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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 No. 0-21639
NCO GROUP, INC.
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(Exact Name of Registrant as Specified in its Charter)
Pennsylvania 23-2858652
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(State or Other Jurisdiction of (IRS Employer Identification No.)
Incorporation or Organization)
507 Prudential Road
Horsham, Pennsylvania 19044
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(Address of principal (Zip Code)
executive offices)
Registrant's Telephone Number, Including Area Code (215) 441-3000
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Securities Registered Pursuant to Section 12(b) of the Act: None
Securities Registered Pursuant to Section 12(g) of the Act:
Common stock, no par value 25,874,000
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(Title of Class) (Number of Shares Outstanding
as of March 18, 2002)
Indicate by check mark whether the Registrant (i) 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 (ii) 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 voting stock held by non-affiliates of the
Registrant is approximately $529,637,000(1)
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the Company's Proxy Statement to be filed in connection with
its 2002 Annual Meeting of Shareholders are incorporated by reference into Part
III of this Report. Other documents incorporated by reference are listed in the
Exhibit Index.
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(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 $27.370, the last reported sale price
for the Company's common stock on March 18, 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.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business. 1
Item 2. Properties. 19
Item 3. Legal Proceedings. 20
Item 4. Submission of Matters to a Vote of Security Holders. 20
Item 4.1 Executive Officers of the Registrant who are not also Directors. 20
PART II
Item 5. Market for Registrant's Common Stock and 22
Related Shareholder Matters.
Item 6. Selected Financial Data. 23
Item 7. Management's Discussion and Analysis of Financial 24
Condition and Results of Operations.
Item 7a Quantitative and Qualitative Disclosures about Market Risk. 38
Item 8. Financial Statements and Supplementary Data. 38
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosures. 38
PART III
Item 10. Directors and Executive Officers of the Registrant. 39
Item 11. Executive Compensation. 39
Item 12. Security Ownership of Certain Beneficial Owners and Management. 39
Item 13. Certain Relationships and Related Transactions. 39
PART IV
Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 40
Signatures. 46
Index to Consolidated Financial Statements and Financial
Statement Schedule. F-1
As used in this Annual Report on Form 10-K, unless the context otherwise
requires, "we,""us," "our,""Company" or "NCO" refers to NCO Group, 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," other than historical facts,
are forward-looking statements (as such term is defined in the Securities
Exchange Act of 1934, and the regulations thereunder), which are intended to be
covered by the safe harbors created thereby. Forward-looking statements include,
without limitation, statements as to the Company's expected future results of
operations, the Company's growth strategy, the Company's internet and e-commerce
strategy, the effects of the terrorist attacks and the economy on the Company's
business, expected increases in operating efficiencies, anticipated trends in
the accounts receivable management industry, estimates of future cash flows of
purchased accounts receivable, the effects of legal or governmental proceedings,
the effects of changes in accounting pronouncements and statements as to trends
or the Company's or management's beliefs, expectations and opinions.
Forward-looking statements are subject to risks and uncertainties and may be
affected by various factors that may cause actual results to differ materially
from those in the forward-looking statements. In addition to the factors
discussed in this report, certain risks, uncertainties and other factors,
including, without limitation, the risk that the Company will not be able to
achieve expected future results of operations, the risk that the Company will
not be able to implement its growth strategy as and when planned, risks
associated with the recent expansion of NCO Portfolio Management, Inc. ("NCO
Portfolio"), risks associated with growth and future acquisitions, the risk that
the Company will not be able to realize operating efficiencies in the
integration of its acquisitions, fluctuations in quarterly operating results,
risks relating to the timing of contracts, risks related to purchased accounts
receivable, risks associated with technology, the Internet and the Company's
e-commerce strategy, risks related to past or possible future terrorist attacks,
risks related to the economy, and other risks described under Item 1. "Business
- - Investment Considerations" or in the Company's other filings made from time to
time with the Securities and Exchange Commission, 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 believe we are the largest provider of outsourced accounts receivable
management and collection services in the world, serving a wide range of clients
in North America and abroad. Our extensive industry knowledge, technological
expertise, management depth, and long-standing client relationships enable us to
deliver customized solutions that improve our clients' accounts receivable
recovery rates, thus improving their financial performance. Our services are
provided through the utilization of sophisticated technologies including
advanced workstations, leading-edge client interface systems, and call
management systems comprised of predictive dialers, automated call distribution
systems, digital switching and customized computer software. We have
approximately 9,000 employees who provide our services through the operation of
80 centers.
-1-
Industry Background
Increasingly, companies are outsourcing many non-core functions to focus on
revenue-generating activities, reduce costs and improve productivity. In
particular, many large corporations are recognizing the advantages of
outsourcing accounts receivable management and collection. This trend is being
driven by a number of industry-specific factors:
o First, the complexity of accounts receivable management and collection
functions in certain industries has increased dramatically in recent
years. For example, with the increasing popularity of health
maintenance organizations, or HMOs, and preferred provider
organizations, or PPOs, healthcare institutions now face the challenge
of billing not only large insurance companies but also individuals who
are required to pay small, one-time co-payments.
o Second, the increasing complexity of the collection process that
requires sophisticated call management and database systems for
efficient collections.
o Third, the trend in certain industries to outsource non-core
functions, due to competitive pressures, changing regulations and/or
required capital expenditures.
o Fourth, the increased focus by credit grantors on early identification
and intervention in pre-delinquent debt (i.e., debt with an average
age of less than 90 days).
We operate in a large industry with positive growth dynamics. Growth in our
industry is fundamentally driven by the continuing growth in consumer and
commercial debt. According to The Kaulkin Report, an industry publication,
overall consumer debt in 2000 exceeded $8.3 trillion. Approximately $135 billion
of delinquent consumer debt was estimated to have been placed for collection
with third-party collection agencies during 2000, nearly double the $73 billion
placed in 1990 according to The Kaulkin Report. The primary market sectors
within our industry are financial services, healthcare, and retail and
commercial. Other important market sectors include telecommunications,
utilities, and government.
The accounts receivable management and collection industry is highly
fragmented. Based on information obtained from the American Collectors
Association, there are approximately 6,500 accounts receivable management and
collection companies in the United States, the majority of which are small,
local businesses. We believe that many smaller competitors have insufficient
capital to expand and invest in technology and are unable to adequately meet the
geographic coverage and quality standards demanded by businesses seeking to
outsource their accounts receivable management function.
Strategy
Our strategy is to maintain our market dominance as we become a global
provider of accounts receivable management and collection services. Our strategy
to achieve these objectives includes the following elements:
-2-
Expand our relationships with clients - A significant amount of our growth
stems from the expansion of existing client relationships. These relationships
and the resulting opportunities continue to grow in scale, complexity and profit
potential. Over time, we believe these relationships should transition from the
operational delivery of services to the strategic development of long-term,
goal-oriented partnerships where we are sharing in the improved profitability
and operational efficiencies created for our clients.
Enhance our operating margins - Until 1999, we focused primarily on
realizing efficiencies through the integration of acquired companies. Over the
next several years, we intend to continue to pursue the following initiatives to
increase profitability:
o standardization of systems and practices;
o consolidation of facilities;
o automation of clerical functions;
o use of statistical analysis to improve performance and reduce direct
unit costs; and
o leveraging our purchasing power.
Enhance our technology capabilities - We will continue to enhance our
technology platform as well as continue to update and modernize our equipment,
including the workstations and predictive dialers used by account
representatives. In addition, we will continue to update and refine our NCO
ACCESS(TM) interface, which translates client account information into a
standard presentation format that provides our account representatives with a
common visual interface that links directly into disparate client host systems.
The Internet offers the potential for significant operational benefits.
There are a variety of cost-reducing applications available, such as improved
data exchange capabilities and the replacement of direct mail with e-mail. We
are creating client-specific web pages that will facilitate reporting of
payments and account activity, online tracking of collection results, and online
statistical modeling.
Expand internationally - We believe that business process outsourcing is
gaining widespread acceptance throughout Canada, Europe and Australasia. Our
international expansion strategy is designed to capitalize on each of these
markets in the near term, as well as continue to monitor all developing
opportunities to determine the timing of entry into new markets. We operate in
Canada and the United Kingdom through wholly owned subsidiaries and are one of
the largest providers of consumer collection services in both of these markets.
We expect to further penetrate these markets through increased sales of accounts
receivable management and collection services. Additionally, we expect to pursue
direct investments, strategic alliances and partnerships as well as further
explore acquisitions in these markets. For example, we formed strategic
alliances with Receivables Management Group Pty Ltd. in 2000 and MIRARE Credit
Information Services in 2001 to provide an entree into the Australasian and
Korean markets, respectively. These alliances enhance our service offerings as
well as increase the awareness of NCO as a global provider of accounts
receivable management and collection services.
We also provide our domestic clients with a cost-effective option of using
foreign labor markets such as India to provide effective services at a reduced
price. We currently have approximately 150 telephone representatives working in
India for our U.S clients. We expect to expand our presence in India as well as
explore new opportunities in other labor markets such as Australia.
-3-
Increase purchases of delinquent accounts receivable through NCO Portfolio
- - Since 1991, we have purchased, collected and managed portfolios of purchased
accounts receivable. These portfolios have consisted primarily of delinquent
accounts receivable. Due to the profitability of these purchases, we expanded
our presence in this marketplace in 1999 and determined that it would be
beneficial to further expand our presence, while at the same time limiting our
exposure to credit risk. Through the merger of our subsidiary NCO Portfolio with
Creditrust in February 2001, we have created one of the only publicly traded
companies purchasing delinquent accounts receivable. Under the terms of our
credit agreement, our investment in NCO Portfolio currently is limited to our
$25.0 million equity investment and a $50.0 million credit sub-facility. During
2001, NCO Portfolio invested $574,000 for a 50% ownership interest in a joint
venture, InoVision-MEDCLR NCOP Ventures, LLC ("Joint Venture") with IMNV
Holdings, LLC ("Marlin"). The Joint Venture was set up to purchase utility,
medical and other various small balance accounts receivable. The Joint Venture
is accounted for using the equity method of accounting. 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. In the future, NCO Portfolio
may develop additional growth opportunities including partnerships with banks,
commercial lenders, and other investors who will provide additional funding
sources for purchases of delinquent accounts receivable. By utilizing such risk
sharing partnerships, we will gain access to capital while limiting both our and
NCO Portfolio's exposure to credit risk.
Continue to explore strategic acquisition opportunities - The accounts
receivable management and collection industry is highly fragmented with over
6,500 participants in the United States. The vast majority of these participants
are small, local businesses. Although our focus is on internal growth, we
believe we will continue to find attractive acquisition opportunities over time.
Services
Accounts Receivable Management and Collection
We provide a wide range of accounts receivable management and collection
services to our clients by utilizing an extensive technological infrastructure.
Although most of our accounts receivable management and collection services to
date have focused on the recovery of traditional delinquent accounts, we do
engage in the recovery of current accounts receivable and early stage
delinquencies (generally, accounts which are 90 days or less past due). We
generate approximately 60% of our revenue from the recovery of delinquent
accounts receivable on a contingency fee basis. In addition, we generate revenue
from fixed fees for certain accounts receivable management and collection and
other related services. We seek to be a low cost provider and, as such, our
contingent fees typically range from 15% to 35% of the amounts recovered on
behalf of our clients. However, fees can range from 6% for the management of
accounts placed early in the accounts receivable cycle to 50% for accounts that
have been serviced extensively by the client or by third-party providers. Our
average fee across all industries was approximately 19% during 2001, as
compared to 19% during 2000.
-4-
Accounts receivable management and collection services typically include
the following activities:
Management Planning. Our approach to accounts receivable management and
collection for each client is determined by a number of factors including
account size and demographics, the client's specific requirements and
management's estimate of the collectibility of the account. We have developed a
library of standard processes for accounts receivable management and collection,
which is based upon our accumulated experience. We integrate these processes
with our client's requirements to create a customized recovery solution. In many
instances, the approach will evolve and change as the relationship with the
client develops and both parties evaluate the most effective means of recovering
accounts receivable. Our standard approach, which may be tailored to the
specialized requirements of each client, defines and controls the steps that
will be undertaken by us on behalf of the client and the manner in which we will
report data to the client. Through our systematic approach to accounts
receivable management and collection, we remove most decision making from the
recovery staff and ensure uniform, cost-effective performance.
Once the approach has been defined, we electronically or manually transfer
pertinent client data into our information system. When the client's records
have been established in our system, we begin the recovery process.
Skiptracing. In cases where the customer's telephone number or address is
unknown, we systematically search the U.S. Post Office National Change of
Address service, consumer databases, electronic telephone directories, credit
agency reports, tax assessor and voter registration records, motor vehicle
registrations, military records and other sources. The geographic expansion of
banks, credit card companies, national and regional telecommunications
companies, and managed healthcare providers, along with the mobility of
consumers, has increased the demand for locating the client's customers. Once we
have located the customer, the notification process can begin.
Account Notification. We initiate the recovery process by forwarding an
initial letter that is designed to seek payment of the amount due or open a
dialogue with customers who cannot afford to pay at the current time. This
letter also serves as an official notification to each customer of his or her
rights as required by the Federal Fair Debt Collection Practices Act. We
continue the recovery process with a series of mail and telephone notifications.
Telephone representatives remind the customer of their obligation, inform them
that their account has been placed for collection with us and begin a dialogue
to develop a payment program.
Credit Reporting. At a client's request, we will electronically report
delinquent accounts to one or more of the national credit bureaus where it will
remain for a period of up to seven years. The denial of future credit often
motivates the payment of all past due accounts.
Payment Process. After we receive payment from the customer, we either
remit the amount received minus our fee to the client or remit the entire amount
received to the client and bill the client for our services.
-5-
Activity Reports. Clients are provided with a system-generated set of
standardized or customized reports that fully describe all account activity and
current status. These reports are typically generated monthly; however, the
information included in the report and the frequency that the reports are
generated can be modified to meet the needs of the client.
Quality Tracking. We emphasize quality control throughout all phases of the
accounts receivable management and collection process. Some clients may specify
an enhanced level of supervisory review and others may request customized
quality reports. Large national credit grantors will typically have exacting
performance standards which require sophisticated capabilities such as
documented complaint tracking and specialized software to track quality metrics
to facilitate the comparison of our performance to that of our peers.
Delinquency Management
We provide pre-charge-off delinquency management services that enable
clients to manage their at-risk customers and quickly restore the relationships
to a current payment status. We mail reminder letters and make first-party calls
to the clients' customers, reminding them of the past due balance and
encouraging them to make immediate repayment using pay-by-phone direct debit
checks or, in certain cases, credit cards. Our services include responding to
inbound calls seven days a week. We apply our extensive database and predictive
modeling techniques to the customer's profile, assigning more intense efforts to
higher risk customers.
Customer Service and Support
We utilize our communications and information system infrastructure to
supplement or replace the customer service function of our clients. For example,
we are currently engaged by a large regional utility company to provide customer
service functions for a segment of the utility's customer base that is
delinquent. For other clients, we provide a wide range of specialized services
such as fraud prevention, over-limit calling, inbound calling for customer
credit application and approval processes, and general back-office support. We
can provide customer contact through inbound or outbound calling, or customized
web-enabled functions.
Billing
We complement existing service lines by offering adjunct billing services
to clients as an outsourcing option. Additionally, we can assist healthcare
clients in the billing and management of third-party insurance.
Additional Services
We selectively provide other related services that complement our
traditional accounts receivable management and collection business and leverage
our technological infrastructure. We believe that the following services will
provide additional growth opportunities for us:
Attorney Network Services. We coordinate litigation undertaken on behalf of
our clients through a nationwide network of more than 150 law firms whose
attorneys specialize in collection litigation. Our collection support staff
manages the attorney relationships and facilitates the transfer of all necessary
documentation.
-6-
NCO ePayments. We can provide clients with a virtual 24-hour payment center
that is accessible by the use of telephones, personal computers or the Internet.
Credit and Investigative Reporting Service. We develop the information
needed to profile commercial debtors and make decisions affecting extensions of
credit.
NCO Benefit Systems. We administer compliant COBRA administration services
for human resources departments.
Technology and Infrastructure
We have made a substantial investment in our information systems such as
"thin client" network computing devices, predictive dialers, automated call
distribution systems, digital switching and customized computer software,
including the NCO ACCESS interface product. As a result, we believe we are able
to address accounts receivable management and collection activities more
reliably and more efficiently than our competitors. Our systems also permit
network access to enable clients to electronically communicate with us and
monitor operational activity on a real-time basis. We provide our services
through the operation of 80 centers that are electronically linked through an
international wide area network, with the exception of our two United Kingdom
centers.
We also utilize a custom-developed NCO ACCESS interface product that
leverages industry standard visual basic and thin client server technology in
order to facilitate the critical process of "real-time" translation of account
data from our clients' host systems to our system. The NCO ACCESS interface
product set allows rapid ramp up of new client projects and the ability to work
online with client host systems while completely integrating and leveraging the
power of our base accounts receivable management software infrastructure.
Additionally, this technology allows sophisticated reporting capabilities that
are not always available on clients' host systems. The NCO ACCESS interface
product translates client account information into a standard presentation
format that provides our account representatives with a common visual interface
that links directly into disparate client host systems. Key benefits of the NCO
ACCESS interface include dramatic reduction in project ramp-up time, reduction
in training costs, and an overall increase in account representative
productivity.
Our call centers utilize predictive dialers with over 4,200 stations to
address our low balance, high-volume accounts. These systems scan our databases,
simultaneously initiate calls on all available telephone lines and determine if
a live connection is made. Upon determining that a live connection has been
made, the computer immediately switches the call to an available representative
and instantaneously displays the associated account record on the
representative's workstation. Calls that reach other signals, such as a busy
signal, telephone company intercept or no answer, are tagged for statistical
analysis and placed in priority recall queues or multiple-pass calling cycles.
The system also automates virtually all record keeping and follow-up activities
including letter and report generation. Our automated method of operations
dramatically improves the productivity of our collection staff.
Our MIS staff is comprised of approximately 240 employees led by a Chief
Information Officer. We maintain disaster recovery contingency plans and have
implemented procedures to protect against the loss of data resulting from power
outages, fire and other casualties. We have implemented a security system to
protect the integrity and confidentiality of our computer systems and data and
maintain comprehensive business interruption and critical systems insurance on
our telecommunications and computer systems.
-7-
Sales and Marketing
Our sales force is organized at the corporate level to address clients by
need, based upon their respective complexity, geography and industry. We utilize
a focused and professional direct selling effort in which sales representatives
personally cultivate relationships with prospective and existing clients. Our
sales effort consists of an approximately 60-person direct sales force, and for
the commercial sector, approximately 330 telephone sales representatives. Each
sales representative is charged with identifying leads, qualifying prospects and
closing sales. When appropriate, our operating personnel will join in the sales
effort to provide detailed information and advice regarding our operational
capabilities. We supplement our direct sales effort with print media and
attendance at trade shows.
Many of our prospective clients issue a request for proposal as part of the
contract award process. We have a staff of technical writers for the purpose of
preparing detailed, professional responses to requests for proposals.
Quality Assurance and Client Service
Our reputation for quality service is critical to acquiring and retaining
clients. Therefore, we and our clients monitor our representatives for strict
compliance with the clients' specifications and our policies. We regularly
measure the quality of our services by capturing and reviewing such information
as the amount of time spent talking with clients' customers, level of customer
complaints and operating performance. In order to provide ongoing improvement to
our telephone representatives' performance and to ensure compliance with our
policies and standards, quality assurance personnel monitor each telephone
representative on a frequent basis and provide ongoing training to the
representative based on this review. Our information systems enable us to
provide clients with reports on a real-time basis as to the status of their
accounts and clients can choose to network with our computer system to access
such information directly.
We maintain a client service department to promptly address client issues
and questions and alert senior executives of potential problems that require
their attention. In addition to addressing specific issues, a team of client
service representatives will contact clients on a regular basis in order to
establish a close rapport, determine clients' overall level of satisfaction and
identify practical methods of improving their satisfaction.
