<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ Quarterly report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended September 30, 1997, or
/ / Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from to
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COMMISSION FILE NUMBER 0-21639
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NCO GROUP, INC.
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA
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(State or other jurisdiction of incorporation or organization)
515 Pennsylvania Avenue, Fort Washington, Pennsylvania
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(Address of principal executive offices)
23-2858652
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(IRS Employer Identification Number)
19034
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(Zip Code)
215-793-9300
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(Registrant's telephone number including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
----- -----
The number of shares outstanding of each of the issuer's classes of
common stock was 8,810,829 shares common stock, no par value, outstanding as of
November 5, 1997
1
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NCO GROUP, INC.
INDEX
PAGE
Part I FINANCIAL INFORMATION
Item 1 CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets -
December 31, 1996 and September 30, 1997 3
Consolidated Statements of Income -
Three months and nine months ended
September 30, 1996 and 1997 4
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1996 and 1997 5
Pro Forma Consolidated Statement of Income -
Nine months ended September 30, 1997 6
Notes to Consolidated Financial Statements 7
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11
PART II 16
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Shareholders
Item 5. Other Information
Item 6. Exhibits and Reports on 8-K
2
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Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Unaudited)
<TABLE>
<CAPTION>
December 31, September 30,
ASSETS 1996 1997
------------ -------------
Current assets:
<S> <C> <C>
Cash and cash equivalents $12,058,798 $33,422,370
Accounts receivable, trade, net of
allowance for doubtful accounts of $79,000
and $338,020, respectively 4,701,364 11,080,676
Other current assets 499,815 306,280
----------- -----------
Total current assets 17,259,977 44,809,326
Funds held in trust for clients
Property and equipment, net 2,830,062 6,927,431
Other assets:
Intangibles, net of accumulated amortization 14,673,155 38,240,944
Deferred taxes 70,760 50,986
Deferred financing costs 684,390 565,532
Deposits on acquisitions -- 4,700,000
Other assets 308,011 849,160
----------- -----------
Total other assets 15,736,316 44,406,622
----------- -----------
Total assets $35,826,355 $96,143,379
=========== ===========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 46,946 $ 54,961
Capitalized lease obligations, current portion 62,131 172,519
Corporate taxes payable 216,709 507,708
Accounts payable 657,647 2,264,189
Accrued expenses 1,044,536 3,580,376
Accrued compensation and related expenses 1,376,982 2,543,212
Unearned revenue, net of related costs 225,817 68,075
----------- -----------
Total current liabilities 3,630,768 9,191,040
Funds held in trust for clients
Long-term liabilities:
Long term debt, net of current portion 1,091,901 1,159,378
Capitalized lease obligations, net of current portion 385,683 271,457
Unearned revenue, net of related costs 70,385 107,388
Commitments and contingencies
Shareholders' equity:
Preferred stock, no par value, 5,000,000 shares authorized,
no shares issued and outstanding
Common stock, no par value, 25,000,000 shares authorized,
6,713,447 and 8,779,868 shares issued and outstanding
at December 31, 1996 and September 30, 1997, respectively 29,362,326 78,297,211
Unexercised warrants 396,054 1,122,546
Retained earnings 889,238 5,994,359
----------- -----------
Total shareholders' equity 30,647,618 85,414,116
----------- -----------
Total liabilities and shareholders' equity $35,826,355 $96,143,379
=========== ===========
</TABLE>
The accompanying notes are an integral part of this consolidated statement.
3
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NCO GROUP, INC.
Consolidated Statements of Income
(Unaudited)
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
------------------------------------- ------------------------------------
1996 1997 1996 1997
----------------- ---------------- ---------------- ----------------
<S> <C> <C> <C> <C>
Revenue $ 7,714,803 $ 21,738,891 $ 20,257,467 $ 60,977,700
Operating costs and expenses:
Payroll and related expenses 3,630,042 10,696,528 9,583,937 30,279,194
Selling, general and administrative
expenses 2,501,251 7,085,606 6,595,877 19,777,042
Depreciation and amortization expense 400,476 844,483 823,290 2,387,604
----------------- ---------------- ---------------- ----------------
Total operating costs and expenses 6,531,769 18,626,617 17,003,104 52,443,840
----------------- ---------------- ---------------- ----------------
Income from operations 1,183,034 3,112,274 3,254,363 8,533,860
Other income (expense):
Interest and investment income 33,419 444,993 80,834 607,314
Interest expense (249,405) (85,262) (606,899) (507,454)
Loss on disposal of fixed assets - (40,506) - (40,506)
----------------- ---------------- ---------------- ----------------
(215,986) 319,225 (526,065) 59,354
----------------- ---------------- ---------------- ----------------
Income before provision for income taxes 967,048 3,431,499 2,728,298 8,593,214
Income tax expense (benefit) (1,328) 1,349,851 (1,328) 3,488,093
----------------- ---------------- ---------------- ----------------
Net income $ 968,376 $ 2,081,648 $ 2,729,626 $ 5,105,121
================= ================ ================ ================
Pro Forma Pro Forma
----------------- ----------------
Historical income before income taxes $ 967,048 $ 2,728,298
Pro forma provision for income taxes 388,409 1,092,409
----------------- ----------------
Pro forma net income $ 578,639 $ 1,635,889
================= ================
Net income per share $ 0.12 $ 0.23 $ 0.34 $ 0.64
================= ================ ================ ================
Weighted average shares outstanding 4,752,780 9,078,066 4,752,780 8,013,713
================= ================ ================ ================
</TABLE>
The accompanying notes are an integral part of this consolidated statement.
4
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NCO GROUP, INC.
