PRA Group
PORTFOLIO RECOVERY ASSOCIATES INC (Form: 10-Q, Received: 08/01/2008 16:22:31)
 
 
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
 
FORM 10-Q
     
þ   QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the quarterly period ended June 30, 2008
     
o   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 þ NO o
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” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):
             
Large accelerated filer þ     Accelerated filer o     Non-accelerated filer   o
(Do not check if a smaller reporting company)
  Smaller Reporting Company o  
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YES o NO þ
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 July 18, 2008
     
Common Stock, $0.01 par value   15,360,378
 
 

 


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
INDEX
         
    Page(s)
PART I. FINANCIAL INFORMATION
       
 
       
Item 1. Financial Statements
       
 
       
Consolidated Balance Sheets (unaudited) as of June 30, 2008 and December 31, 2007
    3  
 
       
Consolidated Income Statements (unaudited) For the three and six months ended June 30, 2008 and 2007
    4  
 
       
Consolidated Statement of Changes in Stockholders’ Equity (unaudited) For the six months ended June 30, 2008
    5  
 
       
Consolidated Statements of Cash Flows (unaudited) For the six months ended June 30, 2008 and 2007
    6  
 
       
Notes to Consolidated Financial Statements (unaudited)
    7-18  
 
       
Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations
    19-38  
 
       
Item 3. Quantitative and Qualitative Disclosure About Market Risk
    39  
 
       
Item 4. Controls and Procedures
    39  
 
       
PART II. OTHER INFORMATION
       
 
       
Item 1. Legal Proceedings
    39  
 
       
Item 1A. Risk Factors
    39  
 
       
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
    39  
 
       
Item 3. Defaults Upon Senior Securities
    40  
 
       
Item 4. Submission of Matters to a Vote of the Security Holders
    40  
 
       
Item 5. Other Information
    40  
 
       
Item 6. Exhibits
    40  
 
       
SIGNATURES
    41  

2


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS
June 30, 2008 and December 31, 2007
(unaudited)
(Amounts in thousands, except per share amounts)
                 
         June 30,          December 31,  
    2008     2007  
Assets
               
Cash and cash equivalents
  $ 16,333     $ 16,730  
Finance receivables, net
    515,367       410,297  
Income taxes receivable
    3,539       3,022  
Property and equipment, net
    17,332       16,171  
Goodwill
    18,620       18,620  
Intangible assets, net
    4,322       5,046  
Other assets
    5,775       6,421  
 
           
 
               
Total assets
  $ 581,288     $ 476,307  
 
           
Liabilities and Stockholders’ Equity
               
 
               
Liabilities:
               
Accounts payable
  $ 4,630     $ 4,055  
Accrued expenses
    4,647       4,471  
Accrued payroll and bonuses
    4,833       6,819  
Deferred tax liability
    72,577       57,579  
Line of credit
    234,300       168,000  
Obligations under capital lease
    45       103  
 
           
Total liabilities
    321,032       241,027  
 
           
 
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, authorized shares, 30,000, issued and outstanding shares — 15,197 at June 30, 2008, and 15,159 at December 31, 2007
    152       152  
Additional paid-in capital
    73,121       71,443  
Retained earnings
    186,983       163,685  
 
           
Total stockholders’ equity
    260,256       235,280  
 
           
 
               
Total liabilities and stockholders’ equity
  $ 581,288     $ 476,307  
 
           
The accompanying notes are an integral part of these consolidated financial statements.

3


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED INCOME STATEMENTS
For the Three and Six Months Ended June 30, 2008 and 2007
(unaudited)
(Amounts in thousands, except per share amounts)
                                 
    Three Months Ended     Six Months Ended  
    June 30,     June 30,  
    2008     2007     2008     2007  
Revenues:
                               
Income recognized on finance receivables, net
  $ 53,047     $ 46,387     $ 105,675     $ 91,853  
Commissions
    10,567       8,389       22,043       16,931  
 
                       
 
                               
Total revenues
    63,614       54,776       127,718       108,784  
 
                               
Operating expenses:
                               
Compensation and employee services
    20,872       16,681       41,999       33,116  
Outside legal and other fees and services
    15,118       11,246       29,691       22,683  
Communications
    2,403       2,005       5,272       3,889  
Rent and occupancy
    869       739       1,707       1,398  
Other operating expenses
    1,595       1,478       2,951       2,862  
Depreciation and amortization
    1,507       1,362       2,976       2,657  
 
                       
 
                               
Total operating expenses
    42,364       33,511       84,596       66,605  
 
                       
 
                               
Income from operations
    21,250       21,265       43,122       42,179  
 
                               
Other income and (expense):
                               
Interest income
    3       121       33       300  
Interest expense
    (2,649 )     (339 )     (5,149 )     (405 )
 
                       
 
                               
Income before income taxes
    18,604       21,047       38,006       42,074  
 
                               
Provision for income taxes
    7,178       8,058       14,708       16,204  
 
                       
 
                               
Net income
  $ 11,426     $ 12,989     $ 23,298     $ 25,870  
 
                       
 
                               
Net income per common share:
                               
Basic
  $ 0.75     $ 0.81     $ 1.53     $ 1.62  
Diluted
  $ 0.75     $ 0.80     $ 1.53     $ 1.60  
Weighted average number of shares outstanding:
                               
Basic
    15,193       16,005       15,182       15,999  
Diluted
    15,268       16,168       15,252       16,154  
The accompanying notes are an integral part of these consolidated financial statements.

4


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS’ EQUITY
For the Six Months Ended June 30, 2008
(unaudited)
(Amounts in thousands)
                                 
            Additional             Total  
    Common     Paid-in     Retained     Stockholders’  
    Stock     Capital     Earnings     Equity  
Balance at December 31, 2007
  $ 152     $ 71,443     $ 163,685     $ 235,280  
 
                               
Net income
                23,298       23,298  
Exercise of stock options and vesting of nonvested shares
          297             297  
Amortization of share-based compensation
          1,163             1,163  
Income tax benefit from share-based compensation
          218             218  
 
                       
 
                               
Balance at June 30, 2008
  $ 152     $ 73,121     $ 186,983     $ 260,256  
 
                       
The accompanying notes are an integral part of these consolidated financial statements.

5


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the Six Months Ended June 30, 2008 and 2007
(unaudited)
(Amounts in thousands)
                 
    Six Months Ended  
    June 30,  
    2008     2007  
Cash flows from operating activities:
               
Net income
  $ 23,298     $ 25,870  
Adjustments to reconcile net income to net cash provided by operating activities:
               
Amortization of share-based compensation
    1,163       1,364  
Depreciation and amortization
    2,976       2,657  
Deferred tax expense
    14,998       10,517  
Changes in operating assets and liabilities:
               
Other assets
    646       (271 )
Accounts payable
    575       (435 )
Income taxes
    (517 )     (721 )
Accrued expenses
    176       821  
Accrued payroll and bonuses
    (1,986 )     (1,918 )
 
           
 
               
Net cash provided by operating activities
    41,329       37,884  
 
           
 
               
Cash flows from investing activities:
               
Purchases of property and equipment
    (3,413 )     (3,993 )
Acquisition of finance receivables, net of buybacks
    (163,839 )     (102,263 )
Collections applied to principal on finance receivables
    58,769       40,062  
 
           
 
               
Net cash used in investing activities
    (108,483 )     (66,194 )
 
           
 
               
Cash flows from financing activities:
               
Dividends paid
          (16,070 )
Proceeds from exercise of options
    297       1,298  
Income tax benefit from share-based compensation
    218       952  
Proceeds from line of credit
    83,800       41,000  
Principal payments on line of credit
    (17,500 )     (3,000 )
Repurchases of common stock
          (5,190 )
Principal payments on long-term debt
          (671 )
Principal payments on capital lease obligations
    (58 )     (69 )
 
           
 
               
Net cash provided by financing activities
    66,757       18,250  
 
           
 
               
Net decrease in cash and cash equivalents
    (397 )     (10,060 )
 
               
Cash and cash equivalents, beginning of period
    16,730       25,101  
 
           
 
               
Cash and cash equivalents, end of period
  $ 16,333     $ 15,041  
 
           
 
               
Supplemental disclosure of cash flow information:
               
Cash paid for interest
  $ 5,205     $ 211  
Cash paid for income taxes
  $ 2     $ 5,260  
The accompanying notes are an integral part of these consolidated financial statements.

6


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
1. Organization and Business:
     Portfolio Recovery Associates, LLC (“PRA”) was formed on March 20, 1996. Portfolio Recovery Associates, Inc. (“PRA Inc”) was formed in August 2002. On November 8, 2002, PRA Inc completed its initial public offering (“IPO”) of common stock. As a result, all of the membership units and warrants of PRA were exchanged on a one to one basis for warrants and shares of a single class of common stock of PRA Inc. PRA Inc owns all outstanding membership units of PRA, PRA Holding I, LLC (“PRA Holding I”), PRA Holding II, LLC (“PRA Holding II”), PRA Receivables Management, LLC (d/b/a Anchor Receivables Management) (“Anchor”), PRA Location Services, LLC (d/b/a IGS Nevada) (“IGS”), PRA Government Services, LLC (d/b/a Alatax and RDS) (“RDS”) and PRA Bankruptcy Services, LLC (“PRA BS”). PRA Inc, a Delaware corporation, and its subsidiaries (collectively, the “Company”) are full-service providers of outsourced receivables management and related services. The Company is engaged in the business of purchasing, managing and collecting portfolios of defaulted consumer receivables as well as offering a broad range of accounts receivable management services. The majority of the Company’s business activities involve the purchase, management and collection of defaulted consumer receivables. These are purchased from sellers of finance receivables and collected by a highly skilled staff whose purpose is to locate and contact customers and arrange payment or resolution of their debts. The Company, through its Legal Recovery Department, collects accounts judicially, either by using its own attorneys, or by contracting with independent attorneys throughout the country through whom the Company takes legal action to satisfy consumer debts. The Company also services receivables on behalf of clients on either a commission or transaction-fee basis. Clients include entities in the financial services, auto, retail, utility, health care and government sectors. Services provided to these clients include standard collection services on delinquent accounts, obtaining location information for clients in support of their collection activities (known as skip tracing), and the management of both delinquent and non-delinquent tax receivables for government entities.
     The consolidated financial statements of the Company include the accounts of PRA Inc, PRA, PRA Holding I, PRA Holding II, Anchor, IGS, RDS and PRA BS.
     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 June 30, 2008, its consolidated income statements for the three and six months ended June 30, 2008 and 2007, its consolidated statement of changes in stockholders’ equity for the six months ended June 30, 2008, and its consolidated statements of cash flows for the six months ended June 30, 2008 and 2007. The income statement of the Company for the three and six months ended June 30, 2008 and 2007 may not be indicative of future results. These unaudited consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A, as filed for the year ended December 31, 2007.
2. Finance Receivables, net:
     The Company’s principal business consists of the acquisition and collection of accounts that have experienced deterioration of credit quality between origination and the Company’s acquisition of the accounts. The amount paid for an account reflects the Company’s determination that it is probable the Company will be unable to collect all amounts due according to the account’s contractual terms. At acquisition, the Company reviews the portfolio both by account and aggregate pool to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that the Company will be unable to collect all amounts due according to the account’s contractual terms. If both conditions exist, the Company determines whether each such account is to be accounted for individually or whether such accounts will be assembled into pools based on common risk characteristics. The Company considers expected prepayments and estimates the amount and timing of undiscounted expected principal, interest and other cash flows for each acquired portfolio and subsequently aggregated pools of accounts. The Company determines the excess of the pool’s scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount that should not be accreted (nonaccretable difference) based on the Company’s proprietary acquisition models. The remaining amount, representing the excess of the account’s cash flows expected to be collected over the amount paid, is accreted into income recognized on finance receivables over the remaining life of the account or pool (accretable yield).

7


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     Prior to January 1, 2005, the Company accounted for its investment in finance receivables using the interest method under the guidance of Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans.” Effective January 1, 2005, the Company adopted and began to account for its investment in finance receivables using the interest method under the guidance of American Institute of Certified Public Accountants (“AICPA”) Statement of Position (“SOP”) 03-3, “Accounting for Loans or Certain Securities Acquired in a Transfer.” For loans acquired in fiscal years beginning prior to December 15, 2004, Practice Bulletin 6 is still effective; however, Practice Bulletin 6 was amended by SOP 03-3 as described further in this note. For loans acquired in fiscal years beginning after December 15, 2004, SOP 03-3 is effective. Under the guidance of SOP 03-3 (and the amended Practice Bulletin 6), static pools of accounts may be established. These pools are aggregated based on certain common risk criteria. Each static pool is recorded at cost, which includes certain direct costs of acquisition paid to third parties, and is accounted for as a single unit for the recognition of income, principal payments and loss provision. Once a static pool is established for a quarter, individual receivable accounts are not added to the pool (unless replaced by the seller) or removed from the pool (unless sold or returned to the seller). SOP 03-3 (and the amended Practice Bulletin 6) requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue or expense or on the balance sheet. SOP 03-3 initially freezes the internal rate of return, referred to as IRR, estimated when the accounts receivable are purchased as the basis for subsequent impairment testing. Significant increases in actual, or expected future cash flows may be recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining life. Any increase to the IRR then becomes the new benchmark for impairment testing. Effective for fiscal years beginning after December 15, 2004 under SOP 03-3 (and the amended Practice Bulletin 6), rather than lowering the estimated IRR if the collection estimates are not received or projected to be received, the carrying value of a pool would be written down to maintain the then current IRR and is shown as a reduction in revenue in the consolidated income statements with a corresponding valuation allowance offsetting the finance receivables, net, on the balance sheet. Income on finance receivables is accrued quarterly based on each static pool’s effective IRR. Quarterly cash flows greater than the interest accrual will reduce the carrying value of the static pool. This reduction in carrying value is defined as payments applied to principal (also referred to as finance receivable amortization). Likewise, cash flows that are less than the accrual will accrete the carrying balance. The Company generally does not allow accretion in the first six to twelve months. The IRR is estimated and periodically recalculated based on the timing and amount of anticipated cash flows using the Company’s proprietary collection models. A pool can become fully amortized (zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue when received. Additionally, the Company uses the cost recovery method when collections on a particular pool of accounts cannot be reasonably predicted. These pools are not aggregated with other portfolios. Under the cost recovery method, no revenue is recognized until the Company has fully collected the cost of the portfolio, or until such time that the Company considers the collections to be probable and estimable and begins to recognize income based on the interest method as described above. At June 30, 2008 and 2007, the Company had unamortized purchased principal (purchase price) in pools accounted for under the cost recovery method of $3,951,461 and $5,142,887, respectively.
     The Company establishes valuation allowances for all acquired accounts subject to SOP 03-3 to reflect only those losses incurred after acquisition (that is, the present value of cash flows initially expected at acquisition that are no longer expected to be collected). Valuation allowances are established only subsequent to acquisition of the accounts. At June 30, 2008 and 2007, the Company had an allowance against its finance receivables of $10,975,000 and $1,755,000, respectively. Prior to January 1, 2005, in the event that a reduction of the yield to as low as zero in conjunction with estimated future cash collections that were inadequate to amortize the carrying balance, an allowance charge would be taken with a corresponding write-off of the receivable balance.

