Back to GetFilings.com
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
[ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 1999
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File No. 0-21639
NCO GROUP, INC.
---------------------------------------------------------------
(Exact Name of Registrant as Specified in its Charter)
Pennsylvania 23-2858652
------------ ----------
(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
515 Pennsylvania Ave.
Ft. Washington, Pennsylvania 19034-3313
---------------------------- ----------
(Address of principal (Zip Code)
executive offices)
Registrant's Telephone Number, Including Area Code (215) 793-9300
--------------
Securities Registered Pursuant to Section 12(b) of the Act: None
----
Securities Registered Pursuant to Section 12(g) of the Act:
Common stock, no par value 25,547,398
--------------------------- ----------
(Title of Class) (Number of Shares Outstanding
as of March 22, 2000)
Indicate by check mark whether the Registrant (i) 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 (ii) has been subject to such filing
requirements for the past 90 days.
Yes [ X ] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant is $600,726,000 (1)
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Proxy Statement to be filed in connection with
its 1999 Annual Meeting of Shareholders are incorporated by reference in Part I
and Part III of this Report. Other documents incorporated by reference are
listed in the Exhibit Index.
-----------------
(1) The aggregate dollar amount of the voting stock set forth equals the number
of shares of the Company's common stock outstanding, reduced by the amount of
common stock held by officers, directors and shareholders owning 10% or more of
the Company's common stock, multiplied by $30.875, the last reported sale price
for the Company's common stock on March 22, 2000. The information provided shall
in no way be construed as an admission that any officer, director or 10%
shareholder in the Company may be deemed an affiliate of the Company or that he
is the beneficial owner of the shares reported as being held by him, and any
such inference is hereby disclaimed. The information provided herein is included
solely for record keeping purposes of the Securities and Exchange Commission.
TABLE OF CONTENTS
PART I
Page
----
Item 1. Business. 1
Item 2. Properties. 20
Item 3. Legal Proceedings. 20
Item 4. Submission of Matters to a Vote of Security Holders. 20
Item 4.1 Executive Officers of the Registrant who are not also Directors. 21
PART II
Item 5. Market for Registrant's Common Equity and 23
Related Shareholder Matters.
Item 6. Selected Financial Data. 25
Item 7. Management's Discussion and Analysis of Financial 26
Condition and Results of Operations.
Item 7a Quantitative and Qualitative Disclosure about Market Risk. 35
Item 8. Financial Statements and Supplementary Data. 35
Item 9. Changes in and Disagreements with Accountants on Accounting and 35
Financial Disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant. 36
Item 11. Executive Compensation. 36
Item 12. Security Ownership of Certain Beneficial Owners and Management. 36
Item 13. Certain Relationships and Related Transactions. 36
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 37
Signatures 42
Index to Consolidated Financial Statements F-1
All share and per share data have been restated to reflect the three-for-two
stock split of the Company's common stock paid in December 1997.
PART I
Forward-Looking Statements
Certain statements included in this Annual Report on Form 10-K, other than
historical facts, are forward-looking statements (as such term is defined in the
Securities Exchange Act of 1934, and the regulations thereunder) which are
intended to be covered by the safe harbors created thereby. Forward-looking
statements include, without limitation, statements as to the Company's five-year
growth strategy, statements as to the Company's objective to focus on internal
growth, strategic acquisitions and alliances, and integration, the impact of
acquisitions on the Company's earnings, the Company's ability to realize
operating efficiencies in the integration of its acquisitions, trends in the
Company's future operating performance, expected increases in operating
efficiencies, anticipated trends in the accounts receivable management industry,
year 2000 compliance, the effects of legal or governmental proceedings, the
effects of changes in accounting pronouncements and statements as to the
Company's or management's beliefs, expectations and opinions. Forward-looking
statements are subject to risks and uncertainties and may be affected by various
factors which may cause actual results to differ materially from those in the
forward-looking statements. In addition to the factors discussed in this report,
certain risks, uncertainties and other factors, including, without limitation,
risks associated with growth and future acquisitions, the risk that the Company
will not be able to realize operating efficiencies in the integration of its
acquisitions, fluctuations in quarterly operating results, risks relating to the
timing of contracts, risks related to year 2000 compliance and the other risks
detailed from time to time in the Company's filings with the Securities and
Exchange Commission, including the Company's Registration Statement on Form S-3,
filed on September 3, 1999, can cause actual results and developments to be
materially different from those expressed or implied by such forward-looking
statements. See Item 1. - "Business - Investment Considerations."
Item 1. Business.
--------
General
NCO Group, Inc. ("NCO" or the "Company") provides a broad spectrum of
accounts receivable management and outsourcing services to a wide range of
businesses in national and international markets. The Company uses its
technological and management expertise to build seamless partnerships with its
clients, delivering customized solutions that improve client revenue, financial
performance, and customer service. The Company provides these services through
the use of advanced workstations, "thin client" network computing devices, and
sophisticated call management systems comprised of predictive dialers, automated
call distribution systems, digital switching and customized computer software.
The Company provides these services on an international basis from 94 call
centers located throughout North America and in the United Kingdom and Puerto
Rico. The Company's clients are primarily in the financial services, healthcare,
education, retail, commercial, utilities, government and telecommunications
sectors. The Company's principal executive offices are located at 515
Pennsylvania Avenue, Fort Washington, Pennsylvania 19034, and its telephone
number is (215) 793-9300.
Through efficient utilization of technology and intensive management of
human resources, the Company has achieved rapid growth in recent years. Since
April 1994, the Company has completed eighteen acquisitions that have enabled it
to increase the scale and scope of its services and establish itself as a
dominant player in the accounts receivable management market. In addition, the
Company has leveraged its sales infrastructure in order to take advantage of
cross-selling opportunities by offering additional services to existing markets
as well as establish a presence in certain new markets.
-1-
The following is a summary of the acquisitions completed by the Company
since 1994 (dollars in thousands):
Revenue for the
Date Value of Fiscal Year Prior
Acquired Business Purchase Price to Acquisition
----------- ------------------------- ------------------- -------------------
Compass International Services 8/20/99 A/R Management and $ 104,100 $ 105,800(1)
Corporation Telemarketing
Co-Source Corporation 5/21/99 Commercial Receivables 124,600 61,100
Management
JDR Holdings, Inc. 3/31/99 Technology-Based 103,100 51,000
Outsourcing , A/R
Management and
Telemarketing
Medaphis Services Corporation 11/30/98 Healthcare Receivables 107,500(2) 96,700
Management
MedSource, Inc. 7/1/98 Healthcare Receivables 35,700(3) 22,700
Management
FCA International Ltd. 5/5/98 A/R Management 69,900 62,800
The Response Center 2/6/98 Market Research 15,000 8,000
Collections Division of American 1/1/98 A/R Management 1,700 1,700
Financial Enterprises, Inc.
ADVANTAGE Financial 10/1/97 A/R Management 5,000 5,100
Services, Inc.
Credit Acceptance Corporation 10/1/97 A/R Management 1,800 2,300
Collections Division of CRW 2/2/97 A/R Management 12,800 25,900
Financial, Inc.
CMS A/R Services 1/31/97 A/R Management 5,100 6,800
Tele-Research Center, Inc. 1/30/97 Market Research and 2,200 1,800
Telemarketing
Goodyear & Associates, Inc. 1/22/97 A/R Management 5,400 5,500
Management Adjustment 9/5/96 A/R Management 9,000 13,500
Bureau, Inc.
Collections Division of Trans 1/3/96 A/R Management 4,800 7,000
Union Corporation
Eastern Business Services, Inc. 8/1/95 A/R Management 2,000 2,000
B. Richard Miller, Inc. 4/29/94 A/R Management 1,400 1,300
(1) Pro Forma Revenue - Assumes the acquisitions completed by Compass
International Services Corporation in 1998 and the sale of its Print
and Mail Division were all completed on January 1, 1998.
(2) Does not include an earn-out of up to $10.0 million that will be
paid-out during 2000.
(3) Includes $17.3 million of debt repaid by the Company.
During 1999 and 1998, the Company completed several acquisitions that
established NCO as a dominant service provider in many key markets such as
healthcare and commercial. As a result, the Company was organized into market
specific operating divisions that were responsible for all aspects of client
sales and client service as well as operational delivery of services. During
1999, the operating divisions, which were each headed by a divisional chief
executive officer, included Accounts Receivable Management Services, Healthcare
Services, Technology-Based Outsourcing, Commercial Services, Market
-2-
Strategy and International Operations. As a result of the progress made to date
in the integration and assimilation of the acquired companies, the Company
reduced the number of operating divisions from six to four in order to focus on
the operational delivery of services. The Company's focus on the operational
delivery of services will allow it to take advantage of significant
cross-selling opportunities and enhance the level of service provided to its
clients. The new divisions will be Accounts Receivable Management Services
(formerly Accounts Receivable Management, Commercial and Healthcare Bad Debt),
Technology-Based Outsourcing (formerly Technology-Based Outsourcing and
Healthcare Outsourcing), International Operations and Market Strategy. Each of
these divisions will maintain industry specific functional groups including
healthcare, commercial, banking, retail, education, utilities,
telecommunications, and government.
Services
Accounts Receivable Management
The Company provides a wide range of accounts receivable management
services to its clients utilizing an extensive technological infrastructure.
Although most of the Company's accounts receivable management services to date
have focused on recovery of traditional delinquent accounts, the Company does
engage in the recovery of current receivables and early stage delinquencies
(generally, accounts which are 90 days or less past due). The Company generates
approximately 60% of its revenue from the recovery of delinquent accounts
receivable on a contingent fee basis. In addition, the Company generates revenue
from fixed fees for certain accounts receivable management and other related
services. The Company seeks to be a low cost provider and, as such, its
contingent fees typically range from 15% to 35% of the amount recovered on
behalf of the Company's clients. However, fees can range from 6% for the
management of accounts placed early in the accounts receivable cycle to 50% for
accounts that have been serviced extensively by the client or by third-party
providers. The Company's average fee is approximately 25% across all industries,
with the exception of healthcare. The nature of the collections business for the
healthcare industry is very different from the remainder of the Company's
business and, as a result, the average fee for the healthcare industry is
approximately 15%.
Accounts receivable management services typically include the following:
Management Planning. The Company's approach to accounts receivable
management for each client is determined by a number of factors including
account size and demographics, the client's specific requirements and
management's estimate of the collectability of the account. The Company has
developed a library of standard processes for accounts receivable management,
which is based upon its accumulated experience. The Company will integrate these
processes with its client's requirements to create a customized recovery
solution. In many instances, the approach will evolve and change as the
relationship with the client develops and both parties evaluate the most
effective means of recovering accounts receivable. The Company's standard
approach, which may be tailored to the specialized requirements of its clients,
defines and controls the steps that will be undertaken by the Company on behalf
of the client and the manner in which data will be reported to the client.
Through its systemized approach to accounts receivable management, the Company
removes most decision making from the recovery staff and ensures uniform,
cost-effective performance.
Once the approach has been defined, the Company electronically or manually
transfers pertinent client data into its information system. When the client's
records have been established in the Company's system, the Company commences the
recovery process.
-3-
Skiptracing. In cases where the customer's telephone number or address is
unknown, the Company systematically searches the United States Post Office
National Change of Address service, consumer data bases, electronic telephone
directories, credit agency reports, tax assessor and voter registration records,
motor vehicle registrations, military records, and other sources. The geographic
expansion of banks, credit card companies, national and regional
telecommunications companies, and managed healthcare providers along with the
mobility of consumers has increased the demand for locating the client's
customers. Once the Company has located the customer, the notification process
can begin.
Account Notification. The Company initiates the recovery process by
forwarding an initial letter which is designed to seek payment of the amount due
or open a dialogue with customers who cannot afford to pay at the current time.
This letter also serves as an official notification to each customer of their
rights as required by the federal Fair Debt Collection Practices Act. The
Company continues the recovery process with a series of mail and telephone
notifications. Telephone representatives remind the customer of their
obligation, inform them that their account has been placed for collection with
the Company and begin a dialogue to develop a payment program.
Credit Reporting. At a client's request, the Company will electronically
report delinquent accounts to one or more of the national credit bureaus where
it will remain for a period of up to seven years. The denial of future credit
often motivates the payment of all past due accounts.
Payment Process. After the Company receives payment from the customer, it
either remits the amount received net of its fee to the client or remits the
entire amount received to the client and bills the client for its services.
Activity Reports. Clients are provided with a system-generated set of
standardized or customized reports that fully describe all account activity and
current status. These reports are typically generated monthly, however, the
information included in the report and the frequency that the reports are
generated can be modified to meet the needs of the client.
Quality Tracking. The Company emphasizes quality control throughout all
phases of the accounts receivable management process. Some clients may specify
an enhanced level of supervisory review and others may request customized
quality reports. Large national credit grantors will typically have exacting
performance standards which require sophisticated capabilities such as
documented complaint tracking and specialized software to track quality metrics
to facilitate the comparison of the Company's performance to that of its peers.
-4-
Delinquency Management
The Company provides pre-charge-off delinquency management services that
enable clients to manage their at-risk customers and quickly restore
relationships to a current payment status. The Company mails reminder letters
and makes first-party calls to the clients' customers, reminding of the past due
balance and encouraging them to make immediate repayment using pay-by-phone
direct debit checks or credit cards. Service includes responding to inbound
calls, seven days a week. The Company uses its extensive database and predictive
modeling techniques to the customer's profile, assigning more intense efforts to
higher risk customers.
Customer Service and Support
The Company utilizes its communications and information system
infrastructure to supplement or replace the customer service function of its
clients. For example, the Company is currently engaged by a large regional
utility company to provide customer service functions for a segment of the
utility's customer base that is delinquent. For other clients, the Company
provides a wide range of specialized services such as fraud-prevention,
over-limit calling, inbound calling for customer credit application and approval
processes, and general back office support. Customer contact can be provided
through inbound or outbound calling, or customized web-enabled functions.
Billing
The Company complements existing service lines by offering adjunct billing
services to clients as an outsourcing option. Additionally, the Company can
assist healthcare clients in the billing and management of third party
insurance.
Market Strategy
The Company has 1,000 workstations dedicated to its Market Strategy
services. The Company has the capabilities to provide a high volume of outbound
calling and can answer thousands of inbound calls daily. The Company offers
shared and dedicated inbound service, as well as an integrated inbound/outbound
option, its capabilities include patch through calling, recorded message
transmission, and more. The Company's Market Strategy services include the
following:
Market Research. The Company provides full-service custom market research
services to the telecommunications, financial services, utilities, healthcare,
pharmaceutical and consumer products sectors. Its capabilities include problem
conceptualization, program design, data gathering (by telephone, mail, and focus
groups), as well as data tabulation, results analysis and consulting.
Telemarketing. The Company provides telemarketing services for clients,
including lead generation and qualification, and the booking of appointments for
a client's sales representatives.
Additional Services
The Company selectively provides other related services which complement
its traditional accounts receivable management business and which leverage its
technological infrastructure. The Company believes that the following services
will provide additional growth opportunities for the Company:
Attorney Network Services. The Company will also coordinate litigation
undertaken by a nationwide network of more than 150 law firms whose attorneys
specialize in collection litigation. The Company's collection support staff
manages the attorney relationships and facilitates the transfer of all necessary
documentation.
-5-
ePayments. The Company can provide a virtual 24-hour payment center that is
accessible by the use of telephones, personal computers or the Internet.
Credit and Investigative Reporting Service. The Company develops the
information needed to profile debtors and make decisions affecting extensions of
credit.
NCO Benefit Systems. The Company administers complaint COBRA administration
services for human resource departments.
Strategy
In February 2000, the Company announced a five-year strategy for creating
long-term shareholder value. The initiatives outlined below are designed to
maintain the Company's market dominance as it transitions itself into a global
provider of integrated accounts receivable management products.
International Expansion
Business process outsourcing is gaining widespread acceptance throughout
Europe, Asia and the United Kingdom. The Company's international expansion
strategy is designed to capitalize on each of these markets in the near term as
outlined below, as well as continue to monitor all developing opportunities to
determine the timing of entry into new markets.
The Company operates in Canada and the United Kingdom through wholly owned
subsidiaries under the trade name Financial Collection Agencies ("FCA"). FCA is
the largest provider of consumer collection services in Canada and approximately
the seventh largest provider of consumer collection services in the United
Kingdom. The Company expects to further penetrate these markets through
increased sales of strategic outsourcing services, additional bad debt
purchases, and deployment of the Company's commercial sales model in order to
further develop business-to-business opportunities. Additionally, the Company
expects to pursue strategic alliances and partnerships and further explore
acquisitions in these markets.
The Company formed a strategic alliance with Alec Burlington N.V. in 1999
to provide the Company with an entree into the European market to service its
U.S. clients. This alliance enhances the Company's service offerings as well as
increases the awareness of NCO as a world-class provider of receivables
management services. To date, the Company has signed two customer contracts as a
result of this alliance.
Strategic Acquisitions
The Company's acquisition strategy has been an integral part of its
development. Since mid-1999, the Company has been on an acquisition moratorium.
This has enabled the Company to integrate and assimilate its most recent
acquisitions. Post-moratorium, the Company will focus on strategic acquisitions
that create long-term shareholder value by helping the Company to enhance its
scope of services, build on its current market leadership position and help it
to sustain its competitive advantage for the future. These acquisitions are
expected to be funded primarily with stock. Additionally, the Company intends to
maintain its policy of not pursuing transactions that are expected to be
dilutive to its earnings per share.
-6-
Strategic Partnerships with Clients
A significant amount of the Company's organic growth stems from the
expansion of existing clients relationships. These relationships and the
resultant opportunities continue to grow in both scale and complexity, however
they are still primarily responsive to client requests. Over time, management
believes these relationships must transition from the operational delivery of
services to the strategic development of long-term, goal-oriented partnerships
where NCO is sharing in the improved profitability and operational efficiencies
created for its clients. The Company is currently in preliminary discussions
with a number of larger clients to develop longer-term strategic relationships
that will assist them in managing risk from an accounts receivable perspective.
These discussions include e-commerce strategy, risk assessment and control, and
customer care.
Increased Penetration in the Bad Debt Purchase Marketplace
Since 1996, the Company has purchased, collected and managed defaulted
consumer receivables. The Company has achieved excellent returns on its
purchased portfolios and has determined that it would be beneficial to expand
this business segment.
The Company believes that the appropriate market expansion strategy for
this product is to develop partnerships with banks, commercial lenders and other
investors who will provide a funding source for large-scale purchases of
defaulted receivables. By utilizing such risk-sharing partnerships, the Company
will gain access to capital and share in the upside, while limiting its exposure
to credit risk. Currently, the Company's purchase portfolio exposure is limited
by its credit agreement to a maximum of $25 million of unamortized purchase
price.
Technology
The Company is in the process of completing a series of systems conversions
that will reduce its infrastructure to three collection software applications
running on one integrated platform. The Company's integrated information
technologies will consist of one network across all Company facilities, one to
two data centers, and one information technology department. Over the next three
to five years, the Company will continue to migrate its system infrastructure
toward the ultimate goal of one core enterprise application.
The continuing integration of the Company's application software is
critical to the tactical delivery of its services. However, the ongoing
integration process towards one system cannot interfere with continued
deployment of Universal Collector Interface ("UCI") thin client technology
across industry sectors serviced by the Company or with the development and
deployment of NCO's e-commerce strategy. UCI technology has already been
deployed in the banking/retail and utilities/telecommunications sectors and will
shortly be deployed in healthcare. The continued deployment of this
"first-to-market" technology, in conjunction with the e-commerce strategy
discussed below, should give NCO a sustainable, competitive advantage in
technology and act as a barrier to entry by others in the large-scale
outsourcing area.
e-Commerce Strategy
NCO's e-commerce initiatives are broken down into two distinct categories:
operational and strategic.
