<PAGE>
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ Quarterly report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended September 30, 1999, or
/ / Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from to
COMMISSION FILE NUMBER 0-21639
NCO GROUP, INC.
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA
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(State or other jurisdiction of incorporation or organization)
515 Pennsylvania Avenue, Fort Washington, Pennsylvania
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(Address of principal executive offices)
23-2858652
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(IRS Employer Identification Number)
19034
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(Zip Code)
215-793-9300
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(Registrant's telephone number including area code)
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(Former name, former address and former fiscal
year, if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes X No
--- ---
The number of shares outstanding of each of the issuer's classes of
common stock was 25,374,145 shares common stock, no par value, outstanding as of
November 12, 1999.
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<PAGE>
NCO GROUP, INC.
INDEX
PAGE
Part I FINANCIAL INFORMATION
Item 1 CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets -
December 31, 1998 and September 30, 1999 3
Consolidated Statements of Income -
Three months and nine months ended
September 30, 1998 and 1999 4
Consolidated Statements of Cash Flows -
Nine months ended September 30, 1998 and 1999 5
Notes to Consolidated Financial Statements 6
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 15
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 20
PART II 21
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Shareholders
Item 5. Other Information
Item 6. Exhibits and Reports on 8-K
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<PAGE>
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Unaudited)
(Amounts in thousands)
<TABLE>
<CAPTION>
December 31, September 30,
ASSETS 1998 1999
------------ -------------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 23,560 $ 48,845
Accounts receivable, trade, net of allowance for
doubtful accounts of $3,998 and $5,284, respectively 54,443 84,003
Purchased accounts receivable 1,597 5,771
Deferred taxes 1,348 1,617
Other current assets 2,930 5,822
--------- --------
Total current assets 83,878 146,058
Funds held in trust for clients
Property and equipment, net 27,062 45,020
Other assets:
Intangibles, net of accumulated amortization 297,347 571,491
Other assets 6,522 6,024
--------- --------
Total other assets 303,869 577,515
--------- --------
Total assets $ 414,809 $768,593
========= ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 8,288 $ 2,054
Corporate taxes payable 7,737 18,007
Accounts payable 8,485 13,694
Accrued expenses 13,346 28,096
Accrued compensation and related expenses 10,507 18,280
--------- --------
Total current liabilities 48,363 80,131
Funds held in trust for clients
Long-term liabilities:
Long term debt, net of current portion 143,910 323,792
Deferred taxes 6,832 11,625
Other long-term liabilities 4,357 11,101
Redeemable preferred stock 11,882 -
Commitments and contingencies
Shareholders' equity:
Preferred stock 1,853 -
Common stock, no par value, 37,500 shares authorized,
20,100 and 25,189 shares issued, respectively, and
19,744 and 25,189 shares outstanding, respectively 177,835 300,962
Unexercised warrants 5,450 2,800
Foreign currency translation adjustment (2,169) (974)
Retained earnings 20,604 39,156
Treasury stock, at cost (4,108) -
--------- --------
Total shareholders' equity 199,465 341,944
--------- --------
Total liabilities and shareholders' equity $ 414,809 $768,593
========= ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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<PAGE>
NCO GROUP, INC.
Consolidated Statements of Income
(Unaudited)
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
For the Three Months Ended For the Nine Months Ended
September 30, September 30,
---------------------------- --------------------------
1998 1999 1998 1999
-------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue $ 63,585 $ 136,078 $ 156,126 $ 342,646
Operating costs and expenses:
Payroll and related expenses 33,173 71,465 80,782 181,077
Selling, general and administrative
expenses 18,767 37,105 45,544 94,339
Depreciation and amortization expense 2,725 6,386 6,375 15,749
Non-recurring acquisition costs - - - 4,601
-------- --------- --------- ---------
Total operating costs and expenses 54,665 114,956 132,701 295,766
-------- --------- --------- ---------
Income from operations 8,920 21,122 23,425 46,880
Other income (expense):
Interest and investment income 322 366 818 866
Interest expense (911) (5,869) (2,347) (13,126)
-------- --------- --------- ---------
Total other income (expense) (589) (5,503) (1,529) (12,260)
-------- --------- --------- ---------
Income before provision for income taxes 8,331 15,619 21,896 34,620
Income tax expense 3,951 6,717 9,145 15,691
-------- --------- --------- ---------
Net income 4,380 8,902 12,751 18,929
Accretion of preferred stock to redemption value (626) - (1,231) (377)
-------- --------- --------- ---------
Net income applicable to common shareholders $ 3,754 $ 8,902 $ 11,520 $ 18,552
======== ========= ========= =========
Net income per share:
Basic $ 0.19 $ 0.38 $ 0.65 $ 0.84
Diluted $ 0.17 $ 0.37 $ 0.61 $ 0.81
Weighted average shares outstanding:
Basic 20,289 23,169 17,641 22,034
Diluted 21,606 24,152 19,006 22,992
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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<PAGE>
NCO GROUP, INC.
