SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q
(Mark One)
[X] QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d)
OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2002
--------------------------------
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 333-16867
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Outsourcing Solutions Inc.
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(Exact name of registrant as specified in its charter)
Delaware 58-2197161
- -------------------------------------- --------------------------------------
(State or other jurisdiction of (I.R.S. Employer
incorporation or organization) Identification Number)
390 South Woods Mill Road, Suite 350
Chesterfield, Missouri 63017
- -------------------------------------- --------------------------------------
(Address of principal executive office) (Zip Code)
Registrant's telephone number, including area code: (314) 576-0022
Indicate by checkmark whether the registrant: (1) has filed all reports required
to be filed by Sections 13 or 15(d) of the Securities Exchange Act of 1934
during the preceding 12 months (or for such shorter period that the registrant
was required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes X No
----- -----
Indicate the number of shares outstanding of each of the issuers classes of
common stock as of the latest practicable date.
Outstanding at
Class June 30, 2002
- ----------------------- --------------
Senior common stock 489,795.93
Voting common stock 6,129,295.63
Non-voting common stock 480,321.30
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7,099,412.86
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PAGE 2
OUTSOURCING SOLUTIONS INC.
AND SUBSIDIARIES
TABLE OF CONTENTS
Part I. Financial Information Page
----
Item 1. Financial Statements (unaudited)
Condensed Consolidated Balance Sheets
June 30, 2002 and December 31, 2001.............................. 3
Condensed Consolidated Statements of Operations for
the three and six months ended June 30, 2002 and 2001............ 4
Condensed Consolidated Statements of Cash Flows for
the six months ended June 30, 2002 and 2001...................... 5
Notes to Condensed Consolidated Financial Statements............. 6
Item 2. Management's Discussion and Analysis of Financial Condition
and Results of Operations........................................ 12
Item 3. Quantitative and Qualitative Disclosures About Market Risk....... 18
Part II. Other Information................................................ 19
PAGE 3
OUTSOURCING SOLUTIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS (UNAUDITED)
(In thousands, except share and per share amounts)
- --------------------------------------------------------------------------------
ASSETS June 30, December 31,
2002 2001
----------- ------------
Cash and cash equivalents $10,587 $ 9,535
Cash and cash equivalents held for clients 24,986 25,920
Accounts receivable - trade, less allowance
for doubtful receivables of $1,034 and $1,080 72,402 60,100
Purchased loans and accounts receivable portfolios 17,049 17,477
Property and equipment, net 46,188 46,952
Goodwill, less accumulated amortization of $70,824 422,064 421,871
Deferred financing costs, less accumulated
amortization of $11,493 and $8,844 19,915 18,665
Other assets 34,996 39,690
-------- --------
TOTAL $648,187 $640,210
======== ========
LIABILITIES AND STOCKHOLDERS' DEFICIT
Accounts payable - trade $19,257 $16,192
Collections due to clients 24,986 25,920
Accrued salaries, wages and benefits 16,161 13,325
Debt 530,877 539,020
Other liabilities 74,992 76,346
Commitments and contingencies (Notes 2 and 9)
Mandatorily redeemable preferred stock; redemption
amount of $157,528 and $140,560 141,773 123,482
Stockholders' deficit:
Senior common stock; $.01 par value; authorized
900,000 shares, 489,795.93 issued and
outstanding 5 5
Voting common stock; $.01 par value; authorized
20,000,000 shares, 9,207,544.70 and
9,166,728.37 shares issued 92 92
Non-voting common stock; $.01 par value;
authorized 2,000,000 shares, 480,321.30 issued
and outstanding 5 5
Paid-in capital 225,277 223,277
Accumulated deficit (241,832) (231,754)
Accumulated other comprehensive loss (6,530) (8,883)
Notes receivable from management for shares sold (2,019) (1,960)
Voting common stock in treasury, at cost;
3,078,249.07 shares (134,857) (134,857)
-------- --------
Total stockholders' deficit (159,859) (154,075)
-------- --------
TOTAL $648,187 $640,210
======== ========
The accompanying notes are an integral part of the unaudited
condensed consolidated financial statements.
PAGE 4
OUTSOURCING SOLUTIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS (UNAUDITED)
(In thousands)
- --------------------------------------------------------------------------------
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- --------------------
2002 2001 2002 2001
REVENUES $156,426 $157,433 $317,524 $309,019
EXPENSES:
Salaries and benefits 75,356 75,859 153,479 150,183
Service fees and other operating
and administrative expenses 53,719 52,722 107,781 100,341
Amortization of purchased loans and
accounts receivable portfolios 8,956 5,012 17,065 11,991
Amortization of goodwill - 4,161 - 8,213
Depreciation expense 3,987 3,605 7,879 7,307
Conversion, realignment and
relocation expenses - - 2,500 -
-------- -------- -------- --------
Total expenses 142,018 141,359 288,704 278,035
-------- -------- -------- --------
OPERATING INCOME 14,408 16,074 28,820 30,984
INTEREST EXPENSE - Net 15,410 13,819 27,232 30,080
-------- -------- -------- --------
INCOME (LOSS) BEFORE INCOME TAXES (1,002) 2,255 1,588 904
PROVISION FOR INCOME TAXES 200 175 375 350
-------- -------- -------- --------
NET INCOME (LOSS) (1,202) 2,080 1,213 554
PREFERRED STOCK DIVIDEND
REQUIREMENTS AND ACCRETION OF
SENIOR PREFERRED STOCK 5,887 4,928 11,291 9,710
-------- -------- -------- --------
NET LOSS TO COMMON STOCKHOLDERS $(7,089) $(2,848) $(10,078) $(9,156)
======== ======== ======== ========
The accompanying notes are an integral part of the
unaudited condensed consolidated financial statements.
