**UNITED STATES**

**SECURITIES AND EXCHANGE COMMISSION**

Washington, D.C. 20549

Form 10-K

(Mark One)

| **ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES****EXCHANGE ACT OF 1934**
For the Fiscal Year ended December 31, 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 No. 0-21639

**NCO    GROUP, INC.**

(Exact name of registrant as specified in its charter)

Pennsylvania

 

23-2858652

(State or other jurisdiction ofincorporation or organization)

 

(IRS Employer Identification No.)

 

507 Prudential Road, Horsham, Pennsylvania(Address of principal executive offices)

 

19044(Zip Code)

Registrant’s telephone number, including area code (215) 441-3000

Securities registered pursuant to Section 12(b) of the Act:  None

 

Securities registered pursuant to Section 12(g) of the Act:

Common stock, no par value(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      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   No 

The aggregate market value of voting and nonvoting common equity held by nonaffiliates was approximately $774,361,507 (1).

The number of shares of the registrant’s common stock outstanding as of March 14, 2005 was 32,081,981.

 

 

DOCUMENTS INCORPORATED BY REFERENCE

Certain portions of the registrant’s Proxy Statement to be filed in connection with its 2005 Annual Meeting of Shareholders are incorporated by reference into Part III of this Report; provided, however, that the Compensation Committee Report, the Audit Committee Report, the graph showing the performance of the Company’s stock and any other information in such Proxy Statement that is not required to be included in this Annual Report on Form 10-K, shall not be deemed to be incorporated herein or filed for the purposes of the Securities Act of 1933 or the Securities Exchange Act of 1934. 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 $26.69, the last reported sale price for the registrant’s common stock on June 30, 2004, 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 such person, and any such inference is hereby disclaimed. The information provided herein isincluded solely for record-keeping purposes of the Securities and Exchange Commission.

 

 

**TABLE OF CONTENTS**

 

 

 

 

**Page******

 

 

**PART I**

 

 

 

 

 

 

 

 

 

Item 1.

 

****Business******.******

2

 

 

 

 

Item 2.

 

****Properties******.**

29

 

 

 

 

Item 3.

 

****Legal Proceedings******.**

30

 

 

 

 

Item 4.

 

****Submission of Matters to a Vote of Security Holders******.**

31

 

 

 

 

Item 4.1.

 

****Executive          Officers of the Registrant who are not also Directors******.**

32

 

 

 

 

 

 

 

 

 

 

**PART II**

 

 

 

 

 

 

 

 

 

Item 5.

 

****Market for Registrant’s Common Equity, Related Shareholder Matters, and Issuer Purchases of Equity Securities******.**

34

 

 

 

 

Item 6.

 

****Selected          Financial Data******.**

35

 

 

 

 

Item 7.

 

****Management’s          Discussion and Analysis of Financial Condition and Results****of Operations******.**

36

 

 

 

 

Item 7A.

 

****Quantitative and Qualitative Disclosures about Market Risk******.**

52

 

 

 

 

Item 8.

 

****Financial Statements and Supplementary Data******.**

52

 

 

 

 

Item 9.

 

****Changes in and Disagreements with Accountants on Accounting and Financial Disclosure******.**

52

 

 

 

 

Item 9A.

 

****Controls and Procedures******.**

52

 

 

 

 

Item 9B.

 

****Other Information******.**

53

 

 

 

 

 

 

 

 

 

 

**PART III**

 

 

 

 

 

 

 

 

 

Item 10.

 

****Directors and Executive Officers of the Registrant******.**

54

 

 

 

 

Item 11.

 

****Executive Compensation******.**

54

 

 

 

 

Item          12.

 

****Security Ownership of Certain Beneficial Owners and Management and Related Shareholder Matters******.**

54

 

 

 

 

Item          13.

 

****Certain Relationships and Related Transactions******.**

55

 

 

 

 

Item          14.

 

****Principal Accountant Fees and Services******.**

55

 

 

 

 

 

 

 

 

 

 

**PART IV**

 

 

 

 

 

 

 

 

 

Item          15.

 

****Exhibits and Financial Statement Schedules******.**

56

 

 

 

 

 

 

****Signatures******.**

62

 

 

 

 

 

 

****Index to Consolidated Financial Statements******.**

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,” other than statements of historical fact, 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, fluctuations in quarterly operating results, the integration of acquisitions, the long-term collection contract, the risk associated with the environmental liability related to the Medaphis Services Corporation acquisition, referred to asthe Medaphis acquisition, the final outcome of the Company’s litigation with its former landlord, the effects of terrorist attacks, war and the economy on the Company’s business, expected increases in operating efficiencies, anticipated trends in the business process outsourcing industry, referred to as BPO, estimates of future cash flows of purchased accounts receivable, estimates of goodwill impairments and amortization expense of other intangible assets, the effects of legal proceedings, regulatory investigations or tax examinations, the effects of changes in accounting pronouncements, and statements as to trends or the Company’s or management’s beliefs, expectations and opinions. The words “anticipate,” “believe,” “estimate,” “expect,” “intend,” “may,” “plan,” “will,” “would,” “should,” “guidance,” “potential,” “continue,”“project,” “forecast,” “confident,” and similar expressions are typically used to identify forward-looking statements. 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 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 related topossible impairment of goodwill and other intangible assets, risks associated with technology, risks related to the ERP implementation, risks related to the environmental liability related to the Medaphis acquisition, risks related to the final outcome of the Company’s litigation with its former landlord, risks related to the Company’s litigation, regulatory investigations and tax examinations, risks related to past or possible future terrorist attacks, risks related to the threat or outbreak of war or hostilities, risks related to the domestic and international economy, the risk that the Company will not be able to improve margins, risks related to the Company’s international operations, risks related to the availability of qualified employees, particularly in new or more cost-effective locations, risks related to currency fluctuations, risks related to reliance on independent telecommunications service providers, risks related to changes in government regulationsaffecting the teleservices and telecommunications industries, risks related to competition from other outside providers of BPO services and the in-house operations of existing and potential clients, risks related to the final outcome of the SEC matter, 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, referred to as the SEC, can cause actual results and developments to be materially different from those expressed or implied by such forward-looking statements. 

 

 

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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.

**PART I**

**Item          1.**

**Business.**

**General**

NCO is a global provider of business process outsourcing services, referred to as BPO, primarily focused on accounts receivable management, referred to as ARM, and customer relationship management, referred to as CRM. Our ARM business is composed of three operating divisions: ARM North America, ARM International and Portfolio Management. Our portfolio of outsourcing solutions includes accounts receivable management, contact center support and back office support services for a diversified customer base. We support essential business functions across key portions of the customer life cycle including acquisition, growth, care, resolution and retention. Our extensive industry knowledge, technological expertise, management depth, and long-standing client relationships enable us to deliver customized solutions that help our clients reduce their operating costs and increase cash flow, thus improving theirfinancial performance. We provide our services through our customer-driven model that delivers best-in-class performance, cutting-edge technology, proven efficiency and quality, to a wide range of clients in North America and abroad. We have approximately 16,600 full and part-time employees who provide our services through our global network of approximately 87 offices. 

We also purchase and manage past due consumer accounts receivable from consumer creditors such as banks, finance companies, retail merchants, and other consumer-oriented companies.

Our website is www.ncogroup.com. We make available on our website, free of charge, 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 to our investors, 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:  Investor Relations

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 non-core functions to focus on revenue-generating activities and core competencies, reduce costs and improve productivity. In particular, many large corporations are recognizing the advantages of outsourcing accounts receivable 

 

 

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management and customer service and support. This trend is being driven by a number of industry-specific factors: 

 

**•**

First, companies are under greater pressure to streamline resources, cut costs and focus on core competencies.

 

**•**

Second, the increasing complexity of collection and other customer service processes requires sophisticated call management and database systems for efficient operations.

 

**•**

Third, many businesses lack the expertise, resources and infrastructure necessary to provide optimal customer support due to the growing scope and complexity of such activities.

 

**•**

Fourth, the trend in certain industries to outsource non-core functions due to competitive pressures, regulatory considerations and/or required capital expenditures.

We operate in a large industry with growth opportunities. Growth in the BPO industry has been driven by the increasing utilization of BPO services, the continuing growth in consumer and commercial debt, and an increased focus on building long-term customer relationships. IDC, a global market intelligence and advisory firm, expects such positive market dynamics to overcome any inhibitors over the next year and expects the BPO industry to expand in the next five years. Additionally, the Gartner Group, a research firm, expects BPO revenues to reach $143 billion in 2005 and $157 billion in 2006. The primary market sectors we support are financial services, telecommunications, healthcare, utilities, retail and commercial, transportation/logistics, education, technology and government.

The BPO industry is highly fragmented. The top providers are large multinational companies, however, according to IDC, no single service provider has more than a seven percent share of the total market. 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 regulatory and quality standards demanded by businesses seeking to outsource their non-core business functions.

**Strategy**

Our strategy is to continue to transition into a global provider of BPO services while maintaining our market dominance as a global provider of accounts receivable management and collection services. We aim to achieve sustainable long-term growth that builds shareholder value while meeting the day-to-day challenges of our operating environment. Our plan 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 and complexity. Over time, we believe these relationships will 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** - We intend to continue to pursue the following initiatives to increase profitability:

 

**•**

standardization of systems and practices;

 

**•**

consolidation of facilities;

 

**•**

automation of clerical functions;

 

**•**

utilization of foreign labor;

 

**•**

statistical analysis to improve performance and reduce operational expenses; and
 
 

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**•**

leveraging our global size and reach.

**Business process improvements -**We continually strive to 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:

**•**     *Enterprise resource planning system:*  During 2004, we began planning for the implementation of an enterprise resource planning system, referred to as ERP, to improve customer service, enhance operating efficiencies, and provide more effective management of business operations. This will enable us to more efficiently meet the changing technological requirements of our industry and the needs of our clients. The first phase of the implementation was rolled out on January 1, 2005. We expect the implementation, as currently planned, will be completed in several phases through 2006.

**•**      *Enhanced    data management and analytics:* **We have improved our suite of segmentation tools to    help focus collection efforts. Additionally, alternative treatments are    continually identified and tested within segments. These efforts, coupled    with our investment in data warehousing and the intelligent    application of automation, provide benefits in the form of both reduced operational    expenses and increased collection revenues.

**•**     *Online access for subcontractor agencies:*  Leveraging the technology put in place to service our Attorney Network System, which brings us online with over 100 law firms across the United States, we have expanded this system to also support the data exchange needs with other agencies we utilize to service accounts. These agencies are now able to receive, process, and return updates for all forwarded accounts using the latest web server technology.

**•**     *Quality    control over client data exchange:* We have continued    to enhance a proprietary software product that tracks both the client inbound    files and the client remittance files. This system now incorporates all the    features for both quality and production control. 

**•**      *E-commerce         initiatives:*We have implemented e-commerce         initiatives  for specific client programs in key market sectors.    Additionally we are implementing technologies to allow communication with          our clients’ customers through other web-based tools, including          email  response, interactive chat, and voice over Internet protocol          technologies,    as well as electronic bill presentment and payment. We have developed web-based           platforms that process real-time credit card authorizations    and electronic bank draft payments that are applied to customer accounts          on  our clients’ 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.

**•**      *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    multiple client systems concurrently from a single interface 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. 

**•**     *On-going    business process reengineering:* We continue to drive    improved performance and reduced cost through our on-going focus on business    process improvement. We implemented significant behind-the-scenes technology    to streamline and improve all operations, including 

 

 

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automated internal skip tracing, dedicated connectivity between facilities, automated mail extraction and payment posting equipment, and additional systems storage capacity. We also implemented web-enabled reporting technology to replace the need for other forms of electronic reporting or hard copy reports.

**•**      *Technology    support center:* Our 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 first and second 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 and business management.

**•**      *Enhanced data security:* We continue to deploy both physical and system security enhancements to help ensure ongoing protection and privacy of NCO and client data as well as network and systems hardening.We implemented stricter corporate-wide password and access policies and require two-factor authentication for remote access. We haveupdated and enhanced our security policies as well as our security awareness training programs.

**•**     *HIPAA compliance:*****We have developed and implemented a comprehensive compliance program designed to ensure our continuing compliance with the standards for privacy, data security, and administrative simplification under the Health Insurance Portability and Accountability Act of 1996, referred to as HIPAA. We enhanced our data security programs, and tested and upgraded, as necessary, physical security at all healthcare service centers. All healthcare employees are trained and tested on HIPAA privacy requirements, and all new healthcare employees complete the training and testing within forty-five days of the start of their employment. The training and testing programs are completed on-line using a web-based program. Our HIPAA Coordinating Committeemonitors changes in the HIPAA rules and regulations and recommends changes in operating procedures to ensure continuing compliance. We continued the rollout of HIPAA privacy practices as the “best practices” across all of our business lines to ensure the protection and the confidentiality of all clients’ data.

**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 we are one of the largest providers of BPO services in both of these markets. We expect to further penetrate these markets through increased sales of ARM and CRM services. Additionally, we expect to pursue direct investments, strategic alliances and partnerships as well as further explore acquisitions in these markets. 

In addition to providing services to these core markets, we also provide our domestic clients with a cost-effective option of using such foreign labor markets as Canada, the Philippines, India, Barbados and Panama to provide effective services. We currently have approximately 6,400, 540, 500, 180 and 80 telephone representatives working in Canada, the Philippines, India, Barbados and Panama for our U.S. clients, respectively. We are in the process of expanding our presence in these markets as well as exploring new opportunities in other labor markets such as Australia, Eastern Europe, Central America and other parts of the Caribbean. In January 2005, we completed the acquisition of International Market Access SRL, the Barbados company that we previously used as a subcontractor. In February 2005, we began using approximately 25 employees through a subcontractor in Antigua to provideservices for our U.S. clients.

 

 

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**Purchase of delinquent accounts receivable** - Since 1999, we have expanded our portfolio purchase platform. Purchases have grown steadily each year since we entered the business in 1991 despite an increasingly competitive market. Purchases totaled $89.7 million for 2004, compared to $74.3 million in 2003 and $72.7 million in 2002. Our strategic plan is to seek opportunities for larger purchases, which is a less competitive arena. In 2004, we were successful in executing our plan by acquiring several larger portfolios, including a purchase of $27 million, which was our largest single purchase since entering the business. 

Looking forward, the market for distressed consumer receivables continues to attract significant new capital. Over the last two years, long established companies have launched initial public offerings, private and public competitors have announced new credit facilities to purchase portfolios, and several new entrants have emerged. The number of portfolios available for sale has increased as well, but we believe the demand of new capital outweighs the supply, and as a result, pricing has been on the rise for some time. Our strategy of seeking out more sizable opportunities has met with success, and we will continue to pursue larger opportunities. We believe our combination of financial capability, coupled with our sophisticated servicing platform, focus on compliance, and the scalability of our servicing platform gives us an advantage over our competition. 

We expect to see growth in our international purchase opportunities. We recently entered into a fixed price agreement, or “forward-flow” agreement with a major Canadian retail merchant that obligates us to purchase, on a monthly basis, portfolios of charged-off accounts receivable meeting certain criteria for a 12-month period. Since the acquisition of the minority interest in NCO Portfolio Management, Inc. in 2004, we are now better positioned to unite our U.S.-based purchasing group with our international purchasing groups under one combined set of underwriting, purchasing and performance maximization teams. 

While    our principal portfolios continue to be larger credit card and similar U.S.    based consumer receivables, our growth strategy includes the expansion into    telecommunications, utilities, medical and other generally smaller balance    receivables. Through our joint venture with InoVision-MEDCLR NCOP Ventures,    LLC, referred to as the Joint Venture, we have invested $3.9 million in the    medical and utilities sectors as of December 31, 2004. While the Joint Venture    provided us with significant advantages, the expiration of the purchasing    restrictions contained in the Joint Venture agreement in early 2005 allows us to invest directly in the segment and    we plan to expand on our existing core investment in this arena. 

We have increased our focus on improving collections, reducing servicing costs and maximizing returns on our investments. In order to be more effective and competitive, we have enhanced our analysis of performance resulting in servicing strategies targeted on more profitable segments within a portfolio, teamed up with specialty purchasers willing to purchase accounts at all stages of a portfolio’s life cycle, and enhanced our proprietary scoring models.

In the future, we may develop additional growth opportunities including acquiring other purchasers, as well as partnerships with banks, commercial lenders, and other investors who may provide both product for purchases and additional funding sources. By utilizing such risk-sharing partnerships, such as our large purchase financing arrangement with a lender and our previous Joint Venture, we believe we will be able to gain access to capital while limiting our exposure to credit risk.

**Explore strategic acquisition opportunities**– During 2004, we completed the acquisitions of RMH Teleservices, Inc., referred to as RMH, and the minority interest of NCO Portfolio Management, Inc., referred to as NCO Portfolio. 

 

 

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The business process outsourcing industry is highly fragmented in the United States. The vast majority of these participants are small, local businesses. Although our current focus is on internal growth and the integration of the RMH and NCO Portfolio acquisitions, we believe we will continue to find attractive acquisition opportunities over time. 

**Services**

We provide the following BPO services:

**Accounts Receivable Management and Collection**

We provide a wide range of ARM services to our clients by utilizing an extensive technological infrastructure. Although traditional ARM services have focused on the recovery of delinquent accounts, we also engage in the recovery of current accounts receivable and early stage delinquencies (generally, accounts that are 90 days or less past due). We generate approximately 63 percent of our ARM 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 cycleto 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 one long-term collection contract, was approximately 19 percent during 2004, 2003 and 2002. 

ARM 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 beundertaken 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. 

***Account Notification.***We initiate the recovery process by forwarding a preliminary 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 

 

 

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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.

***Skip Tracing.***In cases where the client’s customer’s contact information 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.

***First Party Early Stage Delinquency Calls.***Although companies understand the importance of contacting customers early in the delinquency cycle, some do not possess the resources necessary to sustain consistent and cost-effective outbound telephone campaigns. We provide a customized, service approach to contact our clients’ customers and remind them of their obligation to pay their accounts.

We typically conduct reminder calls in the client’s name to recently past due customers and courtesy collection calls to more seriously delinquent customers. Our representatives leave courteous messages if telephone contact attempts are unsuccessful after the second day.

***Third Party Collection Services.***The most common challenges encountered by service providers is how to prompt seriously delinquent customers to make payment before they are charged off as uncollectible or to collect the full balance after charge-off. Our Third Party Collection Services communicate a sense of urgency to seriously delinquent customers during these periods, reducing net charge-offs and the cost of collection.

***Credit Reporting.***Credit bureau reporting is used as a collection tool in accordance with NCO’s policy, federal statutes, and client guidelines. 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, depending on the terms of our contract with the client, 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 collection services.

***Activity Reports.***Clients are provided with a system-generated set of customized reports that fully describe all account activity and current status. These reports are typically generated monthly; however, the information included in the report and the frequency that the reports are generated can be modified to meet the needs of the client. 

***Quality Tracking.***We emphasize quality control throughout all phases of the accounts receivable management and collection process. Some clients may specify an enhanced level of supervisory review and others may request customized quality reports. Large financial services organizations 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.

 

 

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**Customer Relationship Management**

Our CRM services allow our clients to strengthen their customer relationships by providing a high level of support to their customers and generate incremental sales by acquiring new customers. We design and implement customized outsourced customer care solutions including the following: 

***Customer Care and Retention.***Our representatives specialize in developing and maintaining the relationships that our clients value. Customer care programs vary depending upon each client’s specific goals, but often include services such as customer development and outbound and inbound calling campaigns. Our representatives handle customer care inquiries such as billing questions, product and service inquiries, and complaint resolution. We also place calls on behalf of clients in welcoming new customers, retaining current customers, delivering notifications and conducting market research or satisfaction surveys. All programs include specialized training so every representative is a seamless extension of our clients’ businesses. 

