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OFX Group LimitedPeRfoRmiNg i N a T u R Bu l e N T T i m e 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 8 a n n u a l R e p o r t $383.5 $563.8 21.1% 19.9% 19.8% 17.3% $410.3 $298.2 $261.4 $205.2 $226.4 $193.6 ’05 ’06 ’07 ’08 ’05 ’06 ’07 ’08 ’05 ’06 ’07 ’08 Cash Receipts ($ in millions) Return on Equity (in percent) Net Finance Receivables ($ in millions) Cash Re ceipts ($ in millions) Return on Equity (in percent) Net Finance Receivables ($ in millions) $48.2 $45.4 $44.5 $36.8 31.0% 26.8% $283.9 $247.3 $235.3 $195.3 19.3% 17.2% ’05 ’06 ’07 ’08 ’05 ’06 ’07 ’08 ’05 ’06 ’07 ’08 Net Income ($ in millions) Annual Revenue Growth (in percent) Stockholders’ Equity ($ in millions) Net Income ($ in millions) Annual Revenue Growth Shareholder’s Equity (in percent) ($ in millions) 400 350 300 250 200 150 100 50 0 50 40 30 20 10 0 25 20 15 10 5 0 35 30 25 20 15 10 5 0 600 500 400 300 200 100 0 300 250 200 150 100 50 0 Portfolio Recovery Associates, Inc. and its subsidiaries purchase and manage portfolios of defaulted consumer receivables and provide a broad range of accounts receivable man agement services to lenders, service providers, governments, and others. The Company combines a disciplined approach to portfolio acquisitions with a longterm view of collections and a commitment to continuous innovation. We have created a rewarding organization for our employees, who produce exceptional results for our investors and clients alike. PRA began operations in 1996 and has been a public company since November 2002. Since our initial public offering, our purchased portfolio has increased to $39.9 billion from $5.1 billion in face value, and our earnings have increased to $2.97 per diluted share from $0.94. At yearend 2008, we employed 2,032 people in eight office locations from Virginia to California. F in ancial Highl ight s (in thousands, except per share amounts) Revenues Operating income Net income Diluted earnings per share Weightedaverage shares (diluted) Operating margin Net margin Return on average equity Working capital Finance receivables, net Total assets Total debt Stockholders’ equity 2008 2007 2006 $ 263,275 $ 84,837 $ 45,362 2.97 $ 15,292 $ 220,748 $ 81,184 $ 48,241 3.06 $ 15,779 $ 188,322 $ 72,000 $ 44,490 2.77 $ 16,082 32.2% 17.2% 17.3% 36.8% 21.9% 19.8% 38.2% 23.6% 19.9% $ 11,549 $ 563,830 $ 657,840 $ 268,305 $ 283,863 $ 10,827 $ 410,297 $ 476,307 $ 168,103 $ 235,280 $ 18,981 $ 226,447 $ 293,378 $ 932 $ 247,278 1 DeAR FellOW SHAReHOlDeRS: last year’s economic meltdown tested the mettle of corporations and individuals alike. Hit hardest were our customers, who dealt with job and home equity losses that took dead aim at their sources of funds for paying bills. Your management team and Board navigated the Company through the prevailing fear and hysteria by seeking out the market opportuni ties that always appear during turbulent times. We also focused on improving the efficiency and effectiveness of our operations—a strat egy that always yields solid paybacks down the line. Over the years, for example, we have spent a great deal of time devising and updat ing what we believe are sensible, probable, and conservative models for use in our under writing, investing, and accounting functions. Those models have served us well. Before I turn to the particulars of 2008, let me say that our market and business fundamentals still look good—an encouraging sign since they have an important bearing on our ability to maximize shareholder value. Market conditions in our industry turned more favorable in 2007, accelerating in the second half of the year. For buyers of distressed debt who could properly execute, the turnaround opened up opportunities to realize exceptional longterm returns. During 2008, the supply of distressed debt skyrocketed as average credit card chargeoff rates increased over 40%. At the same time, buyer demand deteriorated, pummeled by the credit crunch. The combination of weakened demand and increased supply provided a compelling market oppor tunity that continues today. Wellcapitalized debt buyers with underwriting proficiency and proven, scalable operations can make portfolio investments capable of generating size able lifetime returns. I am pleased to say that PRA has the rare combination of available capital, robust pricing models, operating capacity, and expertise necessary to capitalize on these substantial opportunities. We intend to act quickly when they appear, but also prudently. As for business fundamentals, we feel strongly that the best way to navigate successfully through business cycles and changing conditions is to have diverse operations. We have achieved this diversity in two ways: by purchasing a broad spectrum of distressed consumer debt, including bankrupt accounts, and by purchasing and operating complementary businesses. In addition to our debtpurchasing operations, we run three feeforservice businesses: IGS, a collateral location and recovery enterprise that serves the auto finance industry; RDS, which provides revenue administration, audit, and collection ser vices for government agencies; and MuniServices, which specializes in revenue enhancement for government clients. The clients of these three busi nesses tend to use their services to a greater degree during economic downturns. As delinquency rates climb, auto finance companies need help more often with finding and recovering their collateral. And as the economy slows, so do tax revenues. That is when governments turn to com panies like RDS and MuniServices for help with identifying and capturing tax dollars owed to them. We intend to continue growing our fee businesses organically and through tuckin acquisitions. last year, for example, we purchased the assets of Broussard Partners, a provider of audit services to local tax authorities in louisiana, and folded this business into RDS. We also continue to scour the market for other interesting fee businesses to add to our company. Some of the same market forces that have pushed distresseddebt prices lower have also made business acquisitions better priced and more compelling than we have seen in some time. Now for 2008. last year was the first time in our 13year history that we did not produce net income growth. It was the first time since we went public in 2002 that we did not generate return on equity of 20% or better. So from a shortterm view of financial performance, PRA fell short of its targets. 2 Steve Fredrickson Chairman, President & Chief executive Officer From a longerterm perspective, however, I am ver y encouraged by what we were able to accomplish last year. Our employees made extraordinary efforts as we worked together to manage through an extremely difficult economic environment. We underwrote new portfolios with several added layers of conservatism, and we created significant portfolio diversification by buying large quantities of chargedoff and bankrupt accounts from many different sources. Although our productivity figures were down modestly yearoveryear, I feel this was due to the extraordinary eco nomic situation we confronted, not to our own missteps. In fact, we refined our collection scoring and segmentation models and tripled our automated dialing capacity during the year, allowing us to make millions of more calls, at a lower cost, to highervalue customers than we did in 2007. We also expanded our ability to pursue legal actions on our own behalf, rather than depending largely on thirdparty attorneys—and in so doing reduced our legal cost per account. These improvements to our ability to collect more efficiently and effectively helped soften the force of the economic headwinds faced by our collection operations. Without such significant operational improvements, I believe our results would have suffered much more. As noted earlier, we continued to diversify our lines of business in 2008, buying not only MuniServices, but the assets of Broussard Partners. Both companies brought experienced management teams, expanded product lines, new clients, and geographic diversification to our growing government services business. Revenue from our feefor service businesses totaled $56.8 million in 2008 compared with $7.1 million in 2004, the year we acquired IGS. Our fee businesses accounted for 22% of total revenues in 2008, up from 16% in 2007, and contributed a record 28% of total revenues in Q4 2008. For all of 2008, feebusiness revenue growth was 58%, even with our decision at midyear to cease operations of our contingentfee business, Anchor Receivables Management. Anchor’s results were determined to be continuously and inappropriately low relative to the employees and infrastructure deployed in that business. We redeployed essentially all employees from this unit to our ownedportfolio collections operation, where they are producing substantially improved returns for the Company. PRA’s fee businesses are well positioned to continue pros pering in the difficult economic environment we now face. While we did many things well in 2008, we also took some actions that turned out to be less than optimal. In 2007, as we saw portfolio pricing begin to fall, we began buying in larger quantities. In doing so we misread the pace at which pricing would continue falling throughout the year and into 2008. We locked into several forward flows during 2007 and early 2008 that will be less profitable than what we might have obtained had we postponed that buying. This lower expectation has already been reflected in our eRC forecasts and is clearly visible when comparing our 2006–2008 eRC to purchase price multiples. Unfortunately, we have no per fect crystal ball to use in making such decisions. Our only tools are study and discussion; then we have to live with the consequences. Right now, we don’t know when and at what pace economic conditions will improve, and what will happen to collectability and purchase pricing at that time. Consequently, we are underwriting assuming a protracted downturn without a return to historical collection heights. As always, in each quarter we will compare our assump tions to our actual collection results, and change our future assumptions accordingly. We also will continue to update the investment community about our performance to date and about our expectations. I can assure you that PRA’s management team is focusing on the right things, including prudent and accurate under writing, daily execution, capital availability, and employee recruitment and retention. I look forward to sharing with you the progress we make in 2009 and beyond. Steve Fredrickson Chairman, President & Chief executive Officer 3 OPeR ATING PRINCIPleS FOR T He M A N AGeMeN T OF P OR T FOl IO ReCOV eR Y A S S OCI AT e S The current year will undoubtedly offer more of the same chal lenges we faced in 2008. Yet with all the turmoil, risk, and failure served up in times like this, opportunities abound. Competitors become fewer. Asset pricing becomes more attractive. Talented employees become easier to attract and retain. By relying on our wellestablished Operating Principles, we are determined to exit this economic downturn stronger than ever. These are the same ideals we have published in each annual report dating back to 2002. On the following pages we will go through each principle and let you know what we have been doing to carry it out. 4 1—Disclose. Be HONeST AND OPeN WITH SHAReHOlDeRS. leT THeM kNOW WHAT IS GOING ON. 2—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. 3—Keep the business simple. OPeRATe FeWeR, lARGeR CAll CeNTeRS. 4—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. 5—maintain a conservative capital structure. AllOW ROOM FOR eRROR. keeP DeBT leVelS lOW. WHeN BORROWING IS ReQUIReD BeCAUSe OF OPPORTUNITY, USe lOWCOST, NONPARTICIPATING DeBT. 6—builD an integrateD business. PORTFOlIO BUYING AND COlleC TIONS MUST Be UNDeR THe SAMe ROOF. 7—employ steaDy, controlleD growth. We OPeRATe PROCeSS AND PeOPle INTeNSIVe BUSINeSSeS. exPeRIeNCeD eMPlOYeeS ARe SIG NIFICANTlY 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. 8—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. 9—Develop anD support employees. PROVIDe AND SUPPORT ONGOING eMPlOYee SkIll DeVelOPMeNT TO HelP CReATe eVeRINCReASING leVelS OF INDIVIDUAl POTeNTIAl WITH HIGH leVelS OF PeRFORMANCe FOR CONTINUING PeRSONAl AND COMPANY GROWTH. 5 1 DISClOS e Be HONeST AND OPeN WITH SHAReHOlDeRS. leT THeM kNOW WHAT IS GOING ON. A company’s operations should be transparent to the company’s owners. Unfortunately, recent history has way too many examples of companies that fail to fulfill this critical responsibility. We always try to approach the issue of disclosure from a position of “why not” as opposed to “why.” As a result, PRA has been an industry leader in the transparent disclosure of coherent financial metrics. Disclosure goes beyond filing required reports each quarter. It also includes fully answering investor questions after each quarterly earnings report, whether those questions are friendly or otherwise. It means being honest and letting investors know what you know, when you know it, and what you are unsure of. Companies that don’t have the time or appetite for the exercise quite frankly shouldn’t be public. For investors to fully understand our company’s performance, they need to see not just the basic financial results, but also a careful analysis of our static pool results (i.e., results for all pools acquired during a calendar year) and amortization rate dynamics. Our supplemental data disclosure provides this clarity, enabling investors to identify return multiples and revenue recognition trends. We will continue to provide regular updates to this data in each of our quarterly filings. During 2008 cash collections increased 25% to a record $326.7 million. Collections on our purchased bankruptcy pools grew 110% to $56.8 million, while collections on our core charged off pools grew 15% to $269.9 million. However, for the period 2006–2008, eRCtopurchase price multiples are the lowest in the Company’s history, reflecting the difficult pricing environment of 2006 and the increasingly difficult collections environment we have faced since 2007. Time will prove whether we will be able to extract upside from the 2007 and 2008 pools. Our lower eRC ratios resulted in higher amortization rates, which in turn reduced the propor tion of cash collections we recognized as revenue. This effect, combined with increased collec tion costs resulting from the tougher operating environment, and higher interest expense resulting from our substantial borrowing increase, explain our 6% decrease in net income to $45.4 million in 2008. The following two tables show the cash collections made on our bankruptcy and chargedoff portfolios in each year, by year of portfolio purchase. Other pool performance data is provided on pages 38 and 40 of the enclosed 10k. Our cash collections increased 25% while our cash receipts increased 29% and our net income decreased 6% during 2008. 6 Cash Collections by Year, by Year of Purchase—Purchased Bankruptcy Portfolio Only ($ in thousands) Purchase Period Purchase Price 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Total Cash Collection Period $ — $ — $ — $ — $ — $ — $ — $ — $ — $ — $ — $ — $ — $ — — — — — — — 7,469 29,302 17,643 78,933 111,063 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — 743 — — — — — — — — — — — — — — — — — — — — — — — — — — $ — $ — $ — $ — $ — $ — $ — $ — — — — — — — — 4,554 3,777 — — — 3,956 2,777 1,455 $ 13,485 15,500 11,934 6,845 $ 38,056 5,608 — — 9,455 2,850 6,522 $ 21,585 27,972 $ 30,822 — 14,024 $ 14,024 Total $ 244,410 $ — $ — $ — $ — $ — $ — $ — $ — $ 743 $ 8,331 $ 25,064 $ 27,016 $ 56,818 $ 117,972 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 2006 2007 2008 Total Cash Collection Period $ 3,080 $ 548 $ 2,484 $ 1,890 $ 1,348 $ 1,025 $ 730 $ 496 $ 398 $ 285 $ 210 $ 237 $ 102 $ 83 $ 9,836 5,215 3,776 4,069 6,807 3,347 6,398 2,630 5,152 5,138 13,069 12,090 1,829 3,948 9,598 1,324 2,797 7,336 1,022 2,200 5,615 860 1,811 4,352 6,894 19,498 19,478 16,628 14,098 10,924 597 1,415 3,032 8,067 437 882 2,243 5,202 346 $ 24,183 616 $ 35,802 1,533 $ 64,006 3,604 $ 104,393 7,685 — 2,507 11,089 18,898 25,020 33,481 42,325 61,449 51,709 113,911 90,159 179,839 167,448 — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — — 13,048 28,831 28,003 26,717 22,639 16,048 10,011 6,164 $ 151,461 — — — — — — — — 15,073 36,258 35,742 32,497 24,729 16,527 9,772 $ 170,598 — — — — — — — — — — — — 24,308 49,706 52,640 43,728 30,695 18,818 $ 219,895 — — — — — 17,276 41,921 36,468 27,973 17,884 $ 141,522 — — — — 15,191 59,645 57,928 42,731 $ 175,495 — — — 17,363 43,737 34,038 $ 95,138 — — 39,413 87,039 $ 126,452 — 47,253 $ 47,253 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Total $ 806,093 $ 548 $ 4,991 $ 10,881 $ 17,362 $ 30,733 $ 53,148 $ 79,253 $ 117,052 $ 152,661 $ 183,045 $ 211,329 $ 235,150 $ 269,881 $ 1,366,034 7 2 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. During 2008 we benefited from the continued decline in portfolio purchase prices. As the underlying collection environment became more difficult during the year, we underwrote our deals more conservatively by incorporating lower cash flow assumptions into our models and increasing our returnrate hurdle to further compensate for the increased economic risk. Through careful monitoring of the economy and its impact on cash flow, we attempted to keep our adjustments to collections ahead of the weakening economy, anticipating further softening. For the year, we invested a total of $280.3 million in new portfolios. Purchasing was diversified between bankruptcy portfolios ($113.1 million, or 40%) and chargedoff portfolios ($167.2 million, or 60%). Within the chargedoff portfolios, purchasing was distributed across different recall classifications (the number of rounds of post chargeoff collections the accounts had already gone through). The graph below shows the percentage distribution of our portfolio investment each year by type of paper purchased. As you can see, we are an opportunistic buyer who will shift our investment from year to year to capitalize on those market segments that we feel offer the best riskreward characteristics. INVESTMENT PERCE NTAGE BY PAPER TYPE 100 80 60 40 20 0 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 Warehouse Quad/Quint Tertiary Mixed Secondary Primary Fresh Paying Legal/Judgment BK Trustees a96 a97 a98 a99 a00 a01 a02 a03 a04 a05 a06 a07 a08 8 100 80 60 40 20 0 We hold ourselves to the same standards of careful investing when buying businesses as we do when buying portfolios of bad debt. Our goal is to build an increasingly diverse revenue and income stream for the Company. During 2008 we significantly expanded our presence in the government revenue administration market by acquiring MuniServices and the contracts and employees of Broussard Partners. Despite the cessation of our Anchor Receivables Management business during Q2 and the resulting loss of revenue, we were still able to grow feeforservice revenue to a record $18.9 million in Q4 2008. In fact, during this quarter, the revenue and net operating income (i.e., earnings before interest and taxes) attributable to our feeforservice businesses were similar to the corresponding results for the entire Company in Q4 of 2002, our first reporting period as a public company. The growth in our fee business is not an accident, but rather a deliberate strategy we have deployed consistently for years. The diversity of our fee businesses permits the Company to grow more steadily and minimize concentration risk from any single market in which we compete. These businesses can give us added growth when the debtpurchase markets may offer less, while requiring little of our precious capital to fund their expansion. We intend to continue to build our fee businesses through positive and negative economic cycles, further diversifying our activities and the markets and clients we serve. Courtesy of the NASDAQ OMx Group 9 3 keeP THe BUSINeSS SIMPle OPeRATe FeWeR, lARGeR CAll CeNTeRS. Amen. Fully leverage the capabilities of great managers, physical facilities, and network hardware and connectivity, plus corporate support services such as Accounting, Informa tion Technology, and Human Resources. Our Norfolk campus now houses more than 800 employees, organized into groups with manageable sizes. We prefer 14person collection units reporting to a single manager, with 9 managers reporting to an Assistant Vice President. These 126person groups are large enough to allow for great diversity in skill sets, schedul ing capabilities, and absenteeism coverage, but small enough to permit strong personal bonds, effective communication, and a sense of belonging and contribution. In our Hampton, Virginia call center, almost 230 owned portfolio collectors are organized into two teams, with each reporting to an Assistant Vice President. There is a similarly sized and managed group in jackson, Tennessee, and a 190collector group in Hutchinson kansas, split roughly into two equal teams. With the transition of employees from Anchor to PRA, we have some 50 collectors working in Birmingham, Alabama. each of our ownedportfolio collection offices works similar accounts, on the same computer systems, using standardized processes. With hopes of capitalizing on a significant labor cost arbitrage, we opened a test center in the Philippines in March 2008, anticipating solid growth. At yearend, its performance had not improved to required levels, so we have not expanded this experiment. During 2009 we anticipate either making satisfac tory headway in improving performance there or discontinu ing the experiment altogether. Our main IGS call center in las Vegas is at capacity with 150 employees. Therefore, we will be moving the business to a new 30,000 squarefoot operations center in April of 2009 in order to support its continued growth. RDS has about 60 employees in Birmingham, Alabama, Broussard Partners in Houston, Texas, employs 24, and MuniServices has approxi mately 120 employees, most of whom are located at its Fresno, California, headquarters. 10 keeP COSTS lOW AND PRODUCTIVIT Y HIGH 4 DeVelOP AND ReTAIN GReAT eMPlOYeeS. keeP SUPPORT STAFF AS SMAll AS POSSIBle, WHIle PROVIDING exCel leNT SeRVICe TO THe COlleCTION OPeRATION. Although we pride ourselves on continuous vigilance over expenses, nothing focuses a man agement team on lowering costs and increasing productivity like a recession. A tougher collection environment generally causes lower productivity and higher costs, since collectors must work harder on each account to arrange realistic payments with customers. As the graph at the bottom of this page shows, our hourly productivity, as measured in dollars collected per hour paid, peaked in 2006 before falling about 7% in 2007 and then a further 3% in 2008. We regard these declines as rather modest given the economic environment of the past two years and the substantial growth in our collection staff, which depresses short term productivity. We implemented several major productivity initiatives during 2008. To dramatically increase the phone call production of our employees, we invested heavily in predictive dialer systems. By yearend, we were making seven times the number of phone calls per month that we had made just a year earlier. Without this investment, we feel, we would have seen a greater falloff in productivity than we actually experienced. We also improved upon our already robust ability to segment our portfolio, an action that helps us to better allocate precious collection resources to our highestvalue accounts. In addition, we focused intensely on optimizing our return on investment from each slice of our portfolio and each type of collection action we took. These initiatives were vital to offset the economy’s depressive effect on our cash collections. The following graph shows total ownedportfolio collector hours paid, together with several hourly productivity measures from 1998 through 2008. HO URLY PRODUCTIVITY VS. HOUR S PA ID (collections per hour paid in dollars) r H / d e r e v o c e R $ $150 120 90 60 30 2,500,000 $131.29 2,000,000 $96.95 H o u r s P a i d 1,500,000 1,000,000 500,000 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 0 ’08 a98 a99 a00 a01 a02 a03 a04 a05 a06 a07 a08 Hours Paid $ Recovered/Hr Paid $ Recovered/Hr Paid WO Legal 11 a98 a99 a00 a01 a02 a03 a04 a05 a06 a07 a08 150 120 90 60 30 2500 2000 1500 1000 500 0 5 MAINTAIN A CONSeRVATIVe CAPITAl STRUCTURe AllOW ROOM FOR eRROR. keeP DeBT leVelS lOW. WHeN BORROWING IS ReQUIReD BeCAUSe OF OPPORTUNITY, USe lOWCOST, NONPARTICIPATING DeBT. Operating essentially debtfree from the end of 2002 through early 2007, we decided to utilize financial leverage to amplify returns to our shareholders. We continued and expanded this practice in 2008, increasing our borrowings to $268.3 million from $168.0 million at the end of 2007. By yearend we were enjoying a fully loaded borrowing cost of about 1.86% on the $218.3 million portion of this debt on our credit line, which dramatically lowers our weighted average cost of capital. Our credit line borrowing rate is equal to 30day lIBOR plus 1.40%. An interest rate swap executed in 2008 fixes our lIBOR index at 1.89% for a $50.0 million portion of our credit line from january 2010 through May 2011, yielding a total future borrowing cost of 3.29% on that segment. Another $50.0 million of our debt is priced at a 6.80% fixed rate through mid2012. With a current debttoequity ratio of about 95%, we consider our debt load highly manageable and conservative. Importantly, we are using our borrowing power to acquire wellpriced pools of chargedoff and bankruptcy debt during a time when we feel market forces are creating extraordinary opportunities. As we acquire new pools of accounts, and layer these purchases year after year, we create an annuity stream of longlasting cash flow that is more than sufficient to meet our debt service obligations. We used the additional $100 million we borrowed in 2008, together with internal cash flow, to 1] purchase $280 million of chargedoff and bankrupt accounts, 2] acquire MuniServices and the assets of Broussard Partners for about $25 million, and 3] make $6 million in capital expenditures. We understand that with leverage comes risk. We intend to keep our leverage modest, and to use it only when it appropriately enhances riskadjusted returns to our shareholders. We feel that now is just such a time. Our current line of credit is a borrowing base–driven revolver with a maximum commitment of $365.0 million. Since this commitment extends through May of 2011, we presently see no need to further expand the line; however, we will be on the lookout for extraordinary opportunities that justify an increase. But we will not lose sight of our Operating Principle: Maintain a conservative capital structure. Allow room for error. keep debt levels low. 12 BUIlD AN INTeGRATeD BUSINeSS 6 PORTFOlIO BUYING AND COlleCTIONS MUST Be UNDeR THe SAMe ROOF. We continue to be huge believers in our integrated business model. We operate our own collection call centers because we feel underwriting, strategy, and collection must operate as a cohesive, coordinated set of functions. We are constantly experimenting with different collection techniques and processes, something we could never accomplish as effectively in an outsourced collection environment. What we learn about the portfolios stays within our walls, and is shared across collection sites so that collectors can quickly benefit from learning curve improvements without directly or indirectly educating our competitors. likewise, during challenging economic times such as these, it is more important than ever for our acquisition and underwriting staffs to obtain monthly, daily, and even hourly results from all of our pools and collection processes. This allows us to be highly responsive to collection trends as they evolve, increasing the accuracy of our underwriting projections. During 2008 we pushed integration even further by insourcing much of our legal collection work, eliminating our reliance upon the lowperforming portion of our thirdparty attorney network. By further expanding this internal capability, we believe we can improve our legal liquidation rates while maintaining a lower cost structure. Our philosophy of integration yields huge benefits in the form of feedback about control processes and collection results. It also widens our profit margins because we retain profit that would otherwise be paid to a thirdparty collector. OWNeD PORTFOlIO CASH COlleCTI ONS P eR P URCH ASe P eRI OD ($ in millions) $350 300 250 200 150 100 50 0 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 13 a96 a97 a98 a99 a00 a01 a02 a03 a04 a05 a06 a07 a08 350000 300000 250000 200000 150000 100000 50000 0 a08 a07 a06 a05 a04 a03 a02 a01 a00 a99 a98 a97 a96 7 eMPlOY STeADY, CONTROlleD GROW TH We OPeRATe PROCeSS AND PeOPle INTeNSIVe BUSI NeSSeS. exPeRIeNCeD eMPlOYeeS ARe SIGNIFICANTlY MORe PRODUCTIVe THAN NeWeR eMPlOYeeS. GROWING TOO QUICklY PUTS TOO MANY leSS PRODUCTIVe, lOWeR MARGIN PeOPle INTO THe WORkFORCe MIx, WHICH DRIVeS DOWN PRODUCTIVITY, MARGIN, AND NeT INCOMe. This principle required us to be more disciplined in 2008, given the significant opportunities we saw to invest in new baddebt portfolios. We must always balance the potential to profitably grow our business with the ability to maintain integrated operations. Our ownedportfolio collectors are well trained and generally become more productive as their tenure with us increases. As a result, during periods of greater increases in new collector staff, we suffer depressed productivity and compressed margins. This tradeoff was clearly evident during 2007 as we opened our new jackson, Tennessee, site and aggressively filled it with new employees. We have seen many competitors implode as a result of hypergrowth, so this principle is one of which we never lose sight. During 2008, we increased our ownedportfolio collection staff by 191 employees, or 18%. Although this was a large increase, we were able to raise the productivity of the new hires (along with that of our existing employees) by using improved scoring, port folio segmentation, and account strategy design, and by installing a significant number of predictive dialer seats. As opportunities continue to present themselves, we will be mindful to pursue them only to the extent that operational control and productivity do not suffer. PORTFOLIO PURCHASE S BY YEAR ($ in millions) $300 250 200 150 100 50 0 ’96 ’97 ’98 ’99 ’00 ’01 ’02 ’03 ’04 ’05 ’06 ’07 ’08 a96 a97 a98 a99 a00 a01 a02 a03 a04 a05 a06 a07 a08 300 250 200 150 100 50 0 14 MANAGeMeNT SHOUlD Be OWNeRS, NOT HIReD GUNS 8 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. The four named executive officers of the Company and the Board of Directors were together net buyers of PRA common stock during the year, exercising options and covering the exercise cost and taxes out of pocket. The Board of Directors has established common stock ownership guidelines for itself and senior executives. All named executive officers own in excess of the prescribed guidelines. PRA also has a strong bias towards having executives earn their pay—both cash and equity— instead of simply giving it to them. Since 2007 the Board of Directors has required that the majority of executive equity awards be triggered by the achievement of specific operating goals that are meant to be challenges, not layups. This approach, combined with the difficult economic environment, appears to be driving the 2007 longTerm Incentive plan to a zero payout, with similar prospects for the 2008 plan. PRA has never repriced its options or renegotiated equity incentives due to deteriorating market conditions. We simply don’t believe in it. likewise, we avoid executive perks of any kind that are not also offered to every other employee. Private plane use, country club dues, housing allowances, tax grossups, financial planning services, and even reserved parking spaces are simply not part of the PRA benefit scheme. Instead, we seek to pay fair cash com pensation based upon market conditions and performance, and let the executive decide how to spend his or her own money. This supports our principle of thinking and acting like owners. likewise, the management team has fair but not excessive employment contracts. The CeO’s base salary has been targeted at the 25th percentile of peer figures, with the ability to earn median total cash compensation through bonus only if goals are achieved. PRA prefers to put a large portion of pay at risk in the form of bonuses. That way, good performance can be rewarded, while substandard performance results in lowerthanaverage pay. The management team fully supports the notion that changeofcontrol severance clauses should not exist at PRA. Shareholders should not have to pay off management that is no longer deemed valuable in the further operation of the Company. Simply being an incumbent should provide no right to a windfall. We are owners, but we are managing your company. We do not forget that for a moment. 