10-K 1 ten-k.txt FORM 10-K UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549 Form 10-K (Mark One) [ X ] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the Fiscal Year ended December 31, 2001 or [ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 For the transition period from ___________ to ___________ Commission File No. 0-21639 NCO GROUP, INC. ------------------------------------------------------ (Exact Name of Registrant as Specified in its Charter) Pennsylvania 23-2858652 ------------ ---------- (State or Other Jurisdiction of (IRS Employer Identification No.) Incorporation or Organization) 507 Prudential Road Horsham, Pennsylvania 19044 --------------------- ---------- (Address of principal (Zip Code) executive offices) Registrant's Telephone Number, Including Area Code (215) 441-3000 -------------- Securities Registered Pursuant to Section 12(b) of the Act: None Securities Registered Pursuant to Section 12(g) of the Act: Common stock, no par value 25,874,000 -------------------------- ----------------------------- (Title of Class) (Number of Shares Outstanding as of March 18, 2002) Indicate by check mark whether the Registrant (i) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (ii) has been subject to such filing requirements for the past 90 days. Yes [ X ] No [ ] Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of the Registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ] The aggregate market value of voting stock held by non-affiliates of the Registrant is approximately $529,637,000(1) DOCUMENTS INCORPORATED BY REFERENCE Certain portions of the Company's Proxy Statement to be filed in connection with its 2002 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report. Other documents incorporated by reference are listed in the Exhibit Index. ----------------- (1) The aggregate market value of the voting stock set forth equals the number of shares of the Company's common stock outstanding, reduced by the amount of common stock held by officers, directors and shareholders owning 10% or more of the Company's common stock, multiplied by $27.370, the last reported sale price for the Company's common stock on March 18, 2002. The information provided shall in no way be construed as an admission that any officer, director or 10% shareholder in the Company may be deemed an affiliate of the Company or that he is the beneficial owner of the shares reported as being held by him, and any such inference is hereby disclaimed. The information provided herein is included solely for record keeping purposes of the Securities and Exchange Commission. TABLE OF CONTENTS
Page ---- PART I Item 1. Business. 1 Item 2. Properties. 19 Item 3. Legal Proceedings. 20 Item 4. Submission of Matters to a Vote of Security Holders. 20 Item 4.1 Executive Officers of the Registrant who are not also Directors. 20 PART II Item 5. Market for Registrant's Common Stock and 22 Related Shareholder Matters. Item 6. Selected Financial Data. 23 Item 7. Management's Discussion and Analysis of Financial 24 Condition and Results of Operations. Item 7a Quantitative and Qualitative Disclosures about Market Risk. 38 Item 8. Financial Statements and Supplementary Data. 38 Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures. 38 PART III Item 10. Directors and Executive Officers of the Registrant. 39 Item 11. Executive Compensation. 39 Item 12. Security Ownership of Certain Beneficial Owners and Management. 39 Item 13. Certain Relationships and Related Transactions. 39 PART IV Item 14. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 40 Signatures. 46 Index to Consolidated Financial Statements and Financial Statement Schedule. F-1
As used in this Annual Report on Form 10-K, unless the context otherwise requires, "we,""us," "our,""Company" or "NCO" refers to NCO Group, Inc. and its subsidiaries. Forward-Looking Statements Certain statements included in this Annual Report on Form 10-K, including without limitation statements in Item 7. "Management's Discussion and Analysis of Financial Condition and Results of Operations," other than historical facts, are forward-looking statements (as such term is defined in the Securities Exchange Act of 1934, and the regulations thereunder), which are intended to be covered by the safe harbors created thereby. Forward-looking statements include, without limitation, statements as to the Company's expected future results of operations, the Company's growth strategy, the Company's internet and e-commerce strategy, the effects of the terrorist attacks and the economy on the Company's business, expected increases in operating efficiencies, anticipated trends in the accounts receivable management industry, estimates of future cash flows of purchased accounts receivable, the effects of legal or governmental proceedings, the effects of changes in accounting pronouncements and statements as to trends or the Company's or management's beliefs, expectations and opinions. Forward-looking statements are subject to risks and uncertainties and may be affected by various factors that may cause actual results to differ materially from those in the forward-looking statements. In addition to the factors discussed in this report, certain risks, uncertainties and other factors, including, without limitation, the risk that the Company will not be able to achieve expected future results of operations, the risk that the Company will not be able to implement its growth strategy as and when planned, risks associated with the recent expansion of NCO Portfolio Management, Inc. ("NCO Portfolio"), risks associated with growth and future acquisitions, the risk that the Company will not be able to realize operating efficiencies in the integration of its acquisitions, fluctuations in quarterly operating results, risks relating to the timing of contracts, risks related to purchased accounts receivable, risks associated with technology, the Internet and the Company's e-commerce strategy, risks related to past or possible future terrorist attacks, risks related to the economy, and other risks described under Item 1. "Business - Investment Considerations" or in the Company's other filings made from time to time with the Securities and Exchange Commission, can cause actual results and developments to be materially different from those expressed or implied by such forward-looking statements. PART I Item 1. Business. General We believe we are the largest provider of outsourced accounts receivable management and collection services in the world, serving a wide range of clients in North America and abroad. Our extensive industry knowledge, technological expertise, management depth, and long-standing client relationships enable us to deliver customized solutions that improve our clients' accounts receivable recovery rates, thus improving their financial performance. Our services are provided through the utilization of sophisticated technologies including advanced workstations, leading-edge client interface systems, and call management systems comprised of predictive dialers, automated call distribution systems, digital switching and customized computer software. We have approximately 9,000 employees who provide our services through the operation of 80 centers. -1- Industry Background Increasingly, companies are outsourcing many non-core functions to focus on revenue-generating activities, reduce costs and improve productivity. In particular, many large corporations are recognizing the advantages of outsourcing accounts receivable management and collection. This trend is being driven by a number of industry-specific factors: o First, the complexity of accounts receivable management and collection functions in certain industries has increased dramatically in recent years. For example, with the increasing popularity of health maintenance organizations, or HMOs, and preferred provider organizations, or PPOs, healthcare institutions now face the challenge of billing not only large insurance companies but also individuals who are required to pay small, one-time co-payments. o Second, the increasing complexity of the collection process that requires sophisticated call management and database systems for efficient collections. o Third, the trend in certain industries to outsource non-core functions, due to competitive pressures, changing regulations and/or required capital expenditures. o Fourth, the increased focus by credit grantors on early identification and intervention in pre-delinquent debt (i.e., debt with an average age of less than 90 days). We operate in a large industry with positive growth dynamics. Growth in our industry is fundamentally driven by the continuing growth in consumer and commercial debt. According to The Kaulkin Report, an industry publication, overall consumer debt in 2000 exceeded $8.3 trillion. Approximately $135 billion of delinquent consumer debt was estimated to have been placed for collection with third-party collection agencies during 2000, nearly double the $73 billion placed in 1990 according to The Kaulkin Report. The primary market sectors within our industry are financial services, healthcare, and retail and commercial. Other important market sectors include telecommunications, utilities, and government. The accounts receivable management and collection industry is highly fragmented. Based on information obtained from the American Collectors Association, there are approximately 6,500 accounts receivable management and collection companies in the United States, the majority of which are small, local businesses. We believe that many smaller competitors have insufficient capital to expand and invest in technology and are unable to adequately meet the geographic coverage and quality standards demanded by businesses seeking to outsource their accounts receivable management function. Strategy Our strategy is to maintain our market dominance as we become a global provider of accounts receivable management and collection services. Our strategy to achieve these objectives includes the following elements: -2- Expand our relationships with clients - A significant amount of our growth stems from the expansion of existing client relationships. These relationships and the resulting opportunities continue to grow in scale, complexity and profit potential. Over time, we believe these relationships should transition from the operational delivery of services to the strategic development of long-term, goal-oriented partnerships where we are sharing in the improved profitability and operational efficiencies created for our clients. Enhance our operating margins - Until 1999, we focused primarily on realizing efficiencies through the integration of acquired companies. Over the next several years, we intend to continue to pursue the following initiatives to increase profitability: o standardization of systems and practices; o consolidation of facilities; o automation of clerical functions; o use of statistical analysis to improve performance and reduce direct unit costs; and o leveraging our purchasing power. Enhance our technology capabilities - We will continue to enhance our technology platform as well as continue to update and modernize our equipment, including the workstations and predictive dialers used by account representatives. In addition, we will continue to update and refine our NCO ACCESS(TM) interface, which translates client account information into a standard presentation format that provides our account representatives with a common visual interface that links directly into disparate client host systems. The Internet offers the potential for significant operational benefits. There are a variety of cost-reducing applications available, such as improved data exchange capabilities and the replacement of direct mail with e-mail. We are creating client-specific web pages that will facilitate reporting of payments and account activity, online tracking of collection results, and online statistical modeling. Expand internationally - We believe that business process outsourcing is gaining widespread acceptance throughout Canada, Europe and Australasia. Our international expansion strategy is designed to capitalize on each of these markets in the near term, as well as continue to monitor all developing opportunities to determine the timing of entry into new markets. We operate in Canada and the United Kingdom through wholly owned subsidiaries and are one of the largest providers of consumer collection services in both of these markets. We expect to further penetrate these markets through increased sales of accounts receivable management and collection services. Additionally, we expect to pursue direct investments, strategic alliances and partnerships as well as further explore acquisitions in these markets. For example, we formed strategic alliances with Receivables Management Group Pty Ltd. in 2000 and MIRARE Credit Information Services in 2001 to provide an entree into the Australasian and Korean markets, respectively. These alliances enhance our service offerings as well as increase the awareness of NCO as a global provider of accounts receivable management and collection services. We also provide our domestic clients with a cost-effective option of using foreign labor markets such as India to provide effective services at a reduced price. We currently have approximately 150 telephone representatives working in India for our U.S clients. We expect to expand our presence in India as well as explore new opportunities in other labor markets such as Australia. -3- Increase purchases of delinquent accounts receivable through NCO Portfolio - Since 1991, we have purchased, collected and managed portfolios of purchased accounts receivable. These portfolios have consisted primarily of delinquent accounts receivable. Due to the profitability of these purchases, we expanded our presence in this marketplace in 1999 and determined that it would be beneficial to further expand our presence, while at the same time limiting our exposure to credit risk. Through the merger of our subsidiary NCO Portfolio with Creditrust in February 2001, we have created one of the only publicly traded companies purchasing delinquent accounts receivable. Under the terms of our credit agreement, our investment in NCO Portfolio currently is limited to our $25.0 million equity investment and a $50.0 million credit sub-facility. During 2001, NCO Portfolio invested $574,000 for a 50% ownership interest in a joint venture, InoVision-MEDCLR NCOP Ventures, LLC ("Joint Venture") with IMNV Holdings, LLC ("Marlin"). The Joint Venture was set up to purchase utility, medical and other various small balance accounts receivable. The Joint Venture is accounted for using the equity method of accounting. The Joint Venture has access to capital through a specialty finance lender who, at its option, lends 90% of the value of the purchased accounts receivable to the Joint Venture. The debt is cross-collateralized by all static pools in which the lender participates, and is non-recourse to NCO Portfolio. In the future, NCO Portfolio may develop additional growth opportunities including partnerships with banks, commercial lenders, and other investors who will provide additional funding sources for purchases of delinquent accounts receivable. By utilizing such risk sharing partnerships, we will gain access to capital while limiting both our and NCO Portfolio's exposure to credit risk. Continue to explore strategic acquisition opportunities - The accounts receivable management and collection industry is highly fragmented with over 6,500 participants in the United States. The vast majority of these participants are small, local businesses. Although our focus is on internal growth, we believe we will continue to find attractive acquisition opportunities over time. Services Accounts Receivable Management and Collection We provide a wide range of accounts receivable management and collection services to our clients by utilizing an extensive technological infrastructure. Although most of our accounts receivable management and collection services to date have focused on the recovery of traditional delinquent accounts, we do engage in the recovery of current accounts receivable and early stage delinquencies (generally, accounts which are 90 days or less past due). We generate approximately 60% of our revenue from the recovery of delinquent accounts receivable on a contingency fee basis. In addition, we generate revenue from fixed fees for certain accounts receivable management and collection and other related services. We seek to be a low cost provider and, as such, our contingent fees typically range from 15% to 35% of the amounts recovered on behalf of our clients. However, fees can range from 6% for the management of accounts placed early in the accounts receivable cycle to 50% for accounts that have been serviced extensively by the client or by third-party providers. Our average fee across all industries was approximately 19% during 2001, as compared to 19% during 2000. -4- Accounts receivable management and collection services typically include the following activities: Management Planning. Our approach to accounts receivable management and collection for each client is determined by a number of factors including account size and demographics, the client's specific requirements and management's estimate of the collectibility of the account. We have developed a library of standard processes for accounts receivable management and collection, which is based upon our accumulated experience. We integrate these processes with our client's requirements to create a customized recovery solution. In many instances, the approach will evolve and change as the relationship with the client develops and both parties evaluate the most effective means of recovering accounts receivable. Our standard approach, which may be tailored to the specialized requirements of each client, defines and controls the steps that will be undertaken by us on behalf of the client and the manner in which we will report data to the client. Through our systematic approach to accounts receivable management and collection, we remove most decision making from the recovery staff and ensure uniform, cost-effective performance. Once the approach has been defined, we electronically or manually transfer pertinent client data into our information system. When the client's records have been established in our system, we begin the recovery process. Skiptracing. In cases where the customer's telephone number or address is unknown, we systematically search the U.S. Post Office National Change of Address service, consumer databases, electronic telephone directories, credit agency reports, tax assessor and voter registration records, motor vehicle registrations, military records and other sources. The geographic expansion of banks, credit card companies, national and regional telecommunications companies, and managed healthcare providers, along with the mobility of consumers, has increased the demand for locating the client's customers. Once we have located the customer, the notification process can begin. Account Notification. We initiate the recovery process by forwarding an initial letter that is designed to seek payment of the amount due or open a dialogue with customers who cannot afford to pay at the current time. This letter also serves as an official notification to each customer of his or her rights as required by the Federal Fair Debt Collection Practices Act. We continue the recovery process with a series of mail and telephone notifications. Telephone representatives remind the customer of their obligation, inform them that their account has been placed for collection with us and begin a dialogue to develop a payment program. Credit Reporting. At a client's request, we will electronically report delinquent accounts to one or more of the national credit bureaus where it will remain for a period of up to seven years. The denial of future credit often motivates the payment of all past due accounts. Payment Process. After we receive payment from the customer, we either remit the amount received minus our fee to the client or remit the entire amount received to the client and bill the client for our services. -5- Activity Reports. Clients are provided with a system-generated set of standardized or customized reports that fully describe all account activity and current status. These reports are typically generated monthly; however, the information included in the report and the frequency that the reports are generated can be modified to meet the needs of the client. Quality Tracking. We emphasize quality control throughout all phases of the accounts receivable management and collection process. Some clients may specify an enhanced level of supervisory review and others may request customized quality reports. Large national credit grantors will typically have exacting performance standards which require sophisticated capabilities such as documented complaint tracking and specialized software to track quality metrics to facilitate the comparison of our performance to that of our peers. Delinquency Management We provide pre-charge-off delinquency management services that enable clients to manage their at-risk customers and quickly restore the relationships to a current payment status. We mail reminder letters and make first-party calls to the clients' customers, reminding them of the past due balance and encouraging them to make immediate repayment using pay-by-phone direct debit checks or, in certain cases, credit cards. Our services include responding to inbound calls seven days a week. We apply our extensive database and predictive modeling techniques to the customer's profile, assigning more intense efforts to higher risk customers. Customer Service and Support We utilize our communications and information system infrastructure to supplement or replace the customer service function of our clients. For example, we are currently engaged by a large regional utility company to provide customer service functions for a segment of the utility's customer base that is delinquent. For other clients, we provide a wide range of specialized services such as fraud prevention, over-limit calling, inbound calling for customer credit application and approval processes, and general back-office support. We can provide customer contact through inbound or outbound calling, or customized web-enabled functions. Billing We complement existing service lines by offering adjunct billing services to clients as an outsourcing option. Additionally, we can assist healthcare clients in the billing and management of third-party insurance. Additional Services We selectively provide other related services that complement our traditional accounts receivable management and collection business and leverage our technological infrastructure. We believe that the following services will provide additional growth opportunities for us: Attorney Network Services. We coordinate litigation undertaken on behalf of our clients through a nationwide network of more than 150 law firms whose attorneys specialize in collection litigation. Our collection support staff manages the attorney relationships and facilitates the transfer of all necessary documentation. -6- NCO ePayments. We can provide clients with a virtual 24-hour payment center that is accessible by the use of telephones, personal computers or the Internet. Credit and Investigative Reporting Service. We develop the information needed to profile commercial debtors and make decisions affecting extensions of credit. NCO Benefit Systems. We administer compliant COBRA administration services for human resources departments. Technology and Infrastructure We have made a substantial investment in our information systems such as "thin client" network computing devices, predictive dialers, automated call distribution systems, digital switching and customized computer software, including the NCO ACCESS interface product. As a result, we believe we are able to address accounts receivable management and collection activities more reliably and more efficiently than our competitors. Our systems also permit network access to enable clients to electronically communicate with us and monitor operational activity on a real-time basis. We provide our services through the operation of 80 centers that are electronically linked through an international wide area network, with the exception of our two United Kingdom centers. We also utilize a custom-developed NCO ACCESS interface product that leverages industry standard visual basic and thin client server technology in order to facilitate the critical process of "real-time" translation of account data from our clients' host systems to our system. The NCO ACCESS interface product set allows rapid ramp up of new client projects and the ability to work online with client host systems while completely integrating and leveraging the power of our base accounts receivable management software infrastructure. Additionally, this technology allows sophisticated reporting capabilities that are not always available on clients' host systems. The NCO ACCESS interface product translates client account information into a standard presentation format that provides our account representatives with a common visual interface that links directly into disparate client host systems. Key benefits of the NCO ACCESS interface include dramatic reduction in project ramp-up time, reduction in training costs, and an overall increase in account representative productivity. Our call centers utilize predictive dialers with over 4,200 stations to address our low balance, high-volume accounts. These systems scan our databases, simultaneously initiate calls on all available telephone lines and determine if a live connection is made. Upon determining that a live connection has been made, the computer immediately switches the call to an available representative and instantaneously displays the associated account record on the representative's workstation. Calls that reach other signals, such as a busy signal, telephone company intercept or no answer, are tagged for statistical analysis and placed in priority recall queues or multiple-pass calling cycles. The system also automates virtually all record keeping and follow-up activities including letter and report generation. Our automated method of operations dramatically improves the productivity of our collection staff. Our MIS staff is comprised of approximately 240 employees led by a Chief Information Officer. We maintain disaster recovery contingency plans and have implemented procedures to protect against the loss of data resulting from power outages, fire and other casualties. We have implemented a security system to protect the integrity and confidentiality of our computer systems and data and maintain comprehensive business interruption and critical systems insurance on our telecommunications and computer systems. -7- Sales and Marketing Our sales force is organized at the corporate level to address clients by need, based upon their respective complexity, geography and industry. We utilize a focused and professional direct selling effort in which sales representatives personally cultivate relationships with prospective and existing clients. Our sales effort consists of an approximately 60-person direct sales force, and for the commercial sector, approximately 330 telephone sales representatives. Each sales representative is charged with identifying leads, qualifying prospects and closing sales. When appropriate, our operating personnel will join in the sales effort to provide detailed information and advice regarding our operational capabilities. We supplement our direct sales effort with print media and attendance at trade shows. Many of our prospective clients issue a request for proposal as part of the contract award process. We have a staff of technical writers for the purpose of preparing detailed, professional responses to requests for proposals. Quality Assurance and Client Service Our reputation for quality service is critical to acquiring and retaining clients. Therefore, we and our clients monitor our representatives for strict compliance with the clients' specifications and our policies. We regularly measure the quality of our services by capturing and reviewing such information as the amount of time spent talking with clients' customers, level of customer complaints and operating performance. In order to provide ongoing improvement to our telephone representatives' performance and to ensure compliance with our policies and standards, quality assurance personnel monitor each telephone representative on a frequent basis and provide ongoing training to the representative based on this review. Our information systems enable us to provide clients with reports on a real-time basis as to the status of their accounts and clients can choose to network with our computer system to access such information directly. We maintain a client service department to promptly address client issues and questions and alert senior executives of potential problems that require their attention. In addition to addressing specific issues, a team of client service representatives will contact clients on a regular basis in order to establish a close rapport, determine clients' overall level of satisfaction and identify practical methods of improving their satisfaction. Client Relationships Our client base currently includes over 50,000 companies in the financial services, healthcare, retail and commercial, utilities, education, telecommunications, and government sectors. Our 10 largest clients in 2001 accounted for approximately 28% of our revenue. In 2001, no client accounted for more than 6% of total revenue. In 2001, we derived 34.4% of our revenue, excluding purchased accounts receivable, from financial services (which included the banking and insurance sectors), 25.5% from healthcare organizations, 21.3% from retail and commercial entities, 6.4% from utilities, 5.6% from educational organizations, 5.1% from telecommunications companies, and 1.7% from government entities. -8- We enter into contracts with most of our clients that define, among other things, fee arrangements, scope of services and termination provisions. Clients may usually terminate such contracts on 30 or 60 days notice. In the event of termination, however, clients typically do not withdraw accounts referred to us prior to the date of termination, thus providing us with an ongoing stream of revenue from such accounts, which diminish over time. Under the terms of our contracts, clients are not required to place accounts with us but do so on a discretionary basis. Personnel and Training Our success in recruiting, hiring and training a large number of employees is critical to our ability to provide high quality accounts receivable management and collection, customer support and teleservices programs to our clients. We seek to hire personnel with previous experience in accounts receivable management and collection or as telephone representatives. We generally offer competitive compensation and benefits and offer internal promotion opportunities. All our collection personnel receive comprehensive training that consists of a combination of classroom and practical experience. Prior to customer contact, new employees receive one week of training in our operating systems, procedures and telephone techniques and instruction in applicable federal and state regulatory requirements. Our personnel also receive a wide variety of continuing professional education consisting of both classroom and role-playing sessions. As of December 31, 2001, we had a total of approximately 8,100 full-time employees and 900 part-time employees, of which 7,400 are telephone representatives. None of our employees are represented by a labor union. We believe that our relations with our employees are good. Competition The accounts receivable management and collection industry is highly competitive. We compete with a large number of providers, including large national corporations such as Outsourcing Solutions, Inc., IntelliRisk Management Corporation, Risk Management Alternatives, Inc., and GC Services LP, as well as many regional and local firms. Some of our competitors may offer more diversified services and/or operate in broader geographic areas than we do. In addition, many companies perform the accounts receivable management and collection services offered by us in-house. Moreover, many larger clients retain multiple accounts receivable management and collection providers, which exposes us to continuous competition in order to remain a preferred vendor. We believe that the primary competitive factors in obtaining and retaining clients are the ability to provide customized solutions to a client's requirements, personalized service, sophisticated call and information systems, and price. Regulation The accounts receivable management and collection industry is regulated both at the federal and state level. The Federal Fair Debt Collection Practices Act regulates any person who regularly collects or attempts to collect, directly or indirectly, consumer debts owed or asserted to be owed to another person. The Fair Debt Collection Practices Act establishes specific guidelines and procedures that debt collectors must follow in communicating with consumer debtors, including the time, place and manner of such communications. Further, it prohibits harassment or abuse by debt collectors, including the threat of violence or criminal prosecution, obscene language or repeated telephone calls made with the intent to abuse or harass. The Fair Debt Collection Practices Act also places restrictions on communications with individuals other than consumer debtors in connection with the collection of any consumer debt and sets forth specific procedures to be followed when communicating with such third parties for purposes of obtaining location information about the consumer. Additionally, the Fair Debt Collection Practices Act contains various notice and disclosure requirements and prohibits unfair or misleading representations by debt collectors. We are also subject to the Fair Credit Reporting Act, which regulates the consumer credit reporting industry and which may impose liability on us to the extent that the adverse credit information reported on a consumer to a credit bureau is false or inaccurate. The Federal Trade Commission has the authority to investigate consumer complaints against debt collection companies and to recommend enforcement actions and seek monetary penalties. The accounts receivable management and collection business is also subject to state regulation. Some states require that we be licensed as a debt collection company. We believe that we currently hold applicable licenses from all states where required. -9- The collection of accounts receivable by collection agencies in Canada is regulated at the provincial and territorial level in substantially the same fashion as is accomplished by federal and state laws in the United States. The manner in which we carry on the business of collecting accounts is subject, in all provinces and territories, to established rules of common law or civil law and statute. Such laws establish rules and procedures governing the tracing, contacting and dealing with debtors in relation to the collection of outstanding accounts. These rules and procedures prohibit debt collectors from engaging in intimidating, misleading and fraudulent behavior when attempting to recover outstanding debts. In Canada, our collection operations are subject to licensing requirements and periodic audits by government agencies and other regulatory bodies. Generally, such licenses are subject to annual renewal. We believe that we hold all necessary licenses in those provinces and territories that require them. If we engage in other teleservice activities in Canada, there are several provincial and territorial consumer protection laws of more general application. This legislation defines and prohibits unfair practices by telemarketers, such as the use of undue pressure and the use of false, misleading or deceptive consumer representations. In addition, the accounts receivable management and collection industry is regulated in the United Kingdom, including a licensing requirement. If we expand our international operations, we may become subject to additional government control and regulation in other countries, which may be more onerous than those in the United States. Several of the industries served by us are also subject to varying degrees of government regulation. Although compliance with these regulations is generally the responsibility of our clients, we could be subject to a variety of enforcement or private actions for our failure or the failure of our clients to comply with such regulations. We devote significant and continuous efforts, through training of personnel and monitoring of compliance, to ensure that we are in compliance with all federal and state regulatory requirements. We believe that we are in material compliance with all such regulatory requirements. -10- History of Acquisitions The following is a summary of the acquisitions we completed since 1994 (dollars in thousands):
