##### Table of Contents



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549
   FORM 10-Q/A QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934  COMMISSION FILE NUMBER: 000-21629   KROLL INC.  Delaware
(State or other jurisdiction of
incorporation)
    
    13-4131019
(I.R.S. Employer
Identification Number)900 Third Avenue
New York, NY
(Address of principal executive offices)
    
    10022
(Zip code)
 (212) 593-1000
(Registrants telephone number, including area code) Indicate by check mark whether the Registrant
(1) has filed all reports required to be filed
by Section 13 or 15(d) of the Securities
Exchange Act of 1934 during the preceding 12
months (or for such shorter period that the
Registrant was required to file such reports),
and (2) has been subject to such filing
requirements for the past 90 days: Yes [ X ] No [  ] Indicate by check mark whether the Registrant
is an accelerated filer (as defined in Rule
12b-2 of the Exchange Act): Yes [ X ]
No [  ] The number of shares outstanding of the
Registrants common stock was 40,052,403 shares
as of April 30, 2004.




---



INDEX PART I
    
    FINANCIAL INFORMATIONItem 1.
    
    Financial StatementsConsolidated Condensed Balance Sheets (Unaudited) as of March 31, 2004 and December 31, 2003
    
    
    1Consolidated Condensed Statements of Income and Comprehensive Income (Unaudited) for the three months ended March 31, 2004 and 2003
    
    
    3Consolidated Condensed Statements of Cash
Flows (Unaudited) for the three months ended March 31, 2004 and 2003
    
    
    4Notes to Consolidated Condensed
Financial Statements (Unaudited)
    
    
    5Item 2.
    
    Managements Discussion and Analysis of Financial
Condition and Results of Operations
    
    
    17Item 3.
    
    Quantitative and Qualitative
Disclosure about Market Risk
    
    
    29Item 4.
    
    Controls and Procedures
    
    
    30PART II
    
    OTHER INFORMATIONItem 1.

    
    Legal Proceedings
    
    
    31Item 2.
    
    Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities
    
    
    32Item 6.
    
    Exhibits and Report on Form 8-K
    
    
    33Signatures
    
    
    34AMENDMENT TO EMPLOYMENT AGREEMENTAMENDMENT TO EMPLOYMENT AGREEMENTEMPLOYMENT AGREEMENT FOR MICHAEL PETRULLOEMPLOYMENT AGREEMENT FOR SABRINA H. PERELEMPLOYMENT AGREEMENT FOR MICHAEL A. BEBERCERTIFICATIONCERTIFICATIONCERTIFICATIONCERTIFICATION
  EXPLANATORY NOTE The
purpose of this Form 10-Q/A is to add As Restated (see Note
14) to the heading above the Three Months ended March 31, 2003
column in Krolls Consolidated Condensed Statement of Cash flows to
indicate that certain amounts reported in this column of the
financial statement in Krolls Quarterly Report on Form 10-Q for
the quarterly period ended March 31, 2004 filed May 7, 2004
had been restated as
well as to add a footnote disclosing this restatement. See
Note 14 of the Notes to Consolidated Condensed Financial
Statements. i




---



##### Table of Contents



PART I. FINANCIAL INFORMATION 
 ITEM 1. FINANCIAL STATEMENTS KROLL INC.
CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited)
(In thousands) March 31,
    
    December 31,2004
    
    2003ASSETSCURRENT ASSETS:Cash and cash equivalents
    
    $
    98,255
    
    
    $
    22,835Trade accounts receivable, net of allowance for
doubtful accounts of $7,123 and $6,435 at March 31,
2004 and December 31, 2003, respectively
    
    
    88,848
    
    
    
    71,640Unbilled revenues
    
    
    44,049
    
    
    
    38,322Related party receivables
    
    
    300
    
    
    
    155Deferred tax assets
    
    
    2,102
    
    
    
    2,087Assets of discontinued operations (Note 6)
    
    
    169
    
    
    
    169Prepaid expenses and other current assets
    
    
    11,390
    
    
    
    10,862Total current assets
    
    
    245,113
    
    
    
    146,070PROPERTY, PLANT AND EQUIPMENT, at cost:Land
    
    
    194
    
    
    
    194Buildings
    
    
    2,378
    
    
    
    2,296Leasehold improvements
    
    
    17,821
    
    
    
    16,092Furniture and fixtures
    
    
    10,580
    
    
    
    9,723Equipment
    
    
    57,602
    
    
    
    52,77688,575
    
    
    
    81,081Less: accumulated depreciation and amortization
    
    
    (47,310
    )
    
    
    (43,239
    )41,265
    
    
    
    37,842GOODWILL (Note 8)
    
    
    381,152
    
    
    
    376,988OTHER INTANGIBLE ASSETS, net of accumulated amortization of
$16,548 and $13,466 at March 31, 2004 and December 31,
2003, respectively (Note 8)
    
    
    109,375
    
    
    
    95,488OTHER ASSETS
    
    
    28,814
    
    
    
    23,221Total Assets
    
    $
    805,719
    
    
    $
    679,609
 The accompanying notes are an integral part of these consolidated condensed unaudited financial statements. 1




---



##### Table of Contents



KROLL INC. 
 CONSOLIDATED CONDENSED BALANCE SHEETS (Unaudited) (Continued)
(In thousands, except share data)
 March 31,
    
    December 31,2004
    
    2003LIABILITIES AND STOCKHOLDERS EQUITYCURRENT LIABILITIES:Revolving lines of credit (Note 9)
    
    $
    10
    
    
    $
    2,929Current portion of long-term debt (Note 9)
    
    
    4,278
    
    
    
    4,328Trade accounts payable
    
    
    18,213
    
    
    
    18,354Related party payables
    
    
    22
    
    
    
    606Accrued payroll and related benefits
    
    
    23,224
    
    
    
    29,683Other accrued liabilities
    
    
    17,146
    
    
    
    13,868Income taxes payable
    
    
    19,761
    
    
    
    13,245Liabilities of discontinued operations (Note 6)
    
    
    237
    
    
    
    250Deferred revenue
    
    
    11,437
    
    
    
    13,891Total current liabilities
    
    
    94,328
    
    
    
    97,154DEFERRED INCOME TAXES
    
    
    7,718
    
    
    
    7,718CONVERTIBLE SENIOR SUBORDINATED NOTES, net of unamortized
discount of $7,159 and $7,695 at March 31, 2004 and December 31,
2003, respectively (Note 9)
    
    
    22,841
    
    
    
    22,305CONVERTIBLE SUBORDINATED NOTES (Note 9)
    
    
    175,000
    
    
    
    OTHER LONG-TERM DEBT, net of current portion (Note 9)
    
    
    3,205
    
    
    
    3,608OTHER LONG-TERM LIABILITIES
    
    
    2,017
    
    
    
    1,981Total liabilities
    
    
    305,109
    
    
    
    132,766COMMITMENTS AND CONTINGENCIES (Note 10)STOCKHOLDERS EQUITY (Note 11):Preferred stock, $0.01 par value, 5,000,000 shares authorized,
none issued
    
    
    
    
    
    
    Common stock, $0.01 par value, 100,000,000 shares authorized,
42,732,793 and 41,916,288 shares issued at March 31, 2004 and
December 31, 2003, respectively
    
    
    427
    
    
    
    419Common shares to be issued for acquisition
    
    
    
    
    
    
    16,250Additional paid-in-capital
    
    
    577,029
    
    
    
    557,668Accumulated deficit
    
    
    (5,890
    )
    
    
    (20,595
    )Accumulated other comprehensive income
    
    
    672
    
    
    
    565Treasury stock, at cost, 2,777,777 and 250,300 shares at
March 31, 2004 and December 31, 2003, respectively
    
    
    (70,754
    )
    
    
    (6,441
    )Deferred compensation
    
    
    (874
    )
    
    
    (1,023
    )Total stockholders equity
    
    
    500,610
    
    
    
    546,843Total liabilities and stockholders equity
    
    $
    805,719
    
    
    $
    679,609
 The accompanying notes are an integral part of these consolidated condensed unaudited financial statements. 2




---



##### Table of Contents



KROLL INC. 
 CONSOLIDATED CONDENSED STATEMENTS OF INCOME
AND COMPREHENSIVE INCOME (Unaudited)
(In thousands, except per share amounts)
 Three Months EndedMarch 31,2004
    
    2003NET SALES
    
    $
    165,269
    
    
    $
    103,488COST OF SALES
    
    
    87,090
    
    
    
    48,808Gross profit
    
    
    78,179
    
    
    
    54,680OPERATING EXPENSES:Selling and marketing
    
    
    12,843
    
    
    
    6,922General and administrative
    
    
    32,192
    
    
    
    24,151Research and development
    
    
    3,228
    
    
    
    3,161Amortization of other intangible assets
    
    
    3,173
    
    
    
    1,195Operating expenses
    
    
    51,436
    
    
    
    35,429Operating income
    
    
    26,743
    
    
    
    19,251OTHER INCOME (EXPENSE):Interest expense
    
    
    (2,205
    )
    
    
    (1,057
    )Interest income
    
    
    279
    
    
    
    227Other
    
    
    107
    
    
    
    (2
    )Income before provision for income taxes
    
    
    24,924
    
    
    
    18,419Provision for income taxes
    
    
    10,219
    
    
    
    7,091Income from continuing operations
    
    
    14,705
    
    
    
    11,328Discontinued Operations (Note 6):Loss from video surveillance subsidiary, net of taxes
    
    
    
    
    
    
    (52
    )Net income
    
    
    14,705
    
    
    
    11,276OTHER COMPREHENSIVE INCOME (LOSS), NET OF TAX:Foreign currency translation adjustment
    
    
    107
    
    
    
    (324
    )Comprehensive income
    
    $
    14,812
    
    
    $
    10,952BASIC PER SHARE DATA (Note 4):Income from continuing operations
    
    $
    0.37
    
    
    $
    0.28Net income
    
    $
    0.37
    
    
    $
    0.28Weighted average shares outstanding
    
    
    40,087
    
    
    
    40,003DILUTED PER SHARE DATA (Note 4):Income from continuing operations
    
    $
    0.35
    
    
    $
    0.28Net income
    
    $
    0.35
    
    
    $
    0.28Weighted average shares outstanding
    
    
    44,167
    
    
    
    40,948
 The accompanying notes are an integral part of these consolidated condensed unaudited financial statements. 3




---



##### Table of Contents



KROLL INC. 
 CONSOLIDATED CONDENSED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
 Three Months EndedMarch 31,2004
    
    2003As Restated(see
Note 14)OPERATING ACTIVITIES:Net income
    
    $
    14,705
    
    
    $
    11,276Adjustments to reconcile net income to net cash provided by
operating activities:Depreciation and amortization
    
    
    7,097
    
    
    
    3,596Bad debt expense
    
    
    1,412
    
    
    
    1,357Non-cash interest expense
    
    
    798
    
    
    
    532Non-cash compensation expense
    
    
    149
    
    
    
    84Loss from discontinued operations, net of taxes (Note 6)
    
    
    
    
    
    
    52Change in operating assets and liabilities, excluding the impact of
acquisitions and dispositions:Trade accounts receivable and unbilled revenues
    
    
    (23,532
    )
    
    
    (6,298
    )Prepaid expenses and other current assets
    
    
    (394
    )
    
    
    (123
    )Trade accounts payable
    
    
    (253
    )
    
    
    (1,003
    )Amounts due to/from related parties
    
    
    (730
    )
    
    
    49Accrued liabilities
    
    
    (2,838
    )
    
    
    2,102Income taxes payable
    
    
    6,448
    
    
    
    6,172Deferred revenue
    
    
    (2,476
    )
    
