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UNITED STATES
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
For the quarterly period ended September 30, 2002
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the transition period from_______________ to________________
Commission File Number: 000-21629
KROLL INC.
(Exact name of registrant as specified in its charter)
Delaware 31-1470817
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
900 Third Avenue
New York, NY 10022
(Address of principal executive (Zip code)
offices) (212) 593-1000
(Registrant's telephone number, including area code)
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.
36,973,898
-------------------------------------------------------
(Shares of common stock outstanding as of November 11, 2002)
================================================================================
KROLL INC.
FORM 10-Q
FOR THE QUARTERLY PERIOD ENDED
September 30, 2002
Page
PART I - FINANCIAL INFORMATION
Item 1: Financial Statements
Consolidated Balance Sheets (unaudited) as of
September 30, 2002 and December 31, 2001............ 1
Consolidated Statements of Operations and
Comprehensive Income (Loss) (unaudited) for
the three and nine months ended September 30,
2002 and 2001....................................... 3
Consolidated Statements of Cash Flows
(unaudited) for the nine months ended
September 30, 2002 and 2001......................... 4
Notes to Consolidated Unaudited Financial
Statements.......................................... 5
Item 2: Management's Discussion and Analysis of Financial
Condition and Results of Operations................. 23
Item 3: Quantitative and Qualitative Disclosures About
Market Risk......................................... 37
Item 4: Controls and Procedures............................. 38
PART II - OTHER INFORMATION
Item 1: Legal Proceedings................................... 39
Item 2: Changes in Securities and Use of Proceeds........... 40
Item 6: Exhibits and Reports on Form 8-K.................... 41
Signatures............................................................ 43
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KROLL INC.
CONSOLIDATED BALANCE SHEETS (Unaudited)
As of September 30, 2002 and December 31, 2001
(Dollars in Thousands)
September 30, December 31,
2002 2001
------------ -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents ..................................................... $ 32,377 $ 11,485
Trade accounts receivable, net of allowance for
doubtful accounts of $9,221 and $6,798 at September
30, 2002 and December 31, 2001, respectively ................................ 52,548 37,780
Unbilled revenues ............................................................. 28,330 25,600
Related party receivables ..................................................... 1,948 2,417
Prepaid expenses and other current assets ..................................... 5,974 4,524
---------- ----------
Total current assets ........................................................ 121,177 81,806
---------- ----------
PROPERTY, PLANT AND EQUIPMENT, at cost:
Land .......................................................................... 194 194
Buildings and improvements .................................................... 2,091 2,001
Leasehold improvements ........................................................ 10,911 7,440
Furniture and fixtures ........................................................ 6,605 5,135
Machinery and equipment ....................................................... 38,195 27,905
Construction-in-progress ...................................................... -- 500
---------- ----------
57,996 43,175
Less-accumulated depreciation and amortization ................................ (33,672) (27,108)
---------- ----------
24,324 16,067
---------- ----------
DATABASES, net of accumulated amortization of $36,980 and
$33,672 at September 30, 2002 and December 31, 2001,
respectively .................................................................. 10,673 10,530
COSTS IN EXCESS OF ASSETS ACQUIRED, net of accumulated
amortization of $8,033 and $8,033 at September 30, 2002
and December 31, 2001, respectively (Note 15) ................................. 303,405 50,436
OTHER INTANGIBLE ASSETS, net of accumulated amortization
of $4,803 and $3,403 at September 30, 2002 and December
31, 2001, respectively (Note 15) .............................................. 20,888 6,720
OTHER ASSETS ..................................................................... 8,649 4,227
---------- ----------
Total Assets ................................................................ $ 489,116 $ 169,786
========= =========
The accompanying notes are an integral part of these consolidated unaudited
financial statements.
1
KROLL INC.
==============================================================================
CONSOLIDATED BALANCE SHEETS (Unaudited)
As of September 30, 2002 and December 31, 2001
(in Thousands, except share amounts)
September 30, December 31,
2002 2001
------------ -----------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit (Note 10) .................. $ 1,112 $ 2,561
Current portion of long-term debt (Note 10) .......... 5,333 318
Trade accounts payable ............................... 12,310 10,360
Related party payables ............................... 7,884 --
Accrued payroll and related benefits ................. 9,081 7,622
Other accrued liabilities ............................ 13,452 8,769
Income taxes payable ................................. 2,802 1,434
Deferred income taxes ................................ 213 1,936
Deferred revenue ..................................... 8,392 4,389
Net current liabilities of discontinued operation .... -- 503
--------- ---------
Total current liabilities .......................... 60,579 37,892
DEFERRED INCOME TAXES ................................... 1,163 346
CONVERTIBLE NOTES, net of unamortized discount of $10,021
and $11,200 at September 30, 2002 and December 31,
2001, respectively (Note 10) ......................... 19,979 18,800
LONG-TERM DEBT, net of current portion (Note 10) ........ 69,762 278
--------- ---------
OTHER LONG-TERM LIABILITIES ............................. 1,841 1,337
--------- ---------
Total liabilities .................................. 153,324 58,653
--------- ---------
SHAREHOLDERS' EQUITY:
Preferred stock, $.01 par value, 5,000,000 shares
authorized, none issued (Note 2) ................... -- --
Common stock, $.01 par value, 100,000,000 shares
authorized, 30,628,616 and 22,793,871 shares issued
and outstanding at September 30, 2002 and December
31, 2001, respectively (Note 2) .................... 306 228
Common shares to be issued for acquisition ........... 55,280 --
Additional paid-in-capital ........................... 341,445 183,421
Accumulated deficit .................................. (56,670) (67,971)
Accumulated other comprehensive loss ................. (4,569) (4,545)
--------- ---------
Total shareholders' equity ......................... 335,792 111,133
--------- ---------
$ 489,116 $ 169,786
========= =========
The accompanying notes are an integral part of these consolidated unaudited
financial statements.
2
KROLL INC.
CONSOLIDATED STATEMENTS OF OPERATIONS
AND COMPREHENSIVE INCOME (LOSS) (Unaudited)
(In Thousands, Except per Share Amounts)
For the three months ended For the nine months ended
September 30, September 30,
-------------------------- -------------------------
2002 2001 2002 2001
--------- --------- --------- ---------
NET SALES ...................................................... $ 79,699 $ 49,356 $ 195,434 $ 148,715
COST OF SALES .................................................. 38,609 32,076 101,808 90,281
--------- --------- --------- ---------
Gross profit ............................................. 41,090 17,280 93,626 58,434
--------- --------- --------- ---------
OPERATING EXPENSES:
Selling and marketing ....................................... 8,764 4,624 18,529 13,906
General and administrative .................................. 19,724 14,701 51,064 44,584
Research and development .................................... 2,821 -- 3,272 --
Amortization of other intangible assets ..................... 830 207 1,374 620
Failed separation costs (Note 2) ............................ -- 214 -- 607
Restructuring expenses (Note 3) ............................. -- 237 -- 2,834
Impairment of assets (Note 4) ............................... -- 807 -- 807
Failed financing costs (Note 10) ............................ -- 880 -- 880
Loss on sale of business unit (Note 7) ...................... -- 545 -- 545
--------- --------- --------- ---------
Operating expenses ........................................ 32,139 22,215 74,239 64,783
--------- --------- --------- ---------
Operating income (loss) .................................. 8,951 (4,935) 19,387 (6,349)
--------- --------- --------- ---------
OTHER INCOME (EXPENSE):
Interest expense, net ....................................... (1,162) (1,179) (3,006) (3,438)
Other income (expense) ...................................... 49 (326) 191 (170)
--------- --------- --------- ---------
Income (loss) from continuing operations before
provision for income taxes ............................ 7,838 (6,440) 16,572 (9,957)
Provision for income taxes .................................. 2,090 817 4,972 2,051
--------- --------- --------- ---------
Income (loss) from continuing operations ................. 5,748 (7,257) 11,600 (12,008)
Discontinued operations (Note 5):
Income (loss) from discontinued
security products and services group,
net of tax .............................................. -- (6,295) 70 (6,647)
Loss from discontinued voice and data
communications group, net of tax ........................ -- (1,831) -- (1,935)
--------- --------- --------- ---------
Income (loss) before extraordinary item ................... 5,748 (15,383) 11,670 (20,590)
Extraordinary item, net of tax benefit of
$159 and $193 for 2002 and 2001,
respectively (Note 10) .................................... (371) (344) (371) (344)
--------- --------- --------- ---------
Net income (loss) ........................................ $ 5,377 $ (15,727) $ 11,299 $ (20,934)
--------- --------- --------- ---------
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Foreign currency translation adjustment,
net of tax benefit of $11 and $1,258
for 2002 and 2001, respectively ........................... (23) (2,051)
Gain in accumulated other comprehensive
loss from the sale of Security Products
and Services Group, net of tax of $2,538 .................. -- 4,140
--------- ---------
Other comprehensive income (loss) ........................ (23) 2,089
--------- ---------
Comprehensive income (loss) .............................. $ 11,276 $ (18,845)
========= =========
PER SHARE DATA (Note 9):
BASIC EARNINGS (LOSS) PER SHARE
Earnings (loss) from continuing
operations .............................................. $ 0.18 $ (0.33) $ 0.44 $ (0.54)
========= ========= ========= =========
Earnings (loss) from discontinued
operations .............................................. $ -- $ (0.36) $ 0.00 $ (0.38)
========= ========= ========= =========
Extraordinary item (Note 10) .............................. $ (0.01) $ (0.01) $ (0.01) $ (0.01)
========= ========= ========= =========
Earnings (loss) per share ................................. $ 0.17 $ (0.70) $ 0.43 $ (0.93)
========= ========= ========= =========
Weighted average shares outstanding ....................... 31,408 22,446 26,281 22,427
========= ========= ========= =========
DILUTED EARNINGS (LOSS) PER SHARE
Earnings (loss) from continuing
operations .............................................. $ 0.18 $ (0.33) $ 0.42 $ (0.54)
========= ========= ========= =========
Earnings (loss) from discontinued
operations .............................................. $ -- $ (0.36) $ 0.00 $ (0.38)
========= ========= ========= =========
Extraordinary item (Note 10) .............................. $ (0.01) $ (0.01) $ (0.01) $ (0.01)
========= ========= ========= =========
Earnings (loss) per share ................................. $ 0.17 $ (0.70) $ 0.41 $ (0.93)
========= ========= ========= =========
Weighted average shares outstanding ....................... 32,454 22,446 27,423 22,427
========= ========= ========= =========
The accompanying notes are an integral part of these consolidated unaudited
financial statements.
3
KROLL INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 12)
(Unaudited)
For the Nine Months Ended September 30, 2002 and 2001
(Dollars in Thousands)
September 30, September 30,
2002 2001
------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income (loss) ........................................................... $ 11,299 $(20,934)
Adjustments to reconcile net income (loss) to net cash
provided by continuing operations--
Loss (income) from discontinued operations ................................ (70) 8,582
Depreciation and amortization ............................................. 9,756 10,175
Bad debt expense .......................................................... 2,481 4,298
Loss on sale of business unit (Note 7) .................................... -- 545
Loss on extraordinary item (Note 10) ...................................... 371 344
Non-cash interest expense ................................................. 1,442 --
Non-cash compensation expense ............................................. -- 259
Change in assets and liabilities, net of effects of
acquisitions and dispositions--
Receivables--trade and unbilled ........................................... (4,034) (1,134)
Prepaid expenses and other current assets ................................. (312) 177
Trade accounts payable and income taxes payable ........................... 2,089 (1,013)
Amounts due to/from related parties ....................................... 887 (377)
Deferred income taxes ..................................................... -- (657)
Deferred revenue .......................................................... (1,056) 1,029
Accrued liabilities ....................................................... (3,686) 1,287
Other long-term liabilities ............................................... (272) 1,051
-------- --------
Net cash provided by operating activities of
continuing operations ................................................. 18,895 3,632
-------- --------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment .................................. (4,694) (2,160)
Additions to databases ...................................................... (3,074) (3,304)
Additions to intangible assets .............................................. (4,232) (181)
Acquisitions, net of cash acquired (Note 8) ................................. (70,851) --
Sale of marketable securities ............................................... 5,594 --
Purchase of investments ..................................................... 32 --
-------- --------
Net cash used in investing activities of continuing
operations .............................................................. (77,225) (5,645)
-------- --------
CASH FLOWS FROM FINANCING ACTIVITIES:
Net payments under revolving line of credit ................................. (4,618) (29,228)
Proceeds from issuance of debt .............................................. 75,000 --
Payments of long-term debt .................................................. (927) (22,351)
Foreign currency translation ................................................ 2,268 (1,157)
Proceeds from exercise of stock options and warrants ........................ 8,084 527
-------- --------
Net cash provided by (used in) financing activities of
continuing operations ................................................... 79,807 (52,209)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........................... 21,477 (54,222)
Effects of foreign currency exchange rates on cash and cash
equivalents ................................................................. (153) (99)
Net cash provided by (used in) discontinued operations ......................... (432) 52,755
CASH AND CASH EQUIVALENTS, beginning of period ................................. 11,485 6,277
-------- --------
CASH AND CASH EQUIVALENTS, end of period ....................................... $ 32,377 $ 4,711
======== ========
The accompanying notes are an integral part of these consolidated unaudited
financial statements.
4
KROLL INC.
NOTES TO THE CONSOLIDATED UNAUDITED FINANCIAL STATEMENTS
As of September 30, 2002 and December 31, 2001
(1) General
Kroll Inc., together with its subsidiaries (collectively, Kroll), is a
leading global provider of a broad range of specialized services that are
designed to provide solutions to a variety of risk mitigation and security
needs. Kroll offers: (1) Consulting Services, which provides business and
financial investigations, forensic accounting, business valuation, litigation
consulting, due diligence, litigation intelligence, asset tracing and analysis,
monitoring and special inquiries, market intelligence, and intellectual property
and infringement investigations; (2) Corporate Advisory & Restructuring, which
provides corporate restructuring, operational turnaround, strategic advisory
services, financial crisis management, and corporate finance services; (3)
Technology Services, which provides electronic discovery, data recovery, and
computer forensics services, along with related software solutions; (4) Security
Services, which provides security architecture and design, corporate security
consulting and crisis management, emergency management, environmental services,
and protective services operations and training; and (5) Background Screening
Services, which provides pre-employment and security background screening, drug
testing, and surveillance. The former Security Products and Services Group
(SPSG) marketed ballistic and blast protected vehicles and security services
(see Note 5(a) - Discontinued Operations). The consolidated unaudited financial
statements include the historical consolidated financial statements of Kroll and
(a) the businesses it has acquired, since their respective dates of acquisition,
under the purchase method of accounting; and (b) the financial position, results
of operations and cash flows of entities which were merged with Kroll in
connection with pooling of interests business combinations. 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 consolidated unaudited financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America 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 accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (consisting
of normal recurring adjustments) considered necessary for fair presentation have
been included. Operating results for the three and nine months ended September
30, 2002 and 2001 are not necessarily indicative of the results that may be
expected for a full year. The accompanying consolidated unaudited financial
statements should be read in conjunction with the consolidated financial
statements and notes thereto included in Kroll's annual report on Form 10-K for
the year ended December 31, 2001.