Revenue for the Date Value of Fiscal Year Prior Acquired Business Purchase Price to Acquisition ----------- ------------------------- ------------------- ------------------ Creditrust Corporation 2/20/01 Purchased A/R $ 25,000 (1) $ 36,491 Compass International Services 8/20/99 A/R Management and 104,100 105,800 (2) Corporation Telemarketing Co-Source Corporation 5/21/99 Commercial A/R 124,600 61,100 Management JDR Holdings, Inc. 3/31/99 Technology-Based 103,100 51,000 Outsourcing, A/R Management and Telemarketing Medaphis Services Corporation 11/30/98 Healthcare A/R 117,500 96,700 Management MedSource, Inc. 7/1/98 Healthcare A/R 35,700 (3) 22,700 Management FCA International Ltd. 5/5/98 A/R Management 69,900 62,800 The Response Center 2/6/98 Market Research 15,000 8,000 Collections Division of American 1/1/98 A/R Management 1,700 1,700 Financial Enterprises, Inc. ADVANTAGE Financial 10/1/97 A/R Management 5,000 5,100 Services, Inc. Credit Acceptance Corporation 10/1/97 A/R Management 1,800 2,300 Collections Division of CRW 2/2/97 A/R Management 12,800 25,900 Financial, Inc. CMS A/R Services 1/31/97 A/R Management 5,100 6,800 Tele-Research Center, Inc. 1/30/97 Market Research and 2,200 1,800 Telemarketing Goodyear & Associates, Inc. 1/22/97 A/R Management 5,400 5,500 Management Adjustment 9/5/96 A/R Management 9,000 13,500 Bureau, Inc. Collections Division of Trans 1/3/96 A/R Management 4,800 7,000 Union Corporation Eastern Business Services, Inc. 8/1/95 A/R Management 2,000 2,000 B. Richard Miller, Inc. 4/29/94 A/R Management 1,400 1,300
(1) We merged our subsidiary NCO Portfolio Management, Inc. with Creditrust Corporation. We own approximately 63% of the post-merger company. (2) Pro Forma Revenue - Assumes the acquisitions completed by Compass International Services Corporation in 1998 and the sale of its Print and Mail Division were all completed on January 1, 1998. (3) Includes $17.3 million of debt repaid by us. -11- Investment Considerations You should carefully consider the risks described below. If any of the risks actually occur, our business, financial condition or results of future operations could be materially adversely affected. This Annual Report on Form 10-K contains forward-looking statements that involve risk and uncertainties. Our actual results could differ materially from those anticipated in the forward-looking statements as a result of many factors, including the risks faced by us described below and elsewhere in this Annual Report on Form 10-K. Terrorist attacks and threats of war may negatively impact our results of operations, revenue, and stock price. Terrorist attacks and threats of war may negatively impact our results of operations, revenue, and stock price. Recent terrorist attacks in the United States, as well as future events occurring in response or in connection to them, including, without limitation, future terrorist attacks against United States targets and threats of war or actual conflicts involving the United States or its allies, may impact our operations, including affecting our ability to collect our clients' accounts receivable. More generally, any of these events could cause consumer confidence and spending to decrease or result in increased volatility in the economy. They could also result in the deepening of the economic recession in the United States. Any of these occurrences could have a material adverse effect on our operating results, collections and revenue and may result in the volatility of the market price for our common stock. Our business is dependent on our ability to grow internally. Our business is dependent on our ability to grow internally, which is dependent upon (1) our ability to retain existing clients and expand our existing client relationships and (2) our ability to attract new clients. Our ability to retain existing clients and expand those relationships is subject to a number of risks, including, the risk that: o we fail to maintain the quality of services we provide to our clients; o we fail to maintain the level of attention expected by our clients; and o we fail to successfully leverage our existing client relationships to sell additional services. Our ability to attract new clients is subject to a number of risks, including: o the market acceptance of our service offerings; o the quality and effectiveness of our sales force; and o the competitive factors within the accounts receivable management and collection industry. If our efforts to retain and expand our client relationships and to attract new clients do not prove effective it could have a materially adverse effect on our business, results of operations and financial condition. -12- If we are not able to respond to technological changes in telecommunications and computer systems in a timely manner, we may not be able to remain competitive. Our success depends in large part on our sophisticated telecommunications and computer systems. We use these systems to identify and contact large numbers of debtors and to record the results of collection efforts. If we are not able to respond to technological changes in telecommunications and computer systems in a timely manner, we may not be able to remain competitive. We have made a significant investment in technology to remain competitive and we anticipate that it will be necessary to continue to do so in the future. Computer and telecommunications technologies are changing rapidly and are characterized by short product life cycles, so that we must anticipate technological developments. If we are not successful in anticipating, managing, or adopting technological changes on a timely basis or if we do not have the capital resources available to invest in new technologies, our business would be materially adversely affected. We are highly dependent on our telecommunications and computer systems. As noted above, our business is highly dependent on our telecommunications and computer systems. These systems could be interrupted by natural disasters, power losses, or similar events. Our business also is materially dependent on services provided by various local and long distance telephone companies. If our equipment or systems cease to work or become unavailable, or if there is any significant interruption in telephone services, we may be prevented from providing services. Because we generally recognize income only as accounts are collected, any failure or interruption of services would mean that we would continue to incur payroll and other expenses without any corresponding income. We currently utilize three computer hardware systems and are in the process of transitioning to one system. If we do not succeed in that transition, our business may be materially adversely affected. We compete with a large number of providers in the accounts receivable management and collection industry. This competition could have a materially adverse effect on our future financial results. We compete with a large number of companies in providing accounts receivable management and collection services. We compete with other sizable corporations in the United States and abroad such as Outsourcing Solutions, Inc., IntelliRisk Management Corporation, Risk Management Alternatives, Inc., and GC Services LP, as well as many regional and local firms. We may lose business to competitors that offer more diversified services and/or operate in broader geographic areas than we do. We may also lose business to regional or local firms who are able to use their proximity to or contacts at local clients as a marketing advantage. In addition, many companies perform the accounts receivable management and collection services offered by us in-house. Many larger clients retain multiple accounts receivable management and collection providers, which exposes us to continuous competition in order to remain a preferred provider. Because of this competition, in the future we may have to reduce our collection fees to remain competitive and this competition could have a materially adverse effect on our future financial results. -13- Many of our clients are concentrated in the financial services, healthcare, and retail and commercial sectors. If any of these sectors performs poorly or if there are any adverse trends in these sectors it could materially adversely affect us. For the year ended December 31, 2001, we derived approximately 34.4% of our revenue, excluding purchased accounts receivable, from clients in the financial services sector, approximately 25.5% of our revenue from clients in the healthcare sector and approximately 21.3% of our revenue from clients in the retail and commercial sectors. If any of these sectors performs poorly, clients in these sectors may have fewer or smaller accounts to refer to us, or they may elect to perform accounts receivable management and collection services in-house. If there are any trends in any of these sectors to reduce or eliminate the use of third-party accounts receivable management and collection services, the volume of referrals to us could decrease. Most of our contracts do not require clients to place accounts with us, they may be terminated on 30 or 60 days notice, and they are on a contingent fee basis. We cannot guarantee that existing clients will continue to use our services at historical levels, if at all. Under the terms of most of our contracts, clients are not required to give accounts to us for collection and usually have the right to terminate our services on 30 or 60 days notice. Accordingly, we cannot guarantee that existing clients will continue to use our services at historical levels, if at all. In addition, most of these contracts provide that we are entitled to be paid only when we collect accounts. Under applicable accounting principles, therefore, we can recognize revenues only as accounts are recovered. We are subject to risks as a result of our investment in NCO Portfolio. We are subject to risks as a result of our investment in NCO Portfolio, including: o The operations of NCO Portfolio could divert management's attention from our daily operations, particularly that of Michael J. Barrist, our Chairman, President and Chief Executive Officer, who is also serving in the same capacities for NCO Portfolio, and otherwise require the use of other of our management, operational and financial resources. o Our investment in NCO Portfolio currently is limited to our $25.0 million equity investment and a $50.0 million credit sub-facility. If NCO Portfolio defaults on that credit, it would be a default under our credit agreement with our lenders, or if the value of our investment is impaired, it would have a material adverse effect on us. NCO Portfolio will have additional business risks that may have an adverse effect on our combined financial results. NCO Portfolio is subject to additional business-related risks common to the purchase and management of defaulted consumer accounts receivable business. The results of NCO Portfolio will be consolidated into our results. To the extent that those risks have an adverse effect on NCO Portfolio, they will have an adverse effect on our combined financial results. Some of those risks are: -14- o Collections may not be sufficient to recover the cost of investments in purchased accounts receivable and support operations - NCO Portfolio purchases delinquent accounts receivable generated primarily by consumer credit transactions. These are obligations that the individual consumer has failed to pay when due. The accounts receivable are purchased from consumer creditors such as banks, finance companies, retail merchants and other consumer oriented companies. Substantially all of the accounts receivable consist of account balances that the credit grantor has made numerous attempts to collect, has subsequently deemed uncollectible, and charged-off its books. After purchase, collections on accounts receivable could be reduced by consumer bankruptcy filings, which have been on the rise. The accounts receivable are purchased at a significant discount to the amount the customer owes and, although the belief is that the recoveries on the accounts receivable will be in excess of the amount paid for the accounts receivable, actual recoveries on the accounts receivable may vary and may be less than the amount expected. The timing or amounts to be collected on those accounts receivable cannot be assured. If cash flows from operations are less than anticipated as a result of our inability to collect NCO Portfolio's accounts receivable, NCO Portfolio will not be able to purchase new accounts receivable after it has exhausted the availability under the sub-facility, and its future growth and profitability will be materially adversely affected. There can be no assurance that NCO Portfolio's operating performance will be sufficient to service debt on the sub-facility or finance the purchase of new accounts receivable. o Use of estimates in reporting results - NCO Portfolio's revenue is recognized based on estimates of future collections on static pools of accounts receivable purchased. Although estimates are based on statistical analysis, the actual amount collected on these static pools and the timing of those collections may differ materially from NCO Portfolio's estimates. If collections on static pools are materially less than estimated, NCO Portfolio will be required to record impairment expenses that will reduce earnings and could materially adversely affect earnings, financial condition, and creditworthiness. o Possible shortage of accounts receivable for purchase at favorable prices - The availability of portfolios of delinquent accounts receivable for purchase at favorable prices depends on a number of factors outside of NCO Portfolio's control, including the continuation of the current growth trend in consumer debt and competitive factors affecting potential purchasers and sellers of portfolios of accounts receivable. The growth in consumer debt may also be affected by changes in credit grantors' underwriting criteria and regulations governing consumer lending. Any slowing of the consumer debt growth trend could result in less credit being extended by credit grantors. Consequently, fewer delinquent accounts receivable could be available at prices that NCO Portfolio finds attractive. If competitors raise the prices they are willing to pay for portfolios of accounts receivable above those NCO Portfolio wishes to pay, NCO Portfolio may be unable to buy delinquent accounts receivable at prices consistent with its historic return targets. In addition, NCO Portfolio may overpay for portfolios of delinquent accounts receivable, which may have a materially adverse effect on our combined financial results. o Government regulation of NCO Portfolio operations - Federal and state consumer protection and related laws and regulations govern the relationship of a customer and a creditor. Significant laws include the Fair Debt Collection Practices Act, the Federal Truth-In-Lending Act, the Fair Credit Billing Act, the Equal Credit Opportunity Act, the Fair Credit Reporting Act and the Electronic Funds Transfer Act, and various federal regulations that relate to these acts, as well as comparable statutes in the states where account debtors reside or where credit grantors are located. Some of these laws may apply to NCO Portfolio's activities. If credit grantors who sell accounts receivable to NCO Portfolio fail to comply with these laws, NCO Portfolio's ability to collect on those accounts receivable could be limited regardless of any act or omission on its part. NCO Portfolio's failure to comply with these laws may also limit its ability to collect on the accounts receivable. -15- Our success depends on our senior management team and if we are not able to retain them, it could have a materially adverse effect on us. We are highly dependent upon the continued services and experience of our senior management team, including Michael J. Barrist, our Chairman, President and Chief Executive Officer. NCO depends on the services of Mr. Barrist and the other members of our senior management team to, among other things, continue our growth strategies and maintain and develop our client relationships. We may seek to make strategic acquisitions of companies. Acquisitions involve additional risks that may adversely affect us. We may be unable to make acquisitions because suitable companies in the accounts receivable management and collection business are not available at favorable prices due to increased competition for these companies. We may have to borrow money or incur liabilities, or sell stock, to pay for future acquisitions and we may not be able to do so at all or on terms favorable to us. Additional borrowings and liabilities may have a materially adverse effect on our liquidity and capital resources. If we issue stock for all or a portion of the purchase price for future acquisitions, our shareholders' ownership interest may be diluted. If the price of our common stock decreases or potential sellers are not willing to accept our common stock as payment for the sale of their businesses, we may be required to use more of our cash resources, if available, in order to continue our acquisition program. Completing acquisitions involves a number of risks, including diverting management's attention from our daily operations and other additional management, operational and financial resources. We might not be able to successfully integrate future acquisitions into our business or operate the acquired businesses profitably, and we may be subject to unanticipated problems and liabilities of acquired companies. We are dependent on our employees and a higher turnover rate would materially adversely affect us. We are dependent on our ability to attract, hire and retain qualified employees. The accounts receivable management and collection industry experiences a high employee turnover rate. Many of our employees receive modest hourly wages and some of these employees are employed on a part-time basis. A higher turnover rate among our employees would increase our recruiting and training costs and could materially adversely impact the quality of services we provide to our clients. If we were unable to recruit and retain a sufficient number of employees, we would be forced to limit our growth or possibly curtail our operations. Growth in our business will require us to recruit and train qualified personnel at an accelerated rate from time to time. We cannot assure you that we will be able to continue to hire, train and retain a sufficient number of qualified employees. Any increase in hourly wages, costs of employee benefits or employment taxes also could materially adversely affect us. If we fail to comply with government regulation of the collections industry, it could result in the suspension or termination of our ability to conduct business. The collections industry is regulated under various United States federal and state, Canadian and United Kingdom laws and regulations. Many states, as well as Canada and the United Kingdom, require that we be licensed as a debt collection company. The Federal Trade Commission has the authority to investigate consumer complaints against debt collection companies and to recommend enforcement actions and seek monetary penalties. If we fail to comply with applicable laws and regulations, it could result in the suspension or termination of our ability to conduct collections, which would have a materially adverse effect on us. In addition, new federal, state or foreign laws or regulations, or changes in the ways these rules or laws are interpreted or enforced, could limit our activities in the future or significantly increase the cost of regulatory compliance. If we expand our international operations, we may become subject to additional government controls and regulations in other countries, which may be stricter or more burdensome than those in the United States. -16- Several of the industries served by us are also subject to varying degrees of government regulation. Although our clients are generally responsible for complying with these regulations, we could be subject to a variety of enforcement or private actions for our failure, or the failure of our clients, to comply with these regulations. We may experience variations from quarter to quarter in operating results and net income that could adversely affect the price of our common stock. Factors that could cause quarterly fluctuations include, among other things, the following: o the timing of our clients' accounts receivable management and collection programs and the commencement of new contracts and termination of existing contracts; o the timing and amount of collections on purchased accounts receivable; o customer contracts that require us to incur costs in periods prior to recognizing revenue under those contracts; o the effects of a change of business mix on profit margins; o the timing of additional selling, general, and administrative expenses to support new business; o the costs and timing of completion and integration of acquisitions; and o that our business tends to be slower in the third and fourth quarters of the year due to the summer and holiday seasons. If we do not achieve the results projected in our public forecasts, it could have a materially adverse effect on the market price of our common stock. We have publicly announced our investor guidance concerning our expected results of operations for the first and second quarters of 2002. Our investor guidance contains forward-looking statements and may be affected by various factors discussed in "Risk Factors" and elsewhere in this Annual Report on Form 10-K that may cause actual results to differ materially from the results discussed in the investor guidance. Our investor guidance reflects numerous assumptions, including our anticipated future performance, general business and economic conditions and other matters, some of which are beyond our control. In addition, unanticipated events and circumstances may affect our actual financial results. Our investor guidance is not a guarantee of future performance and the actual results throughout the periods covered by the investor guidance may vary from the projected results. If we do not achieve the results projected in our investor guidance, it could have a materially adverse effect on the market price of our common stock. -17- Goodwill represented 55.3% of our total assets at December 31, 2001. Effective January 1, 2002, we were required to adopt the Financial Accounting Standards Board's ("FASB") SFAS No. 142, "Goodwill and Other Intangibles." If the goodwill is deemed to be impaired under FASB 142, we may need to take a charge to earnings to write-down the goodwill to its fair value. Our balance sheet includes amounts designated as intangibles, which predominantly consist of "goodwill." Goodwill represents the excess of purchase price over the fair market value of the net assets of the acquired businesses based on their respective fair values at the date of acquisition. Effective January 1, 2002, we were required to adopt the Financial Accounting Standards Board's ("FASB") SFAS No. 142, "Goodwill and Other Intangibles." FASB 142 concluded that purchased goodwill will not be amortized but will be reviewed for impairment when certain events indicate that the goodwill of a reporting unit is impaired. The impairment test will use a fair-value based approach, whereby if the implied fair value of a reporting unit's goodwill is less than its carrying amount, goodwill would be considered impaired. As of December 31, 2001, our balance sheet included goodwill that represented 55.3% of total assets and 124.3% of shareholders' equity. If the goodwill is deemed to be impaired under FASB 142, we may need to take a charge to earnings to write-down the goodwill to its fair value. Investors should be aware that our earnings for periods beginning after December 31, 2001 will not include charges for the amortization of goodwill and should consider this when comparing such earnings with historical earnings for periods ended on or before December 31, 2001, which included goodwill amortization charges. Our stock price has been and is likely to continue to be volatile, which may make it difficult for shareholders to resell common stock when they want at prices they find attractive. The trading price of our common stock has been and is likely to be highly volatile. Our stock price could be subject to wide fluctuations in response to a variety of factors, including the following: o announcements of fluctuations in our, or our competitors', operating results; o the timing and announcement of acquisitions by us or our competitors; o changes in our publicly available guidance of future results of operations; o government regulatory action; o changes in estimates or recommendations by securities analysts; o adverse or unfavorable publicity about us or our services; o the commencement of material litigation, or an unfavorable verdict, against us; o additions or departures of key personnel; and o sales of common stock. In addition, the stock market in recent years has experienced significant price and volume fluctuations and a significant cumulative decline in recent months. Such volatility and decline have affected many companies irrespective of, or disproportionately to, the operating performance of these companies. These broad fluctuations may materially adversely affect the market price of our common stock. -18- Most of our outstanding shares are available for resale in the public market without restriction. The sale of a large number of these shares could adversely affect our stock price and could impair our ability to raise capital through the sale of equity securities or make acquisitions for stock. Sales of our common stock could adversely affect the market price of our common stock and could impair our future ability to raise capital through the sale of equity securities or make acquisitions for stock. As of March 18, 2002, there were 25,874,000 shares of our common stock outstanding. Most of these shares are available for resale in the public market without restriction, except for shares held by our affiliates. Generally, our affiliates may either sell their shares under a registration statement or in compliance with the volume limitations and other requirements imposed by Rule 144 adopted by the SEC. In addition, as of March 18, 2002, we had the authority to issue up to approximately 4,730,000 shares of our common stock under our stock option plans. We also had outstanding notes convertible into an aggregate of 3,797,000 shares of our common stock at a conversion price of $32.92 per share. Additionally, we had outstanding warrants to purchase approximately 22,000 shares of our common stock. "Anti-takeover" provisions may make it more difficult for a third party to acquire control of us, even if the change in control would be beneficial to shareholders. We are a Pennsylvania corporation. Anti-takeover provisions in Pennsylvania law and our charter and bylaws could make it more difficult for a third party to acquire control of us. These provisions could adversely affect the market price of our common stock and could reduce the amount that shareholders might receive if we are sold. For example, our charter provides that our board of directors may issue preferred stock without shareholder approval. In addition, our bylaws provide for a classified board, with each board member serving a staggered three-year term. Directors may be removed only for cause and only with the approval of the holders of at least 65% of our common stock. Item 2. Properties. We currently lease 77 offices throughout North America, two offices in the United Kingdom and one office in Puerto Rico. The leases of these facilities expire between 2002 and 2016, and most contain renewal options. Effective March 11, 2002, we relocated our corporate headquarters to 507 Prudential Road, Horsham, PA 19044. We believe that our facilities are adequate for our current operations, but additional facilities may be required to support growth. We believe that suitable additional or alternative space will be available as needed on commercially reasonable terms. -19- Item 3. Legal Proceedings. The discussions concerning our litigation with the landlord of our Fort Washington facilities contained in "Management's Discussion and Analysis of Financial Condition and Results of Operations" are incorporated herein by reference. AssetCare, Inc., our subsidiary acquired as part of Medaphis Services Corporation, has been identified in an administrative order issued by the State of California as a party that is partially responsible for cleanup costs and natural resource damages associated with a former scrap recycling site next to Humboldt Bay in California. The subsidiary was identified as a successor-in-interest to a former scrap recycler who conducted limited operations at the site. The subsidiary has also been named in a civil proceeding brought by one of the owners of the site as a party that is responsible for the costs that will be incurred by the owner for complying with the terms of the order. Although we are still investigating these claims and cannot predict the outcome of the proceedings or quantify the ultimate liability of the subsidiary in light of the early stage of the litigation, based upon: (i) the fact that the former scrap recycler conducted scrap recycling operations for a four-year period during the 100-year operational history of the site; and (ii) the possibility of indemnification and contribution claims against other entities, any costs incurred or assessed against the subsidiary are not expected to have a materially adverse effect on our financial condition or results of operations. The subsidiary intends to vigorously defend these matters. We are involved in other legal proceedings from time to time in the ordinary course of our business. Our management believes that none of these legal proceedings will have a materially adverse effect on our financial condition or results of operations. Item 4. Submission of Matters to a Vote of Security Holders. None. Item 4.1 Executive Officers of the Registrant who are not Directors.
