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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
Commission File Number: 000-21629
KROLL INC.
(Exact name of Registrant as specified in its charter)
DELAWARE 13-4131019
(State or other jurisdiction of (I.R.S. Employer
incorporation) Identification Number)
900 THIRD AVENUE
NEW YORK, NY 10022
(Address of principal executive offices) (Zip code)
(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 [ ]
Indicate by check mark whether the Registrant is an accelerated filer (as
defined in Rule 12b-2 of the Exchange Act): Yes [ X ] No [ ]
The number of shares outstanding of the Registrant's common stock was
40,079,327 shares as of April 30, 2003.
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INDEX
Page
PART I - FINANCIAL STATEMENTS
Item 1. Financial Statements
Consolidated Condensed Balance Sheets (unaudited) as of
March 31, 2003 and December 31, 2002 ......................... 1
Consolidated Condensed Statements of Income and Comprehensive
Income (Loss) (unaudited) for the three months ended March 31,
2003 and 2002................................................. 3
Consolidated Condensed Statements of Cash Flows (unaudited)
for the three months ended March 31, 2003 and 2002............ 4
Notes to Consolidated Condensed Financial Statements
(unaudited) .................................................. 5
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations..................................... 16
Item 3. Quantitative and Qualitative Disclosures About Market Risk.... 25
Item 4. Controls and Procedures ...................................... 26
PART II - OTHER INFORMATION
Item 1. Legal Proceedings ............................................ 27
Item 2. Changes in Securities and Use of Proceeds..................... 28
Item 6. Exhibits and Reports on Form 8-K ............................. 29
Signatures ................................................... 31
Certifications ............................................... 32
i
PART I. FINANCIAL INFORMATION
ITEM 1. FINANCIAL STATEMENTS
KROLL INC.
CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited)
(In thousands, except share data)
March 31, December 31,
2003 2002
--------- -----------
ASSETS
CURRENT ASSETS:
Cash and cash equivalents .............................................. $ 79,618 $ 77,317
Trade accounts receivable, net of allowance for
doubtful accounts of $7,842 and $6,992 at March 31,
2003 and December 31, 2002, respectively ............................. 48,733 49,347
Unbilled revenues ...................................................... 36,353 29,999
Related party receivables .............................................. 734 720
Deferred tax asset ..................................................... 5,284 5,304
Prepaid expenses and other current assets .............................. 8,689 8,315
--------- ---------
Total current assets ................................................. 179,411 171,002
--------- ---------
PROPERTY, PLANT AND EQUIPMENT, at cost:
Land ................................................................... 194 194
Buildings and improvements ............................................. 2,092 2,092
Leasehold improvements ................................................. 13,068 12,555
Furniture and fixtures ................................................. 7,594 7,496
Machinery and equipment ................................................ 40,820 39,591
--------- ---------
63,768 61,928
Less-accumulated depreciation and amortization ......................... (37,008) (34,510)
--------- ---------
26,760 27,418
--------- ---------
DATABASES, net of accumulated amortization of $39,265 and
$38,200 at March 31, 2003 and December 31, 2002,
respectively ........................................................... 10,816 10,715
GOODWILL, net of accumulated amortization of $8,007 and
$8,001 at March 31, 2003 and December 31, 2002,
respectively ........................................................... 300,812 299,582
OTHER INTANGIBLE ASSETS, net of accumulated amortization
of $6,980 and $5,809 at March 31, 2003 and December 31,
2002, respectively (Note 7) ............................................ 27,674 25,685
OTHER ASSETS .............................................................. 10,079 5,220
--------- ---------
Total Assets ......................................................... $ 555,552 $ 539,622
========= =========
The accompanying notes are an integral part of these consolidated condensed
unaudited financial statements.
1
KROLL INC.
CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited)
(In thousands, except share data)
March 31, December 31,
2003 2002
---------- -----------
LIABILITIES AND STOCKHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit (Note 8) .......................................... $ 926 $ 4,209
Current portion of long-term debt (Note 8) .................................. 64 73
Trade accounts payable ...................................................... 10,327 10,870
Related party payables ...................................................... 1,820 2,253
Accrued payroll and related benefits ........................................ 11,292 9,904
Other accrued liabilities ................................................... 11,395 10,873
Income taxes payable ........................................................ 8,678 2,448
Deferred revenue ............................................................ 13,505 14,488
--------- ---------
Total current liabilities ................................................. 58,007 55,118
DEFERRED INCOME TAXES .......................................................... 5,358 5,358
CONVERTIBLE NOTES, net of unamortized discount of $9,153
and $9,599 at March 31, 2003 and December 31, 2002,
respectively (Note 8) ....................................................... 20,847 20,401
LONG-TERM DEBT, net of current portion (Note 8) ................................ 25 18
OTHER LONG-TERM LIABILITIES .................................................... 1,759 1,820
--------- ---------
Total liabilities ......................................................... 85,996 82,715
--------- ---------
COMMITMENTS AND CONTINGENCIES (Note 9)
STOCKHOLDERS' EQUITY (Note 10):
Preferred stock, $.01 par value, 5,000,000 shares
authorized, none issued ................................................... -- --
Common stock, $.01 par value, 100,000,000 shares
authorized, 40,058,794 and 36,994,758 shares issued
and outstanding at March 31, 2003 and December 31, 2002,
respectively .............................................................. 401 370
Common shares to be issued for acquisition (Note 6) ......................... -- 55,280
Additional paid-in-capital .................................................. 514,182 456,843
Accumulated deficit ......................................................... (40,314) (51,590)
Accumulated other comprehensive loss ........................................ (4,276) (3,952)
Deferred compensation ....................................................... (437) (44)
--------- ---------
Total stockholders' equity ................................................ 469,556 456,907
--------- ---------
$ 555,552 $ 539,622
========= =========
The accompanying notes are an integral part of these consolidated condensed
unaudited financial statements.
2
KROLL INC.
CONSOLIDATED CONDENSED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME (LOSS) (Unaudited)
(In thousands, except per share amounts)
Three Months Ended
March 31,
--------------------------
2003 2002
--------- ---------
NET SALES .................................................................. $ 104,762 $ 56,016
COST OF SALES .............................................................. 48,296 31,029
--------- ---------
Gross profit ......................................................... 56,466 24,987
--------- ---------
OPERATING EXPENSES:
Selling and marketing ................................................... 9,232 4,376
General and administrative .............................................. 23,742 15,900
Research and development ................................................ 3,161 --
Amortization of other intangible assets ................................. 1,206 217
--------- ---------
Operating expenses .................................................... 37,341 20,493
--------- ---------
Operating income ..................................................... 19,125 4,494
OTHER INCOME (EXPENSE):
Interest expense, net ................................................... (830) (912)
Other income (expense), net ............................................. 40 (28)
--------- ---------
Income before provision for income taxes ............................. 18,335 3,554
Provision for income taxes .............................................. 7,059 1,237
--------- ---------
Net Income ........................................................... 11,276 2,317
OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:
Foreign currency translation adjustment, net of tax benefit
of $203 and $989 for 2003 and 2002, respectively ...................... (324) (485)
--------- ---------
Comprehensive income ................................................. $ 10,952 $ 1,832
========= =========
PER SHARE DATA (Note 5):
BASIC
Earnings per share .................................................... $ 0.28 $ 0.10
========= =========
Weighted average shares outstanding ................................... 40,003 22,870
========= =========
DILUTED
Earnings per share .................................................... $ 0.28 $ 0.10
========= =========
Weighted average shares outstanding ................................... 40,948 23,788
========= =========
The accompanying notes are an integral part of these consolidated condensed
unaudited financial statements.
3
KROLL INC.
CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
Three Months Ended
March 31,
-------------------------
2003 2002
OPERATING ACTIVITIES:
Net income ............................................................... $ 11,276 $ 2,317
Adjustments to reconcile net income to net cash provided
by operating activities:
Depreciation and amortization .......................................... 4,719 2,678
Bad debt expense ....................................................... 1,381 693
Non-cash interest expense .............................................. 532 441
Non-cash compensation expense .......................................... 84 --
Change in operating assets and liabilities, excluding the
impact of acquisitions and dispositions:
Trade accounts receivable and unbilled revenues ........................ (6,346) (4,558)
Prepaid expenses and other current assets .............................. (116) (2)
Trade accounts payable ................................................. (1,014) (1,402)
Income taxes payable ................................................... 6,172 981
Amounts due to/from related parties .................................... 49 993
Deferred revenue ....................................................... (1,022) (621)
Accrued liabilities .................................................... 2,039 (424)
Other long-term liabilities ............................................ (66) (121)
-------- --------
Net cash provided by operating activities .............................. 17,688 975
-------- --------
INVESTING ACTIVITIES:
Purchases of property, plant and equipment ............................... (1,890) (887)
Additions to databases ................................................... (1,163) (1,090)
Additions to other intangible assets ..................................... (3,137) (444)
Acquisitions, net of cash acquired ....................................... (2,544) --
Other investments ........................................................ (1,451) --
-------- --------
Net cash used in investing activities .................................. (10,185) (2,421)
-------- --------
FINANCING ACTIVITIES:
Net borrowings (payments) under revolving line of credit ................. (4,020) 1,088
Cash collateralization related to letters of credit ...................... (2,173) --
Payments of long-term debt ............................................... -- (553)
Foreign currency translation ............................................. (296) (375)
Proceeds from Employee Stock Purchase Plan contributions ................. 563 --
Proceeds from exercise of stock options .................................. 621 819
-------- --------
Net cash provided by (used in) financing activities .................... (5,305) 979
-------- --------
Effects of foreign currency exchange rates on cash and cash
equivalents .............................................................. 103 (84)
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS ........................ 2,301 (551)
CASH AND CASH EQUIVALENTS, beginning of period .............................. 77,317 11,485
-------- --------
CASH AND CASH EQUIVALENTS, end of period .................................... $ 79,618 $ 10,934
======== ========
The accompanying notes are an integral part of these consolidated condensed
unaudited financial statements.
4
KROLL INC.
NOTES TO THE CONSOLIDATED CONDENSED FINANCIAL STATEMENTS
(UNAUDITED)
1. Nature of Operations
Kroll Inc., together with its subsidiaries (collectively, 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 Kroll to provide its clients with
comprehensive, single source, risk consulting services. These five groups are:
(1) Corporate Advisory and Restructuring Services, which provides corporate
restructuring, operational turnaround, strategic advisory services, financial
crisis management and corporate finance services; (2) 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; (3) Technology Services,
which provides electronic discovery, data recovery and computer forensics
services, along with related software solutions; (4) Background Screening
Services, which provides pre-employment and security background screening,
substance abuse testing and surveillance services; and (5) Security Services,
which provides security architecture and design, corporate security consulting,
emergency management and environmental services as well as protective services,
operations and training.
2. Basis of Presentation
The accompanying consolidated condensed unaudited financial statements
include the historical consolidated financial statements of Kroll; the
businesses it has acquired, since their respective dates of acquisition, under
the purchase method of accounting; and the financial position, results of
operations and cash flows of entities which were merged with Kroll in connection
with pooling of interests business combinations prior to July 1, 2001. All
intercompany accounts and transactions are eliminated in consolidation.
Investments in 20% to 50% owned entities are accounted for using the equity
method. Affiliated entities are not included in the accompanying consolidated
condensed financial statements.
The consolidated condensed 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. The operating results for the three months ended March 31, 2003 and
2002 are not necessarily indicative of the results that may be expected for a
full year or any subsequent interim period. In addition, management is required
to make estimates and assumptions that affect the amounts reported and related
disclosures. Estimates, by their nature, are based on judgement and available
information. Accordingly, actual results could differ from these estimates. The
accompanying consolidated condensed 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,
2002.
3. Recent Accounting Pronouncements
On January 1, 2003, Kroll adopted Statement of Financial Accounting
Standards ("SFAS") No. 143, "Accounting for Asset Retirement Obligations." SFAS
143 addresses financial accounting and reporting for obligations and costs
associated with the retirement of tangible long-lived assets. The adoption of
SFAS No. 143 did not have any material impact on Kroll's consolidated results of
operations or financial position.
5
On January 1, 2003, Kroll adopted the SFAS No. 145, "Rescission of FASB
Statements Nos. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections". This statement eliminates the automatic classification of gains or
losses on the extinguishment of debt as an extraordinary item of income and
requires that such gains or losses be evaluated for extraordinary classification
under the criteria of Accounting Principal Board ("APB") No. 30 "Reporting
Results of Operations". In addition, any prior period extraordinary items that
do not meet the criteria of APB No. 30 will be required to be reclassified to
continuing operations. This statement also requires sales-leaseback accounting
for certain modifications that have economic effects that are similar to
sales-leaseback transactions, and makes various other technical corrections to
existing pronouncements.
On January 1, 2003, Kroll adopted the SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 supersedes 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)" and 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 December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of FASB
Statement No. 123". SFAS No. 148 amends SFAS No. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used in reporting results.
Management complied with the additional annual and interim disclosure
requirements effective December 31, 2002 and March 31, 2003, respectively. (See
Note 4 for the additional interim disclosures required by SFAS No. 148.)
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an Interpretation of FASB Statements Nos.
5, 57, and 107 and Rescission of FASB Interpretation No. 34" ("FIN No. 45"). FIN
No. 45 requires that upon issuance of a guarantee, an entity must recognize a
liability for the fair value of the obligation it assumes under that obligation.
This interpretation is intended to improve the comparability of financial
reporting by requiring identical accounting for guarantees issued with
separately identified consideration and guarantees issued without separately
identified consideration. For Kroll, the initial recognition and measurement
provisions of FIN No. 45 applicable to guarantees issued or modified after
December 31, 2002 did not have any impact on its consolidated results of
operations or financial condition. Kroll adopted the additional disclosure
provisions of FIN No. 45 effective December 31, 2002.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which addresses consolidation by business
enterprises of variable interest entities ("FIN No. 46"). In general, a variable
interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities. A
variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in research and development or other
activities on behalf of another company. The objective of FIN No. 46 is not to
restrict the use of variable interest entities but to improve financial
reporting by companies involved with variable interest entities. Until now, a
company generally has included another entity in its consolidated financial
statements only if it controlled the entity through voting interests. FIN No. 46
changes that by requiring a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of FIN No. 46
apply immediately to variable interest entities created after January 31, 2003
and the first fiscal year or interim period beginning after June 15, 2003 for
older entities. Certain of the disclosure requirements apply in all financial
statements issued
6
after January 31, 2003, regardless of when the variable interest entity was
established. Kroll adopted the additional disclosure provisions of FIN No. 46
effective December 31, 2002 and the consolidation requirements of FIN No. 46 to
variable interest entities created after January 31, 2003, the effect of which
did not have any impact on Kroll's consolidated results of operations or
financial condition. Kroll does not expect the adoption of FIN No. 46 to older
entities to have a material effect on its consolidated results of operations or
financial position.
On April 30, 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No.
133 on Derivative Instruments and Hedging Activities." The Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. This Statement is effective for contracts entered into or modified
after June 30, 2003, except as stated below, and for hedging relationships
designated after June 30, 2003. The guidance should be applied prospectively.
The provisions of this Statement that relate to SFAS No. 133 Implementation
Issues that have been effective for fiscal quarters that began prior to June 15,
2003, should continue to be applied in accordance with their respective
effective dates. In addition, certain provisions relating to forward purchases
or sales of when-issued securities or other securities that do not yet exist,
should be applied to existing contracts as well as new contracts entered into
after June 30, 2003. Kroll does not expect the adoption of SFAS No. 149 to have
any material effect on its consolidated results of operations or financial
position.
4. Stock-Based Compensation
Kroll accounts for the cost of its employee stock options and other forms
of employee stock-based compensation plans utilizing the intrinsic value method
prescribed in APB Opinion 25 as allowed by SFAS No. 123, "Accounting for
Stock-Based Compensation". Under the intrinsic value method prescribed in APB
Opinion 25, compensation cost for stock-based compensation plans is required to
be recognized based on the difference, if any, between the fair market value of
the stock on the date of grant and the option exercise price. SFAS No. 123
established a fair value-based method of accounting for compensation cost
related to stock options and other forms of stock-based compensation plans.
However, SFAS No. 123 allows an entity to continue to measure compensation cost
using the principles of APB Opinion 25 if certain pro forma disclosures are
made.
