NCO GROUP INC - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
FORM 10-Q

(Mark one)

Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended September 30, 2004, 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 NUMBER 0-21639


NCO GROUP, INC.

(Exact name of registrant as specified in its charter)

	PENNSYLVANIA		23-2858652

	(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification Number)

507 Prudential Road, Horsham, Pennsylvania 19044

(Address of principal executive offices) (Zip Code)

215-441-3000

(Registrant’s telephone number, including area code)

Not Applicable

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (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 No

Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes No

The number of shares outstanding of each of the issuer’s classes of common stock as of November 8, 2004 was: 32,042,635 shares of common stock, no par value.

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NCO GROUP, INC.
INDEX

		PAGE
PART I - FINANCIAL INFORMATION

Item 1.	FINANCIAL STATEMENTS (Unaudited)

	Condensed Consolidated Balance Sheets - September 30, 2004 and December 31, 2003	1

	Condensed Consolidated Statements of Income - Three and nine months ended September 30, 2004 and 2003	2

	Condensed Consolidated Statements of Cash Flows - Nine months ended September 30, 2004 and 2003	3

	Notes to Condensed Consolidated Financial Statements	4

Item 2.	MANAGEMENT’S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS	23

Item 3.	QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK	30

Item 4.	CONTROLS AND PROCEDURES	30

PART II - OTHER INFORMATION		32

Item 1.	LEGAL PROCEEDINGS
Item 2.	UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS
Item 3.	DEFAULTS UPON SENIOR SECURITIES
Item 4.	SUBMISSION OF MATTERS TO A VOTE OF SHAREHOLDERS
Item 5.	OTHER INFORMATION
Item 6.	EXHIBITS


SIGNATURES		34

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Part 1 - Financial Information
Item 1 - Financial Statements

NCO GROUP, INC.
Condensed Consolidated Balance Sheets
(Amounts in thousands)

ASSETS	September 30, 2004 (Unaudited)			December 31, 2003

Current assets:
Cash and cash equivalents	$	35,381		$	45,644
Restricted cash		1,382			5,850
Accounts receivable, trade, net of allowance for
doubtful accounts of $7,606 and $7,447, respectively		112,861			80,640
Purchased accounts receivable, current portion		47,466			59,371
Deferred income taxes		13,525			12,280
Bonus receivable, current portion		6,417			7,646
Prepaid expenses and other current assets		25,389			18,021

Total current assets		242,421			229,452
Funds held on behalf of clients
Property and equipment, net		111,368			74,085
Other assets:
Goodwill		589,487			506,370
Other intangibles, net of accumulated amortization		27,005			12,375
Purchased accounts receivable, net of current portion		94,582			93,242
Bonus receivable, net of current portion		—			320
Deferred income taxes		3,164			—
Other assets		31,239			30,267

Total other assets		745,477			642,574

Total assets	$	1,099,266		$	946,111
LIABILITIES AND SHAREHOLDERS’ EQUITY
Current liabilities:
Long-term debt, current portion	$	80,861		$	66,523
Income taxes payable		5,401			—
Accounts payable		6,328			4,281
Accrued expenses		43,321			25,901
Accrued compensation and related expenses		26,095			15,601
Deferred revenue, current portion		17,547			10,737

Total current liabilities		179,553			123,043
Funds held on behalf of clients
Long-term liabilities:
Long-term debt, net of current portion		193,496			248,964
Deferred revenue, net of current portion		754			13,819
Deferred income taxes		29,656			38,676
Other long-term liabilities		18,896			4,344
Minority interest		—			26,848
Commitments and contingencies
Shareholders’ equity:
Preferred stock, no par value, 5,000 shares authorized,
no shares issued and outstanding		—			—
Common stock, no par value, 50,000 shares authorized,
32,007 and 25,988 shares issued and outstanding, respectively		472,011			323,511
Other comprehensive income		8,985			6,646
Deferred compensation		(4,000	)		—
Retained earnings		199,915			160,260

Total shareholders’ equity		676,911			490,417

Total liabilities and shareholders’ equity	$	1,099,266		$	946,111

See accompanying notes.

