<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, 1998, 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 17,958,843 shares common stock, no par value, outstanding as of
October 30, 1998.
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<PAGE>
NCO GROUP, INC.
INDEX
PAGE
Part I FINANCIAL INFORMATION
Item 1 CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets -
December 31, 1997 and September 30, 1998 3
Consolidated Statements of Income -
Three months and nine months ended
September 30, 1997 and 1998 4
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1997 and 1998 5
Notes to Consolidated Financial Statements 6
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11
PART II 17
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
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<PAGE>
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Unaudited)
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
December 31, September 30,
ASSETS 1997 1998
---------------- ----------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 29,539 $ 27,571
Accounts receivable, trade, net of allowance for
doubtful accounts of $365 and $550, respectively 13,442 29,341
Other current assets 2,357 1,239
--------- --------
Total current assets 45,338 58,151
Funds held in trust for clients
Property and equipment, net 7,469 14,031
Other assets:
Intangibles, net of accumulated amortization 46,403 157,596
Deferred taxes - 9,081
Deposits on acquisitions 1,650 -
Other assets 776 4,999
--------- --------
Total other assets 48,829 171,676
--------- --------
Total assets $ 101,636 $ 243,858
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 560 $ 1,453
Capitalized lease obligations, current portion 114 243
Corporate taxes payable 286 2,564
Accounts payable 1,913 4,791
Accrued expenses 3,209 6,462
Accrued compensation and related expenses 2,844 6,468
Accrued pension and other benefits, current portion - 995
--------- --------
Total current liabilities 8,926 22,976
Funds held in trust for clients
Long-term liabilities:
Long term debt, net of current portion 1,437 25,500
Capitalized lease obligations, net of current portion 248 828
Deferred taxes 1,691 -
Accrued pension and other benefits, net of current portion - 4,683
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 17,956 shares issued and outstanding, respectively 80,249 171,777
Unexercised warrants 1,122 875
Foreign currency translation adjustment - (658)
Retained earnings 7,963 17,877
--------- ---------
Total shareholders' equity 89,334 189,871
--------- ---------
Total liabilities and shareholders' equity $ 101,636 $ 243,858
========= =========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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NCO GROUP, INC.
Consolidated Statements of Income
(Unaudited)
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
----------------------------------- -----------------------------------
1997 1998 1997 1998
----------------------------------- -----------------------------------
<S> <C> <C> <C> <C>
Revenue $ 21,739 $ 51,420 $ 60,978 $ 118,019
Operating costs and expenses:
Payroll and related expenses 10,697 26,453 30,279 60,722
Selling, general and administrative
expenses 7,086 14,855 19,777 34,709
Depreciation and amortization expense 844 2,239 2,388 4,927
-------- --------- -------- ---------
Total operating costs and expenses 18,627 43,547 52,444 100,358
-------- --------- -------- ---------
Income from operations 3,112 7,873 8,534 17,661
Other income (expense):
Interest and investment income 445 318 607 810
Interest expense (85) (573) (507) (1,283)
Loss on disposal of fixed assets (41) - (41) -
-------- --------- -------- ---------
319 (255) 59 (473)
-------- --------- -------- ---------
Income before provision for income taxes 3,431 7,618 8,593 17,188
Income tax expense 1,350 3,294 3,488 7,274
-------- --------- -------- ---------
Net income $ 2,081 $ 4,324 $ 5,105 $ 9,914
======== ========= ======== =========
Net income per share:
Basic $ 0.16 $ 0.24 $ 0.44 $ 0.65
======== ========= ======== =========
Diluted $ 0.15 $ 0.24 $ 0.43 $ 0.63
======== ========= ======== =========
Weighted average shares outstanding:
Basic 13,003 17,905 11,503 15,256
Diluted 13,632 18,356 12,103 15,769
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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NCO GROUP, INC
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
1997 1998
---------------- ----------------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 5,105 $ 9,914
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 915 1,652
Amortization of intangibles 1,473 3,275
Loss on disposal of fixed assets 41 -
Provision for doubtful accounts 121 349
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (1,974) (3,325)
Other current assets 452 1,244
Deferred taxes (34) 2,170
Other assets (27) (813)
Accounts payable (821) -
Corporate taxes payable 280 2,554
Accrued expenses 1,193 (341)
Accrued compensation and related costs 541 843
------ -------
Net cash provided by operating activities 7,265 17,522
Cash flows from investing activities:
Purchase of property and equipment (2,561) (5,226)
Net cash paid for acquisitions (22,876) (107,127)
------ -------
Net cash used in investing activities (25,437) (112,353)
Cash flows from financing activities:
Repayment of notes payable (8,386) (847)
Repayment of acquired notes payable - (21,919)
Borrowings under credit agreement 8,350 109,000
Repayment of borrowings under credit agreement - (83,500)
Payment of fees to acquire new debt - (493)
Issuance of common stock, net 39,571 91,281
------ -------
Net cash provided by financing activities 39,535 93,522
Effect of exchange rate on cash - (659)
------ -------
Net increase (decrease) in cash and cash equivalents 21,363 (1,968)
Cash and cash equivalents at beginning of period 12,059 29,539
------ -------
Cash and cash equivalents at end of period $ 33,422 $ 27,571
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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<PAGE>
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 other outsourced services. The Company's client base is comprised
of companies located throughout the United States, Canada, United Kingdom and
Puerto Rico in the financial services, healthcare, retail and commercial,
education, telecommunications, utilities and government sectors.
