<PAGE>
UNITED STATES
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 March 31, 2000, 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)
Not Applicable
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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 25,609,502 shares common stock, no par value, outstanding as of
May 12, 2000.
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NCO GROUP, INC.
INDEX
PAGE
Part I FINANCIAL INFORMATION
Item 1 CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets -
December 31, 1999 and March 31, 2000 3
Consolidated Statements of Operations -
Three months ended March 31, 1999 and 2000 4
Consolidated Statements of Cash Flows -
Three months ended March 31, 1999 and 2000 5
Notes to Consolidated Financial Statements 6
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 12
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 15
PART II 16
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Shareholders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
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<PAGE>
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Amounts in thousands)
<TABLE>
<CAPTION>
March 31,
December 31, 2000
ASSETS 1999 (Unaudited)
-------- --------
<S> <C> <C>
Current assets:
Cash and cash equivalents $ 50,513 $ 35,607
Accounts receivable, trade, net of allowance for
doubtful accounts of $5,391 and $5,813, respectively 70,430 80,009
Purchased accounts receivable 6,719 12,955
Deferred taxes 2,965 3,055
Other current assets 5,800 6,933
-------- --------
Total current assets 136,427 138,559
Funds held on behalf of clients
Property and equipment, net 53,714 58,391
Other assets:
Intangibles, net of accumulated amortization 553,879 550,687
Net assets of discontinued operations 41,492 20,112
Other assets 6,180 8,188
-------- --------
Total other assets 601,551 578,987
-------- --------
Total assets $791,692 $775,937
======== ========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 1,302 $ 1,342
Corporate taxes payable 11,490 7,435
Accounts payable 8,457 6,891
Accrued expenses 30,430 32,775
Accrued compensation and related expenses 14,609 14,795
-------- --------
Total current liabilities 66,288 63,238
Funds held on behalf of clients
Long-term liabilities:
Long-term debt, net of current portion 323,949 323,584
Deferred taxes 25,747 27,392
Other long-term liabilities 10,820 7,157
Commitments and contingencies
Shareholders' equity:
Common stock, no par value, 37,500 shares authorized,
25,533 and 25,548 shares issued and outstanding, respectively 314,601 314,609
Foreign currency translation adjustment 694 689
Retained earnings 49,593 39,268
-------- --------
Total shareholders' equity 364,888 354,566
-------- --------
Total liabilities and shareholders' equity $791,692 $775,937
======== ========
</TABLE>
See accompanying notes.
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NCO GROUP, INC.
Consolidated Statements of Operations
(Unaudited)
(Amounts in thousands, except per share data)
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
----------------------------------
1999 2000
--------- ---------
<S> <C> <C>
Revenue $ 89,528 $ 143,998
Operating costs and expenses:
Payroll and related expenses 47,159 70,646
Selling, general and administrative
expenses 25,367 41,558
Depreciation and amortization expense 4,097 7,545
Nonrecurring acquisition costs 4,601 --
--------- ---------
Total operating costs and expenses 81,224 119,749
--------- ---------
Income from operations 8,304 24,249
Other income (expense):
Interest and investment income 217 503
Interest expense (2,763) (6,421)
Other income (expense) -- 1,313
--------- ---------
Total other income (expense) (2,546) (4,605)
--------- ---------
Income before provision for income taxes 5,758 19,644
Income tax expense 3,436 8,251
--------- ---------
Income from continuing operations 2,322 11,393
Accretion of preferred stock to redemption value (377) --
--------- ---------
Income from continuing operations applicable to
common shareholders 1,945 11,393
Discontinued operations, net of taxes:
Income (loss) from discontinued operations 184 (904)
Expected loss on disposal of discontinued operations -- (20,814)
--------- ---------
Net income (loss) applicable to common shareholders $ 2,129 $ (10,325)
========= =========
Income from continuing operations applicable to common shareholders per share:
Basic $ 0.09 $ 0.45
Diluted $ 0.09 $ 0.44
Net income (loss) applicable to common shareholders per share:
Basic $ 0.10 $ (0.40)
Diluted $ 0.10 $ (0.40)
Weighted average shares outstanding:
Basic 21,440 25,540
Diluted 22,476 25,852
</TABLE>
See accompanying notes.