PAGE 5
OUTSOURCING SOLUTIONS INC. AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED)
(In thousands)
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Six Months Ended
June 30,
-----------------------
2002 2001
OPERATING ACTIVITIES AND PORTFOLIO PURCHASING:
Net income $ 1,213 $ 554
Adjustments to reconcile net income to
net cash from operating activities and
portfolio purchasing:
Depreciation and amortization 12,251 17,727
Amortization of purchased loans and accounts
receivable portfolios 17,065 11,991
Non-cash compensation expense related to
variable stock options - 741
Change in assets and liabilities excluding
the effects of acquisitions:
Purchases of loans and accounts
receivable portfolios (16,637) (6,691)
Accounts receivable and other assets (8,031) (11,572)
Accounts payable, accrued expenses
and other liabilities 4,765 (1,943)
-------- --------
Net cash from operating activities and
portfolio purchasing 10,626 10,807
-------- --------
INVESTING ACTIVITIES:
Acquisition of property and equipment (4,439) (5,657)
Payment for acquisitions, net of cash acquired - (21,254)
Purchases of loans and accounts receivable
portfolios for resale to FINCO - (43,629)
Sales of loans and accounts receivable
portfolios to FINCO - 43,629
Other 15 (3,025)
-------- --------
Net cash used by investing activities (4,424) (29,936)
-------- --------
FINANCING ACTIVITIES:
Borrowings under revolving credit agreement 70,300 160,800
Repayments under revolving credit agreement (66,300) (160,400)
Repayments of debt (12,376) (5,126)
Proceeds from issuance of preferred and
common stock 7,000 22,004
Deferred financing fees (3,774) (162)
-------- --------
Net cash from financing activities (5,150) 17,116
-------- --------
NET INCREASE (DECREASE) IN CASH AND CASH EQUIVALENTS 1,052 (2,013)
CASH AND CASH EQUIVALENTS, BEGINNING OF PERIOD 9,535 10,273
-------- --------
CASH AND CASH EQUIVALENTS, END OF PERIOD $ 10,587 $ 8,260
======== ========
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION:
Cash paid during period for interest $ 22,693 $ 28,647
======== ========
Net cash paid during period for taxes $ 355 $ 321
======== ========
SUPPLEMENTAL DISCLOSURE OF NONCASH INFORMATION:
Accrued dividends on mandatorily redeemable
preferred stock $ 9,968 $ 8,430
======== ========
Accretion of mandatorily redeemable
preferred stock $ 1,323 $ 1,280
======== ========
Capital lease obligations incurred for the
purchase of equipment $ 323 $ -
======== ========
Issuance of voting common stock for the
purchase of equipment $ 2,000 $ -
======== ========
The accompanying notes are an integral part of the
unaudited condensed consolidated financial statements.
OUTSOURCING SOLUTIONS INC. AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED)
(In thousands, except for share and per share amounts)
NOTE 1. BASIS OF PRESENTATION
The accompanying unaudited condensed consolidated financial statements have been
prepared in accordance with accounting principles generally accepted in the
United States for interim financial information and with the instructions to
Form 10-Q and Article 10 of Regulation S-X. Accordingly, they do not include all
of the information and footnotes required by accounting principles generally
accepted in the United States for complete financial statements. In the opinion
of management, all adjustments (consisting of normal recurring items) considered
necessary for a fair presentation have been included. Operating results for the
three and six months ended June 30, 2002 are not necessarily indicative of the
results that may be expected for the year ending December 31, 2002. These
Condensed Consolidated Financial Statements should be read in conjunction with
the Consolidated Financial Statements and notes thereto contained in the
Company's Form 10-K for the year ended December 31, 2001.
NOTE 2. LITIGATION
From time to time, the Company and certain of its subsidiaries are subject to
various investigations, claims and legal proceedings covering a wide range of
matters that arise in the normal course of business and are routine to the
nature of the Company's businesses. In addition, as a result of the acquisition
in a prior year of The Union Corporation, certain subsidiaries of the Company
are a party to several on-going environmental remediation investigations by
federal and state governmental agencies and clean-ups and, along with other
companies, have been named a "potentially responsible party" for certain waste
disposal sites. While the results of litigation cannot be predicted with
certainty, the Company has provided for the estimated uninsured amounts and
costs to resolve the pending suits and management, in consultation with legal
counsel, believes that reserves established for the ultimate resolution of
pending matters are adequate at June 30, 2002.
NOTE 3. PURCHASED LOANS AND ACCOUNTS RECEIVABLE PORTFOLIOS FINANCING
OSI Funding LLC ("FINCO") is a special-purpose finance company with the Company
having approximately 29% of the voting rights. An unrelated third party holds
the majority voting rights of FINCO and has decision-making authority over
FINCO's operations. The Company's investment in FINCO is accounted for under the
equity method. FINCO entered into a revolving warehouse financing arrangement
(the "Warehouse Facility") for up to $100,000 of funding capacity for the
purchase of loans and accounts receivable portfolios, principally bankcard
receivables, over its five year term which expires in October 2003. In
connection with the establishment of the Warehouse Facility, FINCO entered into
an agreement with a subsidiary of the Company to provide certain administrative
and collection services on a contingent fee basis (i.e., fee is based on a
percent of amount collected). The Company believes the fee structure agreed to
by FINCO is representative of a fee structure that would exist with an unrelated
party. The services provided by the Company to FINCO are similar to those
provided to unrelated parties. Revenue from FINCO is generally recognized by the
Company as collections are received. All borrowings by FINCO under the Warehouse
Facility are without recourse to the Company.
