PRA Group
PORTFOLIO RECOVERY ASSOCIATES INC (Form: 10-Q, Received: 05/08/2014 15:10:18)

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, 2014 .
¨
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 1, 2014
Common Stock, $0.01 par value
 
50,060,005



PORTFOLIO RECOVERY ASSOCIATES, INC.
INDEX
 
 
 
Page(s)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 

2


Part I. FINANCIAL INFORMATION
Item 1. Financial Statements
PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS
March 31, 2014 and December 31, 2013
(unaudited)
(Amounts in thousands, except per share amounts)
 
 
March 31,
2014
 
December 31,
2013
Assets
 
 
 
Cash and cash equivalents
$
191,819

 
$
162,004

Finance receivables, net
1,253,961

 
1,239,191

Accounts receivable, net
11,551

 
12,359

Income taxes receivable
1,015

 
11,710

Net deferred tax asset
1,369

 
1,361

Property and equipment, net
35,130

 
31,541

Goodwill
104,086

 
103,843

Intangible assets, net
14,714

 
15,767

Other assets
28,968

 
23,456

Total assets
$
1,642,613

 
$
1,601,232

Liabilities and Equity
 
 
 
Liabilities:
 
 
 
Accounts payable
$
24,199

 
$
14,819

Accrued expenses and other liabilities
28,351

 
27,655

Accrued compensation
8,684

 
27,431

Net deferred tax liability
220,883

 
210,071

Borrowings
450,278

 
451,780

Total liabilities
732,395

 
731,756

Commitments and contingencies (Note 9)

 

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, 50,060 issued and outstanding shares at March 31, 2014, and 49,840 issued and outstanding shares at December 31, 2013
501

 
498

Additional paid-in capital
134,892

 
135,441

Retained earnings
770,345

 
729,505

Accumulated other comprehensive income
4,480

 
4,032

Total stockholders’ equity
910,218

 
869,476

Total liabilities and equity
$
1,642,613

 
$
1,601,232

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, 2014 and 2013
(unaudited)
(Amounts in thousands, except per share amounts)
 
 
Three Months Ended March 31,
 
2014
 
2013
Revenues:
 
 
 
Income recognized on finance receivables, net
$
177,970

 
$
154,792

Fee income
15,952

 
14,767

Total revenues
193,922

 
169,559

Operating expenses:
 
 
 
Compensation and employee services
51,385

 
44,997

Legal collection fees
10,833

 
10,529

Legal collection costs
26,533

 
20,501

Agent fees
1,450

 
1,609

Outside fees and services
10,791

 
7,447

Communications
9,154

 
8,079

Rent and occupancy
2,147

 
1,687

Depreciation and amortization
3,947

 
3,366

Other operating expenses
6,092

 
5,457

Total operating expenses
122,332

 
103,672

Income from operations
71,590

 
65,887

Other income and (expense):
 
 
 
Interest income
1

 

Interest expense
(4,860
)
 
(2,689
)
Income before income taxes
66,731

 
63,198

Provision for income taxes
25,891

 
24,681

Net income
$
40,840

 
$
38,517

Adjustment for loss attributable to redeemable noncontrolling interest

 
83

Net income attributable to Portfolio Recovery Associates, Inc.
$
40,840

 
$
38,600

Net income per common share attributable to Portfolio Recovery Associates, Inc:
 
 
 
Basic
$
0.82

 
$
0.76

Diluted
$
0.81

 
$
0.75

Weighted average number of shares outstanding:
 
 
 
Basic
49,929

 
50,811

Diluted
50,363

 
51,273

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, 2014 and 2013
(unaudited)
(Amounts in thousands)
 
 
Three Months Ended March 31,
 
2014
 
2013
Net income
$
40,840

 
$
38,517

Other comprehensive income:
 
 
 
Foreign currency translation adjustments
448

 
(4,418
)
Total other comprehensive income
448

 
(4,418
)
Comprehensive income
41,288

 
34,099

Comprehensive loss attributable to noncontrolling interest

 
83

Comprehensive income attributable to Portfolio Recovery Associates, Inc.
$
41,288

 
$
34,182

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, 2014
(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, 2013
49,840

 
$
498

 
$
135,441

 
$
729,505

 
$
4,032

 
$
869,476

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

 

 

 
40,840

 

 
40,840

Foreign currency translation adjustment

 

 

 

 
448

 
448

Vesting of nonvested shares
220

 
3

 
(3
)
 

 

 

Amortization of share-based compensation

 

 
2,836

 

 

 
2,836

Income tax benefit from share-based compensation

 

 
4,115

 

 

 
4,115

Employee stock relinquished for payment of taxes

 

 
(7,497
)
 

 

 
(7,497
)
Balance at March 31, 2014
50,060

 
$
501

 
$
134,892

 
$
770,345

 
$
4,480

 
$
910,218

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, 2014 and 2013
(unaudited)
(Amounts in thousands)
 
Three Months Ended March 31,
 
2014
 
2013
Cash flows from operating activities:
 
 
 
Net income
$
40,840

 
$
38,517

Adjustments to reconcile net income to net cash provided by operating activities:
 
 
 
Amortization of share-based compensation
2,836

 
2,986

Depreciation and amortization
3,947

 
3,366

Amortization of debt discount
998

 

Deferred tax expense
10,812

 
529

Changes in operating assets and liabilities:
 
 
 
Other assets
(5,496
)
 
(2,070
)
Accounts receivable
821

 
1,149

Accounts payable
9,361

 
588

Income taxes
10,695

 
19,088

Accrued expenses
686

 
(2,503
)
Accrued compensation
(26,245
)
 
(3,537
)
Net cash provided by operating activities
49,255

 
58,113

Cash flows from investing activities:
 
 
 
Purchases of property and equipment
(6,416
)
 
(2,466
)
Acquisition of finance receivables, net of buybacks
(150,087
)
 
(212,389
)
Collections applied to principal on finance receivables
135,397

 
120,671

Net cash used in investing activities
(21,106
)
 
(94,184
)
Cash flows from financing activities:
 
 
 
Income tax benefit from share-based compensation
4,115

 
2,207

Proceeds from line of credit

 
95,000

Principal payments on line of credit

 
(50,000
)
Repurchases of common stock

 
(1,912
)
Cash paid for purchase of portion of noncontrolling interest

 
(1,150
)
Distributions paid to noncontrolling interest

 
(51
)
Principal payments on long-term debt
(2,500
)
 
(1,384
)
Net cash provided by financing activities
1,615

 
42,710

Effect of exchange rate on cash
51

 
(215
)
Net increase in cash and cash equivalents
29,815

 
6,424

Cash and cash equivalents, beginning of period
162,004

 
32,687

Cash and cash equivalents, end of period
$
191,819

 
$
39,111

Supplemental disclosure of cash flow information:
 
 
 
Cash paid for interest
$
5,731

 
$
2,656

Cash paid for income taxes
1,868

 
2,866

Supplemental disclosure of non-cash information:
 
 
 
