UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
/X/ Quarterly report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the quarterly period ended June 30, 2001, or
/ / Transition report pursuant to Section 13 or 15(d) of
the Securities Exchange Act of 1934
For the transition period from to
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COMMISSION FILE NUMBER 0-21639
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NCO GROUP, INC.
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(Exact name of registrant as specified in its charter)
PENNSYLVANIA
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(State or other jurisdiction of incorporation or organization)
515 Pennsylvania Avenue, Fort Washington, Pennsylvania
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(Address of principal executive offices)
23-2858652
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(IRS Employer Identification Number)
19034
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(Zip Code)
215-793-9300
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(Registrant's telephone number including area code)
Not Applicable
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(Former name, former address and former fiscal year,
if changed since last report)
Indicate by check mark whether the registrant (1) has filed all reports
required to be filed by Section 13 or 15(d) of the Securities Exchange Act of
1934 during the preceding 12 months, and (2) has been subject to such filing
requirements for the past 90 days.
Yes _X_ No ___
The number of shares outstanding of each of the issuer's classes of
common stock was 25,811,238 shares common stock, no par value, outstanding as of
August 14, 2001.
NCO GROUP, INC.
INDEX
PAGE
PART I - FINANCIAL INFORMATION
Item 1 CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)
Consolidated Balance Sheets -
December 31, 2000 and June 30, 2001 1
Consolidated Statements of Income -
Three months and six months ended June 30, 2000 and 2001 2
Consolidated Statements of Cash Flows -
Six months ended June 30, 2000 and 2001 3
Notes to Consolidated Financial Statements 4
Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF
FINANCIAL CONDITION AND RESULTS OF OPERATIONS 13
Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES
ABOUT MARKET RISK 19
PART II - OTHER INFORMATION 20
Item 1. Legal Proceedings
Item 2. Changes in Securities
Item 3. Defaults Upon Senior Securities
Item 4. Submission of Matters to a Vote of Shareholders
Item 5. Other Information
Item 6. Exhibits and Reports on Form 8-K
Part 1 - Financial Information
Item 1 - Financial Statements
NCO GROUP, INC.
Consolidated Balance Sheets
(Amounts in thousands)
June 30,
December 31, 2001
ASSETS 2000 (Unaudited)
------------ -----------
Current assets:
Cash and cash equivalents $ 13,490 $ 20,401
Restricted cash - 1,125
Accounts receivable, trade, net of allowance for
doubtful accounts of $7,080 and $6,435, respectively 93,971 105,765
Purchased accounts receivable, current portion 10,861 37,310
Deferred income taxes 2,287 7,113
Other current assets 7,925 8,959
--------- ---------
Total current assets 128,534 180,673
Funds held on behalf of clients
Property and equipment, net 66,401 72,447
Other assets:
Intangibles, net of accumulated amortization 536,750 532,595
Purchased accounts receivable, net of current portion 23,614 105,152
Notes receivable 18,250 18,250
Other assets 10,457 18,094
--------- ---------
Total other assets 589,071 674,091
--------- ---------
Total assets $ 784,006 $ 927,211
========= =========
LIABILITIES AND SHAREHOLDERS' EQUITY
Current liabilities:
Long-term debt, current portion $ 642 $ 23,564
Corporate taxes payable 1,328 300
Accounts payable 12,360 13,191
Accrued expenses 19,168 29,907
Accrued compensation and related expenses 15,304 17,746
--------- ---------
Total current liabilities 48,802 84,708
Funds held on behalf of clients
Long-term liabilities:
Long-term debt, net of current portion 303,920 373,610
Deferred income taxes 40,549 37,421
Other long-term liabilities 4,309 5,390
Minority interest - 18,933
Shareholders' equity:
Preferred stock, no par value, 5,000 shares authorized,
no shares issued and outstanding - -
Common stock, no par value, 50,000 shares authorized,
25,627 and 25,811 shares issued and outstanding, respectively 316,372 320,800
Other comprehensive loss (1,525) (1,956)
Retained earnings 71,579 88,305
--------- ---------
Total shareholders' equity 386,426 407,149
--------- ---------
Total liabilities and shareholders' equity $ 784,006 $ 927,211
========= =========
See accompanying notes.
-1-
NCO GROUP, INC.
Consolidated Statements of Income
(Unaudited)
(Amounts in thousands, except per share data)
For the Three Months For the Six Months
Ended June 30, Ended June 30,
------------------------------ -----------------------------
2000 2001 2000 2001
---------- ---------- ---------- ----------
Revenue $ 154,048 $ 183,275 $ 298,046 $ 354,304
Operating costs and expenses:
Payroll and related expenses 73,842 99,475 144,488 182,387
Selling, general, and administrative expenses 46,135 58,164 87,693 109,287
Depreciation and amortization expense 7,973 9,623 15,518 18,577
--------- --------- --------- ---------
Total operating costs and expenses 127,950 167,262 247,699 310,251
--------- --------- --------- ---------
Income from operations 26,098 16,013 50,347 44,053
Other income (expense):
Interest and investment income 463 888 966 1,804
Interest expense (6,394) (7,295) (12,815) (14,716)
Other income - - 1,313 -
--------- --------- --------- ---------
Total other income (expense) (5,931) (6,407) (10,536) (12,912)
--------- --------- --------- ---------
Income before income tax expense 20,167 9,606 39,811 31,141
Income tax expense 8,544 3,719 16,795 12,385
--------- --------- --------- ---------
Income from continuing operations before
minority interest 11,623 5,887 23,016 18,756
Minority interest - (1,438) - (2,030)
--------- --------- --------- ---------
Income from continuing operations 11,623 4,449 23,016 16,726
Discontinued operations, net of income taxes:
Loss from discontinued operations (71) - (975) -
Loss on disposal of discontinued operations - - (20,814) -
--------- --------- --------- ---------
Net income $ 11,552 $ 4,449 $ 1,227 $ 16,726
========= ========= ========= =========
Income from continuing operations per share:
Basic $ 0.45 $ 0.17 $ 0.90 $ 0.65
Diluted $ 0.45 $ 0.17 $ 0.89 $ 0.63
Net income per share:
Basic $ 0.45 $ 0.17 $ 0.05 $ 0.65
Diluted $ 0.45 $ 0.17 $ 0.05 $ 0.63
Weighted average shares outstanding:
Basic 25,579 25,781 25,560 25,734
Diluted 25,922 26,229 25,887 28,100
See accompanying notes.
