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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, 1997
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 23-2858652
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
515 Pennsylvania Ave.
Ft. Washington, Pennsylvania 19034-3313
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(Address of principal (Zip Code)
executive offices)
Registrant's Telephone Number, Including Area Code (215) 793-9300
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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 13,391,584
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(Title of Class) (Number of Shares Outstanding
as of March 30, 1998)
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. [X]
The aggregate market value of voting stock held by non-affiliates of the
Registrant is $240,384,419(1)
Certain portions of the Company's Proxy Statement to be filed in connection
with its 1998 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 $25.25, the last reported sale price
for the Company's Common Stock on March 30, 1998. The information provided shall
in no way be construed as an admission that any officer, director or 10%
shareholder in the Company may be deemed an affiliate of the Company or that he
is the beneficial owner of the shares reported as being held by him, and any
such inference is hereby disclaimed. The information provided herein is included
solely for record keeping purposes of the Securities and Exchange Commission.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business 1
Item 2. Properties. 19
Item 3. Legal Proceedings. 20
Item 4. Submission of Matters to a Vote of Security Holders. 20
Item 4.1 Executive Officers of the Registrant who are not also Directors. 20
PART II
Item 5. Market for Registrant's Common Equity and 20
Related Shareholder Matters.
Item 6. Selected Financial Data. 23
Item 7. Management's Discussion and Analysis of Financial 25
Condition and Results of Operations.
Item 7a Quantitative and Qualitative Disclosure about Market Risk 34
Item 8. Financial Statements and Supplementary Data. 34
Item 9. Changes in and Disagreements with Accountants on Accounting and 34
Financial Disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant. 35
Item 11. Executive Compensation. 35
Item 12. Security Ownership of Certain Beneficial Owners and Management. 35
Item 13. Certain Relationships and Related Transactions. 35
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 36
Signatures 41
Index to Consolidated Financial Statements F-1
All share and per share data have been restated to reflect the three-for-two
stock split of the Company's Common Stock paid in December 1997.
PART I
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 management
solutions for clients. The Company provides these services on a national basis
from 23 call centers located in 15 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 completed twelve acquisitions which
have enabled it to increase its penetration of existing markets, establish a
presence in certain new markets, offer additional services, and realize
significant operating efficiencies. In addition, the Company has leveraged its
infrastructure by offering additional services including telemarketing, customer
service call centers, market research and other outsourced administrative
services. The Company believes that it is currently among the five largest
accounts receivable management companies in the United States.
The Company provides its services principally to clients in the financial
services, healthcare, education, telecommunications, retail and commercial,
utilities and government sectors. In 1997, the Company had over 8,000 clients,
including Bell Atlantic Corporation, Mellon Bank, N.A., NationsBank, Citicorp,
MCI Communication, Federal Express Corporation, and Airborne Express. No client
accounted for more than 4.0% of the Company's actual revenue in 1997. 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
25.5% in 1997. According to the 1996 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 services 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 $116.0 billion in 1996, 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 from the ACA, there are currently
approximately 6,500 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.
-1-
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 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 services. The Company regularly reviews
various strategic acquisition opportunities and periodically engages in
discussions regarding such possible acquisitions.
The Company's principal executive offices are located at 515 Pennsylvania
Avenue, Fort Washington, Pennsylvania, and its telephone number is (215)
793-9300.
Acquisition History
Since 1994, the Company has completed twelve strategic acquisitions which
have expanded its client base and geographic presence, increased its presence in
key industries, added complementary services, 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 and add complementary
service applications. The Company regularly reviews various strategic
acquisition opportunities and periodically engages in discussions regarding such
possible acquisitions.
In March 1998, the Company entered into an agreement with FCA
International Ltd. ("FCA") under which NCO or an affiliate, will make a cash
tender offer (which is expected to be mailed on or before April 7, 1998) for
all of the outstanding common shares of FCA at $9.60 per share, Canadian
(equivalent to $6.77 in U.S. dollars based upon an exchange rate of .7053) as
of March 24, 1998, the "Date of the Agreement". The acquisition is valued at
approximately $68.0 million (U.S. dollars), based upon an exchange rate of
.7053, and is subject to the tender of two-thirds of the outstanding common
shares, on a fully diluted basis, and customary conditions including normal
regulatory approval. FCA's Board of Directors unanimously approved the
agreement and has agreed, subject to certain conditions to recommend that
shareholders tender their common shares into the offer. Pursuant to the
agreement, Fairfax Financial Holdings Limited has agreed, subject to certain
conditions, to tender to the bid, the common shares of FCA owned or controlled
by it. Fairfax currently owns or controls approximately 2,840,485 common
shares, representing approximately 27% of the common shares outstanding on a
fully-diluted basis.
-2-
A summary of completed acquisitions is as follows:
The Response Center
On February 6, 1998, the Company purchased certain assets of The
Response Center ("TRC"), which was an independent division of TeleSpectrum
Worldwide, Inc., for $15.0 million in cash, plus an earn-out based on the value
of the Company's market research business at December 31, 1998. The Response
Center is a full-service custom market research company providing services to
the telecommunications, financial services, utilities, healthcare,
pharmaceutical and consumer products sectors. Its capabilities include problem
conceptualization, program design, data gathering (by telephone, mail, and focus
groups), as well as data tabulation, results analysis and consulting. The
Response Center, located in Upper Darby, Pennsylvania, and Philadelphia,
Pennsylvania, had 1997 revenues of approximately $8.0 million.
Collection Division of American Financial Enterprises, Inc.
On December 31, 1997, effective January 1, 1998, the Company purchased
certain assets of the Collection Division of American Financial Enterprises,
Inc. ("AFECD") for $1.65 million in cash. AFECD, an accounts receivable
management company, will expand NCO's penetration into the governmental and
insurance sectors. The Collection Division of American Financial Enterprises had
1997 revenues of approximately $1.7 million.
ADVANTAGE Financial Services, Inc.
On October 1, 1997, the Company purchased all of the outstanding stock
of ADVANTAGE Financial Services, Inc. ("AFS") for $2.9 million in cash, a $1.0
million note payable which bears interest payable at a rate of 8.0% per annum
with one-half of the principal due in April 1998 and the balance due in January
1999 , and 46,442 shares of the Company's common stock. The acquisition was
valued at approximately $5.0 million. AFS, an accounts receivable management
company located in Dayton, Ohio and Bristol, Tennessee, will allow NCO further
penetration into the medical, telecommunications and commercial sectors. AFS had
1996 revenues of approximately $5.1 million.
Credit Acceptance Corp.
On October 1, 1997, the Company purchased all of the outstanding stock
of Credit Acceptance Corp. ("CAC") for $1.8 million in cash. CAC, an accounts
receivable management company located in Pittsburgh, Pennsylvania, will provide
NCO with further penetration into the healthcare sector. CAC had 1996 revenues
of $2.3 million.
Collections Division of CRW Financial, Inc.
On February 2, 1997, NCO purchased certain assets and assumed certain
liabilities of the Collections Division of CRW Financial, Inc. ("CRWCD") for
$3.75 million in cash, 517,767 shares of Common Stock and warrants to purchase
375,000 shares of Common Stock at an exercise price of $18.417 per share. The
purchase price was valued at approximately $12.8 million. CRWCD provided
accounts receivable management services principally to the telecommunications,
education, financial, government and utility sectors from 14 offices located
throughout the United States. In addition, CRWCD had a commercial collections
division.
CMS A/R Services
On January 31, 1997, NCO purchased certain assets of CMS A/R Services
("CMSA/R"), a division of CMS Energy Corporation, for $5.1 million in cash.
CMSA/R, 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, outsourced administrative services,
early stage accounts receivable management and database management services.
-3-
Tele-Research Center, Inc.
On January 30, 1997, NCO purchased certain assets of Tele-Research Center,
Inc. ("Tele-Research"), for $1.6 million in cash, which increased in January
1998 by an additional $600,000 when certain revenue targets were reached in the
period following the acquisition. Tele-Research, located in Philadelphia,
Pennsylvania, provided market research, data collection, and other teleservices
to market research companies as well as end-users.
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 $14.117 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, provided accounts receivable management services principally to
the telecommunications, education, and utility sectors.
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. In July 1997, the note was converted into 115,385
shares of the Company's Common Stock which were sold by the holder in the
Company's public offering completed in July 1997. MAB, based in Buffalo, New
York, provided accounts receivable management services, principally to the
education, financial services, telecommunications and utility sectors.
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 sectors from offices in Pennsylvania, Ohio and Kansas.
Eastern Business Services, Inc.
On August 1, 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, with a face amount of $252,000 ($207,000, net
of unamortized discount based on an imputed interest rate of 10%), 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 sectors.
-4-
B. Richard Miller, Inc.
On April 29, 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 185,705 shares of Common Stock and an option
to acquire 130,322 shares of Common Stock at an exercise price of $1.44 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,
previously based in Ardmore, Pennsylvania, provided accounts receivable
management services, principally to the education industry.
Collectively, the acquisitions of Goodyear, CMSA/R, Tele-Research, and
CRWCD are known as the "1Q97 Acquisitions." Collectively, the 1Q97 Acquisitions,
CAC and AFS are known as the "1997 Acquisitions." Collectively, the acquisition
of AFECD and TRC are known as the "1Q98 Acquisitions."
Financial Impact of Acquisitions
The Company financed the acquisition of AFS, CAC, AFECD and TRC with
proceeds of the Company's public offering of stock completed in July 1997 (the
"1997 Offering"). The Company financed the acquisitions of Goodyear, CMSA/R,
Tele-Research and CRWCD with borrowings of approximately $8.4 million on its
revolving credit facility with Mellon Bank, N.A., the net proceeds of the
Company's initial public offering (the "IPO") and funds from operations. The
borrowings on the revolving credit facility were repaid with a portion of the
proceeds from the 1997 Offering. The Company financed the MAB, TCD, Eastern and
BRM acquisitions with borrowings from Mellon Bank, N.A. which borrowings were
repaid with proceeds from the IPO. 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 263,297 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 69,840
shares and 27,750 shares of Common Stock at an exercise price of $8.67 per share
in consideration for increasing the revolving credit facility to $15.0 million
and to $25.0 million, respectively. An affiliate of the bank has exercised all
of these warrants. In March 1998, the bank increased the line of credit to $75.0
million in connection with the proposed cash tender offer for FCA International
Ltd., subject to the satisfaction of certain closing conditions.
The acquisitions have been accounted for under the purchase method of
accounting for financial reporting purposes. Through December 31, 1997, these
acquisitions have created goodwill estimated at $41.8 million which is being
amortized over a 15 to 25 year period resulting in amortization expense of
approximately $2.1 million annually.
-5-
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 client's 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 client's customer, the
notification process can begin.