Adjustment of the noncontrolling interest measurement amount
$

 
$
(60
)
Distributions payable relating to noncontrolling interest

 
2

Purchase of noncontrolling interest

 
9,162

Employee stock relinquished for payment of taxes
(7,497
)
 
(4,002
)
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.  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 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, 2014 and 2013 and long-lived assets held at March 31, 2014 and 2013 by geographical location (amounts in thousands):
 
As Of And For The
 
As Of And For The
 
Three Months Ended March 31, 2014
 
Three Months Ended March 31, 2013
 
Revenues
 
Long-Lived Assets
 
Revenues
 
Long-Lived Assets
United States
$
191,188

 
$
32,669

 
$
166,929

 
$
23,770

United Kingdom
2,734

 
2,461

 
2,630

 
1,700

Total
$
193,922

 
$
35,130

 
$
169,559

 
$
25,470

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, 2014 , its consolidated income statements and statements of comprehensive income for the three months ended March 31, 2014 and 2013 , its consolidated statement of changes in stockholders’ equity for the three months ended March 31, 2014 , and its consolidated statements of cash flows for the three months ended March 31, 2014 and 2013 . The consolidated income statements of the Company for the three months ended March 31, 2014 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 2013 Annual Report on Form 10-K, filed on February 28, 2014.

2.
Finance Receivables, net:
Changes in finance receivables, net for the three months ended March 31, 2014 and 2013 were as follows (amounts in thousands):
 

Three Months Ended March 31, 2014
 
Three Months Ended March 31, 2013
Balance at beginning of period
$
1,239,191

 
$
1,078,951

Acquisitions of finance receivables, net of buybacks
150,087

 
212,389

Foreign currency translation adjustment
80

 
(922
)
Cash collections
(313,367
)
 
(275,463
)
Income recognized on finance receivables, net
177,970

 
154,792

Cash collections applied to principal
(135,397
)
 
(120,671
)
Balance at end of period
$
1,253,961

 
$
1,169,747


8

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


At the time of acquisition, the life of each pool is generally estimated to be between 60 and 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, 2014 are estimated to be as follows for the twelve months in the periods ending (amounts in thousands):
 
March 31, 2015
$
440,446

March 31, 2016
338,324

March 31, 2017
251,391

March 31, 2018
166,246

March 31, 2019
53,679

March 31, 2020
3,875

 
$
1,253,961

During the three months ended March 31, 2014 and 2013 , the Company purchased approximately $1.91 billion and $1.85 billion , respectively, in face value of charged-off consumer receivables. At March 31, 2014 , the estimated remaining collections (“ERC”) on the receivables purchased in the three months ended March 31, 2014 and 2013 , were $235.0 million and $266.4 million , respectively. At March 31, 2014 , the Company had unamortized purchased principal (purchase price) in pools accounted for under the cost recovery method of $28.3 million ; at December 31, 2013 , the amount was $26.1 million .
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, 2014 and 2013 were as follows (amounts in thousands):

 
Three Months Ended March 31,

2014
 
2013
Balance at beginning of period
$
1,430,067

 
$
1,239,674

Income recognized on finance receivables, net
(177,970
)
 
(154,792
)
Additions
106,197

 
182,505

Net reclassifications from nonaccretable difference
91,636

 
53,764

Foreign currency translation adjustment
1,071

 
(4,007
)
Balance at end of period
$
1,451,001

 
$
1,317,144


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 previous expectations. Factors that may contribute to the recording of valuation allowances include both internal as well as external factors. External factors that 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 that 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, 2014 and 2013 (amounts in thousands):


9

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


 
Three Months Ended March 31, 2014
 
Three Months Ended March 31, 2013
 
Core Portfolio  (1)
 
Purchased Bankruptcy
Portfolio 
(2)
 
Total
 
Core Portfolio  (1)
 
Purchased Bankruptcy
Portfolio 
(2)
 
Total
Valuation allowance - finance receivables:

 

 

 
 
 
 
 
 
Beginning balance
$
65,626

 
$
25,475

 
$
91,101

 
$
74,500

 
$
18,623

 
$
93,123

Allowance charges
1,387

 

 
1,387

 
300

 
4,660

 
4,960

Reversal of previous recorded allowance charges
(3,090
)
 
(250
)
 
(3,340
)
 
(2,700
)
 
(87
)
 
(2,787
)
Net allowance (reversals)/charges
(1,703
)
 
(250
)
 
(1,953
)
 
(2,400
)
 
4,573

 
2,173

Ending balance
$
63,923

 
$
25,225

 
$
89,148

 
$
72,100

 
$
23,196

 
$
95,296

Finance Receivables, net:
$
722,989

 
$
530,972

 
$
1,253,961

 
$
598,870

 
$
570,877

 
$
1,169,747

 
 
 
 
 
 
 
 
 
 
 
 
(1)
“Core” accounts or portfolios refer to accounts or portfolios that are defaulted consumer receivables and are not in a bankrupt status upon purchase. For this table, the Core Portfolio also includes accounts purchased in the United Kingdom. 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.
Borrowings:
The Company's borrowings consisted of the following as of the dates indicated (in thousands):
 
March 31,
2014
 
December 31,
2013
Line of credit, term loan
$
192,500

 
$
195,000

Convertible notes
287,500

 
287,500

Less: Debt discount
(29,722
)
 
(30,720
)
Total
$
450,278

 
$
451,780

Revolving Credit and Term Loan Facility
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”). The Credit Agreement was amended and modified during 2013 and the first quarter of 2014. Under the terms of the Credit Agreement as amended and modified, the credit facility includes an aggregate principal amount available of $628.0 million (subject to the borrowing base and applicable debt covenants), which consists of a $192.5 million floating rate term loan that amortizes and matures on December 19, 2017 and a $435.5 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 (as defined in the Credit Agreement) plus 0.50% , (b) Bank of America’s prime rate, and (c) the Eurodollar rate plus 1.00% . The Company’s revolving credit facility includes a $20 million swingline loan sublimit, a $20 million letter of credit sublimit and a $20 million alternative currency equivalent sublimit. The credit facility contains an accordion loan feature that allows the Company to request an increase of up to $214.5 million in the amount available for borrowing under the facility, whether from existing or new lenders, subject to terms of the Credit Agreement.
On April 1, 2014, the Company entered into a Lender Joinder Agreement and Lender Commitment Agreement (collectively, the “Commitment Increase Agreements”) to exercise this accordion feature.  The Commitment Increase Agreements expanded the maximum amount of revolving credit availability under the Credit Agreement by $214.5 million , elevated the revolving credit commitments of certain lenders and added three new lenders to the Credit Agreement. Giving effect to the $214.5 million increase in the amount of revolving credit availability pursuant to the Commitment Increase Agreements, the total credit facility under the Credit Agreement now includes an aggregate principal amount of $842.5 million (subject to compliance with a borrowing base), which consists of (i) a fully-funded $192.5 million term loan, (ii) a $630 million domestic revolving credit facility, of which $630 million is available to be drawn, and (iii) a $20 million multi-currency revolving credit facility, of which $20 million is available

