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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, DC 20549
FORM 10-Q
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15 (D) OF THE SECURITIES
EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2003
OR
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15 (D)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from _____ to _____
Commission File Number 000-32403
NCO PORTFOLIO MANAGEMENT, INC.
(Exact name of Registrant as Specified in its charter)
Delaware 23-3005839
(State or other jurisdiction (I.R.S. Employer
of incorporation or organization) Identification No.)
1804 Washington Blvd., Dept. 200, Baltimore, Maryland 21230
(Address of principal executive offices) (Zip code)
Registrant's telephone number, including area code: (443) 263-3020
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(D) of the Securities Exchange Act of 1934 during
the preceding 12 months (or such shorter period that the registrant was required
to file such reports), and (2) has been subject to such filing requirements for
the past 90 days Yes [X] No [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [ ] No [X]
The number of shares outstanding of the registrant's common stock as of May 15,
2003 was 13,576,519.
NCO PORTFOLIO MANAGEMENT, INC.
FORM 10-Q
INDEX
PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements (Unaudited)
Page
Consolidated Balance Sheets
As of December 31, 2002 and March 31, 2003.................................................... 3
Consolidated Statements of Income
For the Three Months Ended March 31, 2002 and 2003............................................ 4
Consolidated Statements of Cash Flows
For the Three Months Ended March 31, 2002 and 2003............................................ 5
Notes to Consolidated Financial Statements.................................................... 6
Item 2. Management's Discussion and Analysis of Financial
Condition and Results of Operations........................................................... 15
Item 3. Quantitative and Qualitative Disclosures about Market Risk........................................ 20
Item 4. Controls and Procedures........................................................................... 20
PART II. OTHER INFORMATION
Item 1. Legal Proceedings................................................................................. 21
Item 2. Changes in Securities and Use of Proceeds......................................................... 21
Item 3. Defaults Upon Senior Securities................................................................... 21
Item 4. Submission of Matters to a Vote of Shareholders................................................... 21
Item 5. Other Information................................................................................. 21
Item 6. Exhibits and Reports on Form 8-K.................................................................. 21
SIGNATURES................................................................................................ 22
CERTIFICATIONS............................................................................................ 23
2
Part 1 - Financial Information
Item 1 - Financial Statements
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Balance Sheets
(Amounts in thousands, except par values)
(Unaudited)
December 31, March 31,
ASSETS 2002 2003
---------- ----------
Cash and cash equivalents $ 6,388 $ 11,317
Restricted cash 900 900
Purchased accounts receivable 148,968 147,697
Investment in securitization 7,474 7,474
Deferred costs 547 446
Investment in joint venture 3,362 3,835
Other assets 158 206
--------- ---------
Total assets $ 167,797 $ 171,875
========= =========
LIABILITIES AND STOCKHOLDERS' EQUITY
Liabilities:
Accounts payable $ 89 $ 41
Accrued expenses 3,936 5,839
Accrued compensation and related expenses 155 202
Secured notes payable 55,264 55,900
Note payable - affiliate 36,880 36,250
Deferred income taxes 4,276 5,137
Minority interest 560 500
Stockholders' equity:
Preferred stock, $.01 par value, 5,000 shares authorized,
no shares issued and outstanding - -
Common stock, $.01 par value, 35,000 shares authorized,
13,576 shares issued and outstanding 136 136
Additional paid-in capital 40,826 40,826
Other comprehensive loss (7) (72)
Retained earnings 25,682 27,116
--------- ---------
Total stockholders' equity 66,637 68,006
--------- ---------
Total liabilities and stockholders' equity $ 167,797 $ 171,875
========= =========
See accompanying notes.
3
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Statements of Income
(Unaudited)
(Amounts in thousands, except per share data)
For the Three Months
Ended March 31,
2002 2003
-------- --------
Revenue $ 16,270 $ 18,232
Operating costs and expenses:
Payroll and related expenses 554 480
Servicing fee expenses 8,300 11,873
Selling, general, and administrative expenses 566 938
Amortization expense 75 108
Impairment of purchased accounts receivable 797 310
-------- --------
Total operating costs and expenses 10,292 13,709
-------- --------
Income from operations 5,978 4,523
Other income (expense):
Interest and other income 131 494
Interest expense (1,867) (2,653)
-------- --------
Total other income (expense) (1,736) (2,159)
-------- --------
Income before income tax expense 4,242 2,364
Income tax expense 1,591 860
-------- --------
Income from operations before minority interest 2,651 1,504
Minority interest - (70)
-------- --------
Net income $ 2,651 $ 1,434
======== ========
Net income per share applicable to common stockholders:
Basic and diluted $ 0.20 $ 0.11
======== ========
Weighted average shares outstanding:
Basic and diluted 13,576 13,576
======== ========
See accompanying notes.
4
NCO PORTFOLIO MANAGEMENT, INC.
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)
For the Three Months
Ended March 31,
--------------------
2002 2003
------- --------
Cash flows from operating activities:
Net income $ 2,651 $ 1,434
Adjustments to reconcile net income to net cash
provided by operating activities:
Amortization of deferred costs 75 108
Impairment of purchased accounts receivable 797 310
Income from investment in securitization (28) -
Equity income from investment in joint venture (83) (473)
Minority interest - 70
Changes in operating assets and liabilities:
Deferred income taxes 1,591 860
Other assets (1) (48)
Accounts payable and accrued expenses (64) 1,992
------- --------
Net cash provided by operating activities 4,938 4,253
------- --------
Cash flows from investing activities:
Purchases of accounts receivable (9,044) (16,870)
Collections applied to principal of purchased accounts receivable 11,059 18,691
Investment in joint venture, net of distributions (197) -
Distributions of minority interest - (130)
------- --------
Net cash provided by investing activities 1,818 1,691
------- --------
Cash flows from financing activities:
Borrowings under note payable - affiliate 370 1,000
Repayments of note payable - affiliate - (1,630)
Borrowings under secured notes payable - 6,054
Repayment of secured notes payable (4,239) (6,432)
Payment of fees to acquire new debt - (7)
------- --------
Net cash used in financing activities (3,869) (1,015)
------- --------
Net increase in cash and cash equivalents 2,887 4,929
Cash and cash equivalents at beginning of period 6,509 6,388
------- --------
Cash and cash equivalents at end of period $ 9,396 $ 11,317
======= ========
See accompanying notes.
5
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Note A - Organization and Business
NCO Portfolio Management, Inc. ("NCO Portfolio" or the "Company") was
incorporated in Delaware on January 22, 1999 (date of inception) under the name
of NCO Portfolio Funding, Inc. The Company changed its name from NCO Portfolio
Funding, Inc. to NCO Portfolio Management, Inc. in February 2001. NCO Portfolio
purchases and manages past due consumer accounts receivable from consumer
creditors such as banks, finance companies, retail merchants, hospitals,
utilities, and other consumer-oriented companies. NCO Portfolio's purchased
accounts receivable originate from consumers located throughout the United
States, Canada, and the United Kingdom. NCO Portfolio has funded its purchased
accounts receivable through internal cash flows, financing from NCO Group, Inc.
("NCO Group" or the "Parent"), and other financing facilities. NCO Portfolio was
a wholly owned subsidiary of NCO Group, Inc. until NCO Portfolio's merger with
Creditrust Corporation ("Creditrust") on February 20, 2001 (the "Merger"). In
connection with the Merger, NCO Portfolio became a publicly traded company
(NASDAQ: NCPM).
As part of the acquisition, NCO Portfolio entered into a ten year service
agreement that appointed a wholly owned subsidiary of NCO Group, NCO Financial
Systems, Inc. ("NCOF") as the provider of collection services to NCO Portfolio.
NCO Group has agreed to offer all of its future U.S. accounts receivable
purchase opportunities to NCO Portfolio. Additionally, NCO Group amended its
credit agreement with Citizens Bank of Pennsylvania ("Citizens Bank") to provide
a credit facility to NCO Portfolio in the form of a subfacility. See Note G -
Related Party Transactions.