Under APB Opinion 25, no stock-based employee compensation cost relating
to Kroll's option plans was reflected in net income, as all options granted
under its plans had an exercise price equal to the market value of the
underlying common stock on the date of grant. The following tables illustrate
the effect on net income and earnings per share if Kroll had applied the fair
value recognition provisions of SFAS No. 123 to stock-based employee
compensation:
Three Months Ended
March 31,
-----------------------
2003 2002
---------- --------
(in thousands)
Net income, as reported .............................. $11,276 $ 2,317
Deduct: Total stock-based employee
compensation expense determined under fair
value based method for all awards, net of
related tax effects ............................... 1,761 1,515
------- -------
Pro forma net income .............................. $ 9,515 $ 802
======= =======
7
Three Months Ended
March 31,
-------------------------------
2003 2002
---------- ------------
Earnings per share:
Basic
As Reported ............................. $0.28 $0.10
Pro Forma ............................... $0.24 $0.04
Diluted
As Reported ............................. $0.28 $0.10
Pro Forma ............................... $0.23 $0.03
The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following assumptions used
for grants:
Three Months Ended
March 31,
------------------------------
2003 2002
----------- -------------
Dividend yield ............................. -- --
Expected volatility ........................ 55.0% 59.0%
Risk-free interest rate .................... 3.0% 3.0%
Expected lives ............................. 5.0 years 5.0 years
5. Earnings Per Share
Pursuant to the provisions of SFAS No. 128 "Earnings Per Share", basic
earnings per share is computed by dividing net income by the weighted average
number of shares of common stock outstanding during the period. Diluted earnings
per share is computed by dividing net income by the weighted average number of
shares of common stock and common stock equivalents outstanding during the
period. Dilutive common stock equivalents represent shares issuable upon assumed
exercise of stock options and warrants and assumed issuance of restricted stock.
The beginning weighted average number of shares of common stock
outstanding for the three months ended March 31, 2003 in the following table
includes the effect of 2.9 million shares issued in January 2003 relating to the
acquisition of Zolfo Cooper, LLC ("Zolfo Cooper") on September 5, 2002, the
closing date of the acquisition (see Notes 6 and 10).
Three Months Ended
March 31,
--------------------------
2003 2002
-------- --------
(in thousands)
Weighted average shares outstanding:
Basic ................................... 40,003 22,870
Stock options ........................... 945 918
------- -------
Diluted ................................. 40,948 23,788
======= =======
At March 31, 2003, 8,719 warrants and 1,675,441 options to purchase an
equivalent number of shares of common stock of Kroll at $25.69 per warrant and a
range from $19.21 to $26.94 per
8
option were outstanding but were not included in the shares in the above table
because the warrants' and options' exercise prices were greater than the average
market price of the common shares. Also excluded from the above table is the
potential conversion of the $30.0 million 6% Convertible Notes into 2,777,777
shares of Kroll common stock, as it was determined that such conversion would
have an anti-dilutive effect on the earnings per share calculation.
At March 31, 2002, 9,526 warrants and 621,256 options to purchase an
equivalent number of shares of common stock of Kroll at a range from $19.52 to
$25.69 per warrant and a range from $17.79 to $30.75 per option were outstanding
but were not included in the shares in the above table because the warrants' and
options' exercise prices were greater than the average market price of the
common shares. Also excluded from the above table is the potential conversion of
the $30.0 million 6% Convertible Notes into 2,777,777 shares of Kroll common
stock, as it was determined that such conversion would have an anti-dilutive
effect on the earnings per share calculation.
6. Acquisitions
On January 15, 2003, Kroll issued 2.9 million shares of its common stock,
valued at approximately $55.3 million, to the former owners of Zolfo Cooper (see
Note 10).
On March 14, 2003, Kroll consummated an asset purchase agreement with
Certico Verification Services, LLC ("Certico"). Under the agreement, Kroll
acquired most of Certico's assets and assumed certain liabilities, for a
purchase price of $3.3 million paid in cash. Certico provides background
checking services and its results of operations are included within the
Background Screening Services segment subsequent to the date of acquisition.
On March 21 2003, Kroll completed the acquisition of Personnel Risk
Management ("PRM") for a purchase price of $1.4 million paid in cash. An
additional payment of up to $1.9 million will become payable after one year if
agreed upon profit levels are achieved. PRM provides pre-employment screening
services in the UK, and its results of operations are included within the
Background Screening Services segment subsequent to the date of acquisition.
Also during the first quarter of 2003, Kroll acquired the remaining 50%
equity ownership interest it did not own in Invex for a purchase price of $1.0
million in cash and invested $1.0 million in iJet. Invex, which provides
corporate financial services in the UK, is included as part of the Corporate
Advisory and Restructuring Services segment. The investment in iJet, which is an
intelligence organization focused on delivering proactive travel risk management
services and real-time alerts to travelers, expatriates, corporations,
government and non-governmental organizations, learning institutions and the
travel industry, is convertible into preferred stock of iJet upon iJet raising
additional equity financing.
7. Intangible Assets
In accordance with SFAS No. 142, "Goodwill and Other Intangible Assets",
Kroll did not record any amortization expense for goodwill during the three
months ended March 31, 2003 and 2002.
Kroll has not changed the amortization periods or ceased amortizing
intangible assets other than goodwill as a result of its review of indefinite
lived assets to date. Kroll has conducted impairment tests of the goodwill
recorded on its books as required by SFAS No. 142. These tests determined that
Kroll's recorded goodwill was not impaired as of January 1, 2002. As part of
Kroll's review of intangible assets under SFAS No. 142, certain assets were
re-evaluated at December 31, 2002. As a result of this review, Kroll determined
that these assets were not impaired at year end. Impairment tests will be
conducted annually in the third quarter, or sooner if circumstances indicate an
impairment may have taken place.
9
As of March 31, 2003, Kroll had recorded cost and accumulated amortization
for other intangible assets of $34.7 million and $7.0 million, respectively. Of
this amount, $19.5 million relates to the cost and $4.2 million relates to
accumulated amortization for acquired customer lists. An additional $12.3
million pertains to the cost and $1.3 million pertains to accumulated
amortization for internally developed software. The remaining $2.9 million and
$1.5 million of cost and accumulated amortization, respectively, is primarily
related to non-compete agreements.
Amortization expense for other intangible assets of $1.2 million and $0.2
million was recognized during the three months ended March 31, 2003 and 2002,
respectively. Approximately $20.1 million of amortization expense is anticipated
to be recognized over the next five years as follows: $5.3 million in 2004, $4.8
million in 2005, $4.1 million in 2006, $3.0 million in 2007 and $2.9 million in
2008.
8. Debt
(a) Revolving Line of Credit
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.
During the term of the credit facility, Kroll paid Foothill a fee equal to
0.375% per annum of the unused portion of the credit facility. The credit
facility required Kroll to maintain a minimum level of earnings before interest,
taxes, depreciation and amortization ("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 with Foothill. No borrowings were made under
the terminated $15 million credit facility. Concurrently, Kroll entered into a
new $100 million credit facility with Goldman Sachs that included a $25 million
revolving credit facility and a $75 million term loan (see Note 8(c) for a
discussion of the term loan portion of this facility). Kroll wrote-off financing
fees of $0.4 million related to the replacement of the Foothill revolving credit
facility during the third quarter of 2002.
The $25 million revolving credit facility with Goldman Sachs was subject
to borrowing base limitations and had a three year term. The available borrowing
amount was 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 bore interest, at Kroll's election, at a rate per annum equal to
the base rate plus applicable margin or the Eurodollar rate plus applicable
margin. The applicable margin was determined by the leverage ratio, calculated
as of the last day of any fiscal quarter as the ratio of consolidated total debt
as of that day to adjusted EBITDA for the four fiscal quarters ending on such
date.
The Goldman Sachs revolving credit facility required 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, additional indebtedness and dividends.
The Goldman Sachs revolving credit facility also required Kroll to pay a
fee equal to 0.75% per annum of the unused portion of this facility. Upon the
repayment of the term loan in October 2002 with the proceeds of Kroll's common
stock offering, this fee was reduced to 0.375% per annum (see Notes 8(c) and
10). The revolving credit facility was secured by a lien on substantially all of
Kroll's assets and those of most of Kroll's domestic subsidiaries.