10

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


to be drawn, all of which mature on December 19, 2017. The Credit Agreement is secured by a first priority lien on substantially all of the Company’s assets. The Credit Agreement, as amended and modified, contains restrictive covenants and events of default including the following:
borrowings may not exceed 33% 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 $40 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;
investments in loans and/or capital contributions cannot exceed $950 million to consummate the acquisition of the equity of Aktiv Kapital AS (“Aktiv”);
permitted acquisitions (as defined in the Credit Agreement) during any fiscal year cannot exceed $250 million except for the fiscal year ending December 31, 2014, during which fiscal year permitted acquisitions cannot exceed $25 million ;
indebtedness in the form of senior, unsecured convertible notes or other unsecured financings cannot exceed $300 million in the aggregate (without respect to the Company’s 3.00% Convertible Senior Notes due 2020);
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 line fee of 0.375%  per annum, payable quarterly in arrears.
The Company's borrowings on its credit facility at March 31, 2014 consisted of $192.5 million outstanding on the term loan with an annual interest rate as of March 31, 2014 of 2.65% . At December 31, 2013, the Company's borrowings on its credit facility consisted of $195.0 million outstanding on the term loan with an annual interest rate as of December 31, 2013 of 2.67% .
Convertible Senior Notes
On August 13, 2013, the Company completed the private offering of $287.5 million in aggregate principal amount of the Company’s 3.00% Convertible Senior Notes due 2020 (the “Notes”). The Notes were issued pursuant to an Indenture, dated August 13, 2013 (the "Indenture") between the Company and Wells Fargo Bank, National Association, as trustee. The Indenture contains customary terms and covenants, including certain events of default after which the Notes may be due and payable immediately. The Notes are senior unsecured obligations of the Company. Interest on the Notes is payable semi-annually, in arrears, on February 1 and August 1 of each year, beginning on February 1, 2014. Prior to February 1, 2020, the Notes will be convertible only upon the occurrence of specified events. On or after February 1, 2020, the Notes will be convertible at any time. Upon conversion, the Notes may be settled, at the Company’s option, in cash, shares of the Company’s common stock, or any combination thereof. Holders of the Notes have the right to require the Company to repurchase all or some of their Notes at 100% of their principal amount, plus any accrued and unpaid interest, upon the occurrence of a fundamental change (as defined in the Indenture). In addition, upon the occurrence of a make-whole fundamental change (as defined in the Indenture), the Company may, under certain circumstances, be required to increase the conversion rate for the Notes converted in connection with such a make-whole fundamental change. The conversion rate for the Notes is initially 15.2172 shares per $1,000 principal amount of Notes, which is equivalent to an initial conversion price of approximately $65.72 per share of the Company’s common stock, and is subject to adjustment in certain circumstances pursuant to the Indenture. The Company does not have the right to redeem the Notes prior to maturity. As of March 31, 2014, none of the conditions allowing holders of the Notes to convert their Notes had occurred.
As noted above, upon conversion, holders of the Notes will receive cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election. However, the Company’s current intent is to settle conversions through combination settlement (i.e ., the Notes will be converted into cash up to the aggregate principal amount, and shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election, for the remainder). As a result and in accordance with authoritative guidance related to derivatives and hedging and earnings per share, only the conversion spread is included in the diluted earnings per share calculation, if dilutive. Under such method, the settlement of the conversion spread has a dilutive effect when the average share price of the Company’s common stock during any quarter exceeds  $65.72 .

11

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


The net proceeds from the sale of the Notes were approximately $279.3 million , after deducting the initial purchasers’ discounts and commissions and the estimated offering expenses payable by the Company. The Company used $174.0 million of the net proceeds from this offering to repay the outstanding balance on its revolving credit facility and used $50.0 million to repurchase shares of its common stock.
The Company determined that the fair value of the Notes at the date of issuance was approximately $255.3 million , and designated the residual value of approximately $32.2 million as the equity component. Additionally, the Company allocated approximately $7.3 million of the $8.2 million original Notes issuance cost as debt issuance cost and the remaining $0.9 million as equity issuance cost.
ASC 470-20, Debt with Conversion and Other Options (“ASC 470-20”), requires that, for convertible debt instruments that may be settled fully or partially in cash upon conversion, issuers must separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Additionally, debt issuance costs are required to be allocated in proportion to the allocation of the liability and equity components and accounted for as debt issuance costs and equity issuance costs, respectively.
The balances of the liability and equity components of all of the Notes outstanding were as follows as of the dates indicated (in thousands):
 
 
March 31,
2014
 
December 31,
2013
Liability component - principal amount
 
$
287,500

 
$
287,500

Unamortized debt discount
 
(29,722
)
 
(30,720
)
Liability component - net carrying amount
 
257,778

 
256,780

Equity component
 
$
31,306

 
$
31,306

The debt discount is being amortized into interest expense over the remaining life of the Notes using the effective interest rate, which is 4.92% .
Interest expense related to the Notes was as follows for the periods indicated (in thousands):
 
 
Three Months Ended March 31, 2014
 
Three Months Ended March 31, 2013
Interest expense - stated coupon rate
 
$
2,156

 
$

Interest expense - amortization of debt discount
 
998

 

Total interest expense - convertible notes
 
$
3,154


$

The Company was in compliance with all covenants under its financing arrangements as of March 31, 2014 and December 31, 2013.
The following principal payments are due on the Company's borrowings as of March 31, 2014 for the twelve month periods ending (amounts in thousands):
March 31, 2015
$
11,250

March 31, 2016
16,250

March 31, 2017
25,000

March 31, 2018
140,000

March 31, 2019

Thereafter
287,500

Total
$
480,000




12

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


4.
Property and Equipment, net:
Property and equipment, at cost, consisted of the following as of the dates indicated (amounts in thousands):
 
 
March 31,
2014
 
December 31,
2013
Software
$
35,673

 
$
34,108

Computer equipment
19,039

 
17,072

Furniture and fixtures
9,007

 
8,616

Equipment
11,545

 
10,351

Leasehold improvements
11,974

 
11,147

Building and improvements
7,054

 
7,026

Land
1,269

 
1,269

Accumulated depreciation and amortization
(60,431
)
 
(58,048
)
Property and equipment, net
$
35,130

 
$
31,541

Depreciation and amortization expense relating to property and equipment for the three months ended March 31, 2014 and 2013, was $2.8 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, 2014 and December 31, 2013, the Company incurred and capitalized approximately $10.8 million and $10.3 million , respectively, of these direct payroll costs and external direct costs related to software developed for internal use. Of these costs, at March 31, 2014 and December 31, 2013, approximately $1.5 million and $1.7 million , respectively, was 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. Amortization expense for the three months ended March 31, 2014 and 2013, was approximately $0.4 million and $0.3 million , respectively.  The remaining unamortized costs relating to internally developed software at March 31, 2014 and December 31, 2013 were approximately $4.7 million and $4.4 million , respectively.
 