The following summarizes the transactions between the Company and FINCO for the
periods ended June 30:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2002 2001 2002 2001
Sales of purchased loans and
accounts receivable portfolios
by the Company to FINCO $ - $27,007 $ - $43,629
Servicing fees paid by FINCO
to the Company $ 7,569 $ 9,170 $16,276 $20,169
Sales of purchased loans and accounts receivable portfolios ("Receivables") by
the Company to FINCO, when such Receivables are financed by the Warehouse
Facility, were in the same amount and occurred shortly after such portfolios
were acquired by the Company from the various unrelated sellers. As such, the
Company's Statements of Operations do not include revenues or expenses related
to these loans and accounts receivable portfolios. In conjunction with an
agreement to provide certain administrative and collection services to FINCO,
the Company can achieve a bonus fee if amounts in excess of the original
purchase price of a portfolio are recovered. Payment of any bonus is subject to
certain collateral and collection sharing requirements as outlined in the
agreement. Receivables from FINCO, which are included in other assets in the
accompanying condensed consolidated balance sheet, were $12,468 at June 30, 2002
and $17,014 at December 31, 2001.
At June 30, 2002 and December 31, 2001, FINCO had unamortized Receivables of
$45,212 and $75,921, respectively. At June 30, 2002 and December 31, 2001, FINCO
had outstanding borrowings of $40,761 and $66,391, respectively, under its
Warehouse Facility. See Note 11.
FINCO's summarized results from operations for the periods ended June 30 are as
follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------ ------------------
2002 2001 2002 2001
Revenues $22,062 $32,220 $50,797 $59,190
Income from operations 2,250 3,009 4,190 4,631
Net income 1,874 1,977 3,343 2,437
NOTE 4. DERIVATIVES AND HEDGING ACTIVITIES
The Company is subject to the risk of fluctuating interest rates in the normal
course of business. The Company's interest rate hedges are primarily classified
as cash flow hedges. For a cash flow hedge of an anticipated transaction, the
ineffective portion of the change in fair value of the derivative is recorded in
earnings as incurred, whereas the effective portion is deferred in accumulated
other comprehensive income (loss) on the balance sheet until the transaction is
realized, at which time any deferred hedging gains or losses are recorded in
earnings. During the quarters ended June 30, 2002 and 2001, the Company
recorded, as part of interest expense, a loss of $2,220 and a gain of $518,
respectively, due to the impact of the interest rate hedges. For the six months
ended June 30, 2002 and 2001, the net impact on interest expense was an increase
of $1,848 and zero, respectively, as a result of the interest rate hedges. At
June 30, 2002 and December 31, 2001, the related liability (included in other
liabilities) is $11,429 and $11,934, respectively. At June 30, 2002 and December
31, 2001, the amount included in accumulated other comprehensive income (loss)
is $6,530 and $8,883, respectively.
NOTE 5. COMPREHENSIVE INCOME (LOSS)
The components of total comprehensive income (loss) for the periods ended June
30 are as follows:
Three Months Ended Six Months Ended
June 30, June 30,
------------------- -------------------
2002 2001 2002 2001
Net income (loss) $(1,202) $ 2,080 $ 1,213 $ 554
Other comprehensive income item:
Net income (loss) on cash flow
hedging instruments 105 (83) 2,353 (6,621)
------- ------- ------- -------
Total comprehensive income (loss) $(1,097) $ 1,997 $ 3,566 $(6,067)
======= ======= ======= =======
NOTE 6. CONVERSION, REALIGNMENT AND RELOCATION EXPENSES
For the six months ended June 30, 2002, the Company incurred $2,500 of
nonrecurring consolidation, realignment and relocation expenses. These expenses
include costs resulting from closure of certain call centers, severance
associated with these office closures, severance as a result of cost reductions
and certain other one-time costs including certain investigative costs resulting
from the inaccurate financial reporting of certain transactions during and prior
to 2001 at one of the Company's subsidiaries, North Shore Agency, Inc. See
further discussion in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001. Accrued costs at June 30, 2002 were $930, all of which
should be substantially settled during 2002.
NOTE 7. GOODWILL
On January 1, 2002, the Company adopted Statement of Financial Accounting
Standards ("SFAS") No. 142, Goodwill and Other Intangible Assets. SFAS No. 142
eliminates the amortization of goodwill and instead requires goodwill be tested
for impairment at least annually. Intangible assets deemed to have an indefinite
life under SFAS No. 142 are no longer amortized, but instead are reviewed at
least annually for impairment. Intangible assets with finite lives are amortized
over their useful life.
As required by SFAS No. 142, the results prior to 2002 were not restated in the
condensed consolidated statements of operations. A reconciliation between net
income (loss) reported by the Company and the net income (loss) as adjusted to
reflect the impact of SFAS No. 142 for the periods ended June 30 is as follows:
Three Months Ended Six Months Ended
June 30, June 30,
-------------------- -------------------
2002 2001 2002 2001
Net income (loss), as reported $(1,202) $ 2,080 $ 1,213 $ 554
Goodwill amortization - 4,161 - 8,213
------- ------- ------- -------
Adjusted net income (loss) $(1,202) $ 6,241 $ 1,213 $ 8,767
======= ======= ======= =======
The provisions of SFAS No. 142 also require the completion of the first step of
the transitional goodwill impairment by June 30, 2002. The Company completed the
transitional impairment test of goodwill and determined that there was no
goodwill impairment.
NOTE 8. SEGMENT INFORMATION
The Company has three reportable segments, Outsourcing Services, Portfolio
Services and Recovery Services. The Outsourcing Services segment provides
services such as contract management of accounts receivable, billing and
teleservicing services, letter series programs and banking and financial
services transaction processing. Portfolio Services involve acquiring portfolios
of charged-off consumer receivables from credit grantors or other owners,
servicing such portfolios and retaining all amounts collected and servicing
customer owned portfolios for an agreed upon servicing fee. The Recovery
Services segment collects delinquent or charged-off consumer accounts for a
fixed percentage of realized collections or a fixed fee per account. The Company
derives substantially all of its revenues from domestic customers.