Note B - Summary of Significant Accounting Policies
Basis of Accounting
The financial statements and disclosures included herein for the three months
ended March 31, 2002 and 2003 are unaudited. These financial statements and
disclosures have been prepared by the Company in accordance with generally
accepted accounting principles for interim financial information. Accordingly,
they do not include all of the information and footnotes required by generally
accepted accounting principles for complete financial statements. In the opinion
of management, all adjustments (consisting of adjustments of a normal and
recurring nature) considered necessary for a fair presentation have been
included. Operating results for the three month period ended March 31, 2003 are
not necessarily indicative of the results that may be expected for the year
ended December 31, 2003. For further information, refer to the consolidated
financial statements and footnotes thereto included in the Company's Annual
Report on Form 10-K filed with the Securities and Exchange Commission on March
13, 2003.
Principles of Consolidation
The consolidated financial statements include the accounts of the Company and
all affiliated subsidiaries and entities controlled by the Company (see Note G -
Related Party transactions). All significant intercompany accounts and
transactions have been eliminated. Two affiliates that the Company does not
control are InoVision-MEDCLR-NCOP Ventures, LLC and Creditrust SPV98-2, LLC
("SPV 98-2") and are not included in the consolidated financial statements. See
Note D - Investments in Unconsolidated Subsidiaries.
Cash and Cash Equivalents and Restricted Cash
NCO Portfolio considers all highly liquid securities purchased with an initial
maturity of three months or less to be cash equivalents. One securitization that
is accounted for as secured borrowing has provisions that restrict NCO
Portfolio's use of cash. Restricted cash as of December 31, 2002 and March 31,
2003 was $900,000.
6
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note B - Summary of Significant Accounting Policies (Continued)
Purchased Accounts Receivable
NCO Portfolio accounts for its investment in purchased accounts receivable on an
accrual basis under the guidance of the American Institute of Certified Public
Accountants' Practice Bulletin No. 6, "Amortization of Discounts on Certain
Acquired Loans," using unique and exclusive portfolios. Portfolios are
established with accounts having similar attributes. Typically, each portfolio
consists of an individual acquisition of accounts that are initially recorded at
cost, which includes external costs of acquiring portfolios. Once a portfolio is
acquired, the accounts in the portfolio are not changed. Proceeds from the sale
of accounts and return of accounts within a portfolio are accounted for as
collections in that portfolio. The discount between the cost of each portfolio
and the face value of the portfolio is not recorded since NCO Portfolio expects
to collect a relatively small percentage of each portfolio's face value.
Collections on the portfolios are allocated to revenue and principal reduction
based on the estimated internal rate of return ("IRR") for each portfolio. The
IRR for each portfolio is derived based on the expected monthly collections over
the estimated economic life of each portfolio (generally five years, based on
NCO Portfolio's collection experience), compared to the original purchase price.
Revenue on purchased accounts receivable is recorded monthly based on each
portfolio's effective IRR for the quarter applied to each portfolio'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 portfolio, 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 portfolio may be increased for the
difference between the revenue accrual and collections.
To the extent actual collections differ from estimated projections, NCO
Portfolio prospectively adjusts the IRR. If the carrying value of a particular
portfolio exceeds its expected future collections, a charge to income would be
recognized in the amount of such impairment. Additional impairments on each
quarter's previously impaired portfolios may occur if the current estimated
future collections projection, after being adjusted prospectively for actual
collection results, is less than the carrying value recorded. After the
impairment of a portfolio, all collections are recorded as a return of capital
and no income is recorded on that portfolio until the full carrying value of the
portfolio has been recovered. The estimated IRR for each portfolio is based on
estimates of future collections, and actual collections will vary from current
estimates. The difference could be material.
Third party legal and professional fees incurred with respect to the acquisition
of purchase accounts receivable are capitalized as part of the cost of the
portfolio, and amortized over the life of the portfolio. For the three months
ended March 31, 2002 and 2003, no legal and professional fees were capitalized.
Use of Estimates
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and accompanying notes.
In the ordinary course of accounting for purchased accounts receivable,
estimates have been made by management as to the amount and timing of future
collections expected from each portfolio. The estimated future collections of
each portfolio are used to compute the IRR for the portfolio. The IRR is used to
allocate collections between revenue and principal reduction of the carrying
values of the purchased accounts receivable.
On an ongoing basis, the Company compares the historical trends of each
portfolio to projected collections. The future projections are then increased,
within preset limits, or decreased based on the actual cumulative performance of
each portfolio. The Company reviews each portfolio's adjusted projected
collections to determine if further upward or downward adjustment is warranted.
Management regularly reviews the trends in collection patterns and uses its best
efforts to improve collections of under-performing portfolios. On newly acquired
portfolios, additional reviews are made to determine if the purchase budget
requires upward or downward adjustment due to unusual collection patterns in the
early months of ownership. However, actual results will differ from these
estimates and a material change in these estimates could occur within one year.
See Note C - Purchased Accounts Receivable.
7
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note B - Summary of Significant Accounting Policies (Continued)
Investments in Debt and Equity Securities
NCO Portfolio accounts for investments, such as the investment in
securitization, SPV 98-2, in accordance with Statement of Financial Accounting
Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity
Securities." As such, investments are recorded as either trading, available for
sale, or held to maturity based on management's intent relative to those
securities. NCO Portfolio records its investment in securitization as an
available for sale debt security. Such security is recorded at fair value, and
unrealized gains and losses, net of taxes, are not reflected in income but are
recorded as other comprehensive income in stockholders' equity until realized. A
decline in the value of an available for sale security below cost that is deemed
other than temporary is charged to earnings as an impairment and results in the
establishment of a new cost basis for the security.
The investment in securitization represents the residual interest in a
securitized portfolio of purchased accounts receivable acquired in the Merger.
The investment in securitization accrues interest at an IRR that is estimated
based on the expected monthly collections over the estimated economic life of
the investment (approximately five years). The cost of this investment
approximates fair value at March 31, 2003. See Note D - Investments in
Unconsolidated Subsidiaries.
Foreign Currency Translation
NCO Portfolio consolidates an entity whose functional currency is the British
Pound. For this entity, 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 stockholders' equity as other comprehensive loss and
are not included in determining net income.
Income Taxes
Effective with the Merger, NCO Portfolio files its own income tax returns. 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 expected future tax consequences of temporary differences
between the financial reporting and tax basis of assets and liabilities.
The portfolios of purchased accounts receivable are composed of distressed debt.
Collection results are not guaranteed until received; accordingly, for tax
purposes, any gain on a particular portfolio is deferred until the full cost of
its acquisition is recovered. Revenue for financial reporting purposes is
recognized over the life of the portfolio. Deferred tax liabilities arise from
deferrals created during the early stages of the portfolio. These deferrals
reverse after the cost basis of the portfolio is recovered. The creation of new
tax deferrals from future purchases of portfolios are expected to offset a
significant portion of the reversal of the deferrals from portfolios where the
collections have become fully taxable.
Earnings Per Share
Basic earning per share ("EPS") was computed by dividing net income applicable
to common stockholders for the three months ended March 31, 2002 and 2003, by
the weighted average number of common shares outstanding. Diluted EPS was
computed by dividing net income applicable to common stockholders for the three
months ended March 31, 2002 and 2003, by the weighted average number of common
shares outstanding plus all common equivalent shares. Outstanding options have
been utilized in calculating diluted net income per share only when their effect
would be dilutive. As of March 31, 2002 and 2003, there were 581,000 and 706,500
options outstanding to purchase shares of common stock, respectively. For the
three months ended March 31, 2002 and 2003, none of the outstanding options were
dilutive.
Deferred Costs
NCO Portfolio capitalized legal and professional fees incurred in connection
with new debt facilities. The costs are being amortized over the terms of the
facilities, which range from twenty-four to thirty-six months.
