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 September 30, 2005March 31, 2006
   
o TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period fromto ___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.
YESþ            YesNOo¨ No
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, (as definedor a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act).Act.
Large accelerated filer¨ Accelerated filerþ YesNon-accelerated filero¨ No
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).
YESo¨            YesNOþ No
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 OctoberApril 19, 20052006
   
Common Stock, $0.01 par value 15,717,39315,894,763
 
 

 

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
INDEX
     
  Page(s) 
PART I.
FINANCIAL INFORMATION
    
Item 1. 
Item 1.Financial Statements
    
  
Consolidated Balance Sheets (unaudited)  3 
as of September 30, 2005March 31, 2006 and December 31, 20042005    
  
Consolidated Income Statements (unaudited)  4 
For the three and nine months ended September 30,March 31, 2006 and 2005 and 2004    
  
Consolidated Statements of Changes in Stockholders’ Equity (unaudited)  5 
For the ninethree months ended September 30, 2005March 31, 2006    
  
Consolidated Statements of Cash Flows (unaudited)  6 
For the ninethree months ended September 30,March 31, 2006 and 2005 and 2004    
  
Notes to Consolidated Financial Statements (unaudited)  7-177-16
Item 2.Management’s Discussion and Analysis of Financial17-31 
  
Item 2.Management’s Discussion and Analysis of Financial
18-35
Condition and Results of Operations    
Item 3. 
Item 3.Quantitative and Qualitative Disclosure About Market Risk
  3632
Item 4.Controls and Procedures32 
     
Item 4.Controls and Procedures
36
  
PART II.
OTHER INFORMATION
    
Item 1.Legal Proceedings33
Item 1A.Risk Factors33
Item 2.Unregistered Sales of Equity Securities and Use of Proceeds33
Item 3.Defaults Upon Senior Securities33
Item 4.Submission of Matters to a Vote of the Security Holders33
Item 5.Other Information33
Item 6.Exhibits33
SIGNATURES    
Item 6.Exhibits and Reports on Form 8-K
37
SIGNATURES
3834 

2

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED BALANCE SHEETS
September 30, 2005March 31, 2006 and December 31, 20042005
(unaudited)
                
 September 30, December 31,  March 31, December 31, 
 2005 2004  2006 2005 
Assets
  
 
Cash and cash equivalents $67,398,268 $24,512,575  $23,351,708 $15,984,855 
Investments — 23,950,000 
Finance receivables, net 117,246,471 105,188,906  189,847,379 193,644,670 
Property and equipment, net 7,431,544 5,752,489  7,569,227 7,186,418 
Goodwill 18,287,511 6,397,138  18,287,511 18,287,511 
Intangible assets, net 9,777,568 6,318,838  8,455,503 9,022,666 
Other assets 1,687,821 3,056,023  3,747,692 3,646,126 
          
  
Total assets $221,829,183 $175,175,969  $251,259,020 $247,772,246 
          
 
Liabilities and Stockholders’ Equity
  
  
Liabilities:  
Accounts payable $2,738,360 $1,413,726  $3,623,858 $2,332,685 
Accrued expenses 1,963,799 1,563,285  4,515,535 2,239,267 
Income taxes payable 3,485,759 182,221  5,008,999 3,054,883 
Accrued payroll and bonuses 5,535,060 4,475,919  3,657,249 5,942,618 
Deferred tax liability 21,864,507 13,650,722  23,378,354 22,345,995 
Revolving lines of credit — 15,000,000 
Long-term debt 1,269,331 1,924,422  1,035,361 1,151,965 
Obligations under capital lease 427,742 576,234  344,541 382,658 
          
Total liabilities 37,284,558 23,786,529  41,563,897 52,450,071 
  
Commitments and contingencies (Note 11) 
 
Commitments and contingencies (Note 10) 
Stockholders’ equity:  
Preferred stock, par value $0.01, authorized shares, 2,000,000, issued and outstanding shares - 0 — —  — — 
Common stock, par value $0.01, authorized shares, 30,000,000, issued and outstanding shares - 15,714,463 at September 30, 2005, and 15,498,210 at December 31, 2004 157,145 154,982 
Common stock, par value $0.01, authorized shares, 30,000,000, issued and outstanding shares - 15,879,763 at March 31, 2006, and 15,767,443 at December 31, 2005 158,798 157,674 
Additional paid in capital 106,735,523 100,905,851  111,705,706 108,063,899 
Retained earnings 77,651,957 50,328,607  97,830,619 87,100,602 
     
      
Total stockholders’ equity 184,544,625 151,389,440  209,695,123 195,322,175 
          
  
Total liabilities and stockholders’ equity $221,829,183 $175,175,969  $251,259,020 $247,772,246 
          
The accompanying notes are an integral part of these consolidated financial statements.