In June 1998, the Company completed a public offering (the "1998 Offering") of
4,329,110 shares of Common Stock at a price to the public of $21.50 per share,
including 4,000,000 shares issued by the Company, 180,000 shares sold by
management and related shareholders and 149,110 shares sold by certain
non-management shareholders. The proceeds of the offering, after underwriting
discounts and expenses, were approximately $81.1 million.
In July 1998, in connection with the underwriters' exercise of the
over-allotment option granted pursuant to the 1998 Offering, the Company issued
469,366 shares and 180,000 shares were sold by management and related
shareholders at a price to the public of $21.50 per share. The proceeds from the
underwriters' exercise of the over-allotment option, after underwriting
discounts and expenses, were approximately $9.6 million.
2. Summary of Significant Accounting Policies:
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 only
normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three month and nine month periods
ended September 30, 1998 are not necessarily indicative of the results that may
be expected for the year ending December 31, 1998 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, 1998.
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries after elimination of significant intercompany
accounts and transactions.
Revenue Recognition:
The Company generates revenues from contingency fees and contractual services.
Contingency fee revenue is recognized upon collection of funds on behalf of
clients. Contractual services revenue is deferred and recognized as services are
performed.
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<PAGE>
Income Taxes:
The Company accounts for income taxes using Statement of Financial Accounting
Standards No. 109, "Accounting for Income Taxes." This standard requires an
asset and liability approach that takes into account changes in tax rates when
valuing the deferred tax amounts to be reported on the balance sheet. If it is
more likely than not that some or all of a deferred tax asset will not be
realized, a valuation allowance is recognized.
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.
Goodwill:
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 40 years. The Company periodically reviews the
recoverability of goodwill. In making such determination with respect to
goodwill, the Company evaluates the operating cash flows of the underlying
business that gave rise to such amount.
Estimates Utilized in the Preparation of Financial Statements:
The preparation of financial statements in conformity with generally accepted
accounting principles requires management to make estimates and assumptions that
affect the reported amounts of assets and liabilities and disclosure of
contingent assets and liabilities at the date of the financial statements and
the reported amounts of revenues and expenses during the reporting period.
Actual results could differ from those estimates.
Earnings Per Share:
All earnings per share computations and presentations are in accordance with
SFAS No. 128, "Earnings per Share."
3. Acquisitions:
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 $4.9
million.
On January 30, 1997, the Company purchased substantially all the assets of
Tele-Research Center, Inc. ("Tele-Research") for $2.2 million in cash including
contingent consideration paid. The Company recognized goodwill of $1.6 million.
On January 31, 1997, the Company purchased certain assets of CMS A/R Services
("CMSA/R"), the Collection Division of CMS Energy Corporation, for $5.1 million
in cash. The Company recognized goodwill of $3.2 million.
On February 2, 1997, the Company purchased certain assets and assumed certain
liabilities of the Collections Division of CRW Financial, Inc. ("CRWCD") for
$3.8 million in cash, 518,000 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 $10.2 million.
