Portfolio Recovery Associates, Inc.
P
o
r
t
f
o
l
i
o
R
e
c
o
v
e
r
y
A
s
s
o
c
i
a
t
e
s
,
I
n
c
.
Portfolio Recovery Associates, Inc.
Riverside Commerce Center
120 Corporate Blvd., Suite 100
Norfolk, Virginia 23502
A year for dis cipline and per for mance
2004 Annual Report
Corporate Governance
MANAGEMENT
Steve Fredrickson
President and
Chief Executive Officer
Kevin Stevenson
Executive Vice President,
Chief Financial Officer,
Treasurer and Asst.
Secretary
Craig Grube
Executive Vice President,
Acquisitions
Judith Scott
Executive Vice President,
General Counsel and
Secretary
BOARD OF DIRECTORS
CORPORATE INFORMATION
Steve Fredrickson
Chairman of the Board
William Brophey
Director
STOCK EXCHANGE LISTING
Portfolio Recovery Associates’ common stock trades on the Nasdaq
National Market under the symbol “PRAA.” Price information for the
common stock appears daily in major newspapers.
TRANSFER AGENT AND REGISTRAR
Continental Stock Transfer
17 Battery Place, 8th Floor
New York, New York 10004
Tel: 212-509-4000
Fax: 212-509-5150
AUDITORS
PricewaterhouseCoopers LLP
McLean, Virginia
LEGAL COUNSEL
Dechert, LLP
New York, New York
FINANCIAL PUBLICATIONS/INVESTOR INQUIRIES
Shareholders may acquire copies of the 2004 Form 10-K, Annual
Report and other filed documents by visiting the company’s website at
www.portfoliorecovery.com or by writing to us at:
Portfolio Recovery Associates
Attn: Investor Relations
120 Corporate Blvd., Suite 100
Norfolk, Virginia 23502
PRICE RANGE OF COMMON STOCK
The Company’s common stock began trading on the Nasdaq National
Market under the symbol “PRAA” on November 8, 2002. The following
table sets forth the high and low sales price for the common stock for
the year 2004.
2004
$41.80
$23.89
High
Low
As of March 5, 2005, there were approximately 25 holders of record of
the common stock. Based on information provided by the Company’s
transfer agent and registrar, the Company believes that there are
approximately 15,128 beneficial owners of the common stock.
Peter Cohen
Director
David Roberts
Director
Scott Tabakin
Director
James Voss
Director
m
o
c
.
s
r
o
n
n
o
c
-
n
a
r
r
u
c
.
w
w
w
/
.
c
n
i
,
s
r
o
n
n
o
c
&
n
a
r
r
u
c
y
b
d
e
n
g
i
s
e
d
PORTFOLIO RECOVERY
ASSOCIATES, INC. and its subsidiaries purchase,
manage, and collect defaulted consumer receivables. Our
business is both people-intensive and highly analytical. Through a
disciplined approach to pricing and a long-term view of collections, we have
been able to build a company that produces exceptional results for investors and
clients alike, while creating a rewarding organization for our employees.
We operate five call centers. When current office expansions are completed by mid-2005, we will
own or lease more than 110,000 square feet of office space which has the capacity to house 1,150
employees. At December 31, 2004 we employed 948 people.
FINANCIAL HIGHLIGHTS
(in thousands, except per share amounts)
2004
2003
2002
2001
2000
Revenues
Operating income
Net income/Pro forma net income*
Diluted earnings per share
Diluted operating cash flow per share
Shares outstanding (diluted)
Operating margin
Pretax margin
Return on average equity
Working capital
Finance receivables, net
Total assets
Stockholders’ equity (members’ equity prior to 2002)
$ 113,396 $ 84,927
$ 34,455
$ 44,890
$ 20,714
$ 27,451
1.32
$
1.73
$
$
$
2.23
3.11
15,712
15,853
$ 55,847
$ 20,963
$ 11,371
$ 0.94
$ 1.81
12,066
$ 32,336
$ 8,766
$ 3,526
$ 0.31
$ 0.57
11,458
$ 19,334
$ 4,305
$ 1,639
$ 0.14
$ 0.27
11,366
39.6%
39.5%
20.4%
40.6%
39.9%
20.3%
37.5%
33.2%
27.9%
27.1%
17.4%
13.7%
22.3%
13.1%
7.7%
$ 21,612
$ 43,767
$ 105,189 $ 92,569
$ 175,176 $ 126,394
$ 151,389 $ 119,148
$ 13,039
$ 65,526
$ 88,288
$ 80,608
$ 3,156
$ 47,987
$ 57,049
$ 27,752
$ 2,664
$ 41,124
$ 47,188
$ 22,705
*Unaudited adjusted to show impact of corporate income tax prior to the Company’s conversion to a corporation in 2002.
CASH RECEIP TS
CASH RECEIP TS
($ in millions)
($ in millions)
RETUR N ON EQUITY
RETUR N ON EQUITY
(in percent)
(in percent)
200
200
150
150
100
100
50
50
0
0
30
30
25
25
20
20
15
15
10
10
5
5
0
0
2001
2001
2002
2002
2003
2003
2004
2004
NET INCOME
NET INCOME
($ in millions)
($ in millions)
2001*
2001*
2002*
2002*
2003
2003
2004
2004
* Unaudited adjusted for corporate tax effect.
* Unaudited adjusted for corporate tax effect.
30
30
25
25
20
20
15
15
10
10
5
5
0
0
120
120
100
100
80
80
0
0
40
40
20
20
0
0
200000
200000
150000
150000
100000
100000
50000
50000
0
0
200
200
150
150
100
100
50
50
0
0
30000
30000
25000
25000
20000
20000
15000
15000
10000
10000
5000
5000
0
0
30
30
25
25
20
20
15
15
10
10
5
5
0
0
120
120
100
100
80
80
60
60
40
40
20
20
0
0
2001
2001
2002
2002
2003
2003
2004
2004
a01
a01
a02
a02
a03
a03
a04
a04
a01
a01
a02
a02
a03
a03
a04
a04
a01
a01
a02
a02
a03
a03
a04
a04
ANNUAL R EV ENUE
ANNUAL R EV ENUE
($ in millions)
($ in millions)
2001
2001
2002
2002
2003
2003
2004
2004
a01
a01
a02
a02
a03
a03
a04
a04
a01
a01
a02
a02
a03
a03
a04
a04
2
CEO’s Letter
Dear Fellow Shareholders:
Discipline and Performance. In 2004, Portfolio Recovery Associates proved the two need not be mutually exclusive
and delivered strong performance by virtually all measures. I am extremely proud of the employees of PRA, as they
executed day in and day out, working tirelessly and efficiently to increase revenue, manage expenses and build our
company for a strong future.
Cash receipts up 34% to $161 million. Revenue up 34% to $113 million. Net income up 33% to $27.5 million. All
this accomplished as we kept the balance sheet essentially debt free and almost doubled cash and investments to
$48.5 million. Performance like that doesn’t just happen. It requires skilled employees, dedicated managers, and a
diligent executive team committed to the execution of a proven business model and a solid forward strategy.
The year 2004 saw the continuation of a strong track record that we intend to perpetuate for the company. But it certainly
won’t happen without our continued vigilance. The markets we operate in are competitive, perhaps as much so in 2004
as we have seen in the past several years. Our response to what we viewed as overly exuberant valuations on bad debt
portfolio sales was to stay disciplined, even as many of our competitors stepped up for ever larger purchasing volumes.
Funny thing about the bad debt sale market. Everyone claims it is currently overpriced, but no one admits to paying too
much for paper, even as their buying volume increases. We have seen this all before, with ugly results for the over-
aggressive buyer. Staying disciplined, building cash, and diversifying revenue streams was the strategy we executed
throughout the year. We look for the same disciplined approach in 2005.
We spent considerable resources during 2004 to become better collectors, to make sure that our buying discipline did
not translate into lack of performance. We began the year with an important systems upgrade for our owned portfolio
platform, one that paid dividends throughout the year as we significantly improved production times. We also improved
the way we delivered key customer data to our collection work force, giving them instant, lower cost access to a variety
of essential third-party data. We became more sophisticated with our account segmentation and collection strategies,
finding better ways to collect more money from more accounts. And we reviewed all of our vendor relationships for
optimal utilization, with significant cost savings and efficiency improvements as a result.
Moves such as these helped us to continue to drive up productivity. Dollars collected per hour paid rose to $117.59 from
$108.27 in 2003. We did this while growing our owned portfolio collector workforce more than 10%, from 590 at year
end in 2003 to 652 at year end in 2004.
We remain convinced that our operating strategy of building and operating a vertically integrated business is superior
to the strategy of utilizing significant outsourcing. Our ability to get real-time data from our collection operation to feed
back into our valuation models is essential in driving the best possible pricing decisions. Full, minute-by-minute control
3
of our own call centers and collection process permits us to optimize strategies, test approaches, and alter our meth-
ods as results and circumstances dictate, all designed around a long-term perspective. As we work our own accounts,
our profit margins are improved as we pocket the “profit” a third-party collector demands of any client. This ultimately
makes us more price competitive as we bid on new acquisitions. We do strategically use third parties, but only to sup-
plement our collection operations. Collection attorneys, specialized collection agencies, letter providers, and balance
transfer partners are all examples of third parties that we feel can execute certain strategies for us in a more cost-
effective manner than we could ourselves. They all are an essential part of our game plan.
You will notice that sale is not a part of our core philosophy. We prefer long-term steady cash flow that holding permits.
In addition, those that sell can mask shortcomings with a lack of disclosure. We prefer full visibility and consistency for
our shareholders.
While this operating philosophy includes the operation of large call centers, the actual fixed costs of doing so are rela-
tively modest. We would never buy accounts simply to keep our centers operating at full capacity. In fact, our fixed
occupancy costs are so reasonable that we have tended to operate with significant call center capacity throughout the
life of the company. At $1.74 million for all of 2004, rent and occupancy expense was 2.5% of all operating expenses,
just 1.5% of revenue, and just over 1% of cash receipts.
Our purchase of the asset location and skip tracing business, IGS Nevada, during late 2004, was an example of our
strategy of seeking expertise outside our existing areas of competency. This purchase not only diversifies our revenue
stream, but permits us to sell another valued collection service to our clients, strengthening those key relationships.
Of course, this all takes place as we work to grow IGS and bring to realization what we all believe is a bright future for
this business.
I am extremely pleased with our results in 2004 and look forward to performing for our shareholders again in 2005.
With record levels of consumer debt, new debt sellers entering the market all the time, and increasing interest rates
potentially pushing up default rates, I expect Portfolio Recovery Associates to continue to thrive. Discipline with
performance. Watch us deliver.
Steve Fredrickson
Chairman, President & Chief Executive Officer
4
The markets we serve are large and diverse. During 2004, Portfolio Recovery Associates further developed
its suite of skills and services to more completely exploit this broad market. During 2004 we:
• Began buying bankrupt accounts in earnest, building on expertise we have developed collecting our
own bankrupt accounts since the company’s founding in 1996. This followed an extensive period of
preparation as we built pricing models, administrative systems, and business rules. Although 2004
was a modest start for this business, we are pleased with the team we have built and the market
opportunity we see for further rational growth.
• Continued our careful expansion into newer product types, including the acquisition of land-line and
cellular telecom accounts and utility paper. Although deal flow in these areas increased dramatically
during the year, so too did pricing, tempering the volumes we ultimately purchased. We look for
continued strong growth in market volume from these sectors in the near future.
• Made several modest purchases of new asset types which we will study until we gain greater comfort
with their performance characteristics. This is the continuation of an operating philosophy we have long
held, with modest investment being increased only after performance is sufficiently proven.
• Purchased IGS Nevada and added skip tracing and asset location services to our corporate skill set.
Using IGS’ well developed operating techniques and combining them with PRA’s infrastructure,
technological base, and client list gives us a powerful new engine for revenue and growth.
C A L L C E N T E R S
2002
2003
2004
Capacity
N U M B E R O F C O L L E C T O R S
Norfolk, VA
Norfolk, VA
Hampton, VA
Hutchinson, KS
Las Vegas, NV
47
342
–
83
–
57
326
178
86
–
69
338
210
104
28
112
378
255
148*
131*
5
Total
Expanding our reach in a diverse market.
647
749
472
1,024
* Pending completion of facilities underway
ACCOUNTS RECEIVABLE
MANAGEMENT (ARM)
Credit
Card
Auto
Installment
Loans
Student
Loans
Health
Care
Bankruptcy
Utility
Telecom
Gov’t
R E C E I VA B L E T Y P E S
Debt Buying
Fee for Service
Existing activity
New activity
Blank - potential activity
The table above shows some of the many types of receivables available in both the debt buying and fee-for-
service arenas of the account receivables management (ARM) industry. Although historically our efforts in
both debt buying and fee work have been concentrated more heavily in the very large credit card and install-
ment loan arenas, we have developed meaningful expertise and experience in many other market segments
and look to continue that evolution. This diversification allows us to better avoid irrational pricing in any one
market area, as well as more broadly serve some of our most substantial client relationships.
6
Analytics and discipline are at the core of our acquisition strategy. We estimate the
collectibility of each account we purchase, analyzing numerous customer and account
attributes against the millions of data points we have recorded since our inception. Our
due diligence process creates a detailed estimate of the timing and magnitude of all cash
flows and related collection expenses anticipated with each portfolio acquisition. These
estimates are then compared each month to our actual static pool results as we monitor
portfolio performance and profitability. Throughout our history we have established an
enviable track record of being able to rationally and accurately forecast performance.
These results are shared with the investing public in each of our quarterly filings, as
shown in the top graph on the opposite page.
We are ever-vigilant monitoring the performance of our owned portfolio pools. Having the ability to accurately
forecast, and then closely review results is absolutely essential in ensuring appropriate revenue recognition
for these pools. The bottom graph on the opposite page shows both our stated (gross) and effective (core)
amortization rates over the past two years. Amortization is how we describe the amount of our cash collec-
tions that are applied to reduce the carrying value of each purchased pool on the balance sheet. For each
period, cash collections are “separated” into two components, revenue and amortization. The higher the
amortization rate, the lower the revenue recognized. Stated amortization rate is simply amortization divided
by cash collections. Core amortization rate removes collections from zero basis pools (where no further
amortization can occur) and focuses on amortization applied only to those pools remaining on our balance
sheet. Currently, almost half of our more than 500 owned pools are fully amortized, creating more than
$23.5 million in cash collections in 2004 from these zero basis assets. This phenomenon has created the
growing variance between our stated and effective amortization rates and is the reason why we feel it is
important for investors to understand this issue in detail.
Consistent performance and rational projections.
ACTUAL CASH COLLECTIONS VS. ORIGINAL PROJECTIONS
($ in millions)
500
400
300
200
100
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
Actual Cash Collections
Original Projections
AMORTIZATION RATES
7
500000
400000
300000
200000
100000
0
40%
30%
20%
10%
0%
120
100
80
60
Q1
’03
Q2
’03
Q3
’03
Q4
’03
Q1
’04
Q2
’04
Q3
’04
Q4
’04
Core Amortization Rate
Gross Amortization Rate
OWNED PORTFOLIO CASH COLLECTION PER HOUR PAID
(collection per hour paid in dollars)
$117.59
5/31/96
9/30/96
1/31/97
5/31/97
9/30/97
1/31/98
5/31/98
9/30/98
1/31/99
5/31/99
9/30/99
1/31/00
5/31/00
9/30/00
1/31/01
5/31/01
9/30/01
1/31/02
5/31/02
9/30/02
1/31/03
5/31/03
9/30/03
1/31/04
2/28/04
3/31/04
4/30/04
5/31/04
6/30/04
7/31/04
8/31/04
9/30/04
10/31/04
11/30/04
12/31/04
6/30/96
10/31/96
2/28/97
6/30/97
10/31/97
2/28/98
6/30/98
10/31/98
2/28/99
6/30/99
10/31/99
2/29/00
6/30/00
10/31/00
2/28/01
6/30/01
10/31/01
2/28/02
6/30/02
10/31/02
2/28/03
6/30/03
10/30/03
7/31/96
11/30/96
3/31/97
7/31/97
11/30/97
3/31/98
7/31/98
11/30/98
3/31/99
7/31/99
11/30/99
3/31/00
7/31/00
11/30/00
3/31/01
7/31/01
11/30/01
3/31/02
7/31/02
11/30/02
3/31/03
7/31/03
11/30/03
8/31/96
12/31/96
4/30/97
8/31/97
12/31/97
4/30/98
8/31/98
12/31/98
4/30/99
8/31/99
12/31/99
4/30/00
8/31/00
12/31/00
4/30/01
8/31/01
12/31/01
4/30/02
8/31/02
12/31/02
4/30/03
8/31/03
12/30/03
40
35
30
25
20
15
10
5
0
40
35
30
25
20
15
10
5
0
120
100
80
60
2001
2002
2003
2004
a01
a02
a03
a04
8
A disciplined approach to buying in a competitive market led to flat year over year levels of
portfolio purchases, as illustrated in the top graph on the following page. On an historical
basis, however, our 2004 purchases are quite substantial. It is important to understand
that the long-term collection strategy at the heart of our owned portfolio business is not
dependant upon near-term buying to produce strong levels of cash collections and the
corresponding revenues. Each year’s purchases generate cash for a period of seven years
or more, creating a layering effect of one year’s purchases on top of another, as shown in
the bottom graph on the following page. This phenomenon gives PRA tremendous buying
flexibility and the ability to combine discipline and performance without inordinately
affecting near-term collections or revenue.
The table in the middle of page 9 breaks the purchase and collection data down even further, showing cash
collections by year, by year of purchase, as well as the ERC or estimated remaining collections amount. ERC
is our accounting projection of how much cash we will collect in future periods. The final column in this
table shows our current estimate of total lifetime collections in relation to purchase price for each year of
buying. Projected lifetime collections is a total of life to date collections and ERC. This figure is at the heart
of the pace at which we recognize revenue, and is a critical element for the investment community to be
able to adequately understand the company’s collection expectations.
PORTFOLIO PURCHASES* BY YEAR
($ in millions)
70
60
50
40
30
20
10
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
a96
a97
a98
a99
a00
a01
a02
a03
a04
*Original purchase price
9
70
60
50
40
30
20
10
0
CASH COLLECTIONS BY YEAR, BY YEAR OF PURCHASE
($ in thousands)
Purchase
Period
Purchase
Price
1996
1997
1998
1999
2000
2001
2002
2003
2004
Total
Cash Collection Period(1)
$ 3,080 $ 548 $ 2,484 $ 1,890 $ 1,348 $ 1,025 $
730 $
496 $
398 $
285 $ 9,204 $
1996
1997
1998
1999
2000
2001
2002
2003
7,685
— 2,507
11,089
18,898
25,015
33,472
42,282
61,528
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
2004
61,355 —
—
—
—
—
5,215
3,776
4,069
6,807
3,347
6,398
2,630
5,152
1,829
3,948
9,598
1,324
2,797
7,336
1,022 $ 21,943
2,200 $ 31,078
5,138
13,069
12,090
5,615 $ 52,846
3,532
6,894
19,498
19,478
16,628
14,098 $ 76,596
10,295
— 13,048
28,831
28,003
26,717 $ 96,599
27,209
—
—
— 15,073
36,258
35,742 $ 87,073
51,511
—
—
—
—
24,308
49,706 $ 74,014
92,432
—
18,019 $ 18,019 121,936
ERC
95
274
827
Total Est.
Collections
to Price(2)
304%
295%
288%
302%
349%
386%
328%
271%
228%
Total
$ 264,404 $ 548 $ 4,991 $ 10,881 $ 17,362 $ 30,733 $ 53,148 $ 79,253 $ 117,052 $ 153,404 $ 467,372 $ 308,111
(1)Cash collections do not include cash sales of finance receivables.
(2) Total estimated collections to price refers to the actual cash collections, including cash sales, plus estimated remaining collections, divided by the purchase price.
OWNED PORTFOLIO CASH COLLECTIONS PER PURCHASE PERIOD
($ in millions)
160
140
120
100
80
60
40
20
0
1996
1997
1998
1999
2000
2001
2002
2003
2004
160000
120000
80000
40000
0
a04
a03
a02
a01
a00
a99
a98
a97
a96
a96
a97
a98
a99
a00
a01
a02
a03
a04
10
We carefully manage our staffing levels to complement our buying levels. Many variables
play into our capacity planning decisions such as productivity levels, collection phases
and liquidity levels of our many owned pools, as well as individual call center populations
and production dynamics. Due to the fact that we build our call centers to permit us to
occupy real estate densely, we have very reasonable occupancy costs and so can afford
to carry some level of excess call center capacity without any significant financial impact.
The first table on the following page shows how we have grown into our various facilities
over time, as well as the meaningful existing expansion space that we currently enjoy.
The second chart on the following page demonstrates our ability to increase employee productivity, even
as we have substantially grown our employee base over time. We attribute this increase to lengthening
employee tenure, improved systems, better portfolio segmentation, more sophisticated collection strategies
and improved training.
11
C A L L C E N T E R S
2002
2003
2004
Capacity
N U M B E R O F C O L L E C T O R S
AMORTIZATION RATES
57
47
Norfolk, VA
Norfolk, VA
40%
30%
Hampton, VA
20%
10%
Hutchinson, KS
0%
Las Vegas, NV
Q1
’03
Q2
’03
342
–
83
–
Q4
’03
Q3
’03
69
338
210
104
326
178
86
Q1
’04
–
Q2
’04
28
Q3
’04
Q4
’04
112
378
255
148*
131*
Core Amortization Rate
Gross Amortization Rate
Total
472
647
749
1,024
* Pending completion of facilities underway
OWNED PORTFOLIO CASH COLLECTION PER HOUR PAID
(collection per hour paid in dollars)
120
R E C E I VA B L E T Y P E S
$117.59
ACCOUNTS RECEIVABLE
100
MANAGEMENT (ARM)
Credit
Card
Auto
Installment
Loans
Student
Loans
Health
Care
Bankruptcy
Utility
Telecom
Gov’t
Debt Buying
80
Fee for Service
60
2001
2002
2003
2004
Existing activity
New activity
Blank - potential activity
40
35
30
25
20
15
10
5
0
40
35
30
25
20
15
10
5
0
120
100
80
60
a01
a02
a03
a04
12
OPERATING PRINCIPLES FOR THE MANAGEMENT OF PORTFOLIO RECOVERY ASSOCIATES
Disclose. Be honest and open with shareholders. Let them know what is going on.
Invest carefully. Build a diverse portfolio. Never bet the ranch. Make sure each investment, be it a portfolio or a business, has been
reviewed, judged objectively, and priced to achieve appropriate profit hurdles.
Keep the business simple. Operate fewer, larger call centers.
Keep costs low and productivity high. Develop and retain great employees. Keep support staff as small as possible, while providing
excellent service to the collection operation.
Maintain a conservative capital structure. Allow room for error. Keep debt levels low. When borrowing is required because of opportunity,
use low cost, non-participating debt.
Build an integrated business. Portfolio buying and collections must be under the same roof.
Employ steady, controlled growth. We operate process- and people-intensive businesses. Experienced employees are significantly
more productive than newer employees. Growing too quickly puts too many less productive, lower margin people into the workforce
mix, driving down productivity, margin and net income.
Management should be owners, not hired guns. We act like owners because we are. Our senior managers have a significant portion
of their net worth invested in the Company. We expect our senior managers to retain substantial stock ownership positions—
common stock, not just options—throughout their terms of employment.
Develop and support employees. Provide and support ongoing employee skill development to help create ever increasing levels of
individual potential with high levels of performance for continuing personal and company growth.
SAFE HARBOR ACT
Statements in this Annual Report which are not historical, including statements of the Company’s
Chairman, President and Chief Executive Officer, in his letter which begins, “Dear Fellow Shareholders”
(including, without limitation, information regarding earnings, financial results, the outlook for the
economy, management’s intentions, hopes, beliefs, expectations, representations, projections, plan
or predictions of the future), are forward-looking statements within the meaning of Section 21(e) of
the Securities Exchange Act of 1934. Such statements are not statements of historical fact. Forward-
looking statements involve risks, uncertainties and assumptions, some of which are not currently
known to us, which could cause the Company’s results to differ materially from its management’s
current expectations. Actual events or results may differ from those expressed or implied in any such
forward-looking statements as a result of various factors, including the risk factors listed from time to
time in the Company’s filings with the Securities and Exchange Commission, including but not limited
to, its Registration Statements on Form S-3 and Forms S-8, and its Annual and Quarterly Reports.
The content of this Annual Report includes time-sensitive information and is accurate as of the date
hereof, April 15, 2005, which is the approximate date of the mailing of the Annual Report. The Company
disclaims any intention or obligation to update or revise these forward-looking statements.
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
____________
FORM 10-K
X
ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE
ACT OF 1934
For the fiscal year ended December 31, 2004
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: 000-50058
Portfolio Recovery Associates, Inc.
(Exact name of registrant as specified in its charter)
Delaware
(State or Other Jurisdiction of
Incorporation or Organization)
120 Corporate Boulevard, Norfolk, Virginia
(Address of Principal Executive Offices)
75-3078675
(I.R.S. Employer
Identification No.)
23502
(Zip Code)
Registrant’s telephone number, including area code: (888) 772-7326
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $0.01 par value per share
(Title of Class)
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or
15(d) of the Securities and 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.
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not
contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or
information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form
10-K. __
YES X NO ___
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the
Exchange Act).
The aggregate market value of the voting stock held by non-affiliates of the registrant as of February 16,
YES X NO ___
2005 was $428,781,004.
The number of shares of the registrant’s Common Stock outstanding as of February 16, 2005 was
15,504,210.
Documents incorporated by reference: Portions of the Proxy Statement to be filed by April 30, 2005 for our
2005 Annual Meeting of Stockholders are incorporated by reference into Items 11, 12 and 13 of Part III of this
Form 10-K.
1
Table of Contents
Part 1
Item 1. Business
Item 2. Properties
Item 3. Legal Proceedings
Item 4.
Submission of Matters to a Vote of Securityholders
Part II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters
and Issuer Purchases of Equity Securities
Item 6.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results
Selected Financial Data
of Operations
Item 7A. Quantitative and Qualitative Disclosure about Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and
Financial Disclosure
Item 9A. Disclosure Controls and Procedures
Item 9B. Other Information
Part III
Item 10. Directors and Executive Officers of the Registrant
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management
Item 13. Certain Relationship and Related Transactions
Item 14. Principal Accountant Fees and Services
Part IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K
Signatures
Consent of Independent Registered Public Accounting Firm
Section 302 Certification of Chief Executive Officer
Section 302 Certification of Chief Financial Officer
Certification of CEO and CFO to Section 906
3
23
23
23
24
25
28
43
44
69
69
69
70
73
73
73
73
75
77
2
Cautionary Statements Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform
Act of 1995:
This report contains forward-looking statements within the meaning of the federal securities laws. These
forward-looking statements involve risks, uncertainties and assumptions that, if they never materialize or prove
incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking
statements. All statements, other than statements of historical fact, are forward-looking statements, including
statements regarding overall trends, operating cost trends, liquidity and capital needs and other statements of
expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning
matters that are not historical facts. The risks, uncertainties and assumptions referred to above may include the
following:
•
•
•
•
•
•
•
•
•
our ability to purchase defaulted consumer receivables at appropriate prices;
changes in the business practices of credit originators in terms of selling defaulted consumer receivables
or outsourcing defaulted consumer receivables to third-party contingent fee collection agencies;
changes in government regulations that affect our ability to collect sufficient amounts on our acquired or
serviced receivables;
our ability to employ and retain qualified employees, especially collection personnel;
changes in the credit or capital markets, which affect our ability to borrow money or raise capital to
purchase or service defaulted consumer receivables;
the degree and nature of our competition;
our ability to comply with the provisions of the Sarbanes-Oxley Act of 2002 and the rules and
regulations promulgated thereunder;
our ability to successfully integrate our newly acquired subsidiary, IGS Nevada (“IGS”), into our
business operations;
the sufficiency of our funds generated from operations, existing cash and available borrowings to
finance our current operations; and
•
the risk factors listed from time to time in our filings with the Securities and Exchange Commission.
PART I
Item 1. Business.
