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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
For the Fiscal Year ended December 31, 1998
or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ 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
Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common stock, no par value 18,083,836
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(Title of Class) (Number of Shares Outstanding
as of March 29, 1999)
Indicate by check mark whether the Registrant (i) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (ii) has been subject to such filing
requirements for the past 90 days.
Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of voting stock held by non-affiliates of the
Registrant is $491,828,000(1)
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Proxy Statement to be filed in connection with
its 1999 Annual Meeting of Shareholders are incorporated by reference in Part I
and Part III of this Report. Other documents incorporated by reference are
listed in the Exhibit Index.
-----------------
(1) The aggregate dollar amount of the voting stock set forth equals the number
of shares of the Company's common stock outstanding, reduced by the amount of
common stock held by officers, directors and shareholders owning 10% or more of
the Company's common stock, multiplied by $35.00, the last reported sale price
for the Company's common stock on March 29, 1999. 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
PART I
Item 1. Business. 1
Item 2. Properties. 19
Item 3. Legal Proceedings. 19
Item 4. Submission of Matters to a Vote of Security Holders. 19
Item 4.1 Executive Officers of the Registrant who are not also Directors. 19
PART II
Item 5. Market for Registrant's Common Equity and
Related Shareholder Matters. 20
Item 6. Selected Financial Data. 22
Item 7. Management's Discussion and Analysis of Financial 23
Condition and Results of Operations.
Item 7a Quantitative and Qualitative Disclosure about Market Risk. 31
Item 8. Financial Statements and Supplementary Data. 31
Item 9. Changes in and Disagreements with Accountants on Accounting and 31
Financial Disclosure.
PART III
Item 10. Directors and Executive Officers of the Registrant. 32
Item 11. Executive Compensation. 32
Item 12. Security Ownership of Certain Beneficial Owners and Management. 32
Item 13. Certain Relationships and Related Transactions. 32
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 33
Signatures 36
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 other outsourced services. The Company develops and
implements customized management solutions for clients. The Company provides
these services on a national basis from 65 call centers located throughout North
America and in the United Kingdom and Puerto Rico. 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 fifteen 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 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 is currently organized into market segment specific operating
divisions that are responsible for all aspects of client sales, client service
and operational delivery of services. The operating divisions, which are each
headed by a divisional chief executive officer, include Accounts Receivable
Management, Healthcare Services, Marketing Strategy and International
Operations. The Company provides its services principally to clients in the
financial services, healthcare, education, retail and commercial, utilities,
government, and telecommunications sectors. In 1998, the Company had over 11,500
clients, including Bell Atlantic Corporation, NationsBank Corporation, Citicorp,
MCI WorldCom, PECO Energy Company, Federal Express Corporation, Airborne Freight
Corporation and the United States Department of Education. No client accounted
for more than 4% of the Company's actual revenue in 1998. For its accounts
receivable management services, the Company generates approximately 75% 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 24% in 1998.
For many of its other outsourced services, 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. While
significant economies of scale exist for large accounts receivable management
companies, the industry remains highly fragmented. Based on information obtained
from the American Collectors Association (the "ACA"), and industry trade group,
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 continue to experience consolidation in
the future.
-1-
The Company strives to be a cost-effective, client service driven provider
of accounts receivable management and other outsourced services 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 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 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 outsourced services. In addition, 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 and add complementary services.
The Company's principal executive offices are located at 515 Pennsylvania
Avenue, Fort Washington, Pennsylvania 19034, and its telephone number is (215)
793-9300.
Acquisition History
Since 1994, the Company has completed fifteen 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. In addition, the Company currently has one
acquisition pending that is expected to be completed on March 31, 1999. 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.
A summary of the acquisitions completed during 1998 and 1997, and the
pending acquisition is as follows:
JDR Holdings, Inc.
On November 2, 1998, the Company signed a definitive agreement to acquire
all of the outstanding shares of JDR Holdings, Inc. ("JDR") for approximately
3.4 million shares of NCO common stock. The acquisition is expected to be valued
at approximately $103.1 million. JDR is a leading provider of technology-based
outsourcing and accounts receivable management services. The transaction, which
is expected to be accounted for as a pooling of interests and a tax-free
reorganization, is expected to close on March 31, 1999. JDR's revenue for the
year ended December 31, 1998 was approximately $51.0 million.
-2-
Medaphis Services Corporation
On November 30, 1998, the Company purchased all of the outstanding stock of
Medaphis Services Corporation ("MSC"), a wholly owned subsidiary of Medaphis
Corporation, for $107.5 million in cash plus an earn-out of up to $10 million
based on MSC achieving certain operational targets during 1999. MSC, together
with its subsidiary AssetCare, Inc., was one of the largest providers of
accounts receivable management services and business co-sourcing services to
hospitals located throughout the United States. The acquisition of MSC
significantly enhanced NCO's position as one of the largest providers of
accounts receivable management services and business co-sourcing to the
healthcare sector. MSC's revenue for the year ended December 31, 1997 was
approximately $96.7 million.
MedSource, Inc.
On July 1, 1998, the Company purchased all of the outstanding stock of
MedSource, Inc. ("MedSource") for $18.4 million in cash. In connection with the
acquisition, the Company repaid debt of $17.3 million. MedSource provided
traditional accounts receivable management services and pre-delinquency
outsourcing services primarily to hospitals located throughout the United
States. MedSource's revenue for the year ended December 31, 1997 was
approximately $22.7 million.
FCA International Ltd.
On May 5, 1998, the Company purchased all of the outstanding common shares
of FCA International Ltd. ("FCA") at $9.60 per share, Canadian (equivalent to
$6.77 in U.S. dollars based upon the exchange rate as of the date of the
agreement). The purchase price was valued at approximately $69.9 million. FCA,
which had offices throughout the United States, Canada, and the United Kingdom,
provided accounts receivable management and related services through 16
fully-automated call centers. FCA's revenue for the year ended December 31, 1997
was approximately $62.8 million.
The Response Center
On February 6, 1998, the Company purchased certain assets of The Response
Center ("TRC"), which was an operating division of TeleSpectrum Worldwide, Inc.,
for $15.0 million in cash, plus a performance based earn-out. TRC was a
full-service custom market research company providing services to the
telecommunications, financial services, utilities, healthcare, pharmaceutical
and consumer products sectors. Its capabilities included problem
conceptualization, program design, data gathering (by telephone, mail, and focus
groups), as well as data tabulation, results analysis and consulting. TRC, with
offices in Upper Darby, Pennsylvania, and Philadelphia, Pennsylvania, had
revenue of approximately $8.0 million for the year ended December 31, 1997.
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 $1.7 million in cash. AFECD, an accounts receivable
management company, expanded NCO's penetration into the governmental and
insurance sectors. AFECD's revenue for the year ended December 31, 1997 was
approximately $1.7 million.
-3-
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 and 46,442 shares of the Company's common stock. The note bears
interest payable monthly 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. The purchase
price was valued at approximately $5.0 million. AFS, an accounts receivable
management company with offices in Dayton, Ohio and Bristol, Tennessee, allowed
NCO further penetration into the medical, telecommunications and commercial
sectors. AFS's revenue for the year ended December 31, 1996 was 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, provided NCO
with further penetration into the healthcare sector. CAC's revenue for the year
ended December 31, 1996 was approximately $2.3 million.
Collections Division of CRW Financial, Inc.
On February 2, 1997, NCO purchased substantially all of the assets of the
Collections Division of CRW Financial, Inc. ("CRWCD") for $3.8 million in cash,
517,767 shares of common stock and warrants to purchase 375,000 shares of common
stock at an exercise price of $18.42 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 throughout the United States. In addition, CRWCD had a
commercial collections division. CRWCD's revenue for the year ended December 31,
1996 was approximately $25.9 million.
CMS A/R Services
On January 31, 1997, NCO purchased certain assets of CMS A/R Services ("CMS
A/R"), a division of CMS Energy Corporation, for $5.1 million in cash. CMS A/R,
located in Jackson, Michigan, specialized 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. CMS A/R's
revenue for the year ended December 31, 1996 was approximately $6.8 million.
Tele-Research Center, Inc.
On January 30, 1997, NCO purchased certain assets of Tele-Research Center,
Inc. ("Tele-Research"), for $2.2 million in cash including contingent
consideration paid. Tele-Research, located in Philadelphia, Pennsylvania,
provided market research, data collection, and other teleservices to market
research companies as well as end-users. Tele-Research's revenue for the year
ended December 31, 1996 was approximately $1.8 million.
Goodyear & Associates, Inc.
On January 22, 1997, NCO purchased all of the outstanding stock of Goodyear
& Associates, Inc. ("Goodyear") for $4.5 million in cash and a $900,000
convertible note. On February 15, 1999, the $900,000 convertible note was
converted into 63,755 shares of NCO common stock. Goodyear, based in Charlotte,
North Carolina, provided accounts receivable management services principally to
the telecommunications, education, and utility sectors. Goodyear's revenue for
the year ended December 31, 1996 was approximately $5.5 million.
-4-
Financial Impact of Acquisitions
The Company financed the MSC acquisition with borrowings of approximately
$107.5 million on its revolving credit facility. The Company financed the
MedSource acquisition with borrowings of approximately $25.5 million on its
revolving credit facility and a portion of the net proceeds of the Company's
public offering of stock completed in June 1998 (the "1998 Offering"). The
Company financed the FCA acquisition with borrowings of approximately $69.9
million on its revolving credit facility which were subsequently repaid with a
portion of the net proceeds from the 1998 Offering. The Company financed the
acquisition of AFS, CAC, AFECD and TRC with a portion of the proceeds of the
Company's public offering of stock completed in July 1997 (the "1997 Offering").
The Company financed the acquisitions of Goodyear, CMS A/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 from the acquisitions of Goodyear, CMS A/R,
Tele-Research and CRWCD were repaid with a portion of the proceeds from the 1997
Offering.
The bank increased the Company's revolving credit 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 acquisition of FCA International Ltd. In November
1998, the bank increased credit agreement to provide for borrowings up to $200
million consisting of a term loan of $125 million and a revolving credit
facility of up to $75 million. The borrowings under this credit facility bear
interest equal to either, at the option of NCO, Mellon Bank's prime rate (7.75%
at March 29, 1999) or LIBOR plus a margin ranging from 1.25% to 2.25% depending
on NCO's consolidated funded debt to EBITDA ratio (LIBOR was 4.90% at March 29,
1999).
The pending JDR acquisition is expected to be financed with approximately
3.4 million shares of NCO common stock.
All of the acquisitions, with the exception of the pending acquisition of
JDR, have been accounted for under the purchase method of accounting for
financial reporting purposes. Through December 31, 1998, these acquisitions have
created goodwill estimated at $281.9 million which is being amortized over a 15
to 40 year period resulting in amortization expense of approximately $9.5
million annually.
The pending JDR acquisition is expected to be accounted for using the
pooling of interests method of accounting, with the historical results of
operations of JDR being combined with that of the Company.
Accounts Receivable Management Services
The Company provides a wide range of accounts receivable management
services to its clients utilizing an extensive technological infrastructure.
Although most of the Company's accounts receivable management services to date
have focused on recovery of traditional delinquent accounts, the Company does
engage in the recovery of current receivables and early stage delinquencies
(generally, accounts which are 90 days or less past due). The Company generates
approximately 75% 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.
-5-
Recovery activities typically include the following:
Management Planning. The Company's approach to accounts receivable
management for each client is determined by a number of factors including
account size and demographics, the client's specific requirements and
management's estimate of the collectability of the account. The Company has
developed a library of standard processes for accounts receivable management
which is based upon its accumulated experience. The Company will integrate these
processes with its client's requirements to create a customized recovery
solution. In many instances, the approach will evolve and change as the
relationship with the client develops and both parties evaluate the most
effective means of recovering accounts receivable. The Company's standard
approach, which may be tailored to the specialized requirements of its clients,
defines and controls the steps that will be undertaken by the Company on behalf
of the client and the manner in which data will be reported to the client.
Through its systemized approach to accounts receivable management, the Company
removes most decision making from the recovery staff and ensures uniform,
cost-effective performance.
Once the approach has been defined, the Company electronically or manually
transfers pertinent client data into its information system. Once the client's
records have been established in the Company's system, the Company commences the
recovery process.
Skip Tracing. In cases where the customer's telephone number or address is
unknown, the Company systematically searches the United States Post Office
National Change of Address service, consumer data bases, electronic telephone
directories, credit agency reports, tax assessor and voter registration records,
motor vehicle registrations, military records and other sources. The geographic
expansion of banks, credit card companies, national and regional
telecommunications companies and managed healthcare providers along with the
mobility of consumers has increased the demand for locating the client's
customers. Once the Company has located the customer, the notification process
can begin.
Account Notification. The Company initiates the recovery process by
forwarding an initial letter which is designed to seek payment of the amount due
or open a dialogue with customers who cannot afford to pay at the current time.
This letter also serves as an official notification to each customer of their
rights as required by the federal Fair Debt Collection Practices Act. The
Company continues the recovery process with a series of mail and telephone
notifications. Telephone representatives remind the customer of their
obligation, inform them that their account has been placed for collection with
the Company and begin a dialogue to develop a payment program.
Credit Reporting. At a client's request, the Company will electronically
report delinquent accounts to one or more of the national credit bureaus where
it will remain for a period of up to seven years. The denial of future credit
often motivates the payment of all past due accounts.
