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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, 2003
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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
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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 executive offices) (Zip Code)
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
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Securities registered pursuant to Section 12(g) of the Act: Common stock, no par value
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of 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. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as
defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of voting and nonvoting common equity held by
nonaffiliates was approximately $412,067,723(1).
The number of shares of the registrant's common stock outstanding as of March
12, 2004 was 26,035,777.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's Proxy Statement to be filed in connection
with its 2004 Annual Meeting of Shareholders are incorporated by reference into
Part III of this Report; provided, however, that the Compensation Committee
Report, the Audit Committee Report, the graph showing the performance of the
Company's stock and any other information in such Proxy Statement that is not
required to be included in this Annual Report on Form 10-K, shall not be deemed
to be incorporated herein or filed for the purposes of the Securities Act of
1933 or the Securities Exchange Act of 1934. Other documents incorporated by
reference are listed in the Exhibit Index.
_________________
(1)The aggregate market value of the voting and nonvoting common equity held by
nonaffiliates set forth equals the number of shares of the registrant's common
stock outstanding, reduced by the number of shares of common stock held by
officers, directors and shareholders owning 10 percent or more of the
registrant's common stock, multiplied by $17.89, the last reported sale price
for the registrant's common stock on June 30, 2003, the last business day of
the registrant's most recently completed second fiscal quarter. The information
provided shall in no way be construed as an admission that any person whose
holdings are excluded from this figure is an affiliate of the registrant or that
such person is the beneficial owner of the shares reported as being held by such
person, 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. 2
Item 2. Properties. 27
Item 3. Legal Proceedings. 28
Item 4. Submission of Matters to a Vote of Security Holders. 28
Item 4.1 Executive Officers of the Registrant who are not also Directors. 29
PART II
Item 5. Market for Registrant's Common Equity and
Related Shareholder Matters. 31
Item 6. Selected Financial Data. 32
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 33
Item 7a Quantitative and Qualitative Disclosures about Market Risk. 47
Item 8. Financial Statements and Supplementary Data. 47
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. 47
Item 9a. Controls and Procedures. 47
PART III
Item 10. Directors and Executive Officers of the Registrant. 49
Item 11. Executive Compensation. 49
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Shareholder Matters. 49
Item 13. Certain Relationships and Related Transactions. 49
Item 14. Principal Accountant Fees and Services. 49
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 50
Signatures. 56
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 1. "Business" and 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 pending
acquisitions of RMH Teleservices, Inc., referred to as RMH, and the minority
interest of NCO Portfolio Management, Inc., referred to as NCO Portfolio,
fluctuations in quarterly operating results, the long-term collection contract,
the final outcome of the environmental liability, the final outcome of the
Company's litigation with its former landlord, the final outcome of the Federal
Trade Commission investigation, the effects of terrorist attacks, war 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, estimates of goodwill
impairments and amortization expense of other intangible assets, 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 acquisition of RMH and the minority
interest of NCO Portfolio and their operations, 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,
risks related to the final outcome of the environmental liability, risks related
to the final outcome of the Company's litigation with its former landlord, risks
related to the final outcome of the Federal Trade Commission investigation,
risks related to the Company's litigation, regulatory investigations and tax
examinations, risks related to past or possible future terrorist attacks, risks
related to the threat or outbreak of war or hostilities, risks related to the
domestic and international economy, risks related to the Company's international
operations, 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.
The Company disclaims any intent or obligation to publicly update or revise
any forward-looking statements, regardless of whether new information becomes
available, future developments occur or otherwise.
-1-
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 composed 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
77 centers.
Our website is www.ncogroup.com. We make available on our website, free of
charge, our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports, filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably
practicable after such material is electronically filed with or furnished to the
SEC.
In addition, we will provide, at no cost, paper or electronic copies of our
reports and other filings (excluding exhibits) made with the SEC. Requests
should be directed to:
NCO Group, Inc.
507 Prudential Road
Horsham, PA 19044
Attention: Steven L. Winokur, Executive Vice President, Finance;
Chief Financial Officer; Chief Operating Officer
of Shared Services; and Treasurer
The information on the website listed above, is not and should not be
considered part of this annual report on Form 10-K and is not incorporated by
reference in this document. This website is and is only intended to be an
inactive textual reference.
Industry Background
Increasingly, companies are outsourcing many noncore 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 collections. 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.
-2-
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 noncore 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. The primary market sectors within our industry are financial
services, healthcare, and retail and commercial. Other important market sectors
include telecommunications, utilities, education, 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 privacy and quality standards demanded by businesses
seeking to outsource their accounts receivable management function.
Strategy
Our strategy is to transition into a global provider of business process
outsourcing services while maintaining our market dominance as a global provider
of accounts receivable management and collection services. Our strategy to
achieve these objectives includes the following elements:
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 2001, 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;
o leveraging our purchasing power; and
o leveraging foreign labor.
-3-
Business Process Improvements - We continually develop and enhance our
technology and infrastructure with initiatives that improve the efficiency of
our operations and enhance client service. Examples of recent initiatives
include:
o Online access for subcontractor agencies: Leveraging the technology put
in place to service our Attorney Network System (NCOeForwardEase), which brings
us online with over 80 attorneys from across the United States, we have expanded
this system to also support the needs of data exchange with other agencies we
utilize to service accounts. These agencies are now able to receive, process,
and return updates for all forwarded accounts using the latest web server
technology.
o Quality control over client data exchange: We have continued to enhance a
proprietary software product that tracks both the client inbound files and the
client remittance files. This system now incorporates all the features for both
quality and production control.
o Web-enabled electronic bill payment for our clients and their customers:
We have developed web-based platforms that process real-time credit card
authorizations and electronic bank draft payments that are then applied to
customer accounts on the client's billing system. The system is available to the
clients' employees inside their own call centers and to their customers for
self-service over the Internet.
o Improved client host integration: We continue to see increased efficiency
gains by integrating and automating client host connections and their associated
workflows utilizing the NCO ACCESS Interface Manager. Our representatives are
able to work on our systems and the client systems together from a single
interface that is common across all call centers, yet customized to accommodate
each client's workflow. This delivers benefits including a reduction in project
ramp-up time, a reduction in training costs, and an overall increase in account
representative productivity.
o On-going business process reengineering: We continue to drive improved
performance and reduced cost through our on-going focus on business process
improvement. Through the deployment of enhanced imaging technology we will
continue to reduce the dependency on paper-driven processes and give us the
flexibility to complete these administrative tasks at any location, on-shore,
near-shore, or off-shore.
o Technology support center: This industry-leading IT Infrastructure
monitoring and management system provides graphical displays and a notification
system that rapidly alerts trained staff to potential business-impacting
problems. In many cases, the staff is alerted before the end-user community is
affected. This industry innovation allows us to combine the classic IT Help Desk
and the first and second levels of systems and network administration roles to
provide maximized return on investment, increased quality of end-user support,
and a single point of information coordination and dissemination to our end
users, IT engineers and business management.
o Enhanced data security: We continue to deploy both physical and system
security enhancements to help ensure ongoing protection and privacy of NCO and
client data as well network and systems hardening.
-4-
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 develop access to lower-cost
foreign labor. We operate in Canada and the United Kingdom through wholly owned
subsidiaries and we 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. These types of alliances enhance our service offerings as well as
increase the awareness of NCO as a global provider of accounts receivable
management and collection services.
In addition to providing services to these core markets, we also provide
our domestic clients with a cost-effective option of using such foreign labor
markets as Canada, India and Barbados to provide effective services. We
currently have approximately 1,100, 450 and 80 telephone representatives working
in Canada, India and Barbados for our U.S. clients, respectively. We are in the
process of expanding our presence in India and Barbados as well as exploring new
opportunities in other labor markets such as Australia, Eastern Europe, Central
America and the Caribbean.
Continued 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. Under the terms of our credit agreement, our investment
in NCO Portfolio currently is limited to $50.0 million. In order to take
advantage of larger purchase opportunities without increasing its exposure to
individual portfolios, NCO Portfolio entered into a four-year financing
agreement with CFSC Capital Corp. XXXIV ("Cargill") in August 2002. The
agreement stipulates that all purchases of accounts receivable by NCO Portfolio
with a purchase price in excess of $4.0 million must be first offered to Cargill
for the opportunity to finance. Cargill, at its sole discretion, has the right
to refuse to finance any of the purchased accounts receivable. Borrowings under
this financing agreement are nonrecourse to us and NCO Portfolio but are
collateralized by the accounts receivable purchased through Cargill and
cross-collateralized with all other accounts receivable purchases financed by
Cargill.
As of December 31, 2003, NCO Portfolio had an investment of $4.0 million
for its 50 percent ownership interest in a joint venture, InoVision-MEDCLR NCOP
Ventures, LLC, referred to as the Joint Venture, with IMNV Holdings, LLC,
referred to as 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 percent of the value of the purchased accounts receivable to the Joint
Venture. The debt is cross-collateralized by all portfolios in which the lender
participates and is nonrecourse 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, NCO Portfolio will gain
access to capital while limiting both our and NCO Portfolio's exposure to credit
risk.
-5-
Continue to explore strategic acquisition opportunities - During 2002, we
completed the acquisitions of Great Lakes Collection Bureau, Inc. and The
Revenue Maximization Group, Inc.
On November 18, 2003, NCO and RMH Teleservices, Inc., referred to as RMH, a
provider of customer relationship management services, announced that they
entered into an agreement by which RMH would be merged with a wholly owned
subsidiary of NCO. Pursuant to the proposed merger, we would acquire RMH in a
transaction expected to be tax-free to the shareholders of RMH. Under the RMH
merger agreement, as amended, RMH's shareholders will receive 0.2150 shares of
NCO common stock for each share of RMH common stock. The transaction is subject
to a collar arrangement. It is anticipated that the Company will issue
approximately 3.4 million shares of NCO common stock to RMH's shareholders. It
is also anticipated that the Company will issue approximately 593,000 additional
shares of NCO common stock upon the exercise of currently outstanding options
and warrants to purchase RMH common stock to be assumed by the Company in the
merger. This acquisition is expected to be completed in April 2004. We believe
that RMH's customer relationship management services will enhance our ability to
provide a broader range of business process outsourcing services to our clients
in various industry sectors.
On December 15, 2003, NCO and NCO Portfolio announced that they entered
into an agreement by which NCO Portfolio would be merged with a wholly owned
subsidiary of NCO. We currently own approximately 63.3 percent of the
outstanding stock of NCO Portfolio and pursuant to the proposed merger would
acquire all NCO Portfolio shares that we do not own in a transaction expected to
be tax-free to the stockholders of NCO Portfolio. Michael J. Barrist, chairman
of the board, president and chief executive officer of NCO, also serves as
chairman of the board, president and chief executive officer of NCO Portfolio
and beneficially owns 2.8 percent of NCO Portfolio's outstanding common stock,
excluding stock options. Under the NCO Portfolio merger agreement, NCO
Portfolio's minority stockholders will receive 0.36187 of a share of NCO common
stock for each share of NCO Portfolio common stock. We will issue approximately
1.8 million shares of NCO common stock to NCO Portfolio's minority stockholders.
Under the NCO Portfolio merger agreement, if the average closing sale price of
NCO common stock for the 10 day trading period ending on the second day prior to
the closing date of the transaction were to be less than $21.50 per share, NCO
Portfolio would have the right to terminate the NCO Portfolio merger agreement
unless we were to agree to improve the exchange ratio so that the NCO Portfolio
minority stockholders receive that number of shares of NCO common stock with a
value equivalent to the $21.50 price, based on such 10 trading day average stock
price. We will also assume all outstanding NCO Portfolio stock options. This
transaction is expected to be completed in March 2004. We believe that the
combined company will be able to more effectively pursue, in a coordinated
manner, strategic growth opportunities and other expansion strategies, in part
due to improved integration and coordination between NCO Portfolio and us.
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 current focus is
on internal growth and the integration of the RMH and NCO Portfolio
acquisitions, we believe we will continue to find attractive acquisition
opportunities over time.
HIPAA compliance - During 2003, we completed the implementation of new
policies and procedures designed to ensure our continuing compliance with the
new standards for privacy, data security, and administrative simplification
under the Health Insurance Portability and Accountability Act of 1996, referred
to as HIPAA. We enhanced our data security programs, tested and upgraded, as
necessary, physical security at all healthcare service centers, and completed
the implementation of HIPAA privacy training for all healthcare staff. We
continued the rollout of HIPAA privacy practices as the "best practices" across
all of our business lines to ensure the protection and the confidentiality of
all clients' data.
-6-
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 also
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 70 percent 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 percent to 35 percent of the amounts
recovered on behalf of our clients. However, fees can range from six percent for
the management of accounts placed early in the accounts receivable cycle to 50
percent for accounts that have been serviced extensively by the client or by
third-party providers. Our average fee for contingency-based revenue across all
industries, excluding the long-term collection contract, was approximately 19
percent during 2003, 2002 and 2001.
Accounts receivable management and collection services typically include
the following activities:
Engagement 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 client's 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 client's customer, the notification process
can begin.
-7-
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 client's customers who cannot afford to pay at the current time.
This letter also serves as an official notification to each client's 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 client's 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 possible denial of future credit
often motivates the resolution of past due accounts.
Payment Process. After we receive payment from the client's customer,
depending on the terms of our contract with the client, we can either remit the
amount received minus our fee to the client or remit the entire amount received
to the client and subsequently bill the client for our services.
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.
-8-
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 80 law firms whose
attorneys specialize in collection litigation. Our collection support staff
manages the attorney relationships and facilitates the transfer of all necessary
documentation.
NCOePayments. We can provide clients with a virtual 24-hour payment center
that is accessible by the use of telephones or the Internet.
Credit and Investigative Reporting Service. We develop the information
needed to profile commercial debtors and make decisions affecting extensions of
credit.
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 Manager. 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 Information Technology
staff is comprised of approximately 200 employees led by a Chief Information
Officer. We provide our services through the operation of 77 centers that are
electronically linked through an international wide area network, with the
exception of our two United Kingdom centers.
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 we maintain
comprehensive business interruption and critical systems insurance on our
telecommunications and computer systems. Our systems also permit network access
to enable clients to electronically communicate with us and monitor operational
activity on a real-time basis.
Our call centers utilize predictive dialers with over 5,200 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.
-9-
Sales and Marketing
Our sales force is organized into three functional groups to best match our
sales professionals' experience and expertise with the appropriate target
market. This cost-effective structure allows us to strategically allocate
resources corresponding to potential revenue and partnership opportunities.
The largest group consists of approximately 300 telephone sales
representatives who specialize in business-to-business accounts receivable
solutions for small to mid-sized companies.
Our core sales force, composed of approximately 70 sales professionals, is
organized by industry vertical and geographical location to ensure the highest
level of focus and service to potential and existing business partners. This
group specializes in direct sales efforts aimed at delivering customized
outsourced solutions primarily within the accounts receivable management market
space.
To help facilitate our successful entrance into the business process
outsourcing arena, we recently implemented an additional group responsible for
enterprise-wide sales efforts. This team consists of approximately 10 seasoned
sales veterans who focus on forming and cultivating strategic, long-term
partnerships with large, multinational firms in order to maximize outsourcing
opportunities via our full suite of accounts receivable and customer
relationship management services.
Our in-house marketing department provides innovative customer contact
solutions and sales support by performing a wide range of personalized services
such as customer database administration, advertising, marketing campaigns and
direct mailings, collateral development, trade show and site visit management,
market and competitive research, and more. They also maintain a dedicated team
of skilled writers who prepare detailed, professional responses to formal
requests for proposals and requests for information.
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 client 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 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.
-10-
Client Relationships
Our client base currently includes over 50,000 companies in the financial
services, healthcare, retail and commercial, telecommunications, utilities,
education and government sectors. Our 10 largest clients in 2003 accounted for
approximately 31 percent of our revenue. In 2003, our largest client accounted
for 10.3 percent of total revenue. No other client accounted for more than 10
percent of total revenue. In 2003, we derived 40.0 percent of our revenue,
excluding purchased accounts receivable, from financial services (which included
the banking and insurance sectors), 23.2 percent from healthcare organizations,
13.7 percent from retail and commercial entities, 10.2 percent from
telecommunications companies, 7.3 percent from utilities, 4.7 percent from
educational organizations, and 0.9 percent from government entities.
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.
We have a long-term collection contract with a large client to provide
collection services. We receive a base service fee based on collections. We also
earn a bonus to the extent collections are in excess of the guarantees. We are
required to pay the client, subject to limits, if collections do not reach the
guarantees. Any guarantees in excess of the limits will only be satisfied with
future collections. We are entitled to recoup at least 90 percent of any such
guarantee payments from subsequent collections in excess of any remaining
guarantees.
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 collections or with experience as telephone
representatives. We generally offer internal promotion opportunities and
competitive compensation and benefits.
All of 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, 2003, we had a total of approximately 8,300 full-time
employees and 700 part-time employees, of which 7,400 are telephone
representatives. As of December 31, 2003, we also utilized 450 and 80 telephone
representatives through a subcontractor in India and Barbados, respectively. Our
employees are not represented by a labor union. We believe that our relations
with our employees are good.
-11-
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 in the United
States 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.
We provide services to healthcare clients, which as providers of healthcare
services are considered "covered entities" under Health Insurance Portability
and Accountability Act of 1996, referred to as HIPAA. As covered entities, our
clients must comply with the new standards for privacy, transaction and code
sets, and data security. Under HIPAA, we have been deemed to be a "business
associate", which requires that we protect the security and privacy of
"protected health information" provided to us by our clients for the collection
of payments for healthcare services. In 2003, we implemented HIPAA compliance
training and awareness programs for our healthcare service employees. We also
have undertaken an ongoing process to test data security at all relevant levels.
In addition, we reviewed physical security at all healthcare operation centers
and, as appropriate, upgraded or added security systems to control access to all
work areas.
-12-
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 conduct 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 that have 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 various
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 comply with all federal and
state regulatory requirements. We believe that we are in material compliance
with all such regulatory requirements.
Segment and Geographical Financial Information
See note 20 in our Notes to Consolidated Financial Statements for
disclosure of financial information regarding our segments and geographic areas.
-13-
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
---------- ---------------------- ---------------- -------------------
The Revenue Maximization 12/9/02 A/R Management $ 17,500(1) $ 24,648
Group, Inc.
Great Lakes Collection Bureau, Inc. 8/19/02 A/R Management and 33,000(2) 52,250
Purchased A/R
Creditrust Corporation 2/20/01 Purchased A/R 25,000(3) 36,491
Compass International Services 8/20/99 A/R Management and 104,100 105,800(4)
Corporation Telemarketing
Co-Source Corporation 5/21/99 A/R Management 124,600 61,100
JDR Holdings, Inc. 3/31/99 A/R Management and 103,100 51,000
Telemarketing
Medaphis Services Corporation 11/30/98 A/R Management 117,500 96,700
MedSource, Inc. 7/1/98 A/R Management 35,700(5) 22,700
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) Includes $889,000 of debt repaid by us.
(2) NCO Group, Inc. acquired the net assets and the results of operations for
$10.1 million, and NCO Portfolio Management, Inc. acquired the purchased
accounts receivable for $22.9 million.
(3) We merged our subsidiary NCO Portfolio Management, Inc. with Creditrust
Corporation. We own approximately 63 percent of the post-merger company.
(4) 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.
(5) Includes $17.3 million of debt repaid by us.
-14-
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.
Risks Related to Our Business
Decreases in our collections due to the economic condition in the United
States may have an adverse effect on our results of operations, revenue and
stock price.
Due to the economic condition in the United States, which has led to high
rates of unemployment and personal bankruptcy filings, the ability of consumers
to pay their debts has significantly decreased. Defaulted consumer loans that we
service or purchase are generally unsecured, and we may be unable to collect
these loans in case of the personal bankruptcy of a consumer. Because of higher
unemployment rates and bankruptcy filings, our collections may significantly
decline, which may adversely impact our results of operations, revenue and stock
price.
Terrorist attacks, war and threats of attacks and war may adversely impact
our results of operations, revenue and stock price.
Terrorist attacks, war and threats of attacks and war may adversely impact
our results of operations, revenue and stock price. Recent terrorist attacks in
the United States and on United States targets abroad, 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 adversely 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 an adverse effect on the economy of the United States. Any
of these occurrences could have a material adverse effect on our results of
operations, 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:
o our ability to retain existing clients and expand our existing client
relationships; and
o 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.