3

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED INCOME STATEMENTS
For the Three and Nine Months Ended September 30,March 31, 2006 and 2005 and 2004
(unaudited)
                        
 Three Months Three Months Nine Months Nine Months  Three Months Three Months 
 Ended Ended Ended Ended  Ended Ended 
 September 30, September 30, September 30, September 30,  March 31, March 31, 
 2005 2004 2005 2004  2006 2005 
Revenues:  
Income recognized on finance receivables $33,987,480 $27,069,524 $100,060,121 $77,867,413  $39,373,409 $32,249,670 
Commissions 3,517,617 1,216,054 9,139,288 3,826,564  5,967,868 3,528,698 
              
  
Total revenue 37,505,097 28,285,578 109,199,409 81,693,977  45,341,277 35,778,368 
  
Operating expenses:  
Compensation and employee services 11,215,665 9,154,696 32,491,172 26,902,987  14,096,577 10,860,931 
Outside legal and other fees and services 7,417,463 5,347,702 22,153,943 15,038,953  9,060,279 7,161,783 
Communications 1,115,603 840,321 3,213,324 2,658,619  1,613,952 1,057,899 
Rent and occupancy 554,675 434,541 1,543,004 1,296,577  560,568 475,765 
Other operating expenses 833,815 648,512 2,315,722 2,028,266  1,076,456 752,854 
Depreciation and amortization 1,288,649 487,757 3,268,654 1,398,091  1,252,640 940,721 
              
  
Total operating expenses 22,425,870 16,913,529 64,985,819 49,323,493  27,660,472 21,249,953 
              
  
Income from operations 15,079,227 11,372,049 44,213,590 32,370,484  17,680,805 14,528,415 
  
Other income and (expense):  
Interest income 188,220 77,259 475,680 105,841  72,894 95,612 
Interest expense  (59,001)  (69,383)  (185,816)  (206,451)  (167,946)  (63,894)
              
  
Income before income taxes 15,208,446 11,379,925 44,503,454 32,269,874  17,585,753 14,560,133 
  
Provision for income taxes 5,866,624 4,405,160 17,180,104 12,533,777  6,855,736 5,640,301 
              
  
Net income $9,341,822 $6,974,765 $27,323,350 $19,736,097  $10,730,017 $8,919,832 
              
 
Net income per common share  
Basic $0.60 $0.45 $1.75 $1.29  $0.68 $0.57 
Diluted $0.58 $0.44 $1.69 $1.25  $0.67 $0.55 
Weighted average number of shares outstanding  
Basic 15,692,417 15,341,801 15,607,596 15,322,675  15,871,563 15,531,779 
Diluted 16,172,657 15,831,660 16,132,869 15,793,935  16,064,968 16,152,162 
The accompanying notes are an integral part of these consolidated financial statements.

4

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CHANGES IN STOCKHOLDERS’ EQUITY
For the NineThree Months Ended September 30, 2005March 31, 2006
(unaudited)
                 
      Additional      Total 
  Common  Paid in  Retained  Stockholders’ 
  Stock  Capital  Earnings  Equity 
Balance at December 31, 2004 $154,982  $100,905,851  $50,328,607  $151,389,440 
             
                 
Net income  —   —   27,323,350   27,323,350 
Exercise of stock options, warrants and vesting of restricted shares  1,826   2,215,575   —   2,217,401 
Issuance of common stock for acquisition  337   1,443,426   —   1,443,763 
Amortization of stock-based compensation  —   382,523   —   382,523 
Stock-based compensation income tax benefits  —   1,788,148   —   1,788,148 
             
                 
Balance at September 30, 2005 $157,145  $106,735,523  $77,651,957  $184,544,625 
             
                 
      Additional      Total 
  Common  Paid in  Retained  Stockholders’ 
  Stock  Capital  Earnings  Equity 
Balance at December 31, 2005 $157,674  $108,063,899  $87,100,602  $195,322,175 
             
                 
Net income  —   —   10,730,017   10,730,017 
Exercise of stock options, warrants and vesting of restricted shares  1,124   1,417,777   —   1,418,901 
Amortization of stock-based compensation  —   431,817   —   431,817 
FAS123R adoption reclass of payroll liability to additional paid in capital  —   426,752   —   426,752 
Income tax benefit from share based compensation  —   1,365,461   —   1,365,461 
             
                 
Balance at March 31, 2006 $158,798  $111,705,706  $97,830,619  $209,695,123 
             
The accompanying notes are an integral part of these consolidated financial statements.

5

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
CONSOLIDATED STATEMENTS OF CASH FLOWS
For the NineThree Months Ended September 30,March 31, 2006 and 2005 and 2004
(unaudited)
                
 Nine Months Nine Months  Three Months Three Months 
 Ended Ended  Ended Ended 
 September 30, September 30,  March 31, March 31, 
 2005 2004  2006 2005 
Operating activities:  
Net income $27,323,350 $19,736,097  $10,730,017 $8,919,832 
Adjustments to reconcile net income to cash provided by operating activities:  
Increase in equity from vested options and warrants 718,942 456,379 
Income tax benefit from stock option exercises 1,788,148 437,514 
Increase in equity from options and restricted shares 431,817 133,038 
Income tax benefit from share based compensation — 777,137 
Depreciation and amortization 3,268,654 1,398,091  1,252,640 940,721 
Deferred tax expense 8,213,785 11,729,031  1,032,359 2,025,515 
Changes in operating assets and liabilities:  
Other assets 1,742,935 558,704   (101,566) 339,086 
Accounts payable 313,433  (114,556) 1,291,173 339,766 
Income taxes 3,303,538 499,590  1,954,116 2,583,455 
Accrued expenses 241,765 699,745  2,276,268 139,757 
Accrued payroll and bonuses 1,059,141 682,866   (1,858,619)  (1,347,656)
          
  
Net cash provided by operating activities 47,973,691 36,083,461  17,008,205 14,850,651 
          
  
Cash flows from investing activities:  
Purchases of property and equipment  (3,074,499)  (1,967,964)  (1,068,284)  (800,109)
Acquisition of finance receivables, net of buybacks  (56,133,504)  (37,626,129)  (15,318,806)  (17,735,629)
Collections applied to principal on finance receivables 44,075,939 34,882,955  19,116,097 15,580,134 
Acquisition of RDS, net of acquisition costs and cash received  (14,983,332) — 
Purchase of auction rate certificates  (84,475,000)  (20,950,000) —  (7,000,000)
Sales of auction rate certificates 108,425,000  —  — 30,950,000 
          
