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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT OF 1934
For the fiscal year ended December 31, 1998
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(D) OF
THE SECURITIES EXCHANGE ACT of 1934
For the transition period from
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COMMISSION FILE NUMBER 000-21629
THE KROLL-O'GARA COMPANY
(Exact name of registrant as specified in its charter)
OHIO 31-1470817
(State or other jurisdiction (I.R.S. Employer
of incorporation) Identification No.)
9113 LESAINT DRIVE
FAIRFIELD, OHIO 45014
(513) 874-2112
(Address, including zip code, and telephone number, including area code, of
registrant's principal executive offices)
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act: Common Stock,
$.01 par value
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 if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment of this
Form 10-K [ ]
The aggregate market value of the Common Stock of the registrant held by
non-affiliates of the registrant was approximately $452,736,538 as of March 9,
1999. As of March 9, 1999, 20,844,398 shares of Common Stock were outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Part III information either will be incorporated by reference from
Kroll-O'Gara's Proxy Statement for its 1999 Annual Meeting of Shareholders or
will be filed by amendment no later than April 30, 1999.
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PART I
ITEM 1. BUSINESS
GENERAL
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The Kroll-O'Gara Company is a leading global provider of a broad range of
specialized products and services that are designed to provide solutions to a
variety of security needs. Worldwide, governments, businesses and individuals
increasingly are recognizing the need for products and services that mitigate
the growing risks associated with fraud, electronic threats, physical threats
and uninformed decisions based upon incomplete or inaccurate information.
Through its network of 60 offices located in 19 countries, Kroll-O'Gara is
meeting these needs by providing information, analysis, training, advice and
products to its customers.
Kroll-O'Gara's operations are divided among the following four business
segments:
Investigations and Intelligence. Kroll-O'Gara's Investigations and
Intelligence Group provides: (1) financial services, including forensic
accounting, asset tracing services and pre-acquisition due diligence; (2)
business investigations and intelligence, including litigation support,
monitoring, and intellectual property infringement investigations; (3)
corporate services, including pre-employment background checking, drug
testing, surveillance and vendor integrity programs; (4) corporate
security, including security architecture and planning; and (5) computer
forensics.
Security Products and Services. Kroll-O'Gara's Security Products and
Services Group provides: (1) armored products, including ballistic and
blast protected armoring systems for commercial and military vehicles,
aircraft and missile components; and (2) security services, including
advanced driver training, force protection training and risk and crisis
management.
Information Security. Kroll-O'Gara's Information Security Group
provides objective information security services, including (1) network and
system security review and repair; (2) product assessment; (3) the creation
and implementation of security policies; (4) architecture and design; and
(5) training.
Voice and Data Communications. Kroll-O'Gara's Voice and Data
Communications Group (1) resells satellite communication and navigation
equipment through a network of over 1200 distributors around the world; (2)
sells airtime for satellite telephones; and (3) designs and installs
integrated satellite communication systems in vehicles for use in areas of
the world without reliable communication services and for those with
specific secure communication needs.
Kroll-O'Gara has pursued a strategy of aggressive growth and has completed
numerous acquisitions, particularly during 1997 and 1998. Some of these
acquisitions have been accounted for as poolings of interest. Kroll-O'Gara's
consolidated financial statements and the other financial information presented
in this annual report have been restated to include these businesses as if they
always had been a part of Kroll-O'Gara. As a result, period-to-period
comparability is not affected by these acquisitions. Other acquisitions have
been accounted for as purchases. The financial results of these businesses are
included in Kroll-O'Gara's results from the effective date of each acquisition
forward. Therefore, period-to-period comparability is affected by these
acquisitions. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations" for a chart which provides information on
Kroll-O'Gara's acquisitions.
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PRODUCTS AND SERVICES
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The following table presents the net sales of Kroll-O'Gara's products and
services by Group for the periods indicated (in thousands):
YEAR ENDED DECEMBER 31,
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1996 1997 1998
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Security Products and Services Group........................ $ 79,156 $105,557 $136,844
Investigations and Intelligence Group....................... 77,992 83,109 110,232
Information Security Group.................................. -- -- 116
Voice and Data Communications Group......................... 7,770 17,437 17,653
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$164,918 $206,103 $264,845
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In addition to the information presented above, see the Notes to
Kroll-O'Gara's Consolidated Financial Statements, included elsewhere in this
annual report, for business segment data and for information concerning foreign
and domestic operations and export sales.
SECURITY PRODUCTS AND SERVICES GROUP
The Security Products and Services Group has three product categories: (1)
commercial products; (2) military products; and (3) security services. Net sales
for the Security Products and Services Group totaled $136.8 million for fiscal
year 1998. The following table presents the aggregate net sales for each of the
three product categories for the periods indicated.
YEAR ENDED DECEMBER 31,
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1996 1997 1998
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Commercial products......................................... $ 18,304 $ 54,541 $ 67,594
Military products........................................... 54,596 43,719 59,839
Security services........................................... 6,256 7,297 9,411
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$ 79,156 $105,557 $136,844
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COMMERCIAL PRODUCTS
Kroll-O'Gara armors a variety of vehicles, including limousines, sedans,
sport utility vehicles, commercial trucks and money transport vehicles, to
protect against varying degrees of ballistic and blast threats. The armoring
process begins with the disassembly of a base vehicle which is purchased new
from a dealership or directly from the factory. This disassembly normally
involves the removal of the interior trim, seats, doors and windows. The
passenger compartment then is armored with both opaque armor (metallic, fibrous
and ceramic materials) and transparent armor (glass/plastic laminate). Other
features, such as run flat tires and non-exploding gas tanks, also may be added.
Finally, the vehicle is reassembled as close to its original appearance as
possible. The types of commercial products produced by Kroll-O'Gara are
described below. During 1998, Kroll-O'Gara shipped approximately 990 commercial
armored vehicles.
Armored vehicles. Kroll-O'Gara produces fully armored vehicles and light
armored vehicles. Fully armored vehicles, such as limousines, large sedans (such
as a Cadillac, Mercedes Benz S600 or Volvo S90) or sport utility vehicles (such
as the GMC/Chevrolet Suburban), typically are armored to protect against attacks
from military assault rifles such as AK-47s and M16s and from certain underbody
explosives. These vehicles also can be blast protected by enhancing the
ballistic and underbody protection with proprietary materials and installation
methods that protect the occupants against a defined blast threat.
Blast-protected vehicles defend against threats such as pipe bombs attached to
the exterior of the vehicle and nondirectional charges of 20 kg of TNT detonated
approximately five meters from the vehicle. Fully armored vehicles typically
sell for $70,000 to $200,000 exclusive of the cost of the base vehicle.
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Fully armored vehicles also include Parade Cars, which are formal
limousines used predominantly for official functions by a president or other
head of state. These vehicles are usually customized based upon a commercially
available chassis which Kroll-O'Gara essentially rebuilds from the ground up.
Because the threat of organized assassination attempts is greater for heads of
state, these vehicles normally incorporate more advanced armor and sophisticated
protection systems. They usually have special features such as supplemental air
and oxygen systems, air purification systems to protect against chemical or
biological contamination, underbody fire suppressant systems, tear gas
launchers, anti-explosive self-sealing fuel tanks, electric deadbolt door locks,
gun ports and bomb scanners. Parade Cars normally sell for $300,000 to in excess
of $1.0 million inclusive of the cost of the base vehicle.
Light armored vehicles are similar in all respects to fully armored
vehicles except that substantially less total- weight of armoring is added.
Therefore, it is possible to armor smaller vehicles such as the Volkswagen Jetta
and the General Motors Omega, as well as larger vehicles such as the Mercedes
Benz S600 and the Jeep Cherokee. Light armored vehicles are designed to protect
against attacks from handguns, such as a 9 mm or .357 Magnum. The price of a
light armored vehicle ranges from $5,000 to $60,000 exclusive of the cost of the
base vehicle.
Other vehicles. Kroll-O'Gara also produces specialty vehicles,
cash-in-transit money transport vehicles and commercial truck bodies. Specialty
vehicles are custom built for a specific mission, such as Escort Cars (usually a
convertible) and Chase Cars (usually a closed-top vehicle) in which security
personnel ride while in a head of state motorcade. Cash-in-transit vehicles are
used by banks or other businesses to transport currency and other valuables.
After starting with a van or small truck, Kroll-O'Gara modifies the base vehicle
to provide protection for the cargo and passengers from ballistic and blast
threats. Kroll-O'Gara believes that conditions in many emerging growth countries
will promote high demand for these vehicles. Kroll-O'Gara also builds commercial
truck bodies. The truck bodies are manufactured primarily for 3.5 ton trucks and
are installed on chassis produced by a variety of manufacturers.
MILITARY PRODUCTS
Up-Armored HMMWVs. Kroll-O'Gara is the prime contractor to the U.S.
Military for the supply of armoring and blast protection for High Mobility
Multi-Purpose Wheeled Vehicles, commonly known as HMMWVs. The HMMWV chassis are
produced by AM General Corporation and shipped directly to Kroll-O'Gara's
facility in Fairfield, Ohio where armor and blast protection components are
added. These Up-Armored HMMWVs provide exterior protection against 7.62 mm
armor-piercing ammunition (such as that fired by the AK-47 military assault
rifle), overhead airburst protection against a 155 mm shell, front underbody
blast protection against a 12 lb. anti-tank mine and rear underbody blast
protection against a 4 lb. antipersonnel mine. In addition, Kroll-O'Gara
installs other features designed to enhance crew safety, comfort and
performance, such as air conditioning, weapon turrets and mounts, door locks and
shock-absorbing seats. Kroll-O'Gara charges its customers $70,000 to $110,000
for these ballistic and blast protective systems, which is in addition to the
cost of the vehicle. During 1998, Kroll-O'Gara shipped 460 Up-Armored HMMWVs.
Kroll-O'Gara also supplies engineering design and prototype services in support
of the Up-Armored HMMWV Program, supplies spare parts and logistic support and
produces field- installable armoring kits.
Other armor systems. Kroll-O'Gara markets armor sub-systems for other
tactical wheeled vehicles, such as .5 ton and 5.0 ton trucks. Kroll-O'Gara also
produces various armor systems as a subcontractor to larger defense contractors,
such as Lockheed Martin Corporation and The Boeing Company. These products
include armor for containers for fuels and missile launchers and for pilot
protection, and typically involve the use of materials or methods which are
unique to Kroll-O'Gara.
SECURITY SERVICES
Kroll-O'Gara provides a variety of services designed to protect and help
its clients manage risks and respond to crisis situations. These services
include training and risk and crisis management.
Training. Kroll-O'Gara offers comprehensive training programs in advanced
driving, ballistics, security and counterintelligence, and surveillance.
Kroll-O'Gara utilizes various facilities around the world, including its
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Force Protection Institute in San Antonio, Texas and its newest facility in
Mexico City. Kroll-O'Gara offers ballistics training in a progressive and
realistic 360 degree, .223 caliber ballistic shooting house, encompassing 6,800
square feet of training space, at its facility near Washington, DC. Ballistics
training consists of a wide spectrum of combat marksmanship skills which focuses
on realistic situations, exposing students to stress while under difficult
firing situations. Kroll-O'Gara also offers security and counterintelligence
training courses for both U.S. Government agencies and clients in the private
sector. These courses provide a history of U.S. counterintelligence efforts and
current issues in the field. The training includes instruction on methods of
recognizing and deterring political and business intelligence risks.
Additionally, Kroll-O'Gara provides training in the detection of, and responses
to, surveillance. Students learn methodologies utilized by terrorists, what
information is needed by terrorists in order to plan an attack and how to block
or manipulate this flow of intelligence.
Risk and crisis management. Kroll-O'Gara provides consulting services to
assist businesses in managing risks to their personnel and assets and in meeting
and managing unexpected crises. Kroll-O'Gara's crisis management services are
provided in a variety of contexts, including the crisis response to a kidnapping
of a company's executive, the safety of consumers, the contamination of a
consumer product or the environment and the potential damage to the reputation
of a corporate client as a result of disclosure of adverse events. Kroll-O'Gara
maintains a crisis management center in Vienna, Virginia where personnel are on
duty 24 hours a day, 365 days a year, to handle requests for information and
provide initial advice and immediate contact with members of Kroll-O'Gara's
professional staff specializing in the particular crisis presented.
As part of its risk and crisis management service, Kroll-O'Gara furnishes
periodic information including: reports providing city-specific advisories to
business travelers on conditions and other relevant information with respect to
almost 300 cities around the world; a comprehensive country security risk
assessment service that includes daily intelligence briefings containing early
warnings of events and up-to-date information about political unrest, terrorist
activities, product contaminations, health emergencies and other similar events;
a monthly bulletin that reviews and analyzes safety and security issues relating
to air travel around the world; a monthly intelligence review that provides a
global survey of political risk development in countries around the world; and
special reports on topics, such as kidnappings or specific regions or countries,
that are relevant to business travelers.
INVESTIGATIONS AND INTELLIGENCE GROUP
The Investigations and Intelligence Group has five service categories: (1)
financial services, including forensic accounting, asset tracing services, and
pre-acquisition due diligence; (2) business investigations and intelligence,
including litigation support, monitoring, and intellectual property infringement
investigations; (3) corporate services, including pre-employment background
checking, drug testing, surveillance and vendor integrity programs; (4)
corporate security, including security architecture and planning; and (5)
computer forensics. Kroll-O'Gara's investigative and intelligence services are
provided by professionals with backgrounds in law, finance, business,
consulting, law enforcement, engineering, accounting, journalism, environmental
science and technology. Kroll-O'Gara believes that its blend of talent and
expertise is important to the success of this Group. The following table
presents the aggregate net sales for each of the Group's five product categories
for the periods indicated.
YEAR ENDED DECEMBER 31,
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1996 1997 1998
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Financial services.......................................... $15,959 $20,956 $ 29,044
Business investigations and intelligence.................... 44,077 40,295 46,442
Corporate services.......................................... 8,774 14,251 24,215
Corporate security.......................................... 9,182 7,607 10,531
Computer forensics.......................................... -- -- --
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$77,992 $83,109 $110,232
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FINANCIAL SERVICES
Kroll-O'Gara's financial services include forensic accounting, asset
tracing services and pre-acquisition due diligence.
Forensic accounting. Kroll-O'Gara's forensic and investigative accountants
work with corporations, governments, law firms, financial institutions and
individuals to assist them in successfully resolving complex, high risk,
financial and investigative concerns on a worldwide basis. Forensic accounting,
by definition, is the application of financial knowledge and skills, in
conjunction with investigative strategies and techniques, to resolve matters
that are financial in nature in a legally defensible manner. Kroll-O'Gara's
services include: commercial litigation support, corporate investigations,
statutory and regulatory compliance, insurance claims, business valuations,
financial due diligence and visual strategies.
Asset tracing and analysis. Kroll-O'Gara's asset tracing services consist
of tracing and locating assets anywhere in the world and developing financial
profiles and life style assessments in connection with bankruptcy cases, loan
defaults, internal investigations and other due diligence requests by clients.
In many cases, Kroll-O'Gara has worked with trustees in bankruptcy and
insolvency, creditors' committees, bankers in workout and restructuring
departments, litigators and bankruptcy attorneys, conducting searches for
concealed or undisclosed assets. In other contexts, clients may be interested in
a financial profile or asset analysis of a person in connection with a potential
business relationship, lawsuit or internal investigation. Kroll-O'Gara believes
that its asset searching and analysis techniques are effective both in
uncovering assets and in bringing debtors to the negotiating table. In
identifying assets, Kroll-O'Gara relies both on a range of investigative
techniques and on the highly sophisticated use of electronic databases. Tactics
employed include searching publicly available, but sometimes obscure, local
records, reviewing financial documents and conducting discreet interviews with
people associated with the subject.
Pre-acquisition due diligence. The due diligence and background information
and analysis furnished by Kroll-O'Gara is intended to be useful for lenders,
underwriters, potential acquirers and other businesses concerned with assessing
and attempting to minimize the risks related to major financial and other
business decisions. These services include pre-transaction intelligence, due
diligence investigations, competitor intelligence and analysis, intelligence in
contests for corporate control, new market entry intelligence and intelligence
on business partners, customers and critical vendors.
BUSINESS INVESTIGATIONS AND INTELLIGENCE
Kroll-O'Gara's business investigations and intelligence services include
litigation support, monitoring and intellectual property infringement
investigations.
Litigation services. Kroll-O'Gara provides litigation support services to a
client's outside counsel and in-house lawyers in preparation for litigation or
arbitration proceedings and in designing settlement strategies. These services
include developing evidence to support a claim or a defense, identifying and
locating material witnesses, investigating adverse witnesses, locating and
evaluating recoverable or relevant assets of adverse parties, assessing the
strategic goals and financial commitment of the opposition and helping to assess
whether an adequate recovery can be obtained if a lawsuit is successful.
Kroll-O'Gara's wide-ranging information gathering can help businesses and legal
strategists decide whether to sue, go to trial or employ alternative dispute
resolution, and whether, and at what level, to negotiate a settlement. In
complex litigation, Kroll-O'Gara uses sophisticated link-analysis software to
track and process voluminous documentation, as well as extensive database
material, in order to identify elusive connections and produce investigative
leads.
Monitoring services and special inquiries. Kroll-O'Gara provides monitoring
services to, and conducts special inquiries for, clients that require an
independent fact finder to end fraud and install systems that monitor
compliance. Kroll-O'Gara's lawyers, forensic accountants, investigators,
analysts and industry experts seek to
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identify violations of federal or state regulatory requirements or corporate
policies and consult with clients with respect to establishing systems to audit
and ensure compliance with these regulatory requirements or policies.
Kroll-O'Gara serves as an objective fact finder, whose work product might well
be turned over to a questioning government regulator or a skeptical and vocal
segment of the public. Kroll-O'Gara's fact finding efforts have been enlisted by
management and by audit committees concerned about problems that need to be
resolved within an enterprise.
Intellectual property infringement. Kroll-O'Gara's investigators help to
investigate and devise a strategy to solve such problems as thefts of trade
secrets, threats and hostile acts, gray market and counterfeit products, and
patent and trademark infringements. Kroll-O'Gara attempts to determine the
source and extent of the problem, develop information about the parties
responsible, minimize damage to the client and propose effective measures to
prevent further losses.
CORPORATE SERVICES
Kroll-O'Gara's corporate services include pre-employment background checks,
drug testing, surveillance and vendor integrity programs.
Pre-employment background checks. Kroll-O'Gara verifies job applicant
background information for employers. The background investigations are made
through the use of data bases and independent contractors. The searches include
reviews of credit histories, reference checks, criminal records, workers'
compensation histories and driving records as well as education and credential
verification.
Drug testing. Kroll-O'Gara owns and operates a state-of-the-art laboratory
providing drug testing services to corporate and institutional clients seeking
to detect and deter the use of illegal drugs. The laboratory is certified by the
federal Substance Abuse and Mental Health Services Administration to conduct
drug testing using forensic procedures required for legal defensibility of test
results. Kroll-O'Gara's drug testing services also include assisting clients
with the development of drug testing programs, training client personnel,
managing specimen collections, arranging for transportation of specimens to
Kroll-O'Gara's laboratory, identifying trends in local and national drug use,
interpreting test results and providing expert testimony concerning test
results.
Surveillance. Kroll-O'Gara provides video surveillance services to its
clients in connection with investigating exaggerated disability claims and other
frauds. In performing surveillance, Kroll-O'Gara utilizes its fleet of over 125
vans stationed throughout the United States, each containing state-of-the-art
equipment designed to obtain clear footage without detection. Agents with
extensive training and experience man the surveillance vans.
Vendor integrity programs. Kroll-O'Gara provides profiles of a client's
vendors, using information provided by the vendors and obtained from independent
sources. A client utilizes these profiles to insure that its vendors adhere to
the client's standards for ethical business practices. The fees for this service
may be paid either through nominal fees charged to each participating vendor or
billed directly to the client.
CORPORATE SECURITY
Kroll-O'Gara's corporate security services include security architecture
and design as well as security planning.
Security architecture. Kroll-O'Gara offers comprehensive planning,
engineering and design services customized to meet the requirements of customers
for physical site protection. These services are primarily intended to protect
business facilities, embassies, VIPs' homes and public facilities against
unauthorized intrusions. Generally, a project begins with a security survey,
which identifies areas of vulnerability and recommends methods for protecting
the facility. Specific pieces of hardware are selected, processes and procedures
are outlined, engineering documentation is provided and control centers are
detailed.
Corporate security planning services. Kroll-O'Gara designs corporate
security programs that help to safeguard clients' operations and premises.
Security programs and systems are designed to protect the safety of
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key executives, preserve assets and protect the integrity of computer and
telecommunications systems. Additionally, in several areas of the world,
Kroll-O'Gara provides special escort and general protective services to
executives and VIPs.
COMPUTER FORENSICS
Businesses face a variety of risks from both employees and outsiders who
infiltrate computer systems by various means including e-mail and internet
access points. For example, disgruntled employees or competitors may cause
unauthorized changes to a company's website, redirect message traffic to an
alternative website or create "hate sites" containing negative and often untrue
information about a business. Kroll-O'Gara's investigators usually are able to
track down the perpetrators of these activities and analyze how the incident
occurred. Kroll-O'Gara also can help a client locate information vital to a
lawsuit, and do so in a manner that assists in proving the admissability of the
evidence. The information is located by the use of forensic software that allows
Kroll-O'Gara to recover previously deleted computer files, obtain access to
password protected files, and search a hard drive for up to 256 words or phrases
simultaneously.
INFORMATION SECURITY GROUP
The Information Security Group has five service categories: (1) network and
system security services; (2) product evaluation and assessment; (3) security
policy implementations; (4) security architecture and design; and (5) security
training.
Network and system security services. Kroll-O'Gara can determine categories
of threats and risks to the critical systems, services (including e-commerce)
and information resources of clients and recommend cost-effective
countermeasures. Kroll-O'Gara has world-class, on-staff expertise in analyzing
design strengths and weaknesses in secure protocols and cryptographic
algorithms.
Product evaluation and assessment. Kroll-O'Gara understands that no
information system can be made completely secure for practical use in the real
world. Therefore, Kroll-O'Gara works to determine the residual risks that are
acceptable to specific clients based on the needs of the client and the
product's function, security features and interaction with other security
products. Once the analysis is made, the recommendations can include product
enhancements, rules for deploying and configuring the product, and internal
technical guidance.
Security policy implementation. Kroll-O'Gara has specialists who focus on
the development of corporate policies that pertain to computer security. A
comprehensive security policy is as unique as the organization that owns it
because every organization has different requirements. A security policy not
only addresses specific systems, but also describes the organization structure,
guidelines and procedures necessary to support the policy.
Security architecture and design. The Information Security Group
specializes in the architecture, design and implementation of e-commerce
systems. Its staff includes some of the inventors of the technology that
provides the security to these systems. Kroll-O'Gara assists its customers in
all phases of e-commerce applications, including evaluations of products and
vendors, application design and implementation, and continuing assistance in
monitoring, administering and responding to problems in the operation of
e-commerce sites.
Security training. The weakest link in most security systems is usually the
human aspect. To defend against accidental "social compromises" within an
organization, Kroll-O'Gara provides corporate user awareness training, combined
with an implementation service in order to ensure the smooth operation of new
procedures or technology. Kroll-O'Gara offers different training to various
groups within a client's organization, including training solely directed at
specific groups, such as system administrators, development engineers and
security directors, and training directed to the total employee population.
VOICE AND DATA COMMUNICATIONS GROUP
Distribution of satellite communication and navigation equipment.
Kroll-O'Gara resells, through its network of over 1200 distributors, portable
satellite terminals, mobile antennas and Global Positioning Satellite Systems,
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commonly known as GPS. The satellite terminals are designed for use on land, in
the air or at sea and allow the user to make voice and data transmissions via
satellite link anywhere in the world. Kroll-O'Gara's distributors, while
primarily based in the United Kingdom and Europe, are located throughout the
world. As a worldwide reseller of satellite communication equipment and GPS
systems, Kroll-O'Gara is able to enter into distribution arrangements with a
variety of manufacturers in order to offer the best available products to its
customers.
Sale of airtime. Kroll-O'Gara has entered into arrangements with several
satellite earth stations to offer airtime packages to customers. Some of these
packages allow customers to purchase additional airtime anywhere in the world by
using credit cards.
System integration. Kroll-O'Gara offers design and hardware and software
integration services customized to meet specific satellite communication
requirements of its customers. This involves the integration of satellite
terminals into vehicles. Usually these systems are designed for remote or
security intensive operations.
CUSTOMERS
SECURITY PRODUCTS AND SERVICES GROUP
Commercial products. Kroll-O'Gara's armored commercial vehicle customers
include governmental and private buyers. U.S. and foreign governmental buyers
purchase both fully and light-armored vehicles. Governmental buyers also
comprise the market for Parade Cars. Typically, governmental buyers consist of
ministries of foreign affairs, defense and internal affairs and offices of
presidential security. These customers are not constrained in their purchasing
decisions by considerations such as import duties and taxes and are free to
search globally for the best product available. The procurement cycles of
governmental buyers can range from relatively rapid, when the vehicles are for
the use of the head of state or in response to a particular crisis, to prolonged
bureaucratic bids and evaluations for normally budgeted items. Kroll-O'Gara's
private customers for armored commercial vehicles include corporations and
individuals. Private buyers are much more sensitive to cost (of which import
duties and taxes may be a substantial part) and, therefore, often will buy a
locally produced product, if one exists that meets their needs. Local servicing
of the vehicle is also a critical concern to private buyers. Kroll-O'Gara's
customers for cash-in-transit vehicles are generally financial institutions.
Purchasing decisions for cash-in-transit vehicles depend on many criteria
including the ownership of the institution (private or governmental), insurance
requirements and cost. The geographic distribution of 1998 sales of
Kroll-O'Gara's commercial armored vehicles, as a percentage of total 1998 sales
for those products, was as follows:
PERCENTAGE OF 1998 COMMERCIAL SALES BY GEOGRAPHIC AREA
Europe................................................. 43%
Central and South America.............................. 29%
North America.......................................... 11%
Middle East............................................ 6%
Far East............................................... 2%
Other.................................................. 9%
Military products. Kroll-O'Gara's market for military hardware products is
worldwide in scope, including the U.S. Military and foreign defense forces.
Kroll-O'Gara's major contracts for delivery of Up-Armored HMMWVs are with the
U.S. Military. Additionally, Kroll-O'Gara provides protected container systems,
typically used to protect missile systems from small arms fire, to the U.S.
Military under a subcontract with Lockheed Martin. Kroll-O'Gara has sold
Up-Armored HMMWVs to Qatar and Luxembourg, either directly or through the U.S.
Foreign Military Sales Program, and is seeking to expand its sales of these
vehicles to foreign defense forces.
Training. Kroll-O'Gara began offering advanced driver training, firearms
training and surveillance detection training courses after its acquisition of
ITI, which had an established customer base of U.S. and foreign governmental
agencies and corporate customers. Many private sector clients are drawn to
Kroll-O'Gara's training courses due to Kroll-O'Gara's reputation of providing
these services to various governmental agencies. Kroll-O'Gara markets its
various courses to its armored commercial vehicle customers and vice versa.
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Risk and crisis management. A significant portion of Kroll-O'Gara's
customers for investigating and negotiating ransom demands in connection with
kidnappings and for investigating incidents of product tampering or
disparagement arise from a contract with American International Group, Inc.
("AIG"), an international multi-risk insurance company, under which Kroll-O'Gara
investigates claims by AIG's insureds. Although Kroll-O'Gara is paid by AIG
after claims are made, Kroll-O'Gara's customer is the affected person or entity.
Kroll-O'Gara's customers for its information services relating to travel safety
are multinational corporations and individuals. Kroll-O'Gara markets its
information services to many of its customers for other products and services.
INVESTIGATIONS AND INTELLIGENCE GROUP
Kroll-O'Gara's clients for investigative and intelligence services include
multinational corporations, leading law firms, financial institutions,
government agencies and individuals in a wide range of business sectors. The
financial institutions to which Kroll-O'Gara provides services include many of
the largest international investment banks, numerous commercial banks, insurance
companies and other significant credit institutions.
Kroll-O'Gara classifies its investigative and intelligence sales by where
the services are delivered; international sales are services delivered outside
the United States. For the years ended December 31, 1996, 1997 and 1998, 77%,
73%, and 69%, respectively, of this Group's net sales were attributable to
services delivered in the United States; the balance were attributable to
services delivered outside the United States.