5.
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 2013, the Company underwent its annual review of goodwill. Based upon the results of this review, which was conducted as of October 1, 2013, 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, 2014 that would indicate a triggering event and thereby necessitate further evaluation of goodwill or other intangible assets. The Company expects to perform its next annual goodwill review during the fourth quarter of 2014.
At March 31, 2014 and December 31, 2013, the carrying value of goodwill was $104.1 million and $103.8 million , respectively. The following table represents the changes in goodwill for the three months ended March 31, 2014 and 2013 (amounts in thousands):
 
Three Months Ended March 31,
 
2014
 
2013
Balance at beginning of period
$
103,843

 
$
109,488

Foreign currency translation adjustment
243

 
(2,576
)
Balance at end of period
$
104,086

 
$
106,912


13

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


Intangible assets, excluding goodwill, consist of the following at March 31, 2014 and December 31, 2013 (amounts in thousands):
 
March 31, 2014
 
December 31, 2013
 
Gross Amount
 
Accumulated
Amortization
 
Gross Amount
 
Accumulated
Amortization
Client and customer relationships
$
40,949

 
$
27,550

 
$
40,870

 
$
26,581

Non-compete agreements
3,896

 
3,764

 
3,880

 
3,723

Trademarks
3,501

 
2,318

 
3,491

 
2,170

Total
$
48,346

 
$
33,632

 
$
48,241

 
$
32,474

Total intangible asset amortization expense for the three months ended March 31, 2014 and 2013 was $1.1 million and $1.2 million , respectively. The Company reviews these intangible assets for possible impairment upon the occurrence of a triggering event.
 
6.
Share-Based Compensation:
The Company has an Omnibus Incentive Plan to assist the Company in attracting and retaining selected individuals to serve as employees and directors, who are expected to contribute to the Company's success and to achieve long-term objectives that will benefit stockholders of the Company. The 2013 Omnibus Incentive Plan (the “Plan”) was approved by the Company's stockholders at the 2013 Annual Meeting.  The Plan enables the Company to award shares of the Company's common stock to select employees and directors, as described in the Plan, not to exceed 5,400,000 shares as authorized by the Plan. The Plan replaced the 2010 Stock Plan.
As of March 31, 2014, total future compensation costs related to nonvested awards of nonvested shares (not including nonvested shares granted under the Long-Term Incentive ("LTI") Program) is estimated to be $6.2 million with a weighted average remaining life for all nonvested shares of 1.9 years (not including nonvested shares granted under the LTI program). As of March 31, 2014, there are no future compensation costs related to stock options and there are no remaining vested stock options to be exercised.
Total share-based compensation expense was $2.8 million and $3.0 million for the three months ended March 31, 2014 and 2013, respectively. Tax benefits resulting from tax deductions in excess of share-based compensation expense (windfall tax benefits) recognized under the provisions of ASC Topic 718 "Compensation-Stock Compensation" ("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 $7.5 million and $4.0 million for the three months ended March 31, 2014 and 2013, respectively.
All share amounts presented in this Note 6 have been adjusted to reflect the three-for-one stock split by means of a stock dividend declared by the Company's board of directors on June 10, 2013.
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.

14

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


The following summarizes all nonvested share transactions, excluding those related to the LTI program, from December 31, 2012 through March 31, 2014 (share amounts in thousands):
 
Nonvested Shares
Outstanding
 
Weighted-Average
Price at Grant Date
December 31, 2012
288

 
$
20.84

Granted
110

 
37.31

Vested
(143
)
 
19.75

Cancelled
(29
)
 
20.57

December 31, 2013
226

 
29.58

Granted
66

 
48.22

Vested
(93
)
 
25.85

Cancelled
(2
)
 
21.90

March 31, 2014
197

 
$
37.66

The total grant date fair value of shares vested during the three months ended March 31, 2014 and 2013, was $2.4 million and $2.1 million , respectively.
Pursuant to the 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 program share transactions from December 31, 2012 through March 31, 2014 (share amounts in thousands):
 
Nonvested LTI Shares
Outstanding
 
Weighted-Average
Price at Grant Date
December 31, 2012
497

 
$
21.71

Granted at target level
124

 
34.59

Adjustments for actual performance
108

 
17.91

Vested
(279
)
 
19.10

Cancelled
(16
)
 
25.01

December 31, 2013
434

 
25.79

Granted at target level
97

 
48.09

Adjustments for actual performance
95

 
25.17

Vested
(225
)
 
25.17

March 31, 2014
401

 
$
31.39

The total grant date fair value of shares vested during the three months ended March 31, 2014 and 2013, was $5.7 million and $2.6 million , respectively.
At March 31, 2014, 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 $9.6 million . The Company assumed a 7.5% forfeiture rate for these grants and the remaining shares have a weighted average life of 1.4 years at March 31, 2014.

7.
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, 2014 and 2013.
The Internal Revenue Service (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 tax revenue recognition using the cost recovery method 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 required. The Company believes cost recovery to be an acceptable tax revenue recognition method for companies in the bad debt purchasing industry. For

15

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


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.  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. Payment of the assessed taxes and interest could have an adverse effect 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.
At March 31, 2014, 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 2010, 2009 and 2008 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 months ended March 31, 2014 or 2013.
 
8.
Earnings per Share:
Basic earnings per share (“EPS”) are computed by dividing net income available to common stockholders 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 the Notes and nonvested share awards, if dilutive. For the Notes, only the conversion spread is included in the diluted earnings per share calculation, if dilutive. Under such method, the settlement of the conversion spread has a dilutive effect when the average share price of the Company’s common stock during any quarter exceeds  $65.72 , which did not occur during the period from which the Notes were issued on August 13, 2013 through March 31, 2014. The Notes were not outstanding during the three months ending March 31, 2013. 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, 2014 and 2013 (amounts in thousands, except per share amounts):
 
For the Three Months Ended March 31,
 
2014
 
2013
 
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
$
40,840

 
49,929

 
$
0.82

 
$
38,600

 
50,811

 
$
0.76

Dilutive effect of nonvested share awards
 
 
434

 
 
 
 
 
462

 
 
Diluted EPS
$
40,840

 
50,363

 
$
0.81

 
$
38,600

 
51,273

 
$
0.75

All prior year share amounts presented in this Note 8 have been adjusted to reflect the three-for-one stock split by means of a stock dividend declared by the Company's board of directors on June 10, 2013.
There were no antidilutive options outstanding for the three months ended March 31, 2014 and 2013.


16

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


9.
Commitments and Contingencies:
Business Acquisitions:

Aktiv Kapital, A.S.

On February 19, 2014, the Company entered into an agreement to acquire the equity of Aktiv for approximately $880 million and assume approximately $435 million of Aktiv’s debt, resulting in an acquisition of estimated total enterprise value of $1.3 billion . The transaction is expected to close in the second or third quarter of 2014, upon successful completion of customary closing conditions, including approval of the transaction by applicable competition authorities and our ability to obtain the necessary financing to consummate the transaction.