  
Net cash (used in) investing activities  (6,165,396)  (25,661,138)
Net cash provided by investing activities 2,729,007 20,994,396 
          
  
Cash flows from financing activities:  
Proceeds from exercise of options and warrants 1,880,981 309,570  1,418,901 913,191 
Proceeds from long-term debt — 750,000 
Income tax benefit from share based compensation 1,365,461 — 
Payments on lines of credit  (15,000,000) — 
Payments on long-term debt  (655,091)  (357,226)  (116,604)  (127,019)
Payments on capital lease obligations  (148,492)  (221,257)  (38,117)  (50,356)
          
  
Net cash provided by financing activities 1,077,398 481,087 
Net cash (used in) provided by financing activities  (12,370,359) 735,816 
          
  
Net increase in cash and cash equivalents 42,885,693 10,903,410  7,366,853 36,580,863 
  
Cash and cash equivalents, beginning of period 24,512,575 24,911,841  15,984,855 24,512,575 
          
  
Cash and cash equivalents, end of period $67,398,268 $35,815,251  $23,351,708 $61,093,438 
          
  
Supplemental disclosure of cash flow information:  
Cash paid for interest $185,816 $206,451  $200,776 $63,894 
Cash paid for income taxes $3,874,533 $280,642  $2,503,800 $254,950 
  
Noncash investing and financing activities: 
Capital lease obligations incurred $— $296,910 
Acquisition of RDS — Common stock issued $1,443,763 $— 
Noncash investing activities: 
FAS 123R adoption reclass of payroll liability to additional paid in capital $426,752 $— 
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 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 Thomas West Associates, LLC (“TWA”). PRA Inc, a Delaware corporation, and its subsidiaries (collectively, the “Company”) are full-service providers of outsourced receivables management and related services. The Company is engaged in the business of purchasing, managing and collecting portfolios of defaulted consumer receivables as well as offering a broad range of accounts receivable management services. The majority of the Company’s business activities involve the purchase, management and collection of defaulted consumer receivables. These are purchased from sellers of finance receivables and collected by a highly skilled staff whose purpose is to locate and contact customers and arrange payment or resolution of their debts. The Company, through its subsidiary TWA and its Legal Recovery Department, collectscollect accounts judicially, either by using its own attorneys, or by contracting with independent attorneys throughout the country withthrough 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, Anchor, TWA, IGS TWA and RDS. Certain 2004 amounts have been reclassified to conform to the 2005 presentation.
     The accompanying unaudited 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 and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity withrequired by U.S. generally accepted accounting principles generally accepted in the United States of America.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 statementpresentation of the Company’s balance sheet as of September 30, 2005,March 31, 2006, its income statements for the three and nine month periods ended September 30,March 31, 2006 and 2005, and 2004its statements of changes in stockholders’ equity for the three month period ended March 31, 2006 and its statements of cash flows for the ninethree month periods ended September 30,March 31, 2006 and 2005, and 2004, respectively. The income statements of the Company for the three and nine month periods ended September 30,March 31, 2006 and 2005 and 2004 may not be indicative of future results. These 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, as filed for the year ended December 31, 2004.2005.
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 each account to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that the Company will be unable to collect all amounts due according to the account’s contractual terms. If both conditions exist, the Company determines whether each such account is to be accounted for individually or whether such accounts will be assembled into pools based on common risk characteristics. The Company considers expected prepayments and estimates the amount and timing of undiscounted expected principal, interest and other cash flows for each acquired portfolio and subsequently aggregated pools of accounts. The Company determines the excess of the pool’s scheduled contractual principal and contractual interest payments over all cash flows expected at