Consolidated Statements of Cash Flows
(Unaudited)
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
----------------------------
1996 1997
------------ ------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 2,729,626 $ 5,105,121
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 284,459 915,044
Amortization of intangibles 480,432 1,353,702
Amortization of deferred financing costs 58,399 118,858
Loss on disposal of equipment -- 40,506
Gain on sales of securities (338) --
Provision for doubtful accounts 383 120,503
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (1,459,651) (1,973,854)
Notes receivable 155,856 --
Other current assets (165,375) 451,698
Deferred taxes (152,306) (33,532)
Other assets 130,552 (26,826)
Accounts payable 326,210 (820,666)
Corporate taxes payable 167,753 279,799
Accrued expenses (559,547) 1,314,001
Accrued compensation and related costs 240,508 541,270
Unearned revenue (72,943) (120,739)
------------ ------------
Net cash provided by operating activities 2,164,018 7,264,885
Cash flows from investing activities:
Purchase of property and equipment (708,121) (2,560,257)
Purchase of securities (159,562) --
Proceeds from sale of securities 127,887 --
Net cash paid for acquisitions (12,664,218) (22,876,256)
------------ ------------
Net cash used in investing activities (13,404,014) (25,436,513)
Cash flows from financing activities:
Repayment of notes payable (125,466) (8,386,297)
Borrowings under credit agreement 12,550,000 8,350,000
Payment of fees to acquire new debt (130,000) --
Issuance of common stock, net -- 39,571,497
Decrease in notes receivable, shareholders 82,873 --
Distributions to shareholders (851,978) --
------------ ------------
Net cash provided by financing activities 11,525,429 39,535,200
------------ ------------
Net increase in cash and cash equivalents 285,433 21,363,572
Cash and cash equivalents at beginning of period 804,550 12,058,798
------------ ------------
Cash and cash equivalents at end of period $ 1,089,983 $ 33,422,370
============ ============
Supplemental disclosures of cash flow information:
Cash paid for interest $ 519,499 $ 493,724
Cash paid for income taxes -- 3,140,856
Noncash investing and financing activities:
Fair value of assets acquired 4,087,253 7,986,816
Liabilities assumed from acquisitions -- 3,400,271
Convertible note payable, issued for acquisition 1,000,000 900,000
Convertible note payable, exercised for Common Stock -- 1,000,000
Warrants issued for acquisitions -- 875,000
Common stock issued for acquisitions -- 8,214,880
Value of fixed assets traded for new fixed assets -- 233,847
Property acquired under capital leases 348,586 --
</TABLE>
The accompanying notes are an integral part of this consolidated statement.
5
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NCO Group, Inc.
Pro Forma Consolidated Statements of Income
For the Nine Months Ended September 30, 1997
(Unaudited)
<TABLE>
<CAPTION>
Historical
----------------------------------- Offering and
NCO Group, Acquired Acquisition Pro Forma
Inc. Companies (1,2) Adustments (3) Combined
------------ --------------- ---------------- ----------
<S> <C> <C> <C> <C>
Revenue $ 60,977,700 $ 2,841,578 $ -- $ 63,819,278
Operating costs and expenses:
Payroll and related expenses 30,279,194 1,381,883 (103,258) 31,557,819
Selling, general and administrative expenses 19,777,042 1,159,470 (54,093) 20,882,419
expenses
Depreciation and amortization expense 2,387,604 156,915 (27,378) 2,517,141
------------ ------------ ------------ ------------
Total operating costs and expenses 52,443,840 2,698,268 (184,729) 54,957,379
------------ ------------ ------------ ------------
Income from operations 8,533,860 143,310 184,729 8,861,899
Other income (expense):
Interest and investment income 607,314 607,314
Interest expense (507,454) (273) 333,201 (174,526)
Loss on disposal of fixed assets (40,506) (40,506)
------------ ------------ ------------ ------------
59,354 (273) 333,201 392,282
------------ ------------ ------------ ------------
Income before provision for income taxes 8,593,214 143,037 517,930 9,254,181
Income tax expense 3,488,093 268,294 3,756,387
------------ ------------ ------------ ------------
Net income $ 5,105,121 $ 143,037 $ 249,636 $ 5,497,794
============ ============ ============ ============
Net income per share $ 0.64 $ 0.66
============ ============ ============ ============
Weighted average shares outstanding 8,013,713 8,361,216
============ ============
</TABLE>
(1) Pro forma information includes the pro forma effect of the acquisitions of
Goodyear & Associates, CMS A/R Services, Tele-Research Center and CRW Financial,
Inc., Collections Division as if they had occurred on January 1, 1997
(2) Pro forma information does not include the pro forma effect of the
acquisitions of Credit Acceptance Corporation or ADVANTAGE Financial, Inc. These
acquisitions were completed on September 29, 1997 and September 30, 1997
respectively, but were not effective until October 1, 1997.
(3) Gives effect to: (i) the reduction of certain redundant operating costs and
expenses that were immediately identifiable at the time of the acquisitions;
(ii) the issuance of 76,923 shares of stock in connection with the conversion of
a $1.0 million seller-financed note payable; and (iii) the elimination of
additional interest expense associated with acquisition-related debt assumed to
be repaid on January 1, 1997 with the proceeds of the Company's July 1997 public
offering
6
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NCO GROUP, INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. Nature of Operations:
NCO Group, Inc. (the "Company") is a leading provider of accounts receivable
management and related services utilizing an extensive teleservices
infrastructure. The Company's client base is comprised of companies located
throughout the United States in the following sectors: financial services,
government, education, healthcare, retail and commercial, telecommunications,
and utilities.