15 9 DeVelOP AND SUPPORT eMPlOYeeS PROVIDe AND SUPPORT ONGOING eMPlOYee SkIll DeVel OPMeNT TO HelP CReATe eVeRINCReASING le VelS OF INDIVIDUAl POTeNTIAl WITH HIGH leVelS OF PeR FORMANCe FOR CONTINUING PeRSONAl AND COMPANY GROWTH. just as the down economy creates opportunities to purchase companies and bad debt portfo lios, so too does it enhance the likelihood of attracting exceptional employees. In 2008 we hired a number of executives, managers, analysts, and hourly employees whom it would have been difficult, if not impossible for us to hire in better times. As lenders and others cut back or otherwise create uncertainty for their employees, we move in and acquire the very best talent we can find. Then we pay them right, treat them right, and watch them perform. PRA believes in investing in its people. In difficult times, many companies are quick to slash their training budgets to improve their bottom line. We know that this is a temporary fix with disastrous longterm consequences, and have taken the opposite approach. employees, especially those who have phone contact with customers, will only achieve their full potential if they are highly skilled and confident. Skill results from both natural ability and training, and confidence comes from practice. Our new collector training program provides weeks of regulatory, negotiation, and system instruction. employees then graduate into a side byside training phase, in which they practice collecting under close management supervision. They are then allocated to teams containing more seasoned associates who act as mentors. Finally, these employees participate in advanced collections training in order to keep their skills fresh throughout their careers. With over 1,200 collectors, the investment we make in such skill development is not insignificant, but we believe that it provides PRA with a sustain able competitive advantage. 16 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 8 F i n a n c i a l I n f o r m a t i o n 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 earnings, 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 20, 2009. 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. 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, 2008 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: Common Stock, $0.01 par value per share (Title of Class) Securities registered pursuant to Section 12(g) of the Act: None 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 (cid:59) Accelerated filer (cid:133) Non-accelerated filer (cid:133) Smaller reporting company (cid:133). Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). The aggregate market value of the common stock held by non-affiliates of the registrant as of June 30, 2008 was $556,412,722 based on the $37.50 closing price as reported on the NASDAQ Global Stock Market. YES (cid:133) NO (cid:59) The number of shares of the registrant’s Common Stock outstanding as of February 20, 2009 was 15,332,615. Documents incorporated by reference: Portions of the Proxy Statement to be filed by approximately April 22, 2009 for our 2009 Annual Meeting of Stockholders are incorporated by reference into Items 11, 12 and 13 of Part III of this Form 10-K. 1 Table of Contents Part 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 18 26 27 27 27 28 30 32 50 51 80 80 80 81 83 83 83 84 85 87 2 Cautionary Statements Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995: This report contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks, uncertainties and assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. All statements, other than statements of historical fact, are forward-looking statements, including statements regarding overall trends, operating cost trends, liquidity and capital needs and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. The risks, uncertainties and assumptions referred to above may include, but are not limited to, the following: • • • • • • • • • • • • • • • continued deterioration of the economic environment including the stability of the financial system; 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 or interpretation of tax laws; deterioration in economic conditions in the United States that may have an adverse effect on the our collections, results of operations, revenue and stock price; changes in bankruptcy or collection agency laws that could negatively affect our business; our ability to employ and retain qualified employees, especially collection personnel; our work force could become unionized in the future, which could adversely affect the stability of our production and increase our costs; changes in the credit or capital markets, which affect our ability to borrow money or raise capital to purchase or service defaulted consumer receivables; the degree and nature of our competition; our ability to comply with the provisions of the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder; our ability to retain existing clients and obtain new clients 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 (the “SEC”). 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. 3 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” section beginning on page 18, as well as “Business” section beginning on page 4 and the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” section beginning on page 32. 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. 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 contingent and fee-based services, including collateral-location services for credit originators via PRA Location Services, LLC (“IGS”) and revenue administration, audit and debt discovery/recovery services for government entities through PRA Government Services, LLC (“RDS”) and MuniServices, LLC (“MuniServices”). 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 purchased from sellers of defaulted consumer debt. 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. “Income Recognized on Finance Receivables” refers to income derived from our owned debt portfolios and is shown net of valuation allowances. “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, 2008, we acquired 1,290 portfolios with a face value of $39.9 billion for $1.1 billion, representing more than 19.1 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 twelve year period, which has enabled us to generate increasing profits and positive operational cash flow. 4 We have achieved strong financial results since our formation, with cash collections growing from $10.9 million in 1998 to $326.7 million in 2008. Total revenue has grown from $6.8 million in 1998 to $263.3 million in 2008, a compound annual growth rate of 44%. Similarly, pro forma net income has grown from $402,000 in 1998 to net income of $45.4 million in 2008. We were initially formed as Portfolio Recovery Associates, L.L.C., a Delaware limited liability company, on March 20, 1996. Prior to the formation of Portfolio Recovery Associates, Inc., members of our current management team played key roles in the development of a defaulted consumer receivables acquisition and divestiture operation for Household Recovery Services, a subsidiary of Household International, now owned by HSBC. In connection with our 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 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. The information that is filed with the SEC may be read or copied at the SEC’s Public Reference Room at 100 F Street, NE, Washington, DC 20549. In addition, information on the operation of the Public Reference Room may be obtained by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements and other information regarding issuers that file electronically with the SEC at: www.sec.gov. 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, Inc. 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 locate collateral on their behalf for either a fee-for-service or a success fee. We can purchase 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. Through our RDS and MuniServices businesses, we have the ability to provide these services to local and state 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 twelve year period, which has enabled us to generate increasing profits and operational cash flow. In order to price portfolios and forecast the targeted collection results for a portfolio, we use two separate internally 5 developed statistical models and one externally developed model, 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 and external models analyze 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, 2008, we have acquired 1,290 portfolios with a face value of $39.9 billion. Ability to Hire, Develop and Retain Productive Collectors We place considerable focus on our ability to hire, develop and retain effective collectors who are key to our continued growth and profitability. Several large military bases and numerous telemarketing, customer service and reservation phone centers are located near our headquarters and regional offices in Virginia, providing access to a large pool of eligible personnel. The Hutchinson, Kansas, Las Vegas, Nevada, Birmingham, Alabama, Jackson, Tennessee, Houston, Texas and Fresno, California 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, 2005 and 2006. We have a comprehensive 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 been unable 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. 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 6 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 accounts, deficiency balances of various types, legal judgments, and trade payables, all from a variety of debt owners. These debt owners include major banks, credit unions, consumer finance companies, telecommunication providers, retailers, utilities, insurance companies, 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, 2008 into the major asset types represented (amounts in thousands): Asset Type Visa/MasterCard/Discover Consumer Finance Private Label Credit Cards Auto Deficiency Total: No. of Accounts 10,954 4,955 2,681 484 19,074 % 57.4% 26.0% 14.1% 2.5% 100.0% Life to Date Purchased Face Value of Defaulted Consumer Receivables⁽¹⁾ $ 29,197,790 4,324,737 3,347,550 3,051,001 $ 39,921,078 % 73.2% 10.8% 8.4% 7.6% 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 consumer lenders in the United States. Since our formation, we have purchased accounts from approximately 150 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 660 days past due and charged-off, have been placed with two or three contingent fee servicers and receive even lower purchase prices. We also purchase accounts previously worked by four or more agencies and these are typically 1,260 days or more past due and receive an even lower price. In addition, we purchase accounts that are included in consumer bankruptcies. These bankrupt accounts are typically filed under 7 Chapter 13 of the U.S. Bankruptcy Code and have an associated payment plan that can range from 3 to 5 years. We purchase bankrupt accounts in both forward flow and spot transactions and consequently, they can be at any age in the bankruptcy plan life cycle. As shown in the following chart, as of December 31, 2008, we purchase accounts at any point in the delinquency cycle (amounts in thousands): Account Type No. of Accounts % Life to Date Purchased Face Value of Defaulted Consumer Receivables⁽¹⁾ Fresh Primary Secondary Tertiary BK Trustees Other Total: 783 4.1% $ 2,897,585 2,396 12.6% 4,086,581 3,272 17.2% 5,039,470 3,672 19.3% 4,633,690 2,053 10.7% 8,631,036 6,898 36.1% 14,632,716 % 7.3% 10.2% 12.6% 11.6% 21.6% 36.7% 19,074 100.0% $ 39,921,078 100.0% (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. 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, 2008 (amounts in thousands): Geographic Distribution Texas California Florida New York Pennsylvania North Carolina Illinois Ohio Georgia New Jersey Michigan Virginia Massachusetts Tennessee South Carolina Arizona Other (3) No. of Accounts 3,321 1,838 1,446 1,144 658 660 763 639 576 445 487 504 352 387 338 291 Life to Date Purchased Face Value of Defaulted Consumer Receivables (1) $ 5,042,635 4,745,725 3,834,238 2,686,008 1,591,432 1,399,197 1,354,505 1,331,921 1,254,007 1,213,562 1,005,867 835,264 824,884 821,304 755,429 736,685 % 17% 10% 8% 6% 3% 3% 4% 3% 3% 2% 3% 3% 2% 2% 2% 2% Original Purchase Price of Defaulted Consumer Receivables (2) $ 113,280 110,357 90,289 69,125 46,224 37,896 41,385 44,583 41,698 31,934 33,127 24,947 21,500 27,617 20,246 17,268 % 13% 12% 10% 7% 4% 4% 3% 3% 3% 3% 3% 2% 2% 2% 2% 2% % 11% 10% 8% 6% 4% 4% 4% 4% 4% 3% 3% 2% 2% 3% 2% 2% Total: 5,225 28% 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. 10,488,415 39,921,078 $ 25% 100% 27% 100% $ 1,071,963 300,487 19,074 (2) The “Original Purchase Price of Defaulted Consumer Receivables” represents the cash paid to sellers to acquire portfolios of defaulted consumer receivables. (3) Each state included in "Other" represents less than 2% of the face value of total defaulted consumer receivables. 8 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, take bids and negotiate the terms of sale. 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 adhered to, the contract will allow for the early termination of the forward flow contract by the purchaser or call for a price renegotiation. 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 and one externally developed model, 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. Finally, we use a model that creates statistically similar portfolios from our existing accounts and develops collection curves for them that are used in our price modeling. 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. Finally, we use the statistically similar portfolio analysis model to refine our curves. Using the three 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 and expenses 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. 9 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 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, President and Chief Executive Officer, Kevin Stevenson, Executive Vice President, Chief Financial and Administrative Officer, Craig Grube, Executive Vice President – Acquisitions, Mike Petit, President, Bankruptcy Services and Neal Stern, Senior Vice President and Chief Operating Officer – Owned Portfolios. Due to travel arrangements, alternates can be named from time to time. 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 collectability forecast for a newly acquired portfolio will help determine our initial 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. After owning an account for a month we begin reassessing the collectability on a daily basis based on a set of observed account behaviors. 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. 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 which enables us to make 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. 10 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. During 2004, we began using a combination of internal staff (attorney and support), as well as external attorneys, to pursue legal collections in certain states and under certain circumstances. This has grown to over 40 states, utilizing the lower courts, in which we initiate law suits in amounts up to the jurisdictional limits of the respective courts. This distribution channel allows us to work accounts that we would not normally pursue through the use of contingent fee collection attorneys because of cost. Our legal recovery department also collects claims against estates in cases involving deceased debtors having assets at the time of death. 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 50 independent law firms who work on a flat fee or contingent fee basis. Legal cash collections generated by both our in house attorneys and outside independent contingent fee attorneys constituted approximately 28% of our total cash collections in 2008. 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. Our bankruptcy department manages consumer filings under the U.S. Bankruptcy Code on debtor accounts derived from three sources; 1) the company’s purchased pools of charged off and delinquent accounts, 2) our purchased pools of bankrupt accounts, and 3) our third party servicing client relationships. On company owned accounts, we file proofs of claim (“POCs”) or claim transfers and actively manage these accounts through the entire life cycle of the bankruptcy proceeding in order to substantiate our claims and ensure that we participate in any distributions to creditors. On accounts managed under a third party relationship, we work on either a full service contingency fee basis or a menu style fee for service basis. We developed our proprietary Bankruptcy Management System (“BMS”) as a secure and highly automated platform for providing bankruptcy notification services, filing POCs and claim transfers, managing documents, administering our case load, posting and reconciling payments and providing customized reports. BMS is a robust system designed to manage claims processing and case management in a high volume environment. The system is highly flexible and its capacity is easily expanded. Daily processing volumes are managed to meet individual bar dates associated with each bankruptcy case and specific client turnaround times. BMS and its underlying business rules were developed with emphasis first on minimizing risks through strict compliance to the bankruptcy code, then on maximizing recoveries from automated claim filing and case administration. Each of our employees goes through an entry level training program to familiarize them with BMS and the bankruptcy process, including a general overview of how we interact with the courts, debtor’s attorneys and trustees. We also use a tiered process of cross training designed to familiarize advancing employees with a variety of operational assignments and analytical tasks. For example, we utilize specially trained employees to perform advanced data matching and analytics for clients, while others are tasked with resolving objections directly with attorneys and trustees. In rare circumstances, resolution to these objections may need to be affected by working through our network of local counsel. 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 ARM third-party contingent fee collections operation 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 twelve months. At the end of this fixed period, the third-party agency will return the uncollected defaulted consumer receivables to the 11 debt owner, which may then place the defaulted consumer receivables with another collection agency or sell the portfolio of receivables. We discontinued our ARM contingent fee operation during the second quarter of 2008. 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 national skip tracing, asset location and collateral recovery 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 and a resolution on the account occurred, 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 create a positive resolution on the account. For RDS and MuniServices, our government processing and collection businesses, their 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 audits are conducted, 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 the line item “Commissions” and the expense is included in the line item “Compensation and employee services.” The second item is for expenses incurred while conducting the audit. Most jurisdictions will reimburse us for direct expenses incurred for the audit including such items as travel and meals. The billed amounts are included in the line item “Commissions” and the expense component is included in its appropriate expense category, generally, “Other operating expenses.” 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 and our ability to collect on various asset types. 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. 12 Information Technology Technology Operating Systems and Server Platform The architecture and design 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 Microsoft Windows 2000/2003 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 software systems are being leveraged to manage location information and operational applications for MuniServices, 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 PRA being able to operate nationwide in a cost-effective manner. Our centralized computer-based information systems support the core processing functions of our business under a set of integrated databases and are designed to be both replicable and scalable to accommodate our internal growth. This integrated approach helps to assure that data 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 and Oracle 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. MuniServices, IGS and RDS all maintain unique, proprietary software systems that manage the movement of data, accounts and information throughout these business units. We believe these systems will be sufficient for our needs in the foreseeable future. Redundancy, System Backup, Security and Disaster Recovery Our data centers provide the infrastructure for collection services and uninterrupted support of data, applications and hardware for all of our business units. 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, Kansas, Alabama and Tennessee in order to help provide redundancy for data and processes should one site be completely disabled. We have a 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 telecommunications feeds, uninterruptible power supplies and natural gas and diesel-generators, all of which provide a level of redundancy should a power outage or interruption occur. We also have generators installed at each of our remote call centers, as well as our subsidiary locations in Alabama and as of April 2009, Nevada. 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. 13 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. Predictive Dialer Technology The Avaya Proactive Contact Dialer ensures that our collection staff focuses on certain defaulted consumer receivables according to our specifications. Its predictive technology takes into account all campaign and dialing parameters and is able to automatically adjust its dialing pace to match changes in campaign conditions and provide the lowest possible wait times and abandon rates, with the highest volume of outbound calls. In addition, the dialer allows our collectors to handle only live voice calls by leaving automated messages on all calls where answering machines are detected. This feature allows our representatives to speak with more debtors per agent hour, and also increases our inbound call volume. Employees We employed 2,032 persons on a full-time basis, including the following number of front line operations employees by business: 1,478 on our owned portfolios, 158 working in our IGS operations, 67 working in our RDS government collections operation, and 71 working in our MuniServices operations, as of December 31, 2008. None of our employees are represented by a union or covered by a collective bargaining agreement. We believe that our relations with our employees are good. Hiring We recognize that our collectors are critical to the success of our business as a majority of our collection efforts occur as a result of telephone contact with consumers. We have found that the tenure and productivity of our collectors are directly related. Therefore, attracting, hiring, training, retaining and motivating our collection personnel is a major focus for us. We pay our collectors competitive wages and offer employees a full benefits program which includes comprehensive medical coverage, short and long term disability, life insurance, dental and vision coverage, pre-paid legal plan, an employee assistance program, supplemental indemnity, cancer, hospitalization, accident insurance, a flexible spending account for child care and a matching 401(k) program. In addition to a base wage, we provide collectors with the opportunity to receive unlimited compensation through an incentive compensation program that pays bonuses above a set monthly base, based upon each collector's collection results. This program is designed to ensure that employees are paid based not only on performance, but also on consistency. We have awarded stock based compensation to many of our tenured collectors. We believe that these practices have helped us achieve an annual post-training turnover rate of 59% in 2008. 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 several military bases 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, Birmingham, Alabama, Jackson, Tennessee, Houston, Texas and Fresno, California areas to provide a large potential workforce of eligible personnel. Training We provide a comprehensive multi-week training program for all new owned portfolio collectors. The first 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 additional 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, as well as once a year thereafter. In addition, we conduct continuing advanced classes in our four training centers. Our 14 technology and systems allow us to monitor individual employees and then offer additional training in areas of deficiency to increase productivity and ensure compliance. Outsourced Collections Department 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. Additionally, we review accounts using a proprietary scoring model and select those accounts reflecting a high propensity to pay in a legal environment. 