7

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
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 are established. These pools are aggregated based on certain common risk criteria. Each static pool is recorded at cost, which includes certain direct costs of acquisition paid to third parties, and is accounted for as a single unit for the recognition of income, principal payments and loss provision. Once a static pool is established for a quarter, individual receivable accounts are not added to the pool (unless replaced by the seller) or removed from the pool (unless sold or returned to the seller). SOP 03-3 (and the amended Practice Bulletin 6) requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue or expense or on the balance sheet. The SOP initially freezes the internal rate of return, referred to as IRR, estimated when the accounts receivable are purchased as the basis for subsequent impairment testing. Significant increases in actual, or expected future cash flows may be recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining life. Any increase to the IRR then becomes the new benchmark for impairment testing. Effective for fiscal years beginning after December 15, 2004 under SOP 03-3 and the amended Practice Bulletin 6, rather than lowering the estimated IRR if the collection estimates are not received or projected to be received, the carrying value of a pool would be written down to maintain the then current IRR. Income on finance receivables is accrued quarterly based on each static pool’s effective IRR. Quarterly cash flows greater than the interest accrual will reduce the carrying value of the static pool. Likewise, cash flows that are less than the accrual will accrete the carrying balance. The IRR is estimated and periodically recalculated based on the timing and amount of anticipated cash flows using the Company’s proprietary collection models. A pool can become fully amortized (zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue when received. Additionally, the Company uses the cost recovery method when collections on a particular pool of accounts cannot be reasonably predicted. Under the cost recovery method, no revenue is recognized until the Company has fully collected the cost of the portfolio, or until such time that the Company considers the collections to be probable and estimable and begins to recognize income based on the interest method as described above. At September 30,March 31, 2006 and 2005, the Company had unamortized purchased principal (purchase price) of $1,656,746 in pools accounted for under the cost recovery method.method of $3,093,322 and $2,563,884, 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 September 30,March 31, 2006 and 2005, the Company had no valuationan allowance onagainst its finance receivables.receivables of $375,000 and $0, respectively. Prior to January 1, 2005, in the event that estimated future cash collections would be inadequate to amortize the carrying balance, an impairment charge would be taken with a corresponding write-off of the receivable balance.
     The Company capitalizes certain fees paid to third parties related to the direct acquisition of a portfolio of accounts. These fees are added to the acquisition cost of the portfolio and accordingly are amortized over the life of the portfolio using the interest method. The balance of the unamortized capitalized fees at September 30,March 31, 2006 and 2005 was $979,426 and 2004 was $998,192 and $1,225,998,$1,017,052, respectively. During the three and nine months ended September 30,March 31, 2006 and 2005 the Company capitalized $228,150$98,043 and $353,730,$85,536, respectively, of these direct acquisition fees. During the three and nine months ended September 30, 2004 the Company capitalized $354,751 and $688,765, respectively, of these direct acquisition fees. During the three and nine months ended September 30, 2005 the Company amortized $138,193 and $454,054, respectively, of these direct acquisition fees. During the three and nine months ended September 30, 2004 the Company amortized $163,906 and $734,312, respectively, of these direct acquisition fees. At June 30, 2004 the Company wrote-off $530,580 related to the capitalization of fees paid to third parties for address correction and other customer data associated with the acquisition of portfolios purchased over the past five years. As a result of a review of the Company’s accounting, the Company determined these capitalized acquisition fees should be expensed.

8

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
March 31, 2006 and 2005 the Company amortized $146,686 and $167,000, 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 paid in full, settled or disputed prior to sale. The representation and warranty period permitting the return of these accounts from the Company to the seller is typically 90 to 180 days. Any funds received from the seller of finance receivables as a return of purchase price are referred to as buybacks. Buyback funds are simply applied against the finance receivable balance received and are not included in the Company’s cash collections from operations. In some cases, the seller will replace the returned accounts with new accounts in lieu of returning the purchase price. In that case, the old account is removed from the pool and the new account is added.
     As of September 30,March 31, 2006 and 2005, and 2004, the Company had $117,246,471$189,847,379 and $95,311,731,$107,344,401, respectively, remaining of finance receivables. Changes in finance receivables for the threeat March 31, 2006 and nine months ended September 30, 2005 and 2004 were as follows:
        
                 Three Months Three Months 
 Three Months Three Months Nine Months Nine Months  Ended Ended 
 Ended Ended Ended Ended  March 31, March 31, 
 September 30, September 30, September 30, September 30,  2006 2005 
 2005 2004 2005 2004  
Balance at beginning of period $114,837,794 $96,270,285 $105,188,906 $92,568,557  $193,644,670 $105,188,906 
Acquisitions of finance receivables, net of buybacks 15,916,690 10,821,842 56,133,504 37,626,129  15,318,806 17,735,629 
  
Cash collections  (47,495,493)  (38,849,920)  (144,136,060)  (112,750,368)  (58,489,506)  (47,829,804)
Income recognized on finance receivables 33,987,480 27,069,524 100,060,121 77,867,413  39,373,409 32,249,670 
              
Cash collections applied to principal  (13,508,013)  (11,780,396)  (44,075,939)  (34,882,955)  (19,116,097)  (15,580,134)
              
  
Balance at end of period $117,246,471 $95,311,731 $117,246,471 $95,311,731  $189,847,379 $107,344,401 
              
     As of March 31, 2006 the Company had $189,847,379 in finance receivables. Based upon current projections, cash collections applied to principal is estimated to be as follows for the twelve months in the periods ending:
     
September 30, 2006 $33,753,214 
September 30, 2007  29,397,388 
September 30, 2008  25,693,090 
September 30, 2009  16,891,519 
September 30, 2010  9,072,231 
September 30, 2011  2,439,029 
    
  $117,246,471 
    
     
March 31, 2007 $44,479,002 
March 31, 2008  48,608,065 
March 31, 2009  38,368,720 
March 31, 2010  27,337,665 
March 31, 2011  23,457,279 
March 31, 2012  7,585,414 
March 31, 2013  11,234 
    
  $189,847,379 
    

9

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     Accretable yield represents the amount of income the Company can expect to generate over the remaining life of its existing portfolios based on estimated future cash flows as of September 30, 2005March 31, 2006 and 2004.2005. Reclassifications from nonaccretable difference to accretable yield primarily result from the Company’s increase in its estimate of future cash flows. Changes in accretable yield for the threeat March 31, 2006 and nine months ended September 30, 2005 and 2004 were as follows:

9

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
        
                 Three Months Three Months 
 Three Months Three Months Nine Months Nine Months  Ended Ended 
 Ended Ended Ended Ended  March 31, March 31, 
 September 30, September 30, September 30, September 30,  2006 2005 
 2005 2004 2005 2004  
Balance at beginning of period $224,453,203 $187,970,086 $202,841,339 $175,098,132  $299,280,328 $202,841,339 
Income recognized on finance receivables  (33,987,480)  (27,069,524)  (100,060,121)  (77,867,413)  (39,373,409)  (32,249,670)
Additions 20,054,019 15,613,073 60,482,154 55,958,806  16,016,515 12,960,224 
Sales — — — — 
Reclassifications from nonaccretable difference 22,268,147 14,909,816 69,524,517 38,233,926  12,537,509 22,959,045 
              