-15-
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.
Implementation of an enterprise resource planning system could cause business
interruptions and negatively affect our profitability and cash flows.
We are planning to begin the process of implementing an enterprise resource
planning, referred to as ERP, system in 2004 to improve customer service,
enhance operating efficiencies, and provide more effective management of
business operations. This implementation will enable us to better meet both the
changing standards of industry technology and the needs of our customer base.
Implementation of ERP systems and software carry risks such as cost overruns,
project delays, business interruptions and delays, and the diversion of
management's attention from operations. These risks could adversely affect us,
and could have a material adverse effect on our business, results of operations,
financial condition and cash flows.
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 record the results of our 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. Telecommunications
and computer technologies are changing rapidly and are characterized by short
product life cycles, so 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 could 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 terrorist acts,
natural disasters, power losses, or similar events. Our business is also
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 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.
-16-
Many of our clients are concentrated in the financial services and
healthcare sectors. If either 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, 2003, we derived approximately 40.0 percent
of our revenue, excluding purchased accounts receivable, from clients in the
financial services sector, and approximately 23.2 percent of our revenue from
clients in the healthcare sector. If either 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 we receive could decrease.
We have international operations and various factors relating to our
international operations could affect our results of operations.
We operate in Canada and the United Kingdom. Approximately 5.4% of our 2003
revenues were derived from Canada and the United Kingdom. Political or economic
instability in Canada or the United Kingdom could have an adverse impact on our
results of operations due to diminished revenues in these countries. Our future
revenue, costs of operations and profit results could be affected by a number of
factors related to our international operations, including changes in foreign
currency exchange rates, changes in economic conditions from country to country,
changes in a country's political condition, trade protection measures, licensing
and other legal requirements, and local tax issues.
Unanticipated currency fluctuations in the Canadian Dollar, British Pound
or Euro could lead to lower reported consolidated results of operations due to
the translation of these currencies into U.S. dollars when we consolidate our
financial results. In addition, NCO Group provides services to its U.S. clients
through call centers in India and Barbados. The employees of the call centers
are hired through a subcontractor. Any political or economic instability in
India or Barbados could have an adverse impact on NCO Group's results of
operations.
Most of our contracts do not require clients to place accounts with us, may
be terminated on 30 or 60 days notice and 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. Therefore, under applicable accounting principles, we
can recognize revenues only upon the collection of funds on behalf of clients.
-17-
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 $50.0 million. If
the value of our investment is impaired, it would have a material adverse
effect on us.
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. We depend on the services of Mr. Barrist and the
other members of our senior management team to, among other things, continue the
development and implementation of 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 or the business process
outsourcing business are not available at favorable prices due to increased
competition for these companies.
We may have to borrow money, incur liabilities, or sell or issue 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 have a
material adverse effect on 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.
-18-
Our employees are not represented by a labor union. If our employees
attempt to organize a labor union, and are successful, this could increase our
recruiting and training costs and could decrease our operating efficiency and
productivity.
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 U.S. 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 materially adversely affect 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.
Several of the industries we serve 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 various 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.
-19-
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 routinely publicly announce investor guidance concerning our expected
results of operations. Our investor guidance contains forward-looking statements
and may be affected by various factors discussed in "Investment Considerations"
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.
If the acquisitions of RMH and the minority interest of NCO Portfolio are
completed, merger related accounting impairment and amortization charges might
reduce our profitability.
If the acquisitions of RMH and the minority interest of NCO Portfolio are
completed, under generally accepted accounting principles, the minority interest
component of the acquired assets and assumed liabilities of NCO Portfolio and
the acquired assets and assumed liabilities of RMH will be recorded on our books
at their fair values at the dates the respective mergers are completed. Any
excess of the value of the consideration paid by us at the date the merger is
completed over the fair value of the minority interest component of the
identifiable tangible and intangible assets of NCO Portfolio and over the fair
value of the identifiable tangible and intangible assets of RMH, including
customer lists for RMH, will be treated as excess of purchase price over the
fair value of net assets acquired (commonly known as goodwill). Goodwill is not
amortized for accounting purposes. However, the amounts allocable to certain
identifiable intangible assets, including customer lists, are amortized over
their respective useful lives. As a result, we may incur substantial accounting
amortization charges that will affect our profitability. In addition, if in the
future the book value of the goodwill is in excess of its fair value or we lose
a significant RMH client, we may need to record an impairment charge to reduce
goodwill or the customer list to its fair value.
Goodwill represented 53.5 percent of our total assets at December 31, 2003.
If the goodwill is deemed to be impaired, we may need to take a charge to
earnings to write-down the goodwill to its fair value.
Our balance sheet includes goodwill, which 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 adopted Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangibles," referred to as SFAS 142. As
a result of adopting SFAS 142, we no longer amortize goodwill. Goodwill must be
tested at least annually for impairment. The annual impairment test will be
completed as of October 1st of each year. The test for impairment uses 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. We make significant assumptions to estimate the future revenue and
cash flows used to determine the fair value of our reporting units. If the
expected revenue and cash flows are not realized or if a sustained significant
depression in our market capitalization indicates that our assumptions are not
accurately estimating our fair value, impairment losses may be recorded in the
future.
-20-
As of December 31, 2003, our balance sheet included goodwill that
represented 53.5 percent of total assets and 103.3 percent of shareholders'
equity. If the goodwill is deemed to be impaired under SFAS 142, we may need to
take a charge to earnings to write-down the goodwill to its fair value and this
could have a materially adverse effect on the market price of our common stock.
You should be aware that our earnings for periods beginning after December
31, 2001, do not include charges for the amortization of goodwill and you 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 to
and 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 terrorist attacks, war and threats of attacks and war;
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. 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.
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 12, 2004,
there were 26,035,777 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 12, 2004, we had the authority to issue up to
approximately 4,691,793 shares of our common stock under our stock option plans.
We also had outstanding notes convertible into an aggregate of 3,797,084 shares
of our common stock at a conversion price of $32.92 per share. Additionally, we
had outstanding warrants to purchase approximately 21,762 shares of our common
stock.
-21-
If shareholders of RMH or stockholders of NCO Portfolio who receive our
common stock in the mergers sell that stock immediately, it could cause a
decline in the market price of our common stock.
If the acquisitions of RMH and the minority interest of NCO Portfolio are
completed at the anticipated exchange ratios, we will issue approximately 5.2
million shares of common stock and assume options to issue approximately 852,000
shares of common stock. All of these shares will be immediately available for
resale in the public market, except that shares issued in the RMH merger to RMH
shareholders who entered into lock up agreements with us and shares issued in
the mergers to shareholders who are affiliates of RMH or NCPM before the mergers
or who become affiliates of us after the merger, will be subject to certain
restrictions on transferability. As a result of future sales of such common
stock, or the perception that these sales could occur, the market price of our
common stock may decline and could decline significantly before or at the time
the mergers are completed or immediately thereafter. If this occurs, or if other
shareholders sell significant amounts of our common stock immediately after the
mergers are completed, these sales could cause a decline in the market price 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 up to 5,000,000 shares of 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 percent of
our common stock.
Risks Related to NCO Portfolio's Business.
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 are 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:
Collections may not be sufficient to recover the cost of investments in
purchased accounts receivable and support operations.
NCO Portfolio purchases past due 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, hospitals,
utilities, 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 uncollectable, 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, typically less than
10% of face value, to the amount the customer owes and, although NCO Portfolio
estimates 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 will vary and may be less than the amount expected, and may even be
less than the purchase price paid for such accounts. 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 may not be able to purchase new
accounts receivable 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 its debt or finance the purchase of
new accounts receivable.
-22-
NCO Portfolio uses estimates in reporting results. If collections on
portfolios are materially less than expected, NCO Portfolio may be required to
record impairment expenses that could have a materially adverse effect on NCO
Portfolio.
NCO Portfolio's revenue is recognized based on estimates of future
collections on portfolios of accounts receivable purchased. Although estimates
are based on analytics, the actual amount collected on portfolios and the timing
of those collections will differ from NCO Portfolio's estimates. If collections
on portfolios are materially less than estimated, NCO Portfolio may be required
to record impairment expenses that will reduce earnings and could materially
adversely affect its earnings, financial condition and creditworthiness.
NCO Portfolio may be adversely affected by possible shortages of available
accounts receivable for purchase at favorable prices.
The availability of portfolios of past due consumer 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 the type and quantity of past due 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.
NCO Portfolio may be unable to compete with other purchasers of past due
accounts receivable, which may have an adverse effect on our combined financial
results.
NCO Portfolio faces bidding competition in its acquisitions of portfolios
of past due consumer accounts receivable. Some of its existing competitors and
potential new competitors may have greater financial and other resources that
allow them to offer higher prices for the accounts receivable portfolios. New
purchasers of such portfolios entering the market also cause upward price
pressures. NCO Portfolio may not have the resources or ability to compete
successfully with its existing and potential new competitors. To remain
competitive, NCO Portfolio may have to increase its bidding prices, which may
have an adverse impact on our combined financial results.
-23-
Risks Related to RMH's Business
We have agreed to acquire RMH subject to conditions to closing. RMH is
engaged in the outsourced customer relationship management business, also
referred to as CRM. RMH has additional business risks that may have an adverse
effect on the combined company if that acquisition is completed. If any of the
following risks were to occur, RMH's business, financial condition or results of
operations could be materially harmed and this could in turn significantly
affect the value of our common stock after the merger with RMH.
RMH has incurred significant losses in recent years. If the acquisition of
RMH is completed, RMH's financial condition and results of operations could have
an adverse effect on us.
RMH incurred significant losses in fiscal 2003, 2002 and 2001 primarily as
a result of bad debt expenses, impairment and restructuring charges, a charge
associated with projected minimum purchase requirements under agreements with
telephone long distance carriers related to the migration from outbound to
inbound CRM services, underutilization of capacity, and unfavorable currency
exchange rates between the United States and Canada which have resulted in
higher operating costs in Canada to support clients in the United States. RMH
incurred a significant loss in the first quarter of fiscal 2004 primarily as a
result of a decline in billable hours resulting from the timing of telemarketing
campaigns, reductions in outsourcing associated with recent economic conditions,
the impact of the Do-Not-Call Implementation Act which resulted in a continued
decline in outbound customer relationship management services, and continued
unfavorable currency exchange rates between the United States and Canada. In
addition, RMH had a working capital deficit of $17,241,000 and $14,569,000 at
December 31, 2003 and September 30, 2003, respectively. The report of RMH's
independent auditors on its financial statements for the year ended September
30, 2003 states that RMH's recurring losses from operations, uncertainty
regarding the ability to remain in compliance with restrictive debt covenants
under the revolving credit facility, and uncertainty regarding the ability to
obtain additional financing to fund RMH's operations and capital requirements
raise substantial doubt about RMH's ability to continue as a going concern. If
the acquisition of RMH is completed, RMH's financial condition and results of
operations could have an adverse effect on us.
If we are not able to integrate RMH's operations into our business in a
timely manner, the anticipated benefits of the proposed acquisition of RMH may
not be realized in a timely fashion, or at all, and our existing business may be
adversely affected.
The success of the RMH acquisition will depend, in part, on our ability to
realize the anticipated revenue enhancements, growth opportunities and synergies
of combining with RMH and to effectively utilize the resources we will have
following the merger. The merger involves risks related to the integration and
management of acquired technology, operations and personnel. The integration of
RMH's business will be a complex, time-consuming and potentially expensive
process and may disrupt our business if not completed in a timely and efficient
manner. Some of the difficulties that may be encountered by us include:
o integration of administrative, financial, and information technology
efforts and resources and coordination of marketing and sales efforts;
o maintaining client relationships;
o the diversion of management's attention from other ongoing business
concerns; and potential conflicts between business cultures.
-24-
If our management focuses too much time, money and effort to integrate
RMH's operations and assets with ours, they may not be able to execute our
overall business strategy or realize the anticipated benefits of the merger with
RMH.
RMH relies on a few major clients for a significant portion of its
revenues. The loss of any of these clients or their failure to pay RMH could
reduce RMH's revenues and adversely affect RMH's results of operations.
Substantial portions of RMH's revenues are generated from a few key
clients. One client, MCI WORLDCOM Communications, Inc. and MCI WORLDCOM Network
Services, Inc., each a subsidiary of WorldCom, Inc. and collectively referred to
as MCI, accounted for 34.2% of RMH's net revenues in 2003. MCI accounted for
32.0% and 32.5% of RMH's net revenues in the first quarter of fiscal 2004 and
2003, respectively. In addition, two other clients each accounted for over 10%
of RMH's net revenues in 2003. Most of RMH's clients are not contractually
obligated to continue to use RMH's services at historic levels or at all. If any
of these clients were to significantly reduce the amount of services RMH
performs for them, fail to pay RMH, or terminate the relationship altogether,
RMH's revenues and business would be harmed.
On July 21, 2002, WorldCom, Inc. announced that it had filed for voluntary
relief under Chapter 11 of the United States Bankruptcy Code. While RMH
continued to provide services to MCI, these events create uncertainty about
RMH's future business relationship with MCI, which, if not resolved in a manner
favorable to RMH, could have a significant adverse impact on RMH's future
operating results and liquidity. In the event that RMH's business relationship
with MCI were to terminate, RMH's contracts with MCI call for certain wind-down
periods and the payment by RMH of certain termination fees, as defined in such
contracts, during which time RMH would seek new business volume. However,
replacing lost MCI business volume is subject to significant uncertainty, could
take substantially longer than the wind-down periods, and would be dependent on
a variety of factors which RMH's management cannot predict at this time.
A decrease in demand for RMH's services in one or more of the industries to
which RMH provides services could reduce RMH's revenues and adversely affect
RMH's results of operations.
RMH's success is dependent in large part on continued demand for its
services from businesses within the telecommunications, financial services,
insurance, technology and logistics industries. A reduction in or the
elimination of the use of outsourced CRM services within any of these industries
could harm RMH's business.
An increase in communication rates or a significant interruption in
communication service could harm RMH's business.
RMH's ability to offer services at competitive rates is highly dependent
upon the cost of communication services provided by various local and long
distance telephone companies. Any change in the telecommunications market that
would affect RMH's ability to obtain favorable rates on communication services
could harm RMH's business. Moreover, any significant interruption in
communication service or developments that could limit the ability of telephone
companies to provide RMH with increased capacity in the future could harm RMH's
existing operations and prospects for future growth.
-25-
Fluctuations in currency exchange rates could adversely affect RMH's
business.
A significant portion of RMH's business is conducted in Canada. RMH's
results of operations have been negatively impacted by the increase in the value
of the Canadian dollar in relation to the value of the U.S. dollar over the past
nine months, which has increased RMH's cost of doing business in Canada. Further
increases in the value of the Canadian dollar in relation to the value of the
U.S. dollar would further increase such costs and adversely affect RMH's results
of operations. In addition, RMH expects to expand its operations into other
countries and, accordingly, will face similar exchange rate risk with respect to
the costs of doing business in such countries as a result of any increases in
the value of the U.S. dollar in relation to the currencies of such countries.
There is no guarantee that RMH will be able to successfully hedge its foreign
currency exposure in the future.
RMH may not be able to effectively win business against its competition.
The CRM services industry is highly competitive. RMH competes with:
o the in-house CRM operations of its clients or potential clients;
o other outsourced CRM providers, some of which have greater resources than
RMH has; and
o providers of other marketing and CRM formats and, in particular, other
forms of direct marketing such as interactive shopping and data
collection through television, the internet and other media.
Many businesses that are significant consumers of CRM services use more
than one CRM services firm at a time and reallocate work among various firms
from time to time. RMH and other firms seeking to perform outsourced CRM
services are frequently required to compete with each other as individual
programs are initiated. RMH cannot be certain that it will be able to compete
effectively against its current competitors or that additional competitors, some
of which may have greater resources than RMH has, will not enter the industry
and compete effectively against it. As competition in the industry increases,
RMH may face increasing pressure on the prices for its services. RMH will face
continued pricing pressure as its competitors migrate call centers to lower cost
labor markets.
Consumer resistance to outbound services could harm the customer
relationship management services industry.
As the CRM services industry continues to grow, the effectiveness of CRM
services as a direct marketing tool may decrease as a result of consumer
saturation and increased consumer resistance to customer acquisition activities,
particularly direct sales.
Government regulation of the customer relationship management industry and
the industries RMH serves may increase RMH's costs and restrict the operation
and growth of RMH's business.
The CRM services industry is subject to an increasing amount of regulation
in the United States and Canada. Most of the statutes and regulations in the
United States allow a private right of action for the recovery of damages or
provide for enforcement by the Federal Trade Commission, state attorneys general
or state agencies permitting the recovery of significant civil or criminal
penalties, costs and attorneys' fees in the event that regulations are violated.
The Canadian Radio-Television and Telecommunications Commission enforces rules
regarding unsolicited communications using automatic dialing and announcing
devices, live voice and fax. If the acquisition of RMH is completed, we cannot
assure you that RMH will be in compliance with all applicable regulations at all
times. We also cannot assure you that new laws, if enacted, will not adversely
affect or limit RMH's current or future operations.
-26-
Several of the industries served by RMH, particularly the insurance,
financial services and telecommunications industries, are subject to government
regulation. RMH could be subject to a variety of private actions or regulatory
enforcement for RMH's failure or the failure of RMH's clients to comply with
these regulations. RMH's results of operations could be adversely impacted if
the effect of government regulation of the industries RMH serves is to reduce
the demand for RMH's services or expose RMH to potential liability. RMH and its
employees who sell insurance products are required to be licensed by various
state insurance commissions for the particular type of insurance product sold
and to participate in regular continuing education programs. RMH's participation
in these insurance programs requires RMH to comply with certain state
regulations, changes in which could materially increase RMH's operating costs
associated with complying with these regulations.
RMH may be unable to hire or retain qualified personnel.
By its nature, RMH's industry is labor intensive. CRM representatives, who
make up a significant portion of RMH's workforce, generally receive modest
hourly wages. RMH's recruiting and training costs are increased and RMH's
operating efficiency and productivity are decreased by:
o any increases in hourly wages, costs of employee benefits or employment
taxes;
o the high turnover rate experienced in RMH's industry;
o the high degree of training necessary for some of RMH's CRM service
offerings, particularly insurance product customer acquisition and
technology customer service;
o RMH's rapid growth; and
o competition for qualified personnel with other CRM service firms and with
other employers in labor markets in which RMH's customer interaction
centers are located.
Additionally, some of RMH's employees have attempted to organize a labor
union, which, if successful, could further increase RMH's recruiting and
training costs and could further decrease RMH's operating efficiency and
productivity. RMH may not be able to continue to cost-effectively recruit, train
and retain a sufficient number of qualified personnel to meet the needs of RMH's
business or to support RMH's growth. If RMH is unable to do so, RMH's results of
operations could be harmed.
Item 2. Properties.
We currently lease 66 offices in the United States, including our corporate
headquarters, eight offices in Canada, two offices in the United Kingdom, and
one office in Puerto Rico. The leases of these facilities expire between 2004
and 2016, and most contain renewal options.
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.
-27-
Item 3. Legal Proceedings.
In October 2003, we were notified by the Federal Trade Commission ("FTC")
that it intends to pursue a claim against us for violations of the Fair Credit
Reporting Act ("FCRA") relating to certain aspects of our credit reporting
practices during 1999 and 2000.
The allegations relate primarily to a large group of consumer accounts from
one client that were transitioned to us for servicing during 1999. We received
incorrect information from the prior service provider at the time of transition.
We became aware of the incorrect information during 2000 and ultimately removed
the incorrect information from the consumers' credit files. We have currently
negotiated a tentative settlement of this matter with the FTC, although no
assurance can be given that a settlement will be reached. In the event that we
are required to pay an assessment, we may assert certain claims for
indemnification from the owners of the consumer accounts.
We are also a party to a class action litigation regarding this group of
consumer accounts. A tentative settlement of the class action litigation has
been agreed to and is subject to court approval. We believe that the class
action litigation is covered by insurance, subject to applicable deductibles.
The FTC is also alleging that certain reporting violations occurred on a
small subset of our purchased accounts receivable.