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<PAGE>
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,
46,000 shares of common stock and $1.0 million in notes payable. The acquisition
was valued at approximately $5.0 million. The Company recognized goodwill of
$5.1 million.
On October 1, 1997, the Company purchased the outstanding stock of Credit
Acceptance Corp. ("CAC") for $1.8 million in cash. The Company recognized
goodwill of $1.8 million.
On December 31, 1997, effective January 1, 1998, the Company purchased certain
assets of the Collections Division of American Financial Enterprises, Inc.
("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 $2.1
million.
On February 6, 1998, the Company purchased certain assets of The Response Center
("TRC"), which was an independent division of TeleSpectrum Worldwide, Inc., for
$15.0 million in cash plus an earn-out based on the value of the Company's
market research business at December 31, 1998. The Company recognized goodwill
of $13.9 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
acquisition was valued at approximately $69.9 million. The allocation of the
fair market value to the acquired assets and liabilities of FCA was based on
preliminary estimates and is subject to change. The Company recognized goodwill
of $69.8 million.
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 financed the
majority of the acquisition with $25.5 million of borrowings under the Company's
revolving credit facility and with $9.5 million of the proceeds received in July
1998 from the underwriters' exercise of the over-allotment option granted
pursuant to the 1998 Offering. The allocation of the fair market value to the
acquired assets and liabilities of MedSource was based on preliminary estimates
and is subject to change. The Company recognized goodwill of $36.6 million.
The following summarizes the unaudited pro forma results of operations for the
nine months ended September 30, 1997 and 1998, assuming the FCA and MedSource
acquisitions occurred as of the beginning of the respective periods. The
following information does not give effect to the pro forma results of any other
completed or pending acquisitions. The pro forma information is provided for
informational purposes only and was prepared in accordance with Article 11 of
Regulation S-X. 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 (amounts in thousands,
except per share data):
For the nine months ended
September 30,
----------------------------
1997 1998
------------ ------------
Revenue $ 124,849 $ 148,387
Net income $ 7,439 $ 9,697
Earnings per share - basic $ 0.47 $ 0.54
Earnings per share - diluted $ 0.46 $ 0.53
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<PAGE>
On October 15, 1998, the Company signed a definitive agreement to acquire all of
the outstanding stock of Medaphis Services Corporation, a wholly owned
subsidiary of Medaphis Corporation for $107.5 million, plus an earn-out of up to
$10 million based on the acquired Medaphis Services Corporation achieving
operational targets during 1999. Medaphis Services Corporation, together with
its subsidiary AssetCare, Inc, ("MSC"), is one of the largest providers of
accounts receivable management services and business co-sourcing services to
hospitals in the United States. The completion of this acquisition is subject to
regulatory approval.
On November 2, 1998, the Company signed a definitive agreement to acquire all of
the outstanding shares of JDR Holdings, Inc. for approximately 3.7 million
shares of NCO Common Stock. The acquisition is being valued at approximately
$111.0 million. The transaction is expected to be accounted for as a pooling of
interests and a tax-free reorganization. JDR Holdings, Inc. is a leading
provider of technology-based outsourcing and accounts receivable management
services. The completion of this acquisition is subject to regulatory and
shareholder approval.
4. 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. The Company's comprehensive income is as follows
(amounts in thousands):
For the three months For the nine months
ended September 30, ended September 30,
--------------------- ---------------------
1997 1998 1997 1998
---- ---- ---- ----
Net income $2,081 $4,324 $5,105 $9,914
Foreign currency translation
adjustment - (392) - (658)
------ ------ ------ ------
Comprehensive income 2,081 3,932 5,105 9,256
====== ====== ====== ======
5. Funds Held in Trust for Clients:
In the course of the Company's regular business activities as an accounts
receivable management company, the Company receives clients' funds arising from
the collection of accounts placed with the Company. These funds are placed in
segregated cash accounts and are generally remitted to clients within 30 days.
Funds held in trust for clients of $8.1 million and $31.4 million at December
31, 1997 and September 30, 1998, respectively, have been shown net of their
offsetting liability for financial statement presentation purposes.
