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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
Form 10-K
(Mark One)
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year ended December 31, 2002
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or
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE
SECURITIES EXCHANGE ACT OF 1934
For the transition period from ___________ to ___________
Commission File No. 0-21639
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NCO GROUP, INC.
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(Exact name of registrant as specified in its charter)
Pennsylvania 23-2858652
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(State or other jurisdiction of (IRS Employer
incorporation or organization) Identification No.)
507 Prudential Road, Horsham, Pennsylvania 19044
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(Address of principal executive offices) (Zip Code)
Registrant's telephone number, including area code (215) 441-3000
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Securities registered pursuant to Section 12(b) of the Act: None
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Securities registered pursuant to Section 12(g) of the Act:
Common stock, no par value
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(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required
to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during
the preceding 12 months (or for such shorter period that the registrant was
required to file such reports), and (2) has been subject to such filing
requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405
of Regulation S-K is not contained herein, and will not be contained, to the
best of registrant's knowledge, in definitive proxy or information statements
incorporated by reference in Part III of this Form 10-K or any amendment to this
Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer
(as defined in Rule 12b-2 of the Act). Yes [X] No [ ]
The aggregate market value of voting and nonvoting common equity held by
nonaffiliates was approximately $430,810,000(1).
The number of shares of the registrant's common stock outstanding as of March
11, 2003 was 25,908,000.
DOCUMENTS INCORPORATED BY REFERENCE
Certain portions of the registrant's Proxy Statement to be filed in connection
with its 2003 Annual Meeting of Shareholders are incorporated by reference into
Part III of this Report. Other documents incorporated by reference are listed in
the Exhibit Index.
_________________
(1) The aggregate market value of the voting and nonvoting common equity held by
nonaffiliates set forth equals the number of shares of the registrant's common
stock outstanding, reduced by the number of shares of common stock held by
officers, directors and shareholders owning 10 percent or more of the
registrant's common stock, multiplied by $22.09, the last reported sale price
for the registrant 's common stock on June 28, 2002, the last business day of
the registrant's most recently completed second fiscal quarter. The information
provided shall in no way be construed as an admission that any person whose
holdings are excluded from this figure is an affiliate of the registrant or that
such person is the beneficial owner of the shares reported as being held by
him/it, and any such inference is hereby disclaimed. The information provided
herein is included solely for record-keeping purposes of the Securities and
Exchange Commission.
TABLE OF CONTENTS
Page
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PART I
Item 1. Business. 2
Item 2. Properties. 23
Item 3. Legal Proceedings. 23
Item 4. Submission of Matters to a Vote of Security Holders. 23
Item 4.1 Executive Officers of the Registrant who are not also Directors. 24
PART II
Item 5. Market for Registrant's Common Equity and
Related Shareholder Matters. 25
Item 6. Selected Financial Data. 26
Item 7. Management's Discussion and Analysis of Financial
Condition and Results of Operations. 27
Item 7a Quantitative and Qualitative Disclosures about Market Risk. 44
Item 8. Financial Statements and Supplementary Data. 44
Item 9. Changes in and Disagreements with Accountants on Accounting
and Financial Disclosure. 44
PART III
Item 10. Directors and Executive Officers of the Registrant. 45
Item 11. Executive Compensation. 45
Item 12. Security Ownership of Certain Beneficial Owners and Management
and Related Shareholder Matters. 45
Item 13. Certain Relationships and Related Transactions. 45
Item 14. Controls and Procedures. 45
PART IV
Item 15. Exhibits, Financial Statement Schedules, and Reports on Form 8-K. 47
Signatures. 53
Section 302 Certifications. 54
Index to Consolidated Financial Statements and Financial
Statement Schedule. F-1
As used in this Annual Report on Form 10-K, unless the context otherwise
requires, "we," "us," "our," "Company" or "NCO" refers to NCO Group, Inc. and
its subsidiaries.
Forward-Looking Statements
Certain statements included in this Annual Report on Form 10-K, including
without limitation statements in Item 1. "Business" and Item 7. "Management's
Discussion and Analysis of Financial Condition and Results of Operations," and
statements other than historical facts, are forward-looking statements (as such
term is defined in the Securities Exchange Act of 1934, and the regulations
thereunder), which are intended to be covered by the safe harbors created
thereby. Forward-looking statements include, without limitation, statements as
to the Company's expected future results of operations, the Company's growth
strategy, the Company's Internet and e-commerce strategy, the final outcome of
the environmental liability and the Company's litigation with its former
landlord, the effects of the terrorist attacks, war and the economy on the
Company's business, expected increases in operating efficiencies, anticipated
trends in the accounts receivable management industry, estimates of future cash
flows of purchased accounts receivable, estimates of goodwill impairments and
amortization expense of other intangible assets, the effects of legal or
governmental proceedings, the effects of changes in accounting pronouncements
and statements as to trends or the Company's or management's beliefs,
expectations and opinions. Forward-looking statements are subject to risks and
uncertainties and may be affected by various factors that may cause actual
results to differ materially from those in the forward-looking statements. In
addition to the factors discussed in this report, certain risks, uncertainties
and other factors, including, without limitation, the risk that the Company will
not be able to achieve expected future results of operations, the risk that the
Company will not be able to implement its growth strategy as and when planned,
risks associated with NCO Portfolio Management, Inc. ("NCO Portfolio"), risks
associated with growth and future acquisitions, the risk that the Company will
not be able to realize operating efficiencies in the integration of its
acquisitions, fluctuations in quarterly operating results, risks relating to the
timing of contracts, risks related to purchased accounts receivable, risks
associated with technology, the Internet and the Company's e-commerce strategy,
risks related to the environmental liability, risks relating to the Company's
litigation and regulatory investigations, risks related to past or possible
future terrorist attacks, risks related to the threat or outbreak of war or
hostilities, risks related to the current economic condition in the United
States, risks related to the Company's foreign operations, risks related to the
economy, and other risks described under Item 1. "Business - Investment
Considerations" or in the Company's other filings made from time to time with
the Securities and Exchange Commission, can cause actual results and
developments to be materially different from those expressed or implied by such
forward-looking statements.
The Company disclaims any intent or obligation to publicly update or revise
any forward-looking statements, regardless of whether new information becomes
available, future developments occur or otherwise.
Restatement of Financial Statements
On February 6, 2003, our independent auditors informed us that, based on
their further internal review and consultation, they no longer considered our
methodology for revenue recognition for a long-term guarantee contract
appropriate under revenue recognition guidelines. Further review by us with our
independent auditors led us to conclude that we should change our method of
revenue recognition for the contract. The change resulted in the deferral of the
recognition of revenue under the contract until such time as any contingencies
related to the realization of revenue have been resolved. Our financial
statements and the accompanying notes for the years ended December 31, 2000 and
2001, have been restated for a correction of an error due to this change.
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PART I
Item 1. Business.
General
We believe we are the largest provider of outsourced accounts receivable
management and collection services in the world, serving a wide range of clients
in North America and abroad. Our extensive industry knowledge, technological
expertise, management depth, and long-standing client relationships enable us to
deliver customized solutions that improve our clients' accounts receivable
recovery rates, thus improving their financial performance. Our services are
provided through the utilization of sophisticated technologies including
advanced workstations, leading-edge client interface systems, and call
management systems composed of predictive dialers, automated call distribution
systems, digital switching and customized computer software. We have
approximately 9,300 employees who provide our services through the operation of
76 centers.
Our website is www.ncogroup.com. We make available, free of charge, on our
website, our annual report on Form 10-K, quarterly reports on Form 10-Q, current
reports on Form 8-K, and all amendments to those reports, filed or furnished
pursuant to Section 13(a) or 15(d) of the Exchange Act, as soon as reasonably
practicable after such material is electronically filed with or furnished to the
SEC.
In addition, we will provide, at no cost, paper or electronic copies of our
reports and other filings (excluding exhibits) made with the SEC. Requests
should be directed to:
NCO Group, Inc.
507 Prudential Road
Horsham, PA 19044
Attention: Steven L. Winokur, Executive Vice President, Finance,
Chief Financial Officer and Treasurer
The information on the website listed above, is not and should not be
considered part of this annual report on Form 10-K and is not incorporated by
reference in this document. This website is and is only intended to be an
inactive textual reference.
Industry Background
Increasingly, companies are outsourcing many noncore functions to focus on
revenue-generating activities, reduce costs and improve productivity. In
particular, many large corporations are recognizing the advantages of
outsourcing accounts receivable management and collections. This trend is being
driven by a number of industry-specific factors:
o First, the complexity of accounts receivable management and collection
functions in certain industries has increased dramatically in recent years.
For example, with the increasing popularity of health maintenance
organizations, or HMOs, and preferred provider organizations, or PPOs,
healthcare institutions now face the challenge of billing not only large
insurance companies but also individuals who are required to pay small,
one-time co-payments.
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o Second, the increasing complexity of the collection process that requires
sophisticated call management and database systems for efficient collections.
o Third, the trend in certain industries to outsource noncore functions, due to
competitive pressures, changing regulations and/or required capital
expenditures.
o Fourth, the increased focus by credit grantors on early identification and
intervention in pre-delinquent debt (i.e., debt with an average age of less
than 90 days).
We operate in a large industry with positive growth dynamics. Growth in our
industry is fundamentally driven by the continuing growth in consumer and
commercial debt. According to The Kaulkin Report, an industry publication,
overall consumer debt in 2000 exceeded $8.3 trillion. Approximately $135 billion
of delinquent consumer debt was estimated to have been placed for collection
with third-party collection agencies during 2000, nearly double the $73 billion
placed in 1990. The primary market sectors within our industry are financial
services, healthcare, and retail and commercial. Other important market sectors
include telecommunications, utilities, and government.
The accounts receivable management and collection industry is highly
fragmented. Based on information obtained from the American Collectors
Association, there are approximately 6,500 accounts receivable management and
collection companies in the United States, the majority of which are small,
local businesses. We believe that many smaller competitors have insufficient
capital to expand and invest in technology and are unable to adequately meet the
geographic coverage and quality standards demanded by businesses seeking to
outsource their accounts receivable management function.
