<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 June 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 ____________
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COMMISSION FILE NUMBER 0-21639
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NCO GROUP, INC.
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA
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(State or other jurisdiction of incorporation or organization)
515 Pennsylvania Avenue, Fort Washington, Pennsylvania
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(Address of principal executive offices)
23-2858652
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(IRS Employer Identification Number)
19034
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(Zip Code)
215-793-9300
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(Registrant's telephone number including area code)
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days. Yes _X_ No ___
The number of shares outstanding of each of the issuer's classes of
common stock was 21,595,406 shares common stock, no par value, outstanding as of
August 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 June 30, 1999 3
Consolidated Statements of Income -
Three months and six months ended
June 30, 1998 and 1999 4
Consolidated Statements of Cash Flows -
Six months ended June 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 16
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 21
PART II 22
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, June 30,
ASSETS 1998 1999
------------ ---------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 23,560 $ 30,972
Accounts receivable, trade, net of allowance for
doubtful accounts of $3,998 and $4,235, respectively 54,443 70,417
Purchased accounts receivable 1,597 4,143
Deferred taxes 1,348 740
Other current assets 2,930 4,964
-------- --------
Total current assets 83,878 111,236
Funds held in trust for clients
Property and equipment, net 27,062 34,195
Other assets:
Intangibles, net of accumulated amortization 297,347 441,182
Other assets 6,522 5,506
-------- --------
Total other assets 303,869 446,688
-------- --------
Total assets $414,809 $592,119
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 8,288 $ 866
Corporate taxes payable 7,737 8,126
Accounts payable 8,485 7,012
Accrued expenses 13,346 20,249
Accrued compensation and related expenses 10,507 11,948
-------- --------
Total current liabilities 48,363 48,201
Funds held in trust for clients
Long-term liabilities:
Long-term debt, net of current portion 143,910 298,347
Deferred taxes 6,832 9,052
Other long-term liabilities 4,357 10,931
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 21,509 shares issued , respectively, and
19,744 and 21,509 shares outstanding, respectively 177,835 193,690
Unexercised warrants 5,450 2,800
Foreign currency translation adjustment (2,169) (1,156)
Retained earnings 20,604 30,254
Treasury stock, at cost (4,108) -
-------- --------
Total shareholders' equity 199,465 225,588
-------- --------
Total liabilities and shareholders' equity $414,809 $592,119
======== ========
</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
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NCO GROUP, INC.
Consolidated Statements of Income
(Unaudited)
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
For the Three Months Ended For the Six Months Ended
June 30, June 30,
--------------------------- ---------------------------
1998 1999 1998 1999
------- -------- ------- --------
<S> <C> <C> <C> <C>
Revenue $51,935 $110,704 $92,541 $206,568
Operating costs and expenses:
Payroll and related expenses 26,821 58,552 47,609 109,612
Selling, general and administrative
expenses 14,588 30,319 26,777 57,234
Depreciation and amortization expense 2,008 4,944 3,650 9,363
Non-recurring acquisition costs -- -- -- 4,601
------- -------- ------- --------
Total operating costs and expenses 43,417 93,815 78,036 180,810
------- -------- ------- --------
Income from operations 8,518 16,889 14,505 25,758
Other income (expense):
Interest and investment income 264 281 496 500
Interest expense (996) (4,258) (1,436) (7,257)
------- -------- ------- --------
Total other income (expense) (732) (3,977) (940) (6,757)
------- -------- ------- --------
Income before provision for income taxes 7,786 12,912 13,565 19,001
Income tax expense 3,135 5,391 5,194 8,974
------- -------- ------- --------
Net income 4,651 7,521 8,371 10,027
Accretion of preferred stock to redemption value (304) -- (605) (377)
------- -------- ------- --------
Net income applicable to common shareholders $ 4,347 $ 7,521 $ 7,766 $ 9,650
======= ======== ======= ========
Net income per share:
Basic $0.26 $0.35 $0.48 $0.45
Diluted $0.24 $0.34 $0.44 $0.43
Weighted average shares outstanding:
Basic 17,009 21,492 16,317 21,466
Diluted 18,387 22,347 17,706 22,411
</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
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NCO GROUP, INC.