Litigation Management. When account balances are sufficient, the Company
will also coordinate litigation undertaken by a nationwide network of attorneys
that the Company utilizes on a routine basis. Typically, account balances must
be in excess of $1,000 to warrant litigation and the client is asked to advance
legal costs such as filing fees and court costs. Attorneys 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.
-6-
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
technological 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 company 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.
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 a
large 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.
-7-
Operations
Technology and Infrastructure. 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 65 state-of-the-art call centers which are electronically linked
through a international wide area network. The Company currently utilizes three
computer platform systems. One system consists of multiple Unix-based NCR 4300
series servers which are linked to 1,200 workstations and which provide
necessary redundancy (a spare system can take over in the event of the failure
of the primary system) and excess capacity for future growth. The second system
consists of multiple Unix-based Hewlett-Packard 9000 series servers which are
linked to 2,835 workstations. The third system consists of a TANDEM server which
is linked to 825 workstations. The TANDEM system is being used as a transitional
system as a result of the FCA International Ltd. acquisition. The data and the
users on this system will be transitioned to the NCR servers by the fourth
quarter of 1999. The Company's 4,860 workstations consist of personal computers
and terminals that are linked via network to the servers.
The Company utilizes 37 predictive dialer locations with 927 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 150 person MIS staff led by a 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 11,500 companies in the
financial services, healthcare, education, retail and commercial, utilities,
government and telecommunications sectors. The Company's 10 largest clients in
1998 accounted for approximately 19.6% of the Company's revenue. In 1998, no
client accounted for more than 4.0% of total revenue. In 1998, the Company
derived 32.7% of its referrals from financial institutions (which includes
banking and insurance sectors), 22.7% from healthcare organizations, 17.5% from
educational organizations, 10.8% from retail and commercial entities, 6.9% from
utilities, 5.0% from government entities and 4.4% from telecommunications
companies.
The following table sets forth a list of certain of the Company's key
clients:
Financial Services Healthcare Retail and Commercial
- ---------------------------------- -------------------------------- --------------------------------
Capital One Financial Corporation Catholic Healthcare West - Airborne Freight Corporation
Citicorp Shared Business Services Dayton Hudson Corporation
First Union National Bank, N.A. EMCARE, Inc. Emery Worldwide N.A.
NationsBank Corporation Health Management Associates, Inc. Federal Express Corporation
The Progressive Corporation Medical Center of Delaware Sears, Roebuck and Co.
Premium Purchasing Partners LP
Education Telecommunications Utilities and Government
- ---------------------------------- --------------------------------- --------------------------------
California Student Aid Bell Atlantic Corporation Consumer Energy
Commission BellSouth Telecommunications, Inc. PECO Energy Company
New York State Higher Education Frontier Cellular The City of Philadelphia, Water
Service Corporation MCI WorldCom Revenue Bureau
Pennsylvania Higher Education Sprint Corporation The United States Department of
Assistance Agency Treasury
Penn State University Virginia Power
The United States Department of
Education
The Company enters into contracts with most of its clients which define,
among other things, fee arrangements, scope of services and termination
provisions. Clients may usually terminate such contracts on 30 or 60 days
notice. In the event of termination, however, clients typically do not withdraw
accounts referred to the Company prior to the date of termination, thus
providing the Company with an ongoing stream of revenue from such accounts which
diminish over time. Under the terms of the Company's contracts, clients are not
required to place accounts with the Company but do so on a discretionary basis.
-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 56
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 a staff of
technical writers 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, 1998, the Company had a total of 6,700 full-time
employees and 300 part-time employees, of which 4,900 were telephone
representatives. None of the Company's employees are represented by a labor
union. The Company believes that its relations with its employees are good.
Competition
The accounts receivable management industry is highly competitive. The
Company competes with approximately 6,500 providers, including large national
corporations such as Outsourcing Solutions, Inc., GC Services, Inc., Compass
International Services Corporation and Equifax, as well as many regional and
local firms. Some of the Company's competitors have greater resources, offer
more diversified services and operate in broader geographic areas than the
Company. In addition, the accounts receivable management services offered by the
Company, are performed in-house by many companies. Moreover, many larger clients
retain multiple accounts receivable management providers which exposes the
Company to continuous competition in order to remain a preferred vendor. The
Company believes that the primary competitive factors in obtaining and retaining
clients are the ability to provide customized solutions to a client's
requirements, personalized service, sophisticated call and information systems
and price. 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.
The collection of accounts receivable by collection agencies in Canada is
regulated at the provincial and territorial level in substantially the same
fashion as is accomplished by federal and state laws in the United States. The
manner in which the Company carries on the business of collecting accounts is
subject, in all provinces and territories, to established rules of common law or
civil law and statute. Such laws establish rules and procedures governing the
tracing, contacting and dealing with debtors in relation to the collection of
outstanding accounts. These rules and procedures prohibit debt collectors from
engaging in intimidating, misleading and fraudulent behavior when attempting to
recover outstanding debts. In Canada, the Company's collection operations are
subject to licensing requirements and periodic audits by government agencies and
other regulatory bodies. Generally, such licenses are subject to annual renewal.
Management believes that the Company holds all necessary licenses in those
provinces and territories that require them.
If the Company engages in other teleservice activities in Canada, including
telemarketing, there are several provincial and territorial consumer protection
laws of more general application. This legislation defines and prohibits unfair
practices by telemarketers, such as the use of undue pressure and the use of
false, misleading or deceptive consumer representations.
In addition, accounts receivable management and telemarketing industries
are regulated in the United Kingdom, including a licensing requirement. If the
Company expands its international operation, it may become subject to additional
government control and regulation in other countries, which may be more onerous
than those in the United States.
-11-
Several of the industries served by the Company are also subject to varying
degrees of government regulation. Although compliance with these regulations is
generally the responsibility of the Company's clients, the Company could be
subject to a variety of enforcement or private actions for its failure or the
failure of its clients to comply with such regulations.
The Company devotes significant and continuous efforts, through training of
personnel and monitoring of compliance, to ensure that it is in compliance with
all federal and state regulatory requirements. The Company believes that it is
in material compliance with all such regulatory requirements.
Investment Considerations
Certain statements included in this Annual Report on Form 10-K, other than
historical facts, are forward-looking statements (as such term is defined in the
Securities Exchange Act of 1934, and the regulations thereunder) which are
intended to be covered by the safe harbors created thereby. Forward-looking
statements include, without limitation, statements as to the Company's objective
to grow through strategic acquisitions and internal growth, the impact of
acquisitions on the Company's earnings, the Company's ability to realize
operating efficiencies in the integration of its acquisitions, trends in the
Company's future operating performance, Year 2000 Compliance, the effects of
legal or governmental proceedings, the effects of changes in accounting
pronouncements and statements as to the Company's or management's beliefs,
expectations and opinions. Forward-looking statements are subject to risks and
uncertainties and may be affected by various factors which may cause actual
results to differ materially from those in the forward-looking statements. The
factors discussed below, and elsewhere in this Annual Report on Form 10-K, could
cause actual results and developments to be materially different from those
expressed in or implied by such forward looking statements. Accordingly, in
addition to the other information contained, or incorporated by reference, in
this Annual Report on Form 10-K, the following factors should be considered
carefully in evaluating an investment in the Company's common stock.
The businesses acquired by NCO in 1998 and the pending acquisition of JDR
Holdings, Inc. ("JDR") had combined revenues of $223.2 million in 1997
which was 262% of NCO's revenue of $85.3 million in 1997. If NCO is unable
to successfully manage these new businesses, NCO may not realize the
expected benefits from these acquisitions.
The businesses acquired by NCO in 1998 and to be acquired in the pending
JDR acquisition had combined revenues of $223.2 million in 1997 compared to
NCO's revenue of $85.3 million in 1997. If NCO is unable to successfully manage
these new businesses and integrate them into NCO's operations, NCO may not be
able to realize expected operating efficiencies, eliminate redundant costs or
operate the businesses profitably. The integration of these businesses is
subject to a number of risks, including risks that:
o the conversion of the acquired companies computer and operating
systems to NCO's systems may take longer or cost more than expected;
o NCO may be unable to retain clients or key employees of the acquired
companies; and
o the acquired companies might have additional liabilities that NCO did
not anticipate at the time of the acquisitions.
-12-
NCO's growth strategy depends on acquisitions. If NCO is unable to make
acquisitions, its future growth would be limited and the price of its stock
may be adversely affected.
NCO growth strategy includes acquisitions that expand and complement NCO's
business. If NCO is unable make acquisitions, it may not be able to meet or
exceed historical levels of growth and earnings. As a result, NCO's stock price
may be aversely affected.
NCO may be unable to make acquisitions due to, among other reasons:
o NCO may not be able to identify suitable companies to buy because
many of the companies in the accounts receivable management business
are relatively small when compared to NCO; and
o NCO may not be able to purchase companies at favorable prices, or at
all, due to increased competition for these companies.
NCO may have to borrow money or incur liabilities, or sell stock, to pay
for future acquisitions. This could have a material adverse effect on NCO's
liquidity and capital resources or dilute NCO shareholders. If NCO does not
have sufficient cash resources or is not able to use its common stock as
payment for acquisitions, it may not be able to accomplish its growth
strategy
NCO may have to borrow money or incur liabilities, or sell stock, to pay
for future acquisitions and it may not be able to do so or on terms favorable to
NCO. Additional borrowings and liabilities may have a material adverse effect on
NCO's liquidity and capital resources. If NCO issues stock for all or a portion
of the purchase price for future acquisitions, existing shareholders may be
diluted. If the price of NCO's common stock decreases or potential sellers are
not willing to accept NCO's common stock as payment for the sale of their
businesses, NCO may be required to use more of its cash resources, if available,
in order to continue its acquisition program. If NCO does not have sufficient
cash resources or is not able to use its common stock as payment for
acquisitions, its growth through acquisitions could be limited.
Completed acquisitions involve additional risks that may adversely affect
NCO.
Acquisitions also may involve a number of additional risks including:
o Future acquisitions could divert management's attention from the
daily operations of NCO and otherwise require additional management,
operational and financial resources;
o NCO might not be able to successfully integrate future acquisitions
into its business or operate such acquired businesses profitably;
o NCO will be required to amortize acquired intangible assets which
will reduce its income in future years; and
-13-
o NCO may be subject to unanticipated problems and liabilities of
acquired companies.
NCO's significant internal growth may be difficult to manage or to
continue. If NCO is not able to manage or continue that growth, it could
have a materially adverse effect on NCO's business, results of operations
and financial condition.
NCO has experienced significant internal growth over the past several years
and intends to continue its internal growth. Future internal growth is subject
to a number of risks, including the risks that:
o NCO may not be able to develop and maintain new clients;
o by focusing on new clients, NCO may lose existing clients through
inattention or because NCO fails to maintain the quality of services
it provides to its clients; and
o NCO may have difficulty hiring, training and retaining new employees
to handle the increased workload.
NCO's internal growth has placed significant demands on NCO's
administrative, operational and financial resources. To continue its future
growth, NCO will also be required to improve its operational and financial
systems and obtain additional management, operational and financial resources.
These additional costs may outweigh the benefits NCO expects to obtain from
internal growth.
Goodwill represented 72.2% of NCO's total assets at December 31, 1998. If
management has incorrectly overstated the permissible length of the
amortization period for goodwill, earnings reported in periods immediately
following the acquisition would be overstated. In later years, NCO would be
burdened by a continuing charge against earnings.
NCO's balance sheet includes amounts designated as "goodwill." Goodwill
represents the excess of purchase price over the fair market value of the net
assets of the acquired businesses based on their respective fair values at the
date of acquisition. GAAP requires that this and all other intangible assets be
amortized over the period benefited. Management has determined that period to
range from 15 to 40 years based on the attributes of each acquisition.
As of December 31, 1998, NCO's balance sheet included goodwill that
represented 72.2% of total assets and 140.3% of shareholders' equity.
If management has incorrectly overstated the permissible length of the
amortization period for goodwill, earnings reported in periods immediately
following the acquisition would be overstated. In later years, NCO would be
burdened by a continuing charge against earnings without the associated benefit
to income valued by management in arriving at the consideration paid for the
business. Earnings in later years also could be significantly affected if
management determined then that the remaining balance of goodwill was impaired.
Management has reviewed with its independent accountants all of the factors
and related future cash flows which it considered in arriving at the amount
incurred for each acquisition. Management concluded that the anticipated future
cash flows associated with intangible assets recognized in the acquisitions will
continue indefinitely, and there is no persuasive evidence that any material
portion will dissipate over a period shorter than the respective amortization
period.
-14-
The number of shares of NCO's common stock that is traded daily on the
Nasdaq stock market averages less than 1.0% of the outstanding common
stock. As a result, the market price of NCO common stock may be volatile.
As a result of NCO's low trading volume, the market price for NCO common
stock may be volatile and may be affected by many factors, including the
following:
o announcements of fluctuations in NCO's or its competitors' operating
results;
o the timing and announcement of acquisitions by NCO or its
competitors; and
o government regulatory action.
In addition, the stock market in recent years has experienced significant
price and volume fluctuations that often have been unrelated or disproportionate
to the operating performance of companies. These broad fluctuations may
materially adversely affect the market price of NCO common stock.
As of March 29, 1999, approximately 77.7% of NCO's outstanding shares will
be available for resale in the public market without restriction. The sale
of a large number of these shares could adversely affect NCO's stock price
and could impair NCO's ability to raise capital through the sale of equity
securities or make acquisitions for stock.