6. Long-Term Debt:
In March 1998, Mellon Bank, N.A. increased the revolving credit facility to
$75.0 million from $25.0 million and changed the interest rate from a fixed rate
of 2.5% over LIBOR to a variable rate ranging from LIBOR plus 0.75% to LIBOR
plus 2.0% (LIBOR was 5.42% at September 30, 1998) based on the Company's
interest coverage ratios. There were no outstanding borrowings as of December
31, 1997. As of September 30, 1998, there were $25.5 million of outstanding
borrowings against the revolving credit line. 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 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.
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<PAGE>
7. Earnings Per Share:
Basic earnings per share were computed by dividing the net income for the three
months and nine months ended September 30, 1997 and 1998 by the weighted average
number of shares outstanding. Diluted earnings per share were computed by
dividing the net income, adjusted for the effects of interest expense
attributable to convertible debt, for the three months and nine months ended
September 30, 1997 and 1998 by the weighted average number of shares outstanding
including all dilutive potential common shares. All outstanding options,
warrants and convertible securities have been utilized in calculating diluted
net income per share only when their effect would be dilutive.
The reconciliation of basic to diluted earnings per share ("EPS") consists of
the following (amounts in thousands, except per share amounts):
<TABLE>
<CAPTION>
For the three months ended Sept. 30, For the nine months ended Sept. 30,
----------------------------------------- -----------------------------------------
1997 1998 1997 1998
-------------------- -------------------- -------------------- --------------------
Shares EPS Shares EPS Shares EPS Shares EPS
--------- ---------- --------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Basic 13,003 $ 0.16 17,905 $ 0.24 11,503 $ 0.44 15,256 $ 0.65
Dilutive effect of warrants 128 - 66 - 74 - 85 -
Dilutive effect of options 437 (0.01) 321 - 386 (0.01) 364 (0.02)
Dilutive effect of
convertible notes 64 - 64 - 140 - 64 -
------- ------- ------ ------ ------ ------ ------ ------
Diluted 13,632 $ 0.15 18,356 $ 0.24 12,103 $ 0.43 15,769 $ 0.63
======= ======= ====== ====== ====== ====== ====== ======
</TABLE>
8. Supplemental Cash Flow Information:
The following are supplemental disclosures of cash flow information for the nine
months ended September 30, (amounts in thousands):
1997 1998
----------- -----------
Noncash investing and financing activities:
Fair value of assets acquired $7,987 $ 40,772
Liabilities assumed from acquisitions 3,400 39,653
Convertible note payable, issued for acquisition 900 -
Convertible note payable, exercised for
common stock 1,000 -
Common stock issued for acquisition 8,215 -
Warrants issued for acquisitions 875 -
Warrants exercised - 247
Value of fixed assets traded for new fixed assets 234 -
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<PAGE>
Item 2
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Certain statements included in this Report on Form 10-Q, other than
historical facts, are 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 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 classification of the Company's
investment portfolio, 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 Annual Report on Form 10-K, filed on March 31, 1998, as amended, and
the Company's Registration Statement on Form S-3, filed on May 4, 1998, as
amended on June 2, 1998, can cause actual results and developments to be
materially different from those expressed or implied by such forward-looking
statements.
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, 1998, as amended, and
the Company's Registration Statement on Form S-3 filed with the Securities and
Exchange Commission on May 4, 1998, as amended on June 2, 1998.
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.
Three Months Ended September 30, 1998 Compared to Three Months Ended
September 30, 1997
Revenue. Revenue increased $29.7 million or 136.5% to $51.4 million for the
three months ended September 30, 1998 from $21.7 million for the comparable
period in 1997. Of the increase, $6.5 million was attributable to the addition
of new clients and growth in business from existing clients. Revenue
attributable to the MedSource acquisition completed in July 1998 and the FCA
International Ltd. ("FCA") acquisition completed in May 1998 represented $6.1
million and $13.3 million of the increase, respectively. In addition, $2.6
million of the increase was attributable to the Collection Division of American
Financial Enterprises, Inc. ("AFECD") and The Response Center ("TRC")
acquisitions completed in the first quarter of 1998 and $1.2 million of the
increase was attributable to the ADVANTAGE Financial Services, Inc. ("AFS") and
the Credit Acceptance Corporation ("CAC") acquisitions completed in October
1997.