Although many of Kroll-O'Gara's clients utilize these services on a
periodic basis, comparatively few clients utilize Kroll-O'Gara's services on a
continuing basis and the clients that account for a material percentage of net
sales in any year may vary widely.
In the United States, Kroll-O'Gara generally charges for its investigative
and intelligence services on an hourly basis at varying rates, depending upon
the type of service being provided and the competition that exists in providing
the service. Kroll-O'Gara also provides these services, particularly outside the
United States, on a negotiated project, or fixed fee, basis. Providing services
on a fixed fee basis enhances the potential for higher profit margins. However,
these arrangements also can result in unexpected losses on a particular project.
Kroll-O'Gara believes that this risk is reduced by being spread over a large
number of fixed fee arrangements.
INFORMATION SECURITY GROUP
Kroll-O'Gara markets its information security services to its corporate and
governmental customers. These clients either are concerned about potential
infiltration of their proprietary databases or have had their databases
infiltrated by employees or third parties. Emerging customers are those
interested in the development of e-commerce and the security associated with
these transactions. Generally, Kroll-O'Gara charges on an hourly basis for these
services.
VOICE AND DATA COMMUNICATIONS GROUP
Satellite communication integration. Principal customers for satellite
communications services include private corporations and individuals,
governmental agencies, peacekeeping forces and disaster relief organizations.
These customers generally operate in lesser-developed countries that lack a
telecommunications infrastructure, in rural areas of developed countries or in
disaster scenarios in which the traditional forms of telecommunications are
rendered inoperable. Increasingly, customers are demanding that the satellite
communication channels provided be secure. Depending on the level of security
desired, satellite communication systems can be implemented using a variety of
encryption methods up to and including fully secure U.S. Government STU-III
systems. Most of Kroll-O'Gara's satellite communication customers are located
outside of the United States, in part because the U.S. Federal Communications
Commission does not permit private corporations or individuals to use terminals
in the United States which do not utilize the American Mobile Satellite Corp.
satellite network. Many terminals marketed by Kroll-O'Gara access the INMARSAT
network rather than the American Mobile Satellite network. In addition, many
distributorship agreements with manufacturers limit Kroll-O'Gara's territory to
the United Kingdom and Europe.
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Navigation systems. Kroll-O'Gara resells GPS equipment through
approximately 1,200 independent distributors and retailers in the United Kingdom
and France. Marine GPS units are sold through distributors and retailers which
specialize in marine electronics and dealers in general boat equipment. Outdoor
(recreational) GPS units are sold through sporting goods retailers, camping and
outdoor stores and general electronics stores. Aviation GPS equipment is sold
through aviation equipment retailers.
MARKETING AND SALES
Commercial. Kroll-O'Gara believes that it enjoys excellent name recognition
and a strong reputation in the security industry. The central element of
Kroll-O'Gara's commercial marketing strategy is to utilize the name recognition
and reputation of its products and services to position Kroll-O'Gara as a global
provider of one-stop risk mitigation services and products. In this manner,
Kroll-O'Gara believes it can capitalize on its existing customer base, maximize
the benefits of its long history of supplying security-related products and
services around the world and enhance its leadership niche in the risk
mitigation market. Kroll-O'Gara tailors its marketing strategy to each
geographic area of the world and often will tailor its product and services
offerings by country. Kroll-O'Gara actively cross markets its products and
services and believes this strengthens the image of each product group.
On a worldwide basis, Kroll-O'Gara employs 48 full-time sales professionals
in its Security Products and Services Group. These employees operate out of
Washington, D.C.; Miami, Florida; Fairfield, Ohio; Sao Paulo, Brazil; Lamballe,
France; Paris, France; Mexico City, Mexico; Subic Bay, the Philippines; Manila,
the Philippines; Moscow, Russia; Bogota, Colombia; and Geneva, Switzerland. All
personnel have a geographic and/or product- specific responsibility. In most
cases, the sales personnel also recruit and maintain sales agents or
distributors. The agents or distributors have geographic and product-specific
agreements, and compensation in most cases is based upon a commission
arrangement. The sales personnel use a consultative approach when offering
solutions to customers' security problems. Sales cycles for commercial physical
security products can range from several months to a matter of days, depending
upon the product and the urgency associated with the security problem being
addressed. Physical security products which are readily available, such as the
fully armored Standard Suburban, allow Kroll-O'Gara to assist customers who
have, or believe they have, developed an immediate threat.
In its Investigations and Intelligence Group and its Information Security
Group, Kroll-O'Gara relies on its professionals not only to provide services to
existing clients, but also for new business development and marketing.
Kroll-O'Gara obtains engagements from a client's board of directors, chief
executive, chief financial and chief information officers, general counsel and a
variety of other corporate officials, including business development officers,
security managers, risk managers and human resource personnel. Kroll-O'Gara's
senior professionals act as relationship managers for Kroll-O'Gara's major
clients, and a significant amount of Kroll-O'Gara's marketing consists of
maintaining and developing these personal relationships. In addition, in its
Investigations and Intelligence Group, Kroll-O'Gara has a professional staff in
New York City and in each of its regional headquarters that includes marketing,
sales and public relations professionals who support and coordinate
Kroll-O'Gara's marketing efforts on a worldwide basis. These marketing efforts
include seminars, briefings, receptions, breakfast and lunch meetings, direct
mail and selected advertising in trade and other journals. Kroll-O'Gara's
services and marketing events are promoted through its Internet website and a
publication mailed periodically to approximately 20,000 clients and prospective
clients.
Kroll-O'Gara's marketing efforts attempt to increase business with existing
clients by expanding clients' awareness of the range of services offered by
Kroll-O'Gara and by broadening the decision makers within a client's
organization that are aware of the range of services offered by Kroll-O'Gara.
Kroll-O'Gara's business development staff periodically conducts surveys of
clients to assess their perception of the range and quality of its services and,
after the completion of an assignment, clients are often asked to complete a
quality control questionnaire.
Because most of the product sales of Kroll-O'Gara's Voice and Data
Communications Group are through independent distributors and retailers,
Kroll-O'Gara employs only eight sales professionals in that Group, most of whom
operate out of its Deer Park, New York and Salisbury, United Kingdom facilities.
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Military. Kroll-O'Gara has positioned itself in the marketplace as a
commercial company with a military production capability. As such, Kroll-O'Gara
emphasizes its ability to develop new products, or product adaptations, quickly
and more cost-effectively than traditional defense contractors. In marketing its
products to the military, Kroll-O'Gara also places strong emphasis on its
superior antitank and antipersonnel mine protection for the occupants of
tactical wheeled vehicles. Kroll-O'Gara markets its military products through a
combination of trade show exhibitions, print advertising in military-related
periodicals and direct customer visits. Kroll-O'Gara emphasizes the
cross-marketing of military and commercial products, which it believes
strengthens the image of each product group. Kroll-O'Gara also has entered into
exclusive teaming and joint marketing agreements with AM General, the
manufacturer of the basic HMMWV, for sales in the military and commercial
arenas. These agreements designate Kroll-O'Gara as the exclusive armorer to AM
General for HMMWVs and allow Kroll-O'Gara to benefit from the AM General
distribution network and save on certain costs, such as exhibitions where AM
General and Kroll-O'Gara otherwise would both show products. Additionally,
Kroll-O'Gara currently is working with other military vehicle manufacturers
whose products are more popular in other areas of the world to develop armored
configurations for their vehicles.
Kroll-O'Gara's military sales activities are directed toward identifying
contract bid opportunities with various U.S. Government agencies, private
enterprises acting as prime contractors on government contracts, sales through
the Foreign Military Sales Program, and military sales directly to foreign
military organizations. Kroll-O'Gara has two full-time business development
managers who are responsible for this activity and also has contractual
arrangements with several outside consultants who assist the business
development managers in their activities. Proposal preparation and presentation
for government projects is done by a team which normally consists of program
managers, a contracting officer, a cost accountant and various manufacturing and
engineering personnel.
ENGINEERING AND DEVELOPMENT
Kroll-O'Gara's engineering and development activities are centered on
products offered by its Security Products and Services Group. Kroll-O'Gara
emphasizes engineering excellence and has an extensive engineering staff. Design
engineers use state-of-the-art two-dimensional and three-dimensional computer
aided design and engineering (CAD/CAE) systems in conjunction with coordinate
measuring machines to develop electronic models which generally are converted to
solid models or prototypes. Manufacturing engineers concentrate on improvements
in the production process and on overall cost reductions from better methods,
fewer components and less expensive materials with equal or superior quality.
Applying these techniques, in the last several years Kroll-O'Gara has been able
to produce savings in both the time and cost necessary to produce its armored
vehicles.
Quality engineering is responsible for assuring that manufacturing and
design plans are consistent with a reliable, quality product that meets the
specifications of the customer. Quality engineers also are responsible for
identifying in-process quality inspection points in the work orders.
Kroll-O'Gara's ballistic engineer, in conjunction with its design and
manufacturing engineers, develops new ballistic and blast protection systems
that meet ever-changing threats. The ballistic engineer also is responsible for
the ballistic testing required by customers, the assignment of ballistic
specifications to final products and the issuance of ballistic specifications
for internal quality control. Advanced engineering is responsible for new
product development in conjunction with design engineering, manufacturing
engineering and ballistic engineering. Kroll-O'Gara estimates that it expended
approximately $2.8 million, $2.9 million and $3.7 million in 1996, 1997 and
1998, respectively, on its engineering and development efforts. The amounts for
1997 and 1998 include expensed amounts reimbursed under a Systems Technical
Support Contract described under "U.S. Government Contracts."
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U.S. GOVERNMENT CONTRACTS
Kroll-O'Gara serves as the U.S. Military's sole source contractor for
armoring the HMMWV fleet. Since its initial contract in August 1993 to armor 59
HMMWVs, Kroll-O'Gara has been awarded contracts to armor a total of 1,993
HMMWVs. Of these, 1,498 Up-Armored HMMWVs have been shipped, as follows:
NUMBER OF
YEAR SHIPPED HMMWVS
------------ ---------
1993........................................................ 0
1994........................................................ 139
1995........................................................ 26
1996........................................................ 507
1997........................................................ 366
1998........................................................ 460
-----
Total............................................. 1,498
=====
Kroll-O'Gara's most recent contract with the U.S. Military covers 738
Up-Armored HMMWVs for the U.S. Army and the U.S. Air Force, to be delivered from
August 1998 through December 1999. The contract for 378 of those vehicles for
the U.S. Air Force was signed in March 1998, with the remaining amount
contracted for in April 1998. The award includes an option for an additional 216
vehicles. As the Up-Armored HMMWV fleet grows, Kroll-O'Gara is experiencing
continued growth in sales of spare parts and related fleet management activity,
including a $2.0 million annual contract to support field requirements. This
contract was most recently renewed in March 1998.
In January 1997, Kroll-O'Gara signed a Systems Technical Support ("STS")
contract with the U.S. Military to support continued research and development on
the Up-Armored HMMWV program. The four year contract, three of which are option
years, was budgeted for $2.5 million in 1997, with $2.5 million options in each
of 1998 and 1999 and a $2.0 million option in 2000. In September 1997, the U.S.
Military exercised its options for 1998 and 1999. The STS contract, in part,
allows Kroll-O'Gara to make design improvements, to conduct additional testing
of materials, components and vehicles and to explore alternate and more advanced
armor configurations. The contract requires Kroll-O'Gara to provide 25,000 hours
per year of engineering and development time to the U.S. Military. Kroll-O'Gara
believes that the knowledge gained from STS contract work also has been of value
to its commercial manufacturing programs.
As a subcontractor to Lockheed Martin Corporation, Kroll-O'Gara has
provided armoring for certain missile weapons systems. Kroll-O'Gara was first
engaged in September 1993 by Lockheed Martin to armor launch systems of
missiles. Kroll-O'Gara was most recently engaged by Lockheed Martin in February
1999 to provide this armoring and believes that it is well positioned for future
engagements.
COMPETITION
The markets for Kroll-O'Gara's products and services are highly
competitive. Kroll-O'Gara competes in a variety of fields, with competitors
ranging from small businesses to multinational corporations.
SECURITY PRODUCTS AND SERVICES GROUP
Kroll-O'Gara believes that its design, engineering and production expertise
in providing fully integrated ballistic and blast protected vehicles gives it a
competitive advantage over those competitors who provide protection against only
selected ballistic threats. The largest competitor on a worldwide basis in the
production of armored commercial vehicles is DaimlerChrysler AG, which sells its
armored Mercedes Benz products on a special order basis, and BMW AG, which sells
its products through its worldwide dealer distribution system. In addition,
there are a number of other vehicle armorers in Europe, the Middle East and
Latin America which armor primarily locally manufactured automobiles. U.S. based
protected passenger automobile armorers include the Pittston Company (owner of
Brinks armored vehicles), Moloney Coachbuilders, Inc., Armor Holdings, Inc., and
Armet Armored Vehicles, Inc. The principal competitive factors are price,
quality of engineering and design,
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production capability and capacity, ability to meet delivery schedules and
reputation in the industry. There are a large number of companies, such as
Simula, Inc., that provide specific armoring packages for tactical wheeled
vehicles, helicopters and selected other military applications. Kroll-O'Gara
believes that, as the size of the Up-Armored HMMWV requirement continues to
grow, competition from major defense contractors may increase.
With regard to the security services provided by this Group, Kroll-O'Gara
competes with numerous local integrators and small consultant-type businesses,
such as Control Risks Group Ltd., and also with large suppliers of
security-related equipment such as Western Resources, Inc., Pinkerton's, Inc.,
The Wackenhut Corporation, Borg-Warner Security Corporation, Pittway
Corporation, Armor Holdings, Inc., ICTS International, N.V. and Tyco
International Ltd. The principal competitive factors are the best approach to
solving the problems, expertise, price, trust, availability and the company or
individual reputation.
INVESTIGATIONS AND INTELLIGENCE GROUP
In this area, Kroll-O'Gara competes with local, regional, national and
international firms, including investigative and security firms, guard companies
and specialized consultants in areas such as kidnapping. Kroll-O'Gara believes
that it is one of the largest companies in the world providing a broad array of
corporate investigation, risk and crisis management and business intelligence
services on a global basis and that it enjoys strong name recognition in its
industry. Nevertheless, Kroll-O'Gara faces significant, and increasing,
competition in the United States and elsewhere in the world from a variety of
companies that provide some of the services offered by Kroll-O'Gara. In most
service areas in which Kroll-O'Gara operates, there is at least one competitor
that is significantly larger or more established than Kroll-O'Gara. Many of the
national and international accounting firms, along with other companies such as
Decision Strategies/Fairfax International, LLC and Investigations Group, Inc.,
provide consulting services similar to some of the services provided by
Kroll-O'Gara. Some of these firms have indicated an interest in providing
corporate investigation and business intelligence services on a broader scale.
The accounting firms have significantly larger financial and other resources
than Kroll-O'Gara and have long-established relationships with their clients,
which also are likely to be clients or prospective clients of Kroll-O'Gara. In
addition, large multinational security product and service providers have
indicated an interest in expanding their services to include value-added
services such as some of the investigation and consulting services provided by
Kroll-O'Gara.
INFORMATION SECURITY GROUP
This Group provides services in an area which is subject to rapid change
and is highly competitive. Primary competitors include participants from a
variety of market segments, including national and international accounting
firms, systems consulting and implementation firms, application software firms,
service groups of computer equipment companies, outsourcing firms, systems
integration companies and general management consulting firms. Many of these
competitors have significantly greater financial, technical and marketing
resources and greater name recognition in the field than Kroll-O'Gara.
VOICE AND DATA COMMUNICATIONS GROUP
In this Group, the products distributed by Kroll-O'Gara compete with those
offered by many companies, including STN Atlas Elektronik, GmbH and Nera AS.
Kroll-O'Gara believes that the competitive factors in this portion of its
business include product reliability, the incorporation of advanced
technological features, price, ease of installation, availability and service.
With respect to secure custom communications systems integration services,
Kroll-O'Gara competes with small and large communications systems integrators.
SEASONALITY, BACKLOG AND RELATED MATTERS
Approximately 23% of Kroll-O'Gara's net sales during 1998 were derived from
U.S. Military contracts and an additional 5% were derived from commercial
contracts with U.S. governmental agencies or foreign governments. For 1997,
these percentages were 21% and 5%, respectively. Military and governmental
contracts generally are awarded on a periodic or sporadic basis. Kroll-O'Gara
frequently receives substantial orders in one quarter, the revenues from which
are not recognized until one or more subsequent quarters. As a result,
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Kroll-O'Gara has significant fluctuations from time to time in its business.
Historically, these fluctuations have not been seasonal. Kroll-O'Gara does not
believe that its business is seasonal overall, although historically the first
quarter has been weaker than the other three. 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.
Kroll-O'Gara's backlog at December 31, 1997 and 1998 was approximately
$50.0 million and $29.3 million, respectively. Backlog consists of net sales
value for firm orders not previously included in net sales on the basis of
percentage-of-completion accounting. Because many timing and cost factors affect
the production and delivery of Kroll-O'Gara's products, there is no certainty as
to when net sales will be recognized from Kroll-O'Gara's backlog. Year-to-year
comparisons of backlog are not necessarily indicative of future operating
results.
Kroll-O'Gara's net sales from government contracts and most commercial
contracts for its armoring products are recognized using the
percentage-of-completion method. Under this method, contract revenues are
reported based on the percentage that costs to date bear to total estimated
costs. Estimated contract losses are recognized in full in the period in which
it becomes likely that a loss will occur. Accordingly, contract revenues and
total cost estimates are reviewed and revised periodically as the work
progresses and as change orders are approved, and adjustments based upon the
percentage-of-completion are reflected in contract revenues in the period when
such estimates are revised. See "Management's Discussion and Analysis of
Financial Condition and Results of Operations."
EMPLOYEES
As of February 28, 1998, Kroll-O'Gara had 2,446 employees, comprised of 110
in marketing and sales, 1,192 in operations, 506 in professional services, 65 in
engineering and 573 in general and administrative. Kroll-O'Gara's U.S. employees
are not represented by any union and are not covered by any collective
bargaining agreements. Approximately 134 employees of Labbe are employed under
agreements with the Confederation Francaise Democratique du Travail. Wage
increase parameters are set twice a year by Kroll-O'Gara's local management in
consultation with the union. Kroll-O'Gara has not experienced any work stoppages
or employee related slowdowns and believes that its relationship with its
employees is good.
GOVERNMENT REGULATION
Kroll-O'Gara's services are subject to various federal, state, local and
foreign laws, including laws designed to protect the privacy of persons.
Subsidiaries of Kroll-O'Gara hold private investigative licenses from, and their
investigative activities are subject to regulation by, the state and local
licensing authorities in the locations where such subsidiaries do business.
Kroll-O'Gara also utilizes data from outside sources, including data from third
party vendors and various government and public record services, in performing
its services. Use of this data is subject to compliance with applicable law.
Additionally, Kroll-O'Gara's drug testing laboratory is certified on the
federal level and licensed in a number of states. If the laboratory's
certification were suspended or lost, it would have a material adverse effect on
this aspect of Kroll-O'Gara's business.
As a contractor with agencies of the U.S. Government, Kroll-O'Gara is
obligated to comply with a variety of regulations governing its operations and
the workplace. Additionally, Kroll-O'Gara's contracts give the contracting
agency the right to conduct audits of Kroll-O'Gara's facilities and operations,
and these audits occur routinely. An audit involves a governmental agency's
review of Kroll-O'Gara's compliance with the prescribed procedures established
in connection with the government contract.
Regulations promulgated by the U.S. Commerce Department require
Kroll-O'Gara to obtain a general destination license in connection with the sale
of certain commercial products in foreign countries, and U.S. State Department
regulations require Kroll-O'Gara to file an export license in connection with
sales of military equipment in foreign countries. Furthermore, the U.S. State
Department prohibits all sales of military equipment to certain countries, and
the U.S. complies with United Nations trade embargos. Additionally, foreign
countries in
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which Kroll-O'Gara does business or into which it expects to expand have laws
and regulations which may restrict Kroll-O'Gara's business.
ENVIRONMENTAL MATTERS
Kroll-O'Gara and its operations are subject to a number of environmental
laws, regulations and ordinances, both in the U.S. and various foreign
countries, governing activities that may have adverse environmental effects,
such as discharges to air and water, as well as handling, storage and disposal
practices for solid and hazardous materials. These laws also impose liability
for the cost of remediating, and damages resulting from, sites of past releases
of hazardous materials. Environmental laws continue to change rapidly, and it is
likely that Kroll-O'Gara will be subject to increasingly stringent environmental
standards in the future. Kroll-O'Gara believes that it currently conducts its
activities and operations in substantial compliance with applicable
environmental laws.
PATENTS, TRADEMARKS AND COPYRIGHTS
Kroll-O'Gara currently has six issued U.S. patents relating to its armoring
business. Kroll-O'Gara also currently has three federally registered trademarks
and pending applications for several others and has registered its trademarks in
numerous foreign countries. Kroll-O'Gara has no federally registered copyrights.
Although Kroll-O'Gara does not believe that its ability to compete in any of its
product markets is dependent on its intellectual property, Kroll-O'Gara does
believe that the protection afforded by its "Armoring Assembly" and "Vehicle
Mine Protection Structure" patents, both of which relate to vehicle underbody
blast protection, provides Kroll-O'Gara with important technological advantages
over its competitors. Although Kroll-O'Gara has protected its technologies to
the extent that it believes appropriate, there can be no assurance that
Kroll-O'Gara's measures to protect its proprietary rights will deter or prevent
unauthorized use of Kroll-O'Gara's technologies. In other countries,
Kroll-O'Gara's proprietary rights may not be protected to the same extent as in
the United States.
RISK FACTORS
Inability to Manage Planned Growth
Kroll-O'Gara plans to develop further its existing lines of business in
current markets and to expand into new geographic markets. To do this, it will
need to enhance the capabilities of its operational and financial systems and
will require additional employees, management and operational and financial
resources. If Kroll-O'Gara cannot do these things when necessary, it could be
adversely affected.
Kroll-O'Gara also plans to grow through the acquisition of additional
companies that will complement its existing operations or provide it with an
entry into markets it does not currently serve. Since January 1, 1997,
Kroll-O'Gara has made multiple acquisitions. It currently intends to continue
making acquisitions for the foreseeable future. When companies are acquired,
Kroll-O'Gara may not be able to integrate or manage these businesses so as to
produce returns that justify the investment. Additionally, issues relating to
new acquisitions may divert the attention of Kroll-O'Gara's management from
existing operations.
The expansion of Kroll-O'Gara's business eventually will require additional
capital. Kroll-O'Gara may not be able to generate adequate cash from operations
or obtain adequate financing from external sources for this purpose. The
issuance of additional Kroll-O'Gara common stock to raise capital or to finance
acquisitions may result in dilution to holders of Kroll-O'Gara common stock. Any
debt financing may increase significantly Kroll-O'Gara's leverage and may
involve restrictive covenants which limit Kroll-O'Gara's operations. Future
acquisitions by Kroll-O'Gara also may require approval under Kroll-O'Gara's
credit facility. See "Management's Discussion and Analysis of Financial
Condition and Results of Operations--Liquidity and Capital Resources."
Competition by Companies with Greater Resources
There are a large number of companies, both public and private, that
provide products or services similar to
those offered by Kroll-O'Gara. Kroll-O'Gara also may encounter competition from
future industry entrants. Some of Kroll-O'Gara's current competitors have, and
new competitors may have, substantially greater financial and other resources
than Kroll-O'Gara and may be more resistant to pricing pressures. A number also
have long
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established relationships with their clients. For example, some accounting firms
and other large security product and service providers have indicated an
interest in expanding their product offerings to certain of the investigative
and consulting services provided by Kroll-O'Gara. These companies could be
formidable competitors if they elect to devote the necessary resources to
businesses which are competitive with Kroll-O'Gara. See "Business--Competition."
Loss or Reduction of U.S. Military Contracts
U.S. Military contracts account for a significant portion of Kroll-O'Gara's
business, representing 33%, 21% and 23% of net sales for 1996, 1997 and 1998,
respectively. The U.S. Military funds these contracts in annual increments, and
the contracts require subsequent authorization and appropriation which may not
occur or which may provide less than the total amount of the contract.
Kroll-O'Gara may not receive future contracts and the size of any contracts that
are received may vary. Fluctuations in spending by the U.S. Government for
national defense could adversely affect Kroll-O'Gara's ability to receive future
contracts. Also, the U.S. Government generally may cancel its contracts
unilaterally, at its convenience. The loss of, or a significant reduction in,
this business would have a material adverse effect on Kroll-O'Gara. See
"Business-U.S. Government Contracts."
Dependence of Security Products and Services Group on Certain Single and Primary
Source Suppliers
Kroll-O'Gara is the prime contractor to the U.S. Military for the supply of
armoring and blast protection for HMMWVs. HMMWVs armored by Kroll-O'Gara are
manufactured by AM General Corporation under separate U.S. Military contracts.
Should deliveries of HMMWVs to Kroll-O'Gara be significantly interrupted, there
could be a material adverse effect on Kroll-O'Gara.
In 1998, Kroll-O'Gara obtained approximately 46% of the glass used in
armoring its vehicles from Pilkington Aerospace Limited. If Kroll-O'Gara ever
needed to select one or more additional or substitute suppliers, delays could be
encountered in obtaining glass which meets Kroll-O'Gara's specifications.
Anticipated Importance of New Information Security Group
In late December 1998, Kroll-O'Gara established its Information Security
Group by acquiring Securify Inc. The Information Security Group provides
objective information security services to businesses and government agencies,
including network and system security review and repair, product assessment,
creation and implementation of security policies, architecture and design, and
training. Kroll-O'Gara expects this Group to make a significant contribution to
its business in the future. The Group's success will depend, in large part, on
its ability to remain fully up-to-date in a number of technical areas which are
changing and evolving rapidly. These include the nature of software and hardware
offerings by other parties and encryption technologies. Equally important is the
Group's need to attract and retain highly qualified people with experience and
expertise in these areas. Failure in either regard could have a material adverse
effect on the future prospects of the Information Security Group.
Fluctuations in Operating Results
Kroll-O'Gara derived approximately 23% of its net sales for 1998 from U.S.
Military contracts and an additional 5% from commercial contracts with U.S.
governmental agencies or foreign governments. Kroll-O'Gara reports these
contracts through its Security Products and Services Group. Because these
contracts generally are awarded on a periodic and/or sporadic basis, the
Security Products and Services Group has significant fluctuations from time to
time in its business. Period-to-period comparisons within a given year or
between years may not be meaningful or indicative of operating results over a
full year.
Kroll-O'Gara generally does not have long term contracts with clients in
its Investigations and Intelligence Group or its Information Security Group, and
the businesses of these Groups depend on obtaining many new projects each year,
most of which are of relatively short duration. As a result, Kroll-O'Gara's net
sales and net income from year-to-year and period-to-period in its
Investigations and Intelligence Group and its Information Security Group are not
predictable. Additionally, the level of corporate acquisitions and other
financial transactions affects the demand for Kroll-O'Gara's investigative and
intelligence services, and clients may reduce their reliance on certain of
Kroll-O'Gara's services during periods when there is a decline in these
activities. See
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"Business--Seasonality, Backlog and Related Matters" and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
Risk of Losses on Fixed Price Contracts
Fixed price contracts are used for a substantial portion of Kroll-O'Gara's
projects, particularly in its Security Products and Services Group. Kroll-O'Gara
attempts to cover anticipated increases in labor, material and other costs in
the original prices of these contracts. However, due to unexpected events over
the life of a fixed-price contract, the results actually realized often will
vary from that originally expected. Depending on the size of a contract, these
variations from estimated contract performance could have a material adverse
effect on Kroll-O'Gara's results of operations for any quarter or year.
Possible Negative Adjustments Related to Percentage-of-Completion Accounting
Kroll-O'Gara recognizes net sales from government contracts and most
commercial contracts in its Security Products and Services Group using the
percentage-of-completion method. Under this method, Kroll-O'Gara accrues
estimated contract revenues based generally on the percentage that costs to date
bear to total estimated costs and recognizes estimated contract losses in full
when determined. Accordingly, Kroll-O'Gara periodically reviews and revises
contract revenues and total cost estimates as the work progresses and as change
orders are approved. It reflects adjustments in contract revenues, based upon
the percentage-of-completion, in the period when the estimates are revised. To
the extent that these adjustments result in a reduction or an elimination of
previously reported contract revenues, Kroll-O'Gara would recognize a charge
against current earnings, which could be material. See "Management's Discussion
and Analysis of Financial Condition and Results of Operations."