Name Age Position -------------------------------------------------- -------- ------------------------------------------------ Stephen W. Elliott..................... 40 Executive Vice President, Information Technology and Chief Information Officer Joshua Gindin, Esq..................... 45 Executive Vice President and General Counsel Steven Leckerman....................... 49 Executive Vice President, U.S. Operations Paul E. Weitzel, Jr.................... 43 Executive Vice President, Corporate Development and International Operations Steven L. Winokur...................... 42 Executive Vice President, Finance; Chief Financial Officer; and Treasurer
-20- Stephen W. Elliott - Mr. Elliott joined us in 1996 as Senior Vice President, Technology and Chief Information Officer after having provided consulting services to us for the year prior to his arrival. Mr. Elliott became an Executive Vice President in February 1999. Prior to joining us, Mr. Elliott was employed by Electronic Data Systems, a computer services company, for almost 10 years, most recently as Senior Account Manager. Joshua Gindin, Esq. - Mr. Gindin joined us in May 1998. Prior to joining us, Mr. Gindin was a partner in the law firm of Kessler & Gindin, which served as our legal counsel since 1986. Steven Leckerman - Mr. Leckerman joined us in 1995 as Senior Vice President, Collection Operations, and became Executive Vice President, U.S. Operations in January 2001. From 1982 to 1995, Mr. Leckerman was employed by Allied Bond Corporation, a division of Union Corporation, where he served as manager of dialer and special projects. Paul E. Weitzel, Jr. - Mr. Weitzel joined us through the acquisition of MedSource, Inc. in July 1998. Prior to joining us, Mr. Weitzel was Chairman and Chief Executive Officer of MedSource, Inc. since 1997. Prior to joining MedSource, Inc., Mr. Weitzel was with MedQuist, Inc., a medical transcription company, for four years, most recently as President and Chief Executive Officer. Mr. Weitzel is a Certified Public Accountant. Steven L. Winokur - Mr. Winokur joined us in December 1995. Prior to that, Mr. Winokur acted as a part-time consultant to us since 1986. From February 1992 to December 1995, Mr. Winokur was the principal of Winokur & Associates, a certified public accounting firm. From March 1981 to February 1992, Mr. Winokur was with Gross & Company, a certified public accounting firm, where he most recently served as Administrative Partner. Mr. Winokur is a Certified Public Accountant. -21- PART II Item 5. Market for the Registrant's Common Stock and Related Shareholder Matters. The Company's common stock is listed on the Nasdaq National Market under the symbol "NCOG." The following table sets forth, for the fiscal quarters indicated, the high and low closing sale prices for the common stock, as reported by Nasdaq. High Low ---- --- 2000 First Quarter $ 31.94 $ 18.13 Second Quarter 34.38 21.06 Third Quarter 27.00 11.88 Fourth Quarter 30.94 12.69 2001 First Quarter $ 34.48 $ 25.56 Second Quarter 32.70 23.25 Third Quarter 29.73 12.02 Fourth Quarter 24.50 13.45 On March 18, 2002, the last reported sale price of our common stock as reported on The Nasdaq National Market was $27.37 per share. On March 18, 2002, there were approximately 70 holders of record of our common stock. Dividend Policy We do not anticipate paying cash dividends on our common stock in the foreseeable future. In addition, our credit agreement prohibits us from paying cash dividends without the lender's prior consent. We currently intend to retain future earnings to finance our operations and fund the growth of our business. Any payment of future dividends will be at the discretion of our board of directors and will depend upon, among other things, our earnings, financial condition, capital requirements, level of indebtedness, contractual restrictions with respect to the payment of dividends and other factors that our board of directors deems relevant. -22- Item 6. Selected Financial Data. SELECTED FINANCIAL DATA (1) (Amounts in thousands, except per share data)
For the years ended December 31, -------------------------------------------------------------------------- 1997 1998 1999 2000 2001 ----------- ------------ ------------ ----------- ------------ Statement of Income Data: Revenue $ 99,720 $ 209,947 $ 460,311 $ 605,884 $ 701,506 Operating costs and expenses: Payroll and related expenses 51,493 106,787 237,709 293,292 350,634 Selling, general and administrative expenses 34,379 61,607 128,177 179,924 237,690 Depreciation and amortization expense 4,052 8,615 21,805 32,360 38,205 Nonrecurring acquisition costs - - 4,601 - - ----------- ------------ ------------ ----------- ------------ Income from operations 9,796 32,938 68,019 100,308 74,977 Other income (expense) (419) (1,794) (16,899) (22,126) (23,335) ----------- ------------ ------------ ----------- ------------ Income before provision for income taxes 9,377 31,144 51,120 78,182 51,642 Income tax expense 4,638 12,881 22,821 32,042 21,463 ----------- ------------ ------------ ----------- ------------ Income from continuing operations before minority interest 4,739 18,263 28,299 46,140 30,179 Minority interest - - - - (4,310) ----------- ------------ ------------ ----------- ------------ Income from continuing operations 4,739 18,263 28,299 46,140 25,869 Accretion of preferred stock to redemption value (1,617) (1,604) (377) - - ----------- ------------ ------------ ----------- ------------ Income from continuing operations applicable to common shareholders 3,122 16,659 27,922 46,140 25,869 Discontinued operations, net of taxes: (Loss) income from discontinued operations (148) 82 1,067 (975) - Loss on disposal of discontinued operations - - - (23,179) - ----------- ------------ ------------ ----------- ------------ Net income applicable to common shareholders $ 2,974 $ 16,741 $ 28,989 $ 21,986 $ 25,869 =========== ============ ============ =========== ============ Income from continuing operations applicable to common shareholders per share: Basic $ 0.23 $ 0.91 $ 1.22 $ 1.80 $ 1.00 =========== ============ ============ =========== ============ Diluted $ 0.21 $ 0.84 $ 1.17 $ 1.79 $ 0.99 =========== ============ ============ =========== ============ Net income applicable to common shareholders per share: Basic $ 0.22 $ 0.91 $ 1.27 $ 0.86 $ 1.00 =========== ============ ============ =========== ============ Diluted $ 0.20 $ 0.85 $ 1.22 $ 0.85 $ 0.99 =========== ============ ============ =========== ============ Weighted average shares outstanding: Basic 13,736 18,324 22,873 25,587 25,773 =========== ============ ============ =========== ============ Diluted 14,808 19,758 23,799 25,842 28,897 =========== ============ ============ =========== ============ Other Financial Data: EBITDA (2) $ 13,848 $ 41,553 $ 89,824 $ 132,668 $ 113,182 December 31, -------------------------------------------------------------------------- 1997 1998 1999 2000 2001 ----------- ------------ ------------ ----------- ------------ Balance Sheet Data: Cash and cash equivalents $ 30,194 $ 22,528 $ 50,513 $ 13,490 $ 32,161 Working capital 37,825 31,517 65,937 79,732 112,373 Net assets of discontinued operations 9,484 27,740 41,492 - - Total assets 129,301 410,992 791,692 784,006 931,025 Long-term debt, net of current portion 14,940 143,831 323,949 303,920 357,868 Minority interest - - - - 21,213 Redeemable preferred stock 6,522 11,882 - - - Shareholders' equity 94,336 199,465 364,888 386,426 414,095
(1) Gives effect to the restatement of our historical financial statements for: (i) the acquisition of JDR Holdings, Inc. using the pooling-of-interests method of accounting; and (ii) the treatment of the Market Strategy division as discontinued operations. This data should be read in conjunction with the consolidated financial statements, including the accompanying notes, included elsewhere in this report on Form 10-K. (2) Earnings before interest, taxes, depreciation, and amortization, referred to as EBITDA, is used by management to measure results of operations and is not intended to report results of operations in conformity with generally accepted accounting principles. -23- Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations. Overview We believe we are the largest outsourced accounts receivable management and collection company in the world, serving a wide range of clients in North America and abroad. We generate approximately 60% of our revenue from the recovery of delinquent accounts receivable on a contingency fee basis. Our contingency fees typically range from 15% to 35% of the amount recovered on behalf of our clients. However, fees can range from 6% for the management of accounts placed early in the accounts receivable cycle to 50% for accounts that have been serviced extensively by the client or by third-party providers. Our average fee across all industries was approximately 19% during 2001, as compared to 19% during 2000. In addition, we generate revenue from fixed fee services for certain accounts receivable management and collection services. Revenue is earned and recognized upon collection of accounts receivable for contingency fee services and as work is performed for fixed fee services. We enter into contracts with most of our clients that define, among other things, fee arrangements, scope of services and termination provisions. Clients typically have the right to terminate their contracts on 30 or 60 days notice. Our operating costs consist principally of payroll and related costs; selling, general, and administrative costs; and depreciation and amortization. Payroll and related expenses consist of wages and salaries, commissions, bonuses, and benefits for all of our employees, including management and administrative personnel. Selling, general, and administrative expenses include telephone, postage and mailing costs and other collection costs as well as expenses that directly support operations including facilities costs, equipment maintenance, sales and marketing, data processing, professional fees, and other management costs. We have grown rapidly, through both internal growth as well as acquisitions. To date, all of our acquisitions, except the acquisition in 1999 of JDR Holdings, Inc., referred to as JDR, have been accounted for under the purchase method of accounting with the results of the acquired companies included in our operating results beginning on the date of acquisition. JDR was accounted for under the pooling-of-interests method of accounting. On April 14, 2000, our Board of Directors approved a plan to divest our Market Strategy division. The Market Strategy division provided market research and telemarketing services and was divested as part of our strategic plan to increase long-term shareholder value by focusing on our core accounts receivable management and collection services business. The Market Strategy division's operations for all periods presented prior to April 14, 2000, have been presented separately as income or loss from discontinued operations in our consolidated statements of income. We completed the divestiture in October 2000 and recorded a loss of $23.2 million. This loss reflects the difference between the net assets and the proceeds from the divestiture as well as the operating losses from April 14, 2000, through the completion of the divestiture. During 2000, the continued integration of our infrastructure facilitated the reduction of our operating divisions from three to two. Effective October 1, 2000, the new operating divisions included U.S. Operations (formerly Accounts Receivable Management Services and Technology-Based Outsourcing) and International Operations. Each of these divisions maintains industry specific functional groups. Management's discussion of operating results has been adjusted for this change. -24- In February 2001, the Portfolio Management division was created after we completed the merger of our subsidiary, NCO Portfolio Management, Inc., referred to as NCO Portfolio, with Creditrust Corporation, referred to as Creditrust. As a result of the merger, referred to as the Creditrust Merger, our results of operations are more significantly impacted by purchases of and collections on delinquent accounts receivable. NCO Portfolio recognizes revenue based on estimates of future portfolio collections and the timing of these collections. On a periodic basis, NCO Portfolio reviews and adjusts the amount and timing of expected future collections, based on the performance of the portfolio to date. We own approximately 63% of NCO Portfolio after the Creditrust Merger. The results of NCO Portfolio are consolidated into our results, with a charge for minority interest and elimination of significant intercompany transactions. Critical Accounting Policies General The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. We believe the following accounting policies include the estimates that are the most critical and could have the most potential impact on our results of operations. Revenue Recognition for Purchased Accounts Receivable In the ordinary course of accounting for purchased accounts receivable, estimates have been made by management as to the amount of future cash flows expected from each static pool. The estimated future cash flow of each static pool is used to compute the internal rate of return, referred to as IRR, for each static pool. The IRR is used to allocate cash flow between revenue and amortization of the carrying values of the purchased accounts receivable. On an ongoing basis, we compare the historical trends of each static pool to projected collections. The future projections are then increased or decreased, within parameters, in accordance with the historical trend. The results are further reviewed by management with a view towards specifically addressing any particular static pool's performance. Actual results will differ from these estimates and a material change in these estimates could occur within one year. Total cash flow for the year ended December 31, 2001 was unaffected by the change in future estimates. The result of the change in future estimates was a reduction in revenue and an increase in the amount of collections applied to the principal of purchased accounts receivable. The differences between actual and estimated collections on existing static pools as of the beginning of 2001 resulted in a reduction in net income and earnings per share $980,000 and $0.04 per diluted share, respectively for the year ended December 31, 2001. Bad Debts We maintain an allowance for doubtful accounts for estimated losses resulting from the non-payment of our trade accounts receivable. If our estimate is not sufficient to cover actual losses, we would be required to take additional charges to our earnings. -25- Deferred Taxes Income taxes or tax benefits have been provided in the results of operations based on the statutory federal and state rates of 37.5% of pre-tax income for NCO Portfolio. For financial reporting purposes, revenue is recognized over the life of the static pool. Because the static pools of purchased accounts receivable are comprised of distressed debt and collection results are not guaranteed until received, for tax purposes, any gain on a particular static pool is deferred until the full cost of the static pool is recovered (cost recovery method). Temporary differences arise because revenue is recognized on the cost recovery method for income tax purposes. Permanent differences between the statutory rates and actual rates are minimal. Temporary differences in recognition of revenue on purchased accounts receivable have resulted in deferred tax liabilities. Assumed utilization of net operating losses acquired in the Creditrust Merger has resulted in deferred tax assets. Our deferred tax liabilities grew significantly through 2001 as a result of the increase in purchased accounts receivable, providing us with additional liquidity. As of December 31, 2001, NCO Portfolio's net deferred tax asset of $1 million was the result of the combination of deferred tax assets generated principally by the assumed utilization of net operating loss carryforwards from the Creditrust Merger, offset by the deferred tax liabilities arising from book tax differences on purchased accounts receivable, including the purchased accounts receivable acquired in the Creditrust Merger. The utilization of net operating loss carryforwards is an estimate based on a number of factors beyond our control including the level of taxable income available from successful operations in the future. The utilization of net operating losses have been further impacted by Tax Law provisions that limit the amount of net operating loss carryforwards that can be utilized subsequent to a change in control such as the Creditrust Merger. Results of Operations The following table sets forth selected historical income statement data (amounts in thousands):
For the years ended December 31, -------------------------------------------------------------------------- 1999 (1) 2000 2001 ----------------------- ---------------------- ----------------------- Amount Ratio Amount Ratio Amount Ratio ------------ -------- ----------- -------- ----------- --------- Revenue $460,311 100.0% $605,884 100.0% $701,506 100.0% Payroll and related expenses 237,709 51.6 293,292 48.4 350,634 50.0 Selling, general, and administrative expenses 128,177 27.9 179,924 29.7 237,690 33.9 Nonrecurring acquisition costs 4,601 1.0 - - - - ---------- -------- -------- ------- --------- ------- EBITDA (2) 89,824 19.5 132,668 21.9 113,182 16.1 Depreciation and amortization 21,805 4.7 32,360 5.3 38,205 5.4 Other expense 16,899 3.7 22,126 3.7 23,335 3.3 Income tax expense 22,821 5.0 32,042 5.3 21,463 3.1 Minority interest - - - - 4,310 0.6 ---------- -------- -------- ------- --------- ------- Income from continuing operations $ 28,299 6.1% $ 46,140 7.6% $ 25,869 3.7% ========== ======= ======== ======= ========= =======
(1) Gives effect to the restatement of our historical financial statements for the treatment of the Market Strategy division as discontinued operations. We divested our Market Strategy division in October 2000. (2) Earnings before interest, taxes, depreciation, and amortization ("EBITDA") is used by management to measure results of operations and is not intended to report results of operations in conformity with generally accepted accounting principles. -26- Year ended December 31, 2001 Compared to Year ended December 31, 2000 Revenue. Revenue increased $95.6 million, or 15.8%, to $701.5 million for the year ended December 31, 2001, from $605.9 million for the comparable period in 2000. Our U.S. Operations, Portfolio Management, and International Operations divisions represented $633.4 million, $62.9 million, and $37.8 million, respectively, of the 2001 revenue. The U.S. Operations' revenue included $27.5 million of revenue earned on services performed for the Portfolio Management division that was eliminated upon consolidation. The International Operations' revenue included $5.1 million of revenue earned on services performed for the U.S. Operations division that was eliminated upon consolidation. Our U.S. Operations, Portfolio Management, and International Operations divisions represented $566.8 million, $13.2 million and $31.7 million, respectively, of the revenue for 2000. The U.S. Operations' revenue included $5.8 million of revenue earned on services performed for the Portfolio Management division that was eliminated upon consolidation. U.S. Operation's revenue increased $66.6 million, or 11.8%, to $633.4 million in 2001, from $566.8 million in 2000. The increase in our U.S. Operations division's revenue was attributable to the addition of new clients and the growth in business from existing clients. Portfolio Management's revenue increased $49.7 million, or 378.5%, to $62.9 million in 2001, from $13.2 million in 2000. This increase in the Portfolio Management's revenue was partially attributable to an increase in purchases of accounts receivable. The remainder of the increase was attributable to purchased accounts receivable obtained from the Creditrust Merger in February 2001. International Operation's revenue increased $6.1 million, or 19.2%, to $37.8 million in 2001, from $31.7 million in 2000. This increase in our International Operations division's revenue was primarily attributable to new services provided for our U.S. Operations, the addition of new clients, and growth in business from existing clients. Payroll and related expenses. Payroll and related expenses increased $57.3 million to $350.6 million for the year ended December 31, 2001, from $293.3 million for the comparable period in 2000, and increased as a percentage of revenue to 50.0% from 48.4%. The majority of the increase in the percentage of revenue was attributable to $10.7 million of one-time charges incurred during the second quarter of 2001 related to a comprehensive streamlining of our expense structure designed to counteract the effects of operating in a more difficult collection environment. These costs primarily consisted of the elimination or acceleration of certain contractual employment obligations, severance costs related to terminated employees, and costs related to a decision to change the structure of our healthcare benefit program. Excluding the one-time charges, payroll and related expenses as a percentage of revenue was 48.5% for 2001. During 2001, we experienced reduced collectibility within our contingent revenue stream due to the difficult collection environment. Accordingly, in order to mitigate the effects of the decreased collectibility while maintaining performance for our clients, we increased payroll costs. The effects of the difficult collection environment were exasperated by diminished consumer payment patterns following the September 11, 2001 terrorist attacks. The increase in payroll costs, excluding one-time charges, did not translate into a significant increase in the percentage of payroll and related expenses to revenue due to an increase in productivity that was achieved through the expansion of predictive dialing equipment and the result of spreading the fixed portion of the payroll cost structure over a larger revenue base. In addition, a portion of these increases was offset by the increase in the size of our Portfolio Management division, which has a lower payroll cost structure than the remainder of our business. -27- The payroll and related expenses of our U.S Operations division increased $56.8 million to $332.5 million in 2001, from $275.7 million in 2000, and increased as a percentage of revenue to 52.5% from 48.6%. A portion of the increase in the percentage of revenue was attributable to $10.0 million of one-time charges incurred during the second quarter of 2001 related to a comprehensive streamlining of the expense structure designed to counteract the effects of operating in a more difficult collection environment. These costs primarily consisted of the elimination or acceleration of certain contractual employment obligations, severance costs related to terminated employees, and costs related to a decision to change the structure of our healthcare benefit programs from a large, singular benefit platform to individual plans across the country. Excluding the one-time charges, payroll and related expenses as a percentage of revenue was 50.9% for 2001. During 2001, we experienced reduced collectibility within our contingent revenue stream due to the difficult collection environment. Accordingly, in order to mitigate the effects of the decreased collectibility while maintaining performance for our clients, we increased payroll costs. The effects of the difficult collection environment were exasperated by diminished consumer payment patterns following the September 11, 2001, terrorist attacks. The increase in payroll costs, excluding one-time charges, did not translate into a significant increase in the percentage of payroll and related expenses to revenue due to an increase in productivity that was achieved through the expansion of predictive dialing equipment