Account Notification. The Company initiates the recovery process by
forwarding an initial letter which is designed to seek payment of the amount due
or open a dialogue with the client's 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 client's
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.
-6-
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 generally are
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.
Market Research. The Company provides full-service custom market research
services to the telecommunications, financial services, utilities, healthcare,
pharmaceutical and consumer products sectors. Its capabilities include problem
conceptualization, program design, data gathering (by telephone, mail, and focus
groups), as well as data tabulation, results analysis and consulting.
Telemarketing. The Company provides telemarketing services for clients,
including lead generation and qualification, and the actual booking of
appointments for a client's sales representatives.
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 a
large regional utility to provide customer service functions for a segment of
the utility's customer base that is delinquent.
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.
-7-
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 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.
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 23 state-of-the-art call centers which are electronically linked
through a national wide area network. The Company utilizes two computer platform
systems. One system consists of two Unix-based NCR 4300 computers which are
linked via network servers to 873 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 479 workstations. The computers are linked via network servers to the
Company's 1352 workstations, which consist of personal computers and terminals
that are linked to the microcomputers, but do not necessarily have separate
processors.
The Company utilizes 20 predictive dialer locations with 542 stations 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 for statistical
analysis and placed in priority recall queues or multiple-pass calling cycles.
The system also automates virtually all record keeping and follow-up activities
including letter and report generation. The Company's automated method of
operations dramatically improves the productivity of the Company's collection
staff.
The Company employs a 20 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.
-8-
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 over 8,000 companies in the
financial services, healthcare, retail and commercial, education,
telecommunications, utilities and government sectors. The Company's 10 largest
clients in 1997 accounted for approximately 21.7% of the Company's revenue on a
pro forma basis assuming that the 1997 Acquisitions had occurred on January 1,
1997. In 1997, no client accounted for more than 4.0% of total revenue (on an
actual or a pro forma basis). In 1997, the Company on a pro forma basis derived
50.1% of its referrals from financial institutions (which includes banking and
insurance sectors), 19.7% from healthcare organizations, 10.6% from retail and
commercial entities, 7.5% from educational organizations, 6.1% from
telecommunications companies, 3.6% from utilities, and 2.3% from government
entities.
The following table sets forth a list of certain of the Company's key clients:
Financial Services Healthcare Retail and Commercial
- ------------------------------- -------------------------------- ---------------------------------
First Union Corporation Catholic Healthcare Airborne Freight Corporation
Initiatives
Mellon Bank Corporation Hutchinson Hospital Emery Worldwide
Corporation
NationsBank Corporation Kaiser Permanente Federal Express Corporation
The Progressive Corporation Medical Center of Delaware The Bon Ton Stores, Inc.
United Healthcare Corporation Reimbursement Technologies,
Inc.
Government
Education Telecommunications and Utilities
- ------------------------------- ------------------------------- ---------------------------------
California Student Aid Bell Atlantic Corporation Commonwealth Edison Company
Commission BellSouth Corporation Massachusetts Department of
Pennsylvania State Frontier Cellular Revenue
University
Pennsylvania Higher Education MCI Communication New York State Electric & Gas
Assistance Agency Sprint Corporation Corporation
Rutgers University PECO Energy Company
University of Pennsylvania City of Philadelphia
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.
-9-
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 31
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 has on staff a
technical writer for the purpose of preparing detailed, professional responses
to RFPs.
Personnel and Training
The Company's success in recruiting, hiring and training a large number
of employees is critical to its ability to provide high quality accounts
receivable management, customer support and teleservices programs to its
clients. The Company seeks to hire personnel with previous experience in
accounts receivable management or as a telephone representative. NCO generally
offers competitive compensation and benefits and offers promotion opportunities
within the Company.
All Company personnel receive a comprehensive training course that
consists of a combination of classroom and practical experience. Prior to
customer contact, new employees receive one week of training in the Company's
operating systems, procedures and telephone techniques and instruction in
applicable federal and state regulatory requirements. Company personnel also
receive a wide variety of continuing professional education consisting of both
classroom and role playing sessions.
As of December 31, 1997, the Company had a total of 1,325 full-time
employees and 493 part-time employees, of which 1,447 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 6,500 providers, including large national
corporations such as Outsourcing Solutions, Inc., GC Services, Inc., and
Equifax, as well as 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.
-10-
Regulation
The accounts receivable management industry is regulated both at the
federal and state level. The federal Fair Debt Collection Practices Act (the
"FDCPA") regulates any person who regularly collects or attempts to collect,
directly or indirectly, consumer debts owed or asserted to be owed to another
person. The FDCPA establishes specific guidelines and procedures which debt
collectors must follow in communicating with consumer debtors, including the
time, place and manner of such communications. Further, it prohibits harassment
or abuse by debt collectors, including the threat of violence or criminal
prosecution, obscene language or repeated telephone calls made with the intent
to abuse or harass. The FDCPA also places restrictions on communications with
individuals other than consumer debtors in connection with the collection of any
consumer debt and sets forth specific procedures to be followed when
communicating with such third parties for purposes of obtaining location
information about the consumer. Additionally, the FDCPA contains various notice
and disclosure requirements and prohibits unfair or misleading representations
by debt collectors. The Company is also subject to the Fair Credit Reporting Act
which regulates the consumer credit reporting industry and which may impose
liability on the Company to the extent that the adverse credit information
reported on a consumer to a credit bureau is false or inaccurate. The accounts
receivable management business is also subject to state regulation. Some states
require that the Company be licensed as a debt collection company. Management
believes that the Company currently holds applicable licenses from all states
where required.
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.
-11-
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, the anticipated changes in revenues from acquired
companies, 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. The factors discussed below, and elsewhere in this
Annual Report on Form 10-K, could cause actual results and developments to be
materially different from those expressed in or implied by such 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 businesses acquired in the first quarter of 1998 had combined
revenues of $9.7 million in 1997 compared to the Company's revenue of $85.3
million in 1997 ($103.5 million on a pro forma basis assuming that the 1997
Acquisitions and the 1Q98 Acquisitions had occurred on January 1, 1997. The
Company is currently in the process of integrating the acquisition of AFS, CAC,
and the 1Q98 Acquisitions as well as completing the integration of the 1Q97
Acquisitions. Such integration will likely place significant demands on the
Company's management and infrastructure. There can be no assurance that
businesses acquired in the 1997 Acquisitions or the 1Q98 Acquisitions 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.
Risks Associated with Rapid 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."
-12-
Risks Associated with Future Acquisitions
A primary element of the Company's growth strategy is to continue to
pursue strategic acquisitions that expand and complement the Company's business.
The Company regularly reviews various strategic acquisition opportunities and
periodically engages in discussions regarding such possible acquisitions.
Currently the Company is not a party to any agreements, understandings,
arrangements or negotiations regarding any material acquisitions except as noted
regarding the agreement with FCA International Ltd. under which NCO or an
affiliate, will make a cash tender offer for all of the outstanding common
shares of FCA. However, as the result of the Company's process of regularly
reviewing acquisition prospects, negotiations may occur from time to time if
appropriate opportunities arise. 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 also 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 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 acquired businesses profitably. Acquisitions also may involve a
number of additional 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. See "Item 1 - Business - Growth Strategy."
The Company may require 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."
Risks related to FCA Tender offer
In March 1998, the Company entered into an agreement with FCA
International Ltd. ("FCA") under which NCO or an affiliate, will make a cash
tender offer (which is expected to be mailed on or before April 7, 1998) for all
of the outstanding common shares of FCA at $9.60 per share, Canadian (equivalent
to $6.77 in U.S. dollars based upon an exchange rate of .7053). The acquisition
is valued at approximately $68.0 million [USD], based upon an exchange rate of
.7053, and is subject to the tender of two-thirds of the outstanding common
shares, on a fully diluted basis, and customary conditions including normal
regulatory approvals. There can be no assurance that the FCA tender offer will
be successful. The Company will be required to borrow some or all of the
proceeds to pay for the FCA tender offer. In the event that the Company is
successful in the acquisition of FCA, the integration of FCA could divert
management's attention from the daily operation of the Company, require
additional management, operational and financial resources, and place
significant demands on the Company's management and infrastructure. There can be
no assurance that if acquired, FCA's operations can be successfully integrated
with that of the Company, that the Company will be able to realize operating
efficiencies or eliminate redundant costs, or that its business will be operated
profitably. Further, there can be no assurance that clients of FCA will continue
to do business with the Company, or that the Company will be able to retain key
employees.
-13-
Fluctuations in Quarterly Operating Results
The Company has experienced and expects to continue to experience
quarterly variations in revenue 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 effect of the change of business
mix on margins and the timing of additional selling, general and administrative
expenses to support new business. In connection with certain customer contracts,
the Company could incur costs in periods prior to recognizing revenue under
those contracts which may adversely affect the Company's operating results in a
particular quarter. 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
"Management's Discussion and Analysis of Financial Condition and Results of
Operations."
The Company's quarterly operating results could also be affected by the
costs and timing of completion and integration of acquisitions.
Dependence on Key Personnel
The Company is highly dependent upon the continued services and
experience of its senior management team, including Michael J. Barrist, Chairman
of the Board, President and Chief Executive Officer. 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 $2.0 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 1998 Annual Meeting of Shareholders.
Dependence on Certain Sectors; Contract Risks
Most of the Company's revenues are derived from clients in the
financial services, healthcare, retail and commercial, education,
telecommunications, utilities and government sectors. A significant downturn in
any of these sectors 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 "Item 1 - Business."
-14-
Competition
The accounts receivable management industry is highly competitive. The
Company competes with approximately 6,500 providers, including large national
corporations such as Outsourcing Solutions, Inc., GC Services, Inc., and
Equifax, as well as 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 "Item 1 - 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 require 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
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 "Item 1 - Business - Operations."
Risks Associated with Year 2000
NCO has initiated a program to evaluate and address the impact of the
year 2000 on its information systems in order to insure that its network,
computer systems and software will manage and manipulate data involving the
transition of dates from 1999 to 2000 without functional or data abnormality and
without inaccurate results related to such data. Based on information known at
this time about the Company's systems, management does not expect year 2000
compliance costs to have a material adverse impact on the Company's business or
results of operations. No assurance can be given, however, that unanticipated or
undiscovered year 2000 compliance problems will not have a material adverse
effect on the Company's business or results of operations. In addition, if the
Company's clients or significant suppliers and contractors do not successfully
achieve year 2000 compliance, the Company's business and results of operations
could be adversely affected.
-15-
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 "Item 1
- - 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 actions for
its failure or the failure of its clients to comply with such regulations. See
"Business-Government Regulation."