    
    (1,022
    )Other long-term assets and liabilities
    
    
    105
    
    
    
    (133
    )Net cash provided by operating activities
    
    
    491
    
    
    
    16,641INVESTING ACTIVITIES:Purchases of property, plant and equipment
    
    
    (7,478
    )
    
    
    (1,890
    )Acquisitions, net of cash acquired (Note 5)
    
    
    (20,477
    )
    
    
    (5,681
    )Investments
    
    
    500
    
    
    
    (1,451
    )Net cash used in investing activities
    
    
    (27,455
    )
    
    
    (9,022
    )FINANCING ACTIVITIES:Net repayments under revolving lines of credit
    
    
    (2,911
    )
    
    
    (6,193
    )Proceeds from issuance of long-term debt
    
    
    175,000
    
    
    
    Deferred financing fees
    
    
    (5,549
    )
    
    
    Payment of long-term debt
    
    
    (1,333
    )
    
    
    Proceeds from exercise of employee stock options
    
    
    1,697
    
    
    
    621Purchase of treasury stock
    
    
    (64,313
    )
    
    
    Proceeds from Employee Stock Purchase Plan activity
    
    
    937
    
    
    
    563Other
    
    
    (1,163
    )
    
    
    (296
    )Net cash provided by (used in) financing activities
    
    
    102,365
    
    
    
    (5,305
    )Effects of foreign currency exchange rates on cash and cash equivalents
    
    
    32
    
    
    
    103Net cash used in discontinued operations
    
    
    (13
    )
    
    
    (116
    )NET INCREASE IN CASH AND CASH EQUIVALENTS
    
    
    75,420
    
    
    
    2,301CASH AND
CASH EQUIVALENTS, beginning of period
    
    
    22,835
    
    
    
    77,317CASH AND CASH EQUIVALENTS, end of period
    
    $
    98,255
    
    
    $
    79,618
 The accompanying notes are an integral part of these consolidated condensed unaudited financial statements. 4




---



##### Table of Contents



KROLL INC. 
 NOTES TO CONSOLIDATED CONDENSED FINANCIAL STATEMENTS (UNAUDITED)
  1.
    
    Nature of Operations Kroll Inc., together with its subsidiaries (collectively, Kroll), is a
leading global provider of complementary risk consulting services. Kroll
assists businesses, governments and individuals throughout the world in
preventing, mitigating and responding to risk through an integrated suite of
services. Effective January 1, 2004, Krolls Security Services segment was
integrated into its Consulting Services segment, reducing the number of
business groups to four. These four business groups enable Kroll to provide its
clients with comprehensive, single source, risk consulting services as follows:
(1) Consulting Services, which provides business and financial investigations,
forensic accounting, business valuation, litigation consulting, due diligence,
litigation intelligence, asset tracing and analysis, monitoring and special
inquiries, market intelligence, intellectual property and infringement
investigations, security architecture and design, corporate security
consulting, emergency management and environmental services and protective
services, operations and training; (2) Corporate Advisory and Restructuring
Services, which provides corporate restructuring, operational turnaround,
strategic advisory services, financial crisis management and corporate finance
services; (3) Background Screening Services, which provides employee and vendor
background investigations, credit screening, substance abuse testing and
identity fraud solutions and (4) Technology Services, which provides electronic
discovery, data recovery and computer forensics services, along with related
software solutions.  2.
    
    Basis of Presentation The accompanying consolidated condensed unaudited financial statements
include the historical consolidated financial statements of Kroll and the
businesses it has acquired since their respective dates of acquisition. All
material intercompany accounts and transactions are eliminated in
consolidation. Investments in 20% to 50% owned entities are accounted for using
the equity method. Investments in less than 20% owned entities are accounted
for under the cost method. The consolidated condensed unaudited financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States of America for interim financial information and with the
instructions to Form 10-Q and Article 10 of Regulation S-X. Accordingly, they
do not include all of the information and footnotes required by accounting
principles generally accepted in the United States of America for complete
financial statements. In the opinion of management, all adjustments (consisting of normal
recurring adjustments) considered necessary for fair presentation have been
included. The operating results for the three months ended March 31, 2004 and
2003 are not necessarily indicative of the results that may be expected for a
full year or any subsequent interim period. In addition, management is required
to make estimates and assumptions that affect the amounts reported and related
disclosures. Estimates, by their nature, are based on judgment and available
information. Accordingly, actual results could differ from these estimates. The
accompanying consolidated condensed unaudited financial statements should be
read in conjunction with the consolidated financial statements and notes
thereto included in Krolls Annual Report on Form 10-K for the year ended
December 31, 2003. Certain reclassifications have been made to prior period amounts to
conform to the current year presentation.  3.
    
    Stock-Based Compensation As permitted by Statement of Financial Accounting Standards (SFAS) No.
123, Accounting for Stock-Based Compensation, as amended by SFAS No. 148,
Accounting for Stock-Based Compensation  Transition and Disclosure  an
amendment of FASB Statement No. 123, Kroll accounts for the cost of its
employee stock options and other forms of employee stock-based compensation
plans utilizing the intrinsic value 5




---



##### Table of Contents



method prescribed in Accounting Principles
Board (APB) Opinion No. 25, Accounting for Stock Issued to Employees, and
its related interpretations. Under this method, compensation expense is
recognized based on the difference, if any, between the fair market value of
the stock option award on the date of grant and the option exercise price. SFAS
No. 123 also established a fair value-based method of accounting for
compensation cost related to stock options and other forms of stock-based
compensation plans. However, SFAS No. 148 allows an entity to continue to
measure compensation cost using the principles of APB Opinion No. 25 only if
certain pro forma disclosures are made which are included below. With respect
to restricted stock awards, the market value at date of grant of the shares of
restricted stock issued is recorded as compensation expense over the period of
restriction. Under APB Opinion No. 25, no stock-based employee compensation expense
relating to Krolls stock option plans was reflected in net income as all
options granted under its option plans had an exercise price equal to the
market value of the underlying common stock on the date of grant. The following table illustrates the effect on net income and net income
per share if Kroll had applied the fair value recognition provisions of SFAS
No. 123 to employee stock option awards (in thousands, except per share data). Three Months EndedMarch 31,2004
    
    2003Net Income:As reported
    
    $
    14,705
    
    
    $
    11,276Deduct: Total
stock-based employee
compensation expense
determined under fair
value based method for
all awards, net of
related tax effects
    
    
    2,720
    
    
    
    1,761Pro forma
    
    $
    11,985
    
    
    $
    9,515Basic Net Income Per Share:As reported
    
    $
    0.37
    
    
    $
    0.28Pro forma
    
    $
    0.30
    
    
    $
    0.24Diluted Net Income Per Share:As reported
    
    $
    0.35
    
    
    $
    0.28Pro forma
    
    $
    0.29
    
    
    $
    0.23
 Diluted
net income per share amounts for the three months ended
March 31, 2004 reflect the impact of adding back interest
expense, net of tax, or $828,000, on Krolls $30 million 6%
Senior Subordinated Convertible Notes due 2006 since such securities
were dilutive for the period. The fair value of each option grant is estimated on the date of grant
using the Black-Scholes option pricing model with the following assumptions
used for grants: Three Months EndedMarch 31,2004
    
    2003Dividend yield
    
    
    
    
    
    
    Expected volatility
    
    
    52.3
    %
    
    
    55.0
    %Risk-free interest rate
    
    3.04% to 3.36%
    
    2.75% to 3.01%Expected lives
    
    5.0 years
    
    5.0 years
  4.
    
    Earnings per Share Pursuant to the provisions of SFAS No. 128, Earnings per Share, basic
earnings per share is computed by dividing net income by the weighted average
number of shares of common stock outstanding during the period, excluding
non-vested restricted stock. Diluted earnings per share is computed by dividing
net income by the weighted average number of shares of common stock and common
stock equivalents outstanding during the 6




---



##### Table of Contents



period. Common stock equivalents
represent shares issuable upon the assumed exercise of stock options and
warrants and the assumed vesting of restricted stock, shares issuable under
contingent stock agreements and shares issuable upon potential conversion of
convertible debt securities. Basic and diluted earnings per share were as follows: Three Months EndedMarch 31,2004
    
    2003Basic:Income from continuing operations
    
    $
    0.37
    
    
    $
    0.28Loss from discontinued operations
    
    
    
    
    
    
    Net income
    
    $
    0.37
    
    
    $
    0.28Diluted:Income from continuing operations
    
    $
    0.35
    
    
    $
    0.28Loss from discontinued operations
    
    
    
    
    
    
    Net income
    
    $
    0.35
    
    
    $
    0.28
 Basic and diluted weighted average shares outstanding were as follows (in
thousands): Three Months EndedMarch 31,2004
    
    2003Basic
    
    
    40,087
    
    
    
    40,003Add:Stock options and non-vested restricted shares
    
    
    1,302
    
    
    
    945Shares issuable upon potential conversion of 6% Convertible Notes
    
    
    2,778
    
    
    
    Diluted
    
    
    44,167
    
    
    
    40,948
 At March 31, 2004, there were 274,300 options outstanding to purchase an
equivalent number of shares of common stock of Kroll at a range of $26.29 to
$26.94 per option that were not included in the shares in the above table
because the options exercise prices were greater than the average market price
of the common shares. Also excluded from the above table for the three months
ended March 31, 2004 is the potential conversion of Krolls $175 million 1.75%
Convertible Subordinated Notes due 2014 into 4,991,087 shares of common stock,
as the conditions for their conversion were not satisfied (see Note
9). In addition, diluted net income per share amounts for the three
months ended March 31, 2004 reflect the impact of adding back
interest expense, net of tax, or $828,000, on Krolls $30 million
6% Senior Subordinated Convertible Notes due 2006 since such
securities were dilutive for the period. At March 31, 2003, there were 8,719 warrants and 1,675,441 options
outstanding to purchase an equivalent number of shares of common stock of Kroll
at $25.69 per warrant and a range of $19.21 to $26.94 per option that were not
included in the shares in the above table because the warrants and options
exercise prices were greater than the average market price of the common
shares. The warrants expired during the second quarter of 2003. Also excluded
from the above table for the three months ended March 31, 2003 is the potential
conversion of Krolls $30.0 million 6% Senior Subordinated Convertible Notes
due 2006 into 2,777,777 shares of Kroll common stock, as it was determined that
such conversion would have an anti-dilutive effect on the earnings per share
calculation.  5.
    
