<PAGE>
- -------------------------------------------------------------------------------
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
----------------------------------
FORM 8-K/A
CURRENT REPORT
Pursuant to Section 13 or 15(d) of the
Securities Exchange Act of 1934
-----------------------------------
Date of Report (Date of earliest event reported): March 31, 1999
NCO GROUP, INC.
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(Exact name of Registrant as specified in its charter)
Pennsylvania 0-21639 23-2858652
- ----------------------------- ----------------- ----------------------
(State or other jurisdiction (Commission File (I.R.S. Employer
of incorporation or Number) Identification Number)
organization)
515 Pennsylvania Avenue
Fort Washington, Pennsylvania 19034
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(Address of principal executive offices, including zip code)
Registrant's telephone number, including area code: (215) 793-9300
<PAGE>
Item 5. Other Events
------------
On April 15, 1999, NCO Group, Inc. ("NCO") filed a Current Report on
Form 8-K with the SEC to report the acquisition of JDR Holdings, Inc. ("JDR").
The acquisition of JDR was accounted for using the pooling-of-interests method
of accounting. NCO is amending such Current Report on Form 8-K to provide NCO's
restated historical financial information to include the historical financial
information of JDR.
Item 7. Financial Statements and Exhibits.
----------------------------------
The following exhibits are being filed as part of this report:
(a) Financial Statements of Businesses Acquired.
Financial Statements of JDR:
Previously filed with Current Report on Form 8-K/A filed on
May 28, 1999.
Restated Financial Statements of NCO and Subsidiaries:
<TABLE>
<S> <C>
Management's Discussion and Analysis of Financial Condition
and Results of Operations............................................. F-1
Report of Independent Accountants........................................ F-11
Consolidated Balance Sheets as of December 31, 1997 and 1998............. F-12
Consolidated Statements of Income for each of the three years
in the period ended December 31, 1998................................. F-13
Consolidated Statements of Redeemable Preferred Stock and
Shareholders' Equity for each of the three years in the period
ended December 31, 1998................................................ F-14
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 1998................................. F-15
Notes to the Consolidated Financial Statements........................... F-16
</TABLE>
(b) Pro Forma Financial Information.
Pro forma financial information giving effect to the
acquisition of JDR is contained in the restated financial
statements of NCO contained in Item 7(a) above.
<PAGE>
SIGNATURES
Pursuant to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned hereunto duly authorized.
NCO GROUP, INC.
By: /s/ Steven L. Winokur
-------------------------------------
Steven L. Winokur
Executive Vice President, Finance,
Chief Executive Officer and Treasurer
Date: June 11, 1999
<PAGE>
Management's Discussion and Analysis of
Financial Condition and Results of Operations.
Results of Operations
The following table sets forth the historical income statement data as
a percentage of revenue:
<TABLE>
<CAPTION>
Years Ended December 31,
----------------------------------------------------------
1994 1995 1996 1997 1998
------ ------ ------ ------ ------
<S> <C> <C> <C> <C> <C>
Revenue 100.0% 100.0% 100.0% 100.0% 100.0%
Operating costs and expenses:
Payroll and related expenses 53.1 53.4 47.6 52.7 51.9
Selling, general and administrative
expenses 31.2 31.7 32.6 33.7 28.9
Depreciation and amortization expense 2.5 2.7 4.1 4.2 4.3
----- ----- ----- ----- -----
Total operating costs and expenses 86.8 87.8 84.3 90.6 85.1
----- ----- ----- ----- -----
Income from operations 13.2 12.2 15.7 9.4 14.9
Other income (expense) (0.5) (1.4) (1.9) (0.7) (1.2)
----- ----- ----- ----- -----
Income before provision for income taxes 12.7 10.8 13.8 8.7 13.7
Income tax expense(1) 5.1 4.3 5.5 4.4 5.7
----- ----- ----- ----- -----
Net income 7.6% 6.5% 8.3% 4.3% 8.0%
===== ===== ===== ===== =====
</TABLE>
(1) The Company was taxed as an S Corporation prior to September 3, 1996.
Accordingly, income tax expense and net income have been provided on a pro
forma basis as if the Company had been subject to income taxes in all
periods presented.
Year ended December 31, 1998 Compared to Year ended December 31, 1997
Revenue. Revenue increased $121.9 million or 112.8% to $230.0 million for
1998 from $108.1 million in 1997. Of this increase in revenue, $28.2 million was
attributable to a full year of revenue from JDR Holdings, Inc. ("JDR"), which
completed a recapitalization that resulted in a new basis of accounting on May
29, 1997, compared to revenue in 1997 for the period from May 29, 1997 to
December 31, 1997. In addition, $8.5 million was attributable to the acquisition
of Medaphis Services Corporation ("MSC") completed in November 1998, $12.3
million was attributable to the acquisition of MedSource, Inc. ("MedSource")
completed in July 1998, $35.3 million was attributable to the acquisition of FCA
International Ltd. ("FCA") completed in May 1998, $8.9 million was attributable
to the acquisitions of American Financial Enterprises, Inc. Collections Division
("AFECD") and The Response Center ("TRC") completed in the first quarter of
1998, and $4.3 million was attributable to the acquisitions of ADVANTAGE
Financial Services, Inc. ("AFS") and Credit Acceptance Corp. ("CAC") completed
in the fourth quarter of 1997. The addition of new clients and growth in
business from existing clients represented $24.4 million of the increase in
revenue.
F-1
<PAGE>
Payroll and related expenses. Payroll and related expenses increased $62.4
million to $119.3 million for 1998 from $56.9 million in 1997, and decreased as
a percentage of revenue to 51.9% from 52.7%. Payroll and related expenses
decreased as a percentage of revenue primarily as a result of JDR's increased
productivity and greater efficiencies achieved as a result of JDR's acquisitions
and the absorption of management and administrative costs over a larger revenue
base. In addition, a portion of this decrease was the result of lower payroll
costs related to MedSource and by spreading the cost of management and
administrative personnel over a larger revenue base. The decrease was partially
offset by higher payroll costs related to FCA and the market research division.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $30.2 million to $66.6 million for 1998 from
$36.4 million in 1997. Selling, general and administrative expenses decreased as
a percentage of revenue to 28.9% from 33.7%. This decrease resulted from the
Company realizing operating efficiencies and by spreading selling, general and
administrative expenses over a larger revenue base. In addition, a portion of
this decrease can be attributed to the increase in the size of the Marketing
Strategy Division since it has a lower selling, general and administrative cost
structure than the remainder of the Company.
Depreciation and amortization. Depreciation and amortization increased to
$9.9 million for 1998 from $4.6 million in 1997. Of this increase, $999,000 was
attributable to the acquisitions completed by JDR in May 1997, $335,000 was
attributable to the MSC acquisition, $849,000 was attributable to the MedSource
acquisition, $1.3 million was attributable to the FCA acquisition, $653,000 was
attributable to the acquisitions of AFECD and TRC completed in the first quarter
of 1998, and $367,000 was attributable to the acquisitions of AFS and CAC
completed in the fourth quarter of 1997. The remaining $797,000 consisted of
depreciation resulting from normal capital expenditures incurred in the ordinary
course of business.
Other income (expense). Interest and investment income increased $110,000
to $1.1 million for 1998 from the comparable period in 1997. This increase was
primarily attributable to an increase in operating funds and funds held in trust
for clients. Interest expense increased to $3.9 million for 1998 from $1.8
million in 1997. The increase was partially attributable to the Company
financing the May 1998 acquisition of FCA with $74.0 million of borrowings under
its revolving credit facility. In June 1998, the $74.0 million from the
revolving credit facility was repaid with a portion of the proceeds from the
Company's public offering completed in June 1998 (the "1998 Offering"). In
addition, the Company financed $25.5 million of the MedSource acquisition with
borrowings under the revolving credit facility. The Company also financed the
November 1998 acquisition of Medaphis Services Corporation with $107.5 million
of borrowings under its revolving credit facility.
F-2
<PAGE>
Income tax expense. Income tax expense for 1998 increased to $13.1 million,
or 42% of income before taxes, from $4.8 million, or 51% of income before taxes,
for 1997. Income taxes were computed after giving effect to non-deductible
goodwill expenses resulting from certain of the acquired companies. The decrease
in the effective tax rate resulted from JDR having a loss in 1997 for federal
income tax purposes for which no tax benefit was realized during 1997. This
decrease was partially offset by the full-year impact of the non-deductible
goodwill related to certain acquisitions completed during 1997 and the impact of
the non-deductible goodwill related to certain acquisitions completed during
1998.
Net income. Net income in 1998 increased to $18.3 million from net income
of $4.6 million in 1997, a 299.6% increase.
Year ended December 31, 1997 Compared to Year ended December 31, 1996
Revenue. Revenue increased $77.3 million or 251.3% to $108.1 million for
1997 from $30.8 million in 1996. Of this increase in revenue, $22.8 million was
attributable to JDR, which completed a recapitalization that resulted in a new
basis of accounting on May 29, 1997, for the period from May 29, 1997 to
December 31, 1997. In addition, $8.7 million was attributable to the acquisition
of Management Adjustment Bureau, Inc. ("MAB") completed in September 1996, and
$37.1 million was attributable to the acquisitions of Goodyear & Associates,
Inc. ("Goodyear"), Tele-Research Center, Inc. ("Tele-Research"), CMS A/R
Services ("CMS A/R"), Collections Division of CRW Financial, Inc. ("CRWCD"),
AFS, and CAC completed during 1997 (collectively the "1997 Acquisitions"). The
addition of new clients and growth in business from existing clients represented
$8.7 million of the increase in revenue.
Payroll and related expenses. Payroll and related expenses increased $42.2
million to $56.9 million for 1997 from $14.7 million in 1996, and increased as a
percentage of revenue to 52.7% from 47.6%. Payroll and related expenses
increased as a percentage of revenue primarily as a result of JDR and the
businesses acquired in the MAB acquisition and the acquisitions which closed in
the first quarter of 1997 having higher cost structures than that of the
Company. This increase was partially offset by spreading the cost of management
and administrative personnel over a larger revenue base. In addition, in the
fourth quarter of 1997 there was $339,000 of additional payroll expense
attributable to the start up of a contract with the United States Department of
Education (the "DOE Contract") which required the Company to hire and train a
certain number of collection personnel prior to realizing any revenue under the
contract.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $26.4 million to $36.4 million for 1997 from
$10.0 million in 1996. Selling, general and administrative expenses increased as
a percentage of revenue to 33.7% from 32.6% due to start up costs attributable
to the DOE Contract of $274,000. Also, JDR and the businesses acquired in the
1997 Acquisitions had a higher cost structure than that of the Company and the
Company has continued to experience increased costs as a result of changes in
business mix which require the increased use of national databases and credit
reporting services. The increases were offset by realizing operating
efficiencies and by spreading selling, general and administrative expenses over
a larger revenue base.
F-3
<PAGE>
Depreciation and amortization. Depreciation and amortization increased to
$4.6 million for 1997 from $1.3 million in 1996. Of this increase, $1.2 million
was a result of the acquisitions completed by JDR in May 1997 and $1.8 million
was a result of the MAB acquisition and the 1997 Acquisitions. The remaining
$260,000 consisted of amortization of deferred financing charges and
depreciation resulting from capital expenditures incurred in the normal course
of business.
Other income (expense). Interest and investment income increased $783,000
to $1.0 million for 1997 from the comparable period in 1996. This increase was
primarily attributable to the investment of funds remaining from the Company's
public offering completed in July 1997 (the "1997 Offering"), as well as an
increase in operating funds and funds held in trust for clients. Interest
expense increased to $1.8 million for 1997 from $818,000 in 1996. This increase
was primarily attributable to the debt acquired as a result of the JDR merger.
