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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2001
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 000-32403
NCO PORTFOLIO MANAGEMENT, INC.
(Exact name of Registrant as specified in its charter)
Delaware 23-3005839
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1705 Whitehead Road, Baltimore, Maryland 21207-4004
(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code: (410) 594-7000
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act: Common Stock, par
value $0.01 per share
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 (or for such shorter period that the Registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of the Registrant's knowledge, in definitive proxy or information
statements incorporated by reference in Part III of this Form 10-K or any
amendment to this Form 10-K. [ ]
The aggregate market value of the outstanding shares of the Registrant's
Common Stock held by non-affiliates was approximately $29.4 million. (1)
Indicate the number of shares outstanding of each of the Registrant's classes of
common stock, as of the most recent practicable date.
Outstanding at
Title of Class March 14, 2002
-------------- --------------
Common stock, par value $0.01 per share...................... 13,576,519 shares
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Information Statement to be filed in
connection with its 2002 Annual Meeting of Shareholders to be held on May 20,
2002, are incorporated by reference into Part III of this Report. Other
documents incorporated by reference are listed in the Exhibit Index.
---------------------
(1) The aggregate market value of the voting stock set forth equals the number
of shares of the Company's common stock outstanding, reduced by the amount of
common stock held by officers, directors and shareholders owning 10% or more of
the Company's common stock, multiplied by $6.40, the last reported sale price
for the Company's common stock on March 14, 2002. The information provided shall
in no way be construed as an admission that any officer, director or 10%
shareholder in the Company may be deemed an affiliate of the Company or that he
is the beneficial owner of the shares reported as being held by him, and any
such inference is hereby disclaimed. The information provided herein is included
solely for record keeping purposes of the Securities and Exchange Commission.
FORM 10-K TABLE OF CONTENTS
Page
----
PART I
Item 1. Business............................................................................................. 1
Item 2. Properties........................................................................................... 8
Item 3. Legal Proceedings.................................................................................... 8
Item 4. Submission of Matters to a Vote of Security Holders.................................................. 8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters................................ 9
Item 6. Selected Financial Data.............................................................................. 10
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations................ 12
Item 7A. Quantitative and Qualitative Disclosures About Market Risk........................................... 19
Item 8. Consolidated Financial Statements and Supplementary Data............................................. 20
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure................. 38
PART III
Item 10. Directors and Executive Officers of the Registrant................................................... 38
Item 11. Executive Compensation............................................................................... 38
Item 12. Security Ownership of Certain Beneficial Owners and Management....................................... 38
Item 13. Certain Relationships and Related Transactions....................................................... 38
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.................................... 39
Signatures........................................................................................... 44
As used in this Annual Report on Form 10-K, unless the context otherwise
requires, "we", "us", "our", "Company", "NCPM", or "NCO Portfolio" refers to NCO
Portfolio Management, Inc. and its subsidiaries.
Forward-Looking Statements
Certain statements included in this Annual Report on Form 10-K, including,
without limitation, statements in Item 7. "Management's Discussion and Analysis
of Financial Condition and Results of Operations," statements as to the
Company's or management's outlook as to financial results in 2002 and beyond,
statements as to the effects of the terrorist attacks and the economy on the
Company's business, statements as to the Company's or management's beliefs,
expectations or opinions, and all other statements in this report on Form 10-K,
other than historical facts, are forward-looking statements, as such term is
defined in the Securities Exchange Act of 1934, which are intended to be covered
by the safe harbors created thereby. Forward-looking statements are subject to
risks and uncertainties, are subject to change at any time, and may be affected
by various factors that may cause actual results to differ materially from the
expected or planned results. In addition to the factors discussed above, certain
other factors, including without limitation, risks relating to growth and future
accounts receivable purchases, risks related to the Company's debt, risks
related to the recoverability of the purchased receivables, risks related to the
use of estimates, risks related to the ability to purchase accounts receivable
at favorable prices in the open market, risks related to regulatory oversight,
risks related to the retention of the senior management team, risks related to
securitization transactions, risks related to the fluctuation in quarterly
results, risks related to NCO Group's ownership control of the Company, risks
related to the dependency on NCO Group for collections, and other risks
described under Item 1. "Investment Considerations," can cause actual results
and developments to be materially different from those expressed or implied by
such forward-looking statements.
PART I
Item 1. Business
General
We were incorporated in Delaware on January 22, 1999 (date of inception) under
the name NCO Portfolio Funding, Inc. We changed our name from NCO Portfolio
Funding, Inc. to NCO Portfolio Management, Inc. in February 2001. We purchase
and manage investments in defaulted accounts receivable from consumer creditors
such as banks, finance companies, retail merchants and other consumer oriented
companies. Our purchased accounts receivable originate from consumers throughout
the United States. On February 20, 2001, Creditrust Corporation ("Creditrust")
merged with and into us (the "Merger"). Included in the statement of income are
the results of operations of the assets acquired in the Merger of Creditrust for
the period February 21, 2001 through December 31, 2001.
NCO Group, Inc. ("NCO Group," "NCOG," or "Parent") owns approximately 63% of our
outstanding common stock, subject to certain adjustments. As part of the Merger,
we entered into a ten-year service agreement with NCO Financial Systems, Inc.
("NCOF"), a wholly owned subsidiary of NCO Group, to be the provider of
collection services. NCO Group has agreed to offer all of its future U.S.
accounts receivable purchase opportunities to us. The relationship with NCO
Group allows us to manage investment risk by leveraging NCO Group's client
relationships, experience, analytical databases and scale. We are one of the
largest companies, and one of the few public companies, in our industry.
Defaulted consumer receivables are the unpaid debts of individuals to consumer
creditors such as banks, finance companies, retail merchants and other consumer
oriented companies. Most of our receivables are VISA(R) and MasterCard(R) credit
card accounts that the issuing banks have charged off their books due to
non-payment. Since our founding in 1999 through December 31, 2001, we have
invested $179.9 million to purchase accounts receivable at a significant
discount, including the accounts receivable acquired in the Merger. At December
31, 2001, we managed over 2.3 million accounts with an original charged-off
amount of approximately $6.6 billion. Our focus is on maximizing the returns on
our purchased accounts receivable while minimizing our risk of ownership.
1
Accounts Receivable Analysis and Acquisition
We are an analytically based purchaser of defaulted consumer accounts receivable
that were originated through VISA(R), MasterCard(R), private label credit cards,
and consumer loans issued by consumer creditors such as banks, finance
companies, retail merchants and other consumer oriented companies. We use our
proprietary pricing models, extensive databases and collection experience to
evaluate and value accounts receivable purchases. The accounts receivable
typically were charged-off by the credit grantors due to non-payment. We have
found that the average portfolio of accounts receivable have an estimated
economic life of 60 months.
We purchase portfolios of accounts receivable typically for less than 10% of the
unpaid balance at the time of charge-off by the credit grantors. Some credit
grantors pursue an auction type sales approach by constructing a portfolio of
accounts receivable and seeking bids from specially invited competing parties.
Other means of purchasing accounts receivable include privately negotiated
direct sales when the credit grantors contact known, reputable purchasers and
the terms are negotiated. Credit grantors have also entered into "forward flow"
contracts that provide for a credit grantor to sell some or all of its accounts
receivable over a period of time to a single third party on the terms agreed to
in a contract.
We had historically funded our accounts receivable purchases and the expansion
of our business through internal cash flows and borrowings from NCO Group.
Effective with the Merger, NCO Group amended its credit agreement with Citizens
Bank of Pennsylvania ("Citizens Bank") to provide us with a $50 million
revolving line of credit from NCO Group in the form of a sub-facility under NCO
Group's existing revolving credit facility. We borrowed $36.3 million under this
arrangement to fund the Merger. Purchases of accounts receivable subsequent to
the Merger have been made from internal cash flows and borrowing on the credit
facility. Most of the accounts receivable acquired in the Merger were originally
purchased by Creditrust through bank lines of credit and securitizations. The
borrowing capacity of the sub-facility is subject to mandatory reductions
including four quarterly reductions of $2.5 million beginning March 31, 2002
through December 31, 2002. Effective March 31, 2003, quarterly reductions of
$3.75 million are required until the earlier of the Maturity Date or the date at
which the sub-facility is reduced to $25 million. The outstanding balance on the
sub-facility as of December 31, 2001 was $47.1 million.
Our acquisition personnel meet with consumer credit grantors and brokers to
develop sources of defaulted consumer accounts receivable for purchase. Once a
portfolio has been located, the acquisition personnel are responsible for
evaluating and determining the appropriate price to pay for the portfolio. Then
they coordinate the due diligence, including site visits as needed, coordinating
ordering, receipt, tracking and distribution of account documentation and
related media, and ensuring that our purchase costs stay within clearly defined
parameters. The acquisition personnel also supervise the post-purchase liaison
group, a group that verifies buy-backs and returns with sellers after the
purchase of accounts receivable. Buy-backs and returns are accounts that have
been returned to the seller because they did not fit the purchase criteria
because of death or bankruptcy of the customer prior to purchase. The
post-purchase liaison group also coordinates the import of purchased portfolios
into the servicer's collection recovery software system.
Collection Services
As part of the Merger, we entered into a ten-year service agreement that
appointed NCOF as the provider of our collection services. NCOF is paid a
commission ranging from 20% to 40% of the collected amount depending on the
nature of the accounts. NCO Group has agreed to offer all of its future U.S.
accounts receivable purchase opportunities to us. For the year ended December
31, 2001, servicing fees paid to NCOF totaled $27.5 million. We believe that the
commission rates paid are reasonable and are consistent with rates charged by
other collection agencies for the same type of services. We monitor NCOF's
performance in the normal course of business.
Legal Recovery Department
A component of our collection efforts involves the Legal Recovery Department to
pursue consumers with past due obligations who have the financial resources to
repay their debts but are unwilling to do so. We employ one in-house attorney
and a support staff to process thousands of court cases each year. The Legal
Recovery Department is responsible for coordinating a network of attorneys
nationwide, determining the suit criteria for each individual jurisdiction,
placing cases for immediate suit, obtaining judgment, seizing bank accounts,
coordinating sales of property and instituting wage garnishments to satisfy
judgments.
2
Competition
Our business is highly competitive. We compete with other purchasers of
defaulted consumer accounts receivable and with third-party collection agencies.
Successful bids are won based on a combination of price and relationship. Our
ability to obtain new customers is also significantly affected by the financial
services companies that choose to manage their own defaulted consumer accounts
receivable. Some of those companies have substantially greater personnel and
financial resources.
Regulation
The accounts receivable management and collection industry is regulated both at
the federal and state level. The Federal Fair Debt Collection Practices Act
regulates any person who regularly collects or attempts to collect, directly or
indirectly, consumer debts owed or asserted to be owed to another person. The
Fair Debt Collection Practices Act establishes specific guidelines and
procedures which debt collectors must follow in communicating with consumer
debtors, including the time, place and manner of such communications. Further,
it prohibits harassment or abuse by debt collectors, including the threat of
violence or criminal prosecution, obscene language or repeated telephone calls
made with the intent to abuse or harass. The Fair Debt Collection Practices Act
also places restrictions on communications with individuals other than consumer
debtors in connection with the collection of any consumer debt and sets forth
specific procedures to be followed when communicating with such third parties
for purposes of obtaining location information about the consumer. Additionally,
the Fair Debt Collection Practices Act contains various notice and disclosure
requirements and prohibits unfair or misleading representations by debt
collectors. We are also subject to the Fair Credit Reporting Act, which
regulates the consumer credit reporting industry and which may impose liability
on us to the extent that the adverse credit information reported on a consumer
to a credit bureau is false or inaccurate. The Federal Trade Commission has the
authority to investigate consumer complaints against debt collection companies
and to recommend enforcement actions and seek monetary penalties. The accounts
receivable management and collection business is also subject to state
regulation.
It is our policy and a condition of our agreement with NCOF, that all collection
activities by NCOF on our behalf, comply with the provisions of the Fair Debt
Collection Practices Act and comparable state statutes in all of its collection
activities. NCOF's failure to comply with such laws could have a materially
adverse effect on us.
Employees
As of the date of this report, we had 20 full-time employees. None of our
employees are represented by a labor union.
3
Investment Considerations
You should carefully consider the risks described below. If any of the risks
actually occur, our business, financial condition or results of future
operations could be materially adversely affected. This Annual Report on Form
10-K contains forward-looking statements that involve risk and uncertainties.
Our actual results could differ materially from those anticipated in the
forward-looking statements as a result of many factors, including the risks
faced by us described below and elsewhere in this Annual Report on Form 10-K.
Terrorist attacks and threats or war may negatively impact our results of
operations, revenue, and stock price.
Recent terrorist attacks in the United States, as well as future events
occurring in response or in connection to them, including, without limitation,
future terrorist attacks against United States targets, threats of war or actual
conflicts involving the United States or its allies, may impact our operations,
including affecting our ability to collect our accounts receivable. More
generally, any of these events could cause consumer confidence and spending to
decrease or result in increased volatility in the economy. They could also
result in the deepening of the economic recession in the United States. Any of
these occurrences could have a material adverse effect on our operating results,
collections and revenue, and may result in the volatility of the market price
for our common stock.
We may not be able to grow our business.
We intend to expand and rapidly grow our business, which could place great
demands on our administrative, operational and financial resources. Furthermore,
we may not be able to finance our continued growth, or to manage it effectively,
which would harm our business, results of operations and financial condition,
and our ability to meet our debt service obligations. Future growth and
development will depend on numerous factors, including our ability to:
o develop and expand relationships with credit grantors;
o maintain underwriting criteria in purchasing defaulted
accounts receivable;
o recruit, train and retain qualified employees;
o maintain quality service to customers and credit grantors;
o enhance and maintain information technology, operational and
financial systems; and
o access sufficient sources of funding to purchase additional
accounts receivable.
We have substantial debt, which could have adverse effects on our business.
At December 31, 2001, we had total assets of approximately $154 million, total
debt (including certain non-recourse debt and accounts payable) of approximately
$96 million and stockholders' equity of approximately $58 million. This
relatively high level of debt could result in a number of adverse effects,
including:
o increasing our vulnerability to a business downturn;
o limiting our ability to obtain necessary financing in the
future;
o requiring us to dedicate a substantial portion of our cash
flows from operations to pay debt service obligations rather
than for other purposes, such as working capital, or
purchasing additional portfolios of consumer accounts
receivable;
4
o limiting our flexibility to react to changes in our business
and market; and
o making us more highly leveraged than some of our competitors,
which may place us at a competitive disadvantage.
Most of our debt is interest rate sensitive. Any significant rise in interest
rates could increase interest expense, which could decrease net income.
Approximately $45.4 million of debt on our balance sheet is non-recourse to us.
The cash flows on assets associated with some of the debt may be restricted to
servicing the non-recourse debt and may not be generally available to us.