(2) Corporate Initiatives
Kroll has considered a variety of corporate initiatives within the periods
presented in the accompanying consolidated unaudited financial statements.
In September 2000, the Board of Directors approved an agreement and plan
of reorganization and dissolution of Kroll that would have resulted in the
spinoff of its two principal operating segments, SPSG and the Investigations
and Intelligence Group, into two public companies. On April 20, 2001, the Board
of Directors decided not to pursue this separation alternative. Costs associated
with this proposed separation were approximately zero and $0.6 million for the
nine months ended September 30, 2002 and 2001, respectively, and consisted
primarily of fees for attorneys, accountants, investment bankers and other
related charges. Kroll does not anticipate any additional expenses related to
this terminated separation alternative.
5
On August 22, 2001, Kroll completed the sale of SPSG to Armor Holdings,
Inc. (Armor) for up to $55.7 million, consisting of $37.2 million in cash, $15.0
million in Armor common stock and $1.5 million placed in escrow, pending
agreement on the closing date balance sheet audit. The purchase and sale
agreement also provides for a potential deferred payment of up to $2.0 million
by Armor to Kroll based on the achievement of a gross profit target by SPSG for
the year ended December 31, 2001. Resolution of this deferred payment is still
under review. The $1.5 million in escrow had not been included in determining
the estimated loss on the sale of SPSG. Similarly, Kroll has not included the
impact of the potential $2.0 million deferred payment by Armor to Kroll in
determining the estimated loss on the sale of SPSG (see Note 5(a)).
On May 6, 2002, agreement was reached on SPSG's closing date balance
sheet, which resulted in a payment to Kroll of $1.1 million of the amount held
in escrow. In conjunction with this escrow payment, Kroll forgave certain
obligations due to Kroll by Armor of approximately $1.6 million, primarily
relating to SPSG's Central American operations. On May 15, 2002, Kroll received
$0.6 million from Armor, representing the residual balance due from the sale of
the $15.0 million in common stock (see Note 5(a)).
In March, April and October 2001, Kroll entered into amended and restated
agreements for its revolving credit facility, letters of credit facility and its
senior notes, which extended the date of repayment of all outstanding debt to
November 16, 2001. On November 14, 2001, these debt instruments were retired
using the proceeds from the issuance of the convertible notes discussed below
(see Note 10(a)).
In November 2001, Kroll obtained $30.0 million of financing in the form of
6% Senior Secured Subordinated Convertible Notes due 2006. On November 14, 2001,
Kroll issued $25.0 million of notes and issued an additional $5.0 million of
notes on November 20, 2001. The notes mature on November 14, 2006 and bear
interest at the rate of 6% per annum payable semi-annually. However, 12% per
annum will accrue on any principal payment that is past due. The notes were
secured by a security interest in substantially all the assets of Kroll and its
material domestic subsidiaries, and a pledge of the stock of certain of Kroll's
subsidiaries.
Kroll may redeem these convertible notes at par plus accrued interest, in
whole or in part, beginning on November 14, 2004, provided the note holders have
been notified in writing 20 days in advance. The note holders may at any time
prior to one day before the earlier of the maturity date or the redemption date,
convert all or a portion of the principal amount of the notes into Kroll common
stock at the conversion price of $10.80 per share. The $30.0 million of notes
are immediately convertible into 2,777,777 shares of Kroll common stock, subject
to customary and other anti-dilution adjustments. In connection with the
issuance of the notes, Kroll recorded a notes discount of approximately $11.4
million based on the difference between the closing price of its stock on the
issuance date and the conversion price. In addition to the stated 6% interest,
the discount will be amortized as non-cash interest expense over the expected
5-year life of the notes. Barring early conversion by the noteholders or early
redemption by Kroll, the additional non-cash interest expense, resulting from
the amortization of this discount will average approximately $2.3 million, or
7.6% per year, on the $30.0 million principal amount of the notes (see Note
10(c)).
On September 5, 2002, the convertible notes agreement was amended to
accommodate a new $100 million credit facility (see Note 10(a), 10(c) and
10(d)). The amendment terminated the noteholders' security interest in the
assets of Kroll and its material domestic subsidiaries and a pledge of the stock
of certain of Kroll's subsidiaries. In conjunction with this amended security
interest, the Company has agreed to pay the original remaining noteholder
approximately $1.6 million, which the Company has recorded as an accrued
liability as of September 30, 2002.
On February 21, 2002, Kroll executed agreements with Foothill Capital
Corporation (Foothill) to provide a revolving credit facility of up to $15
million, subject to borrowing base limitations, for a term of three years. The
asset-based loan agreement required Kroll to maintain a minimum level of EBITDA
(earnings before interest, taxes, depreciation and amortization) and contained
restrictions on the incurrence of additional debt, the creation of any liens on
any of Kroll's assets, certain acquisitions, distributions to certain
subsidiaries and other affirmative and negative covenants customarily contained
in debt agreements of this type. The credit facility was
6
secured by the same assets of Kroll and its material domestic subsidiaries and
the same pledge of the stock of certain of Kroll's subsidiaries as the
convertible notes, except that Foothill was senior to the convertible notes. In
connection with the new $100 million credit facility put into place on September
5, 2002 (see Note 10(d)), Kroll amended and ultimately terminated the $15
million revolving credit facility agreement. No borrowings were made under the
terminated $15 million credit agreement (see Note 10 (a)).
In May 2002, Kroll executed agreements to sell to local management its
interest in its Russian armored car businesses that were not sold to Armor.
Kroll received $150,000 upon closing and an additional $10,000 in the third
quarter of 2002. The agreements provide for Kroll to receive $117,000 within one
year of the closing date and an additional $50,000 within two years of the
closing date. Kroll has recorded in its financial statements only those payments
actually received. Expected future payments have not been recorded in the
financial statements, but will be reflected upon receipt. These transactions
relieve Kroll of any liability associated with its Russian businesses (see Note
5(a)).
On May 23, 2002, Kroll received $500,000 from Securify, representing
payment of an unsecured short-term note, undertaken as part of the refinancing
and restructuring of Securify's debt (see Note 6).
On July 2, 2002, Kroll Inc., formerly an Ohio corporation, became a
Delaware corporation pursuant to a merger in which the Ohio corporation merged
with and into its wholly-owned Delaware subsidiary. In connection with the
reincorporation in Delaware, Kroll Inc.'s authorized capital increased to
100,000,000 shares of common stock and 5,000,000 shares of preferred stock.
On September 5, 2002, Kroll entered into a $100 million credit facility
with a syndicate led by Goldman Sachs Credit Partners L.P., as sole lead
arranger, together with Bear Stearns & Co., Inc. and Credit Suisse First Boston.
In connection with this new credit facility, Kroll incurred financing costs,
which will be amortized as additional interest expense over the credit
facility's three year life (see Note 10(d)).
(3) Restructuring of Operations
In the second quarter of 2001, Kroll began implementation of a
restructuring plan (the 2001 Plan) to reduce costs and improve operating
efficiencies. The 2001 Plan was substantially completed by the end of 2001. The
total pre-tax restructuring charge recorded pursuant to the 2001 Plan was
approximately $2.7 million, of which approximately $2.6 million was recorded in
the second quarter of 2001. Kroll does not expect to incur any other significant
restructuring charges in future periods related to the 2001 Plan. Total payments
or writeoffs made pursuant to the 2001 Plan through September 30, 2002, were
approximately $2.3 million. The principal elements of the restructuring plan
were the closure of four Investigations and Intelligence Group offices and the
elimination of approximately 98 employees. The components of the restructuring
accrued balances as of September 30, 2002 are as follows:
Description Accrual
- ---------------------------------------------------------- ----------
Severance and related costs ............................... $113,532
Lease termination costs ................................... 269,269
--------
382,801
Less--Current portion ..................................... 382,801
--------
$ --
========
7
(4) Asset Impairment
In June 2000, Kroll began to develop a contact and relationship management
("CRM") database software program. The Company had capitalized approximately
$0.4 million in software and hardware costs along with an additional $0.4
million in consulting and related costs to prepare the database for its intended
purpose. The Company chose not to implement the CRM software program and charged
impairment of assets during the three months ended September 30, 2001, for the
accumulated costs of approximately $0.8 million. No salvage value was realized.
(5) Discontinued Operations
(a) Security Products and Services Group - On August 22, 2001, Kroll sold
the common stock of most of the active companies that comprise SPSG to Armor for
up to $55.7 million, consisting of $37.2 million in cash, $15.0 million in Armor
common stock, and an additional $1.5 million placed in escrow, pending agreement
on the closing date balance sheet audit. The purchase and sale agreement also
provides for a potential deferred payment of up to $2.0 million by Armor to
Kroll based on the achievement of a gross profit target by SPSG for the year
ended December 31, 2001. Resolution of this deferred payment is still under
review. The sale did not include the subsidiaries that provide kidnap and ransom
and risk information services. Also excluded from the sale was the Russian
business although it was included in SPSG discontinued operations, as further
described below. The $1.5 million in escrow had not been included in determining
the estimated loss on the sale of SPSG. Similarly, Kroll has not included the
impact of the potential $2.0 million deferred payment by Armor to Kroll in
determining the estimated loss on the sale of SPSG.
On May 6, 2002, agreement was reached on SPSG's closing date balance
sheet, which resulted in a payment to Kroll of $1.1 million of the amount held
in escrow. In conjunction with this escrow payment, Kroll forgave certain
obligations due to Kroll by Armor of approximately $1.6 million primarily
relating to SPSG's Central American operations. On May 15, 2002, Kroll received
$0.6 million from Armor, representing the residual balance due from the sale of
the $15.0 million in Armor common stock.
The results of operations have been classified as discontinued and all
prior periods have been restated accordingly. The results of the discontinued
SPSG reflect Kroll's administrative costs attributable to SPSG. To the extent
that such identification was not practicable, these costs were allocated based
on SPSG's sales as a percentage of Kroll's sales. The results of the
discontinued SPSG also reflect an allocation of corporate interest expense based
on Kroll's weighted average interest rate applied to intercompany advances.
Although Kroll's Russian businesses were not sold to Armor, the Russian
businesses were part of the plan to discontinue SPSG and, therefore, have been
included in discontinued operations of SPSG. In May 2002, Kroll executed
agreements to sell to local management its interest in its Russian armored car
businesses. Kroll received $150,000 upon closing and an additional $10,000 in
the third quarter. These agreements provide that Kroll will receive
approximately $117,000 within one year of the closing date and an additional
$50,000 within two years of the closing date. Payments not received on the due
date will accrue interest at 10% per annum. These transactions relieve Kroll of
any liability associated with its Russian businesses.
8
Net sales and results of operations of SPSG are as follows:
Period ended
August 22, 2001
---------------------
(dollars in thousands)
Net sales................................................... $ 79,359
Cost of sales............................................... 67,477
-----------
Gross profit............................................. 11,882
Operating expenses.......................................... 15,680
-----------
Operating loss......................................... (3,798)
Other expense............................................... (3,050)
-----------
Loss before provision for income taxes................. (6,848)
Provision for income taxes.................................. 379
-----------
Net loss............................................... $ (7,227)
===========
(b) Voice and Data Communications Group - On April 16, 2001, the Board of
Directors approved a formal plan to discontinue operations of the Voice and Data
Communications Group (VDCG), which offered secure satellite communication
equipment and satellite navigation systems.
On June 27, 2001, Kroll sold its ownership in the stock of VDCG to an
unrelated third party for notes that are due and payable in 2004 with a
contingent value of up to $4.0 million. As the realization of the $4.0 million
in notes was contingent upon subsequent factors, at June 30, 2001, these notes
were valued at $1.8 million. Kroll subsequently determined the collectibility of
the notes to be uncertain and, as a result, the notes were written down to zero
in the third quarter of 2001.
The results of operations of VDCG have been classified as discontinued
operations and all prior periods have been restated accordingly. The results of
VDCG reflect an allocation of interest expense based on VDCG's average net
assets. The tax effects of the results of operations of VDCG were not
significant for the periods presented. Net sales and results of operations of
this discontinued operation are as follows:
Nine Months ended
September 30, 2001
---------------------
(dollars in thousands)
Net sales....................................................... $ 4,590
Interest expense allocation..................................... $ 60
Net loss from discontinued VDCG operations...................... $ (104)
Net loss from sale of discontinued VDCG operations.............. $ (1,831)
A valuation allowance for VDCG's net operating loss carryforwards has
been provided, as the tax benefit will not be realized.
(6) Sale of Stock by Information Security Group
In October 2000, Kroll's then wholly owned subsidiary, Securify,
completed a sale of preferred stock through a private equity offering to certain
unrelated third parties. Kroll recognized a pre-tax gain on this transaction of
approximately $1.6 million and an after-tax loss of approximately $0.5 million,
net of approximately $2.1 million of unrealizable operating loss carryforwards
and other deferred tax assets that Kroll did not retain. At December 31, 2001,
Kroll had a fully reserved receivable from Securify of approximately $5.4
million, which was represented by a promissory note with a five-year repayment
schedule.
9
As a result of this transaction, as of December 31, 2000, Kroll's voting
control in Securify approximated 27 percent. The investment in Securify, which
had been previously consolidated, was then accounted for using the equity
method. Kroll does not have any carrying value for its investment as of
September 30, 2002. Securify has realized continuing losses since October 2000.
Since Kroll has not provided any guarantees and is not committed to provide any
future funding to Securify, it has not recorded its equity share of Securify
losses.
In January 2002, Kroll agreed with Securify to restructure its existing
debt, receiving in its place the following:
(1) $500,000 short-term subordinated unsecured promissory note (the
"Short-Term Note"),
(2) $500,000 long-term subordinated unsecured promissory note (the
"Long-Term Note"),
(3) $2.5 million subordinated unsecured convertible promissory note
(the "Convertible Note"),
(4) 58,666 shares of Class B common stock of Securify, and
(5) A non-exclusive license to use proprietary software developed by
Securify.
In May 2002, Securify obtained additional equity financing. In
conjunction with this financing the parties restructured the January 2002
agreement as follows:
(1) Securify paid Kroll $500,000 in payment of the Short-Term Note,
(2) Kroll cancelled the Long-Term Note,
(3) $250,000 of the Convertible Note was exchanged for an equivalent
value of Securify Series B Preferred Stock, and
(4) The remaining balance of the Convertible Note was cancelled.