Political and Economic Risks of Doing Significant Business Outside the United
States
In addition to its U.S. facilities, Kroll-O'Gara has operations and assets
in Argentina, Australia, Brazil, Canada, China, Colombia, France, Germany,
India, Italy, Japan, Mexico, the Philippines, Russia, Saudi Arabia, Singapore,
Switzerland and the United Kingdom. Kroll-O'Gara also sells its products and
services in other foreign countries and is seeking to increase its level of
international business activity. Kroll-O'Gara's international business exposes
it to various risks, including exchange rate fluctuations, foreign currency
restrictions, U.S. imposed embargoes of sales to specific countries,
expropriation of assets, war, civil uprisings and riots, government instability
and the vagaries of foreign legal systems. Kroll-O'Gara also may be subject to
unanticipated taxes, duties, or other governmental assessments. These risks
could result in a loss of business, significant unexpected write-offs of assets
or other unexpected costs which could have a material adverse effect on
Kroll-O'Gara. See "Business--Government Regulation."
Inability to Comply with Stringent Governmental Regulations and Licensing
Requirements
As a contractor with agencies of the U.S. Government, Kroll-O'Gara must
comply with a variety of regulations governing aspects of its operations and the
workplace. These agencies also may, and routinely do, conduct audits of
Kroll-O'Gara's facilities and operations. Kroll-O'Gara may be subject to
investigations as a result of an audit or for other causes. Adverse findings in
an audit or other investigation, including violations of environmental or labor
laws, could result in fines or other penalties up to and including
disqualification as a U.S. Government contractor. In addition, U.S. Government
contracts may contain specific delivery requirements. Kroll-O'Gara could incur
penalties or lost profits if it fails to meet these requirements.
Regulations promulgated by the U.S. Commerce Department require
Kroll-O'Gara to obtain a general destination license in connection with the sale
of certain commercial products in foreign countries, and U.S. State Department
regulations require Kroll-O'Gara to file an export license in connection with
sales of military equipment in foreign countries. Foreign countries in which
Kroll-O'Gara does business or into which it expects to expand also have laws and
regulations which may restrict Kroll-O'Gara's business.
The services provided by Kroll-O'Gara's Investigations and Intelligence
Group are subject to various federal, state, local and foreign laws, including
privacy laws. Subsidiaries of Kroll-O'Gara hold private
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investigative licenses from, and their investigative activities are regulated
by, government agencies in various jurisdictions. Kroll-O'Gara also utilizes
certain data from outside sources, including data from third party vendors and
various government and public record services, in performing its services. To
date, applicable laws and regulations have not interfered materially with the
manner in which Kroll-O'Gara obtains information and conducts its operations,
including Kroll-O'Gara's access to data used in its business. However, changes
in these laws and regulations, particularly those relating to privacy, could
have a material adverse effect on Kroll-O'Gara.
Additionally, Kroll-O'Gara's drug testing laboratory is certified on the
federal level and licensed in a number of states. If the subsidiary fails to
continue to meet all applicable requirements, its certification could be
suspended or lost, which would have a material adverse effect on this aspect of
Kroll-O'Gara's business. See "Business-- Government Regulation."
Retention of Key Personnel
Kroll-O'Gara believes that its business success has been, and for the
foreseeable future will continue to be dependent on the leadership of its
executive officers, particularly Jules B. Kroll, its Chairman and Chief
Executive Officer, and Wilfred T. O'Gara, its President and Chief Operating
Officer, each of whom has substantial experience and expertise in one or more
significant areas of Kroll-O'Gara's business. Although Kroll-O'Gara's employment
agreements with its executive officers are designed to provide a measure of
protection against competition, neither the employment agreements nor their
covenants-not-to-compete are long term. Kroll-O'Gara also is highly dependent on
the quality and efforts of its senior managers and its professional and
technical staff, including particularly those in its Information Security Group,
to provide services and to attract and retain clients. Competition for qualified
management, professional and technical employees is intense. Kroll-O'Gara's
business could be materially and adversely affected if its executive officers
unexpectedly become unable or decide not to continue in their present positions,
or if a number of senior managers fail to continue with Kroll-O'Gara and
Kroll-O'Gara is unable to attract and retain qualified replacements.
Liability to Clients and Others
The very nature of Kroll-O'Gara's business exposes it to potential
liability claims in instances in which its clients suffer losses in spite of
Kroll-O'Gara's efforts to mitigate their risks. Kroll-O'Gara maintains product
liability and professional liability insurance policies with limits of $25
million and $15 million, respectively; however, a successful claim could result
in liability in excess of coverage limits and have a material adverse effect on
Kroll-O'Gara. Also, in the ordinary course of its business, Kroll-O'Gara is
subject to claims of third parties other than clients alleging trespass,
invasion of privacy and other tortious conduct by its investigators and other
personnel. Although Kroll-O'Gara endeavors to minimize the risk of such claims,
they could have a material adverse effect on Kroll-O'Gara.
Failure of Third Parties to Resolve Their Year 2000 Issues
Kroll-O'Gara has implemented a Year 2000 program intended to ensure that
its computer systems and applications will function properly beyond 1999.
Kroll-O'Gara currently expects to complete its own Year 2000 conversions on a
timely basis and without costs that are material to its financial condition or
results of operations. However, many of Kroll-O'Gara's operations, especially in
the Voice and Data and the Investigations and Intelligence Groups, rely on third
party computer systems and data bases. The failure of third parties to address
adequately their Year 2000 issues could have a material adverse effect on
Kroll-O'Gara. See "Management's Discussion and Analysis of Financial Condition
and Results of Operations--Liquidity and Capital Resources."
ITEM 2. PROPERTIES
Kroll-O'Gara maintains executive offices and regional headquarters in New
York, New York, and Fairfield, Ohio, and other regional headquarters in London,
England; Hong Kong; Miami, Florida; Lamballe, France; and Sao Paulo, Brazil. In
addition, Kroll-O'Gara maintains 28 domestic offices or facilities in 14 states
and 32 foreign
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offices or facilities in 18 foreign countries around the world. Kroll-O'Gara's
principal properties and facilities as of December 31, 1998 were as follows:
BUILDING
LOCATION SQUARE FOOTAGE STATUS
-------- -------------- ------
Fairfield, Ohio................................. 130,000 owned
Lamballe, France................................ 125,000 leased
Sao Paulo, Brazil............................... 50,000 leased
New York, New York.............................. 39,000 leased
Gretna, Louisiana............................... 20,000 owned
Mexico City, Mexico............................. 20,000 owned
Washington, D.C. area........................... n/a leased
San Antonio, Texas.............................. n/a owned
Fairfield, Ohio. In addition to executive offices, this facility contains
full production and assembly facilities for Kroll-O'Gara's armored commercial
vehicles and the manufacturing and distribution of Up Armored HMMWVs. The
facility is financed through tax-exempt debt and is pledged to secure the
repayment of the debt. The facility includes a complete fabrication and machine
shop equipped with a computer controlled plasma cutter, a computer controlled
press break, mills, automated grinders, a robotic welder and two coordinate
measuring machines, paint booths and ancillary equipment for both military and
commercial painting.
Lamballe, France. The site contains facilities for production of armored
commercial and cash-in-transit vehicles, design studios for development of
prototypes, integrated computer systems, and areas for parts, fabrication,
painting and quality control. This facility also contains a ballistics range. It
currently is leased for a term expiring in September 2000. For accounting
purposes, this is treated as an operating lease.
Sao Paulo, Brazil. This facility, which was expanded to include a second
facility on an adjacent location in December 1996, is used for manufacturing and
sales of a full product line of armored commercial vehicles. It currently is
leased for a term expiring in March 2000. For accounting purposes, this lease is
treated as an operating lease.
New York, New York. This facility contains executive offices and serves as
the headquarters for Kroll-O'Gara's Investigations and Intelligence Group. The
space is leased for a term expiring in December 2007. For accounting purposes,
this lease is treated as an operating lease.
Gretna, Louisiana. This facility houses Kroll-O'Gara's drug testing
laboratory as well as serving as offices for Kroll-O'Gara's drug testing
subsidiary.
Mexico City, Mexico. This facility is used for manufacturing and sales of a
full product line of armored commercial vehicles. This facility was purchased in
1996.
Washington D.C. area. This facility is used for advanced security training
and includes a portion of an abandoned airport runway that is used for advanced
driver training. The facility is leased for a term expiring in May 2009. For
accounting purposes, this lease is treated as an operating lease.
San Antonio, Texas. This facility, which was acquired in 1997, consists of
165 acres of land used for advanced driver and force protection training.
Kroll-O'Gara's manufacturing capabilities include fully integrated
manufacturing programs which link production control, materials control, quality
control and accounting. Kroll-O'Gara's non-executive offices range from
approximately 320 square feet to approximately 8,800 square feet and are subject
to leases expiring through May 2002. Kroll-O'Gara believes that its facilities
are adequate for its current needs and that its properties, including machinery
and equipment, are generally in good condition, well maintained and suitable for
intended current and foreseeable uses.
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ITEM 3. LEGAL PROCEEDINGS
Kroll-O'Gara is involved in litigation from time to time in the ordinary
course of its business; however, Kroll-O'Gara does not believe that there is any
currently pending or threatened litigation, individually or in the aggregate,
that is likely to have a material adverse effect on its business or financial
condition.
ITEM 4. SUBMISSION OF MATTERS TO A VOTE OF SECURITY HOLDERS
Not Applicable.
DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
SEE ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT.
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PART II
ITEM 5. MARKET FOR REGISTRANT'S COMMON EQUITY AND RELATED STOCKHOLDER MATTERS
Kroll-O'Gara common stock trades on the Nasdaq National Market under the
symbol "KROG." On February 28, 1999, there were approximately 1,900 beneficial
owners of Kroll-O'Gara common stock.
The table below sets forth the high and low sale prices for Kroll-O'Gara
common stock as reported by The Nasdaq Stock Market for the periods indicated.
HIGH LOW
------ ------
1997
First Quarter............................................... $13.25 $ 9.00
Second Quarter.............................................. 13.00 9.00
Third Quarter............................................... 15.00 10.25
Fourth Quarter.............................................. 20.00 16.00
1998
First Quarter............................................... 19.25 16.50
Second Quarter.............................................. 22.00 17.00
Third Quarter............................................... 26.00 18.50
Fourth Quarter.............................................. 40.50 20.00
DIVIDENDS
Kroll-O'Gara expects that any future earnings will be retained to finance
its operations and for the growth and development of its business. Accordingly,
Kroll-O'Gara currently does not expect to pay cash dividends on its common stock
in the foreseeable future. Additionally, the terms of Kroll-O'Gara's Senior
Notes and the credit agreement with its bank require maintenance of certain
financial ratios which may limit the funds available for cash dividends. The
payment of any future dividends will be subject to the discretion of the Board
of Directors of Kroll-O'Gara and will depend on Kroll-O'Gara's results of
operations, financial position and capital requirements, general business
conditions, restrictions imposed by financing arrangements, if any, legal
restrictions on the payment of dividends and other factors its Board of
Directors deems relevant.
SALE OF UNREGISTERED SECURITIES
During the fourth quarter of 1998, Kroll-O'Gara issued shares of Common
Stock to the former owners or shareholders of the following companies in
connection with the acquisition of each entity:
COMPANY DATE NUMBER OF SHARES
------- ---- ----------------
Holder Associates, S.A. (1 person)................ October 1 46,287
Schiff & Associates (6 persons)................... December 31 169,521
Securify Inc. (18 persons)........................ December 31 1,430,936
In each case the issuances were exempt from registration pursuant to
Section 4(2) of the Securities Act of 1933.
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ITEM 6. SELECTED FINANCIAL DATA (IN THOUSANDS, EXCEPT PER SHARE DATA)
The following selected financial data reflects mergers during 1997 and 1998
which were accounted for as poolings of interest. The prior period consolidated
financial information has been restated as though the entities had always been
part of Kroll-O'Gara. The selected financial data also includes the completion
of other acquisitions in 1997 and 1998 that utilized the purchase method of
accounting, which requires including the reported results of each acquired
business from the effective date of its acquisition. The selected historical
financial data presented as of December 31, 1997 and 1998 and for each of the
three years ended December 31, 1998, have been derived from the audited
Consolidated Financial Statements of Kroll-O'Gara presented elsewhere in this
annual report. The consolidated financial data as of December 31, 1994, 1995,
and 1996 and for the years ended December 31, 1994 and 1995 are derived from
Kroll-O'Gara's unaudited consolidated financial statements not included in this
annual report. The selected financial data should be read in conjunction with
the Consolidated Financial Statements and Notes thereto and "Management's
Discussion and Analysis of Financial Condition and Results of Operations."
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
STATEMENT OF OPERATIONS DATA:
Net sales............................. $91,784 $94,998 $164,918 $206,103 $264,845
Cost of sales......................... 58,480 66,764 117,298 139,766 173,317
------- ------- -------- -------- --------
Gross profit........................ 33,304 28,234 47,620 66,337 91,527
Selling, general and administrative
expenses, including amortization.... 32,227 31,809 37,712 47,646 61,773
Asset impairment...................... -- -- 125 -- --
Merger related expenses............... -- -- -- 7,205 5,339
------- ------- -------- -------- --------
Operating income (loss)............. 1,077 (3,575) 9,783 11,486 24,414
Interest expense...................... (2,599) (2,897) (3,261) (5,092) (4,482)
Other income (expense), net........... 533 18 386 (332) 623
------- ------- -------- -------- --------
Income (loss) from continuing
operations before minority
interest, provision (benefit) for
income taxes, extraordinary item
and cumulative effect of change
in accounting principle.......... (989) (6,454) 6,908 6,062 20,555
Minority interest..................... -- -- -- (156) --
------- ------- -------- -------- --------
Income (loss) from continuing
operations before provision
(benefit) for income taxes,
extraordinary item and cumulative
effect of change in accounting
principle........................ (989) (6,454) 6,908 5,906 20,555
Provision (benefit) for income
taxes............................... (1,540) (824) 365 3,305 7,466
------- ------- -------- -------- --------
Income (loss) from continuing
operations before extraordinary
item and cumulative effect of
change in accounting principle... 551 (5,630) 6,543 2,601 13,089
Loss from operations and disposal of
discontinued clinical business,
net of tax....................... -- -- (1,274) -- --
------- ------- -------- -------- --------
Income (loss) before extraordinary
item and cumulative effect of
change in accounting principle... 551 (5,630) 5,268 2,601 13,089
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YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
Extraordinary item, net of tax........ -- -- -- (194) --
------- ------- -------- -------- --------
Income (loss) before cumulative
effect of change in accounting
principle........................ 551 (5,630) 5,268 2,407 13,089
Cumulative effect of change in
accounting principle, net of tax.... -- -- -- (360) --
------- ------- -------- -------- --------
Net income (loss)..................... $ 551 $(5,630) $ 5,268 $ 2,047 $ 13,089
======= ======= ======== ======== ========
Basic earnings (loss) per share from
continu-ing operations.............. $ 0.06 $ (0.52) $ 0.45 $ 0.15 $ 0.71
======= ======= ======== ======== ========
Basic weighted average shares
outstanding......................... 8,926 10,884 11,607 14,007 18,439
======= ======= ======== ======== ========
Diluted earnings (loss) per share from
continuing operations............... $ 0.01 $ (0.52) $ 0.42 $ 0.14 $ 0.69
======= ======= ======== ======== ========
Diluted weighted average shares
outstanding......................... 9,384 10,884 12,161 14,799 18,965
======= ======= ======== ======== ========
YEAR ENDED DECEMBER 31,
------------------------------------------------------
1994 1995 1996 1997 1998
------- ------- -------- -------- --------
BALANCE SHEET DATA:
Working capital....................... $17,396 $ 7,627 $ 11,991 $ 35,278 $ 83,370
Net property, plant, and equipment.... 7,752 8,305 10,763 17,560 23,893
Total assets.......................... 70,907 75,440 92,064 150,484 248,956
Long-term debt, including current
portion............................. 28,010 31,953 27,939 54,239 41,223
Shareholders' equity.................. 16,926 11,471 23,117 38,467 141,095
ITEM 7. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
The following discussion of results of operations and financial condition
is based upon and should be read in conjunction with Kroll-O'Gara's Consolidated
Financial Statements and Notes. As a result of the acquisitions made by the
Company in 1997 and 1998 (see below), financial results from period-to-period
may lack comparability. Additionally, effective December 31, 1998, the Company
established the Information Security Group. Historical revenue amounts have been
reclassified to conform to the current categories.
GENERAL
Kroll-O'Gara is a leading global provider of a broad range of specialized
products and services that are designed to provide solutions to a variety of
security needs. Historically, Kroll-O'Gara reported its revenue through three
groups. The Security Products and Services Group markets ballistic and blast
protected vehicles and security services. The Investigations and Intelligence
Group offers business intelligence and investigation services. The Voice and
Data Communications Group offers secure satellite communication equipment and
satellite navigation systems. With the acquisition of Securify Inc.,
Kroll-O'Gara established a new Information Security Group. The Information
Security Group offers information and computer security services, including
network and system security review and repair.
On May 5, 1998, Kroll-O'Gara completed a public offering of 3,200,000
shares of its common stock at $20.50 per share, resulting in net proceeds to
Kroll-O'Gara of $60.4 million. A portion of the net proceeds was used to pay off
$14.8 million of indebtedness, with the balance available for potential
acquisitions, working capital and other general corporate purposes. In addition
to the shares sold by Kroll-O'Gara, certain shareholders sold 1,860,000 shares
of Kroll-O'Gara common stock in conjunction with the offering. The offering
followed Kroll-O'Gara's initial public offering, which was completed on November
15, 1996 and resulted in the issuance of 2,048,000 shares of common stock.
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Merger with Kroll Holdings. The merger with Kroll Holdings, Inc. ("KHI")
was completed on December 1, 1997. In the KHI merger, 6,098,561 shares of common
stock were issued and an aggregate of $14.5 million in outstanding indebtedness
of KHI was repaid. Approximately 550,000 additional shares of Kroll-O'Gara
common stock were reserved for issuance upon the exercise of options held by KHI
employees, which were assumed by Kroll-O'Gara. Revenues of KHI comprise all of
those reported by the Investigations and Intelligence Group as well as certain
revenues in the other two Groups.
Other Acquisitions. Kroll-O'Gara has pursued a strategy of aggressive
growth and has completed numerous other acquisitions in 1997 and 1998, some of
which have been accounted for as poolings of interest and others of which have
been accounted for as purchases. These acquisitions are listed in the chart
which follows.
POOLINGS(1)
COMPANY BUSINESS GROUP DATE ACQUIRED PRICE
------- -------- ----- ------------- -----
Laboratory Drug testing Investigations and December 7, 1998 1,209,053 shares
Specialists of Intelligence
America, Inc.(2)
Securify Inc. Information security Information Security December 31, 1998 1,430,936 shares
services
Schiff & Associates, Security architectural Investigations and December 31, 1998 169,521 shares
Inc. services Intelligence
PURCHASES(3)
COMPANY BUSINESS GROUP DATE ACQUIRED PRICE
------- -------- ----- ------------- -----
Labbe, S.A. Armors commercial Security Products January 1, 1997 $10.7 million in cash
vehicles and builds and Services and 376,597 shares
truck bodies in France
Next Destination, Distributes high Voice and Data February 1, 1997 170,234 shares and $1.6
Limited technology products for Communications million in financing
the global positioning
satellite and satellite
communications markets
International Advanced security Security Products March 1, 1997 $0.5 million in cash,
Training, Inc. training and Services 68,086 shares and $1.2
million in financing
ZAO IMEA Armors cash-in transit Security Products December 2, 1997 $0.6 million in cash and
vehicles and distributes and Services 138,889 shares
commercial bank
equipment in Russia
Corplex, Inc. Investigative and Investigations and March 1, 1998 29,207 shares
executive protection Intelligence
services
Lindquist Avey Forensic and Investigations and June 1, 1998 $4.7 million in cash and
MacDonald investigative accounting Intelligence 278,340 shares
Baskerville, Inc. services; headquartered
in Canada
Kizorek, Inc. Video surveillance Investigations and July 1, 1998 $0.8 million in cash and
services Intelligence 352,381 shares
Protec S.A. Armors cars in Colombia Security Products September 30, $3.2 million in cash and
and Services 1998 38,788 shares
Holder Associates, Security services in Investigations and October 1, 1998 $4.5 million in cash and
S.A. Argentina Intelligence 46,287 shares
Fact Finders Limited Investigates Investigations and November 1, 1998 $3.2 million in cash,
intellectual property Intelligence plus a 3-year earn-out
infringement cases in based on profits
Hong Kong and the
Peoples Republic of
China
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- ---------------
(1) Pooling of interest accounting requires the restating of all prior period
consolidated financial information as though the acquired entity had always
been a part of Kroll-O'Gara.
(2) In 1997 and 1998 Laboratory Specialists paid a total of approximately $5.9
million to acquire customer lists and related assets from Pathology
Laboratories, Ltd., Harrison Laboratories, Inc., Accu-Path Medical
Laboratory, Inc., and TOXWORX Laboratories, Inc.
(3) Kroll-O'Gara's consolidated financial statements include the reported
results of each entity from its effective date of acquisition forward.
On January 21, 1998, Kroll-O'Gara entered into a definitive agreement to
acquire all of the capital stock of Background America, Inc. of Nashville,
Tennessee, in exchange for approximately 900,000 shares of Kroll-O'Gara common
stock. Background America provides background investigation services to
government, corporate, not-for-profit, professional and other clients. The
transaction is expected to be accounted for as a pooling of interests.
Background America will report revenue through the Investigations and
Intelligence Group.
On March 1, 1999, Kroll-O'Gara acquired all of the capital stock of
Financial Research, Inc. of Fort Washington, Pennsylvania, in exchange for
101,555 shares of Kroll-O'Gara common stock (valued at approximately $3.3
million or $32.49 per share). The acquisition has been accounted for as a
pooling of interests. Financial Research provides business valuation and
economic damage analysis services throughout the United States. It reports
revenue through the Investigation and Intelligence Group.
Revenue recognition. Kroll-O'Gara recognizes net sales from government and
most commercial armoring contracts using the percentage-of-completion method
calculated utilizing the cost-to-cost approach. Under this method, Kroll-O'Gara
accrues estimated contract revenues based generally on the percentage that costs
to date bear to total estimated costs and recognizes estimated contract losses
in full when it becomes likely that a loss will occur. Accordingly, Kroll-O'Gara
periodically reviews and revises contract revenues and total cost estimates as
the work progresses and as change orders are approved. It reflects adjustments
in contract revenues, based upon the percentage of completion, in the period
when the estimates are revised. To the extent that these adjustments result in
an increase, a reduction or an elimination of previously reported contract
revenues, Kroll-O'Gara recognizes a credit or a charge against current earnings,
which could be material. Contract costs include all direct material and labor
costs, along with certain overhead costs allocated to contract production.
Kroll-O'Gara records provisions for any estimated total contract losses on
uncompleted contracts in the period in which it conclude that such losses will
occur. Changes in estimated total contract costs result in revisions to contract
revenue. The revisions are recognized when determined.
Kroll-O'Gara recognizes revenue from investigative and intelligence
services as the services are performed. It records either billed or unbilled
accounts receivable based on case-by-case invoicing determinations.
Kroll-O'Gara recognizes information security service revenues, which
consist of consulting fees on information security projects, ratably over the
period of the agreement or according to the completed contract method of
accounting for contract revenues, depending on the nature of the agreement.
Kroll-O'Gara recognizes revenue related to telecommunications equipment and
services as equipment is shipped or as services are provided. It records revenue
and related direct costs of brokered satellite time when payments are received
from customers.
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RESULTS OF OPERATIONS
The following table sets forth, for the periods indicated, the items noted
as a percentage of net sales:
YEAR ENDED DECEMBER 31,
-----------------------
1996 1997 1998
----- ----- -----
Security products and services
Commercial................................................ 14.9% 30.0% 29.1%
Military.................................................. 33.1 21.2 22.6
Investigations and intelligence............................. 47.3 40.3 41.6
Information security........................................ -- -- --
Voice and data communications............................... 4.7 8.5 6.7
----- ----- -----
Total net sales........................................... 100.0% 100.0% 100.0%
Cost of sales............................................... 71.1 67.8 65.4
----- ----- -----
Gross profit.............................................. 28.9 32.2 34.6
Operating expenses:
Selling and marketing..................................... 6.3 7.3 8.3
General and administrative................................ 16.6 15.8 15.0
Asset impairment.......................................... 0.1 -- --
Merger related costs...................................... -- 3.5 2.0
----- ----- -----
Operating income............................................ 5.9 5.6 9.2
Other income (expense):
Interest expense.......................................... (1.9) (2.5) (1.7)
Interest income........................................... 0.0 0.0 0.4
Other, net................................................ 0.2 (0.2) (0.2)
----- ----- -----
Income from continuing operations before provision (benefit)
for income taxes, extraordinary item and cumulative effect
of accounting change...................................... 4.2 2.9 7.8
Provision for income taxes.................................. 0.2 1.6 2.8
----- ----- -----
Income from continuing operations before extraordinary item
and cumulative effect of accounting change................ 4.0 1.3 4.9
Loss from operations and disposal of discontinued clinical
business, net of tax...................................... (0.8) -- --
----- ----- -----
Income before extraordinary item and cumulative effect of
accounting change......................................... 3.2 1.3 4.9
Extraordinary item.......................................... -- (0.1) --
Cumulative effect of accounting change...................... -- (0.2) --
----- ----- -----
Net income.................................................. 3.2% 1.0% 4.9%
===== ===== =====
1998 COMPARED TO 1997
NET SALES. Net sales for the year ended December 31, 1998 increased $58.7
million, or 29%, from $206.1 million in 1997 to $264.8 million in 1998.
Security Products and Services Group. For the year ended December 31, net
sales for the Security Products and Services Group increased $31.3 million, or
30%, from $105.6 million in 1997 to $136.8 million in 1998. The increase
includes net sales of commercial products and services, which increased $15.2
million, or 25%, from $61.8 million in 1997 to $77.0 million in 1998. The
increase in commercial net sales was primarily due to continued growth in
Kroll-O'Gara's international armoring divisions. During 1996, 1997, and 1998,
Kroll-O'Gara initiated start-up armoring operations in Mexico, Brazil and the
Philippines, and acquired Labbe, IMEA and the assets of Protec. Kroll-O'Gara
will continue its efforts to expand the operations of its existing
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foreign subsidiaries along with evaluating new acquisition opportunities and
opportunities for entry into new markets.
Increases in net sales for security services also contributed to the
increase in commercial net sales for the Security Products and Services Group.
Net sales of these services increased $2.1 million, or 29%, for the year ended
December 31, 1998 in comparison with 1997.
Net sales for the Security Products and Services Group include sales of
military products and services, which increased $16.1 million, or 37%, from
$43.7 million in 1997 to $59.8 million in 1998. In April 1998, Kroll-O'Gara
began work on a new contract with the U.S. Military to supply 738 Up-Armored
HMMWVs to the U.S. Army and the U.S. Air Force (the "738 Contract"). Production
on Kroll-O'Gara's previous contract with the U.S. Military for 360 Up-Armored
HMMWVs (the "360 Contract") continued through July 1998. The combination of
production on the two contracts was a factor in the increase in net sales.
Currently, HMMWV production is based only on the 738 Contract.
Based on certain internal requirements, the U.S. Air Force has dictated an
aggressive delivery schedule for the 738 Contract. This delivery schedule has
required Kroll-O'Gara to maintain an increased level of production for the
Up-Armored HMMWV in comparison with production levels in previous periods.
Management expects to maintain the increased level of production and net sales
in 1999, with decreases as the 738 Contract nears completion at the end of the
year.
Investigations and Intelligence Group. For the year ended December 31, net
sales for the Investigations and Intelligence Group increased $27.1 million, or
33%, from $83.1 million in 1997 to $110.2 million in 1998. The increases in 1998
were primarily due to the inclusion of net sales from the acquisitions of
Lindquist Avey, InPhoto, Corplex, Fact Finders, and Holder. Excluding net sales
reported by these acquired entities, net sales for the Investigations and
Intelligence Group would have been $90.9 million for the year ended December 31,
1998, in comparison with $83.1 million for the year ended December 31, 1997, an
increase of 9%.