8
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note B - Summary of Significant Accounting Policies (Continued)
Stock Option Plan
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 SFAS 123, "Accounting for
Stock-Based Compensation", the Company does not recognize compensation cost
based on the fair value of the options granted at grant date. If the Company had
elected to recognize compensation cost based on the fair value of the options
granted at grant date, net income and net income per share would have been
reduced to the pro forma amounts indicated in the following table for the three
months ended March 31, (amounts in thousands, except per share amounts):
2002 2003
---- ----
Net income - as reported.................... $ 2,651 $ 1,434
Proforma compensation, net of taxes..... (93) (183)
------- -------
Net income -- pro forma..................... $ 2,558 $ 1,251
======= =======
Net income per share - as reported:
Basic and diluted...................... $ 0.20 $ 0.11
======= =======
Net income per share -- pro forma:
Basic and diluted...................... $ 0.19 $ 0.09
======= =======
Court Cost Reimbursements
NCO Portfolio incurs court cost expenses related to the collection of accounts
that have been placed in the NCO Attorney Network. NCO Portfolio is reimbursed
for these court cost expenses when the debtor makes payments on their account.
The reimbursement of these costs has been recorded as revenue in the
accompanying Statements of Income in accordance with EITF 01-14, "Income
Statement Characterization of Reimbursements Received for `Out-of-Pocket'
Expenses Incurred", which amounted to $198,000 for the three months ended March
31, 2003.
Reclassifications
Certain amounts for the three months ended March 31, 2002 have been reclassified
to conform with the 2003 presentation for comparative purposes
Note C - Purchased Accounts Receivable
NCO Portfolio purchases defaulted consumer accounts receivable at a discount
from the actual principal balance. The following summarizes the change in
purchased accounts receivable for the year ended December 31, 2002, and for the
three months ended March 31, 2003 (amounts in thousands):
2002 2003
---- ----
Balance, at beginning of period............................................................. $ 136,339 $ 148,968
Purchases of accounts receivable.......................................... 71,579 17,782
Collections on purchased accounts receivable.............................. (116,394) (36,725)
Purchase price adjustment................................................. (4,000) --
Revenue recognized on purchased accounts receivable....................... 63,379 18,034
Foreign currency translation.............................................. -- (52)
Impairment of purchased accounts receivable............................... (1,935) (310)
--------- ---------
Balance, at end of period................................................................... $ 148,968 $ 147,697
========= =========
9
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note C - Purchased Accounts Receivable (Continued)
During the three months ended March 31, 2002 and 2003, an impairment charge of
$797,000 and $310,000, respectively, was recorded as a charge to income on
portfolios where the carrying values exceeded the expected future collections.
No revenue will be recorded on these portfolios until their carrying values have
been fully recovered. As of December 31, 2002 and March 31, 2003, the combined
carrying values on all impaired portfolios aggregated $5.8 million and $6.7
million, respectively, or 3.9 percent and 4.6 percent of total purchased
accounts receivable, respectively, representing their net realizable value.
Revenue from fully cost recovered portfolios was $116,000 for the three months
ended March 31, 2003. Included in collections for the three months ended March
31, 2003, was $1.5 million in proceeds from the sale of accounts. For the three
months ended March 31, 2003, a foreign currency translation loss of $52,000 was
recorded on accounts receivable whose functional currency is the British Pound.
Note D - Investments in Unconsolidated Subsidiaries
NCO Portfolio owns a 100 percent retained residual interest in an investment in
securitization, SPV 98-2, which was acquired in the Merger. This transaction
qualified for gain on sale accounting when the purchased accounts receivable
were originally securitized by Creditrust. This securitization issued a
nonrecourse note that is due the earlier of January 2004 or satisfaction of the
note from collections, carries an interest rate of 8.61 percent, and had a
balance of $2.4 million and $1.7 million as of December 31, 2002 and March 31,
2003, respectively. The retained interest represents the present value of the
residual interest in SPV 98-2 using discounted future collections after the
securitization note is fully repaid, plus a cash reserve. As of March 31, 2003,
the investment in SPV 98-2 was $7.5 million, composed of $4.2 million in present
value of discounted residual cash flows plus $3.3 million in cash reserves. The
investment accrues noncash income at a rate of 8 percent per annum on the
residual cash flow component only. The income earned increases the investment
balance until the securitization note has been repaid, after which, collections
are split between income and amortization of the investment in SPV 98-2 based on
the discounted cash flows. No income was recorded for the three months ended
March 31, 2003 as the investment was offset by a temporary decline in market
value. NCO Portfolio recorded $28,000 in income on this investment for the three
months ended March 31, 2002. The off balance sheet 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 E - Notes Payable.
NCO Portfolio has a 50 percent ownership interest in a joint venture,
InoVision-MEDCLR-NCOP Ventures, LLC ("Joint Venture") with IMNV Holdings, LLC
("IMNV"). This Joint Venture was established in 2001 to purchase utility,
medical and various other small balance accounts receivable and is accounted for
using the equity method of accounting. NCO Portfolio had an investment in the
Joint Venture of $3.4 million and $3.8 million as of December 31, 2002 and March
31, 2003, respectively. Included in the Statements of Income, in "other income,"
for the three months ended March 31, 2002 and 2003, was $83,000 and $473,000,
respectively, representing the Company's 50 percent share of operating income
from this unconsolidated subsidiary. The Joint Venture has access to capital
through CFSC Capital Corp. XXXIV ("Cargill Financial") who, at its option, lends
90 percent of the cost of the purchased accounts receivable to the Joint
Venture. Borrowings carry interest at the prime rate plus 4.25 percent (prime
rate was 4.25 percent as of March 31, 2003). Debt service payments equal total
collections less servicing fees and expenses until each individual borrowing is
fully repaid and the Joint Venture's investment is returned, including interest.
Thereafter, Cargill Financial is paid a residual of 50 percent of collections
less servicing costs. Individual loans are required to be repaid based on
collections, but not more than two years from the date of borrowing. The debt is
cross-collateralized by all portfolios in which the lender participates, and is
nonrecourse to NCO Portfolio. The following table summarizes the financial
information of the Joint Venture as of December 31, 2002 and March 31, 2003, and
for the three months ended March 31, 2002 and 2003 (amounts in thousands):
2002 2003
---- ----
Total assets..................... $ 11,638 $ 11,972
Total liabilities................ $ 4,944 $ 4,346
Revenue.......................... $ 1,860 $ 3,360
Net income....................... $ 166 $ 946
10
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note E - Notes Payable
NCO Portfolio assumed four securitized notes payable in connection with the
Merger, one of which is included in an unconsolidated subsidiary, SPV 98-2 (see
note E - Investments in Unconsolidated Subsidiaries). The remaining three notes
are reflected in notes payable. These notes payable were originally established
to fund the purchase of accounts receivable. Each of the notes payable is
nonrecourse to the Company and NCO Group, is secured by a portfolio of purchased
accounts receivable, and is bound by an indenture and servicing agreement.
Pursuant to the Merger, the trustee appointed NCOF as the successor servicer for
each portfolio of purchased accounts receivable within these securitized notes.
When the notes payable were established, a separate nonrecourse special purpose
finance subsidiary was created to hold the assets and issue the debt. These are
term notes without the ability to reborrow. 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 London InterBank Offered
Rate ("LIBOR") plus .65 percent per annum, and the final due date of all
payments under the facility is the earlier of March 2005, or satisfaction of the
note from collections. A $900,000 liquidity reserve is included in restricted
cash as of December 31, 2002 and March 31, 2003, and is restricted as to use
until the facility is retired. Interest expense, trustee fees and guarantee fees
aggregated $167,000 and $124,000 for the three months ended March 31, 2002 and
2003, respectively. As of December 31, 2002 and March 31, 2003, the amount
outstanding on this facility was $15.4 million and $15.0 million, respectively.
Pursuant to the Merger, the note insurer, Radian Group, Inc., has been
guaranteed against loss by the Company for up to $4.5 million, which will be
reduced if and when cash reserves and residual collections from another
securitization, SPV 98-2, are posted as additional collateral for this facility.
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 carried interest at 9.43 percent per annum. This facility was repaid
and retired in May 2002. Interest expense and trustee fees aggregated $52,000
for the three months ended March 31, 2002.
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 percent per annum, with a final payment date of
the earlier of December 2004, or satisfaction of the note from collections.