Kroll now owns 131,854 shares of Securify common stock and retains the
non-exclusive license to use proprietary software developed by Securify. As a
result of the additional financing obtained by Securify, Kroll's voting interest
in Securify was reduced to approximately 1%. Accordingly, Securify, formerly
accounted for under the equity method, is now accounted for as a cost basis
investment, which the Company has valued at zero.
(7) Sale of Decision Resources, Inc.
On September 10, 2001, Kroll sold Decision Resources, Inc. to the former
owner. As payment, $0.2 million of the unpaid portion of notes payable to the
former owner was forgiven and Kroll received from the purchaser a note for $0.1
million. The notes payable that were forgiven were the unpaid portion of the
original purchase price. Kroll recognized a loss on the sale of the business
unit of approximately $0.5 million, which was recorded in the quarter ended
September 30, 2001.
(8) Acquisitions
(a) Ontrack Acquisition - On April 1, 2002, Kroll entered into an
agreement to acquire all of the outstanding shares of Ontrack Data
International, Inc. ("Ontrack"). The agreement provided that a wholly owned
subsidiary of Kroll would merge with and into Ontrack, resulting in Ontrack
becoming a wholly owned subsidiary of Kroll. The acquisition was consummated
effective June 13, 2002. The transaction, which qualifies as a tax-free
reorganization for federal income tax purposes, is valued at approximately $154
million. Ontrack shareholders received 0.6447 shares of Kroll common stock for
each share of Ontrack. In addition, pursuant to the acquisition agreement, Kroll
assumed Ontrack's existing stock option plans. As a result of the acquisition,
Kroll has issued approximately 7.2 million shares of its common stock, including
approximately 0.3 million shares issued on the exercise of Ontrack options. An
additional 0.7 million shares may be issued upon the future exercise of Ontrack
options.
10
In connection with the acquisition with Ontrack, assets were acquired and
liabilities assumed as follows (dollars in thousands):
Ontrack
------------
VALUATION OF ONTRACK TRANSACTION:
Value of shares issued................................. $ 137,706
Value of options assumed............................... 12,313
Transaction costs...................................... 3,900
Purchase price......................................... $ 153,919
ASSETS ACQUIRED:
Current assets......................................... 44,331
Property, plant and equipment, net..................... 9,451
Other non-current assets............................... 2,922
Total assets acquired................................ 56,704
Current liabilities assumed.......................... (4,468)
Net assets acquired................................ 52,236
Intangible assets acquired......................... $ 101,683
INTANGIBLE ASSETS:
Goodwill recognized.................................... 95,183
Identifiable intangible assets......................... 6,500
Intangible assets acquired........................... $ 101,683
The above schedule is based on a preliminary valuation of the assets and
liabilities involved. A final determination will be made within 12 months of the
effective acquisition date.
(b) Zolfo Cooper Acquisition - On September 5, 2002, Kroll acquired all of
the equity interests of Zolfo Cooper, LLC ("Zolfo Cooper"), and certain of its
related parties. At the closing, Kroll paid $100 million in cash and, on January
15, 2003, the Company will issue 2.9 million shares of its common stock to the
former owners of Zolfo Cooper, valued at approximately $55.3 million. In
addition, Kroll will issue, as contingent consideration, 625,000 additional
shares of common stock per year if Zolfo Cooper achieves operating profit levels
of $30 million, $31 million, $32 million and $33 million in 2003, 2004, 2005 and
2006, respectively. To the extent Zolfo Cooper's operating profit exceeds the
targeted level for a particular year, 100% of the excess will be credited to the
previous year's operating profit to determine if a contingent payment should
have been made in that year. Additionally, 50% of the remaining excess, up to $5
million, will be credited to the following year's operating profit to determine
if a contingency consideration payment is payable. All of the contingent
consideration is payable in full if Kroll undergoes a change of control or if
the employment of any one of the three former principal owners of Zolfo Cooper
is terminated without cause. The Company also granted options to purchase
600,000 shares of Kroll common stock to Kroll Zolfo Cooper's professional staff.
The options were granted at the September 5, 2002 closing price of $18.37 and
will vest over four years.
In connection with the acquisition, the three former principal owners and
other senior professionals of Zolfo Cooper entered into employment agreements
to serve as executives of Kroll Zolfo Cooper following the acquisition. The
employment agreements expire December 31, 2006 and include customary
non-compete and non-solicitation provisions that remain in effect during the
terms of the employment agreements and for one year thereafter, unless the
employee is terminated without cause prior to January 1, 2005. Kroll has also
agreed to pay an entity controlled by the former principal owners of Zolfo
Cooper for the cost of operating for business purposes an airplane owned by the
entity, up to a total of $2 million per year. To the extent the airplane is
used in connection with a client engagement, the client may reimburse Kroll.
11
In connection with the acquisition of Zolfo Cooper, assets were acquired
and liabilities assumed as follows (dollars in thousands):
Zolfo Cooper
------------
VALUATION OF ZOLFO COOPER TRANSACTION:
Cash................................................... $ 100,000
Common stock issuable.................................. 55,280
Transaction costs...................................... 3,518
-----------
Purchase price......................................... $ 158,798
===========
ASSETS ACQUIRED:
Current assets......................................... 15,199
Property, plant and equipment, net..................... 652
Other non-current assets............................... 43
-----------
Total assets acquired................................ 15,894
Current liabilities assumed.......................... (15,242)
-----------
Net assets acquired................................ 652
-----------
Intangible assets acquired......................... $ 158,146
===========
INTANGIBLE ASSETS:
Goodwill recognized.................................... 153,146
Identifiable intangible assets......................... 5,000
-----------
Intangible assets acquired........................... $ 158,146
===========
The above schedule is based on a preliminary valuation of the assets and
liabilities involved. A final determination will be made within 12 months of the
effective acquisition date.
(c) Crucible Acquisition - On July 3, 2002, Kroll acquired Crucible Inc.,
a privately held company which provides elite training and protective services.
Kroll paid $1.0 million upon closing and the purchase agreement provides for an
additional $1.0 million to be paid in equal annual installments over the next
four years, with the first payment due July 3, 2003. At September 30, 2002,
$750,000 has been included in other long term liabilities and $ 250,000 has been
included in accrued liabilities on the balance sheet.
12
(d) Pro Forma Financial Data
(i) The following unaudited pro forma combined results of operations
for the nine months ended September 30, 2002 assumes that the Ontrack
acquisition occurred as of January 1, 2002. Unaudited pro forma
financial information is presented for illustrative purposes only and
is not necessarily indicative of the operating results that would have
been achieved if the Ontrack acquisition had been consummated on
January 1, 2002 (in thousands, except per share data):
Kroll/Ontrack
For the Nine Months
Ended September 30, 2002
------------------------
Sales........................................... $ 221,831
Income from continuing operations............... $ 13,164
Net income...................................... $ 12,863
Earnings per share:
Basic........................................ $ 0.43
Diluted...................................... $ 0.42
(ii) The following unaudited pro forma combined results of operations
for the three and nine months ended September 30, 2002, assumes that
the Ontrack and Zolfo Cooper acquisitions occurred as of January 1,
2002. Unaudited pro forma financial information is presented for
illustrative purposes only and is not necessarily indicative of the
operating results that would have been achieved if the Ontrack and
Zolfo Cooper acquisitions had been consummated on January 1, 2002 (in
thousands, except per share data):
Kroll/Ontrack/Zolfo Cooper
--------------------------------------
For the Three For the Nine
Months Ended Months Ended
September 30, 2002 September 30, 2002
--------------------------------------
Sales..................................... $ 90,934 $ 264,860
Income from continuing operations ........ $ 10,486 $ 27,799
Net Income................................ $ 10,115 $ 27,498
Earnings per share:
Basic.................................. $ 0.29 $ 0.76
Diluted................................ $ 0.28 $ 0.74
(9) Earnings Per Share
Pursuant to the provisions of SFAS No. 128 "Earnings Per Share", basic
earnings per share are computed by dividing net income (loss) by the weighted
average number of shares of common stock outstanding during the year. Diluted
earnings per share are computed by dividing net income (loss) 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 and assumed
issuance of restricted stock.
13
The beginning basic weighted average shares in the following table include
2.9 million shares to be issued in January 2003 relating to the acquisition of
Zolfo Cooper. The shares are weighted effective September 5, 2002, the closing
date of the acquisition. The following is a reconciliation of the numerator and
denominator for basic and diluted earnings per share for the nine months ended
September 30, 2002 and 2001:
Nine Months Ended September 30, 2002
-----------------------------------------
Weighted
Net Income (Loss) Average Shares Per Share
(Numerator) (Denominator) Amount
---------------- -------------- ---------
(in thousands, except per share data)
Basic earnings (loss) per share:
Income before extraordinary item......... $ 11,670 $ 0.44
Extraordinary item....................... (371) (0.01)
---------- ----------
Total.................................... $ 11,299 26,281 $ 0.43
=========== ==========
Effect of dilutive securities:
Options.................................. 1,142 (0.02)
-------
Diluted earnings per share.................. $ 11,299 27,423 $ 0.41
=======
Nine Months Ended September 30, 2001
-----------------------------------------
Weighted
Net Income (Loss) Average Shares Per Share
(Numerator) (Denominator) Amount
---------------- -------------- ---------
(in thousands, except per share data)
Basic and diluted loss per share:
Continuing operations.................... $ (12,008) $ (0.54)
Discontinued operations ................. (8,582) (0.38)
---------- ----------
Loss before extraordinary item........... (20,590) (0.92)
Extraordinary item....................... (344) (0.01)
---------- ----------
Total.................................... $ (20,934) 22,427 $ (0.93)
=========== ==========
(10) Debt
(a) Revolving Line of Credit
In April 2001, Kroll entered into an amended and restated loan agreement
to provide for a revolving credit facility that initially amounted to $40.0
million. The loan agreement was secured by substantially all assets of Kroll and
its subsidiaries, and a pledge of the stock of essentially all Kroll's
subsidiaries, all of which jointly and severally guaranteed obligations under
the agreement. The assets and the joint and several guarantee also secured
Kroll's $35.0 million senior notes. Advances under the revolving credit facility
bore interest at the greater of (a) 8.56% or (b) the prime rate plus 1.5%, plus
0.5% times the number of 30-day periods which expired since April 20, 2001 (or,
if less, the highest rate allowed by law). Kroll's agreement to sell the
entities that comprise the Security Products and Services Group discussed in
Note 5(a) caused an acceleration of all amounts due under the loan agreement 60
days after the closing of the sale, resulting in the expiration of the agreement
on October 22, 2001, which was then extended to November 16, 2001. Kroll used
approximately $28.2 million of the proceeds from the sale of SPSG to pay down
this line of credit during the third quarter of 2001. The remaining balance
under this agreement was subsequently repaid on November 14, 2001, thus
terminating the agreement.
Anticipating the spin-off of SPSG, Kroll endeavored to obtain
approximately $45.0 million of financing but did not reach an agreement
14
acceptable to the Company as of September 30, 2001. As a result, pursuit of this
alternative was terminated. Kroll's direct expense of $0.9 million, including
commitment and due diligence fees and the cost of extending the then-existing
bank loan, was written off as failed financing costs in the quarter ended
September 30, 2001.
On February 21, 2002, Kroll executed agreements with Foothill Capital
Corporation to provide a revolving credit facility of up to $15 million, subject
to borrowing base limitations, for a term of three years. During the term of the
credit facility, Kroll paid Foothill Capital a fee equal to the product of
0.375% per annum and the unused portion of the credit facility. The credit
facility agreement required Kroll to maintain a minimum level of EBITDA, and
contained restrictions on the incurrence of additional debt, the creation of any
liens on any of Kroll's assets, certain acquisitions, distributions to certain
subsidiaries and other affirmative and negative covenants customarily contained
in debt agreements of this type. The credit facility was secured by a security
interest in substantially all of the assets of Kroll and its material domestic
subsidiaries and a pledge of the stock of certain of Kroll's subsidiaries.
On September 5, 2002, Kroll amended and ultimately terminated the $15
million revolving credit facility agreement. The remaining unamortized deferred
financing costs associated with the facility in the amount of $0.5 million was
accelerated, resulting in an extraordinary loss of $0.4 million, net of taxes,
in the quarter ended September 30, 2002 (see SFAS No. 145 in Note 11 regarding
2003 treatment of extraordinary items). No borrowings were made under the
terminated $15 million credit agreement. Concurrently, Kroll entered into a new
$100 million credit facility that includes a $25 million revolving credit
facility (see Note 10 (d)).
The $25 million revolving credit facility is subject to borrowing base
limitations and has a three year term. The available borrowing amount is
calculated based on an analysis of Kroll's accounts receivable as of the month
end preceding the borrowing date. Borrowings under the revolving credit facility
bear interest, at Kroll's election, at a rate per annum equal to:
o base rate plus applicable margin; or
o Eurodollar rate plus applicable margin.
The applicable margin is determined by the leverage ratio, calculated as
the ratio of the last day of any fiscal quarter, of consolidated total debt as
of that day to adjusted EBITDA for the four fiscal quarters ending on such date.
The revolving credit facility requires Kroll to comply with certain
customary restrictive covenants, including maintaining certain ratios such as
EBITDA to fixed charges and EBITDA to debt, and limiting capital expenditures
and incurring additional indebtedness.
The revolving credit facility required Kroll to pay a fee equal to 0.75%
per annum of the unused revolving credit facility. Upon the repayment of the
term loan in October 2002, this fee was reduced to 0.375% per annum (see note
10(d)). Through September 30, 2002, Kroll has not borrowed any funds under the
revolving credit facility. The revolving credit facility is secured by a lien on
substantially all of Kroll's assets and those of most of Kroll's domestic
subsidiaries.
(b) Senior Notes
Kroll's $35.0 million of senior notes were amended in April 2001 to bear
interest at the greater of (a) 8.56% or (b) the prime rate plus 1.5%, plus 0.5%
times the number of 30-day periods which expired after April 20, 2001 (or, if
less, the highest rate allowed by law). These agreements were also secured by
substantially all assets of Kroll and its subsidiaries and a pledge of the stock
of essentially all the subsidiaries and were jointly and severally guaranteed by
essentially all of Kroll's subsidiaries. Kroll's sale of the entities that
comprised the Security Products and Services Group on August 22, 2001 (see Note
5(a)) resulted in the acceleration of all amounts due under the revolving credit
facility and the senior notes to a date 60 days after the closing of the sale of
SPSG.
15
Kroll obtained from the lenders an extension from October 22, 2001 to November
16, 2001. Kroll used approximately $21.2 million of the proceeds from the sale
of SPSG to repay the note holders during the third quarter of 2001. On November
14, 2001, all remaining outstanding debt under the senior notes was repaid.
