E X E C U T I N G F O R
S H A R E H O L D E R S
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 .
2 0 0 5 A nnu al Re p o r t
205.2
205.2
160.6
160.6
120.2
120.2
81.2
81.2
205.2
205.2
’02
’02
’03
’03
160.6
160.6
’04
’04
’05
’05
Cash Receipts
Cash Receipts
120.2
120.2
($ in millions)
($ in millions)
81.2
81.2
20.3
20.3
20.4
20.4
21.1
21.1
27.9
27.9
27.9
27.9
’02
’02
20.3
20.3
’03
’03
20.4
20.4
’04
’04
21.1
21.1
’05
’05
Return on Equity
(in percent)
Return on Equity
(in percent)
’02
’02
’03
’03
’04
’04
’05
’05
36.8
36.8
Cash Receipts
Cash Receipts
($ in millions)
($ in millions)
27.5
27.5
20.7
20.7
11.4*
11.4*
36.8
36.8
72.7
72.7
’02
’02
72.7
72.7
’03
’03
’04
’04
’05
’05
Return on Equity
(in percent)
Return on Equity
(in percent)
52.1
52.1
33.5
33.5
31.0
31.0
’02
’02
’03
’03
27.5
27.5
’04
’04
’05
’05
20.7
20.7
Net Income
Net Income
($ in millions)
($ in millions)
11.4*
11.4*
* Unaudited adjusted for corporate
* Unaudited adjusted for corporate
tax effect.
tax effect.
’02
’02
’03
’03
’04
’04
’05
’05
Net Income
Net Income
($ in millions)
($ in millions)
* Unaudited adjusted for corporate
tax effect.
* Unaudited adjusted for corporate
tax effect.
’02
’02
52.1
52.1
’03
’03
’04
’04
’05
’05
Annual Revenue Growth
Annual Revenue Growth
33.5
33.5
(in percent)
(in percent)
31.0
31.0
’02
’02
’03
’03
’04
’04
’05
’05
Annual Revenue Growth
(in percent)
Annual Revenue Growth
(in percent)
Net Income
Net Income
($ in millions)
($ in millions)
Annual Revenue Growth
Annual Revenue Growth
(in percent)
(in percent)
250000
250000
200000
200000
150000
150000
100000
100000
250000
250000
50000
50000
200000
200000
0
0
150000
150000
100000
100000
50000
50000
0
0
40000
40000
35000
35000
30000
30000
25000
25000
20000
20000
15000
15000
40000
10000
40000
10000
35000
5000
35000
5000
30000
30000
0
0
25000
25000
20000
20000
15000
15000
10000
10000
5000
5000
0
0
30
30
25
25
20
20
15
15
10
10
30
30
5
5
25
25
0
0
20
20
15
15
10
10
5
5
0
0
80
80
70
70
60
60
50
50
40
40
30
30
80
20
80
20
70
10
70
10
60
0
60
0
50
50
40
40
30
30
20
20
10
10
0
0
Cash Receipts
Cash Receipts
($ in millions)
($ in millions)
Return on Equity
Return on Equity
(in percent)
(in percent)
Cash Receipts
Cash Receipts
($ in millions)
($ in millions)
Return on Equity
Return on Equity
(in percent)
(in percent)
Net Income
Net Income
($ in millions)
($ in millions)
Annual Revenue Growth
Annual Revenue Growth
(in percent)
(in percent)
Financial Highlights
(in thousands, except per share amounts)
2005
2004
2003
2002
2001
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)
$ 148,525
$ 59,600
$ 36,772
2.28
$
3.58
$
16,149
$ 113,396
$ 44,890
$ 27,451
1.73
$
3.11
$
15,853
$ 84,927
$ 34,455
$ 20,714
1.32
$
2.23
$
15,712
40.1%
40.4%
21.1%
39.6%
39.5%
20.4%
40.6%
39.9%
20.3%
$ 55,847
$ 20,963
$ 11,371*
$
$
0.94
1.81
12,066
37.5%
33.2%
27.9%
$ 6,062
$ 193,645
$ 247,772
$ 195,322
$ 43,883
$ 105,189
$ 175,176
$ 151,389
$ 21,612
$ 92,569
$ 126,394
$ 119,148
$ 13,039
$ 65,526
$ 88,288
$ 80,608
$32,336
$ 8,766
$ 3,526*
$ 0.31
$ 0.57
11,458
27.1%
17.4%
13.7%
$ 3,156
$ 47,987
$ 57,108
$ 27,752
*Unaudited adjusted to show impact of corporate income tax prior to the Company’s conversion to a corporation in 2002.
Portfolio Recovery Associates, Inc. and its subsidiaries purchase and manage portfolios of defaulted con-
sumer receivables and provide a broad range of accounts receivable management services for lenders,
service providers, governments and others. Through a disciplined approach to pricing and portfolio acqui-
sitions and a long-term view of collections with a dedication to reputation, customer service and innova-
tion, 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 six call centers. At year end 2005 we owned or leased more than 110,000 square feet of
office space, which has the capacity to house more than 1,200 employees. At December 31, 2005 we
employed 1,100 people in Virginia, Kansas, Alabama, and Nevada.
1
Ge t Hot— K eep Moving
Don’ t Wa s t e a Pr ecious Minu t e.
Dear Fellow Shareholders:
We decided to utilize the theme from one of the
highly variable depending on the training, motiva-
vintage posters that hangs in our Norfolk call cen-
tion and management of the person doing the
ter in an effort to help tell the story of Portfolio
job. We sincerely believe that operating our own
Recovery Associates in 2005. Our financial results
call centers and closely managing our working
are driven not only by technology, detailed statisti-
environment and productivity through strict daily
cal analysis, and cutting edge MIS (intellectual
capital), but also by paying careful attention to old
operating practices is a skill set that sets PRA
apart from many competitors. In order to get the
fashioned values exemplified by the numerous
best people and keep them producing at the high-
vintage posters and images contained throughout
est possible level, the Company is constantly
this year’s report—“hard work.” The production
striving to develop the best employment experi-
mind set of our call centers is well represented
in the vintage poster shown on the cover of this
ence in the industry. This focus is one of the
principal reasons that PRA was around to cele-
report, “Get Hot—Keep Moving—Don’t Waste a
brate its 10th anniversary during March of 2006,
Precious Minute.” At the end of the day, anyone
and did so as a strong, growing public company.
in the bad debt business, whether operating an
outsourced model or a vertically integrated busi-
ness such as PRA, depends on a well trained col-
lector having a professional, effective interaction
with a customer in order to drive in cash. The
quality and quantity of this type of work can be
I am extremely pleased to be able to write this
letter with another strong year of performance
delivered to our shareholders. Once again, the
employees of PRA, including all of our subsidiary
companies, stepped up and generated what I
view as superior results. I am very proud of all
2
Portfolio Acquisitions—Craig Grube and his team source, underwrite, and purchase all of our non-bankrupt
owned accounts, in addition to overseeing the portfolio strategy used in the collection of our owned portfolio
business. Their strong relationships and impeccable reputation in the industry permit PRA access to virtually
all sellers, broadening our potential market.
our people. They are the ones that “Get Hot,”
Debt Buying
and then “Keep Hot,” each and every minute
We have long talked about being an opportunistic
as we operate our call centers in Norfolk, VA;
buyer of bad debt. We have built cash and carried
Hampton, VA; Hutchinson, KS; Las Vegas, NV;
it on our balance sheet for years, waiting for the
and Birmingham, AL.
The year 2005 presented plenty of highlights:
Let’s start with net income growth of 34%.
Revenue growth was 31%. Cash collections
grew 25%. Debt purchases were off the charts,
increasing about 150% to nearly $150 million.
We advanced our expertise with bankrupt paper
and initiated targeted efforts into healthcare
account buying. We continued to develop our fee
for service businesses and added government
collections to our skill set. Our return on equity
right opportunity to put it to work. We got our
shot in Q4 2005 thanks, at least in part, to the
Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005, also known as the
Bankruptcy Reform Act, which went into effect
on October 17, 2005. This act created an unprece-
dented surge in bankruptcy filings, especially in
the days and weeks just prior to its effective date.
As a result, significant portfolios of charged off
debt came to market as credit issuers reacted to
their own surge in bankruptcies and/or charge offs.
remained above 20% at 21.1%, with little use of
And we were ready. During 2005 we were hard
financial leverage. Consistent with our old fash-
at work negotiating with a new bank group to
ioned values we produced another year of solid
dramatically increase our line of credit while
results, not excuses.
improving our borrowing terms. When it became
obvious that we might be able to use the new
3
General Counsel—Judy Scott and her team work tirelessly to understand the complex web of collection
laws at the federal, state and local level to help maintain PRA’s compliant environment. Working closely
with training and operations, General Counsel works to ensure that our people understand and comply with
all applicable laws.
line, we accelerated its closing in plenty of time.
year’s acquisitions. Note the layering effect that
Our call centers had reasonable capacity and our
each year’s new purchases provide. Obviously the
systems were already properly scaled to handle
2005 portfolio acquisitions will be significant cash
the growth. Since most of the dramatic buying
generators and revenue producers for many years
occurred during the last 45 days of the year, we
to come. For your reference, the numbers that go
experienced very limited 2005 cash collections
from our significant late year investment. We
into this graph are shown in several detailed
tables on page 13 of this report.
Portfolio Purchases* By Year
($ in millions)
1997
1998
1999
2000
2001
2002
2003
2004
2005
a97
a98
a99
a00
a01
a02
a03
a04
a05
*Original purchase price
150
120
90
60
30
0
expect the impact of these deals to begin in
earnest during early 2006 and carry forward
for many years.
This dramatic 2005 buying has given us signifi-
cant raw material to fuel future growth. The graph
to the right shows our buying investment each full
year since the company was founded. The graph
at the top of the following page shows the magni-
tude of collections in each year based on each
150
120
90
60
30
0
4
200
150
100
50
0
Owned Portfolio Cash Collections Per Purchase Period
($ in millions)
process bankruptcy accounts, as these acquired
200000
pools represented 22.6% of our total 2005 buying,
up from 13.6% in 2004. The chart below details
150000
our buying by Recall/Paper Type over the past
ten years. We have altered our investment
100000
percentage by segment dramatically in the past
50000
in reaction to the types of opportunities our
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
analytics determine. We do not consider ourselves
a98
a02
a segment specialist, instead preferring to invest
a00
a01
a97
a96
a99
0
a03
a04
a05
Portfolio Diversity; Bankruptcy and Healthcare
chart evidences this flexibility; a flexibility further
Our buying during the year reflected a growing
enhanced by our development of a bankruptcy
confidence in our ability to effectively price and
buying expertise.
wherever we see the best value at the time. The
Investment Percentage by Paper Type
100
80
60
40
20
0
Warehouse
Quad
Tertiary
Secondary
Primary
Paying
Mixed
Legal/Judgement
Fresh
BK Trustees
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
a96
a97
a98
a99
a00
a01
a02
a03
a04
a05
5
a05
a04
a03
a02
a01
a00
a99
a98
a97
a96
100
80
60
40
20
0
Information Technology—Agostino Pintus and his very talented team operate with a goal to put PRA on a
technological level that our competitors cannot touch. Faster, more robust systems, better access to more
data, reduced keystrokes, more intelligent account and call delivery, intuitive screens that help keep technical
training to a relative minimum, and redundancy that ensures we are always in business are a few of the great
things IT does for us each and every day.
Bankruptcy buying differs from our core buying
the purchased pool. At PRA, we believe that our
activities in a number of key ways. First, collection
proprietary systems and vertically integrated busi-
expenses on bankrupt accounts are dramatically
ness model provide us with a competitive advan-
lower than standard charge off accounts because
tage over many other bankruptcy buyers that lack
creditors are generally precluded from making
the internal capability to collect non-bankrupt
collection calls. Instead, the U.S. Bankruptcy
accounts. In our shop, when a case dismisses,
Trustees manage the recoveries from debtors in
performing Chapter 13 and Chapter 7 cases and
our systems automatically route the account to
the appropriate area in our core collection process
distribute the proceeds directly to creditors.
so that action can be taken immediately.
Because of the trustee’s involvement and the
resulting lower expenses, we can maintain our
targeted IRR levels while purchasing portfolios
with much smaller lifetime collections to purchase
price multiples than we would ever pursue in our
core business. Second, bankruptcy account man-
agement is a very detail oriented business where
efficiencies are driven by a well designed work-
flow process, leveraging IT infrastructure and an
We believe that the amendments to the bankruptcy
law made in October 2005 will affect the magni-
tude and timing of bankruptcy liquidation rates
and so we are being circumspect as we evaluate
accounts that were filed post-amendment. As
time passes, however, and we gain more experi-
ence with these new cash flows, we anticipate
increasing our investment in bankrupt accounts.
intimate knowledge of the bankruptcy laws,
We put considerable effort into expanding our
courts and trustees. This is particularly important
reach into buying healthcare receivables during
in managing cases that get dismissed from bank-
2005, including the hiring of a former Chief
ruptcy proceedings, which depending on the age
Administrative Officer of a leading healthcare pro-
of the accounts, can be a significant portion of
vider to spearhead our marketing efforts. As a
6
E X E C U T I O N
E X E C U T I O N
The Manner, Style, or Result
of Performance.
Execution as defined by PRA
is performing the myriad tasks
each minute, hour, day, week
and month required to generate
superior results for our
shareholders.
7
I N T E G R I T Y
I N T E G R I T Y
Steadfast Adherence to a Strict
Moral or Ethical Code.
Integrity at PRA is doing the
right thing, all the time, and at
every level of the Company,
whether the interaction is with
a customer, shareholder, client,
vendor, fellow employee, or
other member of the commu-
nity. Integrity has to start at the
top and permeate every level
of the organization.
8
Owned Portfolio Collections—Bill O’Daire and his team do the heavy lifting for our debt buying
business, running all of our collection call centers. Bill’s team hires, trains, and manages our most
important employees, the collectors, who are responsible for all customer interactions and who
directly generate most of our cash collections.
result, we were beginning to see the start of rea-
of liquidation. During 2005 we were able to make
sonable deal flow by year end. We see this traction
continued progress on our base productivity mea-
continuing into the early part of 2006, and as a
sure, dollars recovered per hour paid, improving
result foresee the day when healthcare purchas-
that statistic from $117.59 in 2004 to $133.39 in
ing will be a more significant part of our business.
2005, an increase of 13.4%. The following chart
We believe that PRA has much to offer owners of
healthcare receivables as we bring our reputation,
shows our progress in growing productivity over
the past four years.
compliant collection process, financial wherewithal,
and our “no resale” approach to bear in providing
cash for debt holders.
Productivity
Significant buying is great, but charged off accounts
do not liquidate themselves. It takes high quality
work and plenty of it. Portfolio scoring and seg-
mentation, specialized collection techniques mov-
ing the right accounts at the right time into the
right collection method, and well trained, tenured
collectors all help drive the pace and magnitude
Staffing levels became less than optimal during
Q3 as we were not completely prepared for the
Owned Portfolio Cash Collection Per Hour Paid
(collection per hour paid in dollars)
$133.39
150
120
90
60
30
1998
1999
2000
2001
2002
2003
2004
2005
a98
a99
a00
a01
a02
a03
a04
a05
150
120
90
60
30
9
increase in turnover we experienced. Although
year over year, as one examines the relationship
turnover and new hiring are two items we watch
between purchase price and dollars collected.
real time (I receive an e-mail concerning each
employee terminated anywhere in the company,
describing why the termination occurred), a com-
bination of recruiting issues, new class timing
logistics and misread turnover trends caused
us to miss the obvious. We scrambled through
the latter parts of Q3 and into Q4 to rectify the
problem, which by year end was well in hand.