Sales of NCO's common stock could adversely affect the market price of
NCO's common stock and could impair NCO's future ability to raise capital
through the sale of equity securities or make acquisitions for stock. As of
March 29, 1999, there was 18,083,836 shares of NCO common stock outstanding. Of
these shares, approximately 14,052,234 shares, or 77.7% of the total outstanding
shares, will be available for resale in the public market without restriction.
Approximately 4,031,602 shares of NCO common stock, or 22.3% of the total
outstanding shares, are held by affiliates of NCO. Generally, NCO affiliates may
either sell their shares under a registration statement or in compliance with
the volume limitations and other requirements imposed by Rule 144 adopted by the
SEC.
In addition, as of March 29, 1999, NCO has the authority to issue up to
approximately 1,929,086 shares of its common stock under its stock option plans.
NCO also will have outstanding a warrant to purchase 375,000 shares of its
common stock.
NCO may experience variations from quarter to quarter in operating results
and net income which could adversely affect the price of NCO common stock.
Factors which could cause quarterly fluctuations include the following:
o the timing of NCO's clients' accounts receivable management programs
and the commencement of new contracts;
o customer contracts may require NCO to incur costs in periods prior to
recognizing revenue under those contracts;
-15-
o the effect of the change of business mix on profit margins;
o the timing of additional selling, general and administrative expenses
to support new business;
o the costs and timing of completion and integration of acquisitions.
o NCO's business tends to be slower in the third and fourth quarters of
the year due to the summer and holiday seasons.
NCO's business is dependent on clients in the financial services and
healthcare sectors. If either of these sectors performs poorly or if there
are any trends in these sectors to reduce or eliminate the use of
third-party accounts receivable management services provided by companies
like NCO, it could have a materially adverse effect on NCO's business,
financial condition and results of operations.
For the year ended December 31, 1998, NCO derived approximately 32.7% its
revenue from clients in the financial services sector and approximately 22.7% of
its revenue from clients in the healthcare sector. If either of these sectors
performs poorly, clients in these sectors may have fewer or smaller accounts to
refer to NCO or they may elect to perform accounts receivable management
services in-house. If there are any trends in either of these sectors to reduce
or eliminate the use of third-party accounts receivable management services, the
volume of referrals to NCO would decrease.
Most of NCO's contracts do not require clients to place accounts with NCO,
may be terminated on 30 or 60 days notice and are on a contingent fee
basis. Accordingly, NCO can not predict whether existing clients will
continue to use NCO's services at historical levels, if at all.
Under the terms of most of NCO's contracts, clients are not required to
give accounts to NCO for collection and usually have the right to terminate
NCO's services on 30 or 60 days notice. In addition, most of these contracts
provide that NCO is entitled to be paid only when it collects accounts.
Accordingly, NCO can not predict whether existing clients will continue to use
NCO's services at historical levels, if at all.
NCO competes with approximately 6,500 providers in the accounts receivable
management industry. This competition could have a materially adverse
effect on NCO's future financial results.
NCO competes with approximately 6,500 providers in providing accounts
receivable management services. NCO is a national provider of accounts
receivable management services. NCO competes with other large national
corporations such as Outsourcing Solutions, Inc., GC Services, Inc., Compass
International Services Corporation and Equifax, as well as many regional and
local firms. NCO may lose existing or prospective business to competitors that
have greater resources, offer more diversified services or operate in broader
geographic areas than NCO. NCO may also lose business to regional or local firms
who are able to use their proximity to or contacts at local clients as a
marketing advantage. Because of the large numbers of providers, in the future
NCO may have to reduce its collection fees to remain competitive. Many larger
clients retain multiple accounts receivable management providers which exposes
NCO to continuous competition in order to remain a preferred vendor.
-16-
If NCO is not able to respond to technological changes in
telecommunications and computer systems in a timely manner, it may not be
able to remain competitive.
NCO's success depends in large part on its sophisticated telecommunications
and computer systems. NCO uses these systems to identify and contact large
numbers of account debtors and to record the results of the collection effort.
If NCO is not able to respond to technological changes in telecommunications and
computer systems in a timely manner, it may not be able to remain competitive.
NCO has made a significant investment in technology to remain competitive and
anticipates that it will be necessary to continue to do so in the future.
Computer and telecommunication technologies are changing rapidly and are
characterized by short product life cycles, so that NCO must anticipate
technological developments. If NCO is not successful in anticipating, managing
or adopting any technological changes on a timely basis or if NCO does not have
the capital resources available to invest in new technologies, its business
would be materially adversely affected.
If NCO's telecommunications and computer systems fail or become
unavailable, it could have a materially adverse effect on NCO's business.
As noted above, NCO's business is highly dependent on its
telecommunications and computer systems. These systems could be interrupted by
natural disasters, power losses, or similar events. NCO's business also is
materially dependent on service provided by various local and long distance
telephone companies. If NCO's equipment or systems cease to work or become
unavailable, or if there is any significant interruption in telephone services,
NCO may be prevented from providing services. Because NCO generally recognizes
income only as accounts are collected, any failure or interruption of services
would mean that NCO would continue to incur payroll and other expenses without
any corresponding income.
NCO's systems or those of its clients or suppliers may not be Year 2000
compliant. This means that NCO might be unable to provide accounts
receivable management services or engage in similar normal business
activities for a period of time after January 1, 2000 which could have a
material adverse effect on its business, operating results and financial
position.
NCO relies on its telephone and computer systems, software and other
systems in operating and monitoring all aspects of its business. NCO also relies
heavily on the systems of its clients and suppliers. If NCO's present efforts to
address the Year 2000 compliance issues are not successful, or if the systems of
NCO's clients and suppliers and other organizations with which NCO does business
are not Year 2000 compliant, NCO may be unable to provide accounts receivable
management services or engage in similar normal business activities for a period
of time after January 1, 2000. As a result, NCO would be unable to recognize
income. NCO also may lose existing or potential clients and its reputation in
the industry might be damaged.
NCO's success depends on its senior management team and if it is not able
to retain them, it could have a materially adverse effect on NCO.
NCO is highly dependent upon the continued services and experience of its
senior management team, including Michael J. Barrist, Chairman of the Board,
President and Chief Executive Officer. NCO depends on the services of Mr.
Barrist and the other members of NCO's senior management team to, among other
things:
o successfully integrate the operations of NCO with acquired companies;
o continue NCO's acquisition and growth strategies; and
o maintain and develop NCO's client relationships.
-17-
NCO is dependent on its employees and a higher turnover rate would
materially adversely affect NCO.
The accounts receivable management industry is very dependent upon
employees and experiences high turnover rate. Many of NCO's employees receive
modest hourly wages and a portion of these employees are employed on a part-time
basis. A higher turnover rate among NCO's employees would increase NCO's
recruiting and training costs and could materially adversely impact the quality
of services NCO provides to its clients. If NCO were unable to recruit and
retain a sufficient number of employees, it would be forced to limit its growth
or possibly curtail its operations. Growth in NCO's business will require it to
recruit and train qualified personnel at an accelerated rate from time to time.
NCO cannot assure you that it will be able to continue to hire, train and retain
a sufficient number of qualified employees. Additionally, an increase in hourly
wages, costs of employee benefits or employment taxes also could materially
adversely affect NCO.
"Anti-takeover" provisions may make it more difficult for a third party to
acquire control of NCO, even if the change in control would be beneficial
to shareholders.
NCO is a Pennsylvania corporation. Anti-takeover provisions in Pennsylvania
law and NCO's charter and bylaws could make it more difficult for a third party
to acquire control of NCO. These provisions could adversely affect the market
price of NCO common stock and could reduce the amount that shareholders might
receive if NCO is sold. For example, NCO's charter provides that NCO's board of
directors may issue preferred stock without shareholder approval. In addition,
NCO's bylaws provide for a classified board, with each board member serving a
staggered three year term. Directors may be removed only for cause and only with
the approval of the holders of at least 65% of NCO's common stock.
If NCO fails to comply with government regulation of accounts receivable
management and telemarketing industries, it could result in the suspension
or termination of NCO's ability to conduct business which would have a
materially adverse effect on NCO.
The accounts receivable management and telemarketing industries are
regulated under various United States federal and state, Canadian and United
Kingdom laws and regulations. Many states, as well as Canada and the United
Kingdom, require that NCO be licensed as a debt collection company. If NCO fails
to comply with applicable laws and regulations, it could result in the
suspension or termination of NCO's ability to conduct accounts receivable
management or telemarketing services which would have a materially adverse
effect on NCO. In addition, new federal, state or foreign laws or regulations,
or changes in the ways these rules or laws are interpreted or enforced, could
limit the activities of NCO in the future or significantly increase the cost of
regulatory compliance. If NCO expands its international operations, it may
become subject to additional government controls and regulations in other
countries, which may be stricter or more burdensome than those in the United
States.
Several of the industries served by NCO are also subject to varying degrees
of government regulation. Although NCO's clients are generally responsible for
complying with these regulations, NCO could be subject to a variety of
enforcement or private actions for its failure or the failure of its clients to
comply with these regulations.
-18-
Item 2. Properties.
The Company currently leases 62 call centers throughout North America, two call
centers in the United Kingdom and one call center in Puerto Rico. The leases of
these facilities expire between 1999 and 2010, and most contain renewal options.
In addition, the Company leases 14 sales offices located throughout North
America.
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 FCA International Ltd.,
MedSource, Inc. and Medaphis Services Corporation acquisitions.
Item 3. Legal Proceedings.
The Company is involved in legal proceedings from time to time in the
ordinary course of its business. Management believes that none of these legal
proceedings will have a materially adverse effect on the financial condition or
results of operations of the Company.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
Item 4.1 Executive Officers of the Registrant who are not Directors.
Name Age Position
- -------------------------------------------------- -------- ----------------------------------------
Steven L. Winokur...................... 39 Executive Vice President, Finance;
Chief Financial Officer; and Treasurer
Joseph C. McGowan...................... 46 Executive Vice President and
Divisional CEO, Accounts Receivable
Management Services
Stephen W. Elliott..................... 37 Executive Vice President, Information
Technology and Chief Information Officer
Patrick M. Baldasare................... 43 Executive Vice President and
Divisional CEO, Marketing Strategy
Robert Di Sante........................ 47 Executive Vice President and
Divisional CEO, International
Operations
Joshua Gindin, Esq..................... 42 Executive Vice President and General
Counsel
Paul E. Weitzel Jr..................... 40 Executive Vice President, Corporate
Development
-19-
Steven L. Winokur, Executive Vice President, Finance; Chief Financial
Officer; and Treasurer, joined the Company in December 1995. Prior to that, Mr.
Winokur acted as a part-time consultant to the Company since 1986. From February
1992 to December 1995, Mr. Winokur was the principal of Winokur & Associates, a
certified public accounting firm. From March 1981 to February 1992, Mr. Winokur
was with Gross & Company, a certified public accounting firm, where he most
recently served as Administrative Partner. Mr. Winokur is a certified public
accountant.
Joseph C. McGowan, Executive Vice President and Divisional CEO, Accounts
Receivable Management Services, joined the Company in 1990. Prior to joining the
Company, Mr. McGowan was Assistant Manager of the Collections Department at
Philadelphia Gas Works, a public utility, since 1975.
Stephen W. Elliott, Executive Vice President, Information Technology and
Chief Information Officer, joined the Company in 1996 after having provided
consulting services to the Company for the year prior to his arrival. Prior to
joining the Company, Mr. Elliott was employed by Electronic Data Systems, a
computer services company for almost 10 years, most recently as Senior Account
Manager.
Patrick M. Baldasare, Executive Vice President and Divisional CEO,
Marketing Strategy, joined the Company through the acquisition of The Response
Center in February 1998. Prior to joining the Company, Mr. Baldasare was Chief
Executive Oficer and President of The Response Center since it was founded in
1987. From 1983 to 1987, Mr. Baldasare was President of Valley Forge Information
Service, the market research division of Burlington Industries.
Robert Di Sante, Executive Vice President and Divisional CEO, International
Operations, joined the Company through the acquisition of FCA International Ltd.
in May 1998. Prior to joining the Company, Mr. Di Sante was Executive Vice
President, Finance and Corporate Services of FCA International Ltd. Mr. Di Sante
is a chartered accountant.
Joshua Gindin, Esq., Executive Vice President and General Counsel, joined
the Company in May 1998. Prior to joining the Company, Mr. Gindin was a partner
in the law firm of Kessler & Gindin which served as legal counsel to the Company
since 1986.
Paul E. Weitzel, Jr., Executive Vice President, Corporate Development,
joined the Company through the acquisition of MedSource, Inc. in July 1998.
Prior to joining the Company, Mr. Weitzel was Chairman and Chief Executive
Officer of MedSource, Inc. since 1997. Prior to joining MedSource, Inc., Mr.
Weitzel was with MedQuist, Inc. for four years, most recently as President and
Chief Executive Officer. Mr. Weitzel is a certified public accountant.
PART II
Item 5. Market for the Registrant's Common Stock and Related Shareholder
Matters.
Following the Company's initial public offering of common stock on November
6, 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.
High Low
1996
Fourth Quarter (from November 6) $12.96 $11.00
1997
First Quarter 18.92 11.17
Second Quarter 22.50 12.17
Third Quarter 26.50 20.58
Fourth Quarter 28.33 21.00
1998
First Quarter 29.25 21.87
Second Quarter 28.00 20.50
Third Quarter 28.50 17.63
Fourth Quarter 45.00 23.50
-20-
As of March 29, 1999, the Company's common stock was held by approximately
78 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 2,945.