Client Relationships
Our client base currently includes over 50,000 companies in the financial
services, healthcare, retail and commercial, utilities, education,
telecommunications, and government sectors. Our 10 largest clients in 2001
accounted for approximately 28% of our revenue. In 2001, no client accounted for
more than 6% of total revenue. In 2001, we derived 34.4% of our revenue,
excluding purchased accounts receivable, from financial services (which included
the banking and insurance sectors), 25.5% from healthcare organizations, 21.3%
from retail and commercial entities, 6.4% from utilities, 5.6% from educational
organizations, 5.1% from telecommunications companies, and 1.7% from government
entities.
-8-
We enter into contracts with most of our clients that define, among other
things, fee arrangements, scope of services and termination provisions. Clients
may usually terminate such contracts on 30 or 60 days notice. In the event of
termination, however, clients typically do not withdraw accounts referred to us
prior to the date of termination, thus providing us with an ongoing stream of
revenue from such accounts, which diminish over time. Under the terms of our
contracts, clients are not required to place accounts with us but do so on a
discretionary basis.
Personnel and Training
Our success in recruiting, hiring and training a large number of employees
is critical to our ability to provide high quality accounts receivable
management and collection, customer support and teleservices programs to our
clients. We seek to hire personnel with previous experience in accounts
receivable management and collection or as telephone representatives. We
generally offer competitive compensation and benefits and offer internal
promotion opportunities.
All our collection personnel receive comprehensive training that consists
of a combination of classroom and practical experience. Prior to customer
contact, new employees receive one week of training in our operating systems,
procedures and telephone techniques and instruction in applicable federal and
state regulatory requirements. Our personnel also receive a wide variety of
continuing professional education consisting of both classroom and role-playing
sessions.
As of December 31, 2001, we had a total of approximately 8,100 full-time
employees and 900 part-time employees, of which 7,400 are telephone
representatives. None of our employees are represented by a labor union. We
believe that our relations with our employees are good.
Competition
The accounts receivable management and collection industry is highly
competitive. We compete with a large number of providers, including large
national corporations such as Outsourcing Solutions, Inc., IntelliRisk
Management Corporation, Risk Management Alternatives, Inc., and GC Services LP,
as well as many regional and local firms. Some of our competitors may offer more
diversified services and/or operate in broader geographic areas than we do. In
addition, many companies perform the accounts receivable management and
collection services offered by us in-house. Moreover, many larger clients retain
multiple accounts receivable management and collection providers, which exposes
us to continuous competition in order to remain a preferred vendor. We believe
that the primary competitive factors in obtaining and retaining clients are the
ability to provide customized solutions to a client's requirements, personalized
service, sophisticated call and information systems, and price.
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 that 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. Some states require that we be licensed as a debt collection
company. We believe that we currently hold applicable licenses from all states
where required.
-9-
The collection of accounts receivable by collection agencies in Canada is
regulated at the provincial and territorial level in substantially the same
fashion as is accomplished by federal and state laws in the United States. The
manner in which we carry on the business of collecting accounts is subject, in
all provinces and territories, to established rules of common law or civil law
and statute. Such laws establish rules and procedures governing the tracing,
contacting and dealing with debtors in relation to the collection of outstanding
accounts. These rules and procedures prohibit debt collectors from engaging in
intimidating, misleading and fraudulent behavior when attempting to recover
outstanding debts. In Canada, our collection operations are subject to licensing
requirements and periodic audits by government agencies and other regulatory
bodies. Generally, such licenses are subject to annual renewal. We believe that
we hold all necessary licenses in those provinces and territories that require
them.
If we engage in other teleservice activities in Canada, there are several
provincial and territorial consumer protection laws of more general application.
This legislation defines and prohibits unfair practices by telemarketers, such
as the use of undue pressure and the use of false, misleading or deceptive
consumer representations.
In addition, the accounts receivable management and collection industry is
regulated in the United Kingdom, including a licensing requirement. If we expand
our international operations, we may become subject to additional government
control and regulation in other countries, which may be more onerous than those
in the United States.
Several of the industries served by us are also subject to varying degrees
of government regulation. Although compliance with these regulations is
generally the responsibility of our clients, we could be subject to a variety of
enforcement or private actions for our failure or the failure of our clients to
comply with such regulations.
We devote significant and continuous efforts, through training of personnel
and monitoring of compliance, to ensure that we are in compliance with all
federal and state regulatory requirements. We believe that we are in material
compliance with all such regulatory requirements.
-10-
History of Acquisitions
The following is a summary of the acquisitions we completed since 1994
(dollars in thousands):
Revenue for the
Date Value of Fiscal Year Prior
Acquired Business Purchase Price to Acquisition
----------- ------------------------- ------------------- ------------------
Creditrust Corporation 2/20/01 Purchased A/R $ 25,000 (1) $ 36,491
Compass International Services 8/20/99 A/R Management and 104,100 105,800 (2)
Corporation Telemarketing
Co-Source Corporation 5/21/99 Commercial A/R 124,600 61,100
Management
JDR Holdings, Inc. 3/31/99 Technology-Based 103,100 51,000
Outsourcing, A/R
Management and
Telemarketing
Medaphis Services Corporation 11/30/98 Healthcare A/R 117,500 96,700
Management
MedSource, Inc. 7/1/98 Healthcare A/R 35,700 (3) 22,700
Management
FCA International Ltd. 5/5/98 A/R Management 69,900 62,800
The Response Center 2/6/98 Market Research 15,000 8,000
Collections Division of American 1/1/98 A/R Management 1,700 1,700
Financial Enterprises, Inc.
ADVANTAGE Financial 10/1/97 A/R Management 5,000 5,100
Services, Inc.
Credit Acceptance Corporation 10/1/97 A/R Management 1,800 2,300
Collections Division of CRW 2/2/97 A/R Management 12,800 25,900
Financial, Inc.
CMS A/R Services 1/31/97 A/R Management 5,100 6,800
Tele-Research Center, Inc. 1/30/97 Market Research and 2,200 1,800
Telemarketing
Goodyear & Associates, Inc. 1/22/97 A/R Management 5,400 5,500
Management Adjustment 9/5/96 A/R Management 9,000 13,500
Bureau, Inc.
Collections Division of Trans 1/3/96 A/R Management 4,800 7,000
Union Corporation
Eastern Business Services, Inc. 8/1/95 A/R Management 2,000 2,000
B. Richard Miller, Inc. 4/29/94 A/R Management 1,400 1,300
(1) We merged our subsidiary NCO Portfolio Management, Inc. with
Creditrust Corporation. We own approximately 63% of the post-merger
company.
(2) Pro Forma Revenue - Assumes the acquisitions completed by Compass
International Services Corporation in 1998 and the sale of its Print
and Mail Division were all completed on January 1, 1998.
(3) Includes $17.3 million of debt repaid by us.
-11-
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 of war may negatively impact our results of
operations, revenue, and stock price.
Terrorist attacks and threats of 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 and threats of war or actual conflicts involving the United States or
its allies, may impact our operations, including affecting our ability to
collect our clients' 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.
Our business is dependent on our ability to grow internally.
Our business is dependent on our ability to grow internally, which is
dependent upon (1) our ability to retain existing clients and expand our
existing client relationships and (2) our ability to attract new clients.
Our ability to retain existing clients and expand those relationships is
subject to a number of risks, including, the risk that:
o we fail to maintain the quality of services we provide to our clients;
o we fail to maintain the level of attention expected by our clients;
and
o we fail to successfully leverage our existing client relationships to
sell additional services.
Our ability to attract new clients is subject to a number of risks,
including:
o the market acceptance of our service offerings;
o the quality and effectiveness of our sales force; and
o the competitive factors within the accounts receivable management and
collection industry.
If our efforts to retain and expand our client relationships and to attract
new clients do not prove effective it could have a materially adverse effect on
our business, results of operations and financial condition.
-12-
If we are not able to respond to technological changes in
telecommunications and computer systems in a timely manner, we may not be able
to remain competitive.
Our success depends in large part on our sophisticated telecommunications
and computer systems. We use these systems to identify and contact large numbers
of debtors and to record the results of collection efforts. If we are not able
to respond to technological changes in telecommunications and computer systems
in a timely manner, we may not be able to remain competitive. We have made a
significant investment in technology to remain competitive and we anticipate
that it will be necessary to continue to do so in the future. Computer and
telecommunications technologies are changing rapidly and are characterized by
short product life cycles, so that we must anticipate technological
developments. If we are not successful in anticipating, managing, or adopting
technological changes on a timely basis or if we do not have the capital
resources available to invest in new technologies, our business would be
materially adversely affected.
We are highly dependent on our telecommunications and computer systems.
As noted above, our business is highly dependent on our telecommunications
and computer systems. These systems could be interrupted by natural disasters,
power losses, or similar events. Our business also is materially dependent on
services provided by various local and long distance telephone companies. If our
equipment or systems cease to work or become unavailable, or if there is any
significant interruption in telephone services, we may be prevented from
providing services. Because we generally recognize income only as accounts are
collected, any failure or interruption of services would mean that we would
continue to incur payroll and other expenses without any corresponding income.
We currently utilize three computer hardware systems and are in the process
of transitioning to one system. If we do not succeed in that transition, our
business may be materially adversely affected.
We compete with a large number of providers in the accounts receivable
management and collection industry. This competition could have a materially
adverse effect on our future financial results.
We compete with a large number of companies in providing accounts
receivable management and collection services. We compete with other sizable
corporations in the United States and abroad such as Outsourcing Solutions,
Inc., IntelliRisk Management Corporation, Risk Management Alternatives, Inc.,
and GC Services LP, as well as many regional and local firms. We may lose
business to competitors that offer more diversified services and/or operate in
broader geographic areas than we do. We may also lose business to regional or
local firms who are able to use their proximity to or contacts at local clients
as a marketing advantage. In addition, many companies perform the accounts
receivable management and collection services offered by us in-house. Many
larger clients retain multiple accounts receivable management and collection
providers, which exposes us to continuous competition in order to remain a
preferred provider. Because of this competition, in the future we may have to
reduce our collection fees to remain competitive and this competition could have
a materially adverse effect on our future financial results.
-13-
Many of our clients are concentrated in the financial services, healthcare,
and retail and commercial sectors. If any of these sectors performs poorly or if
there are any adverse trends in these sectors it could materially adversely
affect us.
For the year ended December 31, 2001, we derived approximately 34.4% of our
revenue, excluding purchased accounts receivable, from clients in the financial
services sector, approximately 25.5% of our revenue from clients in the
healthcare sector and approximately 21.3% of our revenue from clients in the
retail and commercial sectors. If any of these sectors performs poorly, clients
in these sectors may have fewer or smaller accounts to refer to us, or they may
elect to perform accounts receivable management and collection services
in-house. If there are any trends in any of these sectors to reduce or eliminate
the use of third-party accounts receivable management and collection services,
the volume of referrals to us could decrease.
Most of our contracts do not require clients to place accounts with us,
they may be terminated on 30 or 60 days notice, and they are on a contingent fee
basis. We cannot guarantee that existing clients will continue to use our
services at historical levels, if at all.
Under the terms of most of our contracts, clients are not required to give
accounts to us for collection and usually have the right to terminate our
services on 30 or 60 days notice. Accordingly, we cannot guarantee that existing
clients will continue to use our services at historical levels, if at all. In
addition, most of these contracts provide that we are entitled to be paid only
when we collect accounts. Under applicable accounting principles, therefore, we
can recognize revenues only as accounts are recovered.
We are subject to risks as a result of our investment in NCO Portfolio.
We are subject to risks as a result of our investment in NCO Portfolio,
including:
o The operations of NCO Portfolio could divert management's attention
from our daily operations, particularly that of Michael J. Barrist,
our Chairman, President and Chief Executive Officer, who is also
serving in the same capacities for NCO Portfolio, and otherwise
require the use of other of our management, operational and financial
resources.
o Our investment in NCO Portfolio currently is limited to our $25.0
million equity investment and a $50.0 million credit sub-facility. If
NCO Portfolio defaults on that credit, it would be a default under our
credit agreement with our lenders, or if the value of our investment
is impaired, it would have a material adverse effect on us.
NCO Portfolio will have additional business risks that may have an adverse
effect on our combined financial results.
NCO Portfolio is subject to additional business-related risks common to the
purchase and management of defaulted consumer accounts receivable business. The
results of NCO Portfolio will be consolidated into our results. To the extent
that those risks have an adverse effect on NCO Portfolio, they will have an
adverse effect on our combined financial results. Some of those risks are:
-14-
o Collections may not be sufficient to recover the cost of investments in
purchased accounts receivable and support operations - NCO Portfolio
purchases 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 NCO Portfolio's accounts
receivable, NCO Portfolio will not be able to purchase new accounts
receivable after it has exhausted the availability under the sub-facility,
and its future growth and profitability will be materially adversely
affected. There can be no assurance that NCO Portfolio's operating
performance will be sufficient to service debt on the sub-facility or finance
the purchase of new accounts receivable.
o Use of estimates in reporting results - NCO Portfolio's 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 these static pools and the timing of those
collections may differ materially from NCO Portfolio's estimates. If
collections on static pools are materially less than estimated, NCO Portfolio
will be required to record impairment expenses that will reduce earnings and
could materially adversely affect earnings, financial condition, and
creditworthiness.
o Possible shortage of 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 NCO Portfolio's
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 NCO
Portfolio finds attractive. If competitors raise the prices they are willing
to pay for portfolios of accounts receivable above those NCO Portfolio wishes
to pay, NCO Portfolio may be unable to buy delinquent accounts receivable at
prices consistent with its historic return targets. In addition, NCO
Portfolio may overpay for portfolios of delinquent accounts receivable, which
may have a materially adverse effect on our combined financial results.
o Government regulation of NCO Portfolio operations - 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 that
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 NCO Portfolio's activities. If credit grantors who sell
accounts receivable to NCO Portfolio fail to comply with these laws, NCO
Portfolio's ability to collect on those accounts receivable could be limited
regardless of any act or omission on its part. NCO Portfolio's failure to
comply with these laws may also limit its ability to collect on the accounts
receivable.
-15-
Our success depends on our senior management team and if we are not able to
retain them, it could 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, our Chairman, President
and Chief Executive Officer. NCO depends on the services of Mr. Barrist and the
other members of our senior management team to, among other things, continue our
growth strategies and maintain and develop our client relationships.
We may seek to make strategic acquisitions of companies. Acquisitions
involve additional risks that may adversely affect us.
We may be unable to make acquisitions because suitable companies in the
accounts receivable management and collection business are not available at
favorable prices due to increased competition for these companies.
We may have to borrow money or incur liabilities, or sell stock, to pay for
future acquisitions and we may not be able to do so at all or on terms favorable
to us. Additional borrowings and liabilities may have a materially adverse
effect on our liquidity and capital resources. If we issue stock for all or a
portion of the purchase price for future acquisitions, our shareholders'
ownership interest may be diluted. If the price of our common stock decreases or
potential sellers are not willing to accept our common stock as payment for the
sale of their businesses, we may be required to use more of our cash resources,
if available, in order to continue our acquisition program.
Completing acquisitions involves a number of risks, including diverting
management's attention from our daily operations and other additional
management, operational and financial resources. We might not be able to
successfully integrate future acquisitions into our business or operate the
acquired businesses profitably, and we may be subject to unanticipated problems
and liabilities of acquired companies.
We are dependent on our employees and a higher turnover rate would
materially adversely affect us.
We are dependent on our ability to attract, hire and retain qualified
employees. The accounts receivable management and collection industry
experiences a high employee turnover rate. Many of our employees receive modest
hourly wages and some of these employees are employed on a part-time basis. A
higher turnover rate among our employees would increase our recruiting and
training costs and could materially adversely impact the quality of services we
provide to our clients. If we were unable to recruit and retain a sufficient
number of employees, we would be forced to limit our growth or possibly curtail
our operations. Growth in our business will require us to recruit and train
qualified personnel at an accelerated rate from time to time. We cannot assure
you that we will be able to continue to hire, train and retain a sufficient
number of qualified employees. Any increase in hourly wages, costs of employee
benefits or employment taxes also could materially adversely affect us.
If we fail to comply with government regulation of the collections
industry, it could result in the suspension or termination of our ability to
conduct business.
The collections industry is regulated under various United States federal
and state, Canadian and United Kingdom laws and regulations. Many states, as
well as Canada and the United Kingdom, require that we be licensed as a debt
collection company. The Federal Trade Commission has the authority to
investigate consumer complaints against debt collection companies and to
recommend enforcement actions and seek monetary penalties. If we fail to comply
with applicable laws and regulations, it could result in the suspension or
termination of our ability to conduct collections, which would have a materially
adverse effect on us. In addition, new federal, state or foreign laws or
regulations, or changes in the ways these rules or laws are interpreted or
enforced, could limit our activities in the future or significantly increase the
cost of regulatory compliance. If we expand our international operations, we may
become subject to additional government controls and regulations in other
countries, which may be stricter or more burdensome than those in the United
States.
-16-
Several of the industries served by us are also subject to varying degrees
of government regulation. Although our clients are generally responsible for
complying with these regulations, we could be subject to a variety of
enforcement or private actions for our failure, or the failure of our clients,
to comply with these regulations.
We may experience variations from quarter to quarter in operating results
and net income that could adversely affect the price of our common stock.
Factors that could cause quarterly fluctuations include, among other
things, the following:
o the timing of our clients' accounts receivable management and
collection programs and the commencement of new contracts and
termination of existing contracts;
o the timing and amount of collections on purchased accounts receivable;
o customer contracts that require us to incur costs in periods prior to
recognizing revenue under those contracts;
o the effects of a change of business mix on profit margins;
o the timing of additional selling, general, and administrative expenses
to support new business;
o the costs and timing of completion and integration of acquisitions;
and
o that our business tends to be slower in the third and fourth quarters
of the year due to the summer and holiday seasons.
If we do not achieve the results projected in our public forecasts, it
could have a materially adverse effect on the market price of our common stock.
We have publicly announced our investor guidance concerning our expected
results of operations for the first and second quarters of 2002. Our investor
guidance contains forward-looking statements and may be affected by various
factors discussed in "Risk Factors" and elsewhere in this Annual Report on Form
10-K that may cause actual results to differ materially from the results
discussed in the investor guidance. Our investor guidance reflects numerous
assumptions, including our anticipated future performance, general business and
economic conditions and other matters, some of which are beyond our control. In
addition, unanticipated events and circumstances may affect our actual financial
results. Our investor guidance is not a guarantee of future performance and the
actual results throughout the periods covered by the investor guidance may vary
from the projected results. If we do not achieve the results projected in our
investor guidance, it could have a materially adverse effect on the market price
of our common stock.
-17-
Goodwill represented 55.3% of our total assets at December 31, 2001.
Effective January 1, 2002, we were required to adopt the Financial Accounting
Standards Board's ("FASB") SFAS No. 142, "Goodwill and Other Intangibles." If
the goodwill is deemed to be impaired under FASB 142, we may need to take a
charge to earnings to write-down the goodwill to its fair value.
Our balance sheet includes amounts designated as intangibles, which
predominantly consist of "goodwill." Goodwill represents the excess of purchase
price over the fair market value of the net assets of the acquired businesses
based on their respective fair values at the date of acquisition.
Effective January 1, 2002, we were required to adopt the Financial
Accounting Standards Board's ("FASB") SFAS No. 142, "Goodwill and Other
Intangibles." FASB 142 concluded that purchased goodwill will not be amortized
but will be reviewed for impairment when certain events indicate that the
goodwill of a reporting unit is impaired. The impairment test will use a
fair-value based approach, whereby if the implied fair value of a reporting
unit's goodwill is less than its carrying amount, goodwill would be considered
impaired.
As of December 31, 2001, our balance sheet included goodwill that
represented 55.3% of total assets and 124.3% of shareholders' equity. If the
goodwill is deemed to be impaired under FASB 142, we may need to take a charge
to earnings to write-down the goodwill to its fair value.
Investors should be aware that our earnings for periods beginning after
December 31, 2001 will not include charges for the amortization of goodwill and
should consider this when comparing such earnings with historical earnings for
periods ended on or before December 31, 2001, which included goodwill
amortization charges.
Our stock price has been and is likely to continue to be volatile, which
may make it difficult for shareholders to resell common stock when they want at
prices they find attractive.