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<PAGE>
NCO GROUP, INC
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)
<TABLE>
<CAPTION>
For the Three Months
Ended March 31,
--------------------------------
1999 2000
-------- --------
<S> <C> <C>
Cash flows from operating activities:
Income from continuing operations $ 2,322 $ 11,393
Adjustments to reconcile income from continuing
operations to net cash used in continuing
operating activities:
Depreciation 1,531 3,278
Amortization of intangibles 2,566 4,267
Write-off of deferred financing costs 353 --
Provision for doubtful accounts (145) 657
Compensation expense on stock options granted 34 --
Changes in assets and liabilities, net of acquisitions:
Accounts receivable, trade (7,070) (10,290)
Purchased accounts receivable (238) (6,240)
Deferred taxes (212) 1,555
Other assets 182 (2,696)
Accounts payable and accrued expenses (366) (417)
Corporate taxes payable (4,404) (4,049)
Other long-term liabilities (141) (3,727)
-------- --------
Net cash used in continuing operating activities (5,588) (6,269)
Net cash provided by discontinued operating activities 1,994 1,551
-------- --------
Net cash used in operating activities (3,594) (4,718)
Cash flows from investing activities:
Purchase of property and equipment (4,083) (9,798)
Net cash paid for acquisitions (4,875) --
-------- --------
Net cash used in investing activities (8,958) (9,798)
Cash flows from financing activities:
Repayment of notes payable (681) (398)
Repayment of acquired notes payable (12,500) --
Borrowings under revolving credit agreement 26,525 --
Issuance of common stock, net 36 7
-------- --------
Net cash provided by (used in) financing activities 13,380 (391)
Effect of exchange rate on cash 52 1
-------- --------
Net increase (decrease) in cash and cash equivalents 880 (14,906)
Cash and cash equivalents at beginning of period 23,560 50,513
-------- --------
Cash and cash equivalents at end of period $ 24,440 $ 35,607
======== ========
</TABLE>
See accompanying notes.
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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 and in
the United Kingdom and Puerto Rico in the financial services, healthcare,
retail, commercial, education, utility, government and telecommunications
sectors.
2. Summary of Significant Accounting Policies:
Interim Financial Information:
The accompanying unaudited 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 ended March 31,
2000, are not necessarily indicative of the results that may be expected for the
year ending December 31, 2000, or for any other interim period. For further
information, refer to the consolidated financial statements and footnotes
thereto included in the Company's Annual Report on Form 10-K filed with the
Securities and Exchange Commission on March 27, 2000, as amended on April 11,
2000.
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 revenue from contingent fees and contractual services.
Contingent fee revenue is recognized upon collection of funds on behalf of
clients. Contractual services revenue is recognized as services are performed.
Credit Policy:
The Company has two types of arrangements under which it collects its contingent
fee revenue. For certain clients, the Company remits funds collected on behalf
of the client net of the related contingent fees while, for other clients, the
Company remits gross funds collected on behalf of clients and bills the client
separately for its contingent fees. Management carefully monitors its client
relationships in order to minimize its credit risk and generally does not
require collateral. In many cases, in the event of collection delays from
clients, management may, at its discretion, change from the gross remittance
method to the net remittance method.
Intangibles:
The Company's intangible assets consist primarily of 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 that may be revised at a later date. The Company reviews the
recoverability of its goodwill whenever events or circumstances indicate that
the carrying amount of the goodwill may not be recoverable. In making such
determination with respect to goodwill, the Company evaluates the operating
results of the underlying business that gave rise to such amount.
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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 nondeductible portion of
goodwill expenses attributable to certain acquisitions.
Use of Estimates:
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States 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, 1999, and for the three months ended March 31,
1999, have been reclassified for comparative purposes.
3. Discontinued Operations:
During April 2000, the Company's Board of Directors approved a plan to divest
the Company's Market Strategy division as part of its strategic plan to increase
long-term shareholder value and focus on its core business of accounts
receivable management services. The Market Strategy division provides market
research and telemarketing services. The market research assets were acquired
through the January 1997 acquisition of the Tele-Research Center, Inc. and the
February 1998 acquisition of The Response Center. The telemarketing assets were
acquired as non-core components of the March 1999 acquisition of JDR Holdings,
Inc., and the August 1999 acquisition of Compass International Services
Corporation. The Company expects to complete the divestiture of the Market
Strategy division by the end of the third quarter of 2000.