8


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The Company capitalizes certain fees paid to third parties related to the direct acquisition of a portfolio of accounts. These fees are added to the acquisition cost of the portfolio and accordingly are amortized over the life of the portfolio using the interest method. The balance of the unamortized capitalized fees at June 30, 2008 and 2007 was $2,968,805 and $1,798,722, respectively. During the three and six months ended June 30, 2008, the Company capitalized $297,048 and $867,529, respectively, of these direct acquisition fees. During the three and six months ended June 30, 2007, the Company capitalized $549,937 and $793,709, respectively, of these direct acquisition fees. During the three and six months ended June 30, 2008, the Company amortized $170,685 and $333,640, respectively, of these direct acquisition fees. During the three and six months ended June 30, 2007, the Company amortized $165,106 and $317,708, respectively, of these direct acquisition fees.
     The agreements to purchase the aforementioned receivables include general representations and warranties from the sellers covering account holder death or bankruptcy and accounts settled or disputed prior to sale. The representation and warranty period permitting the return of these accounts from the Company to the seller is typically 90 to 180 days. Any funds received from the seller of finance receivables as a return of purchase price are referred to as buybacks. Buyback funds are simply applied against the finance receivable balance received and are not included in the Company’s cash collections from operations. In some cases, the seller will replace the returned accounts with new accounts in lieu of returning the purchase price. In that case, the old account is removed from the pool and the new account is added.
     Changes in finance receivables, net for the three and six months ended June 30, 2008 and 2007 were as follows (amounts in thousands):
                                 
    Three Months Ended     Three Months Ended     Six Months Ended     Six Months Ended  
    June 30, 2008     June 30, 2007     June 30, 2008     June 30, 2007  
Balance at beginning of period
  $ 477,754     $ 243,568     $ 410,297     $ 226,447  
Acquisitions of finance receivables, net of buybacks
    69,608       63,299       163,839       102,263  
 
                               
Cash collections
    (85,042 )     (64,606 )     (164,444 )     (131,915 )
Income recognized on finance receivables, net
    53,047       46,387       105,675       91,853  
 
                       
Cash collections applied to principal
    (31,995 )     (18,219 )     (58,769 )     (40,062 )
 
                       
 
                               
Balance at end of period
  $ 515,367     $ 288,648     $ 515,367     $ 288,648  
 
                       
     At the time of acquisition, the life of each pool is generally estimated to be between 84 to 96 months based on projected amounts and timing of future cash receipts using the proprietary models of the Company. As of June 30, 2008, the Company had $515,366,646 in net finance receivables. Based upon current projections, cash collections applied to principal are estimated to be as follows for the twelve months in the periods ending (amounts in thousands):
         
June 30, 2009
  $ 111,788  
June 30, 2010
    121,120  
June 30, 2011
    107,644  
June 30, 2012
    87,267  
June 30, 2013
    52,181  
June 30, 2014
    28,441  
June 30, 2015
    6,926  
 
     
 
  $ 515,367  
 
     
     During the three and six months ended June 30, 2008, the Company purchased approximately $957.4 million and $2.42 billion, respectively, of face value of charged-off consumer receivables. During the three and six months ended June 30, 2007, the Company purchased approximately $2.54 billion and $4.84 billion, respectively, of face value of charged-off consumer receivables. At June 30, 2008, the estimated remaining collections on the receivables purchased in the three and six months ended June 30, 2008 were $136,486,299 and $310,288,148, respectively. At June 30, 2008, the estimated remaining collections on the receivables purchased in the three and six months ended June 30, 2007 were $99,947,333 and $162,102,214, respectively.

9


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     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 June 30, 2008 and 2007. Reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase in its estimate of future cash flows. Reclassifications to nonaccretable difference from accretable yield results from allowance charges that exceed the Company’s increase in its estimate of future cash flows. Changes in accretable yield for the three and six months ended June 30, 2008 and 2007 were as follows (amounts in thousands):
                                 
    Three Months Ended     Three Months Ended     Six Months Ended     Six Months Ended  
    June 30, 2008     June 30, 2007     June 30, 2008     June 30, 2007  
Balance at beginning of period
  $ 535,559     $ 354,526     $ 492,269     $ 326,775  
Income recognized on finance receivables, net
    (53,047 )     (46,387 )     (105,675 )     (91,853 )
Additions
    69,405       74,375       163,390       126,590  
Reclassifications from/(to) nonaccretable difference
    (2,201 )     28,329       (268 )     49,331  
 
                       
Balance at end of period
  $ 549,716     $ 410,843     $ 549,716     $ 410,843  
 
                       
     During the three and six months ended June 30, 2008, the Company recorded $4,100,000 and $6,885,000, respectively, in allowance charges on pools that had underperformed the Company’s most recent expectations as of June 30, 2008. During the three and six months ended June 30, 2008, the Company also reversed $140,000 of allowance charges recorded in prior periods. During the three and six months ended June 30, 2007, the Company recorded $90,000 and $700,000, respectively, in allowance charges on pools that had underperformed the Company’s most recent expectations as of June 30, 2007. During the three and six months ended June 30, 2007, the Company also reversed $0 and $245,000, respectively, of allowance charges recorded in prior periods. The change in the valuation allowance for the three and six months ended June 30, 2008 and 2007 is as follows (amounts in thousands):
                                 
    Three Months Ended     Three Months Ended     Six Months Ended     Six Months Ended  
    June 30, 2008     June 30, 2007     June 30, 2008     June 30, 2007  
Balance at beginning of period
  $ 7,015     $ 1,665     $ 4,230     $ 1,300  
Allowance charges recorded
    4,100       90       6,885       700  
Reversal of previously recorded allowance charges
    (140 )           (140 )     (245 )
 
                       
Change in allowance charge
    3,960       90       6,745       455  
 
                       
Balance at end of period
  $ 10,975     $ 1,755     $ 10,975     $ 1,755  
 
                       
3. Line of Credit:
     On November 29, 2005, the Company entered into a Loan and Security Agreement for a revolving line of credit jointly offered by Bank of America, N. A. and Wachovia Bank, National Association. The agreement was amended on May 9, 2006 to include RBC Centura Bank as an additional lender, again on May 4, 2007 to increase the line of credit to $150,000,000 and incorporate a $50,000,000 non-revolving fixed rate sub-limit, again on October 26, 2007 to increase the line of credit to $270,000,000, again on March 18, 2008 to increase the non-revolving fixed rate sub-limit to $100,000,000 and again on May 2, 2008 to include SunTrust Bank as an additional lender and to increase the line of credit to $340,000,000. The agreement is a revolving line of credit in an amount equal to the lesser of $340,000,000 or 30% of the Company’s estimated remaining collections of all its eligible asset pools. Borrowings under the revolving credit facility bear interest at a floating rate equal to the LIBOR Market Index Rate plus 1.40% and the facility expires on May 2, 2011. The loan is collateralized by substantially all the tangible and intangible assets of the Company. The agreement provides as follows:

10


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
    monthly borrowings may not exceed 30% of estimated remaining collections;
 
    funded debt to EBITDA (defined as net income, less income or plus loss from discontinued operations and extraordinary items, plus income taxes, plus interest expense, plus depreciation, depletion, amortization (including finance receivable amortization) and other non-cash charges) ratio must be less than 2.0 to 1.0 calculated on a rolling twelve-month average;
 
    tangible net worth must be at least 100% of prior quarter tangible net worth plus 25% of cumulative positive net income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering without giving effect to reductions in tangible net worth due to repurchases of up to $100,000,000 of the Company’s common stock; and
 
    restrictions on change of control.
     As of June 30, 2008, outstanding borrowings under the facility totaled $234,300,000, of which $50,000,000 was part of the non-revolving fixed rate sub-limit which bears interest at 6.80% and expires on May 4, 2012. As of June 30, 2008, the Company is in compliance with all of the covenants of the agreement.
4. Property and Equipment, net:
     Property and equipment, at cost, consist of the following as of the dates indicated (amounts in thousands):
                 
         June 30,          December 31,  
    2008     2007  
Software
  $ 7,106     $ 6,147  
Computer equipment
    6,378       6,083  
Furniture and fixtures
    4,912       4,758  
Equipment
    5,121       4,742  
Leasehold improvements
    3,317       2,557  
Building and improvements
    5,841       5,123  
Land
    992       939  
Accumulated depreciation and amortization
    (16,335 )     (14,178 )
 
           
Property and equipment, net
  $ 17,332     $ 16,171  
 
           
     Depreciation and amortization expense, relating to property and equipment, for the three and six months ended June 30, 2008 was $1,144,893 and $2,252,855, respectively. Depreciation and amortization expense, relating to property and equipment, for the three and six months ended June 30, 2007 was $871,312 and $1,675,526, respectively.
     Beginning in July 2006 upon initiation of certain internally developed software projects, in accordance with the provisions of SOP 98-1, “Accounting for the Costs of Computer Software Developed or Obtained for Internal Use,” the Company began capitalizing qualifying computer software costs incurred during the application development stage and amortizing them over their estimated useful life of three to five 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 June 30, 2008, the Company has incurred and capitalized $616,325 of these direct payroll costs related to software developed for internal use. Of these costs, $173,610 is for projects that are in the development stage and, therefore are a component of Other Assets. Once the projects are completed, the costs will be transferred to Software and amortized over their estimated useful life of three to five years. Amortization expense for the three and six months ended June 30, 2008 was $22,136 and $44,272, respectively. Amortization expense for the three and six months ended June 30, 2007 was $3,313 and $6,625, respectively. The remaining unamortized costs relating to this internally developed software at June 30, 2008 and 2007 were $376,990 and $57,418, respectively.

11


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
5. Goodwill and Intangible Assets, net:
     With the acquisition of IGS on October 1, 2004, RDS on July 29, 2005 and The Palmer Group on July 25, 2007, the Company purchased certain tangible and intangible assets. Intangible assets purchased included client and customer relationships, non-compete agreements and goodwill. In accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard (“SFAS”) No. 142, “Goodwill and Other Intangible Assets” (“SFAS 142”), the Company is amortizing the IGS client relationships over seven years, the RDS customer relationships over ten years and the non-compete agreements over three years for both the IGS and RDS acquisitions, with a combined original weighted average amortization period of 7.54 years. For The Palmer Group acquisition, the Company is amortizing the customer relationship over the remaining life of the contract, which at the date of acquisition, was 29 months. The Company reviews these relationships at least annually for impairment. Total amortization expense was $361,670 and $723,340 for the three and six months ended June 30, 2008, respectively. Total amortization expense was $490,670 and $981,339 for the three and six months ended June 30, 2007, respectively. In addition, goodwill, pursuant to SFAS 142, is not amortized but rather is reviewed at least annually for impairment. During the fourth quarter of 2007, the Company underwent its annual review of goodwill. Based upon the results of this review, which was conducted as of October 1, 2007, 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 June 30, 2008 that would necessitate an impairment charge to goodwill or the other intangible assets. The Company will undergo its annual goodwill review during the fourth quarter of 2008. At June 30, 2008 and December 31, 2007, the carrying value of goodwill was $18,620,277.
6. Share-Based Compensation:
     The Company has a stock option and nonvested share plan. The Amended and Restated Portfolio Recovery Associates 2002 Stock Option Plan and 2004 Restricted Stock Plan was approved by the Company’s shareholders at its Annual Meeting of Shareholders on May 12, 2004, enabling the Company to issue to its employees and directors nonvested shares of stock, as well as stock options.
     Effective January 1, 2002, the Company adopted the fair value recognition provisions of SFAS No. 123 (“SFAS 123”), “Accounting for Stock-Based Compensation,” prospectively to all employee awards granted, modified, or settled after January 1, 2002. All stock-based compensation measured under the provisions of APB 25 became fully vested during 2002. All stock-based compensation expense recognized thereafter was derived from stock-based compensation based on the fair value method prescribed in SFAS 123. Effective January 1, 2006, the Company adopted SFAS No. 123R (“SFAS 123R”), “Share-Based Payment” using the modified prospective approach. The adoption of SFAS 123R had no material impact on the Company’s Consolidated Income Statement or on previously reported interim periods. As of June 30, 2008, total future compensation costs related to nonvested awards of stock options and nonvested shares (not including nonvested shares granted under the Long-Term Incentive Program) is estimated to be $11,000 and $3.9 million, respectively, with a weighted average remaining life of 1.6 years for stock options and 3.1 years for nonvested shares (not including nonvested shares granted under the Long-Term Incentive Programs). Based upon historical data, the Company used an annual forfeiture rate of 13.72% for stock options and 15-35% for nonvested shares for most of the employee grants. Grants made to key employee hires and directors of the Company were assumed to have no forfeiture rates associated with them due to the historically low turnover among this group. In addition, commensurate with the adoption of SFAS 123R, all previous references to “restricted” stock are now referred to as “nonvested” shares.
     Total share-based compensation expense was $424,006 and $1,162,601 for the three and six months ended June 30, 2008, respectively. Total share-based compensation expense was $837,758 and $1,364,364 for the three and six months ended June 30, 2007, respectively. Tax benefits resulting from tax deductions in excess of share-based compensation expense recognized under the fair value recognition provisions of SFAS 123R (windfall tax benefits) are credited to additional paid-in capital in the Company’s Consolidated Balance Sheets. Realized tax shortfalls are first offset against the cumulative balance of windfall tax benefits, if any, and then charged directly to income tax expense. The total tax benefit realized from share-based compensation was $210,733 and $452,817 for the three and six months ended June 30, 2008, respectively. The total tax benefit realized from share-based compensation was $1.2 million and $1.3 million for the three and six months ended June 30, 2007, respectively.