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could be subject to wide fluctuations in response to a
variety of factors, including the following:
o announcements of fluctuations in our, or our competitors', operating
results;
o the timing and announcement of acquisitions by us or our competitors;
o changes in our publicly available guidance of future results of
operations;
o government regulatory action;
o changes in estimates or recommendations by securities analysts;
o adverse or unfavorable publicity about us or our services;
o the commencement of material litigation, or an unfavorable verdict,
against us;
o additions or departures of key personnel; and
o sales of common stock.
In addition, the stock market in recent years has experienced significant
price and volume fluctuations and a significant cumulative decline in recent
months. Such volatility and decline have affected many companies irrespective
of, or disproportionately to, the operating performance of these companies.
These broad fluctuations may materially adversely affect the market price of our
common stock.
-18-
Most of our outstanding shares are available for resale in the public
market without restriction. The sale of a large number of these shares could
adversely affect our stock price and could impair our ability to raise capital
through the sale of equity securities or make acquisitions for stock.
Sales of our common stock could adversely affect the market price of our
common stock and could impair our future ability to raise capital through the
sale of equity securities or make acquisitions for stock. As of March 18, 2002,
there were 25,874,000 shares of our common stock outstanding. Most of these
shares are available for resale in the public market without restriction, except
for shares held by our affiliates. Generally, our affiliates may either sell
their shares under a registration statement or in compliance with the volume
limitations and other requirements imposed by Rule 144 adopted by the SEC.
In addition, as of March 18, 2002, we had the authority to issue up to
approximately 4,730,000 shares of our common stock under our stock option plans.
We also had outstanding notes convertible into an aggregate of 3,797,000 shares
of our common stock at a conversion price of $32.92 per share. Additionally, we
had outstanding warrants to purchase approximately 22,000 shares of our common
stock.
"Anti-takeover" provisions may make it more difficult for a third party to
acquire control of us, even if the change in control would be beneficial to
shareholders.
We are a Pennsylvania corporation. Anti-takeover provisions in Pennsylvania
law and our charter and bylaws could make it more difficult for a third party to
acquire control of us. These provisions could adversely affect the market price
of our common stock and could reduce the amount that shareholders might receive
if we are sold. For example, our charter provides that our board of directors
may issue preferred stock without shareholder approval. In addition, our bylaws
provide for a classified board, with each board member serving a staggered
three-year term. Directors may be removed only for cause and only with the
approval of the holders of at least 65% of our common stock.
Item 2. Properties.
We currently lease 77 offices throughout North America, two offices in the
United Kingdom and one office in Puerto Rico. The leases of these facilities
expire between 2002 and 2016, and most contain renewal options.
Effective March 11, 2002, we relocated our corporate headquarters to 507
Prudential Road, Horsham, PA 19044.
We believe that our facilities are adequate for our current operations, but
additional facilities may be required to support growth. We believe that
suitable additional or alternative space will be available as needed on
commercially reasonable terms.
-19-
Item 3. Legal Proceedings.
The discussions concerning our litigation with the landlord of our Fort
Washington facilities contained in "Management's Discussion and Analysis of
Financial Condition and Results of Operations" are incorporated herein by
reference.
AssetCare, Inc., our subsidiary acquired as part of Medaphis Services
Corporation, has been identified in an administrative order issued by the State
of California as a party that is partially responsible for cleanup costs and
natural resource damages associated with a former scrap recycling site next to
Humboldt Bay in California. The subsidiary was identified as a
successor-in-interest to a former scrap recycler who conducted limited
operations at the site. The subsidiary has also been named in a civil proceeding
brought by one of the owners of the site as a party that is responsible for the
costs that will be incurred by the owner for complying with the terms of the
order. Although we are still investigating these claims and cannot predict the
outcome of the proceedings or quantify the ultimate liability of the subsidiary
in light of the early stage of the litigation, based upon: (i) the fact that the
former scrap recycler conducted scrap recycling operations for a four-year
period during the 100-year operational history of the site; and (ii) the
possibility of indemnification and contribution claims against other entities,
any costs incurred or assessed against the subsidiary are not expected to have a
materially adverse effect on our financial condition or results of operations.
The subsidiary intends to vigorously defend these matters.
We are involved in other legal proceedings from time to time in the
ordinary course of our business. Our management believes 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.
None.
Item 4.1 Executive Officers of the Registrant who are not Directors.
Name Age Position
- -------------------------------------------------- -------- ------------------------------------------------
Stephen W. Elliott..................... 40 Executive Vice President, Information
Technology and Chief Information Officer
Joshua Gindin, Esq..................... 45 Executive Vice President and General Counsel
Steven Leckerman....................... 49 Executive Vice President, U.S. Operations
Paul E. Weitzel, Jr.................... 43 Executive Vice President, Corporate
Development and International Operations
Steven L. Winokur...................... 42 Executive Vice President, Finance; Chief
Financial Officer; and Treasurer
-20-
Stephen W. Elliott - Mr. Elliott joined us in 1996 as Senior Vice
President, Technology and Chief Information Officer after having provided
consulting services to us for the year prior to his arrival. Mr. Elliott became
an Executive Vice President in February 1999. Prior to joining us, Mr. Elliott
was employed by Electronic Data Systems, a computer services company, for almost
10 years, most recently as Senior Account Manager.
Joshua Gindin, Esq. - Mr. Gindin joined us in May 1998. Prior to joining
us, Mr. Gindin was a partner in the law firm of Kessler & Gindin, which served
as our legal counsel since 1986.
Steven Leckerman - Mr. Leckerman joined us in 1995 as Senior Vice
President, Collection Operations, and became Executive Vice President, U.S.
Operations in January 2001. From 1982 to 1995, Mr. Leckerman was employed by
Allied Bond Corporation, a division of Union Corporation, where he served as
manager of dialer and special projects.
Paul E. Weitzel, Jr. - Mr. Weitzel joined us through the acquisition of
MedSource, Inc. in July 1998. Prior to joining us, Mr. Weitzel was Chairman and
Chief Executive Officer of MedSource, Inc. since 1997. Prior to joining
MedSource, Inc., Mr. Weitzel was with MedQuist, Inc., a medical transcription
company, for four years, most recently as President and Chief Executive Officer.
Mr. Weitzel is a Certified Public Accountant.
Steven L. Winokur - Mr. Winokur joined us in December 1995. Prior to that,
Mr. Winokur acted as a part-time consultant to us since 1986. From February 1992
to December 1995, Mr. Winokur was the principal of Winokur & Associates, a
certified public accounting firm. From March 1981 to February 1992, Mr. Winokur
was with Gross & Company, a certified public accounting firm, where he most
recently served as Administrative Partner. Mr. Winokur is a Certified Public
Accountant.
-21-
PART II
Item 5. Market for the Registrant's Common Stock and
Related Shareholder Matters.
The Company's common stock is listed on the Nasdaq National Market under
the symbol "NCOG." The following table sets forth, for the fiscal quarters
indicated, the high and low closing sale prices for the common stock, as
reported by Nasdaq.
High Low
---- ---
2000
First Quarter $ 31.94 $ 18.13
Second Quarter 34.38 21.06
Third Quarter 27.00 11.88
Fourth Quarter 30.94 12.69
2001
First Quarter $ 34.48 $ 25.56
Second Quarter 32.70 23.25
Third Quarter 29.73 12.02
Fourth Quarter 24.50 13.45
On March 18, 2002, the last reported sale price of our common stock as
reported on The Nasdaq National Market was $27.37 per share. On March 18, 2002,
there were approximately 70 holders of record of our common stock.
Dividend Policy
We do not anticipate paying cash dividends on our common stock in the
foreseeable future. In addition, our credit agreement prohibits us from paying
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.
-22-
Item 6. Selected Financial Data.
SELECTED FINANCIAL DATA (1)
(Amounts in thousands, except per share data)
For the years ended December 31,
--------------------------------------------------------------------------
1997 1998 1999 2000 2001
----------- ------------ ------------ ----------- ------------
Statement of Income Data:
Revenue $ 99,720 $ 209,947 $ 460,311 $ 605,884 $ 701,506
Operating costs and expenses:
Payroll and related expenses 51,493 106,787 237,709 293,292 350,634
Selling, general and administrative expenses 34,379 61,607 128,177 179,924 237,690
Depreciation and amortization expense 4,052 8,615 21,805 32,360 38,205
Nonrecurring acquisition costs - - 4,601 - -
----------- ------------ ------------ ----------- ------------
Income from operations 9,796 32,938 68,019 100,308 74,977
Other income (expense) (419) (1,794) (16,899) (22,126) (23,335)
----------- ------------ ------------ ----------- ------------
Income before provision for income taxes 9,377 31,144 51,120 78,182 51,642
Income tax expense 4,638 12,881 22,821 32,042 21,463
----------- ------------ ------------ ----------- ------------
Income from continuing operations before
minority interest 4,739 18,263 28,299 46,140 30,179
Minority interest - - - - (4,310)
----------- ------------ ------------ ----------- ------------
Income from continuing operations 4,739 18,263 28,299 46,140 25,869
Accretion of preferred stock to redemption value (1,617) (1,604) (377) - -
----------- ------------ ------------ ----------- ------------
Income from continuing operations applicable
to common shareholders 3,122 16,659 27,922 46,140 25,869
Discontinued operations, net of taxes:
(Loss) income from discontinued operations (148) 82 1,067 (975) -
Loss on disposal of discontinued operations - - - (23,179) -
----------- ------------ ------------ ----------- ------------
Net income applicable to common shareholders $ 2,974 $ 16,741 $ 28,989 $ 21,986 $ 25,869
=========== ============ ============ =========== ============
Income from continuing operations applicable
to common shareholders per share:
Basic $ 0.23 $ 0.91 $ 1.22 $ 1.80 $ 1.00
=========== ============ ============ =========== ============
Diluted $ 0.21 $ 0.84 $ 1.17 $ 1.79 $ 0.99
=========== ============ ============ =========== ============
Net income applicable to common shareholders per share:
Basic $ 0.22 $ 0.91 $ 1.27 $ 0.86 $ 1.00
=========== ============ ============ =========== ============
Diluted $ 0.20 $ 0.85 $ 1.22 $ 0.85 $ 0.99
=========== ============ ============ =========== ============
Weighted average shares outstanding:
Basic 13,736 18,324 22,873 25,587 25,773
=========== ============ ============ =========== ============
Diluted 14,808 19,758 23,799 25,842 28,897
=========== ============ ============ =========== ============
Other Financial Data:
EBITDA (2) $ 13,848 $ 41,553 $ 89,824 $ 132,668 $ 113,182
December 31,
--------------------------------------------------------------------------
1997 1998 1999 2000 2001
----------- ------------ ------------ ----------- ------------
Balance Sheet Data:
Cash and cash equivalents $ 30,194 $ 22,528 $ 50,513 $ 13,490 $ 32,161
Working capital 37,825 31,517 65,937 79,732 112,373
Net assets of discontinued operations 9,484 27,740 41,492 - -
Total assets 129,301 410,992 791,692 784,006 931,025
Long-term debt, net of current portion 14,940 143,831 323,949 303,920 357,868
Minority interest - - - - 21,213
Redeemable preferred stock 6,522 11,882 - - -
Shareholders' equity 94,336 199,465 364,888 386,426 414,095
(1) Gives effect to the restatement of our historical financial statements for:
(i) the acquisition of JDR Holdings, Inc. using the pooling-of-interests
method of accounting; and (ii) the treatment of the Market Strategy
division as discontinued operations. This data should be read in
conjunction with the consolidated financial statements, including the
accompanying notes, included elsewhere in this report on Form 10-K.
(2) Earnings before interest, taxes, depreciation, and amortization, referred
to as 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 principles.
-23-
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.
Overview
We believe we are the largest outsourced accounts receivable management and
collection company in the world, serving a wide range of clients in North
America and abroad. We generate approximately 60% of our revenue from the
recovery of delinquent accounts receivable on a contingency fee basis. Our
contingency fees typically range from 15% to 35% of the amount recovered on
behalf of our clients. However, fees can range from 6% for the management of
accounts placed early in the accounts receivable cycle to 50% for accounts that
have been serviced extensively by the client or by third-party providers. Our
average fee across all industries was approximately 19% during 2001, as compared
to 19% during 2000. In addition, we generate revenue from fixed fee services for
certain accounts receivable management and collection services. Revenue is
earned and recognized upon collection of accounts receivable for contingency fee
services and as work is performed for fixed fee services. We enter into
contracts with most of our clients that define, among other things, fee
arrangements, scope of services and termination provisions. Clients typically
have the right to terminate their contracts on 30 or 60 days notice.
Our operating costs consist principally of payroll and related costs;
selling, general, and administrative costs; and depreciation and amortization.
Payroll and related expenses consist of wages and salaries, commissions,
bonuses, and benefits for all of our employees, including management and
administrative personnel. Selling, general, and administrative expenses include
telephone, postage and mailing costs and other collection costs as well as
expenses that directly support operations including facilities costs, equipment
maintenance, sales and marketing, data processing, professional fees, and other
management costs.
We have grown rapidly, through both internal growth as well as
acquisitions. To date, all of our acquisitions, except the acquisition in 1999
of JDR Holdings, Inc., referred to as JDR, have been accounted for under the
purchase method of accounting with the results of the acquired companies
included in our operating results beginning on the date of acquisition. JDR was
accounted for under the pooling-of-interests method of accounting.
On April 14, 2000, our Board of Directors approved a plan to divest our
Market Strategy division. The Market Strategy division provided market research
and telemarketing services and was divested as part of our strategic plan to
increase long-term shareholder value by focusing on our core accounts receivable
management and collection services business. The Market Strategy division's
operations for all periods presented prior to April 14, 2000, have been
presented separately as income or loss from discontinued operations in our
consolidated statements of income. We completed the divestiture in October 2000
and recorded a loss of $23.2 million. This loss reflects the difference between
the net assets and the proceeds from the divestiture as well as the operating
losses from April 14, 2000, through the completion of the divestiture.
During 2000, the continued integration of our infrastructure facilitated
the reduction of our operating divisions from three to two. Effective October 1,
2000, the new operating divisions included U.S. Operations (formerly Accounts
Receivable Management Services and Technology-Based Outsourcing) and
International Operations. Each of these divisions maintains industry specific
functional groups. Management's discussion of operating results has been
adjusted for this change.
-24-
In February 2001, the Portfolio Management division was created after we
completed the merger of our subsidiary, NCO Portfolio Management, Inc., referred
to as NCO Portfolio, with Creditrust Corporation, referred to as Creditrust. As
a result of the merger, referred to as the Creditrust Merger, our results of
operations are more significantly impacted by purchases of and collections on
delinquent accounts receivable. NCO Portfolio recognizes revenue based on
estimates of future portfolio collections and the timing of these collections.
On a periodic basis, NCO Portfolio reviews and adjusts the amount and timing of
expected future collections, based on the performance of the portfolio to date.
We own approximately 63% of NCO Portfolio after the Creditrust Merger. The
results of NCO Portfolio are consolidated into our results, with a charge for
minority interest and elimination of significant intercompany transactions.
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.
Revenue Recognition for Purchased Accounts Receivable
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 internal rate of return, referred to as IRR, for
each 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.
Total cash flow for the year ended December 31, 2001 was unaffected by the
change in future estimates. The result of the change in future estimates was a
reduction in revenue and an increase in the amount of collections applied to the
principal of purchased accounts receivable. The differences between actual and
estimated collections on existing static pools as of the beginning of 2001
resulted in a reduction in net income and earnings per share $980,000 and $0.04
per diluted share, respectively for the year ended December 31, 2001.
Bad Debts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the non-payment of our trade accounts receivable. If our estimate
is not sufficient to cover actual losses, we would be required to take
additional charges to our earnings.
-25-
Deferred Taxes
Income taxes or tax benefits have been provided in the results of
operations based on the statutory federal and state rates of 37.5% of pre-tax
income for NCO Portfolio. 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 Creditrust Merger has 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, NCO Portfolio's 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 Creditrust Merger, offset by the deferred tax liabilities arising from book
tax differences on purchased accounts receivable, including the purchased
accounts receivable acquired in the Creditrust 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 Creditrust Merger.
Results of Operations
The following table sets forth selected historical income statement data
(amounts in thousands):
For the years ended December 31,
--------------------------------------------------------------------------
1999 (1) 2000 2001
----------------------- ---------------------- -----------------------
Amount Ratio Amount Ratio Amount Ratio
------------ -------- ----------- -------- ----------- ---------
Revenue $460,311 100.0% $605,884 100.0% $701,506 100.0%
Payroll and related expenses 237,709 51.6 293,292 48.4 350,634 50.0
Selling, general, and
administrative
expenses 128,177 27.9 179,924 29.7 237,690 33.9
Nonrecurring acquisition costs 4,601 1.0 - - - -
---------- -------- -------- ------- --------- -------
EBITDA (2) 89,824 19.5 132,668 21.9 113,182 16.1
Depreciation and amortization 21,805 4.7 32,360 5.3 38,205 5.4
Other expense 16,899 3.7 22,126 3.7 23,335 3.3
Income tax expense 22,821 5.0 32,042 5.3 21,463 3.1
Minority interest - - - - 4,310 0.6
---------- -------- -------- ------- --------- -------
Income from continuing operations $ 28,299 6.1% $ 46,140 7.6% $ 25,869 3.7%
========== ======= ======== ======= ========= =======
(1) Gives effect to the restatement of our historical financial statements for
the treatment of the Market Strategy division as discontinued operations.
We divested our Market Strategy division in October 2000.
(2) 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 principles.
-26-
Year ended December 31, 2001 Compared to Year ended December 31, 2000
Revenue. Revenue increased $95.6 million, or 15.8%, to $701.5 million for
the year ended December 31, 2001, from $605.9 million for the comparable period
in 2000. Our U.S. Operations, Portfolio Management, and International Operations
divisions represented $633.4 million, $62.9 million, and $37.8 million,
respectively, of the 2001 revenue. The U.S. Operations' revenue included $27.5
million of revenue earned on services performed for the Portfolio Management
division that was eliminated upon consolidation. The International Operations'
revenue included $5.1 million of revenue earned on services performed for the
U.S. Operations division that was eliminated upon consolidation. Our U.S.
Operations, Portfolio Management, and International Operations divisions
represented $566.8 million, $13.2 million and $31.7 million, respectively, of
the revenue for 2000. The U.S. Operations' revenue included $5.8 million of
revenue earned on services performed for the Portfolio Management division that
was eliminated upon consolidation.
U.S. Operation's revenue increased $66.6 million, or 11.8%, to $633.4
million in 2001, from $566.8 million in 2000. The increase in our U.S.
Operations division's revenue was attributable to the addition of new clients
and the growth in business from existing clients.
Portfolio Management's revenue increased $49.7 million, or 378.5%, to $62.9
million in 2001, from $13.2 million in 2000. This increase in the Portfolio
Management's revenue was partially attributable to an increase in purchases of
accounts receivable. The remainder of the increase was attributable to purchased
accounts receivable obtained from the Creditrust Merger in February 2001.
International Operation's revenue increased $6.1 million, or 19.2%, to
$37.8 million in 2001, from $31.7 million in 2000. This increase in our
International Operations division's revenue was primarily attributable to new
services provided for our U.S. Operations, the addition of new clients, and
growth in business from existing clients.
Payroll and related expenses. Payroll and related expenses increased $57.3
million to $350.6 million for the year ended December 31, 2001, from $293.3
million for the comparable period in 2000, and increased as a percentage of
revenue to 50.0% from 48.4%. The majority of the increase in the percentage of
revenue was attributable to $10.7 million of one-time charges incurred during
the second quarter of 2001 related to a comprehensive streamlining of our
expense structure designed to counteract the effects of operating in a more
difficult collection environment. These costs primarily consisted of the
elimination or acceleration of certain contractual employment obligations,
severance costs related to terminated employees, and costs related to a decision
to change the structure of our healthcare benefit program. Excluding the
one-time charges, payroll and related expenses as a percentage of revenue was
48.5% for 2001. During 2001, we experienced reduced collectibility within our
contingent revenue stream due to the difficult collection environment.
Accordingly, in order to mitigate the effects of the decreased collectibility
while maintaining performance for our clients, we increased payroll costs. The
effects of the difficult collection environment were exasperated by diminished
consumer payment patterns following the September 11, 2001 terrorist attacks.