Throughout, the retention of our more tenured
people was steady, with the issue revolving
around newer hires. This incident serves as one
more reminder to the PRA team that we are in
a very people driven business and that constant
operational vigilance is a requirement for success.
Owned Portfolio Performance
At the heart of our portfolio purchasing and perfor-
mance measurement is static pool analysis: the
process of measuring the performance of each
individual pool, or group of pools, in order to deter-
mine performance relative to time, purchase price,
and original expectations. We measure each pool
we purchase (at year end more than 650 of them)
at least once per month, offering aggregated sta-
tistics to the investment community each quarter,
disclosing dollars collected during each period bro-
ken down by the year in which they were originally
acquired. The first year’s collections (collections
occurring in the year in which the pool was pur-
chased) are difficult to compare to other years due
to the great variability of purchase timing within a
year, while the first full year of collections and sub-
sequent results offer a much better comparison,
The introduction of our bankruptcy acquisition
strategy in 2004 began to blur what historically has
been fairly homogenous collection data. Although
our charged off account buying includes many
different types of accounts with widely varying
ages and quality, we find that when taken as a
blend with other purchases, liquidation results
tend to behave with a reasonable degree of con-
sistency. Therefore, year two collections from our
2003 acquisitions in relation to purchase price
may be compared to year two collections from
2002, 2001 or any other prior year in order to
examine our collection efficiency.
Purchased bankrupt pools, however, have dramati-
cally different collection attributes which disrupt
the usual relationships. PRA always seeks to
purchase accounts that will meet or exceed a
targeted internal rate of return. This IRR is our
driving pricing metric, not multiple of purchase
price, absolute rate paid, or any other measure-
ment. Therefore, maintaining a steady IRR causes
the percentage of purchase price (or multiple of
purchase price) collected to change dramatically
when accounts with widely varying collection
attributes are compared. For example, when
the purchased bankrupt pool liquidation results
are included in our quarterly statistics, overall
performance of the normal charged off pools
would appear to be depressed.
In order to provide more clarity, the following two
tables were included in our 10-K which break out
10
H A R D W O R K
H A R D W O R K
Demanding Considerable
Effort or Skill.
At PRA hard work is part of our
fabric and it always has been.
No amount of great technology,
smart people, or clever strategy
can eliminate the need for hard
work to drive our results in an
optimal manner.
11
D I S C I P L I N E
D I S C I P L I N E
Control Obtained by Enforcing
Compliance or Order.
Discipline is essential across our
business. Discipline to invest
or accept client work only when
appropriate returns can be made.
Discipline to always think long
term and never compromise
even a single account claim for
sake of short term results if it
disadvantages the company in
the long run. Discipline to always
be compliant, even if doing so
does not maximize collection
results. Discipline has kept us
growing and healthy for the past
ten years and will be a corner-
stone for our future activities.
12
the impact of the bankrupt pools by showing
competitors. For that reason, we will refresh this
results for just bankrupt and non-bankrupt pools
data only in our annual report and 10-K. We will,
separately. For the time being we feel that dis-
however, continue to produce the cash collections
closing this data quarterly will disadvantage
table for our entire portfolio each quarter as we
our shareholders as we show too much data to
have historically.
Cash Collections by Year, by Year of Purchase—Purchased Bankruptcy only Portfolio ($ in thousands)
Purchase
Period
Purchase
Price
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Total
Cash Collection Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
$ — $ — $ — $ — $ — $ — $ — $ — $ — $ — $ — $ —
— $ —
— $ —
— $ —
— $ —
— $ —
— $ —
— $ —
$ 5,297
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
743
—
—
—
—
—
—
—
—
7,499
30,544
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
—
4,554
3,777 $ 3,777
Total
$ 38,043
$ — $ — $ — $ — $ — $ — $ — $ — $
743
$ 8,331
$ 9,074
Cash Collections by Year, by Year of Purchase—Entire Portfolio Less Purchased Bankruptcy Portfolio ($ in thousands)
Purchase
Period
Purchase
Price
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Total
Cash Collection Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
$ 3,080
7,685
11,089
18,898
25,015
33,468
42,279
61,475
52,338
116,147 —
$ 548
—
—
—
—
—
—
—
—
$ 2,484
2,507
—
—
—
—
—
—
—
—
$ 1,890
5,215
3,776
—
—
—
—
—
—
—
$ 1,348
4,069
6,807
5,138
—
—
—
—
—
—
$ 1,025
3,347
6,398
13,069
6,894
$
$ 730
2,630
5,152
12,090
19,498
— 13,048
—
—
—
—
$ 496
1,829
3,948
9,598
19,478
28,831
— 15,073
—
—
—
398
1,324
2,797
7,336
16,628
28,003
36,258
— 24,308
—
—
—
—
$
285
1,022
2,200
5,615
14,098
26,717
35,742
49,706
17,276
—
$
210
860
1,811
4,352
10,924
22,639
32,497
52,640
41,921
15,191 $ 15,191
$ 9,414
$ 22,803
$ 32,889
$ 57,198
$ 87,520
$ 119,238
$ 119,570
$ 126,654
$ 59,197
Total
$ 371,524 $ 548 $ 4,991 $ 10,881 $ 17,362 $ 30,733 $ 53,148 $ 79,253 $ 117,052 $ 152,661
$ 183,045 $ 649,674
Revenue Recognition
net finance receivable (remaining unamortized
Our amortization, or the amount of our cash col-
purchase price) that we carry on our balance
lections applied to principal, links our balance
sheet. Over the life of any pool, its amortization
sheet and income statement. As we drive collec-
rate will be the inverse of its ratio of collections to
tion results, our accounting models split that cash
purchase price. Thus, a pool that collects three
into two components. The first component is
times its purchase price over its life will have a
“Income on Finance Receivables” which can be
lifetime 33% amortization rate, while a two times
seen on the face of our income statement. The
second component is “Amortization.” Amortization
deal will have a 50% amortization rate. Historically
we have tended to collect more cash from pools
is the portion of cash collections that reduces the
than we originally estimated, causing numerous
13
pools to have no remaining net finance receivable
Fee for Service Businesses
before the end of their economic life. When a
pool has no cost basis or net finance receivable
The year started off great for our asset location
and skip tracing business, IGS. We were building
remaining on the balance sheet, it is said to be
out a new state-of-the-art call center, working on
fully amortized, and all future cash collections
marketing plans, and completing a new technol-
from the pool will be recognized 100% as reve-
ogy platform when in April a large client changed
nue. It is our stated accounting goal to accurately
strategy and dramatically reduced placements to
match amortization with cash collections, in a per-
us. We were well aware of the large client con-
fect world creating a situation where the last dol-
centration issues at IGS when we bought the
lar of cash collections goes to amortize the final
company in fall 2004 and we were already work-
remaining net finance receivable outstanding from
ing on more aggressively marketing the compa-
that pool. Collections from fully amortized pools
ny’s services. Our plan was to begin diversifying
have the effect of making our stated amortization
our client base in 2005 by bringing on multiple
rate lower than it effectively is, so we also dis-
new clients, which is something that had not
cuss “core amortization,” that is the rate of amor-
been done at IGS in years due to capacity issues.
tization against the non-zero basis portfolios
Unfortunately, our timing was not what we had
during a given period.
During 2005, as a result of a new accounting
hoped for, and after April we found ourselves with
reduced placement levels and declining revenue.
rule (SOP 03-3), we began aggregating all similar
The IGS management team reacted magnificently,
pools purchased in a single quarter. Over time the
and despite the fact that the drop in revenue
effect of this change should be to enable us to be
caused them to personally forego a $2,000,000
more accurate in our collection curves and thus,
contingent purchase payment, they remained
our amortization. This would cause the instance
focused, motivated and effective. Working with
of early amortization and hence zero basis pools
to decline, and therefore should have downward
marketing staff at both PRA (portfolio acquisitions)
and Anchor, IGS was able to sign client after client,
pressure on amortization rates (all other variables
including a number that are existing PRA and/or
remaining unchanged) as core amortization and
Anchor customers. The slide in revenue bottomed
stated amortization rates converge. The following
in June and then slowly but surely made sequential
chart shows our core and stated amortization
rates for the past two years.
Amortization Rates
monthly progress in each month for the remainder
of 2005. Although IGS December revenue was
double that of June, it was still well below the
levels with which we began the year. Our mission
40
35
25
15
5
for 2006 is to continue aggressively marketing to
30
new clients, provide best in class results to exist-
30
ing clients, and grow revenue back to, and then
20
20
beyond, the levels of early 2005. We continue to
10
10
0
be big believers in the management team, busi-
ness model and future of IGS.
0
40
35
25
15
5
40%
30%
20%
10%
0%
Q1
’04
Q2
’04
Q3
’04
Q4
’04
Q1
’05
Q2
’05
Q3
’05
Q4
’05
Core Amortization Rate
Gross Amortization Rate
14
During 2005, growth was slower than desired at
the performance of the RDS team thus far and
our collection agency, Anchor Receivables
believe this is a business that can be grown very
Management. Although we were a top performer
successfully over time.
for many clients and gained market share and
new product placements, in a number of instances
we had to contend with lost business as a result
of client mergers. In other cases our relative per-
formance was not as strong as it could have
been, causing a loss of some business share. The
result was a steady, but modestly growing busi-
ness. We responded by realigning our manage-
ment team, upgrading our staff, increasing our
marketing personnel and efforts, and altering our
hiring practices. The results began to show in Q4,
with increased levels of placements and substan-
tially stronger revenue growth rates, which have
continued into the new year. We look forward to a
strong year of growth from Anchor in 2006.
Let me close with a comment on the nature of
our business. We acknowledge we are not pro-
ducing any break-through cures for major dis-
eases, nor are we directly affecting world peace
or ending hunger (although the company and our
employees do support these ideals by giving gen-
erously to a variety of charities). Rather, in an
economy driven by the consumer, in which con-
sumer credit in all its forms plays an enormous
role in our nation, we are helping to minimize bor-
rowing costs and the charges consumers incur for
many services by assisting lenders and service
providers in the recovery of their loans and bills.
While our mission may not be popular with some,
it is vital in keeping our economy healthy. I am
In August we made our second acquisition as a
extremely proud of all our employees who take
public company and purchased the assets of
their profession very seriously, working diligently
RDS/Alatax, a Birmingham, Alabama based firm
and compassionately with consumers, many of
that performs revenue administration, audit, col-
whom are in severe financial distress, to arrive at
lection and other services for governments. The
appropriate arrangements on their delinquent
majority shareholders of this firm were absentee
owners who wanted to exit. The management
accounts. Perhaps surprising to some, in many
instances these great employees make the deci-
team owned a minority position and wanted to
sion that the right thing to do is not pursue further
stay and grow the firm. This acquisition gives us a
collection efforts. PRA will continue to set the
solid presence in an entirely new market for us,
right course in a tough industry, proving that old
government collections, which we feel offers tre-
mendous opportunity. Our immediate plans for
fashioned values of execution, integrity, hard
work, and discipline help drive ethical and suc-
2006 include moving the company into a new,
cessful customer interactions and exceptional
larger, state-of-the-art collection and processing
performance for shareholders.
center, which will help support client expansion
and future growth. We are integrating consumer
collection processes performed for governments
into Anchor to capitalize on our expertise in that
segment. We are also aggressively marketing
Steve Fredrickson
RDS’ other services. We have been pleased with
Chairman, President & Chief Executive Officer
15
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
Certain 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, regarding earn-
ings, financial results, the outlook for the economy, management’s intentions, beliefs and expectations, growth opportunities,
business prospects, projections, plans or predictions of the future, and other similar matters, 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 assumptions, uncertainties and risks, 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, many
of which are beyond our control, which could affect our operations, performance, business strategy and results, and could cause
our experience to differ materially from the expectations and objectives expressed in any forward-looking statements. These
factors include, but are not limited to, the factors, risks and uncertainties that are described from time to time in the company’s
filings with the Securities and Exchange Commission, including but not limited to, its annual reports on Form 10-K, its quarterly
reports on Form 10-Q and its Current Reports on Form 8-K, which contain more detailed discussions of the company’s business,
including risks and uncertainties that may affect our future.
Due to such uncertainties and risks, readers are cautioned not to place undue reliance on any forward-looking statements, which
speak only as of the dates on which they are made. The content of this Annual Report includes time-sensitive information, and
is accurate as of the date hereof, April 14, 2006, which is the approximate date of the mailing of this Annual Report. The
company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking
statements contained herein, any changes in the company’s expectations with regard thereto, or the impact of circumstances,
events or conditions that may arise after the dates such statements are made. The reader should, however, consult any further
disclosures we may make in future Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q and Current Reports on
Form 8-K, which we may file after the date hereof.
16
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, 2005
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 if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the
Securities Act. YES (cid:133) NO (cid:59)
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15 (d)
of the Act.
YES (cid:133) NO (cid:59)
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
YES (cid:59) NO (cid:133)
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. ___
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-
accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange
Act. Large accelerated filer Accelerated filer X Non-accelerated filer _____
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange
Act).
YES (cid:133) NO (cid:59)
The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2005
was $630,758,858 based on the $42.02 closing price as reported on the NASDAQ Stock Market.
The number of shares of the registrant’s Common Stock outstanding as of February 14, 2006 was
15,870,443.
1
Documents incorporated by reference: Portions of the Proxy Statement to be filed by April 30, 2006 for our
2006 Annual Meeting of Stockholders are incorporated by reference into Items 11, 12 and 13 of Part III of this
Form 10-K.
2
Table of Contents
Part I
Item 1. Business
Item 1A. Risk Factors
Item 1B. Unresolved Staff Comments
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
Selected Financial Data
Item 6.
Item 7. Management’s Discussion and Analysis of Financial Condition and Results
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. 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 and
Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions
Item 14. Principal Accountant Fees and Services
Part IV
Item 15. Exhibits and Financial Statement Schedules
Signatures
Exhibit List
4
17
23
23
24
24
24
26
29
44
45
70
70
70
71
74
74
74
74
76
78
3
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;
changes in bankruptcy laws that could negatively affect our business;
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 future 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 IGS and Alatax/RDS businesses (we refer to these businesses in
this document as “IGS” and “RDS”, respectively) into our business operations;
our ability to secure sufficient levels of placements for our fee-for-service businesses;
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.
You should assume that the information appearing in this annual report is accurate only as of the date it was
issued. Our business, financial condition, results of operations and prospects may have changed since that date.
For a discussion of the risks, uncertainties and assumptions that could affect our future events,
developments or results, you should carefully review the “ Risk Factors” described beginning on page 17, as well
as “Business” beginning on page 4 and “Management’s Discussion and Analysis of Financial Condition and
Results of Operations” beginning on page 29.
Our forward-looking statements could be wrong in light of these and other risks, uncertainties and
assumptions. The future events, developments or results described in this report could turn out to be materially
different. We have no obligation to publicly update or revise our forward-looking statements after the date of this
annual report and you should not expect us to do so.
4
Investors should also be aware that while we do, from time to time, communicate with securities analysts
and others, we do not, by policy, selectively disclose to them any material nonpublic information or other
confidential commercial information. Accordingly, stockholders should not assume that we agree with any
statement or report issued by any analyst regardless of the content of the statement or report. We do not, by
policy, confirm forecasts or projections issued by others. Thus, to the extent that reports issued by securities
analysts contain any projections, forecasts or opinions, such reports are not our responsibility.