***Customer Acquisition and Sales.***We support inbound and outbound sales efforts by conducting customized programs designed to acquire new customers, renew current customers, and win back or win over targeted customers. We execute every phase of the sales order process, pre- and post-sale, from answering product related questions and making sales presentations to up selling, cross selling and order processing. 

***Product and Technical Support.***In support of the increasing dependence of customers and businesses on technology, prompt and accurate responses to technology complaints, product-related support issues, and service related concerns has become a cornerstone to maintaining high customer satisfaction and achieving retention goals. Our product support services include help desk, troubleshooting, warranty, recall, and upgrade support. We strive for first call resolution and are committed to meeting client service level requirements. Our highly trained customer contact staff is knowledgeable in all components of technical support and help desk related service requirements, and is adept at troubleshooting, evaluation and escalation procedures and resolving complaints quickly and effectively to increase our clients’ customer retention and loyalty. 

***Interactive Voice Response.***We use interactive voice response technology to cost-effectively facilitate customer care for our clients. Customers can efficiently obtain account balance information, transfer funds, place an order, check status of an order, pay a bill, or answer a survey. Incoming calls are routed to representatives through systematic call transfer protocols or as a result of a toll-free number being included on customer correspondence. The process is completely automated, and if the caller wants to speak to a representative they can choose to be connected to a live NCO customer service professional. This combination of live and recorded telephone interaction benefits the customer through efficient, 24-hour service, and decreased operating costs.

***Email Management.***The key to attracting and retaining customers is easy accessibility. Our email management services allow our clients’ customers to communicate with them whenever, day or night, 24 hours a day, seven days a week. Our response generation and intelligent routing provide an efficient means to respond to customer needs while increasing our clients’ operational effectiveness and decreasing their costs. 

***Web Chat.***We have the ability to communicate with clients’ customers through our live Web chat service. Faster than email, our Web chat solution allows customers to interact with agents in real time. We can leverage our Web chat technology to provide customer care, answer product questions, or offer technical support. 

 

 

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***In-Language Contact.***Our global network of call centers support all major languages, including English, Spanish, French, Arabic, Korean, Hindi, Polish, Russian, Tagalog, and numerous Asian dialects. We have a wealth of experience supporting multilingual programs and can work with clients to meet any language requirement.

***Facilities Management.***Our Facilities Management Services allow us to take on operational responsibility for an existing call center facility when outsourcing to an alternate location is not in our clients’ best interests.

**Portfolio Management**

Since 1991, we have purchased, collected and managed portfolios of purchased accounts receivable. These portfolios have consisted primarily of delinquent accounts receivable. We are ranked among the top 10 debt purchasers, according to data gathered by Credit & Collections World, an industry analyst, serving numerous domestic and international market sectors, including financial services, healthcare, telecommunications, and utilities.

**Additional Services**

We selectively provide other related services that complement our traditional ARM and CRM businesses and leverage our technological infrastructure. We believe that the following services will provide additional growth opportunities for us: 

***Attorney Network Services.***We coordinate and implement legal collection solutions undertaken on behalf of our clients through the management of nationwide legal resources specializing in collection litigation. Our collection support staff manages the attorney relationships and facilitates the transfer of all necessary documentation.

***NCOePayments.***We can provide our clients’ customers with multiple secure payment options, accessible via the telephone or the Internet, 24 hours a day, 365 days a year.

***Credit and Investigative Reporting Service.***We develop the information needed to profile commercial debtors and make decisions affecting extensions of credit.

***Back Office Support.***We can coordinate customizable back office solutions including: Billing, Payment Process, Medical Certification, Bankruptcies, and Accounting.

**Technology and Infrastructure**

We have implemented a scalable technical infrastructure that can flexibly support growing client volume while delivering the highest levels of service. Our customer contact centers feature state-of-the-art technologies, including predictive dialers, automated call distribution systems, digital switching, digital recording, workforce management systems and customized computer software, including the NCO ACCESS Interface Manager. As a result, we believe we are able to address outsourced business process activities more reliably and more efficiently than our competitors. Our Information Technology staff is comprised of approximately 275 employees. We provide our services through the operation of approximately 87 centers that are electronically linked through an international wide area network.

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 believe fast 

 

 

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recovery and continuous operation are ensured with multiple redundancies, uninterruptible power supplies and contracted backup and recovery services. We have implemented a security system to protect the integrity and confidentiality of our computer systems and data, and we maintain comprehensive business interruption and critical systems insurance on our telecommunications and computer systems. Our systems also permit secure network access to enable clients to electronically communicate with us and monitor operational activity on a real-time basis. We employ a variety of measures including firewalls, encryption, data access, permissions, and site security to ensure data remains safe and secure.

Our ARM call centers utilize predictive dialers with a total of over 5,000 stations to address our low-balance, high-volume accounts, and our CRM centers utilize approximately 1,400 predictive dialer stations to conduct our clients’ outbound calling campaigns. 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 andfollow-up activities including letter and report generation. Our automated method of operations dramatically improves the productivity of our staff.

**Quality Assurance and Client Service**

Our reputation for quality service is critical to acquiring and retaining clients. Therefore, our representatives are supervised, by both NCO and our clients, for strict compliance with client 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, as well as federal, state and local guidelines, quality assurance personnel supervise 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 thestatus 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 contacts 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    active client base currently includes over 24,000 companies in the financial    services, telecommunications, healthcare, utilities, transportation/logistics,    education, retail and commercial, technology, and government sectors. Our    10 largest clients in 2004 accounted for approximately 40 percent of our    revenue. In 2004, our largest client was Capital One Financial Corporation    and it accounted for 10.4 percent of our total revenue. No other client accounted    for more than 10 percent of total    revenue.    In 2004, we derived 36.8 percent of our revenue, excluding purchased accounts    receivable, from financial services (which includes the banking and insurance    sectors), 20.3 percent from telecommunications companies, 18.6 percent from    healthcare organizations, 6.6 percent from utilities, 6.4 percent from retail    and commercial 

 

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entities, 3.9 percent from transportation/logistics companies, 3.7 percent from educational organizations, 2.8 percent from technology companies, and 0.9 percent from government entities. 

We enter into ARM 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 collection contract with a large client to provide collection services. This long-term collection contract only covers placements by the client from January 1, 2000 through December 31, 2003. 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, subject to limits, if collections do not reach the guarantees. Any guarantees in excess of the limits can only be satisfied with future collections. We are entitled to recoup at least 90 percent of any such guarantee payments from subsequent collections in excess of any remaining guarantees. 

Our CRM contracts are generally for terms of up to three years. Contracts are typically terminable by either party upon 60 days notice; however, in some cases, particularly in our longer term inbound contracts which often require substantial capital expenditures on our part, a client may be required to pay us a termination fee in connection with an early termination of the contract. We have one CRM contract that contains a termination clause that requires us to pay the client a termination fee under certain circumstances.

In addition, certain inbound CRM contracts may contain minimum volume commitments requiring our clients to provide us with agreed-upon levels of calls during the terms of the contracts. Our fees for services rendered under these contracts are based on pre-determined contracted chargeable rates that may include a base rate per hour plus a higher rate or “bonus” rate if we meet pre-determined objective performance criteria. These objective performance criteria include such items as sales generated during a defined period. Additionally, we may receive additional discretionary client determined bonuses based upon criteria established by our clients.

We have certain customer contracts that provide for limited currency rate protection below certain pre-determined exchange rate levels and limited gain sharing above certain pre-determined exchange rate levels. Such contracts may mitigate certain currency risks, however, there can be no assurance that new contracts will be successfully negotiated with such provisions or that existing contract provisions will result in the reduction of currency risk for such contracts.

On occasion we enter into “forward-flow” agreements for the purchase of accounts receivable from consumer credit grantors. A forward-flow agreement is a commitment to purchase a defined volume of accounts from a seller for a designated period of time, typically three to 12 months, at a fixed price.

**Personnel and Training**

Our success in recruiting, hiring and training a large number of employees is critical to our ability to provide high quality BPO services programs to our clients. We seek to hire personnel with previous experience in the industry or with experience as telephone representatives. We generally offer internal promotion opportunities and competitive compensation and benefits. 

 

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All of our call center personnel receive comprehensive training that consists of three stages: Introduction Training, Behavioral Training and Functional Training. These programs are conducted through a combination of classroom and role-playing sessions. 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 and on-going refresher training, as well as additional product training on an as needed basis.

As of December 31, 2004, we had a total of approximately 13,300 full-time employees and 3,300 part-time employees, of which 14,300 are telephone representatives. Our employees are not represented by a labor union. We believe that our relations with our employees are good. In addition, as of December 31, 2004, we also utilized 500, 180 and 80 telephone representatives through a subcontractor in India, Barbados and Panama, respectively. In January 2005, we completed the acquisition of International Market Access SRL, the Barbados company that we previously utilized as a subcontractor. In February 2005, we began utilizing approximately 25 employees through a subcontractor in Antigua to provide services for our U.S. clients. 

**Sales and Marketing**

Our sales force is organized into three functional groups to best match our sales professionals’ experience and expertise with the appropriate target market. This structure allows us to strategically allocate resources corresponding to potential revenue and partnership opportunities. 

The largest group consists of approximately 300 telephone sales representatives who specialize in business-to-business BPO solutions for small to mid-sized companies. 

Our core sales force, composed of approximately 70 sales professionals, is organized by industry vertical and geographical location to ensure the highest level of focus and service to potential and existing business partners. This group specializes in direct sales efforts aimed at delivering customized outsourced solutions primarily within the ARM market space.

The Enterprise Team consists of approximately five seasoned sales veterans who focus on forming and cultivating strategic, long-term partnerships with large, multinational firms in order to maximize outsourcing opportunities via our full suite of BPO services.

During the fourth quarter of 2004, we began the installation of the Client Relationship Management Module of our ERP. This module will provide new tools to support both Sales and Operations in the management of client relationships from initial identification of a prospect to the care and retention of long-term clients. The module is expected to be fully implemented by the end of the third quarter of 2005.

Our in-house marketing department provides innovative customer contact solutions and sales support by performing a wide range of personalized services such as customer database administration, advertising, marketing campaigns and direct mailings, collateral development, trade show and site visit management, market and competitive research, and more. We also maintain a dedicated team of skilled writers who prepare detailed, professional responses to formal requests for proposals and requests for information.

 

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**Competition**

The BPO industry is highly competitive. We compete with a large number of ARM providers, including large national corporations such as GC Services LP, IntelliRisk Management Corporation, Outsourcing Solutions, Inc., and Risk Management Alternatives, Inc., as well as many regional and local firms. We also compete with large customer care outsourcing providers such as Convergys Corporation, Precision Response Corporation, SITEL Corporation, TeleTech Holdings, Inc., and West Corporation. 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 BPO services offered by us in-house. Moreover, many larger clients retain multiple outsourcing providers, which exposes us to continuous competition in order to remain a preferred vendor. We believe that the primary competitive factors in obtaining andretaining clients are the ability to provide customized solutions to a client’s requirements, personalized quality service, sophisticated call and information systems, and price.

Portfolio Management competes with other purchasers of consumer delinquent accounts receivable, such as Asset Acceptance Capital Corp., Asta Funding, Inc., Encore Capital Group, Inc. and Portfolio Recovery Associates, Inc. The purchased accounts receivable business has become increasingly competitive over the past few years, with several new companies entering the market. While portfolios available for sale have increased somewhat, we believe the demand outweighs the supply, which has caused pricing to increase. Our competitors may have greater access to credit to purchase portfolios than we do, and may be able to outbid us on available portfolios. We believe the primary competitive factor in this business is the ability to purchase portfolios at reasonable prices.

**Regulation**

**Accounts Receivable Management and Collection**

The ARM industry in the United States is regulated both at the federal and state level. The Federal Fair Debt Collection Practices Act, referred to as the FDCPA, 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 FDCPA 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 FDCPA also places restrictions on communications with individuals other than consumer debtors in connection with the collection of any consumer debt and sets forth specific proceduresto be followed when communicating with such third parties for purposes of obtaining location information about the consumer. Additionally, the FDCPA 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, referred to as the FTC, has the authority to investigate consumer complaints against debt collection companies and to recommend enforcement actions and seek monetary penalties. The ARM 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.

 

 

 

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We provide services to healthcare clients, which as providers of healthcare services are considered “covered entities” under the Health Insurance Portability and Accountability Act of 1996, referred to as HIPAA. As covered entities, our clients must comply with the new standards for privacy, transaction and code sets, and data security. Under HIPAA, we have been deemed to be a “business associate,” which requires that we protect the security and privacy of “protected health information” provided to us by our clients for the collection of payments for healthcare services. In 2003, we implemented HIPAA compliance training and awareness programs for our healthcare service employees. We also have undertaken an ongoing process to test data security at all relevant levels to ensure that we meet or exceed the electronic data security standards that become effectivein April 2005. In addition, we reviewed physical security at all healthcare operation centers and, as appropriate, upgraded or added security systems to control access to all work areas.

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 aresubject to annual renewal. We believe that we hold all necessary licenses in those provinces and territories that require them.

In addition, the ARM 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.

**Customer Relationship Management**

In the United States, there are two major federal laws that specifically address telemarketing, the Telephone Consumer Protection Act, referred to as TCPA, which authorized the Federal Communications Commission, referred to as the FCC, to adopt rules implementing the TCPA, and the Telemarketing and Consumer Fraud and Abuse Prevention Act, referred to as the Fraud Prevention Act, which authorized the FTC, to adopt the Telemarketing Sales Rule, referred to as the TSR. Over the past two years, the TSR has been amended to include several new restrictions on telemarketing activities. In addition, the states have various regulatory restrictions and requirements for telemarketing companies. 

The TCPA places restrictions on unsolicited automated telephone calls to residential telephone subscribers by means of automatic telephone dialing systems, prerecorded or artificial voice messages and telephone fax machines. In addition, the regulations require CRM firms to develop a “do not call” list and to train their CRM personnel to comply with these restrictions. The TCPA creates a right of action for both consumers and state attorneys general. A court may award 

 

 

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damages or impose penalties of $500 per violation, which may be trebled for willful or knowing violations. Currently, we train our service representatives to comply with the regulations of the TCPA. On March 11, 2003, the Do-Not-Call Implementation Act, referred to as the Do-Not-Call Act, was signed into law. The Do-Not-Call Act required the FCC to issue final rules under the TCPA to maximize the consistency of the TCPA with the FTC’s December 18, 2002 amendments to the TSR, as discussed below. Accordingly, on July 3, 2003, the FCC issued rules regarding the national do-not-call registry, call abandonment and caller ID requirements. 

The FTC regulates both general sales practices and telemarketing specifically and has broad authority to prohibit a variety of advertising or marketing practices that may constitute “unfair or deceptive acts or practices.” Pursuant to its general enforcement powers, the FTC can obtain a variety of types of equitable relief, including injunctions, refunds, disgorgement, the posting of bonds and bars from continuing to do business for a violation of the acts and regulations it enforces. 

The FTC also administers the Fraud Prevention Act under which the FTC has issued the TSR prohibiting a variety of deceptive, unfair or abusive practices in direct telephone sales. Generally, these rules prohibit misrepresentations of the cost, quantity, terms, restrictions, performance or characteristics of products or services offered by telephone solicitation or of refund, cancellation or exchange policies. The rules also regulate the use of prize promotions in direct telephone sales to prevent deception and require that a telemarketer identify promptly and clearly the seller on whose behalf the CRM representative is calling, the purpose of the call, the nature of the goods or services offered and that no purchase or payment is necessary to win a prize. The regulations also require that providers of services maintain records on various aspects of their businesses. 

On December 18, 2002, the FTC amended the TSR. The major change was the creation of a centralized national “do not call” registry. Federal enforcement of the National Do Not Call Registry began on October 1, 2003. A consumer who receives a telemarketing call despite being on the registry can file a complaint with the FTC, either online or by calling a toll free number. Violators could be fined up to $11,000 per incident. In addition, the amended TSR restricts call abandonment (with certain safe harbors) and unauthorized billing. Further, as of January 29, 2004, the amended TSR requires telemarketers to transmit their telephone numbers and, if possible, their names to consumers’ “caller id” services. 

At the state level, most states have enacted consumer protection statutes prohibiting unfair or deceptive acts or practices as they relate to telemarketing sales. For example, telephone sales in certain states are not final until a written contract is delivered to and signed by the buyer, and such a contract often may be canceled within three business days. At least one state also prohibits parties conducting direct telephone sales from requesting credit card numbers in certain situations, and several other states require certain providers of such services to register annually, post bonds or submit sales scripts to the state’s attorney general. Under these general enabling statutes, depending on the willfulness and severity of the violation, penalties can include imprisonment, fines and a range of equitable remedies such as consumer redress or the posting of bonds before continuing in business. 

Additionally, some states have enacted laws and others are considering enacting laws targeted at direct telephone sales practices. Some examples include laws regulating electronic monitoring of telephone calls and laws prohibiting any interference by direct telephone sales with “caller id” devices. Most of these statutes allow a private right of action for the recovery of damages or provide for enforcement by state agencies permitting the recovery of significant civil or criminal 

 

 

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penalties, costs and attorneys’ fees. There can be no assurance that any such laws, if enacted, will not adversely affect or limit our current or future operations. 

To date, fourteen states have established statewide “do not call” lists. Twenty-six states have opted to use the FTC’s Do Not Call list as the official state list. 

The industries we serve are also subject to government regulation, and, from time to time, bills are introduced in Congress, which, if enacted, could affect our operations. We, and our employees who sell insurance products, are required to be licensed by various state and provincial insurance commissions for the particular type of insurance product to be sold and are required to participate in regular continuing education programs. 

Telecommunications is another industry we serve that is subject to government regulation. For example, “slamming” is the illegal practice of changing a consumer’s telephone service without permission. The FCC has promulgated regulations regarding slamming rules that apply solely to the telecommunications carrier and not the telemarketer or the independent party verifying the service change. However, some state slamming rules may extend liability for violations to agents and other representatives of telecommunications carriers, such as telemarketers. 

Our representatives undergo an extensive training program, part of which is designed to educate them about applicable laws and regulations and to try to ensure their compliance with such laws and regulations. Also, we program our call management system to avoid initiating telephone calls during restricted hours or to individuals maintained on our “do not call” list. We believe that we operate in compliance with all applicable laws and regulations. 

In Canada, the Canadian Radio-Television and Telecommunications Commission, referred to as CRTC, enforces rules regarding unsolicited communications using automatic dialing and announcing devices, live voice and fax. Companies that violate any of the restrictions on unsolicited calls may have their telephone service terminated after two business days’ notice from the telephone company. Effective October 1, 2004, the CRTC required telemarketers to provide consumers with a unique registration number confirming a consumer’s do not call request.

In 2001, the federal government of Canada enacted the Personal Information Protection and Electronic Documents Act, referred to as the Federal Act. Effective January 1, 2004, the Federal Act requires all commercial enterprises to obtain consent for the collection, use, and disclosure of an individual’s personal information. Failure to comply with the Federal Act could result in significant fines and penalties or possible damage awards for the tort of public humiliation. In addition to the foregoing sanctions, the Federal Act also contemplates that any finding of an improper use of personal information will be subject to public disclosure by the Privacy Commissioner. The Federal Act permits any Province of Canada to enact substantially similar legislation governing the subject matter of the Federal Act, in which case the legislation of the Province will override the provisions of theFederal Act. Our Canadian operations are located primarily in the Provinces of Ontario, British Columbia and New Brunswick. British Columbia has enacted legislation, referred to as the B.C. Act, governing the subject matter of the Federal Act. The federal government of Canada has not yet declared the B.C. Act substantially similar to the Federal Act. Until such time as the federal government of Canada makes such declaration, both the B.C. Act and the Federal Act will apply concurrently to our operations in British Columbia. Though neither has yet enacted legislation which is substantially similar to the Federal Act, both Ontario and New Brunswick have indicated that they may enact legislation governing the subject matter of the Federal Act. Failure to comply with the Federal Act, the B.C. Act, as well as, any such future 

 

 

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legislation enacted by Ontario, New Brunswick or any other provinces in which we operate, may have an adverse affect on, or limit our current or future, operations. 