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)
<TABLE>
<CAPTION>
For the Nine Months Ended
September 30,
------------------------------
1998 1999
---------- -------
<S> <C> <C>
Cash flows from operating activities:
Net income $12,751 $18,929
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 2,628 5,733
Amortization of intangibles 3,747 10,016
Write-off of deferred financing costs - 353
Provision for doubtful accounts 635 1,172
Compensation expense on stock options granted 652 34
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (6,697) (17,366)
Purchased accounts receivable 432 (4,174)
Deferred taxes 1,902 2,521
Other assets 749 (1,100)
Accounts payable and accrued expenses (1,330) 4,191
Corporate taxes payable 2,792 4,821
Other long-term liabilities 2,403 1,028
-------- --------
Net cash provided by operating activities 20,664 26,158
Cash flows from investing activities:
Purchase of property and equipment (5,977) (14,348)
Net cash paid for acquisitions (107,127) (130,897)
-------- --------
Net cash used in investing activities (113,104) (145,245)
Cash flows from financing activities:
Repayment of notes payable (1,181) (7,672)
Repayment of acquired notes payable (21,919) (42,000)
Borrowings under revolving credit agreement 109,279 196,965
Repayment of borrowings under revolving credit agreement (84,193) (4,000)
Payment of fees to acquire new debt (493) (3,565)
Issuance of common stock, net 91,281 4,588
Redemption of common stock, net (11) -
-------- --------
Net cash provided by financing activities 92,763 144,316
Effect of exchange rate on cash (659) 56
-------- --------
Net increase in cash and cash equivalents (336) 25,285
Cash and cash equivalents at beginning of period 30,379 23,560
-------- --------
Cash and cash equivalents at end of period $ 30,043 $ 48,845
======== ========
</TABLE>
The accompanying notes are an integral part of these
consolidated financial statements.
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<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. Nature of Operations:
NCO Group, Inc. (the "Company") is a leading provider of accounts receivable
management and other outsourced revenue cycle management 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, retail,
commercial, education, utilities, government and telecommunications sectors.
2. Summary of Significant Accounting Policies:
Interim Financial Information:
The accompanying consolidated financial statements have been prepared in
accordance with generally accepted accounting principles for interim financial
information and with the instructions for Form 10-Q and Rule 10-01 of Regulation
S-X. Accordingly, they do not include all of the information and footnotes
required by generally accepted accounting principles for complete financial
statements. In the opinion of management, all adjustments (consisting of only
normal recurring accruals) considered necessary for a fair presentation have
been included. Operating results for the three month period and nine month
period ended September 30, 1999 are not necessarily indicative of the results
that may be expected for the year ending December 31, 1999 or for any other
interim period. For further information, refer to the consolidated financial
statements and footnotes thereto included in the Company's Current Report on
Form 8-K/A filed with the Securities and Exchange Commission on June 11, 1999.
Principles of Consolidation:
The consolidated financial statements include the accounts of the Company and
its wholly-owned subsidiaries after elimination of significant intercompany
accounts and transactions.
Revenue Recognition:
The Company generates revenues from contingency fees and contractual services.
Contingency fee revenue is recognized upon collection of funds on behalf of
clients. Contractual services revenue is recognized as services are performed.
Income Taxes:
The Company accounts for income taxes using an 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.
Income taxes were computed after giving effect to the non-deductible portion of
goodwill expenses attributable to certain acquisitions and non-recurring
acquisition costs attributable to the acquisition of JDR Holdings, Inc. on March
31, 1999.
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.
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<PAGE>
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. Goodwill is amortized on a straight-line basis over
its estimated useful life. The estimated useful lives of goodwill ranges from 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.
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.
Reclassifications:
Certain amounts for December 31, 1998 and for the three months and nine months
ended September 30, 1998 have been reclassified for comparative purposes.