Item 1. Business.
General
PART I
We are a full-service provider of outsourced receivables management and related services. Our primary
business is the purchase, collection and management of portfolios of defaulted consumer receivables. These are
the unpaid obligations of individuals to credit originators, which include banks, credit unions, consumer and auto
finance companies and retail merchants. We also provide a broad range of collection services, including
collateral-location services for credit originators via IGS, fee-based collections through Anchor Receivables
Management and revenue administration, audit and debt discovery/recovery services for government entities
through RDS which we commenced after our acquisition of the assets of Alatax, Inc. in July 2005. 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. 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 collections on our
owned portfolios together with commission income and sales of finance receivables. “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.
We specialize in receivables that have been charged-off by the credit originator. Because 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, 2005, we acquired 658 portfolios with a face value of $16.4 billion for $415.4 million,
representing more than 7.8 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. Since inception, we have been able to collect at an average rate of 2.5 to
3.0 times our purchase price for defaulted consumer receivables portfolios, as measured over a five to ten 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 $191.4 million in 2005. Total revenue has grown from $6.8 million in 1998 to $148.5 million
in 2005, a compound annual growth rate of 55%. Similarly, pro forma net income has grown from $402,000 in
1998 to net income of $36.8 million in 2005.
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
5
HSBC. In connection with our 2002 initial public offering (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.
The Company maintains an Internet website at the following address: www.portfoliorecovery.com.
We make available on or through our website certain reports that we file with or furnish to the Securities and
Exchange Commission (the “SEC”) in accordance with the Securities Exchange Act of 1934. These include our
annual reports on Form 10-K, our quarterly reports on Form 10-Q and our current reports on Form 8-K. We
make this information available on our website free of charge as soon as reasonably practicable after we
electronically file the information with or furnish it to the SEC.
Reports filed with or furnished to the SEC are also available free of charge upon request by contacting our
corporate office at:
Portfolio Recovery Associates
Attn: Investor Relations
120 Corporate Boulevard, Suite 100
Norfolk, Virginia 23502
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 July 29, 2005 acquisition of the RDS business from Alatax, Inc.
further broadened the services we can offer to debt owners and local governments.
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. Since inception, we have been able to collect at an average rate
of 2.5 to 3.0 times our purchase price for defaulted consumer receivables portfolios, as measured over a five to
ten 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, which we may supplement with on-site due diligence and data obtained from 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, 2005 we have acquired 658 portfolios with a face
value of $16.4 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
6
to a large pool of eligible personnel. The Hutchinson, Kansas, Las Vegas, Nevada and Birmingham, Alabama
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 our IPO, and many tenured collectors were awarded nonvested shares in 2004 and 2005.
Most RDS employees were awarded nonvested shares at the time of our purchase of the assets of Alatax, Inc. in
July 2005. 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, we believe that our
technology infrastructure is flexible, secure, reliable and redundant, to ensure the protection of our sensitive data
and to mitigate 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 on a regular basis 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 debt buyer which has a reputation for violating
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 legally compliant manner. We believe our strong
relationships with major credit 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 original management team has been
expanded to include a group of experienced, seasoned executives.
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
7
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, medical groups/hospitals, 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, 2005 into the major
asset types represented.
Asset Type
No. of
Accounts
%
Life to Date Purchased
Face Value of Defaulted
Consumer Receivables (1)
Visa/MasterCard/Discover
Consumer Finance
Private Label Credit Cards
Auto Deficiency
3,606,331
2,733,259
1,298,856
202,879
46.0%
34.8%
16.6%
$ 10,961,264,456
2,310,736,704
1,944,892,888
2.6%
1,213,989,712
%
66.7%
14.1%
11.8%
7.4%
Total:
7,841,325
100.0%
$
16,430,883,760
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 95 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
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 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 360 to 450 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 540 days past due and charged-off, have been placed with two or three contingent fee
servicers and receive even lower purchase prices.
8
As shown in the following chart, as of December 31, 2005, a majority of our accounts consist of 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)
Fresh
Primary
Secondary
Tertiary
Other
201,476
2.6% $ 645,897,478
1,060,140
13.5% 2,574,683,359
1,903,013
24.3% 3,767,365,777
2,830,613
36.1% 3,398,968,101
1,846,083
23.5% 6,043,969,045
%
3.9%
15.7%
22.9%
20.7%
36.8%
Total:
7,841,325
100.0%
$
16,430,883,760
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.
The following chart sets forth our overall life to date portfolio of defaulted consumer receivables
geographically as of December 31, 2005:
Geographic Distribution
Texas
California
Florida
New York
Pennsylvania
Illinois
North Carolina
Ohio
New Jersey
Georgia
Michigan
Massachusetts
Missouri
South Carolina
Virginia
Tennessee
Other (3)
No. of
Accounts
1,824,480
729,403
527,952
357,352
207,952
254,379
210,004
246,384
144,706
181,201
213,786
163,180
266,847
139,047
132,898
120,160
2,121,594
Life to Date Face Value of
Defaulted Consumer
Receivables (1)
%
23% $ 2,239,805,865
9% 1,958,304,012
7% 1,610,390,119
5% 1,114,648,841
3% 591,440,322
3% 536,690,148
3% 535,913,460
3% 532,263,050
2% 458,675,351
2% 456,479,315
3% 407,756,561
2% 382,012,802
3% 318,247,272
2% 315,076,097
2% 308,152,334
2% 302,951,506
26% 4,362,076,705
Original Purchase Price of
Defaulted Consumer
Receivables (2)
%
14% $ 51,700,454
12% 45,638,872
10% 39,112,004
7% 29,923,504
4% 16,742,650
3% 14,340,056
3% 13,852,200
3% 13,878,303
3% 13,207,879
3% 13,437,704
2% 11,635,901
2% 9,048,146
2% 7,676,758
2% 7,646,275
2% 8,752,976
2% 8,518,550
26% 110,301,485
%
12%
11%
9%
7%
4%
3%
3%
3%
3%
3%
3%
2%
2%
2%
2%
2%
29%
Total:
7,841,325
100%
$
16,430,883,760
100%
$
415,413,717
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 The “Original Purchase Price” represents the cash paid to sellers to acquire portfolios of defaulted consumer
receivables
(3 Each state included in "Other" represents under 2% of the face value of total defaulted consumer receivables.
9
Purchasing Process
We acquire portfolios from debt owners through auctions and negotiated sales. In an auction process, the
seller will assemble a portfolio of receivables and will either broadly offer the portfolio to the market or 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 our 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.
In order to determine a purchase price for a portfolio, we use two separate internally developed computer
models, which we may supplement 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 as a whole 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
aforementioned 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 ten 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 about the portfolio or the debt
owner of which management may be aware. 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
10
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, Chief Executive Officer and President, Kevin
Stevenson, Chief Financial and Administrative Officer 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 another 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. 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 which enables us to make monthly withdrawals from a
consumer's bank account, in accordance with the directions of the customer.
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, or verifying the accuracy of such
information. 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.
11
Our legal recovery department oversees our internal legal collections 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 flat fee or contingent fee basis. Legal cash collections currently constitute approximately 33% 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 and continuing into
2005, we began using internal 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 legal recovery
department also collects claims against estates in cases involving deceased debtors having assets at the time of
death.
Our bankruptcy department processes proofs of claims for recovery on receivables which are included in
consumer bankruptcies filed under Chapter 13 of the U.S. Bankruptcy Code. The Bankruptcy Act establishes
income criteria for the filing of a Chapter 7 bankruptcy petition, which may force more debtors to file bankruptcy
petitions under Chapter 13, rather than Chapter 7 of the U.S. Bankruptcy Code. Consequently, fewer debtors may
be able to have their obligations completely discharged in Chapter 7 bankruptcy actions, and might instead resort
to filing bankruptcy petitions under Chapter 13, which requires that the debtor establish a payment plan. If this
scenario occurs it would 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 Businesses
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
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.
Revenues from IGS are accounted for as commission revenue. IGS performs skip tracing services,
principally for auto finance companies, for a fee. The amount of fee earned is generally dependent on several
different outcomes: whether the debtor was found, if the collateral was repossessed or if payment was made by
the debtor to the debt owner. 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.
RDS computes revenue using both of the aforementioned approaches. RDS collects delinquent taxes and
earns a contingent fee. This fee can vary based on the age of the debt being collected. RDS also processes tax
payments for taxing authorities. For this work, they are paid a per transaction fee. RDS also performs tax audit
services, for which they are paid at an hourly rate. RDS provides local, state and federal governments a range of
revenue enhancement services including revenue administration, revenue discovery and recovery, aged
receivables management and compliance auditing.
12
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
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. Our proprietary hardware and
software systems are being leveraged to manage location information, phone and operational applications for
IGS and RDS. 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 and Software 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
13
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. RDS, our newly acquired business unit,
maintains a unique, proprietary software system that manages the movement of data, accounts and information
throughout the unit. We believe this system will be sufficient for our needs in the foreseeable future. Our
contingent fee collections operations database incorporates an integrated and proprietary predictive dialing
platform used with our predictive dialer discussed below.
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, all of which 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 facilities which currently
house IGS and RDS feature 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 and RDS at a
later time.
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. During the first quarter of 2006, we are replacing our Noble dialer with a more
powerful predictive dialer from Avaya.
Employees
We employed 1,110 persons on a full-time basis, including the following number of front line operations
employees by business: 809 on our owned portfolios, 92 working in our contingent fee collections operations, 45
working in our IGS operations and 28 working in our RDS government collections operations, as of December
31, 2005. 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
14
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 achieve an annual post-training turnover rate of 52% in 2005.
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,
Hutchinson, Kansas and Birmingham, Alabama 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
15
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 internal legal collections
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, most of which work on a contingent fee basis. Legal cash
collections currently constitute approximately 33% 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 and continuing into 2005, we began using internal 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 processes proofs of claims for recovery on accounts which are included in
consumer bankruptcies filed under Chapter 13 of the U.S. Bankruptcy Code. The passage of the Bankruptcy Act
could have an impact upon our operations, because it establishes income criteria for the filing of a Chapter 7
bankruptcy petition. This is may cause more debtors to file bankruptcy petitions under Chapter 13, rather than
Chapter 7 of the U.S. Bankruptcy Code. Consequently, fewer debtors may be able to have their obligations
completely discharged in Chapter 7 bankruptcy actions, and may instead resort to filing bankruptcy petitions
under Chapter 13, which requires that the debtor establish a payment plan. If this scenario occurs, it would
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 works with our
Internal Auditor and the Audit Committee of our Board of Directors in the implementation of our Ethics Policy.
In that connection, we have established a confidential telephone hotline to report suspected policy violations,
fraud, embezzlement, deception in record keeping and reporting, accounting, auditing matters and other acts
which are inappropriate, criminal and/or unethical. Our Ethics Policy is available at the Investors Relations page
of our website. 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
16
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
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
17
healthcare receivables, must comply with certain privacy standards established by HIPAA to ensure that the
information provided will be safeguarded from misuse.
• 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.
Item 1A. Risk Factors.
To the extent not described elsewhere in this Annual Report, the following are risks related to our business.
18
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 primarily 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 52% in 2005. 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.
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
19
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,
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, 2004 we acquired substantially all of the assets of IGS Nevada, Inc. 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.
20
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
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.
21
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 and
administrative 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 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 and administrative officer, respectively, it would
constitute a default. 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
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, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the "Bankruptcy Act") is
expected to temporarily disrupt our historical bankruptcy collection curves, making it more difficult to
accurately price bankrupt accounts created after October 17, 2005, the effective date of the Bankruptcy Act.
Further, 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.
22
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. The Bankruptcy Act
may affect the process in which the various bankruptcy courts administer bankruptcy plans as well as our ability
to recover on bankrupt consumer receivables.
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 American Institute of Certified
Public Accountants Statement of Position 03-3
In October 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of
Position (“SOP”) 03-3, “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-
3, 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.
We incur increased costs as a result of enacted and proposed changes in laws and regulations
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 implement their requirements. These rules have made it more
difficult or more costly for us to obtain certain types of insurance, including director and officer liability
insurance, and we have been 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
23
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
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.
24
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.
Item 1B. Unresolved Staff Comments
None.
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 a
recently expanded approximately 20,000 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 160 employees. 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. We also
lease a facility located in approximately 21,000 square feet of space in Hampton, Virginia which can
accommodate approximately 285 employees.
In January 2005, we signed a new lease for a 13,500 square foot call center in Las Vegas, Nevada and
moved from the existing 5,000 square foot facility into the new facility in the second quarter of 2005.
In connection with the purchase of Alatax, Inc. and the commencement of our RDS business, we assumed
existing leases for 5,600 square feet of office space in Birmingham, Alabama and approximately 400 square feet
of space in Montgomery, Alabama.
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.
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.
PART II
25
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.
2004
Quarter ended March 31, 2004
Quarter ended June 30, 2004
Quarter ended September 30, 2004
Quarter ended December 31, 2004
2005
Quarter ended March 31, 2005
Quarter ended June 30, 2005
Quarter ended September 30, 2005
Quarter ended December 31, 2005
High
$28.63
$29.53
$30.05
$41.80
$41.85
$42.15
$44.30
$48.03
Low
$23.89
$24.06
$25.16
$29.10
$33.66
$32.33
$39.33
$35.45
As of February 14, 2006, there were 24 holders of record of the Common Stock. Based on information
provided by our transfer agent and registrar, we believe that there are 18,996 beneficial owners of the Common
Stock.
26
Equity Incentives
The table below provides information with respect to securities authorized for issuance under our equity
compensation plans as of December 31, 2005:
Number of Securities
Authorized for
Issuance Under the
Plan
Number of Securities to be Issued
Upon Exercise of Outstanding
Options, Warrants, and Rights or
Upon Vesting of Nonvested Shares
Under the Plan
Weighted-average
Exercise Price of
Outstanding Options,
Warrants and Rights (1)
Number of Securities
Remaining Available for
Future Issuance Under
Equity Compensation
Plans (2)
2,000,000
None
643,596
None
$11.88
N/A
1,095,320
None
Plan Category
Equity Compensation plans
approved by security holders
Equity Compensation plans not
approved by security holders
Total
(1) Includes grants of nonvested shares, for which there is no exercise price, but with respect to which
2,000,000
643,596
$11.88
1,095,320
shares are awarded without cost when the restrictions have been realized. Excluding the impact of the
nonvested shares, the weighted average exercise price of outstanding options, warrants and rights is
$15.04.
(2) Excludes 261,084 exercised options and vested shares, which are not available for re-issuance.
Dividend Policy
Our board of directors sets our dividend policy. We do not currently 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.
27
Item 6. Selected Financial Data.
The following selected financial data should be read in conjunction with the audited financial statements.
2005
2004
2003
2002
2001
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
$
134,674
13,851
-
148,525
$
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
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 income/(expenses)
Income before income taxes
Provision for income taxes
Net income (1)
Pro forma income taxes(2)
Pro forma net income(2)
Net income per share
Basic
Diluted
Pro forma net income per share(3)
Basic
Diluted
Weighted average shares (3)
Basic
Diluted
44,332
29,965
4,424
2,101
3,424
4,679
88,925
59,600
-
331
59,931
23,159
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
$
36,772
$
27,451
$
20,714
$
$
2.35
2.28
$
$
1.79
1.73
$
$
1.42
1.32
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
$
11,371
$
3,526
$
$
1.08
0.94
$
$
0.35
0.31
15,642
16,149
15,357
15,853
14,546
15,712
10,529
12,066
10,000
11,458
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)
88%
_________________________________________________
$
205,226
43%
149,645
5,307,918
$
$
1,110
$
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
$
$
948
89%
798
90%
581
88%
501
90%
(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.