Strategy
Our strategy is to maintain our market dominance as we become a global
provider of accounts receivable management and collection services. Our strategy
to achieve these objectives includes the following elements:
Expand our relationships with clients - A significant amount of our growth
stems from the expansion of existing client relationships. These relationships
and the resulting opportunities continue to grow in scale, complexity and profit
potential. Over time, we believe these relationships should transition from the
operational delivery of services to the strategic development of long-term,
goal-oriented partnerships where we are sharing in the improved profitability
and operational efficiencies created for our clients.
Enhance our operating margins - Until 2001, we focused primarily on
realizing efficiencies through the integration of acquired companies. Over the
next several years, we intend to continue to pursue the following initiatives to
increase profitability:
o standardization of systems and practices;
o consolidation of facilities;
o automation of clerical functions;
o use of statistical analysis to improve performance and reduce direct unit
costs;
o leveraging our purchasing power; and
o leveraging foreign labor.
-3-
Business Process Improvements - We continually develop and enhance our
technology and infrastructure with initiatives that improve the efficiency of
our operations and enhance client service. Examples of recent initiatives
include:
o Online access for Attorney Network Services: We went "live" with our new
Attorney Network System (E-Recoverease), which brings us online with over 70
attorneys from across the United States. They are now able to receive,
process, and return updates for all forwarded accounts using the latest web
server technology.
o Quality control over client data exchange: We have continued to develop a
proprietary software product that tracks both the client inbound files and
the client remittance files. The system now incorporates all the features for
both quality and production control.
o Enhanced technology for commercial collections: We completed a comprehensive
re-engineering of the business processes for our commercial collections. This
re-engineering, coupled with the introduction of redesigned proprietary
software, will improve both sales and collections, as well as credit
investigative reporting services.
o Web enabled electronic bill payment for our clients and their customers: We
have developed web-based platforms that process real-time credit card
authorizations and electronic bank drafts that are then applied to customer
accounts on the client's billing system. The system is available to the
clients' employees inside their own call centers and to their customers for
self service over the Internet.
o Improved client host integration: We continue to see increased efficiency
gains by integrating and automating client host connections and their
associated workflows utilizing the NCO ACCESS Interface Manager. Our
representatives are able to work on our systems and the client systems
together from a single interface that is common across all call centers, yet
customized to accommodate each client's workflow. This delivers benefits
including a reduction in project ramp-up time, a reduction in training costs,
and an overall increase in account representative productivity.
o On-going business process reengineering: We continue to drive improved
performance and reduced cost through our on-going focus on business process
improvement. For instance, we are in the final stages of automating a
clerical area that has historically managed our bankruptcy notification
process. In the past this area manually processed over half a million paper
bankruptcy notifications per year, all according to unique internal and
external customer requirements. We took this from a paper-based process, with
an average turn around time of weeks, to an entirely electronic process, with
a turn around measured in hours.
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o Technology Support Center: We have just completed construction and
integration of our Technology Support Center. This industry-leading IT
Infrastructure monitoring and management system provides graphical displays
and a notification system that rapidly alerts trained staff to potential
business-impacting problems. In many cases, the staff is alerted before the
end-user community is affected. This industry innovation allows us to combine
the classic IT Help Desk and the 1st and 2nd levels of systems and network
administration roles to provide maximized return on investment, increased
quality of end-user support, and a single point of information coordination
and dissemination to our end users, IT engineers, and business management.
Expand internationally - We believe that business process outsourcing is
gaining widespread acceptance throughout Canada, Europe and Australasia. Our
international expansion strategy is designed to capitalize on each of these
markets in the near term, as well as continue to develop access to lower cost
foreign labor. We operate in Canada and the United Kingdom through wholly owned
subsidiaries and are one of the largest providers of consumer collection
services in both of these markets. We expect to further penetrate these markets
through increased sales of accounts receivable management and collection
services. Additionally, we expect to pursue direct investments, strategic
alliances and partnerships as well as further explore acquisitions in these
markets. For example, we formed a strategic alliance with MIRAE Credit
Information Services in 2001 to provide an entry into the Korean market. These
type of alliances enhance our service offerings as well as increase the
awareness of NCO as a global provider of accounts receivable management and
collection services.
In addition to providing services to these core markets, we also provide
our domestic clients with a cost-effective option of using foreign labor markets
such as India to provide effective services. We currently have approximately 190
telephone representatives working in India for our U.S clients. We are in the
process of expanding our presence in India as well as exploring new
opportunities in other labor markets such as Australia, Central America and the
Caribbean.
Increase purchases of delinquent accounts receivable through NCO Portfolio
- - Since 1991, we have purchased, collected and managed portfolios of purchased
accounts receivable. These portfolios have consisted primarily of delinquent
accounts receivable. Due to the profitability of these purchases, we expanded
our presence in this marketplace in 1999 and determined that it would be
beneficial to further expand our presence, while at the same time limiting our
exposure to credit risk. Through the merger of our subsidiary NCO Portfolio with
Creditrust in February 2001, we have created one of the few publicly traded
companies purchasing delinquent accounts receivable. Under the terms of our
credit agreement, our investment in NCO Portfolio currently is limited to our
$25.0 million equity investment and a credit subfacility. The borrowing capacity
of the subfacility is subject to quarterly reductions and the borrowing capacity
was $40.0 million as of December 31, 2002. In order to take advantage of larger
purchase opportunities without increasing its exposure to individual portfolios,
NCO Portfolio entered into a four-year financing agreement with CFSC Capital
Corp. XXXIV ("Cargill") in August 2002. The agreement stipulates that all
purchases of accounts receivable by NCO Portfolio with a purchase price in
excess of $4.0 million, with limited exceptions, must be first offered to
Cargill for the opportunity to finance. Cargill, at its sole discretion, has the
right to refuse to finance any of the purchased accounts receivable. Borrowings
under this financing agreement are nonrecourse to us and NCO Portfolio but are
collateralized by the accounts receivable purchased through Cargill and
cross-collateralized with all other accounts receivable purchases financed by
Cargill.
-5-
As of December 31, 2002, NCO Portfolio had an investment of $3.4 million
for its 50 percent ownership interest in a joint venture, InoVision-MEDCLR NCOP
Ventures, LLC ("Joint Venture") with IMNV Holdings, LLC ("Marlin"). The Joint
Venture was set up to purchase utility, medical and other various small balance
accounts receivable. The Joint Venture is accounted for using the equity method
of accounting. The Joint Venture has access to capital through a specialty
finance lender who, at its option, lends 90 percent of the value of the
purchased accounts receivable to the Joint Venture. The debt is
cross-collateralized by all portfolios in which the lender participates, and is
nonrecourse to NCO Portfolio.
In the future, NCO Portfolio may develop additional growth opportunities
including partnerships with banks, commercial lenders, and other investors who
will provide additional funding sources for purchases of delinquent accounts
receivable. By utilizing such risk-sharing partnerships, NCO Portfolio will gain
access to capital while limiting both our and NCO Portfolio's exposure to credit
risk.
Continue to explore strategic acquisition opportunities - During 2002, we
completed the acquisitions of Great Lakes Collection Bureau, Inc. and The
Revenue Maximization Group, Inc. The accounts receivable management and
collection industry is highly fragmented with over 6,500 participants in the
United States. The vast majority of these participants are small, local
businesses. Although our focus is on internal growth, we believe we will
continue to find attractive acquisition opportunities over time.
HIPAA compliance - With the enactment of new standards for privacy, data
security, and administrative simplification under the Health Insurance
Portability and Accountability Act of 1996, referred to as HIPAA, we have
concluded an in-depth analysis to identify areas for further improvement in all
of our privacy compliance practices. In 2003, this will result in the
implementation of additional compliance training and awareness programs for our
healthcare service employees, as well as enhanced security at various
facilities. This investment in HIPAA compliance sets a high standard for "best
practices" that will be applied across all of our business lines to ensure the
protection and the confidentiality of our clients' data.
Services
Accounts Receivable Management and Collection
We provide a wide range of accounts receivable management and collection
services to our clients by utilizing an extensive technological infrastructure.
Although most of our accounts receivable management and collection services to
date have focused on the recovery of traditional delinquent accounts, we also
engage in the recovery of current accounts receivable and early stage
delinquencies (generally, accounts which are 90 days or less past due). We
generate approximately 70 percent of our revenue from the recovery of delinquent
accounts receivable on a contingency fee basis. In addition, we generate revenue
from fixed fees for certain accounts receivable management and collection and
other related services. We seek to be a low-cost provider and, as such, our
contingent fees typically range from 15 percent to 35 percent of the amounts
recovered on behalf of our clients. However, fees can range from six percent for
the management of accounts placed early in the accounts receivable cycle to 50
percent for accounts that have been serviced extensively by the client or by
third-party providers. Our average fee for contingency based revenue across all
industries, excluding the long-term guarantee contract, was approximately 19
percent during 2002, 2001 and 2000.
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Accounts receivable management and collection services typically include
the following activities:
Engagement Planning. Our approach to accounts receivable management and
collection for each client is determined by a number of factors including
account size and demographics, the client's specific requirements and
management's estimate of the collectibility of the account. We have developed a
library of standard processes for accounts receivable management and collection,
which is based upon our accumulated experience. We integrate these processes
with our client's requirements to create a customized recovery solution. In many
instances, the approach will evolve and change as the relationship with the
client develops and both parties evaluate the most effective means of recovering
accounts receivable. Our standard approach, which may be tailored to the
specialized requirements of each client, defines and controls the steps that
will be undertaken by us on behalf of the client and the manner in which we will
report data to the client. Through our systematic approach to accounts
receivable management and collection, we remove most decision making from the
recovery staff and ensure uniform, cost-effective performance.
Once the approach has been defined, we electronically or manually transfer
pertinent client data into our information system. When the client's records
have been established in our system, we begin the recovery process.
Skip-tracing. In cases where the client's customer's telephone number or
address is unknown, we systematically search the U.S. Post Office National
Change of Address service, consumer databases, electronic telephone directories,
credit agency reports, tax assessor and voter registration records, motor
vehicle registrations, military records and other sources. The geographic
expansion of banks, credit card companies, national and regional
telecommunications companies, and managed healthcare providers, along with the
mobility of consumers, has increased the demand for locating the client's
customers. Once we have located the client's customer, the notification process
can begin.
Account Notification. We initiate the recovery process by forwarding an
initial letter that is designed to seek payment of the amount due or open a
dialogue with client's customers who cannot afford to pay at the current time.