Interest expense and trustee fees aggregated $876,000 and $753,000 for the three
months ended March 31, 2002 and 2003, respectively. As of December 31, 2002 and
March 31, 2003, the amount outstanding on this facility was $20.1 million and
$19.9 million, respectively.
In August 2002, the Company entered into a four year exclusivity agreement with
Cargill Financial. The agreement stipulates that all purchases of accounts
receivable with a purchase price in excess of $4 million, with limited
exceptions, shall be first offered to Cargill Financial for financing at its
discretion. The agreement has no minimum or maximum credit authorization. The
Company may terminate the agreement at any time after two years for a cost of
$125,000 per month for each month of the remaining four years, payable monthly.
If Cargill Financial chooses to participate in the financing of a portfolio of
accounts receivable, the financing will be at 90 percent of the purchase price,
unless otherwise negotiated, with floating interest at the prime rate plus 3.25
percent (prime rate was 4.25 percent as of March 31, 2003). Each borrowing is
due twenty-four months after the loan is made. Debt service payments equal
collections less servicing fees and interest expense. As additional interest,
Cargill Financial will receive 40 percent of the residual collections, unless
otherwise negotiated, which is defined as all cash collections after servicing
fees, floating rate interest, repayment of the note and the initial investment
by the Company, including imputed interest. Borrowings under this financing
agreement are nonrecourse to the Company and NCO Group, except for the assets
within the special purpose entities established in connection with the financing
agreement. This loan agreement contains a collections performance requirement,
among other covenants, that, if not met, provides for cross-collateralization
with any other Cargill Financial financed portfolios, in addition to other
remedies. As of March 31, 2003, NCO Portfolio was in compliance with all
required covenants.
During the three months ended March 31, 2003, the Company purchased accounts
receivable from major credit card institutions that were financed through
Cargill Financial under the exclusivity agreement. The total amount of new
borrowings under the exclusivity agreement amounted to $6.1 million. The total
amount outstanding under the exclusivity agreement as of December 31, 2002 and
March 31, 2003 was $17.6 million and $17.9 million, respectively. The final
payment date on the outstanding notes range from August 2004 to February 2005,
or satisfaction of the notes from collections. Interest expense on all notes
totaled $1.1 million for the three months ended March 31, 2003, which includes
$780,000 of accrued interest representing Cargill Financial's residual interest
earned. Total accrued interest expense attributable to the residual liability
was $831,000 and $1.6 million as of December 31, 2002 and March 31, 2003,
respectively. The effective interest rate on all notes, including the residual
interest component was approximately 24.6 percent for the three months ended
March 31, 2003.
11
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note F - Commitments and Contingencies
Forward-Flow Agreement
In May 2002, NCO Portfolio entered into a fixed price, three month renewable
agreement ("forward-flow") with a major financial institution that obligates NCO
Portfolio to purchase, on a monthly basis, portfolios of charged off accounts
receivable meeting certain criteria. As of March 31, 2003, NCO Portfolio was
obligated to purchase accounts receivable at a maximum of $1.8 million per month
through May 2003. A portion of the purchase price is deferred for twelve months,
including a nominal rate of interest. NCO Group guarantees this forward-flow
agreement. Included in secured notes payable is $3.1 million of deferred
purchase price as of March 31, 2003, with the first payment beginning June 2003.
At the time of this filing, an agreement in principal has been reached to renew
the forward-flow agreement which will obligate NCO Portfolio to purchase
accounts receivable for a maximum of $2.5 million per month through May 2004. A
portion of the purchase price will be deferred for twenty-four months, including
a nominal rate of interest.
Litigation
NCO Portfolio is party, from time to time, to various legal proceedings
incidental to its business. In the opinion of management, none of these items
individually or in the aggregate will have a significant effect on the financial
position, results of operations, cash flows, or liquidity of NCO Portfolio.
Note G - Related Party Transactions
Servicing Fees
As part of the Merger, NCO Portfolio entered into a ten year service agreement
that appointed NCOF as the provider of collection services to NCO Portfolio. NCO
Group has agreed to offer all of its future U.S. accounts receivable purchase
opportunities to NCO Portfolio. NCO Portfolio pays NCOF to perform collection
services for its purchased accounts receivable. Generally, NCOF is paid a
commission ranging from 20 percent to 40 percent depending on the nature of the
accounts. NCOF may outsource collections activities. As customary in the market,
the cost of outsourcing is generally higher as accounts age and are passed to
another placement level. Management believes that the commission rates paid are
reasonable and are consistent with rates charged by other collection agencies
for the same type of services. Servicing fees paid to NCOF amounted to $8.3
million and $11.9 million for the three months ended March 31, 2002 and 2003,
respectively.
Shared Services
NCO Group paid certain costs on behalf of NCO Portfolio during the quarters
ended March 31, 2002 and 2003. NCO Portfolio reimbursed NCO Group in full for
these costs. These costs related to certain shared services, including office
space, human resources, insurance, legal, payroll processing, external
reporting, management information systems and certain other administrative
expenses. Shared services amounted to $45,000 for the three months ended March
31, 2002 and 2003, respectively.
NCO Group Credit Facility
NCO Group has a credit agreement with Citizens Bank, for itself and as
administrative agent for other participating lenders that originally provided
for borrowings up to $350 million, structured as a revolving credit facility.
The borrowing capacity of the revolving credit facility is subject to mandatory
reductions including a quarterly reduction of $5.2 million until maturity, and
50 percent of the net proceeds received from any offering of debt or equity. As
of March 31, 2003, there was $54.2 million available under the revolving credit
agreement. NCO Group's borrowings are collateralized by substantially all the
assets of NCO Group, including its common stock of NCO Portfolio. Pursuant to
the Merger, NCO Portfolio entered into a credit agreement with NCO Group in the
form of a subfacility under its existing credit facility. Certain of NCO
Portfolio's assets have been pledged to Citizens Bank and other participating
lenders to secure its borrowings under the subfacility. The balance under the
subfacility will become due on May 20, 2004 ("Maturity Date"). The borrowing
capacity of the subfacility is subject to mandatory quarterly reductions.
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 subfacility is
reduced to $25 million. The maximum borrowing capacity on the subfacility was
reduced to $36.25 million as of March 31, 2003. The NCO Group credit agreement
and the NCO Portfolio subfacility contain certain financial covenants such as
maintaining net worth and funded debt to earnings before interest, taxes,
depreciation, and amortization ("EBITDA") requirements, and include restrictions
on, among other things, acquisitions and distributions to shareholders. As of
March 31, 2003, NCO Group and NCO Portfolio were in compliance with all of the
financial covenants.
12
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note G - Related Party Transactions (Continued)
NCO Group Credit Facility
The subfacility carries interest at two percent over NCO Group's underlying rate
from Citizens Bank and other participating lenders, of which one percent is paid
to the lenders and one percent is paid to NCO Group. At the option of NCO Group,
NCO Group's borrowings bear interest at a rate equal to either Citizens Bank's
prime rate plus a margin ranging from 0.25 percent to 0.50 percent that is
determined quarterly based upon NCO Group's consolidated funded debt to EBITDA
ratio (Citizens Bank's prime rate was 4.25 percent at March 31, 2003), or LIBOR
plus a margin ranging from 1.25 percent to 2.25 percent depending on NCO Group's
consolidated funded debt to EBITDA ratio (LIBOR was 1.31 percent at March 31,
2003). The subfacility contains a provision which provides Citizens Bank and
other participating lenders with an additional commitment fee of 0.25 percent
per quarter on the full commitment from August 20, 2001 to March 31, 2003, which
is included as part of interest expense. NCO Portfolio is charged a fee on the
unused portion of the subfacility ranging from 0.13 percent to 0.38 percent
depending on NCO Group's consolidated funded debt to EBITDA ratio. As of
December 31, 2002 and March 31, 2003, the outstanding balance under the
subfacility was $36.9 million and $36.25 million, respectively. Interest expense
for the three months ended March 31, 2002 and 2003 amounted to $830,000 and
$629,000, respectively.