The increase in net sales without acquisitions in the Investigations and
Intelligence Group was the result of an internal growth plan carried out by the
Group in 1998. During the year, the Investigations and Intelligence Group opened
offices in Dallas, Boston, Houston and Mexico City. The internal growth plan
will continue in 1999, with the Group seeking additional markets for its
products, both domestic and foreign.
Information Security Group. The Information Security Group initiated
operations in 1998, recording net sales of $0.1 million. Management expects the
Information Security Group's product offerings to result in significantly higher
Group sales in 1999.
Voice and Data Communications Group. For the year ended December 31, net
sales for the Voice and Data Communications Group increased $0.2 million, or 1%,
from $17.4 million in 1997 to $17.6 million in 1998. Late in the second quarter
of 1998, Kroll-O'Gara was approached by a third party interested in purchasing
the Voice and Data Communications Group. The Group's management during the
latter part of the second quarter and throughout a majority of the third quarter
was focused on negotiations, due diligence requests, and related demands on
their time. The diversion resulted in a decrease in net sales in the third
quarter of 1998. Due to several factors, the potential buyer decided not to
complete the transaction, and all discussions were abandoned. Kroll-O'Gara does
not expect to incur any material charges associated with these discussions.
COST OF SALES AND GROSS PROFIT. For the year ended December 31, cost of
sales increased $33.6 million, or 24%, from $139.8 million in 1997 to $173.3
million in 1998. The increase in cost of sales was due to the increased level of
business activity experienced in 1998. Gross profit as a percentage of net sales
was 32.2% and 34.6% for 1997 and 1998, respectively. This increase is primarily
due to an increase in gross profit as a percent of net sales experienced in the
Investigations and Intelligence Group. This increase, approximately 5%, was due
to a more efficient use of subcontract services and certain high margin
engagements booked during the year which are historically infrequent in nature.
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The gross profit percents for the Security Products and Services Group were
28.5% and 28.4% in 1998 and 1997, respectively. In the Voice and Data
Communications Group, gross margin percent increased from 17.9% in 1997 to 20.0%
in 1998 due to a one time reconciliation of cost recognized on air time sold
with the satellite communications equipment.
Because these engagements are historically infrequent, management does not
expect to maintain the level of gross profit as a percent of net sales reflected
in the results of the Investigations and Intelligence Group for the year ended
December 31, 1998. As always, the gross profit percent will vary on the mix of
sales from the four groups. Kroll-O'Gara historically has experienced its
highest levels of gross profit as a percent of net sales in the Investigations
and Intelligence Group and its lowest in the Voice and Data Communications
Group. As revenue from the Investigations and Intelligence Group increases as a
percent of total net sales, the gross profit percent should increase as well.
OPERATING EXPENSES. Operating expenses for the year ended December 31,
1998, increased $12.3 million, or 22%, to $67.1 million from $54.9 million for
the same period in 1997. Included in operating expenses in 1997 were
approximately $7.2 million in expenses related to the merger with KHI. In 1998
Kroll-O'Gara recorded approximately $5.3 million in merger related expenses
associated with the Laboratory Specialists, Schiff, and Securify mergers.
Before merger related expenses, operating expenses increased $14.2 million,
or 30%, from $47.6 million in 1997 to $61.8 million in 1998. The increase was
primarily attributable to an increase in the level of personnel and professional
services required to administer the growth experienced by Kroll-O'Gara in 1998.
As a percent of net sales, operating expenses, before merger related costs,
were 23% in 1997 and 1998. As a result of investments made by Kroll-O'Gara in
facilities and personnel in previous periods, Kroll-O'Gara did not require
additional commitment of fixed cost relative to the level of net sales in 1998.
As sales increase further, Kroll-O'Gara will be required to commit additional
amounts of fixed cost to secure increased incremental net sales.
INTEREST EXPENSE. Interest expense for the year ended December 31, 1998
decreased $0.6 million, or 12%, to $4.5 million, compared to $5.1 million in
1997. With the completion of Kroll-O'Gara's May 1998 offering, a significant
portion of Kroll-O'Gara's indebtedness was paid off (approximately $14.8
million). As a result, Kroll-O'Gara experienced lower interest expense starting
in the third quarter of 1998 and expects interest expense to be lower in
comparison with periods prior to that offering.
On May 30, 1997, Kroll-O'Gara entered into an agreement with certain
institutional investors to issue and sell $35.0 million worth of Senior Notes.
This agreement contained a provision for a reduction of the interest rate if
certain criteria were met. Kroll-O'Gara complied with the specified criteria and
the step down of rates commenced in the second quarter of 1998. The reduction,
which changed the interest rate from 9.56% to 8.56%, contributed to the decrease
in interest expense in 1998.
INTEREST INCOME. Interest income for the year ended December 31, 1998
increased $1.1 million, or 1396%, to $1.2 million, compared to $0.1 million in
1997. Net proceeds of the May 1998 offering that were not used to pay down debt
were invested in short-term instruments with maturities of three months or less.
The return on these investments was responsible for the increase in interest
income in 1998. Management anticipates that it will continue to have funds
available for investment in the foreseeable future. As a result, Kroll-O'Gara
anticipates it will continue to experience higher levels of interest income in
1999 in comparison with periods prior to the May 1998 offering.
PROVISION FOR INCOME TAXES. The provision for income taxes was $7.5 million
for the year ended December 31, 1998 in comparison with $3.3 million for the
same period in 1997. The effective tax rates for the periods were 56% in 1997
and 36% in 1998. In 1997, Kroll-O'Gara booked taxes at an effective rate
significantly higher than it had previously experienced largely due to the
non-deductibility of certain merger related expenses incurred in the period. In
1998, Kroll-O'Gara determined that certain of the KHI merger expenses qualified
for future deductibility which favorably impacted the effective tax rate in
1998.
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In addition, the 1998 tax provision also reflects the favorable impact of
certain foreign locations with statutory tax rates at levels below U.S. tax
rates and the reversal of the valuation allowance related to certain foreign net
operating loss carryforwards. Management expects the effective tax rate to be
approximately 40% in 1999.
1997 COMPARED TO 1996
NET SALES. Net sales increased $41.2 million, or 25%, from $164.9 million
in 1996 to $206.1 million in 1997. The primary reasons for this change were the
acquisitions made in Kroll-O'Gara's Security Products and Services Group and
Voice and Data Communications Group in 1997.
Security Products and Services Group. Net sales for the Security Products
and Services Group increased $26.4 million, or 33%, from $79.2 million in 1996
to $105.6 in 1997.
The Group's net sales for 1997 from commercial products and services were
$61.8 million, an increase of $37.3 million, or 152%, over 1996. This increase
was due to several factors, including primarily the incorporation of net sales
from Labbe and ITI in the Groups's results. Excluding acquisitions, net sales
from commercial products and services increased $12.7 million, or 52%.
Kroll-O'Gara experienced significant growth in its Brazilian and Mexican
armoring subsidiaries, a trend management believes will continue for the
forseeable future. With the purchase of IMEA and the initiation of a start-up
armoring operation in the Philippines, the Security Products and Services Group
continued its expansion in existing and new markets.
In 1996, the U.S. Military requested accelerated production of Up-Armored
HMMWV's. This resulted in net sales of $54.6 million in 1996. Military net sales
returned to a non-accelerated level in 1997, resulting in net sales from
military products decreasing by $10.9 million, or 20%, to $43.7 million in 1997.
Investigations and Intelligence Group. Net sales for the Investigations and
Intelligence Group increased $5.1 million, or 7%, from $78.0 million in 1996 to
$83.1 million in 1997. This increase was primarily due to an increase in
specimens analyzed by Laboratory Specialists, Kroll-O'Gara's drug testing
subsidiary. The increase in specimens analyzed was due to certain asset
purchases made in early 1997, along with additional accounts obtained through
normal sales and marketing efforts.
Most of the revenue reported by the Investigations and Intelligence Group
is generated by KHI. Throughout 1997, KHI was actively involved in various
strategic discussions that contemplated the sale of the company. Pending the
outcome of such discussions, KHI delayed implementation of its internal growth
plans. In addition, uncertainties surrounding the outcome of the discussions
resulted in the departure of certain KHI managers prior to the KHI merger.
Finally, in connection with the KHI merger and in an effort to improve its cost
structure, Kroll-O'Gara reduced personnel in certain markets. As a result,
revenue growth at KHI was flat in comparison with 1996.
Voice and Data Communications Group. During 1997, Kroll-O'Gara replaced its
primary wholesale distributor, acquired Next Destination, a subdistributor, and
reconfigured its distribution product mix to focus on the sale of satellite
communications equipment in addition to satellite navigation equipment. As a
result, Kroll-O'Gara experienced a higher than normal growth rate in 1997. Net
sales for the Voice and Data Communications Group were $17.4 million in 1997, an
increase of $9.7 million, or 124%, from $7.8 million in 1996.
COST OF SALES AND GROSS PROFIT. Cost of sales increased $22.5 million, or
19%, from $117.3 million in 1996 to $139.8 million in 1997. The increase in cost
of sales was due to increases in Kroll-O'Gara's level of business activity as a
result of the acquisitions made in 1997.
Security Products and Services Group. Gross profit as a percentage of net
sales for the Security Products and Services Group improved from 25.8% in 1996
to 28.4% in 1997. As revenues and costs are recognized using the
percentage-of-completion method of accounting, actual cost and gross profit may
be revised from previously estimated amounts. Historically Kroll-O'Gara has
experienced a higher gross profit percent related to net sales of commercial
armoring products in comparison with those of military armoring products. In the
future, Kroll-O'Gara expects to increase its percentage of sales from commercial
armoring products. However, because
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Kroll-O'Gara's gross profit percentage was affected favorably by adjustments
resulting from performance on certain contracts in 1997, Kroll-O'Gara does not
expect to maintain the 1997 gross profit percentage level in 1998.
Investigations and Intelligence Group. Gross profit as a percent of net
sales for the Investigations and Intelligence Group increased from 32.1% in 1996
to 40.0% in 1997. Gross profit percent in 1996 was unfavorably affected by a
write-off of $5.0 million in uncollectible accounts receivable relating to
services provided in earlier periods. Without the write-off, the gross profit
percentages would have been comparable between periods.
Voice and Data Communications Group. Prior to the acquisition of Next
Destination, Kroll-O'Gara's Voice and Data Communications Group realized a
higher gross profit percentage due to its mix of integrated products versus
distributed products. As a distributor, Next Destination's gross profit
percentages were relatively lower. As a result, the inclusion of revenue from
Next Destination caused a decrease in gross profit as a percent of net sales for
the Voice and Data Communications Group from 27.6% in 1996 to 17.9% in 1997.
Management expects the level of gross profit percentage experienced in 1997 to
be maintained in future periods.
OPERATING EXPENSES. Excluding expenses of $7.2 million related to the KHI
merger, operating expenses increased $9.8 million, or 26%, from $37.8 million in
1996 to $47.6 million in 1997. The $7.2 million in expenses related to the KHI
merger consisted of approximately $4.6 million in professional fees and expenses
and approximately $2.6 million relating to the integration of the operations of
the two companies. Included in the integration expenses were bonuses paid to
certain key employees as incentives to remain with Kroll-O'Gara and severance
payments made to employees who left Kroll-O'Gara in connection with the merger.
Also included was a charge made as a result of the acceleration of the vesting
of certain shares of restricted KHI stock immediately prior to the merger. All
of the costs related to the KHI merger were recognized in 1997 and will have no
effect on the earnings of Kroll-O'Gara in future periods.
The primary reason for the increase in operating expenses, exclusive of
expenses related to the KHI merger, was the inclusion of operations from the
acquisitions made in 1997. In addition, the increase in operating expenses
reflects Kroll-O'Gara's efforts to expand into new markets, both in the Security
Products and Service Group and the Investigations and Intelligence Group.
Excluding expenses related to the KHI merger, operating expenses as a percent of
net sales stayed essentially consistent between the periods at 23.1% in 1997 and
22.9% in 1996.
Prior to the KHI merger, KHI was involved in merger discussions with
Choicepoint, Inc., a subsidiary of Equifax, Inc. Choicepoint and KHI did not
reach a final agreement, and as result did not consummate the transaction.
Certain professional fees, which totaled approximately $0.5 million, associated
with the Choicepoint transaction are included in Kroll-O'Gara's operating
expenses in 1997.
INTEREST EXPENSE. Interest expense for 1997 increased $1.8 million, or 56%,
to $5.1 million, compared to $3.3 million in 1996. The increase in 1997 was the
result of increased borrowing to finance Kroll-O'Gara's 1997 acquisitions.
Kroll-O'Gara retired a portion of its debt with proceeds from the May 1998
offering. As a result, interest expense is expected to the lower in 1998 than in
1997.
OTHER, NET. Other income (expense), net decreased from $0.3 million of
income in 1996 to ($0.4) million in expense in 1997. The change was primarily
due to an increase in foreign currency translation losses recognized in 1997.
PROVISION FOR INCOME TAXES. The provision for income taxes was increased
from $0.4 million in 1996 to $3.3 million in 1997. Kroll-O'Gara's O'Gara-Hess &
Eisenhardt Armoring Company ("OHE") subsidiary did not book a tax provision for
the first ten months of 1996 due to OHE's S Corporation status, which was
terminated on October 28, 1996 in conjunction with a reorganization in advance
of Kroll-O'Gara's initial public offering.
Kroll-O'Gara incurred taxes at the effective rate of 56% in 1997 due to the
non-deductibility of certain expenses related to the KHI merger in the period
and the impact of foreign losses for which no benefit can be
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provided. Management believes that the rate is substantially higher than
Kroll-O'Gara will experience in 1998 and for future periods.
CUMULATIVE EFFECT OF CHANGE IN ACCOUNTING PRINCIPLE. Kroll-O'Gara had
previously capitalized costs related to the reengineering of certain information
systems. The capitalized amount, approximately $0.6 million before tax, was
expensed in 1997 in accordance with Emerging Issues Task Force No. 97-13
"Accounting for Costs Incurred in Connection with a Consulting Contract that
Combines Business Process Reengineering and Information Technology
Transformation." The amount expensed is shown net of applicable tax benefit of
$0.2 million.
DISCONTINUED OPERATIONS. In connection with the acquisition of National
Psychopharmacology Laboratory, Inc. Kroll-O'Gara's Laboratory Specialists
subsidiary attempted to sell the clinical testing and analysis lines of business
of National Psychopharmacology without success. In the fourth quarter of 1996,
Laboratory Specialists discontinued these operations resulting in a loss from
the discontinued operation of $0.5 million and a loss on the disposal of $0.8
million, after giving effect to a tax benefit of $0.3 million and $0.5 million,
respectively.
LIQUIDITY AND CAPITAL RESOURCES
General. Kroll-O'Gara historically has met its operating cash needs by
utilizing borrowings under its credit arrangements and net proceeds from public
offerings to supplement cash provided by operations, excluding non-cash charges
such as depreciation and amortization.
Credit Facility. Kroll-O'Gara's credit agreement with KeyBank National
Association ("KeyBank"), entered into in May 1997, was amended effective October
30, 1998. The amendment to the credit agreement allows Kroll-O'Gara to maintain
the same capacity on its revolving credit facility ($7.0 million) and its letter
of credit facility (approximately $7.7 million), while reducing the applicable
interest rates and revising the covenant restrictions. The interest rate on the
revolving credit facility will vary, based on certain financial ratios between
prime less 1.75% to prime less 0.25%, or, at Kroll-O'Gara's option, LIBOR plus
0.75% to LIBOR plus 1.50%. The covenants contained in the original credit
agreement were no longer appropriate given Kroll-O'Gara's capital structure
following the May 1998 offering. The covenants were adjusted to reflect the
changes experienced by Kroll-O'Gara and the changes anticipated in future
periods.
As of March 16, 1999, there were no borrowings under the revolving credit
agreement. The remaining proceeds from the May 1998 offering along with the
unused capacity on the revolving line of credit will be sufficient to fund the
working capital needs of Kroll-O'Gara for the foreseeable future.
Cash flows from operating activities. Operating activities used $12.4
million in net cash for the year ended December 31, 1998 in comparison with $6.2
million in net cash provided by operating activities in 1997. Since the
inception of Kroll-O'Gara's contract with the U.S. Government to armor the HMMWV
through the time of the merger with KHI and the acquisitions completed in 1997
and the first quarter of 1998, Kroll-O'Gara was designated a Small Business
according to U.S. Government procurement regulations. Thereafter, the
Kroll-O'Gara's designation was changed to Large Business for government
procurement purposes.
The change in designation affects progress payments made by the government
to Kroll-O'Gara over the course of a contract, and Kroll-O'Gara's cash flow, in
two ways. First, the progress payments are determined using a smaller percentage
of total cost committed than before. Second, Kroll-O'Gara is reimbursed for
vendor invoices paid instead of expenses incurred. Although these changes will
not affect the total amount ultimately collected, they defer certain amounts
previously included as part of a progress payment until the vehicles are
delivered.
The majority of these adjustments to the way Kroll-O'Gara is reimbursed for
its military business were applied to the HMMWV contracts in 1998. This resulted
in a significant increase in the balance of Cost and Estimated Earnings in
Excess of Billings on Uncompleted Contracts and its related effect on cash flows
from operating activities.
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Kroll-O'Gara will continue to absorb the effect of the change in
procurement designation throughout the life of the HMMWV contract. Although
there will be no effect on Cash Flows from Operating Activities on a cumulative
basis, the change in payment terms will impact accounts receivable and cost and
estimated earnings in excess of billings on uncompleted contracts from
period-to-period.
Also, Kroll-O'Gara's level of accounts receivable was higher in 1998
compared to 1997 due to the increased level of business activity experienced in
1998. Additionally, due to provisions of the purchase agreement, Kroll-O'Gara
did not record any accounts receivable on the opening balance sheet in
connection with the acquisition of Lindquist Avey. As of December 31, 1998,
Lindquist Avey had approximately $2.8 million recorded in accounts receivable,
helping to explain the significant amount of cash used by changes in accounts
receivable.
Cash flows from investing activities. Historically, Kroll-O'Gara has
limited its capital expenditure requirements by leasing certain assets. Capital
expenditures totaled $6.9 million for the year ended December 31, 1998, and $5.5
million for the same period in 1997. Additions to databases totaled $4.2 million
and $3.9 million for the year ended December 31, 1998 and 1997, respectively.
The levels of capital expenditures and additions to databases are in excess
of the amounts permitted by the credit agreement between Kroll-O'Gara and
KeyBank, due mainly to Kroll-O'Gara's mergers and acquisitions in 1998. KeyBank
has provided Kroll-O'Gara a waiver from the requirements of these covenants.
In addition to capital expenditures, 1997 investing activities included the
acquisitions of Labbe, IMEA and ITI, which required a total cash outlay of $10.7
million, net of cash acquired. In 1998, the acquisitions of Lindquist Avey,
InPhoto, Holder and Fact Finders as well as the assets of Protec, Pathology
Laboratories, Accu-Path, Harrison Laboratories and TOXWORX Laboratories required
cash of approximately $18.4 million, net of cash acquired. Management
anticipates that, as Kroll-O'Gara continues to pursue strategic acquisitions,
additional cash outlays will be required.
Cash flows from financing activities. Net cash provided by financing
activities was $58.3 million and $17.9 million for the year ended December 31,
1998 and 1997, respectively. Cash from financing activities in 1998 includes the
net proceeds from the May 1998 offering (approximately $60.4 million) completed
in the second quarter. In addition, Laboratory Specialists completed a private
offering of its stock in June 1998 with proceeds of approximately $2.3 million.
A portion of the proceeds from these transactions was used to pay off certain
indebtedness of the Company (approximately $14.8 million). The amounts not used
to pay off debt were invested in short-term instruments and are being used as
necessary for acquisitions, working capital and other general corporate
purposes.
Cash flows from Financing Activities also include convertible preferred
stock issued by Securify in 1998 (which was converted to Kroll-O'Gara common
stock in Kroll-O'Gara's acquisition of Securify). The net proceeds to Securify
associated with these shares were approximately $5.5 million.
Net cash provided by financing activities in 1997 largely reflects
borrowing under the Senior Notes that was used to finance certain acquisitions
and working capital requirements.
Foreign operations. Kroll-O'Gara attempts to mitigate the risks of doing
business in foreign countries by separately incorporating its operations in such
countries, maintaining reserves for credit losses, maintaining insurance on
equipment to protect against losses related to political risks and terrorism,
and using financial instruments to hedge Kroll-O'Gara's risk from translation
gains and losses.
Kroll-O'Gara utilizes derivative financial instruments, in the form of
forward contracts, to hedge some of its exposure to foreign currency rate
fluctuations. At December 31, 1998 eight such contracts, maturing between
January 1999 and December 2000, were outstanding in connection with intercompany
demand notes with Labbe and Lindquist Avey. These contracts are intended to
hedge Kroll-O'Gara's exposure to deterioration in the amount outstanding due to
changes in currency translation rates. The notional amount (together with
amortized premium) and the fair market value associated with these forward
contracts were $18.3 million and $0.9 million, respectively. Gains or losses on
existing forward instruments are offset against the translation effects
reflected in
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shareholders' equity. The fair value of forward contracts is not recognized in
the consolidated financial statements since they are accounted for as hedges.
Kroll-O'Gara does not hold or issue derivative financial instruments for trading
purposes.
Year 2000 Issues. Kroll-O'Gara has initiated a program to prepare for the
year 2000. During 1997, Kroll-O'Gara began the process of replacing the
enterprise systems at its two largest subsidiaries, both for the purpose of
making the systems Year 2000 compliant and to enhance the information systems
capabilities of these subsidiaries. The new systems are scheduled to be
operational by the end of the third quarter of 1999.
Additionally, Kroll-O'Gara is implementing a plan to prepare its remaining
systems for Year 2000. Kroll-O'Gara has completed an inventory of all its
computer software and embedded technology and has prepared a master database of
all technology potentially impacted by the Year 2000 issue. In conjunction with
outside consultants, Kroll-O'Gara now is in the process of evaluating the
findings from its inventory and formulating plans of action. Kroll-O'Gara
anticipates that it will have taken all the necessary steps to ensure no
interruption of services as result of the Year 2000 issue by the third quarter
of 1999. Total Year 2000 compliance cost is estimated to be approximately $4.0
million, of which approximately $3.6 million relates to the new enterprise
systems and will be capitalized. The remaining approximately $0.4 million will
be charged to expense over several reporting periods in accordance with
established accounting pronouncements, and is not expected to be material to
Kroll-O'Gara's results of operations or cash flows.
If systems are not in place or if all appropriate actions have not been
taken, Kroll-O'Gara's ability to administer and report revenue will be greatly
compromised. Both of Kroll-O'Gara's largest revenue Groups are, for the most
part, manual operations. The manufacture of bullet resistant vehicles and the
investigation and intelligence services provided by Kroll-O'Gara are not largely
dependent on embedded technology. Barring a catastrophic collapse from third
party sources, such as a lack of electrical power, Kroll-O'Gara should be able
to maintain production in its main revenue producing groups, although at a
reduced level.
Kroll-O'Gara's Voice and Data Communications Group relies on third party
compliance with the Year 2000 issue to ensure Kroll-O'Gara can continue to
operate in this area. The satellite and global positioning equipment marketed by
the Voice and Data Communications Group is exclusively dependent on the
compliance of the manufacturers of the equipment and the agencies that maintain
the satellites for its revenue. Limited services in Kroll-O'Gara's
Investigations and Intelligence Group, including certain intelligence gathering
services, rely solely on third party sources, such as Lexis-Nexis, for their
continued operation. Lack of compliance by third parties would significantly
impact Kroll-O'Gara in these areas.
Quarterly fluctuations. Kroll-O'Gara's operations may fluctuate on a
quarterly basis as a result of the timing of contract costs and revenues of its
Security Products and Services Group, particularly from its military and
governmental contracts which are generally awarded in a periodic and/or sporadic
basis. Kroll-O'Gara generally does not have long-term contracts with its clients
in its Investigations and Intelligence Group and its ability to generate net
sales is dependant upon obtaining many new projects each year, most of which are
of a relatively short duration. Period-to-period comparisons within a given year
or between years may not be meaningful or indicative of operating results over a
full fiscal year.
Forward-Looking Statements. Forward-looking statements, within the meaning
of Section 21E of the Securities Exchange Act of 1934, are made both in this
Management's Discussion and Analysis of Financial Condition and Results of
Operations and throughout this document. Forward-looking statements can be
identified by the use of language such as "may," "will," "expect," "anticipate,"
"estimate," "continue" or other similar words. Kroll-O'Gara's results may differ
materially from those in the forward-looking statements. Forward-looking
statements are based on management's current views and assumptions, and involve
risks and uncertainties that could significantly affect expected results. For
example, operating results may be affected by a number of external factors such
as actions of competitors, changes in laws and regulations, customer demand,
effectiveness of programs, strategic relations, fluctuations in the cost and
availability of resources, and foreign economic conditions, including currency
rate fluctuations.
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ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
See "Risk Factors" and "Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Foreign operations." In addition, the
information set forth in Note 13 "Fair Value of Financial Instruments" in the
Company's 1998 consolidated financial statements is incorporated herein by
reference.
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36
ITEM 8. FINANCIAL STATEMENTS AND SUPPLEMENTARY DATA
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To The Kroll-O'Gara Company:
We have audited the accompanying consolidated balance sheets of THE
KROLL-O'GARA COMPANY (Note 1) and subsidiaries as of December 31, 1997 and 1998
and the related consolidated statements of operations, shareholders' equity and
cash flows for each of the three years in the period ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits. We did not audit the 1996 financial statements of Kroll Holdings,
Inc., a company acquired during 1997 in a transaction accounted for as a pooling
of interests, as discussed in Note 1. Such statements are included in the
consolidated financial statements of The Kroll-O'Gara Company and reflect total
revenues of 43 percent of the consolidated totals. These statements were audited
by other auditors whose report has been furnished to us and our opinion, insofar
as it relates to amounts included for Kroll Holdings, Inc., is based solely upon
the report of the other auditors.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits and the report of other auditors provide a reasonable
basis for our opinion.
In our opinion based on our audits and the report of the other auditors,
the consolidated financial statements referred to above present fairly, in all
material respects, the financial position of The Kroll-O'Gara Company and
subsidiaries as of December 31, 1997 and 1998 and the results of their
operations and their cash flows for each of the three years in the period ended
December 31, 1998, in conformity with generally accepted accounting principles.
As explained in Note 2(s) to the consolidated financial statements,
effective in the fourth quarter of 1997, the Company changed its method of
accounting for costs incurred in connection with business process reengineering
activities.
Arthur Andersen LLP
Cincinnati, Ohio
March 19, 1999
35
37
INDEPENDENT AUDITORS' REPORT
The Stockholders of
Kroll Holdings, Inc.
We have audited the consolidated statements of operations, changes in
stockholders' equity and cash flows (not presented separately herein) of Kroll
Holdings, Inc. (the "Company") and subsidiaries for the year ended December 31,
1996. These consolidated financial statements are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated financial statements based on our audit.
We conducted our audit in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, such consolidated financial statements present fairly, in
all material respects, the results of the Company's and subsidiaries' operations
and their cash flows for the year ended December 31, 1996 in conformity with
generally accepted accounting principles.