The increase in payroll costs, excluding one-time charges, did not translate
into a significant increase in the percentage of payroll and related expenses to
revenue due to an increase in productivity that was achieved through the
expansion of predictive dialing equipment and the result of spreading the fixed
portion of the payroll cost structure over a larger revenue base. In addition, a
portion of these increases was offset by the increase in the size of our
Portfolio Management division, which has a lower payroll cost structure than the
remainder of our business.
-27-
The payroll and related expenses of our U.S Operations division increased
$56.8 million to $332.5 million in 2001, from $275.7 million in 2000, and
increased as a percentage of revenue to 52.5% from 48.6%. A portion of the
increase in the percentage of revenue was attributable to $10.0 million of
one-time charges incurred during the second quarter of 2001 related to a
comprehensive streamlining of the expense structure designed to counteract the
effects of operating in a more difficult collection environment. These costs
primarily consisted of the elimination or acceleration of certain contractual
employment obligations, severance costs related to terminated employees, and
costs related to a decision to change the structure of our healthcare benefit
programs from a large, singular benefit platform to individual plans across the
country. Excluding the one-time charges, payroll and related expenses as a
percentage of revenue was 50.9% for 2001. During 2001, we experienced reduced
collectibility within our contingent revenue stream due to the difficult
collection environment. Accordingly, in order to mitigate the effects of the
decreased collectibility while maintaining performance for our clients, we
increased payroll costs. The effects of the difficult collection environment
were exasperated by diminished consumer payment patterns following the September
11, 2001, terrorist attacks. The increase in payroll costs, excluding one-time
charges, did not translate into a significant increase in the percentage of
payroll and related expenses to revenue due to an increase in productivity that
was achieved through the expansion of predictive dialing equipment and the
result of spreading the fixed portion of the payroll cost structure over a
larger revenue base.
The increase as a percentage of revenue, excluding the one-time charges,
was primarily the result of reduced collectibility within our U.S. Operations
division's contingent revenue stream due to the difficult collection
environment. Accordingly, in order to mitigate the effects of the decreased
collectibility while maintaining performance for our clients, we increased
spending for payroll costs. The effects of the difficult collection environment
were exasperated by diminished consumer payment patterns following the September
11, 2001 terrorist attacks. A portion of these increases was offset by an
increase in productivity that was achieved through the expansion of predictive
dialing equipment and the result of spreading the fixed portion of the payroll
cost structure over a larger revenue base.
The payroll and related expenses of our Portfolio Management division
increased $1.3 million to $1.6 million in 2001, from $327,000 in 2000, and
increased as a percentage of revenue to 2.6% from 2.5%. Our Portfolio Management
division outsources all of the collection services to our U.S. Operations
division and, therefore, has a relatively small fixed payroll cost structure.
However, due to the expansion of this division and the February 2001 Creditrust
Merger, our Portfolio Management division required additional employees to
operate NCO Portfolio as a separate public company.
The payroll and related expenses of our International Operations division
increased $4.5 million to $21.7 million in 2001, from $17.2 million in 2000, and
increased as a percentage of revenue to 57.4% from 54.4%. The increase in the
percentage of revenue was attributable to the $736,000 of the one-time charges
incurred during the second quarter of 2001 related to a comprehensive
streamlining of the expense structure designed to counteract the effects of
operating in a more difficult collection environment. These costs primarily
consisted of the elimination or acceleration of certain contractual employment
obligations and severance costs related to terminated employees.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $57.8 million to $237.7 million in 2001 from
$179.9 million in 2000. Selling, general and administrative expenses increased
as a percentage of revenue to 33.9% in 2001 from 29.7% in 2000. A portion of the
overall increase as a percentage of revenue was the result of $13.0 million of
one-time charges incurred during the second and third quarters of 2001.
Approximately $11.2 million of these one-time charges were incurred in
connection with the June 2001 flood of our Fort Washington, PA, corporate
headquarters and the resultant decision to relocate the corporate headquarters
to Horsham, PA. The remaining $1.8 million of one-time charges related to a
comprehensive streamlining of our expense structure designed to counteract the
effects of operating in a more difficult collection environment. These costs
primarily related to real estate obligations for closed facilities and equipment
rental obligations. Excluding the one-time charges, selling, general, and
administrative expenses as a percentage of revenue was 32.0% for 2001. The
increase as a percentage of revenue, excluding the one-time charges, was
primarily the result of the reduced collectibility within our contingent revenue
stream due to a difficult collection environment. Accordingly, in order to
mitigate the effects of the decreased collectibility while maintaining
performance for our clients, we had to increase spending for direct costs of
collection. These costs included telephone, letter writing and postage,
third party servicing fees, credit reporting, skiptracing, and legal and
forwarding fees. The effects of the difficult collection environment were
exasperated by diminished consumer payment patterns following the September 11,
2001, terrorist attacks.
-28-
Depreciation and amortization. Depreciation and amortization increased to
$38.2 million in 2001 from $32.4 million in 2000. This increase consisted of
depreciation resulting from normal capital expenditures made in the ordinary
course of business during 2000 and 2001. These capital expenditures included
purchases associated with predictive dialers and other equipment required to
expand our infrastructure to handle future growth and our planned migration
towards a single, integrated information technology platform.
Other income (expense). Interest and investment income increased $1.1
million to $3.6 million for 2001 compared to 2000. This increase was primarily
attributable to interest income from the notes receivable received in connection
with the divestiture of the Market Strategy division in October 2000. Interest
expense increased to $27.0 million for 2001, from $25.9 million for 2000. This
increase was partially attributable to the Portfolio Management division
borrowing $36.3 million in connection with the February 2001 Creditrust Merger
and subsequent borrowings used to purchase accounts receivable portfolios. In
addition, a portion of the increase was attributable to interest from
securitized debt that was assumed as part of the Creditrust Merger. A portion of
these increases was offset by a decrease in interest rates and debt repayments
made during 2000 and 2001. In addition, a portion of these increases was offset
by the April 2001 sale of $125.0 million aggregate principal amount of 4.75%
Convertible Subordinated Notes due 2006. The net proceeds of $121.3 million were
used to repay debt under the revolving credit agreement. During 2000, we
received insurance proceeds of approximately $1.3 million for flood and
telephone outages experienced in the fourth quarter of 1999.
Income tax expense. Income tax expense for 2001 decreased to $21.5 million,
or 41.6% of income before income tax expense, from $32.0 million, or 41.0% of
income before income tax expense, for 2000. The effective tax rates were
relatively comparable despite the one-time charges incurred during the second
and third quarters of 2001. The one-time charges lowered pretax income and
increased the impact of the nondeductible goodwill related to certain
acquisitions. The effect of the one-time charges was partially offset by the
expansion of the Portfolio Management division, which has a lower effective tax
rate than the remainder of our business. In addition, the impact of the one-time
charges was also mitigated by the implementation of certain tax savings
initiatives during the fourth quarter of 2000.
Discontinued operations. The Market Strategy division had a net loss from
operations of $975,000 for the period from January 1, 2000 to April 14, 2000.
For the year ended December 31, 2000, we recorded a $23.2 million net loss on
the disposal of the Market Strategy division. The loss on disposal included the
operations for the period from April 14, 2000 to completion of the divestiture.
We completed the divestiture of the Market Strategy division on October 26,
2000.
-29-
Year ended December 31, 2000 Compared to Year ended December 31, 1999
Revenue. Revenue increased $145.6 million, or 31.6%, to $605.9 million in
2000, from $460.3 million in 1999. Our U.S. Operations, Portfolio Management,
and International Operations divisions represented $566.8 million, $13.2 million
and $31.7 million, respectively, of the revenue for 2000. The U.S. Operations'
revenue included $5.8 million of revenue earned on services performed for the
Portfolio Management division that was eliminated upon consolidation. Our U.S.
Operations, Portfolio Management, and International Operations divisions
represented $428.3 million, $2.0 million and $31.0 million, respectively, of the
revenue for 1999. The U.S. Operations' revenue included $981,000 of revenue
earned on services performed for the Portfolio Management division that was
eliminated upon consolidation.
U.S. Operation's revenue increased $138.5 million, or 32.3%, to $566.8
million in 2000, from $428.3 million in 1999. A full year of revenue from the
acquisitions of Compass International Services Corporation, referred to as
Compass, on August 20, 1999 and Co-Source Corporation, referred to as Co-Source,
on May 21, 1999 represented $42.5 million and $33.5 million of this increase,
respectively. The remainder of the increase in our U.S. Operations division's
revenue was attributable to the addition of new clients and the growth in
business from existing clients.
Portfolio Management's revenue increased $11.2 million, or 571.3%, to $13.2
million in 2000, from $2.0 million in 1999. This increase in the Portfolio
Management's revenue was attributable to an increase in purchases of accounts
receivable.
International Operation's revenue increased $665,000, or 2.1%, to $31.7
million in 2000, from $31.0 million in 1999. This increase in our International
Operations division's revenue was primarily attributable to the addition of new
clients and growth in business from existing clients. However, the growth was
limited due to the effects of a weak Canadian economy.
Payroll and related expenses. Payroll and related expenses increased $55.6
million to $293.3 million in 2000, from $237.7 million in 1999, but decreased as
a percentage of revenue to 48.4% from 51.6%.
The payroll and related expenses of our U.S Operations division increased
$55.8 million to $275.7 million in 2000, from $219.9 million in 1999, but
decreased as a percentage of revenue to 48.6% from 51.4%. This decrease as a
percentage of revenue was partially attributable to the continuing process of
rationalizing staff levels in both our U.S. Operations division's acquired and
existing businesses, as well as an increase in productivity that was achieved
through the expansion of our use of predictive dialing equipment. The remaining
portion of the percentage decrease was the result of spreading the fixed portion
of our payroll cost structure over a larger revenue base.
The payroll and related expenses of our Portfolio Management division
increased $147,000 to $327,000 in 2000, from $180,000 in 1999, but decreased as
a percentage of revenue to 2.5% from 9.2%. The Portfolio Management division
outsources all of its collection services to the U.S. Operations division and,
therefore, has a relatively small fixed payroll cost structure. The decrease in
the percentage of revenue was attributable to spreading the fixed payroll costs
over a larger revenue base.
The payroll and related expenses of our International Operations division
decreased $352,000 to $17.2 million in 2000, from $17.6 million in 1999, and
decreased as a percentage of revenue to 54.4% from 56.7%. This decrease as a
percentage of revenue was partially attributable to the reduction of redundant
information technology staff upon the completion of an internal systems
migration. In addition, a portion of the decrease was attributable to the
continuing process of rationalizing staff levels, as well as an increase in
productivity that was achieved through the expansion of our use of predictive
dialing equipment.
-30-
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $51.7 million to $179.9 million in 2000 from
$128.2 million in 1999. Selling, general and administrative expenses increased
as a percentage of revenue to 29.7% in 2000 from 27.9% in 1999. The increase as
a percentage of revenue was primarily attributable to increased information
technology costs associated with the expansion of our use of predictive dialing
equipment. However, increased productivity more than offset the increase in
selling, general, and administrative expenses through a reduction in payroll and
related expenses. The remaining increase was primarily attributable to start-up
costs incurred as a result of new client relationships, further integration of
information technology infrastructure and increased collection costs attributed
to certain adverse changes in the payment patterns of consumers which made
collections more difficult in the second half of 2000.
Depreciation and amortization. Depreciation and amortization increased to
$32.4 million in 2000 from $21.8 million in 1999. Of this increase, $3.0 million
was attributable to a full year of depreciation related to the Compass
acquisition and $1.6 million was attributable to a full year of depreciation
related to the Co-Source acquisition. The remaining $6.0 million increase
consisted of depreciation resulting from normal capital expenditures made in the
ordinary course of business during 2000. These capital expenditures included
purchases associated with our planned migration towards a single, integrated
information technology platform, and predictive dialers and other equipment
required to expand our infrastructure to handle future growth.
Non-recurring acquisition costs. In the first quarter of 1999, we incurred
$4.6 million of nonrecurring acquisition costs in connection with the
acquisition of JDR. These costs consisted primarily of investment banking fees,
legal and accounting fees, and printing costs.
Other income (expense). Interest and investment income increased $1.1
million to $2.5 million for 2000 over the comparable period in 1999. This
increase was primarily attributable to an increase in funds held on behalf of
clients and the implementation of our new cash investment strategy. Interest
expense increased to $25.9 million for the year ended December 31, 2000, from
$18.3 million for the comparable period in 1999. The increase was primarily
attributable to our financing the May 1999 Co-Source acquisition with borrowings
of $122.7 million under the revolving credit facility. Additionally, a portion
of the increase was attributable to borrowings under the revolving credit
facility of $29.5 million that were used to repay debt that was assumed as a
result of the August 1999 acquisition of Compass. The remainder of the increase
was attributable to an increase in interest rates that was partially offset by
repayments of debt made during 2000. In addition, we received insurance proceeds
of approximately $1.3 million during 2000 for flood and telephone outages
experienced in the fourth quarter of 1999.
Income tax expense. Income tax expense for 2000 increased to $32.0 million,
or 41.0% of income before income tax expense, from $22.8 million, or 44.6% of
income before income tax expense, for 1999. The decrease in the effective tax
rate was primarily attributable to the nondeductible portion of the $4.6 million
of nonrecurring acquisition costs incurred during the first quarter of 1999 in
connection with the JDR acquisition. A portion of the decrease was attributable
to higher revenues diluting the impact of the nondeductible goodwill related to
certain acquisitions. In addition, as the result of tax savings initiatives
implemented during 2000, we were able to utilize, on a one-time basis,
previously generated tax benefits of $850,000.
-31-
Accretion of preferred stock to redemption value. The accretion of
preferred stock to redemption value relates to JDR's preferred stock that was
outstanding prior to its conversion into our common stock on March 31, 1999.
This non-cash accretion represents the periodic amortization of the difference
between the original carrying amount and the mandatory redemption amount.
Discontinued operations. The Market Strategy division had a net loss from
operations of $975,000 for the period from January 1, 2000 to April 14, 2000, as
compared to net income of $1.1 million for the year ended December 31, 1999. For
the year ended December 31, 2000, we recorded a $23.2 million net loss on the
disposal of the Market Strategy division. The loss on disposal included the
operations for the period from April 14, 2000 to completion of the divestiture.
We completed the divestiture of the Market Strategy division on October 26,
2000.
Quarterly Results of Operations (Unaudited)
The following table sets forth selected historical financial data for the
calendar quarters of 2000 and 2001. This quarterly information is Unaudited, but
has been prepared on a basis consistent with our audited financial statements
presented elsewhere herein and, in management's opinion, includes all
adjustments (consisting only of normal recurring adjustments) necessary for a
fair presentation of the information for the quarters presented. The operating
results for any quarter are not necessarily indicative of results for any future
period.
2000 Quarters Ended
------------------------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31
----------- ----------- ----------- -----------
(Amounts in thousands, except per share data)
Revenue $ 143,998 $ 154,048 $ 153,858 $ 153,980
Income from operations 24,249 26,098 25,835 24,126
Income from continuing operations 11,393 11,623 11,547 11,577
Loss from discontinued operations, net of taxes 21,718 71 2,365 -
Net (loss) income (10,325) 11,552 9,182 11,577
Income from continuing operations per share:
Basic $ 0.45 $ 0.45 $ 0.45 $ 0.45
Diluted $ 0.44 $ 0.45 $ 0.45 $ 0.45
Net (loss) income per share:
Basic $ (0.40) $ 0.45 $ 0.36 $ 0.45
Diluted $ (0.40) $ 0.45 $ 0.36 $ 0.45
2001 Quarters Ended
------------------------------------------------------
Mar. 31 June 30 Sept. 30 Dec. 31
----------- ----------- ----------- -----------
(Amounts in thousands, except per share data)
Revenue $ 171,029 $ 183,275 $ 174,347 $ 172,855
Income from operations 28,040 16,013 10,241 20,683
Net income 12,277 4,449 952 8,191
Net income per share:
Basic $ 0.48 $ 0.17 $ 0.04 $ 0.32
Diluted $ 0.47 $ 0.17 $ 0.04 $ 0.31
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We have experienced and expect to continue to experience quarterly
variations in operating results as a result of many factors, including:
- the timing of our clients' accounts receivable management and
collection programs and the commencement of new contracts and
termination of existing contracts
- the timing and amount of collections on purchased accounts receivable
- customer contracts that require us to incur costs in periods prior to
recognizing revenue under those contracts
- the effect of a change of business mix on profit margins
- the timing of additional selling, general, and administrative expenses
to support new business
- the costs and timing of completion and integration of acquisitions,
and
- that our business tends to be slower in the third and fourth quarters
of the year due to the summer and holiday seasons.
Additionally, our planned operating expenditures are based on revenue
forecasts, and, if revenue is below expectations in any given quarter, operating
results would likely be materially adversely affected.
Liquidity and Capital Resources
Historically, our primary sources of cash have been bank borrowings, public
offerings, and cash flows from operations. Cash has been used for acquisitions,
repayments of bank borrowings, purchases of equipment, purchases of accounts
receivable, and working capital to support our growth.
We believe that funds generated from operations, together with existing
cash and available borrowings under our credit agreement will be sufficient to
finance our current operations, planned capital expenditure requirements, and
internal growth at least through the next twelve months. However, we could
require additional debt or equity financing if we were to make any other
significant acquisitions for cash during that period.
The cash flow from our contingency collection business and our purchased
portfolio business is dependent upon our ability to collect from consumers and
businesses. Many factors, including the economy and our ability to hire and
retain qualified collectors and managers, are essential to our ability to
generate cash flows. Fluctuations in these trends that cause a negative impact
on our business could have a material impact on our expected future cash flows.
Cash Flows from Operating Activities. Cash provided by operating activities
was $85.9 million in 2001, compared to $52.3 million in 2000. The increase in
cash provided by operations was primarily attributable to the net effect of the
one-time charges incurred during the second and third quarters of 2001, a
smaller increase in accounts receivable, and a smaller decrease in income taxes
payable. The smaller increase in accounts receivable was attributable to a
reallocation of internal resources to focus on the collection of client accounts
receivable. The smaller decrease in income taxes payable was the result of tax
payments made during the first nine months of 2000 and the implementation of
certain tax savings initiatives during the fourth quarter of 2000.
Cash provided by operating activities was $52.3 million in 2000, compared
to $47.7 million in 1999. The increase in cash provided by operations was
primarily due to the increase in income from continuing operations to $46.1
million in 2000 from $28.3 million in 1999 and the increase in non-cash charges,
depreciation and amortization, to $32.4 million in 2000 from $21.8 million in
1999. A portion of these increases was offset by the $14.8 million increase in
accounts receivable and the $8.2 million decrease in other long-term
liabilities.
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Cash Flows from Investing Activities. Cash used in investing activities was
$51.5 million in 2001, compared to $69.6 million in 2000. The decrease was due
primarily to an increase in collections applied to the principal of purchased
accounts receivable. This decrease was partially offset by an increase in the
purchase of delinquent accounts receivable.
Cash used in investing activities was $69.6 million in 2000, compared to
$170.0 million in 1999. The decrease was due primarily to cash paid in 1999 to
acquire Co-Source and Compass. We financed these acquisitions with borrowings
under our revolving credit agreement. This increase was partially offset by a
$25.3 million increase in the purchase of delinquent accounts receivable.
Capital expenditures were $27.9 million, $31.0 million, and $29.6 million
in 2001, 2000, and 1999, respectively.
Cash Flows from Financing Activities. Cash used in financing activities was
$15.5 million in 2001, compared to $19.8 million in 2000. During 2001, we
received cash from borrowings under the revolving credit facility made in
connection with the Creditrust Merger that were used to repay the acquired notes
payable, finance purchased accounts receivable, and repay other acquisition
related liabilities. Additionally, we received $121.3 million of net proceeds
from the issuance of convertible notes. These net proceeds were used for the
repayment of borrowings under the revolving credit facility. We also used cash
to repay a portion of our borrowings under the revolving credit facility and to
repay a portion of the securitized debt assumed as part of the Creditrust
Merger.
