-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, MfOY4hAKgsxfgt9tXl6fczUp1MhvSue3nFOQbyNI1sjiS2F7naK/RgvW2/SbgFSL EGO46McpNoqHALP/3I4tNQ== 0000950116-97-002091.txt : 19971117 0000950116-97-002091.hdr.sgml : 19971117 ACCESSION NUMBER: 0000950116-97-002091 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 2 CONFORMED PERIOD OF REPORT: 19970930 FILED AS OF DATE: 19971114 SROS: NONE FILER: COMPANY DATA: COMPANY CONFORMED NAME: NCO GROUP INC CENTRAL INDEX KEY: 0001022608 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-CONSUMER CREDIT REPORTING, COLLECTION AGENCIES [7320] IRS NUMBER: 232858652 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: SEC FILE NUMBER: 000-21639 FILM NUMBER: 97719627 BUSINESS ADDRESS: STREET 1: 1740 WALTON RD CITY: BLUE BELL STATE: PA ZIP: 19422-0987 BUSINESS PHONE: 6108321440 10-Q 1 SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q /X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended September 30, 1997, or / / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to - ------------------------------------------------------------------------------- COMMISSION FILE NUMBER 0-21639 - ------------------------------------------------------------------------------- NCO GROUP, INC. - ------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) PENNSYLVANIA - ------------------------------------------------------------------------------- (State or other jurisdiction of incorporation or organization) 515 Pennsylvania Avenue, Fort Washington, Pennsylvania - ------------------------------------------------------------------------------- (Address of principal executive offices) 23-2858652 - ------------------------------------------------------------------------------- (IRS Employer Identification Number) 19034 - ------------------------------------------------------------------------------- (Zip Code) 215-793-9300 - ------------------------------------------------------------------------------- (Registrant's telephone number including area code) - ------------------------------------------------------------------------------- (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 8,810,829 shares common stock, no par value, outstanding as of November 5, 1997 1 NCO GROUP, INC. INDEX PAGE Part I FINANCIAL INFORMATION Item 1 CONSOLIDATED FINANCIAL STATEMENTS (Unaudited) Consolidated Balance Sheets - December 31, 1996 and September 30, 1997 3 Consolidated Statements of Income - Three months and nine months ended September 30, 1996 and 1997 4 Consolidated Statements of Cash Flows - Nine months ended September 30, 1996 and 1997 5 Pro Forma Consolidated Statement of Income - Nine months ended September 30, 1997 6 Notes to Consolidated Financial Statements 7 Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 11 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 8-K 2 Part 1 - Financial Information Item 1 - Financial Statements NCO GROUP, INC. Consolidated Balance Sheets (Unaudited)
December 31, September 30, ASSETS 1996 1997 ------------ ------------- Current assets: Cash and cash equivalents $12,058,798 $33,422,370 Accounts receivable, trade, net of allowance for doubtful accounts of $79,000 and $338,020, respectively 4,701,364 11,080,676 Other current assets 499,815 306,280 ----------- ----------- Total current assets 17,259,977 44,809,326 Funds held in trust for clients Property and equipment, net 2,830,062 6,927,431 Other assets: Intangibles, net of accumulated amortization 14,673,155 38,240,944 Deferred taxes 70,760 50,986 Deferred financing costs 684,390 565,532 Deposits on acquisitions -- 4,700,000 Other assets 308,011 849,160 ----------- ----------- Total other assets 15,736,316 44,406,622 ----------- ----------- Total assets $35,826,355 $96,143,379 =========== =========== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Long-term debt, current portion $ 46,946 $ 54,961 Capitalized lease obligations, current portion 62,131 172,519 Corporate taxes payable 216,709 507,708 Accounts payable 657,647 2,264,189 Accrued expenses 1,044,536 3,580,376 Accrued compensation and related expenses 1,376,982 2,543,212 Unearned revenue, net of related costs 225,817 68,075 ----------- ----------- Total current liabilities 3,630,768 9,191,040 Funds held in trust for clients Long-term liabilities: Long term debt, net of current portion 1,091,901 1,159,378 Capitalized lease obligations, net of current portion 385,683 271,457 Unearned revenue, net of related costs 70,385 107,388 Commitments and contingencies Shareholders' equity: Preferred stock, no par value, 5,000,000 shares authorized, no shares issued and outstanding Common stock, no par value, 25,000,000 shares authorized, 6,713,447 and 8,779,868 shares issued and outstanding at December 31, 1996 and September 30, 1997, respectively 29,362,326 78,297,211 Unexercised warrants 396,054 1,122,546 Retained earnings 889,238 5,994,359 ----------- ----------- Total shareholders' equity 30,647,618 85,414,116 ----------- ----------- Total liabilities and shareholders' equity $35,826,355 $96,143,379 =========== ===========
The accompanying notes are an integral part of this consolidated statement. 3 NCO GROUP, INC. Consolidated Statements of Income (Unaudited)
For the Three Months Ended For the Nine Months Ended September 30, September 30, ------------------------------------- ------------------------------------ 1996 1997 1996 1997 ----------------- ---------------- ---------------- ---------------- Revenue $ 7,714,803 $ 21,738,891 $ 20,257,467 $ 60,977,700 Operating costs and expenses: Payroll and related expenses 3,630,042 10,696,528 9,583,937 30,279,194 Selling, general and administrative expenses 2,501,251 7,085,606 6,595,877 19,777,042 Depreciation and amortization expense 400,476 844,483 823,290 2,387,604 ----------------- ---------------- ---------------- ---------------- Total operating costs and expenses 6,531,769 18,626,617 17,003,104 52,443,840 ----------------- ---------------- ---------------- ---------------- Income from operations 1,183,034 3,112,274 3,254,363 8,533,860 Other income (expense): Interest and investment income 33,419 444,993 80,834 607,314 Interest expense (249,405) (85,262) (606,899) (507,454) Loss on disposal of fixed assets - (40,506) - (40,506) ----------------- ---------------- ---------------- ---------------- (215,986) 319,225 (526,065) 59,354 ----------------- ---------------- ---------------- ---------------- Income before provision for income taxes 967,048 3,431,499 2,728,298 8,593,214 Income tax expense (benefit) (1,328) 1,349,851 (1,328) 3,488,093 ----------------- ---------------- ---------------- ---------------- Net income $ 968,376 $ 2,081,648 $ 2,729,626 $ 5,105,121 ================= ================ ================ ================ Pro Forma Pro Forma ----------------- ---------------- Historical income before income taxes $ 967,048 $ 2,728,298 Pro forma provision for income taxes 388,409 1,092,409 ----------------- ---------------- Pro forma net income $ 578,639 $ 1,635,889 ================= ================ Net income per share $ 0.12 $ 0.23 $ 0.34 $ 0.64 ================= ================ ================ ================ Weighted average shares outstanding 4,752,780 9,078,066 4,752,780 8,013,713 ================= ================ ================ ================