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)
<TABLE>
<CAPTION>
For the Six Months Ended
June 30,
---------------------------
1998 1999
------- --------
<S> <C> <C>
Cash flows from operating activities:
Net income $ 8,371 $ 10,027
Adjustments to reconcile net income
to net cash provided by operating activities:
Depreciation 1,646 3,461
Amortization of intangibles 2,007 5,907
Write-off of deferred financing costs -- 353
Provision for doubtful accounts 243 462
Compensation expense on stock options granted 618 34
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (3,700) (13,447)
Purchased accounts receivable 230 (2,546)
Deferred taxes 567 221
Other assets 2,699 (812)
Accounts payable and accrued expenses (1,743) (1,536)
Corporate taxes payable 1,857 469
Other long-term liabilities -- 612
------- --------
Net cash provided by operating activities 12,795 3,205
Cash flows from investing activities:
Purchase of property and equipment (2,984) (7,995)
Net cash paid for acquisitions (86,964) (132,603)
------- --------
Net cash used in investing activities (89,948) (140,598)
Cash flows from financing activities:
Repayment of notes payable (894) (7,069)
Repayment of acquired notes payable (4,653) (12,500)
Borrowings under revolving credit agreement 74,279 167,465
Repayment of borrowings under revolving credit agreement (74,000) -
Payment of fees to acquire new debt (403) (3,565)
Issuance of common stock, net 81,406 342
------- --------
Net cash provided by financing activities 75,735 144,673
Effect of exchange rate on cash -- 132
------- --------
Net (decrease) increase in cash and cash equivalents (1,418) 7,412
Cash and cash equivalents at beginning of period 30,379 23,560
------- --------
Cash and cash equivalents at end of period $28,961 $ 30,972
======= ========
</TABLE>
The accompanying notes are an integral
part of these consolidated financial statements.
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<PAGE>
NCO GROUP, INC.
Notes to Consolidated Financial Statements
(Unaudited)
1. Nature of Operations:
NCO Group, Inc. (the "Company") is a leading provider of accounts receivable
management and other outsourced services. The Company's client base is comprised
of companies located throughout 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:
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 six month period
ended June 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.
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<PAGE>
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.
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
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 six months
ended June 30, 1998 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 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.
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<PAGE>
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.
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 is subject to change.
The following summarizes the unaudited pro forma results of operations for the
six months ended June 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 six months ended
June 30,
------------------------
1998 1999
---------- ----------
Revenue $205,983 $231,211
Net income $ 2,510 $ 9,193
Earnings per share - basic $ 0.11 $ 0.43
Earnings per share - diluted $ 0.11 $ 0.42
On May 13, 1999, the Company signed a definitive agreement to acquire all of the
outstanding shares of Compass International Services Corporation ("Compass") for
approximately 3.3 million shares of NCO common stock. The acquisition of Compass
is based on an exchange ratio of .23739 shares of NCO common stock for each
outstanding share of Compass stock. The purchase price is expected to be valued
at approximately $101.8 million. The transaction will be accounted for using the
purchase method of accounting and is expected to be treated as a tax-free
reorganization. The acquisition is subject to the following contingencies: (i)
sale of Compass's Print and Mail Division; (ii) Compass shareholder approval;
and (iii) Compass's option to terminate the transaction if the average closing
price of NCO's common stock for the five days prior to the closing date falls
below $27.50. The acquisition is scheduled to close during the third quarter of
1999.
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<PAGE>
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 six months ended June 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 six months ended June 30, 1999 (amounts in thousands, except per share
data):
<TABLE>
<CAPTION>
For the three months ended For the six months ended
June 30, June 30,
-------------------------- ------------------------
1998 1999 1998 1999
--------- --------- --------- ---------
<S> <C> <C> <C> <C>
Revenue:
NCO (as originally reported for 1998) $38,990 $110,704 $66,599 $192,091
JDR 12,945 -- 25,942 14,477
------- -------- ------- --------
Combined $51,935 $110,704 $92,541 $206,568
======= ======== ======= ========
Net income applicable to common shareholders:
NCO (as originally reported for 1998) $ 3,274 $ 7,521 $ 5,590 $ 12,766
JDR 1,073 -- 2,176 578
Non-recurring acquisition costs, net of taxes -- -- -- (3,694)
------- -------- ------- --------
Combined $ 4,347 $ 7,521 $ 7,766 $ 9,650
======= ======== ======= ========
Diluted net income per share:
As originally reported $0.22 $0.39
JDR 0.02 0.05
======= =======
Combined $0.24 $0.44
======= =======
</TABLE>
For the six months ended June 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 caused the effective tax rate to increase from 42.0% for the
year ended December 31, 1998 to 47.2% for the six months ended June 30, 1999.
