PRA Group
PORTFOLIO RECOVERY ASSOCIATES INC (Form: 10-Q, Received: 05/08/2013 16:05:23)

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
 
 
FORM 10-Q
 
 
 
ý
QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended March 31, 2013 .
¨
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
 
75-3078675
(State or other jurisdiction of
incorporation or organization)
 
(I.R.S. Employer
Identification No.)
 
 
120 Corporate Boulevard, Norfolk, Virginia
 
23502
(Address of principal executive offices)
 
(zip code)
(888) 772-7326
(Registrant’s telephone number, including area code)
 
 
 
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    YES   ý     NO   ¨
Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    YES   ý     NO   ¨
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer,” “non-accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.
Large accelerated filer
 
ý
  
Accelerated filer
 
¨
 
 
 
 
Non-accelerated filer
 
¨
  
Smaller reporting company
 
¨
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).    YES   ¨     NO   ý
The number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.
 
Class
 
Outstanding as of May 5, 2013
Common Stock, $0.01 par value
 
16,904,120



PORTFOLIO RECOVERY ASSOCIATES, INC.
INDEX
 
 
 
Page(s)
PART I.
FINANCIAL INFORMATION
 
 
 
 
Item 1.
Financial Statements
3

 
 
 
 
Consolidated Balance Sheets (unaudited) as of March 31, 2013 and December 31, 2012
3

 
 
 
 
Consolidated Income Statements (unaudited) for the three months ended March 31, 2013 and 2012
4

 
 
 
 
Consolidated Statements of Comprehensive Income (unaudited) for the three months ended March 31, 2013 and 2012
5

 
 
 
 
Consolidated Statement of Changes in Stockholders’ Equity (unaudited) for the three months ended March 31, 2013
6

 
 
 
 
Consolidated Statements of Cash Flows (unaudited) for the three months ended March 31, 2013 and 2012
7

 
 
 
 
Notes to Consolidated Financial Statements (unaudited)
8-21

 
 
 
Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
22-47

 
 
 
Item 3.
Quantitative and Qualitative Disclosure About Market Risk
47

 
 
 
Item 4.
Controls and Procedures
48

 
 
 
PART II.
OTHER INFORMATION
 
 
 
 
Item 1.
Legal Proceedings
48

 
 
 
Item 1A.
Risk Factors
48

 
 
 
Item 2.
Unregistered Sales of Equity Securities and Use of Proceeds
49

 
 
 
Item 3.
Defaults Upon Senior Securities
49

 
 
 
Item 4.
Mine Safety Disclosure
49

 
 
 
Item 5.
Other Information
49

 
 
 
Item 6.
Exhibits
49

 
 
SIGNATURES
50


2


Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS
March 31, 2013 and December 31, 2012
(unaudited)
(Amounts in thousands, except per share amounts)
 
 
March 31,
2013
 
December 31,
2012
Assets
 
 
 
Cash and cash equivalents
$
39,111

 
$
32,687

Finance receivables, net
1,169,747

 
1,078,951

Accounts receivable, net
9,234

 
10,486

Property and equipment, net
25,470

 
25,312

Goodwill
106,912

 
109,488

Intangible assets, net
18,550

 
20,364

Other assets
13,715

 
11,668

Total assets
$
1,382,739

 
$
1,288,956

Liabilities and Equity
 
 
 
Liabilities:
 
 
 
Accounts payable
$
12,590

 
$
12,155

Accrued expenses and other liabilities
20,283

 
18,953

Income taxes payable
22,349

 
3,125

Accrued payroll and bonuses
9,260

 
12,804

Net deferred tax liability
185,772

 
185,277

Line of credit
172,000

 
127,000

Long-term debt
199,159

 
200,542

Total liabilities
621,413

 
559,856

Commitments and contingencies (Note 11)

 

Redeemable noncontrolling interest
10,336

 
20,673

Stockholders’ equity:
 
 
 
Preferred stock, par value $0.01, authorized shares, 2,000, issued and outstanding shares - 0

 

Common stock, par value $0.01, 60,000 authorized shares, 16,959 issued and outstanding shares at March 31, 2013, and 16,909 issued and outstanding shares at December 31, 2012
170

 
169

Additional paid-in capital
159,596

 
151,216

Retained earnings
592,791

 
554,191

Accumulated other comprehensive (loss)/income
(1,567
)
 
2,851

Total stockholders’ equity
750,990

 
708,427

Total liabilities and equity
$
1,382,739

 
$
1,288,956

The accompanying notes are an integral part of these consolidated financial statements.

3


PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED INCOME STATEMENTS
For the three months ended March 31, 2013 and 2012
(unaudited)
(Amounts in thousands, except per share amounts)
 
 
Three Months Ended March 31,
 
2013
 
2012
Revenues:
 
 
 
Income recognized on finance receivables, net
$
154,792

 
$
124,226

Fee income
14,767

 
15,920

Total revenues
169,559

 
140,146

Operating expenses:
 
 
 
Compensation and employee services
44,997

 
39,694

Legal collection fees
10,529

 
7,617

Legal collection costs
20,501

 
23,669

Agent fees
1,609

 
1,627

Outside fees and services
7,447

 
5,860

Communications
8,961

 
8,253

Rent and occupancy
1,687

 
1,611

Depreciation and amortization
3,366

 
3,656

Other operating expenses
4,575

 
3,738

Total operating expenses
103,672

 
95,725

Income from operations
65,887

 
44,421

Other income and (expense):
 
 
 
Interest income

 
1

Interest expense
(2,689
)
 
(2,653
)
Income before income taxes
63,198

 
41,769

Provision for income taxes
24,681

 
16,580

Net income
$
38,517

 
$
25,189

Adjustment for loss attributable to redeemable noncontrolling interest
(83
)
 
(273
)
Net income attributable to Portfolio Recovery Associates, Inc.
$
38,600

 
$
25,462

Net income per common share attributable to Portfolio Recovery Associates, Inc:
 
 
 
Basic
$
2.28

 
$
1.48

Diluted
$
2.26

 
$
1.47

Weighted average number of shares outstanding:
 
 
 
Basic
16,937

 
17,196

Diluted
17,091

 
17,267

The accompanying notes are an integral part of these consolidated financial statements.

4


PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
For the three months ended March 31, 2013 and 2012
(unaudited)
(Amounts in thousands)
 
 
Three Months Ended March 31,
 
2013
 
2012
Net income
$
38,517

 
$
25,189

Other comprehensive (loss)/income:
 
 
 
Foreign currency translation adjustments
(4,418
)
 
1,347

Total other comprehensive (loss)/income
(4,418
)
 
1,347

Comprehensive income
34,099

 
26,536

Comprehensive loss attributable to noncontrolling interest
(83
)
 
(273
)
Comprehensive income attributable to Portfolio Recovery Associates, Inc.
$
34,182

 
$
26,809

The accompanying notes are an integral part of these consolidated financial statements.

5


PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the three months ended March 31, 2013
(unaudited)
(Amounts in thousands)
 
 
 
 
 
 
 
 
 
 
Accumulated
 
 
 
 
 
 
 
Additional
 
 
 
Other
 
Total
 
Common Stock
 
Paid-in
 
Retained
 
Comprehensive
 
Stockholders’
 
Shares
 
Amount
 
Capital
 
Earnings
 
Income
 
Equity
Balance at December 31, 2012
16,909

 
$
169

 
$
151,216

 
$
554,191

 
$
2,851

 
$
708,427

Components of comprehensive income:
 
 
 
 
 
 
 
 
 
 
 
Net income attributable to Portfolio Recovery Associates, Inc.

 

 

 
38,600

 

 
38,600

Foreign currency translation adjustment

 

 

 

 
(4,418
)
 
(4,418
)
Vesting of nonvested shares
66

 
1

 
(1
)
 

 

 

Repurchase and cancellation of common stock
(16
)
 

 
(1,912
)
 

 

 
(1,912
)
Amortization of share-based compensation

 

 
2,986

 

 

 
2,986

Income tax benefit from share-based compensation

 

 
2,207

 

 

 
2,207

Employee stock relinquished for payment of taxes

 

 
(4,002
)
 

 

 
(4,002
)
Purchase of noncontrolling interest

 

 
9,162

 

 

 
9,162

Adjustment of the noncontrolling interest measurement amount

 

 
(60
)
 

 

 
(60
)
Balance at March 31, 2013
16,959

 
$
170

 
$
159,596

 
$
592,791

 
$
(1,567
)
 
$
750,990

The accompanying notes are an integral part of these consolidated financial statements.

6


PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the three months ended March 31, 2013 and 2012
(unaudited)
(Amounts in thousands)
 
Three Months Ended March 31,
 
2013
 
2012
Cash flows from operating activities:
 
 
 
Net income
$
38,517

 
$
25,189

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization of share-based compensation
2,986

 
2,347

Depreciation and amortization
3,366

 
3,656

Deferred tax expense
529

 
403

Changes in operating assets and liabilities:
 
 
 
Other assets
(2,070
)
 
711

Accounts receivable
1,149

 
2,922

Accounts payable
588

 
(3,687
)
Income taxes
19,088

 
1,118

Accrued expenses
(2,503
)
 
(3,419
)
Accrued payroll and bonuses
(3,537
)
 
(9,181
)
Net cash provided by operating activities
58,113

 
20,059

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(2,466
)
 
(1,152
)
Acquisition of finance receivables, net of buybacks
(212,389
)
 
(108,176
)
Collections applied to principal on finance receivables
120,671

 
93,770

Business acquisition, net of cash acquired

 
(48,653
)
Net cash used in investing activities
(94,184
)
 
(64,211
)
Cash flows from financing activities:
 
 
 
Income tax benefit from share-based compensation
2,207

 
1,440

Proceeds from line of credit
95,000

 
95,000

Principal payments on line of credit
(50,000
)
 
(50,000
)
Repurchases of common stock
(1,912
)
 
(2,081
)
Cash paid for purchase of portion of noncontrolling interest
(1,150
)
 

Distributions paid to noncontrolling interest
(51
)
 

Principal payments on long-term debt
(1,384
)
 
(310
)
Net cash provided by financing activities
42,710

 
44,049

Effect of exchange rate on cash
(215
)
 
1,474

Net increase in cash and cash equivalents
6,424

 
1,371

Cash and cash equivalents, beginning of period
32,687

 
26,697

Cash and cash equivalents, end of period
$
39,111

 
$
28,068

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
2,656

 
$
2,557

Cash paid for income taxes
2,866

 
12,497

Noncash investing and financing activities:
 
 
 
Adjustment of the noncontrolling interest measurement amount
$
(60
)
 
$
(1,225
)
Distributions payable relating to noncontrolling interest
2

 

Purchase of noncontrolling interest
9,162

 

Employee stock relinquished for payment of taxes
(4,002
)
 
(2,066
)
The accompanying notes are an integral part of these consolidated financial statements.