The accompanying notes are an integral part of this consolidated statement. 4 NCO GROUP, INC. Consolidated Statements of Cash Flows (Unaudited)
For the Nine Months Ended September 30, ---------------------------- 1996 1997 ------------ ------------ Cash flows from operating activities: Net income $ 2,729,626 $ 5,105,121 Adjustments to reconcile net income to net cash provided by operating activities: Depreciation 284,459 915,044 Amortization of intangibles 480,432 1,353,702 Amortization of deferred financing costs 58,399 118,858 Loss on disposal of equipment -- 40,506 Gain on sales of securities (338) -- Provision for doubtful accounts 383 120,503 Changes in assets and liabilities, net of acquisitions: Accounts receivable, trade (1,459,651) (1,973,854) Notes receivable 155,856 -- Other current assets (165,375) 451,698 Deferred taxes (152,306) (33,532) Other assets 130,552 (26,826) Accounts payable 326,210 (820,666) Corporate taxes payable 167,753 279,799 Accrued expenses (559,547) 1,314,001 Accrued compensation and related costs 240,508 541,270 Unearned revenue (72,943) (120,739) ------------ ------------ Net cash provided by operating activities 2,164,018 7,264,885 Cash flows from investing activities: Purchase of property and equipment (708,121) (2,560,257) Purchase of securities (159,562) -- Proceeds from sale of securities 127,887 -- Net cash paid for acquisitions (12,664,218) (22,876,256) ------------ ------------ Net cash used in investing activities (13,404,014) (25,436,513) Cash flows from financing activities: Repayment of notes payable (125,466) (8,386,297) Borrowings under credit agreement 12,550,000 8,350,000 Payment of fees to acquire new debt (130,000) -- Issuance of common stock, net -- 39,571,497 Decrease in notes receivable, shareholders 82,873 -- Distributions to shareholders (851,978) -- ------------ ------------ Net cash provided by financing activities 11,525,429 39,535,200 ------------ ------------ Net increase in cash and cash equivalents 285,433 21,363,572 Cash and cash equivalents at beginning of period 804,550 12,058,798 ------------ ------------ Cash and cash equivalents at end of period $ 1,089,983 $ 33,422,370 ============ ============ Supplemental disclosures of cash flow information: Cash paid for interest $ 519,499 $ 493,724 Cash paid for income taxes -- 3,140,856 Noncash investing and financing activities: Fair value of assets acquired 4,087,253 7,986,816 Liabilities assumed from acquisitions -- 3,400,271 Convertible note payable, issued for acquisition 1,000,000 900,000 Convertible note payable, exercised for Common Stock -- 1,000,000 Warrants issued for acquisitions -- 875,000 Common stock issued for acquisitions -- 8,214,880 Value of fixed assets traded for new fixed assets -- 233,847 Property acquired under capital leases 348,586 --
The accompanying notes are an integral part of this consolidated statement. 5 NCO Group, Inc. Pro Forma Consolidated Statements of Income For the Nine Months Ended September 30, 1997 (Unaudited)
Historical ----------------------------------- Offering and NCO Group, Acquired Acquisition Pro Forma Inc. Companies (1,2) Adustments (3) Combined ------------ --------------- ---------------- ---------- Revenue $ 60,977,700 $ 2,841,578 $ -- $ 63,819,278 Operating costs and expenses: Payroll and related expenses 30,279,194 1,381,883 (103,258) 31,557,819 Selling, general and administrative expenses 19,777,042 1,159,470 (54,093) 20,882,419 expenses Depreciation and amortization expense 2,387,604 156,915 (27,378) 2,517,141 ------------ ------------ ------------ ------------ Total operating costs and expenses 52,443,840 2,698,268 (184,729) 54,957,379 ------------ ------------ ------------ ------------ Income from operations 8,533,860 143,310 184,729 8,861,899 Other income (expense): Interest and investment income 607,314 607,314 Interest expense (507,454) (273) 333,201 (174,526) Loss on disposal of fixed assets (40,506) (40,506) ------------ ------------ ------------ ------------ 59,354 (273) 333,201 392,282 ------------ ------------ ------------ ------------ Income before provision for income taxes 8,593,214 143,037 517,930 9,254,181 Income tax expense 3,488,093 268,294 3,756,387 ------------ ------------ ------------ ------------ Net income $ 5,105,121 $ 143,037 $ 249,636 $ 5,497,794 ============ ============ ============ ============ Net income per share $ 0.64 $ 0.66 ============ ============ ============ ============ Weighted average shares outstanding 8,013,713 8,361,216 ============ ============
(1) Pro forma information includes the pro forma effect of the acquisitions of Goodyear & Associates, CMS A/R Services, Tele-Research Center and CRW Financial, Inc., Collections Division as if they had occurred on January 1, 1997 (2) Pro forma information does not include the pro forma effect of the acquisitions of Credit Acceptance Corporation or ADVANTAGE Financial, Inc. These acquisitions were completed on September 29, 1997 and September 30, 1997 respectively, but were not effective until October 1, 1997. (3) Gives effect to: (i) the reduction of certain redundant operating costs and expenses that were immediately identifiable at the time of the acquisitions; (ii) the issuance of 76,923 shares of stock in connection with the conversion of a $1.0 million seller-financed note payable; and (iii) the elimination of additional interest expense associated with acquisition-related debt assumed to be repaid on January 1, 1997 with the proceeds of the Company's July 1997 public offering 6 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 related services utilizing an extensive teleservices infrastructure. The Company's client base is comprised of companies located throughout the United States in the following sectors: financial services, government, education, healthcare, retail and commercial, telecommunications, and utilities. Effective September 3, 1996, the Company reorganized its corporate structure. At September 3, 1996, the shareholders of NCO Financial Systems, Inc. contributed each of their shares