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NCO GROUP, INC.
Condensed Consolidated Statements of Income
(Unaudited)
(Amounts in thousands, except per share data)

	For the Three Months Ended September 30,						For the Nine Months Ended September 30,

	2004			2003			2004			2003

Revenue	$	246,046		$	188,619		$	702,532		$	566,210

Operating costs and expenses:
Payroll and related expenses		125,287			87,878			349,149			264,506
Selling, general and administrative expenses		84,688			70,623			245,085			210,299
Depreciation and amortization expense		10,480			7,851			29,405			23,746

Total operating costs and expenses		220,455			166,352			623,639			498,551

Income from operations		25,591			22,267			78,893			67,659

Other income (expense):
Interest and investment income		767			1,327			2,362			2,952
Interest expense		(5,339	)		(5,586	)		(15,883	)		(17,267	)
Other (expense) income		(174	)		402			447			1,128

Total other income (expense)		(4,746	)		(3,857	)		(13,074	)		(13,187	)

Income before income tax expense		20,845			18,410			65,819			54,472

Income tax expense		7,592			6,978			25,558			20,661


Income before minority interest		13,253			11,432			40,261			33,811

Minority interest		—			(709	)		(606	)		(1,619	)


Net income	$	13,253		$	10,723		$	39,655		$	32,192


Net income per share:
Basic	$	0.42		$	0.41		$	1.33		$	1.24
Diluted	$	0.39		$	0.39		$	1.24		$	1.17

Weighted average shares outstanding:
Basic		31,919			25,941			29,849			25,919
Diluted		36,257			29,947			34,071			29,811

See accompanying notes.

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NCO GROUP, INC
Condensed Consolidated Statements of Cash Flows
(Unaudited)
(Amounts in thousands)

	For the Nine Months Ended September 30,

	2004			2003
Cash flows from operating activities:
Net income	$	39,655		$	32,192
Adjustments to reconcile income from operations
to net cash provided by operating activities:
Depreciation		23,938			20,257
Amortization of intangibles		5,467			3,489
Amortization of deferred compensation		348			—
Amortization of deferred training asset		1,436			—
Provision for doubtful accounts		1,796			2,841
Impairment of purchased accounts receivable		545			1,198
Accrued noncash interest		4,653			3,271
Loss on disposal of property, equipment and other net assets		157			339
Changes in non-operating income		(1,325	)		(2,319	)
Minority interest		606			1,618
Changes in operating assets and liabilities, net of acquisitions:
Restricted cash		4,468			—
Accounts receivable, trade		(10,482	)		(1,959	)
Deferred income taxes		16,687			6,275
Bonus receivable		1,549			10,366
Other assets		(6,667	)		(2,224	)
Accounts payable and accrued expenses		(7,857	)		(2,583	)
Income taxes payable		7,924			2,970
Deferred revenue		(6,255	)		3,768
Other long-term liabilities		(341	)		(89	)

Net cash provided by operating activities		76,302			79,410

Cash flows from investing activities:
Purchases of accounts receivable		(55,647	)		(41,179	)
Collections applied to principal of purchased accounts receivable		66,712			55,316
Purchases of property and equipment		(21,286	)		(14,037	)
Net distribution from joint venture		1,769			935
Proceeds from notes receivable		948			116
Proceeds from disposal of property, equipment and other net assets		1,013			—
Net cash paid for acquisitions and related costs		(17,130	)		—

Net cash (used in) provided by investing activities		(23,621	)		1,151

Cash flows from financing activities:
Repayment of notes payable		(44,262	)		(22,385	)
Borrowings under notes payable		19,813			10,640
Repayment of borrowings under revolving credit agreement		(53,750	)		(50,430	)
Borrowings under revolving credit agreement		—			1,000
Payment of fees to acquire debt		(97	)		(2,804	)
Issuance of common stock, net		13,928			1,261

Net cash used in financing activities		(64,368	)		(62,718	)
Effect of exchange rate on cash		1,424			1,025

Net (decrease) increase in cash and cash equivalents		(10,263	)		18,868
Cash and cash equivalents at beginning of the period		45,644			25,159

Cash and cash equivalents at end of the period	$	35,381		$	44,027

See accompanying notes.

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NCO GROUP, INC.
Notes to Condensed Consolidated Financial Statements
(Unaudited)

1. Nature of Operations:

NCO Group, Inc., referred to as the Company or NCO, is a leading global provider of business process outsourcing solutions, offering accounts receivable management, referred to as ARM, customer relationship management, referred to as CRM, and other services. NCO provides services through 89 offices in the United States, Canada, the United Kingdom, India, the Philippines, Barbados and Panama. The Company provides services to more than 50,000 clients including many of the Fortune 500, supporting a broad spectrum of industries, including financial services, healthcare, retail and commercial, telecommunications, utility, education, government services and technology. These clients are primarily located throughout the United States of America, Canada, the United Kingdom, and Puerto Rico. The Company’s largest client is in the financial services sector and represented 10.5 percent of the Company’s consolidated revenue for the nine months ended September 30, 2004. The Company also purchases and manages past due consumer accounts receivable from consumer creditors such as banks, finance companies, retail merchants, and other consumer-oriented companies.