On March 6, 2003, Kroll executed agreements with Fleet National Bank
("Fleet") providing a revolving credit facility of up to $25 million for a term
of three years. Kroll's obligations under the Fleet revolving credit
10
facility are guaranteed by its domestic subsidiaries. In addition, the Fleet
revolving credit facility is 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 Kroll's material domestic subsidiaries and 65% of the stock of
certain of the foreign subsidiaries of Kroll and its domestic subsidiaries.
The $25 million Goldman Sachs revolving credit facility undertaken as part
of the $100 million credit facility on September 5, 2002 was simultaneously
retired on March 6, 2003. As a result, Kroll wrote-off approximately $0.1
million of unamortized deferred financing fees relating to this facility as a
charge to operating expenses in the first quarter of 2003. There were no
borrowings made under the retired $25 million revolving credit facility.
The Company was required to cash collateralize letters of credit which had
been issued under the $25 million Goldman Sachs revolving credit facility
totaling $2.2 million. Such amount is included within other long-term assets on
the consolidated condensed balance sheet at March 31, 2003.
Borrowings under the Fleet revolving credit facility will bear interest,
at Kroll's election, at a rate per annum equal to (1) the prime rate of Fleet or
(2) LIBOR plus 2.00%. During the term of the Fleet revolving credit facility,
Kroll will pay Fleet a quarterly fee equal to 0.375% per annum of the unused
portion of the line of credit. The Fleet revolving credit facility requires
Kroll to maintain a minimum level of EBITDA and net income and maximum leverage
and liabilities requirements and contains restrictions on the incurrence of
additional debt, the creation of any liens, certain acquisitions, and
distributions to certain subsidiaries. The Fleet revolving credit facility also
contains other affirmative and negative covenants and events of default
customarily contained in debt agreements of this type. There have been no
borrowing made under this facility. At March 31, 2003, Kroll was in compliance
with all covenants and provisions of this facility.
Prior to 2002, 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 March 31,
2003, the interest rate was 5.25%. During the first quarter of 2003, maximum
borrowings permitted under the demand note decreased from 4.4 million pounds
sterling to 2.9 million pounds sterling, or $4.6 million, as translated at March
31, 2003. Borrowings outstanding under this demand note were approximately $0.1
million, as translated at March 31, 2003, a decrease of $3.7 million from the
amount included at December 31, 2002 due to repayments made during the first
quarter of 2003.
(b) Senior Convertible Notes
During 2001, Kroll obtained additional financing of $30.0 million in the
form of 6% Senior Secured Subordinated Convertible Notes due 2006 ("6%
Convertible Notes"). The notes mature 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. Kroll may redeem these convertible
notes at par plus accrued interest, in whole or in part, beginning 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
subsidiaries and the same pledge of stock of certain of Kroll's subsidiaries as
the Foothill revolving credit facility, except that the notes were subordinate
to the security interest and rights of the credit facility lender.
Kroll has an effective registration statement with the Securities and
Exchange Commission 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.
11
In connection with the issuance of the 6% Convertible 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 is being 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 average
additional non-cash interest expense resulting from this discount amortization
is approximately $2.3 million, or 7.6% per year, on the $30.0 million aggregate
principal amount. The amount of non-cash interest expense resulting from this
discount amortization during the three months ended March 31, 2003 and 2002 was
$.4 million.
On September 5, 2002, Kroll amended certain provisions of its outstanding
6% Convertible Notes. Under the amendments, the security interest of all the
noteholders was terminated and the collateral securing all of the 6% Convertible
Notes was released. In addition, the amendments deleted all of the negative
covenants in respect of all of the 6% Convertible Notes. Furthermore, Palisade,
the only note holder who had the right to designate a board observer, no longer
has this right. Palisade also agreed to subordinate the $20.0 million in
aggregate principal amount of the 6% Convertible Notes that it owned to
borrowings under the $100 million Goldman Sachs credit facility (see Notes 8(a)
and (c)). In connection with these amendments, Kroll agreed to compensate
Palisade based on the performance of Kroll's common stock, and as a result of
this agreement, paid Palisade $1.6 million in October 2002. Such amount was
recorded as an extraordinary item during the third quarter of 2002. During 2003,
any prior period extraordinary items that do not meet the criteria of APB No. 30
will be required to be reclassified to continuing operations.
(c) Long-term Note
In connection with the acquisition of Zolfo Cooper during 2002, Kroll
obtained $75 million in term loan financing through a syndicate arranged by
Goldman Sachs to be repaid under the following terms: $0.8 million by December
31, 2002, an additional $4.5 million within one year of the closing date, $18.7
million within two years of closing and the balance of $51.0 million within
three years of closing.
The term loan was part of a $100 million credit facility with Goldman
Sachs which included a $25 million revolving credit facility (see Note 8(a)).
The cost of obtaining the credit facility was being amortized over the
facility's three year life. The term loan bore interest, at Kroll's election, at
a rate per annum equal to the base rate plus applicable margin or the Eurodollar
rate plus applicable margin. The applicable margin was determined by the
leverage ratio, calculated as of the last day of any fiscal quarter as the ratio
of consolidated total debt, as of that day, to EBITDA for the four fiscal
quarters ending on such date. A provision in the term loan required that
proceeds from any equity offering be used to repay the term loan.
The term loan was repaid in October 2002 with the proceeds from Kroll's
common stock offering (see Note 10). In the fourth quarter of 2002, Kroll
wrote-off financing fees of $1.1 million associated with the repayment of the
$75 million term loan.
9. Commitments and Contingencies
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.
("Blackstone"). Five of the lawsuits were filed in the Court of Common Pleas,
Butler County, Ohio, and were consolidated on November 29, 1999. The remaining
three lawsuits were filed in the United States District Court for the Southern
District of New York and were consolidated on November 30, 1999. 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 American International Group, Inc.
("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 executed a stipulation of settlement providing
for the settlement of these actions. On December 20, 2002, the New York court
signed a Final Judgment and Order Approving the Settlement. On January 7, 2003,
the Ohio court entered a Final Judgment dismissing the Ohio action. The
Settlement included defendants' agreement not to object to plaintiffs' counsels'
application for attorneys' fees and reimbursement of costs and expenses not to
exceed $385,000 in the aggregate. Any such fees or costs approved are to be paid
by Kroll's insurance carrier.
Kroll Lindquist Avey Co. (formerly Lindquist Avey Macdonald & Baskerville
("LAMB")), 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
12
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. The parties attended
mediation on December 11 and 12, 2002, with additional dates to be scheduled in
2003. LAMB is being defended by its former carrier, the Reliance Insurance
Company. Reliance is in liquidation, and while paying all defense costs, has
advised that any claim for damages or settlement greater than $25,000 (USD) will
be a claim in the liquidation, on which distributions will be made as the
liquidation progresses. Kroll believes it may have other liability insurance
available with respect to this claim. Management of Kroll believes LAMB has
meritorious defenses to the claims and intends to defend the claims 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 there is any currently pending litigation,
individually or in the aggregate, that is likely to have a material adverse
effect on its consolidated financial position, results of operations or its cash
flows.
10. Stockholders' Equity
In October 2002, Kroll sold 6.3 million shares of its common stock to the
public in an underwritten public offering and raised approximately $110.6
million of net proceeds, including $0.2 million of accrued expenses. 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 8(c)). The
remaining proceeds were used for working capital to fund operations and other
general company purposes. Because the repayment effectively terminated the term
loan agreement, all unamortized deferred financing fees associated with this
agreement were written-off as an extraordinary item in the fourth quarter of
2002.
On January 1, 2003, Kroll issued 25,000 shares of restricted stock, valued
at approximately $0.5 million. Such amount will be amortized over the vesting
period of three years as additional compensation expense.
On January 15, 2003, Kroll issued 2.9 million shares of its common stock,
valued at approximately $55.3 million, to the former owners of Zolfo Cooper in
connection with the acquisition of Zolfo Cooper on September 5, 2002. These
shares were presented on the December 31, 2002 balance sheet under the caption
"Common shares to be issued for acquisition."
11. Supplemental Cash Flows Disclosures
The following is a summary of cash paid related to certain items:
Three Months Ended
March 31,
---------------------
2003 2002
(dollars in thousands)
Supplemental Disclosure of Cash Flow Activities:
Cash paid for interest .................................. $ 74 $ 85
======= =======
Cash paid for taxes, net of refunds ..................... $ 1,490 $ 371
Supplemental Disclosure of Non-cash Activities:
Deferred compensation related to restricted stock
issuance .............................................. $ 477 $ --
======= =======
Issuance of common shares pertaining to the Zolfo
Cooper Acquisition .................................... $55,280 $ --
======= =======
13
12. Customer and Segment Data
Kroll's reportable operating segments include the following five business
segments: Corporate Advisory and Restructuring Services, Consulting Services,
Technology Services, Background Screening Services and Security Services.