-2-
NCO GROUP, INC
Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)
For the Six Months
Ended June 30,
-----------------------------
2000 2001
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Cash flows from operating activities:
Income from continuing operations $ 23,016 $ 16,726
Adjustments to reconcile income from continuing
operations to net cash provided by
continuing operating activities:
Depreciation 6,964 9,710
Amortization of intangibles 8,554 8,867
Provision for doubtful accounts 2,185 2,202
Impairment of purchased accounts receivable - 463
Minority interest - 2,030
Changes in operating assets and liabilities,
net of acquisitions:
Restricted cash - 2,555
Accounts receivable, trade (13,726) (14,157)
Deferred income taxes 3,048 4,027
Other assets (5,129) (4,101)
Accounts payable and accrued expenses (1,171) 8,327
Corporate taxes payable (4,597) (208)
Other long-term liabilities (4,279) 1,081
-------- --------
Net cash provided by continuing operating activities 14,865 37,522
Net cash provided by discontinued
operating activities 1,384 -
-------- --------
Net cash provided by operating activities 16,249 37,522
Cash flows from investing activities:
Acquisition of purchased accounts receivable (13,211) (26,319)
Collections applied to principal of purchased
accounts receivable 1,978 16,306
Purchase of property and equipment (15,906) (13,491)
Investment in consolidated subsidiary by minority interest - 2,320
Net cash paid for pre-acquisition liabilities and
acquisition related costs (10,000) (11,077)
-------- --------
Net cash used in investing activities (37,139) (32,261)
Cash flows from financing activities:
Repayment of notes payable (816) (10,740)
Repayment of acquired notes payable - (20,084)
Borrowings under revolving credit agreement - 51,330
Repayment of borrowings under revolving credit agreement (10,000) (142,350)
Payment of fees to acquire new debt - (5,055)
Proceeds from issuance of convertible debt - 125,000
Issuance of common stock, net 1,009 3,647
-------- --------
Net cash (used in) provided by financing activities (9,807) 1,748
Effect of exchange rate on cash 41 (98)
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Net (decrease) increase in cash and cash equivalents (30,656) 6,911
Cash and cash equivalents at beginning of period 50,513 13,490
-------- --------
Cash and cash equivalents at end of period $ 19,857 $ 20,401
======== ========
See accompanying notes.
-3-
NCO GROUP, INC.
Notes to Consolidated Financial Statements
(Unaudited)
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, commercial,
education, utilities, government and telecommunications sectors. These clients
are primarily located throughout the United States of America, Canada, the
United Kingdom, and Puerto Rico.
2. Accounting Policies:
Interim Financial Information:
The accompanying unaudited consolidated financial statements have been prepared
in accordance with generally accepted accounting principles for interim
financial information and with the instructions for Form 10-Q and Rule 10-01 of
Regulation S-X. Accordingly, they do not include all of the information and
footnotes required by generally accepted accounting principles for complete
financial statements. In the opinion of management, all adjustments (consisting
of only normal recurring accruals) considered necessary for a fair presentation
have been included. Operating results for the three-month and six-month periods
ended June 30, 2001, are not necessarily indicative of the results that may be
expected for the year ending December 31, 2001, or for any other interim period.
For further information, refer to the consolidated financial statements and
footnotes thereto included in the Company's Annual Report on Form 10-K filed
with the Securities and Exchange Commission on March 16, 2001.
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.
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 pool consists of an individual acquisition of accounts. Once a static pool
is established, the accounts in the pool are not changed.
Each static pool is initially recorded at cost. Collections on the pools are
allocated to revenue and principal reduction based on the estimated internal
rate of return for each pool. The internal rate of return for each static pool
is estimated based on the expected monthly collections over the estimated
economic life of each 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 internal rate of return 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 internal rate of return 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 pool may be accreted for the difference
between the revenue accrual and the carrying value.
-4-
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 adjusts the yield (the internal rate
of return) accordingly. To the extent that the carrying amount of a particular
static pool exceeds its expected future cash flows, a charge to earnings would
be recognized in the amount of such impairment. After the impairment of a static
pool, no income is recorded on that static pool and collections are recorded as
a return of capital. The estimated yield for each static pool is based on
estimates of future cash flows from collections, and actual cash flows may vary
from current estimates. The difference could be material.
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.
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.
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.
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.
The static pools of purchased accounts receivable are comprised of distressed
debt. Collection results are not guaranteed until received; accordingly, for tax
purposes, any gain on a particular static pool is deferred until the full cost
of its acquisition is recovered. Revenue for financial reporting purposes is
recognized over the life of the static pool. Deferred tax liabilities arise from
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.
-5-
2. Accounting Policies (continued):
Use of Estimates:
The preparation of financial statements in conformity with accounting principles
generally accepted in the United States requires management to make estimates
and assumptions that affect the reported amounts of assets and liabilities and
disclosure of contingent assets and liabilities at the date of the financial
statements and the reported amounts of revenues and expenses during the
reporting period. Actual results could differ from those estimates.
Significant estimates have been made by management with respect to the amount of
future cash flows of purchased accounts receivable portfolios. The estimated
future cash flows of the portfolios are used to recognize revenue and amortize
the carrying values of the purchased accounts receivable. Actual results could
differ from these estimates, making it reasonably possible that a change in
these estimates could occur within one year. On a quarterly basis, management
reviews the estimate of future collections, and it is reasonably possible that
its assessment may change based on actual results and other factors. The change
could be material.
Reclassifications:
Certain amounts for the six months ended June 30, 2000, 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 Holdings, Inc., 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 until 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.
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.