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. During 2004, we began using a combination of internal staff (attorney and support), as well as external attorneys, to pursue legal collections in certain states and under certain circumstances. This has grown to 40 states, utilizing the lower courts, in which we initiate law suits in amounts up to the jurisdictional limits of the respective courts. This distribution channel allows us to work accounts that we would not normally pursue through the use of contingent fee collection attorneys because of cost. Our legal recovery department also collects claims against estates in cases involving deceased debtors having assets at the time of death. 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 50 independent law firms, all of which work on a contingent fee basis. Legal cash collections generated by both our in house attorneys and outside independent contingent fee attorneys constituted approximately 28% of our total cash collections in 2008. 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. Bankruptcy Our bankruptcy department manages consumer filings under the U.S. Bankruptcy Code on debtor accounts derived from three sources; 1) the company’s purchased pools of charged off and delinquent accounts, 2) our purchased pools of bankrupt accounts, and 3) our third party servicing client relationships. On company owned accounts, we file proofs of claim (“POCs”) or claim transfers and actively manage these accounts through the entire life cycle of the bankruptcy proceeding in order to substantiate our claims and ensure that we participate in any distributions to creditors. On accounts managed under a third party relationship, we work on either a full service contingency fee basis or a menu style fee for service basis. We developed our proprietary Bankruptcy Management System (“BMS”) as a secure and highly automated platform for providing bankruptcy notification services, filing POCs and claim transfers, managing documents, administering our case load, posting and reconciling payments and providing customized reports. BMS is a robust system designed to manage claims processing and case management in a high volume environment. The system is highly flexible and its capacity is easily expanded. Daily processing volumes are managed to meet individual bar dates associated with each bankruptcy case and specific client turnaround times. BMS and its underlying business rules were developed with emphasis first on minimizing risks through strict compliance to the bankruptcy code, then on maximizing recoveries from automated claim filing and case administration. Each of our employees goes through an entry level training program to familiarize them with BMS and the bankruptcy process, including a general overview of how we interact with the courts, debtor’s attorneys and trustees. We also use a tiered process of cross training designed to familiarize advancing employees with a variety of operational assignments and analytical tasks. For example, we utilize specially trained employees to perform advanced data matching and analytics for clients, while others are tasked with resolving objections directly with attorneys and trustees. In rare circumstances, resolution to these objections may need to be affected by working through our network of local counsel. 15 Corporate Legal Department Our corporate legal department manages general corporate governance, litigation management, insurance and risk management, corporate transactions, intellectual property, contract and document preparation and review, including real estate purchase and lease agreements and portfolio purchase documents, compliance with federal securities laws and other regulations and statutes, 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 Code of Ethics. In that connection, we have implemented companywide ethics training and mandatory ethics quizzes and 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 Code of Ethics policy is available at the Investor Relations page of our website. Our corporate legal department also provides guidance to our quality control department and assists with training our staff in relevant areas including 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. This includes overseeing the letter process and approving all communications to account debtors. 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 skip-tracing or collecting accounts. Regulation Federal and state statutes establish specific guidelines and procedures which debt collectors must follow when collecting consumer accounts. It is our policy to comply with the provisions of all applicable federal laws and comparable state statutes in all of our recovery activities, even in circumstances in which we may not be specifically subject to these laws. Our failure to comply with these laws could have a material adverse effect on us in the event and to the extent that they apply to some or all of our recovery activities. Federal and state 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 and a right to sue debt collectors who fail to comply with its provisions, including the right to recover their attorney fees. • 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 to prevent such information from being furnished to credit reporting agencies. • 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. 16 • Electronic Funds Transfer Act. This act regulates the use of the Automated Clearing House ("ACH") system to make electronic funds transfers. All ACH transactions must comply with the rules of the National Automated Check Clearing House Association ("NACHA") and Uniform Commercial Code § 3-402. This act, the NACHA regulations and the Uniform Commercial Code give the consumer, among other things, certain privacy rights with respect to the transactions, the right to stop payments on a pre-approved fund transfer, and the right to receive certain documentation of the transaction. This act also gives consumers a right to sue institutions which cause financial damages as a result of their failure to comply with its provisions. • Telephone Consumer Protection Act. In the process of collecting accounts, we use automated predictive dialers to place calls to consumers. This act and similar state laws place certain restrictions on telemarketers and users of automated dialing equipment who place telephone calls to consumers. • Servicemembers Civil Relief Act. The Soldiers’ and Sailors’ Civil Relief Act of 1940 was amended in December 2003 as the Servicemembers Civil Relief Act (“SCRA”). The SCRA gives U.S. military service personnel relief from credit obligations they may have incurred prior to entering military service, and may also apply in certain circumstances to obligations and liabilities incurred by a servicemember while serving on active duty. The SCRA prohibits creditors from taking specified actions to collect the defaulted accounts of servicemembers. The SCRA impacts many different types of credit obligations, including installment contracts and court proceedings, and tolls the statute of limitations during the time that the servicemember is engaged in active military service. The SCRA also places a cap on interest bearing obligations of servicemembers to an amount not greater than 6% per year, inclusive of all related charges and fees. • Health Insurance Portability and Accountability Act. The Health Insurance Portability and Accountability Act (“HIPAA”) provides standards to protect the confidentiality of patients’ personal healthcare and financial information. Pursuant to HIPAA, business associates of health care providers, such as agencies which collect healthcare receivables, must comply with certain privacy and security standards established by HIPAA to ensure that the information provided will be safeguarded from misuse. This act is enforced by the Department of Health and Human Services and does not afford a private cause of action to consumers who may wish to pursue legal action against an institution for violations of this act. • 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 some state 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 17 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 owners are required to replace the receivables with similar receivables or repurchase the receivables. These provisions limit to some extent our losses on such accounts. In addition to our obligation to comply with applicable federal, state and local laws and regulations, we are also obligated to comply with judicial decisions reached in court cases involving legislation passed by any such governmental bodies. Item 1A. Risk Factors. To the extent not described elsewhere in this Annual Report, the following are risks related to our business. A deterioration in economic conditions in the United States may have an adverse effect on our collections, results of operations, revenue and stock price Our performance may be affected by economic conditions in the United States. If the United States economy deteriorates, personal bankruptcy filings may increase, and the ability of consumers to pay their debts could be adversely affected. This may in turn adversely impact our financial condition, results of operations, revenue and stock price. Other factors associated with the economy that could influence our performance include the financial stability of the lenders on our line of credit, our access to credit, and financial factors affecting consumers. The current financial turmoil affecting the banking system and financial markets and the possibility that financial institutions may consolidate, go out of business or be taken over by the federal government have resulted in a tightening in credit markets. There could be a number of follow-on effects from the credit crisis and/or the federal government’s response to the credit crisis on our business, including a decrease in the value of the our financial investments, the insolvency of lending institutions, including the lenders on our line of credit, resulting in our inability to obtain credit, and the inability of our customers to obtain credit to re-finance their obligations with us. These and other economic factors could have a material adverse effect on our financial condition and results of operations. 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. 18 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 be unable to obtain account documents for some of the accounts that we purchase. Our inability to provide account documents on accounts that are subject to judicial collections may negatively impact the liquidation rate on these accounts When we collect accounts judicially, courts in certain jurisdictions require that a copy of the account statements or applications be attached to the pleadings in order to obtain a judgment against the account debtors. If we are unable to produce account documents, these courts will deny our claims. 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. Our work force could become unionized in the future, which could adversely affect the stability of our production and increase our costs Currently, none of our employees are represented by unions. However, our employees have the right at any time under the National Labor Relations Act to form or affiliate with a union. If some or all of our workforce were to become unionized and the terms of the collective bargaining agreement were significantly different from our current compensation arrangements, it could adversely affect the stability of our work force and increase our costs. In 2007, the Employee Free Choice Act H.R. 800 ("EFCA") was passed in the U.S. House of Representatives, and currently remains in the Senate. The EFCA aims to amend the National Labor Relations Act, by making it easier for workers to organize unions and increasing the penalties employers may incur if they engage in labor practices in violation of the National Labor Relations Act. The EFCA requires the National Labor Relations Board ("NLRB") to review petitions filed by employees for the purpose of creating a labor organization and to certify a bargaining representative without directing an election, if a majority of the bargaining unit employees have authorized designation of the representative. The EFCA also requires the parties to begin bargaining within 10 days of the receipt of the petition, or longer time if mutually agreed upon. EFCA would also require the NLRB to seek a federal injunction against an employer whenever there is reasonable cause to believe that the employer has discharged or discriminated against an employee to encourage or discourage membership in the labor organization, threatened to discharge or otherwise discriminate against an employee in order to interfere with, restrain, or coerce employees in the exercise of guaranteed collective bargaining rights, or engaged in any other related unfair labor practice that significantly interferes with, restrains, or coerces employees in the exercise of such guaranteed rights. The EFCA adds additional remedies for such violations, including back pay plus liquidated damages and civil penalties to be determined by the NLRB not to exceed $20,000 per infraction. This bill or a variation of it could be enacted in the future and could have an adverse impact on our operations. 19 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 multi-week training program, was 59% in 2008. 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 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 and potential changes to existing legislation, 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 20 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. 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, RDS or MuniServices customers could negatively affect our operations With respect to the acquisitions of IGS, RDS and MuniServices, a significant portion of the valuation was tied to existing client and customer 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 and customer relationships. We may not be able to continually replace our defaulted consumer receivables with additional receivables portfolios sufficient to operate efficiently and profitably To operate profitably, we must continually acquire and service a sufficient amount of defaulted consumer receivables to generate revenue that exceeds our expenses. Fixed costs such as salaries and lease or other facility costs constitute a significant portion of our overhead and, if we do not continually replace the defaulted consumer receivables portfolios we service with additional portfolios, we may have to reduce the number of our collection personnel. We would then have to rehire collection staff as we obtain additional defaulted consumer receivables portfolios. These practices could lead to: • low employee morale; • fewer experienced employees; • higher training costs; • disruptions in our operations; • loss of efficiency; and • excess costs associated with unused space in our facilities. Furthermore, heightened regulation of the credit card and consumer lending industry or changing credit origination strategies may result in decreased availability of credit to consumers, potentially leading to a future reduction in defaulted consumer receivables available for purchase from debt owners. We cannot predict how our ability to identify and purchase receivables and the quality of those receivables would be affected if there is a shift in consumer lending practices, whether caused by changes in the regulations or accounting practices applicable to debt owners, a sustained economic downturn or otherwise. 21 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. 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 22 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. Our ability to recover and enforce our defaulted consumer receivables may be limited under federal and state laws The businesses conducted by the Company’s operating subsidiaries are subject to licensing and regulation by governmental and regulatory bodies in the many jurisdictions in which the Company operates and conducts its business. 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. Such laws and regulations are extensive and subject to change. 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, legislative proposals that would regulate the collection of our defaulted consumer receivables. 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) could negatively impact our ability to collect or cause us to incur additional expenses. Although we cannot predict if or how any future legislation would impact our business, our failure to comply with any current or future laws or regulations applicable to us could limit our ability to collect on our defaulted consumer receivables, which could reduce our profitability and harm our business. Our ability to recover on portfolios of bankrupt consumer receivables may be impacted by changes in federal laws or changes in the administrative practices of the various bankruptcy courts We recover on consumer receivables that have filed for bankruptcy protection under available U.S. bankruptcy laws. 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. Our ability to recover on portfolios of bankruptcy consumer receivables may be impacted by changes in federal laws or changes in administrative practices of the various bankruptcy courts. Congress is considering legislation which, if passed, could allow bankruptcy judges to reduce and or modify mortgages and interest rates on a chapter 13 debtor’s principal residence. If passed, this legislation may affect our ability to collect bankrupt accounts and it may temporarily disrupt our historical bankruptcy collection curves, making it more difficult to accurately price bankrupt accounts. We are subject to examinations and challenges by tax authorities Our industry is relatively unique and as a result there is not a set of well defined laws or regulations for us to follow that match our particular facts and circumstances for some tax positions. Therefore, certain tax positions we take are based on industry practice, tax advice and drawing similarities of our facts and circumstances to those in case law. These tax positions may relate to tax compliance, sales and use, franchise, gross receipts, payroll, property and income tax issues, including tax base and apportionment. Challenges made by tax authorities to our application of tax rules may result in adjustments to the timing or amount of taxable income or deductions or the allocation of income among tax jurisdictions, as well as, inconsistent positions between different jurisdictions on similar matters. If any such challenges are made and are not resolved in our favor, they could have an adverse effect on our financial condition and result of operations. 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 23 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 03-3 (“SOP 03-3”), “Accounting for Loans or Certain Securities Acquired in a Transfer.” SOP 03-3 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. SOP 03-3 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 03-3 effective date. SOP 03-3 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. SOP 03-3 requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue, expense, or on the balance sheet. SOP 03-3 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. SOP 03-3 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. SOP 03-3 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 SOP 03-3 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 Global Stock Market, have resulted in increased costs to us as we implement their requirements. We continue to evaluate and monitor 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 and the rules and regulations promulgated thereunder is unclear 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 report on the effectiveness of the company’s internal controls over financial reporting. 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 24 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. We may not be able to retain, renegotiate or replace our existing credit facility If we are unable to retain, renegotiate or replace such facility, our growth could be adversely affected, which could negatively impact our business operations and the price of our common stock. We may not be able to continue to satisfy the restrictive covenants in our debt agreements All of our receivable portfolios are pledged to secure amounts owed to our lenders. Our debt agreements impose a number of restrictive covenants on how we operate our business. Failure to satisfy any one of these covenants could result in all or any of the following consequences, each of which could have a materially adverse effect on our ability to conduct business: • acceleration of outstanding indebtedness; • our inability to continue to purchase receivables needed to operate our business; or • our inability to secure alternative financing on favorable terms, if at all. Our hedging strategies may not be successful in mitigating our risks associated with changes in interest rates and could adversely affect our results of operations and financial condition, as could our failure to comply with hedge accounting principles and interpretations We entered into an interest rate swap transaction in December 2008 to mitigate our interest rate risk. Our hedging strategies rely on assumptions and projections. If these assumptions and projections prove to be incorrect or our hedges do not adequately mitigate the impact of changes in interest rates, we may experience volatility in our earnings that could adversely affect our results of operations and financial condition. In addition, hedge accounting in accordance with SFAS 133 requires the application of significant subjective judgments to a body of accounting concepts that is complex and for which the interpretations have continued to evolve within the accounting profession and amongst the standard-setting bodies. Our failure to comply with hedge accounting principles and interpretations could result in the loss of the applicability of hedge accounting which could adversely affect our results of operations and financial condition. Terrorist attacks, war and threats of attacks and war may adversely impact results of operations, revenue, and stock price Terrorist attacks, war and the outcome of war and threats of attacks may adversely affect our results of operations, revenue and stock price. Any or all of these occurrences could have a material adverse effect on our results of operations, revenue and stock price. Failure to comply with government regulation of the collections industry could result in the suspension or termination of our ability to conduct its business The collections industry is governed by various US federal and state laws and regulations. Many states require us to be a licensed debt collector. The Federal Trade Commission has the authority to investigate consumer complaints against debt collection companies and to recommend enforcement actions and seek monetary penalties. If we fail to comply with applicable laws and regulations, it could result in the suspension, or termination of our ability to conduct collections which would materially adversely affect us. In addition, new federal and state laws or regulations or changes in the ways these rules or laws are interpreted or enforced could limit our activities in the future or significantly increase the cost of compliance. 25 Changes in governmental laws and regulations could increase our costs and liabilities or impact our operations Changes in laws and regulations and the manner in which they are interpreted or applied may alter our business environment. This could affect our results of operations or increase our liabilities. These negative impacts could result from changes in collection laws, laws related to credit reporting, consumer bankruptcy, accounting standards, taxation requirements, employment laws and communications laws, among others. It is possible that we could become subject to additional liabilities in the future resulting from changes in laws and regulations that could result in an adverse effect on our results of operations and financial condition. 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 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. 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. 26 Item 2. Properties. Our principal executive offices and primary operations facility are located in approximately 100,000 square feet of leased space in three adjacent buildings in Norfolk, Virginia. This site can currently accommodate approximately 975 employees. We own a two-acre parcel of land across from our headquarters which we developed into a parking lot for use by our employees. We own an approximately 22,000 square foot facility in Hutchinson, Kansas, comprised of two buildings, and contiguous parcels of land which are used primarily for employee parking. The Hutchinson site can currently accommodate approximately 250 employees. We also lease a facility located in approximately 23,000 square feet of space in Hampton, Virginia which can accommodate approximately 300 employees. We also lease a 13,500 square foot call center in Las Vegas, Nevada which can accommodate approximately 150 employees. In December 2008, we entered into a lease for an approximately 30,000 square foot call center in Las Vegas, Nevada. The leased space is currently under renovations and is expected to be completed during the second quarter of 2009. The newly leased space will be able to accommodate approximately 270 employees and will replace the 13,500 square foot call center. We also lease a 15,000 square-foot facility in Birmingham, Alabama which can accommodate approximately 160 employees and approximately 400 square feet of space in Montgomery, Alabama. We own a 34,000 square foot building and a nine-acre parcel of land in Jackson, Tennessee which can accommodate approximately 430 employees. For our MuniServices business, we lease approximately 26,000 square feet of office space in several offices around the country, the majority of which is in Fresno, California. These offices can accommodate approximately 140 employees. We also lease a facility located in approximately 6,000 square feet of space in Houston, Texas which can accommodate approximately 30 employees. 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, most of 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. While we cannot predict the outcome of these proceedings, or of any other claims that may be brought against us, we do not believe that the collections related matters represent a substantial volume of our account, and it is not expected that these or any other legal proceedings or claims in which we are involved will, individually or in the aggregate, have a material impact on 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. 27 PART II Item 5. Market for Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities. Price Range of Common Stock Our common stock (“Common Stock”) began trading on the NASDAQ Global Stock 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 Global Stock Market, for the periods indicated. 