We believe that pro forma net income for periods prior to 2003 may be compared to net income for periods
subsequent to 2002.
(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.
(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.
28
(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
Finance receivables, net
Total assets
Long-term debt
Total debt, including obligations under capital lease and revolving lines of credit
Total stockholders' equity
2005
2004
As of December 31,
2003
2002
2001
$
15,985
-
193,645
247,772
1,152
16,535
195,322
$
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
Below is listed the quarterly income statements for the years ended December 31, 2005 and 2004:
(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,
2005
Sept. 30,
2005
June 30,
2005
For the Quarter Ended
Mar. 31,
Dec. 31,
2004
2005
Sept. 30,
2004
June 30,
2004
Mar. 31,
2004
$
34,614
4,712
39,326
$
33,987
3,518
37,505
$
33,823
2,093
35,916
$
32,249
3,529
35,778
$
28,387
3,315
31,702
$
27,070
1,216
28,286
$
26,890
1,254
28,144
$
23,908
1,357
25,265
11,841
7,811
1,211
558
1,108
1,410
23,939
15,387
41
15,428
5,980
11,216
7,417
1,116
555
834
1,288
22,426
15,079
129
15,208
5,866
10,415
7,575
1,040
512
729
1,039
21,310
14,606
129
14,735
5,673
10,861
7,162
1,058
476
753
940
21,250
14,528
32
14,560
5,640
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
$
9,448
$
9,342
$
9,062
$
8,920
$
7,715
$
6,975
$
6,750
$
6,011
$
$
0.60
0.58
$
$
0.60
0.58
$
$
0.58
0.56
$
$
0.57
0.55
$
$
0.50
0.48
$
$
0.45
0.44
$
$
0.44
0.43
$
$
0.39
0.38
15,745
16,196
15,692
16,173
15,599
16,074
15,532
16,152
15,462
16,030
15,342
15,832
15,322
15,776
15,304
15,774
29
Below is listed the quarterly balance sheet for the years ended December 31, 2005 and 2004:
Dec. 31,
2005
Sept. 30,
2005
June 30,
2005
Mar. 31,
2005
Dec. 31,
2004
Sept. 30,
2004
June 30,
2004
Mar. 31,
2004
Quarter Ended
(Dollars in thousands)
BALANCE SHEET DATA:
Assets
Cash and cash equivalents
Investments
Finance receivables, net
Property and equipment, net
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
Revolving lines of credit
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
$
$
$
$
$
$
$
$
15,985
-
193,645
7,186
-
18,287
9,023
3,646
247,772
67,398
-
117,246
7,432
-
18,288
9,777
1,688
221,829
68,515
-
114,838
6,755
-
6,397
5,429
1,689
203,623
61,093
-
107,344
6,057
-
6,397
5,874
2,717
189,482
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
$
$
$
$
$
$
$
$
$
2,333
2,239
3,055
5,943
22,346
15,000
1,152
382
52,450
$
2,738
1,964
3,486
5,535
21,865
-
1,269
428
37,285
$
313
1,837
6,940
4,865
15,408
-
1,669
477
31,509
$
1,754
1,703
2,766
3,128
15,676
-
1,797
526
27,350
$
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
158
108,063
87,101
195,322
247,772
$
157
106,735
77,652
184,544
221,829
$
156
103,648
68,310
172,114
203,623
$
156
102,728
59,248
162,132
189,482
$
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
$
30
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, 2005, 2004 and 2003:
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
Interest income
Interest expense
Income before income taxes
Provision for income taxes
Net income
_______
2005
2004
2003
$
134,674,344
13,850,805
148,525,149
44,332,298
29,964,999
4,424,080
2,100,914
3,423,791
4,678,598
88,924,680
59,600,469
611,490
(280,503)
59,931,456
23,159,461
36,771,995
$
90.7%
9.3
100.0
29.8
20.2
3.0
1.4
2.3
3.2
59.9
40.1
0.4
(0.2)
40.4
15.6
24.8%
$
106,254,441
7,141,796
113,396,237
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
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
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%
Year Ended December 31, 2005 Compared to Year Ended December 31, 2004
Revenue
Total revenue was $148.5 million for the year ended December 31, 2005, an increase of $35.1 million or
31.0% compared to total revenue of $113.4 million for the year ended December 31, 2004.
Income Recognized on Finance Receivables
Income recognized on finance receivables was $134.7 million for the year ended December 31, 2005, an
increase of $28.4 million or 26.7% compared to income recognized on finance receivables of $106.3 million for
the year ended December 31, 2004. The majority of the increase was due to an increase in our cash collections
on our owned defaulted consumer receivables to $191.4 million from $153.4 million, an increase of 24.8%. Our
amortization rate on owned portfolios for the year ended December 31, 2005 was 29.6% while for the year ended
December 31, 2004 it was 30.7%. During the year ended December 31, 2005, we acquired defaulted consumer
receivables portfolios with an aggregate face value amount of $5.3 billion at an original purchase price of $149.6
million, of which more than 60% was purchased in the fourth quarter. During the year ended December 31,
2004, we acquired defaulted consumer receivable portfolios with an aggregate face value of $3.3 billion at an
original purchase price of $61.2 million. 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.
However, regardless of the average purchase price, we intend to target a similar internal rate of return (after
direct expenses) in pricing our portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant
to estimated profitability of a period’s buying.
Income recognized on finance receivables is shown net of valuation allowances recognized under SOP 03-
3, which requires that a valuation allowance be taken for decreases in expected cash flows. For the year ended
December 31, 2005 we booked an allowance charge of $200,000. For the year ended December 31, 2004 we
accounted for defaulted consumer receivables under Practice Bulletin 6, which allowed lowering of yields for
decreases in expected cash flows, and therefore no valuation allowances were recognized.
31
Commissions
Commissions were $13.9 million for the year ended December 31, 2005, an increase of $6.8 million or
95.8% compared to commissions of $7.1 million for the year ended December 31, 2004. Commissions increased
as a result of the additions of our IGS fee-for-service business in the fourth quarter of 2004 and our RDS
government processing and collection business in the third quarter of 2005, as well as a slight increase in revenue
generated by our Anchor contingent fee business compared to the prior year period.
Operating Expenses
Total operating expenses were $88.9 million for the year ended December 31, 2005, an increase of $20.4
million or 29.8% compared to total operating expenses of $68.5 million for the year ended December 31, 2004.
Total operating expenses, including compensation expenses, were 43.3% of cash receipts excluding sales for the
year ended December 31, 2005 compared with 42.7% for the same period in 2004.
Compensation and Employee Services
Compensation and employee services expenses were $44.3 million for the year ended December 31, 2005,
an increase of $7.7 million or 21.0% compared to compensation and employee services expenses of $36.6 million
for the year ended December 31, 2004. Compensation and employee services expenses increased as total
employees grew from 948 at December 31, 2004 to 1,110 at December 31, 2005. Additionally, existing
employees received normal salary increases. Compensation and employee services expenses as a percentage of
cash receipts excluding sales decreased to 21.6% for the year ended December 31, 2005 from 22.8% of cash
receipts excluding sales for the same period in 2004.
Outside Legal and Other Fees and Services
Outside legal and other fees and services expenses were $30.0 million for the year ended December 31,
2005, an increase of $8.6 million or 40.2% compared to outside legal and other fees and services expenses of
$21.4 million for the year ended December 31, 2004. 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
33.1% of total cash collections for the year ended December 31, 2005, up from 30.2% for the year ended
December 31, 2004. Total legal expenses for the year ended December 31, 2005 were 35.1% of legal cash
collections compared to 34.5% for the year ended December 31, 2004.
Communications
Communications expenses were $4.4 million for the year ended December 31, 2005, an increase of $786,000
or 21.8% compared to communications expenses of $3.6 million for the year ended December 31, 2004. 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 94.9% or
$746,000 of this increase, while the remaining 5.1% or $40,000 was attributable to higher phone charges.
Rent and Occupancy
Rent and occupancy expenses were $2.1 million for the year ended December 31, 2005, an increase of
$356,000 or 20.9% compared to rent and occupancy expenses of $1.7 million for the year ended December 31,
2004. The increases were mainly attributable to rent escalations at our Norfolk, Virginia location, the
commencement of our RDS business, the opening of our new IGS location which opened in April 2005 and
higher utility and other occupancy charges generally. Of the $356,000 increase in 2005, the new IGS space
accounted for $188,000 of the increase, the Norfolk rent escalations accounted for $81,000 of the increase, the
new RDS location accounted for $33,000 and utility and other occupancy charges accounted for $72,000 of the
32
increase. This was offset by a decrease of $18,000 related to the Virginia Beach, Virginia administrative space
that was vacated in January 2004 and other storage spaces.
Other Operating Expenses
Other operating expenses were $3.4 million for the year ended December 31, 2005, an increase of $712,000
or 26.3% compared to other operating expenses of $2.7 million for the year ended December 31, 2004. The
increase was due to increases in taxes, fees and, licenses, travel and meals, advertising and marketing, repairs and
maintenance, insurance expenses and other miscellaneous expenses. Taxes, fees and, licenses increased by
$184,000, travel and meals increased by $179,000, advertising and marketing increased by $111,000, repairs and
maintenance expenses increased by $42,000, insurance expenses increased by $58,000 and other expense items
increased by $138,000.
Depreciation and Amortization
Depreciation and amortization expenses were $4.7 million for the year ended December 31, 2005, an
increase of $2.3 million or 95.8% compared to depreciation and amortization expenses of $2.4 million for the
year ended December 31, 2004. The increase was attributable to the depreciation and amortization of the
acquired assets of IGS and RDS and the continued capital expenditures on equipment, software and computers
related to our growth and systems upgrades. The amortization of the IGS and RDS intangible assets accounted
for $1.8 million of the increase while the remaining increase of $0.5 million resulted from continued capital
expenditures on equipment, software and computers.
Interest Income
Interest income was $611,000 for the year ended December 31, 2005, an increase of $388,000 or 174.0%
compared to interest income of $223,000 for the year ended December 31, 2004. This increase is the result of the
investment of larger balances in higher yielding auction rate certificates and tax exempt money market accounts
in 2005 than in 2004.
Interest Expense
Interest expense was $281,000 for the year ended December 31, 2005, an increase of $8,000 or 2.9%
compared to interest expense of $273,000 for the year ended December 31, 2004. The increase is due to a higher
unused line fee under the new revolving credit arrangement offset by a decrease due to lower balances on our
long-term debt and obligations under capital leases.
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 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
33
December 31, 2004 from 2.77% of face value for the year ended December 31, 2003. 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, 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 (after direct expenses) 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 Anchor contingent fee subsidiary and fees earned by our IGS fee-for-service
business after its addition in the fourth quarter of 2004. The increase from Anchor is related to a growing
inventory of accounts.
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.
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.
34
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 $284,000 in the fourth quarter of 2003.
35
Supplemental Performance Data
Owned Portfolio Performance:
The following tables show certain data related to our owned portfolio. These tables describe the purchase
price, cash collections and related multiples. Further, these tables disclose our entire portfolio, the portfolio of
purchased bankrupt accounts only and our entire portfolio less the impact of our purchased bankrupt accounts.
The accounts represented in the purchased bankruptcy tables are those accounts that were bankrupt at the time of
purchase. This contrasts with accounts that file bankruptcy after we purchase them.
($ in thousands)
Entire Portfolio
Purchase Purchase
Price(1)
Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
$3,080
$7,685
$11,089
$18,898
$25,015
$33,468
$42,279
$61,475
$59,887
$146,691
Unamortized
Purchase Price
Balance at
December 31, 2005 (2)
Percentage
of Purchase Price
Actual Cash
Collections
Estimated
Remaining Unamortized Including Cash Remaining Total Estimated
Collections (4) Collections (5)
at December 31, 2005 (3)
Sales
Total Estimated
Collections to
Purchase Price (6)
$0
$0
$0
$66
$0
$1,718
$5,794
$17,232
$29,637
$139,198
0%
0%
0%
0%
0%
5%
14%
28%
49%
95%
$9,475
$23,294
$32,933
$57,890
$87,982
$124,728
$119,581
$126,654
$64,500
$18,968
$83
$323
$757
$2,236
$6,142
$22,753
$32,654
$64,391
$82,939
$280,646
$9,558
$23,617
$33,690
$60,126
$94,124
$147,481
$152,235
$191,045
$147,439
$299,614
310%
307%
304%
318%
376%
441%
360%
311%
246%
204%
Purchased Bankruptcy only Portfolio
Unamortized
Purchase Price
Balance at
December 31, 2005 (2)
Purchase Purchase
Price(1)
Period
Percentage
of Purchase Price
Actual Cash
Collections
Estimated
Remaining Unamortized Including Cash Remaining Total Estimated
Collections (4) Collections (5)
at December 31, 2005 (3)
Sales
Total Estimated
Collections to
Purchase Price (6)
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
$0
$0
$0
$0
$0
$0
$0
$0
$7,499
$30,544
$0
$0
$0
$0
$0
$0
$0
$0
$4,239
$27,820
0%
0%
0%
0%
0%
0%
0%
0%
57%
91%
$0
$0
$0
$0
$0
$0
$0
$0
$5,297
$3,777
$0
$0
$0
$0
$0
$0
$0
$0
$9,260
$39,453
$0
$0
$0
$0
$0
$0
$0
$0
$14,557
$43,230
0%
0%
0%
0%
0%
0%
0%
0%
194%
142%
Entire Portfolio less Purchased Bankruptcy Portfolio
Purchase Purchase
Price(1)
Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
$3,080
$7,685
$11,089
$18,898
$25,015
$33,468
$42,279
$61,475
$52,388
$116,147
Unamortized
Purchase Price
Balance at
December 31, 2005 (2)
Percentage
of Purchase Price
Actual Cash
Collections
Estimated
Remaining Unamortized Including Cash Remaining Total Estimated
Collections (4) Collections (5)
at December 31, 2005 (3)
Sales
Total Estimated
Collections to
Purchase Price (6)
$0
$0
$0
$66
$0
$1,718
$5,794
$17,232
$25,398
$111,378
0%
0%
0%
0%
0%
5%
14%
28%
48%
96%
$9,475
$23,294
$32,933
$57,890
$87,982
$124,728
$119,581
$126,654
$59,203
$15,191
$83
$323
$757
$2,236
$6,142
$22,753
$32,654
$64,391
$73,679
$241,193
$9,558
$23,617
$33,690
$60,126
$94,124
$147,481
$152,235
$191,045
$132,882
$256,384
310%
307%
304%
318%
376%
441%
360%
311%
254%
221%
(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
36
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) Unamortized purchase price balance refers to the purchase price less amortization over the life of the
portfolio.
(3) Percentage of purchase price remaining unamortized refers to the amount of unamortized purchase price
divided by the purchase price.
(4) Estimated remaining collections refers to the sum of all future projected cash collections on our owned
portfolios.
(5) Total estimated collections refers to the actual cash collections, including cash sales, plus estimated
remaining collections.
(6) Total estimated collections to purchase price refers to the total estimated collections divided by the
purchase price.
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
$160,000,000
$140,000,000
$120,000,000
$100,000,000
$80,000,000
$60,000,000
$40,000,000
$20,000,000
$-
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
We utilize a long-term approach to collecting our owned portfolios of receivables. This approach has
historically caused us to realize significant cash collections and revenues from purchased portfolios of finance
receivables years after they are originally acquired. As a result, we have in the past been able to temporarily
reduce our level of current period acquisitions without a corresponding negative current period impact on cash
collections and revenue.