3. Acquisitions:
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 transaction was 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. The following
reconciles the amounts originally reported for revenue, net income applicable to
common shareholders and diluted net income per common share for the three months
and nine months ended September 30, 1998 to the restated amounts, and discloses
the amount of revenue and net income applicable to common shareholders
separately for each company for the period prior to the acquisition for the
three months and nine months ended September 30, 1999 (amounts in thousands,
except per share data):
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
----------------------------- -----------------------------
1998 1999 1998 1999
------------ ------------ ------------ -------------
<S> <C> <C> <C> <C>
Revenue:
NCO (as originally reported for 1998) $ 51,420 $136,078 $ 118,019 $ 328,169
JDR (for the period prior to the acquisition) 12,165 - 38,107 14,477
-------- ------- --------- ---------
Combined $ 63,585 $ 136,078 $ 156,126 $ 342,646
======== ========= ========= =========
Net income applicable to common shareholders:
NCO (as originally reported for 1998) $ 4,324 $ 8,902 $ 9,914 $ 21,668
JDR (for the period prior to the acquisition) (570) - 1,606 578
Non-recurring acquisition costs, net of taxes - - - (3,694)
-------- ------- --------- ---------
Combined $ 3,754 $ 8,902 $ 11,520 $ 18,552
======== ======= ========= =========
Diluted net income per share:
NCO (as originally reported) $ 0.24 $ 0.63
JDR (0.07) (0.02)
======== =========
Combined $ 0.17 $ 0.61
======== =========
</TABLE>
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<PAGE>
For the nine months ended September 30, 1999, the Company incurred $4.6 million
of non-recurring acquisition costs in connection with the JDR acquisition. These
costs consisted primarily of investment banking, accounting, and legal fees, and
printing costs. Theses costs were predominantly non-deductible for tax purposes
and as a result, in conjunction with the amortization expense from
non-deductible goodwill, caused the effective tax rate to increase from 42.0%
for the year ended December 31, 1998 to 45.3% for the nine months ended
September 30, 1999.
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 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.
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 in cash plus a performance based earn-out.
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.
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.
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.
On May 21, 1999, the Company acquired all of the outstanding stock of Co-Source
Corporation ("Co-Source") for approximately $122.7 million in cash plus a
warrant to purchase 250,000 shares of NCO common stock. The purchase price was
valued at approximately $124.6 million. The allocation of the fair market value
to the acquired assets and liabilities of Co-Source was based on preliminary
estimates and may be subject to change.
On August 20, 1999, the Company acquired all of the outstanding shares of
Compass International Services Corporation ("Compass") for approximately 3.3
million shares of NCO common stock and stock options to purchase approximately
215,000 shares of NCO common stock. The purchase price was valued at
approximately $103.0 million. The allocation of the fair market value to the
acquired assets and liabilities of Compass was based on preliminary estimates
and may be subject to change.
The following summarizes the unaudited pro forma results of operations for the
nine months ended September 30, 1998 and 1999, 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:
For the nine months ended
September 30,
-------------------------
1998 1999
--------- ---------
Revenue $ 389,099 $ 432,279
Net income $ 10,216 $ 16,952
Earnings per share - basic $ 0.38 $ 0.68
Earnings per share - diluted $ 0.36 $ 0.66
-8-
<PAGE>
4. Comprehensive Income:
Comprehensive income consists of net income from operations, plus certain
changes in assets and liabilities that are not included in net income but are
reported as a separate component of shareholders' equity under generally
accepted accounting principles. The Company's comprehensive income is as follows
(amounts in thousands):
<TABLE>
<CAPTION>
For the three months For the nine months
ended September 30, ended September 30,
------------------------- --------------------------
1998 1999 1998 1999
----------- ------------ ------------ ------------
<S> <C> <C> <C> <C>
Net income $ 4,380 $ 8,902 $ 12,751 $ 18,929
Foreign currency translation adjustment
(392) 182 (658) 1,195
--------- --------- --------- ---------
Comprehensive income $ 3,988 $ 9,084 $ 12,093 $ 20,124
========= ========= ========= =========
</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 $32.2 million and $50.8 million at December
31, 1998 and September 30, 1999, respectively, have been shown net of their
offsetting liability for financial statement presentation purposes.
6. Long-Term Debt:
In May 1999, 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 $350.0 million, structured as a $350.0 million revolving credit
facility. Borrowings bear interest at a rate equal to, at the option of the
Company, Mellon Bank's prime rate plus a margin from 0.00% to 0.25% depending on
the Company's consolidated funded debt to earnings before interest, taxes,
depreciation and amortization ("EBITDA") ratio (Mellon Bank's prime rate was
8.25% at September 30, 1999) or LIBOR plus a margin from 1.00% to 2.00%
depending on the Company's consolidated funded debt to EBITDA ratio (LIBOR was
5.40% at September 30, 1999). Borrowings are collateralized by substantially all
the assets of the Company. The balance under the revolving credit facility 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.
Prior to the acquisition on March 31, 1999, 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.
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<PAGE>
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 Note 7) and $2.7 million was
repaid with borrowings under the JDR Credit Facility.
On February 15, 1999, the $900,000 convertible note issued in connection with
the Goodyear acquisition was converted into 63,755 shares of NCO common stock.
7. Redeemable Preferred Stock:
<TABLE>
<CAPTION>
December 31,
1998
---------------
<S> <C>
Redeemable Series A Preferred stock, no par value, 416,645 shares
authorized, 271,148 shares issued and outstanding $ 5,394,000
Convertible Series A Preferred stock, no par value, 554,970 shares
authorized, 362,725 shares issued and outstanding 4,601,000
Convertible Series B Preferred stock, no par value, 204,033 shares
authorized, 148,758 shares issued and outstanding 1,887,000
==============
$ 11,882,000
==============
</TABLE>
JDR issued 271,148 shares of Redeemable Series A stock to repay $6.6 million of
borrowings under the JDR Bridge Loan (see Note 6) 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.