7

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)


1.
Organization and Business:
Portfolio Recovery Associates, Inc., a Delaware corporation, and its subsidiaries (collectively, the “Company”) is a financial and business service company operating principally in the United States and the United Kingdom.  Two call centers, one in the Philippines and one in Panama, operate under contract with the Company. The Company’s primary business is the purchase, collection and management of portfolios of defaulted consumer receivables. The Company also services receivables on behalf of clients on either a commission or transaction-fee basis and provides class action claims settlement recovery services and related payment processing to corporate clients.
The consolidated financial statements of the Company are prepared in accordance with U.S. generally accepted accounting principles and include the accounts of all of its subsidiaries. All significant intercompany accounts and transactions have been eliminated. Under the guidance of the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“ASC”) Topic 280 “Segment Reporting” (“ASC 280”), the Company has determined that it has several operating segments that meet the aggregation criteria of ASC 280, and therefore, it has one reportable segment, accounts receivable management, based on similarities among the operating units including homogeneity of services, service delivery methods and use of technology.
The following table shows the amount of revenue generated for the three months ended March 31, 2013 and 2012 and long-lived assets held at March 31, 2013 and 2012 by geographical location (amounts in thousands):
 
 
As Of And For The
 
As Of And For The
 
Three Months Ended March 31, 2013
 
Three Months Ended March 31, 2012
 
Revenues
 
Long-Lived
Assets
 
Revenues
 
Long-Lived
Assets
United States
$
166,929

 
$
23,770

 
$
135,508

 
$
25,137

United Kingdom
2,630

 
1,700

 
4,638

 
1,232

Total
$
169,559

 
$
25,470

 
$
140,146

 
$
26,369

Revenues are attributed to countries based on the location of the related operations. Long-lived assets consist of net property and equipment.
The accompanying unaudited consolidated financial statements of the Company have been prepared in accordance with Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (“SEC”) and, therefore, do not include all information and disclosures required by U.S. generally accepted accounting principles for complete financial statements. In the opinion of the Company, however, the accompanying unaudited consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s consolidated balance sheet as of March 31, 2013 , its consolidated income statements and statements of comprehensive income for the three months ended March 31, 2013 and 2012, its consolidated statement of changes in stockholders’ equity for the three months ended March 31, 2013 , and its consolidated statements of cash flows for the three months ended March 31, 2013 and 2012. The consolidated income statements of the Company for the three months ended March 31, 2013 may not be indicative of future results. Certain reclassifications have been made to prior year amounts to conform to the current year presentation. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s 2012 Annual Report on Form 10-K, filed on February 28, 2013.

2.
Finance Receivables, net:
The Company accounts for its investment in finance receivables under the guidance of ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”).  The Company acquires portfolios of accounts that have experienced deterioration of credit quality between origination and the Company's acquisition of the accounts. The amount paid for a portfolio reflects the Company's determination that it is probable the Company will be unable to collect all amounts due according to an account's contractual terms. At acquisition, the Company reviews the accounts 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 loan's contractual terms.  If both conditions exist, the Company then 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 (expected at acquisition) for each acquired portfolio based on the Company's proprietary models, and the Company subsequently aggregates portfolios of accounts into pools. The Company determines the excess of the

8

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

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). The remaining amount, representing the excess of the pool's cash flows expected to be collected over the amount paid, is accreted into income recognized on finance receivables over the remaining estimated life of the pool (accretable yield). ASC 310-30 requires that the excess of the contractual cash flows over expected cash flows, based on the Company's estimates derived from its proprietary collection models, not be recognized as an adjustment of revenue or expense or on the balance sheet.
Under ASC 310-30 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 may include certain direct costs of acquisition paid to third parties, and is accounted for as a single unit for the recognition of income, payments applied to principal and loss provision. Once a static pool is established for a calendar 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). ASC 310-30, utilizing the interest method, initially freezes the yield, estimated when the accounts are purchased, as the basis for subsequent impairment testing. The yield is estimated and periodically recalculated based on the timing and amount of anticipated cash flows using the Company's proprietary collection models. Income on finance receivables is accrued quarterly based on each static pool's effective yield. Significant increases in expected future cash flows may be recognized prospectively, through an upward adjustment of the yield, over a pool's remaining life.  Any increase to the yield then becomes the new benchmark for impairment testing. Under ASC 310-30, rather than lowering the estimated yield 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 yield and is shown as a reduction in revenue in the consolidated income statements with a corresponding valuation allowance offsetting finance receivables, net, on the consolidated balance sheets. Cash flows greater than the interest accrual will reduce the carrying value of the static pool. This reduction in carrying value is defined as payments applied to principal (also referred to as principal amortization). Likewise, cash flows that are less than the interest accrual will accrete the carrying balance. Generally, the Company does not record accretion in the first six to twelve months of the life of the pool; accordingly, the Company utilizes either the cost recovery method or cash method when necessary to prevent accretion as permitted by ASC 310-30. Under the cash method, revenue is recognized as it would be under the interest method up to the amount of cash collections. Under the cost recovery method, no revenue is recognized until the Company has fully collected the cost of the pool. 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 cost recovery pools are not aggregated with other pools. Under the cost recovery method, no revenue is recognized until the Company has fully collected the cost of the pool, 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 March 31, 2013 and 2012, the Company had unamortized purchased principal (purchase price) in pools accounted for under the cost recovery method of $12.3 million and $0.8 million , respectively; at December 31, 2012, the amount was $4.2 million .
The Company establishes valuation allowances, if necessary, for acquired accounts subject to ASC 310-10. Valuation allowances are established only subsequent to acquisition of the accounts. At March 31, 2013 and 2012, the Company had a valuation allowance against its finance receivables of $95.3 million and $87.1 million , respectively; at December 31, 2012, the valuation allowance was $93.1 million .
The Company implements the accounting for income recognized on finance receivables under ASC 310-30 as follows. The Company creates each accounting pool using its projections of estimated cash flows and expected economic life.  The Company then computes the effective yield that fully amortizes the pool to the end of its expected economic life based on the current projections of estimated cash flows. As actual cash flow results are recorded, the Company balances those results to the data contained in its proprietary models to ensure accuracy, then reviews each pool watching for trends, actual performance versus projections and curve shape (a graphical depiction of the timing of cash flows), regularly re-forecasting future cash flows utilizing the Company's statistical models. The review process is primarily performed by the Company's finance staff; however, the Company's operational and statistical staffs are also involved, providing updated statistical input and cash projections to the finance staff. If there is an increase in expected cash flows, the Company will recognize the effect of the increase prospectively through an increase in yield. If a valuation allowance had been previously recognized for that pool, the allowance is reversed before recording any prospective yield adjustments. If the over performance is considered more of an acceleration of cash flows (a timing difference), the Company will: a) adjust estimated future cash flows downward which effectively extends the amortization period to fall within a reasonable expectation of the pool's economic life, b) introduce some level of future cash adjustment as noted previously coupled with an increase in yield in order for the amortization period to fall within a reasonable expectation of the pool's economic life, or c) take no action at all if the amortization period falls within a reasonable expectation of the pool's expected economic life. To the extent there is underperformance, the Company will record an allowance if the underperformance is significant

9

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

and will also consider revising estimated future cash flows based on current period information, or take no action if the pool's amortization period is reasonable and falls within the currently projected economic life.
Changes in finance receivables, net for the three months ended March 31, 2013 and 2012 were as follows (amounts in thousands):
 

Three Months Ended
March 31, 2013

Three Months Ended
March 31, 2012
Balance at beginning of period
$
1,078,951


$
926,734

Acquisitions of finance receivables, net of buybacks
212,389


112,093

Foreign currency translation adjustment
(922
)

185

Cash collections
(275,463
)

(217,996
)
Income recognized on finance receivables, net
154,792


124,226

Cash collections applied to principal
(120,671
)

(93,770
)
Balance at end of period
$
1,169,747


$
945,242

 
At the time of acquisition, the life of each pool is generally estimated to be between 60 to 96 months based on projected amounts and timing of future cash collections using the proprietary models of the Company. Based upon current projections, cash collections applied to principal on finance receivables as of March 31, 2013 are estimated to be as follows for the twelve months in the periods ending (amounts in thousands):
 
March 31, 2014
$
392,143

March 31, 2015
327,492

March 31, 2016
249,805

March 31, 2017
146,491

March 31, 2018
53,816


$
1,169,747

During the three months ended March 31, 2013 and 2012, the Company purchased approximately $1.85 billion and $1.46 billion , respectively, in face value of charged-off consumer receivables. At March 31, 2013, the estimated remaining collections (“ERC”) on the receivables purchased in the three months ended March 31, 2013 and 2012, were $378.0 million and $151.9 million , 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 the balance sheet date. Additions represent the original expected accretable yield, on portfolios purchased during the period, to be earned by the Company based on its proprietary buying models. Net reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase in its estimate of future cash flows. When applicable, net reclassifications to nonaccretable difference from accretable yield result from the Company’s decrease in its estimates of future cash flows and allowance charges that exceed the Company’s increase in its estimate of future cash flows. Changes in accretable yield for the three months ended March 31, 2013 and 2012 were as follows (amounts in thousands):
 

Three Months Ended
March 31, 2013

Three Months Ended
March 31, 2012
Balance at beginning of period
$
1,239,674


$
1,026,614

Income recognized on finance receivables, net
(154,792
)

(124,226
)
Additions
182,505


99,552

Net reclassifications from nonaccretable difference
53,764


86,638

Foreign currency translation adjustment
(4,007
)