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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 six months ended
ended June 30, June 30,
-------------------- ------------------------
1998 1999 1998 1999
-------- -------- -------- --------
<S> <C> <C> <C> <C>
Net income $4,651 $7,521 $8,371 $10,027
Foreign currency translation adjustment -- 950 -- 1,013
------ ------ ------ -------
Comprehensive income $4,651 $8,471 $8,371 $11,040
====== ====== ====== =======
</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 $44.3 million at December
31, 1998 and June 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
7.75% at June 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 5.22% at June
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 using a conversion ratio of one-for-one.
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 at a conversion ratio of one-for-one. 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.
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<PAGE>
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 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.
8. Shareholders' Equity:
Preferred Stock
At December 31, 1998, the Company 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. 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 $1.9 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.
Common Stock
At December 31, 1998, the Company 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 using a conversion ratio of one-for-one.
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 using a conversion ratio of
one-for-one.
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
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.
9. Earnings Per Share:
Basic earnings per share was computed by dividing the net income available to
common shareholders for the three months and six months ended June 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 six months ended June 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 six months
ended June 30, 1998 and the six months ended June 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.
-12-
<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 June 30, For the six months ended June 30,
----------------------------------------- -----------------------------------------
1998 1999 1998 1999
-------------------- -------------------- -------------------- --------------------
Shares EPS Shares EPS Shares EPS Shares EPS
<S> <C> <C> <C> <C> <C> <C> <C> <C>
--------- ---------- --------- ---------- --------- ---------- --------- ----------
Basic 17,009 $ 0.26 21,492 $ 0.35 16,317 $ 0.48 21,466 $ 0.45
Dilutive effect of warrants 726 (0.01) 160 -- 729 (0.02) 171 --
Dilutive effect of options 588 (0.01) 695 (0.01) 596 (0.02) 758 (0.02)
Dilutive effect of
convertible notes 64 -- -- -- 64 -- 16 --
------ ------ ------ ------- ------ ------- ------ -------
Diluted 18,387 $ 0.24 22,347 $ 0.34 17,706 $ 0.44 22,411 $ 0.43
====== ====== ====== ======= ====== ======= ====== =======
</TABLE>
10. Supplemental Cash Flow Information:
The following are supplemental disclosures of cash flow information for the six
months ended June 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 $34,093 $5,831
Liabilities assumed from acquisitions 19,732 5,245
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.
The Accounts Receivable Management division provides accounts receivable
management and collection services to consumer and commercial accounts for all
market segments, serving clients of all sizes in local, regional and national
markets.
-13-
<PAGE>
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.
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 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 table represents the segment information for the three months
ended June 30, 1998 (amounts in thousands):
<TABLE>
<CAPTION>
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
------- ----------- --------------- ------
<S> <C> <C> <C> <C>
A/R Management $31,880 $15,893 $ 9,256 $ 6,731
Tech-Based Outsourcing 11,353 5,840 2,873 2,640
Healthcare Services -- -- -- --
Commercial Services -- -- -- --
International Operations 4,334 2,365 1,339 630
Marketing Strategy 4,368 2,723 1,120 525
------- ------- ------- -------
EBITDA $51,935 $26,821 $14,588 $10,526
======= ======= ======= =======
</TABLE>
The following table represents the segment information for the three months
ended June 30, 1999 (amounts in thousands):
<TABLE>
<CAPTION>
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
-------- ----------- --------------- -------
<S> <C> <C> <C> <C>
A/R Management $38,453 $18,920 $11,275 $ 8,258
Tech-Based Outsourcing 12,703 6,944 3,220 2,539
Healthcare Services 35,283 18,396 9,820 7,067
Commercial Services 9,331 5,353 2,201 1,777
International Operations 8,185 4,761 2,235 1,189
Marketing Strategy 6,749 4,178 1,568 1,003
-------- ------- ------- -------
EBITDA $110,704 $58,552 $30,319 $21,833
======== ======= ======= =======
</TABLE>
-14-
<PAGE>
The following table represents the segment information for the six months ended
June 30, 1998 (amounts in thousands):
<TABLE>
<CAPTION>
Payroll and Selling General
Related and Admin.