The Company expects to finance this transaction with a combination of cash, $170 million of seller financing (which will bear interest at a variable rate equal to LIBOR plus 3.75% per annum and will mature 12 months after the date of issuance), and up to $650 million from its domestic revolving credit facility (subject to borrowing base restrictions). The Company may choose to use other debt instruments to expand, replace or pay down any of these financing options. The Company anticipates total transaction costs of approximately $15 million of which $4.4 million was incurred during the first quarter of 2014.

Pamplona Capital Management, LLP

On January 31, 2014, the Company entered into an agreement to acquire certain operating assets from Pamplona Capital Management, LLP ("PCM").  These assets include PCM’s IVA Master Servicing Platform as well as other operating assets associated with PCM’s IVA business.  The purchase price of these assets is approximately $5 million and will be paid from the Company’s existing cash balances.  The transaction is expected to close on July 1, 2014.
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, 2014, the estimated future compensation under these agreements is approximately $7.5 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, 2014 total approximately $29.7 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, 2014 is approximately $198.9 million .
Contingent Purchase Price:
The asset purchase agreement entered into in connection with the acquisition of certain finance receivables and certain operating assets of National Capital Management, LLC ("NCM") in 2012, 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 . The Company paid the year one earn-out during December 2013 in the amount of $6.2 million . As of March 31, 2014, the Company has recorded a present value amount for the expected remaining liability of $4.0 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.

17

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


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 or demands 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, 2014.  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.

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 ("TCPA") 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 stay this litigation until such time as the FCC has ruled on various petitions concerning the TCPA.

Internal Revenue Service Audit

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

18

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


has asserted that tax revenue recognition using the cost recovery method 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 required. 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 7 “Income Taxes” for additional information.

10.
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, 2014 and December 31, 2013, under the indicated captions (amounts in thousands):
 
March 31, 2014
 
December 31, 2013
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
Financial assets:
 
 
 
 
 
 
 
Cash and cash equivalents
$
191,819

 
$
191,819

 
$
162,004

 
$
162,004

Finance receivables, net
1,253,961

 
1,702,786

 
1,239,191

 
1,722,100

Financial liabilities:
 
 
 
 
 
 
 
Long-term debt
192,500

 
192,500

 
195,000

 
195,000

Convertible debt
257,778

 
339,170

 
256,780

 
316,857

As of March 31, 2014, and December 31, 2013, 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.

19

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


Revolving 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.
Convertible debt: The Notes are carried at historical cost, adjusted for debt discount. The fair value estimate for these Notes incorporates quoted market prices which were obtained from secondary market broker quotes which were derived from a variety of inputs including client orders, information from their pricing vendors, modeling software, and actual trading prices when they occur. Accordingly, the Company uses level 2 inputs for its fair value estimates.

11.
Recent Accounting Pronouncements:
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 adopted ASU 2013-05 in the first quarter of 2014 which had no material impact on its consolidated financial statements.


20

Table of Contents

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 successfully close the Aktiv acquisition and subsequently integrate the Aktiv business;
our ability to manage risks associated with our international operations, which risks will increase as a result of the Aktiv Acquisition;
our ability to recognize the anticipated synergies and benefits of the Aktiv acquisition;
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”).

21

Table of Contents

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.
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 2013 Annual Report on Form 10-K, filed on February 28, 2014.
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.
“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 3,621 team members. The Company's shares of common stock are traded on the NASDAQ Global Select Market under the symbol “PRAA.”

On February 19, 2014, we entered into an agreement to acquire the equity of Aktiv Kapital AS (“Aktiv”), a Norway-based company specializing in the acquisition and servicing of non-performing consumer loans throughout Europe and in Canada, for approximately $880 million, we also agreed to assume approximately $435 million of Aktiv's corporate debt, resulting in an acquisition of estimated total enterprise value of $1.3 billion. This acquisition will provide us entry into thirteen new markets,

22

Table of Contents

providing us additional geographical diversity in portfolio purchasing and collection, and with entry into new growth markets. We expect Aktiv's Chief Executive Officer and his executive team and the more than 400 Aktiv employees to join our workforce upon the closing of the transaction. The transaction is expected to close in the second or third quarter of 2014, upon successful completion of customary closing conditions, including approval of the transaction by applicable financial supervisory or competition authorities and our ability to obtain the necessary financing to consummate the transaction.

We expect to finance this transaction with a combination of cash, $170 million of seller financing (which will bear interest at a variable rate equal to LIBOR plus 3.75% per annum and will mature 12 months after the date of issuance) and $650 million from our domestic revolving credit facility. We may choose to use other debt instruments to expand, replace or pay down any of these financing options. We anticipate total transaction costs of approximately $15 million, which we expect to incur between both the first and second quarters of 2014. During the first quarter of 2014, we incurred approximately $4.4 million of the total estimated transaction costs of $15 million. Our total borrowings are projected to be approximately $1.8 billion after closing the Aktiv acquisition, compared to PRA’s total borrowings of $450 million at March 31, 2014.

A publicly traded company from 1997 until early 2012, Aktiv has developed a mixed in-house and outsourced collection strategy. It maintains in-house servicing platforms in eight markets, and owns portfolios in fifteen markets. Aktiv has more than 20 years of experience and data in a wide variety of consumer asset classes, across an extensive geographic background. Aktiv has acquired more than 2,000 portfolios, with a face value of more than $38 billion. In 2013, Aktiv collected $318 million on its portfolios and purchased $248 million in new portfolios, up from $222 million in 2012. Aktiv’s total assets were approximately $900 million at December 31, 2013.
Earnings Summary
During the first quarter of 2014 , net income attributable to the Company was $40.8 million, or $0.81 per diluted share, compared with $38.6 million, or $0.75 per diluted share, in the first quarter of 2013 . Total revenue was $193.9 million in the first quarter of 2014 , up 14.3% from the first quarter of 2013 . Revenues in the first quarter of 2014 consisted of $178.0 million in income recognized on finance receivables, net of allowance charges, and $16.0 million in fee income. Income recognized on finance receivables, net of allowance charges, in the first quarter of 2014 increased $23.2 million, or 15.0%, over the first quarter of 2013 , primarily as a result of a significant increase in cash collections. Cash collections, which drives our finance receivable income, were $313.4 million in the first quarter of 2014 , up 13.8%, or $37.9 million, as compared to the first quarter of 2013 . During the first quarter of 2014 , we incurred $2.0 million in net allowance charge reversals, compared with $2.2 million of net allowance charges in the first quarter of 2013 . 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 increased to $16.0 million in the first quarter of 2014 from $14.8 million in the first quarter of 2013 , primarily due to higher fee income generated by Claims Compensation Bureau, LLC ("CCB") and PRA Government Services, LLC ("PGS"). This was partially offset by lower fee income generated in the first quarter of 2014 by Mackenzie Hall Holdings, Limited, ("PRA UK") and PRA Location Services (“PLS”) when compared to the first quarter of 2013.
A summary of how our income was generated during the three months ended March 31, 2014 and 2013 is as follows:
 