Payroll and related expenses. Payroll and related expenses increased $15.8
million to $26.5 million for the three months ended September 30, 1998 from
$10.7 million for the comparable period in 1997, and increased as a percentage
of revenue to 51.4% from 49.2%. 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. In addition, the start up of a contract with the United States
Department of Education (the "DOE Contract") required the Company to hire and
train a certain number of collection personnel during the start-up phase of the
contract in excess of the Company's normal hiring procedures. These higher costs
were partially offset by lower payroll costs related to the MedSource
acquisition and by spreading the cost of management and administrative personnel
over a larger revenue base.
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<PAGE>
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $7.8 million to $14.9 million for the three
months ended September 30, 1998 from $7.1 million for the comparable period in
1997, but decreased as a percentage of revenue to 28.9% from 32.6%. The decrease
as a percentage of revenue was, in part, the result of additional operating
efficiencies obtained when selling, general and administrative expenses were
spread over a larger revenue base. In addition, a portion of the decrease was
attributable to the market research division having a lower selling, general and
administrative expense structure than that of the Company's core business. These
decreases as a percentage of revenue were partially offset by the higher cost
structures of acquired companies.
Depreciation and amortization. Depreciation and amortization increased to
$2.2 million for the three months ended September 30, 1998 from $844,000 for the
comparable period in 1997. Of this increase, $412,000 was attributable to the
MedSource acquisition, $481,000 was attributable to the FCA acquisition,
$177,000 was attributable to the TRC and AFECD acquisitions and $96,000 was
attributable to the AFS and CAC acquisitions. The remaining $229,000 consisted
of depreciation resulting from normal capital expenditures incurred in the
ordinary course of business.
Other income (expense). Interest and investment income decreased $127,000
to $318,000 for the three months ended September 30, 1998 from $445,000 for the
comparable period in 1997. This decrease was primarily attributable to the funds
remaining from the Company's public offering completed in July 1997 (the "1997
Offering") being used for the acquisitions completed in the fourth quarter of
1997 and the first quarter of 1998. Interest expense increased to $573,000 for
the three months ended September 30, 1998 from $85,000 for the comparable period
in 1997. The increase was primarily attributable to the Company financing the
MedSource acquisition with borrowings of $25.5 million under the revolving
credit facility.
Income tax expense. Income tax expense increased to $3.3 million, or 43.2%
of income before taxes, for the three months ended September 30, 1998 from $1.4
million, or 39.3% of income before taxes, for the comparable period in 1997.
Income taxes were computed after giving effect to non-deductible goodwill
expenses resulting from certain of the acquired companies.
Net income. Net income increased $2.2 million or 107.8% to $4.3 million for
the three months ended September 30, 1998 from $2.1 million for the comparable
period in 1997.
Nine Months Ended September 30, 1998 Compared to Nine Months Ended
September 30, 1997
Revenue. Revenue increased $57.0 million or 93.5% to $118.0 million for the
nine months ended September 30, 1998 from $61.0 million for the comparable
period in 1997. Of the increase, $17.8 million was attributable to the addition
of new clients and growth in business from existing clients. Revenue
attributable to the MedSource acquisition completed in July 1998 and the FCA
acquisition completed in May 1998 represented $6.1 million and $21.9 million of
the increase, respectively. In addition, $6.5 million of the increase was
attributable to the AFECD and TRC acquisitions completed in the first quarter of
1998 and $4.7 million of the increase was attributable to the AFS and the CAC
acquisitions completed in October 1997.
Payroll and related expenses. Payroll and related expenses increased $30.4
million to $60.7 million for the nine months ended September 30, 1998 from $30.3
million for the comparable period in 1997, and increased as a percentage of
revenue to 51.5% from 49.7%. 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. In addition, the start up of the DOE Contract required the Company to
hire and train a certain number of collection personnel the cost of which was
only partially offset by revenues generated by the contract during its startup
phase. These higher costs were partially offset by lower payroll costs related
to the AFS, CAC and MedSource acquisitions and by spreading the cost of
management and administrative personnel over a larger revenue base.
-12-
<PAGE>
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $14.9 million to $34.7 million for the nine
months ended September 30, 1998 from $19.8 million for the comparable period in
1997, and decreased as a percentage of revenue to 29.4% from 32.4%. The decrease
as a percentage of revenue was, in part, the result of additional operating
efficiencies obtained when selling, general and administrative expenses were
spread over a larger revenue base. In addition, a portion of the decrease was
attributable to the market research division having a lower selling, general and
administrative expense structure than that of the Company's core business. These
decreases as a percentage of revenue were partially offset by the higher cost
structures of acquired companies.