General
We are a full-service provider of outsourced receivables management and related services. We purchase,
collect and manage portfolios of defaulted consumer receivables which includes providing collateral location
services for credit originators and other debt owners. Defaulted consumer receivables are the unpaid obligations
of individuals to credit originators, including banks, credit unions, consumer and auto finance companies, retail
merchants and other providers of goods and services. We believe that the strengths of our business are our
sophisticated approach to portfolio pricing and servicing, our emphasis on developing and retaining our
collection personnel, our sophisticated collections systems and procedures and our relationships with many of the
largest consumer lenders in the United States. Our proven ability to service defaulted consumer receivables
allows us to offer debt owners a complete outsourced solution to address their defaulted consumer receivables.
The defaulted consumer receivables we collect are generally either purchased from sellers of defaulted consumer
debt or are collected on behalf of debt owners on a commission fee basis. On October 1, 2004, we acquired the
assets of IGS Nevada, Inc., which specializes in the location of collateral, securing primarily automobile loans.
3
We believe that this acquisition is highly complementary and inherently related to our collection activities and
broadens the services we can offer to our clients. We intend to continue to build on our strengths and grow our
business through the disciplined approach that has contributed to our success to date.
We use the following terminology throughout our reports: “Cash Receipts” refers to all collections of cash,
regardless of the source. “Cash Collections” refers to collections on our owned portfolios only, exclusive of
commission income and sales of finance receivables. “Amortization Rate” refers to cash collections applied to
principal as a percentage of total cash collections. “Cash Sales of Finance Receivables” refers to the sales of our
owned portfolios. “Commissions” refers to fee income generated from our wholly-owned contingent fee and fee-
for-service subsidiaries. Prior to our initial public offering on November 8, 2002 (our “IPO”), we were
organized as a limited liability company with all income taxes charged to the partners of the partnership. Pro
forma adjustments have been made to show the impact of corporate taxes for all periods prior to our conversion
to a corporation.
We specialize in receivables that have been charged-off by the credit originator. Since the credit originator
and/or other debt servicing companies have unsuccessfully attempted to collect these receivables, we are able to
purchase them at a substantial discount to their face value. From our 1996 inception through December 31, 2004,
we acquired 514 portfolios with a face value of $11.1 billion for $265.8 million, or 2.39% of face value,
representing more than 6.2 million customer accounts. The success of our business depends on our ability to
purchase portfolios of defaulted consumer receivables at appropriate valuations and to collect on those
receivables effectively and efficiently. To date, we have been able to collect at a rate of 2.5 to 3.0 times our
purchase price for defaulted consumer receivables portfolios, as measured over a five to eight year period, which
has enabled us to generate increasing profits and positive cash flow.
We have achieved strong financial results since our formation, with cash collections growing from $10.9
million in 1998 to $153.4 million in 2004. Total revenue has grown from $6.8 million in 1998 to $113.4 million
in 2004, a compound annual growth rate of 60%. Similarly, pro forma net income has grown from $402,000 in
1998 to net income of $27.5 million in 2004. Excluding the impact of proceeds from occasional portfolio sales,
cash collections have increased every quarter since our formation.
We were initially formed as Portfolio Recovery Associates, L.L.C., a Delaware limited liability company, on
March 20, 1996. Prior to the formation of Portfolio Recovery Associates, Inc., members of our current
management team played key roles in the development of a defaulted consumer receivables acquisition and
divestiture operation for Household Recovery Services, a subsidiary of Household International, now owned by
HSBC. In connection with our IPO, all of the membership units of Portfolio Recovery Associates, L.L.C. were
exchanged, simultaneously with the effectiveness of our registration statement, for a single class of the common
stock of Portfolio Recovery Associates, Inc., a new Delaware corporation formed on August 7, 2002.
Accordingly, the members of Portfolio Recovery Associates, L.L.C. became the common stockholders of
Portfolio Recovery Associates, Inc., which became the parent company of Portfolio Recovery Associates, L.L.C.
and its subsidiaries.
Competitive Strengths
Complete Outsourced Solution for Debt Owners
We offer debt owners a complete outsourced solution to address their defaulted consumer receivables.
Depending on a debt owner’s timing and needs, we can either purchase their defaulted consumer receivables,
providing immediate cash, or service those receivables on their behalf for either a fee-for-service or a
commission fee based on a percentage of our collections. We can purchase or service receivables throughout the
entire delinquency cycle, from receivables that have only been processed for collection internally by the debt
owner to receivables that have been subject to multiple internal and external collection efforts. This flexibility
helps us meet the needs of debt owners and allows us to become a trusted resource. Furthermore, our strength
across multiple transaction and asset types provides the opportunity to cross-sell our services to debt owners,
building on successful engagements. Our acquisition of IGS further broadens the services we can offer to debt
owners to include skip tracing and asset location.
4
Disciplined and Proprietary Underwriting Process
One of the key components of our growth has been our ability to price portfolio acquisitions at levels that
have generated profitable returns on investment. To date, we have been able to collect at a rate of 2.5 to 3.0 times
our purchase price for defaulted consumer receivables portfolios, as measured over a five to eight year period,
which has enabled us to generate increasing profits and cash flow. In order to price portfolios and forecast the
targeted collection results for a portfolio, we use two separate statistical models developed internally that may be
supplemented with on-site due diligence of the debt owner’s collection process and loan files. One model
analyzes the portfolio as one unit based on demographic comparisons while the second model analyzes each
account in a portfolio using variables in a regression analysis. As we collect on our portfolios, the results are
input back into the models in an ongoing process which we believe increases their accuracy. Through December
31, 2004 we have acquired 514 portfolios with a face value of $11.1 billion.
Ability to Hire, Develop and Retain Productive Collectors
We place considerable focus on our ability to hire, develop and retain effective collectors who are key to our
continued growth and profitability. Several large military bases and numerous telemarketing, customer service
and reservation phone centers are located near our headquarters and regional offices in Virginia, providing access
to a large pool of eligible personnel. The Hutchinson, Kansas and Las Vegas, Nevada areas also provide a
sufficient potential workforce of eligible personnel. We have found that tenure is a primary driver of our
collector effectiveness. We offer our collectors a competitive wage with the opportunity to receive unlimited
incentive compensation based on performance, as well as an attractive benefits package, a comfortable working
environment and the ability to work on a flexible schedule. Stock options were awarded to many of our
collectors at the time of the initial public offering in 2002, and many tenured collectors were awarded nonvested
shares in 2004. Most IGS employees were awarded nonvested shares at the time of our purchase of IGS in
October 2004. We have a comprehensive six week training program for new owned portfolio collectors and
provide continuing advanced training classes which are conducted in our four training centers. Recognizing the
demands of the job, our management team has endeavored to create a professional and supportive environment
for all of our employees.
Established Systems and Infrastructure
We have devoted significant effort to developing our systems, including statistical models, databases and
reporting packages, to optimize our portfolio purchases and collection efforts. In addition, our technology
infrastructure is flexible, secure, reliable and redundant to ensure the protection of our sensitive data and to
ensure minimal exposure to systems failure or unauthorized access. We believe that our systems and
infrastructure give us meaningful advantages over our competitors. We have developed financial models and
systems for pricing portfolio acquisitions, managing the collections process and monitoring operating results.
We perform a static pool analysis monthly on each of our portfolios, inputting actual results back into our
acquisition models, to enhance their accuracy. We monitor collection results continuously, seeking to identify
and resolve negative trends immediately. Our comprehensive management reporting package is designed to fully
inform our management team so that they may make timely operating decisions. This combination of hardware,
software and proprietary modeling and systems has been developed by our management team through years of
experience in this industry and we believe provides us with an important competitive advantage from the
acquisition process all the way through collection operations.
Strong Relationships with Major Credit Originators
We have done business with most of the top consumer lenders in the United States. We maintain an
extensive marketing effort and our senior management team is in contact with known and prospective credit
originators. We believe that we have earned a reputation as a reliable purchaser of defaulted consumer
receivables portfolios and as responsible collectors. Furthermore, from the perspective of the selling credit
originator, the failure to close on a negotiated sale of a portfolio consumes valuable time and expense and can
have an adverse effect on pricing when the portfolio is re-marketed. We have never failed to close on a
transaction. Similarly, if a credit originator sells a portfolio to a group that violates industry standard collecting
practices, it can taint the reputation of the credit originator. We go to great lengths to collect from consumers in
a responsible, professional and compliant manner. We believe our strong relationships with major credit
5
originators provide us with access to quality opportunities for portfolio purchases and contingent fee collection
placements.
Experienced Management Team
We have an experienced management team with considerable expertise in the accounts receivable
management industry. Prior to our formation, our founders played key roles in the development and management
of a consumer receivables acquisition and divestiture operation of Household Recovery Services, a subsidiary of
Household International, now owned by HSBC. As we have grown, the management team has been expanded
with a group of successful, seasoned executives.
Risks Related to Our Business
To the extent not described elsewhere in this Annual Report, the following are risks related to our business.
We may not be able to purchase defaulted consumer receivables at appropriate prices, and a decrease in our
ability to purchase portfolios of receivables could adversely affect our ability to generate revenue
If we are unable to purchase defaulted receivables from debt owners at appropriate prices, or one or more
debt owners stop selling defaulted receivables to us, we could lose a potential source of income and our business
may be harmed.
The availability of receivables portfolios at prices which generate an appropriate return on our investment
depends on a number of factors both within and outside of our control, including the following:
• the continuation of current growth trends in the levels of consumer obligations;
• sales of receivables portfolios by debt owners; and
• competitive factors affecting potential purchasers and credit originators of receivables.
Because of the length of time involved in collecting defaulted consumer receivables on acquired portfolios
and the volatility in the timing of our collections, we may not be able to identify trends and make changes in our
purchasing strategies in a timely manner.
We may not be able to collect sufficient amounts on our defaulted consumer receivables to fund our operations
Our business consists of acquiring and servicing receivables that consumers have failed to pay and that the
credit originator has deemed uncollectible and has generally charged-off. The debt owners generally make
numerous attempts to recover on their defaulted consumer receivables, often using a combination of in-house
recovery efforts and third-party collection agencies. These defaulted consumer receivables are difficult to collect
and we may not collect a sufficient amount to cover our investment associated with purchasing the defaulted
consumer receivables and the costs of running our business.
We experience high employee turnover rates and we may not be able to hire and retain enough sufficiently
trained employees to support our operations
The accounts receivables management industry is very labor intensive and, similar to other companies in our
industry, we typically experience a high rate of employee turnover. Our annual turnover rate, excluding those
employees that do not complete our six week training program, was 46% in 2004. We compete for qualified
personnel with companies in our industry and in other industries. Our growth requires that we continually hire
and train new collectors. A higher turnover rate among our collectors will increase our recruiting and training
costs and limit the number of experienced collection personnel available to service our defaulted consumer
receivables. If this were to occur, we would not be able to service our defaulted consumer receivables effectively
and this would reduce our ability to continue our growth and operate profitability.
6
We serve markets that are highly competitive, and we may be unable to compete with businesses that may have
greater resources than we have
We face competition in both of the markets we serve — owned portfolio and fee based accounts receivable
management — from new and existing providers of outsourced receivables management services, including other
purchasers of defaulted consumer receivables portfolios, third-party contingent fee collection agencies and debt
owners that manage their own defaulted consumer receivables rather than outsourcing them. The accounts
receivable management industry is highly fragmented and competitive, consisting of approximately 6,000
consumer and commercial agencies, most of which compete in the contingent fee business.
We face bidding competition in our acquisition of defaulted consumer receivables and in our placement of
fee based receivables, and we also compete on the basis of reputation, industry experience and performance.
Some of our current competitors and possible new competitors may have substantially greater financial,
personnel and other resources, greater adaptability to changing market needs, longer operating histories and more
established relationships in our industry than we currently have. In the future, we may not have the resources or
ability to compete successfully. As there are few significant barriers for entry to new providers of fee based
receivables management services, there can be no assurance that additional competitors with greater resources
than ours will not enter the market. Moreover, there can be no assurance that our existing or potential clients will
continue to outsource their defaulted consumer receivables at recent levels or at all, or that we may continue to
offer competitive bids for defaulted consumer receivables portfolios. If we are unable to develop and expand our
business or adapt to changing market needs as well as our current or future competitors are able to do, we may
experience reduced access to defaulted consumer receivables portfolios at appropriate prices and reduced
profitability.
We may not be successful at acquiring receivables of new asset types or in implementing a new pricing structure
We may pursue the acquisition of receivables portfolios of asset types in which we have little current
experience. We may not be successful in completing any acquisitions of receivables of these asset types and our
limited experience in these asset types may impair our ability to collect on these receivables. This may cause us
to pay too much for these receivables and consequently, we may not generate a profit from these receivables
portfolio acquisitions.
In addition, we may in the future provide a service to debt owners in which debt owners will place consumer
receivables with us for a specific period of time for a flat fee. This fee may be based on the number of collectors
assigned to the collection of these receivables, the amount of receivables placed or other bases. We may not be
successful in determining and implementing the appropriate pricing for this pricing structure, which may cause
us to be unable to generate a profit from this business.
Our collections may decrease if certain types of bankruptcy filings involving liquidations increase
Various economic trends may contribute to an increase in the amount of personal bankruptcy filings. Under
certain bankruptcy filings a debtor’s assets may be sold to repay creditors, but since the defaulted consumer
receivables we service are generally unsecured we often would not be able to collect on those receivables. We
cannot ensure that our collection experience would not decline with an increase in personal bankruptcy filings or
a change in bankruptcy regulations or practices. If our actual collection experience with respect to a defaulted
bankrupt consumer receivables portfolio is significantly lower than we projected when we purchased the
portfolio, our financial condition and results of operations could deteriorate.
We may make acquisitions that prove unsuccessful or strain or divert our resources
We intend to consider acquisitions of other companies in our industry that could complement our business,
including the acquisition of entities offering greater access and expertise in other asset types and markets that are
related but that we do not currently serve. We have little experience in completing acquisitions of other
businesses. If we do acquire other businesses, we may not be able to successfully integrate these businesses with
our own and we may be unable to maintain our standards, controls and policies. Further, acquisitions may place
additional constraints on our resources by diverting the attention of our management from other business
concerns. Through acquisitions, we may enter markets in which we have no or limited experience. Moreover,
7
any acquisition may result in a potentially dilutive issuance of equity securities, the incurrence of additional debt
and amortization expenses of related intangible assets, all of which could reduce our profitability and harm our
business.
The loss of IGS customers could negatively affect our operations
On October 1, we acquired substantially all of the assets of IGS for consideration of $14 million. A
significant portion of the valuation was tied to existing client relationships. Our customers, in general, may
terminate their relationship with us on 90 days’ prior notice. In the event a customer or customers terminate or
significantly cut back any relationship with us, it could reduce our profitability and harm our business and could
potentially give rise to an impairment charge related to an intangible asset specifically ascribed to existing client
relationships.
We may not be able to continually replace our defaulted consumer receivables with additional receivables
portfolios sufficient to operate efficiently and profitably
To operate profitably, we must continually acquire and service a sufficient amount of defaulted consumer
receivables to generate revenue that exceeds our expenses. Fixed costs such as salaries and lease or other facility
costs constitute a significant portion of our overhead and, if we do not continually replace the defaulted
consumer receivables portfolios we service with additional portfolios, we may have to reduce the number of our
collection personnel. We would then have to rehire collection staff as we obtain additional defaulted consumer
receivables portfolios. These practices could lead to:
• low employee morale;
• fewer experienced employees;
• higher training costs;
• disruptions in our operations;
• loss of efficiency; and
• excess costs associated with unused space in our facilities.
Furthermore, heightened regulation of the credit card and consumer lending industry or changing credit
origination strategies may result in decreased availability of credit to consumers, potentially leading to a future
reduction in defaulted consumer receivables available for purchase from debt owners. We cannot predict how
our ability to identify and purchase receivables and the quality of those receivables would be affected if there is a
shift in consumer lending practices, whether caused by changes in the regulations or accounting practices
applicable to debt owners, a sustained economic downturn or otherwise.
We may not be able to manage our growth effectively
We have expanded significantly since our formation and we intend to maintain our growth focus. However,
our growth will place additional demands on our resources and we cannot ensure that we will be able to manage
our growth effectively. In order to successfully manage our growth, we may need to:
• expand and enhance our administrative infrastructure;
• continue to improve our management, financial and information systems and controls; and
• recruit, train, manage and retain our employees effectively.
Continued growth could place a strain on our management, operations and financial resources. We cannot
ensure that our infrastructure, facilities and personnel will be adequate to support our future operations or to
8
effectively adapt to future growth. If we cannot manage our growth effectively, our results of operations may be
adversely affected.
Our operations could suffer from telecommunications or technology downtime or increased costs
Our success depends in large part on sophisticated telecommunications and computer systems. The
temporary or permanent loss of our computer and telecommunications equipment and software systems, through
casualty or operating malfunction, could disrupt our operations. In the normal course of our business, we must
record and process significant amounts of data quickly and accurately to access, maintain and expand the
databases we use for our collection activities. Any failure of our information systems or software and our backup
systems would interrupt our business operations and harm our business. Our headquarters are located in a
region that is susceptible to hurricane damage, which may increase the risk of disruption of information systems
and telephone service for sustained periods.
Further, our business depends heavily on services provided by various local and long distance telephone
companies. A significant increase in telephone service costs or any significant interruption in telephone services
could reduce our profitability or disrupt our operations and harm our business.
We may not be able to successfully anticipate, manage or adopt technological advances within our industry
Our business relies on computer and telecommunications technologies and our ability to integrate these
technologies into our business is essential to our competitive position and our success. Computer and
telecommunications technologies are evolving rapidly and are characterized by short product life cycles. We
may not be successful in anticipating, managing or adopting technological changes on a timely basis.
While we believe that our existing information systems are sufficient to meet our current demands and
continued expansion, our future growth may require additional investment in these systems. We depend on
having the capital resources necessary to invest in new technologies to acquire and service defaulted consumer
receivables. We cannot ensure that adequate capital resources will be available to us at the appropriate time.
Our senior management team is important to our continued success and the loss of one or more members of
senior management could negatively affect our operations
The loss of the services of one or more of our key executive officers or key employees could disrupt our
operations. We have employment agreements with Steve Fredrickson, our president, chief executive officer and
chairman of our board of directors, Kevin Stevenson, our executive vice president and chief financial officer,
Craig Grube, our executive vice president of portfolio acquisitions, and most of our other senior executives. The
current agreements contain non-compete provisions that survive termination of employment. However, these
agreements do not and will not assure the continued services of these officers and we cannot ensure that the non-
compete provisions will be enforceable. Our success depends on the continued service and performance of our
key executive officers, and we cannot guarantee that we will be able to retain those individuals. The loss of the
services of Mr. Fredrickson, Mr. Stevenson, Mr. Grube or one or more of our other key executive officers could
seriously impair our ability to continue to acquire or collect on defaulted consumer receivables and to manage
and expand our business. Under one of our credit agreements, if both Mr. Fredrickson and Mr. Stevenson cease
to be president and chief financial officer, respectively, it would constitute a default unless we have a
replacement acceptable to our lenders within ten days. We maintain key man life insurance on Mr. Fredrickson.
Our ability to recover and enforce our defaulted consumer receivables may be limited under federal and state
laws
Federal and state laws may limit our ability to recover and enforce our defaulted consumer receivables
regardless of any act or omission on our part. Some laws and regulations applicable to credit issuers may
preclude us from collecting on defaulted consumer receivables we purchase if the credit issuer previously failed
to comply with applicable laws in generating or servicing those receivables. Collection laws and regulations also
directly apply to our business. Additional consumer protection and privacy protection laws may be enacted that
would impose additional requirements on the enforcement of and collection on consumer credit receivables. Any
new laws, rules or regulations that may be adopted, as well as existing consumer protection and privacy
9
protection laws, may adversely affect our ability to collect on our defaulted consumer receivables and may harm
our business. In addition, federal and state governmental bodies are considering, and may consider in the future,
other legislative proposals that would regulate the collection of our defaulted consumer receivables.
Additionally, new tax law changes such as Internal Revenue Code Section 6050P (requiring 1099-C returns to be
filed on discharge of indebtedness in excess of $600.00) could negatively impact our ability to collect or cause us
to incur additional expenses. Although we cannot predict if or how any future legislation would impact our
business, our failure to comply with any current or future laws or regulations applicable to us could limit our
ability to collect on our defaulted consumer receivables, which could reduce our profitability and harm our
business.
Our ability to recover on portfolios of bankrupt consumer receivables may be impacted by changes in federal
laws or the change in administrative practices of the various bankruptcy courts
We recover on consumer receivables that have filed for bankruptcy protection under available U.S.
bankruptcy legislation. We recover on consumer receivables that have filed for bankruptcy protection after we
acquired them, and we also purchase accounts that are currently in bankruptcy proceedings. If this legislation is
amended, or the process in which the various bankruptcy courts administer bankruptcy plans is changed, our
ability to recover on bankrupt consumer receivables may be negatively affected.
We utilize the interest method of revenue recognition for determining our income recognized on finance
receivables, which is based on an analysis of projected cash flows that may prove to be less than anticipated and
could lead to reductions in future revenues or impairment charges
We utilize the interest method to determine income recognized on finance receivables. Under this method,
static pools of receivables we acquire are modeled upon their projected cash flows. A yield is then established
which, when applied to the unamortized purchase price of the receivables, results in the recognition of income at
a constant yield relative to the remaining balance in the pool of defaulted consumer receivables. Each static pool
is analyzed monthly to assess the actual performance compared to that expected by the model. If the accuracy of
the modeling process deteriorates or there is a decline in anticipated cash flows, we would suffer reductions in
future revenues or a decline in the carrying value of our receivables portfolios or impairment charges, which in
any case would result in lower earnings in future periods and could negatively impact our stock price.
We may be required to incur impairment charges as a result of the application of the new American Institute of
Certified Public Accountants Statement of Position 03-03
In October 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of
Position (“SOP”) 03-03, “Accounting for Loans or Certain Securities Acquired in a Transfer.” The SOP provides
guidance on accounting for differences between contractual and expected cash flows from an investor’s initial
investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to
credit quality. The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004 and
amends Practice Bulletin 6 which remains in effect for loans acquired prior to the SOP effective date. The SOP
limits the revenue that may be accrued to the excess of the estimate of expected future cash flows over a
portfolio’s initial cost of accounts receivable acquired. The SOP 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.
The SOP initially freezes the internal rate of return, referred to as 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, effective January 1, 2005, the carrying value of a portfolio will be written
down to maintain the then-current IRR. The SOP also amends Practice Bulletin 6 in a similar manner and applies
to all loans acquired prior to January 1, 2005. Increases in expected future cash flows can be recognized
prospectively through an upward adjustment of the IRR over a portfolio’s remaining life. Any increased yield
then becomes the new benchmark for impairment testing. The SOP provides that previously issued annual
financial statements would not need to be restated. Historically, as we have applied the guidance of Practice
Bulletin 6, we have moved yields upward and downward as appropriate under that guidance. However, since the
new SOP guidance does not permit yields to be lowered, under either the revised Practice Bulletin 6 or SOP 03-
03, it will increase the probability of us having to incur impairment charges in the future, which could reduce our
profitability in a given period and could negatively impact our stock price.
10
We incur increased costs as a result of recently enacted and proposed changes in laws and regulations
Recently enacted and proposed changes in the laws and regulations affecting public companies, including
the provisions of the Sarbanes-Oxley Act of 2002 and rules proposed by the SEC and by the Nasdaq Stock
Market, have resulted in increased costs to us as we evaluate the implications of any new rules and respond to
and implement their requirements. The new rules could make it more difficult or more costly for us to obtain
certain types of insurance, including director and officer liability insurance, and we may be forced to accept
reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage. The
impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on
our board of directors, our board committees or as executive officers. We are presently evaluating and
monitoring developments with respect to new and proposed rules and cannot predict or estimate the amount of
the additional costs we will incur or the timing of such costs.
The future impact on us of Section 404 of the Sarbanes-Oxley Act of 2002 relating to financial controls is unclear
at this time
As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public
companies to include a report by management on the company’s internal control over financial reporting in our
annual reports on Form 10-K. This report is required to contain an assessment by management of the
effectiveness of such company’s internal controls over financial reporting. In addition, the public accounting firm
auditing a public company’s financial statements must attest to and report on management’s assessment of the
effectiveness of the company’s internal controls over financial reporting. As is the case with many public
companies, at this time the long-term impact of Section 404 on us is unclear. In the future, if we are unable to
comply with the requirements of Section 404 in a timely manner, it could result in an adverse reaction in the
financial markets due to a loss of confidence in the reliability of our internal controls over financial reporting,
which could cause the market price of our common stock to decline and make it more difficult for us to finance
our operations.
The market price of our shares of common stock could fluctuate significantly
Wide fluctuations in the trading price or volume of our shares of common stock could be caused by many
factors, including factors relating to our company or to investor perception of our company (including changes in
financial estimates and recommendations by research analysts), but also factors relating to (or relating to investor
perception of) the accounts receivable management industry or the economy in general.
Our certificate of incorporation, by-laws and Delaware law contain provisions that may prevent or delay a
change of control or that may otherwise be in the best interest of our stockholders
Our certificate of incorporation and by-laws contain provisions that may make it more difficult, expensive or
otherwise discourage a tender offer or a change in control or takeover attempt by a third-party, even if such a
transaction would be beneficial to our stockholders. The existence of these provisions may have a negative
impact on the price of our common stock by discouraging third-party investors from purchasing our common
stock. In particular, our certificate of incorporation and by-laws include provisions that:
• classify our board of directors into three groups, each of which, after an initial transition period, will serve
for staggered three-year terms;
• permit a majority of the stockholders to remove our directors only for cause;
• permit our directors, and not our stockholders, to fill vacancies on our board of directors;
• require stockholders to give us advance notice to nominate candidates for election to our board of directors
or to make stockholder proposals at a stockholders’ meeting;
• permit a special meeting of our stockholders be called only by approval of a majority of the directors, the
11
chairman of the board of directors, the chief executive officer, the president or the written request of
holders owning at least 30% of our common stock;
• permit our board of directors to issue, without approval of our stockholders, preferred stock with such
terms as our board of directors may determine;
• permit the authorized number of directors to be changed only by a resolution of the board of directors; and
• require the vote of the holders of a majority of our voting shares for stockholder amendments to our by-
laws.
In addition, we are subject to Section 203 of the Delaware General Corporation Law which provides certain
restrictions on business combinations between us and any party acquiring a 15% or greater interest in our voting
stock other than in a transaction approved by our board of directors and, in certain cases, by our stockholders.
These provisions of our certificate of incorporation and by-laws and Delaware law could delay or prevent a
change in control, even if our stockholders support such proposals. Moreover, these provisions could diminish
the opportunities for stockholders to participate in certain tender offers, including tender offers at prices above
the then-current market value of our common stock, and may also inhibit increases in the trading price of our
common stock that could result from takeover attempts or speculation.
Portfolio Acquisitions
Our portfolio of defaulted consumer receivables includes a diverse set of accounts that can be categorized by
asset type, age and size of account, level of previous collection efforts and geography. To identify attractive
buying opportunities, we maintain an extensive marketing effort with our senior officers contacting known and
prospective sellers of defaulted consumer receivables. We acquire receivables of Visa®, MasterCard® and
Discover® credit cards, private label credit cards, installment loans, lines of credit, bankrupt, deficiency balances
of various types, legal judgments, and trade payables, all from a variety of debt owners. These debt owners
include major banks, credit unions, consumer finance companies, telecommunication providers, retailers,
utilities, insurance companies, other debt buyers and auto finance companies. In addition, we exhibit at trade
shows, advertise in a variety of trade publications and attend industry events in an effort to develop account
purchase opportunities. We also maintain active relationships with brokers of defaulted consumer receivables.
The following chart categorizes our life to date owned portfolios as of December 31, 2004 into the major
asset types represented.
Asset Type
Visa/MasterCard/Discover
Consumer Finance
Private Label Credit Cards
Auto Deficiency
Total:
No. of Accounts
2,597,772
2,314,898
1,218,119
92,516
6,223,305
%
41.7%
37.2%
19.6%
1.5%
100.0%
Life to Date Purchased Face
Value of Defaulted Consumer
Receivables(1)
$ 6,756,515,773
1,964,866,306
1,833,797,058
563,641,429
$
11,118,820,566
%
60.8%
17.7%
Finance Receivables, net as of
December 31, 2004
$ 69,215,200
12,273,607
16.5% 20,056,840
3,643,259
$
5.0%
100.0%
105,188,906
%
65.8%
11.7%
19.1%
3.4%
100.0%
(1)
The “Life to Date Purchased Face Value of Defaulted Consumer Receivables” represents the original face
amount purchased from sellers and has not been decremented by any adjustments including payments and
buybacks (“buybacks” are defined as purchase price refunded by the seller due to the return of non-compliant
accounts).