 
For the Three Months Ended March 31,
($ in thousands)
2014
 
2013
Cash collections
$
313,367

 
$
275,463

Amortization of finance receivables
(137,350
)
 
(118,498
)
Net allowance reversals/(charges)
1,953

 
(2,173
)
Finance receivable income
177,970

 
154,792

Fee income
15,952

 
14,767

Total revenue
$
193,922

 
$
169,559

Operating expenses were $122.3 million in the first quarter of 2014 , up 17.9% over the first quarter of 2013, due primarily to increases in compensation expense, legal collection costs and outside fees and services. Compensation expense increased primarily as a result of larger staff sizes, increases in incentive compensation paid as a result of collector performance and normal pay increases. Compensation and employee services expenses increased as total employees grew 11.4% to 3,621 as of March 31,

23

Table of Contents

2014 , from 3,250 as of March 31, 2013 . Legal collection costs increased from $20.5 million in the first quarter of 2013 to $26.5 million in the first quarter of 2014 , an increase of $6.0 million, or 29.4%.  This increase was the result of our continued expansion of the accounts brought into the legal collection process. Outside fees and services expenses increased $3.4 million, or 46.0%, mainly attributable to the transaction costs incurred in the first quarter of 2014 related to the pending Aktiv acquisition.
During the three months ended March 31, 2014 , we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $1.91 billion at a cost of $152.7 million. During the three months ended March 31, 2013 , we acquired defaulted consumer receivable portfolios with an aggregate face value of $1.85 billion at a cost of $214.9 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, 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.
Results of Operations
The results of operations include the financial results of the Company and all of our subsidiaries.

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,
 
2014
 
2013
Revenues:
 
 
 
Income recognized on finance receivables, net
91.8
%
 
91.3
%
Fee income
8.2
%
 
8.7
%
Total revenues
100.0
%
 
100.0
%
Operating expenses:
 
 
 
Compensation and employee services
26.5
%
 
26.5
%
Legal collection fees
5.6
%
 
6.2
%
Legal collection costs
13.7
%
 
12.1
%
Agent fees
0.7
%
 
0.9
%
Outside fees and services
5.6
%
 
4.4
%
Communication expenses
4.7
%
 
4.8
%
Rent and occupancy
1.1
%
 
1.0
%
Depreciation and amortization
2.0
%
 
2.0
%
Other operating expenses
3.1
%
 
3.2
%
Total operating expenses
63.0
%
 
61.1
%
Income from operations
37.0
%
 
38.9
%
Other expense:
 
 
 
Interest expense
2.5
%
 
1.6
%
Income before income taxes
34.5
%
 
37.3
%
Provision for income taxes
13.4
%
 
14.6
%
Net income
21.1
%
 
22.7
%
Adjustment for loss attributable to redeemable noncontrolling interest
%
 
%
Net income attributable to Portfolio Recovery Associates, Inc.
21.1
%
 
22.6
%


24

Table of Contents

Three Months Ended March 31, 2014 Compared To Three Months Ended March 31, 2013
Revenues
Total revenues were $193.9 million for the three months ended March 31, 2014 , an increase of $24.3 million, or 14.3%, compared to total revenues of $169.6 million for the three months ended March 31, 2013 .
Income Recognized on Finance Receivables, net
Income recognized on finance receivables, net was $178.0 million for the three months ended March 31, 2014 , an increase of $23.2 million, or 15.0%, compared to income recognized on finance receivables, net of $154.8 million for the three months ended March 31, 2013 . The increase was primarily due to an increase in cash collections on our finance receivables to $313.4 million for the three months ended March 31, 2014 , from $275.5 million for the three months ended March 31, 2013 , an increase of $37.9 million, or 13.8%. Our finance receivables amortization rate, including net allowance charges, was 43.2% for the three months ended March 31, 2014 compared to 43.8% for the three months ended March 31, 2013 .
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. Increases in future cash flows may occur as portfolios age and actual cash collections exceed those originally expected. If those cash flows are determined to be incremental to the portfolio’s original forecast, future projections of cash flows are generally increased resulting in higher expected revenue and hence increases in accretable yield. During the three months ended March 31, 2014 and 2013, the Company reclassified amounts from nonaccretable difference to accretable yield due primarily to increased cash collection forecasts relating to pools acquired from 2009-2012. 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.
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, 2014 , we recorded net allowance charge reversals of $2.0 million. On our Core portfolios, we recorded net allowance reversals of $3.1 million on portfolios purchased between 2005 and 2008, offset by net allowance charges of $0.9 million on portfolios purchased in 2010. On our purchased bankruptcy portfolios, we recorded net allowance charge reversals of $0.3 million on portfolios primarily purchased in 2007. We also recorded a net allowance charge of $0.5 million on our UK portfolios purchased in 2012. 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 previous 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 increased to $16.0 million for the three months ended March 31, 2014 , from $14.8 million for the three months ended March 31, 2013 , primarily due to higher fee income generated by CCB and PGS. This was partially offset by lower fee income generated in the first quarter of 2014 by PRA UK and PLS when compared to the prior year period.
Income from Operations
Income from operations was $71.6 million for the three months ended March 31, 2014 , an increase of $5.7 million or 8.7% compared to income from operations of $65.9 million for the three months ended March 31, 2013 . Income from operations was 37.0% of total revenue for the three months ended March 31, 2014 compared to 38.9% for the three months ended March 31, 2013 .