174

Balance at end of period
$
1,317,144


$
1,088,752


10

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

A valuation allowance is recorded for significant decreases in expected cash flows or a change in the expected timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. In any given period, the Company may be required to record valuation allowances due to pools of receivables underperforming expectations. Factors that may contribute to the recording of valuation allowances may include both internal as well as external factors. External factors which may have an impact on the collectability, and subsequently on the overall profitability of purchased pools of defaulted consumer receivables would include: new laws or regulations relating to collections, new interpretations of existing laws or regulations, and the overall condition of the economy. Internal factors which may have an impact on the collectability, and subsequently the overall profitability of purchased pools of defaulted consumer receivables would include: necessary revisions to initial and post-acquisition scoring and modeling estimates, non-optimal operational activities (which relate to the collection and movement of accounts on both the collection floor of the Company and external channels), as well as decreases in productivity related to turnover and tenure of the Company’s collection staff. The following is a summary of activity within the Company’s valuation allowance account, all of which relates to loans acquired with deteriorated credit quality, for the three months ended March 31, 2013 and 2012 (amounts in thousands):
 
Three Months Ended March 31, 2013
 
Core Portfolio  (1)
 
Purchased Bankruptcy
Portfolio 
(2)
 
Total
Valuation allowance - finance receivables:





Beginning balance
$
74,500


$
18,623


$
93,123

Allowance charges
300


4,660


4,960

Reversal of previous recorded allowance charges
(2,700
)

(87
)

(2,787
)
Net allowance charges
(2,400
)

4,573


2,173

Ending balance
$
72,100


$
23,196


$
95,296

Finance receivables, net (3):
$
586,916


$
570,877


$
1,157,793

   
 
Three Months Ended March 31, 2012
 
Core Portfolio  (1)
 
Purchased Bankruptcy
Portfolio 
(2)
 
Total
Valuation allowance - finance receivables:
 
 
 
 
 
Beginning balance
$
76,580

 
$
9,991

 
$
86,571

Allowance charges
1,350

 
1,100

 
2,450

Reversal of previous recorded allowance charges
(1,820
)
 
(136
)
 
(1,956
)
Net allowance charges
(470
)
 
964

 
494

Ending balance
$
76,110

 
$
10,955

 
$
87,065

Finance receivables, net (3):
$
453,709

 
$
486,137

 
$
939,846

(1)
“Core” accounts or portfolios refer to accounts or portfolios that are defaulted consumer receivables and are not in a bankrupt status upon purchase. These accounts are aggregated separately from purchased bankruptcy accounts.
(2)
“Purchased bankruptcy” accounts or portfolios refer to accounts or portfolios that are in bankruptcy status when purchased, and as such, are purchased as a pool of bankrupt accounts.
(3)
At March 31, 2013 , the MHH finance receivables balance was $12.0 million against which there was no valuation allowance recorded; therefore it is not included in this roll-forward.

3.
Line of Credit:
On December 19, 2012, the Company entered into a credit agreement with Bank of America, N.A., as administrative agent, and a syndicate of lenders named therein (the “Credit Agreement”). Under the terms of the Credit Agreement, the credit facility includes an aggregate principal amount available of $600.0 million (subject to the borrowing base and applicable debt covenants) which consists of a $200.0 million floating rate term loan that matures on December 19, 2017 and a $400.0 million revolving credit facility that matures on December 19, 2017. The term and revolving loans accrue interest, at the option of the Company, at either the base rate or the Eurodollar rate (as defined in the Credit Agreement) for the applicable term plus 2.50%  per annum in the case of the Eurodollar rate loans and 1.50% in the case of the base rate loans. The base rate is the highest of (a) the Federal Funds Rate plus 0.50% , (b) Bank of America’s prime rate, and (c) the Eurodollar rate plus 1.00% . The Company’s revolving

11

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

credit facility includes a $20 million swingline loan sublimit, a $20 million letter of credit sublimit and a $20 million alternative currency equivalent sublimit. It also contains an accordion loan feature that allows the Company to request an increase of up to $250.0 million in the amount available for borrowing under the revolving credit facility, whether from existing or new lenders, subject to terms of the Credit Agreement. No existing lender is obligated to increase its commitment. The Credit Agreement is secured by a first priority lien on substantially all of the Company’s assets. The Credit Agreement contains restrictive covenants and events of default including the following:
borrowings may not exceed 30% of the ERC of all its eligible asset pools plus 75% of its eligible accounts receivable;
the consolidated leverage ratio (as defined in the Credit Agreement) cannot exceed 2.0 to 1.0 as of the end of any fiscal quarter;
consolidated tangible net worth (as defined in the Credit Agreement) must equal or exceed $455,091,200 plus 50% of positive cumulative consolidated net income for each fiscal quarter beginning with the quarter ended December 31, 2012, plus 50% of the cumulative net proceeds of any equity offering;
capital expenditures during any fiscal year cannot exceed $30 million ;
cash dividends and distributions during any fiscal year cannot exceed $20 million ;
stock repurchases during the term of the agreement cannot exceed $250 million and cannot exceed $100 million in a single fiscal year;
permitted acquisitions (as defined in the Credit Agreement) during any fiscal year cannot exceed $250 million ;
the Company must maintain positive consolidated income from operations (as defined in the Credit Agreement) during any fiscal quarter; and
restrictions on changes in control.
The revolving credit facility also bears an unused commitment fee of 0.375%  per annum, payable quarterly in arrears.
The Company's borrowings at March 31, 2013 consisted of $148.0 million in 30-day Eurodollar rate loans and $24.0 million in base rate loans with a weighted average interest rate of 2.74% . In addition, the Company had $198.8 million outstanding on the term loan at March 31, 2013 with an annual interest rate as of March 31, 2013 of 2.70% . Refer to Note 4 "Long-Term Debt" for payment details related to the term loan.
The Company had $370.8 million and $327.0 million of borrowings outstanding on its credit facilities as of March 31, 2013 and December 31, 2012, respectively. These total borrowings include long-term debt as discussed in Note 4 "Long-Term Debt".
The Company was in compliance with all covenants of its credit facilities as of March 31, 2013 and December 31, 2012.

4.
Long-Term Debt:
On December 19, 2012 , the Company entered into the Credit Agreement. Under the terms of the Credit Agreement, the credit facility includes a $200 million floating rate term loan that matures on December 19, 2017. The term loan accrues interest, at the option of the Company, at either the base rate or the Eurodollar rate (as defined in the Credit Agreement) for the applicable term plus 2.50%  per annum. See Note 3 "Line of Credit" for additional details regarding interest rates and restrictive covenants. The term loan includes quarterly principal payments on the last day of each calendar quarter beginning March 31, 2013 and ending on the maturity date of December 19, 2017.
On December 15, 2010, the Company entered into a commercial loan agreement to finance computer software and equipment purchases in the amount of approximately $1.6 million . The loan is collateralized by the related computer software and equipment. The loan term is 3 years with a fixed rate of 3.69% with monthly installments, including interest, of $46,108 beginning on January 15, 2011, and it matures on December 15, 2013 .
The following principal payments are due on the Company's long-term debt as of March 31, 2013 for the twelve month periods ending (amounts in thousands):
March 31, 2014
$
6,659

March 31, 2015
11,250

March 31, 2016
16,250

March 31, 2017
25,000

March 31, 2018
140,000

Total
$
199,159


12

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

5.
Property and Equipment, net:
Property and equipment, at cost, consisted of the following as of the dates indicated (amounts in thousands):
 
 
March 31,
2013
 
December 31,
2012
Software
$
30,137

 
$
29,467

Computer equipment
13,862

 
14,129

Furniture and fixtures
7,311

 
7,220

Equipment
9,434

 
8,674

Leasehold improvements
7,323

 
7,231

Building and improvements
7,012

 
7,014

Land
1,269

 
1,269

Accumulated depreciation and amortization
(50,878
)
 
(49,692
)
Property and equipment, net
$
25,470

 
$
25,312

Depreciation and amortization expense relating to property and equipment for the three months ended March 31, 2013 and 2012, was $2.2 million and $2.2 million , respectively.
The Company, in accordance with the guidance of FASB ASC Topic 350-40 “Internal-Use Software” (“ASC 350-40”), capitalizes qualifying computer software costs incurred during the application development stage and amortizes them over their estimated useful life of three to seven 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 March 31, 2013 and December 31, 2012, the Company incurred and capitalized approximately $8.4 million and $7.8 million , respectively, of these direct payroll costs and external direct costs related to software developed for internal use. Of these costs, at March 31, 2013 and December 31, 2012, approximately $1.4 million and $1.3 million , respectively, is for projects that were in the development stage and, therefore are a component of “Other Assets.” Once the projects are completed, the costs are transferred to Software and amortized over their estimated useful life of three to seven years. Amortization expense for the three months ended March 31, 2013 and 2012, was approximately $0.3 million and $0.3 million , respectively. The remaining unamortized costs relating to internally developed software at March 31, 2013 and December 31, 2012 were approximately $4.0 million and $3.9 million , respectively.
 
6.
Redeemable Noncontrolling Interest:
In accordance with ASC 810, the Company has consolidated all financial statement accounts of Claims Compensation Bureau, LLC (“CCB”) in its consolidated balance sheets and its consolidated income statements. The redeemable noncontrolling interest amount is separately stated on the consolidated balance sheets and represents the 19% and 38% interest in CCB not owned by the Company at March 31, 2013 and December 31, 2012, respectively. In addition, net income/loss attributable to the noncontrolling interest is stated separately in the consolidated income statements.
The Company has the right through February 28, 2015 to purchase the remaining 19% of CCB at certain multiples of earnings before interest, taxes, depreciation and amortization (“EBITDA”). In addition, beginning March 1, 2012 and ending February 28, 2015, the noncontrolling interest can require the Company to purchase up to one-third of its membership units in CCB per annual period at pre-defined multiples of EBITDA, subject to achievement of a minimum amount of trailing EBITDA. Beginning March 31, 2015 and ending February 28, 2018, the noncontrolling interest can require the Company to purchase all or any portion of its remaining membership units in CCB at pre-defined multiples of EBITDA, with no restrictions.
On February 1, 2013, the Company purchased one-half of the remaining interest in CCB for a purchase price of $1.1 million . The purchase price was derived from the formula stipulated in the contractual agreement and was based on prior levels of EBITDA.
The maximum redemption value of the noncontrolling interest, as if it were currently redeemable by the holder of the put option under the terms of the put arrangement, was $11.4 million at March 31, 2013.

