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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 [FEE REQUIRED]
For the Fiscal Year ended December 31, 1996
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES
EXCHANGE ACT OF 1934 [NO FEE REQUIRED]
For the transition period from ___________ to ___________
Commission File No. 0-21639
NCO GROUP, INC.
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(Exact Name of Registrant as Specified in its Charter)
Pennsylvania 23-1670927
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
1740 Walton Road
Blue Bell Pennsylvania 19422-0987
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(Address of principal (Zip Code)
executive offices)
Registrant's Telephone Number, Including Area Code (610) 832-1440
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Securities Registered Pursuant to Section 12(b) of the Act: None
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Securities Registered Pursuant to Section 12(g) of the Act:
Common Stock, no par value 7,058,625
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(Title of Class) (Number of Shares Outstanding
as of March 27, 1997)
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 $80,052,177. (1)
Certain portions of the Company's Proxy Statement to be filed in
connection with its 1997 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.
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(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 $24.875, the last
reported sale price for the Company's Common Stock on March 27, 1997. 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 recordkeeping
purposes of the Securities and Exchange Commission.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business 1
Item 2. Properties. 17
Item 3. Legal Proceedings. 18
Item 4. Submission of Matters to a Vote of Security Holders. 18
Item 4.1 Executive Officers of the Registrant who are not also Directors. 18
PART II
Item 5. Market for Registrant's Common Equity and 19
Related Shareholder Matters.
Item 6. Selected Financial Data. 21
Item 7. Management's Discussion and Analysis of Financial 22
Condition and Results of Operations.
Item 8. Financial Statements and Supplementary Data. 28
Item 9. Changes in and Disagreements with Accountants on Accounting and 28
Financial Disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant. 29
Item 11. Executive Compensation. 29
Item 12. Security Ownership of Certain Beneficial Owners and Management. 29
Item 13. Certain Relationships and Related Transactions. 29
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 30
Signatures 35
Index to Consolidated Financial Statements F-1
PART I
Item 1. Business.
General
NCO Group, Inc. ("NCO" or the "Company") is a leading provider of
accounts receivable management and related services utilizing an extensive
teleservices infrastructure. The Company develops and implements customized
accounts receivable management solutions for clients. From 24 call centers
located in 17 states, the Company employs advanced workstations and
sophisticated call management systems comprised of predictive dialers, automated
call distribution systems, digital switching and customized computer software.
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 made eight acquisitions which have enabled it to increase
its penetration of existing markets, establish a presence in certain new markets
and realize significant operating efficiencies. In addition, the Company has
leveraged its infrastructure by offering additional services including
telemarketing, customer service call centers and other outsourced administrative
services. The Company believes that it is currently among the ten largest
accounts receivable management companies in the United States.
The Company provides its services principally to educational
organizations, financial institutions, healthcare organizations,
telecommunications companies, utilities and government entities. In 1996, the
Company had over 7,000 clients, including Bell Atlantic Corporation, City of
Philadelphia Water Revenue Bureau, First Union Corporation, NationsBank and the
University of Pennsylvania. No client accounted for more than 10% of the
Company's actual revenue in 1996. For its accounts receivable management
services, the Company generates substantially all of its revenue on a
contingency fee basis. The Company seeks to be a low cost provider and as such
its fees typically range from 15% to 35% of the amount recovered on behalf of
the Company's clients, with an average of approximately 25% in 1996. According
to the 1995 Top Collection Markets Survey published by the American Collectors
Association, Inc. ("ACA"), an industry trade group, the average fees realized by
the accounts receivable management companies surveyed were in the range of 30%
to 43% depending upon the industries served. For many of its other outsourced
teleservices, the Company is paid on a fixed fee basis. While NCO's contracts
are relatively short-term, the Company seeks to develop long-term relationships
with its clients and works closely with them to provide quality, customized
solutions.
Increasingly, companies are outsourcing many non-core functions to
focus on revenue generating activities, reduce costs and improve productivity.
In particular, many corporations are recognizing the advantages of outsourcing
accounts receivable management and other teleservices as a result of numerous
factors including: (i) the increasing complexity of such functions; (ii)
changing regulations and increased competition in certain industries; and (iii)
the development of sophisticated call management systems requiring substantial
capital investment, technical capabilities and human resource commitments.
Consequently, receivables referred to third parties for management and recovery
in the United States have grown substantially from approximately $43.7 billion
in 1990 to approximately $79.0 billion in 1994, according to estimates published
by the ACA. While significant economies of scale exist for large accounts
receivable management companies, the industry remains highly fragmented. Based
on information obtained
-1-
from the ACA, there are currently approximately 6,300 accounts receivable
management companies in operation, the majority of which are small, local
businesses. Given the financial and competitive constraints facing these small
companies and the limited number of liquidity options for the owners of such
businesses, the Company believes that the industry will experience consolidation
in the future.
The Company strives to be a cost-effective, client service driven
provider of accounts receivable management and other related teleservices to
companies with substantial outsourcing needs. The Company's business strategy
encompasses a number of key elements which management believes are necessary to
ensure quality service and to achieve consistently strong financial performance.
First, the Company focuses on the efficient utilization of its technology and
infrastructure to constantly improve productivity. The Company's teleservices
infrastructure enables it to perform large scale accounts receivable management
programs cost effectively and to rapidly and efficiently integrate the Company's
acquisitions. A second critical component is NCO's commitment to client service.
Management believes that the Company's emphasis on designing and implementing
customized accounts receivable management programs for its clients provides it
with a significant competitive advantage. Third, the Company seeks to be a low
cost provider of accounts receivable management services by centralizing all
administrative functions and minimizing overhead at all branch locations.
Lastly, the Company is targeting larger clients which offer significant
cross-selling opportunities and have greater teleservices outsourcing
requirements.
The Company seeks to continue its rapid expansion through both internal
and external growth. The Company intends to continue to take advantage of the
fragmented nature of the accounts receivable management industry by making
strategic acquisitions. Through selected acquisitions, the Company will seek to
serve new geographic markets, expand its presence in its existing markets or add
complementary services. In addition, the Company has experienced and expects to
continue to experience strong internal growth by continually striving to
increase its market share, expand its industry-specific market expertise and
develop and offer new value-added teleservices. The Company regularly reviews
various strategic acquisition opportunities and periodically engages in
discussions regarding such possible acquisitions. See "Acquisition History."
The Company's principal executive offices are located at 1740 Walton
Road, Blue Bell, Pennsylvania 19422, and its telephone number is (610) 832-1440.
Acquisition History
Since 1994, the Company has completed eight strategic acquisitions
which have expanded its client base and geographic presence, increased its
presence in key industries and substantially increased its revenues and
profitability. A key element of the Company's growth strategy is to pursue
selected strategic acquisitions to serve new geographic markets or industries,
expand its presence in its existing markets or add complementary service
applications. The Company regularly reviews various strategic acquisition
opportunities and periodically engages in discussions regarding such possible
acquisitions. A summary of the completed acquisitions follows:
-2-
Collections Division of CRW Financial, Inc.
On February 2, 1997, NCO purchased certain assets of the Collections
Division of CRW Financial, Inc. ("CRWCD") for $3.75 million in cash, 345,178
shares of Common Stock and warrants to purchase 250,000 shares of Common Stock
at an exercise price of $27.625 per share. The purchase price was valued at
approximately $12.8 million. CRWCD provides accounts receivable management
services principally to the telecommunications, education, financial, government
and utility industries from 14 offices located throughout the United States. In
addition, CRWCD has a commercial collections division. CRWCD's revenues for the
year ended December 31, 1996 were $25.9 million.
CMS A/R Services
On January 31, 1997, NCO purchased certain assets of CMS A/R Services,
a division of CMS Energy Corporation, owner of Consumers Energy, one of the
nation's largest utility companies, for $5.1 million in cash. CMS A/R Services,
located in Jackson, Michigan, specializes in providing a wide range of accounts
receivable management services to the utility industry, including traditional
recovery of delinquent accounts, project outsourcing, early intervention, and
database management services. CMS A/R Services' revenues for the year ended
December 31, 1996 were $6.8 million.
Tele-Research Center, Inc.
On January 30, 1997, NCO purchased certain assets of Tele-Research
Center, Inc. ("TRC"), for $1.6 million in cash. The purchase price may be
increased by a maximum of up to $600,000 if the TRC business achieves certain
revenue targets during the three year period following the closing date. At the
option of the seller, the purchase price adjustment may be paid in cash or
Common Stock, based on the fair market value of NCO Common Stock as of the date
that the purchase price adjustment accrues. TRC, located in Philadelphia,
Pennsylvania, provides market research, data collection, and other teleservices
to market research companies as well as end-users. TRC's revenues for the year
ended December 31, 1996 were $1.8 million.
Goodyear & Associates, Inc.
On January 22, 1997, NCO purchased all of the outstanding stock of
Goodyear & Associates, Inc. ("Goodyear") for $4.5 million in cash and a $900,000
convertible note. The note is convertible into the Company's Common Stock, at
any time, at $21.175 per share and bears interest payable monthly at a rate of
8.0% per annum with principal due in January 2002. Goodyear, based in Charlotte,
North Carolina, provides accounts receivable management services principally to
the telecommunications, education, and utility industries. Goodyear's revenues
for the year ended December 31, 1996 were $5.5 million.
Management Adjustment Bureau, Inc.
On September 5, 1996, NCO purchased all of the outstanding stock of
Management Adjustment Bureau, Inc. ("MAB") for $8.0 million in cash and a $1.0
million convertible note. The note is convertible at any time into an aggregate
of up to 76,923 shares of the Company's
-3-
Common Stock and bears interest payable monthly at a rate of 8.0% per annum with
principal due in September 2001. MAB, based in Buffalo, New York, provides
accounts receivable management services, principally to the education, financial
services, telecommunications and utility industries. MAB's clients included
NationsBank, NYNEX, Marine Midland Bank and Boston Edison.
Trans Union Corporation Collections Division
On January 3, 1996, NCO purchased certain assets of the Trans Union
Corporation Collections Division ("TCD") for $4.8 million in cash. TCD provided
accounts receivable management services, principally to the telecommunications,
utility and healthcare industries from offices in Pennsylvania, Ohio and Kansas.
TCD's clients included Bell Atlantic Corporation, Western Resources Corporation
and Hutchinson Hospital.
Eastern Business Services, Inc.
In August 1995, NCO purchased certain assets of Eastern Business
Services, Inc. ("Eastern") for $1.6 million in cash and the assumption of a
non-interest bearing note payable in the amount of $252,000 and certain other
accounts payable in the amount of $209,000. Eastern, based in Beltsville,
Maryland, provided accounts receivable management services, principally to the
utility and healthcare industries. Eastern's clients included Bell Atlantic
Corporation and George Washington University Hospital.
B. Richard Miller, Inc.
In April 1994, NCO purchased certain assets of B. Richard Miller, Inc.
("BRM") for $1.0 million in cash, the issuance by the Company of a $127,000
promissory note and the issuance of 123,803 shares of Common Stock and an option
to acquire 86,881 shares of Common Stock at an exercise price of $2.16 per share
(which option was exercised in 1995). In connection with the acquisition, BRM's
principal shareholder became an executive officer of the Company. BRM, based in
Ardmore, Pennsylvania, provided accounts receivable management services,
principally to the education industry. BRM's clients included University of
Pennsylvania, Rutgers University and Seton Hall University.
Financial Impact of Acquisitions
The Company financed the acquisitions of Goodyear, CMS A/R Services,
TRC and CRWCD by borrowing a total of $7.35 million on its revolving credit
facility with Mellon Bank, N.A. and financed the remainder through funds raised
in the Company's initial public offering and through existing working capital.
The Company financed the MAB, TCD, Eastern and BRM acquisitions with borrowings
from Mellon Bank, N.A. In September 1996, the bank increased the Company's
revolving credit facility from $7.0 million to $15.0 million to finance the
acquisition of MAB. The bank further increased this facility to $25.0 million at
an interest rate of LIBOR plus 2.5% in December 1996. The Company granted the
bank a warrant to acquire 175,531 shares of Common Stock at a nominal exercise
price in consideration for establishing the revolving credit facility for
acquisitions, and granted additional warrants to purchase 46,560 shares and
18,500 shares of Common Stock at an exercise price of $13.00 per share in
consideration for increasing the revolving credit facility to $15.0 million and
to $25.0 million, respectively.
