-----BEGIN PRIVACY-ENHANCED MESSAGE----- Proc-Type: 2001,MIC-CLEAR Originator-Name: webmaster@www.sec.gov Originator-Key-Asymmetric: MFgwCgYEVQgBAQICAf8DSgAwRwJAW2sNKK9AVtBzYZmr6aGjlWyK3XmZv3dTINen TWSM7vrzLADbmYQaionwg5sDW3P6oaM5D3tdezXMm7z1T+B+twIDAQAB MIC-Info: RSA-MD5,RSA, BG46ETRoiX+JYFecuxDQcy/IB3RN2IXsHkyeoPFDGzW7xxEUkZtW5OrN1ktZi2nI UCtYTQu7fn/tMS6HWByMFg== 0000950116-04-002415.txt : 20040809 0000950116-04-002415.hdr.sgml : 20040809 20040809171926 ACCESSION NUMBER: 0000950116-04-002415 CONFORMED SUBMISSION TYPE: 10-Q PUBLIC DOCUMENT COUNT: 6 CONFORMED PERIOD OF REPORT: 20040630 FILED AS OF DATE: 20040809 FILER: COMPANY DATA: COMPANY CONFORMED NAME: NCO GROUP INC CENTRAL INDEX KEY: 0001022608 STANDARD INDUSTRIAL CLASSIFICATION: SERVICES-CONSUMER CREDIT REPORTING, COLLECTION AGENCIES [7320] IRS NUMBER: 232858652 STATE OF INCORPORATION: PA FISCAL YEAR END: 1231 FILING VALUES: FORM TYPE: 10-Q SEC ACT: 1934 Act SEC FILE NUMBER: 000-21639 FILM NUMBER: 04962302 BUSINESS ADDRESS: STREET 1: 507 PRUDENTIAL ROAD CITY: HORSHAM STATE: PA ZIP: 19044 BUSINESS PHONE: 215-441-3000 MAIL ADDRESS: STREET 1: 507 PRUDENTIAL ROAD CITY: HORSHAM STATE: PA ZIP: 19044 10-Q 1 ten-q.txt 10-Q UNITED STATES SECURITIES AND EXCHANGE COMMISSION WASHINGTON, D.C. 20549 FORM 10-Q (Mark one) /X/ Quarterly report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the quarterly period ended June 30, 2004, or / / Transition report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 For the transition period from to - -------------------------------------------------------------------------------- COMMISSION FILE NUMBER 0-21639 - -------------------------------------------------------------------------------- NCO GROUP, INC. - -------------------------------------------------------------------------------- (Exact name of registrant as specified in its charter) PENNSYLVANIA 23-2858652 - -------------------------------------------------------------------------------- (State or other jurisdiction of (IRS Employer Identification Number) incorporation or organization) 507 Prudential Road, Horsham, Pennsylvania 19044 - -------------------------------------------------------------------------------- (Address of principal executive offices) (Zip Code) 215-441-3000 - -------------------------------------------------------------------------------- (Registrant's telephone number, including area code) Not Applicable - -------------------------------------------------------------------------------- (Former name, former address and former fiscal year, if changed since last report) Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes X No ______ --- Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act). Yes X No ______ --- The number of shares outstanding of each of the issuer's classes of common stock as of August 6, 2004 was: 31,851,396 shares of common stock, no par value. NCO GROUP, INC. INDEX PAGE PART I - FINANCIAL INFORMATION Item 1 FINANCIAL STATEMENTS (Unaudited) Condensed Consolidated Balance Sheets - June 30, 2004 and December 31, 2003 1 Condensed Consolidated Statements of Income - Three and six months ended June 30, 2004 and 2003 2 Condensed Consolidated Statements of Cash Flows - Six months ended June 30, 2004 and 2003 3 Notes to Condensed Consolidated Financial Statements 4 Item 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS 22 Item 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK 29 Item 4 CONTROLS AND PROCEDURES 29 PART II - OTHER INFORMATION 30 Item 1. Legal Proceedings Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of equity securities Item 3. Defaults Upon Senior Securities Item 4. Submission of Matters to a Vote of Shareholders Item 5. Other Information Item 6. Exhibits and Reports on Form 8-K Signatures 33 PART 1 - FINANCIAL INFORMATION ITEM 1 - FINANCIAL STATEMENTS
NCO GROUP, INC. CONDENSED CONSOLIDATED BALANCE SHEETS (AMOUNTS IN THOUSANDS) JUNE 30, 2004 DECEMBER 31, ASSETS (UNAUDITED) 2003 ---------- -------- Current assets: Cash and cash equivalents $ 58,798 $ 45,644 Restricted cash 1,381 5,850 Accounts receivable, trade, net of allowance for doubtful accounts of $8,149 and $7,447, respectively 111,921 80,640 Purchased accounts receivable, current portion 44,608 59,371 Deferred income taxes 25,336 12,280 Bonus receivable, current portion 2,562 7,646 Prepaid expenses and other current assets 18,801 18,021 ---------- -------- Total current assets 263,407 229,452 Funds held on behalf of clients Property and equipment, net 109,829 74,085 Other assets: Goodwill 585,526 506,370 Other intangibles, net of accumulated amortization 33,983 12,375 Purchased accounts receivable, net of current portion 86,222 93,242 Bonus receivable, net of current portion - 320 Other assets 31,253 30,267 ---------- -------- Total other assets 736,984 642,574 ---------- -------- Total assets $1,110,220 $946,111 ========== ======== LIABILITIES AND SHAREHOLDERS' EQUITY Current liabilities: Long-term debt, current portion $ 72,235 $ 66,523 Accounts payable 11,469 4,281 Accrued expenses 45,379 25,901 Accrued compensation and related expenses 27,489 15,601 Deferred revenue, current portion 17,193 10,737 ---------- -------- Total current liabilities 173,765 123,043 Funds held on behalf of clients Long-term liabilities: Long-term debt, net of current portion 229,048 248,964 Deferred revenue, net of current portion 697 13,819 Deferred income taxes 32,025 38,676 Other long-term liabilities 18,610 4,344 Minority interest - 26,848 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, 31,830 and 25,988 shares issued and outstanding, respectively 464,653 323,511 Other comprehensive income 5,381 6,646 Deferred compensation (621) - Retained earnings 186,662 160,260 ---------- -------- Total shareholders' equity 656,075 490,417 ---------- -------- Total liabilities and shareholders' equity $1,110,220 $946,111 ========== ========
See accompanying notes. -1-
NCO GROUP, INC. CONDENSED CONSOLIDATED STATEMENTS OF INCOME (UNAUDITED) (AMOUNTS IN THOUSANDS, EXCEPT PER SHARE DATA) FOR THE THREE MONTHS FOR THE SIX MONTHS ENDED JUNE 30, ENDED JUNE 30, ------------------------ ------------------------ 2004 2003 2004 2003 -------- -------- -------- -------- Revenue $255,255 $188,574 $456,486 $377,591 Operating costs and expenses: Payroll and related expenses 132,823 88,330 223,862 176,628 Selling, general and administrative expenses 83,752 70,718 160,397 139,676 Depreciation and amortization expense 11,147 8,039 18,925 15,895 -------- -------- -------- -------- Total operating costs and expenses 227,722 167,087 403,184 332,199 -------- -------- -------- -------- Income from operations 27,533 21,487 53,302 45,392 Other income (expense): Interest and investment income 599 789 1,595 1,625 Interest expense (5,256) (5,862) (10,544) (11,681) Other income 621 726 621 726 -------- -------- -------- -------- Total other income (expense) (4,036) (4,347) (8,328) (9,330) -------- -------- -------- -------- Income before income tax expense 23,497 17,140 44,974 36,062 Income tax expense 9,078 6,504 17,966 13,683 -------- -------- -------- -------- Income before minority interest 14,419 10,636 27,008 22,379 Minority interest - (359) (606) (910) -------- -------- -------- -------- Net income $ 14,419 $ 10,277 $ 26,402 $ 21,469 ======== ======== ======== ======== Net income per share: Basic $ 0.46 $ 0.40 $ 0.92 $ 0.83 Diluted $ 0.43 $ 0.38 $ 0.86 $ 0.78 Weighted average shares outstanding: Basic 31,502 25,908 28,814 25,908 Diluted 35,723 29,768 32,979 29,743
See accompanying notes. -2-
NCO GROUP, INC CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS (UNAUDITED) (AMOUNTS IN THOUSANDS) FOR THE SIX MONTHS ENDED JUNE 30, ----------------------- 2004 2003 -------- -------- Cash flows from operating activities: Net income $26,402 $21,469 Adjustments to reconcile income from operations to net cash provided by operating activities: Depreciation 15,444 13,526 Amortization of intangibles 3,481 2,369 Amortization of deferred compensation 56 - Amortization of deferred training asset 174 - Provision for doubtful accounts 1,784 2,100 Impairment of purchased accounts receivable 449 962 Accrued noncash interest 2,937 2,016 Loss on disposal of property and equipment 38 330 Changes in non-operating income (1,036) (1,678) Minority interest 606 906 Changes in operating assets and liabilities, net of acquisitions: Restricted cash 4,469 - Accounts receivable, trade (9,287) (5,859) Deferred income taxes 7,789 3,411 Bonus receivable 5,404 2,285 Other assets (750) (3,494) Accounts payable and accrued expenses 1,313 (4,250) Income taxes payable 2,446 747 Deferred revenue (8,495) 398 Other long-term liabilities 2,103 509 -------- -------- Net cash provided by operating activities 55,327 35,747 Cash flows from investing activities: Purchases of accounts receivable (22,947) (29,190) Collections applied to principal of purchased accounts receivable 45,309 36,938 Purchases of property and equipment (14,479) (10,169) Net distribution from joint venture 1,420 72 Proceeds from notes receivable 617 - Net cash paid for acquisitions and related costs (12,358) - -------- -------- Net cash used in investing activities (2,438) (2,349) Cash flows from financing activities: Repayment of notes payable (21,702) (14,239) Borrowings under notes payable 5,388 10,640 Repayment of acquired notes payable (11,447) - Borrowings under revolving credit agreement - 1,000 Repayment of borrowings under revolving credit agreement (22,500) (27,130) Payment of fees to acquire debt (90) (42) Issuance of common stock, net 10,696 - -------- -------- Net cash used in financing activities (39,655) (29,771) Effect of exchange rate on cash (80) 920 -------- -------- Net increase in cash and cash equivalents 13,154 4,547 Cash and cash equivalents at beginning of the period 45,644 25,159 -------- -------- Cash and cash equivalents at end of the period $58,798 $29,706 ======== ========
See accompanying notes. -3- NCO GROUP, INC. NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (UNAUDITED) 1. NATURE OF OPERATIONS: NCO Group, Inc., referred to as the Company or NCO, is a leading global provider of business process outsourcing solutions, offering accounts receivable management, referred to as ARM, customer relationship management, referred to as CRM, and other services. NCO provides services through over 90 offices in the United States, Canada, the United Kingdom, India, the Philippines, Barbados and Panama. The Company provides services to more than 50,000 clients including many of the Fortune 500, supporting a broad spectrum of industries, including financial services, healthcare, retail and commercial, telecommunications, utility, education, government services and technology. These clients are primarily located throughout the United States of America, Canada, the United Kingdom, and Puerto Rico. The Company's largest client is in the financial services sector and represented 10.9 percent of the Company's consolidated revenue for the six months ended June 30, 2004. The Company also purchases and manages past due consumer accounts receivable from consumer creditors such as banks, finance companies, retail merchants, and other consumer-oriented companies. 2. ACCOUNTING POLICIES: Interim Financial Information: The accompanying unaudited condensed consolidated financial statements have been prepared in accordance with generally accepted accounting principles for interim financial information and with the instructions for Form 10-Q and Rule 10-01 of Regulation S-X. Accordingly, they do not include all of the information and footnotes required by generally accepted accounting principles for complete financial statements. In the opinion of management, all adjustments (consisting of only normal recurring accruals) considered necessary for a fair presentation have been included. Because of the seasonal nature of the Company's business, operating results for the three-month and six-month periods ended June 30, 2004, are not necessarily indicative of the results that may be expected for the year ending December 31, 2004, or for any other interim period. For further information, refer to the consolidated financial statements and footnotes thereto included in the Company's Annual Report on Form 10-K filed with the Securities and Exchange Commission on March 15, 2004. Principles of Consolidation: The condensed consolidated financial statements include the accounts of the Company and all affiliated subsidiaries and entities controlled by the Company. All significant intercompany accounts and transactions have been eliminated. The Company does not control InoVision-MEDCLR NCOP Ventures, LLC (see note 14) and, accordingly, its financial condition and results of operations are not consolidated with the Company's financial statements. Revenue Recognition: ARM Contingency Fees: ARM contingency fee revenue is recognized upon collection of funds on behalf of clients. ARM Contractual Services: Fees for ARM contractual services are recognized as services are performed and accepted by the client. -4- 2. ACCOUNTING POLICIES (CONTINUED): Revenue Recognition (continued): Long-Term Collection Contract: The Company has a long-term collection contract with a large client to provide collection services that includes guaranteed collections, subject to limits. The Company also earns a bonus to the extent collections are in excess of the guarantees. The Company is required to pay the client, subject to limits, if collections do not reach the guarantees. Any guarantees in excess of the limits will only be satisfied with future collections. The Company is entitled to recoup at least 90 percent of any such guarantee payments from subsequent collections in excess of any remaining guarantees. This long-term collection contract only covers placements by the client from January 1, 2000 through December 31, 2003. The Company defers all of the base service fees, subject to the limits, until the collections exceed the collection guarantees. At the end of each reporting period, the Company assesses the need to record an additional liability if deferred fees are less than the estimated guarantee payments, if any, due to the client, subject to the limits. There was no additional liability recorded as of June 30, 2004 and December 31, 2003. CRM Hourly: Revenue is recognized based on the billable hours of each CRM representative as defined in the client contract. The rate per billable hour charged is based on a predetermined contractual rate, as agreed in the underlying contract. The contractual rate can fluctuate based on certain pre-determined objective performance criteria related to quality and performance. The impact of the performance criteria on the rate per billable hour is continually updated as revenue is recognized. Some clients are contractually entitled to penalties when the Company is not in compliance with certain obligations as defined in the client contract. Penalties are recorded as a reduction to revenues as incurred. CRM Performance Based: Under performance-based arrangements, the Company is paid by its customers based on achievement of certain levels of sales or other client-determined criteria specified in the client contract. The Company recognizes performance-based revenue by measuring its actual results against the performance criteria specified in the contracts. Amounts collected from customers prior to the performance of services are recorded as deferred revenues. Training Revenues: In connection with the provisions of certain inbound and outbound CRM services, the Company incurs costs to train its CRM representatives. Training programs relate to both program start-up training in connection with new CRM programs, referred to as Start-up Training, and on-going training for updates of existing CRM programs, referred to as On-going Training. The Company bills some of its customers for the costs incurred under these training programs based on the terms in the contract. Training revenue is integral to CRM revenues being generated over the course of a contract and cannot be separated as a discrete earning process under SEC Staff Accounting Bulletin No. 104. As a result, all training revenues are deferred. Start-up Training and On-going Training revenues are amortized over the term of the customer contract, or over the period to be benefited. Direct costs associated with providing Start-up Training and On-going Training, which consist exclusively of salary and benefit costs, are also deferred and amortized over a time period consistent with the deferred training revenues. When a business relationship is terminated with one of the Company's customers, the unamortized deferred training revenue and unamortized deferred direct costs associated with that customer are immediately recognized. -5- 2. ACCOUNTING POLICIES (CONTINUED): Revenue Recognition (continued): Purchased Accounts Receivable: The Company accounts for its investment in purchased accounts receivable on an accrual basis under the guidance of American Institute of Certified Public Accountants' Practice Bulletin 6, "Amortization of Discounts on Certain Acquired Loans," using unique and exclusive portfolios. Portfolios are established with accounts having similar attributes. Typically, each portfolio consists of an individual acquisition of accounts that are initially recorded at cost, which includes external costs of acquiring portfolios. Once a portfolio is acquired, the accounts in the portfolio are not changed. Proceeds from the sale of accounts and return of accounts within a portfolio are accounted for as collections in that portfolio. The discount between the cost of each portfolio and the face value of the portfolio is not recorded since the Company expects to collect a relatively small percentage of each portfolio's face value. Collections on the portfolios are allocated to revenue and principal reduction based on the estimated internal rate of return, referred to as IRR, for each portfolio. The IRR for each portfolio is derived based on the expected monthly collections over the estimated economic life of each portfolio (generally five years, based on the Company's collection experience), compared to the original purchase price. Revenue on purchased accounts receivable is recorded monthly based on applying each portfolio's effective IRR for the quarter to its carrying value. To the extent collections exceed the revenue, the carrying value is reduced and the reduction is recorded as collections applied to principal. Because the IRR reflects collections for the entire economic life of the portfolio, and those collections are not constant, lower collection rates, typically in the early months of ownership, can result in a situation where the actual collections are less than revenue. In this situation, the carrying value of the portfolio may be increased by the difference between revenue and collections. To the extent actual collections differ from estimated projections, the Company prospectively adjusts projected collections, which adjusts the IRR. If the carrying value of a particular portfolio exceeds its expected future collections, a charge to income would be recognized in the amount of such impairment. Additional impairments on each quarter's previously impaired portfolios may occur if the current estimated future cash flow projection, after being adjusted prospectively for actual collection results, is less than the current carrying value. After the impairment of a portfolio, all collections are recorded as a return of capital and no income is recorded on that portfolio until the full carrying value of the portfolio has been recovered. Once the full cost of the carrying value has been recovered, all collections are recorded as revenue. The estimated IRR for each portfolio is based on estimates of future collections, and actual collections will vary from current estimates. The difference could be material. Credit Policy: The Company has two types of arrangements under which it collects its ARM contingency fee revenue. For certain clients, the Company remits funds collected on behalf of the client net of the related contingent fees while, for other clients, the Company remits gross funds collected on behalf of clients and bills the client separately for its contingent fees. Management carefully monitors its client relationships in order to minimize the Company's credit risk and maintains a reserve for potential collection losses when such losses are deemed to be probable. The Company generally does not require collateral and it does not charge finance fees on outstanding trade receivables. In many cases, in the event of collection delays from ARM clients, management may, at its discretion, change from the gross remittance method to the net remittance method. Trade accounts receivable are written off to the allowance for doubtful accounts when collection appears highly unlikely. -6- 2. ACCOUNTING POLICIES (CONTINUED): Goodwill: Goodwill represents the excess of purchase price over the fair market value of the net assets of the acquired businesses based on their respective fair values at the date of acquisition. The Company accounts for goodwill pursuant to Statement of Financial Accounting Standard No. 142, "Goodwill and Other Intangible Assets," referred to as SFAS 142. Under SFAS 142, goodwill is no longer amortized but instead must be tested for impairment at least annually and as triggering events occur, including an initial test that was completed in connection with the adoption of SFAS 142. The test for impairment uses a fair-value based approach, whereby if the implied fair value of a reporting unit's goodwill is less than its carrying amount, goodwill would be considered impaired. Fair value estimates are based upon the discounted value of estimated cash flows. The Company did not incur any impairment charges in connection with the adoption of SFAS 142 or the subsequent annual impairment tests, and does not believe that goodwill is impaired as of June 30, 2004. The annual impairment analysis is completed on October 1st of each year (see note 7). Other Intangible Assets: Other intangible assets consist primarily of customer relationships and deferred financing costs, which relate to debt issuance costs incurred. Customer relationships are amortized over five years and deferred financing costs are amortized over the term of the debt (see note 7). Stock Options: The Company accounts for stock option grants in accordance with APB Opinion 25, "Accounting for Stock Issued to Employees," referred to as APB 25, and related interpretations. Under APB 25, because the exercise price of the stock options equaled the fair value of the underlying common stock on the date of grant, no compensation cost was recognized. In accordance with SFAS 123, "Accounting for Stock-Based Compensation," the Company does not recognize compensation cost based on the fair value of the options granted at the grant date. If the Company had elected to recognize compensation cost based on the fair value of the options granted at the grant date, net income and net income per share would have been reduced to the pro forma amounts indicated in the following table (amounts in thousands, except per share amounts):
For the Three Months For the Six Months Ended June 30, Ended June 30, -------------------- ----------------- 2004 2003 2004 2003 ------- ------- ------- ------- Net income - as reported $14,419 $10,277 $26,402 $21,469 Pro forma compensation cost, net of taxes 855 1,068 1,711 2,138 ------- ------- ------- ------- Net income - pro forma $13,564 $ 9,209 $24,691 $19,331 ======= ======= ======= ======= Net income per share - as reported: Basic $0.46 $0.40 $0.92 $0.83 Diluted $0.43 $0.38 $0.86 $0.78 Net income per share - pro forma: Basic $0.43 $0.36 $0.86 $0.75 Diluted $0.41 $0.34 $0.80 $0.71