-7-
From an operational viewpoint, the Internet creates a variety of
opportunities for operational efficiencies that should lead to a competitive
advantage in pricing and performance. Outlined below are several examples of the
types of operational benefits the Company expects to derive from the Internet.
o Increased client awareness and marketing opportunities through use of
the Company's website
o Improved client access through client-specific web pages that will
facilitate:
- Placement of accounts by clients
- Reporting of payments and account activity
- Online tracking of collection results
- Online statistical modeling
o Increased access to account information for consumers including
online payment options such as Electronic Bill Presentment and
Payment ("EBPP")
o Improved data file exchange capabilities
o Elimination of direct network connections through the use of
Virtual Private Networks ("VPNs") for small NCO offices, NCO
representatives working at client locations,
and clients accessing NCO systems.
o Elimination of large quantities of first class mail and replacement
with email
While the aforementioned initiatives present limitless opportunities for
both immediate and long-term competitive advantages, the true benefit of the
Internet to NCO will not be operational, but strategic.
Most of the Company's clients will, over time, create web access and
e-commerce strategies designed to meet the needs of their average customers.
These sites will not be equipped to handle the specialized needs of their
at-risk consumers. NCO, either through direct web access or through a link to
the client's own website, intends to create client-specific, web-enabled
customer care operational sites. These sites will allow delinquent and past due
customers to access their account information and to pay using a variety of
different options. Additionally, clients will have access to a customer care
specialist through interactive chat, email, or a telephonic call back and
ultimately through a voice-over-internet connection.
All aspects of a client-specific program will be handled in a "mass
customization" mode, delivered using shared technology and human resources. This
methodology is consistent with how the Company delivers service through its
other business units. The ability to provide consumers of any size with
web-enabled access for their at-risk (past due/delinquent) consumers may
represent the most powerful opportunity for NCO in the 21st century.
Profitability Initiatives
Over the past six years, NCO has integrated its acquisitions, rationalized
redundant staff, shut down over 25 facilities, converted computer systems and
taken advantage of opportunities to leverage its economics of scale. Over the
past year, the Company has begun exploring reengineering opportunities using
technology, best practices and scale to leverage additional cost reductions. An
example of one of the most recent successes is the deployment of automated cash
application
-8-
equipment at the Fort Washington facility. This initiative has reduced staff by
25 full-time employees to date. Over the next several years, some of the
Company's major initiatives will be in the following categories:
o Standardization of all systems and practices.
o Future consolidation of facilities.
o Further automation of all clerical functions.
o Use of statistical analysis to improve performance and reduce direct
unit costs.
o Reduction of debt.
o Continued leveraging of the Company's purchasing
power in every buying opportunity.
Technology and Infrastructure
The Company has made a substantial investment in its management systems
such as "thin client" network computing devices, predictive dialers, automated
call distribution systems, digital switching and customized computer software,
including the Universal Collector Interface product. As a result, the Company
believes it is able to address accounts receivable management and outsourcing
activities more reliably and more efficiently than many other accounts
receivable management companies. The Company's systems also permit network
access to enable clients to electronically communicate with NCO and monitor
operational activity on a real-time basis.
NCO provides its accounts receivable management services through the
operation of 93 state-of-the-art call centers that are electronically linked
through an international wide area network. The Company has substantially
completed with the migration of its international wide area network from an
outsourced MCI Worldcom frame relay to an in-house AT&T private network. The
change to the in-house AT&T private network will result in an increase in
network speed and reliability. The migration is expected to be completed by the
end of the second quarter of 2000.
The Company currently utilizes three core computer platform systems. One
system consists of multiple Unix-based NCR 4300/4400 series servers that are
linked to over 2,000 workstations. The second system consists of multiple
Unix-based Hewlett-Packard 9000 series servers that are linked to over 3,400
workstations. The third system, which consists of Compaq clustered servers, is
linked to over 1,500 workstations. The Company has recently completed the total
migration and retirement of the TANDEM system, which was the legacy system used
by FCA International Ltd. Each of the system configurations maintain the
necessary redundancy (a spare system can take over in the event of the failure
of the primary system) and additional capacity for future growth. The Company's
6,900 workstations consist of personal computers, "thin client" network
computing devices, and terminals that are linked via our international wide area
network to the servers.
NCO also utilizes a custom developed Universal Collector Interface ("UCI")
product that leverages industry standard Visual Basic and thin client server
technology in order to facilitate the critical process of "real-time"
translation of account data from our clients' host systems to NCO's system. The
UCI product set allows rapid ramp up of new client projects and the ability to
work online with client host systems, while completely integrating and
leveraging the power of NCO's base receivables management software
infrastructure. Additionally, the UCI technology allows sophisticated reporting
capabilities that are not always available on clients' host systems. The UCI
product translates client account information into a standard presentation
format that provides NCO account representatives with a common visual interface
that links directly into disparate client host systems. Key benefits of UCI
include dramatic reduction in project ramp up time, reduction in training costs,
and an overall increase in account representative productivity.
-9-
The Company utilizes 35 predictive dialer locations with over 1,600
stations to address its low balance, high volume accounts. These systems scan
the Company's databases and simultaneously initiate calls on all available
telephone lines and determine if a live connection is made. Upon determining
that a live connection has been made, the computer immediately switches the call
to an available representative and instantaneously displays the associated
account record on the representative's workstation. Calls that reach other
signals, such as a busy signal, telephone company intercept or no answer, are
tagged for statistical analysis and placed in priority recall queues or
multiple-pass calling cycles. The system also automates virtually all record
keeping and follow-up activities including letter and report generation. The
Company's automated method of operations dramatically improves the productivity
of the Company's collection staff.
The Company employs a 200 person MIS staff led by a Chief Information
Officer. The Company maintains disaster recovery contingency plans and has
implemented procedures to protect against the loss of data resulting from power
outages, fire and other casualties. The Company has implemented a security
system to protect the integrity and confidentiality of its computer systems and
data and maintains comprehensive business interruption and critical systems
insurance on its telecommunications and computer systems.
Sales and Marketing
The Company's sales organization will be combined at the corporate level to
address clients by need based upon their respective complexity, geography and
industry. The shared sales resources will continue to support and facilitate
interrelationships among the divisions and allow for continued leverage of
operating efficiencies as well as provide cross-selling opportunities.
The Company utilizes a focused and highly professional direct selling
effort in which sales representatives personally cultivate relationships with
prospects and existing clients. The Company's sales effort consists of a 60
person direct sales force and 300 telephone sales representatives for the
commercial sector. Each sales representative is charged with identifying leads,
qualifying prospects and closing sales. When appropriate, Company operating
personnel will join in the sales effort to provide detailed information and
advice regarding the Company's operational capabilities. Sales and operating
personnel also work together to take advantage of potential cross-selling
opportunities. The Company supplements its direct sales effort with print media
and attendance at trade shows.
The Company is currently developing a plan to apply the highly successful
telemarketing sales model of the commercial sector to other sectors of its
business. This telephone sales based model will provide a cost-effective way to
market the Company's services to smaller, but valuable clients.
Many of the Company's prospective clients issue requests-for-proposals
("RFPs") as part of the contract award process. The Company has a staff of
technical writers for the purpose of preparing detailed, professional responses
to RFPs.
Quality Assurance and Client Service
The Company's reputation for quality service is critical to acquiring and
retaining clients. Therefore, the Company and its clients monitor the Company's
representatives for strict compliance with the clients' specifications and the
Company's policies. The Company regularly measures the quality of its services
by capturing and reviewing such information as the amount of time spent talking
with clients' customers, level of customer complaints and operating performance.
In order to provide ongoing improvement to the Company's telephone
representatives' performance and to assure compliance with the Company's
policies and standards, quality assurance personnel monitor each telephone
representative on a frequent basis and provide ongoing training to the
representative based on this review. The Company's information systems enable it
to provide clients with reports on a real-time basis as to the status of their
accounts and clients can choose to network with the Company's computer system to
access such information directly.
-10-
The Company maintains a client service department to promptly address
client issues and questions and alert senior executives of potential problems
that require their attention. In addition to addressing specific issues, a team
of client service representatives will contact clients on a regular basis in
order to establish a close rapport, determine the client's overall level of
satisfaction and identify practical methods of improving their satisfaction.
Client Relationships
The Company's client base currently includes over 13,500 companies in the
financial services, healthcare, education, retail, utilities, government and
telecommunications sectors, and over 55,000 companies in the commercial sector.
The Company's 10 largest clients in 1999 accounted for approximately 21.7% of
the Company's revenue (19.3% on a pro forma basis, assuming all of the
acquisitions completed during 1999 occurred on January 1, 1999). In 1999, no
client accounted for more than 4.6% of total revenue (3.9% on a pro forma basis,
assuming all of the acquisitions completed during 1999 occurred on January 1,
1999). In 1999, the Company derived 32.9% of its revenue from healthcare
organizations, 25.8% from financial institutions (which includes banking and
insurance sectors), 21.7% from retail and commercial entities, 6.2% from
educational organizations, 5.7% from telecommunications companies, 5.5% from
utilities, and 2.2% from government entities.
The following table sets forth a list of certain of the Company's key
clients:
Financial Services Healthcare Retail and Commercial
- ------------------------------------- ------------------------------------- -----------------------------------
Capital One Financial Corporation Columbia/HCA Healthcare Corporation Airborne Freight Corporation
Citicorp Business Services Dayton Hudson Corporation
First Union National Bank, N.A. EMCARE, Inc. Emery Worldwide
Banc of America Health Management Associates, Inc. Federal Express Corporation
The Progressive Corporation Sears, Roebuck and Co.
Education Telecommunications Utilities and Government
- ------------------------------------- ------------------------------------- -----------------------------------
California Student Aid Bell Atlantic Corporation Consumer Energy
Commission / ED Fund BellSouth Telecommunications, Inc. PECO Energy Company
New York State Higher Education Frontier Cellular The City of Philadelphia, Water
Service Corporation MCI WorldCom Revenue Bureau
Pennsylvania Higher Education Sprint Corporation The United States Department of
Assistance Agency Treasury
Penn State University Virginia Power
The United States Department of
Education
The Company enters into contracts with most of its clients which define,
among other things, fee arrangements, scope of services and termination
provisions. Clients may usually terminate such contracts on 30 or 60 days
notice. In the event of termination, however, clients typically do not withdraw
accounts referred to the Company prior to the date of termination, thus
providing the Company with an ongoing stream of revenue from such accounts which
diminish over time. Under the terms of the Company's contracts, clients are not
required to place accounts with the Company but do so on a discretionary basis.
-11-
Personnel and Training
The Company's success in recruiting, hiring and training a large number of
employees is critical to its ability to provide high quality accounts receivable
management, customer support and teleservices programs to its clients. The
Company seeks to hire personnel with previous experience in accounts receivable
management or as a telephone representative. NCO generally offers competitive
compensation and benefits and offers promotion opportunities within the Company.
All Company personnel receive a comprehensive training course that consists
of a combination of classroom and practical experience. Prior to customer
contact, new employees receive one week of training in the Company's operating
systems, procedures and telephone techniques and instruction in applicable
federal and state regulatory requirements. Company personnel also receive a wide
variety of continuing professional education consisting of both classroom and
role playing sessions.
As of December 31, 1999, the Company had a total of approximately 8,800
full-time employees and 1,200 part-time employees, of which 6,900 were telephone
representatives. None of the Company's employees are represented by a labor
union. The Company believes that its relations with its employees are good.
Competition
The accounts receivable management industry is highly competitive. The
Company competes with approximately 6,500 providers, including large national
corporations such as Outsourcing Solutions, Inc., GC Services, Inc., IntelliRisk
Mangement Corporation, and CreditTrust, as well as many regional and local
firms. Some of the Company's competitors may have greater resources, offer more
diversified services and operate in broader geographic areas than the Company.
In addition, the accounts receivable management services offered by the Company,
are performed in-house by many companies. Moreover, many larger clients retain
multiple accounts receivable management providers which exposes the Company to
continuous competition in order to remain a preferred vendor. The Company
believes that the primary competitive factors in obtaining and retaining clients
are the ability to provide customized solutions to a client's requirements,
personalized service, sophisticated call and information systems and price.
Regulation
The accounts receivable management industry is regulated both at the
federal and state level. The federal Fair Debt Collection Practices Act (the
"FDCPA") regulates any person who regularly collects or attempts to collect,
directly or indirectly, consumer debts owed or asserted to be owed to another
person. The FDCPA establishes specific guidelines and procedures which debt
collectors must follow in communicating with consumer debtors, including the
time, place and manner of such communications. Further, it prohibits harassment
or abuse by debt collectors, including the threat of violence or criminal
prosecution, obscene language or repeated telephone calls made with the intent
to abuse or harass. The FDCPA also places restrictions on communications with
individuals other than consumer debtors in connection with the collection of any
consumer debt and sets forth specific procedures to be followed when
communicating with such third parties for purposes of obtaining location
information about the consumer. Additionally, the FDCPA contains various notice
and disclosure requirements and prohibits unfair or misleading representations
by debt collectors. The Company is also subject to the Fair Credit Reporting Act
which regulates the consumer credit reporting industry and which may impose
liability on the Company to the extent that the adverse credit information
reported on a consumer to a credit bureau is false or inaccurate. The accounts
receivable management business is also subject to state regulation. Some states
require that the Company be licensed as a debt collection company. Management
believes that the Company currently holds applicable licenses from all states
where required.
-12-
With respect to the other teleservices offered by the Company, including
telemarketing, the federal Telemarketing and Consumer Fraud and Abuse Prevention
Act of 1994 (the "TCFAPA") broadly authorizes the Federal Trade Commission (the
"FTC") to issue regulations prohibiting misrepresentations in telemarketing
sales. The FTC's telemarketing sales rules prohibit misrepresentations of the
cost, terms, restrictions, performance or duration of products or services
offered by telephone solicitation and specifically address other perceived
telemarketing abuses in the offering of prizes and the sale of business
opportunities or investments. The federal Telephone Consumer Protection Act of
1991 (the "TCPA") limits the hours during which telemarketers may call consumers
and prohibits the use of automated telephone dialing equipment to call certain
telephone numbers. A number of states also regulate telemarketing. For example,
some states have enacted restrictions similar to the federal TCPA. From time to
time, Congress and the states consider legislation that would further regulate
the Company's telemarketing operations and the Company cannot predict whether
additional legislation will be enacted and, if enacted, what effect it would
have on the telemarketing industry and the Company's business.
The collection of accounts receivable by collection agencies in Canada is
regulated at the provincial and territorial level in substantially the same
fashion as is accomplished by federal and state laws in the United States. The
manner in which the Company carries on the business of collecting accounts is
subject, in all provinces and territories, to established rules of common law or
civil law and statute. Such laws establish rules and procedures governing the
tracing, contacting and dealing with debtors in relation to the collection of
outstanding accounts. These rules and procedures prohibit debt collectors from
engaging in intimidating, misleading and fraudulent behavior when attempting to
recover outstanding debts. In Canada, the Company's collection operations are
subject to licensing requirements and periodic audits by government agencies and
other regulatory bodies. Generally, such licenses are subject to annual renewal.
Management believes that the Company holds all necessary licenses in those
provinces and territories that require them.
If the Company engages in other teleservice activities in Canada, including
telemarketing, there are several provincial and territorial consumer protection
laws of more general application. This legislation defines and prohibits unfair
practices by telemarketers, such as the use of undue pressure and the use of
false, misleading or deceptive consumer representations.
In addition, accounts receivable management and telemarketing industries
are regulated in the United Kingdom, including a licensing requirement. If the
Company expands its international operation, it may become subject to additional
government control and regulation in other countries, which may be more onerous
than those in the United States.
Several of the industries served by the Company are also subject to varying
degrees of government regulation. Although compliance with these regulations is
generally the responsibility of the Company's clients, the Company could be
subject to a variety of enforcement or private actions for its failure or the
failure of its clients to comply with such regulations.
-13-
The Company devotes significant and continuous efforts, through training of
personnel and monitoring of compliance, to ensure that it is in compliance with
all federal and state regulatory requirements. The Company believes that it is
in material compliance with all such regulatory requirements.
Investment Considerations
Certain statements included in this Annual Report on Form 10-K, other than
historical facts, are forward-looking statements (as such term is defined in the
Securities Exchange Act of 1934, and the regulations thereunder) which are
intended to be covered by the safe harbors created thereby. Forward-looking
statements include, without limitation, statements as to the Company's five-year
growth strategy, statements as to the Company's objective to focus on internal
growth, strategic acquisitions and alliances, and integration, the impact of
acquisitions on the Company's earnings, the Company's ability to realize
operating efficiencies in the integration of its acquisitions, trends in the
Company's future operating performance, expected increases in operating
efficiencies, anticipated trends in the accounts receivable management industry,
year 2000 compliance, the effects of legal or governmental proceedings, the
effects of changes in accounting pronouncements and statements as to the
Company's or management's beliefs, expectations and opinions. Forward-looking
statements are subject to risks and uncertainties and may be affected by various
factors which may cause actual results to differ materially from those in the
forward-looking statements. The factors discussed below, and elsewhere in this
Annual Report on Form 10-K, could cause actual results and developments to be
materially different from those expressed in or implied by such forward-looking
statements. Accordingly, in addition to the other information contained, or
incorporated by reference, in this Annual Report on Form 10-K, the following
factors should be considered carefully in evaluating an investment in the
Company's common stock.
The businesses acquired by NCO in 1999 had combined pro forma revenues of
$217.8 million in 1998 which was 121.7% of NCO's revenue of $179.0 million in
1998, prior to the restatement to reflect the JDR acquisition. If NCO is unable
to successfully manage these new businesses, NCO may not realize the expected
benefits from these acquisitions.
The businesses acquired by NCO in 1999 had combined pro forma revenues of
$217.8 million in 1998 compared to NCO's revenue of $179.0 million in 1998,
prior to the restatement to reflect the JDR acquisition. If NCO is unable to
successfully manage these new businesses and integrate them into NCO's
operations, NCO may not be able to realize expected operating efficiencies,
eliminate redundant costs or operate the businesses profitably. The integration
of these businesses is subject to a number of risks, including risks that:
o the conversion of the acquired companies' computer and operating
systems to NCO's systems may take longer or cost more than expected;
o NCO may be unable to retain clients or key employees of the acquired
companies; and
o the acquired companies might have additional liabilities that NCO did
not anticipate at the time of the acquisitions.
-14-
Historically, NCO's growth strategy has included acquisitions. NCO recently
announced that it would not make any acquisitions during the first half of 2000
to allow it to complete the integration of companies which have been acquired.
After that period, NCO intends to consider acquisitions on an opportunistic
basis. As a result of this change in growth strategy, NCO's future growth may be
limited and the price of its stock may be adversely affected.
Historically, NCO's growth strategy has included acquisitions. NCO recently
announced that it would not make any acquisitions during the first half of 2000
to allow it to complete the integration of companies which have been acquired.
Because of this change in its acquisition strategy, if NCO is unable to maintain
its internal growth, it may not be able to meet or exceed historical levels of
growth and earnings. As a result, NCO's stock price may be adversely affected.
NCO's significant internal growth may be difficult to manage or to
continue. If NCO is not able to manage or continue that growth, it could have a
materially adverse effect on NCO's business, results of operations and financial
condition.
NCO has experienced significant internal growth over the past several years
and intends to continue its internal growth. Future internal growth is subject
to a number of risks, including the risks that:
o NCO may not be able to develop and maintain new clients;
o by focusing on new clients, NCO may lose existing clients through
inattention or because NCO fails to maintain the quality of services
it provides to its clients; and
o NCO may have difficulty hiring, training and retaining new employees
to handle the increased workload.
NCO's internal growth has placed significant demands on NCO's
administrative, operational and financial resources. To continue its future
growth, NCO will also be required to improve its operational and financial
systems and obtain additional management, operational and financial resources.
These additional costs may outweigh the benefits NCO expects to obtain from
internal growth.