2007 Quarter ended March 31, 2007 Quarter ended June 30, 2007 Quarter ended September 30, 2007 Quarter ended December 31, 2007 2008 Quarter ended March 31, 2008 Quarter ended June 30, 2008 Quarter ended September 30, 2008 Quarter ended December 31, 2008 High $49.20 $62.61 $65.66 $54.89 $50.50 $47.75 $52.73 $49.49 Low $41.63 $43.50 $44.26 $36.28 $27.43 $37.12 $35.09 $24.70 As of February 4, 2009, there were 31 holders of record of the Common Stock. Based on information provided by our transfer agent and registrar, we believe that there are 24,183 beneficial owners of the Common Stock. Stock Performance The following graph compares from December 31, 2003, to December 31, 2008, the cumulative stockholder returns assuming an initial investment of $100 on January 1, 2004 in the Company’s Common Stock, the stocks comprising the NASDAQ Global Market Composite Index, the NASDAQ Market Index (U.S.) and the stocks comprising a peer group index consisting of six peers. Any dividends paid during the five year period are assumed to be reinvested. Stock Performance $200 $100 $0 Dec 31, 2003 Dec 31, 2004 Dec 31, 2005 Dec 31, 2006 Dec 31, 2007 Dec 31, 2008 PRAA Peer Group Index NASDAQ Global Market Composite Index NASDAQ Market Index (U.S.) As of December 31, PRAA NASDAQ Global Market Composite Index NASDAQ Market Index (U.S.) Peer Group Index 2004 155 109 109 116 The comparisons of stock performance shown above are not intended to forecast or be indicative of possible future performance of the Company’s common stock. The Company does not make or endorse any predictions as to its future stock performance. $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ $ 2003 100 100 100 100 2006 176 121 127 136 2005 175 110 113 139 2008 130 61 81 88 2007 152 126 139 133 28 Equity Incentives The table below provides information with respect to securities authorized for issuance under our equity compensation plans as of December 31, 2008: Plan Category Equity Compensation plans approved by security holders Equity Compensation plans not approved by security holders Total Number of Securities Authorized for Issuance Under the Plan Number of Securities to be Issued Upon Exercise of Outstanding Options or Nonvested Shares Under the Plan Weighted-average Exercise Price of Outstanding Options and Nonvested Shares(1) Remaining Available for Future Issuance Under the Equity Compensation Plan(2) 2,000,000 None 2,000,000 378,255 None 378,255 $5.61 N/A $5.61 843,495 None 843,495 (1) Includes grants of nonvested shares, for which there is no exercise price, but with respect to which 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 is $17.24. (2) Excludes 778,250 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 regular dividends on our Common Stock; however, our board of directors may determine in the future to declare or pay dividends on our Common Stock. On April 23, 2007, the Company’s Board of Directors authorized a special one-time cash dividend of $1.00 per share with a record date of May 9, 2007. The cash dividends were paid on June 8, 2007 and totaled $16,069,694. No dividends were paid during 2008. 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. 29 Item 6. Selected Financial Data. The following selected financial data should be read in conjunction with the audited consolidated financial statements. 2008 2007 Years Ended December 31, 2006 2005 2004 (Dollars in thousands, except per share data) INCOME STATEMENT DATA: Revenues: Income recognized on finance receivables, net Commissions Total revenues 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/(expenses) Income before income taxes Provision for income taxes Net income Net income per share Basic Diluted Weighted average shares Basic Diluted OPERATING AND OTHER FINANCIAL DATA: Cash collections and commissions (1) Operating expenses to cash collections and commissions Return on equity (2) Acquisitions of finance receivables, at cost (3) Acquisitions of finance receivables, at face value Employees at period end: Total employees Ratio of collection personnel to total employees (4) $ 206,486 56,789 263,275 $ 184,705 36,043 220,748 $ 163,357 24,965 188,322 $ 134,674 13,851 148,525 $ 106,254 7,142 113,396 88,073 61,752 10,304 3,908 6,977 7,424 178,438 84,837 (11,091) 73,746 28,384 69,022 47,474 8,531 3,105 5,915 5,517 139,564 81,184 (3,285) 77,899 29,658 58,142 40,139 5,876 2,276 4,758 5,131 116,322 72,000 206 72,206 27,716 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 $ 45,362 $ 48,241 $ 44,490 $ 36,772 $ 27,451 $ $ 2.98 2.97 $ $ 3.08 3.06 $ $ 2.80 2.77 $ $ 2.35 2.28 $ $ 1.79 1.73 15,229 15,292 15,646 15,779 15,911 16,082 15,642 16,149 15,357 15,853 $ 383,488 47% $ 298,209 47% $ 261,357 45% $ 205,226 43% $ 160,546 43% 17% 20% 20% 21% 20% $ $ 280,336 4,588,234 $ $ 263,809 11,113,830 $ $ 112,406 7,788,158 $ $ 149,645 5,307,918 $ $ 61,165 3,340,434 2,032 87% 1,677 88% 1,291 88% 1,110 88% 948 89% (1) Includes both cash collected on finance receivables and commission fees earned during the relevant period. (2) Calculated by dividing net income for each year by average monthly stockholders’ equity for the same year. (3) 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. (4) Includes all collectors and all first-line collection supervisors at December 31. Below is listed certain 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 line of credit Total stockholders' equity 2008 2007 As of December 31, 2006 2005 2004 $ 13,901 - 563,830 657,840 - 268,305 283,863 $ 16,730 - 410,297 476,307 - 168,103 235,280 $ 25,101 - 226,447 293,378 690 932 247,278 $ 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 30 Below is listed the quarterly consolidated income statements for the years ended December 31, 2008 and 2007: (Dollars in thousands, except per share data) INCOME STATEMENT DATA: Revenues: Income recognized on finance receivables, net Commissions Total revenues 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, 2008 Sept. 30, 2008 June 30, 2008 For the Quarter Ended Mar. 31, Dec. 31, 2007 2008 Sept. 30, 2007 June 30, 2007 Mar. 31, 2007 $ 48,073 18,898 66,971 $ 52,738 15,848 68,586 $ 53,047 10,567 63,614 $ 52,628 11,476 64,104 $ 46,741 10,583 57,324 $ 46,111 8,529 54,640 $ 46,387 8,389 54,776 $ 45,466 8,542 54,008 23,091 15,352 2,769 1,078 2,114 2,285 46,689 20,282 (2,927) 17,355 6,746 22,983 16,709 2,263 1,123 1,912 2,162 47,152 21,434 (3,049) 18,385 6,930 20,872 15,118 2,403 869 1,595 1,507 42,364 21,250 (2,646) 18,604 7,178 21,127 14,573 2,869 838 1,356 1,470 42,233 21,871 (2,469) 19,402 7,530 18,584 12,944 2,604 888 1,449 1,405 37,874 19,450 (2,107) 17,343 6,667 17,322 11,847 2,038 819 1,605 1,455 35,086 19,554 (1,072) 18,482 6,787 16,681 11,246 2,005 739 1,478 1,362 33,511 21,265 (218) 21,047 8,058 16,435 11,437 1,884 659 1,383 1,295 33,093 20,915 112 21,027 8,146 $ 10,609 $ 11,455 $ 11,426 $ 11,872 $ 10,676 $ 11,695 $ 12,989 $ 12,881 $ $ 0.69 0.69 $ $ 0.75 0.75 $ $ 0.75 0.75 $ $ 0.78 0.78 $ $ 0.71 0.70 $ $ 0.76 0.75 $ $ 0.81 0.80 $ $ 0.81 0.80 15,283 15,329 15,267 15,336 15,193 15,268 15,170 15,237 15,136 15,230 15,451 15,577 16,005 16,168 15,993 16,140 Below is listed the quarterly consolidated balance sheets for the years ended December 31, 2008 and 2007: Dec. 31, 2008 Sept. 30, 2008 June 30, 2008 Mar. 31, 2008 Dec. 31, 2007 Sept. 30, 2007 June 30, 2007 Mar. 31, 2007 Quarter Ended (Dollars in thousands) BALANCE SHEET DATA: Assets Cash and cash equivalents Finance receivables, net Property and equipment, net Income taxes 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 Line of credit Long-term debt Obligations under capital lease Total liabilities $ $ $ $ $ $ $ $ 13,901 563,830 23,884 3,587 27,546 13,429 11,663 657,840 28,006 535,430 23,354 3,715 28,058 13,747 9,251 641,561 16,333 515,367 17,332 3,539 18,620 4,322 5,775 581,288 16,816 477,754 16,631 2,791 18,620 4,684 5,923 543,219 16,730 410,297 16,171 3,022 18,620 5,046 6,422 476,308 14,464 326,476 15,217 2,621 18,620 5,399 4,435 387,232 15,042 288,648 13,510 2,424 18,287 5,773 4,354 348,038 27,883 243,568 12,201 - 18,288 6,263 4,614 312,817 $ $ $ $ $ $ $ $ $ 3,438 4,314 - 9,850 88,070 268,300 - 5 373,977 $ 4,527 5,294 - 9,605 81,350 267,300 - 23 368,099 $ 4,630 4,647 - 4,833 72,577 234,300 - 45 321,032 $ 4,008 4,499 - 4,818 64,661 216,800 - 70 294,856 $ 4,055 4,471 - 6,820 57,579 168,000 - 103 241,028 $ 2,815 3,614 - 6,445 51,018 100,000 - 138 164,030 $ 2,456 3,477 - 4,327 43,970 38,000 19 174 92,423 $ 4,220 3,063 1,765 4,203 37,849 - 572 208 51,880 Stockholders' equity Common stock Additional paid in capital Retained earnings Accumulated other comprehensive income Total stockholders' equity Total liabilities and stockholders' equity 153 74,574 209,047 89 283,863 657,840 $ 153 74,873 198,436 - 273,462 641,561 $ 152 73,121 186,983 - 260,256 581,288 $ 152 72,654 175,557 - 248,363 543,219 $ 152 71,443 163,685 - 235,280 476,308 $ 151 70,044 153,007 - 223,202 387,232 $ 160 114,142 141,313 - 255,615 348,038 $ 160 116,383 144,394 - 260,937 312,817 $ 31 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 revenues for the years ended December 31, 2008, 2007 and 2006: (Dollars in thousands) Revenues: Income recognized on finance receivables, net Commissions Total revenues 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 2008 2007 2006 $ 206,486 56,789 263,275 88,073 61,752 10,304 3,908 6,977 7,424 178,438 84,837 60 (11,151) 73,746 28,384 45,362 $ 78.4% 21.6 100.0 33.5 23.5 3.9 1.4 2.7 2.8 67.8 32.2 0.0 (4.2) 28.0 10.8 17.2% $ 184,705 36,043 220,748 69,022 47,474 8,531 3,105 5,915 5,517 139,564 81,184 419 (3,704) 77,899 29,658 48,241 $ 83.7% 16.3 100.0 31.3 21.5 3.9 1.4 2.6 2.5 63.2 36.8 0.2 (1.7) 35.3 13.4 21.9% $ 163,357 24,965 188,322 58,142 40,139 5,876 2,276 4,758 5,131 116,322 72,000 584 (378) 72,206 27,716 44,490 $ 86.7% 13.3 100.0 30.9 21.3 3.1 1.2 2.6 2.7 61.8 38.2 0.3 (0.2) 38.3 14.7 23.6% Year Ended December 31, 2008 Compared to Year Ended December 31, 2007 Revenues Total revenues were $263.3 million for the year ended December 31, 2008, an increase of $42.6 million or 19.3% compared to total revenues of $220.7 million for the year ended December 31, 2007. Income Recognized on Finance Receivables, net Income recognized on finance receivables, net was $206.5 million for the year ended December 31, 2008, an increase of $21.8 million or 11.8% compared to $184.7 million for the year ended December 31, 2007. The majority of the increase was due to an increase in our cash collections on our owned defaulted consumer receivables to $326.7 million from $262.2 million, an increase of $64.5 million or 24.6%. Our finance receivables amortization rate, including the net allowance charge, on our owned portfolios for the year ended December 31, 2008 was 36.8% while for the year ended December 31, 2007 it was 29.6%. During the year ended December 31, 2008, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $4.6 billion at an original purchase price of $280.3 million. During the year ended December 31, 2007, we acquired defaulted consumer receivable portfolios with an aggregate face value of $11.1 billion at an original purchase price of $263.8 million. In any period, we acquire defaulted consumer receivable portfolios 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. In addition, market forces can drive pricing rates up or down in any period, irrespective of other quality fluctuations. 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 changes in valuation allowances recognized under SOP 03-3, which requires that a valuation allowance be taken for decreases in expected cash flows or change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the years ended December 31, 2008 and 2007, we recorded net allowance charges of $19.4 million and $2.9 million, respectively. 32 Commissions Commissions were $56.8 million for the year ended December 31, 2008, an increase of $20.8 million or 57.8% compared to commissions of $36.0 million for the year ended December 31, 2007. Commissions grew as a result of the acquisition of MuniServices, LLC (“MuniServices”) on July 1, 2008, as well as increases in revenue generated by our IGS fee-for-service business and RDS government processing and collection business, partially offset by a decrease in our Anchor contingent fee business, which ceased operations during the second quarter of 2008, as compared to the prior year period. Operating Expenses Total operating expenses were $178.4 million for the year ended December 31, 2008, an increase of $38.8 million or 27.8% compared to total operating expenses of $139.6 million for the year ended December 31, 2007. Total operating expenses were 46.5% of cash receipts for the year ended December 31, 2008 compared with 46.8% for the same period in 2007. Compensation and Employee Services Compensation and employee services expenses were $88.1 million for the year ended December 31, 2008, an increase of $19.1 million or 27.7% compared to compensation and employee services expenses of $69.0 million for the year ended December 31, 2007. This increase is mainly due to the acquisition of MuniServices as well as an overall increase in our owned portfolio collection staff. This increase was offset by a reversal or decrease of $1.2 million during 2008 of estimated share-based compensation costs that had been accrued in 2007 related to the 2007 Long Term Incentive Programs because the achievement of the performance targets of the program were unlikely to be achieved. Compensation and employee services expenses increased as total employees grew from 1,677 at December 31, 2007 to 2,032 at December 31, 2008. Additionally, existing employees received normal salary increases. Compensation and employee services expenses as a percentage of cash receipts decreased to 23.0% for the year ended December 31, 2008 from 23.2% of cash receipts for the same period in 2007. Outside Legal and Other Fees and Services Outside legal and other fees and services expenses were $61.8 million for the year ended December 31, 2008, an increase of $14.3 million or 30.1% compared to outside legal and other fees and services expenses of $47.5 million for the year ended December 31, 2007. Of the $14.3 million increase, $6.6 million was attributable to increases in agency fees mainly incurred by our IGS subsidiary, $0.9 million was attributable to an increase in corporate legal and accounting fees, $1.3 million was attributable to an increase in other outside fees and services, partially offset by a $0.6 million decrease in credit bureau fees. Of the remaining $6.1 million increase, $2.2 million was attributable to incremental legal costs advanced to our third party collection attorneys. Based on an analysis of our legal accounts and their liquidation potential, it was determined that we were underinvested in terms of costs advanced to attorneys. The remaining $3.9 million was attributable to the increased legal fees and costs incurred resulting from the increased number of accounts referred to both our in house attorneys and outside independent contingent fee attorneys. Total outside legal expenses paid to independent contingent fee attorneys for the year ended December 31, 2008 were 39.4% of legal cash collections generated by independent contingent fee attorneys compared to 34.6% for the year ended December 31, 2007. Outside legal fees and costs paid to independent contingent fee attorneys increased from $29.1 million for the year ended December 31, 2007 to $33.3 million, an increase of $4.2 million or 14.4%, for the year ended December 31, 2008. Additionally, as disclosed previously, we also effectuate legal collections using our own in house attorneys. Total legal expenses incurred by our in house attorneys for the year ended December 31, 2008 were 41.4% of legal cash collections generated by our in house attorneys compared to 29.0% for the year ended December 31, 2007. Legal fees and costs incurred by our in house attorneys increased from $1.6 million for the year ended December 31, 2007 to $3.5 million, an increase of $1.9 million or 119.0%, for the year ended December 31, 2008. 33 Communications Communications expenses were $10.3 million for the year ended December 31, 2008, an increase of $1.8 million or 21.2% compared to communications expenses of $8.5 million for the year ended December 31, 2007. The increase was attributable to growth in mailings and higher telephone expenses driven by a greater number of defaulted consumer receivables to work, as well as a significant expansion of our automated dialer seats and related calls that are generated by the dialer. Mailings were responsible for 54.8% or $1.0 million of this increase, while the remaining 45.2% or $0.8 million was attributable to increased call volumes. Rent and Occupancy Rent and occupancy expenses were $3.9 million for the year ended December 31, 2008, an increase of $0.8 million or 25.8% compared to rent and occupancy expenses of $3.1 million for the year ended December 31, 2007. The increase was primarily due to the expansion of space in our Norfolk, Virginia administrative and executive facility and the acquisition of MuniServices, as well as increased utility charges. The new Norfolk, Virginia administrative and executive facility accounted for $355,000 of the increase, the MuniServices location accounted for $293,000 of the increase and other occupancy charges accounted for $253,000 of the increase. In addition, there was a decrease of $74,000 in storage and other facility charges. Other Operating Expenses Other operating expenses were $7.0 million for the year ended December 31, 2008, an increase of $1.1 million or 18.6% compared to other operating expenses of $5.9 million for the year ended December 31, 2007. The increase was due to increases in travel and meals, miscellaneous expenses, repairs and maintenance, dues and subscriptions and other expenses as well as decreases in taxes (non-income), fees and licenses and hiring expenses. Travel and meals increased by $201,000, miscellaneous expenses increased by $268,000, repairs and maintenance increased by $508,000, dues and subscriptions increased by $125,000 and other expenses increased by $75,000. Taxes (non-income), fees and licenses decreased by $37,000 and hiring expenses decreased by $77,000. Depreciation and Amortization Depreciation and amortization expenses were $7.4 million for the year ended December 31, 2008, an increase of $1.9 million or 34.5% compared to depreciation and amortization expenses of $5.5 million for the year ended December 31, 2007. The increase is mainly due to capital purchases in our administrative and executive facility in Norfolk, Virginia as well as additional expense incurred related to the amortization of intangible assets in the acquisition of MuniServices on July 1, 2008, and the acquisition of the assets of Broussard Partners and Associates, Inc. (“BPA”) on August 1, 2008. Additional increases are the result of continued capital expenditures on equipment, software and computers related to our growth and systems upgrades. Interest Income Interest income was $60,000 for the year ended December 31, 2008, a decrease of $359,000 or 85.7% compared to interest income of $419,000 for the year ended December 31, 2007. This decrease is mainly due to lower average invested cash and cash equivalents balances during the year ended December 31, 2008 compared to the same period in 2007. Interest Expense Interest expense was $11.2 million for the year ended December 31, 2008, an increase of $7.5 million compared to interest expense of $3.7 million for the year ended December 31, 2007. The increase is mainly due to a significant increase in outstanding borrowings on our line of credit during the year ended December 31, 2008 compared to the same period in 2007. The increase was offset by a decrease in our weighted average interest rate which decreased to 4.60% for the year ended December 31, 2008 as compared to 6.64% for the year ended December 31, 2007. 34 Provision for Income Taxes Income tax expense was $28.4 million for the year ended December 31, 2008, a decrease of $1.3 million or 4.4% compared to income tax expense of $29.7 million for the year ended December 31, 2007. The decrease is mainly due to a 5.4% decrease in pre-tax income, down from $77.9 million in 2007, to $73.7 million in 2008, offset by a slight increase in the effective tax rate from 38.1% for the year ended December 31, 2007 to 38.5% for the year ended December 31, 2008. The higher effective tax rate was due mainly to more state tax credits generated during the year ended December 31, 2007 as compared to the same period in 2008. Year Ended December 31, 2007 Compared to Year Ended December 31, 2006 Revenues Total revenues were $220.7 million for the year ended December 31, 2007, an increase of $32.4 million or 17.2% compared to total revenues of $188.3 million for the year ended December 31, 2006. Income Recognized on Finance Receivables, net Income recognized on finance receivables, net was $184.7 million for the year ended December 31, 2007, an increase of $21.3 million or 13.0% compared to $163.4 million for the year ended December 31, 2006. The majority of the increase was due to an increase in our cash collections on our owned defaulted consumer receivables to $262.2 million from $236.4 million, an increase of $25.8 million or 10.9%. Our finance receivables amortization rate, including the allowance charge, on our owned portfolios for the year ended December 31, 2007 was 29.6% while for the year ended December 31, 2006 it was 30.9%. During the year ended December 31, 2007, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $11.1 billion at an original purchase price of $263.8 million. During the year ended December 31, 2006, we acquired defaulted consumer receivable portfolios with an aggregate face value of $7.8 billion at an original purchase price of $112.4 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 changes in valuation allowances recognized under SOP 03-3, which requires that a valuation allowance be taken for decreases in expected cash flows or change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the years ended December 31, 2007 and 2006, we recorded net allowance charges of $2.9 million and $1.1 million, respectively. Commissions Commissions were $36.0 million for the year ended December 31, 2007, an increase of $11.0 million or 44.0% compared to commissions of $25.0 million for the year ended December 31, 2006. Commissions grew as a result of increases in revenue generated by our IGS fee-for-service business and RDS government processing and collection business offset by a decrease in our ARM contingent fee business compared to the prior year period. Operating Expenses Total operating expenses were $139.6 million for the year ended December 31, 2007, an increase of $23.3 million or 20.0% compared to total operating expenses of $116.3 million for the year ended December 31, 2006. Total operating expenses were 46.8% of cash receipts for the year ended December 31, 2007 compared with 44.5% for the same period in 2006. 35 Compensation and Employee Services Compensation and employee services expenses were $69.0 million for the year ended December 31, 2007, an increase of $10.9 million or 18.8% compared to compensation and employee services expenses of $58.1 million for the year ended December 31, 2006. Compensation and employee services expenses increased as total employees grew from 1,291 at December 31, 2006 to 1,677 at December 31, 2007, primarily to accommodate our owned portfolio purchasing growth. Additionally, existing employees received normal salary increases. Compensation and employee services expenses as a percentage of cash receipts increased to 23.2% for the year ended December 31, 2007 from 22.3% of cash receipts for the same period in 2006, mainly due to a significant increase in employee staffing, especially in our newer Jackson, Tennessee call center, with a corresponding decrease in collector productivity caused mostly by the addition of this less tenured collection staff. Outside Legal and Other Fees and Services Outside legal and other fees and services expenses were $47.5 million for the year ended December 31, 2007, an increase of $7.4 million or 18.5% compared to outside legal and other fees and services expenses of $40.1 million for the year ended December 31, 2006. Of the $7.4 million increase, $4.6 million was attributable to increases in agency fees mainly incurred by our IGS subsidiary, $0.4 million was attributable to increases in outside fees and services, and $0.2 million was attributable to increases in credit bureau fees. This was offset by a $0.1 million decrease in corporate legal expenses. The remaining $2.3 million increase was attributable to the increased legal fees and costs incurred resulting from the increased number of accounts referred to both our in house attorneys and outside independent contingent fee attorneys. Total outside legal expenses paid to independent contingent fee attorneys for the year ended December 31, 2007 were 34.6% of legal cash collections generated by independent contingent fee attorneys compared to 36.1% for the year ended December 31, 2006. Outside legal fees and costs paid to independent contingent fee attorneys increased from $27.5 million for the year ended December 31, 2006 to $29.1 million, an increase of $1.6 million or 5.8%, for the year ended December 31, 2007. Additionally, as disclosed previously, we also effectuate legal collections using our own in house attorneys. Total legal expenses incurred by our in house attorneys for the year ended December 31, 2007 were 29.0% of legal cash collections generated by our in house attorneys compared to 26.4% for the year ended December 31, 2006. Legal fees and costs incurred by our in house attorneys increased from $1.0 million for the year ended December 31, 2006 to $1.6 million, an increase of $0.6 million or 37.5%, for the year ended December 31, 2007. Communications Communications expenses were $8.5 million for the year ended December 31, 2007, an increase of $2.6 million or 44.1% compared to communications expenses of $5.9 million for the year ended December 31, 2006. 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 as well as the addition of our new call center in Jackson, Tennessee. Mailings were responsible for 53.8% or $1.4 million of this increase, while the remaining 46.2% or $1.2 million was attributable to increased call volumes. Rent and Occupancy Rent and occupancy expenses were $3.1 million for the year ended December 31, 2007, an increase of $0.8 million or 34.8% compared to rent and occupancy expenses of $2.3 million for the year ended December 31, 2006. The increase was primarily due to the addition of our new RDS facility, the addition of our new Norfolk, Virginia administrative and executive facility as well as increased utility charges. Of the $0.8 million increase in 2007, the new RDS location accounted for $123,000 of the increase, the new Norfolk, Virginia administrative and executive facility accounted for $391,000 of the increase and utility and other occupancy charges accounted for $233,000 of the increase. In addition, there was an increase of $83,000 in storage and other facility charges. Other Operating Expenses Other operating expenses were $5.9 million for the year ended December 31, 2007, an increase of $1.2 million or 22.9% compared to other operating expenses of $4.8 million for the year ended December 31, 2006. The increase was due to increases in travel and meals, miscellaneous expenses, repairs and maintenance, taxes 36 (non-income), fees and licenses and other expenses. Travel and meals increased by $317,000, miscellaneous expenses increased by $465,000, repairs and maintenance increased by $114,000, taxes (non-income), fees and licenses increased by $231,000 and other expenses increased by $30,000. Depreciation and Amortization Depreciation and amortization expenses were $5.5 million for the year ended December 31, 2007, an increase of $0.4 million or 7.8% compared to depreciation and amortization expenses of $5.1 million for the year ended December 31, 2006. The increase is mainly due to capital purchases for our new call center in Jackson, Tennessee, as well as capital purchases for the addition of our new RDS facility, our new administrative and executive facility in Norfolk, Virginia and our expanded call center in Hutchinson, Kansas. These increases were offset by a decrease in the amortization expense on intangible assets of $0.4 million for the year ended December 31, 2007, when compared to the prior year period. Interest Income Interest income was $419,000 for the year ended December 31, 2007, a decrease of $165,000 or 28.3% compared to interest income of $584,000 for the year ended December 31, 2006. This decrease is the result of lower average invested cash and cash equivalents balances during the year ended December 31, 2007 compared to the same period in 2006. Interest Expense Interest expense was $3,704,000 for the year ended December 31, 2007, an increase of $3,325,000 compared to interest expense of $379,000 for the year ended December 31, 2006. The increase is mainly due to a significant increase in outstanding borrowings on our lines of credit during the year ended December 31, 2007 compared to the same period in 2006. Provision for Income Taxes Income tax expense was $29.7 million for the year ended December 31, 2007, an increase of $2.0 million or 7.2% compared to income tax expense of $27.7 million for the year ended December 31, 2006. The increase is mainly due to a 7.9% increase in pre-tax income, up from $72.2 million in 2006, to $77.9 million in 2007, offset by a slight reduction in the effective tax rate from 38.4% for year ended December 31, 2006 versus 38.1% for the year ended December 31, 2007. The lower effective tax rate was due mainly to state tax credits. 