Collections may not be sufficient to recover the cost of investments in
purchased accounts receivable and support operations.
We purchase delinquent accounts receivable generated primarily by consumer
credit transactions. These are obligations that the individual consumer has
failed to pay when due. The accounts receivable are purchased from consumer
creditors such as banks, finance companies, retail merchants and other consumer
oriented companies. Substantially all of the accounts receivable consist of
account balances that the credit grantor has made numerous attempts to collect,
has subsequently deemed uncollectible, and charged-off its books. After
purchase, collections on accounts receivable could be reduced by consumer
bankruptcy filings, which have been on the rise. The accounts receivable are
purchased at a significant discount to the amount the customer owes and,
although the belief is that the recoveries on the accounts receivable will be in
excess of the amount paid for the accounts receivable, actual recoveries on the
accounts receivable may vary and may be less than the amount expected. The
timing or amounts to be collected on those accounts receivable cannot be
assured. If cash flows from operations are less than anticipated as a result of
our inability to collect our accounts receivable, we will not be able to
purchase new accounts receivable after we have exhausted the availability under
the sub-facility, and our future growth and profitability will be materially
adversely affected. There can be no assurance that our operating performance
will be sufficient to service debt on the sub-facility or finance the purchase
of new accounts receivable.
We use estimates in reporting our results.
Our revenue is recognized based on estimates of future collections on static
pools of accounts receivable purchased. Although estimates are based on
statistical analysis, the actual amount collected on static pools and the timing
of those collections may differ materially from estimates. If collections on
static pools are materially less than estimated, we will be required to record
impairment expenses that will reduce earnings and could materially adversely
affect our earnings, financial condition, and creditworthiness.
We may experience a shortage of available accounts receivable for purchase at
favorable prices.
The availability of portfolios of delinquent accounts receivable for purchase at
favorable prices depends on a number of factors outside of our control,
including the continuation of the current growth trend in consumer debt and
competitive factors affecting potential purchasers and sellers of portfolios of
accounts receivable. The growth in consumer debt may also be affected by changes
in credit grantors underwriting criteria and regulations governing consumer
lending. Any slowing of the consumer debt growth trend could result in less
credit being extended by credit grantors. Consequently, fewer delinquent
accounts receivable could be available at prices that we find attractive. If
competitors raise the prices they are willing to pay for portfolios of accounts
receivable above those we wish to pay, we may be unable to buy delinquent
accounts receivable at prices consistent with our historic return targets. In
addition, we may overpay for portfolios of delinquent accounts receivable, which
may have a materially adverse effect on our financial results.
Our operations are subject to extensive regulation.
Federal and state consumer protection and related laws and regulations govern
the relationship of a customer and a creditor. Significant laws include the Fair
Debt Collection Practices Act, the Federal Truth-In-Lending Act, the Fair Credit
Billing Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and
the Electronic Funds Transfer Act, and various Federal regulations which relate
to these acts, as well as comparable statutes in the states where account
debtors reside or where credit grantors are located. Some of these laws may
apply to our activities. If credit grantors who sell accounts receivable to us
fail to comply with these laws, our ability to collect on those accounts
receivable could be limited regardless of any act or omission on our part. Our
failure to comply with these laws may also limit our ability to collect on the
accounts receivable.
5
Our success depends on our senior management team and if we are not able to
retain them, it would have a materially adverse effect on us.
We are highly dependent upon the continued services and experience of our senior
management team, including Michael J. Barrist, Chairman of the Board, President
and Chief Executive Officer. We depend on the services of Mr. Barrist and the
other members of our senior management team to, among other things, successfully
implement our business plan, manage existing accounts receivable portfolios and
find, negotiate and purchase new consumer accounts receivable portfolios. The
loss of service of one or more members of the senior management team could have
a material adverse effect on us.
We engage in securitization transactions which could expose us to risk.
Prior to the Merger, Creditrust completed four securitization transactions, two
of which resulted in a gain on sale. We intend only to pursue securitization
transactions that will not qualify as a sale for accounting purposes. Our
quarterly financial statements could be materially affected by any possible
future write-downs associated with changes in the fair value of the residual
investment in the one remaining previous securitization that resulted in a gain
on sale, Creditrust SPV98-2, LLC ("SPV 98-2"). If NCOF were to lose the right to
service the accounts receivable included in the securitizations, then such loss
could have a material adverse effect on us.
The market price for our common stock may be adversely affected by fluctuations
in our quarterly operating results.
Because of the nature of our business, our quarterly operating results may
fluctuate in the future, which may adversely effect the market price of our
common stock. The reasons our results may fluctuate include:
o the timing and amount of collections on our accounts
receivable;
o a decline in value of our residual investment in
securitization;
o increases in operating expenses associated with the growth of
our operations;
o announcements of fluctuations in our, or our competitors'
operating results; and
o general market conditions.
In addition, the stock market in recent years has experienced significant price
and volume fluctuations that often have been unrelated or disproportionate to
the operating performance of companies. These broad fluctuations may adversely
effect the market price of our common stock.
NCOG owns approximately 63% of our common stock and controls our affairs.
NCOG owns approximately 63% of our outstanding voting securities. Additional
shares may be issued to NCOG in accordance with the Merger, which could cause
NCOG to own possibly more than 63% (but not more than 64%) of our common stock.
Accordingly, NCOG can elect all of the directors and approve or control most
other matters presented for approval by our stockholders. Under Delaware law and
our certificate of incorporation, owners of a majority of our outstanding common
stock are able to elect all of our directors and approve significant corporate
transactions without the approval of the other stockholders. As a result, NCOG
will have the unilateral ability to elect all of our directors and to control
the vote on all matters submitted to a vote of the holders of our common stock,
including any privatization transaction, merger, consolidation or sale of all or
substantially all of our assets. There can be no assurance that the interests of
NCOG will not conflict with the interests of other stockholders.
6
We are dependent upon NCOF for the collection of our accounts receivable.
We have entered into a servicing agreement with NCOF pursuant to which we have
granted to NCOF the exclusive right to service all of our accounts receivable,
subject to minor exceptions, for a period of 10 years. We will be materially
dependent upon NCOF's efforts under the servicing agreement to collect our
accounts receivable and will be able to terminate that agreement only due to
NCOF default under the agreement. Any poor performance under, or breach of,
adverse change in or termination of, the servicing agreement could have a
material adverse effect on our business, assets, financial condition, results of
operations and liquidity.
Because of NCOG's control of us, potential conflicts could arise between NCOG
and us.
Mr. Barrist, who is the Chairman of the Board, President and Chief Executive
Officer of NCOG, holds the same positions with us. In addition, Mr. Joshua
Gindin, the Executive Vice President, General Counsel and Secretary of NCOG,
also holds the same positions with us. These persons may have conflicts of
interest with respect to matters concerning us and our relationship with NCOG,
and do not devote their full time and attention to our business.
Although we do not currently intend to enter into any other material
transactions with NCOG or its subsidiaries, other than the servicing agreement,
we may enter into such transactions with NCOG or its subsidiaries in the future.
We have not adopted any formal procedures regarding potential conflicts of
interest with NCOG, although any material transaction would be subject to review
and approval by the independent directors on our Audit Committee.
Executive Officers of the Registrant
Name Age Position
---- --- --------
Michael J. Barrist........................ 41 Chairman of the Board, Chief Executive Officer, and President
Joshua Gindin............................. 45 Executive Vice President, General Counsel and Secretary
Michael B. Meringolo...................... 54 Senior Vice President Operations
Richard J. Palmer......................... 50 Senior Vice President, Chief Financial Officer and Treasurer
Michael J. Barrist, Chairman of the Board, Chief Executive Officer, and
President. Mr. Barrist has served as our Chairman of the Board, President and
Chief Executive Officer since February 2001. Mr. Barrist has served as Chairman
of the Board, President and Chief Executive Officer of NCO Group since
purchasing that company in 1986. Mr. Barrist was employed by U.S. Heathcare Inc.
from 1984 to 1986, most recently as Vice President of Operations, and was
employed by Gross & Company, a certified public accounting firm, from 1980
through 1984. Mr. Barrist is a Certified Public Accountant.
Joshua Gindin, Executive Vice President, General Counsel and Secretary. Mr.
Gindin has served as Executive Vice President and General Counsel since February
2001. Mr. Gindin has served as Executive Vice President and General Counsel of
NCO Group since May 1998. Prior to joining NCO Group, Mr. Gindin was a partner
in the law firm of Kessler & Gindin since 1995. Mr. Gindin has practiced law
since 1983 and has represented NCOF since 1986 and NCOG since its formation in
1996.
Michael B. Meringolo, Senior Vice President Operations. Mr. Meringolo has served
as Senior Vice President of Operations since February 2001. Prior to our merger
with Creditrust, Mr. Meringolo was employed by NCO Financial Systems, Inc., a
subsidiary of NCO Group, since September 1997, most recently as Senior Vice
President, Portfolio Acquisitions and Management. Prior to that, from 1991 to
1997, Mr. Meringolo was employed by First Union National Bank, most recently as
Vice President of Consumer Products, with responsibility for managing the
collection of consumer lending products.
Richard J. Palmer, Senior Vice President, Chief Financial Officer and Treasurer.
Mr. Palmer has served as Senior Vice President, Chief Financial Officer and
Treasurer since February 2001. Mr. Palmer was Chief Financial Officer of
Creditrust from 1996 to 2001. From 1983 to 1996, Mr. Palmer served as Chief
Financial Officer of, and in various other financial functions for, CRI, Inc., a
national real estate investment company with headquarters in Rockville,
Maryland. Prior to CRI, Inc., Mr. Palmer was with Grant Thornton LLP from 1976
until 1983 and KPMG Peat Marwick from 1973 to 1976. Mr. Palmer is a Certified
Public Accountant.
7
Item 2. Properties
Our headquarters facility is located at 1705 Whitehead Road, Baltimore, Maryland
21207. We lease our space of approximately 5,000 square feet from NCOF.
Item 3. Legal Proceedings
We are involved in legal proceedings from time to time in the ordinary course of
business. We believe that none of these legal proceedings will have a materially
adverse effect on our financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders
Not applicable.
8
PART II
Item 5. Market for Registrant's Common Equity and Related Stockholder Matters
Price Range of Common Stock
Our common stock was listed on the Nasdaq National Market on April 4, 2001 under
the symbol "NCPM". Prior to listing on the Nasdaq National Market, the stock
traded on the over the counter market from February 23, 2001, the first
available quote, to April 3, 2001. The following table sets forth the high and
low closing sales prices for the common stock, as reported by Nasdaq and the
over the counter market:
High Low
---- ---
2001
----
First Quarter (from February 23, 2001)..........$ 10.50 $ 0.75
Second Quarter.................................. 7.85 5.25
Third Quarter................................... 7.70 5.96
Fourth Quarter.................................. 7.18 5.25
On March 14, 2002, approximately 25 holders of record hold our common stock.
Dividend Policy
We have never declared or paid dividends on our common stock, and do not
anticipate paying cash dividends on our common stock in the foreseeable future.
In addition, our line of credit facility restricts the payments of cash
dividends without the lender's prior consent. We currently intend to retain
future earnings to finance our operations and fund the growth of our business.
Any payment of future dividends will be at the discretion of our board of
directors and will depend upon, among other things, our earnings, financial
condition, capital requirements, level of indebtedness, contractual restrictions
with respect to the payment of dividends and other factors that our board of
directors deems relevant.
9
Item 6. Selected Financial Data
The following table sets forth selected balance sheet information as of December
31, 2000 and 2001, and statement of income and cash flow data for the period
January 22, 1999 (date of inception) to December 31, 1999 and each of the years
in the two-year period ended December 31, 2001. The selected financial data for
the period January 22, 1999 (date of inception) to December 31, 1999 and the
years ended December 31, 2000 and 2001 have been derived from our audited
financial statements. The consolidated balance sheets as of December 31, 2000
and 2001 and the consolidated statements of income, stockholders' equity and
cash flows for the period January 22, 1999 (date of inception) to December 31,
1999, and the years ended December 31, 2000 and 2001 are included elsewhere in
this Form 10-K. The selected financial data presented below should be read in
conjunction with the consolidated financial statements and the related notes,
and Item 7. "Management's Discussion and Analysis of Financial Condition and
Results of Operations" included in this Form 10-K.
For the period As of and for the
January 22, 1999 years ended December 31,
(date of inception) to -------------------------
(Amounts in thousands, except per share data) December 31, 1999 2000 2001 (5)
----------------- ---- --------
Statement of income data:
Revenue........................................................ $ 1,959 $ 13,151 $ 62,929
Operating costs and expenses:
Payroll and related expenses................................. 180 327 1,624
Servicing fee expenses....................................... 981 5,741 27,771
Selling, general, and administrative expenses................ 57 112 2,017
Amortization expense......................................... -- -- 250
Impairment of purchased accounts receivable.................. -- -- 2,649
------- -------- --------
Total operating costs and expenses............................. 1,218 6,180 34,311
------- -------- --------
Income from operations......................................... 741 6,971 28,618
Other income (expense):........................................
Interest and other income.................................... -- -- 531
Interest expense............................................. (253) (1,334) (8,230)
------- -------- --------
Total other expense...................................... (253) (1,334) (7,699)
------- -------- --------
Income before income tax expense............................... 488 5,637 20,919
Income tax expense............................................. 183 2,114 7,845
------- -------- --------
Net income..................................................... $ 305 $ 3,523 $ 13,074
======= ======== ========
Basic and diluted net income per common share.................. $ 0.04 $ 0.41 $ 1.02
Weighted average number of basic and diluted shares outstanding 8,599 8,599 12,871
Other data:
Revenue as a percentage of collections (1)..................... 48.2% 74.2% 60.5%
Collections on managed accounts receivable (2)................. $ 4,064 $ 17,716 $ 104,080
Collections applied to principal of managed accounts
receivable (3) .............................................. 2,105 4,565 41,151
EBITDA (4)..................................................... 741 6,971 28,868
Cash flows provided by (used in):
Operating activities.......................................... 928 7,840 23,032
Investing activities.......................................... (4,694) (27,452) (25,067)
Financing activities.......................................... 3,766 19,612 8,544
Balance sheet data:
Cash and cash equivalents...................................... -- 6,509
Purchased accounts receivable.................................. 31,480 136,339
Total debt..................................................... 23,377 92,509
Stockholders' equity........................................... 3,829 57,864
10
(1) Revenue as a percentage of collections is presented because we rely on this
indicator in the management of our business as a key measure of our overall
return on investment on purchased accounts receivable.
(2) Managed accounts receivable include purchased accounts receivable that we
own and accounts receivable that we invest in but do not own, including
purchased accounts receivable in our investment in securitization, SPV
98-2.