This letter also serves as an official notification to each client's customer of
his or her rights as required by the Federal Fair Debt Collection Practices Act.
We continue the recovery process with a series of mail and telephone
notifications. Telephone representatives remind the client's customer of their
obligation, inform them that their account has been placed for collection with
us and begin a dialogue to develop a payment program.
Credit Reporting. At a client's request, we will electronically report
delinquent accounts to one or more of the national credit bureaus where it will
remain for a period of up to seven years. The possible denial of future credit
often motivates the resolution of past due accounts.
Payment Process. After we receive payment from the client's customer, we
can either remit the amount received minus our fee to the client or remit the
entire amount received to the client and subsequently bill the client for our
services.
Activity Reports. Clients are provided with a system-generated set of
standardized or customized reports that fully describe all account activity and
current status. These reports are typically generated monthly; however, the
information included in the report and the frequency that the reports are
generated can be modified to meet the needs of the client.
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Quality Tracking. We emphasize quality control throughout all phases of the
accounts receivable management and collection process. Some clients may specify
an enhanced level of supervisory review and others may request customized
quality reports. Large national credit grantors will typically have exacting
performance standards which require sophisticated capabilities such as
documented complaint tracking and specialized software to track quality metrics
to facilitate the comparison of our performance to that of our peers.
Delinquency Management
We provide pre-charge-off delinquency management services that enable
clients to manage their at-risk customers and quickly restore the relationships
to a current payment status. We mail reminder letters and make first-party calls
to the clients' customers, reminding them of the past due balance and
encouraging them to make immediate repayment using pay-by-phone direct debit
checks or, in certain cases, credit cards. Our services include responding to
inbound calls seven days a week. We apply our extensive database and predictive
modeling techniques to the customer's profile, assigning more intense efforts to
higher risk customers.
Customer Service and Support
We utilize our communications and information system infrastructure to
supplement or replace the customer service function of our clients. For example,
we are currently engaged by a large regional utility company to provide customer
service functions for a segment of the utility's customer base that is
delinquent. For other clients, we provide a wide range of specialized services
such as fraud prevention, over-limit calling, inbound calling for customer
credit application and approval processes, and general back-office support. We
can provide customer contact through inbound or outbound calling, or customized
web-enabled functions.
Billing
We complement existing service lines by offering adjunct billing services
to clients as an outsourcing option. Additionally, we can assist healthcare
clients in the billing and management of third-party insurance.
Additional Services
We selectively provide other related services that complement our
traditional accounts receivable management and collection business and leverage
our technological infrastructure. We believe that the following services will
provide additional growth opportunities for us:
Attorney Network Services. We coordinate litigation undertaken on behalf of
our clients through a nationwide network of more than 150 law firms whose
attorneys specialize in collection litigation. Our collection support staff
manages the attorney relationships and facilitates the transfer of all necessary
documentation.
NCOePayments. We can provide clients with a virtual 24-hour payment center
that is accessible by the use of telephones or the Internet.
Credit and Investigative Reporting Service. We develop the information
needed to profile commercial debtors and make decisions affecting extensions of
credit.
-8-
NCO Benefit Systems. We administer compliant COBRA administration
services for human resources departments.
Technology and Infrastructure
We have made a substantial investment in our information systems such as
"thin client" network computing devices, predictive dialers, automated call
distribution systems, digital switching and customized computer software,
including the NCO ACCESS Interface Manager. As a result, we believe we are able
to address accounts receivable management and collection activities more
reliably and more efficiently than our competitors. Our Information Technology
staff is comprised of approximately 200 employees led by a Chief Information
Officer. We provide our services through the operation of 76 centers that are
electronically linked through an international wide area network, with the
exception of our two United Kingdom centers.
We maintain disaster recovery contingency plans and have implemented
procedures to protect against the loss of data resulting from power outages,
fire and other casualties. We have implemented a security system to protect the
integrity and confidentiality of our computer systems and data and maintain
comprehensive business interruption and critical systems insurance on our
telecommunications and computer systems. Our systems also permit network access
to enable clients to electronically communicate with us and monitor operational
activity on a real-time basis.
Our call centers utilize predictive dialers with over 4,650 stations to
address our low balance, high-volume accounts. These systems scan our databases,
simultaneously initiate calls on all available telephone lines and determine if
a live connection is made. Upon determining that a live connection has been
made, the computer immediately switches the call to an available representative
and instantaneously displays the associated account record on the
representative's workstation. Calls that reach other signals, such as a busy
signal, telephone company intercept or no answer, are tagged for statistical
analysis and placed in priority recall queues or multiple-pass calling cycles.
The system also automates virtually all record keeping and follow-up activities
including letter and report generation. Our automated method of operations
dramatically improves the productivity of our collection staff.
Sales and Marketing
Our sales force is organized at the corporate level to address clients by
need, based upon their respective complexity, geography and industry. We utilize
a focused and professional direct selling effort in which sales representatives
personally cultivate relationships with prospective and existing clients. Our
direct sales force consists of approximately 70 people, and for the commercial
sector, approximately 270 telephone sales representatives. Each sales
representative is charged with identifying leads, qualifying prospects and
closing sales. When appropriate, our operating personnel will join in the sales
effort to provide detailed information and advice regarding our operational
capabilities. We supplement our direct sales effort with print media and
attendance at trade shows.
Many of our prospective clients issue a request for proposal as part of the
contract award process. We have a staff of technical writers for the purpose of
preparing detailed, professional responses to requests for proposals.
-9-
Quality Assurance and Client Service
Our reputation for quality service is critical to acquiring and retaining
clients. Therefore, we and our clients monitor our representatives for strict
compliance with the clients' specifications and our policies. We regularly
measure the quality of our services by capturing and reviewing such information
as the amount of time spent talking with clients' customers, level of customer
complaints and operating performance. In order to provide ongoing improvement to
our telephone representatives' performance and to ensure compliance with our
policies and standards, quality assurance personnel monitor each telephone
representative on a frequent basis and provide ongoing training to the
representative based on this review. Our information systems enable us to
provide clients with reports on a real-time basis as to the status of their
accounts and clients can choose to network with our computer system to access
such information directly.
We maintain a client service department to promptly address client issues
and questions and alert senior executives of potential problems that require
their attention. In addition to addressing specific issues, a team of client
service representatives will contact clients on a regular basis in order to
establish a close rapport, determine clients' overall level of satisfaction and
identify practical methods of improving their satisfaction.
Client Relationships
Our client base currently includes over 50,000 companies in the financial
services, healthcare, retail and commercial, utilities, education,
telecommunications and government sectors. Our 10 largest clients in 2002
accounted for approximately 31 percent of our revenue. In 2002, no client
accounted for more than 8 percent of total revenue. In 2002, we derived 39.2
percent of our revenue, excluding purchased accounts receivable, from financial
services (which included the banking and insurance sectors), 24.5 percent from
healthcare organizations, 18.1 percent from retail and commercial entities, 6.2
percent from utilities, 5.7 percent from telecommunications companies, 4.6
percent from educational organizations, and 1.7 percent from government
entities.
We enter into contracts with most of our clients that define, among other
things, fee arrangements, scope of services and termination provisions. Clients
may usually terminate such contracts on 30 or 60 days notice. In the event of
termination, however, clients typically do not withdraw accounts referred to us
prior to the date of termination, thus providing us with an ongoing stream of
revenue from such accounts, which diminish over time. Under the terms of our
contracts, clients are not required to place accounts with us but do so on a
discretionary basis.
We have a long-term guarantee contract with a large client to provide
collection services. We receive a base service fee based on collections. We also
earn a bonus to the extent collections are in excess of the guarantees. We are
required to pay the client if collections do not reach the guarantees but we are
entitled to recoup at least 90 percent of any such guarantee payments from
subsequent collections.
Personnel and Training
Our success in recruiting, hiring and training a large number of employees
is critical to our ability to provide high quality accounts receivable
management and collection, customer support and teleservices programs to our
clients. We seek to hire personnel with previous experience in accounts
receivable management and collections or as telephone representatives. We
generally offer internal promotion opportunities and competitive compensation
and benefits.
All our collection personnel receive comprehensive training that consists
of a combination of classroom and practical experience. Prior to customer
contact, new employees receive one week of training in our operating systems,
procedures and telephone techniques and instruction in applicable federal and
state regulatory requirements. Our personnel also receive a wide variety of
continuing professional education consisting of both classroom and role-playing
sessions.
-10-
As of December 31, 2002, we had a total of approximately 8,500 full-time
employees and 800 part-time employees, of which 7,600 are telephone
representatives. As of December 31, 2002, we also utilized 190 telephone
representatives through a subcontractor in India. Our employees are not
represented by a labor union. We believe that our relations with our employees
are good.
Competition
The accounts receivable management and collection industry is highly
competitive. We compete with a large number of providers, including large
national corporations such as Outsourcing Solutions, Inc., IntelliRisk
Management Corporation, Risk Management Alternatives, Inc., and GC Services LP,
as well as many regional and local firms. Some of our competitors may offer more
diversified services and/or operate in broader geographic areas than we do. In
addition, many companies perform the accounts receivable management and
collection services offered by us in-house. Moreover, many larger clients retain
multiple accounts receivable management and collection providers, which exposes
us to continuous competition in order to remain a preferred vendor. We believe
that the primary competitive factors in obtaining and retaining clients are the
ability to provide customized solutions to a client's requirements, personalized
service, sophisticated call and information systems, and price.
Regulation
The accounts receivable management and collection industry in the United
States is regulated both at the federal and state level. The Federal Fair Debt
Collection Practices Act regulates any person who regularly collects or attempts
to collect, directly or indirectly, consumer debts owed or asserted to be owed
to another person. The Fair Debt Collection Practices Act establishes specific
guidelines and procedures that debt collectors must follow in communicating with
consumer debtors, including the time, place and manner of such communications.
Further, it prohibits harassment or abuse by debt collectors, including the
threat of violence or criminal prosecution, obscene language or repeated
telephone calls made with the intent to abuse or harass. The Fair Debt
Collection Practices Act also places restrictions on communications with
individuals other than consumer debtors in connection with the collection of any
consumer debt and sets forth specific procedures to be followed when
communicating with such third parties for purposes of obtaining location
information about the consumer. Additionally, the Fair Debt Collection Practices
Act contains various notice and disclosure requirements and prohibits unfair or
misleading representations by debt collectors. We are also subject to the Fair
Credit Reporting Act, which regulates the consumer credit reporting industry and
which may impose liability on us to the extent that the adverse credit
information reported on a consumer to a credit bureau is false or inaccurate.