13

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

The following table represents the changes in the redeemable noncontrolling interest for the three months ended March 31, 2013 and 2012 (amounts in thousands):
 
Three Months Ended
March 31, 2013
 
Three Months Ended
March 31, 2012
Balance at beginning of period
$
20,673

 
$
17,831

Net loss attributable to redeemable noncontrolling interest
(83
)
 
(273
)
Distributions payable
(2
)
 

Purchase of portion of noncontrolling interest
(10,312
)
 

Adjustment of the noncontrolling interest measurement amount
60

 
1,225

Balance at end of period
$
10,336

 
$
18,783

In accordance with the limited liability company agreement of CCB, distributions due to the members of CCB are accrued each quarter and are payable as soon as reasonably possible subsequent to each quarter end.

7.
Goodwill and Intangible Assets, net:
In connection with the Company’s previous business acquisitions, the Company acquired certain tangible and intangible assets. Intangible assets purchased included client and customer relationships, non-compete agreements, trademarks and goodwill. Pursuant to ASC 350, goodwill is not amortized but rather is reviewed at least annually for impairment. During the fourth quarter of 2012, the Company underwent its annual review of goodwill. Based upon the results of this review, which was conducted as of October 1, 2012, 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 March 31, 2013 that would indicate a triggering event and thereby necessitate further evaluation of goodwill or other intangible assets. Accordingly, there were no impairment losses during the three months ended March 31, 2013 and 2012. The Company expects to perform its next annual goodwill review during the fourth quarter of 2013. At March 31, 2013 and December 31, 2012, the carrying value of goodwill was $106.9 million and $109.5 million , respectively. The following table represents the changes in goodwill for the three months ended March 31, 2013 and 2012 (amounts in thousands):
 
 
Three Months Ended March 31, 2013
 
Three Months Ended March 31, 2012
Balance at beginning of period
$
109,488

 
$
61,678

Acquisition of MHH

 
34,270

Foreign currency translation adjustment
(2,576
)
 
1,532

Balance at end of period
$
106,912

 
$
97,480

Intangible assets, excluding goodwill, consist of the following at March 31, 2013 and December 31, 2012 (amounts in thousands):
 
 
March 31, 2013
 
December 31, 2012
 
Gross Amount
 
Accumulated
Amortization
 
Gross Amount
 
Accumulated
Amortization
Client and customer relationships
$
40,046

 
$
23,448

 
$
40,698

 
$
22,516

Non-compete agreements
3,837

 
3,585

 
3,880

 
3,581

Trademarks
3,412

 
1,712

 
3,477

 
1,594

Total
$
47,295

 
$
28,745

 
$
48,055

 
$
27,691

Total intangible asset amortization expense for the three months ended March 31, 2013 and 2012 was $1.2 million and $1.5 million , respectively. The Company reviews these intangible assets for possible impairment upon the occurrence of a triggering event.
 


14

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

8.
Share-Based Compensation:
The Company has a stock option and nonvested share plan. The Company created the 2002 Stock Option Plan (the “Plan”) on November 7, 2002. The Plan was amended in 2004 (the “Amended Plan”) to enable the Company to issue nonvested shares of stock to its employees and directors. On March 19, 2010, the Company adopted the 2010 Stock Plan (the "2010 Stock Plan"), which was approved by its shareholders at the 2010 Annual Meeting. The 2010 Stock Plan is a further amendment to the Amended Plan, and contains, among other things, specific performance metrics with respect to performance-based stock awards. Up to 2,000,000 shares of common stock may be issued under the 2010 Stock Plan.
As of March 31, 2013, total future compensation costs related to nonvested awards of nonvested shares (not including nonvested shares granted under the Long-Term Incentive Program (“LTI”)) is estimated to be $5.7 million with a weighted average remaining life for all nonvested shares of 2.1 years (not including nonvested shares granted under the LTI program). As of March 31, 2013, there are no future compensation costs related to stock options and there are no remaining vested stock options to be exercised. Based upon historical data, the Company used an annual forfeiture rate of 14% for stock options and 15 - 40% for nonvested shares for most of the employee grants. Grants made to key employees and directors of the Company were assumed to have no forfeiture rates associated with them due to the historically low turnover among this group.
Total share-based compensation expense was $3.0 million and $2.3 million for the three months ended March 31, 2013, and 2012, respectively. Tax benefits resulting from tax deductions in excess of share-based compensation expense (windfall tax benefits) recognized under the provisions of ASC 718 are credited to additional paid-in capital in the Company's Consolidated Balance Sheets. Realized tax shortfalls, if any, 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 was approximately $4.0 million and $2.7 million for the three months ended March 31, 2013 and 2012, respectively.
Nonvested Shares
With the exception of the awards made pursuant to the LTI program and a few employee and director grants the nonvested shares vest ratably over three to five years and are expensed over their vesting period.
The following summarizes all nonvested share transactions, excluding those related to the LTI program, from December 31, 2011 through March 31, 2013 (share amounts in thousands):
 
 
Nonvested Shares
Outstanding
 
Weighted-Average
Price at Grant Date
December 31, 2011
81

 
$
59.31

Granted
53

 
65.99

Vested
(34
)
 
59.36

Cancelled
(4
)
 
69.92

December 31, 2012
96

 
62.52

Granted
31

 
104.54

Vested
(37
)
 
56.90

Cancelled
(6
)
 
65.40

March 31, 2013
84

 
$
80.30

The total grant date fair value of shares vested during the three months ended March 31, 2013, and 2012, was $2.1 million and $1.2 million , respectively.

15

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Long-Term Incentive Program
Pursuant to the Amended Plan, the Compensation Committee may grant time-vested and performance based nonvested shares. All shares granted under the LTI program were granted to key employees of the Company. The following summarizes all LTI share transactions from December 31, 2011 through March 31, 2013 (share amounts in thousands):
 
Nonvested LTI Shares
Outstanding
 
Weighted-Average
Price at Grant Date
December 31, 2011
183

 
$
51.03

Granted at target level
66

 
62.20

Adjustments for actual performance
40

 
54.01

Vested
(118
)
 
37.75

Cancelled
(5
)
 
67.66

December 31, 2012
166

 
65.14

Granted at target level
41

 
103.77

Adjustments for actual performance
35

 
53.62

Vested
(53
)
 
48.71

Cancelled
(1
)
 
75.50

March 31, 2013
188

 
$
75.53

The total grant date fair value of shares vested during the three months ended March 31, 2013, and 2012, was $2.6 million and $2.0 million , respectively.
At March 31, 2013, total future compensation costs, assuming the current estimated performance levels are achieved, related to nonvested share awards granted under the LTI program are estimated to be approximately $10.6 million . The Company assumed a 7.5% forfeiture rate for these grants and the remaining shares have a weighted average life of 1.5 years at March 31, 2013.

9.
Income Taxes:
The Company follows the guidance of FASB ASC Topic 740 “Income Taxes” (“ASC 740”) as it relates to the provision for income taxes and uncertainty in income taxes. The guidance 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. There were no unrecognized tax benefits at March 31, 2013 and 2012.
The Company was notified on June 21, 2007 that it was being examined by the Internal Revenue Service (IRS) for the 2005 calendar year. The IRS concluded the audit and on March 19, 2009 issued Form 4549-A, Income Tax Examination Changes, for tax years ended December 31, 2007, 2006 and 2005. The IRS has asserted that cost recovery for tax revenue recognition does not clearly reflect taxable income and that unused line fees paid on credit facilities should be capitalized and amortized rather than taken as a current deduction. The Company believes it has sufficient support for the technical merits of its positions and that it is more likely than not they will ultimately be sustained; therefore, a reserve for uncertain tax positions is not necessary. The Company believes cost recovery to be an acceptable tax revenue recognition method for companies in the bad debt purchasing industry. 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.  On April 22, 2009, the Company filed a formal protest of the findings contained in the examination report prepared by the IRS. On August 26, 2011, the IRS issued a Notice of Deficiency for the tax years ended December 31, 2007, 2006, and 2005.  On November 2, 2011, the Company filed a petition in the United States Tax Court. If the Company is unsuccessful in the United States Tax Court, it can appeal to the federal Circuit Court of Appeals. Payment of the assessed taxes and interest could have an adverse affect on the Company’s financial condition, be material to the Company’s results of operations, and possibly require additional financing from other sources. In accordance with the Internal Revenue Code, underpayments of federal tax accrue interest, compounded daily, at the applicable federal short term rate plus three percentage points. An additional two percentage points applies to large corporate underpayments of $100,000 or more to periods after the applicable date as defined in the Internal Revenue Code. The Company files taxes in multiple state jurisdictions; therefore, any underpayment of state tax will accrue interest in accordance with the respective state statute. On June 30, 2011, the Company was notified by the IRS that the audit period will be expanded to include the tax years ended December 31, 2009 and 2008.

16

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

At March 31, 2013, the tax years subject to examination by the major taxing jurisdictions, including the IRS, are 2003, 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. The examination periods for the 2007, 2006 and 2005 tax years were extended through December 31, 2011; however, because the IRS issued the Notice of Deficiency prior to December 31, 2011, the period for assessment is suspended until a decision of the Tax Court becomes final. The statute of limitations for the 2008, 2009 and 2010 tax years has been extended to September 26, 2014.
ASC 740 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. No interest or penalties were accrued or reversed in the three month periods ended March 31, 2013 or 2012.
 
10.
Earnings per Share:
Basic earnings per share (“EPS”) are computed by dividing net income available to common shareholders of Portfolio Recovery Associates, Inc. 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 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 nonvested shares is computed using the treasury stock method, which assumes any proceeds that could be obtained upon the 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 tables provide reconciliation between the computation of basic EPS and diluted EPS for the three months ended March 31, 2013 and 2012 (amounts in thousands, except per share amounts):
 
 
For the Three Months Ended March 31,
 
2013
 
2012
 
Net Income
attributable to  Portfolio
Recovery  Associates, Inc.
 
Weighted  Average
Common  Shares
 
EPS
 
Net Income
attributable to  Portfolio
Recovery  Associates, Inc.
 
Weighted  Average
Common  Shares
 
EPS
Basic EPS
$
38,600

 
16,937

 
$
2.28

 
$
25,462

 
17,196

 
$
1.48

Dilutive effect of nonvested share awards
 
 
154

 
 
 
 
 
71

 
 
Diluted EPS
$
38,600

 
17,091

 
$
2.26

 
$
25,462

 
17,267

 
$
1.47

There were no antidilutive options outstanding for the three months ended March 31, 2013 and 2012.