We believe that the resolution of the above matters will not have a
material adverse effect on our financial position, results of operations or
business.
In June 2001, the first floor of our Fort Washington, Pennsylvania,
headquarters was severely damaged by a flood caused by remnants of Tropical
Storm Allison. As previously reported, during the third quarter of 2001, we
decided to relocate our corporate headquarters to Horsham, Pennsylvania. We
filed a lawsuit in the Court of Common Pleas, Montgomery County, Pennsylvania
(Civil Action No. 01-15576) against the current landlord and the former landlord
of the Fort Washington facilities to terminate the leases and to obtain other
relief. The landlord and former landlord have filed counter-claims against us.
Due to the uncertainty of the outcome of the lawsuit, we recorded the full
amount of rent due under the remaining terms of the leases during the third
quarter of 2001.
In January 2004, the Court, in ruling on the preliminary objections,
allowed the former landlord defendants' suit to proceed, but struck from the
complaint the allegations against our individual officers. Therefore, the
litigation will proceed in its course with the current landlord, the former
landlord and us as parties.
We are involved in other legal proceedings, regulatory investigations and
tax examinations from time to time in the ordinary course of its business.
Management believes that none of these other legal proceedings, regulatory
investigations or tax examinations 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.
-28-
Item 4.1 Executive Officers of the Registrant who are not Directors.
Name Age Position
- --------------------------------------- -------- ------------------------------------------------
Paul J. Burkitt........................ 42 Executive Vice President, Sales and Marketing
Charles F. Burns....................... 43 Executive Vice President, Business Process
Outsourcing
Stephen W. Elliott..................... 42 Executive Vice President, Information
Technology and Chief Information Officer
Joshua Gindin, Esq..................... 47 Executive Vice President and General Counsel
Steven Leckerman....................... 51 Executive Vice President, U.S. Operations
Paul E. Weitzel, Jr.................... 45 Executive Vice President, Corporate
Development and International Operations
Steven L. Winokur...................... 44 Executive Vice President, Finance; Chief
Financial Officer; Chief Operating Officer of
Shared Services; and Treasurer
Albert Zezulinski...................... 56 Executive Vice President, Corporate and
Government Affairs
Paul J. Burkitt - Mr. Burkitt joined us in 2003 as Executive Vice
President, Sales and Marketing. Mr. Burkitt has nearly 20 years of sales
experience. Prior to joining us, Mr. Burkitt was Executive Vice President of
Sales for RMH Teleservices, Inc., a provider of customer relationship management
services. In September 2003, in connection with an investigation by the SEC into
trading in the securities of RMH in 2001, Mr. Burkitt, without admitting or
denying the SEC's allegations of securities laws violations, agreed to pay a
civil penalty of $33,987 and to the entry of a final judgment permanently
enjoining him from violating Section 17(a) of the Securities Act of 1933 and
Section 10(b) of the Securities Exchange Act of 1934 and Rule 10b-5 promulgated
thereunder.
Charles F. Burns - Mr. Burns joined us in 2003 as Executive Vice President,
Business Process Outsourcing. Mr. Burns has nearly 20 years of sales and
consulting experience. Prior to joining us, Mr. Burns was a partner in
BearingPoint, Inc., formerly KPMG Consulting, Inc., a business systems
integrator and full-service consulting firm.
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.
-29-
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 had
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 collection company that was a division of TransUnion
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. from 1997 through the acquisition.
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 as Executive
Vice President, Finance and Chief Financial Officer, and also became Chief
Operations Officer of Shared Services in August 2003. 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.
Albert Zezulinski - Mr. Zezulinski joined us in January 2001 as Executive
Vice President, Health Services and became Executive Vice President, Corporate
and Government Affairs in May 2002. Mr. Zezulinski has more than 30 years of
consulting and healthcare experience. Prior to joining us, Mr. Zezulinski was
the Director of Healthcare Financial Services for BDO Seidman, LLP, an
international accounting and consulting firm.
-30-
PART II
Item 5. Market for Registrant's Common Equity and Related Shareholder Matters.
Our 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 sale prices for our common stock, as reported by Nasdaq.
High Low
---- ---
2002
First Quarter $ 29.75 $ 18.30
Second Quarter 29.19 20.61
Third Quarter 22.55 11.33
Fourth Quarter 16.80 10.56
2003
First Quarter $ 17.15 $ 12.55
Second Quarter 20.43 14.50
Third Quarter 26.00 17.14
Fourth Quarter 26.18 20.63
On March 12, 2004, the last reported sale price of our common stock as
reported on The Nasdaq National Market was $23.12 per share. On March 12, 2004,
there were approximately 92 holders of record of our common stock.
Dividend Policy
We have never declared or paid cash dividends on our common stock, and 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.
Equity Compensation Plan
See Part III, Item 12, of this Annual Report on Form 10-K for disclosure
regarding our equity compensation plans.
-31-
Item 6. Selected Financial Data.
SELECTED FINANCIAL DATA (1)
(Amounts in thousands, except per share data)
For the years ended December 31,
------------------------------------------------------------------------
1999 2000 2001 (2) 2002 2003
--------- --------- --------- --------- ---------
Statement of Income Data:
Revenue $ 460,311 $ 587,452 $ 683,873 $ 703,450 $ 753,816
Operating costs and expenses:
Payroll and related expenses 237,709 293,292 350,634 335,405 350,369
Selling, general and administrative expenses 128,177 179,924 237,690 249,672 282,268
Depreciation and amortization expense 21,805 32,360 38,205 27,324 31,628
Nonrecurring acquisition costs 4,601 - - - -
--------- --------- --------- --------- ---------
Income from operations 68,019 81,876 57,344 91,049 89,551
Other income (expense) (16,899) (22,126) (23,335) (17,970) (17,943)
--------- --------- --------- --------- ---------
Income before provision for income taxes 51,120 59,750 34,009 73,079 71,608
Income tax expense 22,821 24,572 14,661 27,702 26,732
--------- --------- --------- --------- ---------
Income from continuing operations before
minority interest 28,299 35,178 19,348 45,377 44,876
Minority interest - - (4,310) (3,218) (2,430)
--------- --------- --------- --------- ---------
Income from continuing operations 28,299 35,178 15,038 42,159 42,446
Accretion of preferred stock to redemption value (377) - - - -
--------- --------- --------- --------- ---------
Income from continuing operations applicable
to common shareholders 27,922 35,178 15,038 42,159 42,446
Discontinued operations, net of 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 $ 11,024 $ 15,038 $ 42,159 $ 42,446
========= ========= ========= ========= =========
Income from continuing operations applicable to
common shareholders per share:
Basic $ 1.22 $ 1.38 $ 0.58 $ 1.63 $ 1.64
========= ========= ========= ========= =========
Diluted $ 1.17 $ 1.36 $ 0.58 $ 1.54 $ 1.54
========= ========= ========= ========= =========
Net income applicable to common shareholders per share:
Basic $ 1.27 $ 0.43 $ 0.58 $ 1.63 $ 1.64
========= ========= ========= ========= =========
Diluted $ 1.22 $ 0.43 $ 0.58 $ 1.54 $ 1.54
========= ========= ========= ========= =========
Weighted average shares outstanding:
Basic 22,873 25,587 25,773 25,890 25,934
========= ========= ========= ========= =========
Diluted 23,799 25,842 26,091 29,829 29,895
========= ========= ========= ========= =========
December 31,
------------------------------------------------------------------------
1999 2000 2001 2002 2003
--------- --------- --------- --------- ---------
Balance Sheet Data:
Cash and cash equivalents $ 50,513 $ 13,490 $ 32,161 $ 25,159 $ 45,644
Working capital 65,937 76,824 97,478 107,731 106,409
Net assets of discontinued operations 41,492 - - - -
Total assets 791,692 781,257 928,864 966,281 946,111
Long-term debt, net of current portion 323,949 303,920 357,868 334,423 248,964
Minority interest - - 21,213 24,427 26,848
Shareholders' equity 364,888 375,464 392,302 435,762 490,417
(1) The years ended December 31, 1999, 2000, and 2001, included goodwill
amortization expense, net of tax, of $11.2 million, $11.8 million, and
$11.9 million, respectively. In accordance with the adoption of FASB 142,
we stopped amortizing goodwill on January 1, 2002. 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) The year ended December 31, 2001, included flood and restructuring related
charges, net of tax, of $14.5 million.
-32-
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 70 percent of our revenue from the
recovery of delinquent accounts receivable on a contingency fee basis. Our
contingency fees typically range from 15 percent to 35 percent of the amount
recovered on behalf of our clients. However, fees can range from six percent for
the management of accounts placed early in the accounts receivable cycle to 50
percent for accounts that have been serviced extensively by the client or by
third-party providers. Our average fee for contingency-based revenue across all
industries, excluding the long-term collection contract, was approximately 19
percent during 2003, 2002 and 2001. In addition, we generate revenue from fixed
fee services for certain accounts receivable management and collection services.
Generally, 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, outside collection attorneys and other
third-party collection services providers, and other collection costs, as well
as expenses that directly support operations, including facility 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. During 2002, we completed two acquisitions: Great Lakes Collection
Bureau, Inc., referred to as Great Lakes, in August 2002, and The Revenue
Maximization Group Inc., referred to as RevGro, in December 2002.
On November 18, 2003, we announced that we entered into an agreement with
RMH Teleservices, Inc., referred to as RMH, a provider of customer relationship
management services, by which RMH would be merged with our wholly owned
subsidiary. Pursuant to the merger agreement, we agreed to acquire RMH in a
transaction expected to be tax-free to the shareholders of RMH. Under the RMH
merger agreement, as amended, RMH's shareholders will receive 0.2150 shares of
our common stock for each share of RMH common stock. The transaction is subject
to a collar arrangement. It is anticipated that we will issue approximately 3.4
million shares of our common stock to RMH's shareholders. It is also anticipated
that we will issue approximately 593,000 additional shares of our common stock
upon the exercise of currently outstanding options and warrants to purchase RMH
common stock to be assumed by us in the merger. We believe that RMH's customer
relationship management services will enhance our ability to provide a broader
range of business process outsourcing services to our clients in various
industry sectors.
-33-
On December 15, 2003, we announced that we have entered into an agreement
with NCO Portfolio, by which NCO Portfolio would be merged with our wholly owned
subsidiary. We currently own approximately 63.3 percent of the outstanding stock
of NCO Portfolio, and pursuant to the proposed merger, would acquire all NCO
Portfolio shares that we do not own in a transaction expected to be tax-free to
the stockholders of NCO Portfolio. Michael J. Barrist, our chairman of the
board, president and chief executive officer, also serves as chairman of the
board, president and chief executive officer of NCO Portfolio and beneficially
owns 2.8 percent of NCO Portfolio's outstanding common stock, excluding stock
options. Under the NCO Portfolio merger agreement, NCO Portfolio 's minority
stockholders will receive 0.36187 of a share of our common stock for each share
of NCO Portfolio common stock. We will issue approximately 1.8 million shares of
our common stock to NCO Portfolio's minority stockholders. Under the NCO
Portfolio merger agreement, if the average closing sale price of our common
stock for the 10-day trading period ending on the second day prior to the
closing date of the transaction were to be less than $21.50 per share, NCO
Portfolio would have the right to terminate the NCO Portfolio merger agreement,
unless we were to agree to improve the exchange ratio so that the NCO Portfolio
minority stockholders receive that number of shares of our common stock with a
value equivalent to the $21.50 price, based on such 10 trading day average stock
price. We will also assume all outstanding NCO Portfolio stock options. We
believe that the combined company will be able to more effectively pursue, in a
coordinated manner, strategic growth opportunities and other expansion
strategies, in part due to improved integration and coordination between NCO
Portfolio and us.
Our company consists of three operating divisions: U.S. Operations,
Portfolio Management, and International Operations. U.S. Operations and
International Operations maintain industry-specific functional groups.
Critical Accounting Policies and Estimates
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. For a discussion of these and other accounting
policies, see note 2 in our Notes to Consolidated Financial Statements.
Goodwill
Our balance sheet includes amounts designated as "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.
As of December 31, 2003, our balance sheet included goodwill that
represented 53.5 percent of total assets and 103.3 percent of shareholders'
equity.
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangible Assets," referred to as SFAS
142. Under SFAS 142, goodwill is no longer amortized but instead must be tested
for impairment at least annually and as triggering events occur, including an
initial test that was completed in connection with the adoption of SFAS 142. The
annual impairment test is completed as of October 1st of each year. The test for
impairment uses 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 and we would be required to take a charge to earnings,
which could be material. We did not incur any impairment charges in connection
with the adoption of SFAS 142 or the annual impairment tests performed on
October 1, 2002 and 2003, and we do not believe that goodwill was impaired as of
December 31, 2003.
-34-
We make significant assumptions to estimate the future revenue and cash
flows used to determine the fair value of our reporting units. These assumptions
include future growth rates, discount factors, future tax rates, and other
factors. If the expected revenue and cash flows are not realized, or if a
sustained significant depression in our market capitalization indicates that our
assumptions are not accurately estimating our fair value, impairment losses may
be recorded in the future.
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 portfolio. The estimated future cash flow of each portfolio
is used to compute the internal rate of return, referred to as IRR, for each
portfolio. The IRR is used to allocate collections between revenue and
amortization of the carrying values of the purchased accounts receivable.
On an ongoing basis, we compare the historical trends of each portfolio to
projected collections. Projected collections are then increased, within preset
limits, or decreased based on the actual cumulative performance of each
portfolio. We review each portfolio's adjusted projected collections to
determine if further downward adjustment is warranted. Management regularly
reviews the trends in collection patterns and uses its best efforts to improve
under-performing portfolios. However, actual results will differ from these
estimates and a material change in these estimates could occur within one
reporting period. For the year ended December 31, 2001, differences between
actual and estimated collections on existing portfolios, as of the beginning of
2001, resulted in a reduction in net income of $980,000, or $0.04 per diluted
share. For the year ended December 31, 2002, differences between actual and
estimated collections on existing portfolios as of the beginning of 2002
resulted in a reduction in net income of $3.0 million, or $0.10 per diluted
share. For the year ended December 31, 2003, differences between actual and
estimated collections on existing portfolios, as of the beginning of 2003,
resulted in a reduction in net income of $114,000 and no change in diluted
earnings per share.
If management came to a different conclusion as to the future estimated
collections, it could have had a significant impact of the amount of revenue
that was recorded from the purchased accounts receivable during the year ended
December 31, 2003. For example, a five percent increase in the amount of future
expected collections would have resulted in a $534,000, or $0.02 per diluted
share, increase in net income for 2003, and a five percent decrease in the
amount of future expected collections would have resulted in an $558,000, or
$0.02 per diluted share, reduction in net income for 2003.
-35-
Allowance for Doubtful Accounts
Allowances for doubtful accounts are estimated based on estimates of losses
related to customer receivable balances. In establishing the appropriate
provision for customer receivables balances, we make assumptions with respect to
their future collectibility. Our assumptions are based on an individual
assessment of a customer's credit quality as well as subjective factors and
trends, including the aging of receivable balances. Generally, these individual
credit assessments occur at regular reviews during the life of the exposure and
consider factors such as a customer's ability to meet and sustain their
financial commitments, a customer's current financial condition and historical
payment patterns. Once the appropriate considerations referred to above have
been taken into account, a determination is made as to the probability of
default. An appropriate provision is made, which takes into account the severity
of the likely loss on the outstanding receivable balance. Our level of reserves
for our customer accounts receivable fluctuates depending upon all of the
factors mentioned above, in addition to any contractual rights that allow us to
reduce outstanding receivable balances through the application of future
collections. If our estimate is not sufficient to cover actual losses, we would
be required to take additional charges to our earnings.
Notes Receivable
As of December 31, 2003, our balance sheet included $16.8 million of notes
receivable. We review the recoverability of these notes receivable on a
quarterly basis to determine if an impairment charge is required. In completing
our analysis, we make assumptions with respect to the future collectibility of
the notes receivable. Our assumptions are based on assessments of an obligor's
financial condition and historical payment patterns, as well as subjective
factors and trends, including financial projections. Once the appropriate
considerations referred to above have been taken into account, a determination
is made as to the probability of default. If it is deemed to be required, an
impairment charge would be recorded to reduce the notes receivable to its
recoverable value. If our assessment of the recoverability of the notes
receivable is incorrect, we may need to incur additional impairment charges in
the future.
Deferred Taxes
We account for income taxes in accordance with SFAS No. 109, "Accounting
for Income Taxes," which requires that deferred tax assets and liabilities be
recognized using enacted tax rates for the effect of temporary differences
between the book and tax bases of recorded assets and liabilities. SFAS No. 109
also requires that deferred tax assets be reduced by a valuation allowance, if
it is more likely than not that some portion or all of the deferred tax asset
will not be realized. Deferred taxes have not been provided on the cumulative
undistributed earnings of foreign subsidiaries because such amounts are expected
to be reinvested indefinitely.
Our balance sheet includes a deferred tax asset of $32.2 million for the
assumed utilization of net operating loss carryforwards acquired in the
Creditrust merger. We believe that we will be able to utilize the net operating
loss carryforwards so we have not reduced the deferred tax asset by a valuation
allowance. 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. If we are unable to
utilize the net operating loss carryforwards, it may result in incremental tax
expense in future periods.
-36-
Results of Operations
The following table sets forth selected historical income statement data
(amounts in thousands):
For the years ended December 31,
---------------------------------------------------------------------------
2001 2002 2003
------------------------ ----------------------- ----------------------
Amount Ratio Amount Ratio Amount Ratio
------------- -------- ------------ -------- ----------- --------
Revenue $683,873 100.0% $703,450 100.0% $753,816 100.0%
Payroll and related expenses 350,634 51.3 335,405 47.7 350,369 46.5
Selling, general and administrative
expenses 237,690 34.7 249,672 35.5 282,268 37.4
Depreciation and amortization 38,205 5.6 27,324 3.9 31,628 4.2
-------- ----- -------- ----- -------- -----
Income from operations 57,344 8.4 91,049 12.9 89,551 11.9
Other expense 23,335 3.4 17,970 2.5 17,943 2.4
Income tax expense 14,661 2.1 27,702 3.9 26,732 3.6
Minority interest 4,310 0.7 3,218 0.5 2,430 0.3
-------- ----- -------- ----- -------- -----
Net income $ 15,038 2.2% $ 42,159 6.0% $ 42,446 5.6%
======== ===== ======== ===== ======== =====
Year ended December 31, 2003 Compared to Year ended December 31, 2002
Revenue. Revenue increased $50.3 million, or 7.2 percent, to $753.8 million
for 2003, from $703.5 million in 2002. U.S. Operations, Portfolio Management,
and International Operations accounted for $686.9 million, $75.5 million, and
$69.3 million, respectively, of the 2003 revenue. U.S. Operations' revenue
included $49.6 million of intercompany revenue earned on services performed for
Portfolio Management that was eliminated upon consolidation. International
Operations' revenue included $28.3 million of intercompany revenue earned on
services performed for the U.S. Operations that was eliminated upon
consolidation.
U.S. Operation's revenue increased $47.4 million, or 7.4 percent, to $686.9
million in 2003, from $639.5 million in 2002. The increase in U.S. Operations
revenue was partially attributable growth in business from existing clients and
the addition of new clients. The increase was also a result of the acquisitions
of Great Lakes collection operations in August 2002 and RevGro in December 2002.
Great Lakes contributed $20.9 million to U.S. Operations' 2003 revenue, compared
to $9.1 million for the period from August 19, 2002 to December 31, 2002. RevGro
contributed $20.4 million to U.S. Operations' 2003 revenue compared to $1.7
million for the period from December 2, 2002 to December 31, 2002. An increase
in fees from collection services performed for Portfolio Management also
contributed to the increase. These additional fees from Portfolio Management
included the fees from servicing the Great Lakes portfolio acquired by NCO
Portfolio in August 2002.