(3) Collections applied to principal of managed accounts receivable is
calculated by subtracting revenue recognized from collections on managed
accounts receivable. Collections applied to principal of owned purchased
accounts receivable amounted to $2,105, $4,565, and $34,159 for the period
January 22, 1999 (date of inception) to December 31, 1999, and the years
ended December 31, 2000 and 2001, respectively.
(4) Earnings before interest, taxes, depreciation and amortization ("EBITDA")
is used by management to measure results of operations and is not intended
to report results of operations in conformity with generally accepted
accounting principals.
(5) The information presented as of and for the year ended December 31, 2001
includes the results of the Merger, and are not comparable to the prior
periods presented.
11
Item 7. Management's Discussion and Analysis of Financial Condition and
Results of Operations
Overview
We are a leading analytics-based purchaser and manager of defaulted consumer
accounts receivable. Accounts receivable are the unpaid debts of individuals to
consumer creditors such as banks, finance companies, retail merchants and other
consumer oriented companies. We use our proprietary pricing models and extensive
analytical information databases to evaluate and value accounts receivable
purchases. Most of our accounts receivable are VISA(R) and MasterCard(R) credit
card accounts that the issuing banks have charged off their books for
non-payment. By purchasing accounts receivable, we allow credit grantors to make
a recovery on these charged-off accounts.
On February 20, 2001, Creditrust merged with and into us, at which time we
became a publicly traded company. The Merger was accounted for using the
purchase method of accounting. As a result of the Merger, we issued 4,977,482
shares of common stock resulting in a total of 13,576,519 shares of our common
stock outstanding, including 291,732 shares held in escrow. Shareholders will be
eligible to receive the shares of our common stock held in escrow based upon the
resolution of certain disputed and administrative claims. The purchase price was
valued at approximately $25 million. Additional acquisition related costs
incurred in connection with the Merger were $4.2 million. We allocated the
purchase price based on the fair value of the net assets acquired, principally
to purchased accounts receivable, deferred tax asset and certain assumed
liabilities. The net deferred tax asset of $14.4 million was the result of the
combination of a significant net operating loss carryforward acquired in the
Merger, offset by deferred tax liabilities arising from book tax differences in
the carrying value of the acquired accounts receivable. The purchase price
allocation and determination of certain income tax valuations estimated at the
Merger date have been finalized and are reflected in the financial statements as
of December 31, 2001.
From our inception in 1999, we have invested $179.9 million ($6.8 million in
1999, $31.4 million in 2000, and $141.7 million in 2001 including $93.5 million
from the Merger)in charged-off accounts receivable. At December 31, 2001, we
managed over 2.3 million accounts with an original charged-off amount of over
$6.6 billion measured as the amount charged off by the credit grantors that
originated the charged-off VISA(R), MasterCard(R), private label credit card and
consumer loan accounts at the date of charge-off.
The following table illustrates our revenue and collection experience for the
periods indicated (Amounts in thousands):
For the period
January 22, 1999 For the years ended December 31,
(date of inception) to --------------------------------
December 31, 1999 2000 2001 (4)
---------------------- ---- --------
Revenue.................................................................. $ 1,959 $ 13,151 $ 62,929
Revenue as a percentage of collections (1)............................... 48.2% 74.2% 60.5%
Collections on managed accounts receivable (2)........................... $ 4,064 $ 17,716 $ 104,080
Collections applied to principal on managed accounts receivable (3)...... $ 2,105 $ 4,565 $ 41,151
(1) Revenue as a percentage of collections is presented because we rely on
this indicator in the management of our business as a key measure of
our overall return on investment on purchased accounts receivable.
(2) Managed accounts receivable means purchased accounts receivable that
we own and accounts receivable that we invest in but do not own,
including purchased accounts receivable in our investment in
securitization, SPV 98-2.
(3) Collections applied to principal of managed accounts receivable is
calculated by subtracting revenue recognized from collections on
managed accounts receivable. Collections applied to principal of owned
purchased accounts receivable amounted to $2,105, $4,565, and $34,159
for the period January 22, 1999 (date of inception) to December 31,
1999, and the years ended December 31, 2000 and 2001, respectively.
(4) The information presented for the year ended December 31, 2001
includes the results of the Merger, and are not comparable to the
prior periods presented.
12
Critical Accounting Policies
General
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and the accompanying notes. Actual results could differ
from those estimates. We believe the following accounting policies include the
estimates that are the most critical and could have the most potential impact on
our results of operations.
Purchased Accounts Receivable
We account for our investment in purchased accounts receivable on an accrual
basis under the guidance of Practice Bulletin 6, "Amortization of Discounts on
Certain Acquired Loans," using unique and exclusive static pools. Static pools
are established with accounts having similar attributes. Typically, each static
pool consists of an individual acquisition of accounts. Once a static pool is
established, the accounts in the static pool are not changed. Proceeds from the
sale of accounts within a static pool are accounted for as collections in that
static pool. Collections on replacement accounts received from the originator of
the loans are included as collections in the corresponding static pools. The
discount between the cost of each static pool and the face value of the static
pool is not recorded since we expect to collect a relatively small percentage of
each static pool's face value.
Each static pool is initially recorded at cost. Collections on the static pools
are allocated to revenue and principal reduction based on the estimated internal
rate of return ("IRR") for each static pool. The IRR for each static pool is
estimated based on the expected monthly collections over the estimated economic
life of each static pool (generally five years, based on our collection
experience), compared to the original purchase price. Revenue on purchased
accounts receivable is recorded monthly based on each static pool's effective
IRR applied to each static pool's monthly opening carrying value (effective
interest method). To the extent collections exceed the revenue, the carrying
value is reduced and the reduction is recorded as collections applied to
principal. Because the IRR reflects collections for the entire economic life of
the static pool, and those collections are not constant, lower collection rates,
typically in the early months of ownership, can result in a situation where the
actual collections are less than the revenue accrual. In this situation, the
carrying value of the static pool may be increased by the difference between the
revenue accrual and collections.
To the extent the estimated future cash flow increases or decreases from the
expected level of collections, we prospectively adjust the IRR accordingly. If
the carrying value of a particular static pool exceeds its expected future cash
flows, a charge to income would be recognized in the amount of such impairment.
Additional impairments on previously impaired static pools may occur if the
current estimated future cash flow projection, after being adjusted
prospectively for actual collection results, are less than the carrying value
recorded. After the impairment of a static pool, no income is recorded on that
static pool and collections are recorded as a return of capital until the full
carrying value of the static pool has been recovered. The estimated yield for
each static pool is based on estimates of future cash flows from collections,
and actual cash flows will vary from current estimates. The difference could be
material. For the year ended December 31, 2001, an impairment of $2.6 million
was recorded as a charge to income on static pools where the carrying amounts
exceeded the expected future cash flows. No income will be recognized on these
static pools until the carrying values have been fully recovered. The combined
carrying values on these static pools, after impairment, aggregated
approximately $5.7 million, or 4.2% of purchased accounts receivable, as of
December 31, 2001, representing their net realizable value. There were no
impairments recorded in 1999 and 2000.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and the accompanying notes.
In the ordinary course of accounting for purchased accounts receivable,
estimates have been made by management as to the amount of future cash flows
expected from each static pool. The estimated future cash flow of each static
pool is used to compute the IRR for the static pool. The IRR is used to allocate
cash flow between revenue and amortization of the carrying values of the
purchased accounts receivable.
On an ongoing basis, we compare the historical trends of each static pool to
projected collections. The future projections are then increased or decreased,
within parameters, in accordance with the historical trend. The results are
further reviewed by management with a view towards specifically addressing any
particular static pool's performance. Actual results will differ from these
estimates and a material change in these estimates could occur within one year.
13
Investments in debt and equity securities
We acquired an investment in securitization in connection with the Merger. The
investment in securitization, SPV 98-2, qualified as a sale under generally
accepted accounting principles in 1998 when the securitization was completed.
The investment in securitization is accounted for under the provisions of SFAS
115 as a debt security held available-for-sale. This investment accrues income
as a non-cash item included in the statement of income as other income, and in
the balance sheet as a component of the fair value of the investment in
securitization. Once the securitization note is retired, recoveries will be
applied to reduce the carrying value of the investment in securitization. We
record our investment in securitization at fair value and any unrealized gain or
loss, net of the related tax effect, generally is not reflected in earnings but
is recorded as a separate component of stockholders' equity until realized. As
of December 31, 2001, the carrying value approximated fair value. A decline in
the value of the investment in securitization below cost that is deemed other
than temporary would be charged to income as an impairment and result in the
establishment of a new cost basis for the security. No impairment was recorded
in 2001.
Income Taxes
Income taxes or tax benefits have been provided in the results of operations
based on the statutory Federal and state rates at 37.5% of pre-tax income. For
financial reporting purposes, revenue is recognized over the life of the static
pool. Because the static pools of purchased accounts receivable are comprised of
distressed debt and collection results are not guaranteed until received, for
tax purposes, any gain on a particular static pool is deferred until the full
cost of the static pool is recovered (cost recovery method). Temporary
differences arise because revenue is recognized on the cost recovery method for
income tax purposes. Permanent differences between the statutory rates and
actual rates are minimal. Temporary differences in recognition of revenue on
purchased accounts receivable have resulted in deferred tax liabilities. Assumed
utilization of net operating losses acquired in the Merger have resulted in
deferred tax assets. Our deferred tax liabilities grew significantly through
2001 as a result of the increase in purchased accounts receivable, providing us
with additional liquidity. As of December 31, 2001, the net deferred tax asset
of $1 million was the result of the combination of deferred tax assets generated
principally by the assumed utilization of net operating loss carryforwards from
the Merger, offset by the deferred tax liabilities arising from book tax
differences on purchased accounts receivable, including the purchased accounts
receivable acquired in the Merger. The utilization of net operating loss
carryforwards is an estimate based on a number of factors beyond our control
including the level of taxable income available from successful operations in
the future. The utilization of net operating losses have been further impacted
by Tax Law provisions that limit the amount of net operating loss carryforwards
that can be utilized subsequent to a change in control such as the Merger.
Results of Operations
The following table sets forth certain data from the statement of income on an
historical basis, each as a percentage of revenue:
For the period
January 22, 1999 For the years ended December 31,
(date of inception) to --------------------------------
December 31, 1999 2000 2001 (1)
---------------------- ---- --------
Revenue............................................................. 100.0% 100.0% 100.0%
Operating costs and expenses:
Payroll and related expenses.................................... 9.2 2.5 2.6
Servicing fee expenses.......................................... 50.1 43.7 44.1
Selling, general, and administrative expenses................... 2.9 0.8 3.2
Amortization expense............................................ -- -- 0.4
Impairment of purchased accounts receivable..................... -- -- 4.2
----- ----- -----
Total operating costs and expenses.................................. 62.2 47.0 54.5
----- ----- -----
Income from operations.............................................. 37.8 53.0 45.5
Other income (expense):
Interest and other income....................................... -- -- 0.8
Interest expense................................................ (12.9) (10.1) (13.1)
----- ----- -----
Total other expense................................................. (12.9) (10.1) (12.3)
----- ----- -----
Income before income tax expense.................................... 24.9 42.9 33.2
----- ----- -----
Income tax expense.................................................. 9.3 16.1 12.5
----- ----- -----
Net income.......................................................... 15.6% 26.8% 20.7%
===== ===== =====
EBITDA.............................................................. 37.8% 53.0% 45.9%
(1) The information presented for the year ended December 31, 2001 includes the
results of the Merger, and are not comparable to the prior periods
presented.
14
Year Ended December 31, 2001 Compared to Year Ended December 31, 2000
Revenue. Total revenue increased by $49.7 million, or 378.5%, from $13.2 million
for the year ended December 31, 2000 to $62.9 million for the year ended
December 31, 2001. The increase in revenue was attributable to the purchase of
$141.7 million in accounts receivable, consisting of $93.5 million of accounts
receivable acquired in our merger with Creditrust, and an additional $48.2
million in accounts receivable purchased in 2001 through normal operations.
Revenue is calculated using the effective interest method, and is directly
related to the carrying value of the purchased accounts receivable, which
increased significantly over the prior year. Collections on purchased accounts
receivable increased from $17.7 million for the year ended December 31, 2000 to
$104.1 million for the year ended December 31, 2001 due to the increase in
purchased accounts receivable. Revenue as a percentage of collections was 74%
and 60% for the years ended December 31, 2000 and 2001, respectively.
Revenue as a percentage of collections can fluctuate period over period due to a
number of factors including: (i) the relative under or over achievement of
collection estimates. Exceeding collection estimates will tend to lower the
percentage and not meeting collection estimates will tend to increase the
percentage; (ii) the differences in the mix at the point in time of the life
cycle of the total portfolios. Over the life cycle of a static pool, the
percentage will fluctuate due to the variable collection stream. However, in the
aggregate, the percentage of collections recognized as revenue should
approximate the lifetime profit we recognize and the remainder is amortized as a
return of capital; (iii) the mix of the targeted IRRs present in all of the
static pools combined. Fresher purchased accounts receivable (static pools with
few or no placements to collection agencies prior to purchase) generally have
lower IRRs than purchased accounts receivable that have been placed with
multiple collection agencies prior to purchase. Fresher accounts receivable
typically cost more. However, net of servicing fees, lower IRRs are offset by
lower costs to collect, resulting in similar targeted net returns. And finally;
(iv) collection trends will increase or decrease our expected IRR. Increases or
decreases in collections have the effect of raising or lowering (within
specified parameters) the future projections on all static pools, which
translates into higher or lower IRRs, and in turn, affects the percentage of
collections recognized as revenue.
Revenue as a percentage of collections for this year declined principally due to
changes in the mix of purchased accounts receivable in 2001 versus 2000.
Purchased accounts receivable acquired in the Merger were acquired at a lower
IRR compared to accounts receivable purchased in prior years. Net after
servicing costs, these purchased accounts receivable are expected to equal or
exceed our usual targeted net returns. Further affecting the lower percentage
for 2001 were current acquisitions which had returns that were targeted lower at
the time of acquisition due to the tougher economic climate facing us in the
near term. Finally, the overall percentage was lowered due to a slow down in
collections due to the softening economic climate in the first three quarters of
2001, accelerated by the events of September 11. Decreases in collections have
the effect of lowering the future projections on most static pools, which
translates to lower revenue in the current period. Differences between actual
and estimated collections on existing static pools as of the beginning of 2001
resulted in a reduction in net operating income, net income and earnings per
share of $2.5 million, $1.5 million and $0.12 per diluted share, respectively
for the year ended December 31, 2001.
Static pools with $5.7 million in carrying value, or 4.2% of purchased accounts
receivable, as of December 31, 2001 were impaired during 2001 and placed on cost
recovery. Accordingly, no revenue was recorded on these static pools after their
impairment, equating to a lower ratio of revenue to collections. See impairment
of purchased accounts receivable below.