The Federal Trade Commission has the authority to investigate consumer
complaints against debt collection companies and to recommend enforcement
actions and seek monetary penalties. The accounts receivable management and
collection business is also subject to state regulation. Some states require
that we be licensed as a debt collection company. We believe that we currently
hold applicable licenses from all states where required.
We provide services to healthcare clients that will be required to comply
with the new standards for privacy, transaction and code sets and data security
under the Health Insurance Portability and Accountability Act of 1996, referred
to as HIPAA. There are three compliance dates under HIPAA: (i) April 2003, for
the new HIPAA privacy standards; (ii) October 2003, for the new HIPAA
transaction and code set standards; and (iii) April 2005 for the new HIPAA
security standards. In connection with our agreements with these clients, we
will be required to agree to maintain the confidentiality of the health
information we receive from them. We have concluded a review of our operating
policies and procedures to identify areas for strengthening compliance with the
new privacy requirements. In 2003, this will result in the implementation of
additional compliance training and awareness programs for our healthcare service
employees. While the code set requirements will affect our clients, we do not
expect that they will have any material effect on our business. We have
implemented a plan to enhance security at all relevant levels, which is expected
to meet or exceed the standards in advance of the deadline.
-11-
The collection of accounts receivable by collection agencies in Canada is
regulated at the provincial and territorial level in substantially the same
fashion as is accomplished by federal and state laws in the United States. The
manner in which we conduct the business of collecting accounts is subject, in
all provinces and territories, to established rules of common law or civil law
and statute. Such laws establish rules and procedures governing the tracing,
contacting and dealing with debtors in relation to the collection of outstanding
accounts. These rules and procedures prohibit debt collectors from engaging in
intimidating, misleading and fraudulent behavior when attempting to recover
outstanding debts. In Canada, our collection operations are subject to licensing
requirements and periodic audits by government agencies and other regulatory
bodies. Generally, such licenses are subject to annual renewal. We believe that
we hold all necessary licenses in those provinces and territories that require
them.
If we engage in other teleservice activities in Canada, there are several
provincial and territorial consumer protection laws that have more general
application. This legislation defines and prohibits unfair practices by
telemarketers, such as the use of undue pressure and the use of false,
misleading or deceptive consumer representations.
In addition, the accounts receivable management and collection industry is
regulated in the United Kingdom, including a licensing requirement. If we expand
our international operations, we may become subject to additional government
control and regulation in other countries, which may be more onerous than those
in the United States.
Several of the industries served by us are also subject to varying degrees
of government regulation. Although compliance with these regulations is
generally the responsibility of our clients, we could be subject to various
enforcement or private actions for our failure or the failure of our clients to
comply with such regulations.
We devote significant and continuous efforts, through training of personnel
and monitoring of compliance, to ensure that we comply with all federal and
state regulatory requirements. We believe that we are in material compliance
with all such regulatory requirements.
Segment and Geographical Financial Information
See note 21 in our Notes to Consolidated Financial Statements for
disclosure of financial information regarding our segments and geographic areas.
-12-
History of Acquisitions
The following is a summary of the acquisitions we completed since 1994
(dollars in thousands):
Revenue for the
Date Value of Fiscal Year Prior
Acquired Business Purchase Price to Acquisition
----------- ----------------- ------------------- -------------------
The Revenue Maximization 12/9/02 A/R Management $ 17,500(1) $24,648
Group, Inc.
Great Lakes Collection Bureau, Inc. 8/19/02 A/R Management and $ 33,000(2) $52,250
Purchased A/R
Creditrust Corporation 2/20/01 Purchased A/R $ 25,000(3) $36,491
Compass International Services 8/20/99 A/R Management and 104,100 105,800(4)
Corporation Telemarketing
Co-Source Corporation 5/21/99 A/R Management 124,600 61,100
JDR Holdings, Inc. 3/31/99 A/R Management and 103,100 51,000
Telemarketing
Medaphis Services Corporation 11/30/98 A/R Management 117,500 96,700
MedSource, Inc. 7/1/98 A/R Management 35,700(5) 22,700
FCA International Ltd. 5/5/98 A/R Management 69,900 62,800
The Response Center 2/6/98 Market Research 15,000 8,000
Collections Division of American 1/1/98 A/R Management 1,700 1,700
Financial Enterprises, Inc.
ADVANTAGE Financial 10/1/97 A/R Management 5,000 5,100
Services, Inc.
Credit Acceptance Corporation 10/1/97 A/R Management 1,800 2,300
Collections Division of CRW 2/2/97 A/R Management 12,800 25,900
Financial, Inc.
CMS A/R Services 1/31/97 A/R Management 5,100 6,800
Tele-Research Center, Inc. 1/30/97 Market Research and 2,200 1,800
Telemarketing
Goodyear & Associates, Inc. 1/22/97 A/R Management 5,400 5,500
Management Adjustment 9/5/96 A/R Management 9,000 13,500
Bureau, Inc.
Collections Division of Trans 1/3/96 A/R Management 4,800 7,000
Union Corporation
Eastern Business Services, Inc. 8/1/95 A/R Management 2,000 2,000
B. Richard Miller, Inc. 4/29/94 A/R Management 1,400 1,300
(1) Includes $889,000 of debt repaid by us.
(2) NCO Group, Inc. acquired the net assets and the results of operations
for $10.1 million, and NCO Portfolio Management, Inc.
acquired the purchased accounts receivable for $22.9 million.
(3) We merged our subsidiary NCO Portfolio Management, Inc. with
Creditrust Corporation. We own approximately 63 percent of the
post-merger company.
(4) Pro Forma Revenue - Assumes the acquisitions completed by Compass
International Services Corporation in 1998 and the sale of
its Print and Mail Division were all completed on January 1, 1998.
(5) Includes $17.3 million of debt repaid by us.
-13-
Investment Considerations
You should carefully consider the risks described below. If any of the
risks actually occur, our business, financial condition or results of future
operations could be materially adversely affected. This Annual Report on Form
10-K contains forward-looking statements that involve risk and uncertainties.
Our actual results could differ materially from those anticipated in the
forward-looking statements as a result of many factors, including the risks
faced by us described below and elsewhere in this Annual Report on Form 10-K.
Decrease in our collections due to the current economic condition may have
an adverse effect on our operating results, revenue and stock price.
Due to the current economic condition in the United States, which has led
to increasing rates of unemployment and personal bankruptcy filings, the ability
of consumers to pay their debts has significantly decreased. Defaulted consumer
loans that we service or purchase are generally unsecured, and we may often be
unable to collect these loans in case of the personal bankruptcy of a consumer.
Because of increased unemployment rates and bankruptcy filings, our collections
may significantly decline, which may adversely impact our results of operations,
revenue and stock price.
Terrorist attacks, war and threats of attacks and war may adversely impact
our results of operations, revenue and stock price.
Terrorist attacks, war and threats of attacks and war may adversely impact
our results of operations, revenue and stock price. Recent terrorist attacks in
the United States, as well as future events occurring in response or in
connection to them, including, without limitation, future terrorist attacks
against U.S. targets and threats of war or actual conflicts involving the United
States or its allies, may adversely impact our operations, including affecting
our ability to collect our clients' accounts receivable. More generally, any of
these events could cause consumer confidence and spending to decrease or result
in increased volatility in the economy. They could also result in the deepening
of the economic recession in the United States. Any of these occurrences could
have a material adverse effect on our operating results, collections and
revenue, and may result in the volatility of the market price for our common
stock.
Our business is dependent on our ability to grow internally.
Our business is dependent on our ability to grow internally, which is
dependent upon (1) our ability to retain existing clients and expand our
existing client relationships and (2) our ability to attract new clients.
Our ability to retain existing clients and expand those relationships is
subject to a number of risks, including the risk that:
o we fail to maintain the quality of services we provide to our clients;
o we fail to maintain the level of attention expected by our clients; and
o we fail to successfully leverage our existing client relationships to sell
additional services.
-14-
Our ability to attract new clients is subject to a number of risks,
including:
o the market acceptance of our service offerings;
o the quality and effectiveness of our sales force; and
o the competitive factors within the accounts receivable management and
collection industry.
If our efforts to retain and expand our client relationships and to attract
new clients do not prove effective, it could have a materially adverse effect on
our business, results of operations and financial condition.
If we are not able to respond to technological changes in
telecommunications and computer systems in a timely manner, we may not be able
to remain competitive.
Our success depends in large part on our sophisticated telecommunications
and computer systems. We use these systems to identify and contact large numbers
of debtors and to record the results of our collection efforts. If we are not
able to respond to technological changes in telecommunications and computer
systems in a timely manner, we may not be able to remain competitive. We have
made a significant investment in technology to remain competitive and we
anticipate that it will be necessary to continue to do so in the future.
Computer and telecommunications technologies are changing rapidly and are
characterized by short product life cycles, so that we must anticipate
technological developments. If we are not successful in anticipating, managing,
or adopting technological changes on a timely basis or if we do not have the
capital resources available to invest in new technologies, our business would be
materially adversely affected.
We are highly dependent on our telecommunications and computer systems.
As noted above, our business is highly dependent on our telecommunications
and computer systems. These systems could be interrupted by terrorist acts,
natural disasters, power losses, or similar events. Our business also is
materially dependent on services provided by various local and long distance
telephone companies. If our equipment or systems cease to work or become
unavailable, or if there is any significant interruption in telephone services,
we may be prevented from providing services. Because we generally recognize
income only as accounts are collected, any failure or interruption of services
would mean that we would continue to incur payroll and other expenses without
any corresponding income.
We currently utilize two computer hardware systems and are in the process
of transitioning to one system. If we do not succeed in that transition, our
business may be materially adversely affected.
We compete with a large number of providers in the accounts receivable
management and collection industry. This competition could have a materially
adverse effect on our future financial results.