37 Supplemental Performance Data Owned Portfolio Performance: The following tables show certain data related to our owned portfolio. These tables describe the purchase price, cash collections and related multiples. Further, these tables disclose our entire portfolio, the portfolio of purchased bankrupt accounts only and our entire portfolio less the impact of our purchased bankrupt accounts. The accounts represented in the purchased bankruptcy tables are those accounts that were bankrupt at the time of purchase. This contrasts with accounts that file bankruptcy after we purchase them. Entire Portfolio ($ in thousands) Purchase Period Purchase Price(1) Life to Date Reserve Allowance (2) Unamortized Purchase Price Balance at December 31, 2008 (3) Percentage of Purchase Price Remaining Unamortized at December 31, 2008 (4) Actual Cash Collections Including Cash Sales Estimated Remaining Collections (5) Total Estimated Collections (6) Total Estimated Collections to Purchase Price (7) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 $3,080 $7,685 $11,089 $18,898 $25,020 $33,481 $42,325 $61,449 $59,178 $143,213 $107,802 $258,772 $278,511 $0 $0 $0 $0 $0 $105 $0 $495 $1,760 $5,750 $7,510 $7,380 $620 $0 $0 $0 $0 $0 $234 $0 $2,156 $4,630 $50,272 $55,384 $193,669 $257,485 0% 0% 0% 0% 0% 1% 0% 4% 8% 35% 51% 75% 92% $9,898 $24,688 $35,831 $64,698 $104,855 $156,953 $170,609 $219,894 $155,011 $213,551 $116,723 $157,274 $61,277 $30 $150 $362 $866 $2,650 $5,040 $6,587 $15,665 $26,575 $106,958 $107,490 $355,745 $487,447 $9,928 $24,838 $36,193 $65,564 $107,505 $161,993 $177,196 $235,559 $181,586 $320,509 $224,213 $513,019 $548,724 322% 323% 326% 347% 430% 484% 419% 383% 307% 224% 208% 198% 197% Purchased Bankruptcy Portfolio ($ in thousands) Purchase Period Purchase Price(1) Life to Date Reserve Allowance (2) Unamortized Purchase Price Balance at December 31, 2008 (3) Percentage of Purchase Price Remaining Unamortized at December 31, 2008 (4) Actual Cash Collections Including Cash Sales Estimated Remaining Collections (5) Total Estimated Collections (6) Total Estimated Collections to Purchase Price (7) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 $0 $0 $0 $0 $0 $0 $0 $0 $7,469 $29,302 $17,643 $78,933 $111,063 $0 $0 $0 $0 $0 $0 $0 $0 $1,240 $535 $1,360 $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $332 $3,598 $3,038 $62,077 $105,049 0% 0% 0% 0% 0% 0% 0% 0% 4% 12% 17% 79% 95% $0 $0 $0 $0 $0 $0 $0 $0 $13,485 $38,056 $21,585 $30,822 $14,024 $0 $0 $0 $0 $0 $0 $0 $0 $745 $5,414 $6,151 $87,556 $167,098 $0 $0 $0 $0 $0 $0 $0 $0 $14,230 $43,470 $27,736 $118,378 $181,122 0% 0% 0% 0% 0% 0% 0% 0% 191% 148% 157% 150% 163% Entire Portfolio less Purchased Bankruptcy Portfolio ($ in thousands) Purchase Period Purchase Price(1) Life to Date Reserve Allowance (2) Unamortized Purchase Price Balance at December 31, 2008 (3) Percentage of Purchase Price Remaining Unamortized at December 31, 2008 (4) Actual Cash Collections Including Cash Sales Estimated Remaining Collections (5) Total Estimated Collections (6) Total Estimated Collections to Purchase Price (7) 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 $3,080 $7,685 $11,089 $18,898 $25,020 $33,481 $42,325 $61,449 $51,709 $113,911 $90,159 $179,839 $167,448 $0 $0 $0 $0 $0 $105 $0 $495 $520 $5,215 $6,150 $7,380 $620 $0 $0 $0 $0 $0 $234 $0 $2,156 $4,298 $46,674 $52,346 $131,592 $152,436 $9,898 $24,688 $35,831 $64,698 $104,855 $156,953 $170,609 $219,894 $141,526 $175,495 $95,138 $126,452 $47,253 $30 $150 $362 $866 $2,650 $5,040 $6,587 $15,665 $25,830 $101,544 $101,339 $268,189 $320,349 $9,928 $24,838 $36,193 $65,564 $107,505 $161,993 $177,196 $235,559 $167,356 $277,039 $196,477 $394,641 $367,602 322% 323% 326% 347% 430% 484% 419% 383% 324% 243% 218% 219% 220% 0% 0% 0% 0% 0% 1% 0% 4% 8% 41% 58% 73% 91% 38 (1) Purchase price refers to the cash paid to a seller to acquire defaulted consumer receivables, plus certain capitalized costs, less the purchase price refunded by the seller due to the return of non-compliant accounts (also defined as buybacks). Non-compliant refers to the contractual representations and warranties provided for in the purchase and sale contract between the seller and us. These representations and warranties from the sellers generally cover account holders’ death or bankruptcy and accounts settled or disputed prior to sale. The seller can replace or repurchase these accounts. (2) Life to date reserve allowance refers to the total amount of allowance charges incurred on our owned portfolios net of any reversals. (3) Unamortized purchase price balance refers to the purchase price less amortization over the life of the portfolio. (4) Percentage of purchase price remaining unamortized refers to the amount of unamortized purchase price divided by the purchase price. (5) Estimated remaining collections refers to the sum of all future projected cash collections on our owned portfolios. (6) Total estimated collections refers to the actual cash collections, including cash sales, plus estimated remaining collections. (7) Total estimated collections to purchase price refers to the total estimated collections divided by the purchase price. The following graph shows the purchase price of our owned portfolios by year beginning in 1996. The purchase price number represents the cash paid to the seller to acquire defaulted consumer receivables, plus certain capitalized costs, less the purchase price refunded by the seller due to the return of non-compliant accounts. Portfolio Purchases by Year ($ in thousands) $300,000 $280,000 $260,000 $240,000 $220,000 $200,000 $180,000 $160,000 $140,000 $120,000 $100,000 $80,000 $60,000 $40,000 $20,000 $0 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 We utilize a long-term approach to collecting our owned portfolios of receivables. This approach has historically caused us to realize significant cash collections and revenues from purchased portfolios of finance receivables years after they are originally acquired. As a result, we have in the past been able to temporarily reduce our level of current period acquisitions without a corresponding negative current period impact on cash collections and revenue. 39 The following tables, which exclude any proceeds from cash sales of finance receivables, demonstrates our ability to realize significant multi-year cash collection streams on our owned portfolios. Cash Collections By Year, By Year of Purchase - Entire Portfolio ($ in thousands) Purchase Period 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 3,080 7,685 11,089 18,898 25,020 33,481 42,325 61,449 59,178 143,213 107,802 258,772 278,511 1,050,503 Purchase Price $ 1996 $ 1997 1998 1999 2000 $ $ $ $ Cash Collection Period 2002 $ 2001 $ 548 - - - - - - - - - - - - 548 2,484 2,507 - - - - - - - - - - - 4,991 1,890 5,215 3,776 - - - - - - - - - - 10,881 1,348 4,069 6,807 5,138 - - - - - - - - - 17,362 1,025 3,347 6,398 13,069 6,894 - - - - - - - - 30,733 730 2,630 5,152 12,090 19,498 13,048 - - - - - - - 53,148 2003 2004 2005 2006 2007 $ 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 18,019 - - - - $ 210 860 1,811 4,352 10,924 22,639 32,497 52,640 46,475 18,968 - - - $ 237 597 1,415 3,032 8,067 16,048 24,729 43,728 40,424 75,145 22,971 - - $ 102 437 882 2,243 5,202 10,011 16,527 30,695 30,750 69,862 53,192 42,263 - $ 117,052 $ 153,404 $ 191,376 $ 236,393 $ 262,166 496 1,829 3,948 9,598 19,478 28,831 15,073 - - - - - - 79,253 2008 $ 83 346 616 1,533 3,604 6,164 9,772 18,818 19,339 49,576 40,560 115,011 61,277 326,699 Total $ $ $ $ $ $ $ $ $ $ $ $ $ $ 9,836 24,183 35,802 64,006 104,393 151,461 170,598 219,895 155,007 213,551 116,723 157,274 61,277 1,484,006 Total $ $ $ $ $ $ $ $ $ Cash Collections By Year, By Year of Purchase – Purchased Bankruptcy Portfolio 1996 - $ - - - - - - - - - - - - $ - 1997 - $ - - - - - - - - - - - - $ - 1998 - $ - - - - - - - - - - - - $ - 1999 - $ - - - - - - - - - - - - $ - 2000 - $ - - - - - - - - - - - - - $ Cash Collection Period 2002 - $ - - - - - - - - - - - - - 2001 - $ - - - - - - - - - - - - - $ $ 2003 - $ - - - - - - - - - - - - - $ 2004 2005 2006 2007 2008 Total - $ - - - - - - - 743 - - - - 743 $ - $ - - - - - - - 4,554 3,777 - - - 8,331 $ - $ - - - - - - - 3,956 15,500 5,608 - - 25,064 $ - $ - - - - - - - 2,777 11,934 9,455 2,850 - 27,016 $ - $ - - - - - - - 1,455 6,845 6,522 27,972 14,024 56,818 $ $ - $ - $ - $ - $ - $ - $ - $ - $ 13,485 $ 38,056 $ 21,585 $ 30,822 $ 14,024 $ 117,972 ($ in thousands) Purchase Period 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Purchase Price - $ - - - - - - - 7,469 29,302 17,643 78,933 111,063 244,410 $ Total Cash Collections By Year, By Year of Purchase - Entire Portfolio less Purchased Bankruptcy Portfolio ($ in thousands) Purchase Period 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 Purchase Price $ 3,080 7,685 11,089 18,898 25,020 33,481 42,325 61,449 51,709 113,911 90,159 179,839 167,448 806,093 1996 $ 1997 1998 1999 2000 $ $ $ $ Cash Collection Period 2002 $ 2001 $ 548 - - - - - - - - - - - - 548 2,484 2,507 - - - - - - - - - - - 4,991 1,890 5,215 3,776 - - - - - - - - - - 10,881 1,348 4,069 6,807 5,138 - - - - - - - - - 17,362 1,025 3,347 6,398 13,069 6,894 - - - - - - - - 30,733 730 2,630 5,152 12,090 19,498 13,048 - - - - - - - 53,148 496 1,829 3,948 9,598 19,478 28,831 15,073 - - - - - - 79,253 2003 2004 2005 2006 2007 $ 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 - - - $ 237 597 1,415 3,032 8,067 16,048 24,729 43,728 36,468 59,645 17,363 - - $ 102 437 882 2,243 5,202 10,011 16,527 30,695 27,973 57,928 43,737 39,413 - 2008 $ 83 346 616 1,533 3,604 6,164 9,772 18,818 17,884 42,731 34,038 87,039 47,253 269,881 Total $ $ $ $ $ $ $ $ $ $ $ $ $ $ 9,836 24,183 35,802 64,006 104,393 151,461 170,598 219,895 141,522 175,495 95,138 126,452 47,253 1,366,034 Total $ $ $ $ $ $ $ $ 117,052 $ 152,661 $ 183,045 $ 211,329 $ 235,150 $ $ 40 When we acquire a new portfolio of finance receivables, our estimates typically result in a 84-96 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 $1,600 $1,400 $1,200 $1,000 $800 $600 $400 $200 $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 6 0 - n a J 6 0 - y a M 6 0 - p e S 7 0 - n a J 7 0 - y a M 7 0 - p e S 8 0 - n a J 8 0 - y a M 8 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 tables display various productivity measures that we track. Tenure at: One year +(1) Less than one year (2) Total(2) 12/31/04 298 349 647 12/31/05 327 364 691 12/31/06 340 375 715 12/31/07 327 553 880 12/31/08 452 739 1191 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 Total cash collections Non-legal cash collections(2) Non-bk cash collections(3) Cash Collections per Hour Paid (1) 12/31/06 $146.03 $99.06 $132.15 12/31/05 $133.39 $89.25 $128.02 12/31/04 $117.59 $82.06 - 12/31/07 $135.77 $91.93 $123.10 12/31/08 $131.29 $96.95 $111.17 (1) Cash collections (assigned and unassigned) divided by total hours paid (including holiday, vacation and sick time) to all collectors (including those in training). (2) Represents total cash collections less legal cash collections. (3) Represents total cash collections less bankruptcy cash collections. Although we began bankruptcy portfolio purchasing in 2004, we began calculating this metric in 2005. Cash collections have substantially exceeded revenue in each quarter since our formation. The following chart illustrates the consistent excess of our cash collections on our owned portfolios over income recognized on finance receivables on a quarterly basis. The difference between cash collections and income recognized on finance receivables is referred to as payments applied to principal. It is also referred to as amortization of purchase price. This amortization is the portion of cash collections that is used to recover the cost of the portfolio investment represented on the balance sheet. 41 Cash Collections(1) vs. Income Recognized on Finance Receivables, net ($ in millions) Payments applied to principal or "amortization of purchase price" Cash Collections Income recognized on finance receivables, net $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 8 9 - 1 Q 8 9 - 2 Q 8 9 - 3 Q 8 9 - 4 Q 9 9 - 1 Q 9 9 - 2 Q 9 9 - 3 Q 9 9 - 4 Q 0 0 - 1 Q 0 0 - 2 Q 0 0 - 3 Q 0 0 - 4 Q 1 0 - 1 Q 1 0 - 2 Q 1 0 - 3 Q 1 0 - 4 Q 2 0 - 1 Q 2 0 - 2 Q 2 0 - 3 Q 2 0 - 4 Q 3 0 - 1 Q 3 0 - 2 Q 3 0 - 3 Q 3 0 - 4 Q 4 0 - 1 Q 4 0 - 2 Q 4 0 - 3 Q 4 0 - 4 Q 5 0 - 1 Q 5 0 - 2 Q 5 0 - 3 Q 5 0 - 4 Q 6 0 - 1 Q 6 0 - 2 Q 6 0 - 3 Q 6 0 - 4 Q 7 0 - 1 Q 7 0 - 2 Q 7 0 - 3 Q 7 0 - 4 Q 8 0 - 1 Q 8 0 - 2 Q 8 0 - 3 Q 8 0 - 4 Q (1) Includes cash collections on finance receivables only. Excludes commissions and cash proceeds from sales of defaulted consumer receivables. Seasonality We depend on the ability to collect on our owned and serviced defaulted consumer receivables. Collections tend to be higher in the first and second quarters of the year and lower in the third and fourth quarters of the year, due to consumer payment patterns in connection with seasonal employment trends, income tax refunds and holiday spending habits. Historically, our growth has partially masked the impact of this seasonality. Quarterly Cash Collections(1) ($ in millions) $90 $80 $70 $60 $50 $40 $30 $20 $10 $0 8 9 - 1 Q 8 9 - 2 Q 8 9 - 3 Q 8 9 - 4 Q 9 9 - 1 Q 9 9 - 2 Q 9 9 - 3 Q 9 9 - 4 Q 0 0 - 1 Q 0 0 - 2 Q 0 0 - 3 Q 0 0 - 4 Q 1 0 - 1 Q 1 0 - 2 Q 1 0 - 3 Q 1 0 - 4 Q 2 0 - 1 Q 2 0 - 2 Q 2 0 - 3 Q 2 0 - 4 Q 3 0 - 1 Q 3 0 - 2 Q 3 0 - 3 Q 3 0 - 4 Q 4 0 - 1 Q 4 0 - 2 Q 4 0 - 3 Q 4 0 - 4 Q 5 0 - 1 Q 5 0 - 2 Q 5 0 - 3 Q 5 0 - 4 Q 6 0 - 1 Q 6 0 - 2 Q 6 0 - 3 Q 6 0 - 4 Q 7 0 - 1 Q 7 0 - 2 Q 7 0 - 3 Q 7 0 - 4 Q 8 0 - 1 Q 8 0 - 2 Q 8 0 - 3 Q 8 0 - 4 Q (1) Includes cash collections on finance receivables only. Excludes commission fees and cash proceeds from sales of defaulted consumer receivables. 42 The following table displays our quarterly cash collections by source, for the periods indicated. Cash Collection Source ($ in thousands) Call Center & Other Collections External Legal Collections Internal Legal Collections Purchased Bankruptcy Collections Q42008 Q32008 $43,949 $41,268 21,590 18,424 2,106 2,652 15,362 16,904 Q22008 Q12008 Q42007 Q32007 Q22007 Q12007 $37,841 $46,892 20,844 22,471 1,400 1,947 7,223 13,732 $44,883 21,880 1,819 10,820 $35,551 20,861 1,443 7,245 $36,001 21,384 1,449 6,317 $36,107 20,911 1,357 6,231 The following table shows the components of outside legal and other fees and services for the years ended December 31, 2008, 2007 and 2006 (amounts in thousands): Legal fees and costs (1) Agency fees (2) Other outside fee and services 2008 2007 2006 $ 36,805 $ 30,720 $ 28,412 16,065 8,882 9,467 7,287 4,906 6,821 $ 61,752 $ 47,474 $ 40,139 (1) Legal fees and costs represent legal fees and costs incurred by both our inhouse attorneys and outside contingent fee attorneys. (2) Agency fees are primarily incurred by our IGS skip tracing business. The following table shows the changes in finance receivables, including the amounts paid to acquire new portfolios, for the years ended December 31, 2008, 2007 and 2006 (amounts in thousands): 2008 2007 2006 Balance at beginning of year Acquisitions of finance receivables, net of buybacks (1) Cash collections applied to principal on finance receivables (2) $ 410,297 273,746 $ 226,448 261,310 $ 193,645 105,838 (120,213) (77,461) (73,035) Balance at end of year $ 563,830 $ 410,297 $ 226,448 Estimated Remaining Collections ("ERC")(3) $ 1,115,565 $ 902,565 $ 553,223 _________ (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 allowance 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, business acquisitions, repurchase of our common stock, payment of cash dividends, 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 43 debt or equity financing if we were to make any other significant acquisitions requiring cash during that period. In addition, we file taxes using the cost recovery method for income recognition. If we were to receive an unfavorable ruling on our tax method, we may be required to pay our current deferred taxes in the near-term, possibly requiring additional financing from other sources. 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 $81.7 million, $80.4 million and $59.5 million for the years ended December 31, 2008, 2007 and 2006, respectively. In these periods, cash from operations was generated primarily from net income earned through cash collections and commissions received for the period. The increase was due mostly to changes in deferred taxes. Net income decreased to $45.4 million for the year ended December 31, 2008 from $48.2 million for the year ended December 31, 2007 and increased from $44.5 million for the year ended December 31, 2006. Net cash provided by operating activities was also impacted by the amount of income taxes paid during the period which was $3,200, $5.3 million and $18.8 million for the years ended December 31, 2008, 2007 and 2006, respectively. The remaining changes were due to net changes in other accounts related to our operating activities. Our investing activities used cash of $185.7 million, $192.9 million and $39.7 million for the years ended December 31, 2008, 2007 and 2006, respectively. The majority of the change was due to acquisitions of finance receivables which increased to $273.7 million for the year ended December 31, 2008 from $261.3 million for the year ended December 31, 2007 and $105.8 million for the year ended December 31, 2006. Cash provided by investing activities is primarily driven by cash collections applied to principal on finance receivables. Cash used in investing activities is primarily driven by acquisitions of defaulted consumer receivables, purchases of property and equipment and business acquisitions. Our financing activities provided cash of $101.2 and $104.2 million in 2008 and 2007, respectively, and used cash of $10.7 million in 2006. Cash used in financing activities is primarily driven by payments on our line of credit, principal payments on long-term debt and capital lease obligations, repurchases of our common stock and cash dividends paid on our common stock. Cash provided by financing activities is primarily driven by proceeds from draws on our line of credit and stock option exercises. The majority of the change was due to net proceeds received from our line of credit partially offset by cash used to pay a cash dividend on our common stock and the repurchase of 1,000,000 shares of our common stock during the year ended December 31, 2007. We had net draws on our line of credit of $100.3 and 168.0 million for 2008 and 2007, respectively, compared to net repayments of $15.0 million for 2006. Also, in accordance with the adoption of SFAS 123R on January 1, 2006, the benefit derived from share-based compensation was $0.4 million, $1.6 million and $2.4 million in 2008, 2007 and 2006, respectively. This was previously classified in operating activities. In addition, the exercise of stock options and stock warrants generated cash from financing activities of $0.6 million for the year ended December 31, 2008, $2.1 million for the year ended December 31, 2007 and $2.5 million for the year ended December 31, 2006. Cash paid for interest expense was approximately $11,322,000, $2,779,000 and $411,000 for the years ended December 31, 2008, 2007 and 2006, respectively. The majority of interest expenses were paid on our lines of credit, capital lease obligations and other long-term debt. The increase was caused by higher average balances on our line of credit for the year ended December 31, 2008 when compared to the years ended December 31, 2007 and December 31, 2006. This increase was offset by a decrease in the weighted average interest rate on our line of credit which decreased to 4.60% for the year ended December 31, 2008 as compared to 6.64% and 6.23% for the years ended December 31, 2007 and 2006, respectively. 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 was amended on May 9, 2006 to include RBC Centura Bank as an additional lender, again on May 4, 2007 to increase the line of credit to $150,000,000 and incorporate a $50,000,000 non-revolving fixed rate sub-limit, again on October 26, 2007 to increase the line of credit to $270,000,000, again on March 18, 2008 to increase the non-revolving fixed rate sub-limit to $100,000,000, again on May 2, 2008 to include SunTrust Bank as an additional lender and to increase the line of credit to $340,000,000, and again on September 3, 2008 to include JP 44 Morgan Chase Bank as an additional lender and to increase the line of credit to $365,000,000. The agreement is a line of credit in an amount equal to the lesser of $365,000,000 or 30% of our estimated remaining collections of all our eligible asset pools. Borrowings under the revolving credit facility bear interest at a floating rate equal to the one month LIBOR Market Index Rate plus 1.40%, which was 1.836% at December 31, 2008, and the facility expires on May 2, 2011. We also pays an unused line fee equal to three-tenths of one percent, or 30 basis points, on any unused portion of the line of credit. The loan is collateralized by substantially all of our tangible and intangible assets. The agreement provides as follows: • monthly borrowings may not exceed 30% of estimated remaining collections; • funded debt to EBITDA (defined as net income, less income or plus loss from discontinued operations and extraordinary items, plus income taxes, plus interest expense, plus depreciation, depletion, amortization (including finance receivable amortization) and other non-cash charges) ratio must be less than 2.0 to 1.0 calculated on a rolling twelve-month average; tangible net worth must be at least 100% of tangible net worth reported at September 30, 2005, plus 25% of cumulative positive net income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering without giving effect to reductions in tangible net worth due to repurchases of up to $100,000,000 of the Company’s common stock; and restrictions on change of control. • • As of December 31, 2008, outstanding borrowings under the facility totaled $268,300,000, of which $50,000,000 was part of the non-revolving fixed rate sub-limit which bears interest at 6.80% and expires on May 4, 2012. As of December 31, 2008, we are in compliance with all of the covenants of the agreement. Contractual Obligations The following summarizes our contractual obligations that exist as of December 31, 2008 (amounts in thousands): Contractual Obligations Operating Leases Line of Credit (1) Capital Lease Obligations Purchase Commitments (2) Employment Agreements Total Less than 1 year $ 3,638 8,352 5 74,678 9,080 95,753 $ Payments due by period 1 - 3 years 4 - 5 years $ 6,756 $ 6,064 More than 5 years $ 5,266 233,795 - 442 7,397 248,390 51,133 - - - 18 - 57,215 $ - - 5,266 $ $ Total $ 21,724 293,280 5 75,138 16,477 406,624 $ (1) To the extent that a balance is outstanding on our lines of credit, the revolving portion would be due in May, 2011 and the non-revolving fixed rate sub-limit portion would be due in May 2012. This amount also includes estimated interest and unused line fees due on the line of credit for both the fixed rate and variable rate components as well as interest due on our interest rate swap. This estimate also assumes that the balance on the line of credit remains constant from the December 31, 2008 balance of $268.3 million and the balance is paid in full at its respective maturity. (2) This amount includes the maximum remaining amount to be purchased under forward flow contracts for the purchase of charged-off consumer debt in the amount of approximately $71.6 million. 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. 45 Recent Accounting Pronouncements On September 15, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. SFAS 157 was originally effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years but was amended on February 6, 2008 to defer the effective date for one year for certain nonfinancial assets and liabilities. We adopted SFAS 157 on January 1, 2008, which had no material impact on our consolidated financial statements. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 is effective for fiscal years beginning after November 15, 2007. SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. We adopted SFAS 159 on January 1, 2008, which had no material impact on our consolidated financial statements. In December 2007, the FASB issued SFAS No. 141R “Business Combinations” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination, recognizing assets acquired and liabilities assumed arising from contingencies, and determining what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for acquisitions consummated in fiscal years beginning after December 15, 2008. We expect SFAS 141R will have an impact on our consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate after the effective date. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method significantly changes the accounting for transactions with minority interest holders. SFAS 160 is effective for fiscal years beginning after December 15, 2008 with early application prohibited. We believe that SFAS 160 will have no material impact on our consolidated financial statements. In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities"(“SFAS 161”). SFAS 161 requires expanded disclosures regarding the location and amounts of derivative instruments in an entity’s financial statements, how derivative instruments and related hedged items are accounted for under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”, and how derivative instruments and related hedged items affect an entity’s financial position, operating results and cash flows. SFAS 161 is effective for periods beginning on or after November 15, 2008. We believe SFAS 161 will have no material impact on our consolidated financial statements. In April 2008, the FASB issued FSP 142-3, “Determination of the Useful Life of Intangible Assets”, (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets”. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. We believe FSP 142-3 will have no material impact on our consolidated financial statements. 46 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. 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 may be 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. SOP 03-3 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 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 and is recorded as a reduction in revenue in the consolidated income statements with a corresponding valuation allowance offsetting the finance receivables, net, on the consolidated balance sheets. 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 47 pool. Likewise, cash flows that are less than the accrual will accrete the carrying balance. We generally do not allow accretion in the first six to twelve months. 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. These pools are not aggregated with other portfolios. 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, 2008 and 2007, we had a $23.6 million and $4.2 million valuation allowance on our finance receivables, respectively. Prior to January 1, 2005, in the event that a reduction of the yield to as low as zero in conjunction with estimated future cash collections that were inadequate to amortize the carrying balance, an allowance 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. 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, the portfolios which are placed for servicing are owned by our clients and are placed under a contingent fee commission arrangement. Our subsidiary is paid to collect funds from the client’s debtors and earns a commission generally expressed as a percentage of the gross collection amount. The “Commissions” line of our income statement reflects the contingent fee amount earned, and not the gross collection amount. We discontinued our ARM contingent fee operation during the second quarter of 2008. Our skip tracing subsidiary utilizes gross reporting under EITF 99-19. We generate revenue by working an account and successfully locating a customer for our client. An “investigative fee” 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 we conduct 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 the line item “Commissions” and the expense is included in the line item “Compensation and employee services.” The second item is for expenses incurred while conducting the audit. Most jurisdictions will reimburse us for direct expenses incurred for the audit including such items as travel and meals. The billed amounts are included in the line item “Commissions” and the expense component is included in its appropriate expense category, generally “Other operating expenses.” We account for our gain on cash sales of finance receivables under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” Gains on sale of finance receivables, representing the difference between the sales price and the unamortized value of the finance receivables sold, are recognized when finance receivables are sold. 48 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 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 is allocated to various reporting units of our business to which it relates; and (2) we estimate the fair value of those reporting units to which the goodwill relates and then determine the book value of those reporting units. If the estimated fair value of reporting units with allocated goodwill is determined to be less than their book value, we are required to estimate the fair value of all identifiable assets and liabilities of those reporting units in a manner similar to a purchase price allocation for an acquired business. This requires independent valuation of certain unrecognized assets. Once this process is complete, the amount of goodwill impairment, if any, can be determined. We believe that, as of December 31, 2008, 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 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. Beginning with the adoption of FASB Interpretation No. 48, Accounting for Uncertainty in Income Taxes (“FIN 48”) as of January 1, 2007, we recognize the effect of the income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgement occurs. Effective with our 2002 tax filings, we adopted the cost recovery method of income recognition for tax purposes. We believe 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. 