/s/ DELOITTE & TOUCHE LLP
New York, New York
March 13, 1997
(August 8, 1997 as to Notes 7 and 17)
36
38
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1998
1997 1998
------------ ------------
ASSETS (NOTE 7)
CURRENT ASSETS:
Cash and cash equivalents.............................. $ 9,765,422 $ 12,862,928
Marketable securities.................................. 22,969 13,285,322
Trade accounts receivable, net of allowance for
doubtful accounts of approximately $3,100,064 and
$3,769,624 in 1997 and 1998, respectively (Notes 2
and 4)............................................... 40,796,471 55,570,815
Unbilled revenues (Note 2)............................. 3,081,481 7,766,015
Related party receivables (Note 6)..................... 939,894 2,720,464
Costs and estimated earnings in excess of billings on
uncompleted contracts (Note 4)....................... 12,078,464 26,408,097
Inventories (Note 4)................................... 19,562,899 22,397,939
Prepaid expenses and other............................. 6,786,288 7,794,242
Deferred tax asset (Note 5)............................ 572,697 --
------------ ------------
Total current assets.............................. 93,606,585 148,805,822
------------ ------------
PROPERTY, PLANT AND EQUIPMENT, at cost (Notes 2 and 8):
Land................................................... 1,831,042 1,856,003
Buildings and improvements............................. 8,100,454 8,271,967
Leasehold improvements................................. 5,242,607 6,290,089
Furniture and fixtures................................. 4,752,974 5,950,409
Machinery and equipment................................ 13,500,247 18,351,528
Construction-in-progress............................... 1,037,528 2,860,011
------------ ------------
34,464,852 43,580,007
Less -- accumulated depreciation....................... (16,904,830) (19,686,536)
------------ ------------
17,560,022 23,893,471
------------ ------------
DATABASES, net of accumulated amortization of $19,505,625
and $22,788,857 in 1997 and 1998, respectively (Note 2)... 8,335,211 9,238,903
COSTS IN EXCESS OF ASSETS ACQUIRED AND OTHER INTANGIBLE
ASSETS, net of accumulated amortization of $1,691,307 and
$4,213,426 in 1997 and 1998, respectively (Notes 2 and
3)........................................................ 26,651,017 60,938,886
OTHER ASSETS (Note 4)....................................... 4,331,645 6,078,977
------------ ------------
39,317,873 76,256,766
------------ ------------
$150,484,480 $248,956,059
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
37
39
THE KROLL-O'GARA COMPANY
CONSOLIDATED BALANCE SHEETS
AS OF DECEMBER 31, 1997 AND 1998
1997 1998
------------ ------------
LIABILITIES AND SHAREHOLDERS' EQUITY
CURRENT LIABILITIES:
Revolving lines of credit (Note 7)........................ $ 559,112 $ --
Current portion of long-term debt (Note 8)................ 4,038,080 1,965,752
Trade accounts payable.................................... 32,328,154 35,553,818
Related party payables (Note 6)........................... 1,184,439 341,358
Billings in excess of costs and estimated earnings on
uncompleted contracts.................................. 320,662 182,656
Accrued liabilities....................................... 15,212,260 22,013,571
Income taxes currently payable............................ 845,753 617,942
Deferred income taxes (Note 5)............................ -- 895,108
Customer deposits......................................... 3,839,770 3,865,219
------------ ------------
Total current liabilities......................... 58,328,230 65,435,424
OTHER LONG-TERM LIABILITIES................................. 1,532,730 1,542,588
DEFERRED INCOME TAXES (Note 5).............................. 2,514,606 1,625,363
LONG-TERM DEBT, net of current portion (Note 8)............. 49,641,484 39,257,245
------------ ------------
Total liabilities................................. 112,017,050 107,860,620
------------ ------------
COMMITMENTS AND CONTINGENCIES (Notes 9 and 12)
SHAREHOLDERS' EQUITY (Note 1):
Preferred stock, $.01 par value, 1,000,000 shares
authorized; none issued................................ -- --
Common stock, $.01 par value, 50,000,000 shares
authorized, 14,795,244 and 20,685,629 shares issued and
outstanding in 1997 and 1998, respectively............. 147,952 206,856
Additional paid-in-capital................................ 58,912,209 149,993,769
Retained deficit.......................................... (20,208,821) (7,119,915)
Deferred compensation..................................... -- (1,113,936)
Accumulated other comprehensive income (loss)............. (383,910) (871,335)
------------ ------------
Total shareholders' equity........................ 38,467,430 141,095,439
------------ ------------
$150,484,480 $248,956,059
============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated balance sheets.
38
40
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF OPERATIONS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
1996 1997 1998
------------ ------------ ------------
NET SALES.................................................. $164,918,313 $206,102,605 $264,844,847
COST OF SALES.............................................. 117,298,266 139,765,613 173,317,466
------------ ------------ ------------
Gross profit...................................... 47,620,047 66,336,992 91,527,381
OPERATING EXPENSES:
Selling and marketing.................................. 10,401,530 15,054,990 21,956,479
General and administrative............................. 27,310,521 32,590,832 39,817,057
Asset impairment (Note 2(i))........................... 124,531 -- --
Merger related costs................................... -- 7,204,926 5,339,358
------------ ------------ ------------
Operating expenses................................ 37,836,582 54,850,748 67,112,894
------------ ------------ ------------
Operating income.................................. 9,783,465 11,486,244 24,414,487
OTHER INCOME (EXPENSE):
Interest expense....................................... (3,260,945) (5,092,372) (4,481,823)
Interest income........................................ 41,260 79,438 1,181,579
Other, net............................................. 344,398 (411,576) (558,873)
------------ ------------ ------------
Income from continuing operations before minority
interest, provision for income taxes,
extraordinary item and cumulative effect of
change in accounting principle.................. 6,908,178 6,061,734 20,555,370
Minority interest...................................... -- (156,223) --
------------ ------------ ------------
Income from continuing operations before provision
for income taxes, extraordinary item and
cumulative effect of change in accounting
principle....................................... 6,908,178 5,905,511 20,555,370
Provision for income taxes............................. 365,547 3,304,993 7,466,464
------------ ------------ ------------
Income from continuing operations before
extraordinary item and cumulative effect of
change in accounting principle.................. 6,542,631 2,600,518 13,088,906
Discontinued operations (Note 2(h)):
Loss from operations of discontinued clinical
business, net of tax benefit of $257,904........ (500,636) -- --
Loss on disposal of clinical business, net of tax
benefit of $489,420............................. (773,580) -- --
------------ ------------ ------------
Income before extraordinary item and cumulative
effect of change in accounting principle........ 5,268,415 2,600,518 13,088,906
Extraordinary loss, net of applicable tax benefit of
$129,250 (Note 7).................................... -- (193,875) --
------------ ------------ ------------
Income before cumulative effect of change in
accounting principle............................ 5,268,415 2,406,643 13,088,906
Cumulative effect of change in accounting principle,
net of applicable tax benefit of $240,000 (Note
2(s))................................................ -- (360,000) --
------------ ------------ ------------
Net income........................................ $ 5,268,415 $ 2,046,643 $ 13,088,906
============ ============ ============
Earnings per share (Note 2(p)):
Basic............................................. $ 0.45 $ 0.15 $ 0.71
============ ============ ============
Diluted........................................... $ 0.42 $ 0.14 $ 0.69
============ ============ ============
Weighted average shares outstanding (Note 2(p)):
Basic............................................. 11,607,329 14,006,638 18,438,919
============ ============ ============
Diluted........................................... 12,160,974 14,799,322 18,964,734
============ ============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
39
41
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF SHAREHOLDERS' EQUITY
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
ADDITIONAL
COMPREHENSIVE COMMON PAID-IN RETAINED DEFERRED
SHARES INCOME STOCK CAPITAL DEFICIT COMPENSATION
---------- ------------- -------- ------------ ------------ ------------
BALANCE, December 31, 1995, as
previously reported.............. 10,020,277 $ 70,534 $ 22,040,722 $(17,652,332) $ --
Adjustment for pooling of interests
(Note 3)......................... 862,846 8,628 5,374,337 1,430,709 --
---------- -------- ------------ ------------ -----------
BALANCE, December 31, 1995, as
restated......................... 10,883,123 79,162 27,415,059 (16,221,623)
Distributions to shareholders,
prior to the offering............ -- -- -- (230,000) --
Sale of common stock between
shareholders prior to the
offering......................... -- -- 39,780 -- --
Issuances of stock under employee
benefit plans (Note 11).......... 528,308 4,073 911,813 -- --
Initial public offering of common
stock, net of issuance costs of
approximately $3,550,000 (Note
1)............................... 2,048,000 51,359 14,820,458 -- --
Distribution of previously taxed S
Corp earnings to S Corp
shareholders (Note 1)............ -- -- -- (9,000,000) --
Forgiveness of affiliate obligation
(Note 6)......................... -- -- -- 122,000 --
Comprehensive income:
Net income................... -- $ 5,268,415 -- -- 5,268,415 --
-----------
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of $237,000 tax
benefit.................. -- (355,534) -- -- -- --
Unrealized appreciation of
marketable securities,
net of $9,000 tax
provision................ -- 14,167 -- -- -- --
-----------
Other comprehensive income
(loss)................... -- (341,367) -- -- -- --
-----------
Comprehensive income....... -- $ 4,927,048 -- -- -- --
---------- =========== -------- ------------ ------------ -----------
BALANCE, December 31, 1996......... 13,459,431 134,594 43,187,110 (20,061,208) --
Issuances of stock under employee
benefit plans, including related
tax benefit (Note 11)............ 749,757 7,497 6,296,786 -- --
Issuance of stock in conjunction
with the acquisition of
businesses and minority interest
(Note 3)......................... 823,371 8,234 9,695,009 -- --
Issuance of stock in conjunction
with the settlement of a note
payable.......................... 21,721 217 232,282 -- --
Purchase and retirement of common
stock (Note 11 (c)).............. (259,036) (2,590) (498,978) (2,194,256) --
Comprehensive income:
Net income................... -- $ 2,046,643 -- -- 2,046,643 --
-----------
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of $157,000 tax
benefit.................. -- (236,393) -- -- -- --
Unrealized depreciation of
marketable securities,
net of $2,400 tax
benefit.................. -- (3,698) -- -- -- --
-----------
Other comprehensive income
(loss)................... -- (240,091) -- -- -- --
-----------
Comprehensive income....... -- $ 1,806,552 -- -- -- --
---------- =========== -------- ------------ ------------ -----------
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME (LOSS) TOTAL
------------- ------------
BALANCE, December 31, 1995, as
previously reported.............. $ 197,548 $ 4,656,472
Adjustment for pooling of interests
(Note 3)......................... -- 6,813,674
--------- ------------
BALANCE, December 31, 1995, as
restated......................... 197,548 11,470,146
Distributions to shareholders,
prior to the offering............ -- (230,000)
Sale of common stock between
shareholders prior to the
offering......................... -- 39,780
Issuances of stock under employee
benefit plans (Note 11).......... -- 915,886
Initial public offering of common
stock, net of issuance costs of
approximately $3,550,000 (Note
1)............................... -- 14,871,817
Distribution of previously taxed S
Corp earnings to S Corp
shareholders (Note 1)............ -- (9,000,000)
Forgiveness of affiliate obligation
(Note 6)......................... -- 122,000
Comprehensive income:
Net income................... -- 5,268,415
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of $237,000 tax
benefit.................. -- --
Unrealized appreciation of
marketable securities,
net of $9,000 tax
provision................ -- --
Other comprehensive income
(loss)................... (341,367) (341,367)
Comprehensive income....... -- --
--------- ------------
BALANCE, December 31, 1996......... (143,819) 23,116,677
Issuances of stock under employee
benefit plans, including related
tax benefit (Note 11)............ -- 6,304,283
Issuance of stock in conjunction
with the acquisition of
businesses and minority interest
(Note 3)......................... -- 9,703,243
Issuance of stock in conjunction
with the settlement of a note
payable.......................... -- 232,499
Purchase and retirement of common
stock (Note 11 (c)).............. -- (2,695,824)
Comprehensive income:
Net income................... -- 2,046,643
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of $157,000 tax
benefit.................. -- --
Unrealized depreciation of
marketable securities,
net of $2,400 tax
benefit.................. -- --
Other comprehensive income
(loss)................... (240,091) (240,091)
Comprehensive income....... -- --
--------- ------------
40
42
ADDITIONAL
COMPREHENSIVE COMMON PAID-IN RETAINED DEFERRED
SHARES INCOME STOCK CAPITAL DEFICIT COMPENSATION
---------- ------------- -------- ------------ ------------ ------------
BALANCE, December 31, 1997......... 14,795,244 147,952 58,912,209 (20,208,821) --
Public and private offerings of
common stock, net of issuance
costs of approximately
$1,431,000....................... 4,716,757 47,168 68,289,755 -- --
Net issuances of stock under
employee benefit plans, including
related tax benefit (Note 11).... 428,625 4,286 4,473,859 -- --
Issuance of stock in conjunction
with the acquisition of
businesses (Note 3).............. 745,003 7,450 17,125,850 -- --
Deferred compensation related to
stock options.................... -- -- 1,192,096 -- (1,113,936)
Comprehensive income:
Net income................... -- $13,088,906 -- -- 13,088,906 --
-----------
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of $764,000 tax
benefit.................. -- (476,956) -- -- -- --
Reclassification adjustment
for gain on securities
included in net income,
net of $7,000 tax
benefit.................. -- (10,469) -- -- -- --
-----------
Other comprehensive income
(loss)................... -- (487,425) -- -- -- --
-----------
Comprehensive income....... -- $12,601,481 -- -- -- --
---------- =========== -------- ------------ ------------ -----------
BALANCE, December 31, 1998......... 20,685,629 $206,856 $149,993,769 $ (7,119,915) $(1,113,936)
========== ======== ============ ============ ===========
ACCUMULATED
OTHER
COMPREHENSIVE
INCOME (LOSS) TOTAL
------------- ------------
BALANCE, December 31, 1997......... (383,910) 38,467,430
Public and private offerings of
common stock, net of issuance
costs of approximately
$1,431,000....................... -- 68,336,923
Net issuances of stock under
employee benefit plans, including
related tax benefit (Note 11).... -- 4,478,145
Issuance of stock in conjunction
with the acquisition of
businesses (Note 3).............. -- 17,133,300
Deferred compensation related to
stock options.................... -- 78,160
Comprehensive income:
Net income................... -- 13,088,906
Other comprehensive income,
net of tax:
Foreign currency
translation adjustment,
net of $764,000 tax
benefit.................. -- --
Reclassification adjustment
for gain on securities
included in net income,
net of $7,000 tax
benefit.................. -- --
Other comprehensive income
(loss)................... (487,425) (487,425)
Comprehensive income....... -- --
--------- ------------
BALANCE, December 31, 1998......... $(871,335) $141,095,439
========= ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
41
43
THE KROLL-O'GARA COMPANY
CONSOLIDATED STATEMENTS OF CASH FLOWS (NOTE 15)
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
1996 1997 1998
---------- ------------ ------------
CASH FLOWS FROM OPERATING ACTIVITIES:
Net income............................................ $5,268,415 $ 2,046,643 $ 13,088,906
Adjustments to reconcile net income to net cash
provided by (used in) operating activities-
Depreciation and amortization....................... 5,248,788 6,519,454 8,598,827
Bad debt expense.................................... 8,555,063 2,083,080 2,513,506
Shareholder stock compensation...................... 930,846 1,356,280 --
Loss on write-off of notes receivable............... -- 35,434 --
Share in net income of joint ventures............... (19,224) (121,650) --
Gain on sale of marketable securities............... (108,646) (14,503) (10,469)
Asset impairment.................................... 174,531 -- --
Disposal of clinical business....................... 1,263,000 -- --
Noncash compensation expense........................ -- -- 78,160
Change in assets and liabilities, net of effects of
acquisitions-
Receivables-trade and unbilled...................... (7,191,858) (9,974,669) (13,253,384)
Costs and estimated earnings in excess of billings
on uncompleted contracts......................... (7,626,473) 3,499,084 (14,329,633)
Inventories, prepaid expenses and other assets...... (3,274,443) (7,184,407) (4,089,617)
Accounts payable and income taxes currently
payable.......................................... 1,539,236 8,101,505 901,853
Billings in excess of costs and estimated earnings
on uncompleted contracts......................... (375,640) (1,009,740) (138,006)
Amounts due to/from related parties................. (294,471) 443,290 (2,623,651)
Deferred taxes...................................... (1,150,316) (156,892) (725,135)
Accrued liabilities, long-term liabilities and
customer deposits................................ 5,016,351 571,909 (2,446,382)
---------- ------------ ------------
Net cash provided by (used in) operating
activities................................... 7,955,159 6,194,818 (12,435,025)
---------- ------------ ------------
CASH FLOWS FROM INVESTING ACTIVITIES:
Purchases of property, plant and equipment, net....... (3,473,979) (5,521,131) (6,947,155)
Additions to databases................................ (3,250,360) (3,856,914) (4,186,924)
Decrease in notes receivable -- shareholder........... 233,253 -- --
Acquisitions, net of cash acquired (Note 3)........... (2,139,123) (10,710,128) (18,462,000)
Sales (purchases) of marketable securities, net....... 200,313 35,424 (13,262,353)
Other................................................. (66,711) 266,004 --
---------- ------------ ------------
Net cash used in investing activities.......... (8,496,607) (19,786,745) (42,858,432)
---------- ------------ ------------
CASH FLOWS FROM FINANCING ACTIVITIES:
Loan financing fees................................... -- (723,727) --
Net repayments under revolving lines of credit........ (252,818) (9,376,835) (559,112)
Proceeds from debt.................................... 179,569 44,902,987 284,857
Payments of long-term debt............................ (5,832,603) (10,042,503) (13,662,425)
Proceeds from notes payable -- shareholder............ 2,000,000 500,000 --
Repayment of notes payable -- shareholder............. (803,745) (7,238,766) --
Net proceeds from issuances of common stock........... 14,871,817 -- 68,336,923
Purchase and retirement of stock...................... -- (2,695,824) --
Foreign currency translation.......................... (46,187) (160,462) (593,494)
Distributions to shareholders, including preferred
dividends........................................... (9,230,000) -- --
Proceeds from exercise of stock options and
warrants............................................ 445 2,776,466 4,478,145
---------- ------------ ------------
Net cash provided by financing activities...... 886,478 17,941,336 58,284,914
---------- ------------ ------------
NET INCREASE IN CASH AND CASH EQUIVALENTS............... 345,030 4,349,409 2,991,457
Effects of foreign currency exchange rates on cash and
cash equivalents...................................... 34,032 (75,931) 106,049
---------- ------------ ------------
CASH AND CASH EQUIVALENTS, beginning of year............ 5,112,882 5,491,944 9,765,422
---------- ------------ ------------
CASH AND CASH EQUIVALENTS, end of year.................. $5,491,944 $ 9,765,422 $ 12,862,928
========== ============ ============
The accompanying notes to consolidated financial statements
are an integral part of these consolidated statements.
42
44
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
FOR THE YEARS ENDED DECEMBER 31, 1996, 1997 AND 1998
(1) NATURE OF OPERATIONS AND BASIS OF PRESENTATION
The Kroll-O'Gara Company, an Ohio corporation, together with its
subsidiaries (collectively the "Company"), is a leading global provider of a
broad range of specialized products and services that are designed to provide
solutions to a variety of security needs. The Company's Security Products and
Services Group markets ballistic and blast protected vehicles and security
services. The Investigations and Intelligence Group offers business intelligence
and investigation services. The Voice and Data Communications Group offers
secure satellite communication equipment and satellite navigation systems. The
Information Security Group offers information and computer security services,
including network and system security review and repair.
The Company was originally formed in 1996 for the purposes of becoming a
holding company, effecting a reorganization and a combination of certain
affiliated entities and carrying out an initial public offering of common stock.
On October 28, 1996, various O'Gara entities (primarily O'Gara-Hess & Eisenhardt
Armoring Company (OHE)) and their related shareholders (primarily one
shareholder who owned or controlled approximately 86% to 88% of each entity)
entered into the reorganization plan. Accordingly, the accompanying consolidated
financial statements present, as a combination of entities under common control
as if using the pooling method of accounting, the financial position and related
results of operations of the O'Gara entities on a consolidated basis for all
periods presented.
In December 1997, a wholly owned subsidiary of The O'Gara Company (O'Gara)
was merged into Kroll Holdings, Inc. (Kroll). At the time of the merger, the
Company's name was changed from The O'Gara Company to The Kroll-O'Gara Company.
The consolidated financial statements include the historical consolidated
financial statements of the Company and the financial position, results of
operations and cash flows of entities which were merged with the Company in
connection with pooling of interests business combinations (See Note 3).
(2) SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES
(a) Consolidation -- The consolidated financial statements include the
accounts of all majority-owned subsidiaries. All material intercompany accounts
and transactions are eliminated. Investments in 20% to 50% owned entities are
accounted for on the equity method and investments in less than 20% owned
entities are accounted for on the cost method. Affiliated entities are not
included in the accompanying consolidated financial statements, and include
entities that are directly or indirectly owned by current shareholders or former
shareholders.
(b) Revenue Recognition -- Revenue related to contracts for security
products (both government and commercial) results principally from long-term
fixed price contracts and is recognized on the percentage-of-completion method
calculated utilizing the cost-to-cost approach. The percent deemed to be
complete is calculated by comparing the costs incurred to date to estimated
total costs for each contract. This method is used because management considers
costs incurred to be the best available measure of progress on these contracts.
However, adjustments to this measurement are made when management believes that
costs incurred materially exceed effort expended. Contract costs include all
direct material and labor costs, along with certain direct overhead costs
related to contract production.
Provisions for any estimated total contract losses on uncompleted contracts
are recorded in the period in which it becomes known that such losses will
occur. Changes in estimated total contract costs will result in revisions to
contract revenue. These revisions are recognized when determined.
Revenue from intelligence and investigation services and information
security services is recognized as the services are performed. The Company
records either billed or unbilled accounts receivable based on case-by-case
invoicing determination.
43
45
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Revenue related to voice and data communications equipment and services is
recognized as equipment is shipped or as services are provided. Revenue and
related direct costs of brokered satellite time are recorded when payments are
received from customers.
(c) Cash and Cash Equivalents -- Cash equivalents consist of all highly
liquid debt instruments with an initial maturity of three months or less at the
date of purchase. The Company invests excess cash in overnight repurchase
agreements, which are government collateralized securities. The carrying amount
of cash and cash equivalents approximates fair value of those instruments due to
their short maturity.
(d) Marketable Securities -- The Company adopted the provisions of
Statement of Financial Accounting Standards No. 115, "Accounting for Certain
Investments in Debt and Equity Securities," (SFAS 115), for the year ended
December 31, 1996. Under SFAS 115, the Company must classify its debt and
marketable securities as either trading, available-for-sale or held-to-maturity.
The Company's marketable security investments consist largely of
available-for-sale municipal obligations. These securities are valued at current
market value, which approximates cost.
Unrealized holding gains and losses, net of the related income tax effect
on the available-for-sale securities are excluded from earnings and are reported
as a separate component of shareholders' equity until realized. The Company
recorded an unrealized loss of $3,698 as of December 31, 1997. There were no
such unrealized gains (losses) as of December 31, 1998.
(e) Concentrations of Credit Risk -- Financial instruments that subject the
Company to credit risk consist principally of trade receivables. Concentrations
of credit risk with respect to accounts receivable are limited by the number of
clients that comprise the Company's client base, along with the different
industries and geographic regions in which the Company's clients operate. The
Company does not generally require collateral or other security to support
client receivables, although the Company does require retainers, up-front
deposits or irrevocable letters-of-credit in many situations. The Company has
established an allowance for doubtful accounts based upon facts surrounding the
credit risk of specific clients and past history. Management does not anticipate
incurring losses on its trade receivables in excess of established allowances.
(f) Property, Plant and Equipment -- Property, plant and equipment are
stated at cost. Depreciation is computed on the straight-line method over the
estimated useful lives of the related assets as follows:
Buildings and improvements............................. 5-40 years
Furniture and fixtures................................. 5-10 years
Machinery and equipment................................ 5-12 years
Leasehold improvements................................. Life of lease
Vehicles............................................... 5 years
(g) Databases -- Databases are capitalized costs incurred to obtain
information from third party providers. The Company relies on this information
to create and maintain its proprietary and non-proprietary databases. Because of
the continuing accessibility of the information and its usefulness to future
investigative procedures, the cost of acquiring the information is capitalized
and amortized over a five year period. Amortization of databases for the years
ended December 31, 1996, 1997 and 1998 was $2,949,134, $2,937,152 and
$3,283,232, respectively.
(h) Discontinued Operation -- In connection with the acquisition of a
company specializing in forensic and clinical testing and analysis, the Company
shut down the clinical operations effective in the fourth quarter of 1996. The
Company had intended to sell the clinical business, however, negotiations with
three potential buyers failed. The revenues related to the discontinued clinical
operation for the year ended December 31, 1996 were approximately $3,413,000.
The related operating loss and shut down expenses of the clinical business are
included in the accompanying consolidated statements of operations as
"discontinued operation" and "disposition of discontinued operation,"
respectively.
44
46
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(i) Impairment of Long-Lived Assets -- Effective January 1, 1996, the
Company adopted the provisions of SFAS No. 121, "Accounting for the Impairment
of Long-Lived Assets and for Long-Lived Assets to Be Disposed Of" (SFAS 121).
This standard requires that long-lived assets, certain identifiable intangibles
and goodwill related to those assets be reviewed for impairment by asset group
for which the lowest level of independent cash flows can be identified. In
accordance with this standard, the Company periodically reviews the carrying
value of these assets and impairments are recognized when the expected
undiscounted future cash flows are less than the carrying amount of the asset.
Based on its most recent analysis, the Company believes no impairment exists at
December 31, 1998. However, it is possible, due to a change in circumstances,
that the carrying value could become impaired in the future. Such impairment
could have a material effect on the results of operations in a particular
reporting period.
The adoption of SFAS 121 in 1996 resulted in no adjustment to the
consolidated financial statements of the Company. However, during the fourth
quarter of 1996, the Company made a decision to hold for sale a former
laboratory building, which resulted in an impairment of approximately $111,000
being recorded, which reduced the net book value of the building to $225,000.
This impairment, in addition to an approximate $13,000 laboratory equipment
impairment, is included in "asset impairment" in the accompanying consolidated
statements of operations.
(j) Costs in Excess of Assets Acquired -- Costs in excess of assets
acquired represents the excess of the purchase cost over the fair value of net
assets acquired in a purchase business combination. Amortization is recorded on
a straight-line basis over periods ranging from 15 to 40 years. Amortization of
costs in excess of assets acquired for the years ended December 31, 1996, 1997
and 1998 was $129,243, $784,442 and $1,617,041, respectively.
(k) Other Intangible Assets -- Other intangible assets, comprised mainly of
customer lists and non-compete agreements, are amortized on a straight-line
basis. Customer lists are amortized over a fifteen year period and non-compete
agreements are amortized over the lives of the respective agreements, which
range from six months to five years. Amortization of other intangible assets for
the years ended December 31, 1996, 1997 and 1998 was $138,646, $333,898 and
$905,078, respectively.
(l) Foreign Currency Translation -- Assets and liabilities of foreign
operations are translated using year-end exchange rates and revenues and
expenses are translated using exchange rates prevailing during the year, with
gains or losses resulting from translation included in a separate component of
shareholders' equity.
Gains or losses resulting from foreign currency transactions are translated
to local currency at the rates of exchange prevailing at the dates of the
transactions. Amounts receivable or payable in foreign currencies, other than
the subsidiary's local currency, are translated at the rates of exchange
prevailing at the balance sheet date. The effect of transactional gains or
losses is included in other income (expense) in the accompanying consolidated
statements of operations.
(m) Use of Estimates -- The preparation of financial statements in
conformity with generally accepted accounting principles requires management to
make estimates and assumptions that affect the reported amounts of assets and
liabilities and disclosure of contingent assets and liabilities at the date of
the financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those estimates.
(n) Research and Development -- Research and development costs are expensed
as incurred. The Company incurred approximately $130,000, $136,000 and $537,000
for the years ended December 31, 1996, 1997 and 1998, respectively, for research
and development. These costs are included in general and administrative expenses
in the accompanying consolidated statements of operations.
(o) Advertising -- The Company expenses the cost of advertising as
incurred. Advertising expenses for the years ended December 31, 1996, 1997 and
1998 were $782,000, $1,534,000 and $2,020,000, respectively.
45
47
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(p) Earnings Per Share -- In 1997, the Company adopted Statement of
Financial Accounting Standards No. 128, "Earnings Per Share" (SFAS 128). In
accordance with SFAS 128, basic earnings per share are computed by dividing net
income by the weighted average number of shares of common stock outstanding
during the year. Diluted earnings per share are computed by dividing net income
by the weighted average number of shares of common stock and common stock
equivalents outstanding during the year. Dilutive common stock equivalents
represent shares issuable upon assumed exercise of stock options and warrants,
assumed issuance of restricted stock and assumed conversion of the convertible
note payable. The following is a reconciliation of the numerator and denominator
for basic and diluted earnings per share for the years ended December 31, 1996,
1997 and 1998:
YEAR ENDED DECEMBER 31, 1996
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Basic earnings per share....................... $ 5,268,415 11,607,329 $0.45
=====
Effect of dilutive securities:
Options...................................... -- 131,932
Restricted stock............................. (162,443) 287,482
Warrants..................................... -- 101,797
Convertible note payable..................... -- 32,434
----------- ----------
Diluted earnings per share..................... $ 5,105,972 12,160,974 $0.42
=========== ========== =====
YEAR ENDED DECEMBER 31, 1997
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Basic earnings per share....................... $ 2,046,643 14,006,638 $0.15
=====
Effect of dilutive securities:
Options...................................... -- 238,570
Restricted stock............................. -- 443,152
Warrants..................................... -- 96,740
Convertible note payable..................... -- 14,222
----------- ----------
Diluted earnings per share..................... $ 2,046,643 14,799,322 $0.14
=========== ========== =====
YEAR ENDED DECEMBER 31, 1998
-----------------------------------------
INCOME SHARES PER SHARE
(NUMERATOR) (DENOMINATOR) AMOUNT
----------- ------------- ---------
Basic earnings per share....................... $13,088,906 18,438,919 $0.71
=====
Effect of dilutive securities:
Options...................................... -- 524,040
Warrants..................................... -- 1,775
----------- ----------
Diluted earnings per share..................... $13,088,906 18,964,734 $0.69
=========== ========== =====
Basic and diluted earnings per share based on income from continuing
operations were $0.56 and $0.52, respectively, for the year ended December 31,
1996. The basic and diluted per share impact of the discontinued operations were
$0.11 and $0.10, respectively.