U.S. Operation's revenue for 2003 and 2002 included revenue recorded from a
long-term collection contract. The method of recognizing revenue for this
long-term collection contract defers certain revenues into future periods until
collections exceed collection guarantees. During 2003, U.S. Operations
recognized $4.2 million of previously deferred revenue, on a net basis, compared
to $8.3 million in 2002. Included in the 2003 revenue from the long-term
collection contract was a $6.9 million benefit from an amendment to the
contract. The amendment limits our exposure on the guarantee component of the
contract to a maximum of $19.5 million at the last two settlement dates ($6.0
million at the May 31, 2004 settlement and $13.5 million at the May 31, 2005
settlement). Any guarantee at the settlement dates in excess of these limits
will be deducted from future bonuses, if any, as they are earned. We are not
responsible to pay the client if future bonuses are inadequate to cover the
additional guarantee. Had we not renegotiated the contract, the net effect of
the long-term collection contract for 2003 would have been a negative impact of
$2.7 million due to additional deferred revenue as a result of an increase in
placements. As of December 31, 2003, we had deferred sufficient revenue to meet
our maximum exposure at the respective settlement dates. Accordingly, there will
be no further deferrals of revenue under this contract.
-37-
Portfolio Management's revenue increased $12.1 million, or 19.1 percent, to
$75.5 million in 2003, from $63.4 million in 2002. Portfolio Management's
collections increased $34.7 million, or 29.8 percent, to $151.1 million in 2003,
from $116.4 million in 2002. Portfolio Management's revenue represented 50
percent of collections in 2003, as compared to 54 percent of collections in
2002. Revenue increased due to the increase in collections from new purchases,
including the Great Lakes portfolio. The effect of the increase in collections
on revenue was partially offset by the decrease in revenue recognition rate.
Revenue as a percentage of collections declined principally due to a number of
factors, including an increase in the average age of the portfolios, timing of
collections, and lower targeted returns on more recent portfolios due to the
current economic environment. In addition, portfolios with $15.4 million in
carrying value, or 10.3 percent of total purchased accounts receivable as of
December 31, 2003, were being accounted for under the cost recovery method,
compared to $5.8 million, or 3.9 percent as of December 31, 2002. Accordingly,
no revenue was recorded on these portfolios. Of the $15.4 million of portfolios,
$11.2 million represented impaired portfolios, and $4.2 million represented
portfolios acquired in connection with the elimination of an off-balance sheet
securitization. Additionally, included in collections for 2003 were $7.6 million
of proceeds from the sale of accounts, compared to $3.7 million in 2002.
International Operations' revenue increased $21.7 million, or 45.5 percent,
to $69.3 million in 2003, from $47.6 million in 2002. The increase in
International Operations' revenue was primarily attributable to an increase in
the services provided to our U.S. Operations and favorable changes in the
foreign currency exchange rates used to translate the International Operations'
results of operations into U.S. dollars. In addition, a portion of the increase
was attributable to the addition of new clients and growth in business from
existing clients.
Payroll and related expenses. Payroll and related expenses increased $15.0
million to $350.4 million in 2003, from $335.4 million in 2002, but decreased as
a percentage of revenue to 46.5 percent from 47.7 percent.
U.S Operations' payroll and related expenses increased $19.5 million to
$336.5 million in 2003, from $317.0 million in 2002, but decreased as a
percentage of revenue to 49.0 percent from 49.6 percent. The decrease in payroll
and related expenses as a percentage of revenue was partially due to the shift
of more of our collection work to outside attorneys and other third-party
service providers, and the continued rationalization of staff. This shift was
associated with the continuing efforts to maximize collections for clients. The
costs associated with the increase in the use of outside attorneys and other
third-party service providers are included in selling, general and
administrative expenses. A portion of the decrease in the percentage of revenue
was offset by the recognition of $4.2 million of previously deferred revenue, on
a net basis, from the long-term collection contract that was recorded during
2003, as compared to $8.3 million of previously deferred revenue, on a net
basis, that was recorded during 2002. Since the expenses associated with this
revenue are expensed as incurred, the recognition of previously deferred revenue
decreases the payroll and related expenses as a percentage of revenue.
-38-
Portfolio Management's payroll and related expenses increased $202,000 to
$1.7 million in 2003, from $1.5 million in 2002, but decreased as a percentage
of revenue to 2.3 percent from 2.4 percent. Portfolio Management outsources all
of the collection services to U.S. Operations and, therefore, has a relatively
small fixed payroll cost structure.
International Operations' payroll and related expenses increased $11.9
million to $40.3 million in 2003, from $28.4 million in 2002, but decreased as a
percentage of revenue to 58.2 percent from 59.6 percent. The decrease as a
percentage of revenue was attributable to the continued focus on managing the
amount of labor required to attain revenue goals.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $32.6 million to $282.3 million in 2003, from
$249.7 million in 2002, and increased as a percentage of revenue to 37.4 percent
from 35.5 percent. The increase in the percentage of revenue was partially
attributable to the recognition of $4.2 million of previously deferred revenue,
on a net basis, from the long-term collection contract that was recorded during
2003, as compared to $8.3 million of previously deferred revenue, on a net
basis, that was recorded during 2002. Since the expenses associated with this
revenue are expensed as incurred, the recognition of previously deferred revenue
decreases the payroll and related expenses as a percentage of revenue. A portion
of the increase in the percentage of revenue was attributable to the shift of
more of the collection work to outside attorneys and other third-party service
providers.
Depreciation and amortization. Depreciation and amortization increased to
$31.6 million in 2003, from $27.3 million in 2002. This increase was the result
of additional depreciation resulting from normal capital expenditures made in
the ordinary course of business during 2002 and 2003. These capital expenditures
included expenditures related to the relocation of our corporate headquarters
and purchases of predictive dialers and other equipment required to expand our
infrastructure to handle future growth. The increase was also attributable to
the amortization of the customer lists acquired in the Great Lakes and RevGro
acquisitions.
Other income (expense). Interest and investment income included investment
income of $2.2 million for 2003, as compared to $762,000 for 2002, from its 50
percent ownership interest in a joint venture that purchases utility, medical
and other various small balance accounts receivable. Interest expense increased
to $23.0 million for 2003, from $21.0 million for 2002. This increase was due to
Portfolio Management's additional nonrecourse borrowings from CFSC Capital Corp.
XXXIV to purchase accounts receivable, including the $20.6 million of borrowings
to purchase Great Lakes' accounts receivable portfolios. This increase was
partially offset by lower interest rates and lower principal balances as a
result of debt repayments made in excess of borrowings against the credit
facility during 2002 and 2003. Other income for 2003, included: $476,000 of
income from our ownership interest in one of our insurance carriers that was
sold; $402,000 gain related to a benefit from a deferred compensation plan
assumed as part of the acquisition of FCA International Ltd. in May 1998; and
$250,000 of income from a partial recovery from a third party of an
environmental liability. Other expense for 2002 included: an expense of $1.3
million from the estimated settlement of the environmental liability, net of a
$305,000 recovery from a third party; a $1.3 million insurance gain that
resulted from the settlement of the insurance claim related to the June 2001
flood of the Fort Washington facilities; and a $250,000 write-down of an
investment. The insurance gain was principally due to greater than estimated
insurance proceeds.
-39-
Year ended December 31, 2002 Compared to Year ended December 31, 2001
Revenue. Revenue increased $19.6 million, or 2.9 percent, to $703.5 million
for the year ended December 31, 2002, from $683.9 million for the comparable
period in 2001. U.S. Operations, Portfolio Management, and International
Operations accounted for $639.5 million, $63.4 million, and $47.6 million,
respectively, of the 2002 revenue. U.S. Operations' revenue included $35.5
million of revenue earned on services performed for Portfolio Management that
was eliminated upon consolidation. International Operations' revenue included
$11.5 million of revenue earned on services performed for the U.S. Operations
that was eliminated upon consolidation.
U.S. Operation's revenue increased $23.8 million, or 3.9 percent, to $639.5
million in 2002, from $615.7 million in 2001. The increase in our U.S.
Operations division's revenue was attributable to the recognition of deferred
revenues from the long-term collection contract, an increase in collection
services provided to Portfolio Management, the addition of new clients, and the
growth in business from existing clients. These increases were partially offset
by lower revenues due to further weakening of consumer payment patterns during
2002.
Portfolio Management's revenue increased $450,000, or 0.7 percent, to $63.4
million in 2002, from $62.9 million in 2001. Portfolio Management's collections
increased $19.3 million, or 19.9 percent, to $116.4 million in 2002, from $97.1
million in 2001. Portfolio Management's revenue represented 54 percent of
collections in 2002, as compared to 65 percent of collections in 2001. Although
collections increased, revenue only increased slightly due to the decrease in
the revenue recognition rate. Revenue as a percentage of collections declined
principally due to changes in the total composition of purchased accounts
receivable in 2001 versus 2002. Purchased accounts receivable acquired in, and
subsequent to, the Creditrust Merger were acquired at a lower internal rate of
return, referred to as IRR, compared to accounts receivable purchased prior to
the Creditrust Merger. Purchases of accounts receivable made in the second half
of 2001 and in 2002 have returns that have been targeted lower at the time of
acquisition due to reduced collection estimates due to the tougher economic
climate. In addition, the overall percentage was also lowered due to a slow down
in collections on existing portfolios as a result of the softening economic
climate in the last quarter of 2001 and in 2002. Additionally, included in
collections for 2002 was approximately $1.7 million received as a partial
payment on the sale of certain accounts to a leading credit card issuer. These
additional proceeds included in collections had a marginal impact on revenue as
the rate at which revenue 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. Additionally, portfolios with $5.8 million in carrying value,
or 3.9 percent of purchased accounts receivable, as of December 31, 2002, have
been impaired and placed on cost recovery status. Accordingly, no revenue will
be recorded on these portfolios after their impairment until their carrying
value has been fully recovered, resulting in a lower percentage of revenue to
collections. However, during the third quarter of 2002, Portfolio Management
concluded a contract re-negotiation with the seller of several existing
portfolios resulting in a $4.0 million cash price reduction on purchases from
2000 and 2001. The renegotiation included a purchase price adjustment, as well
as a reimbursement for estimated lost earnings. The $4.0 million proceeds were
recorded as an adjustment to purchase price of the affected portfolios during
the third quarter of 2002. On several previously impaired portfolios, the cash
price reduction reduced the carrying value of such portfolios, resulting in the
carrying value of certain of the portfolios becoming fully recovered. Included
in revenue for 2002 was $803,000 that resulted from the contract price reduction
of these fully recovered portfolios.
-40-
International Operations' revenue increased $9.8 million, or 26.0 percent,
to $47.6 million in 2002, from $37.8 million in 2001. The 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 decreased $15.2
million to $335.4 million in 2002, from $350.6 million in 2001, and decreased as
a percentage of revenue to 47.7 percent from 51.3 percent.
U.S Operations' payroll and related expenses decreased $15.5 million to
$317.0 million in 2002, from $332.5 million in 2001, and decreased as a
percentage of revenue to 49.6 percent from 54.0 percent. The higher level of
payroll as a percentage of revenue in 2001 was primarily attributable to $10.0
million of charges incurred by U.S. Operations 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. A portion of the decrease as a percentage
of revenue was also attributable to incurring costs in 2001 related to the
long-term collection contract, but deferring the revenue until 2002 and
subsequent years. In addition, we continued to focus on managing our staffing
levels to our business volumes, despite the difficult collection environment.
Portfolio Management's payroll and related expenses decreased $92,000 to
$1.5 million in 2002, from $1.6 million in 2001, and decreased as a percentage
of revenue to 2.4 percent from 2.6 percent. Portfolio Management outsources all
of the collection services to U.S. Operations and, therefore, has a relatively
small fixed payroll cost structure.
International Operations' payroll and related expenses increased $6.7
million to $28.4 million in 2002, from $21.7 million in 2001, and increased as a
percentage of revenue to 59.6 percent from 57.4 percent. The increase as a
percentage of revenue was primarily attributable to the increase in outsourcing
services provided to U.S. Operations and other clients because those services
typically have a higher payroll cost structure than the remainder of
International Operations' business. This increase was partially offset by
$736,000 of charges incurred by International Operations during the second
quarter of 2001 related to a comprehensive streamlining of its expense
structure. 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 $12.0 million to $249.7 million in 2002, from
$237.7 million in 2001, and increased as a percentage of revenue to 35.5 percent
from 34.8 percent. The increase as a percentage of revenue was primarily
attributable to reduced collectibility within our contingency revenue stream due
to the effects of the difficult collection environment. 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 collections. These
costs included telephone, letter writing and postage, third party servicing
fees, credit reporting, skip tracing, and legal and forwarding fees. The
increase as a percentage of revenue was partially offset by $11.2 million of
charges incurred during the third quarter of 2001 in connection with the June
2001 flood of the Company's Fort Washington, PA, corporate headquarters and the
resultant decision to relocate the corporate headquarters to Horsham, PA.
Additionally, a portion of the increase was offset by $1.8 million of 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
related to real estate obligations for closed facilities and equipment rental
obligations.
-41-
Depreciation and amortization. Depreciation and amortization decreased to
$27.3 million in 2002, from $38.2 million in 2001. This decrease was the result
of the adoption of Statement of Financial Accounting Standard No. 142, "Goodwill
and Other Intangibles" ("SFAS 142") on January 1, 2002. SFAS 142 eliminated the
amortization of goodwill, which was $15.7 million in 2001. Partially offsetting
the $15.7 million decrease was additional depreciation resulting from normal
capital expenditures made in the ordinary course of business during 2001 and
2002. These capital expenditures included purchases associated with our planned
migration towards a single, integrated information technology platform, the
relocation of our corporate headquarters to Horsham, PA, and the acquisition of
predictive dialers and other equipment required to expand our infrastructure to
handle future growth. The decrease was also partially offset by the amortization
of the customer lists acquired in the Great Lakes and RevGro acquisitions.
Other income (expense). Interest and investment income decreased $405,000
to $3.2 million for 2002, compared to $3.6 million in 2001. This decrease was
primarily attributable to lower interest rates earned on operating cash, funds
held in trust on behalf of clients, and notes receivable. Interest expense
decreased to $21.0 million for 2002, from $27.0 million for 2001. This decrease
was primarily attributable to lower interest rates and lower principal balances
as a result of debt repayments made during 2001 and 2002. The decrease was
partially offset by a full year of interest from Portfolio Management's $36.3
million of borrowings made in connection with the Creditrust merger in February
2001 and its subsequent borrowings used to purchase accounts receivable
portfolios, including $20.6 million of borrowings to purchase Great Lakes'
accounts receivable portfolios. In addition, a portion of the decrease was
offset by a full year of interest expense from securitized debt that was assumed
as part of the Creditrust Merger. During 2002, we recorded net other expenses of
$216,000. This was the net effect of a $1.3 million insurance gain, a $1.3
million net expense from the settlement of an environmental liability, and a
$250,000 write-down of an investment. The gain resulted from the settlement of
the insurance claim related to the June 2001 flood of the Fort Washington
facilities. The insurance gain was principally due to greater than estimated
insurance proceeds. The expense from the environmental liability was the result
of contamination that allegedly occurred in the pre-acquisition operations of a
company acquired by a subsidiary of Medaphis Services Corporation. We acquired
Medaphis Services Corporation in November 1998. These operations were unrelated
to the accounts receivable outsourcing business.
Income tax expense. Income tax expense for 2002 increased to $27.7 million
from $14.7 million for 2001, but the effective tax rate decreased to 37.9
percent of income before income tax expense from 43.1 percent for 2001. The
decrease in the effective tax rate was primarily attributable to the elimination
of the amortization of nondeductible goodwill related to certain acquisitions.
The goodwill amortization was eliminated upon the adoption of SFAS 142 on
January 1, 2002.
-42-
Liquidity and Capital Resources
Historically, our primary sources of cash have been bank borrowings, equity
and debt 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 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 $101.1 million in 2003, compared to $64.0 million in 2002. The increase in
cash provided by operations was partially attributable to a $6.6 million
decrease in accounts payable and accrued expenses, as compared to a $19.5
million decrease for the same period in the prior year. The decrease in 2002 was
primarily attributable to the payment of certain accruals made in connection
with the $23.8 million of charges incurred during the second and third quarter
of 2001, in connection with the flood and restructuring. The increase in cash
provided by operations was also attributable to a $6.0 million deposit made in
the first quarter of 2002, in connection with a long-term collection contract.
This deposit was part of the $10.2 million we received in July 2003 in
connection with the long-term collection contract. An increase in deferred tax
liabilities also contributed to the increase. A portion of the increases in cash
provided by operations was offset by an overpayment of income taxes due to
favorable tax adjustments during 2003 and an increase in restricted cash related
to NCO Portfolio's securitized debt.
Cash provided by operating activities was $64.0 million in 2002, compared
to $85.9 million in 2001. The decrease in cash provided by operations was
primarily attributable to a $19.5 million decrease in accounts payable and
accrued expenses, as compared to a $13.1 million increase for the same period in
the prior year. The increase in 2001 was primarily attributable to the accruals
made in connection with the $23.8 million of charges incurred during the second
and third quarter of 2001 in connection with the flood and the restructuring.
The payment of many of these accruals occurred during 2002, including the
termination liability from our prior healthcare plan. Of the $27.1 million
increase in net income, $15.5 million represented the increase after the
elimination of goodwill amortization. This increase in net income, net of
goodwill amortization, also partially offset the decrease.
Cash Flows from Investing Activities. Cash used in investing activities was
$10.2 million in 2003, compared to $64.0 million in 2002. The decrease in cash
used in investing activities was primarily attributable to the $28.0 million of
net cash paid during 2002 in connection with the acquisition of Great Lakes in
August 2002 and RevGro in December 2002. The decrease was also due to higher
purchases of property and equipment during 2002 and higher collections on the
purchased accounts receivable. The increase in collections was due to
collections from accounts receivables purchased during 2003 and 2002, including
the portfolio acquired from Great Lakes.
-43-
Cash used in investing activities was $64.0 million in 2002, compared to
$51.5 million in 2001. Purchases of accounts receivables in 2002 was $70.7
million, including the $22.9 million purchase of the Great Lakes portfolio, as
compared to $50.6 million in 2001, and collections applied to principal of
purchased accounts receivable was $58.4 million, as compared to $35.3 million.
The increase in collections applied to principal was due to collections from
accounts receivables purchased during 2002 and 2001, and a year of collections
from the accounts receivables purchased as part of the February 2001, Creditrust
merger. Net cash paid during 2002 in connection with the acquisition of Great
Lakes in August 2002 and RevGro in December 2002, was $28.0 million, as compared
to $11.1 million of net cash paid during 2001, in connection with the Creditrust
Merger.
Cash Flows from Financing Activities. Cash used in financing activities was
$72.1 million in 2003, compared to $7.4 million in 2002. The increase in cash
used in financing activities during 2003 resulted from higher repayments of
borrowings under our senior credit facility, nonrecourse debt used to purchase
large accounts receivable portfolios, and securitized debt assumed as part of
the Creditrust merger. The increase in cash used in financing activities was
also attributable to borrowings under the revolving credit facility made during
2002 to fund the acquisitions of Great Lakes' collection operations and RevGro,
and purchases of accounts receivable portfolios by NCO Portfolio.
Cash used in financing activities was $7.4 million in 2002, compared to
$15.5 million in 2001. The cash used in financing activities during 2002
resulted from repayments of borrowings under our revolving credit facility and
repayments of securitized debt assumed as part of the Creditrust Merger. These
repayments were partially offset by the borrowings under the revolving credit
facility to fund the acquisitions of Great Lakes' collection operations and
RevGro, as well as purchases of accounts receivables by NCO Portfolio. In
addition, NCO Portfolio borrowed $20.6 million from CFSC Capital Corp. XXXIV to
purchase Great Lakes' accounts receivable portfolio. The cash used in financing
activities during 2001 related to the net 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 other
acquisition related liabilities.
Credit Facility. On August 13, 2003, we amended our credit agreement with
Citizens Bank of Pennsylvania, ("Citizens Bank"), for itself and as
administrative agent for other participating lenders. The amendment extended the
maturity date from May 20, 2004 to March 15, 2006, referred to as the Maturity
Date. The amended credit facility is structured as a $150 million term loan and
a $50 million revolving credit facility. We are required to make quarterly
repayments of $6.3 million on the term loan until the Maturity Date. The
remaining balance outstanding under the term loan and the balance under the
revolving credit facility will become due on the Maturity Date. As of December
31, 2003, there was $47.9 million available under the revolving credit facility.