    Acquisitions and Other Investments On February 5, 2004, Kroll acquired AIR Credit Reporting, Inc. (AIR
Credit), a mortgage credit reporting company, for a purchase price of $1.3
million in cash. In addition, Kroll issued a note for $0.9 million, which
accrues interest at 6% per year and is payable over three years. The results of
operations of AIR Credit are included within the Background Screening Services
Group subsequent to the date of acquisition. 7




---



##### Table of Contents



On March 2, 2004, Kroll acquired The Credit Network Trust, a mortgage
credit reporting company, for a purchase price of $19.0 million in cash. In
addition, $1.5 million is to be paid in annual installments of $500,000 over
the next three years to the extent aggregate gross revenue is in excess of a
predetermined amount. The results of operations of The Credit Network Trust are
included within the Background Screening Services Group subsequent to the date
of acquisition. In connection with the above acquisitions, the amount assigned to
amortizable and non-amortizable intangible assets consisted of the following: Weighted AverageFair Value
    
    Amortization PeriodAmortizable:Customer lists and customer relationships
    
    $
    16,154
    
    
    15 yearsNon-compete agreements
    
    
    650
    
    
    3 yearsTotal
    
    
    16,804
    
    
    15 yearsNon-amortizable:Goodwill
    
    $
    4,146
 The goodwill recorded by Kroll above is deductible for federal income tax
purposes. In addition, any adjustments to the fair value of amortizable
intangible assets or other identifiable net assets recorded would result
in an adjustment to the amount of goodwill recorded. Pro
forma financial data for the preceding acquisitions is not presented
as such acquisitions were not material to Krolls consolidated
results of operations or financial position. On March 27, 2003, Kroll invested $1.0 million in convertible notes of
iJet Travel Intelligence Inc. (iJet) and received warrants to purchase shares
of iJet preferred stock. The notes were convertible into preferred stock of
iJet upon iJet raising additional equity financing. This $1.0 million
investment was in addition to $1.5 million of Series B preferred stock of iJet
that Kroll acquired in August 2002. At that time, Kroll also received warrants
to purchase approximately 2.6 million shares of iJet common stock. In February
2004, Kroll converted $500,000 of the iJet convertible notes into shares of
Series C preferred stock of iJet and received approximately $535,000, including
accrued interest, in cash from iJet as repayment in full of the remaining
convertible notes. iJet is an intelligence organization focused on delivering
proactive travel risk management services and real-time alerts to travelers,
expatriates, corporations, government and non-governmental organizations,
learning institutions and the travel industry. This investment is accounted for
under the cost basis method.  6.
    
    Discontinued Operations On June 18, 2003, Kroll sold its video surveillance subsidiary, InPhoto
Surveillance Inc. (InPhoto), which was part of Krolls Background Screening
Services segment. Summarized statement of operations data for InPhoto consisted of (in
thousands): Three Months EndedMarch 31,2004
    
    2003Net sales
    
    $
    
    
    
    $
    1,286Loss from Discontinued Operations:Loss before benefit from income taxes
    
    
    
    
    
    
    (84
    )Benefit from income taxes
    
    
    
    
    
    
    (32
    )Loss from discontinued operations, net of taxes
    
    $
    
    
    
    $
    (52
    )
 8




---



##### Table of Contents



Summarized balance sheet data for InPhoto consisted of (in thousands): March 31,
    
    December 31,2004
    
    2003Assets of Discontinued Operations:Current assets
    
    $
    169
    
    
    $
    169Total assets of discontinued operations
    
    $
    169
    
    
    $
    169Liabilities of Discontinued Operations:Current liabilities
    
    $
    237
    
    
    $
    250Total liabilities of discontinued operations
    
    $
    237
    
    
    $
    250
  7.
    
    Restructuring Charge During 2003, Kroll recorded restructuring expenses of $6.2 million in
connection with the closure of 10 non-hub offices worldwide and the elimination
of 102 employees (the 2003 Plan). The 2003 Plan was undertaken to reduce
costs and improve operating efficiencies. Approximately $4.2 million of the
2003 Plan represents severance and related benefits. The remaining $2.0 million
relates primarily to lease rental payments, net of sublease income, associated
with the elimination of offices. The total cash portion of the 2003 Plan is
$5.8 million, of which $4.2 million relates to employee severance costs, $1.2
million relates to lease rental payments and $0.4 million relates to other exit
costs. The breakdown was $4.9 million, $0.8 million, $0.3 million and $0.2
million within Consulting Services, Corporate Advisory and Restructuring
Services, Background Screening Services and Corporate, respectively. The initial recognition of the 2003 restructuring charge and the
corresponding utilization from inception by category is as follows (in
thousands): Initial
    
    
    
    
    
    
    
    
    
    Balance at
    
    
    
    
    
    
    
    
    
    Balance atRestructuring
    
    Cash
    
    Other
    
    December 31,
    
    Cash
    
    Other
    
    March 31,Charge
    
    Payments
    
    Reductions
    
    2003
    
    Payments
    
    Adjustments
    
    2004Employee related
    
    $
    4,167
    
    
    $
    (2,415
    )
    
    $
    
    
    
    $
    1,752
    
    
    $
    (865
    )
    
    $
    (17
    )
    
    $
    870Lease rentals
    
    
    1,218
    
    
    
    (546
    )
    
    
    
    
    
    
    672
    
    
    
    (114
    )
    
    
    
    
    
    
    558Write-off of leasehold
improvements
    
    
    205
    
    
    
    
    
    
    
    (205
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment of equipment
    
    
    120
    
    
    
    
    
    
    
    (120
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other exit costs
    
    
    443
    
    
    
    (443
    )
    
    
    
    
    
    
    
    
    
    
    (17
    )
    
    
    17
    
    
    
    $
    6,153
    
    
    $
    (3,404
    )
    
    $
    (325
    )
    
    $
    2,424
    
    
    $
    (996
    )
    
    $
    
    
    
    $
    1,428
 The 2003 Plan was substantially completed during the first quarter of
2004. Liabilities associated with these initiatives are classified as a
component of other accrued liabilities. During 2001, Kroll recorded a $2.7 million restructuring charge (the 2001
Plan) in connection with the closure of four offices and the elimination of 98
employees. The 2001 Plan was substantially completed by the end of 2001. During
2003, the accrued balance related to the 2001 Plan was reduced by $0.4 million
as a result of a change in the original estimate of costs to be incurred. Total
payments and write-offs from inception of the 2001 Plan through March 31, 2004
were $2.1 million. The remaining accrued balance of $0.2 million represents
severance and lease termination costs. 9




---



##### Table of Contents



8. Intangible Assets Intangible assets consisted of the following (in thousands): March 31, 2004
    
    December 31, 2003Accumulated
    
    
    
    
    
    AccumulatedCost
    
    Amortization
    
    Cost
    
    AmortizationGoodwill
    
    $
    381,152
    
    
    
    
    
    
    $
    376,988Other Intangible Assets:AmortizableCustomer lists and customer relationships
    
    $
    66,321
    
    
    $
    7,557
    
    
    $
    51,139
    
    
    $
    6,397Internally developed software
    
    
    15,650
    
    
    
    3,569
    
    
    
    15,650
    
    
    
    2,934Franchise and license agreements
    
    
    7,800
    
    
    
    820
    
    
    
    7,800
    
    
    
    484Trademarks
    
    
    9,932
    
    
    
    731
    
    
    
    9,901
    
    
    
    566Non-compete agreements and other
    
    
    15,620
    
    
    
    3,871
    
    
    
    13,864
    
    
    
    3,085115,323
    
    
    $
    16,548
    
    
    
    98,354
    
    
    $
    13,466Non-AmortizableEvergreen contracts
    
    
    10,600
    
    
    
    
    
    
    
    10,600Total other intangible assets
    
    $
    125,923
    
    
    
    
    
    
    $
    108,954
 Evergreen contracts were recorded as part of Krolls acquisition of
Factual Data Corp. on August 21, 2003 and consist of contracts with Fannie Mae
and Freddie Mac for which a useful life is indeterminate. Amortization of other intangible assets for the three months ended March
31, 2004 and 2003 was $3.1 million and $1.2 million, respectively.
Approximately $54.0 million of amortization expense is anticipated to be
recognized over the next five years as follows: $12.0 million in 2005, $11.4
million in 2006, $11.0 million in 2007, $10.6 million 2008 and $9.0 million in
2009. The following table summarizes the changes in the carrying amount of
goodwill by segment (in thousands): Balance as of
    
    Goodwill
    
    
    
    
    
    Balance as ofDecember 31, 2003
    
    Acquired
    
    Other
    
    March 31, 2004Consulting Services
    
    $
    23,115
    
    
    $
    
    
    
    $
    (24
    )
    
    $
    23,091Corporate Advisory and
Restructuring Services
    
    
    174,667
    
    
    
    
    
    
    
    
    
    
    
    174,667Background Screening Services
    
    
    74,512
    
    
    
    4,146
    
    
    
    42
    
    
    
    78,700Technology Services
    
    
    104,694
    
    
    
    
    
    
    
    
    
    
    
    104,694Consolidated
    
    $
    376,988
    
    
    $
    4,146
    
    
    $
    18
    

    
    $
    381,152
 During the three months ended March 31, 2004, goodwill increased by $4.1
million primarily due to the acquisitions of The Credit Network Trust ($3.7
million) and AIR Credit ($0.4 million). Other adjustments reflect currency
fluctuations from Krolls foreign operations of approximately $18,000 included
in Accumulated other comprehensive income on the Consolidated Condensed
Balance Sheet. 10




---



##### Table of Contents



9.
    
    Debt Revolving Lines of Credit On March 6, 2003, Kroll executed an agreement with Fleet National Bank
(Fleet) providing a revolving credit facility of up to $25 million for a term
of three years. Krolls obligations under the Fleet revolving credit facility
are guaranteed by its domestic subsidiaries. In addition, the Fleet revolving
credit facility is secured by a security interest in substantially all of the
assets of Kroll and its material domestic subsidiaries and a pledge of the
stock of Krolls material domestic subsidiaries and 65% of the stock of certain
of the foreign subsidiaries of Kroll and its domestic subsidiaries. Borrowings under the Fleet revolving credit facility will bear interest,
at Krolls election, at a rate per annum equal to (1) the prime rate of Fleet
or (2) LIBOR plus 2.00%. During the term of the Fleet revolving credit
facility, Kroll will pay Fleet a quarterly fee equal to 0.375% per annum of the
unused portion of the line of credit. The Fleet revolving credit facility
requires Kroll to maintain a minimum level of EBITDA and net income, contains
maximum leverage and liabilities requirements and contains restrictions on the
incurrence of additional debt, the creation of any liens, the payment of cash
dividends, certain acquisitions and distributions to certain subsidiaries. The
Fleet revolving credit facility also contains other affirmative and negative
covenants and events of default customarily contained in agreements of this
type. There have been no borrowings made under this facility. At March 31,
2004, Kroll was in compliance with all covenants and provisions of this
facility. In addition, a UK subsidiary of Kroll maintains a demand note facility.
The demand note bears interest at the Bank of Englands base rate plus 1.5%.
During 2003, maximum borrowings permitted under the demand note decreased from
4.4 million pounds sterling to 4.0 million pounds sterling, or $7.1 million, as
translated at December 31, 2003. During the three months ended March 31, 2004,
maximum borrowings permitted under the demand note decreased to 2.5 million
pounds sterling, or $4.9 million, as translated at March 31, 2004. There were
no borrowings outstanding under this demand note at March 31, 2004, a decrease
of $2.2 million from the amount outstanding at December 31, 2003 due to
repayments made during the three months ended March 31, 2004. The interest rate
at March 31, 2004 was 5.5%. Convertible Senior Subordinated Notes During 2001, Kroll obtained additional financing of $30.0 million in the
form of 6% Senior Subordinated Convertible Notes due 2006, as amended (6%
Convertible Notes). The notes mature November 14, 2006 and bear interest at
the rate of 6% per annum payable semi-annually. However, 12% per annum will
accrue on any principal payment that is past due. Kroll may redeem these
convertible notes at par plus accrued interest, in whole or in part, beginning
November 14, 2004, provided the note holders have been notified in writing 20
days in advance. The note holders may, at any time prior to one day before the
earlier of the maturity date or the redemption date, convert all or a portion
of the principal amount of the notes into Kroll common stock at the conversion
price of $10.80 per share. The $30.0 million of notes are presently convertible
into 2,777,777 shares of Kroll common stock, subject to customary and other
anti-dilution adjustments. In connection with the issuance of the 6% Convertible Notes, Kroll
recorded a debt discount of approximately $11.4 million based on the difference
between the closing price of its stock on the issuance date and the conversion
price. The discount is being amortized as non-cash interest expense over the
5-year life of the notes in addition to the stated 6% interest. The amount of
non-cash interest expense resulting from this discount amortization for the
three months ended March 31, 2004 and 2003 was $0.5 million and $0.4 million,
respectively. Kroll currently intends to redeem the 6% Convertible Notes in
November 2004. Convertible Subordinated Notes On January 2, 2004, Kroll issued $175.0 million aggregate principal amount
of 1.75% Convertible Subordinated Notes due January 2014 (1.75% Convertible
Notes). Kroll will pay interest on the notes on 11