We have done business with most of the largest 25 consumer lenders in the United States. Since our
formation, we have purchased accounts from approximately 68 debt owners.
We have acquired portfolios at various price levels, depending on the age of the portfolio, its geographic
distribution, our historical experience with a certain asset type or credit originator and similar factors. A typical
defaulted consumer receivables portfolio ranges from $1 million to $150 million in face value and contains
12
defaulted consumer receivables from diverse geographic locations with average initial individual account
balances of $400 to $7,000.
The age of a defaulted consumer receivables portfolio (the time since an account has been charged-off) is an
important factor in determining the maximum price at which we will purchase a receivables portfolio. Generally,
there is an inverse relationship between the age of a portfolio and the price at which we will purchase the
portfolio. This relationship is due to the fact that older receivables typically are more difficult to collect. The
accounts receivables management industry places receivables into categories depending on the number of
collection agencies that have previously attempted to collect on the receivables. Fresh accounts are typically past
due 120 to 270 days and charged-off by the credit originator, that are either being sold prior to any post-charge-
off collection activity or are placed with a third-party for the first time. These accounts typically sell for the
highest purchase price. Primary accounts are typically 270 to 360 days past due and charged-off, have been
previously placed with one contingent fee servicer and receive a lower purchase price. Secondary and tertiary
accounts are typically more than 360 days past due and charged-off, have been placed with two or three
contingent fee servicers and receive even lower purchase prices.
As shown in the following chart, as of December 31, 2004, a majority of our accounts are secondary and
tertiary accounts, but we purchase or service accounts at any point in the delinquency cycle.
Account Type
No. of Accounts
%
Life to Date Purchased Face
Value of Defaulted Consumer
Receivables(1)
%
Finance Receivables, net as of
December 31, 2004
%
Fresh
Primary
Secondary
Tertiary
Other
178,111
868,084
1,647,742
2,721,277
808,091
2.9% $ 574,045,987
2,280,076,757
3,125,641,410
3,103,321,798
2,035,734,614
13.9%
26.5%
43.7%
13.0%
5.2% $ 5,772,493
34,040,507
35,466,864
13,372,294
16,536,748
20.5%
28.1%
27.9%
18.3%
5.5%
32.4%
33.7%
12.7%
15.7%
Total:
6,223,305
100.0%
$
11,118,820,566
100.0%
$
105,188,906
100.0%
(1)
The “Life to Date Purchased Face Value of Defaulted Consumer Receivables” represents the original face
amount purchased from sellers and has not been decremented by any adjustments including payments and
buybacks (“buybacks” are defined as purchase price refunded by the seller due to the return of non-compliant
accounts).
We also review the geographic distribution of accounts within a portfolio because we have found that certain
states have more debtor-friendly laws than others and, therefore, are less desirable from a collectibility
perspective. In addition, economic factors and bankruptcy trends vary regionally and are factored into our
maximum purchase price equation.
13
The following chart sets forth our overall life to date portfolio of defaulted consumer receivables
geographically as of December 31, 2004:
Geographic Distribution
Texas
California
Florida
New York
Pennsylvania
North Carolina
Illinois
New Jersey
Ohio
Georgia
Massachusetts
Michigan
South Carolina
Missouri
Maryland
Tennessee
Other
No. of
Accounts
1,601,265
545,267
392,920
283,998
158,195
154,112
208,962
113,954
175,397
123,590
123,140
164,597
105,785
242,916
85,520
88,891
1,654,796
%
26%
9%
6%
5%
3%
2%
3%
2%
3%
2%
2%
3%
2%
4%
1%
1%
26%
Life to Date Purchased Face
Value of Defaulted Consumer
Receivables(1)
$ 1,619,034,346
1,323,273,564
1,088,999,811
803,459,120
396,715,998
365,070,174
345,243,649
336,564,202
316,303,826
291,493,486
279,409,707
257,463,702
236,267,231
217,551,425
200,093,308
192,370,612
2,849,506,405
%
15%
12%
10%
7%
4%
3%
3%
3%
3%
3%
3%
2%
2%
2%
2%
2%
24% (2)
Total:
6,223,305
100%
$
11,118,820,566
100%
__________
(1)
The “Life to Date Purchased Face Value of Defaulted Consumer Receivables” represents the original face
amount purchased from sellers and has not been decremented by any adjustments including payments and
buybacks (defined as purchase price refunded by the seller due to the return of non-compliant accounts).
(2) Each state included in "Other" represents under 2% of the face value of total defaulted consumer receivables.
Purchasing Process
We acquire portfolios from debt owners through both an auction and a negotiated sale process. In an auction
process, the seller will assemble a portfolio of receivables and either broadly offer the portfolio to the market or
will seek purchase prices from specifically invited potential purchasers. In a privately negotiated sale process,
the debt owner will contact known, reputable purchasers directly and negotiate the terms of sale. On a limited
basis, we also acquire accounts in forward flow contracts. Under a forward flow contract, we agree to purchase
defaulted consumer receivables from a debt owner on a periodic basis, at a set percentage of face value of the
receivables over a specified time period. These agreements typically have a provision requiring that the
attributes of the receivables to be sold will not significantly change each month and that the debt owner efforts to
collect these receivables will not change. If this provision is not provided for, the contract will allow for the
early termination of the forward flow contract by the purchaser. Forward flow contracts are a consistent source
of defaulted consumer receivables for accounts receivables management providers and provide the debt owner
with a reliable source of revenue and a professional resolution of defaulted consumer receivables.
In a typical sale transaction, a debt owner distributes a computer data file containing ten to fifteen basic data
fields on each receivables account in the portfolio offered for sale. Such fields typically include the consumer's
name, address, outstanding balance, date of charge-off, date of last payment and the date the account was opened.
We perform our initial due diligence on the portfolio by electronically cross-checking the data fields on the
computer disk or data tape against the accounts in its owned portfolios and against national demographic and
credit databases. We compile a variety of portfolio level reports examining all demographic data available.
When valuing pools of bankrupt consumer receivables, we seek to access information on the status of each
account’s bankruptcy case.
14
In order to determine a maximum purchase price for a portfolio, we use two separate computer models
developed internally that may be supplemented with on-site due diligence of the seller’s collection operation
and/or a review of their loan origination files, collection notes and work processes. We analyze the portfolio
using our proprietary multiple regression model, which analyzes each account of the portfolio using variables in
the regression model. In addition, we analyze the portfolio using an adjustment model, which uses an
appropriate cash flow model depending upon whether it is a purchase of fresh, primary, secondary or tertiary
accounts. Then, adjustments can be made to the cash flow model to compensate for demographic attributes
supported by a detailed analysis of demographic data. From these models we derive our quantitative purchasing
analysis which is used to help price transactions. The multiple regression model is also used to prioritize
collection work efforts subsequent to purchase. With respect to prospective forward flow contracts and other
long-term relationships, in addition to the procedures outlined above, as we receive new flows under the
aforementionened contract we may obtain a representative test portfolio to evaluate and compare the performance
of the portfolio to the projections we developed in our purchasing analysis. In addition, when purchasing
bankrupt consumer receivables, we utilize a specifically designed pricing model.
Our due diligence and portfolio review results in a comprehensive analysis of the proposed portfolio. This
analysis compares defaulted consumer receivables in the prospective portfolio with our collection history in
similar portfolios. We then use our multiple regression model to value each account. Using the two valuation
approaches, we determine cash collections over the life of the portfolio. We then summarize all anticipated cash
collections and associated direct expenses and project a collectibility value expressed both in dollars and
liquidation percentage and a detailed expense projection over the portfolio's estimated six to seven year economic
life. We use the total projected collectibility value to determine an appropriate purchase price.
We maintain a detailed static pool analysis on each portfolio that we have acquired, capturing all
demographic data and revenue and expense items for further analysis. We use the static pool analysis to refine
the underwriting models that we use to price future portfolio purchases. The results of the static pool analysis are
input back into our models, increasing the accuracy of the models as the data set increases with every portfolio
purchase and each day's collection efforts.
The quantitative and qualitative data derived in our due diligence is evaluated together with our knowledge
of the current defaulted consumer receivables market and any subjective factors that management may know
about the portfolio or the debt owner. A portfolio acquisition approval memorandum is prepared for each
prospective portfolio before a purchase price is submitted to the debt owner. This approval memorandum, which
outlines the portfolio's anticipated collectibility and purchase structure, is distributed to members of our
investment committee. The approval by the committee sets a maximum purchase price for the portfolio. The
investment committee is currently comprised of Steve Fredrickson, CEO and President, Kevin Stevenson, CFO
and Craig Grube, Executive Vice President - Acquisitions.
Once a portfolio purchase has been approved by our investment committee and the terms of the sale have
been agreed to with the debt owner, the acquisition is documented in an agreement that contains customary terms
and conditions. Provisions are typically incorporated for bankrupt, disputed, fraudulent or deceased accounts
and typically, the debt owner either agrees to repurchase these accounts or replace them with acceptable
replacement accounts within certain time frames.
Owned Collection Operations
Our work flow management system places, recalls and prioritizes accounts in collectors' work queues, based
on our analyses of our accounts and other demographic, credit and prior work collection attributes. We use this
process to focus our work effort on those consumers most likely to pay on their accounts and to rotate to other
collectors the non-paying but most likely to pay accounts from which other collectors have been unsuccessful in
receiving payment. The majority of our collections occur as a result of telephone contact with consumers.
The collectibility forecast for a newly acquired portfolio will help determine collection strategy. Accounts
which are determined to have the highest predicted collection probability may be sent immediately to collectors'
work queues. Less collectible accounts may be set aside as house accounts to be collected using a predictive
dialer or other passive, low cost method. Some accounts may be worked using a letter and/or settlement strategy.
We may obtain credit reports for various accounts after the collection process begins.
15
When a collector establishes contact with a consumer, the account information is placed automatically in the
collector's work queue. Our computer system allows each collector to view all the scanned documents relating to
the consumer's account, which can include the original account application and payment checks. A typical
collector work queue may include 650 to 1,000 accounts or more, depending on the skill level and tenure of the
collector. The work queue is depleted and replenished automatically by our computerized work flow system.
On the initial contact call, the consumer is given a standardized presentation regarding the benefits of
resolving his or her account with us. Emphasis is placed on determining the reason for the consumer's default in
order to better assess the consumer's situation and create a plan for repayment. The collector is incentivized to
have the consumer pay the full balance of the account. If the collector cannot obtain payment of the full balance,
the collector will suggest a repayment plan which generally includes an approximate 20% down payment with
the balance to be repaid over an agreed upon period. At times, when determined to be appropriate, and in many
cases with management approval, a reduced lump-sum settlement may be agreed upon. If the consumer elects to
utilize an installment plan, we have developed a system to make monthly withdrawals from a consumer's bank
account.
If a collector is unable to establish contact with a consumer based on information received, the collector
must undertake skip tracing procedures to develop important account information. Skip tracing is the process of
developing new phone, address, job or asset information on a consumer. Each collector does his or her own skip
tracing using a number of computer applications available at his or her workstation, as well as a series of
automated skip tracing procedures implemented by us on a regular basis.
Accounts for which the consumer has the likely ability, but not the willingness, to resolve their obligations
are reviewed for legal action. Depending on the balance of the defaulted consumer receivable and the applicable
state collection laws, we determine whether to commence legal action to judicially collect on the receivable. The
legal process can take an extended period of time, but it also generates cash collections that likely would not have
been realized otherwise.
Our legal recovery department oversees and coordinates an independent nationwide collections attorney
network which is responsible for the preparation and filing of judicial collection proceedings in multiple
jurisdictions, determining the suit criteria, coordinating sales of property and instituting wage garnishments to
satisfy judgments. This network consists of approximately 70 independent law firms who work on a contingent
fee basis. Legal cash collections currently constitute approximately 30% of our total cash collections. As our
portfolio matures, a larger number of accounts will be directed to our legal recovery department for judicial
collection; consequently, we anticipate that legal cash collections will grow commensurately and comprise a
larger percentage of our total cash collections. During 2004, we began using staff attorneys to pursue legal
collections in certain states and under certain circumstances. This practice is currently very limited, but is
expected to grow over time.
Our bankruptcy department also processes proofs of claims for recovery on receivables which are included
in consumer bankruptcies filed under Chapter 13 of the U.S. Bankruptcy Code, and submits claims against
estates in cases involving deceased debtors having assets at the time of death. Proposed amendments to federal
bankruptcy laws, if passed, could have an impact upon our operations. The amendments, which, among other
things, propose to establish income criteria for the filing of a Chapter 7 bankruptcy petition, are expected to cause
more debtors to file bankruptcy petitions under Chapter 13, rather than Chapter 7 of the U.S. Bankruptcy Code.
Consequently, if this legislation is passed, we expect that fewer debtors will be able to have their obligations
completely discharged in Chapter 7 bankruptcy actions, and will instead resort to filing bankruptcy petitions
under Chapter 13, which requires that the debtor establish a payment plan. We expect that this will enable us to
generate recoveries from a larger number of bankrupt debtors through the filing of proofs of claims with the
trustees of bankruptcy courts.
Fee-for-Service Collections Operations
In order to provide debt owners with alternative collection solutions and to capitalize on common
competencies between a fee-for-service collections operation and an acquired receivables portfolio business, we
commenced our third-party contingent fee collections operations in March 2001. In a contingent fee
arrangement, debt owners typically place defaulted receivables with a third party collection agency once they
16
have ceased their recovery efforts. The debt owners then pay the third-party agency a commission fee based
upon the amount actually collected from the consumer. A contingent fee placement of defaulted consumer
receivables is usually for a fixed time frame, typically four to six months, or as long as nine months. At the end
of this fixed period, the third-party agency will return the uncollected defaulted consumer receivables to the debt
owner, which may then place the defaulted consumer receivables with another collection agency or sell the
portfolio of receivables.
The determination of the commission fee to be paid for third-party collections is generally based upon the
age and potential collectibility of the defaulted consumer receivables being assigned for placement. For example,
if there has been no prior third-party collection activity with respect to the defaulted consumer receivables, the
commission fee would be lower than if there had been one or more previous collection agencies attempting to
collect on the receivables. The earlier the placement of defaulted consumer receivables in the collection process,
the higher the probability of receiving a cash collection and, therefore, the lower the cost to collect and the lower
the commission fee. Other factors, such as the location of the consumers, the size of the defaulted consumer
receivables, competition among third party agencies, and the clients' collection procedures and work standards
also contribute to establishing a commission fee.
In addition to our historical contingent fee business as described above, revenues from our new IGS business
are accounted for as commission revenue. IGS performs skip tracing services for auto finance companies for a
fee. The fee earned is generally determined by whether the debtor was located, we coordinate repossession of the
collateral, we coordinate payment between the client and the customer or if the debtor is found. For example, if
the debtor is not found, our fee is less than if the debtor is found and we are able to arrange for an agent to take
possession of the collateral securing the loan.
Competition
We face competition in both of the markets we serve — owned portfolio and fee-for-service accounts
receivable management — from new and existing providers of outsourced receivables management services,
including other purchasers of defaulted consumer receivables portfolios, third-party contingent fee collection
agencies and debt owners that manage their own defaulted consumer receivables rather than outsourcing them.
The accounts receivable management industry (owned portfolio and contingent fee) is highly fragmented and
competitive, consisting of approximately 6,000 consumer and commercial agencies. We estimate that more than
90% of these agencies compete in the contingent fee market. There are few significant barriers for entry to new
providers of contingent fee receivables management services and, consequently, the number of agencies serving
the contingent fee market may continue to grow. Greater capital needs and the need for portfolio evaluation
expertise sufficient to price portfolios effectively constitute significant barriers for entry to new providers of
owned portfolio receivables management services.
We face bidding competition in our acquisition of defaulted consumer receivables and in obtaining
placement of fee-for-service receivables. We also compete on the basis of reputation, industry experience and
performance. Among the positive factors which we believe influence our ability to compete effectively in this
market are our ability to bid on portfolios at appropriate prices, our reputation from previous transactions
regarding our ability to close transactions in a timely fashion, our relationships with originators of defaulted
consumer receivables, our team of well-trained collectors who provide quality customer service and compliance
with applicable collections laws, our ability to collect on various asset types and our ability to provide both
purchased and contingent fee solutions to debt owners. Among the negative factors which we believe could
influence our ability to compete effectively in this market are that some of our current competitors and possible
new competitors may have substantially greater financial, personnel and other resources, greater adaptability to
changing market needs, longer operating histories and more established relationships in our industry than we
currently have.
Information Technology
Technology Operating Systems and Server Platform
The scalability of our systems provides us with a technology system that is flexible, secure, reliable and
redundant to ensure the protection of our sensitive data. We utilize Intel-based servers running industry standard
17
open systems coupled with Microsoft Windows 2000/2003 and NT Server operating systems. In addition, we
utilize a blend of purchased and proprietary software systems tailored to the needs of our business. These
systems are designed to eliminate inefficiencies in our collections, continue to meet business objectives in a
changing environment and meet compliance obligations with regulatory entities. We believe that our
combination of purchased and proprietary software packages provide collections automation that is superior to
our competitors. Our proprietary hardware and software systems are being leveraged to manage location
information, phone and operational applications for IGS. We believe our custom solutions will enhance the
overall investigative capabilities of this business while meeting compliance obligations with regulatory entities.
Network Technology
To provide delivery of our applications, we utilize Intel-based workstations across our entire business
operations. The environment is configured to provide speeds of 100 megabytes to the desktops of our collections
and administration staff. Our one gigabyte server network architecture supports high-speed data transport. Our
network system is designed to be scalable and meet expansion and inter-building bandwidth and quality of
service demands.
Database Systems
The ability to access and utilize data is essential to us being able to operate nationwide in a cost-effective
manner. Our centralized computer-based information systems support the core processing functions of our
business under a set of integrated databases and are designed to be both replicable and scalable to accommodate
our internal growth. This integrated approach helps to assure that consistent sources are processed efficiently.
We use these systems for portfolio and client management, skip tracing, check taking, financial and management
accounting, reporting, and planning and analysis. The systems also support our consumers, including on-line
access to account information, account status and payment entry. We use a combination of Microsoft, Oracle
and Cache database software to manage our portfolios, financial, customer and sales data, and we believe these
systems will be sufficient for our needs for the foreseeable future. Our contingent fee collections operations
database incorporates an integrated and proprietary predictive dialing platform used with our predictive dialer
discussed below. For our newly acquired business unit, IGS, we are completing initial development of a
proprietary platform that will be enhanced for scalability in the future.
Redundancy, System Backup, Security and Disaster Recovery
Our data centers provide the infrastructure for innovative collection services and uninterrupted support of
hardware and server management, server co-location and an all-inclusive server administration for our business.
We believe our facilities and operations include sufficient redundancy, file back-up and security to ensure
minimal exposure to systems failure or unauthorized access. The preparations in this area include the use of call
centers in Virginia and in Kansas in order to help provide redundancy for data and processes should one site be
completely disabled. We have a comprehensive disaster recovery plan covering our business that is tested on a
periodic basis. The combination of our locally distributed call control systems provides enterprise-wide call and
data distribution between our call centers for efficient portfolio collection and business operations. In addition to
data replication between the sites, incremental backups of both software and databases are performed on a daily
basis and a full system backup is performed weekly. Backup data tapes are stored at an offsite location along
with copies of schedules and production control procedures, procedures for recovery using an off-site data
center, documentation and other critical information necessary for recovery and continued operation. Our
Virginia headquarters has two separate power and telecommunications feeds, an uninterruptible power supply
and a diesel-generator power plant, that provide a level of redundancy should a power outage or interruption
occur. We also employ rigorous physical and electronic security to protect our data. Our call centers have
restricted card key access and appropriate additional physical security measures. Electronic protections include
data encryption, firewalls and multi-level access controls. The facility which currently houses IGS features
uninterruptible power supply units and electronic protections. Full-scale site power, telecommunication and all of
the other systems abilities of our other sites will be installed at IGS during 2005.
18
Plasma Displays for Real Time Data Utilization
We utilize plasma displays at our main facility to aid in recovery of portfolios. The displays provide real-
time business-critical information to our collection personnel for efficient collection efforts such as telephone,
production, employee status, goal trending, training and corporate information.
Dialer Technology
The Noble Systems Predictive Dialer ensures that our collection staff focuses on certain defaulted consumer
receivables according to our specifications. Our predictive dialer takes account of all campaign and dialing
parameters and is able to constantly adjust its dialing pace to match changes in campaign conditions and provide
the lowest possible wait times.
Employees
We employed 948 persons on a full-time basis, including 652 collectors on our owned portfolios, an
additional 69 collectors working in our contingent fee collections operations and 28 collectors working in our
IGS operations, as of December 31, 2004. None of our employees are represented by a union or covered by a
collective bargaining agreement. We believe that our relations with our employees are good.
Hiring
We recognize that our collectors are critical to the success of our business as a majority of our collection
efforts occur as a result of telephone contact with consumers. We have found that the tenure and productivity of
our collectors are directly related. Therefore, attracting, hiring, training, retaining and motivating our collection
personnel is a major focus for us. We pay our collectors competitive wages and offer employees a full benefits
program which includes comprehensive medical coverage, short and long term disability, life insurance, dental
and vision coverage, pre-paid legal plan, an employee assistance program, supplemental indemnity, cancer,
hospitalization, accident insurance, a flexible spending account for child care and a matching 401(k) program. In
addition to a base wage, we provide collectors with the opportunity to receive unlimited compensation through
an incentive compensation program that pays bonuses above a set monthly base, based upon each collector's
collection results. This program is designed to ensure that employees are paid based not only on performance,
but also on consistency. We have awarded stock based compensation to many of our tenured collectors. We
believe that these practices have helped us maintain a relatively low annual post-training turnover rate of 46% in
2004.
A large number of telemarketing, customer-service and reservation phone centers are located near our
Virginia headquarters. We believe that we offer a competitive and, in many cases, a higher base wage than many
local employers and therefore have access to a large number of eligible personnel. In addition, there are
approximately 100,000 active-duty military personnel in the area. We employ numerous military spouses and
retirees and find them to be an excellent source of employees. We have also found the Las Vegas, Nevada and
Hutchinson, Kansas areas to provide a large potential workforce of eligible personnel.
Training
We provide a comprehensive six week training program for all new owned portfolio collectors. The first
three weeks of the training program is comprised of lectures to learn collection techniques, state and federal
collection laws, systems, negotiation skills, skip tracing and telephone use. These sessions are then followed by
an additional three weeks of practical experience conducting live calls with additional managerial supervision in
order to provide employees with confidence and guidance while still contributing to our profitability. Each
trainee must successfully pass a comprehensive examination before being assigned to the collection floor. In
addition, we conduct continuing advanced classes in our four training centers. Our technology and systems
allow us to monitor individual employees and then offer additional training in areas of deficiency to increase
productivity.
Outsourced Collections Department
19
Legal Recovery
An important component of our collections effort involves our outsourced collections department and the
judicial collection of accounts of customers who have the ability, but not the willingness, to resolve their
obligations. Accounts for which the consumer is not cooperative and for which we can establish a garnishable
job or attachable asset are reviewed for legal action. Depending on the balance of the defaulted consumer
receivable and the applicable state collection laws, we determine whether to commence legal action to collect on
the receivable. The legal process can take an extended period of time, but it also generates cash collections that
likely would not have been realized otherwise. Our legal recovery department oversees and coordinates an
independent nationwide attorney network which is responsible for the preparation and filing of judicial collection
proceedings in multiple jurisdictions, determining the suit criteria, coordinating sales of property and instituting
wage garnishments to satisfy judgments. This nationwide collections attorney network consists of approximately
70 independent law firms who work on a contingent fee basis. Legal cash collections currently constitute
approximately 30% of our total collections. As our portfolio matures, a larger number of accounts will be
directed to our outsourced collections department for judicial collection; consequently, we anticipate that legal
collections will grow commensurately and comprise a larger percentage of our total cash collections. During
2004, we began using staff attorneys to pursue legal collections in certain states and under certain circumstances.
This practice is currently very limited, but is expected to grow over time.
Bankruptcy
Our bankruptcy department also processes proofs of claims for recovery on accounts which are included in
consumer bankruptcies filed under Chapter 13 of the U.S. Bankruptcy Code. Proposed amendments to federal
bankruptcy laws, if passed, could have an impact upon our operations. The amendments, which, among other
things, propose to establish income criteria for the filing of a Chapter 7 bankruptcy petition, are expected to cause
more debtors to file bankruptcy petitions under Chapter 13, rather than Chapter 7 of the U.S. Bankruptcy Code.
Consequently, if this legislation is passed, we expect that fewer debtors will be able to have their obligations
completely discharged in Chapter 7 bankruptcy actions, and will instead resort to filing bankruptcy petitions
under Chapter 13, which requires that the debtor establish a payment plan. We expect that this will enable us to
generate recoveries from a larger number of bankrupt debtors through the filing of proofs of claims with the
trustees of bankruptcy courts.
Corporate Legal Department
Our corporate legal department manages general corporate legal matters, such as litigation management,
insurance management and risk assessment, contract and document preparation and review, including real estate
purchase and lease agreements and portfolio purchase documents, federal securities law and other regulatory and
statutory compliance, obtaining and maintaining multi-state licensing, bonding and insurance, and dispute and
complaint resolution. As a part of its compliance functions, our corporate legal department also provides
oversight to our Quality Control Department and assists with training for our staff in relevant areas. We provide
employees with extensive training on the Fair Debt Collection Practices Act and other relevant laws and
regulations. Our corporate legal department distributes guidelines and procedures for collection personnel to
follow when communicating with customers, customer’s agents, attorneys and other parties during our recovery
efforts. In addition, our corporate legal department regularly researches, and provides collections personnel and
our Training Department with summaries and updates of changes in, federal and state statutes and relevant case
law, so that they are aware of and in compliance with changing laws and judicial decisions when tracing or
collecting accounts.
Regulation
Federal and state statutes establish specific guidelines and procedures which debt collectors must follow
when collecting consumer accounts. It is our policy to comply with the provisions of all applicable federal laws
and comparable state statutes in all of our recovery activities, even in circumstances in which we may not be
specifically subject to these laws. Our failure to comply with these laws could have a material adverse effect on
us in the event and to the extent that they apply to some or all of our recovery activities. Federal and state
20
consumer protection, privacy and related laws and regulations extensively regulate the relationship between debt
collectors and debtors, and the relationship between customers and credit card issuers. Significant federal laws
and regulations applicable to our business as a debt collector include the following:
• Fair Debt Collection Practices Act. This act imposes certain obligations and restrictions on the practices of
debt collectors, including specific restrictions regarding communications with consumer customers, including the
time, place and manner of the communications. This act also gives consumers certain rights, including the right
to dispute the validity of their obligations.
• Fair Credit Reporting Act. This act places certain requirements on credit information providers regarding
verification of the accuracy of information provided to credit reporting agencies and investigating consumer
disputes concerning the accuracy of such information. We provide information concerning our accounts to the
three major credit reporting agencies, and it is our practice to correctly report this information and to investigate
credit reporting disputes. The Fair and Accurate Credit Transactions Act amended the Fair Credit Reporting Act
to include additional duties applicable to data furnishers with respect to information in the consumer’s credit file
that the consumer identifies as resulting from identity theft, and requires that data furnishers have procedures in
place as of December 1, 2004 to prevent such information from being furnished to credit reporting agencies. We
have instituted measures to effect compliance with these requirements.
• Gramm-Leach-Bliley Act. This act requires that certain financial institutions, including collection agencies,
develop policies to protect the privacy of consumers’ private financial information and provide notices to
consumers advising them of their privacy policies. This act also requires that if private personal information
concerning a consumer is shared with another unrelated institution, the consumer must be given an opportunity to
opt out of having such information shared. Since we do not share consumer information with non-related entities,
except as required by law, or except as needed to collect on the receivables, our consumers are not entitled to any
opt-out rights under this act. This act is enforced by the Federal Trade Commission, which has retained exclusive
jurisdiction over its enforcement, and does not afford a private cause of action to consumers who may wish to
pursue legal action against a financial institution for violations of this act.