(c) Senior Secured Subordinated Convertible Notes
In November 2001, Kroll obtained $30.0 million of financing in the form
of 6% Senior Secured Subordinated Convertible Notes due 2006. On November 14,
2001, Kroll issued $25.0 million of notes and issued an additional $5.0 million
of notes on November 20, 2001. The notes mature on November 14, 2006 and bear
interest at the rate of 6% per annum payable semi-annually. However, 12% per
annum will accrue on any principal payment that is past due. In May 2002, Kroll
made the first required interest payment of approximately $0.9 million. Kroll
may redeem these convertible notes at par plus accrued interest, in whole or in
part, beginning on November 14, 2004, provided the note holders have been
notified in writing 20 days in advance. The note holders may, at any time prior
to one day before the earlier of the maturity date or the redemption date,
convert all or a portion of the principal amount of the notes into Kroll common
stock at the conversion price of $10.80 per share. The $30.0 million of notes
are immediately convertible into 2,777,777 shares of Kroll common stock, subject
to customary and other anti-dilution adjustments.
The notes were secured by the same assets of Kroll and its material
domestic subsidiaries and the same pledge of stock of certain of Kroll's
subsidiaries as the $15 million revolving credit facility, except that the notes
were subordinate to the obligations under the credit facility.
The notes contained certain customary covenants, including covenants that
prohibit Kroll from disposing of any material subsidiary, incurring or
permitting to exist any senior or pari-passu debt other than the $15 million
credit facility, or any liability for borrowed money, guaranteeing the
obligations for borrowed money of any third party, creating or permitting to
exist any material liens on assets of material subsidiaries or entering into a
transaction prior to November 14, 2003 that would involve a "change in control"
of Kroll (as defined in the notes). The notes are payable upon any change in
control of Kroll at the option of the holders. The note holders had the right to
designate an observer to the Board of Directors. The observer was entitled to
attend Audit and Compensation Committee meetings.
Kroll has an effective registration statement under the Securities Act of
1933, as amended, covering the resale of the notes, and the shares of common
stock issuable upon conversion of these notes, and is required to keep the
registration statement effective until November 2003.
In connection with the issuance of the notes, Kroll recorded a notes
discount of approximately $11.4 million based on the difference between the
closing price of its stock on the issuance date and the conversion price of the
notes. In addition to the stated 6% interest, the discount will be amortized as
non-cash interest expense over the expected 5-year life of the notes. Barring
early conversion by the noteholders or early redemption by Kroll, the additional
non-cash interest expense resulting from the amortization of this discount will
average approximately $2.3 million or 7.6% per year on the $30.0 million
principal amount of the notes. During the nine months ended September 30, 2002,
$1.2 million of this discount was amortized.
A significant portion of the proceeds from the convertible note financing
was used to retire Kroll's amended bank loan and senior notes. The remaining
deferred financing costs associated with the former financing in the amount of
$0.5 million was accelerated, resulting in an extraordinary loss of $0.3
million, net of taxes, in the quarter ended September 30, 2001 (see SFAS No. 145
in Note 11 regarding 2003 treatment of extraordinary items).
On September 5, 2002, the convertible notes agreement was amended to
accommodate a new $100 million credit facility (see Notes 10(a) and 10(d)). The
amendment terminated the noteholders' security interest in the assets of Kroll
and its material domestic subsidiaries and the pledge of the stock of certain of
Kroll's
16
subsidiaries. In addition, the amendment deleted the restrictive covenants and
board representation rights discussed above. In conjunction with this amended
security interest, the Company has agreed to pay the original remaining
noteholder approximately $1.6 million, which the Company has recorded as an
accrued liability as of September 30, 2002.
(d) Long-term Note
In connection with the Zolfo Cooper acquisition (see Note 8(b)), Kroll
obtained $75 million in term loan financing through a syndicate arranged by
Goldman Sachs Credit Partners L.P. to be repaid under the following terms: $0.8
million by December 31, 2002, an additional $4.5 million within one year of
closing date, $18.7 million within two years of closing and the balance ($51.0
million) within three years of closing.
The term loan was part of a $100 million credit facility which includes a
$25 million revolving credit facility (see Note 10(a)). The cost of obtaining
the credit facility is being amortized over the facility's three year life. The
term loan bears interest, at Kroll's election, at a rate per annum equal to:
o base rate plus applicable margin; or
o Eurodollar rate plus applicable margin.
The applicable margin is determined by the leverage ratio, calculated as
the ratio of the last day of any fiscal quarter of consolidated total debt as of
that day to adjusted EBITDA for the four fiscal quarters ending on such date. A
provision in the term loan agreement required that proceeds from any equity
offering would be used to pay down the term loan.
The term loan was repaid in October 2002 with the proceeds from Kroll's
common stock offering (see Note 16).
(11) New Accounting Pronouncements
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" (SFAS No. 142), which established accounting and reporting
standards for goodwill and other intangible assets that are acquired
individually or with a group of other assets. The provisions of this statement
are effective for fiscal years beginning after December 15, 2001. SFAS No. 142
requires goodwill and similar intangible assets to be accounted for using an
impairment-only method instead of the amortization method previously used.
Accordingly, effective January 1, 2002, Kroll ceased amortizing goodwill and
similar intangible assets. In addition, Kroll has conducted impairment tests of
the goodwill recorded on its books as required by SFAS 142. These tests
determined that Kroll's recorded goodwill is not impaired. Impairment tests will
be conducted annually, or sooner if circumstances indicate an impairment may
have taken place. Refer to Note 15 for the effect of implementation of SFAS No.
142.
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143), which
addresses financial accounting and reporting for obligations and costs
associated with the retirement of tangible long-lived assets. Kroll is required
to implement SFAS No. 143 on January 1, 2003, and management expects that the
adoption of this statement will not have a material impact on the Company's
results of operations or financial position.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS No. 144), which replaces SFAS No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and
establishes accounting and reporting standards for long-lived assets to be
disposed of by sale. This standard applies to all long-lived assets, including
discontinued operations. SFAS No. 144 requires that those assets be measured at
the lower of carrying amount or fair value less cost to sell. SFAS No. 144 also
broadens the reporting of discontinued
17
operations to include all components of an entity with operations that can be
distinguished from the rest of the entity that will be eliminated from the
ongoing operations of the entity in a disposal transaction. Kroll implemented
SFAS No. 144 on January 1, 2002. There was no material impact relating to the
implementation of this statement on its consolidated results of operations or
financial position.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". This statement eliminates the automatic classification of gain or
loss on extinguishment of debt as an extraordinary item of income and requires
that such gain or loss be evaluated for extraordinary classification under the
criteria of Accounting Principles Board (APB) No. 30 "Reporting Results of
Operations". This statement also requires sale-leaseback accounting for certain
lease modifications that have economic effects that are similar to
sale-leaseback transactions, and makes various other technical corrections to
existing pronouncements. This statement will be effective for the Company for
the year ending December 31, 2003. For 2003 financial statements, Kroll will
reclassify as operating expenses prior period extraordinary items that do not
meet the criteria of APB No. 30.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 will supersede EITF
Issue No. 94-3, "Liability Recognition for Certain Employee Termination Benefits
and Other Costs to Exit an Activity (including Certain Costs Incurred in a
Restructuring)". SFAS No. 146 requires that costs associated with an exit or
disposal plan be recognized when incurred rather than at the date of a
commitment to an exit or disposal plan. SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
In September 2000, the Emerging Issues Task Force (EITF) announced Issue
No. 00-20, "Accounting for Costs Incurred to Acquire or Originate Information
for Database Content and Other Collections of Information", stating that the
EITF is considering different views for the accounting for database costs. One
of the views would require Kroll to expense some or all of the database costs
that Kroll currently capitalizes and amortizes, which is currently an acceptable
alternative. Adoption of a different method of accounting for database costs
could have a material impact on Kroll's financial position and results of
operations. To date, the EITF has not made any official determinations on this
issue.
18
(12) Supplemental Cash Flows Disclosures
The following is a summary of cash paid related to certain items:
Nine Months Ended September 30,
-------------------------------
2002 2001
-------- ---------
(dollars in thousands)
Supplemental Disclosure of Cash Flow Information:
Cash paid for interest of continuing operations ..................... $ 1,153 $ 5,379
======== ========
Cash paid for interest of discontinued operations ................... $ -- $ 141
======== ========
Cash paid for taxes of continuing operations, net of
refunds ........................................................... $ 2,381 $ (685)
======== ========
Cash paid for taxes of discontinued operations, net of
refunds ........................................................... $ -- $ 63
======== ========
Supplemental Disclosure of Non-cash Activities:
Notes forgiven in connection with the sale of DRI (Note
7) ................................................................ $ -- $ 190
======== ========
Receipts of notes receivable from the sale of
businesses, including VDCG, SPSG, and DRI (Notes 5 & 7)............ $ -- $ 2,543
======== ========
Write-down of discounted notes receivable from the sale
of VDCG to estimated realizable value (Note 5 (b)) ................ $ -- $ (1,831)
======== ========
Equity financing from the acquisition of a business
(common stock $69 and additional paid-in-capital .................. $150,019 $ --
$149,950 - Note 8) ======== ========
(13) Derivative Financial Instruments
Financial instruments in the form of foreign currency exchange contracts
were utilized by Kroll in 2001 to hedge its exposure to movements in foreign
currency exchange rates. Kroll does not hold or issue derivative financial
instruments for trading purposes. As of September 30, 2001, the foreign currency
hedge contracts had a notional amount of $3.2 million, which approximated their
estimated fair value. During the nine months ended September 30, 2002, Kroll did
not utilize foreign currency exchange contracts.
(14) Customer and Segment Data
As a result of the sale of SPSG to Armor on August 22, 2001 (see Note
5(a)), SPSG was accounted for as a discontinued operation and all prior periods
have been restated accordingly in the accompanying consolidated unaudited
financial statements. As a result of Kroll's recent acquisitions of Ontrack and
Zolfo Cooper, the Company is now reporting its operations in five business
segments: Consulting Services, Corporate Advisory and Restructuring, Technology
Services, Security Services and Background Screening Services. Prior year
amounts have been restated to conform to the Company's current segment
structure. Kroll's reportable segments are now organized, managed and operated
along product lines, as these product lines are provided to similar clients, are
offered together as packaged offerings, generally produce similar margins and
are managed under a consolidated operations management.
The Consulting Services segment includes revenues and expenses from
business and financial investigations, forensic accounting, business valuation,
litigation consulting, due diligence, litigation intelligence, asset tracing and
analysis, monitoring and special inquiries, market intelligence, and
intellectual property and infringement investigations.
The Corporate Advisory & Restructuring segment includes revenues and
expenses from corporate restructuring, operational turnaround, strategic
advisory services, financial crisis management, and corporate finance services.
19
The Technology Services segment includes revenues and expenses from
electronic discovery, data recovery, and computer forensics services, along with
related software solutions.
The Security Services segment includes revenues and expenses from
security architecture and design, corporate security consulting and crisis
management, emergency management, environmental services, and protective
services operations and training.
The Background Screening Services segment includes revenues and expenses
from pre-employment and security background screening, drug testing and
surveillance.
The following summarizes information about Kroll's business segments for
the three and nine months ended September 30, 2002 and 2001:
Corporate
Consulting Advisory & Technology Security Background
Services Restructuring Services Services Screening Other Consolidated
-------- ------------- -------- -------- --------- ----- ------------
(dollars in thousands)
Three Months Ended September 30, 2002
Net sales to unaffiliated customers ..... $ 26,002 $ 18,420 $ 15,992 $ 6,235 $ 13,050 $ -- $ 79,699
========= ========= ========= ========= ========= ======== =========
Gross profit ............................ $ 10,367 $ 10,961 $ 10,953 $ 2,551 $ 6,258 $ -- $ 41,090
========= ========= ========= ========= ========= ======== =========
Operating income (loss) ................. $ 2,728 $ 6,262 $ 2,142 $ 586 $ 2,982 $ (5,749) $ 8,951
========= ========= ========= ========= ========= ======== =========
Three Months Ended September 30, 2001
Net sales to unaffiliated customers ..... $ 24,726 $ 6,918 $ 1,159 $ 5,406 $ 11,147 $ -- $ 49,356
========= ========= ========= ========= ========= ======== =========
Gross profit ............................ $ 6,261 $ 3,723 $ 690 $ 1,608 $ 4,998 $ -- $ 17,280
========= ========= ========= ========= ========= ======== =========
Operating income (loss) ................. $ (3,604) $ 1,257 $ 160 $ 234 $ 1,159 $ (4,141) $ (4,935)
========= ========= ========= ========= ========= ======== =========
Nine Months Ended September 30, 2002
Net sales to unaffiliated customers ..... $ 77,692 $ 38,583 $ 20,899 $ 20,501 $ 37,759 $ -- $ 195,434
========= ========= ========= ========= ========= ======== =========
Gross profit ............................ $ 31,709 $ 22,432 $ 14,073 $ 7,431 $ 17,981 $ -- $ 93,626
========= ========= ========= ========= ========= ======== =========
Operating income (loss) ................. $ 9,429 $ 11,203 $ 2,882 $ 3,549 $ 8,105 $(15,781) $ 19,387
========= ========= ========= ========= ========= ======== =========
Identifiable assets ..................... $ 58,365 $ 37,436 $ 40,417 $ 14,798 $ 26,944 $ -- $ 177,960
========= ========= ========= ========= ========= ========
Corporate assets ........................ $ 311,156
---------
Total assets ............................ $ 489,116
=========
Nine Months Ended September 30, 2001
Net sales to unaffiliated customers ..... $ 78,058 $ 19,371 $ 3,059 $ 15,371 $ 32,856 $ -- $ 148,715
========= ========= ========= ========= ========= ======== =========
Gross profit ............................ $ 26,010 $ 10,434 $ 1,881 $ 5,098 $ 15,011 $ -- $ 58,434
========= ========= ========= ========= ========= ======== =========
Operating income (loss) ................. $ (3,923) $ 3,395 $ 533 $ 241 $ 3,036 $ (9,631) $ (6,349)
========= ========= ========= ========= ========= ======== =========
Total net sales by segment include sales to unaffiliated customers.
Inter-segment sales are nominal. Operating income equals gross profit less
operating expenses. Operating income does not include the following items:
interest expense, other expenses and income taxes. The "Other" column includes
the cost of Kroll's corporate headquarters. Identifiable assets by segment are
those assets that are used in Kroll's operations in each segment. Corporate
assets are principally cash, computer software, costs in excess of assets
acquired and certain prepaid expenses.