Kroll's reportable segments are organized, managed and operated along product
lines. 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 Corporate Advisory and Restructuring Services segment includes
revenues and expenses from corporate restructuring, operational turnaround,
strategic advisory services, financial crisis management and corporate finance
services.
The Consulting Services segment includes revenues and expenses from
business and financial investigations, forensic accounting, business valuation,
litigation consulting, due diligence, litigation intelligence, asset training
and analysis, monitoring and special inquiries, marketing intelligence, and
intellectual property and infringement investigations.
The Technology Services segment includes revenues and expenses from
electronic discovery, data recovery and computer forensics services, along with
related software solutions.
The Background Screening Services segment includes revenues and expenses
from pre-employment background checking, substance abuse testing and
surveillance services.
The Security Services segment includes revenues and expenses from security
architecture and design, corporate security consulting, emergency management and
environmental services as well as protective services, operations and training.
14
The following summarizes information about Kroll's business segments for
the three months ended March 31, 2003 and 2002:
Corporate
Advisory and Background Consoli-
Restructuring Consulting Technology Screening Security Other dated
------------- ---------- ---------- --------- -------- ----- --------
(In thousands)
Three Months Ended March 31, 2003
Net sales to unaffiliated customers ......... $ 39,405 $ 30,298 $ 16,911 $ 12,459 $ 5,689 $ -- $104,762
======== ======== ======== ======== ======== ======== ========
Gross profit ................................ $ 23,607 $ 13,232 $ 12,122 $ 5,826 $ 1,679 $ -- $ 56,466
======== ======== ======== ======== ======== ======== ========
Operating income (loss) ..................... $ 17,489 $ 4,418 $ 2,531 $ 1,729 $ (733) $ (6,309) $ 19,125
======== ======== ======== ======== ======== ======== ========
Identifiable assets ......................... $ 44,901 $ 58,990 $ 26,300 $ 31,597 $ 11,254 $ -- $173,042
======== ======== ======== ======== ======== ======== ========
Corporate assets ............................ 382,510
========
Total assets ................................ $555,552
========
Three Months Ended March 31, 2002
Net sales to unaffiliated customers ......... $ 10,329 $ 26,196 $ 763 $ 11,096 $ 7,632 $ -- $ 56,016
======== ======== ======== ======== ======== ======== ========
Gross profit ................................ $ 6,283 $ 10,180 $ 340 $ 5,184 $ 3,000 $ -- $ 24,987
======== ======== ======== ======== ======== ======== ========
Operating income (loss) ..................... $ 2,490 $ 3,182 $ (162) $ 2,077 $ 2,313 $ (5,406) $ 4,494
======== ======== ======== ======== ======== ======== ========
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, interest income, other income (expense) 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, Goodwill and
certain prepaid expenses.
--------------------------------------------
15
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 our Consolidated Condensed
Unaudited Financial Statements and accompanying notes thereto included elsewhere
herein.
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, 2002.
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 Kroll to provide its
clients with comprehensive, single source, risk consulting services. These five
business groups are:
o Corporate Advisory and Restructuring Services. 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 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 Technology Services. Kroll provides electronic discovery, data
recovery and computer forensics services, along with related software
solutions.
o Background Screening Services. Kroll provides pre-employment and
security background screening, substance abuse testing and
surveillance services.
16
o Security Services. Kroll provides security architecture and design,
corporate security consulting, emergency management and environmental
services as well as protective services, operations and training.
Critical Accounting Policies
Kroll's significant accounting policies, including the assumptions and
judgments underlying them, are more fully described in Kroll's annual report on
Form 10-K for the year ended December 31, 2002. Some of Kroll's accounting
policies require the application of significant judgment by management in the
preparation of the 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:
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 are recognized based upon the achievement of
certain milestones or progress points within the project plan. The impact of any
revisions in estimated total revenue and direct contract costs is recognized in
the period in which they become known. Expenses incurred by professional staff
in the generation of revenue are billed to the client and included in revenue.
Kroll records either billed or unbilled accounts receivable based on
case-by-case invoicing determinations. Software revenue is recognized when
shipped, with the exception of royalty-based products, where revenue is
recognized as applicable royalty reports are received. Software revenue is
stated net of estimated customer returns and allowances. Kroll recognizes
contingent fees as earned, i.e., upon satisfaction of all conditions to their
payment.
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 exchange rates prevailing at the balance
sheet date 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 stockholders' 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.
Accounting for intangible and long-lived assets. In accordance with SFAS
No. 142, Kroll no longer amortizes goodwill and indefinite-lived intangible
assets. Instead, Kroll conducts annual impairment tests of goodwill and
indefinite-lived intangible assets recorded on its books in order to ascertain
if an impairment has taken place. Impairment tests will be conducted sooner if
circumstances indicate that an impairment has occurred. In accordance with SFAS
No. 144, Kroll tests for impairment its long-lived assets held and used whenever
events or changes in circumstances indicate that the carrying amount of such
assets may not be recoverable. The carrying amount of a long-lived asset is not
recoverable if it exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset. An impairment loss
will be measured as the amount by which the carrying amount of a long-lived
asset exceeds its fair value. In
17
addition, in accordance with SFAS No. 144, Kroll measures long-lived assets to
be disposed of by sale, including discontinued operations, at the lower of
carrying amount or fair value less cost to sell.
Results of Operations
The following table sets forth the items noted as a percentage of total net
sales:
Three Months Ended
March 31,
------------------
2003 2002
------ -----
Net sales:
Corporate Advisory and Restructuring Services ................... 37.7% 18.4%
Consulting Services ............................................. 28.9 46.8
Technology Services ............................................. 16.1 1.4
Background Screening Services ................................... 11.9 19.8
Security Services ............................................... 5.4 13.6
----- -----
Total net sales ............................................... 100.0% 100.0%
Cost of sales ...................................................... 46.1 55.4
----- -----
Gross profit .................................................. 53.9 44.6
----- -----
Selling and marketing .............................................. 8.8 7.8
General and administrative ......................................... 22.6 28.5
Research and development ........................................... 3.0 --
Amortization of other intangible assets ............................ 1.2 0.4
----- -----
Operating expenses ............................................ 35.6 36.7
----- -----
Operating income .............................................. 18.3 7.9
Other income (expense): ----- -----
Interest expense, net ........................................... (0.8) (1.6)
Other income (expense), net .................................... -- --
----- -----
Total other income (expense) ................................ (0.8) (1.6)
----- -----
Income before provision for income taxes ...................... 17.5 6.3
Provision for income taxes ......................................... 6.7 2.2
----- -----
Net income .................................................... 10.8% 4.1%
===== =====
18
Three Months Ended March 31, 2003 Compared to Three Months Ended March 31, 2002
Net sales. Net sales increased $48.8 million, or 87.0%, from $56.0 million
in the three months ended March 31, 2002 to $104.8 million in the three months
ended March 31, 2003.
Corporate Advisory and Restructuring Services - Net sales for the
Corporate Advisory and Restructuring Services segment increased $29.1 million,
or 281.5%, from $10.3 million for the three months ended March 31, 2002 to $39.4
million for the three months ended March 31, 2003. This increase is due to a
32.8% increase in revenues from Kroll's European recovery and turnaround
division and the inclusion of Kroll Zolfo Cooper . (Zolfo Cooper was acquired on
September 5, 2002). Kroll Zolfo Cooper recognized $3.4 million of success fees
during the three months ended March 31, 2003.
Consulting Services - Net sales for the Consulting Services segment
increased $4.1 million, or 15.7%, from $26.2 million for the three months ended
March 31, 2002 to $30.3 million for the three months ended March 31, 2003. This
increase was primarily due to higher revenues in Europe (44%) and in the United
States (43%). The increase in Europe was due to strong demand for our financial
and investigative services. The increase in the United States was due to strong
demand for our forensic and litigation support services. Asia also had growth,
but their increase of 12% was less than the consulting services average.