Revenue Expenses Expenses EBITDA
-------- ----------- --------------- -------
<S> <C> <C> <C> <C>
A/R Management $57,163 $28,368 $17,305 $11,490
Tech-Based Outsourcing 22,884 11,602 6,025 5,257
Healthcare Services -- -- -- --
Commercial Services -- -- -- --
International Operations 4,334 2,365 1,339 630
Marketing Strategy 8,160 5,274 2,101 785
Other -- -- 7 (7)
-------- ------- ------- -------
EBITDA $92,541 $47,609 $26,777 $18,155
======== ======= ======= =======
</TABLE>
The following table represents the segment information for the six months ended
June 30, 1999 (amounts in thousands):
<TABLE>
<CAPTION>
Selling Non-
Payroll and General and Recurring
Related Admin. Acquisition
Revenue Expenses Expenses Costs EBITDA
-------- ----------- ----------- ----------- ------
<S> <C> <C> <C> <C>
A/R Management $ 76,854 $ 37,770 $22,212 $ -- $16,872
Tech-Based Outsourcing 24,829 13,712 6,331 -- 4,786
Healthcare Services 67,013 35,659 19,065 -- 12,289
Commercial Services 9,331 5,353 2,201 -- 1,777
International Operations 15,456 9,018 4,256 -- 2,182
Marketing Strategy 13,085 8,100 3,164 -- 1,821
Other -- -- 5 4,601 (4,606)
-------- -------- ------- ------ -------
EBITDA $206,568 $109,612 $57,234 $4,601 $35,121
======== ======== ======= ====== =======
</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 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.
-15-
<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 grow through strategic acquisitions and internal growth, the impact of
acquisitions on the Company's earnings, the Company's ability to realize
operating efficiencies in the integration of its acquisitions, trends in the
Company's future operating performance, year 2000 compliance, the effects of
legal or governmental proceedings, the effects of changes in accounting
pronouncements and statements as to the Company's or management's beliefs,
expectations and opinions. Forward-looking statements are subject to risks and
uncertainties and may be affected by various factors which may cause actual
results to differ materially from those in the forward-looking statements. In
addition to the factors discussed in this Report, certain risks, uncertainties
and other factors, including, without limitation the risk that the Company will
not be able to realize operating efficiencies in the integration of its
acquisitions, risks associated with growth and future acquisitions, fluctuations
in quarterly operating results, risks relating to year 2000 compliance and the
other risks detailed from time to time in the Company's filings with the
Securities and Exchange Commission, including the Company's Annual Report on
Form 10-K, filed on March 31, 1999, and the Company's Registration Statement on
Form S-4, filed on July 20, 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 June 30, 1999 Compared to Three Months Ended June 30, 1998
Revenue. Revenue increased $58.8 million or 113.2% to $110.7 million for
the three months ended June 30, 1999 from $51.9 million for the comparable
period in 1998. Of the increase, $7.9 million was attributable to the addition
of new clients and growth in business from existing clients. In addition, $1.7
million of the increase was attributable to addition of new clients and growth
in business from existing clients from 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: $7.6 million was attributable to the acquisition of Co-Source
Corporation ("Co-Source") on May 21, 1999; $29.2 million was attributable to the
acquisition of Medaphis Services Corporation ("MSC") on November 30, 1998; $6.7
million was attributable to the acquisition of MedSource, Inc. ("MedSource") on
July 1, 1998; and $5.7 million was attributable to the acquisition of FCA
International Ltd. ("FCA") on May 5, 1998.
Payroll and related expenses. Payroll and related expenses increased $31.8
million to $58.6 million for the three months ended June 30, 1999 from $26.8
million for the comparable period in 1998, and increased as a percentage of
revenue to 52.9% from 51.6%. Payroll and related expenses increased as a
percentage of revenue primarily as a result of higher payroll costs from the
MSC, JDR and Co-Source 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 higher costs were partially offset by lower
payroll costs related to the MedSource acquisition and by spreading the cost of
management and administrative personnel over a larger revenue base.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $15.7 million to $30.3 million for the three
months ended June 30, 1999 from $14.6 million for the comparable period in 1998,
but decreased as a percentage of revenue to 27.4% from 28.1%. 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
$4.9 million for the three months ended June 30, 1999 from $2.0 million for the
comparable period in 1998. Of this increase, $320,000 was attributable to the
Co-Source acquisition, $1,042,000 was attributable to the MSC acquisition,
$430,000 was attributable to the MedSource acquisition, and $534,000 was
attributable to the FCA acquisition. The remaining $610,000 million consisted of
depreciation resulting from normal capital expenditures incurred in the ordinary
course of business.