JDR issued 37,986 shares of Series A Preferred stock to repay $438,000 of
borrowings under the JDR Bridge Loan (see Note 6). In addition, JDR issued
12,660 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. In addition, the holders of the Series A
Preferred stock could have 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 125,227 shares of Series B Preferred stock to repay $1.3 million of
borrowings under the JDR Bridge Loan (see Note 6) 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. 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.
-10-
<PAGE>
8. Shareholders' Equity:
Preferred Stock
At December 31, 1998, JDR had 236,678 shares designated as Series C Preferred
stock, of which 146,091 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. JDR 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.
The Series C Preferred stock had a liquidation value of $1.9 million, including
dividends of $167,000, at December 31, 1998. All of the Series C Preferred stock
was converted into NCO common stock on March 31, 1999.
Nonvoting Common Stock
At December 31, 1998, JDR had 4,896,795 shares of nonvoting common stock
authorized, of which 1,088,000 shares were issued and 1,044,000 shares were
outstanding. 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 620,841 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.
On May 21, 1999, the Company issued warrants to purchase a total of 250,000
shares of common stock at an exercise price of $32.97 per share as part of the
purchase price from the Co-Source Corporation acquisition. The warrants expire
on May 20, 2009.
Treasury Stock
JDR 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.
9. Earnings Per Share:
Basic earnings per share was computed by dividing the net income available to
common shareholders for the three months and nine months ended September 30,
1998 and 1999 by the weighted average number of shares outstanding. Diluted
earnings per share were computed by dividing the net income available to common
shareholders for the three months and nine months ended September 30, 1998 and
1999 by the weighted average number of shares outstanding including all common
equivalent shares. The diluted earnings per share computations for the three
months and nine months ended September 30, 1998 and the nine months ended
September 30, 1999 have also been adjusted for the effects of interest expense
attributable to convertible debt. Outstanding options, warrants and convertible
securities have been utilized in calculating diluted net income per share only
when their effect would be dilutive.
-11-
<PAGE>
The reconciliation of basic to diluted earnings per share ("EPS") consists of
the following (amounts in thousands, except per share amounts):
<TABLE>
<CAPTION>
For the three months ended For the nine months ended
September 30, September 30,
----------------------------------------- -----------------------------------------
1998 1999 1998 1999
-------------------- -------------------- -------------------- --------------------
Shares EPS Shares EPS Shares EPS Shares EPS
--------- ---------- --------- ---------- --------- ---------- --------- ----------
<S> <C> <C> <C> <C> <C> <C> <C> <C>
Basic 20,289 $ 0.19 23,169 $ 0.38 17,641 $ 0.65 22,034 $ 0.84
Dilutive effect of warrants 725 (0.01) 266 - 730 (0.02) 203 (0.01)
Dilutive effect of options 528 (0.01) 717 (0.01) 571 (0.02) 744 (0.02)
Dilutive effect of
convertible notes 64 - - - 64 - 11 -
-------- --------- ------- -------- ------- --------- ------- ---------
Diluted 21,606 $ 0.17 24,152 $ 0.37 19,006 $ 0.61 22,992 $ 0.81
======== ========= ======= ======== ======= ======== ======= =========
</TABLE>
10. Supplemental Cash Flow Information:
The following are supplemental disclosures of cash flow information for the
nine months ended September 30, 1998 and 1999 (amounts in
thousands):
<TABLE>
<CAPTION>
1998 1999
----------- -----------
<S> <C> <C>
Non-cash investing and financing activities:
Fair value of assets acquired $ 40,772 $ 30,339
Liabilities assumed from acquisitions 39,653 52,422
Common stock issued for acquisitions - 101,526
Stock options issued for acquisitions - 1,500
Convertible note payable, exercised for
common stock - 900
Warrants issued for acquisitions - 1,925
Warrants exercised 247 4,575
</TABLE>
11. 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 Services, Technology-Based Outsourcing Services, Healthcare Services,
Commercial Services, International Operations and Marketing Strategy.
-12-
<PAGE>
The Accounts Receivable Management division provides accounts receivable
management and collection services to consumer 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 to all market
segments, serving clients of all sizes in local, regional and national markets.
The Healthcare Services division primarily focuses on providing comprehensive
outsourcing services for the hospital market. In addition, the Healthcare
Services division provides receivable management programs for physician groups
and allied health service providers.
With the acquisition of Co-Source, the Commercial Services division was created.
The Commercial Services division focuses on providing accounts receivable
management and collection services to the commercial market.
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 tables represent the revenue, payroll and related expenses,
selling general and administrative expenses, and earnings before interest,
taxes, depreciation and amortization ("EBITDA") for each segment for the three
and nine months ended September 30, 1998 and 1999. EBITDA is used by the
Company's management to measure the segments' operating performance and is not
intended to report the segments' operating results in conformity with generally
accepted accounting principles.