12


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Stock Options
     The Company created the 2002 Stock Option Plan (the “Plan”) on November 7, 2002. The Plan was amended in 2004 (the “Amended Plan”) to enable the Company to issue nonvested shares of stock to its employees and directors. The Amended Plan was approved by the Company’s shareholders at its Annual Meeting on May 12, 2004. Up to 2,000,000 shares of common stock may be issued under the Amended Plan. The Amended Plan expires November 7, 2012. With the exception of the Long-Term Incentive Program, all options and nonvested shares issued under the Amended Plan vest ratably over five years. Granted options expire seven years from grant date. Expiration dates range between November 7, 2009 and January 16, 2011. Options granted to a single person cannot exceed 200,000 in a single year. At June 30, 2008, 895,000 options have been granted under the Amended Plan, of which 118,305 have been cancelled.
     The Company granted no options during the three or six months ended June 30, 2008 and 2007. All of the stock options which have been granted under the Amended Plan were granted to employees of the Company except for 40,000 which were granted to non-employee directors. The total intrinsic value of options exercised during the three and six months ended June 30, 2008 was approximately $70,000 and $550,000, respectively. The total intrinsic value of options exercised during the three and six months ended June 30, 2007 was approximately $2.4 million and $2.6 million, respectively.
     The following summarizes all option related transactions from December 31, 2006 through June 30, 2008 (amounts in thousands except per share amounts):
                         
            Weighted-Average     Weighted-Average  
    Options     Exercise Price Per     Fair Value Per  
    Outstanding     Share     Share  
December 31, 2006
    301     $ 16.43     $ 3.27  
Exercised
    (130 )     15.97       3.33  
Cancelled
    (8 )     13.00       2.71  
 
                 
December 31, 2007
    163       16.97       3.25  
Exercised
    (23 )     13.14       2.74  
Cancelled
    (1 )     25.48       5.48  
 
                 
June 30, 2008
    139     $ 17.51     $ 3.31  
 
                 
     The following information is as of June 30, 2008 (amounts in thousands except per share amounts):
                                                         
    Options Outstanding     Options Exercisable  
                    Weighted-Average                     Weighted-Average        
Exercise   Number     Average Remaining     Exercise Price Per     Aggregate     Number     Exercise Price Per     Aggregate  
Prices   Outstanding     Contractual Life     Share     Intrinsic Value     Exercisable     Share     Intrinsic Value  
$13.00
    93       1.4     $ 13.00     $ 2,272       93     $ 13.00     $ 2,272  
$16.16
    6       1.4       16.16       139       6       16.16       139  
$27.77 – $29.79
    40       2.2       28.19       372       27       28.27       249  
 
                                         
Total as of June 30, 2008
    139       1.6     $ 17.51     $ 2,783       126     $ 16.43     $ 2,660  
 
                                         
     The Company utilizes the Black-Scholes option pricing model to calculate the value of the stock options when granted. This model was developed to estimate the fair value of traded options, which have different characteristics than employee stock options. In addition, changes to the subjective input assumptions can result in materially different fair market value estimates. Therefore, the Black-Scholes model may not necessarily provide a reliable single measure of the fair value of employee stock options.

13


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Nonvested Shares
     Prior to the approval of the Amended Plan, nonvested shares were permitted to be issued as an incentive to attract new employees and, effective commensurate with the adoption of the Amended Plan at the meeting of shareholders held on May 12, 2004, are permitted to be issued to directors and existing employees. With the exception of the awards made pursuant to the Long-Term Incentive Program, the terms of the nonvested share awards are similar to those of the stock option awards, wherein the nonvested shares vest ratably over five years and are expensed over their vesting period.
     The following summarizes all nonvested share transactions from December 31, 2006 through June 30, 2008 (amounts in thousands except per share amounts):
                 
    Nonvested     Weighted-  
    Shares     Average Price  
    Outstanding     at Grant Date  
December 31, 2006
    171     $ 40.59  
Granted
    9       43.42  
Vested
    (41 )     38.74  
Cancelled
    (16 )     38.23  
 
           
December 31, 2007
    123       41.72  
Granted
    15       38.26  
Vested
    (15 )     45.42  
Cancelled
    (10 )     38.99  
 
           
June 30, 2008
    113     $ 41.01  
 
           
     The total grant date fair value of shares vested during the three and six months ended June 30, 2008 was $517,345 and $679,870, respectively. The total grant date fair value of shares vested during the three and six months ended June 30, 2007 was $556,566 and $697,056, respectively.
Long-Term Incentive Programs
     Pursuant to the Amended Plan, on March 30, 2007 and January 4, 2008, the Compensation Committee approved the grant of 96,550 and 80,000, respectively, of performance based nonvested shares. The shares were granted to key employees of the Company. The grant is performance based and cliff vests after the requisite service period of three years if certain financial goals are met. The goals are based upon cumulative diluted earnings per share (“EPS”) totals for the 2007, 2008 and 2009 years for the 2007 grant and EPS totals for the 2008, 2009 and 2010 years for the 2008 grant, as well as the return on invested capital for the same periods. The number of shares granted can double if the financial goals are exceeded or no shares can be granted if the financial goals are not met. For both the 2007 and 2008 grants, the Company is expensing the nonvested shares over the requisite service period of three years beginning January 1, 2007 and 2008, respectively. If the Company believes that the number of shares granted will be more or less than originally projected, an adjustment to the expense will be made at that time based on the probable outcome. At June 30, 2008, total future compensation costs related to nonvested share awards granted under the Long-Term Incentive Programs are estimated to be approximately $2.6 million. The Company assumed a 7.5% forfeiture rate for these grants and the shares have a weighted average life of 1.96 years at June 30, 2008. The following summarizes all performance based nonvested share transactions from December 31, 2006 through June 30, 2008 (amounts in thousands except per share amounts):
                 
    Performance Based     Weighted-  
    Nonvested Shares     Average Price  
    Outstanding     at Grant Date  
December 31, 2006
        $  
Granted
    97       44.65  
Cancelled
    (2 )     44.65  
 
           
December 31, 2007
    95       44.65  
Granted
    80       36.22  
Cancelled
    (4 )     41.10  
 
           
June 30, 2008
    171     $ 40.78  
 
           

14


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
7. Income Taxes – FIN 48:
     On July 13, 2006, the FASB issued Interpretation No. 48 (“FIN 48”), “Accounting for Uncertainty in Income Taxes—an interpretation of FASB Statement No. 109.” FIN 48 clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109, “Accounting for Income Taxes.” FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. The evaluation of a tax position in accordance with FIN 48 is a two-step process. The first step is recognition: the enterprise determines whether it is more-likely-than-not that a tax position will be sustained upon examination, including resolution of any related appeals or litigation processes, based on the technical merits of the position. In evaluating whether a tax position has met the more-likely-than-not recognition threshold, the enterprise should presume that the position will be examined by the appropriate taxing authority that would have full knowledge of all relevant information. The second step is measurement: a tax position that meets the more-likely-than-not recognition threshold is measured to determine the amount of benefit to recognize in the financial statements. The tax position is measured as the largest amount of benefit that is greater than 50 percent likely of being realized upon ultimate settlement. Tax positions that previously failed to meet the more-likely-than-not recognition threshold should be recognized in the first subsequent financial reporting period in which that threshold is met. Previously recognized tax positions that no longer meet the more-likely-than-not recognition threshold should be derecognized in the first subsequent financial reporting period in which that threshold is no longer met.
     The Company adopted the provisions of FIN 48 with respect to all of its tax positions as of January 1, 2007. Total unrecognized tax benefits at June 30, 2008 and 2007 were approximately $180,000 and $388,000, respectively. Due to the approval by the Internal Revenue Service of an application for a change in accounting method with respect to one of the Company’s tax positions, the balance of unrecognized tax benefits at the date adoption was reduced by $208,000. This reduction did not have an impact on the annual effective rate since the ultimate deductibility of these benefits was highly certain, and only the timing of deductibility was uncertain. The remaining unrecognized tax benefits balance of $180,000 at June 30, 2008 relates to items that when recognized would result in an adjustment to additional paid-in capital and, therefore, would not affect the annual effective tax rate.
     The Company was notified on June 21, 2007 that it is currently being examined by the Internal Revenue Service for the 2005 calendar year. At June 30, 2008, the tax years that remain subject to examination by the major taxing jurisdictions, including the Internal Revenue Service, are 2002 and subsequent years. The 2002 and 2003 tax years are still open to examination because of net operating losses that originated in those years but were not fully utilized until the 2004 and 2005 tax years.

15


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     FIN 48 requires the recognition of interest, if the tax law would require interest to be paid on the underpayment of taxes, and recognition of penalties, if a tax position does not meet the minimum statutory threshold to avoid payment of penalties. Penalties and interest may be classified as either penalties and interest expense or income tax expense. Management has elected to classify accrued penalties and interest as income tax expense. Accrued penalties and interest as of January 1, 2007, in the amount of $77,000, were recorded to beginning of year retained earnings at the date of adoption. Due to the approved application for change in accounting method, the balance of accrued penalties and interest was reduced by $67,000 during 2007. There were no material increases to the amount of accrued interest and penalties for the three or six months ended June 30, 2008.
8. Earnings per Share:
     Basic EPS are computed by dividing income available to common shareholders by weighted average common shares outstanding. Diluted EPS are computed using the same components as basic EPS with the denominator adjusted for the dilutive effect of stock options and nonvested share awards. Share-based awards that are contingent upon the attainment of performance goals are not included in the computation of diluted EPS until the performance goals have been attained. The following tables provide a reconciliation between the computation of basic EPS and diluted EPS for the three and six months ended June 30, 2008 and 2007 (amounts in thousands except per share amounts):
                                                 
    For the three months ended June 30,  
            2008                     2007        
            Weighted Average                     Weighted Average        
    Net Income     Common Shares     EPS     Net Income     Common Shares     EPS  
     
Basic EPS
  $ 11,426       15,193     $ 0.75     $ 12,989       16,005     $ 0.81  
Dilutive effect of stock options
and nonvested share awards
            75                       163          
 
                                           
Diluted EPS
  $ 11,426       15,268     $ 0.75     $ 12,989       16,168     $ 0.80  
 
                                           
                                                 
    For the six months ended June 30,  
            2008                     2007        
            Weighted Average                     Weighted Average        
    Net Income     Common Shares     EPS     Net Income     Common Shares     EPS  
     
Basic EPS
  $ 23,298       15,182     $ 1.53     $ 25,870       15,999     $ 1.62  
Dilutive effect of stock options
and nonvested share awards
            70                       155          
 
                                           
Diluted EPS
  $ 23,298       15,252     $ 1.53     $ 25,870       16,154     $ 1.60  
 
                                           
     There were no antidilutive options or nonvested shares outstanding for the three or six months ended June 30, 2008 or 2007.
9. Commitments and Contingencies:
Employment Agreements:
     The Company has employment agreements with all of its executive officers and with several members of its senior management group, most of which expire on December 31, 2008. Such agreements provide for base salary payments as well as bonus entitlement, based on the attainment of specific personal and Company goals. Estimated future compensation under these agreements is approximately $4.0 million and is expected to be paid through December 31,2011. The agreements also contain confidentiality and non-compete provisions.
Leases:
     The Company is party to various operating and capital leases with respect to its facilities and equipment. For further discussion of these leases please refer to the Company’s audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K/A, as filed for the year ended December 31,2007.

16


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 June 30, 2008 is approximately $89.6 million.
Litigation:
     The Company is from time to time subject to routine legal proceedings which are incidental to the ordinary course of our business. The Company initiates lawsuits against consumers and is occasionally countersued by them in such actions. Also, consumers initiate litigation against the Company, in which they allege that the Company has violated a state or federal law in the process of collecting on an account. The Company believes that the results of any pending legal proceedings will not have a material adverse effect on the financial condition, results of operations or liquidity of the Company.
10. Recent Accounting Pronouncements:
     On September 15, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. SFAS 157 was originally effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years but was amended on February 6, 2008 to defer the effective date for one year for certain nonfinancial assets and liabilities. The Company adopted of SFAS 157 on January 1, 2008, which had no material impact on its financial statements.
     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 is effective for fiscal years beginning after November 15, 2007. SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. The Company adopted of SFAS 159 on January 1, 2008, which had no material impact on its financial statements
     In December 2007, the FASB issued SFAS No. 141R, “Business Combinations,” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination, recognizing assets acquired and liabilities assumed arising from contingencies, and determining what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for acquisitions consummated in fiscal years beginning after December 15, 2008. The Company expects SFAS 141R will have an impact on its consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions that the Company consummates after the effective date.
     In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method significantly changes the accounting for transactions with minority interest holders. SFAS 160 is effective for fiscal years beginning after December 15, 2008 with early application prohibited. The Company believes SFAS 160 will have no material impact on its consolidated financial statements.

17


 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities” (“SFAS 161”). SFAS 161 requires expanded disclosures regarding the location and amounts of derivative instruments in an entity’s financial statements, how derivative instruments and related hedged items are accounted for under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”, and how derivative instruments and related hedged items affect an entity’s financial position, operating results and cash flows. SFAS 161 is effective for periods beginning on or after November 15, 2008. The Company is currently evaluating what impact SFAS 161 will have on its consolidated financial statements.
     In April 2008, the FASB issued Staff Position (“FSP”) 142-3, “Determination of the Useful Life of Intangible Assets”, (“FSP 142-3”). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets”. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. The Company is currently evaluating what impact FSP 142-3 will have on its consolidated financial statements.
11. Subsequent Event:
     On July 1, 2008, the Company acquired 100% of the membership interests of MuniServices, LLC (“MuniServices”), a privately held company specializing in revenue enhancement for government clients. The transaction was completed at a price of $24.6 million, consisting of $22.5 million in cash and $2.1 million in PRA Inc common stock. The total purchase price could increase by a total of $4.5 million in stock through contingent payments in 2008 and 2009, related to specific operating goals. MuniServices President and Chief Executive Officer, Marc Herman, and his top management team have signed long-term employment agreements and will continue to manage MuniServices.
     The common stock component of the purchase price resulted in the issuance of 163,622 shares of unregistered stock to the sellers of MuniServices of which 112,018 shares are being held in escrow and are subject to the earn out and target revenue provisions of the asset purchase agreement. The share count was determined by using a formula agreed to by both parties and contained within the asset purchase agreement.
     The Company is currently in the process of obtaining an independent valuation of the acquisition. When completed, the Company will account for the acquisition in accordance with FAS141, “Business Combinations” and will apply the provisions of FAS142, “Goodwill and Other Intangible Assets” to the acquired intangible assets.