Dividend Policy
The Company does not anticipate paying cash dividends on its common stock
in the foreseeable future. In addition, the Company's revolving credit agreement
prohibits the Company from paying cash dividends without the lender's prior
consent. The Company currently intends to retain future earnings to finance its
operations and fund the growth of its business. Any payment of future dividends
will be at the discretion of the Board of Directors of the Company and will
depend upon, among other things, the Company's earnings, financial condition,
capital requirements, level of indebtedness, contractual restrictions with
respect to the payment of dividends and other factors that the Company's Board
of Directors deems relevant.
Sales of Unregistered Securities during 1998
Set forth below is information concerning certain issuances of common stock
during 1998 which were not registered under the Securities Act and which have
not been previously reported.
From January to December 1998, 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
----------- --------------- --------------
January 1998 52,500 $24.38
February 1998 25,000 $29.19
June 1998 26,500 $21.49
July 1998 20,000 $21.57
August 1998 262,750 $21.00
October 1998 82,900 $26.70
November 1998 58,000 $36.88
December 1998 242,350 $33.81
In June 1998, the Company issued options in accordance with the 1996
Non-Employee Director Stock Option Plan to purchase 3,000 shares of common stock
to each of Eric S. Siegel and Alan F. Wise. These options were granted at an
exercise price of $21.63 per share. The options were issued in reliance upon the
exemption from the registration requirements provided by Section 4(2) of the
Securities Act.
In February 1999, the Company issued 63,755 shares of common stock upon the
conversion of a $900,000 convertible note issued as part of the consideration in
the acquisition of Goodyear & Associates, Inc. The shares were issued in
reliance upon the exemption from the registration requirements provided by
Section 3(a)(a) of the Securities Act.
-21-
Item 6. Selected Financial Data.
SELECTED FINANCIAL DATA
(Amounts in thousands, except per share data)
For the years ended December 31,
---------------------------------------------------------------------------
1994 1995 1996 1997 1998
------------ ------------ ----------- ------------ ------------
Statement of Income Data:
Revenue $8,578 $12,733 $30,760 $85,284 $178,976
Operating costs and expenses:
Payroll and related expenses 4,558 6,797 14,651 42,502 92,201
Selling, general and administrative
expenses 2,674 4,042 10,032 27,947 52,206
Depreciation and amortization
expense 215 348 1,254 3,369 7,856
--------- ---------- --------- ---------- ----------
Income from operations 1,131 1,546 4,823 11,466 26,713
Other income (expense) (45) (180) (576) 388 (1,341)
--------- ---------- --------- ---------- ----------
Income before provision for income taxes 1,086 1,366 4,247 11,854 25,372
Income tax expense (1) -- -- 613 4,780 10,656
--------- ---------- --------- ---------- ----------
Net income $1,086 $ 1,366 $ 3,634 $ 7,074 $ 14,716
========= ========== ========= ========== ==========
Pro forma income tax expense (1) 434 546 1,093
--------- ---------- ---------
Pro forma net income (1) $ 652 $ 820 $ 2,541
========= ========== =========
Net income per share:
Basic $ 0.19 $ 0.48 $ 0.59 $ 0.92
========== ========= ========== ==========
Diluted $ 0.19 $ 0.48 $ 0.57 $ 0.89
========== ========= ========== ==========
Pro forma net income per share:
Basic (1) $ 0.12 $ 0.34
========== =========
Diluted (1) $ 0.12 $ 0.34
========== =========
Weighted average shares outstanding:
Basic 7,093(2) 7,630(2) 11,941 15,939
============ ========= ========== ==========
Diluted 7,093(2) 7,658(2) 12,560 16,513
============ ========= ========== ==========
December 31,
---------------------------------------------------------------------------
1994 1995 1996 1997 1998
------------ ------------ ----------- ------------ ------------
Balance Sheet Data:
Cash and cash equivalents $ 526 $ 805 $12,059 $ 29,539 $ 21,108
Working capital 473 812 13,629 36,412 29,710
Total assets 3,359 6,644 35,826 101,636 379,912
Long-term obligations, net of
current portion 732 2,593 1,478 1,685 130,843
Shareholders' equity 1,423 2,051 30,648 89,334 195,518
(1) The Company was taxed as an S corporation prior to September 3, 1996.
Accordingly, income tax expense and net income have been provided on a pro
forma basis as if the Company had been subject to income taxes in all
periods presented.
(2) Assumes that the Company issued 374,637 shares of common stock at $8.67 per
share to fund the distribution of undistributed S corporation earnings of
$3.2 million through September 3, 1996, the termination date of the
Company's S corporation status, to existing shareholders of the Company.
-22-
Item 7. Management's Discussion and Analysis of Financial Condition and Results
of Operations.
Results of Operations
The following table sets forth historical income statement data as a
percentage of revenue:
Years Ended December 31,
-----------------------------------------------------
1994 1995 1996 1997 1998
------ ------- -------- ------- ---------
Revenue 100.0% 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Payroll and related expenses 53.1 53.4 47.6 49.8 51.5
Selling, general and administrative
expenses 31.2 31.7 32.6 32.8 29.2
Depreciation and
amortization expense 2.5 2.7 4.1 4.0 4.4
----- ----- ----- ----- -----
Total operating costs and expenses 86.8 87.8 84.3 86.6 85.1
----- ----- ----- ----- -----
Income from operations 13.2 12.2 15.7 13.4 14.9
Other income (expense) (0.5) (1.4) (1.9) 0.5 (0.7)
----- ----- ----- ----- -----
Income before provision for income taxes 12.7 10.8 13.8 13.9 14.2
Income tax expense(1) 5.1 4.3 5.5 5.6 6.0
----- ----- ----- ----- -----
Net income 7.6% 6.5% 8.3% 8.3% 8.2%
===== ===== ===== ===== =====
(1) The Company was taxed as an S Corporation prior to September 3, 1996.
Accordingly, income tax expense and net income have been provided on a pro
forma basis as if the Company had been subject to income taxes in all
periods presented.
Year ended December 31, 1998 Compared to Year ended December 31, 1997
Revenue. Revenue increased $93.7 million or 109.9% to $179.0 million for
1998 from $85.3 million in 1997. Of this increase in revenue, $8.5 million was
attributable to the acquisition of Medaphis Services Corporation ("MSC")
completed in November 1998, $12.3 million was attributable to the acquisition of
MedSource, Inc. ("MedSource") completed in July 1998, $35.3 million was
attributable to the acquisition of FCA International Ltd. ("FCA") completed in
May 1998, $8.9 million was attributable to the acquisitions of American
Financial Enterprises, Inc. Collections Division ("AFECD") and The Response
Center ("TRC") completed in the first quarter of 1998, and $4.3 million was
attributable to the acquisitions of ADVANTAGE Financial Services, Inc. ("AFS")
and Credit Acceptance Corp. ("CAC") completed in the fourth quarter of 1997. The
addition of new clients and growth in business from existing clients represented
$24.4 million of the increase in revenue.
Payroll and related expenses. Payroll and related expenses increased $49.7
million to $92.2 million for 1998 from $42.5 million in 1997, and increased as a
percentage of revenue to 51.5% from 49.8%. Payroll and related expenses
increased as a percentage of revenue primarily as a result of FCA and the market
research division having higher payroll cost structures than that of the
remainder of the Company. These higher costs were partially offset by lower
payroll costs related to the MedSource acquisition completed in July 1998 and by
spreading the cost of management and administrative personnel over a larger
revenue base.
-23-
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $24.3 million to $52.2 million for 1998 from
$27.9 million in 1997. Selling, general and administrative expenses decreased as
a percentage of revenue to 29.2% from 32.8%. This decrease resulted from the
Company realizing operating efficiencies and by spreading selling, general and
administrative expenses over a larger revenue base. In addition, a portion of
this decrease can be attributed to the increase in the size of the Marketing
Strategy Division since it has a lower selling, general and administrative cost
structure than the remainder of the Company.
Depreciation and amortization. Depreciation and amortization increased to
$7.9 million for 1998 from $3.4 million in 1997. Of this increase, $335,000 was
attributable to the MSC acquisition, $849,000 was attributable to the MedSource
acquisition, $1.3 million was attributable to the FCA acquisition, $653,000 was
attributable to the acquisitions of AFECD and TRC completed in the first quarter
of 1998 acquisitions and $367,000 was attributable to the acquisitions of AFS
and CAC completed in the fourth quarter of 1997. The remaining $1.0 million
consisted of depreciation resulting from normal capital expenditures incurred in
the ordinary course of business.
Other income (expense). Interest and investment income increased $102,000
to $1.1 million for 1998 from the comparable period in 1997. This increase was
primarily attributable to an increase in operating funds and funds held in trust
for clients. Interest expense increased to $2.5 million for 1998 from $591,000
in 1997. The increase was attributable to the Company financing the May 1998
acquisition of FCA with $74.0 million of borrowings under its revolving credit
facility. In June 1998, the $74.0 million from the revolving credit facility was
repaid with a portion of the proceeds from the Company's public offering
completed in June 1998 (the "1998 Offering"). In addition, the Company financed
$25.5 million of the MedSource acquisition with borrowings under the revolving
credit facility. The Company also financed the November 1998 acquisition of
Medaphis Services Corporation with $107.5 million of borrowings under its
revolving credit facility.
Income tax expense. Income tax expense for 1998 increased to $10.7 million,
or 42.0% of income before taxes, from $4.8 million, or 40.3% of income before
taxes, for 1997. Income taxes were computed after giving effect to
non-deductible goodwill expenses resulting from certain of the acquired
companies. The increase in the effective tax rate resulted from the full-year
impact of the non-deductible goodwill related to certain acquisitions completed
during 1997 and the impact of the non-deductible goodwill related to certain
acquisitions completed during 1998.
Net income. Net income in 1998 increased to $14.7 million from net income
of $7.1 million in 1997, a 108.0% increase.
Year ended December 31, 1997 Compared to Year ended December 31, 1996
Revenue. Revenue increased $54.5 million or 177.3% to $85.3 million for
1997 from $30.8 million in 1996. Of this increase in revenue, $8.7 million was
attributable to the acquisition of Management Adjustment Bureau, Inc. ("MAB")
completed in September 1996, and $37.1 million was attributable to the
acquisitions of Goodyear & Associates, Inc. ("Goodyear"), Tele-Research Center,
Inc. ("Tele-Research"), CMS A/R Services ("CMS A/R"), Collections Division of
CRW Financial, Inc. ("CRWCD"), AFS, and CAC completed during 1997 (collectively
the "1997 Acquisitions"). The addition of new clients and growth in business
from existing clients represented $8.7 million of the increase in revenue.
-24-
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 acquisitions which closed in the first
quarter of 1997 having higher cost structures 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
the start up of a contract with the United States Department of Education (the
"DOE Contract") which required the Company to hire and train a certain number of
collection personnel prior to realizing any revenue under the contract.
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. Selling, general and administrative expenses increased
slightly as a percentage of revenue to 32.8% from 32.6% due to start up costs
attributable to the DOE Contract of $274,000. Also, the business acquired in the
1997 Acquisitions had a higher cost structure than that of the Company and 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. The increases were offset by realizing operating
efficiencies and 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.
Other income (expense). 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 Company's
public offering completed in July 1997 (the "1997 Offering"), as well as an
increase in operating funds and funds held in trust for clients. 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 Company's initial public offering completed in November 1996
(the "IPO"), the Company borrowed $8.4 million on its revolving credit facility
to partially finance the 1997 Acquisitions which closed in the first quarter of
1997, 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 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. 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 3, 1996 and, accordingly, there was
no income tax expense until that time. The income tax expense of $1.7 million
for 1996 (assuming the Company was taxed as a C Corporation for the entire year)
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 from net income of
$2.5 million in 1996 (assuming the Company was taxed as a C Corporation for the
entire year), a 178.4% increase.
-25-
Quarterly Results (Unaudited)
The following table sets forth selected historical financial data for the
calendar quarters of 1997 and 1998. This quarterly information is unaudited but
has been prepared on a basis consistent with the Company's audited financial
statements incorporated by reference herein and, in Management'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.
Quarters Ended
-----------------------------------------------------------------------------------------------
1997 1998
------------------------------------------------- ---------------------------------------------
Mar. June Sept. Dec. Mar. June Sept. Dec.
31 30 30 31 31 30 30 31
-------- -------- --------- -------- --------- --------- --------- ---------
(Dollars in thousands)
Revenue $18,077 $21,162 $21,739 $24,306 $27,609 $38,990 $51,420 $60,957
Income from
operations 2,383 3,039 3,112 2,932 3,742 6,046 7,873 9,052
Net income 1,307 1,717 2,082 1,968 2,316 3,274 4,324 4,802
As a percentage of revenue:
Income from
operations 13.2% 14.4% 14.3% 12.1% 13.6% 15.5% 15.3% 14.8%
Net income 7.2% 8.1% 9.6% 8.1% 8.4% 8.4% 8.4% 7.9%
The Company has experienced and expects to continue to experience quarterly
variations in operating results as a result of many factors, including the costs
and timing of completion and integration of acquisitions, the timing of clients'
accounts receivable management programs, the commencement of new contracts, the
termination of existing contracts, costs to support growth by acquisition or
otherwise, and integration of acquisitions, the effect of the change of business
mix on margins and the timing of additional selling, general and administrative
expenses to support new business. Additionally, the Company's planned operating
expenditures are based on revenue forecasts, and if revenues are below
expectations in any given quarter, operating results would likely be materially
adversely affected. While the effects of seasonality on the Company's business
historically have been obscured by its rapid growth, the Company's business
tends to be slower in the third and fourth quarters of the year due to the
summer and holiday seasons.