25

Table of Contents

Operating Expenses
Total operating expenses were $122.3 million for the three months ended March 31, 2014 , an increase of $18.6 million or 17.9% compared to total operating expenses of $103.7 million for the three months ended March 31, 2013 . Total operating expenses were 37.1% of cash receipts for the three months ended March 31, 2014 compared to 35.7% for the three months ended March 31, 2013 .
Compensation and Employee Services
Compensation and employee services expenses were $51.4 million for the three months ended March 31, 2014 , an increase of $6.4 million, or 14.2%, compared to compensation and employee services expenses of $45.0 million for the three months ended March 31, 2013 . Compensation expense increased primarily as a result of larger staff sizes in addition to increases in incentive compensation and normal pay increases. Compensation and employee services expenses increased as total employees grew 11.4% to 3,621 as of March 31, 2014 , from 3,250 as of March 31, 2013 . Compensation and employee services expenses as a percentage of cash receipts increased to 15.6% for the three months ended March 31, 2014 , from 15.5% of cash receipts for the three months ended March 31, 2013 .
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 $10.8 million for the three months ended March 31, 2014 , an increase of $0.3 million, or 2.9%, compared to legal collection fees of $10.5 million for the three months ended March 31, 2013 .  This increase was the result of an increase in cash collections from outside attorneys from $47.9 million in the three months ended March 31, 2013 to $51.0 million for the three months ended March 31, 2014 , an increase of $3.1 million, or 6.5%. Legal collection fees for the three months ended March 31, 2014 were 3.3% of cash receipts, compared to 3.6% for the three months ended March 31, 2013 .
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 $26.5 million for the three months ended March 31, 2014 , an increase of $6.0 million, or 29.3%, compared to legal collection costs of $20.5 million for the three months ended March 31, 2013 .  Since the beginning 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 we expect to drive additional future cash collections and revenue. Legal collection costs for the three months ended March 31, 2014 were 8.1% of cash receipts, compared to 7.1% for the three months ended March 31, 2013 .
Agent Fees
Agent fees primarily represent costs paid to repossession agents to repossess vehicles. Agent fees were $1.5 million and $1.6 million for the three months ended March 31, 2014 and 2013 , respectively.
Outside Fees and Services
Outside fees and services expenses were $10.8 million for the three months ended March 31, 2014 , an increase of $3.4 million, or 46.0%, compared to outside fees and services expenses of $7.4 million for the three months ended March 31, 2013 . The increase of $3.3 million was mainly attributable to the transaction costs incurred in the first quarter of 2014 related to the pending Aktiv acquisition.
Communication Expenses
Communication expenses were $9.2 million for the three months ended March 31, 2014 , an increase of $1.1 million, or 13.6%, compared to communications expenses of $8.1 million for the three months ended March 31, 2013 . The increase was primarily due to additional postage expense resulting from an increase in special collection letter campaigns as well as a larger customer base. The remaining increase was attributable to higher telephone expenses. Expenses related to customer mailings were responsible for 52.2%, or $0.6 million, of this increase, and the remaining 47.8%, or $0.5 million, was attributable to increases in telephone related charges.
Rent and Occupancy
Rent and occupancy expenses were $2.1 million for the three months ended March 31, 2014 , an increase of $0.4 million, or 23.5%, compared to rent and occupancy expenses of $1.7 million for the three months ended March 31, 2013 . The increase

26

Table of Contents

was primarily due to the additional space leased at our Norfolk headquarters during the second half of 2013 and the additional space leased as a result of the opening of our North Richland Hills, Texas, call center in December of 2013.
Depreciation and Amortization
Depreciation and amortization expenses were $3.9 million for the three months ended March 31, 2014 , an increase of $0.5 million, or 14.7%, compared to depreciation and amortization expenses of $3.4 million for the three months ended March 31, 2013 . The increase was primarily due to a large investment in capital expenditures resulting from the additional space leased at our Norfolk headquarters during the second half of 2013 and the additional space leased as a result of the opening of our North Richland Hills, Texas, call center in December of 2013.
Other Operating Expenses
Other operating expenses were $6.1 million for the three months ended March 31, 2014 , an increase of $0.6 million, or 10.9%, compared to other operating expenses of $5.5 million for the three months ended March 31, 2013 . Of the $0.6 million increase, $0.4 million was due to an increase in repairs and maintenance expenses, $0.3 million was due to an increase in insurance costs and $0.3 million was due to an increase in general office expenses. This was partially offset by a $0.9 million reversal of accrued estimated contingent payments related to a previous acquisition. None of the remaining $0.5 million increase was attributable to any significant identifiable items.
Interest Expense
Interest expense was $4.9 million and $2.7 million for the three months ended March 31, 2014 and 2013 , respectively. The increase was primarily due to the completion on August 13, 2013, through a private offering of $287.5 million in aggregate principal amount of the Company’s 3.00% Convertible Senior Notes due 2020, offset by a decrease in average borrowings under our variable rate credit facility for the three months ended March 31, 2014 compared to the same prior year period.   The average borrowings on our variable rate credit facility were $195.0 million and $359.6 million for the three months ended March 31, 2014 and 2013 , respectively.
Provision for Income Taxes
Provision for income taxes was $25.9 million for the three months ended March 31, 2014 , an increase of $1.2 million, or 4.9%, compared to provision for income taxes of $24.7 million for the three months ended March 31, 2013 . The increase is primarily due to an increase of 5.5% in income before taxes for the three months ended March 31, 2014 , compared to the three months ended March 31, 2013 , offset by a decrease in the effective tax rate to 38.8% for the three months ended March 31, 2014 , compared to an effective tax rate of 39.1% for the three months ended March 31, 2013 . The decrease in the effective tax rate is primarily attributable to state revenue apportionment changes and tax credits.

27

Table of Contents

Below are certain key financial data and ratios for the periods indicated:
 
Three Months Ended
 
 
March 31,
%
 
2014
2013
Change
EARNINGS (in thousands)
 
 
 
Income recognized on finance receivables, net
$
177,970

$
154,792

15
 %
Fee income
15,952

14,767

8
 %
Total revenues
193,922

169,559

14
 %
Operating expenses
122,332

103,672

18
 %
Income from operations
71,590

65,887

9
 %
Net interest expense
4,859

2,689

81
 %
Net income
40,840

38,517

6
 %
Net income attributable to Portfolio Recovery Associates, Inc.
40,840

38,600

6
 %
 
 
 
 
PERIOD-END BALANCES (in thousands)
 
 
 
Cash and cash equivalents
$
191,819

$
39,111

390
 %
Finance receivables, net
1,253,961

1,169,747

7
 %
Goodwill and intangible assets, net
118,800

125,462

(5
)%
Total assets
1,642,613

1,382,739

19
 %
Borrowings
450,278

371,159

21
 %
Total liabilities
732,395

621,413

18
 %
Total equity
910,218

750,990

21
 %
 
 
 
 
FINANCE RECEIVABLE COLLECTIONS (dollars in thousands)
 
 
 
Cash collections
$
313,367

$
275,463

14
 %
Cash collections on fully amortized pools
16,516

6,345

160
 %
Principal amortization without allowance charges
137,350

118,498

16
 %
Principal amortization with allowance charges
135,397

120,671

12
 %
Principal amortization w/ allowance charges as % of cash collections:
 
 
 
   Including fully amortized pools
43.2
 %
43.8
%
(1
)%
   Excluding fully amortized pools
45.6
 %
44.8
%
2
 %
 
 
 
 
ALLOWANCE FOR FINANCE RECEIVABLES (dollars in thousands)
 
 
 
Allowance (reversal)/charge
$
(1,953
)
$
2,173

(190
)%
Allowance (reversal)/charge to period-end net finance receivables
(0.2
)%
0.2
%
(184
)%
Allowance (reversal)/charge to net finance receivable income
(1.1
)%
1.4
%
(178
)%
Allowance (reversal)/charge to cash collections
(0.6
)%
0.8
%
(179
)%
 
 
 
 
PURCHASES OF FINANCE RECEIVABLES (dollars in thousands)
 
 
 
Cash paid - core
$
79,085

$
126,951

(38
)%
Face value - core
837,036

1,398,960

(40
)%
Cash paid - bankruptcy
65,501

86,595

(24
)%
Face value - bankruptcy
557,220

436,508

28
 %
Cash paid - other
8,128

1,387

486
 %
Face value - other
519,118

18,570

2,695
 %
Cash paid - total
152,714

214,933

(29
)%
Face value - total
1,913,374

1,854,038

3
 %
Number of portfolios - total
104

91

14
 %
 
 
 