Goodwill represented 75.5% of NCO's total assets at December 31, 1999. If
management has incorrectly overstated the permissible length of the amortization
period for goodwill, earnings reported in periods immediately following the
acquisition would be overstated. In later years, NCO would be burdened by a
continuing charge against earnings.
NCO's balance sheet includes amounts designated as "goodwill." Goodwill
represents the excess of purchase price over the fair market value of the net
assets of the acquired businesses based on their respective fair values at the
date of acquisition. GAAP requires that this and all other intangible assets be
amortized over the period benefited. Management has determined that period to
range from 15 to 40 years based on the attributes of each acquisition.
As of December 31, 1999, NCO's balance sheet included goodwill that
represented 75.5% of total assets and 165.1% of shareholders' equity.
If management has incorrectly overstated the permissible length of the
amortization period for goodwill, earnings reported in periods immediately
following the acquisition would be overstated. In later years, NCO would be
burdened by a continuing charge against earnings without the associated benefit
to income valued by management in arriving at the consideration paid for the
business. Earnings in later years also could be significantly affected if
management determined then that the remaining balance of goodwill was impaired.
-15-
Management has concluded that the anticipated future cash flows associated
with intangible assets recognized in the acquisitions will continue
indefinitely, and there is no persuasive evidence that any material portion will
dissipate over a period shorter than the respective amortization period.
The number of shares of NCO's common stock that was traded daily on the
Nasdaq stock market during 1999 averaged less than 1.5% of the average
outstanding common stock during 1999. As a result, he market price of NCO common
stock may be volatile.
As a result of NCO's low trading volume, the market price for NCO common
stock may be volatile and may be affected by many factors, including the
following:
o announcements of fluctuations in NCO's or its competitors' operating
results;
o the timing and announcement of acquisitions by NCO or its
competitors; and
o government regulatory action.
In addition, the stock market in recent years has experienced significant
price and volume fluctuations that often have been unrelated or disproportionate
to the operating performance of companies. These broad fluctuations may
materially adversely affect the market price of NCO common stock.
As of March 22, 2000, approximately 86.7% of NCO's outstanding shares are
available for resale in the public market without restriction. The sale of a
large number of these shares could adversely affect NCO's stock price and could
impair NCO's ability to raise capital through the sale of equity securities or
make acquisitions for stock.
Sales of NCO's common stock could adversely affect the market price of
NCO's common stock and could impair NCO's future ability to raise capital
through the sale of equity securities or make acquisitions for stock. As of
March 22, 2000, there were 25,547,398 shares of NCO common stock outstanding. Of
these shares, approximately 22,145,154 shares, or 86.7% of the total outstanding
shares, are available for resale in the public market without restriction.
Approximately 3,402,244 shares of NCO common stock, or 13.3% of the total
outstanding shares, are held by affiliates of NCO. Generally, NCO affiliates may
either sell their shares under a registration statement or in compliance with
the volume limitations and other requirements imposed by Rule 144 adopted by the
SEC.
In addition, as of March 22, 2000, NCO has the authority to issue up to
approximately 3,997,000 shares of its common stock under its stock option plans.
NCO also has outstanding warrants to purchase 397,000 shares of its common
stock.
-16-
NCO may experience variations from quarter to quarter in operating results
and net income which could adversely affect the price of NCO common stock.
Factors which could cause quarterly fluctuations include the following:
o the timing of NCO's clients' accounts receivable management programs
and the commencement of new contracts;
o customer contracts may require NCO to incur costs in periods prior to
recognizing revenue under those contracts;
o the effect of the change of business mix on profit margins;
o the timing of additional selling, general and administrative expenses
to support new business;
o the costs and timing of completion and integration of acquisitions.
o NCO's business tends to be slower in the third and fourth quarters of
the year due to the summer and holiday seasons.
NCO's business is dependent on clients in the healthcare and financial
services sectors. If either of these sectors performs poorly or if there are any
trends in these sectors to reduce or eliminate the use of third-party accounts
receivable management services provided by companies like NCO, it could have a
materially adverse effect on NCO's business, financial condition and results of
operations.
For the year ended December 31, 1999, NCO derived approximately 32.9% of
its revenue from clients in the healthcare sector and approximately 25.8% of its
revenue from clients in the financial services sector. If either of these
sectors performs poorly, clients in these sectors may have fewer or smaller
accounts to refer to NCO or they may elect to perform accounts receivable
management services in-house. If there are any trends in either of these sectors
to reduce or eliminate the use of third-party accounts receivable management
services, the volume of referrals to NCO would decrease.
Most of NCO's contracts do not require clients to place accounts with NCO,
may be terminated on 30 or 60 days notice and are on a contingent fee basis.
Accordingly, NCO can not predict whether existing clients will continue to use
NCO's services at historical levels, if at all.
Under the terms of most of NCO's contracts, clients are not required to
give accounts to NCO for collection and usually have the right to terminate
NCO's services on 30 or 60 days notice. In addition, most of these contracts
provide that NCO is entitled to be paid only when it collects accounts.
Accordingly, NCO can not predict whether existing clients will continue to use
NCO's services at historical levels, if at all.
-17-
NCO competes with approximately 6,500 providers in the accounts receivable
management industry. This competition could have a materially adverse effect on
NCO's future financial results.
NCO competes with approximately 6,500 providers in providing accounts
receivable management services. NCO is a national provider of accounts
receivable management services. NCO competes with other large national
corporations such as Outsourcing Solutions, Inc., GC Services, Inc., IntelliRisk
Management Corporation and CrediTrust, as well as many regional and local firms.
NCO may lose existing or prospective business to competitors that have greater
resources, offer more diversified services or operate in broader geographic
areas than NCO. NCO may also lose business to regional or local firms who are
able to use their proximity to or contacts at local clients as a marketing
advantage. Because of the large numbers of providers, in the future NCO may have
to reduce its collection fees to remain competitive. Many larger clients retain
multiple accounts receivable management providers which exposes NCO to
continuous competition in order to remain a preferred vendor.
If NCO is not able to respond to technological changes in
telecommunications and computer systems in a timely manner, it may not be able
to remain competitive.
NCO's success depends in large part on its sophisticated telecommunications
and computer systems. NCO uses these systems to identify and contact large
numbers of account debtors and to record the results of the collection effort.
If NCO is not able to respond to technological changes in telecommunications and
computer systems in a timely manner, it may not be able to remain competitive.
NCO has made a significant investment in technology to remain competitive and
anticipates that it will be necessary to continue to do so in the future.
Computer and telecommunication technologies are changing rapidly and are
characterized by short product life cycles, so that NCO must anticipate
technological developments. If NCO is not successful in anticipating, managing
or adopting any technological changes on a timely basis or if NCO does not have
the capital resources available to invest in new technologies, its business
would be materially adversely affected.
If NCO's telecommunications and computer systems fail or become
unavailable, it could have a materially adverse effect on NCO's business.
As noted above, NCO's business is highly dependent on its
telecommunications and computer systems. These systems could be interrupted by
natural disasters, power losses, or similar events. NCO's business also is
materially dependent on service provided by various local and long distance
telephone companies. If NCO's equipment or systems cease to work or become
unavailable, or if there is any significant interruption in telephone services,
NCO may be prevented from providing services. Because NCO generally recognizes
income only as accounts are collected, any failure or interruption of services
would mean that NCO would continue to incur payroll and other expenses without
any corresponding income.
-18-
NCO's success depends on its senior management team and if it is not able
to retain them, it could have a materially adverse effect on NCO.
NCO is highly dependent upon the continued services and experience of its
senior management team, including Michael J. Barrist, Chairman of the Board,
President and Chief Executive Officer. NCO depends on the services of Mr.
Barrist and the other members of NCO's senior management team to, among other
things:
o successfully integrate the operations of NCO with acquired companies;
o continue NCO's acquisition and growth strategies; and
o maintain and develop NCO's client relationships.
NCO is dependent on its employees and a higher turnover rate would
materially adversely affect NCO.
The accounts receivable management industry is very dependent upon
employees and experiences high turnover rate. Many of NCO's employees receive
modest hourly wages and a portion of these employees are employed on a part-time
basis. A higher turnover rate among NCO's employees would increase NCO's
recruiting and training costs and could materially adversely impact the quality
of services NCO provides to its clients. If NCO were unable to recruit and
retain a sufficient number of employees, it would be forced to limit its growth
or possibly curtail its operations. Growth in NCO's business will require it to
recruit and train qualified personnel at an accelerated rate from time to time.
NCO cannot assure you that it will be able to continue to hire, train and retain
a sufficient number of qualified employees. Additionally, an increase in hourly
wages, costs of employee benefits or employment taxes also could materially
adversely affect NCO.
"Anti-takeover" provisions may make it more difficult for a third party to
acquire control of NCO, even if the change in control would be beneficial to
shareholders.
NCO is a Pennsylvania corporation. Anti-takeover provisions in Pennsylvania
law and NCO's charter and bylaws could make it more difficult for a third party
to acquire control of NCO. These provisions could adversely affect the market
price of NCO common stock and could reduce the amount that shareholders might
receive if NCO is sold. For example, NCO's charter provides that NCO's board of
directors may issue preferred stock without shareholder approval. In addition,
NCO's bylaws provide for a classified board, with each board member serving a
staggered three-year term. Directors may be removed only for cause and only with
the approval of the holders of at least 65% of NCO's common stock.
If NCO fails to comply with government regulation of accounts receivable
management and telemarketing industries, it could result in the suspension or
termination of NCO's ability to conduct business which would have a materially
adverse effect on NCO.
-19-
The accounts receivable management and telemarketing industries are
regulated under various United States federal and state, Canadian and United
Kingdom laws and regulations. Many states, as well as Canada and the United
Kingdom, require that NCO be licensed as a debt collection company. If NCO fails
to comply with applicable laws and regulations, it could result in the
suspension or termination of NCO's ability to conduct accounts receivable
management or telemarketing services which would have a materially adverse
effect on NCO. In addition, new federal, state or foreign laws or regulations,
or changes in the ways these rules or laws are interpreted or enforced, could
limit the activities of NCO in the future or significantly increase the cost of
regulatory compliance. If NCO expands its international operations, it may
become subject to additional government controls and regulations in other
countries, which may be stricter or more burdensome than those in the United
States.
Several of the industries served by NCO are also subject to varying degrees
of government regulation. Although NCO's clients are generally responsible for
complying with these regulations, NCO could be subject to a variety of
enforcement or private actions for its failure or the failure of its clients to
comply with these regulations.
Item 2. Properties.
----------
The Company offices currently leases 93 offices throughout North America,
three offices in the United Kingdom and one office in Puerto Rico. The leases of
these facilities expire between 2000 and 2013, and most contain renewal options.
The Company believes that its facilities are adequate for its current
operations, but additional facilities may be required to support growth. The
Company believes that suitable additional or alternative space will be available
as needed on commercially reasonable terms. In addition, the Company intends to
close or consolidate certain offices acquired in the MedSource Corporation,
Medaphis Services Corporation, Co-Source Corporation and Compass International
Services Corporation acquisitions.
Item 3. Legal Proceedings.
-----------------
The Company is involved in legal proceedings from time to time in the
ordinary course of its business. Management believes that none of these legal
proceedings will have a materially adverse effect on the financial condition or
results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
----------------------------------------------------
None.
-20-
Item 4.1 Executive Officers of the Registrant who are not Directors.
-----------------------------------------------------------
Name Age Position
- -------------------------------------------------- -------- ------------------------------------------------
Robert Di Sante........................ 48 Executive Vice President and Divisional Chief
Executive Officer, International Operations
Stephen W. Elliott..................... 38 Executive Vice President, Information
Technology and Chief Information Officer
Joshua Gindin, Esq..................... 43 Executive Vice President and General Counsel
Joseph C. McGowan...................... 47 Executive Vice President and Divisional Chief
Executive Officer, Accounts Receivable
Management Services
Louis A. Molettiere.................... 56 Executive Vice President and Chief Operating
Officer
Richard Raquet......................... 38 Executive Vice President and Divisional Chief
Executive Officer, Marketing Strategy
Paul E. Weitzel, Jr.................... 41 Executive Vice President, Corporate
Development
Steven L. Winokur...................... 40 Executive Vice President, Finance; Chief
Financial Officer; and Treasurer
Robert Di Sante, Executive Vice President and Divisional Chief Executive
Officer, International Operations, joined the Company through the acquisition of
FCA International Ltd. in May 1998. Prior to joining the Company, Mr. Di Sante
was Executive Vice President, Finance and Corporate Services of FCA
International Ltd. Mr. Di Sante is a chartered accountant.
Stephen W. Elliott, Executive Vice President, Information Technology and
Chief Information Officer, joined the Company in 1996 after having provided
consulting services to the Company for the year prior to his arrival. Prior to
joining the Company, Mr. Elliott was employed by Electronic Data Systems, a
computer services company for almost 10 years, most recently as Senior Account
Manager.
Joshua Gindin, Esq., Executive Vice President and General Counsel, joined
the Company in May 1998. Prior to joining the Company, Mr. Gindin was a partner
in the law firm of Kessler & Gindin which served as legal counsel to the Company
since 1986.
-21-
Joseph C. McGowan, Executive Vice President and Divisional Chief Executive
Officer, Accounts Receivable Management Services, joined the Company in 1990.
Prior to joining the Company, Mr. McGowan was Assistant Manager of the
Collections Department at Philadelphia Gas Works, a public utility, since 1975.
Louis A. Molettiere, Executive Vice President and Chief Operating Officer,
joined the Company through the acquisition of the Co-Source Corporation in May
1999. Prior to joining the Company, Mr. Molettiere was Vice President of
Marketing of Milliken & Michaels, a subsidiary of Co-Source Corporation, since
1993. Prior to joining Milliken & Michaels, Mr. Molettiere was with AT&T for
twenty-two years, most recently as General Marketing Manager - National and
Major Markets.
Richard Raquet, Executive Vice President and Divisional Chief Executive
Officer, Market Strategy, joined the Company through the acquisition of The
Response Center in February 1998. Prior to joining the Company, Mr. Raquet was
Chief Operating Officer of The Response Center.
Paul E. Weitzel, Jr., Executive Vice President, Corporate Development,
joined the Company through the acquisition of MedSource, Inc. in July 1998.
Prior to joining the Company, Mr. Weitzel was Chairman and Chief Executive
Officer of MedSource, Inc. since 1997. Prior to joining MedSource, Inc., Mr.
Weitzel was with MedQuist, Inc. for four years, most recently as President and
Chief Executive Officer. Mr. Weitzel is a certified public accountant.
Steven L. Winokur, Executive Vice President, Finance; Chief Financial
Officer; and Treasurer, joined the Company in December 1995. Prior to that, Mr.
Winokur acted as a part-time consultant to the Company since 1986. From February
1992 to December 1995, Mr. Winokur was the principal of Winokur & Associates, a
certified public accounting firm. From March 1981 to February 1992, Mr. Winokur
was with Gross & Company, a certified public accounting firm, where he most
recently served as Administrative Partner. Mr. Winokur is a certified public
accountant.
-22-
PART II
Item 5. Market for the Registrant's Common Stock and
Related Shareholder Matters.
The Company's common stock is listed on the Nasdaq National Market under
the symbol "NCOG." The following table sets forth, for the fiscal quarters
indicated, the high and low closing sale prices for the common stock, as
reported by Nasdaq.
High Low
---- ---
1998
First Quarter $ 29.25 $ 21.87
Second Quarter 28.00 20.50
Third Quarter 28.50 17.63
Fourth Quarter 45.00 23.50
1999
First Quarter $ 43.75 $ 28.81
Second Quarter 38.00 25.75
Third Quarter 49.88 36.38
Fourth Quarter 52.75 25.88
As of March 22, 2000, the Company's common stock was held by approximately
85 holders of record. Based on information obtained from the Company's transfer
agent, the Company believes that the number of beneficial owners of its common
stock is in excess of 5,245.
Dividend Policy
The Company does not anticipate paying cash dividends on its common stock
in the foreseeable future. In addition, the Company's revolving credit agreement
prohibits the Company from paying cash dividends without the lender's prior
consent. The Company currently intends to retain future earnings to finance its
operations and fund the growth of its business. Any payment of future dividends
will be at the discretion of the Board of Directors of the Company and will
depend upon, among other things, the Company's earnings, financial condition,
capital requirements, level of indebtedness, contractual restrictions with
respect to the payment of dividends and other factors that the Company's Board
of Directors deems relevant.
Sales of Unregistered Securities during 1999
Set forth below is information concerning certain issuances of common stock
during 1999 which were not registered under the Securities Act and which have
not been previously reported.
From January to December 1999, the Company granted options to certain
executive officers and key employees under the 1996 Stock Option Plan on the
dates and at the exercise prices set forth below. Generally, options will become
exercisable in equal one-third installments beginning on the first anniversary
of the date of grant. All of the options were issued in connection with such
employee's employment with the Company and no cash or other consideration was
received by the
-23-
Company in exchange for the grant of such options. The grants of the
options were not registered under the Securities Act because there was no "sale"
of the options; however, the stock issued upon the exercise of the options has
been registered on Form S-8.
Date Issued Options Granted Exercise Price
----------- --------------- --------------
March 1999 68,000 $37.00
April 1999 10,000 $33.13
May 1999 101,000 $32.13
June 1999 12,000 $31.90
August 1999 13,000 $43.81
December 1999 1,074,000 $29.94
In May 1999, the Company issued options in accordance with the 1996
Non-Employee Director Stock Option Plan to purchase 3,000 shares of common stock
to each of Eric S. Siegel and Alan F. Wise and 15,000 shares of common stock to
Stuart Wolf. These options were granted at an exercise price of $33.00 per
share. The grants of the options were not registered under the Securities Act
because there was no "sale" of the options; however, the stock issued upon the
exercise of the options has been registered on Form S-8.
-24-
Item 6. Selected Financial Data.
------------------------
SELECTED FINANCIAL DATA
(Amounts in thousands, except per share data)
For the years ended December 31,
---------------------------------------------------------------------------
1995 1996 1997 1998 1999
----------- ------------ ------------ ------------ ------------
C>
Statement of Income Data:
Revenue $ 12,733 $ 30,760 $ 108,073 $ 229,952 $ 492,354
Operating costs and expenses:
Payroll and related expenses 6,797 14,651 56,949 119,314 257,877
Selling, general and administrative
expenses 4,042 10,032 36,372 66,588 135,508
Depreciation and amortization
expense 348 1,254 4,564 9,851 23,311
Non-recurring acquisition costs - - - - 4,601
----------- ------------ ------------ ------------ ------------
Income from operations 1,546 4,823 10,188 34,199 71,057
Other income (expense) (180) (576) (797) (2,723) (17,997)
----------- ------------ ------------ ------------ ------------
Income before provision for income taxes 1,366 4,247 9,391 31,476 53,060
Income tax expense (1) - 613 4,800 13,131 23,694
----------- ------------ ------------ ------------ ------------
Net income 1,366 3,634 4,591 18,345 29,366
Accretion of preferred stock
to redemption value - - (1,617) (1,604) (377)
----------- ------------ ------------ ------------ ------------
Net income applicable to
common shareholders $ 1,366 $ 3,634 $ 2,974 $ 16,741 $ 28,989
=========== ============ ============ ============ ============
Pro forma income tax expense (1) 546 1,093
----------- ------------
Pro forma net income (1) $ 820 $ 2,541
=========== ============
Net income per share:
Basic $ 0.19 $ 0.48 $ 0.22 $ 0.91 $ 1.27
=========== ============ ============ ============ ============
Diluted $ 0.19 $ 0.48 $ 0.20 $ 0.85 $ 1.22
=========== ============ ============ ============ ============
Pro forma net income per share:
Basic (1) $ 0.12 $ 0.34
=========== ============
Diluted (1) $ 0.12 $ 0.34
=========== ============
Weighted average shares outstanding:
Basic 7,093 (2) 7,630 (2) 13,736 18,324 22,873
=========== ============ ============ ============ ============
Diluted 7,093 (2) 7,658 (2) 14,808 19,758 23,799
=========== ============ ============ ============ ============
December 31,
---------------------------------------------------------------------------
1995 1996 1997 1998 1999
----------- ------------ ------------ ------------ ------------
Balance Sheet Data:
Cash and cash equivalents $ 805 $ 12,059 $ 30,379 $ 23,560 $ 52,380
Working capital 812 13,629 38,223 35,515 77,625
Total assets 6,644 35,826 131,492 414,809 797,940
Long-term debt, net of
current portion 2,593 1,478 15,211 143,910 323,949
Shareholders' equity 2,051 30,648 94,336 199,465 364,888
(1) The Company was taxed as an S corporation prior to September 3, 1996.