In addition, although the Company's revolving credit facility had been repaid
with a portion of the net proceeds from the Company's initial public offering
completed in November 1996 (the "IPO"), the Company borrowed $8.4 million on its
revolving credit facility to partially finance the 1997 Acquisitions which
closed in the first quarter of 1997, and issued a $900,000 convertible note
payable in connection with the Goodyear acquisition in January 1997. The
revolving credit facility was repaid with a portion of the proceeds from the
1997 Offering. In addition, the $1.0 million convertible note payable issued in
connection with the MAB acquisition in September 1996 was converted to common
stock in connection with the 1997 Offering. As a result of the disposal of
certain fixed assets in the move of the Company's corporate headquarters in July
1997, the Company incurred a loss on the disposal of fixed assets in the amount
of $41,000.
Income tax expense. Income tax expense for 1997 was $4.8 million or 51% of
income before taxes and was computed after giving effect to non-deductible
goodwill expenses resulting from certain of the acquired companies. In 1996, the
Company was an S Corporation until September 3, 1996 and, accordingly, there was
no income tax expense until that time. The income tax expense of $1.7 million
for 1996 (assuming the Company was taxed as a C Corporation for the entire year)
was computed utilizing an assumed rate of 40% after giving effect to
non-deductible goodwill. The increase in the effective tax rate resulted from
JDR having a loss in 1997 for federal income tax purposes for which no tax
benefit was realized during 1997.
Net income. Net income in 1997 increased to $4.6 million from pro forma net
income of $2.5 million in 1996 (assuming the Company was taxed as a C
Corporation for the entire year), a 80.7% increase.
F-4
<PAGE>
Quarterly Results (Unaudited)
The following table sets forth selected historical financial data for the
calendar quarters of 1997 and 1998. This quarterly information is unaudited but
has been prepared on a basis consistent with the Company's audited financial
statements incorporated by reference herein and, in Management's opinion,
includes all adjustments (consisting only of normal recurring adjustments)
necessary for a fair presentation of the information for the quarters presented.
The operating results for any quarter are not necessarily indicative of results
for any future period.
<TABLE>
<CAPTION>
Quarters Ended
---------------------------------------------------------------------------------------------------
1997 1998
------------------------------------------------- -------------------------------------------------
Mar. June Sept. Dec. Mar. June Sept. Dec.
31 30 30 31 31 30 30 31
------------ ----------- ------------ ----------- ------------ ----------- ----------- -----------
(Dollars in thousands)
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Revenue $18,077 $24,120 $30,865 $35,011 $40,606 $51,935 $63,585 $73,826
Income from operations 2,383 1,133 3,238 3,434 5,987 8,518 8,920 10,774
Net income 1,307 (679) 1,864 2,099 3,720 4,651 4,380 5,594
As a percentage of revenue:
Income from operations 13.2% 4.7% 10.5% 9.8% 14.7% 16.4% 14.0% 14.6%
Net income 7.2% (2.81)% 6.0% 6.0% 9.2% 8.9% 6.9% 7.6%
</TABLE>
The Company has experienced and expects to continue to experience quarterly
variations in operating results as a result of many factors, including the costs
and timing of completion and integration of acquisitions, the timing of clients'
accounts receivable management programs, the commencement of new contracts, the
termination of existing contracts, costs to support growth by acquisition or
otherwise, and integration of acquisitions, the effect of the change of business
mix on margins and the timing of additional selling, general and administrative
expenses to support new business. Additionally, the Company's planned operating
expenditures are based on revenue forecasts, and if revenues are below
expectations in any given quarter, operating results would likely be materially
adversely affected. While the effects of seasonality on the Company's business
historically have been obscured by its rapid growth, the Company's business
tends to be slower in the third and fourth quarters of the year due to the
summer and holiday seasons.
Liquidity and Capital Resources
In July 1997, the Company completed a public offering (the "1997
Offering"), selling 2,166,000 shares of common stock and received net proceeds
of approximately $40.4 million.
In June 1998, the Company completed a public offering (the "1998
Offering"), selling 4,000,000 shares of common stock and received net proceeds
of approximately $81.7 million.
In July 1998, the Company sold 469,366 shares of common stock in connection
with the underwriters' exercise of the over-allotment option granted in
accordance with the 1998 Offering. The Company received net proceeds of
approximately $9.6 million.
F-5
<PAGE>
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.
Cash provided by operating activities was $23.4 million in 1998 and $5.4
million in 1997. The increase in cash provided by operations was primarily due
to the increase in net income to $18.3 million in 1998 compared to $4.6 million
in 1997, and the increase in non-cash charges, primarily depreciation and
amortization, to $9.9 million in 1998 compared to $4.6 million in 1997. In
addition, the increase was also attributable to a $2.8 million decrease in other
current assets in 1998 compared to a $1.7 million increase in 1997. These
increases were partially offset by a $10.7 million increase in accounts
receivable in 1998 compared to a $4.6 million increase in 1997.
Cash provided by operating activities was $5.4 million in 1997 and $2.8
million in 1996. The increase in cash provided by operations was primarily due
to the increase in net income to $4.6 million in 1997 compared to $3.6 million
in 1996, and the increase in non-cash charges, primarily depreciation and
amortization, to $4.6 million in 1997 compared to $1.3 million in 1996. These
increases were offset by a $4.6 million increase in accounts receivable in 1997
compared to a $1.8 million increase in 1996. Approximately $1.0 million of
accounts payable and accrued expenses in acquired companies were reduced in
order to bring the balances in line with NCO's payment policies.
Cash used in investing activities was $233.1 million in 1998 compared to
$30.2 million for 1997. The increase was primarily due to the acquisitions of
FCA International Ltd., MedSource, Inc., and Medaphis Services Corporation. The
Company financed these acquisitions with the proceeds of the 1998 Offering and
borrowings under the Company's revolving credit agreement.
Cash used in investing activities was $30.2 million in 1997 compared to
$13.3 million for 1996. The increase was primarily due to the 1997 Acquisitions
compared with the acquisitions of TCD and MAB in 1996. The Company financed the
1997 Acquisitions with the proceeds of the 1997 Offering and the IPO, borrowings
under the Company's revolving credit agreement, seller financing and working
capital.
In addition to equipment financed under operating leases, capital
expenditures were $10.3 million, $4.8 million, and $976,000 in 1998, 1997 and
1996, respectively.
Cash provided by financing activities was $203.0 million in 1998 compared
to $43.2 million in 1997. Net proceeds of $91.3 million from the 1998 Offering
and net borrowings of $135.6 million were the Company's primary sources of cash
from financing activities which were used for acquisitions.
F-6
<PAGE>
Cash provided by financing activities was $43.2 million in 1997 compared to
$21.8 million in 1996. Net proceeds of $40.4 million from the 1997 Offering was
the Company's primary source of cash from financing activities which was used
for acquisitions and to repay outstanding indebtedness.
In November 1998, the Company's credit agreement with Mellon Bank, N.A.,
for itself and as administrative agent for other participating lenders, was
amended, among other things, to increase the Company's revolving credit facility
to provide for borrowings up to $200.0 million consisting of a term loan of
$125.0 million and a revolving credit facility of up to $75.0 million.
Borrowings bear interest at a rate equal to, at the option of the Company ,
Mellon Bank's prime rate (7.75% at March 29, 1999) or LIBOR plus a margin from
1.25% to 2.25% depending on the Company's consolidated funded debt to EBITDA
ratio (LIBOR was 4.90% at March 29, 1999). Borrowings are collateralized by
substantially all the assets of the Company and are payable upon the expiration
of the five year term, except that certain quarterly payments on the term loan
are payable beginning on September 30, 1999. The credit agreement contains
certain financial covenants such as maintaining minimum working capital and net
worth requirements and includes restrictions on, among other things,
acquisitions, capital expenditures and distributions to shareholders.
The Company believes that funds generated from operations, together with
existing cash and available borrowings under its current credit agreement will
be sufficient to finance its current operations, planned capital expenditure
requirements and internal growth at least through the next twelve months. In
addition, the Company believes that funds generated from operations will be
sufficient to fund the future scheduled repayment of the existing borrowings
under the Company's credit facility. However, the Company could require
additional debt or equity financing if it were to make any other significant
acquisitions for cash.
Market Risk
The Company is exposed to various types of market risk in the normal course
of business, including the impact of interest rate changes, foreign currency
exchange rate fluctuations and changes in corporate tax rates. The Company
employs risk management strategies that may include the use of derivatives such
as interest rate swap agreements, interest rate ceilings and floors, and foreign
currency forwards and options to manage these exposures. The Company does not
hold derivatives for trading purposes.
Goodwill
The Company's balance sheet includes amounts designated as "goodwill."
Goodwill represents the excess of purchase price over the fair market value of
the net assets of the acquired businesses based on their respective fair values
at the date of acquisition. GAAP requires that this and all other intangible
assets be amortized over the period benefited. Management has determined that
period to range from 15 to 40 years based on the attributes of each acquisition.
F-7
<PAGE>
As of December 31, 1998, the Company's balance sheet included goodwill that
represented approximately 70.5% of total assets and 146.7% of shareholders'
equity.
If management has incorrectly overstated the permissible length of the
amortization period for goodwill, earnings reported in periods immediately
following the acquisition would be overstated. In later years, NCO would be
burdened by a continuing charge against earnings without the associated benefit
to income valued by management in arriving at the consideration paid for the
business. Earnings in later years also could be significantly affected if
management determined then that the remaining balance of goodwill was impaired.
Management concluded that the anticipated future cash flows associated with
intangible assets recognized in the acquisitions will continue indefinitely, and
there is no persuasive evidence that any material portion will dissipate over a
period shorter than the respective amortization period.
Year 2000 System Modifications
NCO has implemented a program to evaluate and address the impact of the
year 2000 on its information technology systems in order to insure that its
network and software will manage and manipulate data involving the transition of
dates from 1999 to 2000 without functional or data abnormality and without
inaccurate results related to such data. This program includes steps to: (a)
identify software that require date code remediation; (b) establish timelines
for availability of corrective software releases; (c) implement the fix to a
test environment and test the remediated product; (d) integrate the updated
software to NCO's production environment; (e) communicate and work with clients
to implement year 2000 compliant data exchange formats; and (f) provide
management with assurance of a seamless transition to the year 2000. The
identification phase has been completed and the final software updates have been
received. The testing and acceptance procedures are currently being finalized
and the Company expects to complete this portion of the program by the end of
the second quarter of 1999. The Company will continue to coordinate the year
2000 compliance effort throughout the balance of 1999 to synchronize data
exchange formats with clients.
NCO has also implemented a program to evaluate and address the impact of
year 2000 on its non-information technology systems, which include the Company's
telecommunications systems, business machines, and building and premises
systems. This program includes steps to: (a) review existing systems to identify
potential issues; (b) review these issues with major external suppliers; and (c)
develop a contingency plan. The Company is currently in the process of
identifying the issues and reviewing them with its external suppliers. The
Company expects to complete the development of a contingency plan by the end of
the second quarter of 1999.
F-8
<PAGE>
As of December 31, 1998, the Company has incurred total pre-tax expenses of
approximately $224,000 in connection with the year 2000 compliance program. This
amount does not include expenses incurred by companies prior to their
acquisition by the Company. For the years 1999 and 2000, the Company expects to
incur total pre-tax expenses of approximately $1,210,000 and $180,000, per year,
respectively. These costs are associated with both internal and external
staffing resources for the necessary planning, coordination, remediation,
testing and other expenses to prepare its systems for the year 2000. However, a
portion of these expenses will not be incremental, but rather represent a
redeployment of existing information technology resources. The Company's
software has been provided by third-party vendors and the third-party vendors
are incorporating the necessary modifications as part of their normal system
maintenance. The majority of the costs will be incurred through the modification
and testing of electronic data interchange formats with the Company's clients
and the testing of modifications performed by its third-party vendors. The cost
of planning and initial remediation incurred to date has not been significant.