-6-
3. Discontinued Operations (continued):
The following summary of the Market Strategy division's operations prior to the
Measurement Date have been presented net in the Company's consolidated statement
of income for the three months and six months ended June 30, 2000 (amounts in
thousands):
Three months ended Six months ended
June 30, 2000 June 30, 2000
------------------ ----------------
Revenue
$ 1,195 $ 7,802
======= =======
Loss from discontinued operations
before income tax benefit $ (95) $(1,498)
Income tax benefit (24) (523)
------- -------
Loss from discontinued operations,
net of income tax benefit $ (71) $ (975)
======= =======
During the six months ended June 30, 2000, the Company recorded a $20.8 million
loss (net of a tax benefit of $2.9 million), or $0.80 loss per share on a
diluted basis, on the disposal of the Market Strategy division. This loss
reflected management's estimate of the difference between the net assets of the
Market Strategy division over the proceeds from the divestiture and the
estimated operating losses from the Measurement Date through the completion of
the divestiture.
4. Acquisition:
In February 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. After the 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 acquisition, 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 acquisition, NCO Group amended its credit agreement with
Mellon Bank, N.A., for itself and as administrative agent for other
participating lenders, to make $50.0 million of its credit facility available
for the use of NCO Portfolio. Upon completion of the acquisition, NCO Group
borrowed $36.3 million for NCO Portfolio under this credit facility.
The following summarizes the unaudited pro forma results of operations for the
six months ended June 30, 2000 and 2001, assuming the Creditrust acquisition
occurred as of the beginning of the respective periods. 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):
For the six months ended June 30,
---------------------------------
2000 2001
----------- -----------
Revenue $326,376 $357,884
Net income $(34,782) $ 7,758
Earnings per share - basic $ (1.36) $ 0.30
Earnings per share - diluted $ (1.36) $ 0.30
-7-
5. Comprehensive Income:
Comprehensive income consists of net income from operations, plus certain
changes in assets and liabilities that are not included in net income but are
reported as a separate component of shareholders' equity. The Company's
comprehensive income for the three months and six months ended June 30, 2000 and
2001 was as follows (amounts in thousands):
For the three months For the six months
ended June 30, ended June 30,
-------------------- ------------------
2000 2001 2000 2001
-------- ------- ------- --------
Net income $ 11,552 $ 4,449 $ 1,227 $ 16,726
Foreign currency translation adjustment (634) 1,830 (639) (431)
-------- ------- ------- --------
Comprehensive income $ 10,918 $ 6,279 $ 588 $ 16,295
======== ======= ======= ========
6. Purchased Accounts Receivable:
The Company purchases defaulted consumer receivables at a discount from the
actual principal balance. The following summarizes the change in purchased
accounts receivable for the year ended December 31, 2000 and for the six months
ended June 30, 2001:
December 31, June 30,
2000 2001
------------ ----------
Balance, at beginning of period $ 6,719 $ 34,475
Purchased accounts receivable acquired
from Creditrust - 98,988
Purchases of accounts receivable 32,961 26,319
Collections on purchased accounts receivable (20,495) (47,623)
Revenue recognized 15,411 30,797
Impairment of purchased accounts receivable - (463)
Foreign currency translation adjustment (121) (31)
-------- ---------
Balance, at end of period $ 34,475 $ 142,462
======== =========
To the extent that the carrying amount of a static pool exceeds its fair value,
an impairment would be recognized as a charge to earnings. After the impairment
of a static pool, no revenue is recognized on that static pool, and all
collections are treated as a return of capital. During the quarter ended June
30, 2001, an impairment in the amount of $463,000 was recorded as the carrying
value of six static pools exceeded their fair value. No revenue will be recorded
on these static pools until their carrying amounts have been fully recovered.
The combined carry amounts on these static pools after impairment totaled
approximately $1.8 million as of June 30, 2001, representing their net
realizable value.
7. 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 $59.4 million at
December 31, 2000 and June 30, 2001, respectively, have been shown net of their
offsetting liability for financial statement presentation.
-8-
8. Long-Term Debt:
Revolving Credit Facility
The Company has a credit agreement with Mellon Bank, N.A. ("Mellon Bank"), for
itself and as administrative agent for other participating lenders, that
originally provided for borrowings up to $350.0 million, structured as a
revolving credit facility. The borrowing capacity of the revolving credit
facility is subject to mandatory reductions including quarterly reductions of
$6.3 million beginning on March 31, 2001 and 50 percent of the net proceeds
received from any offering of debt or equity. As of June 30, 2001, the maximum
borrowing capacity of the revolving credit agreement was $276.9 million.
At the option of NCO, the borrowings bear interest at a rate equal to either
Mellon Bank's prime rate plus a margin of 0.25% to 0.50% that is determined
quarterly based upon the Company's consolidated funded debt to earnings before
interest, taxes, depreciation, and amortization ("EBITDA") ratio (Mellon Bank's
prime rate was 6.75% at June 30, 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 3.84% at June 30, 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. At the option of NCO, the
borrowings bear interest at a rate equal to either Mellon 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.
Borrowings are collateralized by substantially all the assets of the Company,
including the common stock of NCO Portfolio, and certain assets of NCO
Portfolio. The balance under the revolving credit facility shall 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.
Convertible Debt
In April 2001, the Company 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 NCO common stock at an initial
conversion price of $32.92 per share. 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
NCO Portfolio has assumed three securitized notes payable in connection with the
acquisition of Creditrust. These notes payable were originally established to
fund the purchase of accounts receivable. Each of the notes payable is
non-recourse to the Company and NCO Portfolio, secured by a 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 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.
-9-
8. Long-Term Debt (continued):
Securitized Debt (continued)
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 June 30, 2001,
and is restricted as to use until the facility is retired. Interest expense,
trustee fees and guarantee fees aggregated $216,000 and $473,000 for the three
months ended June 30, 2001 and the period from February 21, 2001 to June 30,
2001, respectively. As of June 30, 2001, the amount outstanding on the facility
was $19.4 million. The note issuer, 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
are posted as additional collateral for this facility.