<TABLE>
<CAPTION>
For the three months ended September 30, 1998
(amounts in thousands)
-------------------------------------------------------------------------
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
----------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C>
A/R Management $35,018 $17,331 $10,588 $ 7,099
Tech-Based Outsourcing 10,532 5,779 3,152 1,601
Healthcare Services 6,154 2,878 1,954 1,322
Commercial Services -- -- -- --
International Operations 6,925 4,105 1,780 1,040
Marketing Strategy 4,956 3,080 1,293 583
------- ------- ------- -------
Total $63,585 $33,173 $18,767 $11,645
======= ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
For the three months ended September 30, 1999
(amounts in thousands)
-------------------------------------------------------------------------
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
---------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C>
A/R Management $ 46,716 $ 22,572 $ 13,890 $ 10,254
Tech-Based Outsourcing 16,360 8,573 4,603 3,184
Healthcare Services 36,000 19,080 9,898 7,022
Commercial Services 20,072 11,723 3,994 4,355
International Operations 7,952 4,579 2,093 1,280
Marketing Strategy 8,978 4,938 2,627 1,413
--------- --------- ---------- ---------
Total $ 136,078 $ 71,465 $ 37,105 $ 27,508
========= ========= ========== =========
</TABLE>
-13-
<PAGE>
<TABLE>
<CAPTION>
For the nine months ended September 30, 1998
(amounts in thousands)
-------------------------------------------------------------------------
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
----------------- ------------------ ------------------ -----------------
<S> <C> <C> <C> <C>
A/R Management $92,181 $45,699 $27,900 $18,582
Tech-Based Outsourcing 33,416 17,381 9,177 6,858
Healthcare Services 6,154 2,878 1,954 1,322
Commercial Services -- -- -- --
International Operations 11,259 6,470 3,119 1,670
Marketing Strategy 13,116 8,354 3,394 1,368
-------- ------- ------- -------
Total $156,126 $80,782 $45,544 $29,800
======== ======= ======= =======
</TABLE>
<TABLE>
<CAPTION>
For the nine months ended September 30, 1999
(amounts in thousands)
-------------------------------------------------------------------------
Selling Non-
Payroll and General and Recurring
Related Admin. Acquisition
Revenue Expenses Expenses Costs EBITDA
-------------- -------------- --------------- -------------- --------------
<S> <C> <C> <C> <C> <C>
A/R Management $ 123,570 $ 60,342 $ 36,104 $ - $ 27,124
Tech-Based Outsourcing 41,189 22,285 10,935 - 7,969
Healthcare Services 103,013 54,739 28,965 - 19,309
Commercial Services 29,403 17,076 6,195 - 6,132
International Operations 23,408 13,597 6,349 - 3,462
Marketing Strategy 22,063 13,038 5,791 - 3,234
Other - - - 4,601 (4,601)
---------- -------- -------- -------- ---------
Total $ 342,646 $181,077 $ 94,339 $ 4,601 $ 62,629
========== ======== ======== ======== =========
</TABLE>
12. Recent Accounting Pronouncements:
In June 1998, the Financial Accounting Standards Board issued SFAS No. 133,
"Accounting for Derivative Instruments and Hedging Activities," which was
subsequently amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133"
(collectively "SFAS No. 133"). SFAS No. 133 is effective for the fiscal years
beginning after June 15, 2000 and 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 2001. 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.
-14-
<PAGE>
Item 2
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Certain statements included in this Report on Form 10-Q, other than
historical facts, are forward-looking statements (as such term is defined in the
Securities Exchange Act of 1934, and the regulations thereunder) 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 focus on internal growth, strategic acquisitions and alliances, and
integration, fluctuations in quarterly operating results, 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 risks associated with growth
and future acquisitions, risks relating to year 2000 compliance and the other
risks detailed from time to time in the Company's filings with the Securities
and Exchange Commission, including the Company's Annual Report on Form 10-K,
filed on March 31, 1999, and the Company's Registration Statement on Form S-3,
filed on September 3, 1999, can cause actual results and developments to be
materially different from those expressed or implied by such forward-looking
statements.
A copy of the Annual Report on Form 10-K can be obtained, without charge
except for exhibits, by written request to Steven L. Winokur, Executive Vice
President, Finance/CFO, NCO Group, Inc., 515 Pennsylvania Avenue, Ft.
Washington, PA 19034.