Effective September 3, 1996, the Company reorganized its corporate structure. At
September 3, 1996, the shareholders of NCO Financial Systems, Inc. contributed
each of their shares of common stock in exchange for one share common stock of
the Company, a recently formed corporation. The Company effected a 46.56 for 1
stock split in September 1996 and increased the number of authorized shares to
5,000,000 shares of preferred stock and 25,000,000 shares of common stock. All
per share and related amounts have been adjusted to reflect the stock exchange
and stock split.
In July 1997, the Company completed a public offering (the "1997 Offering")
selling 2,875,000 shares of common stock at a price to the public of $29.50 per
share, including 1,444,000 shares issued by the Company, 433,579 shares and
375,000 over-allotment shares sold by existing shareholders, 50,320 shares
acquired by employees through the exercise of stock options, 150,000 shares
acquired by the Company's bank (Mellon Bank, N.A.) through the exercise of stock
warrants, 76,923 shares acquired through the conversion of the Company's
convertible note, and 345,178 shares acquired by CRW Financial, Inc. in
connection with the acquisition by NCO of CRWCD. The proceeds of the offering,
after underwriting discounts and expenses, were approximately $39.4 million.
After the offering, the Company had 8,779,868 shares of Common Stock
outstanding.
2. Summary of Significant Accounting Policies:
Revenue Recognition:
The Company generates revenues from contingency fees and contractual services.
Contingency fee revenue is recognized upon collection of funds on behalf of
clients. Contractual services revenue is deferred and recognized as services are
performed.
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, and losses and tax credits were utilized directly by, the
shareholders of the Company.
The Company terminated its S Corporation status on September 3, 1996. Upon
termination of its S Corporation status, the Company adopted SFAS No. 109,
"Accounting for Income Taxes". This standard requires an asset and liability
approach that takes into account changes in tax rates when valuing the deferred
tax amounts to be reported in the balance sheet.
Credit Policy:
The Company has two types of arrangements under which it collects its
contingency fee revenue. For certain clients, the Company remits funds collected
on behalf of the client net of the related contingency fees while, for other
clients, the Company remits gross funds collected on behalf of clients and bills
the client separately for its contingency fees. Management carefully monitors
its client relationships in order to minimize its credit risk and generally does
not require collateral. In the event of collection delays from clients,
management may at its discretion change from the gross remittance method to the
net remittance method.
7
<PAGE>
Goodwill and Acquisition Costs:
Goodwill represents the excess of purchase price over the fair market value of
the net assets of the acquired businesses. Goodwill is amortized on a
straight-line basis over 15 to 25 years. The recoverability of goodwill is
periodically reviewed by the Company. In making such determination with respect
to goodwill, the Company evaluates the operating cash flows of the underlying
business which gave rise to such amount.
Deferred Financing Costs:
Deferred financing costs relate to debt issuance costs incurred which are
capitalized and amortized over the term of the debt.
Estimates Utilized in the Preparation of Financial Statements:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Earnings Per Share:
Earnings per share were computed by dividing the pro forma net income for the
three and nine month periods ended September 30, 1997 and 1996 by the pro forma
weighted average number of shares outstanding. Pro forma net income amounts are
used because the 1996 historical net income does not include the impact of
federal and state income taxes as if the Company had been subject to income
taxes for the entire period. Pro forma weighted average shares outstanding are
based on the weighted average number of shares outstanding including common
equivalent shares. All outstanding options and warrants have been treated as
common equivalent shares in calculating pro forma net income per share, using
the treasury stock method and the initial public offering price of $13.00 per
share for periods before the initial public offering, only when their effect
would be dilutive. For September 30, 1996, the pro forma weighted average number
of shares outstanding have also been adjusted to include the number of shares of
common stock (250,000 shares) that the Company would have needed to issue at the
initial public offering price of $13.00 per share to finance the distribution of
undistributed S Corporation earnings through the date on which the Company
terminated its S Corporation status. Fully diluted earnings per share are not
materially different from primary earnings per share.
In March 1997, the Financial Accounting Standards Board issued Statement of
Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share." This
Statement establishes standards for computing and presenting earnings per share
(EPS) and applies to entities with publicly held common stock or potential
common stock. This Statement is effective for financial statements issued for
periods ending after December 15, 1997; earlier application is not permitted.
This Statement requires restatement of all prior-period EPS data presented. The
Company is currently evaluating the impact, if any, adoption of SFAS No. 128
will have on its financial statements.
Interim Financial Information:
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions for Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of normal
recurring accruals) considered necessary for a fair presentation have been
included. Operating results for the three and nine month periods ended September
30, 1997 are not necessarily indicative of the results that may be expected for
the year ending December 31, 1997 or for any other interim period. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K, as amended, filed
with the Securities and Exchange Commission on March 31, 1997.
8
<PAGE>
3. Acquisitions:
On January 3, 1996 the Company purchased certain assets of Trans Union
Corporation Collections Division ("TCD") for $4,750,000 in cash. TCD provided
accounts receivable management services, principally to the telecommunications,
utility and healthcare sectors from offices in Pennsylvania, Ohio and Kansas.
This acquisition resulted in goodwill of $3.7 million.
On September 5, 1996 the Company purchased the outstanding stock of Management
Adjustment Bureau, Inc. ("MAB") for $9,000,000 comprised of $8,000,000 in cash
and a $1,000,000 convertible note. The note is convertible into 76,923 shares of
the Company's Common Stock, at any time, and bears interest payable monthly at a
rate of 8.0% per annum with principal due in September 2001. This note was
converted to Common Stock in July 1997. MAB, based in Buffalo, New York,
provided accounts receivable management services, principally to the education,
financial services, telecommunications and utility sectors. This acquisition
resulted in goodwill of $8.7 million.