In accordance with the Accounting Principles Board Opinion No. 30, "Reporting
the Results of Operations - Reporting the Effects of Disposal of a Business, and
Extraordinary, Unusual and Infrequently Occurring Events and Transactions," the
consolidated financial statements and the accompanying notes of the Company have
been presented to reflect the Market Strategy division as discontinued
operations for all periods presented.
The following summary of the Market Strategy division's assets and liabilities
has been presented net in the Company's consolidated balance sheets (amounts in
thousands):
<TABLE>
<CAPTION>
December 31, 1999 March 31, 2000
----------------- --------------
<S> <C> <C>
Current assets $13,734 $9,260
Total assets 47,740 23,757
Current liabilities 6,248 3,586
Total liabilities 6,248 3,645
Net assets of discontinued operations 41,492 20,112
</TABLE>
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<PAGE>
The following summary of the Market Strategy division's operations has been
presented net in the Company's consolidated statements of operations (amounts in
thousands):
<TABLE>
<CAPTION>
For the three months ended
March 31,
-------------------------------
1999 2000
--------------- --------------
<S> <C> <C>
Revenue $ 6,336 $ 6,607
=============== ==============
Income (loss) from discontinued operations
before provision for income taxes $ 331 $ (1,403)
Income tax expense (benefit) 147 (499)
--------------- --------------
Income (loss) from discontinued operations,
net of taxes $ 184 $ (904)
=============== ==============
</TABLE>
For the three months ended March 31, 2000, the Company recorded a $20.8 million
expected loss (net of a tax benefit of $2.9 million), or $0.81 loss per share on
a diluted basis, on the disposal of the Market Strategy division. This loss
reflects management's estimate of the difference between the net assets of the
Market Strategy division over the expected proceeds from the divestiture and the
estimated operating losses through the expected disposal at the end of the third
quarter of 2000.
4. 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
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 ended March 31, 1999 (amounts in thousands, except per share data):
For the three months ended March 31, 1999:
Revenue:
NCO $ 77,382
JDR (for the period prior to the acquisition) 12,146
---------
Combined $ 89,528
=========
Income from continuing operations
applicable to common shareholders:
NCO $ 5,192
JDR (for the period prior to the acquisition) 447
Nonrecurring acquisition costs, net of taxes (3,694)
---------
Combined $ 1,945
=========
For the three months ended March 31, 1999, the Company incurred $4.6 million of
nonrecurring acquisition costs in connection with the JDR acquisition. These
costs consisted primarily of investment banking fees, legal and accounting fees,
and printing costs.
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<PAGE>
Purchase Transactions:
The following acquisitions represent the acquisitions that were completed by the
Company during 1999 and the last quarter of 1998. 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. These accruals included 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 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 in cash, plus a $10.0 million earn-out. The
Company paid the $10.0 million earn-out in April 2000.
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 the assumption of stock options to
purchase approximately 200,000 shares of NCO common stock. The purchase price
was valued at approximately $104.1 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.
5. Comprehensive Income:
Comprehensive income consists of net income (loss) from operations, plus certain
changes in assets and liabilities that are not included in net income (loss) but
are reported as a separate component of shareholders' equity under accounting
principles generally accepted in the United States. The Company's comprehensive
income (loss) is as follows (amounts in thousands):
For the three months
ended March 31,
-------------------------
1999 2000
----------- ------------
Net income (loss) $ 2,506 $ (10,325)
Foreign currency translation adjustment
63 (5)
----------- ------------
Comprehensive income (loss) $ 2,569 $ (10,330)
=========== ============
6. Funds Held on Behalf of 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 on behalf of clients of $47.7 million and $54.7 million at December
31, 1999 and March 31, 2000, respectively, have been shown net of their
offsetting liability for financial statement presentation.