Payroll and related expenses. Payroll and related expenses increased from
$327,000 for the year ended December 31, 2000 to $1.6 million for the year ended
December 31, 2001. The increase was attributable to an increase in personnel
during the first quarter of 2001 directly related to the Merger. Payroll and
related expenses after the Merger increased as more staffing was implemented for
us to operate as an independent public company and to manage a significant
increase in purchased accounts receivable due to the Merger and internal growth.
Servicing fee expenses. Servicing fee expenses increased $22.1 million, or
383.7%, from $5.7 million for the year ended December 31, 2000 to $27.8 million
for the year ended December 31, 2001. Servicing fees are paid as a commission on
collections, and include contingency legal fees. The increase in servicing fee
expenses is directly attributable to the increase in collections on purchased
accounts receivable. Servicing fees paid as a percentage of collections were
32.4% and 26.7% for the years ended December 31, 2000 and 2001, respectively.
Servicing fees paid to NCOF totaled $5.7 million and $27.5 million for the years
ended December 31, 2000 and 2001, respectively. The decrease in servicing fees
as a percentage of collections was principally attributable to the lower serving
fees paid in connection with the purchased accounts receivable acquired in the
Merger. Though the mix of accounts acquired in the Merger were generally older
and had been through multiple placements (compared to current purchases), they
had a demonstrated track record of producing a stream of cash flows.
Accordingly, the servicing fees agreed to in the ten-year servicing agreement
were lower than would be the case for comparably aged accounts. Purchases in the
normal course of business are selected by the sellers as non-performing accounts
receivable (with no track record of cash flow streams). We expect to see
increases in servicing fees going forward as the mix of accounts under
management ages.
15
Selling, general and administrative expenses. Selling, general and
administrative expenses increased from $112,000 for the year ended December 31,
2000 to $2 million for the year ended December 31, 2001. Selling, general and
administrative expenses consist primarily of court costs associated with legal
collections, insurance, professional fees, trustee fees, and office expenses.
The increase was attributable to costs incurred in connection with being an
independent public company, and outside collection costs related to the accounts
receivable acquired in the Merger.
Impairment of purchased accounts receivable. On an ongoing basis, static pools
are reviewed to assess the expected future cash flows as they relate to the
carrying values of the purchased accounts receivable. If the estimated future
cash flows are not sufficient to cover the remaining carrying value of a static
pool, an impairment has occurred and the static pool is written down to its net
realizable value. Additional impairments on previously impaired static pools may
occur if the current estimated future cash flow projection, after being adjusted
prospectively for actual collection results, is less than the carrying value
recorded. Once a static pool is impaired, no revenue will be recorded until the
carrying value has been fully recovered. During 2001, we recorded an impairment
of $2.6 million. The combined remaining carrying value on impaired static pools
aggregated $5.7 million, or 4.2% of purchased accounts receivable, as of
December 31, 2001. No impairments were recorded in 2000.
Other income (expense). Other income (expense) consisted principally of interest
expense and increased $6.4 million, or 477.1%, from $1.3 million for the year
ended December 31, 2000 to $7.7 million for the year ended December 31, 2001.
This increase was principally attributable to an increase in interest expense as
a result of $65.3 million in debt incurred and assumed in connection with the
Merger, as well as increased borrowings from NCO Group to fund the purchase of
accounts receivable in 2001. Included in other income is $329,000 of income from
two unconsolidated subsidiaries. We own a 100% interest in a trust, SPV 98-2,
acquired in connection with the Merger, and a 50% interest in a joint venture
accounted for under the equity method.
Income tax expense. Income tax expense was recorded at 37.5% of pre-tax income
for the years ended December 31, 2000 and 2001. Our effective tax rate may
fluctuate as a result of changes in pre-tax income and nondeductible expenses.
Cash payments for taxes are deferred due to the book tax difference of
accounting for purchased accounts receivable on the accrual basis for GAAP and
the cost recovery basis for tax reporting. Prior to the Merger, we were included
in the consolidated tax return of NCO Group. We received a tax sharing payment
of $601,000 from NCO Group for tax losses incurred in that period.
Year Ended December 31, 2000 Compared to Period from January 22, 1999 (date of
inception) to December 31, 1999
Revenue. Total revenue increased by $11.2 million, or 571.3%, from $2.0 million
for the period January 22, 1999 (date of inception) to December 31, 1999 to
$13.2 million for the year ended December 31, 2000. The increase in revenue was
attributable to the purchase of $31.4 million in accounts receivable during
2000, compared to $6.8 million in 1999. Revenue is calculated using the
effective interest method, and is directly related to the carrying value of the
purchased accounts receivable, which increased significantly over the prior
year. Collections on purchased accounts receivable increased from $4.1 million
for the period January 22, 1999 (date of inception) to December 31, 1999 to
$17.7 million for the year ended December 31, 2000 due to the increase in
purchased accounts receivable. Revenue as a percentage of collections was 48%
and 74% for the period January 22, 1999 (date of inception) to December 31, 1999
and the year ended December 31, 2000, respectively. Revenue as a percentage of
collections was lower in 1999 compared to 2000 principally due to the relatively
larger mix of older accounts receivable acquired in 2000 compared to 1999.
Payroll and related expenses. Payroll and related expenses increased from
$180,000 from the period January 22, 1999 to December 31, 1999 to $327,000 for
the year ended December 31, 2000. Payroll and related expenses were nominal for
both periods since staffing was at a minimum in these periods.
Servicing fee expenses. Servicing fee expenses increased by $4.7 million, or
485.2%, from $1 million for the period January 22, 1999 (date of inception) to
December 31, 1999 to $5.7 million for the year ended December 31, 2000.
Servicing fees are paid as a commission on collections. The increase in
servicing fee expenses was directly attributable to the increase in collections
on purchased accounts receivable. Servicing fees paid as a percentage of
collections was 24.1% and 32.4% for the period January 22, 1999 (date of
inception) to December 31, 1999 and the year ended December 31, 2000,
respectively. All of the servicing fees were paid to NCOF. The increase in
servicing fees as a percentage of collections was principally due to a greater
mix of collections from accounts with longer periods from date of charge-off, or
multiple prior placements, which generally demand higher service fees than
fresher accounts.
16
Selling, general and administrative expenses. Selling, general and
administrative expenses increased from $57,000 for the period January 22, 1999
(date of inception) to December 31, 1999 to $112,000 for the year ended December
31, 2000. Selling, general and administrative expenses were nominal for both
periods.
Other income (expense). Other income (expense) consisted of interest expense and
increased from $253,000 for the period January 22, 1999 (date of inception) to
December 31, 1999 to $1.3 million for the year ended December 31, 2000. Other
income (expense) was comprised entirely of interest expense paid to NCO Group on
borrowings to purchase accounts receivable. The increase in interest expense was
directly related to the increase in outstanding borrowings incurred in
connection with the purchase of additional accounts receivable during 2000.
Income tax expense. Income tax expense was recorded at 37.5% of pre-tax income
for the period January 22, 1999 (date of inception) to December 31, 1999 and the
year ended December 31, 2000. Our effective tax rate may fluctuate as a result
of changes in pre-tax income and nondeductible expenses. Cash payments for taxes
are deferred due to the book tax difference of accounting for purchased accounts
receivable on the accrual basis for GAAP and the cost recovery basis for tax
reporting.
Liquidity and Capital Resources
Historically, we derived all of our cash flow from collections on purchased
accounts receivable and borrowings from NCO Group. Effective with the Merger, we
entered into a credit agreement with NCO Group, which provides us with a $50
million revolving line of credit from NCO Group in the form of a sub-facility
under NCO Group's existing credit facility. Cash has been used primarily for the
purchase of accounts receivable, the Merger and working capital to support our
growth.
The debt service requirements associated with borrowings under our secured
credit facilities and the mandatory reductions on our revolving credit facility
have increased liquidity requirements. However, we anticipate that cash flows
from operations will be sufficient to fund all principal payments on the credit
facility, secured debt, operating expenses, interest expense and future
purchases of accounts receivable including our existing forward flow agreement.
Cash flows from operations are directly related to the amount of collections
actually received. Estimates are used to forecast collections and revenue. A
decrease in cash flows from operations due to a decrease in collections from
changes in the economy or the performance of NCOF as service provider, may
require us to reduce the amount of accounts receivable purchased. The effect of
reduced accounts receivable purchases would be a reduction in planned
collections and revenue in the periods affected.
Cash Flows from Operating Activities. Net cash provided by operating activities
was $23 million for the year ended December 31, 2001, compared to $7.8 million
for the year ended December 31, 2000. The increase in cash and cash equivalents
provided by operations was principally attributable to the large increase in net
income and deferred income tax expense. Net income grew due to the significant
increase in revenue generated from the $93.5 million of accounts receivable
acquired in the Merger, and $48.2 million in other accounts receivable purchased
in the normal course of business in 2001. Additionally, approximately $2.6
million in restricted cash was used to pay down debt in the first quarter of
2001 pursuant to the Merger.
Net cash provided by operating activities was $7.8 million for the year ended
December 31, 2000, compared to $900,000 for the period January 22, 1999 (date of
inception) to December 31, 1999. The increase in cash and cash equivalents
provided by operations was principally attributable to the large increase in net
income and deferred income tax expense. Net income grew due to the significant
increase in revenue generated from $31.4 million of accounts receivable
purchased in the normal course of business in 2000.
Cash Flows from Investing Activities. Net cash used in investing activities was
$25.1 million for the year ended December 31, 2001, compared to $27.5 million
for the year ended December 31, 2000. Cash used in investing activities is a
function of the amount of accounts receivable purchased, offset by collections
applied to principal of purchased accounts receivable. In addition, in 2001,
there were pre-acquisition liabilities and related costs paid. Collections
applied to principal of purchased accounts receivable is the difference between
total collections and revenue. Purchases of accounts receivable, net of
collections applied to principal of purchased accounts receivable, were $14
million and $26.8 million for the years ended December 31, 2001 and 2000,
respectively. While cash purchases of accounts receivable grew to $48.2 million
in 2001 from $31.4 million in 2000, the amount of collections applied to
principal of purchased accounts receivable grew to $34.1 million in 2001 from
$4.6 million in 2000. Additionally, in 2001, $11.1 million in cash was paid for
pre-acquisition liabilities and related costs in connection with the Merger.
Net cash used in investing activities was $27.5 million for the year ended
December 31, 2000, compared to $4.7 million for the period January 22, 1999
(date of inception) to December 31, 1999. Purchases of accounts receivable, net
of collections applied to principal of purchased accounts receivable, were $26.8
million and $4.7 million for the year ended December 31, 2000, and the period
January 22, 1999 (date of inception) to December 31, 1999, respectively. While
purchases of accounts receivable grew to $31.4 million in 2000 from $6.8 million
in 1999, the amount of collections applied to principal of purchased accounts
receivable grew to $4.6 million in 2000 from $2.1 million in 1999. Additionally,
in 2000, $666,000 in cash was paid for pre-acquisition liabilities and related
costs in connection with the Merger.
17
Cash Flows from Financing Activities. Net cash provided by financing activities
was $8.5 million for the year ended December 31, 2001, compared to $19.6 million
for the year ended December 31, 2000. Total borrowings increased to $47.1
million in 2001, of which $36.3 million related to debt incurred in the Merger,
from $19.6 million in 2000. Partially offsetting total borrowings, $40.0 million
was repaid on notes payable during 2001. All of the borrowings in 2001 were from
the NCO Group credit facility. Additionally, there was $2.3 million in proceeds
from the issuance of common stock at the time of the Merger, and $901,000 in
fees paid to secure the NCO Group credit facility.
Net cash provided by financing activities was $19.6 million for the year ended
December 31, 2000, compared to $3.8 million for the period January 22, 1999
(date of inception) to December 31, 1999. Financing activities were comprised of
borrowings from NCO Group to finance growth in operations through the purchase
of accounts receivable.
Credit Facility. NCO Group has a credit agreement with Citizens Bank, for itself
and as administrative agent for other participating lenders, that originally
provided for borrowings up to $350 million, structured as a revolving credit
facility. The borrowing capacity of the revolving credit facility is subject to
mandatory reductions including a quarterly reduction of $6.3 million on March
31, 2001, subsequent quarterly reductions of $5.2 million until maturity, and 50
percent of the net proceeds received from any offering of debt or equity. As of
December 31, 2001, there was $58.3 million available under the revolving credit
agreement. NCO Group's borrowings are collateralized by substantially all the
assets of NCO Group, including our common stock. Pursuant to the Merger, we
entered into a credit agreement with NCO Group, which provides us with a $50
million revolving line of credit from NCO Group in the form of a sub-facility
under its existing credit facility. Certain of our assets have been pledged to
Citizens Bank to secure our borrowings under the $50 million sub-facility. The
balance under the revolving sub-facility will become due on May 20, 2004 (the
"Maturity Date"). The borrowing capacity of the sub-facility is subject to
mandatory reductions including four quarterly reductions of $2.5 million
beginning March 31, 2002 through December 31, 2002. Effective March 31, 2003,
quarterly reductions of $3.75 million are required until the earlier of the
Maturity Date or the date at which the sub-facility is reduced to $25 million.
The outstanding balance on the sub-facility as of December 31, 2001 was $47.1
million.
The NCO Group credit agreement and our sub-facility contain certain financial
covenants such as maintaining net worth and funded debt to EBITDA requirements,
and include restrictions on, among other things, acquisitions and distributions
to shareholders. As of December 31, 2001, NCO Group and NCO Portfolio were in
compliance with all required financial covenants.
The credit agreement carries interest at 2% over NCO Group's underlying rate
from Citizens Bank, of which 1% is paid to the bank and 1% is paid to NCO Group.
At the option of NCO Group, NCO Group's borrowings bear interest at a rate equal
to either Citizens Bank's prime rate plus a margin ranging from 0.25% to 0.50%,
which is determined quarterly based upon NCO Group's consolidated funded debt to
income before interest, taxes, depreciation, and amortization ("EBITDA") ratio
(Citizens Bank's prime rate was 4.75% at December 31, 2001), or the London
InterBank Offered Rate ("LIBOR") plus a margin ranging from 1.25% to 2.25%
depending on NCO Group's consolidated funded debt to EBITDA ratio (LIBOR was
1.88% at December 31, 2001). The credit agreement contains a provision which
provides Citizens Bank with an additional commitment fee of 0.25% per quarter
commencing August 20, 2001. This charge will continue until the facility is
reduced to $25 million. We were charged an additional 0.25% per quarter on the
full commitment from August 20, 2001 to December 31, 2001. We are charged a fee
on the unused portion of the sub-facility ranging from 0.13% to 0.38% depending
on NCO Group's consolidated funded debt to EBITDA ratio. As of December 31,
2001, there was approximately $2.9 million available under this sub-facility.
We currently have a "forward-flow" agreement with a major financial institution,
which obligates us to purchase, on a monthly basis, portfolios of charged-off
accounts receivable meeting certain criteria. As of December 31, 2001, we were
obligated to purchase accounts receivable to a maximum of $1.8 million per month
from January 2002 through May 2002.