-15-
We compete with a large number of companies in providing accounts
receivable management and collection services. We compete with other sizable
corporations in the United States and abroad such as Outsourcing Solutions,
Inc., IntelliRisk Management Corporation, Risk Management Alternatives, Inc.,
and GC Services LP, as well as many regional and local firms. We may lose
business to competitors that offer more diversified services and/or operate in
broader geographic areas than we do. We may also lose business to regional or
local firms who are able to use their proximity to or contacts at local clients
as a marketing advantage. In addition, many companies perform the accounts
receivable management and collection services offered by us in-house. Many
larger clients retain multiple accounts receivable management and collection
providers, which exposes us to continuous competition in order to remain a
preferred provider. Because of this competition, in the future we may have to
reduce our collection fees to remain competitive and this competition could have
a materially adverse effect on our future financial results.
Many of our clients are concentrated in the financial services, healthcare,
and retail and commercial sectors. If any of these sectors performs poorly or if
there are any adverse trends in these sectors it could materially adversely
affect us.
For the year ended December 31, 2002, we derived approximately 39.2 percent
of our revenue, excluding purchased accounts receivable, from clients in the
financial services sector, approximately 24.5 percent of our revenue from
clients in the healthcare sector and approximately 18.1 percent of our revenue
from clients in the retail and commercial sectors. If any of these sectors
performs poorly, clients in these sectors may have fewer or smaller accounts to
refer to us, or they may elect to perform accounts receivable management and
collection services in-house. If there are any trends in any of these sectors to
reduce or eliminate the use of third-party accounts receivable management and
collection services, the volume of referrals to us could decrease.
We operate in Canada and the United Kingdom, and various factors relating
to our international operations could affect our results of operations.
We operate in Canada and the United Kingdom. Approximately 5.1% of our
revenues are derived from Canada and the United Kingdom. Political or economic
instability in Canada or the United Kingdom could have an adverse impact on our
results of operations due to diminished revenues in these countries. Our future
revenues, costs of operations and profit results could be affected by a number
of factors related to our international operations, including changes in foreign
currency exchange rates, changes in economic conditions from country to country,
changes in a country's political condition, trade protection measures, licensing
and other legal requirements and local tax issues. Unanticipated currency
fluctuations in the Canadian Dollar, British Pound or Euro could lead to lower
reported consolidated revenues due to the translation of these currencies into
U.S. dollars when we consolidate our revenues.
Most of our contracts do not require clients to place accounts with us,
they may be terminated on 30 or 60 days notice, and they are on a contingent fee
basis. We cannot guarantee that existing clients will continue to use our
services at historical levels, if at all.
Under the terms of most of our contracts, clients are not required to give
accounts to us for collection and usually have the right to terminate our
services on 30 or 60 days notice. Accordingly, we cannot guarantee that existing
clients will continue to use our services at historical levels, if at all. In
addition, most of these contracts provide that we are entitled to be paid only
when we collect accounts. Under applicable accounting principles, therefore, we
can recognize revenues only as accounts are recovered.
-16-
We are subject to risks as a result of our investment in NCO Portfolio.
We are subject to risks as a result of our investment in NCO Portfolio,
including:
o The operations of NCO Portfolio could divert management's attention from our
daily operations, particularly that of Michael J. Barrist, our Chairman,
President and Chief Executive Officer, who is also serving in the same
capacities for NCO Portfolio, and otherwise require the use of other of our
management, operational and financial resources.
o Our investment in NCO Portfolio currently is limited to our $25.0 million
equity investment and a $40.0 million credit subfacility. If NCO Portfolio
defaults on that credit, it would be a default under our credit agreement
with our lenders, or if the value of our investment is impaired, it would
have a material adverse effect on us.
NCO Portfolio has additional business risks that may have an adverse effect
on our combined financial results.
NCO Portfolio is subject to additional business-related risks common to the
purchase and management of defaulted consumer accounts receivable business. The
results of NCO Portfolio will be consolidated into our results. To the extent
that those risks have an adverse effect on NCO Portfolio, they will have an
adverse effect on our combined financial results. Some of those risks are:
o Collections may not be sufficient to recover the cost of investments in
purchased accounts receivable and support operations - NCO Portfolio
purchases past due accounts receivable generated primarily by consumer credit
transactions. These are obligations that the individual consumer has failed
to pay when due. The accounts receivable are purchased from consumer
creditors such as banks, finance companies, retail merchants, hospitals,
utilities, and other consumer-oriented companies. Substantially all of the
accounts receivable consist of account balances that the credit grantor has
made numerous attempts to collect, has subsequently deemed uncollectable, and
charged off its books. After purchase, collections on accounts receivable
could be reduced by consumer bankruptcy filings, which have been on the rise.
The accounts receivable are purchased at a significant discount, typically
less than 10 percent of face value, to the amount the customer owes and,
although we estimate that the recoveries on the accounts receivable will be
in excess of the amount paid for the accounts receivable, actual recoveries
on the accounts receivable will vary and may be less than the amount
expected, or even the purchase price paid for such accounts. The timing or
amounts to be collected on those accounts receivable cannot be assured. If
cash flows from operations are less than anticipated as a result of our
inability to collect NCO Portfolio's accounts receivable, NCO Portfolio will
not be able to purchase new accounts receivable after it has exhausted the
availability under the subfacility, and its future growth and profitability
will be materially adversely affected. There can be no assurance that NCO
Portfolio's operating performance will be sufficient to service debt on the
subfacility or finance the purchase of new accounts receivable.
o Use of estimates in reporting results - NCO Portfolio's revenue is recognized
based on estimates of future collections on portfolios of accounts receivable
purchased. Although estimates are based on analytics, the actual amount
collected on portfolios and the timing of those collections will differ from
NCO Portfolio's estimates. If collections on portfolios are materially less
than estimated, NCO Portfolio will be required to record impairment expenses
that will reduce earnings and could materially adversely affect earnings,
financial condition, and creditworthiness.
-17-
o Possible shortage of available accounts receivable for purchase at favorable
prices - The availability of portfolios of past due consumer accounts
receivable for purchase at favorable prices depends on a number of factors
outside of NCO Portfolio's control, including the continuation of the current
growth trend in consumer debt and competitive factors affecting potential
purchasers and sellers of portfolios of accounts receivable. The growth in
consumer debt may also be affected by changes in credit grantors'
underwriting criteria and regulations governing consumer lending. Any slowing
of the consumer debt growth trend could result in less credit being extended
by credit grantors. Consequently, fewer delinquent accounts receivable could
be available at prices that NCO Portfolio finds attractive. If competitors
raise the prices they are willing to pay for portfolios of accounts
receivable above those NCO Portfolio wishes to pay, NCO Portfolio may be
unable to buy the type and quantity of past due accounts receivable at prices
consistent with its historic return targets. In addition, NCO Portfolio may
overpay for portfolios of delinquent accounts receivable, which may have a
materially adverse effect on our combined financial results.
o NCO Portfolio may be unable to compete with other purchasers of past due
accounts receivable, which may have an adverse effect on our financial
results. NCO Portfolio faces bidding competition in its acquisitions of
portfolios of past due consumer accounts receivable. Some of its existing
competitors and potential new competitors may have greater financial and
other resources that allow them to offer higher prices for the accounts
receivable portfolios. New purchasers of such portfolios entering the market
also cause upward price pressures. NCO Portfolio may not have the resources
or ability to compete successfully with its existing and potential new
competitors. To remain competitive, NCO Portfolio may have to increase its
bidding prices, which may have an adverse impact on our combined financial
results.
Our success depends on our senior management team and if we are not able to
retain them, it could have a materially adverse effect on us.
We are highly dependent upon the continued services and experience of our
senior management team, including Michael J. Barrist, our Chairman, President
and Chief Executive Officer. NCO depends on the services of Mr. Barrist and the
other members of our senior management team to, among other things, continue the
development and implementation of our growth strategies, and maintain and
develop our client relationships.
We may seek to make strategic acquisitions of companies. Acquisitions
involve additional risks that may adversely affect us.
We may be unable to make acquisitions because suitable companies in the
accounts receivable management and collection business are not available at
favorable prices due to increased competition for these companies.
We may have to borrow money, incur liabilities, or sell stock to pay for
future acquisitions and we may not be able to do so at all or on terms favorable
to us. Additional borrowings and liabilities may have a materially adverse
effect on our liquidity and capital resources. If we issue stock for all or a
portion of the purchase price for future acquisitions, our shareholders'
ownership interest may be diluted. If the price of our common stock decreases or
potential sellers are not willing to accept our common stock as payment for the
sale of their businesses, we may be required to use more of our cash resources,
if available, in order to continue our acquisition program.
-18-
Completing acquisitions involves a number of risks, including diverting
management's attention from our daily operations and other additional
management, operational and financial resources. We might not be able to
successfully integrate future acquisitions into our business or operate the
acquired businesses profitably, and we may be subject to unanticipated problems
and liabilities of acquired companies.
We are dependent on our employees and a higher turnover rate would
materially adversely affect us.
We are dependent on our ability to attract, hire and retain qualified
employees. The accounts receivable management and collection industry
experiences a high employee turnover rate. Many of our employees receive modest
hourly wages and some of these employees are employed on a part-time basis. A
higher turnover rate among our employees would increase our recruiting and
training costs and could materially adversely impact the quality of services we
provide to our clients. If we were unable to recruit and retain a sufficient
number of employees, we would be forced to limit our growth or possibly curtail
our operations. Growth in our business will require us to recruit and train
qualified personnel at an accelerated rate from time to time. We cannot assure
you that we will be able to continue to hire, train and retain a sufficient
number of qualified employees. Any increase in hourly wages, costs of employee
benefits or employment taxes also could materially adversely affect us.
If we fail to comply with government regulation of the collections
industry, it could result in the suspension or termination of our ability to
conduct business.
The collections industry is regulated under various U.S. federal and state,
Canadian and United Kingdom laws and regulations. Many states, as well as Canada
and the United Kingdom, require that we be licensed as a debt collection
company. The Federal Trade Commission has the authority to investigate consumer
complaints against debt collection companies and to recommend enforcement
actions and seek monetary penalties. If we fail to comply with applicable laws
and regulations, it could result in the suspension or termination of our ability
to conduct collections, which would have a materially adverse effect on us. In
addition, new federal, state or foreign laws or regulations, or changes in the
ways these rules or laws are interpreted or enforced, could limit our activities
in the future or significantly increase the cost of regulatory compliance. If we
expand our international operations, we may become subject to additional
government controls and regulations in other countries, which may be stricter or
more burdensome than those in the United States.