-16-
Control by Principal Shareholders
Michael J. Barrist beneficially owns approximately 19.9% of the Common
Stock, and together with the other executive officers of the Company,
beneficially owns approximately 33.3%. As a result of such voting concentration,
Mr. Barrist, together with other executive officers of the Company, would likely
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 1998 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. As of March 30, 1998, the Company had 13,391,584 shares of Common
Stock outstanding. Of these shares, a total of 8,968,254 shares are freely
tradable without restriction or further registration under the Securities Act of
1933 (the "Securities Act"). The remaining 4,423,330 shares are "restricted
securities," as that term is defined in Rule 144 under the Securities Act, and
may be sold only in accordance with an exemption from registration, such as the
exemption provided by Rule 144. The Company also has outstanding a $900,000
Convertible Note convertible into 63,755 shares of Common Stock at any time on
or before January 22, 2002 issued in connection with the Goodyear acquisition
and a warrant to purchase 375,000 shares issued in connection with the CRWCD
acquisition, exercisable at anytime on or before January 31, 2002. The holders
of the convertible notes and the warrants are entitled to certain demand and/or
piggy-back registration rights. The earn-out payable in connection with the TRC
acquisition provides, among other things, that the seller may elect to be paid
the earn-out in the form of a convertible note, convertible into NCO Common
Stock at a price equal to $3.00 above NCO's trailing thirty day average closing
per share price. In addition, the Company has reserved approximately 1,051,841
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. As of March 30, 1998,
options to purchase an aggregate of 923,650 shares of Common Stock are
outstanding under all such plans.
-17-
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.
-18-
Item 2. Properties.
The Company currently operates 23 leased facilities. The chart below
summarizes the Company's call center facilities as of December 31, 1997:
Approximate
Location of Facility Square Footage
------------------------------------ --------------
Fort Washington, PA 82,000
Aurora, CO 4,800
Bristol, TN 4,000
Buffalo, NY 30,000
Charlotte, NC 14,993
Cleveland, OH 6,948
Columbia, SC 10,500
Dayton, OH 13,060
Fort Washington, PA 12,300
Honolulu, HI 2,878
Hutchinson, KS 900
Jackson, MI 754
New Orleans, LA 6,920
Odenton, MD 13,336
Philadelphia, PA 4,720
Philadelphia, PA 5,700
Pittsburgh, PA 3,600
Richardson, TX 6,109
San Diego, CA 3,151
Tulsa, OK 13,907
Wichita, KS 10,000
In the 1Q98 Acquisitions, the Company acquired two additional
processing centers in Philadelphia, Pennsylvania, and a processing center and
headquarters for the market research operations in Upper Darby, Pennsylvania.
The leases of these facilities expire between 1998 and 2010, and most
contain renewal options. In addition, the Company leases sales offices in
Austin, Texas; Boston, MA; Jericho, NY; Las Vegas, NV; Little Rock, AK; McAllen,
TX; Stafford, TX; Tucson, AZ.
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.
Prior to July 1997, the Company leased space in four buildings in Blue
Bell, Pennsylvania from three limited partnerships of which Messrs. Barrist,
Piola and Miller and Mr. Barrist's mother, are limited partners and Michael J.
Barrist is the sole shareholder of the corporate general partners, pursuant to
leases expiring between 1998 and 2000. These leases were terminated with the
Company's move to its new Corporate Headquarters. See "Management - Certain
Transactions - Leases" contained in, and incorporated by reference to, the
Company's Proxy Statement relating to the 1998 Annual Meeting of Shareholders.
-19-
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...................... 38 Executive Vice President, Finance,
Chief Financial Officer and Treasurer
Joseph C. McGowan...................... 45 Executive Vice President and Chief
Operating Officer
Steven L. Winokur joined the Company in December 1995 as Vice
President, Finance, Chief Financial Officer and Treasurer and became Executive
Vice President in September 1997. 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 Executive Vice President and Chief Operating Officer in
September 1997. Prior to joining the Company, Mr. McGowan was Assistant Manager
of the Collections Department at Philadelphia Gas Works, a public utility, since
1975.
PART II
Item 5. Market for the Registrant's Common Stock and
Related Shareholder Matters.
Following the Company's IPO of Common Stock on November 6, 1996, 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, adjusted to reflect a three-for-two stock split paid in
December 1997.
-20-
High Low
---- ---
1996
Fourth Quarter (from November 6) $13 $11
1997
First Quarter 18 15/16 11 3/16
Second Quarter 22 1/2 12 3/16
Third Quarter 26 1/2 20 9/16
Fourth Quarter 28 5/16 21
As of March 30, 1998, the Company's Common Stock was held by
approximately 49 holders of record. Based on information obtained from the
Company's transfer agent, the Company believes that the number of beneficial
owners of its Common Stock is in excess of 1000.
Dividend Policy
Prior to September 1996, the Company 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 $1.1 million and $876,838 in respect of the Company's S
Corporation earnings for 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.
Sales of Unregistered Securities during 1997
Set forth below is information concerning certain issuances of Common
Stock during 1997 which were not registered under the Securities Act and which
have not been previously reported.
-21-
From June to December 1997, the Company granted options to certain
executive officers and key employees under the 1996 Stock Option Plan on the
dates and at the exercise prices set forth below. Generally, options will become
exercisable in equal one-third installments beginning on the first anniversary
of the date of grant. All of the options were issued in connection with such
employee's employment with the Company and no cash or other consideration was
received by the 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.
Date Issued Options Granted Exercise Price
----------- --------------- --------------
September 1997 37,200 $23.334
December 1997 148,825 $24.50
In June 1997, the Company issued options pursuant to the 1996
Non-Employee Director Stock Option Plan to purchase 3,000 shares of Common Stock
to each of Eric S. Siegel and Alan F. Wise. These options were granted at an
exercise price of $19.416 per share. The options were issued in reliance upon
the exemption from the registration requirements provided by Section 4(2) of the
Securities Act.
-22-
Item 6. Selected Financial Data.
SELECTED FINANCIAL AND OPERATING DATA
(Dollars in thousands, except per share data)
-----------------------------------------------------------------------------------------------
1993 1994 1995 1996 1997
----------- ----------- ----------- ------------ ------------------------------
Pro
Actual Forma (1)(2)
------------ ------------
Statement of Income Data:
Revenue $ 7,445 $ 8,578 $ 12,733 30,760 $ 85,283 $ 103,460
Operating costs and expenses:
Payroll and related expenses 4,123 4,558 6,797 14,651 42,502 51,996
Selling, general and
administrative expenses 2,391 2,674 4,042 10,033 27,947 33,844
Depreciation and amortization
expenses 141 215 348 1,254 3,368 4,344
----------- ----------- ----------- ------------ ------------ ------------
Income from operations 790 1,131 1,546 4,822 11,466 13,276
other income (expense) 11 (45) (180) (575) 388 748
----------- ----------- ----------- ------------ ------------ ------------
Income before income taxes 801 1,086 1,366 4,247 11,854 14,024
Provision for income taxes (3) 320 434 546 1,706 4,780 5,652
----------- ----------- ----------- ------------ ------------ ------------
Net income (3) 481 $ 652 $ 820 $ 2,541 $ 7,074 $ 8,372
=========== =========== =========== ============ ============ ============
Net income per share - basic (3) $ 0.12 (4) $ 0.34 (4) $ 0.59 $ 0.67
=========== ============ ============ ============
Weighted average shares
outstanding - basic (3) 7,093,359 (4) 7,630,104 (4) 11,941,144 12,514,297
=========== ============ ============ ============
Net income per share - diluted (3) $ 0.12 (4) $ 0.34 (4) $ 0.57 $ 0.64
=========== ============ ============ ============
Weighted average shares
outstanding - diluted (3) 7,093,359 (4) 7,657,691 (4) 12,560,493 13,090,305
=========== ============ ============ ============
Selected Operating Data:
Total value of accounts referred $ 199,108 $ 281,387 $ 431,927 $ 1,173,342 $ 3,989,810 $ 4,152,699
Average fee 20.2% 22.5% 22.4% 25.2% 25.5% 25.6%
December 31,
-------------------------------------------------------------------------------
1993 1994 1995 1996 1997
-------- -------- -------- -------- --------
Balance Sheet Data:
Cash and cash equivalents $ 562 $ 526 $ 805 $ 12,058 $ 29,539
Working capital 445 473 812 13,629 36,440
Total assets 1,990 3,359 6,644 35,826 101,636
Long-term debt, net of current portion 59 732 2,593 1,091 1,437
Shareholders' equity 876 1,423 2,051 30,647 89,334
- 23 -
(1) Assumes that the 1997 Acquisitions and the AFECD and TRC acquisitions
occurred on January 1, 1997.
(2) Gives effect to: (i) the reduction of certain redundant operating costs and
expenses that were immediately identifiable at the time of the acquisitions;
(ii) the increase in amortization expense as if the acquisitions had occurred
on January 1, 1997 and the elimination of deprecation and amortization expense
related to assets revalued or not acquired by NCO as part of the acquisitions;
(iii) the elimination of interest expense associated with acquisition related
debt to be repaid with proceeds of the IPO and the 1997 Offering; (iv) the
issuance of 517,767 shares of Common Stock and warrants exercisable for 375,000
shares of Common Stock in connection with the acquisition of CRWCD; (v) the
issuance of 1,425,753 shares of Common Stock at the public offering price in
the 1997 Offering of $19.67 per share which, net of the underwriting discount
and estimated offering expenses payable by the Company, would be sufficient to
repay acquisition related debt of $8.4 million and to fund the acquisitions of
the AFECD and TRC acquisitions; and (vi) the issuance of 46,442 shares of
Common stock issued in connection with the acquisition of AFS.
(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 prior to such date. Accordingly, the historical financial statements do
not include a provision for federal and state income taxes for such periods. A
pro forma provision for income taxes, pro forma net income and pro forma net
income per share have been computed as if the Company had been fully subject to
federal and state income taxes for all periods presented. See Note 9 to
Consolidated Financial Statements.
(4) Assumes that the Company issued 374,637 shares of Common Stock at $8.67 per
share to fund the distribution of undistributed S Corporation earnings of $3.2
million through September 3, 1996, the termination date of the Company S
Corporation status, to existing shareholders of the Company.
-24-
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,
------------------------------------------------------------------
1993 1994 1995 1996 1997
------- ------- -------- -------- ---------------------
Pro
Actual Forma
--------- --------
Revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Payroll and related expenses 55.4 53.1 53.4 47.6 49.8 48.8
Selling, general and
administrative
expenses
32.1 31.2 31.7 32.6 32.8 33.3
Depreciation and amortization
expense 1.9 2.5 2.7 4.1 4.0 4.1
------- ------- -------- -------- --------- --------
Total operating costs and
expenses 89.4 86.8 87.8 84.3 86.6 86.2
------- ------- -------- -------- --------- --------
Income from operations
10.6 13.2 12.2 15.7 13.4 13.8
Other income (expense):
0.1 (0.5) (1.4) (1.9) 0.5 0.3
------- ------- -------- -------- --------- --------
Income before provision for income
taxes 10.7 12.7 10.8 13.8 13.9 14.1
Provision for income taxes(1)
4.3 5.1 4.3 2.0 5.6 5.6
------- ------- -------- -------- --------- --------
Pro forma net income 6.4% 7.6% 6.5% 11.8% 8.3% 8.5%
======= ======= ======== ======== ========= ========
(1) The Company was taxed as an S Corporation prior to September 3, 1996.