Basic and diluted earnings per share based on income from continuing
operations before extraordinary item and cumulative effect of change in
accounting principle were $0.19 and $0.18, respectively, for the year ended
46
48
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
December 31, 1997. The basic and diluted per share impact of the extraordinary
item was $0.01 and the basic and diluted per share impact of the change in
accounting principle were $0.03 and $0.02, respectively.
During 1997, 66,000 warrants to purchase a total of 27,746 shares of common
stock of the Company at $7.20 per warrant were outstanding but were not included
in the computation of diluted earnings per share because the warrants' exercise
price was greater than the average market price of the common shares.
During 1998, 11,666 warrants to purchase an equivalent amount of shares of
common stock of the Company at $25.69 per warrant were outstanding but were not
included in the computation of diluted earnings per share because the warrants'
exercise price was greater than the average market price of the common shares.
(q) New Accounting Pronouncements -- In 1998, the Company adopted Statement
of Financial Accounting Standards No. 130, "Reporting Comprehensive Income"
(SFAS 130), which established standards for reporting and displaying
comprehensive income and its components in a financial statement that is
displayed with the same prominence as other financial statements. The Company
has chosen to disclose comprehensive income, which encompasses net income,
foreign currency translation adjustments and unrealized holding gains of
marketable securities, in the consolidated statement of shareholder's equity.
Prior years have been restated to conform to the SFAS 130 requirements. The
accumulated other comprehensive income (loss) balance of ($0.1) million at
December 31, 1996 consisted of ($0.2) million of foreign currency translation
adjustments and $0.01 million of unrealized appreciation of marketable
securities. The accumulated other comprehensive income (loss) balance of ($0.4)
million at December 31, 1997 consisted of ($0.4) million of foreign currency
translation adjustments and $0.01 million of unrealized appreciation of
marketable securities. The accumulated other comprehensive income (loss) balance
of ($0.9) million at December 31, 1998 consisted entirely of foreign currency
translation adjustments.
In June 1997, the FASB issued Statement of Financial Accounting Standards
No. 131, "Disclosures About Segments of an Enterprise and Related Information"
(SFAS 131), effective for fiscal years beginning after December 15, 1997. This
statement requires disclosure for each segment into which a company is organized
by the chief operating decision maker for the purposes of making operating
decisions and assessing performance. Reportable segments are based on products
and services, geography, legal structure, management structure and any manner in
which management disaggregates a company. The Company adopted SFAS 131 during
fiscal 1998. This statement, which requires expansion or modification to
existing disclosures, had no impact on the Company's reported consolidated
financial position, results of operations or cash flows.
In April 1998, the American Institute of Certified Public Accountants
released Statement of Position (SOP) 98-5 "Reporting on the Cost of Start-Up
Activities." The SOP requires costs of start-up activities, including
preoperating costs, organization costs and other start-up costs, to be expensed
as incurred. The Company's current practice is to capitalize certain of these
expenses and amortize them over periods ranging from one to five years. The
Company is required to adopt the provisions of this statement no later than the
first quarter of fiscal 1999. Included in the accompanying December 31, 1997 and
1998 consolidated balance sheets are approximately $1.0 million and $1.2
million, respectively, of preoperating, organization and start-up costs which
would have been expensed had this statement already been implemented.
In June 1998, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards No. 133, "Accounting for Derivative Instruments
and Hedging Activities" (SFAS 133). SFAS 133 establishes accounting and
reporting standards requiring that every derivative instrument (including
certain derivative instruments embedded in other contracts) be recorded in the
balance sheet as either an asset or liability measured at its fair value. SFAS
133 requires that changes in the derivative's fair value be recognized currently
in earnings unless specific hedge accounting criteria are met. SFAS 133 is
effective for fiscal years beginning after June 15, 1999. The Company has
several forward contracts in place in association with demand notes from certain
subsidiaries. These instruments qualify for hedge accounting. The Company has
not yet quantified the impact of adopting SFAS 133 on its financial statements
and has not determined the timing of or method of
47
49
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
adoption of SFAS 133. However, SFAS 133 could increase volatility in earnings
and other comprehensive income.
(r) Stock-Based Compensation -- The Company has elected to account for the
cost of its employee stock options and other forms of employee stock-based
compensation plans utilizing the intrinsic value method prescribed in Accounting
Principles Board Opinion No. 25 (APB 25) as allowed by Statement of Financial
Accounting Standards No. 123, "Accounting for Stock-Based Compensation" (SFAS
123). APB 25 requires compensation cost for stock-based compensation plans to be
recognized based on the difference, if any, between the fair market value of the
stock on the date of grant and the option exercise price. SFAS 123 established a
fair value-based method of accounting for compensation cost related to stock
options and other forms of stock-based compensation plans. SFAS 123 allows an
entity to continue to measure compensation cost using the principles of APB 25
if certain pro forma disclosures are made. The pro forma disclosures required by
SFAS 123 are presented in Note 11(e).
(s) Change in Accounting Principle -- In the fourth quarter of 1997, the
Company changed its method of accounting for costs incurred in connection with
business process reengineering activities relating to information technology
transformation. Consistent with a consensus reached by the Emerging Issues Task
Force (EITF) under Issue 97-13, in late November 1997, the Company expensed
costs previously capitalized in earlier quarters of 1997 (approximately
$360,000, net of tax benefit of $240,000) as a cumulative effect of change in
accounting principle.
(t) Derivative Financial Instruments -- Financial instruments in the form
of foreign currency exchange contracts are utilized by the Company to hedge its
exposure to movements in foreign currency exchange rates. The Company does not
hold or issue derivative financial instruments for trading purposes. Gains and
losses on foreign exchange contracts are deferred and amortized as an adjustment
to the cumulative foreign currency translation adjustment component of equity
over the terms of the agreements in accordance with hedge accounting standards.
The fair value of foreign currency exchange contracts is not recognized in the
consolidated financial statements since they are accounted for as hedges.
(u) Reclassifications -- Certain reclassifications have been reflected in
1996 and 1997 to conform with the current period presentation.
(3) MERGERS AND ACQUISITIONS
The Company has completed numerous business combinations in the periods
presented. These transactions were accounted for as both purchase business
combinations and pooling of interests business combinations as follows:
(a) Pooling of Interests Transactions -- In December 1997, a wholly owned
subsidiary of the Company was merged with and into Kroll. Effective upon the
consummation of the merger with Kroll, each then issued and outstanding share of
Kroll common stock, including shares subject to issuance under the Kroll
restricted stock plan (See Note 11), were converted into 62.52 shares of common
stock of the Company or 6,098,561 shares of Company common stock in total.
Outstanding employee stock options of Kroll were converted at the same exchange
factor into options to purchase 551,492 shares of Company common stock (See Note
11).
The merger constituted a tax-free reorganization and has been accounted for
as a pooling of interests. Accordingly, all prior period consolidated financial
statements presented have been restated to include the combined results of
operations, financial position and cash flows of Kroll as though it had always
been a part of the Company.
There were no transactions between O'Gara and Kroll prior to the
combination, and immaterial adjustments were recorded to conform Kroll's
accounting policies. Certain reclassifications were made to the Kroll financial
48
50
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
statements to conform to the Company's presentations. The results of operations
for the separate companies and the combined amounts presented in the
consolidated financial statements follow:
O'GARA KROLL COMBINED
----------- ----------- ------------
Nine months ended September 30, 1997
(unaudited)
Revenue...................................... $82,567,200 $53,823,958 $136,391,158
Extraordinary item........................... (193,875) -- (193,875)
Net income................................... 4,181,387 1,796,124 5,977,511
Year ended December 31, 1996
Revenue...................................... 82,777,691 70,883,058 153,660,749
Net income (loss)............................ 6,658,962 (801,740) 5,857,222
In connection with the Kroll merger in 1997, the Company recorded, in the
fourth quarter, a charge to operating expenses of approximately $7.2 million
($5.7 million after taxes, or $0.39 per diluted share) for direct and other
merger-related costs pertaining to the merger transaction. Merger transaction
costs are nonrecurring and include $0.8 million for stock based compensation
costs triggered by the change in control of Kroll, $1.8 million for stay bonuses
and severance and $4.6 million which consisted primarily of fees for investment
bankers, attorneys, accountants, financial printing, travel and other related
charges.
In December 1998, a wholly owned subsidiary of the Company was merged with
and into Laboratory Specialists of America, Inc. (LSAI). Effective upon the
consummation of the merger, each then issued and outstanding share of LSAI
common stock was converted into .2102 shares of common stock of the Company or
1,209,053 shares of the Company's common stock in total. Outstanding stock
options and stock warrants of LSAI were converted at the same exchange factor
into options to purchase 39,094 and 24,386 shares, respectively, of the
Company's common stock (See Note 11). The financial position and results of
operations of LSAI are reported as part of the Company's Investigations and
Intelligence Group.
In December 1998, a wholly owned subsidiary of the Company was merged with
and into Schiff & Associates, Inc. (Schiff). Effective upon the consummation of
the merger, each then issued and outstanding share of Schiff common stock was
converted into approximately 131.41 shares of common stock of the Company or
169,521 shares of the Company's common stock in total. The financial position
and results of operations of Schiff are reported as part of the Company's
Investigations and Intelligence Group.
In December 1998, a wholly owned subsidiary of the Company was merged with
and into Securify Inc. (Securify). Effective upon the consummation of the
merger, all of the outstanding stock of Securify was converted to shares of the
Company's common stock at a rate of .110793 for Series A Preferred, .118273 for
Series B Preferred and .0955252 for Securify common stock. In total, the Company
issued 1,430,936 shares of common stock. In addition, outstanding employee stock
options of Securify were converted at the same exchange factor as Securify
common stock into options to purchase 179,877 shares of the Company's common
stock. Effective with the consummation of the merger, the Company created the
Information Security Group and Securify's results of operations and financial
position are reported in this group.
The mergers with LSAI, Schiff and Securify constituted tax-free
reorganizations and have been accounted for as pooling of interests
transactions. Accordingly, all prior period consolidated financial statements
presented have been restated to include the combined results of operations,
financial position and cash flows of LSAI, Schiff and Securify as though they
had always been a part of the Company.
There were no transactions between the Company and LSAI, Schiff and
Securify prior to the combination and immaterial adjustments were recorded to
conform LSAI's, Schiff's and Securify's accounting policies. Certain
reclassifications were made to the Company's, LSAI's, Schiff's and Securify's
financial statements to
49
51
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
conform presentation. The results of operations for the separate companies and
the combined amounts presented in the consolidated financial statements follow:
KROLL-O'GARA
HISTORICAL LSAI SCHIFF SECURIFY COMBINED
------------ ----------- ---------- --------- ------------
Nine months ended
September 30, 1998 (unaudited)
Revenue.................... $178,943,336 $12,039,154 $3,531,062 $ 48,000 $194,561,552
Net income (loss).......... 11,559,576 1,440,725 582,254 (944,196) 12,638,359
Year ended December 31, 1997
Revenue....................... 190,413,349 12,836,953 2,852,303 -- 206,102,605
Extraordinary item............ (193,875) -- -- -- (193,875)
Cumulative effect of change in
accounting principle....... (360,000) -- -- -- (360,000)
Net income.................... 709,866 1,329,103 7,674 -- 2,046,643
Year ended December 31, 1996
Revenue....................... 153,660,749 8,726,799 2,530,765 -- 164,918,313
Discontinued operations....... -- (1,274,216) -- -- (1,274,216)
Net income (loss)............. 5,857,222 (585,711) (3,096) -- 5,268,415
In 1998, the Company recorded, in the fourth quarter, a charge to operating
expenses of approximately $5.3 million ($3.9 million after taxes, or $0.21 per
diluted share) for direct and other merger and integration related costs. Merger
transaction costs are non-recurring and include $0.8 million for stay bonuses
and $4.1 million which consisted primarily of fees for investment bankers,
attorneys, accountants, financial printing, travel and other related charges.
Integration costs relate primarily to the merger with Kroll consummated in
December 1997 and were approximately $0.4 million.
(b) Purchase Transactions -- In addition to the merger with Kroll, the
Company completed six other acquisitions in 1997 which were accounted for as
purchase business combinations. Three of the 1997 purchase acquisitions have
been included in the Company's Security Products and Services Group, two in the
Investigations and Intelligence Group and one in the Voice and Data
Communications Group. The aggregate purchase price of these six acquisitions
amounted to approximately $26.0 million and consisted of $13.4 million in cash,
$4.1 million in seller-provided financing and 753,806 shares of common stock
(valued at approximately $8.5 million or an average of $11.28 per share). In
connection with these acquisitions, the Company entered into various employment
and non-compete agreements with officers and key employees of the acquired
companies with varying terms and conditions. The results of operations of the
acquired businesses are included in the consolidated financial statements from
the respective effective dates of acquisition. The resulting goodwill from these
transactions is being amortized over periods ranging from fifteen to thirty
years. In addition to these 1997 acquisitions, the Company also exercised its
option to acquire the minority interest in its O'Gara Brazilian subsidiary for
approximately 69,565 shares of common stock valued at approximately $1.2
million.
The Company made one significant acquisition in 1997 which is included
above. In February 1997, Labbe, S.A. (Labbe), a company located in France
specializing in vehicle armoring systems, was acquired for approximately $14.2
million, consisting of $10.7 million in cash and 376,597 shares of the Company's
common stock valued at approximately $3.5 million or $9.29 per share. For
accounting purposes, the acquisition was effective on January 1, 1997 and the
results of operations of Labbe are included in the consolidated results of
operations of the Company from that date forward. The following unaudited pro
forma combined results of
50
52
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
operations for the year ended December 31, 1996 assumes the Labbe acquisition
occurred as of January 1, 1996 (in thousands, except per share data):
YEAR ENDED
DECEMBER 31, 1996
-----------------
Sales............................................... $189,036
Net income.......................................... $ 5,463
Earnings per share:
Basic............................................. $ 0.46
Diluted........................................... $ 0.42
In addition to the mergers with LSAI, Schiff and Securify, the Company
completed eight other acquisitions in 1998, all of which were accounted for as
purchase business combinations. Seven of the 1998 purchase acquisitions have
been included in the Company's Investigations and Intelligence Group and the
eighth has been included in the Security Products and Services Group. The
aggregate purchase price of these eight acquisitions amounted to approximately
$36.5 million and consisted of $19.4 million in cash and 745,003 shares of
common stock (valued at approximately $17.1 million or an average of $22.95 per
share). The $36.5 million aggregate purchase price for the 1998 acquisitions
excludes a potential earnout of $3.25 million applicable to one of the acquired
companies, which is payable over three years and is contingent upon the
achievement of specified operating income targets. In addition, in connection
with these acquisitions, the Company entered into various employment and
non-compete agreements with officers and key employees of the acquired companies
with varying terms and conditions. The results of operations of the acquired
businesses are included in the consolidated financial statements from the
respective effective dates of acquisition. The resulting goodwill from these
transactions is being amortized over periods ranging from fifteen to twenty-five
years.
The Company made one significant acquisition in 1998 which is included
above. In September 1998, Kizorek, Inc., now renamed InPhoto Surveillance, Inc.
(InPhoto), a company located in Illinois specializing in video surveillance
services, was acquired for approximately $9.0 million, consisting of $0.8
million in cash and 352,381 shares of the Company's common stock valued at
approximately $8.2 million or $23.35 per share. For accounting purposes, the
acquisition was effective on July 1, 1998 and the results of operations of
InPhoto are included in the consolidated results of operations of the Company
from that date forward. The following unaudited pro forma combined results of
operations for the years ended December 31, 1997 and 1998 assumes the InPhoto
acquisition occurred as of January 1, 1997 (in thousands, except per share
data):
YEAR ENDED DECEMBER 31,
------------------------
1997 1998
---------- ----------
Sales.......................................... $220,579 $271,230
Income before extraordinary item............... $ 3,095 $ 13,005
Net income..................................... $ 2,541 $ 13,005
Earnings per share:
Basic........................................ $ 0.22 $ 0.70
Diluted...................................... $ 0.20 $ 0.68
51
53
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
In connection with the 1997 and 1998 purchase acquisitions, assets were
acquired and liabilities were assumed as follows (dollars in thousands):
1997 1998
----------------------- -----------------------
OTHER 1997 OTHER 1998
LABBE ACQUISITIONS INPHOTO ACQUISITIONS
-------- ------------ -------- ------------
FAIR VALUE OF ASSETS ACQUIRED INCLUDING:
Cash............................................ $ 3,501 $ 125 $ 192 $ 701
Accounts Receivable............................. 4,689 2,072 1,743 5,146
Inventories..................................... 3,392 1,829 -- --
Unbilled revenue................................ -- -- 269 1,561
Other current assets............................ 316 11 450 551
Property, plant and equipment................... 3,360 378 955 1,213
Other non-current assets........................ 2,357 4 -- 266
Costs in excess of assets acquired and other
intangible assets............................ 7,802 11,727 8,995 27,476
-------- ------- ------- --------
25,417 16,146 12,604 36,914
Less: Cash paid for net assets.................. (10,730) (2,700) (800) (18,555)
Fair value of debt issued....................... -- (4,126) -- --
Fair value of stock issued...................... (3,431) (5,029) (8,228) (8,904)
-------- ------- ------- --------
$ 11,256 $ 4,291 $ 3,576 $ 9,455
======== ======= ======= ========
LIABILITIES ASSUMED INCLUDING:
Liabilities assumed and acquisition costs....... $ 9,287 $ 4,272 $ 3,376 $ 8,746
Debt............................................ 1,969 19 200 709
-------- ------- ------- --------
$ 11,256 $ 4,291 $ 3,576 $ 9,455
======== ======= ======= ========
(4) BALANCE SHEET ACCOUNTS
(a) Trade Accounts Receivable and Costs and Estimated Earnings in Excess of
Billings on Uncompleted Contracts -- The following summarizes the components of
trade accounts receivable and costs and estimated earnings in excess of billings
on uncompleted contracts:
DECEMBER 31,
--------------------------
1997 1998
----------- -----------
United States Military:
Billed receivables...................................... $ 3,756,035 $ 3,225,664
Costs and estimated earnings in excess of billings on
uncompleted contracts................................ 9,253,872 21,042,185
----------- -----------
Total United States Military.................... $13,009,907 $24,267,849
=========== ===========
Other contracts:
Billed receivables...................................... $37,040,436 $52,345,151
Costs and estimated earnings in excess of billings on
uncompleted contracts................................ 2,824,592 5,365,912
----------- -----------
Total other contracts................................... $39,865,028 $57,711,063
=========== ===========
Total trade accounts receivable......................... $40,796,471 $55,570,815
=========== ===========
Total costs and estimated earnings in excess of billings
on uncompleted contracts............................. $12,078,464 $26,408,097
=========== ===========
52
54
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Costs and estimated earnings in excess of billings on uncompleted contracts
are net of $89,875,813 and $107,374,834 of progress billings to the United
States Military at December 31, 1997 and 1998, respectively.
Costs and estimated earnings in excess of billings on uncompleted contracts
represent revenue recognized on long-term contracts in excess of billings
because amounts were not billable at the balance sheet date. It is anticipated
such unbilled amounts attributable to the United States Military will generally
be billed over the next 180 days as the contract is substantially completed.
Amounts receivable on other contracts are generally billed as shipments are
made. It is estimated that substantially all of such amounts will be billed
within one year, although contract extensions may delay certain collections
beyond one year.
The following summarizes activity in the allowance for doubtful accounts on
trade accounts receivable:
ADDITIONS
BALANCE CHARGED TO BALANCE
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
---------- ---------- ----------- ----------
Year ended December 31, 1996..... $2,700,171 $3,778,583 $(3,954,870) $2,523,884
Year ended December 31, 1997..... $2,523,884 $2,097,342 $(1,521,162) $3,100,064
Year ended December 31, 1998..... $3,100,064 $2,513,506 $(1,843,946) $3,769,624
(b) Inventories -- Inventories are stated at the lower of cost or market
using the first-in, first-out (FIFO) method and include the following:
DECEMBER 31,
--------------------------
1997 1998
----------- -----------
Raw materials............................................. $ 9,551,152 $ 8,148,000
Vehicle costs and work-in-process......................... 10,011,747 14,249,939
----------- -----------
$19,562,899 $22,397,939
=========== ===========
The following summarizes activity in valuation reserves for inventory
obsolescence:
ADDITIONS
BALANCE CHARGED TO BALANCE
BEGINNING COSTS AND END OF
OF PERIOD EXPENSES DEDUCTIONS PERIOD
--------- ---------- ---------- --------
Year ended December 31, 1996........... $ -- $264,114 $ -- $264,114
Year ended December 31, 1997........... $264,114 $113,567 $(23,782) $353,899
Year ended December 31, 1998........... $353,899 $ 7,971 $ -- $361,870
53
55
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(c) Other Assets -- Other assets are stated at cost less accumulated
amortization and are being amortized on a straight line basis over their
estimated useful lives, as applicable. Other assets consist of the following:
DECEMBER 31,
USEFUL LIFE ------------------------
DESCRIPTION (YEARS) 1997 1998
----------- ----------- ---------- ----------
Advance to vendor............................... -- $1,275,437 $1,130,361
Preoperating and start-up costs................. -- 1,029,784 1,185,574
Security deposits............................... -- 471,859 989,908
Pending acquisition costs....................... -- -- 573,035
Long-term receivable............................ -- 380,000 380,000
Non-refundable deposit on an equipment lease
with a related party.......................... 5 297,025 537,784
Deferred financing fees......................... 7-30 876,667 906,667
Long-term investments........................... -- 101,630 --
Other long-term assets.......................... -- 65,720 584,857
---------- ----------
4,498,122 6,288,176
(166,477) (209,209)
---------- ----------
$4,331,645 $6,078,977
========== ==========
Preoperating and start-up costs include costs applicable to bids in process
which are deferred when management believes it is probable that future contracts
will be obtained. These costs are transferred to contract costs when contracts
are awarded or are expensed when the contract award is no longer considered
probable. Preoperating and start-up costs also include certain costs incurred in
connection with establishing operations in new locations. In accordance with SOP
98-5, all such costs will be expensed in the first quarter of fiscal 1999 (see
Note 2(q)).
(d) Accrued Liabilities -- Accrued liabilities consist of the following at
December 31, 1997 and 1998:
DECEMBER 31,
--------------------------
DESCRIPTION 1997 1998
----------- ----------- -----------
Payroll and related benefits.............................. $ 8,205,962 $ 9,720,120
Property, sales and other taxes payable................... 773,846 2,160,417
Accrued professional fees................................. 385,403 3,485,486
Accrued interest.......................................... 564,168 460,923
Accrued satellite time.................................... 1,009,162 1,948,557
Accrued hedge contract settlement......................... -- 710,760
Accrued customer list installment payments................ 510,345 515,538
Other accruals............................................ 3,763,374 3,011,770
----------- -----------
$15,212,260 $22,013,571
=========== ===========
(5) INCOME TAXES
Prior to October 28, 1996, OHE was an S Corporation and generally was not
responsible for payment of income taxes. Rather, the OHE shareholders were taxed
on OHE's taxable income at their respective individual federal and state income
tax rates. Therefore, the income generated by OHE was not subject to federal,
state or certain foreign income taxes prior to the date of OHE's reorganization
on October 28, 1996. Schiff was also an
54
56
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
S Corporation for all periods prior to December 31, 1998. Accordingly, the
accompanying consolidated financial statements only reflect a provision
(benefit) for income taxes for Kroll and LSAI, both of which were C
Corporations, for all periods prior to October 28, 1996.
The Company accounts for income taxes under the liability method pursuant
to Statement of Financial Accounting Standards No. 109, "Accounting for Income
Taxes." Under the liability method, deferred tax liabilities and assets are
determined based on the differences between the financial reporting and tax
bases of assets and liabilities using enacted tax rates.
The Company's provision (benefit) for income taxes on income (loss) from
continuing operations for all periods is summarized as follows:
1996 1997 1998
--------- ----------- ----------
Currently payable:
Federal.............................. $ 470,479 $ 2,800,720 $5,530,085
State and local...................... 383,563 576,837 965,158
Foreign.............................. 83,000 1,364,873 1,834,143
--------- ----------- ----------
937,042 4,742,430 8,329,386
--------- ----------- ----------
Deferred:
Federal.............................. (425,558) (1,213,147) (733,485)
State and local...................... (145,937) (224,290) (129,437)
Foreign.............................. -- -- --
--------- ----------- ----------
(571,495) (1,437,437) (862,922)
--------- ----------- ----------
$ 365,547 $ 3,304,993 $7,466,464
========= =========== ==========
A reconciliation between the statutory federal income tax rate and the
effective tax rate is summarized as follows:
1996 1997 1998
------------------ ------------------ -----------------
AMOUNT RATE AMOUNT RATE AMOUNT RATE
---------- ----- ---------- ----- ---------- ----
Provision for income taxes at the
federal statutory rate.......... $2,349,834 34.0% $2,005,265 34.0% $7,070,920 34.4%
State and local income taxes, net
of federal benefit.............. 156,912 2.3 295,119 5.0 637,004 3.1
Impact of S Corp income/loss,
prior to reorganization......... (2,087,529) (30.2) -- -- -- --
Impact of foreign income, prior to
reorganization.................. (199,095) (2.9) -- -- -- --
Nondeductible expenses............ 34,766 0.5 1,424,333 24.1 241,748 1.2
Change in valuation allowance..... 109,303 1.6 (755,044) (12.8) (528,695) (2.6)
Effect of foreign income/loss..... (8,768) (0.1) 577,743 9.8 145,786 0.7
Other............................. 10,124 0.1 (242,423) (4.1) (100,299) (0.5)
---------- ----- ---------- ----- ---------- ----
Provision for income
taxes................. $ 365,547 5.3% $3,304,993 56.0% $7,466,464 36.3%
========== ===== ========== ===== ========== ====
55
57
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The components of the Company's consolidated deferred income tax assets and
liabilities as of December 31 are summarized below:
1997 1998
----------- -----------
Deferred tax assets:
Allowance for doubtful accounts......................... $ 844,101 $ 432,027
Depreciation and amortization........................... 564,262 244,693
Net operating loss carryforwards........................ 1,839,743 2,100,179
Payroll and other benefits.............................. 594,401 1,721,081
Other accruals.......................................... 336,817 707,708
Acquisition costs....................................... 440,000 1,697,885
Other................................................... 981,610 512,382
----------- -----------
5,600,934 7,415,955
Valuation allowance..................................... (2,126,035) (1,742,925)
----------- -----------
Net deferred tax assets......................... 3,474,899 5,673,030
----------- -----------
Deferred tax liabilities:
Nonaccrual service fee receivable....................... (212,079) (156,804)
Deferred revenue........................................ (1,908,823) (3,540,825)
Database capitalization................................. (2,779,790) (2,951,351)
S to C conversion....................................... (5,223) (5,223)
Customer lists, net of amortization..................... (344,000) (310,667)
Percentage of completion on foreign subsidiaries........ -- (381,917)
Foreign leasing transactions............................ -- (125,827)
Other................................................... (166,893) (720,887)
----------- -----------
(5,416,808) (8,193,501)
----------- -----------
Net deferred tax liability...................... $(1,941,909) $(2,520,471)
=========== ===========
The Company has certain foreign and domestic net operating loss
carryforwards, which approximated $1.8 million and $2.1 million at December 31,
1997 and 1998, respectively. The foreign net operating loss carryforwards relate
primarily to the United Kingdom, France and the Philippines. The carryforwards
expire beginning in 2001. A valuation allowance for the majority of all existing
foreign carryforwards has been provided as it is not certain that the tax
benefit will be realized in the foreseeable future. Adjustments to the valuation
allowance, if any, will be recorded in the periods in which it is determined the
asset is realizable.