On January 22, 1997, NCO purchased all of the outstanding stock of Goodyear &
Associates, Inc. ("Goodyear") for $4.5 million in cash and a $900,000
convertible note. The note is convertible into 42,503 shares of the Company's
Common Stock, at any time, and bears interest payable monthly at a rate of 8.0%
per annum with principal due in January 2002. Goodyear, based in Charlotte,
North Carolina, provided accounts receivable management services principally to
the telecommunications, education, and utility sectors. Goodyear's revenues in
1996 were $5.5 million. This acquisition resulted in goodwill of $5.3 million.
On January 30, 1997, NCO purchased certain assets of Tele-Research Center, Inc.
("TRC") for $1.6 million in cash. TRC, located in Philadelphia, Pennsylvania,
provided market research, data collection, and other teleservices to market
research companies as well as end-users. TRC's revenues in 1996 were $1.8
million. This acquisition resulted in goodwill of $1.6 million.
On January 31, 1997, NCO purchased substantially all the assets of CMS A/R
Services ("CMSA/R"), formerly a division of CMS Energy Corporation, for $5.1
million in cash. Specializing in the utility industry, CMSA/R, located in
Jackson, Michigan, provided a wide range of accounts receivable management
services in addition to traditional recovery of delinquent accounts including
project outsourcing, early intervention, and database management services.
CMSA/R's revenues in 1996 were $6.8 million. This acquisition resulted in
goodwill of $3.5 million.
On February 2, 1997, NCO purchased substantially all the assets of CRW
Financial, Inc. Collections Division ("CRWCD") for $3.75 million in cash,
345,178 shares of its Common Stock and warrants for 250,000 shares of common
stock. The purchase price was valued at approximately $12.8 million. CRWCD
provided accounts receivable management services principally to the
telecommunications, education, financial, government and utility sectors from 14
offices located throughout the United States. In addition, CRWCD had a
commercial collections division. CRWCD's revenues in 1996 were $25.9 million.
Due to the consolidation or closing of certain CRWCD branch offices, and the
loss of certain contracts during 1996, revenue for CRWCD for 1997 is anticipated
to be 10-15% lower than the revenue shown on the historical financial
statements. This acquisition resulted in goodwill of $14.0 million.
Effective October 1, 1997, NCO purchased all of the outstanding stock of Credit
Acceptance Corp. ("CAC") for $1.8 million in cash. CAC, based in Pittsburgh,
Pennsylvania, provided accounts receivable management services principally to
the medical sector. CAC had revenues in 1996 of $2.3 million. Cash paid for the
acquisition of CAC is included on the balance sheet at September 30, 1997 under
the caption "Deposits on acquisitions."
9
<PAGE>
Effective October 1, 1997, NCO purchased all of the outstanding stock of
ADVANTAGE Financial Services, Inc. ("Advantage") for $2.9 million in cash,
30,961 shares of its Common Stock and $1,000,000 in notes payable. The purchase
price was valued at $5.0 million. The notes bear interest payable monthly at a
rate of 8.0% per annum with principal due in September 2002. Advantage, based in
Dayton, Ohio and Bristol, Tennessee, provided accounts receivable management
services principally to the medical, telecommunications and commercial sectors.
Advantage had revenues in 1996 of $5.1 million. Cash paid for the acquisition of
Advantage is included on the balance sheet at September 30, 1997 under the
caption "Deposits on acquisitions."
The acquisitions of Goodyear, TRC, CMSA/R, and CRWCD are known collectively as
the "1997 Q1 Acquisitions." The acquisitions of CAC and Advantage are known
collectively as the "1997 Q4 Acquisitions." The 1997 Q1 Acquisitions and the
1997 Q4 Acquisitions are known collectively as the "1997 Acquisitions."
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 $9,499,272 and $3,835,409 at September 30,
1997 and December 31, 1996, respectively, have been shown net of their
offsetting liability for financial statement presentation purposes.
5. Long-term debt:
In July 1995, the Company entered into a $7,000,000 revolving credit agreement.
In connection with the agreement, the bank received a warrant for 175,531 shares
of Common Stock, exercisable at a nominal value. The line of credit is
collateralized by substantially all the assets of the Company and contains,
among other provisions, requirements for maintaining defined levels of working
capital, net worth, capital expenditures, various financial ratios and
restrictions on distributions to shareholders. In September 1996, the credit
agreement was increased to $15,000,000 to provide financing for the acquisition
of MAB and the bank received a warrant for 46,560 shares, exercisable at $13.00
per share. In December 1996, the bank increased the credit agreement to
$25,000,000 and received a warrant to purchase an additional 18,500 shares,
exercisable at $13.00 per share.
The Company financed the 1997 Q1 Acquisitions by borrowing $7.35 million on its
revolving credit facility and financed the remainder through funds raised in the
initial public offering and through its existing working capital. During March
1997, the Company borrowed an additional $1.0 million to fund the reduction of
accounts payable assumed as part of the CRWCD acquisition. The line of credit
was repaid in full with funds raised in the Company's initial public offering in
November 1996 and the 1997 Offering.
6. Investment Considerations:
In analyzing whether to make, or to continue, an investment in the Company,
investors should consider, among other factors, certain risk factors and other
information contained in the Company's filings with the Securities and Exchange
Commission, including, without limitation, the Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 31, 1997, as amended, and
the Company's Registration Statements on Form S-1 filed with the Securities and
Exchange Commission on June 11, 1997 and September 11, 1996, as amended.