Limited Partnership
In December 2002, NCO Portfolio invested $2.4 million for an 80 percent limited
partnership interest in a portfolio from a major financial institution in the
United Kingdom. The portfolio is comprised of charged off consumer loans to
residents of the United Kingdom. NCO Portfolio's 20 percent general partner in
the transaction is NCO Financial Services (UK) Ltd. ("NCO (UK)"), a wholly owned
subsidiary of NCO Group. NCO (UK) is in the business of contingency fee based
collections in the United Kingdom, and also purchases accounts receivable in the
United Kingdom. NCO (UK) has been servicing the portfolio since originally
outsourced by the seller and will continue to do so under the partnership
agreement between the two companies. Under the partnership agreement, NCO (UK)
will receive a 15 percent preferred distribution for its services to the
partnership, including the ongoing servicing of the portfolio. Thereafter,
collections are split 80 percent to NCO Portfolio and 20 percent to NCO (UK).
The operating results of the partnership have been included in NCO Portfolio's
consolidated results. NCO (UK)'s 20 percent interest is deducted from earnings
as a minority interest in consolidated earnings. Minority interest for the three
months ended March 31, 2003 was $70,000.
Court Costs
Effective April 1, 2003, NCO Portfolio amended its servicing agreement with
NCOF. Since NCOF is responsible for the operational decisions on referrals to
collection attorneys through the NCO Attorney Network, it was agreed that NCOF
will pay for most court costs and filings fees, and will be reimbursed for those
costs from most debtor payments once all principal and interest are paid by the
debtor. To transition from the prior arrangement to the current arrangement,
NCOF agreed to reduce court costs and filing fees incurred for the three months
ended March 31, 2003 by $1.1 million.
Note H - Supplemental Cash Flow Information
The following are supplemental disclosures of cash flow information for the
three months ended March 31, 2002 and 2003 (amounts in thousands):
2002 2003
---- ----
Cash paid for interest....................................... $ 1,831 $ 1,894
Noncash investing and financing activities:
Deferred portion of purchased accounts receivable..... $ -- $ 912
13
NCO PORTFOLIO MANAGEMENT, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS -- (CONTINUED)
Note I - Comprehensive Income
Comprehensive income consists of net income from operations, plus certain
changes in assets and liabilities that are not included in net income but are
reported as a separate component of shareholders' equity. The Company's
comprehensive income was as follows for the three months ended March 31,
(amounts in thousands):
2002 2003
---- ----
Net income....................................... $ 2,651 $ 1,434
Other comprehensive income (loss):
Foreign currency translation adjustment....... -- (65)
------- -------
Comprehensive income............................. $ 2,651 $ 1,369
======= =======
14
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS
OF OPERATIONS
Certain statements in this report on Form 10-Q, including, without limitation,
statements as to the Company's or management's outlook as to financial results
in 2003 and beyond; statements as to the effects of the economy on the Company's
business; statements as to the Company's or management's beliefs, expectations
or opinions, and all other statements in this report on Form 10-Q, other than
historical facts, are forward-looking statements, as such term is defined in the
Private Securities Litigation Reform Act of 1995, which are intended to be
covered by the safe harbors created thereby. Forward-looking statements are
subject to risks and uncertainties, are subject to change at any time, and may
be affected by various factors that may cause actual results to differ
materially from the expected or planned results. The Company disclaims any
intent or obligation to update forward-looking statements contained in this Form
10-Q. Certain risk factors, including without limitation, risks related to the
current economic condition in the United States, threats of war or future
terrorist attacks, risks relating to growth and future accounts receivable
purchases, risks related to the Company's debt, risks related to the
recoverability of the purchased accounts receivable, risks related to the use of
estimates, risks related to the ability to purchase accounts receivable at
favorable prices in the open market, risks related to competition, risks related
to regulatory oversight, risks related to the retention of the senior management
team, risks related to securitization transactions, risks related to the
fluctuation in quarterly results, risks related to NCO Group's ownership control
of the Company by NCO Group, risks related to the dependency on NCO Group's
subsidiary for collections, risks related to the dependency on NCOG's
telecommunications and computer systems, and other risks detailed from time to
time in the Company's filings with the Securities and Exchange Commission,
including the Annual Report on Form 10-K, filed on March 13, 2003, can cause
actual results and developments to be materially different from those expressed
or implied by such forward-looking statements.
A copy of the Annual Report on Form 10-K can be obtained, without charge except
for exhibits, by written request to Richard J. Palmer, Senior Vice President,
Finance/CFO, NCO Portfolio Management, Inc., 1804 Washington Blvd., Department
200, Baltimore, Maryland 21230.
Quarter Ended March 31, 2003 Compared to Quarter Ended March 31, 2002
Revenue. Total revenue increased $1.9 million, or 11.7 percent, from $16.3
million for the three months ended March 31, 2002 to $18.2 million for the three
months ended March 31, 2003. Revenue from purchased accounts receivable totaled
$16.3 million and $18.0 million for the three months ended March 31, 2002 and
2003, respectively, which includes revenue from fully cost recovered portfolios
of $116,000 for the three months ended March 31, 2003. Included in revenue for
the three months ended March 31, 2003 was $198,000 of revenue from the
reimbursement of court cost expenditures. Collections on purchased accounts
receivable increased $9.4 million, or 34.4 percent, from $27.3 million for the
three months ended March 31, 2002 to $36.7 million for the three months ended
March 31, 2003. Included in collections for the three months ended March 31,
2003 was $1.5 million in proceeds from the sale of accounts.
Revenue on purchased accounts receivable as a percentage of collections was 60
percent and 49 percent for the three months ended March 31, 2002 and 2003,
respectively. Revenue on purchased accounts receivable as a percentage of
collections can fluctuate period over period due to a number of factors
including:
(i) the relative under or over-achievement of actual collections versus
the established estimates. Actual collections exceeding estimates will tend to
lower the percentage because revenue on purchased accounts receivable is not
impacted at the same rate as the change in collections due to the effective
interest method of computing revenue, and conversely, not meeting collection
estimates will tend to increase the percentage;
(ii) the differences in the composition of portfolios at a point in
time in their life cycle. Over the life cycle of a portfolio, the percentage
will fluctuate due to the variable collection stream. However, in the aggregate,
the percentage of collections recognized as revenue should approximate the
lifetime profit, before servicing costs, recognized and the remainder is
amortized as a return of capital;
(iii) the composition of the targeted IRRs present in all of the
portfolios combined. Fresher purchased accounts receivable (portfolios with few
or no placements to collection agencies prior to purchase) generally have lower
IRRs than purchased accounts receivable that have been placed with multiple
collection agencies prior to purchase. Fresher accounts receivable typically
cost more. However, net of servicing fees, lower IRRs are offset by lower costs
to collect, resulting in similar targeted net returns;
(iv) collection trends will increase or decrease our expected IRR.
Increases or decreases in collections have the effect of raising (within
specified parameters) or lowering the future collection projections on all
portfolios, which translates into higher or lower IRRs, and in turn, affects the
percentage of collections recognized as revenue on purchased accounts
receivable;
(v) portfolios that become impaired are placed on cost recovery, and no
revenue on purchased accounts receivable will be recognized until their carrying
value has been fully recovered. After the carrying value has been fully
recovered, all collections are recorded as revenue on purchased accounts
receivable, and finally;
15
(vi) the occurrence of account sales in a quarter tend to reduce the
percentage of revenue recognized as account sale proceeds only marginally
increase the IRRs of the portfolios involved. The majority of the account sale
proceeds being allocated to principal amortization.
Revenue on purchased accounts receivable as a percentage of collections for the
three months ended March 31, 2003 declined compared to the same quarter last
year due to a number of these factors. First, purchases of accounts receivable
made in 2002 through March 31, 2003 have returns that were targeted lower at the
time of acquisition due to reduced collection estimates caused by the tougher
economic climate facing us in the near term. Additionally, larger purchases with
components of reperforming accounts (past due accounts that are now performing)
sometimes have lower targeted IRRs set at the time of purchase. Second, the
overall percentage was lowered due to a slow down in collections on existing
portfolios as a result of the continued weaknesses in the economy. Current
period collection shortfalls has the effect of lowering the future collection
projections on most older portfolios, which translated to lower IRRs and revenue
on purchased accounts receivable. Third, proceeds from resales of accounts
totaling $1.5 million are included in collections and had a marginal impact on
revenue from purchased accounts receivable as the rate at which revenue from
purchased accounts receivable is recognized period-to-period is not affected at
the same rate as changes in collections due to the effective interest method of
computing revenue. Finally, portfolios with $6.7 million in carrying value, or
4.6 percent of total purchased accounts receivable as of March 31, 2003 have
been impaired and placed on cost recovery status. Accordingly, no revenue from
purchased accounts receivable was recorded on these portfolios after their
impairment. All of these factors contributed to a lower ratio of revenue from
purchased accounts receivable to collections.