-4-
The acquisitions have been accounted for under the purchase method of
accounting for financial reporting purposes. These acquisitions have created
goodwill estimated at $23.4 million which is being amortized over a 15- to
25-year period resulting in amortization expense of approximately $936,000
annually.
Accounts Receivable Management Services
The Company provides a wide range of accounts receivable management
services to its clients utilizing an extensive teleservices 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
substantially all of its revenue from the recovery of delinquent accounts
receivable on a contingency fee basis. In addition, the Company generates
revenue from fixed fees for certain accounts receivable management and other
related services. Contingency fees typically range from 15% to 35% of the amount
recovered on behalf of the Company's clients, but can range from 6% for the
management of accounts placed early in the accounts receivable cycle to 50% for
accounts which have been serviced extensively by the client or by third-party
providers.
Recovery activities 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. Once the
client's records have been established in the Company's system, the Company
commences the recovery process.
Skip Tracing. 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.
-5-
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.
Litigation Management. When account balances are sufficient, the
Company will also coordinate litigation undertaken by a nationwide network of
attorneys that the Company utilizes on a routine basis. Typically, account
balances must be in excess of $1,000 to warrant litigation and the client is
asked to advance legal costs such as filing fees and court costs. Attorneys are
generally compensated on a contingency fee basis. The Company's Collection
Support staff manages the Company's attorney relationships and facilitates the
transfer of all necessary documentation.
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 describes 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.
Other Services
The Company selectively provides other related services which
complement its traditional accounts receivable management business and which
leverage its teleservices infrastructure. The Company believes that the
following services will provide additional growth opportunities for the Company.
Telemarketing. The Company provides telemarketing services for clients,
including lead generation and qualification, the actual booking of appointments
for a client's sales representatives and information gathering for market
research purposes.
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Customer Service Call Center. 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 PECO Energy Company, a regional utility, to function as its customer service
department to field and respond to calls concerning new services which the
utility is beginning to develop and offer. In this manner, the utility can focus
on developing these services without investing the resources to build the
in-house infrastructure necessary to respond to customer inquiries.
Accounts Receivable Outsourcing. 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.
Custom Designed Business Applications. The Company has the ability to
provide outsourced administrative and other back-office responsibilities
currently conducted by its clients. For example, the Company was recently
engaged by United Healthcare, a national health insurer, to assume all
administrative operations for its COBRA and individual conversion coverage,
including all responsibility for premium billing and payment processing,
customer service call center and policy fulfillment. The Company also was
engaged by Independence Blue Cross to audit its base of small business employer
accounts to determine if individuals insured through these accounts were, in
fact, employees.
Operations
Technology and Infrastructure. Over the past five years, the Company
has made a substantial investment in its call management systems such as
predictive dialers, automated call distribution systems, digital switching and
customized computer software. As a result, the Company believes it is able to
address accounts receivable management 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 24 state-of-the-art call centers which are electronically linked
through the MFS Datanet ATM Network. The Company utilizes two computer platform
systems. One system consists of two Unix-based NCR 3455 computers which are
linked via network servers to 583 workstations and which provide necessary
redundancy (either computer can operate the system in the event of the failure
of the other) and excess capacity for future growth. The other system consists
of three Unix-based Hewlett-Packard computers which are linked via network
servers to 754 workstations. The Company's workstations consist of personal
computers and terminals that are linked to the microcomputers but do not
necessarily have separate processors.
The Company maintains ten predictive dialers to address its low
balance, high volume accounts. These systems scan the Company's database 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
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for statistical analysis and placed in priority recall queues or multiple-pass
calling cycles. The system also automates virtually all recordkeeping 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 15 person MIS staff led by a Vice President Chief
Information Officer. The Company maintains disaster recovery contingency plans
and has implemented procedures to protect the loss of data against power loss,
fire and other casualty. The Company has implemented a security system to
protect the integrity and confidentiality of its computer system and data and
maintains comprehensive business interruption and critical systems insurance on
its telecommunications and computer systems.
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.
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 accounts on a regular basis in
order to establish a close client rapport, determine the client's overall level
of satisfaction and identify practical methods of improving the client's
satisfaction.
Client Relationships
The Company's client base currently includes of over 7,000 companies in
such industries as education, financial services, healthcare, telecommunications
and utilities. The Company's 10 largest clients in 1996 accounted for
approximately 32.1% of the Company's revenue on a pro forma basis assuming that
the MAB acquisition had occurred on January 1, 1996. In 1996, the City of
Philadelphia Water Revenue Bureau, the Company's largest account by revenue,
accounted for 9.5% of total revenue (7.3% on a pro forma basis with MAB). In
1996, the Company on a pro forma basis derived 15.2% of its referrals from
educational organizations, 38.5% from financial institutions, 13.6% from
healthcare organizations, 4.7% from telecommunications companies, 8.1% from
utilities, 15.1% from government entities and 4.8% from retail and commercial
entities.
-8-
The following table sets forth a list of certain of the Company's key clients:
Financial Services Healthcare Education
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First Union Corporation Reimbursement Technologies, Inc. Pennsylvania Higher Education Assistance
Mellon Bank, N.A. Medical Center of Delaware Agency
NationsBank, N.A. Franciscan Healthcare University of Pennsylvania
The Progressive Corporation Hutchinson Hospital Corporation Seton Hall University
United Healthcare Penn State University
Rutgers University
University of Virginia
Telecommunications Utilities Government
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Bell Atlantic Corporation New York State Electric & Gas Water Revenue Bureau, City of Philadelphia
NYNEX National Fuel Gas Distribution State of New Jersey Motor Vehicle Services
ATX Telecommunications Corporation
Frontier Cellular PECO Energy Company
Boston Edison Company
Western Resources Corporation
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.
Sales and Marketing
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 44
person direct sales force. 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.
Many of the Company's prospective clients issue requests-for-proposals
("RFPs") as part of the contract award process. The Company retains a technical
writer for the purpose of preparing detailed, professional responses to RFPs. In
addition, the effect of the Company's direct sales force in maintaining contact
with the prospective client often allow them to serve in an informal advisory
capacity to the prospective client with respect to the requirements of the RFP
which the Company believes gives it a competitive edge in responding to the RFP.
-9-
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 March 27, 1997, the Company had a total of 1,146 full-time
employees and 249 part-time employees, of which 1,083 were telephone
representatives. None of the Company's employees is 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 6,300 providers, including large national
corporations such as First Data Corporation, Payco American Corporation and
Union Corporation, and many regional and local firms. Many of the Company's
competitors have substantially 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, in many
instances, are performed in-house. Moreover, many larger clients retain multiple
accounts receivable management and recovery 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. The
Company also competes with other firms, such as SITEL Corporation, APAC
TeleServices, Inc. and Teletech Holdings, Inc., in providing teleservices.
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
-10-
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.
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.
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.
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,
including, without limitation, statements regarding the anticipated growth in
the amount of accounts receivable placed for third-party management, the
continuation of trends favoring outsourcing of other administrative functions,
the Company's objective to grow through strategic acquisitions and its ability
to realize operating efficiencies upon the completion of recent acquisitions and
other acquisitions that may occur in the future, the Company's ability to expand
its service offerings, trends in the Company's future operating performance and
statements as to the Company's or management's beliefs, expectations and
opinions, are forward-looking statements, and the
-11-
factors discussed below could cause actual results and developments to be
materially different from those expressed in or implied by such 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.
Risks Associated with Recent Acquisitions
The Goodyear, Tele-Research, CMS A/R Services and CRWCD acquisitions
were consummated in January and February 1997. These entities had combined
revenues of $40.0 million in 1996 compared to the Company's revenues of $30.8
million in 1996 ($39.9 million on a pro forma basis assuming that the MAB
acquisition had occurred on January 1, 1996). The Company's efforts in
integrating these acquisitions are in the initial stages. Such integration will
likely place significant demands on the Company's management and infrastructure.
There can be no assurance that Goodyear's, Tele-Research's, CMS A/R Services' or
CRWCD's businesses will be successfully integrated with that of the Company,
that the Company will be able to realize operating efficiencies or eliminate
redundant costs or that their businesses will be operated profitably. Further,
there can be no assurance that clients of the acquired businesses will continue
to do business with the Company or that the Company will be able to retain key
employees.
Ability to Manage and Sustain Growth
The Company has experienced rapid growth over the past several years
which has placed significant demands on its administrative, operational and
financial resources. The Company seeks to continue such rapid growth which could
place additional demands on its resources. Future internal growth will depend on
a number of factors, including the effective and timely initiation and
development of client relationships, the Company's ability to maintain the
quality of services it provides to its clients and the recruitment, motivation
and retention of qualified personnel. Sustaining growth will also require the
implementation of enhancements to its operational and financial systems and will
require additional management, operational and financial resources. There can be
no assurance that the Company will be able to manage its expanding operations
effectively or that it will be able to maintain or accelerate its growth, and
any failure to do so could have a materially adverse effect on the Company's
business, results of operations and financial condition. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Risks Associated with Future Acquisitions
A primary element of the Company's growth strategy is to pursue
strategic acquisitions that expand or complement the Company's business. The
Company regularly reviews various strategic acquisition opportunities and
periodically engages in discussions regarding such possible acquisitions. There
can be no assurance that the Company will be able to identify additional
acquisition candidates on terms favorable to the Company or in a timely manner,
enter into acceptable agreements or close any such transactions. There can be no
assurance that the Company will be able to continue its acquisition strategy,
and any failure to do so could have a materially adverse effect on the Company's
business, financial condition, results of operations and ability to sustain
growth. In addition, the Company believes that it will compete for attractive
acquisition candidates
-12-
with other larger companies, consolidators or investors in the accounts
receivable management industry. Increased competition for such acquisition
candidates could have the effect of increasing the cost to the Company of
pursuing this growth strategy or could reduce the number of attractive
candidates to be acquired. Future acquisitions could divert management's
attention from the daily operations of the Company and otherwise require
additional management, operational and financial resources. Moreover, there is
no assurance that the Company will successfully integrate future acquisitions
into its business or operate such acquisitions profitably. Acquisitions also may
involve a number of special risks including: adverse short term effects on the
Company's operating results; dependence on retaining key personnel; amortization
of acquired intangible assets; and risks associated with unanticipated problems,
liabilities or contingencies.
The Company may raise additional debt or equity financing to fund any
future acquisitions, which may not be available on terms favorable to the
Company, if at all. To the extent the Company uses its capital stock for all or
a portion of the consideration to be paid for future acquisitions, dilution may
be experienced by existing shareholders. In the event that the Company's capital
stock does not maintain sufficient value or potential acquisition candidates are
unwilling to accept the Company's capital stock as consideration for the sale of
their businesses, the Company may be required to utilize more of its cash
resources, if available, in order to continue its acquisition program. If the
Company does not have sufficient cash resources or is not able to use its
capital stock as consideration for acquisitions, its growth through acquisitions
could be limited. See "Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations -- Liquidity and Capital Resources."
Fluctuations in Quarterly Operating Results
The Company has experienced and expects to continue to experience
quarterly variations in revenues and net income as a result of many factors,
including the timing of clients' accounts receivable management programs, the
commencement of new contracts, the termination of existing contracts, costs to
support growth by acquisition or otherwise, the costs and timing of completion
of additional 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. 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. See "Item 7.
Management's Discussion and Analysis of Financial Condition and Results of
Operations."
Dependence on Key Personnel
The Company is highly dependent upon the continued services and
experience of its senior management team, including Michael J. Barrist,
President and Chief Executive Officer. The loss of the services of Mr. Barrist
or other members of its senior management could have a materially adverse effect
on the Company. The Company has five-year employment contracts with Mr. Barrist
and certain other key executives. In addition, the Company has a $4.0 million
key person life insurance policy on Mr. Barrist. See "Management" contained in,
and incorporated by reference to, the Company's Proxy Statement relating to the
1997 Annual Meeting of Shareholders.
-13-
Dependence on Certain Industries; Contract Risks
Most of the Company's revenues are derived from clients in the
education, financial services, healthcare, telecommunications and utilities
industries. A significant downturn in any of these industries or any trends to
reduce or eliminate the use of third-party accounts receivable management
services could have a materially adverse impact on the Company's business,
results of operations and financial condition. 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. Accordingly, there can be no assurance that
existing clients will continue to use the Company's services at historical
levels, if at all. Under the terms of these contracts, clients are not required
to place accounts with the Company but do so on a discretionary basis. In
addition, substantially all of the Company's contracts are on a contingent fee
basis where the Company recognizes revenues only as accounts are recovered. See
"Business."