The chief operating decision maker evaluates performance of the segments based
on Adjusted Operating Earnings (operating income before depreciation,
amortization, corporate and shared expenses and conversion, realignment and
relocation expenses, but after amortization of purchased loans and accounts
receivable portfolios). Adjusted Operating Earnings includes only the costs
directly attributable to the operations of the individual segment. Eliminations
represent intercompany revenue. Assets are not identified by the individual
segments and, therefore, are not reported by segment.
The following table presents certain data by business segment for the periods
ended June 30:
Three Months Ended Six Months Ended
June 30, June 30,
--------------------- --------------------
2002 2001 2002 2001
Revenues
- --------
Outsourcing services $ 87,189 $ 88,339 $177,554 $168,842
Portfolio purchasing services 23,783 23,185 49,215 46,587
Recovery services 50,247 51,397 101,623 104,299
Eliminations (4,793) (5,488) (10,868) (10,709)
-------- -------- -------- --------
Total revenues $156,426 $157,433 $317,524 $309,019
======== ======== ======== ========
Adjusted Operating Earnings
- ---------------------------
Outsourcing services $ 12,443 $ 14,728 $ 25,287 $ 28,147
Portfolio purchasing services 964 5,993 3,183 9,870
Recovery services 12,621 11,616 26,441 24,801
-------- -------- -------- --------
Total adjusted operating earnings $ 26,028 $ 32,337 $ 54,911 $ 62,818
======== ======== ======== ========
NOTE 9. COMMITMENTS AND CONTINGENCIES
From time to time, the Company enters into servicing agreements with companies
which service loans for others. The servicers handle the collection efforts on
certain nonperforming loans and accounts receivable on the Company's behalf.
Payments to the servicers vary depending on the servicing contract. Current
contracts expire on the anniversary date of such contracts but are automatically
renewable at the option of the Company.
A subsidiary of the Company has several portfolio flow purchase agreements,
whereby the subsidiary has a monthly commitment to purchase nonperforming loans
meeting certain criteria for an agreed upon price subject to due diligence. The
duration of these agreements do not extend beyond one year. The purchases under
the portfolio flow purchase agreements were $9,445 and $1,713, which excludes
amounts purchased and subsequently sold to FINCO (see Note 3), for the six
months ended June 30, 2002 and 2001, respectively.
NOTE 10. MANDATORILY REDEEMABLE PREFERRED STOCK
In April 2002, the Company completed a sale of $7,000 of Series B junior
preferred stock to certain members of its existing investor group, including
Madison Dearborn Capital Partners III, L.P., the Company's majority stockholder.
NOTE 11. AMENDMENT TO CREDIT AND WAREHOUSE FACILITIES
During the finalization of the Company's consolidated financial statements as of
and for the year ended December 31, 2001, the Company identified inaccurate
financial reporting of certain transactions at one of the Company's
subsidiaries, North Shore Agency, Inc. ("NSA"). The Board of Directors
authorized the Audit and Compliance Committee (the "Committee") to conduct an
independent investigation, with the assistance of special counsel retained by
the Committee, to identify the causes of these discrepancies and to make
recommendations to ensure similar issues do not recur in the future. The
Committee retained Bryan Cave LLP as special counsel, and Bryan Cave LLP engaged
an independent accounting firm to assist in the investigation. As a result of
the investigation, it was determined that certain assets were overstated
(primarily accounts receivable and prepaid postage) and trade accounts payable
was understated at NSA due to the inaccurate financial reporting of certain
transactions. Consequently, the Company breached certain covenants,
representations and warranties of its bank credit facility (the "Credit
Facility") and Warehouse Facility.
The Company and the lenders to the Credit Facility amended the facility
effective April 10, 2002. The amendment to the Credit Facility included
provisions that amended the financial covenants, waived certain defaults of
covenants and breaches in representations and warranties, increased the interest
rate on borrowings pursuant to the facility (as discussed below), and, during
2002, reduced the Company's availability under its Credit Facility by $5,000,
and limited capital expenditures, investments and acquisitions. In connection
with the amendment, the Company also issued 7,000 shares of its Series B Junior
Preferred Stock with attached warrants to acquire 71,429 shares of the Company's
Senior Common Stock to certain members of its existing investor group, including
Madison Dearborn Capital Partners III, L.P. and Madison Dearborn Special Equity
III, L.P. for a total purchase price of $7,000. The proceeds of this sale were
used to repay the Revolving Facility in the amount of $3,500 and the balance
pro-rata to the Term A and B loans, as provided in the Credit Facility. From
April 10, 2002 until such time as the Company delivers to the lenders a
compliance certificate for the period ended December 31, 2002, borrowings under
the Revolving Facility and Term A Loan of the Credit Facility will bear
interest, at the Company's option at (a) the lender's prime rate plus 2.75% or
at (b) the Eurodollar rate plus 3.75%. Borrowings under the Term B Loan will
bear interest, at the Company's option, at (a) the lender's prime rate plus
3.50% or (b) the Eurodollar rate plus 4.50%. The amortization and maturity were
not amended. Following this amendment, the Company is in compliance with the
Credit Facility, both of which were subsquently amended as discussed below.
The Company, FINCO and the lenders to the Warehouse Facility amended the
facility effective July 8, 2002. The amendment includes provisions that amend
the financial covenants and waive prior covenant defaults and any existing
Wind-Down Events, as defined in the Warehouse Facility. In addition, the
amendment also places certain limitations on bonus fee payments which can be
paid to OSI and its affiliates.