Balance at end of period $232,787,889 $191,423,451 $232,787,889 $191,423,451  $288,460,943 $206,510,938 
              
     During the three and ninemonth period ended March 31, 2006, the Company recorded a $175,000 allowance charge on two pools that had recently underperformed expectations. There was no allowance charge during the three months ended September 30,March 31, 2005. The change in the valuation allowance for the quarter ended March 31, 2006 is as follows:
     
Balance at December 31, 2005 $200,000 
Allowance charge  175,000 
    
Balance at March 31, 2006 $375,000 
    
     During the three months ended March 31, 2006 and 2005, the Company purchased $445.3$3.87 billion and $659.9 million and $2.47 billion of face value of charged-off consumer receivables. During the three and nine months ended September 30, 2004, the Company purchased $564.9 million and $2.67 billion of face value of charged-off consumer receivables. At September 30, 2005,March 31, 2006, the estimated remaining collections on the receivables purchased in the three and nine months ended September 30,March 31, 2006 and 2005 are $36,404,931is $29,574,397 and $109,415,694, respectively. At September 30, 2005, the estimated remaining collections on the receivables purchased in the three and nine months ended September 30, 2004 are $17,809,235 and $58,503,723,$18,874,295, respectively.
3. Investments:
     The Company accounts for its investments under the guidance of SFAS 115, “Accounting for Certain Investments in Debt and Equity Securities.” At December 31, 2004, theThe Company had investments totaling $23,950,000 which consist oftypically invests in variable rate auction rate certificates classifiedand variable rate demand notes which it classifies as available-for-sale securities. At March 31, 2006 and 2005, the Company did not have any investments on the Balance Sheet however it did purchase investments during the three month period ended March 31, 2005. These securities are recorded at cost, which approximates fair market value due to their variable interest rates, which typically reset every 7 to 35 days, and, despite the long term nature of their stated contractual maturities, the Company has the ability to quickly liquidate these investments. As a result, the Company had no cumulative gross unrealized holding gains (losses) or gross realized gains (losses) from these investments and all income generated was recorded as interest income. The Company may continue to invest in these types of securities within a given reporting period.

10

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
4. Revolving LineLines of Credit:
     The Company maintainsmaintained a $25.0 million revolving line of credit pursuant to an agreement entered into with RBC Centura Bank on November 28, 2003 and amended on November 22, 2004. This facility was terminated on November 28, 2005. The credit facility bearsbore interest at a spread of 2.50% over LIBOR and extendsextended through November 28, 2006. The agreement callscalled for:
 • restrictions on monthly borrowings are limited to 20% of estimated remaining collections;
 
 • a debt coverage ratio of at least 8.0 to 1.0, calculated on a rolling twelve-month average;
 
 • a debt to tangible net worth ratio of less than 0.40 to 1.00;
 
 • net income per quarter of at least $1.00, calculated on a consolidated basis; and
 
 • restrictions on change of control.
     This facility had no amounts outstanding during 2005 through the time of its termination.
     On November 29, 2005, the Company entered into a Loan and Security Agreement for a revolving line of credit jointly offered by Bank of America, N. A. and Wachovia Bank, National Association. The agreement is a revolving line of credit in an amount equal to the lesser of $75,000,000 or twenty percent of the Company’s estimated remaining collections of all its eligible asset pools. Borrowings under the new revolving credit facility will bear interest at September 30, 2005.a floating rate equal to the LIBOR Market Index Rate plus 1.75% and expires on November 29, 2008. The loan is collateralized by substantially all the tangible and intangible assets of the Company. The agreement provides for:
•restrictions on monthly borrowings are limited to 20% of estimated remaining collections;
•a funded debt to EBITDA ratio of less than 1.0 to 1.0 calculated on a rolling twelve-month average;
•tangible net worth of at least 100% of prior quarter tangible net worth plus 25% of cumulative positive net income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering; and
•restrictions on change of control.
     This facility had no amounts outstanding at March 31, 2006. As of September 30, 2005March 31, 2006, the Company is in compliance with all of the covenants of this agreement.
     In accordance with the credit agreement, the Company obtained approval from the lender for the RDS acquisition.

10

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
5. Long-Term Debt:
     In July 2000, the Company purchased a building in Hutchinson, Kansas. The building was financed with a commercial loan for $550,000 with a variable interest rate based on LIBOR. This commercial loan is collateralized by the real estate in Kansas. Monthly principal payments on the loan wereare $4,583 for an amortized term of 10 years. A balloon payment of $275,000 was duemade on July 21, 2005 which resultedto pay this loan in a five-year principal payout. The loan was paid in full at its maturity date of July 21, 2005.full.
     On February 9, 2001, the Company purchased a generator for its Norfolk location. The generator was financed with a commercial loan for $107,000 with a fixed rate of 7.9%. This commercial loan is collateralized by the generator. Monthly payments on the loan are $2,170 and the loan maturesmatured on February 1, 2006. The loan was paid in full at its maturity date of February 1, 2006.
     On February 20, 2002, the Company completed the construction of a satellite parking lot at its Norfolk location. The parking lot was financed with a commercial loan for $500,000 with a fixed rate of 6.47%. The loan is collateralized by the parking lot. The loan required only interest payments during the first six months. Beginning October 1, 2002, monthly payments on the loan are $9,797 and the loan matures on September 1, 2007.
     On May 1, 2003, the Company secured financing for its computer equipment purchases related to the Hampton, Virginia office opening. The computer equipment was financed with a commercial loan for $975,000 with a fixed rate of 4.25%. This loan is collateralized by computer equipment. Monthly payments are $18,096 and the loan matures on May 1, 2008.