The second securitized note ("SPV99-1 Financing") was established in August 1999
through Creditrust SPV99-1, LLC, a special purpose finance subsidiary. SPV99-1
Financing 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
June 30 2001, and is restricted as to use until the facility is retired.
Interest expense, trustee fees and guarantee fees aggregated $257,000 and
$398,000 for the three months ended June 30, 2001 and the period from February
21, 2001 to June 30, 2001, respectively. As of June 30, 2001, the amount
outstanding on the facility was $9.6 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, trustee fees and guarantee fees aggregated $1.0
million and $1.4 million for the three months ended June 30, 2001 and the period
from February 21, 2001 to June 30, 2001, respectively. As of June 30, 2001, the
amount outstanding on the facility was $26.4 million.
9. Earnings Per Share:
Basic earnings per share ("EPS") were computed by dividing the income from
continuing operations and the net income for the three months and six months
ended June 30, 2000 and 2001, by the weighted average number of common shares
outstanding. Diluted EPS were computed by dividing the income from continuing
operations and the net income for the three months and six months ended June 30,
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 net income per share only
when their effect would be dilutive. For the three months ended June 30, 2001,
the common stock to be issued assuming the conversion of the 4.75% convertible
notes issued in April 2001 were antidilutive and, therefore, excluded from
computing diluted EPS.
The reconciliation of basic to diluted weighted average shares outstanding for
the three months and six months ended June 30, 2000 and 2001 was as follows
(amounts in thousands):
For the three months ended For the six months ended
June 30, June 30,
----------------------- ------------------------
2000 2001 2000 2001
------ ------ ------ ------
Basic 25,579 25,781 25,560 25,734
Dilutive effect of convertible debt - - - 1,815
Dilutive effect of options 214 313 209 406
Dilutive effect of warrants 129 135 118 145
------ ------ ------ ------
Diluted 25,922 26,229 25,887 28,100
====== ====== ====== ======
-10-
10. Supplemental Cash Flow Information:
The following are supplemental disclosures of cash flow information for the six
months ended June 30, 2000 and 2001 (amounts in thousands):
2000 2001
------ ------
Non-cash investing and financing activities:
Fair value of assets acquired $ - $ 121,511
Liabilities assumed from acquisitions - 106,627
11. 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 healthcare, commercial, banking, retail,
education, utilities, telecommunications, and government. The Company created
the Portfolio Management division as a result of the February 2001 acquisition
of Creditrust. Prior to the acquisition, NCO's portfolio business was part of
the U.S. Operations division. The segment information for the three months and
six months ended June 30, 2000, has been restated to reflect the three
continuing operating segments.
The accounting policies of the segments are the same as those described in Note
2, "Accounting Policies."
The U.S Operations division provides accounts receivable management services to
consumer and commercial accounts for all market segments, serving 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 receivables and customer relationship management solutions to all
market segments, serving clients of all sizes in local, regional and national
markets. The U.S. Operations division is the exclusive provider of accounts
receivable management services to Portfolio Management. U.S. Operations had
total assets, net of any intercompany balances, of $704.5 million and $724.8
million at December 31, 2000 and June 30, 2001, respectively.
The Portfolio Management division purchases and manages defaulted consumer
receivables 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 $155.5 million at
December 31, 2000 and June 30, 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 sub-contractor to perform accounts receivable
management services to some of its clients. International Operations had total
assets, net of any intercompany balances, of $47.4 million and $46.9 million at
December 31, 2000 and June 30, 2001, respectively.
-11-
11. Segment Reporting (continued):
The following tables represent the revenue, payroll and related expenses,
selling, general, and administrative expenses, and earnings before interest,
taxes, depreciation, and amortization ("EBITDA") for each segment for the three
months and six months ended June 30, 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 accounting
principles generally accepted in the United States.
For the three months ended June 30, 2000
(amounts in thousands)
------------------------------------------------------------------------
Selling,
Payroll and General and
Revenue Related Expenses Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
U.S. Operations $ 144,410 $ 69,629 $ 43,781 $ 31,000
Portfolio Management 2,837 74 1,018 1,745
International Operations 7,804 4,139 2,339 1,326
Eliminations (1,003) - (1,003) -
--------- -------- -------- --------
Total $ 154,048 $ 73,842 $ 46,135 $ 34,071
========= ======== ======== ========
For the three months ended June 30, 2001
(amounts in thousands)
------------------------------------------------------------------------
Selling,
Payroll and General and
Revenue Related Expenses Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
U.S. Operations $ 164,842 $ 93,931 $ 54,349 $ 16,562
Portfolio Management 17,916 551 8,799 8,566
International Operations 9,276 6,057 2,711 508
Eliminations (8,759) (1,064) (7,695) -
--------- -------- -------- --------
Total $ 183,275 $ 99,475 $ 58,164 $ 25,636
========= ======== ======== ========
For the six months ended June 30, 2000
(amounts in thousands)
------------------------------------------------------------------------
Selling,
Payroll and General and
Revenue Related Expenses Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
U.S. Operations $ 280,523 $ 135,831 $ 82,966 $ 61,726
Portfolio Management 3,727 148 1,541 2,038
International Operations 15,315 8,509 4,705 2,101
Eliminations (1,519) - (1,519) -
--------- --------- -------- --------
Total $ 298,046 $ 144,488 $ 87,693 $ 65,865
========= ========= ======== ========
For the six months ended June 30, 2001
(amounts in thousands)
------------------------------------------------------------------------
Selling,
Payroll and General and
Revenue Related Expenses Admin. Expenses EBITDA
---------------- ----------------- ----------------- ---------------
U.S. Operations $ 320,614 $ 172,622 $ 102,278 $ 45,714
Portfolio Management 30,534 808 14,904 14,822
International Operations 18,044 10,799 5,151 2,094
Eliminations (14,888) (1,842) (13,046) -
--------- --------- -------- --------
Total $ 354,304 $ 182,387 $ 109,287 $ 62,630
========= ========= ======== ========
-12-
Item 2 Management's Discussion and Analysis of Financial Condition and Results
of Operations
Certain statements included in this Report on Form 10-Q, 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, expected increases in operating efficiencies,
anticipated trends in the accounts receivable management industry, estimate 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.,
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
and other risks detailed from time to time in the Company's filings with the
Securities and Exchange Commission, including the Company's Annual Report on
Form 10-K, filed March 16, 2001, can cause actual results and developments to be
materially different from those expressed or implied by such forward-looking
statements.