A copy of the Annual Report on Form 10-K can be obtained, without charge except
for exhibits, by written request to Steven L. Winokur, Executive Vice-President,
Finance/CFO, NCO Group, Inc., 515 Pennsylvania Avenue, Ft. Washington,
PA 19034.
10
<PAGE>
Item 2
Management's Discussion and Analysis of
Financial Condition and Results of Operations
The information contained in this Report on Form 10-Q, other than
historical facts, contains forward-looking statements (as such term is defined
in the Securities Exchange Act of 1934, and the regulations thereunder)
including, without limitation, statements as to the Company's objective to grow
through strategic acquisitions and internal growth, the Company's ability to
realize operating efficiencies in the integration of its acquisitions, trends in
the Company's future operating performance, the classification of the Company's
investment portfolio, 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, and the other risks detailed from
time to time in the Company's filings with the Securities and Exchange
Commission, including the Company's Annual Report on Form 10-K, filed on March
31, 1997, as amended, can cause actual results and developments to be materially
different from those expressed or implied by such forward-looking statements.
A copy of the Annual Report on Form 10-K can be obtained, without charge except
for exhibits, by written request to Steven L. Winokur, Executive Vice-President,
Finance/CFO, NCO Group, Inc., 515 Pennsylvania Avenue, Ft. Washington,
PA 19034.
Pro Forma Compared to Actual Results of Operations
Pro forma operating data for the nine month period ended September 30, 1997
assume that the 1997 Q1 Acquisitions were consummated on January 1, 1997. Pro
forma adjustments have been made to reflect the elimination of certain expenses
that were immediately identifiable at the time of the acquisitions. For
instance, pro forma adjustments to the 1997 Q1 Acquisitions include the
elimination of approximately 110 redundant administrative and collection
personnel, the reduction of the salaries of the principal shareholder of
Goodyear, the closing or consolidation of four existing call centers, as well as
the downsizing of three call centers into customer service locations. At the
time of the acquisitions, the acquired companies had a higher cost structure
than that of the Company's core business. The Company intends to leverage its
infrastructure to realize additional operating efficiencies in order to bring
the cost structure of the acquired companies in line with NCO's current
operating results. These other costs savings include: (i) further reduction in
payroll and related expenses relating primarily to redundant collections and
administrative personnel; (ii) further reductions in facilities costs; and (iii)
reduction of certain expenses such as telephone, mailing and data processing.
Management believes it will realize these cost savings with respect to the
acquired companies, although no assurances can be given that such cost savings
will be realized. Due to the higher cost structures of the acquired business and
the fact that all expected expense savings are not reflected in pro forma
adjustments, certain pro forma operating percentages compare unfavorably to
actual operating percentages for the periods under consideration. Due to the
consolidation or closing of certain CRWCD branch offices, and the loss of
certain contracts during 1996, revenue for CRWCD for 1997 is anticipated to be
10% to 15% lower than CRWCD's revenue for 1996.
Pro forma operating data does not include the recent acquisitions of CAC
and Advantage which were completed on September 29, 1997 and September 30, 1997,
respectively, but were not effective until October 1, 1997.
Three months Ended September 30, 1997 Compared to Three Months ended September
30, 1996
Revenue. Revenue increased $14.0 million or 181.8% to $21.7 million for the
three months ended September 30, 1997 from $7.7 million for the comparable
period in 1996. The addition of new clients and growth in business from existing
clients represented $2.0 million of the increase in revenue, and revenue
attributable to the MAB acquisition completed in September 1996 represented $2.4
million of the increase. In addition, $5.6 million of revenue was attributable
to the CRWCD acquisition completed in February 1997, and $4.0 million was
attributable to the Goodyear, CMS A/R, and TRC acquisitions completed in January
1997.
11
<PAGE>
Payroll and related expenses. Payroll and related expenses increased $7.1
million to $10.7 million for the three months ended September 30, 1997 from $3.6
million for the comparable period in 1996, and increased as a percentage of
revenue to 49.2% from 47.1%. Payroll and related expenses increased as a
percentage of revenue primarily as a result of the MAB, Goodyear, TRC, and CRWCD
acquisitions having a higher cost structure than that of the Company. This
increase was partially offset by spreading the cost of management and
administrative personnel over a larger revenue base.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $4.6 million to $7.1 million for the three
months ended September 30, 1997 from $2.5 million for the comparable period in
1996, and increased as a percentage of revenue to 32.6% from 32.4%. The
businesses acquired in the 1997 Q1 Acquisitions have 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. These increases were partially
offset by operating efficiencies obtained by spreading selling, general and
administrative expenses over a larger revenue base.
Depreciation and amortization. Depreciation and amortization increased to
$844,000 for the three months ended September 30, 1997 from $400,000 for the
comparable period in 1996. Amortization from the MAB and 1997 Q1 Acquisitions
increased $508,000 over the same period in 1996. Amortization of deferred
financing charges and depreciation resulting from normal capital expenditures
incurred in the ordinary course of business decreased $64,000 to $317,000 for
the three months ended September 30, 1997 as a result of the disposition of
certain fixed assets in the move of the Company's corporate headquarters.
Other income (expense). Interest expense decreased to $85,000 for the three
months ended September 30, 1997 from $249,000 for the comparable period in 1996.