The Competition Act contains a number of provisions that regulate the conduct of telemarketers in Canada, in particular the manner in which outbound calls are to be conducted. Failure to comply with such legislation could adversely affect our business.

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 19 in our Notes to Consolidated Financial Statements for disclosure of financial information regarding our segments and geographic areas.

 

 

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**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. 

**Risks Related to Our Business**

**Terrorist attacks, war and threats of attacks and war may adversely impact our results of operations, revenue and stock price.**

Terrorist attacks in the United States and abroad, as well as war and threats of war or actual conflicts involving the United States or other countries in which we operate, 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. They could also result in an adverse effect on the economies of the United States and other countries in which we operate. Any of these occurrences could have a material adverse effect on our results of operations, 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:

 

**•**

our ability to retain existing clients and expand our existing client relationships; and

 

**•**

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:

 

**•**

we fail to maintain the quality of services we provide to our clients;

 

**•**

we fail to maintain the level of attention expected by our clients; 

 

**•**

we fail to successfully leverage our existing client relationships to sell additional services; and

 

**•**

we fail to maintain competitively priced services to our clients.

Our ability to attract new clients is subject to a number of risks, including:

 

**•**

the market acceptance of our service offerings;

 

**•**

the quality and effectiveness of our sales force; and

 

**•**

the competitive factors within the BPO 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.

 

 

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**Implementation of our ERP system could cause business interruptions and negatively affect our profitability and cash flows.**

During 2004, we began planning for the implementation of an ERP system, and the first phase was rolled out on January 1, 2005. We expect the implementation, as currently planned, will be completed in several phases through 2006. Implementation of ERP systems and the accompanying software carry risks such as cost overruns, project delays, business interruptions and delays, and the diversion of management’s attention from operations. These risks could adversely affect us, and could have a material adverse effect on our business, results of operations, financial condition and cash flows.

**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 record the results of our collection efforts, as well as to provide customer service to our clients’ customers. 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. Telecommunications and computer technologies are changing rapidly and are characterized by short product life cycles, so 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 thecapital resources available to invest in new technologies, our business could 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 is also 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 revenue only as ARM accounts are collected and CRM services are provided, any failure or interruption of services would mean that we would continue to incur payroll and other expenses without any corresponding income.

**An increase in communication rates or a significant interruption in communication service could harm our business.**

Our ability to offer services at competitive rates is highly dependent upon the cost of communication services provided by various local and long distance telephone companies. Any change in the telecommunications market that would affect our ability to obtain favorable rates on communication services could harm our business. Moreover, any significant interruption in communication service or developments that could limit the ability of telephone companies to provide us with increased capacity in the future could harm existing operations and prospects for future growth.

 

 

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**We compete with a large number of providers in the ARM and CRM industries, and other purchasers of consumer debt. This competition could have a materially adverse effect on our future financial results.**

We compete with a large number of companies in the industries in which we provide services. In the ARM industry, we compete with other sizable corporations in the United States and abroad such as GC Services LP, IntelliRisk Management Corporation, Outsourcing Solutions, Inc., and Risk Management Alternatives, Inc., as well as many regional and local firms. In the CRM industry, we compete with large customer care outsourcing providers such as Convergys Corporation, Precision Response Corporation, SITEL Corporation, TeleTech Holdings, Inc., and West Corporation. 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 BPO servicesoffered by us in-house. Many larger clients retain multiple BPO 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 fees to remain competitive and this competition could have a materially adverse effect on our future financial results.

Portfolio Management competes with other purchasers of consumer delinquent accounts receivable, such as Asset Acceptance Capital Corp., Asta Funding, Inc., Encore Capital Group, Inc. and Portfolio Recovery Associates, Inc. The purchased accounts receivable business has become increasingly competitive over the past few years, with several new companies entering the market. While the number of portfolios available for sale have increased, we believe the demand outweighs the supply, which has caused pricing to increase. Our competitors may have greater access to credit to purchase portfolios than we do, and may be able to outbid us on available portfolios. In the future we may have to pay more for our portfolios, which could have an adverse impact on our financial results.

**Many of our clients are concentrated in the financial services, telecommunications, and healthcare 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, 2004, we derived approximately 36.8 percent of our revenue, excluding purchased accounts receivable, from clients in the financial services sector, approximately 20.3 percent of our revenue from clients in the telecommunications industry, and approximately 18.6 percent of our revenue from clients in the healthcare sector. If any of these sectors performs poorly, clients in these sectors may do less business with us, or they may elect to perform the services provided by us in-house. If there are any trends in any of these sectors to reduce or eliminate the use of third-party BPO service providers, it could harm our business.

**We have international operations and utilize foreign sources of labor, and various factors relating to our international operations, including fluctuations in currency exchange rates, could adversely affect our results of operations.**

Approximately 4.6% of our 2004 revenues were derived from clients in Canada and the United Kingdom for ARM services. 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 revenue, costs of operations and profit results could also be affected by a number of other factors related to our international operations, including changes in economic conditions from country to country, changes in a country’s political condition, trade protection 

 

 

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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 results of operations due to the translation of these currencies into U.S. dollars when we consolidate our financial results.

We provide ARM and CRM services to our U.S. clients utilizing foreign sources of labor through call centers in Canada, India, Barbados, the Philippines, Panama, and Antigua. Any political or economic instability in these countries could have an adverse impact on our results of operations. A decrease in the value of the U.S. dollar in relation to the currencies of the countries in which we operate could increase our cost of doing business in those countries. In addition, we expect to expand our operations into other countries and, accordingly, will face similar exchange rate risk with respect to the costs of doing business in such countries as a result of any decreases in the value of the U.S. dollar in relation to the currencies of such countries. There is no guarantee that we will be able to successfully hedge our foreign currency exposure in the future.

**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. We depend 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.**

From time to time, we may seek to make opportunistic acquisitions of companies in the BPO business. We may be unable to make acquisitions because suitable companies in the BPO business are not available at favorable prices due to increased competition for these companies. 

We may have to borrow money, incur liabilities, or sell or issue stock to pay for future acquisitions and we may not be able to do so at all or on terms favorable to us. Additional borrowings and liabilities may have a materially adverse effect on our liquidity and capital resources. If we issue stock for all or a portion of the purchase price for future acquisitions, our shareholders’ ownership interest may be diluted. If the price of our common stock decreases or potential sellers are not willing to accept our common stock as payment for the sale of their businesses, we may be required to use more of our cash resources, if available, in order to continue our acquisition program. 

Completing acquisitions involves a number of risks, including diverting management’s attention from our daily operations and other additional management, operational and financial resources. We might not be able to successfully integrate future acquisitions into our business or operate the acquired businesses profitably, and we may be subject to unanticipated problems and liabilities of acquired companies. 

**We are dependent on our employees and a higher turnover rate would have a material adverse effect on us. In the past, some of our employees have attempted to organize labor unions.**

 

 

-22-

 

We are dependent on our ability to attract, hire and retain qualified employees. The BPO industry, by its nature, is labor intensive and 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 to meet the needs of ourbusiness or to support our growth. If we are unable to do so, our results of operations could be harmed. Any increase in hourly wages, costs of employee benefits or employment taxes could also have a materially adverse affect.

In the past, some of our employees have attempted to organize a labor union. If any of our employees are successful in organizing a labor union at any of our locations, it could further increase labor costs and could decrease operating efficiency and productivity in the future. 

**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:

 

**•**

the timing of our clients’ programs and the commencement of new contracts and termination of existing contracts;

 

**•**

the timing and amount of collections on purchased accounts receivable;

 

**•**

customer contracts that require us to incur costs in periods prior to recognizing revenue under those contracts;

 

**•**

the effects of a change of business mix on profit margins;

 

**•**

the timing of additional selling, general and administrative expenses to support new business;

 

**•**

fluctuations in foreign currency exchange rates;

 

**•**

the amount and timing of new business;

 

**•**

the costs and timing of completion and integration of acquisitions; and

 

**•**

that our business tends to be slower in the third and fourth quarters of the year due to the summer and holiday seasons.

**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 routinely publicly announce investor guidance concerning our expected results of operations. 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 resultsprojected in our investor guidance, it could have a materially adverse effect on the market price of our common stock.

 

 

-23-

 

**Goodwill and other intangible assets represented 57.0 percent of our total assets at December 31, 2004. If the goodwill or the other intangible assets, primarily our customer relationships, are deemed to be impaired, we may need to take a charge to earnings to write-down the goodwill or other intangibles to its fair value.**

Our balance sheet includes goodwill, which 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. Other intangibles are primarily composed of customer relationships, which represents the information and regular contact we have with our clients.

Under Statement of Financial Accounting Standard No. 142, “Goodwill and Other Intangibles,” referred to as SFAS 142, goodwill is no longer amortized but must be tested at least annually for impairment. The annual impairment test is completed as of October 1st of each year. 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 berecorded in the future. 

SFAS 142 also requires our other intangibles, including customer relationships, to be reviewed for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. The loss of a larger client could require a review of the customer relationship for impairment. We made significant assumptions to estimate the future cash flows used to determine the fair value of the customer relationship. If we lost a significant customer relationship, the future cash flows expected to be generated by the customer relationship would be less then the carrying amount, and an impairment loss may be recorded. 

As of December 31, 2004, our balance sheet included goodwill and other intangibles that represented 54.7 percent and 2.3 percent of total assets, respectively, and 87.6 percent and 3.6 percent of shareholders’ equity, respectively. If our goodwill or customer relationships are deemed to be impaired under SFAS 142, we may need to take a charge to earnings to write-down the asset to its fair value and this could have a materially adverse effect on the market price of our common stock. 

You should be aware that our earnings for periods beginning after December 31, 2001, do not include charges for the amortization of goodwill and you 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:

 

**•**

announcements of fluctuations in our operating results or our competitors’ operating results;

 

**•**

the timing and announcement of acquisitions by us or our competitors;

 

**•**

changes in our publicly available guidance of future results of operations;
 
 

-24-

 

 

**•**

government regulatory action;

 

**•**

changes in estimates or recommendations by securities analysts;

 

**•**

adverse or unfavorable publicity about us, our services, or our competitors;

 

**•**

the commencement of material litigation, or an unfavorable verdict, against us;

 

**•**

terrorist attacks, war and threats of attacks and war;

 

**•**

additions or departures of key personnel; and

 

**•**

sales of common stock.

In addition, the stock market in recent years has experienced significant price and volume fluctuations. 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.

**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 14, 2005, there were 32,081,981 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 14, 2005, we had the authority to issue up to approximately    5,858,205 shares of our common    stock under our stock option plans. We also had outstanding notes convertible    into an aggregate of 3,797,084 shares of our common stock at a conversion    price of $32.92 per share. Additionally, we had outstanding warrants to purchase    approximately 21,762 shares of our common stock at $32.97 per share, and 323,000    warrants assumed in connection with the RMH acquisition at a weighted average    price of $39.38 per share. 

**“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 under 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 up to 5,000,000 shares of 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.

 

 

-25-

 

**If we fail to maintain an effective system of internal controls, we may not be able to accurately report our financial results or prevent fraud. As a result, current and potential shareholders could lose confidence in our financial reporting, which could harm our business and the trading price of our common stock.**

Beginning in early 2003, we began a process to document and evaluate our internal controls over financial reporting in order to satisfy the requirements of Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations, which require annual management assessments of the effectiveness of our internal controls over financial reporting and a report by our independent auditors addressing these assessments. In this regard, we have dedicated internal resources, engaged outside consultants and adopted a detailed work plan to: (i) assess and document the adequacy of internal controls over financial reporting; (ii) take steps to improve control processes, where appropriate; (iii) validate through testing that controls are functioning as documented; and (iv) implement a continuous reporting and improvement process for internal control over financial reporting. Our efforts to complywith Section 404 of the Sarbanes-Oxley Act of 2002 and the related regulations regarding our assessment of our internal controls over financial reporting and our independent auditors’ audit of that assessment have resulted, and are likely to continue to result, in increased expenses. We cannot be certain that these measures will ensure that we implement and maintain adequate controls over our financial processes and reporting in the future. Any failure to implement required new or improved controls, or difficulties encountered in their implementation, could harm our operating results or cause us to fail to meet our reporting obligations. If we fail to correct any issues in the design or operating effectiveness of internal controls over financial reporting or fail to prevent fraud, current and potential shareholders could lose confidence in our financialreporting, which could harm our business and the trading price of our common stock.

**Risks Related to our ARM Business**

*We are subject to business-related risks specific to the ARM business. Some of those risks are:*

**Decreases in our collections due to the economic condition in the United States may have an adverse effect on our results of operations, revenue and stock price.**

Due to the economic condition in the United States, which has led to high 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 be unable to collect these loans in case of the personal bankruptcy of a consumer. Because of higher unemployment rates and bankruptcy filings, our collections may significantly decline, which may adversely impact our results of operations, revenue and stock price.

**Most of our ARM contracts do not require clients to place accounts with us, may be terminated on 30 or 60 days notice and 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 ARM 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. Therefore, under applicable accounting principles, we can recognize revenues only upon the collection of funds on behalf of clients.

 

 

-26-

 

**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 materially adversely affect 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 maybecome 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.

**Risks    Related to our CRM Business**

*We    are engaged in the outsourced CRM business, which has additional business    risks that may have an adverse effect on us. Some of those risks are:*

**Consumer    resistance to outbound services could harm the CRM services industry.**

As    the CRM services industry continues to grow, the effectiveness of CRM services    as a direct marketing tool may decrease as a result of consumer saturation    and increased consumer resistance to customer acquisition activities, particularly    direct sales.

**Government    regulation of the CRM industry and the industries we serve may increase our    costs and restrict the operation and growth of our CRM business.**

The    CRM services industry is subject to an increasing amount of regulation in    the United States and Canada. In the United States, the FCC places restrictions    on unsolicited automated telephone calls to residential telephone subscribers    by means of automatic telephone dialing systems, prerecorded or artificial    voice messages and telephone fax machines, and requires CRM firms to develop    a “do not call” list and to train their CRM personnel to comply    with these restrictions. The FTC regulates both general sales practices and    telemarketing specifically and has broad authority to prohibit a variety of    advertising or marketing practices that may constitute “unfair or deceptive    acts or practices.” Most of the statutes and regulations in the United    States allow a private right of action for the recovery of damages or provide    for enforcement by the Federal Trade Commission, state attorneys general or    state agencies permitting the recovery of significant civil or criminal penalties,    costs and attorneys’ fees in the event that regulations are violated.    The Canadian Radio-Television and Telecommunications Commission enforces rules    regarding unsolicited communications using automatic dialing and announcing    devices, live voice and fax. We cannot assure you that we will be in compliance    with all applicable regulations at all times. We also cannot assure you that    new laws, if enacted, will not adversely affect or limit our current or future    operations.

 

 

-27-

 

Several of the industries we serve, particularly the insurance, financial services and telecommunications industries, are subject to government regulation. We could be subject to a variety of private actions or regulatory enforcement for our failure or the failure of our clients to comply with these regulations. Our results of operations could be adversely impacted if the effect of government regulation of the industries we serve is to reduce the demand for our CRM services or expose us to potential liability. We, and our employees who sell insurance products, are required to be licensed by various state insurance commissions for the particular type of insurance product sold and to participate in regular continuing education programs. Our participation in these insurance programs requires us to comply with certain state regulations, changes in which could materially increase ouroperating costs associated with complying with these regulations. 

**The CRM division relies on a few major clients for a significant portion of its revenues. The loss of any of these clients or their failure to pay us could reduce revenues and adversely affect results of operations.**

The CRM division is characterized by substantial revenues from a few key clients. While no individual client represented more than 10 percent of our consolidated revenue, we are exposed to customer concentration within this division. Most of these clients are not contractually obligated to continue to use our services at historic levels or at all. If any of these clients were to significantly reduce the amount of service, fail to pay, or terminate the relationship altogether, our CRM business could be harmed. 

**A decrease in demand for CRM services in one or more of the industries to which we provide services could reduce revenues and adversely affect results of operations.**

Our CRM business is concentrated in the telecommunications industry. During 2004, announcements were made by a number of telecommunications companies that they were significantly reducing their participation in consumer markets. As a result, there have been reductions of services performed for certain of our telecommunications clients. A further reduction of such services or the elimination of the use of outsourced CRM services in this or any other industry could harm our CRM business.

**Risks Related to our Purchased Accounts Receivable Business**

*We are subject to additional business-related risks common to the purchase and management of defaulted consumer accounts receivable business. Some of those risks are:*

**Collections may not be sufficient to recover the cost of investments in purchased accounts receivable and support operations.**

We purchase 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 uncollectible, and charged off. After purchase, collections on accounts receivable could be reduced by consumer bankruptcy filings, which have been increasing. The accounts receivable are purchased at a significant discount, typically less than 10% of face value, to the amount the customer owes and, although we estimate that the recoveries on the accounts receivable will be in excess ofthe amount paid for the accounts receivable, actual recoveries on the accounts receivable will vary and may be less than the amount expected, and

 

 

-28-

 

may even be less than 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 accounts receivable, we may not be able to purchase new accounts receivable and our future growth and profitability will be materially adversely affected. There can be no assurance that our operating performance will be sufficient to service our debt or finance the purchase of new accounts receivable.

**We use estimates in reporting results. If collections on portfolios are materially less than expected, we may be required to record impairment expenses that could have a materially adverse effect on us.**

Our 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 our estimates. If collections on portfolios are materially less than estimated, we may be required to record impairment expenses that will reduce earnings and could materially adversely affect our earnings, financial condition and creditworthiness.

In    October 2003, the American Institute of Certified Public Accountants issued    Statement of Position 03-03, “Accounting for Loans or Certain Securities    Acquired in a Transfer” (“SOP 03-3”). SOP 03-3 addresses    accounting for differences between contractual and expected cash flows from    an investor’s initial investment in certain loans when such differences    are attributable, in part, to credit quality. The concept of loans under    SOP 03-3 includes our purchased accounts receivable portfolios. SOP 03-3    is effective for loans acquired in fiscal years beginning after December    15, 2004, and amends Practice Bulletin No. 6 for loans acquired in fiscal    years before the effective date. We adopted SOP 03-3 on January 1, 2005.    Previously issued annual financial statements are not restated and there    is no prior period effect of these new provisions (see our Critical Accounting    Policies and Estimates, included in Item 7. “Management’s Discussion   and Analysis of Financial Condition and Results of Operations”).

**We may be adversely affected by possible shortages 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 our 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 we find attractive. If competitors raise the prices they are willing to pay for portfolios of accounts receivable above those we wish to pay, we may be unable to buy the type and quantity of past due accountsreceivable at prices consistent with our historic return targets. In addition, we may overpay for portfolios of delinquent accounts receivable, which may have a materially adverse effect on our financial results. 

**We may be unable to compete with other purchasers of past due accounts receivable, which may have an adverse effect on our combined financial results.**

We face bidding competition in our acquisitions of portfolios of past due consumer accounts receivable. Some of our 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. We may not have the resources or ability to compete successfully with our existing and potential new competitors. To remain competitive, we may have to increase our bidding prices, which may have an adverse impact on our financial results.