Liquidity and Capital Resources
In July 1997, the Company completed a public offering (the "1997
Offering"), selling 2,166,000 shares of common stock and received net proceeds
of approximately $40.4 million.
In June 1998, the Company completed a public offering (the "1998
Offering"), selling 4,000,000 shares of common stock and received net proceeds
of approximately $81.7 million.
In July 1998, the Company sold 469,366 shares of common stock in connection
with the underwriters' exercise of the over-allotment option granted in
accordance with the 1998 Offering. The Company received net proceeds of
approximately $9.6 million.
Since 1996, the Company's primary sources of cash have been public
offerings, cash flows from operations and bank borrowings. Cash has been used
for acquisitions, purchases of equipment and working capital to support the
Company's growth.
-26-
Cash provided by operating activities was $19.5 million in 1998 and $6.7
million in 1997. The increase in cash provided by operations was primarily due
to the increase in net income to $14.7 million in 1998 compared to $7.1 million
in 1997, and the increase in non-cash charges, primarily depreciation and
amortization, to $7.9 million in 1998 compared to $3.4 million in 1996. In
addition, the increase was also attributable to a $2.8 million decrease in other
current assets in 1998 compared to a $1.5 million increase in 1997. These
increases were partially offset by a $6.5 million increase in accounts
receivable in 1998 compared to a $4.0 million increase in 1997.
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. 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 used in investing activities was $231.8 million in 1998 compared to
$29.2 million for 1997. The increase was primarily due to the acquisitions of
FCA International Ltd., MedSource, Inc., and Medaphis Services Corporation. The
Company financed these acquisitions with the proceeds of the 1998 Offering and
borrowings under the Company's revolving credit agreement.
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 1997 Acquisitions
compared with the acquisitions of TCD and MAB in 1996. The Company financed the
1997 Acquisitions with the proceeds of the 1997 Offering and the IPO, borrowings
under the Company's revolving credit agreement, seller financing and working
capital. The 1997 Acquisitions collectively resulted in goodwill of $37.0
million.
In addition to equipment financed under operating leases, capital
expenditures were $9.0 million, $3.4 million, and $976,000 in 1998, 1997 and
1996, respectively.
Cash provided by financing activities was $203.9 million in 1998 compared
to $40.0 million in 1997. Net proceeds of $91.3 million from the 1998 Offering
and net borrowings of $136.0 million were the Company's primary sources of cash
from financing activities which were used for acquisitions.
Cash provided by financing activities was $40.0 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.
In November 1998, the Company's credit agreement with Mellon Bank, N.A.,
for itself and as administrative agent for other participating lenders, was
amended, among other things, to increase the Company's revolving credit facility
to provide for borrowings up to $200.0 million consisting of a term loan of
$125.0 million and a revolving credit facility of up to $75.0 million.
Borrowings bear interest at a rate equal to, at the option of the Company ,
Mellon Bank's prime rate (7.75% at March 29, 1999) or LIBOR plus a margin from
1.25% to 2.25% depending on the Company's consolidated funded debt to EBITDA
ratio (LIBOR was 4.90% at March 29, 1999). Borrowings are collateralized by
substantially all the assets of the Company and are payable upon the expiration
of the five year term, except that certain quarterly payments on the term loan
are payable beginning on September 30, 1999. The credit agreement contains
certain financial covenants such as maintaining minimum working capital and net
worth requirements and includes restrictions on, among other things,
acquisitions, capital expenditures and distributions to shareholders.
-27-
On November 2, 1998, the Company signed a definitive agreement to acquire
all of the outstanding shares of JDR Holdings, Inc. for approximately 3.4
million shares of NCO common stock. The acquisition is being valued at
approximately $103.1 million. The transaction, which is expected to be accounted
for as a pooling of interests and a tax-free reorganization, is expected to
close on March 31, 1999.
The Company believes that funds generated from operations, together with
existing cash and available borrowings under its credit agreement will be
sufficient to finance its current operations, planned capital expenditure
requirements and internal growth at least through the next twelve months. In
addition, the Company believes that funds generated from operations will be
sufficient to fund the future scheduled repayment of the existing borrowings
under the Company's revolving credit facility. However, the Company could
require additional debt or equity financing if it were to make any other
significant acquisitions for cash.
Market Risk
The Company is exposed to various types of market risk in the normal course
of business, including the impact of interest rate changes, foreign currency
exchange rate fluctuations and changes in corporate tax rates. The Company
employs risk management strategies that may include the use of derivatives such
as interest rate swap agreements, interest rate ceilings and floors, and foreign
currency forwards and options to manage these exposures. The Company does not
hold derivatives for trading purposes.
Goodwill
The Company's balance sheet includes amounts designated as "goodwill."
Goodwill represents the excess of purchase price over the fair market value of
the net assets of the acquired businesses based on their respective fair values
at the date of acquisition. GAAP requires that this and all other intangible
assets be amortized over the period benefited. Management has determined that
period to range from 15 to 40 years based on the attributes of each acquisition.
As of December 31, 1998, the Company's balance sheet included goodwill that
represented approximately 72.2% of total assets and 140.3% of shareholders'
equity.
If management has incorrectly overstated the permissible length of the
amortization period for goodwill, earnings reported in periods immediately
following the acquisition would be overstated. In later years, NCO would be
burdened by a continuing charge against earnings without the associated benefit
to income valued by management in arriving at the consideration paid for the
business. Earnings in later years also could be significantly affected if
management determined then that the remaining balance of goodwill was impaired.
Management concluded that the anticipated future cash flows associated with
intangible assets recognized in the acquisitions will continue indefinitely, and
there is no persuasive evidence that any material portion will dissipate over a
period shorter than the respective amortization period.
Year 2000 System Modifications
NCO has implemented a program to evaluate and address the impact of the
year 2000 on its information technology 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 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 has been completed and the final software updates have been
received. The testing and acceptance procedures are currently being finalized
and the Company expects to complete this portion of the program by the end of
the second quarter of 1999. The Company will continue to coordinate the year
2000 compliance effort throughout the balance of 1999 to synchronize data
exchange formats with clients.
-28-
NCO has also implemented a program to evaluate and address the impact of
year 2000 on its non-information technology systems, which include the Company's
telecommunications systems, business machines, and building and premises
systems. This program includes steps to: (a) review existing systems to identify
potential issues; (b) review these issues with major external suppliers; and (c)
develop a contingency plan. The Company is currently in the process of
identifying the issues and reviewing them with its external suppliers. The
Company expects to complete the development of a contingency plan by the end of
the second quarter of 1999.
As of December 31, 1998, the Company has incurred total pre-tax expense of
approximately $224,000 in connection with the year 2000 compliance program. This
amount does not include expenses incurred by companies prior to their
acquisition by the Company. For the years 1999 and 2000, the Company expects to
incur total pre-tax expenses of approximately $1,185,000 and $180,000, per year,
respectively. 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. The Company's
software has been provided by third-party vendors and the third-party vendors
are incorporating the 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
and the testing of modifications performed by its third-party vendors. The cost
of planning and initial remediation incurred to date has not been significant.
The Company does not expect the impact of the year 2000 to have a material
adverse impact on the Company's business or results of operations. As part of
its due diligence process, the Company reviewed the impact of year 2000 on all
completed and pending acquisitions. 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, resulting from, among other
things, the Company's inability to properly exchange and/or receive data with
its clients.
Recent Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for the fiscal years beginning after June 15, 1999. SFAS No. 133
requires that an entity recognize all derivative instruments as either assets or
liabilities on its balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction, and, if it is, the type of hedge transaction. The Company
will adopt SFAS No. 133 by the first quarter of 2000. Due to the Company's
limited use of derivative instruments, SFAS No. 133 is not expected to have a
material impact on the consolidated results of operations, financial condition
or cash flows of the Company.
-29-
Forward Looking Statements
Certain statements included in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, as well as elsewhere in this
Annual Report on Form 10-K, other than historical facts, are forward-looking
statements (as such term is defined in the Securities Exchange Act of 1934, and
the regulations thereunder) which are intended to be covered by the safe harbors
created thereby. Forward-looking statements include, without limitation,
statements as to the Company's objective to grow through strategic acquisitions
and internal growth, the impact of acquisitions on the Company's earnings, the
Company's ability to realize operating efficiencies in the integration of its
acquisitions, trends in the Company's future operating performance, Year 2000
Compliance, the effects of legal or governmental proceedings, the effects of
changes in accounting pronouncements and statements as to the Company's or
management's beliefs, expectations and opinions. Forward-looking statements are
subject to risks and uncertainties and may be affected by various factors which
may cause actual results to differ materially from those in the forward-looking
statements. In addition to the factors discussed in this report, certain risks,
uncertainties and other factors, including, without limitation the risk that the
Company will not be able to realize operating efficiencies in the integration of
its acquisitions, risks associated with growth and future acquisitions,
fluctuations in quarterly operating results, risks relating to Year 2000
compliance and the other risks detailed from time to time in the Company's
filings with the Securities and Exchange Commission, including the Company's
Registration Statement on Form S-4, filed on March 1, 1999, as amended, can
cause actual results and developments to be materially different from those
expressed or implied by such forward-looking statements. See Item 1. - "Business
- - Investment Considerations."
-30-
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.
Included in Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, included in this Report on Form 10-K.
Item 8. Financial Statements and Supplementary Data.
The financial statements, financial statement schedules and related
documents that are filed with this Report are listed in Item 14(a) of this
Report on Form 10-K and begin on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure.
None.
-31-
PART III
Item 10. Directors and Executive Officers of the Registrant.
Incorporated by reference from the Company's Proxy Statement relating to
the 1999 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K, except information concerning certain executive
officers of the Company which is set forth in Section 4.1 of this Annual Report
on Form 10-K.
Item 11. Executive Compensation.
Incorporated by reference from the Company's Proxy Statement relating to
the 1999 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Incorporated by reference from the Company's Proxy Statement relating to
the 1999 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
Item 13. Certain Relationships and Related Transactions.
Incorporated by reference from the Company's Proxy Statement relating to
the 1999 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
-32-
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K.
(a). Documents filed as part of this report:
1. List of Consolidated Financial Statements. The following consolidated
financial statements and the accompanying notes of NCO Group, Inc., have been
included in this Report on Form 10-K beginning on page F-1:
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 1997 and 1998
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1998
Consolidated Statements of Shareholders' Equity for each of the three years
in the period ended December 31, 1998
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1998
Notes to Consolidated Financial Statements
2. List of Financial Statement Schedules. The following financial statement
schedule of NCO Group, Inc. has been included in this Report on Form 10-K
beginning on page S-1:
II - Valuation and Qualifying Accounts
All other financial statement schedules are omitted because the required
information is not present or not present in amounts sufficient to require
submission of the schedule or because the information required is included in
the respective financial statements or notes thereto contained herein.
3. List of Exhibits filed in accordance with Item 601 of Regulation S-K.
The following exhibits are incorporated by reference in, or filed with, this
Report on Form 10-K. Management contracts and compensatory plans, contracts and
arrangements are indicated by "*":
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
2.1(4) Asset Acquisition Agreement by and among The Response Center Division of TeleSpectrum
Worldwide, Inc., and NCO dated January 16, 1998. NCO will furnish to the Securities
and Exchange Commission a copy of any omitted schedules upon request.
2.2(6) Agreement dated March 24, 1998 among the Company, FCA International Ltd. and
Fairfax concerning the FCA Tender Offer. NCO will furnish to the Securities
and Exchange Commission a copy of any omitted schedules upon request.
2.3(8) Stock Purchase Agreement dated May 4, 1998 among the Company, MedSource, Whitney
Subordinated Debt fund, L.P., Whitney Equity Partners, L.P., C.B. Hellman, Jr.,
Mark Gorman, John O'Hara and HealthCare Business Management, Ltd. NCO will furnish to the Securities
and Exchange Commission a copy of any omitted schedules upon request.
2.4(10) Amended and Restated Stock Purchase Agreement by and between NCO and Medaphis Services
Corporation dated as of October 15, 1998 as amended and restated on November 30, 1998. NCO will furnish
to the Securities and Exchange Commission a copy of any omitted schedules upon request.
2.5(11) Agreement and Plan of Reorganization dated November 2, 1998 among JDR Holdings, Inc., NCO Group,
Inc. and JDR Acquisition Inc. NCO will furnish to the Securities and Exchange Commission a copy of any
omitted schedules upon request.
2.6(11) Agreement and Plan of Merger dated November 2, 1998, among JDR Holdings, Inc., NCO Group, Inc.
and JDR Acquisition Inc.
3.1(1) The Company's amended and restated Articles of Incorporation.
3.2(7) Amendment to Amended and Restated Articles of Incorporation.
3.3(1) The Company's amended and restated Bylaws.
4.1(1) Specimen of Common Stock Certificate.
*10.1(1) Employment Agreement, dated September 1, 1996, between the Company and Bernard R.
Miller.
*10.2 Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Bernard R. Miller.
*10.3(1) Employment Agreement, dated September 1, 1996, between the Company and Michael J.
Barrist.
-33-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
*10.4 Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Michael J. Barrist.
*10.5(1) Employment Agreement, dated September 1, 1996, between the Company and Charles C.
Piola, Jr.
*10.6 Addendum, dated May 1, 1998, to the Employment Agreement, dated September 1, 1996,
between the Company and Charles C. Piola, Jr.