Cash used in financing activities was $19.8 million in 2000, compared to
cash provided by financing activities of $149.7 million in 1999. During 2000, we
did not have any significant sources of cash from financing activities and we
repaid $19.0 million of borrowings under our revolving credit agreement. During
1999, our primary source of cash from financing activities was borrowings under
the revolving credit facility that were used to repay the existing debt under
the JDR credit facility and to finance the acquisition of Co-Source.
Credit Facility. We have a credit agreement with Citizens Bank of
Pennsylvania, formerly Mellon Bank, N.A., ("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 balance under the revolving credit facility shall become due on May 20, 2004
(the "Maturity Date"). 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
the Maturity Date, 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 facility.
At our option, the borrowings bear interest at a rate equal to either
Citizens Bank's prime rate plus a margin of 0.25% to 0.50%, which is determined
quarterly based upon our consolidated funded debt to earnings before interest,
taxes, depreciation, and amortization, also referred to as EBITDA, ratio
(Citizens Bank's prime rate was 4.75% at December 31, 2001), or the London
InterBank Offered Rate, also referred to as LIBOR, plus a margin of 1.25% to
2.25% depending on our consolidated funded debt to EBITDA ratio (LIBOR was 1.88%
at December 31, 2001).
In connection with the Creditrust Merger, we amended our revolving credit
facility to allow us to provide NCO Portfolio with a $50 million revolving line
of credit in the form of a sub-facility under our existing revolving credit
facility. 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. At our option,
the borrowings bear interest at a rate equal to either Citizens Bank's prime
rate plus a margin of 1.25% to 1.50% that is determined quarterly based upon our
consolidated funded debt to EBITDA ratio, or LIBOR plus a margin of 2.25% to
3.25% depending on our consolidated funded debt to EBITDA ratio. As of December
31, 2001, there was $2.9 million available under the NCO Portfolio sub-facility.
-34-
During February 2002, we entered into interest rate swap agreements to
reduce the impact of changes in LIBOR on a portion of the debt borrowed from our
revolving credit facility. The interest rate swap agreements fixed LIBOR at a
rate of 2.82%. The initial notional amount of the interest rate swap agreements
is $102.0 million. The notional amount of the interest rate swap agreements is
subject to scheduled quarterly reductions. The interest rate swap agreements
expire in September 2003.
Borrowings under the revolving credit facility are collateralized by
substantially all of our assets, including the common stock of NCO Portfolio,
and certain assets of NCO Portfolio. The balance under the revolving credit
facility will become due on May 20, 2004. The credit agreement contains certain
financial covenants such as maintaining net worth and funded debt to EBITDA
requirements, and includes restrictions on, among other things, acquisitions and
distributions to shareholders. As of December 31, 2001, we were in compliance
with all required financial covenants.
Convertible Notes. In April 2001, we completed the sale of $125.0 million
aggregate principal amount of 4.75% Convertible Subordinated Notes due 2006
("Notes") in a private placement pursuant to Rule 144A and Regulation S under
the Securities Act of 1933. The Notes are convertible into our common stock at
an initial conversion price of $32.92 per share. We used the $121.3 million of
net proceeds from this offering to repay debt under our revolving credit
agreement. In accordance with the terms of the credit agreement, 50% of the net
proceeds from the Notes permanently reduced the maximum borrowings available
under the revolving credit facility.
Off-Balance Sheet Arrangements
NCO Portfolio owns a 100% retained residual interest in an investment in
securitization, Creditrust SPV 98-2, LLC, which was acquired as part of the
merger with Creditrust. This transaction qualified for gain on sale accounting
when the purchased accounts receivable were originally securitized. 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 which the collections are split between income and amortization of
the investment in securitization based on the discounted cash flows. NCO
Portfolio recorded $211,000 of 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.
NCO Portfolio has a 50% ownership interest in a joint venture,
InoVision-MEDCLR NCOP Ventures, LLC ("Joint Venture") with IMNV Holdings, LLC
("Marlin"). The 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 NCO
Portfolio'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.
-35-
Stock Repurchase Plan
In September 2001, our Board of Directors and our lender group authorized
the repurchase of up to $15.0 million of our currently issued common stock,
subject to a limit of one million shares. The share purchases may be made from
time to time, depending on market conditions, until March 31, 2002. Shares may
be purchased either in the open market or through privately negotiated
transactions. The repurchase program did not obligate us to acquire any specific
number of shares and could be discontinued at any time. As of December 31, 2001,
we had not repurchased any shares under the stock repurchase plan.
Market Risk
We are exposed to various types of market risk in the normal course of
business, including the impact of interest rate changes, foreign currency
exchange rate fluctuations, and changes in corporate tax rates. A material
change in these rates could adversely affect our operating results and cash
flows. A 25 basis-point increase in interest rates could increase our annual
interest expense by $250,000 for each $100 million of variable debt outstanding
for the entire year. We employ risk management strategies that may include the
use of derivatives such as interest rate swap agreements, interest rate ceilings
and floors, and foreign currency forwards and options to manage these exposures.
Goodwill
Our balance sheet includes amounts designated as intangibles, which
predominantly consist of "goodwill." Goodwill represents the excess of purchase
price over the fair market value of the net assets of the acquired businesses
based on their respective fair values at the date of acquisition.
Effective January 1, 2002, we are required to adopt the Financial
Accounting Standards Board's ("FASB") SFAS No. 142, "Goodwill and Other
Intangibles. "FASB 142 concluded that purchased goodwill would not be amortized
but would be reviewed for impairment when certain events indicate that the
goodwill of a reporting unit is impaired. The impairment test will use a
fair-value based approach, whereby if the implied fair value of a reporting
unit's goodwill is less than its carrying amount, goodwill would be considered
impaired.
As of December 31, 2001, our balance sheet included goodwill that
represented 55.3% of total assets and 124.3% of shareholders' equity. During the
year ended December 31, 2001, our statement of income included $15.7 million of
goodwill amortization charges that will not be incurred after the adoption of
FASB 142 on January 1, 2002. If the goodwill is deemed to be impaired under FASB
142, we may need to take a charge to earnings to write-down the goodwill to its
fair value.
-36-
Impact of Recently Issued and Proposed Accounting Pronouncements
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No.s 141 and 142, "Business Combinations" and "Goodwill and Other Intangibles."
FASB 141 requires all business combinations initiated after July 1, 2001, to be
accounted for using the purchase method. FASB 142 concluded that purchased
goodwill would not be amortized but would be reviewed for impairment when
certain events indicate that the goodwill of a reporting unit is impaired. The
impairment test will use a fair-value based approach, whereby if the implied
fair value of a reporting unit's goodwill is less than its carrying amount,
goodwill would be considered impaired. FASB 142 does not require that goodwill
be tested for impairment upon adoption unless an indicator of impairment exists
at that date. However, it would require that a benchmark assessment be performed
for all existing reporting units within six months of the date of adoption. The
new goodwill model applies not only to goodwill arising from acquisitions
completed after the effective date, but also to goodwill previously recorded. We
adopted FASB 142 in the first quarter of 2002. We are in the process of
determining the impact of these pronouncements on our financial position and
results of operations.
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 a
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 internal rate of return ("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.
-37-
Item 7a. Quantitative and Qualitative Disclosures about Market Risk.
Included in Item 7, Management's Discussion and Analysis of Financial
Condition and Results of Operations, of this Report on Form 10-K.
Item 8. Financial Statements and Supplementary Data.
The financial statements, financial statement schedules and related
documents that are filed with this Report are listed in Item 14(a) of this
Report on Form 10-K and begin on page F-1.
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosures.
Previously reported.
-38-
PART III
Item 10. Directors and Executive Officers of the Registrant.
Incorporated by reference from the Company's Proxy Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K, except information concerning certain executive
officers of the Company which is set forth in Section 4.1 of this Annual Report
on Form 10-K.
Item 11. Executive Compensation.
Incorporated by reference from the Company's Proxy Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
Incorporated by reference from the Company's Proxy Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
Item 13. Certain Relationships and Related Transactions.
Incorporated by reference from the Company's Proxy Statement relating to
the 2002 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
-39-
PART IV
Item 14. Exhibits, Financial Statements and Reports on Form 8-K.
(a). Documents filed as part of this report:
1. List of Consolidated Financial Statements. The following
consolidated financial statements and the accompanying notes of NCO Group, Inc.,
have been included in this Report on Form 10-K beginning on page F-1:
Report of Independent Auditors
Report of Independent Accountants
Consolidated Balance Sheets as of December 31, 2000 and 2001
Consolidated Statements of Income for each of the three years
in the period ended December 31, 2001
Consolidated Statements of Redeemable Preferred Stock and Shareholders'
Equity for each of the three years in the period ended December 31, 2001
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2001
Notes to Consolidated Financial Statements
Consolidating Statement of Income for the year ended December 31, 2001
(Unaudited)
2. List of Financial Statement Schedules. The following financial
statement schedule of NCO Group, Inc., has been included in this Report on Form
10-K beginning on page S-1:
II - Valuation and Qualifying Accounts
All other financial statement schedules are omitted because the
required information is not present or not present in amounts sufficient to
require submission of the schedule or because the information required is
included in the respective financial statements or notes thereto contained
herein.
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. Management contracts and compensatory plans, contracts
and arrangements are indicated by "*":
-40-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
2.1(5) Agreement and Plan of Reorganization, dated November 2, 1998, among JDR Holdings, Inc.,
NCO Group, Inc., and JDR Acquisition Inc. NCO will furnish to the Securities and
Exchange Commission a copy of any omitted schedules upon request.
2.2(5) Agreement and Plan of Merger, dated November 2, 1998, among JDR Holdings, Inc., NCO
Group, Inc. and JDR Acquisition Inc. NCO will furnish to the Securities and Exchange
Commission a copy of any omitted schedules upon request.
2.3(7) Stock Purchase Agreement dated April 17, 1999, among Co-Source Corporation, its
shareholders and option holders, H.I.G.-DCI Investments, L.P. and NCO Group,
Inc. NCO will furnish to the Securities and Exchange Commission a copy of any omitted
schedules upon request.
2.4(8) Agreement and Plan of Merger dated May 12, 1999, by and among Compass International
Services Corporation, NCO Group, Inc. and Cardinal Acquisition Corporation. NCO will
furnish to the Securities and Exchange Commission a copy of any omitted schedules upon
request.
2.5(13) Asset Purchase Agreement dated October 26, 2000, among TRC Holdings, Inc., and NCO
Group, Inc. and its wholly owned subsidiary, NCO Teleservices, Inc. NCO will furnish to
the Securities and Exchange Commission a copy of any omitted schedules upon request.
2.6(13) Asset Purchase Agreement dated September 29, 2000, among Creative Marketing Strategies,
Inc. and NCO Group, Inc. and its wholly owned subsidiary, NCO Teleservices, Inc. NCO
will furnish to the Securities and Exchange Commission a copy of any omitted schedules
upon request.
2.7(12) Second Amended and Restated Agreement and Plan of Merger dated September 20, 2000, by
and among Creditrust Corporation, and NCO Group, Inc. and its wholly owned subsidiaries,
NCO Portfolio Funding, Inc. and NCO Financial Systems, Inc. NCO will furnish to the
Securities and Exchange Commission a copy of any omitted schedules upon request.
3.1(1) The Company's amended and restated Articles of Incorporation.
3.2(2) Amendment to Amended and Restated Articles of Incorporation.
3.3(15) Amendment to Amended and Restated Articles of Incorporation.
3.4(4) The Company's amended and restated Bylaws.
4.1(1) Specimen of Common Stock Certificate.
4.2(7) Form of warrant to purchase NCO Group, Inc. common stock.
4.3(14) Purchase Agreement dated as of March 29, 2001, between NCO Group, Inc. and Deutsche Bank
Alex. Brown Inc.
4.4(14) Indenture dated as of April 4, 2001, between NCO Group, Inc. and Bankers Trust Company,
as Trustee
4.5(14) Registration Rights Agreement dated as of April 4, 2001, between NCO Group, Inc. and
Deutsche Bank Alex. Brown Inc.
4.6(14) Global Note dated April 4, 2001 of NCO Group, Inc.
*10.1(1) Employment Agreement, dated September 1, 1996, between the Company and Michael J.
Barrist.
-41-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
*10.2(9) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Michael J. Barrist.
*10.3(1) Employment Agreement, dated September 1, 1996, between the Company and Steven L.
Winokur.
*10.4(9) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Steven L. Winokur.
*10.5(13) Employment Agreement, dated June 5, 1998, between the Company and Joshua Gindin.
*10.6(13) Addendum, dated January 1, 1999, to the Employment Agreement, dated June 5, 1998,
between the Company and Joshua Gindin.
*10.7(11) Employment Agreement, dated May 2, 1998, between the Company and Paul E. Weitzel, Jr.
*10.8(11) Addendum, dated January 1, 1999, to the Employment Agreement, dated May 2, 1998, between
the Company and Paul E. Weitzel, Jr.
*10.9(1) Amended and Restated 1995 Stock Option Plan.
*10.10(4) 1996 Stock Option Plan, as amended.
*10.11(4) 1996 Non-Employee Director Stock Option Plan, as amended.
10.12(1) Distribution and Tax Indemnification Agreement
10.13(1) Irrevocable Proxy Agreement by and between Michael J. Barrist and Annette H. Barrist.
10.14(2) Nontransferable Common Stock Purchase Warrant dated February 2, 1997, issued to CRW
Financial, Inc.
10.15(2) Registration Rights Agreement dated February 2, 1997, between NCO and CRW Financial, Inc.
10.16(11) Fifth Amended and Restated Credit Agreement dated as of December 31, 1999, by and among
NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender,
and the Financial Institutions identified therein as Lenders and such other Agents as
may be appointed from time to time. NCO will furnish to the Securities and Exchange
Commission a copy of any omitted schedules upon request.
10.17(3) Executive Salary Continuation Agreement.
10.18(9) Transfer Agreement dated January 26, 1998, among NCO, CRW Financial, Inc. and Swiss Bank
Corporation.
*10.19(6) Compass International Services Corporation Employee Incentive Compensation Plan
*10.20(10) JDR 1997 Option Plan
-42-
Exhibit No. Description
- -------------------- -------------------------------------------------------
10.21(13) First Amendment, dated March 24, 2000, to the Fifth
Amended and Restated Credit Agreement dated as of
December 31, 1999, by and among NCO Group, Inc., as
Borrower, Mellon Bank, N.A., as Administrative Agent
and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be
appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any
omitted schedules upon request.
10.22(13) Second Amendment and Waiver, dated October 26, 2000, to
the Fifth Amended and Restated Credit Agreement dated
as of December 31, 1999, by and among NCO Group, Inc.,
as Borrower, Mellon Bank, N.A., as Administrative Agent
and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be
appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any
omitted schedules upon request.
10.23(13) Third Amendment, dated December 15, 2000, to the Fifth
Amended and Restated Credit Agreement dated as of
December 31, 1999, by and among NCO Group, Inc., as
Borrower, Mellon Bank, N.A., as Administrative Agent
and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be
appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any
omitted schedules upon request.
10.24(13) Fourth Amendment, dated January 23, 2001, to the Fifth
Amended and Restated Credit Agreement dated as of
December 31, 1999 by and among NCO Group, Inc., as
Borrower, Mellon Bank, N.A., as Administrative Agent
and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be
appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any
omitted schedules upon request.
10.25(13) Fifth Amendment, dated February 20, 2001, to the Fifth
Amended and Restated Credit Agreement dated as of
December 31, 1999 by and among NCO Group, Inc., as
Borrower, Mellon Bank, N.A., as Administrative Agent
and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be
appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any
omitted schedules upon request.
10.26(13) Credit Agreement, dated as of February 20, 2001, by and
between NCO Portfolio Management, Inc., as Borrower,
and NCO Group, Inc., as Lender.
10.27(13) Note Receivable, dated October 27, 2000, from Creative
Marketing Strategies, Inc. for the original principal
amount of $6.0 million, as payment of the purchase
price for the acquisition of certain assets of NCO
Teleservices, Inc.
10.28(13) Note Receivable, dated October 26, 2000, from TRC
Holdings, Inc. for the principal amount of $11.25
million, as payment of the purchase price for the
acquisition of certain assets of NCO Teleservices, Inc.
-43-
Exhibit No. Description
- -------------------- -------------------------------------------------------
*10.29 Employment Agreement, dated January 31, 2002, between
the Company and Stephen W. Elliott.
*10.30 Employment Agreement, dated November 21, 2001, between
the Company and Steven Leckerman.
10.31 Sixth Amendment, dated March 14, 2001, to the Fifth
Amended and Restated Credit Agreement dated as of
December 31, 1999 by and among NCO Group, Inc., as
Borrower, Mellon Bank, N.A., as Administrative Agent
and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be
appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any
omitted schedules upon request.
10.32 Seventh Amendment, dated September 24, 2001, to the
Fifth Amended and Restated Credit Agreement dated as of
December 31, 1999 by and among NCO Group, Inc., as
Borrower, Mellon Bank, N.A., as Administrative Agent
and a Lender, and the Financial Institutions identified
therein as Lenders and such other Agents as may be
appointed from time to time. NCO will furnish to the
Securities and Exchange Commission a copy of any
omitted schedules upon request.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
23.2 Consent of PricewaterhouseCoopers LLP.
- ---------------------
(1) Incorporated by reference to the Company's Registration Statement on Form
S-1 (Registration No. 333-11745), as amended, filed with the Securities
and Exchange Commission on September 11, 1996.
(2) Incorporated by reference to the Company's Current Report on Form 8-K/A
(File No. 0-21639) filed with the Securities and Exchange Commission on
February 18, 1997.
(3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 1998 (File No. 0-21639), filed with the
Securities and Exchange Commission on May 4, 1998.
(4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 1998 (File No. 0-21639), filed with the
Securities and Exchange Commission on August 14, 1998.
(5) Incorporated by reference to the Company's Registration Statement on Form
S-4 (Registration No. 333-73087), as amended, filed with the Securities
and Exchange Commission on February 26, 1998.
-44-
(6) Incorporated by reference to Compass International Service Corporation's
Registration Statement on Form S-1 (Registration No. 333-50021), as
amended, filed with the Securities and Exchange Commission on April 13,
1998.
(7) Incorporated by reference to the Company's Current Report on Form 8-K/A
(File No. 0-21639) filed with the Securities and Exchange Commission on
August 4, 1999.
(8) Incorporated by reference to the Company's Proxy/Registration Statement on
Form-S-4 (Registration No. 333-83229) filed with the Securities and
Exchange Commission on July 20, 1999.
(9) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1998 (File No. 0-21639), as amended,
filed with the Securities and Exchange Commission on March 31, 1999.
(10) Incorporated by reference to the Company's Current Report on Form 8-K
(File No. 0-21639) filed with the Securities and Exchange Commission on
April 15, 1999.
(11) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 1999 (File No. 0-21639), as amended,
filed with the Securities and Exchange Commission on March 27, 2000.
(12) Incorporated by reference to the Company's Current Report on Form 8-K
(File No. 0-21639) filed with the Securities and Exchange Commission on
March 5, 2001.
(13) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2000 (File No. 0-21639), as amended,
filed with the Securities and Exchange Commission on March 16, 2001.
(14) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended March 31, 2001.
(15) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2001.
(b). Reports on Form 8-K
Date of Report Item Reported
- -------------- -------------
10/1/01 Item 5 - Press release commenting on preliminary results
for the third quarter of 2001
11/14/01 Item 5 - Press release and conference call transcript
from the earnings release for the third quarter
of 2001
-45-
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities and
Exchange Act of 1934, the Registrant has duly caused this Report to be signed on
its behalf by the undersigned, thereunto duly authorized.
NCO GROUP, INC.
Date: March 19, 2002 By: /s/ Michael J. Barrist
----------------------------
Michael J. Barrist, Chairman of the
Board, President and Chief
Executive Officer
Pursuant to the requirements of the Securities Exchange Act of 1934, this
Report has been signed below by the following persons on behalf of the
registrant in the capacities and on the date indicated.