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 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. 49 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. The average borrowings on our variable rate credit line were $182.4 million for the year ended December 31, 2008. Assuming a 200 basis point increase in interest rates, interest expense would have increased by $3.7 million and $0.6 million for the years ended December 31, 2008 and 2007, respectively. As of December 31, 2008 and 2007, we had $218.3 million and $118.0 million, respectively, of variable rate debt outstanding on our credit lines. We do not have any other variable rate debt outstanding as of December 31, 2008. Significant increases in future interest rates on the variable rate credit line could lead to a material decrease in future earnings assuming all other factors remained constant. 50 Item 8. Financial Statements and Supplementary Data. Index to Financial Statements Reports of Independent Registered Public Accounting Firms Consolidated Balance Sheets as of December 31, 2008 and 2007 Consolidated Income Statements for the years ended December 31, 2008, 2007 and 2006 Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2008, 2007 and 2006 Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006 Notes to Consolidated Financial Statements Page 52-55 56 57 58 59 60-79 51 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Portfolio Recovery Associates, Inc.: We have audited Portfolio Recovery Associates, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). Portfolio Recovery Associates, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting (Item 9A). Our responsibility is to express an opinion on the Company’s internal control over financial reporting based on our audit. We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion. A company's internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company's internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide 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. Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate. In our opinion, Portfolio Recovery Associates, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO). 52 Portfolio Recovery Associates, Inc. acquired MuniServices, LLC (MuniServices) during 2008, and management excluded from its assessment of the effectiveness of Portfolio Recovery Associates, Inc.’s internal control over financial reporting as of December 31, 2008, MuniServices’ internal control over financial reporting associated with less than 5% of the total assets and total revenues reflected in the consolidated financial statements of Portfolio Recovery Associates, Inc. and subsidiaries as of and for the year ended December 31, 2008. Our audit of internal control over financial reporting of Portfolio Recovery Associates, Inc. also excluded an evaluation of the internal control over financial reporting of MuniServices. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated balance sheets of Portfolio Recovery Associates, Inc. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated income statements, and statements of changes in stockholders’ equity and comprehensive income, and cash flows for the years then ended, and our report dated February 27, 2009 expressed an unqualified opinion on those consolidated financial statements. /s/ KPMG LLP Norfolk, Virginia February 27, 2009 53 Report of Independent Registered Public Accounting Firm The Board of Directors and Stockholders Portfolio Recovery Associates, Inc.: We have audited the accompanying consolidated balance sheets of Portfolio Recovery Associates, Inc. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated income statements, and statements of changes in stockholders’ equity and comprehensive income, and cash flows for the years then ended. These consolidated financial statements are the responsibility of the Company’s management. Our responsibility is to express an opinion on these consolidated financial statements based on our audits. We conducted our audits in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statements are free of material misstatement. An audit includes examining, on a test basis, evidence supporting the amounts and disclosures in the financial statements. An audit also includes assessing the accounting principles used and significant estimates made by management, as well as evaluating the overall financial statement presentation. We believe that our audits provide a reasonable basis for our opinion. In our opinion, the consolidated financial statements referred to above present fairly, in all material respects, the financial position of Portfolio Recovery Associates, Inc. and subsidiaries as of December 31, 2008 and 2007, and the results of their operations and their cash flows for the years then ended in conformity with U.S. generally accepted accounting principles. As discussed in note 2 to the consolidated financial statements, the Company adopted the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainty in Income Taxes, an interpretation of FASB Statement No. 109, effective January 1, 2007. We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), Portfolio Recovery Associates, Inc.’s internal control over financial reporting as of December 31, 2008, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (COSO), and our report dated February 27, 2009 expressed an unqualified opinion on the effectiveness of the Company’s internal control over financial reporting. /s/ KPMG LLP Norfolk, Virginia February 27, 2009 54 Report of Independent Registered Public Accounting Firm To the Board of Directors and Stockholders of Portfolio Recovery Associates, Inc.: In our opinion, the consolidated statements of income, stockholders’ equity, and cash flows for the year ended December 31, 2006 present fairly, in all material respects, the results of operations and cash flows of Portfolio Recovery Associates, Inc. and its subsidiaries for the year ended December 31, 2006, 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 audit. We conducted our audit 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 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 audit provides a reasonable basis for our opinion. /s/ PricewaterhouseCoopers LLP McLean, Virginia March 1, 2007 55 Portfolio Recovery Associates, Inc. Consolidated Balance Sheets December 31, 2008 and 2007 (Amounts in thousands, except per share amounts) Assets 2008 2007 Cash and cash equivalents Finance receivables, net Income taxes receivable Property and equipment, net Goodwill Intangible assets, net Other assets Total assets Liabilities and Stockholders' Equity Liabilities: Accounts payable Accrued expenses Accrued payroll and bonuses Deferred tax liability Line of credit Obligations under capital lease Total liabilities Commitments and contingencies (Note 18) Stockholders' equity: Preferred stock, par value $0.01, authorized shares, 2,000, issued and outstanding shares - 0 Common stock, par value $0.01, authorized shares, 30,000, 15,398 issued and 15,286 outstanding shares - at December 31, 2008, and 15,159 issued and outstanding at December 31, 2007 Additional paid-in capital Retained earnings Accumulated other comprehensive income Total stockholders' equity $ 13,901 563,830 3,587 23,884 27,546 13,429 11,663 $ 16,730 410,297 3,022 16,171 18,620 5,046 6,421 $ 657,840 $ 476,307 $ 3,438 4,314 9,850 88,070 268,300 5 373,977 $ 4,055 4,471 6,819 57,579 168,000 103 241,027 - - 153 74,574 209,047 89 283,863 152 71,443 163,685 - 235,280 Total liabilities and stockholders' equity $ 657,840 $ 476,307 The accompanying notes are an integral part of these consolidated financial statements. 56 Portfolio Recovery Associates, Inc. Consolidated Income Statements For the years ended December 31, 2008, 2007 and 2006 (Amounts in thousands, except per shares amounts) Revenues: Income recognized on finance receivables, net Commissions $ 206,486 56,789 $ 184,705 36,043 $ 163,357 24,965 2008 2007 2006 Total revenues 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 Other income and (expense): Interest income Interest expense Income before income taxes Provision for income taxes 263,275 220,748 188,322 88,073 61,752 10,304 3,908 6,977 7,424 178,438 84,837 60 (11,151) 73,746 28,384 69,022 47,474 8,531 3,105 5,915 5,517 139,564 81,184 419 (3,704) 77,899 29,658 58,142 40,139 5,876 2,276 4,758 5,131 116,322 72,000 584 (378) 72,206 27,716 Net income $ 45,362 $ 48,241 $ 44,490 Net income per common share Basic Diluted Weighted average number of shares outstanding Basic Diluted $ $ 2.98 2.97 $ $ 3.08 3.06 $ $ 2.80 2.77 15,229 15,292 15,646 15,779 15,911 16,082 The accompanying notes are an integral part of these consolidated financial statements. 57 Portfolio Recovery Associates, Inc. Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income For the years ended December 31, 2008, 2007 and 2006 (Amounts in thousands, except per share amount) Balance at December 31, 2005 Common Stock $ 158 Additional Paid-in Capital Retained Earnings Accumulated Other Comprehensive Income Total Stockholders' Equity $ 108,064 $ 87,101 $ - $ 195,323 Net income Exercise of stock options, warrants and vesting of nonvested shares Amortization of share-based compensation SFAS123R adoption reclass of payroll liability to additional paid-in capital Income tax benefit from share-based compensation - 2 - - - - 2,501 2,117 426 2,420 44,490 - - - - Balance at December 31, 2006 $ 160 $ 115,528 $ 131,591 $ - Net income Exercise of stock options and vesting of nonvested shares Issuance of common stock for acquisition Repurchase and cancellation of common stock Cash dividends paid ($1.00 per common share) Amortization of share-based compensation Income tax benefit from share-based compensation Adoption of FIN 48 - 2 (10) - - - - - 2,072 50 (50,547) - 2,575 1,575 190 48,241 - - - (16,070) - - (77) Balance at December 31, 2007 $ 152 $ 71,443 $ 163,685 $ - Net income Net unrealized change in: Interest rate swap derivative Comprehensive income Exercise of stock options and vesting of nonvested shares Issuance of common stock for acquisition Amortization of share-based compensation Income tax benefit from share-based compensation Reversal of FIN 48 reserve - - 1 - - - - - - 606 1,847 141 357 180 45,362 - - - - - - - - - - - - - - - - - - - - 89 - - - - - 44,490 2,503 2,117 426 2,420 $ 247,279 48,241 2,074 50 (50,557) (16,070) 2,575 1,575 113 $ 235,280 45,362 89 45,451 607 1,847 141 357 180 Balance at December 31, 2008 $ 153 $ 74,574 $ 209,047 $ 89 $ 283,863 The accompanying notes are an integral part of these consolidated financial statements. 58 Portfolio Recovery Associates, Inc. Consolidated Statements of Cash Flows For the years ended December 31, 2008, 2007 and 2006 Cash flows from operating activities: Net income Adjustments to reconcile net income to net cash provided by operating activities: Amortization of share-based compensation Depreciation and amortization Deferred tax expense Changes in operating assets and liabilities: Other assets Accounts payable Income taxes Accrued expenses Accrued payroll and bonuses Net cash provided by operating activities 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, including acquisition costs and net of cash acquired 2008 2007 2006 $ 45,362 $ 48,241 $ 44,490 141 7,424 30,854 (2,218) (1,167) (385) (413) 2,120 81,718 (6,139) (273,746) 120,213 - - (26,041) 2,575 5,517 24,126 (2,339) 1,164 (1,319) 1,816 575 80,356 (8,662) (261,310) 77,461 - - (409) 2,117 5,131 11,107 (437) 559 (4,568) 339 729 59,467 (6,869) (105,838) 73,035 (1,450) 1,450 - Net cash used in investing activities (185,713) (192,920) (39,672) Cash flows from financing activities: Dividends paid Proceeds from exercise of options and warrants Income tax benefit from share-based compensation Draws on line of credit Principal payments on line of credit Repurchases of common stock Principal payments on long-term debt Principal payments on capital lease obligations Net cash provided by/(used in) financing activities Net (decrease)/increase in cash and cash equivalents Cash and cash equivalents, beginning of year - 607 357 171,300 (71,000) - - (98) - 101,166 (2,829) 16,730 (16,070) 2,074 1,575 171,000 (3,000) (50,557) (690) (139) - 104,193 (8,371) 25,101 - 2,503 2,420 - (15,000) - (462) (140) - (10,679) 9,116 15,985 Cash and cash equivalents, end of year $ 13,901 $ 16,730 $ 25,101 Supplemental disclosure of cash flow information: Cash paid for interest Cash paid for income taxes Noncash investing and financing activities: $ 11,322 $ 3 $ $ 2,779 5,289 $ $ 411 18,764 SFAS123R adoption reclass of payroll liability to additional paid-in capital Acquisitions - Common stock issued Net unrealized change in interest rate swap derivative $ - $ 1,847 $ 89 $ - $ 50 $ - $ 426 $ - $ - The accompanying notes are an integral part of these consolidated financial statements. 59 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 1. Organization and Business: Portfolio Recovery Associates, LLC (“PRA”) was formed on March 20, 1996. Portfolio Recovery Associates, Inc. (“PRA Inc”) was formed in August 2002. On November 8, 2002, PRA Inc completed its initial public offering (“IPO”) of common stock. As a result, all of the membership units and warrants of PRA were exchanged on a one to one basis for warrants and shares of a single class of common stock of PRA Inc. Two of PRA Inc’s wholly owned subsidiaries, Thomas West Associates, LLC (“TWA”), and PRA Bankruptcy Services, LLC (“PRA BS”) were dissolved as entities on May 8, 2006 and August 8, 2008, respectively. 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 Legal Recovery Department, collects accounts judicially, either by using its own attorneys, or by contracting with independent attorneys throughout the country through 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 member. The purpose of PRA Holding I is to enter into leases of office space and hold the Company’s real property (see Note 10) in Hutchinson, Kansas, 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) (“Anchor”) and was the sole initial member. Anchor was organized as a contingent collection agency and contracted 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. The Company purchased the equity interest in Anchor from PRA immediately after the IPO. The Company discontinued its Anchor contingent fee operation during the second quarter of 2008, but PRA Receivables Management, LLC continues to serve as the operational entity for the Company’s bankruptcy department. 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”). On September 10, 2004, the Company created a wholly owned subsidiary, PRA Location Services, LLC d/b/a IGS to operate 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”). Although most of its clients are located in Alabama, RDS, through PRA Government Services, LLC, a wholly owned subsidiary formed by the Company on June 23, 2005, began expanding into surrounding states. PRA Funding, LLC and PRA III were merged into PRA on November 24, 2003. On October 13, 2006, PRA formed a wholly owned subsidiary, PRA Holding II, LLC (“PRA Holding II”), and is the sole member. The purpose of PRA Holding II is to hold the Company’s real property in Jackson, Tennessee and other real and personal property. On July 1, 2008, the Company acquired 100% of the membership interests of MuniServices, LLC (the resulting business is referred to herein as “MuniServices”). MuniServices was founded in 1978 and is a provider of revenue enhancement and related services to state and local governments. Although most of its clients are in California, it also serves clients in Texas, Florida, Pennsylvania, Georgia, Nevada and the District of Columbia. MuniServices has a workforce of approximately 115 employees. The President of MuniServices and three other members of the management team have entered into long-term employment agreements with the Company and continue to manage 60 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements MuniServices. The consolidated income statement includes the results of operations of MuniServices for the period from July 1, 2008 through December 31, 2008. The transaction was completed at a price of $24.6 million, consisting of $22.5 million in cash and $2.1 million in PRA Inc common stock. The total purchase price could increase by a total of $4.5 million in stock through contingent payments in 2009 and 2010, related to specific operating goals. On August 1, 2008, the Company acquired substantially all of the assets of Broussard Partners and Associates, Inc. (“BPA”), which is operating as a part of RDS. BPA, founded in 1995, is a provider of audit services to parishes in Louisiana, with 34 of the state’s 64 parishes as clients. BPA has a workforce of approximately 25 employees. The President of BPA has entered into a long-term employment agreement with RDS. The consolidated income statement includes the results of operations of BPA for the period from August 1, 2008 through December 31, 2008. 2. Summary of Significant Accounting Policies: Principles of accounting and consolidation: The consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles and include the accounts of PRA Inc, PRA, PRA Holding I, PRA Holding II, IGS, RDS and MuniServices. 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 $1,112,175 and $1,263,563 at December 31, 2008 and 2007, respectively. There is an offsetting liability that is included in “Accounts payable” on the accompanying consolidated balance sheets. Investments: The Company accounts for its investments under the guidance of the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 115 (“SFAS 115”), “Accounting for Certain Investments in Debt and Equity Securities.” At December 31, 2008 and 2007, the Company did not have any investments on the consolidated balance sheets; however, it did purchase investments during 2006. Other assets: Other assets consist mainly of trade accounts receivable, prepaid expenses and derivatives used for hedging purposes. 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. Derivative Instruments and Hedging Activities: The Company accounts for derivatives and hedging activities in accordance with FASB Statement No. 133, “Accounting for Derivative Instruments and Certain Hedging Activities,” as amended, which requires entities to recognize all derivative instruments as either assets or liabilities in the balance sheet at their respective fair values. For derivatives designated in hedging relationships, changes in the fair value are either offset through earnings against the change in fair value of the hedged item attributable to the risk being hedged or recognized in accumulated other comprehensive income until the hedged item is recognized in earnings. The Company only enters into derivative contracts that it intends to designate as a hedge of a forecasted transaction or the variability of cash flows to be received or paid related to a recognized asset or liability (cash flow hedge). For all hedging relationships, the Company formally documents the hedging relationship and its risk-management objective and strategy for undertaking the hedge, the hedging instrument, the hedged item, the nature of the risk being hedged, how the hedging instrument’s effectiveness in offsetting the hedged risk will be assessed prospectively and retrospectively, and a description of the method of measuring ineffectiveness. The Company also formally assesses, both at the hedge’s inception and on an ongoing basis, whether the derivatives that are used in hedging transactions are highly effective in offsetting cash flows of hedged items. For derivative instruments that are designated and qualify as a cash-flow hedge, the effective portion of the gain or loss on the 61 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements derivative is reported as a component of other comprehensive income and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings. The Company discontinues hedge accounting prospectively when it determines that the derivative is no longer effective in offsetting cash flows of the hedged item, the derivative expires or is sold, terminated, or exercised, the derivative is dedesignated as a hedging instrument because it is unlikely that a forecasted transaction will occur, or management determines that designation of the derivative as a hedging instrument is no longer appropriate. In all situations in which hedge accounting is discontinued and the derivative is retained, the Company continues to carry the derivative at its fair value on the balance sheet and recognizes any subsequent changes in its fair value in earnings. When it is probable that a forecasted transaction will not occur, the Company discontinues hedge accounting and recognizes immediately in earnings gains and losses that were accumulated in other comprehensive income. 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 the portfolio both by account and aggregate pool 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 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 may be 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. SOP 03-3 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 and is recorded as a reduction in revenue in the consolidated income statements with a corresponding valuation allowance offsetting the finance receivables, net, on the consolidated balance sheets. Income on finance receivables is accrued quarterly based on each static pool’s effective IRR. Quarterly cash flows greater than the 62 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 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 Company generally does not allow accretion in the first six to twelve months. 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. These pools are not aggregated with other portfolios. 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, 2008 and 2007, the Company had unamortized purchased principal (purchase price) in pools accounted for under the cost recovery method of $3,668,133 and $6,301,373, respectively. 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, 2008 and 2007, the Company had an allowance against its finance receivables of $23.6 million and $4.2 million, respectively. Prior to January 1, 2005, in the event that a reduction of the yield to as low as zero in conjunction with estimated future cash collections that were inadequate to amortize the carrying balance, an allowance 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, 2008, 2007 and 2006 was $3,078,560, $2,434,916 and $1,322,721, respectively. During the years ended December 31, 2008, 2007 and 2006 the Company capitalized $1,250,940, $1,683,951 and $805,640, respectively, of these direct acquisition fees. During the years ended December 31, 2008, 2007 and 2006 the Company amortized $607,296, $571,756 and $511,320, respectively, of these direct acquisition fees. The agreements to purchase the aforementioned receivables include general representations and warranties from the sellers covering account holder death or bankruptcy and accounts settled or disputed prior to sale. The representation and warranty period permitting the return of these accounts from the Company to the seller is typically 90 to 180 days. Any funds received from the seller of finance receivables as a return of purchase price are referred to as buybacks. Buyback funds are simply applied against the finance receivable balance received and are not included in the Company’s cash collections from operations. 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. 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 record 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 considers each of these factors to determine the correct method of recognizing revenue from its subsidiaries. For the Company’s contingent fee collection subsidiary, the portfolios that are placed for servicing are owned by its clients and are placed under a contingent fee commission arrangement. The Company’s subsidiary is paid to collect funds from the client’s debtors and earns a commission generally expressed as a percentage of the gross collection amount. The “Commissions” line of the income statement reflects the contingent fee amount earned, and not the gross collection amount. The Company discontinued its Anchor contingent fee operation during the second quarter of 2008. The Company’s skip tracing subsidiary utilizes gross reporting under EITF 99-19. IGS generates revenue by working an account and successfully locating a customer for their client. An “investigative fee” 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 63 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 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 subsidiaries utilize both gross and net reporting under EITF 99-19. The Company’s 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 audits are conducted, 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 the line item “Commissions” and the expense is included in the line item “Compensation and employee services.” The second item is for expenses incurred while conducting the audit. Most jurisdictions will reimburse the Company for direct expenses incurred for the audit including such items as travel and meals. The billed amounts are included in the line item “Commissions” and the expense component is included in its appropriate expense category, generally, “Other operating expenses.” 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 is amortized or depreciated over three to five years. Furniture and fixtures are depreciated over five years. Equipment is depreciated over five to seven years. Leasehold improvements are depreciated over the lesser of the useful life, which ranges from three to ten years, or the remaining life of the leased property. 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 acquisitions of IGS on October 1, 2004, RDS on July 29, 2005, The Palmer Group on July 25, 2007, MuniServices on July 1, 2008, and BPA on August 1, 2008, the Company purchased certain tangible and intangible assets. Intangible assets purchased included client and customer relationships, non-compete agreements, trademarks and goodwill. In accordance with SFAS 142, the Company is amortizing the IGS client relationships over seven years, The Palmer Group customer relationship over 2.42 years, the RDS and BPA customer relationships over ten years and the MuniServices customer relationships over 11 years. The Company is amortizing the non-compete agreements over three years for the IGS, RDS and MuniServices acquisitions and 2.42 years for the BPA acquisition. The Company is amortizing trademarks over 14 years for the MuniServices acquisition. The Company reviews these intangible assets at least annually for impairment, and when a triggering event occurs. In addition, goodwill, pursuant to SFAS 142, is not amortized but rather reviewed annually for impairment, and when a triggering event occurs. 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,” (“SFAS 109”) 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. Beginning with the adoption of FASB Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) as of January 1, 2007, the Company recognizes the effect of the income tax positions only if those positions are more likely than not of being sustained. Recognized income tax positions are measured at the largest amount that is greater than 50% likely of being realized. Changes in recognition or measurement are reflected in the period in which the change in judgment occurs. Prior to the adoption of FIN 48, the Company recognized the effect of income tax positions only if such positions were probable of being sustained. 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 tax revenue recognition 64 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 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 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. In addition, future minimum lease payments (including the impact of rent escalations) are expensed on a straight-lined basis over the life of the lease. Material leasehold improvements are capitalized and depreciated over the remaining 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 amortized on a straight-line basis over the shorter of the lease term or the estimated useful life of the asset. 