Prior to the sale of the Security Products and Services Group to Armor,
corporate costs relating to the above five segments were allocated in the
calculation of operating income for each of those segments. This mirrored the
management of those businesses as one segment, the Investigations and
Intelligence Group, at that time. Subsequent to the sale of SPSG, Kroll's
remaining business was the Investigations and Intelligence Group, which has been
broken out into the five described segments. Corporate costs relating to each of
these segments are now included in the table above under "Other" in order to
reflect the post-sale management structure of Kroll. For
20
the three and nine months ended September 30, 2001, corporate costs of
approximately $4.1 million and $10.8 million, respectively, relating to these
five segments, were included in the calculation of segment operating income. Had
these costs been included with "Other" corporate costs in 2001, the operating
loss relating to "Other" would have been approximately $8.2 million and $20.4
million for the three and nine months ended September 30, 2001, respectively.
(15) Effect of the Implementation of SFAS No. 142
In accordance with SFAS No. 142, Kroll no longer records amortization
expense for goodwill. This had the following effect on reported earnings:
Three Months Ended Nine Months Ended
September 30, September 30,
----------------------- ------------------------
2002 2001 2002 2001
--------- ---------- ---------- ----------
(in thousands, except per share data)
Net income (loss) as reported ..... $ 5,377 $ (15,727) $ 11,299 $ (20,934)
Amortization of goodwill, net of
tax ............................ -- 375 -- 1,162
--------- ---------- ---------- ----------
Adjusted net income (loss) ..... $ 5,377 $ (15,352) $ 11,299 $ (19,772)
========= ========== ========== ==========
Diluted income (loss) per share as
reported ....................... $ 0.17 $ (0.70) $ 0.41 $ (0.93)
Amortization of goodwill, net of
tax ............................ -- 0.02 -- 0.05
--------- ---------- ---------- ----------
Adjusted income (loss) per share $ 0.17 $ (0.68) $ 0.41 $ (0.88)
========= ========== ========== ==========
Kroll has not changed the amortization periods or ceased amortizing
intangible assets other than goodwill as a result of our review of indefinite
lived assets to date. Kroll has conducted impairment tests of the goodwill
recorded on its books as required by SFAS 142. These tests determined that
Kroll's recorded goodwill was not impaired as of June 2002. Management is not
aware of any condition as of September 30, 2002 which would require the Company
to conduct an updated impairment test. Impairment tests will be conducted
annually, or sooner if circumstances indicate an impairment may have taken
place.
As of September 30, 2002, Kroll had recorded cost and accumulated
amortization of intangible assets of $25.7 million and $4.8 million,
respectively. Of this amount, $16.3 million and $3.2 million related to the cost
and accumulated amortization of intangible assets of acquired customer lists. An
additional $6.5 million and $0.5 million pertaining to the cost valuation and
related accumulated amortization of in-house systems software was recorded as
part of the Company's acquisition of Ontrack. The remaining $2.9 million and
$1.1 million of cost and accumulated amortization are primarily related to
non-compete agreements.
Amortization expense for intangible assets of $1.4 million was recognized
in the nine months ended September 30, 2002. Approximately $16.4 million of
amortization expense is anticipated to be recognized over the next five years.
21
(16) Subsequent Events
Kroll Common Stock Offering
In October 2002 the Company sold 6.3 million shares of its common stock to
the public in an underwritten public offering and raised approximately $110
million of net proceeds. Kroll used a portion of these proceeds to repay its
three-year $75 million term loan incurred on September 5, 2002 to acquire Zolfo
Cooper (see Note 10(d)). Because the repayment effectively terminated the term
loan agreement, all unamortized deferred financing fees will be written off as
an extraordinary item in the fourth quarter of 2002.
22
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's Consolidated
Financial Statements and Notes for the year ended December 31, 2001. On August
22, 2001, Kroll sold most of the active companies that comprised the Security
Products and Services Group (SPSG) to Armor Holdings, Inc. (Armor). Historical
amounts have been reclassified to conform to the current categories.
Forward-Looking Statements
This Quarterly Report on Form 10-Q contains "forward-looking statements"
within the meaning of the Private Securities Litigation Reform Act of 1995.
These statements can sometimes be identified by the use of forward-looking words
such as "anticipate," "believe," "estimate," "expect," "intend," "may," "will"
and similar expressions. These statements are based on management's current
expectations and are subject to risks, uncertainties and assumptions. Should one
or more of these risks or uncertainties materialize or should underlying
assumptions prove incorrect, actual results may vary materially from those
anticipated, expected, estimated or projected.
The following factors, among others, could cause actual results to differ
materially from those described in the forward-looking statements: changes in
the demand for, or in the mix of, Kroll's services; project delays or
cancellations; cost overruns with regard to fixed price projects; competitive
pricing and other competitive pressures; changes in United States and foreign
governmental regulation and licensing requirements; currency exchange rate
fluctuations; foreign currency restrictions; general economic conditions;
political instability in foreign countries in which Kroll operates; Kroll's
ability to implement its internal growth strategy and to integrate and manage
successfully any business Kroll acquires; and other factors that are set forth
in Kroll's annual report on Form 10-K for the year ended December 31, 2001.
Recent Developments
Kroll has considered a variety of corporate initiatives within the periods
presented in the accompanying consolidated unaudited financial statements.
On April 16, 2001, the Board of Directors approved a formal plan to
discontinue operations of the Voice and Data Communications Group (VDCG), which
offered secure satellite communication equipment and satellite navigation
systems. On June 27, 2001, Kroll sold its ownership in the stock of VDCG. The
results of operations of VDCG have been classified as discontinued operations
and all prior periods have been restated accordingly (see Note 5(b) to the Notes
to the Consolidated Unaudited Financial Statements).
On April 20, 2001, Kroll entered into a definitive agreement to sell most
of the active companies that comprised its Security Products and Services Group
(SPSG), other than SPSG's subsidiaries that provide kidnap and ransom and risk
information services and its Russian businesses, to Armor Holdings, Inc.
(Armor). On August 22, 2001, Kroll completed the sale of SPSG to Armor for up to
$55.7 million, consisting of $37.2 million in cash, $15.0 million in Armor
common stock, and $1.5 million placed in escrow pending agreement on the closing
date balance sheet audit. In May 2002, agreement was reached on SPSG's closing
date balance sheet, which resulted in the payment to Kroll of $1.1 million of
the amount held in escrow. In conjunction with this escrow payment, Kroll
forgave certain obligations due to Kroll by Armor of approximately $1.6 million
primarily relating to SPSG's Central American operations. The agreement also
provides for a potential deferred payment of up to $2.0 million by Armor to
Kroll if a gross profit target is achieved by SPSG for the year ended December
31, 2001. Neither the $1.5 million escrow nor the $2.0 million was included in
calculating the loss on the sale of SPSG. Resolution of this deferred payment is
still under review (see Note 5(a) to the Notes to the Consolidated Unaudited
Financial Statements).
23
On September 14, 2001, Kroll converted approximately $14.1 million in
Armor common stock into cash. An additional $0.3 million was converted to cash
on September 21, 2001. The remaining balance of approximately $0.6 million was
received from Armor on May 15, 2002. Kroll used the proceeds from the sale of
SPSG to repay approximately $49.4 million of debt during the third quarter of
2001.
In November 2001, Kroll obtained $30.0 million of financing in the form of
6% Senior Secured Subordinated Convertible Notes due 2006. On November 14, 2001,
Kroll issued $25.0 million of notes and issued an additional $5.0 million of
notes on November 20, 2001. The notes mature on November 14, 2006 and bear
interest at the rate of 6% per annum payable semi-annually. However, 12% per
annum will accrue on any principal payment that is past due. The notes were
secured by the same assets of Kroll and its material domestic subsidiaries and
the same pledge of stock of certain of Kroll's subsidiaries as the $15 million
credit facility discussed below, except that the notes are subordinate to the
obligations under the credit facility. Kroll may redeem these convertible notes
at par plus accrued interest, in whole or in part, beginning on November 14,
2004, provided the note holders have been notified in writing 20 days in
advance. The note holders may at any time prior to one day before the earlier of
the maturity date or the redemption date, convert all or a portion of the
principal amount of the notes into Kroll common stock at the conversion price of
$10.80 per share. The $30.0 million of notes are immediately convertible into
2,777,777 shares of Kroll common stock, subject to customary and other
anti-dilution adjustments (see Note 10(c) of the Notes to the Consolidated
Unaudited Financial Statements).
On September 5, 2002, the convertible notes agreement was amended to
accommodate a new $100 million credit facility (see Notes 10(a), 10(c) and 10(d)
of the Notes to the Consolidated Unaudited Financial Statements). The amendment
terminated the noteholders' security interest in the assets of Kroll and its
subsidiaries.
In January 2002, Kroll restructured its debt with Securify, receiving in
its place a $0.5 million short-term and a $0.5 million long-term note, along
with a $2.5 million convertible note, approximately 60,000 shares of Securify
common stock, and a non-exclusive license to use proprietary software developed
by Securify. In May 2002, the parties restructured the January agreement, and
Kroll received $0.5 million in payment of the short-term note and converted
approximately $0.3 million of the convertible note into an equivalent value of
preferred stock. The remaining balance of the convertible note as well as the
$0.5 million long term note were forgiven. Kroll retained its shares of Securify
stock and the non-exclusive license (see Note 6 of the Notes to the Consolidated
Unaudited Financial Statements).
On February 21, 2002, Kroll executed agreements with Foothill Capital
Corporation to provide a revolving credit facility of up to $15 million, subject
to borrowing base limitations, for a term of three years. During the term of the
credit facility, Kroll paid Foothill Capital a fee equal to the product of
0.375% per annum and the unused portion of the credit facility. The credit
facility agreement required Kroll to maintain a minimum level of EBITDA
(earnings before interest, taxes, depreciation and amortization), and contained
restrictions on the incurrence of additional debt, the creation of any liens on
any of Kroll's assets, certain acquisitions, distributions to certain
subsidiaries and other affirmative and negative covenants customarily contained
in debt agreements of this type. The credit facility was secured by a security
interest in substantially all of the assets of Kroll and its material domestic
subsidiaries and a pledge of the stock of certain of Kroll's subsidiaries (see
Note 10(a) of the Notes to the Consolidated Unaudited Financial Statements).
On September 5, 2002, the Company amended and ultimately terminated the
$15 million revolving credit facility agreement to accommodate a new $100
million credit facility which includes $25 million revolving credit facility
(see Note 10(a) of the Notes to the Consolidated Unaudited Financial
Statements).
On April 1, 2002, Kroll entered into an agreement to acquire all of the
outstanding shares of Ontrack Data International, Inc. ("Ontrack"). The
agreement provided that a wholly owned subsidiary of Kroll would be merged with
and into Ontrack, resulting in Ontrack becoming a wholly owned subsidiary of
Kroll. The acquisition was consummated effective June 13, 2002. The transaction,
which qualifies as a tax-free
24
reorganization for federal income tax purposes, is valued at approximately $154
million. Each share of outstanding Ontrack common stock was converted into
0.6447 of one share of Kroll's common stock. In addition, pursuant to the
acquisition agreement, Kroll assumed Ontrack's existing stock option plans. As a
result of the acquisition, Kroll has issued approximately 7.2 million shares of
its common stock, including approximately 0.3 million shares issued on the
exercise of Ontrack options. An additional 0.7 million shares may be issued upon
the future exercise of Ontrack options (see Note 8(a) of the Notes to the
Consolidated Unaudited Financial Statements).
In May 2002, Kroll executed agreements to sell to local management its
interest in its Russian armored car businesses that were not sold to Armor.
Kroll received $150,000 upon closing and an additional $10,000 in the third
quarter. The agreements provide for Kroll to receive approximately $117,000
within one year of the closing date and an additional $50,000 within two years
of the closing date. Payments not received on the due date will accrue interest
at 10% per annum. These transactions relieve Kroll of any liability associated
with its Russian businesses (see Note 5(a) of the Notes to the Consolidated
Unaudited Financial Statements).
On September 5, 2002, Kroll acquired all of the equity interests of Zolfo
Cooper, LLC ("Zolfo Cooper"), and certain of its related parties. At the
closing, Kroll paid $100 million in cash and, on January 15, 2003, the Company
will issue 2.9 million shares of its common stock to the former owners of Zolfo
Cooper, valued at approximately $55.3 million. In addition, Kroll will issue, as
contingent consideration, 625,000 additional shares of common stock per year if
Zolfo Cooper achieves certain operating profit levels over the next four years.
The Company also granted options to purchase 600,000 shares of Kroll common
stock to Kroll Zolfo Cooper's professional staff. The options were granted at
the September 5, 2002 closing price of $18.37 and will vest over four years.
General
Kroll is a leading global provider of complementary risk consulting
services. Kroll assists businesses, governments, and individuals throughout the
world in preventing, mitigating, and responding to risk through an integrated
suite of services. Kroll's five business groups enable the Company to provide
its clients with comprehensive, single source, risk consulting services. These
five business groups are:
o Consulting Services. Kroll provides independent consulting
services free from the audit conflicts incurred by major
accounting firms. These consulting services include business and
financial investigations, forensic accounting, business valuation,
litigation consulting, due diligence, litigation intelligence,
asset tracing and analysis, monitoring and special inquiries,
market intelligence, and intellectual property and infringement
investigations.
o Corporate Advisory and Restructuring. Kroll acts both in an
advisory capacity to, and as interim management of, financially
troubled companies throughout North America and Europe, and
advises all the various stakeholders involved in the
reorganization process. In this context, Kroll provides corporate
restructuring, operational turnaround, strategic advisory
services, financial crisis management, and corporate finance
services. o Technology Services. Kroll provides electronic
discovery, data recovery, and computer forensics services, along
with related software solutions.
o Security Services. Kroll provides security architecture and
design, corporate security consulting and crisis management,
emergency management, environmental services, and protective
services operations and training.
o Background Screening Services. Kroll provides pre-employment and
security background screening, drug testing, and surveillance.
25
Critical Accounting Policies
Kroll's significant accounting policies, including the assumptions and
judgments underlying them, are more fully described in the Notes to the
Consolidated Financial Statements included in Kroll's annual report on Form 10K
for the year ended December 31, 2001. Some of our accounting policies require
the application of significant judgment by management in the preparation of our
financial statements, and as a result they are subject to a greater degree of
uncertainty. In applying these policies, management uses its judgment to
determine the appropriate assumptions to be used in calculating estimates that
affect the reported amounts of assets, liabilities, revenues and expenses.
Management bases its estimates and assumptions on historical experience and on
various other factors that are believed to be reasonable under the
circumstances. Kroll's significant accounting policies include the following:
Use of Estimates. The preparation of financial statements in conformity
with accounting principles generally accepted in the United States 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.
Revenue recognition. Revenue is recognized as the services are performed
pursuant to the applicable contractual arrangements. Revenue related to time and
materials arrangements is recognized in the period in which the services are
performed. Revenue from standard hourly rate engagements is recognized as hours
are incurred and revenue from standard daily rate arrangements is recognized at
amounts represented by the agreed-upon billing amounts as incurred. Revenue
related to fixed price arrangements is recognized based upon costs incurred as a
percentage of the estimated total direct costs of the respective arrangements.