Payroll and related expenses. Payroll and related expenses decreased $74,000, or
13.4 percent, from $554,000 for the three months ended March 31, 2002 to
$480,000 for the three months ended March 31, 2003. Payroll and related expenses
remain a small part of the business model as a percentage of revenue because our
collection activities and many administrative functions are outsourced to NCOF.
The decrease in payroll and related expenses was principally due to the legal
recovery and agency outsourcing groups being transferred to the NCOF attorney
network in mid 2002.
Servicing fee expenses. Servicing fee expenses increased $3.6 million, or 43.4
percent, from $8.3 million for the three months ended March 31, 2002 to $11.9
million for the three months ended March 31, 2003. Servicing fees are paid as a
commission on collections, and include contingency legal fees. Servicing fees
are impacted by volume of collections on purchased accounts receivable and the
type of accounts receivable acquired, which affects the servicing fee rates
charged by NCOF. Servicing fees paid as a percentage of collections was 30.4
percent and 32.3 percent for the three months ended March 31, 2002 and 2003,
respectively. All of the servicing fees were paid to NCOF during the three
months ended March 31, 2002 and 2003. Servicing fees as a percentage of
collections increased from 2002 to 2003 as the composition of accounts
receivable has changed and aged over the previous twelve months. In general, the
accounts receivable acquired in the Merger have lower servicing fees as compared
to other accounts receivable purchased since the Merger because collections were
more predictable as a result of Creditrust's experience with these portfolios,
which also had a component of reperforming accounts. We expect that servicing
fees as a percentage of collections will increase in the future as collections
from accounts receivable acquired in the Merger decline in proportion to total
collections, and as the other portfolios age in general. Further, NCOF has and
may continue to outsource collections in an attempt to offset negative economic
trends, to test itself, and generally to augment resources. The cost to us
resulting from outsourcing is generally higher on such accounts since they are
relatively more difficult to resolve.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $372,000, or 65.7 percent, from $566,000 for
the three months ended March 31, 2002 to $938,000 for the three months ended
March 31, 2003. Selling, general and administrative expenses consist primarily
of court costs associated with legal collections, insurance, professional fees,
trustee fees, and office expenses. The increase was principally due to an
increase in court costs associated with legal collections and professional fees
associated with operational compliance activities. We and NCOF have renegotiated
how court costs and related filing fees for referrals to collection attorneys
are billed to us. Since NCOFS is responsible for the operational decisions on
referrals, the companies have agreed that effective with the second quarter of
2003, NCOF will pay most court costs and filing fees, and will be reimbursed
from most debtor payments once all principal and interest are paid by the
debtor. For the three months ended March 31, 2003, to transition from the prior
arrangement to the new arrangement, NCOF agreed to reduce court costs and filing
fee charges. This resulted in approximately $1.1 million less court costs for
the three months ended March 31, 2003. We expect that, as a result thereof,
court costs and filing fees, and court cost reimbursements by debtors, will
decrease significantly in future quarters as new court costs, net of all
reimbursed costs, will be born by NCOF.
16
Impairment of purchased accounts receivable. Impairment charges of $797,000 and
$310,000 for the three months ended March 31, 2002 and 2003, respectively, were
recorded. The combined remaining carrying value on impaired portfolios as of
March 31, 2002 and 2003 aggregated $7.4 million and $6.7 million, respectively,
or 5.5 percent and 4.6 percent, respectively, of purchased accounts receivable.
Impairments have occurred principally on older portfolios acquired prior to the
Merger at higher prices and with original projections estimated with higher
collections experienced historically compared to portfolios recently purchased.
A decline in impairment charges occurred principally as most of the older
portfolios were previously impaired in 2001 and 2002. Further, by adjusting
under performing portfolios by each portfolio's historical trend, the remaining
collection estimates are lowered and the likelihood of additional impairments is
reduced.
Other income (expense). Other income (expense) increased $500,000, or 29.4
percent, from $1.7 million for the three months ended March 31, 2002 to $2.2
million for the period ended March 31, 2003. Interest expense increased from
$1.9 million for the three months ended March 31, 2002, to $2.7 million for the
three months ended March 31, 2003. This increase is due to increased borrowings
from Cargill Financial. Offsetting interest expense is interest income and
income from two unconsolidated subsidiaries, which totaled $131,000 and $494,000
for the three months ended March 31, 2002 and 2003, respectively. The increase
was due to growth in net earnings due to additional purchased portfolios in our
investment in the Joint Venture.
Income tax expense. Income tax expense was recorded at 37.5 percent of pre-tax
income before minority interest for the three months ended March 31, 2002 and
2003. Our effective tax rate may fluctuate as a result of changes in pre-tax
income and nondeductible expenses. Tax payments for the three months ended March
31, 2002 and 2003 were deferred due to the book tax difference of accounting for
purchased accounts receivable on the accrual basis for Generally Accepted
Accounting Principles and the cost recovery basis for tax reporting.
Liquidity and Capital Resources
Historically, we have derived all of our cash flow from collections on purchased
accounts receivable and borrowings from NCO Group. Effective with the Merger, we
entered into a credit agreement with NCO Group in the form of a subfacility
under its existing credit facility. Borrowings under the subfacility have been
used primarily for the purchase of accounts receivable, the Merger and working
capital to support our growth.
NCO Group has a credit agreement with Citizens Bank, for itself and as
administrative agent for other participating lenders that originally provided
for borrowings up to $350 million, structured as a revolving credit facility.
The borrowing capacity of the credit facility is subject to quarterly reductions
of $5.2 million until maturity, and 50 percent of the net proceeds received from
any offering of debt or equity. As of March 31, 2003, there was $54.2 million
available under the credit agreement. NCO Group's borrowings are collateralized
by substantially all the assets of NCO Group, including our common stock owned
by NCO Group. Pursuant to the Merger, we entered into a credit agreement with
NCO Group in the form of a subfacility under its existing credit facility.
Certain of our assets have been pledged to Citizens Bank and other participating
lenders to secure our borrowings under the subfacility. The balance on the NCOG
credit facility and our subfacility will become due on May 20, 2004. The
borrowing capacity of the subfacility is subject to quarterly reductions.
Effective March 31, 2003, quarterly reductions of $3.75 million are required
until the earlier of May 20, 2004 or the date at which the subfacility is
reduced to $25 million. The maximum borrowing capacity on the subfacility was
reduced by $3.75 million on March 31, 2003 and was $36.25 million as of March
31, 2003.
The NCO Group credit agreement and the NCOG subfacility contain certain
financial covenants such as maintaining net worth and funded debt to EBITDA
ratio requirements, and include restrictions on, among other things,
acquisitions and distributions to stockholders. As of March 31, 2003, NCOG and
we were in compliance with all of the financial covenants.
The subfacility carries interest at two percent over NCO Group's underlying rate
from Citizens Bank and other participating lenders, of which one percent is paid
to the lenders and one percent is paid to NCO Group. At the option of NCO Group,
NCO Group's borrowings bear interest at a rate equal to either Citizens Bank's
prime rate plus a margin ranging from 0.25 percent to 0.50 percent that is
determined quarterly based upon NCO Group's consolidated funded debt to EBITDA
ratio (Citizens Bank's prime rate was 4.25 percent at March 31, 2003), or LIBOR
plus a margin ranging from 1.25 percent to 2.25 percent depending on NCO Group's
consolidated funded debt to EBITDA ratio (LIBOR was 1.31 percent at March 31,
2003). As of December 31, 2002 and March 31, 2003, the outstanding balance under
the subfacility was $36.9 million and $36.25 million, respectively. There was no
availability under the subfacility as of March 31, 2003.