Three Months Ended September 30, 1999 Compared to Three Months Ended
September 30, 1998
Revenue. Revenue increased $72.5 million or 114.0% to $136.1 million for
the three months ended September 30, 1999 from $63.6 million for the comparable
period in 1998. $14.5 million of the increase was attributable to the addition
of new clients and growth in business from existing clients. The $14.5 million
increase includes $3.8 million attributable to JDR Holdings, Inc. ("JDR") which
was acquired on March 31, 1999 and was accounted for under the
pooling-of-interests method of accounting. The remainder of the increase was
attributable to the following: $11.2 million was attributable to the acquisition
of Compass International Services Corporation ("Compass") on August 20, 1999;
$17.4 million was attributable to the acquisition of Co-Source Corporation
("Co-Source") on May 21, 1999; $28.4 million was attributable to the acquisition
of Medaphis Services Corporation ("MSC") on November 30, 1998; and $1.0 million
was attributable to the acquisition of FCA International Ltd. ("FCA") on May 5,
1998.
Payroll and related expenses. Payroll and related expenses increased $38.3
million to $71.5 million for the three months ended September 30, 1999 from
$33.2 million for the comparable period in 1998, and slightly increased as a
percentage of revenue to 52.5% from 52.2%. Payroll and related expenses
increased as a percentage of revenue primarily as a result of higher payroll
costs from the MSC, JDR, Co-Source and Compass acquisitions during their
transition into the NCO operating cost model. In addition, the market research
division and the commercial services division have higher payroll cost
structures than that of the remainder of the Company. These increases were
partially offset by spreading the cost of management and administrative
personnel over a larger revenue base.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $18.3 million to $37.1 million for the three
months ended September 30, 1999 from $18.8 million for the comparable period in
1998, but decreased as a percentage of revenue to 27.3% from 29.5%. The decrease
as a percentage of revenue was, in part, the result of additional operating
efficiencies obtained when selling, general and administrative expenses were
spread over a larger revenue base. In addition, a portion of the decrease was
attributable to the market research division and the commercial services
division having lower selling, general and administrative expense structures
than that of the Company's core business. These decreases as a percentage of
revenue were partially offset by the higher cost structures of some of the
acquired companies.
-15-
<PAGE>
Depreciation and amortization. Depreciation and amortization increased to
$6.4 million for the three months ended September 30, 1999 from $2.7 million for
the comparable period in 1998. Of this increase, $385,000 was attributable to
the Compass acquisition, $784,000 was attributable to the Co-Source acquisition,
$687,000 was attributable to the MSC acquisition, and $239,000 was attributable
to the FCA acquisition. The remaining $1.6 million primarily consisted of
depreciation resulting from normal capital expenditures incurred in the ordinary
course of business.
Other income (expense). Interest and investment income increased $44,000 to
$366,000 for the three months ended September 30, 1999 from $322,000 for the
comparable period in 1998. Interest expense increased to $5.9 million for the
three months ended September 30, 1999 from $911,000 for the comparable period in
1998. The increase was primarily attributable to the Company financing a portion
of the MedSource acquisition and all of the MSC and Co-Source acquisitions with
borrowings of $25.5 million, $107.5 million and $126.2 million, respectively,
under the revolving credit facility. Additionally, a portion of the increase was
attributable to borrowings under the revolving credit facility of $29.5 million
that were used to repay debt that was assumed as a result of the Compass
acquisition.
Income tax expense. Income tax expense increased to $6.7 million, or 43.0%
of income before taxes, for the three months ended September 30, 1999 from $4.0
million, or 47.4% of income before taxes, for the comparable period in 1998. The
decrease in the effective tax rate was primarily attributable to the increase in
net income diluting the effects of the non-deductible goodwill related to
certain acquisitions.
Net income. Net income increased $4.5 million or 103.2% to $8.9 million for
the three months ended September 30, 1999 from $4.4 million for the comparable
period in 1998.
Accretion of preferred stock to redemption value. The accretion of
preferred stock to the redemption value in the third quarter of 1998 relates to
JDR's preferred stock that was outstanding prior to its conversion into NCO
common stock on March 31, 1999. This non-cash accretion represents the periodic
amortization of the difference between the original carrying amount and the
mandatory redemption amount.
Nine Months Ended September 30, 1999 Compared to Nine Months Ended
September 30, 1998
Revenue. Revenue increased $186.5 million or 119.5% to $342.6 million for
the nine months ended September 30, 1999 from $156.1 million for the comparable
period in 1998. $33.2 million of the increase was attributable to the addition
of new clients and growth in business from existing clients. The $33.2 million
increase includes $7.0 million attributable to JDR which was acquired on March
31, 1999 and was accounted for under the pooling-of-interests method of
accounting. The remainder of the increase was attributable to the following:
$11.2 million was attributable to the acquisition of Compass; $25.0 million was
attributable to the acquisition of Co-Source; $84.3 million was attributable to
the acquisition of MSC; $13.0 million was attributable to the acquisition of
MedSource; and $19.8 million was attributable to the acquisition of FCA.