of common stock in exchange for one share common stock of the Company, a recently formed corporation. The Company effected a 46.56 for 1 stock split in September 1996 and increased the number of authorized shares to 5,000,000 shares of preferred stock and 25,000,000 shares of common stock. All per share and related amounts have been adjusted to reflect the stock exchange and stock split. In July 1997, the Company completed a public offering (the "1997 Offering") selling 2,875,000 shares of common stock at a price to the public of $29.50 per share, including 1,444,000 shares issued by the Company, 433,579 shares and 375,000 over-allotment shares sold by existing shareholders, 50,320 shares acquired by employees through the exercise of stock options, 150,000 shares acquired by the Company's bank (Mellon Bank, N.A.) through the exercise of stock warrants, 76,923 shares acquired through the conversion of the Company's convertible note, and 345,178 shares acquired by CRW Financial, Inc. in connection with the acquisition by NCO of CRWCD. The proceeds of the offering, after underwriting discounts and expenses, were approximately $39.4 million. After the offering, the Company had 8,779,868 shares of Common Stock outstanding. 2. Summary of Significant Accounting Policies: Revenue Recognition: The Company generates revenues from contingency fees and contractual services. Contingency fee revenue is recognized upon collection of funds on behalf of clients. Contractual services revenue is deferred and recognized as services are performed. Income Taxes: The Company had elected to be taxed as an "S Corporation" under the Internal Revenue Code and the Pennsylvania Tax Code. While this election was in effect, no provision was made for income taxes by the Company since all income was taxed directly to, and losses and tax credits were utilized directly by, the shareholders of the Company. The Company terminated its S Corporation status on September 3, 1996. Upon termination of its S Corporation status, the Company adopted SFAS No. 109, "Accounting for Income Taxes". This standard requires an asset and liability approach that takes into account changes in tax rates when valuing the deferred tax amounts to be reported in the balance sheet. Credit Policy: The Company has two types of arrangements under which it collects its contingency fee revenue. For certain clients, the Company remits funds collected on behalf of the client net of the related contingency fees while, for other clients, the Company remits gross funds collected on behalf of clients and bills the client separately for its contingency fees. Management carefully monitors its client relationships in order to minimize its credit risk and generally does not require collateral. In the event of collection delays from clients, management may at its discretion change from the gross remittance method to the net remittance method. 7 Goodwill and Acquisition Costs: Goodwill represents the excess of purchase price over the fair market value of the net assets of the acquired businesses. Goodwill is amortized on a straight-line basis over 15 to 25 years. The recoverability of goodwill is periodically reviewed by the Company. In making such determination with respect to goodwill, the Company evaluates the operating cash flows of the underlying business which gave rise to such amount. Deferred Financing Costs: Deferred financing costs relate to debt issuance costs incurred which are capitalized and amortized over the term of the debt. Estimates Utilized in the Preparation of Financial Statements: The preparation of financial statements in conformity with generally accepted accounting principles requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Actual results could differ from those estimates. Earnings Per Share: Earnings per share were computed by dividing the pro forma net income for the three and nine month periods ended September 30, 1997 and 1996 by the pro forma weighted average number of shares outstanding. Pro forma net income amounts are used because the 1996 historical net income does not include the impact of federal and state income taxes as if the Company had been subject to income taxes for the entire period. Pro forma weighted average shares outstanding are based on the weighted average number of shares outstanding including common equivalent shares. All outstanding options and warrants have been treated as common equivalent shares in calculating pro forma net income per share, using the treasury stock method and the initial public offering price of $13.00 per share for periods before the initial public offering, only when their effect would be dilutive. For September 30, 1996, the pro forma weighted average number of shares outstanding have also been adjusted to include the number of shares of common stock (250,000 shares) that the Company would have needed to issue at the initial public offering price of $13.00 per share to finance the distribution of undistributed S Corporation earnings through the date on which the Company terminated its S Corporation status. Fully diluted earnings per share are not materially different from primary earnings per share. In March 1997, the Financial Accounting Standards Board issued Statement of Financial Accounting Standards (SFAS) No. 128 "Earnings Per Share." This Statement establishes standards for computing and presenting earnings per share (EPS) and applies to entities with publicly held common stock or potential common stock. This Statement is effective for financial statements issued for periods ending after December 15, 1997; earlier application is not permitted. This Statement requires restatement of all prior-period EPS data presented. The Company is currently evaluating the impact, if any, adoption of SFAS No. 128 will have on its financial statements. 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 normal recurring accruals) considered necessary for a fair presentation have been included. Operating results for the three and nine month periods ended September 30, 1997 are not necessarily indicative of the results that may be expected for the year ending December 31, 1997 or for any other interim period. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K, as amended, filed with the Securities and Exchange Commission on March 31, 1997. 