Offsetting these regions' growth were decreases in revenue in our Canadian and
Latin American operations of 13% and 6%, respectively.
Technology Services - Net sales for the Technology Services segment
increased $16.1 million from $0.8 million for the three months ended March 31,
2002 to $16.9 million for the three months ended March 31, 2003. This increase
is due to the inclusion of Kroll Ontrack. Ontrack was acquired on June 13, 2002.
Background Screening Services - Net sales for the Background Screening
Services segment increased $1.4 million, or 12.3%, from $11.1 million for the
three months ended March 31, 2002 to $12.5 million for the three months ended
March 31, 2003. This increase was primarily the result of an increase of 16% in
the demand for our domestic pre-employment background checking services and an
increase of 12% in our Laboratory testing services. These increases were
partially offset by a decrease of 24% in our surveillance services company.
Security Services - Net sales for the Security Services segment decreased
$1.9 million, or 25.5%, from $7.6 million for the three months ended March 31,
2002 to $5.7 million for the three months ended March 31, 2003. This decrease
was primarily the result of a decrease in corporate activity due to the current
domestic economic environment and a delay in the issuance of additional
government contracts.
Cost of sales and gross margin. Cost of sales increased $17.3 million, or
55.6%, from $31.0 million for the three months ended March 31, 2002 to $48.3
million for the three months ended March 31, 2003. Gross margin as a percentage
of sales increased 9.3 percentage points from 44.6% for the three months ended
March 31, 2002 to 53.9% for the three months ended March 31, 2003.
Corporate Advisory and Restructuring Services - Gross margin for the
Corporate Advisory and Restructuring Services segment decreased 0.9 percentage
points from 60.8% for the three months ended March 31, 2002 to 59.9% for the
three months ended March 31, 2003. This was primarily attributable to higher
professional expenses incurred to handle our increased case load. This was
partially offset by the recognition of $3.4 million in success fees during the
first quarter of 2003.
Consulting Services - Gross margin for the Consulting Services segment
increased 4.8 percentage points from 38.9% for the three months ended March 31,
2002 to 43.7% for the three months ended March 31, 2003. This was primarily
attributable to increased utilization in our domestic and European consulting
businesses, which was driven by new business and cross-selling within Kroll's
Corporate Advisory and Restructuring Services segment.
19
Technology Services - Gross margin for the Technology Services Segment
increased 27.1 percentage points from 44.6% for the three months ended March 31,
2002 to 71.7% for the three months ended March 31, 2003. This increase is
primarily due to the inclusion of Ontrack. Ontrack was acquired on June 13,
2002.
Background Screening Services - Gross margin for the Background Screening
Services segment increased 0.1 percentage points from 46.7% for the three months
ended March 31, 2002 to 46.8% for the three months ended March 31, 2003. This
increase was primarily attributable to increased margins in our domestic
pre-employment background checking business.
Security Services - Gross margin for the Security Services segment
decreased 9.8 percentage points from 39.3% for the three months ended March 31,
2002 to 29.5% for the three months ended March 31, 2003. This decrease is
primarily attributable to the 25.5% decrease in revenues in the first quarter of
2003.
Operating expenses. Operating expenses increased $16.8 million, or 82.2%,
from $20.5 million for the three months ended March 31, 2002 to $37.3 million
for the three months ended March 31, 2003. This increase is primarily due to the
inclusion of the operating expenses for Ontrack and Kroll Zolfo Cooper for the
three months ended March 31, 2003. Ontrack and Zolfo Cooper were acquired on
June 13, 2002 and September 5, 2002, respectively.
As a percent of net sales, selling, general and administrative expenses
decreased 4.7 percentage points from 36.2% for the three months ended March 31,
2002 to 31.5% for the three months ended March 31, 2003.
Interest expense, net. Interest expense, net decreased $0.1 million during
the three months ended March 31, 2003 due to interest earnings from larger
short-term investments made possible by our increased cash position.
Provision for income taxes. The provision for income taxes increased $5.8
million from $1.2 million for the three months ended March 31, 2002 to $7.1
million for the three months ended March 31, 2003. The increase in the provision
for income taxes is due to higher pre-tax income and an increase in our
effective income tax rate. The increase in the effective tax rate was caused
primarily by the benefit realized in 2002 from the utilization of our tax loss
carry forwards during the period.
Net income. Net income improved $9.0 million from $2.3 million for the
three months ended March 31, 2002 to $11.3 million for the three months ended
March 31, 2003 as a result of the above mentioned items.
20
Liquidity and Capital Resources
General
Kroll historically has met its operating cash needs by utilizing
borrowings under its credit arrangements to supplement cash provided by
operations.
Kroll currently believes that cash on hand, cash flows from operations and
available borrowings under its credit facility will be sufficient to meet its
current funding requirements and obligations.
Cash Flows
Cash flows from operating activities. Operating activities provided $17.7
million during the three months ended March 31, 2003, compared with $1.0 million
provided from operating activities during the three months ended March 31, 2002.
The $16.7 million increase reflects strong sales growth from existing operations
and contributions from strategic acquisitions completed during 2002. In
addition, $5.2 million of cash was used to fund working capital investments in
the 2002 period, compared with $0.3 million used to fund working capital
investments in the 2003 period.
Cash flows used in investing activities. Investing activities used $10.2
million during the three months ended March 31, 2003, compared with $2.4 million
used in investing activities during the three months ended March 31, 2002. In
the 2002 period, $0.9 million was used for capital expenditures, $1.1 million
was used for database additions and $0.4 million was used for intangible assets,
compared with $1.9 million used for capital expenditures, $1.2 million used for
database additions and $3.1 million used for intangible assets in the 2003
period. The $3.1 million used for intangible assets in the 2003 period resulted
primarily from the acquisition of Certico on March 14, 2003. In addition,
acquisitions, net of cash acquired, amounted to $2.5 million and other
investments amounted to $1.5 million in the 2003 period.
Cash flows from (used in) financing activities. Financing activities used
$5.3 million during the three months ended March 31, 2003, compared with $1.0
million provided from financing activities during the three months ended March
31, 2002. In the 2002 period, Kroll's net borrowings of debt provided $0.5
million, compared to payments on debt of $3.5 million in the 2003 period. In
2003, Kroll paid additional financing fees of $0.5 million and segregated $2.2
million to cash-collateralize certain obligations until additional financing was
completed. In addition, $0.8 million was provided from the exercise of stock
options in the 2002 period, compared with $0.6 million provided from the
exercise of stock options and $0.6 million provided from Kroll's Employee Stock
Purchase Plan contributions in the 2003 period.
Revolving Line of Credit
On March 6, 2003, Kroll executed agreements with Fleet providing a
revolving credit facility of up to $25 million for a term of three years.
Kroll's obligations under the Fleet revolving credit facility are guaranteed by
its domestic subsidiaries. In addition, the Fleet revolving credit facility is
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 Kroll's material
domestic subsidiaries and 65% of the stock of certain of the foreign
subsidiaries of Kroll and its domestic subsidiaries.
The $25 million Goldman Sachs revolving credit facility undertaken as part
of a $100 million credit facility on September 5, 2002 was simultaneously
retired on March 6, 2003. As a result, Kroll wrote-off approximately $0.1
million of unamortized deferred financing fees relating to this facility as a
charge to operating expenses in the first quarter of 2003. There were no
borrowings made under the retired $25 million revolving credit facility.
21
The Company was required to cash collateralize letters of credit which had
been issued under the $25 million Goldman Sachs revolving credit facility
totaling $2.2 million. Such amount is included within other long-term assets on
the consolidated condensed balance sheet at March 31, 2003.
Borrowings under the Fleet revolving credit facility will bear interest,
at Kroll's election, at a rate per annum equal to (1) the prime rate of Fleet or
(2) LIBOR plus 2.00%. During the term of the Fleet revolving credit facility,
Kroll will pay Fleet a quarterly fee equal to 0.375% per annum of the unused
portion of the line of credit. The Fleet revolving credit facility requires
Kroll to maintain a minimum level of EBITDA and net income and maximum leverage
and liabilities requirements and contains restrictions on the incurrence of
additional debt, the creation of any liens, certain acquisitions, and
distributions to certain subsidiaries. The Fleet revolving credit facility also
contains other affirmative and negative covenants and events of default
customarily contained in debt agreements of this type. There have been no
borrowing made under this facility. At March 31, 2003, Kroll was in compliance
with all covenants and provisions of this facility.