As of September 30, 2004, the Company’s business consisted of four operating divisions: ARM North America, CRM, Portfolio Management and ARM International.

2. Accounting Policies:

Interim Financial Information:

The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with accounting principles generally accepted in the United States for interim financial information and with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission. Accordingly, they do not include all of the information and footnotes required by accounting principles generally accepted in the United States for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring accruals, except as otherwise disclosed herein) considered necessary for a fair presentation have been included. Because of the seasonal nature of the Company’s business, operating results for the three-month and nine-month periods ended September 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004, or for any other interim period. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company’s Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2004.

Principles of Consolidation:

The condensed consolidated financial statements include the accounts of the Company and all affiliated subsidiaries and entities controlled by the Company. All intercompany accounts and transactions have been eliminated. The Company does not control InoVision-MEDCLR NCOP Ventures, LLC (see note 14) and, accordingly, its financial condition and results of operations are not consolidated with the Company’s financial statements.

Revenue Recognition:

ARM Contingency Fees:

ARM contingency fee revenue is recognized upon collection of funds on behalf of clients or, in the case where payment is made directly to the client, upon notification of receipt of applicable funds by clients.

ARM Contractual Services:

Fees for ARM contractual services are recognized as services are performed and earned under service arrangements with clients where fees are fixed or determinable and collectibility is reasonably assured.

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2. Accounting Policies (continued):

Revenue Recognition (continued):

Long-Term Collection Contract:

The Company has a long-term collection contract with a large client to provide collection services that includes guaranteed collections, subject to limits. The Company also earns a bonus to the extent collections are in excess of the guarantees. The Company is required to pay the client, subject to limits, if collections do not reach the guarantees. Any guarantees in excess of the limits will only be satisfied with future collections. The Company is entitled to recoup at least 90 percent of any such guarantee payments from subsequent collections in excess of any remaining guarantees. This long-term collection contract only covers placements by the client from January 1, 2000 through December 31, 2003.

The Company defers all of the base service fees, subject to the limits, until the collections exceed the collection guarantees. At the end of each reporting period, the Company assesses the need to record an additional liability if deferred fees are less than the estimated guarantee payments, if any, due to the client, subject to the limits. There was no additional liability recorded as of September 30, 2004 and December 31, 2003.

CRM Hourly:

Revenue is recognized based on the billable hours of each CRM representative as defined in the client contract. The rate per billable hour charged is based on a predetermined contractual rate, as agreed in the underlying contract. The contractual rate can fluctuate based on certain pre-determined objective performance criteria related to quality and performance as measured on a monthly basis. The impact of the performance criteria on the rate per billable hour is continually updated as revenue is recognized. Some clients are contractually entitled to penalties when the Company is not in compliance with certain obligations as defined in the client contract. Monthly performance penalties are recorded as a reduction to revenues as incurred.

CRM Performance Based:

Under performance-based arrangements, the Company is paid by its customers based on achievement of certain levels of sales or other client-determined criteria specified in the client contract. The Company recognizes performance-based revenue by measuring its actual results against the performance criteria specified in the contracts. Amounts collected from customers prior to the performance of services are recorded as deferred revenues.

Training Revenue:

In connection with the provisions of certain inbound and outbound CRM services, the Company incurs costs to train its CRM representatives. Training programs relate to both program start-up training in connection with new CRM programs, referred to as Start-up Training, and on-going training for updates of existing CRM programs, referred to as On-going Training. The Company bills some of its customers for the costs incurred under these training programs based on the terms in the contract. Training revenue is integral to the CRM revenue being generated over the course of a contract and cannot be separated as a discrete earning process under SEC Staff Accounting Bulletin No. 104. Start-up Training and On-going Training revenues are recognized over the term of the customer contract, or over the period to be benefited. Direct costs associated with providing Start-up Training and On-going Training, which consist exclusively of salary and benefit costs, are also deferred and amortized over a time period consistent with the deferred training revenue. When a business relationship is terminated with one of the Company’s customers, the unamortized deferred training revenue and unamortized deferred direct costs associated with that customer are immediately recognized. At September 30, 2004, the balance of deferred training revenue was $1.3 million.