The Company's revolving credit facility, which had $15.0 million outstanding as
of September 30, 1996, was repaid with part of the proceeds from the Company's
initial public offering of Common Stock in November 1996 (the "IPO") and a $1.0
million convertible note payable issued in connection with the MAB acquisition
in September 1996 was converted to Common Stock concurrent with the 1997
Offering. Offsetting these decreases in interest expense is an $900,000
convertible note issued in connection with the Goodyear acquisition in January
1997. Interest and investment income increased to $445,000 for the three months
ended September 30, 1997 from $33,000 for the comparable period in 1996. This
increase was primarily attributable to the investment of funds remaining from
the 1997 Offering, as well as an increase in operating funds and funds held in
trust for clients. As a result of the disposal of certain fixed assets in the
move of the Company's corporate headquarters in July 1997, the Company incurred
a loss on the disposal of fixed assets in the amount of $41,000.
Income tax expense. Income tax expense for the three months ended September
30, 1997 was $1.3 million and was computed using an assumed rate of 39.3% after
giving effect to non-deductible goodwill resulting from certain of the acquired
companies. The Company was an S Corporation until September 3, 1996 and,
accordingly, there was no provision for income taxes until that time. The pro
forma provision for income taxes of $388,000 for the three months ended
September 30, 1996 was computed utilizing an assumed rate of 40.0% after giving
effect to non-deductible goodwill.
Net income. Net income increased to $2.1 million for the three months ended
September 30, 1997 from the pro forma net income of $579,000 for the comparable
period in 1996, a 259.7% increase.
Nine months Ended September 30, 1997 Compared to Nine Months ended September 30,
1996
Revenue. Revenue increased $40.7 million or 201.0% to $61.0 million for the
nine months ended September 30, 1997 from $20.3 million for the comparable
period in 1996. The addition of new clients and growth in business from existing
clients represented $4.8 million of the increase in revenue and revenue
attributable to the MAB acquisition completed in September 1996 represented $9.3
million of the increase. In addition, $15.4 million of revenue was attributable
to the CRWCD acquisition completed in February 1997, and $11.2 million was
attributable to the Goodyear, CMS A/R, and TRC acquisitions completed in January
1997.
12
<PAGE>
Payroll and related expenses. Payroll and related expenses increased $20.7
million to $30.3 million for the nine months ended September 30, 1997 from $9.6
million for the comparable period in 1996, and increased as a percentage of
revenue to 49.7% from 47.3%. Payroll and related expenses increased as a
percentage of revenue primarily as a result of the businesses acquired in the
MAB acquisition and the 1997 Q1 Acquisitions having a higher cost structure than
that of the Company. This increase was partially offset by spreading the cost of
management and administrative personnel over a larger revenue base.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $13.2 million to $19.8 million for the nine
months ended September 30, 1997 from $6.6 million for the comparable period in
1996, and decreased as a percentage of revenue to 32.4% from 32.6%. The business
acquired in the 1997 Q1 Acquisitions have 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. These increases were more than offset
by operating efficiencies obtained by spreading selling, general and
administrative expenses over a larger revenue base.
Depreciation and amortization. Depreciation and amortization increased to
$2.4 million for the nine months ended September 30, 1997 from $823,000 for the
comparable period in 1996. $1.4 million of the increase was a result of the MAB
acquisition and the 1997 Q1 Acquisitions. Amortization of deferred financing
charges and depreciation resulting from normal capital expenditures incurred in
the ordinary course of business increased $155,000 to $959,000 for the nine
months ended September 30, 1997.
Other income (expense). Interest expense decreased to $507,000 for the nine
months ended September 30, 1997 from $607,000 for the comparable period in 1996.
Although the Company's revolving credit facility had been repaid with a portion
of the net proceeds from the IPO, the Company borrowed $8.4 million on its
revolving credit facility to partially finance the 1997 Q1 Acquisitions.
Additionally, the Company issued a $1.0 million convertible note payable in
connection with the MAB acquisition in September 1996 which was converted to
Common Stock in connection with the 1997 Offering, and an $900,000 convertible
note payable in connection with the Goodyear acquisition in January 1997.
Interest and investment income increased $526,000 to $607,000 for the nine
months ended September 30, 1997 from the comparable period in 1996. This
increase was primarily attributable to the investment of funds remaining from
the 1997 Offering, as well as an increase in operating funds and funds held in
trust for clients. As a result of the disposal of certain fixed assets in the
move of the Company's corporate headquarters in July 1997, the Company incurred
a loss on the disposal of fixed assets in the amount of $41,000.
Income tax expense. Income tax expense for the nine months ended September
30, 1997 was $3.5 million and was computed using an assumed rate of 40.6% after
giving effect to non-deductible goodwill resulting from certain of the acquired
companies. The Company was an S Corporation until September 1, 1996 and,
accordingly, there was no provision for income taxes until that time. The pro
forma provision for income of $1.1 million for the nine months ended September
30, 1996 was computed utilizing an assumed rate of 40.0% after giving effect to
non-deductible goodwill.
Net income. Net income in 1997 increased to $5.1 million for the nine
months ended September 30, 1997 from the pro forma net income of $1.6 million
for the comparable period in 1996, a 212.1% increase.
Liquidity and Capital Resources
The Company's primary sources of cash have historically been cash flows
from operations and bank borrowings, and the net proceeds from public offerings.
Cash has been used for acquisitions, distributions to shareholders, purchases of
equipment and working capital to support the Company's growth.
13
<PAGE>
In July 1997, the Company completed a public offering, selling
2,875,000 shares of common stock including 1,444,000 shares issued by the
Company, 433,579 shares and 375,000 over-allotment shares sold by existing
shareholders, 50,320 shares acquired by employees through the exercise of stock
options, 76,923 shares acquired through the conversion of the Company's
convertible note, 150,000 shares acquired by the Company's bank (Mellon Bank,
N.A.) through the exercise of a portion of their stock warrants, and 345,178
shares acquired by CRW Financial, Inc. in connection with the acquisition by NCO
of the Collections Division of CRW Financial, Inc. The net proceeds to the
Company were approximately $39.4 million. In November 1996, the Company
completed its IPO of 2,500,000 shares of its Common Stock at a price of $13.00
per share. The net proceeds to the Company were approximately $28.8 million.