37
The following tables, which exclude any proceeds from cash sales of finance receivables, demonstrates our
ability to realize significant multi-year cash collection streams on our owned portfolios.
Cash Collections By Year, By Year of Purchase - Entire Portfolio
($ in thousands)
Purchase Purchase
Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Total
3,080
7,685
11,089
18,898
25,015
33,468
42,279
61,475
59,887
146,691
409,567
1996
$
548
-
-
-
-
-
-
-
-
-
$
548
Price
$
1997
1998
1999
$
$
$
Cash Collection Period
2001
$
$
2000
2002
$
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
-
-
2004
$
285
1,022
2,200
5,615
14,098
26,717
35,742
49,706
18,019
-
$
117,052
$
153,404
2005
$
210
860
1,811
4,352
10,924
22,639
32,497
52,640
46,475
18,968
191,376
Total
$
$
$
$
$
$
$
$
$
$
$
9,414
22,803
32,889
57,198
87,520
119,238
119,570
126,654
64,494
18,968
658,748
$
$
$
$
$
$
$
$
Cash Collections By Year, By Year of Purchase - Purchased Bankruptcy only Portfolio
($ in thousands)
Purchase Purchase
Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Total
Price
$
-
-
-
-
-
-
-
-
7,499
30,544
38,043
$
1996
$
-
-
-
-
-
-
-
-
-
-
$
-
1997
$
-
-
-
-
-
-
-
-
-
-
$
-
1998
$
-
-
-
-
-
-
-
-
-
-
$
-
Cash Collection Period
2001
$
-
-
-
-
-
-
-
-
-
-
$
-
2000
$
-
-
-
-
-
-
-
-
-
-
$
-
1999
$
-
-
-
-
-
-
-
-
-
-
$
-
2002
$
-
-
-
-
-
-
-
-
-
-
$
-
2003
$
-
-
-
-
-
-
-
-
-
-
$
-
2004
$
-
-
-
-
-
-
-
-
743
-
743
$
2005
$
-
-
-
-
-
-
-
-
4,554
3,777
8,331
$
Total
$
-
-
$
-
$
-
$
-
$
-
$
$
-
$
-
$
5,297
$
3,777
$
9,074
Cash Collections By Year, By Year of Purchase - Entire Portfolio less Purchased Bankruptcy Portfolio
($ in thousands)
Purchase Purchase
Period
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
Total
Price
$
$
$
$
$
$
$
$
$
$
$
3,080
7,685
11,089
18,898
25,015
33,468
42,279
61,475
52,388
116,147
371,524
1996
$
548
-
$
-
$
-
$
-
$
-
$
$
-
-
$
-
$
-
$
$
548
1997
1998
1999
2,484
$
$
2,507
-
$
-
$
-
$
-
$
$
-
-
$
-
$
$
-
$
4,991
1,890
$
5,215
$
$
3,776
$
-
$
-
-
$
$
-
$
-
$
-
$
-
$
10,881
2000
Cash Collection Period
2001
730
$
2,630
$
5,152
$
12,090
$
19,498
$
13,048
$
$
-
-
$
$
-
$
-
$
53,148
1,025
$
3,347
$
6,398
$
13,069
$
$
6,894
-
$
$
-
-
$
-
$
$
-
$
30,733
1,348
$
4,069
$
6,807
$
$
5,138
-
$
-
$
$
-
-
$
-
$
$
-
$
17,362
2002
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
$
$
17,276
$
-
$
152,661
2005
$
$
$
$
$
$
$
$
$
$
$
210
860
1,811
4,352
10,924
22,639
32,497
52,640
41,921
15,191
183,045
Total
$
$
$
$
$
$
$
$
$
$
$
9,414
22,803
32,889
57,198
87,520
119,238
119,570
126,654
59,197
15,191
649,674
38
When we acquire a new portfolio 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)
Actual Cash Collections
Original Projections
$700.0
$600.0
$500.0
$400.0
$300.0
$200.0
$100.0
$0.0
8
9
-
n
a
J
8
9
-
y
a
M
8
9
-
p
e
S
9
9
-
n
a
J
9
9
-
y
a
M
9
9
-
p
e
S
0
0
-
n
a
J
0
0
-
y
a
M
0
0
-
p
e
S
1
0
-
n
a
J
1
0
-
y
a
M
1
0
-
p
e
S
2
0
-
n
a
J
2
0
-
y
a
M
2
0
-
p
e
S
3
0
-
n
a
J
3
0
-
y
a
M
3
0
-
p
e
S
4
0
-
n
a
J
4
0
-
y
a
M
4
0
-
p
e
S
5
0
-
n
a
J
5
0
-
y
a
M
5
0
-
p
e
S
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.
Tenure at:
One year +(1)
Less than one year (2)
Total(2)
12/31/01
151
218
369
12/31/02
210
223
433
12/31/03
241
338
579
12/31/04
298
349
647
12/31/05
327
364
691
Collector by Tenure
(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)
12/31/01
$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
12/31/05
$16,694
8,491
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
Cash Collections per Hour Paid(1)
12/31/03
$108.27
$80.10
12/31/02
$96.37
$77.72
12/31/01
$77.20
$66.87
12/31/04
$117.59
$82.06
12/31/05
$133.39
$89.25
(1) Cash collections (assigned and unassigned) divided by total hours paid (including holiday, vacation and
sick time) to all collectors (including those in training).
39
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. Incom e Recognized on Finance Receivables
Payments applied to principal or "amortization of purchase price"
Income recognized on finance receivables
Cash Collections
$60.0
$50.0
$40.0
$30.0
$20.0
$10.0
$0.0
8
9
-
1
Q
8
9
-
2
Q
8
9
-
3
Q
8
9
-
4
Q
9
9
-
1
Q
9
9
-
2
Q
9
9
-
3
Q
9
9
-
4
Q
0
0
-
1
Q
0
0
-
2
Q
0
0
-
3
Q
0
0
-
4
Q
1
0
-
1
Q
1
0
-
2
Q
1
0
-
3
Q
1
0
-
4
Q
2
0
-
1
Q
2
0
-
2
Q
2
0
-
3
Q
2
0
-
4
Q
3
0
-
1
Q
3
0
-
2
Q
3
0
-
3
Q
3
0
-
4
Q
4
0
-
1
Q
4
0
-
2
Q
4
0
-
3
Q
4
0
-
4
Q
5
0
-
1
Q
5
0
-
2
Q
5
0
-
3
Q
5
0
-
4
Q
(1)
Includes cash collections on finance receivables only. Excludes commissions and cash proceeds from sales
of defaulted consumer receivables.
Seasonality
We depend on the ability to collect on our owned and serviced defaulted consumer receivables. Collections
tend to be higher in the first and second quarters of the year and lower in the third and fourth quarters of the year,
due to consumer payment patterns in connection with seasonal employment trends, income tax refunds and
holiday spending habits. Historically, our growth has partially masked the impact of this seasonality.
Quarterly Cash Collections (1)
($ in millions)
$50.0
$45.0
$40.0
$35.0
$30.0
$25.0
$20.0
$15.0
$10.0
$5.0
$-
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
5
0
-
1
Q
5
0
-
2
Q
5
0
-
3
Q
5
0
-
4
Q
(1) Includes cash collections on finance receivables only. Excludes commission fees and cash proceeds from
sales of defaulted consumer receivables.
40
The following table shows the changes in finance receivables, including the amounts paid to acquire new
portfolios.
2005
2004
2003
Balance at beginning of year
Acquisitions of finance receivables, net of buybacks(1)
Cash collections applied to principal on finance receivables(2)
$
105,188,906
$
92,568,557
$
65,526,235
145,157,090
59,770,354
62,298,316
(56,701,326)
(47,150,005)
(35,255,994)
Balance at end of year
$
193,644,670
$
105,188,906
$
92,568,557
Estimated Remaining Collections ("ERC")(3)
$
492,924,998
$
308,111,355
$
267,666,689
_________
(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, net of impairment charges.
(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.
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, corporate acquisitions, 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 $57.9 million, $49.3 million and $35.1 million for the years ended
December 31, 2005, 2004 and 2003, respectively. In these periods, cash from operations was generated
primarily from net income earned through cash collections and commissions received. Net income increased to
$36.8 million for the year ended December 31, 2005 from $27.5 million for the year ended December 31, 2004
and $20.7 million for the year ended December 31, 2003. In addition, we realized tax benefits derived from
stock option and stock warrant exercises of $2.2 million in 2005, $1.1 million in 2004 and $16.4 million in 2003.
Our investing activities used cash of $83.0 million, $50.8 million and $23.5 million for the years ended
December 31, 2005, 2004 and 2003, respectively. 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 2005, we purchased the assets of Alatax, Inc. for $15.0
million in cash including acquisition costs and in 2004, we purchased the assets of IGS Nevada, Inc. for $12.1
million in cash including acquisition costs. Cash provided by investing activities is primarily driven from sales
of auction rate certificates.
41
Our financing activities provided cash of $16.6 million, $1.1 million and $1.4 million for the years ended
December 31, 2005, 2004 and 2003, respectively. Cash provided by financing activities was generated primarily
from draws on lines of credit and proceeds from long-term debt. In addition, the exercise of stock options and
stock warrants generated cash from financing activities of $2.6 million for the year ended December 31, 2005,
$1.1 million for the year ended December 31, 2004 and $1.4 million for the year ended December 31, 2003.
Cash used by financing activities was primarily driven by payments on long-term debt and capital lease
obligations.
Cash paid for interest expense was approximately $281,000, $273,000 and $281,000 for the years ended
December 31, 2005, 2004 and 2003, respectively. The majority of interest expenses were paid on long-term debt
and capital lease obligations.
On November 29, 2005, we entered into a Loan and Security Agreement for a revolving line of credit
jointly offered by Bank of America, N. A. and Wachovia Bank, National Association. The agreement is a
revolving line of credit in an amount equal to the lesser of $75,000,000 or twenty percent of our estimated
remaining collections of all its eligible asset pools. The new line of credit replaces our previous $25,000,000
credit facility with RBC Centura Bank, which was terminated (without having any borrowings under the line in
2005) on November 28, 2005. Borrowings under the new revolving credit facility bear interest at a floating rate
equal to the LIBOR Market Index Rate plus 1.75% and expires on November 29, 2008. The loan is
collateralized by substantially all of our tangible and intangible assets. The agreement provides for:
• restrictions on monthly borrowings are limited to 20% of Estimated Remaining Collections;
• a funded debt to EBITDA ratio of less than 1.0 to 1.0 calculated on a rolling twelve-month average;
• tangible net worth of at least 100% of prior quarter tangible net worth plus 25% of cumulative positive net
income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering; and
• restrictions on change of control.
This facility had $15 million outstanding at December 31, 2005. As of December 31, 2005 we are in
compliance with all of the covenants of this agreement.
As of December 31, 2005 there are four loans outstanding. 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.
42
Contractual Obligations
The following summarizes our contractual obligations that exist as of December 31, 2005:
Contractual Obligations
Operating Leases
Long-Term Debt
Capital Lease Obligations
Purchase Commitments (1)
Employment Agreements
Total
Total
12,655,439
1,224,044
410,090
5,514,903
13,283,325
33,087,801
$
$
$
Less
than 1
year
1,770,654
506,757
155,904
5,182,047
4,465,550
12,080,912
Payments due by period
1 - 3
years
4 - 5
years
3,599,871
703,312
248,488
265,356
8,817,775
13,634,802
$
3,373,931
13,975
5,698
67,500
-
More
than 5
years
$
3,910,983
-
-
-
-
$
$
$
$
3,461,104
$
3,910,983
(1) Of this amount, $2,000,000 represents the potential payout we may incur as additional purchase price in the
years 1-3 column 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”) 03-3, “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 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 03-3, it will increase the probability of us having 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
43
on the company’s stock price. FAS 123R is effective for fiscal years 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.
Revenue Recognition
We acquire accounts that have experienced deterioration of credit quality between origination and our
acquisition of the accounts. The amount paid for an account reflects our determination that it is probable we will
be unable to collect all amounts due according to the account's contractual terms. At acquisition, we review each
account to determine whether there is evidence of deterioration of credit quality since origination and if it is
probable that we will be unable to collect all amounts due according to the account's contractual terms. If both
conditions exist, we determine whether each such account is to be accounted for individually or whether such
accounts will be assembled into pools based on common risk characteristics. We consider expected prepayments
and estimate the amount and timing of undiscounted expected principal, interest and other cash flows for each
acquired portfolio and subsequently aggregated pools of accounts. We determine the excess of the pool's
scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as
an amount that should not be accreted (nonaccretable difference) based on our proprietary acquisition models.
The remaining amount, representing the excess of the account's cash flows expected to be collected over the
amount paid, is accreted into income recognized on finance receivables over the remaining life of the account or
pool (accretable yield).
Prior to January 1, 2005, we accounted for our investment in finance receivables using the interest method
under the guidance of Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans.” Effective
January 1, 2005, we adopted and began to account for our investment in finance receivables using the interest
method under the guidance of AICPA SOP 03-3, “Accounting for Loans or Certain Securities Acquired in a
Transfer.” For loans acquired in fiscal years beginning prior to December 15, 2004, Practice Bulletin 6 is still
effective; however, Practice Bulletin 6 was amended by SOP 03-3 as described further in this note. For loans
acquired in fiscal years beginning after December 15, 2004, SOP 03-3 is effective. Under the guidance of SOP
03-3 (and the amended Practice Bulletin 6), static pools of accounts are established. Pools purchased during a
given quarter are aggregated based on certain common risk criteria. Each static pool is recorded at cost, which
includes certain direct costs of acquisition paid to third parties, and is accounted for as a single unit for the
recognition of income, principal payments and loss provision. Once a static pool is established for a quarter,
individual receivable accounts are not added to the pool (unless replaced by the seller) or removed from the pool
(unless sold or returned to the seller). SOP 03-3 (and the amended Practice Bulletin 6) requires that the excess of
the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue or expense or
on the balance sheet. The SOP initially freezes the internal rate of return, referred to as IRR, estimated when the
accounts receivable are purchased as the basis for subsequent impairment testing. Significant increases in
expected future cash flows may be recognized prospectively through an upward adjustment of the IRR over a
44
portfolio’s remaining life. Any increase to the IRR then becomes the new benchmark for impairment testing.
Effective for fiscal years beginning after December 15, 2004 under SOP 03-3 and the amended Practice Bulletin
6, rather than lowering the estimated IRR if the collection estimates are not received, the carrying value of a pool
would be written down to maintain the then current IRR. Income on finance receivables is accrued quarterly
based on each static pool’s effective IRR. Quarterly cash flows greater than the interest accrual will reduce the
carrying value of the static pool. Likewise, cash flows that are less than the accrual will accrete the carrying
balance. The IRR is estimated and periodically recalculated based on the timing and amount of anticipated cash
flows using our proprietary collection models. A pool can become fully amortized (zero carrying balance on the
balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue
when received. Additionally, we use the cost recovery method when collections on a particular pool of accounts
cannot be reasonably predicted. Under the cost recovery method, no revenue is recognized until we have fully
collected the cost of the portfolio, or until such time that we consider the collections to be probable and estimable
and begin to recognize income based on the interest method as described above.