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 (“APB”) Opinion No. 25, “Accounting for Stock Issued to Employees,” for all warrants issued to employees prior to January 1, 2002. For warrants and options issued to non-employees, the Company followed the fair value method of accounting as prescribed under SFAS No. 123, “Accounting for Stock Based Compensation” (“SFAS 123”). On January 1, 2002, the Company adopted SFAS 123 on a prospective basis for all warrants and options granted and reported the change in accounting principle using the retroactive restatement method as prescribed in SFAS No. 148 “Accounting for Stock-Based Compensation – Transition and Disclosure.” Effective January 1, 2006, the Company adopted FASB Statement No. 123R (“SFAS 123R”), “Share-Based Payment” using the modified prospective approach. Use of estimates: The preparation of financial statements in conformity with U.S. generally accepted accounting principles 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 timing and amount of future cash collections of the Company’s finance receivables 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 estimates of future cash collections, and whether it is reasonably possible that its assessments 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, finance receivables, net, line of credit and derivative instruments. See Note 13 for additional disclosure. 65 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements Recent Accounting Pronouncements: On September 15, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. SFAS 157 was originally effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years but was amended on February 6, 2008 to defer the effective date for one year for certain nonfinancial assets and liabilities. The Company adopted SFAS 157 on January 1, 2008, which had no material impact on its consolidated financial statements. In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 is effective for fiscal years beginning after November 15, 2007. SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. The Company adopted SFAS 159 on January 1, 2008, which had no material impact on its consolidated financial statements In December 2007, the FASB issued SFAS No. 141R, “Business Combinations” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination, recognizing assets acquired and liabilities assumed arising from contingencies, and determining what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for acquisitions consummated in fiscal years beginning after December 15, 2008. The Company expects SFAS 141R will have an impact on its consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions that the Company consummates after the effective date. In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method significantly changes the accounting for transactions with minority interest holders. SFAS 160 is effective for fiscal years beginning after December 15, 2008 with early application prohibited. The Company believes SFAS 160 will have no material impact on its consolidated financial statements. In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 requires expanded disclosures regarding the location and amounts of derivative instruments in an entity’s financial statements, how derivative instruments and related hedged items are accounted for under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”, and how derivative instruments and related hedged items affect an entity’s financial position, operating results and cash flows. SFAS 161 is effective for periods beginning on or after November 15, 2008. The Company believes SFAS 161 will have no material impact on its consolidated financial statements. In April 2008, the FASB issued Staff Position (“FSP”) 142-3, “Determination of the Useful Life of Intangible Assets” (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets”. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. The Company believes FSP 142-3 will have no material impact on its consolidated financial statements. 3. Finance Receivables, net: As of December 31, 2008 and 2007, the Company had $563,830,227 and $410,296,594, respectively, remaining of finance receivables, net. Changes in finance receivables, net for the years ended December 31, 2008 and 2007, were as follows (amounts in thousands): 66 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 2008 2007 Balance at beginning of year Acquisitions of finance receivables, net of buybacks $ 410,297 273,746 $ 226,448 261,310 Cash collections Income recognized on finance receivables, net Cash collections applied to principal (326,699) 206,486 (120,213) (262,166) 184,705 (77,461) Balance at end of year $ 563,830 $ 410,297 At the time of acquisition, the life of each pool is generally estimated to be between 84 to 96 months based on projected amounts and timing of future cash receipts using the proprietary models of the Company. As of December 31, 2008, the Company had $563,830,227 in finance receivables, net included in the consolidated balance sheet. Based upon current projections, cash collections applied to principal will be as follows for the following years ending December 31, (amounts in thousands): 2009 2010 2011 2012 2013 2014 2015 2016 $ $ 123,092 137,922 125,508 97,999 47,108 22,250 8,478 1,473 563,830 During the year ended December 31, 2008, the Company purchased $4.6 billion of face value of charged-off consumer receivables. During the year ended December 31, 2007, the Company purchased $11.1 billion of face value of charged-off consumer receivables. At December 31, 2008, the estimated remaining collections on the receivables purchased during 2008 and 2007 were $487,446,858 and $355,745,176, respectively. Accretable yield represents the amount of income recognized on finance receivables the Company can expect to generate over the remaining life of its existing portfolios based on estimated future cash flows as of December 31, 2008 and 2007. Reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase in its estimate of future cash flows. Reclassifications to nonaccretable difference from accretable yield results from allowance charges that exceed the Company’s increase in its estimate of future cash flows. Changes in accretable yield for the years ended December 31, 2008 and 2007 were as follows (amounts in thousands): 2008 2007 $ $ 492,268 (206,486) 288,854 (22,901) 551,735 326,775 (184,705) 279,726 70,472 492,268 $ $ Balance at beginning of year Income recognized on finance receivables, net Additions Reclassifications (to)/from nonaccretable difference Balance at end of year 67 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements During the years ended December 31, 2008, 2007 and 2006, the Company recorded a $20,405,000, $3,210,000 and $1,100,000 allowance charge, respectively, on portfolios that had underperformed expectations. During the years ended December 31, 2008 and 2007, the Company also reversed $1,015,000 and $280,000, respectively, of allowance charges recorded in prior periods. The changes in the valuation allowance for finance receivables for the years ended December 31, 2008, 2007 and 2006 are as follows (amounts in thousands): 2008 2007 2006 Balance at beginning of year Allowance charges recorded Reversal of previously recorded allowance charges Change in allowance charge Balance at end of year 4. Operating Leases: $ $ $ 4,230 20,405 (1,015) 19,390 23,620 1,300 3,210 (280) 2,930 4,230 200 1,100 - 1,100 1,300 $ $ $ The Company rents office space and equipment under operating leases. Rental expense was $3,060,710, $2,511,842 and $1,915,103 for the years ended December 31, 2008, 2007 and 2006, respectively. Future minimum lease payments for operating leases at December 31, 2008, are as follows (amounts in thousands): 2009 2010 2011 2012 2013 Thereafter $ 3,638 3,646 3,111 3,031 3,034 5,266 $ 21,726 5. Intangible Assets, net: With the acquisition of IGS on October 1, 2004, RDS on July 29, 2005, The Palmer Group on July 25, 2007, MuniServices on July 1, 2008, and BPA on August 1, 2008, the Company purchased certain tangible and intangible assets. Intangible assets purchased included client and customer relationships, non-compete agreements, trademarks and goodwill. In accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), the Company is amortizing the IGS client relationships over seven years, The Palmer Group customer relationship over 2.42 years, the RDS and BPA customer relationships over ten years and the MuniServices customer relationships over 11 years. The Company is amortizing the non-compete agreements over three years for the IGS, RDS and MuniServices acquisitions and 2.42 years for the BPA acquisition. The Company is amortizing trademarks over 14 years for the MuniServices acquisition. The combined original weighted average amortization period is 9.14 years. The Company reviews these relationships at least annually for impairment. Total amortization expense for the years ended December 31, 2008, 2007 and 2006 was $2,140,942, $1,834,404 and $2,268,652, respectively. Intangible assets consist of the following at December 31, 2008 and 2007 (amounts in thousands): 2008 2007 Client and customer relationships Non-compete agreements Trademarks Accumulated amortization Intangible assets, net $ $ 17,823 2,527 2,100 (9,021) 13,429 9,926 2,000 - (6,880) 5,046 $ $ 68 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 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, MuniServices and BPA non-compete agreements and a pattern of economic benefit concept for the RDS non-compete agreements. Amortization expense relating to the client and customer relationships is calculated using a pattern of economic benefit concept for the IGS, RDS and MuniServices acquisitions, straight-line over the length of the contract for The Palmer Group acquisition and straight-line over their estimated useful lives of ten years for the BPA acquisition. Amortization expense relating to the trademarks is calculated using a pattern of economic benefit concept for the MuniServices acquisition. 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 estimated to be as follows as of December 31, 2008 (amounts in thousands): 2009 2010 2011 2012 2013 Thereafter $ 2,673 2,552 2,033 1,414 1,190 3,567 13,429 $ In addition, goodwill, pursuant to SFAS 142, is not amortized but rather is reviewed at least annually for impairment. During the fourth quarter of 2008, the Company underwent its annual review of goodwill. Based upon the results of this review, which was conducted as of October 1, 2008, 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 occurred since the review was performed through December 31, 2008, that would indicate a triggering event and thereby necessitate an impairment charge to goodwill or the other intangible assets. At December 31, 2008 and December 31, 2007, the carrying value of goodwill was $27,545,582 and $18,620,277, respectively. The changes in goodwill for the years ended December 31, 2008 and 2007 are as follows (amounts in thousands): Goodwill December 31, 2006 Acquistion of The Palmer Group December 31, 2007 Acquistion of MuniServices and BPA December 31, 2008 6. Acquisitions: $ $ 18,287 333 18,620 8,926 27,546 On July 1, 2008, the Company acquired 100% of the membership interests of MuniServices. MuniServices was founded in 1978 and is a provider of revenue enhancement and related services to state and local governments. Although most of its clients are in California, it also serves clients in Texas, Florida, Pennsylvania, Georgia, Nevada and the District of Columbia. MuniServices has a workforce of approximately 115 employees. The President of MuniServices and three other members of the management team have entered into long-term employment agreements. The consolidated income statement for 2008 includes the results of operations of MuniServices for the period from July 1, 2008 through December 31, 2008. The transaction was completed at a price of $24.6 million, consisting of $22.5 million in cash and $2.1 million in PRA Inc common stock. The total purchase price could increase by a total of $4.5 million in stock through contingent payments in 2009 and 2010, related to specific operating goals. The common stock component of the purchase price resulted in the issuance of 163,622 shares of unregistered stock to the sellers of MuniServices of which 112,018 shares are being held in escrow and are subject to the earn out and target revenue provisions of the asset purchase agreement. If the earn out and target revenue provisions are met, the shares held in escrow will be issued resulting in additional purchase price which will be allocated to goodwill. The share count was determined by using a formula agreed to by both parties and contained within the purchase agreement. 69 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements On August 1, 2008, the Company acquired substantially all of the assets of Broussard Partners and Associates, Inc. (“BPA”), which is operating as a part of RDS. BPA, founded in 1995, is a provider of audit services to parishes in Louisiana, with 34 of the state's 64 parishes as clients. BPA has a workforce of approximately 25 employees. The President of BPA has entered into a long-term employment agreement with RDS. The consolidated income statement for 2008 includes the results of operations of BPA for the period from August 1, 2008 through December 31, 2008. Both of these acquisitions provided the Company additional clients and contracts in the government sector. These clients are located in geographic regions the Company had not previously been servicing. The following is an allocation of the purchase price to the assets acquired and liabilities assumed in connection with the acquisitions of MuniServices and BPA (amounts in thousands): Purchase price, including acquisition costs and net of cash received Accounts receivable and prepaid expenses (included in other assets) Customer relationships Non-compete agreements Trademarks Fixed assets Deferred tax asset Accounts payable Accrued expenses Accrued payroll Goodwill $27,888 (2,935) (7,898) (527) (2,100) (6,857) (363) 549 257 912 $8,926 7. Capital Leases: Leased assets included in property and equipment consists of the following as of December 31, 2008 and 2007 (amounts in thousands): Software Computer equipment Furniture and fixtures Equipment Less accumulated amortization 2008 2007 $ 270 39 1,260 27 (1,519) $ 270 48 1,260 27 (1,413) $ 77 $ 192 Amortization expense recognized on capital leases for the years ended December 31, 2008, 2007 and 2006 was $115,079, $143,313 and $183,904, respectively. Future minimum lease payments for these capital leases as of December 31, 2008 were $5,675, and these leases were paid in full in January 2009. 8. 401(k) Retirement Plan: 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 $959,902, $843,387 and $682,115 for the years ended December 31, 2008, 2007 and 2006, respectively. 70 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 9. Line of Credit: 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 was amended on May 9, 2006 to include RBC Centura Bank as an additional lender, again on May 4, 2007 to increase the line of credit to $150,000,000 and incorporate a $50,000,000 non-revolving fixed rate sub-limit, again on October 26, 2007 to increase the line of credit to $270,000,000, again on March 18, 2008 to increase the non- revolving fixed rate sub-limit to $100,000,000, again on May 2, 2008 to include SunTrust Bank as an additional lender and to increase the line of credit to $340,000,000, and again on September 3, 2008 to include J.P. Morgan Chase Bank as an additional lender and to increase the line of credit to $365,000,000. The agreement is a line of credit in an amount equal to the lesser of $365,000,000 or 30% of the Company’s estimated remaining collections of all its eligible asset pools. Borrowings under the revolving credit facility bear interest at a floating rate equal to the one month LIBOR Market Index Rate plus 1.40%, which was 1.836% at December 31, 2008, and the facility expires on May 2, 2011. The Company also pays an unused line fee equal to three-tenths of one percent, or 30 basis points, on any unused portion of the line of credit. The loan is collateralized by substantially all the tangible and intangible assets of the Company. The agreement provides as follows: • monthly borrowings may not exceed 30% of estimated remaining collections; • funded debt to EBITDA (defined as net income, less income or plus loss from discontinued operations and extraordinary items, plus income taxes, plus interest expense, plus depreciation, depletion, amortization (including finance receivable amortization) and other non-cash charges) ratio must be less than 2.0 to 1.0 calculated on a rolling twelve-month average; tangible net worth must be at least 100% of tangible net worth reported at September 30, 2005, plus 25% of cumulative positive net income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering without giving effect to reductions in tangible net worth due to repurchases of up to $100,000,000 of the Company’s common stock; and restrictions on change of control. • • As of December 31, 2008 and 2007, outstanding borrowings under the facility totaled $268,300,000 and $168,000,000, respectively, of which $50,000,000 was part of the non-revolving fixed rate sub-limit which bears interest at 6.80% and expires on May 4, 2012. As of December 31, 2008, the Company is in compliance with all of the covenants of the agreement. 10. Derivative Instruments: The Company may periodically enter into derivative financial instruments, typically interest rate swap agreements, to reduce its exposure to fluctuations in interest rates on variable-rate debt and their impact on earnings and cash flows. The Company does not utilize derivative financial instruments with a level of complexity or with a risk greater than the exposure to be managed nor does it enter into or hold derivatives for trading or speculative purposes. The Company periodically reviews the creditworthiness of the swap counterparty to assess the counterparty’s ability to honor its obligation. Based on the provisions of SFAS No. 133, “Accounting for Derivative Instruments and Hedging Activities” as amended and interpreted, the Company records derivative financial instruments at fair value. On December 16, 2008, the Company entered into an interest rate forward rate swap transaction (the "Swap") with J.P. Morgan Chase Bank, National Association pursuant to an ISDA Master Agreement which contains customary representations, warranties and covenants. The Swap has an effective date of January 1, 2010, with an initial notional amount of $50,000,000. Under the Swap, the Company will receive a floating interest rate based on 1-month LIBOR Market Index Rate and will pay a fixed interest rate of 1.89% through maturity of the Swap on May 1, 2011. Notwithstanding the terms of the Swap, the Company is ultimately obligated for all amounts due and payable under the credit facility. The Company’s financial derivative instrument is designated and qualifies as a cash flow hedge, and the effective portion of the gain or loss on such hedge is reported as a component of other comprehensive income in the consolidated financial statements. To the extent that the hedging relationship is not effective, the ineffective portion of the change in fair value of the derivative is recorded in other income (expense). The hedge was considered effective for the period from December 16, 2008 through December 31, 2008. Hedges that receive designated 71 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements hedge accounting treatment are evaluated for effectiveness at the time that they are designated, as well as through the hedging period. The fair value of the Company’s cash flow hedge has been recorded as an asset and is included with other assets in the consolidated balance sheet. The fair value of the asset was $88,813 at December 31, 2008. Changes in fair value were recorded as an adjustment to other comprehensive income of $88,813 at December 31, 2008. The Company had no derivative instruments as of December 31, 2007. Amounts in other comprehensive income will be reclassified into earnings under certain situations; for example, if the occurrence of the transaction is no longer probable or no longer qualifies for hedge accounting. The Company does not expect to reclassify any amount currently included in other comprehensive income into earnings within the next 12 months. 11. Property and equipment, net: Property and equipment, at cost, consist of the following as of December 31, 2008 and 2007 (amounts in thousands): 2008 2007 Software Computer equipment Furniture and fixtures Equipment Leasehold improvements Building and improvements Land Accumulated depreciation and amortization Property and equipment, net $ $ 14,380 7,951 5,150 5,370 3,449 5,948 992 (19,356) 23,884 6,147 6,083 4,758 4,742 2,557 5,123 939 (14,178) 16,171 $ $ Depreciation and amortization expense, relating to property and equipment, for the years ended December 31, 2008, 2007 and 2006 was $5,283,058, $3,682,686 and $2,861,976, respectively. Beginning in July 2006 upon initiation of certain internally developed software projects, in accordance with the provisions of SOP 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” the Company began capitalizing qualifying computer software costs incurred during the application development stage and amortizing them over their estimated useful life of three years on a straight-line basis beginning when the project is completed. Costs associated with preliminary project stage activities, training, maintenance and all other post implementation stage activities are expensed as incurred. The Company’s policy provides for the capitalization of certain direct payroll costs for employees who are directly associated with internal use computer software projects, as well as external direct costs of services associated with developing or obtaining internal use software. Capitalizable personnel costs are limited to the time directly spent on such projects. As of December 31, 2008 and 2007, the Company has incurred and capitalized $1,036,275 and $524,456, respectively, of these direct payroll costs related to software developed for internal use. As of December 31, 2008 and 2007, of these costs, $593,560 and $98,511, respectively, are for projects that are in the development stage and therefore are a component of Other Assets. Once the projects are completed the costs will be transferred to Software and amortized over their estimated useful life of three to seven years. Amortization expense and remaining unamortized costs relating to this internally developed software as of and for the year ended December 31, 2008 were $88,543 and $332,718, respectively. Amortization expense and remaining unamortized costs relating to this internally developed software as of and for the year ended December 31, 2007 were $21,454 and $404,491, respectively. 12. Long-Term Debt: 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 was 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 were $9,797 and the loan was paid in full at its maturity date of September 1, 2007. 72 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 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 was collateralized by computer equipment. Monthly payments were $18,096, and the loan was paid in full on May 7, 2007. On January 9, 2004, the Company entered into a commercial loan agreement to finance equipment purchases at one of its leased Norfolk facilities in the amount of $750,000 with a fixed rate of 4.45%. Monthly payments were $13,975, and the loan was paid in full on May 7, 2007. 13. Estimated Fair Value of Financial Instruments: The accompanying consolidated financial statements include various estimated fair value information as of December 31, 2008 and 2007, as required by SFAS No. 107, “Disclosures About Fair Value of Financial Instruments” and amended by SFAS No. 157 (“SFAS 157”), “Fair Value Measurements.” SFAS 157 defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. SFAS 157 also requires the consideration of differing levels of inputs in the determination of fair values. Based upon the fact there are no quoted prices in active markets or other observable market data, the Company used unobservable inputs for computation of the fair value of finance receivables, net. 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. 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 as amended by SOP 03-3. The carrying amount of finance receivables, net, as of December 31, 2008 and 2007 was approximately $564,000,000 and $410,000,000, respectively. The Company computed the fair value of these receivables using proprietary pricing models that the Company utilizes to make portfolio purchase decisions. As of December 31, 2008 and 2007, using the aforementioned methodology, the Company computed the approximate fair value to be $565,000,000 and $451,000,000, respectively. Line of credit: The carrying amount approximates fair value, as the interest rates approximate the rate currently offered to the Company for similar debt instruments of comparable maturities by the Company’s bankers. Derivative instrument: The carrying amount approximates fair value, which is determined using pricing models developed based on the LIBOR swap rate and other observable market data, adjusted for nonperformance risk of both the counterparty and the Company. 14. Share-Based Compensation: The Company has a stock option and nonvested share plan. The Amended and Restated Portfolio Recovery Associates 2002 Stock Option Plan and 2004 Restricted Stock Plan (“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 nonvested shares of stock, as well as stock options. Effective January 1, 2002, the Company adopted the fair value recognition provisions of SFAS No. 123 (“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. Effective January 1, 2006, the Company adopted SFAS No. 123R (“SFAS 123R”), “Share-Based Payment” using the modified prospective approach. The adoption of SFAS 123R had no material impact on the Company’s Consolidated Income Statement or on previously reported interim periods. As of December 31, 2008, total estimated future compensation costs related to awards of nonvested shares (not including nonvested shares granted under the Long-Term Incentive Program) were approximately $3.3 million. The weighted average remaining life is 1.1 years for stock options and 3.4 years for nonvested shares (not including nonvested shares granted under the Long-Term Incentive Program). Based upon 73 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements historical data, the Company used an annual forfeiture rate of 14% for stock options and between 20%-40% for nonvested shares for most of the employee grants. Grants made to key employee hires and directors of the Company were assumed to have no forfeiture rates associated with them due to the historically low turnover among this group. In addition, commensurate with the adoption of SFAS 123R, all previous references to “restricted stock” are now referred to as “nonvested shares”. Total share-based compensation expense was $140,590, $2,575,253 and $2,116,631 for the years ended December 31, 2008, 2007 and 2006, respectively. Tax benefits resulting from tax deductions in excess of share- based compensation expense recognized under the fair value recognition provisions of SFAS 123R (windfall tax benefits) are credited to additional paid-in capital in the Company’s Consolidated Balance Sheets. Realized tax shortfalls are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense. The total tax benefit realized from share-based compensation expense was approximately $0.9 million, $2.4 million and $3.0 million for the years ended December 31, 2008, 2007 and 2006, respectively. Stock Options The Company created the 2002 Stock Option Plan on November 7, 2002. The plan was amended in 2004 to enable the Company to issue restricted shares of stock to its employees and directors. 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, 2008, 895,000 options have been granted under the Amended Plan, of which 118,905 have been cancelled and are eligible for regrant. These options are accounted for under SFAS 123R and all expenses for 2008, 2007 and 2006 are included in earnings as a component of compensation and employee services expense. The following summarizes all option related transactions from December 31, 2005 through December 31, 2008 (amounts in thousands, except per share amounts): December 31, 2005 Exercised Cancelled December 31, 2006 Exercised Cancelled December 31, 2007 Exercised Cancelled December 31, 2008 Options Outstanding 505 (189) (15) 301 (130) (8) 163 (38) (2) 123 Weighted-Average Exercise Price Per Share $ Weighted-Average Fair Value Per Share $ 15.12 13.19 13.00 16.43 15.97 13.00 16.97 15.87 21.50 17.24 3.06 2.76 2.71 3.27 3.33 2.71 3.25 3.31 4.60 3.21 $ $ 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 20,000 stock options in 2004. No stock options were granted in 2008, 2007 or 2006. The total intrinsic value of options exercised during the years ended December 31, 2008, 2007 and 2006, was approximately $0.9 million, $4.1 million, and $6.3 million, respectively. The following information is as of December 31, 2008 (amounts in thousands except per share amounts): Options Exercisable Weighted-Average Exercise Price Per Share Weighted-Average Exercise Price Per Share Average Remaining Contractual Life Aggregate Intrinsic Value Number Outstanding Number Exercisable Options Outstanding Exercise Prices Aggregate Intrinsic Value $ 13.00 $ 16.16 $ 27.77 - $ 29.79 Total as of December 31, 2008 85 5 33 123 0.9 0.9 1.7 1.1 $ $ 13.00 16.16 28.28 17.24 $ $ 1,763 97 183 2,043 85 5 30 120 74 $ $ 13.00 16.16 28.22 16.95 $ $ 1,763 97 169 2,029 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements The Company utilizes the Black-Scholes option-pricing model to calculate the value of the stock options when granted. This model was developed to estimate the fair value of traded options, which have different characteristics than employee stock options. In addition, changes to the subjective input assumptions can result in materially different fair market value estimates. Therefore, the Black-Scholes model may not necessarily provide a reliable single measure of the fair value of employee stock options. 