**Item          2.**

**Properties.**

We currently lease 67 offices in the United States, including our corporate headquarters, 15 offices in Canada, two offices in the United Kingdom, one office in Puerto Rico, one office in Barbados, and one office in the Philippines. The leases of these facilities expire between 2005 and 2016, and most contain renewal options.

 

 

-29-

 

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.**

*FTC:*

In October 2003, we were notified by the Federal Trade Commission, referred to as the FTC, that it intended to pursue a claim against us for violations of the Fair Credit Reporting Act, relating to certain aspects of our credit reporting practices during 1999 and 2000.

The    allegations related primarily to a large group of consumer accounts from    one client that were transitioned to us for servicing during 1999. We received    incorrect information from the prior service provider at the time of transition.    We became aware of the incorrect information during 2000 and ultimately removed    the incorrect information from the consumers’ credit    files. During the first quarter of 2004, we made a settlement offer to the    FTC and recorded a charge of $1.5 million related to this matter. The FTC    agreed to this settlement and the amount was paid in the second quarter of    2004. During the fourth quarter of 2004, we reached an agreement with the    owners of the consumer accounts to partially reimburse us for our indemnification    claims under the servicing agreement.

*Fort Washington Flood:*

In June 2001, the first floor of our Fort Washington, Pennsylvania, headquarters was severely damaged by a flood caused by remnants of Tropical Storm Allison. As previously reported, during the third quarter of 2001, we decided to relocate our corporate headquarters to Horsham, Pennsylvania. We filed a lawsuit in the Court of Common Pleas, Montgomery County, Pennsylvania (Civil Action No. 01-15576) against the current landlord and the former landlord of the Fort Washington facilities to terminate the leases and to obtain other relief. The landlord and former landlord have filed counter-claims against us. 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.

In April 2003, the former landlord defendants filed a joinder complaint against Michael J. Barrist, the Chairman, President and Chief Executive Officer of the Company, Charles C. Piola, Jr., a director and former Executive Vice President of the Company, and Bernard R. Miller, a former Executive Vice President and director of the Company, to name such persons as additional defendants and alleging, among other things, that they breached their fiduciary duties to the Company.

In January 2004, the Court, in ruling on the preliminary objections, allowed the former landlord defendants’ suit to proceed against these individuals, but struck from the complaint the breach of fiduciary duty allegations asserting violations of duties owed by individual officers to the Company. 

*Securities and Exchange Commission:*

In January 2005, we received notification from the Staff of the Securities and Exchange Commission, referred to as the Staff, informing us that it intended to issue a formal notification (commonly known as a “Wells notice”) to NCO and certain of its officers recommending that the

 

 

-30-

 

Securities and Exchange Commission, referred to as the SEC, bring civil proceedings against NCO and such officers alleging violations of certain non-fraud provisions of the federal securities laws relating to financial reporting and internal control requirements. The potential violations relate to our revenue recognition policy relating to a long-term collection contract, which we had previously corrected in 2003, and our revenue recognition policy regarding the timing of revenue recognized on certain cash receipts related to contingency revenues.

The    notification from the Staff informed us that their interpretation of Staff    Accounting Bulletin No. 104, referred to as SAB 104, was inconsistent with    our long-standing policy with respect to the timing of revenue recognized    on certain cash receipts related to contingency revenues. We previously recognized    contingency fee revenue attributable to payments postmarked prior to the    end of the period and received in the mail from the consumers on the first    business day after such period as applicable to the prior reporting period.    This revenue recognition policy had been in effect since prior to NCO becoming    a public company and was consistently applied over time. We corrected our    policy in order to recognize revenue when physically received. The impact    of this    correction was a $2.7 million reduction in revenues and a $947,000 reduction    in net income, or $0.03 per diluted share, for the year ended December 31,    2004. No restatement of prior period financial statements was required for   this correction.

*Other:*

We are involved in other legal proceedings, regulatory investigations and tax examinations from time to time in the ordinary course of business. Management believes that none of these other legal proceedings, regulatory investigations, or tax examinations 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.

 

 

-31-

 

**Item          4.1**

**Executive Officers of the Registrant who are not Directors.**

 

**Name******

 ****

**Age******

 ****

**Position******

 

 

 

 

 

 

 

Charles F. Burns

 

44

 

Executive Vice President, Business Process Outsourcing

 

 

 

 

 

Stephen W. Elliott

 

43

 

Executive Vice President, Information Technology and Chief Information Officer

 

 

 

 

 

Joshua Gindin, Esq.

 

48

 

Executive Vice President and General Counsel

 

 

 

 

 

Steven Leckerman

 

52

 

Executive Vice President, Chief Operating Officer – Accounts Receivable Management, North America

 

 

 

 

 

John R. Schwab

 

37

 

Senior Vice President, Finance and Chief Accounting Officer

 

 

 

 

 

Paul E. Weitzel, Jr.

 

46

 

Executive Vice President, Corporate Development and International Operations

 

 

 

 

 

Steven L. Winokur

 

45

 

Executive Vice President; Chief Financial Officer and Chief Operating Officer - Shared Services

 

 

 

 

 

Albert Zezulinski

 

57

 

Executive Vice President, Corporate and Government Affairs

Charles F. Burns - Mr. Burns joined us in 2003 as Executive Vice President, Business Process Outsourcing. Mr. Burns has nearly 20 years of sales and consulting experience. Prior to joining us, Mr. Burns was a partner in BearingPoint, Inc., formerly KPMG Consulting, Inc., a business systems integrator and full-service consulting firm.

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, became Executive Vice President, U.S. Operations in January 2001, and in August 2003 became Executive Vice President and Chief Operating Officer – Accounts Receivable Management, North America. From 1982 to 1995, Mr. Leckerman was employed by Allied Bond Corporation, a collection company that was a division of TransUnion Corporation, where he served as manager of dialer and special projects.

 

 

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John    R. Schwab – Mr. Schwab joined us through the acquisition of RMH    Teleservices, Inc., in April 2004, where he was the Chief Financial Officer    since 2003. From 2000 to 2003, Mr. Schwab was employed by Inrange Technologies,    Inc., a data storage networking company, most recently as the Chief Financial    Officer. Prior to    that, Mr. Schwab worked for Arthur Andersen for 11 years, most recently as    Senior Manager in the Growth Company Practice. Mr. Schwab is a Certified    Public Accountant.

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 as Executive Vice President, Finance and Chief Financial Officer, and also became Chief Operating Officer - Shared Services in August 2003. 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.

Albert Zezulinski - Mr. Zezulinski joined us in January 2001 as Executive Vice President, Health Services, and became Executive Vice President, Corporate and Government Affairs in May 2002. Mr. Zezulinski has more than 30 years of consulting and healthcare experience. Prior to joining us, Mr. Zezulinski was the Director of Healthcare Financial Services for BDO Seidman, LLP, an international accounting and consulting firm.

 

 

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**PART II**

**Item          5.**

**Market for Registrant’s Common Equity,**

**Related    Shareholder Matters and Issuer Purchases of Equity Securities.**

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**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**2003**

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

17.15

 

$

12.55

 

 

 

Second Quarter

 

 

20.43

 

 

14.50

 

 

 

Third Quarter

 

 

26.00

 

 

17.14

 

 

 

Fourth Quarter

 

 

26.18

 

 

20.63

 

 

 

 

 

 

 

 

 

 

 

**2004**

 

 

 

 

 

 

 

 

 

 

First Quarter

 

$

24.86

 

$

20.75

 

 

 

Second Quarter

 

 

26.69

 

 

22.51

 

 

 

Third Quarter

 

 

26.97

 

 

24.19

 

 

 

Fourth Quarter

 

 

27.70

 

 

24.19

 

On March 14, 2005, the last reported sale price of our common stock as reported on The Nasdaq National Market was $19.03 per share. On March 14, 2005, there were approximately 129 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 Plans**

See Part III, Item 12, of this Annual Report on Form 10-K for disclosure regarding our equity compensation plans.

**Sales of Unregistered Securities during 2004**

During    2004, the Company issued 15,857 shares of common stock upon the exercise    of warrants which were assumed in connection with the acquisition of RHM    Teleservices, Inc. The issuance of the common stock was exempt from registration    under the SecuritiesAct of 1933 pursuant to Section 4(2) of such Act.

 

 

-34-

 

**Item          6.**

**Selected Financial Data.**

**SELECTED FINANCIAL DATA (1)**

**(Amounts in thousands, except per share data)**    

 

 

 

**For the years ended December 31,**

 

 

 

 

 

 

**2000**

 

**2001 (2)**

 

**2002**

 

**2003**

 

**2004**

 

 

 

 

 

 

 

 

**Statement of Income Data:**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

587,452

 

$

683,873

 

$

703,450

 

$

753,816

 

$

939,797

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Payroll and related expenses

 

 

293,292

 

 

350,634

 

 

335,405

 

 

350,369

 

 

472,915

 

Selling, general and administrative expenses

 

 

179,924

 

 

237,690

 

 

249,672

 

 

282,268

 

 

324,187

 

Depreciation and amortization expense

 

 

32,360

 

 

38,205

 

 

27,324

 

 

31,628

 

 

40,225

 

 

 

 

 

 

 

 

Income from operations

 

 

81,876

 

 

57,344

 

 

91,049

 

 

89,551

 

 

102,470

 

Other expense

 

 

22,126

 

 

23,335

 

 

17,970

 

 

17,943

 

 

17,612

 

 

 

 

 

 

 

 

Income before provision for income taxes

 

 

59,750

 

 

34,009

 

 

73,079

 

 

71,608

 

 

84,858

 

Income tax expense

 

 

24,572

 

 

14,661

 

 

27,702

 

 

26,732

 

 

32,389

 

 

 

 

 

 

 

 

Income from continuing operations before minority interest

 

 

35,178

 

 

19,348

 

 

45,377

 

 

44,876

 

 

52,469

 

Minority interest

 

 

—

 

 

(4,310

)

 

(3,218

)

 

(2,430

)

 

(606

)

 

 

 

 

 

 

 

Income from continuing operations

 

 

35,178

 

 

15,038

 

 

42,159

 

 

42,446

 

 

51,863

 

Discontinued operations, net of taxes:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Income (loss) from discontinued operations

 

 

(975

)

 

—

 

 

—

 

 

—

 

 

—

 

Loss on disposal of discontinued operations

 

 

(23,179

)

 

—

 

 

—

 

 

—

 

 

—

 

 

 

 

 

 

 

 

Net income

 

$

11,024

 

$

15,038

 

$

42,159

 

$

42,446

 

$

51,863

 

 

 

 

 

 

 

 

Income from continuing operations per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.38

 

$

0.58

 

$

1.63

 

$

1.64

 

$

1.71

 

 

 

 

 

 

 

 

Diluted

 

$

1.36

 

$

0.58

 

$

1.54

 

$

1.54

 

$

1.60

 

 

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

$

0.43

 

$

0.58

 

$

1.63

 

$

1.64

 

$

1.71

 

 

 

 

 

 

 

 

Diluted

 

$

0.43

 

$

0.58

 

$

1.54

 

$

1.54

 

$

1.60

 

 

 

 

 

 

 

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Basic

 

 

25,587

 

 

25,773

 

 

25,890

 

 

25,934

 

 

30,397

 

 

 

 

 

 

 

 

Diluted

 

 

25,842

 

 

26,091

 

 

29,829

 

 

29,895

 

 

34,652

 

 

 

 

 

 

 

 

 

 

 

**December 31,**

 

 

 

 

 

 

**2000**

 

 

**2001**

 

 

**2002**

 

 

**2003**

 

 

**2004**

 

 

 

 

 

 

 

 

**Balance Sheet Data:**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

13,490

 

$

32,161

 

$

25,159

 

$

45,644

 

$

26,334

 

Working capital

 

 

76,824

 

 

97,478

 

 

107,731

 

 

106,409

 

 

70,470

 

Total assets

 

 

781,257

 

 

928,864

 

 

966,281

 

 

946,111

 

 

1,113,889

 

Long-term debt, net of current portion

 

 

303,920

 

 

357,868

 

 

334,423

 

 

248,964

 

 

186,339

 

Minority interest

 

 

—

 

 

21,213

 

 

24,427

 

 

26,848

 

 

—

 

Shareholders’ equity

 

 

375,464

 

 

392,302

 

 

435,762

 

 

490,417

 

 

695,601

 

(1)

The years ended December 31, 2000 and 2001, included goodwill amortization expense, net of tax, of $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 this Report on Form 10-K.

(2)

The year ended December 31, 2001, included flood and restructuring related charges, net of tax, of $14.5 million.

 

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**Item          7.**

**Management’s          Discussion and Analysis of**

 
 
**Financial          Condition and Results of Operations.**

**Overview**

We are a global provider of business process outsourcing services, referred to as BPO, primarily focused on accounts receivable management, referred to as ARM, and customer relationship management, referred to as CRM, serving a wide range of clients in North America and abroad through our global network of approximately 87 offices. We also purchase and manage past due consumer accounts receivable from consumer creditors such as banks, finance companies, retail merchants, and other consumer-oriented companies.

We generate approximately 63 percent of our ARM revenue from the recovery of delinquent accounts receivable on a contingency fee basis. Our ARM contingency fees 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 ARM contingency-based revenue across all industries, excluding the long-term collection contract, was approximately 19 percent during 2004, 2003 and 2002. In addition, we generate revenue from fixed fee services for certain ARM 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 ofservices, and termination provisions. Clients typically have the right to terminate their contracts on 30 or 60 days’ notice.

Approximately 73 percent of our CRM revenue is generated from inbound services, which consist primarily of customer service and technical support programs, although some acquisition and retention services are also performed on an inbound basis. Inbound services involve the processing of incoming calls, often placed by our clients’ customers using toll-free numbers, to a customer service representative for service, order fulfillment or information. Outbound services, which consist of customer acquisition and customer retention services, represented approximately 27 percent of our CRM revenue.

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, outside collection attorneys and other third-party collection services providers, 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 2004, we completed two acquisitions: the minority interest of NCO Portfolio Management, Inc., referred to as NCO Portfolio, in March 2004, and RMH Teleservices, Inc., referred to as RMH, in April 2004. The acquisition of RMH created our CRM division, which added $159.0 million to revenue and $4.6 million to net income from the date of acquisition  through December 31, 2004.

In January 2005, we received notification from the Staff of the SEC that their interpretation of Staff Accounting Bulletin No. 104, referred to as SAB 104, was inconsistent with our long-standing policy with respect to the timing of revenue recognized on certain cash receipts related to contingency revenues. We previously recognized contingency fee revenue attributable to

 

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payments    postmarked prior to the end of the period and received in the mail from the    consumers on the first business day after such period as applicable to the    prior reporting period. This revenue recognition policy had been in effect    since prior to NCO becoming a public company and was consistently applied    over time. We corrected our policy in order to recognize revenue when physically    received. The impact of this correction was a $2.7 million reduction in revenue    and a $947,000 reduction in net income, or $0.03 per diluted share, for the    year ended December 31, 2004. No restatement of prior period financial statements    was required for this correction.

In January 2005, we completed the acquisition of International Market Access SRL, a Barbados company that we previously utilized as a subcontractor. In February 2005, we began utilizing a subcontractor in Antigua to provide services for our U.S. clients.

Effective July 1, 2004, we reorganized our business segments to facilitate the expansion of our international operations. The Canadian ARM business, previously reported in ARM International, has been combined with ARM U.S., and this division has been renamed ARM North America. The United Kingdom subsidiary continues to operate as ARM International. The information presented below has been restated to reflect this reorganization. 

Our business currently consists of four operating divisions: ARM North America, CRM, Portfolio Management and ARM International. 

**Critical Accounting Policies and Estimates**

*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 and estimates that are the most critical and could have the most 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 and Other Intangible Assets*

Our balance sheet includes amounts designated as “Goodwill” and “Other    intangibles.” 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. Other intangible assets    consist primarily of customer relationships and deferred financing costs,   which relate to debt issuance costs incurred.

As of December 31, 2004, our balance sheet included goodwill and other intangibles that represented 54.7 percent and 2.3 percent of total assets, respectively, and 87.6 percent and 3.6 percent of shareholders’ equity, respectively.

Goodwill is tested for impairment at least annually and as triggering events occur. The annual impairment test is completed as of October 1st of each year. The test for impairment is performed 

 

 

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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 the 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 is less than the carrying amount, the reporting unit’s goodwill would be considered impaired and we would be required to take a charge to earnings, which could be material. We did not record any impairment charges in connection with the annual impairment tests performed on October 1, 2004, 2003 and 2002, and we do not believe that goodwill was impaired as of December 31, 2004. 

We make significant assumptions to estimate the future revenue and cash flows used to determine the fair value of our reporting units. These assumptions include future growth rates, discount factors, future tax rates, and other factors. 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. 

*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. We have maintained historical collection records for all of our purchased accounts receivable, as well as debtor records, since our entrance into this business in 1991 and for the acquired predecessor business since 1986, which provides us a reasonable basis for our judgment that it is probable that we will ultimately collect the recorded amount of our purchased accounts receivable plus a premium or yield. The historical collection amounts also provide a reasonable basis for determining the timing of the collections. We use all available information to forecast the cash flows of our purchased accounts receivable including, but not limited to, historical collections, payment patterns on similar purchases, creditscores of the underlying debtors, seller’s credit policies, and location of the debtor. The estimated future cash flow of each portfolio is used to compute the internal rate of return, referred to as the 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 or upward 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, 2004, differences between actual and estimated collections on existing portfolios, as of the beginning of 2004, resulted in an increase in net income of $5.4 million, or $0.16 per diluted share. For the year ended December 31, 2003,differences between actual and estimated collections on existing portfolios, as of the beginning of 2003, resulted in a reduction in net income of $114,000 and no change in diluted earnings per share. 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 of $3.0 million, or $0.10 per diluted share. 

If management came to a different conclusion as to the future estimated collections, it could have had a significant impact on the amount of revenue that was recorded from the purchased accounts receivable during the year ended December 31, 2004. For example, a five percent

 

 

-38-

 

 increase in the amount of future expected collections would have resulted in a $536,000, or $0.02 per diluted share, increase in net income for 2004, and a five percent decrease in the amount of future expected collections would have resulted in an $589,000, or $0.02 per diluted share, reduction in net income for 2004.

On January 1, 2005, we adopted AICPA Statement of Position 03-3 – Accounting for Certain Loans or Debt Securities Acquired in a Transfer, referred to as SOP 03-3. SOP 03-3 limits the revenue that may be accrued to the excess of the estimate of expected cash flows over a portfolio’s initial cost. SOP 03-3 does not allow the original estimate of the effective interest, or the IRR, to be lowered for revenue recognition or for subsequent testing for provision for bad debts. If the original collection estimates are lowered, an allowance is established in the amount required to maintain the original IRR. If collection estimates are raised, increases are first used to recover any previously recorded allowances and then recognized prospectively through an increase in the IRR, which are realized over a portfolio’s remaining life.Any increase in the IRR must be used for subsequent revenue recognition and allowance testing. Based on our adoption of SOP 03-3, for 2005, we expect that a five percent increase in the amount of future expected collections would result in an increase in net income of approximately $340,000, or $0.01 per diluted share, since increases in future expected collections are recognized over the portfolio’s remaining life. A five percent decrease in the amount of future expected collections would result in a decrease in net income of approximately $2.4 million, or $0.07 per diluted share, since decreases in future expected collections are recognized in the current period. These projections are based upon the portfolios we have as of December 31, 2004.