A copy of the Annual Report on Form 10-K can be obtained, without
charge except for exhibits, by written request to Steven L. Winokur, Executive
Vice President, Finance/CFO, NCO Group, Inc., 515 Pennsylvania Avenue, Fort
Washington, PA 19034.
Three Months Ended June 30, 2001, Compared to Three Months Ended June
30, 2000
Revenue. Revenue increased $29.3 million, or 19.0%, to $183.3 million
for the three months ended June 30, 2001, from $154.0 million for the comparable
period in 2000. The U.S. Operations, Portfolio Management, and International
Operations divisions represented $164.9 million, $17.9 million, and $9.3
million, respectively, of the revenue for the three months ended June 30, 2001.
The U.S. Operations' revenue included $7.7 million of revenue earned on services
performed for the Portfolio Management division that was eliminated upon
consolidation. The International Operations' revenue included $1.1 million of
revenue earned on services performed for the U.S. Operations division that was
eliminated upon consolidation.
U.S. Operations' revenue increased $20.5 million, or 14.1%, to $164.9
million for the three months ended June 30, 2001, from $144.4 million for the
comparable period in 2000. This increase in the U.S. Operations' revenue was
attributable to the addition of new clients and the growth in business from
existing clients.
Portfolio Management's revenue increased $15.1 million, or 531.5%, to
$17.9 million for the three months ended June 30, 2001, from $2.8 million for
the comparable period in 2000. This increase in the Portfolio Management's
revenue was partially attributable to an increase in acquisitions of purchased
accounts receivable. The remainder of the increase was attributable to the
acquisition of Creditrust in February 2001.
International Operations' revenue increased $1.5 million, or 18.9%, to
$9.3 million for the three months ended June 30, 2001, from $7.8 million for the
comparable period in 2000. This increase in the International Operations'
revenue was primarily attributable to new sub-contractor services provided for
U.S. Operations.
-13-
Payroll and related expenses. Payroll and related expenses increased
$25.7 million to $99.5 million for the three months ended June 30, 2001, from
$73.8 million for the comparable period in 2000, and increased as a percentage
of revenue to 54.3% from 47.9%. A portion of the overall increase as a
percentage of revenue was the result of reduced collectibility within the
Company's contingent revenue stream. Accordingly, in order to mitigate the
effects of the decreased collectibility while maintaining its performance for
its clients, the Company had to increase spending for payroll costs. In
addition, the Company incurred $10.7 million of one-time charges during the
second quarter of 2001 related to a comprehensive streamlining of its expense
structure designed to counteract the effects of operating in a more difficult
collection environment. These costs primarily consisted of the elimination or
acceleration of certain contractual employment obligations, severance costs
related to terminated employees, and costs related to a decision to change the
structure of our healthcare benefit programs from a large, singular benefit
platform to individual plans across the country. A portion of these increases
was offset by the increase in the size of the Portfolio Management division,
which has a lower payroll cost structure than the remainder of the Company.
The payroll and related expenses of the U.S Operations division
increased $24.3 million to $93.9 million for the three months ended June 30,
2001, from $69.6 million for the comparable period in 2000, and increased as a
percentage of revenue to 57.0% from 48.2%. A portion of the increase as a
percentage of revenue was the result of reduced collectibility within the U.S.
Operations' contingent revenue stream. Accordingly, in order to mitigate the
effects of the decreased collectibility while maintaining its performance for
its clients, the Company had to increase spending for payroll costs. In
addition, the U.S. Operations incurred $10.0 million of the one-time charges
during the second quarter of 2001, as discussed above.
The payroll and related expenses of the Portfolio Management division
increased $477,000 to $551,000 for the three months ended June 30, 2001, from
$74,000 for the comparable period in 2000, and increased as a percentage of
revenue to 3.1% from 2.6%. 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. However, due to the expansion of
this division and the February 2001 acquisition of Creditrust, the Portfolio
Management division required additional employees to operate NCO Portfolio
Management, Inc. as a separate public company.
The payroll and related expenses of the International Operations
division increased $2.0 million to $6.1 million for the three months ended June
30, 2001, from $4.1 million for the comparable period in 2000, and increased as
a percentage of revenue to 65.3% from 53.0%. A portion of the increase as a
percentage of revenue was the result of upfront costs related to new projects
started in the second quarter of 2001. The increase was also attributable to new
sub-contractor services provided to the U.S. Operations at lower margins. In
addition, the International Operations incurred $736,000 of the one-time charges
during the second quarter of 2001, as discussed above.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $12.1 million to $58.2 million for the three
months ended June 30, 2001, from $46.1 million for the comparable period in
2000, and increased as a percentage of revenue to 31.7% from 29.9%. A portion of
the overall increase as a percentage of revenue was the result of reduced
collectibility within the Company's contingent revenue stream. Accordingly, in
order to mitigate the effects of the decreased collectibility while maintaining
its performance for its clients, the Company 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. In addition, the Company incurred $1.8 million of one-time
charges during the second quarter of 2001 related to a comprehensive
streamlining of its 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.
Depreciation and amortization. Depreciation and amortization increased
to $9.6 million for the three months ended June 30, 2001 from $8.0 million for
the comparable period 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 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.
-14-
Other income (expense). Interest and investment income increased
$425,000 to $888,000 for the three months ended June 30, 2001 over the
comparable period in 2000. This increase was primarily attributable to increases
in operating cash and funds held on behalf of clients. Interest expense
increased to $7.3 million for the three months ended June 30, 2001, from $6.4
million for the comparable period in 2000. This increase was partially
attributable to the Portfolio Management division borrowing $36.3 million in
connection with the February 2001 acquisition of Creditrust Corporation
("Creditrust"). In addition, a portion of the increase was attributable to
interest from securitized debt that was assumed as part of the Creditrust
acquisition. A portion of these increases was offset by a decrease in interest
rates and debt repayments made during 2000 and the first half of 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.