The Company does not expect the impact of the year 2000 to have a material
adverse impact on the Company's business or results of operations. As part of
its due diligence process, the Company reviewed the impact of year 2000 on all
completed and pending acquisitions. No assurance can be given, however, that
unanticipated or undiscovered year 2000 compliance problems will not have a
material adverse effect on the Company's business or results of operations. In
addition, if the Company's clients or significant suppliers and contractors do
not successfully achieve year 2000 compliance, the Company's business and
results of operations could be adversely affected, resulting from, among other
things, the Company's inability to properly exchange and/or receive data with
its clients.
Recent Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for the fiscal years beginning after June 15, 1999. SFAS No. 133
requires that an entity recognize all derivative instruments as either assets or
liabilities on its balance sheet at their fair value. Changes in the fair value
of derivatives are recorded each period in current earnings or other
comprehensive income, depending on whether a derivative is designated as part of
a hedge transaction, and, if it is, the type of hedge transaction. The Company
will adopt SFAS No. 133 by the first quarter of 2000. Due to the Company's
limited use of derivative instruments, SFAS No. 133 is not expected to have a
material impact on the consolidated results of operations, financial condition
or cash flows of the Company.
F-9
<PAGE>
Forward Looking Statements
Certain statements included in this Management's Discussion and Analysis of
Financial Condition and Results of Operations, other than historical facts, are
forward-looking statements (as such term is defined in the Securities Exchange
Act of 1934, and the regulations thereunder) which are intended to be covered by
the safe harbors created thereby. Forward-looking statements include, without
limitation, statements as to the Company's objective to grow through strategic
acquisitions and internal growth, the impact of acquisitions on the Company's
earnings, the Company's ability to realize operating efficiencies in the
integration of its acquisitions, trends in the Company's future operating
performance, Year 2000 Compliance, the effects of legal or governmental
proceedings, the effects of changes in accounting pronouncements and statements
as to the Company's or management's beliefs, expectations and opinions.
Forward-looking statements are subject to risks and uncertainties and may be
affected by various factors which may cause actual results to differ materially
from those in the forward-looking statements. In addition to the factors
discussed in this report, certain risks, uncertainties and other factors,
including, without limitation the risk that the Company will not be able to
realize operating efficiencies in the integration of its acquisitions, risks
associated with growth and future acquisitions, fluctuations in quarterly
operating results, risks relating to Year 2000 compliance and the other risks
detailed from time to time in the Company's filings with the Securities and
Exchange Commission, including the Annual Report on Form 10-K, filed on March
31, 1999, and the Company's Joint Proxt/Registration Statement on Form S-4,
filed on February 26, 1999, as amended, can cause actual results and
developments to be materially different from those expressed or implied by such
forward-looking statements.
F-10
<PAGE>
Report of Independent Accountants
---------------------------------
To the Board of Directors
and the Shareholders of NCO Group, Inc.,
We have audited the accompanying balance sheet of NCO Group, Inc. and its
subsidiaries (the "Company") at December 31, 1998 and 1997 and the related
consolidated statements of income, redeemable preferred stock and shareholders'
equity, and cash flows for each of the three years in the period ended December
31, 1998. These financial statements are the responsibility of the Company's
management. Our responsibility is to express an opinion on these financial
statements based on our audit.
We conducted our audit in accordance with generally accepted auditing standards.
Those standards require that we plan and perform the audit to obtain reasonable
assurance about whether the financial statements are free of material
misstatement. An audit includes examining, on a test basis, evidence supporting
the amounts and disclosures in the financial statements. An audit also includes
assessing the accounting principles used and significant estimates made by
management, as well as evaluating the overall financial statement presentation.
We believe that our audit provides a reasonable basis for our opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the financial position of NCO Group, Inc. and its
subsidiaries as of December 31, 1998 and 1997, and the results of its operations
and its cash flows for each of the three years in the period ended December 31,
1998 in conformity with generally accepted accounting principles.
We previously audited and reported on the consolidated balance sheets at
December 31, 1998 and 1997 and the related consolidated statements of income,
shareholders' equity, and cash flows of NCO Group, Inc. and its subsidiaries for
each of the three years in the period ended December 31, 1998 prior to their
restatement for the 1999 pooling of interests with JDR Holdings, Inc. The
contribution of NCO Group, Inc. and subsidiaries to revenues and net income
represented seventy-eight percent and eighty-eight percent and seventy-nine
percent and one hundred percent of the respective restated totals for the years
ended December 31, 1998 and 1997. Separate financial statements of JDR Holdings,
Inc. included in the consolidated balance sheets at December 31, 1998 and 1997
and the related consolidated statements of income, redeemable preferred stock
and shareholders' equity, and cash flows for the year ended December 31, 1998
and the period May 29, 1997 to December 31, 1997 were audited and reported on
separately by other auditors. We also audited the combination of the
accompanying consolidated statements of income and cash flows for each of the
two years in the period ended December 31, 1998, after restatement for the 1999
pooling of interests; in our opinion, such consolidated statements have been
properly combined on the basis described in Note 3 of notes to consolidated
financial statements.
PricewaterhouseCoopers LLP
Philadelphia, Pennsylvania
February 18, 1999, except as to the information presented in Note 3 related to
the pooling of interests with JDR Holdings, Inc., for which the date is March
31, 1999
F-11
<PAGE>
NCO GROUP, INC.
Consolidated Balance Sheets
(Amounts in thousands)
<TABLE>
<CAPTION>
December 31,
----------------------------------
ASSETS 1997 1998
------------ -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 30,379 $ 23,560
Accounts receivable, trade, net of allowance for
doubtful accounts of $718 and $3,998, respectively 18,094 56,040
Deferred taxes - 1,348
Other current assets 2,795 2,930
---------- ---------
Total current assets 51,268 83,878
Funds held in trust for clients
Property and equipment, net 11,951 27,062
Other assets:
Intangibles, net of accumulated amortization 65,698 297,347
Deposits on acquisitions 1,650 -
Other assets 925 6,522
---------- ---------
Total other assets 68,273 303,869
---------- ---------
Total assets $ 131,492 $ 414,809
========== =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 1,477 $ 8,288
Corporate taxes payable 320 7,737
Accounts payable 3,972 8,485
Accrued expenses 3,703 13,346
Accrued compensation and related expenses 3,573 10,507
---------- ---------
Total current liabilities 13,045 48,363
Funds held in trust for clients
Long-term liabilities:
Long term debt, net of current portion 15,211 143,910
Deferred taxes 2,378 6,832
Other long-term liabilities - 4,357
Redeemable peferred stock 6,522 11,882
Commitments and contingencies
Shareholders' equity:
Preferred stock 1,746 1,853
Common stock, no par value, 37,500 shares authorized,
15,297 and 20,100 shares issued, respectively, and
15,277 and 19,744 shares outstanding, respectively 83,264 177,835
Unexercised warrants 5,697 5,450
Foreign currency translation adjustment - (2,169)
Retained earnings 3,863 20,604
Treasury stock, at cost (234) (4,108)
---------- ---------
Total shareholders' equity 94,336 199,465
---------- ---------
Total liabilities and shareholders' equity $ 131,492 $ 414,809
========== =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-12
<PAGE>
NCO GROUP, INC.
Consolidated Statements of Income
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------------------------------
1996 1997 1998
----------------- ---------------- ----------------
<S> <C> <C> <C>
Revenue $ 30,760 $ 108,073 $ 229,952
Operating costs and expenses:
Payroll and related expenses 14,651 56,949 119,314
Selling, general and administrative
expenses 10,032 36,372 66,588
Depreciation and amortization expense 1,254 4,564 9,851
------------- ------------ ------------
Total operating costs and expenses 25,937 97,885 195,753
------------- ------------ ------------
Income from operations 4,823 10,188 34,199
Other income (expense):
Interest and investment income 242 1,025 1,135
Interest expense (818) (1,781) (3,858)
Loss on disposal of fixed assets - (41) -
------------- ------------ ------------
Total other income (expense) (576) (797) (2,723)
------------- ------------ ------------
Income before provision for income taxes 4,247 9,391 31,476
Income tax expense 613 4,800 13,131
------------- ------------ ------------
Net income 3,634 4,591 18,345
Accretion of preferred stock to redemption value - (1,617) (1,604)
------------- ------------ ------------
Net income applicable to common shareholders $ 3,634 $ 2,974 $ 16,741
============= ============ ============
Pro Forma
-------------
Historical income before provision for income taxes $ 4,247
Pro forma income tax expense 1,706
-------------
Pro forma net income $ 2,541
=============
Net income per share:
Basic $ 0.34 $ 0.22 $ 0.91
Diluted $ 0.34 $ 0.20 $ 0.85
Weighted average shares outstanding:
Basic 7,630 13,736 18,324
Diluted 7,658 14,808 19,758
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-13
<PAGE>
NCO GROUP, INC.
Consolidated Statements of Redeemable Preferred Stock
and Shareholders' Equity
For the Years Ended December 31, 1996, 1997 and 1998
(Amounts in thousands)
<TABLE>
<CAPTION>
-----------------------------------------------------------------------------------
Redeemable Preferred Stock Preferred Stock Common Stock
-------------------------- --------------- ------------
Number of Number of Number of Unexercised
Shares Amount Shares Amount Shares Amount Warrants
--------- ------ ------ ------ ------ ------ --------
<S> <C> <C> <C> <C> <C> <C>
Balance, January 1, 1996 - $ - - $ - 6,320 $ 538 $ 177
Issuance of common stock - - - - 3,750 28,825 -
Warrants issued - - - - - - 219
Note repayments - - - - - - -
Net income - - - - - - -
Distributions to shareholders - - - - - - -
------- ------ ------ ------ ------ ------ ------
Balance, December 31, 1996 - - - - 10,070 29,363 396
Capital contribution 13 157 - - 590 (3,137) -
Issuance of common stock 3,146 50,886 (149)
Issuance of series C preferred, voting common
and nonvoting common in connection with
acquisitions - - 146 1,686 1,455 16,799 -
Reclass of carryover basis adjustment - - - - - (11,065) -
Conversion of loan into and sale of
preferred stock 434 8,934 - - - - -
Issuance of warrants in conjunction with
the issuances of common stock and debt - (4,126) - - - - 4,575
Issuance of warrants in conjunction with
acquisitions - - - - - - 875
Exercise of nonvoting common options - - - - 36 418 -
Redemption of nonvoting common - - - - (36) - -
Redemption of nonvoting common and
issuance of nonvoting common in private
placement - - - - 16 - -
Accretion of preferred to redemption value 4 1,557 3 60 - - -
Net income - - - - - - -
------- ------ ------ ------ ------ ------ ------
Balance, December 31, 1997 451 6,522 149 1,746 15,277 83,264 5,697
Issuance of common stock - - - - 4,802 93,884 (247)
Exercise of voting and nonvoting
common conversion option 334 3,863 - - (334) - -
Accretion of preferred to redemption value - 1,497 - 107 - - -
Common stock option granted to consultant - - - - - 687 -
Redemption of nonvoting common - - - - (1) - -
Comprehensive income:
Net income - - - - - - -
Other comprehensive income:
Cumulative translation adjustment - - - - - - -
Total comprehensive income
------- -------- ------ ------- ------- -------- --------
Balance, December 31, 1998 785 $ 11,882 149 $ 1,853 19,744 $177,835 $ 5,450
======= ======== ====== ======= ====== ======== ========
</TABLE>
<PAGE>
NCO GROUP, INC.
