounting; inability of subcontractors to perform on
schedule and meet demand; unexpected competitive pressures resulting in lower
margins and volumes; uncertainties in connection with start-up operations and
opening new offices; higher-than-anticipated costs of financing the business;
loss of senior personnel; and changes in the general level of business activity.
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PART II -- OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
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. 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, the 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 Capital
Partners III 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 the Company and also seek class certification. On
behalf of Kroll-O'Gara and the putative plaintiff classes of shareholders, they
seek a declaration that the individual defendants breached their fiduciary duty
and 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. Section 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 vendor's alleged failure to have certified welders. Kroll-O'Gara strongly
disputes the Government's contention against it and will vigorously contest the
Government's claims.
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 any such additional currently
pending litigation, individually or in the aggregate, that is likely to have a
material adverse effect on its business, financial condition, results of
operations or cash flows.
ITEM 6. EXHIBITS
(a) Exhibits
27 Financial Data Schedule (Edgar version only)
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SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934,
the Registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized as of the 18th day of August, 2000.
THE KROLL-O'GARA COMPANY
By /s/ Nicholas P. Carpinello
Nicholas P. Carpinello
Controller and Treasurer
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