and the result of spreading the fixed portion of the payroll cost structure over a larger revenue base. The increase as a percentage of revenue, excluding the one-time charges, was primarily the result of reduced collectibility within our U.S. Operations division's contingent revenue stream due to the difficult collection environment. Accordingly, in order to mitigate the effects of the decreased collectibility while maintaining performance for our clients, we increased spending for payroll costs. The effects of the difficult collection environment were exasperated by diminished consumer payment patterns following the September 11, 2001 terrorist attacks. A portion of these increases was offset by an increase in productivity that was achieved through the expansion of predictive dialing equipment and the result of spreading the fixed portion of the payroll cost structure over a larger revenue base. The payroll and related expenses of our Portfolio Management division increased $1.3 million to $1.6 million in 2001, from $327,000 in 2000, and increased as a percentage of revenue to 2.6% from 2.5%. Our Portfolio Management division outsources all of the collection services to our U.S. Operations division and, therefore, has a relatively small fixed payroll cost structure. However, due to the expansion of this division and the February 2001 Creditrust Merger, our Portfolio Management division required additional employees to operate NCO Portfolio as a separate public company. The payroll and related expenses of our International Operations division increased $4.5 million to $21.7 million in 2001, from $17.2 million in 2000, and increased as a percentage of revenue to 57.4% from 54.4%. The increase in the percentage of revenue was attributable to the $736,000 of the one-time charges incurred during the second quarter of 2001 related to a comprehensive streamlining of the expense structure designed to counteract the effects of operating in a more difficult collection environment. These costs primarily consisted of the elimination or acceleration of certain contractual employment obligations and severance costs related to terminated employees. Selling, general and administrative expenses. Selling, general and administrative expenses increased $57.8 million to $237.7 million in 2001 from $179.9 million in 2000. Selling, general and administrative expenses increased as a percentage of revenue to 33.9% in 2001 from 29.7% in 2000. A portion of the overall increase as a percentage of revenue was the result of $13.0 million of one-time charges incurred during the second and third quarters of 2001. Approximately $11.2 million of these one-time charges were incurred in connection with the June 2001 flood of our Fort Washington, PA, corporate headquarters and the resultant decision to relocate the corporate headquarters to Horsham, PA. The remaining $1.8 million of one-time charges related to a comprehensive streamlining of our expense structure designed to counteract the effects of operating in a more difficult collection environment. These costs primarily related to real estate obligations for closed facilities and equipment rental obligations. Excluding the one-time charges, selling, general, and administrative expenses as a percentage of revenue was 32.0% for 2001. The increase as a percentage of revenue, excluding the one-time charges, was primarily the result of the reduced collectibility within our contingent revenue stream due to a difficult collection environment. Accordingly, in order to mitigate the effects of the decreased collectibility while maintaining performance for our clients, we had to increase spending for direct costs of collection. These costs included telephone, letter writing and postage, third party servicing fees, credit reporting, skiptracing, and legal and forwarding fees. The effects of the difficult collection environment were exasperated by diminished consumer payment patterns following the September 11, 2001, terrorist attacks. -28- Depreciation and amortization. Depreciation and amortization increased to $38.2 million in 2001 from $32.4 million in 2000. This increase consisted of depreciation resulting from normal capital expenditures made in the ordinary course of business during 2000 and 2001. These capital expenditures included purchases associated with predictive dialers and other equipment required to expand our infrastructure to handle future growth and our planned migration towards a single, integrated information technology platform. Other income (expense). Interest and investment income increased $1.1 million to $3.6 million for 2001 compared to 2000. This increase was primarily attributable to interest income from the notes receivable received in connection with the divestiture of the Market Strategy division in October 2000. Interest expense increased to $27.0 million for 2001, from $25.9 million for 2000. This increase was partially attributable to the Portfolio Management division borrowing $36.3 million in connection with the February 2001 Creditrust Merger and subsequent borrowings used to purchase accounts receivable portfolios. In addition, a portion of the increase was attributable to interest from securitized debt that was assumed as part of the Creditrust Merger. A portion of these increases was offset by a decrease in interest rates and debt repayments made during 2000 and 2001. In addition, a portion of these increases was offset by the April 2001 sale of $125.0 million aggregate principal amount of 4.75% Convertible Subordinated Notes due 2006. The net proceeds of $121.3 million were used to repay debt under the revolving credit agreement. During 2000, we received insurance proceeds of approximately $1.3 million for flood and telephone outages experienced in the fourth quarter of 1999. Income tax expense. Income tax expense for 2001 decreased to $21.5 million, or 41.6% of income before income tax expense, from $32.0 million, or 41.0% of income before income tax expense, for 2000. The effective tax rates were relatively comparable despite the one-time charges incurred during the second and third quarters of 2001. The one-time charges lowered pretax income and increased the impact of the nondeductible goodwill related to certain acquisitions. The effect of the one-time charges was partially offset by the expansion of the Portfolio Management division, which has a lower effective tax rate than the remainder of our business. In addition, the impact of the one-time charges was also mitigated by the implementation of certain tax savings initiatives during the fourth quarter of 2000. Discontinued operations. The Market Strategy division had a net loss from operations of $975,000 for the period from January 1, 2000 to April 14, 2000. For the year ended December 31, 2000, we recorded a $23.2 million net loss on the disposal of the Market Strategy division. The loss on disposal included the operations for the period from April 14, 2000 to completion of the divestiture. We completed the divestiture of the Market Strategy division on October 26, 2000. -29- Year ended December 31, 2000 Compared to Year ended December 31, 1999 Revenue. Revenue increased $145.6 million, or 31.6%, to $605.9 million in 2000, from $460.3 million in 1999. Our U.S. Operations, Portfolio Management, and International Operations divisions represented $566.8 million, $13.2 million and $31.7 million, respectively, of the revenue for 2000. The U.S. Operations' revenue included $5.8 million of revenue earned on services performed for the Portfolio Management division that was eliminated upon consolidation. Our U.S. Operations, Portfolio Management, and International Operations divisions represented $428.3 million, $2.0 million and $31.0 million, respectively, of the revenue for 1999. The U.S. Operations' revenue included $981,000 of revenue earned on services performed for the Portfolio Management division that was eliminated upon consolidation. U.S. Operation's revenue increased $138.5 million, or 32.3%, to $566.8 million in 2000, from $428.3 million in 1999. A full year of revenue from the acquisitions of Compass International Services Corporation, referred to as Compass, on August 20, 1999 and Co-Source Corporation, referred to as Co-Source, on May 21, 1999 represented $42.5 million and $33.5 million of this increase, respectively. The remainder of the increase in our U.S. Operations division's revenue was attributable to the addition of new clients and the growth in business from existing clients. Portfolio Management's revenue increased $11.2 million, or 571.3%, to $13.2 million in 2000, from $2.0 million in 1999. This increase in the Portfolio Management's revenue was attributable to an increase in purchases of accounts receivable. International Operation's revenue increased $665,000, or 2.1%, to $31.7 million in 2000, from $31.0 million in 1999. This increase in our International Operations division's revenue was primarily attributable to the addition of new clients and growth in business from existing clients. However, the growth was limited due to the effects of a weak Canadian economy. Payroll and related expenses. Payroll and related expenses increased $55.6 million to $293.3 million in 2000, from $237.7 million in 1999, but decreased as a percentage of revenue to 48.4% from 51.6%. The payroll and related expenses of our U.S Operations division increased $55.8 million to $275.7 million in 2000, from $219.9 million in 1999, but decreased as a percentage of revenue to 48.6% from 51.4%. This decrease as a percentage of revenue was partially attributable to the continuing process of rationalizing staff levels in both our U.S. Operations division's acquired and existing businesses, as well as an increase in productivity that was achieved through the expansion of our use of predictive dialing equipment. The remaining portion of the percentage decrease was the result of spreading the fixed portion of our payroll cost structure over a larger revenue base. The payroll and related expenses of our Portfolio Management division increased $147,000 to $327,000 in 2000, from $180,000 in 1999, but decreased as a percentage of revenue to 2.5% from 9.2%. The Portfolio Management division outsources all of its collection services to the U.S. Operations division and, therefore, has a relatively small fixed payroll cost structure. The decrease in the percentage of revenue was attributable to spreading the fixed payroll costs over a larger revenue base. The payroll and related expenses of our International Operations division decreased $352,000 to $17.2 million in 2000, from $17.6 million in 1999, and decreased as a percentage of revenue to 54.4% from 56.7%. This decrease as a percentage of revenue was partially attributable to the reduction of redundant information technology staff upon the completion of an internal systems migration. In addition, a portion of the decrease was attributable to the continuing process of rationalizing staff levels, as well as an increase in productivity that was achieved through the expansion of our use of predictive dialing equipment. -30- Selling, general and administrative expenses. Selling, general and administrative expenses increased $51.7 million to $179.9 million in 2000 from $128.2 million in 1999. Selling, general and administrative expenses increased as a percentage of revenue to 29.7% in 2000 from 27.9% in 1999. The increase as a percentage of revenue was primarily attributable to increased information technology costs associated with the expansion of our use of predictive dialing equipment. However, increased productivity more than offset the increase in selling, general, and administrative expenses through a reduction in payroll and related expenses. The remaining increase was primarily attributable to start-up costs incurred as a result of new client relationships, further integration of information technology infrastructure and increased collection costs attributed to certain adverse changes in the payment patterns of consumers which made collections more difficult in the second half of 2000. Depreciation and amortization. Depreciation and amortization increased to $32.4 million in 2000 from $21.8 million in 1999. Of this increase, $3.0 million was attributable to a full year of depreciation related to the Compass acquisition and $1.6 million was attributable to a full year of depreciation related to the Co-Source acquisition. The remaining $6.0 million increase consisted of depreciation resulting from normal capital expenditures made in the ordinary course of business during 2000. These capital expenditures included purchases associated with our planned migration towards a single, integrated information technology platform, and predictive dialers and other equipment required to expand our infrastructure to handle future growth. Non-recurring acquisition costs. In the first quarter of 1999, we incurred $4.6 million of nonrecurring acquisition costs in connection with the acquisition of JDR. These costs consisted primarily of investment banking fees, legal and accounting fees, and printing costs. Other income (expense). Interest and investment income increased $1.1 million to $2.5 million for 2000 over the comparable period in 1999. This increase was primarily attributable to an increase in funds held on behalf of clients and the implementation of our new cash investment strategy. Interest expense increased to $25.9 million for the year ended December 31, 2000, from $18.3 million for the comparable period in 1999. The increase was primarily attributable to our financing the May 1999 Co-Source acquisition with borrowings of $122.7 million under the revolving credit facility. Additionally, a portion of the increase was attributable to borrowings under the revolving credit facility of $29.5 million that were used to repay debt that was assumed as a result of the August 1999 acquisition of Compass. The remainder of the increase was attributable to an increase in interest rates that was partially offset by repayments of debt made during 2000. In addition, we received insurance proceeds of approximately $1.3 million during 2000 for flood and telephone outages experienced in the fourth quarter of 1999. Income tax expense. Income tax expense for 2000 increased to $32.0 million, or 41.0% of income before income tax expense, from $22.8 million, or 44.6% of income before income tax expense, for 1999. The decrease in the effective tax rate was primarily attributable to the nondeductible portion of the $4.6 million of nonrecurring acquisition costs incurred during the first quarter of 1999 in connection with the JDR acquisition. A portion of the decrease was attributable to higher revenues diluting the impact of the nondeductible goodwill related to certain acquisitions. In addition, as the result of tax savings initiatives implemented during 2000, we were able to utilize, on a one-time basis, previously generated tax benefits of $850,000. -31- Accretion of preferred stock to redemption value. The accretion of preferred stock to redemption value relates to JDR's preferred stock that was outstanding prior to its conversion into our common stock on March 31, 1999. This non-cash accretion represents the periodic amortization of the difference between the original carrying amount and the mandatory redemption amount. Discontinued operations. The Market Strategy division had a net loss from operations of $975,000 for the period from January 1, 2000 to April 14, 2000, as compared to net income of $1.1 million for the year ended December 31, 1999. For the year ended December 31, 2000, we recorded a $23.2 million net loss on the disposal of the Market Strategy division. The loss on disposal included the operations for the period from April 14, 2000 to completion of the divestiture. We completed the divestiture of the Market Strategy division on October 26, 2000. Quarterly Results of Operations (Unaudited) The following table sets forth selected historical financial data for the calendar quarters of 2000 and 2001. This quarterly information is Unaudited, but has been prepared on a basis consistent with our audited financial statements presented elsewhere herein and, in management's opinion, includes all adjustments (consisting only of normal recurring adjustments) necessary for a fair presentation of the information for the quarters presented. The operating results for any quarter are not necessarily indicative of results for any future period.
2000 Quarters Ended ------------------------------------------------------ Mar. 31 June 30 Sept. 30 Dec. 31 ----------- ----------- ----------- ----------- (Amounts in thousands, except per share data) Revenue $ 143,998 $ 154,048 $ 153,858 $ 153,980 Income from operations 24,249 26,098 25,835 24,126 Income from continuing operations 11,393 11,623 11,547 11,577 Loss from discontinued operations, net of taxes 21,718 71 2,365 - Net (loss) income (10,325) 11,552 9,182 11,577 Income from continuing operations per share: Basic $ 0.45 $ 0.45 $ 0.45 $ 0.45 Diluted $ 0.44 $ 0.45 $ 0.45 $ 0.45 Net (loss) income per share: Basic $ (0.40) $ 0.45 $ 0.36 $ 0.45 Diluted $ (0.40) $ 0.45 $ 0.36 $ 0.45 2001 Quarters Ended ------------------------------------------------------ Mar. 31 June 30 Sept. 30 Dec. 31 ----------- ----------- ----------- ----------- (Amounts in thousands, except per share data) Revenue $ 171,029 $ 183,275 $ 174,347 $ 172,855 Income from operations 28,040 16,013 10,241 20,683 Net income 12,277 4,449 952 8,191 Net income per share: Basic $ 0.48 $ 0.17 $ 0.04 $ 0.32 Diluted $ 0.47 $ 0.17 $ 0.04 $ 0.31
-32- We have experienced and expect to continue to experience quarterly variations in operating results as a result of many factors, including: - the timing of our clients' accounts receivable management and collection programs and the commencement of new contracts and termination of existing contracts - the timing and amount of collections on purchased accounts receivable - customer contracts that require us to incur costs in periods prior to recognizing revenue under those contracts - the effect of a change of business mix on profit margins - the timing of additional selling, general, and administrative expenses to support new business - the costs and timing of completion and integration of acquisitions, and - that our business tends to be slower in the third and fourth quarters of the year due to the summer and holiday seasons. Additionally, our planned operating expenditures are based on revenue forecasts, and, if revenue is below expectations in any given quarter, operating results would likely be materially adversely affected. Liquidity and Capital Resources Historically, our primary sources of cash have been bank borrowings, public offerings, and cash flows from operations. Cash has been used for acquisitions, repayments of bank borrowings, purchases of equipment, purchases of accounts receivable, and working capital to support our growth. We believe that funds generated from operations, together with existing cash and available borrowings under our credit agreement will be sufficient to finance our current operations, planned capital expenditure requirements, and internal growth at least through the next twelve months. However, we could require additional debt or equity financing if we were to make any other significant acquisitions for cash during that period. The cash flow from our contingency collection business and our purchased portfolio business is dependent upon our ability to collect from consumers and businesses. Many factors, including the economy and our ability to hire and retain qualified collectors and managers, are essential to our ability to generate cash flows. Fluctuations in these trends that cause a negative impact on our business could have a material impact on our expected future cash flows. Cash Flows from Operating Activities. Cash provided by operating activities was $85.9 million in 2001, compared to $52.3 million in 2000. The increase in cash provided by operations was primarily attributable to the net effect of the one-time charges incurred during the second and third quarters of 2001, a smaller increase in accounts receivable, and a smaller decrease in income taxes payable. The smaller increase in accounts receivable was attributable to a reallocation of internal resources to focus on the collection of client accounts receivable. The smaller decrease in income taxes payable was the result of tax payments made during the first nine months of 2000 and the implementation of certain tax savings initiatives during the fourth quarter of 2000. Cash provided by operating activities was $52.3 million in 2000, compared to $47.7 million in 1999. The increase in cash provided by operations was primarily due to the increase in income from continuing operations to $46.1 million in 2000 from $28.3 million in 1999 and the increase in non-cash charges, depreciation and amortization, to $32.4 million in 2000 from $21.8 million in 1999. A portion of these increases was offset by the $14.8 million increase in accounts receivable and the $8.2 million decrease in other long-term liabilities. -33- Cash Flows from Investing Activities. Cash used in investing activities was $51.5 million in 2001, compared to $69.6 million in 2000. The decrease was due primarily to an increase in collections applied to the principal of purchased accounts receivable. This decrease was partially offset by an increase in the purchase of delinquent accounts receivable. Cash used in investing activities was $69.6 million in 2000, compared to $170.0 million in 1999. The decrease was due primarily to cash paid in 1999 to acquire Co-Source and Compass. We financed these acquisitions with borrowings under our revolving credit agreement. This increase was partially offset by a $25.3 million increase in the purchase of delinquent accounts receivable. Capital expenditures were $27.9 million, $31.0 million, and $29.6 million in 2001, 2000, and 1999, respectively. Cash Flows from Financing Activities. Cash used in financing activities was $15.5 million in 2001, compared to $19.8 million in 2000. During 2001, we received cash from borrowings under the revolving credit facility made in connection with the Creditrust Merger that were used to repay the acquired notes payable, finance purchased accounts receivable, and repay other acquisition related liabilities. Additionally, we received $121.3 million of net proceeds from the issuance of convertible notes. These net proceeds were used for the repayment of borrowings under the revolving credit facility. We also used cash to repay a portion of our borrowings under the revolving credit facility and to repay a portion of the securitized debt assumed as part of the Creditrust Merger. Cash used in financing activities was $19.8 million in 2000, compared to cash provided by financing activities of $149.7 million in 1999. During 2000, we did not have any significant sources of cash from financing activities and we repaid $19.0 million of borrowings under our revolving credit agreement. During 1999, our primary source of cash from financing activities was borrowings under the revolving credit facility that were used to repay the existing debt under the JDR credit facility and to finance the acquisition of Co-Source. Credit Facility. We have a credit agreement with Citizens Bank of Pennsylvania, formerly Mellon Bank, N.A., ("Citizens Bank"), for itself and as administrative agent for other participating lenders, that originally provided for borrowings up to $350 million, structured as a revolving credit facility. The balance under the revolving credit facility shall become due on May 20, 2004 (the "Maturity Date"). The borrowing capacity of the revolving credit facility is subject to mandatory reductions including a quarterly reduction of $6.3 million on March 31, 2001, subsequent quarterly reductions of $5.2 million until the Maturity Date, and 50 percent of the net proceeds received from any offering of debt or equity. As of December 31, 2001, there was $58.3 million available under the revolving credit facility. At