*Allowance for Doubtful Accounts*

Allowances for doubtful accounts are estimated based on estimates of losses related to customer receivable balances. In establishing the appropriate provision for customer receivables balances, we make assumptions with respect to their future collectibility. Our assumptions are based on an individual assessment of a customer’s credit quality as well as subjective factors and trends, including the aging of receivable balances. Generally, these individual credit assessments occur at regular reviews during the life of the exposure and consider factors such as a customer’s ability to meet and sustain their financial commitments, a customer’s current financial condition and historical payment patterns. Once the appropriate considerations referred to above have been taken into account, a determination is made as to the probability of default. An appropriate provision is made,which takes into account the severity of the likely loss on the outstanding receivable balance. Our level of reserves for our customer accounts receivable fluctuates depending upon all of the factors mentioned above, in addition to any contractual rights that allow us to reduce outstanding receivable balances through the application of future collections. If our estimate is not sufficient to cover actual losses, we would be required to take additional charges to our earnings. 

*Notes Receivable*

As    of December 31, 2004, our balance sheet included $17.7 million of notes receivable,    recorded under current and long-term other assets, received in connection    with the sale of certain businesses. We review the recoverability of these    notes receivable on a quarterly basis to determine if an impairment charge    is required. In completing our analysis, we make assumptions with respect    to the future collectibility of the notes receivable. Our assumptions are   based on assessments of an obligor’s financial condition and historical payment patterns, as well as subjective factors and trends, including financial projections. Once the appropriate considerations referred to above have been taken into account, a determination is made as to the probability of default. If we determine 

 

-39-

 

that a default in the note receivable is probable, an impairment charge would be recorded to reduce the notes receivable to its recoverable value. If our assessment of the recoverability of the notes receivable is incorrect, we may need to incur additional impairment charges in the future.

*Income Taxes*

We account for income taxes in accordance with SFAS No. 109, “Accounting for Income Taxes,” 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 No. 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.

Our    balance sheet includes deferred tax assets of $15.6 and $15.3 million for    the assumed utilization of federal net operating loss carryforwards acquired    in the merger with Creditrust Corporation, referred to as Creditrust, and    the RMH acquisition, respectively. We believe that we will be able to utilize    the  net operating loss carryforwards so we have not reduced the deferred    tax asset by a valuation allowance. However, we have provided a $13.7 million    valuation allowance against the deferred tax asset for state net operating    loss carryforwards due to the uncertainty that they can be realized. 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. If we are unable to utilize    the federal net operating loss carryforwards, it may result in incremental    tax expense in future periods.

Our annual provision for income taxes and the determination of the resulting deferred tax assets and liabilities involve a significant amount of judgment and are based on the latest information available at the time. We are subject to audit within the federal, state and international taxing jurisdictions, and these audits can involve complex issues that may require an extended period of time to resolve. We maintain reserves for estimated tax exposures, which are ultimately settled primarily through the settlement of audits within these tax jurisdictions, changes in applicable tax law, or other factors. We believe that an appropriate liability has been established for estimated purposes, however actual results may differ from these estimates.

**Results of Operations**

The following table sets forth selected historical income statement data (amounts in thousands):

 

 

 

**For the years ended December 31,**

 

 

 

 

 

 

**2004**

 

**2003**

 

**2002**

 

 

 

 

 

 

 

 

**Amount**

 

**Ratio**

 

**Amount**

 

**Ratio**

 

**Amount**

 

**Ratio**

 

 

 

 

 

 

 

 

 

Revenue

 

$

939,797

 

100.0

%

$

753,816

 

100.0

%

$

703,450

 

100.0

%

Payroll and related expenses

 

 

472,915

 

50.3

 

 

350,369

 

46.5

 

 

335,405

 

47.7

 

Selling, general and administrative expenses

 

 

324,187

 

34.5

 

 

282,268

 

37.4

 

 

249,672

 

35.5

 

Depreciation and amortization

 

 

40,225

 

4.3

 

 

31,628

 

4.2

 

 

27,324

 

3.9

 

 

 

 

 

 

 

 

 

Income from operations

 

 

102,470

 

10.9

 

 

89,551

 

11.9

 

 

91,049

 

12.9

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Other expense

 

 

17,612

 

1.9

 

 

17,943

 

2.4

 

 

17,970

 

2.5

 

Income tax expense

 

 

32,389

 

3.4

 

 

26,732

 

3.6

 

 

27,702

 

3.9

 

Minority interest

 

 

606

 

0.1

 

 

2,430

 

0.3

 

 

3,218

 

0.5

 

 

 

 

 

 

 

 

 

Net income

 

$

51,863

 

5.5

%

$

42,446

 

5.6

%

$

42,159

 

6.0

%

 

 

 

 

 

 

 

 

***Year ended December 31, 2004 Compared to Year ended December 31, 2003***

***Revenue.***Revenue increased $186.0 million, or 24.7 percent, to $939.8 million for 2004, from $753.8 million in 2003. ARM North America, CRM, Portfolio Management, and ARM International accounted for $732.6 million, $159.0 million, $98.0 million, and $13.6 million, respectively, of the 2004 revenue. ARM North America’s revenue included $63.1 million of 

 

 

-40-

 

intercompany revenue earned on services performed for Portfolio Management that was eliminated upon consolidation. ARM International’s revenue included $398,000 of intercompany revenue earned on services performed for Portfolio Management that was eliminated upon consolidation. The CRM division was formed in the second quarter of 2004 with the acquisition of RMH on April 2, 2004, and, accordingly, is not included in the results for 2003.

ARM North America’s revenue increased $18.7 million, or 2.6 percent, to $732.6 million in 2004, from $713.9 million in 2003. The increase in ARM North America’s revenue was partially attributable to an increase in fees from collection services performed for Portfolio Management, growth in business from existing clients and the addition of new clients. 

As discussed above, we changed our revenue recognition policy in order to recognize revenue when physically received. The impact of this correction was a $2.7 million reduction in revenue for the year ended December 31, 2004.

ARM North America’s    revenue for 2004 and 2003 included revenue recorded from a long-term collection    contract. The contract was amended so that we are required to pay the client    the difference between the actual collections and guaranteed collections    on May 31, 2004 and May 31, 2005, subject to limits of $6.0 million and $13.5    million, respectively. We defer all of the base service fees, subject to    the limits, 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, subject to the limits. During 2004, ARM North    America recognized $8.5 million of revenue that was deferred in previous    years, on a net basis, compared to $4.2 million in 2003. Included in the    2003 revenue from the long-term collection contract was a $6.9 million benefit    from the amendment to the contract. Any guarantee at the settlement dates    in excess of the limits will be deducted from future bonuses, if any, as    they are earned. We are not responsible to pay the client if future bonuses    are inadequate to cover the additional guarantee. Had we not renegotiated    the contract, the net effect of the long-term collection contract for 2003    would have been a negative impact of $2.7 million due to additional deferred    revenue as a result of an increase in placements. As of December 31, 2004    and 2003, we had deferred sufficient revenue to meet our maximum exposure    at the respective settlement dates. Accordingly, there will be no further   deferrals of revenue under this contract.

Portfolio Management’s revenue increased $22.5 million, or 29.9 percent, to $98.0 million in 2004, from $75.5 million in 2003. Portfolio Management’s collections increased $26.1 million, or 17.3 percent, to $177.2 million in 2004, from $151.1 million in 2003. Portfolio Management’s revenue represented 55 percent of collections in 2004, as compared to 50 percent of collections in 2003. Revenue increased due to the increase in collections resulting from a better collection environment, especially on certain large portfolios that continued to outperform expectations. In addition, the carrying amount of impaired portfolios decreased to $2.7 million, or 2.0 percent of total purchased accounts receivable as of December 31, 2004, from $15.4 million, or 10.3 percent as of December 31, 2003. No revenue was recorded on these portfolios since they are accounted for under the costrecovery method. Of the $2.7 million and $15.4 million of portfolios at December 31, 2004 and 2003, $2.1 million and $11.2 million, respectively, represented impaired portfolios, and $629,000 and $4.2 million, respectively, represented portfolios acquired in connection with the end of an on-balance sheet securitization. Additionally, included in collections for 2004 were $12.7 million of proceeds from the sale of portfolios and $5.2 million in proceeds 

 

 

-41-

 

from the dissolution and sale of an off-balance sheet securitization, compared to $7.6 million of proceeds from the sale of portfolios in 2003. However, proceeds from portfolio sales had a minimal impact on revenue since the majority of the proceeds were applied to the principal of purchased accounts receivable.

ARM International’s revenue decreased $395,000, or 2.8 percent, to $13.6 million in 2004, from $14.0 million in 2003. The decrease in ARM International’s revenue was primarily attributable to several delays by clients in the placement of accounts receivable during the third quarter of 2004, partially offset by favorable changes in the foreign currency exchange rates used to translate ARM International’s results of operations into U.S. dollars. 

***Payroll and related expenses.***Payroll and related expenses increased $122.5 million to $472.9 million in 2004, from $350.4 million in 2003, and increased as a percentage of revenue to 50.3 percent from 46.5 percent. These increases were primarily attributable to the CRM division, which was formed with the acquisition of RMH on April 2, 2004. The CRM business has a more significant portion of their expense structure in payroll and related expenses as compared to the ARM business.

ARM North America’s payroll and related expenses increased $8.3 million to $349.4 million in 2004, from $341.1 million in 2003, and decreased slightly as a percentage of revenue to 47.7 percent from 47.8 percent. A portion of the decrease in payroll and related expenses as a percentage of revenue was attributable to the recognition of $8.5 million of previously deferred revenue, on a net basis, from the long-term collection contract that was recorded during 2004, as compared to $4.2 million of previously deferred revenue, on a net basis, that was recorded during 2003. Since the expenses associated with this revenue are expensed as incurred, the recognition of previously deferred revenue decreases the payroll and related expenses as a percentage of revenue. The decrease in payroll and related expenses as a percentage of revenue was also partially due to the shift of more of ourcollection work to outside attorneys and other third-party service providers, and the continued rationalization of staff. This shift was associated with the continuing efforts to maximize collections for clients. The costs associated with the increase in the use of outside attorneys and other third-party service providers are included in selling, general and administrative expenses. 

Portfolio Management’s payroll and related expenses increased $361,000 to $2.1 million in 2004, from $1.7 million in 2003, but decreased as a percentage of revenue to 2.1 percent from 2.3 percent. Portfolio Management outsources all of the collection services to ARM North America and, therefore, has a relatively small fixed payroll cost structure. The decrease in payroll and related expenses as a percentage of revenue was due to the absorption of the fixed payroll costs over a larger revenue base.

ARM International’s payroll and related expenses increased $340,000 to $7.9 million in 2004, from $7.6 million in 2003, and increased as a percentage of revenue to 58.2 percent from 54.1 percent. The increase as a percentage of revenue was attributable to the absorption of the fixed payroll expenses over a smaller revenue base.

***Selling,        general and administrative expenses.***Selling,        general and administrative expenses increased $41.7 million to $324.0        million in 2004, from $282.3 million in 2003, but decreased as a percentage        of revenue to 34.5 percent from 37.4 percent. The increase in selling,        general and administrative expense in 2004 was due primarily to the CRM        division, which was formed with the acquisition of RMH on April 2, 2004,        as well as an increase in ARM North America due to a higher volume of        business.

 

 

-42-

 

The decrease in selling, general and administrative expenses as a percentage of revenue was partially attributable to the CRM division, which has a more significant portion of their expense structure in payroll and related expenses as compared to the ARM business. Partially offsetting the decrease as a percentage of revenue was an increase in the use of outside collection attorneys and other third-party service providers by ARM North America. 

***Depreciation and amortization.***Depreciation and amortization increased to $40.2 million in 2004, from $31.6 million in 2003. This increase was primarily attributable to $5.8 million of additional depreciation resulting from the assets acquired in the RMH acquisition. The remainder of the increase was attributable to the amortization of the customer relationships acquired in the RMH acquisition.

***Other income (expense).***Interest    and investment income included investment income of $1.6 million for 2004,    as compared to $2.2 million for 2003, from its 50 percent ownership interest    in a joint venture that purchases utility, medical and other various small    balance accounts receivable. Interest expense decreased to $21.2 million    for 2004, from $23.0 million for 2003. This decrease was due to lower principal    balances as a result of debt repayments made against the credit facility    during 2004 and 2003. The decrease was partially offset by Portfolio Management’s additional nonrecourse borrowings to purchase accounts receivable. Other income (expense) for 2004 principally included $621,000 of proceeds from an insurance policy related to a deferred compensation plan assumed as part of the acquisition of FCA International Ltd. in May 1998, and $157,000 in losseson the disposal of fixed assets and other net assets. Other income for 2003 included: $476,000 of income from our ownership interest in one of our insurance carriers that was sold; $402,000 of proceeds from an insurance policy related to a deferred compensation plan assumed as part of the acquisition of FCA International Ltd. in May 1998; and $250,000 of income from a partial recovery from a third party of an environmental liability. 

***Income taxes.***The effective income tax rate increased to 38.2 percent from 37.3 percent due mainly to changes in state and other income taxes offset by positive effects from two concluded IRS audits.

***Year ended December 31, 2003 Compared to Year ended December 31, 2002***

***Revenue.***Revenue increased $50.3 million, or 7.2 percent, to $753.8 million for 2003, from $703.5 million in 2002. ARM North America, Portfolio Management, and ARM International accounted for $713.9 million, $75.5 million, and $14.0 million, respectively, of the 2003 revenue. ARM North America’s revenue included $49.1 million of intercompany revenue earned on services performed for Portfolio Management that was eliminated upon consolidation. ARM International’s revenue included $425,000 of intercompany revenue earned on services performed for Portfolio Management that was eliminated upon consolidation.

ARM North America’s revenue increased $50.2 million, or 7.6 percent, to $713.9 million in 2003, from $663.7 million in 2002. The increase in ARM North America’s revenue was partially attributable growth in business from existing clients and the addition of new clients. The increase was also a result of the acquisitions of Great Lakes Collection Bureau, Inc., referred to as Great Lakes, collection operations in August 2002 and The Revenue Maximization Group, Inc., referred to as RevGro, in December 2002. Great Lakes contributed $20.9 million to ARM North America’s 2003 revenue, compared to $9.1 million for the period from August 19, 2002 to December 31, 2002. RevGro contributed $20.4 million to ARM North America’s 2003 revenue compared to $1.7 

 

 

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million for the period from December 2, 2002 to December 31, 2002. An increase in fees from collection services performed for Portfolio Management also contributed to the increase. These additional fees from Portfolio Management included the fees from servicing the Great Lakes portfolio acquired by NCO Portfolio in August 2002. 

ARM North America’s revenue for 2003 and 2002 included revenue recorded from a long-term collection contract. The method of recognizing revenue for this long-term collection contract deferred certain revenues into future periods until collections exceed collection guarantees. During 2003, ARM North America recognized $4.2 million of previously deferred revenue, on a net basis, compared to $8.3 million in 2002. Included in the 2003 revenue from the long-term collection contract was a $6.9 million benefit from an amendment to the contract. The amendment limited our exposure on the guarantee component of the contract to a maximum of $19.5 million at the last two settlement dates ($6.0 million at the May 31, 2004 settlement and $13.5 million at the May 31, 2005 settlement). Had we not amended the contract, the net effect of the long-term collection contract for 2003 would have been anegative impact of $2.7 million due to additional deferred revenue as a result of an increase in placements. As of December 31, 2003, we had deferred sufficient revenue to meet our maximum exposure at the respective settlement dates. Accordingly, there will be no further deferrals of revenue under this contract.

Portfolio Management’s revenue increased $12.1 million, or 19.1 percent, to $75.5 million in 2003, from $63.4 million in 2002. Portfolio Management’s collections increased $34.7 million, or 29.8 percent, to $151.1 million in 2003, from $116.4 million in 2002. Portfolio Management’s revenue represented 50 percent of collections in 2003, as compared to 54 percent of collections in 2002. Revenue increased due to the increase in collections from new purchases, including the Great Lakes portfolio. The effect of the increase in collections on revenue was partially offset by the decrease in revenue recognition rate. Revenue as a percentage of collections declined principally due to a number of factors, including an increase in the average age of the portfolios, timing of collections, and lower targeted returns on more recent portfolios due to the economic environment. Inaddition, portfolios with $15.4 million in carrying value, or 10.3 percent of total purchased accounts receivable as of December 31, 2003, were being accounted for under the cost recovery method, compared to $5.8 million, or 3.9 percent as of December 31, 2002. Accordingly, no revenue was recorded on these portfolios. Of the $15.4 million of portfolios, $11.2 million represented impaired portfolios, and $4.2 million represented portfolios acquired in connection with the elimination of an off-balance sheet securitization. Additionally, included in collections for 2003 were $7.6 million of proceeds from the sale of accounts, compared to $3.7 million in 2002. 

ARM International’s revenue increased $2.1 million, or 1.8 percent, to $14.0 million in 2003, from $11.9 million in 2002. The increase in ARM International’s revenue was primarily attributable to favorable changes in the foreign currency exchange rates used to translate ARM International’s results of operations into U.S. dollars. In addition, a portion of the increase was attributable to the addition of new clients and growth in business from existing clients. 

***Payroll and related expenses.***Payroll and related expenses increased $15.0 million to $350.4 million in 2003, from $335.4 million in 2002, but decreased as a percentage of revenue to 46.5 percent from 47.7 percent. 

ARM North America’s payroll and related expenses increased $13.4 million to $341.1 million in 2003, from $327.7 million in 2002, but decreased as a percentage of revenue to 47.8 percent from 49.3 percent. The decrease in payroll and related expenses as a percentage of revenue was partially due to the shift of more of our collection work to outside attorneys and other third-party service providers, and the continued rationalization of staff. This shift was associated with the

 

 

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 continuing efforts to maximize collections for clients. The costs associated with the increase in the use of outside attorneys and other third-party service providers are included in selling, general and administrative expenses. A portion of the decrease in the percentage of revenue was offset by the recognition of $4.2 million of previously deferred revenue, on a net basis, from the long-term collection contract that was recorded during 2003, as compared to $8.3 million of previously deferred revenue, on a net basis, that was recorded during 2002. Since the expenses associated with this revenue are expensed as incurred, the recognition of previously deferred revenue decreases the payroll and related expenses as a percentage of revenue.

Portfolio Management’s payroll and related expenses increased $202,000 to $1.7 million in 2003, from $1.5 million in 2002, but decreased as a percentage of revenue to 2.3 percent from 2.4 percent. Portfolio Management outsources all of the collection services to ARM North America and, therefore, has a relatively small fixed payroll cost structure. 

ARM International’s payroll and related expenses increased $1.4 million to $7.6 million in 2003, from $6.2 million in 2002, and increased as a percentage of revenue to 54.1 percent from 52.1 percent. The increase as a percentage of revenue was attributable to increased staffing levels compared to the prior year, due to an increased volume of new business during the year.

***Selling, general and administrative expenses.***Selling, general and administrative expenses increased $32.6 million to $282.3 million in 2003, from $249.7 million in 2002, and increased as a percentage of revenue to 37.4 percent from 35.5 percent. The increase in the percentage of revenue was partially attributable to the recognition of $4.2 million of previously deferred revenue, on a net basis, from the long-term collection contract that was recorded during 2003, as compared to $8.3 million of previously deferred revenue, on a net basis, that was recorded during 2002. Since the expenses associated with this revenue are expensed as incurred, the recognition of previously deferred revenue decreases the payroll and related expenses as a percentage of revenue. A portion of the increase in the percentage of revenue was attributable to the shift of more ofthe collection work to outside attorneys and other third-party service providers.

***Depreciation and amortization.***Depreciation and amortization increased to $31.6 million in 2003, from $27.3 million in 2002. This increase was the result of additional depreciation resulting from normal capital expenditures made in the ordinary course of business during 2002 and 2003. These capital expenditures included expenditures related to the relocation of our corporate headquarters and purchases of predictive dialers and other equipment required to expand our infrastructure to handle future growth. The increase was also attributable to the amortization of the customer relationships acquired in the Great Lakes and RevGro acquisitions.