Competition
The accounts receivable management industry is highly competitive. The
Company competes with approximately 6,300 providers, including large national
corporations such as First Data Corporation, Payco American Corporation, Union
Corporation and many regional and local firms. Many of the Company's competitors
have substantially 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, in many instances, are
performed in-house. Moreover, many larger clients retain multiple accounts
receivable management providers which exposes the Company to continuous
competition in order to remain a preferred vendor. There can be no assurance
that outsourcing of the accounts receivable management function will continue or
that the Company's clients which currently outsource such services will not
bring them in-house. The Company also competes with other firms, such as SITEL
Corporation, APAC Teleservices, Inc. and Teletech Holdings, Inc., in providing
teleservices. As a result of these factors, there can be no assurance that
competition from existing or potential competitors will not have a materially
adverse effect on the Company's results of operations. See
"Business-Competition."
Risk of Business Interruption; Reliance on Computer and Telecommunications
Infrastructure
The Company's success is dependent in large part on its continued
investment in sophisticated telecommunications and computer systems, including
predictive dialers, automated call distribution systems and digital switching.
The Company has invested significantly in technology in an effort to remain
competitive and anticipates that it will be necessary to continue to do so in
the future. Moreover, computer and telecommunication technologies are evolving
rapidly and are characterized by short product life cycles, which requires the
Company to anticipate technological developments. There can be no assurance that
the Company will be successful in anticipating, managing or adopting such
technological changes on a timely basis or that the Company will have the
capital resources available to invest in new technologies. In addition, the
Company's business is highly dependent on its computer and telecommunications
equipment and software systems, the temporary or permanent loss of which,
through casualty or operating malfunction, could have a materially adverse
effect on the Company's business. The Company's business is materially dependent
on service provided by various local and long distance telephone companies. A
-14-
significant increase in the cost of telephone services that is not recoverable
through an increase in the price of the Company's services, or any significant
interruption in telephone services, could have a materially adverse impact on
the Company. See "Business - Operations."
Dependence on Labor Force
The accounts receivable management industry is very labor intensive and
experiences high personnel turnover. Many of the Company's employees receive
modest hourly wages and a portion of these employees are employed on a part-time
basis. A higher turnover rate among the Company's employees would increase the
Company's recruiting and training costs and could adversely impact the quality
of services the Company provides to its clients. If the Company 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 the Company's business
will require it to recruit and train qualified personnel at an accelerated rate
from time to time. There can be no assurance that the Company 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 the Company. See
"Business - Personnel and Training."
Government Regulation
The accounts receivable management and telemarketing industries are
regulated under various federal and state statutes. In particular, the Company
is subject to the federal Fair Debt Collection Practices Act which establishes
specific guidelines and procedures which debt collectors must follow in
communicating with consumer debtors, including the time, place and manner of
such communications. 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, and some
states require that the Company be licensed as a debt collection company. With
respect to the other teleservices offered by the Company, including
telemarketing, the federal Telemarketing and Consumer Fraud and Abuse Prevention
Act of 1994 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 and some states have enacted
restrictions similar to the federal TCPA. The failure to comply with applicable
statutes and regulations could have a materially adverse effect on the Company.
There can be no assurance that additional federal or state legislation, or
changes in regulatory implementation, would not limit the activities of the
Company in the future or significantly increase the cost of regulatory
compliance.
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
-15-
actions for its failure or the failure of its clients to comply with such
regulations. See "Business- Government Regulation."
Control by Principal Shareholders
Michael J. Barrist beneficially owns approximately 33.0% of the Common
Stock, and together with the other executive officers of the Company,
beneficially owns approximately 52.6%. As a result of such voting concentration,
Mr. Barrist, together with other executive officers of the Company, will be able
to effectively control most matters requiring approval by the Company's
shareholders, including the election of directors. Such voting concentration may
have the effect of delaying, deferring or preventing a change in control of the
Company. See "Management" and "Beneficial Ownership of Common Stock" contained
in, and incorporated by reference to, the Company's Proxy Statement relating to
the 1997 Annual Meeting of Shareholders.
Possible Volatility of Stock Price
The Company's Common Stock is listed on the Nasdaq National Market.
Numerous factors, including announcements of fluctuations in the Company's or
its competitors' operating results and market conditions for accounts receivable
management, telemarketing industry or business services stocks in general, the
timing and announcement of acquisitions by the Company or its competitors or
government regulatory action, could have a significant impact on the future
price of the Common Stock. 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 adversely affect the market price of the Common Stock.
Shares Eligible for Future Sale
Sales of the Company's Common Stock in the public market could
adversely affect the market price of the Company's Common Stock and could impair
the Company's future ability to raise capital through the sale of equity
securities. The Company currently has 7,058,625 shares of Common Stock
outstanding, including 345,178 shares issued in connection with the CRWCD
acquisition (the "CRW Shares"). The Company also has outstanding warrants to
purchase an aggregate of 240,591 shares of Common Stock exercisable at any time
on or before July 31, 2005 issued in connection with the Company's revolving
credit facility, a warrant to purchase 250,000 shares of Common Stock
exercisable at any time on or before January 31, 2002 issued in connection with
the CRWCD acquisition, a $1.0 million Convertible Note convertible into 76,923
shares of Common Stock at any time on or before September 5, 2001 issued in
connection with the MAB acquisition and a $900,000 Convertible Note convertible
into 42,503 shares of Common Stock at any time on or before January 22, 2002
issued in connection with the Goodyear acquisition. The CRW Shares, the warrants
and convertible notes are entitled to certain demand and/or piggy-back
registration rights. In addition, the Company intends to register approximately
724,258 shares of Common Stock reserved for issuance to its employees,
directors, consultants and advisors under the Company's 1995 Stock Option Plan,
1996 Stock Option Plan and Non-Employee Director Stock Option Plan. Options to
purchase an aggregate of 438,971 shares of Common Stock currently are
outstanding under all such plans.
-16-
Anti-Takeover Provisions
The Company's Amended and Restated Articles of Incorporation (the
"Articles") and Bylaws (the "Bylaws") contain provisions which may be deemed to
be "anti-takeover" in nature in that such provisions may deter, discourage or
make more difficult the assumption of control of the Company by another
corporation or person through a tender offer, merger, proxy contest or similar
transaction. The Articles permit the Board of Directors to establish the rights,
preferences, privileges and restrictions of, and to issue, up to 5,000,000
shares of Preferred Stock without shareholder approval. The Company's Bylaws
also provide for the staggered election of directors to serve for one-, two- and
three-year terms, and for successive three-year terms thereafter, subject to
removal only for cause upon the vote of not less than 65% of the shares of
Common Stock represented at a shareholders' meeting. Certain provisions of the
Articles and Bylaws may not be amended except by a similar 65% vote. In
addition, the Company is subject to certain anti-takeover provisions of the
Pennsylvania Business Corporation Law.
Item 2. Properties.
The Company leases all of its facilities. The chart below summarizes
the Company's facilities as of December 31, 1996:
Location Approximate
of Facility Square Footage Function
- -------------------- ---------------------- ----------------------------
Denver, CO 4,800 Processing center
Hutchinson, KS 900 Processing center
Wichita, KS 10,000 Processing center
Beltsville, MD 4,700 Processing center
Buffalo, NY 30,000 Processing center
Cleveland, OH 7,000 Processing center
Blue Bell, PA 36,500 Corporate headquarters
and processing center
Philadelphia, PA 5,700 Processing center
The leases of these facilities expire between 1997 and 2010, and most
contain renewal options. In addition, the Company leases sales offices in
Birmingham, Alabama and Canton, Massachusetts.
As a result of the four acquisitions consummated in 1997, the Company
acquired 19 additional leased facilities located throughout the country. 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 1997 acquisitions.
-17-
The Company leases space in four buildings in Blue Bell, Pennsylvania
from three limited partnerships of which the existing shareholders of the
Company are limited partners and Michael J. Barrist is the sole shareholder of
the corporate general partners, pursuant to leases expiring between 1998 and
2000. See "Management - Certain Transactions - Leases" contained in, and
incorporated by reference to, the Company's Proxy Statement relating to the 1997
Annual Meeting of Shareholders.
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.
Item 4.1 Executive Officers of the Registrant who are not Directors.
Name Age Position
- -------------------------------------------- ------------ ------------------------------------------------------
Steven L. Winokur......................... 37 Vice President, Finance, Chief Financial
Officer and Treasurer
Joseph C. McGowan......................... 43 Co-Chief Operating Officer
Michael G. Noah........................... 51 Co-Chief Operating Officer
Steven L. Winokur joined the Company in December 1995 as Vice
President, Finance and Chief Financial Officer. 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 a partner with Gross & Company, a certified public accounting firm, where he
most recently served as Administrative Partner. Mr. Winokur is a certified
public accountant.
Joseph C. McGowan joined the Company in 1990 as Vice President,
Operations and became Co-Chief Operating Officer in February 1997. Prior to
joining the Company, Mr. McGowan was Assistant Manager of the Collections
Department at Philadelphia Gas Works, a public utility, since 1975.
Michael G. Noah has been President of MAB since May 1994. He became
Co-Chief Operating Officer of the Company in February 1997. Prior to joining
MAB, he was an Executive Vice President of Everest National Bank, a subsidiary
of GE Capital, since August 1991.
-18-
PART II
Item 5. Market for the Registrant's Common Stock and
Related Shareholder Matters.
Following the Company's initial public offering of Common Stock on
November 6, 1997, the Company's Common Stock has been 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
1996
Fourth Quarter (from November 6) $19.00 $16.25
1997
First Quarter (through March 27) 29.75 16.3125
As of March 26, 1997, the Company's Common Stock was held by
approximately 25 holders of record.
Dividend Policy
The Company historically was treated for federal and state income tax
purposes as an S Corporation under Subchapter S of the Internal Revenue Code of
1986, as amended (the "Code"), and under Pennsylvania law. As a result of the
Company's status as an S Corporation, the Company's shareholders, rather than
the Company, were taxed directly on the earnings of the Company for federal and
certain state income tax purposes, whether or not such earnings were
distributed. The Company made cash distributions to the then current
shareholders aggregating $658,000, $813,000, $1.1 million and $876,838 in
respect of the Company's S Corporation earnings for 1993, 1994, 1995 and 1996
(through September 3, 1996), respectively. On September 3, 1996 (the
"Termination Date"), the Company terminated its status as an S Corporation and
thereupon became subject to federal and state income taxes at applicable C
Corporation rates. In November 1996, the Company paid to shareholders of record
as of the Termination Date a distribution of $3,246,851 representing the
Company's undistributed S Corporation earnings through the Termination Date.
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.
-19-
Sales of Unregistered Securities during 1996
Set forth below is information concerning certain issuances of Common
Stock during 1996 which were not registered under the Securities Act of 1933.
The Company issued a warrant to purchase 46,560 shares of Common Stock
to Mellon Bank, N.A. upon the amendment of the Company's Credit Agreement in
September 1996. The Company issued an additional warrant to purchase 18,500
shares of Common Stock to Mellon Bank, N.A. in connection with the Bank's
commitment to increase the credit facility to $25.0 million. These warrants have
an exercise price of $13.00 per share and expire on July 31, 2005. All of the
warrants were issued in reliance upon the exemption from the registration
requirements provided by Section 4(2) of the Securities Act.
In September 1996, the Company acquired all of the outstanding stock of
MAB. As part of the purchase price, the Company issued a Convertible Note in the
aggregate principal amount of $1.0 million. This note is convertible at any time
into 76,923 shares of Common Stock at an conversion price of $13.00 per share.
The note was issued in reliance on the exemption from the registration
requirements provided by Section 4(2) of the Securities Act.