In May 2004, the Company's shareholders approved the 2004 Equity Incentive Plan, referred to as the 2004 Plan. The 2004 Plan authorizes grants to employees and directors of incentive stock options, options not intended to qualify as incentive stock options, stock appreciation rights, restricted and unrestricted stock awards, restricted stock units, performance awards, supplemental cash awards and combinations of the foregoing. The aggregate number of shares of Common Stock for which awards may be granted under the 2004 Plan is 2.0 million. -7- 2. ACCOUNTING POLICIES (CONTINUED): Income Taxes: The Company accounts for income taxes in accordance with SFAS No. 109, "Accounting for Income Taxes," referred to as SFAS No. 109, which requires that deferred tax assets and liabilities be recognized using enacted tax rates for the effect of temporary differences between the book and tax bases of recorded assets and liabilities. SFAS 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. Use of Estimates: The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. In the ordinary course of accounting for the long-term collection contract, estimates are made by management as to the payments due to the client. Actual results could differ from those estimates and a material change could occur within one reporting period. In the ordinary course of accounting for purchased accounts receivable, estimates are made by management as to the amount and timing of future cash flows expected from each portfolio. The estimated future cash flow of each portfolio is used to compute the IRR for the portfolio and any impairment. The IRR is used to allocate collections between revenue and principal reduction of the carrying values of the purchased accounts receivable. On an ongoing basis, the Company compares the historical trends of each portfolio to projected collections. Future projected collections are then increased, within preset limits, or decreased based on the actual cumulative performance of each portfolio. Management reviews each portfolio's adjusted projected collections to determine if further upward or downward adjustment is warranted. Management regularly reviews the trends in collection patterns and uses its best efforts to improve the collections of under-performing portfolios. On newly acquired portfolios, additional reviews are made to determine if the estimated collections at the time of purchase require upward or downward adjustment due to unusual collection patterns in the early months of ownership. However, actual results will differ from these estimates and a material change in these estimates could occur within one reporting period (see note 5). Derivative Financial Instruments: SFAS No. 133, "Accounting for Derivative Instruments and Hedging Activities", referred to as SFAS No. 133, requires companies to recognize all of their derivative instruments as either assets or liabilities in the balance sheet at fair value. The Company has certain nonrecourse notes payable that have derivative instruments embedded within them. The embedded derivatives are not hedge instruments and, accordingly, changes in their estimated fair value are reported as other income (expense) in the accompanying statements of income. The embedded derivatives are included in long-term debt on the accompanying balance sheets as they are not separable from the notes payable and they have the same counterparty. The Company is exposed to foreign currency fluctuations relating to its operations in Canada, the United Kingdom and the Philippines. In order to partially hedge cash flow exposure, the Company periodically enters into forward exchange contracts in order to minimize the impact of currency fluctuations on transactions, cash flows and firm commitments. These contracts are recorded at fair value on the accompanying balance sheets, and changes in fair value are recorded in other comprehensive income (see note 10). Reclassifications: Certain amounts for the six months ended June 30, 2003 have been reclassified for comparative purposes. -8- 3. BUSINESS COMBINATIONS: The following acquisitions have been accounted for under the purchase method of accounting. As part of the purchase accounting, the Company recorded accruals for acquisition-related expenses. These accruals included professional fees and other costs related to the acquisition. On March 26, 2004, the Company completed the merger of NCO Portfolio Management, Inc., referred to as NCO Portfolio, with a wholly owned subsidiary of the Company. The Company owned approximately 63.3 percent of the outstanding stock of NCO Portfolio prior to the merger and, pursuant to the merger, acquired all NCO Portfolio shares that it did not own for 1.8 million shares of NCO common stock valued at $39.8 million. The value of the stock issued was based on the average closing price of the Company's common stock for the period beginning two days before and ending two days after the announcement of the merger on December 15, 2003. The Company recorded goodwill of $15.8 million, most of which is not deductible for tax purposes. The allocation of the fair market value to the acquired assets and liabilities of NCO Portfolio was based on preliminary estimates and may be subject to change. During the three months ended June 30, 2004, the Company revised the estimated allocation of the fair market value that resulted in an increase in goodwill of $1.1 million. As a result of the acquisition, the Company expects to expand its portfolio base and reduce the cost of operations through economies of scale. Therefore, the Company believes the allocation of a portion of the purchase price to goodwill is appropriate. The following is a preliminary allocation of the purchase price of the minority interest of NCO Portfolio (amounts in thousands): Purchase price $ 39,891 Transaction costs 1,902 Fair value adjustment to: Purchased accounts receivable 2,324 Other assets (526) Liabilities (299) Minority interest (27,454) -------- Goodwill $ 15,838 ======== On April 2, 2004, the Company completed the acquisition of RMH Teleservices, Inc., referred to as RMH, a provider of CRM services. The Company issued 3.4 million shares of NCO common stock for all of the outstanding shares of RMH and assumed 339,000 warrants and 248,000 stock options. The total value of the consideration was $88.8 million. The Company also repaid $11.4 million of RMH's pre-acquisition debt. The values of the stock, warrants and stock options were based on the average closing price of the Company's common stock for the period beginning two days before and ending two days after the announcement of the first amendment to the agreement on January 22, 2004. The Company allocated $25.0 million of the purchase price to the customer relationships and recorded goodwill of $64.5 million, most of which is not deductible for tax purposes. As part of the purchase accounting, the Company recorded accruals for acquisition related expenses including termination costs related to certain redundant personnel that were scheduled to be eliminated upon completion of the acquisition and certain future rental obligations attributable to facilities which are scheduled to be closed. The allocation of the fair market value to the acquired assets and liabilities of RMH was based on preliminary estimates and may be subject to change. As a result of the acquisition, the Company expects to expand RMH's current customer base, strengthen its relationship with certain existing customers, and reduce the cost of providing services to the acquired customers through economies of scale. Therefore, the Company believes the allocation of a portion of the purchase price to goodwill is appropriate. The following is a preliminary allocation of the purchase price to the assets acquired and liabilities assumed of RMH (amounts in thousands): Purchase price $ 88,808 Accounts receivable (23,824) Customer relationship (25,000) Property and equipment (37,235) Deferred tax asset (26,597) Other assets (6,180) Long-term debt 29,233 Other assumed liabilities 29,907 Accrued acquisition costs: Lease obligations for office closures 18,493 Severance 4,210 Other 12,914 Foreign currency translation of goodwill (239) -------- Goodwill $ 64,490 ======== -9- 3. BUSINESS COMBINATIONS (CONTINUED): The following summarizes the unaudited pro forma results of operations, assuming the NCO Portfolio and RMH acquisitions occurred as of the beginning of the respective periods. The pro forma information is provided for informational purposes only. It is based on historical information, and does not necessarily reflect the actual results that would have occurred, nor is it indicative of future results of operations of the consolidated entities (amounts in thousands, except per share data): For the Six Months Ended June 30, -------------------- 2004 2003 -------- -------- Revenue $523,694 $520,041 Net income $ 26,065 $ 17,965 Earnings per share - basic $0.76 $0.58 Earnings per share - diluted $0.73 $0.56 4. COMPREHENSIVE INCOME: Comprehensive income consists of net income from operations, plus certain changes in assets and liabilities that are not included in net income but are reported as a separate component of shareholders' equity. The Company's comprehensive income was as follows (amounts in thousands):
For the Three Months For the Six Months Ended June 30, Ended June 30, ----------------- ------------------ 2004 2003 2004 2003 ------- ------- ------------------ Net income $14,419 $10,277 $26,402 $21,469 Other comprehensive income (expense): Foreign currency translation adjustment (1,231) 4,087 (1,602) 6,956 Change in fair value of foreign currency hedge 337 - 337 - Unrealized gain on interest rate swap - 183 - 351 ------- ------- -------- ------- Comprehensive income $13,525 $14,547 $25,137 $28,776 ======= ======= ======== =======
The foreign currency translation adjustment was attributable to changes in the exchange rates used to translate the financial statements of the Canadian, United Kingdom and Philippines subsidiaries into U.S. dollars. -10- 5. PURCHASED ACCOUNTS RECEIVABLE: The Company's Portfolio Management and ARM International divisions purchase defaulted consumer accounts receivable at a discount from the actual principal balance. On certain international portfolios, Portfolio Management and ARM International jointly purchase defaulted consumer accounts receivable. The following summarizes the change in purchased accounts receivable (amounts in thousands):
For the Six Months Ended For the Year Ended June 30, 2004 December 31, 2003 ------------- ------------------ Balance at beginning of period $152,613 $152,448 Purchases of accounts receivable 26,235 74,299 Collections on purchased accounts receivable (91,433) (154,121) Revenue recognized 46,124 76,735 Impairment of purchased accounts receivable (449) (1,751) Residual purchased accounts receivable from previously unconsolidated subsidiary - 4,515 Fair value purchase accounting adjustment (2,324) - Foreign currency translation adjustment 64 488 -------- --------- Balance at end of period $130,830 $152,613 ======== =========
Included in collections for the three and six months ended June 30, 2004 was $4.2 million of proceeds from portfolio sales. Included in collections for the three and six months ended June 30, 2003 was $80,000 and $1.5 million, respectively, of proceeds from the sale of accounts. During the three months ended June 30, 2004 and 2003, impairment charges of $61,000 and $632,000, respectively, were recorded from portfolios where the carrying values exceeded the expected future undiscounted cash flows. During the six months ended June 30, 2004 and 2003, impairment charges of $449,000 and $962,000, respectively, were recorded. As of June 30, 2004 and December 31, 2003, the combined carrying values on all impaired portfolios aggregated $4.9 million and $11.4 million, respectively, or 3.8 percent and 7.5 percent of total purchased accounts receivable, respectively, representing their net realizable value. As of June 30, 2004 and December 31, 2003, one portfolio with a carrying value of $2.0 million and $4.2 million, respectively, which was acquired in connection with the dissolution of an off-balance sheet securitization, was also being accounted for under the cost recovery method. 6. FUNDS HELD ON BEHALF OF CLIENTS: In the course of the Company's regular business activities as a provider of accounts receivable management services, the Company receives clients' funds arising from the collection of accounts placed with the Company. These funds are placed in segregated cash accounts and are generally remitted to clients within 30 days. Funds held on behalf of clients of $67.2 million and $59.3 million as of June 30, 2004 and December 31, 2003, respectively, have been shown net of their offsetting liability for financial statement presentation. -11- 7. INTANGIBLE ASSETS: Goodwill: SFAS 142 requires goodwill to be allocated and tested at the reporting unit level. The Company's reporting units under SFAS 142 are ARM U.S., CRM, Portfolio Management and ARM International, and had the following goodwill (amounts in thousands): June 30, 2004 December 31, 2003 ------------- ----------------- ARM U.S. $471,558 $471,558 CRM 64,490 - Portfolio Management 15,838 - ARM International 33,640 34,812 -------- -------- Total $585,526 $506,370 ======== ======== CRM's goodwill resulted from the acquisition of RMH (see note 3). Portfolio Management's goodwill resulted from the purchase of the minority interest of NCO Portfolio (see note 3). The change in ARM International's goodwill balance from December 31, 2003 to June 30, 2004, was due to changes in the exchange rates used for the foreign currency translation. Other Intangible Assets: Other intangible assets consist primarily of deferred financing costs and customer relationships. The following represents the other intangible assets (amounts in thousands):
June 30, 2004 December 31, 2003 ------------------------------ ------------------------------ Gross Carrying Accumulated Gross Carrying Accumulated Amount Amortization Amount Amortization -------------- ------------ -------------- ------------ Deferred financing costs $15,335 $10,967 $15,321 $ 9,687 Customer relationships 33,761 4,230 8,761 2,104 Other intangible assets 975 891 900 816 ------- ------- ------- ------- Total $50,071 $16,088 $24,982 $12,607 ======= ======= ======= =======
The Company recorded amortization expense for all other intangible assets of $2.4 million and $1.2 million during the three months ended June 30, 2004 and 2003, respectively, and $3.5 million and $2.4 million during the six months ended June 30, 2004 and 2003, respectively. The following represents the Company's estimated amortization expense from these other intangible assets over the next five years (amounts in thousands): For the Years Ended Estimated December 31, Amortization Expense ----------------------- ----------------------- 2004 $8,170 2005 9,294 2006 7,350 2007 6,401 2008 5,000 -12- 8. LONG-TERM DEBT: Long-term debt consisted of the following (amounts in thousands): June 30, 2004 December 31, 2003 ------------- ----------------- Credit facility $110,000 $132,500 Convertible notes 125,000 125,000 Securitized nonrecourse debt 27,857 33,210 Other nonrecourse debt 14,461 17,591 Capital leases and other 23,965 7,186 Less current portion (72,235) (66,523) -------- -------- $229,048 $248,964 ======== ======== Credit Facility: On August 13, 2003, the Company amended its credit agreement with Citizens Bank of Pennsylvania, referred to as Citizens Bank, for itself and as administrative agent for other participating lenders. The amendment extended the maturity date from May 20, 2004 to March 15, 2006, referred to as the Maturity Date. The amended credit facility is structured as a $150 million term loan and a $50 million revolving credit facility. The Company is required to make quarterly repayments of $6.3 million on the term loan until the Maturity Date. The remaining balance outstanding under the term loan and the balance under the revolving credit facility will become due on the Maturity Date. The availability of the revolving credit facility is reduced by any unused letters of credit. As of June 30, 2004, the Company had unused letters of credit of $2.8 million and $47.2 million remaining availability under the revolving credit facility. Prior to February 28, 2004, all borrowings carried interest at a rate equal to either, at the option of the Company, Citizens Bank's prime rate plus a margin of 1.25 percent, or the London InterBank Offered Rate, referred to as LIBOR, plus a margin of 3.00 percent. After February 28, 2004, all borrowings carried interest at a rate equal to either, at the option of the Company, Citizens Bank's prime rate (Citizens Bank's prime rate was 4.25 percent at June 30, 2004) plus a margin of 0.75 percent to 1.25 percent, which is determined quarterly based upon the Company's consolidated funded debt to earnings before interest, taxes, depreciation, and amortization, referred to as EBITDA, ratio, or LIBOR (LIBOR was 1.36 percent at June 30, 2004) plus a margin of 2.25 percent to 3.00 percent depending on the Company's consolidated funded debt to EBITDA ratio. The Company is charged a fee on the unused portion of the credit facility of 0.50 percent until February 28, 2004, and ranging from 0.38 percent to 0.50 percent depending on the Company's consolidated funded debt to EBITDA ratio after February 28, 2004. The effective interest rate on credit facility was approximately 3.60 percent and 4.31 percent for the three months ended June 30, 2004 and 2003, respectively, and 3.82 percent and 4.38 percent for the six months ended June 30, 2004 and 2003, respectively. Borrowings under the credit agreement are collateralized by substantially all the assets of the Company. The credit agreement contains certain financial covenants such as maintaining net worth and funded debt to EBITDA requirements, and includes restrictions on, among other things, acquisitions, 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 and foreclose on the pledged assets. As of June 30, 2004, the Company was in compliance with all required financial covenants and the Company was not aware of any events of default. Convertible Debt: In April 2001, the Company completed the sale of $125.0 million aggregate principal amount of 4.75 percent Convertible Subordinated Notes due 2006, referred to as Notes, in a private placement pursuant to Rule 144A and Regulation S under the Securities Act of 1933. The Notes are convertible into NCO common stock at an initial conversion price of $32.92 per share. The Company will be required to repay the $125.0 million of aggregate principal if the Notes are not converted prior to their maturity in April 2006. -13- 8. LONG-TERM DEBT (CONTINUED): Securitized Nonrecourse Debt: NCO Portfolio has two securitized nonrecourse notes payable that were originally established to fund the purchase of accounts receivable. Each of the notes payable is nonrecourse to the Company, is secured by a portfolio of purchased accounts receivable, and is bound by an indenture and servicing agreement. The Company is servicer for each portfolio of purchased accounts receivable within these securitized notes. These are term notes without the ability to re-borrow. Monthly principal payments on the notes equal all collections after servicing fees, collection costs, interest expense, and administrative fees. The first securitized note was established in September 1998 through a special purpose finance subsidiary. This note carries a floating interest rate of LIBOR plus 0.65 percent per annum. The final due date of all payments under the facility is the earlier of March 2005, or satisfaction of the note from collections. A liquidity reserve of $900,000 and $5.4 million was included in restricted cash as of June 30, 2004 and December 31, 2003, respectively. As of June 30, 2004 and December 31, 2003, the amount outstanding on the facility was $8.8 million and $13.9 million, respectively. The note issuer was guaranteed against loss by NCO Portfolio for up to $4.5 million. In December 2003, the $4.5 million guarantee was funded using $3.3 million of restricted cash from another securitization and $1.2 million of operating cash. In January 2004, the $4.5 million from the guarantee was used to pay down a portion of the securitized note. The second securitized note was established in August 1999 and carries interest at 15.00 percent per annum. The final due date of all payments under the facility is the earlier of December 2004, or satisfaction of the note from collections. As of June 30, 2004 and December 31, 2003, the amount outstanding on the facility was $19.1 million and $19.3 million, respectively. Other Nonrecourse Debt: In August 2002, NCO Portfolio entered into a four-year exclusivity agreement with CFSC Capital Corp. XXXIV, referred to as Cargill. The agreement stipulates that all purchases of accounts receivable by NCO Portfolio with a purchase price in excess of $4.0 million must be first offered to Cargill for financing at its discretion. The agreement has no minimum or maximum credit authorization. NCO Portfolio may terminate the agreement at any time after August 2004 for a cost of $125,000 per month for each remaining month. If Cargill chooses to participate in the financing of a portfolio of accounts receivable, the financing will be at 90 percent of the purchase price, unless otherwise negotiated, with floating interest at the prime rate plus 3.25 percent (prime rate was 4.25 percent at June 30, 2004). Each borrowing is due two years after the loan is made. Debt service payments equal collections less servicing fees and interest expense. As additional return, Cargill will receive 40 percent of the residual cash flow, unless otherwise negotiated, which is defined as all cash collections after servicing fees, floating rate interest, repayment of the note, and the initial investment by NCO Portfolio, including imputed interest. The effective interest rate on these notes, including the residual interest component, was approximately 33.6 percent and 29.06 percent for the three months ended June 30, 2004 and 2003, respectively, and 34.2 percent and 26.84 percent for the six months ended June 30, 2004 and 2003, respectively. Borrowings under this financing agreement are nonrecourse to the Company, except for the assets within the special purpose entities established in connection with the financing agreement. This loan agreement contains a collections performance requirement, among other covenants, that, if not met, provides for cross-collateralization with any other Cargill financed portfolios, in addition to other remedies. Total debt outstanding under this facility was $14.5 million and $17.6 million as of June 30, 2004 and December 31, 2003, respectively, which included $5.8 million and $4.7 million of accrued residual interest, respectively. As of June 30, 2004, NCO Portfolio was in compliance with all required covenants. Upon full satisfaction of the notes payable and the return of members' capital as it relates to each purchase of accounts receivable, the Company is obligated to pay Cargill a contingent payment amount equal to 50 percent of collections received, unless otherwise negotiated, net of servicing fees and other related charges. The contingent payment has been accounted for as an embedded derivative in accordance with SFAS 133. At issuance, the proceeds received were allocated to the note payable and the embedded derivative. The resulting original issue discount on the note payable is amortized to interest expense through maturity using the effective interest method. At June 30, 2004 and December 31, 2003, the estimated fair value of the embedded derivative was $5.8 million and $4.7 million respectively. -14- 8. LONG-TERM DEBT (CONTINUED): Capital Leases: The Company leases certain equipment under agreements that are classified as capital leases. The equipment leases have original terms ranging from 24 to 60 months and have purchase options at the end of the original lease term. 9. EARNINGS PER SHARE: Basic earnings per share, referred to as EPS, was computed by dividing the net income for the three and six months ended June 30, 2004 and 2003, by the weighted average number of common shares outstanding. Diluted EPS was computed by dividing the adjusted net income for the three and six months ended June 30, 2004 and 2003, by the weighted average number of common shares outstanding plus all common equivalent shares. Net income is adjusted to add-back interest expense on the convertible debt, net of taxes, if the convertible debt is dilutive. The interest expense on the convertible debt, net of taxes, included in the diluted EPS calculation was $913,000 and $920,000 for the three months ended June 30, 2004 and 2003, respectively, and $1.8 million for the six months ended June 30, 2004 and 2003. Outstanding options, warrants, and convertible securities have been utilized in calculating diluted amounts only when their effect would be dilutive. The reconciliation of basic to diluted weighted average shares outstanding was as follows (amounts in thousands):
For the Three Months For the Six Months Ended June 30, Ended June 30, ------------------ ----------------- 2004 2003 2004 2003 ------ ------ ------ ------ Basic 31,502 25,908 28,814 25,908 Dilutive effect of convertible debt 3,797 3,797 3,797 3,797 Dilutive effect of options 314 63 313 38 Dilutive effect of warrants 110 - 55 - ------ ------ ------ ------ Diluted 35,723 29,768 32,979 29,743 ======= ====== ====== ======
10. DERIVATIVE FINANCIAL INSTRUMENTS: The Company selectively uses derivative financial instruments to manage interest costs and minimize currency exchange risk. The Company does not hold derivatives for trading purposes. While these derivative financial instruments are subject to fluctuations in value, these fluctuations are generally offset by the value of the underlying exposures being hedged. The Company minimizes the risk of credit loss by entering into these agreements with major financial institutions that have high credit ratings. A portion of the Company's business is performed in Canada for clients in the United States, which exposes the Company's earnings, cash flows, and financial position to risk from foreign currency denominated transactions. The Company also has operations in the Philippines for clients in the United States, which creates exposure from foreign currency denominated transactions that will increase as these operations grow. Due to the growth of the Canadian operations, a policy was established to minimize cash flow exposure to adverse changes in currency exchange rates by identifying and evaluating the risk that cash flows would be affected due to changes in exchange rates and by determining the appropriate strategies necessary to manage such exposures. The Company's objective is to maintain economically balanced currency risk management strategies that provide adequate downside protection. -15- 10. DERIVATIVE FINANCIAL INSTRUMENTS (CONTINUED): In order to partially hedge cash flow economic exposure in Canada, the Company entered into forward exchange contracts to minimize the impact of currency fluctuations on transactions, cash flows and firm commitments. The Company had forward exchange contracts for the purchase of $15.8 million of Canadian dollars outstanding at June 30, 2004, which mature within 90 days, with a fair market value of $336,593. 11. SUPPLEMENTAL CASH FLOW INFORMATION: The following are supplemental disclosures of cash flow information (amounts in thousands):
For the Six Months Ended June 30, ------------------ 2004 2003 -------- ------ Noncash investing and financing activities: Common stock issued for acquisitions $128,699 $ - Fair value of assets acquired 213,517 - Liabilities assumed from acquisitions 84,925 - Deferred portion of purchased accounts receivable 3,288 2,383 Deferred compensation from restricted stock 677 -