11.
Commitments and Contingencies:
Employment Agreements:
The Company has employment agreements, most of which expire on December 31, 2014 , with all of its executive officers and with several members of its senior management group. Such agreements provide for base salary payments as well as bonuses which are based on the attainment of specific management goals. At March 31, 2013, the estimated future compensation under these agreements is approximately $11.3 million . The agreements also contain confidentiality and non-compete provisions.
Leases:
The Company is party to various operating leases with respect to its facilities and equipment. The future minimum lease payments at March 31, 2013 is approximately $23.6 million .
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 March 31, 2013 is approximately $283.8 million .

17

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

Redeemable Noncontrolling Interest:
In connection with the Company’s acquisition of 62% of the membership units of CCB on March 15, 2010, the Company acquired the right through February 28, 2015 to purchase, at a predetermined price, the remaining 38% of the membership units of CCB not held by the Company. In February 2013, the Company exercised its right to acquire one-half of the noncontrolling interest resulting in ownership of 81% of the membership units as of March 31, 2013. Also, the owners of the noncontrolling interest can require the Company to purchase their respective interest during the period beginning on March 1, 2012 and ending on February 28, 2018 at pre-defined multiples of EBITDA, subject to achievement of a minimum amount of trailing EBITDA. While the actual amount or timing of any future payment related to the remaining 19% of outstanding interest is unknown at this time, the maximum amount of consideration to be paid for that interest is $11.4 million .
Contingent Purchase Price:
The NCM acquisition includes an earn-out provision whereby the sellers are able to earn additional cash consideration for achieving certain cash collection thresholds over a five year period. The maximum amount of earn-out during the period is $15.0 million . As of March 31, 2013, the Company has recorded a present fair value amount for this liability of $7.3 million .
Finance Receivables:
Certain agreements for the purchase of finance receivables portfolios contain provisions that may, in limited circumstances, require the Company to refund a portion or all of the collections subsequently received by the Company on particular accounts. The potential refunds as of the balance sheet date are not considered to be significant.
Litigation:
The Company is from time to time subject to routine legal claims and proceedings, most of which are incidental to the ordinary course of its business. The Company initiates lawsuits against customers and is occasionally countersued by them in such actions. Also, customers, either individually, as members of a class action, or through a governmental entity on behalf of customers, may 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.  From time to time, other types of lawsuits are brought against the Company. Additionally, the Company receives subpoenas and other requests for information from regulators or governmental authorities who are investigating the Company's debt collection activities. The Company makes every effort to respond appropriately to such requests.
The Company accrues for potential liability arising from legal proceedings when it is probable that such liability has been incurred and the amount of the loss can be reasonably estimated.  This determination is based upon currently available information for those proceedings in which the Company is involved, taking into account the Company's best estimate of such losses for those cases for which such estimates can be made. The Company's estimate involves significant judgment, given the varying stages of the proceedings (including the fact that many of them are currently in preliminary stages), the number of unresolved issues in many of the proceedings (including issues regarding class certification and the scope of many of the claims), and the related uncertainty of the potential outcomes of these proceedings. In making determinations of the likely outcome of pending litigation, the Company considers many factors, including, but not limited to, the nature of the claims, the Company's experience with similar types of claims, the jurisdiction in which the matter is filed, input from outside legal counsel, the likelihood of resolving the matter through alternative mechanisms, the matter's current status and the damages sought or demands made. Accordingly, the Company's estimate will change from time to time, and actual losses could be more than the current estimate.
Subject to the inherent uncertainties involved in such proceedings, the Company believes, based upon its current knowledge and after consultation with counsel, that the legal proceedings currently pending against it, including those that fall outside of the Company's routine legal proceedings, should not, either individually or in the aggregate, have a material adverse impact on the Company's financial condition.  However, it is possible in light of the uncertainties involved in such proceedings or due to unexpected future developments, that an unfavorable resolution of a legal proceeding or claim could occur which may be material to the Company's financial condition, results of operations, or cash flows for a particular period.
Excluding the matters described below and other putative class action suits which the Company believes are not material, the high end of the range of potential litigation losses in excess of the amount accrued is estimated by management to be less than $1,000,000 as of March 31, 2013.  Notwithstanding our attempt to estimate a range of possible losses in excess of the amount accrued based on current information, actual future losses may exceed both the Company's accrual and the range of potential litigation losses disclosed above.

18

Table of Contents
PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

In certain legal proceedings, the Company may have recourse to insurance or third party contractual indemnities to cover all or portions of its litigation expenses, judgments, or settlements. Loss estimates and accruals for potential liability related to legal proceedings are exclusive of potential recoveries, if any, under the Company's insurance policies or third party indemnities. The Company has not recorded any potential recoveries under the Company's insurance policies or third party indemnities.
The matters described below fall outside of the normal parameters of the Company’s routine legal proceedings.
Telephone Consumer Protection Act Litigation
The Company has been named as defendant in a number of putative class action cases, each alleging that the Company violated the Telephone Consumer Protection Act by calling consumers' cellular telephones without their prior express consent.  On December 21, 2011, the United States Judicial Panel on Multi-District Litigation entered an order transferring these matters into one consolidated proceeding in the United States District Court for the Southern District of California.  On November 14, 2012, the putative class plaintiffs filed their amended consolidated complaint in the matter, now styled as In re Portfolio Recovery Associates, LLC Telephone Consumer Protection Act Litigation, case No. 11-md-02295 (the “MDL action”).  The Company has filed a motion to dismiss the amended consolidated complaint.
On October 12, 2012, the United States Court of Appeals for the Ninth Circuit, affirmed the decision of the United States District Court for the Southern District of California in the matter of Meyer v. Portfolio Recovery Associates, LLC, Case No. 11-cv-01008, which imposed a preliminary injunction prohibiting the Company from using its Avaya Proactive Contact Dialer to place calls to cellular telephones with California area codes that were obtained through skip-tracing.  On December 28, 2012, the United States Court of Appeals for the Ninth Circuit denied the Company's petition seeking a rehearing en banc. Thereafter, the Company filed a Petition for Writ of Certiorari with the United States Supreme Court on March 28, 2013. The Supreme Court has yet to decide whether or not it will review this matter.   Meyer is one of the cases included in the MDL action listed above. Both Meyer and the MDL action are ongoing and no final determination on the merits in either has been made.
Internal Revenue Service Audit
The U.S. Internal Revenue Service (the “IRS”) examined the Company's tax returns for the 2005 calendar year. The IRS concluded the audit and on March 19, 2009 issued Form 4549-A, Income Tax Examination Changes, for tax years ended December 31, 2007, 2006 and 2005. The IRS has asserted that cost recovery for tax revenue recognition does not clearly reflect taxable income and that unused line fees paid on credit facilities should be capitalized and amortized rather than taken as a current deduction. The Company believes it has sufficient support for the technical merits of its positions and that it is more likely than not these positions will ultimately be sustained; therefore, a reserve for uncertain tax positions is not necessary. On April 22, 2009, the Company filed a formal protest of the findings contained in the examination report prepared by the IRS. On August 26, 2011, the IRS issued a Notice of Deficiency for the tax years ended December 31, 2007, 2006, and 2005.  The Company subsequently filed a petition in the United States Tax Court to which the IRS responded on January 12, 2012. If the Company is unsuccessful in the United States Tax Court, it can appeal to the federal Circuit Court of Appeals.  Refer to Note 9 “Income Taxes” for additional information.

12.
Fair Value Measurements and Disclosures:
In accordance with the disclosure requirements of FASB ASC Topic 825, “Financial Instruments” (“ASC 825”), the table below summarizes fair value estimates for the Company’s financial instruments. The total of the fair value calculations presented does not represent, and should not be construed to represent, the underlying value of the Company. The carrying amounts in the table are recorded in the consolidated balance sheet at March 31, 2013 and December 31, 2012, under the indicated captions (amounts in thousands):

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PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

 
 
March 31, 2013
 
December 31, 2012
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
39,111

 
$
39,111

 
$
32,687

 
$
32,687

Finance receivables, net
1,169,747

 
1,825,476

 
1,078,951

 
1,776,049

Financial liabilities:
 
 
 
 
 
 
 
Line of credit
$
172,000

 
$
172,000

 
$
127,000

 
$
127,000

Long-term debt
199,159

 
199,159

 
200,542

 
200,542

As of March 31, 2013, and December 31, 2012, the Company did not account for any financial assets or financial liabilities at fair value. As defined by FASB ASC Topic 820, “Fair Value Measurements and Disclosures” (“ASC 820”), fair value is 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. ASC 820 also requires the consideration of differing levels of inputs in the determination of fair values. Those levels of input are summarized as follows:

Level 1 - Quoted prices in active markets for identical assets and liabilities.
 
Level 2 - Observable inputs other than level 1 quoted prices, such as quoted prices for similar instruments in active markets, quoted prices for identical or similar instruments in markets that are not active, and model-based valuation techniques for which all significant assumptions are observable in the market.

Level 3 - Unobservable inputs that are supported by little or no market activity. Level 3 assets and liabilities include financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques as well as instruments for which the determination of fair value requires significant management judgment or estimation.
The level in the fair value hierarchy within which a fair value measurement in its entirety falls is based on the lowest level input that is significant to the fair value measurement in its entirety.
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 and quoted prices for identical assets can be found in active markets. Accordingly, the Company estimates the fair value of cash and cash equivalents using level 1 inputs.
Finance receivables, net: The Company records purchased receivables at cost, which represents a significant discount from the contractual receivable balances due. The Company computed the estimated fair value of these receivables using proprietary pricing models that the Company utilizes to make portfolio purchase decisions. Accordingly, the Company's fair value estimates use level 3 inputs as there is little observable market data available and management is required to use significant judgment in its estimates.
Line of credit: The carrying amount approximates fair value due to the short-term nature of the interest rate periods and the observable quoted prices for similar instruments in active markets. Accordingly, the Company uses level 2 inputs for its fair value estimates.
Long-term debt: The carrying amount approximates fair value due to the short-term nature of the interest rate periods and the observable quoted prices for similar instruments in active markets. Accordingly, the Company uses level 2 inputs for its fair value estimates.