56
58
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(6) RELATED PARTY TRANSACTIONS
(a) Summary of Related Party Transactions -- The following summarizes
transactions with related parties:
YEARS ENDED DECEMBER 31,
------------------------------------
1996 1997 1998
---------- ---------- ----------
Sales
to Shareholder............................ $5,325,559 $6,412,244 $4,877,478
to affiliated entities.................... 236,000 21,000 --
Purchases
from Shareholder.......................... 824,348 814,154 474,800
from affiliated entities.................. 1,176,000 411,000 1,325,410
Lease expense to affiliated entities........... 1,179,000 813,000 839,000
Consulting, commission and legal services
expense
provided by affiliated entities........... 348,000 -- --
provided by minority shareholders......... 118,000 -- --
provided by LSAI Director................. 30,000 170,000 190,000
Non-interest bearing advances to
shareholders................................. 288,829 525,996 568,213
Air charter fees included in costs of the
offering or merger costs..................... 327,000 576,000 566,000
Interest on shareholder notes payable.......... 27,000 -- --
Forgiveness of note payable to affiliated
entity....................................... 122,000 -- --
Noninterest bearing advances to affiliates..... -- 282,346 615,851
(b) Notes Payable-Shareholders -- OHE had certain notes payable to
shareholders, which were repaid upon the completion of the Company's initial
public offering in 1996. Interest expense associated with these obligations
approximated $27,000 for the year ended December 31, 1996.
The Company has certain amounts due to/from shareholders which include the
following amounts at December 31:
1997 1998
--------- --------
Amounts due from certain shareholders....................... $ 525,996 $568,213
--------- --------
Amounts due to certain shareholders......................... (309,500) --
--------- --------
Net due from (due to) shareholders................ $ 216,496 $568,213
========= ========
Balances included in amounts due to/from shareholders are classified as
open advance accounts or term loans. Substantially all amounts due to and due
from shareholders were paid off in connection with the Kroll merger except for a
loan payable of $309,500 which was paid off during 1998.
(c) Sales-Shareholder -- During 1996, 1997 and 1998, the Company rendered
services to a corporation which is also a shareholder of the Company. Total
revenue recognized for the years ended December 31, 1996, 1997 and 1998 was
$5,325,559, $6,412,244 and $4,877,478, respectively. Additionally, this
corporation provided certain services to the Company which have been included in
cost of sales and operating expenses in the accompanying consolidated statements
of operations. These costs were approximately $824,348, $814,154 and $474,800
for the years ended December 31, 1996, 1997 and 1998, respectively. The yearend
accounts receivable balance for this customer was approximately $897,361 and
$1,290,558 at December 31, 1997 and 1998, respectively.
57
59
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(d) Building and Equipment Leases -- Affiliated Entities -- Effective June
1, 1998, the Company reached an agreement to terminate the corporate aircraft
lease which originated in February 1995 with an affiliated entity. The terms of
the aircraft lease addendum will provide the Company with a future hourly
discount from the normal commercial hourly rate in order to amortize the
remaining portion of existing lease deposits from the original aircraft lease.
Rental expense, including amortization recognized, approximated $422,000,
$234,000 and $292,000 for the years ended December 31, 1996, 1997 and 1998,
respectively. The Company also paid this affiliated entity $327,000 in fiscal
1996 for usage of the aircraft during the roadshow for the initial public stock
offering and included such amount in issuance costs. The Company paid $576,000
in fiscal 1997 for usage of the aircraft to consummate the merger with Kroll and
included such amount in merger related costs. The Company paid $296,000 in 1998
for usage of the aircraft during the roadshow for a stock offering and included
such amount in stock issuance costs. The Company also paid $270,000 in fiscal
1998 for usage of the aircraft to consummate the merger with Securify and
included such amount in merger related costs. Management is of the opinion that
the hourly rate paid by the Company was equivalent to the rate charged by the
affiliated entity to other unrelated companies for similar services and it was
favorably comparable to rates charged by another unrelated charter service for
similar aircraft. As of December 31, 1997 and 1998, the Company had
approximately $297,025 and $484,371, respectively in unamortized lease deposits
with this affiliated entity.
The Company is also currently leasing equipment and a manufacturing
facility from two affiliated entities under various three year and
month-to-month lease agreements which began in July 1995. Rental expense
approximated $757,000, $579,000 and $547,000 for the years ended December 31,
1996, 1997 and 1998, respectively.
(7) REVOLVING LINES OF CREDIT
On October 30, 1998, the Company amended and restated its credit agreement
to provide for a revolving line of credit of $7.0 million and a letter of credit
facility of approximately $7.6 million which matures on May 31, 2000. The
revolving credit facility bears interest at rates ranging from prime less 1.75%
to prime less .25%, or, at the Company's option, LIBOR plus .75% to LIBOR plus
1.5%, dependent upon a defined financial ratio. Average borrowings under the
revolving line of credit and its predecessors were $9,915,663, $4,568,994 and
$1,659,131 during 1996, 1997 and 1998, respectively, at approximate weighted
average interest rates of 8.27%, 8.46% and 7.96%, respectively. The maximum
borrowings outstanding during 1996, 1997, and 1998 were $12,145,000, $11,600,000
and $7,735,029, respectively. Borrowings under this line of credit were $559,112
at December 31, 1997. There were no outstanding borrowings under this line of
credit at December 31, 1998.
In connection with a refinancing in 1997, the Company fully amortized the
remaining deferred financing costs from a previous agreement, resulting in a one
time extraordinary charge to the Company's net income of $193,875, after income
tax benefits of $129,250, or $0.01 per diluted share.
This credit agreement includes financial covenants, which among other
restrictions, require the maintenance of certain financial ratios, including
fixed charge coverage and net worth, and impose limitations on foreign
investment, total intangible assets, additional indebtedness and capital
expenditures. The Company was not in compliance with certain of these covenants
as of December 31, 1997 and 1998. These events of non compliance were waived by
the lender.
58
60
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(8) LONG-TERM DEBT-
The components of long-term debt are as follows at:
DECEMBER 31,
--------------------------
1997 1998
----------- -----------
Senior unsecured notes payable to various institutions,
interest at 8.56% (9.56% prior to May 1998) payable
semi-annually, principal payable at maturity in May 2004,
subject to prepayment penalties........................... $35,000,000 $35,000,000
Economic Development Revenue Bonds, variable interest rate
approximating 85% of the bond equivalent yield of 13 week
U.S. Treasury bills (not to exceed 12%), which
approximated 4.52% at December 31, 1998, payable in
scheduled installments through September 2016, subject to
optional tender by the bondholders and a corresponding
remarketing agreement, secured by the property, plant and
equipment of OHE and a bank letter of credit (Note 12).... 1,432,224 1,357,224
Notes payable to former shareholders of acquired companies,
interest at fixed rates ranging from 6% to 10%, payable in
scheduled installments through February 2000, certain
notes secured by acquired assets.......................... 3,345,989 526,361
Notes payable to banks, variable interest rates at prime to
prime plus 0.5% or LIBOR plus 2.5%, fixed rates ranging
from 8.65% to 10.95%, payable in scheduled installments
through April 2003 with certain instruments subject to
prepayment penalties, collateralized by certain real and
personal property......................................... 9,801,780 1,001,204
Note payable to former shareholder of Kroll, non interest
bearing, paid in full in January 1998..................... 1,255,402 --
Other notes payable, interest at 7% to 10.9%, payable in
scheduled installments through September 2007, certain
notes secured by various equipment........................ 2,844,169 1,338,208
----------- -----------
53,679,564 41,222,997
Less- current portion....................................... (4,038,080) (1,965,752)
----------- -----------
$49,641,484 $39,257,245
=========== ===========
The Company's $35 million of senior unsecured notes payable also contains
financial covenants, which among other restrictions, require the maintenance of
net worth and fixed charge coverage ratios.
Scheduled maturities of long-term debt at December 31, 1998 are as follows:
1999...................................................... $ 1,965,752
2000...................................................... 2,416,592
2001...................................................... 404,637
2002...................................................... 225,981
2003...................................................... 196,119
Thereafter................................................ 36,013,916
-----------
$41,222,997
===========
59
61
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(9) OPERATING LEASES
The Company leases office space and certain equipment and supplies under
agreements with terms from one to ten years. The following is a schedule, by
year, of approximate future minimum rental or usage payments required under
operating leases that have initial or non-cancelable lease terms in excess of
one year as of December 31, 1998:
TOTAL
-----------
1999........................................................ $ 6,442,482
2000........................................................ 5,503,777
2001........................................................ 3,708,492
2002........................................................ 2,843,961
2003........................................................ 2,438,388
Thereafter.................................................. 8,766,311
-----------
$29,703,411
===========
Rental expense charged against current operations amounted to approximately
$4,595,000, $4,115,000 and $6,430,000, for the years ended December 31, 1996,
1997 and 1998, respectively.
(10) DEFINED CONTRIBUTION AND BONUS PLANS
As of December 31, 1998, the Company had the following employee benefit
plans in place:
(a) Defined Contribution Plans -- The Company and its subsidiaries have
established various non-contributory profit sharing/401(k) plans covering
substantially all of the Company's employees. Contributions to the plans are
discretionary and are determined annually by the Company's Board of Directors.
Certain plans also offer a matching contribution whereby the Company will
contribute a percentage of the amount a participant contributes, limited to
certain maximum amounts. Plan contribution expense charged against current
operations for all such plans amounted to approximately $1,243,000, $1,211,140
and $797,003, for the years ended December 31, 1996, 1997 and 1998,
respectively.
(b) Profit and Revenue Sharing Plans -- The Company and its subsidiaries
have established various profit and revenue sharing plans covering substantially
all of the Company's employees. The plans were established to provide employees
an annual cash incentive bonus based on various operating and non-operating
criteria. The Company may amend, modify or terminate these plans at any time.
The Company expensed approximately $2,288,000, $516,000 and $476,000
associated with the profit and revenue sharing plans in 1996, 1997 and 1998,
respectively.
(11) EQUITY ARRANGEMENTS
(a) Stock Option Plans -- In 1996, the Company adopted a stock option plan
(the 1996 Plan) for employee, non-employee directors and consultants. The
Company may grant options for up to 1,757,000 shares under the 1996 Plan.
Options for 180,000, 482,050 and 360,000 shares were granted during 1996, 1997
and 1998, respectively. Options granted under the 1996 Plan are generally
granted at fair market value at the date of grant and are exercisable over
periods not exceeding ten years. Additionally, effective with the mergers with
Kroll, LSAI and Securify each outstanding stock option was converted at the
respective exchange factor into options to purchase Company common stock. After
conversion, total stock options granted under the previously existing Kroll,
LSAI and Securify stock option plans in 1996, 1997 and 1998 were for 209,629,
124,018 and 218,319 shares, respectively.
In connection with stock options granted by Securify during the year ended
December 31, 1998, the Company recorded deferred compensation of $1,192,096,
representing the difference between the deemed value
60
62
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
of the common stock for accounting purposes and the option exercise price of
such options at the date of grant. This amount is presented as a reduction of
shareholders' equity and will be amortized ratably over the vesting periods of
the applicable options. Approximately $78,000 was expensed during the year ended
December 31, 1998, and the balance will be expensed ratably over the next four
years as the options vest.
(b) Restricted Stock Plan -- Effective June 14, 1993, Kroll replaced a
previously existing long-term incentive plan with a restricted stock plan. The
restricted stock plan provided for cliff vesting after a five-year period from
the date the stock was awarded. Under the provisions of the plan, a participant
had the ability to put the stock back to Kroll and receive cash for the then
fair value of the stock. In addition, the plan included a provision which
resulted in accelerated vesting of all shares in the event of a change in
control of Kroll. The Company has accounted for this plan as a fixed plan and,
accordingly, compensation expense was based on the fair market value as
determined by independent appraisal at the date of grant. During 1996, 259,271
shares of restricted stock fully vested and were issued. Based on a valuation of
Kroll, the total value assigned to these shares was $572,286.
Kroll also had entered into other agreements with certain of its senior
executives which provided additional grants. During 1996, all 144,421 of these
previously granted shares fully vested and were issued. Based on a valuation of
Kroll, the total value assigned to these shares on the vesting date was
$318,780. As a result of the Kroll merger in December 1997, all remaining shares
associated with the restricted stock plan vested and all restrictions lapsed on
the merger date. In connection with this accelerated vesting the Company
recognized compensation expense of approximately $800,000 in 1997, which is
included with merger related costs in the accompanying consolidated statement of
operations. In addition to the regular tax benefits based on compensation
expense recognized, the Company also realized a tax benefit for the fair market
value of all restricted shares which became fully vested in 1997. This benefit
of approximately $2.2 million has been recognized as an increase to additional
paid in capital in the accompanying consolidated statement of shareholders'
equity. This balance represents the spread between cumulative compensation
expense recognized by the Company for accounting purposes and the cumulative
compensation expense recognized for tax purposes based on the fair market value
of the shares. No shares were outstanding under the plan as of December 31, 1997
and effective January 2, 1998, further issuances under the plan were ceased by a
board resolution.
Effective August 12, 1998, the Company adopted a stock incentive plan (the
1998 Stock Incentive Plan) for employees. The Company may grant up to 500,000
shares under the 1998 Stock Incentive Plan. There were no shares granted under
the plan during 1998, however, effective January 4, 1999, 38,000 shares were
granted under the plan.
(c) Purchase and Retirement of Common Stock -- In accordance with Kroll's
historical bylaws, restricted stock and stock option agreements, Kroll acquired
259,036 shares (representing shares and shares under options) of a former
director for approximately $2.7 million upon his leaving the employment of Kroll
in January 1997.
(d) Common Stock Warrants -- In connection with LSAI's initial public
offering on October 11, 1994, LSAI issued 660,000 warrants. No warrants had been
exercised at December 31, 1996. Until April 15, 1997, each warrant could be
exercised to purchase .4204 shares of common stock of the Company for $16.65 per
share. After April 15, 1997, each warrant could be exercised to purchase .4204
shares of common stock for $9.51 per share. On September 3, 1997, LSAI gave
notice to the holders of these warrants of LSAI's election to redeem the
outstanding warrants at $0.01 each on October 14, 1997, unless extended, at the
sole discretion of LSAI, to a date not later than November 7, 1997 (the "Warrant
Redemption"). As a result, 658,290 of the warrants were exercised in September
and October 1997, and the remaining 1,710 warrants were redeemed.
As a portion of the public offering underwriting compensation, LSAI also
issued warrants to purchase 66,000 units at $7.32 per unit, consisting of .4204
shares of common stock of the Company and one warrant for .4204 additional
shares of common stock of the Company, exercisable during a four-year period
commencing on October 11, 1995 (the "Underwriter Warrants"). The warrants
included within each unit were exercisable under
61
63
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
the same terms as the warrants issued in connection with the public offering as
described above. As a result of the Warrant Redemption, 62,000 of these warrants
were exercised for $0.12 per warrant plus $9.51 per share in September and
October 1997, and the remaining 4,000 warrants were redeemed. After the Warrant
Redemption, the holders of the Underwriter Warrants continue to have the right
to exercise the Underwriter Warrants with respect to the .4204 shares of common
stock of the Company comprising the unit for $7.20. In November 1997, 30,000 of
the Underwriter Warrants were exercised with respect to the .4204 shares of
common stock of the Company comprising the unit for $7.20. The remaining 36,000
of the Underwriter Warrants with respect to the .4204 shares of common stock had
not been exercised and were outstanding at December 31, 1997. The proceeds from
the exercise of all warrants during 1997 are included in net proceeds from
exercise of stock options and warrants in the accompanying consolidated
statement of cash flows and approximated $2.7 million, net of commissions and
other offering expenses.
In connection with the Warrant Redemption, LSAI issued warrants to purchase
30,281 shares of common stock of the Company to various investment bankers as a
portion of their compensation for serving as managers of the Warrant Redemption
and certain other services. These warrants have an exercise price per share of
$10.47 and expire on October 14, 2000. Both the number of shares and the
exercise price per share are subject to adjustment under certain circumstances.
The value of these warrants, recognized as compensation paid to the investment
bankers for services provided, was treated as a reduction in the recognized net
proceeds to LSAI from the Warrant Redemption. The value of the outstanding
warrants is included in paid in capital in excess of par and entirely offsets
the recognized compensatory value of the warrants, resulting in no net effect on
shareholders' equity.
As of December 31, 1998, 24,386 warrants were still outstanding.
(e) Stock Based Compensation Disclosure -- SFAS 123 requires, at a minimum,
pro forma disclosures of expense for stock-based awards based on their fair
values. Had compensation cost for these plans been determined consistent with
SFAS 123, the Company's net income and diluted earnings per share for the years
ended December 31, 1996, 1997 and 1998 would have been as follows:
1996 1997 1998
---------- ---------- -----------
Net income:
As reported............................... $5,268,415 $2,046,643 $13,088,906
Pro forma................................. $5,157,960 $ 979,899 $10,677,643
Diluted earnings per share:
As reported............................... $ 0.42 $ 0.14 $ 0.69
Pro forma................................. $ 0.42 $ 0.07 $ 0.56
The fair value of each option grant is estimated on the date of grant using
the Black-Scholes option pricing model with the following weighted average
assumptions used for grants in 1996, 1997 and 1998:
YEAR ENDED DECEMBER 31,
-----------------------------------------
1996 1997 1998
----------- ----------- -----------
Dividend yield......................... -- -- --
Expected volatility.................... 35%-39.3% 38%-40.5% 41.4%
Risk-free interest rate................ 6%-6.5% 5.96%-6.76% 4.61%-5.67%
1.5-7.5
Expected lives......................... 5-7.5 years 5-7.5 years years
Option grants by the Company during 1996 for 218,887 shares have a
weighted-average exercise price of $9.72, a weighted-average fair value of $5.06
and remaining contractual lives, on a weighted-average basis, of 7.9 years. The
remaining 170,742 options granted by the Company during 1996 were determined to
have a fair value of $0. The 606,068 options granted by the Company during 1997
have a weighted-average exercise price of
62
64
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
$14.95, a weighted-average fair value of $7.68 per option and remaining
contractual lives, on a weighted-average basis, of 9.9 years. The 578,319
options granted by the Company during 1998 have a weighted-average exercise
price of $13.03, a weighted-average fair value of $9.03 and remaining
contractual lives, on a weighted-average basis, of 9.7 years.
A summary of the status of the Company's stock option plans at December 31,
1996, 1997 and 1998, and the change during the years then ended is presented in
the table below:
1996 1997 1998
------------------ -------------------- --------------------
WEIGHTED WEIGHTED WEIGHTED
AVERAGE AVERAGE AVERAGE
EXERCISE EXERCISE EXERCISE
SHARES PRICE SHARES PRICE SHARES PRICE
------- -------- --------- -------- --------- --------
Outstanding, beginning of
year........................ 407,022 $6.91 796,651 $ 6.72 1,306,443 $ 9.47
Granted....................... 389,629 6.52 606,068 14.95 578,319 13.03
Exercised..................... -- -- (5,777) 9.14 (477,894) 8.52
Forfeited/Expired/
Cancelled................... -- -- (90,500) 11.76 (33,850) 19.11
------- ----- --------- -------- --------- --------
Outstanding, end of year...... 796,651 $6.72 1,306,442 $ 9.47 1,373,018 $ 12.12
======= ===== ========= ======== ========= ========
Exercisable, end of year...... 261,538 $6.14 761,825 $ 6.52 855,122 $ 8.31
======= ===== ========= ======== ========= ========
Of the options outstanding at December 31, 1998, 312,389 options are
exercisable at prices per share ranging from $0.52 to $2.40 per share, 748,399
options are exercisable at prices per share ranging from $6.40 to $18.50 per
share and 312,230 options are exercisable at prices per share ranging from
$20.22 to $28.54 per share.
(12) COMMITMENTS AND CONTINGENCIES
(a) Letters of Credit -- Under the terms of the Economic Development
Revenue Bonds Agreement, OHE is required to maintain a letter of credit
supporting the debt. As of December 31, 1998, the Company's lender was committed
to providing this letter of credit through May 31, 2000. As of December 31,
1998, the Company had an outstanding letter of credit in the amount of
$1,681,750.
At December 31, 1998, the Company had standby and purchase letters of
credit, issued by the Company's lender, in the aggregate amount of $3,263,081.
(b) Purchase Agreements -- In June 1995, the Company entered into a firm
purchase agreement with Glocom, Inc. ("Glocom"). The agreement provided for an
irrevocable purchase order for the purchase of 4,000 units of the Compact-M
portable satellite telecommunication unit for approximately $12,000,000. In
October 1997, the agreement was amended to provide certain pricing concessions
to the Company for purchases by the Company of products sold by Glocom and to
provide a reduction in the quantity of the original units that must be
purchased. The amendment also provided certain licensing rights to the Company.
In November 1998, the Company entered into a purchase agreement with Glocom to
acquire a new type of portable satellite telecommunication terminal. This
contract provided for approximately a $3,000,000 purchase commitment. The
agreement restated that the pricing concession provided on units purchased set
forth in the above referenced amendment in order to continue to amortize the
remaining balance of the original advance applies to the purchase of the new
terminals. At December 31, 1998, the Company was committed to purchase
approximately 240 INMARSAT B terminals at a total cost of approximately
$3,000,000. In accordance with the original agreement, the Company advanced a
total of $3,000,000 to Glocom for the funding of the related production costs.
As of December 31, 1997 and 1998, the Company had advances to the above vendor
of $1,673,123 and $1,130,361, respectively.
(c) Employment Agreements -- The Company has employment agreements with its
executive officers and management level personnel with annual compensation
ranging in value from $57,000 to $400,000, over varying periods extending to
December 2003. The agreements generally provide for salary continuation in the
event of termination without cause for the greater of the remainder of the
agreement or one year. The agreements also
63
65
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
contain certain non-competition clauses and generally provide for one year's
salary if the agreement is not renewed.
As of December 31, 1998, the remaining aggregate commitment under these
employment agreements if all individuals were terminated without cause was
approximately $33.2 million.
(d) Legal Matters -- The Company is party to various legal proceedings
arising from its operations. Management of the Company believes that the outcome
of these proceedings, individually and in the aggregate, will have no material
adverse effect on the Company's financial position, results of operations or its
cash flows.
(13) FAIR VALUE OF FINANCIAL INSTRUMENTS
The fair values of significant current assets, current liabilities and
long-term debt approximate their respective historical carrying amounts.
The Company has entered into eight foreign currency exchange contracts to
effectively hedge its exposure to certain foreign currency rate fluctuations on
demand loans to subsidiaries which are denominated in foreign currencies. By
virtue of these contracts, the Company has fixed the total dollar amount which
it will receive under the aforementioned subsidiary loans through the maturity
dates of the contracts regardless of the fluctuations in the exchange rate. As
of December 31, 1998, the total notional amount of the contracts, which mature
between January 1999 and December 2000, was $18.3 million. The Company's
cumulative foreign currency translation adjustment component of shareholders'
equity was increased by $346,000 in 1997 and decreased by $702,000 in 1998 as a
result of these agreements.
The Company has estimated the fair value of their foreign exchange
contracts based on information obtained from the counterparty of the amount the
Company would receive at December 31, 1998 in order to terminate the agreements.
As of December 31, 1998, the Company would have paid approximately $1,031,000
upon cancellation of all contracts.
(14) CUSTOMER AND SEGMENT DATA
Segment Data. During 1996 and 1997, the Company operated in three business
segments, the Security Products and Services Group, the Investigations and
Intelligence Group and the Voice and Data Communications Group. In addition, in
1998, the Company created the Information Security Group in connection with the
merger with Securify.
The following summarizes information about the Company's business segments:
SECURITY INVESTIGATIONS
PRODUCTS AND VOICE AND DATA INFORMATION
AND SERVICES INTELLIGENCE COMMUNICATIONS SECURITY
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
------------ -------------- -------------- ----------- ------- ------------
(DOLLARS IN THOUSANDS)
1996
Net sales to
unaffiliated
customers.......... $ 79,156 $ 77,992 $ 7,770 $ -- $ -- $164,918
======== ======== ======= ======= ======= ========
Gross profit......... $ 20,438 $ 25,036 $ 2,146 $ -- $ -- $ 47,620
======== ======== ======= ======= ======= ========
Operating income..... $ 6,953 $ 2,292 $ 538 $ $ $ 9,783
======== ======== ======= ======= ======= ========
Identifiable assets
at year-end........ $ 38,380 $ 45,511 $ 6,816 $ -- $ -- $ 90,707
======== ======== ======= =======
Corporate assets..... -- 1,357
------- --------
Total assets at
year-end........... $ -- $ 92,064
======= ========
64
66
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SECURITY INVESTIGATIONS
PRODUCTS AND VOICE AND DATA INFORMATION
AND SERVICES INTELLIGENCE COMMUNICATIONS SECURITY
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
------------ -------------- -------------- ----------- ------- ------------
(DOLLARS IN THOUSANDS)
1997
Net sales to
unaffiliated
customers.......... $105,557 $ 83,109 $17,437 $ -- $ -- $206,103
======== ======== ======= ======= ======= ========
Gross profit......... $ 30,017 $ 33,206 $ 3,114 $ -- $ -- $ 66,337
======== ======== ======= ======= ======= ========
Operating income..... $ 8,014 $ 3,180 $ 292 $ -- $ -- $ 11,486
======== ======== ======= ======= ======= ========
Identifiable assets
at year-end........ $ 74,283 $ 53,468 $13,449 $ -- $ -- $141,200
======== ======== ======= =======
Corporate assets..... -- 9,284
------- --------
Total assets at
year-end........... $ -- $150,484
======= ========
1998
Net sales to
unaffiliated
Customers.......... $136,844 $110,232 $17,653 $ 116 -- $264,845
======== ======== ======= ======= ======= ========
Gross profit
(loss)............. $ 39,345 $ 49,380 $ 3,522 $ (395) (325) $ 91,527
======== ======== ======= ======= ======= ========
Operating income
(loss)............. $ 22,822 $ 13,282 $ (122) $(2,194) $(9,374) $ 24,414
======== ======== ======= ======= ======= ========
Identifiable assets
at year-end........ $102,294 $103,657 $13,351 $ 4,288 $ -- $223,590
======== ======== ======= ======= ========
Corporate assets..... -- 25,366
------- --------
Total assets at
year-end........... $ -- $248,956
======= ========
Total net sales by segment includes sales to unaffiliated customers.
Intersegment sales are nominal. Operating income (loss) is total net sales less
operating expenses. Operating income (loss) does not include the following
items: interest expense, other expenses and income taxes. The Other column
includes the Company's corporate headquarters costs. Depreciation expense and
capital expenditures for each of the Company's business segments for the years
ended December 31, 1996, 1997 and 1998 are as follows:
SECURITY INVESTIGATIONS
PRODUCTS AND VOICE AND DATA INFORMATION
AND SERVICES INTELLIGENCE COMMUNICATIONS SECURITY
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
------------ -------------- -------------- ----------- ------- ------------
(DOLLARS IN THOUSANDS)
1996
Depreciation
expense............ $ 841 $ 1,071 $ -- $ -- $ -- $ 1,912
======== ======== ======= ======= ======= ========
Capital
expenditures....... $ 2,627 $ 858 $ -- $ -- $ -- $ 3,485
======== ======== ======= ======= ======= ========
1997
Depreciation
expense............ $ 1,427 $ 1,164 $ 16 $ -- $ -- $ 2,607
======== ======== ======= ======= ======= ========
Capital
expenditures....... $ 3,149 $ 2,767 $ 43 $ -- $ -- $ 5,959
======== ======== ======= ======= ======= ========
65
67
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
SECURITY INVESTIGATIONS
PRODUCTS AND VOICE AND DATA INFORMATION
AND SERVICES INTELLIGENCE COMMUNICATIONS SECURITY
GROUP GROUP GROUP GROUP OTHER CONSOLIDATED
------------ -------------- -------------- ----------- ------- ------------
(DOLLARS IN THOUSANDS)
1998
Depreciation
expense............ $ 1,282 $ 1,439 $ 24 $ 24 $ 13 $ 2,782
======== ======== ======= ======= ======= ========
Capital
expenditures....... $ 3,427 $ 2,619 $ 68 $ 186 $ 647 $ 6,947
======== ======== ======= ======= ======= ========
Identifiable assets by segment are those assets that are used in the
Company's operations in each segment. Corporate assets are principally cash,
marketable securities, computer software, certain intangible assets and certain
prepaid expenses.