We establish valuation allowances for all acquired accounts subject to SOP 03-3 to reflect only those losses
incurred after acquisition (that is, the present value of cash flows initially expected at acquisition that are no
longer expected to be collected). Valuation allowances are established only subsequent to acquisition of the
accounts. At December 31, 2005, we recorded a $200,000 allowance charge on our finance receivables. Prior to
January 1, 2005, in the event that estimated future 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.
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, skip-tracing and
government processing and collection subsidiaries. Under our arrangements, we recognize a percentage of the
amount collected as our contractual collection fee. 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 an assessment of 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 was 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.
Our government processing and collection business’s primary source of income is derived from servicing
taxing authorities in several different ways: processing all of their tax payments and tax forms, collecting
delinquent taxes, identifying taxes that are not being paid and auditing tax payments. The processing and
collection pieces are standard commission based billings or fee for service transactions. When RDS conducts an
audit, there are two components. The first is a charge for the hours incurred on conducting the audit. This
charge is for hours worked. This charge is up-charged from the actual costs incurred. The gross billing is a
component of Commissions and the expense is included in compensation. The second item is for expenses
incurred while conducting the audit. Most jurisdictions will reimburse RDS for direct expenses incurred for the
audit including such items as travel and meals. The billed amounts are included in Commissions and the expense
component is included in their appropriate expense category, generally, other operating expenses.
We account for our gain on cash sales of finance receivables under Statement of Financial Accounting Standards
(“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.
45
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.
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 underwent a SFAS 142 review as of October 1, 2005 and believe that, as of December 31, 2005, there
was no impairment of goodwill or other intangible assets. 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 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 our variable rate credit line. As of December
31, 2005, we had $15,000,000 variable rate debt outstanding on our revolving credit lines. We do not have any
other variable rate debt outstanding as of December 31, 2005. 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.
46
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, 2005 and 2004
Consolidated Income Statements
For the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows
For the years ended December 31, 2005, 2004 and 2003
Notes to Consolidated Financial Statements
Page
46-47
48
49
50
51
52-69
47
Report of Independent Registered Public Accounting Firm
To Board of Directors and Stockholders of
Portfolio Recovery Associates, Inc.:
We have completed integrated audits of Portfolio Recovery Associates, Inc.’s 2005 and 2004 consolidated financial
statements and of its internal control over financial reporting as of December 31, 2005 and an audit of its December 31,
2003 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, 2005 and
December 31, 2004, and the results of their operations and their cash flows for each of the three years in the period
ended December 31, 2005 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, 2005 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, 2005, 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.
48
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.
As described in Management’s Report on Internal Control Over Financial Reporting, management has excluded RDS
from its assessment of internal control over financial reporting as of December, 31 2005 because it was acquired by the
Company in a purchase business combination during 2005. We have also excluded RDS from our audit of internal
control over financial reporting. RDS is a wholly-owned subsidiary whose total assets and total revenues represent
approximately 8% and approximately 2%, respectively, of the related consolidated financial statement amounts as of and
for the year ended December 31, 2005.
/s/ PricewaterhouseCoopers LLP
McLean, Virginia
March 1, 2006
49
Portfolio Recovery Associates, Inc.
Consolidated Balance Sheets
December 31, 2005 and 2004
Assets
Cash and cash equivalents
Investments
Finance receivables, net
Property and equipment, net
Goodwill
Intangible assets, net
Other assets
December 31,
2005
December 31,
2004
$
15,984,855
-
193,644,670
7,186,418
18,287,511
9,022,666
3,646,126
$
24,512,575
23,950,000
105,188,906
5,752,489
6,397,138
6,318,838
3,056,023
Total assets
$
247,772,246
$
175,175,969
Liabilities and Stockholders' Equity
Liabilities:
Accounts payable
Accrued expenses
Income taxes payable
Accrued payroll and bonuses
Deferred tax liability
Revolving lines of credit
Long-term debt
Obligations under capital lease
Total liabilities
$
2,332,685
2,239,267
3,054,883
5,942,618
22,345,995
15,000,000
1,151,965
382,658
52,450,071
$
1,413,726
1,563,285
182,221
4,475,919
13,650,722
-
1,924,422
576,234
23,786,529
Commitments and contingencies (Note 17)
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 - 15,767,443 at December 31, 2005,
and 15,498,210 at December 31, 2004
Additional paid in capital
Retained earnings
Total stockholders' equity
-
-
157,674
108,063,899
87,100,602
195,322,175
154,982
100,905,851
50,328,607
151,389,440
Total liabilities and stockholders' equity
$
247,772,246
$
175,175,969
The accompanying notes are an integral part of these consolidated financial statements.
50
Portfolio Recovery Associates, Inc.
Consolidated Income Statements
For the years ended December 31, 2005, 2004 and 2003
2005
2004
2003
Revenues:
Income recognized on finance receivables
Commissions
$
134,674,344
13,850,805
$
106,254,441
7,141,796
$
81,796,209
3,131,054
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
148,525,149
113,396,237
84,927,263
44,332,298
29,964,999
4,424,080
2,100,914
3,423,791
4,678,598
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
Total operating expenses
88,924,680
68,506,012
50,472,558
Income from operations
59,600,469
44,890,225
34,454,705
Other income and (expense):
Interest income
Interest expense
611,490
(280,503)
222,718
(273,355)
60,173
(602,072)
Income before income taxes
59,931,456
44,839,588
33,912,806
Provision for income taxes
23,159,461
17,388,148
13,199,303
Net income
$
36,771,995
$
27,451,440
$
20,713,503
Net income per common share
Basic
Diluted
Weighted average number of shares outstanding
Basic
Diluted
$
$
2.35
2.28
$
$
1.79
1.73
$
$
1.42
1.32
15,641,862
16,148,703
15,357,475
15,852,916
14,545,985
15,711,956
The accompanying notes are an integral part of these consolidated financial statements.
51
Portfolio Recovery Associates, Inc.
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2005, 2004 and 2003
Common
Stock
Additional
Paid in
Capital
Retained
Earnings
Total
Stockholders'
Equity
Balance at December 31, 2002
135,200
78,308,754
2,163,664
80,607,618
Net income
Exercise of stock options and warrants
Amortization of stock-based compensation
Stock-based compensation income tax benefits
-
17,747
-
-
-
1,377,148
422,127
16,009,903
20,713,503
-
-
-
20,713,503
1,394,895
422,127
16,009,903
Balance at December 31, 2003
$
152,947
$
96,117,932
$
22,877,167
$
119,148,046
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
-
1,336
699
-
-
-
1,195,013
1,999,540
507,091
1,086,275
27,451,440
-
-
-
-
27,451,440
1,196,349
2,000,239
507,091
1,086,275
Balance at December 31, 2004
$
154,982
$
100,905,851
$
50,328,607
$
151,389,440
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
-
2,355
337
-
-
-
3,001,532
1,443,426
520,845
2,192,245
36,771,995
-
-
-
-
36,771,995
3,003,887
1,443,763
520,845
2,192,245
Balance at December 31, 2005
$
157,674
$
108,063,899
$
87,100,602
$
195,322,175
The accompanying notes are an integral part of these consolidated financial statements.
52
Portfolio Recovery Associates, Inc.
Consolidated Statements of Cash Flows
For the years ended December 31, 2005, 2004 and 2003
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 amortization
Deferred tax expense (benefit), net
Changes in operating assets and liabilities:
Other assets
Accounts payable
Income taxes
Accrued expenses
Accrued payroll and bonuses
2005
2004
2003
$
36,771,995
$
27,451,440
$
20,713,503
967,281
2,192,245
4,678,598
8,695,272
(215,371)
(92,241)
2,872,662
517,233
1,466,699
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
Net cash provided by operating activities
57,854,373
49,285,183
35,080,889
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
Acquisitions, net of acquisition costs and cash acquired
(3,484,415)
(145,157,090)
56,701,326
(105,725,000)
129,675,000
(14,983,332)
(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
-
Net cash used in investing activities
(82,973,511)
(50,808,182)
(23,546,460)
Cash flows from financing activities:
Proceeds from exercise of options and warrants
Public offering costs
Draws 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
2,557,451
-
15,000,000
-
(772,457)
(193,576)
16,591,418
(8,527,720)
24,512,575
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
Cash and cash equivalents, end of period
$
15,984,855
$
24,512,575
$
24,911,841
Supplemental disclosure of cash flow information:
Cash paid for interest
Cash paid for income taxes
Noncash investing and financing activities:
Capital lease obligations incurred
Acquisitions - Common stock issued
$
$
280,503
9,399,281
$
$
273,355
390,000
$
$
281,332
389,600
-
1,443,763
296,910
2,000,239
362,813
-
The accompanying notes are an integral part of these consolidated financial statements.
53
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”), which was formed in March
1996, 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”) are full-service
providers of outsourced receivables management and related services. The Company is engaged in the business
of purchasing, managing and collecting portfolios of defaulted consumer receivables as well as offering a broad
range of accounts receivable management services. The majority of the Company’s business activities involve
the purchase, management and collection of defaulted consumer receivables. These are purchased from sellers
of finance receivables and collected by a highly skilled staff whose purpose is to locate and contact customers
and arrange payment or resolution of their debts. The Company, through its subsidiary Thomas West
Associates, LLC (“TWA”) and its Legal Recovery Department, collect accounts judicially, either by using its
own attorneys, or by contracting with independent attorneys throughout the country with whom the Company
takes legal action to satisfy consumer debts. The Company also services receivables on behalf of clients on
either a commission or transaction-fee basis. Clients include entities in the financial services, auto, retail, utility,
health care and government sectors. Services provided to these clients include standard collection services on
delinquent accounts, obtaining location information for clients in support of their collection activities (known as
skip tracing), and the management of both delinquent and non-delinquent tax receivables for government
entities.
On December 28, 1999, PRA formed a wholly owned subsidiary, PRA Holding I, LLC (“PRA Holding I”),
and is the sole initial member. The purpose of PRA Holding I is to enter into leases of office space and hold the
Company’s real property in Hutchinson, Kansas (see Note 11), Norfolk, Virginia and other real and personal
property.
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, the Company acquired the assets of IGS Nevada, Inc., a privately held company
specializing in asset-location and debt resolution services (the resulting business is referred to herein as “IGS”).
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 $2 million, through a contingent cash payment of
$2 million in 2007, based upon the performance of the acquired entity during 2006. On September 10, 2004, the
Company created a wholly owned subsidiary, PRA Location Services, LLC d/b/a IGS Nevada to operate IGS.
IGS Nevada, Inc.’s founder and his top management team signed long-term employment agreements and
continue to manage IGS.
On July 29, 2005, the Company acquired substantially all of the assets and liabilities of Alatax, Inc., a
provider of outsourced business revenue administration, audit and debt discovery/recovery services for local
governments (the resulting business is referred to herein as “RDS”). The transaction was completed for
consideration of $17.5 million, consisting of $16.1 million in cash and 33,684 shares of the Company’s common
stock, valued at $1.4 million at the closing in accordance with the calculation set forth in the asset purchase
agreement. Alatax Inc.’s two top executives both signed long-term employment agreements and continue to
manage the company. Although most of its clients are located in Alabama (where it operates as Alatax), RDS,
through PRA Government Services, LLC, a wholly owned subsidiary formed by the Company on June 23, 2005,
recently began expanding into surrounding states (where it operates as Revenue Discovery Systems (RDS)).
The income statement includes the results of operations of RDS for the period from August 1, 2005 through
December 31, 2005.
PRA Funding, LLC and PRA III were merged into PRA on November 24, 2003.
54
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The consolidated financial statements of the Company include the accounts of PRA Inc, PRA, PRA
Holding I, Anchor, TWA, IGS and RDS.
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, TWA, IGS and RDS. 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. Included in cash and cash equivalents are funds held on
the behalf of others arising from the collection of accounts placed with the Company. The balance of the funds
held on behalf of others was $656,407 and $4,445 at December 31, 2005 and 2004, respectively. There is an
offsetting liability that is included in “Accounts payable” on the balance sheet.
Investments: The Company accounts for its investments under the guidance of the Financial Accounting
Standards Board (“FASB”) Statement of Financial Accounting Standard No. 115 (“SFAS 115”), “Accounting
for Certain Investments in Debt and Equity Securities.” At December 31, 2005 and 2004, the Company had
investments totaling $0 and $23,950,000, respectively, 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
31, 2005 and 2004, the Company had highly liquid investments, with two investment brokerage firms, totalling
$0 and $23,950,000, respectively. These investments have ratings of AA or better.
Finance receivables and income recognition: The Company’s principal business consists of the acquisition
and collection of accounts that have experienced deterioration of credit quality between origination and the
Company's acquisition of the accounts. The amount paid for an account reflects the Company’s determination
that it is probable the Company will be unable to collect all amounts due according to the account's contractual
terms. At acquisition, the Company reviews each account to determine whether there is evidence of deterioration
of credit quality since origination and if it is probable that the Company will be unable to collect all amounts due
according to the account's contractual terms. If both conditions exist, the Company determines whether each
such account is to be accounted for individually or whether such accounts will be assembled into pools based on
common risk characteristics. The Company considers expected prepayments and estimates the amount and
timing of undiscounted expected principal, interest and other cash flows for each acquired portfolio and
subsequently aggregated pools of accounts. The Company determines the excess of the pool's scheduled
contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount
that should not be accreted (nonaccretable difference) based on the Company’s proprietary acquisition models.
The remaining amount, representing the excess of the account's cash flows expected to be collected over the
amount paid, is accreted into income recognized on finance receivables over the remaining life of the account or
pool (accretable yield).
Prior to January 1, 2005, the Company accounted for its investment in finance receivables using the
interest method under the guidance of Practice Bulletin 6, “Amortization of Discounts on Certain Acquired
Loans.” Effective January 1, 2005, the Company adopted and began to account for its investment in finance
receivables using the interest method under the guidance of American Institute of Certified Public Accountants
(“AICPA”) Statement of Position (“SOP”) 03-3, “Accounting for Loans or Certain Securities Acquired in a
55
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Transfer.” For loans acquired in fiscal years beginning prior to December 15, 2004, Practice Bulletin 6 is still
effective; however, Practice Bulletin 6 was amended by SOP 03-3 as described further in this note. For loans
acquired in fiscal years beginning after December 15, 2004, SOP 03-3 is effective. Under the guidance of SOP
03-3 (and the amended Practice Bulletin 6), static pools of accounts are established. These pools are aggregated
based on certain common risk criteria. Each static pool is recorded at cost, which includes certain direct costs of
acquisition paid to third parties, and is accounted for as a single unit for the recognition of income, principal
payments and loss provision. Once a static pool is established for a quarter, individual receivable accounts are
not added to the pool (unless replaced by the seller) or removed from the pool (unless sold or returned to the
seller). SOP 03-3 (and the amended Practice Bulletin 6) requires that the excess of the contractual cash flows
over expected cash flows not be recognized as an adjustment of revenue or expense or on the balance sheet. The
SOP initially freezes the internal rate of return, referred to as IRR, estimated when the accounts receivable are
purchased as the basis for subsequent impairment testing. Significant increases in actual, or expected future cash
flows may be recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining
life. Any increase to the IRR then becomes the new benchmark for impairment testing. Effective for fiscal years
beginning after December 15, 2004 under SOP 03-3 and the amended Practice Bulletin 6, rather than lowering
the estimated IRR if the collection estimates are not received or projected to be received, the carrying value of a
pool would be written down to maintain the then current IRR. Income on finance receivables is accrued
quarterly based on each static pool’s effective IRR. Quarterly cash flows greater than the interest accrual will
reduce the carrying value of the static pool. Likewise, cash flows that are less than the accrual will accrete the
carrying balance. The IRR is estimated and periodically recalculated based on the timing and amount of
anticipated cash flows using the Company’s proprietary collection models. A pool can become fully amortized
(zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash
collections are recognized as revenue when received. Additionally, the Company uses the cost recovery method
when collections on a particular pool of accounts cannot be reasonably predicted. Under the cost recovery
method, no revenue is recognized until the Company has fully collected the cost of the portfolio, or until such
time that the Company considers the collections to be probable and estimable and begins to recognize income
based on the interest method as described above. At December 31, 2005, the Company had unamortized
purchased principal (purchase price) of $1,312,032 in pools accounted for under the cost recovery method.