13.
Stockholders' Equity:
On February 2, 2012, the Board of Directors of the Company authorized a share repurchase program of up to $100 million of the Company’s outstanding shares of common stock on the open market. During the first quarter of 2013, the Company repurchased and retired 16,200 shares at an average price of $118.03 (including acquisition costs). At March 31, 2013, the maximum remaining purchase price for share repurchases under the plan is approximately $75.4 million.


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PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)

14.
Recent Accounting Pronouncements:
 
In July 2012, the FASB issued ASU 2012-02, “Intangibles-Goodwill and Other (Topic 350): Testing Indefinite-Lived Intangible Assets for Impairment” to amend the accounting guidance on intangible asset impairment testing. The ASU permits entities to perform an optional qualitative assessment for determining whether it is more likely than not that an indefinite-lived intangible asset is impaired. The guidance is effective for annual and interim impairment tests performed for fiscal years beginning after September 15, 2012. Early adoption is permitted. The Company adopted ASU 2012-02 in the first quarter of 2013 which had no material impact on its consolidated financial statements.
In February 2013, the FASB issued ASU 2013-02, "Comprehensive Income (Topic 220): Reporting of Amounts Reclassified Out of Accumulated Other Comprehensive Income," which requires entities to provide information about the amounts reclassified out of accumulated other comprehensive income, by component. In addition, entities are required to present, either on the face of the statement where net income is presented or in the notes, significant amounts reclassified out of accumulated other comprehensive income by the respective line items of net income but only if the amount reclassified is required under U.S. GAAP to be reclassified to net income in its entirety in the same reporting period. For other amounts that are not required under U.S. GAAP to be reclassified in their entirety to net income, entities are required to cross-reference to other disclosures required under U.S. GAAP that provide additional detail on these amounts. The Company adopted ASU 2013-02 in the first quarter of 2013 which had no material impact on its consolidated financial statements.
In March 2013, the FASB issued ASU 2013-05, "Foreign Currency Matters (Topic 830): Parent's Accounting for the Cumulative Translation Adjustment upon Derecognition of Certain Subsidiaries or Groups of Assets within a Foreign Entity or of an Investment in a Foreign Entity," which defines the treatment of the release of cumulative translation adjustments upon derecognition of certain subsidiaries or groups of assets within a foreign entity or of an investment in a foreign entity. This ASU is effective for fiscal years, and interim periods within those years, beginning after December 15, 2013. Early adoption is permitted and prior periods should not be adjusted. The Company does not expect the adoption of this guidance to have a material impact on its consolidated financial statements.


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Item 2.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
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, gross margin trends, operating cost trends, liquidity and capital needs and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. The risks, uncertainties and assumptions referred to above may include the following:
a prolonged economic recovery or a deterioration in the economic or inflationary environment in the United States or the European Union, particularly the United Kingdom, including the interest rate environment, may have an adverse effect on our collections, results of operations, revenue and stock price or on the stability of the financial system as a whole;
changes in the credit or capital markets, which affect our ability to borrow money or raise capital;
our ability to purchase defaulted consumer receivables at appropriate prices;
our ability to replace our defaulted consumer receivables with additional receivables portfolios;
our ability to obtain accurate and authentic account documents relating to accounts that we acquire and the possibility that documents that we provide could contain errors;
our ability to successfully acquire receivables of new asset types;
our ability to collect sufficient amounts on our defaulted consumer receivables;
changes in tax laws regarding earnings of our subsidiaries located outside of the United States;
changes in bankruptcy or collection laws that could negatively affect our business, including by causing an increase in certain types of bankruptcy filings involving liquidations, which may cause our collections to decrease;
changes in state or federal laws or the administrative practices of various bankruptcy courts, which may impact our ability to collect on our defaulted receivables;
our ability to collect and enforce our finance receivables may be limited under federal and state laws;
our ability to employ and retain qualified employees, especially collection personnel, and our senior management team;
our work force could become unionized in the future, which could adversely affect the stability of our production and increase our costs;
the degree, nature, and resources of our competition;
the possibility that we could incur goodwill or other intangible asset impairment charges;
our ability to retain existing clients and obtain new clients for our fee-for-service businesses;
our ability to comply with existing and new regulations of the collection industry, the failure of which could result in penalties, fines, litigation, damage to our reputation or the suspension or termination of our ability to conduct our business;
changes in governmental laws and regulations which could increase our costs and liabilities or impact our operations;
the possibility that new business acquisitions prove unsuccessful or strain or divert our resources;
our ability to maintain, renegotiate or replace our credit facility;
our ability to satisfy the restrictive covenants in our debt agreements;
our ability to manage risks associated with our international operations;
the possibility that compliance with foreign and U.S. laws and regulations that apply to our international operations could increase our cost of doing business in international jurisdictions;
the imposition of additional taxes on us;
changes in interest or exchange rates, which could reduce our net income, and the possibility that future hedging strategies may not be successful, which could adversely affect our results of operations and financial condition, as could our failure to comply with hedge accounting principles and interpretations;
the possibility that we could incur significant allowance charges on our finance receivables;
our loss contingency accruals may not be adequate to cover actual losses;
our ability to manage growth successfully;
the possibility that we could incur business or technology disruptions or cyber incidents, or not adapt to technological advances;
the possibility that we or our industry could experience negative publicity or reputational attacks; 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 quarterly 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.

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For a discussion of the risks, uncertainties and assumptions that could affect our future events, developments or results, you should carefully review the following “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” as well as the discussion of “Business” and “Risk Factors” described in our 2012 Annual Report on Form 10-K, filed on February 28, 2013.
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. Except as required by law, we assume no obligation to publicly update or revise our forward-looking statements after the date of this 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.
Definitions
We use the following terminology throughout this document:
“Allowance charges” refers to a reduction in income recognized on finance receivables on pools of finance receivables whose cash collection estimates are not received or projected to not be received.
“Amortization rate” refers to cash collections applied to principal on finance receivables as a percentage of total cash collections.
“Buybacks” refers to purchase price refunded by the seller due to the return of non-compliant accounts.
“Cash collections” refers to collections on our owned portfolios.
“Cash receipts” refers to collections on our owned portfolios plus fee income.
“Core” accounts or portfolios refer to accounts or portfolios that are defaulted consumer receivables and are not in a bankrupt status upon purchase. These accounts are aggregated separately from purchased bankruptcy accounts. Unless otherwise noted, Core accounts do not include the accounts we purchase in the United Kingdom.
“EBITDA” refers to earnings before interest, taxes, depreciation and amortization.
“Estimated remaining collections” or "ERC" refers to the sum of all future projected cash collections on our owned portfolios.
“Fee income” refers to revenues generated from our fee-for-service businesses.
“Income recognized on finance receivables” refers to income derived from our owned debt portfolios.
“Income recognized on finance receivables, net” refers to income derived from our owned debt portfolios and is shown net of allowance charges.
“Net finance receivable balance” is recorded on our balance sheet and refers to the purchase price less principal amortization and net allowance charges.
“Principal amortization” refers to cash collections applied to principal on finance receivables.
“Purchase price” refers to the cash paid to a seller to acquire defaulted consumer receivables, plus certain capitalized costs, less buybacks.
“Purchase price multiple” refers to the total estimated collections on owned debt portfolios divided by purchase price.
“Purchased bankruptcy” accounts or portfolios refer to accounts or portfolios that are in bankruptcy when we purchase them and as such are purchased as a pool of bankrupt accounts.
“Total estimated collections” refers to the actual cash collections, including cash sales, plus estimated remaining collections.

Overview
The Company is a financial and business services company. Our primary business is the purchase, collection and management of portfolios of defaulted consumer receivables. We also service receivables on behalf of clients on either a commission or transaction-fee basis and provide class action claims settlement recovery services and related payment processing to corporate clients.
The Company is headquartered in Norfolk, Virginia, and employs approximately 3,250 team members. The Company's shares of common stock are traded on the NASDAQ Global Select Market under the symbol “PRAA.”
Earnings Summary
During the first quarter of 2013, net income attributable to the Company was $38.6 million, or $2.26 per diluted share, compared with $25.5 million, or $1.47 per diluted share, in the first quarter of 2012. Total revenue was $169.6 million in the first quarter of 2013, up 21.1% from the same quarter one year earlier. Revenues in the recently completed quarter consisted of $154.8 million in income recognized on finance receivables, net of allowance charges, and $14.8 million in fee income. Income recognized

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on finance receivables, net of allowance charges, increased $30.6 million, or 24.6%, over the same period in 2012, primarily as a result of a significant increase in cash collections. Cash collections were $275.5 million in the first quarter of 2013, up 26.4% or $57.5 million as compared to the first quarter of 2012. During the quarter, $2.2 million in net allowance charges were incurred, compared with $0.5 million in the comparable quarter of 2012. Our performance has been positively impacted by operational efficiencies surrounding the cash collections process, including the continued refinement of account scoring analytics as it relates to both legal and non-legal collection channels. Additionally, we have continued to develop our internal legal collection staff resources, which enables us to place accounts into that channel that otherwise would have been prohibitively expensive for legal action and to collect these accounts more efficiently and profitably.
Fee income decreased to $14.8 million in the first quarter of 2013 from $15.9 million in the first quarter of 2012 primarily due to lower fee income generated by MHH in the first quarter of 2013, as well as decreases in revenue generated by our PRA Government Services (“PGS”) business and PRA Location Services (“PLS”) business. This was partially offset by higher fee income generated in the first quarter of 2013 by CCB and our Bankruptcy Services business when compared to the prior year period.
A summary of how our income was generated during the three months ended March 31, 2013 and 2012 is as follows:
 
 
For the Three Months Ended
March 31,
($ in thousands)
2013
 
2012
Cash collections
$
275,463

 
$
217,996

Amortization of finance receivables
(118,498
)
 
(93,276
)
Net allowance charges
(2,173
)
 
(494
)
Finance receivable income
154,792

 
124,226

Fee income
14,767

 
15,920

Total revenue
$
169,559

 
$
140,146

Operating expenses were $103.7 million in the first quarter of 2013, up 8.3% over the first quarter of 2012, due primarily to increases in compensation expense, legal collection fees and outside fees and services. Compensation expense increased primarily as a result of larger staff sizes. Compensation and employee services expenses increased as total employees grew 7.8% to 3,250 as of March 31, 2013, from 3,014 as of March 31, 2012. Legal collection fees increased from $7.6 million in the first quarter of 2012 to $10.5 million in the first quarter of 2013, an increase of $2.9 million or 38.2%. This increase was the result of an increase in cash collections from outside attorneys from $34.9 million in the three months ended March 31, 2012 to $47.9 million for the three months ended March 31, 2013, an increase of $13.0 million or 37.2%. Outside fees and services increased primarily as a result of corporate legal related expenses as well as increases in other outside fees and services.
Results of Operations
The results of operations include the financial results of the Company and all of our subsidiaries, all of which are in the receivables management business. Under the guidance of the FASB ASC Topic 280 “Segment Reporting” (“ASC 280”), we have determined that we have several operating segments that meet the aggregation criteria of ASC 280, and therefore, we have one reportable segment, accounts receivables management, based on similarities among the operating units including homogeneity of services, service delivery methods and use of technology.