11

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     On January 9, 2004, the Company entered into a commercial loan agreement in the amount of $750,000 to finance equipment purchases at its newly leased Norfolk facility. This loan bears interest at a fixed rate of 4.45%, matures on January 1, 2009 and is collateralized by the purchased equipment. Monthly payments are $13,975 and the loan matures on January 1, 2009.
     These fourThe three outstanding loans are collateralized by the related asset and are subject to the following covenants:
 • net worth greater than $20,000,000; and$20,000,000, and;
 
 • a cash flow coverage ratio of at least 1.5 to 1 calculated on a rolling twelve-month average.
6. Property and Equipment:
     Property and equipment, at cost, consist of the following as of the dates indicated:
        
         March 31, December 31, 
 September 30, December 31,  2006 2005 
 2005 2004  
Software $3,179,806 $2,550,224  $3,910,208 $3,253,454 
Computer equipment 3,540,678 2,964,333  3,927,759 3,626,353 
Furniture and fixtures 2,138,222 1,729,792  2,204,839 2,182,388 
Equipment 2,605,665 1,876,081  2,811,478 2,743,966 
Leasehold improvements 1,617,441 1,146,489  1,660,887 1,644,566 
Building and improvements 1,673,353 1,142,017  1,718,195 1,714,353 
Land 150,922 150,922  150,922 150,922 
Less accumulated depreciation  (7,474,543)  (5,807,369)  (8,815,061)  (8,129,584)
          
 
Property and equipment, net $7,431,544 $5,752,489  $7,569,227 $7,186,418 
          

11

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)     Depreciation expense for the three months ended March 31, 2006 and 2005 was $685,477 and $495,863, respectively.
7. Acquisition of RDS:
     On July 29, 2005, the Company acquired substantially all of the assets and liabilities of Alatax, Inc. for consideration of $17.5 million, consisting of $16.1 million in cash and 33,684 shares of our common stock, valued at $1.4 million at the closing in accordance with the calculation set forth in the asset purchase agreement. The assets acquired from Alatax, Inc. consisted of cash, accounts receivable, prepaid expenses, customer relationships, fixed assets, non-competition protection and goodwill. Liabilities assumed consisted of accounts payable and accrued expenses.
     The following is an allocation of the purchase price to the assets acquired and liabilities assumed of Alatax, Inc.:
     
Purchase price including acquisition costs $17,825,717 
Cash  (1,398,622)
Accounts receivable and prepaid expenses (included in other assets)  (374,732)
Customer relationships  (4,800,000)
Non-compete agreements  (200,000)
Fixed assets  (331,939)
Accounts payable  1,011,200 
Accrued expenses  158,749 
    
Goodwill $11,890,373 
    
     Alatax, Inc., which is based in Birmingham, Alabama, was founded in 1980 and has become a leading provider of outsourced business revenue administration, audit and debt discovery/recovery services for local governments. Alatax, Inc. has a workforce of about 80 employees and contractors. Alatax Inc.’s two top executives have both signed long-term employment agreements and will continue to manage the company. Although most of its clients are located in Alabama (where it operates as Alatax), the company recently has begun expanding into surrounding states (where it operates as Revenue Discovery Systems (RDS)). The income statement includes the results of operations of RDS for the period from August 1, 2005 through September 30, 2005.
8. Intangible Assets:
     With the acquisitionsacquisition of IGS on October 1, 2004 and RDS on July 29, 2005, the Company purchased certain tangible and intangible assets. Intangible assets purchased included client and customer relationships, non-compete agreements and goodwill. In accordance with the Financial Accounting Standards Board (“FASB”) Statement of Financial Accounting Standard 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. The Company reviews them at least annually for impairment. Total amortization expense was $651,554$567,163 and $1,541,270$444,858 for the three and nine months ended September 30,March 31, 2006 and 2005, respectively. Total amortization expense was $0 for the three and nine months ended September 30, 2004. In addition, goodwill, pursuant to SFAS 142, is not amortized but rather is reviewed at least annually for impairment. The annual review, which is conducted as of October 1, 2005, has not been completed at the time of the filing of this Form 10-Q.

12

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
9.8. Stock-Based Compensation:
     The Company has a stock option and restricted (nonvested)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 restrictednonvested shares of stock, as well as stock options. Also, in connection with the IPO, all existing PRA warrants that were owned by certain individuals and entities were exchanged for an equal number of PRA Inc warrants. Prior to 2002, the Company accounted for stock compensation issued under the recognition and measurement provisions of APB Opinion No. 25 (“APB 25”), “Accounting for Stock Issued to Employees,” and related Interpretations.