8 3. Acquisitions: On January 3, 1996 the Company purchased certain assets of Trans Union Corporation Collections Division ("TCD") for $4,750,000 in cash. TCD provided accounts receivable management services, principally to the telecommunications, utility and healthcare sectors from offices in Pennsylvania, Ohio and Kansas. This acquisition resulted in goodwill of $3.7 million. On September 5, 1996 the Company purchased the outstanding stock of Management Adjustment Bureau, Inc. ("MAB") for $9,000,000 comprised of $8,000,000 in cash and a $1,000,000 convertible note. The note is convertible into 76,923 shares of the Company's Common Stock, at any time, and bears interest payable monthly at a rate of 8.0% per annum with principal due in September 2001. This note was converted to Common Stock in July 1997. MAB, based in Buffalo, New York, provided accounts receivable management services, principally to the education, financial services, telecommunications and utility sectors. This acquisition resulted in goodwill of $8.7 million. On January 22, 1997, NCO purchased all of the outstanding stock of Goodyear & Associates, Inc. ("Goodyear") for $4.5 million in cash and a $900,000 convertible note. The note is convertible into 42,503 shares of the Company's Common Stock, at any time, and bears interest payable monthly at a rate of 8.0% per annum with principal due in January 2002. Goodyear, based in Charlotte, North Carolina, provided accounts receivable management services principally to the telecommunications, education, and utility sectors. Goodyear's revenues in 1996 were $5.5 million. This acquisition resulted in goodwill of $5.3 million. On January 30, 1997, NCO purchased certain assets of Tele-Research Center, Inc. ("TRC") for $1.6 million in cash. TRC, located in Philadelphia, Pennsylvania, provided market research, data collection, and other teleservices to market research companies as well as end-users. TRC's revenues in 1996 were $1.8 million. This acquisition resulted in goodwill of $1.6 million. On January 31, 1997, NCO purchased substantially all the assets of CMS A/R Services ("CMSA/R"), formerly a division of CMS Energy Corporation, for $5.1 million in cash. Specializing in the utility industry, CMSA/R, located in Jackson, Michigan, provided a wide range of accounts receivable management services in addition to traditional recovery of delinquent accounts including project outsourcing, early intervention, and database management services. CMSA/R's revenues in 1996 were $6.8 million. This acquisition resulted in goodwill of $3.5 million. On February 2, 1997, NCO purchased substantially all the assets of CRW Financial, Inc. Collections Division ("CRWCD") for $3.75 million in cash, 345,178 shares of its Common Stock and warrants for 250,000 shares of common stock. The purchase price was valued at approximately $12.8 million. CRWCD provided accounts receivable management services principally to the telecommunications, education, financial, government and utility sectors from 14 offices located throughout the United States. In addition, CRWCD had a commercial collections division. CRWCD's revenues in 1996 were $25.9 million. Due to the consolidation or closing of certain CRWCD branch offices, and the loss of certain contracts during 1996, revenue for CRWCD for 1997 is anticipated to be 10-15% lower than the revenue shown on the historical financial statements. This acquisition resulted in goodwill of $14.0 million. Effective October 1, 1997, NCO purchased all of the outstanding stock of Credit Acceptance Corp. ("CAC") for $1.8 million in cash. CAC, based in Pittsburgh, Pennsylvania, provided accounts receivable management services principally to the medical sector. CAC had revenues in 1996 of $2.3 million. Cash paid for the acquisition of CAC is included on the balance sheet at September 30, 1997 under the caption "Deposits on acquisitions." 9 Effective October 1, 1997, NCO purchased all of the outstanding stock of ADVANTAGE Financial Services, Inc. ("Advantage") for $2.9 million in cash, 30,961 shares of its Common Stock and $1,000,000 in notes payable. The purchase price was valued at $5.0 million. The notes bear interest payable monthly at a rate of 8.0% per annum with principal due in September 2002. Advantage, based in Dayton, Ohio and Bristol, Tennessee, provided accounts receivable management services principally to the medical, telecommunications and commercial sectors. Advantage had revenues in 1996 of $5.1 million. Cash paid for the acquisition of Advantage is included on the balance sheet at September 30, 1997 under the caption "Deposits on acquisitions." The acquisitions of Goodyear, TRC, CMSA/R, and CRWCD are known collectively as the "1997 Q1 Acquisitions." The acquisitions of CAC and Advantage are known collectively as the "1997 Q4 Acquisitions." The 1997 Q1 Acquisitions and the 1997 Q4 Acquisitions are known collectively as the "1997 Acquisitions." 4. 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 $9,499,272 and $3,835,409 at September 30, 1997 and December 31, 1996, respectively, have been shown net of their offsetting liability for financial statement presentation purposes. 5. Long-term debt: In July 1995, the Company entered into a $7,000,000 revolving credit agreement. In connection with the agreement, the bank received a warrant for 175,531 shares of Common Stock, exercisable at a nominal value. The line of credit is collateralized by substantially all the assets of the Company and contains, among other provisions, requirements for maintaining defined levels of working capital, net worth, capital expenditures, various financial ratios and restrictions on distributions to shareholders. In September 1996, the credit agreement was increased to $15,000,000 to provide financing for the acquisition of MAB and the bank received a warrant for 46,560 shares, exercisable at $13.00 per share. In December 1996, the bank increased the credit agreement to $25,000,000 and received a warrant to purchase an additional 18,500 shares, exercisable at $13.00 per share. The Company financed the 1997 Q1 Acquisitions by borrowing $7.35 million on its revolving credit facility and financed the remainder through funds raised in the initial public offering and through its existing working capital. During March 1997, the Company borrowed an additional $1.0 million to fund the reduction of accounts payable assumed as part of the CRWCD acquisition. The line of credit was repaid in full with funds raised in the Company's initial public offering in November 1996 and the 1997 Offering. 6. Investment Considerations: In analyzing whether to make, or to continue, an investment in the Company, investors should consider, among other factors, certain risk factors and other information contained in the Company's filings with the Securities and Exchange Commission, including, without limitation, the Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 31, 1997, as amended, and the Company's Registration Statements on Form S-1 filed with the Securities and Exchange Commission on June 11, 1997 and September 11, 1996, as amended. 