18


 

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:
    our ability to purchase defaulted consumer receivables at appropriate prices;
 
    changes in the business practices of credit originators in terms of selling defaulted consumer receivables or outsourcing defaulted consumer receivables to third-party contingent fee collection agencies;
 
    changes in government regulations that affect our ability to collect sufficient amounts on our acquired or serviced receivables;
 
    changes in income tax laws or challenges by taxing authorities could have an adverse effect on our financial condition and results of operations;
 
    changes in bankruptcy laws that could negatively affect our business;
 
    our ability to employ and retain qualified employees, especially collection and information technology personnel;
 
    changes in the credit or capital markets, which affect our ability to borrow money or raise capital to purchase or service defaulted consumer receivables;
 
    the degree and nature of our competition;
 
    our ability to comply with the provisions of the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder;
 
    our ability to secure sufficient levels of placements for our fee-for-service businesses;
 
    the sufficiency of our funds generated from operations, existing cash and available borrowings to finance our current operations; and
 
    the risk factors listed from time to time in our filings with the SEC.
     You should assume that the information appearing in this quarterly report is accurate only as of the date it was issued. Our business, financial condition, results of operations and prospects may have changed since that date.
     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 2007 Annual Report on Form 10-K/A, filed on March 12, 2008.
     Our forward-looking statements could be wrong in light of these and other risks, uncertainties and assumptions. The future events, developments or results described in this report could turn out to be materially different. We have no obligation to publicly update or revise our forward-looking statements after the date of this 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.

19


 

Results of Operations
     The following table sets forth certain operating data as a percentage of total revenues for the periods indicated:
                                 
    For the Three Months   For the Six Months
    Ended June 30,   Ended June 30,
    2008   2007   2008   2007
Revenues:
                               
Income recognized on finance receivables, net
    83.4 %     84.7 %     82.7 %     84.4 %
Commissions
    16.6 %     15.3 %     17.3 %     15.6 %
 
                               
Total revenues
    100.0 %     100.0 %     100.0 %     100.0 %
Operating expenses:
                               
Compensation and employee services
    32.8 %     30.5 %     32.9 %     30.4 %
Outside legal and other fees and services
    23.7 %     20.5 %     23.3 %     20.9 %
Communications
    3.8 %     3.7 %     4.1 %     3.6 %
Rent and occupancy
    1.4 %     1.3 %     1.3 %     1.3 %
Other operating expenses
    2.5 %     2.7 %     2.3 %     2.6 %
Depreciation and amortization
    2.4 %     2.5 %     2.3 %     2.4 %
 
                               
Total operating expenses
    66.6 %     61.2 %     66.2 %     61.2 %
 
                               
Income from operations
    33.4 %     38.8 %     33.8 %     38.8 %
Other income and (expense):
                               
Interest income
    0.1 %     0.2 %     0.0 %     0.3 %
Interest expense
    (4.2 %)     (0.6 %)     (4.0 %)     (0.4 %)
 
                               
Income before income taxes
    29.3 %     38.4 %     29.8 %     38.7 %
Provision for income taxes
    11.3 %     14.7 %     11.5 %     14.9 %
 
                               
Net income
    18.0 %     23.7 %     18.3 %     23.8 %
 
                               
     We use the following terminology throughout our reports: “Cash Receipts” refers to all collections of cash, regardless of the source. “Cash Collections” refers to collections on our owned portfolios only, exclusive of commission income and sales of finance receivables. “Cash Sales of Finance Receivables” refers to the sales of our owned portfolios. “Commissions” refers to fee income generated from our wholly-owned contingent fee and fee-for-service subsidiaries.
Three Months Ended June 30, 2008 Compared To Three Months Ended June 30, 2007
Revenues
     Total revenues were $63.6 million for the three months ended June 30, 2008, an increase of $8.8 million or 16.1% compared to total revenues of $54.8 million for the three months ended June 30, 2007.
Income Recognized on Finance Receivables, net
     Income recognized on finance receivables, net was $53.0 million for the three months ended June 30, 2008, an increase of $6.6 million or 14.2% compared to income recognized on finance receivables, net of $46.4 million for the three months ended June 30, 2007. The majority of the increase was due to an increase in our cash collections on our owned defaulted consumer receivables to $85.0 million from $64.6 million, an increase of 31.6%. Our finance receivables amortization rate, including the allowance charge, on our owned portfolio for the three months ended June 30, 2008 was 37.6% while for the three months ended June 30, 2007 it was 28.2%. During the three months ended June 30, 2008, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $957.4 million at a cost of $71.1 million. During the three months ended June 30, 2007, we acquired defaulted consumer receivable portfolios with an aggregate face value of $2.54 billion at a cost of $63.4 million. In any period, we acquire defaulted consumer receivables that can vary dramatically in their age, type and ultimate collectibility. We may pay significantly different purchase rates for purchased receivables within any period as a result of this quality fluctuation. In addition, market forces can drive pricing rates up or down in any period, irrespective of other quality fluctuations. As a result, the average purchase rate paid for any given period can fluctuate dramatically based on our particular buying activity in that period. However, regardless of the average purchase price, we intend to target a similar internal rate of return in pricing our portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to estimated profitability of a period’s buying.

20


 

     Income recognized on finance receivables, net is shown net of changes in valuation allowances recognized under SOP 03-3, which requires that a valuation allowance be taken for decreases in expected cash flows or change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the three months ended June 30, 2008 we recorded net allowance charges of $3,960,000. For the three months ended June 30, 2007. we recorded net allowance charges of $90,000.
Commissions
     Commissions were $10.6 million for the three months ended June 30, 2008, an increase of $2.2 million or 26.2% compared to commissions of $8.4 million for the three months ended June 30, 2007, Commissions grew as a result of increases in revenue generated by our IGS fee-for-service business and RDS government processing and collection business partially offset by a decrease in our Anchor contingent fee business compared to the prior year period.
Operating Expenses
     Total operating expenses were $42.4 million for the three months ended June 30, 2008, an increase of $8.9 million or 26.6% compared to total operating expenses of $33.5 million for the three months ended June 30, 2007. Total operating expenses, including compensation and employee services expenses, were 44.3% of cash receipts for the three months ended June 30, 2008 compared to 45.9% for the same period in 2007.
Compensation and Employee Services
     Compensation and employee services expenses were $20.9 million for the three months ended June 30, 2008, an increase of $4.2 million or 25.1% compared to compensation and employee services expenses of $16.7 million for the three months ended June 30, 2007. Compensation and employee services expenses increased as total employees grew 24.8% to 1,798 as of June 30, 2008 from 1,441 as of June 30, 2007. Compensation and employee services expenses as a percentage of cash receipts decreased to 21.8% for the three months ended June 30, 2008 from 22.9% of cash receipts for the same period in 2007, mainly due to increased productivity in non-legal cash collections compared to the prior year period as well as increased productivity in our IGS fee-for-service business.
Outside Legal and Other Fees and Services
     Outside legal and other fees and services expenses were $15.1 million for the three months ended June 30, 2008, an increase of $3.9 million or 34.8% compared to outside legal and other fees and services expenses of $11.2 million for the three months ended June 30, 2007. Of the $3.9 million increase, $1.9 million was attributable to increases in agency fees mainly incurred by our IGS subsidiary, $0.2 million was attributable to an increase in legal and accounting fees, $0.5 million was attributable to an increase in other outside fees and services, and a $0.1 million decrease in credit bureau fees. The remaining $1.4 million of the increase was attributable to the increased cash collections resulting from the increased number of accounts referred to independent contingent fee attorneys. This increase is consistent with the growth we experienced in our portfolio of defaulted consumer receivables and a portfolio management strategy shift implemented in mid-2002. This strategy resulted in our referring to the legal suit process more previously unsuccessfully liquidated accounts that have an identified means of repayment but that are nearing their legal statute of limitations, than had been referred historically. Legal cash collections generated by independent contingent fee attorneys represented 26.4% of total cash collections for the three months ended June 30, 2008 compared to 32.4% for the three months ended June 30, 2007. Total outside legal expenses for the three months ended June 30, 2008 were 40.1% of legal cash collections generated by independent contingent fee attorneys compared to 36.6% for the three months ended June 30, 2007. Additionally, as disclosed previously, we also effectuate legal collections using our own in house attorneys. Their results are not shown in the legal cash collections generated by independent contingent fee attorneys, however, the court costs they generate are included in this expense line item. Our in house attorneys contributed $1.9 million and $1.4 million in cash collections for the three months ended June 30, 2008 and 2007, respectively. Taking that into consideration, if we exclude the legal fees and costs incurred by our in house attorneys, the outside legal expenses to legal cash collection ratio would change from 40.1% to 36.1% for the three months ended June 30, 2008 and from 36.6% to 35.2% for the three months ended June 30, 2007. Outside legal fees and costs increased from $7.6 million for the three months ended June 30, 2007 to $9.0 million, an increase of $1.4 million or 18.4%, for the three months ended June 30, 2008.

21


 

Communications
     Communications expenses were $2.4 million for the three months ended June 30, 2008, an increase of $0.4 million or 20.0% compared to communications expenses of $2.0 million for the three months ended June 30, 2007. The increase was attributable to growth in mailings and higher telephone expenses incurred to collect on a greater number of defaulted consumer receivables owned and serviced. Mailing expenses were responsible for 40.4% of this increase, while the remaining 59.6% was mainly attributable to higher telephone expenses.
Rent and Occupancy
     Rent and occupancy expenses were $869,000 for the three months ended June 30, 2008, an increase of $130,000 or 17.6% compared to rent and occupancy expenses of $739,000 for the three months ended June 30, 2007. The increase was primarily due to the addition of our new Norfolk, Virginia administrative and executive facility as well as increased utility charges.
Other Operating Expenses
     Other operating expenses were $1.6 million for the three months ended June 30, 2008, an increase of $0.1 million or 6.7% compared to other operating expenses of $1.5 million for the three months ended June 30, 2007. The increase was due to increases in taxes (non-income), fees and licenses, repairs and maintenance, dues and subscriptions and other miscellaneous expenses, as well as decreases in travel and meals, hiring, and insurance expenses. Taxes (non-income), fees and licenses expenses increased by $18,000, repairs and maintenance expenses increased by $63,000, dues and subscriptions expenses increased by $15,000, and other miscellaneous expenses increased by $119,000. Travel and meals expenses decreased by $31,000, hiring expenses decreased by $52,000, and insurance expenses decreased by $15,000.
Depreciation and Amortization
     Depreciation and amortization expenses were $1.5 million for the three months ended June 30, 2008, an increase of $0.1 million or 7.1% compared to depreciation and amortization expenses of $1.4 million for the three months ended June 30, 2007. The increase is mainly due to capital purchases in our new administrative and executive facility in Norfolk, Virginia and continued capital expenditures on equipment, software and computers related to our growth and systems upgrades.
Interest Income
     Interest income was $3,000 for the three months ended June 30, 2008, a decrease of $118,000 compared to interest income of $ 121,000 for the three months ended June 30, 2007. This decrease is the result of lower average invested cash and cash equivalents balances during the three months ended June 30, 2008 compared to the same period in 2007.
Interest Expense
     Interest expense was $2.6 million for the three months ended June 30, 2008, an increase of $2.3 million compared to interest expense of $0.3 million for the three months ended June 30, 2007. The increase is mainly due to a significant increase in outstanding borrowings on our line of credit during the three months ended June 30, 2008 compared to the same period in 2007.
Provision for Income Taxes
     Income tax expense was $7.2 million for the three months ended June 30, 2008, a decrease of $0.9 million or 11.1% compared to income tax expense of $8.1 million for the three months ended June 30, 2007. The decrease is mainly due to an 11.6% decrease in pretax income partially offset by a slight increase in the effective tax rate to 38.6% for the three months ended June 30, 2008, as compared to 38.3% for the three months ended June 30, 2007.

22


 

Six Months Ended June 30, 2008 Compared To Six Months Ended June 30, 2007
Revenues
     Total revenues were $127.7 million for the six months ended June 30, 2008, an increase of $18.9 million or 17.4% compared to total revenues of $108.8 million for the six months ended June 30, 2007.
Income Recognized on Finance Receivables, net
     Income recognized on finance receivables, net was $105.7 million for the six months ended June 30, 2008, an increase of $13.8 million or 15.0% compared to income recognized on finance receivables, net of $91.9 million for the six months ended June 30, 2007. The majority of the increase was due to an increase in our cash collections on our owned defaulted consumer receivables to $164.4 million from $131.9 million, an increase of 24.6%. Our finance receivables amortization rate, including the allowance charge, on our owned portfolio for the six months ended June 30, 2008 was 35.7% while for the six months ended June 30, 2007 it was 30.4%. During the six months ended June 30, 2008, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $2.42 billion at a cost of $166.6 million. During the six months ended June 30, 2007, we acquired defaulted consumer receivable portfolios with an aggregate face value of $4.84 billion at a cost of $103.0 million. In any period, we acquire defaulted consumer receivables that can vary dramatically in their age, type and ultimate collectibility. We may pay significantly different purchase rates for purchased receivables within any period as a result of this quality fluctuation. In addition, market forces can drive pricing rates up or down in any period, irrespective of other quality fluctuations. As a result, the average purchase rate paid for any given period can fluctuate dramatically based on our particular buying activity in that period. However, regardless of the average purchase price, we intend to target a similar internal rate of return in pricing our portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to estimated profitability of a period’s buying.
     Income recognized on finance receivables, net is shown net of valuation allowances recognized under SOP 03-3, which requires that a valuation allowance be taken for decreases in expected cash flows or change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the six months ended June 30, 2008, we recorded net allowance charges of $6,745,000. For the six months ended June 30, 2007, we recorded net allowance charges of $455,000.
Commissions
     Commissions were $22.0 million for the six months ended June 30, 2008, an increase of $5.1 million or 30.2% compared to commissions of $16.9 million for the six months ended June 30, 2007. Commissions grew as a result of increases in revenue generated by our IGS fee-for-service business and RDS government processing and collection business partially offset by a decrease in our Anchor contingent fee business compared to the prior year period.
Operating Expenses
     Total operating expenses were $84.6 million for the six months ended June 30, 2008, an increase of $18.0 million or 27.0% compared to total operating expenses of $66.6 million for the six months ended June 30, 2007. Total operating expenses, including compensation and employee services expenses, were 45.4% of cash receipts for the six months ended June 30, 2008 compared to 44.8% for the same period in 2007.
Compensation and Employee Services
     Compensation and employee services expenses were $42.0 million for the six months ended June 30, 2008, an increase of $8.9 million or 26.9% compared to compensation and employee services expenses of $33.1 million for the six months ended June 30, 2007. Compensation and employee services expenses increased as total employees grew 24.8% to 1,798 as of June 30, 2008 from 1,441 as of June 30, 2007. Compensation and employee services expenses as a percentage of cash receipts increased to 22.5% for the six months ended June 30, 2008 from 22.3% of cash receipts for the same period in 2007, mainly due to a significant increase in employee staffing, especially in our newer Jackson, Tennessee call center, with a corresponding decrease in collector productivity caused mostly by the addition of this less tenured collection staff.