17
We have two secured notes payable that were assumed in the Merger that have debt
service payments equal to total collections less servicing fees and expenses. No
additional borrowings are available on these notes. The combined balances of
these two secured notes payable amounted to $35.5 million and $34.9 million as
of December 31, 2002 and March 31, 2003, respectively. These borrowings carry
interest at LIBOR plus 0.65 percent and 15 percent, respectively, and mature on
March 2005 and December 2004, respectively. One of these secured notes has a
$900,000 liquidity reserve that restricts our use of cash. The reserve will be
posted as additional collateral of another off-balance sheet securitization
assumed in the Merger upon full satisfaction of the note. As of March 31, 2003,
we were in compliance with all of the financial covenants under the notes.
We also have a note payable related to our unconsolidated subsidiary that we
assumed in connection with the Merger. This note payable matures on January
2004, carries an interest rate of 8.61 percent, and had a balance of $2.4
million and $1.7 million as of December 31, 2002 and March 31, 2003,
respectively. In May 2002, the final secured note assumed in the Merger was paid
off. All collections from this note are now remitted directly to us, and are
used to purchase new accounts receivable and fund operations.
In August 2002, we entered into a four-year financing agreement with Cargill
Financial to provide financing for larger purchases of accounts receivable at 90
percent of the purchase price, unless otherwise negotiated. Cargill Financial,
at their sole discretion, has the right to finance any purchase of $4 million or
more. This agreement gives us the financing to purchase larger portfolios that
we may not otherwise be able to purchase, and has no minimum or maximum credit
authorization. Borrowings carry interest at the prime rate plus 3.25 percent
(prime rate was 4.25 percent as of March 31, 2003), and are nonrecourse to us
and NCOG, except for the assets within the special purpose entities established
in connection with this financing agreement. Debt service payments equal total
collections less servicing fees and expenses until each individual borrowing is
fully repaid, and our original investment is returned, including interest.
Thereafter, Cargill Financial is paid a residual of 40 percent of collections
less servicing costs, unless otherwise negotiated. Individual loans are required
to be repaid based on collections, but not more than two years from the date of
borrowing. Total debt outstanding under this facility as of December 31, 2002
and March 31, 2003 was $17.6 million and $17.8 million. As of March 31, 2002, we
were in compliance with all of the financial covenants.
In May 2002, we entered into a fixed price, three-month renewable forward-flow
agreement with a major financial institution that obligates us to purchase, on a
monthly basis, portfolios of charged off receivables meeting certain criteria.
As of March 31, 2003, we were obligated to purchase accounts receivable to a
maximum of $1.8 million per month through May 2003. A portion of the purchase
price is deferred for twelve months, including a nominal rate of interest. NCOG
guarantees this forward-flow agreement. Included in notes payable is $3.1
million of deferred purchase price as of March 31, 2003, with the first payment
beginning in June 2003. At the time of this filing, an agreement in principal
has been reached to renew the forward-flow agreement which will obligate us to
purchase accounts receivable for a maximum of $2.5 million per month through May
2004. A portion of the purchase price will be deferred for twenty-four months,
including a nominal rate of interest.
The debt service requirements associated with borrowings under our secured
credit facilities, including the borrowings under the Cargill Financial
agreement, the forward-flow agreement, and the mandatory reductions on our
subfacility from NCOG have increased liquidity requirements. The availability
under the subfacility was reduced to $36.25 as of March 31, 2003, and provides
for additional mandatory reductions of $3.75 million per quarter starting March
31, 2003 until the subfacility is reduced to $25 million. All of our secured
debt requires amortization of principal based on total collections net of
servicing fees and expenses on the secured portfolios. We anticipate that cash
flows from operations will be sufficient to fund all payments due through March
31, 2004 on the subfacility, debt service payments on secured debt through March
31, 2004, operating expenses, interest expense and mandatory purchases of
accounts receivable under our existing forward-flow agreement. Cash flows from
operations are directly related to the amount of collections actually received.
Estimates are used to forecast collections and revenue. A decrease in cash flows
from operations due to a decrease in collections from changes in the economy or
the performance of NCOF as service provider, may require us to reduce the amount
of accounts receivable purchased. The effect of reduced accounts receivable
purchases would be a reduction in planned collections and revenue in the periods
affected.
Cash Flows from Operating Activities. Net cash provided by operating activities
was $4.9 million for the three months ended March 31, 2002, compared to $4.3
million for the three months ended March 31, 2003. The decrease in cash and cash
equivalents provided by operations was principally attributable to a decrease in
net income, deferred income tax expense, and the noncash income from investment
in our joint venture, offset by an increase in accounts payable and accrued
expenses.
Cash Flows from Investing Activities. Net cash provided by investing activities
was $1.8 million for the three months ended March 31, 2002, compared to $1.7
million for the three months ended March 31, 2003. Cash used in or provided by
investing activities is principally a function of the amount of accounts
receivable purchased, offset by collections applied to principal on purchased
accounts receivable. Collections applied to principal on purchased accounts
receivable is the difference between collections and revenue. Cash purchases of
accounts receivable were $9.0 million and $16.9 million in the three months
ended March 31, 2002 and 2003, respectively, while the amount of collections
applied to principal on purchased accounts receivable were $11.1 million and
$18.7 million for the three months ended March 31, 2002 and 2003, respectively.
18
Cash Flows from Financing Activities. Net cash used in financing activities was
$3.9 million for the three months ended March 31, 2002, compared to $1.0 million
for the three months ended March 31, 2003. Total borrowings on the NCOG
subfacility for the three months ended March 31, 2002, were $370,000 compared to
$7.1 million of total borrowings, including Cargill Financial and the NCOG
subfacility, for the three months ended March 31, 2003. Borrowings were offset
by $4.2 million in repayments on secured notes payable for the three months
ended March 31, 2002, versus repayments of $8.1 million on secured notes payable
and the NCOG subfacility for the three months ended March 31, 2003.
Critical Accounting Policies
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 will differ
from those estimates. We believe that 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, and deferred taxes. These and other critical accounting policies are
described in Note B to these financial statements, and in "Management's
Discussion and Analysis of Financial Condition and Results of Operations" and
Note B to our 2002 financial statements contained in our Annual Report on Form
10-K for the year ended December 31, 2002.
Impact of Recently Issued and Proposed Accounting Pronouncements
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities"
In January 2003, the Financial Accounting Standards Board ("FASB") issued
Interpretation No. 46 ("FIN 46"), "Consolidation of Variable Interest Entities".
The objective of FIN 46 is to improve financial reporting by companies involved
with variable interest entities. FIN 46 defines variable interest entities and
requires that variable interest entities be consolidated by a company if that
company is subject to a majority of the risk of loss from the variable interest
entity's activities or is entitled to receive a majority of the entity's
residual returns or both. The disclosure requirements are effective for periods
ending after December 15, 2002. The consolidation requirements apply immediately
to variable interest entities created after January 31, 2003, and apply to
existing variable interest entities in the first fiscal year or interim period
beginning after June 15, 2003. We adopted the disclosure requirements of FIN 46,
and do not believe the adoption of FIN 46 will have a material impact on our
financial position and results of operations.
Accounting for Certain Purchased Loans or Debt Securities
During 2001, the Accounting Staff Executive Committee approved an exposure draft
on Accounting for Certain Purchased Loans or Debt Securities (formerly known as
Discounts Related to Credit Quality) (Exposure Draft-December 1998). The
proposal would apply to all companies that acquire loans for which it is
probable at the acquisition date that all contractual amounts due under the
acquired loans will not be collected. The proposal addresses accounting for
differences between contractual and expected future cash flows from an
investor's initial investment in certain loans when such differences are
attributable, in part, to credit quality. The scope also includes such loans
acquired in purchased business combinations. If adopted, the proposed Statement
of Position, referred to as SOP, would supersede Practice Bulletin 6,
Amortization of Discounts on Certain Acquired Loans. In June 2001, the Financial
Accounting Standards Board, referred to as FASB, cleared the SOP for issuance
subject to minor editorial changes and planed to issue a final SOP in early
2002. The SOP has not yet been issued. The proposed SOP would limit the revenue
that may be accrued to the excess of the estimate of expected future cash flows
over a portfolio'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,
referred to as 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
portfolio 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 portfolio'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.