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. 10 Item 2 Management's Discussion and Analysis of Financial Condition and Results of Operations The information contained in this Report on Form 10-Q, other than historical facts, contains forward-looking statements (as such term is defined in the Securities Exchange Act of 1934, and the regulations thereunder) including, without limitation, statements as to the Company's objective to grow through strategic acquisitions and internal growth, the Company's ability to realize operating efficiencies in the integration of its acquisitions, trends in the Company's future operating performance, the classification of the Company's investment portfolio, 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, 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, 1997, as amended, 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. Pro Forma Compared to Actual Results of Operations Pro forma operating data for the nine month period ended September 30, 1997 assume that the 1997 Q1 Acquisitions were consummated on January 1, 1997. Pro forma adjustments have been made to reflect the elimination of certain expenses that were immediately identifiable at the time of the acquisitions. For instance, pro forma adjustments to the 1997 Q1 Acquisitions include the elimination of approximately 110 redundant administrative and collection personnel, the reduction of the salaries of the principal shareholder of Goodyear, the closing or consolidation of four existing call centers, as well as the downsizing of three call centers into customer service locations. At the time of the acquisitions, the acquired companies had a higher cost structure than that of the Company's core business. The Company intends to leverage its infrastructure to realize additional operating efficiencies in order to bring the cost structure of the acquired companies in line with NCO's current operating results. These other costs savings include: (i) further reduction in payroll and related expenses relating primarily to redundant collections and administrative personnel; (ii) further reductions in facilities costs; and (iii) reduction of certain expenses such as telephone, mailing and data processing. Management believes it will realize these cost savings with respect to the acquired companies, although no assurances can be given that such cost savings will be realized. Due to the higher cost structures of the acquired business and the fact that all expected expense savings are not reflected in pro forma adjustments, certain pro forma operating percentages compare unfavorably to actual operating percentages for the periods under consideration. Due to the consolidation or closing of certain CRWCD branch offices, and the loss of certain contracts during 1996, revenue for CRWCD for 1997 is anticipated to be 10% to 15% lower than CRWCD's revenue for 1996. Pro forma operating data does not include the recent acquisitions of CAC and Advantage which were completed on September 29, 1997 and September 30, 1997, respectively, but were not effective until October 1, 1997. Three months Ended September 30, 1997 Compared to Three Months ended September 30, 1996 Revenue. Revenue increased $14.0 million or 181.8% to $21.7 million for the three months ended September 30, 1997 from $7.7 million for the comparable period in 1996. The addition of new clients and growth in business from existing clients represented $2.0 million of the increase in revenue, and revenue attributable to the MAB acquisition completed in September 1996 represented $2.4 million of the increase. In addition, $5.6 million of revenue was attributable to the CRWCD acquisition completed in February 1997, and $4.0 million was attributable to the Goodyear, CMS A/R, and TRC acquisitions completed in January 1997. 11 Payroll and related expenses. Payroll and related expenses increased $7.1 million to $10.7 million for the three months ended September 30, 1997 from $3.6 million for the comparable period in 1996, and increased as a percentage of revenue to 49.2% from 47.1%. Payroll and related expenses increased as a percentage of revenue primarily as a result of the MAB, Goodyear, TRC, and CRWCD acquisitions having a higher cost structure than that of the Company. This increase was partially offset by spreading the cost of management and administrative personnel over a larger revenue base. Selling, general and administrative expenses. Selling, general and administrative expenses increased $4.6 million to $7.1 million for the three months ended September 30, 1997 from $2.5 million for the comparable period in 1996, and increased as a percentage of revenue to 32.6% from 32.4%. The businesses acquired in the 1997 Q1 Acquisitions have a higher cost structure than that of the Company and the Company has continued to experience increased costs as a result of changes in business mix which require the increased use of national databases and credit reporting services. These increases were partially offset by operating efficiencies obtained by spreading selling, general and administrative expenses over a larger revenue base. Depreciation and amortization. Depreciation and amortization increased to $844,000 for the three months ended September 30, 1997 from $400,000 for the comparable period in 1996. Amortization from the MAB and 1997 Q1 Acquisitions increased $508,000 over the same period in 1996. Amortization of deferred financing charges and depreciation resulting from normal capital expenditures incurred in the ordinary course of business decreased $64,000 to $317,000 for the three months ended September 30, 1997 as a result of the disposition of certain fixed assets in the move of the Company's corporate headquarters. Other income (expense). Interest expense decreased to $85,000 for the three months ended September 30, 1997 from $249,000 for the comparable period in 1996. The Company's revolving credit facility, which had $15.0 million outstanding as of September 30, 1996, was repaid with part of the proceeds from the Company's initial public offering of Common Stock in November 1996 (the "IPO") and a $1.0 million convertible note payable issued in connection with the MAB acquisition in September 1996 was converted to Common Stock concurrent with the 1997 Offering. Offsetting these decreases in interest expense is an $900,000 convertible note issued in connection with the Goodyear acquisition in January 1997. Interest and investment income increased to $445,000 for the three months ended September 30, 1997 from $33,000 for the comparable period in 1996. This increase was primarily attributable to the investment of funds remaining from the 1997 Offering, as well as an increase in operating funds and funds held in trust for clients. As a result of the disposal of certain fixed assets in the move of the Company's corporate headquarters in July 1997, the Company incurred a loss on the disposal of fixed assets in the amount of $41,000. Income tax expense. Income tax expense for the three months ended September 30, 1997 was $1.3 million and was computed using an assumed rate of 39.3% after giving effect to non-deductible goodwill resulting from certain of the acquired companies. The Company was an S Corporation until September 3, 1996 and, accordingly, there was no provision for income taxes until that time. The pro forma provision for income taxes of $388,000 for the three months ended September 30, 1996 was computed utilizing an assumed rate of 40.0% after giving effect to non-deductible goodwill. Net income. Net income increased to $2.1 million for the three months ended September 30, 1997 from the pro forma net income of $579,000 for the comparable period in 1996, a 259.7% increase. Nine months Ended September 30, 1997 Compared to Nine Months ended September 30, 1996 Revenue. Revenue increased $40.7 million or 201.0% to $61.0 million for the nine months ended September 30, 1997 from $20.3 million for the comparable period in 1996. The addition of new clients and growth in business from existing clients represented $4.8 million of the increase in revenue and revenue attributable to the MAB acquisition completed in September 1996 represented $9.3 million of the increase. In addition, $15.4 million of revenue was attributable to the CRWCD acquisition completed in February 1997, and $11.2 million was attributable to the Goodyear, CMS A/R, and TRC acquisitions completed in January 1997. 12 Payroll and related expenses. Payroll and related expenses increased $20.7 million to $30.3 million for the nine months ended September 30, 1997 from $9.6 million for the comparable period in 1996, and increased as a percentage of revenue to 49.7% from 47.3%. Payroll and related expenses increased as a percentage of revenue primarily as a result of the businesses acquired in the MAB acquisition and the 1997 Q1 Acquisitions having a higher cost structure than that of the Company. This increase was partially offset by spreading the cost of management and administrative personnel over a larger revenue base. Selling, general and administrative expenses. Selling, general and administrative expenses increased $13.2 million to $19.8 million for the nine months ended September 30, 1997 from $6.6 million for the comparable period in 1996, and decreased as a percentage of revenue to 32.4% from 32.6%. The business acquired in the 1997 Q1 Acquisitions have a higher cost structure than that of the Company and the Company has continued to experience increased costs as a result of changes in business mix which require the increased use of national databases and credit reporting services. These increases were more than offset by operating efficiencies obtained by spreading selling, general and administrative expenses over a larger revenue base. Depreciation and amortization. Depreciation and amortization increased to $2.4 million for the nine months ended September 30, 1997 from $823,000 for the comparable period in 1996. $1.4 million of the increase was a result of the MAB acquisition and the 1997 Q1 Acquisitions. Amortization of deferred financing charges and depreciation resulting from normal capital expenditures incurred in the ordinary course of business increased $155,000 to $959,000 for the nine months ended September 30, 1997. Other income (expense). Interest expense decreased to $507,000 for the nine months ended September 30, 1997 from $607,000 for the comparable period in 1996. Although the Company's revolving credit facility had been repaid with a portion of the net proceeds from the IPO, the Company borrowed $8.4 million on its revolving credit facility to partially finance the 1997 Q1 Acquisitions. Additionally, the Company issued a $1.0 million convertible note payable in connection with the MAB acquisition in September 1996 which was converted to Common Stock in connection with the 1997 Offering, and an $900,000 convertible note payable in connection with the Goodyear acquisition in January 1997. Interest and investment income increased $526,000 to $607,000 for the nine months ended September 30, 1997 from the comparable period in 1996. This increase was primarily attributable to the investment of funds remaining from the 1997 Offering, as well as an increase in operating funds and funds held in trust for clients. As a result of the disposal of certain fixed assets in the move of the Company's corporate headquarters in July 1997, the Company incurred a loss on the disposal of fixed assets in the amount of $41,000. Income tax expense. Income tax expense for the nine months ended September 30, 1997 was $3.5 million and was computed using an assumed rate of 40.6% after giving effect to non-deductible goodwill resulting from certain of the acquired companies. The Company was an S Corporation until September 1, 1996 and, accordingly, there was no provision for income taxes until that time. The pro forma provision for income of $1.1 million for the nine months ended September 30, 1996 was computed utilizing an assumed rate of 40.0% after giving effect to non-deductible goodwill. Net income. Net income in 1997 increased to $5.1 million for the nine months ended September 30, 1997 from the pro forma net income of $1.6 million for the comparable period in 1996, a 212.1% increase. Liquidity and Capital Resources The Company's primary sources of cash have historically been cash flows from operations and bank borrowings, and the net proceeds from public offerings. Cash has been used for acquisitions, distributions to shareholders, purchases of equipment and working capital to support the Company's growth. 