Accordingly, income tax expense and net income have been provided on a pro
forma basis as if the Company had been subject to income taxes in all
periods presented.
(2) Assumes that the Company issued 374,637 shares of common stock at $8.67 per
share to fund the distribution of undistributed S corporation earnings of
$3.2 million through September 3, 1996, the termination date of the
Company's S corporation status, to existing shareholders of the Company.
-25-
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.
Results of Operations
The following table sets forth historical income statement data as a
percentage of revenue:
Years Ended December 31,
--------------------------------------------------------
1995 1996 1997 1998 1999
------- -------- --------- --------- ---------
Revenue 100.0% 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Payroll and related expenses 53.4 47.6 52.7 51.9 52.4
Selling, general and administrative
expenses 31.7 32.6 33.7 28.9 27.5
Depreciation and amortization
expense 2.7 4.1 4.2 4.3 4.7
Non-recurring acquisition costs - - - - 0.9
------- -------- --------- --------- ---------
Total operating costs and
expenses 87.8 84.3 90.6 85.1 85.5
------- -------- --------- --------- ---------
Income from operations 12.2 15.7 9.4 14.9 14.5
Other income (expense) (1.4) (1.9) (0.7) (1.2) (3.7)
------- -------- --------- --------- ---------
Income before provision for income taxes 10.8 13.8 8.7 13.7 10.8
Income tax expense(1) 4.3 5.5 4.4 5.7 4.8
------- -------- --------- --------- ---------
Net income 6.5% 8.3% 4.3% 8.0% 6.0%
======= ======== ========= ========= =========
(1) The Company was taxed as an S Corporation prior to September 3, 1996.
Accordingly, income tax expense and net income have been provided on a pro forma
basis as if the Company had been subject to income taxes in all periods
presented.
Year ended December 31, 1999 Compared to Year ended December 31, 1998
Revenue. Revenue increased $262.4 million, or 114.1%, to $492.4 million in
1999, from $230.0 million in 1998. $50.7 million of the increase was
attributable the addition of new clients and growth in business from existing
clients. The $50.7 million increase includes $11.9 million attributable to JDR
Holdings, Inc. ("JDR"), which was acquired on March 31, 1999 and was accounted
for under the pooling-of-interests method of accounting. The remainder of the
increase was attributable to the following: $33.6 million from the acquisition
of Compass International Services Corporation ("Compass") on August 20, 1999;
$44.2 million from the acquisition of Co-Source Corporation ("Co-Source") on May
21, 1999; $101.4 million from the acquisition of Medaphis Services Corporation
("MSC") on November 30, 1998; $12.3 million from the acquisition of MedSource,
Inc. ("MedSource") on July 1, 1998; and $20.2 million from the acquisition of
FCA International Ltd. ("FCA") on May 5, 1998.
Payroll and related expenses. Payroll and related expenses increased $138.6
million to $257.9 million in 1999, from $119.3 million in 1998, and increased as
a percentage of revenue to 52.4% from 51.9%. Payroll and related expenses
increased as a percentage of revenue primarily as a result of some of the recent
acquisitions having a higher cost structure than the remainder of the Company.
In addition, a portion of this increase was attributable to increases in the
size of the Market Strategy and the Commercial Services divisions, which have
higher payroll cost structures than the remainder of the Company. However, the
higher payroll structures of the Commercial Services and Market Strategy
divisions were offset by their lower selling, general and administrative cost
structures. Payroll and related expenses as a percentage of revenue are expected
to decrease by continuing to integrate the recent acquisitions and by spreading
the Company's payroll costs over a larger revenue base.
-26-
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $68.9 million to $135.5 million in 1999 from
$66.6 million in 1998. Selling, general and administrative expenses decreased as
a percentage of revenue to 27.5% from 28.9%. This decrease resulted from the
Company realizing operating efficiencies and by spreading selling, general and
administrative expenses over a larger revenue base. In addition, a portion of
this decrease can be attributed to increases in the size of the Market Strategy
and the Commercial Services divisions, which have lower selling, general and
administrative cost structures than the remainder of the Company.
Depreciation and amortization. Depreciation and amortization increased to
$23.3 million in 1999 from $9.9 million in 1998. Of this increase, $1.7 million
was attributable to the Compass acquisition, $2.2 million was attributable to
the Co-Source acquisition, $4.0 million was attributable to the MSC acquisition,
$940,000 was attributable to the MedSource acquisition, and $1.8 million was
attributable to the FCA acquisition. The remaining $2.8 million consisted of
depreciation resulting from capital expenditures made in the ordinary course of
business during 1999. These capital expenditures included purchases associated
with the Company's planned migration towards a single, integrated information
technologies platform, the expansion of the Company's infrastructure to handle
future growth, and the Company's year 2000 compliance program.
Non-recurring acquisition costs. In the first quarter of 1999, the Company
incurred $4.6 million of non-recurring acquisition costs in connection with the
acquisition of JDR. These costs consisted primarily of investment banking fees,
legal and accounting fees, and printing costs.
Other income (expense). Interest and investment income increased $230,000
to $1.4 million for 1999 over the comparable period in 1998. This increase was
primarily attributable to an increase in operating funds and funds held on
behalf of clients. Interest expense increased to $19.4 million in 1999 from $3.9
million in 1998. The increase was partially attributable to a full year of
interest expense from the Company financing a portion of the July 1998
acquisition of MedSource and all of the November 1998 acquisition of MSC with
borrowings of $25.5 million and $107.5 million, respectively, under the
revolving credit facility. In addition, the Company financed the May 1999
acquisition of Co-Source with borrowings of $122.7 million under a revolving
credit facility. A portion of the increase was attributable to borrowings under
a revolving credit facility of $29.5 million that were used to repay debt that
was assumed as a result of the Compass acquisition.
Income tax expense. Income tax expense for 1999 increased to $23.7 million,
or 44.7% of income before taxes, from $13.1 million, or 41.7% of income before
taxes, for 1998. The increase in the effective tax rate was partially
attributable to the impact of the non-deductible goodwill related to certain
acquisitions. In addition, the increase was also attributable to the
non-deductible portion of the $4.6 million of non-recurring acquisition costs
incurred during the first quarter of 1999 in connection with the acquisition of
JDR.
-27-
Net income. Net income in 1999 increased 60.1% to $29.4 million from $18.3
million in 1998. Included in net income for 1999 were $3.7 million of expenses
attributable to non-recurring acquisition costs, net of taxes. Without these
costs, net income would have been $33.1 million, or $1.39 per share on a diluted
basis, an increase of $14.7 million, or 80.2%, over 1998.
Accretion of preferred stock to redemption value. The accretion of
preferred stock to redemption value relates to JDR's preferred stock that was
outstanding prior to its exchange for NCO common stock on March 31, 1999. This
non-cash accretion represents the periodic amortization of the difference
between the original carrying amount and the mandatory redemption amount.
Year ended December 31, 1998 Compared to Year ended December 31, 1997
Revenue. Revenue increased $121.9 million, or 112.8%, to $230.0 million in
1998 from $108.1 million in 1997. Of this increase, $28.2 million was
attributable to a full year of revenue from JDR as compared to revenue in 1997
for the period from May 29, 1997 to December 31, 1997. The partial year of
revenue in 1997 resulted from the recapitalization completed by JDR on May 29,
1997 which resulted in a new basis of accounting. In addition, $8.5 million was
attributable to the acquisition of MSC, completed in November 1998, $12.3
million was attributable to the acquisition of MedSource, completed in July
1998, $35.3 million was attributable to the acquisition of FCA, completed in May
1998, $8.9 million was attributable to the acquisitions of the Collections
Division of American Financial Enterprises, Inc. ("AFECD") and The Response
Center ("TRC"), completed in the first quarter of 1998, and $4.3 million was
attributable to the acquisitions of ADVANTAGE Financial Services, Inc. ("AFS")
and Credit Acceptance Corp. ("CAC"), completed in the fourth quarter of 1997.
The addition of new clients and growth in business from existing clients
represented $24.4 million of the increase in revenue.
Payroll and related expenses. Payroll and related expenses increased $62.4
million to $119.3 million in 1998 from $56.9 million in 1997, and decreased as a
percentage of revenue to 51.9% from 52.7%. Payroll and related expenses
decreased as a percentage of revenue primarily as a result of JDR's increased
productivity and greater efficiencies achieved as a result of the acquisitions
completed by JDR and the absorption of management and administrative costs over
a larger revenue base. In addition, a portion of this decrease was the result of
lower payroll costs related to MedSource and by spreading the cost of management
and administrative personnel over a larger revenue base. The decrease was
partially offset by higher payroll costs related to FCA and the Market Strategy
Division.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $30.2 million to $66.6 million in 1998 from
$36.4 million in 1997. Selling, general and administrative expenses decreased as
a percentage of revenue to 28.9% from 33.7%. This decrease resulted from the
Company realizing operating efficiencies and by spreading selling, general and
administrative expenses over a larger revenue base. In addition, a portion of
this decrease can be attributed to the increase in the size of the Market
Strategy division since it has a lower selling, general and administrative cost
structure than the remainder of the Company.
Depreciation and amortization. Depreciation and amortization increased to
$9.9 million in 1998 from $4.6 million in 1997. Of this increase, $999,000 was
attributable to the recapitalization completed by JDR in May 1997, $335,000 was
attributable to the MSC acquisition, $849,000 was attributable to the MedSource
acquisition, $1.3 million was attributable to the FCA acquisition,
-28-
$653,000 was attributable to the acquisitions of AFECD and TRC, completed in the
first quarter of 1998, and $367,000 was attributable to the acquisitions of AFS
and CAC, completed in the fourth quarter of 1997. The remaining $797,000
consisted of depreciation resulting from capital expenditures incurred in the
ordinary course of business.
Other income (expense). Interest and investment income increased $110,000
to $1.1 million in 1998 from the comparable period in 1997. This increase was
primarily attributable to an increase in operating funds and funds held on
behalf of clients. Interest expense increased to $3.9 million for 1998 from $1.8
million in 1997. The increase was partially attributable to the Company
financing the May 1998 acquisition of FCA with $74.0 million of borrowings under
its revolving credit facility. In June 1998, the $74.0 million from the
revolving credit facility was repaid with a portion of the proceeds from the
Company's public offering completed in June 1998. In addition, the Company
financed $25.5 million of the MedSource acquisition with borrowings under the
revolving credit facility. The Company also financed the November 1998
acquisition of MSC with $107.5 million of borrowings under its revolving credit
facility.
Income tax expense. Income tax expense for 1998 increased to $13.1 million,
or 41.7% of income before taxes, from $4.8 million, or 51.1% of income before
taxes, for 1997. Income taxes were computed after giving effect to
non-deductible goodwill expenses resulting from certain acquired companies. The
decrease in the effective tax rate resulted from JDR having a loss in 1997 for
federal income tax purposes, for which no tax benefit was realized during 1997.
This decrease was partially offset by the full-year impact of the non-deductible
goodwill related to certain acquisitions completed during 1997 and the impact of
the non-deductible goodwill related to certain acquisitions completed during
1998.
Net income. Net income in 1998 increased to $18.3 million from $4.6 million
in 1997, a 299.6% increase.
Accretion of preferred stock to redemption value. The accretion of
preferred stock to redemption value relates to JDR's preferred stock that was
outstanding prior to its exchange for NCO common stock on March 31, 1999. This
non-cash accretion represents the periodic amortization of the difference
between the original carrying amount and the mandatory redemption amount.
Quarterly Results (Unaudited)
The following table sets forth selected historical financial data for the
calendar quarters of 1998 and 1999. This quarterly information is unaudited, but
has been prepared on a basis consistent with the Company's audited financial
statements presented elsewhere herein and, in management's opinion,
-29-
includes all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the information for the quarters presented.
The operating results for any quarter are not necessarily indicative of results
for any future period.
Quarters Ended
---------------------------------------------------------------------------------------------------------
1998 1999
------------------------------------------------- -----------------------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31 Mar. 31 June 30 Sept. 30 Dec. 31
---------- ---------- ---------- ---------- ---------- ---------- ----------- -----------
(Dollars in thousands)
Revenue $40,606 $ 51,935 $ 63,585 $ 73,826 $ 95,864 $ 110,704 $ 136,078 $ 149,708
Income from
operations 5,987 8,518 8,920 10,774 8,869 16,889 21,122 24,177
Net income 3,720 4,651 4,380 5,594 2,506 7,521 8,902 10,437
Net income per
share:
Basic $ 0.22 $ 0.26 $ 0.19 $ 0.26 $ 0.10 $ 0.35 $ 0.38 $ 0.41
Diluted $ 0.20 $ 0.24 $ 0.17 $ 0.24 $ 0.10 $ 0.34 $ 0.37 $ 0.40
As a percentage of
revenue:
Income from
operations 14.7% 16.4% 14.0% 14.6% 9.3% 15.3% 15.5% 16.1%
Net income 9.2% 8.9% 6.9% 7.6% 2.6% 6.8% 6.5% 7.0%
The Company has experienced and expects to continue to experience quarterly
variations in operating results as a result of many factors, including the costs
and timing of completion and integration of acquisitions, the timing of clients'
accounts receivable management programs, the commencement of new contracts, the
termination of existing contracts, the costs to support growth by acquisition or
otherwise, the integration of acquisitions, the effect of the change of business
mix on margins, and the timing of additional selling, general and administrative
expenses to support new business. Additionally, the Company's planned operating
expenditures are based on revenue forecasts, and, if revenues are below
expectations in any given quarter, operating results would likely be materially
adversely affected. While the effects of seasonality on the Company's business
historically have been obscured by its rapid growth, the Company's business
tends to be slower in the third and fourth quarters of the year due to the
summer and holiday seasons.
Liquidity and Capital Resources
Since 1996, the Company's primary sources of cash have been bank
borrowings, public offerings, and cash flows from operations. Cash has been used
for acquisitions, purchases of equipment, and working capital to support the
Company's growth.
In July 1997, the Company completed a public offering (the "1997
Offering"), selling 2,166,000 shares of common stock and received net proceeds
of approximately $40.4 million.
In June 1998, the Company completed a public offering (the "1998
Offering"), selling 4,000,000 shares of common stock and received net proceeds
of approximately $81.7 million.
In July 1998, the Company sold 469,000 shares of common stock in connection
with the underwriters' exercise of the over-allotment option granted in
connection with the 1998 Offering. The Company received net proceeds of
approximately $9.6 million.
-30-
Cash provided by operating activities was $43.5 million in 1999 and $23.4
million in 1998. The increase in cash provided by operations was primarily due
to the increase in net income to $29.4 million in 1999 from $18.3 million in
1998 and the increase in non-cash charges, primarily depreciation and
amortization, to $23.3 million in 1999 from $9.9 million in 1998. In addition, a
portion of the increase was the result of deferred taxes that were recorded as a
result of acquisition accounting. A portion of these increases was offset by the
$17.5 million increase in accounts receivable and the $5.3 million decrease in
accounts payable and accrued expenses.
Cash provided by operating activities was $23.4 million in 1998 and $5.4
million in 1997. The increase in cash provided by operations was primarily due
to the increase in net income to $18.3 million in 1998 compared to $4.6 million
in 1997 and the increase in non-cash charges, primarily depreciation and
amortization, to $9.9 million in 1998, compared to $4.6 million in 1997. In
addition, the increase was also attributable to a $3.1 million increase in
deferred taxes in 1998, compared to a $1.8 million increase in 1997. These
increases were partially offset by a $10.8 million increase in accounts
receivable in 1998, compared to a $4.6 million increase in 1997.
Cash used in investing activities was $164.9 million in 1999, compared to
$233.1 million for 1998. The decrease was due primarily to cash paid in 1998 to
acquire TRC, FCA, MedSource, and MSC. The Company financed these acquisitions
with the proceeds from the 1998 Offering and borrowings under the Company's
revolving credit agreement. This increase was partially offset by the Company
financing the May 1999 acquisition of Co-Source with borrowings under the
Company's revolving credit facility.
Cash used in investing activities was $233.1 million in 1998, compared to
$30.2 million in 1997. The increase was due primarily to the acquisitions of
FCA, MedSource, and MSC. The Company financed these acquisitions with the
proceeds from the 1998 Offering and borrowings under the Company's revolving
credit agreement.
In addition to equipment financed under operating leases, capital
expenditures were $29.6 million, $10.3 million, and $4.8 million in 1999, 1998,
and 1997, respectively.
Cash provided by financing activities was $150.0 million in 1999, compared
to $203.0 million in 1998. During 1999, the Company's primary source of cash
from financing activities was borrowings under the revolving credit facility
that were used to repay the existing debt under the JDR credit facility and to
finance the acquisition of Co-Source. Net proceeds of $91.3 million from the
1998 Offering and net borrowings of $135.6 million were the Company's primary
sources of cash from financing activities in 1998, which were used for the
acquisitions of FCA, MedSource and MSC.
Cash provided by financing activities was $203.0 million in 1998, compared
to $43.2 million in 1997. Net proceeds of $91.3 million from the 1998 Offering
and net borrowings of $135.6 million were the Company's primary sources of cash
from financing activities, which were used for acquisitions.
In May 1999, the Company's credit agreement with Mellon Bank, N.A., for
itself and as administrative agent for other participating lenders, was amended
to, among other things, increase the Company's credit facility to provide for
borrowings up to $350.0 million, structured as a $350.0 million revolving credit
facility. At the option of the Company, the borrowings bear interest at a rate
equal to either Mellon Bank's prime rate plus a margin ranging from 0.25% to
0.50% depending on the Company's consolidated funded debt to EBITDA ratio
(Mellon Bank's prime rate was 8.50% on December 31, 1999) or LIBOR plus a margin
ranging from 1.25% to 2.25% depending on the Company's consolidated funded debt
to EBITDA ratio (LIBOR was 5.83% on December 31, 1999). Borrowings are
collateralized by substantially all the assets of the Company. The balance under
the revolving credit facility will be due upon the expiration of the five-year
term. The credit agreement contains certain financial covenants such as
maintaining net worth and funded debt to EBITDA requirements and includes
restrictions on, among other things, acquisitions, capital expenditures, and
distributions to shareholders.
-31-
The Company believes that funds generated from operations, together with
existing cash and available borrowings under its credit agreement will be
sufficient to finance its current operations, planned capital expenditure
requirements, and internal growth at least through the next twelve months.
However, the Company could require additional debt or equity financing if it
were to make any other significant acquisitions for cash during that period.
Market Risk
The Company is exposed to various types of market risk in the normal course
of business, including the impact of interest rate changes, foreign currency
exchange rate fluctuations, and changes in corporate tax rates. The Company
employs risk management strategies that may include the use of derivatives such
as interest rate swap agreements, interest rate ceilings and floors, and foreign
currency forwards and options to manage these exposures. The Company does not
hold derivatives for trading purposes.
Goodwill
The Company's balance sheet includes amounts designated as "goodwill."
Goodwill represents the excess of purchase price over the fair market value of
the net assets of the acquired businesses, based on their respective fair values
at the date of acquisition. GAAP requires that this and all other intangible
assets be amortized over the period benefited. Management has determined that
period to range from 15 to 40 years based on the attributes of each acquisition.