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2. Accounting Policies (continued):

Revenue Recognition (continued):

Purchased Accounts Receivable:

The Company accounts for its investment in purchased accounts receivable on an accrual basis under the guidance of American Institute of Certified Public Accountants’ Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans,” using unique and exclusive portfolios. Portfolios are established with accounts having similar attributes. Typically, each portfolio consists of an individual acquisition of accounts that are initially recorded at cost, which includes external costs of acquiring portfolios. Once a portfolio is acquired, the accounts in the portfolio are not changed. Proceeds from the sale of accounts and return of accounts within a portfolio are accounted for as collections in that portfolio.

Collections on the portfolios are allocated to revenue and principal reduction based on the estimated internal rate of return, referred to as IRR, for each portfolio. The IRR for each portfolio is derived based on the expected monthly collections over the estimated economic life of each portfolio (generally five years, based on the Company’s collection experience), compared to the original purchase price. Revenue on purchased accounts receivable is recorded monthly based on applying each portfolio’s effective IRR for the quarter to its carrying value. To the extent collections exceed the revenue, the carrying value is reduced and the reduction is recorded as collections applied to principal. Because the IRR reflects collections for the entire economic life of the portfolio, and those collections are not constant, lower collection rates, typically in the early months of ownership, can result in a situation where the actual collections are less than the revenue. In this situation, the carrying value of the portfolio may be increased by the difference between the revenue and collections.

To the extent actual collections differ from estimated projections, the Company prospectively adjusts projected collections, which also adjusts the IRR. If the carrying value of a particular portfolio exceeds its expected future collections, a charge to income would be recognized in the amount of such impairment. Additional impairments on each quarter’s previously impaired portfolios may occur if the current estimated future cash flow projection, after being adjusted prospectively for actual collection results, is less than the current carrying value. After the impairment of a portfolio, all collections are recorded as a return of capital and no income is recorded on that portfolio until the full carrying value of the portfolio has been recovered. Once the full cost of the carrying value has been recovered, all collections are recorded as revenue. The estimated IRR for each portfolio is based on estimates of future collections, and actual collections will vary from current estimates. The difference could be material.

Credit Policy:

The Company has two types of arrangements under which it collects its ARM contingency fee revenue. For certain clients, the Company remits funds collected on behalf of the client net of the related contingency fees while, for other clients, the Company remits gross funds collected on behalf of clients and bills the client separately for its contingency fees.

Management carefully monitors its client relationships in order to minimize the Company’s credit risk and maintains a reserve for potential collection losses when such losses are deemed to be probable. The Company generally does not require collateral and it does not charge finance fees on outstanding trade receivables. In many cases, in the event of collection delays from ARM clients, management may, at its discretion, change from the gross remittance method to the net remittance method. Trade accounts receivable are written off to the allowance for doubtful accounts when collection appears highly unlikely.

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2. Accounting Policies (continued):

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. Goodwill is tested for impairment at least annually and as triggering events occur. The goodwill impairment test is performed at the reporting unit level and involves a two-step approach, the first step identifies any potential impairment and the second step measures the amount of impairment, if applicable. The first test for potential impairment uses a fair-value based approach, whereby the implied fair value of a reporting unit’s goodwill is compared to its carrying amount, if the fair value exceeds the carrying amount the reporting unit’s goodwill would be considered impaired. Fair value estimates are based upon the discounted value of estimated cash flows. The Company does not believe that goodwill is impaired as of September 30, 2004. The annual impairment analysis is completed as of October 1st of each year (see note 7).

Other Intangible Assets:

Other intangible assets consist primarily of customer relationships and deferred financing costs, which relate to debt issuance costs incurred. Customer relationships are amortized over five years and deferred financing costs are amortized over the term of the debt (see note 7).