13 In July 1997, the Company completed a public offering, selling 2,875,000 shares of common stock including 1,444,000 shares issued by the Company, 433,579 shares and 375,000 over-allotment shares sold by existing shareholders, 50,320 shares acquired by employees through the exercise of stock options, 76,923 shares acquired through the conversion of the Company's convertible note, 150,000 shares acquired by the Company's bank (Mellon Bank, N.A.) through the exercise of a portion of their stock warrants, and 345,178 shares acquired by CRW Financial, Inc. in connection with the acquisition by NCO of the Collections Division of CRW Financial, Inc. The net proceeds to the Company were approximately $39.4 million. In November 1996, the Company completed its IPO of 2,500,000 shares of its Common Stock at a price of $13.00 per share. The net proceeds to the Company were approximately $28.8 million. Cash provided by operating activities was $7.3 million during the nine months ended September 30, 1997, and $2.2 million for the comparable period in 1996. The increase in cash provided by operations was primarily due to the increase in net income to $5.1 million for the nine months ended September 30, 1997 compared to $2.7 million for the comparable period in 1996, and the increase in non-cash charges, primarily depreciation and amortization, to $2.4 million during the nine months ended September 30, 1997 compared to $823,000 for the comparable period in 1996. Additionally, accounts payable and accrued expenses increased $1.0 million during the nine months ended September 30, 1997 compared to an increase of $7,000 in the comparable period in 1996. These increases were offset by a $2.0 million increase in accounts receivable in the nine months ended September 30, 1997 compared to a $1.5 million increase in the comparable period in 1996. Cash used in investing activities was $25.4 million during the nine months ended September 30, 1997 compared to $13.4 million for the comparable period in 1996. The increase was primarily due to the 1997 Acquisitions versus the acquisition of TCD during the first quarter of 1996 and the acquisition of MAB during the third quarter of 1996. In February 1997, NCO purchased substantially all of the assets of CRWCD for $3.75 million in cash, 345,178 shares of Common Stock and warrants for 250,000 shares of Common Stock. In January 1997, the Company purchased substantially all of the assets of CMS A/R for $5.1 million in cash, certain assets of TRC for $1.6 million in cash and all of the outstanding stock of Goodyear for $4.5 million in cash and a $900,000 Convertible Note. The Note is convertible into an aggregate of 42,503 shares of Common Stock at any time and bears interest payable monthly at a rate of 8.0% per annum with principal due in January 2002. The Company financed the cash portion of the purchase price for the 1997 Q1 Acquisitions with borrowings of $7.4 million under its Credit Agreement and financed the balance with proceeds of its IPO and existing working capital. During March 1997, the Company borrowed an additional $1.0 million under the Credit Agreement to pay certain accounts payable assumed as part of the CRWCD acquisition. These borrowings were repaid during the third quarter 1997. In addition, the Company has accrued $1.1 million of acquisition related expenses. The 1997 Q1 Acquisitions collectively resulted in goodwill of $24.5 million. On September 29, 1997, effective October 1, 1997, NCO purchased all of the outstanding stock CAC for $1.8 million in cash. On September 30, 1997, effective October 1, 1997, NCO purchased all of the outstanding stock of Advantage for $2.9 million in cash, 30,961 shares of its Common Stock and $1,000,000 in notes payable. The purchase price was valued at $5.0 million. The notes bear interest payable monthly at a rate of 8.0% per annum with principal due in September 2002. Cash paid for the acquisitions of CAC and Advantage is included on the balance sheet at September 30, 1997, under the caption "Deposits on acquisitions." During the nine months ended September 30, 1997, capital expenditures were $2.6 million compared to $708,000 in comparable period in 1996. In connection with the Company's move to new corporate headquarters the Company was able to exchange certain furniture and equipment with a net book value of $234,000 for credit toward the purchase of new fixed assets. Other assets were abandoned and the loss of $41,000 has been reflected in the accompanying financial statements. Cash provided by financing activities was $39.5 million during the nine months ended September 30, 1997 compared to $11.5 million for the comparable period in 1996. Bank borrowings had been the Company's primary source of cash from financing activities and were used for acquisitions and, along with cash provided by operations, for distributions to shareholders. The Company raised net proceeds of approximately $39.4 million in the 1997 Offering. The Company used a portion of the proceeds from the IPO and the 1997 Offering to repay $8.35 million of outstanding indebtedness under the Credit Agreement. In addition, the Company received $211,000 from the exercise of employee stock options during the third quarter of 1997. The Company raised net proceeds of approximately $28.8 million in the IPO in November 1996 of which $15.0 million was used to repay outstanding indebtedness under the Credit Agreement and approximately $3.2 million was used to pay undistributed S Corporation earnings during the nine months ended September 30, 1996. Total distributions to shareholders were $852,000 for the nine months ended September 30, 1996. 14 In July 1995, the Company entered into a revolving credit agreement with Mellon Bank, N.A. which provided for borrowings up to $7.0 million at an interest rate equal to prime plus 1.375%, which was subsequently increased to $15.0 million in September 1996, to be utilized for working capital and strategic acquisitions. Subsequent to the IPO, Mellon Bank, N.A. increased the revolving credit facility to $25.0 million and decreased the rate of interest to 2.5% over LIBOR. Mellon Bank, N.A. reduced the interest rate to 1.5% over LIBOR upon the completion of the Company's 1997 Offering. Outstanding borrowings under the Credit Agreement at September 30, 1997 and 1996 were $0.0 and $7.0 million, respectively. The revolving credit line is collateralized by substantially all the assets of the Company and includes certain financial covenants such as maintaining minimum working capital and net worth requirements and includes restrictions on, among other things, capital expenditures and distributions to shareholders. The outstanding borrowings on the revolving credit facility were repaid in full with the proceeds of the IPO and the 1997 Offering. In connection with entering into the original Credit Agreement, the Company recorded deferred charges of approximately $135,000 relating primarily to bank and legal fees. The Company also issued a warrant to the bank exercisable for an aggregate of 175,351 shares of the Company's Common Stock. The warrant expires on July 31, 2005 and is exercisable for nominal consideration. A portion of this warrant was exercised in July 1997 for 150,000 shares sold in connection with the