Income tax expense. Income tax expense for the three months ended June
30, 2001 decreased to $3.7 million, or 38.7% of income before income tax
expense, from $8.5 million, or 42.4% of income before income tax expense, for
the comparable period in 2000. A portion of the decrease was attributable to the
expansion of the Portfolio Management division, which has a lower effective tax
rate than the remainder of the Company. The lower effective tax rate of the
Portfolio Management division had a larger impact on the overall effective tax
rate for the second quarter of 2001 due to the $12.5 million of one-time charges
incurred by the remainder of the Company. In addition, a portion of the decrease
was the result of the implementation of certain tax savings initiatives during
the fourth quarter of 2000.
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 had a loss from operations of
$71,000 for the period from April 1, 2000 to the Measurement Date. The
operations for the period from the Measurement Date to June 30, 2000 were
recorded during the first quarter of 2000 as part of the expected loss on the
disposal of the Market Strategy division. The Company completed the divestiture
of the Market Strategy division on October 26, 2000.
Six Months Ended June 30, 2001, Compared to Six Months Ended June 30,
2000
Revenue. Revenue increased $56.3 million, or 18.9%, to $354.3 million
for the six months ended June 30, 2001, from $298.0 million for the comparable
period in 2000. The U.S. Operations, Portfolio Management, and International
Operations divisions represented $320.6 million, $30.5 million, and $18.1
million, respectively, of the revenue for the six months ended June 30, 2001.
The U.S. Operations' revenue included $13.0 million of revenue earned on
services performed for the Portfolio Management division that was eliminated
upon consolidation. The International Operations' revenue included $1.9 million
of revenue earned on services performed for the U.S. Operations division that
was eliminated upon consolidation.
U.S. Operations' revenue increased $40.1 million, or 14.3%, to $320.6
million for the six months ended June 30, 2001, from $280.5 million for the
comparable period in 2000. This increase in the U.S. Operations' revenue was
attributable to the addition of new clients and the growth in business from
existing clients.
Portfolio Management's revenue increased $26.8 million, or 719.3%, to
$30.5 million for the six months ended June 30, 2001, from $3.7 million for the
comparable period in 2000. This increase in the Portfolio Management's revenue
was partially attributable to an increase in acquisitions of purchased accounts
receivable. The remainder of the increase was attributable to the acquisition of
Creditrust in February 2001.
International Operations' revenue increased $2.8 million, or 17.8%, to
$18.1 million for the six months ended June 30, 2001, from $15.3 million for the
comparable period in 2000. This increase in the International Operations'
revenue was primarily attributable to the addition of new clients and growth in
business from existing clients.
Payroll and related expenses. Payroll and related expenses increased
$37.9 million to $182.4 million for the six months ended June 30, 2001, from
$144.5 million for the comparable period in 2000, and increased as a percentage
of revenue to 51.5% from 48.5%. A portion of the overall increase as a
percentage of revenue was the result of reduced collectibility within the
Company's contingent revenue stream. Accordingly, in order to mitigate the
effects of the decreased collectibility while maintaining its performance for
-15-
its clients, the Company had to increase spending for payroll costs. In
addition, the Company incurred $10.7 million of one-time charges during the
second quarter of 2001 related to a comprehensive streamlining of its expense
structure designed to counteract the effects of operating in a more difficult
collection environment. These costs primarily consisted of the elimination or
acceleration of certain contractual employment obligations, severance costs
related to terminated employees, and costs related to a decision to change the
structure of our healthcare benefit programs from a large, singular benefit
platform to individual plans across the country. A portion of 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. In addition, a
portion of these increases was offset by the increase in the size of the
Portfolio Management division, which has a lower payroll cost structure than the
remainder of the Company.
The payroll and related expenses of the U.S Operations division
increased $36.8 million to $172.6 million for the six months ended June 30,
2001, from $135.8 million for the comparable period in 2000, and increased as a
percentage of revenue to 53.8% from 48.4%. A portion of the increase as a
percentage of revenue was the result of reduced collectibility within the U.S.
Operations' contingent revenue stream. Accordingly, in order to mitigate the
effects of the decreased collectibility while maintaining its performance for
its clients, the Company had to increase spending for payroll costs. In
addition, the U.S. Operations incurred $10.0 million of the one-time charges
during the second quarter of 2001, as discussed above.
The payroll and related expenses of the Portfolio Management division
increased $660,000 to $808,000 for the six months ended June 30, 2001, from
$148,000 for the comparable period in 2000, but decreased as a percentage of
revenue to 2.6% from 4.0%. 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 payroll and related expenses of the International Operations
division increased $2.3 million to $10.8 million for the six months ended June
30, 2001, from $8.5 million for the comparable period in 2000, and increased as
a percentage of revenue to 59.8% from 55.6%. This increase as a percentage of
revenue was primarily attributable to the $736,000 of the one-time charges
incurred during the second quarter of 2001, as discussed above.
Selling, general and administrative expenses. Selling, general and
administrative expenses increased $21.6 million to $109.3 million for the six
months ended June 30, 2001, from $87.7 million for the comparable period in
2000, and increased as a percentage of revenue to 30.8% from 29.4%. A portion of
the overall increase as a percentage of revenue was the result of reduced
collectibility within the Company's contingent revenue stream. Accordingly, in
order to mitigate the effects of the decreased collectibility while maintaining
its performance for its clients, the Company 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. In addition, the Company incurred $1.8 million of one-time
charges during the second quarter of 2001 related to a comprehensive
streamlining of its 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.
Depreciation and amortization. Depreciation and amortization increased
to $18.6 million for the six months ended June 30, 2001 from $15.5 million for
the comparable period 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 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.