Consolidated Statements of Reedemable Preferred Stock
and Shareholders' Equity
For the Years Ended December 31, 1996, 1997 and 1998
(Amounts in thousands)
<TABLE>
<CAPTION>
Shareholders' Equity
----------------------------------------------------------------------------------
Treasury Stock
Notes Carryover --------------------------
Receivable Basis Number of
Shareholder Adjustment Shares Amount
----------- ---------- ------ ------
<S> <C> <C> <C> <C>
Balance, January 1, 1996 $ (83) $ - - $ -
Issuance of common stock - - - -
Warrants issued - - - -
Note repayments 83 - - -
Net income - - - -
Distributions to shareholders - - - -
------ ------ ------ -------
Balance, December 31, 1996 - - - -
Capital contribution - - - -
Issuance of common stock - - - -
Issuance of series C preferred, voting common
and nonvoting common in connection with
acquisitions - (11,065) - -
Reclass of carryover basis adjustment - 11,065 - -
Conversion of loan into and sale of
preferred stock - - - -
Issuance of warrants in conjunction with
the issuances of common stock and debt - - - -
Issuance of warrants in conjunction with
acquisitions - - - -
Exercise of nonvoting common options - - - -
Redemption of nonvoting common - - 36 (418)
Redemption of nonvoting common and
issuance of nonvoting common in private
placement - - (16) 184
Accretion of preferred to redemption value - - - -
Net income - - - -
------ ------ ------ -------
Balance, December 31, 1997 - - 20 (234)
Issuance of common stock - - - -
Exercise of voting and nonvoting
common conversion option - - 335 (3,863)
Accretion of preferred to redemption value - - - -
Common stock option granted to consultant - - - -
Redemption of nonvoting common - - 1 (11)
Comprehensive income:
Net income - - - -
Other comprehensive income:
Cumulative translation adjustment - - - -
Total comprehensive income
------ ------ ------ -------
Balance, December 31, 1998 $ - $ - 356 $ (4,108)
====== ====== ====== ========
</TABLE>
<PAGE>
NCO GROUP, INC.
Consolidated Statements of Redeemable Preferred Stock
and Shareholders' Equity
For the Years Ended December 31, 1996, 1997 and 1998
(Amounts in thousands)
<TABLE>
<CAPTION>
Accumulated
Other
Comprehensive Retained Comprehensive
Income Earnings Income Total
------ -------- ------------- -----
<S> <C> <C> <C> <C>
Balance, January 1, 1996 $ 41 $ 1,379 $ 2,052
Issuance of common stock - - 28,825
Warrants issued - - 219
Note repayments - - 83
Net income - 3,634 3,634
Distributions to shareholders (41) (4,124) (4,165)
------- ------- --------
Balance, December 31, 1996 - 889 30,648
Capital contribution - - (3,137)
Issuance of common stock - - 50,737
Issuance of series C preferred, voting common
and nonvoting common in connection with
acquisitions - - 7,420
Reclass of carryover basis adjustment - - -
Conversion of loan into and sale of
preferred stock - - -
Issuance of warrants in conjunction with
the issuances of common stock and debt - - 4,575
Issuance of warrants in conjunction with
acquisitions - - 875
Exercise of nonvoting common options - - 418
Redemption of nonvoting common - - (418)
Redemption of nonvoting common and
issuance of nonvoting common in private
placement - - 184
Accretion of preferred to redemption value - (1,617) (1,557)
Net income - 4,591 4,591
------- ------- --------
Balance, December 31, 1997 - 3,863 94,336
Issuance of common stock - - 93,637
Exercise of voting and nonvoting
common conversion option - - (3,863)
Accretion of preferred to redemption value - (1,604) (1,497)
Common stock option granted to consultant - - 687
Redemption of nonvoting common - - (11)
Comprehensive income:
Net income - 18,345 $ 18,345 18,345
Other comprehensive income:
Cumulative translation adjustment (2,169) - (2,169) (2,169)
--------
Total comprehensive income $ 16,176
------- -------- ======== ---------
Balance, December 31, 1998 $ (2,169) $ 20,604 $ 199,465
======== ======== =========
</TABLE>
The accompanying notes are an integral part of these consolidated
financial statements.
F-14
<PAGE>
NCO GROUP, INC
Consolidated Statements of Cash Flows
(Amounts in thousands)
<TABLE>
<CAPTION>
For the Years Ended December 31,
--------------------------------
1996 1997 1998
-------- -------- --------
<S> <C> <C> <C>
Cash flows from operating activities:
Net income $ 3,634 $ 4,591 $ 18,345
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 466 2,140 3,945
Amortization of intangibles 788 2,424 5,906
Loss on disposal of fixed assets - 41 -
Gain on sale of securities (70) - -
Provision for doubtful accounts 56 356 1,187
Compensation expense on stock options granted - 418 686
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (1,825) (4,565) (10,652)
Other current assets (313) (1,685) 2,818
Deferred taxes (155) 1,781 3,090
Other assets (10) (43) (3,516)
Accounts payable 423 (1,127) (211)
Corporate taxes payable 217 68 59
Accrued expenses (1,017) 582 1,124
Accrued compensation and related costs 599 405 570
-------- -------- ---------
Net cash provided by operating activities 2,793 5,386 23,351
Cash flows from investing activities:
Repayment of notes receivable 156 - -
Purchase of property and equipment (976) (4,849) (10,292)
Purchase of securities (78) - -
Proceeds from sale of securities 407 - -
Net cash paid for acquisitions (12,857) (25,399) (222,843)
-------- -------- ---------
Net cash used in investing activities (13,348) (30,248) (233,135)
Cash flows from financing activities:
Repayment of notes payable (303) (7,012) (1,256)
Repayment of acquired notes payable - - (21,919)
Borrowings under revolving credit agreement 12,550 32,686 94,789
Repayment of borrowings under revolving credit agreement (15,000) (18,165) (84,193)
Borrowings under term loan - - 125,000
Payment of fees to acquire new debt (222) (401) (3,015)
Issuance of common stock, net 28,825 40,428 93,637
Proceeds from issuance of preferred and common stock
and exercise of common stock options - 1,068 -
Redemption of common stock - (5,931) (11)
Payment of dividends - (188)
Decrease in notes receivable, shareholders 83 - -
Distributions to shareholders (4,124) - -
Capital contributions - 697 -
-------- -------- ---------
Net cash provided by financing activities 21,809 43,182 203,032
Effect of exchange rate on cash - - (67)
-------- -------- ---------
Net increase (decrease) in cash and cash equivalents 11,254 18,320 (6,819)
Cash and cash equivalents at beginning of period 805 12,059 30,379
-------- -------- ---------
Cash and cash equivalents at end of period $ 12,059 $ 30,379 $ 23,560
======== ======== =========
The accompanying notes are an integral part of these consolidated financial statements.
</TABLE>
F-15
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements
1. Nature of operations:
NCO Group, Inc. (the "Company") is a leading provider of accounts
receivable management and other outsourced services. The Company's client
base is comprised of companies located throughout North America, the United
Kingdom and in Puerto Rico in the financial services, healthcare,
education, retail and commercial, utilities, government and
telecommunications sectors.
2. Summary of significant accounting policies:
Principles of Consolidation:
The consolidated financial statements include the accounts of NCO Group,
Inc. and its wholly-owned subsidiaries after elimination of significant
intercompany accounts and transactions.
Revenue Recognition:
The Company generates revenues from contingency fees and contractual
services. Contingency fee revenue is recognized upon collection of funds on
behalf of clients. Contractual services revenue is recognized as services
are performed.
Property and Equipment:
Property and equipment is stated at cost, less accumulated depreciation.
Depreciation is provided over the estimated useful life of each class of
assets using the straight-line method. The estimated useful lives are five
years, five to twelve years, and two to five years for computer equipment,
furniture and fixtures, and leased assets, respectively. Expenditures for
maintenance and repairs are charged to expense as incurred. Renewals and
betterments are capitalized. When property is sold or retired, the cost and
related accumulated depreciation are removed from the balance sheet and any
gain or loss on the transaction is included in the statement of income.
The Company reviews long-lived assets and certain identifiable intangibles
for impairment, based on the estimated future cash flows, whenever events
or changes in circumstances indicate that the carrying amount of the asset
may not be recoverable.
Income Taxes:
The Company had elected to be taxed as an S Corporation under the Internal
Revenue Code and the Pennsylvania Tax Code. While this election was in
effect, no provision was made for income taxes by the Company since all
income was taxed directly to the shareholders of the Company.
The Company terminated its S Corporation status on September 3, 1996 and
adopted the use of the asset and liability approach. The asset and
liability approach requires the recognition of deferred tax assets and
liabilities for the expected future tax consequences of temporary
differences between the financial reporting basis and the tax basis of
assets and liabilities.
F-16
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies (continued):
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with an
initial maturity of three months or less to be cash equivalents. These
financial instruments potentially subject the Company to concentrations of
credit risk.
At December 31, 1997 and 1998, the Company had cash and cash equivalents,
excluding funds held in trust for clients, in excess of federally insured
limits of approximately $10,305,000 and $8,449,000, respectively, based on
the bank balance which does not include outstanding checks and other
reconciling items. The Company's cash deposits have been placed with large
national banks to minimize risk.
Credit Policy:
The Company has two types of arrangements under which it collects its
contingency fee revenue. For certain clients the Company remits funds
collected on behalf of the client net of the related contingency fees
while, for other clients, the Company remits gross funds collected on
behalf of clients and bills the client separately for its contingency fees.
Management carefully monitors its client relationships in order to minimize
its credit risk and generally does not require collateral. In many cases,
in the event of collection delays from clients, management may at its
discretion change from the gross remittance method to the net remittance
method.
Intangibles:
Intangibles consists primarily of goodwill and deferred financing costs.
Goodwill represents the excess of purchase price over the fair market value
of the net assets of the acquired businesses based on their respective fair
values at the date of acquisition. Goodwill is amortized on a straight-line
basis over 15 to 40 years. For certain acquisitions, such allocations have
been based on estimates which may be revised at a later date. The
recoverability of goodwill is periodically reviewed by the Company. In
making such determination with respect to goodwill, the Company evaluates
the operating results of the underlying business which gave rise to such
amount.
Deferred financing costs relate to debt issuance costs incurred which are
capitalized and amortized over the term of the debt.
Accumulated amortization at December 31, 1997 and 1998 totaled $3.2 million
and $9.1 million, respectively.
Foreign Currency Translation:
The Company has foreign subsidiaries whose local currency has been
determined to be the functional currency. For these foreign subsidiaries,
the assets and liabilities have been translated using the current exchange
rates, and the income and expenses have been translated using the
historical exchange rates. The adjustments resulting from translation have
been recorded as a separate component of shareholders' equity and are not
included in determining consolidated net income.
F-17
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Summary of significant accounting policies (continued):
Estimates Utilized in the Preparation of Financial Statements:
The preparation of financial statements in conformity with generally
accepted accounting principles requires management to make estimates and
assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses
during the reporting period. Actual results could differ from those
estimates.
Comprehensive Income:
Effective January 1, 1998, the Company adopted Statement of Financial
Accounting Standards ("SFAS") No. 130, "Reporting Comprehensive Income."
SFAS No. 130 establishes standards for the reporting and display of
comprehensive income. Comprehensive income consists of net income from
operations, plus certain changes in assets and liabilities that are not
included in net income but are reported as a separate component of
shareholders' equity under generally accepted accounting principles.
Reclassifications:
Certain amounts for December 31, 1996 and 1997 and the years then ended
have been reclassified for comparative purposes.
3. Acquisitions:
Purchase Transactions:
All of the following acquisitions have been accounted for under the
purchase method of accounting. As part of the purchase accounting, the
Company recorded accruals for acquisition related expenses. The accruals
for acquisition related expenses include professional fees related to the
acquisition, termination costs related to certain redundant personnel
immediately eliminated at the time of the acquisitions, and certain future
rental obligations attributable to facilities which were closed at the time
of the acquisitions.