Several of the industries we serve are also subject to varying degrees of
government regulation. Although our clients are generally responsible for
complying with these regulations, we could be subject to various enforcement or
private actions for our failure, or the failure of our clients, to comply with
these regulations.
-19-
We may experience variations from quarter to quarter in operating results
and net income that could adversely affect the price of our common stock.
Factors that could cause quarterly fluctuations include, among other
things, the following:
o the timing of our clients' accounts receivable management and collection
programs and the commencement of new contracts and termination of existing
contracts;
o the timing and amount of collections on purchased accounts receivable;
o customer contracts that require us to incur costs in periods prior to
recognizing revenue under those contracts;
o the effects of a change of business mix on profit margins;
o the timing of additional selling, general and administrative expenses to
support new business;
o the costs and timing of completion and integration of acquisitions; and
o that our business tends to be slower in the third and fourth quarters of the
year due to the summer and holiday seasons.
If we do not achieve the results projected in our public forecasts, it
could have a materially adverse effect on the market price of our common stock.
We have publicly announced our investor guidance concerning our expected
results of operations for the first quarter of 2003 and in total for the year
2003. Our investor guidance contains forward-looking statements and may be
affected by various factors discussed in "Investment Considerations" and
elsewhere in this Annual Report on Form 10-K that may cause actual results to
differ materially from the results discussed in the investor guidance. Our
investor guidance reflects numerous assumptions, including our anticipated
future performance, general business and economic conditions and other matters,
some of which are beyond our control. In addition, unanticipated events and
circumstances may affect our actual financial results. Our investor guidance is
not a guarantee of future performance and the actual results throughout the
periods covered by the investor guidance may vary from the projected results. If
we do not achieve the results projected in our investor guidance, it could have
a materially adverse effect on the market price of our common stock.
Goodwill represented 54.4 percent of our total assets at December 31, 2002.
Effective January 1, 2002, we adopted Statement of Financial Accounting Standard
No. 142, "Goodwill and Other Intangibles." If the goodwill is deemed to be
impaired under SFAS 142, we may need to take a charge to earnings to write-down
the goodwill to its fair value.
Our balance sheet includes "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.
-20-
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangibles." SFAS 142 concluded that
purchased goodwill will not be amortized but will be reviewed for impairment at
least annually when certain events indicate that the goodwill of a reporting
unit is impaired. The impairment test uses a fair-value based approach, whereby
if the implied fair value of a reporting unit's goodwill is less than its
carrying amount, goodwill would be considered impaired. We make significant
assumptions to estimate the future revenue and cash flows used to determine the
fair value of our reporting units. If the expected revenue and cash flows are
not realized or if a sustained significant depression in our market
capitalization indicates that our assumptions are not accurately estimating our
fair value, impairment losses may be recorded in the future. We anticipate that
the annual impairment analysis will be completed on October 1st of each year.
As of December 31, 2002, our balance sheet included goodwill that
represented 54.4 percent of total assets and 120.7 percent of shareholders'
equity. If the goodwill is deemed to be impaired under SFAS 142, we may need to
take a charge to earnings to write-down the goodwill to its fair value and this
could have a materially adverse effect on the market price of our common stock.
Investors should be aware that our earnings for periods beginning after
December 31, 2001 will not include charges for the amortization of goodwill and
should consider this when comparing such earnings with historical earnings for
periods ended on or before December 31, 2001, which included goodwill
amortization charges.
Our stock price has been and is likely to continue to be volatile, which
may make it difficult for shareholders to resell common stock when they want to
and at prices they find attractive.
The trading price of our common stock has been and is likely to be highly
volatile. Our stock price could be subject to wide fluctuations in response to a
variety of factors, including the following:
o announcements of fluctuations in our or our competitors' operating results;
o the timing and announcement of acquisitions by us or our competitors;
o changes in our publicly available guidance of future results of operations;
o government regulatory action;
o changes in estimates or recommendations by securities analysts;
o adverse or unfavorable publicity about our services or us;
o the commencement of material litigation, or an unfavorable verdict, against
us;
o terrorist attacks, war and threats of attacks and war;
o additions or departures of key personnel; and
o sales of common stock.
In addition, the stock market in recent years has experienced significant
price and volume fluctuations and a significant cumulative decline in recent
months. Such volatility and decline have affected many companies irrespective
of, or disproportionately to, the operating performance of these companies.
These broad fluctuations may materially adversely affect the market price of our
common stock.
-21-
Most of our outstanding shares are available for resale in the public
market without restriction. The sale of a large number of these shares could
adversely affect our stock price and could impair our ability to raise capital
through the sale of equity securities or make acquisitions for stock.
Sales of our common stock could adversely affect the market price of our
common stock and could impair our future ability to raise capital through the
sale of equity securities or make acquisitions for stock. As of March 11, 2003,
there were 25,908,000 shares of our common stock outstanding. Most of these
shares are available for resale in the public market without restriction, except
for shares held by our affiliates. Generally, our affiliates may either sell
their shares under a registration statement or in compliance with the volume
limitations and other requirements imposed by Rule 144 adopted by the SEC.
In addition, as of March 11, 2003, we had the authority to issue up to
approximately 4,334,000 shares of our common stock under our stock option plans.
We also had outstanding notes convertible into an aggregate of 3,797,000 shares
of our common stock at a conversion price of $32.92 per share. Additionally, we
had outstanding warrants to purchase approximately 22,000 shares of our common
stock.
"Anti-takeover" provisions may make it more difficult for a third party to
acquire control of us, even if the change in control would be beneficial to
shareholders.
We are a Pennsylvania corporation. Anti-takeover provisions in Pennsylvania
law and our charter and bylaws could make it more difficult for a third party to
acquire control of us. These provisions could adversely affect the market price
of our common stock and could reduce the amount that shareholders might receive
if we are sold. For example, our charter provides that our board of directors
may issue preferred stock without shareholder approval. In addition, our bylaws
provide for a classified board, with each board member serving a staggered
three-year term. Directors may be removed only for cause and only with the
approval of the holders of at least 65 percent of our common stock.
-22-
Item 2. Properties.
We currently lease 66 offices in the United States, including our corporate
headquarters, seven offices in Canada, two offices in the United Kingdom, and
one office in Puerto Rico. The leases of these facilities expire between 2003
and 2016, and most contain renewal options.
In March 2002, we moved our corporate headquarters to 507 Prudential Road,
Horsham, PA 19044.
We believe that our facilities are adequate for our current operations, but
additional facilities may be required to support growth. We believe that
suitable additional or alternative space will be available as needed on
commercially reasonable terms.
Item 3. Legal Proceedings.
In June 2001, the first floor of our Fort Washington, PA, headquarters was
severely damaged by a flood caused by remnants of Tropical Storm Allison. During
the third quarter of 2001, we decided to relocate our corporate headquarters to
Horsham, PA. We have filed a lawsuit against the landlord of the Fort Washington
facilities to terminate the leases. Due to the uncertainty of the outcome of the
lawsuit, we recorded the full amount of rent due under the remaining terms of
the leases during the third quarter of 2001.
AssetCare, Inc., our subsidiary acquired as part of the Medaphis Services
Corporation acquisition, was identified in an administrative order issued by the
State of California as a party that is partially responsible for cleanup costs
associated with a former scrap recycling site next to Humboldt Bay in
California. The subsidiary was identified as a successor-in-interest to a former
scrap recycler who conducted limited operations at the site. The subsidiary was
also named in a civil proceeding brought by one of the owners of the site as a
party that is responsible for the costs that will be incurred by the owner for
complying with the terms of the order. AssetCare agreed to pay $1,410,000 to
settle the claims in the litigation with the owner in exchange for a full
release from the owner. Subsequently, we reached an agreement with the former
owner of Medaphis Services Corporation pursuant to which they agreed to
partially reimburse us for our indemnification claims under the acquisition
agreement. Notwithstanding the settlement with the owner, AssetCare, Inc. is
still a party to the California administrative order.
We are involved in legal proceedings and regulatory investigations from
time to time in the ordinary course of our business. Management believes that
none of these legal proceedings or regulatory investigations will have a
materially adverse effect on our financial condition or results of operations.
Item 4. Submission of Matters to a Vote of Security Holders.
None.
-23-
Item 4.1 Executive Officers of the Registrant who are not Directors.
Name Age Position
- -------------------------------------------------- -------- ------------------------------------------------
Stephen W. Elliott..................... 41 Executive Vice President, Information
Technology and Chief Information Officer
Joshua Gindin, Esq..................... 46 Executive Vice President and General Counsel
Steven Leckerman....................... 50 Executive Vice President, U.S. Operations
Paul E. Weitzel, Jr.................... 44 Executive Vice President, Corporate
Development and International Operations
Steven L. Winokur...................... 43 Executive Vice President, Finance; Chief
Financial Officer; and Treasurer
Stephen W. Elliott - Mr. Elliott joined us in 1996 as Senior Vice
President, Technology and Chief Information Officer after having provided
consulting services to us for the year prior to his arrival. Mr. Elliott became
an Executive Vice President in February 1999. Prior to joining us, Mr. Elliott
was employed by Electronic Data Systems, a computer services company, for almost
10 years, most recently as Senior Account Manager.
Joshua Gindin, Esq. - Mr. Gindin joined us in May 1998. Prior to joining
us, Mr. Gindin was a partner in the law firm of Kessler & Gindin, which had
served as our legal counsel since 1986.
Steven Leckerman - Mr. Leckerman joined us in 1995 as Senior Vice
President, Collection Operations, and became Executive Vice President, U.S.
Operations in January 2001. From 1982 to 1995, Mr. Leckerman was employed by
Allied Bond Corporation, a collection company that was a division of Union
Corporation, where he served as manager of dialer and special projects.
Paul E. Weitzel, Jr. - Mr. Weitzel joined us through the acquisition of
MedSource, Inc. in July 1998. Prior to joining us, Mr. Weitzel was Chairman and
Chief Executive Officer of MedSource, Inc. from 1997 through the acquisition.
Prior to joining MedSource, Inc., Mr. Weitzel was with MedQuist, Inc., a medical
transcription company, for four years, most recently as President and Chief
Executive Officer. Mr. Weitzel is a Certified Public Accountant.