The credit agreement contains certain financial and other covenants, such
as maintaining net worth and funded debt to EBITDA requirements, and includes
restrictions on, among other things, acquisitions, the incurrence of additional
debt, the issuance of equity, and distributions to shareholders. If an event of
default, such as failure to comply with covenants, material adverse change, or
change of control, were to occur under the credit agreement, the lenders would
be entitled to declare all amounts outstanding under it immediately due and
payable. As of December 31, 2003, we were in compliance with all required
financial covenants and we were not aware of any events of default.
-44-
Convertible Notes. In April 2001 we completed the sale of $125.0 million
aggregate principal amount of 4.75 percent convertible subordinated notes due
2006, referred to as 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
credit agreement.
Nonrecourse Debt. In August 2002, NCO Portfolio entered into a four-year
financing agreement with CFSC Capital Corp. XXXIV, referred to as Cargill, to
provide financing for larger purchases of accounts receivable at 90 percent of
the purchase price, unless otherwise negotiated. Cargill, at their sole
discretion, has the right to finance any purchase of $4.0 million or more.
Cargill may or may not choose to finance a transaction. This agreement gives NCO
Portfolio the financing to purchase larger portfolios that they 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 4.00 percent at December 31, 2003) and are nonrecourse to NCO
Portfolio and us, except for the assets financed through Cargill. Debt service
payments equal total collections less servicing fees and expenses until each
individual borrowing is fully repaid and NCO Portfolio's original investment is
returned, including interest. Thereafter, Cargill 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, 2003, was $17.6 million, including accrued residual
interest. As of December 31, 2003, NCO Portfolio was in compliance with all of
the financial covenants.
Contractual Obligations. The following summarizes our contractual
obligations as of December 31, 2003 (amounts in thousands). For a detailed
discussion of these contractual obligations, see notes 9, 10 and 19 in our Notes
to Consolidated Financial Statements. The following contractual obligations do
not include any contractual obligations of the off-balance sheet arrangements
described below.
Payments Due by Period
---------------------------------------------------------------------
Less than 1 More than 5
Total Year 1 to 3 Years 3 to 5 Years Years
--------- ----------- ------------ ------------ -----------
Term loan $ 132,500 $ 25,000 $ 107,500 $ - $ -
Convertible notes (1) 125,000 - 125,000 - -
Securitized debt 33,210 25,008 8,202 - -
Nonrecourse debt 17,591 15,108 2,483 - -
Capital leases and other 7,186 1,407 5,287 149 343
Operating leases (2) 148,036 25,905 46,301 32,901 42,929
Purchase commitments 55,153 19,937 30,116 5,100 -
Long-term collection contract 19,500 6,000 13,500 - -
Forward-flow agreement 12,500 12,500 - - -
--------- --------- --------- -------- --------
Total contractual obligations $ 550,676 $ 130,865 $ 338,389 $ 38,150 $ 43,272
========= ========= ========= ======== ========
(1) Assumes that the convertible notes are not converted into common stock prior
to the maturity date.
(2) Does not include the leases from our former Fort Washington locations (see
notes 19 and 22 in our Notes to Consolidated Financial Statements).
-45-
Off-Balance Sheet Arrangements
In connection with the Creditrust merger, NCO Portfolio acquired a 100
percent retained residual interest in an investment in securitization,
Creditrust SPV 98-2, LLC. This securitization issued a nonrecourse note that was
due the earlier of January 2004 or satisfaction of the note from collections. No
income was recorded from this investment during the year ended December 31,
2003, due to concerns related to the future recoverability of the investment. We
recorded $211,000 and $162,000 of income on this investment for the period from
February 21, 2001 to December 31, 2001, and for the year ended December 31,
2002, respectively. In December 2003, the nonrecourse note was repaid in full,
at which time the purchased accounts receivables portfolio with a carrying value
of $4.5 million reverted back to NCO Portfolio's control. Immediately following
payoff, the cash reserves of $3.3 million plus an additional $1.2 million were
placed into the reserve account of another securitization to satisfy the
guarantee to the note insurer.
NCO Portfolio has a 50 percent ownership interest in a joint venture,
InoVision-MEDCLR-NCOP Ventures, LLC, referred to as the Joint Venture, with IMNV
Holdings, LLC, referred to as IMNV. The Joint Venture was established in 2001 to
purchase utility, medical and other various small balance accounts receivable
and is accounted for using the equity method of accounting. Included in "other
assets" on the balance sheets was NCO Portfolio's investment in the Joint
Venture of $3.4 million and $4.0 million as of December 31, 2002 and 2003,
respectively. Included in the statements of income, in "interest and investment
income," was $118,000, $762,000 and $2.2 million for the years ended December
31, 2001, 2002 and 2003, respectively, representing NCO Portfolio's 50 percent
share of operating income from this unconsolidated subsidiary.
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. A 10 percent change in the foreign currency exchange rates
is not expected to have a material impact on our business. 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.
Impact of Recently Issued and Proposed Accounting Pronouncements
SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a
Transfer. We currently follow the accounting guidance in Practice Bulletin #6
for the accounting for purchased accounts receivable portfolios. Practice
Bulletin #6 has been superceded by SOP 03-3 - Accounting for Certain Loans or
Debt Securities Acquired in a Transfer. SOP 03-3 is effective for loans acquired
in fiscal years beginning after December 15, 2004, although early adoption is
permitted. SOP 03-3 applies 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. SOP 03-3 addresses accounting for
differences between contractual and expected cash flows from an investor's
initial investment in certain loans when such differences are attributable, in
part, to credit quality. SOP 03-3 also addresses such loans acquired in
purchased business combinations.
-46-
SOP 03-3 limits the revenue that may be accrued to the excess of the
estimate of expected cash flows over a portfolio's initial cost of accounts
receivable acquired. SOP 03-3 requires that the excess of the contractual cash
flows over expected cash flows not be recognized as an adjustment of revenue,
expense, or on the balance sheet. SOP 03-3 freezes the internal rate of return,
referred to as the IRR, originally estimated when the accounts receivable are
purchased for subsequent impairment testing. Rather than lower the estimated IRR
if the original collection estimates are not received, the carrying value of a
portfolio is written down to maintain the original IRR. Increases in expected
cash flows are to be recognized prospectively through adjustment of the IRR over
a portfolio's remaining life. Loans acquired in the same fiscal quarter with
common risk characteristics may be aggregated for the purpose of applying this
SOP. We are in the process of determining the effect SOP 03-3 will have on our
financial position and results of operations.
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities".
In January 2003, the FASB issued Interpretation No. 46, "Consolidation of
Variable Interest Entities," referred to as FIN 46. 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
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. On
January 1, 2004, we adopted FIN 46. We have an $11.1 million note receivable and
a $5.7 million note receivable included in our balance sheet under current and
long-term other assets as of December 31, 2003. These notes receivable are from
two separate companies that comprised our Market Strategy division that was
divested during 2000. Under FIN 46, the companies that issued these notes
receivable are considered variable interest entities. Based on our initial
evaluation of these variable interest entities, we do not believe we are
required to consolidate theses entities under FIN 46.
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 15(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 Disclosure.
None.
Item 9a. Controls and Procedures.
Our management, with participation of our chief executive officer and chief
financial officer, conducted an evaluation of the effectiveness of our
disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e),
as of December 31, 2003. Based on that evaluation, our chief executive officer
and chief financial officer concluded that our disclosure controls and
procedures were effective in reaching a reasonable level of assurance that
management is timely alerted to material information relating to us during the
period when our periodic reports are being prepared.
-47-
Our management, with participation of our chief executive officer and chief
financial officer, also conducted an evaluation of our internal control over
financial reporting, as defined in Exchange Act Rule 13a-15(f), to determine
whether any changes occurred during the quarter ended December 31, 2003, that
have materially affected, or are reasonably likely to materially affect, our
internal control over financial reporting. Based on that evaluation, there were
no such changes during the quarter ended December 31, 2003.
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
controls systems, no evaluation of controls can provide absolute assurance that
all control issues and instances of fraud, if any, within our company have been
detected. Because of the inherent limitations in a cost-effective control
system, misstatements due to error or fraud may occur and not be detected.
-48-
PART III
Item 10. Directors and Executive Officers of the Registrant.
Incorporated by reference from the Company's Proxy Statement relating to
the 2004 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 that 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 2004 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 and
Related Shareholder Matters.
Incorporated by reference from the Company's Proxy Statement relating to
the 2004 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 2004 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
Item 14. Principal Accountant Fees and Services.
Incorporated by reference from the Company's Proxy Statement relating to
the 2004 Annual Meeting of Shareholders to be filed in accordance with General
Instruction G(3) to Form 10-K.
-49-
PART IV
Item 15. Exhibits, Financial Statements and Reports on Form 8-K.
(a). Documents filed as part of this report:
1. List of Consolidated Financial Statements. The 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
Consolidated Balance Sheets as of December 31, 2002 and 2003
Consolidated Statements of Income for each of the three years
in the period ended December 31, 2003
Consolidated Statements of Shareholders' Equity for each of the three years
in the period ended December 31, 2003
Consolidated Statements of Cash Flows for each of the three years in the
period ended December 31, 2003
Notes to Consolidated Financial Statements
Consolidating Statement of Income for the
year ended December 31, 2003 (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 "*":
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
2.1(7) 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.
-50-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
2.2(12) Asset Acquisition Agreement dated August 19, 2002, among Great Lakes Collection Bureau,
Inc., General Electric Capital Corporation, NCO Group, Inc. and Great lakes Acquisition
Corporation. NCO will furnish to the Securities and Exchange Commission a copy of any
omitted schedules upon request.
2.3(14) Agreement and Plan of Merger by and among NCO Group, Inc., NCOG Acquisition Corporation,
and RMH Teleservices, Inc., dated as of November 18, 2003. NCO will furnish to the
Securities and Exchange Commission a copy of any omitted schedules upon request.
2.4(16) First Amendment to the Agreement and Plan of Merger by and among NCO Group, Inc., NCOG
Acquisition Corporation, and RMH Teleservices, Inc., dated as of January 22, 2004.
NCO will furnish to the Securities and Exchange Commission a copy of any omitted
schedules upon request.
2.5(17) Second Amendment to the Agreement and Plan of Merger by and among NCO Group, Inc.,
NCOG Acquisition Corporation, and RMH Teleservices, Inc., dated as of March 3, 2004.
NCO will furnish to the Securities and Exchange Commission a copy of any omitted
schedules upon request.
2.6(15) Agreement and Plan of Merger by and among NCO Group, Inc., NCPM Acquisition
Corporation, and NCO Portfolio Management, Inc., dated as of December 12, 2003. 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(10) Amendment to Amended and Restated Articles of Incorporation.
3.4(1) The Company's Amended and Restated Bylaws.
4.1(1) Specimen of Common Stock Certificate.
4.2(4) Form of warrant to purchase NCO Group, Inc. common stock.
4.3(9) Purchase Agreement dated as of March 29, 2001, between NCO Group, Inc. and Deutsche Bank
Alex. Brown Inc.
4.4(9) Indenture dated as of April 4, 2001, between NCO Group, Inc. and Bankers Trust Company,
as Trustee
4.5(9) Registration Rights Agreement dated as of April 4, 2001, between NCO Group, Inc. and
Deutsche Bank Alex. Brown Inc.
4.6(9) 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.
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Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
*10.2(5) 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(5) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996,
between the Company and Steven L. Winokur.
*10.5(8) Employment Agreement, dated June 5, 1998, between the Company and Joshua Gindin.
*10.6(8) Addendum, dated January 1, 1999, to the Employment Agreement, dated June 5, 1998,
between the Company and Joshua Gindin.
*10.7(6) Employment Agreement, dated May 2, 1998, between the Company and Paul E. Weitzel, Jr.
*10.8(6) 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(3) 1996 Stock Option Plan, as amended.
*10.11(3) 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(13) Sixth Amended and Restated Credit Agreement dated as of August 13, 2003, by and among
NCO Group, Inc., as Borrower, Citizens Bank of Pennsylvania, as Administrative Agent and
a Lender, and the Financial Institutions identified therein as Lenders and such other
Co-Arrangers, Co-Documentation Agents, Co-Agents, and 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.
10.15(2) Executive Salary Continuation Agreement.
10.16 First Amendment, dated November 20, 2003, to the Sixth Amended and Restated Credit
Agreement dated as of August 13, 2003, by and among NCO Group, Inc., as Borrower,
Citizens Bank of Pennsylvania, as Administrative Agent and a Lender, and the Financial
Institutions identified therein as Lenders and such other Co-Arrangers, Co-Documentation
Agents, Co-Agents, and 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(8) Credit Agreement, dated as of February 20, 2001, by and between NCO Portfolio
Management, Inc., as Borrower, and NCO Group, Inc., as Lender.
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Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
10.18(8) 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.
10.19(8) Note Receivable, dated October 26, 2000, from TRC Holdings, Inc. for the principal
amount of $12.25 million, as payment of the purchase price for the acquisition of
certain assets of NCO Teleservices, Inc.
*10.20(11) Employment Agreement, dated January 31, 2002, between the Company and Stephen W.
Elliott.
*10.21(11) Employment Agreement, dated November 21, 2001, between the Company and Steven Leckerman.
*10.22 Employment Agreement, dated May 15, 2003, between the Company and Paul J. Burkitt.
*10.23 Employment Agreement, dated July 7, 2003, between the Company and Charles F. Burns.
10.24 First Amendment, dated as of November 1, 2002, to the Credit Agreement, dated as of
February 20, 2001, by and between NCO Portfolio Management, Inc., as Borrower, and NCO
Group, Inc., as Lender.
10.25 Second Amendment, dated as of August 13, 2003, to the Credit Agreement, dated as of
February 20, 2001, by and between NCO Portfolio Management, Inc., as Borrower, and NCO
Group, Inc., as Lender.
10.26 Amended and Restated Note Receivable, dated June 1, 2003, 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.
10.27 Amended and Restated Note Receivable, dated April 1, 2002, 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.
*10.28 Second Addendum, dated July 1, 2003, to the Employment Agreement, dated September 1,
1996, as amended, between the Company and Michael J. Barrist.
*10.29 Second Addendum, dated July 1, 2003, to the Employment Agreement, dated September 1,
1996, as amended, between the Company and Steven L. Winokur.
*10.30 Second Addendum, dated July 1, 2003, to the Employment Agreement, dated June 5, 1998, as
amended, between the Company and Joshua Gindin.
*10.31 Second Addendum, dated July 1, 2003, to the Employment Agreement, dated May 2, 1998, as
amended, between the Company and Paul E. Weitzel, Jr.
*10.32 Employment Agreement, dated December 8, 2000, between the Company and Albert Zezulinski.
21.1 Subsidiaries of the Registrant.
23.1 Consent of Ernst & Young LLP.
31.1 Rule 13a-14(a) Certification of Chief Executive Officer
-53-
Exhibit No. Description
- -------------------- ----------------------------------------------------------------------------------------
31.2 Rule 13a-14(a) Certification of Chief Financial Officer
32.1 Section 1350 Certification
- ----------------
(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 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.
(3)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.
(4) 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.
(5) 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.
(60 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.
(7) 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.
(8) 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.
(9) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for
the quarter ended March 31, 2001.
(10) Incorporated by reference to the Company's Quarterly Report on Form 10-Q
for the quarter ended June 30, 2001.
(11) Incorporated by reference to the Company's Annual Report on Form 10-K for
the fiscal year ended December 31, 2001 (File No. 0-21639), filed with the
Securities and Exchange Commission on March 19, 2002.
-54-
(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
September 3, 2002.
(13) 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 August
19, 2003.
(14) 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 November
20, 2003.
(15) 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 December
16, 2003.
(16) 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 January
23, 2004.
(17) 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 3,
2004.
(b). Reports on Form 8-K filed or furnished during fourth quarter of 2003
Date of Report Item Reported
- -------------- -------------
12/16/03 Item 5 and Item 7 - Press release for the acquisition of
the minority interest of NCO Portfolio
Management, Inc.
11/20/03 Item 5 and Item 7 - Press release for the acquisition of
RMH Teleservices, Inc.
11/7/03 Item 7 and Item 9 - Conference call transcript from the
earnings release for the third quarter
of 2003
11/6/03 Item 7 and Item 9 - Press release from the earnings
release for the third quarter of 2003.
-55-
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 12, 2004 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 and in the capacities and on the dates indicated.
SIGNATURE TITLE(S) DATE
--------- -------- ----
/s/ Michael J. Barrist Chairman of the Board, President and Chief March 12, 2004
- -------------------------- Executive Officer (principal executive
Michael J. Barrist officer)
/s/ Steven L. Winokur Executive Vice President, Finance; Chief March 12, 2004
- -------------------------- Financial Officer; Chief Operating Officer
Steven L. Winokur of Shared Services; and Treasurer
(principal financial and accounting officer)
/s/ William C. Dunkelberg Director March 12, 2004
- --------------------------
William C. Dunkelberg
/s/ Charles C. Piola, Jr. Director March 12, 2004
- --------------------------
Charles C. Piola, Jr.
/s/ Leo J. Pound Director March 12, 2004
- --------------------------
Leo J. Pound
/s/ Eric S. Siegel Director March 12, 2004
- --------------------------
Eric S. Siegel
/s/ Allen F. Wise Director March 12, 2004
- --------------------------
Allen F. Wise
-56-
INDEX TO CONSOLIDATED FINANCIAL STATEMENTS
AND FINANCIAL STATEMENT SCHEDULE
Financial Statements:
Report of Independent Auditors.............................................F-2
Consolidated Balance Sheets as of December 31, 2002 and 2003 ..............F-3
Consolidated Statements of Income for each of the three years
in the period ended December 31, 2003...................................F-4
Consolidated Statements of Shareholders' Equity for each of the
three years in the period ended December 31, 2003.......................F-5
Consolidated Statements of Cash Flows for each of the three years
in the period ended December 31, 2003...................................F-6
Notes to Consolidated Financial Statements.................................F-7
Consolidating Statement of Income for
the year ended December 31, 2003 (Unaudited)............................F-31
Financial Statement Schedule:
For the years ended December 31, 2001, 2002 and 2003:
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, 2002 and 2003, and the related consolidated statements of
income, shareholders' equity, and cash flows for each of the three years in the
period ended December 31, 2003. Our audits also included the consolidated
financial statement schedule listed in the Index at Item 15(a). These
consolidated financial statements and schedule are the responsibility of the
Company's management. Our responsibility is to express an opinion on these
consolidated 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 consolidated financial statements referred to above present
fairly, in all material respects, the consolidated financial position of NCO
Group, Inc. at December 31, 2002 and 2003, and the consolidated results of its
operations and its cash flows for each of the three years in the period ended
December 31, 2003, in conformity with accounting principles generally accepted
in the United States. Also, in our opinion, the related consolidated financial
statement schedule, when considered in relation to the basic consolidated
financial statements taken as a whole, presents fairly in all material respects
the information set forth therein.
As discussed in Note 2 to the consolidated financial statements, in 2002 NCO
Group, Inc. adopted Statement of Financial Accounting Standards No. 142,
"Goodwill and Other Intangible Assets," which resulted in NCO Group, Inc.
changing its method of accounting for goodwill and its related amortization.
/s/ Ernst & Young LLP
Philadelphia, Pennsylvania
February 6, 2004
F-2
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Amounts in thousands)
December 31,
----------------------------
ASSETS 2002 2003
--------- ---------
Current assets:
Cash and cash equivalents $ 25,159 $ 45,644
Restricted cash 900 5,850
Accounts receivable, trade, net of allowance for
doubtful accounts of $7,285 and $7,447, respectively 86,857 80,640
Purchased accounts receivable, current portion 60,693 59,371
Deferred income taxes 16,389 12,280
Bonus receivable, current portion 15,584 7,646
Prepaid expenses and other current assets 9,644 18,021
--------- ---------
Total current assets 215,226 229,452
Funds held on behalf of clients
Property and equipment, net 79,603 74,085
Other assets:
Goodwill 525,784 506,370
Other intangibles, net of accumulated amortization 14,069 12,375
Purchased accounts receivable, net of current portion 91,755 93,242
Bonus receivable, net of current portion 408 320
Other assets 39,436 30,267
--------- ---------
Total other assets 671,452 642,574
--------- ---------
Total assets $ 966,281 $ 946,111
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 40,678 $ 66,523
Income taxes payable 2,222 -
Accounts payable 8,285 4,281
Accrued expenses 28,848 25,901
Accrued compensation and related expenses 15,374 15,601
Deferred revenue, current portion 12,088 10,737
--------- ---------
Total current liabilities 107,495 123,043
Funds held on behalf of clients
Long-term liabilities:
Long-term debt, net of current portion 334,423 248,964
Deferred revenue, net of current portion 11,678 13,819
Deferred income taxes 48,605 38,676
Other long-term liabilities 3,891 4,344
Minority interest 24,427 26,848
Shareholders' equity:
Preferred stock, no par value, 5,000 shares authorized,
no shares issued and outstanding - -
Common stock, no par value, 50,000 shares authorized,
25,908 and 25,988 shares issued and outstanding, respectively 321,824 323,511
Other comprehensive (loss) income (3,876) 6,646
Retained earnings 117,814 160,260
--------- ---------
Total shareholders' equity 435,762 490,417
--------- ---------
Total liabilities and shareholders' equity $ 966,281 $ 946,111
========= =========
See accompanying notes.