• Electronic Funds Transfer Act. This act regulates the use of the Automated Clearing House ("ACH")
system to make electronic funds transfers. All ACH transactions must comply with the rules of the National
Automated Check Clearing House Association ("NACHA") and Uniform Commercial Code § 3-402. This act,
the NACHA regulations and the Uniform Commercial Code give the consumer, among other things, certain
privacy rights with respect to the transactions, the right to stop payments on a pre-approved fund transfer, and the
right to receive certain documentation of the transaction. This act also gives consumers a right to sue institutions
which cause financial damages as a result of their failure to comply with its provisions.
• Telephone Consumer Protection Act. In the process of collecting accounts, we use automated predictive
dialers to place calls to consumers. This act and similar state laws place certain restrictions on telemarketers and
users of automated dialing equipment who place telephone calls to consumers.
• Servicemembers Civil Relief Act. The Soldiers’ and Sailors’ Civil Relief Act of 1940 was amended in
December 2003 as the Servicemembers Civil Relief Act (“SCRA”). The SCRA gives U.S. military service
personnel relief from credit obligations they may have incurred prior to entering military service, and may also
apply in certain circumstances to obligations and liabilities incurred by a servicemember while serving on active
duty. The SCRA prohibits creditors from taking specified actions to collect the defaulted accounts of
servicemembers. The SCRA impacts many different types of credit obligations, including installment contracts
and court proceedings, and tolls the statute of limitations during the time that the servicemember is engaged in
active military service. The SCRA also places a cap on interest bearing obligations of servicemembers to an
amount not greater than 6% per year, inclusive of all related charges and fees.
• Health Insurance Portability and Accountability Act. The Health Insurance Portability and Accountability
Act (“HIPAA”) provides standards to protect the confidentiality of patients’ personal healthcare and financial
information. Pursuant to HIPAA, business associates of health care providers, such as agencies which collect
healthcare receivables, must comply with certain privacy standards established by HIPAA to ensure that the
information provided will be safeguarded from misuse.
21
• U.S. Bankruptcy Code. In order to prevent any collection activity with bankrupt debtors by creditors and
collection agencies, the U.S. Bankruptcy Code provides for an automatic stay, which prohibits certain contacts
with consumers after the filing of bankruptcy petitions.
Additionally, there are in some states statutes and regulations comparable to the above federal laws, and
specific licensing requirements which affect our operations. State laws may also limit credit account interest rates
and the fees, as well as limit the time frame in which judicial actions may be initiated to enforce the collection of
consumer accounts.
Although we are not a credit originator, some of these laws directed toward credit originators may
occasionally affect our operations because our receivables were originated through credit transactions, such as
the following laws, which apply principally to credit originators:
• Truth in Lending Act;
• Fair Credit Billing Act; and
• Equal Credit Opportunity Act.
Federal laws which regulate credit originators require, among other things, that credit card issuers disclose to
consumers the interest rates, fees, grace periods, and balance calculation methods associated with their credit
card accounts. Consumers are entitled under current laws to have payments and credits applied to their accounts
promptly, to receive prescribed notices, and to require billing errors to be resolved promptly. Some laws prohibit
discriminatory practices in connection with the extension of credit. Federal statutes further provide that, in some
cases, consumers cannot be held liable for, or their liability is limited with respect to, charges to the credit card
account that were a result of an unauthorized use of the credit card. These laws, among others, may give
consumers a legal cause of action against us, or may limit our ability to recover amounts owing with respect to
the receivables, whether or not we committed any wrongful act or omission in connection with the account. If the
credit originator fails to comply with applicable statutes, rules and regulations, it could create claims and rights
for consumers that could reduce or eliminate their obligations to repay the account, and have a possible material
adverse effect on us.
Accordingly, when we acquire defaulted consumer receivables, we contractually require credit originators to
indemnify us against any losses caused by their failure to comply with applicable statutes, rules and regulations
relating to the receivables before they are sold to us.
The U.S. Congress and several states have enacted legislation concerning identity theft. Additional consumer
protection and privacy protection laws may be enacted that would impose additional requirements on the
enforcement of and recovery on consumer credit card or installment accounts. Any new laws, rules or regulations
that may be adopted, as well as existing consumer protection and privacy protection laws, may adversely affect
our ability to recover the receivables. In addition, our failure to comply with these requirements could adversely
affect our ability to enforce the receivables.
We cannot assure you that some of the receivables were not established as a result of identity theft or
unauthorized use of a credit card and, accordingly, we could not recover the amount of the defaulted consumer
receivables. As a purchaser of defaulted consumer receivables, we may acquire receivables subject to legitimate
defenses on the part of the consumer. Our account purchase contracts allow us to return to the debt owners
certain defaulted consumer receivables that may not be collectible, due to these and other circumstances. Upon
return, the debt collectors are required to replace the receivables with similar receivables or repurchase the
receivables. These provisions limit to some extent our losses on such accounts.
22
Item 2. Properties.
Our principal executive offices and primary operations facility are located in approximately 65,000 square
feet of leased space in two adjacent buildings in Norfolk, Virginia. We own a two-acre parcel of land across from
our headquarters which we developed into a parking lot for use by our employees. In addition, we own an
approximately 15,000 square foot facility in Hutchinson, Kansas, and contiguous parcels of land which are used
primarily for employee parking. The Hutchinson site can currently accommodate approximately 100 employees.
We also lease a facility located in approximately 21,000 square feet of space in Hampton, Virginia which can
accommodate approximately 285 employees. As a result of the IGS acquisition, since October 1, 2004 we have
occupied 5,000 square feet of office space in Las Vegas, Nevada. We do not consider any specific leased or
owned facility to be material to our operations. We believe that equally suitable alternative facilities are
available in all areas where we currently do business.
During December 2004, we began work on a 4,000 square foot expansion to our Hutchinson, Kansas call
center. The expansion will permit us to add approximately 56 collectors and four managers to that facility. In
conjunction with the expansion, we acquired an additional 4,000 square foot building and 35,000 square feet of
adjacent land in order to secure parking for the expanded facility.
During January 2005, we signed a new lease for a 13,500 square foot call center in Las Vegas, Nevada. This
site is currently undergoing tenant improvements and will house our IGS operation. In the second quarter of
2005, we anticipate moving from the existing 5,000 square foot facility into this new one. Our lease obligation
on the existing 5,000 square foot facility will end at that time.
Item 3. Legal Proceedings.
From time to time, we are involved in various legal proceedings which are incidental to the ordinary course
of our business. We regularly initiate lawsuits against consumers and are occasionally countersued by them in
such actions. Also, consumers occasionally initiate litigation against us, in which they allege that we have
violated a state or federal law in the process of collecting on an account. We do not believe that these routine
matters represent a substantial volume of our accounts or that, individually or in the aggregate, they are material
to our business or financial condition.
We are not a party to any material legal proceedings and we are unaware of any contemplated material
actions against us.
Item 4. Submission of Matters to a Vote of Securityholders.
None.
23
PART II
Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and
Issuer Purchases of Equity Securities.
Price Range of Common Stock
Our common stock (“Common Stock”) began trading on the Nasdaq National Market under the symbol
“PRAA” on November 8, 2002. Prior to that time there was no public trading market for our common stock.
The following table sets forth the high and low sales price for the Common Stock, as reported by the Nasdaq
National Market, for the periods indicated.
2002
Quarter ended December 31, 2002
2003
Quarter ended March 31, 2003
Quarter ended June 30, 2003
Quarter ended September 30, 2003
Quarter ended December 31, 2003
2004
Quarter ended March 31, 2004
Quarter ended June 30, 2004
Quarter ended September 30, 2004
Quarter ended December 31, 2004
High
$20.50
$25.00
$33.95
$32.50
$30.61
$28.63
$29.53
$30.05
$41.80
Low
$14.75
$17.76
$20.40
$24.30
$22.55
$23.89
$24.06
$25.16
$29.10
As of February 16, 2005, there were 25 holders of record of the Common Stock. Based on information
provided by our transfer agent and registrar, we believe that there are 15,128 beneficial owners of the Common
Stock.
Shares Registered After Initial Public Offering
A secondary offering of our shares of common stock was completed on May 21, 2003, in which 4,025,000
shares were sold (including the overallotment option.)
On November 7, 2003, we filed two Registration Statements with the Securities and Exchange Commission,
both of which were filed on Form S-8, to register (a) the 2,000,000 shares of the Common Stock underlying our
2002 Employee Stock Option Plan and (b) 142,500 shares of the Common Stock underlying Warrants held by
certain of our key employees.
A secondary offering of our shares of common stock was completed on November 17, 2004, in which
1,955,000 shares (including the overallotment option) were sold by existing stockholders. The registration of
these shares was completed with the Securities and Exchange Commission on Form S-3. We did not receive any
of the proceeds from the sale of these shares. All offering related expenses were paid by the selling shareholders.
Holders of 3,999,599 shares of our common stock which were not sold in the secondary offering agreed to a 90-
day “lock-up” with respect to these shares, which restricted their ability to sell these shares during the 90 days
following the date of the prospectus, or until February 17, 2005. These shares may now be sold in accordance
with the provisions of the federal securities laws, including Rule 144.
24
Dividend Policy
Our board of directors sets our dividend policy. We do not pay dividends on the Common Stock; however,
our board of directors may determine in the future to declare or pay cash dividends on the Common Stock. Any
future determination as to the declaration and payment of dividends will be at the discretion of our board of
directors and will depend on then existing conditions, including our financial condition, results of operations,
contractual restrictions, capital requirements, business prospects and other factors that our board of directors may
consider relevant.
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with the audited financial statements.
2004
2003
2002
2001
2000
Year Ended December 31,
(Dollars in thousands, except per share data)
INCOME STATEMENT DATA:
Revenue:
Income recognized on finance receivables
Commissions
Net gain on cash sales of defaulted consumer receivables
Total revenue
$
106,254
7,142
-
113,396
$
81,796
3,131
-
84,927
$
53,803
1,944
100
55,847
$
31,221
214
901
32,336
$
18,991
-
343
19,334
Operating expenses:
Compensation and employee services
Outside legal and other fees and services
Communications
Rent and occupancy
Other operating expenses
Depreciation and amortization
Total operating expenses
Income from operations
Loss on extinguishment of debt
Net interest expenses
Income before income taxes
Provision for income taxes
Net income (1)
Pro forma income taxes (unaudited) (2)
Pro forma net income (unaudited)(2)
Net income per share
Basic
Diluted
Pro forma net income per share (unaudited)(3)
Basic
Diluted
Weighted average shares (3)
Basic
Diluted
OPERATING AND OTHER FINANCIAL DATA:
Cash collections and commissions (4)
Operating expenses to cash collections and commissions
Acquisitions of finance receivables, at cost (5)
Acquisitions of finance receivables, at face value
Employees at period end:
Total employees
Ratio of collection personnel to total employees (6)
36,620
21,408
3,638
1,745
2,712
2,383
68,506
44,890
-
51
44,839
17,388
28,987
14,147
2,772
1,189
1,932
1,445
50,472
34,455
-
542
33,913
13,199
$
27,451
$
20,714
21,701
8,093
1,915
799
1,436
940
34,884
20,963
-
2,425
18,538
1,473
17,065
5,694
15,644
3,627
1,645
712
1,265
677
23,570
8,766
(424)
2,716
5,626
-
5,626
2,100
9,883
2,583
871
603
652
437
15,029
4,305
-
1,765
2,540
-
2,540
901
$
11,371
$
3,526
$
1,639
$
$
1.79
1.73
$
$
1.42
1.32
$
$
1.08
0.94
$
$
0.35
0.31
$
$
0.16
0.14
15,357
15,853
14,546
15,712
10,529
12,066
10,000
11,458
10,000
11,366
$
160,546
43%
61,165
3,340,434
$
$
$
120,183
42%
61,815
2,229,682
$
$
$
81,198
43%
42,382
1,966,296
$
$
$
53,362
44%
33,381
1,592,353
$
$
$
30,733
49%
24,663
1,004,114
$
$
948
89%
798
90%
581
88%
501
90%
370
89%
_________________________________________________
(1) At the time of our initial public offering, which commenced on November 8, 2002, we changed our legal
structure from a limited liability company to a corporation. As a limited liability company we were not
subject to Federal or state corporate income taxes. Therefore, net income does not give effect to taxes for all
periods prior to our initial public offering.
(2) For comparison purposes, for periods prior to 2003 we have presented pro forma net income, which reflects
income taxes assuming we had been a corporation since the time of our formation and assuming tax rates
equal to the rates that would have been in effect had we been required to report tax expenses in such years.
The pro forma income taxes and pro forma net income information are unaudited. We believe that pro
25
forma net income for periods prior to 2003 may be compared to net income for the 2003 and 2004 periods.
(3) For periods prior to 2003, pro forma net income per share assumes the Company had reorganized as a
corporation since the beginning of the period presented. The pro forma net income per share information is
unaudited. For the 2003 and 2004 periods, pro forma net income per share is the actual net income per
share for the period presented.
(4) Includes both cash collected on finance receivables and commission fees received during the relevant
period.
(5) Represents cash paid for finance receivables. It does not include certain capitalized costs or purchase price
refunded by the seller due to the return of non-compliant accounts (also defined as buybacks). Non-
compliant refers to the contractual representations and warranties provided for in the purchase and sale
contract between the seller and us. These representations and warranties from the sellers generally cover
account holders’ death or bankruptcy and accounts settled or disputed prior to sale. The seller can replace
or repurchase these accounts.
(6) Includes all collectors and all first-line collection supervisors at December 31.
Below is listed some key balance sheet data for the periods presented:
(Dollars in thousands)
BALANCE SHEET DATA:
Cash and cash equivalents
Investments (1)
Finance receivables, net
Total assets
Long-term debt
Total debt, including capital lease obligations
Total stockholders' equity
2004
2003
2002
2001
2000
As of December 31,
$
24,513
23,950
105,189
175,176
1,924
2,501
151,389
$
24,912
-
92,569
126,394
1,657
2,208
119,148
$
11,989
5,950
65,526
88,288
966
1,465
80,608
$
4,780
-
47,987
57,108
568
26,771
27,752
$
3,191
-
41,124
47,188
532
23,300
22,705
(1) Investment balances were previously reported as cash and cash equivalents for the periods presented.
Below is listed the quarterly income statements for the years ended December 31, 2004 and 2003:
(Dollars in thousands, except per share data)
INCOME STATEMENT DATA:
Revenue:
Income recognized on finance receivables
Commissions
Total revenue
Operating expenses:
Compensation and employee services
Outside legal and other fees and services
Communications
Rent and occupancy
Other operating expenses
Depreciation and amortization
Total operating expenses
Income from operations
Net interest income (expense)
Income before income taxes
Provision for income taxes
Net income
Net income per share
Basic
Diluted
Weighted average shares
Basic
Diluted
Dec. 31,
2004
Sept. 30,
2004
June 30,
2004
For the Quarter Ended,
Mar. 31,
Dec. 31,
2003
2004
Sept. 30,
2003
June 30,
2003
Mar. 31,
2003
$
28,387
3,315
31,702
$
27,070
1,216
28,286
$
26,890
1,254
28,144
$
23,908
1,357
25,265
$
22,172
864
23,036
$
21,389
784
22,173
$
20,618
785
21,403
$
17,618
698
18,316
9,717
6,369
980
448
684
985
19,183
12,519
50
12,569
4,854
9,155
5,348
840
434
649
488
16,914
11,372
8
11,380
4,405
9,211
5,450
811
433
689
463
17,057
11,087
(43)
11,044
4,294
8,537
4,241
1,008
429
691
448
15,354
9,911
(65)
9,846
3,835
7,545
4,168
769
317
610
391
13,800
9,236
(328)
8,908
3,467
7,370
3,886
702
317
393
383
13,051
9,122
(84)
9,038
3,509
7,679
3,276
667
310
456
371
12,759
8,644
(75)
8,569
3,324
6,393
2,817
634
245
473
301
10,863
7,453
(56)
7,397
2,899
$
7,715
$
6,975
$
6,750
$
6,011
$
5,441
$
5,529
$
5,245
$
4,498
$
$
0.50
0.48
$
$
0.45
0.44
$
$
0.44
0.43
$
$
0.39
0.38
$
$
0.36
0.35
$
$
0.36
0.35
$
$
0.37
0.33
$
$
0.33
0.29
15,462
16,030
15,342
15,832
15,322
15,776
15,304
15,774
15,249
15,756
15,149
15,751
14,241
15,750
13,545
15,590
Below is listed the quarterly Balance Sheet for the years ended December 31, 2004 and 2003:
26
(Dollars in thousands)
BALANCE SHEET DATA:
Assets
Cash and cash equivalents
Investments (1)
Finance receivables, net
Property and equipment, net
Deferred tax asset
Income tax receivable
Goodwill
Intangible assets, net
Other assets
Total assets
Liabilities and Stockholders' Equity
Liabilities
Accounts payable
Accrued expenses
Income taxes payable
Accrued payroll and bonuses
Deferred tax liability
Long-term debt
Obligations under capital lease
Total liabilities
Stockholders' equity
Common stock
Additional paid in capital
Retained earnings
Total stockholders' equity
Total liabilities and stockholders' equity
Dec. 31,
2004
Sept. 30,
2004
June 30,
2004
Mar. 31,
2004
Dec. 31,
2003
Sept. 30,
2003
June 30,
2003
Mar. 31,
2003
Quarter Ended
$
$
$
$
$
$
$
$
24,513
23,950
105,189
5,752
-
-
6,397
6,319
3,056
175,176
35,815
20,950
95,312
6,033
-
-
-
-
827
158,937
27,402
14,950
96,270
6,022
-
147
-
-
1,333
146,124
29,691
-
95,628
5,878
-
357
-
-
1,476
133,030
24,912
-
92,569
5,166
2,009
352
-
-
1,386
126,394
14,810
-
89,836
5,233
5,414
1,856
-
-
1,122
118,271
7,979
-
86,689
5,059
8,915
2,122
-
-
1,304
112,068
$
$
$
$
$
$
$
$
10,122
1,950
74,418
4,996
-
-
-
-
1,211
92,697
$
1,414
1,563
182
4,476
13,651
1,924
576
23,786
$
1,176
1,213
148
3,916
9,719
2,050
627
18,849
$
1,049
557
-
3,404
5,631
2,174
679
13,494
$
656
392
-
1,697
1,676
2,296
755
7,472
$
1,291
514
-
3,233
-
1,657
551
7,246
$
1,132
599
-
2,383
-
1,744
634
6,492
$
1,314
353
-
2,351
-
1,829
540
6,387
$
861
333
2,603
1,495
368
925
618
7,203
155
100,906
50,329
151,390
175,176
$
154
97,321
42,613
140,088
158,937
$
153
96,839
35,638
132,630
146,124
$
153
96,517
28,888
125,558
133,030
$
153
96,118
22,877
119,148
126,394
$
152
94,191
17,436
111,779
118,271
$
151
93,623
11,907
105,681
112,068
$
136
78,696
6,662
85,494
92,697
$
(1) Investment balances were previously reported as cash and cash equivalents for the periods presented.
27
Item 7. Management’s Discussion and Analysis of Financial Condition and Results of
Operations.
Results of Operations
The following table sets forth certain operating data in dollars and as a percentage of total revenue for the
years ended December 31, 2004, 2003 and 2002:
2004
2003
2002
Revenue:
Income recognized on finance receivables
Commissions
Net gain on cash sales of defaulted consumer receivables
Total revenue
Operating expenses:
$
106,254,441
7,141,796
-
113,396,237
Compensation and employee services
Outside legal and other fees and services
Communications
Rent and occupancy
Other operating expenses
Depreciation and amortization
Total operating expenses
Income from operations
Interest income
Interest expense
Income before income taxes
Provision for income taxes
Net income
Pro forma income taxes (unaudited) (1)
Pro forma net income (unaudited) (1)
36,620,054
21,407,570
3,638,144
1,744,885
2,712,463
2,382,896
68,506,012
44,890,225
222,718
(273,355)
44,839,588
17,388,148
27,451,440
$
93.7%
6.3
0.0
100.0
32.3
18.9
3.2
1.5
2.4
2.1
60.4
39.6
0.2
(0.2)
39.5
15.3
24.2%
$
81,796,209
3,131,054
-
84,927,263
28,986,795
14,147,394
2,772,110
1,189,379
1,932,055
1,444,825
50,472,558
34,454,705
60,173
(602,072)
33,912,806
13,199,303
20,713,503
$
96.3%
3.7
0.0
100.0
34.1
16.7
3.3
1.4
2.3
1.7
59.4
40.6
0.1
(0.7)
39.9
15.5
24.4%
$
53,802,718
1,944,428
100,156
55,847,302
96.3%
3.5
0.2
100.0
21,700,918
8,092,460
1,914,557
799,323
1,436,438
940,352
34,884,048
20,963,254
21,548
(2,446,620)
18,538,182
1,473,073
17,065,109
$
38.9
14.5
3.4
1.4
2.6
1.7
62.5
37.5
0.0
(4.4)
33.2
2.6
30.6
5,693,788
11,371,321
$
10.2
20.4%
__________
(1) During most of 2002 our legal structure was a limited liability company. As a limited liability company we
were not subject to federal or state corporate income taxes. For comparison purposes, pro forma net
income is presented, which reflects income taxes assuming we had been a corporation since the time of its
formation and assuming tax rates equal to the rates that would have been in effect had we been required to
report tax expense in such years.
Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Revenue
Total revenue was $113.4 million for the year ended December 31, 2004, an increase of $28.5 million or
33.6% compared to total revenue of $84.9 million for the year ended December 31, 2003.
Income Recognized on Finance Receivables
Income recognized on finance receivables under the guidance of Practice Bulletin 6, was $106.3 million for
the year ended December 31, 2004, an increase of $24.5 million or 30.0% compared to income recognized on
finance receivables of $81.8 million for the year ended December 31, 2003. The majority of the increase was
due to an increase in our cash collections on our owned defaulted consumer receivables to $153.4 million from
$117.1 million, an increase of 31.0%. Our amortization rate on owned portfolios for the year ended December
31, 2004 was 30.7% while for the year ended December 31, 2003 it was 30.1%. During the year ended
December 31, 2004, we acquired defaulted consumer receivables portfolios with an aggregate face value amount
of $3.3 billion at an original purchase price of $61.2 million. During the year ended December 31, 2003, we
acquired defaulted consumer receivable portfolios with an aggregate face value of $2.2 billion at an original
purchase price of $61.8 million. Our relative cost of acquiring defaulted consumer receivable portfolios
decreased to 1.83% of face value for the year ended December 31, 2004 from 2.77% of face value for the year
ended December 31, 2003. As a percentage of total face acquired in 2004, we purchased 1.4% fresh, 14.1%
primary, 8.6% secondary, 41.1% tertiary, and 34.8% other, while in 2003 we purchased 2.5% fresh, 24.6%
primary, 41.3% secondary, 17.9% tertiary and 13.7% other. In any period, we acquire defaulted consumer
28
receivables that can vary dramatically in their age, type and ultimate collectibility. We may pay significantly
different purchase rates for purchased receivables within any period as a result of this quality fluctuation. As a
result, the average purchase rate paid for any given period can fluctuate dramatically based on our particular
buying activity in that period. During the year ended December 31, 2004, we bought a higher concentration of
older, lower priced portfolios, which resulted in a lower purchase price when compared to the year ended
December 31, 2003. However, regardless of the average purchase price, we intend to target a similar internal rate
of return in pricing its portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to
estimated profitability of a period’s buying.
Commissions
Commissions were $7.1 million for the year ended December 31, 2004, an increase of $4.0 million or
129.0% compared to commissions of $3.1 million for the year ended December 31, 2003. Included in
commissions are fees earned by our contingent fee subsidiary (Anchor), and in the fourth quarter of 2004 fees
earned by our newly acquired skip tracing business (IGS). The increase from Anchor is related to a growing
inventory of accounts.
Net gain on cash sales of defaulted consumer receivables
Net gain on cash sales, recognized under the guidance of FAS 140, of defaulted consumer receivables was
$0 for both the years ended December 31, 2004 and December 31, 2003. We retained our accounts for our
collection.
Operating Expenses
Total operating expenses were $68.5 million for the year ended December 31, 2004, an increase of $18.0
million or 35.6% compared to total operating expenses of $50.5 million for the year ended December 31, 2003.
Total operating expenses, including compensation expenses, were 42.7% of cash receipts excluding sales for the
year ended December 31, 2004 compared with 42.0% for the same period in 2003.
Compensation and Employee Services
Compensation and employee services expenses were $36.6 million for the year ended December 31, 2004,
an increase of $7.6 million or 26.2% compared to compensation and employee services expenses of $29.0 million
for the year ended December 31, 2003. Compensation and employee services expenses increased as total
employees grew from 798 at December 31, 2003 to 948 at December 31, 2004. Additionally, existing employees
received normal salary increases. Compensation and employee services expenses as a percentage of cash receipts
excluding sales decreased to 22.8% for the year ended December 31, 2004 from 24.1% of cash receipts
excluding sales for the same period in 2003.
Outside Legal and Other Fees and Services
Outside legal and other fees and services expenses were $21.4 million for the year ended December 31,
2004, an increase of $7.3 million or 51.8% compared to outside legal and other fees and services expenses of
$14.1 million for the year ended December 31, 2003. The increase was attributable to the increased cash
collections resulting from the increased number of accounts placed with independent contingent fee attorneys.
This increase is consistent with the growth we experienced in our portfolio of defaulted consumer receivables
and a portfolio management strategy implemented in mid 2002. This strategy resulted in us referring to the legal
suit process more unsuccessfully liquidated accounts that have an identified means of repayment but that are
nearing their legal statute of limitations, than had been referred historically. Legal cash collections represented
30.2% of total cash collections for the year ended December 31, 2004, up from 26.0% for the year ended
December 31, 2003. Total legal expenses for the year ended December 31, 2004 were 34.5% of legal cash
collections compared to 35.7% for the year ended December 31, 2003.
29
Communications
Communications expenses were $3.6 million for the year ended December 31, 2004, an increase of $800,000
or 28.6% compared to communications expenses of $2.8 million for the year ended December 31, 2003. The
increase was attributable to growth in mailings and higher telephone expenses incurred to collect on a greater
number of defaulted consumer receivables owned and serviced. Mailings were responsible for 80.3% of this
increase, while the remaining 19.7% was attributable to higher phone charges.
Rent and Occupancy
Rent and occupancy expenses were $1.7 million for the year ended December 31, 2004, an increase of
$500,000 or 41.7% compared to rent and occupancy expenses of $1.2 million for the year ended December 31,
2003. The increase was attributable to increased leased space due to the opening of a call center in Hampton,
Virginia in March 2003 and at our new Norfolk, Virginia location which opened in January 2004. Of the
$500,000 increase in 2004, the new Hampton call center accounted for $59,000 of the increase, the new Norfolk
location accounted for $449,000 of the increase and the new IGS location accounted for $23,000 of the increase
offset by a decrease of $31,000 related to the Virginia Beach, Virginia administrative space that was vacated in
January 2004.
Other Operating Expenses
Other operating expenses were $2.7 million for the year ended December 31, 2004, an increase of $800,000
or 42.1% compared to other operating expenses of $1.9 million for the year ended December 31, 2003. The
increase was due to increases in repairs and maintenance, taxes, fees and, licenses and insurance expenses.
Repairs and maintenance expenses increased by $80,000, taxes, fees and, licenses increased by $237,000,
insurance expense increased by $454,000, and other expense items increased by $29,000.
Depreciation and Amortization
Depreciation and amortization expenses were $2.4 million for the year ended December 31, 2004, an
increase of $1.0 million or 71.4% compared to depreciation and amortization expenses of $1.4 million for the
year ended December 31, 2003. The increase was attributable to the depreciation and amortization of the
acquired assets of IGS and the continued capital expenditures on equipment, software and computers related to
our growth and systems upgrades. The amortization of the IGS intangible assets accounted for $481,000 of the
increase while the remaining increase of $519,000 resulted from continued capital expenditures on equipment,
software and computers.
Interest Income
Interest income was $223,000 for the year ended December 31, 2004, an increase of $163,000 or 271.7%
compared to interest income of $60,000 for the year ended December 31, 2003. These amounts are the result of
investing in tax-exempt auction rate certificates in 2003 and 2004. The increase is due to larger invested
balances in 2004 than in 2003 as well as a higher rate of return.
Interest Expense
Interest expense was $273,000 for the year ended December 31, 2004, a decrease of $327,000 or 54.5%
compared to interest expense of $600,000 for the year ended December 31, 2003. The decrease is due to a lower
unused line fee under the new revolving credit arrangement. In addition, with the termination of a revolving line
of credit, we wrote off $284,000 in the fourth quarter of 2003.