Accordingly, pro forma provisions for income taxes and pro forma net income have
been provided as if the Company had been subject to income taxes in all periods
presented.
Pro Forma Compared to Actual Results of Operations
Pro forma operating data for 1997 assume that the 1997 Acquisitions and the
1Q98 Acquisitions were consummated on January 1, 1997. Pro forma adjustments
have been made to reflect the elimination of certain expenses that were
immediately identifiable at the time of the acquisitions. For instance, pro
forma adjustments to 1997 include the elimination of approximately 155 redundant
administrative and collection personnel, the reduction of the salaries of the
principal shareholders of Goodyear and AFS, the closing or consolidation of five
existing call centers, as well as the downsizing of four call centers into
customer service locations. At the time of the acquisitions, the acquired
companies had higher cost structures than that of the Company's core business.
The Company intends to continue to leverage its infrastructure to realize
additional operating efficiencies in order to bring the cost structure of the
acquired companies 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. Management believes it will
-25-
realize these cost savings with respect to the acquired companies, although no
assurances can be given that such cost savings will be realized. 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, 1997 Compared to Year ended December 31, 1996
Revenue. Revenue increased $54.5 million or 177.2% to $85.3 million for
1997 from $30.8 million in 1996. Of this income, $13.8 million of revenue was
attributable to the MAB acquisition completed in September 1996 and $37.1
million of revenue was attributable to the 1997 Acquisitions. The addition of
new clients and growth in business from existing clients represented $8.6
million of the increase in revenue. Revenue from other related services, which
became an area of focus in 1996, increased $4.6 million to $6.1 million in 1997
from $1.5 million in 1996.
Payroll and related expenses. Payroll and related expenses increased $27.9
million to $42.5 million for 1997 from $14.7 million in 1996, and increased as a
percentage of revenue to 49.8% from 47.6%. Payroll and related expenses
increased as a percentage of revenue primarily as a result of the businesses
acquired in the MAB acquisition and the 1Q97 Acquisitions having a higher cost
structure than that of the Company. This increase was partially offset by
spreading the cost of management and administrative personnel over a larger
revenue base. In addition, in the fourth quarter of 1997 there was $339,000 of
additional payroll expense attributable to a contract with the United States
Department of Education which did not have any corresponding revenue. Without
these costs, payroll as a percentage of revenue would have been 49.4% for 1997
compared with 47.6% in 1996.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $17.9 million to $27.9 million for 1997 from
$10.0 million in 1996, and increased as a percentage of revenue to 32.8% from
32.6%. Selling, general and administrative costs attributable to the United
States Department of Education contract were $274,000. Without these costs,
selling, general and administrative costs as a percentage of revenue would have
been 32.4% for 1997 compared with 32.6% in 1996. Also, the business acquired in
the 1997 Acquisitions had a higher cost structure than that of the Company and,
as a result of the acquisitions, the Company has continued to experience
increased costs as a result of changes in business mix which require the
increased use of national databases and credit reporting services. These
increases were offset by operating efficiencies obtained by spreading selling,
general and administrative expenses over a larger revenue base.
Depreciation and amortization. Depreciation and amortization increased to
$3.4 million for 1997 from $1.3 million in 1996. Of this increase, $1.8 million
was a result of the MAB acquisition and the 1997 Acquisitions. The remaining
$260,000 consisted of amortization of deferred financing charges and
depreciation resulting from capital expenditures incurred in the normal course
of business.
-26-
Other income (expense). Interest expense decreased to $591,000 for 1997
from $818,000 in 1996. Although the Company's revolving credit facility had been
repaid with a portion of the net proceeds from the IPO, the Company borrowed
$8.4 million on its revolving credit facility to partially finance the 1Q97
Acquisitions, and issued a $900,000 convertible note payable in connection with
the Goodyear acquisition in January 1997. The revolving credit facility was
repaid with a portion of the proceeds from the Company's public offering
completed in July 1997 (the "1997 Offering"). In addition, the $1.0 million
convertible note payable issued in connection with the MAB acquisition in
September 1996 was converted to Common Stock in connection with the 1997
Offering. Interest and investment income increased $778,000 to $1.0 million for
1997 from the comparable period in 1996. This increase was primarily
attributable to the investment of funds remaining from the 1997 Offering, as
well as an increase in operating funds and funds held in trust for clients. As a
result of the disposal of certain fixed assets in the move of the Company's
corporate headquarters in July 1997, the Company incurred a loss on the disposal
of fixed assets in the amount of $41,000.
Income tax expense. Income tax expense for 1997 was $4.8 million or 40.3%
of income before taxes, and was computed after giving effect to non-deductible
goodwill expenses resulting from certain of the acquired companies. In 1996, the
Company was an S Corporation until September 1, 1996 and, accordingly, there was
no provision for income taxes until that time. The pro forma provision for
income taxes of $1.7 million for 1996 was computed utilizing an assumed rate of
40.0% after giving effect to non-deductible goodwill.
Net income. Net income in 1997 increased to $7.1 million for 1997 from
the pro forma net income of $2.5 million in 1996, a 178.4% increase.
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. Additionally, $4.8 million of increase was due to
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 $7.9
million to $14.7 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.
-27-
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.
Pro forma provision for income taxes. The pro forma provision for income
taxes of $1.7 million and $546,000 in 1996 and 1995, respectively, was computed
using an assume tax rate of 40.0% after giving effect to non-deductible goodwill
from certain of the acquired companies.
Pro forma net income. Pro forma net income increased to $2.5 million in
1996 from $820,000 in 1995, a 210.0% increase.
Quarterly Results
The following table sets forth selected actual historical financial
data for the calendar quarters of 1996 and 1997. 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
---------------------------------------------------------------------------------------------------
1996 1997
------------------------------------------------- -------------------------------------------------
Mar. June Sept. Dec. Mar. June Sept. Dec.
31 30 30 31 31 30 30 31
----------- ------------ ----------- ----------- ----------- ----------- ------------ -----------
(dollars in thousands)
Revenue $6,044 $6,499 $7,715 $10,502 $18,077 $21,162 $21,739 $24,306
Income from
operations 915 1,156 1,183 1,569 2,383 3,039 3,112 2,932
Net income 760 1,001 968 906 1,307 1,717 2,082 1,968
-28-
Quarter ended
---------------------------------------------------------------------------------------------------
1996 1997
------------------------------------------------- -------------------------------------------------
Mar. June Sept. Dec. Mar. June Sept. Dec.
31 30 30 31 31 30 30 31
----------- ------------ ----------- ----------- ----------- ----------- ------------ -----------
(dollars in thousands)
Revenue 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% 100.0%
Income from
operations 15.1% 17.8% 15.3% 14.9% 13.2% 14.4% 14.3% 12.1%
Net income 12.6% 15.4% 12.5% 8.6% 7.2% 8.1% 9.6% 8.1%
The Company has experienced and expects to continue to experience quarterly
variations in revenue and operating 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 effect of the change of business
mix on margins and the timing of additional selling, general and administrative
expenses to support new business. In connection with certain contracts, the
Company could incur costs in periods prior to recognizing revenue under those
contracts. The Company's planned operating expenditures are based on revenue
forecasts, and if revenues are below expectation in any given quarter, operating
results would likely be materially adversely affected. While the effects of
seasonality on the Company'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.
The Company's quarterly operating results could also be affected by the
costs and timing of completion and integration of acquisitions. In the fourth
quarter of 1996, income from operations and net income as a percentage of
revenue were lower than in prior quarters of 1996 largely as a result of the
higher payroll and related expenses of MAB as compared to the Company's core
business. Similarly, in the first quarter of 1997, the Company's operating and
net margins were adversely affected by the higher cost structures of MAB and the
1Q97 Acquisitions as compared to the Company's core business.
Liquidity and Capital Resources
In July 1997, the Company completed the 1997 Offering selling 4,312,500
shares of common stock at a price to the public of $19.67 per share, including
2,166,000 shares issued by the Company, 650,369 shares and 562,500
over-allotment shares sold by existing shareholders, 75,480 shares acquired by
employees through the exercise of stock options, 225,000 shares acquired by the
Company's bank (Mellon Bank, N.A.) through the exercise of stock warrants,
115,385 shares acquired through the conversion of the Company's convertible
note, and 517,767 shares acquired by CRW Financial, Inc. in connection with the
acquisition by NCO of CRWCD. The proceeds of the Offering, after underwriting
discounts and expenses, were approximately $40.4 million.
In November 1996, the Company completed its IPO selling 4,312,500 shares of
its Common Stock at a price of $8.67 per share, including 3,750,000 shares
issued by the Company, and 562,500 over-allotment shares sold by existing
shareholders. The net proceeds to the Company were $28.8 million.
The Company's primary sources of cash have historically been cash flow from
operations, bank borrowings and, in 1996 and 1997, the net proceeds from the IPO
and the 1997 Offering, respectively. Cash has been used for acquisitions,
distributions to shareholders, purchases of equipment and working capital to
support the Company's growth.
-29-
Cash provided by operating activities was $6.7 million in 1997 and $2.8
million in 1996. The increase in cash provided by operations was primarily due
to the increase in net income to $7.0 million in 1997 compared to $3.6 million
in 1996, and the increase in non-cash charges, primarily depreciation and
amortization, to $3.4 million in 1997 compared to $1.3 million in 1996. These
increases were offset by a $3.9 million increase in accounts receivable in 1997
compared to a $1.8 million increase in 1996 and a $262,000 increase in accounts
payable and accrued expenses in 1997 compared to a $222,000 increase in the
comparable period in 1996. Approximately $1.0 million of accounts payable and
accrued expenses in acquired companies were reduced in order to bring the
balances in line with NCO's payment policies.
Cash provided by operating activities was $2.8 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 $572,000 increase in 1995 and a $222,000 increase in accounts
payable and accrued expenses in 1996 compared to an $858,000 increase in 1995.