---



##### Table of Contents



January 15 and July 15 of each
year, beginning on July 15, 2004. The interest rate is subject to upward
adjustment during certain periods and under certain circumstances. The notes may be converted into shares of Kroll common stock initially at
a conversion rate of 28.5205 shares of common stock per $1,000 principal amount
of notes, or 4,991,087 shares, which is equivalent to an initial conversion
price of approximately $35.06 per share (subject to adjustment in certain
events), under the following circumstances: (1) during specified periods, if
the closing sale price of Krolls common stock reaches, or the trading price of
the notes falls below, specified levels, (2) Kroll calls the notes for
redemption, (3) during any period in which the credit ratings assigned to the
notes by Moodys and S&P are below specified levels or are suspended or
withdrawn by both rating agencies or (4) specified corporate transactions
occur. The notes are subordinated, unsecured obligations and rank equal in right
of payment with all of Krolls other unsecured and subordinated indebtedness.
The notes are subordinated in right of payment to all of Krolls existing and
future senior indebtedness. The notes are not guaranteed by any of Krolls
subsidiaries and, accordingly, the notes are structurally subordinated to any
existing and future indebtedness and other liabilities of Krolls subsidiaries.
The indenture governing the notes does not limit Krolls right or the right of
Krolls subsidiaries to incur indebtedness in the future. The notes will mature on January 15, 2014. On or after January 15, 2009,
Kroll may redeem all or a portion of these convertible notes at a price equal
to 100% of the principal amount, plus accrued and unpaid interest to, but not
including, the date of redemption. On January 15, 2009 and 2011, or upon a
change in control (as defined in the indenture governing the notes), the note
holders may require Kroll to repurchase all or a portion of the notes at 100%
of the principal amount, plus accrued and unpaid interest to, but not
including, the date of repurchase. Kroll
will pay cash for any notes so repurchased on January 15, 2009 but, at
Krolls option, may pay cash, shares of Kroll common stock (valued at 95% of
its market price) or a combination of cash and shares of Kroll common stock for
repurchases made on January 15, 2011 or upon a change of control. Kroll is required to mark to market an embedded interest rate derivative
instrument contained within the convertible notes. Any increase or decrease in
the fair value of the derivative instrument is recorded as an adjustment to
interest expense in Krolls Consolidated Statement of Income. There was no
value related to this derivative instrument at March 31, 2004. Kroll has filed a shelf registration statement covering resales of the
notes and the shares of common stock into which the notes are convertible. If
the registration statement is not declared effective by June 29, 2004,
liquidated damages will accrue as additional interest on the notes until the
registration statement is declared effective. The liquidated damages will
accrue at rates of 0.25% of the principal amount per annum up to and including
the 90th day after the failure to have the registration statement declared
effective and 0.5% of the principal amount per annum from and after the 91st
day after the failure to have the registration statement declared effective.
Liquidated damages on the notes may also accrue if the registration statement
ceases to be effective or Kroll prevents or restricts sales under an effective
registration statement for certain periods of time. Other Long-term Debt Other long-term debt at March 31, 2004 consists of $7.5 million (including
current portion) of Kroll Factual Data debt as follows: $3.0 million of notes
issued in connection with acquisitions, $4.3 million of capitalized service
license agreements for consumer credit reporting services and $0.2 million
related to capitalized lease obligations for office furniture and fixtures and
computer equipment and software. The $3.0 million of notes payable bears interest at different rates
ranging from 5% to 12% per annum and matures at different times from May 2004
through November 2008. The capitalized service license agreements for consumer credit reporting
services have an initial term of ten years and continue for successive one-year
periods unless either party delivers a written notice of intent not to 12




---



##### Table of Contents



renew
the agreement at least six months before the end of the initial ten-year term
or any one-year renewal period. These agreements expire in April and November
2010 and January 2011 and are payable over a five-year term. The $0.2 million of capitalized lease obligations have interest rates
ranging from 8.47% to 10.43% and expire June 2005.  10.
    
    Commitments and Contingencies Legal Matters Kroll Lindquist Avey Co. (formerly Lindquist Avey Macdonald & Baskerville
(LAMB)), a subsidiary of Kroll, and several of its principals have been named
as third-party defendants in a lawsuit filed in the Ontario Superior Court of
Justice by HSBC Securities (Canada) Inc., formerly Gordon Capital, an
investment dealer (HSBC). HSBC filed the underlying suit against Gordon
Capitals former law firm, Davies, Ward & Beck, (DW&B) seeking damages in the
amount of approximately $40,000,000 (Cdn.). HSBC alleges DW&B negligently
advised Gordon Capital during 1991 through 1993 with respect to its rights
concerning trading losses and irregularities by a client account manager and
various insurance bonds relating to such losses and irregularities. HSBC
further alleges various suits and declaratory judgment actions involving the
insurers were filed in 1993 and that summary judgment granted in favor of the
insurers in 1996 was affirmed on appeal to the Supreme Court of Canada on the
basis that the limitation period under the bonds had expired without an action
being commenced for recovery of Gordon Capitals losses. Gordon Capital, DW&B
and LAMB entered into various tolling agreements until the matters pending with
the insurers were exhausted. In April 2000, HSBC filed suit against DW&B. In
July 2001, DW&B filed a third-party claim against LAMB and certain principals
for contribution and indemnity. An amended third-party claim was filed in
September 2001. The third-party claim alleges DW&B retained LAMB in June 1991
to examine the trading irregularities and to advise Gordon Capital in respect
of its dealings with its insurers and that LAMB acted negligently in carrying out these services. Third
party claims have also been filed against some entities formerly known as Peat
Marwick Thorne, Gordon Capitals alleged former auditors, and AON Reed
Stenhouse, Inc., Gordon Capitals alleged former insurance broker. The parties
attended mediation in December 2002 and October 2003. Representatives of LAMB
attended but did not participate. LAMB is being defended by its former carrier,
the Reliance Insurance Company. Reliance is in liquidation, and while paying
all defense costs, has advised that any claim for damages or settlement greater
than $25,000 (Cdn.) will be a claim in the liquidation, on which distributions
will be made as the liquidation progresses. A hearing on the parties motions
for summary judgment originally scheduled for January 2004 was postponed while DW&B seeks to examine a former
employee of Gordon Capital with respect to the motions for summary judgment. A
trial date has been scheduled for September 2006. Management of Kroll believes
LAMB has meritorious defenses to the claims and intends to defend the claims
vigorously. On June 27, 2003, a shareholder of Factual Data filed a lawsuit against
Factual Data and its directors in the District Court for the County of Larimer,
Colorado, styled Troxler v. Factual Data Corporation [sic], Jerald H. Donnan,
Todd A. Neiberger, Robert J. Terry, J. Barton Goodwin, Daniel G. Helle, Abdul
H. Rajput and James N. Donnan. On August 1, 2003, the plaintiff filed an
amended complaint. In the amended complaint, the plaintiff alleges, among other
things, that the individual defendants engaged in self-dealing in connection
with the negotiation and approval of the merger agreement and the merger. The
plaintiff also claims the individual defendants obtained benefits not shared by
the plaintiff, and that they breached their fiduciary duties of care, loyalty,
candor and independence owed under Colorado law to Factual Datas public
shareholders. The plaintiff seeks certification of the case as a class action.
The plaintiff requests damages, certain equitable relief, attorneys fees and
costs and an order rescinding the merger. On August 12, 2003, Factual Data
moved to dismiss the plaintiffs amended complaint. On September 15, 2003, the
plaintiff filed a response to Factual Datas motion to dismiss. On September
26, 2003, Factual Data filed an amended reply in support of its motion to
dismiss the first amended complaint. On December 9, 2003, the court denied
Factual Datas motion to dismiss the amended 13




---



##### Table of Contents



complaint. The parties have not
engaged in any discovery to date. Kroll and Factual Data believe that the
allegations in the amended complaint are without merit and will defend the suit
vigorously. The ultimate outcome of these matters cannot presently be determined.
Accordingly, the ultimate resolution of these matters could have a material
adverse effect on its consolidated financial position, results of operations or
its cash flows. In addition to the matters discussed above, Kroll is involved in
litigation from time to time in the ordinary course of its business; however,
Kroll does not believe that there is any currently pending litigation,
individually or in the aggregate, that is likely to have a material adverse
effect on Krolls consolidated financial position, results of operations or its
cash flows.  11.
    
    Stockholders Equity During the three months ended March 31, 2004, Kroll repurchased 2,527,477
shares of its common stock pursuant to a repurchase plan approved by Krolls
Board of Directors in December 2003. Of this amount, approximately 2.0 million
shares were repurchased on January 2, 2004 concurrently with the completion of
the offering of the 1.75% Convertible Subordinated Notes (see Note 9). As of
March 31, 2004, Kroll had repurchased an aggregate of approximately 2.78
million shares of its common stock for
approximately $70.8 million, resulting in the completion of its repurchase
plan. On March 15, 2004, Kroll issued 625,000 additional shares of its common
stock, valued at approximately $16.3 million, to the former owners of Zolfo
Cooper LLC as a result of Kroll Zolfo Coopers operating profit for 2003
exceeding the targeted level for that year pursuant to the contingent
consideration provisions of the acquisition agreement entered into during 2002,
as amended. These shares appeared on the December 31, 2003 Consolidated
Condensed Balance Sheet under the caption Common shares to be issued for
acquisition.  12.
    
    Supplemental Cash Flows Disclosures The following is a summary of cash paid related to certain items (in
thousands): Three Months EndedMarch 31,2004
    
    2003Supplemental Disclosure of Cash Flow Activities:Cash paid for interest
    
    $
    248
    
    
    $
    74Cash paid for taxes
    
    $
    3,867
    
    
    $
    1,490Supplemental Disclosure of Non-Cash Activities:Deferred compensation related to restricted stock
    
    $
    
    
    
    $
    477Issuance of additional common shares pertaining to the Zolfo
Cooper acquisition
    
    $
    16,250
    
    
    $
    55,280Exchange of iJet convertible notes into Series C preferred stock
    
    $
    500
    
    
    $
    Notes issued in connection with acquisition of business
    
    $
    900
    
    
    $
    
 For
the three months ended March 31, 2004, cash paid for taxes
reflects
tax savings of approximately $1.0 million. These tax savings result from the
amortization of goodwill, for tax purposes, in connection with Krolls
acquisition of Zolfo Cooper in 2002.  13.
    