Depreciation and amortization. Depreciation and amortization increased to
$4.9 million for the nine months ended September 30, 1998 from $2.4 million for
the comparable period in 1997. Of this increase, $412,000 was attributable to
the MedSource acquisition, $742,000 was attributable to the FCA acquisition,
$472,000 was attributable to the TRC and AFECD acquisitions and $272,000 was
attributable to the AFS and CAC acquisitions. The remaining $641,000 consisted
of depreciation resulting from normal capital expenditures incurred in the
ordinary course of business.
Other income (expense). Interest and investment income increased $203,000
to $810,000 for the nine months ended September 30, 1998 from $607,000 for the
comparable period in 1997. This increase was primarily attributable to the
investment of funds remaining from the 1997 Offering and the 1998 Offering, as
well as an increase in operating funds and funds held in trust for clients.
Interest expense increased to $1.3 million for the nine months ended September
30, 1998 from $507,000 for the comparable period 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 addition, the
Company financed $25.5 million of the MedSource acquisition with borrowings
under the 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
1998 Offering.
Income tax expense. Income tax expense increased to $7.3 million, or 42.3%
of income before taxes, for the nine months ended September 30, 1998 from $3.5
million, or 40.6% of income before taxes, for the comparable period in 1997.
Income taxes were computed after giving effect to non-deductible goodwill
expenses resulting from certain of the acquired companies.
Net income. Net income increased $4.8 million or 94.2% to $9.9 million for
the nine months ended September 30, 1998 from $5.1 million for the comparable
period in 1997.
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 the 1998 Offering, selling 4,000,000
shares of Common Stock and received net proceeds of approximately $81.1 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 pursuant to
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.
-13-
<PAGE>
Cash provided by operating activities was $17.5 million during the nine
months ended September 30, 1998, and $7.3 million for the comparable period in
1997. The increase in cash provided by operations was primarily due to the
increase in net income to $9.9 million for the nine months ended September 30,
1998 compared to $5.1 million for the comparable period in 1997, and the
decrease in other current assets by $1.2 million for the nine months ended
September 30, 1998 compared to $452,000 for the comparable period in 1997. In
addition, the increase in cash provided by operations was also attributable to
the decrease in deferred taxes by $2.2 million for the nine months ended
September 30, 1998 compared to an increase of $34,000 for the comparable period
in 1997, and the increase in corporate taxes payable by $2.6 million for the
nine months ended September 30, 1998 compared to $280,000 for the comparable
period in 1997. These increases were partially offset by the increase in
accounts receivable by $3.3 million for the nine months ended September 30, 1998
compared to $2.0 million for the comparable period in 1997, and the increase in
other assets by $813,000 for the nine months ended September 30, 1998 compared
to $27,000 for the comparable period in 1997.
Cash used in investing activities was $112.4 million during the nine months
ended September 30, 1998, and $25.4 million for the comparable period in 1997.
The increase was primarily due to the cash portion of the purchase price paid
for the acquisitions of AFECD, TRC, FCA and MedSource during the nine months
ended September 30, 1998 compared to the cash portion of the purchase price paid
for the acquisitions completed during the comparable period in 1997. In
addition, during the nine months ended September 30, 1998, capital expenditures
were $5.2 million compared to $2.6 million for the comparable period in 1997.
Cash provided by financing activities was $93.5 million during the nine
months ended September 30, 1998 compared to $39.5 million for the comparable
period in 1997. The Company borrowed $74.0 million against its revolving credit
facility to finance the acquisition of FCA in May 1998. The Company repaid the
borrowings under the revolving credit agreement in June 1998 with a portion of
the $81.1 million of net proceeds raised in the 1998 Offering. The Company also
borrowed $35.0 million against its revolving credit facility to finance the
acquisition of MedSource in July 1998. The Company repaid $9.5 million of the
borrowings under the revolving credit agreement in July 1998 with a portion of
the net proceeds raised in connection with the underwriters' exercise of the
over-allotment option granted pursuant to the 1998 Offering.