12. COMMITMENTS AND CONTINGENCIES: Purchase Commitments: The Company enters into noncancelable agreements with various telecommunications and other vendors that require minimum purchase commitments. These agreements expire between 2004 and 2007. The following represents the future minimum payments, by year and in the aggregate, under noncancelable purchase commitments (amounts in thousands): 2004 $23,043 2005 21,030 2006 14,453 2007 6,500 ------- $65,026 ======= The Company incurred $8.6 million and $3.5 million of expense in connection with these purchase commitments for the three months ended June 30, 2004 and 2003, respectively, and $15.8 million and $6.6 million for the six months ended June 30, 2004 and 2003, respectively. Long-Term Collection Contract: The Company has a long-term collection contract with a large client to provide collection services that includes guaranteed collections, subject to limits. The Company is required to pay the client the difference between actual collections and the guaranteed collections on May 31, 2004 and May 31, 2005, subject to limits of $6.0 million and $13.5 million, respectively. Any guarantees in excess of the limits will only be satisfied with future collections. The Company is entitled to recoup at least 90 percent of any such guarantee payments from subsequent collections in excess of any remaining guarantees. On May 31, 2004, the actual collections were $7.5 million below the guaranteed collections, or $1.5 million in excess of the $6.0 million limit. Since the Company prepaid the client $5.5 million from prior bonuses, it was only required to pay approximately $528,000 as of May 31, 2004. Almost all of the remaining $1.5 million of guaranteed collections was paid to the client from bonuses earned during June 2004. -16- 12. COMMITMENTS AND CONTINGENCIES (CONTINUED): Termination Fee: The Company has a contract with a client to perform CRM services that includes a termination clause. This contract expires on October 31, 2007. In the event the client terminates the services agreement due to the Company's material breach or a transaction in which a competitor of the client acquired control of the Company or in the event the Company terminates the services agreement for convenience after October 1, 2004, the Company is required to pay a minimum termination fee of $153,000 for each month remaining in the agreement (or $6.1 million at June 30, 2004). In most other instances (as defined in the services agreement) in which either party terminates the services agreement, the Company is required to pay a termination fee of $77,000 for each month remaining in the services agreement (or $3.1 million at June 30, 2004). Forward-Flow Agreement: NCO Portfolio was party to a fixed price agreement that ended in May 2004, referred to as forward-flow, with a major financial institution that obligated NCO Portfolio to purchase, on a monthly basis, portfolios of charged-off accounts receivable meeting certain criteria. A portion of the purchase price is deferred for 24 months, including a nominal rate of interest. The deferred purchase price payable is included in long-term debt and as of June 30, 2004 and December 31, 2003, was $9.0 million and $6.5 million, respectively. Litigation and Investigations: The Company is party, from time to time, to various legal proceedings, regulatory investigations and tax examinations incidental to its business. The Company continually monitors these legal proceedings, regulatory investigations and tax examinations to determine the impact and any required accruals. FTC: In October 2003, the Company was notified by the Federal Trade Commission, referred to as the FTC, that it intended to pursue a claim against the Company for violations of the Fair Credit Reporting Act relating to certain aspects of the Company's 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 the Company for servicing during 1999. The Company received incorrect information from the prior service provider at the time of transition. The Company 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, the Company made a settlement offer for this matter to the FTC. The FTC accepted the offer during the second quarter of 2004. The Company is asserting certain claims for indemnification from the owners of the consumer accounts. In connection with the proposed settlement offer made in the first quarter of 2004, the Company recorded its expected exposure to this claim. -17- 12. COMMITMENTS AND CONTINGENCIES (CONTINUED): Litigation and Investigations (continued): FTC (continued): The Company is also a party to a class action litigation regarding this group of consumer accounts. The class action litigation was settled and was covered by insurance, subject to applicable deductibles. The FTC is also alleging that certain reporting violations occurred on a small subset of the Company's purchased accounts receivable. The Company believes that the resolution of the above matters will not have a material adverse effect on its financial position, results of operations or business. Fort Washington Flood: In June 2001, the first floor of the Company's 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, the Company decided to relocate its corporate headquarters to Horsham, Pennsylvania. The Company 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 the former landlord filed counter-claims against the Company. Due to the uncertainty of the outcome of the lawsuit, the Company 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, but struck from the complaint the breach of fiduciary duty allegations asserting violations of duties owed by individual officers to the Company. Other: The Company is involved in other legal proceedings, regulatory investigations and tax examinations from time to time in the ordinary course of its business. Management believes that none of these other legal proceedings, regulatory investigations or tax examinations will have a materially adverse effect on the financial condition or results of operations of the Company. 13. SEGMENT REPORTING: As of June 30, 2004, the Company's business consisted of four operating divisions: ARM U.S., formerly known as U.S. Operations, CRM, Portfolio Management and ARM International, formerly known as International Operations. The accounting policies of the segments are the same as those described in note 2, "Accounting Policies." Effective July 1, 2004, the Company will combine the Canadian portion of ARM International with ARM U.S., and this division will be referred to as ARM North America. The United Kingdom subsidiary will continue to operate as ARM International. The information presented below does not reflect this reorganization. -18- 13. SEGMENT REPORTING (CONTINUED): ARM U.S. provides accounts receivable management services to consumer and commercial accounts for all market sectors including financial services, healthcare, retail and commercial, telecommunications, utilities, education, and government. ARM U.S. serves clients of all sizes in local, regional, and national markets. In addition to traditional accounts receivable collections, these services include developing the client relationship beyond bad debt recovery and delinquency management, and delivering cost-effective accounts receivable and customer relationship management solutions to all market sectors. ARM U.S. had total assets, net of any intercompany balances, of $728.7 million and $714.2 million at June 30, 2004 and December 31, 2003, respectively. ARM U.S. had capital expenditures of $11.9 million and $8.9 million for the six months ended June 30, 2004 and 2003, respectively. ARM U.S. also provides accounts receivable management services to Portfolio Management. ARM U.S. recorded revenue of $16.7 million and $12.1 million for these services for the three months ended June 30, 2004 and 2003, respectively, and $31.8 million and $24.4 million for the six months ended June 30, 2004 and 2003, respectively. The accounting policies used to record the revenue from Portfolio Management are the same as those described in note 2, "Accounting Policies." With the April 2004 acquisition of RMH, the CRM division was formed. The CRM division provides customer relationship management services to clients in the United States through offices in the United States, Canada, the Philippines and Panama. CRM had total assets, net of any intercompany balances, of $171.3 million at June 30, 2004. CRM had capital expenditures of $1.5 million for the six months ended June 30, 2004. The accounting policies used to record the revenue from CRM are the same as those described in note 2, "Accounting Policies." Portfolio Management purchases and manages defaulted consumer accounts receivable from consumer creditors such as banks, finance companies, retail merchants, and other consumer oriented companies. Portfolio Management had total assets, net of any intercompany balances, of $148.0 million and $170.4 million at June 30, 2004 and December 31, 2003, respectively. ARM International provides accounts receivable management services across Canada and the United Kingdom. ARM International had total assets, net of any intercompany balances, of $62.2 million and $61.5 million at June 30, 2004 and December 31, 2003, respectively. ARM International had capital expenditures of $1.1 million and $1.3 million for the six months ended June 30, 2004 and 2003, respectively. ARM International also provides accounts receivable management services to ARM U.S. ARM International recorded revenue of $10.6 million and $6.8 million for these services for the three months ended June 30, 2004 and 2003, respectively, and $20.3 million and $12.5 million for the six months ended June 30, 2004 and 2003, respectively. The accounting policies used to record the revenue from ARM U.S. are the same as those described in note 2, "Accounting Policies." The following tables represent the revenue, payroll and related expenses, selling, general, and administrative expenses, and EBITDA for each segment. EBITDA is used by the Company's management to measure the segments' operating performance and is not intended to report the segments' operating results in conformity with accounting principles generally accepted in the United States.
For the Three Months Ended June 30, 2004 (amounts in thousands) --------------------------------------------------- Payroll and Selling, General Related and Admin. Revenue Expenses Expenses EBITDA -------- -------- --------------- ------- ARM U.S. $177,712 $ 87,579 $68,612 $21,521 CRM 59,445 42,476 10,147 6,822 Portfolio Management 24,132 485 17,012 6,635 ARM International 21,329 12,903 4,724 3,702 Eliminations (27,363) (10,620) (16,743) - -------- -------- -------- ------- Total $255,255 $132,823 $83,752 $38,680 ======== ======== ======== =======
-19- 13. SEGMENT REPORTING (CONTINUED):
For the Three Months Ended June 30, 2003 (amounts in thousands) --------------------------------------------------- Payroll and Selling, General Related and Admin. Revenue Expenses Expenses EBITDA -------- -------- ---------------- ------- ARM U.S. $172,011 $84,411 $65,214 $22,386 Portfolio Management 18,086 563 13,382 4,141 ARM International 17,361 10,128 4,234 2,999 Eliminations (18,884) (6,772) (12,112) - -------- -------- -------- ------- Total $188,574 $88,330 $70,718 $29,526 ======== ======== ======== =======
For the Six Months Ended June 30, 2004 (amounts in thousands) --------------------------------------------------- Payroll and Selling, General Related and Admin. Revenue Expenses Expenses EBITDA -------- -------- ---------------- ------- ARM U.S. $361,131 $175,358 $139,839 $45,934 CRM 59,445 42,476 10,147 6,822 Portfolio Management 45,734 1,132 33,103 11,499 ARM International 42,340 25,237 9,131 7,972 Eliminations (52,164) (20,341) (31,823) - -------- -------- -------- ------- Total $456,486 $223,862 $160,397 $72,227 ======== ======== ======== =======
For the Six Months Ended June 30, 2003 (amounts in thousands) --------------------------------------------------- Payroll and Selling, General Related and Admin. Revenue Expenses Expenses EBITDA -------- ----------- ---------------- ------- ARM U.S. $345,116 $168,912 $129,601 $46,603 Portfolio Management 36,318 1,043 26,503 8,772 ARM International 33,115 19,212 7,991 5,912 Eliminations (36,958) (12,539) (24,419) - -------- -------- -------- ------- Total $377,591 $176,628 $139,676 $61,287 ======== ======== ======== =======
14. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY: NCO Portfolio 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 various other small balance accounts receivable and is accounted for using the equity method of accounting. Included in "other assets" on the Balance Sheets were NCO Portfolio's investment in the Joint Venture of $4.1 million and $4.0 million as of June 30, 2004 and December 31, 2003, respectively. Included in the Statements of Income, as "interest and investment income," was, $442,000 and $479,000 for the three months ended June 30, 2004 and 2003, respectively, representing NCO Portfolio's 50 percent share of net income from this unconsolidated subsidiary. Income of $1.0 million and $952,000 was recorded from this unconsolidated subsidiary for the six months ended June 30, 2004 and 2003, respectively. NCO Portfolio received distributions of $1.4 million and $72,000 during the six months ended June 30, 2004 and June 30, 2003, respectively. NCO Portfolio's 50 percent share of the Joint Venture's retained earnings was $1.0 million and $1.3 million as of June 30, 2004 and -20- 14. INVESTMENT IN UNCONSOLIDATED SUBSIDIARY (CONTINUED): December 31, 2003, respectively. The Company performs collection services for the Joint Venture and recorded service fee revenue of $1.8 million and $1.4 million for the three months ended June 30, 2004 and 2003, respectively, and $3.7 million and $3.0 million for the six months ended June 30, 2004 and 2003, respectively. The Company had receivables of $1.4 million and $269,000 on its balance sheets as of June 30, 2004 and December 31, 2003, respectively, for these service fees. The Company also performs collection services for an affiliate of IMNV and recorded service fee revenue of $2.6 million and $2.9 million for the three months ended June 30, 2004 and 2003, respectively, and $5.5 million for the six months ended June 30, 2004 and 2003. The following tables summarize the financial information of the Joint Venture (amounts in thousands): As of -------------------------------------------- June 30, 2004 December 31, 2003 -------------------- --------------------- Total assets $13,648 $15,344 Total liabilities 6,397 7,415 For the Six Months Ended June 30, -------------------------- 2004 2003 ------------ ----------- Revenue $7,987 $6,440 Net income 2,150 1,903 -21- ITEM 2 MANAGEMENT'S DISCUSSION AND ANALYSIS OF FINANCIAL CONDITION AND RESULTS OF OPERATIONS Certain statements included in this Report on Form 10-Q, other than historical facts, are forward-looking statements (as such term is defined in the Securities Exchange Act of 1934, and the regulations thereunder) which are intended to be covered by the safe harbors created thereby. Forward-looking statements include, without limitation, statements as to the Company's expected future results of operations, the Company's growth strategy, fluctuations in quarterly operating results, the integration of acquisitions, the long-term collection contract, the final outcome of the environmental liability, 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 accounts receivable management industry, estimates of future cash flows of purchased accounts receivable, estimates of goodwill impairments and amortization expense for other intangible assets, the effects of legal proceedings, regulatory investigation 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. 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 to possible impairments of goodwill and other intangible assets, risks associated with technology, risks related to the ERP implementation, risks related to the final outcome of the environmental liability, risks related to the final outcome of the Company's litigation with its former landlord, risks relating 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, risks related to the Company's international operations, and other risks detailed from time to time in the Company's filings with the Securities and Exchange Commission, including the Company's Annual Report on Form 10-K for the year ended December 31, 2003, can cause actual results and developments to be materially different from those expressed or implied by such forward-looking statements. The Company disclaims any intent or obligation to publicly update or revise any forward-looking statements, regardless of whether new information becomes available, future developments occur, or otherwise. The Company's website is www.ncogroup.com. The Company makes available, free of charge, on its website, its Annual Report on Form 10-K, including all amendments. In addition, the Company will provide additional paper or electronic copies of its Annual Report on Form 10-K for 2003, as filed with the Securities and Exchange Commission, without charge except for exhibits to the report. Requests should be directed to: Steven L. Winokur, Executive Vice President of Finance, Chief Financial Officer, and Chief Operating Officer of Shared Services, NCO Group, Inc., 507 Prudential Rd., Horsham, PA 19044. The information on the website listed above is not and should not be considered part of this Quarterly Report on Form 10-Q and is not incorporated by reference in this document. This website is and is only intended to be an inactive textual reference. THREE MONTHS ENDED JUNE 30, 2004, COMPARED TO THREE MONTHS ENDED JUNE 30, 2003 Revenue. Revenue increased $66.7 million, or 35.4 percent, to $255.3 million for the three months ended June 30, 2004, from $188.6 million for the three months ended June 30, 2003. Our operations are organized into four market specific divisions that include: ARM U.S., CRM, Portfolio Management, and ARM International. For the three months ended June 30, 2004, these divisions accounted for $177.7 million, $59.4 million, $24.1 million, and $21.3 million of revenue, respectively. Included in ARM U.S.'s revenue was $16.7 million of intercompany revenue from Portfolio Management, which was eliminated upon consolidation and included in ARM International's revenue was $10.6 million of intercompany revenue from ARM -22- U.S., which was eliminated upon consolidation. For the three months ended June 30, 2003, the ARM U.S., Portfolio Management and ARM International divisions accounted for $172.0 million, $18.1 million and $17.4 million of revenue, respectively. Included in ARM U.S.'s revenue was $12.1 million of intercompany revenue from Portfolio Management that was eliminated upon consolidation and included in ARM International's revenue was $6.8 million of intercompany revenue from ARM U.S. that was eliminated upon consolidation. The CRM division was formed in the second quarter of 2004 with the acquisition of RMH Teleservices, Inc., referred to as RMH, on April 2, 2004 and, accordingly, is not included in the results for 2003. ARM U.S.'s revenue increased $5.7 million, or 3.3 percent, to $177.7 million for the three months ended June 30, 2004, from $172.0 million for the three months ended June 30, 2003. The increase in ARM U.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. ARM U.S.'s revenue for the three months ended June 30, 2004 and 2003 included revenue recorded from the long-term collection contract. The method of recognizing revenue for this long-term collection contract defers certain revenues into future periods until collections exceed collection guarantees, subject to limits. During the three months ended June 30, 2004, ARM U.S. earned $956,000 of revenue from bonuses and recovery of penalties, compared to an additional deferral of revenue of $1.7 million for the three months ended June 30, 2003. Portfolio Management's revenue increased $6.0 million, or 33.4 percent, to $24.1 million for the three months ended June 30, 2004, from $18.1 million for the three months ended June 30, 2003. Portfolio Management's collections increased $11.0 million, or 30.7 percent, to $46.6 million for the three months ended June 30, 2004, from $35.6 million for the three months ended June 30, 2003. Portfolio Management's revenue represented 52 percent of collections for the three months ended June 30, 2004, as compared to 51 percent of collections for the three months ended June 30, 2003. Revenue increased due to the increase in collections from new purchases of receivables and higher collections due to a better collection environment, especially on certain large portfolios that continued to outperform expectations. Collections for the three months ended June 30, 2004 and 2003, included proceeds from portfolio sales of $4.2 million and $80,000, respectively. ARM International's revenue increased $4.0 million, or 22.9 percent, to $21.3 million for the three months ended June 30, 2004, from $17.4 million for the three months ended June 30, 2003. The increase in ARM International's revenue was primarily attributable to an increase in the services provided to ARM U.S. In addition, a portion of the increase was attributable to the addition of new clients, growth in business from existing clients and 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 $44.5 million to $132.8 million for the three months ended June 30, 2004, from $88.3 million for the three months ended June 30, 2003, and increased as a percentage of revenue to 52.0 percent from 46.8 percent. The increase in payroll and related expenses as a percentage of revenue was primarily attributable to the CRM division, which was formed with the acquisition of RMH in April 2004. The CRM division has a more significant amount of payroll and related expenses as compared to the ARM business. ARM U.S.'s payroll and related expenses increased $3.2 million to $87.6 million for the three months ended June 30, 2004, from $84.4 million for the three months ended June 30, 2003, and increased slightly as a percentage of revenue to 49.3 percent from 49.1 percent. Portfolio Management's payroll and related expenses decreased $78,000 to $485,000 for the three months ended June 30, 2004, from $563,000 for the three months ended June 30, 2003, and decreased as a percentage of revenue to 2.0 percent from 3.1 percent. Portfolio Management outsources all of the collection services to ARM U.S. 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 $2.8 million to $12.9 million for the three months ended June 30, 2004, from $10.1 million for the three months ended June 30, 2003, and increased as a percentage of revenue to 60.5 percent from 58.3 percent. The increase as a percentage of revenue was attributable to an increase in outsourcing services because those services typically have a higher payroll cost structure than the remainder of ARM -23- International's business. However, the higher payroll costs are generally offset by a lower selling, general and administrative cost structure. A portion of this increase was offset by the effect of the continued focus on managing the amount of labor required to attain revenue goals. Selling, general and administrative expenses. Selling, general and administrative expenses increased $13.1 million to $83.8 million for the three months ended June 30, 2004, from $70.7 million for the three months ended June 30, 2003, but decreased as a percentage of revenue to 32.8 percent from 37.5 percent. The decrease in selling, general and administrative expenses as a percentage of revenue was primarily attributable to the CRM division, which was formed with the acquisition of RMH on April 2, 2004. The CRM division has a more significant portion of their expense structure in payroll and related expenses as compared to the ARM business. Depreciation and amortization. Depreciation and amortization increased to $11.1 million for the three months ended June 30, 2004, from $8.0 million for the three months ended June 30, 2003. The increase was attributable to the amortization of the fair value assigned to the customer relationships acquired in connection with the RMH acquisition and the depreciation of property and equipment acquired in connection with the RMH acquisition. Other income (expense). Interest and investment income included investment income of $442,000 for the three months ended June 30, 2004, as compared to $479,000 for the three months ended June 30, 2003, from the 50 percent ownership interest in a joint venture that purchases utility, medical and other various small balance accounts receivable. Interest expense decreased to $5.3 million for the three months ended June 30, 2004, from $5.9 million for the three months ended June 30, 2003. The decrease was attributable to lower principal balances as a result of debt repayments made in excess of borrowings against the credit facility during 2004 and 2003, and lower interest rates. The decrease was partially offset by Portfolio Management's additional nonrecourse borrowings from CFSC Capital Corp. XXXIV, referred to as Cargill, to purchase accounts receivable. Other income for the three months ended June 30, 2004, included a $621,000 gain related to a benefit from a deferred compensation plan assumed as part of the acquisition of FCA International Ltd. in May 1998. Other income for the three months ended June 30, 2003, included $476,000 of income from our ownership interest in one of our insurance carriers that was sold and $250,000 of income from a partial recovery from a third party of an environmental liability. Income tax expense. Income tax expense for the three months ended June 30, 2004, increased to $9.1 million, or 38.6 percent of income before income tax expense, from $6.5 million, or 37.9 percent of income before income tax expense, for the three months ended June 30, 2003. The increase in the effective tax rate was primarily attributable to changes in state income taxes. SIX MONTHS ENDED JUNE 30, 2004, COMPARED TO SIX MONTHS ENDED JUNE 30, 2003 Revenue. Revenue increased $78.9 million, or 20.9 percent, to $456.5 million for the six months ended June 30, 2004, from $377.6 million for the six months ended June 30, 2003. For the six months ended June 30, 2004, our ARM U.S., CRM, Portfolio Management, and ARM International divisions accounted for $361.1 million, $59.5 million, $45.7 million, and $42.3 million of revenue, respectively. Included in ARM U.S.'s revenue was $31.8 million of intercompany revenue from Portfolio Management, which was eliminated upon consolidation and included in ARM International's revenue was $20.3 million of intercompany revenue from ARM U.S., which was eliminated upon consolidation. For the six months ended June 30, 2003, the ARM U.S., Portfolio Management and ARM International divisions accounted for $345.1 million, $36.3 million and $33.1 million of revenue, respectively. Included in ARM U.S.'s revenue was $24.4 million of intercompany revenue from Portfolio Management that was eliminated upon consolidation and included in ARM International's revenue was $12.5 million of intercompany revenue from ARM U.S. that was eliminated upon consolidation. The CRM division was formed in the second quarter of 2004 in connection with the acquisition of RMH on April 2, 2004 and, accordingly, is not included in the results for 2003. ARM U.S.'s revenue increased $16.0 million, or 4.6 percent, to $361.1 million for the six months ended June 30, 2004, from $345.1 million for the six months ended June 30, 2003. The increase in ARM U.S.'