Payroll and related expenses. Payroll and related expenses increased $100.3
million to $181.1 million for the nine months ended September 30, 1999 from
$80.8 million for the comparable period in 1998, and increased as a percentage
of revenue to 52.8% from 51.7%. Payroll and related expenses increased as a
percentage of revenue primarily as a result of higher payroll costs from the
MSC, JDR, Co-source and Compass acquisitions during their transition into the
NCO operating cost model. In addition, the market research division and the
commercial services division have higher payroll cost structures than that of
the remainder of the Company. These increases were partially offset by spreading
the cost of management and administrative personnel over a larger revenue base.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $48.8 million to $94.3 million for the nine
months ended September 30, 1999 from $45.5 million for the comparable period in
1998, but decreased as a percentage of revenue to 27.5% from 29.2%. The decrease
as a percentage of revenue was, in part, the result of additional operating
efficiencies obtained when selling, general and administrative expenses were
spread over a larger revenue base. In addition, a portion of the decrease was
attributable to the market research division and the commercial services
division having lower selling, general and administrative expense structures
than that of the Company's core business. These decreases as a percentage of
revenue were partially offset by the higher cost structures of some of the
acquired companies.
-16-
<PAGE>
Depreciation and amortization. Depreciation and amortization increased to
$15.7 million for the nine months ended September 30, 1999 from $6.4 million for
the comparable period in 1998. Of this increase, $385,000 was attributable to
the Compass acquisition, $1.0 million was attributable to the Co-Source
acquisition, $2.1 million was attributable to the MSC acquisition, $707,000 was
attributable to the MedSource acquisition, and $1.2 million was attributable to
the FCA acquisition. The remaining $3.9 million primarily consisted of
depreciation resulting from normal capital expenditures incurred in the ordinary
course of business.
Non-recurring acquisition costs. In the first quarter of 1999, the Company
incurred $4.6 million of non-recurring acquisition costs in connection with the
acquisition of JDR. These costs consisted primarily of investment banking,
legal, and accounting fees, and printing costs.
Other income (expense). Interest and investment income increased $48,000 to
$866,000 for the nine months ended September 30, 1999 from $818,000 for the
comparable period in 1998. Interest expense increased to $13.1 million for the
nine months ended September 30, 1999 from $2.3 million for the comparable period
in 1998. The increase was primarily attributable to the Company financing a
portion of the MedSource acquisition and all of the MSC and Co-Source
acquisitions with borrowings of $25.5 million, $107.5 million and $126.2
million, respectively, under the revolving credit facility. Additionally, a
portion of the increase was attributable to borrowings under the revolving
credit facility of $29.5 million that were used to repay debt that was assumed
as a result of the Compass acquisition.
Income tax expense. Income tax expense increased to $15.7 million, or 45.3%
of income before taxes, for the nine months ended September 30, 1999 from $9.1
million, or 41.8% of income before taxes, for the comparable period in 1998. The
increase in the effective tax rate was partially attributable to the $4.6
million of non-recurring acquisition costs, a portion of which were
non-deductible for tax purposes, incurred in the first quarter of 1999. In
addition, the increase in the effective tax rate was also related to the impact
of the non-deductible goodwill related to certain acquisitions.
Net income. Net income increased $6.1 million or 48.5% to $18.9 million for
the nine months ended September 30, 1999 from $12.8 million for the comparable
period in 1998. Included in net income for the nine months ended September 30,
1999 was $3.4 million of expenses attributable to the non-recurring acquisition
costs net of taxes. Without these costs, net income would have been $22.4
million or $0.96 per share on a diluted basis, an increase of $9.6 million or
75.3%.
Accretion of preferred stock to redemption value. The accretion of
preferred stock to the redemption value relates to JDR's preferred stock that
was outstanding prior to its conversion into NCO common stock on March 31, 1999.
This non-cash accretion represents the periodic amortization of the difference
between the original carrying amount and the mandatory redemption amount.
Liquidity and Capital Resources
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.
In June 1998, the Company completed a public offering (the "1998
Offering"), selling 4.0 million 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.
-17-
<PAGE>
Cash provided by operating activities was $26.2 million during the nine
months ended September 30, 1999 compared to $20.7 million for the comparable
period in 1998. The increase in cash provided by operating activities was
primarily due the increase in net income to $18.9 million for the nine months
ended September 30, 1999 compared to $12.8 million for the comparable period in
1998, and the increase in depreciation and amortization, to $15.7 million for
the nine months ended September 30, 1999 compared to $6.4 million for the
comparable period in 1998. Additionally, a portion of the increase was
attributable to a $4.2 million increase in accounts payable and accrued expenses
for the nine months ended September 30, 1999 as compared to a decrease of $1.3
million for the comparable period in 1998. These increases were partially offset
by a $17.4 million increase in accounts receivable for the nine months ended
September 30, 1999 as compared to an increase of $6.3 million for the comparable
period in 1998, and a $4.2 million increase in purchased accounts receivable for
the nine months ended September 30, 1999 as compared to a decrease of $432,000
for the comparable period in 1998. In addition a portion of the increase was
offset by $4.6 million of non-recurring acquisition costs paid in the second
quarter of 1999 as a result of the acquisition of JDR on March 31, 1999.