Cash used in investing activities was $29.2 million in 1997 compared to
$13.3 million for 1996. The increase was primarily due to the 1Q97 and 1997
Acquisitions versus the acquisition of TCD and MAB in 1996. In January 1997, the
Company purchased substantially all of the assets of CMS A/R for $5.1 million in
cash, certain assets of TeleResearch for $1.6 million in cash, and all of the
outstanding stock of Goodyear for $4.5 million in cash and a $900,000
convertible Note. The Note is convertible into an aggregate of 63,755 shares of
Common Stock at any time and bears interest payable monthly at a rate of 8.0%
per annum with principal due in January 2002. In February 1997, NCO purchased
substantially all of the assets of CRWCD for $3.75 million in cash, 517,767
shares of Common Stock (which were sold in the 1997 Offering) and warrants for
375,000 shares of Common Stock. The Company financed the cash portion of the
purchase price for the 1Q97 Acquisitions with borrowings of $7.4 million under
its Credit Agreement and financed the balance with proceeds of its IPO and
existing working capital. During March 1997, the Company borrowed an additional
$1.0 million under the Credit Agreement to pay certain accounts payable assumed
as part of the CRWCD acquisition. On October 1, 1997, the Company purchased the
outstanding stock of ADVANTAGE Financial Services, Inc. and related companies
("AFS") for $2.9 million in cash, 46,442 shares of common stock and $1.0 million
in notes payable. The acquisition was valued at approximately $5.0 million. On
October 1, 1997, the Company purchased the outstanding stock of Credit
Acceptance Corp. ("CAC") for $1.8 million in cash. The cash portion of the AFS
and CAC acquisitions were financed with a portion of the proceeds of the 1997
Offering. In addition, the Company has accrued $1.1 million of acquisition
related expenses. The 1997 Acquisitions collectively resulted in goodwill of
$37.0 million.
-30-
Cash used in investing activities was $13.3 million in 1996 compared to
$2.1 in 1995. The increase was primarily due to the acquisitions of MAB and TCD
in 1996. 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
$8.67 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.
The 1996 acquisitions collectively resulted in goodwill of $14.0 million.
In addition to equipment financed under operating leases, capital
expenditures were $298,000, $976,000 and $3.4 million in 1995, 1996 and 1997,
respectively.
Cash provided by financing activities was $39.9 million in 1997 compared to
$21.8 million in 1996. Net proceeds of $40.4 million from the 1997 offering was
the Company's primary source of cash from financing activities which was used
for acquisitions and to repay outstanding indebtedness.
Cash provided by financing activities was $21.8 million in 1996 compared to
$280,000 in 1995. Bank borrowings had been the Company's primary source of cash
from financing activities and were used for acquisitions and, along with cash
provided by operations, for distributions to shareholders. The Company raised
net proceeds of approximately $28.8 million in the IPO of which $15.0 million
was used to repay outstanding indebtedness under the Credit Agreement and
approximately $3.2 million was used to pay undistributed S Corporation earnings.
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 IPO, Mellon Bank, N.A. increased the
revolving credit facility to $25.0 million and decreased the rate of interest to
2.5% over LIBOR. In December 1996, Mellon Bank N.A. reduced the interest rate to
1.5% over LIBOR. Outstanding borrowings under the Credit Agreement at December
31, 1995 were $2.5 million. There were no outstanding borrowings as of December
31, 1996 or 1997. 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 March 1998, the bank increased the line of credit to $75.0
million in connection with the proposed acquisition of FCA International Ltd.
In connection with entering into the original 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 263,297 shares of the Company's Common Stock. The warrant expires
on July 31, 2005 and is exercisable for nominal consideration. In connection
with the increase of the line of credit available under the Credit Agreement 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 an aggregate of 97,590 shares
of Common Stock exercisable at $8.67 per share. 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. In July 1997, the bank exercised
225,000 warrants for Common Stock which was sold in the 1997 offering. The
remainder of the warrants were exercised in January 1998.
-31-
In March 1998, the Company entered into an agreement with FCA International
Ltd. under which NCO or an affiliate, will make a cash tender offer (which is
expected to be mailed on or before April 7, 1998) for all of the outstanding
common shares of FCA at $9.60 per share, Canadian, or $6.77 in U.S. dollars. The
acquisition is valued at approximately $68.0 million [USD], based upon an
exchange rate of .7053 and is subject to the tender of two-thirds of the
outstanding common shares, on a fully diluted basis, and after customary
conditions, including normal regulatory approval. FCA's Board of Directors
unanimously approved the agreement and has agreed, subject to certain
conditions, to recommend that shareholders tender their common shares into the
offer. Pursuant to the agreement, Fairfax Financial Holdings Limited has agreed,
subject to certain conditions, to tender to the bid, the common shares of FCA
owned or controlled by it. Fairfax currently owns or controls approximately
2,840,485 common shares, representing approximately 27% of the common shares
outstanding on a fully-diluted basis.
The Company believes that funds generated from operations, together with
existing cash, the net proceeds from the Offering and available borrowings under
its Credit Agreement will be sufficient to finance its current operations and
planned capital expenditure requirements and internal growth at least through
December 31, 1998. In addition, the Company believes it will have sufficient
funds to make selected acquisitions. However, the Company could require
additional debt or equity financing if it were to make any significant
acquisitions for cash.
Year 2000 System Modifications
NCO has initiated a program to evaluate and address the impact of the year
2000 on its information systems in order to insure that its network and software
will manage and manipulate data involving the transition of dates from 1999 to
2000 without functional or data abnormality and without inaccurate results
related to such data. This program includes steps to: (a) identify software
vendors areas that require date code remediation; (b) establish timelines for
availability of corrective software releases; (c) implement the fix to a test
environment and test the remediated product, (d) integrate the updated software
to NCO's production environment, (e) communicate and work with clients to
implement year 2000 compliant data exchange formats, and (f) provide management
with assurance of a seamless transition to the year 2000. The identification
phase is substantially complete and delivery of the final software updates are
scheduled for the third quarter of 1998. Management expects to complete the
major portion of testing and acceptance procedures in 1998. The Company will
continue to coordinate the year 2000 compliance effort throughout the balance of
1998 and into 1999 to synchronize data exchange formats with clients.
For the years 1998 and 1999, the Company expects to incur total pre-tax
expenses of approximately $200,000 to $250,000, per year. These costs are
associated with both internal and external staffing resources for the necessary
planning, coordination, remediation, testing, and other expenses to prepare its
systems for the year 2000. However, a portion of these expenses will not be
incremental, but rather represent a redeployment of existing information
technology resources. Management does not expect substantial additional license
fee costs associated directly with year 2000 compliance because the Company's
software vendors are incorporating necessary modifications as part of their
normal system maintenance. The majority of the costs will be incurred through
the modification and testing of electronic data interchange formats with the
Company's clients. The cost of planning and initial remediation incurred through
1997 has not been significant.
-32-
Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standard Board issued SFAS No. 130,
"Reporting Comprehensive Income." SFAS No. 130 establishes standards for the
reporting and display of comprehensive income, requiring its components to be
reported in a financial statement that is displayed with the same prominence as
other financial statements. The Company will adopt this standard in the first
quarter of 1998. Management believes that the adoption of SFAS No. 130 will have
not have a material impact on its consolidated results of operations, financial
condition or cash flows.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 establishes standards for reporting financial information about operating
segments in annual financial statements and requires reporting of selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customer. The Company is
required to disclose this information for the first time it publishes its 1998
annual report. Management is in the process of evaluating the segment
disclosures for purposes of reporting under SFAS No. 131. Management has not
determined what impact the adoption of SFAS. No. 131 will have on the
consolidated results of operations, financial condition or cash flows.
Forward Looking Statements
Certain statements included in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, as well as elsewhere in this
Annual Report on Form 10-K, 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, the anticipated
changes in revenues from acquired companies, 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
actual results and developments may be materially different from those expressed
in or implied by such statements. See Item 1. - "Business - Investment
Considerations."
-33-
Item 7a. Quantitative and Qualitative Disclosures about Market Risk
Not Applicable
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.
-34-
PART III
Item 10. Directors and Executive Officers of the Registrant.
Incorporated by reference from the Company's Proxy Statement relating
to the 1998 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 1998 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 1998 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 1998 Annual Meeting of Shareholders to be filed pursuant to General
Instruction G(3) to Form 10-K.
-35-
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 included in this
Report on Form 10-K:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1996 and 1997
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1997
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1997
Consolidated Statements of Shareholders' Equity for each of the years
in the period ended December 31, 1997
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 "*":
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.
*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.
-36-
Exhibit No. Description
- ----------------- -----------------------------------------------------------------------------------------
*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.
10.19 Second 1996 Warrant Agreement, dated December 13, 1996, by
and between the Company and APT Holdings Corporation, an
affiliate of 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.
-37-
Exhibit No. Description
- ----------------- -----------------------------------------------------------------------------------------
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 263,297 shares issued to APT Holdings Corporation, an
affiliate of Mellon Bank, N.A.
10.25(1) 1996 Common Stock Purchase Warrant for 69,840 shares issued
to APT Holdings Corporation, an affiliate of Mellon Bank,
N.A.
10.26 Second 1996 Common Stock Purchase Warrant for 27,750 shares
issued to APT Holdings Corporation, an affiliate of 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. NCO will
furnish to the Securities and Exchange Commission a copy of
any omitted schedule upon request.
10.29(1) Asset Purchase Agreement dated December 8, 1995 by and
between the Company and Trans Union Corporation. NCO will
furnish to the Securities and Exchange Commission a copy of
any omitted schedule upon request.
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. 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.
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.
-38-
Exhibit No. Description
- ----------------- -----------------------------------------------------------------------------------------
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.
10.34(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.
10.36(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.
10.40(5) Asset Acquisition Agreement by and among The Response
Center Division of TeleSpectrum Worldwide, Inc., , and NCO
dated January 16, 1998. NCO will furnish to the Securities
and Exchange Commission a copy of any omitted schedules
upon request.
10.41 Lease dated March 18, 1997 between Indiana Avenue
Associates, L.P. and the Company related to the lease of
Fort Washington corporate headquarters.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Coopers and Lybrand LLP
27.1 Financial Data Schedules.
- ------------------------------
(1)Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-11745), as amended, filed with the Securities
Exchange Commission on September 11, 1996.
(2)Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on February 6,
1997.
(3)Incorporated by reference to the Company's Current Report on Form 8-K/A
(File No. 0-21639) filed with the Securities Exchange Commission on February
18, 1997.
-39-
(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.
(5)Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on February 25,
1998.
(b). Reports on Form 8-K. No reports on Form 8-K were filed during the
quarter ended December 31, 1997.
-40-
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, 1998 By: /s/ Michael J. Barrist
-----------------------
Michael J. Barrist, Chairman of the
Board, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934,
this Report has been signed below by the following persons on behalf of the
registrant in the capacities and on the date indicated.