As of December 31, 1999, the Company's balance sheet included goodwill that
represented approximately 75.5% of total assets and 165.1% of shareholders'
equity.
If management has incorrectly overstated the permissible length of the
amortization period for goodwill, earnings reported in periods immediately
following the acquisition would be overstated. In later years, NCO would be
burdened by a continuing charge against earnings without the associated benefit
to income valued by management in arriving at the consideration paid for the
business. Earnings in later years also could be significantly affected if
management determined then that the remaining balance of goodwill was impaired.
Management has concluded that the anticipated future cash flows associated
with intangible assets recognized in the acquisitions will continue
indefinitely, and there is no persuasive evidence that any material portion will
dissipate over a period shorter than the respective amortization period.
Year 2000 System Modifications
NCO completed a program to evaluate and address the impact of the year 2000
on its information technology systems in order to ensure that its network and
software would successfully manage and manipulate data involving the transition
of dates from the year 1999 to the year 2000 without functional or data
abnormality and without inaccurate results related to such data. This program
included steps to: (a) identify software that required date code remediation;
(b) establish timelines for availability of corrective software releases; (c)
implement the fix to a test environment and test the remediated product; (d)
integrate the updated software to NCO's production environment; (e) communicate
and work with clients to implement year 2000 compliant data exchange formats;
and (f) provide management with assurance of a seamless transition to the year
2000. As a result, the Company did not experience any significant disruptions of
its information technology systems as the dates were transitioned from the year
1999 to the year 2000.
-32-
NCO also completed a program to evaluate and address the impact of year
2000 on its non-information technology systems, which include the Company's
telecommunications systems, business machines, and building and premises
systems. This program included steps to: (a) review existing systems to identify
potential issues; (b) review these issues with major external suppliers; and (c)
develop a contingency plan. As a result, the Company did not experience any
significant disruptions of its non-information technology systems as the dates
were transitioned from year the 1999 to year the 2000.
During 1998 and 1999, the Company incurred total pre-tax expenses of
approximately $224,000 and $1.6 million, respectively, in connection with the
year 2000 compliance program. These amounts do not include expenses incurred by
companies prior to their acquisition by the Company. These costs are associated
with both internal and external staffing resources for the necessary planning,
coordination, remediation, testing, and other expenses to prepare its systems
for the year 2000. However, a portion of these expenses were not incremental,
but rather represented a redeployment of existing information technology
resources. The Company's software was provided by third-party vendors, and the
third-party vendors incorporated the necessary modifications as part of their
normal systems maintenance. The majority of the costs were incurred through the
modification and testing of electronic data interchange formats with the
Company's clients and the testing of modifications performed by its third-party
vendors. The cost of planning and initial remediation incurred to date has not
been significant. For the year 2000, the Company expects to incur total pre-tax
expenses of approximately $180,000. These costs are associated with both
internal and external staffing resources for the necessary testing to verify
that the Company's systems are properly transitioning dates from year 1999 to
year 2000.
The Company has not experienced, and does not expect to experience, any
material adverse impacts on its business or results of operations as a result of
the transition of dates from year the 1999 to the year 2000. No assurance can be
given, however, that unanticipated or undiscovered year 2000 compliance problems
will not have a material, adverse effect on the Company's business or results of
operations. In addition, if the Company's clients or significant suppliers and
contractors did not successfully achieve year 2000 compliance, the Company's
business and results of operations could be adversely affected, resulting from,
among other things, the Company's inability to properly exchange and/or receive
data with its clients.
Recent Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which was
subsequently amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133"
(collectively "SFAS No. 133"). SFAS No. 133 is effective for the fiscal years
beginning after June 15, 2000 and requires that an entity recognize all
derivative instruments as either assets or liabilities on its balance sheet at
their fair values. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction, and, if it is, the type
of hedge transaction. The Company will adopt SFAS No. 133 by the first quarter
of 2001. Due to the Company's limited use of derivative instruments, SFAS No.
133 is not expected to have a material impact on the consolidated results of
operations, financial condition, or cash flows of the Company.
-33-
Forward-Looking Statements
Certain statements included in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, as well as elsewhere in this
Annual Report on Form 10-K, other than historical facts, are forward-looking
statements (as such term is defined in the Securities Exchange Act of 1934, and
the regulations thereunder) which are intended to be covered by the safe harbors
created thereby. Forward-looking statements include, without limitation,
statements as to the Company's five-year growth strategy, statements as to the
Company's objective to focus on internal growth, strategic acquisitions and
alliances, and integration, the impact of acquisitions on the Company's
earnings, the Company's ability to realize operating efficiencies in the
integration of its acquisitions, trends in the Company's future operating
performance, expected increases in operating efficiencies, anticipated trends in
the accounts receivable management industry, year 2000 compliance, the effects
of legal or governmental proceedings, the effects of changes in accounting
pronouncements and statements as to the Company's or management's beliefs,
expectations and opinions. Forward-looking statements are subject to risks and
uncertainties and may be affected by various factors which may cause actual
results to differ materially from those in the forward-looking statements. In
addition to the factors discussed in this report, certain risks, uncertainties
and other factors, including, without limitation, risks associated with growth
and future acquisitions, the risk that the Company will not be able to realize
operating efficiencies in the integration of its acquisitions, fluctuations in
quarterly operating results, risks relating to the timing of contracts, risks
related to year 2000 compliance and the other risks detailed from time to time
in the Company's filings with the Securities and Exchange Commission, including
the Company's Registration Statement on Form S-3, filed on September 3, 1999,
can cause actual results and developments to be materially different from those
expressed or implied by such forward-looking statements. See Item 1. --
"Business -- Investment Considerations."
-34-
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.
-----------------------------------------------------------
Included in Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, of this Report on Form 10-K.
Item 8. Financial Statements and Supplementary Data.
--------------------------------------------
The financial statements, financial statement schedules and related
documents that are filed with this Report are listed in Item 14(a) of this
Report on Form 10-K and begin on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
---------------------------------------------------------------
Financial Disclosure.
---------------------
None.
-35-
PART III
Item 10. Directors and Executive Officers of the Registrant.
---------------------------------------------------
Incorporated by reference from the Company's Proxy Statement relating to
the 2000 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K, except information concerning certain executive
officers of the Company which is set forth in Section 4.1 of this Annual Report
on Form 10-K.
Item 11. Executive Compensation.
----------------------
Incorporated by reference from the Company's Proxy Statement relating to
the 2000 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
---------------------------------------------------------------
Incorporated by reference from the Company's Proxy Statement relating to
the 2000 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
Item 13. Certain Relationships and Related Transactions.
-----------------------------------------------
Incorporated by reference from the Company's Proxy Statement relating to
the 2000 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
-36-
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K.
------------------------------------------------------
(a). Documents filed as part of this report:
1. List of Consolidated Financial Statements. The following consolidated
financial statements and the accompanying notes of NCO Group, Inc., have been
included in this Report on Form 10-K beginning on page F-1:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1998 and 1999
Consolidated Statements of Income for each of the three years in the
period ended December 31, 1999
Consolidated Statements of Redeemable Preferred Stock and Shareholders'
Equity for each of the three years in the period ended December 31, 1999
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 1999
Notes to Consolidated Financial Statements
2. List of Financial Statement Schedules. The following financial statement
schedule of NCO Group, Inc., has been included in this Report on Form 10-K
beginning on page S-1:
II - Valuation and Qualifying Accounts
All other financial statement schedules are omitted because the required
information is not present or not present in amounts sufficient to require
submission of the schedule or because the information required is included in
the respective financial statements or notes thereto contained herein.
3. List of Exhibits filed in accordance with Item 601 of Regulation S-K.
The following exhibits are incorporated by reference in, or filed with, this
Report on Form 10-K. Management contracts and compensatory plans, contracts and
arrangements are indicated by "*":
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
2.1(4) Asset Acquisition Agreement by and among The Response Center Division of TeleSpectrum
Worldwide, Inc., and NCO dated January 16, 1998. NCO will furnish to the Securities
and Exchange Commission a copy of any omitted schedules upon request.
2.2(6) Agreement dated March 24, 1998 among the Company, FCA and Fairfax concerning the FCA
Tender Offer. NCO will furnish to the Securities and Exchange Commission a
copy of any omitted schedules upon request.
-37-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
2.3(8) Stock Purchase Agreement dated May 4, 1998 among the Company, MedSource, Whitney
Subordinated Debt fund, L.P., Whitney Equity Partners, L.P., C.B. Hellman, Jr., Mark
Gorman, John O'Hara and HealthCare Business Management, Ltd. NCO will furnish to the
Securities and Exchange Commission a copy of any omitted schedules upon request.
2.4(10) Amended and Restated Stock Purchase Agreement by and between NCO and Medaphis Services
Corporation dated as of October 15, 1998 as amended and restated on November
30, 1998. NCO will furnish to the Securities and Exchange Commission a copy of any omitted
schedules upon request.
2.5(11) Agreement and Plan of Reorganization, dated November 2, 1998, among JDR Holdings,
Inc., NCO Group, inc. and JDR Acquisition Inc. NCO will furnish to the Securities and
Exchange Commission a copy of any omitted schedules upon request.
2.6(11) Agreement and Plan of Merger, dated November 2, 1998, among JDR Holdings, Inc., NCO
Group, Inc. and JDR Acquisition Inc. NCO will furnish to the Securities and Exchange
Commission a copy of any omitted schedules upon request.
2.7(13) Stock Purchase Agreement dated April 17, 1999 among Co-Source Corporation, its shareholders and
optionholders, H.I.G.-DCI Investments, L.P. and NCO Group, Inc. NCO will furnish to the Securities and
Exchange Commission a copy of any omitted schedules upon request.
2.8(14) Agreement and Plan of Merger, dated May 12, 1999, by and among Compass International
Services Corporation, NCO Group, Inc. and Cardinal Acquisition Corporation. NCO will
furnish to the Securities and Exchange Commission a copy of any omitted schedules upon
request.
3.1(1) The Company's amended and restated Articles of Incorporation.
3.2(7) Amendment to Amended and Restated Articles of Incorporation.
3.3(1) The Company's amended and restated Bylaws.
4.1(1) Specimen of Common Stock Certificate.
4.2(13) Form of warrant to purchase NCO Group, Inc. common stock.
*10.1(1) Employment Agreement, dated September 1, 1996, between the Company and Bernard R.
Miller.
*10.2(15) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Bernard R. Miller.
*10.3(1) Employment Agreement, dated September 1, 1996, between the Company and Michael J.
Barrist.
-38-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
*10.4(15) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Michael J. Barrist.
*10.5(1) Employment Agreement, dated September 1, 1996, between the Company and Charles C.
Piola, Jr.
*10.6(15) Addendum, dated May 1, 1998, to the Employment Agreement, dated September 1, 1996,
between the Company and Charles C. Piola, Jr.
*10.7(1) Employment Agreement, dated September 1, 1996, between the Company and Joseph C.
McGowan.
*10.8(15) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Joseph C. McGowan.
*10.9(1) Employment Agreement, dated September 1, 1996, between the Company and Steven L.
Winokur.
*10.10(15) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Steven L. Winokur.
*10.11(1) Amended and Restated 1995 Stock Option Plan.
*10.12(9) 1996 Stock Option Plan, as amended.
*10.13(9) 1996 Non-Employee Director Stock Option Plan, as amended.
10.14(1) Distribution and Tax Indemnification Agreement
10.15(1) Irrevocable Proxy Agreement by and between Michael J. Barrist and Annette H. Barrist.
10.16(2) Non-negotiable Subordinated Convertible Promissory Note dated January 22, 1997, made
by the Company in the principal amount of $900,000, as partial payment of the purchase
price for the acquisition of Goodyear & Associates, Inc.
10.17(3) Non-Transferable Common Stock Purchase Warrant dated February 2, 1997 issued to CRW
Financial, Inc.
10.18(3) Registration Rights Agreement dated February 2, 1997 between NCO and CRW Financial,
Inc.
10.19(6) Lease dated March 18, 1997 between Indiana Avenue Associates, L.P. and the Company
related to the lease of Fort Washington corporate headquarters.
10.20 Fifth Amended and Restated Credit Agreement dated as of December 31, 1999 by and among NCO Group, Inc., as
Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any omitted schedules upon request.
10.21(7) Executive Salary Continuation Agreement.
-39-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
10.22(15) Transfer Agreement dated January 26, 1998 among NCO, CRW Financial, Inc. and Swiss
Bank Corporation.
*10.23(12) Compass International Services Corporation Employee Incentive Compensation Plan
*10.24(16) JDR 1997 Option Plan
*10.25 Employment Agreement, dated March 31, 1999, between the Company and David E. D'Anna.
*10.26 Employment Agreement, dated May 2, 1998, between the Company and Paul E. Weitzel, Jr.
*10.27 Addendum, dated January 1, 1999, to the Employment Agreement, dated May 2, 1998,
between the Company and Paul E. Weitzel, Jr.
*10.28 Employment Agreement, dated June 1, 1998, between the Company and Robert Di Sante.
*10.29 Employment Agreement, dated February 12, 1998, between the Company and Richard Raquet.
*10.30 Addendum, dated June 25, 1999, to the Employment Agreement, dated February 12, 1998,
between the Company and Richard Raquet.
21.1(11) Subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers LLP.
23.2 Consent of Arthur Andersen LLP.
27.1 Financial Data Schedules.
- ------------------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-11745), as amended, filed with the Securities
Exchange Commission on September 11, 1996.
(2) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on February 6,
1997.
(3) Incorporated by reference to the Company's Current Report on Form 8-K/A
(File No. 0-21639) filed with the Securities Exchange Commission on
February 18, 1997.
(4) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on February 25,
1998.
(5) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997 (File No. 0-21639), as amended,
filed with the Securities Exchange Commission on March 31, 1998.
-40-
(6) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on May 4, 1998.
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-K
for the quarter ended March 31, 1998 (File No. 0-21639), filed with the
Securities Exchange Commission on May 4, 1998.
(8) Incorporated by reference to the Company's Registration Statement on Form
S-3 (Registration No. 333-51787), as amended, filed with the Securities
Exchange Commission on May 8, 1998.
(9) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998 (File No. 0-21639), filed with the
Securities Exchange Commission on August 14, 1998.
(10) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on December 15,
1998.
(11) Incorporated by reference to the Company's Registration Statement on Form
S-4 (Registration No. 333-73087), as amended, filed with the Securities
Exchange Commission on February 26, 1998.
(12) Incorporated by reference to Compass International Service Corporation's
Registration Statement on Form S-1 (Registration No. 333-50021), as
amended, filed with the Securities Exchange Commission on April 13, 1998.
(13) Incorporated by reference to the Company's Current Report on Form 8-K/A
(File No. 0-21639) filed with the Securities Exchange Commission on August
4, 1999.
(14) Incorporated by reference to the Company's Proxy/Registration Statement on
Form-S-4 (Registration No. 333-83229) filed with the Securities Exchange
Commission on July 20, 1999.
(15) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1998 (File No. 0-21639), as amended,
filed with the Securities Exchange Commission on March 31, 1999.
(16) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on April 15,
1999.
(b). Reports on Form 8-K
None - not applicable
-41-
SIGNATURES
----------
Pursuant to the requirements of Section 13 or 15(d) of the Securities
and Exchange Act of 1934, the Registrant has duly caused this Report to be
signed on its behalf by the undersigned, thereunto duly authorized.
NCO GROUP, INC.
Date: March 24, 2000 By: /s/ Michael J. Barrist
-----------------------
Michael J. Barrist, Chairman of the
Board, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
registrant in the capacities and on the date indicated.
SIGNATURE TITLE(S) DATE
--------- -------- ------
/s/ Michael J. Barrist Chairman of the Board, President and Chief March 24, 2000
- ------------------------------- Executive Officer (principal executive
Michael J. Barrist officer)
/s/ Steven L. Winokur Executive Vice President, Finance; Chief March 24, 2000
- ----------------------------- Financial Officer; and Treasurer (principal
Steven L. Winokur financial and accounting officer)
/s/ David E. D'Anna Executive Vice President; Divisional Chief March 24, 2000
- ---------------------------- Executive Officer, Technology-Based
David E. D'Anna Outsourcing Services; and Director
/s/ Charles C. Piola, Jr. Director March 24, 2000
- -------------------------
Charles C. Piola, Jr.
/s/ Eric S. Siegel Director March 24, 2000
- ---------------------------------
Eric S. Siegel
/s/ Allen F. Wise Director March 24, 2000
- -----------------------------
Allen F. Wise
/s/ Stuart Wolf Director March 24, 2000
- -------------------------------
Stuart Wolf
-42-
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Financial Statements:
Report of Independent Accountants...............................................................................F-2
Consolidated Balance Sheets as of December 31, 1998 and 1999 ...................................................F-4
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1999......................................................................F-5
Consolidated Statements of Redeemable Preferred Stock and Shareholders' Equity for each of the three years
in the period ended December 31, 1999......................................................................F-6
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1999......................................................................F-7
Notes to Consolidated Financial Statements......................................................................F-8
Financial Statement Schedules:
For the years ended December 31, 1997, 1998 and 1999:
II - Valuation and Qualifying Accounts......................................................................S-1
F-1
Report of Independent Accountants
To the Board of Directors and
Shareholders of NCO Group, Inc.:
In our opinion, based on our audits and the report of other auditors, the
consolidated financial statements listed in the index appearing under Item
14(a)(1) present fairly, in all material respects, the financial position of NCO
Group, Inc. and its subsidiaries at December 31, 1998 and 1999, and the results
of their operations and their cash flows for each of the three years in the
period ended December 31, 1999 in conformity with accounting principles
generally accepted in the United States. In addition, in our opinion, the
financial statement schedule listed in the index appearing under Item 14(a)(2)
presents fairly, in all material respects, the information set forth therein
when read in conjunction with the related consolidated financial statements.
These financial statements and the financial statement schedule are the
responsibility of the Company's management; our responsibility is to express an
opinion on these financial statements and financial statement schedule based on
our audits. The consolidated financial statements and the financial statement
schedule give retroactive effect to the merger of JDR Holdings, Inc. on March
31, 1999 in a transaction accounted for as a pooling of interests, as described
in Note 3 to the consolidated financial statements. We did not audit the
financial statements of JDR Holdings, Inc., which statements reflect total
assets of $35,145,119 as of December 31, 1998 and total revenues of $22,788,523
and $50,976,251 for the period from May 29, 1997 to December 31, 1997 and for
the year ended December 31, 1998, respectively. Those statements were audited by
other auditors whose report thereon has been furnished to us, and our opinion
expressed herein, insofar as it relates to the amounts included for JDR
Holdings, Inc., is based solely on the report of the other auditors. We
conducted our audits of these statements in accordance with auditing standards
generally accepted in the United States, which require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements
are free of material misstatement. An audit includes examining, on a test basis,
evidence supporting the amounts and disclosures in the financial statements,
assessing the accounting principles used and significant estimates made by
management, and evaluating the overall financial statement presentation. We
believe that our audits and the report of other auditors provide a reasonable
basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
- -------------------------------
PricewaterhouseCoopers LLP
Philadelphia, PA
February 16, 2000
F-2
REPORT OF INDEPENDENT PUBLIC ACCOUNTANTS
To JDR Holdings, Inc.:
We have audited the accompanying consolidated balance sheets of JDR Holdings,
Inc. (a Delaware corporation) and subsidiaries as of December 31, 1997 and 1998,
and the related consolidated statements of operations, redeemable preferred and
common stock and stockholders' equity (deficit), and cash flows for the period
from May 29, 1997 to December 31, 1997 and for the year ended December 31, 1998.
These financial statements are the responsibility of the Company's management.
Our responsibility is to express an opinion on these financial statements based
on our audits.
We conducted our audits in accordance with generally accepted auditing
standards. Those standards require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audits provide a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of JDR Holdings, Inc. and
subsidiaries as of December 31, 1997 and 1998, and the results of their
operations and their cash flows for the period from May 29, 1997 to December 31,
1997 and for the year ended December 31, 1998 in conformity with generally
accepted accounting principles.