F-3
NCO GROUP, INC.
Consolidated Statements of Income
(Amounts in thousands, except per share data)
For the Years Ended December 31,
------------------------------------------------
2001 2002 2003
---------- --------- ---------
Revenue $ 683,873 $ 703,450 $ 753,816
Operating costs and expenses:
Payroll and related expenses 350,634 335,405 350,369
Selling, general and administrative expenses 237,690 249,672 282,268
Depreciation and amortization expense 38,205 27,324 31,628
---------- --------- ---------
Total operating costs and expenses 626,529 612,401 664,265
---------- --------- ---------
Income from operations 57,344 91,049 89,551
Other income (expense):
Interest and investment income 3,627 3,222 3,927
Interest expense (26,962) (20,976) (22,998)
Other income (expense) - (216) 1,128
---------- --------- ---------
Total other income (expense) (23,335) (17,970) (17,943)
---------- --------- ---------
Income before income tax expense 34,009 73,079 71,608
Income tax expense 14,661 27,702 26,732
---------- --------- ---------
Income before minority interest 19,348 45,377 44,876
Minority interest (4,310) (3,218) (2,430)
---------- --------- ---------
Net income $ 15,038 $ 42,159 $ 42,446
========== ========= =========
Net income per share:
Basic $ 0.58 $ 1.63 $ 1.64
Diluted $ 0.58 $ 1.54 $ 1.54
Weighted average shares outstanding:
Basic 25,773 25,890 25,934
Diluted 26,091 29,829 29,895
See accompanying notes.
F-4
NCO GROUP, INC.
Consolidated Statements of Shareholders' Equity
For the Years Ended December 31, 2001, 2002 and 2003
(Amounts in thousands)
Common Stock
----------------------- Other
Number of Comprehensive Retained Comprehensive
Shares Amount Income (Loss) Earnings Income (Loss) Total
--------- --------- ------------- -------- ------------- ---------
Balance, January 1, 2001 25,627 $ 316,372 $ (1,525) $ 60,617 $ 375,464
Issuance of common stock 189 4,621 - - 4,621
Comprehensive income, net of tax:
Net income - - - 15,038 $ 15,038 15,038
Other comprehensive income (loss):
Foreign currency translation adjustment - - (2,821) - (2,821) (2,821)
--------
Total comprehensive income (loss) $ 12,217
------ --------- -------- -------- ======== ---------
Balance, December 31, 2001 25,816 320,993 (4,346) 75,655 392,302
Issuance of common stock 92 831 - - 831
Comprehensive income, net of tax:
Net income - - - 42,159 $ 42,159 42,159
Other comprehensive income (loss):
Foreign currency translation adjustment - - 930 - 930 930
Unrealized loss on interest rate swap - - (460) - (460) (460)
--------
Total comprehensive income (loss) $ 42,629
------ --------- -------- -------- ======== ---------
Balance, December 31, 2002 25,908 321,824 (3,876) 117,814 435,762
Issuance of common stock 80 1,687 - - 1,687
Comprehensive income, net of tax:
Net income - - - 42,446 $ 42,446 42,446
Other comprehensive income (loss):
Foreign currency translation adjustment - - 10,062 - 10,062 10,062
Unrealized loss on interest rate swap - - 460 - 460 460
--------
Total comprehensive income (loss) $ 52,968
------ --------- -------- -------- ======== ---------
Balance, December 31, 2003 25,988 $ 323,511 $ 6,646 $160,260 $ 490,417
====== ========= ======== ======== =========
See accompanying notes.
F-5
NCO GROUP, INC
Consolidated Statements of Cash Flows
(Amounts in thousands)
For the Years Ended December 31,
----------------------------------------------
2001 2002 2003
-------- -------- --------
Cash flows from operating activities:
Net income $ 15,038 $ 42,159 $ 42,446
Adjustments to reconcile income from operations
to net cash provided by operating activities:
Depreciation 20,142 24,162 27,035
Amortization of intangibles 18,063 3,162 4,593
Provision for doubtful accounts 4,250 8,293 4,816
Impairment of purchased accounts receivable 2,738 1,999 1,751
Accrued noncash interest - 831 4,922
Loss (gain) on disposal of property and equipment 827 (847) 386
Changes in non-operating income (118) (512) (2,642)
Minority interest 4,310 3,218 2,421
Changes in operating assets and liabilities, net of acquisitions:
Restricted cash 2,555 225 (4,950)
Accounts receivable, trade (3,494) (2,368) 1,707
Deferred income taxes 3,833 12,572 18,816
Bonus receivable (3,662) (11,663) 8,026
Other assets (3,817) 4,122 1,655
Accounts payable and accrued expenses 13,066 (19,517) (6,561)
Income taxes payable (252) 2,127 (4,008)
Deferred revenue 12,153 (2,597) 790
Other long-term liabilities 218 (1,361) (147)
-------- -------- --------
Net cash provided by operating activities 85,850 64,005 101,056
Cash flows from investing activities:
Purchases of accounts receivable (50,621) (70,654) (68,272)
Collections applied to principal of purchased accounts receivable 35,284 58,351 77,386
Purchases of property and equipment (27,940) (27,331) (20,498)
Net distribution from joint venture - - 1,540
Proceeds from notes receivable - 1,000 394
Proceeds from disposal of property and equipment 560 2,633 -
Investment in consolidated subsidiary by minority interest 2,320 - -
Net cash paid for acquisitions and related costs (11,077) (27,966) (720)
-------- -------- --------
Net cash used in investing activities (51,474) (63,967) (10,170)
Cash flows from financing activities:
Repayment of notes payable (21,869) (18,606) (30,947)
Borrowings under notes payable - 24,477 20,916
Repayment of acquired notes payable (20,084) - -
Borrowings under revolving credit agreement 65,230 34,170 1,000
Repayment of borrowings under revolving credit agreement (162,350) (47,620) (61,680)
Payment of fees to acquire debt (5,138) (552) (2,899)
Proceeds from issuance of convertible debt 125,000 - -
Issuance of common stock, net 3,721 747 1,531
-------- -------- --------
Net cash used in financing activities (15,490) (7,384) (72,079)
Effect of exchange rate on cash (215) 344 1,678
-------- -------- --------
Net increase (decrease) in cash and cash equivalents 18,671 (7,002) 20,485
Cash and cash equivalents at beginning of the period 13,490 32,161 25,159
-------- -------- --------
Cash and cash equivalents at end of the period $ 32,161 $ 25,159 $ 45,644
======== ======== ========
See accompanying notes.
F-6
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 63 percent
of NCO Portfolio Management, Inc., a separate public company that purchases and
manages past due consumer accounts receivable from consumer creditors, such as
banks, finance companies, retail merchants, and other consumer oriented
companies. The Company's client base includes companies in the financial
services, healthcare, retail and commercial, telecommunications, utilities,
education and government sectors. These clients are primarily located throughout
the United States of America, Canada, the United Kingdom, and Puerto Rico. The
Company's largest client is in the financial services sector and represented
10.3 percent of the 2003 consolidated revenue.
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. The
Company does not control InoVision-MEDCLR-NCOP Ventures, LLC (see note 23) and,
accordingly, its financial condition and results of operations are not
consolidated with the Company's financial statements.
Revenue Recognition:
Contingency Fees:
Contingency fee revenue is recognized upon collection of funds on behalf of
clients.
Contractual Services:
Fees for contractual services are recognized as services are performed and
accepted by the client.
Long-Term Collection Contract:
The Company has a long-term collection contract with a large client to provide
collection services that includes guaranteed collections, subject to limits. The
Company also earns a bonus to the extent collections are in excess of the
guarantees. The Company is required to pay the client, subject to limits, if
collections do not reach the guarantees. Any guarantees in excess of the limits
will only be satisfied with future collections. The Company is entitled to
recoup at least 90 percent of any such guarantee payments from subsequent
collections in excess of any remaining guarantees.
In accordance with the provision of Staff Accounting Bulletin No. 101, "Revenue
Recognition in Financial Statements," the Company defers all of the base service
fees, subject to the limits, until the collections exceed the collection
guarantees. At the end of each reporting period, the Company assesses the need
to record an additional liability if deferred fees are less than the estimated
guarantee payments, if any, due to the client, subject to the limits. There was
no additional liability recorded as of December 31, 2002 and 2003.
F-7
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
2. Accounting Policies (continued):
Revenue Recognition (continued):
Purchased Accounts Receivable:
The Company accounts for its investment in purchased accounts receivable on an
accrual basis under the guidance of American Institute of Certified Public
Accountants' Practice Bulletin 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 the Company 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
the Company's collection experience), compared to the original purchase price.
Revenue on purchased accounts receivable is recorded monthly based on applying
each portfolio's effective IRR for the quarter to its carrying value. To the
extent collections exceed the revenue, the carrying value is reduced and the
reduction is recorded as collections are 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 by the difference between the revenue accrual and
collections.
To the extent actual collections differ from estimated projections, the Company
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 cash
flow projection, after being adjusted prospectively for actual collection
results, is less than the current 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. Once the full cost of the carrying value has been
recovered, all collections will be recorded as revenue. 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.
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 the
Company's credit risk and maintains a reserve for potential collection losses
when such losses are deemed to be probable. The Company generally does not
require collateral and it does not charge finance fees on outstanding trade
receivables. 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. Trade accounts receivable are written off to the
allowance for doubtful accounts when collection appears highly unlikely.
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.
F-8
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.
Long-Lived Assets:
The Company periodically evaluates the net realizable value of long-lived
assets, including property and equipment and certain identifiable intangible
assets, 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.
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, the Company adopted
Statement of Financial Accounting Standard No. 142, "Goodwill and Other
Intangible Assets" ("SFAS 142"). Under SFAS 142, goodwill is no longer amortized
but instead must be tested for impairment at least annually and as triggering
events occur, including an initial test that was completed in connection with
the adoption of SFAS 142. The test for impairment uses 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. Fair value
estimates are based upon the discounted value of estimated cash flows. The
Company did not incur any impairment charges in connection with the adoption of
SFAS 142 or the subsequent annual impairment tests, and does not believe that
goodwill is impaired as of December 31, 2003. The annual impairment analysis is
completed on October 1st of each year (see note 7).
Other Intangible Assets:
Other intangible assets consist primarily of customer lists and deferred
financing costs, which relate to debt issuance costs incurred. Customer lists
are amortized over five years and deferred financing costs are amortized over
the term of the debt (see note 7).
Interest Rate Hedges:
The Company previously accounted for its interest rate swap agreements in its
balance sheet measured at fair value. Changes in the fair value of the interest
rate swap agreements were recorded separately in shareholders' equity as "other
comprehensive income (loss)" since the interest rate swap agreements were
designated and qualified as cash flow hedges. The Company was party to two
interest rate swap agreements that expired on September 1, 2003.
F-9
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
2. Accounting Policies (continued):
Stock Options:
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 (amounts in
thousands, except per share amounts) (see note 14):
For the Years Ended December 31,
--------------------------------------
2001 2002 2003
-------- -------- --------
Net income - as reported $ 15,038 $ 42,159 $ 42,446
Pro forma compensation cost, net of taxes 5,011 5,417 4,372
-------- -------- --------
Net income - pro forma $ 10,027 $ 36,742 $ 38,074
======== ======== ========
Net income per share - as reported:
Basic $ 0.58 $ 1.63 $ 1.64
Diluted $ 0.58 $ 1.54 $ 1.54
Net income per share - pro forma:
Basic $ 0.39 $ 1.42 $ 1.47
Diluted $ 0.38 $ 1.36 $ 1.40
The estimated weighted average, grant-date fair values of the options granted
during the years ended December 31, 2001, 2002 and 2003 were $10.37, $8.40 and
$8.96, 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 on a weighted
average basis:
For the Years Ended December 31,
------------------------------------
2001 2002 2003
---------- ---------- ----------
Risk-free interest rate 4.42% 3.18% 3.72%
Expected life in years 4.33 5.00 5.00
Volatility factor 58.95% 56.59% 47.92%
Dividend yield None None None
Forfeiture rate 5.00% 5.00% 5.00%
Income Taxes:
The Company accounts for income taxes in accordance with SFAS No. 109,
"Accounting for Income Taxes," which requires that deferred tax assets and
liabilities be recognized using enacted tax rates for the effect of temporary
differences between the book and tax bases of recorded assets and liabilities.
SFAS No. 109 also requires that deferred tax assets be reduced by a valuation
allowance, if it is more likely than not that some portion or all of the
deferred tax asset will not be realized. Deferred taxes have not been provided
on the cumulative undistributed earnings of foreign subsidiaries because such
amounts are expected to be reinvested indefinitely.
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 (loss)" and are not included
in determining consolidated net income. As of December 31, 2002 and 2003, other
comprehensive income (loss) included $3.4 million of cumulative losses and $6.6
million of cumulative income, respectively, from foreign currency translation.
Use of Estimates:
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the amounts reported in the financial statements and
the accompanying notes. Actual results could differ from those estimates.
In the ordinary course of accounting for a long-term collection contract,
estimates are made by management as to the payments due to the client. Actual
results could differ from those estimates and a material change could occur
within one reporting period.
In the ordinary course of accounting for purchased accounts receivable,
estimates are made by management as to the amount and timing of future cash
flows expected from each portfolio. The estimated future cash flow of each
portfolio is 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. Future projected collections are then
increased, within preset limits, or decreased based on the actual cumulative
performance of each portfolio. Management reviews each portfolio's adjusted
projected collections to determine if further downward adjustment is warranted.
Management regularly reviews the trends in collection patterns and uses its best
efforts to improve under-performing portfolios. However, actual results will
differ from these estimates and a material change in these estimates could occur
within one reporting period (see note 4).
Reclassifications:
Certain amounts as of December 31, 2002, and for the years ended December 31,
2001 and 2002 have been reclassified for comparative purposes.
3. Business Combinations:
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 and termination costs related to certain redundant
personnel immediately eliminated at the time of the acquisitions.
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 (Nasdaq: NCPM) focused on the
purchase of accounts receivable (the "Creditrust Merger"). After the Creditrust
Merger, the Company owned approximately 63 percent 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 provided NCO Portfolio with a $50
million revolving line of credit, subject to future reductions in availability
(see note 24). Initially, NCO Portfolio borrowed $36.3 million to fund the
Creditrust Merger.
F-11
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
3. Business Combinations (continued):
On August 19, 2002, the Company acquired certain assets and related operations,
excluding the purchased accounts receivable portfolio, and assumed certain
liabilities of Great Lakes Collection Bureau, Inc. ("Great Lakes"), a subsidiary
of GE Capital Corporation ("GE Capital"), for $10.1 million in cash. The Company
funded the purchase with borrowings under its revolving credit agreement. NCO
Portfolio acquired the purchased accounts receivable portfolio of Great Lakes
for $22.9 million. NCO Portfolio funded the purchase with $2.3 million of
existing cash and $20.6 million of nonrecourse financing provided by CFSC
Capital Corp. XXXIV (see note 9). This nonrecourse financing is collateralized
by the Great Lakes purchased accounts receivable portfolio. As part of the
acquisition, the Company and GE Capital signed a multi-year agreement under
which the Company will provide services to GE Capital. The Company allocated
$4.1 million of the purchase price to the customer list and recognized goodwill
of $2.3 million. All of the goodwill is deductible for tax purposes. During the
year ended December 31, 2003, the Company revised the estimated allocation of
the fair market value that resulted in an increase in goodwill of $248,000. As a
result of the acquisition, the Company expects to expand its current customer
base, strengthen its relationship with certain existing customers and reduce the
cost of providing services to the acquired customers through economies of scale.
Therefore, the Company believes the allocation of a portion of the purchase
price to goodwill is appropriate.
On December 9, 2002, the Company acquired all of the stock of The Revenue
Maximization Group, Inc. ("RevGro") for $17.5 million in cash, including the
repayment of $889,000 of RevGro's pre-acquisition debt. The Company funded the
purchase with $16.8 million of borrowings under its revolving credit agreement
and existing cash. The Company allocated $4.7 million of the purchase price to
the customer list and recognized goodwill of $8.2 million. None of the goodwill
is deductible for tax purposes. During the year ended December 31, 2003, the
Company revised the estimated allocation of the fair market value that resulted
in a decrease in goodwill of $1.1 million. As a result of the acquisition, the
Company expects to expand its current customer base, strengthen its relationship
with certain existing customers and reduce the cost of providing services to the
acquired customers through economies of scale. Therefore, the Company believes
the allocation of a portion of the purchase price to goodwill is appropriate.
4. 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, 2003, the carrying values of Portfolio
Management's and International Operations' purchased accounts receivable were
$149.7 million and $2.9 million, respectively. The following summarizes the
change in purchased accounts receivable (amounts in thousands):
For the Years Ended December 31,
---------------------------------------
2001 2002 2003
--------- --------- ---------
Balance, at beginning of period $ 34,475 $ 140,001 $ 152,448
Purchased accounts receivable acquired from
Creditrust 93,518 - -
Purchases of accounts receivable 50,621 72,680 74,299
Collections on purchased accounts receivable (99,868) (120,513) (154,121)
Purchase price adjustment - (4,000) -
Revenue recognized 64,065 66,162 76,735
Impairment of purchased accounts receivable (2,738) (1,999) (1,751)
Residual purchased accounts receivable from
previously unconsolidated subsidiary - - 4,515
Foreign currency translation adjustment (72) 117 488
--------- --------- ---------
- - -
Balance, at end of period $ 140,001 $ 152,448 $ 152,613
========= ========= =========
F-12
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
4. Purchased Accounts Receivable (continued):
During the years ended December 31, 2001, 2002 and 2003, impairments of $2.7
million, $2.0 million and $1.8 million, respectively, were recorded as a charge
to income on portfolios where the carrying values exceeded the expected future
cash flows. No income will be recorded on these portfolios until the carrying
values have been fully recovered. As of December 31, 2002 and 2003, the combined
carrying values on all impaired portfolios aggregated $6.1 million and $11.4
million, respectively, or 4.0 percent and 7.5 percent of total purchased
accounts receivable, respectively, representing their net realizable value.
As of December 31, 2003, one portfolio with a carrying value of $4.2 million,
which was acquired in connection with the dissolution of Creditrust SPV 98-2,
LLC (see note 23), is also being accounted for under the cost recovery method.
Included in collections for the years ended December 31, 2002 and 2003, was $3.7
million and $7.6 million in proceeds from the sale of accounts, respectively.
During the year ended December 31, 2002, NCO Portfolio concluded a contract
renegotiation with the seller of several existing portfolios resulting in a $4.0
million cash price reduction on several purchases from 2000 and 2001. The $4.0
million proceeds were recorded as a reduction to purchase price of the affected
portfolios during 2002 and included in "Collections applied to principal of
purchased accounts receivable" in the Consolidated Statement of Cash Flows.
5. 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 $60.2 million and $59.3 million at
December 31, 2002 and 2003, respectively, have been shown net of their
offsetting liability for financial statement presentation.
6. Property and Equipment:
Property and equipment, at cost, consisted of the following (amounts in
thousands):
December 31,
Estimated ----------------------------
Useful Life 2002 2003
-------------- -------- --------
Computer equipment 5 years $ 87,470 $ 96,680
Computer software developed
for internal use 5 years 33,542 41,850
Furniture and fixtures 5 to 10 years 17,576 20,546
Leasehold improvements 5 to 15 years 12,829 14,295
-------- --------
151,417 173,371
Less accumulated depreciation 71,814 99,286
-------- --------
$ 79,603 $ 74,085
======== ========
Depreciation charged to operations amounted to $20.1 million, $24.2 million and
$27.0 million for the years ended December 31, 2001, 2002 and 2003,
respectively.