In 1996, the Company granted options to certain executive officers and
key employees to purchase an aggregate of 292,854 shares of Common Stock under
the 1995 Stock Option Plan and 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 Company in exchange for such options. The options were issued in reliance
upon the exemption from the registration requirements provided by Section 4(2)
of the Securities Act and, with respect to options issued prior to November 6,
1997, by Rule 701 under the Securities Act.
Date Issued Options Granted Exercise Price
----------- --------------- --------------
July 1996 33,258 $13.00
September 1996 38,801 13.00
October 1996 156,145 13.00
December 1996 64,650 17.00
In December 1996, the Company issued options pursuant to the 1996
Non-Employee Director Stock Option Plan to purchase 1,000 shares of Common Stock
to each of Eric S. Siegel and Alan F. Wise upon their appointment to the Board
of Directors. These options were granted at an exercise price of $18.125 per
share. The options were issued in reliance upon the exemption from the
registration requirements provided by Section 4(2) of the Securities Act.
-20-
Item 6. Selected Financial Data.
SELECTED FINANCIAL AND OPERATING DATA
(Dollars in thousands, except per share data)
For the Years Ended December 31,
---------------------------------------------------------------------------------------------------
1992 1993 1994 1995 1996
------------ ------------ ----------- ----------- -------------------------------
Pro
Actual Forma (1)(2)
-------------- --------------
Statement of Income Data:
Revenue $ 5,822 $ 7,445 $ 8,578 $ 12,733 $ 30,760 $ 39,923
Operating costs and
expenses:
Payroll and related
expenses 3,058 4,123 4,558 6,797 14,651 19,497
Selling, general and
administrative
expenses 2,013 2,391 2,674 4,042 10,033 13,287
Depreciation and
amortization
expenses 95 141 215 348 1,254 1,621
------------ ------------ ----------- ----------- -------------- -------------
Income from operations 656 790 1,131 1,546 4,822 5,518
Other income (expense) 15 11 (45) (180) (575) 102
------------ ------------ ----------- ----------- -------------- -------------
Income before income
taxes (3) 671 801 1,086 1,366 4,247 5,620
Pro forma provision for
income taxes(3) 268 320 434 546 613 2,248
------------ ------------ ----------- ----------- -------------- -------------
Pro forma net income(3) $ 403 $ 481 $ 652 $ 820 $ 3,634 $ 3,372
============ ============ =========== =========== ============== =============
Pro forma net income
per share $ 0.17(4) $ 0.50(4) $ 0.54
=========== ============= =============
Pro forma weighted
average shares out-
standing 4,728,906(4) 5,086,736(4) 6,242,660
========== ============= =============
Operating Data:
Total value of accounts
referred $ 150,707 $ 199,108 $ 281,387 $ 431,927 $ 1,173,342 $ 1,581,748
Average fee 16.9% 20.2% 22.5% 22.4% 25.2% 25.0%
December 31,
----------------------------------------------------------------------
1992 1993 1994 1995 1996
----------- ----------- -------------- -------------- --------------
Balance Sheet Data:
Cash and cash equivalents $ 421 $ 562 $ 52 $ 805 $ 12,058
Working capital 362 445 473 812 13,629
Total assets 1,794 1,990 3,359 6,644 35,826
Long-term debt, net of current portion 144 59 732 2,593 1,091
Shareholders' equity 686 876 1,423 2,051 30,647
(1) Assumes that the acquisition of MAB occurred on January 1, 1996
(2) Gives effect to: (i) the reduction of certain redundant operating costs and
expenses that were immediately identifiable at the time of the MAB acquisition;
(ii) the elimination of interest expense associated with acquisition-related
debt repaid with offering proceeds; and (iii) the issuance of 1,604,620 shares
of common stock at $13.00 per share, net of commissions and offering expenses,
sufficient to repay acquisition-related debt of $15.0 million and to fund the
distribution of undistributed S Corporation earnings of $3.2 million.
(3) Prior to September 3, 1996, the Company operated as an S Corporation for
income tax purposes and accordingly was not subject to federal or state income
taxes. Accordingly the historical financial statements do not include a
provision for federal and state income taxes for such periods. Pro forma net
income has been computed as if the Company had been fully subject to federal and
state income taxes for all periods presented.
(4) Assumes that the Company issued 249,758 shares of Common Stock at $13.00
per share to fund the distribution of undistributed S Corporation earnings of
$3.2 million through the Termination Date to existing shareholders of the
Company.
-21-
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations.
Results of Operations:
The following table sets forth income statement data on an historical
and pro forma basis as a percentage of revenue:
Years Ended December 31,
-----------------------------------------------------------------------
1992 1993 1994 1995 1996
------- -------- ------- ------- ------------------
Pro
Actual Forma
-------- --------
Revenue 100.0 % 100.0 % 100.0 % 100.0 % 100.0 % 100.0 %
Operating costs and expenses:
Payroll and related expenses 52.5 55.4 53.1 53.4 47.6 48.8
Selling, general and administrative
expenses 34.6 32.1 31.2 31.7 32.6 33.3
Depreciation and amortization expense 1.6 1.9 2.5 2.7 4.1 4.1
------- -------- ------- -------- -------- --------
Total operating costs and expenses 88.7 89.4 86.8 87.8 84.3 86.2
------- -------- ------- -------- -------- --------
Income from operations 11.3 10.6 13.2 12.2 15.7 13.8
Other income (expense): 0.3 0.1 (0.5) (1.4) (1.9) 0.3
------- -------- ------- -------- -------- --------
Income before provision for income taxes 11.6 10.7 12.7 10.8 13.8 14.1
Pro forma provision for income taxes 4.6 4.3 5.1 4.3 2.0 5.6
------- -------- ------- -------- -------- --------
Pro forma net income 7.0 % 6.4 % 7.6 % 6.5 % 11.8 % 8.5 %
======= ======== ======= ======== ======== ========
Pro Forma Compared to Actual Results of Operations
Pro forma operating data for 1996 assume that the MAB acquisition was
consummated on January 1, 1996. Pro forma adjustments have been made to reflect
the elimination of certain expenses that were immediately identifiable at the
time of the acquisition, including the elimination of certain redundant
collection and administrative personnel. At the time of the acquisition, MAB had
a higher cost structure than the Company. In the months following the
acquisition, the Company has leveraged its infrastructure to realize additional
operating efficiencies in order to bring the cost structure of MAB in line with
NCO's current operating results. These other costs savings include (i) further
reduction in payroll and related expenses relating primarily to redundant
collections and administrative personnel, (ii) further reductions in facilities
costs, and (iii) reduction of certain expenses such as telephone, mailing and
data processing. Due to the higher cost structures of the acquired business and
the fact that all expected expense savings are not reflected in pro forma
adjustments, certain pro forma operating percentages compare unfavorably to
actual operating percentages for the periods under consideration.
Year ended December 31, 1996 Compared to Year ended December 31, 1995
Revenue. Revenue increased $18.0 million or 141.6% to $30.8 million in
1996 from $12.7 million in 1995. Of this increase, $5.0 million was attributable
to the MAB acquisition completed in September 1996, $6.8 million was
attributable to the TCD acquisition completed in January 1996, and $1.3 million
was attributable to a full year of revenue from the Eastern acquisition in 1996
versus three months in 1995. This was partially offset by a decrease in revenue
from the BRM acquisition to $1.3 million in 1996 from $1.4 million in 1995.
Additionally, the
22
Company experienced 46.7% internal growth from the addition of new clients and a
growth in business from existing clients. Of this internal growth, $2.9 million
of the increase was due to a full twelve months of revenue in 1996 from a
contract awarded to the Company by a government agency in April 1995. Revenue
from other related services, which became an area of focus in 1996, increased
$1.2 million to $1.5 million in 1996 from $259,000 in 1995.
Payroll and related expenses. Payroll and related expenses increased
$7.8 million to $14.6 million in 1996 from $6.8 million in 1995, but decreased
as a percentage of revenue to 47.6% from 53.5%. The decrease in payroll and
related expenses as a percentage of revenue was primarily the result of
spreading the relatively fixed costs of management and administrative personnel
over a larger revenue base and the increased utilization of "on-line" computer
services and other outside services, as well as eliminating redundant
administrative staff following the TCD and Eastern acquisitions. These
efficiencies were offset in part by higher payroll and related expenses of MAB
as a percentage of its revenue. The effect of MAB was minimal due to only four
months of the operations of MAB being included in the income statements.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $6.0 million to $10.0 million in 1996, from
$4.0 million in 1995, and increased as a percentage of revenue to 32.6% from
31.7%. A large percentage of the increase was due to the increased costs
associated with litigation management services performed by the Company on
behalf of its clients in states where the laws are more conducive to the
utilization of the legal process for recovery of delinquent accounts. In
addition, the Company experienced increased costs as a result of a change in
business mix which required the increased use of national data bases and credit
reporting services. These increases were offset in part by operating
efficiencies resulting from the TCD acquisition.
Depreciation and amortization. Depreciation and amortization increased
to $1.3 million in 1996 from $348,000 in 1995. Of this increase, $605,000 was a
result of the MAB, TCD and Eastern acquisitions. The remaining $301,000
consisted of amortization of deferred financing charges and depreciation
resulting from capital expenditures incurred in the ordinary course of business.
Other income (expense). Interest expense increased to $818,000 in 1996
from $180,000 in 1995, primarily due to increased borrowings associated with the
acquisitions of MAB, TCD and Eastern. Also included in other income (expense)
for 1995 was a loss from the disposal of assets of $49,000.
Income tax expense, net of benefit:Income tax expense in 1996 was
$768,000. This was offset by the recognition of a deferred tax benefit of
$155,000 attributable to the termination of the S Corporation election by the
Company.
Net income. Net income was $3.6 million and $1.4 million in 1996 and
1995, respectively. Net income pro forma for taxes increased to $2.5 million in
1996 from $820,000 in 1995, a 210.0% increase. Net income pro forma for taxes
includes a provision for federal and state income taxes at an assumed rate of
40% in 1996 and 1995.
Year Ended December 31, 1995 Compared to Year Ended December 31, 1994
Revenue. Revenue increased $4.2 million or 48.4% to $12.7 million in
1995 from $8.6 million in 1994. In 1995, the Company initiated a marketing
program targeted at larger national accounts. As a result, the company
experienced 38% internal growth from the addition of new clients and growth in
business from existing clients. This growth includes approximately $1.3 million
from a contract with a governmental agency awarded in April 1995. In addition to
strong internal growth, approximately $808,000 of the increase in revenue was
attributable to the Eastern acquisition, and $437,000 was attributable to a full
year of operations of BRM in 1995 versus eight months in 1994. This was
partially offset by a decrease in revenue from outsourcing projects to $259,000
in 1995 from $357,000 in 1994. Approximately $300,000 in revenue from
outsourcing projects in 1994 was from a one-time project completed in the first
quarter of 1994.
Payroll and related expenses. Payroll and related expenses increased
$2.2 million to $6.8 million in 1995 from $4.6 million in 1994, and increased
slightly as a percentage of revenue to 53.4% from 53.1%. During the fourth
23
quarter of 1995, the Company hired a Vice President of Collection, as well as 20
additional telephone representatives necessary for two outsourcing projects
which did not generate revenue until the first quarter of 1996. In addition, the
one-time outsourcing project completed during the first quarter of 1994 had
lower payroll and related expenses as a percentage of revenue. The increases in
personnel were partially offset by spreading the relatively fixed costs of the
Company's management and administrative personnel over a larger revenue base, as
well as the elimination of redundant administrative staff related to the Eastern
acquisition.
Selling, general and administrative expenses. Selling general and
administrative expenses increased $1.3 million to $4.0 million in 1995, from
$2.7 million in 1994 and increased as a percentage of revenue to 31.7% from
31.2%. These increases were primarily due to higher data processing and
processing and facilities costs in anticipation of growth and to allow for the
rapid assimilation of the TCD acquisition in the first quarter of 1996 without
having to purchase short-term administrative services from the parent company of
TCD during the post-acquisition transition.
Depreciation and amortization. Depreciation and amortization increased
to $348,000 in 1995 from $215,000 in 1994. Of this increase, $90,000 was
attributable to the Eastern and BRM acquisitions. The remaining $43,000
consisted of amortization of deferred financing charges and depreciation
resulting from capital expenditures incurred in the ordinary course of business.