/s/ Arthur Andersen LLP
-----------------------
Philadelphia, Pa.,
January 29, 1999
F-3
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Amounts in thousands)
December 31,
-----------------------------
ASSETS 1998 1999
--------- ---------
Current assets:
Cash and cash equivalents $ 23,560 $ 52,380
Accounts receivable, trade, net of allowance for
doubtful accounts of $3,998 and $6,425, respectively 54,443 82,207
Purchased accounts receivable 1,597 6,719
Deferred taxes 1,348 2,965
Other current assets 2,930 5,890
--------- ---------
Total current assets 83,878 150,161
Funds held on behalf of clients
Property and equipment, net 27,062 56,823
Other assets:
Intangibles, net of accumulated amortization 297,347 584,702
Other assets 6,522 6,254
--------- ---------
Total other assets 303,869 590,956
--------- ---------
Total assets $ 414,809 $ 797,940
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 8,288 $ 1,672
Corporate taxes payable 7,737 11,490
Accounts payable 8,485 9,284
Accrued expenses 13,346 34,447
Accrued compensation and related expenses 10,507 15,643
--------- ---------
Total current liabilities 48,363 72,536
Funds held on behalf of clients
Long-term liabilities:
Long-term debt, net of current portion 143,910 323,949
Deferred taxes 6,832 25,747
Other long-term liabilities 4,357 10,820
Redeemable preferred stock 11,882 -
Commitments and contingencies
Shareholders' equity:
Preferred stock 1,853 -
Common stock, no par value, 37,500 shares authorized,
20,100 and 25,533 shares issued, respectively, and
19,744 and 25,533 shares outstanding, respectively 177,835 313,558
Unexercised warrants 5,450 1,043
Treasury stock, at cost (4,108) -
Foreign currency translation adjustment (2,169) 694
Retained earnings 20,604 49,593
--------- ---------
Total shareholders' equity 199,465 364,888
--------- ---------
Total liabilities and shareholders' equity $ 414,809 $ 797,940
========= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-4
NCO GROUP, INC.
Consolidated Statements of Income
(Amounts in thousands, except per share data)
For the Years Ended December 31,
-------------------------------------------------
1997 1998 1999
--------- --------- ---------
Revenue $ 108,073 $ 229,952 $ 492,354
Operating costs and expenses:
Payroll and related expenses 56,949 119,314 257,877
Selling, general and administrative
expenses 36,372 66,588 135,508
Depreciation and amortization expense 4,564 9,851 23,311
Non-recurring acquisition costs - - 4,601
--------- --------- ---------
Total operating costs and expenses 97,885 195,753 421,297
--------- --------- ---------
Income from operations 10,188 34,199 71,057
Other income (expense):
Interest and investment income 1,025 1,135 1,365
Interest expense (1,781) (3,858) (19,362)
Other income (expense) (41) - -
--------- --------- ---------
Total other income (expense) (797) (2,723) (17,997)
--------- --------- ---------
Income before provision for income taxes 9,391 31,476 53,060
Income tax expense 4,800 13,131 23,694
--------- --------- ---------
Net income 4,591 18,345 29,366
Accretion of preferred stock to redemption value (1,617) (1,604) (377)
--------- --------- ---------
Net income applicable to common shareholders $ 2,974 $ 16,741 $ 28,989
========= ========== ==========
Net income per share:
Basic $ 0.22 $ 0.91 $ 1.27
Diluted $ 0.20 $ 0.85 $ 1.22
Weighted average shares outstanding:
Basic 13,736 18,324 22,873
Diluted 14,808 19,758 23,799
The accompanying notes are an integral part of these consolidated
financial statements.
F-5
NCO GROUP, INC.
Consolidated Statements of Redeemable Preferred Stock
and Shareholders' Equity
For the Years Ended December 31, 1997, 1998 and 1999
(Amounts in thousands)
Shareholders' Equity
-------------------------------------------------
Redeemable Preferred Stock Preferred Stock Common Stock
-------------------------- --------------------- ----------------------
Number of Number of Number of
Shares Amount Shares Amount Shares Amount
------ ------ ------ ------ ------ ------
Balance, January 1, 1997 - $ - - $ - 10,070 $ 29,363
Capital contribution 13 157 - - 590 (3,137)
Issuance of common stock - - - - 3,146 50,886
Issuance of series C preferred, voting common
and nonvoting common in connection with
acquisitions - - 146 1,686 1,455 16,799
Reclass of carryover basis adjustment - - - - - (11,065)
Conversion of loan into and sale of
preferred stock 434 8,934 - - - -
Issuance of warrants in conjunction with
the issuances of common stock and debt - (4,126) - - - -
Issuance of warrants in conjunction with
acquisitions - - - - - -
Exercise of nonvoting common options - - - - 36 418
Redemption of nonvoting common - - - - (36) -
Redemption of nonvoting common and
issuance of nonvoting common in private
placement - - - - 16 -
Accretion of preferred to redemption value 4 1,557 3 60 - -
Net income - - - - - -
--------- -------- --------- ------- --------- ---------
Balance, December 31, 1997 451 6,522 149 1,746 15,277 83,264
Issuance of common stock - - - - 4,802 93,884
Exercise of voting and nonvoting
common conversion options 334 3,863 - - (334) -
Accretion of preferred to redemption value - 1,497 - 107 - -
Common stock options granted to consultant - - - - - 687
Redemption of nonvoting common - - - - (1) -
Comprehensive income:
Net income - - - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - - - -
Total comprehensive income
--------- -------- --------- ------- --------- ---------
Balance, December 31, 1998 785 11,882 149 1,853 19,744 177,835
Issuance of common stock - - - - 4,747 125,719
Issuance of warrants in conjunction with
acquisitions - - - - - -
Accretion of preferred to redemption value 93 349 15 28 - -
Exchange of redeemable preferred stock
for common stock (878) (12,231) - - 878 12,231
Exchange of convertible preferred stock
for common stock - - (164) (1,881) 164 1,881
Retirement of treasury stock - - - - - (4,108)
Comprehensive income:
Net income - - - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - - - -
Total comprehensive income
--------- -------- --------- ------- --------- ---------
Balance, December 31, 1999 - $ - - $ - 25,533 $ 313,558
========= ======== ========= ======= ========= =========
(RESTUBBED TABLE)
Shareholders' Equity
---------------------------------------------------------------
Treasury Stock
Carryover ------------------------
Unexercised Basis Number of
Warrants Adjustment Shares Amount
-------- ---------- ------ ------
Balance, January 1, 1997 $ 396 $ - - $ -
Capital contribution - - - -
Issuance of common stock (149) - - -
Issuance of series C preferred, voting common
and nonvoting common in connection with
acquisitions - (11,065) - -
Reclass of carryover basis adjustment - 11,065 - -
Conversion of loan into and sale of
preferred stock - - - -
Issuance of warrants in conjunction with
the issuances of common stock and debt 4,575 - - -
Issuance of warrants in conjunction with
acquisitions 875 - - -
Exercise of nonvoting common options - - - -
Redemption of nonvoting common - - 36 (418)
Redemption of nonvoting common and
issuance of nonvoting common in private
placement - - (16) 184
Accretion of preferred to redemption value - - - -
Net income - - - -
------- -------- --------- -------
Balance, December 31, 1997 5,697 - 20 (234)
Issuance of common stock (247) - - -
Exercise of voting and nonvoting
common conversion options - - 335 (3,863)
Accretion of preferred to redemption value - - - -
Common stock options granted to consultant - - - -
Redemption of nonvoting common - - 1 (11)
Comprehensive income:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
------- -------- --------- -------
Balance, December 31, 1998 5,450 - 356 (4,108)
Issuance of common stock (6,332) - - -
Issuance of warrants in conjunction with
acquisitions 1,925 - - -
Accretion of preferred to redemption value - - - -
Exchange of redeemable preferred stock
for common stock - - - -
Exchange of convertible preferred stock
for common stock - - - -
Retirement of treasury stock - - (356) 4,108
Comprehensive income:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
------- -------- --------- -------
Balance, December 31, 1999 $ 1,043 $ - - $ -
======= ======== ========= =======
(RESTUBBED TABLE)
Shareholders' Equity
--------------------------------------------------------------
Accumulated
Other
Comprehensive Retained Comprehensive
Income Earnings Income Total
------ -------- ------ -----
Balance, January 1, 1997 $ - $ 889 $ 30,648
Capital contribution - - (3,137)
Issuance of common stock - - 50,737
Issuance of series C preferred, voting common
and nonvoting common in connection with
acquisitions - - 7,420
Reclass of carryover basis adjustment - - -
Conversion of loan into and sale of
preferred stock - - -
Issuance of warrants in conjunction with
the issuances of common stock and debt - - 4,575
Issuance of warrants in conjunction with
acquisitions - - 875
Exercise of nonvoting common options - - 418
Redemption of nonvoting common - - (418)
Redemption of nonvoting common and
issuance of nonvoting common in private
placement - - 184
Accretion of preferred to redemption value - (1,617) (1,557)
Net income - 4,591 4,591
------- ------- ---------
Balance, December 31, 1997 - 3,863 94,336
Issuance of common stock - - 93,637
Exercise of voting and nonvoting
common conversion options - - (3,863)
Accretion of preferred to redemption value - (1,604) (1,497)
Common stock options granted to consultant - - 687
Redemption of nonvoting common - - (11)
Comprehensive income:
Net income - 18,345 $ 18,345 18,345
Other comprehensive income:
Foreign currency translation adjustment (2,169) - (2,169) (2,169)
---------
Total comprehensive income $ 16,176
------- ------- ========= ---------
Balance, December 31, 1998 (2,169) 20,604 199,465
Issuance of common stock - - 119,387
Issuance of warrants in conjunction with
acquisitions - - 1,925
Accretion of preferred to redemption value - (377) (349)
Exchange of redeemable preferred stock
for common stock - - 12,231
Exchange of convertible preferred stock
for common stock - - -
Retirement of treasury stock - - -
Comprehensive income:
Net income - 29,366 $ 29,366 29,366
Other comprehensive income:
Foreign currency translation adjustment 2,863 - 2,863 2,863
---------
Total comprehensive income $ 32,229
------- ------- ========= ---------
Balance, December 31, 1999 $ 694 $49,593 $ 364,888
======= ======= =========
The accompanying notes are an integral part of these consolidated
financial statements.
F-6
NCO GROUP, INC
Consolidated Statements of Cash Flows
(Amounts in thousands)
For the Years Ended December 31,
------------------------------------------------
1997 1998 1999
-------- -------- --------
Cash flows from operating activities:
Net income $ 4,591 $ 18,345 $ 29,366
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 2,140 3,945 8,808
Amortization of intangibles 2,424 5,906 14,503
Write-off of defered financing costs - - 353
Loss on disposal of fixed assets 41 - -
Provision for doubtful accounts 356 1,187 2,629
Compensation expense on stock options granted 418 686 34
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (4,565) (10,767) (17,536)
Purchased accounts receivable - 115 (5,122)
Deferred taxes 1,781 3,090 16,980
Other assets (1,728) (698) (1,279)
Accounts payable and accrued expenses (140) 1,483 (5,348)
Corporate taxes payable 68 59 (1,644)
Other long-term liabilities - - 1,711
-------- -------- --------
Net cash provided by operating activities 5,386 23,351 43,455
Cash flows from investing activities:
Purchase of property and equipment (4,849) (10,292) (29,631)
Net cash paid for acquisitions (25,399) (222,843) (135,237)
-------- -------- --------
Net cash used in investing activities (30,248) (233,135) (164,868)
Cash flows from financing activities:
Repayment of notes payable (7,012) (1,256) (1,574)
Repayment of acquired notes payable - (21,919) (42,000)
Borrowings under revolving credit agreement 32,686 94,789 190,715
Repayment of borrowings under revolving credit agreement (18,165) (84,193) (4,000)
Borrowings under term loan - 125,000 -
Payment of fees to acquire new debt (401) (3,015) (3,565)
Issuance of common stock, net 40,428 93,637 10,079
Proceeds from issuance of preferred and common stock
and exercise of common stock options 1,068 - -
Redemption of common stock (5,931) (11) -
Payment of dividends (188) - -
Capital contributions 697 - -
-------- -------- --------
Net cash provided by financing activities 43,182 203,032 149,655
Effect of exchange rate on cash - (67) 578
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 18,320 (6,819) 28,820
Cash and cash equivalents at beginning of period 12,059 30,379 23,560
-------- -------- --------
Cash and cash equivalents at end of period $ 30,379 $ 23,560 $ 52,380
======== ======== ========
The accompanying notes are an integral part of these consolidated
financial statements.
F-7
NCO GROUP, INC.
Notes to Consolidated Financial Statements
1. Nature of operations:
NCO Group, Inc. (the "Company") is a leading provider of accounts receivable
management and other outsourced revenue cycle management services. The Company's
client base is comprised of companies located throughout North America and in
the United Kingdom and Puerto Rico in the financial services, healthcare,
retail, commercial, education, utilities, government, and telecommunications
sectors.
2. Summary of significant accounting policies:
Principles of Consolidation:
The consolidated financial statements include the accounts of NCO Group, Inc.
and its wholly-owned subsidiaries after elimination of significant intercompany
accounts and transactions.
Revenue Recognition:
The Company generates revenues from contingent fees and contractual services.
Contingent fee revenue is recognized upon collection of funds on behalf of
clients. Contractual services revenue is recognized as services are performed.
Credit Policy:
The Company has two types of arrangements under which it collects its contingent
fee revenue. For certain clients, the Company remits funds collected on behalf
of the client net of the related contingent fees while, for other clients, the
Company remits gross funds collected on behalf of clients and bills the client
separately for its contingent fees. Management carefully monitors its client
relationships in order to minimize its credit risk and generally does not
require collateral. In many cases, in the event of collection delays from
clients, management may, at its discretion, change from the gross remittance
method to the net remittance method.
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with an initial
maturity of three months or less to be cash equivalents. These financial
instruments potentially subject the Company to concentrations of credit risk.
Property and Equipment:
Property and equipment is stated at cost, less accumulated depreciation.
Depreciation is provided over the estimated useful life of each class of assets
using the straight-line method. Expenditures for maintenance and repairs are
charged to expense as incurred. Renewals and betterments are capitalized. When
property is sold or retired, the cost and related accumulated depreciation are
removed from the balance sheet and any gain or loss on the transaction is
included in the statement of income.
Effective January 1, 1999, the Company adopted Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 identified the characteristics of internal
use software and established guidelines for identifying which costs must be
expensed as incurred and which costs must be capitalized.
F-8
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies (continued):
Property and Equipment (continued:
The Company reviews long-lived assets and certain identifiable intangibles for
impairment, based on the estimated future cash flows, whenever events or changes
in circumstances indicate that the carrying amount of the asset may not be
recoverable.
Intangibles:
Intangibles consists primarily of goodwill and deferred financing costs.
Goodwill represents the excess of purchase price over the fair market value of
the net assets of the acquired businesses based on their respective fair values
at the date of acquisition. Goodwill is amortized on a straight-line basis over
15 to 40 years. For certain acquisitions, such allocations have been based on
estimates that may be revised at a later date. The Company reviews the
recoverability of its goodwill whenever events or changes in circumstances
indicate that the carrying amount of the goodwill may not be recoverable. In
making such a determination with respect to goodwill, the Company evaluates the
operating results of the underlying business that gave rise to such amount.
Deferred financing costs relate to debt issuance costs incurred, which are
capitalized and amortized over the term of the debt.
Accumulated amortization at December 31, 1998 and 1999 totaled $9.1 million and
$24.1 million, respectively.
Income Taxes:
The Company accounts for income taxes using an asset and liability approach. The
asset and liability approach requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary differences
between the financial reporting basis and the tax basis of assets and
liabilities.
Income taxes were computed after giving effect to the non-deductible portion of
goodwill expenses attributable to certain acquisitions and non-recurring
acquisition costs attributable to the acquisition of JDR Holdings, Inc. ("JDR")
on March 31, 1999.
Foreign Currency Translation:
The Company has foreign subsidiaries whose local currency has been determined to
be the functional currency. For these foreign subsidiaries, the assets and
liabilities have been translated using the current exchange rates, and the
income and expenses have been translated using historical exchange rates. The
adjustments resulting from translation have been recorded as a separate
component of shareholders' equity and are not included in determining
consolidated net income.
Estimates Utilized in the Preparation of Financial Statements:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Comprehensive Income:
Comprehensive income consists of net income from operations plus certain changes
in assets and liabilities that are not included in net income but are reported
as a separate component of shareholders' equity under generally accepted
accounting principles.
F-9
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies (continued):
Reclassifications:
Certain amounts for December 31, 1997 and 1998, and for the years then ended
have been reclassified for comparative purposes.
3. Acquisitions:
Pooling-of-Interests Transaction:
On March 31, 1999, the Company acquired all of the outstanding shares of JDR
Holdings, Inc. ("JDR") for approximately 3.4 million shares of NCO common stock.
The transaction was accounted for as a pooling-of-interests and a tax-free
reorganization. Accordingly, the historical financial information of the Company
has been restated to include the historical information of JDR. The following
reconciles the amounts originally reported for revenue, net income applicable to
common shareholders, and diluted net income per common share for the years ended
December 31, 1997 and 1998 to the restated amounts and discloses the amount of
revenue and net income applicable to common shareholders separately for each
company for the period prior to the acquisition for the year ended December 31,
1999 (amounts in thousands, except per share data):
1997 1998 1999
--------- --------- ---------
Revenue:
NCO (as originally reported for 1997
and 1998) $ 85,284 $ 178,976 $ 477,877
JDR (for the period prior to the
acquisition for 1999) (1) 22,789 50,976 14,477
--------- --------- ---------
Combined $ 108,073 $ 229,952 $ 492,354
========= ========= =========
Net income applicable to common shareholders:
NCO (as originally reported for 1997
and 1998) $ 7,074 $ 14,716 $ 32,105
JDR (for the period prior to the
acquisition for 1999) (1) (4,100) 2,025 578
Non-recurring acquisition costs, net
of taxes - - (3,694)
--------- --------- ---------
Combined $ 2,974 $ 16,741 $ 28,989
========= ========= =========
Diluted net income per share:
NCO (as originally reported) $ 0.57 $ 0.89
JDR (1) (0.37) (0.04)
--------- ---------
Combined $ 0.20 $ 0.85
========= =========
(1) On May 29, 1997, JDR completed a recapitalization, which
established a new basis of accounting (see Note 9). As a result, the
results of JDR for the year ended December 31, 1997 represent the
period from May 29, 1997 to December 31, 1997.
For the year ended December 31, 1999, the Company incurred $4.6 million of
non-recurring acquisition costs in connection with the JDR acquisition. These
costs consisted primarily of investment banking fees, legal and accounting fees,
and printing costs.
F-10
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
Purchase Transactions:
All of the following acquisitions have been accounted for under the purchase
method of accounting. As part of the purchase accounting, the Company recorded
accruals for acquisition related expenses. These accruals included professional
fees related to the acquisition, termination costs related to certain redundant
personnel immediately eliminated at the time of the acquisitions, and certain
future rental obligations attributable to facilities which were closed at the
time of the acquisitions.
On January 1, 1998, the Company purchased the net assets of the Collections
Division of American Financial Enterprises, Inc. for $1.7 million in cash. The
Company recognized goodwill of $2.2 million and is amortizing the goodwill on a
straight-line basis over 25 years.
On February 6, 1998, the Company purchased the net assets of The Response
Center, which was an operating division of TeleSpectrum Worldwide, Inc., for
$15.0 million in cash. The Company recognized goodwill of $14.3 million and is
amortizing the goodwill on a straight-line basis over 25 years.