***Other income (expense).***Interest and investment income included investment income of $2.2 million for 2003, as compared to $762,000 for 2002, from its 50 percent ownership interest in a joint venture that purchases utility, medical and other various small balance accounts receivable. Interest expense increased to $23.0 million for 2003, from $21.0 million for 2002. This increase was due to Portfolio Management’s additional nonrecourse borrowings to purchase accounts receivable, including the $20.6 million of borrowings to purchase Great Lakes’ accounts receivable portfolios. This increase was partially offset by lower interest rates and lower principal balances as a result of debt repayments made in excess of borrowings against the credit facility during 2002 and 2003. Other income for 2003, included: $476,000 of income from our ownershipinterest in one of our insurance carriers that was sold; $402,000 gain related to a benefit from a deferred compensation plan assumed as part of the acquisition of FCA International Ltd. in May 1998; and $250,000 of income from a partial recovery from a third party of an environmental liability. Other expense for 2002 included: an expense of $1.3 million from the estimated settlement of the

 

 

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environmental liability, net of a $305,000 recovery from a third party; a $1.3 million insurance gain that resulted from the settlement of the insurance claim related to the June 2001 flood of the Fort Washington facilities; and a $250,000 write-down of an investment. The insurance gain was principally due to greater than estimated insurance proceeds.

**Liquidity and Capital Resources**

Historically, our primary sources of cash have been bank borrowings, equity and debt offerings, and cash flows from operations. Cash has been used for acquisitions, repayments of bank borrowings, purchases of equipment, purchases of accounts receivable, and working capital to support our growth.

We believe that funds generated from operations, together with existing cash and available borrowings under our credit agreement, will be sufficient to finance our current operations, planned capital expenditure requirements, and internal growth at least through the next twelve months. However, we could require additional debt or equity financing if we were to make any significant acquisitions for cash during that period. 

The cash flow from our contingency collection business and our purchased portfolio business is dependent upon our ability to collect from consumers and businesses. Many factors, including the economy and our ability to hire and retain qualified collectors and managers, are essential to our ability to generate cash flows. Fluctuations in these trends that cause a negative impact on our business could have a material impact on our expected future cash flows.

***Cash        Flows from Operating Activities.***Cash    provided by operating activities was $99.0 million in 2004, compared to $101.1    million in 2003. The slight decrease in cash provided by operating activities    was due to an increase in other assets of $13.5 million compared to a decrease    of $1.7 million for 2003, a decrease in accounts payable and accrued expenses    of $17.8 million compared to a decrease of $6.6 million in the prior year,    and a $10.2 million deposit we received in 2003 in connection with a long-term    collection contract. These items were offset by increases in net income and    noncash expenses, a transfer of $4.9 million out of restricted cash to repay    a portion of the securitized nonrecourse debt in 2004 compared to a transfer    of $4.9 million into restricted cash in 2003, and a $28.7 million increase    in deferred income taxes compared to an $18.8million increase in 2003.

Cash provided by operating activities was $101.1 million in 2003, compared to $64.0 million in 2002. The increase in cash provided by operations was partially attributable to a $6.6 million decrease in accounts payable and accrued expenses, as compared to a $19.5 million decrease for the same period in the prior year. The decrease in 2002 was primarily attributable to the payment of certain accruals made in connection with the $23.8 million of charges incurred during the second and third quarter of 2001, in connection with the flood and restructuring. The increase in cash provided by operations was also attributable to a $6.0 million deposit made in the first quarter of 2002, in connection with a long-term collection contract. This deposit was part of the $10.2 million we received in July 2003 in connection with the long-term collection contract. An increase in deferred tax liabilitiesalso contributed to the increase. A portion of the increases in cash provided by operations was offset by an overpayment of income taxes due to favorable tax adjustments during 2003 and an increase in restricted cash related to NCO Portfolio’s securitized debt.

***Cash Flows used in Investing Activities.***Cash used in investing activities was $1.5 million in 2004, compared to cash provided by investing activities of $10.0 million in 2003. Cash flows from

 

 

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investing    activities do not include Portfolio Management’s purchases of large    accounts receivable portfolios financed through an agreement we have with    a lender. It is a noncash transaction since the lender sends payment directly    to the seller of the accounts (see note 16 to our Notes to Consolidated Financial    Statements). The increase in cash used in investing activities was primarily    attributable to cash paid for acquisitions and acquisition related costs    incurred in connection with the acquisitions of RMH and the minority interest    of NCO Portfolio and higher purchases of property and equipment in 2004.    These increases were offset in part by higher collections applied to purchased    accounts receivable and lower purchases of accounts receivable, not financed    through the previously mentioned agreement.

Cash    provided by investing activities was $10.0 million in 2003, compared to cash    used in investing activities of $39.5 million in 2002. Cash flows from investing    activities do not include Portfolio Management’s purchases of large    accounts receivable portfolios financed through an agreement we have with    a lender. It is a noncash transaction since the lender sends payment directly    to the seller of the accounts (see note 16 to our Notes to Consolidated Financial    Statements). The decrease in cash used in investing activities was primarily    attributable to the $28.0 million of net cash paid during 2002 in connection    with the acquisition of Great Lakes in August 2002 and RevGro in December    2002. The decrease was also due to higher purchases of property and equipment    during 2002 and higher collections on the purchased accounts receivable.    The increase in collections was due to collections  from accounts receivables    purchased during 2003 and 2002, including the portfolio acquired from Great    Lakes.

***Cash        Flows used in Financing Activities.***Cash        used in financing activities was $119.5 million in 2004, compared to        $92.2 million in 2003. Cash flows from financing activities do not include        Portfolio Management’s borrowings under nonrecourse debt, used to        purchase large accounts receivable portfolios financed through an agreement        we have with a lender. It is a noncash transaction since the lender sends        payment directly to the seller of the accounts (see note 16 to our Notes        to Consolidated Financial Statements). The increase in cash used in financing        activities during 2004 resulted from the repayment of a note payable        and capitalized leases assumed in connection with the RMH acquisition,        higher repayments of borrowings under nonrecourse debt by Portfolio Management,        and higher repayments of borrowings under our senior credit facility.        These  repayments were partially offset by higher proceeds from the exercise        of stock options in 2004.

Cash    used in financing activities was $92.2 million in 2003, compared to $31.9    million in 2002. Cash flows from financing activities do not include Portfolio    Management’s borrowings under nonrecourse debt, used to purchase large    accounts receivable portfolios financed through an agreement we have with    a lender. It is a noncash transaction since the lender sends payment directly    to the seller of the accounts (see note 16 to our Notes to Consolidated Financial    Statements). The increase in cash used in financing activities during 2003    resulted from higher repayments of borrowings under our senior credit facility,    nonrecourse debt used to purchase large accounts receivable portfolios, and    securitized debt assumed as part of the Creditrust merger. The increase in    cash used in financing activities was also attributable to borrowings under    the revolving credit facility made during 2002 to  fund the acquisitions    of Great Lakes’ collection operations and RevGro.

***Senior Credit Facility.*** We have a $200 million senior credit facility with various participating lenders. The senior credit facility was originally structured as a $150 million term loan and a $50 million revolving credit facility. The maturity date is March 15, 2006, referred to as the Maturity Date. We are required to make quarterly repayments of $6.3 million on the term loan until the Maturity Date. In 2004, we repaid $45 million in excess of the requirements. The remaining 

 

 

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balance outstanding under the term loan and the balance under the revolving credit facility will become due on the Maturity Date. At December 31, 2004, the balance outstanding on the term loan was $62.5 million. The availability of the revolving credit facility is reduced by any unused letters of credit. As of December 31, 2004, we had unused letters of credit of $1.6 million and had remaining availability of $48.4 million under the revolving credit facility. 

The credit agreement contains certain financial and other covenants, such as maintaining net worth and funded debt to EBITDA requirements, and includes restrictions on, among other things, acquisitions, the incurrence of additional debt, the issuance of equity, and distributions to shareholders. If an event of default, such as failure to comply with covenants, material adverse change, or change of control, were to occur under the credit agreement, the lenders would be entitled to declare all amounts outstanding under it immediately due and payable. As of December 31, 2004, we were in compliance with all required financial covenants and we were not aware of any events of default.

***Convertible Notes.***At December 31, 2004, we had $125.0 million aggregate principal amount of 4.75 percent convertible subordinated notes due April 15, 2006, referred to as the Notes. The Notes are convertible into our common stock at a conversion price of $32.92 per share. We believe that we will have sufficient liquidity to repay the Notes upon maturity in April 2006. 

***Nonrecourse Credit Facility.***Portfolio Management has a four-year financing agreement with a lender that expires August 2006  to provide financing for larger purchases of accounts receivable at 90 percent of the purchase price, unless otherwise negotiated. The lender, at their sole discretion, has the right to finance any purchase of $4.0 million or more. The lender may or may not choose to finance a transaction. This agreement gives Portfolio Management the financing to purchase larger portfolios that they may not otherwise be able to purchase, and has no minimum or maximum credit authorization. Borrowings carry interest at the prime rate plus 3.25 percent (prime rate was 5.25 percent at December 31, 2004) and are nonrecourse to us, except for the assets financed through the lender. Debt service payments equal total collections less servicing fees andexpenses until each individual borrowing is fully repaid and Portfolio Management’s original investment is returned, including interest. Thereafter, the lender is paid a residual of 40 percent of collections, less servicing costs, unless otherwise negotiated. Individual loans are required to be repaid based on collections, but not more than two years from the date of borrowing. This loan agreement contains a collections performance requirement, among other covenants, that, if not met, provides for cross-collateralization with any other portfolios financed through the agreement, in addition to other remedies. Total debt outstanding under this facility as of December 31, 2004, was $39.8 million, including a $5.6 million embedded derivative representing the accrued residual interest. As of December 31, 2004, Portfolio Management was in compliance with all of the financial covenants.

***Contractual Obligations.***The following summarizes our contractual obligations as of December 31, 2004 (amounts in thousands). For a detailed discussion of these contractual obligations, see notes 9, 10 and 18 in our Notes to Consolidated Financial Statements. The following contractual obligations do not include any contractual obligations of the equity investment described below.

 

 

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**Payments Due by Period**

 

 

 

 

 

 

**Total**

 

**Less than 1****Year**

 

**1 to 3****Years**

 

**3 to 5****Years**

 

**More than****5 Years**

 

 

 

 

 

 

 

 

Convertible notes (1)

 

$

125,000

 

$

—

 

$

125,000

 

$

—

 

$

—

 

Senior credit facility

 

 

62,500

 

 

25,000

 

 

37,500

 

 

—

 

 

—

 

Nonrecourse credit facility

 

 

39,786

 

 

20,842

 

 

16,358

 

 

2,586

 

 

—

 

Securitized debt

 

 

8,158

 

 

8,158

 

 

—

 

 

—

 

 

—

 

Other

 

 

15,579

 

 

10,684

 

 

4,476

 

 

152

 

 

267

 

Operating leases (2)

 

 

186,262

 

 

38,111

 

 

58,724

 

 

40,720

 

 

48,707

 

Purchase commitments

 

 

95,063

 

 

36,426

 

 

56,257

 

 

2,380

 

 

—

 

Long-term collection contract, net of prepayments

 

 

7,625

 

 

7,625

 

 

—

 

 

—

 

 

—

 

 

 

 

 

 

 

 

Total contractual obligations

 

$

539,973

 

$

146,846

 

$

298,315

 

$

45,838

 

$

48,974

 

 

 

 

 

 

 

 

 

(1)

Assumes that the convertible notes are not converted into common stock prior to the maturity date.

 

(2)

Does not include the leases from our former Fort Washington locations (see note 18 in our Notes to Consolidated Financial Statements).

**Equity Investment**

Portfolio Management has a 50 percent ownership interest in a joint venture, InoVision-MEDCLR-NCOP Ventures, LLC, referred to as the Joint Venture, with IMNV Holdings, LLC, referred to as IMNV. The Joint Venture was established in 2001 to purchase utility, medical and other various small balance accounts receivable and is accounted for using the equity method of accounting. Included in “other assets” on the balance sheets was Portfolio Management’s investment in the Joint Venture of $3.9 million and $4.0 million as of December 31, 2004 and 2003, respectively. Portfolio Management does not have an obligation to invest further in the Joint Venture. Included in the statements of income, in “interest and investment income,” was $1.6 million, $2.2 million and $762,000 for the years ended December 31, 2004, 2003 and 2002, respectively, representing PortfolioManagement’s 50 percent share of operating income from this unconsolidated subsidiary. 

**Market Risk**

We are exposed to various types of market risk in the normal course of business, including the impact of interest rate changes, foreign currency exchange rate fluctuations, and changes in corporate tax rates. We employ risk management strategies that may include the use of derivatives, such as interest rate swap agreements, interest rate ceilings and floors, and foreign currency forwards and options to manage these exposures. 

***Foreign Currency Risk.***Foreign currency exposures arise from transactions denominated in a currency other than the functional currency and from foreign denominated revenue and profit translated into U.S. dollars. The primary currencies to which we are exposed include the Canadian dollar, the British pound and the Philippine peso. Due to the growth of the Canadian operations, we currently use forward exchange contracts to limit potential losses in earnings or cash flows from adverse foreign currency exchange rate movements. These contracts are entered into to protect against the risk that the eventual cash flows resulting from such contracts will be adversely affected by changes in exchange rates. Our objective is to maintain economically balanced currency risk management strategies that provide adequate downside protection. In the third quarter of 2004and continuing into the fourth quarter, the U.S. dollar continued to weaken compared to the Canadian dollar. A five percent change in the Canadian exchange rate could have an annual impact of approximately $4.0 million on our business, excluding the impact of foreign currency hedges.

 

 

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***Interest Rate Risk.***At December 31, 2004, we had $110.4 million in outstanding variable rate borrowings. A material change in interest rates could adversely affect our operating results and cash flows. A 25 basis-point increase in interest rates could increase our annual interest expense by $125,000 for each $50 million of variable debt outstanding for the entire year. 

**Impact of Recently Issued and Proposed Accounting Pronouncements**

***FASB Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment.”***  In December 2004, the FASB issued Statement of Financial Accounting Standards No. 123 (revised 2004), “Share-Based Payment,” referred to as SFAS 123R, which is a revision of Statement of Financial Accounting Standards No. 123, “Accounting for Stock-Based Compensation,” and supercedes APB Opinion No. 25, “Accounting for Stock Issued to Employees,” referred to as APB 25. SFAS 123R requires that the cost of all share-based payments to employees, including stock option grants, be recognized in the financial statements based on their fair values, as currently permitted but not required under SFAS 123. The standard will apply to newly granted awards and previously granted awards that are not fully vested on the date ofadoption. SFAS 123R is effective for public companies at the beginning of the first interim or annual period beginning after June 15, 2005. Accordingly, we will adopt the standard on July 1, 2005. 

Under SFAS 123R, we must determine the appropriate fair value model to be used for valuing share-based payments, the amortization method for compensation cost and the transition method to be used when the standard is adopted. Transition methods allowed under the standard are retrospective adoption, in which prior periods my be restated either as of the beginning of the year of adoption or for all periods presented, or prospective adoption, which requires that compensation expense be recorded for all unvested stock options at the beginning of the first quarter of adoption of SFAS 123R. We are currently evaluating the requirements of SFAS 123R and have not yet determined the method of adoption. 

We currently account for stock option grants to employees under APB 25 using the intrinsic value method, as permitted by SFAS 123. Under APB 25, because the exercise price of the stock options equals the fair value of the underlying common stock on the date of grant, no compensation cost is recognized. Since SFAS 123R requires the recognition of compensation expense, we expect that the adoption of SFAS 123R could have a material adverse effect on our results of operations. 

***FASB Staff Position No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004.”***  In December 2004 the FASB issued FSP No. FAS 109-2, “Accounting and Disclosure Guidance for the Foreign Earnings Repatriation Provision within the American Jobs Creation Act of 2004,” referred to as FAS 109-2, in response to the American Jobs Creation Act of 2004, referred to as the Act, which was signed into law by the President in October 2004. The Act allows U.S. companies a one-time tax deduction of 85 percent of certain foreign earnings that are repatriated to the United States. FAS 109-2 provides accounting and disclosure guidance for this repatriation provision, and provides additional time, beyond the financial reporting period of enactment, for companies toevaluate the effect of the Act for purposes of applying Statement of Financial Accounting Standards No. 109, “Accounting for Income Taxes.” We will not repatriate any foreign earnings under this provision and will continue to reinvest the earnings of our foreign subsidiaries indefinitely. Accordingly, we have not provided for U.S. deferred income taxes on the undistributed earnings of our foreign subsidiaries.

 

 

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***SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer.***In    October 2003, the American Institute of Certified Public Accountants issued    Statement of Position 03-03, “Accounting for Loans or Certain Securities    Acquired in a Transfer,” referred to as SOP 03-3. SOP 03-3 addresses    accounting for differences between contractual balances of an investor’s    initial investment, or the face value, of certain acquired loans and the    expected cash flows from those loans when such differences are attributable,    in part, to credit quality. SOP 03-3 applies to our purchased accounts receivable    portfolios and effective for portfolios acquired in fiscal years beginning    after December 15, 2004, and amends Practice Bulletin No. 6 for portfolios   acquired in fiscal years before the effective date.

Under    SOP 03-3, if the collection estimates established when acquiring a portfolio    are subsequently lowered, an allowance for impairment and a corresponding    expense is established in the current period for the amount required to maintain    the original internal rate of return, or “IRR,” expectations.    Prior guidance required lowering the IRR for the remaining life of the portfolio.    If collection estimates are raised, increases are first used to recover any    previously recorded allowances and the remainder is recognized prospectively    through an increase in the IRR. This updated IRR must be used for subsequent   impairment testing.

We    adopted SOP 03-3 on January 1, 2005, however previously issued annual financial    statements will not be restated and there is no prior period effect of these    new provisions. Portfolios acquired prior to December 31, 2004 will continue    to be governed by PB6, as amended by SOP 03-3, which will set the IRR at    December 31, 2004 as the IRR to be used for impairment testing in the future.    Because any reductions in expectations are recognized as an expense in the    current period and any increases in expectations are recognized over the    remaining life of the portfolio, SOP 03-3 increases the probability that   we will incur impairments in the future, and these impairments could be material.

 

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***FASB Interpretation No. 46, “Consolidation of Variable Interest Entities”****.*********In January 2003, the FASB issued Interpretation No. 46, “Consolidation of Variable Interest Entities,” referred to as FIN 46. The objective of FIN 46 is to improve financial reporting by companies involved with variable interest entities. FIN 46 defines variable interest entities and requires that variable interest entities be consolidated by a company if that company is subject to a majority of the risk of loss from the variable interest entity’s activities, or is entitled to receive a majority of the entity’s residual returns, or both.Effective March 31,  2004, we adopted FIN 46. We have $15.6 million of notes receivable included in our balance sheet under current and long-term other assets as of December 31, 2004, from two separate companies that we previously owned. Under FIN 46, the companies that issued these notes receivable are considered variable interest entities. Based on our evaluation of these variable interest entities, we are not the primary beneficiary of either of these companies; therefore, we are not required to consolidate theses entities under FIN 46. 

**Item          7A.**

**Quantitative****and Qualitative Disclosures about Market Risk.**

Included in Item 7, Management’s Discussion and Analysis of Financial Condition and Results of Operations, of this Report on Form 10-K.

**Item          8.**

**Financial****Statements and Supplementary Data.**

The financial statements, financial statement schedules and related documents that are filed with this Report are listed in Item 15(a) of this Report on Form 10-K and begin on page F-1.

**Item          9.**

**Changes          in and Disagreements with Accountants on Accounting and Financial Disclosure.**

None.