Stock Options:

The Company accounts for stock option grants in accordance with APB Opinion 25, “Accounting for Stock Issued to Employees,” referred to as APB 25, and related interpretations. Under APB 25, because the exercise price of the stock options equaled the fair value of the underlying common stock on the date of grant, no compensation cost was recognized. In accordance with SFAS 123, “Accounting for Stock-Based Compensation,” the Company does not recognize compensation cost based on the fair value of the options granted at the grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date, net income and net income per share would have been reduced to the pro forma amounts indicated in the following table (amounts in thousands, except per share amounts):

	For the Three Months Ended September 30,				For the Nine Months Ended September 30,

		2004		2003		2004		2003

Net income - as reported	$	13,253	$	10,723	$	39,655	$	32,192
Pro forma compensation cost, net of taxes		914		1,028		2,625		3,083

Net income - pro forma	$	12,339	$	9,695	$	37,030	$	29,109

Net income per share - as reported:
Basic	$	0.42	$	0.41	$	1.33	$	1.24
Diluted	$	0.39	$	0.39	$	1.24	$	1.17

Net income per share - pro forma:
Basic	$	0.39	$	0.37	$	1.24	$	1.12
Diluted	$	0.37	$	0.35	$	1.17	$	1.07

In May 2004, the Company’s shareholders approved the 2004 Equity Incentive Plan, referred to as the 2004 Plan. The 2004 Plan authorizes grants to employees and directors of incentive stock options, options not intended to qualify as incentive stock options, stock appreciation rights, restricted and unrestricted stock awards, restricted stock units, deferred stock units, performance awards, supplemental cash awards and combinations of the foregoing. The aggregate number of shares of Common Stock for which awards may be granted under the 2004 Plan is 2.0 million. During the three and nine months ended September 30, 2004, compensation expense of $292,000 and $348,000, respectively, was recorded for deferred stock units.

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2. Accounting Policies (continued):

Income Taxes:

The Company accounts for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes”, referred to as SFAS 109, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS 109 also requires that deferred tax assets be reduced by a valuation allowance if it is more likely than not that some portion or all of the deferred tax asset will not be realized. Deferred taxes have not been provided on the cumulative undistributed earnings of foreign subsidiaries because such amounts are expected to be reinvested indefinitely.

Use of Estimates:

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates.

In the ordinary course of accounting for the long-term collection contract, estimates are made by management as to the payments due to the client. Actual results could differ from those estimates and a material change could occur within one reporting period.

In the ordinary course of accounting for purchased accounts receivable, estimates are made by management as to the amount and timing of future cash flows expected from each portfolio. The estimated future cash flow of each portfolio is used to compute the IRR for the portfolio and any impairment. The IRR is used to allocate collections between revenue and principal reduction of the carrying values of the purchased accounts receivable.

On an ongoing basis, the Company compares the historical trends of each portfolio to projected collections. Future projected collections are then increased, within preset limits, or decreased based on the actual cumulative performance of each portfolio. Management reviews each portfolio’s adjusted projected collections to determine if further upward or downward adjustment is warranted. Management regularly reviews the trends in collection patterns and uses its best efforts to improve the collections of under-performing portfolios. On newly acquired portfolios, additional reviews are made to determine if the estimated collections at the time of purchase require upward or downward adjustment due to unusual collection patterns in the early months of ownership. However, actual results will differ from these estimates and a material change in these estimates could occur within one reporting period (see note 5).

Derivative Financial Instruments:

The Company selectively uses derivative financial instruments to manage interest costs and minimize currency exchange risk. The Company does not hold derivatives for trading purposes. While these derivative financial instruments are subject to fluctuations in value, these fluctuations are generally offset by the value of the underlying exposures being hedged. The Company minimizes the risk of credit loss by entering into these agreements with major financial institutions that have high credit ratings. The Company accounts for its derivative financial instruments in accordance with SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities”, referred to as SFAS 133, which requires companies to recognize all of their derivative instruments as either assets or liabilities in the balance sheet at fair value.

The Company is exposed to foreign currency fluctuations relating to its operations in Canada, the United Kingdom and the Philippines. In order to partially hedge cash flow exposure, the Company periodically enters into forward exchange contracts in order to minimize the impact of currency fluctuations on transactions and cash flows. These contracts are designated as cash flow hedges and recorded at their fair value on the accompanying balance sheets. Changes in the fair value of a cash flow hedge, to the extent that the hedge is effective, are recorded, net of tax, in other comprehensive income, until earnings are affected by the variability of the hedged cash flows. Cash flow hedge ineffectiveness, defined as the extent that the changes in fair value of the derivative exceed the variability of cash flows of the forecasted transaction, is recorded currently in the statement of income (see note 10).