On January 3, 1996 the Company purchased the net assets of Trans Union
Corporation Collections Division ("TCD") for $4.8 million in cash. The
Company recognized goodwill of $3.7 million.
On September 5, 1996 the Company purchased the outstanding stock of
Management Adjustment Bureau, Inc. ("MAB") for $9.0 million comprised of
$8.0 million in cash and a $1.0 million convertible note. The Company
recognized goodwill of $9.0 million.
On January 22, 1997 the Company purchased the outstanding stock of Goodyear
& Associates, Inc. ("Goodyear") for $5.4 million comprised of $4.5 million
in cash and a $900,000 convertible note. The Company recognized goodwill of
$5.4 million.
On January 30, 1997 the Company purchased the net assets of Tele-Research
Center, Inc. ("Tele-Research") for $1.6 million in cash, which was
increased in January 1998 by an additional $600,000 when certain revenue
targets were reached in the period following the acquisition. The Company
recognized goodwill of $2.2 million.
On January 31, 1997 the Company purchased the net assets of the CMS A/R
Services ("CMS A/R"), the Collection Division of CMS Energy Corporation,
for $5.1 million in cash. The Company recognized goodwill of $3.9 million.
F-18
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
On February 2, 1997 the Company purchased the net assets of the Collections
Division of CRW Financial, Inc. ("CRWCD") for $3.8 million in cash, 517,767
shares of common stock and warrants for 375,000 shares of common stock. The
acquisition was valued at approximately $12.8 million. The Company
recognized goodwill of $14.5 million.
On October 1, 1997 the Company purchased the outstanding stock of ADVANTAGE
Financial Services, Inc. and related companies ("AFS") for $2.9 million in
cash, 46,442 shares of common stock and $1.0 million in notes payable. The
purchase price was valued at approximately $5.0 million. The Company
recognized goodwill of $7.1 million.
On October 1, 1997 the Company purchased the outstanding stock of Credit
Acceptance Corp. ("CAC") for $1.8 million in cash. The Company recognized
goodwill of $2.1 million.
On December 31, 1997, effective January 1, 1998, the Company purchased the
net assets of American Financial Enterprises, Inc. Collections Division
("AFECD") for $1.7 million in cash. Cash paid for the acquisition of AFECD
is included on the Consolidated Balance Sheet at December 31, 1997 under
the caption "Deposits on acquisitions." The Company recognized goodwill of
$2.0 million.
On February 6, 1998, the Company purchased the net assets of The Response
Center ("TRC"), which was an operating division of TeleSpectrum Worldwide,
Inc., for $15.0 million plus a performance based earn-out. The Company
recognized goodwill of $14.3 million.
On May 5, 1998, the Company purchased all of the outstanding common shares
of FCA International Ltd. ("FCA") at $9.60 per share, Canadian (equivalent
to $6.77 in U.S. dollars based upon the exchange rate at the date of the
agreement). The purchase price was valued at approximately $69.9 million.
The Company recognized goodwill of $83.3 million. Included in this goodwill
is an accrual of $10.6 million for acquisition related expenses. As of
December 31, 1998, there was $3.1 million remaining from this accrual for
acquisition related expenses.
On July 1, 1998, the Company purchased all of the outstanding stock of
MedSource, Inc. ("MedSource") for $18.4 million in cash. In connection with
the acquisition, the Company repaid debt of $17.3 million. The Company
recognized goodwill of $34.9 million. Included in this goodwill is an
accrual of $5.8 million for acquisition related expenses. As of December
31, 1998, there was $1.7 million remaining from this accrual for
acquisition related expenses.
On November 30, 1998, the Company acquired all of the outstanding stock of
Medaphis Services Corporation ("MSC"), a wholly owned subsidiary of
Medaphis Corporation for $107.5 million, plus an earn-out of up to $10.0
million based on MSC achieving operational targets during 1999. The
allocation of the fair market value to the acquired assets and liabilities
of MSC was based on preliminary estimates and is subject to change. The
Company recognized goodwill of $96.7 million. Included in this goodwill is
an accrual of $15.0 million for acquisition related expenses. As of
December 31, 1998, there was $12.8 million remaining from this accrual for
acquisition related expenses.
F-19
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
The following summarizes unaudited pro forma results of operations for the
years ended December 31, 1997 and 1998, assuming the above acquisitions
occurred as of the beginning of the respective periods. The pro forma
information is provided for informational purposes only. It is based on
historical information, and does not necessarily reflect the actual results
that would have occurred, nor is it indicative of future results of
operations of the consolidated entities:
1997 1998
------------ -------------
(Unaudited)
Revenue $306,665,000 $ 353,789,000
Net income $ 181,000 $ 10,341,000
Earnings per share-basic $ (0.07) $ 0.42
Earnings per share-diluted $ (0.06) $ 0.39
Pooling-of-Interests Transaction:
On March 31, 1999, the Company acquired all of the outstanding shares of
JDR Holdings, Inc. ("JDR") for approximately 3.4 million shares of NCO
common stock. The purchase price was valued at approximately $103.1
million. The transaction has been accounted for as a pooling-of-interests
and a tax-free reorganization. Accordingly, the historical financial
information of the Company has been restated to include the historical
information of JDR. Additionally, the historical share amounts for JDR
common stock, JDR series A redeemable preferred stock, and JDR convertible
preferred stock have been converted to the equivalent shares of NCO common
stock based on exchange rates of 326.453, 144.92 and 326.453, respectively.
These exchange rates represent the exchange rates used to convert the
respective outstanding shares into NCO common stock on March 31, 1999. The
following reconciles the amounts originally reported for revenue, net
income and net income per common share for each of the years ended December
31, 1996, 1997 and 1998 to the restated amounts (amounts in thousands,
except per share data):
<TABLE>
<CAPTION>
1996 1997 1998
------------- -------------- -------------
<S> <C> <C> <C>
Revenue:
As originally reported $ 30,760 $ 85,284 $ 178,976
JDR (1) -- 22,789 50,976
------------- -------------- -------------
Combined $ 30,760 $ 108,073 $ 229,952
============= ============== =============
Net income:
As originally reported $ 3,634 $ 7,074 $ 14,716
JDR (1) -- (2,483) 3,629
------------- -------------- -------------
Combined $ 3,634 $ 4,591 $ 18,345
============= ============== =============
Diluted net income per share:
As originally reported $ 0.34 $ 0.57 $ 0.89
JDR (1) -- (0.37) (0.04)
------------- -------------- -------------
Combined $ 0.34 $ 0.20 $ 0.85
============= ============== =============
</TABLE>
(1) On May 29, 1997, JDR completed a recapitalization which
established a new basis of accounting (See Note 4) and, as a
result, the results of JDR for 1997 represent the period from May
29, 1997 to December 31, 1997.
F-20
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Acquisitions (continued):
As of December 31, 1998, the Company recorded deferred charges of $857,000
for restructuring costs associated with the acquisition of JDR. These costs
were deferred until the completion of the transaction on March 31, 1999 and
primarily consisted of investment banking, legal, and accounting fees, and
printing costs.
4. JDR recapitalization:
On May 29 and 30, 1997, JDR completed a series of transactions that
substantially changed its size and capital structure. These transactions,
which are described further below, included the repayment of outstanding
debt, the repurchase of all capital stock held by two former institutional
investors, certain executive officers of JDR and an individual investor,
the issuance of new preferred shares, the purchase of several companies
that were previously partially owned by the JDR's majority stockholder and
President, and a recapitalization of JDR. After the repurchase of capital
stock, JDR's President became the only holder of Voting Common ("JDR's Sole
Stockholder"). At that point, the Sole Stockholder's basis in his
investment was "pushed down" to the JDR's books, as required by Staff
Accounting Bulletin No. 54. This established a new basis of accounting for
JDR on May 29, 1997 and the financial statements, therefore, include the
period from that date to the Company's fiscal year end, December 31, 1997.
On May 29, 1997, JDR amended and restated its certificate of incorporation
to authorize the issuance of 17,955,000 shares of stock, consisting of (i)
9,794,000 shares of Common stock (" JDR Common") consisting of 4,897,000
shares of Voting Common stock and 4,897,000 shares of Nonvoting Common
stock ("Nonvoting Common"), (ii) 8,161,000 shares of Preferred stock
("Preferred") of which 417,000 shares were designated as Redeemable Series
A Preferred stock, no par value ("Redeemable Series A"), 555,000 shares
were designated as Convertible Series A Preferred stock, no par value
("Series A Preferred"), 204,000 were designated as Convertible Series B
Preferred stock, no par value ("Series B Preferred") and 237,000 were
designated as Convertible Series C Preferred stock, no par value ("Series C
Preferred") (see Notes 14 and 15).
Also on May 29, 1997, JDR received a bridge loan of $11.0 million (see Note
8), the proceeds of which were used to repay $5.4 million of outstanding
long-term debt, to pay debt issuance costs of $185,000 (see Note 8) and to
repurchase for $5.4 million all of the Voting Common held by shareholders
other than JDR's Sole Stockholder and certain shares of Redeemable Series A
and Series B Preferred stock. This transaction resulted in the push down of
JDR's Sole Stockholder's basis in his investment in JDR's stock onto JDR's
books. The establishment of this new basis of accounting resulted in JDR
recording an increase in equity of $6.7 million, which represented the
difference between the JDR's net book value at May 29, 1997 and JDR's Sole
Stockholder's accounting basis. The entire amount of the increase in equity
was allocated to goodwill, which is being amortized over 40 years on a
straight-line basis.
F-21
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
4. JDR recapitalization (continued):
The repurchase and exchange of stock included the following:
<TABLE>
<CAPTION>
<S> <C>
Repurchase of 401,000 shares of Voting Common $ 4,624,000
Repurchase of 92,000 shares of Redeemable Series A
and Series B Preferred stock plus accrued dividends of $165,142 802,000
Exchange of 40,000 shares of Redeemable Series A and Series B Preferred
stock, plus accrued dividends of $22,650 for 13,000 shares of Series A
Preferred 146,000
Exchange of 129,000 shares of Voting Common stock for 129,000 shares of
Nonvoting Common 1,493,000
Exchange of 1,000 shares of Voting Common for 1,000 shares of Series B
Preferred 11,000
-----------
Total value of shares repurchased and
exchanged $ 7,076,000
===========
On May 30, 1997, JDR issued Preferred stock to two new institutional
investors (see Note 14) as follows:
Issued 271,000 shares of Redeemable Series A $ 7,050,000
Issued 38,000 shares of Series A Preferred 439,000
Issued 125,000 shares of Series B Preferred 1,445,000
-----------
$ 8,934,000
===========
</TABLE>
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 $15,018,000 and
$32,232,000 at December 31, 1997 and 1998, respectively, have been shown
net of their offsetting liability for financial statement presentation.
At December 31, 1997 and 1998, the Company had funds held in trust in
excess of federally insured limits of approximately $17,102,000 and
$42,851,000, respectively, based on the bank balance which does not include
outstanding checks and other reconciling items. The funds held in trust
have been placed with large national banks to minimize risk.
F-22
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
6. Property and equipment:
At December 31, 1997 and 1998, property and equipment, at cost, consists of
the following:
1997 1998
----------- -----------
Computer equipment $11,606,000 $23,794,000
Furniture and fixtures 2,822,000 8,158,000
Leased assets 452,000 1,983,000
----------- -----------
14,880,000 33,935,000
Less accumulated depreciation 2,929,000 6,873,000
----------- -----------
$11,951,000 $27,062,000
=========== ===========
Depreciation charged to operations amounted to $466,000, $2,139,000 and
$3,945,000 for the years ended 1996, 1997 and 1998, respectively.