On May 5, 1998, the Company purchased all of the outstanding common shares of
FCA International Ltd. ("FCA") for $69.9 million in cash. The Company recognized
goodwill of $93.2 million and is amortizing the goodwill on a straight-line
basis over 40 years. Included in this goodwill is an accrual of $15.2 million
for acquisition related expenses. As of December 31, 1999, there was $3.6
million remaining from this accrual for acquisition related expenses.
On July 1, 1998, the Company purchased all of the outstanding stock of
MedSource, Inc. for $18.4 million in cash. In connection with the acquisition,
the Company repaid debt of $17.3 million. The Company recognized goodwill of
$37.2 million and is amortizing the goodwill on a straight-line basis over 25
years. Included in this goodwill is an accrual of $5.8 million for acquisition
related expenses. As of December 31, 1999, there was $551,000 remaining from
this accrual for acquisition related expenses.
On November 30, 1998, the Company acquired all of the outstanding stock of
Medaphis Services Corporation ("MSC"), a wholly owned subsidiary of Medaphis
Corporation, for $107.5 million in cash, plus an earn-out of up to $10.0 million
based on MSC achieving certain operational targets during 1999. The Company
recognized goodwill of $115.7 million and is amortizing the goodwill on a
straight-line basis over 40 years. Included in this goodwill is an accrual of
$3.3 million for acquisition related expenses. As of December 31, 1999, there
was $2.5 million remaining from this accrual for acquisition related expenses.
F-11
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
Purchase Transactions (continued):
On May 21, 1999, the Company acquired all of the outstanding stock of Co-Source
Corporation ("Co-Source") for approximately $122.7 million in cash plus a
warrant to purchase 250,000 shares of NCO common stock. The purchase price was
valued at approximately $124.6 million. The Company recognized goodwill of
$128.6 million and is amortizing the goodwill on a straight-line basis over 40
years. Included in this goodwill is an accrual of $2.2 million for acquisition
related expenses. As of December 31, 1999, there was $800,000 remaining from
this accrual for acquisition related expenses. The allocation of the fair market
value to the acquired assets and liabilities of Co-Source was based on
preliminary estimates and may be subject to change.
On August 20, 1999, the Company acquired all of the outstanding shares of
Compass International Services Corporation ("Compass") for approximately 3.3
million shares of NCO common stock. In connection with the acquisition, the
Company assumed outstanding stock options to purchase approximately 200,000
shares of NCO common stock. The purchase price was valued at approximately
$104.1 million. The Company recognized goodwill of $139.1 million and is
amortizing the goodwill on a straight-line basis over 40 years. Included in this
goodwill is an accrual of $12.5 million for acquisition related expenses. As of
December 31, 1999, there was $3.6 million remaining from this accrual for
acquisition related expenses. The allocation of the fair market value to the
acquired assets and liabilities of Compass was based on preliminary estimates
and may be subject to change.
The following summarizes the unaudited pro forma results of operations for the
years ended December 31, 1998 and 1999, assuming the above acquisitions had
occurred as of the beginning of the respective periods. The pro forma
information is provided for informational purposes only. It is based on
historical information and does not necessarily reflect the actual results that
would have occurred, nor is it indicative of future results of operations of the
consolidated entities:
1998 1999
--------- ---------
(Unaudited)
Revenue $ 519,874 $ 581,987
Net income $ 13,253 $ 27,387
Earnings per share - basic $ 0.48 $ 1.10
Earnings per share - diluted $ 0.45 $ 1.06
4. Funds held on behalf of clients:
In the course of the Company's regular business activities as an accounts
receivable management company, the Company receives clients' funds arising from
the collection of accounts placed with the Company. These funds are placed in
segregated cash accounts and are generally remitted to clients within 30 days.
Funds held on behalf of clients of $32.2 million and $47.7 million at December
31, 1998 and 1999, respectively, have been shown net of their offsetting
liability for financial statement presentation.
F-12
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
5. Property and equipment:
At December 31, 1998 and 1999, property and equipment, at cost, consisted of the
following:
Estimated
Useful Life 1998 1999
-------------- ------------ ------------
Computer equipment 5 years $ 23,794,000 $ 47,423,000
Furniture and fixtures 5 to 10 years 6,250,000 9,325,000
Computer software developed
for internal use 5 years - 8,750,000
Leasehold improvements 5 to 12 years 1,908,000 4,471,000
Leased assets 2 to 5 years 1,983,000 2,465,000
------------ ------------
33,935,000 72,434,000
Less accumulated depreciation 6,873,000 15,611,000
------------ ------------
$ 27,062,000 $ 56,823,000
============ ============
Depreciation charged to operations amounted to $2.1 million, $3.9 million and
$8.8 million for the years ended 1997, 1998, and 1999, respectively.
6. Long-term debt:
1998 1999
------------- -------------
Revolving credit loan $ 11,035,000 $ 322,750,000
Term loan; 7.37%, payable in quarterly
installments, ranging from $3.0 to $5.3 million,
through November 2003 when the remaining
balance becomes payable 125,000,000 -
JDR revolving credit agreement 12,500,000 -
Subordinated seller notes payable; interest rates
ranging from 7.16% to 8.00%, $750,000 due May
2000 through August 2000 and $130,000 due May
2001
- 880,000
Subordinated seller note payable; 8.00%, due
February 2002, converted to common stock at
$14.12 per share on February 15, 1999 900,000 -
Subordinated seller notes payable; 8.00%, due
January 1999 500,000 -
Other 36,000 -
Capital leases 2,227,000 1,991,000
Less current portion (8,288,000) (1,672,000)
------------- -------------
$ 143,910,000 $ 323,949,000
============= =============
F-13
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
6. Long-term debt (continued):
The following summarizes the Company's required debt payments for the next
five years:
2000 $ 1,672,000
2001 680,000
2002 261,000
2003 97,000
2004 322,911,000
In May 1999, the Company's credit agreement with Mellon Bank, N.A. ("Mellon
Bank"), for itself and as administrative agent for other participating lenders,
was amended to, among other things, increase the Company's credit facility to
provide for borrowings up to $350.0 million, structured as a $350.0 million
revolving credit facility. Prior to this amendment, the credit facility was
structured as a $125.0 million term loan and a $75.0 million revolving credit
facility. At the option of NCO, the borrowings bear interest at a rate equal to
either Mellon Bank's prime rate plus a margin ranging from 0.25% to 0.50% that
is determined quarterly based upon the Company's consolidated funded debt to
EBITDA ratio (Mellon Bank's prime rate was 8.50% at December 31, 1999), or LIBOR
plus a margin ranging from 1.25% to 2.25% depending on the Company's
consolidated funded debt to EBITDA ratio (LIBOR was 5.83% at December 31, 1999).
Borrowings are collateralized by substantially all the assets of the Company.
The balance under the revolving credit facility will be due upon the expiration
of the five-year term. The credit agreement contains certain financial covenants
such as maintaining net worth and funded debt to EBITDA requirements and
includes restrictions on, among other things, acquisitions, capital
expenditures, and distributions to shareholders.
Mellon Bank received warrants to purchase an aggregate of 361,000 shares of the
Company's common stock for establishing the credit facility initially in 1995
and for subsequent amendments to increase the Company's borrowing capacity under
the credit facility. In July 1997, the bank exercised and sold 225,000 warrants
for common stock. The remainder of the warrants were exercised in January 1998.
As of December 31, 1998, JDR had $12.5 million of borrowings outstanding against
its revolving credit facility (the "JDR Credit Facility"). On March 31, 1999,
the Company repaid the outstanding balance on the JDR Credit Facility with
borrowings from its revolving credit agreement with Mellon Bank and cancelled
the JDR Credit Facility. Deferred financing costs of $353,000 were written-off
on March 31, 1999 as a result of the cancellation of the JDR Credit Facility.
Under the terms of the JDR Credit Facility, JDR could borrow up to $20.0
million. Advances under the JDR Credit Facility bore interest at optional
borrowing rates of either the then current prime rate plus a margin that ranged
from 0.50% to 1.50 % or LIBOR, plus a margin that ranged from 2.00% to 3.00%,
depending on certain conditions specified in the JDR Credit Facility agreement.
JDR also paid a commitment fee of 0.375% on the unused borrowing capacity.
Borrowings under the JDR Credit Facility were collateralized by substantially
all of the assets of JDR.
On May 29, 1997, JDR entered into a credit agreement (the "JDR Bridge Loan")
whereby JDR borrowed $11.0 million to redeem common stock owned by two
stockholders and repay all outstanding indebtedness of JDR. Borrowings under the
JDR Bridge Loan bore interest at 10%. On May 30, 1997, $8.3 million of
borrowings under the JDR Bridge Loan were converted into redeemable preferred
stock (see Notes 9 and 10) and $2.7 million was repaid with borrowings under the
JDR Credit Facility. In connection with the JDR Bridge Loan, JDR recorded debt
issuance costs of $185,000, which were fully amortized upon conversion and
repayment of the JDR Bridge Loan.
In connection with the JDR Credit Facility, the lender purchased 18,000 shares
of JDR Redeemable Series A and 11,000 shares of JDR Series B Preferred for
$603,000 (see Notes 9 and 10).
At December 31, 1999, the Company had unused letters of credit of $1.7 million.
F-14
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
6. Long-term debt (continued):
On February 15, 1999, the $900,000 convertible note issued in connection with
the 1997 acquisition of Goodyear & Associates, Inc. ("Goodyear") was converted
into 64,000 shares of NCO common stock.
The Company leases certain equipment under agreements which are classified as
capital leases. The equipment leases have original terms ranging from 24 to 120
months and have purchase options at the end of the original lease term.
7. Operating leases:
The Company leases certain equipment and real estate facilities under
non-cancelable operating leases. Future minimum payments, by year and in the
aggregate, under non-cancelable operating leases with initial or remaining terms
of one year or more consisted of the following at December 31, 1999:
2000 $ 17,928,000
2001 14,491,000
2002 9,709,000
2003 7,084,000
2004 5,517,000
Thereafter 10,853,000
------------
$ 65,582,000
============
Rent expense was $3.7 million, $7.8 million and $15.0 million for the years
ended December 31, 1997, 1998, and 1999, respectively. The total amount of base
rent payments is being charged to expense on the straight-line method over the
term of the lease.
8. Income taxes:
A summary of the components of the tax provision at December 31, 1997, 1998, and
1999 is as follows:
1997 1998 1999
------------ ------------ ------------
Currently payable:
Federal $ 2,233,000 $ 7,699,000 $ 9,574,000
State 484,000 1,355,000 576,000
Foreign - 331,000 500,000
Deferred:
Federal 1,752,000 3,035,000 10,699,000
State 29,000 711,000 2,345,000
Valuation allowance 302,000 - -
----------- ------------ ------------
Provision for income taxes $ 4,800,000 $ 13,131,000 $ 23,694,000
=========== ============ ============
Deferred tax assets (liabilities) at December 31, 1998 and 1999 consisted of the
following:
1998 1999
------------ -------------
Deferred tax assets:
Net operating loss carryforwards $ 569,000 $ -
Contractual revenue recognition - -
Accrued expenses 1,056,000 2,965,000
------------ -------------
1,625,000 2,965,000
Deferred tax liabilities:
Amortization 4,999,000 21,310,000
Depreciation 1,735,000 4,437,000
Cash basis of accounting 375,000 -
------------ -------------
7,109,000 25,747,000
------------ -------------
Net deferred tax liability $ (5,484,000) $ (22,782,000)
============ =============
F-15
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
8. Income taxes (continued):
A reconciliation of the U.S. statutory income tax rate to the effective rate
(excluding the effect of the change in tax status) is as follows:
1997 1998 1999
-------- --------- ---------
U.S. statutory income tax rate 34% 35% 35%
Non-deductible goodwill and other
expenses 3% 2% 6%
State taxes, net of federal 5% 6% 4%
Utilization of net operating loss
carryforwards - (1%) -
JDR operating losses not tax deductible 9% - -
-------- --------- ---------
Effective tax rate 51% 42% 45%
======== ========= =========
9. JDR Recapitalization:
On May 29 and 30, 1997, JDR completed a series of transactions that
substantially changed its size and capital structure. These transactions, which
are described further below, included the repayment of outstanding debt, the
repurchase of all capital stock held by two former institutional investors,
certain executive officers of JDR and an individual investor, the issuance of
new preferred shares, the purchase of several companies that were previously
partially-owned by JDR's majority stockholder and President, and a
recapitalization of JDR. After the repurchase of capital stock, JDR's President
became the only holder of Voting Common ("JDR's Sole Stockholder"). At that
point, the Sole Stockholder's basis in his investment was "pushed down" to the
JDR's books, as required by Staff Accounting Bulletin No. 54. This established a
new basis of accounting for JDR on May 29, 1997 and NCO's financial statements,
therefore, include the period from that date to the Company's fiscal year end,
December 31, 1997.
On May 29, 1997, JDR amended and restated its certificate of incorporation to
authorize the issuance of 17,955,000 shares of stock, consisting of: (i)
9,794,000 shares of common stock ("JDR Common") consisting of 4,897,000 shares
of voting common stock ("Voting Common") and 4,897,000 shares of nonvoting
common stock ("Nonvoting Common"); and (ii) 8,161,000 shares of preferred stock
("Preferred"), of which 417,000 shares were designated as Redeemable Series A
Preferred stock, no par value ("Redeemable Series A"), 555,000 shares were
designated as Convertible Series A Preferred stock, no par value ("Series A
Preferred"), 204,000 were designated as Convertible Series B Preferred stock, no
par value ("Series B Preferred") and 237,000 were designated as Convertible
Series C Preferred stock, no par value ("Series C Preferred") (see Notes 10 and
11).
Also on May 29, 1997, JDR received a bridge loan of $11.0 million (see Note 6),
the proceeds of which were used to repay $5.4 million of outstanding long-term
debt, to pay debt issuance costs of $185,000 (see Note 6) and to repurchase for
$5.4 million all of the Voting Common held by shareholders other than JDR's Sole
Stockholder and certain shares of Redeemable Series A and Series B Preferred
stock. This transaction resulted in the push down of JDR's Sole Stockholder's
basis in his investment in JDR's stock onto JDR's books. The establishment of
this new basis of accounting resulted in JDR recording an increase in equity of
$6.7 million, which represented the difference between JDR's net book value at
May 29, 1997 and JDR's Sole Stockholder's accounting basis. The entire amount of
the increase in equity was allocated to goodwill, which is being amortized over
40 years on a straight-line basis.
F-16
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
9. JDR Recapitalization (continued):
The repurchase and exchange of stock included the following:
Repurchase of 401,000 shares of Voting Common $ 4,624,000
Repurchase of 92,000 shares of Redeemable Series A
and Series B Preferred stock plus accrued dividends of $165,000 802,000
Exchange of 40,000 shares of Redeemable Series A and Series B Preferred
stock, plus accrued dividends of $23,000 for 13,000 shares of Series
A Preferred 146,000
Exchange of 129,000 shares of Voting Common for 129,000 shares
of Nonvoting Common 1,493,000
Exchange of 1,000 shares of Voting Common for 1,000 shares of Series B
Preferred 11,000
-----------
Total value of shares repurchased and exchanged $ 7,076,000
===========
On May 30, 1997, JDR issued preferred stock to two new institutional
investors (see Note 10) as follows:
Issued 271,000 shares of Redeemable Series A $ 7,050,000
Issued 38,000 shares of Series A Preferred 439,000
Issued 125,000 shares of Series B Preferred 1,445,000
-----------
$ 8,934,000
===========
10. Redeemable preferred stock:
All of the Redeemable Series A Preferred stock, the Convertible Series A
Preferred stock and the Convertible Series B Preferred stock was exchanged for
NCO common stock on March 31, 1999.
December 31, 1998
-----------------
Redeemable Series A Preferred stock, no par value,
417,000 shares authorized, 271,000 shares issued and
outstanding $ 5,394,000
Convertible Series A Preferred stock, no par value,
555,000 shares authorized, 365,000 shares issued and
outstanding 4,601,000
Convertible Series B Preferred stock, no par value,
204,000 shares authorized, 149,000 shares issued and
outstanding 1,887,000
------------
$ 11,882,000
============
JDR issued 271,000 shares of Redeemable Series A stock to repay $6.6 million of
borrowings under the JDR Bridge Loan (see Notes 6 and 9) and for cash proceeds
of $476,000. The Redeemable Series A stock required a dividend (payable in kind)
of 7.0% per year. The holders of the Redeemable Series A stock could have
redeemed these shares for their liquidation value beginning on May 30, 2003. JDR
would have been obligated to redeem these shares on May 30, 2004. The Redeemable
Series A stock had limited voting rights, was senior to the Series C Preferred
stock and common stock.
JDR issued 38,000 shares of Series A Preferred stock to repay $439,000 of
borrowings under the JDR Bridge Loan (see Notes 6 and 9). In addition, JDR
issued 13,000 shares of Series A Preferred stock in exchange for certain
Redeemable Series A and Series B Preferred stock. The Series A Preferred
required a dividend (payable in kind) of 6.0% per year. The holders of the
Series A Preferred stock could have converted their shares at any time into
voting common stock. In addition, the holders of the Series A Preferred stock
could have redeemed their shares for their liquidation value beginning on May
30, 2002. The Series A Preferred stock had limited voting rights, was senior to
the Series C Preferred stock and common stock.
F-17
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
10. Redeemable preferred stock (continued):
JDR issued 125,000 shares of Series B Preferred stock to repay $1.3 million of
borrowings under the JDR Bridge Loan (see Notes 6 and 9) and for cash proceeds
of $127,000. The Series B Preferred stock required a dividend (payable in kind)
of 6.0% per year. The holders of the Series B Preferred stock could have
converted their shares at any time into nonvoting common stock. In addition, the
holders of the Series B Preferred stock could have redeemed these shares for
their liquidation value beginning on May 30, 2002. The Series B Preferred stock
had limited voting rights, was senior to the Series C Preferred stock and common
stock.
11. Shareholders' equity:
Preferred Stock
At December 31, 1998, JDR had 237,000 shares designated as Series C Preferred
stock, of which 149,000 shares were issued and outstanding. The Series C
Preferred stock required a dividend (payable in kind) of 6.0% per year. JDR
could have redeemed the Series C Preferred, at any time, for its liquidation
value. The holders of the Series C Preferred stock could have converted their
shares at any time after May 30, 2000, or at the time any shares of Series A
Preferred stock or Series B Preferred stock were converted into common stock,
into nonvoting common stock. The Series C Preferred stock had a liquidation
value of $1.9 million, including dividends of $167,000, at December 31, 1998.
All of the Series C Preferred stock was converted into NCO common stock on March
31, 1999.
Common Stock
In December 1997, the Company effected a three-for-two stock split and increased
the authorized shares of common stock to 37,500,000. All per share and related
amounts have been adjusted to reflect the stock exchange and stock splits.
In July 1997, the Company completed a public offering, selling 2,166,000 shares
of common stock at a price to the public of $19.67 per share. The Company
received net proceeds, after underwriting discounts and expenses, of
approximately $40.4 million.
In June 1998, the Company completed a public offering, selling 4,469,000 shares
of common stock (469,000 of which were over-allotment shares exercised in July
1998) at a price to the public of $21.50 per share. The Company received net
proceeds, after underwriting discounts and expenses, of approximately $91.3
million.
Nonvoting Common Stock
At December 31, 1998, JDR had 4,897,000 shares of nonvoting common stock
authorized, of which 1,088,000 shares were issued and 1,044,000 shares were
outstanding. All of the nonvoting common stock was exchanged for NCO common
stock on March 31, 1999.
Common Stock Warrants
On May 30, 1997, JDR issued warrants to purchase 621,000 shares of nonvoting
common stock at a nominal value in connection with the sale of capital stock and
the JDR Credit Facility (see Note 8). All of the warrants were exercised and
exchanged for NCO common stock on March 31, 1999.