23


 

Outside Legal and Other Fees and Services
     Outside legal and other fees and services expenses were $29.7 million for the six months ended June 30, 2008, an increase of $7.0 million or 30.8% compared to outside legal and other fees and services expenses of $22.7 million for the six months ended June 30, 2007. Of the $7.0 million increase, $0.7 million was attributable to increases in outside fees and services, $3.6 million was attributable to increases in agency fees mainly incurred by our IGS subsidiary, $0.4 million was attributable to an increase in legal and accounting fees, and the remaining $2.3 million of the increase was attributable to the increased cash collections resulting from the increased number of accounts referred to independent contingent fee attorneys. This increase is consistent with the growth we experienced in our portfolio of defaulted consumer receivables and a portfolio management strategy shift implemented in mid-2002. This strategy resulted in our referring to the legal suit process more previously unsuccessfully liquidated accounts that have an identified means of repayment but that are nearing their legal statute of limitations, than had been referred historically. Legal cash collections generated by independent contingent fee attorneys represented 27.0% of total cash collections for the six months ended June 30, 2008 compared to 31.7% for the six months ended June 30, 2007. Total outside legal expenses for the six months ended June 30, 2008 were 39.5% of legal cash collections generated by independent contingent fee attorneys compared to 36.4% for the six months ended June 30, 2007. Additionally, as disclosed previously, we also effectuate legal collections using our own in house attorneys. Their results are not shown in the legal cash collections generated by independent contingent fee attorneys, however, the court costs they generate are included in this expense line item. Our in house attorneys contributed $3.8 million and $2.8 million in cash collections for the six months ended June 30, 2008 and 2007, respectively. Taking that into consideration, if we exclude the legal fees and costs incurred by our in house attorneys, the outside legal expenses to legal cash collection ratio would change from 39.5% to 36.3% for the six months ended June 30, 2008 and from 36.4% to 34.6% for the six months ended June 30, 2007. Outside legal fees and costs increased from $15.2 million for the six months ended June 30, 2007 to $17.5 million, an increase of 15.1%, for the six months ended June 30, 2008.
Communications
     Communications expenses were $5.3 million for the six months ended June 30, 2008, an increase of $1.4 million or 35.9% compared to communications expenses of $3.9 million for the six months ended June 30, 2007. The increase was attributable to growth in mailings and higher telephone expenses incurred to collect on a greater number of defaulted consumer receivables owned and serviced. Mailing expenses were responsible for 67.7% of this increase, while the remaining 32.3% was attributable to higher telephone expenses.
Rent and Occupancy
     Rent and occupancy expenses were $1.7 million for the six months ended June 30, 2008, an increase of $0.3 million or 21.4% compared to rent and occupancy expenses of $1.4 million for the six months ended June 30, 2007. The increase was primarily due to the addition of our new Norfolk, Virginia administrative and executive facility as well as increased utility charges.
Other Operating Expenses
     Other operating expenses were $3.0 million for the six months ended June 30, 2008, an increase of $0.1 million or 3.4% compared to other operating expenses of $2.9 million for the six months ended June 30, 2007. The increase was due to increases in repairs and maintenance, hiring, dues and subscriptions, advertising and marketing, and other miscellaneous expenses, as well as decreases in taxes (non-income), fees and licenses, travel and meals, and insurance. Repairs and maintenance expenses increased by $54,000, hiring expenses increased by $10,000, dues and subscriptions expenses increased by $29,000, advertising and marketing expenses increased by $11,000, and other miscellaneous expenses increased by $85,000. Travel and meals expenses decreased by $56,000, taxes (non-income), fees and licenses expenses decreased by $17,000, and insurance expenses decreased by $27,000.

24


 

Depreciation and Amortization
     Depreciation and amortization expenses were $3.0 million for the six months ended June 30, 2008, an increase of $0.3 million or 11.1% compared to depreciation and amortization expenses of $2.7 million for the six months ended June 30, 2007. The increase is mainly due to capital purchases in our new administrative and executive facility in Norfolk, Virginia and continued capital expenditures on equipment, software and computers related to our growth and systems upgrades.
Interest Income
     Interest income was $33,000 for the six months ended June 30, 2008, a decrease of $267,000 compared to interest income of $300,000 for the six months ended June 30, 2007. This decrease is the result of lower average invested cash and cash equivalents balances during the six months ended June 30, 2008 compared to the same period in 2007.
Interest Expense
     Interest expense was $5.1 million for the six months ended June 30, 2008, an increase of $4.7 million compared to interest expense of $0.4 million for the six months ended June 30, 2007. The increase is due to a higher average outstanding balance on our line of credit during the six months ended June 30, 2008 compared to the same period in 2007.
Provision for Income Taxes
     Income tax expense was $14.7 million for the six months ended June 30, 2008, a decrease of $1.5 million or 9.3% compared to income tax expense of $16.2 million for the six months ended June 30, 2007. The decrease is mainly due to a 9.7% decrease in pre-tax income, partially offset by a slight increase in the effective tax rate to 38.7% for the six months ended June 30, 2008, as compared to 38.5% for the six months ended June 30, 2007.

25


 

Supplemental Performance Data
Owned Portfolio Performance:
     The following tables show certain data related to our owned portfolio. These tables describe the purchase price, cash collections and related multiples. Further, these tables disclose our entire portfolio, the portfolio of purchased bankrupt accounts and our entire portfolio less the impact of our purchased bankrupt accounts. The accounts represented in the purchased bankruptcy tables are those portfolios of accounts that were bankrupt at the time of purchase. This contrasts with accounts that file bankruptcy after we purchase them.
Entire Portfolio ($ in thousands)
                                                         
            Unamortized   Percentage   Actual Cash                
            Purchase Price   of Purchase Price   Collections   Estimated           Total Estimated
Purchase   Purchase   Balance at   Remaining Unamortized   Including Cash   Remaining   Total Estimated   Collections to
Period   Price (1)   June 30, 2008 (2)   at June 30, 2008 (3)   Sales   Collections (4)   Collections (5)   Purchase Price (6)
1996
  $ 3,080     $ 0       0 %   $ 9,863     $ 15     $ 9,878       321 %
1997
  $ 7,685     $ 0       0 %   $ 24,551     $ 101     $ 24,652       321 %
1998
  $ 11,089     $ 0       0 %   $ 35,535     $ 192     $ 35,727       322 %
1999
  $ 18,898     $ 0       0 %   $ 63,989     $ 605     $ 64,594       342 %
2000
  $ 25.020     $ 0       0 %   $ 103,230     $ 3,399     $ 106,629       426 %
2001
  $ 33,481     $ 278       1 %   $ 154,232     $ 6,198     $ 160,430       479 %
2002
  $ 42,325     $ 0       0 %   $ 166,128     $ 7,149     $ 173,277       409 %
2003
  $ 61,450     $ 3,122       5 %   $ 211,522     $ 22,331     $ 233,853       381 %
2004
  $ 59,180     $ 5,929       10 %   $ 146.233     $ 34,343     $ 180,576       305 %
2005
  $ 143,219     $ 59,327       41 %   $ 191,617     $ 130,625     $ 322,242       225 %
2006
  $ 107,807     $ 65,071       60 %   $ 98,366     $ 128,986     $ 227,352       211 %
2007
  $ 260,606     $ 221,081       85 %   $ 105,491     $ 420,851     $ 526,342       202 %
YTD 2008
  $ 166,667     $ 160,559       96 %   $ 18,251     $ 310,288     $ 328,539       197 %
Purchased Bankruptcy Portfolio ($ in thousands)
                                                         
            Unamortized   Percentage   Actual Cash                
            Purchase Price   of Purchase Price   Collections   Estimated           Total Estimated
Purchase   Purchase   Balance at   Remaining Unamortized   Including Cash   Remaining   Total Estimated   Collections to
Period   Price (1)   June 30, 2008 (2)   at June 30, 2008 (3)   Sales   Collections (4)   Collections (5)   Purchase Price (6)
1996
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
1997
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
1998
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
1999
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
2000
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
2001
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
2002
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
2003
  $ 0     $ 0       0 %   $ 0     $ 0     $ 0       0 %
2004
  $ 7,470     $ 825       11 %   $ 12,910     $ 1,644     $ 14,554       195 %
2005
  $ 29,302     $ 5,505       19 %   $ 35,252     $ 8,774     $ 44,026       150 %
2006
  $ 17,643     $ 4,871       28 %   $ 18,595     $ 9,802     $ 28,397       161 %
2007
  $ 80,378     $ 71,753       89 %   $ 16,627     $ 103,731     $ 120,358       150 %
YTD 2008
  $ 56,067     $ 55,400       99 %   $ 2,322     $ 88,536     $ 90,858       162 %
Entire Portfolio Less Purchased Bankruptcy Portfolio ($ in thousands)
                                                         
            Unamortized   Percentage   Actual Cash                
            Purchase Price   of Purchase Price   Collections   Estimated           Total Estimated
Purchase   Purchase   Balance at   Remaining Unamortized   Including Cash   Remaining   Total Estimated   Collections to
Period   Price (1)   June 30, 2008 (2)   at June 30,2008 (3)   Sales   Collections (4)   Collections (5)   Purchase Price (6)
1996
  $ 3,080     $ 0       0 %   $ 9,863     $ 15     $ 9,878       321 %
1997
  $ 7,685     $ 0       0 %   $ 24,551     $ 101     $ 24,652       321 %
1998
  $ 11,089     $ 0       0 %   $ 35,535     $ 192     $ 35,727       322 %
1999
  $ 18,898     $ 0       0 %   $ 63,989     $ 605     $ 64,594       342 %
2000
  $ 25,020     $ 0       0 %   $ 103,230     $ 3,399     $ 106,629       426 %
2001
  $ 33,481     $ 278       1 %   $ 154,232     $ 6,198     $ 160,430       479 %
2002
  $ 42,325     $ 0       0 %   $ 166,128     $ 7,149     $ 173,277       409 %
2003
  $ 61,450     $ 3,122       5 %   $ 211,522     $ 22,331     $ 233,853       381 %
2004
  $ 51,710     $ 5,104       10 %   $ 133,323     $ 32,699     $ 166,022       321 %
2005
  $ 113,917     $ 53,822       47 %   $ 156,365     $ 121,851     $ 278,216       244 %
2006
  $ 90,164     $ 60,200       67 %   $ 79,771     $ 119,184     $ 198,955       221 %
2007
  $ 180,228     $ 149,328       83 %   $ 88,864     $ 317,120     $ 405,984       225 %
YTD 2008
  $ 110,600     $ 105,159       95 %   $ 15,929     $ 221,752     $ 237,681       215 %

26


 

 
(1)   Purchase price refers to the cash paid to a seller to acquire defaulted consumer receivables, plus certain capitalized costs, less the purchase price refunded by the seller due to the return of non-compliant accounts (also defined as buybacks). Non-compliant refers to the contractual representations and warranties provided for in the purchase and sale contract between the seller and us. These representations and warranties from the sellers generally cover account holders’ death or bankruptcy and accounts settled or disputed prior to sale. The seller can replace or repurchase these accounts.
 
(2)   Unamortized purchase price balance refers to the purchase price less Finance receivable amortization over the life of the portfolio.
 
(3)   Percentage of purchase price remaining unamortized refers to the amount of unamortized purchase price divided by the purchase price.
 
(4)   Estimated remaining collections refers to the sum of all future projected cash collections on our owned portfolios.
 
(5)   Total estimated collections refers to the actual cash collections, including cash sales, plus estimated remaining collections.
 