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. ARM U.S.'s revenue for the six months ended June 30, 2004 and 2003 included revenue recorded from the long-term collection contract. The -24- method of recognizing revenue for this long-term collection contract defers certain revenues into future periods until collections exceed collection guarantees, subject to limits. During the six months ended June 30, 2004, ARM U.S. earned $2.6 million of revenue from bonuses and recovery of penalties, compared to an additional deferral of revenue of $2.7 million for the six months ended June 30, 2003. Portfolio Management's revenue increased $9.4 million, or 25.9 percent, to $45.7 million for the six months ended June 30, 2004, from $36.3 million for the six months ended June 30, 2003. Portfolio Management's collections increased $17.7 million, or 24.5 percent, to $90.1 million for the six months ended June 30, 2004, from $72.4 million for the six months ended June 30, 2003. Portfolio Management's revenue represented 51 percent of collections for the six months ended June 30, 2004, as compared to 50 percent of collections for the six months ended June 30, 2003. Revenue increased due to the increase in collections from new purchases of receivables and higher collections due to a better collection environment, especially on certain large portfolios that continued to outperform expectations. Collections for the six months ended June 30, 2004 and 2003, included proceeds from portfolio sales of $4.2 million and $1.5 million, respectively. ARM International's revenue increased $9.2 million, or 27.9 percent, to $42.3 million for the six months ended June 30, 2004, from $33.1 million for the six months ended June 30, 2003. The increase in ARM International's revenue was primarily attributable to an increase in the services provided to ARM U.S. In addition, a portion of the increase was attributable to the addition of new clients, growth in business from existing clients and 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 $47.2 million to $223.9 million for the six months ended June 30, 2004, from $176.6 million for the six months ended June 30, 2003, and increased as a percentage of revenue to 49.0 percent from 46.6 percent. The increase in payroll and related expenses as a percentage of revenue was primarily attributable to the CRM division, which was formed with the acquisition of RMH on April 2, 2004. The CRM division has a more significant amount of payroll and related expenses as compared to the ARM business. ARM U.S.'s payroll and related expenses increased $6.5 million to $175.4 million for the six months ended June 30, 2004, from $168.9 million for the six months ended June 30, 2003, and decreased slightly as a percentage of revenue to 48.6 percent from 48.9 percent. The decrease in the payroll and related expenses as a percentage of revenue was attributable to the deferral of $2.7 million of revenue from the long-term contract recorded for the six months ended June 30, 2003. Portfolio Management's payroll and related expenses increased $89,000 to $1.1 million for the six months ended June 30, 2004, from $1.0 million for the six months ended June 30, 2003, but decreased as a percentage of revenue to 2.5 percent from 2.9 percent. Portfolio Management outsources all of the collection services to ARM U.S. 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 $6.0 million to $25.2 million for the six months ended June 30, 2004, from $19.2 million for the six months ended June 30, 2003, and increased as a percentage of revenue to 59.6 percent from 58.0 percent. The increase as a percentage of revenue was attributable to an increase in outsourcing services because those services typically have a higher payroll cost structure than the remainder of ARM International's business. However, the higher payroll costs are generally offset by a lower selling, general and administrative cost structure. A portion of this increase was offset by the effect of the continued focus on managing the amount of labor required to attain revenue goals. Selling, general and administrative expenses. Selling, general and administrative expenses increased $20.7 million to $160.4 million for the six months ended June 30, 2004, from $139.7 million for the six months ended June 30, 2003, but decreased as a percentage of revenue to 35.1 percent from 37.0 percent. The decrease in selling, general and administrative expenses as a percentage of revenue was primarily attributable to the CRM division, which was formed with the acquisition of RMH on April 2, 2004. The CRM division has a more significant portion of their expense structure in payroll and related expenses as compared to the ARM business. -25- Depreciation and amortization. Depreciation and amortization increased to $18.9 million for the six months ended June 30, 2004, from $15.9 million for the six months ended June 30, 2003. The increase was attributable to the amortization of the customer relationships and property and equipment acquired in the RMH acquisition on April 2, 2004. Other income (expense). Interest and investment income included investment income of $1.0 million for the six months ended June 30, 2004, as compared to $952,000 for the six months ended June 30, 2003, from the 50 percent ownership interest in a joint venture that purchases utility, medical and other various small balance accounts receivable. Interest expense decreased to $10.5 million for the six months ended June 30, 2004, from $11.7 million for the six months ended June 30, 2003. The decrease was attributable to lower principal balances as a result of debt repayments made in excess of borrowings against the credit facility during 2004 and 2003, and lower interest rates. The decrease was partially offset by Portfolio Management's additional nonrecourse borrowings from Cargill to purchase accounts receivable. Other income for the six months ended June 30, 2004, included a $621,000 gain related to a benefit from a deferred compensation plan assumed as part of the acquisition of FCA International Ltd. in May 1998. Other income for the six months ended June 30, 2003, included $476,000 of income from our ownership interest in one of our insurance carriers that was sold and $250,000 of income from a partial recovery from a third party of an environmental liability. Income tax expense. Income tax expense for the six months ended June 30, 2004, increased to $18.0 million, or 39.9 percent of income before income tax expense, from $13.7 million, or 37.9 percent of income before income tax expense, for the six months ended June 30, 2003. The increase in the effective tax rate was primarily attributable to the liability recorded related to the proposed settlement offer we made during the three months ended June 30, 2004 related to the Federal Trade Commission's claim against us for alleged violations of the Fair Credit Reporting Act relating to certain aspects of our credit reporting practices during 1999 and 2000. We received incorrect information from the prior service provider at the time of transition and we believe that we may assert certain claims for indemnification from the owners of the consumer accounts. The expense recorded for the claim is not deductible for taxes purposes. However, the reimbursement from the indemnification, if any, may be taxable. The nondeductible expense results in an increase in the effective rate for the first six months of 2004. The increase was also attributable to changes in state income taxes. 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 $55.3 million for the six months ended June 30, 2004, compared to $35.7 million for the six months ended June 30, 2003. The increase in cash provided by operations was partially attributable to increases in net income and non-cash expenses, and a $2.1 million increase in accounts payable and accrued expenses for the six months ended June 30, 2004, as compared to a $4.3 million decrease for the same period in the prior year. A portion of the increase was also attributable to the transfer of $4.5 million out of restricted cash during the first quarter of 2004 to repay a portion of the securitized nonrecourse debt. The increase was partially offset by a larger increase in trade accounts receivable during the six months ended June 30, 2004. -26- Cash Flows from Investing Activities. Cash used in investing activities was $2.4 million for the six months ended June 30, 2004, compared to $2.3 million for the six months ended June 30, 2003. The increase in cash used in investing activities was primarily attributable to the cash paid for RMH related acquisition costs and higher purchases of property and equipment during the six months ended June 30, 2004. These increases were partially offset by lower purchases of accounts receivable and higher collections applied to purchased accounts receivable during the six months ended June 30, 2004. Cash Flows from Financing Activities. Cash used in financing activities was $39.7 million for the six months ended June 30, 2004, compared to $29.8 million for the six months ended June 30, 2003. The increase in cash used in financing activities in the first quarter of 2004 resulted from the repayment of a note payable assumed in connection with the RMH acquisition and higher repayments of borrowings under nonrecourse debt used to purchase large accounts receivable portfolios. These increases were partially offset from the issuance of common stock in connection with stock option exercises. Credit Facility. On August 13, 2003, we amended our credit agreement with Citizens Bank of Pennsylvania, referred to as Citizens Bank, for itself and as administrative agent for other participating lenders. The amendment extended the maturity date from May 20, 2004 to March 15, 2006, referred to as the Maturity Date. The amended credit facility is structured as a $150.0 million term loan and a $50.0 million revolving credit facility. We are required to make quarterly repayments of $6.3 million on the term loan until the Maturity Date. The remaining balance outstanding under the term loan and the balance under the revolving credit facility will become due on the Maturity Date. As of June 30, 2004, there was $47.2 million available under the revolving credit facility. The credit agreement contains certain financial and other covenants, such as maintaining net worth and funded debt to earnings before interest, taxes, depreciation, and amortization, referred to as 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 June 30, 2004, we were in compliance with all required financial covenants and we were not aware of any events of default. Convertible Notes. In April 2001 we completed the sale of $125.0 million aggregate principal amount of 4.75 percent convertible subordinated notes due 2006, referred to as the Notes, in a private placement pursuant to Rule 144A and Regulation S under the Securities Act of 1933. The Notes are convertible into our common stock at an initial conversion price of $32.92 per share. We used the $121.3 million of net proceeds from this offering to repay debt under our credit agreement. Nonrecourse Debt. In August 2002, NCO Portfolio entered into a four-year financing agreement with Cargill to provide financing for larger purchases of accounts receivable at 90 percent of the purchase price, unless otherwise negotiated. Cargill, at its sole discretion, has the right to finance any purchase of $4.0 million or more. Cargill may or may not choose to finance a transaction. This agreement gives NCO Portfolio the financing to purchase larger portfolios that it 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 4.25 percent at June 30, 2004) and are nonrecourse to NCO Portfolio and us, except for the assets financed through Cargill. Debt service payments equal total collections less servicing fees and expenses until each individual borrowing is fully repaid and NCO Portfolio's original investment is returned, including interest. Thereafter, Cargill 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. Total debt outstanding under this facility as of June 30, 2004, was $14.5 million, including $5.8 million of accrued residual interest. As of June 30, 2004, NCO Portfolio was in compliance with all of the financial covenants. Contractual Obligations. On April 2, 2004, in connection with the acquisition of RMH, we assumed purchase obligations of $4.8 million and capital lease commitments of $12.2 million. -27- OFF-BALANCE SHEET ARRANGEMENTS NCO Portfolio 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 NCO Portfolio's investment in the Joint Venture of $4.1 million and $4.0 million as of June 30, 2004 and December 31, 2003, respectively. Included in the Statements of Income, as "interest and investment income," was, $442,000 and $479,000 for the three months ended June 30, 2004 and 2003, respectively, representing NCO Portfolio's 50 percent share of operating income from this unconsolidated subsidiary. Income of $1.0 million and $952,000 was recorded from this unconsolidated subsidiary for the six months ended June 30, 2004 and 2003, respectively. 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. A material change in these 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 $250,000 for each $100 million of variable debt outstanding for the entire year. A 10 percent change in the foreign currency exchange rates could have a material impact on our business. 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. CRITICAL ACCOUNTING POLICIES 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 that the following accounting policies include the estimates that are the most critical and could have the most potential impact on our results of operations: goodwill, customer relationships, revenue recognition for purchased accounts receivable, allowance for doubtful accounts, notes receivable and deferred taxes. These and other critical accounting policies are described in note 2 to these financial statements, and in "Management's Discussion and Analysis of Financial Condition and Results of Operations" and note 2 to our 2003 financial statements contained in our Annual Report on Form 10-K for the year ended December 31, 2003. During the six months ended June 30, 2004, we did not make any material changes to our estimates or methods by which estimates are derived with regard to our critical accounting policies except for recording the goodwill and customer relationships from the acquisition of RMH. Customer Relationships. As a result of one acquisition made during 2004 and two acquisitions made during 2002, the recorded value of customer relationships as of June 30, 2004 was $29.5 million. We made significant assumptions to estimate the future revenue and cash flows used to determine the fair value of the customer relationships. These assumptions included expected life, attrition rates, discount factors, future tax rates, and other factors. If the expected revenue and cash flows are not realized impairment losses may be recorded in the future. IMPACT OF RECENTLY ISSUED AND PROPOSED ACCOUNTING PRONOUNCEMENTS SOP 03-3 Accounting for Certain Loans or Debt Securities Acquired in a Transfer. We currently follow the accounting guidance in Practice Bulletin #6 for the accounting for purchased accounts receivable portfolios. Practice Bulletin #6 has been superceded by SOP 03-3 - Accounting for Certain Loans or Debt Securities Acquired in a Transfer, referred to as SOP 03-3. SOP 03-3 is effective for loans acquired in fiscal years beginning after December 15, 2004, although early adoption is permitted. SOP 03-3 applies to all companies that acquire loans for which it is probable at the acquisition date that all contractual amounts due under the acquired loans will not be collected. 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. SOP 03-3 also addresses such loans acquired in purchased business combinations. 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 of accounts receivable acquired. SOP 03-3 requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue, expense, or on the balance sheet. SOP 03-3 freezes the internal rate of return, referred to as the IRR, originally estimated when the accounts receivable are purchased for subsequent impairment testing. Rather than lower the estimated IRR if the original collection estimates are not received, the carrying value of a portfolio is written down to maintain the original IRR. Increases in expected cash flows are to be recognized prospectively through adjustment of the IRR over -28- a portfolio's remaining life up to the limit of the initial cost of the accounts receivable acquired. Loans acquired in the same fiscal quarter with common risk characteristics may be aggregated for the purpose of applying SOP 03-3. We are in the process of determining the effect SOP 03-3 will have on our financial position and results of operations. 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. The consolidation requirements apply immediately to variable interest entities created after January 31, 2003, and apply to existing variable interest entities in the first fiscal year or interim period beginning after June 15, 2003. On January 1, 2004, we adopted FIN 46. We have a $10.8 million note receivable and a $5.5 million note receivable included in our balance sheet under current and long-term other assets as of June 30, 2004. These notes receivable are from two separate companies that comprised our Market Strategy division that were sold during 2000. 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 required to consolidate theses entities under FIN 46. ITEM 3 QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Included in Item 2, Management's Discussion and Analysis of Financial Condition and Results of Operations, of this Report on Form 10-Q. ITEM 4 CONTROLS AND PROCEDURES Our management, with participation of our chief executive officer and chief financial officer, conducted an evaluation as of the end of the period covered by this report, of the effectiveness of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e). Based on that evaluation, our chief executive officer and chief financial officer concluded that 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. During the quarter ended June 30, 2004, there has not occurred any change in our internal control over financial reporting, as defined in Exchange Act Rule 13a-15(f), that has materially affected, or is reasonably likely to materially affect, 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 control systems, no evaluation of controls can provide absolute assurance that all control issues and instances of fraud, if any, within the 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. -29- PART II. OTHER INFORMATION Item 1. Legal Proceedings ----------------- FTC: In October 2003, the Company was notified by the Federal Trade Commission, referred to as the FTC, that it intends to pursue a claim against the Company for violations of the Fair Credit Reporting Act, relating to certain aspects of the Company's credit reporting practices during 1999 and 2000. The allegations relate primarily to a large group of consumer accounts from one client that were transitioned to the Company for servicing during 1999. The Company received incorrect information from the prior service provider at the time of transition. The Company 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, the Company made a settlement offer for this matter to the FTC. The FTC accepted the offer during the second quarter of 2004. The Company is asserting certain claims for indemnification from the owners of the consumer accounts. In connection with the proposed settlement offer made in the first quarter of 2004, the Company recorded its expected exposure to this claim. The Company is also a party to a class action litigation regarding this group of consumer accounts. The class action litigation was settled and was covered by insurance, subject to applicable deductibles. The FTC is also alleging that certain reporting violations occurred on a small subset of the Company's purchased accounts receivable. The Company believes that the resolution of the above matters will not have a material adverse effect on its financial position, results of operations or business. Fort Washington Flood: In June 2001, the first floor of the Company's 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, the Company decided to relocate its corporate headquarters to Horsham, Pennsylvania. The Company 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 the former landlord filed counter-claims against the Company. Due to the uncertainty of the outcome of the lawsuit, the Company 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, but struck from the complaint the breach of fiduciary duty allegations asserting violations of duties owed by individual officers to the Company. Other: The Company is involved in other legal proceedings and regulatory investigations from time to time in the ordinary course of its business. Management believes that none of these other legal proceedings or -30- regulatory investigations will have a materially adverse effect on the financial condition or results of operations of the Company. Item 2. Changes in Securities, Use of Proceeds, and Issuer Purchases of Equity ---------------------------------------------------------------------- Securities ---------- None - not applicable Item 3. Defaults Upon Senior Securities ------------------------------- None - not applicable Item 4. Submission of Matters to a Vote of Shareholders ----------------------------------------------- The Annual Meeting of Shareholders of the Company was held on May 17, 2004. At the Annual Meeting, the shareholders elected William C. Dunkelberg, Ph. D. and Allen F. Wise as directors to serve for a term of three years as described below: Number of Votes --------------- Withhold Name For Authority ---- --- --------- William C. Dunkelberg, Ph. D. 24,092,091 1,656,674 Allen F. Wise 16,320,390 9,428,375 In addition, the terms of the following directors continued after the Annual Meeting: Michael J. Barrist, Charles C. Piola, Jr., Leo J. Pound, and Eric S. Siegel. At the Annual Meeting, the shareholders also approved the 2004 Equity Incentive Plan as follows: For Against Abstain Broker Non-Vote --- ------- ------- --------------- 17,226,240 5,661,302 27,413 2,833,810 Item 5. Other Information ----------------- None - not applicable Item 6. Exhibits and Reports on Form 8-K -------------------------------- (a) Exhibits 3.4 Amended and Restated Bylaws. 10.1 2004 Equity Incentive Plan (compensatory plan). 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) promulgated under the Exchange Act. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) promulgated under the Exchange Act. 32.1 Certification of the Company's Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -31- (b) Reports on Form 8-K Date of ------- Filing / Furnishing Item Reported ------------------- ------------- 5/19/04 Item 7, Item 9 and Item 12 - Conference call transcript from the earnings release for the first quarter of 2004. 5/13/04 Item 7 and Item 9 - Press release announcing the settlement of FTC claim. 5/4/04 Item 7, Item 9 and Item 12 - Press release announcing the earnings for the first quarter of 2004. 4/2/04 Item 5 and Item 7 - Press release announcing completion of the acquisition of RMH Teleservices, Inc. -32- SIGNATURES Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned thereunto duly authorized. Date: August 9, 2004 By: Michael J. Barrist -------------------------------- Michael J. Barrist Chairman of the Board, President and Chief Executive Officer (principal executive officer) Date: August 9, 2004 By: Steven L. Winokur -------------------------------- Steven L. Winokur Executive Vice President of Finance, Chief Financial Officer, Chief Operating Officer of Shared Services and Treasurer (principal financial and accounting officer) -33- Exhibit Index ------------- Exhibit No. Description - ----------- ----------- 3.4 Amended and Restated Bylaws 10.1 2004 Equity Incentive Plan (compensatory plan). 