our option, the borrowings bear interest at a rate equal to either Citizens Bank's prime rate plus a margin of 0.25% to 0.50%, which is determined quarterly based upon our consolidated funded debt to earnings before interest, taxes, depreciation, and amortization, also referred to as EBITDA, ratio (Citizens Bank's prime rate was 4.75% at December 31, 2001), or the London InterBank Offered Rate, also referred to as LIBOR, plus a margin of 1.25% to 2.25% depending on our consolidated funded debt to EBITDA ratio (LIBOR was 1.88% at December 31, 2001). In connection with the Creditrust Merger, we amended our revolving credit facility to allow us to provide NCO Portfolio with a $50 million revolving line of credit in the form of a sub-facility under our existing revolving credit facility. The borrowing capacity of the sub-facility is subject to mandatory reductions including four quarterly reductions of $2.5 million beginning March 31, 2002 through December 31, 2002. Effective March 31, 2003, quarterly reductions of $3.75 million are required until the earlier of the Maturity Date or the date at which the sub-facility is reduced to $25 million. At our option, the borrowings bear interest at a rate equal to either Citizens Bank's prime rate plus a margin of 1.25% to 1.50% that is determined quarterly based upon our consolidated funded debt to EBITDA ratio, or LIBOR plus a margin of 2.25% to 3.25% depending on our consolidated funded debt to EBITDA ratio. As of December 31, 2001, there was $2.9 million available under the NCO Portfolio sub-facility. -34- During February 2002, we entered into interest rate swap agreements to reduce the impact of changes in LIBOR on a portion of the debt borrowed from our revolving credit facility. The interest rate swap agreements fixed LIBOR at a rate of 2.82%. The initial notional amount of the interest rate swap agreements is $102.0 million. The notional amount of the interest rate swap agreements is subject to scheduled quarterly reductions. The interest rate swap agreements expire in September 2003. Borrowings under the revolving credit facility are collateralized by substantially all of our assets, including the common stock of NCO Portfolio, and certain assets of NCO Portfolio. The balance under the revolving credit facility will become due on May 20, 2004. The credit agreement contains certain financial covenants such as maintaining net worth and funded debt to EBITDA requirements, and includes restrictions on, among other things, acquisitions and distributions to shareholders. As of December 31, 2001, we were in compliance with all required financial covenants. Convertible Notes. In April 2001, we completed the sale of $125.0 million aggregate principal amount of 4.75% Convertible Subordinated Notes due 2006 ("Notes") in a private placement pursuant to Rule 144A and Regulation S under the Securities Act of 1933. The Notes are convertible into our common stock at an initial conversion price of $32.92 per share. We used the $121.3 million of net proceeds from this offering to repay debt under our revolving credit agreement. In accordance with the terms of the credit agreement, 50% of the net proceeds from the Notes permanently reduced the maximum borrowings available under the revolving credit facility. Off-Balance Sheet Arrangements NCO Portfolio owns a 100% retained residual interest in an investment in securitization, Creditrust SPV 98-2, LLC, which was acquired as part of the merger with Creditrust. This transaction qualified for gain on sale accounting when the purchased accounts receivable were originally securitized. This securitization issued a note that is due in January 2004 and had a balance of $5.5 million as of December 31, 2001. The retained interest represents the present value of the residual interest in the securitization using discounted future cash flows after the securitization note is fully repaid plus a cash reserve. As of December 31, 2001, the investment in securitization was $7.3 million, comprised of $4.0 million in present value of discounted residual cash flows plus $3.3 million in cash reserves. The investment accrues non-cash income at a rate of 8% per annum on the residual cash flow component only. The income earned increases the investment balance until the securitization note has been repaid, after which the collections are split between income and amortization of the investment in securitization based on the discounted cash flows. NCO Portfolio recorded $211,000 of income on this investment for the period from February 21, 2001 to December 31, 2001. The cash reserves of $3.3 million plus the first $1.3 million in residual cash collections received after the securitization note has been repaid have been pledged as collateral against another securitized note. NCO Portfolio has a 50% ownership interest in a joint venture, InoVision-MEDCLR NCOP Ventures, LLC ("Joint Venture") with IMNV Holdings, LLC ("Marlin"). The Joint Venture was set up to purchase utility, medical and various other small balance accounts receivable and is accounted for using the equity method of accounting. As of December 31, 2001, both Joint Venture members have each invested $574,000 for the purchase of accounts receivable. Included in the Statement of Income, in "other income," was $118,000 representing NCO Portfolio's 50% share of operating income from this unconsolidated subsidiary for the year ended December 31, 2001. The Joint Venture has access to capital through a specialty finance lender who, at its option, lends 90% of the value of the purchased accounts receivable to the Joint Venture. The debt is cross-collateralized by all static pools in which the lender participates, and is non-recourse to NCO Portfolio. -35- Stock Repurchase Plan In September 2001, our Board of Directors and our lender group authorized the repurchase of up to $15.0 million of our currently issued common stock, subject to a limit of one million shares. The share purchases may be made from time to time, depending on market conditions, until March 31, 2002. Shares may be purchased either in the open market or through privately negotiated transactions. The repurchase program did not obligate us to acquire any specific number of shares and could be discontinued at any time. As of December 31, 2001, we had not repurchased any shares under the stock repurchase plan. Market Risk We are exposed to various types of market risk in the normal course of business, including the impact of interest rate changes, foreign currency exchange rate fluctuations, and changes in corporate tax rates. A material change in these rates could adversely affect our operating results and cash flows. A 25 basis-point increase in interest rates could increase our annual interest expense by $250,000 for each $100 million of variable debt outstanding for the entire year. We employ risk management strategies that may include the use of derivatives such as interest rate swap agreements, interest rate ceilings and floors, and foreign currency forwards and options to manage these exposures. Goodwill Our balance sheet includes amounts designated as intangibles, which predominantly consist of "goodwill." Goodwill represents the excess of purchase price over the fair market value of the net assets of the acquired businesses based on their respective fair values at the date of acquisition. Effective January 1, 2002, we are required to adopt the Financial Accounting Standards Board's ("FASB") SFAS No. 142, "Goodwill and Other Intangibles. "FASB 142 concluded that purchased goodwill would not be amortized but would be reviewed for impairment when certain events indicate that the goodwill of a reporting unit is impaired. The impairment test will use a fair-value based approach, whereby if the implied fair value of a reporting unit's goodwill is less than its carrying amount, goodwill would be considered impaired. As of December 31, 2001, our balance sheet included goodwill that represented 55.3% of total assets and 124.3% of shareholders' equity. During the year ended December 31, 2001, our statement of income included $15.7 million of goodwill amortization charges that will not be incurred after the adoption of FASB 142 on January 1, 2002. If the goodwill is deemed to be impaired under FASB 142, we may need to take a charge to earnings to write-down the goodwill to its fair value. -36- Impact of Recently Issued and Proposed Accounting Pronouncements In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.s 141 and 142, "Business Combinations" and "Goodwill and Other Intangibles." FASB 141 requires all business combinations initiated after July 1, 2001, to be accounted for using the purchase method. FASB 142 concluded that purchased goodwill would not be amortized but would be reviewed for impairment when certain events indicate that the goodwill of a reporting unit is impaired. The impairment test will use a fair-value based approach, whereby if the implied fair value of a reporting unit's goodwill is less than its carrying amount, goodwill would be considered impaired. FASB 142 does not require that goodwill be tested for impairment upon adoption unless an indicator of impairment exists at that date. However, it would require that a benchmark assessment be performed for all existing reporting units within six months of the date of adoption. The new goodwill model applies not only to goodwill arising from acquisitions completed after the effective date, but also to goodwill previously recorded. We adopted FASB 142 in the first quarter of 2002. We are in the process of determining the impact of these pronouncements on our financial position and results of operations. During 2001, the Accounting Staff Executive Committee approved an exposure draft on a proposed Statement of Position, "Accounting for Discounts Related to Credit Quality" ("SOP"). The proposed SOP would limit the revenue that may be accrued to the excess of the estimate of expected future cash flows over a static pool's initial cost of accounts receivable acquired. The proposed SOP would require that the excess of the contractual cash flows over expected future cash flows not be recognized as an adjustment of revenue, expense or on the balance sheet. The proposed SOP would freeze the internal rate of return ("IRR") originally estimated when the accounts receivable are purchased for subsequent impairment testing. Rather than lower the estimated IRR if the original collection estimates are not received, the carrying value of a static pool would be written down to maintain the original IRR. Increases in expected future cash flows would be recognized prospectively through adjustment of the IRR over a static pool's remaining life. The exposure draft provides that previously issued annual financial statements would not need to be restated. Until final issuance of this SOP, we cannot ascertain its effect on our reporting. -37- Item 7a. Quantitative and Qualitative Disclosures about Market Risk. Included in Item 7, Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Report on Form 10-K. Item 8. Financial Statements and Supplementary Data. The financial statements, financial statement schedules and related documents that are filed with this Report are listed in Item 14(a) of this Report on Form 10-K and begin on page F-1. Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosures. Previously reported. -38- PART III Item 10. Directors and Executive Officers of the Registrant. Incorporated by reference from the Company's Proxy Statement relating to the 2002 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K, except information concerning certain executive officers of the Company which is set forth in Section 4.1 of this Annual Report on Form 10-K. Item 11. Executive Compensation. Incorporated by reference from the Company's Proxy Statement relating to the 2002 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K. Item 12. Security Ownership of Certain Beneficial Owners and Management. Incorporated by reference from the Company's Proxy Statement relating to the 2002 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K. Item 13. Certain Relationships and Related Transactions. Incorporated by reference from the Company's Proxy Statement relating to the 2002 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K. -39- PART IV Item 14. Exhibits, Financial Statements and Reports on Form 8-K. (a). Documents filed as part of this report: 1. List of Consolidated Financial Statements. The following consolidated financial statements and the accompanying notes of NCO Group, Inc., have been included in this Report on Form 10-K beginning on page F-1: Report of Independent Auditors Report of Independent Accountants Consolidated Balance Sheets as of December 31, 2000 and 2001 Consolidated Statements of Income for each of the three years in the period ended December 31, 2001 Consolidated Statements of Redeemable Preferred Stock and Shareholders' Equity for each of the three years in the period ended December 31, 2001 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2001 Notes to Consolidated Financial Statements Consolidating Statement of Income for the year ended December 31, 2001 (Unaudited) 2. List of Financial Statement Schedules. The following financial statement schedule of NCO Group, Inc., has been included in this Report on Form 10-K beginning on page S-1: II - Valuation and Qualifying Accounts All other financial statement schedules are omitted because the required information is not present or not present in amounts sufficient to require submission of the schedule or because the information required is included in the respective financial statements or notes thereto contained herein. 3. List of Exhibits filed in accordance with Item 601 of Regulation S-K. The following exhibits are incorporated by reference in, or filed with, this Report on Form 10-K. Management contracts and compensatory plans, contracts and arrangements are indicated by "*": -40-
Exhibit No. Description -------------------- ---------------------------------------------------------------------------------------- 2.1(5) Agreement and Plan of Reorganization, dated November 2, 1998, among JDR Holdings, Inc., NCO Group, Inc., and JDR Acquisition Inc. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 2.2(5) Agreement and Plan of Merger, dated November 2, 1998, among JDR Holdings, Inc., NCO Group, Inc. and JDR Acquisition Inc. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 2.3(7) Stock Purchase Agreement dated April 17, 1999, among Co-Source Corporation, its shareholders and option holders, H.I.G.-DCI Investments, L.P. and NCO Group, Inc. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 2.4(8) Agreement and Plan of Merger dated May 12, 1999, by and among Compass International Services Corporation, NCO Group, Inc. and Cardinal Acquisition Corporation. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 2.5(13) Asset Purchase Agreement dated October 26, 2000, among TRC Holdings, Inc., and NCO Group, Inc. and its wholly owned subsidiary, NCO Teleservices, Inc. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 2.6(13) Asset Purchase Agreement dated September 29, 2000, among Creative Marketing Strategies, Inc. and NCO Group, Inc. and its wholly owned subsidiary, NCO Teleservices, Inc. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 2.7(12) Second Amended and Restated Agreement and Plan of Merger dated September 20, 2000, by and among Creditrust Corporation, and NCO Group, Inc. and its wholly owned subsidiaries, NCO Portfolio Funding, Inc. and NCO Financial Systems, Inc. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 3.1(1) The Company's amended and restated Articles of Incorporation. 3.2(2) Amendment to Amended and Restated Articles of Incorporation. 3.3(15) Amendment to Amended and Restated Articles of Incorporation. 3.4(4) The Company's amended and restated Bylaws. 4.1(1) Specimen of Common Stock Certificate. 4.2(7) Form of warrant to purchase NCO Group, Inc. common stock. 4.3(14) Purchase Agreement dated as of March 29, 2001, between NCO Group, Inc. and Deutsche Bank Alex. Brown Inc. 4.4(14) Indenture dated as of April 4, 2001, between NCO Group, Inc. and Bankers Trust Company, as Trustee 4.5(14) Registration Rights Agreement dated as of April 4, 2001, between NCO Group, Inc. and Deutsche Bank Alex. Brown Inc. 4.6(14) Global Note dated April 4, 2001 of NCO Group, Inc. *10.1(1) Employment Agreement, dated September 1, 1996, between the Company and Michael J. Barrist.
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Exhibit No. Description -------------------- ---------------------------------------------------------------------------------------- *10.2(9) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996, between the Company and Michael J. Barrist. *10.3(1) Employment Agreement, dated September 1, 1996, between the Company and Steven L. Winokur. *10.4(9) Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996, between the Company and Steven L. Winokur. *10.5(13) Employment Agreement, dated June 5, 1998, between the Company and Joshua Gindin. *10.6(13) Addendum, dated January 1, 1999, to the Employment Agreement, dated June 5, 1998, between the Company and Joshua Gindin. *10.7(11) Employment Agreement, dated May 2, 1998, between the Company and Paul E. Weitzel, Jr. *10.8(11) Addendum, dated January 1, 1999, to the Employment Agreement, dated May 2, 1998, between the Company and Paul E. Weitzel, Jr. *10.9(1) Amended and Restated 1995 Stock Option Plan. *10.10(4) 1996 Stock Option Plan, as amended. *10.11(4) 1996 Non-Employee Director Stock Option Plan, as amended. 10.12(1) Distribution and Tax Indemnification Agreement 10.13(1) Irrevocable Proxy Agreement by and between Michael J. Barrist and Annette H. Barrist. 10.14(2) Nontransferable Common Stock Purchase Warrant dated February 2, 1997, issued to CRW Financial, Inc. 10.15(2) Registration Rights Agreement dated February 2, 1997, between NCO and CRW Financial, Inc. 10.16(11) Fifth Amended and Restated Credit Agreement dated as of December 31, 1999, by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 10.17(3) Executive Salary Continuation Agreement. 10.18(9) Transfer Agreement dated January 26, 1998, among NCO, CRW Financial, Inc. and Swiss Bank Corporation. *10.19(6) Compass International Services Corporation Employee Incentive Compensation Plan *10.20(10) JDR 1997 Option Plan
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Exhibit No. Description -------------------- ------------------------------------------------------- 10.21(13) First Amendment, dated March 24, 2000, to the Fifth Amended and Restated Credit Agreement dated as of December 31, 1999, by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 10.22(13) Second Amendment and Waiver, dated October 26, 2000, to the Fifth Amended and Restated Credit Agreement dated as of December 31, 1999, by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 10.23(13) Third Amendment, dated December 15, 2000, to the Fifth Amended and Restated Credit Agreement dated as of December 31, 1999, by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 10.24(13) Fourth Amendment, dated January 23, 2001, to the Fifth Amended and Restated Credit Agreement dated as of December 31, 1999 by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 10.25(13) Fifth Amendment, dated February 20, 2001, to the Fifth Amended and Restated Credit Agreement dated as of December 31, 1999 by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 10.26(13) Credit Agreement, dated as of February 20, 2001, by and between NCO Portfolio Management, Inc., as Borrower, and NCO Group, Inc., as Lender. 10.27(13) Note Receivable, dated October 27, 2000, from Creative Marketing Strategies, Inc. for the original principal amount of $6.0 million, as payment of the purchase price for the acquisition of certain assets of NCO Teleservices, Inc. 10.28(13) Note Receivable, dated October 26, 2000, from TRC Holdings, Inc. for the principal amount of $11.25 million, as payment of the purchase price for the acquisition of certain assets of NCO Teleservices, Inc.
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Exhibit No. Description -------------------- ------------------------------------------------------- *10.29 Employment Agreement, dated January 31, 2002, between the Company and Stephen W. Elliott. *10.30 Employment Agreement, dated November 21, 2001, between the Company and Steven Leckerman. 10.31 Sixth Amendment, dated March 14, 2001, to the Fifth Amended and Restated Credit Agreement dated as of December 31, 1999 by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 10.32 Seventh Amendment, dated September 24, 2001, to the Fifth Amended and Restated Credit Agreement dated as of December 31, 1999 by and among NCO Group, Inc., as Borrower, Mellon Bank, N.A., as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request. 21.1 Subsidiaries of the Registrant. 23.1 Consent of Ernst & Young LLP. 23.2 Consent of PricewaterhouseCoopers LLP.
--------------------- (1) Incorporated by reference to the Company's Registration Statement on Form S-1 (Registration No. 333-11745), as amended, filed with the Securities and Exchange Commission on September 11, 1996. (2) Incorporated by reference to the Company's Current Report on Form 8-K/A (File No. 0-21639) filed with the Securities and Exchange Commission on February 18, 1997. (3) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 (File No. 0-21639), filed with the Securities and Exchange Commission on May 4, 1998. (4) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 0-21639), filed with the Securities and Exchange Commission on August 14, 1998. (5) Incorporated by reference to the Company's Registration Statement on Form S-4 (Registration No. 333-73087), as amended, filed with the Securities and Exchange Commission on February 26, 1998. -44- (6) Incorporated by reference to Compass International Service Corporation's Registration Statement on Form S-1 (Registration No. 333-50021), as amended, filed with the Securities and Exchange Commission on April 13, 1998. (7) Incorporated by reference to the Company's Current Report on Form 8-K/A (File No. 0-21639) filed with the Securities and Exchange Commission on August 4, 1999. (8) Incorporated by reference to the Company's Proxy/Registration Statement on Form-S-4 (Registration No. 333-83229) filed with the Securities and Exchange Commission on July 20, 1999. (9) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (File No. 0-21639), as amended, filed with the Securities and Exchange Commission on March 31, 1999. (10) Incorporated by reference to the Company's Current Report on Form 8-K (File No. 0-21639) filed with the Securities and Exchange Commission on April 15, 1999. (11) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (File No. 0-21639), as amended, filed with the Securities and Exchange Commission on March 27, 2000. (12) Incorporated by reference to the Company's Current Report on Form 8-K (File No. 0-21639) filed with the Securities and Exchange Commission on March 5, 2001. (13) Incorporated by reference to the Company's Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (File No. 0-21639), as amended, filed with the Securities and Exchange Commission on March 16, 2001. (14) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended March 31, 2001. (15) Incorporated by reference to the Company's Quarterly Report on Form 10-Q for the quarter ended June 30, 2001. (b). Reports on Form 8-K Date of Report Item Reported -------------- ------------- 10/1/01 Item 5 - Press release commenting on preliminary results for the third quarter of 2001 11/14/01 Item 5 - Press release and conference call transcript from the earnings release for the third quarter of 2001 -45- SIGNATURES Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized. NCO GROUP, INC. Date: March 19, 2002 By: /s/ Michael J. Barrist ---------------------------- Michael J. Barrist, Chairman of the Board, President and Chief Executive Officer Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant in the capacities and on the date indicated.