7. Cash value, life insurance:
The cash value of certain split-dollar life insurance policies is included
under the caption "Other assets" on the consolidated balance sheets. The
insurance policies, which were purchased in 1997, separately insure: (i)
the joint lives of Michael J. Barrist and his spouse; and (ii) the joint
lives of Charles C. Piola Jr. and his spouse. Under the terms of the
split-dollar agreement, the Company will pay the premiums for certain
survivorship life insurance policies on the lives of Mr. and Mrs. Barrist
and Mr. and Mrs. Charles C. Piola with an aggregate face value of $50.0
million and $30.0 million, respectively, only to the extent that the
premiums are in excess of the cost of the term insurance coverage. While
the proceeds of the policies are payable to the beneficiaries designated by
the respective executives, the Company has an interest in the insurance
benefits equal to the cumulative amount of premiums it has paid and is not
responsible to pay any premiums in excess of the cash surrender value of
the respective policies.
F-23
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
8. Long-term debt:
<TABLE>
<CAPTION>
1997 1998
------------ ------------
<S> <C> <C>
Revolving credit loan; 7.37%, due November 2003 $ -- $ 11,035,000
Term loan; 7.37%, payable in quarterly installments,
ranging from $3.0 to $5.3 million, through
November 2003 when the remaining balance becomes
payable -- 125,000,000
JDR revolving credit loan 12,913,000 12,500,000
Non-interest bearing note; $36,750 remaining face
amount, payable in monthly installments of $5,250
through July 1999 (less unamortized discount based
on imputed interest rate of 10%) 92,000 36,000
Subordinated seller notes payable; 8.00%,
due January 1999 1,000,000 500,000
Subordinated seller note payable; 8.00%, due
February 2002, converted to common stock
at $14.12 per share on February 15, 1999 900,000 900,000
Capital leases 1,783,000 2,227,000
Less current portion (1,477,000) (8,288,000)
------------ ------------
$ 15,211,000 $143,910,000
============ ============
</TABLE>
The following summarizes the Company's required debt payments for the next
five years:
1999 $ 8,288,000
2000 12,688,000
2001 15,394,000
2002 18,169,000
2003 97,565,000
In November 1998, the Company's credit agreement with Mellon Bank, N.A.,
for itself and as administrative agent for other participating lenders, was
amended to, among other things, increase the Company's credit facility to
provide for borrowings up to $200.0 million consisting of a term loan of
$125.0 million and a revolving credit facility of up to $75.0 million.
Borrowings bear interest at a rate equal to, at the option of the Company,
Mellon Bank's prime rate (7.75% at December 31, 1998) or LIBOR plus a
margin from 1.25% to 2.25% depending on the Company's consolidated funded
debt to EBITDA ratio (LIBOR was 5.12% at December 31, 1998). Borrowings are
collateralized by substantially all the assets of the Company and are
payable in quarterly payments for the term loan beginning on September 30,
1999. The balance will be due upon the expiration of the five year term.
The credit agreement contains certain financial covenants such as
maintaining net worth and funded debt to EBITDA requirements and includes
restrictions on, among other things, acquisitions, capital expenditures and
distributions to shareholders.
F-24
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
8. Long-term debt (continued):
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.
As of December 31, 1998, JDR had $12.5 million of borrowings outstanding
against its revolving credit facility (the "JDR Credit Facility"). On March
31, 1999, the Company repaid the outstanding balance on the JDR Credit
Facility with borrowings from its revolving credit agreement with Mellon
Bank, N.A, and cancelled the JDR Credit Facility. Deferred financing costs
of $353,000 were written-off on March 31, 1999 as a result of the
cancellation of the JDR Credit Facility.
Under the terms of the JDR Credit Facility, dated May 30, 1997, the Company
could borrow up to the lessor of $20 million less any outstanding letters
of credit, or an amount equal to: (i) adjusted EBITDA times the leverage
multiple, as defined, which ranged from 3.0 to 4.0; (ii) less outstanding
senior debt; and (iii) less any outstanding letters of credit. Previously,
advances under the JDR Credit Facility would bear interest at optional
borrowing rates of either the then current prime rate plus a margin that
ranged from 0.50% to 1.50 % or LIBOR, plus a margin that ranged from 2.00%
to 3.00%, depending on certain conditions specified in the JDR Credit
Facility agreement. The Company also paid a commitment fee of .375% on the
unused borrowing capacity. The Credit Facility made available to the
Company letters of credit, which could be issued on the unused portion of
the JDR Credit Facility. The letters of credit could not exceed $1.0
million and had a fee equal to 2.00% per year on the face amount of each
letter of credit. Borrowings under the JDR Credit Facility were secured by
substantially all of the assets of JDR. The JDR Credit Facility agreement
contained various financial and non-financial covenants and would have
terminated on May 31, 2001.
On May 29, 1997, JDR entered into a credit agreement (hereinafter referred
to as the " JDR Bridge Loan") whereby JDR borrowed $11.0 million to redeem
common stock owned by two stockholders and repay all outstanding
indebtedness of JDR. Borrowings under the JDR Bridge Loan bore interest at
10%. In connection with the JDR Bridge Loan, the Company recorded debt
issuance costs of $185,000, which were fully amortized upon conversion and
repayment of the JDR Bridge Loan. On May 30, 1997, $8.3 million of
borrowings under the JDR Bridge Loan were converted into redeemable
preferred stock (see Notes 4 and 14) and $2.7 million was repaid with
borrowings under the JDR Credit Facility.
In connection with the Credit Facility, the lender purchased 18,000 shares
of Redeemable Series A and 11,000 shares of Series B Preferred for
$603,000 (see Notes 4 and 14).
On February 15, 1999, the $900,000 convertible note issued in connection
with the Goodyear acquisition was converted into 64,000 shares of NCO
common stock.
The Company leases certain equipment under agreements which are classified
as capital leases. The equipment leases have original terms ranging from 24
to 120 months and have purchase options at the end of the original lease
term.
F-25
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
9. Financial instruments:
The Company selectively uses derivative financial instruments to manage
interest costs and minimize currency exchange risk. The Company does not
hold derivatives for trading purposes. While these derivative financial
instruments are subject to fluctuations in value, these fluctuations are
generally offset by the value of the underlying exposures being hedged. The
Company minimizes the risk of credit loss by entering into these agreements
with major financial institutions that have high credit ratings.
Interest Rate Swap and Interest Rate Collar Agreements:
During 1998, the Company entered into an interest rate swap agreement and
an interest rate collar agreement to reduce the impact of changes in
interest rates on portions of the debt borrowed from its revolving credit
facility.
The interest rate swap agreement exchanges the floating rate on the
Company's outstanding debt from its revolving credit facility for a fixed
interest rate of 5.12%. This agreement expires in June of 1999 and covers a
notional amount of approximately $136.0 million.
The interest rate collar agreement consists of a rate ceiling and floor
that is based on different notional amounts. The ceiling portion of the
collar is at a rate of 7.75% covering a notional amount of $30.0 million
and the floor portion of the collar is at 4.75% covering a notional amount
of $15.0 million. The notional amounts of this interest rate collar
agreement is used to measure interest to be paid or received and does not
represent the amount of exposure due to credit loss. The net cash amounts
paid or received on the interest rate collar agreement are accrued and
recognized as an adjustment to interest expense. The interest rate collar
agreement expires in September of 2001.
Foreign Exchange Contracts:
As part of the acquisition of FCA International Ltd. ("FCA"), the Company
obtained forward exchange contracts which where entered into by FCA. Theses
forward exchange contracts may be used by the Company to minimize the
impact of currency fluctuations on transactions, cash flows and firm
commitments. The Company has approximately $3.4 million of contracts
outstanding at December 31, 1998. These contracts are for the purchase of
Canadian Dollars and mature within one to 30 months. The Company has
determined that the gains and losses associated with these contracts are
not material.
F-26
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
10. Income taxes:
A summary of the components of the tax provision at December 31, 1996, 1997
and 1998 is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
----------- ----------- -----------
<S> <C> <C> <C>
Currently payable:
Federal $ 620,000 $ 2,233,000 $ 7,699,000
State 147,000 484,000 1,355,000
Foreign -- -- 331,000
Deferred:
Federal 1,000 1,752,000 3,035,000
State -- 29,000 711,000
Valuation allowance -- 302,000 --
----------- ----------- -----------
Provision for income taxes 768,000 4,800,000 13,131,000
(excluding effect of
change in tax status)
Effect of accounting change:
Federal 124,000 -- --
State 31,000 -- --
----------- ----------- -----------
Total provision $ 613,000 $ 4,800,000 $13,131,000
=========== =========== ===========
</TABLE>
Deferred tax assets (liabilities) at December 31, 1997 and 1998 consist of
the following:
<TABLE>
<CAPTION>
1997 1998
----------- -----------
<S> <C> <C>
Deferred tax assets:
Net operating loss carryforwards $ 302,000 $ 569,000
Contractual revenue recognition 26,000 --
Accrued expenses 113,000 1,056,000
----------- -----------
441,000 1,625,000
Deferred tax liabilities:
Amortization 1,710,000 4,999,000
Depreciation 350,000 1,735,000
Cash basis of accounting 457,000 375,000
----------- -----------
2,517,000 7,109,000
----------- -----------
Valuation allowance 302,000 --
----------- -----------
Net deferred tax liability $(2,378,000) $(5,484,000)
=========== ===========
</TABLE>
F-27
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
10. Income taxes (continued):
A reconciliation of the U.S. statutory income tax rate to the effective
rate (excluding the effect of the change in tax status) is as follows:
<TABLE>
<CAPTION>
1996 1997 1998
------ ------ ------
<S> <C> <C> <C>
U.S. statutory income tax rate 34% 34% 35%
Income allocable to S Corporation (27%) -- --
Non-deductible goodwill
and other expenses 5% 3% 2%
State taxes, net of federal 2% 5% 6%
Utilization of net operating
loss carryforwards -- -- (1%)
JDR operating losses not tax benefited -- 9% --
--- --- ---
Effective tax rate 14% 51% 42%
=== === ===
</TABLE>
11. Employee benefit plans:
The Company has a savings plan under Section 401(k) of the Internal Revenue
Code (the "Plan"). The Plan allows all eligible employees to defer up to
15% of their income on a pretax basis through contributions to the Plan.
The Company will match 25% of employee contributions for an amount up to 6%
of each employee's base salary. The charge to operations for the matching
contributions was $72,000, $220,000, and $755,000, for 1996, 1997 and 1998,
respectively.
12. Supplemental cash flow information:
The following are supplemental disclosures of cash flow information:
<TABLE>
<CAPTION>
1996 1997 1998
------------ ------------ ------------
<S> <C> <C> <C>
Cash paid for interest $ 818,000 $ 1,570,000 $ 2,905,000
Cash paid for income taxes 600,000 4,181,000 5,726,000
Noncash investing and
financing activities:
Fair value of assets acquired 4,081,000 12,320,000 47,872,000
Fair value of contributed capital -- -- (3,834,000)
Property acquired under
capital leases 349,000 967,000 138,000
Value of fixed assets traded for
new fixed assets -- 238,000 --
Liabilities assumed from
acquisitions 2,006,000 7,019,000 46,730,000
Convertible note payable,
issued for acquisition 1,000,000 900,000 --
Notes payable,
issued for acquisition -- 1,000,000 --
Convertible note payable,
converted to common stock -- 1,000,000 --
Common stock issued for
acquisitions -- 9,310,000 --
Warrants issued 219,000 5,450,000 --
Warrants exercised -- 149,000 247,000
</TABLE>
F-28
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
13. Operating leases:
The Company leases certain equipment under non-cancelable operating leases.