NOTE 12: NEW ACCOUNTING PRONOUNCEMENTS
In April 2002, the Financial Accounting Standards Board ("FASB") issued SFAS No.
145, Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB
Statement No. 13, and Technical Corrections. SFAS No. 145 updates, clarifies and
simplifies existing accounting pronouncements. Generally, the provisions apply
for transactions occurring after May 15, 2002. The Company determined that the
adoption of SFAS No. 145 will not have a material effect on its financial
statements.
The FASB issued SFAS No. 146, Accounting for Exit or Disposal Activities. SFAS
No. 146 provides direction for accounting and disclosure regarding specific
costs related to an exit or disposal activity. These include, but are not
limited to, costs to terminate a contract that is not a capital lease, costs to
consolidate facilities or relocate employees, and certain termination benefits
provided to employees that are involuntarily terminated under the terms of a
one-time benefit arrangement. The Company is required to adopt SFAS No. 146 for
any disposal activities initiated after December 31, 2002, although early
adoption is allowed. The Company is currently reviewing the impact of the
adoption of SFAS No. 146 on its financial statements.
ITEM 2. MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND
RESULTS OF OPERATIONS
For discussion of the Company's critical accounting policies, see the Company's
Annual Report on Form 10-K for the year ended December 31, 2001.
Results of Operations
- ---------------------
Three Months Ended June 30, 2002 Compared to Three Months Ended June 30, 2001
- -----------------------------------------------------------------------------
Consolidated revenues for the three months ended June 30, 2002 were $156.4
million, a decrease of $1.0 million or 0.6% from $157.4 million for the three
months ended June 30, 2001. Revenues by segment prior to the elimination of
intercompany revenues are as follows (in millions):
Three Months Ended
----------------------------------
June 30, 2002 June 30, 2001
-------------- --------------
Outsourcing services $ 87.2 $ 88.3
Portfolio purchasing services 23.8 23.2
Recovery services 50.2 51.4
Eliminations (4.8) (5.5)
------- -------
$ 156.4 $ 157.4
======= =======
Outsourcing services' revenues of $87.2 million for the three months ended June
30, 2002 decreased $1.1 million, or 1.2%, from $88.3 million in 2001. The lower
revenues resulted primarily from lower collection letter products business and
back office services revenue offset partially by increased financial services
business.
Revenues from the Company's portfolio purchasing segment were up $0.6 million,
or 2.6%, to $23.8 million for the three months ended June 30, 2002 from $23.2
million in 2001. The increased revenue was primarily attributable to higher
strategic sales of purchased portfolios offset partially by lower servicing fee
revenue resulting from lower portfolio purchasing by FINCO.
Recovery services' revenues decreased by 2.3% for the three months ended June
30, 2002 on revenue of $50.2 million compared to $51.4 million in 2001 primarily
as a result of lower student loan, financial services and telecommunications
revenue offset by increased bank card and government revenue.
Consolidated operating expenses, inclusive of salaries and benefits, service
fees and other operating and administrative expenses, were $129.1 million for
the three months ended June 30, 2002 compared to $128.6 million in 2001, a
slight increase of 0.4%. The increase in these operating expenses resulted
primarily from increased collection-related expenses and postage and supplies
expenses in the letter products business. Operating expenses for the three
months ended June 30, 2001 included non-cash compensation expense related to
variable stock options of approximately $0.7 million. For the three months ended
June 30, 2002, amortization and depreciation charges of $12.9 million were
higher than the $12.8 million for the comparable period in 2001. The higher
amortization and depreciation charges were due primarily to higher amortization
of purchased loans and accounts receivable portfolios due to higher strategic
sales of purchased portfolios and higher depreciation resulting from current and
prior years' capital expenditures offset by the cessation of goodwill
amortization which approximated $4.2 million in 2001.
Outsourcing services' operating income before depreciation, amortization,
corporate and shared expenses and conversion, realignment and relocation
expenses but after amortization of purchased loans and accounts receivable
portfolios ("Adjusted Operating Earnings") was $12.4 million for the three
months ended June 30, 2002 compared to $14.7 million in 2001. The 15.6% decrease
primarily resulted from lower collection letter products business and back
office services revenue and higher postage expense offset partially by increased
financial services business.
Adjusted Operating Earnings for portfolio purchasing services was $1.0 million
for the three months ended June 30, 2002 compared to $6.0 million in 2001. The
decrease of $5.0 million was primarily attributable to the increased
amortization of purchased loans and accounts receivable portfolios as a result
of the higher strategic sales of purchased portfolios and lower servicing fee
revenue.
Recovery services' Adjusted Operating Earnings of $12.6 million for the three
months ended June 30, 2002 compared favorably to prior year of $11.6 million.
The favorable variance was primarily due to increased revenues and improved
margins in the bank card and government industry groups offset partially by the
lower student loan and telecommunications revenue.
The Company's earnings before interest expense, taxes, depreciation and
amortization ("EBITDA") for the three months ended June 30, 2002 was $27.4
million compared to $28.9 million for the same period in 2001. The decrease was
primarily attributable to the lower outsourcing services' Adjusted Operating
Earnings of $2.3 million offset partially by the higher recovery services'
Adjusted Operating Earnings of $1.0 million.
As a result of the above, the Company's operating income of $14.4 million for
the three months ended June 30, 2002 compared unfavorably to $16.1 million for
the same period in 2001.
Net interest expense for the three months ended June 30, 2002 was $15.4 million
compared to $13.8 million for the comparable period in 2001. The increase was
due primarily to the unfavorable non-cash impact of the Company's interest rate
hedges of $2.7 million offset partially by lower interest rates.