SIGNATURE TITLE(S) DATE --------- -------- ---- /s/ Michael J. Barrist Chairman of the Board, President and Chief March 19, 2002 ------------------------------- Executive Officer (principal executive Michael J. Barrist officer) /s/ Steven L. Winokur Executive Vice President, Finance; Chief March 19, 2002 ------------------------------- Financial Officer; and Treasurer (principal Steven L. Winokur financial and accounting officer) /s/ William C. Dunkelberg Director March 19, 2002 ------------------------------- William C. Dunkelberg /s/ Charles C. Piola, Jr. Director March 19, 2002 ------------------------------- Charles C. Piola, Jr. /s/ Leo J. Pound Director March 19, 2002 ------------------------------- Leo J. Pound /s/ Eric S. Siegel Director March 19, 2002 ------------------------------- Eric S. Siegel /s/ Allen F. Wise Director March 19, 2002 ------------------------------- Allen F. Wise /s/ Stuart Wolf Director March 19, 2002 ------------------------------- Stuart Wolf
-46- INDEX TO CONSOLIDATED FINANCIAL STATEMENTS AND FINANCIAL STATEMENT SCHEDULE Financial Statements: Report of Independent Auditors...............................................F-2 Report of Independent Accountants............................................F-3 Consolidated Balance Sheets as of December 31, 2000 and 2001 ................F-4 Consolidated Statements of Income for each of the three years in the period ended December 31, 2001...................................F-5 Consolidated Statements of Redeemable Preferred Stock and Shareholders' Equity for each of the three years in the period ended December 31, 2001...................................F-6 Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2001...................................F-7 Notes to Consolidated Financial Statements...................................F-8 Consolidating Statement of Income for the year ended December 31, 2001 (Unaudited)..........................................F-29 Financial Statement Schedule: For the years ended December 31, 1999, 2000 and 2001: II - Valuation and Qualifying Accounts...................................S-1 F-1 Report of Independent Auditors To the Board of Directors and Shareholders of NCO Group, Inc. We have audited the accompanying consolidated balance sheets of NCO Group, Inc. as of December 31, 2000 and 2001, and the related consolidated statements of income, redeemable preferred stock and shareholders' equity, and cash flows for each of the two years in the period ended December 31, 2001. Our audits also included the financial statement schedule for the years ended December 31, 2000 and 2001 listed in the Index at Item 14(a). These financial statements and schedule are the responsibility of the Company's management. Our responsibility is to express an opinion on these financial statements and schedule based on our audits. We conducted our audits in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of NCO Group, Inc. at December 31, 2000 and 2001, and the consolidated results of its operations and its cash flows for each of the two years in the period ended December 31, 2001, in conformity with accounting principles generally accepted in the United States. Also, in our opinion, the related financial statement schedule for the years ended December 31, 2000 and 2001, when considered in relation to the basic financial statements taken as a whole, presents fairly in all material respects the information set forth therein. We also audited the reclassification of the 1999 consolidated statements of income and cash flows as a result of the discontinued operations described in Note 3. In our opinion, the reclassification adjustments are appropriate and have been properly applied. /s/ Ernst & Young LLP Philadelphia, Pennsylvania February 12, 2002 F-2 Report of Independent Accountants To the Board of Directors and Shareholders of NCO Group, Inc.: In our opinion the consolidated statements of income, redeemable preferred stock and shareholders' equity and of cash flows present fairly, in all material respects, the results of the operations and cash flows of NCO Group, Inc. and its subsidiaries for the year ended December 31, 1999 prior to their restatement for discontinued operations (and, therefore, are not presented herein) in conformity with accounting principles generally accepted in the United States of America. In addition, in our opinion, Schedule II - Valuation and Qualifying Accounts (the financial statement schedule) presents fairly, in all material respects, the information set forth therein for the year ended December 31, 1999 prior to its restatement for discontinued operations (and, therefore, is not presented herein) when read in conjunction with the related consolidated financial statements. These financial statements and financial statement schedule are the responsibility of the Company's management; our responsibility is to express an opinion on these financial statements and financial statement schedule (prior to their restatement) based on our audits. The consolidated financial statements and financial statement schedule give retroactive effect to the merger of JDR Holdings, Inc. on March 31, 1999 in a transaction accounted for as a pooling of interests, as described in Note 4 to the consolidated financial statements. We conducted our audits of these statements (prior to restatement) in accordance with auditing standards generally accepted in the United States of America, which require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements, assessing the accounting principles used and significant estimates made by management, and evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for the opinion expressed above. /s/ PricewaterhouseCoopers LLP Philadelphia, PA February 16, 2000 F-3 Part 1 - Financial Information Item 1 - Financial Statements NCO GROUP, INC. Consolidated Balance Sheets (Amounts in thousands)
December 31, ---------------------- ASSETS 2000 2001 --------- --------- Current assets: Cash and cash equivalents $ 13,490 $ 32,161 Restricted cash -- 1,125 Accounts receivable, trade, net of allowance for doubtful accounts of $7,080 and $5,311, respectively 93,971 99,055 Purchased accounts receivable, current portion 10,861 47,341 Deferred income taxes 2,287 8,336 Other current assets 7,925 14,784 --------- --------- Total current assets 128,534 202,802 Funds held on behalf of clients Property and equipment, net 66,401 71,457 Other assets: Intangibles, net of accumulated amortization 536,750 522,090 Purchased accounts receivable, net of current portion 23,614 92,660 Notes receivable 18,250 18,250 Other assets 10,457 23,766 --------- --------- Total other assets 589,071 656,766 --------- --------- Total assets $ 784,006 $ 931,025 ========= ========= LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Long-term debt, current portion $ 642 $ 21,922 Income taxes payable 1,328 176 Accounts payable 12,360 12,164 Accrued expenses 19,168 39,382 Accrued compensation and related expenses 15,304 16,785 --------- --------- Total current liabilities 48,802 90,429 Funds held on behalf of clients Long-term liabilities: Long-term debt, net of current portion 303,920 357,868 Deferred income taxes 40,549 42,855 Other long-term liabilities 4,309 4,565 Minority interest -- 21,213 Shareholders' equity: Preferred stock, no par value, 5,000 shares authorized, no shares issued and outstanding -- -- Common stock, no par value, 37,500 and 50,000 shares authorized, 25,627 and 25,816 shares issued and outstanding, respectively 316,372 320,993 Other comprehensive loss (1,525) (4,346) Retained earnings 71,579 97,448 --------- --------- Total shareholders' equity 386,426 414,095 --------- --------- Total liabilities and shareholders' equity $ 784,006 $ 931,025 ========= =========
See accompanying notes. F-4 NCO GROUP, INC. Consolidated Statements of Income (Amounts in thousands, except per share data)
For the Years Ended December 31, ----------------------------------- 1999 2000 2001 --------- --------- --------- Revenue $ 460,311 $ 605,884 $ 701,506 Operating costs and expenses: Payroll and related expenses 237,709 293,292 350,634 Selling, general, and administrative expenses 128,177 179,924 237,690 Depreciation and amortization expense 21,805 32,360 38,205 Nonrecurring acquisition costs 4,601 -- -- --------- --------- --------- Total operating costs and expenses 392,292 505,576 626,529 --------- --------- --------- Income from operations 68,019 100,308 74,977 Other income (expense): Interest and investment income 1,363 2,503 3,627 Interest expense (18,262) (25,942) (26,962) Other income -- 1,313 -- --------- --------- --------- Total other income (expense) (16,899) (22,126) (23,335) --------- --------- --------- Income before income tax expense 51,120 78,182 51,642 Income tax expense 22,821 32,042 21,463 --------- --------- --------- Income from continuing operations before minority interest 28,299 46,140 30,179 Minority interest -- -- (4,310) --------- --------- --------- Income from continuing operations 28,299 46,140 25,869 Accretion of preferred stock to redemption value (377) -- -- --------- --------- --------- Income from continuing operations applicable to common shareholders 27,922 46,140 25,869 Discontinued operations, net of income taxes: Income (loss) from discontinued operations 1,067 (975) -- Loss on disposal of discontinued operations -- (23,179) -- --------- --------- --------- Net income applicable to common shareholders $ 28,989 $ 21,986 $ 25,869 ========= ========= ========= Income from continuing operations applicable to common shareholders per share: Basic $ 1.22 $ 1.80 $ 1.00 Diluted $ 1.17 $ 1.79 $ 0.99 Net income applicable to common shareholders per share: Basic $ 1.27 $ 0.86 $ 1.00 Diluted $ 1.22 $ 0.85 $ 0.99 Weighted average shares outstanding: Basic 22,873 25,587 25,773 Diluted 23,799 25,842 28,897
See accompanying notes. F-5 NCO GROUP, INC. Consolidated Statements of Redeemable Preferred Stock and Shareholders' Equity For the Years Ended December 31, 1999, 2000 and 2001 (Amounts in thousands)
Shareholders' Equity --------------------------- Redeemable Preferred Stock Preferred Stock ------------------------------- --------------------------- Number of Number of Shares Amount Shares Amount --------------- -------------- -------------- ----------- Balance, January 1, 1999 785 $ 11,882 149 $ 1,853 Issuance of common stock - - - - Issuance of warrants in conjunction with acquisitions - - - - Accretion of preferred to redemption value 93 349 15 28 Exchange of redeemable preferred stock for common stock (878) (12,231) - - Exchange of convertible preferred stock for common stock - - (164) (1,881) Retirement of treasury stock - - - - Comprehensive income, net of tax: Net income - - - - Other comprehensive income: Foreign currency translation adjustment - - - - Total comprehensive income --------------- -------------- -------------- ----------- Balance, December 31, 1999 - - - - Issuance of common stock - - - - Comprehensive income, net of tax: Net income - - - - Other comprehensive income: Foreign currency translation adjustment - - - - Total comprehensive income --------------- -------------- -------------- ----------- Balance, December 31, 2000 - - - - Issuance of common stock - - - - Comprehensive income, net of tax: Net income - - - - Other comprehensive income: Foreign currency translation adjustment - - - - Total comprehensive income --------------- -------------- -------------- ----------- Balance, December 31, 2001 - $ - - $ - =============== ============== ============== =========== Shareholders' Equity ---------------------------------------------------------------------- Common Stock Treasury Stock -------------------------------- ---------------------------------- Number of Number of Shares Amount Shares Amount -------------- ---------------- ---------------- ---------------- Balance, January 1, 1999 19,744 $ 183,285 356 $ (4,108) Issuance of common stock 4,747 119,387 - - Issuance of warrants in conjunction with acquisitions - 1,925 - - Accretion of preferred to redemption value - - - - Exchange of redeemable preferred stock for common stock 878 12,231 - - Exchange of convertible preferred stock for common stock 164 1,881 - - Retirement of treasury stock - (4,108) (356) 4,108 Comprehensive income, net of tax: Net income - - - - Other comprehensive income: Foreign currency translation adjustment - - - - Total comprehensive income -------------- ---------------- ---------------- ---------------- Balance, December 31, 1999 25,533 314,601 - - Issuance of common stock 94 1,771 - - Comprehensive income, net of tax: Net income - - - - Other comprehensive income: Foreign currency translation adjustment - - - - Total comprehensive income -------------- ---------------- ---------------- ---------------- Balance, December 31, 2000 25,627 316,372 - - Issuance of common stock 189 4,621 - - Comprehensive income, net of tax: Net income - - - - Other comprehensive income: Foreign currency translation adjustment - - - - Total comprehensive income -------------- ---------------- ---------------- ---------------- Balance, December 31, 2001 25,816 $ 320,993 - $ - ============== ================= ================ ================
[RESTUBBED TABLE]
Shareholders' Equity ------------------------------------------------------------------------- Other Comprehensive Retained Comprehensive Income (Loss) Earnings Income Total ------------------- ------------- ------------------- --------------- Balance, January 1, 1999 $ (2,169) $ 20,604 $ 199,465 Issuance of common stock - - 119,387 Issuance of warrants in conjunction with acquisitions - - 1,925 Accretion of preferred to redemption value - (377) (349) Exchange of redeemable preferred stock for common stock - - 12,231 Exchange of convertible preferred stock for common stock - - - Retirement of treasury stock - - - Comprehensive income, net of tax: Net income - 29,366 $ 29,366 29,366 Other comprehensive income: Foreign currency translation adjustment 2,863 - 2,863 2,863 ------------------- Total comprehensive income $ 32,229 ------------------- ------------- =================== --------------- Balance, December 31, 1999 694 49,593 364,888 Issuance of common stock - - 1,771 Comprehensive income, net of tax: Net income - 21,986 $ 21,986 21,986 Other comprehensive income: Foreign currency translation adjustment (2,219) - (2,219) (2,219) ------------------- Total comprehensive income $ 19,767 ------------------- ------------- =================== --------------- Balance, December 31, 2000 (1,525) 71,579 386,426 Issuance of common stock - - 4,621 Comprehensive income, net of tax: Net income - 25,869 $ 25,869 25,869 Other comprehensive income: Foreign currency translation adjustment (2,821) - (2,821) (2,821) ------------------- Total comprehensive income $ 23,048 ------------------- ------------- =================== --------------- Balance, December 31, 2001 $ (4,346) $ 97,448 $ 414,095 =================== ============= ===============
See accompanying notes. F-6 NCO GROUP, INC Consolidated Statements of Cash Flows (Amounts in thousands)
For the Years Ended December 31, -------------------------------------------------------- 1999 2000 2001 ----------------- ---------------- ---------------- Cash flows from operating activities: Income from continuing operations $ 28,299 $ 46,140 $ 25,869 Adjustments to reconcile income from continuing operations to net cash provided by continuing operating activities: Depreciation 8,342 15,180 20,142 Amortization of intangibles 13,463 17,180 18,063 Net loss on property and equipment disposed of in connection with the flood/corporate headquarters relocation - - 827 Write-off of deferred financing costs 353 - - Provision for doubtful accounts 2,553 5,906 4,250 Impairment of purchased accounts receivable - - 2,738 Minority interest - - 4,310 Compensation expense on stock options granted 34 - - Changes in operating assets and liabilities, net of acquisitions: Restricted cash - - 2,555 Accounts receivable, trade (14,906) (29,696) (10,341) Deferred income taxes 16,980 15,480 10,635 Other assets (1,496) (5,293) (7,935) Accounts payable and accrued expenses (6,067) 977 14,733 Income taxes payable (1,644) (9,568) (252) Other long-term liabilities 1,711 (6,511) 256 ----------------- ---------------- ---------------- Net cash provided by continuing operating activities 47,622 49,795 85,850 Net cash provided by discontinued operating activities 120 2,487 - ----------------- ---------------- ---------------- Net cash provided by operating activities 47,742 52,282 85,850 Cash flows from investing activities: Purchases of accounts receivable (7,660) (32,961) (50,621) Collections applied to principal of purchased accounts receivable 2,538 5,084 35,284 Purchases of property and equipment (29,631) (31,042) (27,940) Insurance proceeds from involuntary conversion of property and equipment - - 560 Investment in consolidated subsidiary by minority interest - - 2,320 Net cash paid for pre-acquisition liabilities and acquisition related costs (135,237) (10,665) (11,077) ----------------- ---------------- ---------------- Net cash used in investing activities (169,990) (69,584) (51,474) Cash flows from financing activities: Repayment of notes payable (1,574) (1,934) (21,869) Repayment of acquired notes payable (42,000) - (20,084) Borrowings under revolving credit agreement 190,715 - 65,230 Repayment of borrowings under revolving credit agreement (4,000) (19,000) (162,350) Payment of fees to acquire debt (3,565) - (5,138) Proceeds from issuance of convertible debt - - 125,000 Issuance of common stock, net 10,079 1,175 3,721 ----------------- ---------------- ---------------- Net cash provided by (used in) financing activities 149,655 (19,759) (15,490) Effect of exchange rate on cash 578 38 (215) ----------------- ---------------- ---------------- Net increase (decrease) in cash and cash equivalents 27,985 (37,023) 18,671 Cash and cash equivalents at beginning of the period 22,528 50,513 13,490 ----------------- ---------------- ---------------- Cash and cash equivalents at end of the period $ 50,513 $ 13,490 $ 32,161 ================= ================ ================
See accompanying notes. F-7 NCO GROUP, INC. Notes to Consolidated Financial Statements 1. Nature of operations: NCO Group, Inc. (the "Company" or "NCO") is a leading provider of accounts receivable management and collection services. The Company also owns approximately 63% of NCO Portfolio Management, Inc., a separate public company that purchases and manages accounts receivable. The Company's client base includes companies in the financial services, healthcare, retail and commercial, utilities, education, telecommunications, and government sectors. These clients are primarily located throughout the United States of America, Canada, the United Kingdom, and Puerto Rico. 2. Accounting policies: Principles of Consolidation: The consolidated financial statements include the accounts of the Company and all affiliated subsidiaries and entities controlled by the Company. All significant intercompany accounts and transactions have been eliminated. Two entities that the Company does not control are InoVision-MEDCLR NCOP Ventures, LLC and Creditrust SPV98-2, LLC (see note 21). Contingency Fees and Contractual Services: The Company generates revenue from contingent fees and contractual services. Contingent fee revenue is recognized upon collection of funds on behalf of clients. Contractual services revenue is recognized as services are performed and accepted by the client. Purchased Accounts Receivable: The Company accounts for its investment in purchased accounts receivable on an accrual basis under the guidance of Practice Bulletin 6, "Amortization of Discounts on Certain Acquired Loans," using unique and exclusive static pools. Static pools are established with accounts having similar attributes. Typically, each static pool consists of an individual acquisition of accounts. Once a static pool is established, the accounts in the static pool are not changed. Proceeds from the sale of accounts within a static pool are accounted for as collections in that static pool. Collections on replacement accounts received from the originator of the loans are included as collections in the corresponding static pools. The discount between the cost of each static pool and the face value of the static pool is not recorded since the Company expects to collect a relatively small percentage of each static pool's face value. Each static pool is initially recorded at cost. Collections on the static pools are allocated to revenue and principal reduction based on the estimated internal rate of return ("IRR") for each pool. The IRR for each static pool is estimated based on the expected monthly collections over the estimated economic life of each static pool (generally five years, based on the Company's collection experience), compared to the original purchase price. Revenue on purchased accounts receivable is recorded monthly based on each static pool's effective IRR applied to each static pool's monthly opening carrying value. To the extent collections exceed the revenue, the carrying value is reduced and the reduction is recorded as collections applied to principal. Because the IRR reflects collections for the entire economic life of the static pool and those collections are not constant, lower collection rates, typically in the early months of ownership, can result in a situation where the actual collections are less than the revenue accrual. In this situation, the carrying value of the static pool may be increased by the difference between the revenue accrual and collections. F-8 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 2. Accounting policies (continued): Purchased Accounts Receivable (continued): To the extent the estimated future cash flow increases or decreases from the expected level of collections, the Company prospectively adjusts the IRR accordingly. If the carrying value of a particular static pool exceeds its expected future cash flows, a charge to income would be recognized in the amount of such impairment. Additional impairments on previously impaired static pools may occur if the current estimated future cash flow projection, after being adjusted prospectively for actual collection results, is less than the carrying value recorded. After the impairment of a static pool, no income is recorded on that static pool and collections are recorded as a return of capital until the full carrying value of the static pool has been recovered. The estimated yield for each static pool is based on estimates of future cash flows from collections, and actual cash flows will vary from current estimates. The difference could be material. Credit Policy: The Company has two types of arrangements under which it collects its contingent fee revenue. For certain clients, the Company remits funds collected on behalf of the client net of the related contingent fees while, for other clients, the Company remits gross funds collected on behalf of clients and bills the client separately for its contingent fees. Management carefully monitors its client relationships in order to minimize its credit risk and generally does not require collateral. In many cases, in the event of collection delays from clients, management may, at its discretion, change from the gross remittance method to the net remittance method. Cash and Cash Equivalents: The Company considers all highly liquid investments purchased with an initial maturity of three months or less to be cash equivalents. These financial instruments potentially subject the Company to concentrations of credit risk. The Company minimizes this risk by dealing with major financial institutions that have high credit ratings. Investments in Debt and Equity Securities: The Company accounts for investments, such as the investment in securitization, Creditrust SPV 98-2, LLC (see note 21), in accordance with Statement of Financial Accounting Standards (SFAS) No. 115, "Accounting for Certain Investments in Debt and Equity Securities." As such, investments are recorded as either trading, available for sale, or held to maturity based on management's intent relative to those securities. The Company records its investment in securitization as an available for sale debt security. Such a security is recorded at fair value, and unrealized gain or loss, net of the related tax effect, is not reflected in earnings but is recorded as other comprehensive income in the consolidated statement of shareholders' equity until realized. A decline in the value of an available for sale security below cost that is deemed other than temporary is charged to income as an impairment and results in the establishment of a new cost basis for the security. The investment in securitization is included in other assets and represents the residual interest in a securitized pool of purchased accounts receivable acquired in connection with the merger of Creditrust Corporation ("Creditrust") into NCO Portfolio Management, Inc. ("NCO Portfolio"). The investment in securitization accrues interest at an effective IRR, which is estimated based on the expected monthly collections over the estimated economic life of the investment (approximately five years). Cost approximated the fair value of this investment as of December 31, 2001. F-9 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 2. Accounting policies (continued): Property and Equipment: Property and equipment is stated at cost, less accumulated depreciation. Depreciation is provided over the estimated useful life of each class of assets using the straight-line method. Expenditures for maintenance and repairs are charged to expense as incurred. Renewals and betterments are capitalized. When property is sold or retired, the cost and related accumulated depreciation are removed from the balance sheet and any gain or loss on the transaction is included in the statement of income. Effective January 1, 1999, the Company adopted Statement of Position 98-1, "Accounting for the Costs of Computer Software Developed or Obtained for Internal Use" ("SOP 98-1"). SOP 98-1 identified the characteristics of internal use software and established guidelines for identifying which costs must be expensed as incurred and which costs must be capitalized. The Company reviews long-lived assets and certain identifiable intangibles for impairment, based on the estimated undiscounted future cash flows, whenever events or changes in circumstances indicate that the carrying amount of the asset may not be recoverable. Intangibles: Intangibles consist primarily of goodwill and deferred financing costs. Goodwill represents the excess of purchase price over the fair market value of the net assets of the acquired businesses based on their respective fair values at the date of acquisition. Goodwill is amortized on a straight-line basis over 15 to 40 years. The Company reviews the recoverability of its goodwill whenever events or circumstances indicate that the carrying amount of the goodwill may not be recoverable. If such circumstances arise, the Company would use an estimate of the undiscounted value of expected future operating cash flows to determine whether the goodwill is recoverable. Deferred financing costs relate to debt issuance costs incurred, which are capitalized and amortized over the term of the debt. Accumulated amortization at December 31, 2000 and 2001 totaled $39.8 million and $57.2 million, respectively. Income Taxes: The Company accounts for income taxes using an asset and liability approach. The asset and liability approach requires the recognition of deferred tax assets and liabilities for the expected future tax consequences of temporary differences between the financial reporting basis and the tax basis of assets and liabilities. Income taxes were computed after giving effect to the nondeductible portion of goodwill expenses attributable to certain acquisitions and, in 1999, nonrecurring acquisition costs attributable to the acquisition of JDR Holdings, Inc. ("JDR") on March 31, 1999. The static pools of purchased accounts receivable are comprised of distressed debt. Collection results are not guaranteed until received; accordingly, for tax purposes, any gain on a particular static pool is deferred until the full cost of its acquisition is recovered. Revenue for financial reporting purposes is recognized ratably over the life of the static pool. Deferred tax liabilities arise from income tax deferrals created during the early stages of the static pool. These deferrals reverse after the cost basis of the static pool is recovered. The creation of new tax deferrals from future purchases of static pools are expected to offset the reversal of the deferrals from static pools where the collections have become fully taxable. F-10 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 2. Accounting policies (continued): Foreign Currency Translation: The Company has foreign subsidiaries whose local currency has been determined to be the functional currency. For these foreign subsidiaries, the assets and liabilities have been translated using the current exchange rates, and the income and expenses have been translated using historical exchange rates. The adjustments resulting from translation have been recorded separately in shareholders' equity as other comprehensive income and are not included in determining consolidated net income. Use of Estimates: The preparation of consolidated financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. In the ordinary course of accounting for purchased accounts receivable, estimates have been made by management as to the amount of future cash flows expected from each static pool. The estimated future cash flow of each static pool is used to compute the IRR for the static pool. The IRR is used to allocate cash flow between revenue and amortization of the carrying values of the purchased accounts receivable. On an ongoing basis, we compare the historical trends of each static pool to projected collections. The future projections are then increased or decreased, within parameters, in accordance with the historical trend. The results are further reviewed by management with a view towards specifically addressing any particular static pool's performance. Actual results will differ from these estimates and a material change in these estimates could occur within one year. Reclassifications: Certain amounts for the year ended December 31, 1999 have been reclassified for comparative purposes. 