Cash used in investing activities was $145.2 million during the nine months
ended September 30, 1999 compared to $113.1 million for the comparable period in
1998. The increase was primarily due to the cash portion of the purchase price
of Co-Source and the acquisition related expenses from MSC and Compass paid
during the first nine months of 1999 compared to the cash portion of the
purchase prices for the acquisitions of AFECD, TRC, FCA and MedSource during the
first nine months of 1998.
During the nine months ended September 30, 1999, capital expenditures were
$14.3 million compared to $6.0 million for the comparable period in 1998.
Cash provided by financing activities was $144.3 million during the nine
months ended September 30, 1999 compared to $92.8 million for the comparable
period in 1998. This increase was primarily attributable to the borrowings under
the Company's revolving credit facility during the first nine months of 1999
that were used to finance the acquisition of Co-Source and repay debt that was
assumed as a result of the Compass acquisition compared to the borrowings under
the Company's revolving credit facility during the first nine months of 1998
that were used to finance the acquisition of MSC.
In May 1999, 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 $350.0 million, structured as a $350.0 million revolving credit
facility. Borrowings bear interest at a rate equal to, at the option of the
Company, Mellon Bank's prime rate plus a margin from 0.00% to 0.25% depending on
the Company's consolidated funded debt to EBITDA ratio (Mellon Bank's prime rate
was 8.25% at September 30, 1999) or LIBOR plus a margin from 1.00% to 2.00%
depending on the Company's consolidated funded debt to EBITDA ratio (LIBOR was
5.40% at September 30, 1999). Borrowings are collateralized by substantially all
the assets of the Company. The balance under the revolving credit facility 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.
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.
However, the Company could require additional debt or equity financing if it
were to make any other significant acquisitions for cash during that period.
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.
-18-
<PAGE>
Goodwill
The Company's balance sheet includes amounts designated as "goodwill."
Goodwill represents the excess of purchase price over the fair market value of
the net assets of the acquired businesses based on their respective fair values
at the date of acquisition. GAAP requires that this and all other intangible
assets be amortized over the period benefited. Management has determined that
period to range from 15 to 40 years based on the attributes of each acquisition.
As of September 30, 1999, the Company's balance sheet included goodwill
that represented approximately 73.5% of total assets and 165.2% of shareholders'
equity.
If management has incorrectly overestimated the 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. In addition, the testing and acceptance procedures have been
completed. 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 has identified the issues and reviewed
them with its external suppliers. As a result, a contingency plan was developed
that includes procedures designed to: (i) re-route inbound and outbound
telephone calls; (ii) switch to alternative providers of telecommunications
services; (iii) utilize power generators at certain facilities; and (iv) arrange
for alternative transportation for employees dependent on public transportation.
As of September 30, 1999, the Company has incurred total pre-tax expenses
of approximately $1.1 million 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 remainder of 1999 and for 2000, the
Company expects to incur total pre-tax expenses of approximately $503,000 and
$185,000, 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.
-19-
<PAGE>
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 was
subsequently amended by SFAS No. 137, "Accounting for Derivative Instruments and
Hedging Activities - Deferral of the Effective Date of FASB Statement No. 133"
(collectively "SFAS No. 133"). SFAS No. 133 is effective for the fiscal years
beginning after June 15, 2000 and 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 2001. 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.
Item 3
Quantitative and Qualitative Disclosures about Market Risk
Included in Item 2, Management's Discussion and Analysis of Financial
Condition and Results of Operations, of this Report on Form 10-Q.
-20-
<PAGE>
Part II. Other Information
Item 1. Legal Proceedings
-----------------
The Company is involved in legal proceedings from time to time in the
ordinary course of its business. Management believes that none of these
legal proceedings will have a materially adverse effect on the financial
condition or results of operations of the Company.
Item 2. Changes in Securities
---------------------
None - not applicable
Item 3. Defaults Upon Senior Securities
-------------------------------
None - not applicable
Item 4. Submission of Matters to a Vote of Shareholders
-----------------------------------------------
None - not applicable
Item 5. Other Information
-----------------
None - not applicable
Item 6. Exhibits and Reports on 8-K
---------------------------
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
Date of Report Item Reported
-------------- -------------
9/1/99 Item 2 and Item 7 - Compass International
Services Corporation acquisition
-21-
<PAGE>
Signatures
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: November 15, 1999 By: /s/ Michael J. Barrist
------------------------------------
Michael J. Barrist
Chairman of the Board, President
and Chief Executive Officer
(principal executive officer)
Date: November 15, 1999 By: /s/ Steven L. Winokur
------------------------------------
Steven L. Winokur
Executive Vice President, Finance,
Chief Financial Officer and
Treasurer
-22-
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