31.1 Certification of Chief Executive Officer pursuant to Rule 13a-14(a) promulgated under the Exchange Act. 31.2 Certification of Chief Financial Officer pursuant to Rule 13a-14(a) promulgated under the Exchange Act. 32.1 Certification of the Company's Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002. -34- EX-3 2 ex3-4.txt EXHIBIT 3.4 EXHIBIT 3.4 NCO GROUP, INC. AMENDED AND RESTATED BYLAWS --------------------------- These Bylaws are supplemental to the Pennsylvania Business Corporation Law as the same shall from time to time be in effect. ARTICLE I. SHAREHOLDERS. Section 101. Place of Shareholders' Meetings. All meetings of the shareholders shall be held at such place or places, inside or outside the Commonwealth of Pennsylvania, as determined by the Board of Directors from time to time. Section 102. Annual Shareholders' Meeting. The annual meeting of the shareholders for the election of directors and the transaction of such other business as may properly come before such meeting shall be held at such time and place as determined by the Board of Directors. Any business which is a proper subject for shareholder action may be transacted at the annual meeting, irrespective of whether the notice of said meeting contains any reference thereto, except as otherwise provided by applicable law. Section 103. Special Meetings of Shareholders. Special meetings of the shareholders may be called at any time by the Board of Directors or the Chairman of the Board or the Chief Executive Officer. Section 104. Conduct of Shareholders' Meetings. The Chairman of the Board shall preside at all shareholders' meetings. In the absence of the Chairman of the Board, the Lead Director shall preside or, in his or her absence, the Chief Executive Officer shall preside or, in his or her absence, any officer designated by the Board of Directors shall preside. The officer presiding over the shareholders' meeting may establish such rules and regulations for the conduct of the meeting as he or she may deem to be reasonably necessary or desirable for the orderly and expeditious conduct of the meeting. Unless the officer presiding over the shareholders' meeting otherwise requires, shareholders need not vote by ballot on any questions. ARTICLE II. DIRECTORS. Section 201. Management by Board of Directors. The business and affairs of the Corporation shall be managed by its Board of Directors. The Board of Directors may exercise all such powers of the Corporation and do all such lawful acts and things as are not by statute, regulation, the Amended and Restated Articles of Incorporation or these Amended and Restated Bylaws directed or required to be exercised or done by the shareholders. Section 202. Nomination for Directors and Submission of Proposals. (a) Nominations for directors to be elected may be made at a meeting of shareholders only by (i) the Board of Directors (or any committee thereof), or (ii) a shareholder of the Corporation entitled to vote for the election of directors at the meeting who complies with the procedure set forth in Section 202(b) of these Bylaws. Business may be conducted at a meeting of the shareholders of the Corporation only if such business (i) was specified in the notice of meeting (or any supplement thereto) given by the Board of Directors, (ii) is otherwise properly brought before the meeting by the Board of Directors, or (iii) is otherwise properly brought before the meeting by a shareholder of the Corporation in accordance with the procedure set forth in Section 202(b) of these Bylaws. (b) Beginning with the annual meeting of the shareholders to be held in 1997, nominations by shareholders for directors to be elected, or proposals by shareholders to be considered, at a meeting of shareholders and which have not been previously approved by the Board of Directors must be submitted to the Secretary of the Corporation in writing, either by personal delivery, nationally-recognized express mail or United States mail, postage prepaid, not later than (i) with respect to an election to be held, or a proposal to be considered, at an annual meeting of shareholders, the latest date upon which shareholder proposals must be submitted to the Corporation for inclusion in the Corporation's proxy statement relating to such meeting pursuant to Rule 14a-8 under the Securities Exchange Act of 1934, as amended, or other applicable rules or regulations under the federal securities laws or, if no such rules apply, at least ninety (90) days prior to the date one year from the date of the immediately preceding annual meeting of shareholders, and (ii) with respect to an election to be held, or a proposal to be considered, at a special meeting of shareholders, the close of business on the tenth day following the date on which notice of such meeting is first given to shareholders. Each such nomination or proposal shall set forth: (i) the name and address of the shareholder making the nomination or proposal and the person or persons nominated, or the subject matter of the proposal submitted; (ii) a representation that the shareholder is a holder of record of capital stock of the Corporation entitled to vote at such meeting and intends to appear in person or by proxy at the meeting to vote for the person or persons nominated, or the proposal submitted; (iii) a description of all arrangements and understandings between the shareholder and each nominee and any other person or persons (naming such person or persons) pursuant to which the nomination was made, or the proposal was submitted, by the shareholder; (iv) such other information regarding each nominee proposed by such shareholder as would be required to be included in a proxy statement filed pursuant to the proxy rules of the Securities and Exchange Commission had the nominee been nominated by the Board of Directors; and (v) the consent of each nominee to serve as a director of the Corporation if so elected. All late nominations and proposals shall be rejected. Subject to applicable law and SEC regulations: (a) the Board of Directors shall have the sole authority to select the nominees to be considered for election or appointment as a director, provided however, the Board of Directors shall have the right to establish a Nominating Committee with the sole authority to select, or recommend to the Board of Directors, the nominees to be considered for election or appointment as a director and (b) the Board of Directors shall have the sole authority to accept or reject any shareholder proposal. The officer presiding over the meeting, in his or her sole and -2- absolute discretion, may reject any nomination or proposal not made in accordance with this Section. Notwithstanding the foregoing, at any time prior to the election of directors at a meeting of shareholders, the Board of Directors may designate a substitute nominee to replace any bona fide nominee who was nominated as set forth above and who, for any reason, becomes unavailable for election as a director. Section 203. Number and Classification of Directors. The Board of Directors shall consist of not less than three (3) and not more than seven (7) directors. Effective upon completion of the Corporation's initial public offering of securities under the federal Securities Act of 1933, as amended, the directors shall be divided into three (3) classes, as nearly equal in number as possible, known as Class I, consisting of not more than two (2) directors; Class II, consisting of not more than two (2) directors; and Class III, consisting of not more than three (3) directors. The initial directors of Class I shall serve until the annual meeting of shareholders to be held in 1997. At the 1997 annual meeting of the shareholders, the directors of Class I shall be elected for a term of three (3) years and, after expiration of such term, shall thereafter be elected every three (3) years for three (3) year terms. The initial directors of Class II shall serve until the annual meeting of the shareholders to be held in 1998. At the 1998 annual meeting of the shareholders, the directors of Class II shall be elected for a term of three (3) years and, after the expiration of such term, shall thereafter be elected every three (3) years for three (3) year terms. The initial directors of Class III shall serve until the annual meeting of shareholders to be held in 1999. At the 1999 annual meeting of the shareholders, the directors of Class III shall be elected for a term of three (3) years and, after the expiration of such term, shall thereafter be elected every three (3) years for three (3) year terms. The number of directors to be elected, subject to the foregoing limits, shall be determined from time to time by the Board of Directors. Each director shall serve until his or her successor shall have been elected and shall qualify, even though his or her term of office as herein provided has otherwise expired, except in the event of his or her earlier resignation, removal or disqualification. Section 204. Vacancies in the Board of Directors. Subject to the rights of the holders of any series of the Corporation's Preferred Stock then outstanding, vacancies in the Board of Directors, including vacancies resulting from an increase in the number of directors, shall be filled by the affirmative vote of at least a majority of the remaining members of the Board, even though less than a quorum, and each person so elected shall be a director until his successor is elected by the shareholders. Any director elected to fill a vacancy in the Board of Directors shall become a member of the same class of directors in which the vacancy existed; but if the vacancy is due to an increase in the number of directors, a majority of the members of the Board of Directors shall designate such directorship as belonging to Class I, Class II or Class III so as to maintain the three (3) classes of directors as nearly equal in number as possible. Each director so elected shall hold office for the unexpired term of the class to which he has been elected, and thereafter until his or her successor shall have been duly elected and qualified, except in the event of his or her earlier resignation, removal or disqualification. Section 205. Resignations of Directors. Any director may resign at any time. Such resignation shall be in writing, but the acceptance thereof shall not be necessary to make it effective. -3- Section 206. Compensation of Directors. No director shall be entitled to any salary as such, but the Board of Directors may fix, from time to time, a reasonable annual fee for acting as a director, a member of committee or chairman thereof and/or a reasonable fee to be paid each director for his or her services in attending meetings of the Board or committees thereof. Section 207. Regular Meetings. Regular meetings of the Board of Directors shall be held on such day, at such hour, and at such place, consistent with applicable law, as the Board shall from time to time designate or as may be designated in any notice from the Secretary calling the meeting. The Board of Directors shall meet for reorganization at the first regular meeting following the annual meeting of shareholders at which the directors are elected. Notice need not be given of regular meetings of the Board of Directors which are held at the time and place designated by the Board of Directors. If a regular meeting is not to be held at the time and place designated by the Board of Directors, notice of such meeting, which need not specify the business to be transacted thereat and which may be either oral or written (which shall include e-mail and facsimile), shall be given by the Secretary to each member of the Board at least twenty-four hours before the time of the meeting. Section 208. Special Meetings. Special meetings of the Board of Directors may be called by the Chairman of the Board, the Lead Director or the Chief Executive Officer and shall be called whenever a majority of the members of the Board so request in writing. A special meeting of the Board of Directors shall be deemed to be any meeting other than the regular meeting of the Board of Directors. Notice of the time and place of every special meeting, which need not specify the business to be transacted thereat and which may be either oral or written (which shall include e-mail and facsimile), shall be given by the Secretary to each member of the Board at least twenty-four hours before the time of such meeting. Section 209. Reports and Records. The reports of officers and committees and the records of the proceedings of all committees shall be filed with the Secretary of the Corporation and presented to the Board of Directors, if practicable, at its next regular meeting. The Board of Directors shall keep complete records of its proceedings in a minute book kept for that purpose. When a director shall request it, the vote of each director upon a particular question shall be recorded in the minutes. Section 210. Committees. The following committees of the Board of Directors may be established by the Board of Directors in addition to any other committee the Board of Directors may in its discretion establish: (a) Executive Committee; (b) Audit Committee; (c) Compensation Committee; and (d) Nominating and Corporate Governance Committee. Section 211. Executive Committee. The Executive Committee shall consist of at least two (2) directors. Meetings of the Committee may be called at any time by the Chairman of the Executive Committee and shall be called whenever two or more members of the Committee so request in writing. The Executive Committee shall have and exercise the authority of the Board of Directors in the management of the business of the Corporation between the dates of regular meetings of the Board. -4- Section 212. Audit Committee. The Audit Committee shall consist of at least three (3) directors, who shall meet such qualifications as shall be set forth in the Audit Committee Charter as approved by the Board of Directors from time to time. The Audit Committee shall have the authority, powers and responsibilities as shall be set forth in the Audit Committee Charter. Section 213. Compensation Committee. The Compensation Committee shall consist of at least three (3) directors, who shall meet such qualifications as shall be set forth in the Compensation Committee Charter as approved by the Board of Directors from time to time. The Compensation Committee shall have the authority, powers and responsibilities as shall be set forth in the Compensation Committee Charter. Section 214. Nominating and Corporate Governance Committee. The Nominating and Corporate Governance Committee shall consist of at least two (2) directors, who shall meet such qualifications as shall be set forth in the Nominating and Corporate Governance Committee Charter as approved by the Board of Directors from time to time. The Nominating and Corporate Governance Committee shall have the authority, powers and responsibilities as shall be set forth in the Nominating and Corporate Governance Committee Charter. Section 215. Appointment of Committee Members. The Board of Directors shall appoint or shall establish a method of appointing the members of the Executive, Audit, Compensation and Nominating and Corporate Governance Committees and of any other committee established by the Board of Directors, and the Chairman of each such committee, to serve until the next annual meeting of shareholders. Section 216. Organization and Proceedings. Each committee of the Board of Directors shall effect its own organization by the appointment of a Secretary and such other officers, including the Chairman if not otherwise appointed by the Board of Directors, as it may deem necessary. The Secretary of the Executive Committee shall be the Secretary of the Corporation, but the Secretary of the Audit, Compensation and Nominating and Corporate Governance Committees and of any other committee need not be the Secretary of the Corporation. A record of the proceedings of all committees shall be kept by the Secretary of such committee and filed and presented as provided in Section 209 of these Bylaws. Section 217. Absentee Participation in Meetings. A director may participate in a meeting of the Board of Directors or a meeting of a committee established by the Board of Directors by use of a conference telephone or similar communications equipment, by means of which all persons participating in the meeting can hear each other. Section 218. Lead Director. The Board of Directors may appoint an independent director as "Lead Director." If appointed, the Lead Director may (i) organize and preside over executive sessions of the independent directors; (ii) preside over meetings of the Board in the absence of the Chairman; (iii) act as the principal liaison between the independent directors and the Chief Executive Officer; (iv) call special meetings of the Board of Directors or independent directors; and (v) exercise and perform such other powers and duties as may from time to time be assigned to him or her by the Board of Directors. -5- ARTICLE III. OFFICERS. Section 301. Officers. The officers of the Corporation shall be a Chairman of the Board, a Chief Executive Officer, a President, one or more Executive Vice Presidents, Senior Vice Presidents or Vice Presidents, a Secretary, a Treasurer, and such other officers and assistant officers as the Board of Directors may from time to time deem advisable. Except for the Chairman of the Board, Chief Executive Officer, President, Secretary and Treasurer, the Board may refrain from filling any of the said offices at any time and from time to time. The same individual may hold any two or more offices. The following officers shall be elected by the Board of Directors at the time, in the manner and for such terms as the Board of Directors from time to time shall determine: Chairman of the Board, Chief Executive Officer, President, Secretary, and Treasurer. The Chief Executive Officer may appoint such other officers and assistant officers as he may deem advisable provided such officers or assistant officers have a title no higher than Executive Vice President, who shall hold office for such periods as the Chief Executive Officer shall determine. Any officer may be removed by the Board of Directors or the Chief Executive Officer (except that the President may not remove the Chairman of the Board, President, Secretary and Treasurer) at any time, with or without cause, and regardless of the term for which such officer was elected. Section 302. Chairman of the Board. The Chairman of the Board shall be a member of the Board of Directors and shall preside at the meetings of the Board and perform such other duties as may be prescribed by the Board of Directors. Section 303. Chief Executive Officer. The Chief Executive Officer shall have general supervision of all of the departments and business of the Corporation; he or she shall prescribe the duties of the other officers and employees and see to the proper performance thereof. The Chief Executive Officer shall be responsible for having all orders and resolutions of the Board of Directors carried into effect. The Chief Executive Officer shall execute on behalf of the Corporation and may affix or cause to be affixed a seal to all authorized documents and instruments requiring such execution, except to the extent that signing and execution thereof shall have been delegated to some other officer or agent of the Corporation by the Board of Directors or by the Chief Executive Officer. In the absence or disability of the Chairman of the Board or the Lead Director or their refusal to act, the Chief Executive Officer shall preside at meetings of the Board. In general, the Chief Executive Officer shall perform all the duties and exercise all the powers and authorities incident to his or her office or as prescribed by the Board of Directors. Section 304. President. The President shall perform such duties as are incident to his or her office or prescribed by the Board of Directors or the Chief Executive Officer. In the event of the absence or disability of the Chief Executive Officer or his or her refusal to act, the President shall perform the duties and have the powers and authorities of the Chief Executive Officer. The President shall execute on behalf of the Corporation and may affix or cause to be affixed a seal to all authorized documents and instruments requiring such execution, except to the extent that signing and execution thereof shall have been delegated to some other officer or agent of the Corporation by the Board of Directors or the President. -6- Section 305. Vice Presidents. The Vice Presidents, including Executive Vice Presidents and Senior Vice Presidents, shall perform such duties, do such acts and be subject to such supervision as may be prescribed by the Board of Directors, the Chief Executive Officer or the President. In the event of the absence or disability of the Chief Executive Officer and the President or their refusal to act, the Vice Presidents, in the order of their rank, and within the same rank in the order of their seniority, shall perform the duties and have the powers and authorities of the Chief Executive Officer and President, except to the extent inconsistent with applicable law. Section 306. Secretary. The Secretary shall act under the supervision of the Chief Executive Officer and President or such other officer as the Chief Executive Officer or President may designate. Unless a designation to the contrary is made at a meeting, the Secretary shall attend all meetings of the Board of Directors and all meetings of the shareholders and record all of the proceedings of such meetings in a book to be kept for that purpose, and shall perform like duties for the standing committees when required by these Bylaws or otherwise. The Secretary shall keep a seal of the Corporation, and, when authorized by the Board of Directors, Chief Executive Officer or the President, cause the seal to be affixed to any documents and instruments requiring it. The Secretary shall perform such other duties as may be prescribed by the Board of Directors, Chief Executive Officer, President or such other supervising officer as the Chief Executive Officer or President may designate. Section 307. Treasurer. The Treasurer shall act under the supervision of the Chief Executive Officer and President or such other officer as the Chief Executive Officer or President may designate. The Treasurer shall have custody of the Corporation's funds and such other duties as may be prescribed by the Board of Directors, Chief Executive Officer, President or such other supervising officer as the Chief Executive Officer or President may designate. Section 308. Assistant Officers. Unless otherwise provided by the Board of Directors, each assistant officer shall perform such duties as shall be prescribed by the Board of Directors, Chief Executive Officer, President or the officer to whom he or she is an assistant. In the event of the absence or disability of an officer or his or her refusal to act, his or her assistant officers shall, in the order of their rank, and within the same rank in the order of their seniority, have the powers and authorities of such officer. Section 309. Compensation. Unless otherwise provided by the Board of Directors or the Compensation Committee and subject to the authority and responsibilities of the Compensation Committee set forth in the Compensation Committee Charter, the salaries and compensation of all officers and assistant officers, except the Chairman of the Board, Chief Executive Officer and President, shall be fixed by or in the manner designated by the Chief Executive Officer. Section 310. General Powers. The officers are authorized to do and perform such corporate acts as are necessary in the carrying on of the business of the Corporation, subject always to the directions of the Board of Directors. -7- ARTICLE IV. PERSONAL LIABILITY AND INDEMNIFICATION. Section 401. Personal Liability of Directors. (a) A director of this Corporation shall not be personally liable, as such, for monetary damages for any action taken, or any failure to take any action, unless: (i) the director has breached or failed to perform the duties of his office under Chapter 17, Subchapter B of the Pennsylvania Business Corporation Law of 1988 (which, as amended from time to time, is hereafter called the Business Corporation Law); and (ii) the breach or failure to perform constitutes self-dealing, willful misconduct or recklessness. (b) This Section 401 shall not apply to a director's liability for monetary damages to the extent prohibited by Section 1713(b) of the Business Corporation Law. Section 402. Mandatory Indemnification. The Corporation shall, to the fullest extent permitted by applicable law, indemnify its directors and officers who were or are a party or are threatened to be made a party to any threatened, pending or completed action, suit or proceeding, whether civil, criminal, administrative or investigative (whether or not such action, suit or proceeding arises or arose by or in the right of the Corporation or other entity) by reason of the fact that such director or officer is or was a director or officer of the Corporation or is or was serving at the request of the Corporation as a director, officer, employee, general partner, agent or fiduciary of another corporation, partnership, joint venture, trust or other enterprise (including service with respect to employee benefit plans), against expenses (including, but not limited to, reasonable attorneys' and investigation fees and costs), judgments, fines (including excise taxes assessed on a person with respect to any employee benefit plan) and amounts paid in settlement actually and reasonably incurred by such director or officer in connection with such action, suit or proceeding, except as otherwise provided in Section 404 hereof. Persons who were directors or officers of the Corporation prior to the date this Section is approved by members of the Corporation, but who do not hold such office on or after such date, shall not be covered by this Section 402. A director or officer of the Corporation entitled to indemnification under this Section 402 is hereafter called a "person covered by Section 402 hereof". Section 403. Expenses. Expenses incurred by a person covered by Section 402 hereof in defending a threatened, pending or completed civil or criminal action, suit or proceeding shall be paid by the Corporation in advance of the final disposition of such action, suit or proceeding upon receipt of an undertaking by or on behalf of such person to repay such amount if it shall ultimately be determined that such person is not entitled