    Customer and Segment Data As previously discussed, Krolls Security Services segment was integrated
into the Consulting Services segment effective January 1, 2004
and the segment data for the
period ended March 31, 2003 has been restated to conform to
current period presentation. Krolls reportable operating segments include the following four 14




---



##### Table of Contents



business
segments: Consulting Services, Corporate Advisory and Restructuring Services,
Background Screening Services and Technology Services. Krolls reportable
segments are organized, managed and operated along product lines. These product
lines are provided to similar clients, are offered together as packaged
offerings, generally produce similar margins and are managed under a
consolidated operations management. The Consulting Services segment includes revenues and expenses from
business and financial investigations, forensic accounting, business valuation,
litigation consulting, due diligence, litigation intelligence, asset tracing
and analysis, monitoring and special inquiries, marketing intelligence,
intellectual property and infringement investigations, security architecture
and design, corporate security consulting, emergency management and
environmental services and protective services, operations and training. The Corporate Advisory and Restructuring Services segment includes
revenues and expenses from corporate restructuring, operational turnaround,
strategic advisory services, financial crisis management and corporate finance
services. The Background Screening Services segment includes revenues and expenses
from employee and vendor background investigations, credit screening, substance
abuse testing and identity fraud solutions. The Technology Services segment includes revenues and expenses from
electronic discovery, data recovery and computer forensics services, along with
related software solutions. The following summarizes information about Krolls business segments as of
March 31, 2004 and for the three months ended March 31, 2004 and 2003 (in
thousands): CorporateAdvisory and
    
    BackgroundConsulting
    
    Restructuring
    
    Screening
    
    TechnologyServices
    
    Services
    
    Services
    
    Services
    
    Other
    
    ConsolidatedThree Months Ended March 31, 2004Net sales to unaffiliated customers
    
    $
    62,456
    
    
    $
    38,111
    
    
    $
    40,336
    
    
    $
    24,366
    
    
    $
    
    
    
    $
    165,269Gross profit
    
    $
    23,466
    
    
    $
    19,786
    
    
    $
    19,499
    
    
    $
    15,428
    
    
    $
    
    
    
    $
    78,179Operating income (loss)
    
    $
    11,028
    
    
    $
    12,103
    
    
    $
    8,471
    
    
    $
    4,486
    
    
    $
    (9,345
    )
    
    $
    26,743As of March 31, 2004Goodwill
    
    $
    23,091
    
    
    $
    174,667
    
    
    $
    78,700
    
    
    $
    104,694
    
    
    $
    
    
    
    $
    381,152Identifiable assets at end of quarter
    
    $
    69,844
    
    
    $
    76,336
    
    
    $
    70,896
    
    
    $
    40,873
    
    
    $
    
    
    
    
    257,949Corporate assets
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    166,449Assets of discontinued operations
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    169Total assets at end of quarter
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    $
    805,719Three Months Ended March 31, 2003Net sales to unaffiliated customers
    
    $
    35,987
    
    
    $
    39,405
    
    
    $
    11,185
    
    
    $
    16,911
    
    
    $
    
    
    
    $
    103,488Gross profit
    
    $
    13,847
    
    
    $
    23,434
    
    
    $
    5,277
    
    
    $
    12,122
    
    
    $
    
    
    
    $
    54,680Operating income (loss)
    
    $
    3,685
    
    
    $
    17,489
    
    
    $
    1,855
    
    
    $
    2,531
    
    
    $
    (6,309
    )
    
    $
    19,251
 Total net sales by segment include sales to unaffiliated customers.
Inter-segment sales are not material. Operating income is gross profit less
operating expenses. Operating income does not include the following items:
interest expense, interest income, other income (expense) and income taxes. The
Other column includes the costs of Krolls corporate headquarters and other
centralized administrative costs. Identifiable assets by segment are those
assets that are used in Krolls operations in each segment. Corporate assets
are principally cash, computer software and certain prepaid expenses. 15




---



##### Table of Contents



14.
    
    Database Restatement As
previously disclosed in Krolls Annual Report on Form 10-K for
the fiscal year ended December 31, 2003, Kroll restated its consolidated balance sheet as of December 31, 2002 and the related
consolidated statements of cash flows and stockholders equity for
each of the two years in the period ended December 31, 2002 to
reflect adjustments to its database, deferred income tax and
stockholders equity accounts based on the determination that
the costs incurred in connection with the creation of certain
databases should be expensed in the year such costs are incurred and
should not be capitalized. As a result, Krolls Consolidated Condensed Statement of Cash
Flows for the three months ended March 31, 2003 has also been
restated. A
summary of the significant effects of the restatement is as follows
(in thousands): Three Months EndedMarch 31, 2003As PreviouslyReported(1)
    
    As RestatedOperating Activities:Depreciation and amortization
    
    $
    4,678
    
    
    $
    3,596Other long-term assets and liabilities
    
    $
    (52
    )
    
    $
    (133
    )Investing Activities:Additions to databases
    
    $
    (1,163
    )
    
    $
      (1)
    Amounts previously reported have been adjusted to reflect the
    previously disclosed reclassification of Krolls video
    surveillance subsidiary, InPhoto, as a discontinued operation
    (see Note 6).  15.
    
    Subsequent Events Quality Credit Corporation On April 7, 2004, Kroll acquired Quality Credit Corporation, a mortgage
credit reporting company, for a purchase price of $1.2 million in cash. In
addition, Kroll issued a note for $1.0 million, which accrues interest at 6%
per year and is payable over three years. The results of operations of Quality
Credit Corporation will be included within the Background Screening Services
Group subsequent to the date of acquisition. 16




---



##### Table of Contents



ITEM 2. MANAGEMENTS DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS The following discussion of results of operations and financial condition
is based upon, and should be read in conjunction with, our consolidated
condensed financial statements and accompanying notes thereto included
elsewhere herein. Forward-Looking Statements This Quarterly Report on Form 10-Q contains forward-looking statements
within the meaning of the Private Securities Litigation Reform Act of 1995.
These statements can sometimes be identified by the use of forward-looking
words such as anticipate, believe, estimate, expect, intend, may,
will and similar expressions. These statements are based on managements
current expectations and are subject to risks, uncertainties and assumptions.
Should one or more of these risks or uncertainties materialize or should
underlying assumptions prove incorrect, actual results may vary materially from
those anticipated, estimated, expected, intended or projected. The following factors, among others, could cause actual results to differ
materially from those described in the forward-looking statements: changes in
the demand for, or in the mix of, Krolls services; project delays or
cancellations; cost overruns with regard to fixed price projects; competitive
pricing and other competitive pressures; changes in United States and foreign
governmental regulation and licensing requirements; currency exchange rate
fluctuations; foreign currency restrictions; general economic conditions;
political instability in foreign countries in which Kroll operates; Krolls
ability to implement its internal growth strategy and to integrate and manage
successfully any business Kroll acquires; and other factors that are set forth
in Krolls Annual Report on Form 10-K for the year ended December 31, 2003. General Kroll is a leading global provider of complementary risk consulting
services. Kroll assists businesses, governments and individuals throughout the
world in preventing, mitigating and responding to risk through an integrated
suite of services. Effective January 1, 2004, Krolls Security Services segment
was integrated into its Consulting Services segment, reducing the number of
business groups to four. These business groups enable Kroll to provide its
clients with comprehensive, single source, risk consulting services as follows:
(1) Consulting Services, which provides business and financial investigations,
forensic accounting, business valuation, litigation consulting, due diligence,
litigation intelligence, asset tracing and analysis, monitoring and special
inquiries, market intelligence, intellectual property and infringement
investigations, security architecture and design, corporate security
consulting, emergency management and environmental services and protective
services, operations and training; (2) Corporate Advisory and Restructuring
Services, which provides corporate restructuring, operational turnaround,
strategic advisory services, financial crisis management and corporate finance
services; (3) Background Screening Services, which provides employee and vendor
background investigations, credit screening, substance abuse testing and
identity fraud solutions and (4) Technology Services, which provides electronic
discovery, data recovery and computer forensics services, along with related
software solutions. Overview Kroll continued to experience strong operating results in the first
quarter of 2004. Net sales in the first quarter of 2004 were $165.3 million, an
increase of 59.7% from the first quarter of 2003. Each of Krolls consulting
services, background screening services and technology services segments had
increases in net sales, primarily as a result of an improving US
economy. An
increase in mergers and acquisitions activity has led to increased demand for
many of Krolls consulting services. In addition, the demand for Krolls
background screening services has increased as a result of improvements in
employment, increased employment screening for security reasons, additional
government screening contracts and continued low mortgage interest rates. Net
sales 17




---



##### Table of Contents



for the corporate advisory
and restructuring segment declined, primarily attributable to a
decline in Krolls Domestic restructuring business. However,
Kroll expects its domestic restructuring business in 2004 to perform
consistently with 2003. Gross margin for the first quarter of 2004, as a percentage
of net sales, was 47.3%, a decrease of 5.5 percentage points from the first
quarter of 2003, primarily as a result of the declines in the
higher margin restructuring business, increased costs for the technology
services segment as Kroll made additional investments to support the growth of
its electronic evidence business and lower margins in Krolls new security
services contracts for Iraq. Krolls cost of sales increased by 78.4%,
primarily as a result of the inclusion of the expenses of Kroll Factual Data
Corp. and Kroll Ontrack Legal Technologies Limited (OLT), the additional
investment in technology services and the start-up costs of the new Iraq
security services contracts. Income from continuing operations in the first quarter of 2004 was $14.7
million, an increase of 29.8% from the first quarter of 2003. Effective January 1, 2004, Kroll combined its security services segment
with its consulting services segment. As a result of this integration, Kroll
has been able to realign and refocus its security services. In the first
quarter of 2004, Kroll experienced increased demand within its
Consulting Services segment, due in part by packaging
certain security and intelligence services for high-risk markets such as the
Middle East and Latin America. Kroll expects continued growth for its
integrated consulting services segment as a result of increased security
related to terrorism, an improving economy and a trend in which major
corporations are seeking a single global service provider for both security and
investigative needs. Critical Accounting Policies Krolls significant accounting policies, including the assumptions and
judgments underlying them, are more fully described in Krolls Annual Report on
Form 10-K for the year ended December 31, 2003. Some of Krolls accounting
policies require the application of significant judgment by management in the
preparation of the financial statements, and as a result, they are subject to a
greater degree of uncertainty. In applying these policies, management uses its
judgment to determine the appropriate assumptions to be used in calculating
estimates that affect the reported amounts of assets, liabilities, revenues and
expenses. Management bases its estimates and assumptions on historical
experience and on various other factors that are believed to be reasonable
under the circumstances. Kroll has identified certain of its accounting
policies as the ones that are most important to the portrayal of Krolls
financial condition and results of operations and which require management to
make its most difficult and subjective judgments, often as a result of the need
to make estimates of matters that are inherently uncertain. Krolls critical
accounting policies include the following: Revenue Recognition Revenue is recognized as the services are performed pursuant to the
applicable contractual arrangements. Revenue related to time and materials
arrangements is recognized in the period in which the services are performed.
Revenue from standard hourly rate engagements is recognized as hours are
incurred and revenue from standard daily rate arrangements is recognized at
amounts represented by the agreed-upon billing amounts as incurred. Revenue
related to fixed price arrangements are recognized based upon the achievement
of certain milestones or progress points within the project plan. Revenue
provided from credit services is recognized when the information is delivered
to the customer, either electronically or by other means. The impact of any
revisions in estimated total revenue and direct contract costs is recognized in
the period in which they become known. Expenses incurred by professional staff
in the generation of revenue are billed to the client and included in revenue.
Kroll records either billed or unbilled accounts receivable based on
case-by-case invoicing determinations. Software revenue is recognized when
shipped, with the exception of royalty-based products, for which revenue is
recognized as applicable royalty reports are received. Software revenue is
stated net of estimated customer returns and allowances. Kroll recognizes
contingent fees as earned, i.e., upon satisfaction of all conditions to their
payment. 18