SIGNATURE TITLE(S) DATE
--------- -------- ----
/s/ Michael J. Barrist Chairman of the Board, President and Chief March 19, 2002
- ------------------------------- Executive Officer (principal executive
Michael J. Barrist officer)
/s/ Steven L. Winokur Executive Vice President, Finance; Chief March 19, 2002
- ------------------------------- Financial Officer; and Treasurer (principal
Steven L. Winokur financial and accounting officer)
/s/ William C. Dunkelberg Director March 19, 2002
- -------------------------------
William C. Dunkelberg
/s/ Charles C. Piola, Jr. Director March 19, 2002
- -------------------------------
Charles C. Piola, Jr.
/s/ Leo J. Pound Director March 19, 2002
- -------------------------------
Leo J. Pound
/s/ Eric S. Siegel Director March 19, 2002
- -------------------------------
Eric S. Siegel
/s/ Allen F. Wise Director March 19, 2002
- -------------------------------
Allen F. Wise
/s/ Stuart Wolf Director March 19, 2002
- -------------------------------
Stuart Wolf
-46-
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Financial Statements:
Report of Independent Auditors...............................................F-2
Report of Independent Accountants............................................F-3
Consolidated Balance Sheets as of December 31, 2000 and 2001 ................F-4
Consolidated Statements of Income for each of the three years
in the period ended December 31, 2001...................................F-5
Consolidated Statements of Redeemable Preferred Stock and
Shareholders' Equity for each of the three years
in the period ended December 31, 2001...................................F-6
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2001...................................F-7
Notes to Consolidated Financial Statements...................................F-8
Consolidating Statement of Income for the year ended
December 31, 2001 (Unaudited)..........................................F-29
Financial Statement Schedule:
For the years ended December 31, 1999, 2000 and 2001:
II - Valuation and Qualifying Accounts...................................S-1
F-1
Report of Independent Auditors
To the Board of Directors and
Shareholders of NCO Group, Inc.
We have audited the accompanying consolidated balance sheets of NCO Group, Inc.
as of December 31, 2000 and 2001, and the related consolidated statements of
income, redeemable preferred stock and shareholders' equity, and cash flows for
each of the two years in the period ended December 31, 2001. Our audits also
included the financial statement schedule for the years ended December 31, 2000
and 2001 listed in the Index at Item 14(a). These financial statements and
schedule are the responsibility of the Company's management. Our responsibility
is to express an opinion on these financial statements and schedule based on our
audits.
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 Group, Inc. at
December 31, 2000 and 2001, and the consolidated results of its operations and
its cash flows for each of the two years in the period ended December 31, 2001,
in conformity with accounting principles generally accepted in the United
States. Also, in our opinion, the related financial statement schedule for the
years ended December 31, 2000 and 2001, when considered in relation to the basic
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
We also audited the reclassification of the 1999 consolidated statements of
income and cash flows as a result of the discontinued operations described in
Note 3. In our opinion, the reclassification adjustments are appropriate and
have been properly applied.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 12, 2002
F-2
Report of Independent Accountants
To the Board of Directors
and Shareholders of NCO Group, Inc.:
In our opinion the consolidated statements of income, redeemable preferred stock
and shareholders' equity and of cash flows present fairly, in all material
respects, the results of the operations and cash flows of NCO Group, Inc. and
its subsidiaries for the year ended December 31, 1999 prior to their restatement
for discontinued operations (and, therefore, are not presented herein) in
conformity with accounting principles generally accepted in the United States of
America. In addition, in our opinion, Schedule II - Valuation and Qualifying
Accounts (the financial statement schedule) presents fairly, in all material
respects, the information set forth therein for the year ended December 31, 1999
prior to its restatement for discontinued operations (and, therefore, is not
presented herein) when read in conjunction with the related consolidated
financial statements. These financial statements and financial statement
schedule are the responsibility of the Company's management; our responsibility
is to express an opinion on these financial statements and financial statement
schedule (prior to their restatement) based on our audits. The consolidated
financial statements and financial statement schedule give retroactive effect to
the merger of JDR Holdings, Inc. on March 31, 1999 in a transaction accounted
for as a pooling of interests, as described in Note 4 to the consolidated
financial statements. We conducted our audits of these statements (prior to
restatement) in accordance with auditing standards generally accepted in the
United States of America, which 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, assessing
the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our
audits provide a reasonable basis for the opinion expressed above.
/s/ PricewaterhouseCoopers LLP
Philadelphia, PA
February 16, 2000
F-3
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Amounts in thousands)
December 31,
----------------------
ASSETS 2000 2001
--------- ---------
Current assets:
Cash and cash equivalents $ 13,490 $ 32,161
Restricted cash -- 1,125
Accounts receivable, trade, net of allowance for
doubtful accounts of $7,080 and $5,311, respectively 93,971 99,055
Purchased accounts receivable, current portion 10,861 47,341
Deferred income taxes 2,287 8,336
Other current assets 7,925 14,784
--------- ---------
Total current assets 128,534 202,802
Funds held on behalf of clients
Property and equipment, net 66,401 71,457
Other assets:
Intangibles, net of accumulated amortization 536,750 522,090
Purchased accounts receivable, net of current portion 23,614 92,660
Notes receivable 18,250 18,250
Other assets 10,457 23,766
--------- ---------
Total other assets 589,071 656,766
--------- ---------
Total assets $ 784,006 $ 931,025
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 642 $ 21,922
Income taxes payable 1,328 176
Accounts payable 12,360 12,164
Accrued expenses 19,168 39,382
Accrued compensation and related expenses 15,304 16,785
--------- ---------
Total current liabilities 48,802 90,429
Funds held on behalf of clients
Long-term liabilities:
Long-term debt, net of current portion 303,920 357,868
Deferred income taxes 40,549 42,855
Other long-term liabilities 4,309 4,565
Minority interest -- 21,213
Shareholders' equity:
Preferred stock, no par value, 5,000 shares authorized,
no shares issued and outstanding -- --
Common stock, no par value, 37,500 and 50,000 shares authorized,
25,627 and 25,816 shares issued and outstanding, respectively 316,372 320,993
Other comprehensive loss (1,525) (4,346)
Retained earnings 71,579 97,448
--------- ---------
Total shareholders' equity 386,426 414,095
--------- ---------
Total liabilities and shareholders' equity $ 784,006 $ 931,025
========= =========
See accompanying notes.
F-4
NCO GROUP, INC.
Consolidated Statements of Income
(Amounts in thousands, except per share data)
For the Years Ended December 31,
-----------------------------------
1999 2000 2001
--------- --------- ---------
Revenue $ 460,311 $ 605,884 $ 701,506
Operating costs and expenses:
Payroll and related expenses 237,709 293,292 350,634
Selling, general, and administrative expenses 128,177 179,924 237,690
Depreciation and amortization expense 21,805 32,360 38,205
Nonrecurring acquisition costs 4,601 -- --
--------- --------- ---------
Total operating costs and expenses 392,292 505,576 626,529
--------- --------- ---------
Income from operations 68,019 100,308 74,977
Other income (expense):
Interest and investment income 1,363 2,503 3,627
Interest expense (18,262) (25,942) (26,962)
Other income -- 1,313 --
--------- --------- ---------
Total other income (expense) (16,899) (22,126) (23,335)
--------- --------- ---------
Income before income tax expense 51,120 78,182 51,642
Income tax expense 22,821 32,042 21,463
--------- --------- ---------
Income from continuing operations before minority interest 28,299 46,140 30,179
Minority interest -- -- (4,310)
--------- --------- ---------
Income from continuing operations 28,299 46,140 25,869
Accretion of preferred stock to redemption value (377) -- --
--------- --------- ---------
Income from continuing operations applicable to
common shareholders 27,922 46,140 25,869
Discontinued operations, net of income taxes:
Income (loss) from discontinued operations 1,067 (975) --
Loss on disposal of discontinued operations -- (23,179) --
--------- --------- ---------
Net income applicable to common shareholders $ 28,989 $ 21,986 $ 25,869
========= ========= =========
Income from continuing operations applicable to
common shareholders per share:
Basic $ 1.22 $ 1.80 $ 1.00
Diluted $ 1.17 $ 1.79 $ 0.99
Net income applicable to common shareholders per share:
Basic $ 1.27 $ 0.86 $ 1.00
Diluted $ 1.22 $ 0.85 $ 0.99
Weighted average shares outstanding:
Basic 22,873 25,587 25,773
Diluted 23,799 25,842 28,897
See accompanying notes.
F-5
NCO GROUP, INC.
Consolidated Statements of Redeemable Preferred Stock
and Shareholders' Equity
For the Years Ended December 31, 1999, 2000 and 2001
(Amounts in thousands)
Shareholders' Equity
---------------------------
Redeemable Preferred Stock Preferred Stock
------------------------------- ---------------------------
Number of Number of
Shares Amount Shares Amount
--------------- -------------- -------------- -----------
Balance, January 1, 1999 785 $ 11,882 149 $ 1,853
Issuance of common stock - - - -
Issuance of warrants in conjunction with
acquisitions - - - -
Accretion of preferred to redemption value 93 349 15 28
Exchange of redeemable preferred stock
for common stock (878) (12,231) - -
Exchange of convertible preferred stock
for common stock - - (164) (1,881)
Retirement of treasury stock - - - -
Comprehensive income, net of tax:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
--------------- -------------- -------------- -----------
Balance, December 31, 1999 - - - -
Issuance of common stock - - - -
Comprehensive income, net of tax:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
--------------- -------------- -------------- -----------
Balance, December 31, 2000 - - - -
Issuance of common stock - - - -
Comprehensive income, net of tax:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
--------------- -------------- -------------- -----------
Balance, December 31, 2001 - $ - - $ -
=============== ============== ============== ===========
Shareholders' Equity
----------------------------------------------------------------------
Common Stock Treasury Stock
-------------------------------- ----------------------------------
Number of Number of
Shares Amount Shares Amount
-------------- ---------------- ---------------- ----------------
Balance, January 1, 1999 19,744 $ 183,285 356 $ (4,108)
Issuance of common stock 4,747 119,387 - -
Issuance of warrants in conjunction with
acquisitions - 1,925 - -
Accretion of preferred to redemption value - - - -
Exchange of redeemable preferred stock
for common stock 878 12,231 - -
Exchange of convertible preferred stock
for common stock 164 1,881 - -
Retirement of treasury stock - (4,108) (356) 4,108
Comprehensive income, net of tax:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
-------------- ---------------- ---------------- ----------------
Balance, December 31, 1999 25,533 314,601 - -
Issuance of common stock 94 1,771 - -
Comprehensive income, net of tax:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
-------------- ---------------- ---------------- ----------------
Balance, December 31, 2000 25,627 316,372 - -
Issuance of common stock 189 4,621 - -
Comprehensive income, net of tax:
Net income - - - -
Other comprehensive income:
Foreign currency translation adjustment - - - -
Total comprehensive income
-------------- ---------------- ---------------- ----------------
Balance, December 31, 2001 25,816 $ 320,993 - $ -
============== ================= ================ ================
[RESTUBBED TABLE]
Shareholders' Equity
-------------------------------------------------------------------------
Other
Comprehensive Retained Comprehensive
Income (Loss) Earnings Income Total
------------------- ------------- ------------------- ---------------
Balance, January 1, 1999 $ (2,169) $ 20,604 $ 199,465
Issuance of common stock - - 119,387
Issuance of warrants in conjunction with
acquisitions - - 1,925
Accretion of preferred to redemption value - (377) (349)
Exchange of redeemable preferred stock
for common stock - - 12,231
Exchange of convertible preferred stock
for common stock - - -
Retirement of treasury stock - - -
Comprehensive income, net of tax:
Net income - 29,366 $ 29,366 29,366
Other comprehensive income:
Foreign currency translation adjustment 2,863 - 2,863 2,863
-------------------
Total comprehensive income $ 32,229
------------------- ------------- =================== ---------------
Balance, December 31, 1999 694 49,593 364,888
Issuance of common stock - - 1,771
Comprehensive income, net of tax:
Net income - 21,986 $ 21,986 21,986
Other comprehensive income:
Foreign currency translation adjustment (2,219) - (2,219) (2,219)
-------------------
Total comprehensive income $ 19,767
------------------- ------------- =================== ---------------
Balance, December 31, 2000 (1,525) 71,579 386,426
Issuance of common stock - - 4,621
Comprehensive income, net of tax:
Net income - 25,869 $ 25,869 25,869
Other comprehensive income:
Foreign currency translation adjustment (2,821) - (2,821) (2,821)
-------------------
Total comprehensive income $ 23,048
------------------- ------------- =================== ---------------
Balance, December 31, 2001 $ (4,346) $ 97,448 $ 414,095
=================== ============= ===============
See accompanying notes.
F-6
NCO GROUP, INC
Consolidated Statements of Cash Flows
(Amounts in thousands)
For the Years Ended December 31,
--------------------------------------------------------
1999 2000 2001
----------------- ---------------- ----------------
Cash flows from operating activities:
Income from continuing operations $ 28,299 $ 46,140 $ 25,869
Adjustments to reconcile income from continuing operations
to net cash provided by continuing operating activities:
Depreciation 8,342 15,180 20,142
Amortization of intangibles 13,463 17,180 18,063
Net loss on property and equipment disposed of in connection
with the flood/corporate headquarters relocation - - 827
Write-off of deferred financing costs 353 - -
Provision for doubtful accounts 2,553 5,906 4,250
Impairment of purchased accounts receivable - - 2,738
Minority interest - - 4,310
Compensation expense on stock options granted 34 - -
Changes in operating assets and liabilities, net of acquisitions:
Restricted cash - - 2,555
Accounts receivable, trade (14,906) (29,696) (10,341)
Deferred income taxes 16,980 15,480 10,635
Other assets (1,496) (5,293) (7,935)
Accounts payable and accrued expenses (6,067) 977 14,733
Income taxes payable (1,644) (9,568) (252)
Other long-term liabilities 1,711 (6,511) 256
----------------- ---------------- ----------------
Net cash provided by continuing operating activities 47,622 49,795 85,850
Net cash provided by discontinued operating activities 120 2,487 -
----------------- ---------------- ----------------
Net cash provided by operating activities 47,742 52,282 85,850
Cash flows from investing activities:
Purchases of accounts receivable (7,660) (32,961) (50,621)
Collections applied to principal of purchased accounts receivable 2,538 5,084 35,284
Purchases of property and equipment (29,631) (31,042) (27,940)
Insurance proceeds from involuntary conversion of
property and equipment - - 560
Investment in consolidated subsidiary by minority interest - - 2,320
Net cash paid for pre-acquisition liabilities and
acquisition related costs (135,237) (10,665) (11,077)
----------------- ---------------- ----------------
Net cash used in investing activities (169,990) (69,584) (51,474)
Cash flows from financing activities:
Repayment of notes payable (1,574) (1,934) (21,869)
Repayment of acquired notes payable (42,000) - (20,084)
Borrowings under revolving credit agreement 190,715 - 65,230
Repayment of borrowings under revolving credit agreement (4,000) (19,000) (162,350)
Payment of fees to acquire debt (3,565) - (5,138)
Proceeds from issuance of convertible debt - - 125,000
Issuance of common stock, net 10,079 1,175 3,721
----------------- ---------------- ----------------
Net cash provided by (used in) financing activities 149,655 (19,759) (15,490)
Effect of exchange rate on cash 578 38 (215)
----------------- ---------------- ----------------
Net increase (decrease) in cash and cash equivalents 27,985 (37,023) 18,671
Cash and cash equivalents at beginning of the period 22,528 50,513 13,490
----------------- ---------------- ----------------
Cash and cash equivalents at end of the period $ 50,513 $ 13,490 $ 32,161
================= ================ ================
See accompanying notes.
F-7
NCO GROUP, INC.
Notes to Consolidated Financial Statements
1. Nature of operations:
NCO Group, Inc. (the "Company" or "NCO") is a leading provider of accounts
receivable management and collection services. The Company also owns
approximately 63% of NCO Portfolio Management, Inc., a separate public
company that purchases and manages accounts receivable. The Company's
client base includes companies in the financial services, healthcare,
retail and commercial, utilities, education, telecommunications, and
government sectors. These clients are primarily located throughout the
United States of America, Canada, the United Kingdom, and Puerto Rico.
2. 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 entities that the Company does not control are InoVision-MEDCLR NCOP
Ventures, LLC and Creditrust SPV98-2, LLC (see note 21).
Contingency Fees and Contractual Services:
The Company generates revenue from contingent fees and contractual
services. Contingent fee revenue is recognized upon collection of funds on
behalf of clients. Contractual services revenue is recognized as services
are performed and accepted by the client.
Purchased Accounts Receivable:
The Company 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 the Company expects 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 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
the Company'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.
F-8
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Accounting policies (continued):
Purchased Accounts Receivable (continued):
To the extent the estimated future cash flow increases or decreases from
the expected level of collections, the Company 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.
Credit Policy:
The Company has two types of arrangements under which it collects its
contingent fee revenue. For certain clients, the Company remits funds
collected on behalf of the client net of the related contingent fees while,
for other clients, the Company remits gross funds collected on behalf of
clients and bills the client separately for its contingent fees. Management
carefully monitors its client relationships in order to minimize its credit
risk and generally does not require collateral. In many cases, in the event
of collection delays from clients, management may, at its discretion,
change from the gross remittance method to the net remittance method.
Cash and Cash Equivalents:
The Company considers all highly liquid investments purchased with an
initial maturity of three months or less to be cash equivalents. These
financial instruments potentially subject the Company to concentrations of
credit risk. The Company minimizes this risk by dealing with major
financial institutions that have high credit ratings.
Investments in Debt and Equity Securities:
The Company accounts for investments, such as the investment in
securitization, Creditrust SPV 98-2, LLC (see note 21), 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. The Company
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 earnings but is
recorded as other comprehensive income in the consolidated statement of
shareholders' 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.
The investment in securitization is included in other assets and represents
the residual interest in a securitized pool of purchased accounts
receivable acquired in connection with the merger of Creditrust Corporation
("Creditrust") into NCO Portfolio Management, Inc. ("NCO Portfolio"). The
investment in securitization accrues interest at an effective IRR, which is
estimated based on the expected monthly collections over the estimated
economic life of the investment (approximately five years). Cost
approximated the fair value of this investment as of December 31, 2001.
F-9
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Accounting policies (continued):
Property and Equipment:
Property and equipment is stated at cost, less accumulated depreciation.
Depreciation is provided over the estimated useful life of each class of
assets using the straight-line method. Expenditures for maintenance and
repairs are charged to expense as incurred. Renewals and betterments are
capitalized. When property is sold or retired, the cost and related
accumulated depreciation are removed from the balance sheet and any gain or
loss on the transaction is included in the statement of income.
Effective January 1, 1999, the Company adopted Statement of Position 98-1,
"Accounting for the Costs of Computer Software Developed or Obtained for
Internal Use" ("SOP 98-1"). SOP 98-1 identified the characteristics of
internal use software and established guidelines for identifying which
costs must be expensed as incurred and which costs must be capitalized.
The Company reviews long-lived assets and certain identifiable intangibles
for impairment, based on the estimated undiscounted future cash flows,
whenever events or changes in circumstances indicate that the carrying
amount of the asset may not be recoverable.
Intangibles:
Intangibles consist primarily of goodwill and deferred financing costs.
Goodwill represents the excess of purchase price over the fair market value
of the net assets of the acquired businesses based on their respective fair
values at the date of acquisition. Goodwill is amortized on a straight-line
basis over 15 to 40 years. The Company reviews the recoverability of its
goodwill whenever events or circumstances indicate that the carrying amount
of the goodwill may not be recoverable. If such circumstances arise, the
Company would use an estimate of the undiscounted value of expected future
operating cash flows to determine whether the goodwill is recoverable.
Deferred financing costs relate to debt issuance costs incurred, which are
capitalized and amortized over the term of the debt.
Accumulated amortization at December 31, 2000 and 2001 totaled $39.8
million and $57.2 million, respectively.
Income Taxes:
The Company accounts for income taxes using an asset and liability
approach. The asset and liability approach requires the recognition of
deferred tax assets and liabilities for the expected future tax
consequences of temporary differences between the financial reporting basis
and the tax basis of assets and liabilities.
Income taxes were computed after giving effect to the nondeductible portion
of goodwill expenses attributable to certain acquisitions and, in 1999,
nonrecurring acquisition costs attributable to the acquisition of JDR
Holdings, Inc. ("JDR") on March 31, 1999.
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 ratably over the life of the
static pool. Deferred tax liabilities arise from income tax 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.