12

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     Effective January 1, 2002, the Company adopted the fair value recognition provisions of FASB Statement 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 FASB Statement No. 123R (“SFAS 123R”), “Share-Based Payment” using the modified prospective approach. The adoption of this statement increased cash flows from financing activities and decreased cash flows from operating activities by $1,365,461 relating to income tax benefits from share based compensation and increased equity by $426,752 for the three months ended March 31, 2006. The adoption of SFAS 123R had no material impact on the Company’s Income Statement. The adoption of SFAS 123R had no impact on previously reported interim periods. As of March 31, 2006, total future compensation costs related to nonvested awards of stock options and nonvested shares are $5,393,319 with a weighted average remaining life of 3.7 years for stock options and 3.9 years for nonvested shares. Based upon historical data, the Company used an annual forfeiture rate of 3.38% for stock options and 2.90% 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 low turnover among this group. In addition, commensurate with the adoption of this statement, all previous references to “restricted” stock are now referred to as “nonvested” shares.
     Total equity-based compensation expense was $331,211$431,817 and $808,684$229,853 for the three and nine months ended September 30,March 31, 2006 and 2005, respectively. Total equity-based compensation expense was $220,832 and $516,028 for the three and nine months ended September 30, 2004, respectively.
Stock Warrants
     Prior to the IPO, the PRA management committee was authorized to issue warrants to partners, employees or vendors to purchase membership units. Generally, warrants granted had a term between five5 and seven7 years and vested within three3 years. Warrants had been issued at or above the fair market value on the date of grant. Warrants vest and expire according to terms established at the grant date. All warrants became fully vested at the Company’s IPO in 2002. During the three and nine months ended September 30,March 31, 2006 and 2005, and 2004, no warrants were issued.
     The following summarizes all warrant related transactions from December 31, 20012002 through September 30, 2005:March 31, 2006:
         
      Weighted 
      Average 
  Warrants  Exercise 
  Outstanding  Price 
December 31, 2001  2,195,000  $4.17 
Granted  50,000   10.00 
Exercised  (50,000)  4.20 
Cancelled  (10,000)  4.20 
       
December 31, 2002  2,185,000   4.30 
Exercised  (2,026,000)  4.17 
Cancelled  (51,500)  9.72 
       
December 31, 2003  107,500   4.20 
Exercised  (67,500)  4.20 
       
December 31, 2004  40,000   4.20 
Exercised  (36,250)  4.20 
       
September 30, 2005  3,750  $4.20 
       
     The following information is as of September 30, 2005:
                     
      Warrants Outstanding  Warrants Exercisable 
      Weighted-           
      Average  Weighted-      Weighted- 
      Remaining  Average      Average 
Exercise Number  Contractual  Exercise  Number  Exercise 
Prices Outstanding  Life  Price  Exercisable  Price 
$4.20  3,750   0.5  $4.20   3,750  $4.20 
                
Total at September 30, 2005  3,750   0.5  $4.20   3,750  $4.20 
                
         
  Warrants  Weighted Average 
  Outstanding  Exercise Price 
December 31, 2002  2,185,000  $4.30 
Exercised  (2,026,000)  4.17 
Cancelled  (51,500)  9.72 
       
December 31, 2003  107,500   4.20 
Exercised  (67,500)  4.20 
       
December 31, 2004  40,000   4.20 
Exercised  (36,250)  4.20 
       
December 31, 2005  3,750   4.20 
Exercised  (3,750)  4.20 
       
March 31, 2006  —  $— 
       

13

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     As of March 31, 2006, all warrants have been exercised and/or cancelled and there are no warrants outstanding.
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 restricted (nonvested)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. All options and restrictednonvested 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. As of September 30, 2005,March 31, 2006, 895,000 options have been granted under the Amended Plan, of which 86,05594,155 have been cancelled.
     Options arePrior to January 1, 2006, options were expensed under SFAS 123 and are included in operating expenses as a component of compensation. Effective January 1, 2006, the Company adopted and began expensing options under SFAS 123R. The expense is included in operating expenses as a component of compensation. The Company issued 0no options to non-employee directors during the three and nine months ended September 30,March 31, 2006 and 2005. The Company issued 0 and 20,000 options to non-employee directors during the three and nine months ended September 30, 2004, respectively. All of the stock options which have been issued under the Amended Plan were issued to employees of the Company except for 40,000 which were issued to non-employee directors.
     The following summarizes all option related transactions from December 31, 20012002 through September 30, 2005:March 31, 2006:
                
 Weighted  Options Weighted Average 
 Average 
 Options Exercise 
 Outstanding Price 
December 31, 2001 — $— 
Granted 820,000 13.06 
Exercised — — 
Cancelled  (12,150) 13.00 
      Outstanding Exercise Price 
December 31, 2002 807,850 13.06  807,850 $13.06 
Granted 55,000 27.88  55,000 27.88 
Exercised  (50,915) 13.00   (50,915) 13.00 
Cancelled  (14,025) 13.00   (14,025) 13.00 
          
December 31, 2003 797,910 14.09  797,910 14.09 
Granted 20,000 28.79  20,000 28.79 
Exercised  (63,511) 13.30   (63,511) 13.30 
Cancelled  (47,940) 13.00   (47,940) 13.00 
          
December 31, 2004 706,459 14.65  706,459 14.65 
Exercised  (132,980) 13.00   (181,910) 13.22 
Cancelled  (11,940) 13.00   (20,040) 15.63 
          
September 30, 2005 561,539 $15.07 
December 31, 2005 504,509 15.12 
Exercised  (107,570) 13.04 
          
March 31, 2006 396,939 $15.68 
     
     The following information is as of March 31, 2006:
                     
  Options Outstanding  Options Exercisable 
      Weighted-           
      Remaining  Weighted-      Weighted- 
      Average  Average      Average 
Exercise Number  Contractual  Exercise  Number  Exercise 
Prices Outstanding  Life  Price  Exercisable  Price 
                     
$13.00  320,439   3.6  $13.00   44,979  $13.00 
$16.16  7,500   3.6   16.16   3,500   16.16 
$27.77 - $29.79  69,000   4.4   28.09   27,000   28.07 
                
Total at March 31, 2006  396,939   3.7  $15.68   75,479  $18.54 
                

14

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
The following information is as of September 30, 2005:
                     
      Options Outstanding  Options Exercisable 
      Weighted-           
      Average  Weighted-      Weighted- 
      Remaining  Average      Average 
Exercise Number  Contractual  Exercise  Number  Exercise 
  Prices Outstanding  Life  Price  Exercisable  Price 
$13.00  473,539   4.1  $13.00   56,599  $13.00 
$16.16  14,000   4.1   16.16   5,000   16.16 
$27.77 - $29.79  74,000   5.0   28.11   25,000   27.98 
                
Total at September 30, 2005  561,539   4.2  $15.07   86,599  $17.51 
                
     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.
     