to be indemnified by the Corporation, except as otherwise provided in Section 404. -8- Section 404. Exceptions. No indemnification under Section 402 or advancement or reimbursement of expenses under Section 403 shall be provided to a person covered by Section 402 hereof: (a) with respect to expenses or the payment of profits arising from the purchase or sale of securities of the Corporation in violation of Section 16(b) of the Securities Exchange Act of 1934, as amended; (b) if a final unappealable judgment or award establishes that such director or officer engaged in intentional misconduct or a transaction from which the director or officer derived an improper personal benefit; (c) for expenses or liabilities of any type whatsoever (including, but not limited to, judgments, fines, and amounts paid in settlement) which have been paid directly to, or for the benefit of, such person by an insurance carrier under a policy of officers' and directors' liability insurance whose premiums are paid for by the Corporation or by an individual or entity other than such director or officer; and (d) for amounts paid in settlement of any threatened, pending or completed action, suit or proceeding without the written consent of the Corporation, which written consent shall not be unreasonably withheld. The Board of Directors of the Corporation is hereby authorized, at any time by resolution, to add to the above list of exceptions from the right of indemnification under Section 402 or advancement or reimbursement of expenses under Section 403, but any such additional exception shall not apply with respect to any event, act or omission which occurred prior to the date that the Board of Directors in fact adopts such resolution. Any such additional exception may, at any time after its adoption, be amended, supplemented, waived or terminated by further resolution of the Board of Directors of the Corporation. Section 405. Continuation of Rights. The indemnification and advancement or reimbursement of expenses provided by, or granted pursuant to, this Article IV shall continue as to a person who has ceased to be a member, director or officer of the Corporation, and shall inure to the benefit of the heirs, executors and administrators of such person. Section 406. General Provisions. (a) The term "to the fullest extent permitted by applicable law", as used in this Article IV shall mean the maximum extent permitted by public policy, common law or statute. Any person covered by Section 402 hereof may, to the fullest extent permitted by applicable law, elect to have the right to indemnification or to advancement or reimbursement of expenses, interpreted, at such person's option; (i) on the basis of the applicable law on the date this Section was approved by the shareholders; or (ii) on the basis of the applicable law in effect at the time of the occurrence of the event, act or omission giving rise to the action, suit or proceeding, or (iii) on the basis of the applicable law in effect at the time indemnification is sought. -9- (b) The right of a person covered by Section 402 hereof to be indemnified or to receive an advancement or reimbursement of expenses pursuant to Section 403 (i) may be enforced as a contract right pursuant to which the person entitled thereto may bring suit as if the provisions hereof were set forth in a separate written contract between the Corporation and such person; (ii) to the fullest extent permitted by applicable law, is intended to be retroactive and shall be available with respect to events, acts or omissions occurring prior to the adoption hereof; and (iii) shall continue to exist after the rescission or restrictive modification (as determined by such person) of any provision of this Article IV with respect to events, acts and omissions occurring before such rescission or restrictive modification is adopted. (c) If a request for indemnification or for the advancement or reimbursement of expenses pursuant hereto is not paid in full by the Corporation within thirty (30) days after a written claim has been received by the Corporation together with all supporting information reasonably requested by the Corporation, the claimant may at any time thereafter bring suit against the Corporation to recover the unpaid amount of the claim (plus interest at the prime rate announced from time to time by the Corporation's primary lending bank) and, if successful in whole or in part, the claimant shall be entitled also to be paid the expenses (including, but not limited to, attorneys' and investigation fees and costs) of prosecuting such claim. Neither the failure of the Corporation (including its Board of Directors or independent legal counsel) to have made a determination prior to the commencement of such action that indemnification of or the advancement or reimbursement of expenses to the claimant is proper in the circumstances, nor an actual determination by the Corporation (including its Board of Directors or independent legal counsel) that the claimant is not entitled to indemnification or to the reimbursement or advancement of expenses, shall be a defense to the action or create a presumption that the claimant is not so entitled. (d) The indemnification and advancement or reimbursement of expenses provided by, or granted pursuant to, this Article IV shall not be deemed exclusive of any other rights to which those seeking indemnification or advancement or reimbursement of expenses may be entitled under any bylaw, agreement, vote of shareholders or disinterested directors or otherwise. (e) Nothing contained in this Article IV shall be construed to limit the rights and powers the Corporation possesses under Chapter 17, Subchapter D of the Business Corporation Law, or otherwise, including, but not limited to, the powers to purchase and maintain insurance, create funds to secure or insure its indemnification obligations, and any other rights or powers the Corporation may otherwise have under applicable law. (f) The provisions of this Article IV may, at any time (and whether before or after there is any basis for a claim for indemnification or for the advancement or reimbursement of expenses pursuant hereto), be amended, supplemented, waived, or terminated, in whole or in part, with respect to any person covered by Section 402 hereof by a written agreement signed by the Corporation and such person. (g) The Corporation shall have the right to appoint the attorney for a person covered by Section 402 hereof, provided such appointment is not unreasonable under the circumstances. -10- Section 407. Optional Indemnification. The Corporation may, to the fullest extent permitted by applicable law, indemnify, and advance or reimburse expenses for, persons in all situations other than that covered by Section 402. ARTICLE V. SHARES OF CAPITAL STOCK. Section 501. Authority to Sign Share Certificate. Every share certificate of the Corporation shall be signed by the Chairman, Chief Executive Officer or the President and by the Secretary or one of the Assistant Secretaries. If the certificate is signed by a transfer agent or registrar, the signature of any officer of the Corporation on the certificate may be facsimile, engraved or printed. Section 502. Lost or Destroyed Certificates. Any person claiming a share certificate to be lost, destroyed or wrongfully taken shall receive a replacement certificate if such shareholder: (a) requests such replacement certificate before the Corporation has notice that the shares have been acquired by a bona fide purchaser; (b) files with the Corporation an indemnity bond deemed sufficient by the Board of Directors; and (c) satisfies any other reasonable requirements fixed by the Board of Directors. ARTICLE VI. GENERAL. Section 601. Fiscal Year. The fiscal year of the Corporation shall be determined by the Board of Directors. Section 602. Record Date. The Board of Directors may fix any time prior to the date of any meeting of shareholders as a record date for the determination of shareholders entitled to notice of, or to vote at, the meeting, which time, except in the case of an adjourned meeting, shall be not more than ninety (90) days prior to the date of the meeting of shareholders. The Board of Directors may fix any time whatsoever (whether or not the same is more than ninety (90) days) prior to the date for the payment of any dividend or distribution, or the date for the allotment of rights, or the date when any change or conversion or exchange of shares will be made or will go into effect, as a record date for the determination of the shareholders entitled to receive payment of any such dividend or distribution, or to receive any such allotment of rights, or to exercise the rights in respect to any such change, conversion or exchange of shares. Section 603. Emergency Bylaws. In the event of any emergency resulting from an attack on the United States, a nuclear disaster or another catastrophe as a result of which a quorum cannot be readily assembled and during the continuance of such emergency, the following Bylaw provisions shall be in effect, notwithstanding any other provisions of these Bylaws. (a) A meeting of the Board of Directors or of any committee thereof may be called by any officer or director upon one hour's notice to all persons entitled to notice whom, in the sole judgment of the notifier, it is feasible to notify; -11- (b) The director or directors in attendance at the meeting of the Board of Directors or of any committee thereof shall constitute a quorum; and (c) These Bylaws may be amended or repealed, in whole or in part, by a majority vote of the directors attending any meeting of the Board of Directors, provided such amendment or repeal shall only be effective for the duration of such emergency. Section 604. Severability. If any provision of these Bylaws is illegal or unenforceable as such, such illegality or unenforceability shall not affect any other provision of these Bylaws and such other provisions shall continue in full force and effect. ARTICLE VII. AMENDMENTS. Section 701. Amendment or Repeal by the Board of Directors. Except as provided by applicable law, these Bylaws may be amended or repealed, in whole or in part, by a majority vote of the incumbent directors (as defined herein) on the Board of Directors. The term "incumbent director", as used herein, shall mean any director of the Corporation on the date hereof and any other director whose election or appointment by the Board of Directors of the Corporation, or whose nomination for election by the shareholders of the Corporation, was approved by a vote of at least a majority of the directors then in office who either were directors on the date hereof or whose election or appointment or nomination for election was previously so approved. Section 702. Amendment or Repeal by Shareholders. These Bylaws may be amended or repealed, in whole or in part, by shareholders as follows: (i) in the case of an amendment or repeal which has previously received the approval of at least a majority of the incumbent directors (as defined herein) on the Board of Directors, by a majority of the votes cast by shareholders at any duly convened annual or special meeting of the shareholders; and (ii) in the case of an amendment or repeal which has not previously received the approval of at least a majority of the incumbent directors of the Board of Directors, by the affirmative vote of the shareholders entitled to cast at least sixty-five percent (65%) of the votes entitled to be cast by all shareholders at any duly convened annual or special meeting of the shareholders. This Section 702 may be amended or repealed, in whole or in part, only by the affirmative vote of the shareholders entitled to cast at least sixty-five percent (65%) of the votes entitled to be cast by all shareholders at any duly convened annual or special meeting of the shareholders. The term "incumbent director", as used herein, shall mean any director of the Corporation on the date hereof and any other director whose election or appointment by the Board of Directors of the Corporation, or whose nomination for election by the shareholders of the Corporation, was approved by a vote of at least a majority of the directors then in office who either were directors on the date hereof or whose election or appointment or nomination for election was previously so approved. Section 703. Recording Amendments. The text of all amendments to these Bylaws shall be attached hereto, and a notation of the date of its adoption and a notation of whether it was adopted by the directors or the shareholders shall be made in Section 802 hereof. -12- ARTICLE VIII. ADOPTION OF BYLAWS AND RECORD OF AMENDMENTS THERETO. Section 801. Adoption and Effective Date. These Bylaws have been adopted and approved by the Board of Directors of the Corporation on September 27, 1996 and by the shareholders of the Corporation on September 27, 1996. These Bylaws shall be effective as of September 27, 1996. These Bylaws have been amended and restated by the Board of Directors effective as of July 28, 2004. Section 802. Amendments to Bylaws. Section Amended Date Amended Adopted By - --------------- ------------ ---------- EX-10 3 ex10-1.txt EXHIBIT 10.1 Exhibit 10.1 NCO GROUP, INC. 2004 EQUITY INCENTIVE PLAN 1. Purposes The purposes of the NCO Group, Inc. 2004 Equity Incentive Plan (the "Plan") are to (i) promote the long-term retention of employees of NCO Group, Inc. ("NCO"), and its current and future subsidiaries (collectively, the "Company"), directors of NCO and other persons who are in a position to make significant contributions to the success of the Company; (ii) further reward these employees, directors and other persons for their contributions to the Company's growth and expansion; (iii) provide additional incentive to these employees, directors and other persons to continue to make similar contributions in the future; and (iv) to further align the interests of these employees, directors and other persons with those of NCO's shareholders. These purposes will be achieved by granting to such employees and other persons, in accordance with the provisions of this Plan, Options, Stock Appreciation Rights, Restricted Stock or Unrestricted Stock, Deferred Stock, Restricted Stock Units or Performance Awards, for shares of NCO's common stock, no par value per share ("Common Stock"), or Supplemental Grants, or combinations thereof (collectively, "Awards"). 2. Aggregate Number of Awards 2.1. Shares Subject to the Plan and Maximum Awards. The aggregate number of shares of Common Stock for which Awards may be granted under the Plan shall be 2,000,000 shares, with an individual limit of 150,000 shares per fiscal year for each Participant (as defined in Section 3.1) (excluding grants under any initial employment agreement as an inducement material to the individual's entering into employment with the Company). Such maximum numbers of shares are subject to adjustment in accordance with Section 2.5. Treasury shares, reacquired shares (including shares of Common Stock purchased in the open market) and unissued shares of Common Stock may be used for purposes of the Plan, at NCO's sole discretion. No fractional shares of Common Stock shall be delivered under the Plan. 2.2. Forfeited Awards. Shares of Common Stock that were issuable pursuant to an Award that has terminated but with respect to which such Award had not been exercised, shares of Common Stock that are issued pursuant to an Award but that are subsequently forfeited and shares of Common Stock that were issuable pursuant to an Award that was payable in Common Stock or cash but that was satisfied in cash, shall be available for future Awards under the Plan and shall not count toward the maximum number of shares of Common Stock that may be issued under the Plan as set forth in Section 2.1. 2.3. Shares Used to Pay Exercise Price and Taxes. If a Participant pays the exercise price of an Option by surrendering previously owned shares of Common Stock, as may be permitted by the Compensation Committee ("Committee") of the Board of Directors ("Board") of NCO, and/or arranges to have the appropriate number of shares of Common Stock otherwise issuable upon exercise withheld by the Company to cover the withholding tax liability associated with the Option exercise, the surrendered shares of Common Stock and shares of Common Stock used to pay taxes shall not count towards the maximum number of shares of Common Stock that may be issued under the Plan as set forth in Section 2.1. If a Participant, as permitted by the Committee, arranges to have an appropriate number of shares of a Stock Award withheld by the Company to cover the withholding tax liability associated with such Stock Award, the shares of Common Stock used to pay taxes shall not count towards the maximum number of shares of Common Stock that may be issued under the Plan as set forth in Section 2.1. 2.4. Other Items Not Included in Allocation. The maximum number of shares of Common Stock that may be issued under the Plan as set forth in Section 2.1 shall not be affected by (i) the payment in cash of dividends or dividend equivalents in connection with outstanding Awards; (ii) the granting or payment of stock-denominated Awards which by their terms may be settled only in cash; or (iii) Awards that are granted through the assumption of, or in substitution for, outstanding awards previously granted to individuals who have become employees as a result of a merger, consolidation, or acquisition or other corporate transaction involving the Company. 2.5. Adjustments. In the event of any stock dividend, stock split, combination or exchange of equity securities, merger, consolidation, recapitalization, reorganization, divestiture or other distribution (other than ordinary cash dividends) of assets to shareholders, or any other event affecting the Common Stock that the Committee deems, in its sole discretion, to be similar circumstances, the Committee may make such adjustments as it may deem appropriate, in its discretion, to: (i) the maximum number of shares of Common Stock that may be issued under the Plan as set forth in Section 2.1; (ii) the maximum number of shares of Common Stock that may be granted to any single individual pursuant to Section 2.1; (iii) the number or kind of shares subject to an Award; (iv) the Exercise Price applicable to an Award; (v) any measure of performance that relates to an Award in order to reflect such change in the Common Stock; and/or (vi) any other affected terms of any equity-based Award. The Committee may also make such adjustments to take into account material changes in law or in accounting practices or principles, mergers, consolidations, acquisitions, dispositions or similar corporate transactions, or any other event, as the Committee may determine in its sole discretion. 3. Participation 3.1. Eligible Persons. All current and future employees of the Company, including officers ("Employees"), all directors of NCO (including directors who are Employees and directors who are not Employees) and all other persons who are not Employees or directors who, in the opinion of the Committee, are in a position to make a significant contribution to the success of the Company, shall be eligible to receive Awards under the Plan (each, a "Participant"). No eligible Employee, director or other person shall have any right to receive an Award except as expressly provided in the Plan. 3.2. Considerations to Participation. The Participants who shall actually receive Awards under the Plan shall be determined by the Committee in its sole discretion. In making such determinations, the Committee shall consider the positions and responsibilities of eligible Employees and other persons, their past performance and contributions to the Company's growth and expansion, the value of their services to the Company, the difficulty of finding qualified replacements, and such other factors as the Committee deems pertinent in its sole discretion. 2 3.3. Cancellation and Modification of Awards. In the event of a change in a Participant's duties and responsibilities, or a transfer of the Participant to a different position, the Committee may cancel or modify any Award granted to such Participant or adjust the number of shares of Common Stock subject thereto commensurate with the transfer or change in responsibility, as determined by the Committee, in its discretion, provided that no such action shall violate the provisions of Section 5.1(b)(4), and provided further that the Committee may not modify or cancel Awards exercisable at the time of such change in duties or responsibilities or transfer or to which the Participant was irrevocably entitled at the time of such change or transfer. 4. Administration 4.1. Power and Authority. The Committee shall have full and exclusive power to administer and interpret the Plan, to grant Awards and to adopt such administrative rules, regulations, procedures and guidelines governing the Plan and the Awards as it may deem necessary in its discretion, from time to time. The Committee's authority shall include, but not be limited to, the authority to: (i) determine the type of Awards to be granted under the Plan; (ii) select Award recipients and determine the extent of their participation; (iii) determine the method or formula for establishing the fair market value of the Common Stock for various purposes under the Plan; and (iv) establish all other terms, conditions, restrictions and limitations applicable to Awards and the shares of Common Stock issued pursuant to Awards, including, but not limited to, those relating to a Participant's retirement, death, disability, leave of absence or termination of employment. The Committee may accelerate or defer the vesting or payment of Awards, cancel or modify outstanding Awards, waive any conditions or restrictions imposed with respect to Awards or the Common Stock issued pursuant to Awards and make any and all other interpretations and determinations which it deems necessary with respect to the administration of the Plan, subject to the limitations contained in Section 5.1(b)(4) with respect to all Participants and subject to the provisions of Section 162(m) of the Code with respect to "covered employees" as defined thereunder, except that the Committee may not, without the consent of the holder of an Award or unless specifically authorized by the terms of the Plan or an Award, take any action under this clause with respect to such Award if such action would adversely affect the rights of such holder. The Committee's right to make any decision, interpretation or determination under the Plan shall be in its sole and absolute discretion. 4.2. Administrators of the Plan. The Plan shall be administered by the Committee. The Committee may delegate all or any portion of its authority hereunder to one or more subcommittees consisting of at least one Committee member (and references in this Plan to the "Committee" shall thereafter be to the Committee or such subcommittees). Nothing is this Plan shall limit the ability of the Committee to select a class of Award recipients and the extent of their participation and to direct an appropriate officer of the Company to determine the individual participants and amount and nature of the Award to be issued to such participants, subject to such criteria, limitations and instructions as the Committee shall determine. The Committee shall be comprised of no fewer than three members, each of whom must qualify as (i) an "Independent Director" within the meaning of Rule 4200(a)(15) of the listing standards of the Nasdaq Stock Market, Inc. or any future corresponding rule; (ii) a "non-employee director" within the meaning of Rule 16b-3(b)(3) under the Securities Exchange Act of 1934, as amended (the "1934 Act"), or any future corresponding rule; and (iii) an "outside director" within the meaning of the regulations promulgated 3 under Section 162(m) of the Code, or any future corresponding rule, provided that the failure of the Committee or of the Board for any reason to be composed solely of non-employee directors or outside directors shall not prevent an Award from being considered granted under this Plan. 4.3. Administration of the Plan. The Committee may adopt such rules for the administration of the Plan as it deems necessary or advisable, in its sole discretion. For all purposes of the Plan, a majority of the members of the Committee shall constitute a quorum, and the vote of a majority of the members of the Committee (or written consent of all of the members) on a particular matter shall constitute the act of the Committee on that matter. The Committee shall have the exclusive right to construe the Plan and any Award, to settle all controversies regarding the Plan or any Award, to correct defects and omissions in the Plan and in any Award, and to take such further actions as the Committee deems necessary or advisable, in its sole discretion, to carry out the purpose and intent of the Plan. Such actions shall be final, binding and conclusive upon all parties concerned. 4.4. Liability; Indemnification. No member of the Committee shall be liable for any act or omission (whether or not negligent) taken or omitted in good faith, or for the good faith exercise of any authority or discretion granted in the Plan to the Committee, or for any act or omission of any other member of the Committee. The members of the Committee shall be entitled to indemnification and reimbursement to the fullest extent provided in NCO's articles of incorporation, bylaws and applicable law. In the performance of its functions under the Plan, the Committee shall be entitled to rely upon information and advice furnished by NCO's officers, accountants, counsel and other parties the Committee deems necessary, and no member of the Committee shall be liable for any action taken or not taken in reliance upon such advice. 