Future minimum payments, by year and in the aggregate, under noncancelable
operating leases with initial or remaining terms of one year or more
consist of the following at December 31, 1998:
1999 $ 17,179,000
2000 12,290,000
2001 8,596,000
2002 6,585,000
2003 3,818,000
Thereafter 9,284,000
------------
$ 57,752,000
============
Rent expense was $1,074,000, $3,656,000 and $7,756,000 for the years ended
December 31, 1996, 1997, and 1998, respectively. The related party office
lease expense, which terminated in July 1997, was $490,000 and $232,000,
for 1996, and 1997, respectively. The total amount of base rent payments is
being charged to expense on the straight-line method over the term of the
lease.
14. Redeemable preferred stock:
<TABLE>
<CAPTION>
December 31,
1997 1998
---------- -----------
<S> <C> <C>
Redeemable Series A Preferred stock, no par value,
417,000 shares authorized, 271,000 shares issued and
outstanding $4,408,000 $ 5,394,000
Convertible Series A Preferred stock, no par value,
555,000 shares authorized, 51,000 and 363,000 shares
issued and outstanding, respectively 606,000 4,601,000
Convertible Series B Preferred stock, no par value,
204,000 shares authorized, 126,000 and 149,000 shares
issued and outstanding, respectively 1,508,000 1,887,000
---------- -----------
$6,522,000 $11,882,000
========== ===========
</TABLE>
JDR issued 271,000 shares of Redeemable Series A stock to repay $6.6
million of borrowings under the JDR Bridge Loan (see Note 4) and for cash
proceeds of $476,000. The Redeemable Series A stock required a dividend
(payable in kind) of 7.0% per year, payable quarterly in arrears. The
holders of the Redeemable Series A stock could have redeemed these shares
for their liquidation preference, plus accrued and unpaid dividends,
beginning on May 30, 2003. JDR would have been obligated to redeem these
shares on the earlier of their initial public offering or May 30, 2004. The
Redeemable Series A stock had limited voting rights, was senior to the
Series C Preferred stock and common stock and had a liquidation value of
$7.9 million, including dividends of $819,000, at December 31, 1998. All of
the Redeemable Series A Preferred stock was converted into NCO common stock
on March 31, 1999 using a conversion ratio of one-for-one.
JDR issued 38,000 shares of Series A Preferred stock to repay $439,000 of
borrowings under the JDR Bridge Loan (see Note 4). In addition, JDR issued
13,000 shares of Series A Preferred stock in exchange for certain
Redeemable Series A and Series B Preferred stock. The Series A Preferred
required a dividend (payable in kind) of 6.0% per year, payable quarterly
in arrears. The holders of the Series A Preferred stock could have
converted their shares at any time into voting common stock at a conversion
ratio of one-for-one. In addition, the holders of the Series A Preferred
stock could have
F-29
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
14. Redeemable preferred stock (continued):
redeemed their shares for their liquidation preference, plus accrued but
unpaid dividends, beginning on May 30, 2002. The Series A Preferred stock
had limited voting rights, was senior to the Series C Preferred stock and
common stock and had a liquidation value of $4.6 million, including
dividends of $414,000, at December 31, 1998. All of the Series A Preferred
stock was converted into NCO common stock on March 31, 1999.
JDR issued 125,000 shares of Series B Preferred stock to repay $1.3 million
of borrowings under the JDR Bridge Loan (see Note 4) and for cash proceeds
of $127,000. The Series B Preferred stock required a dividend (payable in
kind) of 6.0% per year, payable quarterly in arrears. The holders of the
Series B Preferred stock could have converted their shares at any time into
nonvoting common stock at a conversion ratio of one-for-one. In addition,
the holders of the Series B Preferred stock could have redeemed these
shares for their liquidation preference, plus accrued but unpaid dividends,
beginning on May 30, 2002. The Series B Preferred stock had limited voting
rights, was senior to the Series C Preferred stock and common stock and had
a liquidation value of $1.9 million, including dividends of $170,000, at
December 31, 1998. All of the Series B Preferred stock was converted into
NCO common stock on March 31, 1999.
15. Shareholders' equity:
Preferred Stock
As of December 31, 1997 and 1998, the Company had 237,000 shares designated
as Series C Preferred stock, of which 146,000 shares were issued and
outstanding. The Series C Preferred stock required a dividend (payable in
kind) of 6.0% per year, payable quarterly in arrears. The Company could
have, at its option, redeemed the Series C Preferred, at any time, for its
liquidation value. The holders of the Series C Preferred stock could have
converted their shares at any time after May 30, 2000, or at the time any
shares of Series A Preferred stock or Series B Preferred stock were
converted into common stock, into nonvoting common stock at a conversion
ratio of one-for-one. The Series C Preferred stock had a liquidation value
of $1.7 million and $1.9 million, including dividends of $60,000 and
$167,000, at December 31, 1997 and 1998, respectively. All of the Series C
Preferred stock was converted into NCO common stock on March 31, 1999.
Common Stock
Effective September 3, 1996, the shareholders of NCO Financial Systems,
Inc. contributed each of their shares of common stock in exchange for one
share of common stock of the Company, a recently formed corporation. In
September 1996, the Company also effected a 46.56-for-one stock split and
increased the number of authorized shares to 5,000,000 shares of preferred
stock and 25,000,000 shares of common stock. In December 1997, the Company
effected a three-for-two stock split and increased the authorized shares of
common stock to 37,500,000. All per share and related amounts have been
adjusted to reflect the stock exchange and stock splits.
On November 13, 1996, the Company completed its initial public offering
(the "IPO"), selling 4,312,500 shares of common stock including 562,500
over-allotment shares sold by existing shareholders at a price to the
public of $8.67 per share. The IPO raised net proceeds of approximately
$28.8 million for the Company. A director of the Company received
compensation of $240,000 for services rendered in connection with the IPO.
In July 1997, the Company completed a public offering (the "1997
Offering"), selling 4,312,500 shares of common stock at a price to the
public of $19.67 per share, including 2,166,000 shares issued by the
Company, 1,212,869 shares (562,500 of which were over-allotment shares)
sold by existing shareholders, 75,480 shares acquired by employees through
the exercise of stock options, 225,000 shares acquired by the Company's
bank (Mellon Bank, N.A.) through the exercise of stock warrants,
F-30
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
15. Shareholders' equity (continued):
115,385 shares acquired through the conversion of the Company's convertible
note issued in connection with the acquisition of Management Adjustment
Bureau Inc. ("MAB") in September 1996, and 517,767 shares acquired by CRW
Financial, Inc. in connection with the acquisition by NCO of the Collection
Division of CRW Financial, Inc. ("CRWCD"). The Company received net
proceeds from the 1997 Offering, after underwriting discounts and expenses,
of approximately $40.4 million.
In June 1998, the Company completed a public offering (the "1998
Offering"), selling 4,978,476 shares of common stock at a price to the
public of $21.50 per share, including 4,469,366 shares (469,366 of which
were over-allotment shares exercised in July 1998) issued by the Company,
360,000 shares (180,000 of which were over-allotment shares exercised in
July 1998) sold by management and related shareholders and 149,110 shares
sold by certain non-management shareholders. The Company received net
proceeds from the 1998 Offering, after underwriting discounts and expenses,
of approximately $91.3 million.
As of December 31, 1997 and 1998, the Company had 4,897,000 shares of
nonvoting common stock authorized, of which 1,088,000 shares were issued
and 1,068,000 and 1,044,000 shares were outstanding, respectively. All of
the nonvoting common stock was converted into NCO common stock on March 31,
1999.
Common Stock Warrants
On May 30, 1997, JDR issued warrants to purchase 621,000 shares of
nonvoting common stock at a nominal value in connection with the sale of
capital stock and the JDR Credit Facility (see Note 6). All of the warrants
were exercised and converted into NCO common stock on March 31, 1999.
Treasury Stock
The Company had 44,000 shares of nonvoting common stock and 312,000 shares
of voting common stock in Treasury at December 31, 1998. All of the
treasury shares were retired on March 31, 1999.
16. Earnings per share:
Basic earnings per share were computed by dividing the net income
(including pro forma income taxes where applicable) for the years ended
December 31, 1996, 1997 and 1998 by the pro forma weighted average number
of shares outstanding. Pro forma net income amounts are used for 1996
because the historical net income does not include the impact of federal
and state income taxes as if the Company had been subject to income taxes.
Diluted earnings per share were computed by dividing the net income
(including pro forma income taxes where applicable), adjusted for the
effects of interest expense attributable to convertible debt, for the years
ended December 31, 1996, 1997 and 1998 by the weighted average number of
shares outstanding including common equivalent shares. All outstanding
options, warrants and convertible securities have been utilized in
calculating diluted net income per share, using the initial public offering
price of $8.67 per share for periods prior to the IPO, only when their
effect would be dilutive. For 1996, the pro forma weighted average number
of shares outstanding have also been adjusted to include the number of
shares of common stock (375,000 shares) that the Company would have needed
to issue at the initial public offering price of $8.67 per share to finance
the distribution of undistributed S Corporation earnings through the date
on which the Company terminated its S Corporation status.
F-31
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
16. Earnings per share (continued):
The reconciliation of basic to diluted earnings per share ("EPS") consists
of the following (amounts in thousands, except EPS amounts) (1996 are pro
forma for taxes):
<TABLE>
<CAPTION>
1996 1997 1998
-------------------- ------------------ --------------------
Shares EPS Shares EPS Shares EPS
--------- --------- --------- -------- ---------- ---------
<S> <C> <C> <C> <C> <C> <C>
Basic 7,630 $ 0.34 13,736 $ 0.22 18,324 $ 0.91
Dilutive effect of warrants -- -- 459 (0.01) 725 (0.03)
Dilutive effect of options -- -- 491 (0.01) 615 (0.03)
Dilutive effect of
preferred dividends -- -- 2 -- 30 --
Dilutive effect of
convertible notes 28 -- 120 -- 64 --
------ ------ ------ ------ ------ ------
Diluted 7,658 $ 0.34 14,808 $ 0.20 19,758 $ 0.85
====== ====== ====== ====== ====== ======
</TABLE>
17. Stock options:
In June 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan"). In September 1996, the Company adopted the 1996 Stock Option Plan
(the "1996 Plan") and the 1996 Non-Employee Director Stock Option Plan (the
"Director Plan") . The 1995 Plan and 1996 Plan, as amended, authorized
333,000 and 1,717,000 shares, respectively, of incentive or non-qualified
stock options. The Director Plan, as amended, authorized 186,000 shares.
The vesting periods for the outstanding options under the 1995 Plan, the
1996 Plan and the Director Plan are three years, three years and one year,
respectively. The maximum exercise period is ten years after the date of
grant.
In June 1997, JDR established the JDR Holdings, Inc. 1997 Stock Option Plan
(the "JDR Plan") for its employees, directors and certain other
individuals. The Company may grant incentive or non-qualified stock options
under the JDR Plan. An aggregate of 69,000 shares of common stock is
reserved for the JDR Plan. The Board of Directors administers the JDR Plan
and determines the terms of the option grants. Options vest as determined
by the Board (generally ratably over five years) and expire no later than
10 years.