During the first quarter of 2003, maximum borrowings permitted under a
demand note acquired by Kroll in connection with the acquisition of Buchler
Philips in 1999 decreased from 4.4 million pounds sterling to 2.9 million pounds
sterling, or $4.6 million, as translated at March 31, 2003. The demand note
bears interest at the Bank of England's base rate plus 1.5%. At March 31, 2003,
the interest rate was 5.25%. Borrowings outstanding under this demand note were
approximately $0.1 million, as translated at March 31, 2003, a decrease of $3.7
million from the amount included at December 31, 2002 due to repayments made
during the first quarter of 2003.
Senior Convertible Notes
The $30.0 million aggregate principal amount of 6% Convertible Notes due
2006 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. Kroll may
redeem these convertible notes at par plus accrued interest, in whole or in
part, beginning 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.
Kroll has an effective registration statement with the Securities and
Exchange Commission 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.
Acquisitions
On January 15, 2003, Kroll issued 2.9 million shares of its common stock,
valued at approximately $55.3 million, to the former owners of Zolfo Cooper (see
Note 10 of the Notes to the consolidated condensed unaudited financial
statements.)
On March 14, 2003, Kroll consummated an asset purchase agreement with
Certico. Under the agreement, Kroll acquired most of Certico's assets and
assumed certain liabilities, for a purchase price of $3.3 million paid in cash.
Certico provides background checking services and its results of operations are
included within the Background Screening Services segment subsequent to the date
of acquisition.
On March 21, 2003, Kroll completed the acquisition of PRM for a purchase
price of $1.4 million paid in cash. An additional payment of up to $1.9 million
will become payable after one year if agreed upon profit levels are achieved.
PRM provides pre-employment screening services in the UK, and its results of
operations are included within the Background Screening Services segment
subsequent to the date of acquisition.
22
Also during the first quarter of 2003, Kroll acquired the remaining 50%
equity ownership interest it did not own in Invex for a purchase price of $1.0
million in cash and invested $1.0 million in iJet. Invex, which provides
corporate financial services in the UK, is included as part of the Corporate
Advisory and Restructuring Services segment. The investment in iJet, which is an
intelligence organization focused on delivering proactive travel risk management
services and real-time alerts to travelers, expatriates, corporations,
government and non-governmental organizations, learning institutions and the
travel industry, is convertible into preferred stock of iJet upon iJet raising
additional equity financing.
Kroll's contractual obligations were comprised of the following as of
March 31, 2003:
Payments due by Period
---------------------------------------------------------------------------
Contractual Obligation After
Total Within 1 Year 2-3 Years 4-5 Years 5 Years
------- ------------- --------- --------- --------
(dollars in thousands)
Long-term debt ............................... $30,089 $ 64 $ 25 $30,000 $ --
Operating leases ............................. 59,303 13,489 22,017 16,697 7,100
Other long-term obligations .................. 1,000 250 500 250 --
------- ------- ------- ------- -------
Total ..................................... $90,392 $13,803 $22,542 $46,947 $ 7,100
======= ======= ======= ======= =======
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.
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.
Recent Accounting Pronouncements
On January 1, 2003, Kroll adopted SFAS No. 143, "Accounting for Asset
Retirement Obligations." SFAS 143 addresses financial accounting and reporting
for obligations and costs associated with the retirement of tangible long-lived
assets. The adoption of SFAS No. 143 did not have any material impact on Kroll's
consolidated results of operations or financial position.
On January 1, 2003, Kroll adopted the SFAS No. 145, "Rescission of FASB
Statements Nos. 4, 44 and 64, Amendment of FASB Statement No. 13 and Technical
Corrections". This statement eliminates the automatic classification of gains or
losses on the extinguishment of debt as an extraordinary item of income and
requires that such gains or losses be evaluated for extraordinary classification
under the criteria of APB No. 30 "Reporting Results of Operations". In addition,
any prior period extraordinary items that do not meet the criteria of APB No. 30
will be required to be reclassified to continuing operations. This statement
also requires sales-leaseback accounting for certain modifications that have
economic effects that are similar to sales-leaseback transactions, and makes
various other technical corrections to existing pronouncements.
On January 1, 2003, Kroll adopted the SFAS No. 146, "Accounting for Costs
Associated with Exit or Disposal Activities". SFAS No. 146 supersedes 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)" and 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.
23
In December 2002, the FASB issued SFAS No. 148, "Accounting for
Stock-Based Compensation - Transition and Disclosure - an amendment of FASB
Statement No. 123". SFAS No. 148 amends SFAS Nos. 123, "Accounting for
Stock-Based Compensation", to provide alternative methods of transition for a
voluntary change to the fair value based method of accounting for stock-based
employee compensation. In addition, this statement amends the disclosure
requirements of SFAS No. 123 to require prominent disclosures in both annual and
interim financial statements about the method of accounting for stock-based
employee compensation and the effect of the method used in reporting results.
Management complied with the additional annual and interim disclosure
requirements effective December 31, 2002 and March 31, 2003, respectively.
In November 2002, the FASB issued Interpretation No. 45, "Guarantor's
Accounting and Disclosure Requirements for Guarantees, Including Indirect
Guarantees of Indebtedness of Others, an Interpretation of FASB Statements Nos.
5, 57, and 107 and Rescission of FASB Interpretation No. 34" ("FIN No. 45"). FIN
No. 45 requires that upon issuance of a guarantee, an entity must recognize a
liability for the fair value of the obligation it assumes under that obligation.
This interpretation is intended to improve the comparability of financial
reporting by requiring identical accounting for guarantees issued with
separately identified consideration and guarantees issued without separately
identified consideration. For Kroll, the initial recognition and measurement
provisions of FIN No. 45 applicable to guarantees issued or modified after
December 31, 2002 did not have any impact on its consolidated results of
operations or financial condition. Kroll adopted the additional disclosure
provisions of FIN No. 45 effective December 31, 2002.
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," which addresses consolidation by business
enterprises of variable interest entities ("FIN No. 46"). In general, a variable
interest entity is a corporation, partnership, trust, or any other legal
structure used for business purposes that either (a) does not have equity
investors with voting rights or (b) has equity investors that do not provide
sufficient financial resources for the entity to support its activities. A
variable interest entity often holds financial assets, including loans or
receivables, real estate or other property. A variable interest entity may be
essentially passive or it may engage in research and development or other
activities on behalf of another company. The objective of FIN No. 46 is not to
restrict the use of variable interest entities but to improve financial
reporting by companies involved with variable interest entities. Until now, a
company generally has included another entity in its consolidated financial
statements only if it controlled the entity through voting interests. FIN No. 46
changes that by requiring a variable interest entity to be consolidated by a
company if that company is subject to a majority of the risk of loss from the
variable interest entity's activities or entitled to receive a majority of the
entity's residual returns or both. The consolidation requirements of FIN No. 46
apply immediately to variable interest entities created after January 31, 2003
and the first fiscal year or interim period beginning after June 15, 2003 for
older entities. Certain of the disclosure requirements apply in all financial
statements issued after January 31, 2003, regardless of when the variable
interest entity was established. Kroll adopted the additional disclosure
provisions of FIN No. 46 effective December 31, 2002 and the consolidation
requirements of FIN No. 46 to variable interest entities created after January
31, 2003, the effect of which did not have any impact on Kroll's consolidated
results of operations or financial condition. Kroll does not expect the adoption
of FIN No. 46 to older entities to have a material effect on its consolidated
results of operations or financial position.
On April 30, 2003, the FASB issued SFAS No. 149, "Amendment of SFAS No.
133 on Derivative Instruments and Hedging Activities." The Statement amends and
clarifies accounting for derivative instruments, including certain derivative
instruments embedded in other contracts, and for hedging activities under SFAS
No. 133. This Statement is effective for contracts entered into or modified
after June 30, 2003, except as stated below, and for hedging relationships
designated after June 30, 2003. The guidance should be applied prospectively.
The provisions of this Statement that relate to SFAS No. 133 Implementation
Issues that have been effective for fiscal quarters that began prior to June 15,
2003, should continue to be applied in accordance with their respective
effective dates. In addition, certain provisions relating to forward purchases
or sales of when-issued securities or other securities that do not yet exist,
should be applied to existing contracts as well as new contracts entered into
after June 30, 2003. Kroll does not expect the adoption of SFAS No. 149 to have
any material effect on its consolidated results of operations or financial
position.