4.5. Costs; Liabilities. All costs incurred in connection with the administration and operation of the Plan shall be paid by the Company. Except for the express obligations of the Company under the Plan and under Awards granted in accordance with the provisions of the Plan, the Company shall have no liability with respect to any Award, or to any Participant or any transferee of shares of Common Stock from any Participant, including, but not limited to, any tax liabilities, capital losses, or other costs or losses incurred by any Participant or any such transferee. 5. Types of Awards 5.1. Options. (a) An Option is an Award entitling the recipient on exercise thereof to purchase Common Stock at a specified exercise price. Both "incentive stock options," as defined in Section 422 of the Code (any Option intended to qualify as an incentive stock option is hereinafter referred to as an "ISO"), and Options that are not incentive stock options (any such Option is hereinafter referred to as a "non-ISO"), may be granted under the Plan. ISOs shall be awarded only to Employees. (b) The exercise price of an Option shall be determined by the Committee subject to the following: 4 (1) The exercise price of an ISO shall not be less than 100% (110% in the case of an ISO granted to a ten percent shareholder) of the fair market value of the Common Stock subject to the ISO, determined as of the time the Option is granted. A ten percent shareholder is any person who at the time of grant owns, directly or indirectly, or is deemed to own by reason of the attribution rules of Section 424(d) of the Code, stock possessing more than 10% of the total combined voting power of all classes of stock of the Company or of any of its subsidiaries. (2) The exercise price of a non-ISO shall not be less than 100% of the fair market value of the Common Stock subject to the non-ISO, determined as of the time the non-ISO is granted. (3) In no case may the exercise price paid for Common Stock which is part of an original issue of authorized Common Stock be less than the par value per share of the Common Stock. (4) In no case may the Committee reduce the exercise price of an Option at any time after the time of grant, including by amendment or cancellation and subsequent issuance, except in the case of an adjustment as set forth in Section 2.5(iv). (5) Notwithstanding (1) and (2) above, an Option (whether an ISO or non-ISO) may be granted with an exercise price determined according to the provisions of Section 424(a) of the Code, if the grant of such Option is pursuant to a transaction described in Section 424(a) of the Code. (c) The period during which an Option may be exercised shall be determined by the Committee, except that the period during which an Option may be exercised shall not exceed ten years (five years, in the case of an ISO granted to a ten percent shareholder) from the day immediately preceding the date the Option was granted. (d) An Option shall become exercisable at such time or times, and on such terms and conditions, as the Committee may determine. The Committee may at any time accelerate the time at which all or any part of the Option may be exercised. Any exercise of an Option must be in writing, signed by the proper person and delivered or mailed to the Company, accompanied by (i) any documents required by the Committee and (ii) payment in full in accordance with Section 5.1(e) below for the number of shares for which the Option is exercised. (e) Stock purchased on exercise of an Option must be paid for as follows: (i) in cash or by check (acceptable to NCO in accordance with guidelines established for this purpose), bank draft or money order payable to the order of NCO or (ii) if so permitted by the instrument evidencing the Option (or in the case of an Option which is not an ISO, by the Board at or after grant of the Option), (A) through the delivery of shares of Common Stock which have been outstanding for at least six months (unless the Board expressly approves a shorter period) and which have a fair market value on the date of exercise at least equal to the exercise price, or (B) by delivery of an unconditional and irrevocable undertaking by a broker to deliver promptly to NCO sufficient funds to pay the exercise price (including in connection with a so-called "cashless exercise" effected by such broker), or (C) by any combination of the permissible forms of payment. 5 (f) In the event a Participant tenders shares of Common Stock to pay the exercise price of an Option and/or arranges to have a portion of the shares otherwise issuable upon exercise withheld or sold to pay the applicable withholding taxes, in no case may the Committee grant "reload" or "restoration" options entitling the Participant to purchase shares of Common Stock equal to the sum of the number of such shares tendered to pay the exercise price and the number of shares used to pay the withholding taxes. (g) Any Employee who disposes of shares acquired upon the exercise of an ISO either (i) within two years after the date of grant of such ISO or (ii) within one year after the transfer of such shares to the Employee shall notify the Company of such disposition and of the amount realized upon such disposition. 5.2. Stock Appreciation Rights. (a) A Stock Appreciation Right ("SAR") is an Award entitling the recipient on its exercise to receive an amount, in cash or Common Stock or a combination thereof (such form to be determined by the Committee), determined in whole or in part by reference to appreciation in Common Stock value. In general, a SAR entitles the Participant to receive, with respect to each share of Common Stock as to which the SAR is exercised, the excess of the share's fair market value on the date of exercise over its fair market value on the date the SAR was granted, except that if a SAR is granted retroactively in substitution for an Option, the fair market value established by the Committee may be the fair market value at the time such Option was granted. Any such substitution of a SAR for an Option granted to a "covered employee" under Section 162(m) of the Code may only be made in compliance with the provisions thereof. (b) Notwithstanding the above, the Committee may provide at the time of grant that the amount the recipient is entitled to receive shall be adjusted upward or downward under rules established by the Committee to take into account the performance of the Common Stock in comparison with the performance of other stocks or an index or indices of other stocks. The Committee may also grant SARs that provide that following a Change in Control of the Company (as defined in Section 6.3(c)) the holder of such SAR shall be entitled to receive, with respect to each share of Common Stock subject to the SAR, an amount equal to the excess of a specified value (which may include an average of values) for a share of Common Stock during a period preceding such Change in Control over the fair market value of a share of Common Stock on the date the SAR was granted. (c) SARs may be granted in tandem with, or independently of, Options granted under the Plan. A SAR granted in tandem with an Option that is not an ISO may be granted either at or after the time the Option is granted. A SAR granted in tandem with an ISO may be granted only at the time the Option is granted. (d) When SARs are granted in tandem with Options, the following rules shall apply: 6 (1) The SAR shall be exercisable only at such time or times, and to the extent, that the related Option is exercisable and shall be exercisable in accordance with the procedure required for exercise of the related Option. (2) The SAR shall terminate and no longer be exercisable upon the termination or exercise of the related Option, except that a SAR granted with respect to less than the full number of shares covered by an Option shall not be reduced until the number of shares as to which the related Option has been exercised or has terminated exceeds the number of shares not covered by the SAR. (3) The Option shall terminate and no longer be exercisable upon the exercise of the related SAR. (4) The SAR shall be transferable only with the related Option. (5) A SAR granted in tandem with an ISO may be exercised only when the market price of the Stock subject to the Option exceeds the exercise price of such option. (e) A SAR not granted in tandem with an Option shall become exercisable at such time or times, and on such terms and conditions, as the Committee may specify. The Committee may at any time accelerate the time at which all or any part of the SAR may be exercised. Any exercise of an independent SAR must be in writing, signed by the proper person and delivered or mailed to NCO, accompanied by any other documents required by the Committee. 5.3. Stock Awards (a) Form of Awards. The Committee may grant Awards ("Stock Awards") which are payable in shares of Common Stock or denominated in units equivalent in value to shares of Common Stock or are otherwise based on or related to shares of Common Stock, including, but not limited to, Awards of Unrestricted Stock, Restricted Stock, Deferred Stock and Restricted Stock Units, subject to such terms, conditions, restrictions and limitations as the Committee may determine to be applicable to such Stock Awards, in its discretion, from time to time. The Committee may consider the impact of the conditions, restrictions or limitations applicable to a Stock Award, as well as the possibility of forfeiture or cancellation, in determining the fair market value for purposes of determining the number of shares of Common Stock allocable to a Stock Award. Without limiting the generality of the foregoing, the Committee may issue Stock Awards to Participants in connection with management or employee stock purchase programs. (b) Unrestricted Stock. Shares of Common Stock may be used as payment for compensation which otherwise would have been delivered in cash (including any compensation that is intended to qualify as performance-based compensation for purposes of Section 162(m) of the Code), and unless otherwise determined by the Committee, no minimum vesting period shall apply to such shares. Any shares of Common Stock used for such payment shall be valued at the fair market value of such shares at the time of payment and shall be subject to such terms, conditions, restrictions and limitations as shall be determined by the Committee at the time of payment. 7 (c) Restricted Stock. A Restricted Stock Award entitles the recipient to acquire shares of Common Stock subject to the restrictions described in Section 5.3(c)(3) ("Restricted Stock") for no consideration, nominal consideration or any higher price, all as determined by the Committee. (1) A Participant who is granted a Restricted Stock Award shall have no rights with respect to such Award unless the Participant accepts the Award by written instrument delivered or mailed to NCO accompanied by payment in full of the specified purchase price, if any, of the shares covered by the Award. Payment may be by certified or bank check or other instrument acceptable to the Committee. (2) A Participant who receives Restricted Stock shall have all the rights of a shareholder with respect to such stock, including voting and dividend rights, subject to the restrictions described in 5.3(c)(3) and any other conditions imposed by the Committee at the time of grant. Unless the Committee otherwise determines, certificates evidencing shares of Restricted Stock shall remain in the possession of the Company until such shares are free of all restrictions under the Plan. (3) Except as otherwise specifically provided by the Plan or the Award, Restricted Stock may not be sold, assigned, exchanged, pledged, gifted or otherwise disposed of, or transferred, and if a Participant suffers a Status Change (as defined in Section 6.1) for any reason (other than by reason of death or permanent disability), must be offered to NCO for purchase for the amount of cash paid for such stock, or forfeited to the Company if no cash was paid. These restrictions shall lapse at such time or times, and on such terms and conditions, as the Committee may determine. The Committee may at any time accelerate the time at which the restrictions on all or any part of the shares shall lapse. (4) Any Participant making, or required by an Award to make, an election under Section 83(b) of the Code with respect to Restricted Stock shall deliver to NCO, within ten days of the filing of such election with the Internal Revenue Service, a copy of such election. (5) The Committee may, at the time any Award described in this Section 5 is granted, provide that any or all the Common Stock delivered pursuant to the Award shall be Restricted Stock. (6) The Committee may, in its sole discretion, approve the sale to any Participant of shares of Common Stock free of restrictions under the Plan for a price which is not less than the par value of the Common Stock. (d) Deferred Stock. A Deferred Stock Award entitles the recipient to receive shares of Common Stock to be delivered in the future. Delivery of the Common Stock shall take place at such time or times, and on such terms and conditions, as the Committee may determine. The Committee may at any time accelerate the time at which delivery of all or any part of the Common Stock shall take place. At the time any Award described in this Section 5 is granted, 8 the Committee may provide that, at the time Common Stock would otherwise be delivered pursuant to the Award, the Participant shall instead receive an instrument evidencing the Participant's right to future delivery of Deferred Stock. Awards of Deferred Stock represent only an unfunded, unsecured promise to deliver shares in the future and do not give Participants any greater rights than those of an unsecured general creditor of the Company. (e) Restricted Stock Units. A Restricted Stock Unit is an Award denominated in shares of Restricted Stock, pursuant to a formula determined by the Committee, which may be settled either in shares of Restricted Stock or in cash, in the discretion of the Committee, subject to such other terms, conditions, restrictions and limitations determined by the Committee from time to time. 5.4. Supplemental Grants. In connection with any Award under this Section 5, the Committee may grant a supplemental cash award to the Participant (a "Supplemental Grant") not to exceed an amount equal to (i) the amount of any Federal, state and local income tax on ordinary income for which the Participant may be liable with respect to the Award, determined by assuming taxation at the highest marginal rate, plus (ii) an additional amount on a grossed-up basis intended to make the Participant whole on an after-tax basis after discharging all the Participant's income tax liabilities arising from all payments under this Section 5. Any payments under this Section 5.4(b) shall be made at the time the Participant incurs Federal income tax liability with respect to the Award. 5.5. Performance Awards. A Performance Award entitles the recipient to receive, without payment, an Award or Awards described in this Section 5 (such form to be determined by the Committee) following the attainment of such performance goals, during such measurement period or periods, and on such other terms and conditions, all as the Committee may determine. Performance goals may be related to personal performance, corporate performance, group or departmental performance or any such other category of performance as the Committee may determine. The Committee shall have the authority to determine the performance goals, the period or period during which performance is to be measured and all other terms and conditions applicable to the Award. 5.6. Section 162(m) Limitations. (a) If the Committee determines at the time an Award that is intended to qualify as performance-based compensation for purposes of Section 162(m) of the Code is granted to a Participant that such Participant is, or may be as of the end of the tax year for which the Company would claim a tax deduction in connection with such Award, a "covered employee," then the Committee may provide that this Section 5.6 is applicable to such Award under such terms as the Committee shall determine. (b) If an Award is subject to this Section 5.6, then any grant shall be subject to the achievement of specified levels of one or more of the following performance goals, unless and until the Company's shareholders approve a change to such performance goals: operating income, net earnings, earnings before interest, taxes, depreciation and amortization (EBITDA), earnings before interest and taxes (EBIT), net income, earnings per share, total shareholder return, cash flow, return on assets, decrease in expenses, Common Stock price, price-earnings multiple, comparisons to market indices, sales growth, market 9 share, the achievement of certain quantitatively and objectively determinable non-financial performance measures including, but not limited to, operational measures, growth strategies, strategic initiatives, corporate development and leadership development, and any combination of the foregoing. The performance goals shall be determined and approved by the Committee within the first 90 days of each fiscal year. Awards subject to this Section 5.6 may not be adjusted upward. The Committee shall retain the discretion to adjust such Awards downward. Prior to the payment of any Award subject to this Section 5.6, the Committee shall certify in writing that the applicable performance goal was satisfied. (c) The Committee shall have the discretion to impose such other restrictions on Awards subject to this Section 5.6 as it may deem necessary or appropriate to ensure that such Awards qualify as performance-based compensation for purposes of Section 162(m) of the Code. In the event that applicable tax/and or securities laws change to permit the Committee the discretion to alter the governing performance goals without obtaining shareholder approval, the Committee shall have the sole discretion to make such changes without obtaining shareholder approval. In addition, in the event that the Committee determines that it is advisable to grant Awards, or modify existing Awards, that shall not qualify as performance-based compensation for purposes of Section 162(m) of the Code, the Committee may make such grants and modifications without satisfying the requirements of Section 162(m) of the Code. 6. Events Affecting Outstanding Awards 6.1. Termination of Service by Death or Permanent Disability. If a Participant who is an Employee or director ceases to be an Employee or director, or if there is a termination of the consulting, service or other relationship in respect of which a non-Employee Participant was granted an Award under the Plan (such termination of employment or other relationship referred to as a "Status Change") in any case by reason of death or permanent disability, the following rules shall apply, unless otherwise determined by the Committee: (a) All Options and SARs held by the Participant at the time of such Status Change shall automatically become exercisable in full and shall continue to be exercisable by the Participant or his or her heirs, executor, administrator or other legal representative for a period of one year days after the Participant's Status Change by reason of death or permanent disability. After the expiration of such one-year period, all such Options and SARs shall terminate. In no event, however, shall an Option or SAR remain exercisable beyond the latest date on which it could have been exercised without regard to this Section 6.1. (b) All Restricted Stock and Restricted Stock Units held by the Participant at the time of such Status Change shall automatically become free of all restrictions and conditions. (c) The Participant shall automatically be entitled to any payment or benefit under all Deferred Stock Awards, Performance Awards or Supplemental Grants, held by the Participant at the time of such Status Change. (d) "Disability" or "Permanent Disability" shall mean disability as defined in Section 22(e)(3) of the Internal Revenue Code or as otherwise determined by the Committee. 10 6.2. Termination of Service Other Than by Death or Permanent Disability. Subject to the provisions of Section 6.4, if a Participant suffers a Status Change other than by reason of death or permanent disability (as determined by the Committee), the following rules shall apply, unless otherwise determined by the Committee: (a) All Options and SARs held by the Participant at the time of such Status Change, to the extent then exercisable, shall continue to be exercisable by the Participant for a period of 90 days after the Participant's Status Change. After the expiration of such 90-day period, all such Options and SARs shall terminate. In no event, however, shall an Option or SAR remain exercisable beyond the latest date on which it could have been exercised without regard to this Section 6.2. All Options and SARs held by a Participant at the time of such Status Change that are not then exercisable shall terminate upon such Status Change. (b) All Restricted Stock held by the Participant at the time of such Status Change shall be transferred to the Company (and, in the event the certificates representing such Restricted Stock are held by the Company, such Restricted Stock shall be so transferred without any further action by the Participant) in accordance with Section 5.3(c) above. (c) Any payment or benefit under a Restricted Stock Unit, Deferred Stock Award, Performance Award, or Supplemental Grant, to which the Participant was not irrevocably entitled at the time of such Status Change shall be forfeited and the Award canceled as of the date of such Status Change. (d) For all purposes of this Section 6.2 and Section 6.3, the employment with the Company of a Participant who is an Employee shall not be deemed to have been terminated if the Participant is transferred from NCO to a subsidiary of NCO, or vice versa, or from one subsidiary of NCO to another and, in the sole discretion of the Committee, a Status Change shall not be deemed to have occurred if, on the date that a Participant's employment, directorship, consulting, service or other relationship with the Company terminates, such Participant has an employment, directorship, consulting, service or other relationship with the Company that would otherwise permit such Participant to receive an Award under this Plan. (e) A termination by the Company of a Participant's employment, directorship, consulting, service or other relationship with the Company shall be for "Cause" if the Committee determines that the Participant: (i) was guilty of fraud, gross negligence or willful misconduct in the performance of his or her duties for the Company, (ii) willfully and continually failed to perform substantially the Participant's duties with the Company (other than any such failure resulting from incapacity due to permanent disability) after delivery of written demand for substantial performance to the Participant by the Board, the Committee or the Chief Executive Officer that specifically identified the manner in which the Board, the Committee or the Chief Executive Officer believed the Participant did not substantially perform his or her duties, (iii) breached or violated, in a material respect, any agreement between the Participant and the Company or any of the Company's codes of conduct or corporate policies, including policy statements regarding conflicts-of-interest, insider trading or confidentiality, (iv) committed a material act of dishonesty or breach of trust, (v) acted in a manner that was inimical or injurious, in a material respect, to the business or interests of the Company, or (vi) was convicted of, or plead guilty or nolo contendere to, a felony or any other crime involving moral turpitude which subjects, or if generally known, would subject, the Company to public ridicule or embarrassment. 