18
Off-Balance Sheet Arrangements
We own a 100% retained residual interest in an investment in securitization, SPV
98-2, which was acquired in the Merger. This transaction qualified for gain on
sale accounting when the purchased receivables were originally securitized. This
securitization issued a non-recourse note that is due in January 2004 and had a
balance of $5.5 million as of December 31, 2001. The retained interest
represents the present value of the residual interest in the securitization
using discounted future cash flows after the securitization note is fully
repaid, plus a cash reserve. As of December 31, 2001, the investment in
securitization was $7.3 million, comprised of $4.0 million in the present value
of discounted residual cash flows plus $3.3 million in cash reserves. The
investment accrues non-cash income at a rate of 8% per annum on the residual
cash flow component only. The income earned increases the investment balance
until the securitization note has been repaid, after which, collections are
split between income and amortization of the investment in securitization based
on the discounted cash flows. We recorded $211,000 in income on this investment
for the period from February 21, 2001 to December 31, 2001. The cash reserves of
$3.3 million plus the first $1.3 million in residual cash collections received,
after the securitization note has been repaid, have been pledged as collateral
against another securitized note.
We have a 50% ownership interest in a joint venture, InoVision-MEDCLR-NCOP
Ventures, LLC ("Joint Venture"), with IMNV Holdings, LLC ("Marlin"). This Joint
Venture was set up to purchase utility, medical and various other small balance
accounts receivable and is accounted for using the equity method of accounting.
As of December 31, 2001, both Joint Venture members have each invested $574,000
for the purchase of accounts receivable. Included in the Statement of Income, in
"other income," was $118,000 representing our 50% share of operating income from
this unconsolidated subsidiary for the year ended December 31, 2001. The Joint
Venture has access to capital through a specialty finance lender who, at its
option, lends 90% of the value of the purchased accounts receivable to the joint
venture. The debt is cross-collateralized by all static pools in which the
lender participates, and is non-recourse to us.
Impact of Recently Issued and Proposed Accounting Pronouncements
Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", was
effective for transfers of financial assets and extinguishments of liabilities
occurring after March 31, 2001. Statement No. 140, which replaces FASB No. 125,
requires transfers of financial assets and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001 to de-recognize
the assets when control has been surrendered, and to de-recognize liabilities
only when they have been extinguished. NCO Portfolio adopted the provisions of
Statement No. 140 in the second quarter of 2001. The effect of the adoption had
no impact on the consolidated financial statements.
During 2001, the Accounting Staff Executive Committee approved an exposure draft
on a proposed Statement of Position, "Accounting for Discounts Related to Credit
Quality" ("SOP"). The proposed SOP would limit the revenue that may be accrued
to the excess of the estimate of expected future cash flows over the static
pool's initial cost of accounts receivable acquired. The proposed SOP would
require that the excess of the contractual cash flows over expected future cash
flows not be recognized as an adjustment of revenue, expense or on the balance
sheet. The proposed SOP would freeze the IRR originally estimated when the
accounts receivable are purchased for subsequent impairment testing. Rather than
lower the estimated IRR if the original collection estimates are not received,
the carrying value of a static pool would be written down to maintain the
original IRR. Increases in expected future cash flows would be recognized
prospectively through adjustment of the IRR over a static pool's remaining life.
The exposure draft provides that previously issued annual financial statements
would not need to be restated. Until final issuance of this SOP, we cannot
ascertain its effect on our reporting.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes and changes in corporate tax
rates. A material change in these rates could adversely effect our operating
results and cash flows. A 25 basis-point increase in interest rates could
increase our annual interest expense by $25,000 for each $10 million of variable
debt outstanding for the entire year. We retain an investment in securitization
with respect to our securitized accounts receivable, which is a market risk
sensitive financial instrument held for purposes other than trading. This
investment exposes us to market risk, which may arise from changes in interest
and discount rates applicable to this investment. The impact of a 1% increase in
the discount rate used by us in the fair value calculations would not have a
material impact on our balance sheet as of December 31, 2001. There would be no
impact on our future cash flows. We do not invest in derivative financial or
commodity instruments.
Inflation
We believe that inflation has not had a material impact on our results of
operations for the period January 22, 1999 (date of inception) to December 31,
1999, and for the years ended December 31, 2000 and 2001.
19
Item 8. Consolidated Financial Statements and Supplementary Data
NCO Portfolio Management, Inc.
Index to Consolidated Financial Statements
Report of Independent Auditors............................................................................... 21
Consolidated Financial Statements:
Consolidated Balance Sheets as of December 31, 2000 and 2001............................................. 22
Consolidated Statements of Income for the period January 22, 1999 (date of inception) to December 31,
1999 and for each of the two years in the period ended December 31, 2001............................... 23
Consolidated Statements of Stockholders' Equity for the period January 22, 1999 (date of inception)
to December 31, 1999 and for each of the two years in the period ended December 31, 2001............... 24
Consolidated Statements of Cash Flows for the period January 22, 1999 (date of inception) to December 31,
1999 and for each of the two years in the period ended December 31, 2001............................... 25
Notes to Consolidated Financial Statements............................................................... 26
20
REPORT OF INDEPENDENT AUDITORS
To the Board of Directors and
Stockholders of NCO Portfolio Management, Inc.
We have audited the accompanying consolidated balance sheets of NCO Portfolio
Management, Inc. as of December 31, 2000 and 2001, and the related consolidated
statements of income, stockholders' equity, and cash flows for the period
January 22, 1999 (date of inception) through December 31, 1999 and for each of
the two years in the period ended December 31, 2001.
We conducted our audits in accordance with auditing standards generally accepted
in the United States. Those standards require that we plan and perform the audit
to obtain reasonable assurance about whether the financial statements are free
of material misstatement. An audit includes examining, on a test basis, evidence
supporting the amounts and disclosures in the financial statements. An audit
also includes assessing the accounting principles used and significant estimates
made by management, as well as evaluating the overall financial statement
presentation. We believe that our audits provide a reasonable basis for our
opinion.
In our opinion, the financial statements referred to above present fairly, in
all material respects, the consolidated financial position of NCO Portfolio
Management, Inc. at December 31, 2000 and 2001, and the consolidated results of
its operations and its cash flows for the period January 22, 1999 (date of
inception) through December 31, 1999 and for each of the two years in the period
ended December 31, 2001, in conformity with accounting principles generally
accepted in the United States.
/s/ Ernst & Young LLP
Philadelphia, PA
January 25, 2002
21
Part 1 - Financial Information
Item 1 - Financial Statements
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Balance Sheets
(Amounts in thousands, except per share data)
December 31,
-------------------------------------
ASSETS 2000 2001
---------------- ---------------
Cash and cash equivalents $ -- $ 6,509
Restricted cash -- 1,125
Purchased accounts receivable 31,480 136,339
Investment in securitization -- 7,312
Deferred income taxes -- 992
Deferred costs -- 651
Other assets 666 784
--------------- ---------------
Total assets $ 32,146 $ 153,712
================ ===============
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable $ -- $ 73
Accrued expenses -- 2,861
Accrued compensation and related expenses -- 405
Notes payable -- 45,379
Note payable - affiliate 23,377 47,130
Deferred income taxes 4,940 --
--------------- ---------------
Total liabilities 28,317 95,848
--------------- ---------------
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized,
no shares issued and outstanding -- --
Common stock, $.01 par value, 8,599 and 35,000 shares authorized, 8,599
and 13,576 shares issued and outstanding in 2000 and 2001, respectively 1 136
Additional paid-in capital -- 40,826
Retained earnings 3,828 16,902
--------------- ---------------
Total stockholders' equity 3,829 57,864
--------------- ---------------
Total liabilities and stockholders' equity $ 32,146 $ 153,712
=============== ===============
See accompanying notes.
22
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Statements of Income
(Amounts in thousands, except per share data)
For the period
January 22, 1999 For the years ended December 31,
(date of inception) to ---------------------------------------------
December 31, 1999 2000 2001
--------------------- -------------------- ---------------------
Revenue $ 1,959 $ 13,151 $ 62,929
Operating costs and expenses:
Payroll and related expenses 180 327 1,624
Servicing fee expenses 981 5,741 27,771
Selling, general, and administrative expenses 57 112 2,017
Amortization expense -- -- 250
Impairment of purchased accounts receivable -- -- 2,649
-------------------- ------------------- --------------------
Total operating costs and expenses 1,218 6,180 34,311
-------------------- ------------------- --------------------
Income from operations 741 6,971 28,618
Other income (expense):
Interest and other income -- -- 531
Interest expense (253) (1,334) (8,230)
-------------------- ------------------- --------------------
Total other expense (253) (1,334) (7,699)
-------------------- ------------------- --------------------
Income before income tax expense 488 5,637 20,919
Income tax expense 183 2,114 7,845
-------------------- ------------------- --------------------
Net income $ 305 $ 3,523 $ 13,074
==================== =================== ====================
Net income per share:
Basic $ 0.04 $ 0.41 $ 1.02
==================== =================== ====================
Diluted $ 0.04 $ 0.41 $ 1.02
==================== =================== ====================
Weighted average shares outstanding:
Basic and diluted 8,599 8,599 12,871
See accompanying notes.
23
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Statements of Stockholders' Equity
(Amounts in thousands)
Common Stock Additional Retained
Shares Amount Paid-in Capital Earnings Total
------ ------ --------------- -------- -----
Balance at January 22, 1999 (date of inception) -- $ -- $ -- $ -- $ --
Issuance of common stock 8,599 1 -- -- 1
Net income -- -- 305 305
------- ------- --------------- --------- ---------
Balance at December 31, 1999 8,599 1 -- 305 306
Net income -- -- -- 3,523 3,523
------- ------- --------------- --------- ---------
Balance at December 31, 2000 8,599 1 -- 3,828 3,829
Issuance of common stock 4,977 135 40,826 -- 40,961
Net income -- -- -- 13,074 13,074
------- ------ --------------- --------- ---------
Balance at December 31, 2001 13,576 $ 136 $ 40,826 $ 16,902 $ 57,864
======= ====== =============== ========= =========
See accompanying notes.
24
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Statements of Cash Flows
(Amounts in thousands)
For the period
January 22, 1999 For the years December 31,
(date of inception) to --------------------------------------------
December 31, 1999 2000 2001
--------------------- --------------------- --------------------
Cash flows from operating activities:
Net income $ 305 $ 3,523 $ 13,074
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deferred costs -- -- 250
Impairment of purchased accounts receivable -- -- 2,649
Changes in operating assets and liabilities,
net of acquisition:
Restricted cash -- -- 2,555
Deferred income taxes 623 4,317 8,446
Other assets -- -- 249
Accounts payable and accrued expenses -- -- (4,191)
-------------------- -------------------- -------------------
Net cash provided by operating activities 928 7,840 23,032
-------------------- -------------------- -------------------
Cash flows from investing activities:
Purchases of accounts receivable (6,799) (31,351) (48,149)
Collections applied to principal of purchased
accounts receivable 2,105 4,565 34,159
Net cash paid for pre-acquisition liabilities and
acquisition related costs -- (666) (11,077)
-------------------- -------------------- -------------------
Net cash used in investing activities (4,694) (27,452) (25,067)
-------------------- -------------------- -------------------
Cash flows from financing activities:
Borrowings under NCO Group credit facility -- -- 47,130
Repayment of notes payable -- (40,005)
Payment of fees to acquire debt -- -- (901)
Issuance of common stock 1 -- 2,320
Notes payable, affiliate borrowings 3,765 19,612 --
-------------------- -------------------- -------------------
Net cash provided by financing activities 3,766 19,612 8,544
-------------------- -------------------- -------------------
Net increase in cash and cash equivalents -- -- 6,509
Cash and cash equivalents at beginning of period -- -- --
-------------------- -------------------- -------------------
Cash and cash equivalents at end of period $ -- $ -- $ 6,509
==================== ==================== ===================
See accompanying notes.
25
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
Note A--Organization and Business
NCO Portfolio Management, Inc. ("NCO Portfolio" or the "Company") was
incorporated in Delaware on January 22, 1999 (date of inception) under the name
of NCO Portfolio Funding, Inc. The Company changed its name from NCO Portfolio
Funding, Inc. to NCO Portfolio Management, Inc. in February 2001. NCO Portfolio
purchases and manages defaulted consumer receivables from consumer creditors
such as banks, finance companies, retail merchants and other consumer oriented
companies. NCO Portfolio's purchased accounts receivable originate from
consumers located throughout the United States. NCO Portfolio has funded its
purchased accounts receivable through internal cash flows and financing from NCO
Group, Inc. ("NCO Group" or the "Parent"). NCO Portfolio was a wholly owned
subsidiary of NCO Group until NCO Portfolio's merger with Creditrust Corporation
("Creditrust") on February 20, 2001 (the "Merger"). In connection with the
Merger, NCO Portfolio became a publicly traded company (NASDAQ: NCPM). Included
in the statement of income are the results of operations of the net assets
acquired in the Merger with Creditrust for the period from February 21, 2001
through December 31, 2001.
NCO Group owns approximately 63% of the outstanding NCO Portfolio common stock,
subject to certain adjustments. As part of the acquisition, NCO Portfolio
entered into a ten-year service agreement that appointed a wholly owned
subsidiary of NCO Group, NCO Financial Systems, Inc. ("NCOF"), as the sole
provider of collection services to NCO Portfolio. NCO Group has agreed to offer
all of its future U.S. accounts receivable purchase opportunities to NCO
Portfolio. Additionally, NCO Group amended its credit agreement with Citizens
Bank of Pennsylvania ("Citizens Bank") to provide a $50 million credit facility
to NCO Portfolio in the form of a sub-facility (Note I). Initially, NCO
Portfolio borrowed $36.3 million to fund the Merger.
Note B--Summary of Significant Accounting Policies
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
all affiliated subsidiaries and entities controlled by the Company. All
significant intercompany accounts and transactions have been eliminated. Two
affiliates that the Company does not control are InoVision-MEDCLR-NCOP Ventures,
LLC and Creditrust SPV98-2, LLC ("SPV 98-2"). See Note F - Investments in
Unconsolidated Subsidiaries.
Cash and Cash Equivalents
NCO Portfolio considers all highly liquid securities purchased with an initial
maturity of three months or less to be cash equivalents. Two securitizations
that are accounted for as secured borrowings have provisions which restrict NCO
Portfolio's use of cash. Restricted cash as of December 31, 2001 was $1.1
million.
Purchased Accounts Receivable
NCO Portfolio accounts for its investment in purchased accounts receivable on an
accrual basis under the guidance of Practice Bulletin 6, "Amortization of
Discounts on Certain Acquired Loans," using unique and exclusive static pools.
Static pools are established with accounts having similar attributes. Typically,
each static pool consists of an individual acquisition of accounts. Once a
static pool is established, the accounts in the static pool are not changed.