The Company establishes valuation allowances for all acquired accounts subject to SOP 03-3 to reflect
only those losses incurred after acquisition (that is, the present value of cash flows initially expected at
acquisition that are no longer expected to be collected). Valuation allowances are established only subsequent to
acquisition of the accounts. At December 31, 2005, the Company had a $200,000 allowance charge on its
finance receivables. Prior to January 1, 2005, in the event that estimated future 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.
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,
2005, 2004 and 2003 was $1,028,401, $1,098,847 and $1,802,194, respectively. During the years ended
December 31, 2005, 2004 and 2003 the Company capitalized $502,556, $708,632 and $1,174,660, respectively,
of these direct acquisition fees. During the years ended December 31, 2005, 2004 and 2003 the Company
amortized $573,002, $881,330 and $1,039,148, respectively, of these direct acquisition fees. At June 30, 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 five years. As a
result of a review of the Company’s accounting, the Company determined these capitalized acquisition fees
should be expensed.
The agreements to purchase the aforementioned receivables include general representations and warranties
from the sellers covering account holder death or bankruptcy and accounts paid in full, 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. In some cases, the
seller will replace the returned accounts with new accounts in lieu of returning the purchase price. In that case,
the old account is removed from the pool and the new account is added.
56
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
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,
skip-tracing and government processing and collection 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 collection 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
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.
The Company’s government processing and collection subsidiary utilizes both gross and net reporting
under this EITF. RDS’s primary source of income is derived from servicing taxing authorities in several
different ways: processing all of their tax payments and tax forms, collecting delinquent taxes, identifying taxes
that are not being paid and auditing tax payments. The processing and collection pieces are standard
commission based billings or fee for service transactions and are included in the line item “Commissions.”
When RDS conducts an audit, there are two components. The first is a charge for the hours incurred on
conducting the audit. This charge is for hours worked and includes a profit margin above our actual cost. The
gross billing is a component of “Commissions” and the expense is included in “Compensation and Employee
Services.” The second item is for expenses incurred while conducting the audit. Most jurisdictions will
reimburse RDS for direct expenses incurred for the audit including such items as travel and meals. The billed
amounts are included in “Commissions” and the expense component is included in their appropriate expense
category, generally “Other operating expenses.”
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
57
depreciated over the lesser 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. When property is sold or
retired, the cost and related accumulated depreciation are removed from the balance sheet and any gain or loss is
included in the income statement.
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 IGS on October 1, 2004, and RDS on July 29, 2005, the Company purchased certain tangible and intangible
assets. Intangible assets purchased included client and customer relationships, non-compete agreements and
goodwill. In accordance with SFAS 142, the Company is amortizing the IGS client relationships over seven
years, the RDS customer relationships over ten years and the non-compete agreements over three years for both
the IGS and RDS acquisitions. The Company reviews them at least annually for impairment. In addition,
goodwill, pursuant to FAS 142, is not amortized but rather reviewed annually for impairment.
Income taxes: The Company records 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 carry-forwards. 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.
Effective with the Company’s 2002 tax filings, the Company adopted the cost recovery method of income
recognition for tax purposes. 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 principal to reduce the finance receivables to zero before
any income is recognized.
The Company believes that 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 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 the Company subsequently realizes
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 management’s expectations could have a material impact on the Company’s results of
operations and financial position.
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.
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
58
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
restatement method as prescribed in SFAS No. 148 “Accounting for Stock-Based Compensation – Transition
and Disclosure.”
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 quarterly basis, management reviews the estimate of future
cash 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, revolving lines of credit, long-term
debt, and obligations under capital leases. See Note 12 for additional disclosure.
Recent Accounting Pronouncements: On December 16, 2004, FASB issued statement No. 123(R), “Share-
Based Payment,” (“SFAS 123R”). SFAS 123R revises FASB statement No. 123, “Accounting for Stock-Based
Compensation,” (“SFAS 123”) and requires companies to expense the fair value of employee stock options and
other forms of stock-based compensation. In addition to revising SFAS 123, SFAS 123R supersedes APB No.
25 and amends FASB Statement No. 95, “Statement of Cash Flows.” SFAS 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. SFAS 123R is effective for annual 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 SFAS 123 on January 1, 2002 and
has been expensing equity based compensation since that time. Management believes the adoption of SFAS
123R will have no material impact on its financial statements.
3.
Finance Receivables:
As of December 31, 2005 and 2004, the Company had $193,644,670 and $105,188,906, respectively,
remaining of finance receivables. Changes in finance receivables at December 31, 2005 and 2004, were as
follows:
2005
2004
Balance at beginning of period
Acquisitions of finance receivables, net of buybacks
$
105,188,906
145,157,090
$
92,568,557
59,770,354
Cash collections
Income recognized on finance receivables
Cash collections applied to principal
(191,375,670)
134,674,344
(56,701,326)
(153,404,446)
106,254,441
(47,150,005)
Balance at end of period
$
193,644,670
$
105,188,906
59
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, 2005 the Company had $193,644,670 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, 2006
December 31, 2007
December 31, 2008
December 31, 2009
December 31, 2010
December 31, 2011
December 31, 2012
$
44,829,565
48,317,858
39,034,033
30,095,569
24,157,994
7,205,401
4,250
193,644,670
$
Accretable yield represents the amount of income the Company can expect to generate over the remaining
life of its existing portfolios based on estimated future cash flows as of December 31, 2005 and 2004.
Reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase
in its estimate of future cash flows. Changes in accretable yield for the years ended December 31, 2005 and
2004 were as follows:
2005
2004
Balance at beginning of period
Income recognized on finance receivables
Additions
Reclassifications from nonaccretable difference
Balance at end of period
$
$
202,922,449
(134,674,344)
157,081,401
73,950,822
299,280,328
175,098,132
(106,254,441)
77,296,786
56,781,972
202,922,449
$
$
During the year ended December 31, 2005, the Company booked a $200,000 allowance charge on a portfolio
that had recently underperformed expectations. The Company previously had not booked any other valuation
allowances on its finance receivables. The change in the valuation allowance for the year ended December 31,
2005 is as follows:
Balance at beginning of period
Allowance charge
Balance at end of period
-
$
200,000
200,000
$
During the year ended December 31, 2005, the Company purchased $5.3 billion of face value of charged-off
consumer receivables. During the year ended December 31, 2004, the Company purchased $3.3 billion of face
value of charged-off consumer receivables. At December 31, 2005, the estimated remaining collections on the
receivables purchased during 2005 are $280,646,035. At December 31, 2005, the estimated remaining
collections on the receivables purchased during 2004 are $82,939,198.
4. Operating Leases:
The Company rents office space and equipment under operating leases. Rental expense was $1,803,812,
$1,520,100, and $1,028,530 for the years ended December 31, 2005, 2004 and 2003, respectively.
60
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Future minimum lease payments at December 31, 2005, are as follows:
2006
2007
2008
2009
2010
Thereafter
$
1,770,654
1,778,810
1,821,061
1,867,784
1,506,147
3,910,983
$
12,655,439
5.
Acquisition of the Assets of Alatax, Inc.:
On July 29, 2005, the Company acquired substantially all of the assets and liabilities of Alatax, Inc. for
consideration of $17.5 million, consisting of $16.1 million in cash and 33,684 shares of common stock, valued at
$1.4 million at the closing in accordance with the calculation set forth in the asset purchase agreement. The assets
acquired from Alatax, Inc. consisted of cash, accounts receivable, prepaid expenses, customer relationships, fixed
assets, non-competition protection and goodwill. Liabilities assumed consisted of accounts payable and accrued
expenses.
The following is an allocation of the purchase price to the assets acquired and liabilities assumed (based on
relative fair values) of Alatax, Inc.:
Purchase price including acquisition costs
Cash
Accounts receivable and prepaid expenses (included in other assets)
Customer relationships
Non-compete agreements
Fixed assets
Accounts payable
Accrued expenses
Goodwill
$17,825,717
(1,398,622)
(374,732)
(4,800,000)
(200,000)
(331,939)
1,011,200
158,749
$11,890,373
Alatax, Inc., which is based in Birmingham, Alabama, was founded in 1980 and has become a leading provider
of outsourced business revenue administration, audit and debt discovery/recovery services for local governments.
Alatax, Inc. has a workforce of about 80 employees and contractors. Alatax Inc.’s two top executives both signed
long-term employment agreements and continue to manage the company. Although most of its clients are located in
Alabama (where it operates as Alatax), the company recently has begun expanding into surrounding states (where it
operates as Revenue Discovery Systems or RDS). The income statement includes the results of operations of RDS
for the period from August 1, 2005 through December 31, 2005.
6.
Intangible Assets:
With the acquisitions of IGS on October 1, 2004 and RDS on July 29, 2005, the Company purchased certain
tangible and intangible assets. Intangible assets purchased included client and customer relationships, non-compete
agreements and goodwill. In accordance with SFAS 142, the Company is amortizing the IGS client relationships
over seven years, the RDS customer relationships over ten years and the non-compete agreements over three years
for both the IGS and RDS acquisitions with a combined weighted average amortization period of 7.54 years. The
Company reviews them at least annually for impairment. Total amortization expense was $2,296,172 and $481,162
for the years ended December 31, 2005 and 2004, respectively.
61
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Intangible assets consist of the following at December 31, 2005:
Client and customer relationships
Non-compete agreements
Accumulated amortization
Intangible assets, net
$
$
9,800,000
2,000,000
(2,777,334)
9,022,666
Amortization expense relating to the non-compete agreements is calculated on a straight-line method (which
approximates the pattern of economic benefit concept) for the IGS non-compete agreements and a pattern of
economic benefit concept for the Alatax non-compete agreements. Amortization expense relating to the client and
customer relationships is calculated using a pattern of economic benefit concept. The pattern of 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, 2005:
2006
2007
2008
2009
2010
Thereafter
$
$
2,268,651
1,812,680
1,354,075
1,177,279
963,579
1,446,402
9,022,666
In addition, goodwill, pursuant to SFAS 142, is not amortized but rather is reviewed at least annually for
impairment. During the fourth quarter of 2005, the Company hired an independent third party to conduct the annual
review. Based upon the results of this review, which was conducted as of October 1, 2005, no impairment charges
to goodwill or the other intangible assets were necessary as of the date of this review. The Company believes that
nothing has happened since the review was performed through December 31, 2005, that would necessitate an
impairment charge to goodwill or the other intangible assets.
7.
Capital Leases:
Leased assets included in property and equipment consists of the following:
Software
Computer equipment
Furniture and fixtures
Equipment
Less accumulated depreciation
2005
2004
$
270,008
59,652
1,260,287
27,249
(1,097,780)
$
270,008
60,369
1,260,287
27,249
(862,616)
$
519,416
$
755,297
Depreciation expense recognized on capital leases for the years ended December 31, 2005, 2004 and 2003
was $235,164, $255,025, and $210,101, respectively.
62
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
Commitments for minimum annual rental payments for these leases as of December 31, 2005 are as follows:
2006
2007
2008
2009
Less amount representing interest and taxes
$
155,904
148,539
99,949
5,698
410,090
27,432
Present value of net minimum lease payments
$
382,658
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 $603,830, $434,778, and $317,018 for the years ended
December 31, 2005, 2004 and 2003, respectively.
9.
Revolving Lines of Credit:
The Company maintained a $25.0 million revolving line of credit pursuant to an agreement entered into with
RBC Centura Bank on November 28, 2003 and amended on November 22, 2004. This facility was terminated on
November 28, 2005. The credit facility bore interest at a spread of 2.50% over LIBOR and extended through
November 28, 2006. The agreement called 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 during 2005 through the time of its termination.
On November 29, 2005, the Company entered into a Loan and Security Agreement for a revolving line of
credit jointly offered by Bank of America, N. A. and Wachovia Bank, National Association. The agreement is a
revolving line of credit in an amount equal to the lesser of $75,000,000 or twenty percent of the Company’s
estimated remaining collections of all its eligible asset pools. Borrowings under the new revolving credit facility
will bear interest at a floating rate equal to the LIBOR Market Index Rate plus 1.75% and expires on November
29, 2008. The loan is collateralized by substantially all the tangible and intangible assets of the Company. The
agreement provides for:
•
•
•
•
restrictions on monthly borrowings are limited to 20% of estimated remaining collections;
a funded debt to EBITDA ratio of less than 1.0 to 1.0 calculated on a rolling twelve-month average;
tangible net worth of at least 100% of prior quarter tangible net worth plus 25% of cumulative positive net
income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering; and
restrictions on change of control.
This facility had $15 million outstanding at December 31, 2005. As of December 31, 2005 the Company
is in compliance with all of the covenants of this agreement.
63
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
10. Property and equipment:
Property and equipment, at cost, consist of the following as of December 31, 2005 and 2004:
Software
Computer equipment
Furniture and fixtures
Equipment
Leasehold improvements
Building and improvements
Land
Less accumulated depreciation
2005
2004
$
3,253,454
3,626,353
2,182,388
2,743,966
1,644,566
1,714,353
150,922
(8,129,584)
$
2,550,224
2,964,333
1,729,792
1,876,081
1,146,489
1,142,017
150,922
(5,807,369)
Property and equipment, net
$
7,186,418
$
5,752,489
Depreciation expense for the years ended December 31, 2005, 2004 and 2003 was $2,382,426, $1,901,734 and
$1,444,825, respectively.
11. 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. Monthly principal payments on the loan were $4,583 for an amortized term of 10
years. A balloon payment of $275,000 was due July 21, 2005, which resulted in a five-year principal payout. The
loan was paid in full at its maturity date of 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 were $2,170 and the loan was paid in full at its maturity date of 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 collateralized 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, 2005 are as follows:
2006
2007
2008
2009
Less amount representing interest
Principal due
64
$
506,757
463,228
240,083
13,976
1,224,044
(72,079)
1,151,965
$
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
These five loans are collateralized by property and buildings that have a book value of $1,290,244 and
$1,805,636 as of December 31, 2005 and 2004, 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.
12. Estimated Fair Value of Financial Instruments:
The accompanying financial statements include various estimated fair value information as of December
31, 2005, 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.
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 is reduced as cash is received
based upon the guidance of Practice Bulletin 6 and SOP 03-3. The balance at December 31, 2005 and 2004 was
$193,644,670 and $105,188,906, respectively. 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,
2005 and 2004, using the aforementioned methodology, we computed the approximate fair value to be
$232,000,000 and $148,700,000, respectively.
Revolving lines of credit: The carrying amount approximates fair value.
Long-term debt: The carrying amount approximates fair value.
Obligations under capital lease: The carrying amount approximates fair value.
13. 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 (the “Amended 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 $1,190,446, $749,754 and $456,340 for the years ended December
31, 2005, 2004 and 2003, respectively.
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.