*10.7(1) Employment Agreement, dated September 1, 1996, between the Company and Joseph C.
McGowan.
*10.8 Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Joseph C. McGowan.
*10.9(1) Employment Agreement, dated September 1, 1996, between the Company and Steven L.
Winokur.
*10.10 Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Steven L. Winokur.
*10.11(1) Amended and Restated 1995 Stock Option Plan.
*10.12(9) 1996 Stock Option Plan, as amended.
*10.13(9) 1996 Non-Employee Director Stock Option Plan, as amended.
10.14(1) Distribution and Tax Indemnification Agreement
10.15(1) Irrevocable Proxy Agreement by and between Michael J. Barrist and Annette H. Barrist.
10.16(2) Non-negotiable Subordinated Convertible Promissory Note dated January 22, 1997, made by
the Company in the principal amount of $900,000, as partial payment of the purchase price
for the acquisition of Goodyear.
10.17(3) Non-Transferable Common Stock Purchase Warrant dated February 2, 1997 issued to CRW Financial, Inc.
10.18(3) Registration Rights Agreement dated February 2, 1997 between NCO and CRW Financial, Inc.
10.19(6) Lease dated March 18, 1997 between Indiana Avenue Associates, L.P. and the Company
related to the lease of Fort Washington corporate headquarters.
10.20(10) Third Amended and Restated Credit Agreement dated as of November 30, 1998 by and among
NCO, its U.S. Subsidiaries, the Financial Institutions listed therein as Lenders and
Mellon Bank, N.A. as administrative agent. NCO will furnish to the Securities
and Exchange Commission a copy of any omitted schedules upon request.
10.21(7) Executive Salary Continuation Agreement.
10.22 Transfer Agreement dated January 26, 1998 among NCO, CRW Financial, Inc.
and Swiss Bank Corporation.
21.1(11) Subsidiaries of the Registrant.
23.1 Consent of PricewaterhouseCoopers 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.
-34-
(2) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on February 6,
1997.
(3) Incorporated by reference to the Company's Current Report on Form 8-K/A
(File No. 0-21639) filed with the Securities Exchange Commission on
February 18, 1997.
(4) Incorporated by reference to the Company's Current Report on Form 8-K/A
(File No. 0-21639) filed with the Securities Exchange Commission on
February 25, 1998.
(5) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1997 (File No. 0-21639), as amended,
filed with the Securities Exchange Commission on March 31, 1998.
(6) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on May 4, 1998.
(7) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1998 (File No. 0-21639), filed with the
Securities and Exchange Commission on May 4, 1998.
(8) Incorporated by reference to the Company's Registration Statement on Form
S-3 (Registration No. 333-51787), as amended, filed with the Securities
Exchange Commission on May 8, 1998.
(9) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998 (File No. 0-21639), filed with the
Securities Exchange Commission on August 14, 1998.
(10) Incorporated by reference to the Company's Current Report on Form 8-K (File
No. 0-21639) filed with the Securities Exchange Commission on December 15,
1998.
(11) Incorporated by reference to the Company's Registration Statement on Form
S-4 (Registration No. 333-73087), as amended, filed with the Securities
and Exchange Commission on February 26, 1999.
(b). Reports on Form 8-K
Date of Report Item Reported
-------------- -------------
12/15/98 Item 2 - Medaphis Services Corporation acquisition,
and
Item 5 - JDR Holdings, Inc. acquisition
-35-
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, 1999 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, 1999
- ---------------------- and Chief Executive Officer
Michael J. Barrist (principal executive officer)
/s/ Charles C. Piola Executive Vice President, March 31, 1999
- ---------------------- Business Development and Director
Charles C. Piola
/s/ Steven L. Winokur Executive Vice President, March 31, 1999
- ---------------------- Finance; Chief Financial Officer;
Steven L. Winokur and Treasurer (principal
financial and accounting officer)
/s/ Bernard R. Miller Executive Vice President, March 31, 1999
- ---------------------- Corporate Development;
Bernard R. Miller Divisional CEO, Healthcare
Services; and Director
/s/ Eric S. Siegel Director March 31, 1999
- ----------------------
Eric S. Siegel
/s/Allen F. Wise Director March 31, 1999
- ----------------------
Allen F. Wise
-36-
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULES
Financial Statements:
Report of Independent Accountants............................................................................F-2
Consolidated Balance Sheets as of December 31, 1997 and 1998 ................................................F-3
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1998......................................................................F-4
Consolidated Statements of Shareholders' Equity for each of the three years
in the period ended December 31, 1998......................................................................F-5
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1998......................................................................F-6
Notes to Consolidated Financial Statements...................................................................F-7
Financial Statement Schedules:
For the years ended December 31, 1996, 1997 and 1998:
II--Valuation and Qualifying Accounts......................................................................S-1
F-1
Report of Independent Accountants
To the Board of Directors and
Shareholders of NCO Group, Inc.
In our opinion, the consolidated financial statements listed in the index
appearing under Item 14(a)(1) present fairly, in all material respects, the
financial position of NCO Group, Inc. and its subsidiaries at December 31, 1997
and 1998, and the results of their operations and their cash flows for each of
the three years in the period ended December 31, 1998, in conformity with
generally accepted accounting principles. In addition, in our opinion, the
financial statement schedules listed in the index appearing under Item 14(a)(2)
present fairly, in all material respects, the information set forth therein when
read in conjunction with the related consolidated financial statements. These
financial statements and financial statement schedules are the responsibility of
the Company's management; our responsibility is to express an opinion on these
financial statements and the financial schedules based on our audits. We
conducted our audits of these statements in accordance with generally accepted
auditing standards which require that we plan and perform the audit to obtain
reasonable assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements, assessing the
accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
February 18, 1999
F-2
NCO GROUP, INC.
Consolidated Balance Sheets
(Amounts in thousands)
December 31,
------------------------
ASSETS 1997 1998
--------- ---------
Current assets:
Cash and cash equivalents $ 29,539 $ 21,108
Accounts receivable, trade, net of allowance for
doubtful accounts of $451 and $3,374, respectively 13,442 47,549
Deferred taxes -- 1,348
Other current assets 2,357 2,520
--------- ---------
Total current assets 45,338 72,525
Funds held in trust for clients
Property and equipment, net 7,469 22,604
Other assets:
Intangibles, net of accumulated amortization 46,403 278,844
Deposits on acquisitions 1,650 --
Other assets 776 5,939
--------- ---------
Total other assets 48,829 284,783
--------- ---------
Total assets $ 101,636 $ 379,912
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 674 $ 7,886
Corporate taxes payable 286 7,278
Accounts payable 1,913 6,730
Accrued expenses 3,209 12,614
Accrued compensation and related expenses 2,844 8,307
--------- ---------
Total current liabilities 8,926 42,815
Funds held in trust for clients
Long-term liabilities:
Long term debt, net of current portion 1,685 130,843
Deferred taxes 1,691 6,379
Other long-term liabilities -- 4,357
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, 5,000 shares authorized,
no shares issued and outstanding
Common stock, no par value, 37,500 shares authorized,
13,216 and 18,018 shares issued and outstanding, respectively 80,249 174,133
Unexercised warrants 1,122 875
Foreign currency translation adjustment -- (2,169)
Retained earnings 7,963 22,679
--------- ---------
Total shareholders' equity 89,334 195,518
--------- ---------
Total liabilities and shareholders' equity $ 101,636 $ 379,912
========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-3
NCO GROUP, INC.
Consolidated Statements of Income
(Amounts in thousands, except per share data)
For the Years Ended December 31,
-----------------------------------------
1996 1997 1998
--------- --------- ---------
Revenue $ 30,760 $ 85,284 $ 178,976
Operating costs and expenses:
Payroll and related expenses 14,651 42,502 92,201
Selling, general and administrative
expenses 10,032 27,947 52,206
Depreciation and amortization expense 1,254 3,369 7,856
--------- --------- ---------
Total operating costs and expenses 25,937 73,818 152,263
--------- --------- ---------
Income from operations 4,823 11,466 26,713
Other income (expense):
Interest and investment income 242 1,020 1,122
Interest expense (818) (591) (2,463)
Loss on disposal of fixed assets -- (41) --
--------- --------- ---------
Total other income (expense) (576) 388 (1,341)
--------- --------- ---------
Income before provision for income taxes 4,247 11,854 25,372
Income tax expense 613 4,780 10,656
--------- --------- ---------
Net income $ 3,634 $ 7,074 $ 14,716
========= ========= =========
Pro Forma
---------
Historical income before provision for income taxes $ 4,247
Pro forma income tax expense 1,706
---------
Pro forma net income $ 2,541
=========
Net income per share:
Basic $ 0.34 $ 0.59 $ 0.92
Diluted $ 0.34 $ 0.57 $ 0.89
Weighted average shares outstanding:
Basic 7,630 11,941 15,939
Diluted 7,658 12,560 16,513
The accompanying notes are an integral part of these
consolidated financial statements.
F-4
NCO GROUP, INC.
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 1996, 1997 and 1998
(Amounts in thousands)
Common Stock
----------------------- Notes
Number of Unexercised Receivable
Shares Amount Warrants Shareholder
------ ------ -------- -----------
Balance, January 1, 1996 6,320 $ 538 $ 177 $ (83)
Issuance of common stock 3,750 28,825 -- --
Warrants issued -- -- 219 --
Note repayments -- -- -- 83
Net income -- -- -- --
Distributions to shareholders -- -- -- --
--------- --------- --------- ---------
Balance, December 31, 1996 10,070 29,363 396 --
Issuance of common stock 3,146 50,886 (149) --
Warrants issued -- -- 875 --
Net income -- -- -- --
--------- --------- --------- ---------
Balance, December 31, 1997 13,216 80,249 1,122 --
Issuance of common stock 4,802 93,884 (247) --
Comprehensive income:
Net income -- -- -- --
Other comprehensive income:
Cumulative translation adjustment -- -- -- --
Total comprehensive income
--------- --------- --------- ---------
Balance, December 31, 1998 18,018 $ 174,133 $ 875 $ --
========= ========= ========= =========
[RESTUBBED FROM TABLE ABOVE]
Accumulated
Other
Comprehensive Retained Comprehensive
Income Earnings Income Total
------ -------- ------ -----
Balance, January 1, 1996 $ 41 $ 1,379 $ 2,052
Issuance of common stock -- -- 28,825
Warrants issued -- -- 219
Note repayments -- -- 83
Net income -- 3,634 3,634
Distributions to shareholders (41) (4,124) (4,165)
--------- --------- ---------
Balance, December 31, 1996 -- 889 30,648
Issuance of common stock -- -- 50,737
Warrants issued -- -- 875
Net income -- 7,074 7,074
--------- --------- ---------
Balance, December 31, 1997 -- 7,963 89,334
Issuance of common stock -- -- 93,637
Comprehensive income:
Net income -- 14,716 $ 14,716 14,716
Other comprehensive income:
Cumulative translation adjustment (2,169) -- (2,169) (2,169)
---------
Total comprehensive income $ 12,547
--------- --------- ========= ---------
Balance, December 31, 1998 $ (2,169) $ 22,679 $ 195,518
========= ========= =========
The accompanying notes are an integral part of these
consolidated financial statements.
F-5
NCO GROUP, INC
Consolidated Statements of Cash Flows
(Amounts in thousands)
For the Years Ended December 31,
---------------------------------------------
1996 1997 1998
--------- --------- ---------
Cash flows from operating activities:
Net income $ 3,634 $ 7,074 $ 14,716
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 466 1,312 2,579
Amortization of intangibles 788 2,057 5,277
Loss on disposal of fixed assets -- 41 --
Gain on sale of securities (70) -- --
Provision for doubtful accounts 56 286 830
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (1,825) (3,978) (6,456)
Other current assets (313) (1,530) 2,790
Deferred taxes (155) 1,762 3,323
Other assets (10) (14) (3,246)
Accounts payable 423 (1,356) 94
Corporate taxes payable 217 68 (366)
Accrued expenses (1,017) 621 886
Accrued compensation and related costs 599 405 (901)
--------- --------- ---------
Net cash provided by operating activities 2,793 6,748 19,526
Cash flows from investing activities:
Repayment of notes receivable 156 -- --
Purchase of property and equipment (976) (3,368) (8,951)
Purchase of securities (78) -- --
Proceeds from sale of securities 407 -- --
Net cash paid for acquisitions (12,857) (25,850) (222,843)
--------- --------- ---------
Net cash used in investing activities (13,348) (29,218) (231,794)
Cash flows from financing activities:
Repayment of notes payable (303) (466) (809)
Repayment of acquired notes payable -- -- (21,919)
Borrowings under revolving credit agreement 12,550 8,350 94,510
Repayment of borrowings under revolving credit agreement (15,000) (8,350) (83,500)
Borrowings under term loan -- -- 125,000
Payment of fees to acquire new debt (222) (12) (3,015)
Issuance of common stock, net 28,825 40,428 93,637
Decrease in notes receivable, shareholders 83 -- --
Distributions to shareholders (4,124) -- --
--------- --------- ---------
Net cash provided by financing activities 21,809 39,950 203,904
Effect of exchange rate on cash -- -- (67)
--------- --------- ---------
Net increase (decrease) in cash and cash equivalents 11,254 17,480 (8,431)
Cash and cash equivalents at beginning of period 805 12,059 29,539
--------- --------- ---------
Cash and cash equivalents at end of period $ 12,059 $ 29,539 $ 21,108
========= ========= =========
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 other outsourced services. The Company's client base is comprised
of companies located throughout North America and in the United Kingdom and
Puerto Rico in the healthcare, financial services, retail and commercial,
education, telecommunications, utilities and government sectors.