Other income (expense). Interest expense increased to $180,000 in 1995
from $72,000 in 1994, primarily due to increased borrowings associated with the
Eastern and BRM acquisitions. The Company recorded a $49,000 loss from the
disposal of assets in 1995.
Net income. Net income pro forma for taxes increased to $820,000 in1995
from $652,000 in 1994, representing a 25.7% increase. Net income pro forma for
taxes includes a provision for federal and state income taxes at an assumed rate
of 40% for the years ended December 31, 1995 and 1994.
Quarterly Results
The following table sets forth selected actual historical financial
data for the calendar quarters of 1995 and 1996. 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 the Company's opinion,
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.
Quarter ended
-------------------------------------------------------------------------------------
1995 1996
-------------------------------------------------------------------------------------
Mar. Jun. Sept. Dec. Mar. Jun. Sept. Dec.
31 30 30 31 31 30 30 31
--------- --------- -------- -------- --------- --------- -------- ---------
(dollars in thousands)
Revenue $2,544 $3,002 $3,480 $3,707 $6,044 $6,499 $7,715 $10,502
Income from
operations 244 485 496 320 915 1156 1183 1569
Net income 227 429 460 250 760 1001 968 906
24
Quarter ended
-------------------------------------------------------------------------------------
1995 1996
-------------------------------------------------------------------------------------
Mar. Jun. Sept. Dec. Mar. Jun. Sept. Dec.
31 30 30 31 31 30 30 31
--------- --------- -------- -------- --------- --------- -------- ---------
(as a percentage of revenue)
Revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Income from
operations 9.6% 16.2% 14.3% 8.6% 15.1% 17.8% 15.3% 14.9%
Net income 8.9% 14.3% 13.2% 6.7% 12.6% 15.4% 12.5% 8.6%
In the past, the company has experienced quarterly fluctuations in
operating expenses. Due to the low revenue base of the company at the time these
costs were incurred, the impact of these fluctuations was more significant than
if they had occurred at the Company's current revenue base. For instance, the
fourth quarter of 1995 included additional costs primarily due to increases in
data processing and facilities costs in anticipation of growth and to allow for
the rapid assimilation of the TCD acquisition.
The Company could experience quarterly variations in revenue and
operating income as a result of many factors, including the timing of clients'
referrals of accounts, the timing of acquisitions that may be effected in the
future, the timing of the hiring of personnel, the timing of additional selling,
general and administrative expenses incurred to support new business and changes
in the Company's revenue mix among its various service offerings. In connection
with certain contracts, the Company could incur costs in periods prior to
recognizing revenue under those contracts. In addition, the Company must plan
its operating expenditures based on revenue forecasts, and a revenue shortfall
below such forecast in any quarter would likely adversely affect the Company's
operating results for the quarter. While the effects of seasonality of NCO's
business have historically been obscured by its rapid growth, the Company's
business tends to be slower in the third and fourth quarter of the year due to
the summer and the holiday seasons.
Liquidity and Capital Resources
The Company's primary sources of cash have historically been cash flow
from operations and bank borrowings. Cash has been used for acquisitions of
accounts receivable management companies and distributions to shareholders, and
for purchases of equipment and working capital to support the Company's growth.
Cash provided by operating activities was $2.9 million in 1996, and
$2.0 million in 1995. The increase in cash provided by operations was primarily
due to the increase in net income to 3.6 million in 1996 compared to $1.4
million in 1995, and the increase in non-cash charges, primarily depreciation
and amortization, to $1.3 million in 1996 compared to $348,000 in 1995. These
increases were offset by a $1.8 million increase in accounts receivable in 1996
compared to a $571,000 increase in 1995 and a $222,000 increase in accounts
payable and accrued expenses in 1996 compared to a $858,000 increase in 1995.
Cash used in investing activities was $13.5 million in 1996 compared to
$2.0 million in 1995. The increase was primarily due to the acquisition of MAB
and TCD. In September 1996, the Company purchased all the outstanding stock of
MAB for $8.0 million in cash and the issuance of a $1.0 million, five-year
convertible note to the principal shareholder of MAB. The note is convertible
into the Common Stock of the Company at the initial public offering price of
$13.00 per share, and bears interest payable monthly at a rate of 8.0% per
annum. In January 1996, the Company purchased all the assets of TCD for $4.8
million in cash. In August 1995, the Company purchased certain assets of Eastern
for $1.6 million in cash and the assumption of a non-interest bearing note
payable of $252,000 and certain other accounts payable in the amount of
$209,000. The Company financed the cash portion of these acquisitions with bank
borrowings. These acquisitions collectively resulted in goodwill of $14.2
million which is being amortized at approximately $722,000 per year.
25
Cash provided by financing activities was $21.8 million in 1996
compared with $280,000 in 1995. Bank borrowings had been the Company's primary
source of cash from financing activities and were used for the acquisition of
MAB, TCD and Eastern and, along with cash provided by operations, for
distributions to shareholders. Following the completion of the Company's initial
public offering in November 1996 (the "Offering"), the Company repaid the
outstanding bank debt and distributed undistributed S Corporation earnings of
approximately $3.2 million using a portion of the net proceeds from the
Offering. Total distributions to shareholders were $4.1 million in 1996 and $1.1
million in 1995.
In July 1995, the Company entered into a revolving credit agreement
with Mellon Bank, N.A. which provided for borrowings up to $7.0 million at an
interest rate equal to prime plus 1.375%, which was subsequently increased to
$15.0 million in September 1996, to be utilized for working capital and
strategic acquisitions. Subsequent to the Offering, the bank increased the
revolving credit facility to $25.0 million and decreased the rate of interest to
2.5% over LIBOR. There were no outstanding borrowings as of December 31, 1996,
and as of December 31, 1995, the outstanding balance under the revolving credit
line was $2.5 million. The revolving credit line is collateralized by
substantially all the assets of the Company and includes certain financial
covenants such as maintaining minimum working capital and net worth requirements
and includes restrictions on, among other things, capital expenditures and
distributions to shareholders.
In connection with entering into the original revolving credit
agreement, the Company recorded deferred charges of approximately $135,000
relating primarily to bank and legal fees. The Company also issued a warrant to
the bank exercisable for an aggregate of 175,531 shares of the Company's Common
Stock. The warrant expires on July 31, 2005 and is exercisable for nominal
consideration. In connection with the expansion of the line of credit in
September 1996 and December 1996, the Company recorded deferred charges of
$261,000 primarily relating to bank charges and legal fees. In addition, the
Company issued additional warrants to the bank for 65,060 shares of Common Stock
exercisable at $13.00 per share. The increase in the revolving credit facility
was completed in December 1996. The warrants have been capitalized on the
balance sheet as a deferred charge and are being amortized over the four-year
life of the credit facility. All the warrants are currently exercisable.
On November 13, 1996, the Company completed its initial public
offering, selling 2,875,000 shares of Common Stock including 375,000
over-allotment shares sold by existing shareholders. The Offering raised net
proceeds of approximately $30.2 million for the Company. After offering
expenses, repayment of acquisition debt and the distribution of S Corporation
earnings, the Company had available at December 31, 1996, for working capital
and general corporate purposes as well as possible future acquisitions, proceeds
of approximately $10.9 million, in addition to existing cash of $1.2 million, as
well as $25 million available for borrowing from the bank on the revolving
credit facility.
The Company believes that funds generated from operations, together
with existing cash, the net proceeds from the Offering and available credit
under its revolving credit line will be sufficient to finance its current
operations and planned capital expenditure requirements and internal growth at
least through 1997. However, the Company may raise additional debt or equity
financing to fund any future acquisitions.
On January 22, 1997, NCO purchased all of the outstanding stock of
Goodyear & Associates, Inc. ("Goodyear") for $4.5 million in cash and a $900,000
convertible note. The note is convertible into the Company's Common Stock, at
any time, at $21.175 per share and bears interest payable monthly at a rate of
8.0% per annum with principal due in January 2002. Goodyear, based in Charlotte,
North Carolina provides accounts receivable management services principally to
the telecommunications, education, and utility industries. Goodyear's revenues
in 1996 were $5.5 million.
On January 30, 1997, NCO purchased certain assets of Tele-Research
Center, Inc. ("TRC"), for $1.6 million in cash. TRC, located in Philadelphia,
Pennsylvania, provides market research, data collection, and other teleservices
to market research companies as well as end-users. TRC's revenues in 1996 were
$1.8 million.
26
On January 31, 1997, NCO purchased certain assets of CMS A/R Services,
a division of CMS Energy Corporation, owner of Consumers Energy, one of the
nation's largest utility companies, for $5.1 million in cash. Specializing in
the utility industry, CMS A/R Services, located in Jackson, Michigan, provided a
wide range of accounts receivable management services in addition to traditional
recovery of delinquent accounts including project outsourcing, early
intervention, and database management services. CMS A/R Services' revenues in
1996 were $6.8 million.
On February 2, 1997, NCO purchased certain assets of the Collections
Division of CRW Financial, Inc. (Nasdaq small market symbol CRWF) ("CRWCD") for
$3.75 million in cash, 345,178 shares of its Common Stock and warrants for
250,000 shares of Common Stock. The acquisition was valued at approximately
$12.8 million. CRWCD provided accounts receivable management services
principally to the telecommunications, education, financial, government and
utility industries from 14 offices located throughout the United States. In
addition, CRWCD has a commercial collections division. CRWCD's revenues in 1996
were $25.9 million.
The Company has begun to realize operating efficiencies from the
Goodyear, CMS A/R Services, TRC and CRWCD acquisitions and has begun to
eliminate redundant collection and administrative personnel, consolidate office
locations, and reduce selling, general and administrative expenses to levels
more consistent with NCO's current operating results. In addition, the Company
has reduced the payroll and related expenses associated with the former
principal shareholder of Goodyear.
The Company financed the acquisitions of Goodyear, CMS A/R Services,
TRC and CRWCD, by borrowing $7.35 million on its revolving credit facility and
financed the remainder through funds raised in the Offering and through its
existing working capital.
The Company accounts for corporate income taxes in accordance with the
Statement of Financial Accounting Standards No.109 (SFAS No. 109). Upon the
termination of the S Corporation election by NCO Financial Systems, Inc. on
September 3, 1996 and upon application of SFAS No. 109, the Company recorded a
deferred tax asset of $155,000, representing cumulative temporary differences.
This deferred tax asset was offset by the $84,000 deferred tax liability
recorded by MAB upon termination of its S Corporation election immediately prior
to its acquisition by NCO Group, Inc.
Recent Accounting Pronouncements:
In March 1995, the FASB issued Statement of Financial Accounting
Standards SFAS No. 121, "Accounting for the Impairment of Long-Lived Assets and
for Long-Lived Assets to Be Disposed of," which was effective for the Company
beginning January 1, 1996. SFAS No. 121 requires that long-lived assets and
certain identifiable intangibles be reviewed 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. SFAS No.
121 had no impact on the financial statements upon adoption.
27
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.
28
PART III
Item 10. Directors and Executive Officers of the Registrant.
Incorporated by reference from the Company's Proxy Statement
relating to the 1997 Annual Meeting of Shareholders to be filed pursuant to
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 hereof.
Item 11. Executive Compensation.
Incorporated by reference from the Company's Proxy Statement
relating to the 1997 Annual Meeting of Shareholders to be filed pursuant to
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 1997 Annual Meeting of Shareholders to be filed pursuant to
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 1997 Annual Meeting of Shareholders to be filed pursuant to
General Instruction G(3) to Form 10-K.
29
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 notes thereto of NCO Group, Inc.,
which are attached hereto beginning on page F-1, have been incorporated by
reference into Item 8 of this Report on Form 10-K:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1996 and 1995
Consolidated Statements of Income for each of the
three years in the three-year period ended December 31, 1996
Consolidated Statements of Shareholders' Equity for each of the
years
in the three-year period ended December 31, 1996
Notes to Consolidated Financial Statements
2. List of Financial Statement Schedules. Not applicable.
3. List of Exhibits filed pursuant to 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 "*":
(a) Exhibits
Exhibit No. Description
- ------------------ ---------------------------------------------------------------------
3.1(1) The Company's amended and restated Articles of Incorporation.
3.2(1) The Company's amended and restated Bylaws.