F-13
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
7. Intangible Assets:
Goodwill:
SFAS 142 requires goodwill to be allocated and tested at the reporting unit
level. The Company's reporting units under SFAS 142 are U.S. Operations,
Portfolio Management and International Operations. Portfolio Management does not
have any goodwill. The U.S. Operations and International Operations had the
following goodwill (amounts in thousands):
December 31,
----------------------------
2002 2003
--------- ---------
U.S. Operations $ 495,575 $ 471,558
International Operations 30,209 34,812
--------- ---------
$ 525,784 $ 506,370
========= =========
The change in U.S. Operations' goodwill balance from 2002 to 2003 was
principally due to a $24.7 million reduction in deferred tax liabilities
associated with the settlement of certain amounts recorded in purchase
accounting. The change in International Operations' goodwill balance from 2002
to 2003 was due to changes in the exchange rates used for the foreign currency
translation.
The following presents the results of operations as if SFAS 142 had been adopted
as of January 1, 2001 (dollars in thousands):
For the Year Ended
December 31, 2001
---------------------------
Diluted
Earnings
Amount Per Share
----------- -----------
Net income, as reported $ 15,038 $ 0.58
Add back of goodwill
amortization, net of tax 11,894 0.44
-------- ------
Adjusted net income $ 26,932 $ 1.02
======== ======
Other Intangible Assets:
Other intangible assets consist primarily of deferred financing costs and
customer lists. The following represents the other intangible assets (amounts in
thousands):
December 31,
---------------------------------------------------------------
2002 2003
---------------------------- ----------------------------
Gross Gross
Carrying Accumulated Carrying Accumulated
Amount Amortization Amount Amortization
-------- ------------ -------- ------------
Deferred financing costs $ 12,422 $ 6,969 $ 15,321 $ 9,687
Customer lists 8,761 357 8,761 2,104
Other intangible assets 900 688 900 816
-------- ------- -------- -------
Total $ 22,083 $ 8,014 $ 24,982 $ 12,607
======== ======= ======== ========
F-14
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
7. Intangible Assets (continued):
Other Intangible Assets (continued):
The Company recorded amortization expense for all other intangible assets of
$2.4 million, $3.2 million and $4.6 million during the years ended December 31,
2001, 2002 and 2003, respectively. The following represents the Company's
expected amortization expense from these other intangible assets
(amounts in thousands):
2004 $ 4,380
2005 4,254
2006 2,341
2007 1,400
8. Accrued Expenses:
Accrued expenses consisted of the following (amounts in thousands):
December 31,
-----------------------------
2002 2003
------------ ------------
Accrued rent and other related
expense associated with the flood of
the Fort Washington locations $ 8,211 $ 8,043
Other accrued expenses 20,637 17,858
-------- --------
$ 28,848 $ 25,901
======== ========
9. Long-Term Debt:
Long-term debt consisted of the following (amounts in thousands):
December 31,
---------------------------------
2002 2003
-------------- --------------
Term loan $ - $ 132,500
Revolving credit facility 193,180 -
Convertible notes 125,000 125,000
Securitized debt 35,523 33,210
Nonrecourse debt 17,632 17,591
Capital leases and other 2,935 7,186
Less current portion (39,847) (66,523)
--------- ---------
$ 334,423 $ 248,964
========= =========
The following summarizes the Company's required debt payments (amounts in
thousands). The payment for 2006 assumes that the convertible notes are not
converted into common stock prior to the maturity date.
2004 $ 66,523
2005 40,900
2006 207,572
2007 74
2008 75
Thereafter 343
F-15
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
9. Long-Term Debt (continued):
Revolving Credit Facility:
On August 13, 2003, the Company amended its credit agreement with Citizens Bank
of Pennsylvania, ("Citizens Bank"), for itself and as administrative agent for
other participating lenders. The amendment extended the maturity date from May
20, 2004 to March 15, 2006 (the "Maturity Date"). The amended credit facility is
structured as a $150 million term loan and a $50 million revolving credit
facility. The Company is required to make quarterly repayments of $6.3 million
on the term loan until the Maturity Date. The remaining balance outstanding
under the term loan and the balance under the revolving credit facility will
become due on the Maturity Date. The availability of the revolving credit
facility is reduced by any unused letters of credit. As of December 31, 2003,
the Company had unused letters of credit of $2.1 million and $47.9 million
remaining availability under the revolving credit facility.
Prior to February 28, 2004, all borrowings carried interest at a rate equal to
either, at the option of the Company, Citizens Bank's prime rate plus a margin
of 1.25 percent (Citizens Bank's prime rate was 4.00 percent at December 31,
2003), or the London InterBank Offered Rate ("LIBOR") plus a margin of 3.00
(LIBOR was 1.12 percent at December 31, 2003). After February 28, 2004, all
borrowings bear interest at a rate equal to either, at the option of the
Company, Citizens Bank's prime rate plus a margin of 0.75 percent to 1.25
percent, which is determined quarterly based upon the Company's consolidated
funded debt to earnings before interest, taxes, depreciation, and amortization
("EBITDA") ratio, or LIBOR plus a margin of 2.25 percent to 3.00 percent
depending on the Company's consolidated funded debt to EBITDA ratio. The Company
is charged a fee on the unused portion of the credit facility of 0.50 percent
until February 28, 2004, and ranging from 0.38 percent to 0.50 percent depending
on the Company's consolidated funded debt to EBITDA ratio after February 28,
2004. The effective interest rate on the credit facility was approximately 4.29
percent for the year ended December 31, 2003.
Borrowings under the credit facility are collateralized by substantially all the
assets of the Company, including the common stock of NCO Portfolio that the
Company owns, and its rights under the credit agreement with NCO Portfolio (see
note 24). The credit agreement contains certain financial and other covenants
such as maintaining net worth and funded debt to EBITDA requirements, and
includes restrictions on, among other things, acquisitions, the incurrence of
additional debt, the issuance of equity, and distributions to shareholders. If
an event of default, such as failure to perform covenants, material adverse
change, or change of control, were to occur under the credit agreement, the
lenders would be entitled to declare all amounts outstanding under it
immediately due and payable. As of December 31, 2003, the Company was in
compliance with all required financial covenants and the Company was not aware
of any events of default.
Convertible Notes:
In April 2001, the Company completed the sale of $125.0 million aggregate
principal amount of 4.75 percent 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 the Company's 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.
Securitized Debt:
NCO Portfolio assumed four securitized notes in connection with the Creditrust
Merger, one of which was repaid in May 2002 and one of which was included in an
unconsolidated subsidiary prior to December 31, 2003, Creditrust SPV 98-2, LLC
(see note 23). The remaining two notes are reflected in long-term debt. These
notes were originally established to fund the purchase of accounts receivable.
Each of the notes payable is nonrecourse to the Company and NCO Portfolio, is
secured by a portfolio of purchased accounts receivable, and is bound by an
indenture and servicing agreement. Pursuant to the Creditrust Merger, the
trustee appointed the Company as the successor servicer for each portfolio of
purchased accounts receivable within these securitized notes. These are term
notes without the ability to re-borrow. Monthly principal payments on the notes
equal all collections after servicing fees, collection costs, interest expense
and administrative fees.
F-16
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
9. Long-Term Debt (continued):
Securitized Debt (continued):
The first securitized note was established in September 1998 and carries a
floating interest rate of LIBOR plus 0.65 percent per annum. The final due date
of all payments under the facility is the earlier of March 2005, or satisfaction
of the note from collections. A liquidity reserve of $900,000 and $5.4 million
was included in restricted cash as of December 31, 2002 and 2003, respectively.
As of December 31, 2002 and 2003, the amount outstanding on the facility was
$15.4 million and $13.9 million, respectively. The note issuer was guaranteed
against loss by NCO Portfolio for up to $4.5 million. In December 2003, the $4.5
million guarantee was funded using $3.3 million of restricted cash from another
securitization, Creditrust SPV 98-2, LLC, (see note 23), and $1.2 million of
operating cash. In January 2004, the $4.5 million from the guarantee was used to
pay down the securitized note.
The second securitized note was established in August 1999 and carries interest
at 15.00 percent per annum. The final due date of all payments under the
facility is the earlier of December 2004, or satisfaction of the note from
collections. As of December 31, 2002 and 2003, the amount outstanding on the
facility was $20.1 million and $19.3 million, respectively.
Nonrecourse Debt:
In August 2002, NCO Portfolio entered into a four-year exclusivity agreement
with CFSC Capital Corp. XXXIV ("Cargill"). The agreement stipulates that all
purchases of accounts receivable by NCO Portfolio with a purchase price in
excess of $4 million must be first offered to Cargill for financing at its
discretion. The agreement has no minimum or maximum credit authorization. NCO
Portfolio 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 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 4.00 percent at December 31, 2003). Each borrowing is due two
years after the loan is made. Debt service payments equal collections less
servicing fees and interest expense. As additional interest, Cargill will
receive 40 percent of the residual cash flow, 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 NCO Portfolio, including
imputed interest. The effective interest rate on these notes, including the
residual interest component was approximately 21.8 percent and 32.0 percent for
the years ended December 31, 2002 and 2003, respectively. Borrowings under this
financing agreement are nonrecourse to NCO Portfolio and the Company, 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 financed portfolios, in addition
to other remedies. As of December 31, 2003, NCO Portfolio was in compliance with
all required covenants.
F-17
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
10. Operating Leases:
The Company leases certain equipment and real estate facilities under
noncancelable operating leases. These leases expire between 2004 and 2016, and
most contain renewal options. The following represents the future minimum
payments, by year and in the aggregate, under noncancelable 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 19 and 22).
2004 $ 25,905
2005 24,326
2006 21,975
2007 18,824
2008 14,077
Thereafter 42,929
--------
$148,036
========
Rent expense was $19.5 million, $20.9 million and $23.7 million for the years
ended December 31, 2001, 2002 and 2003, respectively. The total amount of base
rent payments is being charged to expense on the straight-line method over the
term of the lease.
11. Income Taxes:
Income tax expense consisted of the following components (amounts in thousands):
For the Years Ended December 31,
---------------------------------------
2001 2002 2003
-------- -------- --------
Currently payable:
Federal $ 10,809 $ 9,235 $ 8,776
State 1,047 1,789 1,126
Foreign 376 1,329 3,548
Deferred:
Federal 1,600 14,218 12,222
State (239) 1,131 1,066
Foreign 1,068 - (6)
-------- -------- --------
Income tax expense $ 14,661 $ 27,702 $ 26,732
======== ======== ========
F-18
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
11. Income Taxes (continued):
Deferred tax assets (liabilities) consisted of the following (amounts in
thousands):
December 31,
--------------------------
2002 2003
-------- --------
Deferred tax assets:
Net operating loss carryforwards $ 41,056 $ 43,040
Deferred contractual revenue 13,598 9,822
Accrued expenses 8,054 8,046
-------- --------
Total deferred tax assets 62,708 60,908
Valuation allowance 6,347 9,628
-------- --------
Net deferred tax assets 56,361 51,280
-------- --------
Deferred tax liabilities:
Amortization 39,074 25,943
Depreciation 12,210 11,251
Undistributed earnings of unconsolidated subsidiary 1,876 -
Purchased accounts receivable 35,417 40,482
-------- --------
Total deferred tax liabilities 88,577 77,676
-------- --------
Net deferred tax liabilities $(32,216) $(26,396)
======== ========
The Company had $107.9 million of federal net operating loss carryforwards,
subject to certain limitations, available at December 31, 2003, which will
expire during 2004 through 2021. Almost all of these federal net operating loss
carryforwards relate to net operating loss carryforwards that 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 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. 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.
The Company has recorded state net operating loss carryforwards of $9.6 million
at December 31, 2003. The deferred tax assets created by the state net operating
loss carryforwards have been reduced by a $9.6 million valuation allowance due
to the uncertainty that they can be realized.
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 ratably 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.
During the year ended December 31, 2003, the Company recorded a $24.7 million
reduction in deferred tax liabilities associated with the settlement of certain
amounts recorded in purchase accounting.
F-19
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
11. Income Taxes (continued):
A reconciliation of the U.S. statutory income tax rate to the effective rate was
as follows:
For the Years Ended December 31,
----------------------------------
2001 2002 2003
------ ------ ------
U.S. statutory income tax rate 35.0% 35.0% 35.0%
Nondeductible goodwill and other expenses 8.2 0.2 0.3
State taxes, net of federal 1.3 2.8 2.1
Other, net (1.4) (0.1) (0.1)
---- ---- ----
Effective tax rate 43.1% 37.9% 37.3%
==== ==== ====
Prior to the adoption of SFAS 142 on January 1, 2002, income taxes were computed
after giving effect to the nondeductible portion of goodwill expenses
attributable to certain acquisitions.
Income from operations for the years ended December 31, 2001, 2002 and 2003,
included foreign subsidiary income of $2.7 million, $3.9 million and $9.8
million, respectively.
12. Shareholders' Equity:
Common Stock Warrants
As of December 31, 2003, the Company had warrants outstanding to purchase 22,000
shares of NCO common stock at $32.97 per share. These warrants expire in May
2009.
13. Earnings Per Share:
Basic earnings per share ("EPS") was computed by dividing the net income for the
years ended December 31, 2001, 2002 and 2003, by the weighted average number of
common shares outstanding. Diluted EPS was computed by dividing the adjusted net
income for the years ended December 31, 2001, 2002 and 2003, by the weighted
average number of common shares outstanding plus all common equivalent shares.
Net income is adjusted to add-back convertible interest expense, net of taxes,
if the convertible debt is dilutive. The 2.8 million weighted average shares
from the convertible debt were not included in the diluted share count for 2001
because they were antidilutive. The interest expense on the convertible debt,
net of taxes, included in the diluted EPS calculation was $3.7 million for the
years ended December 31, 2002 and 2003. 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 was
as follows (amounts in thousands):
For the Years Ended December 31,
--------------------------------
2001 2002 2003
------ ------ ------
Basic 25,773 25,890 25,934
Dilutive effect of convertible debt - 3,797 3,797
Dilutive effect of warrants 88 - -
Dilutive effect of options 230 142 164
------ ------ ------
Diluted 26,091 29,829 29,895
====== ====== ======
F-20
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
14. 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 5.2
million shares, respectively, of incentive or nonqualified 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, except that options granted under
the 1996 Plan after May 2003 expire no later than seven years from the date of
grant.
A summary of stock option activity for all of the plans was as follows (amounts
in thousands, except per share amounts):
Weighted
Average
Number of Exercise Price
Options Per Share
--------- --------------
Outstanding at January 1, 2001 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
Granted 504 16.01
Exercised (37) 20.47
Forfeited (271) 26.52
Expired (23) 27.25
----- -------
Outstanding at December 31, 2002 4,171 24.23
Granted 656 19.22
Exercised (80) 19.02
Forfeited (270) 25.81
----- -------
Outstanding at December 31, 2003 4,477 $ 23.50
===== =======
The following table summarizes information about stock options outstanding as of
December 31, 2003 (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 1,095 7.34 years $ 16.68 347 $ 15.50
$20.05 to $24.75 1,475 6.99 years 20.96 942 20.92
$25.19 to $28.75 797 6.82 years 25.33 794 25.32
$29.19 to $33.38 976 5.71 years 30.62 976 30.62
$36.88 to $61.09 134 4.44 years 44.21 134 44.21
----- ---------- ------- ----- -------
4,477 6.69 years $ 23.50 3,193 $ 25.37
===== ========== ======= ===== =======
15. 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. 15. Derivative Financial Instruments (continued):
F-21
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
15. Derivative Financial Instruments (continued):
Interest Rate Hedge:
The Company was party to two interest rate swap agreements that expired on
September 1, 2003. The Company determined that the interest rate swap agreements
qualified as effective cash flow hedges because the interest payment dates, the
underlying index (the London InterBank Offered Rate or "LIBOR"), and the
notional amounts coincide with LIBOR contracts from the revolving credit
facility. These interest rate swap agreements fixed the LIBOR component of
interest at 2.8225 percent on an aggregate amount of $83.3 million of the
variable-rate debt outstanding under the revolving credit facility. The
aggregate notional amount of the interest rate swap agreements was subject to
quarterly reductions that reduced the aggregate notional amount to $62 million
at expiration. As of December 31, 2002, "other comprehensive income (loss)"
included a loss of $460,000, net of a tax benefit of $248,000.
16. 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, Trade Accounts Receivable, and Accounts Payable:
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, 2002 and 2003.
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. The Company reviews the recoverability of the notes
receivable on a quarterly basis to determine if an impairment charge is
required.
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 $106.2 million and $127.2 million as of December
31, 2002 and 2003, respectively, based on the closing market price for the
convertible securities on December 31, 2002 and 2003, respectively.
F-22
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
17. Supplemental Cash Flow Information:
The following are supplemental disclosures of cash flow information (amounts in
thousands):
For the Years Ended December 31,
--------------------------------------------
2001 2002 2003
----------- ------------ ------------
Cash paid for interest $ 25,257 $22,426 $23,044
Cash paid for income taxes 11,410 13,393 12,310
Noncash investing and financing activities:
Fair value of assets acquired 123,978 33,208 -
Liabilities assumed from acquisitions 109,394 6,829 -
Deferred portion of purchased accounts receivable - 2,026 6,027
Dissolution of investment in securitization - - 4,515
Warrants exercised - 875 -
18. Employee Benefit Plans:
The Company has a savings plan under Section 401(k) of the Internal Revenue Code
(the "Plan") for its U.S. Operations and Portfolio Management divisions. The
Plan allows all eligible employees to defer up to 15 percent 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 percent of the first 6 percent of an employee's contribution.
The Company also has similar type plans for its International Operations. The
charges to operations for the matching contributions were $1.9 million, $2.0
million and $2.4 million for 2001, 2002 and 2003, respectively.
19. Commitments and Contingencies:
Purchase Commitments:
The Company enters into noncancelable agreements with various telecommunications
and other vendors that require minimum purchase commitments. These agreements
expire between 2004 and 2007. The following represents the future minimum
payments, by year and in the aggregate, under noncancelable purchase commitments
(amounts in thousands):
2004 $ 19,937
2005 17,378
2006 12,738
2007 5,100
--------
$ 55,153
========
The Company incurred $2.4 million, $7.0 million and $18.9 million of expense in
connection with these purchase commitments for the years ended December 31,
2001, 2002 and 2003, respectively.
Long-Term Collection Contract:
The Company has a long-term collection contract with a large client to provide
collection services that includes guaranteed collections, subject to limits. The
Company is required to pay the client the difference between actual collections
and the guaranteed collections on May 31, 2004 and May 31, 2005, subject to
limits of $6.0 million and $13.5 million, respectively. Any guarantees in excess
of the limits will only be satisfied with future collections. The Company is
entitled to recoup at least 90 percent of any such guarantee payments from
subsequent collections in excess of any remaining guarantees.
F-23
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
19. Commitments and Contingencies (continued):
Forward-Flow Agreement:
In May 2003, NCO Portfolio renewed a fixed price 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 December 31, 2003, NCO Portfolio was obligated to purchase
accounts receivable at a maximum of $2.5 million per month through May 2004. A
portion of the purchase price is deferred for 24 months, including a nominal
rate of interest. The deferred purchase price payable, included in long-term
debt, as of December 31, 2002 and 2003, was $2.1 million and $6.5 million,
respectively.
Litigation and Investigations:
The Company is party, from time to time, to various legal proceedings,
regulatory investigations and tax examinations incidental to its business. The
Company continually monitors these legal proceedings, regulatory investigations
and tax examinations to determine the impact and any required accruals.
FTC:
In October 2003, the Company was notified by the Federal Trade Commission
("FTC") that it intends to pursue a claim against the Company for violations of
the Fair Credit Reporting Act ("FCRA") relating to certain aspects of the
Company's credit reporting practices during 1999 and 2000.