In March 1998, the Company's credit agreement was amended to, among other
things, increase the Company's revolving credit facility with Mellon Bank, N.A.
to provide for borrowings up to $75.0 million at an interest rate ranging from
LIBOR plus 0.75% to LIBOR plus 2.0% (LIBOR was 5.42% at September 30, 1998). The
Company has the right to permanently reduce the revolving credit facility by up
to $25 million. Outstanding borrowings under the revolving credit line at
September 30, 1998 was $25.5 million. There were no outstanding borrowings as of
December 31, 1997. The revolving credit line is collateralized by substantially
all the assets of the Company and includes certain financial covenants such as
maintaining minimum working capital and net worth requirements and includes
restrictions on, among other things, capital expenditures and distributions to
shareholders.
On October 15, 1998, the Company signed a definitive agreement to acquire
Medaphis Services Corporation, a wholly owned subsidiary of Medaphis Corporation
for $107.5 million, plus an earn-out of up to $10 million based on the acquired
Medaphis Services Corporation achieving operational targets during 1999. The
Company expects to finance the acquisition with borrowings under the Company's
revolving credit facility.
On November 2, 1998, the Company signed a definitive agreement to acquire
all of the outstanding shares of JDR Holdings, Inc. for approximately 3.7
million shares of NCO Common Stock. The acquisition is being valued at
approximately $111.0 million. The transaction is expected to be accounted for as
a pooling of interests and a tax-free reorganization.
-14-
<PAGE>
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 and planned capital expenditure
requirements and internal growth at least through the next twelve months.
However, the Company could require additional debt or equity financing if it
were to make any other significant acquisitions for cash.
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 Management expects to complete this portion of the program by the end of the
first quarter of 1999. The Company will continue to coordinate the year 2000
compliance effort throughout the balance of 1998 and into 1999 to synchronize
data exchange formats with clients.
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 first quarter of 1999.
For the years 1998 and 1999, the Company expects to incur total pre-tax
expenses of approximately $200,000 to $250,000, per year. These costs are
associated with both internal and external staffing resources for the necessary
planning, coordination, remediation, testing and other expenses to prepare its
systems for the year 2000. However, a portion of these expenses will not be
incremental, but rather represent a redeployment of existing information
technology resources. 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 acquisitons. 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
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.
In June 1997, the Financial Accounting Standards Board issued SFAS No. 131,
"Disclosures about Segments of an Enterprise and Related Information." SFAS No.
131 establishes standards for reporting financial information about operating
segments in annual financial statements and requires reporting of selected
information about operating segments in interim financial reports issued to
shareholders. It also establishes standards for related disclosures about
products and services, geographic areas, and major customer. The Company is
required to disclose this information for the first time when it publishes its
1998 annual report. Management is in the process of evaluating the segment
disclosures for purposes of reporting under SFAS No. 131. Management has not
determined what impact the adoption of SFAS. No. 131 will have on the
consolidated results of operations, financial condition or cash flows of the
Company.
-15-
<PAGE>
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.
-16-
<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
---------------------
None - not applicable
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
-----------------
Pursuant to recent amendments to the proxy rules under the Securities
Exchange Act of 1934, as amended, the Company's shareholders are notified that
the deadline for providing the Company timely notice of any shareholder proposal
to be submitted for consideration at the Company's 1999 Annual Meeting of
Shareholders (the "Annual Meeting") will be January 29, 1999. As to all such
matters which the Company does not have notice on or prior to January 29, 1999,
the proxy solicited on behalf of the Board of Directors in connection with the
matters to be considered at such Annual Meeting will confer discretionary voting
authority on the persons designated in such proxy.
Shareholder proposals for the 1999 Annual Meeting of Shareholders must be
submitted to the Company by January 29, 1999 to receive consideration for
inclusion in the Company's Proxy Statement relating to the 1999 Annual Meeting
of Shareholders.
Item 6. Exhibits and Reports on 8-K
---------------------------
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
None - not applicable
-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 16, 1998 By: /s/ Michael J. Barrist
----------------------
Michael J. Barrist
Chairman of the Board, President
and Chief Executive Officer
(principal executive officer)
Date: November 16, 1998 By: /s/ Steven L. Winokur
---------------------
Steven L. Winokur
Executive Vice President, Finance,
Chief Financial Officer and
Treasurer
-18-
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<PERIOD-START> JAN-01-1998
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