2. Summary of significant accounting policies:
Principles of Consolidation:
The consolidated financial statements include the accounts of NCO Group, Inc.
and its wholly-owned subsidiaries after elimination of significant intercompany
accounts and transactions.
Revenue Recognition:
The Company generates revenues from contingency fees and contractual services.
Contingency fee revenue is recognized upon collection of funds on behalf of
clients. Contractual services revenue is recognized as services are performed.
Property and Equipment:
Property and equipment is stated at cost, less accumulated depreciation.
Depreciation is provided over the estimated useful life of each class of assets
using the straight-line method. The estimated useful lives are five years, five
to twelve years, and two to five years for computer equipment, furniture and
fixtures, and leased assets, respectively. 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.
The Company reviews long-lived assets and certain identifiable intangibles for
impairment, based on the estimated future cash flows, whenever events or changes
in circumstances indicate that the carrying amount of the asset may not be
recoverable.
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
the use of the asset and liability approach. The asset and liability approach
requires the recognition of deferred tax assets and liabilities for the expected
future tax consequences of temporary differences between the financial reporting
basis and the tax basis of assets and liabilities.
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, 1997 and 1998, the Company had cash and cash equivalents,
excluding funds held in trust for clients, in excess of federally insured limits
of approximately $8,862,000 and $5,832,000, respectively, based on the bank
balance which does not include outstanding checks and other reconciling items.
The Company's cash deposits have been placed with large national banks to
minimize risk.
F-7
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies (continued):
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 many cases, in the event of collection delays from
clients, management may at its discretion change from the gross remittance
method to the net remittance method.
Intangibles:
Intangibles consists primarily of goodwill and deferred financing costs.
Goodwill represents the excess of purchase price over the fair market value of
the net assets of the acquired businesses based on their respective fair values
at the date of acquisition. Goodwill is amortized on a straight-line basis over
15 to 40 years. For certain acquisitions, such allocations have been based on
estimates 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.
Deferred financing costs relate to debt issuance costs incurred which are
capitalized and amortized over the term of the debt.
Accumulated amortization at December 31, 1997 and 1998 totaled $2,611,000 and
$7,888,000, respectively.
Foreign Currency Translation:
The Company has foreign subsidiaries whose local currency has been determined
to be the functional currency. For these foreign subsidiaries, the assets and
liabilities have been translated using the current exchange rates, and the
income and expenses have been translated using the historical exchange rates.
The adjustments resulting from translation have been recorded as a separate
component of shareholders' equity and are not included in determining
consolidated net income.
Estimates Utilized in the Preparation of Financial Statements:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Comprehensive Income:
Effective January 1, 1998, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 130, "Reporting Comprehensive Income." SFAS No. 130
establishes standards for the reporting and display of comprehensive income.
Comprehensive income consists of net income from operations, plus certain
changes in assets and liabilities that are not included in net income but are
reported as a separate component of shareholders' equity under generally
accepted accounting principles.
Reclassifications:
Certain amounts for December 31, 1996 and 1997 and the years then ended have
been reclassified for comparative purposes.
3. Acquisitions:
All of the Company's completed acquisitions have been accounted for under the
purchase method of accounting. As part of the purchase accounting, the Company
recorded accruals for acquisition related expenses. The accruals for acquisition
related expenses include professional fees related to the acquisition,
termination costs related to certain redundant personnel immediately eliminated
at the time of the acquisitions, and certain future rental obligations
attributable to facilities which were closed at the time of the acquisitions.
On January 3, 1996 the Company purchased the net assets of Trans Union
Corporation Collections Division ("TCD") for $4.8 million in cash. The Company
recognized 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 Company recognized goodwill of
$9.0 million.
F-8
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
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 Company recognized goodwill of $5.4
million.
On January 30, 1997 the Company purchased the net 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 Company recognized goodwill of $2.2
million.
On January 31, 1997 the Company purchased the net assets of the CMS A/R Services
("CMS A/R"), the Collection Division of CMS Energy Corporation, for $5.1 million
in cash. The Company recognized goodwill of $3.9 million.
On February 2, 1997 the Company purchased the net assets of the Collections
Division of CRW Financial, Inc. ("CRWCD") for $3.8 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 Company recognized
goodwill of $14.5 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 purchase
price was valued at approximately $5.0 million. The Company recognized goodwill
of $7.1 million.
On October 1, 1997 the Company purchased the outstanding stock of Credit
Acceptance Corp. ("CAC") for $1.8 million in cash. The Company recognized
goodwill of $2.1 million.
On December 31, 1997, effective January 1, 1998, the Company purchased the net
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." The Company recognized goodwill of $2.0 million.
On February 6, 1998, the Company purchased the net assets of The Response Center
("TRC"), which was an operating division of TeleSpectrum Worldwide, Inc., for
$15.0 million plus a performance based earn-out. The Company recognized goodwill
of $14.3 million.
On May 5, 1998, the Company purchased all of the outstanding common shares of
FCA International Ltd. ("FCA") at $9.60 per share, Canadian (equivalent to $6.77
in U.S. dollars based upon the exchange rate at the date of the agreement). The
purchse price was valued at approximately $69.9 million. The Company recognized
goodwill of $83.3 million. Included in this goodwill is an accrual of $10.6
million for acquisition related expenses. As of December 31, 1998, there was
$3.1 remaining from this accrual for acquisition related expenses.
On July 1, 1998, the Company purchased all of the outstanding stock of
MedSource, Inc. ("MedSource") for $18.4 million in cash. In connection with the
acquisition, the Company repaid debt of $17.3 million. The Company recognized
goodwill of $34.9 million. Included in this goodwill is an accrual of $5.8
million for acquisition related expenses. As of December 31, 1998, there was
$1.7 million remaining from this accrual for acquisition related expenses.
On November 30, 1998, the Company acquired all of the outstanding stock of
Medaphis Services Corporation ("MSC"), a wholly owned subsidiary of Medaphis
Corporation for $107.5 million, plus an earn-out of up to $10 million based on
MSC achieving operational targets during 1999. The allocation of the fair market
value to the acquired assets and liabilities of MSC was based on preliminary
estimates and is subject to change. The Company recognized goodwill of $96.7
million. Included in this goodwill is an accrual of $15.0 for acquisition
related expenses. As of December 31, 1998, there was $12.8 million remaining
from this accrual for acquisition related expenses.
F-9
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
The following summarizes unaudited pro forma results of operations for the years
ended December 31, 1997 and 1998, 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:
1997 1998
------------- -------------
(Unaudited)
Revenue $ 283,876,000 $302,813,000
Net income $ 2,664,000 $ 6,712,000
Earnings per share-basic $ 0.14 $ 0.36
Earnings per share-diluted $ 0.14 $ 0.35
On November 2, 1998, the Company signed a definitive agreement to acquire all of
the outstanding shares of JDR Holdings, Inc. for approximately 3.4 million
shares of NCO common stock. The acquisition is being valued at approximately
$103.1 million. The transaction, which is expected to be accounted for as a
pooling of interests and a tax-free reorganization, has an anticipated closing
date of March 31, 1999.
4. 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 $14,898,000 and $31,983,000 at December 31,
1997 and 1998, respectively, have been shown net of their offsetting liability
for financial statement presentation.
At December 31, 1997 and 1998, the Company had funds held in trust in excess of
federally insured limits of approximately $16,856,000 and $42,721,000,
respectively, based on the bank balance which does not include outstanding
checks and other reconciling items. The funds held in trust have been placed
with large national banks to minimize risk.
5. Property and equipment:
At December 31, 1997 and 1998, property and equipment, at cost, consists of the
following:
1997 1998
---------- -----------
Computer equipment $7,161,000 $18,154,000
Furniture and fixtures 2,063,000 7,252,000
Leased assets 324,000 1,856,000
---------- -----------
9,548,000 27,262,000
Less accumulated depreciation 2,079,000 4,658,000
---------- -----------
$7,469,000 $22,604,000
========== ===========
Depreciation charged to operations amounted to $466,000, $1,311,000 and
$2,579,000 for the years ended 1996, 1997 and 1998, respectively.
6. 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-10
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
7. Long-term debt:
1997 1998
---------- ------------
Revolving credit loan; 7.37%, due November 2003 $ - $ 11,035,000
Term loan; 7.37%, payable in quarterly installments,
ranging from $3.0 to $5.3 million, through November
2003 when the remaining balance becomes payable - 125,000,000
Non-interest bearing note; $36,750 remaining face amount,
payable in monthly installments of $5,250 through
July 1999 (less unamortized discount based on imputed
interest rate of 10%) 92,000 36,000
Subordinated seller notes payable; 8.00%,
due January 1999 1,000,000 500,000
Subordinated seller note payable; 8.00%, due
February 2002, converted to common stock
at $14.12 per share on February 15, 1999 900,000 900,000
Capital leases 367,000 1,258,000
Less current portion (674,000) (7,886,000)
---------- ------------
$1,685,000 $130,843,000
========== ============
The following summarizes the Company's required debt payments for the next five
years:
1999 $ 7,886,000
2000 12,358,000
2001 15,254,000
2002 18,082,000
2003 85,056,000
In November 1998, the Company's credit agreement with Mellon Bank, N.A., for
itself and as administrative agent for other participating lenders, was amended
to, among other things, increase the Company's revolving credit facility to
provide for borrowings up to $200.0 million consisting of a term loan of $125.0
million and a revolving credit facility of up to $75.0 million. Borrowings bear
interest at a rate equal to, at the option of the Company, Mellon Bank's prime
rate (7.75% at December 31, 1998) or LIBOR plus a margin from 1.25% to 2.25%
depending on the Company's consolidated funded debt to EBITDA ratio (LIBOR was
5.12% at December 31, 1998). Borrowings are collateralized by substantially all
the assets of the Company and are payable in quarterly payments for the term
loan beginning on September 30, 1999 and the balance will be due upon the
expiration of the five year term. The credit agreement contains certain
financial covenants such as maintaining minimum working capital and net worth
requirements and includes restrictions on, among other things, acquisitions,
capital expenditures and distributions to shareholders.
The bank had received warrants to purchase an aggregate of 361,000 shares of the
Company's common stock for establishing the credit facility initially and for
subsequent amendments to increase the Company's borrowing capacity under such
facility. In July 1997, the bank exercised 225,000 warrants for common stock
which were sold in July 1997. The remainder of the warrants were exercised in
January 1998.
On February 15, 1999, the $900,000 convertible note issued in connection with
the Goodyear acquisition was converted in to 63,755 shares of NCO common stock.
F-11
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
7. Long-term debt (continued):
The Company leases certain equipment under agreements which are classified as
capital leases. The equipment leases have original terms ranging from 24 to 120
months and have purchase options at the end of the original lease term.
8. Financial instruments:
The Company selectively uses derivative financial instruments to manage interest
costs and minimize currency exchange risk. The Company does not hold derivatives
for trading purposes. While these derivative financial instruments are subject
to fluctuations in value, these fluctuations are generally offset by the value
of the underlying exposures being hedged. The Company minimizes the risk of
credit loss by entering into these agreements with major financial institutions
that have high credit ratings.
Interest Rate Swap and Interest Rate Collar Agreements:
During 1998, the Company entered into an interest rate swap agreement and an
interest rate collar agreement to reduce the impact of changes in interest rates
on portions of the debt borrowed from its revolving credit facility.
The interest rate swap agreement exchanges the floating rate on the Company's
outstanding debt from its revolving credit facility for a fixed interest rate of
5.12%. This agreement expires in June of 1999 and covers a notional amount of
approximately $136.0 million.
The interest rate collar agreement consists of a rate ceiling and floor that is
based on different notional amounts. The ceiling portion of the collar is at a
rate of 7.75% covering a notional amount of $30.0 million and the floor portion
of the collar is at 4.75% covering a notional amount of $15.0 million. The
notional amounts of this interest rate collar agreement is used to measure
interest to be paid or received and does not represent the amount of exposure
due to credit loss. The net cash amounts paid or received on the interest rate
collar agreement are accrued and recognized as an adjustment to interest
expense. The interest rate collar agreement expires in September of 2001.
Foreign Exchange Contracts:
As part of the acquisition of FCA International Ltd. ("FCA"), the Company
obtained forward exchange contracts which were entered into by FCA. These
forward exchange contracts may be used by the Company to minimize the impact of
currency fluctuations on transactions, cash flows and firm commitments. The
Company has approximately $3.4 million of contracts outstanding at December 31,
1998. These contracts are for the purchase of Canadian Dollars and mature within
one to 30 months. The Company has determined that the gains and losses
associated with these contracts are not material.