30
Year Ended December 31, 2003 Compared to Year Ended December 31, 2002
Revenue
Total revenue was $84.9 million for the year ended December 31, 2003, an increase of $29.1 million or
52.2% compared to total revenue of $55.8 million for the year ended December 31, 2002.
Income Recognized on Finance Receivables
Income recognized on finance receivables, recognized under the guidance of Practice Bulletin 6, was
$81.8 million for the year ended December 31, 2003, an increase of $28.0 million or 52.0% compared to income
recognized on finance receivables of $53.8 million for the year ended December 31, 2002. The majority of the
increase was due to an increase in our cash collections on our owned defaulted consumer receivables to
$117.1 million from $79.3 million, an increase of 47.7%. Our amortization rate on owned portfolios for the year
ended December 31, 2003 was 30.1% while for the year ended December 31, 2002 it was 32.1%. During the year
ended December 31, 2003, we acquired defaulted consumer receivables portfolios with an aggregate face value
amount of $2.2 billion at an original purchase price of $61.8 million. During the year ended December 31, 2002,
we acquired defaulted consumer receivable portfolios with an aggregate face value of $2.0 billion at an original
purchase price of $42.4 million. Our relative cost of acquiring defaulted consumer receivable portfolios increased
to 2.8% of face value for the year ended December 31, 2003 from 2.2% of face value for the year ended
December 31, 2002. As a percentage of total face acquired in 2003, we purchased 2.5% fresh, 24.6% primary,
41.3% secondary, 17.9% tertiary, and 13.7% other, while in 2002 we purchased 7.5% fresh, 13.2% primary,
35.1% secondary, 39.6% tertiary and 4.6% other. In any period, we acquire defaulted consumer receivables that
can vary dramatically in their age, type and ultimate collectibility. We may pay significantly different purchase
rates for purchased receivables within any period as a result of this quality fluctuation. As a result, the average
purchase rate paid for any given period can fluctuate dramatically based on our particular buying activity in that
period. During the year ended December 31, 2003, we bought a higher concentration of newer, higher priced
portfolios, which resulted in a higher purchase price when compared to the year ended December 31, 2002.
However, regardless of the average purchase price, we intend to target a similar internal rate of return in pricing
its portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to the estimated profitability
of a portfolio.
Commissions
Commissions were $3.1 million for the year ended December 31, 2003, an increase of $1.2 million or
63.2% compared to commissions of $1.9 million for the year ended December 31, 2002. Commissions increased
as a result of a growing inventory of accounts.
Net gain on cash sales of defaulted consumer receivables
Net gain on cash sales, recognized under the guidance of FAS 140, of defaulted consumer receivables were
$0 for the year ended December 31, 2003, a decrease of $100,000 or 100.0% compared to net gain on cash sales
of defaulted consumer receivables of $100,000 for the year ended December 31, 2002, which was derived from
one sale in June 2002.
Operating Expenses
Total operating expenses were $50.5 million for the year ended December 31, 2003, an increase of
$15.6 million or 44.7% compared to total operating expenses of $34.9 million for the year ended December 31,
2002. Total operating expenses, including compensation expenses, were 42.0% of cash receipts excluding sales
for the year ended December 31, 2003 compared with 43.0% for the same period in 2002.
31
Compensation and Employee Services
Compensation and employee services expenses were $29.0 million for the year ended December 31, 2003,
an increase of $7.3 million or 33.6% compared to compensation and employee services expenses of $21.7 million
for the year ended December 31, 2002. Compensation and employee services expenses increased as total
employees grew from 581 at December 31, 2002 to 798 at December 31, 2003. Additionally, existing employees
received normal salary increases. Compensation and employee services expenses as a percentage of cash receipts
excluding sales decreased to 24.1% for the year ended December 31, 2003 from 26.7% of cash receipts
excluding sales for the same period in 2002.
Outside Legal and Other Fees and Services
Outside legal and other fees and services expenses were $14.1 million for the year ended December 31,
2003, an increase of $6.0 million or 74.1% compared to outside legal and other fees and services expenses of
$8.1 million for the year ended December 31, 2002. The increase was attributable to the increased cash
collections resulting from the increased number of accounts placed with independent contingent fee attorneys.
This increase is consistent with the growth we experienced in our portfolio of defaulted consumer receivables
and a portfolio management strategy implemented in mid 2002. This strategy resulted in us referring to the legal
suit process more unsuccessfully liquidated accounts that have an identified means of repayment but that are
nearing their legal statute of limitations, than had been referred historically. Legal cash collections represented
26.0% of total cash collections for the year ended December 31, 2003, up from 19.5% for the year ended
December 31, 2002. Total legal expenses for the year ended December 31, 2003 were 35.7% of legal cash
collections compared to 38.4% for the year ended December 31, 2002.
Communications
Communications expenses were $2.8 million for the year ended December 31, 2003, an increase of
$900,000 or 47.4% compared to communications expenses of $1.9 million for the year ended December 31,
2002. The increase was attributable to growth in mailings and higher telephone expenses incurred to collect on a
greater number of defaulted consumer receivables owned and serviced. Mailings were responsible for 52.2% of
this increase, while the remaining 47.8% was attributable to higher phone charges.
Rent and Occupancy
Rent and occupancy expenses were $1.2 million for the year ended December 31, 2003, an increase of
$401,000 or 50.2% compared to rent and occupancy expenses of $799,000 for the year ended December 31,
2002. The increase was attributable to increased leased space due to the opening of a call center in Hampton,
Virginia, a storage facility, an off-site administrative and mail handling site and contractual increases in annual
rental rates. The Hampton call center accounted for $293,000 of the increase, the new storage facility accounted
for $28,000 of the increase and the administrative/mail site accounted for $19,000 of the increase. The remaining
increase was attributable to contractual increases in annual rental rates.
Other Operating Expenses
Other operating expenses were $1.9 million for the year ended December 31, 2003, an increase of $500,000
or 35.7% compared to other operating expenses of $1.4 million for the year ended December 31, 2002. The
increase was due to increases in repairs and maintenance, hiring and insurance. Repairs and maintenance
expenses increased by $124,000, hiring expenses increased by $139,000 and insurance expense increased by
$257,000, offset by decreases in other expense items of $20,000.
Depreciation and Amortization
Depreciation and amortization expenses were $1.4 million for the year ended December 31, 2003, an
increase of $460,000 or 48.9% compared to depreciation expenses of $940,000 for the year ended December 31,
2002. The increase was attributable to continued capital expenditures on equipment, software, and computers
related to our growth and systems upgrades. Of the increase in depreciation expenses, 61.7% is the result of the
32
March 2003 opening of our new Hampton office and an associated $2.0 million in equipment purchases. The
remaining increase of 38.3% was the result of system upgrades.
Interest Income
Interest income was $60,000 for the year ended December 31, 2003, an increase of $38,000 or 172.7%
compared to interest income of $22,000 for the year ended December 31, 2002. This increase is the result of
investing in short-term municipal instruments during the first half of 2003 versus investments of less than two
months in 2002.
Interest Expense
Interest expense was $600,000 for the year ended December 31, 2003, a decrease of $1.8 million or 75.0%
compared to interest expense of $2.4 million for the year ended December 31, 2002. This decreased primarily as
a result of the payoff of all outstanding revolving debt with the proceeds from our initial public offering, but also
includes a $284,000 charge related to the termination of the Westside Funding facility in the fourth quarter of
2003.
33
Supplemental Performance Data
Owned Portfolio Performance:
The following table shows our portfolio buying activity by year, setting forth, among other things, the
purchase price, actual cash collections and estimated remaining cash collections as of December 31, 2004.
Actual Cash Collections
Including Cash Sales
($ in thousands)
Purchase Period
Ending
December 31,
1996
1997
1998
1999
2000
2001
2002
2003
2004
Purchase Price(1)
$ 3,080
$ 7,685
$ 11,089
$ 18,898
$ 25,015
$ 33,472
$42,282
$ 61,528
$ 61,355
$ 9,265
$ 22,423
$ 31,133
$ 53,539
$ 77,058
$ 102,090
$ 87,084
$ 74,014
$ 18,025
Estimated
Remaining
Collections(2)
$ 95
$ 274
$ 827
$ 3,532
$ 10,295
$ 27,209
$ 51,511
$92,432
$ 121,936
Total
Estimated
Collections(3)
$ 9,361
$ 22,697
$ 31,960
$ 57,070
$ 87,352
$ 129,299
$ 138,596
$ 166,446
$ 139,960
Total Estimated
Collections to
Purchase Price(4)
304%
295%
288%
302%
349%
386%
328%
271%
228%
(1) Purchase price refers to the cash paid to a seller to acquire defaulted consumer receivables, plus certain
capitalized costs, less the purchase price refunded by the seller due to the return of non-compliant
accounts (also defined as buybacks). Non-compliant refers to the contractual representations and
warranties provided for in the purchase and sale contract between the seller and us. These
representations and warranties from the sellers generally cover account holders’ death or bankruptcy
and accounts settled or disputed prior to sale. The seller can replace or repurchase these accounts.
(2) Estimated remaining collections refers to the sum of all future projected cash collections on our owned
portfolios.
(3) Total estimated collections refers to the actual cash collections, including cash sales, plus estimated
remaining collections.
(4) Total estimated collections to purchase price refers to the total estimated collections divided by the
purchase price.
When we acquire a portfolio of defaulted accounts, we generally do so with a forecast of future total
collections to purchase price paid of no more than 2.6 times. Only after the portfolio has established probable
and estimable performance in excess of that projection will estimated remaining collections be increased.
34
The following graph shows the purchase price of our owned portfolios by year beginning in 1996. The
purchase price number represents the cash paid to the seller to acquire defaulted consumer receivables, plus
certain capitalized costs, less the purchase price refunded by the seller due to the return of non-compliant
accounts.
Portfolio Purchases by Year
$70,000,000
$60,000,000
$50,000,000
$40,000,000
$30,000,000
$20,000,000
$10,000,000
$-
1996
1997
1998
1999
2000
2001
2002
2003
2004
We utilize a long-term approach to collecting our owned pools of receivables. This approach has historically
caused us to realize significant cash collections and revenues from purchased pools of finance receivables years
after they are originally acquired. As a result, we have in the past been able to temporarily reduce our level of
current period acquisitions without a corresponding negative current period impact on cash collections and
revenue.
The following table, which excludes any proceeds from cash sales of finance receivables, demonstrates our
ability to realize significant multi-year cash collection streams on our owned pools.
$
$
$
$
$
$
1996
1997
1998
1999
2000
2001
$
2002
$
($ in thousands)
Purchase
Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
Total
Purchase
Price
3,080
7,685
11,089
18,898
25,015
33,472
42,282
61,528
61,355
264,404
Cash Collections By Year, By Year of Purchase
Cash Collection Period
548
-
-
-
-
-
-
-
-
548
2,484
2,507
-
-
-
-
-
-
-
4,991
1,890
5,215
3,776
-
-
-
-
-
-
10,881
1,348
4,069
6,807
5,138
-
-
-
-
-
17,362
1,025
3,347
6,398
13,069
6,894
-
-
-
-
30,733
730
2,630
5,152
12,090
19,498
13,048
-
-
-
53,148
496
1,829
3,948
9,598
19,478
28,831
15,073
-
-
79,253
2003
$
398
1,324
2,797
7,336
16,628
28,003
36,258
24,308
-
$
117,052
2004
$
285
1,022
2,200
5,615
14,098
26,717
35,742
49,706
18,019
153,404
Total
$
$
$
$
$
$
$
$
$
$
9,204
21,943
31,078
52,846
76,596
96,599
87,073
74,014
18,019
467,372
$
$
$
$
$
$
$
$
$
35
When we acquire a new pool of finance receivables, our estimates typically result in a 72-84 month
projection of cash collections. The following chart shows our historical cash collections (including cash sales of
finance receivables) in relation to the aggregate of the total estimated collection projections made at the time of
each respective pool purchase.
Actual Cash Collections and Cash Sales vs. Original Projections
($ in millions)
Original Projections
Actual Cash Collections
$500.0
$450.0
$400.0
$350.0
$300.0
$250.0
$200.0
$150.0
$100.0
$50.0
$0.0
8
9
-
n
a
J
8
9
-
r
p
A
8
9
-
l
u
J
8
9
-
t
c
O
9
9
-
n
a
J
9
9
-
r
p
A
9
9
-
l
u
J
9
9
-
t
c
O
0
0
-
n
a
J
0
0
-
r
p
A
0
0
-
l
u
J
0
0
-
t
c
O
1
0
-
n
a
J
1
0
-
r
p
A
1
0
-
l
u
J
1
0
-
t
c
O
2
0
-
n
a
J
2
0
-
r
p
A
2
0
-
l
u
J
2
0
-
t
c
O
3
0
-
n
a
J
3
0
-
r
p
A
3
0
-
l
u
J
3
0
-
t
c
O
4
0
-
n
a
J
4
0
-
r
p
A
4
0
-
l
u
J
4
0
-
t
c
O
Owned Portfolio Personnel Performance:
We measure the productivity of each collector each month, breaking results into groups of similarly tenured
collectors. The following three tables display various productivity measures that we track.
Collector by Tenure
Tenure at:
One year +(1)
Less than one year (2)
Total(2)
12/31/00
109
180
289
12/31/01
151
218
369
12/31/02
210
223
433
12/31/03
241
338
579
12/31/04
298
349
647
(1) Calculated based on actual employees (collectors) with one year of service or more.
(2) Calculated using total hours worked by all collectors, including those in training to produce a full time
equivalent “FTE.”
Average performance
One year + (2)
Less than one year(3)
12/31/00
$14,081
7,482
12/31/01
$15,205
7,740
12/31/02
$16,927
8,689
12/31/03
$18,158
8,303
12/31/04
$17,129
9,363
Monthly Cash Collections by Tenure(1)
(1) Cash collection numbers include only accounts assigned to collectors. Significant cash collections do occur
on “unassigned” accounts.
(2) Calculated using average YTD monthly cash collections of all collectors with one year or more of tenure.
(3) Calculated using weighted average YTD monthly cash collections of all collectors with less than one year
of tenure, including those in training.
Average performance
Total cash collections
Non-legal cash collections
12/31/00
$64.37
$53.31
12/31/01
$77.20
$66.87
12/31/02
$96.37
$77.72
12/31/03
$108.27
$80.10
12/31/04
$117.59
$82.06
Cash Collections per Hour Paid(1)
36
(1) Cash collections (assigned and unassigned) divided by total hours paid (including holiday, vacation and
sick time) to all collectors (including those in training).
Cash collections have substantially exceeded revenue in each quarter since our formation. The following
chart illustrates the consistent excess of our cash collections on our owned portfolios over income recognized in
finance receivables on a quarterly basis. The difference between cash collections and income recognized is
referred to as payments applied to principal. It is also referred to as amortization of purchase price. This
amortization is the portion of cash collections that is used to recover the cost of the portfolio investment
represented on the Balance Sheet.
Cash Collections(1) vs. Income Recognized on Finance Receivables
Payments applied to principal or "amortization of purchase price"
Cash Collections
Income recognized on finance receivables
$45.0
$40.0
$35.0
$30.0
$25.0
$20.0
$15.0
$10.0
$5.0
$0.0
8
9
-
1
Q
8
9
-
2
Q
8
9
-
3
Q
8
9
-
4
Q
9
9
-
1
Q
9
9
-
2
Q
9
9
-
3
Q
9
9
-
4
Q
0
0
-
1
Q
0
0
-
2
Q
0
0
-
3
Q
0
0
-
4
Q
1
0
-
1
Q
1
0
-
2
Q
1
0
-
3
Q
1
0
-
4
Q
2
0
-
1
Q
2
0
-
2
Q
2
0
-
3
Q
2
0
-
4
Q
3
0
-
1
Q
3
0
-
2
Q
3
0
-
3
Q
3
0
-
4
Q
4
0
-
1
Q
4
0
-
2
Q
4
0
-
3
Q
4
0
-
4
Q
(1)
Includes cash collections on finance receivables only. Excludes commissions and cash proceeds from sales
of defaulted consumer receivables.
37
Seasonality
We depend on the ability to collect on our owned and serviced defaulted consumer receivables. Collections
tend to be higher in the first and second quarters of the year and lower in the third and fourth quarters of the year,
due to consumer payment patterns in connection with seasonal employment trends, income tax refunds, and
holiday spending habits. Due to our historical quarterly cash collections, our growth has partially masked the
impact of this seasonality.
($ in millions)
Quarterly Cash Collections(1)
$45.0
$40.0
$35.0
$30.0
$25.0
$20.0
$15.0
$10.0
$5.0
$-
(1) Includes cash collections on finance receivables only. Excludes commission fees and cash proceeds from
sales of defaulted consumer receivables.
The following table shows the changes in finance receivables, including the amounts paid to acquire new
portfolios.
2004
2003
2002
Balance at beginning of year
Acquisitions of finance receivables, net of buybacks(1)
Cash collections applied to principal on finance receivables(2)
Cost of finance receivables sold, net of allowance for returns
Balance at end of year
$
92,568,557
$
65,526,235
$
47,986,744
59,770,354
62,298,316
42,990,924
(47,150,005)
-
105,188,906
$
(35,255,994)
-
92,568,557
$
(25,450,833)
(600)
65,526,235
$
Estimated Remaining Collections ("ERC")(3)
$
308,111,355
$
267,666,689
$
195,669,147
_________
(1) Agreements to purchase receivables typically include general representations and warranties from the
sellers covering account holders’ death or bankruptcy and accounts settled or disputed prior to sale. The
seller can replace or repurchase these accounts. We refer to repurchased accounts as buybacks. We also
capitalize certain acquisition related costs.
(2) Cash collections applied to principal (also referred to as amortization) on finance receivables consists of
cash collections less income recognized on finance receivables.
(3) Estimated Remaining Collections refers to the sum of all future projected cash collections on our owned
portfolios. ERC is not a balance sheet item, however, it is provided here for informational purposes.
38
Liquidity and Capital Resources
Historically, our primary sources of cash have been cash flows from operations, bank borrowings, and
equity offerings. Cash has been used for acquisitions of finance receivables, repayments of bank borrowings,
purchases of property and equipment, 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 other significant acquisitions requiring cash during that period.
Cash generated from operations is dependent upon our ability to collect on our defaulted consumer
receivables. 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 factors that cause a negative
impact on our business could have a material impact on our expected future cash flows.
Our operating activities provided cash of $49.3 million, $35.1 million and $21.8 million for the years ended
December 31, 2004, 2003 and 2002, respectively. In these periods, cash from operations was generated
primarily from net income earned through cash collections and commissions received. Net income increased to
$27.5 million for the year ended December 31, 2004 from $20.7 million for the year ended December 31, 2003
and $17.1 million for the year ended December 31, 2002. In addition, we realized tax benefits derived from
stock option and stock warrant exercises of $1.1 million in 2004, $16.4 million in 2003 and $0.2 million in 2002.
Our investing activities used cash of $50.8 million, $23.5 million and $24.7 million for the years ended
December 31, 2004, 2003 and 2002, respectively. Net cash used in investing activities is primarily driven by
acquisitions of defaulted consumer receivables, net of cash collections applied to the cost of the receivables and
purchases of auction rate certificates. In addition, in 2004, we purchased the assets of IGS Nevada, Inc. for
$12.1 million in cash including acquisition costs.
Our financing activities provided cash of $1.1 million, $1.4 million and $10.1 million for the years ended
December 31, 2004, 2003 and 2002, respectively. The exercise of stock options and stock warrants generated
cash from financing activities of $1.1 million for the year ended December 31, 2004, $1.4 million for the year
ended December 31, 2003 and $210,000 for the year ended December 31, 2002. In 2002, the IPO generated cash
of $40.4 million. Utilizing proceeds from the IPO, we paid off the outstanding balance of our line of credit of
$29.0 million at the time of the offering.
Cash paid for interest expense was $273,000, $281,000 and $2.7 million for the years ended December 31,
2004, 2003 and 2002, respectively. In 2004 and 2003, the majority of interest expenses were paid on long-term
debt and capital lease obligations. In addition, in 2003, we terminated our line of credit agreement with WestLB
and incurred $284,000 of additional non-cash interest costs. In 2002, the majority of interest expenses were paid
for lines of credit used to finance acquisitions of defaulted consumer receivables portfolios.
We maintain a $25.0 million revolving line of credit with RBC Centura Bank ("RBC") pursuant to an
agreement entered into on November 28, 2003. On November 22, 2004, we amended this revolving line of
credit agreement by entering into an Amended and Restated Commercial Promissory Note with RBC. The only
material change to the original agreement was the extension of the maturity date to November 28, 2006. Other
terms of the original agreement, including the rate of interest, payment terms and available credit, remain the
same. The credit facility bears interest at a spread of 2.50% over LIBOR and extends through November 28,
2006. The agreement provides for:
• restrictions on monthly borrowings are limited to 20% of Estimated Remaining Collections;
• a debt coverage ratio of at least 8.0 to 1.0 calculated on a rolling twelve-month average;
• a debt to tangible net worth ratio of less than 0.40 to 1.00;
39
• net income per quarter of at least $1.00, calculated on a consolidated basis; and
• restrictions on change of control.
This facility had no amounts outstanding at December 31, 2004.
As of December 31, 2004 there are five loans outstanding. On July 20, 2000, one of our subsidiaries entered
into a credit facility for a $550,000 loan, for the purpose of purchasing a building and land in Hutchinson,
Kansas. The loan bears interest at a variable rate based on LIBOR and consists of monthly principal payments for
60 months and a final installment of unpaid principal and accrued interest payable on July 21, 2005. On February
9, 2001, we entered into a commercial loan agreement in the amount of $107,000 in order to purchase equipment
for our Norfolk, Virginia location. This loan bears interest at a fixed rate of 7.9% and matures on February 1,
2006. On February 20, 2002, one of our subsidiaries entered into an additional arrangement for a $500,000
commercial loan in order to finance construction of a parking lot at our Norfolk, Virginia location. This loan
bears interest at a fixed rate of 6.47% and matures on September 1, 2007. On May 1, 2003, we entered into a
commercial loan agreement in the amount of $975,000 to finance equipment purchases for our Hampton,
Virginia location. This loan bears interest at a fixed rate of 4.25% and matures on May 1, 2008. On January 9,
2004, we entered into a commercial loan agreement in the amount of $750,000 to finance equipment purchases at
our newly leased Norfolk facility. This loan bears interest at a fixed rate of 4.45% and matures on January 1,
2009. The loans are collateralized by the related asset and require us to maintain net worth greater than $20
million and a cash flow coverage ratio of at least 1.5 to 1.0 calculated on a rolling twelve-month average.
Contractual Obligations
The following summarizes our contractual obligations that exist as of December 31, 2004:
Contractual Obligations
Operating Leases
Long-Term Debt
Capital Lease Obligations
Purchase Commitments (1)
Employment Agreements
Total
Payments due by period
$
Total
13,172,919
2,072,844
629,463
Less
than 1
year
1,657,219
848,801
219,372
$
1 - 3
years
$
2,999,778
969,984
304,443
6,575,227
3,676,333
26,126,786
1,905,227
2,183,854
6,814,473
$
$
4,490,000
1,492,479
10,256,684
$
$
4 - 5
years
3,165,645
254,059
105,648
180,000
-
More
than 5
years
$
5,350,277
-
-
-
-
$
3,705,352
$
5,350,277
(1) Of this amount, $4,000,000 represents the potential payout we will incur as additional purchase price in years
1-3 in association with the acquisition of the assets of IGS Nevada, Inc. The earn out provisions are defined in
the asset purchase agreement.
Off Balance Sheet Arrangements
We do not have any off balance sheet arrangements as defined by Regulation S-K 303(a)(4) promulgated
under the Securities Exchange Act of 1934.
Recent Accounting Pronouncements
In October 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of
Position (“SOP”) 03-03, “Accounting for Loans or Certain Securities Acquired in a Transfer.” The SOP proposes
guidance on accounting for differences between contractual and expected cash flows from an investor’s initial
investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to
credit quality. The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004 and
amends Practice Bulletin 6 which remains in effect for loans acquired prior to the SOP effective date. The SOP
would limit the revenue that may be accrued to the excess of the estimate of expected future cash flows over a
40
portfolio’s initial cost of accounts receivable acquired. The SOP would require 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. The SOP would initially freeze the internal rate of return, referred to as 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, effective January 1, 2005, the carrying value of a portfolio would
be written down to maintain the then-current IRR. The SOP also amends Practice Bulletin 6 in a similar manner
and applies to all loans acquired prior to January 1, 2005. Increases in expected future cash flows can be
recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining life. Any
increased yield then becomes the new benchmark for impairment testing. The SOP provides that previously
issued annual financial statements would not need to be restated. Historically, as we have applied the guidance of
Practice Bulletin 6, we have moved yields upward and downward as appropriate under that guidance. However,
since the new SOP guidance does not permit yields to be lowered, under either the revised Practice Bulletin 6 or
SOP 03-03, it will increase the probability of us having to incur impairment charges in the future.
In December 2003, the Securities and Exchange Commission released Staff Accounting Bulletin (SAB)
No. 104, Revenue Recognition, which supercedes SAB 101, Revenue Recognition in Financial Statements.
SAB 104 clarifies existing guidance regarding revenue contracts that contain multiple deliverables to make it
consistent with Emerging Issues Task Force (EITF) No. 00-21. The adoption of SAB 104 did not have a material
impact on our results of operations or financial position.
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB statement No.
123(R), “Share-Based Payment,” (“FAS 123R”). FAS 123R revises FASB statement No. 123, “Accounting for
Stock-Based Compensation,” (“FAS 123”) and requires companies to expense the fair value of employee stock
options and other forms of stock-based compensation. In addition to revising FAS 123, FAS 123R supersedes
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and amends FASB
Statement No. 95, “Statement of Cash Flows.” FAS 123R applies to all stock-based compensation transactions
in which a company acquires services by (1) issuing its stock or other equity instruments, except through
arrangements resulting from employee stock-ownership plans (ESOPs) or (2) incurring liabilities that are based
on the company’s stock price. FAS 123R is effective for periods that begin after June 15, 2005; however, early
adoption is encouraged. We believe that all of our existing stock-based awards are equity instruments. We
previously adopted FAS 123 on January 1, 2002 and have been expensing equity based compensation since that
time. We believe the adoption of FAS 123R will have no material impact on our financial statements.
Critical Accounting Policies
The preparation of financial statements and related disclosures in conformity with U.S. generally accepted
accounting principles and our discussion and analysis of our financial condition and results of operations require
our management to make judgments, assumptions, and estimates that affect the amounts reported in our
consolidated financial statements and accompanying notes. Note 2 of the Notes to Consolidated Financial
Statements of this Form 10-K describes the significant accounting policies and methods used in the preparation
of our consolidated financial statements. We base our estimates on historical experience and on various other
assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making
judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and
such differences may be material.
Management believes our critical accounting policies and estimates are those related to revenue recognition,
valuation of acquired intangibles and goodwill and income taxes. Management believes these policies to be
critical because they are both important to the portrayal of our financial condition and results, and they require
management to make judgments and estimates about matters that are inherently uncertain. Our senior
management has reviewed these critical accounting policies and related disclosures with the Audit Committee of
our Board of Directors.
41
Revenue Recognition
We account for our investment in finance receivables using the interest method under the guidance of Practice
Bulletin 6, “Amortization of Discounts on Certain Acquired Loans.” Static pools of relatively homogenous
accounts are established. Once a static pool is established, the receivable accounts in the pool are not changed.
Each static pool is recorded at cost, and is accounted for as a single unit for the recognition of income, principal
payments and loss provision. Income on finance receivables is accrued monthly based on each static pool’s
effective interest rate. This interest rate is estimated and periodically recalculated upward or downward based on
the timing and amount of anticipated cash flows using our proprietary collection model. Monthly cash flows
greater than the interest accrual will reduce the carrying value of the static pool. Likewise, monthly cash flows
that are less than the monthly accrual will accrete the carrying balance. Each pool is reviewed monthly and
compared to our models to ensure complete amortization of the carrying balance at the end of each pool’s life. In
the event that cash collections would be inadequate to amortize the carrying balance, an impairment charge
would be taken with a corresponding write-off of the receivable balance. Accordingly, we do not maintain an
allowance for credit losses.