3. Discontinued operations: On April 14, 2000 (the "Measurement Date"), the Company's Board of Directors approved a plan to divest the Company's Market Strategy division as part of its strategic plan to increase long-term shareholder value and focus on its core business of accounts receivable management services. The Market Strategy division provided market research and telemarketing services. The market research assets were acquired through the January 1997 acquisition of the Tele-Research Center, Inc. and the February 1998 acquisition of The Response Center. The telemarketing assets were acquired as non-core components of the March 1999 acquisition of JDR, and the August 1999 acquisition of Compass International Services Corporation. On October 26, 2000, TRC Holdings, Inc. and Creative Marketing Strategies, Inc., both management-led groups, acquired the assets of the market research and telemarketing businesses, respectively. In consideration for the purchased assets of the market research business, the Company received a $12.25 million note. The note earns interest at a fixed rate of 9% per year and the interest payments are due monthly. The entire principal balance is due on December 31, 2002. In the event that the principal and the remaining interest is not paid in full on December 31, 2002, the principal of the note will be increased by a maximum of $2.0 million. The remaining principal and interest will be due in equal monthly payments through December 31, 2005. In consideration for the purchased assets of the telemarketing business, the Company received a $6.0 million note. The note earns interest at a fixed rate of 9% per year and the interest payments are due monthly. Commencing on December 1, 2003, in addition to the interest payments, principal payments of $25,000 will be due monthly until November 1, 2005. The remaining principal and interest will become due in full on November 1, 2005. F-11 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 3. Discontinued operations (continued): In accordance with the Accounting Principles Board Opinion No. 30, "Reporting the Results of Operations - Reporting the Effects of Disposal of a Business, and Extraordinary, Unusual and Infrequently Occurring Events and Transactions," the consolidated financial statements and the accompanying notes of the Company have been presented to reflect the Market Strategy division as discontinued operations for all periods presented. The following summary of the Market Strategy division's operations prior to the Measurement Date for the years ended December 31, 1999 and 2000 have been presented net in the Company's consolidated statements of operations (amounts in thousands): 1999 2000 ----------- ------------ Revenue $32,043 $7,802 =========== ============ Income (loss) from discontinued operations before income tax expense (benefit) $1,940 $(1,498) Income tax expense (benefit) 873 (523) ----------- ------------ Income (loss) from discontinued operations, net of income taxes $1,067 $ (975) =========== ============ During the year ended December 31, 2000, the Company recorded a $23.2 million loss (net of a tax benefit of $4.3 million), or $0.90 loss per share on a diluted basis, on the disposal of the Market Strategy division. This loss reflects the difference between the net assets of the Market Strategy division and the proceeds from the divestiture as well as the operating losses from the Measurement Date through the completion of the divestiture in October 2000. Included in this loss was a write-off of $29.9 million of goodwill. Also included in this loss was an extraordinary item of $6.3 million (net of taxes of $42,000), or $0.24 per share on a diluted basis, from the loss on the disposal of the portion of the telemarketing business that was acquired with JDR. The purchase of JDR was accounted for as a pooling-of-interests transaction, and the Company had no plans or intentions to dispose of JDR's telemarketing business at the time of the acquisition. For the year ended December 31, 1999 and for the period in 2000 before the Measurement Date, the income (loss) from discontinued operations, net of taxes, included an allocation of interest expense of $1.1 million and $441,000, respectively. For the period in 2000 from the Measurement Date through the divestiture date, the loss on the disposal of discontinued operations included an allocation of interest expense of $706,000. The interest expense was allocated to the Market Strategy division based on the expected proceeds. 4. Acquisitions: Pooling-of-Interests Transaction: On March 31, 1999, the Company acquired all of the outstanding shares of JDR for approximately 3.4 million shares of NCO common stock. The transaction was accounted for as a pooling-of-interests and a tax-free reorganization. Accordingly, the historical financial information of the Company has been restated to include the historical information of JDR. During the year ended December 31, 1999, the Company incurred $4.6 million of nonrecurring acquisition costs in connection with the JDR acquisition. These costs consisted primarily of investment banking fees, legal and accounting fees, and printing costs. F-12 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 4. Acquisitions (continued): Purchase Transactions: The following acquisitions have been accounted for under the purchase method of accounting. As part of the purchase accounting, the Company recorded accruals for acquisition related expenses. These accruals included professional fees related to the acquisition, termination costs related to certain redundant personnel immediately eliminated at the time of the acquisitions, and certain future rental obligations attributable to facilities which were closed at the time of the acquisitions. On May 21, 1999, the Company acquired all of the outstanding stock of Co-Source Corporation ("Co-Source") for approximately $122.7 million in cash plus a warrant to purchase 250,000 shares of NCO common stock. The purchase price was valued at approximately $124.6 million. The Company recognized goodwill of $128.6 million and is amortizing the goodwill on a straight-line basis over 40 years. On August 20, 1999, the Company acquired all of the outstanding shares of Compass International Services Corporation ("Compass") for approximately 3.3 million shares of NCO common stock. In connection with the acquisition, the Company assumed outstanding stock options to purchase approximately 200,000 shares of NCO common stock. The purchase price was valued at approximately $104.1 million. The Company recognized goodwill of $139.1 million and is amortizing the goodwill on a straight-line basis over 40 years. On February 20, 2001, the Company merged NCO Portfolio Management, Inc. ("NCO Portfolio"), its wholly owned subsidiary, with Creditrust Corporation ("Creditrust") to form a new public entity focused on the purchase of accounts receivable (the "Creditrust Merger"). After the Creditrust Merger, the Company owned approximately 63% of the outstanding stock of NCO Portfolio, subject to certain adjustments. The Company's contribution to the NCO Portfolio merger consisted of $25.0 million of purchased accounts receivable. As part of the Creditrust Merger, NCO Portfolio signed a ten-year service agreement that appointed the Company as the sole provider of collection services to NCO Portfolio. The Company has agreed to offer all of its future U.S. accounts receivable purchase opportunities to NCO Portfolio. In connection with the Creditrust Merger, the Company amended its revolving credit facility to allow the Company to provide NCO Portfolio with a $50 million revolving line of credit in the form of a sub-facility under its existing credit facility. Initially, NCO Portfolio borrowed $36.3 million to fund the Creditrust Merger. The following summarizes the unaudited pro forma results of operations for the years ended December 31, 2000 and 2001, assuming the Creditrust Merger had occurred as of the beginning of the respective years. The pro forma information is provided for informational purposes only. It is based on historical information and does not necessarily reflect the actual results that would have occurred, nor is it indicative of future results of operations of the consolidated entities (amounts in thousands, except per share data):
2000 2001 ------------ --------------- (Unaudited) (Unaudited) Revenue $ 648,033 $ 705,086 Income from continuing operations applicable to common shareholders $ 21,819 $ 19,542 Income from continuing operations applicable to common shareholders per share: Basic $ 0.21 $ 0.76 Diluted $ 0.20 $ 0.75
F-13 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 5. Purchased accounts receivable: The Company's Portfolio Management and International Operations divisions purchase defaulted consumer accounts receivable at a discount from the actual principal balance. As of December 31, 2001, the carrying value of the Portfolio Management division's and International Operations division's purchased accounts receivable was $136.3 million and $3.8 million, respectively. The following summarizes the change in purchased accounts receivable for the years ended December 31, 1999, 2000, and 2001:
1999 2000 2001 ------------- ------------- ------------- Balance, at beginning of period $ 1,597 $ 6,719 $ 34,475 Purchased accounts receivable acquired from Creditrust - - 93,518 Purchases of accounts receivable 7,660 32,961 50,621 Collections on purchased accounts receivable (5,967) (20,495) (99,868) Revenue recognized 3,419 15,411 64,065 Impairment of purchased accounts receivable - - (2,738) Foreign currency translation adjustment 10 (121) (72) ------------- ------------- ------------- - - - Balance, at end of period $ 6,719 $ 34,475 $ 140,001 ============= ============= =============
During the year ended December 31, 2001, an impairment of $2.7 million was recorded as a charge to income on static pools where the carrying amounts exceeded the expected future cash flows. No revenue will be recorded on these static pools until the carrying values have been fully recovered. The combined carrying values on these static pools, after impairment, aggregated $5.8 million as of December 31, 2001, representing their net realizable value. No impairments were recorded during the years ended December 31, 1999 and 2000. 6. Funds held on behalf of clients: In the course of the Company's regular business activities as a provider of accounts receivable management services, the Company receives clients' funds arising from the collection of accounts placed with the Company. These funds are placed in segregated cash accounts and are generally remitted to clients within 30 days. Funds held on behalf of clients of $54.1 million and $56.8 million at December 31, 2000 and 2001, respectively, have been shown net of their offsetting liability for financial statement presentation. 7. Property and equipment: Property and equipment, at cost, consisted of the following at December 31, 2000 and 2001 (amounts in thousands):
Estimated Useful Life 2000 2001 -------------- ---------------- ---------------- Computer equipment 5 years $ 60,049 $ 75,086 Computer software developed for internal use 5 years 18,040 24,734 Furniture and fixtures 5 to 10 years 10,638 13,032 Leasehold improvements 5 to 15 years 7,226 6,027 ---------------- ---------------- 95,953 118,879 Less accumulated depreciation 29,552 47,422 ---------------- ---------------- $ 66,401 $ 71,457 ================ ================
Depreciation charged to operations amounted to $8.3 million, $15.2 million, and $20.1 million for the years ended December 31, 1999, 2000, and 2001, respectively. F-14 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 8. Long-term debt: - Long-term debt consisted of the following at December 31, 2000 and 2001 (amounts in thousands):
2000 2001 -------------- -------------- Revolving credit loan $ 303,750 $ 206,630 Convertible notes - 125,000 Securitized debt - 45,379 Subordinated seller notes payable; interest rate of 7.16%, due May 2001 130 - Capital leases 682 2,781 Less current portion (642) (21,922) -------------- -------------- $ 303,920 $ 357,868 ============== ==============
The following summarizes the Company's required debt payments, excluding the convertible notes (amounts in thousands): 2002 $ 21,922 2003 28,476 2004 189,562 2005 14,830 Revolving Credit Facility: The Company has a credit agreement with Citizens Bank of Pennsylvania, formerly Mellon Bank, N.A., ("Citizens Bank"), for itself and as administrative agent for other participating lenders, that originally provided for borrowings up to $350 million, structured as a revolving credit facility. The balance under the revolving credit facility shall become due on May 20, 2004 (the "Maturity Date"). The borrowing capacity of the revolving credit facility is subject to mandatory reductions including a quarterly reduction of $6.3 million on March 31, 2001, subsequent quarterly reductions of $5.2 million until the Maturity Date, and 50 percent of the net proceeds received from any offering of debt or equity. At the option of NCO, the borrowings bear interest at a rate equal to either Citizens Bank's prime rate plus a margin of 0.25% to 0.50%, which is determined quarterly based upon the Company's consolidated funded debt to earnings before interest, taxes, depreciation, and amortization ("EBITDA") ratio (Citizens Bank's prime rate was 4.75% at December 31, 2001), or the London InterBank Offered Rate ("LIBOR") plus a margin of 1.25% to 2.25% depending on the Company's consolidated funded debt to EBITDA ratio (LIBOR was 1.88% at December 31, 2001). The Company is charged a fee on the unused portion of the credit facility ranging from 0.13% to 0.38% depending on the Company's consolidated funded debt to EBITDA ratio. In connection with the merger of Creditrust into NCO Portfolio, the Company amended its revolving credit facility to allow the Company to provide NCO Portfolio with a $50 million revolving line of credit in the form of a sub-facility under its existing credit facility. The borrowing capacity of the sub-facility is subject to mandatory reductions including four quarterly reductions of $2.5 million beginning March 31, 2002 through December 31, 2002. Effective March 31, 2003, quarterly reductions of $3.75 million are required until the earlier of the Maturity Date or the date at which the sub-facility is reduced to $25 million. At the option of NCO, the borrowings bear interest at a rate equal to either Citizens Bank's prime rate plus a margin of 1.25% to 1.50% that is determined quarterly based upon the Company's consolidated funded debt to EBITDA ratio, or LIBOR plus a margin of 2.25% to 3.25% depending on the Company's consolidated funded debt to EBITDA ratio. F-15 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 8. Long-term debt (continued): Revolving Credit Facility (continued): Borrowings under the revolving credit facility are collateralized by substantially all the assets of the Company, including the common stock of NCO Portfolio, and certain assets of NCO Portfolio. The credit agreement contains certain financial covenants such as maintaining net worth and funded debt to EBITDA requirements, and includes restrictions on, among other things, acquisitions and distributions to shareholders. As of December 31, 2001, the Company was in compliance with all required financial covenants. The following summarizes the availability under the revolving credit facility as of December 31, 2001 (amounts in thousands):
NCO Group NCO Portfolio Combined -------------- ------------------ ---------------- Maximum capacity $ 217,525 $ 50,000 $ 267,525 Less: Outstanding borrowings 159,500 47,130 206,630 Unused letters of credit 2,554 - 2,554 -------------- ------------------ ---------------- Available $ 55,471 $ 2,870 $ 58,341 ============== ================== ================
Convertible Notes: In April 2001, the Company completed the sale of $125.0 million aggregate principal amount of 4.75% Convertible Subordinated Notes due April 2006 ("Notes") in a private placement pursuant to Rule 144A and Regulation S under the Securities Act of 1933. The Notes are convertible into NCO common stock at an initial conversion price of $32.92 per share. The Company will be required to repay the $125.0 million of aggregate principal if the Notes are not converted prior to their maturity in April 2006. The Company used the $121.3 million of net proceeds from this offering to repay debt under its revolving credit agreement. In accordance with the terms of the credit agreement, 50% of the net proceeds from the Notes permanently reduced the maximum borrowings available under the revolving credit facility. Securitized Debt: Creditrust established three securitized notes payable to fund the purchase of accounts receivable prior to the Creditrust Merger. Each of the notes payable is non-recourse to the Company and NCO Portfolio, secured by a static pool of purchased accounts receivable, and is bound by an indenture and servicing agreement. Pursuant to the acquisition, the trustee appointed NCO as the successor servicer for each static pool of purchased accounts receivable. When the notes payable were established, a separate special purpose finance subsidiary was created to house the assets and debt. These notes are term notes without the ability to re-borrow. Monthly principal payments on the notes equal all collections after servicing fees, collection costs, interest expense and administrative fees. The first securitized note ("Warehouse Facility") was established in September 1998 through Creditrust Funding I LLC, a special purpose finance subsidiary. The Warehouse Facility carries a floating interest rate of LIBOR plus 0.65% per annum, and the final due date of all payments under the facility is March 2005. A $900,000 liquidity reserve is included in restricted cash as of December 31, 2001, and is restricted as to use until the facility is retired. Interest expense, trustee fees and guarantee fees aggregated $945,000 for period from February 21, 2001 to December 31, 2001, respectively. As of December 31, 2001, the amount outstanding on the facility was $17.8 million. The note issuer, Radian Group, Inc., formerly Asset Guaranty Insurance Company, has been guaranteed against loss by NCO Portfolio for up to $4.5 million, which will be reduced if and when reserves and residual cash flows from another securitization, Creditrust SPV 98-2, LLC, are posted as additional collateral for this facility (see note 21). F-16 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 8. Long-term debt (continued): Securitized Debt (continued): The second securitized note ("SPV99-1 Financing") was established in August 1999 through Creditrust SPV99-1, LLC, a special purpose finance subsidiary. SPV99-1 Financing carries interest at 9.43% per annum, with a final payment date of August 2004. A $225,000 liquidity reserve is included in restricted cash as of December 31, 2001, and is restricted as to use until the facility is retired. Interest expense and trustee fees aggregated $691,000 for the period from February 21, 2001 to December 31, 2001, respectively. As of December 31, 2001, the amount outstanding on the facility was $3.8 million. The third securitized note ("SPV99-2 Financing") was established in August 1999 through Creditrust SPV99-2, LLC, a special purpose finance subsidiary. SPV99-2 Financing carries interest at 15.00% per annum, with a final payment date of December 2004. Interest expense and trustee fees aggregated $3.3 million for the period from February 21, 2001 to December 31, 2001, respectively. As of December 31, 2001, the amount outstanding on the facility was $23.8 million. Other: At December 31, 2001, the Company had unused letters of credit of $2.6 million. The Company leases certain equipment under agreements that are classified as capital leases. The equipment leases have original terms ranging from 23 to 60 months and have purchase options at the end of the original lease term. 9. Operating leases: The Company leases certain equipment and real estate facilities under non-cancelable operating leases. The following represents the future minimum payments, by year and in the aggregate, under non-cancelable operating leases with initial or remaining terms of one year or more (amounts in thousands). The following future minimum payments do not include the leases from the Company's former Fort Washington locations (see notes 18 and 20). 2002 $ 21,455 2003 16,711 2004 14,532 2005 13,311 2006 12,136 Thereafter 43,482 ------------ $ 121,627 ============ Rent expense was $14.3 million, $17.8 million, and $19.5 million for the years ended December 31, 1999, 2000, and 2001, respectively. The total amount of base rent payments is being charged to expense on the straight-line method over the term of the lease. F-17 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 10. Income taxes: Income tax expense consisted of the following components for the years ended December 31, 1999, 2000, and 2001 (amounts in thousands):
1999 2000 2001 ------------ ------------ ------------ Currently payable: Federal $ 9,158 $ 16,280 $ 10,809 State 548 1,613 1,047 Foreign 500 1,269 376 Deferred: Federal 10,314 12,180 7,432 State 2,301 1,353 731 Foreign - (653) 1,068 ------------ ------------ ------------ Income tax expense $ 22,821 $ 32,042 $ 21,463 ============ ============ ============
Deferred tax assets (liabilities) consisted of the following at December 31, 2000 and 2001 (amounts in thousands):
2000 2001 ------------- -------------- Deferred tax assets: Net operating loss carryforwards $ 5,279 $ 39,380 Accrued expenses 3,751 8,697 ------------- -------------- Total deferred tax assets 9,030 48,077 Valuation allowance 3,673 5,014 ------------- -------------- Net deferred tax assets 5,357 43,063 ------------- -------------- Deferred tax liabilities: Amortization 29,576 32,060 Depreciation 9,103 12,400 Undistributed earnings of unconsolidated subsidiary - 2,832 Purchased accounts receivable 4,940 30,290 ------------- -------------- Total deferred tax liabilities 43,619 77,582 ------------- -------------- Net deferred tax liabilities $ (38,262) $ (34,519) ============= ==============
The Company had federal, state, and foreign net operating loss carryforwards in the amount of $175.3 million, subject to certain limitations, available at December 31, 2001, which will expire during the years 2004 through 2021. Of this amount, $100.4 million existed as of the date of the Creditrust Merger. Due to the Creditrust ownership change in 2001, the use of the net operating loss carryforwards could be substantially curtailed by Section 382 of the Internal Revenue Code. The annual use of the net operating loss carryforwards is limited under this section and such limitation is dependent on: i) the fair market value of Creditrust at the time of the ownership change; and ii) the net unrealized built-in gains of Creditrust at the time of the ownership change which are expected to be recognized within five years of the Creditrust Merger date. Based on an analysis performed by the Company, it is anticipated that $81.8 million of the Creditrust net operating loss will be available for utilization after Section 382 limitations. Accordingly, a deferred tax asset based on this amount was recorded at the date of the Creditrust Merger being available to offset future reversing temporary differences and future taxable income. Based on operations for the year, the deferred tax asset was increased by the tax loss recognized by NCO Portfolio for 2001. At year-end, this deferred tax asset was expected to be fully utilized to offset future reversing temporary differences, primarily relating to purchased accounts receivable. F-18 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 10. Income taxes (continued): A reconciliation of the U.S. statutory income tax rate to the effective rate for the years ended December 31, 1999, 2000, and 2001 was as follows:
1999 2000 2001 --------- --------- --------- U.S. statutory income tax rate 35.0% 35.0% 35.0% Nondeductible goodwill and other expenses 5.6 3.6 5.4 State taxes, net of federal 4.0 2.5 2.1 Benefit from foreign net operating losses - (1.1) - Other, net - 1.0 (0.9) --------- --------- --------- Effective tax rate 44.6% 41.0% 41.6% ========= ========= =========
11. Redeemable preferred stock and shareholders' equity: Redeemable Preferred Stock All of JDR's Redeemable Series A Preferred stock, Convertible Series A Preferred stock and Convertible Series B Preferred stock was exchanged for NCO common stock on March 31, 1999. Preferred Stock All of JDR's Series C Preferred stock was converted into NCO common stock on March 31, 1999. Nonvoting Common Stock All of JDR's nonvoting common stock was exchanged for NCO common stock on March 31, 1999. Treasury Stock All of JDR's treasury shares were retired on March 31, 1999. Common Stock Warrants In February 1997, the Company issued warrants to purchase 375,000 shares of NCO common stock, at $18.42 per share, in connection with the acquisition of certain assets and the assumption of certain liabilities of the Collections Division of CRW Financial, Inc. All of these warrants were outstanding as of December 31, 2001. In January 2002, all of the warrants were exercised. The holders of the warrants elected to use the option of forfeiting a portion of their warrants to cover the exercise price. These exercises resulted in the net issuance of 55,000 shares of NCO common stock. In May 1997, JDR issued warrants to purchase 621,000 shares of nonvoting common stock at a nominal value in connection with the sale of capital stock and JDR's credit facility. All of the warrants were exercised and exchanged for NCO common stock on March 31, 1999. In May 1999, the Company issued warrants to purchase 250,000 shares of NCO common stock, at $32.97 per share, in connection with the acquisition of Co-Source. During 1999, warrants to issue 228,000 shares of NCO common stock were exercised. The holders of the warrants elected to use the option of forfeiting a portion of their warrants to cover the exercise price. These exercises resulted in the net issuance of 67,000 shares of NCO common stock. Warrants to purchase 22,000 shares of NCO common stock were outstanding as of December 31, 2001. These warrants expire in May 2009. F-19 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 12. Earnings per share: Basic earnings per share ("EPS") was computed by dividing the income from continuing operations applicable to common shareholders and the net income applicable to common shareholders for the years ended December 31, 1999, 2000, and 2001, by the weighted average number of common shares outstanding. Diluted EPS was computed by dividing the income from continuing operations applicable to common shareholders and the net income applicable to common shareholders for the years ended December 31, 1999, 2000, and 2001, by the weighted average number of common shares outstanding plus all common equivalent shares. Outstanding options, warrants, and convertible securities have been utilized in calculating diluted amounts per share only when their effect would be dilutive. The reconciliation of basic to diluted weighted average shares outstanding for the years ended December 31, 1999, 2000, and 2001 was as follows (amounts in thousands):