Other income (expense). Interest and investment income increased $17,000 to
$281,000 for the three months ended June 30, 1999 from $264,000 for the
comparable period in 1998. Interest expense increased to $4.3 million for the
three months ended June 30, 1999 from $996,000 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, $107.5 and $126.2 million, respectively, under the
revolving credit facility.
Income tax expense. Income tax expense increased to $5.4 million, or 41.8%
of income before taxes, for the three months ended June 30, 1999 from $3.1
million, or 40.3% of income before taxes, for the comparable period in 1998. The
increase in the effective tax rate is primarily attributable to the impact of
the non-deductible goodwill related to certain acquisitions.
Net income. Net income increased $2.8 million or 61.7% to $7.5 million for
the three months ended June 30, 1999 from $4.7 million for the comparable period
in 1998 and 1999.
Accretion of preferred stock to redemption value. The accretion of
preferred stock to the redemption value in the second 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.
Six Months Ended June 30, 1999 Compared to Six Months Ended June 30, 1998
Revenue. Revenue increased $114.1 million or 123.2% to $206.6 million for
the three months ended June 30, 1999 from $92.5 million for the comparable
period in 1998. Of the increase, $15.8 million was attributable to the addition
of new clients and growth in business from existing clients. In addition, $3.2
million of the increase was attributable to addition of new clients and growth
in business from existing clients from JDR. The remainder of the increase was
attributable to the following: $7.6 million was attributable to the acquisition
of Co-Source; $56.0 million was attributable to the acquisition of MSC; $12.7
million was attributable to the acquisition of MedSource; and $18.8 million was
attributable to the acquisition of FCA.
Payroll and related expenses. Payroll and related expenses increased $62.0
million to $109.6 million for the six months ended June 30, 1999 from $47.6
million for the comparable period in 1998, and increased as a percentage of
revenue to 53.1% from 51.4%. Payroll and related expenses increased as a
percentage of revenue primarily as a result of higher payroll costs from the
MSC, JDR and Co-source 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 higher costs were partially offset by lower
payroll costs related to the MedSource acquisition and by spreading the cost of
management and administrative personnel over a larger revenue base.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $30.5 million to $57.2 million for the six
months ended June 30, 1999 from $26.8 million for the comparable period in 1998,
but decreased as a percentage of revenue to 27.7% from 28.9%. 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.
-17-
<PAGE>
Depreciation and amortization. Depreciation and amortization increased to
$9.4 million for the six months ended June 30, 1999 from $3.7 million for the
comparable period in 1998. Of this increase, $320,000 was attributable to the
Co-Source acquisition, $2,087,000 was attributable to the MSC acquisition,
$876,000 was attributable to the MedSource acquisition, and $1,198,000 was
attributable to the FCA acquisition. The remaining $1,232,000 million 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 $4,000 to
$500,000 for the six months ended June 30, 1999 from $496,000 for the comparable
period in 1998. Interest expense increased to $7.3 million for the six months
ended June 30, 1999 from $1.4 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, $107.5 and $126.2 million, respectively, under the
revolving credit facility.
Income tax expense. Income tax expense increased to $9.0 million, or 47.2%
of income before taxes, for the six months ended June 30, 1999 from $5.2
million, or 38.3% of income before taxes, for the comparable period in 1998. The
increase in the effective tax rate is 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 is also related to the impact of the non-deductible
goodwill related to certain acquisitions.
Net income. Net income increased $1.7 million or 19.8% to $10.0 million for
the six months ended June 30, 1999 from $8.4 million for the comparable period
in 1998. Included in net income for the six months ended June 30, 1999 was $3.7
million of expenses attributable to the non-recurring acquisition costs net of
taxes. Without these costs, net income would have been $13.7 million or $0.61
per share, an increase of $5.3 million or 63.5%.
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
In June 1998, the Company completed a public offering (the "1998
Offering"), selling 4,000,000 shares of common stock and received net proceeds
of approximately $81.7 million.
In July 1998, the Company sold 469,366 shares of common stock in connection
with the underwriters' exercise of the over-allotment option granted in
accordance with the 1998 Offering. The Company received net proceeds of
approximately $9.6 million.