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The following table sets forth certain operating data as a percentage of total revenues for the periods indicated:
 
 
For the Three Months
Ended March 31,
 
2013
 
2012
Revenues:
 
 
 
Income recognized on finance receivables, net
91.3
 %
 
88.6
 %
Fee income
8.7
 %
 
11.4
 %
Total revenues
100.0
 %
 
100.0
 %
Operating expenses:
 
 
 
Compensation and employee services
26.5
 %
 
28.3
 %
Legal collection fees
6.2
 %
 
5.4
 %
Legal collection costs
12.1
 %
 
16.9
 %
Agent fees
0.9
 %
 
1.2
 %
Outside fees and services
4.4
 %
 
4.2
 %
Communication expenses
5.3
 %
 
5.9
 %
Rent and occupancy
1.0
 %
 
1.1
 %
Depreciation and amortization
2.0
 %
 
2.6
 %
Other operating expenses
2.7
 %
 
2.7
 %
Total operating expenses
61.1
 %
 
68.3
 %
Income from operations
38.9
 %
 
31.7
 %
Other income and (expense):
 
 
 
Interest income
 %
 
 %
Interest expense
(1.6
)%
 
(1.9
)%
Income before income taxes
37.3
 %
 
29.8
 %
Provision for income taxes
14.6
 %
 
11.8
 %
Net income
22.7
 %
 
18.0
 %
Adjustment for loss attributable to redeemable noncontrolling interest
 %
 
(0.2
)%
Net income attributable to Portfolio Recovery Associates, Inc.
22.8
 %
 
18.2
 %
Three Months Ended March 31, 2013 Compared To Three Months Ended March 31, 2012
Revenues
Total revenues were $169.6 million for the three months ended March 31, 2013 , an increase of $29.5 million, or 21.1%, compared to total revenues of $140.1 million for the three months ended March 31, 2012 .
Income Recognized on Finance Receivables, net
Income recognized on finance receivables, net was $154.8 million for the three months ended March 31, 2013 , an increase of $30.6 million, or 24.6%, compared to income recognized on finance receivables, net of $124.2 million for the three months ended March 31, 2012 . The increase was primarily due to an increase in cash collections on our finance receivables to $275.5 million for the three months ended March 31, 2013 , from $218.0 million for the three months ended March 31, 2012 , an increase of $57.5 million or 26.4%. Our finance receivables amortization rate, including net allowance charges, was 43.8% for the three months ended March 31, 2013 compared to 43.0% for the three months ended March 31, 2012. During the three months ended March 31, 2013 , we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $1.85 billion at a cost of $214.9 million. During the three months ended March 31, 2012 , excluding the initial investment in the MHH portfolio, we acquired defaulted consumer receivable portfolios with an aggregate face value of $1.46 billion at a cost of $111.4 million. In any period, we acquire defaulted consumer receivables that can vary dramatically in their age, type and ultimate collectability. 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 and for similar time frames, we intend to target a similar internal rate of return,

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after direct expenses, in pricing our portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to the estimated profitability of a period's buying.
Income recognized on finance receivables, net, is shown net of changes in valuation allowances recognized under FASB ASC Topic 310-30 “ Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”), which requires that a valuation allowance be recorded for significant decreases in expected cash flows or a change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the three months ended March 31, 2013 , we recorded net allowance charges of $2.2 million, of which $4.6 million related to purchased bankruptcy portfolios primarily purchased in 2007 and 2008, offset by reversals of $2.4 million related to Core portfolios primarily purchased in 2005 and 2008. In any given period, we may be required to record valuation allowances due to pools of receivables underperforming our expectations. Factors that may contribute to the recording of valuation allowances may include both internal as well as external factors. External factors which may have an impact on the collectability, and subsequently to the overall profitability, of purchased pools of defaulted consumer receivables include: new laws or regulations relating to collections, new interpretations of existing laws or regulations, and the overall condition of the economy. Internal factors which may have an impact on the collectability, and subsequently the overall profitability, of purchased pools of defaulted consumer receivables would include: necessary revisions to initial and post-acquisition scoring and modeling estimates, non-optimal operational activities (relating to the collection and movement of accounts on both our collection floor and external channels), and decreases in productivity related to turnover of our collection staff.
Fee Income
Fee income decreased to $14.8 million in the first quarter of 2013 from $15.9 million in the first quarter of 2012 primarily due to lower fee income generated by MHH in the first quarter of 2013, as well as decreases in revenue generated by our PGS business and PLS business. This was partially offset by higher fee income generated in the first quarter of 2013 by CCB and our Bankruptcy Services business when compared to the prior year period.
Operating Expenses
Total operating expenses were $103.7 million for the three months ended March 31, 2013 , an increase of $8.0 million or 8.4% compared to total operating expenses of $95.7 million for the three months ended March 31, 2012 . Total operating expenses were 35.7% of cash receipts for the three months ended March 31, 2013 compared to 40.9% for the same period in 2012.
Compensation and Employee Services
Compensation and employee services expenses were $45.0 million for the three months ended March 31, 2013 , an increase of $5.3 million, or 13.4%, compared to compensation and employee services expenses of $39.7 million for the three months ended March 31, 2012 . Compensation expense increased primarily as a result of larger staff sizes. Compensation and employee services expenses increased as total employees grew 7.8% to 3,250 as of March 31, 2013, from 3,014 as of March 31, 2012. Compensation and employee services expenses as a percentage of cash receipts decreased to 15.5% for the three months ended March 31, 2013 , from 17.0% of cash receipts for the same period in 2012.
Legal Collection Fees
Legal collection fees represent contingent fees incurred for the cash collections generated by our independent third party attorney network. Legal collection fees were $10.5 million for the three months ended March 31, 2013 , an increase of $2.9 million, or 38.2%, compared to legal collection fees of $7.6 million for the three months ended March 31, 2012 . This increase was the result of an increase in cash collections from outside attorneys from $34.9 million in the three months ended March 31, 2012 to $47.9 million for the three months ended March 31, 2013 , an increase of $13.0 million or 37.2%. Legal collection fees for the three months ended March 31, 2013 were 3.6% of cash receipts, compared to 3.3% for the three months ended March 31, 2012 .
Legal Collection Costs
Legal collection costs consist of costs paid to courts where a lawsuit is filed and the cost of documents received from sellers of defaulted consumer receivables. Legal collection costs were $20.5 million for the three months ended March 31, 2013 , a decrease of $3.2 million, or 13.5%, compared to legal collection costs of $23.7 million for the three months ended March 31, 2012 .  During the first quarter of 2012, as a result of the refinement of our internal scoring methodology that expanded our account selections for legal action, we expanded the accounts brought into the legal collection process which resulted in significant initial expenses, which may continue to drive additional future cash collections and revenue. These legal collection costs represent 7.1% and 10.1% of cash receipts for the three month periods ended March 31, 2013 and 2012, respectively.

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Agent Fees
Agent fees primarily represent costs paid to repossession agents to repossess vehicles. Agent fees were $1.6 million for both the three months ended March 31, 2013 and 2012.
Outside Fees and Services
Outside fees and services expenses were $7.4 million for the three months ended March 31, 2013 , an increase of $1.5 million or 25.4% compared to outside fees and services expenses of $5.9 million for the three months ended March 31, 2012 . Of the $1.5 million increase, $0.9 million of the increase was attributable to an increase in legal reserve accruals and corporate legal expenses and the remaining $0.6 million increase was mainly attributable to other outside fees and services.
Communication Expenses
Communication expenses were $9.0 million for the three months ended March 31, 2013 , an increase of $0.7 million, or 8.4%, compared to communications expenses of $8.3 million for the three months ended March 31, 2012 . The increase was primarily due to additional postage expense resulting from an increase in special collection letter campaigns. The remaining increase was attributable to higher telephone expenses. Expenses related to customer mailings were responsible for 85.7% or $0.6 million of this increase, while the remaining 14.3% or $0.1 million was attributable to increases in telephone related charges.
Rent and Occupancy
Rent and occupancy expenses were $1.7 million for the three months ended March 31, 2013 , an increase of $0.1 million, or 6.3%, compared to rent and occupancy expenses of $1.6 million for the three months ended March 31, 2012 .
Depreciation and Amortization
Depreciation and amortization expenses were $3.4 million for the three months ended March 31, 2013 , a decrease of $0.3 million or 8.1% compared to depreciation and amortization expenses of $3.7 million for the three months ended March 31, 2012 . The decrease was primarily due to decreased amortization expense relating to our intangible assets.
Other Operating Expenses
Other operating expenses were $4.6 million for the three months ended March 31, 2013 , an increase of $0.9 million or 24.3% compared to other operating expenses of $3.7 million for the three months ended March 31, 2012 . Of the $0.9 million increase, $0.2 million was due to an increase in the provision for doubtful accounts and $0.1 million was related to insurance costs. None of the remaining $0.6 million increase was attributable to any significant identifiable items.
Interest Income
Interest income was $0 and $1,000 for the three months ended March 31, 2013 and 2012, respectively.
Interest Expense
Interest expense was $2.7 million for both the three months ended March 31, 2013 and 2012.
Provision for Income Taxes
Provision for income taxes was $24.7 million for the three months ended March 31, 2013 , an increase of $8.1 million, or 48.8%, compared to provision for income taxes of $16.6 million for the three months ended March 31, 2012 . The increase is primarily due to an increase of 51.3% in income before taxes for the three months ended March 31, 2013 , compared to the same period in 2012, offset by a decrease in the effective tax rate to 39.1% for the three months ended March 31, 2013 , compared to an effective tax rate of 39.7% for the same period in 2012. The decrease in the effective tax rate is primarily attributable to the tax benefits created by our international operations.