The Company has certain nonrecourse notes payable that have derivative instruments embedded within them. The embedded derivatives are not hedge instruments and, accordingly, changes in their estimated fair value are reported as other income (expense) in the accompanying statements of income. The embedded derivatives are included in long-term debt on the accompanying balance sheets as they are not separable from the notes payable and they have the same counterparty (see note 8).

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2. Accounting Policies (continued):

Reclassifications:

Certain amounts as of December 31, 2003 and for the three and nine months ended September 30, 2003, have been reclassified for comparative purposes.

3. Business Combinations:

The following acquisitions have been accounted for under the purchase method of accounting. As part of the purchase accounting, the Company recorded accruals for acquisition-related expenses. These accruals included professional fees and other costs related to the acquisition.

On March 26, 2004, the Company completed the merger of NCO Portfolio Management, Inc., referred to as NCO Portfolio, with a wholly owned subsidiary of the Company. The Company owned approximately 63.3 percent of the outstanding stock of NCO Portfolio prior to the merger and pursuant to the merger acquired all NCO Portfolio shares that it did not own in exchange for 1.8 million shares of NCO common stock valued at $39.8 million. The value of the stock issued was based on the average closing price of the Company’s common stock for the period beginning two days before and ending two days after the announcement of the merger on December 15, 2003. The Company recorded goodwill of $15.9 million, most of which is not deductible for tax purposes. The allocation of the fair market value to the acquired assets and assumed liabilities of NCO Portfolio was based on preliminary estimates and may be subject to change. From March 26, 2004 through September 30, 2004, the Company revised the estimated allocation of the fair market value that resulted in an increase in goodwill of $1.1 million. As a result of the acquisition, the Company expects to expand its portfolio base and reduce the cost of operations through economies of scale. Therefore, the Company believes the allocation of a portion of the purchase price to goodwill is appropriate. The following is a preliminary allocation of the purchase price of the minority interest of NCO Portfolio (amounts in thousands):


Purchase price	$	39,891
Transaction costs		1,917
Fair value adjustments: Purchased accounts receivable		2,324
Other assets and liabilities		(825	)
Minority interest		(27,454	)

Goodwill	$	15,853

On April 2, 2004, the Company completed the acquisition of RMH Teleservices, Inc., referred to as RMH, a provider of CRM services. The Company issued 3.4 million shares of NCO common stock in exchange for all of the outstanding shares of RMH and assumed 339,000 warrants and 248,000 stock options. The total value of the consideration was $88.8 million. The Company also repaid $11.4 million of RMH’s pre-acquisition debt. The values of the stock, warrants and stock options were based on the average closing price of the Company’s common stock for the period beginning two days before and ending two days after the announcement of the first amendment to the agreement on January 22, 2004. The Company allocated $20.0 million of the purchase price to the customer relationship and recorded goodwill of $68.8 million, most of which is not deductible for tax purposes. During the three months ended September 30, 2004, the Company revised the estimated allocation of the fair market value that resulted in an increase in goodwill of $4.3 million. As part of the purchase accounting, the Company recorded accruals for acquisition related expenses including termination costs related to certain redundant personnel that were scheduled to be eliminated upon completion of the acquisition, certain future rental obligations attributable to facilities which are scheduled to be closed, and other termination contracts. Prior to April 2, 2004, the Company began to formulate a plan to exit certain activities of RMH. The Company expects the exit plan to be completed by December 31, 2004. However, there are continuing payment obligations for lease and other obligations, which could continue to 2010. The allocation of the fair market value to the acquired assets and liabilities of RMH was based on preliminary estimates and may be subject to change. Such changes may include, but are not limited to, subleasing arrangements, the final valuation of customer relationships, resolution of pre-acquisition tax contingencies, and termination fees associated with client servicing agreements. During the three months ended September 30, 2004, the Company revised the estimated allocation of the fair market value that resulted in an increase in goodwill of $4.3 million. As a result of the acquisition, the Company expects to expand RMH’s current customer base, strengthen its relationship with certain existing customers, and reduce the cost of providing services to the acquired customers through economies of scale. Therefore, the Company believes the allocation of a portion of the

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3. Business Combinations (continued):

purchase price to goodwill is appropriate. The following is a preliminary allocation of the purchase price to the assets acquired and liabilities assumed of RMH (amounts in thousands):


Purchase price	$	88,808
Transaction costs		3,919
Accounts receivable		(23,894	)
Customer relationships		(20,000	)
Property and equipment		(38,924	)
Deferred tax asset		(29,215	)