(6)   Total estimated collections to purchase price refers to the total estimated collections divided by the purchase price.
     The following graph shows the purchase price of our owned portfolios by year beginning in 1996 and includes the year to date acquisition amount for the six months ended June 30, 2008 and 2007. The purchase price number represents the cash paid to the seller to acquire defaulted consumer receivables, plus certain capitalized costs, less the purchase price refunded by the seller due to the return of non-compliant accounts.
Portfolio Purchases by Year
(BAR GRAPH)

27


 

     We utilize a long-term approach to collecting our owned pools of receivables. This approach has historically caused us to realize significant cash collections and revenues from purchased pools of finance receivables years after they are originally acquired. As a result, we have in the past been able to reduce our level of current period acquisitions without a corresponding negative current period impact on cash collections and revenue.
     The following table, which excludes any proceeds from cash sales of finance receivables, demonstrates our ability to realize significant multi-year cash collection streams on our owned pools:
Cash Collections By Year, By Year of Purchase — Entire Portfolio
                                                                                                                         
($ in thousands)
Purchase   Purchase                                           Cash Collection   Period                                   YTD    
Period   Price   1996   1997   1998   1999   2000   2001   2002   2003   2004   2005   2006   2007   2008   Total
 
1996
  $ 3,080     $ 548     $ 2,484     $ 1,890     $ 1,348     $ 1,025     $ 730     $ 496     $ 398     $ 285     $ 210     $ 237     $ 102     $ 48     $ 9,801  
1997
    7,685             2,507       5,215       4,069       3,347       2,630       1,829       1,324       1,022       860       597       437       211     $ 24,048  
1998
    11,089                   3,776       6,807       6,398       5,152       3,948       2,797       2,200       1,811       1,415       882       318     $ 35,504  
1999
    18,898                         5,138       13,069       12,090       9,598       7,336       5,615       4,352       3,032       2,243       823     $ 63,296  
2000
    25,020                               6,894       19,498       19,478       16,628       14,098       10,924       8,067       5,202       1,979     $ 102,768  
2001
    33,481                                     13,048       28,831       28,003       26,717       22,639       16,048       10,011       3,444     $ 148,741  
2002
    42,325                                           15,073       36,258       35,742       32,497       24,729       16,527       5,291     $ 166,117  
2003
    61,450                                                 24,308       49,706       52,640       43,728       30,695       10,445     $ 211,522  
2004
    59,180                                                       18,019       46,475       40,424       30,750       10,558     $ 146,226  
2005
    143,219                                                             18,968       75,145       69,862       27,643     $ 191,618  
2006
    107,807                                                                   22,971       53,192       22,204     $ 98,367  
2007
    260,506                                                                         42,263       63,229     $ 105,492  
YTD 2008
    166,657                                                                               18,251     $ 18,251  
 
Total
  $ 940,507     $ 548     $ 4,991     $ 10,881     $ 17,362     $ 30,733     $ 53,148     $ 79,253     $ 117,052     $ 153,404     $ 191,376     $ 236,393     $ 262,166     $ 164,444     $ 1,321,751  
 
Cash Collections By Year, By Year of Purchase — Purchased Bankruptcy Only Portfolio
                                                                                                                         
($ in thousands)
Purchase   Purchase   Cash Collection Period   YTD    
Period   Price   1996   1997   1993   1999   2000   2001   2002   2003   2004   2005   2006   2007   2008   Total
 
1996
  $     $     $     $     $     $     $     $     $     $     $     $     $     $     $  
1997
                                                                                      $  
1998
                                                                                      $  
1999
                                                                                      $  
2000
                                                                                      $  
2001
                                                                                      $  
2002
                                                                                      $  
2003
                                                                                      $  
2004
    7,470                                                       743       4,554       3,956       2,777       880     $ 12,910  
2005
    29,302                                                             3,777       15,500       11,934       4,041     $ 35,252  
2006
    17,643                                                                   5,608       9,455       3,531     $ 18,594  
2007
    80,378                                                                         2,850       13,777     $ 16,627  
YTD 2008
    56,067                                                                                 2,323     $ 2,323  
 
Total
  $ 190,860     $     $     $     $     $     $     $     $     $ 743     $ 8,331     $ 25,064     $ 27,016     $ 24,552     $ 85,706  
 
Cash Collections By Year, By Year of Purchase — Entire Portfolio less Purchased Bankruptcy Portfolio
                                                                                                                         
($ in thousands)
Purchase   Purchase                           Cash Collection Period                                           YTD    
Period   Price   1996   1997   1998   1999   2000   2001   2002   2003   2004   2005   2006   2007   2008   Total
 
1996
  $ 3,080     $ 548     $ 2,484     $ 1,890     $ 1,348     $ 1,025     $ 730     $ 496     $ 398     $ 285     $ 210     $ 237     $ 102     $ 48     $ 9,801  
1997
    7,685             2,507       5,215       4,069       3,347       2,630       1,829       1,324       1,022       860       597       437       211     $ 24,048  
1998
    11,089                   3,776       6,807       6,398       5,152       3,948       2,797       2,200       1,811       1,415       882       318     $ 35,504  
1999
    18,898                         5,138       13,069       12,090       9,598       7,336       5,615       4,352       3,032       2,243       823     $ 63,296  
2000
    25,020                               6,894       19,498       19,478       16,628       14,098       10,924       8,067       5,202       1,979     $ 102,768  
2001
    33,481                                     13,048       28,831       28,003       26,717       22,639       16,048       10,011       3,444     $ 148,741  
2002
    42,325                                           15,073       36,258       35,742       32,497       24,729       16,527       5,291     $ 166,117  
2003
    61,450                                                 24,308       49,706       52,640       43,728       30,695       10,445     $ 211,522  
2004
    51,710                                                       17,276       41,921       36,468       27,973       9,678     $ 133,316  
2005
    113,917                                                             15,191       59,645       57,928       23,602     $ 156,366  
2006
    90,164                                                                   17,363       43,737       18,673     $ 79,773  
2007
    180,228                                                                         39,413       49,452     $ 88,865  
YTD 2008
    110,600                                                                               15,928     $ 15,928  
 
Total
  $ 749,647     $ 548     $ 4,991     $ 10,881     $ 17,362     $ 30,733     $ 53,148     $ 79,253     $ 117,052     $ 152,661     $ 183,045     $ 211,329     $ 235,150     $ 139,892     $ 1,236,045  
 

28


 

When we acquire a new pool of finance receivables, our estimates typically result in an 84 - 96 month projection of cash collections. The following chart shows our historical cash collections (including cash sales of finance receivables) in relation to the aggregate of the total estimated collection projections made at the time of each respective pool purchase, adjusted for buybacks.
Actual Cash Collections and Cash Sales vs. Original Projections
($ in millions)
(GRAPH)
Owned Portfolio Personnel Performance:
     We measure the productivity of each collector each month, breaking results into groups of similarly tenured collectors. The following two tables display various productivity measures that we track.
Collector by Tenure
                                                 
Collector FTE at:   12/31/04     12/31/05     12/31/06     12/31/07     06/30/07     06/30/08  
One year + l
    298       327       340       327       360       348  
Less than one year 2
    349       364       375       553       481       744  
Total 2
    647       691       715       880       841       1,092  
 
1   Calculated based on actual employees (collectors) with one year of service or more.
 
2   Calculated using total hours worked by all collectors, including those in training to produce a full time equivalent “FTE”.
Monthly Cash Collections by Tenure
     Effective beginning in the third quarter of 2007, we are no longer able to produce this data. Changes in our collection processes and call flows would create data statistics that would be historically inconsistent.
YTD Cash Collections per Hour Paid l
                                                 
Average performance YTD   12/31/04     12/31/05     12/31/06     12/31/07     06/30/07     06/30/08  
Total cash collections
  $ 117.59     $ 133.39     $ 146.03     $ 135.77     $ 148.52     $ 134.56  
Non-legal cash collections 2
  $ 82.06     $ 89.25     $ 99.06     $ 91.93     $ 101.39     $ 97.60  
Non-bk cash collections 3
        $ 128.02     $ 132.15     $ 123.10     $ 134.83     $ 115.71  
 
1   Cash collections (assigned and unassigned) divided by total hours paid (including holiday, vacation and sick time) to all collectors (including those in training).
 
2   Represents total cash collections less legal cash collections.
 
3   Represents total cash collections less bankruptcy cash collections. Although we began bankruptcy portfolio purchasing in 2004, we began calculating this metric in 2005.

29


 

     Cash collections have substantially exceeded revenue in each quarter since our formation. The following chart illustrates the consistent excess of our cash collections on our owned portfolios over the income recognized on finance receivables, net on a quarterly basis. The difference between cash collections and income recognized is referred to as payments applied to principal. It is also referred to as finance receivable amortization. This finance receivable amortization is the portion of cash collections that is used to recover the cost of the portfolio investment represented on the balance sheet.
Cash Collections (1) vs. Income Recognized on Finance Receivables, net
(GRAPH)
 
(1)   Includes cash collections on finance receivables only. Excludes commission fees and cash proceeds from sales of defaulted consumer receivables.
Seasonality
     We depend on the ability to collect on our owned and serviced defaulted consumer receivables. Cash collections tend to be higher in the first and second quarters of the year and lower in the third and fourth quarters of the year, due to consumer payment patterns in connection with seasonal employment trends, income tax refunds and holiday spending habits. Historically, our growth has partially masked the impact of this cash collections seasonality.
Quarterly Cash Collections (1)
(GRAPH)
 
(1)   Includes cash collections on finance receivables only. Excludes commission fees and cash proceeds from sales of defaulted consumer receivables.

30


 

     The following table displays our quarterly cash collections by source, for the periods indicated.
                                                                         
Cash Collection Source ($ in thousands)   Q22008     Q12008     Q42007     Q32007     Q22007     Q12007     Q42006     Q32006     Q22006  
 
Call Center Collections & Other
  $ 48,839     $ 46,702     $ 36,994     $ 37,450     $ 37,464     $ 39,241     $ 32,437     $ 32,686     $ 33,736  
Legal
    22,471       21,880       20,861       21,384     20,91l     20,844       19,762       19,607       19,058  
Purchased Bankruptcy
    13,732       10,820       7,245       6,317       6,231       7,223       6,581       7,390       6,645  
     The following table shows the changes in finance receivables, including the amounts paid to acquire new portfolios (amounts in thousands).
                                 
    Three Months     Three Months     Six Months     Six Months  
    Ended     Ended     Ended     Ended  
    June 30,     June 30,     June 30,     June 30,  
    2008     2007     2008     2007  
Balance at beginning of period
  $ 477,754     $ 243,568     $ 410,297       $226,447  
Acquisitions of finance receivables, net of buybacks (1)
    69,608       63,299       163,839       102,263  
Cash collections applied to principal on finance receivables (2)
    (31,995 )     (18,219 )     (58,769 )     (40,062 )
                 
 
                               
Balance at end of period
  $ 515,367     $ 288,648     $ 515,367     $ 288,648  
 
                       
 
                               
Estimated Remaining Collections (“ERC”) (3)
  $ 1,065,083     $ 699,491     $ 1,065,083     $ 699,491  
 
                       
 
(1)   Agreements to purchase receivables typically include general representations and warranties from the sellers covering account holders’ death or bankruptcy and accounts settled or disputed prior to sale. The seller can replace or repurchase these accounts. We refer to repurchased accounts as buybacks. We also capitalize certain acquisition related costs.
 
(2)   Cash collections applied to principal (also referred to as finance receivable amortization) on finance receivables consists of cash collections less income recognized on finance receivables, net.
 
(3)   Estimated Remaining Collections refers to the sum of all future projected cash collections on our owned portfolios. ERC is not a balance sheet item; however, it is provided here for informational purposes.
     The following table categorizes our life to date owned portfolios at June 30, 2008 into the major asset types represented (amounts in thousands):
                                 
                    Life to Date Purchased Face        
                    Value of Defaulted Consumer        
Asset Type   No. of Accounts     %     Receivables (1)     %  
 
Visa/MasterCard/Discover
    10,382       57.6 %   $ 27,856,306       73.8 %
Consumer Finance
    4,572       25.3 %     4,040,255       10.7 %
Private Label Credit Cards
    2,652       14.7 %     3,255,226       8.6 %
Auto Deficiency
    431       2.4 %     2,601,309       6.9 %
     
Total:
    18,037       100.0 %   $ 37,753,096       100.0 %
     
 
(1)   The “Life to Date Purchased Face Value of Defaulted Consumer Receivables” represents the original face amount purchased from sellers and has not been decremented by any adjustments including payments and buybacks (“buybacks” are defined as purchase price refunded by the seller due to the return of non-compliant accounts).

31


 

The following chart shows details of our life to date buying activity as of June 30, 2008 (amounts in thousands). We actively seek to purchase both bankrupt and non-bankrupt accounts at any point in the delinquency cycle.
                                 
                    Life to Date Purchased Face    
                    Value of Defaulted Consumer    
Account Type   No. of Accounts   %   Receivables (1)   %
 
Fresh
    705       3.9 %   $ 2,578,628       6.8 %
Primary
    2,012       11.2 %     3,684,066       9,8 %
Secondary
    3,047       16.9 %     4,810,933       12.7 %
Tertiary
    3,507       19.4 %     4,495,588       11.9 %
BK Trustees
    1,926       10.7 %     8,031,705       21.3 %
Other
    6,840       37.9 %     14,152,176       37.5 %
     
Total:
    18,037       100.0 %   $ 37,753,096       100.0 %
     
 
(1)   The “Life to Date Purchased Face Value of Defaulted Consumer Receivables” represents the original face amount purchased from sellers and has not been decremented by any adjustments including payments and buybacks (“buybacks” are defined as purchase price refunded by the seller due to the return of non-compliant accounts).
     We also review the geographic distribution of accounts within a portfolio because we have found that certain states have more debtor-friendly laws than others and, therefore, are less desirable from a collectibility perspective. In addition, economic factors and bankruptcy trends vary regionally and are factored into our maximum purchase price equation.
     The following chart sets forth our overall life to date portfolio of defaulted consumer receivables geographically at June 30, 2008 (amounts in thousands):
                                                 
                    Life to Date Purchased           Original Purchase Price of    
Geographic   No. of           Face Value of Defaulted           Defaulted Consumer    
Distribution   Accounts   %   Consumer Receivables (1)   %   Receivables (2)   %
 
Texas
    3,106       17 %   $ 4,759,193       13 %   $ 104,154       11 %
California
    1,771       10 %     4,529,032       12 %     97,858       10 %
Florida
    1,377       8 %     3,656,017       10 %     81,129       8 %
New York
    1,066       6 %     2,563,109       7 %     62,662       7 %
Pennsylvania
    629       3 %     1,514,031       4 %     41,870       4 %
North Carolina
    623       3 %     1,313,951       3 %     34,240       4 %
Illinois
    740       4 %     1,287,643       3 %     37,105       4 %
Ohio
    608       3 %     1,252,031       3 %     38,500       4 %
New Jersey
    417       2 %     1,155,331       3 %     28,688       3 %
Georgia
    537       3 %     1,154,043       3 %     36,457       4 %
Michigan
    466       3 %     936,554       2 %     29,362       3 %
Massachusetts
    342       2 %     790,846       2 %     19,045       2 %
Tennessee
    366       2 %     768,299       2 %     24,206       3 %
Virginia
    363       2 %     740,929       2 %     21,853       2 %
South Carolina
    322       2 %     706,592       2 %     17,847       2 %
Arizona
    274       2 %     693,947       2 %     15,537       2 %
Other (3)
    5,030       28 %     9,931,548       27 %     267,681       27 %
     
Total:
    18,037       100 %   $ 37,753,096       100 %   $ 958,194       100 %
     
 
(1)   The “Life to Date Purchased Face Value of Defaulted Consumer Receivables” represents the original face amount purchased from sellers and has not been decremented by any adjustments including payments and buybacks (“buybacks” are defined as purchase price refunded by the seller due to the return of non-compliant accounts).
 