7. 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 (collectively,
"Mellon Bank"), 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. At the option of the Company, the
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<PAGE>
borrowings bear interest at a rate equal to either Mellon Bank's prime rate plus
a margin of 0.25% to 0.50% that is determined quarterly based upon the Company's
consolidated funded debt to earnings before interest, taxes, depreciation and
amortization ("EBITDA") ratio (Mellon Bank's prime rate was 9.0% at March 31,
2000), or the London InterBank Offered Rate ("LIBOR") plus a margin of 1.25% to
2.25% depending on the Company's consolidated funded debt to EBITDA ratio (LIBOR
was 6.13% at March 31, 2000). 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 JDR 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 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.
8. Earnings Per Share:
Basic earnings per share were computed by dividing the income from continuing
operations and the net income (loss) applicable to common shareholders for the
three months ended March 31, 1999 and 2000, by the weighted average number of
shares outstanding. Diluted earnings per share were computed by dividing the
income from continuing operations and the net income (loss) applicable to common
shareholders for the three months ended March 31, 1999 and 2000, by the weighted
average number of shares outstanding including all common equivalent shares.
Outstanding options, warrants and convertible securities have been utilized in
calculating diluted net income per share only when their effect would be
dilutive.
The reconciliation of basic to diluted income from continuing operations per
share and net income (loss) applicable to common shareholders per share
consisted of the following (amounts in thousands, except per share amounts):
<TABLE>
<CAPTION>
For the three months ended March 31,
--------------------------------------------------------------------------------------
1999 2000
----------------------------------------- ------------------------------------------
Income from Income from
Continuing Continuing
Operations Net Income Operations Net Loss
Shares Per Share Per Share Shares Per Share Per Share
---------- ---------------- ------------- ----------- ---------------- -------------
<S> <C> <C> <C> <C> <C> <C>
Basic 21,440 $ 0.09 $ 0.10 25,540 $ 0.45 $ (0.40)
Dilutive effect of
warrants 183 - - 108 - -
Dilutive effect of
options 820 - - 204 (0.01) -
Other 33 - - - - -
---------- ---------------- ------------- ----------- ---------------- -------------
Diluted 22,476 $ 0.09 $ 0.10 25,852 $ 0.44 $ (0.40)
========== ================ ============= =========== ================ =============
</TABLE>
9. Supplemental Cash Flow Information:
The following are supplemental disclosures of cash flow information for the
three months ended March 31, 1999 and 2000 (amounts in thousands):
<TABLE>
<CAPTION>
1999 2000
----------- -----------
Non-cash investing and financing activities:
<S> <C> <C>
Convertible note payable, exercised for common stock $ 900 $ -
Warrants exercised $ 4,575 $ -
</TABLE>
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<PAGE>
10. Segment Reporting:
The Company is organized into market- specific operating divisions that are
responsible for all aspects of client sales, client service, and operational
delivery of services. The accounting policies of the segments are the same as
those described in Note 2, "Summary of significant accounting policies." Segment
data include charges allocating corporate overhead costs to each of the
operating segments based on revenue and employee headcount. During 1999, the
operating divisions, which were each headed by a divisional chief executive
officer, included Accounts Receivable Management Services, Healthcare Services,
Technology-Based Outsourcing, Commercial Services, Market Strategy and
International Operations. In January of 2000, NCO realigned its corporate
structure into three operating divisions. The accounts receivable management
services portion of the Healthcare Services division was merged into the
Accounts Receivable Management Services division, and the pre-delinquency
services portion of the Healthcare Services division was merged into the
Technology-Based Outsourcing division. The Commercial Services division was
merged into the Accounts Receivable Management Services division. The Company is
in the process of divesting the Market Strategy division and, as a result, that
division is reflected as discontinued operations. The segment information for
the three months ended March 31, 1999, has been restated to reflect the three
continuing operating segments.
The Accounts Receivable Management Services division provides accounts
receivable management services to consumer and commercial accounts for all
market segments, serving clients of all sizes in local, regional and national
markets.
The Technology-Based Outsourcing 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 International Operations division provides accounts receivable management
services across Canada and the United Kingdom.
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
months ended March 31, 1999 and 2000. EBITDA is used by the Company's management
to measure the operating results of the segments and is not intended to report
the operating results of the segments in conformity with generally accepted
accounting principles.