The following summarizes information about the Company's different
geographic areas:
UNITED OTHER
STATES FRANCE FOREIGN ELIMINATIONS CONSOLIDATED
-------- ------- ------- ------------ ------------
(DOLLARS IN THOUSANDS)
1996
Net sales to unaffiliated
customers......................... $140,547 $ 2,142 $22,229 $ -- $164,918
Intercompany........................ 3,584 316 2,804 (6,704) --
-------- ------- ------- -------- --------
Total net sales................ $144,131 $ 2,458 $25,033 $ (6,704) $164,918
======== ======= ======= ======== ========
Operating income (loss)............. $ 7,735 $ (118) $ 2,166 $ -- $ 9,783
======== ======= ======= ======== ========
Identifiable assets................. $ 75,569 $ 1,205 $13,933 $ -- $ 90,707
======== ======= ======= ========
Corporate assets.................... 1,357
--------
Total assets at yearend........ $ 92,064
========
1997
Net sales to unaffiliated
customers......................... $134,802 $24,004 $47,297 $ -- $206,103
Intercompany........................ 7,413 208 5,624 (13,245) --
-------- ------- ------- -------- --------
Total net sales................ $142,215 $24,212 $52,921 $(13,245) $206,103
======== ======= ======= ======== ========
Operating income.................... $ 6,325 $ 1,382 $ 3,779 $ -- $ 11,486
======== ======= ======= ======== ========
Identifiable assets................. $ 86,123 $23,706 $31,371 $ -- $141,200
======== ======= ======= ========
Corporate assets.................... 9,284
--------
Total assets at yearend........ $150,484
========
1998
Net sales to unaffiliated
customers......................... $157,711 $28,458 $78,676 $ -- $264,845
Intercompany........................ 2,960 199 4,548 (7,707) --
-------- ------- ------- -------- --------
Total net sales................ $160,671 $28,657 $83,224 $ (7,707) $264,845
======== ======= ======= ======== ========
Operating income.................... $ 12,359 $ 2,251 $ 9,804 $ -- $ 24,414
======== ======= ======= ======== ========
Identifiable assets................. $135,113 $29,047 $59,430 $ -- $223,590
======== ======= ======= ======== ========
Corporate assets.................... 25,366
--------
Total assets at yearend........ $248,956
========
66
68
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
The Company accounts for transfers between geographic areas at cost plus a
proportionate share of operating profit.
The following summarizes the Company's sales in the United States and
foreign locations:
YEARS ENDED DECEMBER 31,
--------------------------------
1996 1997 1998
-------- -------- --------
(DOLLARS IN THOUSANDS)
Sales to unaffiliated customers:
U.S. Government................................. $ 51,505 $ 43,719 $ 62,149
Other United States............................. 72,337 73,848 89,853
Middle East..................................... 7,598 5,887 5,958
Europe.......................................... 11,798 44,022 52,927
Asia............................................ 8,946 10,697 15,467
Central & South America......................... 5,807 20,123 25,850
Other Foreign................................... 6,927 7,807 12,641
-------- -------- --------
$164,918 $206,103 $264,845
======== ======== ========
Export sales by the Company's domestic operations were approximately 14%,
15% and 18% of net sales for the years ended December 31, 1996, 1997 and 1998,
respectively.
The Company is subject to audit and investigation by various agencies which
oversee contract performance in connection with the Company's contracts with the
U.S. Government. Additionally, the Company's laboratory testing operations are
certified and subject to frequent inspections and proficiency tests by certain
federal, state or local jurisdictions. Management believes that potential claims
from such audits and investigations will not have a material adverse effect on
the supplemental consolidated financial statements. In addition, contracts with
the U.S. Government may contain cost or performance incentives or both based on
stated targets or other criteria. Cost or performance incentives are recorded at
the time there is sufficient information to relate actual performance to targets
or other criteria.
The Company has foreign operations and assets in Argentina, Australia,
Brazil, Canada, China, Colombia, France, Germany, India, Italy, Japan, Mexico,
the Philippines, Russia, Saudi Arabia, Singapore, Switzerland and the United
Kingdom. In addition, the Company sells its products and services in other
foreign countries and continues to increase its level of international activity.
Accordingly, the Company is subject to various risks including, among others,
foreign currency restrictions, exchange rate fluctuations, government
instability and complexities of local laws and regulations.
(b) Major Customers -- During the years ended December 31, 1996, 1997 and
1998 sales in the Security Products and Services Group to the U.S. Government
approximated 31%, 21% and 23% of the Company's net sales, respectively.
67
69
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
(15) SUPPLEMENTAL CASH FLOWS DISCLOSURES
The following is a summary of cash paid related to certain items:
1996 1997 1998
---------- ---------- -----------
SUPPLEMENTAL DISCLOSURE OF CASH FLOW
INFORMATION:
Cash paid for interest.................... $4,460,514 $4,853,462 $ 4,581,068
========== ========== ===========
Cash paid for taxes....................... $ 729,193 $3,468,474 $ 4,095,349
========== ========== ===========
SUPPLEMENTAL DISCLOSURE OF NON-CASH
ACTIVITIES:
Issuance of restricted stock.............. $ 891,066 $1,356,280 $ --
========== ========== ===========
Affiliate obligation forgiven in
connection with the reorganization..... $ 122,000 $ -- $ --
========== ========== ===========
Fair value of stock issued in connection
with acquisition of businesses......... $ -- $8,459,769 $17,133,300
========== ========== ===========
Fair value of stock issued in connection
with acquisition of minority
interest............................... $ -- $1,243,474 $ --
========== ========== ===========
Notes issued in connection with
acquisition of businesses.............. $ 505,834 $2,906,513 $ --
========== ========== ===========
Tax benefit of restricted stock vesting... $ -- $2,160,341 $ --
========== ========== ===========
(16) QUARTERLY FINANCIAL DATA (UNAUDITED)
FIRST SECOND THIRD FOURTH
QUARTER QUARTER QUARTER QUARTER
------- ------- ------- -------
(IN THOUSANDS, EXCEPT PER SHARE AMOUNTS)
1998
Net sales................................ $57,195 $64,559 $72,808 $70,283
Gross profit............................. 19,238 22,028 25,331 24,930
Net income............................... 3,185 4,142 5,311 451
Earnings per share:
Basic.................................. $ 0.21 $ 0.23 $ 0.26 $ 0.02
Diluted................................ $ 0.20 $ 0.23 $ 0.26 $ 0.02
1997
Net sales................................ $44,369 $51,441 $52,071 $58,222
Gross profit............................. 14,818 17,623 16,633 17,263
Net income (loss)........................ 1,665 2,640 2,701 (4,959)
Earnings (loss) per share:
Basic.................................. $ 0.12 $ 0.19 $ 0.19 $ (0.35)
Diluted................................ $ 0.09 $ 0.16 $ 0.17 $ (0.35)
(17) SUBSEQUENT EVENTS
On January 21, 1999, the Company entered into a definitive agreement to
acquire all of the outstanding capital stock and common stock equivalents of
Background America, Inc. (BAI) for approximately 989,000 shares of Company
common stock, including approximately 90,000 shares reserved for issuance for
outstanding common stock equivalents. BAI provides employment screening and
compliance services to a variety of
68
70
THE KROLL-O'GARA COMPANY
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
industries and will be included in the Company's Investigations and Intelligence
Group. The acquisition is subject to the approval of the BAI shareholders and
upon completion is expected to qualify as a pooling of interests. Included in
the December 31, 1998 consolidated balance sheet is approximately $573,000 of
merger costs incurred by the Company which, along with other merger costs
subsequently incurred, will be expensed immediately upon consummation of the
transaction on a pooling of interests basis.
On March 1, 1999, the Company acquired all of the capital stock of
Financial Research, Inc. (FRI) for approximately $3.3 million, consisting of
101,555 shares of common stock. FRI provides business valuation and economic
damage analysis services and will be included in the Company's Investigations
and Intelligence Group. The acquisition has been accounted for as a pooling of
interests. The pro forma restated results for 1996, 1997 and 1998 would not be
materially different from the reported results.
69
71
ITEM 9. CHANGES IN AND DISAGREEMENTS WITH ACCOUNTANTS ON ACCOUNTING AND
FINANCIAL DISCLOSURE
None.
PART III
Except as set forth below, the information required by this Part either
will be incorporated by reference from Kroll-O'Gara's definitive Proxy Statement
filed with the SEC in connection with its 1999 Annual Meeting of Shareholders or
will be filed by amendment no later than April 30, 1999.
ITEM 10. DIRECTORS AND EXECUTIVE OFFICERS OF THE REGISTRANT
The following table sets forth certain information as of March 31, 1999
concerning each of Kroll-O'Gara's executive officers and directors:
NAME AGE POSITION
---- --- --------
Jules B. Kroll............................ 57 Chairman of the Board, Chief Executive
Officer and Director
Thomas M. O'Gara.......................... 48 Vice Chairman of the Board and Director
Wilfred T. O'Gara......................... 41 President, Chief Operating Officer and
Director
Nicholas P. Carpinello.................... 49 Controller and Treasurer
Michael G. Cherkasky...................... 49 Chief Operating Officer -- Investigations
and Intelligence Group and Director
Marshall S. Cogan......................... 61 Director
Abram S. Gordon........................... 35 Vice President, General Counsel and
Secretary
Michael J. Lennon......................... 42 Chief Operating Officer -- Security
Products and Services and Director
Raymond E. Mabus.......................... 50 Director
Nazzareno E. Paciotti..................... 53 Chief Financial Officer
Hugh E. Price............................. 62 Director
Jerry E. Ritter........................... 64 Director
William S. Sessions....................... 68 Director
Howard I. Smith........................... 54 Director
Jules B. Kroll has been Chairman of the Board and Chief Executive Officer
of Kroll-O'Gara since the KHI merger on December 1, 1997. He founded
Kroll-O'Gara's Kroll Associates, Inc. subsidiary in 1972 and has been the
Chairman of the Board and Chief Executive Officer of Kroll and KHI since their
foundings. Mr. Kroll also is a director of United Auto Group, Inc. He has been a
director of Kroll-O'Gara since December 1997.
Thomas M. O'Gara has been Vice Chairman of the Board of Kroll-O'Gara since
the KHI merger. He served as Chairman of the Board of Kroll-O'Gara from August
1996 until December 1997. Mr. O'Gara has also been Chairman of the Board of OHE
since 1990 and was OHE's Chief Executive Officer from 1990 until 1995. He has
been a director of Kroll-O'Gara since August 1996 and a director of OHE since
1988. Mr. O'Gara has held numerous executive officer and director positions with
Kroll-O'Gara, its subsidiaries and its predecessors since 1975. From 1984 until
1986, Mr. O'Gara also was Honorary Consul General for the Sultanate of Oman.
Thomas M. O'Gara and Wilfred T. O'Gara are brothers.
Wilfred T. O'Gara is President and Chief Operating Officer of Kroll-O'Gara.
He served as Kroll-O'Gara's Chief Executive Officer from August 1996 until the
KHI merger. Mr. O'Gara has been associated with Kroll-O'Gara, its subsidiaries
and its predecessors since 1983 and has held numerous executive officer and
director positions, including serving as Chief Executive Officer of OHE since
January 1996, President and Chief Operating Officer of OHE from 1991 through
1995 and Vice President -- Sales and Marketing of OHE from
70
72
1988 until 1991. Mr. O'Gara has been a director of Kroll-O'Gara since August
1996 and a director of OHE since 1991. Mr. O'Gara also is a director of LSI
Industries, Inc.
Nicholas P. Carpinello has been Controller and Treasurer of Kroll-O'Gara
since the KHI merger. From August 1996 until December 1997 he served as
Kroll-O'Gara's Executive Vice President, Chief Financial Officer and Treasurer,
positions he also has held with OHE since 1993. Mr. Carpinello has been
associated with Kroll-O'Gara and its predecessors since 1984. From 1975 until
1984, he was employed by Arthur Andersen LLP where he served as a manager in the
audit and small business consulting divisions.
Michael G. Cherkasky became Chief Operating Officer of Kroll-O'Gara's
Investigations and Intelligence Group in December 1997. Prior to the KHI merger
he had been an Executive Managing Director of KHI since April 1997 and Chief
Operating Officer of KHI since January 1997. From November 1995 to January 1997,
he was the head of KHI's North American Region and from February 1994 to
November 1995 he was the head of KHI's Monitoring Group. From June 1993 to
November 1993, Mr. Cherkasky was a candidate for public office. From 1978 to
June 1993, Mr. Cherkasky was with the District Attorney's office for New York
County, his last position being Chief of the Investigation Division. He became a
director of Kroll-O'Gara in December 1997.
Marshall S. Cogan has been Vice Chairman of Foamex International, Inc., a
manufacturer of polyurethane foam products, since May 1997 and Chairman and
Chief Executive Officer of United Auto Group, a franchisor of car and light
truck dealerships, since April 1997. Mr. Cogan was Chairman of the Board and
Chairman of the Executive Committee of Foamex International from 1993 until 1997
and was Chief Executive Officer of Foamex International from 1994 until 1997.
Since 1974, Mr. Cogan has been the principal shareholder, Chairman or Co-
Chairman of the Board of Directors, and Chief Executive Officer or Co-Chief
Executive Officer, of Trace International Holdings, Inc., a holding company
operating businesses in the auto sales, foam, textile and publishing industries.
Mr. Cogan has been a director of Kroll-O'Gara since December 1997.
Abram S. Gordon is Vice President, General Counsel and Secretary of
Kroll-O'Gara. Prior to joining Kroll-O'Gara in January 1997, he was with the law
firm of Taft, Stettinius & Hollister LLP, Cincinnati, Ohio, from October 1987
until December 1996.
Michael J. Lennon became Chief Operating Officer of Kroll-O'Gara's Security
Products and Services Group in December 1997. He also has been the President and
Chief Operating Officer of OHE since January 1996. Mr. Lennon joined OHE in
February 1994 as Manager of Commercial and Military Programs; he became Vice
President for Sales, Marketing and Program Management in October 1994 and served
OHE in that capacity through 1995. Prior to joining OHE, Mr. Lennon had 15
years' experience in engineering, manufacturing, quality control and marketing
with General Electric Company, which he joined in 1979. From 1990 to 1994, he
was Manager of Advanced Technology Marketing for their G.E. Aircraft Engines
business. He became a director of Kroll-O'Gara in March 1998.
Raymond E. Mabus is President of International Management and Development
Group Ltd., a provider of workforce analysis, foreign investment planning and
resource generation services, and of counsel to the law firm of Baker,
Donaldson, Bearman and Caldwell. He also manages a family timber business. He
served as the United States' Ambassador to the Kingdom of Saudi Arabia from 1994
until 1996, as a consultant to Mobil Telecommunications Technology from 1992
until 1994 and as Governor of the State of Mississippi from 1988 until 1992. Mr.
Mabus has been a director of Kroll-O'Gara since November 1996.
Nazzareno E. Paciotti has been Chief Financial Officer of Kroll-O'Gara
since the KHI merger. Prior to the KHI merger he had been the Chief Financial
Officer of KHI since 1992. From 1990 to 1992, he was a Managing Director and the
Controller of the Henley Group (the parent of PneumoAbex Inc. and Fisher
Scientific, a laboratory supply company) and from 1988 to 1990, he was a Vice
President and the Controller of PneumoAbex Inc., an aerospace contractor
specializing in the manufacture of landing gear and flight actuating systems.
Hugh E. Price is engaged in business development activities for
Kroll-O'Gara. During 1995 and 1996, prior to joining Kroll-O'Gara, he was a
consultant to various businesses and organizations. Until his retirement in
1995, Mr. Price had been employed by the Central Intelligence Agency since 1964.
His positions with the Agency included Deputy and Associate Deputy Director for
Operations (1991-1995), Chief and Deputy Chief for
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73
Counterintelligence (1988-1990) and Director of Personnel (1986-1988). Mr. Price
became a director of Kroll-O'Gara in October 1996.
Jerry E. Ritter is currently a consultant to Anheuser-Busch Companies,
Inc., a company engaged in the brewing and family entertainment businesses. He
also is Chairman of the Board of Clark Enterprises, Inc., the general partner of
the Kiel Center and the St. Louis Blues Hockey Club. From 1990 until 1996, Mr.
Ritter served as Executive Vice President and Chief Financial and Administrative
Officer for Anheuser-Busch Companies, Inc. Prior to that time, he served
Anheuser-Busch in various other managerial and executive capacities. Mr. Ritter
also is a director of The Earthgrains Company, Brown Group, Inc. and OmniQuip
International, Inc. He became a director of Kroll-O'Gara in January 1997.
William S. Sessions is a partner in the law firm of Sessions & Sessions
L.C. and is a consultant to various public and private businesses. From 1987
until 1993, Mr. Sessions was Director of the Federal Bureau of Investigation. He
served as a United States District Judge for the Western District of Texas from
1974 until 1987. Mr. Sessions is a director of Zenith National Insurance
Company. He has been a director of Kroll-O'Gara since November 1996.
Howard I. Smith has been Executive Vice President, Chief Financial Officer
and Comptroller of AIG since 1996. From 1984 until 1996, Mr. Smith was Senior
Vice President and Comptroller of AIG. From 1975 until 1984 Mr. Smith was a
partner in the independent public accounting firm of Coopers & Lybrand. Mr.
Smith also is a director of AIG, 20th Century Industries, International Lease
Finance Corporation and Transatlantic Holdings, Inc. He became a director of
Kroll-O'Gara in December 1997.
Directors of Kroll-O'Gara are elected annually. Officers of Kroll-O'Gara
are elected annually and serve at the discretion of the Board of Directors.
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PART IV
ITEM 14. EXHIBITS, FINANCIAL STATEMENT SCHEDULES AND REPORTS OF FORM 8-K
(a)(1) The following consolidated financial statements of Kroll-O'Gara and its
subsidiaries are included in
Item 8:
Reports of Independent Public Accountants
- Arthur Andersen LLP
- Deloitte & Touche LLP
Consolidated Balance Sheets
- As of December 31, 1997 and 1998
Consolidated Statements of Operations
- For the Years Ended December 31, 1996, 1997 and 1998
Consolidated Statements of Shareholders' Equity
- For the Years Ended December 31, 1996, 1997 and 1998
Consolidated Statements of Cash Flows
- For the Years Ended December 31, 1996, 1997 and 1998
Notes to Consolidated Financial Statements
(a)(2) Financial Statement Schedules
Schedules have been omitted because they are either not applicable or
not required or the information has been furnished in the consolidated
financial statements.
(b) Reports on Form 8-K
During the quarter ended December 31, 1998, Kroll-O'Gara filed the
following current reports on
Form 8-K:
- Date of Report: September 1, 1998 (filed October 23, 1998); Items 7(a)
and 7(b), reporting the pro forma financial statements of
Kroll-O'Gara and Kizorek, Inc. and the historical financial
statements of Kizorek, Inc.
- Date of Report: September 22, 1998 (filed October 6, 1998); Item 5,
reporting the completion of the acquisition of all of the assets
of Protec, S.A.
- Date of Report: October 22, 1998 (filed November 23, 1998); Item 5,
reporting the pro forma financial statements of Kroll-O'Gara and
Laboratory Specialists of America, Inc. and the historical
financial statements of Laboratory Specialists of America, Inc.
- Date of Report: December 7, 1998 (filed December 22, 1998); Items 2
and 7(c), reporting the completion of the acquisition of
Laboratory Specialists of America, Inc.
(c) Exhibits: See the Exhibit Index beginning on page .
(d) Financial Statements: Not applicable
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SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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 31st day of
March, 1999.
THE KROLL-O'GARA COMPANY
By /s/ JULES B. KROLL
------------------------------------
Jules B. Kroll
Chairman of the Board
and Chief Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
report has been signed below by the following persons on behalf of the
registrant and in the capacities indicated as of the 31st day of March, 1999.
SIGNATURE TITLE
--------- -----
/s/ JULES B. KROLL Chairman of the Board and Chief Executive Officer
- ----------------------------------------------------- (principal executive officer)
Jules B. Kroll
/s/ THOMAS M. O'GARA* Vice Chairman of the Board
- -----------------------------------------------------
Thomas M. O'Gara
/s/ WILFRED T. O'GARA* Director
- -----------------------------------------------------
Wilfred T. O'Gara
/s/ NAZZARENO E. PACIOTTI Chief Financial Officer (principal financial officer)
- -----------------------------------------------------
Nazzareno E. Paciotti
/s/ NICHOLAS P. CARPINELLO Controller and Treasurer (principal accounting officer)
- -----------------------------------------------------
Nicholas P. Carpinello
/s/ MICHAEL G. CHERKASKY* Director
- -----------------------------------------------------
Michael G. Cherkasky
/s/ MARSHALL S. COGAN* Director
- -----------------------------------------------------
Marshall S. Cogan
/s/ MICHAEL J. LENNON* Director
- -----------------------------------------------------
Michael J. Lennon
/s/ RAYMOND E. MABUS* Director
- -----------------------------------------------------
Raymond E. Mabus
/s/ HUGH E. PRICE* Director
- -----------------------------------------------------
Hugh E. Price
/s/ JERRY E. RITTER* Director
- -----------------------------------------------------
Jerry E. Ritter
/s/ WILLIAM S. SESSIONS* Director
- -----------------------------------------------------
William S. Sessions
/s/ HOWARD I. SMITH* Director
- -----------------------------------------------------
Howard I. Smith
* Pursuant to Power of Attorney
/s/ ABRAM S. GORDON
- -----------------------------------------------------
Abram S. Gordon, Attorney-in-fact
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LIST OF EXHIBITS
EXHIBIT
NO. DESCRIPTION
- ------- -----------
3.1 Amended and Restated Articles of Incorporation of the
Company (1)
3.2 Code of Regulations of the Company (2)
4.1 Note Purchase Agreement, dated as of May 30, 1997, between
and among the Company, Connecticut General Life Insurance
Company, Life Insurance Company of North America,
Massachusetts Mutual Life Insurance Company, The Traveler's
Insurance Company, and the Guardian Life Insurance Company
of America (3)
10.1 Agreement to armor HMMWVs between the Company and the United
States Army Tank and Automotive Command, dated May 12, 1994,
as amended (2)
10.2 Systems Technical Support Agreement between the Company and
the United States Army, dated January 20, 1997 (4)
10.3 Aircraft Lease between O'Gara-Hess & Eisenhardt Armoring
Company and Longline Leasing, Inc. and Excel Armor Products,
Inc., dated February 13, 1995, as amended (2)
10.4 1996 Stock Option Plan, as amended (12)*
10.5 Employment Agreement between the Company and Thomas M.
O'Gara, dated August 23, 1996 (2)*
10.6 Employment Agreement between the Company and Wilfred T.
O'Gara, dated August 23, 1996 (2)*
10.7 Employment Agreement between the Company and Nicholas P.
Carpinello, dated August 23, 1996 (2)*
10.8 Employment Agreement between O'Gara-Hess & Eisenhardt
Armoring Company and Michael J. Lennon, dated August 23,
1996 (2)*
10.9 Plan and Agreement to Merge, dated as of August 8, 1997, by
and among The O'Gara Company, VDE, Inc., Kroll Holdings,
Inc. and Jules B. Kroll (6)
10.10 Amended and Restated Loan Agreement, dated as of December 1,
1997, between The O'Gara Company, O'Gara-Hess & Eisenhardt
Armoring Company, Kroll Holdings, Inc., Kroll Associates,
Inc. and KeyBank National Association (1)
10.11 Supplemental Agreement Modification to acquire 360
additional armored HMMWVs between United States Army Tank
and Automotive Armaments Command and O'Gara-Hess and
Eisenhardt Armoring Company, dated March 31, 1997 (5)
10.12 AUI Retainer Agreement (6)
10.13 Amended and restated lease of office space in New York, New
York between Progress Partners and Kroll Associates, Inc.
(6)
10.14 Registration Rights Agreement, dated August 8, 1997, among
Thomas M. O'Gara, Jules B. Kroll and the Company (6)
10.15 Registration Rights Agreement between American International
Group, Inc. and the Company (1)
10.16 Employment Agreement, dated October 17, 1997, between the
Company and Jules B. Kroll (6)*
10.17 Employment Agreement, dated October 17, 1997, between the
Company and Nazzareno E. Paciotti (6)*
10.18 Employment Agreement, dated October 17, 1997, between the
Company and Abram S. Gordon (6)*
10.19 Amendment to Employment Agreement, dated October 17, 1997,
between O'Gara-Hess & Eisenhardt Armoring Company and
Michael J. Lennon (6)*
10.20 Amendment to Employment Agreement, dated October 17, 1997,
between the Company and Thomas M. O'Gara (6)*
10.21 Amendment to Employment Agreement, dated October 17, 1997,
between the Company and Wilfred T. O'Gara (6)*
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77
EXHIBIT
NO. DESCRIPTION
- ------- -----------
10.22 Amendment to Employment Agreement, dated October 17, 1997,
between the Company and Nicholas P. Carpinello (6)*
10.23 Form of Promissory Note between Jules B. Kroll and Kroll
Associates (6)
10.24 Supplemental Agreement Modifications to acquire 738
additional armored HMMWVs between the United States Army
Tank and Automotive Armaments Command and O'Gara-Hess &
Eisenhardt Armoring Company, dated March 31, 1998 and April
13, 1998 (7)
10.25 Stock Purchase Agreement among The Kroll-O'Gara Company, The
Kroll-O'Gara Canada Company, Kroll Associates, Inc. and the
shareholders of Lindquist Avey MacDonald Baskerville Inc.
and U.S. Holdings, Inc. dated June 1, 1998 (8)
10.26 Agreement and Plan of Merger dated June 30, 1998 among The
Kroll-O'Gara Company, Kroll-O'Gara Acquisition Co., Inc.,
Kizorek, Inc. and William Kizorek (9)
10.27 Agreement and Plan of Merger by and among The Kroll-O'Gara
Company, Kroll-O'Gara Oklahoma, Inc. and Laboratory
Specialists of America, Inc. dated as of October 21, 1998
(10)
10.28 Amended and Restated Loan Agreement, dated October 30, 1998,
among The Kroll-O'Gara Company, O'Gara-Hess & Eisenhardt
Armoring Company, Kroll Holdings, Inc., Kroll Associates,
Inc. and Keybank National Association (10)
10.29 Agreement and Plan of Merger dated as of December 31, 1998
among The Kroll-O'Gara Company, TKOG Delaware, Inc. and
Securify Inc. (11)
10.30 Agreement and Plan of Merger by and among The Kroll-O'Gara
Company, Kroll-O'Gara Tennessee, Inc. and Background
America, Inc. dated as of January 21, 1999 (12)
21.1 Subsidiaries of the Company
23.1 Consent of Arthur Andersen LLP
23.2 Consent of Deloitte & Touche LLP
24.1 Power of Attorney
27.1 Financial Data Schedule
- ---------------
* Executive compensation agreement
(1) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
No. 333-48099 and incorporated herein by reference.
(2) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
No. 333-11093 and incorporated herein by reference.
(3) Filed as an Exhibit to the Company's Current Report on Form 8-K (Date of
Report: May 30, 1997) and incorporated herein by reference.
(4) Filed as an Exhibit to the Company's Annual Report on Form 10-K for the
year ended December 31, 1996 and incorporated herein by reference.
(5) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1997 and incorporated herein by reference.
(6) Filed as an Exhibit to the Company's Registration Statement on Form S-4,
No. 333-35845 and incorporated herein by reference.
(7) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q/A for
the quarter ended March 31, 1998 and incorporated herein by reference.
(8) Filed as an Exhibit to the Company's Quarterly Report on Form 10-Q for the
quarter ended June 30, 1998 and incorporated herein by reference.
(9) Filed as an Exhibit to the Company's Current Report on Form 8-K (Date of
Report: September 1, 1998) and incorporated herein by reference.
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78
(10) Filed as an Exhibit to the Company's Registration Statement on Form S-1,
No. 333-66959 and incorporated herein by reference.
(11) Filed as an Exhibit to the Company's Current Report on Form 8-K (Date of
Report: December 31, 1998) and incorporated herein by reference.
(12) Filed as an Exhibit to the Company's Registration Statement on Form S-4,
No. 333-74063 and incorporated herein by reference.
77