As discussed more fully in this same section under “Recent Accounting Pronouncements,” we will begin to
apply the provisions of SOP 03-03 on January 1, 2005. This SOP will become the basis for our revenue
recognition of our owned finance receivables portfolio.
We utilize the provisions of Emerging Issues Task Force 99-19, “Reporting Revenue Gross as a Principal
versus Net as an Agent” (“EITF 99-19”) to commission revenue from our contingent fee and skip-tracing
subsidiaries. EITF 99-19 requires an analysis to be completed to determine if certain revenues should be
reported gross or reported net of their related operating expense. This analysis includes who retains
inventory/credit risk, who controls vendor selection, who establishes pricing and who remains the primary
obligor on the transaction. Each of these factors were considered to determine the correct method of recognizing
revenue from our subsidiaries.
For our contingent fee subsidiary, revenue is recognized at the time customer (debtor) funds are collected.
The portfolios are owned by the clients and the collection effort is outsourced to our subsidiary under a
commission fee arrangement. The clients retain control and ownership of the accounts we service. These
revenues are reported on a net basis and are included in the line item “Commissions.”
Our skip tracing subsidiary utilizes gross reporting under this EITF. We generate revenue by working an
account and successfully locating a customer for our client. An “investigative fees” is received for these
services. In addition, we incur “agent expenses” where we hire a third-party collector to effectuate repossession.
In many cases we have an arrangement with our client which allows us to bill the client for these fees. We have
determined these fees to be gross revenue based on the criteria in EITF 99-19 and they are recorded as such in
the line item “Commissions,” primarily because we are primarily liable to the third party collector. There is a
corresponding expense in “Outside Legal and Other Fees and Services” for these pass-through items.
We account for our gain on cash sales of finance receivables under SFAS No. 140, “Accounting for
Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” Gains on sale of finance
receivables, representing the difference between the sales price and the unamortized value of the finance
receivables sold, are recognized when finance receivables are sold.
We apply a financial components approach that focuses on control when accounting and reporting for
transfers and servicing of financial assets and extinguishments of liabilities. Under that approach, after a transfer
of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has
incurred, eliminates financial assets when control has been surrendered, and eliminates liabilities when
extinguished. This approach provides consistent standards for distinguishing transfers of financial assets that are
sales from transfers that are secured borrowings.
42
Valuation of Acquired Intangibles and Goodwill
In accordance with Statement of Financial Accounting Standards (SFAS) No. 142, “Goodwill and Other
Intangible Assets,” we are required to perform a review of goodwill for impairment annually, or earlier if
indicators of potential impairment exist. The review of goodwill for potential impairment is highly subjective and
requires that: (1) goodwill be allocated to various reporting units of our business to which it relates; (2) we
estimate the fair value of those reporting units to which the goodwill relates; and (3) we determine the book value
of those reporting units. If the estimated fair value of reporting units with allocated goodwill is determined to be
less than their book value, we are required to estimate the fair value of all identifiable assets and liabilities of
those reporting units in a manner similar to a purchase price allocation for an acquired business. This requires
independent valuation of certain unrecognized assets. Once this process is complete, the amount of goodwill
impairment, if any, can be determined.
We believe as of December 31, 2004 there was no impairment of goodwill. However, changes in various
circumstances including changes in our market capitalization, changes in our forecasts, and changes in our
internal business structure could cause one of our reporting units to be valued differently thereby causing an
impairment of goodwill. Additionally, in response to changes in our industry and changes in global or regional
economic conditions, we may strategically realign our resources and consider restructuring, disposing, or
otherwise exiting businesses, which could result in an impairment of some or all of our identifiable intangibles,
or goodwill.
Income Taxes
We record a tax provision for the anticipated tax consequences of the reported results of operations. In
accordance with SFAS No. 109, “Accounting for Income Taxes,” the provision for income taxes is computed
using the asset and liability method, under which deferred tax assets and liabilities are recognized for the
expected future tax consequences of temporary differences between the financial reporting and tax bases of
assets and liabilities, and for operating losses and tax credit carryforwards. Deferred tax assets and liabilities are
measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those
tax assets are expected to be realized or settled.
We believe it is more likely than not that forecasted income, including income that may be generated as a
result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be
sufficient to fully recover the remaining deferred tax assets. In the event that all or part of the net deferred tax
assets are determined not to be realizable in the future, a valuation allowance would be established and charged
to earnings in the period such determination is made. Similarly, if we subsequently realize deferred tax assets
that were previously determined to be unrealizable, the respective valuation allowance would be reversed,
resulting in a positive adjustment to earnings or a decrease in goodwill in the period such determination is made.
In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of
uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent
with our expectations could have a material impact on our results of operations and financial position.
Item 7A. Quantitative and Qualitative Disclosure About Market Risk.
Our exposure to market risk relates to interest rate risk with its variable rate credit line. As of December 31,
2004, we had no variable rate debt outstanding on our revolving credit lines. We did have variable rate debt
outstanding on our long-term debt collateralized by the Kansas real estate. A 10% change in future interest rates
on the variable rate credit line would not lead to a material decrease in future earnings assuming all other factors
remained constant.
43
Item 8. Financial Statements and Supplementary Data.
Index to Financial Statements
Report of Independent Registered Public Accounting Firm
Consolidated Balance Sheets
As of December 31, 2004 and 2003
Consolidated Income Statements
For the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows
For the years ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
Page
45-46
47
48
49
50
51-68
44
Report of Independent Registered Public Accounting Firm
Board of Directors and Stockholders
Portfolio Recovery Associates, Inc.:
We have completed an integrated audit of Portfolio Recovery Associates, Inc.’s 2004 consolidated financial statements
and of its internal control over financial reporting as of December 31, 2004 and audits of its 2003 and 2002 consolidated
financial statements in accordance with the standards of the Public Company Accounting Oversight Board (United
States). Our opinions, based on our audits, are presented below.
Consolidated financial statements
In our opinion, the consolidated financial statements listed in the accompanying index present fairly, in all material
respects, the financial position of Portfolio Recovery Associates, Inc. and its subsidiaries at December 31, 2004 and
2003, and the results of their operations and their cash flows for each of the three years in the period ended December
31, 2004 in conformity with accounting principles generally accepted in the United States of America. These financial
statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these
financial statements based on our audits. We conducted our audits of these statements in accordance with the standards
of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform
the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An
audit of financial statements includes examining, on a test basis, evidence supporting the amounts and disclosures in the
financial statements, assessing the accounting principles used and significant estimates made by management, and
evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our
opinion.
Internal control over financial reporting
Also, in our opinion, management’s assessment, included in Management’s Report on Internal Control Over Financial
Reporting appearing under Item 9A, that the Company maintained effective internal control over financial reporting as
of December 31, 2004 based on criteria established in Internal Control – Integrated Framework issued by the
Committee of Sponsoring Organizations of the Treadway Commission (COSO), is fairly stated, in all material respects,
based on those criteria. Furthermore, in our opinion, the Company maintained, in all material respects, effective internal
control over financial reporting as of December 31, 2004, based on criteria established in Internal Control – Integrated
Framework issued by the COSO. The Company’s management is responsible for maintaining effective internal control
over financial reporting and for its assessment of the effectiveness of internal control over financial reporting. Our
responsibility is to express opinions on management’s assessment and on the effectiveness of the Company’s internal
control over financial reporting based on our audit. We conducted our audit of internal control over financial reporting
in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards
require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over
financial reporting was maintained in all material respects. An audit of internal control over financial reporting includes
obtaining an understanding of internal control over financial reporting, evaluating management’s assessment, testing and
evaluating the design and operating effectiveness of internal control, and performing such other procedures as we
consider necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinions.
A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding
the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with
generally accepted accounting principles. A company’s internal control over financial reporting includes those policies
and procedures that (i) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the
transactions and dispositions of the assets of the company; (ii) provide reasonable assurance that transactions are
recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting
principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of
management and directors of the company; and (iii) provide reasonable assurance regarding prevention or timely
detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the
financial statements.
45
Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements.
Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become
inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may
deteriorate.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
McLean, Virginia
March 9, 2005
46
Portfolio Recovery Associates, Inc.
Consolidated Balance Sheets
December 31, 2004 and 2003
Assets
Cash and cash equivalents
Investments
Finance receivables, net
Property and equipment, net
Deferred tax asset
Income tax receivable
Goodwill
Intangible assets, net
Other assets
Total assets
Liabilities and Stockholders' Equity
Liabilities:
Accounts payable
Accrued expenses
Income taxes payable
Accrued payroll and bonuses
Deferred tax liability
Long-term debt
Obligations under capital lease
Total liabilities
Commitments and contingencies (Note 18)
Stockholders' equity:
Preferred stock, par value $0.01, authorized shares, 2,000,000,
issued and outstanding shares - 0
Common stock, par value $0.01, authorized shares, 30,000,000,
issued and outstanding shares - 15,498,210 at December 31, 2004,
and 15,294,676 at December 31, 2003
Additional paid in capital
Retained earnings
Total stockholders' equity
December 31,
2004
December 31,
2003
$
2 4,512,575
23,950,000
105,188,906
5,752,489
-
-
6,397,138
6,318,838
3,056,023
$
2 4,911,841
-
92,568,557
5,166,380
2,009,426
351,861
-
-
1,385,706
$
1 75,175,969
$ 1 26,393,771
$
$
1 ,413,726
1,563,285
182,221
4,475,919
13,650,722
1,924,422
576,234
1 ,290,332
513,687
-
3,233,409
-
1,656,972
551,325
23,786,529
7,245,725
-
-
154,982
100,905,851
50,328,607
152,947
96,117,932
22,877,167
151,389,440
119,148,046
Total liabilities and stockholders' equity
$
1 75,175,969
$
1 26,393,771
The accompanying notes are an integral part of these consolidated financial statements.
47
Portfolio Recovery Associates, Inc.
Consolidated Income Statements
For the years ended December 31, 2004, 2003 and 2002
2004
2003
2002
Revenues:
Income recognized on finance receivables
Commissions
Net gain on cash sales of defaulted consumer receivables
$
106,254,441
7,141,796
-
$
81,796,209
3,131,054
-
$
53,802,718
1,944,428
100,156
Total revenue
Operating expenses:
Compensation and employee services
Outside legal and other fees and services
Communications
Rent and occupancy
Other operating expenses
Depreciation and amortization
113,396,237
84,927,263
55,847,302
36,620,054
21,407,570
3,638,144
1,744,885
2,712,463
2,382,896
28,986,795
14,147,394
2,772,110
1,189,379
1,932,055
1,444,825
21,700,918
8,092,460
1,914,557
799,323
1,436,438
940,352
Total operating expenses
68,506,012
50,472,558
34,884,048
Income from operations
44,890,225
34,454,705
20,963,254
Other income and (expense):
Interest income
Interest expense
222,718
(273,355)
60,173
(602,072)
21,548
(2,446,620)
Income before income taxes
44,839,588
33,912,806
18,538,182
Provision for income taxes
17,388,148
13,199,303
1,473,073
Net income
$
27,451,440
$
20,713,503
$
17,065,109
Pro forma income taxes (unaudited)
Pro forma net income (unaudited)
Net income per common share
Basic
Diluted
Pro forma net income per common share (unaudited)
Basic
Diluted
Weighted average number of shares outstanding
Basic
Diluted
$
$
1.79
1.73
$
$
1.42
1.32
5,693,788
$
11,371,321
$
$
1.08
0.94
15,357,475
15,852,916
14,545,985
15,711,956
10,529,452
12,066,202
The accompanying notes are an integral part of these consolidated financial statements.
48
17,065,109
377,303
17,442,412
40,279,884
210,000
100,000
124,386
248,960
(5,549,530)
80,607,618
20,713,503
1,394,895
422,127
16,009,903
$
119,148,046
27,451,440
1,196,349
2,000,239
507,091
1,086,275
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
-
Portfolio Recovery Associates, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2004, 2003 and 2002
Members'
Equity
Common
Stock
Additional
Paid in
Capital
Retained
Earnings
Accumulated
Other
Comprehensive
Loss
Total
Stockholders'
Equity
-
(377,303)
27,751,506
2,163,664
-
-
377,303
28,128,809
14,901,445
-
-
-
(37,480,724)
-
-
(5,549,530)
-
-
-
34,700
500
100,000
-
-
-
-
-
-
40,245,184
209,500
37,480,724
124,386
248,960
-
-
-
-
-
-
-
Balance at December 31, 2001
Net income
Reclassification adjustment on interest rate swap
Total comprehensive income
Proceeds from initial public offering, net of expenses
Exercise of warrants
Recapitalization
Amortization of stock-based compensation
Stock-based compensation income tax benefits
Distributions
Balance at December 31, 2002
Net income
Exercise of stock options and warrants
Amortization of stock-based compensation
Stock-based compensation income tax benefits
Balance at December 31, 2003
$
-
Net income
Exercise of stock options, warrants and vesting of restricted shares
Issuance of common stock for acquisition
Amortization of stock-based compensation
Stock-based compensation income tax benefits
-
-
-
-
-
-
-
-
-
-
135,200
78,308,754
2,163,664
-
17,747
-
-
-
1,377,148
422,127
16,009,903
20,713,503
-
-
-
$
152,947
$
96,117,932
$
22,877,167
$
-
-
1,336
699
-
-
-
1,195,013
1,999,540
507,091
1,086,275
27,451,440
-
-
-
-
Balance at December 31, 2004
$
-
$
154,982
$
100,905,851
$
50,328,607
$
-
$
151,389,440
The accompanying notes are an integral part of these consolidated financial statements.
49
Portfolio Recovery Associates, Inc.
Consolidated Statements of Cash Flows
For the years ended December 31, 2004, 2003 and 2002
Operating activities:
Net income
Adjustments to reconcile net income to cash
provided by operating activities:
Increase in equity from vested options
Income tax benefit related to stock option exercise
Depreciation and amortiztion
Deferred tax expense (benefit), net
Gain on sales of finance receivables, net
Changes in operating assets and liabilities:
Other assets
Accounts payable
Income taxes
Accrued expenses
Accrued payroll and bonuses
2004
2003
2002
$
27,451,440
$
20,713,503
$
17,065,109
575,157
1,086,275
2,382,896
15,660,148
-
(820,317)
123,394
534,082
1,049,598
1,242,510
422,127
16,396,867
1,444,825
(2,296,308)
-
(356,510)
(80,072)
(1,289,092)
(246,524)
372,073
124,386
248,960
940,352
286,882
(100,156)
(67,824)
1,082,269
937,231
137,180
1,186,965
Net cash provided by operating activities
49,285,183
35,080,889
21,841,354
Cash flows from investing activities:
Purchases of property and equipment
Acquisition of finance receivables, net of buybacks
Collections applied to principal on finance
receivables
Purchases of auction rate certificates
Sales of auction rate certificates
Acquisition of IGS Nevada, net of acquisition costs
Proceeds from sale of finance receivables, net
of allowances for returns
(2,090,934)
(59,770,354)
47,150,005
(23,950,000)
-
(12,146,899)
(2,454,138)
(62,298,316)
35,255,994
-
5,950,000
-
(1,316,132)
(42,990,924)
25,450,833
(5,950,000)
-
-
-
-
100,756
Net cash used in investing activities
(50,808,182)
(23,546,460)
(24,705,467)
Cash flows from financing activities:
Proceeds from initial public offering, net of offering costs
Proceeds from exercise of options and warrants
Public offering costs
Distribution of capital
Net payments on lines of credit
Proceeds from long-term debt
Payments on long-term debt
Payments on capital lease obligations
Net cash provided by financing activities
Net (decrease)/increase in cash and cash equivalents
Cash and cash equivalents, beginning of period
-
1,128,283
-
-
-
750,000
(482,550)
(272,000)
1,123,733
(399,266)
24,911,841
-
1,394,895
(386,964)
-
-
975,000
(283,610)
(310,639)
1,388,682
12,923,111
11,988,730
40,379,884
210,000
-
(5,549,530)
(25,000,000)
500,000
(102,850)
(365,060)
10,072,444
7,208,331
4,780,399
Cash and cash equivalents, end of period
$
24,512,575
$
24,911,841
$
11,988,730
Supplemental disclosure of cash flow information:
Cash paid for interest
Cash paid for income taxes
Noncash investing and financing activities:
Capital lease obligations incurred
Acquisition of IGS Nevada - Common stock issued
Basis - swap contract
$
$
273,355
390,000
$
$
281,332
389,600
$
2,698,782
$
-
296,910
2,000,239
-
362,813
-
-
38,896
-
(377,303)
The accompanying notes are an integral part of these consolidated financial statements.
50
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
1. Organization and Business:
Portfolio Recovery Associates, Inc. was formed in August 2002. On November 8, 2002, Portfolio
Recovery Associates, Inc. completed its initial public offering (“IPO”) of common stock. As a result, all of the
membership units and warrants of Portfolio Recovery Associates, LLC (“PRA”) were exchanged on a one to one
basis for warrants and shares of a single class of common stock of Portfolio Recovery Associates, Inc. (“PRA
Inc”). Another subsidiary, PRA II, was dissolved immediately prior to the IPO. PRA Inc, a Delaware
corporation, and its subsidiaries (collectively, the “Company”) purchase, collect and manage portfolios of
defaulted consumer receivables. The defaulted consumer receivables the Company collects are either purchased
from debt sellers or are collected on behalf of clients on a commission fee basis. This is primarily accomplished
by maintaining a staff of collectors whose purpose is to contact the customers and arrange payment of the debt.
Secondarily, PRA has contracted with independent attorneys, with which the Company can undertake legal
action in order to satisfy the outstanding debt.
On December 28, 1999, PRA formed a wholly owned subsidiary, PRA Holding I, LLC (“PRA Holding I”),
and is the sole initial member. PRA Holding I is organized for the sole purpose of holding the real property in
Hutchinson, Kansas (see Note 12) and Norfolk, Virginia.
On June 1, 2000, PRA formed a wholly owned subsidiary, PRA Receivables Management, LLC (d/b/a
Anchor Receivables Management, LLC) (“Anchor”) and was the sole initial member. Anchor is organized as a
contingent collection agency and contracts with holders of finance receivables to attempt collection efforts on a
contingent basis for a stated period of time. Anchor became fully operational during April 2001. PRA, Inc
purchased the equity interest in Anchor from PRA immediately after the IPO.
On October 1, 2004, PRA acquired the assets of IGS Nevada, Inc., a privately held company specializing in
asset-location and debt resolution services. The transaction was completed at a price of $14 million, consisting
of $12 million in cash and $2 million in PRA Inc common stock. The total purchase price could increase by $4
million, through contingent cash payments of $2 million each in 2005 and 2006, based upon the performance of
the acquired entity during each of those two years. The Company created a new wholly owned subsidiary on
September 10, 2004 which holds the acquired assets. This new entity operates under the name of PRA Location
Services, LLC d/b/a IGS Nevada (“IGS”). IGS Nevada, Inc.’s founder and his top management team have
signed long-term employment agreements and will continue to manage IGS.
PRA Funding, LLC and PRA III were dissolved into PRA on November 24, 2003.
2.
Summary of Significant Accounting Policies:
Principles of accounting and consolidation: The consolidated financial statements of the Company are
prepared in accordance with accounting standards generally accepted in the United States of America and
include the accounts of PRA, PRA Holding I, Anchor and IGS. All significant intercompany accounts and
transactions have been eliminated.
Cash and cash equivalents: The Company considers all highly liquid investments with a maturity of three
months or less when purchased to be cash equivalents.
Investments: The Company accounts for its investments under the guidance of SFAS 115, “Accounting for
Certain Investments in Debt and Equity Securities.” At December 31, 2004, the Company had investments
totaling $23,950,000 which consist of variable rate auction rate certificates classified as available-for-sale
securities. These securities are recorded at cost, which approximates fair market value due to their variable
interest rates, which typically reset every 7 to 35 days, and, despite the long term nature of their stated
contractual maturities, the Company has the ability to quickly liquidate these investments. As a result, the
Company had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from these
investments and all income generated was recorded as interest income.
Concentrations of Credit Risk: Financial instruments, which potentially expose the Company to
concentrations of credit risk, consist primarily of cash and cash equivalents and investments. The Company
places its cash and cash equivalents and investments with high quality financial institutions. At times, cash
balances may be in excess of the amounts insured by the Federal Deposit Insurance Corporation. At December
51
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
31,2004 and 2003, the Company had highly liquid investments, with two investment brokerage firms, totaling
$23,950,000 and $0, respectively. These investments have ratings of AA or better.
Finance receivables and income recognition: The Company accounts for its investment in finance receivables
using the interest method under the guidance of Practice Bulletin 6, “Amortization of Discounts on Certain
Acquired Loans.” Static pools of relatively homogenous accounts are established. Once a static pool is
established, the receivable accounts in the pool are not changed. Each static pool is recorded at cost, and is
accounted for as a single unit for the recognition of income, principal payments and loss provision. Income on
finance receivables is accrued monthly based on each static pool’s effective interest rate. This interest rate is
estimated and periodically recalculated upward or downward based on the timing and amount of anticipated cash
flows using the Company’s proprietary collection model. Monthly cash flows greater than the interest accrual
will
that are
less than the monthly accrual will accrete the carrying balance. Each pool is reviewed monthly and compared to
the Company’s models to ensure complete amortization of the carrying balance at the end of each pool’s life.
The cost recovery method prescribed by Practice Bulletin 6 is used when collections on a particular portfolio
cannot be reasonably predicted. Under the cost recovery method, no revenue is recognized until the Company
has fully collected the cost of the portfolio. Additionally, a pool can become fully amortized (zero carrying
balance on the Statement of Financial Position) while still generating cash collections. In this case, all cash
collections are recognized as revenue when received.
Likewise, monthly cash
the carrying value of
the static pool.
reduce
flows
In the event that cash collections would be inadequate to amortize the carrying balance, an impairment
charge would be taken with a corresponding write-off of the receivable balance. Accordingly, the Company
does not maintain an allowance for credit losses.
The Company capitalizes certain fees paid to third parties related to the direct acquisition of a portfolio of
accounts. These fees are added to the acquisition cost of the portfolio and accordingly are amortized over the
life of the portfolio using the interest method. The balance of the unamortized capitalized fees at December 31,
2004, 2003 and 2002 was $1,098,847, $1,802,194 and $1,666,682, respectively. During the years ended
December 31, 2004, 2003 and 2002 the Company capitalized $708,632, $1,174,660 and $1,299,803,
respectively, of these direct acquisition fees. During the years ended December 31, 2004, 2003 and 2002 the
Company amortized $881,330, $1,039,148 and $531,117, respectively, of these direct acquisition fees. During
2004 the Company wrote-off $530,649 related to the capitalization of fees paid to third parties for address
correction and other customer data associated with the acquisition of portfolios purchased over the past 5 years.
The agreements to purchase the aforementioned receivables include general representations and warranties
from the sellers covering account holder death or bankruptcy and accounts settled or disputed prior to sale. The
representation and warranty period permitting the return of these accounts from the Company to the seller is
typically 90 to 180 days. Any funds received from the seller of finance receivables as a return of purchase price
are referred to as buybacks. Buyback funds are simply applied against the finance receivable balance received
and are not included in the Company’s cash collections from operations.
Commissions: The Company utilizes the provisions of Emerging Issues Task Force 99-19, “Reporting Revenue
Gross as a Principal versus Net as an Agent” (“EITF 99-19”) to commission revenue from its contingent fee and
skip-tracing subsidiaries. EITF 99-19 requires an analysis to be completed to determine if certain revenues
should be reported gross or reported net of their related operating expense. This analysis includes who retains
inventory/credit risk, who controls vendor selection, who establishes pricing and who remains the primary
obligor on the transaction. The Company considered each of these factors to determine the correct method of
recognizing revenue from its subsidiaries.
For the Company’s contingent fee subsidiary, revenue is recognized at the time customer (debtor) funds are
collected. The portfolios are owned by the clients and the collection effort is outsourced to the Company’s
subsidiary under a commission fee arrangement. The clients retain control and ownership of the accounts the
Company services. These revenues are reported on a net basis and included in the line item “Commissions.”
The Company’s skip tracing subsidiary utilizes gross reporting under this EITF. They generate revenue by
working an account and successfully locating a customer for their client. An “investigative fees” is received for
these services. In addition, the Company incurs “agent expenses” where it hires a third-party collector to
52
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
effectuate repossession. In many cases the Company has an arrangement with its client which allows it to bill
the client for these fees. The Company has determined these fees to be gross revenue based on the criteria in
EITF 99-19 and they are recorded as such in the line item “Commissions,” primarily because the Company is
primarily liable to the third party collector. There is a corresponding expense in “Outside Legal and Other Fees
and Services” for these pass-through items.
Net gain on cash sales of finance receivables: The Company accounts for its gain on cash sales of finance
receivables under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and
Extinguishments of Liabilities.” Gains on sale of finance receivables, representing the difference between the
sales price and the unamortized value of the finance receivables sold, are recognized when finance receivables
are sold.
The Company applies a financial components approach that focuses on control when accounting and
reporting for transfers and servicing of financial assets and extinguishments of liabilities. Under that approach,
after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the
liabilities it has incurred, eliminates financial assets when control has been surrendered, and eliminates liabilities
when extinguished. This approach provides consistent standards for distinguishing transfers of financial assets
that are sales from transfers that are secured borrowings.
Property and equipment: Property and equipment, including improvements that significantly add to the
productive capacity or extend useful life, are recorded at cost, while maintenance and repairs are expensed
currently. Property and equipment are depreciated over their useful lives using the straight-line method of
depreciation. Software and computer equipment are depreciated over three to five years. Furniture and fixtures
are depreciated over five years. Equipment is depreciated over five to seven years. Leasehold improvements are
depreciated over the lessor of the useful life or the remaining life of the leased property, which ranges from three
to ten years. Building improvements are depreciated over ten to thirty-nine years.
IGS on October 1, 2004,
Intangible assets: The Company adopted SFAS No. 142, “Goodwill and Other Intangible Assets” (“SFAS
142”) on October 1, 2004. Prior to this date, the Company had no assets in this category. With the acquisition
of
intangible assets.
the Company purchased certain
Intangible assets purchased included client relationships, non-compete agreements and goodwill. In accordance
with SFAS 142, the Company is amortizing the client relationships and non-compete agreements over seven and
three years, respectively. In addition, goodwill, pursuant to FAS 142, is not amortized, but rather
reviewed annually for impairment.
tangible and
Income taxes: Taxes are provided on substantially all income and expense items included in earnings,
regardless of the period in which such items are recognized for tax purposes. The Company uses an asset and
liability approach that requires the recognition of deferred tax assets and liabilities for the estimated future tax
consequences of events that have been recognized in the Company’s financial statements or tax returns. In
estimating future tax consequences, the Company generally considers all expected future events other than
enactments of changes in the tax laws or rates. The effect on deferred taxes of a change in tax rates is
recognized in income in the period that includes the enactment date. For periods presented prior to the IPO,
including the ten months ended October 31, 2002, the tax accounts are pro forma disclosures only and not
recorded on the books of the Company.
The Company is subject to compliance reviews by the Internal Revenue Service ("IRS") and other taxing
jurisdictions on various tax matters, including challenges to various positions the Company asserts in its filings.
Certain tax contingencies are recognized when they are determined to be probable and reasonably estimable.
The Company believes it has adequately accrued for tax contingencies that have met both the probable and
reasonably estimable criteria. As of December 31, 2004, there are certain tax contingencies that either are not
considered probable or are not reasonably estimable by the Company at this time. In the event that the IRS or
another taxing jurisdiction levies an assessment in the future, it is possible the assessment could have a material
adverse effect on the Company's consolidated financial condition or results of operations.
Advertising costs: Advertising costs are expensed when incurred.
Operating leases: General abatements or prepaid leasing costs are recognized on a straight-line basis over the
life of the lease.
53
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Capital leases: Leases are analyzed to determine if they meet the definition of a capital lease as defined in
SFAS No. 13, “Accounting for Leases.” Those lease arrangements that meet one of the four criteria are
considered capital leases. As such, the leased asset is capitalized and depreciated. The lease is recorded as a
liability with each payment amortizing the principal balance and a portion classified as interest expense.