The impact of any revisions in estimated total revenue and direct contract costs
is recognized in the period in which they become known. Kroll records either
billed or unbilled accounts receivable based on case-by-case invoicing
determinations. Kroll recognizes contingent fees when earned.
Databases. Databases are capitalized costs incurred in obtaining
information from third party providers. Kroll utilizes this information to
create and maintain its proprietary and non-proprietary databases. Because of
the continuing accessibility of the information and its usefulness to future
investigative procedures, the cost of acquiring the information is capitalized
and amortized over a five year period.
Foreign Currency Translation and Transactions. Assets and liabilities of
foreign operations are translated using period-end exchange rates and revenues
and expenses are translated using exchange rates prevailing during the period,
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.
26
Results of Operations
The following table sets forth the items noted as a percentage of total
net sales:
For the Three Months For the Nine Months
Ended September 30, Ended September 30,
--------------------- ---------------------
2002 2001 2002 2001
------ ------ ------ ------
Net sales:
Consulting Services ......................................... 32.6% 50.1% 39.8% 52.5%
Corporate Advisory & Restructuring .......................... 23.1 14.0 19.7 13.0
Technology Services ......................................... 20.1 2.3 10.7 2.1
Security Services ........................................... 7.8 11.0 10.5 10.3
Background Screening Services ............................... 16.4 22.6 19.3 22.1
----- ----- ----- -----
Total net sales ........................................... 100.0% 100.0% 100.0% 100.0%
Cost of sales .................................................. 48.5 65.0 52.1 60.7
----- ----- ----- -----
Gross profit .............................................. 51.5 35.0 47.9 39.3
----- ----- ----- -----
Selling and marketing .......................................... 11.0 9.4 9.5 9.4
General and administrative ..................................... 24.8 29.8 26.1 30.0
Research and development ....................................... 3.5 -- 1.7 --
Amortization of other intangible assets ........................ 1.0 0.4 0.7 0.4
----- ----- ----- -----
Total recurring operating costs ............................. 40.3 39.6 38.0 39.8
----- ----- ----- -----
Operating income (loss) before
non-recurring operating costs ........................... 11.2 (4.6) 9.9 (0.5)
----- ----- ----- -----
Failed financing, separation and other
non-recurring expenses ...................................... -- 4.9 -- 1.9
Restructuring expenses ......................................... -- 0.5 -- 1.9
----- ----- ----- -----
Operating income (loss) ................................... 11.2 (10.0) 9.9 (4.3)
----- ----- ----- -----
Interest expense, net .......................................... (1.5) (2.4) (1.5) (2.3)
Other, net ..................................................... 0.1 (0.6) 0.1 (0.1)
----- ----- ----- -----
Total other expense ......................................... (1.4) (3.0) (1.4) (2.4)
----- ----- ----- -----
Income (loss) from continuing operations
before provision for income taxes ....................... 9.8 (13.0) 8.5 (6.7)
Provision for income taxes ..................................... 2.6 1.7 2.6 1.4
----- ----- ----- -----
Income (loss) from continuing operations .................. 7.2 (14.7) 5.9 (8.1)
Loss from discontinued operations, net of tax .................. -- (16.5) -- (5.8)
Extraordinary item, net of tax ................................. (0.5) (0.7) (0.1) (0.2)
----- ----- ----- -----
Net income (loss) ......................................... 6.7% (31.9)% 5.8% (14.1)%
===== ===== ===== =====
Three Months Ended September 30, 2002 Compared to Three Months Ended
September 30, 2001
Net sales. Net sales increased $30.3 million, or 61.5%, from $49.4 million
in the three months ended September 30, 2001 to $79.7 million in the three
months ended September 30, 2002.
Consulting Services - Net sales for the Consulting Services segment
increased $1.3 million, or 5.2%, from $24.7 million for the three months ended
September 30, 2001 to $26.0 million in 2002. This increase was primarily due to
strong demand for forensic accounting, business valuation and financial due
diligence services, which experienced a 29.7% revenue growth in the third
quarter 2002. This increase was partially offset by reduced revenues from
business consulting and investigations services due to a relatively weak global
economy.
Corporate Advisory and Restructuring - Net sales for the Corporate
Advisory and Restructuring segment increased $11.5 million, or 166.3%, from $6.9
million for the three months ended 2001 to $18.4 million for 2002.
27
This increase is due to a 64.3% increase in revenues from Kroll's European
recovery and turnaround division, and to the inclusion of Kroll Zolfo Cooper for
one month. Zolfo Cooper was acquired on September 5, 2002.
Technology Services - Net sales for the Technology Services segment
increased $14.8 million from $1.2 million for the three months ended 2001 to
$16.0 million in 2002. This increase is primarily due to the inclusion of Kroll
Ontrack for a full quarter of 2002. Ontrack was acquired on June 13, 2002.
Security Services - Net sales for the Security Services segment increased
$0.8 million, or 15.3%, from $5.4 million for the three months ended September
30, 2001 to $6.2 million in 2002. Our domestic security services business posted
sales growth of approximately $2.1 million, or 64.0%, from $3.3 million in the
2001 period to $5.4 million in the 2002 period as a result of the increased
demand for security consulting and design services in the wake of current
national and international events. This increase was partially offset by a
decrease in sales for security services in Latin America, where poor economic
conditions exist, and a reduction in demand for crisis management services.
Background Screening Services - Net sales for the Background Screening
Services segment increased $1.9 million, or 17.1%, from $11.1 million for the
three months ended September 30, 2001 to $13.0 million in 2002. Demand for
domestic pre-employment background screening increased approximately $2.0
million or 43.0%.
Cost of sales and gross margin. Cost of sales increased $6.5 million, or
20.4%, from $32.1 million for the three months ended September 30, 2001 to $38.6
million for the three months ended September 30, 2002. Gross margin as a
percentage of sales increased 16.5 percentage points from 35.0% for the three
months ended September 30, 2001 to 51.5% for the three months ended September
30, 2002.
Consulting Services - Gross margin for the Consulting Services segment
increased 14.6 percentage points from 25.3% for the three months ended September
30, 2001 to 39.9% in 2002. Our business consulting and investigations products
contributed approximately two thirds of the margin improvement in this segment,
primarily as a result of cost management in a difficult economic environment.
The remaining margin improvements were attributable to strong revenue
performance in Kroll's forensic accounting, business valuation and financial due
diligence services.
Corporate Advisory and Restructuring - Gross margin for the Corporate
Advisory and Restructuring segment increased 5.7 percentage points from 53.8%
for the three months ended September 30, 2001 to 59.5% in 2002. This was due to
increased revenues and staffing at Kroll's European recovery and turnaround
division, as well as the inclusion of Kroll Zolfo Cooper's operations for one
month. Zolfo Cooper was acquired on September 5, 2002.
Technology Services - Gross margin for the Technology Services Segment
increased 9.0 percentage points from 59.5% for the three months ended September
30, 2001 to 68.5% in 2002. This increase is primarily due to the acquisition of
Ontrack on June 13, 2002.
Security Services - Gross margin for the Security Services segment
increased 11.2 percentage points from 29.7% for the three months ended September
30, 2001 to 40.9% in 2002. This increase is primarily the result of efficiencies
associated with the significant increase in sales of domestic security services.
Background Screening Services - Gross margin for the Background Screening
Services segment increased 3.2 percentage points from 44.8% for the three months
ended September 30, 2001, to 48.0% in 2002. This increase was primarily
attributable to increased margins in the domestic pre-employment background
checking business.
28
Operating expenses. Operating expenses increased $9.9 million, or 44.7%,
from $22.2 million for the three months ended September 30, 2001 to $32.1
million in 2002. This includes a full three months of operating expenses for
Ontrack of approximately $9.4 million , and $0.6 million for Zolfo Cooper for
September 2002. The third quarter 2001 operating expenses include $2.7 million
of restructuring, failed financing, asset impairment and other non-recurring
expenses. Excluding non-recurring items, operating expenses increased $12.6
million or 64.6%.
In accordance with SFAS 142, beginning January 1, 2002, Kroll ceased
amortizing goodwill. If SFAS 142 were applied to Kroll's results for the third
quarter of 2001, operating expenses for that period would have been reduced by
$0.6 million, or $0.4 million net of tax.
As a percent of net sales, general and administrative expenses, before
non-recurring expenses, decreased 5.0 percentage points from 29.8% for the three
months ended September 30, 2001 to 24.8% in 2002.
Interest expense. Interest expense was essentially the same at $1.2
million for the third quarter of 2001 and 2002.
Provision for income taxes. The provision for income taxes increased $1.3
million from $0.8 million for the three months ended September 30, 2001 to $2.1
million in 2002. In the third quarter of 2001 Kroll reported tax expense despite
a pretax loss from operations largely as a result of income from certain foreign
and domestic jurisdictions. Additionally, certain domestic and foreign entities
realized losses in 2001 from which Kroll was not able to benefit for tax
purposes.
Discontinued operations. Losses from discontinued operations were reduced
from ($8.1) million for the three months ended September 30, 2001 to zero in
2002. VDCG was sold in June 2001 and SPSG was sold to Armor on August 22, 2001
(see Note 5 of the Notes to the Consolidated Unaudited Financial Statements).
Net income. Net income improved $21.1 million from a loss of ($15.7)
million for the three months ended September 30, 2001 to income of $5.4 million
in 2002. The increase in net income was due primarily to a $23.8 million
increase in gross profit as a result of increased sales in the 2002 period, a
$2.7 million decrease in non-recurring expenses, and a $8.1 million reduction in
losses from discontinued operations. These were partially offset by a $12.6
million increase in recurring operating expenses and a $1.3 million tax
provision increase.
Nine Months Ended September 30, 2002 Compared to Nine Months Ended September
30, 2001
Net sales. Net sales increased $46.7 million, or 31.4%, from $148.7
million in the nine months ended September 30, 2001 to $195.4 million in the
nine months ended September 30, 2002.
Consulting Services - Net sales for the Consulting Services segment
decreased $0.4 million, or 0.5%, from $78.1 million for the nine months ended
September 30, 2001 to $77.7 million in 2002. Forensic accounting, business
valuation and financial due diligence services experienced a 9.0% sales increase
over the 2001 period. These increases were offset by decreases in business
consulting and investigations services in Kroll's Asian operations, where a weak
regional economy and reduced merger and acquisition activity have negatively
impacted sales.
Corporate Advisory and Restructuring - Net sales for the Corporate
Advisory and Restructuring segment increased $19.2 million, or 99.2%, from $19.4
million for the nine months ended September 30, 2001 to $38.6 million in 2002.
This increase is due to a 62.8% increase in Kroll's European recovery and
turnaround division, and to the inclusion of the net sales of Zolfo Cooper for
one month. Zolfo Cooper was acquired on September 5, 2002.
29
Technology Services - Net sales for the Technology Services segment
increased $17.8 million from $3.1 million in the nine months ended September 30,
2001 to $20.9 million in 2002. This increase is primarily due to Kroll's
acquisition of Ontrack Data International on June 13, 2002.
Security Services - Net sales for the Security Services segment increased
$5.1 million, or 33.4%, from $15.4 million in the nine months ended September
30, 2001 to $20.5 million in 2002. The domestic security services business
posted sales growth of approximately $7.6 million, or 82.6%, from $9.2 million
in the 2001 period to $16.8 million in the 2002 period as a result of the
increased demand for security consulting and design services in the wake of
current national and international events. This increase was partially offset by
decreased demand for security services in Latin America, where poor economic
conditions exist, and a reduction in demand for crisis management services.
Background Screening Services - Net sales for the Background Screening
Services segment increased $4.9 million, or 14.9%, from $32.9 million for the
nine months ended September 30, 2001 to $37.8 million in 2002. Demand for
domestic pre-employment background checking increased approximately $5.4 million
or 41.0%. This was partially offset by declines in domestic demand for
surveillance services, primarily as a result of the weak economy.
Cost of sales and gross margin. Cost of sales increased $11.5 million, or
12.8%, from $90.3 million for the nine months ended September 30, 2001, to
$101.8 million for the nine months ended September 30, 2002. Gross margin as a
percentage of sales increased 8.6 percentage points from 39.3% for the nine
months ended September 30, 2001 to 47.9% for the nine months ended September 30,
2002.
Consulting Services - Gross margin for the Consulting Services segment
increased 7.5 percentage points from 33.3% for the nine months ended September
30, 2001 to 40.8% in 2002. Our business consulting and investigations services
contributed approximately one half of this margin improvement, mainly through
cost controls in a difficult economic environment. The remaining improvements
are due to increased sales of our forensic accounting, business valuation and
financial due diligence services.
Corporate Advisory and Restructuring - Gross margin for the Corporate
Advisory and Restructuring segment increased 4.2 percentage points from 53.9%
for the nine months ended September 30, 2001 to 58.1% for 2002. This was due to
increased revenues and staffing at Kroll's European recovery and turnaround
division, as well as the inclusion of Kroll Zolfo Cooper's operations for one
month. Zolfo Cooper was acquired on September 5, 2002.
Technology Services - Gross margin for the Technology Services Segment
increased 5.8 percentage points from 61.5% for the nine months ended September
30, 2001 to 67.3% in 2002. This increase is primarily due to the acquisition of
Ontrack on June 13, 2002.
Security Services - Gross margin for the Security Services segment
increased 3.0 percentage points from 33.2% for the nine months ended September
30, 2001 to 36.2% in 2002. This increase is a result of efficiency gains in
employee utilization associated with the increase in sales of domestic security
services.
Background Screening Services - Gross margin for the Background Screening
Services segment increased 1.9 percentage points from 45.7% for the nine months
ended September 30, 2001 to 47.6% in 2002. This increase is attributable to
increased margins in our domestic background checking business and drug testing
business.
Operating expenses. Operating expenses increased $9.4 million, or 14.6%,
from $64.8 million for the nine months ended September 30, 2001 to $74.2 million
in 2002. This includes expenses of $11.2 million for Ontrack which was acquired
on June 13, 2002 and $0.6 million for Zolfo Cooper, which was acquired on
30
September 5, 2002. The nine months of 2001 included $5.7 million of
restructuring, failed financing, asset impairment and other non-recurring
expenses. Excluding non-recurring items, operating expenses increased $15.1
million or 25.6%.
In accordance with SFAS 142, beginning January 1, 2002 Kroll ceased
amortizing goodwill. If SFAS 142 were applied to Kroll's results for the nine
months ended September 30, 2001, operating expenses for that period would have
been reduced by $1.8 million, or $1.2 million net of tax.
As a percent of net sales, general and administrative expenses, before
non-recurring expenses, decreased 3.9% from 30.0% for the nine months ended
September 30, 2001 to 26.1% in 2002.