Cash provided by operating activities was $7.3 million during the nine
months ended September 30, 1997, and $2.2 million for the comparable period in
1996. The increase in cash provided by operations was primarily due to the
increase in net income to $5.1 million for the nine months ended September 30,
1997 compared to $2.7 million for the comparable period in 1996, and the
increase in non-cash charges, primarily depreciation and amortization, to $2.4
million during the nine months ended September 30, 1997 compared to $823,000 for
the comparable period in 1996. Additionally, accounts payable and accrued
expenses increased $1.0 million during the nine months ended September 30, 1997
compared to an increase of $7,000 in the comparable period in 1996. These
increases were offset by a $2.0 million increase in accounts receivable in the
nine months ended September 30, 1997 compared to a $1.5 million increase in the
comparable period in 1996.
Cash used in investing activities was $25.4 million during the nine months
ended September 30, 1997 compared to $13.4 million for the comparable period in
1996. The increase was primarily due to the 1997 Acquisitions versus the
acquisition of TCD during the first quarter of 1996 and the acquisition of MAB
during the third quarter of 1996. In February 1997, NCO purchased substantially
all of the assets of CRWCD for $3.75 million in cash, 345,178 shares of Common
Stock and warrants for 250,000 shares of Common Stock. In January 1997, the
Company purchased substantially all of the assets of CMS A/R for $5.1 million in
cash, certain assets of TRC for $1.6 million in cash and all of the outstanding
stock of Goodyear for $4.5 million in cash and a $900,000 Convertible Note. The
Note is convertible into an aggregate of 42,503 shares of Common Stock at any
time and bears interest payable monthly at a rate of 8.0% per annum with
principal due in January 2002. The Company financed the cash portion of the
purchase price for the 1997 Q1 Acquisitions with borrowings of $7.4 million
under its Credit Agreement and financed the balance with proceeds of its IPO and
existing working capital. During March 1997, the Company borrowed an additional
$1.0 million under the Credit Agreement to pay certain accounts payable assumed
as part of the CRWCD acquisition. These borrowings were repaid during the third
quarter 1997. In addition, the Company has accrued $1.1 million of acquisition
related expenses. The 1997 Q1 Acquisitions collectively resulted in goodwill of
$24.5 million.
On September 29, 1997, effective October 1, 1997, NCO purchased all of the
outstanding stock CAC for $1.8 million in cash. On September 30, 1997, effective
October 1, 1997, NCO purchased all of the outstanding stock of Advantage for
$2.9 million in cash, 30,961 shares of its Common Stock and $1,000,000 in notes
payable. The purchase price was valued at $5.0 million. The notes bear interest
payable monthly at a rate of 8.0% per annum with principal due in September
2002. Cash paid for the acquisitions of CAC and Advantage is included on the
balance sheet at September 30, 1997, under the caption "Deposits on
acquisitions."
During the nine months ended September 30, 1997, capital expenditures were
$2.6 million compared to $708,000 in comparable period in 1996. In connection
with the Company's move to new corporate headquarters the Company was able to
exchange certain furniture and equipment with a net book value of $234,000 for
credit toward the purchase of new fixed assets. Other assets were abandoned and
the loss of $41,000 has been reflected in the accompanying financial statements.
Cash provided by financing activities was $39.5 million during the nine
months ended September 30, 1997 compared to $11.5 million for the comparable
period in 1996. Bank borrowings had been the Company's primary source of cash
from financing activities and were used for acquisitions and, along with cash
provided by operations, for distributions to shareholders. The Company raised
net proceeds of approximately $39.4 million in the 1997 Offering. The Company
used a portion of the proceeds from the IPO and the 1997 Offering to repay $8.35
million of outstanding indebtedness under the Credit Agreement. In addition, the
Company received $211,000 from the exercise of employee stock options during the
third quarter of 1997. The Company raised net proceeds of approximately $28.8
million in the IPO in November 1996 of which $15.0 million was used to repay
outstanding indebtedness under the Credit Agreement and approximately $3.2
million was used to pay undistributed S Corporation earnings during the nine
months ended September 30, 1996. Total distributions to shareholders were
$852,000 for the nine months ended September 30, 1996.
14
<PAGE>
In July 1995, the Company entered into a revolving credit agreement with
Mellon Bank, N.A. which provided for borrowings up to $7.0 million at an
interest rate equal to prime plus 1.375%, which was subsequently increased to
$15.0 million in September 1996, to be utilized for working capital and
strategic acquisitions. Subsequent to the IPO, Mellon Bank, N.A. increased the
revolving credit facility to $25.0 million and decreased the rate of interest to
2.5% over LIBOR. Mellon Bank, N.A. reduced the interest rate to 1.5% over LIBOR
upon the completion of the Company's 1997 Offering. Outstanding borrowings under
the Credit Agreement at September 30, 1997 and 1996 were $0.0 and $7.0 million,
respectively. The revolving credit line is collateralized by substantially all
the assets of the Company and includes certain financial covenants such as
maintaining minimum working capital and net worth requirements and includes
restrictions on, among other things, capital expenditures and distributions to
shareholders. The outstanding borrowings on the revolving credit facility were
repaid in full with the proceeds of the IPO and the 1997 Offering.