The provision for income taxes of $0.2 million was provided for certain state
and foreign income tax obligations. The net deferred tax assets at June 30, 2002
are fully offset by a valuation allowance. The Company generated a net taxable
operating loss for federal and certain state income tax purposes for which a
full valuation allowance was provided.
Due to the factors stated above, the Company had a net loss for the three months
ended June 30, 2002 of $1.2 million which compared unfavorably to the net income
of $2.1 million for the three months ended June 30, 2001.
Six Months Ended June 30, 2002 Compared to Six Months Ended June 30, 2001
- -------------------------------------------------------------------------
Consolidated revenues for the six months ended June 30, 2002 were $317.5
million, an increase of $8.5 million or 2.8% from $309.0 million for the six
months ended June 30, 2001. Revenues by segment prior to the elimination of
intercompany revenues are as follows (in millions):
Six Months Ended
-----------------------------------
June 30, 2002 June 30, 2001
--------------- ---------------
Outsourcing services $ 177.6 $ 168.8
Portfolio purchasing services 49.2 46.6
Recovery services 101.6 104.3
Eliminations (10.9) (10.7)
-------- --------
$ 317.5 $ 309.0
======== ========
Outsourcing services' revenues of $177.6 million for the six months ended June
30, 2002 increased 5.2% from $168.8 million in 2001. The higher revenues
resulted primarily from new business, increased financial services business and
the effects of the acquisition of Coast to Coast Consulting ("CCC") which was
acquired mid-March 2001 offset partially by lower back office services revenue.
Revenues from the Company's portfolio purchasing segment were up $2.6 million,
or 5.6%, to $49.2 million for the six months ended June 30, 2002 from $46.6
million in 2001. The increased revenue was primarily attributable to higher
strategic sales of purchased portfolios offset partially by lower servicing fee
revenue resulting from lower portfolio purchasing by FINCO.
Recovery services' revenues decreased by 2.6% for the six months ended June 30,
2002 on revenue of $101.6 million compared to $104.3 million in 2001 primarily
as a result of lower student loan, financial services and telecommunications
revenue offset partially by increased bank card and government revenue.
Consolidated operating expenses, inclusive of salaries and benefits, service
fees and other operating and administrative expenses, were $261.3 million for
the six months ended June 30, 2002 compared to $250.5 million in 2001, an
increase of 4.3%. The increase in these operating expenses resulted primarily
from the increased collection-related expenses due to the new and increased
financial outsourcing services revenues, the acquisition of CCC and higher
postage and supplies expenses in the letter products business. Operating
expenses for the six months ended June 30, 2001 included non-cash compensation
expense related to variable stock options of approximately $0.7 million. For the
six months ended June 30, 2002, amortization and depreciation charges of $24.9
million were lower than the $27.5 million for the comparable period in 2001. The
lower amortization and depreciation charges were due primarily to the cessation
of goodwill amortization which approximated $8.2 million in 2001, offset
partially by higher amortization of purchased loans and accounts receivable
portfolios due to higher strategic sales of purchased portfolios.
Outsourcing services' operating income before depreciation, amortization,
corporate and shared expenses and conversion, realignment and relocation
expenses but after amortization of purchased loans and accounts receivable
portfolios ("Adjusted Operating Earnings") was $25.3 million for the six months
ended June 30, 2002 compared to $28.1 million in 2001. The 10.0% decrease
primarily resulted from lower back office services revenue and higher postage
expense offset partially by the new business and increased financial services
revenue.
Adjusted Operating Earnings for portfolio purchasing services was $3.2 million
for the six months ended June 30, 2002 compared to $9.9 million in 2001. The
decrease of $6.7 million was primarily attributable to the increased
amortization of purchased loans and accounts receivable portfolios as a result
of the higher strategic sales of purchased portfolios and lower servicing fee
revenue.
Recovery services' Adjusted Operating Earnings of $26.4 million for the six
months ended June 30, 2002 compared favorably to prior year of $24.8 million.
The favorable variance was primarily due to increased bank card and government
revenue and improved margins in the government business offset partially by the
lower student loan and telecommunications revenue.
For the six months ended June 30, 2002, the Company incurred $2.5 million of
nonrecurring consolidation, realignment and relocation expenses. These expenses
include costs resulting from closure of certain call centers, severance
associated with these office closures, severance as a result of cost reductions
and certain other one-time costs including certain investigative costs resulting
from the inaccurate financial reporting of certain transactions during and prior
to 2001 at one of the Company's subsidiaries, North Shore Agency, Inc. See
further discussion in the Company's Annual Report on Form 10-K for the year
ended December 31, 2001.
The Company's earnings before interest expense, taxes, depreciation and
amortization ("EBITDA") for the six months ended June 30, 2002 was $53.8 million
compared to $58.5 million for the same period in 2001. The decrease was
primarily attributable to the lower outsourcing services' Adjusted Operating
Earnings and the nonrecurring charges of $2.5 million. Adding back the
nonrecurring charges of $2.5 million, EBITDA was $56.3 million compared to $59.2
million after adding back the non-cash stock compensation expense in 2001.
As a result of the above, the Company's operating income of $28.8 million for
the six months ended June 30, 2002 compared unfavorably to $31.0 million for the
same period in 2001.
Net interest expense for the six months ended June 30, 2002 was $27.2 million
compared to $30.1 million for the comparable period in 2001. The decrease was
due primarily to lower interest rates offset partially by the unfavorable
non-cash impact of the Company's interest rate hedges of $1.8 million.
The provision for income taxes of $0.4 million was provided for certain state
and foreign income tax obligations. The net deferred tax assets at June 30, 2002
are fully offset by a valuation allowance. The Company generated a net taxable
operating loss for federal and certain state income tax purposes for which a
full valuation allowance was provided.