4.1 Specimen of Common Stock Certificate.
*10.1(1) Employment Agreement, dated September 1, 1996, between the Company
and Bernard R. Miller.
*10.2(1) Employment Agreement, dated September 1, 1996, between the Company
and Michael J. Barrist.
*10.3(1) Employment Agreement, dated September 1, 1996, between the Company
and Charles C. Piola, Jr.
30
Exhibit No. Description
- ------------------ ---------------------------------------------------------------------
*10.4(1) Employment Agreement, dated September 1, 1996, between the Company
and Joseph C. McGowan.
*10.5(1) Employment Agreement, dated September 1, 1996, between the Company
and Steven L. Winokur.
*10.6(1) Agreements of Lease dated May 9, 1995, as amended,
between the Company and 1710-20 Sentry East
Associates, L.P., relating to the offices located at
1710 Walton Road, Blue Bell, Pennsylvania.
10.7(1) Agreements of Lease dated July 1, 1993 between the
Company and 1740 Sentry East Associates, L.P.,
relating to the offices located at 1740 Walton Road,
Blue Bell, Pennsylvania.
10.8(1) Lease Agreement by and between The Uniland
Partnership, L.P. and Management Adjustment Bureau,
Inc., as amended by First Amendment to Lease, dated
December 10, 1994, as further amended by Second
Amendment to Lease, dated December 10, 1994.
10.9(1) Software License Agreement and Software Purchase
Agreement by and between the Company and CRSoftware,
Inc., relating to computer software (CRS Credit Bureau
Reporting Software) and computer hardware.
*10.10(1) Amended and Restated 1995 Stock Option Plan.
*10.11(1) 1996 Stock Option Plan.
*10.12(1) 1996 Non-Employee Director Stock Option Plan.
10.13(1) Amended and Restated Credit Agreement by and among the
Company, its subsidiaries and Mellon Bank, N.A., dated
September 5, 1996.
10.14(1) Amended and Restated Security Agreement, dated
September 5, 1996, by and among the Company, its
subsidiaries and Mellon Bank, N.A.
10.15(1) Warrant Agreement, dated July 28, 1995, by and between the Company and
Mellon Bank, N.A. and Amendment dated September 5, 1996.
10.16(1) Warrant Agreement, dated September 5, 1996, by and between the
Company and Mellon Bank, N.A.
10.17 Second Amended and Restated Registration Rights
Agreement, dated December 13, 1996, by and between the
Company and Mellon Bank, N.A.
10.18 First Amendment dated December 13, 1996 to Amended and
Restated Credit Agreement by and among the Company,
its subsidiaries and Mellon Bank, N.A., dated
September 5, 1996.
31
Exhibit No. Description
- ------------------ ---------------------------------------------------------------------
10.19 Second 1996 Warrant Agreement, dated December 13,
1996, by and between the Company and Mellon Bank, N.A.
10.20(1) Stock Pledge Agreement, dated as of September 5, 1996 made by NCO
Group, Inc. in favor of Mellon Bank, N.A.
10.21(1) Convertible Note dated September 1, 1996, made by the
Company in the principal amount of $1,000,000, as
partial payment of the purchase price for the
acquisition of MAB.
10.22(1) Distribution and Tax Indemnification Agreement
10.23(1) Irrevocable Proxy Agreement by and between Michael J. Barrist and
Annette H. Barrist.
10.24(1) Common Stock Purchase Warrant for 175,531 shares issued to Mellon
Bank, N.A.
10.25(1) 1996 Common Stock Purchase Warrant for 46,560 shares issued to Mellon
Bank, N.A.
10.26 Second 1996 Common Stock Purchase Warrant for 18,500 shares issued to
Mellon Bank, N.A.
10.27(1) Indemnification Agreement by and between NCO Financial Systems, Inc.,
Management Adjustment Bureau, Inc. and Craig Costanzo.
10.28(1) Stock Purchase Agreement, by and among the Company, and Craig
Costanzo and Andrew J. Boyuka, as Trustee of the Susan E. Costanzo
Grantor Trust and Christopher A. Costanzo Grantor Trust, relating to the
acquisition of MAB.
10.29(1) Asset Purchase Agreement dated December 8, 1995 by and
between the Company and Trans Union Corporation.
10.30(2) Stock Purchase Agreement, dated January 22, 1997, by
and among NCO and the majority shareholders of
Goodyear. NCO will furnish to the Securities and
Exchange Commission a copy of any omitted schedule
upon request.
10.31(2) Stock Purchase Agreement, dated January 22, 1997, by
and among NCO and the minority shareholders of
Goodyear. NCO will furnish to the Securities and
Exchange Commission a copy of any omitted schedule
upon request.
32
Exhibit No. Description
- ------------------ ---------------------------------------------------------------------
10.32(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.
10.33(3) Asset Purchase Agreement, dated January 30, 1997, by
and among NCO, Tele-Research, Strategic Information,
Inc. and the Tele-Research shareholders. NCO will
furnish to the Securities and Exchange Commission a
copy of any omitted schedule upon request.
10.34(4) Asset Purchase Agreement, dated January 21, 1997, by
and among NCO, and CMS A/R Services. NCO will furnish
to the Securities and Exchange Commission a copy of
any omitted schedule upon request.
10.35(4) Asset Acquisition Agreement, dated February 2, 1997, by and among CRW
Financial Systems, Inc. ("CRW"), Kaplan & Kaplan, Inc., NCO, CRWF
Acquisition, Inc., and K&K Acquisition, Inc. dated February 2, 1997. NCO
will furnish to the Securities and Exchange Commission a copy of any
omitted schedule upon request.
10.36(4) Non-Transferable Common Stock Purchase Warrant dated February 2, 1997
issued to CRW.
10.37(4) Registration Rights Agreement dated February 2, 1997 between NCO and
CRW.
10.38(4) Nondisclosure, Nonsolicitation, Noncompetition and Standstill Agreement
dated February 2, 1997 between Jonathan P. Robinson and NCO.
10.39(4) Nondisclosure, Nonsolicitation, Noncompetition and Standstill Agreement
dated February 2, 1997 between J. Brian O'Neill and NCO.
21.1 Subsidiaries of the Registrant.
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 18, 1997.
33
(b). Reports on Form 8-K. No reports on Form 8-K were filed
during the quarter ended December 31, 1996.
34
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 31, 1997 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, March 31, 1997
- ---------------------------------- President and Chief
Michael J. Barrist Executive Officer (principal
executive officer)
/s/ Charles C. Piola
- ---------------------------------- Executive Vice President March 31, 1997
Charles C. Piola and Director
/s/ Steven L. Winokur Vice President of Finance, March 31, 1997
- ----------------------------------- Chief Financial Officer and
Steven L. Winokur Treasurer (principal
financial and accounting
officer)
/s/ Bernard R. Miller
- ----------------------------------- Senior Vice President, March 31, 1997
Bernard R. Miller Development and Director
/s/ Eric S. Siegel
- ----------------------------------- Director March 31, 1997
Eric S. Siegel
/s/ Allen F. Wise
- -----------------------------------
Allen F. Wise Director March 31, 1997
35
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants.........................................F-2
Consolidated Balance Sheets as of December 31, 1996 and 1995 .............F-3
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1996.....................................F-4
Consolidated Statements of Shareholders' Equity for each of the years
in the three year period ended December 31, 1996..........................F-5
Consolidated Statements of Cash Flows for each of the years
in the three year period ended December 31, 1996..........................F-6
Notes to Consolidated Financial Statements................................F-7
F-1
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders of
NCO Group, Inc.
Blue Bell, Pennsylvania
We have audited the accompanying consolidated balance sheets of NCO Group, Inc.
as of December 31, 1996 and 1995 and the related consolidated statements of
income, shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 1996. 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 consolidated financial position of NCO Group, Inc. as
of December 31, 1996 and 1995 and the results of its operations and its cash
flows for each of the three years in the period ended December 31, 1996 in
conformity with generally accepted accounting principles.
Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 7, 1997
F-2
NCO GROUP, INC.
Consolidated Balance Sheets
December 31,
----------------------------------
ASSETS 1996 1995
---------------- ---------------
Current assets:
Cash and cash equivalents $ 12,058,798 $ 804,550
Available-for-sale securities 299,488
Accounts receivable, trade, net of
allowance for doubtful accounts of $79,000 and $23,200, respectively 4,701,364 1,402,546
Notes receivable 100,000
Other current assets 499,815 118,793
---------------- ---------------
Total current assets 17,259,977 2,725,377
Funds held in trust for clients
Property and equipment, net 2,830,062 637,133
Other assets:
Intangibles, net of accumulated amortization 14,673,155 2,774,894
Deferred taxes 70,760
Deferred financing costs 684,390 279,014
Other assets 308,011 227,826
---------------- ---------------
Total other assets 15,736,316 3,281,734
---------------- ---------------
Total assets $ 35,826,355 $ 6,644,244
================ ===============
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 46,946 $ 46,171
Capitalized lease obligations, current portion 62,131
Corporate taxes payable 216,709
Accounts payable 657,647 221,562
Accrued expenses 1,044,536 565,734
Accrued compensation and related expenses 1,376,982 777,985
Unearned revenue, net of related costs 225,817 302,384
---------------- ---------------
Total current liabilities 3,630,768 1,913,836
Funds held in trust for clients
Long-term liabilities:
Long term debt, net of current portion 1,091,901 2,592,906
Capitalized lease obligations, net of current portion 385,683
Unearned revenue, net of related costs 70,385 86,155
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, 5,000,000 shares authorized,
no shares issued and outstanding
Common stock, no par value, 25,000,000 shares authorized,
6,713,447 and 4,213,447 shares issued and outstanding
at December 31, 1996 and 1995 respectively. 29,362,326 537,326
Unexercised warrants 396,054 177,294
Retained earnings 889,238 1,378,261
Unrealized gain on securities 41,339
Note receivable, shareholder (82,873)
---------------- ---------------
Total shareholders' equity 30,647,618 2,051,347
---------------- ---------------
Total liabilities and shareholders' equity $ 35,826,355 $ 6,644,244
================ ===============
The accompanying notes are an integral part
of these consolidated financial statements
F-3
NCO GROUP, INC.
Consolidated Statements of Income
For the Years Ended December 31,
------------------------------------------------------
1996 1995 1994
---------------- ---------------- ---------------
Revenue $ 30,760,452 $ 12,732,597 $ 8,577,895
Operating costs and expenses:
Payroll and related expenses 14,651,384 6,797,338 4,558,351
Selling, general and administrative
expenses 10,032,216 4,042,342 2,673,521
Depreciation and amortization expense 1,253,867 347,503 215,117
---------------- ---------------- ---------------
Total operating costs and expenses 25,937,467 11,187,183 7,446,989
---------------- ---------------- ---------------
Income from operations 4,822,985 1,545,414 1,130,906
Other income (expense):
Interest and investment income 242,380 49,473 26,735
Interest expense (817,951) (180,205) (71,588)
Loss on disposal of property and equipment (49,082)
---------------- ---------------- ---------------
(575,571) (179,814) (44,853)
---------------- ---------------- ---------------
Income before provision for income taxes 4,247,414 1,365,600 1,086,053
Income tax expense 612,748
---------------- ---------------- ---------------
Net income $ 3,634,666 $ 1,365,600 $ 1,086,053
================ ================ ===============
Pro forma (unaudited):
Historical income before income taxes $ 4,247,414 $ 1,365,600 $ 1,086,053
Pro forma provision for income taxes 1,706,485 546,000 434,000
---------------- ---------------- ---------------
Pro forma net income $ 2,540,929 $ 819,600 $ 652,053
================ ================ ===============
Pro forma net income per share $ 0.50 $ 0.17
================ ================
Pro forma weighted average shares
outstanding 5,086,736 4,728,906
================ ================
The accompanying notes are an integral part
of these consolidated financial statements
F-4
NCO GROUP, INC.