**Item          9A.**

**Controls          and Procedures.**

Our management, with the participation of our chief executive officer and chief financial officer, conducted an evaluation of the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e), as of December 31, 2004. Based on that evaluation, our chief executive officer and chief financial officer concluded that, as of the end of the period covered by the Report, our disclosure controls and procedures were effective in reaching a reasonable level of assurance that management is timely alerted to material information relating to us during the period when our periodic reports are being prepared.

Our management, with the participation of our chief executive officer and chief financial officer, also conducted an evaluation of our internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f), to determine whether any changes occurred during the quarter ended December 31, 2004, that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting. Based on that evaluation, there were no such changes during the quarter ended December 31, 2004.

In January 2005, we were notified by the Staff of the Securities and Exchange Commission that their interpretation of Staff Accounting Bulletin No. 104, referred to as SAB 104, was inconsistent

 

 

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with    our long-standing policy with respect to the timing of revenue recognized    on certain cash receipts related to contingency revenues. We previously recognized    contingency fee revenue attributable to payments postmarked prior to the    end of the reporting period and received in the mail from consumers on the    first business day after such period as applicable to the prior reporting    period. This revenue recognition policy had been in effect since prior to    NCO becoming a public company and was consistently applied over time. We    corrected our policy in order to recognize revenue when physically received.    This change to our revenue recognition policy could necessitate changes to    our   internal control over financial reporting.

A control system, no matter how well conceived and operated, can provide only reasonable, not absolute, assurance that the objectives of the control system are met. Further, the design of a control system must reflect the fact that there are resource constraints, and the benefits of controls must be considered relative to their costs. Because of the inherent limitations in all controls systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within our company have been detected. Because of the inherent limitations in a cost-effective control system, misstatements due to error or fraud may occur and not be detected.

Management’s Report on Internal Control over Financial Reporting is included in Item 8, Financial Statements and Supplementary Data, of the Report on Form 10-K.

**Item          9b.**

**Other          Information.**

None.

 

 

-53-

 

**PART III**

**Item          10.**

**Directors          and Executive Officers of the Registrant.**

Incorporated by reference from the Company’s Proxy Statement relating to the 2005 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K, except information concerning certain executive officers of the Company that is set forth in Item 4.1 of this Annual Report on Form 10-K and the information set forth below.

*Code of Ethics:*

The Company has adopted a Code of Ethics and Conduct that applies to all of its directors and employees including, the Company’s principal executive officer, principal financial officer, principal accounting officer and all employees performing similar functions. The Company’s Code of Ethics and Conduct is available from the Company. Requests for a copy of the Code of Ethics and Conduct should be directed to: Josh Gindin, Esq., Corporate Secretary, NCO Group, Inc., 507 Prudential Road Horsham, Pennsylvania 19044. The Company intends to satisfy the disclosure requirement under Item 5.05 of Form 8-K regarding an amendment to a provision of its Code of Ethics and Conduct by posting such information on the Company’s website www.ncogroup.com.

**Item          11.**

**Executive          Compensation.**

Incorporated by reference from the Company’s Proxy Statement relating to the 2005 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K.

**Item          12.**

**Security          Ownership of Certain Beneficial Owners and Management and Related Shareholder          Matters.**

The following table details information regarding the Company’s existing equity compensation plans as of December 31, 2004:

 

 

 

(a)

 

(b)

 

(c)

Plan Category(1)

 

Number of securities to be issued upon exercise of outstanding options, warrants and rights

 

Weighted-average exercise price of outstanding options, warrants and rights

 

Number of securities remaining available for future issuance under equity compensation plans (excluding securities reflected in column (a))

 

 

 

Equity compensation plans approved by security holders

 

3,975,071 

 

$23.33 

 

1,629,116 

Equity compensation plans not approved by security holders

 

— 

 

— 

 

 

— 

 

 

 

 

Total

 

3,957,071 

 

$23.33 

 

1,629,116 

 

 

 

 

 

(1)

The                table does not include information on stock options assumed by                the Company through acquisitions. At December 31, 2004, 5,516                shares of Common Stock were issuable upon the exercise of options                assumed                in connection with the acquisition of JDR Holdings, Inc. The                weighted average exercise price of these options was $51.95.                At December 31, 2004, 103,480 shares of Common Stock were issuable                upon the exercise of options assumed in connection with the acquisition                of Compass International Services Corporation. The weighted average                exercise price of these options was $44.99. At December 31,2004,                110,156 shares of Common Stock were issuable upon the exercise                of options assumed in connection with the acquisition of NCO                Portfolio. The weighted average exercise price of these options          was $18.73. At                  December 31, 2004, 39,223 shares of Common Stock were issuable                  upon the exercise of options assumed in connection with                    the acquisition of RMH Teleservices, Inc. The weighted average      exercise price of these options was $27.56.

 

-54-

 

**Item          13.**

**Certain          Relationships and Related Transactions.**

Incorporated by reference from the Company’s Proxy Statement relating to the 2005 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K.

**Item          14.**

**Principal          Accountant Fees and Services.**

Incorporated by reference from the Company’s Proxy Statement relating to the 2005 Annual Meeting of Shareholders to be filed in accordance with General Instruction G(3) to Form 10-K.

 

 

-55-

 

**PART IV**

**Item          15.**

**Exhibits and Financial Statement Schedules.**

1.       List of Consolidated Financial Statements. The consolidated financial statements and the accompanying notes of NCO Group, Inc., have been included in this Report on Form 10-K beginning on page F-1:

Management’s Report on Internal Control over Financial Reporting

Reports of Independent Registered Public Accounting Firm

Consolidated Balance Sheets as of December 31, 2004 and 2003

Consolidated Statements of Income for each of the three years

in the period ended December 31, 2004

Consolidated Statements of Shareholders’ Equity for each of the 

three years in the period ended December 31, 2004

Consolidated Statements of Cash Flows for each of the three years

in the period ended December 31, 2004

Notes to Consolidated Financial Statements

2.        All financial statement schedules are omitted because the required information is not present or not present in amounts sufficient to require submission of the schedule or because the information required is included in the respective financial statements or notes thereto contained herein.

3.        List    of Exhibits filed in accordance with Item 601 of Regulation S-K. The    warranties, representations and covenants contained in the agreements, documents    and other instruments included or incorporated by reference herein or which    appear as exhibits hereto should not be relied upon by buyers, sellers or    holders of the company's securities and are not intended as warranties, representations    or covenants to any individual or entity except as specifically set forth    in such agreements, documents and other instruments.The    following exhibits are incorporated by reference in, or filed with, this    Report on Form 10-K. Management contracts and compensatory plans, contracts   and arrangements are indicated by “*”:

 

**Exhibit No.******

 

**Description******

 

 

 

 

2.111

 

Asset Acquisition Agreement dated August 19, 2002, among Great Lakes Collection Bureau, Inc., General Electric Capital Corporation, NCO Group, Inc. and Great lakes Acquisition Corporation. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request.

 

 

 

2.214

 

Agreement and Plan of Merger by and among NCO Group, Inc., NCOG Acquisition Corporation, and RMH Teleservices, Inc., dated as of November 18, 2003. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request.

 

 

 

2.316

 

First Amendment to the Agreement and Plan of Merger by and among NCO Group, Inc., NCOG Acquisition Corporation, and RMH Teleservices, Inc., dated as of January 22, 2004. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request.

 

 

 

2.417

 

Second Amendment to the Agreement and Plan of Merger by and among NCO Group, Inc., NCOG Acquisition Corporation, and RMH Teleservices, Inc., dated as of March 3, 2004. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request.

 

-56-

 

**Exhibit No.**

 

**Description**

 

 

 

 

2.515

 

Agreement and Plan of Merger by and among NCO Group, Inc., NCPM Acquisition Corporation, and NCO Portfolio Management, Inc., dated as of December 12, 2003. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request.

 

 

 

3.11

 

The Company’s Amended and Restated Articles of Incorporation.

 

 

 

3.22

 

Amendment to Amended and Restated Articles of Incorporation.

 

 

 

3.39

 

Amendment to Amended and Restated Articles of Incorporation.

 

 

 

3.419

 

The Company’s Amended and Restated Bylaws.

 

 

 

4.11

 

Specimen of Common Stock Certificate.

 

 

 

4.24

 

Form of warrant to purchase NCO Group, Inc. common stock.

 

 

 

4.313

 

Form            of warrant dated October 3, 2003 and executed by RMH Teleservices,            Inc.
   
4.48

 

Purchase Agreement dated as of March 29, 2001, between NCO Group, Inc. and Deutsche Bank Alex. Brown Inc.

 

 

 

4.58

 

Indenture dated as of April 4, 2001, between NCO Group, Inc. and Bankers Trust Company, as Trustee

 

 

 

4.68

 

Registration Rights Agreement dated as of April 4, 2001, between NCO Group, Inc. and Deutsche Bank Alex. Brown Inc.

 

 

 

4.78

 

Global Note dated April 4, 2001 of NCO Group, Inc.

 

 

 

*10.11

 

Employment Agreement, dated September 1, 1996, between the Company and Michael J. Barrist.

 

 

 

*10.25

 

Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996, between the Company and Michael J. Barrist.

 

 

 

*10.31

 

Employment Agreement, dated September 1, 1996, between the Company and Steven L. Winokur.

 

 

 

*10.45

 

Addendum, dated January 1, 1999, to the Employment Agreement, dated September 1, 1996, between the Company and Steven L. Winokur.

 

 

 

*10.57

 

Employment Agreement, dated June 5, 1998, between the Company and Joshua Gindin.

 

 

 

*10.67

 

Addendum, dated January 1, 1999, to the Employment Agreement, dated June 5, 1998, between the Company and Joshua Gindin.

 

 

 

*10.76

 

Employment Agreement, dated May 2, 1998, between the Company and Paul E. Weitzel, Jr.

 

 

 

*10.86

 

Addendum, dated January 1, 1999, to the Employment Agreement, dated May 2, 1998, between the Company and Paul E. Weitzel, Jr.

 

 

 

*10.91

 

Amended and Restated 1995 Stock Option Plan.

 

 

 

*10.103

 

1996 Stock Option Plan, as amended.

 

 

 

*10.113

 

1996 Non-Employee Director Stock Option Plan, as amended.

 

 

 

*10.1219

 

2004 Equity Incentive Plan.

 

-57-

 

**Exhibit No.**

 

**Description**

 

 

 

 

10.131

 

Distribution and Tax Indemnification Agreement

 

 

 

10.141

 

Irrevocable Proxy Agreement by and between Michael J. Barrist and Annette H. Barrist.

 

 

 

10.1512

 

Sixth Amended and Restated Credit Agreement dated as of August 13, 2003, by and among NCO Group, Inc., as Borrower, Citizens Bank of Pennsylvania, as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Co-Arrangers, Co-Documentation Agents, Co-Agents, and other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request.

 

 

 

*10.162

 

Executive Salary Continuation Agreement.

 

 

 

10.1718

 

First Amendment, dated November 20, 2003, to the Sixth Amended and Restated Credit Agreement dated as of August 13, 2003, by and among NCO Group, Inc., as Borrower, Citizens Bank of Pennsylvania, as Administrative Agent and a Lender, and the Financial Institutions identified therein as Lenders and such other Co-Arrangers, Co-Documentation Agents, Co-Agents, and other Agents as may be appointed from time to time. NCO will furnish to the Securities and Exchange Commission a copy of any omitted schedules upon request.

 

 

 

10.187

 

Note Receivable, dated October 27, 2000, from Creative Marketing Strategies, Inc. for the original principal amount of $6.0 million, as payment of the purchase price for the acquisition of certain assets of NCO Teleservices, Inc.

 

 

 

10.197

 

Note Receivable, dated October 26, 2000, from TRC Holdings, Inc. for the principal amount of $12.25 million, as payment of the purchase price for the acquisition of certain assets of NCO Teleservices, Inc.

 

 

 

*10.2010

 

Employment Agreement, dated January 31, 2002, between the Company and Stephen W. Elliott.

 

 

 

*10.2110

 

Employment Agreement, dated November 21, 2001, between the Company and Steven Leckerman.

 

 

 

*10.2218

 

Employment Agreement, dated July 7, 2003, between the Company and Charles F. Burns.

 

 

 

10.2318

 

Amended and Restated Note Receivable, dated June 1, 2003, from Creative Marketing Strategies, Inc. for the original principal amount of $6.0 million, as payment of the purchase price for the acquisition of certain assets of NCO Teleservices, Inc.

 

 

 

10.2418

 

Amended and Restated Note Receivable, dated April 1, 2002, from TRC Holdings, Inc. for the principal amount of $11.25 million, as payment of the purchase price for the acquisition of certain assets of NCO Teleservices, Inc.

 

 

 

*10.2518

 

Second Addendum, dated July 1, 2003, to the Employment Agreement, dated September 1, 1996, as amended, between the Company and Michael J. Barrist.

 

 

 

*10.2618

 

Second Addendum, dated July 1, 2003, to the Employment Agreement, dated September 1, 1996, as amended, between the Company and Steven L. Winokur.

 

-58-

 

**Exhibit No.**

 

**Description**

 

 

 

 

*10.2718

 

Second Addendum, dated July 1, 2003, to the Employment Agreement, dated June 5, 1998, as amended, between the Company and Joshua Gindin.

 

 

 

*10.2818

 

Second Addendum, dated July 1, 2003, to the Employment Agreement, dated May 2, 1998, as amended, between the Company and Paul E. Weitzel, Jr.

 

 

 

*10.2918

 

Employment Agreement, dated December 8, 2000, between the Company and Albert Zezulinski.

 

 

 

*10.3021

 

Addendum, dated January 1, 2005, to the Employment Agreement, dated December 8, 2000, between the Company and Albert Zezulinski.

 

 

 

*10.3120

 

Form of Restricted Stock Unit awarded to Directors under the 2004 Equity Incentive Plan.

 

 

 

*10.3221

 

Executive Deferred Compensation Plan Basic Document.

 

 

 

*10.3321

 

Executive Deferred Compensation Plan Adoption Agreement.

 

 

 

*10.3421

 

Rabbi Trust Agreement with Putnam Fiduciary Trust Company.

 

 

 

*10.3521

 

Form of Restricted Stock Unit Agreement for Executive Officers.

 

 

 

*10.3621

 

Deferred Compensation Plan (applicable only to the Restricted Stock Unit Agreements).

 

 

 

*10.37

 

Summary of Director Compensation Arrangements

 

 

 

21.1

 

Subsidiaries of the Registrant.

 

 

 

23.1

 

Consent            of Independent Registered Public Accounting Firm

 

 

 

31.1

 

Rule 13a-14(a) Certification of Chief Executive Officer

 

 

 

31.2

 

Rule 13a-14(a) Certification of Chief Financial Officer

 

 

 

32.1

 

Section 1350 Certification
**______________**
1Incorporated by reference to the Company’s Registration Statement on Form S-1 (Registration No. 333-11745), as amended, filed with the Securities and Exchange Commission on September 11, 1996.

2Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 1998 (File No. 0-21639), filed with the Securities and Exchange Commission on May 4, 1998.

3Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 1998 (File No. 0-21639), filed with the Securities and Exchange Commission on August 14, 1998.

4Incorporated by reference to the Company’s Current Report on Form 8-K/A (File No. 0-21639), filed with the Securities and Exchange Commission on August 4, 1999.

 

 

-59-

 

5Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1998 (File No. 0-21639), as amended, filed with the Securities and Exchange Commission on March 31, 1999.

6Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 1999 (File No. 0-21639), as amended, filed with the Securities and Exchange Commission on March 27, 2000.

7Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2000 (File No. 0-21639), as amended, filed with the Securities and Exchange Commission on March 16, 2001.

8Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2001 (File No. 0-21639), filed with the Securities and Exchange Commission on May 15, 2001.

9Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended June 30, 2001 (File No. 0-21639), filed with the Securities and Exchange Commission on August 14, 2001.

10Incorporated by reference to the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2001 (File No. 0-21639), filed with the Securities and Exchange Commission on March 19, 2002.

11Incorporated by reference to the Company’s Current Report on Form 8-K (File No. 0-21639), filed with the Securities and Exchange Commission on September 3, 2002.

12Incorporated by reference to the Company’s Current Report on Form 8-K (File No. 0-21639), filed with the Securities and Exchange Commission on August 19, 2003.

13Incorporated    by reference to Exhibit 10.3 to RMH Teleservices, Inc.'s Form 8-K (File No.    00-2133), filed with the Securities and Exchange Commission on October 9,    2003.

14Incorporated    by reference to the Company’s Current Report on Form 8-K (File No. 0-21639),    filed with the Securities and Exchange Commission on November 20, 2003.

15Incorporated    by reference to the Company’s Current Report on Form 8-K (File No. 0-21639),    filed with the Securities and Exchange Commission on December 16, 2003.

16Incorporated    by reference to the Company’s Current Report on Form 8-K (File No. 0-21639),    filed with the Securities and Exchange Commission on January 23, 2004.

17Incorporated    by reference to the Company’s Current Report on Form 8-K (File No. 0-21639),    filed with the Securities and Exchange Commission on March 3, 2004.

18Incorporated    by reference to the Company’s Annual Report on Form 10-K for the fiscal    year ended December 31, 2003 (File No. 0-21639), filed with the Securities    and Exchange Commission on March 15, 2004.

19Incorporated    by reference to the Company’s Quarterly Report on Form 10-Q for the    quarter ended June 30, 2004 (File No. 0-21639), filed with the Securities    and Exchange Commission on August 9, 2004.

 

 

-60-

 

20 Incorporated by reference to the Company’s Quarterly Report on Form 10-Q for the quarter ended September 30, 2004 (File No. 0-21639), filed with the Securities and Exchange Commission on November 9, 2004.

21Incorporated    by reference to the Company’s Current Report on Form 8-K (File No. 0-21639),    filed with the Securities and Exchange Commission on January 6, 2005.

 

 

-61-

 

**SIGNATURES**

Pursuant to the requirements of Section 13 or 15(d) of the Securities and Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized.

 

 

 

NCO GROUP, INC.

Date:                March 16, 2005

 

By: 

/s/ Michael J. Barrist

 

 

 

 

 

Michael J. Barrist, Chairman of theBoard, President and ChiefExecutive Officer

 

Pursuant to the requirements of the Securities Exchange Act of 1934, this Report has been signed below by the following persons on behalf of the registrant and in the capacities and on the dates indicated.

 

**SIGNATURE**

 

**TITLE(S)**

 

**DATE**

 

 

 

 

 

/s/ Michael J. Barrist

 

Chairman of the Board, President and Chief Executive Officer (principal executive officer)

 

March            16, 2005

Michael J. Barrist

 

 

 

 

 

/s/ Steven L. Winokur

 

Executive Vice President, Chief Financial Officer, Chief Operating Officer - Shared Services, and Treasurer (principal financial officer)

 

March            16, 2005

Steven L. Winokur

 

 

 

 

 

/s/ John R. Schwab

 

Senior Vice President, Finance and Chief Accounting Officer (principal accounting officer)

 

March            16, 2005

John R. Schwab

 

 

 

 

 

/s/ William C. Dunkelberg

 

Director

 

March            16, 2005

William C. Dunkelberg

 

 

 

 

 

/s/ Charles C. Piola, Jr.

 

Director

 

March            16, 2005

Charles C. Piola, Jr.