Interest expense. Interest expense decreased $0.4 million, or 12.6%, from
$3.4 million for the nine months ended September 30, 2001 to $3.0 million in
2002, primarily as a result of the reduction in the level of overall
indebtedness following the sale of SPSG.
Provision for income taxes. The provision for income taxes increased $2.9
million from $2.1 million for the nine months ended September 30, 2001 to $5.0
million in 2002. In 2001 Kroll reported tax expense despite a pretax loss from
operations largely as a result of income from certain foreign and domestic
jurisdictions. Additionally, certain domestic and foreign entities realized
losses in 2001 from which Kroll was not able to benefit for tax purposes.
Discontinued operations. Results from discontinued operations improved
from a loss of $8.6 million for the nine months ended September 30, 2001 to
income of $0.1 million in 2002. VDCG was sold in June 2001 and SPSG was sold to
Armor on August 22, 2001 (see Note 5 of the Notes to the Consolidated Unaudited
Financial Statements).
Net income. Net income improved $32.2 million from a loss of $20.9 million
for the nine months ended September 30, 2001 to income of $11.3 million in 2002.
The increase in net income was due primarily to a $35.2 million increase in
gross profit as a result of increased sales in the 2002 period, a $5.7 million
decrease in non-recurring expenses, and an $8.7 million improvement in the
results of discontinued operations. These were partially offset by a $15.1
million increase in recurring operating expenses and a $2.9 million tax
provision increase.
Liquidity and Capital Resources
General. Kroll historically has met its operating cash needs by utilizing
borrowings under its credit arrangements and net proceeds from public offerings
to supplement cash provided by operations.
Credit facilities and senior notes. In 2001, Kroll entered into amended
and restated loan agreements to provide for a revolving credit facility of up to
$40.0 million and senior notes of up to $35.0 million. These loan agreements
were secured by substantially all assets of Kroll and its subsidiaries, and a
pledge of the stock of essentially all the subsidiaries, all of which jointly
and severally guaranteed obligations under these agreements. Borrowings under
these agreements bore interest at the greater of (a) 8.56% or (b) the prime rate
plus 1.5%, plus 0.5% times the number of 30-day periods that expired since April
20, 2001 (or, if less, the highest rate allowed by law). Kroll's agreement to
sell the entities that comprise the Security Products and Services Group (see
Note 5(a) of the Notes to the Consolidated Unaudited Financial Statements)
caused an acceleration of all amounts due, resulting in the expiration of the
agreements on October 22, 2001, which were then extended to November 16, 2001.
Kroll used proceeds from the sale of SPSG to pay down these obligations during
the third quarter of 2001. The remaining balances under these agreements were
subsequently repaid on November 14, 2001, thus terminating the agreements (see
Notes 10(a) and 10(b) of the Notes to the Consolidated Unaudited Financial
Statements).
31
At the closing of the sale of the SPSG business to Armor, Kroll received
approximately $53.7 million, of which approximately $15.0 million was paid in
shares of Armor common stock, $1.5 million was deposited in escrow pending
agreement on SPSG's closing date balance sheet audit and the balance was paid in
cash. Following the closing of the transaction with Armor, proceeds from the
sale of the Armor stock of approximately $14.1 million and an additional $0.3
million subsequently received were paid immediately to the revolving credit
facility lender and senior note holders. The remaining $0.6 million was paid by
Armor to Kroll on May 15, 2002.
In November 2001, Kroll obtained new financing of $30.0 million in the
form of 6% Senior Secured Subordinated Convertible Notes due 2006, a significant
portion of which was used to retire Kroll's amended bank loan and senior notes
(see above and Note 10(c) of the Notes to the Consolidated Unaudited Financial
Statements). Excess proceeds of approximately $8.4 million were used for working
capital to fund operations. The convertible notes were secured exactly as the
$15 million credit facility discussed below, except that the notes were
subordinate to the obligations under the credit facility. The notes mature on
November 14, 2006 and bear interest at the rate of 6% per annum payable
semi-annually, with 12% per annum accruing on any principal payment that is past
due. A discount of approximately $11.4 million, based on the difference between
the closing price of Kroll's stock on the issuance date and the conversion
price, will be amortized as non-cash interest expense over the expected 5-year
life of the notes. Barring early conversion by the noteholders or early
redemption by Kroll, the additional non-cash interest expense will average
approximately $2.3 million or 7.6% per year. Kroll may redeem these convertible
notes at par plus accrued interest, in whole or in part, beginning on November
14, 2004 and the note holders may, at any time prior to one day before the
earlier of the maturity date or the redemption date, convert all or a portion of
the principal amount of the notes into Kroll common stock at the conversion
price of $10.80 per share. The $30.0 million of notes are immediately
convertible into 2,777,777 shares of Kroll common stock, subject to customary
and other anti-dilution adjustments.
The convertible notes contained certain customary covenants, including
covenants that prohibited Kroll from disposing of any material subsidiary,
incurring or permitting to exist any senior or pari-passu debt other than the
$15.0 million credit facility, or any liability for borrowed money, guaranteeing
the obligations for borrowed money of any third party, creating or permitting to
exist any material liens on assets of material subsidiaries or entering into a
transaction prior to November 14, 2003 that involves a "change in control" of
Kroll (as defined in the notes). The notes are payable upon any change in
control of Kroll at the option of the holders. The note holders had the right to
designate an observer to the Board of Directors. The observer was entitled to
attend Audit and Compensation Committee meetings.
On September 5, 2002 the convertible notes agreement was amended to
accommodate a new $100 million credit facility (see Notes 10(a), 10(c) and 10(d)
of the Notes to the Consolidated Unaudited Financial Statements). The amendment
terminated the noteholders' security interest in the assets of Kroll and its
material domestic subsidiaries and the pledge of the stock of certain of Kroll's
subsidiaries. In addition, the amendment deleted the restrictive covenants and
board representation rights described above.
Effective September 3, 1999, with the acquisition of Buchler Phillips,
Kroll acquired a demand note with maximum borrowings of 2.5 million pounds
sterling. The demand note bears interest at the Bank of England's base rate plus
1.5%. At September 30, 2002 the interest rate was 5.5%. In March 2002, maximum
borrowings permitted under the demand note were increased from 2.5 million
pounds sterling to 4.4 million pounds sterling, or $6.9 million as translated at
September 30, 2002. Borrowings outstanding under this demand note were
approximately $0.5 million and $2.6 million, as translated at September 30,
2002 and December 31, 2001, respectively.
On February 21, 2002, Kroll executed agreements with Foothill Capital
Corporation to provide a revolving credit facility of up to $15 million, subject
to borrowing base limitations, for a term of three years. Borrowings under the
credit facility bore interest, at Kroll's election, at a rate per annum equal to
(1) a base rate, which will be the prime rate of Wells Fargo Bank, N.A., plus
0.75% or (2) LIBOR plus 2.75%. During the term
32
of the credit facility, Kroll paid Foothill Capital a fee equal to the product
of 0.375% per annum and the unused portion of the credit facility. The credit
facility agreement required Kroll to maintain a minimum level of EBITDA, and
contains restrictions on the incurrence of additional debt, the creation of any
liens on any of Kroll's assets, certain acquisitions, distributions to certain
subsidiaries and other affirmative and negative covenants customarily contained
in debt agreements of this type. The credit facility was secured by a security
interest in substantially all of the assets of Kroll and its material domestic
subsidiaries and a pledge of stock of certain of Kroll's subsidiaries (see Note
10(a) of the Notes to the Consolidated Unaudited Financial Statements). In
connection with the new $100 million credit facility put into place September 5,
2002 (see Note 10(d) of the Notes to the Consolidated Unaudited Financial
Statements), Kroll amended and ultimately terminated the $15 million revolving
credit facility agreement. No borrowings were made under the terminated $15
million credit agreement (see Note 10(a) of the Notes to the Consolidated
Unaudited Financial Statements).
In May 2002, Kroll and Armor resolved post-closing adjustments to the SPSG
closing date balance sheet, which resulted in the payment to Kroll of $1.1
million of the $1.5 million held in escrow.
In connection with the Zolfo Cooper acquisition (see Note 8(b) of the
Notes to the Consolidated Unaudited Financial Statements), Kroll entered into a
new $100 million credit facility that provides for a $25 million revolving line
of credit and $75 million in term loan financing through a syndicate arranged by
Goldman Sachs Credit Partners L.P. The revolving credit facility, subject to
borrowing base limitations, has a three year term. The borrowing amount is
calculated based on an analysis of Kroll's accounts receivable as of the month
end preceding the borrowing date. The term loan was to be repaid under the
following terms: $0.8 million by December 31, 2002, an additional $4.5 million
within one year of closing date, $18.7 million within two years of closing and
the balance ($51.0 million) within three years of closing.
Both the revolving credit facility and the term loan bear interest at
Kroll's election, at a rate per annum equal to:
o base rate plus applicable margin; or
o Eurodollar rate plus applicable margin.
The applicable margin is determined by the leverage ratio, calculated as
the ratio of the last day of any fiscal quarter of consolidated total debt as of
that day to adjusted EBITDA for the four fiscal quarters ending on such date.
The revolving credit facility requires the Company to comply with certain
customary restrictive covenants, including, maintaining certain ratios such as
EBITDA to fixed charged and EBITDA to debt, and limiting capital expenditures
and incurring additional indebtedness.
The revolving credit facility requires Kroll to pay a fee equal to 0.375%
per annum of the unused portion of the $25 million revolving credit facility.
The revolving credit facility is secured by a lien on substantially all of
Kroll's assets and those of most of Kroll's domestic subsidiaries.
The term loan was subsequently repaid in October 2002 using proceeds from
Kroll's common stock offering (see Note 16 of the Notes to the Consolidated
Unaudited Financial Statements).
Kroll currently believes that the net proceeds from the Company's equity
offering in October 2002, combined with the available borrowings under the
credit facility, the cash acquired in the acquisitions of Ontrack and Zolfo
Cooper, and Kroll's cash from operations, will be sufficient to fund operations
for at least the next 12 months.
Cash flows from operating activities. Operating activities provided $3.6
million in net cash for the nine months ended September 30, 2001 compared to
$18.9 million for the nine months ended September 30, 2002.
33
The $15.3 million increase from the 2001 period to the 2002 period reflects
strong sales growth from existing operations and from strategic acquisitions
made in the 2002 period. The cash provided by this significant increase in sales
resulting in increased profitability was partially offset by a $6.1 million
increase in working capital investments to fund the increased business activity.
Cash flows from investing activities. For the nine months ended September
30, 2001, Kroll used $5.6 million in investing activities compared to $77.0
million used in the nine months ended September 30, 2002. In the 2001 period,
$2.2 million was used for capital expenditures, $3.3 million was used for
database additions and $0.1 million was used for intangible assets. In the 2002
period, Kroll received $32.0 million in cash (and approximately $5.6 million in
short term marketable securities) as a result of acquiring Ontrack and made cash
expenditures of $3.6 million, resulting in net cash provided of $28.4 million.
Also in the 2002 period, $100.0 million of cash was used to purchase the net
assets of Zolfo Cooper, which included cash of $3.3 million. Kroll made
additional cash expenditures of $1.4 million in the acquisition of Zolfo Cooper,
resulting in net cash used of $98.1 million. In addition, in the 2002 period,
Kroll sold marketable securities, which provided net cash of $5.6 million and
made expenditures totaling $12.0 million, which included additions to capital
assets, databases and intangible assets of $4.7 million, $3.1 million and $4.2
million, respectively.
Cash flows from financing activities. Net cash used in financing
activities was $52.2 million for the nine months ended September 30, 2001
compared with net cash provided of $79.8 million for the nine months ended
September 30, 2002. Foreign currency translation accounted for $1.1 million of
the cash used in 2001, while $0.5 million was provided from the exercise of
stock options. Net payments of $29.2 million were made on revolving lines of
credit and $22.4 million was used to pay down long-term debt. In the 2002
period, $75.0 million of cash was provided by a new term loan offset partially
by cash expended for financing fees for current year financing activities of
$3.4 million. An additional $8.1 million of cash was provided from the exercise
of stock options, with net payments of $1.6 million made on revolving lines of
credit and net payments $0.5 million made on long-term debt. Foreign currency
translation accounted for the remaining $2.2 million of cash provided.
Kroll's contractual obligations were comprised of the following as of
September 30, 2002:
Payments due by Period
-------------------------------------------------------------------
Contractual Obligation Total Within 1 Year 2-3 Years 4-5 Years After 5 Years
-------- ------------- --------- --------- -------------
(dollars in thousands)
Long-term debt ................. $105,095 $ 5,333 $ 69,762 $ 30,0 $ --
Operating leases ............... 62,296 13,636 22,176 17,679 8,805
Other long-term obligations..... 1,000 250 500 250 --
-------- -------- -------- -------- --------
Total ....................... $168,391 $ 19,219 $ 92,438 $ 47,929 $ 8,805
======== ======== ======== ======== ========
Cash flows from discontinued operations. Net cash provided by discontinued
operations was $52.8 million for the nine months ended September 30, 2001
compared to net cash used of $0.4 million for the nine months ended September
30, 2002. In September 2001, VDCG was sold and on August 22, 2001 SPSG was sold
to Armor. Kroll's discontinued Russian business accounted for the $0.4 million
of cash used in the 2002 period (see Note 5 to the Notes to the Consolidated
Unaudited Financial Statements).
Foreign operations. Kroll attempts to mitigate the risks of doing business
in foreign countries by separately incorporating its operations in those
countries, maintaining reserves for credit losses and insuring equipment to
protect against losses related to political risks and terrorism. In the 2001
period, Kroll utilized derivative financial instruments, in the form of forward
contracts, to hedge some of its exposure to foreign currency rate fluctuations.
As of September 30, 2001, the foreign currency hedge contracts had a notional
amount of $3.2 million, which approximated their estimated fair value. Kroll did
not utilize derivative financial instruments during the 2002 period.
34
Quarterly fluctuations. Although Kroll does have some long term contracts
with its clients, generally its ability to generate net sales is dependent 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.
New accounting pronouncements. In September 2000, the Emerging Issues Task
Force (EITF) announced Issue No. 00-20, "Accounting for Costs Incurred to
Acquire or Originate Information for Database Content and Other Collections of
Information," stating that the EITF is considering different views for the
accounting for database costs. One of the views would require Kroll to expense
some or all of the database costs that Kroll currently capitalizes and
amortizes, which is currently an acceptable alternative. Adoption of a different
method of accounting for database costs could have a material impact on Kroll's
financial position and results of operations. To date, the EITF has not made any
official determinations concerning this issue.