<TABLE>
<CAPTION>
For the three months ended March 31, 1999
(amounts in thousands)
------------------------------------------------------------------------
Selling,
Payroll and General and
Revenue Related Expenses Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
<S> <C> <C> <C> <C>
A/R Management $ 55,239 $ 26,834 $ 17,094 $ 11,311
Tech-Based Outsourcing 27,018 16,068 6,252 4,698
International Operations 7,271 4,257 2,021 993
---------------- ----------------- ----------------- ---------------
Total $ 89,528 $ 47,159 $ 25,367 $ 17,002
================ ================= ================= ===============
For the three months ended March 31, 2000
(amounts in thousands)
------------------------------------------------------------------------
Selling,
Payroll and General and
Revenue Related Expenses Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
A/R Management $ 99,265 $ 47,640 $ 29,218 $ 22,407
Tech-Based Outsourcing 37,222 18,636 9,974 8,612
International Operations 7,511 4,370 2,366 775
---------------- ----------------- ----------------- ---------------
Total $ 143,998 $ 70,646 $ 41,558 $ 31,794
================ ================= ================= ===============
</TABLE>
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<PAGE>
Item 2
Management's Discussion and Analysis of
Financial Condition and Results of Operations
Certain statements included in this Report on Form 10-Q, other than
historical facts, are forward-looking statements (as such term is defined in the
Securities Exchange Act of 1934, and the regulations thereunder) that are
intended to be covered by the safe harbors created thereby. Forward-looking
statements include, without limitation, statements as to the disposal of the
Market Strategy division and its effect on the Company; 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; the effects of legal or governmental
proceedings; the effects of changes in accounting pronouncements; year 2000
compliance; 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 that may cause actual
results to differ materially from those in the forward-looking statements. In
addition to the factors discussed in this Report on Form 10-Q, certain risks,
uncertainties and other factors, including, without limitation, the risk that
the Company will not be able to implement its five-year strategy as and when
planned; risks associated with growth and future acquisitions; risks relating to
fluctuations in quarterly operating results; risks related to timing of
contracts; risks related to strategic acquisitions and international operations;
risks related to year 2000; 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 27, 2000, as amended on
April 11, 2000, 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, Fort
Washington, PA 19034.
Three Months Ended March 31, 2000, Compared to Three Months Ended March 31,
1999
Revenue. Revenue increased $54.5 million or 60.8% to $144.0 million for the
three months ended March 31, 2000, from $89.5 million for the comparable period
in 1999. The Accounts Receivable Management Services ("A/R Management"),
Technology-Based Outsourcing ("TBO"), and International Operations
("International") divisions represented $99.3 million, $37.2 million, and $7.5
million, respectively, of the revenue for the three months ended March 31, 2000.
The A/R Management division's revenue increased $43.6 million or 78.3% to
$99.3 million for the three months ended March 31, 2000, from $55.7 million for
the comparable period in 1999. The acquisition of Compass International Services
Corporation ("Compass") on August 20, 1999 represented $11.2 million of the
increase and $18.6 million of this increase was attributable to the acquisition
of Co-Source Corporation ("Co-Source") on May 21, 1999. The remainder of the
increase in the A/R Management division's revenue was attributable to the
addition of new clients and growth in business from existing clients.
The TBO division's revenue increased $10.7 million or 40.3% to $37.2
million for the three months ended March 31, 2000, from $26.5 million for the
comparable period in 1999. This increase in the TBO division's revenue was
attributable to the addition of new clients and growth in business from existing
clients.
The International division's revenue increased $200,000 or 2.7% to $7.5
million for the three months ended March 31, 2000, from $7.3 million for the
comparable period in 1999. This increase in the International division's revenue
was attributable to the addition of new clients and growth in business from
existing clients.