Since 1996, the Company's primary sources of cash have been public
offerings, cash flows from operations and bank borrowings. Cash has been used
for acquisitions, purchases of equipment and working capital to support the
Company's growth.
-18-
<PAGE>
Cash provided by operating activities was $3.2 million during the six
months ended June 30, 1999 compared to $12.8 million for the comparable period
in 1998. The decrease in cash flows from operating activities was partially
attributable to the $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.
In addition, the decrease was attributable to the $13.4 million increase in
accounts receivable for the six months ended June 30, 1999 compared to an
increase of $3.7 million for the same period in 1998. This increase in accounts
receivable was primarily attributable to the increase in revenue for the six
months ended June 30, 1999 compared to the same period in 1998. Finally, the
decrease was also attributable to the $2.5 million increase in purchased
accounts receivable for the six months ended June 30, 1999 compared to a
decrease of $230,000 for the same period in 1998.
Cash used in investing activities was $140.60 million during the six months
ended June 30, 1999 compared to $89.9 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 paid during the first
six months of 1999 compared to the cash portion of the purchase prices for the
acquisitions of AFECD, TRC and FCA during the first six months of 1998.
During the six months ended June 30, 1999, capital expenditures were $8.0
million compared to $3.0 million for the comparable period in 1998.
Cash provided by financing activities was $144.7 million during the six
months ended June 30, 1999 compared to $75.7 million for the comparable period
in 1998. This increase was primarily attributable to the borrowings under the
Company's revolving credit facility that were used to finance the acquisition of
Co-Source. A portion of this increase was offset by the proceeds from the 1998
Offering completed in June 1998.
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 7.75% at June 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 5.22% at
June 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.
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.
-19-
<PAGE>
As of June 30, 1999, the Company's balance sheet included goodwill that
represented approximately 73.4% of total assets and 192.7% 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 June 30, 1999, the Company has incurred total pre-tax expenses of
approximately $667,000 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 remainder of 1999 and for 2000, the Company
expects to incur total pre-tax expenses of approximately $864,000 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.
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.
-20-
<PAGE>
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.
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.
-21-
<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
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. The holders are entitled to demand and
piggyback registration rights. These warrants were issued by the Company in
reliance upon the exemption from the registration requirements provided by
Section 4(2) of the Securities Act.
Item 3. Defaults Upon Senior Securities
None - not applicable
Item 4. Submission of Matters to a Vote of Shareholders
The Annual Meeting of Shareholders of the Company was held on May 26,
1999. At the Annual Meeting, the shareholders elected Charles C. Piola, Jr.,
Eric S. Siegel and Stuart Wolf as directors for a term of three years as
described below:
Number of Votes
---------------
Withhold
Name For Authority
---- --- ---------
Charles C. Piola, Jr. 19,232,028 232,024
Eric S. Siegel 19,258,528 205,524
Stuart Wolf 19,282,841 181,211
In addition, the terms of the following directors continued after the
Annual Meeting: Michael J. Barrist, David E. D'Anna, Bernard R. Miller and
Allen F. Wise.
At the Annual Meeting, the shareholders also approved an amendment to
the 1996 Stock Option Plan as follows:
For Against Abstain Broker Non-Vote
--- ------- ------- ---------------
17,054,804 2,394,135 15,113 0
Item 5. Other Information
None - not applicable
-22-
<PAGE>
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
4/15/99 Item 2 - JDR Holdings, Inc. acquisition
5/28/99 Item 7 - JDR Holdings, Inc. acquisition
6/4/99 Item 2 - Co-Source Corporation acquisition and
Item 5 - Compass International Services Corporation
acquisition and Amendment to Credit Agreement
6/11/99 Item 5 and Item 7 - JDR Holdings, Inc. acquisition
8/4/99 Item 5 and Item 7 - Co-Source Corporation acquisition
-23-
<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: August 16, 1999 By: /s/ Michael J. Barrist
--------------------------------
Michael J. Barrist
Chairman of the Board, President
and Chief Executive Officer
(principal executive officer)
Date: August 16, 1999 By: /s/ Steven L. Winokur
--------------------------------
Steven L. Winokur
Executive Vice President,
Finance, Chief Financial Officer
and Treasurer
-24-
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<PERIOD-START> JAN-01-1999
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