(2)   The “Original Purchase Price of Defaulted Consumer Receivables” represents the cash paid to sellers to acquire portfolios of defaulted consumer receivables.
 
(3)   Each state included in “Other” represents less than 2% of the face value of total defaulted consumer receivables.

32


 

Liquidity and Capital Resources
     Historically, our primary sources of cash have been cash flows from operations, bank borrowings and equity offerings. Cash has been used for acquisitions of finance receivables, corporate acquisitions, repurchase of our common stock, payment of cash dividends, repayments of bank borrowings, purchases of property and equipment and working capital to support our growth.
     We believe that funds generated from operations, together with existing cash and available borrowings under our credit agreement will be sufficient to finance our current operations, planned capital expenditure requirements, and internal growth at least through the next twelve months. However, we could require additional debt or equity financing if we were to make any significant acquisitions requiring cash during that period.
     Cash generated from operations is dependent upon our ability to collect on our defaulted consumer receivables. Many factors, including the economy and our ability to hire and retain qualified collectors and managers, are essential to our ability to generate cash flows. Fluctuations in these factors that cause a negative impact on our business could have a material impact on our expected future cash flows.
     Our operating activities provided cash of $41.3 million and $37.9 million for the six months ended June 30, 2008 and 2007, respectively. In these periods, cash from operations was generated primarily from net income earned through cash collections and commissions received for the period. The increase was due mostly to changes in deferred taxes offset by a decrease in net income from $25.9 million for the six months ended June 30, 2007 to $23.3 million for the six months ended June 30, 2008. The remaining changes were due to net changes in other accounts related to our operating activities.
     Our investing activities used cash of $108.5 million and $66.2 million during the six months ended June 30, 2008 and 2007, respectively. Cash provided by investing activities is primarily driven by cash collections applied to principal on finance receivables. Cash used in investing activities is primarily driven by acquisitions of defaulted consumer receivables and purchases of property and equipment. The majority of the increase was due to acquisitions of finance receivables which increased from $102.3 million for the six months ended June 30, 2007, to $163.8 million for the six months ended June 30, 2008.
     Our financing activities provided cash of $66.8 million and $18.3 million during the six months ended June 30, 2008 and 2007, respectively. Cash used in financing activities is primarily driven by payments on our line of credit and principal payments on long-term debt and capital lease obligations. Cash is provided by proceeds from debt financing and stock option exercises. The majority of the change was due to net borrowings on our line of credit which increased to $66.3 million for the six months ended June 30, 2008 compared to $38.0 million for the six months ended June 30, 2007.
     Cash paid for interest was $5,205,494 and $210,798 for the six months ended June 30, 2008 and 2007, respectively. Interest was paid on our line of credit and capital lease obligations. The increase was caused by higher average balances on our line of credit for the six months ended June 30, 2008 when compared to the six months ended June 30, 2007.
     On November 29, 2005, we entered into a Loan and Security Agreement for a revolving line of credit jointly offered by Bank of America, N. A. and Wachovia Bank, National Association. The agreement was amended on May 9, 2006 to include RBC Centura Bank as an additional lender, again on May 4, 2007 to increase the line of credit to $150,000,000 and incorporate a $50,000,000 non-revolving sub-limit, again on October 26, 2007 to increase the line of credit to $270,000,000, again on March 18, 2008 to increase the non-revolving sub-limit to $100,000,000 and again on May 2, 2008 to include SunTrust Bank as an additional lender and to increase the line of credit to $340,000,000. The agreement is a revolving line of credit in an amount equal to the lesser of $340,000,000 or 30% of the Company’s estimated remaining collections of all of our eligible asset pools. Borrowings under the revolving credit facility bear interest at a floating rate equal to the LIBOR Market Index Rate plus 1.40% and the facility expires on May 2, 2011. The loan is collateralized by substantially all of our tangible and intangible assets.

33


 

     The agreement provides as follows:
  monthly borrowings may not exceed 30% of estimated remaining collections;
 
  funded debt to EBITDA (defined as net income, less income or plus loss from discontinued operations and extraordinary items, plus income taxes, plus interest expense, plus depreciation, depletion, amortization (including finance receivable amortization) and other non-cash charges) ratio must be less than 2.0 to 1.0 calculated on a rolling twelve-month average;
 
  tangible net worth must be at least 100% of prior quarter tangible net worth plus 25% of cumulative positive net income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering without giving effect to reductions in tangible net worth due to repurchases of up to $100,000,000 of our common stock; and
 
  restrictions on change of control.
     Outstanding borrowings under the facility totaled $234,300,000 at June 30, 2008, of which $50,000,000 was part of the non-revolving fixed rate sub-limit which bears interest at 6.80% and expires on May 4, 2012. At June 30, 2008, we are in compliance with all of the covenants of the agreement.
Contractual Obligations
     Our contractual obligations at June 30, 2008 are as follows:
                                         
    Payments due by period
            Less                   More
            than 1   1-3   4-5   than 5
Contractual Obligations
  Total   year   years   years   years
 
Operating Leases
  $ 16,263,104     $ 2,703,220     $ 4,870,672     $ 4,512,123     $ 4,177,089  
Line of Credit (1)
    249,073,195       4,558,512       191,681,350       52,833,333        
Capital Lease Obligations
    45,564       45,564                    
Purchase Commitments (2)
    93,936,648       93,188,788       715,360       32,500        
Employment Agreements
    3,952,298       2,802,650       1,149,648              
     
Total
  $ 363,270,809     $ 103,298,734     $ 198,417,030     $ 57,377,956     $ 4,177,089  
     
 
(1)   To the extent that a balance is outstanding on our line of credit, the revolving portion would be due in May 2011 and the non-revolving fixed rate sub-limit portion would be due in May 2012.
 
(2)   This amount includes the maximum remaining amount to be purchased under forward flow contracts for the purchase of charged-off consumer debt in the amount of approximately $89.6 million.
Off Balance Sheet Arrangements
     We do not have any off balance sheet arrangements as defined by Regulation S-K 303(a)(4) promulgated under the Securities Exchange Act of 1934 (the “Exchange Act”).
Recent Accounting Pronouncements
     On September 15, 2006, the FASB issued SFAS No. 157, “Fair Value Measurements” (“SFAS 157”). SFAS 157 establishes a framework for measuring fair value and expands disclosures about fair value measurements. The changes to current practice resulting from the application of SFAS 157 relate to the definition of fair value, the methods used to measure fair value, and the expanded disclosures about fair value measurements. SFAS 157 was originally effective for fiscal years beginning after November 15, 2007 and interim periods within those fiscal years but was amended on February 6, 2008 to defer the effective date for one year for certain nonfinancial assets and liabilities. We adopted SFAS 157 on January 1, 2008 which had no material impact on our financial statements.
     In February 2007, the FASB issued SFAS No. 159, “The Fair Value Option for Financial Assets and Financial Liabilities” (“SFAS 159”). SFAS 159 is effective for fiscal years beginning after November 15, 2007. SFAS 159 allows entities to choose, at specified election dates, to measure eligible financial assets and liabilities at fair value that are not otherwise required to be measured at fair value. If a company elects the fair value option for an eligible item, changes in that item’s fair value in subsequent reporting periods must be recognized in current earnings. SFAS 159 also establishes presentation and disclosure requirements designed to draw comparison between entities that elect different measurement attributes for similar assets and liabilities. We adopted SFAS 159 on January 1, 2008 which had no material impact on our consolidated financial statements.

34


 

     In December 2007, the FASB issued SFAS No. 141R “Business Combinations,” (“SFAS 141R”). SFAS 141R establishes principles and requirements for how the acquirer of a business recognizes and measures in its financial statements the identifiable assets acquired, the liabilities assumed, and any non-controlling interest in the acquiree. The statement also provides guidance for recognizing and measuring the goodwill acquired in the business combination, recognizing assets acquired and liabilities assumed arising from contingencies, and determining what information to disclose to enable users of the financial statement to evaluate the nature and financial effects of the business combination. SFAS 141R is effective for acquisitions consummated in fiscal years beginning after December 15, 2008. We expect SFAS 141R will have an impact on our consolidated financial statements when effective, but the nature and magnitude of the specific effects will depend upon the nature, terms and size of the acquisitions we consummate after the effective date.
     In December 2007, the FASB issued SFAS No. 160, “Noncontrolling Interests in Consolidated Financial Statements” (“SFAS 160”). SFAS 160 changes the accounting and reporting for minority interests, which will be recharacterized as noncontrolling interests and classified as a component of equity. This new consolidation method significantly changes the accounting for transactions with minority interest holders. SFAS 160 is effective for fiscal years beginning after December 15, 2008 with early application prohibited. We believe that SFAS 160 will have no material impact on our consolidated financial statements.
     In March 2008, the FASB issued SFAS 161, “Disclosures about Derivative Instruments and Hedging Activities”(“SFAS 161”). SFAS 161 requires expanded disclosures regarding the location and amounts of derivative instruments in an entity’s financial statements, how derivative instruments and related hedged items are accounted for under SFAS 133, “Accounting for Derivative Instruments and Hedging Activities”, and how derivative instruments and related hedged items affect an entity’s financial position, operating results and cash flows. SFAS 161 is effective for periods beginning on or after November 15, 2008. We are currently evaluating what impact SFAS 161 will have on our consolidated financial statements.
     In April 2008, the FASB issued FSP 142-3, “Determination of the Useful Life of Intangible Assets”, (FSP 142-3). FSP 142-3 amends the factors that should be considered in developing renewal or extension assumptions used to determine the useful life of a recognized intangible asset under SFAS No. 142, “Goodwill and Other Intangible Assets”. FSP 142-3 is effective for fiscal years beginning after December 15, 2008. We are currently evaluating what impact FSP 142-3 will have on our consolidated financial statements.
Critical Accounting Policies
     The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles and our discussion and analysis of our financial condition and results of operations require our management to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and such differences may be material.
     Management believes our critical accounting policies and estimates are those related to revenue recognition, valuation of acquired intangibles and goodwill and income taxes. Management believes these policies to be critical because they are both important to the portrayal of our financial condition and results, and they require management to make judgments and estimates about matters that are inherently uncertain. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors.

35


 

Revenue Recognition
     We acquire accounts that have experienced deterioration of credit quality between origination and our acquisition of the accounts. The amount paid for an account reflects our determination that it is probable we will be unable to collect all amounts due according to the account’s contractual terms. At acquisition, we review each account to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that we will be unable to collect all amounts due according to the account’s contractual terms. If both conditions exist, we determine whether each such account is to be accounted for individually or whether such accounts will be assembled into pools based on common risk characteristics. We consider expected prepayments and estimate the amount and timing of undiscounted expected principal, interest and other cash flows for each acquired portfolio and subsequently aggregated pools of accounts. We determine the excess of the pool’s scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount that should not be accreted (nonaccretable difference) based on our proprietary acquisition models. The remaining amount, representing the excess of the account’s cash flows expected to be collected over the amount paid, is accreted into income recognized on finance receivables over the remaining life of the account or pool (accretable yield).
     Prior to January 1, 2005, we accounted for our investment in finance receivables using the interest method under the guidance of Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans.” Effective January 1, 2005, we adopted and began to account for our investment in finance receivables using the interest method under the guidance of AICPA SOP 03-3, “Accounting for Loans or Certain Securities Acquired in a Transfer.” For loans acquired in fiscal years beginning prior to December 15, 2004, Practice Bulletin 6 is still effective; however, Practice Bulletin 6 was amended by SOP 03-3 as described further in this note. For loans acquired in fiscal years beginning after December 15, 2004, SOP 03-3 is effective. Under the guidance of SOP 03-3 (and the amended Practice Bulletin 6), static pools of accounts may be established. These pools are aggregated based on certain common risk criteria. Each static pool is recorded at cost, which includes certain direct costs of acquisition paid to third parties, and is accounted for as a single unit for the recognition of income, principal payments and loss provision. Once a static pool is established for a quarter, individual receivable accounts are not added to the pool (unless replaced by the seller) or removed from the pool (unless sold or returned to the seller). SOP 03-3 (and the amended Practice Bulletin 6) requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue or expense or on the balance sheet. The SOP initially freezes the internal rate of return, referred to as IRR, estimated when the accounts receivable are purchased as the basis for subsequent impairment testing. Significant increases in expected future cash flows may be recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining life. Any increase to the IRR then becomes the new benchmark for impairment testing. Effective for fiscal years beginning after December 15, 2004 under SOP 03-3 and the amended Practice Bulletin 6, rather than lowering the estimated IRR if the collection estimates are not received, the carrying value of a pool would be written down to maintain the then current IRR. Income on finance receivables is accrued quarterly based on each static pool’s effective IRR. Quarterly cash flows greater than the interest accrual will reduce the carrying value of the static pool. This reduction in carrying value is defined as payments applied to principal (also referred to as finance receivable amortization). Likewise, cash flows that are less than the accrual will accrete the carrying balance. Generally, we do not allow accretion in the first six to twelve months. The IRR is estimated and periodically recalculated based on the timing and amount of anticipated cash flows using our proprietary collection models. A pool can become fully amortized (zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue when received. Additionally, we use the cost recovery method when collections on a particular pool of accounts cannot be reasonably predicted. These pools are not aggregated with other portfolios. Under the cost recovery method, no revenue is recognized until we have fully collected the cost of the portfolio, or until such time that we consider the collections to be probable and estimable and begin to recognize income based on the interest method as described above.
     We establish valuation allowances for all acquired accounts subject to SOP 03-3 to reflect only those losses incurred after acquisition (that is, the present value of cash flows initially expected at acquisition that are no longer expected to be collected). Valuation allowances are established only subsequent to acquisition of the accounts. At June 30, 2008, we had a $10,975,000 valuation allowance on our finance receivables. Prior to January 1, 2005, in the event that a reduction of the yield to as low as zero in conjunction with estimated future cash collections that were inadequate to amortize the carrying balance, an allowance charge would be taken with a corresponding writeoff of the receivable balance.