On May 21, 1999, NCO issued warrants to purchase 250,000 shares of NCO common
stock in connection with the acquisition of Co-Source. During 1999, warrants to
issue 228,000 shares of NCO common stock were exercised. The holders of the
warrants elected to use the option of forfeiting a portion of their warrants to
cover the exercise price. These exercises resulted in the net issuance of 67,000
shares of NCO common stock. Warrants to purchase 22,000 shares of NCO common
stock were still were outstanding as of December 31, 1999.
F-18
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
11. Shareholders' equity (continued):
Treasury Stock
JDR had 44,000 shares of nonvoting common stock and 312,000 shares of voting
common stock in Treasury at December 31, 1998. All of the treasury shares were
retired on March 31, 1999.
12. Earnings per share:
Basic earnings per share were computed by dividing the net income for the years
ended December 31, 1997, 1998, and 1999 by the weighted average number of shares
outstanding. Diluted earnings per share were computed by dividing the net
income, adjusted for the effects of interest expense attributable to convertible
debt, for the years ended December 31, 1997, 1998, and 1999, by the weighted
average number of shares outstanding, including common equivalent shares. All
outstanding options, warrants and convertible securities have been utilized in
calculating diluted net income per share only when their effect would be
dilutive.
The reconciliation of basic to diluted earnings per share ("EPS") consists of
the following (amounts in thousands, except EPS amounts):
1997 1998 1999
-------------------- ------------------ --------------------
Shares EPS Shares EPS Shares EPS
--------- --------- -------- -------- --------- ---------
Basic 13,736 $ 0.22 18,324 $ 0.91 22,873 $ 1.27
Dilutive effect of warrants 459 (0.01) 725 (0.03) 206 (0.01)
Dilutive effect of options 491 (0.01) 615 (0.03) 712 (0.04)
Other 122 - 94 - 8 -
------ ------ ------ ------ ------ ------
Diluted 14,808 $ 0.20 19,758 $ 0.85 23,799 $ 1.22
====== ====== ====== ====== ====== ======
13. Stock options:
In June 1995, the Company adopted the 1995 Stock Option Plan (the "1995 Plan").
In September 1996, the Company adopted the 1996 Stock Option Plan (the "1996
Plan") and the 1996 Non-Employee Director Stock Option Plan (the "Director
Plan"). The 1995 Plan and 1996 Plan, as amended, authorized 333,000 and
2,717,000 shares, respectively, of incentive or non-qualified stock options. The
Director Plan, as amended, authorized 150,000 shares. The vesting periods for
the outstanding options under the 1995 Plan, the 1996 Plan, and the Director
Plan are three years, three years and one year, respectively. The maximum
exercise period is ten years after the date of grant.
F-19
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
13. Stock options (continued):
In June 1997, JDR established the JDR Holdings, Inc. 1997 Stock Option Plan (the
"JDR Plan") and reserved 69,000 shares of common stock. All options that were
issued and outstanding under the JDR Plan as of March 31, 1999 became fully
vested as a result of the acquisition of JDR by NCO. The options expire no later
than ten years from the date of grant.
On August 20, 1999, as part of the acquisition of Compass, NCO assumed the
Compass Employee Incentive Compensation Plan (the "Compass Plan"). The Compass
Plan authorized up to 475,000 shares of non-qualified stock options. The vesting
periods for the outstanding options under the Compass Plan are one to three
years. The maximum exercise period is ten years after the date of grant.
A summary of stock option activity of the 1995 Plan, the 1996 Plan, the Director
Plan, the JDR Plan and the Compass Plan is as follows:
Weighted
Average
Number of Exercise Price
Options Per Share
------------- ---------------
Outstanding at January 1, 1997 658,000 $ 6.80
Granted 493,000 21.21
Exercised (50,000) 4.20
Forfeited (36,000) 10.72
----------- -------
Outstanding at December 31, 1997 1,065,000 13.95
Granted 776,000 27.32
Exercised (230,000) 5.98
Forfeited (32,000) 19.78
----------- -------
Outstanding at December 31, 1998 1,579,000 21.44
Granted 1,497,000 32.58
Exercised (441,000) 16.89
Forfeited (24,000) 26.76
----------- -------
Outstanding at December 31, 1999 2,611,000 $ 28.27
=========== =======
Stock options exercisable at December 31, 1999 695,000 $ 25.55
=========== =======
F-20
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
13. Stock options (continued):
The following table summarizes information about fixed stock options
outstanding as of December 31, 1999:
Stock Options Outstanding Stock Options Exercisable
------------------------------------------------- -----------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Prices Shares Remaining Life Exercise Price Shares Exercise Price
--------------------- ------------ ----------------- --------------- ----------- ---------------
$ 1.82 to $19.42 311,000 7.08 years $ 13.55 246,000 $ 12.72
$21.00 to $24.75 497,000 8.33 years 22.51 194,000 23.14
$28.44 to $29.94 1,170,000 9.84 years 29.83 27,000 29.14
$30.75 to $37.00 449,000 9.11 years 33.70 89,000 33.70
$43.81 to $61.09 184,000 8.36 years 45.47 139,000 45.80
--------- ---------- ------- ------- -------
2,611,000 9.00 years $ 28.27 695,000 $ 25.55
========= ========== ======= ======= =======
The Company applies APB Opinion 25 and related interpretations in accounting for
its stock option plans and, accordingly, does not recognize compensation cost
based on the fair value of the options granted at grant date. If the Company had
elected to recognize compensation cost based on the fair value of the options
granted at grant date, net income and earnings per share for 1997, 1998, and
1999 would have been reduced to the unaudited, pro forma amounts indicated in
the following table:
1997 1998 1999
------------ ------------ ------------
Net income - as reported $ 4,591,000 $ 18,345,000 $ 29,366,000
Net income - pro forma $ 4,115,000 $ 17,264,000 $ 27,050,000
Net income per share:
Basic - as reported $ 0.22 $ 0.91 $ 1.27
Basic - pro forma $ 0.18 $ 0.85 $ 1.17
Diluted - as reported $ 0.20 $ 0.85 $ 1.22
Diluted - pro forma $ 0.17 $ 0.79 $ 1.12
The estimated weighted average, grant-date fair values of the options granted
during the years ended December 31, 1997, 1998, and 1999 were $6.53, $9.86, and
$12.43, respectively. All options granted were at the market price of the stock
on the grant date. For valuation purposes, the Company utilized the
Black-Scholes option pricing model using the following assumptions on a weighted
average basis:
1997 1998 1999
---------- ---------- ----------
Risk-free interest rate 6.19% 4.98% 5.73%
Expected life in years 3.25 3.25 3.25
Volatility factor 40.42% 43.38% 44.04%
Dividend yield None None None
Forfeiture rate 5.00% 5.00% 5.00%
F-21
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
13. Stock options (continued):
For valuation purposes, JDR utilized the Black-Scholes option pricing model
using the following assumptions on a weighted average basis for the options
granted under the JDR Plan: dividend yield of 0%, expected volatility of 0%,
risk-free interest rate of 6.6%, and an expected life of ten years.
At December 31, 1998, the Company had 36,000 options outstanding to purchase JDR
Nonvoting Common stock at $0.02 per share. On March 31, 1999, the 36,000
outstanding options to purchase JDR Nonvoting Common stock at $0.02 per share
were converted into 36,000 options to purchase NCO common stock at $0.02 per
share. During 1999, 22,000 of these options were exercised to purchase NCO
common stock. At December 31, 1999, the Company had 14,000 options outstanding
to purchase NCO common stock at $0.02 per share.
On July 1997, a consultant, who also served as a director of JDR, received
options to purchase 228,000 shares of JDR Nonvoting Common stock at $11.54 per
share. The original vesting schedule of these options was 58% on January 1, 1998
and 14% on January 1, 1999, 2000 and 2001. The Company recorded the $961,000
value as expense as the options vested. For the year ended December 31, 1998 and
the first quarter of 1999, the Company recorded $686,000 and $34,000,
respectively, as consulting expense for these options. The remaining value of
the options was recorded when the they became fully vested upon the completion
of the acquisition of JDR on March 31, 1999.
14. Derivative financial instruments:
The Company selectively uses derivative financial instruments to manage interest
costs and minimize currency exchange risk. The Company does not hold derivatives
for trading purposes. While these derivative financial instruments are subject
to fluctuations in value, these fluctuations are generally offset by the value
of the underlying exposures being hedged. The Company minimizes the risk of
credit loss by entering into these agreements with major financial institutions
that have high credit ratings.
Interest Rate Collar and Interest Rate Swap Agreements:
During 1998 and 1999, the Company entered into interest rate collar agreements
and an interest rate swap agreement to reduce the impact of changes in interest
rates on portions of the debt borrowed from its revolving credit facility.
As of December 31, 1999, the Company was party to three interest rate collar
agreements that consisted of a rate ceiling and floor that is based on different
notional amounts. The first interest rate collar agreement consisted of a
ceiling portion with a rate of 7.75%, covering a notional amount of $30.0
million, and a floor portion with a rate of 4.75%, covering a notional amount of
$15.0 million. This interest rate collar agreement expires in September of 2001.
The other two interest rate collar agreements consisted of a ceiling portion
with a rate of 7.50%, covering a total notional amount of $120.0 million, and a
floor portion with a rate of 5.50%, covering a total notional amount of $120.0
million. These interest rate collar agreements expire in October of 2001. The
notional amounts of these interest rate collar agreements are used to measure
the interest to be paid or received and do not represent the amount of exposure
due to credit loss. The net cash amounts paid or received on the interest rate
collar agreements are accrued and recognized as an adjustment to interest
expense.
The interest rate swap agreement, which expired in June 1999, exchanged the
floating rate on the Company's outstanding debt from its revolving credit
facility for a fixed interest rate of 5.12%. This agreement covered a notional
amount of approximately $136.0 million.
Foreign Exchange Contracts:
As part of the acquisition of FCA International Ltd. ("FCA"), the Company
obtained forward exchange contracts which where entered into by FCA. These
forward exchange contracts were used by the Company to minimize the impact of
currency fluctuations on transactions, cash flows and firm commitments. The
Company had approximately $3.4 million of contracts outstanding at December 31,
1998. These contracts were for the purchase of Canadian dollars and matured
within one to 30 months. In April 1999, the Company elected to finalize its
forward position under these contracts at a cost of approximately $148,000.
F-22
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
15. Fair value of financial instruments:
The following methods and assumptions were used to estimate the fair value of
each class of financial instrument for which it is practicable to estimate that
value:
Cash and Cash Equivalents:
The carrying amount reported in the balance sheet approximates fair value
because of the short maturity of these instruments.
Debt:
The Company's non-seller-financed debt is primarily variable in nature and based
on the prime rate, and, accordingly, the carrying amount of debt instruments
approximates fair value. The stated interest rates of the Company's
non-convertible seller-financed notes approximate market rates for debt with
similar terms and maturities, and, accordingly, the carrying amounts
approximates fair value. The Company's seller-financed debt from the Goodyear
acquisition consisted of a note payable, which contained a conversion option,
which allowed the holder to convert the debt into 64,000 shares of common stock
at a price of $14.12 per share on February 15, 1999. Accordingly, the fair value
of the debt as of December 31, 1998 was calculated using the closing market
price of NCO's common stock on February 15, 1999.
Interest Rate Instruments:
While it is not the Company's intention to terminate any of the interest rate
instruments, the fair value of the instruments was estimated by obtaining quotes
from brokers that represented amounts the Company would have received or paid if
the agreements were terminated at December 31, 1998 and 1999. These fair values
indicated that the gains or losses that would have resulted from the termination
of the interest rate swap agreement and the interest rate collar agreement at
December 31, 1998 and 1999 would have not been material.
Foreign Exchange Contracts:
The fair value of foreign exchange contracts at December 31, 1998 was not
material.
F-23
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
15. Fair value of financial instruments (continued):
The estimated fair value of the Company's financial instruments are as follows
at December 31:
1998 1999
-------------------------------- --------------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------------- -------------- -------------- --------------
Financial assets:
Cash and cash equivalents $ 23,560,000 $ 23,560,000 $ 52,380,000 $ 52,380,000
Financial liabilities:
Non-seller financed debt 148,535,000 148,535,000 322,750,000 322,750,000
Subordinated seller notes
payable 500,000 500,000
880,000 880,000
Subordinated seller notes
payable, convertible 900,000 2,176,000 - -
Non-interest bearing note
payable 36,000 36,000 - -
16. Supplemental cash flow information:
The following are supplemental disclosures of cash flow information:
1997 1998 1999
-------------- --------------- ----------------
Cash paid for interest $ 1,570,000 $ 2,905,000 $ 7,923,000
Cash paid for income taxes 4,181,000 5,726,000 24,331,000
Non-cash investing and financing
activities:
Fair value of assets acquired 12,320,000 47,872,000 28,368,000
Liabilities assumed from
acquisitions 7,019,000 46,730,000 53,713,000
Fair value of contributed capital - 3,834,000 -
Property acquired under
capital leases 967,000 138,000 -
Value of fixed assets traded for
new fixed assets 238,000 - -
Convertible note payable,
issued for acquisition 900,000 - -
Notes payable, issued for acquisitions 1,000,000 - -
Convertible note payable,
converted to common stock 1,000,000 - 900,000
Common stock issued for
acquisitions 9,310,000 - 101,526,000
Common stock options issued
for acquisitions - - 2,562,000
Redemption of redeemable
preferred stock for common stock - - 12,231,000
Warrant issued 5,450,000 - 1,925,000
Warrants exercised 149,000 247,000 6,332,000
F-24
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
17. Employee benefit plans:
The Company has a savings plan under Section 401(k) of the Internal Revenue Code
(the "Plan"). The Plan allows all eligible employees to defer up to 15% of their
income on a pretax basis through contributions to the Plan. The Company will
provide a matching contribution of 25% of an employee's contribution, subject to
a maximum of 1.5% of an employee's base salary. The charges to operations for
the matching contributions were $220,000, $755,000 and $1,407,000, for 1997,
1998, and 1999, respectively.
18. Commitments and contingencies:
The Company is party, from time to time, to various legal proceedings incidental
to its business. In the opinion of management none of these items individually
or in the aggregate would have a significant effect on the financial position,
result of operations, cash flows, or liquidity of the Company.
19. Segment reporting:
The Company is organized into market specific operating divisions that are
responsible for all aspects of client sales, client service, and operational
delivery of services. The accounting policies of the segments are the same as
those described in Note 2, "Summary of significant accounting policies." Segment
data includes a charge allocating corporate overhead costs to each of the
operating segments based on revenue and employee headcount. During 1999, the
operating divisions, which were each headed by a divisional chief executive
officer, included Accounts Receivable Management Services, Healthcare Services,
Technology-Based Outsourcing, Commercial Services, Market Strategy and
International Operations.
The Accounts Receivable Management Services division provides accounts
receivable management services to consumer and commercial accounts for all
market segments, serving clients of all sizes in local, regional and national
markets.
The Healthcare Services division primarily focuses on providing comprehensive
outsourcing services for the hospital market. In addition, the Healthcare
Services division provides accounts receivable management programs for physician
groups and allied health service providers. During the first quarter of 2000,
the accounts receivable management services portion of the Healthcare Services
division was merged into the Accounts Receivable Management Services division,
and the pre-delinquency services portion of the Healthcare Services division was
merged into the Technology-Based Outsourcing division.
With the March 1999 acquisition of JDR, the Technology-Based Outsourcing
division was created. This division continues the growth of the client
relationship beyond bad debt recovery and delinquency management, delivering
cost-effective receivables and customer relationship management solutions to all
market segments, serving clients of all sizes in local, regional and national
markets.
With the May 1999 acquisition of Co-Source, the Commercial Services division was
created. The Commercial Services division focuses on providing accounts
receivable management and collection services to the commercial market. During
the first quarter of 2000, the Commercial Services division was merged into the
Accounts Receivable Management Services division.
The Market Strategy division provides full-service, custom market research
services to the telecommunications, financial services, utilities, healthcare,
pharmaceutical, and consumer products sectors. In addition, the Market Strategy
division provides telemarketing services for clients, including lead generation
and qualification, and the booking of appointments for a client's sales
representatives.
F-25
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
19. Segment reporting (continued):
With the May 1998 acquisition of FCA, the International Operations division was
created. The International Operations division provides accounts receivable
management services across Canada and the United Kingdom.
The following tables represent the revenue, payroll and related expenses,
selling, general and administrative expenses, and earnings before interest,
taxes, depreciation, and amortization ("EBITDA") for each segment for the years
ended December 31, 1997, 1998 and 1999. EBITDA is used by the Company's
management to measure the segments' operating performance and is not intended to
report the segments' operating results in conformity with generally accepted
accounting principles.
For the year ended December 31, 1997
(Amounts in thousands)
------------------------------------------------------------------------
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
---------------- ----------------- ----------------- ---------------
A/R Management $ 81,942 $ 40,550 $ 28,318 $ 13,074
Tech-Based Outsourcing 17,778 10,945 6,165 668
Market Strategy 8,353 5,454 1,889 1,010
--------- -------- -------- --------
Total $ 108,073 $ 56,949 $ 36,372 $ 14,752
========= ======== ======== ========
For the year ended December 31, 1998
(Amounts in thousands)
------------------------------------------------------------------------
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
---------------- ----------------- ----------------- ---------------
A/R Management $ 127,419 $ 63,023 $ 38,649 $ 25,747
Healthcare Services 20,442 9,930 5,978 4,534
Tech-Based Outsourcing 43,530 22,932 11,893 8,705
Market Strategy 20,005 12,527 5,210 2,268
International Operations 18,556 10,902 4,858 2,796
--------- --------- -------- --------
Total $ 229,952 $ 119,314 $ 66,588 $ 44,050
========= ========= ======== ========
For the year ended December 31, 1999
(Amounts in thousands)
---------------------------------------------------------------------------
Selling Non-
Payroll and General and Recurring
Related Admin. Acquisition
Revenue Expenses Expenses Costs EBITDA
-------------- ------------- --------------- ------------- ------------
A/R Management $ 175,225 $ 85,563 $ 50,401 $ - $ 39,261
Healthcare Services 136,375 72,037 39,410 - 24,928
Tech-Based Outsourcing 63,118 32,994 16,964 - 13,160
Commercial Services 54,553 29,673 12,705 - 12,175
Market Strategy 32,043 20,011 7,397 - 4,635
International Operations 31,040 17,599 8,631 - 4,810
Other - - - 4,601 (4,601)
---------- --------- --------- ------- --------
Total $ 492,354 $ 257,877 $ 135,508 $ 4,601 $ 94,368
========= ========= ========= ======= ========
F-26
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
20. Recent accounting pronouncements:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which was
subsequently amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133"
(collectively "SFAS No. 133"). SFAS No. 133 is effective for the fiscal years
beginning after June 15, 2000 and requires that an entity recognize all
derivative instruments as either assets or liabilities on its balance sheet at
their fair values. Changes in the fair value of derivatives are recorded each
period in current earnings or other comprehensive income, depending on whether a
derivative is designated as part of a hedge transaction, and, if it is, the type
of hedge transaction. The Company will adopt SFAS No. 133 by the first quarter
of 2001. Due to the Company's limited use of derivative instruments, SFAS No.
133 is not expected to have a material impact on the consolidated results of
operations, financial condition, or cash flows of the Company.
F-27
NCO GROUP, INC.
Schedule II - Valuation of Qualifying Accounts
Additions
-------------------------
Balance at Charged to Charged to Balance at
beginning costs and other end of
year expenses accounts (1) Deductions (2) year
----------- ----------- ------------- --------------- -------------
Year ended December 31, 1997:
Allowance for doubtful
accounts $ 79,000 665,000 350,000 (376,000) 718,000
Year ended December 31, 1998:
Allowance for doubtful
accounts 718,000 2,652,000 2,122,000 (1,494,000) 3,998,000
Year ended December 31, 1999:
Allowance for doubtful
accounts 3,998,000 2,629,000 1,500,000 (1,702,000) 6,425,000
(1) Allowance for doubtful accounts of acquired companies.
(2) Uncollectible accounts written off, net of recoveries.
S-1