SIGNATURE TITLE(S) DATE
--------- -------- ----
/s/ Michael J. Barrist Chairman of the Board, President March 31, 1998
- ----------------------------- and Chief Executive Officer
Michael J. Barrist (principal executive officer)
/s/ Charles C. Piola Executive Vice President and March 31, 1998
- ----------------------------- Director
Charles C. Piola
/s/ Steven L. Winokur Executive Vice President, March 31, 1998
- ----------------------------- Finance, Chief Financial Officer
Steven L. Winokur and Treasurer (principal
financial and accounting officer)
/s/ Bernard R. Miller Senior Vice President, March 31, 1998
- ----------------------------- Development and Director
Bernard R. Miller
/s/ Eric S. Siegel Director March 31, 1998
- -----------------------------
Eric S. Siegel
/s/Allen F. Wise
- -----------------------------
Allen F. Wise Director March 31, 1998
-41-
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
Report of Independent Accountants..........................................................................F-2
Consolidated Balance Sheets as of December 31, 1996 and 1997 ..............................................F-3
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1997.....................................................................F-4
Consolidated Statements of Shareholders' Equity for each of the years
in the period ended December 31, 1997.....................................................................F-5
Consolidated Statements of Cash Flows for each of the years
in the period ended December 31, 1997.....................................................................F-6
Notes to Consolidated Financial Statements.................................................................F-7
REPORT OF INDEPENDENT ACCOUNTANTS
To the Shareholders of
NCO Group, Inc.
Fort Washington, Pennsylvania
We have audited the accompanying consolidated balance sheets of NCO
Group, Inc. as of December 31, 1996 and 1997 and the related consolidated
statements of income, shareholders' equity, and cash flows for each of
the three years in the period ended December 31, 1997. 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 1997 and the results of its
operations and its cash flows for each of the three years in the period
ended December 31, 1997 in conformity with generally accepted accounting
principles.
/s/ Coopers & Lybrand L.L.P.
Coopers & Lybrand L.L.P.
2400 Eleven Penn Center
Philadelphia, Pennsylvania
March 6, 1998
F-2
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
December 31, December 31,
ASSETS 1996 1997
------------------ ------------------
Current assets:
Cash and cash equivalents $ 12,058,798 $ 29,539,103
Accounts receivable, trade, net of
allowance for doubtful accounts of $79,000
and $365,000, respectively 4,701,364 13,441,513
Other current assets 499,815 2,357,184
------------------ ------------------
Total current assets 17,259,977 45,337,800
Funds held in trust for clients
Property and equipment, net 2,830,062 7,469,388
Other assets:
Intangibles, net of accumulated amortization 14,673,155 45,881,276
Deferred taxes 70,760 -
Deferred financing costs 684,390 521,691
Deposits on acquisitions - 1,650,000
Other assets 308,011 775,872
------------------ ------------------
Total other assets 15,736,316 48,828,839
------------------ ------------------
Total assets $ 35,826,355 $ 101,636,027
================== ==================
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 46,946 $ 560,073
Capitalized lease obligations, current portion 62,131 113,578
Corporate taxes payable 216,709 285,756
Accounts payable 657,647 1,913,270
Accrued expenses 1,044,536 3,074,182
Accrued compensation and related expenses 1,376,982 2,844,025
Unearned revenue, net of related costs 225,817 107,388
------------------ ------------------
Total current liabilities 3,630,768 8,898,272
Funds held in trust for clients
Long-term liabilities:
Long term debt, net of current portion 1,091,901 1,437,293
Capitalized lease obligations, net of current portion 385,683 247,775
Deferred taxes - 1,691,304
Unearned revenue, net of related costs 70,385 27,039
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, 37,500,000 shares authorized,
10,070,171 and 13,216,244 shares issued and outstanding, respectively 29,362,326 80,248,636
Unexercised warrants 396,054 1,122,546
Retained earnings 889,238 7,963,162
------------------ ------------------
Total shareholders' equity 30,647,618 89,334,344
------------------ ------------------
Total liabilities and shareholders' equity $ 35,826,355 $ 101,636,027
================== ==================
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,
-----------------------------------------------------
1995 1996 1997
----------------- ------------- --------------
Revenue $ 12,732,597 $ 30,760,452 $ 85,283,668
Operating costs and expenses:
Payroll and related expenses 6,797,338 14,651,384 42,502,175
Selling, general and administrative expenses 4,042,342 10,032,216 27,947,017
Depreciation and amortization expense 347,503 1,253,867 3,368,528
------------ ------------ ------------
Total operating costs and expenses 11,187,183 25,937,467 73,817,720
------------ ------------ ------------
Income from operations 1,545,414 4,822,985 11,465,948
Other income (expense):
Interest and investment income 49,473 242,380 1,019,901
Interest expense (180,205) (817,951) (591,382)
Loss on disposal of fixed assets (49,082) -- (40,506)
------------ ------------ ------------
(179,814) (575,571) 388,013
------------ ------------ ------------
Income before provision for income taxes 1,365,600 4,247,414 11,853,961
Income tax expense -- 612,748 4,780,037
------------ ------------ ------------
Net income $ 1,365,600 $ 3,634,666 $ 7,073,924
============ ============ ============
Pro Forma
-------------------------------
Historical income before income taxes $ 1,365,600 $ 4,247,414
Pro forma provision for income taxes 546,000 1,706,485
------------ ------------
Pro forma net income $ 819,600 $ 2,540,929
============ ============ ============
Net income per share - basic $ 0.12 $ 0.34 $ 0.59
============ ============ ============
Weighted average shares outstanding - basic 7,093,359 7,630,104 11,941,144
============ ============ ============
Net income per share - diluted $ 0.12 $ 0.34 $ 0.57
============ ============ ============
Weighted average shares outstanding - diluted 7,093,359 7,657,691 12,560,493
============ ============ ============
The accompanying notes are an integral part of these consolidated financial statements.
F-4
NCO GROUP, INC.
Consolidated Statements of Cash Flows
For the Years Ended December 31,
------------------------------------------------------------
1995 1996 1997
----------------- ------------------ ------------------
Cash flows from operating activities:
Net income $ 1,365,600 $ 3,634,666 $ 7,073,924
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 199,123 465,785 1,311,181
Amortization of intangibles 221,813 707,050 1,882,492
Amortization of deferred financing costs 32,443 81,031 174,855
Loss on disposal of equipment 49,082 - 40,506
Gain on sales of securities 2,877 (70,481) -
Provision for doubtful accounts 3,808 55,845 285,851
Deferred taxes - (154,684) 1,762,064
Changes in assets and liabilities, net of acquisitions: -
Accounts receivable, trade (571,611) (1,825,307) (3,976,740)
Other current assets 14,052 (312,743) (1,530,329)
Other assets (105,037) (8,903) (13,151)
Accounts payable 161,601 422,694 (1,356,286)
Corporate taxes payable - 216,709 68,353
Accrued expenses 187,353 (788,709) 782,967
Accrued compensation and related costs 555,398 598,997 404,958
Unearned revenue (46,718) (227,548) (161,775)
----------------- ------------------ ------------------
Net cash provided by operating activities 2,069,784 2,794,402 6,748,870
Cash flows from investing activities:
Notes receivable (36,000) 155,856 -
Purchase of property and equipment (298,076) (976,080) (3,368,430)
Purchase of securities (107,643) (78,307) -
Proceeds from sale of securities 99,256 406,937 -
Net cash paid for acquisitions (1,729,244) (12,857,223) (25,850,074)
----------------- ------------------ ------------------
Net cash used in investing activities (2,071,707) (13,348,817) (29,218,504)
Cash flows from financing activities:
Repayment of notes payable (1,067,117) (303,138) (465,588)
Borrowings under credit agreement 2,450,000 12,550,000 8,350,000
Repayment under credit agreement - (15,000,000) (8,350,000)
Payment of fees to acquire new debt (134,163) (222,383) (12,157)
Issuance of common stock 105,127 32,500,000 43,274,926
Costs related to issuance of common stock - (3,675,000) (2,847,242)
Decrease in notes receivable, shareholders - 82,873 -
Distributions to shareholders (1,073,392) (4,123,689) -
----------------- ------------------ ------------------
Net cash provided by financing activities 280,455 21,808,663 39,949,939
----------------- ------------------ ------------------
Net increase in cash and cash equivalents 278,532 11,254,248 17,480,305
Cash and cash equivalents at beginning of period 526,018 804,550 12,058,798
----------------- ------------------ ------------------
Cash and cash equivalents at end of period $ 804,550 $ 12,058,798 $ 29,539,103
================= ================== ==================
The accompanying notes are an integral part of these consolidated financial statements.
F-5
NCO GROUP, INC.
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 1995, 1996 and 1997
Number of Unexercised Retained
Shares Amount Warrants Earnings
----------------- -------------------- ----------------- ---------------
Balance, January 1, 1995 6,189,849 $ 349,326 $ - $ 1,086,053
Issuance of common stock 130,322 188,000 - -
Warrants issued - - 177,294 -
Note repayments - - - -
Net income - - - 1,365,600
Distributions to shareholders - - - (1,073,392)
Change in unrealized gains
on securities - - - -
----------------- -------------------- ----------------- ---------------
Balance, December 31, 1995 6,320,171 537,326 177,294 1,378,261
Issuance of common stock 3,750,000 28,825,000 - -
Warrants issued - - 218,760 -
Note repayments - - - -
Net income - - - 3,634,666
Distributions to shareholders - - - (4,123,689)
----------------- -------------------- ----------------- ---------------
Balance, December 31, 1996 10,070,171 29,362,326 396,054 889,238
Issuance of common stock 3,146,073 50,886,310 (148,508) -
Warrants issued - - 875,000 -
Net income - - - 7,073,924
----------------- -------------------- ----------------- ---------------
Balance, December 31, 1997 13,216,244 $ 80,248,636 $ 1,122,546 $ 7,963,162
================= ==================== ================= ===============
RESTUBBED
Unrealized
Gains Notes
(Losses) on Receivable
Securities Shareholder Total
--------------- ----------------- -----------------
Balance, January 1, 1995 $ (12,695) $ - $ 1,422,684
Issuance of common stock - (135,888) 52,112
Warrants issued - - 177,294
Note repayments - 53,015 53,015
Net income - - 1,365,600
Distributions to shareholders - - (1,073,392)
Change in unrealized gains
on securities 54,034 - 54,034
--------------- ----------------- -----------------
Balance, December 31, 1995 41,339 (82,873) 2,051,347
Issuance of common stock - - 28,825,000
Warrants issued - - 218,760
Note repayments - 82,873 82,873
Net income - - 3,634,666
Distributions to shareholders (41,339) - (4,165,028)
--------------- ----------------- -----------------
Balance, December 31, 1996 - - 30,647,618
Issuance of common stock - - 50,737,802
Warrants issued - - 875,000
Net income - - 7,073,924
--------------- ----------------- -----------------
Balance, December 31, 1997 $ - $ - $ 89,334,344
=============== ================= =================
The accompanying notes are an integral part of these consolidated financial statements.
F-6
NCO GROUP, INC.