F-32
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
17. Stock options (continued):
A summary of stock option activity since inception of the 1995 Plan, the
1996 Plan, the Director Plan, and the JDR Plan (collectively, the "Plans")
is as follows:
<TABLE>
<CAPTION>
Weighted
Average
Exercise
Number of Price
Options Per Share
------------ -----------
<S> <C> <C>
Outstanding at January 1, 1996 216,000 $ 1.82
Granted 442,000 9.25
------------ -----------
Outstanding at December 31, 1996 658,000 6.80
Granted 493,000 21.21
Exercised (50,000) 4.20
Forfeited (36,000) 10.72
------------ -----------
Outstanding at December 31, 1997 1,065,000 13.95
Granted 776,000 27.32
Exercised (230,000) 5.98
Forfeited (32,000) 19.78
------------ -----------
Outstanding at December 31, 1998 1,579,000 $ 21.44
============ ===========
Stock options exercisable at December 31, 1998 414,000 $ 15.10
============ ===========
</TABLE>
The following table summarizes information about fixed stock options
outstanding as of December 31, 1998:
<TABLE>
<CAPTION>
Stock Options Outstanding Stock Options Exercisable
------------------------------------------------- -----------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Prices Shares Remaining Life Exercise Price Shares Exercise Price
--------------------- ------------ ----------------- --------------- ----------- ---------------
<S> <C> <C> <C> <C> <C>
$ 1.82 27,000 6.41 years $ 1.82 27,000 $ 1.82
$ 8.66 to $12.09 355,000 7.85 years 9.54 214,000 9.71
$15.00 to $19.42 217,000 8.25 years 16.78 83,000 16.94
$21.00 to $25.00 582,000 9.33 years 22.62 63,000 23.25
$28.44 to $36.88 371,000 9.84 years 33.07 9,000 34.63
$45.00 to $57.71 27,000 8.96 years 49.66 18,000 51.94
--------- ---------- ------- ------- -------
1,579,000 8.91 years $ 21.44 414,000 $ 15.10
========= ========== ======= ======= =======
</TABLE>
F-33
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
17. Stock options (continued):
The Company applies APB Opinion 25 and related interpretations in
accounting for its stock option plans and, accordingly, does not recognize
compensation cost based on the fair value of the options granted at grant
date. If the Company had elected to recognize compensation cost based on
the fair value of the options granted at grant date, net income and
earnings per share for 1996, 1997 and 1998 would have been reduced to the
unaudited pro forma amounts indicated in the following table:
<TABLE>
<CAPTION>
1996 1997 1998
---------- ---------- -----------
<S> <C> <C> <C>
Net income - as reported $2,541,000 $4,591,000 $18,345,000
Net income - pro forma $2,483,000 $4,115,000 $17,264,000
Basic:
Earnings per share - as reported $0.34 $0.22 $0.91
Earnings per share - pro forma $0.33 $0.18 $0.85
Diluted:
Earnings per share - as reported $0.34 $0.20 $0.85
Earnings per share - pro forma $0.32 $0.17 $0.79
</TABLE>
The estimated weighted-average grant-date fair values of the options
granted during the years ended December 31, 1996, 1997 and 1998 were $4.35,
$6.53 and $9.86, respectively. All options granted were at the market price
of the stock on the grant date. For valuation purposes, the Company
utilized the Black-Scholes option pricing model using the following
assumptions on a weighted average basis for the options granted under the
1995 Plan, the 1996 Plan and the Director Plan:
1996 1997 1998
------ ------ ------
Risk-free interest rate 6.32% 6.19% 4.98%
Expected life in years 3.25 3.25 3.25
Volatility factor 32.16% 40.42% 43.38%
Dividend yield None None None
Forfeiture rate 5.00% 5.00% 5.00%
For valuation purposes, the Company utilized the Black-Scholes option
pricing model using the following assumptions on a weighted average basis
for the options granted under the JDR Plan: dividend yield of 0%, expected
volatility of 0%, risk-free interest rate of 6.6%, and an expected life of
10 years.
In May 1997, one senior executive of JDR exercised options to purchase
36,000 Nonvoting Common shares at $0.02 per share and one stockholder and
Director of JDR exercised options to purchase 13,000 Nonvoting Common
shares at $0.02 per share. These options were granted in November 1993. At
December 31, 1997 and 1998, the Company had 36,000 options outstanding to
purchase Nonvoting Common stock at $0.02 per share. These options were
granted in November 1993 to a senior executive of JDR.
On July 1997, a consultant to JDR received options to purchase 228,000
shares of Nonvoting Common stock at $11.54 per share. The original vesting
schedule of these options was 4% on January 1, 1998 and 1% on January 1,
1999, 2000 and 2001. These options became fully vested upon the completion
of the acquisition of JDR on March 31, 1999. The Company will record the
$960,975 value as expense as the options vest. For the year ended December
31, 1998, the Company recorded $686,410 as consulting expense for these
options. This consultant also served as a Director of JDR.
F-34
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
18. Fair value of financial instruments:
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate that value:
Cash and Cash Equivalents: The carrying amount reported in the balance
sheet approximates fair value because of the short maturity of these
instruments.
Debt: The Company's non-seller-financed debt is primarily variable in
nature and based on the prime rate, and accordingly, the carrying amount of
debt instruments approximates fair value. Seller-financed debt arising from
the Goodyear acquisition consists of a note payable which contains a
conversion option allowing the holder to convert the debt into shares of
common stock at a price of $14.12 per share. The seller-financed debt was
converted into 63,755 shares of common stock on February 15, 1999.
Accordingly, the fair value of the debt as of December 31, 1998 was
calculated using the closing market price of NCO's common stock on February
15, 1999.
Interest Rate Instruments: While it is not the Company's intention to
terminate any of the interest rate instruments, the fair value of the
instruments was estimated by obtaining quotes from brokers that represented
amounts the Company would have received or paid if the agreements were
terminated at December 31, 1998. These fair values indicated that the gains
or losses that would have resulted from the termination of the interest
rate swap agreement and the interest rate collar agreement at December 31,
1998 would have not been material.
Foreign Exchange Contracts: The fair value of foreign exchange contracts
at December 31, 1998 was not material.
The estimated fair value of the Company's financial instruments are as
follows at December 31:
<TABLE>
<CAPTION>
1997 1998
---------------------- ---------------------
Carrying Fair Carrying Fair
Amount Value Amount Value
-------- ------- -------- -----
<S> <C> <C> <C> <C>
Financial Assets:
Cash and cash equivalents $30,379,000 $30,379,000 $23,560,000 $23,560,000
Financial Liabilities:
Non-interest bearing note payable 92,000 92,000 36,000 36,000
Subordinated seller notes payable 1,000,000 1,000,000 500,000 500,000
Subordinated seller
notes payable, convertible 900,000 1,683,000 900,000 2,176,000
</TABLE>
19. Commitments and contingencies:
The Company is party, from time to time, to various legal proceedings
incidental to its business. In the opinion of management none of these
items individually or in the aggregate would have a significant effect on
the financial position, result of operations, cash flows, or liquidity of
the Company.
F-35
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
20. Transactions with related parties:
For the years ended December 31, 1997 and 1998, revenue includes $496,000
and $328,000 respectively, related to collection services provided to an
affiliate of a shareholder and $91,000 and $69,000, respectively, related
to telemarketing services provided to a company that is owned by two of the
Company's officers. At December 31, 1997 and 1998, accounts receivable
includes $172,000 and $0, respectively, due from these two companies.
The Company has an agreement with a shareholder to provide technical and
management assistance to the Company. This agreement provides for an annual
fee of $75,000. For the years ended December 31, 1997 and 1998, the Company
has charged to expense $44,000 and $75,000, respectively, pursuant to this
contract.
21. Other recent accounting pronouncements:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which is
effective for the fiscal years beginning after June 15, 1999. SFAS No. 133
requires that an entity recognize all derivative instruments as either
assets or liabilities on its balance sheet at their fair value. Changes in
the fair value of derivatives are recorded each period in current earnings
or other comprehensive income, depending on whether a derivative is
designated as part of a hedge transaction, and, if it is, the type of hedge
transaction. The Company will adopt SFAS No. 133 by the first quarter of
2000. Due to the Company's limited use of derivative instruments, SFAS No.
133 is not expected to have a material impact on the consolidated results
of operations, financial condition or cash flows of the Company.
22. Segment reporting:
As of December 31, 1998, the Company adopted Statement of Financial
Accounting Standards No. 131, "Disclosures about Segments of an Enterprise
and Related Information" ("SFAS 131"). SFAS 131 establishes standards for
reporting financial information about operating segments in annual
financial statements and requires reporting of selected information about
operating segments in interim financial reports issued to shareholders. It
also establishes standards for related disclosures about products and
services, geographic areas, and major customers. The adoption of SFAS 131
did not affect results of operations or financial position but did affect
the disclosure of segment information.
The accounting policies of the segments are the same as those described in
note 2, "Summary of significant accounting policies." Segment data includes
a charge allocating corporate overhead costs to each of the operating
segments based on revenue and employee headcount.
The Company is currently organized into market segment specific operating
divisions that are responsible for all aspects of client sales, client
service and operational delivery of services. The operating divisions,
which are each headed by a divisional chief executive officer, include
Accounts Receivable Management, Technology-Based Outsourcing Services,
Healthcare Services, Marketing Strategy and International Operations.
The Accounts Receivable Management division provides accounts receivable
management services to consumer and commercial accounts for all market
segments, serving clients of all sizes in local, regional and national
markets.
With the acquisition of JDR, the Technology-Based Outsourcing Services
division was created. This division continues the growth of the client
relationship beyond bad debt recovery and delinquency management,
delivering cost-effective receivables and customer relationship management
solutions.
F-36
<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
22. Segment reporting (continued):
The Healthcare Services division primarily focuses on providing
comprehensive outsourcing services for the hospital market. In addition,
the Healthcare Services division provides receivable management programs
for physician groups and allied health service providers.
The International Operations division provides accounts receivable
management services across Canada and the United Kingdom.
The Marketing Strategy division provides full-service custom market
research services to the telecommunications, financial services, utilities,
healthcare, pharmaceutical, and consumer products sectors. In addition, the
Marketing Strategy division provides telemarketing services for clients,
including lead generation and qualification, and the actual booking of
appointments for a client's sales representatives.
The following table represents the segment information for the year ended
December 31, 1996 (amounts in thousands):
<TABLE>
<CAPTION>
A/R Tech-Based Healthcare Intl. Marketing Consol. NCO
Mngmnt. Outsrcg. Services Operations Strategy Adj. Consol.
---------- ------------ ----------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue $ 30,760 - - - - $ - $ 30,760
Payroll and
Related expenses 14,651 - - - - - 14,651
Selling general and
admin. expenses 10,024 - - - - 8 10,032
-------- --------- -------- -------- ------- ---- --------
EBITDA $ 6,085 - - - - $ (8) $ 6,077
======== ========= ======== ======== ======= ==== ========
</TABLE>
The following table represents the segment information for the year ended
December 31, 1997 (amounts in thousands):
<TABLE>
<CAPTION>
A/R Tech-Based Healthcare Intl. Marketing Consol. NCO
Mngmnt. Outsrcg. Services Operations Strategy Adj. Consol.
---------- ------------ ----------- ----------- ---------- ---------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue $ 81,942 $ 17,778 - - $ 8,353 $ - $ 108,073
Payroll and
related expenses 40,549 10,945 - - 5,454 1 56,949
Selling general and
admin. expenses 27,041 5,888 - - 1,804 1,639 36,372
-------- --------- -------- -------- ------- -------- ---------
EBITDA $ 14,352 $ 945 - - $ 1,095 $ (1,640) $ 14,752
======== ========= ======== ======== ======= ======== =========
</TABLE>
The following table represents the segment information for the year ended
December 31, 1998 (amounts in thousands):
<TABLE>
<CAPTION>
A/R Tech-Based Healthcare Intl. Marketing Consol. NCO
Mngmnt. Outsrcg. Services Operations Strategy Adj. Consol.
----------- ------------ ----------- ----------- ---------- --------- -----------
<S> <C> <C> <C> <C> <C> <C> <C>
Revenue $127,419 $43,530 $ 20,442 $ 18,556 $ 20,005 $ - $ 229,952
Payroll and
Related expenses 63,023 22,932 9,930 10,902 12,527 - 119,314
Selling general and
admin. expenses 38,628 11,893 5,978 4,858 5,210 21 66,588
-------- ------- -------- -------- -------- ------ ---------
EBITDA $ 25,768 $ 8,705 $ 4,534 $ 2,796 $ 2,268 $ (21) $ 44,050
======== ======= ======== ======== ======== ====== =========
</TABLE>
F-37