---



##### Table of Contents



Accounting for Intangible and Long-lived Assets In accordance with SFAS No. 142, Goodwill and Other Intangible Assets,
Kroll conducts annual impairment tests of goodwill and indefinite-lived
intangible assets recorded on its books in order to determine if any impairment
of value may have taken place. Impairment tests will be conducted sooner if
circumstances indicate that impairment may have occurred. At its annual
evaluation of its goodwill and indefinite-lived intangible assets during the
third quarter of 2003, Kroll determined that such assets were not impaired. Intangible assets with finite useful lives, which primarily consist of
customer lists and customer relationships, internally-developed software,
franchise and license agreements, trademarks and non-compete agreements,
continue to be amortized on a straight-line basis. Customer lists and customer
relationships are amortized over periods ranging from four to fifteen years.
Internally developed software is amortized over periods ranging from seven to
ten years. Franchise and license agreements are amortized over periods ranging
from five to eight years and trademarks are amortized over periods ranging from
three to twenty-five years. Non-compete agreements are amortized over the lives
of the respective agreements, which range from three to seven and one-half
years. In accordance with SFAS No. 144 Accounting for the Impairment or Disposal
of Long-Lived Assets, Kroll tests its long-lived assets, other than goodwill
and indefinite-lived intangible assets, for impairment whenever events or
changes in circumstances indicate that the carrying amount of such assets may
not be recoverable. The value of a long-lived asset is impaired if the carrying
value of the asset exceeds the sum of the undiscounted cash flows expected to
result from the use and eventual disposition of the asset. An impairment loss
will be measured as the amount by which the carrying amount of a long-lived
asset exceeds its fair value. In addition, in accordance with SFAS No. 144,
Kroll measures long-lived assets to be disposed of by sale, including
discontinued operations, at the lower of carrying amount or fair value less
cost to sell. Foreign Currency Translation and Transactions Assets and liabilities of Krolls foreign operations are translated using
period-end exchange rates. Revenues and expenses are translated using exchange
rates prevailing during the period, with gains or losses resulting from
translation included in a separate component of stockholders equity. Gains or losses resulting from foreign currency transactions are
translated to local currency at the rates of exchange prevailing at the dates
of the transactions and are recorded within the statement of operations.
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. 19




---



##### Table of Contents



Results of Operations Our Consolidated Condensed Statements of Operations (Unaudited) comprised
the following (in thousands): Three Months EndedMarch 31,2004
    
    2003Net Sales:Consulting Services
    
    $
    62,456
    
    
    $
    35,987Corporate Advisory and Restructuring Services
    
    
    38,111
    
    
    
    39,405Background Screening Services
    
    
    40,336
    
    
    
    11,185Technology Services
    
    
    24,366
    
    
    
    16,911165,269
    
    
    
    103,488Cost of Sales:Consulting Services
    
    
    38,990
    
    
    
    22,140Corporate Advisory and Restructuring Services
    
    
    18,325
    
    
    
    15,971Background Screening Services
    
    
    20,837
    
    
    
    5,908Technology Services
    
    
    8,938
    
    
    
    4,78987,090
    
    
    
    48,808Gross Profit:Consulting Services
    
    
    23,466
    
    
    
    13,847Corporate Advisory and Restructuring Services
    
    
    19,786
    
    
    
    23,434Background Screening Services
    
    
    19,499
    
    
    
    5,277Technology Services
    
    
    15,428
    
    
    
    12,12278,179
    
    
    
    54,680Operating Expenses:Selling and marketing
    
    
    12,843
    
    
    
    6,922General and administrative
    
    
    32,192
    
    
    
    24,151Research and development
    
    
    3,228
    
    
    
    3,161Amortization of other intangible assets
    
    
    3,173
    
    
    
    1,19551,436
    
    
    
    35,429Operating income
    
    
    26,743
    
    
    
    19,251Other Income (Expense):Interest expense
    
    
    (2,205
    )
    
    
    (1,057
    )Interest income
    
    
    279
    
    
    
    227Other
    
    
    107
    
    
    
    (2
    )Income before provision for income taxes
    
    
    24,924
    
    
    
    18,419Provision for income taxes
    
    
    10,219
    
    
    
    7,091Income from continuing operations
    
    
    14,705
    
    
    
    11,328Discontinued Operations:Loss from video surveillance subsidiary, net of tax
    
    
    
    
    
    
    (52
    )Net income
    
    $
    14,705
    
    
    $
    11,276
 20




---



##### Table of Contents



Three Months Ended March 31, 2004 Compared to Three Months Ended March 31, 2003 Net Sales Net sales increased $61.8 million, or 59.7%, from $103.5 million in the
first quarter of 2003 to $165.3 million in the first quarter of 2004. Consulting Services  Effective January 1, 2004, our Security Services
segment was consolidated into our Consulting Services segment.
Accordingly, prior period results have been restated to conform to the
current years presentation. Net sales for the Consulting Services segment
increased $26.5 million, or 73.6%, from $36.0 million in the first quarter of
2003 to $62.5 million in the first quarter of 2004, primarily due to increased
demand in our core Consulting Services businesses in both the US
and Europe. The US increase is primarily a result of the improving economy and
increased mergers and acquisitions activity, including an increase in our
litigation support and valuation practices resulting from cross marketing our
different services to existing clients and the improving domestic economy. Our
European practice increased 218%, primarily due to our new security services
contracts providing protection in the Middle East, specifically Iraq. Revenues
from these contracts were approximately $13 million in the first quarter of
2004. Corporate Advisory and Restructuring Services  Net sales for the
Corporate Advisory and Restructuring (CARG) segment decreased $1.3 million,
or 3.3%, from $39.4 million in the first quarter of 2003 to $38.1 million in
the first quarter of 2004. This was primarily due to a 16.1% reduction in the
domestic restructuring business resulting from fewer large restructuring
assignments and increased competition for this work. In addition, there were
$2.0 million in success fees recognized in the first quarter of 2004 compared
to $3.5 million in the first quarter of 2003. This decrease was partially
offset by a 45% increase in our European restructuring practice, which is
engaging larger and longer-term assignments. Background Services Group  Net sales for the Background Services segment
increased 260.6% from $11.2 million in the first quarter of 2003 to $40.3
million in the first quarter of 2004. This was primarily due to the inclusion
of operations of Kroll Factual Data, which was acquired in August 2003.
Excluding Kroll Factual Data, net sales for the Background Services segment
grew 35%, primarily as a result of increased demand for our employment
screening services, resulting from the improving employment environment and the
growth in government screening, and the introduction of our new identity theft
product. Technology Services Group  Net sales for the Technology Services segment
increased 44.1% from $16.9 million in the first quarter of 2003 to $24.4
million in the first quarter of 2004. This increase resulted from strong demand
for electronic evidence and data recovery services both domestically and in
Europe, as well as the inclusion of operations of OLT, which was acquired in
December 2003. Net sales of our electronic evidence services increased 104%
from the first quarter of 2003, and net sales of our data recovery services
increased 25% from the first quarter of 2003. Cost of Sales and Gross Profit Cost of sales increased $38.3 million, or 78.4%, from $48.8 million in the
first quarter of 2003 to $87.1 million in the first quarter of 2004, primarily
due to the inclusion of a full quarter of operations of Kroll Factual Data and
OLT, which were acquired in August and December 2003, respectively. Cost of
sales was also impacted by our continued investment in our Technology Services
segment and the start-up costs of the Middle East security work being done from
our London office. Gross margin as a percent of sales decreased 5.5 percentage points from
52.8% in the first quarter of 2003 to 47.3% in the first quarter of 2004. This
reduction was due to lower margins in our Iraq contract work,
including start-up costs, increased investment in equipment, personnel and physical
space in our Technology Services segment and lower margins in our CARG segment
due to lower sales and increased competition for domestic assignments. 21




---



##### Table of Contents



Consulting
Services  Gross margins for the Consulting Services segment
decreased 0.9 percentage points from 38.5% in the first quarter of 2003 to
37.6% in the first quarter of 2004. This decrease is due to lower margins on
approximately $13 million of Iraq security contract work and
increased expenses to support the increase in net sales of our domestic litigation
support and valuation services. Corporate Advisory and Restructuring Service  Gross margins for the
Corporate Advisory and Restructuring segment decreased 7.6 percentage points
from 59.5% in the first quarter of 2003 to 51.9% in the first quarter of 2004.
This decrease is primarily due to the 16.1% reduction in net sales of the
domestic CARG business, the $1.5 million decline in success fees in the first
quarter of 2004 compared to the first quarter of 2003 and increases in
personnel costs in our European operations to support its increase in net
sales. Background Screening Services  Gross margins for the Background Screening
segment increased 1.1 percentage points from 47.2% in the first quarter of 2003
to 48.3% in the first quarter of 2004. This increase is primarily due to the inclusion of
Kroll Factual Data in 2004 results. Kroll Factual Data was acquired in August
2003 and had a strong quarter due to a continued high level of activity in the
mortgage market. Technology Services  Gross margins for the Technology Services segment
decreased 8.4 percentage points from 71.7% in the first quarter of 2003 to
63.3% in the first quarter of 2004. This decrease was primarily due to
increased investment in equipment, personnel and physical space to support
growth in the electronic evidence business. In addition, results for the first
quarter of 2004 included a full quarters operations of OLT, which historically
had lower margins than the electronic evidence and data recovery businesses. Operating Expenses Operating expenses increased $16.0 million, or 45.2%, from $35.4 million
in the first quarter of 2003 to $51.4 million in the first quarter of 2004. The
increase in selling, general and administrative expenses of $14.0 million is
primarily due to the 59.7% increase in net sales and the inclusion of expenses
from Kroll Factual Data and OLT, which were acquired in August and December
2003, respectively. The increase in amortization of other intangible
assets of $20 million is primarily due to intangible assets acquired in connection
with these acquisitions. General and administrative expenses as a percent of net
sales decreased 3.8 percentage points from 23.3% in the first quarter of 2003
to 19.5% in the first quarter of 2004. During 2003, Kroll recorded restructuring expenses of $6.2 million in
connection with its 2003 Plan, which involved the closure of 10 non-hub offices
worldwide and the elimination of 102 employees. The 2003 Plan was undertaken to
reduce costs and improve operating efficiencies. Approximately $4.2 million of
the 2003 Plan represents severance and related benefits. The remaining $2.0
million relates primarily to lease rental payments, net of sublease income,
associated with the elimination of offices. The total cash portion of the 2003
Plan is $5.8 million, of which $4.2 million relates to employee severance
costs, $1.2 million relates to lease rental payments and $0.4 million relates
to other exit costs. The breakdown was $4.9 million, $0.8 million, $0.3 million
and $0.2 million within Consulting Services, Corporate Advisory and
Restructuring Services, Background Screening Services and Corporate,
respectively. 22




---



##### Table of Contents



The initial recognition of the 2003 restructuring charge and the
corresponding utilization from inception by category is as follows (in
thousands): Initial
    
    
    
    
    
    
    
    
    
    Balance at
    
    
    
    
    
    
    
    
    
    Balance atRestructuring
    
    Cash
    
    Other
    
    December 31,
    
    Cash
    
    Other
    
    March 31,Charge
    
    Payments
    
    Reductions
    
    2003
    
    Payments
    
    Adjustments
    
    2004Employee related
    
    $
    4,167
    
    
    $
    (2,415
    )
    
    $
    
    
    
    $
    1,752
    
    
    $
    (865
    )
    
    $
    (17
    )
    
    $
    870Lease rentals
    
    
    1,218
    
    
    
    (546
    )
    
    
    
    
    
    
    672
    
    
    
    (114
    )
    
    
    
    
    
    
    558Write-off of leasehold
improvements
    
    
    205
    
    
    
    
    
    
    
    (205
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Impairment of equipment
    
    
    120
    
    
    
    
    
    
    
    (120
    )
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Other exit costs
    
    
    443
    
    
    
    (443
    )
    
    
    
    
    
    
    
    
    
    
    (17
    )
    
    
    17
    
    
    
    $
    6,153
    
    
    $
    (3,404
    )
    
    $
    (325
    )
    
    $
    2,424
    
    
    $
    (996
    )
    
    $
    
    
    