Notes to Consolidated Financial Statements
1. Nature of operations:
NCO Group, Inc. (the "Company") is a leading provider of accounts
receivable management and related services utilizing an extensive
teleservices infrastructure. The Company's client base is comprised of
companies located throughout the United States in the following sectors:
financial services, healthcare, retail and commercial, education,
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. In December 1997,
the Company effected a three-for-two stock split and increased the
authorized shares of common stock to 37,500,000. All per share and
related amounts have been adjusted to reflect the stock exchange and
stock splits.
On November 13, 1996, the Company completed its initial public offering
(the "IPO"), selling 4,312,500 shares of common stock including 562,500
over-allotment shares sold by existing shareholders at a price to the
public of $8.67 per share. The IPO 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
IPO.
In July 1997, the Company completed a public offering (the "1997
Offering") selling 4,312,500 shares of common stock at a price to the
public of $19.67 per share, including 2,166,000 shares issued by the
Company, 1,212,869 (562,500 of which were over-allotment shares) sold by
existing shareholders, 75,480 shares acquired by employees through the
exercise of stock options, 225,000 shares acquired by the Company's bank
(Mellon Bank, N.A.) through the exercise of stock warrants, 115,385
shares acquired through the conversion of the Company's convertible note
issued in connection with the acquisition of Management Adjustment Bureau
Inc. ("MAB") in September 1996, and 517,767 shares acquired by CRW
Financial, Inc. in connection with the acquisition by NCO of the
Collection Division of CRW Financial, Inc. ("CRWCD"). The net proceeds of
the 1997 Offering, after underwriting discounts and expenses, were
approximately $40.4 million.
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.
F-7
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies, continued:
Property and Depreciation (continued):
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,
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.
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.
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, 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 an
initial 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 1997, the Company had cash and cash equivalents
in excess of federally insured limits of approximately $1,045,605 and
$25,717,894, 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.
Deferred Financing Costs:
Deferred financing costs relate to debt issuance costs incurred which are
capitalized and amortized over the term of the debt.
F-8
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies, continued:
Intangibles:
Intangibles consists primarily of goodwill and also includes 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. Such allocation has been based on estimates which may be revised
at a later date. The recoverability of goodwill is periodically reviewed
by the Company. 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 1997 totaled $762,612 and $2,610,595, respectively.
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:
All earnings per share computations and presentations are in accordance
with SFAS No. 128, "Earnings per Share."
Reclassifications:
Certain amounts for December 31, 1995 and 1996 and the years then ended
have been reclassified for comparative purposes.
3. Acquisitions:
On August 1, 1995, the Company purchased certain assets of Eastern
Business Services, Inc. ("Eastern") for approximately $2.04 million
comprised of $1.63 million in cash and $416,000 of liabilities assumed.
The purchase price was allocated primarily based upon the estimated fair
market values of the acquired assets and liabilities, resulting in
goodwill of $1.8 million.
On January 3, 1996 the Company purchased certain assets of Trans Union
Corporation Collections Division ("TCD") for $4.75 million in cash. The
purchase price was allocated based upon the estimated fair market values
of the acquired assets, resulting in goodwill of $3.7 million.
On September 5, 1996 the Company purchased the outstanding stock of
Management Adjustment Bureau, Inc. ("MAB") for $9.0 million comprised of
$8.0 million in cash and a $1.0 million convertible note. The purchase
price was allocated based upon the estimated fair market values of the
acquired assets and liabilities, resulting in goodwill of $8.5 million.
On January 22, 1997 the Company purchased the outstanding stock of
Goodyear & Associates, Inc. ("Goodyear") for $5.4 million comprised of
$4.5 million in cash and a $900,000 convertible note. The purchase price
was allocated based upon the estimated fair market values of the acquired
assets and liabilities, resulting in goodwill of $4.9 million.
On January 30, 1997 the Company purchased substantially all the assets of
Tele-Research Center, Inc. ("Tele-Research") for $1.6 million in cash,
which was increased in January 1998 by an additional $600,000 when
certain revenue targets were reached in the period following the
acquisition. The purchase price was allocated based upon the estimated
fair market values of the acquired assets, resulting in goodwill of $1.6
million.
F-9
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
On January 31, 1997 the Company purchased certain assets of the CMS A/R
Services ("CMSA/R"), the Collection Division of CMS Energy Corporation,
for $5.1 million in cash. The purchase price was allocated based upon the
estimated fair market values of the acquired assets, resulting in
goodwill of $3.24 million.
On February 2, 1997 the Company purchased certain assets and assumed
certain liabilities of the Collections Division of CRW Financial, Inc.
for $3.75 million in cash, 517,767 shares of common stock and warrants
for 375,000 shares of common stock. The acquisition was valued at
approximately $12.8 million. The purchase price was allocated based upon
the estimated fair market values of the acquired assets and liabilities,
resulting in goodwill of $10.24 million.
On October 1, 1997 the Company purchased the outstanding stock of
ADVANTAGE Financial Services, Inc. and related companies ("AFS") for $2.9
million in cash, 46,442 shares of common stock and $1.0 million in notes
payable. The acquisition was valued at approximately $5.0 million. The
purchase price was allocated based upon the estimated fair market values
of the acquired assets and liabilities, resulting in goodwill of $5.1
million.
On October 1, 1997 the Company purchased the outstanding stock of Credit
Acceptance Corp. ("CAC") for $1.8 million in cash. The purchase price was
allocated based upon the estimated fair market values of the acquired
assets and liabilities, resulting in goodwill of $1.8 million.
The following summarizes unaudited pro forma results of operations for
the years ended December 31, 1996 and 1997, assuming the above
acquisitions occurred as of the beginning of the respective periods. The
pro forma information is provided for informational purposes only. It is
based on historical information, and does not necessarily reflect the
actual results that would have occurred, nor is it indicative of future
results of operations of the consolidated entities:
1996 1997
----------- ------------
Revenue $87,293,957 $93,905,262
Net income $3,159,555 $6,932,900
Earnings per share-basic $0.30 $0.58
Earnings per share-diluted $0.29 $0.55
On December 31, 1997, effective January 1, 1998, the Company purchased
certain assets of American Financial Enterprises, Inc. Collections
Division ("AFECD") for $1.7 million in cash. Cash paid for the
acquisition of AFECD is included on the Consolidated Balance Sheet at
December 31, 1997 under the caption "Deposits on acquisitions."
On February 6, 1998, the Company purchased certain assets of The Response
Center ("TRC"), which was an independent division of TeleSpectrum
Worldwide, Inc., for $15.0 million plus an earn-out based on the value of
the Company's market research business at December 31, 1998.
4. Marketable securities:
In 1995 and 1996, the Company classified all of its securities as
"available-for-sale" and 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 $99,256 in 1995.
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.
F-10
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
4. Marketable securities (continued):
Investment income, included in interest and investment income on the
Consolidated Statements of Income, from available-for-sale securities as
of December 31, 1995 and 1996 consisted of:
1995 1996
-------- ----------
Realized gain on the sales of securities $12,217 $ 86,509
Realized loss on the sales of securities (15,094) (12,186)
Interest income 7,035 33,577
Dividend income 5,892 6,816
-------- ----------
$ 10,050 $114,716
======== ========
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 $14,898,194 at December 31, 1996 and 1997 have been shown net of
their offsetting liability for financial statement presentation.
6. Property and equipment:
At December 31, 1996 and 1997, property and equipment, at cost, consists
of the following:
1996 1997
---------- ----------
Computer equipment $2,461,211 $7,161,209
Furniture and fixtures 1,095,134 2,063,232
Leased assets 324,414 324,414
---------- ----------
3,880,759 9,548,855
Less accumulated depreciation 1,050,697 2,079,467
---------- ----------
$2,830,062 $7,469,388
========== ==========
Depreciation charged to operations amounted to $199,123, $465,785, and
$1,311,181 for the years ended 1995, 1996 and 1997, respectively. The
Company had not entered into any capital lease transactions for the year
ended December 31, 1997.
7. Cash value, life insurance:
The cash value of certain split-dollar life insurance policies is
included under the caption "Other assets" on the consolidated balance
sheets. The insurance policies, which were purchased in 1997, separately
insure: (i) the joint lives of Michael J. Barrist and his spouse; and
(ii) the joint lives of Charles C. Piola Jr. and his spouse. Under the
terms of the split-dollar agreement, the Company will pay the premiums
for certain survivorship life insurance policies on the lives of Mr. and
Mrs. Barrist and Mr. and Mrs. Charles C. Piola with an aggregate face
value of $50.0 million and $30.0 million, respectively, only to the
extent that the premiums are in excess of the cost of the term insurance
coverage. While the proceeds of the policies are payable to the
beneficiaries designated by the respective executives, the Company has an
interest in the insurance benefits equal to the cumulative amount of
premiums it has paid and is not responsible to pay any premiums in excess
of the cash surrender value of the respective policies.
F-11
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
8. Long-term debt:
1996 1997
---------- ---------
Non-interest bearing note; $99,750 remaining
face amount, payable in monthly installments
of $5,250 through July 1999 (less unamortized
discount based on imputed interest rate
of 10%) $ 138,847 $ 91,900
Vehicle loan - from acquired company
payable in monthly installments of $339
through May 1999 - 5,467
Subordinated seller note payable, 8.00% due
September 2001, converted to common stock
in the 1997 Offering 1,000,000 -
Subordinated seller notes payable, 8.00%,
$500,000 due on April 1998 and January 1999 - 1,000,000
Subordinated seller note payable, 8.00% due
February 2002, convertible to common stock
at $14.117 per share - 900,000
Less current portion (46,946) (560,073)
----------- ------------
$1,091,901 $1,437,294
=========== ============
The following summarizes the Company's required debt payments for the
next five years:
1998 $560,073
1999 537,294
2000 -
2001 -
2002 900,000
In July 1995, the Company entered into a $7.0 million revolving credit
agreement. The line of credit is collateralized by substantially all the
assets of the Company. In September 1996, the credit agreement was
increased to $15.0 million and the bank received a warrant for 69,840
shares, exercisable at $8.67 per share. In December 1996, the bank
increased the credit agreement to $25.0 million and received a warrant to
purchase an additional 27,750 shares, exercisable at $8.67 per share. The
credit agreement currently bears interest at LIBOR plus 1.5% on
outstanding borrowings, and a 3/8% charge on the unused portion of the
credit agreement. 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 on dividends. In July 1997, the bank exercised 225,000
warrants for Common Stock which was sold in the 1997 offering. The
remainder of the warrants were exercised in January 1998.
At December 31, 1996 and 1997, there were no borrowings outstanding on
the credit agreement.