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, nonvested share awards are issued at market value and typically vest ratably over five years. Nonvested share grants are expensed over their vesting period. The following summarizes all nonvested share transactions from December 31, 2005 through December 31, 2008(amounts in thousands except per share amounts): December 31, 2005 Granted Vested Cancelled December 31, 2006 Granted Vested Cancelled December 31, 2007 Granted Vested Cancelled December 31, 2008 Nonvested Shares Outstanding 135 83 (28) (19) 171 9 (41) (16) 123 27 (37) (15) 98 Weighted- Average Price at Grant Date $ 34.96 46.88 33.88 37.75 40.59 43.42 38.74 38.23 41.72 37.47 39.55 40.05 41.60 $ The total grant date fair value of shares vested during the years ended December 31, 2008, 2007 and 2006, was $1,446,897, $1,584,621 and $940,644, respectively. Long-Term Incentive Programs Pursuant to the Amended Plan, on March 30, 2007 and January 4, 2008, the Compensation Committee approved the grant of 96,550 and 80,000, respectively, of performance based nonvested shares. The shares were granted to key employees of the Company. The grants are performance based and cliff vest after the requisite service period of three years if certain financial goals are met. The goals are based upon cumulative diluted earnings per share (“EPS”) totals for the 2007, 2008 and 2009 years for the 2007 grant and EPS totals for the 2008, 2009 and 2010 years for the 2008 grant, as well as the return on invested capital for the same periods. The number of shares vested can double if the financial goals are exceeded or no shares can vest if the financial goals are not met. For both the 2007 and 2008 grants, the Company was expensing the nonvested shares over the requisite service period of three years beginning January 1, 2007 and 2008, respectively. During 2008, the Company reversed $1.2 million of estimated compensation costs that had been previously accrued relating to the 2007 Long Term Incentive Program because the achievement of the performance targets of the program were deemed unlikely to be achieved. During 2008, no estimated compensation costs were accrued relating to the 2008 Long Term Incentive Program because the achievement of the performance targets of the program were deemed unlikely to be achieved. In the future, if the Company believes that the performance targets of the programs will be achieved, an adjustment to the 75 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements expense will be made at that time based on the probable outcome. The Company assumed a 7.5% forfeiture rate for these grants and the shares have a weighted average life of 1.47 years at December 31, 2008. 15. Earnings per Share: Basic earnings per share (“EPS”) are computed by dividing income available to common shareholders by weighted average common shares outstanding. Diluted EPS are computed using the same components as basic EPS with the denominator adjusted for the dilutive effect of stock options and nonvested share awards. Share-based awards that are contingent upon the attainment of performance goals are not included in the computation of diluted EPS until the performance goals have been attained. The dilutive effect of stock options and nonvested shares is computed using the treasury stock method, which assumes any proceeds that could be obtained upon the exercise of stock options and vesting of nonvested shares would be used to purchase common shares at the average market price for the period. The assumed proceeds include the windfall tax benefit that would be received upon assumed exercise. The following table provides a reconciliation between the computation of basic EPS and diluted EPS for the years ended December 31, 2008, 2007 and 2006 (amounts in thousands, except per share amounts): 2008 Weighted Average Net Income Common Shares 15,229 $45,362 EPS $2.98 For the years ended December 31, 2007 Weighted Average 2006 Weighted Average Net Income Common Shares EPS Net Income Common Shares EPS 15,911 $2.80 15,646 $3.08 $48,241 $44,490 $45,362 63 15,292 $2.97 $48,241 15,779 $3.06 $44,490 16,082 $2.77 133 171 Basic EPS Dilutive effect of stock options and nonvested share awards Diluted EPS As of December 31, 2008, 2007 and 2006, there were no antidilutive options outstanding. 16. Stockholders’ Equity: Shares of common stock outstanding were as follows for the years ended December, 31 2008, 2007 and 2006 (amounts in thousands): December 31, 2005 Exercise of warrants, options and vesting of nonvested shares December 31, 2006 Exercise of options and vesting of nonvested shares Issuance of common stock for acquisition Repurchase and cancellation of common stock December 31, 2007 Exercise of options and vesting of nonvested shares Issuance of common stock for acquisition December 31, 2008 Common Stock 15,767 220 15,987 171 1 (1,000) 15,159 75 52 15,286 Cash Dividends Paid on Common Stock: On April 23, 2007, the Company’s Board of Directors authorized a special one-time cash dividend of $1.00 per share with a record date of May 9, 2007. The cash dividends were paid on June 8, 2007 and totaled $16,069,694. There were no cash dividends paid or authorized during 2008 or 2006. Share Repurchase Program: On April 23, 2007, the Company’s Board of Directors authorized a share repurchase program to buyback one million of the Company’s outstanding shares of common stock on the open market. The timing and volume of share purchases were dependent on several factors, including market conditions. During the year ended December 31, 2007, the Company purchased 1,000,000 shares of its common stock at an average per share price of $50.56. The program was completed during 2007. 76 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements 17. Income Taxes: The Company records a tax provision for the anticipated tax consequences of the reported results of operations. In accordance with SFAS 109, 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. On July 13, 2006, the FASB issued FIN 48. FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise's financial statements in accordance with SFAS109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is recognition: the enterprise determines whether it is more-likely- than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. The second step is measurement: a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met. The Company adopted the provisions of FIN 48 with respect to all of its tax positions as of January 1, 2007. Total unrecognized tax benefits as of December 31, 2008 and 2007 were $0 and $180,000, respectively. Due to the approval by the Internal Revenue Service of an application for a change in accounting method with respect to one of the Company’s tax positions, the balance of unrecognized tax benefits at the date of adoption was reduced from $388,000 to $180,000 at September 30, 2007. The reduction of $208,000 did not have an impact on the annual effective rate since the ultimate deductibility of these benefits was highly certain, and only the timing of deductibility was uncertain. On September 15, 2008, the 2004 tax year closed and is no longer subject to examination by major taxing jurisdictions, including the Internal Revenue Service. As a result, the remaining unrecognized tax benefits balance of $180,000 was reversed. The reversal was an adjustment to additional paid-in- capital and did not affect the annual effective tax rate. A reconciliation of the beginning and ending amount of unrecognized tax benefits is as follows (amounts in thousands): Balance at January 1, 2007 Additions for tax position of prior year Decrease due to change in accounting method for tax purposes Balance at December 31, 2007 Decrease due to lapse of statute of limitations Balance at December 31, 2008 $ 379 9 (208) 180 (180) $ - $ The Company was notified on June 21, 2007 that it would be examined by the Internal Revenue Service for the 2005 tax year. As of December 31, 2008, the tax years subject to examination by the major taxing jurisdictions, including the Internal Revenue Service, are 2003 and 2005 and subsequent years. The 2003 tax year remains open to examination because of a net operating loss that originated in that year but was not fully utilized until the 2005 tax year. On February 19, 2009, the Company received a “Notice of Proposed Adjustment” dated February 18, 2009. The notice states that the government has made a preliminary finding that the use of cost recovery for tax income recognition purposes does not clearly reflect income. The Company intends to appeal the government’s preliminary findings via the normal administrative process unless an agreement can be reached at the local level. 77 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements The Company believes it has substantial authority for using the cost recovery method and that it is more-likely-than- not that it will be successful in the appeals process. FIN 48 requires the recognition of interest, if the tax law would require interest to be paid on the underpayment of taxes, and recognition of penalties, if a tax position does not meet the minimum statutory threshold to avoid payment of penalties. Penalties and interest may be classified as either penalties and interest expense or income tax expense. Management has elected to classify accrued penalties and interest as income tax expense. Accrued penalties and interest as of January 1, 2007, in the amount of $77,000, were recorded to beginning of year retained earnings. Since January 1, 2007, the Company has accrued additional interest of approximately $34,000. Due to the approved application for change in accounting method, the balance of accrued penalties and interest was reduced by $67,000 during 2007. As a result of the lapse in the statute of limitations, the 2004 tax year closed as of September 15, 2008 resulting in the reversal of the remaining $44,000 of accrued interest. The income tax expense recognized for the years ended December 31, 2008, 2007 and 2006 is composed of the following (amounts in thousands): For the year ended December 31, 2008 Federal State Total For the year ended December 31, 2007 Federal State Total Current tax benefit Deferred tax expense Total income tax expense Current tax expense Deferred tax expense Total income tax expense $ $ $ $ $ $ $ $ $ $ $ $ (2,108) 26,414 24,306 4,870 21,229 26,099 (362) 4,440 4,078 454 3,105 3,559 2,265 1,543 3,808 (2,470) 30,854 28,384 5,324 24,334 29,658 16,610 11,106 27,716 For the year ended December 31, 2006 Federal State Total Current tax expense Deferred tax expense Total income tax expense $ $ 14,345 9,563 23,908 $ $ $ $ The Company has recognized a net deferred tax liability of $88,069,756 and $57,578,782 as of December 31, 2008 and 2007, respectively. The components of this net deferred tax liability are as follows (amounts in thousands): Deferred tax assets: Employee compensation Allowance for doubtful accounts State tax credit Intangible assets and goodwill Section 467 leases Other Total deferred tax assets Deferred tax liabilities: Depreciation expense Prepaid expenses Cost recovery Total deferred tax liability 2008 2007 $ 529 794 685 379 277 133 2,797 $ 898 - 591 501 - 170 2,160 788 658 89,421 90,867 89 418 59,232 59,739 Net deferred tax liabilities $ 88,070 $ 57,579 78 Portfolio Recovery Associates, Inc. Notes to Consolidated Financial Statements A valuation allowance has not been provided at December 31, 2008 or 2007 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 inconsistent with management's expectations could have a material impact on the Company's results of operations and financial position. At December 31, 2008, the Company had state income tax credit carryforwards of approximately $1.1 million which will begin to expire starting in the year ending December 31, 2021. The Company also incurred state net operating loss carryforwards in 2008 of approximately $1.5 million, which will begin to expire starting in the year ending December 31, 2013. The Company believes cost recovery to be an acceptable tax revenue recognition 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 temporary difference from the use of cost recovery for income tax purposes resulted in a deferred tax liability at December 31, 2008 and 2007. A reconciliation of the Company’s expected tax expense at statutory tax rates to actual tax expense for the years ended December 31, 2008, 2007 and 2006 consists of the following components (amounts in thousands): 2008 2007 2006 Federal tax at statutory rates State tax expense, net of federal benefit Other Total income tax expense $ $ 25,811 2,651 (78) 28,384 18. Commitments and Contingencies: Employment Agreements: $ $ 27,265 2,313 80 29,658 $ $ 25,272 2,475 (31) 27,716 The Company has employment agreements with all of its executive officers and with several members of its senior management group, most of which expire on December 31, 2011. Such agreements provide for base salary payments as well as bonuses which are based on the attainment of specific management goals. Future compensation under these agreements is approximately $16.5 million. The agreements also contain confidentiality and non- compete provisions. Litigation: The Company is from time to time subject to routine legal proceedings which are incidental to the ordinary course of our business. The Company initiates lawsuits against consumers and are occasionally countersued by them in such actions. Also, consumers occasionally initiate litigation against the Company, in which they allege that the Company has violated a state or federal law in the process of collecting on an account. 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. Forward Flow Agreements: The Company is party to several forward flow agreements that allow for the purchase of defaulted consumer receivables at pre-established prices. The maximum remaining amount to be purchased under forward flow agreements at December 31, 2008 is $71.6 million. 79 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, 2008, our disclosure controls and procedures were effective. Management's Report on Internal Control Over Financial Reporting. We are responsible for establishing and maintaining effective 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, 2008, 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, KPMG LLP, has issued an audit report on the effectiveness of our internal control over financial reporting, as of December 31, 2008 which is included herein. The scope of management’s assessment of internal controls over financial reporting did not include our recently acquired subsidiary, MuniServices, which was excluded from our evaluation. This business represents less than 5% of total assets and total revenues reflected in our consolidated financial statements as of and for the year ended December 31, 2008. 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, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting. Item 9B. Other Information. None. 80 Item 10. Directors and Executive Officers of the Registrant. PART III The following table sets forth certain information as of February 11, 2009 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 49 44 48 63 71 61 46 50 66 * 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 81 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 appointed as a director of Portfolio Recovery Associates in 2002 and subsequently elected at the Company’s next Annual Meeting of Stockholders. 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 appointed as a director of Portfolio Recovery Associates in 2005 and subsequently elected at the Company’s next Annual Meeting of Stockholders. 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 as a director of Portfolio Recovery Associates in 2004 and subsequently elected at the Company’s next Annual Meeting of Stockholders. Mr. Tabakin has more than 20 years of public-company experience. Mr. Tabakin has served as Executive Vice President and Chief Financial Officer of Bravo Health, Inc., a privately owned Medicare managed health care company since 2006. Early in his career, Mr. Tabakin was an executive with the accounting firm of Ernst & Young. Prior to May 2001, Mr. Tabakin was Executive Vice President and CFO of Beverly Enterprises, Inc., then the nation's largest provider of long-term health care. He served as Executive Vice President and CFO of AMERIGROUP Corporation, a managed health- care company, from May 2001 until October 2003. From November 2003 until July 2006, Mr. Tabakin was an independent financial consultant. Mr. Tabakin 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 appointed as a director of Portfolio Recovery Associates in 2002 and subsequently elected at the Company’s next Annual Meeting of Stockholders. 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. 82 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 Global 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. Certain information required by Item 10 is incorporated herein by reference to the section labeled “Section 16(a) Beneficial Ownership Reporting Compliance” in the Company’s definitive Proxy Statement in connection with the Company’s 2009 Annual Meeting of Stockholders. Item 11. Executive Compensation. The information required by Item 11 is incorporated herein by reference to (a) the section labeled “Compensation Discussion and Analysis” in the Company’s definitive Proxy Statement in connection with the Company’s 2009 Annual Meeting of Stockholders and (b) the section labeled “Compensation Committee Report” in the Company’s definitive Proxy Statement in connection with the Company’s 2009 Annual Meeting of Stockholders, which section (and the report contained therein) shall be deemed to be furnished in this report and shall not be incorporated by reference into any filing under the Securities Act of 1933 or the Securities Exchange Act of 1934 as a result of such furnishing in this Item 11. 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 2009 Annual Meeting of Stockholders. Item 13. Certain Relationships and Related Transactions. The information required by Item 13 is incorporated herein by reference to Item 5 of this report and to the section labeled “Certain Relationships and Related Transactions” in the Company’s definitive Proxy Statement in connection with the Company’s 2009 Annual Meeting of Stockholders. 83 Item 14. Principal Accountant Fees and Services. The aggregate fees billed or expected to be billed by KPMG LLP for the years ended December 31, 2008 and 2007, respectively, are presented in the table below: Audit Fees Annual audit Tax Fees Other Fees: Subscription Fees (1) 2008 2007 $ 551,500 $ 483,000 14,550 1,500 10,900 1,500 Total Accountant Fees $ 567,550 $ 495,400 (1) Subscription fees represent fees paid to KPMG LLP for an annual subscription to their proprietary research tool during 2008 and 2007, respectively. The Audit Committee’s charter provides that the Audit Committee 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 all audit services and 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 non-audit services is compatible with maintaining the auditors’ independence. All the services performed by and fees paid to KPMG LLP were pre-approved by the Audit Committee. 84 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 Reports of Independent Registered Public Accounting Firms 52-55 Consolidated Balance Sheets as of December 31, 2008 and 2007 56 Consolidated Income Statements for the years ended December 31, 2008, 2007 and 2006 Consolidated Statements of Changes in Stockholders’ Equity and Comprehensive Income for the years ended December 31, 2008, 2007 and 2006 Consolidated Statements of Cash Flows for the years ended December 31, 2008, 2007 and 2006 Notes to Consolidated Financial Statements (b) Exhibits. 57 58 59 60-79 2.1 2.2 2.3 3.1 3.2 4.1 4.2 10.1 10.2 10.3 10.4 10.5 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 November 14, 2008, by and between Steven D. Fredrickson and Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.1 of the Form 8-K dated November 20, 2008). Employment Agreement, dated November 14, 2008, by and between Kevin P. Stevenson and Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.2 of the Form 8-K dated November 20, 2008). Employment Agreement, dated November 14, 2008, by and between Craig A. Grube and Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.3 of the Form 8-K dated November 20, 2008). Employment Agreement, dated November 14, 2008, by and between Judith S. Scott and Portfolio Recovery Associates, Inc. (Incorporated by reference to Exhibit 10.4 of the Form 8-K dated November 20, 2008). 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). 85 10.7 10.8 10.9 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). 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). 10.10 Amended and Restated Loan and Security Agreement, dated May 9, 2006, by and between Portfolio Recovery Associates, Inc, Bank of America, Wachovia Bank and RBC Centura Bank. (Incorporated by reference to Exhibit 10.1 of the Form 8-K dated May 11, 2006). 10.11 Second Amendment to the Amended and Restated Loan and Security Agreement, dated May 4, 2007, by and between Portfolio Recovery Associates, Inc, Bank of America, Wachovia Bank and RBC Centura Bank. (Incorporated by reference to Exhibit 10.1 of the Form 8-K dated May 7, 2007). 10.12 Loan Document Modification Agreement, dated October 26, 2007, by and between Portfolio Recovery Associates, Inc, Bank of America, Wachovia Bank and RBC Centura Bank. (Incorporated by reference to Exhibit 10.1 of the Form 8-K dated October 29, 2007). 10.13 Third amendment to the Amended and Restated Loan and Security Agreement, dated as of May 2, 2008, by and between Portfolio Recovery Associates, Inc, Bank of America, N.A., Wachovia Bank, N.A., RBC Centura Bank and SunTrust Bank (Incorporated by reference to Exhibit 10.1 of the Form 8-K filed May 12, 2008). 10.14 Fourth amendment to the Amended and Restated Loan and Security Agreement, dated as of September 3, 2008, by and between Portfolio Recovery Associates, Inc, Bank of America, N.A., Wachovia Bank, N.A., RBC Centura Bank, SunTrust Bank and JP Morgan Chase Bank N.A. (Incorporated by reference to Exhibit 10.1 of the Form 8-K filed September 8, 2008). 21.1 Subsidiaries of Portfolio Recovery Associates, Inc. 23.1 23.2 24.1 31.1 31.2 32.1 Section 906 Certifications of Chief Executive Officer and Chief Financial Officer Consent of KPMG LLP 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 86 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: February 27, 2009 Dated: February 27, 2009 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: February 27, 2009 Dated: February 27, 2009 Dated: February 27, 2009 Dated: February 27, 2009 Dated: February 27, 2009 By:/s/ Steven D. Fredrickson Steven D. Fredrickson President and Chief Executive Officer (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) By:/s/ William P. Brophey William P. Brophey Director By:/s/ Penelope W. Kyle Penelope W. Kyle Director By:/s/ David N. Roberts David N. Roberts Director 87 Dated: February 27, 2009 Dated: February 27, 2009 By:/s/ Scott M. Tabakin Scott M. Tabakin Director By:/s/ James M. Voss James M. Voss Director 88 Exhibit 21.1 SUBSIDIARIES OF THE REGISTRANT Subsidiaries of the Registrant and Jurisdiction of Incorporation or Organization Portfolio Recovery Associates, LLC - Delaware PRA Holding I, LLC – Virginia PRA Holding II, LLC – Virginia PRA Receivables Management, LLC – Virginia PRA Location Services, LLC – Delaware (Doing business as IGS) PRA Government Services, LLC – Delaware (Doing business as RDS) MuniServices, LLC - Delaware 89 Exhibit 23.1 Consent of Independent Registered Public Accounting Firm The Board of Directors Portfolio Recovery Associates, Inc.: We consent to the incorporation by reference in the registration statements (No. 333-110330 and No. 333- 110331) on Form S-8 of Portfolio Recovery Associates, Inc. of our reports dated February 27, 2009, with respect to the consolidated balance sheets of Portfolio Recovery Associates, Inc. and subsidiaries (the Company) as of December 31, 2008 and 2007, and the related consolidated income statements, and statements of changes in stockholders’ equity and comprehensive income, and cash flows for the years then ended, and the effectiveness of internal control over financial reporting as of December 31, 2008, which reports appear in the December 31, 2008 annual report on Form 10-K of Portfolio Recovery Associates, Inc. Our report dated Febraury 27, 2009, on the consolidated financial statements of the Company refers to the Company’s adoption of the provisions of Financial Accounting Standards Board (FASB) Interpretation No. 48, Accounting for Uncertainties in Income Taxes, an interpretation of FASB Statement No. 109, effective January 1, 2007. Our report dated February 27, 2009, on the effectiveness of internal control over financial reporting as of December 31, 2008, contains an explanatory paragraph that states that Portfolio Recovery Associates, Inc. acquired MuniServices, LLC (MuniServices) during 2008, and management excluded from its assessment of the effectiveness of Portfolio Recovery Associates, Inc.’s internal control over financial reporting as of December 31, 2008, MuniServices’ internal control over financial reporting associated with less than 5% of the total assets and total revenues reflected in the consolidated financial statements of the Company as of and for the year ended December 31, 2008. Our audit of internal control over financial reporting of Portfolio Recovery Associates, Inc. also excluded an evaluation of the internal control over financial reporting of MuniServices. /s/ KPMG LLP Norfolk, Virginia February 27, 2009 90 Exhibit 23.2 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, 2007 relating to the financial statements, which appears in this Form 10-K. /s/ PricewaterhouseCoopers LLP McLean, VA February 27, 2009 91 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: February 27, 2009 By: /s/ Steven D. Fredrickson Steven D. Fredrickson Chief Executive Officer, President and Chairman of the Board of Directors (Principal Executive Officer) 92 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: February 27, 2009 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) 93 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, 2008 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: February 27, 2009 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, 2008 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: February 27, 2009 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) 94 CoRPoRaTe goVeRNaNCe mAnAgement BoARd of dIReCtoRs Steve Fredrickson President and Chief executive officer Craig Grube executive Vice President, acquisitions Kevin Stevenson executive Vice President, Chief financial and administrative officer, Treasurer and asst. Secretary Judith Scott executive Vice President, general Counsel and Secretary James Voss director William Brophey director Steve Fredrickson Chairman of the Board Scott Tabakin director Penelope Kyle director David Roberts lead director CoRPoRAte InfoRmAtIon SToCk exChaNge liSTiNg Portfolio Recovery associates’ common stock trades on the NaSdaq global Stock market under the symbol “PRaa.” Price information for the common stock appears daily in major newspapers. TRaNSfeR ageNT aNd RegiSTRaR Continental Stock Transfer & Trust Company 17 Battery Place, 8th floor New York, New York 10004 Tel: 212-509-4000 fax: 212-509-5150 audiToRS kPmg llP Norfolk, Virginia legal CouNSel dechert, llP New York, New York Designed by Curran & Connors, Inc. / www.curran-connors.com fiNaNCial PuBliCaTioNS/iNVeSToR iNquiRieS Shareholders may acquire copies of the 2008 form 10-k, annual Report and other filed documents by visiting the company’s web- site 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 global Stock 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 2008. 2008 high low $52.73 $24.70 as of february 4, 2009, there were 31 holders of record of the common stock. Based on information provided by our transfer agent and registrar, we believe that there are approximately 24,183 beneficial owners of the Common Stock. Portfolio Recovery Associates, Inc. Riverside Commerce Center 120 Corporate Blvd., Suite 100 Norfolk, Virginia 23502
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