Proceeds from the sale of accounts within a static pool are accounted for as
collections in that static pool. Collections on replacement accounts received
from the originator of the loans are included as collections in the
corresponding static pools. The discount between the cost of each static pool
and the face value of the static pool is not recorded since NCO Portfolio
expects to collect a relatively small percentage of each static pool's face
value.
26
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note B--Summary of Significant Accounting Policies (Continued)
Purchased Accounts Receivable (continued)
Each static pool is initially recorded at cost. Collections on the static pools
are allocated to revenue and principal reduction based on the estimated internal
rate of return ("IRR") for each static pool. The IRR for each static pool is
estimated based on the expected monthly collections over the estimated economic
life of each static pool (generally five years, based on NCO Portfolio's
collection experience), compared to the original purchase price. Revenue on
purchased accounts receivable is recorded monthly based on each static pool's
effective IRR applied to each static pool's monthly opening carrying value. To
the extent collections exceed the revenue, the carrying value is reduced and the
reduction is recorded as collections applied to principal. Because the IRR
reflects collections for the entire economic life of the static pool, and those
collections are not constant, lower collection rates, typically in the early
months of ownership, can result in a situation where the actual collections are
less than the revenue accrual. In this situation, the carrying value of the
static pool may be increased by the difference between the revenue accrual and
collections.
To the extent the estimated future cash flow increases or decreases from the
expected level of collections, NCO Portfolio prospectively adjusts the IRR
accordingly. If the carrying value of a particular static pool exceeds its
expected future cash flows, a charge to income would be recognized in the amount
of such impairment. Additional impairments on previously impaired static pools
may occur if the current estimated future cash flow projection, after being
adjusted prospectively for actual collection results, is less than the carrying
value recorded. After the impairment of a static pool, no income is recorded on
that static pool and collections are recorded as a return of capital until the
full carrying value of the static pool has been recovered. The estimated yield
for each static pool is based on estimates of future cash flows from
collections, and actual cash flows will vary from current estimates. The
difference could be material.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes.
In the ordinary course of accounting for purchased accounts receivable,
estimates have been made by management as to the amount of future cash flows
expected from each static pool. The estimated future cash flow of each static
pool is used to compute the IRR for the static pool. The IRR is used to allocate
cash flow between revenue and amortization of the carrying values of the
purchased accounts receivable.
On an ongoing basis, the Company compares the historical trends of each static
pool to projected collections. The future projections are then increased or
decreased, within parameters, in accordance with the historical trend. The
results are further reviewed by management with a view towards specifically
addressing any particular static pool's performance. Actual results will differ
from these estimates and a material change in these estimates could occur within
one year. (See Note E)
Investments in Debt and Equity Securities
NCO Portfolio accounts for investments, such as the investment in
securitization, SPV 98-2, in accordance with Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." As such, investments are recorded as either trading, available for
sale, or held to maturity based on management's intent relative to those
securities. NCO Portfolio records its investment in securitization as an
available for sale debt security. Such a security is recorded at fair value, and
unrealized gain or loss, net of the related tax effect, is not reflected in
income but is recorded as other comprehensive income in stockholders' equity
until realized. A decline in the value of an available for sale security below
cost that is deemed other than temporary is charged to income as an impairment
and results in the establishment of a new cost basis for the security.
27
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note B--Summary of Significant Accounting Policies (Continued)
Investments in Debt and Equity Securities (continued)
The investment in securitization represents the residual interest in a
securitized pool of purchased accounts receivable acquired in the Merger. The
investment in securitization accrues interest at an effective yield (IRR), which
is estimated based on the expected monthly collections over the estimated
economic life of the investment (approximately five years). Cost approximates
fair value of this investment as of December 31, 2001. (See Note F).
Income Taxes
NCO Portfolio was included in NCO Group's consolidated Federal income tax return
during 1999, 2000, and through the effective date of the Merger. Effective for
periods after consummation of the Merger, NCO Portfolio will be filing its own
Federal income tax return. 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 and tax
basis of assets and liabilities.
The static pools of purchased accounts receivable are comprised of distressed
debt. Collection results are not guaranteed until received; accordingly, for tax
purposes, any gain on a particular static pool is deferred until the full cost
of its acquisition is recovered. Revenue for financial reporting purposes is
recognized over the life of the static pool. Deferred tax liabilities arise from
deferrals created during the early stages of the static pool. These deferrals
reverse after the cost basis of the static pool is recovered. The creation of
new tax deferrals from future purchases of static pools are expected to offset
the reversal of the deferrals from static pools where the collections have
become fully taxable.
Earnings Per Share
The Company had no stock options outstanding for the period January 22, 1999
(date of inception) to December 31, 1999 and for the year ended December 31,
2000. As of December 31, 2001, there were 581,000 options outstanding to
purchase shares of common stock, which were not dilutive, and have been excluded
from the computation of earnings per common share.
Stock Split
In February 2001, the Board of Directors of NCO Portfolio declared an
8,599-for-one stock split. All share amounts for all periods presented have been
adjusted to reflect the stock split. The stated par value of each common share
was changed from $1 to $.01.
Deferred Costs
NCO Portfolio capitalized legal and professional fees incurred in connection
with the establishment of the NCO Group credit sub-facility. The costs are being
amortized over the term of the facility (three years).
28
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note C--Acquisitions
On February 20, 2001, Creditrust merged with and into NCO Portfolio, at which
time NCO Portfolio became a publicly traded company. The Merger was accounted
for using the purchase method of accounting. As a result of the Merger, NCO
Portfolio issued 4,977,482 shares of common stock resulting in a total of
13,576,519 shares of NCO Portfolio common stock outstanding, including 291,732
shares held in escrow. Shareholders will be eligible to receive the shares of
NCO Portfolio common stock held in escrow based upon the resolution of certain
disputed and administrative claims related to the bankruptcy of Creditrust. The
purchase price was valued at approximately $25.0 million. Additional acquisition
related costs incurred in connection with the Merger were $4.2 million. The
Company allocated the purchase price based on the fair value of the net assets
acquired, principally to purchased accounts receivable, deferred tax asset and
certain assumed liabilities. The net deferred tax asset of $14.4 million
recorded was the result of the combination of a significant net operating loss
carryforward acquired from Creditrust, offset by deferred tax liabilities
arising from book tax differences in the carrying value of the acquired accounts
receivable and further limited by Tax Law regarding the change in control of
ownership of the Company. The purchase price allocation and determination of
certain income tax valuations estimated at the Merger date have been finalized
and are included in the financial statements as of December 31, 2001.
The following summarizes the unaudited pro forma results of operations for the
years ended December 31, 2000 and 2001, assuming the Merger occurred as of the
beginning of the respective years. The pro forma information is provided for
informational purposes only. It is based on historical information, and does not
necessarily reflect the actual results that would have occurred, nor is it
indicative of the future results of operations of the consolidated entities
(amounts in thousands, except per share data):
For the years ended December 31,
--------------------------------
2000 2001
---- ----
Revenue.................................. $ 55,300 $ 66,509
Net (loss) income ....................... $ (59,751) $ 3,583
Net (loss) income per share - basic...... $ (4.40) $ 0.26
Net (loss) income per share - diluted.... $ (4.40) $ 0.26
Note D--Fair Value of Financial Instruments
The accompanying financial statements include various estimated fair value
information as of December 31, 2000 and 2001, as required by SFAS No. 107,
"Disclosures About Fair Value of Financial Instruments." Such information, which
pertains to NCO Portfolio's financial instruments, is based on the requirements
set forth in the Statement and does not purport to represent the aggregate net
fair value of NCO Portfolio.
The following methods and assumptions were used to estimate the fair value of
each class of financial instruments for which it is practicable to estimate fair
value.
Cash and Cash Equivalents
The carrying amount approximates fair value.
29
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note D--Fair Value of Financial Instruments (Continued)
Purchased Accounts Receivable
NCO Portfolio records purchased accounts receivable at cost, which is discounted
from the contractual receivable balance. NCO Portfolio recorded the accounts
receivable acquired in the Merger at fair value. The carrying value of purchased
accounts receivable, which is estimated based upon future cash flows,
approximates fair value at December 31, 2000 and 2001.
Investment in Securitization
Upon completion of the Merger, NCO Portfolio recorded the investment in
securitization acquired from Creditrust at fair value. As of December 31, 2001,
the carrying value approximates fair value.
Notes Payable
Quoted market prices for the same or similar issues or the current rate offered
to NCO Portfolio for debt of the same remaining maturities are used to estimate
the fair value of NCO Portfolio's notes payable. At December 31, 2000 and 2001,
the carrying amount of the notes payable approximated fair value.
Note E--Purchased Accounts Receivable
NCO Portfolio purchases defaulted consumer receivables at a discount from the
actual principal balance. The following summarizes the change in purchased
accounts receivable for the years ended December 31, (amounts in thousands):
2000 2001
---- ----
Balance, at beginning of period............................... $ 4,694 $ 31,480
Purchased accounts receivable acquired in the Merger..... -- 93,518
Purchases of accounts receivable......................... 31,351 48,149
Collections on purchased accounts receivable............. (17,716) (97,088)
Revenue recognized....................................... 13,151 62,929
Impairment of purchased accounts receivable.............. -- (2,649)
-------- ---------
Balance, at end of period..................................... $ 31,480 $ 136,339
======== =========
During the year ended December 31, 2001, an impairment of $2.6 million was
recorded as a charge to income on static pools where the carrying amounts
exceeded the expected future cash flows. No revenue will be recorded on these
static pools until their carrying values have been fully recovered. The combined
carrying values on these static pools, after impairment, aggregated $5.7
million, or 4.2% of purchased accounts receivable, as of December 31, 2001,
representing their net realizable value. No impairments were recorded in 1999
and 2000.
30
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note F--Investments in Unconsolidated Subsidiaries
NCO Portfolio owns a 100% retained residual interest in an investment in
securitization, SPV 98-2, which was acquired in the Merger. This transaction
qualified for gain on sale accounting when the purchased accounts receivable
were originally securitized by Creditrust. This securitization issued a note
that is due in January 2004 and had a balance of $5.5 million as of December 31,
2001. The retained interest represents the present value of the residual
interest in the securitization using discounted future cash flows after the
securitization note is fully repaid, plus a cash reserve. As of December 31,
2001, the investment in securitization was $7.3 million, comprised of $4.0
million in present value of discounted residual cash flows plus $3.3 million in
cash reserves. The investment accrues non-cash income at a rate of 8% per annum
on the residual cash flow component only. The income earned increases the
investment balance until the securitization note has been repaid. After
repayment of the note, collections are split between income and amortization of
the investment in securitization based on the discounted cash flows. NCO
Portfolio recorded $211,000 in income on this investment for the period from
February 21, 2001 to December 31, 2001. The cash reserves of $3.3 million plus
the first $1.3 million in residual cash collections received, after the
securitization note has been repaid, have been pledged as collateral against the
Warehouse Facility (See Note G).
NCO Portfolio has a 50% ownership interest in a joint venture,
InoVision-MEDCLR-NCOP Ventures, LLC ("Joint Venture") with IMNV Holdings, LLC
("Marlin"). This Joint Venture was established to purchase utility, medical and
other various small balance accounts receivable and is accounted for using the
equity method of accounting. As of December 31, 2001, NCO Portfolio and Marlin
have each invested $574,000 in the Joint Venture for the purchase of accounts
receivable. Included in the Statement of Income, in "other income," is $118,000
representing the Company's 50% share of operating income from this
unconsolidated subsidiary for the year ended December 31, 2001. The Joint
Venture has access to capital through a specialty finance lender who, at its
option, lends 90% of the value of the purchased accounts receivable to the Joint
Venture. The debt is cross-collateralized by all static pools in which the
lender participates, and is non-recourse to NCO Portfolio. The following table
summarizes the financial information of the Joint Venture as of and for the year
ended December 31, 2001 (amounts in thousands):
Total assets.............................. $ 5,581
Total liabilities......................... $ 4,455
Revenue................................... $ 1,061
Operating income.......................... $ 236
Note G--Notes Payable
NCO Portfolio has assumed three securitized notes payable in connection with the
Merger. These notes payable were originally established to fund the purchase of
accounts receivable. Each of the notes payable is non-recourse to the Company
and NCO Group, secured by a static pool of purchased accounts receivable, and is
bound by an indenture and servicing agreement. Pursuant to the Merger, the
trustee appointed NCOF as the successor servicer for each static pool of
purchased accounts receivable. When the notes payable were established, a
separate non-recourse special purpose finance subsidiary was created to house
the assets and issue the debt. These are term notes without the ability to
re-borrow. Monthly principal payments on the notes equal all collections after
servicing fees, collection costs, interest expense and administrative fees.
The first securitized note ("Warehouse Facility") was established in September
1998 through Creditrust Funding I LLC, a special purpose finance subsidiary. The
Warehouse Facility carries a floating interest rate of LIBOR plus 0.65% per
annum, and the final due date of all payments under the facility is March 2005.
A $900,000 liquidity reserve is included in restricted cash as of December 31,
2001, and is restricted as to use until the facility is retired. Interest
expense, trustee fees and guarantee fees aggregated $945,000 for the period from
February 21, 2001 to December 31, 2001. As of December 31, 2001, the amount
outstanding on the facility was $17.8 million. The note insurer, Radian Group,
Inc., formerly Asset Guaranty Insurance Company, has been guaranteed against
loss by the Company for up to $4.5 million, which will be reduced if and when
reserves and residual cash flows from another securitization, SPV 98-2, are
posted as additional collateral for this facility.
31
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note G--Notes Payable (Continued)
The second securitized note ("SPV99-1") was established in August 1999 through
Creditrust SPV99-1, LLC, a special purpose finance subsidiary. SPV99-1 carries
interest at 9.43% per annum, with a final payment date of August 2004. A
$225,000 liquidity reserve is included in restricted cash as of December 31,
2001, and is restricted as to use until the facility is retired. Interest
expense and trustee fees aggregated $691,000 for the period from February 21,
2001 to December 31, 2001. As of December 31, 2001, the amount outstanding on
the facility was $3.8 million.
The third securitized note ("SPV99-2") was established in August 1999 through
Creditrust SPV99-2, LLC, a special purpose finance subsidiary. SPV99-2 carries
interest at 15% per annum, with a final payment date of December 2004. Interest
expense and trustee fees aggregated $3.3 million for the period from February
21, 2001 to December 31, 2001. As of December 31, 2001, the amount outstanding
on the facility was $23.8 million.
The required minimum principal payments payable by NCO Portfolio are included in
the table under Note I.
Note H--Commitments and Contingencies
Forward-Flow Agreement
NCO Portfolio currently has a "forward-flow" agreement with a major financial
institution, which obligates NCO Portfolio to purchase, on a monthly basis,
portfolios of charged-off receivables meeting certain criteria. As of December
31, 2001, NCO Portfolio is obligated to purchase accounts receivable to a
maximum of $1.8 million per month from January 2002 through May 2002.