Due to the factors stated above, the Company had net income for the six months
ended June 30, 2002 of $1.2 million which compared favorably to net income of
$0.6 million for the six months ended June 30, 2001.
Financial Condition, Liquidity and Capital Resources
- ----------------------------------------------------
At June 30, 2002, the Company had cash and cash equivalents of $10.6 million.
The Company's credit agreement currently provides for a $70.0 million revolving
credit facility, which allows the Company to borrow for working capital and
general corporate purposes, subject to certain conditions. As of June 30, 2002,
the Company had $50.0 million outstanding under the revolving credit facility
leaving $10.7 million, after outstanding letters of credit, available under the
revolving credit facility.
In April 2002, the Company completed a sale of $7.0 million of Series B junior
preferred stock to certain members of its existing investor group, including
Madison Dearborn Capital Partners III, L.P., the Company's majority stockholder.
The proceeds from the sale were used to repay debt under the Company's bank
credit facility.
In May 2002, the Company issued 40,816.33 shares of its Voting common stock for
the purchase of $2.0 million of equipment.
Since December 31, 2001, cash and cash equivalents increased $1.1 million
primarily due to cash from operating activities and portfolio purchasing of
$10.6 million, issuance of preferred stock of $7.0 million and borrowings under
the revolving credit facility of $4.0 million offset by cash utilized for debt
repayments of $12.4 million, payment of deferred financing fees of $3.8 million
and capital expenditures of $4.4 million. The Company also held $25.0 million of
cash and cash equivalents for clients in restricted trust accounts at June 30,
2002.
For the six months ended June 30, 2001, cash and cash equivalents decreased $2.0
million primarily due to cash utilized for the acquisitions of CCC and Pacific
Software Consulting of $21.3 million, debt repayments of $5.1 million, an
earnout payment of $3.0 million and capital expenditures of $5.7 million offset
by cash from operating activities and portfolio purchasing of $10.8 million and
net proceeds from the issuance of senior common stock of $22.0 million.
For the first six months in 2002, the Company made capital expenditures of $4.4
million primarily for the replacement and upgrading of equipment, expansion of
facilities and expansion of the Company's information services systems. The
Company anticipates total capital spending of approximately $10.0 million during
2002. Subject to compliance with the provisions of its debt agreements, the
Company expects to finance future capital expenditures with cash flow from
operations, borrowings and capital leases. The Company will reduce its future
capital expenditures to the extent it is unable to fund its capital plan.
During the finalization of the Company's consolidated financial statements as of
and for the year ended December 31, 2001, the Company identified inaccurate
financial reporting of certain transactions at one of the Company's
subsidiaries, North Shore Agency, Inc. ("NSA"). The Board of Directors
authorized the Audit and Compliance Committee (the "Committee") to conduct an
independent investigation, with the assistance of special counsel retained by
the Committee, to identify the causes of these discrepancies and to make
recommendations to ensure similar issues do not recur in the future. The
Committee retained Bryan Cave LLP as special counsel, and Bryan Cave LLP engaged
an independent accounting firm to assist in the investigation. As a result of
the investigation, it was determined that certain assets were overstated
(primarily accounts receivable and prepaid postage) and trade accounts payable
was understated at NSA due to the inaccurate financial reporting of certain
transactions. Consequently, the Company breached certain covenants,
representations and warranties of its bank credit facility (the "Credit
Facility") and Warehouse Facility. See further discussion in the Company's
Annual Report on Form 10-K for the year ended December 31, 2001.
The Company and the lenders to the Credit Facility amended the facility
effective April 10, 2002. The amendment to the Credit Facility included
provisions that amended the financial covenants, waived certain defaults of
covenants and breaches in representations and warranties, increased the interest
rate on borrowings pursuant to the facility (as discussed below), and, during
2002, reduced the Company's availability under its Credit Facility by $5,000,
and limited capital expenditures, investments and acquisitions. In connection
with the amendment, the Company also issued 7,000 shares of its Series B Junior
Preferred Stock with attached warrants to acquire 71,429 shares of the Company's
Senior Common Stock to certain members of its existing investor group, including
Madison Dearborn Capital Partners III, L.P. and Madison Dearborn Special Equity
III, L.P. for a total purchase price of $7,000. The proceeds of this sale were
used to repay the Revolving Facility in the amount of $3,500 and the balance
pro-rata to the Term A and B loans, as provided in the Credit Facility. From
April 10, 2002 until such time as the Company delivers to the lenders a
compliance certificate for the period ended December 31, 2002, borrowings under
the Revolving Facility and Term A Loan of the Credit Facility will bear
interest, at the Company's option at (a) the lender's prime rate plus 2.75% or
at (b) the Eurodollar rate plus 3.75%. Borrowings under the Term B Loan will
bear interest, at the Company's option, at (a) the lender's prime rate plus
3.50% or (b) the Eurodollar rate plus 4.50%. The amortization and maturity were
not amended. Following this amendment, the Company is in compliance with the
Credit Facility.
The Company, FINCO and the lenders to the Warehouse Facility amended the
facility effective July 8, 2002. The amendment to the Warehouse Facility
includes provisions that amend the financial covenants and waive prior covenant
defaults and any existing Wind-Down Events, as defined in the Warehouse
Facility. In addition, the amendment also places certain limitations on bonus
fee payments which can be paid to OSI and its affiliates.