Steven L. Winokur - Mr. Winokur joined us in December 1995. Prior to that,
Mr. Winokur acted as a part-time consultant to us since 1986. From February 1992
to December 1995, Mr. Winokur was the principal of Winokur & Associates, a
certified public accounting firm. From March 1981 to February 1992, Mr. Winokur
was with Gross & Company, a certified public accounting firm, where he most
recently served as Administrative Partner. Mr. Winokur is a Certified Public
Accountant.
-24-
PART II
Item 5. Market for Registrant's Common Equity and
Related Shareholder Matters.
Our common stock is listed on the Nasdaq National Market under the symbol
"NCOG." The following table sets forth, for the fiscal quarters indicated, the
high and low sale prices for our common stock, as reported by Nasdaq.
High Low
-------- -------
2001
First Quarter $ 35.50 $ 25.19
Second Quarter 33.10 22.56
Third Quarter 30.62 11.00
Fourth Quarter 24.50 13.35
2002
First Quarter $ 29.75 $ 18.30
Second Quarter 29.19 20.61
Third Quarter 22.55 11.33
Fourth Quarter 16.80 10.56
On March 11, 2003, the last reported sale price of our common stock as
reported on The Nasdaq National Market was $13.17 per share. On March 11, 2003,
there were approximately 83 holders of record of our common stock.
Dividend Policy
We have never declared or paid cash dividends on our common stock, and we
do not anticipate paying cash dividends on our common stock in the foreseeable
future. In addition, our credit agreement prohibits us from paying cash
dividends without the lender's prior consent. We currently intend to retain
future earnings to finance our operations and fund the growth of our business.
Any payment of future dividends will be at the discretion of our board of
directors and will depend upon, among other things, our earnings, financial
condition, capital requirements, level of indebtedness, contractual restrictions
with respect to the payment of dividends and other factors that our board of
directors deems relevant.
Equity Compensation Plan
See Part III, Item 12 of this Annual Report on Form 10-K for disclosure
regarding our equity compensation plans.
-25-
Item 6. Selected Financial Data.
SELECTED FINANCIAL DATA (1)(2)
(Amounts in thousands, except per share data)
For the years ended December 31,
--------------------------------------------------------------------------
1998 1999 2000 2001 2002
----------- ------------ ------------ ----------- ------------
(Restated) (Restated)
Statement of Income Data:
Revenue $ 209,947 $ 460,311 $ 587,452 $ 683,873 $ 703,450
Operating costs and expenses:
Payroll and related expenses 106,787 237,709 293,292 350,634 335,405
Selling, general and administrative expenses 61,607 128,177 179,924 237,690 249,672
Depreciation and amortization expense 8,615 21,805 32,360 38,205 27,324
Nonrecurring acquisition costs - 4,601 - - -
----------- ------------ ------------ ----------- ------------
Income from operations 32,938 68,019 81,876 57,344 91,049
Other income (expense) (1,794) (16,899) (22,126) (23,335) (17,970)
----------- ------------ ------------ ----------- ------------
Income before provision for income taxes 31,144 51,120 59,750 34,009 73,079
Income tax expense 12,881 22,821 24,572 14,661 27,702
----------- ------------ ------------ ----------- ------------
Income from continuing operations before
minority interest 18,263 28,299 35,178 19,348 45,377
Minority interest - - - (4,310) (3,218)
----------- ------------ ------------ ----------- ------------
Income from continuing operations 18,263 28,299 35,178 15,038 42,159
Accretion of preferred stock to redemption value (1,604) (377) - - -
----------- ------------ ------------ ----------- ------------
Income from continuing operations applicable
to common shareholders 16,659 27,922 35,178 15,038 42,159
Discontinued operations, net of taxes:
Income (loss) from discontinued operations 82 1,067 (975) - -
Loss on disposal of discontinued operations - - (23,179) - -
----------- ------------ ------------ ----------- ------------
Net income applicable to common shareholders $ 16,741 $ 28,989 $ 11,024 $ 15,038 $ 42,159
=========== ============ ============ =========== ============
Income from continuing operations applicable to common
shareholders per share:
Basic $ 0.91 $ 1.22 $ 1.38 $ 0.58 $ 1.63
=========== ============ ============ =========== ============
Diluted $ 0.84 $ 1.17 $ 1.36 $ 0.58 $ 1.54
=========== ============ ============ =========== ============
Net income applicable to common shareholders per share:
Basic $ 0.91 $ 1.27 $ 0.43 $ 0.58 $ 1.63
=========== ============ ============ =========== ============
Diluted $ 0.85 $ 1.22 $ 0.43 $ 0.58 $ 1.54
=========== ============ ============ =========== ============
Weighted average shares outstanding:
Basic 18,324 22,873 25,587 25,773 25,890
=========== ============ ============ =========== ============
Diluted 19,758 23,799 25,842 26,091 29,829
=========== ============ ============ =========== ============
December 31,
--------------------------------------------------------------------------
1998 1999 2000 2001 2002
----------- ------------ ------------ ----------- ------------
(Restated) (Restated)
Balance Sheet Data:
Cash and cash equivalents $ 22,528 $ 50,513 $ 13,490 $ 32,161 $ 25,159
Working capital 31,517 65,937 76,824 97,478 105,984
Net assets of discontinued operations 27,740 41,492 - - -
Total assets 410,992 791,692 781,257 928,864 966,281
Long-term debt, net of current portion 143,831 323,949 303,920 357,868 334,423
Minority interest - - - 21,213 24,427
Redeemable preferred stock 11,882 - - - -
Shareholders' equity 199,465 364,888 375,464 392,302 435,762
(1) Gives effect to the restatement of our historical financial statements for
a correction of an error due to the change in accounting method for the
revenue recognition of a long-term guarantee contract for the years ended
December 31, 2000 and 2001.
(2) The years ended December 31, 1998, 1999, 2000, and 2001, included goodwill
amortization expense, net of tax, of $4.0 million, $11.2 million, $11.8
million, and $11.9 million, respectively. In accordance with the adoption
of FASB 142, we stopped amortizing goodwill on January 1, 2002. This data
should be read in conjunction with the consolidated financial statements,
including the accompanying notes, included elsewhere in this report on Form
10-K.
-26-
Item 7. Management's Discussion and Analysis of
Financial Condition and Results of Operations.
Overview
We believe we are the largest outsourced accounts receivable management and
collection company in the world, serving a wide range of clients in North
America and abroad. We generate approximately 70 percent of our revenue from the
recovery of delinquent accounts receivable on a contingency fee basis. Our
contingency fees typically range from 15 percent to 35 percent of the amount
recovered on behalf of our clients. However, fees can range from 6 percent for
the management of accounts placed early in the accounts receivable cycle to 50
percent for accounts that have been serviced extensively by the client or by
third-party providers. Our average fee for contingency based revenue across all
industries, excluding the long-term guarantee contract, was approximately 19
percent during 2002, 2001 and 2000. In addition, we generate revenue from fixed
fee services for certain accounts receivable management and collection services.
Generally, revenue is earned and recognized upon collection of accounts
receivable for contingency fee services and as work is performed for fixed fee
services. We enter into contracts with most of our clients that define, among
other things, fee arrangements, scope of services, and termination provisions.
Clients typically have the right to terminate their contracts on 30 or 60 days'
notice.
Our operating costs consist principally of payroll and related costs;
selling, general and administrative costs; and depreciation and amortization.
Payroll and related expenses consist of wages and salaries, commissions,
bonuses, and benefits for all of our employees, including management and
administrative personnel. Selling, general and administrative expenses include
telephone, postage and mailing costs, and other collection costs, as well as
expenses that directly support operations including facility costs, equipment
maintenance, sales and marketing, data processing, professional fees, and other
management costs.
We have grown rapidly, through both internal growth as well as
acquisitions. During 2002, we completed two acquisitions, Great Lakes Collection
Bureau, Inc., referred to as Great Lakes, in August 2002 and The Revenue
Maximization Group Inc., referred to as RevGro, in December 2002. All of our
acquisitions, except the acquisition in 1999 of JDR Holdings, Inc., referred to
as JDR, have been accounted for under the purchase method of accounting with the
results of the acquired companies included in our operating results beginning on
the date of acquisition. JDR was accounted for under the pooling-of-interests
method of accounting.
On April 14, 2000, our Board of Directors approved a plan to divest our
Market Strategy division. The Market Strategy division provided market research
and telemarketing services, and was divested as part of our strategic plan to
increase long-term shareholder value by focusing on our core accounts receivable
management and collection services business. The Market Strategy division's
operations for all periods presented prior to April 14, 2000, have been
presented separately as income or loss from discontinued operations in our
consolidated statements of income. We completed the divestiture in October 2000,
and recorded a loss of $23.2 million. This loss reflects the difference between
the net assets and the proceeds from the divestiture as well as the operating
losses from April 14, 2000, through the completion of the divestiture.
During 2000, the continued integration of our infrastructure facilitated
the reduction of our operating divisions from three to two. Effective October 1,
2000, the new operating divisions were U.S. Operations (formerly Accounts
Receivable Management Services and Technology-Based Outsourcing) and
International Operations. Each of these divisions maintains industry-specific
functional groups.
-27-
In February 2001, the Portfolio Management division was created after we
completed the merger of our subsidiary, NCO Portfolio Management, Inc., referred
to as NCO Portfolio, with Creditrust Corporation, referred to as Creditrust. As
a result of the merger, referred to as the Creditrust Merger, our results of
operations are more significantly impacted by purchases of and collections on
delinquent accounts receivable. NCO Portfolio recognizes revenue based on
estimates of future portfolio collections and the timing of these collections.
On a periodic basis, NCO Portfolio reviews and adjusts the amount and timing of
expected future collections, based on the performance of the portfolio to date.
We own approximately 63 percent of NCO Portfolio after the Creditrust Merger.
The results of NCO Portfolio are consolidated into our results, with a charge
for minority interest and elimination of significant intercompany transactions.
Restatement of Financial Statements
On February 6, 2003, our independent auditors informed us that, based on
their further internal review and consultation, they no longer considered our
methodology for revenue recognition for a long-term guarantee contract
appropriate under revenue recognition guidelines. Further review by us with our
independent auditors led us to conclude that we should change our method of
revenue recognition for the contract. The change resulted in the deferral of the
recognition of revenue under the contract until such time as any contingencies
related to the realization of revenue have been resolved. Our financial
statements and the accompanying notes for the years ended December 31, 2000 and
2001, have been restated for a correction of an error due to this change.