Litigation
NCO Portfolio is party, from time to time, to various legal proceedings
incidental to its business. In the opinion of management, none of these items
individually or in the aggregate will have a significant effect on the financial
position, results of operations, cash flows, or liquidity of NCO Portfolio.
Note I--Related Party Transactions
Servicing Fees
As part of the Merger, NCO Portfolio entered into a ten-year service agreement
that appointed NCOF as the provider of collection services to NCO Portfolio. NCO
Group has agreed to offer all of its future U.S. accounts receivable purchase
opportunities to NCO Portfolio. NCO Portfolio pays NCOF to perform collection
services for its purchased accounts receivable. NCOF is paid a commission
ranging from 20% to 40% of collections depending on the nature of the accounts.
Management believes that the commission rates paid are reasonable and are
consistent with rates charged by other collection agencies for the same type of
services. Servicing fees paid to NCOF amounted to $1.0 million, $5.7 million and
$27.5 million for the period January 22, 1999 (date of inception) to December
31, 1999, and the years ended December 31, 2000 and 2001, respectively.
Shared Services
NCO Group paid certain costs on behalf of NCO Portfolio during the period
January 22, 1999 (date of inception) to December 31, 1999, and for the years
ended December 31, 2000 and 2001. NCO Portfolio reimbursed NCO Group in full for
these costs. These costs related to certain shared services, including office
space, human resources, insurance, legal, payroll processing, external
reporting, management information systems and certain other administrative
expenses. Shared services amounted to $57,000 for the period January 22, 1999
(date of inception) to December 31, 1999, and $112,000 and $180,000 for the
years ended December 31, 2000 and 2001, respectively.
32
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note I--Related Party Transactions (Continued)
Note Payable, Affiliate
Prior to the Merger, NCO Portfolio borrowed money from NCO Group to finance the
purchase of accounts receivable and to fund certain operating costs, and
remitted all cash collections to NCO Group. Effective with the Merger, all
collections have been remitted to NCO Portfolio, net of the applicable servicing
fees. NCO Portfolio was charged interest on the net outstanding note balance
using a weighted average interest rate of 9.47% for the period January 22, 1999
(date of inception) to December 31, 1999, 10.24% for the year ended December 31,
2000, and 10.21% for the period January 1, 2001 to February 20, 2001. Interest
expense of $253,000, $1.3 million, and $379,000 was recorded for the period
January 22, 1999 (date of inception) to December 31, 1999, the year ended
December 31, 2000, and the period January 1, 2001 to February 20, 2001,
respectively.
NCO Group Credit Facility
NCO Group has a credit agreement with Citizens Bank, for itself and as
administrative agent for other participating lenders, that originally provided
for borrowings up to $350 million, structured as a revolving credit facility.
The borrowing capacity of the revolving credit facility is subject to mandatory
reductions including a quarterly reduction of $6.3 million on March 31, 2001,
subsequent quarterly reductions of $5.2 million until maturity, and 50 percent
of the net proceeds received from any offering of debt or equity. As of December
31, 2001, there was $58.3 million available under the revolving credit
agreement. NCO Group's borrowings are collateralized by substantially all the
assets of NCO Group, including its common stock of NCO Portfolio. Pursuant to
the Merger, NCO Portfolio entered into a credit agreement with NCO Group, which
provides NCO Portfolio with a $50 million revolving line of credit from NCO
Group in the form of a sub-facility under its existing credit facility. Certain
of NCO Portfolio's assets have been pledged to Citizens Bank to secure our
borrowings under the $50 million sub-facility. The balance under the revolving
sub-facility will become due on May 20, 2004 (the "Maturity Date"). The
borrowing capacity of the sub-facility is subject to mandatory reductions
including four quarterly reductions of $2.5 million beginning March 31, 2002
through December 31, 2002. Effective March 31, 2003, quarterly reductions of
$3.75 million are required until the earlier of the Maturity Date or the date at
which the sub-facility is reduced to $25 million. The NCO Group credit agreement
and the NCO Portfolio sub-facility contain certain financial covenants such as
maintaining net worth and funded debt to EBITDA requirements, and include
restrictions on, among other things, acquisitions and distributions to
shareholders. As of December 31, 2001, NCOG and NCO Portfolio were in compliance
with all of the financial covenants.
The credit agreement carries interest at 2% over NCO Group's underlying rate
from Citizens Bank, of which 1% is paid to the bank and 1% is paid to NCO Group.
At the option of NCO Group, NCO Group's borrowings bear interest at a rate equal
to either Citizens Bank's prime rate plus a margin ranging from 0.25% to 0.50%
that is determined quarterly based upon NCO Group's consolidated funded debt to
income before interest, taxes, depreciation, and amortization ("EBITDA") ratio
(Citizens Bank's prime rate was 4.75% at December 31, 2001), or the London
InterBank Offered Rate ("LIBOR") plus a margin ranging from 1.25% to 2.25%
depending on NCO Group's consolidated funded debt to EBITDA ratio (LIBOR was
1.88% at December 31, 2001). The credit agreement contains a provision which
provides Citizens Bank with an additional commitment fee of 0.25% per quarter
commencing August 20, 2001. This charge will continue until the facility is
reduced to $25 million. NCO Portfolio was charged an additional 0.25% per
quarter on the full commitment from August 20, 2001 to December 31, 2001, which
is included as part of interest expense. NCO Portfolio is charged a fee on the
unused portion of the sub-facility ranging from 0.13% to 0.38% depending on NCO
Group's consolidated funded debt to EBITDA ratio. As of December 31, 2001, the
outstanding balance under the sub-facility was $47.1 million, with $2.9 million
available. Interest expense totaled $3.1 million for the period February 21,
2001 to December 31, 2001.
As of December 31, 2001, required and projected minimum principal payments
payable by NCO Portfolio under the securitized notes (Note G) and the credit
facility are as follows (amounts in thousands):
Year ending December 31,
------------------------
2002............................................. $ 19,939
2003............................................. 27,679
2004............................................. 30,062
2005............................................. 14,829
--------
Total minimum principal payments........... $ 92,509
========
33
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note J--Employee Benefit Plans
Employees of NCO Portfolio are participants in NCO Group's savings plan under
Section 401(k) of the Internal Revenue Code (the "Plan"). The Plan allows all
eligible employees to defer up to 15% of their income on a pretax basis through
contributions to the Plan subject to limitations under Section 401(k) of the
Internal Revenue Code. NCO Portfolio will provide a matching contribution of 25%
of the first 6% of an employee's contribution.
Note K--Income Taxes
Income tax expense consisted of the following components (amounts in thousands):
For the period
January 22, 1999 For the years ended December 31,
(date of inception) to --------------------------------
December 31, 1999 2000 2001
----------------- ---- ----
Current:
Federal................................................ $ -- $ -- $ (601)
------- ----------- ----------
Total current tax benefit................................... -- -- (601)
------- ----------- ----------
Deferred:
Federal................................................ 165 1,897 7,641
State.................................................. 18 217 805
------- ----------- ----------
Total deferred tax expense.................................. 183 2,114 8,446
------- ----------- ----------
Income tax expense.......................................... $ 183 $ 2,114 $ 7,845
======= =========== ==========
The net deferred tax assets (liabilities) consist of the following as of
December 31, (amounts in thousands):
2000 2001
---- ----
Deferred tax assets:
Net operating loss carryforward........................................... $ -- $ 33,720
Other..................................................................... -- 637
----------- ----------
Total deferred tax assets...................................................... -- 34,357
Deferred tax liabilities:
Purchased accounts receivable............................................. 4,940 30,288
Investment in securitization.............................................. -- 2,833
Other..................................................................... -- 244
----------- ----------
Total deferred tax liabilities................................................. 4,940 33,365
----------- ----------
Net deferred tax (liabilities) assets.......................................... $ (4,940) $ 992
=========== ==========
A reconciliation of the U.S. statutory income tax rate to the effective rate is
as follows:
For the period
January 22, 1999 For the years ended December 31,
(date of inception) to --------------------------------
December 31, 1999 2000 2001
----------------- ---- ----
U. S. statutory income tax rate............................... 35.0% 35.0% 35.0%
State taxes, net of federal benefit........................... 2.5% 2.5% 2.5%
---- ---- ----
Effective tax rate............................................ 37.5% 37.5% 37.5%
==== ==== ====
34
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note K--Income Taxes (Continued)
As of December 31, 2001, NCO Portfolio had a federal net operating loss
carryforward of approximately $108.4 million, which fully expires through 2021.
Of this amount, $100.4 million existed as of the date of the Creditrust
acquisition. Due to the Creditrust ownership change in 2001, the use of the net
operating loss carryforward could be substantially curtailed by Section 382 of
the Internal Revenue Code. The annual use of the net operating loss carryforward
is limited under this section and such limitation is dependent on i) the fair
market value of Creditrust at the time of the ownership change and ii) the net
unrealized built-in gains of Creditrust at the time of the ownership change
which are expected to be recognized within five years of the Merger date. Based
on an analysis performed by the Company, it is anticipated that $81.8 million of
the Creditrust net operating loss will be available for utilization after
Section 382 limitations. Accordingly, a deferred tax asset based on this amount
was recorded at the acquisition date being available to offset future reversing
temporary differences and future taxable income. Based on operations for the
year, the deferred tax asset was increased by the tax loss recognized for 2001.
At year end, this deferred tax asset was expected to be fully utilized to offset
future reversing temporary differences, primarily relating to purchased accounts
receivable.
Note L--Stock Option Plan
In November 2000, the Company adopted the 2000 Stock Option Plan (the "2000
Plan"). The 2000 Plan authorized 3.0 million shares of incentive or
non-qualified stock options. The plan is administered by the Board of Directors
and provides for the grant of stock options to directors and to all eligible
employees of NCO Portfolio, including executive officers. Options granted under
the plan vest over three years for employees, and one year for directors. The
options expire no later than ten years from the date of grant.
In September 1996, NCO Group adopted the 1996 Stock Option Plan (the "1996
Plan"). The 1996 Plan, as amended, authorized 3.7 million shares of incentive or
non-qualified stock options. The vesting period for the outstanding options
under the 1996 Plan is three years. The options expire no later than ten years
from the date of grant.
Prior to January 1, 2001, all of the options activity was from the 1996 Plan. A
summary of the stock option activity of the 2000 Plan and the 1996 Plan is as
follows (amounts in thousands, except per share amounts)
Weighted Average
Number of Exercise Price
Options Per Share
------- ---------
Outstanding at January 22, 1999 (date of inception)................ -- $ --
Granted......................................................... 16 27.04
Exercised....................................................... (1) 23.33
---- --------
Outstanding at December 31, 1999................................... 15 27.29
Granted......................................................... 10 25.19
Outstanding at December 31, 2000................................... 25 26.45
Granted......................................................... 581 6.92
Exercised....................................................... (1) 23.33
---- --------
Outstanding at December 31, 2001................................... 605 $ 7.70
==== ========
Stock options exercisable at year-end (the 1996 Plan).............. 16 $ 26.81
==== ========
As of December 31, 2001, there were 605,000 stock options outstanding with a
weighted average remaining life of 9.32 years, and 15,667 stock options
exercisable with a weighted average remaining life of 7.08 years.
35
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note L--Stock and Option Plans (Continued)
The Company accounts for stock option grants in accordance with APB Opinion 25,
"Accounting for Stock Issued to Employees" ("APB 25") and related
interpretations. Under APB 25, because the exercise price of the stock options
equaled the fair value of the underlying common stock on the date of grant, no
compensation cost was recognized. In accordance with FASB 123, "Accounting for
Stock-Based Compensation", the Company does not recognize compensation cost
based on the fair value of the options granted at grant date. If the Company had
elected to recognize compensation cost based on the fair value of the options
granted at grant date, net income and net income per share would have been
reduced to the pro forma amounts indicated in the following table for the
periods ending (amounts in thousands, except per share amounts):
For the period
January 22, 1999 For the years ended December 31,
(date of inception) to --------------------------------
December 31, 1999 2000 2001
----------------- ---- ----
Net income -- pro forma.......................... $ 287 $ 3,494 $ 12,702
Net income per share -- pro forma:
Basic....................................... $ 0.03 $ 0.41 $ 0.99
Diluted..................................... $ 0.03 $ 0.41 $ 0.99
The estimated weighted average, grant date fair values of the options granted
during the period January 22, 1999 (date of inception) to December 31, 1999, and
the years ended December 31, 2000 and 2001 were $12.33, $10.81 and $4.40,
respectively. All stock options granted were at the fair market value of the
stock on the grant date. The fair value of each option grant was estimated on
the date of grant using the Black-Scholes option pricing model using the
following assumptions for grants on a weighted average basis during the periods
ending:
For the period
January 22, 1999 For the years ended December 31,
(date of inception) to --------------------------------
December 31, 1999 2000 2001
----------------- ---- ----
Volatility factor................................ 52.96% 52.96% 73.90%
Risk-free interest rate.......................... 5.80% 5.90% 4.50%
Expected life in years........................... 3.25 3.25 5.00
Dividend yield................................... None None None
Forfeiture rate.................................. 5.00% 5.00% 5.00%
Note M--Supplemental Cash Flows Information
The following are supplemental disclosures of cash flow information for the
period from January 22, 1999 (date of inception) to December 31, 1999, and for
the years ended December 31, 2000 and 2001 (amounts in thousands):
1999 2000 2001
---- ---- ----
Cash paid for interest...................................... $ 253 $ 1,334 $ 7,846
Non-cash investing and financing activities:
Common stock issued for Creditrust acquisition......... $ -- $ -- $ 24,058
Fair value of assets acquired in merger................ $ -- $ -- $ 123,978
Liabilities assumed in merger.......................... $ -- $ -- $ 109,394
36
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS--(CONTINUED)
Note N--Supplementary Financial Information (Unaudited)
The following tables represent selected quarterly financial information for the
three months ended (amounts in thousands, except per share amounts):
March 31, June 30, September 30, December 31,
2000 2000 2000 2000
---- ---- ---- ----
Revenue $ 890 $ 2,837 $ 3,984 $ 5,440
Income from operations 293 1,745 2,093 2,840
Net income 81 914 1,071 1,457
Basic and diluted net income per share $ 0.01 $ 0.11 $ 0.12 $ 0.17
March 31, June 30, September 30, December 31,
2001 2001 2001 2001
---- ---- ---- ----
Revenue $ 12,618 $ 17,916 $ 16,189 $ 16,206
Income from operations 6,232 8,490 6,509 7,387
Net income 2,931 3,923 2,703 3,517
Basic and diluted net income per share $ 0.27 $ 0.29 $ 0.20 $ 0.26
The selected quarterly financial information presented for the four quarterly
periods ended December 31, 2001 include the results of the Merger, and are not
comparable to the prior periods presented.