FINCO is a special purpose and bankruptcy remote entity that is not consolidated
by the Company. The Company accounts for its investment in FINCO under the
equity method of accounting. The Company does not consolidate FINCO because an
unrelated third party investor in FINCO holds the majority voting rights of
FINCO, has decision-making authority over the operations of FINCO, including the
authority to make all decisions and to take all actions with respect to the
retention or removal of a subsidiary of the Company as a provider of collection
services for FINCO's portfolios, and maintains a substantial equity investment
in FINCO. The FASB is currently reviewing the rules surrounding special purpose
entities. The FASB has issued a preliminary draft of proposed rules regarding
the consolidation of special purpose entities. The FASB expects to finalize this
project by August of 2002. If the Company were required to adopt the rules
prescribed in the current FASB project, it would be required to consolidate
FINCO. If required to consolidate FINCO, the Company could possibly be in
violation of its debt covenants and would be required to seek a waiver or amend
its debt agreements.
Recent Accounting Pronouncements
- --------------------------------
See discussion in Note 12 of the Condensed Consolidated Financial Statements
included elsewhere herein.
Forward-Looking Statements
- --------------------------
The following statements in this entire document are or may constitute
forward-looking statements made in reliance upon the safe harbor of the Private
Securities Litigation Reform Act of 1995: (1) statements concerning the
anticipated costs and outcome of legal proceedings and environmental
liabilities, (2) statements regarding anticipated changes in the accounts
receivable management industry, including but not limited to debt levels,
delinquencies, industry consolidation, customer consolidation and outsourcing
trends, (3) statements regarding anticipated changes in the Company's
opportunities in its industry, including but not limited to acquisitions, (4)
statements regarding the Company's plans to reduce costs and improve operational
efficiencies, (5) statements regarding the Company's ability to fund its future
operating expenses and meet its debt service requirements as they become due,
(6) statements regarding the Company's expected capital expenditures and
facilities, (7) any statements preceded by, followed by or that include the word
"believes," "expects," "anticipates," "plans," "intends," "should," "may" or
similar expressions; and (8) other statements contained or incorporated by
reference in this document regarding matters that are not historical facts.
Because such statements are subject to risks and uncertainties, actual results
may differ materially from those expressed or implied by such forward-looking
statements. Factors that could cause actual results to differ materially
include, but are not limited to: (1) the demand for the Company's services, (2)
the demand for accounts receivable management and the availability of portfolios
to purchase generally, (3) general economic conditions, (4) changes in interest
rates, (5) competition, including but not limited to pricing pressures, (6)
changes in governmental regulations including, but not limited to the federal
Fair Debt Collection Practices Act and comparable state statutes, (7) legal
proceedings, (8) environmental investigations and clean up efforts, (9) expected
synergies, economies of scale and cost savings from recent acquisitions by the
Company not being fully realized or realized within the expected time frames,
(10) costs of operational difficulties, including but not limited to those
related to integrating the operations of recently acquired companies with the
Company's operations being greater than expected, (11) unanticipated realignment
costs, (12) the Company's ability to generate cash flow or obtain financing to
fund its operations, service its indebtedness and continue its growth and expand
successfully into new markets and services either through acquisitions or
internal growth, (13) changes in circumstances or the effects of new accounting
standards which may require the Company to consolidate FINCO into its financial
statements, and (14) factors discussed from time to time in the Company's public
filings.
These forward-looking statements speak only as of the date they were made. These
cautionary statements should be considered in connection with any written or
oral forward-looking statements that the Company may issue in the future. The
Company does not undertake any obligation to release publicly any revisions to
such forward-looking statements to reflect later events or circumstances or to
reflect the occurrence of unanticipated events.
ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
The Company is subject to the risk of fluctuating interest rates in the normal
course of business. From time to time and as required by the Company's Credit
Facility, the Company will employ derivative financial instruments as part of
its risk management program. The Company's objective is to manage risks and
exposures and not to trade such instruments for profit or loss.
At December 31, 2001 (the most recent completed fiscal year), the Company had
interest rate swap and collared swap agreements outstanding. Since December 31,
2001, there have been no material changes in these agreements.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
From time to time, the Company and certain of its subsidiaries are
involved in various investigations, claims and legal proceedings
covering a wide range of matters that arise in the normal course of
business and are routine to the nature of the Company's business.
Other information with respect to legal proceedings appears in the
Company's Annual Report on Form 10-K for the year ended December 31,
2001.
Item 2. Changes in Securities
See Note 10 of the Condensed Consolidated Financial Statements
included elsewhere herein. The proceeds from the sale of Series B
junior preferred stock were used to repay debt.
In May 2002, the Company issued 40,816.33 shares of its Voting common
stock for the purchase of $2.0 million of equipment.
Item 3. Defaults Upon Senior Securities
See Note 6 of the Consolidated Financial Statements and notes thereto
contained in the Company's Form 10-K for the year ended December 31,
2001.
Item 4. Submission of Matters to a Vote of Security Holders
None
Item 5. Other Information
None
Item 6. Exhibits and Reports on Form 8-K
(a). Exhibits
Exhibit 99.1 Certification of President and Chief Executive
Officer Pursuant to 18 U.S.C. Section 1350, As Adopted Pursuant
to Section 906 of the Sarbanes-Qxley Act of 2002.
Exhibit 99.2 Certification of Executive Vice President and
Chief Financial Officer Pursuant to 18 U.S.C. Section 1350, As
Adopted Pursuant to Section 906 of the Sarbanes-Qxley Act of
2002.
(b). Reports on Form 8-K
There were no reports on Form 8-K filed for the three-month
period ended June 30, 2002.
SIGNATURES
Pursuant to the requirements 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.
OUTSOURCING SOLUTIONS INC.
(Registrant)
/s/ Timothy G. Beffa
-------------------------------------
Timothy G. Beffa
President and Chief Executive Officer
/s/ Gary L. Weller
-------------------------------------
Gary L. Weller
Executive Vice President
and Chief Financial Officer
Date: August 13, 2002