Stock-based compensation: The Company applied the intrinsic value method provided for under Accounting
Principles Board Opinion (“APB”) No. 25, “Accounting for Stock Issued to Employees,” for all warrants issued
to employees prior to January 1, 2002. For warrants and options issued to non-employees, the Company
followed the fair value method of accounting as prescribed under SFAS No. 123, “Accounting for Stock Based
Compensation” (“SFAS 123”). On January 1, 2002 the Company adopted SFAS 123 on a prospective basis for
all warrants and options granted and reported the change in accounting principle using the retroactive
restatement method as prescribed in SFAS No. 148 “Accounting for Stock-Based Compensation – Transition
and Disclosure.” For warrants issued to employees prior to January 1, 2002, pro forma net income assuming the
warrants were accounted for as prescribed by SFAS 123, has been disclosed in Note 14 to the financial
statements.
Pro forma earnings (unaudited) per share: Basic earnings per share reflect net income adjusted for the pro
forma income tax provision divided by the weighted average number of shares outstanding. Diluted earnings
per share include the effect of dilutive stock options during the period. As of December 31, 2004, no stock
options issued under the 2002 Stock Option Plan were antidilutive.
Use of estimates: The preparation of financial statements in conformity with accounting principles generally
accepted in the United States of America requires management to make estimates and assumptions that affect the
reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the
financial statements and the reported amounts of revenues and expenses during the reporting period. Actual
results could differ from those estimates.
Significant estimates have been made by management with respect to the collectibility of future cash flows
of portfolios. Actual results could differ from these estimates making it reasonably possible that a change in
these estimates could occur within one year. On a monthly basis, management reviews the estimate of future
collections, and whether it is reasonably possible that its assessment of collectibility may change based on actual
results and other factors.
Estimated fair value of financial instruments: The Company applies the provisions of SFAS No. 107,
“Disclosures About Fair Value of Financial Instruments,” to its financial instruments. Its financial instruments
consist of cash and cash equivalents, investments, finance receivables, net, line of credit, long-term debt, and
obligations under capital leases. See Note 13 for additional disclosure.
Reclassifications: Certain 2003 and 2002 amounts have been reclassified to conform to the 2004 presentation.
Revision in the Classification of Certain Securities: In connection with the preparation of this report, the
Company concluded that it was appropriate to classify its auction rate certificates as investments. Previously,
such investments had been classified as cash and cash equivalents. Accordingly, the Company has revised the
classification to report these securities as investments in its Consolidated Balance Sheets as of December 31,
2004 and 2003. The Company has also made corresponding adjustments to its Consolidated Statement of Cash
Flows for the periods ended December 31, 2004, 2003 and 2002 to reflect the gross purchases and sales of these
securities as investing activities rather than as a component of cash and cash equivalents. This change in
classification does not affect previously reported cash flows from operations or from financing activities in its
previously reported Consolidated Statements of Cash Flows, or previously reported Consolidated Income
Statements for any period.
As of December 31, 2004 and 2003, the Company held auction rate securities of $23,950,000 and $0,
respectively. For the fiscal years ended December 31, 2003 and 2002 net cash provided by (used in) investing
activities related to these investments of $5,950,000 and ($5,950,000), respectively, were included in cash and
cash equivalents in its Consolidated Statement of Cash Flows.
54
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Recent Accounting Pronouncements: In October 2003, the American Institute of Certified Public
Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-03, “Accounting for Loans or Certain
Securities Acquired in a Transfer.” The SOP proposes guidance on accounting for differences between
contractual and expected cash flows from an investor’s initial investment in loans or debt securities acquired in a
transfer if those differences are attributable, at least in part, to credit quality. The SOP is effective for loans
acquired in fiscal years beginning after December 15, 2004 and amends Practice Bulletin 6 which remains in
effect for loans acquired prior to the SOP effective date. The SOP would limit the revenue that may be accrued
to the excess of the estimate of expected future cash flows over a portfolio’s initial cost of accounts receivable
acquired. The SOP 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. The SOP initially freezes the internal
rate of return, referred to as 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,
effective January 1, 2005, the carrying value of a portfolio will be written down to maintain the then-current
IRR. The SOP also amends Practice Bulletin 6 in a similar manner and applies to all loans acquired prior to
January 1, 2005. Increases in expected future cash flows will be recognized prospectively through an upward
adjustment of the IRR over a portfolio’s remaining life. Any increased yield then becomes the new benchmark
for impairment testing. The SOP provides that previously issued annual financial statements would not need to
be restated. Historically, the Company has applied the guidance of Practice Bulletin 6, and has moved yields
upward and downward as appropriate under that guidance. However, since the new SOP guidance does not
permit yields to be lowered, under either the revised Practice Bulletin 6 or SOP 03-03, it will increase the
probability that the Company will have to incur impairment charges in the future.
On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB statement No.
123(R), “Share-Based Payment,” (“FAS 123R”). FAS 123R revises FASB statement No. 123, “Accounting for
Stock-Based Compensation,” (“FAS 123”) and requires companies to expense the fair value of employee stock
options and other forms of stock-based compensation. In addition to revising FAS 123, FAS 123R supersedes
Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and amends FASB
Statement No. 95, “Statement of Cash Flows.” FAS 123R applies to all stock-based compensation transactions
in which a company acquires services by (1) issuing its stock or other equity instruments, except through
arrangements resulting from employee stock-ownership plans (ESOPs) or (2) incurring liabilities that are based
on the company’s stock price. FAS 123R is effective for periods that begin after June 15, 2005; however, early
adoption is encouraged. The Company believes that all of its existing stock-based awards are equity
instruments. The Company previously adopted FAS 123 on January 1, 2002 and has been expensing equity
based compensation since that time. Management believes the adoption of FAS 123R will have no material
impact on its financial statements.
3.
Finance Receivables:
As of December 31, 2004 and 2003, the Company had $105,188,906 and $92,568,557, respectively,
remaining of finance receivables. These amounts represent 514 and 412 pools of accounts as of December 31,
2004 and 2003, respectively. Changes in finance receivables at December 31, 2004 and 2003, were as follows:
2004
2003
Balance at beginning of year
Acquisitions of finance receivables, net of buybacks
$
92,568,557
59,770,354
$
65,526,235
62,298,316
Cash collections
Income recognized on finance receivables
Cash collections applied to principal
Balance at end of year
(153,404,446)
106,254,441
(47,150,005)
(117,052,203)
81,796,209
(35,255,994)
$
105,188,906
$
92,568,557
55
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
At the time of acquisition, the life of each pool is generally estimated to be between 72 and 84 months
based on projected amounts and timing of future cash receipts using the proprietary models of the Company. As
of December 31, 2004 the Company had $105,188,906 in finance receivables included in the Balance Sheet.
Based upon current projections, cash collections applied to principal will be as follows for the twelve months in
the years ending:
December 31, 2005
December 31, 2006
December 31, 2007
December 31, 2008
December 31, 2009
December 31, 2010
December 31, 2011
$
30,473,511
30,643,239
25,768,520
12,340,256
4,667,180
1,078,347
217,853
105,188,906
$
4. Operating Leases:
The Company rents office space and equipment under operating leases. Rental expense was $1,520,100,
$1,028,530, and $668,795 for the years ended December 31, 2004, 2003 and 2002, respectively.
Future minimum lease payments at December 31, 2004, are as follows:
2005
2006
2007
2008
2009
Thereafter
$
1,657,219
1,479,298
1,520,480
1,563,327
1,602,318
5,350,277
$
13,172,919
5.
Acquisition of IGS:
On October 1, 2004, the Company acquired substantially all of the assets of IGS Nevada, Inc. for
consideration of $14 million, consisting of $12 million in cash and 69,914 shares of our common stock (less than
one-half of one percent of the issued and outstanding shares of our common stock), valued at $2 million at the
closing in accordance with the calculation set forth in the asset purchase agreement. The assets acquired from
IGS Nevada, Inc. consisted of accounts receivable, client relationships, fixed assets, non-competition protection
and goodwill. The Company also agreed to collect on behalf of the seller, on a fee-for-service basis, certain
accounts receivable not acquired in the acquisition and remit the proceeds, less a collection fee, to the seller. The
total purchase price could increase by $4 million through performance contingency payments of $2 million each,
in 2005 and 2006. These contingent payments will be recorded as an increase to the purchase price if and when
the specific earnings levels are achieved.
The following is an allocation of the purchase price to the assets acquired of IGS Nevada, Inc.:
Purchase price including acquisition costs
Accounts receivable (included in other assets)
Client relationships
Non-compete agreements
Fixed Assets
Goodwill
$14,147,138
(850,000)
(5,000,000)
(1,800,000)
(100,000)
$6,397,138
56
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
IGS specializes in the location of collateral, securing primarily automobile loans. Based in Las Vegas,
Nevada, IGS has a workforce of approximately 35 employees. IGS Nevada’s founder and his management team
have joined the Company and have executed employment and non-competition agreements. The income
statement includes the results of operations of IGS for the period from October 1, 2004 through December 31,
2004.
6.
Intangible Assets:
Upon the acquisition of substantially all of the assets of IGS Nevada, Inc., the Company obtained a third-
party valuation of intangible assets. The valuation assigned $6.8 million to amortizable assets and $6.4 million
to goodwill, a non-amortizable asset. The amortization periods of the intangible assets are three and seven years,
with a weighted average amortization period of 5.9 years.
Intangible assets consist of the following at December 31, 2004:
Client relationships
Non-compete agreements
Accumulated amortization
Intangible assets, net
$5,000,000
1,800,000
(481,162)
$6,318,838
Amortization expense was $481,162 for the year ended December 31, 2004.
Amortization expense relating to the non-compete agreements is calculated on a straight-line method.
Amortization expense relating to the client relationships is calculated using a pattern of economic benefit
concept. The economic benefit concept relies on expected net cash flows from all existing clients. The rate of
amortization of the client relationships will fluctuate annually to match these expected cash flows. The future
amortization of these intangible assets is as follows as of December 31, 2004:
2005
2006
2007
2008
2009
Thereafter
$1,779,431
1,283,909
1,003,118
693,201
647,431
911,748
$6,318,838
The client relationships asset is related to existing client relationships. These clients, in general, may
terminate their relationship with the Company on 90 days prior notice. In the event a client or clients terminate
or significantly cut back its relationship with the Company, it could potentially give rise to an impairment charge
related to the intangible asset specifically ascribed to existing client relationships.
In addition to amortizable intangible assets, the acquisition of IGS Nevada, Inc., resulted in goodwill of
$6,397,138. Goodwill is reviewed annually to determine any need for impairment. Generally, impairment is
required if the fair value of the acquired assets is less then the book value of the goodwill at the time of
assessment or if there is a changing event prior to the annual assessment that would lead to impairment of
goodwill. The Company conducts its review of goodwill annually on October 1. The Company recognized no
impairment charges for the year ended December 31, 2004. The Company believes goodwill will be fully
deductible for tax purposes.
57
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
7.
Capital Leases:
Leased assets included in property and equipment consist of the following:
Software
Computer equipment
Furniture and fixtures
Equipment
Less accumulated depreciation
2004
2003
$
270,008
60,369
1,260,287
27,249
(862,616)
$
270,008
61,086
963,377
27,249
(607,591)
$
755,297
$
714,129
Depreciation expense recognized on capital leases for the years ended December 31, 2004, 2003 and 2002
was $255,025, $210,101, and $213,016, respectively.
Commitments for minimum annual rental payments for these leases as of December 31, 2004 are as follows:
2005
2006
2007
2008
2009
Less amount representing interest and taxes
Present value of net minimum lease payments
$
219,373
155,904
148,539
99,949
5,698
629,463
53,229
$
576,234
8.
401(k) Retirement Plan:
Effective October 1, 1998, the Company sponsors a defined contribution plan. Under the Plan, all
employees over twenty-one years of age are eligible to make voluntary contributions to the Plan up to 100% of
their compensation, subject to Internal Revenue Service limitations after completing six months of service, as
defined in the Plan. The Company makes matching contributions of up to 4% of an employee’s salary. Total
compensation expense related to these contributions was $434,778, $317,018, and $268,415 for the years ended
December 31, 2004, 2003 and 2002, respectively.
58
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
9.
Revolving Line of Credit:
The Company maintains a $25.0 million revolving line of credit with RBC pursuant to an agreement
entered into on November 28, 2003. On November 22, 2004, the Company amended this revolving line of credit
agreement by entering into an Amended and Restated Commercial Promissory Note with RBC. The only
material change to the original agreement was the extension of the maturity date to November 28, 2006. Other
terms of the original agreement, including the rate of interest, payment terms and available credit, remain the
same. The credit facility bears interest at a spread of 2.50% over LIBOR and extends through November 28,
2006. The agreement provides for:
• restrictions on monthly borrowings are limited to 20% of Estimated Remaining Collections;
• a debt coverage ratio of at least 8.0 to 1.0 calculated on a rolling twelve-month average;
• a debt to tangible net worth ratio of less than 0.40 to 1.00;
• net income per quarter of at least $1.00, calculated on a consolidated basis, and;
• restrictions on change of control.
This facility had no amounts outstanding at December 31, 2004.
Prior to the completion of the IGS acquisition, the Company obtained a waiver of the permitted
acquisitions limitation, from RBC, related to the acquisition.
10. Property and equipment:
Property and equipment, at cost, consist of the following as of December 31, 2004 and 2003:
Software
Computer equipment
Furniture and fixtures
Equipment
Leasehold improvements
Building and improvements
Land
Less accumulated depreciation
Property and equipment, net
December 31,
2004
December 31,
2003
$
2,550,224
2,964,333
1,729,792
1,876,081
1,146,489
1,142,017
150,922
(5,807,369)
$
2,030,403
2,193,386
1,283,748
1,602,547
801,516
1,138,924
100,515
(3,984,659)
$
5,752,489
$
5,166,380
11. Hedging Activity:
During 2001, PRA entered into an interest rate swap for the purpose of managing exposure to fluctuations
in interest rates related to variable rate financing. The interest rate swap effectively fixed the interest rate on $10
million of PRA’s outstanding debt. The swap required payment or receipt of the difference between a fixed rate
of 5.33% and a variable rate of interest based on 1-month LIBOR. The unrealized gains and losses associated
with the change in market value of the interest rate swap were recognized as other comprehensive income. This
swap transaction, which was to expire in May 2004, was paid in full and terminated in September 2002.
Interest expense incurred related to the swap agreement was $792,047 for the year ended December 31,
2002. Interest paid in 2002 represents monthly interest plus the final extinguishment amount of $541,762. The
net interest payments are a component of “Interest Expense.”
59
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
12. Long-Term Debt:
In July 2000, the Company purchased a building in Hutchinson, Kansas. The building was financed with a
commercial loan for $550,000 with a variable interest rate based on LIBOR. This commercial loan is
collateralized by the real estate in Kansas. Interest rates varied between 3.23% and 4.35% during 2004 and
3.35% and 3.79% during 2003. Monthly principal payments on the loan are $4,583 for an amortized term of 10
years. A balloon payment of $275,000 is due July 21, 2005, which results in a five-year principal payout. The
loan matures July 21, 2005.
On February 9, 2001, the Company purchased a generator for its Norfolk location. The generator was
financed with a commercial loan for $107,000 with a fixed rate of 7.9%. This commercial loan is collateralized
by the generator. Monthly payments on the loan are $2,170 and the loan matures on February 1, 2006.
On February 20, 2002, the Company completed the construction of a satellite parking lot at its Norfolk
location. The parking lot was financed with a commercial loan for $500,000 with a fixed rate of 6.47%. The loan
is collateralized by the parking lot. The loan required only interest payments during the first six months.
Beginning October 1, 2002, monthly payments on the loan are $9,797 and the loan matures on September 1,
2007.
On May 1, 2003, the Company secured financing for its computer equipment purchases related to the
Hampton, Virginia office opening. The computer equipment was financed with a commercial loan for $975,000
with a fixed rate of 4.25%. This loan is collaterized by computer equipment. Monthly payments are $18,096
and the loan matures on May 1, 2008.
On January 9, 2004, the Company entered into a commercial loan agreement in the amount of $750,000 to
finance equipment purchases at its newly leased Norfolk facility. This loan bears interest at a fixed rate of
4.45%, matures on January 1, 2009 and is collateralized by the purchased equipment.
Annual payments on all loans outstanding as of December 31, 2004 are as follows:
2005
2006
2007
2008
2009
Less amount representing interest
Principal due
$
848,801
506,757
463,228
240,083
13,975
2,072,844
(148,422)
$
1,924,422
These five loans are collateralized by property and buildings that have a book value of $1,805,636 and
$2,031,553 as of December 31, 2004 and 2003, respectively. The loans require the Company to maintain net
worth greater than $20 million and a cash flow coverage ratio of at least 1.5 to 1.0 calculated on a rolling twelve-
month average.
13. Estimated Fair Value of Financial Instruments:
The accompanying financial statements include various estimated fair value information as of December
31, 2004, as required by SFAS No. 107, “Disclosures About Fair Value of Financial Instruments.” Disclosure of
the estimated fair values of financial instruments often requires the use of estimates. The Company uses the
following methods and assumptions to estimate the fair value of financial instruments.
Cash and cash equivalents: The carrying amount approximates fair value.
Investments: The carrying amount approximates fair value.
60
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Finance receivables, net: The Company records purchased receivables at cost, which represents a significant
discount from the contractual receivable balances due. The cost of the receivables are reduced as cash is
received based upon the guidance of Practice Bulletin 6. The balance at December 31, 2004 was $105,188,906.
The Company computed the fair value of these receivables using our proprietary pricing models that the
Company utilizes to make portfolio purchase decisions. At December 31, 2004, using the aforementioned
methodology, we computed the fair value to be $148,726,542. Under this methodology, it was not practicable to
compute this as of December 31, 2003.
Long-term debt: The carrying amount of the Company’s long-term debt approximates fair value.
Obligations under capital lease: The carrying amount of the Company’s obligations under capital lease
approximates fair value.
14. Stock-Based Compensation:
The Company has a stock warrant plan and a stock option plan. The Amended and Restated Portfolio Recovery
2002 Stock Option Plan and 2004 Restricted Stock Plan was approved by the Company’s shareholders at its
Annual Meeting of Shareholders on May 12, 2004, enabling the Company to issue to its employees and directors
restricted shares of stock, as well as stock options. Also, in connection with the IPO, all existing PRA warrants
that were owned by certain individuals and entities were exchanged for an equal number of PRA Inc warrants.
Prior to 2002, the Company accounted for stock compensation issued under the recognition and measurement
provisions of APB Opinion No. 25, “Accounting for Stock Issued to Employees,” and related Interpretations.
Effective January 1, 2002, the Company adopted the fair value recognition provisions of SFAS 123,
“Accounting for Stock-Based Compensation,” prospectively to all employee awards granted, modified, or settled
after January 1, 2002. All stock-based compensation measured under the provisions of APB 25 became fully
vested during 2002. All stock-based compensation expense recognized thereafter was derived from stock-based
compensation based on the fair value method prescribed in SFAS 123.
Total stock-based compensation was $749,754, $456,340 and $73,180 for the years ended December 31,
2004 and 2003 and 2002, respectively.
61
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The following table illustrates the effect on net income and earnings per share if the fair value based
method had been applied to all outstanding and unvested awards in each period.
For the Year
Ended
December 31,
2004
For the Year
Ended
December 31,
2003
For the Year
Ended
December 31,
2002
$
27,451,440
$
20,713,503
$
11,371,321
458,941
272,828
44,889
(458,941)
27,451,440
$
(272,828)
20,713,503
$
(65,777)
11,350,433
$
$
$
1.79
1.79
$
$
1.42
1.42
$
$
1.08
1.08
$
$
1.73
1.73
$
$
1.32
1.32
$
$
0.94
0.94
Net income/Pro forma net income:
As reported
Add: Stock-based
compensation expense included
in reported net income, net of
related tax effects
Less: Total stock based
compensation expense
determined under intrinsic value
method for all awards, net of
related tax effects
Pro forma net income
Earnings per share:
Basic - as reported
Basic - pro forma
Diluted - as reported
Diluted - pro forma
Stock Warrants
Prior to the IPO, the PRA management committee was authorized to issue warrants to partners, employees
or vendors to purchase membership units. Generally, warrants granted had a term between five and seven years
and vested within three years. Warrants had been issued at or above the fair market value on the date of grant.
Warrants vest and expire according to terms established at the grant date. All warrants became fully vested at
the Company’s IPO in 2002.
62
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The following summarizes all warrant related transactions from December 31, 2001 through December 31,
2004:
December 31, 2001
Granted
Exercised
Cancelled
December 31, 2002
Exercised
Cancelled
December 31, 2003
Exercised
December 31, 2004
Warrants
Outstanding
2,195,000
50,000
(50,000)
(10,000)
2,185,000
(2,026,000)
(51,500)
107,500
(67,500)
40,000
Weighted
Average
Exercise
Price
$
4.17
10.00
4.20
4.20
4.30
4.17
9.72
4.20
4.20
4.20
$
The following information is as of December 31, 2004:
Warrants Outstanding
Weighted-
Average
Remaining
Contractual
Life
Weighted-
Average
Exercise
Price
Warrants Exercisable
Number
Exercisable
Weighted-
Average
Exercise
Price
Number
Outstanding
40,000
40,000
1.27
1.27
$
$
4.20
4.20
40,000
40,000
$
$
4.20
4.20
Exercise
Prices
$ 4.20
Total at December 31, 2004
Had compensation cost for warrants granted under the Agreement, prior to January 1, 2002, been
determined pursuant to SFAS 123, the Company’s net income would have decreased. The Company used a fair-
value (minimum value calculation) to calculate the value of the 2002 warrant grants. The following assumptions
were used:
Warrants issue year:
Expected life from
vest date (in years)
Risk-free interest rates
Volatility
Dividend yield
2002
3.00
4.53%
N/A
N/A
The fair value model utilizes the risk-free interest rate at grant with an expected exercise date sometime in
the future generally assuming an exercise date in the first half of 2005. In addition, warrant valuation models
require the input of highly subjective assumptions, including the expected exercise date and risk-free interest
rates. Prior to the IPO, the Company’s warrants had characteristics significantly different from those of traded
warrants, and changes in the subjective input assumptions can materially affect the fair value estimate. Based
upon the above assumptions, the weighted average fair value of employee warrants granted during the year
ended December 31, 2002 was $1.24.
63
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Stock Options
The Company created the 2002 Stock Option Plan (the “Plan”) on November 7, 2002. The Plan was
amended in 2004 to enable the Company to issue restricted shares of stock to its employees and directors. The
Amended Plan was approved by the Company’s shareholders at its Annual Meeting on May 12, 2004. Up to
2,000,000 shares of common stock may be issued under the Amended Plan. The Amended Plan expires
November 7, 2012. All options issued under the Amended Plan vest ratably over five years. Granted options
expire seven years from grant date. Expiration dates range between November 7, 2009 and January 16, 2011.
Options granted to a single person cannot exceed 200,000 in a single year. As of December 31, 2004, 895,000
options have been granted under the Plan of which 74,115 have been cancelled and are eligible for regrant.
These options are accounted for under SFAS 123 and all expenses for 2004, 2003 and 2002 are included in
earnings as a component of compensation and employee services expense.
The following summarizes all option related transactions from December 31, 2001 through December 31,
2004:
Options
Outstanding
-
820,000
(12,150)
807,850
55,000
(50,915)
(14,025)
797,910
20,000
(63,511)
(47,940)
706,459
Weighted
Average
Exercise
Price
-
$
13.06
13.00
13.06
27.88
13.00
13.00
14.09
28.79
13.30
13.00
14.65
$
December 31, 2001
Granted
Cancelled
December 31, 2002
Granted
Exercised
Cancelled
December 31, 2003
Granted
Exercised
Cancelled
December 31, 2004
All of the stock options were issued to employees of the Company except for 40,000 that were issued to
non-employee directors. Non-employee directors received 20,000, 0 and 20,000 stock options during the years
ending December 31, 2004, 2003 and 2002, respectively.
The following information is as of December 31, 2004:
Exercise
Prices
Number
Outstanding
Options Outstanding
Weighted-
Average
Remaining
Contractual
Life
Weighted-
Average
Exercise
Price
Options Exercisable
Number
Exercisable
Weighted-
Average
Exercise
Price
$ 13.00
$ 16.16
$ 27.77 - $ 29.79
Total at December 31, 2004
618,459
14,000
74,000
706,459
4.7
4.9
5.7
4.8
$
$
$
$
13.00
16.16
28.11
14.65
189,579
5,000
10,000
204,579
$
$
$
$
13.00
16.16
27.77
13.80
64
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The Company utilizes the Black-Scholes option-pricing model to calculate the value of the stock options when
granted. This model was developed to estimate the fair value of traded options, which have different
characteristics than employee stock options. In addition, changes to the subjective input assumptions can result
in materially different fair market value estimates. Therefore, the Black-Scholes model may not necessarily
provide a reliable single measure of the fair value of employee stock options.
Options issue year:
2004
2003
2002
Weighted average fair value
of options granted
Expected volatility
Risk-free interest rate
Expected dividend yield
Expected life (in years)
$ 2.85
$ 5.84
13.26% - 13.55% 15.70% - 15.73%
2.92% - 3.19%
0.00%
5.00
3.16% - 3.37%
0.00%
5.00
$ 2.73
15.70%
2.92%
0.00%
5.00
Utilizing these assumptions, each employee stock option granted in 2002 is valued at $2.71 per share and
each non-employee director stock option is valued at $3.37 per share. For stock options issued to employees in
2003, the per share values range between $5.80 and $6.25. Each non-employee director stock option granted in
2004 is valued between $2.62 and $2.92. There were no employee option grants during 2004.
Nonvested Shares
Nonvested shares are permitted to be issued as an incentive to attract new employees and, effective
commensurate with the meeting of shareholders held on May 12, 2004, are permitted to be issued to directors
and existing employees as well. The terms of the nonvested share awards are similar to those of the stock option
awards, wherein the shares are issued at or above market values and vest ratably over five years. Nonvested
shares grants are expensed over their vesting period.
The following summarizes all nonvested share transactions from December 31, 2002 through December
31, 2004:
Nonvested
Shares
Outstanding
-
13,045
13,045
84,350
(2,609)
(4,900)
89,886
Weighted
Average
Price
$
-
27.57
27.57
26.94
27.57
26.08
27.06
$
December 31, 2002
Granted
December 31, 2003
Granted
Vested
Cancelled
December 31, 2004
65
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
15. Earnings per Share:
Basic earnings per share (“EPS”) are computed by dividing income available to common shareholders by
weighted average common shares outstanding. Diluted EPS are computed using the same components as basic
EPS with the denominator adjusted for the dilutive effect of stock warrants, stock options and nonvested stock
awards. The following table provides a reconciliation between the computation of basic EPS and diluted EPS
for the years ended December 31, 2004 and 2003:
Basic EPS
Dilutive effect of stock warrants,
options and restricted stock awards
Diluted EPS
Net Income
$27,451,440
$27,451,440
For the year ended December 31,
2004
Weighted Average
Common Shares
EPS
15,357,475
$1.79
2003
Weighted Average
Common Shares
EPS
14,545,985
$1.42
Net Income
$20,713,503
495,441
15,852,916
$1.73
$20,713,503
1,165,971
15,711,956
$1.32
As of December 31, 2004 and 2003, there were 0 and 55,000 antidilutive options outstanding, respectively.
16. Stockholders’ Equity:
Shares of common stock outstanding were as follows:
December 31, 2001
Initial public offering
Exercise of warrants
December 31, 2002
Exercise of warrants and options
December 31, 2003
Exercise of warrants, options and vesting of nonvested shares
Issuance of common stock for acquisition
December 31, 2004
Common Stock
-
13,470,000
50,000
13,520,000
1,774,676
15,294,676
133,620
69,914
15,498,210
17.
Income Taxes:
Prior to November 8, 2002, the Company was organized as a limited liability company, taxed as a
partnership, and as such was not subject to federal or state income taxes. Immediately before the IPO, the
Company was reorganized as a corporation and became subject to income taxes.