Note O - Impact of Recently Issued and Proposed Accounting Pronouncements
Statement of Financial Accounting Standards No. 140, "Accounting for Transfers
and Servicing of Financial Assets and Extinguishments of Liabilities", was
effective for transfers of financial assets and extinguishments of liabilities
occurring after March 31, 2001. Statement No. 140, which replaces FASB No. 125,
requires transfers of financial assets and servicing of financial assets and
extinguishments of liabilities occurring after March 31, 2001 to de-recognize
the assets when control has been surrendered, and to de-recognize liabilities
only when they have been extinguished. NCO Portfolio adopted the provisions of
Statement No. 140 in the second quarter of 2001. The effect of the adoption had
no impact on the consolidated financial statements.
During 2001, the Accounting Staff Executive Committee approved an exposure draft
on a proposed Statement of Position, "Accounting for Discounts Related to Credit
Quality" ("SOP"). The proposed SOP would limit the revenue that may be accrued
to the excess of the estimate of expected future cash flows over the static
pool's initial cost of accounts receivable acquired. The proposed SOP would
require that the excess of the contractual cash flows over expected future cash
flows not be recognized as an adjustment of revenue, expense or on the balance
sheet. The proposed SOP would freeze the IRR originally estimated when the
accounts receivable are purchased for subsequent impairment testing. Rather than
lower the estimated IRR if the original collection estimates are not received,
the carrying value of a static pool would be written down to maintain the
original IRR. Increases in expected future cash flows would be recognized
prospectively through adjustment of the IRR over a static pool's remaining life.
The exposure draft provides that previously issued annual financial statements
would not need to be restated. Until final issuance of this SOP, management
cannot ascertain its effect on the Company's reporting.
37
Item 9. Changes and Disagreements with Accountants on Accounting and Financial
Disclosure
None.
PART III
Item 10. Directors and Executive Officers of the Registrant
Incorporated by reference from the Company's Information Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with general
Instructions G(3) to Form 10-K.
Item 11. Executive Compensation
Incorporated by reference from the Company's Information Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with general
Instructions G(3) to Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management
Incorporated by reference from the Company's Information Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with general
Instructions G(3) to Form 10-K.
Item 13. Certain Relationships and Related Transactions
Incorporated by reference from the Company's Information Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with general
Instructions G(3) to Form 10-K.
38
PART IV
Item 14. Exhibits, Financial Statements, Schedules and Reports on Form 8-K.
(a)(1) The following consolidated financial statements of NCO Portfolio
Management, Inc. and its subsidiaries are included in Item 8:
Report of Independent Auditors
Consolidated Balance Sheets as of December 31, 2000 and 2001
Consolidated Statements of Income for the period January 22, 1999
(date of inception) to December 31, 1999 and for each of the two
years in the period ended December 31, 2001
Consolidated Statements of Stockholders' Equity for the period
January 22, 1999 (date of inception) to December 31, 1999 and for
each of the two years in the period ended December 31, 2001
Consolidated Statements of Cash Flows for the period January 22, 1999
(date of inception) to December 31, 1999 and for each of the two
years in the period ended December 31, 2001
Notes to Consolidated Financial Statements
(a)(2) No financial statement schedules for the period January 22, 1999
(date of inception) to December 31, 1999 and for years ended December 31,
2000 and 2001 are required to be filed as part of this Report on Form 10-K.
(a)(3) List of Exhibits filed in accordance with Item 601 of Regulation
S-K. The following exhibits are incorporated by reference in, or filed
with, this Report on Form 10-K:
Exhibit No Document
- ---------- --------
3.1 Certificate of Incorporation of NCO Portfolio Management, Inc. (1)
3.2 By-Laws of NCO Portfolio Management, Inc. (1)
10.1 Indenture and Servicing Agreement, dated as of September 1, 1998,
by and among Creditrust Funding I LLC, Norwest Bank Minnesota,
National Association, Creditrust Corporation and Asset Guaranty
Insurance Company. (2)
10.2 Amendment No. 1 to Indenture and Servicing Agreement, dated as of
February 16, 1999, by and among Creditrust Funding I LLC, as
issuer, Norwest Bank Minnesota, National Association, as trustee,
and as backup servicer, Creditrust Corporation, as servicer, and
Asset Guaranty Insurance Company, as note insurer. (3)
10.3 Amendment No. 2 to Indenture and Servicing Agreement, dated as of
March 15, 1999, by and among Creditrust Funding I LLC, as issuer,
Norwest Bank Minnesota, National Association, as trustee, and as
backup servicer, Creditrust Corporation, as servicer, and Asset
Guaranty Insurance Company, as note insurer. (3)
10.4 Amendment No. 3 to Indenture and Servicing Agreement, dated as of
December 31, 1999, by and among Creditrust Funding I LLC, as
issuer, Norwest Bank Minnesota, National Association, as trustee,
and as backup servicer, Creditrust Corporation, as servicer, and
Asset Guaranty Insurance Company, as note insurer. (4)
39
10.5 Amendment No. 4 to Indenture and Servicing Agreement, dated as of
February 29, 2000 by and among Creditrust Funding I LLC, as
issuer, Norwest Bank Minnesota, National Association, as trustee,
and as backup servicer, Creditrust Corporation, as servicer, and
Asset Guaranty Insurance Company, as note insurer. (4)
10.6 Amendment No. 5 to Indenture and Servicing Agreement, dated as of
February 20, 2001, among Creditrust Funding I, LLC, Wells Fargo
Bank Minnesota, National Association, Asset Guaranty Insurance
Company, Wells Fargo Bank Minnesota, National Association and NCO
Financial Systems, Inc. (10)
10.7 Indenture and Servicing Agreement, dated as of December 29, 1998,
by and among Creditrust SPV98-2, LLC, Norwest Bank Minnesota,
National Association, Creditrust Corporation and Asset Guaranty
Insurance Company. (3)
10.8 Amendment No. 1 to Indenture and Servicing Agreement, dated as of
February 16, 1999, by and among Creditrust SPV98-2, LLC, as
issuer, Norwest Bank Minnesota, National Association, as trustee,
and as backup servicer, Creditrust Corporation, as servicer, and
Asset Guaranty Insurance Company, as note insurer. (3)
10.9 Amendment No. 2 to Indenture and Servicing Agreement, dated as of
June 1, 1999, by and among Creditrust SPV98-2, LLC, as issuer,
Norwest Bank Minnesota, National Association, as trustee, and as
backup servicer, Creditrust Corporation, as servicer, and Asset
Guaranty Insurance Company, as note insurer. (4)
10.10 Amendment No. 3 to Indenture and Servicing Agreement, dated as of
December 31, 1999, by and among Creditrust SPV98-2, LLC, issuer,
Norwest Bank Minnesota, National Association, as trustee, and as
backup servicer, Creditrust Corporation, as servicer, and Asset
Guaranty Insurance Company, as note insurer. (4)
10.11 Amendment No. 4 to Indenture and Servicing Agreement, dated as of
February 20, 2001, among Creditrust SPV98-2, LLC, Wells Fargo Bank
Minnesota, National Association, Asset Guaranty Insurance Company,
Wells Fargo Bank Minnesota, National Association and NCO Financial
Systems, Inc. (10)
10.12 Limited Liability Company Agreement of Creditrust SPV98-2, LLC,
dated as of December 29, 1998. (3)
10.13 Bridge Loan Agreement dated as of August 2, 1999 among dated as of
August 2, 1999 among Creditrust SPV 99-2, LLC, Creditrust SPV 99-2
Capital, Inc., Creditrust Corporation, the Lenders named therein,
and Norwest Bank Minnesota, National Association. (5)
10.14 Amendment No. 1 to Bridge Loan Agreement dated as of August 2,
1999 among Creditrust SPV99-2, LLC, CRDT SPV99-2 Capital Inc.,
Creditrust Corporation, the lenders named therein and Norwest Bank
Minnesota, National Association. (6)
10.15 Amendment No. 2 to Bridge Loan Agreement, dated as of February 14,
2001, among Creditrust SPV99-2 Capital, Inc., CRDT SPV99-2
Capital, Inc., the lenders named therein, and Wells Fargo Bank
Minnesota, N.A. (10)
40
10.16 Senior Secured Bridge Note dated August 2, 1999, executed by
Creditrust SPV 99-2, LLC. (5)
10.17 Amended and Restated Limited Liability Company Agreement of
Creditrust SPV99-2, LLC dated as of March 1, 2000. (7)
10.18 Indenture and Servicing Agreement, dated as of August 31, 1999, by
and among Creditrust SPV99-1, LLC, Norwest Bank Minnesota,
National Association, and Creditrust Corporation (5)
10.19 Amendment No. 1 to Indenture and Servicing Agreement, dated as of
February 14, 2001, among Creditrust SPV 99-1, Wells Fargo Bank
Minnesota, National Association and NCO Financial Systems, Inc.
(10)
10.20 Limited Liability Company Agreement of Creditrust SPV99-1, LLC,
dated as of August 31, 1999. (5)
10.21 Amendment No. 1 to Limited Liability Company Agreement of
Creditrust SPV99-1, LLC, dated as of February 14, 2001, between
Creditrust Corporation and GSS Holdings II, Inc. (10)
10.22 Creditrust Corporation Fifth Amended Plan of Reorganization Under
Chapter 11 Bankruptcy dated December 21, 2000. (7)
10.23 Second Amended and Restated Agreement and Plan of Merger dated as
of September 20, 2000 for the Merger of Creditrust Corporation
with and into NCO Portfolio Funding, Inc. (7)
10.24 Fifth Amended Disclosure Statement of Creditrust Corporation dated
December 21, 2000. (7)
10.25 Independent Contractor Agreement between NCO Portfolio Funding,
Inc. and Joseph K. Rensin. (8)
10.26 Order Confirming Fifth Amended Plan of Reorganization (with
Technical Amendments) dated December 21, 2000. (10)
10.27 Amendment No. 1 to Limited Liability Company Agreement, dated as
of February 20, 2001, between Creditrust Corporation and GSS
Holdings II, Inc. (10)
10.28 Amendment No. 1 to Limited Liability Company Agreement of
Creditrust Funding I, LLC, dated as of February 20, 2001, between
Creditrust Corporation and GSS Holdings II, Inc. (10)
10.29 Servicing Agreement, dated as of February 14, 2001, between
Creditrust Corporation and NCO Financial Systems, Inc. (10)
10.30 Servicing Agreement, dated as of February 20, 2001, among
Creditrust SPV99-2, LLC, NCO Financial Systems, Inc. and Wells
Fargo Bank. (10)
10.31 Subscription Agreement between NCO Portfolio Management, Inc. and
Joseph K. Rensin. (10)
41
10.32 Subscription Agreement between NCO Portfolio Management, Inc. and
Michael J. Barrist. (10)
10.33 Credit Agreement, dated as of February 20, 2001, between NCO
Portfolio Management, Inc. and NCO Group, Inc. (10)
10.34 NCO Portfolio Management, Inc. 2000 Stock Option Plan. (9) (10)
10.35 Employment Agreement dated February 20, 2001 by and between NCO
Portfolio Management, Inc. and Michael B. Meringolo. (9) (11)
10.36 Limited Liability Agreement of InoVision-MEDCLR-NCOP Ventures,
L.L.C. (11)
10.37 Limited Liability Agreement of InoVision-MEDCLR-NCOP-F, L.L.C.
(11)
10.38 Limited Liability Agreement of InoVision-MECLR-NCOP-NF, L.L.C.
(11)
10.39 Exclusivity Agreement dated March 9, 2001, by and among Marlin
Integrated Capital Holding Corporation, NCO Portfolio Management,
Inc. NCO Group, Inc. (11)
10.40 Credit Agreement By and Between InoVision-MEDCLR-NCOP-F, L.L.C. as
Borrower and CFSC Capital Corp. XXXIV, as Lender dated as of March
9, 2001 (11)
21.1 List of Subsidiaries. (10)
42
(1) Previously filed as an exhibit to Creditrust's Current Report on Form
8-K dated February 22, 2001.
(2) Previously filed as an exhibit to Creditrust's Quarterly Report on Form
10-Q for the quarterly period ended September 30, 1998 and incorporated
herein by reference.
(3) Previously filed as an exhibit to Creditrust's Registration Statement on
Form S-1 (Reg. No. 333-70845) and incorporated herein by reference.
(4) Previously filed as an exhibit to Creditrust's Annual Report on Form
10-K for the year ended December 31, 1999 and incorporated herein by
reference.
(5) Previously filed as an exhibit to Creditrust's Quarterly Report on Form
10-Q for the quarter ended September 30, 1999 and incorporated herein by
reference. A portion of this exhibit has been omitted based upon a
request for confidential treatment.
(6) Previously filed as an exhibit to Creditrust's Quarterly Report on Form
10-Q for the quarter ended March 31, 2000 and incorporated herein by
reference.
(7) Previously filed as an exhibit to Creditrust's Quarterly Report on Form
10-Q for the quarter ended June 30, 2000 and incorporated herein by
reference.
(8) Previously filed as an exhibit to Creditrust's Quarterly Report on Form
10-Q for the quarter ended September 30, 2000 and incorporated herein by
reference.
(9) Indicates management agreement or compensatory plan or arrangement.
(10) Previously filed as an exhibit to NCO Portfolio Management's Annual
Report on Form 10-K for the year ended December 31, 2000 and
incorporated herein by reference.
(11) Filed herewith.
(b) Reports on Form 8-K.
NCO Portfolio filed an 8-K on October 1, 2001, Item 5 "Other Events", and
Item 7 " Financial Statements and Exhibits".
NCO Portfolio filed an 8-K on November 6, 2001, Item 5 "Other Events", and
Item 7 " Financial Statements and Exhibits".
43
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) 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, in the City of Baltimore,
State of Maryland, on March 19, 2002.
NCO Portfolio Management, Inc.
By: /s/ MICHAEL J. BARRIST
----------------------
Chairman, Chief Executive Officer, and President
Pursuant to the requirements of the Securities Exchange Act of 1934, this report
has been signed by the following persons in the capacities indicated.
Signature Title Date
--------- ----- ----
/s/ Michael J. Barrist Chairman, Chief Executive Officer, and President March 19, 2002
- ---------------------- (Principal Executive Officer)
Michael J. Barrist
/s/ Richard J. Palmer Senior Vice President, Chief Financial March 19, 2002
- --------------------- Officer and Treasurer
Richard J. Palmer (Principal Financial and
Accounting Officer)
/s/ James D. Rosener Director March 19, 2002
- --------------------
James D. Rosener
/s/ James T. Hunter Director March 19, 2002
- -------------------
James T. Hunter
/s/ Jeffrey Schraeder Director March 19, 2002
- ---------------------
Jeffrey Schraeder
/s/ Alan D. Scheinkman Director March 19, 2002
- ----------------------
Alan D. Scheinkman
44