36


 

     We utilize the provisions of Emerging Issues Task Force 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”) to commission revenue from our contingent fee, skip-tracing and government processing and collection subsidiaries. EITF 99-19 requires an analysis to be completed to determine if certain revenues should be reported gross or reported net of their related operating expense. This analysis includes an assessment of who retains inventory/credit risk, who controls vendor selection, who establishes pricing and who remains the primary obligor on the transaction. Each of these factors was considered to determine the correct method of recognizing revenue from our subsidiaries.
     For our contingent fee subsidiary, the portfolios which are placed for servicing are owned by our clients and are placed under a contingent fee commission arrangement. Our subsidiary is paid to collect funds from the client’s debtors and earns a commission generally expressed as a percentage of the gross collection amount. The “Commissions” line of our income statement reflects the contingent fee amount earned, and not the gross collection amount.
     Our skip tracing subsidiary utilizes gross reporting under EITF 99-19. We generate revenue by working an account and successfully locating a customer for our client. An “investigative fee” is received for these services. In addition, we incur “agent expenses” where we hire a third-party collector to effectuate repossession. In many cases we have an arrangement with our client which allows us to bill the client for these fees. We have determined these fees to be gross revenue based on the criteria in EITF 99-19 and they are recorded as such in the line item “Commissions,” primarily because we are primarily liable to the third party collector. There is a corresponding expense in “Outside legal and other fees and services” for these pass-through items.
     Our government processing and collection business’s primary source of income is derived from servicing taxing authorities in several different ways: processing all of their tax payments and tax forms, collecting delinquent taxes, identifying taxes that are not being paid and auditing tax payments. The processing and collection pieces are standard commission based billings or fee for service transactions. When RDS conducts an audit, there are two components. The first is a charge for the hours incurred on conducting the audit. This charge is for hours worked. This charge is up-charged from the actual costs incurred. The gross billing is a component of the line item “Commissions” and the expense is included in the line item “Compensation and employee services.” The second item is for expenses incurred while conducting the audit. Most jurisdictions will reimburse RDS for direct expenses incurred for the audit including such items as travel and meals. The billed amounts are included in the line item “Commissions” and the expense component is included in its appropriate expense category, generally, “Other operating expenses.”
     We account for our gain on cash sales of finance receivables under SFAS No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.” Gains on sale of finance receivables, representing the difference between the sales price and the unamortized value of the finance receivables sold, are recognized when finance receivables are sold.
     We apply a financial components approach that focuses on control when accounting and reporting for transfers and servicing of financial assets and extinguishments of liabilities. Under that approach, after a transfer of financial assets, an entity recognizes the financial and servicing assets it controls and the liabilities it has incurred, eliminates financial assets when control has been surrendered, and eliminates liabilities when extinguished. This approach provides consistent standards for distinguishing transfers of financial assets that are sales from transfers that are secured borrowings.
Valuation of Acquired Intangibles and Goodwill
     In accordance with SFAS No. 142, “Goodwill and Other Intangible Assets,” we are required to perform a review of goodwill for impairment annually or earlier if indicators of potential impairment exist. The review of goodwill for potential impairment is highly subjective and requires that: (1) goodwill is allocated to various reporting units of our business to which it relates; and (2) we estimate the fair value of those reporting units to which the goodwill relates and then determine the book value of those reporting units. If the estimated fair value of reporting units with allocated goodwill is determined to be less than their book value, we are required to estimate the fair value of all identifiable assets and liabilities of those reporting units in a manner similar to a purchase price allocation for an acquired business. This requires independent valuation of certain unrecognized assets. Once this process is complete, the amount of goodwill impairment, if any, can be determined.

37


 

     We believe that, at June 30, 2008, there was no impairment of goodwill or other intangible assets. However, changes in various circumstances including changes in our market capitalization, changes in our forecasts and changes in our internal business structure could cause one of our reporting units to be valued differently thereby causing an impairment of goodwill. Additionally, in response to changes in our industry and changes in global or regional economic conditions, we may strategically realign our resources and consider restructuring, disposing or otherwise exiting businesses, which could result in an impairment of some or all of our identifiable intangibles or goodwill.
Income Taxes
     We record a tax provision for the anticipated tax consequences of the reported results of operations. In accordance with SFAS No. 109, “Accounting for Income Taxes,” the provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax bases of assets and liabilities, and for operating losses and tax credit carry-forwards. Deferred tax assets and liabilities are measured using the currently enacted tax rates that apply to taxable income in effect for the years in which those tax assets are expected to be realized or settled.
     We believe it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to fully recover the remaining deferred tax assets. In the event that all or part of the deferred tax assets are determined not to be realizable in the future, a valuation allowance would be established and charged to earnings in the period such determination is made. Similarly, if we subsequently realize deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in a positive adjustment to earnings or a decrease in goodwill in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations and financial position.
     FIN 48, “Accounting for Uncertainty in Income Taxes—an interpretation of SFAS No. 109”, clarifies the accounting for uncertainty in income taxes recognized in an enterprise’s financial statements in accordance with SFAS No. 109. FIN 48 prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return. FIN 48 also provides guidance on derecognition, classification, interest and penalties, accounting in interim periods, disclosure and transition. We adopted the provisions of FIN 48 on January 1, 2007.

38


 

Item 3. Quantitative and Qualitative Disclosure About Market Risk.
     Our exposure to market risk relates to interest rate risk with our variable rate credit line. The average borrowings on our variable rate credit line were $170.5 million for the three months ended June 30, 2008. Assuming a 200 basis point increase in interest rates, interest expense would have increased by $0.9 million for the three months ended June 30, 2008. At June 30, 2008, we had $184.3 million of variable rate debt outstanding on our credit line. We do not have any other variable rate debt outstanding at June 30, 2008. Significant increases in future interest rates on the variable rate credit line could lead to a material decrease in future earnings assuming all other factors remained constant.
Item 4. Controls and Procedures
Evaluation of Disclosure Controls and Procedures. We maintain disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) that are designed to ensure that information required to be disclosed in our Exchange Act reports is recorded, processed, summarized and reported within the time periods specified in the SEC’s rules and forms, and that such information is accumulated and communicated to our management, including our Chief Executive Officer and Chief Financial and Administrative Officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, management recognized that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives, and management necessarily was required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures. Also, controls may become inadequate because of changes in conditions and the degree of compliance with the policies or procedures may deteriorate. We conducted an evaluation, under the supervision and with the participation of our principal executive officer and principal financial officer, of the effectiveness of our disclosure controls and procedures as of the end of the period covered by this report. Based on this evaluation, the principal executive officer and principal financial officer have concluded that, as of June 30, 2008, our disclosure controls and procedures were effective.
Changes in Internal Control Over Financial Reporting. There was no change in our internal control over financial reporting that occurred during the quarter ended June 30, 2008 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.
PART II. OTHER INFORMATION
Item 1. Legal Proceedings
     From time to time, we are involved in various legal proceedings which are incidental to the ordinary course of our business. We regularly initiate lawsuits against consumers and are occasionally countersued by them in such actions. Also, consumers initiate litigation against us, in which they allege that we have violated a state or federal law in the process of collecting on an account. We do not believe that these routine matters represent a substantial volume of our accounts or that, individually or in the aggregate, they are material to our business or financial condition. We are not a party to any material legal proceedings and we are unaware of any contemplated material actions against us.
Item 1A. Risk Factors
     An investment in our common stock involves a high degree of risk. You should carefully consider the specific risk factors listed under Part I, Item 1A of our Annual Report on Form 10-K/A filed on March 12, 2008, together with all other information included or incorporated in our reports filed with the SEC. Any such risks may materialize, and additional risks not known to us, or that we now deem immaterial, may arise. In such event, our business, financial condition, results of operations or prospects could be materially adversely affected. If that occurs, the market price of our common stock could fall, and you could lose all or part of your investment.
Item 2. Unregistered Sales of Equity Securities and Use of Proceeds
None.

39


 

Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of the Security Holders
On May 16, 2008, we convened our Annual Meeting of Stockholders in Norfolk, Virginia. The matters voted on at the meeting were: (1) the election of two directors, each serving for a term of three years, and (2) the ratification of the selection of KPMG LLP as our independent auditors for the year ending December 31, 2008.
     The voting was as follows for the election of directors:
                 
Election of Directors:   FOR   WITHHELD
James M. Voss
  13,501,022       125,806  
Scott M. Tabakin
  13,490,003       136,826  
     The voting was as follows for the ratification of the selection of KPMG LLP as our independent auditors for the year ending December 31, 2008:
                         
Ratification of independent auditors:   FOR   WITHHELD   ABSTAIN
KPMG LLP
    13,477,295       129,480       19,894  
There were no broker non-votes.
Item 5. Other Information
None.
Item 6. Exhibits
     
10.1
  Third amendment to the Amended and Restated Loan and Security Agreement, dated as of May 2, 2008, by and between Portfolio Recovery Associates, Inc, Bank of America, N.A., Wachovia Bank, N.A., RBC Centura Bank and SunTrust Bank (Incorporated by reference to Exhibit 10.1 of the Form 8-K filed May 12, 2008).
 
   
31.1
  Section 302 Certifications of Chief Executive Officer.
 
   
31.2
  Section 302 Certifications of Chief Financial Officer.
 
   
32.1
  Section 906 Certifications of Chief Executive Officer and Chief Financial Officer.

40


 

SIGNATURES
Pursuant to the requirements of the Exchange Act, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
         
  PORTFOLIO RECOVERY ASSOCIATES, INC.
(Registrant)
 
 
Date: August 1, 2008  By:   /s/ Steven D. Fredrickson    
    Steven D. Fredrickson   
    Chief Executive Officer, President and
Chairman of the Board of Directors
(Principal Executive Officer) 
 
 
     
Date: August 1, 2008   By:   /s/ Kevin P. Stevenson    
    Kevin P. Stevenson   
    Chief Financial and Administrative Officer, Executive Vice President, Treasurer and Assistant Secretary (Principal Financial and Accounting Officer)   
 

41

Exhibit 31.1
I, Steven D. Fredrickson, certify that:
1.   I have reviewed this quarterly report on Form 10-Q of Portfolio Recovery Associates, Inc.;
 
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-15(f) and 15d-15(f)) for the registrant and have;
 
(a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
(a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
             
Date: August 1, 2008
  By:   /s/ Steven D. Fredrickson
 
   
             Steven D. Fredrickson    
             Chief Executive Officer, President and
         Chairman of the Board of Directors
          (Principal Executive Officer)
   

42

Exhibit 31.2
I, Kevin P. Stevenson, certify that:
1.   I have reviewed this quarterly report on Form 10-Q of Portfolio Recovery Associates, Inc.;
 
2.   Based on my knowledge, this report does not contain any untrue statement of a material fact or omit to state a material fact necessary to make the statements made, in light of the circumstances under which such statements were made, not misleading with respect to the periods covered by this report;
 
3.   Based on my knowledge, the financial statements, and other financial information included in this report, fairly present in all material respects the financial condition, results of operations and cash flows of the registrant as of, and for, the periods presented in this report;
 
4.   The registrant’s other certifying officer and I are responsible for establishing and maintaining disclosure controls and procedures (as defined in Exchange Act Rules 13a-15(e) and 15d-15(e)) and internal control over financial reporting (as defined in Exchange Act Rules 13a-l5(f) and 15d-15(f)) for the registrant and have:
 
(a)   Designed such disclosure controls and procedures, or caused such disclosure controls and procedures to be designed under our supervision, to ensure that material information relating to the registrant, including its consolidated subsidiaries, is made known to us by others within those entities, particularly during the period in which this report is being prepared;
 
(b)   Designed such internal control over financial reporting, or caused such internal control over financial reporting to be designed under our supervision to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles;
 
(c)   Evaluated the effectiveness of the registrant’s disclosure controls and procedures and presented in this report our conclusions about the effectiveness of the disclosure controls and procedures, as of the end of the period covered by this report based on such evaluation; and
 
(d)   Disclosed in this report any change in the registrant’s internal control over financial reporting that occurred during the registrant’s most recent fiscal quarter (the registrant’s fourth fiscal quarter in the case of an annual report) that has materially affected, or is reasonably likely to materially affect, the registrant’s internal control over financial reporting; and
 
5.   The registrant’s other certifying officer and I have disclosed, based on our most recent evaluation of internal control over financial reporting, to the registrant’s auditors and the audit committee of the registrant’s board of directors (or persons performing the equivalent functions):
 
(a)   All significant deficiencies and material weaknesses in the design or operation of internal control over financial reporting which are reasonably likely to adversely affect the registrant’s ability to record, process, summarize and report financial information; and
 
(b)   Any fraud, whether or not material, that involves management or other employees who have a significant role in the registrant’s internal control over financial reporting.
         
Date: August 1, 2008
  By:   /s/ Kevin P. Stevenson
 
       
             Kevin P. Stevenson
             Chief Financial and Administrative Officer,
         Executive Vice President, Treasurer and
         Assistant Secretary
         (Principal Financial and Accounting Officer)

43

Exhibit 32.1
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Portfolio Recovery Associates, Inc. (the “Company”) on Form 10-Q for the quarter ended June 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Steven D. Fredrickson, Chief Executive Officer, President and Chairman of the Board of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
             
Date: August 1, 2008
  By:   /s/ Steven D. Fredrickson
 
   
             Steven D. Fredrickson    
             Chief Executive Officer, President and
         Chairman of the Board of Directors
          (Principal Executive Officer)
   
CERTIFICATION PURSUANT TO
18 U.S.C. SECTION 1350,
AS ADOPTED PURSUANT TO
SECTION 906 OF THE SARBANES-OXLEY ACT OF 2002
In connection with the Quarterly Report of Portfolio Recovery Associates, Inc. (the “Company”) on Form 10-Q for the quarter ended June 30, 2008 as filed with the Securities and Exchange Commission on the date hereof (the “Report”), I, Kevin P. Stevenson, Chief Financial and Administrative Officer, Executive Vice President, Treasurer and Assistant Secretary of the Company, certify, pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002, that:
(1) The Report fully complies with the requirements of Section 13(a) or 15(d) of the Securities Exchange Act of 1934; and
(2) The information contained in the Report fairly presents, in all material respects, the financial condition and result of operations of the Company.
             
Date: August 1, 2008
  By:   /s/ Kevin P. Stevenson
 
   
             Kevin P. Stevenson    
             Chief Financial and Administrative Officer,
         Executive Vice President, Treasurer and
         Assistant Secretary
         (Principal Financial and Accounting Officer)
   

44