    $
    1,428
 The 2003 Plan was substantially completed in early 2004. During 2001, Kroll recorded a $2.7 million restructuring charge in
connection with its 2001 Plan, which involved the closure of four offices and
the elimination of 98 employees. The 2001 Plan was substantially completed by
the end of 2001. During 2003, the accrued balance related to the 2001 Plan was
reduced by $0.4 million as a result of a change in the original estimate of
costs to be incurred. Total payments and write-offs from inception of the 2001
Plan through March 31, 2004 were $2.1 million. The remaining accrued balance of
$0.2 million represents severance and lease termination costs. Interest Expense Interest expense increased $1.1 million, or 100%, from $1.1 million in the
first quarter of 2003 to $2.2 million in the first quarter of 2004. This is
primarily due to the interest and amortization of deferred financing costs
relating to our $175 million 1.75% Convertible Notes, which were issued on
January 2, 2004. Interest Income Interest income was essentially flat at $0.3 million and $0.2 million in
the first quarter of 2004 and 2003, respectively. Other Income (Expense) Other income was $0.1 million in the first quarter of 2004 and $0.0
million in the first quarter of 2003. Provision for Income Taxes The provision for income taxes increased $3.1 million, or 44.1%, due to a
35.3% increase in pre-tax income. In addition, our tax rate increased 2.5
percentage points from 38.5% in the first quarter of 2003 to 41.0% in the first
quarter of 2004. The rate increase is due to a greater proportion of our income
being attributable to US based income in the first quarter of 2004, which is
taxed at a higher rate than our foreign income. Income from Continuing Operations Income from continuing operations increased $3.4 million, or 29.8%, from
$11.3 million in the first quarter of 2003 to $14.7 million in the first
quarter of 2004 as a result of the above-discussed factors. Loss from Discontinued Operations Loss from discontinued operations of $0.1 million for the three months
ended March 31, 2003 represents operating losses of InPhoto, which was sold on
June 18, 2003. 23




---



##### Table of Contents



Net Income Net income improved $3.4 million, or 30.4%, from $11.3 million in the
first quarter of 2003 to $14.7 million in the first quarter of 2004 due to a
$23.5 million increase in gross profit which was partially offset by a $16.0
million increase in operating expenses, a $1.1 million increase in interest
expense and a $3.1 million increase in the tax provision. Liquidity and Capital Resources General Kroll historically has met its operating cash needs by utilizing
borrowings under its credit arrangements to supplement cash provided by
operations. Kroll currently believes that cash on hand, cash flows from
operations and available borrowings under its credit facility will be
sufficient to meet its current funding requirements and obligations over the
next twelve months. The
accompanying discussion and analysis of Liquidity and
Capital Resources gives effect to the restatement discussed in Note
14 of the Notes to Consolidated Condensed Financial Statements. Cash Flows Cash Flows from Operating Activities Cash provided by operating activities amounted to $0.5 million and $16.6
million during the three months ended March 31, 2004 and 2003, respectively.
The $16.1 million decrease is primarily due to a higher proportion of net sales
in March 2004, which resulted in higher than normal billed and unbilled
receivables at March 31, 2004. Cash Flows Used in Investing Activities Kroll used $27.5 million and $9.0 million during the three months
ended March 31, 2004 and 2003, respectively. The
$18.5 million increase is primarily a result of higher
acquisition expenditures in the 2004 period. In 2004, Kroll
spent $19.0 million to acquire The Credit Network Trust and
$1.3 million to acquire AIR Credit. In 2003, Kroll spent $3.3 million to acquire
Certico Verification Services, LLC, $1.4 million to acquire Personnel Risk Management
and $1.0 million to acquire Invex Partners Limited. In
addition, expenditures for capital equipment totaled
$7.5 million in the 2004 period, an increase of $5.6 million over the 2003 period, which totaled $1.9
million. The increase is primarily due to Krolls investments of $3.6 million
in computer equipment and leasehold improvements in its Technology Services
Group and $2.5 million for computer equipment and software in its Background
Screening Services Group in the first quarter of 2004, compared with $1.2
million and $0.1 million, respectively, in the first quarter of
2003 for these business groups. Cash Flows from (Used in) Financing Activities Financing
activities provided $102.4 million during the 2004 period and
used $5.3 million during
the 2003 period. In the first
quarter of 2004, Kroll issued convertible notes in the amount of
$175.0 million. Payments on debt and deferred financing fees
incurred totaled $9.8 million, compared
with $6.2 million in the first quarter of 2003. In
addition, Kroll spent $64.3 million purchasing
treasury stock and received $2.6 million from the exercise of
employee stock options and contributions from its employee stock
purchase plan during the 2004 period. In
the first quarter of 2003, Kroll received $1.2 million from
the exercise of employee stock options and contributions from its employee stock purchase plan. Revolving Lines of Credit On March 6, 2003, Kroll executed an agreement with Fleet providing a
revolving credit facility of up to $25 million for a term of three years.
Krolls obligations under the Fleet revolving credit facility are guaranteed by
its domestic subsidiaries. In addition, the Fleet revolving credit facility is
secured by a security interest in substantially all of the assets of Kroll and
its material domestic subsidiaries and a pledge of the stock of Krolls 24




---



##### Table of Contents



material domestic subsidiaries and 65% of the stock of certain of the
foreign subsidiaries of Kroll and its domestic subsidiaries. Borrowings under the Fleet revolving credit facility will bear interest,
at Krolls election, at a rate per annum equal to (1) the prime rate of Fleet
or (2) LIBOR plus 2.00%. During the term of the Fleet revolving credit
facility, Kroll will pay Fleet a quarterly fee equal to 0.375% per annum of the
unused portion of the line of credit. The Fleet revolving credit facility
requires Kroll to maintain a minimum level of EBITDA and net income, contains
maximum leverage and liabilities requirements and contains restrictions on the
incurrence of additional debt, the creation of any liens, the payment of cash
dividends, certain acquisitions and distributions to certain subsidiaries. The
Fleet revolving credit facility also contains other affirmative and negative
covenants and events of default customarily contained in agreements of this
type. There have been no borrowings made under this facility. At March 31,
2004, Kroll was in compliance with all covenants and provisions of this
facility. In addition, a UK subsidiary of Kroll maintains a demand note facility.
The demand note bears interest at the Bank of Englands base rate plus 1.5%.
During 2003, maximum borrowings permitted under the demand note decreased from
4.4 million pounds sterling to 4.0 million pounds sterling, or $7.1 million, as
translated at December 31, 2003. During the three months ended March 31, 2004,
maximum borrowings permitted under the demand note decreased to 2.5 million
pounds sterling, or $4.9 million, as translated at March 31, 2004. There were
no borrowings outstanding under this demand note at March 31, 2004, a decrease
of $2.2 million from the amount outstanding at December 31, 2003 due to
repayments made during the three months ended March 31, 2004. The interest rate
at March 31, 2004 was 5.5%. Convertible Senior Subordinated Notes The $30 million aggregate principal amount of 6% Convertible Notes mature
November 14, 2006 and bear interest at the rate of 6% per annum payable
semi-annually. However, 12% per annum will accrue on any principal payment that
is past due. Kroll may redeem these convertible notes at par plus accrued
interest, in whole or in part, beginning November 14, 2004, provided the note
holders have been notified in writing 20 days in advance. The note holders may,
at any time prior to one day before the earlier of the maturity date or the
redemption date, convert all or a portion of the principal amount of the notes
into Kroll common stock at the conversion price of $10.80 per share. The $30.0
million of notes are presently convertible into 2,777,777 shares of Kroll
common stock, subject to customary and other anti-dilution adjustments. In connection with the issuance of the 6% Convertible Notes, Kroll
recorded a debt discount of approximately $11.4 million based on the difference
between the closing price of its stock on the issuance date and the conversion
price. The discount is being amortized as non-cash interest expense over the
5-year life of the notes in addition to the stated 6% interest. The amount of
non-cash interest expense resulting from this discount amortization for the
three months ended March 31, 2004 and 2003 was $0.5 million and $0.5 million,
respectively. Kroll currently intends to redeem the 6% Convertible Notes in
November 2004. Convertible Subordinated Notes On January 2, 2004, Kroll issued $175.0 million aggregate principal amount
of 1.75% Convertible Notes due January 2014. Kroll will pay interest on the
notes on January 15 and July 15 of each year, beginning on July 15, 2004. The
interest rate is subject to upward adjustment during certain periods and under
certain circumstances. The notes may be converted into shares of Kroll common stock initially at
a conversion rate of 28.5205 shares of common stock per $1,000 principal amount
of notes, or 4,991,087 shares, which is equivalent to an initial conversion
price of approximately $35.06 per share (subject to adjustment in certain
events), under the following circumstances: (1) during specified periods, if
the closing sale price of Krolls common stock reaches, or the trading price of
the notes falls below, specified levels, (2) Kroll calls the notes for
redemption, (3) during any period in which the credit ratings assigned to the
notes by Moodys and S&P are below specified levels or are suspended or
withdrawn by both rating agencies or (4) specified corporate transactions
occur. 25




---



##### Table of Contents



The notes are subordinated, unsecured obligations and rank equal in right
of payment with all of Krolls other unsecured and subordinated indebtedness.
The notes are subordinated in right of payment to all of Krolls existing and
future senior indebtedness. The notes are not guaranteed by any of Krolls
subsidiaries and, accordingly, the notes are structurally subordinated to any
existing and future indebtedness and other liabilities of Krolls subsidiaries.
The indenture governing the notes does not limit Krolls right or the right of
Krolls subsidiaries to incur indebtedness in the future. The notes will mature on January 15, 2014. On or after January 15, 2009,
Kroll may redeem all or a portion of these convertible notes at a price equal
to 100% of the principal amount, plus accrued and unpaid interest to, but not
including, the date of redemption. On January 15, 2009 and 2011, or upon a
change in control (as defined in the indenture governing the notes), the note
holders may require Kroll to repurchase all or a portion of the notes at 100%
of the principal amount, plus accrued and unpaid interest to, but not
including, the date of repurchase. Kroll will pay cash for any notes so
repurchased on January 15, 2009 but, at Krolls option, may pay cash, shares of
Kroll common stock (valued at 95% of its market price) or a combination of cash
and shares of Kroll common stock for repurchases made on January 15, 2011 or
upon a change of control. Kroll is required to mark to market an embedded interest rate derivative
instrument contained within the convertible notes. Any increase or decrease in
the fair value of the derivative instrument is recorded as an adjustment to
interest expense in Krolls Consolidated Statement of Income. There was no
value related to this derivative instrument at March 31, 2004. Kroll has filed a shelf registration statement covering resales of the
notes and the shares of common stock into which the notes are convertible. If
the registration statement is not declared effective by June 29, 2004,
liquidated damages will accrue as additional interest on the notes until the
registration statement is declared effective. The liquidated damages will
accrue at rates of 0.25% of the principal amount per annum up to and including
the 90th day after the failure to have the registration statement declared
effective and 0.5% of the principal amount per annum from and after the 91st
day after the failure to have the registration statement declared effective.
Liquidated damages on the notes may also accrue if the registration statement
ceases to be effective or Kroll prevents or restricts sales under an effective
registration statement for certain periods of time. Other Long-term Debt Other long-term debt at March 31, 2004 consists of $7.5 million (including
current portion) of Kroll Factual Data debt as follows: $3.0 million of notes
issued in connection with acquisitions, $4.3 million of capitalized service
license agreements for consumer credit reporting services and $0.2 million
related to capitalized lease obligations for office furniture and fixtures and
computer equipment and software. The $3.0 million of notes payable bears interest at different rates
ranging from 5% to 12% per annum and matures at different times from May 2004
through November 2008. The capitalized service license agreements for consumer credit reporting
services have an initial term of ten years and continue for successive one-year
periods unless either party delivers a written notice of intent not to renew
the agreement at least six months before the end of the initial ten-year term
or any one-year renewal period. These agreements expire in April and November
2010 and January 2011 and are payable over a five-year term. The $0.2 million of capitalized lease obligations have interest rates
ranging from 8.47% to 10.43% and expire June 2005. Stockholders Equity During the three months ended March 31, 2004, Kroll repurchased 2,527,477
shares of its common stock pursuant to a repurchase plan approved by Krolls
Board of Directors in December 2003. Of this amount, approximately 2.0 million
shares were repurchased on January 2, 2004 concurrently with the completion of
the 26