Consolidated Statements of Shareholders' Equity
Common Stock Unrealized
-------------------------- Gains Notes
Number of Unexercised Retained (Losses) on Receivable
Shares Amount Warrants Earnings Securities Shareholder Total
-------------- --------- ----------- ---------- ------------- -------------- -----------
Balance, January 1, 1994 $4,002,763 $ 49,326 $ 813,366 $ 13,539 $ 876,231
Issuance of common stock 123,803 300,000 300,000
Net income 1,086,053 1,086,053
Distributions to shareholders (813,366) (813,366)
Change in unrealized losses
on securities (26,234) (26,234)
-------------- ----------- ---------- ------------ ---------- ----------- ------------
Balance, December 31, 1994 4,126,566 349,326 1,086,053 (12,695) 1,422,684
Issuance of common stock 86,881 188,000 $ (135,888) 52,112
Warrants issued $ 177,294 177,294
Note repayments 53,015 53,015
Net income 1,365,600 1,365,600
Distributions to shareholders (1,073,392) (1,073,392)
Change in unrealized gains
on securities 54,034 54,034
-------------- ----------- ---------- ------------ ------- ------- ---------
Balance, December 31, 1995 4,213,447 537,326 177,294 1,378,261 41,339 (82,873) 2,051,347
Issuance of common stock 2,500,000 28,825,000 28,825,000
Warrants issued 218,760 218,760
Note repayments 82,873 82,873
Net income 3,634,666 3,634,666
Distributions to shareholders (4,123,689) (41,339) (4,165,028)
------------- ----------- ---------- ------------ -------- -------- -----------
Balance, December 31, 1996 $6,713,447 29,362,326 $ 396,054 $ 889,238 $30,647,618
============= =========== ========== ============= ============ ======= ===========
The accompanying notes are an integral part of these
consolidated financial statements
F-5
NCO GROUP, INC
Consolidated Statements of Cash Flows
For the Years Ended December 31,
------------------------------------------------------
1996 1995 1994
---------------- ---------------- ---------------
Cash flows from operating activities:
Net income $ 3,634,666 $ 1,365,600 $ 1,086,053
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 465,785 199,123 171,378
Loss on disposal of equipment 49,082
(Gain) Loss on sale of securities (70,481) 2,877 4,421
Amortization of intangibles 707,050 221,813 43,739
Amortization of deferred financing costs 81,031 32,443
Provision for doubtful accounts 55,845 3,808 3,903
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (1,825,307) (571,611) (41,675)
Notes receivable 155,856 (36,000) (64,000)
Accounts receivable, purchased (4,755) 36,293 (44,038)
Other current assets (307,988) (22,241) 31,126
Deferred taxes (154,684)
Other assets (8,903) (105,037) (40,112)
Accounts payable 422,694 161,601 (123,094)
Corporate taxes payable 216,709
Accrued expenses (788,709) 187,353 (214)
Accrued compensation and related costs 598,997 555,398 51,755
Unearned revenue (227,548) (46,718) 23,950
------------ ------------ ------------
Net cash provided by operating activities 2,950,258 2,033,784 1,103,192
Cash flows from investing activities:
Purchase of property and equipment (976,080) (298,076) (77,999)
Purchase of securities (78,307) (107,643) (169,785)
Proceeds from sale of securities 406,937 99,256 143,613
Net cash paid for acquisitions (12,857,223) (1,729,244) (1,000,000)
------------ ------------ ------------
Net cash used in investing activities (13,504,673) (2,035,707) (1,104,171)
Cash flows from financing activities:
Repayment of notes payable (303,138) (1,067,117)
Borrowings under credit agreement 12,550,000 2,450,000 1,000,000
Repayment under credit agreement (15,000,000) (222,084)
Payment of fees to acquire new debt (222,383) (134,163)
Issuance of common stock 32,500,000 105,127
Costs related to issuance of common stock (3,675,000)
Decrease in notes receivable, shareholders 82,873
Distributions to shareholders (4,123,689) (1,073,392) (813,366)
------------ ------------ ------------
Net cash provided by (used in) financing activities 21,808,663 280,455 (35,450)
------------ ------------ ------------
Net increase (decrease) in cash and cash equivalents 11,254,248 278,532 (36,429)
Cash and equivalents at beginning of period 804,550 526,018 562,447
------------ ------------ ------------
Cash and equivalents at end of period $ 12,058,798 $ 804,550 $ 526,018
============ ============ ============
The accompanying notes are an integral part
of these consolidated financial statements
F-6
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
1. Nature of operations:
NCO Group, Inc. (the "Company") is a leading provider of accounts receivable
management and related services utilizing an extensive teleservices
infrastructure. The Company's client base is comprised of companies located
throughout the United States in the following industries: education, financial
services, healthcare, telecommunications, utilities and government entities.
Effective September 3, 1996, the shareholders of NCO Financial Systems, Inc.
contributed each of their shares of common stock in exchange for one share of
common stock of the Company, a recently formed corporation. In September 1996,
the Company also effected a 46.56-for-one stock split and increased the number
of authorized shares to 5,000,000 shares of preferred stock and 25,000,000
shares of common stock. All per share and related amounts have been adjusted to
reflect the stock exchange and stock split.
On November 13, 1996, the Company completed its initial public offering (the
"Offering"), selling 2,875,000 shares of common stock including 375,000
over-allotment shares sold by existing shareholders. The Offering raised net
proceeds of approximately $28.8 million for the Company.
A director of the Company received compensation of $240,000 for services
rendered in connection with the Offering.
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 contingency fees and contractual services.
Contingency fee revenue is recognized upon collection of funds on behalf of
clients. Contractual services revenue is deferred and recognized as services are
performed.
Property and Depreciation:
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.
Income Taxes:
The Company had elected to be taxed as an S Corporation under the Internal
Revenue Code and the Pennsylvania Tax Code. While this election was in effect,
no provision was made for income taxes by the Company since all income was taxed
directly to the shareholders of the Company.
F-7
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
2. Summary of significant accounting policies, continued:
Income Taxes, continued:
The Company terminated its S Corporation status on September 3, 1996 and adopted
Statement of Financial Accounting Standards SFAS No. 109, "Accounting for Income
Taxes." This standard requires an asset and liability approach that takes into
account changes in tax rates when valuing the deferred tax amounts to be
reported on the balance sheet. Upon termination of the S Corporation status and
adoption of SFAS No. 109, the Company recorded an estimated net deferred tax
asset. The net deferred tax asset resulted primarily from differences in the
treatment of unearned revenue and acquired account inventory.
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with a maturity of
three months or less to be cash equivalents. These financial instruments
potentially subject the Company to concentrations of credit risk.
At December 31, 1996 and 1995, the Company had bank deposits in excess of
federally insured limits of approximately $1,045,605 and $1,276,000,
respectively. The Company's cash deposits have been placed with a large national
bank to minimize risk.
Credit Policy:
The Company has two types of arrangements under which it collects its
contingency fee revenue. For certain clients the Company remits funds collected
on behalf of the client, net of the related contingency fees while, for other
clients, the Company remits gross funds collected on behalf of clients, and
bills the client separately for its contingency fees. Management carefully
monitors its client relationships in order to minimize its credit risk and
generally does not require collateral. In the event of collection delays from
clients, management may at its discretion change from the gross remittance
method to the net remittance method.
Investment Securities:
The Company adopted Statement of Financial Accounting Standards SFAS 115,
"Accounting for Certain Investments in Debt and Equity Securities," for all
periods presented. The statement requires management to report their investments
as either "held to maturity", "trading securities", or "available for sale".
Deferred Financing Costs:
Deferred financing costs relate to debt issuance costs incurred which are
capitalized and amortized over the term of the debt.
Intangibles:
Intangibles consists of goodwill and acquisition costs and non-compete
covenants. 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 25 years. The recoverability of goodwill is periodically
reviewed by the Company. Such allocation has been based on estimates which may
be revised at a later date. In making such determination with respect to
goodwill, the Company evaluates the operating results of the underlying business
which gave rise to such amount. Accumulated amortization at December 31, 1996
and 1995 totaled $762,612 and $159,676, respectively.
F-8
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
2. Summary of significant accounting policies, continued:
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.
Earnings Per Share:
Earnings per share were computed by dividing the pro forma net income for the
year ended December 31, 1995 and 1996 by the pro forma weighted average number
of shares outstanding. Pro forma net income amounts are used because the
historical net income does not include the impact of federal and state income
taxes as if the Company had been subject to income taxes. Pro forma weighted
average shares outstanding are based on the weighted average number of shares
outstanding including common equivalent shares. All outstanding options and
warrants have been treated as common equivalent shares in calculating pro forma
net income per share, using the treasury stock method and the initial public
offering price of $13.00 per share for periods prior to the initial public
offering, only when their effect would be dilutive. The pro forma weighted
average number of shares outstanding have also been adjusted to include the
number of shares of common stock (250,000 shares) that the Company would have
needed to issue at the initial public offering price of $13.00 per share to
finance the distribution of undistributed S Corporation earnings through the
date on which the Company terminated its S Corporation status. Fully diluted
earnings per share are not materially different from primary earnings per share.
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share." This
Statement establishes standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock or potential
common stock. This Statement is effective for financial statements issued for
periods ending after December 15, 1997, earlier application is not permitted.
This Statement requires restatement of all prior-period EPS data presented. The
Company is currently evaluating the impact, if any, adoption of SFAS No. 128
will have on its financial statements.
Reclassifications:
Certain amounts for December 31, 1995 and 1994 and the years then ended have
been reclassified for comparative purposes.
3. Acquisitions:
On April 29, 1994, the Company purchased certain assets of B. Richard Miller,
Inc. (BRM) at a cost of $1,427,000, which was comprised of $1,000,000 in cash,
common stock valued at $300,000, and a note payable to the seller of $127,000.
The purchase price was allocated based upon the estimated fair market value of
the acquired property, equipment and account inventory and resulted in goodwill
of $984,126.
On August 1, 1995, the Company purchased certain assets of Eastern Business
Services, Inc. (Eastern) for approximately $2,041,000 comprised of $1,625,000 in
cash and $416,000 of liabilities assumed. The purchase price was allocated
primarily based upon the estimated fair market values of acquired property,
equipment, and accounts receivable less notes payable and funds due to clients
which resulted in goodwill of $1,812,000.
F-9
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
3. Acquisitions, continued:
On January 3, 1996 the Company purchased certain assets of Trans Union
Corporation Collections Division (TCD) for $4,750,000 in cash. The purchase
price was allocated based upon the estimated fair market value of acquired
property, equipment, accounts receivable and an agreement not to compete which
resulted in goodwill of $3,681,000.
On September 5, 1996 the Company purchased the outstanding stock of Management
Adjustment Bureau, Inc. ("MAB") for $9,000,000 comprised of $8,000,000 in cash
and a $1,000,000 convertible note. The purchase price was allocated based upon
the estimated fair market value of acquired property, equipment, and accounts
receivable which resulted in goodwill of $8,511,000.
The following summarizes unaudited pro forma results of operations for the years
ended December 31, 1996 and 1995, assuming the above acquisitions occurred as of
the beginning of the respective periods.
1996 1995
---------- ------------
Revenue $39,923,196 $34,509,071
Net income 3,372,491 2,166,501
Earnings per share .54 .36
On January 22, 1997 the Company purchased the outstanding stock of Goodyear &
Associates, Inc. ("Goodyear") for $5,400,000 comprised of $4,500,000 and a
$900,000 convertible note.
On January 30, 1997 the Company purchased substantially all the assets of
Tele-Research Center, Inc. ("TRC") for $1,600,000 in cash, which may be
increased by an additional $600,000 if certain revenue targets are reached in
the three year period following the acquisition.
On January 31, 1997 the Company purchased certain assets of the CMS A/R
Services, the Collection Division of CMS Energy Corporation, for $5,100,000 in
cash.
On February 3, 1997 the Company purchased certain assets and assumed certain
liabilities of the Collections Division of CRW Financial, Inc. for a purchase
price comprised of $3,750,000 in cash, 345,178 shares of its common stock and
warrants for 250,000 shares of common stock. The acquisition is valued at
approximately $12.8 million.
4. Marketable securities:
The Company has classified all of its securities as "available-for-sale" and has
recorded them at fair value and unrealized gains and losses as a separate
component of shareholders' equity.
Proceeds from the sale of investment securities were $406,937 in 1996. As of
December 31, 1996, there were no gross unrealized gains or losses because all
available-for-sale securities were distributed as part of the undistributed S
Corporation earnings and all gains and losses were recognized accordingly.