In connection with entering into the original Credit Agreement, the Company
recorded deferred charges of approximately $135,000 relating primarily to bank
and legal fees. The Company also issued a warrant to the bank exercisable for an
aggregate of 175,351 shares of the Company's Common Stock. The warrant expires
on July 31, 2005 and is exercisable for nominal consideration. A portion of this
warrant was exercised in July 1997 for 150,000 shares sold in connection with
the Company's public offering. In connection with the increase of the line of
credit available under the Credit Agreement in September 1996 and December 1996,
the Company recorded deferred charges of $261,000 primarily relating to bank
charges and legal fees. In addition, the Company issued additional warrants to
the bank for an aggregate of 65,060 shares of Common Stock exercisable at $13.00
per share. The warrants have been capitalized on the balance sheet as a deferred
charge and are being amortized over the life of the credit facility and are
currently exercisable.
The Company believes that funds generated from operations, together with
existing cash, the net proceeds from the 1997 Offering and available borrowings
under its Credit Agreement will be sufficient to finance its current operations
and planned capital expenditure requirements and internal growth at least
through September 30, 1998. However, the Company could require additional debt
or equity financing if it were to make any significant acquisitions for cash.
15
<PAGE>
Part II. Other Information
Item 1. 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 2. Changes in Securities
n July 1997, the Company issued 150,000 shares of Common Stock upon the
exercise of a warrant issued to an affiliate of Mellon Bank in connection with
the Company's Credit Agreement and 76,923 shares of Common Stock upon the
conversion of the Company's $1.0 million Convertible Note issued pursuant to the
MAB acquisition. These shares were issued by the Company in reliance upon the
exemption from the registration requirements provided by Section 4(2)of the
Securities Act and were subsequently sold by the holders in the Company's public
offering completed on such date.
In July 1997, the Company issued 50,320 shares of Common Stock upon the
exercise of a stock options granted to certain employees of the Company. These
shares were issued to the employees in reliance upon the exemption from the
registration requirements provided by Section 4(2) of the Securities Act and/or
Rule 701 promulgated under the Securities Act. These shares were subsequently
sold by the holders in the Company's public offering completed on such date.
On September 30, 1997, effective October 1, 1997, the Company issued 30,961
shares of Common Stock in connection with the acquisition of ADVANTAGE Financial
Services, Inc. These shares were issued by the Company in reliance upon the
exemption from the registration requirements provided by Section 4(2) of the
Securities Act.
The Company completed its initial public offering of Common Stock in
November 1996 (the "IPO") pursuant to its Registration Statement on From S-1
(Registration No. 333-11745) which became effective on November 6, 1996. The
Company's Reports of Sales of Securities and Use of Proceeds Therefrom on Form
SR, as amended, filed witht the Commission on or about February 19, 1997 and May
7, 1997 are hereby incorporated by reference. In such Reports, the Company had
disclosed that all of the net offering proceeds of $28,876,372 from the IPO had
been used except that $3,000,000 of net proceeds was temporarily invested in
short-term investment grade securities. The Issuer hereby updates such Reports
to disclose that all of such remaining proceeds of $3,000,000 were used,
together with a portion of the net proceeds form the Company's July 1997
offering of Common Stock, to repay outstanding borrowings under the Company's
revolving credit facility.
Item 3. Defaults Upon Senior Securities
None - not applicable
Item 4. Submission of Matters to a Vote of Shareholders
None - not applicable
Item 5. Other Information
NCO Group, Inc. has been awarded a contract to perform collection services
for the United States Department of Education. The contract has an initial term
of four years.
16
<PAGE>
The first placement of accounts is anticipated at the beginning of the first
quarter of 1998 and the Company anticipates that the contract will begin to
produce revenue by the end of the first quarter of 1998. The contract should
have no effect on earnings for calendar year 1998 as a whole, and should be
accretive to earnings in 1999. However, the costs in the initial period of the
contract could reduce operating results by as much as $.04 per share for each of
the fourth quarter of 1997 and the first quarter of 1998. Unlike other new
business opportunities which typically allow NCO to closely match the timing of
expenses to coincide with the incoming stream of revenue, this contract requires
the Company to make an investment in additional equipment and a segregated call
center location and to have personnel in place prior to receiving the initial
placement of accounts from the Department of Education. The Company believes
that this initial investment should be more than offset by the size and extended
nature of this contract.
Certain statements in this Item 5, including, without limitation, statements as
to the effects of the Department of Education contract on the Company's
expenses, revenue or its profitability, or as to management's belief,
expectations and opinions, are forward-looking statements that involve risks and
uncertainties and are subject to change at any time. In addition to the factors
discussed above, certain other factors, including without limitation, the risks
that the implementation of the contract will be delayed, that the Company will
incur higher than anticipated costs, that the revenues from the contract will be
less than anticipated or that the Department of Education will terminate the
contract prior to the end of the term, as well as risks associated with growth,
future acquisitions, fluctuations in quarterly operating results, and other
risks detailed from time to time in the Company's filings with the Securities
and Exchange Commission, including the Annual Report on Form 10-K, filed on
March 31, 1997, as amended, can cause actual results and developments to be
materially different from those expressed or implied by such forward-looking
statements
Item 6. Exhibits and Reports on 8-K
(a) Exhibits
27.1 Financial Data Schedule
Reports on Form 8-K
17
<PAGE>
Signatures
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 13, 1997 By: /s/ Michael J. Barrist
-------------------------------
Michael J. Barrist
Chairman and Chief
Executive Officer
Date: November 13, 1997 By: /s/ Steven L. Winokur
-------------------------------
Steven L. Winokur
Executive Vice President, Finance
and Chief Financial Officer
18
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<PERIOD-START> JAN-01-1997
<PERIOD-END> SEP-30-1997
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