1999 2000 2001 ------------ ----------- ----------- Basic 22,873 25,587 25,773 Dilutive effect of convertible debt - - 2,806 Dilutive effect of warrants 206 88 88 Dilutive effect of options 712 167 230 Other 8 - - ------------ ----------- ----------- Diluted 23,799 25,842 28,897 ============ =========== ===========
13. Stock options: In June 1995, the Company adopted the 1995 Stock Option Plan (the "1995 Plan"). In September 1996, the Company adopted the 1996 Stock Option Plan (the "1996 Plan") and the 1996 Non-Employee Director Stock Option Plan (the "Director Plan"). The 1995 Plan and 1996 Plan, as amended, authorized 333,000 and 4.7 million shares, respectively, of incentive or non-qualified stock options. The Director Plan, as amended, authorized 150,000 shares. The vesting periods for the outstanding options under the 1995 Plan, the 1996 Plan, and the Director Plan are three years, three years and one year, respectively. The options expire no later than 10 years from the date of grant. In June 1997, JDR established the JDR Holdings, Inc. 1997 Stock Option Plan (the "JDR Plan") and reserved 69,000 shares of common stock. All options that were issued and outstanding under the JDR Plan as of March 31, 1999 became fully vested as a result of the acquisition of JDR by NCO. The options expire no later than 10 years from the date of grant. On August 20, 1999, as part of the acquisition of Compass, NCO assumed the Compass Employee Incentive Compensation Plan (the "Compass Plan"). The Compass Plan authorized up to 475,000 shares of non-qualified stock options. The vesting periods for the outstanding options under the Compass Plan are one to three years. The options expire no later than 10 years from the date of grant. F-20 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 13. Stock options (continued): A summary of stock option activity of the 1995 Plan, the 1996 Plan, the Director Plan, the JDR Plan and the Compass Plan is as follows (amounts in thousands, except per share amounts):
Weighted Avg. Number of Exercise Price Options Per Share ------------- ---------------- Outstanding at January 1, 1999 1,579 $ 21.44 Granted 1,497 32.58 Exercised (441) 16.89 Forfeited (24) 26.76 ------ --------- Outstanding at December 31, 1999 2,611 28.27 Granted 1,082 24.52 Exercised (94) 12.58 Forfeited (259) 33.39 ------ --------- Outstanding at December 31, 2000 3,340 27.10 Granted 1,116 20.22 Exercised (189) 19.76 Forfeited (269) 28.88 ------ --------- Outstanding at December 31, 2001 3,998 $ 25.41 ====== ========= Stock options exercisable at December 31, 2001 1,932 $ 27.69 ====== =========
The following table summarizes information about stock options outstanding as of December 31, 2001 (shares in thousands):
Stock Options Outstanding Stock Options Exercisable ------------------------------------------------- ----------------------------- Weighted Weighted Weighted Range of Average Average Average Exercise Prices Shares Remaining Life Exercise Price Shares Exercise Price --------------------- ------------ ----------------- --------------- ----------- --------------- $ 8.67 to $19.42 260 5.96 years $ 15.70 217 $ 15.36 $20.05 to $24.75 1,427 9.01 years 20.67 363 22.43 $25.00 to $28.75 929 8.80 years 25.30 314 25.38 $29.19 to $33.38 1,212 7.71 years 30.68 880 30.89 $36.88 to $61.09 170 6.56 years 43.06 158 43.43 ------------ ----------------- --------------- ----------- --------------- 3,998 8.26 years $ 25.41 1,932 $ 27.69 ============ ================= =============== =========== ===============
F-21 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 13. Stock options (continued): The Company accounts for stock option grants in accordance with APB Opinion 25, "Accounting for Stock Issued to Employees" ("APB 25") and related interpretations. Under APB 25, because the exercise price of the stock options equaled the fair value of the underlying common stock on the date of grant, no compensation cost was recognized. In accordance with FASB 123, "Accounting for Stock-Based Compensation," the Company does not recognize compensation cost based on the fair value of the options granted at grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at grant date, net income applicable to common shareholders and net income applicable to common shareholders per share for the years ended December 31, 1999, 2000, and 2001 would have been reduced to the unaudited, pro forma amounts indicated in the following table (amounts in thousands, except per share amounts):
1999 2000 2001 ------------ ----------- ------------ Net income applicable to common shareholders - pro forma $ 26,673 $ 17,783 $ 20,858 Net income applicable to common shareholders per share - pro forma: Basic $ 1.17 $ 0.70 $ 0.81 Diluted $ 1.12 $ 0.69 $ 0.80
The estimated weighted average, grant-date fair values of the options granted during the years ended December 31, 1999, 2000, and 2002 were $12.43, $10.52, and $10.37, respectively. All options granted were at the market price of the stock on the grant date. For valuation purposes, the Company utilized the Black-Scholes option pricing model using the following assumptions for the years ended December 31, 1999, 2000, and 2001 on a weighted average basis: 1999 2000 2001 ---------- ---------- ---------- Risk-free interest rate 5.73% 5.93% 4.42% Expected life in years 3.25 3.25 4.33 Volatility factor 44.04% 52.88% 58.95% Dividend yield None None None Forfeiture rate 5.00% 5.00% 5.00% 14. Derivative financial instruments: The Company selectively uses derivative financial instruments to manage interest costs and minimize currency exchange risk. The Company does not hold derivatives for trading purposes. While these derivative financial instruments are subject to fluctuations in value, these fluctuations are generally offset by the value of the underlying exposures being hedged. The Company minimizes the risk of credit loss by entering into these agreements with major financial institutions that have high credit ratings. Interest Rate Collars: During the year ended December 31, 2001, the Company was party to three interest rate collar agreements that consisted of LIBOR ceilings and floors that are based on different notional amounts. The first interest rate collar agreement consisted of a ceiling portion with a rate of 7.75%, covering a notional amount of $30.0 million, and a floor portion with a rate of 4.75%, covering a notional amount of $15.0 million. This interest rate collar agreement expired in September 2001. The other two interest rate collar agreements consisted of a ceiling portion with a rate of 7.50% and a floor portion with a rate of 5.50%, covering a total notional amount of $120.0 million. These interest rate collar agreements expired in October 2001. The notional amounts of these interest rate collar agreements are used to measure the interest to be paid or received and do not represent the amount of exposure due to credit loss. The net cash amounts paid or received on the interest rate collar agreements are accrued and recognized as an adjustment to interest expense. The fair value of the interest rate collar instruments was determined to be immaterial at December 31, 2000. F-22 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 15. Fair value of financial instruments: The following methods and assumptions were used to estimate the fair value of each class of financial instrument for which it is practicable to estimate that value: Cash and Cash Equivalents: The carrying amount reported in the balance sheets approximates fair value because of the short maturity of these instruments. Purchased Accounts Receivable The Company records purchased accounts receivable at cost, which is discounted from the contractual receivable balance. The Company recorded the accounts receivable acquired as part of Creditrust at fair value. The carrying value of purchased accounts receivable, which is estimated based upon future cash flows, approximates fair value at December 31, 2000 and 2001. Investment in Securitization: Upon completion of the merger with Creditrust, NCO Portfolio recorded the investment in securitization acquired from Creditrust at fair value. As of December 31, 2001, the carrying value approximated fair value. Notes Receivable: The carrying amount reported in the balance sheets approximates market rates for notes with similar terms and maturities, and, accordingly, the carrying amount approximates fair value. Long-Term Debt: The stated interest rates of the Company's nonconvertible debt approximate market rates for debt with similar terms and maturities, and, accordingly, the carrying amounts approximate fair value. The estimated fair value of the Company's convertible debt was $113.9 million as of December 31, 2001 based on the closing market price for the convertible securities on December 31, 2001. 16. Supplemental cash flow information: The following are supplemental disclosures of cash flow information for the years ended December 31, 1999, 2000, and 2001 (amounts in thousands):
1999 2000 2001 ----------- ------------ ------------ Cash paid for interest $19,975 $24,038 $25,257 Cash paid for income taxes 7,923 18,569 11,410 Non-cash investing and financing activities: Notes received as consideration for the divestiture of the Market Strategy Division - 18,250 - Fair value of assets acquired 28,368 - 123,978 Liabilities assumed from acquisitions 53,713 - 109,394 Convertible note payable, converted to common stock 900 - - Common stock issued for acquisitions - - 101,526 Common stock options issued for acquisitions - - 2,562 Redemption of redeemable preferred stock for common stock 12,231 - - Warrants issued 1,925 - - Warrants exercised 6,332 - -
F-23 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 17. Employee benefit plans: The Company has a savings plan under Section 401(k) of the Internal Revenue Code (the "Plan"). The Plan allows all eligible employees to defer up to 15% of their income on a pretax basis through contributions to the Plan, subject to limitations under Section 401(k) of the Internal Revenue Code. The Company will provide a matching contribution of 25% of the first 6% of an employee's contribution. The charges to operations for the matching contributions were $1.4 million, $1.7 million and $1.9 million, for 1999, 2000, and 2001, respectively. 18. Commitments and contingencies: Forward-Flow Agreement NCO Portfolio currently has a "forward-flow" agreement with a major financial institution, which obligates NCO Portfolio to purchase, on a monthly basis, portfolios of charged-off accounts receivable meeting certain criteria. As of December 31, 2001, NCO Portfolio is obligated to purchase accounts receivable to a maximum of $1.8 million per month from January 2002 through May 2002. Litigation The Company is party, from time to time, to various legal proceedings incidental to its business. In June of 2001, the first floor of the Company's Fort Washington, PA, headquarters was severely damaged by a flood caused by remnants of Tropical Storm Allison. During the third quarter of 2001, the Company decided to abandon the Fort Washington facilities and move its corporate headquarters to Horsham, PA. The Company has currently filed a lawsuit against its landlord to terminate the leases for the Fort Washington facilities. Due to the uncertainty of the outcome of the lawsuit, the Company has recorded the full amount of rent due under the remaining terms of the leases during the third quarter of 2001. In the opinion of management no other legal proceedings individually or in the aggregate will have a significant effect on the financial position, results of operations, cash flows, or liquidity of the Company. 19. Segment reporting: During the first nine months of 2000, the Company was organized into operating divisions that were focused on the operational delivery of services. The Company's focus on the operational delivery of services allowed it to take advantage of significant cross-selling opportunities and enhance the level of service provided to its clients. The operating divisions during the first nine months of 2000 included Accounts Receivable Management Services, Technology-Based Outsourcing, and International Operations. During 2000, the continued integration of the Company's infrastructure facilitated the further reduction of the operating divisions from three to two. Effective October 1, 2000, the new operating divisions included U.S. Operations (formerly Accounts Receivable Management Services and Technology-Based Outsourcing) and International Operations. Each of these divisions will maintain industry specific functional groups including financial services, healthcare, retail and commercial, utilities, education, telecommunications, and government. The Company created the Portfolio Management division as a result of the February 2001 Creditrust Merger. Prior to the acquisition, NCO's portfolio business was part of the U.S. Operations division. The accounting policies of the segments are the same as those described in Note 2, "Accounting policies." F-24 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 19. Segment reporting (continued): The U.S Operations division provides accounts receivable management services to consumer and commercial accounts for all market sectors including financial services, healthcare, retail and commercial, utilities, education, telecommunications, and government. The U.S. Operations serve clients of all sizes in local, regional and national markets. In addition to traditional accounts receivable collections, these services include developing the client relationship beyond bad debt recovery and delinquency management, delivering cost-effective accounts receivable and customer relationship management solutions to all market sectors, serving clients of all sizes in local, regional and national markets. The U.S. Operations division had total assets, net of any intercompany balances, of $704.5 million and $732.4 million at December 31, 2000 and 2001, respectively. The Portfolio Management division purchases and manages defaulted consumer accounts receivable from credit grantors, including banks, finance companies, retail merchants and other service providers. Portfolio Management had total assets, net of any intercompany balances, of $32.1 million and $153.7 million at December 31, 2000 and 2001, respectively. The International Operations division provides accounts receivable management services across Canada and the United Kingdom. U.S. Operations uses International Operations as a subcontractor to perform accounts receivable management services to some of its clients. The International Operations division had total assets, net of any intercompany balances, of $47.4 million and $44.9 million at December 31, 2000 and 2001, respectively. The following tables represent the revenue, payroll and related expenses, selling, general and administrative expenses, and earnings before interest, taxes, depreciation, and amortization ("EBITDA") for each segment for the years ended December 31, 1999, 2000 and 2001. EBITDA is used by the Company's management to measure the segments' operating performance and is not intended to report the segments' operating results in conformity with generally accepted accounting principles.
For the year ended December 31, 1999 (Amounts in thousands) ------------------------------------------------------------------------------- Selling, Payroll and General and Nonrecurring Related Admin. Acquisition Revenue Expenses Expenses Costs EBITDA ------------- ------------- ------------- ------------- ------------- U.S. Operations $ 428,293 $ 219,930 $ 119,489 $ -- $ 88,874 Portfolio Management 1,959 180 1,038 -- 741 International Operations 31,040 17,599 8,631 -- 4,810 Eliminations and other (981) -- (981) 4,601 (4,601) ------------- ------------- ------------- ------------- ------------- Total $ 460,311 $ 237,709 $ 128,177 $ 4,601 $ 89,824 ============= ============= ============= ============= ============= For the year ended December 31, 2000 (Amounts in thousands) ------------------------------------------------------------------------ Payroll and Selling, Related General and Revenue Expenses Admin. Expenses EBITDA ---------------- ----------------- ----------------- --------------- U.S. Operations $ 566,769 $ 275,718 $ 170,532 $ 120,519 Portfolio Management 13,151 327 5,853 6,971 International Operations 31,705 17,247 9,280 5,178 Eliminations (5,741) (5,741) - ---------------- ----------------- ----------------- --------------- Total $ 605,884 $ 293,292 $ 179,924 $ 132,668 ================ ================= ================= ===============
F-25 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 19. Segment reporting (continued):
For the year ended December 31, 2001 (Amounts in thousands) ------------------------------------------------------------------------ Payroll and Selling, Related Expenses General and Revenue Admin. Expenses EBITDA ---------------- ----------------- ----------------- --------------- U.S. Operations $ 633,376 $ 332,456 $ 221,995 $ 78,925 Portfolio Management 62,929 1,624 32,437 28,868 International Operations 37,803 21,685 10,729 5,389 Eliminations (32,602) (5,131) (27,471) - ---------------- ----------------- ----------------- --------------- Total $ 701,506 $ 350,634 $ 237,690 $ 113,182 ================ ================= ================= ===============
20. Net loss due to flood and relocation of corporate headquarters: In June of 2001, the first floor of the Company's Fort Washington, PA, headquarters was severely damaged by a flood caused by remnants of Tropical Storm Allison. During the third quarter of 2001, the Company decided to abandon the Fort Washington facilities and move its corporate headquarters to Horsham, PA. The Company has currently filed a lawsuit against its landlord to terminate the leases for the Fort Washington facilities. Due to the uncertainty of the outcome of the lawsuit, the Company has recorded the full amount of rent due under the remaining terms of the leases during the third quarter of 2001. The Company has also recorded other expenses and expected insurance proceeds during the third quarter of 2001 in connection with the flood and the relocation of the corporate headquarters. The net effect of the charges and the gain from the insurance proceeds included in selling, general, and administrative expenses during the third quarter of 2001 was $11.2 million. 21. Investments in unconsolidated subsidiaries: NCO Portfolio owns a 100% retained residual interest in an investment in securitization, Creditrust SPV 98-2, LLC, which was acquired as part of the Creditrust Merger. This transaction qualified for gain on sale accounting when the purchased accounts receivable were originally securitized by Creditrust. This securitization issued a note that is due in January 2004 and had a balance of $5.5 million as of December 31, 2001. The retained interest represents the present value of the residual interest in the securitization using discounted future cash flows after the securitization note is fully repaid plus a cash reserve. As of December 31, 2001, the investment in securitization was $7.3 million, comprised of $4.0 million in present value of discounted residual cash flows plus $3.3 million in cash reserves. The investment accrues non-cash income at a rate of 8% per annum on the residual cash flow component only. The income earned increases the investment balance until the securitization note has been repaid. After repayment of the note, collections are split between income and amortization of the investment in securitization based on the discounted cash flows. The Company recorded $211,000 in income on this investment during the year ended December 31, 2001. The cash reserves of $3.3 million plus the first $1.3 million in residual cash collections received after the securitization note has been repaid have been pledged as collateral against the Warehouse Facility (see note 8). F-26 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 21. Investments in unconsolidated subsidiaries (continued): NCO Portfolio has a 50% ownership interest in a joint venture, InoVision-MEDCLR NCOP Ventures, LLC ("Joint Venture") with IMNV Holdings, LLC ("Marlin"). This Joint Venture was established to purchase utility, medical and other various small balance accounts receivable and is accounted for using the equity method of accounting. As of December 31, 2001, NCO Portfolio and Marlin had each invested $574,000 in the Joint Venture for the purchase of accounts receivable. Included in the Statement of Income, in "other income," was $118,000 representing the Company's 50% share of operating income from this unconsolidated subsidiary for the year ended December 31, 2001. The Joint Venture has access to capital through a specialty finance lender who, at its option, lends 90% of the value of the purchased accounts receivable to the Joint Venture. The debt is cross-collateralized by all static pools in which the lender participates, and is non-recourse to NCO Portfolio. The following table summarizes the financial information of the Joint Venture as of and for the year ended December 31, 2001 (amounts in thousands): Total assets $ 5,581 Total liabilities 4,455 Revenue 1,061 Operating income 236 22. Related party transactions: From time to time, the Company uses an airplane that is partly owned by Michael J. Barrist, Chairman, President, and Chief Executive Officer of NCO. The Company pays to a third party management company, which is not affiliated with Mr. Barrist, the monthly management fee and out-of-pocket costs for the Company's use of the airplane. The Company paid costs of $358,000, $368,000, and $363,000 for the years ended December 31, 1999, 2000, and 2001, respectively. 23. Subsequent event: During February 2002, the Company entered into two interest rate swap agreements to reduce the impact of changes in LIBOR on a portion of the debt borrowed under its revolving credit facility. The interest rate swap agreements fixed LIBOR at a rate of 2.82%. The total initial notional amount of the interest rate swap agreements was $102.0 million. The notional amount of the interest rate swap agreements is subject to scheduled quarterly reductions. The interest rate swap agreements expire in September 2003. 24. Recent accounting pronouncements: In July 2001, the Financial Accounting Standards Board ("FASB") issued SFAS No.s 141 and 142, "Business Combinations" and "Goodwill and Other Intangibles." FASB 141 requires all business combinations initiated after July 1, 2001, to be accounted for using the purchase method. FASB 142 concluded that purchased goodwill would not be amortized but would be reviewed for impairment when certain events indicate that the goodwill of a reporting unit is impaired. The impairment test will use a fair-value based approach, whereby if the implied fair value of a reporting unit's goodwill is less than its carrying amount, goodwill would be considered impaired. FASB 142 does not require that goodwill be tested for impairment upon adoption unless an indicator of impairment exists at that date. However, it would require that a benchmark assessment be performed for all existing reporting units within six months of the date of adoption. The new goodwill model applies not only to goodwill arising from acquisitions completed after the effective date, but also to goodwill previously recorded. The Company adopted FASB 142 in the first quarter of 2002 and is in the process of determining the impact of these pronouncements on its financial position and results of operations. F-27 NCO GROUP, INC. Notes to Consolidated Financial Statements (Continued) 24. Recent accounting pronouncements (continued): During 2001, the Accounting Staff Executive Committee approved an exposure draft on a proposed Statement of Position, "Accounting for Discounts Related to Credit Quality" ("SOP"). The proposed SOP would limit the revenue that may be accrued to the excess of the estimate of expected future cash flows over the static pool's initial cost of accounts receivable acquired. The proposed SOP would require that the excess of the contractual cash flows over expected future cash flows not be recognized as an adjustment of revenue, expense or on the balance sheet. The proposed SOP would freeze the internal rate of return ("IRR") originally estimated when the accounts receivable are purchased for subsequent impairment testing. Rather than lower the estimated IRR if the original collection estimates are not received, the carrying value of a static pool would be written down to maintain the original IRR. Increases in expected future cash flows would be recognized prospectively through adjustment of the IRR over a static pool's remaining life. The exposure draft provides that previously issued annual financial statements would not need to be restated. Until final issuance of this SOP, we cannot ascertain its effect on our reporting. F-28 NCO GROUP, INC. Consolidating Statement of Income (Unaudited) (in thousands, except for per share amounts)
For the Year Ended December 31, 2001 -------------------------------------------------- NCO Intercompany NCO Group Portfolio Eliminations Consolidated --------- --------- ------------ ------------ Revenue $ 666,048 $ 62,929 $ (27,471) $ 701,506 Operating costs and expenses: Payroll and related expenses 349,010 1,624 350,634 Selling, general, and administrative expenses 232,724 32,437 (27,471) 237,690 Depreciation and amortization expense 37,955 250 38,205 --------- --------- --------- --------- 619,689 34,311 (27,471) 626,529 --------- --------- --------- --------- 46,359 28,618 -- 74,977 Other income (expense): Interest and investment income 3,859 531 (763) 3,627 Interest expense (19,495) (8,230) 763 (26,962) --------- --------- --------- --------- (15,636) (7,699) -- (23,335) --------- --------- --------- --------- Income before income tax expense 30,723 20,919 -- 51,642 Income tax expense 13,618 7,845 21,463 --------- --------- --------- --------- Income from operations before minority interest 17,105 13,074 -- 30,179 Minority interest -- -- (4,310) (4,310) --------- --------- --------- --------- Net income $ 17,105 $ 13,074 $ (4,310) $ 25,869 ========= ========= ========= =========
F-29 NCO GROUP, INC. Schedule II - Valuation and Qualifying Accounts
Additions ------------------------- Balance at Charged to Charged to Balance at beginning costs and other end of year Expenses accounts (1) Deductions (2) year ----------- ----------- ------------- --------------- ------------- Year ended December 31, 1999: Allowance for doubtful accounts $3,619,000 $2,553,000 $ 900,000 $ (1,681,000) $ 5,391,000 Year ended December 31, 2000: Allowance for doubtful accounts $5,391,000 $5,906,000 $ - $ (4,217,000) $ 7,080,000 Year ended December 31, 2001: Allowance for doubtful accounts $7,080,000 $4,250,000 $ - $ (6,019,000) $ 5,311,000
(1) Allowance for doubtful accounts of acquired companies. (2) Uncollectible accounts written off, net of recoveries. S-1