11 6.3. Change in Control (a) Notwithstanding the provisions of Section 6.3(b), in the event of a Change in Control (as defined in Section 6.3(c)), the following rules shall apply, unless otherwise expressly provided by the Committee in accordance with Section 6.3(d): (1) Each outstanding Option and SAR shall automatically become exercisable in full upon the occurrence of such Change in Control. This provision shall not prevent an Option or SAR from becoming exercisable sooner as to Common Stock or cash that would otherwise have become available under such Option or SAR during such period. (2) Each outstanding share of Restricted Stock shall automatically become free of all restrictions and conditions upon the occurrence of such Change in Control. This provision shall not prevent the earlier lapse of any restrictions or conditions on Restricted Stock that would otherwise have lapsed during such period. (3) Conditions on Restricted Stock Units, Deferred Stock Awards, Performance Awards and Supplemental Grants, which relate only to the passage of time and continued employment shall automatically terminate upon the occurrence of such Change in Control. This provision shall not prevent the earlier lapse of any conditions relating to the passage of time and continued employment that would otherwise have lapsed during such period. Performance or other conditions (other than conditions relating only to the passage of time and continued employment) shall continue to apply unless otherwise provided in the instrument evidencing the Awards or in any other agreement between the Participant and the Company or unless otherwise agreed to by the Committee. (b) The Committee may, in its discretion, at the time an Award is made hereunder or at any time prior to, coincident with or after the time of a Change in Control: (i) require the purchase and sale of any Awards for an amount of cash equal to the amount which a Participant could have obtained upon the exercise or realization of such rights had such Awards been currently exercisable; (ii) make such adjustment to the Awards then outstanding as the Committee deems appropriate to reflect such Change in Control; and/or (iii) cause the Awards then outstanding to be assumed, or their rights substituted therefor, by the surviving or acquiring corporation in such Change in Control. The Committee may, in its discretion, include such further provisions and limitations in any Award Agreement as it may deem in the best interests of the Company. (c) A "Change in Control" means: (i) the occurrence of an event that would, if known to NCO's management, be required to be reported by NCO as a change in control under Form 8-K pursuant to the 1934 Act; or (ii) the acquisition or receipt, in any manner, by any person (as defined for purposes of the 1934 Act) or any group of persons acting in concert, of direct or indirect beneficial ownership (as defined for purposes of the 1934 Act) of more than 50% of the combined voting securities ordinarily having the right to vote for the election of directors of NCO; or (iii) a change in the constituency of the Board with the result that individuals (the "Incumbent Directors") who are members of 12 the Board on the Effective Date (as defined in Section 13) cease for any reason to constitute at least a majority of the Board, provided that any individual who is elected to the Board after the Effective Date and whose nomination for election was unanimously approved by the Incumbent Directors shall be considered an Incumbent Director beginning on the date of his or her election to the Board, but excluding, for this purpose, any such individual whose initial assumption of office occurs as a result of an actual or threatened election contest (as defined for purposes of the 1934 Act) with respect to the election or removal of directors or other actual or threatened solicitation of proxies or consents by or on behalf of a person other than the Board; or (iv) the sale, exchange, liquidation or other disposition of all or more than 50% of NCO's business or assets; unless in any such case, at least a majority of the Incumbent Directors determine, prior to the occurrence of such Change in Control, that no Change in Control has or will have occurred; or (v) the occurrence of a reorganization, merger, consolidation or other corporate transaction involving NCO, in each case, with respect to which NCO's shareholders immediately prior to such transaction do not, immediately after such transaction, own more than 50% of the combined voting securities ordinarily having the right to vote for the election of directors of NCO or other corporation resulting from such transaction; or (vi) the approval by NCO's shareholders of a complete liquidation or dissolution of NCO; or (vii) any similar transaction, circumstance or event which the Committee determines to constitute a Change in Control. (d) The provisions of Section 6.3(a) shall not apply to the extent expressly determined by at least 75% of the Incumbent Directors at a duly convened meeting of the Board held before the occurrence of a Change in Control. (e) Any good faith determination by the Committee as to whether a Change in Control within the meaning of this Section 6.3 has occurred shall be conclusive and binding on the Participants. 6.4. Special Forfeiture Provisions Following a Termination of Employment. Notwithstanding the provisions of Section 6.2, in any instance where the rights of a Participant with respect to an Award extend beyond a Status Change other than by reason of death, all of such rights shall terminate and be forfeited, if, in the determination of the Committee, the Participant, at any time prior or subsequent to such Status Change breaches or violates, in a material way, the terms of any agreement with the Company, including any employment agreement, termination agreement, confidentiality agreement, non-solicitation agreement or non-competition agreement. 7. Grant and Acceptance of Awards 7.1. Evidence of Approval. The Committee's approval of a grant of an Award under the Plan, including the names of Participants and the size of the Award, including the number of shares of Common Stock subject to the Award, shall be reflected in minutes of meetings held by the Committee or in written consents signed by members of the Committee. Once approved by the Committee, each Award shall be evidenced by such written instrument, containing such terms as are required by the Plan and such other terms, consistent with the provisions of the Plan, as may be approved from time to time by the Committee. 13 7.2. Award Agreements. Each instrument may be in the form of agreements to be executed by both the Participant and the Company, or certificates, letters or similar instruments, which need not be executed by the Participant but acceptance of which shall evidence agreement to the terms thereof. The grant of an Award shall not impose any obligation on the Participant to accept the Award. 7.3. Conditions. Except as specifically provided by the Plan or the instrument evidencing an Award, a Participant shall not become a shareholder of NCO until (i) the Participant makes any required payments in respect of the Common Stock issued or issuable pursuant to the Award, (ii) the Participant furnishes NCO with any required agreements, certificates, letters or other instruments, and (iii) the Participant actually receives the shares of Common Stock. Subject to any terms and conditions imposed by the Plan or the instrument evidencing an Award, upon the occurrence of all of the conditions set forth in the immediately preceding sentence, a Participant shall have all rights of a shareholder with respect to shares of Common Stock, including, but not limited to, the right to vote such shares and to receive dividends and other distributions paid with respect to such shares. The Committee may, upon such terms and conditions as it deems appropriate, provide that a Participant will receive a benefit in lieu of cash dividends that would have been payable on any and all Common Stock subject to the Participant's Award, had such Common Stock been outstanding. Without limitation, the Board may provide for payment to the Participant of amounts representing such dividends, either currently or in the future, or for the investment of such amounts on behalf of the Participant. 7.4. Payments and Deferrals. Payment of Awards may be in the form of cash, shares of Common Stock, other Awards, or combinations thereof as the Committee shall determine, subject to such terms, conditions, restrictions and limitations as it may impose. The Committee may postpone the exercise of Options or SARs, and may require or permit Participants to elect to defer the receipt or issuance of shares of Common Stock pursuant to Awards or the settlement of Awards in cash under such rules and procedures as it may establish, in its discretion, from time to time. It also may provide for deferred settlements of Awards including the payment or crediting of earnings on deferred amounts, or the payment or crediting of dividend equivalents where the deferred amounts are denominated in common share equivalents. In addition, the Committee may stipulate in an Award Agreement, either at the time of grant or by subsequent amendment, that a payment or portion of a payment of an Award be delayed in the event that Section 162(m) of the Code (or any successor or similar provision of the Code) would disallow a tax deduction by the Company for all or a portion of such payment. The period of any such delay in payment shall be until the payment, or portion thereof, is tax deductible, or such earlier date as the Committee shall determine in its discretion. 7.5. Removal of Restrictions. Notwithstanding any other provision of the Plan, the Company shall not be obligated to deliver any shares of Common Stock pursuant to the Plan or to remove any restriction from shares of Common Stock previously delivered under the Plan (i) until all conditions to the Award have been satisfied or removed, (ii) until, in the opinion of counsel to the Company, all applicable Federal and state laws and regulations have been complied with, (iii) if the outstanding Common Stock is at the time listed on any stock exchange or included for quotation on an inter-dealer system, until the shares to be delivered have been listed or included or authorized to be listed or included on such exchange or system upon official notice of notice of 14 issuance, (iv) if it might cause the Company to issue or sell more shares of Common Stock that the Company is then legally entitled to issue or sell, and (v) until all other legal matters in connection with the issuance and delivery of such shares have been approved by counsel to the Company. If the sale of Common Stock has not been registered under the Securities Act of 1933, as amended, the Company may require, as a condition to exercise of an Award, such representations or agreements as counsel to the Company may consider appropriate to avoid violation of such Act and may require that the certificates evidencing such Common Stock bear an appropriate legend restricting transfer. If an Award is exercised by the Participant's legal representative, the Company shall be under no obligation to deliver Common Stock pursuant to such exercise until the Company is satisfied as to the authority of such representative. 8. Tax Withholding The Company shall withhold from any cash payment made pursuant to an Award an amount sufficient to satisfy all Federal, state and local withholding tax requirements (the "withholding requirements"). In the case of an Award pursuant to which Common Stock may be delivered, the Committee shall have the right to require that the Participant or other appropriate person remit to the Company an amount sufficient to satisfy the withholding requirements, or make other arrangements satisfactory to the Committee with regard to such requirements, prior to the delivery of any Common Stock. If and to the extent that such withholding is required, the Committee may permit a Participant or such other person or entity to elect at such time and in such manner as the Committee may determine to have the Company hold back from the shares of Common Stock to be delivered, or to deliver to the Company, Common Stock having a value calculated to satisfy the withholding requirement. If at the time an ISO is exercised, the Committee determines that the Company could be liable for withholding requirements with respect to a disposition of the Common Stock received upon exercise, the Committee may require as a condition of exercise that the person exercising the ISO agree (i) to inform the Company promptly of any disposition (within the meaning of Section 424(c) of the Code) of Common Stock received upon exercise, and (ii) to give such security as the Committee deems adequate to meet the potential liability of the Company for the withholding requirements and to augment such security from time to time in any amount reasonably deemed necessary by the Board to preserve the adequacy of such security. 9. Dividends and Dividend Equivalents The Committee may provide that Stock Awards shall earn dividends or dividend equivalents. Such dividends or dividend equivalents may be paid currently or may be credited to an account maintained on the books of the Company. Any payment or crediting of dividends or dividend equivalents will be subject to such terms, conditions, restrictions and limitations as the Committee may establish, from time to time, including reinvestment in additional shares of Common Stock or common share equivalents. Unless the Committee determines otherwise, any Employee subject to the reporting requirements of Section 16(a) of the 1934 Act may not participate in dividend reinvestment programs established under the Plan. The Committee shall determine the Participant's rights under the Plan with respect to extraordinary dividends or distributions on the shares of Common Stock. 15 10. Voting The Committee shall determine whether a Participant shall have the right to direct the vote of shares of Common Stock allocated to a Stock Award. If the Committee determines that an Award shall carry voting rights, the shares allocated to such Award shall be voted by the Company's Secretary, or such other person as the Committee may designate in accordance with instructions received from the Participant (unless to do so would constitute a violation of fiduciary duties). Shares as to which no instructions are received shall be voted by the Committee or its designee proportionately in accordance with instructions received from Participants in the Plan (unless to do so would constitute a violation of fiduciary duties). 11. Unfunded Plan Unless otherwise determined by the Committee, the Plan shall be unfunded and shall not create (or be construed to create) a trust or a separate fund or funds. The Plan shall not create any fiduciary relationship between the Company on behalf of any Participant or other person. To the extent any Participant holds any rights by virtue of an Award granted under the Plan, such rights shall constitute general unsecured liabilities of the Company and shall not confer upon any Participant any right, title, or interest in any assets of the Company. 12. Rights as Shareholder Unless the Committee determines otherwise, a Participant shall not have any rights as a shareholder with respect to shares of Common Stock covered by an Award until the date the Participant becomes the holder of record with respect to such shares in accordance with Section 7.3. No adjustment shall be made for dividends or other rights for which the record date is prior to such date, except as provided in Section 9. 13. Effective Date and Term of Plan The effective date of this Plan (the "Effective Date") is May 17, 2004, the date on which the Plan was approved by the affirmative vote of the holders of NCO's Common Stock. No Award shall be granted more than ten years after the Effective Date. 14. Effect, Amendment, Suspension and Termination Unless otherwise determined by the Committee, Awards received by Participants under the Plan shall not be deemed a part of a Participant's regular, recurring compensation for purposes of calculating payments or benefits under any Company benefit plan or severance program. No Employee, director or other person shall have any claim or right to be granted an Award under the Plan. There shall be no obligation of uniformity of treatment of Employees, directors or other persons under the Plan and the terms and conditions of Awards and the Committee's determinations and interpretations with respect thereto need not be the same with respect to each Participant (whether or not such Participants are similarly situated). Neither adoption of the Plan nor the grant of Awards to a Participant shall affect the Company's right to grant to such Participant awards that are not subject to the Plan, to issue to such Participant Common Stock as a bonus or otherwise, or to adopt other plans or arrangements under which Common Stock may be issued to Employees or other 16 persons or entities. The Committee reserves the right, at any time and from time to time, to amend the Plan in any way, or to suspend or terminate the Plan, effective as of the date specified by the Committee when it takes such action, which date may be before or after the date the Committee takes such action; provided that any such action shall not affect any Awards granted before the actual date on which such action is taken by the Committee; and further provided that the approval of NCO's shareholders shall be required whenever necessary for the Plan to continue to satisfy the conditions of Rule 16b-3 under the 1934 Act, Section 422 of the Code with respect to the award of ISOs (unless the Board determines that ISOs shall no longer be granted under the Plan), any bylaw, rule or regulation of the market system or stock exchange on which NCO's Common Stock is then listed or admitted to trading, or any other applicable law, rule or regulation. Unless terminated earlier by the Board, this Plan shall terminate on such date (which shall not be prior to May 17, 2014) as all Awards under the Plan have been exercised or shall have terminated. 15. Other Provisions 15.1. Future Rights. Nothing contained in the Plan or any Award shall confer upon any Employee or other Participant the right to continue in the employ of, or to continue to provide service to, the Company or any affiliated person, or interfere in any way with the right of the Company or any affiliated person to terminate the employment or service of any Employee or other Participant for any reason. 15.2. Grant Date. Corporate action constituting an offer by NCO of Common Stock to any Participant under the terms of an Award shall be deemed completed as of the date of grant of the Award, regardless of when the instrument, certificate, or letter evidencing the Award is actually received or accepted by the Participant. 15.3. Transferability. None of a Participant's rights under any Award or under the Plan may be assigned or transferred in any manner other than by will or under the laws of descent and distribution. The foregoing shall not, however, restrict a Participant's rights with respect to Unrestricted Stock or the outright transfer of cash, nor shall it restrict the ability of a Participant's heirs, estate, beneficiaries, or personal or legal representatives to enforce the terms of the Plan with respect to Awards granted to the Participant. Notwithstanding the foregoing, at the discretion of the Committee, the terms of an Award may permit a Participant to transfer such Award to one or more members of the Participant's family or to trusts, family partnerships, or other entities for the benefit of the Participant and/or members of the Participant's family to the extent provided in such Award and permitted under the terms for use of Form S-8 promulgated under the Securities Act of 1933, as amended. 15.4. Governing Law. The Plan, and all Awards granted hereunder, shall be governed by and construed in accordance with the laws of the Commonwealth of Pennsylvania. 15.5. Interpretation. The headings of the Sections of the Plan are for convenience of reference only and shall not affect the interpretation of the Plan. All pronouns and similar references in the Plan shall be construed to be of such number and gender as the context requires or permits. When used in this Plan, the words "including" and "include" shall be deemed followed by the words "without limitation." Except as otherwise indicated, the term "person" as used in the Plan shall include individuals, corporations, partnerships, trusts, estates, limited liability companies and partnerships and any other type of entity. 17 15.6. Severability. If any provision of the Plan is determined to be unenforceable for any reason, then that provision shall be deemed to have been deleted or modified to the extent necessary to make it enforceable, and the remaining provisions of the Plan shall be unaffected. 15.7. Notices. All notices with respect to the Plan shall be in writing and shall be hand delivered or sent by certified mail or reputable overnight delivery service, expenses prepaid. Notices to the Company or the Committee shall be delivered or sent to NCO's headquarters to the attention of its General Counsel. Notices to any Participant or holder of shares of Common Stock issued pursuant to an Award shall be sufficient if delivered or sent to such person's address as it appears in the regular records of the Company or its transfer agent. 15.8. Prior Services. In any case that a Participant purchases Common Stock under an Award for a price equal to the par value of the Common Stock, the Committee may determine, in its sole discretion, that such price has been satisfied by past services rendered by the Participant. 15.9. Fair Market Value. For the purposes of the Plan and any Award granted hereunder, unless otherwise determined by the Committee, the term "fair market value" of Common Stock on a specified date shall mean the last sale price for one share of Common Stock on the last trading day on or before the specified date, as reported on the Nasdaq National Market System, or on such other market system or stock exchange on which NCO's Common Stock is then listed or admitted to trading, or, if the foregoing does not apply, the market value determined by the Board. 15.10. Reduction of Payments. Unless otherwise agreed upon in writing by the Company and a Participant, in the event that any payment, benefit or transfer under the Plan to or for the benefit of a Participant pursuant to a Change in Control from the Company or otherwise (a "Payment") would (i) constitute a "parachute payment" within the meaning of Section 280G of the Code, and (ii) but for this Section 15.10, be subject to the excise tax imposed by Section 4999 of the Code (the "Excise Tax"), then such Payment shall be reduced to the Reduced Amount. The "Reduced Amount" shall be either (x) the largest portion of the Payment that would result in no portion of the Payment being subject to the Excise Tax or (y) the largest portion, up to and including the total, of the Payment, whichever amount, after taking into account all applicable federal, state and local employment taxes, income taxes, and the Excise Tax (all computed at the highest applicable marginal rate), results in the Participant's receipt, on an after-tax basis, of the greater amount of the Payment notwithstanding that all or some portion of the Payment may be subject to the Excise Tax. If a reduction in payments or benefits constituting "parachute payments" is necessary so that the Payment equals the Reduced Amount, reduction shall occur in the following order unless the Participant elects in writing a different order (provided, however, that such election shall be subject to the Company's approval if made on or after the date on which the event that triggers the Payment occurs): reduction of cash payments; cancellation of accelerated vesting of Awards; and reduction of employee benefits. In the event that the acceleration of vesting of Award compensation is to be reduced, such acceleration of vesting shall be cancelled in the reverse order of the date of grant of the Participant's Awards unless the Participant elects in writing a different order for cancellation. 18 15.11. Successors and Assigns. The Plan and any applicable Award Agreement entered into under the Plan shall be binding on all successors and assigns of a Participant, including the estate of such Participant and the executor, administrator or trustee of such estate, or any receiver or trustee in bankruptcy or representative of the Participant's creditors. 19 EX-31 4 ex31-1.txt EXHIBIT 31.1 Exhibit 31.1 I, Michael J. Barrist, certify that: 1. I have reviewed this quarterly report on Form 10-Q of NCO Group, Inc; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [Intentionally omitted] (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 Michael J. Barrist ---------------------------------- Michael J. Barrist President and Chief Executive Officer (principal executive officer) EX-31 5 ex31-2.txt EXHIBIT 31.2 Exhibit 31.2 I, Steven L. Winokur, certify that: 1. I have reviewed this quarterly report on Form 10-Q of NCO Group, Inc; 2. Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the period covered by this report; 3. Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report; 4. The registrant's other certifying officer(s) and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) for the registrant and have: (a) Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared; (b) [intentionally omitted] (c) Evaluated the effectiveness of the registrant's disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and (d) Disclosed in this report any change in the registrant's internal control over financial reporting that occurred during the registrant's most recent fiscal quarter (the registrant's fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant's internal control over financial reporting; and 5. The registrant's other certifying officer(s) and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant's auditors and the audit committee of the registrant's board of directors (or persons performing the equivalent functions): (a) All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant's ability to record, process, summarize and report financial information; and (b) Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant's internal control over financial reporting. Date: August 9, 2004 Steven L. Winokur -------------------------------------------- Steven L. Winokur Executive Vice President of Finance, Chief Financial Officer, Chief Operating Officer of Shared Services and Treasurer (principal financial officer) EX-32 6 ex32-1.txt EXHIBIT 32.1 Exhibit 32.1 NCO GROUP, INC. CERTIFICATION PURSUANT TO 18 U.S.C. SECTION 1350, AS ADOPTED PURSUANT TO SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002 Pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 ( Section 1350 of Chapter 63 of Title 18 of the United States Code), each of the undersigned officers of NCO Group, Inc. (the "Company"), does hereby certify with respect to the Quarterly Report of the Company on Form 10-Q for the period ended June 30, 2004 (the "Report") that: (1) The Report fully complies with the requirements of section 13(a) or 15(d) of the Securities Exchange Act of 1934; and (2) The information contained in the Report fairly presents, in all material respects, the financial condition and results of operations of the Company. Michael J. Barrist ------------------------------------------ Date: August 9, 2004 Michael J. Barrist President and Chief Executive Officer Steven L. Winokur ------------------------------------------ Date: August 9, 2004 Steven L. Winokur Executive Vice President of Finance, Chief Financial Officer, Chief Operating Officer of Shared Services and Treasurer The foregoing certification is being furnished solely pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (Section 1350 of Chapter 63 of Title 18 of the United States Code) and is not being filed as part of the Report or as a separate disclosure document. -----END PRIVACY-ENHANCED MESSAGE-----