24
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK
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 below its fair value as the convertible
price of the Company's 6% Convertible Notes is below the current market price of
its common stock.
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.
25
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.
26
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.
("Blackstone"). Five of the lawsuits were filed in the Court of Common Pleas,
Butler County, Ohio, and were consolidated on November 29, 1999. The remaining
three lawsuits were filed in the United States District Court for the Southern
District of New York and were consolidated on November 30, 1999. 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 American International Group, Inc.
("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 executed a stipulation of settlement providing
for the settlement of these actions. On December 20, 2002, the New York court
signed a Final Judgment and Order Approving the Settlement. On January 7, 2003,
the Ohio court entered a Final Judgment dismissing the Ohio action. The
Settlement included defendants' agreement not to object to plaintiffs' counsels'
application for attorneys' fees and reimbursement of costs and expenses not to
exceed $385,000 in the aggregate. Any such fees or costs approved are to be paid
by Kroll's insurance carrier.
For information on other pending litigation, please see Kroll's Annual
Report on Form 10-K for the year ended December 31, 2002.
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 there is any currently pending litigation,
individually or in the aggregate, that is likely to have a material adverse
effect on its business, financial position, results of operations or cash flows.
ITEM 2. CHANGES IN SECURITIES AND USE OF PROCEEDS
Kroll's revolving credit facility described Under "Management's Discussion
and Analysis of Financial Condition and Results of Operations" includes negative
and financial covenants which, among other things, prohibit the payment of cash
dividends by the Company except in certain limited circumstances, require the
Company to maintain a minimum level of EBITDA, net income and domestic assets
and meet leverage and net worth ratios.
27
ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K
(a) Exhibits
Exhibit
Number Description
------ -----------
3.1 Amended and Restated Certificate of Incorporation of Kroll Inc.
(previously filed as Exhibit 3.4 to Kroll Inc.'s Post-Effective
Amendment No. 1 on Form S-3 to Form S-1 (Reg. No. 222-75972), as
filed with the SEC on May 3, 2002 (the "Post-Effective Amendment").
3.2 Amended and Restated By-laws of the Registrant (previously filed as
Exhibit 3.4 to the Post-Effective Amendment).
4.1 Securities Purchase Agreement, dated as of November 14, 2001, by and
among Palisade Concentrated Equity Partnership, L.P., Pegasus
Partners II, L.P. and Kroll Inc. (previously filed as Exhibit 4.1 to
Kroll Inc.'s Current Report on Form 8-K as filed with the SEC on
November 20, 2001 (the "November 8-K")).
4.2 Registration Rights Agreement, dated as of November 14, 2001, by and
among Palisade Concentrated Equity Partnership, L.P., Pegasus
Partners II, L.P. and Kroll Inc. (previously filed as Exhibit 4.2 to
the November 8-K).
4.3 Form of Senior Secured Subordinated Convertible Note (previously
filed as Exhibit 4.3 to the November 8-K).
4.4 Security Agreement, dated as of November 14, 2001, by and among
Palisade Concentrated Equity Partnership, L.P., as collateral agent
and Kroll Inc. (previously filed as Exhibit 4.5 to the November 8-K).
4.5 Pledge Agreement, dated as of November 14, 2001, by and among Kroll
Inc. to Palisade Concentrated Equity Partnership, L.P., as collateral
agent (previously filed as Exhibit 4.4 to the November 8-K).
4.6 Form of Intercreditor and Subordination Agreement by and among
Foothill Capital Corporation, Palisade Concentrated Equity
Partnership, L.P. and Pegasus Partners II, L.P. (previously filed as
Exhibit 4.6 to Kroll Inc.'s Registration Statement on Form S-1 (Reg.
No. 333-75972), as filed with the SEC on December 26, 2001 (the
"S-1")).
4.7 Termination, Amendment and Consent Agreement by and between Kroll
Inc. and Palisade Concentrated Equity Partnership, L.P. (previously
filed as Exhibit 10.3 to Kroll Inc.'s Current Report on Form 8-K as
filed with the SEC on September 5, 2002 (the "September 8-K)).
4.8 Registration Rights Agreement, dated as of September 5, 2002, by and
among the members of Zolfo Cooper, LLC., the stockholders of Zolfo
Cooper Holdings, Inc. and Kroll Inc. (previously filed as Exhibit 4.1
to the September 8-K).
10.1 Employment Agreement, dated March 13, 2003, between Kroll Inc. and
Jules B. Kroll (previously filed as Exhibit 10.7 to the 10-K).*
10.2 Loan and Security Agreement dated as of February 15, 2002, by and
among Kroll Inc. and each of its subsidiaries that is a signatory
thereto, as Borrowers, and Foothill Capital Corporation, as Lender
(previously filed as Exhibit 99.1 to the Company's Current Report on
Form 8-K filed with the SEC on March 1, 2002 (the "March 2002 8-K)).
28
Exhibit
Number Description
------ -----------
10.3 Stock Pledge Agreement dated as of February 15, 2002, by and among
Kroll Inc., Kroll Holdings, Inc. LAMB Acquisition, Inc., Kroll
Holdings SA, Laboratory Specialists of America, Inc., US Holdings,
Inc., Kroll Associates, Inc. and Foothill Capital Corporation
(previously filed as Exhibit 99.2 to the March 2002 8-K).
10.4 Form of $75 Million Term Loan Note by and among Goldman Sachs Credit
Partners L.P. and Kroll Inc. (previously filed as Exhibit 4.2 to the
September 8-K).
10.5 Form of Revolving Loan Note by and among Goldman Sachs Credit
Partners L.P. and Kroll Inc. (previously filed as Exhibit 4.3 to the
September 8-K).
10.6 Credit and Guaranty Agreement by and among Goldman Sachs Credit
Partners L.P. and Kroll Inc. (previously filed as Exhibit 10.1 to the
September 8-K).
10.7 Pledge and Security Agreement by and among Goldman Sachs Credit
Partners L.P. and Kroll Inc. (previously filed as Exhibit 10.2 to the
September 8-K).
10.8 Loan Agreement dated as of March 6, 2003, by and between Kroll Inc.
and Fleet National Bank, as Lender (previously filed as Exhibit 99.1
to the Registrant's Current Report on Form 8-K as filed with the SEC
on March 7 (the "March 2003 8-K")).
10.9 Pledge Agreement dated as of March 6, 2003, by and among Kroll Inc.
each of its subsidiaries that is a signatory thereto and Fleet
National Bank (previously filed as Exhibit 99.2 to the March 2003
8-K).
10.10 Security Agreement dated as of March 6, 2003 by and among Kroll Inc.,
each of its subsidiaries that is a signatory thereto and Fleet
National Bank (previously filed as Exhibit 99.3 to the March 2003
8-K).
10.11 Trademark Security Agreement dated as of March 6, 2003 by and among
Kroll Inc., each of its subsidiaries that is a signatory thereto and
Fleet National Bank (previously filed as Exhibit 99.4 to the March
2003 8-K).
10.12 Revolving Credit Note dated as of March 6, 2003 by Kroll Inc. in
favor of Fleet National Bank (previously filed as Exhibit 99.5 to the
March 2003 8-K).
10.13 Guaranty dated as of March 6, 2003 by each of the subsidiaries that
is a signatory thereto in favor of Fleet National Bank (previously
filed as Exhibit 99.6 to the March 2003 8-K).
99.1 Certification of Chief Executive Officer
99.2 Certification of Chief Financial Officer
- ------------------
* Executive compensation agreement.
29
(b) Reports on Form 8-K:
During the quarter ended March 31, 2003, Kroll filed the following
current report on Form 8-K:
Date of Report: March 6, 2003 (filed on March 7, 2003); Items 5 and
7.
30
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 12th day of May, 2003.
Kroll Inc.
By: /s/ Steven L. Ford
-------------------------------
Steven L. Ford
Executive Vice President and
Chief Financial Officer
31
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 we 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: May 12, 2003
By: /s/ Michael G. Cherkasky
-----------------------------
Michael G. Cherkasky,
Chief Executive Officer
32
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 we 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: May 12, 2003
By: /s/ Steven L. Ford
--------------------------
Steven L. Ford,
Chief Financial Officer
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