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Below are certain key financial data and ratios for the periods indicated:
FINANCIAL HIGHLIGHTS
 
As of and for the Three Months Ended
 
 
March 31,
%
 
2013
2012
Change
EARNINGS (in thousands)
 
 
 
Income recognized on finance receivables, net
$
154,792

$
124,226

25
 %
Fee income
14,767

15,920

(7
)%
Total revenues
169,559

140,146

21
 %
Operating expenses
103,672

95,725

8
 %
Income from operations
65,887

44,421

48
 %
Net interest expense
2,689

2,652

1
 %
Net income
38,517

25,189

53
 %
Net income attributable to Portfolio Recovery Associates, Inc.
38,600

25,462

52
 %
 
 
 
 
PERIOD-END BALANCES (in thousands)
 
 
 
Cash and cash equivalents
$
39,111

$
28,068

39
 %
Finance receivables, net
1,167,747

945,242

24
 %
Goodwill and intangible assets, net
125,462

124,659

1
 %
Total assets
1,382,739

1,142,026

21
 %
Line of credit and long-term debt
371,159

265,936

40
 %
Total liabilities
621,413

502,531

24
 %
Total equity
750,990

620,712

21
 %
 
 
 
 
FINANCE RECEIVABLE COLLECTIONS (dollars in thousands)
 
 
 
Cash collections
$
275,463

$
217,996

26
 %
Principal amortization without allowance charges
118,498

93,276

27
 %
Principal amortization with allowance charges
120,671

93,770

29
 %
Principal amortization w/ allowance charges as % of cash collections:
 
 
 
   Including fully amortized pools
43.8
%
43.0
%
2
 %
   Excluding fully amortized pools
45.2
%
44.8
%
1
 %
 
 
 
 
ALLOWANCE FOR FINANCE RECEIVABLES (dollars in thousands)
 
 
 
Balance at period-end
$
95,296

$
87,065

9
 %
Allowance charge
2,173

494

340
 %
Allowance charge to period-end net finance receivables
0.19
%
0.05
%
256
 %
Allowance charge to net finance receivable income
1.40
%
0.40
%
253
 %
Allowance charge to cash collections
0.79
%
0.23
%
248
 %
 
 
 
 
PURCHASES OF FINANCE RECEIVABLES (dollars in thousands)
 
 
 
Purchase price - core
$
126,951

$
52,104

144
 %
Face value - core
1,398,960

972,268

44
 %
Purchase price - bankruptcy
86,595

56,892

52
 %
Face value - bankruptcy
436,508

368,447

18
 %
Purchase price - UK
1,387

2,421

(43
)%
Face value - UK
18,570

115,351

(84
)%
Purchase price - total
214,933

111,417

93
 %
Face value - total
1,854,038

1,456,066

27
 %
Number of portfolios - total
91

91

 %
 
 
 
 
ESTIMATED REMAINING COLLECTIONS (in thousands)
 
 
 
Estimated remaining collections - core
$
1,562,383

$
1,236,712

26
 %
Estimated remaining collections - bankruptcy
924,520

796,161

16
 %
Estimated remaining collections - total
2,486,903

2,032,873

22
 %
 
 
 
 
SHARE DATA (share amounts in thousands)
 
 
 
Net income per common share - diluted
$
2.26

$
1.47

54
 %
Weighted average number of shares outstanding - diluted
17,091

17,267

(1
)%
Shares repurchased
16

31

(47
)%
Average price paid per share repurchased (including acquisitions costs)
$
118.03

$
68.02

74
 %
Closing market price
$
126.92

$
71.72

77
 %
 
 
 
 
RATIOS AND OTHER DATA (dollars in thousands)
 
 
 
Return on average equity (1)
21.1
%
16.7
%
26
 %
Return on revenue (2)
22.7
%
18.0
%
26
 %
Operating margin (3)
38.9
%
31.7
%
23
 %
Operating expense to cash receipts (4)
35.7
%
40.9
%
(13
)%
Debt to equity (5)
49.4
%
42.8
%
15
 %
Number of collectors
2,159

1,934

12
 %
Number of full-time equivalent employees
3,250

3,014

8
 %
Cash receipts (4)
$
290,231

$
233,916

24
 %
Line of credit - unused portion at period end
228,000

142,500

60
 %
(1) Calculated as annualized net income divided by average equity for the period
 
 
(2) Calculated as net income divided by total revenues
 
 
 
(3) Calculated as income from operations divided by total revenues
 
 
 
(4) "Cash receipts" is defined as cash collections plus fee income
 
 
 
(5) For purposes of this ratio, "debt" equals the line of credit balance plus long-term debt
 
 

28

Table of Contents


FINANCIAL HIGHLIGHTS
 
As of and for the Quarter Ended
 
March 31,
December 31,
September 30,
June 30,
March 31,
 
2013
2012
2012
2012
2012
EARNINGS (in thousands)
 
 
 
 
 
Income recognized on finance receivables, net
$
154,792

$
138,068

$
135,754

$
132,587

$
124,226

Fee income
14,767

16,183

14,765

15,298

15,920

Total revenues
169,559

154,251

150,519

147,885

140,146

Operating expenses
103,672

94,262

93,461

93,289

95,725

Income from operations
65,887

59,989

57,058

54,596

44,421

Net interest expense
2,689

1,816

2,189

2,374

2,652

Net income
38,517

35,732

33,127

32,051

25,189

Net income attributable to Portfolio Recovery Associates, Inc.
38,600

35,802

33,314

32,015

25,462

 
 
 
 
 
 
PERIOD-END BALANCES (in thousands)
 
 
 
 
 
Cash and cash equivalents
$
39,111

$
32,687

$
31,488

$
42,621

$
28,068

Finance receivables, net
1,167,747

1,078,951

973,594

966,508

945,242

Goodwill and intangible assets, net
125,462

129,852

121,623

121,748

124,659

Total assets
1,382,739

1,288,956

1,169,698

1,173,738

1,142,026

Line of credit and long-term debt
371,159

327,542

250,675

292,850

265,936

Total liabilities
621,413

559,856

479,211

520,911

502,531

Total equity
750,990

708,427

670,489

633,446

620,712

 
 
 
 
 
 
FINANCE RECEIVABLE COLLECTIONS (dollars in thousands)
 
 
 
 
 
Cash collections
$
275,463

$
229,211

$
229,053

$
232,425

$
217,996

Principal amortization without allowance charges
118,498

88,851

91,736

97,634

93,276

Principal amortization with allowance charges
120,671

91,142

93,299

99,838

93,770

Principal amortization w/ allowance charges as % of cash collections:
 
 
 
 
 
   Including fully amortized pools
43.8
%
39.8
%
40.7
%
43.0
%
43.0
%
   Excluding fully amortized pools
45.2
%
40.9
%
42.0
%
44.4
%
44.8
%
 
 
 
 
 
 
ALLOWANCE FOR FINANCE RECEIVABLES (dollars in thousands)
 
 
 
 
 
Balance at period-end
$
95,296

$
93,123

$
90,832

$
89,269

$
87,065

Allowance charge
2,173

2,291

1,563

2,204

494

Allowance charge to period-end net finance receivables
0.19
%
0.21
%
0.16
%
0.23
%
0.05
%
Allowance charge to net finance receivable income
1.40
%
1.66
%
1.15
%
1.66
%
0.40
%
Allowance charge to cash collections
0.79
%
1.00
%
0.68
%
0.95
%
0.23
%
 
 
 
 
 
 
PURCHASES OF FINANCE RECEIVABLES (dollars in thousands)
 
 
 
 
 
Purchase price - core
$
126,951

$
85,476

$
52,703

$
69,512

$
52,104

Face value - core
1,398,960

901,512

674,135

1,033,331

972,268

Purchase price - bankruptcy
86,595

111,001

41,277

53,460

56,892

Face value - bankruptcy
436,508

946,927

341,359

448,244

368,447

Purchase price - UK
1,387

2,631

8,981

2,087

2,421

Face value - UK
18,570

59,953

248,667

44,779

115,351

Purchase price - total
214,933

199,108

102,961

125,059

111,417

Face value - total
1,854,038

1,908,392

1,264,161

1,526,354

1,456,066

Number of portfolios - total
91

104

107

114

91

 
 
 
 
 
 
ESTIMATED REMAINING COLLECTIONS (in thousands)
 
 
 
 
 
Estimated remaining collections - core
$
1,562,383

$
1,410,053

$
1,346,562

$
1,315,809

$
1,236,712

Estimated remaining collections - bankruptcy
924,520

905,136

791,018

802,353

796,161

Estimated remaining collections - total
2,486,903

2,315,189

2,137,580

2,118,162

2,032,873

 
 
 
 
 
 
SHARE DATA (share amounts in thousands)
 
 
 
 
 
Net income per common share - diluted
$
2.26

$
2.10

$
1.96

$
1.87

$
1.47

Weighted average number of shares outstanding - diluted
17,091

17,072

17,022

17,133

17,267

Shares repurchased
16



301

31

Average price paid per share repurchased (including acquisitions costs)
$
118.03

$
93.02

$

$
68.62

$
68.02

Closing market price
$
126.92

$
106.86

$
104.43

$
91.26

$
71.72

 
 
 
 
 
 
RATIOS AND OTHER DATA (dollars in thousands)
 
 
 
 
 
Return on average equity (1)
21.1
%
20.6
%
20.3
%
20.3
%
16.7
%
Return on revenue (2)
22.7
%
23.2
%
22.0
%
21.7
%
18.0
%
Operating margin (3)
38.9
%
38.9
%
37.9
%
36.9
%
31.7
%
Operating expense to cash receipts (4)
35.7
%
38.4
%
38.3
%
37.7
%
40.9
%
Debt to equity (5)
49.4
%
46.2
%
37.4
%
46.3
%
42.8
%
Number of collectors
2,159

2,153

1,992

1,952

1,934

Number of full-time equivalent employees
3,250

3,221

3,103

3,032

3,014