In June 2001, the Financial Accounting Standards Board (FASB) issued
Statement of Financial Accounting Standards No. 142, "Goodwill and Other
Intangible Assets" (SFAS No. 142), which establishes accounting and reporting
standards for goodwill and other intangible assets that are acquired
individually or with a group of other assets. The provisions of this statement
are effective for fiscal years beginning after December 15, 2001. Accordingly,
effective January 1, 2002, Kroll ceased amortizing goodwill and similar
intangible assets. In addition, Kroll has conducted impairment tests of the
goodwill recorded on its books, as required by SFAS 142. The tests determined
that Kroll's recorded goodwill is not impaired. Impairment tests will be
conducted annually, or sooner if circumstances indicate an impairment may have
taken place (see Note 13 of the Notes to the Consolidated Unaudited Financial
Statements).
In June 2001, the FASB issued Statement of Financial Accounting Standards
No. 143, "Accounting for Asset Retirement Obligations" (SFAS No. 143), which
addresses financial accounting and reporting for obligations and costs
associated with the retirement of tangible long-lived assets. Kroll is required
to implement SFAS No. 143 on January 1, 2003, and management expects that the
adoption of this statement will not have a material impact on the Company's
results of operations or financial position.
In August 2001, the FASB issued Statement of Financial Accounting
Standards No. 144, "Accounting for the Impairment or Disposal of Long-Lived
Assets" (SFAS No. 144), which replaces SFAS No. 121 "Accounting for the
Impairment of Long-Lived Assets and for Long-Lived Assets to be Disposed of" and
establishes accounting and reporting standards for long-lived assets to be
disposed of by sale. This standard applies to all long-lived assets, including
discontinued operations. SFAS No. 144 requires that those assets be measured at
the lower of carrying amount or fair value less cost to sell. SFAS No. 144 also
broadens the reporting of discontinued operations to include all components of
an entity with operations that can be distinguished from the rest of the entity
that will be eliminated from the ongoing operations of the entity in a disposal
transaction. Kroll implemented SFAS No. 144 on January 1, 2002, and there was no
material impact relating to the implementation of this statement on its results
of operations or financial position.
In April 2002, the FASB issued SFAS No. 145, "Rescission of FASB
Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical
Corrections". This statement eliminates the automatic classification of gain or
loss on extinguishment of debt as an extraordinary item of income and requires
that such gain or loss be evaluated for extraordinary classification under the
criteria of Accounting Principles Board (APB) No. 30 "Reporting Results of
Operations". This statement also requires sales-leaseback accounting for certain
lease modifications that have economic effects that are similar to
sales-leaseback transactions, and makes various other technical corrections to
existing pronouncements. This statement will be effective for the Company for
the year ending December 31, 2003. For 2003 financial statements, Kroll will
reclassify as operating expenses prior period extraordinary items that do not
meet the criteria of ABP No. 30.
In July 2002, the FASB issued SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 will supersede EITF
Issue No. 94-3, "Liability Recognition for Certain Employee
35
Termination Benefits and Other Costs to Exit an Activity (including Certain
Costs Incurred in a Restructuring)". SFAS No. 146 requires that costs associated
with an exit or disposal plan be recognized when incurred rather than at the
date of a commitment to an exit or disposal plan. SFAS No. 146 is to be applied
prospectively to exit or disposal activities initiated after December 31, 2002.
36
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
Fair Value of Financial Instruments -- The following disclosure of the
estimated fair value of financial instruments is made in accordance with the
requirements of Statement of Financial Accounting Standards No. 107,
"Disclosures about Fair Value of Financial Instruments". Kroll estimated fair
values of financial instruments by using available market information and
appropriate valuation methodologies.
However, considerable judgment is required in interpreting market data to
develop the estimates of fair value. Accordingly, the estimates presented herein
are not necessarily indicative of the amounts that Kroll could realize in
current market exchange.
Kroll does not expect to enter into financial instruments for trading or
hedging purposes. Kroll does not currently anticipate entering into interest
rate swaps and/or similar instruments.
Kroll's carrying values of cash, accounts receivable, accounts payable and
accrued expenses are a reasonable approximation of their fair value. Kroll's
carrying value of its long-term debt is a reasonable approximation of its fair
value as evidenced by its liquidation from the proceeds of Kroll's equity
offering in October 2002.
Kroll's business in this regard is subject to certain risks, including,
but not limited to, differing economic conditions, loss of significant
customers, changes in political climate, differing tax structures, other
regulations and restrictions and foreign exchange rate volatility. Kroll's
future results could be materially and adversely impacted by changes in these or
other factors.
37
ITEM 4. - CONTROLS AND PROCEDURES
Within the 90-day period prior to the filing date of this report, Kroll's
Chief Executive Officer and Chief Financial Officer carried out an evaluation of
the effectiveness of Kroll's disclosure controls and procedures (as defined in
Rules 13a-14(c) and 15d-14(c) of the Securities Exchange Act of 1934, as
amended). Based on that evaluation, these officers concluded that Kroll's
disclosure controls and procedures are adequate and effective. There have been
no significant changes in Kroll's internal controls or in other factors that
could significantly affect these controls subsequent to the date of that
evaluation, including any corrective actions with regard to significant
deficiencies and material weaknesses.
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PART II. OTHER INFORMATION
ITEM 1. LEGAL PROCEEDINGS
Kroll 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'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. The plaintiffs allege that Kroll'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. On behalf of Kroll, they seek a declaration that the individual
defendants breached their fiduciary duty and damages and attorneys' fees in an
unspecified amount. The parties have executed a stipulation of settlement
providing for the settlement of these actions, which is subject to court
approval. The New York court has scheduled a final hearing on the proposed
settlement for December 20, 2002. If the New York court approves the settlement,
the parties will ask the Ohio court to dismiss the Ohio actions. Kroll cannot
guarantee that the proposed settlement will be consummated.
Kroll Lindquist Avey Co. (formerly Lindquist Avey Macdonald &
Baskerville), a subsidiary of Kroll, and several of its principals have been
named as third-party defendants in a lawsuit filed in the Ontario Superior Court
of Justice by HSBC Securities (Canada) Inc., formerly Gordon Capital, an
investment dealer ("HSBC"). HSBC filed the underlying suit against Gordon
Capital's former law firm, Davies, Ward & Beck ("DW&B") seeking damages in the
amount of approximately $40,000,000 (Cdn.). HSBC alleges DW&B negligently
advised Gordon Capital during 1991 through 1993 with respect to its rights
concerning trading losses and irregularities by a client account manager and
various insurance bonds relating to such losses and irregularities. HSBC further
alleges various suits and declaratory judgment actions involving the insurers
were filed in 1993 and that summary judgment granted in favor of the insurers in
1996 was affirmed on appeal to the Supreme Court of Canada on the basis that the
limitation period under the bonds had expired without an action being commenced
for recovery of Gordon Capital's losses. Gordon Capital, DW&B and LAMB entered
into various tolling agreements until the matters pending with the insurers were
exhausted. In April 2000, HSBC filed suit against DW&B. In July 2001, DW&B filed
a third-party claim against LAMB and certain principals for contribution and
indemnity. An amended third-party claim was filed in September 2001. The
third-party claim alleges DW&B retained LAMB in June 1991 to examine the trading
irregularities and to advise Gordon Capital in respect of its dealings with its
insurers and that LAMB acted negligently in carrying out these services. Third
party claims have also been filed against some entities formerly known as Peat
Marwick Thorne, Gordon Capital's alleged former auditors, and AON Reed
Stenhouse, Inc., Gordon Capital's alleged former insurance broker. Discovery
examinations of certain Gordon Capital and Davies Ward & Beck witnesses have
recently occurred. Mediation is currently scheduled for December 11 and 12,
2002. LAMB and its principals believe they have meritorious defenses to the
claims and intend to defend them vigorously.
In addition to the matters discussed above, Kroll is involved in
litigation from time to time in the ordinary course of its business; however,
Kroll does not believe that such litigation, individually or in the aggregate,
is likely to have a material adverse effect on its business, financial
condition, results of operations or cash flows.
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ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
On July 2, 2002, Kroll Inc., an Ohio corporation ("Kroll Ohio"),
consummated a merger with and into its wholly owned subsidiary, Kroll Inc., a
Delaware corporation ("Kroll Delaware") (the "Reincorporation"). As a result
of the Reincorporation, Kroll became a Delaware corporation.
As provided by the Amended and Restated Agreement and Plan of Merger,
dated April 25, 2002, by and between Kroll Ohio and Kroll Delaware (the "Merger
Agreement"), each outstanding share of Kroll Ohio common stock, par value $0.01
per share, was automatically converted into one share of Kroll Delaware common
stock, par value $0.01 per share (the "Common Stock"), at the time the
Reincorporation became effective.
For a description of the material differences between the Kroll Ohio
common stock and the Kroll Delaware common stock, see the section entitled
"Comparison of Rights of Shareholders of Ontrack and Shareholders of Kroll"
contained in Amendment No. 1 to Kroll's Registration Statement on Form S-4 filed
with the Securities and Exchange Commission on May 10, 2002, which section is
incorporated by reference herein.
For a description of Kroll's common stock, see Kroll's Current Report on
Form 8-K filed with the Securities and Exchange Commission on July 9, 2002,
which report is incorporated by reference herein.
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Item 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
2.1 Purchase Agreement, by and between Kroll, the members of Zolfo
Cooper, LLC and the stockholders of Zolfo Cooper Holdings, Inc.
(previously filed as Exhibit 2 to Kroll's Current Report on Form 8-K
as filed with the Securities and Exchange Commission on September 5,
2002 (the "8-K") and incorporated by reference herein).
3.1 Amended and Restated Certificate of Incorporation of Kroll
(previously filed as Exhibit 3.4 to Kroll's Post-Effective Amendment
No. 1 on Form S-3 to Form S-1 (Reg. No. 222-75972), as filed with
the Securities and Exchange Commission on May 3, 2002 (the
"Post-Effective Amendment" and incorporated by reference herein).
3.2 Amended and Restated By-laws of Kroll (previously filed as Exhibit
3.5 to the Post-Effective Amendment and incorporated by reference
herein).
4.1 Registration Rights Agreement, by and between Kroll, the members of
Zolfo Cooper, LLC and the stockholders of Zolfo Cooper Holdings,
Inc. (previously filed as Exhibit 4.1 to the 8-K and incorporated by
reference herein).
4.2 Form of $75 Million Term Loan Note (previously filed as Exhibit 4.2
to the 8-K and incorporated by reference herein).
4.3 Form of Revolving Loan Note (previously filed as Exhibit 4.3 to the
8-K and incorporated by reference herein).
4.5 Senior Secured Subordinated Convertible Note, dated November 14,
2001 (previously filed as Exhibit 4.4 to the 8-K and incorporated by
reference herein).
10.1 Credit and Guaranty Agreement, by and between Kroll and Goldman,
Sachs & Co. (previously filed as Exhibit 10.1 to the 8-K and
incorporated by reference herein).
10.2 Pledge and Security Agreement, by and between Kroll and Goldman,
Sachs & Co. (previously filed as Exhibit 10.2 to the 8-K and
incorporated by reference herein).
10.3 Termination, Amendment, and Consent Agreement, by and between Kroll
and Palisade Concentrated Equity Partnership L.P. (previously filed
as Exhibit 10.3 to the 8-K and incorporated by reference herein).
99.1 Certification of Chief Executive Officer.
99.2 Certification of Chief Financial Officer.
(b) During the quarter ended September 30, 2002, Kroll filed the following
Current Reports on Form 8-K on the dates indicated:
Date of Report: July 9, 2002; Items 5 and 7.
41
August 27, 2002; Item 7. Contains Unaudited Pro Forma Condensed Combining
Financial Statements of Kroll Inc. and Ontrack Data International, Inc. as
of March 31, 2002 and for the three months then ended.
September 5, 2002; Items 2, 5 and 7. Contains (i) Audited Combined
Financial Statements of Zolfo Cooper, LLC and Affiliates as of December
31, 2000 and 2001 and for the three years ended December 31, 1999, 2000
and 2002 and Unaudited Combined Financial Statements as of June 30, 2002
and for the six months ended June 30, 2001 and 2002. and (ii) Unaudited
Pro Forma Condensed Combining Financial Statements of Kroll Inc. and Zolfo
Cooper, LLC and Affiliates as of June 30, 2002 and for the six months then
ended and as of December 31, 2001 and for the year then ended. This
Current Report on Form 8-K was subsequently amended by Current Reports on
Form 8-K/A filed on September 6, 2002, September 13, 2002, September 25,
2002 and October 17, 2002.
September 6, 2002; Item 5.
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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 14th day of November, 2002.
Kroll Inc.
By: /s/ Steven L. Ford
------------------------
Steven L. Ford
Chief Financial Officer
43
I, Michael G. Cherkasky, certify that
1. I have reviewed this quarterly report on Form 10-Q of Kroll Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
By: /s/ Michael G. Cherkasky
--------------------------------
Michael G. Cherkasky
Chief Executive Officer
44
I, Steven L. Ford, certify that
1. I have reviewed this quarterly report on Form 10-Q of Kroll Inc.;
2. Based on my knowledge, this quarterly report does not contain any untrue
statement of a material fact or omit to state a material fact necessary to
make the statements made, in light of the circumstances under which such
statements were made, not misleading with respect to the period covered by
this quarterly report;
3. Based on my knowledge, the financial statements, and other financial
information included in this quarterly report, fairly present in all
material respects the financial condition, results of operations and cash
flows of the registrant as of, and for, the periods presented in this
quarterly report;
4. The registrant's other certifying officers and I are responsible for
establishing and maintaining disclosure controls and procedures (as
defined in Exchange Act Rules 13a-14 and 15d-14) for the registrant and
have:
a) Designed such disclosure controls and procedures to ensure that
material information relating to the registrant, including its
consolidated subsidiaries, is made known to us by others within
those entities, particularly during the period in which this
quarterly report is being prepared;
b) Evaluated the effectiveness of the registrant's disclosure controls
and procedures as of a date within 90 days prior to the filing date
of this quarterly report (the "Evaluation Date"); and
c) Presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on our
evaluation as of the Evaluation Date;
5. The registrant's other certifying officers and I have disclosed, based on
our most recent evaluation, to the registrant's auditors and the audit
committee of registrant's board of directors (or persons performing the
equivalent functions):
a) All significant deficiencies in the design or operation of internal
controls which could adversely affect the registrant's ability to
record, process, summarize and report financial data and have
identified for the registrant's auditors any material weaknesses in
internal controls; and
b) Any fraud, whether or not material, that involves management or
other employees who have a significant role in the registrant's
internal controls; and
6. The registrant's other certifying officers and I have indicated in this
quarterly report whether there were significant changes in internal
controls or in other factors that could significantly affect internal
controls subsequent to the date of our most recent evaluation, including
any corrective actions with regard to significant deficiencies and
material weaknesses.
Date: November 14, 2002
By: /s/ Steven L. Ford
--------------------------
Steven L. Ford
Chief Financial Officer
45