F-10
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
2. Accounting policies (continued):
Foreign Currency Translation:
The Company has foreign subsidiaries whose local currency has been
determined to be the functional currency. For these foreign subsidiaries,
the assets and liabilities have been translated using the current exchange
rates, and the income and expenses have been translated using historical
exchange rates. The adjustments resulting from translation have been
recorded separately in shareholders' equity as other comprehensive income
and are not included in determining consolidated net income.
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. Actual
results could differ from those estimates.
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.
Reclassifications:
Certain amounts for the year ended December 31, 1999 have been reclassified
for comparative purposes.
3. Discontinued operations:
On April 14, 2000 (the "Measurement Date"), the Company's Board of
Directors approved a plan to divest the Company's Market Strategy division
as part of its strategic plan to increase long-term shareholder value and
focus on its core business of accounts receivable management services. The
Market Strategy division provided market research and telemarketing
services. The market research assets were acquired through the January 1997
acquisition of the Tele-Research Center, Inc. and the February 1998
acquisition of The Response Center. The telemarketing assets were acquired
as non-core components of the March 1999 acquisition of JDR, and the August
1999 acquisition of Compass International Services Corporation. On October
26, 2000, TRC Holdings, Inc. and Creative Marketing Strategies, Inc., both
management-led groups, acquired the assets of the market research and
telemarketing businesses, respectively.
In consideration for the purchased assets of the market research business,
the Company received a $12.25 million note. The note earns interest at a
fixed rate of 9% per year and the interest payments are due monthly. The
entire principal balance is due on December 31, 2002. In the event that the
principal and the remaining interest is not paid in full on December 31,
2002, the principal of the note will be increased by a maximum of $2.0
million. The remaining principal and interest will be due in equal monthly
payments through December 31, 2005.
In consideration for the purchased assets of the telemarketing business,
the Company received a $6.0 million note. The note earns interest at a
fixed rate of 9% per year and the interest payments are due monthly.
Commencing on December 1, 2003, in addition to the interest payments,
principal payments of $25,000 will be due monthly until November 1, 2005.
The remaining principal and interest will become due in full on November 1,
2005.
F-11
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
3. Discontinued operations (continued):
In accordance with the Accounting Principles Board Opinion No. 30,
"Reporting the Results of Operations - Reporting the Effects of Disposal of
a Business, and Extraordinary, Unusual and Infrequently Occurring Events
and Transactions," the consolidated financial statements and the
accompanying notes of the Company have been presented to reflect the Market
Strategy division as discontinued operations for all periods presented.
The following summary of the Market Strategy division's operations prior to
the Measurement Date for the years ended December 31, 1999 and 2000 have
been presented net in the Company's consolidated statements of operations
(amounts in thousands):
1999 2000
----------- ------------
Revenue $32,043 $7,802
=========== ============
Income (loss) from discontinued operations
before income tax expense (benefit) $1,940 $(1,498)
Income tax expense (benefit) 873 (523)
----------- ------------
Income (loss) from discontinued operations,
net of income taxes $1,067 $ (975)
=========== ============
During the year ended December 31, 2000, the Company recorded a $23.2
million loss (net of a tax benefit of $4.3 million), or $0.90 loss per
share on a diluted basis, on the disposal of the Market Strategy division.
This loss reflects the difference between the net assets of the Market
Strategy division and the proceeds from the divestiture as well as the
operating losses from the Measurement Date through the completion of the
divestiture in October 2000. Included in this loss was a write-off of $29.9
million of goodwill. Also included in this loss was an extraordinary item
of $6.3 million (net of taxes of $42,000), or $0.24 per share on a diluted
basis, from the loss on the disposal of the portion of the telemarketing
business that was acquired with JDR. The purchase of JDR was accounted for
as a pooling-of-interests transaction, and the Company had no plans or
intentions to dispose of JDR's telemarketing business at the time of the
acquisition.
For the year ended December 31, 1999 and for the period in 2000 before the
Measurement Date, the income (loss) from discontinued operations, net of
taxes, included an allocation of interest expense of $1.1 million and
$441,000, respectively. For the period in 2000 from the Measurement Date
through the divestiture date, the loss on the disposal of discontinued
operations included an allocation of interest expense of $706,000. The
interest expense was allocated to the Market Strategy division based on the
expected proceeds.
4. Acquisitions:
Pooling-of-Interests Transaction:
On March 31, 1999, the Company acquired all of the outstanding shares of
JDR for approximately 3.4 million shares of NCO common stock. The
transaction was accounted for as a pooling-of-interests and a tax-free
reorganization. Accordingly, the historical financial information of the
Company has been restated to include the historical information of JDR.
During the year ended December 31, 1999, the Company incurred $4.6 million
of nonrecurring acquisition costs in connection with the JDR acquisition.
These costs consisted primarily of investment banking fees, legal and
accounting fees, and printing costs.
F-12
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
4. Acquisitions (continued):
Purchase Transactions:
The following acquisitions have been accounted for under the purchase
method of accounting. As part of the purchase accounting, the Company
recorded accruals for acquisition related expenses. These accruals included
professional fees related to the acquisition, termination costs related to
certain redundant personnel immediately eliminated at the time of the
acquisitions, and certain future rental obligations attributable to
facilities which were closed at the time of the acquisitions.
On May 21, 1999, the Company acquired all of the outstanding stock of
Co-Source Corporation ("Co-Source") for approximately $122.7 million in
cash plus a warrant to purchase 250,000 shares of NCO common stock. The
purchase price was valued at approximately $124.6 million. The Company
recognized goodwill of $128.6 million and is amortizing the goodwill on a
straight-line basis over 40 years.
On August 20, 1999, the Company acquired all of the outstanding shares of
Compass International Services Corporation ("Compass") for approximately
3.3 million shares of NCO common stock. In connection with the acquisition,
the Company assumed outstanding stock options to purchase approximately
200,000 shares of NCO common stock. The purchase price was valued at
approximately $104.1 million. The Company recognized goodwill of $139.1
million and is amortizing the goodwill on a straight-line basis over 40
years.
On February 20, 2001, the Company merged NCO Portfolio Management, Inc.
("NCO Portfolio"), its wholly owned subsidiary, with Creditrust Corporation
("Creditrust") to form a new public entity focused on the purchase of
accounts receivable (the "Creditrust Merger"). After the Creditrust Merger,
the Company owned approximately 63% of the outstanding stock of NCO
Portfolio, subject to certain adjustments. The Company's contribution to
the NCO Portfolio merger consisted of $25.0 million of purchased accounts
receivable. As part of the Creditrust Merger, NCO Portfolio signed a
ten-year service agreement that appointed the Company as the sole provider
of collection services to NCO Portfolio. The Company has agreed to offer
all of its future U.S. accounts receivable purchase opportunities to NCO
Portfolio. In connection with the Creditrust Merger, the Company amended
its revolving credit facility to allow the Company to provide NCO Portfolio
with a $50 million revolving line of credit in the form of a sub-facility
under its existing credit facility. Initially, NCO Portfolio borrowed $36.3
million to fund the Creditrust Merger.
The following summarizes the unaudited pro forma results of operations for
the years ended December 31, 2000 and 2001, assuming the Creditrust Merger
had 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 future results of
operations of the consolidated entities (amounts in thousands, except per
share data):
2000 2001
------------ ---------------
(Unaudited) (Unaudited)
Revenue $ 648,033 $ 705,086
Income from continuing operations applicable
to common shareholders $ 21,819 $ 19,542
Income from continuing operations applicable
to common shareholders per share:
Basic $ 0.21 $ 0.76
Diluted $ 0.20 $ 0.75
F-13
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
5. Purchased accounts receivable:
The Company's Portfolio Management and International Operations divisions
purchase defaulted consumer accounts receivable at a discount from the
actual principal balance. As of December 31, 2001, the carrying value of
the Portfolio Management division's and International Operations division's
purchased accounts receivable was $136.3 million and $3.8 million,
respectively. The following summarizes the change in purchased accounts
receivable for the years ended December 31, 1999, 2000, and 2001:
1999 2000 2001
------------- ------------- -------------
Balance, at beginning of period $ 1,597 $ 6,719 $ 34,475
Purchased accounts receivable acquired from
Creditrust - - 93,518
Purchases of accounts receivable 7,660 32,961 50,621
Collections on purchased accounts receivable (5,967) (20,495) (99,868)
Revenue recognized 3,419 15,411 64,065
Impairment of purchased accounts receivable - - (2,738)
Foreign currency translation adjustment 10 (121) (72)
------------- ------------- -------------
- - -
Balance, at end of period $ 6,719 $ 34,475 $ 140,001
============= ============= =============
During the year ended December 31, 2001, an impairment of $2.7 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 the carrying values have been fully recovered. The
combined carrying values on these static pools, after impairment,
aggregated $5.8 million as of December 31, 2001, representing their net
realizable value. No impairments were recorded during the years ended
December 31, 1999 and 2000.
6. Funds held on behalf of clients:
In the course of the Company's regular business activities as a provider of
accounts receivable management services, the Company receives clients'
funds arising from the collection of accounts placed with the Company.
These funds are placed in segregated cash accounts and are generally
remitted to clients within 30 days. Funds held on behalf of clients of
$54.1 million and $56.8 million at December 31, 2000 and 2001,
respectively, have been shown net of their offsetting liability for
financial statement presentation.
7. Property and equipment:
Property and equipment, at cost, consisted of the following at December 31,
2000 and 2001 (amounts in thousands):
Estimated
Useful Life 2000 2001
-------------- ---------------- ----------------
Computer equipment 5 years $ 60,049 $ 75,086
Computer software developed
for internal use 5 years 18,040 24,734
Furniture and fixtures 5 to 10 years 10,638 13,032
Leasehold improvements 5 to 15 years 7,226 6,027
---------------- ----------------
95,953 118,879
Less accumulated depreciation 29,552 47,422
---------------- ----------------
$ 66,401 $ 71,457
================ ================
Depreciation charged to operations amounted to $8.3 million, $15.2 million,
and $20.1 million for the years ended December 31, 1999, 2000, and 2001,
respectively.
F-14
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
8. Long-term debt:
-
Long-term debt consisted of the following at December 31, 2000 and 2001
(amounts in thousands):
2000 2001
-------------- --------------
Revolving credit loan $ 303,750 $ 206,630
Convertible notes - 125,000
Securitized debt - 45,379
Subordinated seller notes payable;
interest rate of 7.16%, due May 2001 130 -
Capital leases 682 2,781
Less current portion (642) (21,922)
-------------- --------------
$ 303,920 $ 357,868
============== ==============
The following summarizes the Company's required debt payments, excluding
the convertible notes (amounts in thousands):
2002 $ 21,922
2003 28,476
2004 189,562
2005 14,830
Revolving Credit Facility:
The Company has a credit agreement with Citizens Bank of Pennsylvania,
formerly Mellon Bank, N.A., ("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 balance under the revolving credit facility shall
become due on May 20, 2004 (the "Maturity Date"). 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 the Maturity Date, and 50
percent of the net proceeds received from any offering of debt or equity.
At the option of NCO, the borrowings bear interest at a rate equal to
either Citizens Bank's prime rate plus a margin of 0.25% to 0.50%, which is
determined quarterly based upon the Company's consolidated funded debt to
earnings 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 of 1.25% to 2.25%
depending on the Company's consolidated funded debt to EBITDA ratio (LIBOR
was 1.88% at December 31, 2001). The Company is charged a fee on the unused
portion of the credit facility ranging from 0.13% to 0.38% depending on the
Company's consolidated funded debt to EBITDA ratio.
In connection with the merger of Creditrust into NCO Portfolio, the Company
amended its revolving credit facility to allow the Company to provide NCO
Portfolio with a $50 million revolving line of credit in the form of a
sub-facility under its existing credit facility. 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. At the option of NCO, the
borrowings bear interest at a rate equal to either Citizens Bank's prime
rate plus a margin of 1.25% to 1.50% that is determined quarterly based
upon the Company's consolidated funded debt to EBITDA ratio, or LIBOR plus
a margin of 2.25% to 3.25% depending on the Company's consolidated funded
debt to EBITDA ratio.
F-15
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
8. Long-term debt (continued):
Revolving Credit Facility (continued):
Borrowings under the revolving credit facility are collateralized by
substantially all the assets of the Company, including the common stock of
NCO Portfolio, and certain assets of NCO Portfolio. The credit agreement
contains certain financial covenants such as maintaining net worth and
funded debt to EBITDA requirements, and includes restrictions on, among
other things, acquisitions and distributions to shareholders. As of
December 31, 2001, the Company was in compliance with all required
financial covenants.
The following summarizes the availability under the revolving credit
facility as of December 31, 2001 (amounts in thousands):
NCO Group NCO Portfolio Combined
-------------- ------------------ ----------------
Maximum capacity $ 217,525 $ 50,000 $ 267,525
Less:
Outstanding borrowings 159,500 47,130 206,630
Unused letters of credit 2,554 - 2,554
-------------- ------------------ ----------------
Available $ 55,471 $ 2,870 $ 58,341
============== ================== ================
Convertible Notes:
In April 2001, the Company completed the sale of $125.0 million aggregate
principal amount of 4.75% Convertible Subordinated Notes due April 2006
("Notes") in a private placement pursuant to Rule 144A and Regulation S
under the Securities Act of 1933. The Notes are convertible into NCO common
stock at an initial conversion price of $32.92 per share. The Company will
be required to repay the $125.0 million of aggregate principal if the Notes
are not converted prior to their maturity in April 2006. The Company used
the $121.3 million of net proceeds from this offering to repay debt under
its revolving credit agreement. In accordance with the terms of the credit
agreement, 50% of the net proceeds from the Notes permanently reduced the
maximum borrowings available under the revolving credit facility.
Securitized Debt:
Creditrust established three securitized notes payable to fund the purchase
of accounts receivable prior to the Creditrust Merger. Each of the notes
payable is non-recourse to the Company and NCO Portfolio, secured by a
static pool of purchased accounts receivable, and is bound by an indenture
and servicing agreement. Pursuant to the acquisition, the trustee appointed
NCO as the successor servicer for each static pool of purchased accounts
receivable. When the notes payable were established, a separate special
purpose finance subsidiary was created to house the assets and debt. These
notes 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 period from February 21, 2001 to December 31, 2001,
respectively. As of December 31, 2001, the amount outstanding on the
facility was $17.8 million. The note issuer, Radian Group, Inc., formerly
Asset Guaranty Insurance Company, has been guaranteed against loss by NCO
Portfolio for up to $4.5 million, which will be reduced if and when
reserves and residual cash flows from another securitization, Creditrust
SPV 98-2, LLC, are posted as additional collateral for this facility (see
note 21).
F-16
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
8. Long-term debt (continued):
Securitized Debt (continued):
The second securitized note ("SPV99-1 Financing") was established in August
1999 through Creditrust SPV99-1, LLC, a special purpose finance subsidiary.
SPV99-1 Financing 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, respectively.
As of December 31, 2001, the amount outstanding on the facility was $3.8
million.
The third securitized note ("SPV99-2 Financing") was established in August
1999 through Creditrust SPV99-2, LLC, a special purpose finance subsidiary.
SPV99-2 Financing carries interest at 15.00% 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,
respectively. As of December 31, 2001, the amount outstanding on the
facility was $23.8 million.
Other:
At December 31, 2001, the Company had unused letters of credit of $2.6
million.
The Company leases certain equipment under agreements that are classified
as capital leases. The equipment leases have original terms ranging from 23
to 60 months and have purchase options at the end of the original lease
term.
9. Operating leases:
The Company leases certain equipment and real estate facilities under
non-cancelable operating leases. The following represents the future
minimum payments, by year and in the aggregate, under non-cancelable
operating leases with initial or remaining terms of one year or more
(amounts in thousands). The following future minimum payments do not
include the leases from the Company's former Fort Washington locations (see
notes 18 and 20).
2002 $ 21,455
2003 16,711
2004 14,532
2005 13,311
2006 12,136
Thereafter 43,482
------------
$ 121,627
============
Rent expense was $14.3 million, $17.8 million, and $19.5 million for the
years ended December 31, 1999, 2000, and 2001, respectively. The total
amount of base rent payments is being charged to expense on the
straight-line method over the term of the lease.
F-17
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
10. Income taxes:
Income tax expense consisted of the following components for the years
ended December 31, 1999, 2000, and 2001 (amounts in thousands):
1999 2000 2001
------------ ------------ ------------
Currently payable:
Federal $ 9,158 $ 16,280 $ 10,809
State 548 1,613 1,047
Foreign 500 1,269 376
Deferred:
Federal 10,314 12,180 7,432
State 2,301 1,353 731
Foreign - (653) 1,068
------------ ------------ ------------
Income tax expense $ 22,821 $ 32,042 $ 21,463
============ ============ ============
Deferred tax assets (liabilities) consisted of the following at December
31, 2000 and 2001 (amounts in thousands):
2000 2001
------------- --------------
Deferred tax assets:
Net operating loss carryforwards $ 5,279 $ 39,380
Accrued expenses 3,751 8,697
------------- --------------
Total deferred tax assets 9,030 48,077
Valuation allowance 3,673 5,014
------------- --------------
Net deferred tax assets 5,357 43,063
------------- --------------
Deferred tax liabilities:
Amortization 29,576 32,060
Depreciation 9,103 12,400
Undistributed earnings of unconsolidated subsidiary - 2,832
Purchased accounts receivable 4,940 30,290
------------- --------------
Total deferred tax liabilities 43,619 77,582
------------- --------------
Net deferred tax liabilities $ (38,262) $ (34,519)
============= ==============
The Company had federal, state, and foreign net operating loss
carryforwards in the amount of $175.3 million, subject to certain
limitations, available at December 31, 2001, which will expire during the
years 2004 through 2021. Of this amount, $100.4 million existed as of the
date of the Creditrust Merger. Due to the Creditrust ownership change in
2001, the use of the net operating loss carryforwards could be
substantially curtailed by Section 382 of the Internal Revenue Code. The
annual use of the net operating loss carryforwards 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 Creditrust 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 date of the Creditrust
Merger 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 by NCO Portfolio 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.
F-18
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
10. Income taxes (continued):
A reconciliation of the U.S. statutory income tax rate to the effective
rate for the years ended December 31, 1999, 2000, and 2001 was as follows:
1999 2000 2001
--------- --------- ---------
U.S. statutory income tax rate 35.0% 35.0% 35.0%
Nondeductible goodwill and other expenses 5.6 3.6 5.4
State taxes, net of federal 4.0 2.5 2.1
Benefit from foreign net operating losses - (1.1) -
Other, net - 1.0 (0.9)
--------- --------- ---------
Effective tax rate 44.6% 41.0% 41.6%
========= ========= =========
11. Redeemable preferred stock and shareholders' equity:
Redeemable Preferred Stock
All of JDR's Redeemable Series A Preferred stock, Convertible Series A
Preferred stock and Convertible Series B Preferred stock was exchanged for
NCO common stock on March 31, 1999.
Preferred Stock
All of JDR's Series C Preferred stock was converted into NCO common stock
on March 31, 1999.
Nonvoting Common Stock
All of JDR's nonvoting common stock was exchanged for NCO common stock on
March 31, 1999.
Treasury Stock
All of JDR's treasury shares were retired on March 31, 1999.
Common Stock Warrants
In February 1997, the Company issued warrants to purchase 375,000 shares of
NCO common stock, at $18.42 per share, in connection with the acquisition
of certain assets and the assumption of certain liabilities of the
Collections Division of CRW Financial, Inc. All of these warrants were
outstanding as of December 31, 2001. In January 2002, all of the warrants
were exercised. The holders of the warrants elected to use the option of
forfeiting a portion of their warrants to cover the exercise price. These
exercises resulted in the net issuance of 55,000 shares of NCO common
stock.
In May 1997, JDR issued warrants to purchase 621,000 shares of nonvoting
common stock at a nominal value in connection with the sale of capital
stock and JDR's credit facility. All of the warrants were exercised and
exchanged for NCO common stock on March 31, 1999.
In May 1999, the Company issued warrants to purchase 250,000 shares of NCO
common stock, at $32.97 per share, in connection with the acquisition of
Co-Source. During 1999, warrants to issue 228,000 shares of NCO common
stock were exercised. The holders of the warrants elected to use the option
of forfeiting a portion of their warrants to cover the exercise price.