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<PAGE>
Payroll and related expenses. Payroll and related expenses increased $23.4
million to $70.6 million for the three months ended March 31, 2000, from $47.2
million for the comparable period in 1999, but decreased as a percentage of
revenue to 49.1% from 52.7%. This decrease as a percentage of revenue was
partially attributable to the Company continuing the process of rationalizing
staff levels in both its acquired and existing businesses. The decrease as a
percentage of revenue was also attributable to the increase in productivity that
was achieved through the expansion of the Company's use of predictive dialing
equipment. The remaining portion of the decrease was the result of spreading the
fixed portion of the Company's payroll cost structure over a larger revenue
base.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $16.2 million to $41.6 million for the three
months ended March 31, 2000, from $25.4 million for the comparable period in
1999, and increased as a percentage of revenue to 28.9% from 28.3%. The slight
increase as a percentage of revenue was primarily attributable to the increased
costs associated with the expansion of the Company's use of predictive dialing
equipment; however, the expanded use of predictive dialing equipment created an
increase in productivity that more than offset the increase in selling, general,
and administrative expense by a reduction in payroll and related expenses.
Depreciation and amortization. Depreciation and amortization increased to
$7.5 million for the three months ended March 31, 2000, from $4.1 million for
the comparable period in 1999. Of this increase, $811,000 was attributable to
the Compass acquisition and $787,000 was attributable to the Co-Source
acquisition. The remaining $1.8 million increase consisted of depreciation
resulting from normal capital expenditures made in the ordinary course of
business during the first quarter of 2000. These capital expenditures included
purchases associated with the Company's planned migration towards a single,
integrated information technologies platform, and predictive dialers and other
equipment required to expand the Company's infrastructure to handle future
growth.
Other income (expense). Interest and investment income increased $286,000
to $503,000 for the three months ended March 31, 2000, from $217,000 for the
comparable period in 1999. This increase was primarily attributable to an
increase in operating funds and funds held on behalf of clients. Interest
expense increased to $6.4 million for the three months ended March 31, 2000,
from $2.8 million for the comparable period in 1999. The increase was primarily
attributable to the Company financing the May 1999 acquisition of Co-Source with
borrowings of $122.7 million 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 August 1999 acquisition of Compass.
Income tax expense. Income tax expense increased to $8.3 million, or 42.0%
of income before taxes, for the three months ended March 31, 2000, from $3.4
million, or 59.7% of income before taxes, for the comparable period in 1999. The
decrease in the effective tax rate was primarily attributable to the
nondeductible portion of the $4.6 million of nonrecurring acquisition costs
incurred during the first quarter of 1999 in connection with the acquisition of
JDR Holdings, Inc. ("JDR").
Accretion of preferred stock to redemption value. The accretion of
preferred stock to 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.
Discontinued operations. During April 2000, the Company's Board of
Directors approved a plan to divest the Company's Market Strategy division as
part of its strategic plan to increase long-term shareholder value and focus on
its core business of accounts receivable management services. The Market
Strategy division had a loss from operations of $904,000 for the three months
ended March 31, 2000, as compared to income of $184,000 for the comparable
period in 1999. For the three months ended March 31, 2000, the Company recorded
a $20.8 million expected loss on the disposal of the Market Strategy division.
The Company expects to complete the divestiture of the Market Strategy division
by the end of the third quarter of 2000.
-13-
<PAGE>
Liquidity and Capital Resources
Since 1996, the Company's primary sources of cash have been bank
borrowings, public offerings, and cash flows from operations. Cash has been used
for acquisitions, purchases of equipment, and working capital to support the
Company's growth.
Cash used in operating activities was $4.7 million during the three months
ended March 31, 2000, compared to $3.6 million for the comparable period in
1999. This increase was primarily attributable to increases in accounts
receivable and purchased accounts receivable, and a decrease in long-term
liabilities. The impact of these changes was partially offset by the increase in
income from continuing operations to $11.4 million for the three months ended
March 31, 2000, from $2.3 million for the comparable period in 1999.
Cash used in investing activities was $9.8 million during the three months
ended March 31, 2000, compared to $9.0 million for the comparable period in
1999. During the three months ended March 31, 2000, capital expenditures were
$9.8 million compared to $4.1 million for the comparable period in 1999. The
increase in capital expenditures was offset by $4.9 million of acquisition
related expenses paid during the first quarter of 1999 in connection with the
acquisition of Medaphis Services Corporation.
Cash used in financing activities was $391,000 during the three months
ended March 31, 2000, compared to cash provided by financing activities of $13.4
million for the comparable period in 1999. This decrease was primarily
attributable to the $14 million of net borrowings from the three months ended
March 31, 1999, that were attributable to the acquisition of JDR.