FASB Statement 148, "Accounting for Stock-Based Compensation - Transition and
Disclosure"
In April 2003, the FASB indicated that it plans to have a new rule in place by
the end of 2004 which will require that stock based compensation should be
recorded as a cost that is recognized in the financial statements.
19
Item 3. Quantitative and Qualitative Disclosures About Market Risk
We are exposed to various types of market risk in the normal course of business,
including the impact of interest rate changes and changes in corporate tax
rates. A material change in these rates could adversely affect our operating
results and cash flows. A 25 basis point increase in interest rates could
increase our annual interest expense by $25,000 for each $10 million of variable
debt outstanding for the entire year. We retain an investment in securitization
with respect to its securitized accounts receivable which is a market risk
sensitive financial instrument held for purposes other than trading. This
investment exposes us to market risk, which may arise from changes in interest
and discount rates applicable to this investment. The impact of a 1 percent
increase in the discount rate used by us in the fair value calculations would
not have a material impact on our balance sheet as of March 31, 2003. There
would be no impact on our future cash flows. We own an 80 percent interest in a
limited partnership that invests in accounts receivable in the United Kingdom.
This investment exposes us to risk due to fluctuations in foreign currency
exchange rates. As of March 31, 2003, exchange rate fluctuations did not have a
material impact on our balance sheet. We do not invest in derivative financial
or commodity instruments.
Inflation
We believe that inflation has not had a material impact on our results of
operations for the three months ended March 31, 2002 and 2003.
Item 4. Controls and Procedures
Quarterly evaluation of the Company's Disclosure Controls. Within the 90 days
prior to the date of this Quarterly Report on Form 10-Q, the Company evaluated
the effectiveness of the design and operation of its "disclosure controls and
procedures" ("Disclosure Controls"). This evaluation ("Controls Evaluation") was
done under the supervision and with the participation of management, including
the Chief Executive Officer ("CEO") and Chief Financial Officer ("CFO").
Limitations on the Effectiveness of Controls. The Company's management,
including the CEO and CFO, does not expect that its Disclosure Controls or its
"internal controls and procedures for financial reporting" ("Internal Controls")
will prevent all error and all fraud. A control system, no matter how well
conceived and operated, can provide only reasonable, not absolute, assurance
that the objectives of the control system are met. Further, the design of a
control system must reflect the fact that there are resource constraints, and
the benefits of controls must be considered relative to their costs. Because of
the inherent limitations in all control systems, no evaluation of controls can
provide absolute assurance that all control issues and instances of fraud, if
any, within the Company have been detected. These inherent limitations include
the realities that judgments in decision-making can be faulty, and that
breakdowns can occur because of simple error or mistake. Additionally, controls
can be circumvented by the individual acts of some persons, by collusion of two
or more people, or by management override of the control. The design of any
system of controls also is based in part upon certain assumptions about the
likelihood of future events, and there can be no assurance that any design will
succeed in achieving its stated goals under all potential future conditions;
over time, controls may become inadequate because of changes in conditions, or
the degree of compliance with the policies or procedures may deteriorate.
Because of the inherent limitations in a cost-effective control system,
misstatements due to error or fraud may occur and not be detected.
Conclusions. Based upon the Controls Evaluation, the CEO and CFO have concluded
that, to the best of their knowledge and subject to the limitations noted above,
the Disclosure Controls are effective to timely alert management to material
information relating to the Company during the period when its periodic reports
are being prepared.
In accordance with SEC requirements, the CEO and CFO note that, to the best of
their knowledge, since the date of the Controls Evaluation to the date of this
Quarterly Report, there have been no significant changes in Internal Controls or
in other factors that could significantly affect Internal Controls, including
any corrective actions with regard to significant deficiencies and material
weaknesses.
20
PART II
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
The Company is involved in legal proceedings from time to time in the ordinary
course of its business. Management believes that none of these legal proceedings
will have a materially adverse effect on the financial condition or results of
operations of the Company.
Item 2. Changes in Securities and Use of Proceeds.
None - not applicable
Item 3. Defaults Upon Senior Securities
None - not applicable
Item 4. Submission of Matters to a Vote of Shareholders
None - not applicable
Item 5. Other Information
None - not applicable
Item 6. Exhibits and Reports on Form 8-K
(A) Exhibits
99.1 Chief Executive Officer Certification Pursuant to U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
99.2 Chief Financial Officer Certification Pursuant to U.S.C. Section 1350,
as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002.
(B) Reports on Form 8-K
NCO Portfolio filed an 8-K on February 27, 2003 Item 7 "Financial Statements and
Exhibits" and Item 9 "Regulation FD Disclosures".
21
SIGNATURES
Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange
Act of 1934, the registrant has duly caused this report to be signed on its
behalf by the undersigned, thereunto duly authorized, in the City of Baltimore,
State of Maryland, on May 15, 2003.
NCO PORTFOLIO MANAGEMENT, INC.
By: MICHAEL J. BARRIST
------------------------------------------------
Michael J. Barrist
Chairman, Chief Executive Officer, and President
By: RICHARD J. PALMER
-----------------------------------------------
Richard J. Palmer
Senior Vice President, Finance and Treasurer
22
CERTIFICATIONS
I, Michael J. Barrist, Chief Executive Officer of NCO Portfolio Management,
Inc., certify that:
1. I have reviewed this quarterly report on Form 10-Q of NCO
Portfolio Management, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
Date: May 15, 2003
MICHAEL J. BARRIST
- ----------------------------
Michael J. Barrist
Chief Executive Officer
(Principal Executive Officer)
23
I, Richard J. Palmer, Chief Financial Officer of NCO Portfolio Management, Inc.,
certify that:
1. I have reviewed this quarterly report on Form 10-Q of NCO
Portfolio Management, Inc.;
2. Based on my knowledge, this quarterly report does not contain any
untrue statement of a material fact or omit to state a material
fact necessary to make the statements made, in light of the
circumstances under which such statements were made, not
misleading with respect to the period covered by this quarterly
report;
3. Based on my knowledge, the financial statements, and other
financial information included in this quarterly report, fairly
present in all material respects the financial condition, results
of operations and cash flows of the registrant as of, and for,
the periods presented in this quarterly report;
4. The registrant's other certifying officer and I are responsible
for establishing and maintaining disclosure controls and
procedures (as defined in Exchange Act Rules 13a-14 and 15d-14)
for the registrant and have:
a. designed such disclosure controls and procedures to ensure
that material information relating to the registrant, including
its consolidated subsidiaries, is made known to us by others
within those entities, particularly during the period in which
this quarterly report is being prepared;
b. evaluated the effectiveness of the registrant's disclosure
controls and procedures as of a date within 90 days prior to the
filing date of this quarterly report (the "Evaluation Date"); and
c. presented in this quarterly report our conclusions about the
effectiveness of the disclosure controls and procedures based on
our evaluation as of the Evaluation Date;
5. The registrant's other certifying officer and I have disclosed,
based on our most recent evaluation, to the registrant's auditors
and the audit committee of registrant's board of directors (or
persons performing the equivalent functions):
a. all significant deficiencies in the design or operation of
internal controls which could adversely affect the registrant's
ability to record, process, summarize and report financial data
and have identified for the registrant's auditors any material
weaknesses in internal controls; and
b. any fraud, whether or not material, that involves management
or other employees who have a significant role in the
registrant's internal controls; and
6. The registrant's other certifying officer and I have indicated in
this quarterly report whether there were significant changes in
internal controls or in other factors that could significantly
affect internal controls subsequent to the date of our most
recent evaluation, including any corrective actions with regard
to significant deficiencies and material weaknesses.
Date: May 15, 2003
RICHARD J. PALMER
- ----------------------------
Richard J. Palmer
Chief Financial Officer
(Principal Financial Officer)
24