Critical Accounting Policies
General
The preparation of consolidated financial statements in conformity with
accounting principles generally accepted in the United States requires
management to make estimates and assumptions that affect the amounts reported in
the financial statements and the accompanying notes. Actual results could differ
from those estimates. We believe the following accounting policies include the
estimates that are the most critical and could have the most potential impact on
our results of operations. For a discussion of these and other accounting
policies, see note 2 in our Notes to Consolidated Financial Statements.
Goodwill
Our balance sheet includes amounts designated as "goodwill." Goodwill
represents the excess of purchase price over the fair market value of the net
assets of the acquired businesses based on their respective fair values at the
date of acquisition.
As of December 31, 2002, our balance sheet included goodwill that
represented 54.4 percent of total assets and 120.7 percent of shareholders'
equity.
-28-
Effective January 1, 2002, we adopted Statement of Financial Accounting
Standard No. 142, "Goodwill and Other Intangibles," referred to as SFAS 142. As
a result of adopting SFAS 142, we no longer amortize goodwill. Goodwill must be
tested at least annually for impairment, including an initial test that was
completed in connection with the adoption of SFAS 142. The test for impairment
uses a fair-value based approach, whereby if the implied fair value of a
reporting unit's goodwill is less than its carrying amount, goodwill would be
considered impaired. We make significant assumptions to estimate the future
revenue and cash flows used to determine the fair value of our reporting units.
If the expected revenue and cash flows are not realized or if a sustained
significant depression in our market capitalization indicates that our
assumptions are not accurately estimating our fair value, impairment losses may
be recorded in the future. We did not incur any impairment charges in connection
with the adoption of SFAS 142 or the annual impairment test performed on October
1, 2002, and we do not believe that goodwill was impaired as of December 31,
2002. We anticipate that the annual impairment analysis will be completed on
October 1st of each year.
Revenue Recognition for a Long-Term Guarantee Contract
We have a long-term guarantee contract with a large client to provide
collection services. We receive a base service fee based on collections. We also
earn a bonus to the extent collections are in excess of the guarantees. We are
required to pay the client if collections do not reach the guarantees but we are
entitled to recoup at least 90 percent of any such guarantee payments from
subsequent collections.
In accordance with the provision of Staff Accounting Bulletin No. 101
"Revenue Recognition in Financial Statements," we defer all of the base service
fees until the collections exceed the collection guarantees. At the end of each
reporting period, we assess the need to record an additional liability if
deferred fees are less than the estimated guarantee payments, if any, due to the
client. There was no additional liability recorded as of December 31, 2001 and
2002.
Revenue Recognition for Purchased Accounts Receivable
In the ordinary course of accounting for purchased accounts receivable,
estimates have been made by management as to the amount of future cash flows
expected from each portfolio. The estimated future cash flow of each portfolio
is used to compute the internal rate of return, referred to as IRR, for each
portfolio. The IRR is used to allocate collections between revenue and
amortization of the carrying values of the purchased accounts receivable.
On an ongoing basis, we compare the historical trends of each portfolio to
projected collections. Projected collections are then increased, within preset
limits, or decreased based on the actual cumulative performance of each
portfolio. We review each portfolio's adjusted projected collections to
determine if further downward adjustment is warranted. Management regularly
reviews the trends in collection patterns and uses its best efforts to improve
under-performing portfolios. However, actual results will differ from these
estimates and a material change in these estimates could occur within one
reporting period. For the year ended December 31, 2001, differences between
actual and estimated collections on existing portfolios as of the beginning of
2001 resulted in a reduction in net income and earnings per share of $980,000
and $0.04 per diluted share, respectively. For the year ended December 31, 2002,
differences between actual and estimated collections on existing portfolios as
of the beginning of 2002 resulted in a reduction in net income and earnings per
share of $2.6 million and $0.10 per diluted share, respectively.
Bad Debts
We maintain an allowance for doubtful accounts for estimated losses
resulting from the nonpayment of our trade accounts receivable. If our estimate
is not sufficient to cover actual losses, we would be required to take
additional charges to our earnings.
-29-
Deferred Taxes
Income taxes or tax benefits have been provided in the results of
operations based on the statutory federal and state rates of 37.5 percent of
pre-tax income for NCO Portfolio. For financial reporting purposes, revenue is
recognized over the life of the portfolio. Because the portfolios of purchased
accounts receivable are comprised of distressed debt and collection results are
not guaranteed until received, for tax purposes, any gain on a particular
portfolio is deferred until the full cost of the portfolio is recovered (cost
recovery method). Temporary differences arise due to the differences in revenue
recognition methods. Permanent differences between the statutory tax rates and
actual rates are minimal. Temporary differences arising from the recognition of
revenue on purchased accounts receivable have resulted in deferred tax
liabilities. Assumed utilization of net operating losses acquired in the
Creditrust Merger has resulted in deferred tax assets. Our deferred tax
liabilities grew significantly through 2002 as a result of the increase in
purchased accounts receivable, providing us with additional liquidity. As of
December 31, 2002, NCO Portfolio's net deferred tax liability of $4.3 million
was the result of the combination of deferred tax assets generated principally
by the assumed utilization of net operating loss carryforwards from the
Creditrust Merger, offset by the deferred tax liabilities arising from book tax
differences on purchased accounts receivable, including the purchased accounts
receivable acquired in the Creditrust Merger. The utilization of net operating
loss carryforwards is an estimate based on a number of factors beyond our
control, including the level of taxable income available from successful
operations in the future. The utilization of net operating losses acquired in
the Creditrust Merger has been further impacted by federal tax law provisions
that limit the amount of net operating loss carryforwards that can be utilized
subsequent to a change in control.
Results of Operations
The following table sets forth selected historical income statement data
(amounts in thousands):
For the years ended December 31,
-----------------------------------------------------------------------
2000 (1) 2001 (1) 2002
--------------------- --------------------- -----------------
Amount Ratio Amount Ratio Amount Ratio
--------- ------ -------- ----- ------ -----
(Restated) (Restated)
Revenue $587,452 100.0% $683,873 100.0% $703,450 100.0%
Payroll and related expenses 293,292 50.0 350,634 51.3 335,405 47.7
Selling, general and administrative
expenses 179,924 30.6 237,690 34.7 249,672 35.5
Depreciation and amortization 32,360 5.5 38,205 5.6 27,324 3.9
--------- ------ --------- ----- -------- -----
Income from operations 81,876 13.9 57,344 8.4 91,049 12.9
Other expense 22,126 3.7 23,335 3.4 17,970 2.5
Income tax expense 24,572 4.2 14,661 2.1 27,702 3.9
Minority interest - - 4,310 0.7 3,218 0.5
--------- ------ --------- ----- -------- -----
Income from continuing operations $ 35,178 6.0% $ 15,038 2.2% $ 42,159 6.0%
========= ====== ============ ===== ======== =====
(1) Gives effect to the restatement of our historical financial statements for
the correction of an error due to a change in method of revenue recognition
for a long-term guarantee contract for the years ended December 31, 2000 and
2001.
-30-
Year ended December 31, 2002, Compared to Year ended December 31, 2001
(Restated)
Revenue. Revenue increased $19.6 million, or 2.9 percent, to $703.5 million
for the year ended December 31, 2002, from $683.9 million for the comparable
period in 2001. U.S. Operations, Portfolio Management, and International
Operations accounted for $639.5 million, $63.4 million, and $47.6 million,
respectively, of the 2002 revenue. U.S. Operations' revenue included $35.5
million of revenue earned on services performed for Portfolio Management that
was eliminated upon consolidation. International Operations' revenue included
$11.5 million of revenue earned on services performed for the U.S. Operations
that was eliminated upon consolidation.
U.S. Operation's revenue increased $23.8 million, or 3.9 percent, to $639.5
million in 2002, from $615.7 million in 2001. The increase in our U.S.
Operations division's revenue was attributable to the recognition of deferred
revenues from the long-term guarantee contract, an increase in collection
services provided to Portfolio Management, the addition of new clients, and the
growth in business from existing clients. These increases were partially offset
by lower revenues due to further weakening of consumer payment patterns during
2002.
Portfolio Management's revenue increased $450,000, or 0.7 percent, to $63.4
million in 2002, from $62.9 million in 2001. Portfolio Management's collections
increased $17.7 million, or 17.0 percent, to $121.8 million in 2002, from $104.1
million in 2001. Portfolio Management's revenue represented 52 percent of
collections in 2002, as compared to 60 percent of collections in 2001. Although
collections increased, revenue only increased slightly due to the decrease in
the revenue recognition rate. Revenue as a percentage of collections declined
principally due to changes in the total composition of purchased accounts
receivable in 2001 versus 2002. Purchased accounts receivable acquired in, and
subsequent to, the Creditrust Merger were acquired at a lower internal rate of
return, referred to as IRR, compared to accounts receivable purchased prior to
the Creditrust Merger. Purchases of accounts receivable made in the second half
of 2001 and in 2002 have returns that have been targeted lower at the time of
acquisition due to reduced collection estimates due to the tougher economic
climate. In addition, the overall percentage was also lowered due to a slow down
in collections on existing portfolios as a result of the softening economic
climate in the last quarter of 2001 and in 2002. Additionally, included in
collections for 2002, was approximately $1.7 million received as a partial
payment on the sale of certain accounts to a leading credit card issuer. These
additional proceeds included in collections had a marginal impact on revenue as
the rate at which revenue is recognized period-to-period is not affected at the
same rate as changes in collections due to the effective interest method of
computing revenue. Additionally, portfolios with $5.8 million in carrying value,
or 3.9 percent of purchased accounts receivable, as of December 31, 2002, have
been impaired and placed on cost recovery status. Accordingly, no revenue will
be recorded on these portfolios after their impairment until their carrying
value has been fully recovered, resulting in a lower percentage of revenue to
collections. However, during the third quarter of 2002, Portfolio Management
concluded a contract re-negotiation with the seller of several existing
portfolios resulting in a $4.0 million cash price reduction on purchases from
2000 and 2001. The renegotiation included a purchase price adjustment, as well
as a reimbursement for estimated lost earnings. The $4.0 million proceeds were
recorded as an adjustment to purchase price of the affected portfolios during