F-12
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
9. Income taxes:
A summary of the components of the tax provision at December 31, 1996 and
1997 is as follows:
1996 1997
--------- ----------
Currently payable:
Federal $620,133 $2,535,009
State 147,299 482,964
Deferred:
Federal 500 1,752,184
State 125 9,880
-------- -----------
Provision for income taxes 768,057 4,780,037
(excluding effect of change
in tax status)
Effect of accounting change:
Federal 124,247 -
State 31,062 -
-------- ----------
Total provision $612,748 $4,780,037
======== ==========
Deferred tax assets (liabilities) at December 31, 1996 and 1997 consist
of the following:
1996 1997
-------- ----------
Deferred tax assets:
Amortization $ 90,083 $ -
Contractual revenue recognition 65,333 25,238
Accrued expenses 38,878 103,199
-------- ---------
194,294 128,437
Deferred tax liabilities:
Amortization - 1,709,982
Depreciation 39,610 109,759
Accrual basis conversion 83,924 -
-------- ----------
123,534 1,819,741
-------- ----------
Net deferred tax asset (liability) $ 70,760 $(1,691,304)
======== ============
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% 34%
Income allocable to S Corporation (27%) -
Non-deductible goodwill and other expenses 5% 2%
State taxes, net of federal 2% 4%
---- -----
Effective tax rate 14% 40%
==== =====
F-13
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
10. 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 $30,027, $71,800, and $178,950, for
1995, 1996 and 1997, respectively.
11. Supplemental cash flow information:
The following are supplemental disclosures of cash flow information:
1995 1996 1997
----------- ----------- -----------
Cash paid for interest $ 157,379 $ 817,950 $ 569,122
Cash paid for income taxes - 600,000 4,153,970
Noncash investing and financing
activities:
Fair value of assets acquired 2,145,578 4,081,005 8,706,137
Property acquired under
capital leases - 348,586 -
Value of fixed assets traded for
new fixed assets - - 238,117
Liabilities assumed from
acquisitions 416,334 2,005,749 4,149,741
Note receivable, shareholder 82,873 - -
Convertible note payable,
issued for acquisition - 1,000,000 900,000
Notes payable,
issued for acquisition - - 1,000,000
Convertible note payable,
converted to Common Stock - - 1,000,000
Common stock issued for
acquisitions - - 9,310,118
Warrants issued with debt 177,294 218,760 -
Warrants issued for acquisitions - - 875,000
Warrants exercised - - 148,508
12. Leases:
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, 1997:
1998 $ 4,299,000
1999 3,668,000
2000 2,686,000
2001 2,082,000
2002 1,547,000
Thereafter 7,749,000
------------
$22,031,000
F-14
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
12. Leases (continued):
Rent expense was $463,916, $1,073,914 and $2,696,819 for the years ended
December 31, 1995, 1996, and 1997, respectively. The related party office
lease expense, which terminated in July 1997, was $385,217, $489,926 and
$231,636, for 1995, 1996, and 1997, respectively. The total amount of
base rent payments is being charged to expense on the straight-line
method over the term of the lease.
13. Earnings per share:
Basic earnings per share were computed by dividing the net income
(including pro forma income taxes where applicable) for the years ended
December 31, 1995, 1996 and 1997 by the pro forma weighted average number
of shares outstanding. Pro forma net income amounts are used for 1995 and
1996 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. Diluted earnings per share were computed by dividing the
net income (including pro forma income taxes where applicable), adjusted
for the effects of interest expense attributable to convertible debt, for
the years ended December 31, 1995, 1996 and 1997 by the weighted average
number of shares outstanding including common equivalent shares. All
outstanding options, warrants and convertible securities have been
utilized in calculating diluted net income per share, using the initial
public offering price of $8.67 per share for periods prior to the IPO,
only when their effect would be dilutive. For 1996, the pro forma
weighted average number of shares outstanding have also been adjusted to
include the number of shares of common stock (375,000 shares) that the
Company would have needed to issue at the initial public offering price
of $8.67 per share to finance the distribution of undistributed S
Corporation earnings through the date on which the Company terminated its
S Corporation status.
The reconciliation of basic to diluted earnings per share ("EPS) consists
of the following (dollars in thousands except EPS amounts (1995 and 1996
are pro forma for taxes):
1995 1996 1997
-------------------- ----------------- -------------------
Shares EPS Shares EPS Shares EPS
--------- --------- -------- -------- ---------- --------
Basic 7,093 $ 0.12 7,630 0.34 11,941 $ 0.59
Dilutive effect of warrants - - - - 96 -
Dilutive effect of options - - - - 403 (0.02)
Dilutive effect of
convertible notes - - 28 - 120 -
-------- -------- ------- ------- -------- -------
Diluted 7,093 $ 0.12 7,658 $0.34 12,560 $ 0.57
======== ======== ======= ======= ======== =======
14. 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"). The 1995 and 1996 plan, as amended, authorized
332,589 and 717,422 shares, respectively, of incentive or non-qualified
stock options. The Director Plan, as amended, authorized 150,000 shares.
The maximum exercise period is ten years after the date of grant. A
summary of stock option activity since inception of the plans is as
follows:
F-15
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
14. Stock options (continued):
Weighted
Average
Number of Option
Price
Options Per Share
-------------- --------------
Outstanding at January 1, 1995 - $ -
Granted 216,086 1.82
-------------- --------------
Outstanding at December 31, 1995 216,086 1.82
Granted 442,371 9.25
-------------- --------------
Outstanding at December 31, 1996 658,457 6.80
Granted 424,075 20.28
Exercised (50,320) 4.20
Forfeited (36,022) 10.72
-------------- --------------
Outstanding at December 31, 1997 996,190 $13.05
============== ==============
Shares exercisable at December 31, 1997 241,201 $ 6.16
============== ==============
The following table summarizes information about fixed stock options
outstanding as of December 31, 1997:
Stock Options Outstanding Stock Options Exercisable
------------------------------------------------- -----------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Prices Shares Remaining Life Exercise Price Shares Exercise Price
-------------------- ------------ ----------------- --------------- ----------- ---------------
$ 1.82 151,490 7.41 years $ 1.82 100,993 $ 1.82
$ 8.66 to $12.09 420,625 8.79 years $ 9.29 140,208 $ 9.29
$15.00 to $19.42 238,050 9.24 years $16.75 - $ -
$23.33 to $25.00 186,025 9.92 years $24.53 - $ -
----------- ----------
996,190 8.90 years 241,201
=========== ==========
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:
1995 1996 1997
-------- ------------ ----------
Net income - as reported $819,600 $2,540,929 $7,073,924
Net income - pro forma $812,023 $2,483,138 $6,633,961
Basic:
Earnings per share - as reported $0.12 $ 0.34 $0.59
Earnings per share - pro forma $.012 $0.33 $0.55
Diluted:
Earnings per share - as reported $.012 $0.34 $0.59
Earnings per share - pro forma $0.12 $0.32 $0.53
F-16
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
14. Stock options (continued):
The estimated weighted-average grant-date fair value of the options
granted during the year ended December 31, 1997 was $7.17. 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 the following assumptions on a weighted average basis:
1995 1996 1997
----- ------ ------
Risk-free interest rate 6.6% 6.32% 6.19%
Expected life in years 3.25 3.25 3.25
Volatility factor 0.00 32.16 40.42
Dividend yield None None None
Forfeiture rate 5.0% 5.0% 5.0%
15. Fair value of financial instruments:
The following methods and assumptions were used to estimate the fair
value of each class of financial instrument for which it is practicable
to estimate that value:
Cash and Cash Equivalents: The carrying amount reported in the balance
sheet approximates fair value because of the short maturity of these
instruments.
Debt: The Company's non-seller-financed debt is primarily variable in
nature and based on the prime rate, and accordingly, the carrying amount
of debt instruments approximates fair value. Seller-financed debt arising
from the MAB and the Goodyear acquisitions consists of two notes payable
which contain a conversion option allowing the holder to convert the debt
into shares of common stock at a price of $8.67 and $14.117 per share,
respectively. Valuation of these subordinated notes assumes a required
rate of return of 13.25% and 10.19%, respectively. For valuation of the
option to convert the notes into 115,385 and 63,755 shares of Common
Stock, respectively, the Company utilized the Black-Scholes option
pricing model and assumed a risk-free interest rate of 6.48% at December
31, 1996 and 5.50% at December 31, 1997, an expected life of three years,
a 35.00% volatility factor at December 31, 1996 and a 37.1% volatility
factor at December 31, 1997, and no expected dividends. The note issued
in connection with the MAB acquisition was converted into Common Stock in
July 1997.
The estimated fair value of the Company's financial instruments are as
follows at December 31:
1996 1997
-------------------------- ------------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
----------- ------------- ----------- -----------
Financial Assets:
Cash and cash equivalents $12,058,798 $12,058,798 $29,539,103 $29,539,103
Financial Liabilities:
Non-interest bearing note payable 138,847 138,847 91,900 91,900
Subordinated seller notes payable - - 1,000,000 1,000,000
Subordinated seller
notes payable, convertible 1,000,000 1,491,016 900,000 1,682,737
16. 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.
F-17
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
16. Quarterly Financial Information (unaudited) (continued):
Quarters Ended
1996 1997
----------------------------------------- -------------------------------------------
Mar. June Sept. Dec. Mar. June Sept. Dec.
31 30 30 31 31 30 30 31
--------- -------- --------- --------- --------- ---------- --------- ---------
Revenue $6,044 $6,499 $7,715 $10,502 $18,077 $21,162 $21,739 $24,306
Income from
operations 915 1,156 1,183 1,569 2,383 3,039 3,112 2,932
Net income
760 1,001 968 906 1,307 1,717 2,082 1,968
17. Commitments and Contingencies:
The Company is party, from time to time, to various legal proceedings
incidental to its business. In the opinion of management none of these
items individually or in the aggregate would have a significant effect on
the financial position, result of operations, cash flows, or liquidity of
the Company.
18. Other Recent Accounting Pronouncements:
In June 1997, the Financial Accounting Standard Board issued SFAS No.
130, "Reporting Comprehensive Income." SFAS No. 130 establishes standards
for the reporting and display of comprehensive income, requiring its
components to be reported in a financial statement that is displayed with
the same prominence as other financial statements. The Company will adopt
this standard in the first quarter of 1998. Management believes that the
adoption of SFAS No. 130 will have not have a material impact on
consolidated results of operations, financial condition or cash flows.
In June 1997, the Financial Accounting Standards Board issued SFAS No.
131, "Disclosures about Segments of an Enterprise and Related
Information." SFAS No. 131 establishes standards for reporting financial
information about operating segments in annual financial statements and
requires reporting of selected information about operating segments in
interim financial reports issued to shareholders. It also establishes
standards for related disclosures about products and services, geographic
areas, and major customer. The Company is required to disclose this
information for the first time it publishes its 1998 annual report.
Management is in the process of evaluating the segment disclosures for
purposes of reporting under SFAS No. 131. The Company has not yet
determined the effect that the adoption of SFAS. No. 131 will have on the
consolidated results of operations, financial condition or cash flows.
F-18