9. Income taxes:
A summary of the components of the tax provision at December 31, 1996, 1997 and
1998 is as follows:
1996 1997 1998
----------- ----------- -----------
Currently payable:
Federal $ 620,000 $ 2,535,000 $ 5,710,000
State 147,000 483,000 636,000
Foreign - - 331,000
Deferred:
Federal 1,000 1,752,000 3,213,000
State - 10,000 766,000
----------- ----------- -----------
Provision for income taxes 768,000 4,780,000 10,656,000
(excluding effect of
change in tax status)
Effect of accounting change:
Federal 124,000 - -
State 31,000 - -
----------- ----------- -----------
Total provision $ 613,000 $ 4,780,000 $10,656,000
=========== =========== ===========
F-12
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
9. Income taxes (continued):
Deferred tax assets (liabilities) at December 31, 1997 and 1998 consist of the
following:
1997 1998
----------- -----------
Deferred tax assets:
Net operating loss carryforwards $ - $ 569,000
Contractual revenue recognition 26,000 -
Accrued expenses 103,000 779,000
----------- -----------
129,000 1,348,000
Deferred tax liabilities:
Amortization 1,710,000 4,999,000
Depreciation 110,000 1,380,000
----------- -----------
1,820,000 6,379,000
----------- -----------
Net deferred tax asset (liability) $(1,691,000) $(5,031,000)
=========== ===========
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:
1996 1997 1998
---- ---- ----
U.S. statutory income tax rate 34% 34% 35%
Income allocable to S Corporation (27%) - -
Non-deductible goodwill and other expenses 5% 2% 2%
State taxes, net of federal 2% 4% 5%
-- -- --
Effective tax rate 14% 40% 42%
== == ==
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 15% 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
$72,000, $179,000, and $655,000, for 1996, 1997 and 1998, respectively.
F-13
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
11. Supplemental cash flow information:
The following are supplemental disclosures of cash flow information:
1996 1997 1998
----------- ----------- -----------
Cash paid for interest $ 818,000 $ 569,000 $ 1,646,000
Cash paid for income taxes 600,000 4,154,000 3,476,000
Noncash investing and financing
activities:
Fair value of assets acquired 4,081,000 8,706,000 47,872,000
Property acquired under
capital leases 349,000 - 138,000
Value of fixed assets traded for
new fixed assets - 238,000 -
Liabilities assumed from
acquisitions 2,006,000 4,150,000 46,730,000
Note receivable, shareholder - - -
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 - 9,310,000 -
Warrants issued with debt 219,000 - -
Warrants issued for acquisitions - 875,000 -
Warrants exercised - 149,000 247,000
12. Operating leases:
The Company leases certain equipment under non-cancelable operating leases.
Future minimum payments, by year and in the aggregate, under noncancelable
operating leases with initial or remaining terms of one year or more
consist of the following at December 31, 1998:
1999 $ 14,043,000
2000 9,953,000
2001 7,568,000
2002 4,911,000
2003 3,219,000
Thereafter 8,493,000
--------------
$ 48,187,000
==============
Rent expense was $1,074,000, $2,697,000 and $5,311,000 for the years ended
December 31, 1996, 1997, and 1998, respectively. The related party office
lease expense, which terminated in July 1997, was $490,000 and $232,000,
for 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.
F-14
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
13. Shareholders' equity:
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 shares (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 Company received net
proceeds from the 1997 Offering, after underwriting discounts and expenses,
of approximately $40.4 million.
In June 1998, the Company completed a public offering (the "1998
Offering"), selling 4,978,476 shares of common stock at a price to the
public of $21.50 per share, including 4,469,366 shares (469,366 of which
were over-allotment shares exercised in July 1998) issued by the Company,
360,000 shares (180,000 of which were over-allotment shares exercised in
July 1998) sold by management and related shareholders and 149,110 shares
sold by certain non-management shareholders. The Company received net
proceeds from the 1998 Offering, after underwriting discounts and expenses,
of approximately $91.3 million.
14. 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, 1996, 1997 and 1998 by the pro forma weighted average number
of shares outstanding. Pro forma net income amounts are used for 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, 1996, 1997 and 1998 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 (amounts in thousands, except EPS amounts) (1996 are pro
forma for taxes):
1996 1997 1998
-------------------- ------------------ --------------------
Shares EPS Shares EPS Shares EPS
--------- --------- --------- -------- ---------- ---------
Basic 7,630 $ 0.34 11,941 $ 0.59 15,939 $ 0.92
Dilutive effect of warrants - - 96 - 104 -
Dilutive effect of options - - 403 (0.02) 406 (0.03)
Dilutive effect of
convertible notes 28 - 120 - 64 -
--------- --------- --------- -------- ---------- ---------
Diluted 7,658 $ 0.34 12,560 $ 0.57 16,513 $ 0.89
========= ========= ========= ======== ========== =========
F-15
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
15. 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 Plan and 1996 Plan, as amended, authorized 333,000 and
1,717,000 shares, respectively, of incentive or non-qualified stock
options. The Director Plan, as amended, authorized 186,000 shares. The
vesting periods for the outstanding options under the 1995 Plan, the 1996
Plan and the Director Plan are three years, three years and one year,
respectively. The maximum exercise period is ten years after the date of
grant. A summary of stock option activity since inception of the Plans is
as follows:
Weighted
Average
Exercise
Number of Price
Options Per Share
-------------- --------------
Outstanding at January 1, 1996 216,000 $ 1.82
Granted 442,000 9.25
-------------- --------------
Outstanding at December 31, 1996 658,000 6.80
Granted 424,000 20.28
Exercised (50,000) 4.20
Forfeited (36,000) 10.72
-------------- --------------
Outstanding at December 31, 1997 996,000 13.05
Granted 776,000 27.32
Exercised (230,000) 5.98
Forfeited (23,000) 23.08
-------------- --------------
Outstanding at December 31, 1998 1,519,000 $ 21.13
============== ==============
Stock options exercisable at December 31, 1998 354,000 $ 12.70
============== ==============
The following table summarizes information about fixed stock options outstanding
as of December 31, 1998:
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 27,000 6.41 years $ 1.82 27,000 $ 1.82
$ 8.66 to $12.09 331,000 7.81 years 9.40 191,000 9.50
$15.00 to $19.42 217,000 8.25 years 16.78 83,000 16.94
$21.00 to $25.00 573,000 9.34 years 22.61 53,000 23.28
$28.44 to $36.88 362,000 9.87 years 33.03 - -
$45.00 9,000 10.00 years 22.61 - -
------------ ----------------- --------------- ----------- ---------------
1,519,000 8.93 years $ 21.13 354,000 $ 12.70
============ ================= =============== =========== ===============
The Company applies APB Opinion 25 and related interpretations in accounting for
its stock option plans and, accordingly, does not recognize compensation cost
based on the fair value of the options granted at grant date. If the Company had
elected to recognize compensation cost based on the fair value of the options
granted at grant date, net income and earnings per share for 1996, 1997 and 1998
would have been reduced to the unaudited pro forma amounts indicated in the
following table:
F-16
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
15. Stock options (continued):
1996 1997 1998
---------- ---------- -----------
Net income - as reported $2,541,000 $7,074,000 $14,716,000
Net income - pro forma $2,483,000 $6,634,000 $13,671,000
Basic:
Earnings per share - as reported $0.34 $0.59 $0.92
Earnings per share - pro forma $0.33 $0.55 $0.86
Diluted:
Earnings per share - as reported $0.34 $0.57 $0.89
Earnings per share - pro forma $0.32 $0.53 $0.83
The estimated weighted-average grant-date fair values of the options granted
during the years ended December 31, 1996, 1997 and 1998 were $4.35, $7.17 and
$9.86, respectively. All options granted were at the market price of the stock
on the grant date. For valuation purposes, the Company utilized the
Black-Scholes option pricing model the following assumptions on a weighted
average basis:
1996 1997 1998
------ ------ ------
Risk-free interest rate 6.32% 6.19% 4.98%
Expected life in years 3.25 3.25 3.25
Volatility factor 32.16% 40.42% 43.38%
Dividend yield None None None
Forfeiture rate 5.00% 5.00% 5.00%
16. 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
Goodyear acquisition consists of a note payable which contains a conversion
option allowing the holder to convert the debt into shares of common stock at a
price of $14.12 per share. The seller-financed debt was converted into 63,755
shares of common stock on February 15, 1999. Accordingly, the fair value of the
debt as of December 31, 1998 was calculated using the closing market price of
NCO's common stock on February 15, 1999.
Interest Rate Instruments: While it is not the Company's intention to terminate
any of the interest rate instruments, the fair value of the instruments were
estimated by obtaining quotes from brokers that represented amounts the Company
would have received or paid if the agreements were terminated at December 31,
1998. These fair values indicated that the gains or losses that would have
resulted from the termination of the interest rate swap agreement and the
interest rate collar agreement at December 31, 1998 would have not been
material.
Foreign Exchange Contracts: The fair value of foreign exchange contracts at
December 31, 1998 was not material.
The estimated fair value of the Company's financial instruments are as follows
at December 31:
1997 1998
--------------------- -------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ----- -------- -----
Financial Assets:
Cash and cash equivalents $29,539,000 $29,539,000 $21,108,000 $21,108,000
Financial Liabilities:
Non-interest bearing note payable 92,000 92,000 36,000 36,000
Subordinated seller notes payable 1,000,000 1,000,000 500,000 500,000
Subordinated seller
notes payable, convertible 900,000 1,683,000 900,000 2,176,000
F-17
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
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 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for the fiscal years beginning after June 15, 1999. SFAS No. 133
requires that an entity recognize all derivative instruments as either
assets or liabilities on its balance sheet at their fair value. Changes in
the fair value of derivatives are recorded each period in current earnings
or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction, and, if it is, the type of hedge
transaction. The Company will adopt SFAS No. 133 by the first quarter of
2000. Due to the Company's limited use of derivative instruments, SFAS No.
133 is not expected to have a material impact on the consolidated results
of operations, financial condition or cash flows of the Company.
19. Segment reporting:
As of December 31, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise
and Related Information" ("SFAS 131"). SFAS 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 customers. The adoption of SFAS 131
did not affect results of operations or financial position but did affect
the disclosure of segment information.
The accounting policies of the segments are the same as those described in
note 2, "Summary of significant accounting policies." Segment data includes
a charge allocating corporate overhead costs to each of the operating
segments based on revenue and employee headcount.
The Company is currently organized into market segment specific operating
divisions that are responsible for all aspects of client sales, client service
and operational delivery of services. The operating divisions, which are each
headed by a divisional chief executive officer, include Accounts Receivable
Management, Healthcare Services, Marketing Strategy and International
Operations.
The Accounts Receivable Management division provides accounts receivable
management services to consumer and commercial accounts for all market
segments, serving clients of all sizes in local, regional and national
markets.
The Healthcare Services division primarily focuses on providing
comprehensive outsourcing services for the hospital market. In addition,
the Healthcare Services division provides receivable management programs
for physician groups and allied health service providers.
The International Operations division provides accounts receivable
management services across Canada and the United Kingdom.
The Marketing Strategy division provides full-service custom market
research services to the telecommunications, financial services, utilities,
healthcare, pharmaceutical, and consumer products sectors. In addition, the
Marketing Strategy division provides telemarketing services for clients,
including lead generation and qualification, and the actual booking of
appointments for a client's sales representatives.
F-18
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
19. Segment reporting (continued):
The following table represents the segment information for the year ended
December 31, 1996 (amounts in thousands):
A/R Healthcare International Marketing Consolidation NCO
Management Services Operations Strategy Adjustments Consolidated
------------- ----------- ------------ ---------- ------------- ------------
Revenue $ 30,760 - - - $ - $ 30,760
Payroll and
Related expenses 14,651 - - - - 14,651
Selling general and
administrative
expenses 10,024 - - - 8 10,032
------------- ----------- ----------- ------------- ------------- -------------
EBITDA $ 6,085 - - - $ (8) $ 6,077
============= =========== =========== ============= ============= =============
The following table represents the segment information for the year ended
December 31, 1997 (amounts in thousands):
A/R Healthcare International Marketing Consolidation NCO
Management Services Operations Strategy Adjustments Consolidated
------------- ----------- ------------ ---------- ------------- ------------
Revenue $ 81,942 - - $ 3,342 $ - $ 85,284
Payroll and
related expenses 40,549 - - 1,952 1 42,502
Selling general and
administrative
expenses 27,041 - - 705 201 27,947
------------- ----------- ----------- ------------- ------------- -------------
EBITDA $ 14,352 - - $ 685 $(202) $ 14,835
============= =========== =========== ============= ============= =============
The following table represents the segment information for the year ended
December 31, 1998 (amounts in thousands):
A/R Healthcare International Marketing Consolidation NCO
Management Services Operations Strategy Adjustments Consolidated
------------- ----------- ------------ ---------- ------------- ------------
Revenue $ 127,419 $ 20,442 $ 18,556 $ 12,559 $ - $ 178,976
Payroll and
Related expenses 63,023 9,930 10,902 8,346 - 92,201
Selling general and
administrative
expenses 38,628 5,978 4,858 2,721 21 52,206
------------- ----------- ----------- ------------- ------------- -------------
EBITDA $ 25,768 $ 4,534 $ 2,796 $ 1,492 $(21) $ 34,569
============= =========== =========== ============= ============= =============
F-19
NCO GROUP, INC.
Schedule II -- Valuation of Qualifying Accounts
Additions
-------------------------
Balance at Charged to Charged to Balance at
beginning costs and other end of
of year expenses accounts(1) Deductions(2) year
---------- ---------- ----------- ------------- -----------
Year ended December 31, 1996:
Allowance for doubtful accounts $ 23,000 $ 139,000 $ 93,000 $(176,000) $ 79,000
Year ended December 31, 1997:
Allowance for doubtful accounts 79,000 507,000 153,000 (288,000) 451,000
Year ended December 31, 1998:
Allowance for doubtful accounts 451,000 1,163,000 2,122,000 (362,000) 3,374,000
(1) Allowance for doubtful accounts of acquired companies
(2) Uncollectible accounts written off, net of recoveries.
S-1