65
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The following summarizes all warrant related transactions from December 31, 2002 through December 31,
2005:
December 31, 2002
Exercised
Cancelled
December 31, 2003
Exercised
December 31, 2004
Exercised
December 31, 2005
Warrants
Outstanding
2,185,000
(2,026,000)
(51,500)
107,500
(67,500)
40,000
(36,250)
3,750
Weighted Average
Exercise Price
$
$
4.30
4.17
9.72
4.20
4.20
4.20
4.20
4.20
The following information is as of December 31, 2005:
Exercise
Prices
Number
Outstanding
Warrants Outstanding
Weighted-
Average
Remaining
Contractual
Life
Weighted-
Average
Exercise
Price
Warrants Exercisable
Number
Exercisable
Weighted-
Average
Exercise
Price
$ 4.20
Total at December 31, 2005
3,750
3,750
0.3
0.3
$
$
4.20
4.20
3,750
3,750
$
$
4.20
4.20
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.
Stock Options
The Company created the 2002 Stock Option Plan on November 7, 2002. The plan was amended in 2004
by the Amended Plan 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, 2005, 895,000
options have been granted under the Amended Plan of which 94,155 have been cancelled and are eligible for
66
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
regrant. These options are accounted for under SFAS 123 and all expenses for 2005, 2004 and 2003 are
included in earnings as a component of compensation and employee services expense.
The following summarizes all option related transactions from December 31, 2002 through December 31,
2005:
December 31, 2002
Granted
Exercised
Cancelled
December 31, 2003
Granted
Exercised
Cancelled
December 31, 2004
Exercised
Cancelled
December 31, 2005
Options
Outstanding
807,850
55,000
(50,915)
(14,025)
797,910
20,000
(63,511)
(47,940)
706,459
(181,910)
(20,040)
504,509
Weighted Average
Exercise Price
$
$
13.06
27.88
13.00
13.00
14.09
28.79
13.30
13.00
14.65
13.22
15.63
15.12
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 were granted 0, 20,000, and 0 stock options during the years
ending December 31, 2005, 2004 and 2003, respectively.
The following information is as of December 31, 2005:
Exercise
Prices
Number
Outstanding
$ 13.00
$ 16.16
$ 27.77 - $ 29.79
Total at December 31, 2005
426,509
9,000
69,000
504,509
Options Outstanding
Weighted-
Average
Remaining
Contractual
Life
Weighted-
Average
Exercise
Price
Options Exercisable
Number
Exercisable
Weighted-
Average
Exercise
Price
3.9
3.9
4.7
4.0
$
$
13.00
16.16
28.09
15.12
151,049
5,000
24,000
180,049
$
$
13.00
16.16
27.96
15.08
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.
67
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The following assumptions were used:
Options issue year:
Weighted average fair value
of options granted
Expected volatility
Risk-free interest rate
Expected dividend yield
Expected life (in years)
2004
2003
$ 2.85
$ 5.84
13.26% - 13.55% 15.70% - 15.73%
3.16% - 3.37%
0.00%
5.00
2.92% - 3.19%
0.00%
5.00
Utilizing these assumptions, each employee stock option granted in 2003 was valued between $5.80 and
$6.25. Each non-employee director stock option granted in 2004 is valued between $2.62 and $2.92. No
options have been awarded to Messrs. Fredrickson, Stevenson or Grube since the IPO in November 2002.
Nonvested Shares
Prior to the approval of the Amended Plan on May 12, 2004, nonvested shares were issued by the
Company as an incentive to attract new employees and, effective May 12, 2004, are being issued pursuant to the
Amended Plan to directors and existing employees as well. Generally, 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
typically vest ratably over five years. Nonvested share grants are expensed over their vesting period. No non-
vested shares have been awarded to Messrs. Fredrickson, Stevenson or Grube since the IPO in November 2002.
The following summarizes all nonvested share transactions from December 31, 2002 through December
31, 2005:
Nonvested
Shares
Outstanding
-
13,045
13,045
84,350
(2,609)
(4,900)
89,886
74,600
(17,389)
(11,760)
135,337
Weighted
Average
Price at
Grant Date
-
$
27.57
27.57
26.94
27.57
26.08
27.06
41.92
27.10
30.40
34.96
$
December 31, 2002
Granted
December 31, 2003
Granted
Vested
Cancelled
December 31, 2004
Granted
Vested
Cancelled
December 31, 2005
68
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
14. 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, 2005 and 2004:
Basic EPS
Dilutive effect of stock warrants,
options and restricted stock awards
Diluted EPS
Net Income
$36,771,995
$36,771,995
For the year ended December 31,
2005
Weighted Average
Common Shares
EPS
15,641,862
$2.35
2004
Weighted Average
Common Shares
EPS
15,357,475
$1.79
Net Income
$27,451,440
506,841
16,148,703
$2.28
$27,451,440
495,441
15,852,916
$1.73
As of December 31, 2005 and 2004, there were 0 antidilutive options outstanding.
15. Stockholders’ Equity:
Shares of common stock outstanding were as follows:
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
Exercise of warrants, options and vesting of nonvested shares
Issuance of common stock for acquisition
December 31, 2005
Common Stock
13,520,000
1,774,676
15,294,676
133,620
69,914
15,498,210
235,549
33,684
15,767,443
16.
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.
69
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
The income tax expense recognized for the years ended December 31, 2005, 2004 and 2003 is composed of
the following:
For the year ended December 31, 2005
Federal
State
Total
Current tax expense
Deferred tax expense
Total income tax expense
$
$
11,741,714
7,817,133
19,558,847
$
$
2,352,431
1,248,183
3,600,614
$
$
14,094,145
9,065,316
23,159,461
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
$
The Company also recognized a net deferred tax liability of $22,345,995 and $13,650,722 as of December
31, 2005 and 2004, respectively. The components of this net liability 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
2005
2004
$
-
-
473,746
473,364
-
947,110
$
638,583
8,623,251
386,133
101,611
19,101
9,768,679
370,923
336,865
22,585,317
23,293,105
682,840
313,289
22,423,272
23,419,401
Net deferred tax liability
$
22,345,995
$
13,650,722
A valuation allowance has not been provided at December 31, 2005 or 2004 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 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
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
70
Portfolio Recovery Associates, Inc.
Notes to Consolidated Financial Statements
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 its 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 principal to reduce the
finance receivables to zero before any taxable income is recognized. The timing difference from the adoption of
cost recovery resulted in a deferred tax liability at December 31, 2005 and 2004.
A reconciliation of the Company’s expected tax expense at statutory tax rates to actual tax expense for the
years ended December 31, 2005, 2004 and 2003 consists of the following components:
2005
2004
2003
Federal tax at statutory rates
State tax expense, net of federal benefit
Other
Total income tax expense
$
$
20,976,009
2,340,399
(156,947)
23,159,461
$
$
15,693,856
1,750,349
(56,057)
17,388,148
$
$
11,869,482
1,323,939
5,882
13,199,303
17. Commitments and Contingencies:
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 December 31, 2008. 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 $13,283,325. 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.
71
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial
Disclosure.
None.
Item 9A. 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, 2005, 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) and 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.
Under the supervision and with the participation of our management, including our principal executive officer and
principal financial officer, we carried out an evaluation of the effectiveness of our internal control over financial
reporting based on the framework in Internal Control - Integrated Framework issued by the Committee of
Sponsoring Organizations (COSO) of the Treadway Commission. Based on its assessment, management has
determined that, as of December 31, 2005, its internal control over financial reporting was effective based on the
criteria set forth in the COSO framework. The company’s independent registered public accounting firm,
PricewaterhouseCoopers LLP, has issued an attestation report on management’s assessment of our internal control
over financial reporting, as stated in their report which is included herein.
The scope of management’s assessment of internal controls over financial reporting did not include our recently
acquired subsidiary, RDS, which was excluded from our evaluation. This business represents approximately 8% of
total assets and approximately 2% of total revenue of the related consolidated financial statement amounts as of and
for the year ended December 31, 2005.
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, 2005 that has materially affected, or is reasonably
likely to materially affect, our internal control over financial reporting.
Item 9B. Other Information.
None.
72
Item 10. Directors and Executive Officers of the Registrant.
PART III
The following table sets forth certain information as of February 11, 2006 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 and Administrative 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*
Penelope W. Kyle ......... Director
David N. Roberts .......... Director
Scott M. Tabakin .......... Director*
James M. Voss .............. Director*
Age
46
41
45
60
68
58
43
47
63
* 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 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 and Administrative 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
73
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.
Penelope W. Kyle, Director. Mrs. Kyle was elected as a director of Portfolio Recovery Associates in 2005.
Mrs. Kyle presently serves as President of Radford University. Prior to her appointment as President of Radford
University in June 2005, she had served since 1994 as Director of the Virginia Lottery. Earlier in her career, she
worked as an attorney at the law firm McGuire, Woods, Battle and Boothe, in Richmond, Virginia. Mrs. Kyle was
later employed at CSX Corporation, where during a 13-year career she became the company's first female officer
and a vice president in the finance department. She earned an MBA at the College of William and Mary and a law
degree from the University of Virginia.
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.
Currently an independent financial consultant, Mr. Tabakin has more than 20 years of public-company experience.
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 in accounting 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.
74
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.
75
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 2006 Annual
Meeting of Stockholders.
Item 12. Security Ownership of Certain Beneficial Owners and Management And Related
Stockholder Matters
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 2006 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 2006 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, 2005 and 2004 are presented in the table below:
Audit Fees
Annual audit
Registration statement (1)
Audit Related Fees
2005
2004
$
410,000
$
370,000
-
410,000
64,225
434,225
56,344
(2)
-
-
1,500
(4)
Consultation on various accounting matters
-
Tax Fees
Advice
Other Fees
(3)
9,975
9,975
1,500
(4)
Total Accountant Fees
$
421,475
$
490,569
(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.
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 relate to work done on cost recovery method research for tax purposes.
Other fees represent fees paid for an annual subscription to the PricewaterhouseCoopers LLP research
tool, Comperio.
76
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.
77
PART IV
Item 15. Exhibits and Financial Statement Schedules
(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 46-47
Consolidated Balance Sheets at December 31, 2005 and 2004
48
Consolidated Income Statements
for the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Changes in Stockholders’ Equity
For the years ended December 31, 2005, 2004 and 2003
Consolidated Statements of Cash Flows
For the years ended December 31, 2005, 2004 and 2003
Notes to Consolidated Financial Statements
(b) Exhibits.
49
50
51
52-69
2.1
2.2
2.3
3.1
3.2
4.1
4.2
10.1
10.2
10.3
10.4
10.5
10.6
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.)
Asset Purchase Agreement dated as of July 29, 2005, by and among Portfolio Recovery
Associates, Inc, PRA Government Services, LLC, Alatax, Inc. and its stockholders (Incorporated
by reference to Exhibit 2.1 of the Form 8-K dated August 2, 2005.)
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 22, 2005, by and between Steven D. Fredrickson and
Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.1 of the Form 8-K
dated January 6, 2006.)
Employment Agreement, dated December 22, 2005, by and between Kevin P. Stevenson and
Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.2 of the Form 8-K
dated January 6, 2006.)
Employment Agreement, dated December 22, 2005, by and between Craig A. Grube and Portfolio
Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.3 of the Form 8-K dated
January 6, 2006.)
Employment Agreement, dated December 22, 2005, by and between Judith S. Scott and Portfolio
Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.4 of the Form 8-K dated
January 6, 2006.)
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 29, 2005, by and between Portfolio Recovery
Associates, Inc, Bank of America and Wachovia Bank. (Incorporated by reference to Exhibit 10.1
of the Form 8-K dated December 5, 2005.)
78
10.7
10.8
10.9
Promissory Note dated November 29, 2005 by and between Portfolio Recovery Associates, Inc,
and Bank of America (Incorporated by reference to Exhibit 10.2 of the Form 8-K dated December
5, 2005.)
Promissory Note dated November 29, 2005 by and between Portfolio Recovery Associates, Inc,
and Wachovia Bank (Incorporated by reference to Exhibit 10.3 of the Form 8-K dated December
5, 2005.)
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).
10.11 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).
10.12 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)
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
Powers of Attorney (included on signature page).
Section 302 Certifications of Chief Executive Officer
Section 302 Certifications of Chief Financial Officer
23.1
24.1
31.1
31.2
32.1 Section 906 Certifications of Chief Executive Officer and Chief Financial Officer
79
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 2, 2006
Dated: March 2, 2006
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 and Administrative 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 2, 2006
Dated: March 2, 2006
Dated: March 2, 2006
Dated: March 2, 2006
Dated: March 2, 2006
Dated: March 2, 2006
By:/s/ Steven D. Fredrickson
Steven D. Fredrickson
President and Chief Executive Officer
By:/s/ Kevin P. Stevenson
Kevin P. Stevenson
Chief Financial and Administrative Officer,
Executive Vice President, Treasurer and Assistant Secretary
(Principal Financial and Accounting Officer)
By:/s/ William P. Brophey
William P. Brophey
Director
By:/s/ Penelope W. Kyle
Penelope W. Kyle
Director
By:/s/ David N. Roberts
David Roberts
Director
By:/s/ Scott M. Tabakin
Scott M. Tabakin
Director
80
Dated: March 2, 2006
By:/s/ James M. Voss
James M. Voss
Director
81
CONSENT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM
We hereby consent to the incorporation by reference in the Registration Statement on Form S-8 (No. 333-110330
and No. 333-110331) of Portfolio Recovery Associates, Inc. of our report dated March 1, 2006 relating to the
financial statements, financial statement schedules, 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 1, 2006
82
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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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 2, 2006
By: /s/ Steven D. Fredrickson
Steven D. Fredrickson
Chief Executive Officer, President and
Chairman of the Board of Directors
(Principal Executive Officer)
83
Exhibit 31.2
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)) and internal control over
financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) 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 2, 2006
By: /s/ Kevin P. Stevenson
Kevin P. Stevenson
Chief Financial and Administrative
Officer, Executive Vice President,
Treasurer and Assistant Secretary
(Principal Financial and Accounting
Officer)
84
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, 2005 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
results of operations of the Company.
Date: March 2, 2006
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, 2005 as filed with the Securities and Exchange Commission on the date hereof (the
"Report"), I, Kevin P. Stevenson, Chief Financial and Administrative 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
results of operations of the Company.
Date: March 2, 2006
By: /s/ Kevin P. Stevenson
Kevin P. Stevenson
Chief Financial and Administrative Officer,
Executive Vice President, Treasurer and Assistant
Secretary
(Principal Financial and Accounting Officer)
85
P o r t f o l i o R e c o v e ry A s s o c i a t e s , I n c .
2 0 0 5 F I N A N C I A L I N F O R M A T I O N
C o r p o r a t e G o v e r n a n c e
Board of Directors
Management
Steve Fredrickson
President and
Chief Executive Officer
Steve Fredrickson
Chairman of the Board
David Roberts
Director
William Brophey
Director
Scott Tabakin
Director
Penelope Kyle
Director
James Voss
Director
Kevin Stevenson
Executive Vice President,
Chief Financial and
Administrative Officer,
Treasurer and Asst.
Secretary
Craig Grube
Executive Vice President,
Acquisitions
Judith Scott
Executive Vice President,
General Counsel and
Secretary
Corporate Information
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
2005 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 2005.
High
Low
2005
$48.03 $32.33
As of February 14, 2006, there were
approximately 24 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 18,996 beneficial
owners of the common stock as of
February 14, 2006.
designed by curran & connors, inc. / www.curran-connors.com
Portfolio Recovery Associates, Inc.
Riverside Commerce Center
120 Corporate Blvd., Suite 100
Norfolk, Virginia 23502