---



##### Table of Contents



offering of the 1.75% Convertible Notes. As of March 31, 2004, Kroll had
repurchased an aggregate of approximately 2.78 million shares of its common
stock for approximately $70.8 million, resulting
in the completion of its repurchase plan. On March 15, 2004, Kroll issued 625,000 additional shares of its common
stock, valued at approximately $16.3 million, to the former owners of Zolfo
Cooper, LLC as a result of Kroll Zolfo Coopers operating profit for 2003
exceeding the targeted level for that year pursuant to the contingent
consideration provisions of the acquisition agreement entered into during 2002,
as amended. Acquisitions On February 5, 2004, Kroll acquired AIR Credit, a mortgage credit
reporting company, for a purchase price of $1.3 million in cash. In addition,
Kroll issued a note for $0.9 million, which accrues interest at 6% per year and
is payable over three years. The results of operations of AIR Credit are
included within the Background Screening Services Group subsequent to the date
of acquisition. On March 2, 2004, Kroll acquired The Credit Network Trust, a mortgage
credit reporting company, for a purchase price of $19.0 million in cash. In
addition, $1.5 million is to be paid in annual installments of $500,000 over
the next three years to the extent aggregate gross revenue is in excess of a
predetermined amount. The results of operations of The Credit Network Trust are
included within the Background Screening Services Group subsequent to the date
of acquisition. On April 7, 2004, Kroll acquired Quality Credit Corporation, a mortgage
credit reporting company, for a purchase price of $1.2 million in cash. In
addition, Kroll issued a note for $1.0 million, which accrues interest at 6%
per year and is payable over three years. The results of operations of Quality
Credit Corporation will be included within the Background Screening Services
Group subsequent to the date of acquisition. Contractual Obligations Krolls contractual obligations were comprised of the following as of
March 31, 2004 (dollars in thousands): Payments Due by PeriodContractual Obligations
    
    Total
    
    Within 1 Year
    
    2-3 Years
    
    4-5 Years
    
    After 5 YearsRevolving lines of credit
    
    $
    10
    
    
    $
    10
    
    
    $
    
    
    
    $
    
    
    
    $
    Current portion of long-term
debt, excluding capitalized
service agreements and lease
obligations
    
    
    1,066
    
    
    
    1,066
    
    
    
    
    
    
    
    
    
    
    
    Capitalized service agreements
    
    
    4,653
    
    
    
    3,379
    
    
    
    1,274
    
    
    
    
    
    
    
    Capitalized lease obligations
    
    
    156
    
    
    
    134
    
    
    
    22
    
    
    
    
    
    
    
    6% Convertible Notes
    
    
    30,000
    
    
    
    
    
    
    
    30,000
    
    
    
    
    
    
    
    1.75% Convertible Notes
    
    
    175,000
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    175,000Other long-term debt
    
    
    1,948
    
    
    
    
    
    
    
    1,384
    
    
    
    564
    
    
    
    Operating leases
    
    
    75,862
    
    
    
    16,104
    
    
    
    25,723
    
    
    
    18,052
    
    
    
    15,983Other long-term obligations
    
    
    750
    
    
    
    250
    
    
    
    500
    
    
    
    
    
    
    
    Total
    
    $
    289,445
    
    
    $
    20,943
    
    
    $
    58,903
    
    
    $
    18,616
    
    
    $
    190,983
 Foreign Operations In addition to its U.S. facilities, Kroll has operations and assets in
Argentina, Australia, Brazil, Canada, China, France, Germany, Hong Kong, India,
Iraq, Italy, Japan, Mexico, the Philippines, Russia, South Africa, Spain,
Switzerland and the United Kingdom. Kroll also offers its services in other
countries and seeks to increase its level of international business activity.
Krolls international business exposes it to various risks. For a 27




---



##### Table of Contents



discussion of these risks, see the risk factors in Krolls Annual Report
on Form 10-K for the year ended December 31, 2003. Kroll attempts to mitigate the risks of doing business in foreign
countries by separately incorporating its operations in those countries,
maintaining reserves for credit losses and insuring equipment to protect
against losses related to political risks and terrorism. Quarterly Fluctuations Although
Kroll does have some long-term contracts with its clients, its
ability to generate sales is generally dependent upon obtaining many new
projects each year, most of which are relatively short term. In addition,
during the latter part of the fourth quarter of every year, Krolls business is
generally impacted by fewer background screening and mortgage requests and
fewer consulting assignments compared with other quarters within the year.
Accordingly, period-to-period comparisons within a given year or between years
will need to take this normal fluctuation into consideration. 28




---



##### Table of Contents



ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURE ABOUT MARKET RISK Kroll does not expect to enter into financial instruments for trading or
hedging purposes. Accordingly, Kroll does not currently anticipate entering
into interest rate swaps and/or similar instruments. At March 31, 2004, the fair value of Krolls long-term debt exceeds the
carrying amount of such debt due primarily to the intrinsic value of the
conversion feature of the 6% Convertible Notes of approximately $45 million.
The book carrying value of cash equivalents, other current assets and current
liabilities approximates fair value due to the short-term nature of these
items. Krolls business is subject to certain risks, including, but not limited
to, differing economic conditions, loss of significant customers, changes in
political climate, differing tax structures, other regulations and restrictions
and foreign exchange rate volatility. 29




---



##### Table of Contents



ITEM 4. CONTROLS AND PROCEDURES Disclosure Controls and Procedures Krolls management, with the participation of Krolls Chief Executive
Officer and Chief Financial Officer, has evaluated the effectiveness of the
Companys disclosure controls and procedures (as such term is defined in Rules
13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934, as amended
(the Exchange Act)), as of the end of the period covered by this report.
Based on such evaluation, Krolls Chief Executive Officer and Chief Financial
Officer have concluded that, as of the end of such period, Krolls disclosure
controls and procedures are effective. Internal Control over Financial Reporting There have not been any changes in Krolls internal controls over
financial reporting (as such term is defined in Rules 13a-15(f) and 15d-15(f)
under the Exchange Act) during the fiscal quarter to which this report relates
that have materially affected, or are reasonably likely to materially affect,
Krolls internal control over financial reporting. 30




---



##### Table of Contents



PART II. OTHER INFORMATION 
 ITEM 1. LEGAL PROCEEDINGS For information on litigation, please see Note 10 of the Notes to
Consolidated Condensed Financial Statements (Unaudited) included elsewhere in
this Quarterly Report on Form 10-Q/A. 31




---



##### Table of Contents



ITEM 2. CHANGES IN SECURITIES, USE OF PROCEEDS AND ISSUER PURCHASES OF EQUITY
SECURITIES Issuance of Securities On January 2, 2004, Kroll issued $175 million aggregate principal amount
of 1.75% Convertible Subordinated Notes due 2014 in an offering to qualified
institutional buyers pursuant to Rule 144A under the Securities Act of 1933, as
amended. For a description of these notes, see Note 9 of the Notes to
Consolidated Condensed Financial Statements (Unaudited). Issuer Purchases of Securities The following table describes purchases of Kroll common stock made by or
on behalf of Kroll or any affiliated purchaser pursuant to the December 16,
2003 repurchase plan during the first quarter of 2004. Total Number of
    
    Maximum Number (orShares Purchased
    
    Approximate Dollar Value) ofTotal Number of
    
    
    
    
    
    as Part of Publicly
    
    Shares that May Yet BeShares
    
    Average Price
    
    Announced Plans
    
    Purchased Under the Plans or2004 Period
    
    Purchased (1)
    
    Paid per Share
    
    or Programs
    
    Programs (2)January 1 to
January 31
    
    
    2,136,600
    
    
    $
    25.51
    
    
    
    2,136,600
    
    
    
    390,877February 1 to
February 29
    
    
    390,877
    
    
    $
    25.07
    
    
    
    390,877
    
    
    
    March 1 to
March 31
    
    
    
    
    
    
    
    
    
    
    
    
    
    
    Total
    
    
    2,527,477
    
    
    $
    25.45
    
    
    
    2,527,477
    
    
    
    
  (1)
    
    All of these shares were purchased in open-market transactions pursuant
to a repurchase plan that was publicly announced on December 16, 2003.
Under the repurchase plan, Kroll would repurchase up to 2.78 million shares of its common stock in connection with its anticipated offering of
$175 million aggregate principal amount of 1.75% Convertible Subordinated
Notes due 2014. No shares were purchased other than through a publicly
announced plan or program.(2)
    
    Kroll does not intend to purchase any additional shares of its common
stock under this repurchase plan and considers this repurchase plan to
have been completed. 32




---



##### Table of Contents



ITEM 6. EXHIBITS AND REPORTS ON FORM 8-K (a) Exhibits ExhibitNumber
    
    Description4.1
    

Indenture dated as of January 2, 2004 between Kroll and The Bank of New York, as
trustee (previously filed as Exhibit 4.1 to Krolls Registration Statement on Form
S-3 (Reg. No. 333-114096), as filed with the Securities and Exchange Commission on
March 31, 2003 (the Registration Statement) and incorporated by reference herein).4.2
    
Form
of Convertible Subordinated Note due 2015 (previously filed as
Exhibit 4.2 to the Registration Statement and incorporated by
reference herein).4.3
    
Registration Rights Agreement between Kroll and Goldman, Sachs & Co., as
representatives of the initial purchasers, dated January 2, 2004 (previously filed as
Exhibit 4.3 to the Registration Statement and incorporated by reference herein).10.1
    
Amendment No. 1 dated April 15, 2004 to the Employment Agreement dated as of March
13, 2003 between Kroll and Jules B. Kroll.10.2
    
Amendment No. 2 dated April 15, 2004 to the Employment Agreement dated as of May 17,
1999, as amended on June 13, 2002, between Kroll and Michael G. Cherkasky.10.3
    
Employment Agreement dated as of December 31, 2003 between Kroll and Michael Petrullo.10.4
    
Employment Agreement dated as of December 31, 2003 between Kroll and Sabrina H. Perel.10.5
    
Employment Agreement dated as of April 6, 2004 between Kroll and Michael A. Beber.31.1
    
Certification of Krolls Chief Executive Officer, as required by Section 302 of the
Sarbanes-Oxley Act of 2002.31.2
    
Certification of Krolls Chief Financial Officer, as required by Section 302 of the
Sarbanes-Oxley Act of 2002.32.1
    
Certification of Krolls Chief Executive Officer, as required by Section 906 of the
Sarbanes-Oxley Act of 2002.32.2
    
Certification of Krolls Chief Financial Officer, as required by Section 906 of the
Sarbanes-Oxley Act of 2002.
 (b) Reports on Form 8-K: During the three months ended March 31, 2004, Kroll filed the
following current report on Form 8-K: Date of Report: February 12, 2004 (filed on February 12, 2004); Items 5 and 7. 33




---



##### Table of Contents



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 25th day
of June 2004. Kroll Inc.By:
    /s/ Steven L. FordSteven L. FordExecutive Vice President and Chief
Financial Officer 34