Proceeds from the sale of investment securities were $99,256 in 1995. Gross
unrealized gains and losses as of December 31, 1995 for available-for-sale
securities are as follows:
F-10
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
4. Marketable securities, continued:
Unrealized Unrealized
Holding Holding Fair
Cost Gain Loss Value
---- ---- ---- -----
Common stock $167,852 $ 41,475 $ (6,164) $203,163
Corporate bonds 90,297 6,028 96,325
---------- ---------- ------------ ----------
$258,149 $ 47,503 $ (6,164) $299,488
======== ========== ========= ========
Investment income, included in interest and investment income on the statement
of income, from available-for-sale securities as of December 31, 1996, 1995 and
1994 consisted of:
1996 1995 1994
------- ------- -----
Realized gain on the sales of securities $86,509 $12,217 $11,749
Realized loss on the sales of securities (12,186) (15,094) (16,170)
Interest income 33,577 7,035 5,142
Dividend income 6,816 5,892 5,211
-------- ------- -------
$114,716 $10,050 $ 5,932
======== ======= =======
The fair values of marketable securities held as of December 31, 1995 by
contractual maturity are as follows: due within one year, $20,425; due after one
year but within 5 years, $10,537; due after five years but within 10 years,
$65,363. Actual maturities will differ from contractual maturities because
borrowers may have the right to call or prepay obligations with or without call
or repayment penalties
5. Funds held in trust for 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 in trust for clients of $3,835,409 and $1,228,889 at December 31,
1996 and 1995 have been shown net of their offsetting liability for financial
statement presentation.
6. Property and equipment:
At December 31, 1996 and 1995, property and equipment, at cost, consists of
the following:
1996 1995
----------- -------
Computer equipment $2,461,211 $905,732
Furniture and fixtures 1,095,134 316,312
Leased assets 324,414
---------- ---------
3,880,759 1,222,044
Less accumulated depreciation 1,050,697 584,911
---------- ---------
$2,830,062 $ 637,133
========== =========
F-11
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
6. Property and equipment (continued):
Depreciation charged to operations amounted to $465,785, $199,123, and $171,378
for the years ended 1996, 1995 and 1994, respectively. The Company had not
entered into any capital lease transactions for the year ended December 31,
1995.
7. Long-term debt:
1996 1995
--------- -----
Non-interest bearing note; $157,500 face amount, $ 138,847 $ 189,077
payable in monthly installments of $5,250 through July
1999 (less unamortized discount based on imputed interest
rate of 10%)
Revolving credit agreement, LIBOR plus 2.5%, due 2,450,000
December 2000
Subordinated seller note payable, 8.00% due
September 2001, convertible to common stock
at $13.00 per share 1,000,000
Less current portion (46,946) (46,171)
---------- ----------
$1,091,901 $2,592,906
========== ==========
The following summarizes the Company's required debt payments for the next five
years:
1997 46,946
1998 56,346
1999 35,555
2000 -
2001 1,000,000
In July 1995, the Company entered into a $7,000,000 revolving credit agreement.
The line of credit is collateralized by substantially all the assets of the
Company.
The revolving credit agreement contains, among other provisions, requirements
for maintaining defined levels of working capital, net worth, capital
expenditures, various financial ratios and restrictions of distributions to
shareholders.
The Company recorded deferred charges of approximately $311,000 in connection
with the revolving credit agreement which consisted primarily of bank charges,
legal fees and 175,531 warrants issued to the bank. The warrants expire on July
31, 2005 and are only exercisable upon certain events at a nominal exercise
price. The bank had the right to put, and the Company had the ability to call,
the warrants during the twelve-month period ending on July 31, 2001. However ,
these rights were eliminated as part of the increase in the credit agreement in
September 1996.
In September 1996, the credit agreement was increased to $15,000,000 to provide
financing for the acquisition of MAB and the bank received a warrant for 46,560
shares, exercisable at $13.00 per share. In December 1996, the bank increased
the credit agreement to $25,000,000 and received a warrant to purchase an
additional 18,500 shares, exercisable at $13.00 per share.
At December 31, 1996, there were no borrowings outstanding on the credit
agreement.
F-12
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
8. Income taxes:
A summary of the components of the tax provision at December 31, 1996 is as
follows:
Currently payable:
Federal $620,133
State 147,299
Deferred:
Federal 500
State 125
--------
Provision for income taxes 768,057
(excluding effect of change in tax status)
Effect of accounting change:
Federal 124,247
State 31,062
--------
Total provision $612,748
Deferred tax assets (liabilities) at December 31, 1996 consist of the following:
Amortization $90,083
Contractual revenue recognition 65,333
Accrued expenses 38,878
-------
Gross deferred tax assets 194,294
Depreciation (39,610)
Accrual basis conversion (83,924)
-------
Gross deferred tax liabilities (123,534)
-------
Net deferred tax asset $70,760
=======
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:
U.S. statutory income tax rate 34%
Income allocable to S Corporation (27%)
Non-deductible goodwill and other expenses 5%
State taxes, net of federal 2%
----
Effective tax rate 14%
====
9. 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 20% of their
income on a pretax basis through contributions to the Plan. The Company will
match 25% of employee contributions for an amount up to 6% of each employee's
base salary. The charge to operations for the matching contributions was
$71,800, $30,027, and $23,536, for 1996, 1995 and 1994, respectively.
F-13
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
10. Supplemental cash flow information:
The following are supplemental disclosures of cash flow information:
1996 1995 1994
-------- --------- -------
Cash paid for interest $817,950 $157,379 $71,588
Cash paid for income taxes 600,000
Noncash investing and financing
activities:
Note receivable, shareholder 82,873
Fair value of assets acquired 4,081,005 2,145,578 442,874
Liabilities assumed from
acquisitions 2,005,749 416,334 127,000
Warrants issued with debt 218,760 177,294
Property acquired under
capital leases 348,586
Common stock issued for
acquisitions 300,000
Convertible note payable,
issued for acquisition 1,000,000
11. Leases:
The Company has entered into various office lease agreements with limited
partnerships owned by certain shareholders of the Company. In addition, the
Company has made disbursements on behalf of the limited partnerships and
recorded a note receivable of $100,000 at December 31, 1995. The notes
outstanding at December 31, 1995 were repaid during 1996.
The Company leases certain equipment under agreements which are classified as
capital leases. The equipment leases have original terms ranging from 36 to 120
months and have purchase options at the end of the original lease term.
The Company also leases certain equipment under non-cancelable operating leases.
Future minimum payments, by year and in the aggregate, under noncancelable
capital leases and operating leases with initial or remaining terms of one year
or more consist of the following at December 31, 1996:
1997 $1,686,000
1998 1,398,000
1999 1,191,000
2000 1,088,000
2001 727,000
Thereafter 476,000
----------
$6,566,000
==========
Rent expense was $1,073,914, $463,916 and $305,308 for the years ended December
31, 1996, 1995, and 1994, respectively. The related party office lease expense
was $489,926, $385,217 and $297,500 for 1996, 1995, and 1994, respectively, and
provides for an escalation clause which takes effect in 1998. The total amount
of base rent payments is being charged to expense on the straight-line method
over the term of the lease.
F-14
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
12. 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"
and collectively with the 1995 Plan and the 1996 Plan, the "Plans"). Payment of
the exercise price for options granted under the Plans may be made in cash,
shares of Common Stock or a combination of both. The 1995 plan authorized
221,719 shares of the Company's common stock to be issued as either incentive or
non-qualified stock options. The 1996 Plan authorized 218,413 shares of the
Company's common stock to be issued as either incentive or non-qualified stock
options and the Director Plan authorized 24,258 shares of the Company's common
stock to be issued as non-qualified stock options. In January 1997, the Board
amended the 1996 Plan, subject to shareholder approval, to increase the number
of shares of Common Stock authorized under that Plan by 259,868 shares to a
total of 478,281 shares. The maximum exercise period is ten years after the date
of grant. A summary of stock option activity since inception of the plan is as
follows:
Weighted Weighted
Average Number of Average
Number of Option Price Shares Exercise Price
Options Per Share Exercisable Per share
------- --------- ----------- ---------
Outstanding at
January 1, 1995
Granted 144,057 $2.73 48,039 $2.73
------- ------ ------ -----
Outstanding at
December 31, 1995
(all at $2.73) 144,057 2.73 48,039 2.73
Granted 294,914 13.88
------- ------ ------ -----
Outstanding at
December 31, 1996
(at $2.73 to $17.00) 438,971 $10.20 48,039 $2.73
======= ======== ====== =====
Effective January 1, 1996, the Company adopted Statement of Financial Accounting
Standards SFAS No. 123, "Accounting for Stock-Based Compensation". In accordance
with the provisions of SFAS 123 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 in accordance with
provisions of SFAS 123, net income and earnings per share for 1996 and 1995
would have been reduced to the unaudited pro forma amounts indicated in the
following table:
1996 1995
---------- -----------
Net income - as reported $2,540,929 $819,600
Net income - pro forma $2,483,138 $812,022
Earnings per share - as reported $.50 $.17
Earnings per share - pro forma $.49 $.17
F-15
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
12. Stock options, continued:
The estimated weighted-average grant-date fair value of the options granted
during the year ended December 31, 1996 was $4.35, and the weighted-average
remaining contractual life of options outstanding at December 31, 1996 was 9.3
years. 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 and assumed a weighted average risk-free interest rate of 6.32%, a
weighted average expected life of 3.25 years, a weighted average 32.16%
volatility factor, no expected dividends and a forfeiture rate of 5% over the
vesting period.
As part of the purchase price for the 1994 acquisition of certain assets of B.
Richard Miller, Inc., 123,803 shares of the Company's common stock were issued
to BRM's principal shareholder who also received an option to purchase up to an
additional 86,881 shares of the Company which was exercised during 1995 at a
cost of $188,000. As a result of the purchase of these shares, a receivable of
$82,873 was due from the seller as of December 31, 1995 which was subsequently
repaid during 1996.
13. 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
Marketable Securities: Available-for-sale securities consisted of debt and
equity securities. Fair values are based on quoted market prices.
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. Seller-financed debt contains a conversion
option which allows the seller to convert the debt into shares of common stock
at a price of $13.00 per share. Valuation of the subordinated note assumes a
required rate of return of 13.25%. For valuation of the option to convert the
note into 76,923 shares of common stock, the Company utilized the Black-Scholes
option pricing model and assumed a risk-free interest rate of 6.48%, an expected
life of three years, a 35.00% volatility factor and no expected dividends.
The estimated fair value of the Company's financial instruments are as follows
at December 31:
1995 1996
------------------------- -----------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
------ ----- ------ -----
Financial Assets:
Cash and cash equivalents $12,058,798 $12,058,798 $ 804,550 $ 804,550
Available-for-sale securities 299,488 299,488
Financial Liabilities:
Non-interest bearing note payable 138,847 138,847 189,077 189,077
Revolving credit agreement 2,450,000 2,450,000
Subordinated seller note payable 1,000,000 1,491,016
F-16
NCO GROUP, INC.
Notes to Consolidated Financial Statements - Continued
14. Quarterly Financial Information (unaudited):
The following table sets forth selected actual unaudited historical financial
data for the calendar quarters of 1995 and 1996. 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 the Company's opinion,
includes all adjustments (consisting only of normal and 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
----------------------------------------------------------------------------------
1995 1996
--------------------------------------- -----------------------------------------
Mar. Jun. Sept. Dec. Mar. Jun. Sept. Dec.
31 30 30 31 31 30 30 31
------- -------- -------- --------- -------- -------- --------- ---------
(dollars in thousands)
Revenue $2,544 $3,002 $3,480 $3,707 $6,044 $6,499 $7,715 $10,502
Income from
operations 244 485 496 320 915 1,156 1,183 1,569
Net income 227 429 460 250 760 1,001 968 906
15. 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 or cash flows of the Company.
16. Other Recent Accounting Pronouncements:
In March 1995, the FASB issued Statement of Financial Accounting Standards SFAS
No. 121, "Accounting for the Impairment of Long-Lived Assets and for Long-Lived
Assets to Be Disposed of," which was effective for the Company beginning January
1, 1996. SFAS No. 121 requires that long-lived assets and certain identifiable
intangibles be reviewed 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. SFAS No. 121 had no impact on the
financial statements upon adoption.
F-17