Other income (expense). Interest and investment income increased
$838,000 to $1.8 million for the six months ended June 30, 2001 over the
comparable period in 2000. This increase was primarily attributable to increases
in operating cash and funds held on behalf of clients, and the implementation of
our new cash investment strategy. Interest expense increased to $14.7 million
for the six months ended June 30, 2001, from $12.8 million for the comparable
period in 2000. This increase was partially attributable to the Portfolio
Management division borrowing $36.3 million in connection with the February 2001
acquisition of Creditrust Corporation ("Creditrust"). In addition, a portion of
the increase was attributable to interest from securitized debt that was assumed
as part of the Creditrust acquisition. A portion of these increases was offset
-16-
by a decrease in interest rates and debt repayments made during 2000 and the
first half of 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 the six months
ended June 30, 2000, the Company recorded 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 the six months ended June
30, 2001 decreased to $12.4 million, or 39.8% of income before income tax
expense, from $16.8 million, or 42.2% of income before income tax expense, for
the comparable period in 2000. A portion of the decrease was attributable to the
expansion of the Portfolio Management division, which has a lower effective tax
rate than the remainder of the Company. The lower effective tax rate of the
Portfolio Management division had a larger impact on the overall effective tax
rate for the six months ended June 30, 2001 due to the $12.5 million of one-time
charges incurred during the second quarter of 2001 by the remainder of the
Company. In addition, a portion of the decrease was the result of the
implementation of certain tax savings initiatives during the fourth quarter
of 2000.
Discontinued operations. The Market Strategy division had a loss from
operations of $975,000 for the period from January 1, 2000 to the Measurement
Date. For the six months ended June 30, 2000, the Company recorded a $20.8
million expected loss on the disposal of the Market Strategy division. The
expected loss on disposal included the estimated operations for the period from
the Measurement Date to the expected disposal date. The Company completed the
divestiture of the Market Strategy division on October 26, 2000.
Liquidity and Capital Resources
Historically, the Company's 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 receivables, and working capital to support the Company's growth.
Cash Flows from Operating Activities. Cash provided by operating
activities was $37.5 million for the six months ended June 30, 2001, compared to
$16.2 million for the comparable period 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 quarter of 2001, a smaller decrease in
corporate taxes payable, and an increase in long-term liabilities compared to a
decrease in the comparable period of 2000. The smaller decrease in corporate
taxes payable was the result of larger tax payments during the first six months
of 2000 and the implementation of certain tax savings initiatives during the
fourth quarter of 2000. The change in long-term liabilities was due to the
reduction of acquisition related liabilities during the six months ended June
30, 2000. The increase in cash provided by operating activities was also
attributable to an increase in depreciation expense, and the restricted cash and
minority interest resulting from the Creditrust acquisition.
Cash Flows from Investing Activities. Cash used in investing activities
was $32.3 million for the six months ended June 30, 2001, compared to $37.1
million for the comparable period in 2000. The decrease was due primarily to an
increase in collections applied to the principal of purchased accounts
receivable and a decrease in the purchase of property and equipment. These
decreases were partially offset by an increase in the purchase of delinquent
receivables.
Capital expenditures were $13.5 million for the six months ended June
30, 2001, compared to $15.9 million for the same period in 2000.
Cash Flows from Financing Activities. Cash provided by financing
activities was $1.7 million for the six months ended June 30, 2001, compared to
cash used in financing activities of $9.8 million for the same period in 2000.
During the first quarter of 2001, the primary source of cash from financing
activities was the borrowings under the revolving credit facility made in
connection with the Creditrust acquisition that were used to repay the acquired
notes payable, finance purchased accounts receivable, and repay other
acquisition related liabilities. During the second quarter of 2001, the Company
received $121.3 million of net proceeds from the issuance of convertible debt.
These net proceeds were used for the repayment of borrowings under the revolving
credit agreement.
Credit Facility. The Company has a credit agreement with Mellon Bank,
N.A. ("Mellon Bank"), for itself and as administrative agent for other
participating lenders, that originally provided for borrowings up to $350.0
million, structured as a revolving credit facility. The borrowing capacity of
the revolving credit facility is subject to mandatory reductions including
quarterly reductions of $6.3 million beginning on March 31, 2001 and 50 percent
of the net proceeds received from any offering of debt or equity. As of June 30,
2001, the maximum borrowing capacity of the revolving credit agreement was
$276.9 million.
-17-
At the Company's option, the borrowings bear interest at a rate equal
to either Mellon Bank's prime rate plus a margin of 0.25% to 0.50% that is
determined quarterly based upon the Company's consolidated funded debt to
earnings before interest, taxes, depreciation, and amortization, also referred
to as EBITDA, ratio (Mellon Bank's prime rate was 6.75% at June 30, 2001), or
the London InterBank Offered Rate, also referred to as LIBOR, plus a margin of
1.25% to 2.25% depending on the Company's consolidated funded debt to EBITDA
ratio (LIBOR was 3.84% at June 30, 2001). As of June 30, 2001, there was $64.1
million available on the revolving credit facility.
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. At the option of NCO, the
borrowings bear interest at a rate equal to either Mellon 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. As of
June 30, 2001, there was $6.8 million available on the NCO Portfolio
sub-facility.
Borrowings are collateralized by substantially all the assets of the
Company, including the common stock of NCO Portfolio, and certain assets of NCO
Portfolio. The balance under the revolving credit facility shall 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.
In April 2001, the Company 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 NCO common stock at
an initial conversion price of $32.92 per share. 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.
Management believes that funds generated from operations, together with
existing cash and available borrowings under the credit agreement will be
sufficient to finance current operations, planned capital expenditure
requirements, and internal growth at least through the next twelve months.
However, additional debt or equity financing could be required if any other
significant acquisitions for cash are made during that period.
Market Risk
The Company is 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 25
basis-point increase in interest rates could increase annual interest expense by
$250,000 for each $100 million of variable debt outstanding for the entire year.
The Company employs 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. The
fair value of the interest rate collar agreements was determined to be
immaterial at December 31, 2000 and June 30, 2001.