 

 

 

 

 

/s/ Leo J. Pound

 

Director

 

March            16, 2005

Leo J. Pound

 

 

 

 

 

/s/ Eric S. Siegel

 

Director

 

March            16, 2005

Eric S. Siegel

 

 

 

 

 

/s/ Allen F. Wise

 

Director

 

March            16, 2005

Allen F. Wise

 

 

 

 

 

 

-62-

 

**INDEX TO CONSOLIDATED FINANCIAL STATEMENTS**

**AND FINANCIAL STATEMENT SCHEDULE**

 

Financial Statements:

 

 

 

Report            of Management on Internal Control over Financial Reporting

F-2

 

 

Report                    of Independent Registered Public Accounting Firm on Financial                    Statements

F-3

 

 

Report of Independent Registered Public Accounting Firm on Internal Control over Financial Reporting

F-4

 

 

Consolidated Balance Sheets as of December 31, 2004 and 2003

F-6

 

 

Consolidated Statements of Income for each of the three years in the period ended December 31, 2004

F-7

 

 

Consolidated Statements of Shareholders’ Equity for each of the three years in the period ended December 31, 2004

F-8

 

 

Consolidated Statements of Cash Flows for each of the three years in the period ended December 31, 2004                                                                                                                                       

F-9

 

 

Notes to Consolidated Financial Statements

F-10

 

F-1

 

**Report   of Management on Internal Control over Financial Reporting**

Management    of NCO Group, Inc. is responsible for establishing and maintaining adequate    internal control over financial reporting, as such term is defined in Exchange    Act Rule 13a-15(f). The Company’s internal control over financial reporting    has been designed under the supervision and with the participation of management    including the Company’s    chief executive officer and chief financial officer, to provide reasonable    assurance    regarding the reliability of financial reporting and the preparation of the    Company’s financial statements for external reporting purposes in accordance    with accounting principles generally accepted in the United States.

As    of December 31, 2004, our management, with the participation of our chief    executive officer and chief financial officer, conducted an assessment of    the effectiveness of the Company’s internal control over financial reporting,    using the framework established in *Internal Control – Integrated    Framework* issued by the Committee of Sponsoring Organizations of the    Treadway Commission (COSO). Based on this assessment, management has concluded    that, as of December 31, 2004, the Company’s    internal control over financial reporting was effective to provide reasonable    assurance regarding the reliability of financial reporting and the preparation    of financial statements for external purposes in accordance with generally   accepted accounting principles.

Ernst & Young   LLP, an independent registered public accounting firm that audited the Company’s   consolidated financial statements included in this Annual Report on Form 10-K,   has issued an attestation report on the Company’s   internal control over financial reporting which appears on page F-4.

On    January 1, 2005, we began using our enterprise resource planning system,    SAP, for general ledger, accounts payable, accounts receivable, and human    resources. The Company believes this is a material change to the Company’s    internal control over financial reporting. The    new system and related processes were not covered by Management’s    assessment of the effectiveness of the Company’s internal control over    financial reporting as of December 31, 2004.

Because    of the inherent limitations in all controls systems, no evaluation of controls    can provide absolute assurance that all control issues and instances of fraud,    if any, within our company have been or will be detected. Because of the    inherent limitations in a cost-effective control system, misstatements due    to error    or fraud may   occur and not be detected.

 

 

F-2

 

**Report of Independent Registered Public Accounting Firm**

To the Board of Directors and Shareholders of NCO Group, Inc. 

We have audited the accompanying consolidated balance sheets of NCO Group, Inc. as of December 31, 2004 and 2003, and the related consolidated statements of income, shareholders’ equity, and cash flows for each of the three years in the period ended December 31, 2004. These financial statements are the responsibility of NCO Group, Inc.’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits.

We conducted our audits in accordance with the Standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion.

In our opinion, the financial statements referred to above present fairly, in all material respects, the consolidated financial position of NCO Group, Inc. at December 31, 2004 and 2003, and the consolidated results of its operations and its cash flows for each of the three years in the period ended December 31, 2004, in conformity with U.S. generally accepted accounting principles. 

We have also audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the effectiveness of NCO Group, Inc.’s internal control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission and our report dated March 8, 2005 expressed an unqualified opinion thereon.

/s/    Ernst & Young LLP
Philadelphia, Pennsylvania

March 8, 2005

 

 

F-3

 

**Report        of Independent Registered Public Accounting Firm on Internal Control        over Financial Reporting**

The Board of Directors and Shareholders of NCO Group, Inc.

We    have audited management’s assessment, included in the accompanying Report    of Management on Internal Control over Financial Reporting, that NCO Group,    Inc. maintained effective internal control over financial reporting as of    December 31, 2004, based on criteria established in Internal Control—Integrated    Framework issued by the Committee of Sponsoring Organizations of the Treadway    Commission (the COSO criteria). NCO Group, Inc.’s management is responsible    for maintaining effective internal control over financial reporting and for    its    assessment of the effectiveness of internal control over financial reporting.   Our responsibility is to express an opinion on management’s assessment   and an opinion on the effectiveness of the company’s internal control   over financial reporting based on our audit. 

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and evaluating the design and operating effectiveness of internal control, and performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonableassurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, management’s assessment that NCO Group, Inc. maintained effective internal control over financial reporting as of December 31, 2004, is fairly stated, in all material respects, based on the COSO criteria. Also, in our opinion, NCO Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2004, based on the COSO criteria.

As    indicated in the Report of Management on Internal Control over Financial    Reporting, NCO Group, Inc. identified a material change related to the installation    of specific modules of a new enterprise resource planning system, relating    to general ledger, accounts payable, accounts receivable, and human resources,    on January 1, 2005, which    was   subsequent to the date of management’s assessment of the effectiveness   of internal control over financial reporting.

 

 

F-4

 

We    also have audited, in accordance with the standards of the Public Company    Accounting Oversight Board (United States), the consolidated balance sheets    as of December 31, 2004 and 2003, and the related consolidated    statements of income, shareholders’ equity, and cash flows for each of the    three years in the period ended December 31, 2004 of NCO Group, Inc. and   our report dated March 8, 2005 expressed an unqualified opinion thereon. 

/s/    Ernst & Young    LLP

Philadelphia, Pennsylvania

March 8, 2005

 

 

F-5

 

**NCO GROUP, INC.**

**Consolidated Balance Sheets**

**(Amounts in thousands)**

 

 

 

**December 31,**

 

 

 

 

 

 

**2004**

 

**2003**

 

 

 

 

 

**ASSETS**

 

 

 

 

 

 

 

Current assets:

 

 

 

 

 

 

 

Cash and cash equivalents

 

$

26,334

 

$

45,644

 

Restricted cash

 

 

900

 

 

5,850

 

Accounts receivable, trade, net of allowance for doubtful accounts of $7,878 and $7,447, respectively

 

 

104,699

 

 

80,640

 

Purchased accounts receivable, current portion

 

 

50,388

 

 

59,371

 

Deferred income taxes

 

 

18,911

 

 

12,280

 

Bonus receivable, current portion

 

 

10,325

 

 

7,646

 

Prepaid expenses and other current assets

 

 

34,282

 

 

18,021

 

 

 

 

 

Total current assets

 

 

245,839

 

 

229,452

 

Funds held on behalf of clients

 

 

 

 

 

 

 

Property and equipment, net

 

 

114,256

 

 

74,085

 

Other assets:

 

 

 

 

 

 

 

Goodwill

 

 

609,562

 

 

506,370

 

Other intangibles, net of accumulated amortization

 

 

25,054

 

 

12,375

 

Purchased accounts receivable, net of current portion

 

 

88,469

 

 

93,242

 

Bonus receivable, net of current portion

 

 

—

 

 

320

 

Deferred income taxes

 

 

—

 

 

—

 

Other assets

 

 

30,709

 

 

30,267

 

 

 

 

 

Total other assets

 

 

753,794

 

 

642,574

 

 

 

 

 

Total assets

 

$

1,113,889

 

$

946,111

 

 

 

 

 

**LIABILITIES AND SHAREHOLDERS’ EQUITY**

 

 

 

 

 

 

 

Current liabilities:

 

 

 

 

 

 

 

Long-term debt, current portion

 

$

64,684

 

$

66,523

 

Income taxes payable

 

 

11,946

 

 

—

 

Accounts payable

 

 

5,022

 

 

4,281

 

Accrued expenses

 

 

53,472

 

 

25,901

 

Accrued compensation and related expenses

 

 

21,424

 

 

15,601

 

Deferred revenue, current portion

 

 

18,821

 

 

10,737

 

 

 

 

 

Total current liabilities

 

 

175,369

 

 

123,043

 

Funds held on behalf of clients

 

 

 

 

 

 

 

Long-term liabilities:

 

 

 

 

 

 

 

Long-term debt, net of current portion

 

 

186,339

 

 

248,964

 

Deferred revenue, net of current portion

 

 

955

 

 

13,819

 

Deferred income taxes

 

 

36,174

 

 

38,676

 

Other long-term liabilities

 

 

19,451

 

 

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, 32,078 and 25,988 shares issued and outstanding, respectively

 

 

473,410

 

 

323,511

 

Other comprehensive income

 

 

13,526

 

 

6,646

 

Deferred compensation

 

 

(3,458

)

 

—

 

Retained earnings

 

 

212,123

 

 

160,260

 

 

 

 

 

Total shareholders’ equity

 

 

695,601

 

 

490,417

 

 

 

 

 

Total liabilities and shareholders’ equity

 

$

1,113,889

 

$

946,111

 

 

 

 

 

See accompanying notes.

 

F-6

 

**NCO GROUP, INC.**

**Consolidated Statements of Income**

**(Amounts in thousands, except per share data)**

 

 

 

**For the Years Ended December 31,**

 

 

 

 

 

 

**2004**

 

**2003**

 

**2002**

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Revenue

 

$

939,797

 

$

753,816

 

$

703,450

 

Operating costs and expenses:

 

 

 

 

 

 

 

 

 

 

Payroll and related expenses

 

 

472,915

 

 

350,369

 

 

335,405

 

Selling, general and administrative expenses

 

 

324,187

 

 

282,268

 

 

249,672

 

Depreciation and amortization expense

 

 

40,225

 

 

31,628

 

 

27,324

 

 

 

 

 

 

Total operating costs and expenses

 

 

837,327

 

 

664,265

 

 

612,401

 

 

 

 

 

 

Income from operations

 

 

102,470

 

 

89,551

 

 

91,049

 

Other income (expense):

 

 

 

 

 

 

 

 

 

 

Interest and investment income

 

 

3,185

 

 

3,927

 

 

3,222

 

Interest expense

 

 

(21,244

)

 

(22,998

)

 

(20,976

)

Other income (expense)

 

 

447

 

 

1,128

 

 

(216

)

 

 

 

 

 

Total other income (expense)

 

 

(17,612

)

 

(17,943

)

 

(17,970

)

 

 

 

 

 

Income before income tax expense

 

 

84,858

 

 

71,608

 

 

73,079

 

Income tax expense

 

 

32,389

 

 

26,732

 

 

27,702

 

 

 

 

 

 

Income before minority interest

 

 

52,469

 

 

44,876

 

 

45,377

 

Minority interest

 

 

(606

)

 

(2,430

)

 

(3,218

)

 

 

 

 

 

Net income

 

$

51,863

 

$

42,446

 

$

42,159

 

 

 

 

 

 

Net income per share:

 

 

 

 

 

 

 

 

 

 

Basic

 

$

1.71

 

$

1.64

 

$

1.63

 

Diluted

 

$

1.60

 

$

1.54

 

$

1.54

 

Weighted average shares outstanding:

 

 

 

 

 

 

 

 

 

 

Basic

 

 

30,397

 

 

25,934

 

 

25,890

 

Diluted

 

 

34,652

 

 

29,895

 

 

29,829

 

 

See accompanying notes.

 

F-7

 

**NCO GROUP, INC.**

**Consolidated Statements of Shareholders’ Equity**

**(Amounts in thousands)**

 

 

 

 

 

**Other****Comprehensive****Income (Loss)**

 

 

 

 

 

 

 

 

 

 

 

**Common          Stock**
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Number of****Shares**

 

**Amount**

 

 

**Deferred****Compensation**

 

**Retained****Earnings**

 

**Comprehensive****Income (Loss)**

 

**Total**

 

 

 

 

 

 

 

 

 

 

**Balance, January 1, 2002**

 

25,816

 

$

320,993

 

$

 (4,346

)

$

—

 

$

75,655

 

 

 

 

$

392,302

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock 

 

92

 

 

831

 

 

—

 

 

—

 

 

—

 

 

 

 

 

831

 

Comprehensive income, net of tax: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income 

 

—

 

 

—

 

 

—

 

 

—

 

 

42,159

 

$

42,159

 

 

42,159

 

Other comprehensive income (loss): 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment 

 

—

 

 

—

 

 

930

 

 

—

 

 

—

 

 

930

 

 

930

 

Unrealized loss on interest rate swap 

 

—

 

 

—

 

 

(460

)

 

—

 

 

—

 

 

(460

)

 

(460

)

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

42,629

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Balance, December 31, 2002**

 

25,908

 

 

321,824

 

 

(3,876

)

 

—

 

 

117,814

 

 

 

 

 

435,762

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock 

 

80

 

 

1,687

 

 

—

 

 

—

 

 

—

 

 

 

 

 

1,687

 

Comprehensive income, net of tax: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income 

 

—

 

 

—

 

 

—

 

 

—

 

 

42,446

 

$

42,446

 

 

42,446

 

Other comprehensive income (loss): 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment 

 

—

 

 

—

 

 

10,062

 

 

—

 

 

—

 

 

10,062

 

 

10,062

 

Unrealized gain on interest rate swap 

 

—

 

 

—

 

 

460

 

 

—

 

 

—

 

 

460

 

 

460

 

 

 

 

 

 

 

 

 

 

Total comprehensive income 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

52,968

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

**Balance, December 31, 2003**

 

25,988

 

 

323,511

 

 

6,646

 

 

—

 

 

160,260

 

 

 

 

 

490,417

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Issuance of common stock in connection with acquisitions 

 

5,184

 

 

128,699

 

 

—

 

 

—

 

 

—

 

 

 

 

 

128,699

 

Issuance of common stock in connection with stock option plans 

 

890

 

 

16,763

 

 

—

 

 

—

 

 

—

 

 

 

 

 

16,763

 

Exercise of common stock warrants 

 

16

 

 

296

 

 

—

 

 

—

 

 

—

 

 

 

 

 

296

 

Issuance of restricted stock 

 

—

 

 

4,141

 

 

—

 

 

(4,141

)

 

—

 

 

 

 

 

—

 

Amortization of deferred compensation 

 

—

 

 

—

 

 

—

 

 

683

 

 

—

 

 

 

 

 

683

 

Comprehensive income, net of tax: 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Net income 

 

—

 

 

—

 

 

—

 

 

—

 

 

51,863

 

$

51,863

 

 

51,863

 

Other comprehensive income (loss): 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Foreign currency translation adjustment 

 

—

 

 

—

 

 

6,593

 

 

—

 

 

—

 

 

6,593

 

 

6,593

 

Change in fair value of foreign currency cash flow hedge, net of taxes of $158 

 

—

 

 

—

 

 

287

 

 

—

 

 

—

 

 

287

 

 

287

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Total comprehensive income

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

$

58,743

 

 

 

 

 

 

 

 

 

 

 

 

 
  32,078 $473,410 $13,526 $(3,458)$212,123    $695,601            
 

See accompanying notes.

 

F-8

 

**NCO GROUP, INC**

**Consolidated Statements of Cash Flows**

**(Amounts in thousands)**

 

 

 

**For the Years Ended December 31,** 

 

 

 

 

 

 

**2004** 

 

**2003** 

 

**2002**

 

 

 

 

 

 

Cash flows from operating activities:

 

 

 

 

 

 

 

 

 

 

Net income

 

$

51,863 

 

$

42,446 

 

$

42,159 

 

Adjustments to reconcile income from operations to net cash provided by operating activities:

 

 

 

 

 

 

 

 

 

 

Depreciation 

 

 

 32,800 

 

 

 27,035 

 

 

 24,162 

 

Amortization of intangibles

 

 

 7,425 

 

 

 4,593 

 

 

 3,162 

 

Amortization of deferred compensation

 

 

683 

 

 

 — 

 

 

 — 

 

Amortization of deferred training asset

 

 

 1,918 

 

 

 — 

 

 

 — 

 

Provision for doubtful accounts

 

 

 2,321 

 

 

 4,816 

 

 

 8,293 

 

Impairment of purchased accounts receivable

 

 

948 

 

 

 1,751 

 

 

 1,999 

 

Accrued noncash interest

 

 

 6,182 

 

 

 4,922 

 

 

 2,032 

 

Loss (gain) on disposal of property, equipment and other net assets

 

 

157

 

 

386

 

 

(847

)

Changes in non-operating income

 

 

(1,591

)

 

(2,642

)

 

 (512

)

Minority interest

 

 

606 

 

 

 2,421 

 

 

 3,218 

 

Changes in operating assets and liabilities, net of acquisitions:

 

 

 

 

 

 

 

 

 

 

Restricted cash

 

 

 4,950 

 

 

(4,950

)

 

225 

 

Accounts receivable, trade

 

 

(2,715

)

 

 1,707 

 

 

(2,368

)

Deferred income taxes

 

 

 28,675 

 

 

 18,816 

 

 

 12,572 

 

Bonus receivable

 

 

(2,359

)

 

 8,026 

 

 

(11,663

)

Other assets

 

 

(13,468

)

 

 1,655 

 

 

 4,122 

 

Accounts payable and accrued expenses

 

 

(17,845

)

 

(6,561

)

 

(19,517

)

Income taxes payable

 

 

545 

 

 

(4,008

)

 

 2,127 

 

Deferred revenue

 

 

(4,780

)

 

790 

 

 

(2,597

)

Other long-term liabilities

 

 

 2,704 

 

 

 (147

)

 

(2,562

)

 

 

 

 

 

Net cash provided by operating activities

 

 

 99,019 

 

 

 101,056 

 

 

 64,005 

 

Cash flows from investing activities:

 

 

 

 

 

 

 

 

 

 

Purchases of accounts receivable

 

 

(43,549

)

 

(48,106

)

 

(46,177

)

Collections applied to principal of purchased accounts receivable

 

 

86,761

 

 

77,386

 

 

58,351

 

Purchases of property and equipment

 

 

(27,188

)

 

(20,498

)

 

(27,331

)

Net distribution from joint venture

 

 

 2,083 

 

 

 1,540 

 

 

 — 

 

Proceeds from notes receivable

 

 

 1,403 

 

 

394 

 

 

 1,000 

 

Proceeds from disposal of property, equipment and other net assets

 

 

1,013

 

 

—

 

 

2,633

 

Net cash paid for acquisitions and acquisition related costs

 

 

(21,981

)

 

(720

)

 

(27,966

)

 

 

 

 

 

Net cash (used in) provided by investing activities

 

 

(1,458

)

 

 9,996

 

 

(39,490

)

Cash flows from financing activities:

 

 

 

 

 

 

 

 

 

 

Repayment of notes payable

 

 

(64,814

)

 

(30,947

)

 

(18,606

)

Borrowings under notes payable

 

 

 — 

 

 

750 

 

 

 — 

 

Repayment of borrowings under revolving credit agreement

 

 

(70,000

)

 

(61,680

)

 

(47,620

)

Borrowings under revolving credit agreement

 

 

 — 

 

 

 1,000 

 

 

 34,170 

 

Payment of fees to acquire debt

 

 

 (103

)

 

(2,899

)

 

 (552

)

Issuance of common stock, net of taxes

 

 

 15,375 

 

 

 1,531 

 

 

747 

 

 

 

 

 

 

Net cash used in financing activities

 

 

(119,542

)

 

(92,245

)

 

(31,861

)

Effect of exchange rate on cash

 

 

 2,671 

 

 

 1,678 

 

 

344 

 

 

 

 

 

 

Net (decrease) increase in cash and cash equivalents

 

 

(19,310

)

 

 20,485

 

 

(7,002

)

Cash and cash equivalents at beginning of the period

 

 

 45,644

 

 

 25,159

 

 

 32,161

 

 

 

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