In May 1999, the Company's credit agreement with Mellon Bank, N.A., for
itself and as administrative agent for other participating lenders ("Mellon
Bank"), 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. At the option of the Company, the borrowings
bear interest at a rate equal to either Mellon Bank's prime rate plus a margin
of 0.25% to 0.50% depending on the Company's consolidated funded debt to EBITDA
ratio (Mellon Bank's prime rate was 9.00% at March 31, 2000) or LIBOR plus a
margin of 1.25% to 2.25% depending on the Company's consolidated funded debt to
EBITDA ratio (LIBOR was 6.13% at March 31, 2000). 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 credit agreement, will be
sufficient to finance its current operations, planned capital expenditure
requirements, and internal growth at least through the next 12 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 "intangibles"
that consist primarily of 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. Accounting
principles generally accepted in the United States require that this and all
other intangible assets be amortized over the period benefited. Management has
determined that period to be from 15 to 40 years based on the attributes of each
acquisition.
-14-
<PAGE>
As of March 31, 2000, the Company's balance sheet included goodwill that
represented approximately 70.2% of total assets and 153.7% 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
During 1999, the Company completed a program to evaluate and address the impact
of the year 2000 on its information technology systems and its non-information
technology systems in order to ensure that these systems would successfully
manage and manipulate data involving the transition of dates from the year 1999
to the year 2000. The Company has not experienced, and does not expect to
experience, any material adverse effects on its business or results of
operations as a result of the transition of dates from year the 1999 to the year
2000. 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 did 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 data with its clients. The Company will continue to monitor
its systems and those of its suppliers and contractors throughout year 2000 to
ensure that any problems that may arise are addressed promptly.
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 effect 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.
-15-
<PAGE>
Part II. Other Information
Item 1. Legal Proceedings
The Company is involved in legal proceedings from time to time in the
ordinary course of its business. Management believes that none of these
legal proceedings will have a materially adverse effect on the financial
condition or results of operations of the Company.
Item 2. Changes in Securities
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 Form 8-K
(a) Exhibits
27.1 Financial Data Schedule
(b) Reports on Form 8-K
Date of Report Item Reported
4/12/00 Item 4 - Change in Independent Public Accountants
5/5/00 Item 5 - Plan to divest of Market Strategy division
-16-
<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: May 15, 2000 By: /s/ Michael J. Barrist
----------------------
Michael J. Barrist
Chairman of the Board, President
and Chief Executive Officer
(principal executive officer)
Date: May 15, 2000 By: /s/ Steven L. Winokur
---------------------
Steven L. Winokur
Executive Vice President, Finance,
Chief Financial Officer and
Treasurer
-17-
<TABLE> <S> <C>
<ARTICLE> 5
<S> <C>
<PERIOD-TYPE> 3-MOS
<FISCAL-YEAR-END> DEC-31-2000
<PERIOD-START> JAN-01-2000
<PERIOD-END> MAR-31-2000
<CASH> 35,607,000
<SECURITIES> 0
<RECEIVABLES> 85,822,000
<ALLOWANCES> 5,813,000
<INVENTORY> 0
<CURRENT-ASSETS> 138,559,000
<PP&E> 76,235,000
<DEPRECIATION> 17,844,000
<TOTAL-ASSETS> 775,937,000
<CURRENT-LIABILITIES> 63,238,000
<BONDS> 0
0
0
<COMMON> 314,609,000
<OTHER-SE> 39,957,000
<TOTAL-LIABILITY-AND-EQUITY> 775,937,000
<SALES> 143,998,000
<TOTAL-REVENUES> 143,998,000
<CGS> 0
<TOTAL-COSTS> 119,092,000
<OTHER-EXPENSES> (1,313,000)
<LOSS-PROVISION> 657,000
<INTEREST-EXPENSE> 5,918,000
<INCOME-PRETAX> 19,644,000
<INCOME-TAX> 8,251,000
<INCOME-CONTINUING> 11,393,000
<DISCONTINUED> (21,718,000)
<EXTRAORDINARY> 0
<CHANGES> 0
<NET-INCOME> (10,325,000)
<EPS-BASIC> (0.40)
<EPS-DILUTED> (0.40)
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