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Goodwill
The Company's balance sheet includes amounts designated as
"intangibles", which are predominantly comprised 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. Accounting principles generally accepted in the United
States require that this and all other intangible assets be amortized over the
period benefited. Management has determined that period to be from 15 to 40
years based on the attributes of each acquisition.
As of June 30, 2001, the Company's balance sheet included goodwill that
represented approximately 56.5% of total assets and 128.6% of shareholders'
equity.
If management has incorrectly overestimated the length of the
amortization period for goodwill, earnings reported in periods immediately
following the acquisition would be overstated. In later years, NCO would be
burdened by a continuing charge against earnings without the associated benefit
to income valued by management in arriving at the consideration paid for the
business. Earnings in later years also could be significantly affected if
management determined then that the remaining balance of goodwill was impaired.
Management has concluded that the anticipated future cash flows associated with
intangible assets recognized in the acquisitions will continue indefinitely, and
there is no persuasive evidence that any material portion will dissipate over a
period shorter than the respective amortization period.
Recent Accounting Pronouncement:
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 June
30, 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 would applies not only to goodwill arising from acquisitions
completed after the effective date, but also to goodwill previously recorded.
The Company will adopt FASB 142 in the first quarter of 2002. The Company is in
the process of determining the impact of these pronouncements on its financial
position and results of operations.
Item 3 Quantitative and Qualitative Disclosures about Market Risk
Included in Item 2, Management's Discussion and Analysis of Financial
Condition and Results of Operations, of this Report on Form 10-Q.
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Part II. Other Information
Item 1. Legal Proceedings
The Company is involved in legal proceedings from time to time in the
ordinary course of its business. Management believes that none of these
legal proceedings will have a materially adverse effect on the financial
condition or results of operations of the Company.
Item 2. Changes in Securities
On April 4, 2001, the Company issued a total of $125,000,000 principal
amount of 4.75% convertible subordinated notes due 2006 (the "Notes"). The
Company issued and sold these Notes to Deutsche Bank Alex. Brown Inc., as
the initial purchaser (the "Initial Purchaser"), in reliance on the
exemption from registration under Section 4(2) of the Securities Act of
1933, as amended (the "Securities Act"). The Company sold the Notes to the
Initial Purchasers at a discount of three percent, for an aggregate
discount of $3.75 million. The Initial Purchasers represented to the
Company that it was a "qualified institutional buyer" (as such term is
defined in Rule 144A under the Securities Act). The Notes are convertible
into approximately 3.8 million shares of the Company's common stock at a
conversion price of $32.92 per share, subject to adjustment upon certain
events described in the Indenture, at any time on or after July 3, 2001,
through maturity, unless previously redeemed or repurchased. The Notes
mature on April 15, 2006.
The Initial Purchaser advised the Company that they proposed to resell
the Notes (1) in the United States only to "qualified institutional buyers"
in reliance on the exemption from registration under Rule 144A and (2)
outside the United States to certain non-United States persons in offshore
transactions in reliance on Rule 904 of Regulation S under the Securities
Act. The Notes and the shares of common stock issuable upon conversion
constitute "restricted securities" within the meaning of Rule 144. The
Company's Confidential Offering Memorandum and related offering documents
and agreements imposed certain restrictions on the resale or other transfer
of the Notes and shares necessary for the availability of the exemptions
from registration under the Securities Act referred to above. In accordance
with the terms of the Note Purchase Agreement, the Company is required to
file not later than July 3, 2001, a registration statement on Form S-3
under the Securities Act to register the Notes and shares for resale by the
holders.
The net proceeds of the Note offering of approximately $121.25 million
were used to repay debt under the Company's Credit Agreement with Mellon
Bank.
Item 3. Defaults Upon Senior Securities
None - not applicable
Item 4. Submission of Matters to a Vote of Shareholders
The Annual Meeting of Shareholders of the Company was held on May 15,
2001. At the Annual Meeting, the shareholders elected William C. Dunkelberg
and Allen F. Wise as directors for a term of three years as described
below:
Number of Votes
-------------------------
Withhold
Name For Authority
---- --- ---------
William C. Dunkelberg 23,119,174 278,670
Allen F. Wise 23,117,674 280,170
In addition, the terms of the following directors continued after the
Annual Meeting: Michael J. Barrist, Charles C. Piola, Jr., Leo J. Pound,
Eric S. Siegel, and Stuart Wolf.
-20-
At the Annual Meeting, the shareholders also approved an amendment to
the Company's Articles of Incorporation to increase the number of
authorized shares by 12,500,000 as follows:
For Against Abstain Broker Non-Vote
--- ------- ------- ---------------
22,295,800 1,081,023 21,021 0
At the Annual Meeting, the shareholders also approved an amendment to
the 1996 Stock Option Plan as follows:
For Against Abstain Broker Non-Vote
--- ------- ------- ---------------
17,424,486 5,859,398 113,960 0
Item 5. Other Information
None - not applicable
Item 6. Exhibits and Reports on Form 8-K
(a) Exhibits
3.1 Amendment to Amended and Restated Articles of Incorporation
99.1 Consolidating Schedule
(b) Reports on Form 8-K
Date of Report Item Reported
4/10/01 Item 5 - Issuance of Convertible Debt
5/4/01 Item 7 - Creditrust Corporation acquisition
5/25/01 Item 7 - Consent of Independent Auditors for Creditrust
Corporation Financial Statements
7/24/01 Item 5 - Press release commenting on preliminary results
for the second quarter of 2001
8/10/01 Item 5 - Press release and conference call transcript
from the earnings release for the second
quarter of 2001
-21-
Signatures
Pursuant to the requirement of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf by the
undersigned thereunto duly authorized.
Date: August 14, 2001 By: /s/ Michael J. Barrist
----------------------
Michael J. Barrist
Chairman of the Board, President
and Chief Executive Officer
(principal executive officer)
Date: August 14, 2001 By: /s/ Steven L. Winokur
---------------------
Steven L. Winokur
Executive Vice President, Finance,
Chief Financial Officer and
Treasurer
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