These exercises resulted in the net issuance of 67,000 shares of NCO common
stock. Warrants to purchase 22,000 shares of NCO common stock were
outstanding as of December 31, 2001. These warrants expire in May 2009.
F-19
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
12. Earnings per share:
Basic earnings per share ("EPS") was computed by dividing the income from
continuing operations applicable to common shareholders and the net income
applicable to common shareholders for the years ended December 31, 1999,
2000, and 2001, by the weighted average number of common shares
outstanding. Diluted EPS was computed by dividing the income from
continuing operations applicable to common shareholders and the net income
applicable to common shareholders for the years ended December 31, 1999,
2000, and 2001, by the weighted average number of common shares outstanding
plus all common equivalent shares. Outstanding options, warrants, and
convertible securities have been utilized in calculating diluted amounts
per share only when their effect would be dilutive.
The reconciliation of basic to diluted weighted average shares outstanding
for the years ended December 31, 1999, 2000, and 2001 was as follows
(amounts in thousands):
1999 2000 2001
------------ ----------- -----------
Basic 22,873 25,587 25,773
Dilutive effect of convertible debt - - 2,806
Dilutive effect of warrants 206 88 88
Dilutive effect of options 712 167 230
Other 8 - -
------------ ----------- -----------
Diluted 23,799 25,842 28,897
============ =========== ===========
13. Stock options:
In June 1995, the Company adopted the 1995 Stock Option Plan (the "1995
Plan"). In September 1996, the Company adopted the 1996 Stock Option Plan
(the "1996 Plan") and the 1996 Non-Employee Director Stock Option Plan (the
"Director Plan"). The 1995 Plan and 1996 Plan, as amended, authorized
333,000 and 4.7 million shares, respectively, of incentive or non-qualified
stock options. The Director Plan, as amended, authorized 150,000 shares.
The vesting periods for the outstanding options under the 1995 Plan, the
1996 Plan, and the Director Plan are three years, three years and one year,
respectively. The options expire no later than 10 years from the date of
grant.
In June 1997, JDR established the JDR Holdings, Inc. 1997 Stock Option Plan
(the "JDR Plan") and reserved 69,000 shares of common stock. All options
that were issued and outstanding under the JDR Plan as of March 31, 1999
became fully vested as a result of the acquisition of JDR by NCO. The
options expire no later than 10 years from the date of grant.
On August 20, 1999, as part of the acquisition of Compass, NCO assumed the
Compass Employee Incentive Compensation Plan (the "Compass Plan"). The
Compass Plan authorized up to 475,000 shares of non-qualified stock
options. The vesting periods for the outstanding options under the Compass
Plan are one to three years. The options expire no later than 10 years from
the date of grant.
F-20
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
13. Stock options (continued):
A summary of stock option activity of the 1995 Plan, the 1996 Plan, the
Director Plan, the JDR Plan and the Compass Plan is as follows (amounts in
thousands, except per share amounts):
Weighted Avg.
Number of Exercise Price
Options Per Share
------------- ----------------
Outstanding at January 1, 1999 1,579 $ 21.44
Granted 1,497 32.58
Exercised (441) 16.89
Forfeited (24) 26.76
------ ---------
Outstanding at December 31, 1999 2,611 28.27
Granted 1,082 24.52
Exercised (94) 12.58
Forfeited (259) 33.39
------ ---------
Outstanding at December 31, 2000 3,340 27.10
Granted 1,116 20.22
Exercised (189) 19.76
Forfeited (269) 28.88
------ ---------
Outstanding at December 31, 2001 3,998 $ 25.41
====== =========
Stock options exercisable at December 31, 2001 1,932 $ 27.69
====== =========
The following table summarizes information about stock options outstanding
as of December 31, 2001 (shares in thousands):
Stock Options Outstanding Stock Options Exercisable
------------------------------------------------- -----------------------------
Weighted Weighted Weighted
Range of Average Average Average
Exercise Prices Shares Remaining Life Exercise Price Shares Exercise Price
--------------------- ------------ ----------------- --------------- ----------- ---------------
$ 8.67 to $19.42 260 5.96 years $ 15.70 217 $ 15.36
$20.05 to $24.75 1,427 9.01 years 20.67 363 22.43
$25.00 to $28.75 929 8.80 years 25.30 314 25.38
$29.19 to $33.38 1,212 7.71 years 30.68 880 30.89
$36.88 to $61.09 170 6.56 years 43.06 158 43.43
------------ ----------------- --------------- ----------- ---------------
3,998 8.26 years $ 25.41 1,932 $ 27.69
============ ================= =============== =========== ===============
F-21
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
13. Stock options (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 applicable
to common shareholders and net income applicable to common shareholders per
share for the years ended December 31, 1999, 2000, and 2001 would have been
reduced to the unaudited, pro forma amounts indicated in the following
table (amounts in thousands, except per share amounts):
1999 2000 2001
------------ ----------- ------------
Net income applicable to common
shareholders - pro forma $ 26,673 $ 17,783 $ 20,858
Net income applicable to common
shareholders per share - pro forma:
Basic $ 1.17 $ 0.70 $ 0.81
Diluted $ 1.12 $ 0.69 $ 0.80
The estimated weighted average, grant-date fair values of the options
granted during the years ended December 31, 1999, 2000, and 2002 were
$12.43, $10.52, and $10.37, respectively. All options granted were at the
market price of the stock on the grant date. For valuation purposes, the
Company utilized the Black-Scholes option pricing model using the following
assumptions for the years ended December 31, 1999, 2000, and 2001 on a
weighted average basis:
1999 2000 2001
---------- ---------- ----------
Risk-free interest rate 5.73% 5.93% 4.42%
Expected life in years 3.25 3.25 4.33
Volatility factor 44.04% 52.88% 58.95%
Dividend yield None None None
Forfeiture rate 5.00% 5.00% 5.00%
14. Derivative financial instruments:
The Company selectively uses derivative financial instruments to manage
interest costs and minimize currency exchange risk. The Company does not
hold derivatives for trading purposes. While these derivative financial
instruments are subject to fluctuations in value, these fluctuations are
generally offset by the value of the underlying exposures being hedged. The
Company minimizes the risk of credit loss by entering into these agreements
with major financial institutions that have high credit ratings.
Interest Rate Collars:
During the year ended December 31, 2001, the Company was party to three
interest rate collar agreements that consisted of LIBOR ceilings and floors
that are based on different notional amounts. The first interest rate
collar agreement consisted of a ceiling portion with a rate of 7.75%,
covering a notional amount of $30.0 million, and a floor portion with a
rate of 4.75%, covering a notional amount of $15.0 million. This interest
rate collar agreement expired in September 2001. The other two interest
rate collar agreements consisted of a ceiling portion with a rate of 7.50%
and a floor portion with a rate of 5.50%, covering a total notional amount
of $120.0 million. These interest rate collar agreements expired in October
2001. The notional amounts of these interest rate collar agreements are
used to measure the interest to be paid or received and do not represent
the amount of exposure due to credit loss. The net cash amounts paid or
received on the interest rate collar agreements are accrued and recognized
as an adjustment to interest expense. The fair value of the interest rate
collar instruments was determined to be immaterial at December 31, 2000.
F-22
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
15. Fair value of financial instruments:
The following methods and assumptions were used to estimate the fair value
of each class of financial instrument for which it is practicable to
estimate that value:
Cash and Cash Equivalents:
The carrying amount reported in the balance sheets approximates fair value
because of the short maturity of these instruments.
Purchased Accounts Receivable
The Company records purchased accounts receivable at cost, which is
discounted from the contractual receivable balance. The Company recorded
the accounts receivable acquired as part of Creditrust 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 with Creditrust, NCO Portfolio recorded the
investment in securitization acquired from Creditrust at fair value. As of
December 31, 2001, the carrying value approximated fair value.
Notes Receivable:
The carrying amount reported in the balance sheets approximates market
rates for notes with similar terms and maturities, and, accordingly, the
carrying amount approximates fair value.
Long-Term Debt:
The stated interest rates of the Company's nonconvertible debt approximate
market rates for debt with similar terms and maturities, and, accordingly,
the carrying amounts approximate fair value. The estimated fair value of
the Company's convertible debt was $113.9 million as of December 31, 2001
based on the closing market price for the convertible securities on
December 31, 2001.
16. Supplemental cash flow information:
The following are supplemental disclosures of cash flow information for the
years ended December 31, 1999, 2000, and 2001 (amounts in thousands):
1999 2000 2001
----------- ------------ ------------
Cash paid for interest $19,975 $24,038 $25,257
Cash paid for income taxes 7,923 18,569 11,410
Non-cash investing and financing activities:
Notes received as consideration for the
divestiture of the Market Strategy Division - 18,250 -
Fair value of assets acquired 28,368 - 123,978
Liabilities assumed from acquisitions 53,713 - 109,394
Convertible note payable, converted to
common stock 900 - -
Common stock issued for acquisitions - -
101,526
Common stock options issued for acquisitions - -
2,562
Redemption of redeemable preferred stock
for common stock 12,231 - -
Warrants issued 1,925 - -
Warrants exercised 6,332 - -
F-23
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
17. Employee benefit plans:
The Company has a 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.
The Company will provide a matching contribution of 25% of the first 6% of
an employee's contribution. The charges to operations for the matching
contributions were $1.4 million, $1.7 million and $1.9 million, for 1999,
2000, and 2001, respectively.
18. 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 accounts receivable 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
The Company is party, from time to time, to various legal proceedings
incidental to its business.
In June of 2001, the first floor of the Company's Fort Washington, PA,
headquarters was severely damaged by a flood caused by remnants of Tropical
Storm Allison. During the third quarter of 2001, the Company decided to
abandon the Fort Washington facilities and move its corporate headquarters
to Horsham, PA. The Company has currently filed a lawsuit against its
landlord to terminate the leases for the Fort Washington facilities. Due to
the uncertainty of the outcome of the lawsuit, the Company has recorded the
full amount of rent due under the remaining terms of the leases during the
third quarter of 2001.
In the opinion of management no other legal proceedings individually or in
the aggregate will have a significant effect on the financial position,
results of operations, cash flows, or liquidity of the Company.
19. Segment reporting:
During the first nine months of 2000, the Company was organized into
operating divisions that were focused on the operational delivery of
services. The Company's focus on the operational delivery of services
allowed it to take advantage of significant cross-selling opportunities and
enhance the level of service provided to its clients. The operating
divisions during the first nine months of 2000 included Accounts Receivable
Management Services, Technology-Based Outsourcing, and International
Operations. During 2000, the continued integration of the Company's
infrastructure facilitated the further reduction of the operating divisions
from three to two. Effective October 1, 2000, the new operating divisions
included U.S. Operations (formerly Accounts Receivable Management Services
and Technology-Based Outsourcing) and International Operations. Each of
these divisions will maintain industry specific functional groups including
financial services, healthcare, retail and commercial, utilities,
education, telecommunications, and government. The Company created the
Portfolio Management division as a result of the February 2001 Creditrust
Merger. Prior to the acquisition, NCO's portfolio business was part of the
U.S. Operations division.
The accounting policies of the segments are the same as those described in
Note 2, "Accounting policies."
F-24
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
19. Segment reporting (continued):
The U.S Operations division provides accounts receivable management
services to consumer and commercial accounts for all market sectors
including financial services, healthcare, retail and commercial, utilities,
education, telecommunications, and government. The U.S. Operations serve
clients of all sizes in local, regional and national markets. In addition
to traditional accounts receivable collections, these services include
developing the client relationship beyond bad debt recovery and delinquency
management, delivering cost-effective accounts receivable and customer
relationship management solutions to all market sectors, serving clients of
all sizes in local, regional and national markets. The U.S. Operations
division had total assets, net of any intercompany balances, of $704.5
million and $732.4 million at December 31, 2000 and 2001, respectively.
The Portfolio Management division purchases and manages defaulted consumer
accounts receivable from credit grantors, including banks, finance
companies, retail merchants and other service providers. Portfolio
Management had total assets, net of any intercompany balances, of $32.1
million and $153.7 million at December 31, 2000 and 2001, respectively.
The International Operations division provides accounts receivable
management services across Canada and the United Kingdom. U.S. Operations
uses International Operations as a subcontractor to perform accounts
receivable management services to some of its clients. The International
Operations division had total assets, net of any intercompany balances, of
$47.4 million and $44.9 million at December 31, 2000 and 2001,
respectively.
The following tables represent the revenue, payroll and related expenses,
selling, general and administrative expenses, and earnings before interest,
taxes, depreciation, and amortization ("EBITDA") for each segment for the
years ended December 31, 1999, 2000 and 2001. EBITDA is used by the
Company's management to measure the segments' operating performance and is
not intended to report the segments' operating results in conformity with
generally accepted accounting principles.
For the year ended December 31, 1999
(Amounts in thousands)
-------------------------------------------------------------------------------
Selling,
Payroll and General and Nonrecurring
Related Admin. Acquisition
Revenue Expenses Expenses Costs EBITDA
------------- ------------- ------------- ------------- -------------
U.S. Operations $ 428,293 $ 219,930 $ 119,489 $ -- $ 88,874
Portfolio Management 1,959 180 1,038 -- 741
International Operations 31,040 17,599 8,631 -- 4,810
Eliminations and other (981) -- (981) 4,601 (4,601)
------------- ------------- ------------- ------------- -------------
Total $ 460,311 $ 237,709 $ 128,177 $ 4,601 $ 89,824
============= ============= ============= ============= =============
For the year ended December 31, 2000
(Amounts in thousands)
------------------------------------------------------------------------
Payroll and Selling,
Related General and
Revenue Expenses Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
U.S. Operations $ 566,769 $ 275,718 $ 170,532 $ 120,519
Portfolio Management 13,151 327 5,853 6,971
International Operations 31,705 17,247 9,280 5,178
Eliminations (5,741) (5,741) -
---------------- ----------------- ----------------- ---------------
Total $ 605,884 $ 293,292 $ 179,924 $ 132,668
================ ================= ================= ===============
F-25
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
19. Segment reporting (continued):
For the year ended December 31, 2001
(Amounts in thousands)
------------------------------------------------------------------------
Payroll and Selling,
Related Expenses General and
Revenue Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
U.S. Operations $ 633,376 $ 332,456 $ 221,995 $ 78,925
Portfolio Management 62,929 1,624 32,437 28,868
International Operations 37,803 21,685 10,729 5,389
Eliminations (32,602) (5,131) (27,471) -
---------------- ----------------- ----------------- ---------------
Total $ 701,506 $ 350,634 $ 237,690 $ 113,182
================ ================= ================= ===============
20. Net loss due to flood and relocation of corporate headquarters:
In June of 2001, the first floor of the Company's Fort Washington, PA,
headquarters was severely damaged by a flood caused by remnants of Tropical
Storm Allison. During the third quarter of 2001, the Company decided to
abandon the Fort Washington facilities and move its corporate headquarters
to Horsham, PA. The Company has currently filed a lawsuit against its
landlord to terminate the leases for the Fort Washington facilities. Due to
the uncertainty of the outcome of the lawsuit, the Company has recorded the
full amount of rent due under the remaining terms of the leases during the
third quarter of 2001. The Company has also recorded other expenses and
expected insurance proceeds during the third quarter of 2001 in connection
with the flood and the relocation of the corporate headquarters. The net
effect of the charges and the gain from the insurance proceeds included in
selling, general, and administrative expenses during the third quarter of
2001 was $11.2 million.
21. Investments in unconsolidated subsidiaries:
NCO Portfolio owns a 100% retained residual interest in an investment in
securitization, Creditrust SPV 98-2, LLC, which was acquired as part of the
Creditrust 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. The Company recorded $211,000 in income on this investment
during the year ended 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 8).
F-26
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
21. Investments in unconsolidated subsidiaries (continued):
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 had each invested $574,000 in the Joint
Venture for the purchase of accounts receivable. Included in the Statement
of Income, in "other income," was $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
22. Related party transactions:
From time to time, the Company uses an airplane that is partly owned by
Michael J. Barrist, Chairman, President, and Chief Executive Officer of
NCO. The Company pays to a third party management company, which is not
affiliated with Mr. Barrist, the monthly management fee and out-of-pocket
costs for the Company's use of the airplane. The Company paid costs of
$358,000, $368,000, and $363,000 for the years ended December 31, 1999,
2000, and 2001, respectively.
23. Subsequent event:
During February 2002, the Company entered into two interest rate swap
agreements to reduce the impact of changes in LIBOR on a portion of the
debt borrowed under its revolving credit facility. The interest rate swap
agreements fixed LIBOR at a rate of 2.82%. The total initial notional
amount of the interest rate swap agreements was $102.0 million. The
notional amount of the interest rate swap agreements is subject to
scheduled quarterly reductions. The interest rate swap agreements expire in
September 2003.
24. Recent accounting pronouncements:
In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS
No.s 141 and 142, "Business Combinations" and "Goodwill and Other
Intangibles." FASB 141 requires all business combinations initiated after
July 1, 2001, to be accounted for using the purchase method. FASB 142
concluded that purchased goodwill would not be amortized but would be
reviewed for impairment when certain events indicate that the goodwill of a
reporting unit is impaired. The impairment test will use a fair-value based
approach, whereby if the implied fair value of a reporting unit's goodwill
is less than its carrying amount, goodwill would be considered impaired.
FASB 142 does not require that goodwill be tested for impairment upon
adoption unless an indicator of impairment exists at that date. However, it
would require that a benchmark assessment be performed for all existing
reporting units within six months of the date of adoption. The new goodwill
model applies not only to goodwill arising from acquisitions completed
after the effective date, but also to goodwill previously recorded. The
Company adopted FASB 142 in the first quarter of 2002 and is in the process
of determining the impact of these pronouncements on its financial position
and results of operations.
F-27
NCO GROUP, INC.
Notes to Consolidated Financial Statements (Continued)
24. Recent accounting pronouncements (continued):
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 internal rate of return ("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.
F-28
NCO GROUP, INC.
Consolidating Statement of Income
(Unaudited)
(in thousands, except for per share amounts)
For the Year Ended December 31, 2001
--------------------------------------------------
NCO Intercompany
NCO Group Portfolio Eliminations Consolidated
--------- --------- ------------ ------------
Revenue $ 666,048 $ 62,929 $ (27,471) $ 701,506
Operating costs and expenses:
Payroll and related expenses 349,010 1,624 350,634
Selling, general, and administrative expenses 232,724 32,437 (27,471) 237,690
Depreciation and amortization expense 37,955 250 38,205
--------- --------- --------- ---------
619,689 34,311 (27,471) 626,529
--------- --------- --------- ---------
46,359 28,618 -- 74,977
Other income (expense):
Interest and investment income 3,859 531 (763) 3,627
Interest expense (19,495) (8,230) 763 (26,962)
--------- --------- --------- ---------
(15,636) (7,699) -- (23,335)
--------- --------- --------- ---------
Income before income tax expense 30,723 20,919 -- 51,642
Income tax expense 13,618 7,845 21,463
--------- --------- --------- ---------
Income from operations before minority interest 17,105 13,074 -- 30,179
Minority interest -- -- (4,310) (4,310)
--------- --------- --------- ---------
Net income $ 17,105 $ 13,074 $ (4,310) $ 25,869
========= ========= ========= =========
F-29
NCO GROUP, INC.
Schedule II - Valuation and Qualifying Accounts
Additions
-------------------------
Balance at Charged to Charged to Balance at
beginning costs and other end of
year Expenses accounts (1) Deductions (2) year
----------- ----------- ------------- --------------- -------------
Year ended December 31, 1999:
Allowance for doubtful
accounts $3,619,000 $2,553,000 $ 900,000 $ (1,681,000) $ 5,391,000
Year ended December 31, 2000:
Allowance for doubtful
accounts $5,391,000 $5,906,000 $ - $ (4,217,000) $ 7,080,000
Year ended December 31, 2001:
Allowance for doubtful
accounts $7,080,000 $4,250,000 $ - $ (6,019,000) $ 5,311,000
(1) Allowance for doubtful accounts of acquired companies.
(2) Uncollectible accounts written off, net of recoveries.
S-1