66
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The income tax expense recognized for the years ended December 31, 2004, 2003 and 2002 is composed of
the following:
For the year ended December 31, 2004
Federal
State
Total
Current tax expense
Deferred tax expense
Total income tax expense
$
638,583
14,056,721
14,695,304
$
2,692,844
2,692,844
$
$
-
$
638,583
16,749,565
17,388,148
For the year ended December 31, 2003
Federal
State
Total
Current tax expense
Deferred tax expense
Total income tax expense
$
$
(116,809)
11,279,283
11,162,474
(21,303)
2,058,132
2,036,829
$
$
(138,112)
13,337,415
13,199,303
$
For the year ended December 31, 2002
Federal
State
Total
Current tax expense
Deferred tax expense
Total income tax expense
$
$
1,005,368
242,633
1,248,001
180,823
44,249
225,072
$
$
$
1,186,191
286,882
1,473,073
The Company also recognized a net deferred tax liability of $13,650,722 as of December 31, 2004, versus
a net deferred tax asset of $2,009,426 as of December 31, 2003. The components of this net liability and asset
are:
Deferred tax assets:
AMT credit
Net operating loss - tax
Employee compensation
Intangible assets and goodwill
Other
Total deferred tax asset
Deferred tax liabilities:
Depreciation expense
Prepaid expenses
Cost recovery
Total deferred tax liability
2004
2003
$
638,583
8,623,251
386,133
101,611
19,101
9,768,679
$
-
21,002,183
181,668
-
6,895
21,190,746
682,840
313,289
22,423,272
23,419,401
516,895
268,712
18,395,713
19,181,320
Net deferred tax (liability) and asset
$
(13,650,722)
$
2,009,426
A valuation allowance has not been provided at December 31, 2004 or 2003 since management believes it
is more likely than not that the deferred tax assets will be realized. In the event that all or part of the net deferred
tax assets are determined not to be realizable in the future, an adjustment to the valuation allowance would be
charged to earnings in the period such determination is made. Similarly, if the Company subsequently realizes
deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would
67
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
be reversed, resulting in a positive adjustment to earnings or a decrease in goodwill in the period such
determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating
the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner
inconsistent with management's expectations could have a material impact on the Company's results of
operations and financial position.
During 2003, the Company recognized a deferred tax asset relating to the net operating loss for tax
purposes. This resulted from the adoption of the cost recovery method of income recognition for tax purposes
combined with the recognition of a tax deduction of approximately $16.4 million relating to stock option and
warrant exercises, net of public offering related expenses. The Company believes cost recovery to be an
acceptable method for companies in the bad debt purchasing industry and results in the reduction of current
taxable income as, for tax purposes, collections on finance receivables are applied first to principle to reduce the
finance receivables to zero before any income is recognized. The timing difference from the adoption of cost
recovery resulted in a deferred tax liability at December 31, 2004 and 2003.
The Company presented pro forma tax information (unaudited) assuming it has been a taxable corporation
since inception and assuming tax rates equal to the rates that would have been in effect had it been required to
report income tax expense in such years. A reconciliation of the Company’s expected tax expense at statutory
tax rates to actual tax expense for the years ended December 31, 2004 and 2003 and the pro forma income tax
expense (unaudited) for the year ended December 31, 2002, consists of the following components:
2004
2003
2002
(unaudited)
Federal tax at statutory rates
State tax expense, net of federal benefit
Other
Total income tax expense
18. Commitments and Contingencies:
$
$
15,693,856
1,750,349
(56,057)
17,388,148
$
$
11,869,482
1,323,939
5,882
13,199,303
$
$
6,488,364
725,246
(46,749)
7,166,861
Employment Agreements:
The Company has employment agreements with all of its executive officers and with several members of
its senior management group, the terms of which expire on March 31, 2005 or December 31, 2005, 2006 or
2007. Such agreements provide for base salary payments as well as bonuses which are based on the attainment
of specific management goals. Estimated future compensation under these agreements is approximately
$3,676,333. The agreements also contain confidentiality and non-compete provisions.
Litigation:
The Company is from time to time subject to routine litigation incidental to its business. The Company
believes that the results of any pending legal proceedings will not have a material adverse effect on the financial
condition, results of operations or liquidity of the Company.
68
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
None.
Item 9A. Disclosure Controls and Procedures.
Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures (as defined in
Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to ensure that information required to be disclosed
in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in
the SEC's rules and forms, and that such information is accumulated and communicated to our management,
including our Chief Executive Officer and Chief Financial Officer, as appropriate, to allow timely decisions
regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management
recognized that any controls and procedures, no matter how well designed and operated, can provide only
reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply
its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, projections of any
evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of
changes in conditions or that the degree of compliance with the policies or procedures may deteriorate. We
conducted an evaluation, under the supervision and with the participation of our principal executive officer and
principal financial officer, of the effectiveness of our disclosure controls and procedures as of the end of the period
covered by this report. Based on this evaluation, the principal executive officer and principal financial officer have
concluded that, as of December 31, 2004, our disclosure controls and procedures were effective.
Management's Report on Internal Control Over Financial Reporting. We are responsible for establishing and
maintaining adequate internal control over financial reporting. Internal control over financial reporting is defined in
Exchange Act Rules 13a-15(f) or 15d-15(f) as a process designed by, or under the supervision of, the company's
principal executive and principal financial officers and effected by the company's board of directors, management
and other personnel, to provide reasonable assurance regarding the reliability of financial reporting and the
preparation of financial statements for external purposes in accordance with generally accepted accounting
principles. Because of its inherent limitations, internal control over financial reporting may not prevent or detect
misstatements. Management's assessment was based on the framework in Internal Control - Integrated Framework
issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its assessment,
management has determined that, as of December 31, 2004, its internal control over financial reporting was
effective. Management's assessment of the effectiveness of our internal control over financial reporting as of
December 31, 2004 has been audited by PricewaterhouseCoopers LLP, an independent registered public accounting
firm, as stated in their report which is included herein.
Changes in Internal Control Over Financial Reporting. There was no change in our internal control over
financial reporting that occurred during the quarter ended December 31, 2004 that has materially affected, or is
reasonably likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
None.
69
Item 10. Directors and Executive Officers of the Registrant.
PART III
The following table sets forth certain information as of February 11, 2005 about the Company’s directors and
executive officers.
Name
Position
Steven D. Fredrickson .. President, Chief Executive Officer and Chairman of the Board
Kevin P. Stevenson…… Executive Vice President, Chief Financial Officer, Treasurer and
Assistant Secretary
Craig A. Grube ............. Executive Vice President — Acquisitions
Judith S. Scott ............... Executive Vice President, General Counsel and Secretary
William P. Brophey ...... Director*
Peter A. Cohen.............. Director*
David N. Roberts .......... Director
Scott M. Tabakin .......... Director*
James M. Voss .............. Director*
Age
45
40
44
59
67
58
42
46
62
* Member of the Company’s audit committee (the “Audit Committee”), which has been established in accordance
with Section 3(a)(58)(A) of the Exchange Act. In the opinion of the Board, Mr. Voss, Mr. Cohen and Mr. Tabakin
are independent directors who qualify as “audit committee financial experts,” pursuant to Section 401(h) of
Regulations S-K.
Steven D. Fredrickson, President, Chief Executive Officer and Chairman of the Board. Prior to co-
founding Portfolio Recovery Associates in 1996, Mr. Fredrickson was Vice President, Director of Household
Recovery Services’ (“HRSC”) Portfolio Services Group from late 1993 until February 1996. At HRSC Mr.
Fredrickson was ultimately responsible for HRSC’s portfolio sale and purchase programs, finance and accounting,
as well as other functional areas. Prior to joining HRSC, he spent five years with Household Commercial Financial
Services managing a national commercial real estate workout team and five years with Continental Bank of Chicago
as a member of the FDIC workout department, specializing in corporate and real estate workouts. He received a
B.S. degree from the University of Denver and a M.B.A. degree from the University of Illinois. He is a past board
member of the American Asset Buyers Association.
Kevin P. Stevenson, Executive Vice President, Chief Financial Officer, Treasurer and Assistant
Secretary. Prior to co-founding Portfolio Recovery Associates in 1996, Mr. Stevenson served as Controller and
Department Manager of Financial Control and Operations Support at HRSC from June 1994 to March 1996,
supervising a department of approximately 30 employees. Prior to joining HRSC, he served as Controller of
Household Bank’s Regional Processing Center in Worthington, Ohio where he also managed the collections,
technology, research and ATM departments. While at Household Bank, Mr. Stevenson participated in eight bank
acquisitions and numerous branch acquisitions or divestitures. He is a certified public accountant and received his
B.S.B.A. with a major in accounting from the Ohio State University.
Craig A. Grube, Executive Vice President — Acquisitions. Prior to joining Portfolio Recovery Associates
in March 1998, Mr. Grube was a senior officer and director of Anchor Fence, Inc., a manufacturing and distribution
business from 1989 to March 1997, when the company was sold. Between the time of the sale and March 1998, Mr.
Grube continued to work for Anchor Fence. Prior to joining Anchor Fence, he managed distressed corporate debt
for the FDIC at Continental Illinois National Bank for five years. He received his B.A. degree from Boston College
and his M.B.A. degree from the University of Illinois.
Judith S. Scott, Executive Vice President, General Counsel and Secretary. Prior to joining Portfolio
Recovery Associates in March 1998, Ms. Scott held senior positions, from 1991 to March 1998, with Old Dominion
University as Director of its Virginia Peninsula campus, from 1985 to 1991, as General Counsel of a computer
manufacturing firm; as Senior Counsel in the Office of the Governor of Virginia from 1982 to 1985; as Senior
Counsel for the Virginia Housing Development Authority from 1976 to 1982, and as Assistant Attorney General for
the Commonwealth of Virginia from 1975 to 1976. Ms. Scott received her B.S. in business administration from
70
Virginia State University, a post baccalaureate degree in economics from Swarthmore College, and a J.D. from the
Catholic University School of Law.
William P. Brophey, Director. Mr. Brophey was elected as a director of Portfolio Recovery Associates in
2002. Currently retired, Mr. Brophey has more than 35 years of experience as president and chief executive officer
of Brad Ragan, Inc., a (formerly) publicly traded automotive product and service retailer and as a senior executive at
The Goodyear Tire and Rubber Company. Throughout his career, he held numerous field and corporate positions at
Goodyear in the areas of wholesale, retail, credit, and sales and marketing, including general marketing manager,
commercial tire products. He served as president and chief executive officer and a member of the board of directors
of Brad Ragan, Inc. (a 75% owned public subsidiary of Goodyear) from 1988 to 1996, and vice chairman of the
board of directors from 1994 to 1996, when he was named vice president, original equipment tire sales world wide
at Goodyear. From 1998 until his retirement in 2000, he was again elected president and chief executive officer and
vice chairman of the board of directors of Brad Ragan, Inc. Mr. Brophey has a business degree from Ohio Valley
College and attended advanced management programs at Kent State University, Northwestern University,
Morehouse College and Columbia University.
Peter A. Cohen, Director. Mr. Cohen was elected as a director of Portfolio Recovery Associates in 2002. Mr.
Cohen began his career on Wall Street at Reynolds & Co. in 1969. In 1970, he joined the firm which would later
become Shearson Lehman Brothers. In 1981, when Shearson merged with American Express, he was appointed
president and chief operating officer. From 1983 to 1990, he served as chairman and chief executive officer of
Shearson. From 1991 to 1994, Mr. Cohen served as an advisor and vice chairman of the board of Republic New
York Corporation. In 1994, he started what is today Ramius Capital Group, an investment management business,
which currently has $3 billion of assets under management. Mr. Cohen has served on numerous boards of directors,
including the New York Stock Exchange, the American Express Company, Olivetti SpA, and Telecom SpA.
Currently, he sits on the boards of Presidential Life Corporation, The Mount-Sinai-NYU Medical Center & Health
System, Kroll Inc., and Titan Corporation. Mr. Cohen has an MBA from Columbia University and a Bachelor’s
Degree from Ohio State University.
David N. Roberts, Director. Mr. Roberts has been a director of Portfolio Recovery Associates since its
formation in 1996. Mr. Roberts joined Angelo, Gordon & Company, L.P. in 1993. He manages the firm’s private
equity and special situations area and was the founder of the firm’s opportunistic real estate area. Mr. Roberts has
invested in a wide variety of real estate, corporate and special situations transactions. Prior to joining Angelo,
Gordon Mr. Roberts was a principal at Gordon Investment Corporation, a Canadian merchant bank from 1989 to
1993, where he participated in a wide variety of principal transactions including investments in the real estate,
mortgage banking and food industries. Prior to joining Gordon Investment Corporation, he worked in the Corporate
Finance Department of L.F. Rothschild where he specialized in mergers and acquisitions. He has a B.S. degree in
economics from the Wharton School of the University of Pennsylvania.
Scott M. Tabakin, Director. Mr. Tabakin was appointed a director of Portfolio Recovery Associates in 2004.
A seasoned financial executive, Mr. Tabakin brings significant public-company experience to Portfolio Recovery
Associates. Mr. Tabakin served as Executive Vice President and CFO of AMERIGROUP Corporation, a managed
health-care company, through the fall of 2003 and prior to that was Executive Vice President and CFO of Beverly
Enterprises, Inc., one of the nation's largest providers of long-term health care. Earlier in his career, Mr. Tabakin
was an executive with the accounting firm of Ernst & Young. He is a certified public accountant and received a
B.S. degree from the University of Illinois.
James M. Voss, Director. Mr. Voss was elected as a director of Portfolio Recovery Associates in 2002. Mr.
Voss has more than 35 years of experience as a senior finance executive. He currently heads Voss Consulting, Inc.,
serving as a consultant to community banks regarding policy, organization, credit risk management and strategic
planning. From 1992 through 1998, he was with First Midwest Bank as executive vice president and chief credit
officer. He served in a variety of senior executive roles during a 24 year career (1965-1989) with Continental Bank
of Chicago, and was chief financial officer at Allied Products Corporation (1990-1991), a publicly traded (NYSE)
diversified manufacturer. Currently, he serves on the board of Elgin State Bank. Mr. Voss has both an MBA and
Bachelor’s Degree from Northwestern University.
71
Corporate Code of Ethics
The Company has adopted a Code of Ethics which is applicable to all directors, officers, and employees and
which complies with the definition of a “code of ethics” set out in Section 406(c) of the Sarbanes-Oxley Act of
2002, and the requirement of a “Code of Conduct” prescribed by Section 4350(n) of the Marketplace Rules of the
NASDAQ Stock Market, Inc. The Code of Ethics is available to the public, and will be provided by the Company at
no charge to any requesting party. Interested parties may obtain a copy of the Code of Ethics by submitting a written
request to Investor Relations, Portfolio Recovery Associates, Inc., 120 Corporate Boulevard, Suite 100, Norfolk,
Virginia, 23502, or by email at info@portfoliorecovery.com. The Code of Ethics is also posted on the Company 's
website at www.portfoliorecovery.com.
72
Item 11. Executive Compensation.
The information required by Item 11 is incorporated herein by reference to the section labeled “Executive
Compensation” in the Company’s definitive Proxy Statement in connection with the Company’s 2005 Annual
Meeting of Stockholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management.
The information required by Item 12 is incorporated herein by reference to the section labeled “Security
Ownership of Certain Beneficial Owners and Management” in the Company’s definitive Proxy Statement in
connection with the Company’s 2005 Annual Meeting of Stockholders.
Item 13. Certain Relationships and Related Transactions.
The information required by Item 13 is incorporated herein by reference to the section labeled “Certain
Relationships and Related Transactions” in the Company’s definitive Proxy Statement in connection with the
Company’s 2005 Annual Meeting of Stockholders.
Item 14. Principal Accountant Fees and Services.
The aggregate fees billed or expected to be billed by PricewaterhouseCoopers, LLP for the years ended
December 31, 2004 and 2003 are presented in the table below:
Audit Fees
Annual audit
Sarbanes-Oxley 404 audit
Registration statement (1)
Audit Related Fees
WestLB attest service
Consultation on various accounting matters
Tax Fees
Advice
2004
2003
$
190,000
180,000
$
130,575
-
64,225
434,225
-
56,344
(3)
-
-
118,739
249,314
4,700
(2)
-
(4)
125,507
125,507
Total Accountant Fees
$
490,569
$
379,521
(1)
(2)
(3)
(4)
The fees related to the registration statement filed on Form S-3 in November 2004 were paid for in full
by one of the selling stockholders.
This fee relates to an annual review conducted by our prior lender.
These include fees associated with our auditor’s review of the treatment of certain accounting matters
and purchase accounting relating to the IGS acquisition.
Tax advice fees were incurred to assist us in implementing bona fide tax strategies as a result of the
November 2002 IPO.
73
The Audit Committee’s charter provides that they will:
• Approve the fees and other significant compensation to be paid to auditors.
• Review the non-audit services to determine whether they are permissible under current law.
• Pre-approve the provision of any permissible non-audit services by the independent auditors and the
related fees of the independent auditors therefore.
• Consider whether the provision of these other services is compatible with maintaining the auditors’
independence.
All the fees paid to PricewaterhouseCoopers were pre-approved by the Audit Committee.
74
PART IV
Item 15. Exhibits, Financial Statement Schedules and Reports on Form 8-K.
(a) Financial Statements.
The following financial statements of the Company are included in Item 8 of this Annual Report on Form 10-K:
Page
Report of Independent Registered Public Accounting Firm 45-46
Consolidated Balance Sheets at December 31, 2004 and 2003
47
Consolidated Income Statements
for the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2004, 2003 and 2002
Consolidated Statements of Cash Flows
For the years ended December 31, 2004, 2003 and 2002
Notes to Consolidated Financial Statements
(b) Exhibits.
48
49
50
51-68
2.1
2.2
3.1
3.2
4.1
4.2
10.1
10.2
10.3
10.4
10.5
10.6
10.7
Equity Exchange Agreement between Portfolio Recovery Associates, L.L.C. and Portfolio
Recovery Associates, Inc. (Incorporated by reference to Exhibit 2.1 of the Registration Statement
on Form S-1.)
Asset Purchase Agreement dated as of October 1, 2004, by and among Portfolio Recovery
Associates, Inc, PRA Location Services, LLC, IGS Nevada, Inc., and James Snead (Incorporated
by reference to Exhibit 2.1 of the Form 8-K dated October 7, 2004.)
Amended and Restated Certificate of Incorporation of Portfolio Recovery Associates, Inc.
(Incorporated by reference to Exhibit 3.1 of the Registration Statement on Form S-1.)
Amended and Restated By-Laws of Portfolio Recovery Associates, Inc. (Incorporated by
reference to Exhibit 3.2 of the Registration Statement on Form S-1.)
Form of Common Stock Certificate (Incorporated by reference to Exhibit 4.1 of the Registration
Statement on Form S-1.)
Form of Warrant (Incorporated by reference to Exhibit 4.2 of the Registration Statement on
Form S-1.)
Employment Agreement, dated December 8, 2002, by and between Steven D. Fredrickson and
Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.8 of the Annual
Report on Form 10-K for the year ended December 31, 2002.)
Employment Agreement, dated December 8, 2002, by and between Kevin P. Stevenson and
Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.9 of the Annual
Report on Form 10-K for the year ended December 31, 2002.)
Employment Agreement, dated December 8, 2002, by and between Craig A. Grube and Portfolio
Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.10 of the Annual Report on
Form 10-K for the year ended December 31, 2002.)
Employment Agreement, dated December 27, 2002, by and between James L. Keown and
Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.12 of the Annual
Report on Form 10-K for the year ended December 31, 2002.)
Employment Agreement, dated December 8, 2002, by and between Judith S. Scott and Portfolio
Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.13 of the Annual Report on
Form 10-K for the year ended December 31, 2002.)
Portfolio Recovery Associates, Inc. Amended and Restated 2002 Stock Option Plan and 2004
Restricted Stock Plan. (Incorporated by reference to Exhibit 10.9 of the form 10-Q for the period
ended June 30, 2004.)
Loan and Security Agreement, dated November 28, 2003, by and between Portfolio Recovery
Associates, Inc. and RBC Centura Bank. (Incorporated by reference to Exhibit 10.18 of the
Annual Report on Form 10-K for the period ended December 31, 2003).
75
10.8
10.9
Amended and Restated Commercial Promissory Note dated November 22, 2004 (Incorporated by
reference to Exhibit 10.1 of the Form 8-K filed November 24, 2004)
Business Loan Agreement, dated January 8, 2004, by and between Portfolio Recovery Associates,
Inc. and RBC Centura Bank. (Incorporated by reference to Exhibit 10.20 of the Annual Report on
Form 10-K for the period ended December 31, 2003).
10.10 Promissory Note, dated January 8, 2004, by and between Portfolio Recovery Associates, Inc. and
RBC Centura Bank. (Incorporated by reference to Exhibit 10.21 of the Annual Report on Form
10-K for the period ended December 31, 2003).
21.1 Subsidiaries of Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 2.1 of
the Registration Statement on Form S-1).
Consent of PricewaterhouseCoopers LLP
23.1
Powers of Attorney (included on signature page).
24.1
31.1
Section 302 Certifications of Chief Executive Officer and Chief Financial Officer
32.1 Section 906 Certifications of Chief Executive Officer and Chief Financial Officer
76
Pursuant to the requirements of Section 13 or 15(d) 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.
SIGNATURES
Dated: March 14, 2005
Dated: March 14, 2005
Portfolio Recovery Associates, Inc.
(Registrant)
By:/s/ Steven D. Fredrickson
Steven D. Fredrickson
President, Chief Executive Officer
and Chairman of the Board
(Principal Executive Officer)
By:/s/ Kevin P. Stevenson
Kevin P. Stevenson
Chief Financial Officer, Executive Vice President,
Treasurer and Assistant Secretary
(Principal Financial and Accounting Officer)
KNOW ALL MEN BY THESE PRESENTS, that each of the undersigned whose signature appears below
constitutes and appoints Steven D. Fredrickson and Kevin P. Stevenson, his true and lawful attorneys-in-fact, with
full power of substitution and resubstitution for him and on his behalf, and in his name, place and stead, in any and
all capacities to execute and sign any and all amendments or post-effective amendments to this Annual Report on
Form 10-K, and to file the same, with all exhibits thereto, and other documents in connection therewith, with the
Securities and Exchange Commission, hereby ratifying and confirming all that said attorneys-in-fact or any of them
or their or his substitute or substitutes, may lawfully do or cause to be done by virtue hereof and the registrant
hereby confers like authority on its behalf.
Pursuant to the requirements of the Securities Exchange Act of 1934, this report has been signed below by the
following persons on behalf of the registrant and in the capacities and on the dates indicated.
Dated: March 14, 2005
Dated: March 14, 2005
Dated: March 14, 2005
Dated: March 14, 2005
Dated: March 14, 2005
Dated: March 14, 2005
By:/s/ Steven D. Fredrickson
Steven D. Fredrickson
President and Chief Executive Officer
By:/s/ Kevin P. Stevenson
Kevin P. Stevenson
Chief Financial Officer, Executive Vice President,
Treasurer and Assistant Secretary
By:/s/ William P. Brophey
William P. Brophey
Director
By:/s/ Peter A. Cohen
Peter A. Cohen
Director
By:/s/ David N. Roberts
David Roberts
Director
By:/s/ Scott M. Tabakin
Scott M. Tabakin
Director
77
Dated: March 14, 2005
By:/s/ James M. Voss
James M. Voss
Director
78
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statements on Form S-8 (No. 333-110330
and No. 333-110331) of Portfolio Recovery Associates, Inc. of our report dated March 14, 2005 relating to the
financial statements and management’s assessment of the effectiveness of internal control over financial reporting
and the effectiveness of internal control over financial reporting, which appears in this Form 10-K.
/s/ PricewaterhouseCoopers LLP
PricewaterhouseCoopers LLP
McLean, Virginia
March 14, 2005
79
Exhibit 31.1
I, Steven D. Fredrickson, certify that:
1.
I have reviewed this annual report on Form 10-K of PORTFOLIO RECOVERY ASSOCIATES, 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 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) Designed such internal controls over financial reporting, or caused such internal controls over financial
reporting to be designed under my supervision to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of the financial statements for external purposes in accordance with
generally accepted accounting principles;
(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 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 controls 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: March 14, 2005
By: /s/ Steven D. Fredrickson
Steven D. Fredrickson
Chief Executive Officer, President and
Chairman of the Board of Directors
(Principal Executive Officer)
80
I, Kevin P. Stevenson, certify that:
1.
I have reviewed this annual report on Form 10-K of PORTFOLIO RECOVERY ASSOCIATES, 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 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) Designed such internal controls over financial reporting, or caused such internal controls over financial
reporting to be designed under my supervision to provide reasonable assurance regarding the reliability of
financial reporting and the preparation of the financial statements for external purposes in accordance with
generally accepted accounting principles;
(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 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 controls 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: March 14, 2005
By: /s/ Kevin P. Stevenson
Kevin P. Stevenson
Chief Financial Officer, Executive Vice
President, Treasurer
and Assistant
Secretary
(Principal Financial and Accounting
Officer)
81
Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Portfolio Recovery Associates, Inc. (the "Company") on Form 10-K for the
fiscal year ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Steven D. Fredrickson, Chief Executive Officer, President and Chairman of the Board of the Company,
certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002,
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
result of operations of the Company.
Date: March 14, 2005
By: /s/ Steven D. Fredrickson
Steven D. Fredrickson
Chief Executive Officer, President and
Chairman of the Board of Directors
(Principal Executive Officer)
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Annual Report of Portfolio Recovery Associates, Inc. (the "Company") on Form 10-K for the
fiscal year ended December 31, 2004 as filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Kevin P. Stevenson, Chief Financial Officer, Executive Vice President, Treasurer and Assistant
Secretary of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the
Sarbanes-Oxley Act of 2002, 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
result of operations of the Company.
Date: March 14, 2005
By: /s/ Kevin P. Stevenson
Kevin P. Stevenson
Chief Financial Officer, Executive Vice President,
Treasurer and Assistant Secretary
(Principal Financial and Accounting Officer)
82
Corporate Governance
MANAGEMENT
Steve Fredrickson
President and
Chief Executive Officer
Kevin Stevenson
Executive Vice President,
Chief Financial Officer,
Treasurer and Asst.
Secretary
Craig Grube
Executive Vice President,
Acquisitions
Judith Scott
Executive Vice President,
General Counsel and
Secretary
BOARD OF DIRECTORS
CORPORATE INFORMATION
Steve Fredrickson
Chairman of the Board
William Brophey
Director
STOCK EXCHANGE LISTING
Portfolio Recovery Associates’ common stock trades on the Nasdaq
National Market under the symbol “PRAA.” Price information for the
common stock appears daily in major newspapers.
TRANSFER AGENT AND REGISTRAR
Continental Stock Transfer
17 Battery Place, 8th Floor
New York, New York 10004
Tel: 212-509-4000
Fax: 212-509-5150
AUDITORS
PricewaterhouseCoopers LLP
McLean, Virginia
LEGAL COUNSEL
Dechert, LLP
New York, New York
FINANCIAL PUBLICATIONS/INVESTOR INQUIRIES
Shareholders may acquire copies of the 2004 Form 10-K, Annual
Report and other filed documents by visiting the company’s website at
www.portfoliorecovery.com or by writing to us at:
Portfolio Recovery Associates
Attn: Investor Relations
120 Corporate Blvd., Suite 100
Norfolk, Virginia 23502
PRICE RANGE OF COMMON STOCK
The Company’s common stock began trading on the Nasdaq National
Market under the symbol “PRAA” on November 8, 2002. The following
table sets forth the high and low sales price for the common stock for
the year 2004.
2004
$41.80
$23.89
High
Low
As of March 5, 2005, there were approximately 25 holders of record of
the common stock. Based on information provided by the Company’s
transfer agent and registrar, the Company believes that there are
approximately 15,128 beneficial owners of the common stock.
Peter Cohen
Director
David Roberts
Director
Scott Tabakin
Director
James Voss
Director
m
o
c
.
s
r
o
n
n
o
c
-
n
a
r
r
u
c
.
w
w
w
/
.
c
n
i
,
s
r
o
n
n
o
c
&
n
a
r
r
u
c
y
b
d
e
n
g
i
s
e
d
PORTFOLIO RECOVERY
ASSOCIATES, INC. and its subsidiaries purchase,
manage, and collect defaulted consumer receivables. Our
business is both people-intensive and highly analytical. Through a
disciplined approach to pricing and a long-term view of collections, we have
been able to build a company that produces exceptional results for investors and
clients alike, while creating a rewarding organization for our employees.
We operate five call centers. When current office expansions are completed by mid-2005, we will
own or lease more than 110,000 square feet of office space which has the capacity to house 1,150
employees. At December 31, 2004 we employed 948 people.
Portfolio Recovery Associates, Inc.
P
o
r
t
f
o
l
i
o
R
e
c
o
v
e
r
y
A
s
s
o
c
i
a
t
e
s
,
I
n
c
.
Portfolio Recovery Associates, Inc.
Riverside Commerce Center
120 Corporate Blvd., Suite 100
Norfolk, Virginia 23502
A year for dis cipline and per for mance
2004 Annual Report