 
ESTIMATED REMAINING COLLECTIONS (in thousands)
 
 
 
Estimated remaining collections - core
$
1,891,511

$
1,547,644

22
 %
Estimated remaining collections - bankruptcy
788,774

924,520

(15
)%
Estimated remaining collections - other
24,439

14,739

66
 %
Estimated remaining collections - total
2,704,724

2,486,903

9
 %
 
 
 
 
SHARE DATA (7) (share amounts in thousands)
 
 
 
Net income per common share - diluted
$
0.81

$
0.75

8
 %
Weighted average number of shares outstanding - diluted
50,363

51,273

(2
)%
Shares repurchased

48

(100
)%
Average price paid per share repurchased (including acquisitions costs)
$

$
39.34

(100
)%
Closing market price
$
57.86

$
42.31

37
 %
 
 
 
 
RATIOS AND OTHER DATA (dollars in thousands)
 
 
 
Return on average equity (1)
18.2
 %
21.1
%
(14
)%
Return on revenue (2)
21.1
 %
22.7
%
(7
)%
Return on average assets (3)
10.0
 %
11.3
%
(12
)%
Operating margin (4)
36.9
 %
38.9
%
(5
)%
Operating expense to cash receipts (5)
37.1
 %
35.7
%
4
 %
Debt to equity (6)
49.5
 %
49.4
%
 %
Number of collectors
2,379

2,159

10
 %
Number of full-time equivalent employees
3,621

3,250

11
 %
Cash receipts (5)
$
329,319

$
290,230

13
 %
Line of credit - unused portion at period end
435,500

228,000

91
 %
(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 annualized net income divided by average assets for the period
 
 
(4) Calculated as income from operations divided by total revenues
 
 
 
(5) "Cash receipts" is defined as cash collections plus fee income
 
 
 
(6) For purposes of this ratio, "debt" equals borrowings
 
 
(7) Share data has been adjusted to reflect the three-for-one stock split by means of a stock dividend which was declared on June 10, 2013 and
paid August 1, 2013
 
 
 

28

Table of Contents

 
 
Quarter Ended
 
 
March 31,
December 31,
September 30,
June 30,
March 31,
 
 
2014
2013
2013
2013
2013
 
EARNINGS (in thousands)
 
 
 
 
 
 
Income recognized on finance receivables, net
$
177,970

$
168,728

$
171,456

$
168,570

$
154,792

 
Fee income
15,952

16,125

26,306

14,391

14,767

 
Total revenues
193,922

184,853

197,762

182,961

169,559

 
Operating expenses
122,332

106,503

118,294

109,135

103,672

 
Income from operations
71,590

78,350

79,468

73,826

65,887

 
Net interest expense
4,859

4,860

3,995

2,923

2,689

 
Net income
40,840

45,777

49,211

43,414

38,517

 
Net income attributable to Portfolio Recovery Associates, Inc.
40,840

45,777

47,338

43,599

38,600

 
 
 
 
 
 
 
 
PERIOD-END BALANCES (in thousands)
 
 
 
 
 
 
Cash and cash equivalents
$
191,819

$
162,004

$
108,705

$
43,459

$
39,111

 
Finance receivables, net
1,253,961

1,239,191

1,256,822

1,236,859

1,169,747

 
Goodwill and intangible assets, net
118,800

119,610

119,636

124,349

125,462

 
Total assets
1,642,613

1,601,232

1,547,985

1,457,246

1,382,739

 
Borrowings
450,278

451,780

452,229

413,774

371,159

 
Total liabilities
732,395

731,756

721,001

655,012

621,413

 
Total equity
910,218

869,476

816,647

791,898

750,990

 
 
 
 
 
 
 
 
FINANCE RECEIVABLE COLLECTIONS (dollars in thousands)
 
 
 
 
 
 
Cash collections
$
313,367

$
278,926

$
291,651

$
296,397

$
275,463

 
Cash collections on fully amortized pools
16,516

9,801

8,762

10,612

6,345

 
Principal amortization without allowance charges
137,350

110,626

122,776

129,012

118,498

 
Principal amortization with allowance charges
135,397

110,197

120,195

127,827

120,671

 
Principal amortization w/ allowance charges as % of cash collections:
 
 
 
 
 
 
   Including fully amortized pools
43.2
 %
39.5
 %
41.2
 %
43.1
 %
43.8
%
 
   Excluding fully amortized pools
45.6
 %
40.9
 %
42.5
 %
44.7
 %
44.8
%
 
 
 
 
 
 
 
 
ALLOWANCE FOR FINANCE RECEIVABLES (dollars in thousands)
 
 
 
 
 
 
Allowance (reversal)/charge
$
(1,953
)
$
(429
)
$
(2,581
)
$
(1,185
)
$
2,173

 
Allowance (reversal)/charge to period-end net finance receivables
(0.2
)%
 %
(0.2
)%
(0.1
)%
0.2
%
 
Allowance (reversal)/charge to net finance receivable income
(1.1
)%
(0.3
)%
(1.5
)%
(0.7
)%
1.4
%
 
Allowance (reversal)/charge to cash collections
(0.6
)%
(0.2
)%
(0.9
)%
(0.4
)%
0.8
%
 
 
 
 
 
 
 
 
PURCHASES OF FINANCE RECEIVABLES (dollars in thousands)
 
 
 
 
 
 
Cash paid - core
$
79,085

$
65,759

$
89,044

$
113,314

$
126,951

 
Face value - core
837,036

774,543

1,352,877

1,178,229

1,398,960

 
Cash paid - bankruptcy
65,501

31,987

41,794

82,273

86,595

 
Face value - bankruptcy
557,220

235,064

215,957

1,926,515

436,508

 
Cash paid - other
8,128

1,763

11,037

4,881

1,387

 
Face value - other
519,118

22,493

218,528

81,852

18,570

 
Cash paid - total
152,714

99,509

141,875

200,468

214,933

 
Face value - total
1,913,374

1,032,100

1,787,362

3,186,596

1,854,038

 
Number of portfolios - total
104

83

79

94

91

 
 
 
 
 
 
 
 
ESTIMATED REMAINING COLLECTIONS (in thousands)
 
 
 
 
 
 
Estimated remaining collections - core
$
1,891,511

$
1,824,132

$
1,762,369

$
1,694,262

$
1,547,644

 
Estimated remaining collections - bankruptcy
788,774

822,988

877,722

925,223

924,520

 
Estimated remaining collections - other
24,439

22,150

32,272

16,744

14,739

 
Estimated remaining collections - total
2,704,724

2,669,270

2,672,363

2,636,229

2,486,903

 
 
 
 
 
 
 
 
SHARE DATA (7) (share amounts in thousands)
 
 
 
 
 
 
Net income per common share - diluted
$
0.81

$
0.91

$
0.93

$
0.85

$
0.75

 
Weighted average number of shares outstanding - diluted
50,363

50,375

50,660

51,183

51,273

 
Shares repurchased


989

166