Company's public offering. In connection with the increase of the line of credit available under the Credit Agreement in September 1996 and December 1996, the Company recorded deferred charges of $261,000 primarily relating to bank charges and legal fees. In addition, the Company issued additional warrants to the bank for an aggregate of 65,060 shares of Common Stock exercisable at $13.00 per share. The warrants have been capitalized on the balance sheet as a deferred charge and are being amortized over the life of the credit facility and are currently exercisable. The Company believes that funds generated from operations, together with existing cash, the net proceeds from the 1997 Offering and available borrowings under its Credit Agreement will be sufficient to finance its current operations and planned capital expenditure requirements and internal growth at least through September 30, 1998. However, the Company could require additional debt or equity financing if it were to make any significant acquisitions for cash. 15 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 n July 1997, the Company issued 150,000 shares of Common Stock upon the exercise of a warrant issued to an affiliate of Mellon Bank in connection with the Company's Credit Agreement and 76,923 shares of Common Stock upon the conversion of the Company's $1.0 million Convertible Note issued pursuant to the MAB acquisition. These shares were issued by the Company in reliance upon the exemption from the registration requirements provided by Section 4(2)of the Securities Act and were subsequently sold by the holders in the Company's public offering completed on such date. In July 1997, the Company issued 50,320 shares of Common Stock upon the exercise of a stock options granted to certain employees of the Company. These shares were issued to the employees in reliance upon the exemption from the registration requirements provided by Section 4(2) of the Securities Act and/or Rule 701 promulgated under the Securities Act. These shares were subsequently sold by the holders in the Company's public offering completed on such date. On September 30, 1997, effective October 1, 1997, the Company issued 30,961 shares of Common Stock in connection with the acquisition of ADVANTAGE Financial Services, Inc. These shares were issued by the Company in reliance upon the exemption from the registration requirements provided by Section 4(2) of the Securities Act. The Company completed its initial public offering of Common Stock in November 1996 (the "IPO") pursuant to its Registration Statement on From S-1 (Registration No. 333-11745) which became effective on November 6, 1996. The Company's Reports of Sales of Securities and Use of Proceeds Therefrom on Form SR, as amended, filed witht the Commission on or about February 19, 1997 and May 7, 1997 are hereby incorporated by reference. In such Reports, the Company had disclosed that all of the net offering proceeds of $28,876,372 from the IPO had been used except that $3,000,000 of net proceeds was temporarily invested in short-term investment grade securities. The Issuer hereby updates such Reports to disclose that all of such remaining proceeds of $3,000,000 were used, together with a portion of the net proceeds form the Company's July 1997 offering of Common Stock, to repay outstanding borrowings under the Company's revolving credit facility. 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 NCO Group, Inc. has been awarded a contract to perform collection services for the United States Department of Education. The contract has an initial term of four years. 16 The first placement of accounts is anticipated at the beginning of the first quarter of 1998 and the Company anticipates that the contract will begin to produce revenue by the end of the first quarter of 1998. The contract should have no effect on earnings for calendar year 1998 as a whole, and should be accretive to earnings in 1999. However, the costs in the initial period of the contract could reduce operating results by as much as $.04 per share for each of the fourth quarter of 1997 and the first quarter of 1998. Unlike other new business opportunities which typically allow NCO to closely match the timing of expenses to coincide with the incoming stream of revenue, this contract requires the Company to make an investment in additional equipment and a segregated call center location and to have personnel in place prior to receiving the initial placement of accounts from the Department of Education. The Company believes that this initial investment should be more than offset by the size and extended nature of this contract. Certain statements in this Item 5, including, without limitation, statements as to the effects of the Department of Education contract on the Company's expenses, revenue or its profitability, or as to management's belief, expectations and opinions, are forward-looking statements that involve risks and uncertainties and are subject to change at any time. In addition to the factors discussed above, certain other factors, including without limitation, the risks that the implementation of the contract will be delayed, that the Company will incur higher than anticipated costs, that the revenues from the contract will be less than anticipated or that the Department of Education will terminate the contract prior to the end of the term, as well as risks associated with growth, future acquisitions, fluctuations in quarterly operating results, and other risks detailed from time to time in the Company's filings with the Securities and Exchange Commission, including the Annual Report on Form 10-K, filed on March 31, 1997, as amended, can cause actual results and developments to be materially different from those expressed or implied by such forward-looking statements Item 6. Exhibits and Reports on 8-K (a) Exhibits 27.1 Financial Data Schedule Reports on Form 8-K 17 Signatures Pursuant to the requirement of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: November 13, 1997 By: /s/ Michael J. Barrist ------------------------------- Michael J. Barrist Chairman and Chief Executive Officer Date: November 13, 1997 By: /s/ Steven L. Winokur ------------------------------- Steven L. Winokur Executive Vice President, Finance and Chief Financial Officer 18 EX-27 2 FINANCIAL DATA SCHEDULE
5 9-MOS DEC-31-1997 JAN-01-1997 SEP-30-1997 33,422,370 0 11,418,696 338,020 0 306,280 8,893,172 1,965,741 96,143,379 9,191,040 0 0 0 78,297,211 7,116,905 96,143,379 60,977,700 60,977,700 0 0 52,192,527 251,313 (59,354) 8,593,214 3,488,093 5,105,121 0 0 0 5,105,121 0 0
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