The allegations relate primarily to a large group of consumer accounts from one
client that were transitioned to the Company for servicing during 1999. The
Company received incorrect information from the prior service provider at the
time of transition. The Company became aware of the incorrect information during
2000 and ultimately removed the incorrect information from the consumers' credit
files. The Company has currently negotiated a tentative settlement of this
matter with the FTC, although no assurance can be given that a settlement will
be reached. In the event that the Company is required to pay an assessment, it
may assert certain claims for indemnification from the owners of the consumer
accounts.
The Company is also a party to a class action litigation regarding this group of
consumer accounts. A tentative settlement of the class action litigation has
been agreed to, and is subject to court approval. The Company believes that the
class action litigation is covered by insurance, subject to applicable
deductibles.
The FTC is also alleging that certain reporting violations occurred on a small
subset of the Company's purchased accounts receivable.
The Company believes that the resolution of the above matters will not have a
material adverse effect on its financial position, results of operations or
business.
Fort Washington Flood:
In June 2001, the first floor of the Company's Fort Washington, Pennsylvania,
headquarters was severely damaged by a flood caused by remnants of Tropical
Storm Allison. As previously reported, during the third quarter of 2001, the
Company decided to relocate its corporate headquarters to Horsham, Pennsylvania.
The Company filed a lawsuit in the Court of Common Pleas, Montgomery County,
Pennsylvania (Civil Action No. 01-15576) against the current landlord and the
former landlord of the Fort Washington facilities to terminate the leases and to
obtain other relief. The landlord and former landlord filed counter-claims
against the Company. Due to the uncertainty of the outcome of the lawsuit, the
Company recorded the full amount of rent due under the remaining terms of the
leases during the third quarter of 2001.
F-24
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
19. Commitments and Contingencies (continued):
Litigation (continued):
Fort Washington Flood (continued):
In January 2004, the Court, in ruling on the preliminary objections, allowed the
former landlord defendants' suit to proceed, but struck from the complaint the
allegations against individual officers of the Company. Therefore, the
litigation will proceed in its course with the Company, the current landlord and
the former landlord as parties.
Other:
The Company is involved in other legal proceedings, regulatory investigations
and tax examinations from time to time in the ordinary course of its business.
Management believes that none of these other legal proceedings, regulatory
investigations or tax examinations will have a materially adverse effect on the
financial condition or results of operations of the Company.
20. Segment Reporting:
The Company's business consists of three operating divisions: U.S. Operations,
Portfolio Management and International Operations. The accounting policies of
the segments are the same as those described in note 2, "Accounting Policies."
U.S Operations provides accounts receivable management services to consumer and
commercial accounts for all market sectors including financial services,
healthcare, retail and commercial, telecommunications, utilities, education, 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.
U.S. Operations had total assets, net of any intercompany balances, of $744.3
million and $714.2 million at December 31, 2002 and 2003, respectively. U.S.
Operations had capital expenditures of $25.9 million, $22.7 million, and $17.0
million of capital expenditures for the years ended December 31, 2001, 2002 and
2003, respectively. U.S. Operations provides accounts receivable management
services to Portfolio Management. U.S. Operations recorded revenue of $27.4
million, $35.5 million and $49.6 million for these services for the years ended
December 31, 2001, 2002 and 2003, respectively. The accounting policies used to
record the revenue from Portfolio Management are the same as those described in
note 2, "Accounting Policies."
Portfolio Management purchases and manages defaulted consumer accounts
receivable from consumer creditors such as banks, finance companies, retail
merchants, and other consumer oriented companies. Portfolio Management had total
assets, net of any intercompany balances, of $167.8 million and $170.4 million
at December 31, 2002 and 2003, respectively.
International Operations provides accounts receivable management services across
Canada and the United Kingdom. International Operations had total assets, net of
any intercompany balances, of $50.2 million and $61.5 million at December 31,
2002 and 2003, respectively. International Operations had capital expenditures
of $2.0 million, $4.6 million, and $3.5 million of capital expenditures for the
years ended December 31, 2001, 2002 and 2003, respectively. International
Operations provides accounts receivable management services to U.S. Operations.
International Operations recorded revenue of $5.1 million, $11.5 million and
$28.3 million for these services for the years ended December 31, 2001, 2002 and
2003, respectively. The accounting policies used to record the revenue from U.S.
Operations are the same as those described in note 2, "Accounting Policies."
F-25
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
20. Segment Reporting (continued):
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. 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, 2001
(amounts in thousands)
-------------------------------------------------------------
Payroll and Selling, General
Related and Admin.
Revenue Expenses Expenses EBITDA
--------- ----------- ---------------- ---------
U.S. Operations $ 615,743 $ 332,456 $ 221,995 $ 61,292
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 $ 683,873 $ 350,634 $ 237,690 $ 95,549
========= ========= ========= =========
For the Year Ended December 31, 2002
(amounts in thousands)
-------------------------------------------------------------
Payroll and Selling, General
Related and Admin.
Revenue Expenses Expenses EBITDA
--------- ----------- ---------------- ---------
U.S. Operations $ 639,497 $ 316,992 $ 231,986 $ 90,519
Portfolio Management 63,379 1,532 40,263 21,584
International Operations 47,636 28,409 12,957 6,270
Eliminations (47,062) (11,528) (35,534) -
--------- --------- --------- ---------
Total $ 703,450 $ 335,405 $ 249,672 $ 118,373
========= ========= ========= =========
For the Year Ended December 31, 2003
(amounts in thousands)
-------------------------------------------------------------
Payroll and Selling, General
Related and Admin.
Revenue Expenses Expenses EBITDA
--------- ----------- ---------------- ---------
U.S. Operations $ 686,874 $ 336,529 $ 261,670 $ 88,675
Portfolio Management 75,456 1,734 53,612 20,110
International Operations 69,301 40,363 16,544 12,394
Eliminations (77,815) (28,257) (49,558) -
--------- --------- --------- ---------
Total $ 753,816 $ 350,369 $ 282,268 $ 121,179
========= ========= ========= =========
F-26
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
21. Unaudited Quarterly Results:
The following tables contain selected unaudited Consolidated Statement of Income
data for each quarter for the years ended December 31, 2002 and 2003 (amounts in
thousands, except per share data). The operating results for any quarter are not
necessarily indicative of results for any future period.
2002 Quarters Ended
----------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
------------ ------------- ------------ ------------
Revenue $ 188,007 $ 175,099 $ 168,119 $ 172,225
Income from operations 34,588 23,755 16,008 16,698
Net income 17,447 11,709 6,199 6,804
Net income per share:
Basic $ 0.68 $ 0.45 $ 0.24 $ 0.26
Diluted $ 0.61 $ 0.42 $ 0.24 $ 0.26
2003 Quarters Ended
---------------------------------------------------------
March 31 June 30 Sept. 30 Dec. 31
------------ ------------- ------------ -----------
Revenue $ 189,017 $ 188,574 $ 188,619 $ 187,606
Income from operations 23,905 21,487 22,267 21,892
Net income 11,192 10,277 10,723 10,254
Net income per share:
Basic $ 0.43 $ 0.40 $ 0.41 $ 0.39
Diluted $ 0.41 $ 0.38 $ 0.39 $ 0.37
22. 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 relocate
its corporate headquarters to Horsham, PA. The Company has filed a lawsuit
against the landlord of the Fort Washington facilities to terminate the leases.
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.
During 2002, the Company received insurance proceeds in excess of its original
estimate, which resulted in a gain of approximately $1.3 million. This gain was
included in the Statement of Income in "other income (expense)."
F-27
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
23. Investments in Unconsolidated Subsidiaries:
In connection with the Creditrust Merger, NCO Portfolio acquired a 100 percent
retained residual interest in an investment in securitization, Creditrust SPV
98-2, LLC (see note 3). This securitization issued a nonrecourse note that was
due the earlier of January 2004 or satisfaction of the note from collections,
and carried an interest rate of 8.61 percent. The investment accrued noncash
income at a rate of 8 percent per annum on the residual cash flow component
only. No income was recorded from this investment during the year ended December
31, 2003, due to concerns related to the future recoverability of the
investment. The Company recorded $211,000 and $162,000 of income on this
investment for the period from February 21, 2001 to December 31, 2001, and for
the year ended December 31, 2002, respectively. In December 2003, the
nonrecourse note was repaid in full, at which time the purchased accounts
receivable portfolio with a carrying value of $4.5 million reverted back to the
Company's control. The purchased accounts receivable portfolio will continue to
be accounted for using the cost recovery method. Immediately following payoff,
the cash reserves of $3.3 million plus an additional $1.2 million were placed
into the reserve account of another securitization to satisfy the guarantee to
the note insurer (see note 9). The Company performed collection services for
Creditrust SPV 98-2, LLC and recorded service fee revenue of $1.9 million, $1.8
million and $1.6 million for the years ended December 31, 2001, 2002 and 2003,
respectively.
NCO Portfolio has a 50 percent ownership interest in a joint venture,
InoVision-MEDCLR-NCOP Ventures, LLC ("Joint Venture"), with IMNV Holdings, LLC
("IMNV"). The Joint Venture was established in 2001 to purchase utility, medical
and other various small balance accounts receivable and is accounted for using
the equity method of accounting. Included in "other assets" on the Balance
Sheets was NCO Portfolio's investment in the Joint Venture of $3.4 million and
$4.0 million as of December 31, 2002 and 2003, respectively. Included in the
Statements of Income, in "interest and investment income," was $118,000,
$762,000 and $2.2 million for the years ended December 31, 2001, 2002 and 2003,
respectively, representing NCO Portfolio's 50 percent share of operating income
from this unconsolidated subsidiary. NCO Portfolio received distributions of
$212,000 and $1.5 million during the years ended December 31, 2002 and 2003,
respectively. NCO Portfolio's 50 percent share of the Joint Venture's retained
earnings was $661,000 and $1.3 million as of December 31, 2002 and 2003,
respectively. The Company performs collection services for the Joint Venture and
recorded service fee revenue of $547,000, $4.7 million and $5.5 million for the
years ended December 31, 2001, 2002 and 2003, respectively. The Company had
receivables of $219,000 and $418,000 on its balance sheets as of December 31,
2002 and 2003, respectively, for these service fees. The Company also performs
collection services for an affiliate of IMNV and recorded service fee revenue of
$6.9 million, $8.8 million, and $10.7 million for the years ended December 31,
2001, 2002 and 2003, respectively.
The following table summarizes the financial information of the Joint Venture
(amounts in thousands):
As of and for the Years
Ended December 31,
----------------------------------------
2001 2002 2003
----------- ----------- -----------
Total assets $ 5,581 $ 11,638 $ 15,344
Total liabilities 4,455 4,944 7,415
Revenue 1,061 9,832 13,523
Operating income 236 1,524 4,327
24. Related Party Transactions:
The Company provides NCO Portfolio with a revolving line of credit with a
current borrowing capacity of $25.0 million. NCO Portfolio's borrowings bear
interest at a rate equal to NCO's interest rate under its credit facility plus
1.00 percent. As of December 31, 2002 and 2003, there was $36.9 million and
$25.0 million outstanding under the revolving line of credit, respectively.
Borrowings under the revolving line of credit are collateralized by certain
assets of NCO Portfolio. The revolving credit agreement contains certain
financial covenants such as maintaining funded debt to EBITDA requirements and
includes restrictions on, among other things, acquisitions and distributions to
shareholders. As of December 31, 2003, NCO Portfolio was in compliance with all
required covenants.
F-28
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
24. Related Party Transactions (continued):
The Company uses an airplane that is partly owned by Michael J. Barrist,
Chairman, President, and Chief Executive Officer of NCO. During 2001 and most of
2002, the Company paid the total monthly management fee associated with the
airplane and its share of out-of-pocket costs to a third-party management
company for its use of the airplane. The third-party management company is not
affiliated with Mr. Barrist. Effective November 2002, the Company changed its
arrangement with Mr. Barrist. The Company now reimburses Mr. Barrist for the use
of the plane based on a per-hour rate. The per-hour rate consists of actual
operating costs plus the hourly cost equivalent for the monthly management fee,
interest and depreciation. The Company paid costs of $363,000, $478,000 and
$719,000 for the years ended December 31, 2001, 2002 and 2003, respectively. In
March 2004, Mr. Barrist's ownership interest in the airplane ended and,
therefore his agreement with the Company terminated.
The Company was party to certain split-dollar life insurance policies, which
were purchased in 1997. These policies separately insure: (i) the joint lives of
Michael J. Barrist and his spouse; and (ii) the joint lives of Charles C. Piola,
Jr. and his spouse. Under the terms of the split-dollar agreement, the Company
paid the premiums for certain survivorship life insurance policies on the lives
of Mr. and Mrs. Barrist and Mr. and Mrs. Charles C. Piola, Jr. with an aggregate
face value of $50.0 million and $30.0 million, respectively, only to the extent
that the premiums are in excess of the cost of the term insurance coverage.
While the proceeds of the policies are payable to the beneficiaries designated
by the respective executives, the Company has an interest in the insurance
benefits equal to the cumulative amount of premiums it has paid and is not
responsible to pay any premiums in excess of the cash surrender value of the
respective policies. In November 2002, it was determined that the Company would
suspend payment of premiums for these policies. Subsequently, the Company has
decided to terminate the split-dollar agreements. In conjunction with this
termination, the Company transferred the existing policies to the insured, and
was reimbursed during 2003 for all premiums paid on theses policies. During
December 2002, the Company inadvertently paid $138,000 of premiums that were
reimbursed by Mr. Barrist and Mr. Piola in January 2003.
25. Recently Issued and Proposed Accounting Pronouncements:
SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a
Transfer:
The Company currently follows the accounting guidance in Practice Bulletin #6
for the accounting for purchased accounts receivable portfolios. Practice
Bulletin #6 has been superceded by SOP 03-3 - Accounting for Certain Loans or
Debt Securities Acquired in a Transfer. SOP 03-3 is effective for loans acquired
in fiscal years beginning after December 15, 2004, although early adoption is
permitted. SOP 03-3 applies 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. SOP 03-3 addresses accounting for
differences between contractual and expected cash flows from an investor's
initial investment in certain loans when such differences are attributable, in
part, to credit quality. SOP 03-3 also addresses such loans acquired in
purchased business combinations.
SOP 03-3 limits the revenue that may be accrued to the excess of the estimate of
expected cash flows over a portfolio's initial cost of accounts receivable
acquired. SOP 03-3 requires that the excess of the contractual cash flows over
expected cash flows not be recognized as an adjustment of revenue, expense, or
on the balance sheet. SOP 03-3 freezes the internal rate of return, referred to
as the IRR, originally estimated when the accounts receivable are purchased for
subsequent impairment testing. Rather than lower the estimated IRR if the
original collection estimates are not received, the carrying value of a
portfolio is written down to maintain the original IRR. Increases in expected
cash flows are to be recognized prospectively through adjustment of the IRR over
a portfolio's remaining life. Loans acquired in the same fiscal quarter with
common risk characteristics may be aggregated for the purpose of applying this
SOP. The Company is in the process of determining the effect SOP 03-3 will have
on its financial position and results of operations.
F-29
NCO GROUP, INC.
Notes to Consolidated Financial Statements (continued)
25. Recently Issued and Proposed Accounting Pronouncements (continued):
FASB Interpretation No. 46, "Consolidation of Variable Interest Entities":
In January 2003, the 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
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. On
January 1, 2004, the Company adopted FIN 46. The Company has an $11.1 million
note receivable and a $5.7 million note receivable included in the balance sheet
under current and long-term other assets as of December 31, 2003. These notes
receivable are from two separate companies that comprised the Market Strategy
division that was divested during 2000. Under FIN 46, the companies that issued
these notes receivable are considered variable interest entities. Based on its
initial evaluation of these variable interest entities, the Company does not
believe it is required to consolidate theses entities under FIN 46.
26. Subsequent Events:
On November 18, 2003, the Company and RMH Teleservices, Inc., referred to as
RMH, a provider of customer relationship management services, announced that
they entered into an agreement by which RMH would be merged with a wholly-owned
subsidiary of the Company. Pursuant to the proposed merger, the Company would
acquire RMH in a transaction expected to be tax-free to the shareholders of RMH.
Under the RMH merger agreement, as amended, RMH's shareholders will receive
0.2150 shares of NCO common stock for each share of RMH common stock. The
transaction is subject to a collar arrangement. It is anticipated that the
Company will issue approximately 3.4 million shares of NCO common stock to RMH's
shareholders. It is also anticipated that the Company will issue approximately
593,000 additional shares of NCO common stock upon the exercise of currently
outstanding options and warrants to purchase RMH common stock to be assumed by
the Company in the merger.
On December 15, 2003, the Company and NCO Portfolio announced that they have
entered into an agreement by which NCO Portfolio would be merged with a wholly
owned subsidiary of the Company. The Company currently owns approximately 63.3
percent of the outstanding stock of NCO Portfolio and pursuant to the proposed
merger would acquire all NCO Portfolio shares that it does not own in a
transaction expected to be tax-free to the stockholders of NCO Portfolio.
Michael J. Barrist, chairman of the board, president and chief executive officer
of the Company, also serves as chairman of the board, president and chief
executive officer of NCO Portfolio and beneficially owns 2.8 percent of NCO
Portfolio's outstanding common stock, excluding options. Under the NCO Portfolio
merger agreement NCO Portfolio 's minority stockholders will receive 0.36187 of
a share of NCO common stock for each share of NCO Portfolio common stock. The
Company will issue approximately 1.8 million shares of NCO common stock to NCO
Portfolio's minority stockholders. Under the NCO Portfolio merger agreement, if
the average closing sale price of NCO common stock for the 10-day trading period
ending on the second day prior to the closing date of the transaction were to be
less than $21.50 per share, NCO Portfolio would have the right to terminate the
NCO Portfolio merger agreement unless the Company were to agree to improve the
exchange ratio so that the NCO Portfolio minority stockholders receive that
number of shares of NCO common stock with a value equivalent to the $21.50
price, based on such 10 trading day average stock price. The Company will also
assume all outstanding NCO Portfolio stock options.
F-30
NCO GROUP, INC.
Consolidating Statement of Income
(Unaudited)
(Amounts in thousands)
For the Year Ended December 31, 2003
----------------------------------------------------------------------------
Intercompany
NCO Group NCO Portfolio Eliminations Consolidated
--------- ------------- ------------ ------------
Revenue $ 727,918 $ 75,456 $ (49,558) $ 753,816
Operating costs and expenses:
Payroll and related expenses 348,635 1,734 - 350,369
Selling, general and administrative expenses 278,214 53,612 (49,558) 282,268
Depreciation and amortization expense 31,249 379 - 31,628
--------- -------- --------- ---------
658,098 55,725 (49,558) 664,265
--------- -------- --------- ---------
69,820 19,731 - 89,551
Other income (expense):
Interest and investment income 2,275 2,232 (580) 3,927
Interest expense (12,218) (11,087) 307 (22,998)
Other income 1,128 - - 1,128
--------- -------- --------- ---------
(8,815) (8,855) (273) (17,943)
--------- -------- --------- ---------
Income before income tax expense 61,005 10,876 (273) 71,608
Income tax expense 22,756 3,976 - 26,732
--------- -------- --------- ---------
Income from operations before minority interest 38,249 6,900 (273) 44,876
Minority interest (1) - (273) (2,157) (2,430)
--------- -------- --------- ---------
Net income $ 38,249 $ 6,627 $ (2,430) $ 42,446
========= ======== ========= =========
(1) NCO Group, Inc. owns 63% percent of the outstanding common stock of NCO
Portfolio Management, Inc.
F-31
NCO GROUP, INC.
Schedule II - Valuation and Qualifying Accounts
Additions
------------------------
Balance at Charged to Charged to Balance at
beginning costs and other end of
of year expenses accounts Deductions (1) year
---------- ------------ ----------- --------------- -------------
Year ended December 31, 2001:
Allowance for doubtful accounts $ 7,080,000 $ 4,250,000 $ - $ (6,019,000) $ 5,311,000
Year ended December 31, 2002:
Allowance for doubtful accounts $ 5,311,000 $ 8,293,000 $ - $ (6,319,000) $ 7,285,000
Year ended December 31, 2003:
Allowance for doubtful accounts $ 7,285,000 $ 4,816,000 $ - $ (4,654,000) $ 7,447,000
(1) Uncollectable accounts written off, net of recoveries.
S-1