Options issue year: 2004 2003
Weighted average fair value of options granted $2.85 $5.84
Expected volatility 13.26% - 13.55% 15.70% - 15.73%
Risk-free interest rate 3.16% - 3.37% 2.92% - 3.19%
Expected dividend yield 0.00% 0.00%
Expected life (in years) 5.00 5.00
Options issue year:2004
Weighted average fair value of options granted$2.85
Expected volatility13.26% - 13.55%
Risk-free interest rate3.16% - 3.37%
Expected dividend yield0.00%
Expected life (in years)5.00
     Utilizing these assumptions, each employee stock option granted in 2003 was valued between $5.80 and $6.25. Each non-employee director stock option granted in 2004 was valued between $2.62 and $2.92. There were no options granted during 2005 or during the three months ending March 31, 2006.
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. The terms of the nonvested share awards are similar to those of the stock option awards, wherein the shares are issued at or above market values and vest ratably over five years. Nonvested share grants are expensed over their vesting period.
     The following summarizes all nonvested stock transactions from December 31, 2002 through March 31, 2006:
         
      Weighted 
  Nonvested  Average 
  Shares  Price at 
  Outstanding  Grant Date 
         
December 31, 2002  —  $— 
Granted  13,045   27.57 
       
December 31, 2003  13,045   27.57 
Granted  84,350   26.94 
Vested  (2,609)  27.57 
Cancelled  (4,900)  26.08 
       
December 31, 2004  89,886   27.06 
Granted  74,600   41.92 
Vested  (17,389)  27.10 
Cancelled  (11,760)  30.40 
       
December 31, 2005  135,337   34.96 
Granted  12,500   46.44 
Vested  (1,000)  24.40 
Cancelled  (6,665)  35.38 
       
March 31, 2006  140,172  $36.04 
       

15

 

PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
     The following summarizes all nonvested stock transactions from December 31, 2002 through September 30, 2005:
         
  Nonvested  Weighted 
  Shares  Average 
  Outstanding  Price 
December 31, 2002  —  $— 
Granted  13,045   27.57 
       
December 31, 2003  13,045   27.57 
Granted  84,350   26.94 
Vested  (2,609)  27.57 
Cancelled  (4,900)  26.08 
       
December 31, 2004  89,886   27.06 
Granted  69,600   42.13 
Vested  (13,339)  25.95 
Cancelled  (7,330)  27.48 
       
September 30, 2005  138,817  $34.70 
       
10.9. Earnings per Share:
     Basic earnings per share (“EPS”) isare computed by dividing income available to common shareholders by weighted average common shares outstanding. Diluted EPS isare computed using the same components as basic EPS with the denominator adjusted for the dilutive effect of stock warrants, stock options and restrictednonvested stock awards. The following tables provide a reconciliation between the computation of basic EPS and diluted EPS for the three and nine months ended September 30, 2005March 31, 2006 and 2004:2005:
                                                
  For the three months ended September 30,  For the three months ended March 31, 
 2005 2004  2006 2005   
 Weighted Average Weighted Average  Weighted Average Weighted Average   
 Net Income Common Shares EPS Net Income Common Shares EPS Net Income Common Shares EPS Net Income Common Shares EPS 
     
Basic EPS $9,341,822 15,692,417 $0.60 $6,974,765 15,341,801 $0.45 $10,730,017 15,871,563 $0.68 $8,919,832 15,531,779 $0.57 
Dilutive effect of stock warrants,
options and restricted stock awards		 480,240 489,859  193,405 620,383 
          
Diluted EPS $9,341,822 16,172,657 $0.58 $6,974,765 15,831,660 $0.44 $10,730,017 16,064,968 $0.67 $8,919,832 16,152,162 $0.55 
          
  For the nine months ended September 30,     
 2005 2004   
 Weighted Average Weighted Average   
 Net Income Common Shares EPS Net Income Common Shares EPS 
   
Basic EPS $27,323,350 15,607,596 $1.75 $19,736,097 15,322,675 $1.29 
Dilutive effect of stock warrants, options and restricted stock awards 525,273 471,260 
     
Diluted EPS $27,323,350 16,132,869 $1.69 $19,736,097 15,793,935 $1.25 
     
     As of September 30, 2005 and 2004, thereThere were 0 and 75,000no antidilutive options outstanding respectively.as of March 31, 2006 or 2005.
11.10. Commitments and Contingencies:
Employment Agreements:
     The Company has employment agreements with all of its executive officers and with several members of its senior management group, the terms of which expire on various dates in 2005, 2006 and 2007.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 $3,871,884.$12,166,938 and is expected to be paid through December 31, 2008. The agreements also contain confidentiality and non-compete provisions.

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PORTFOLIO RECOVERY ASSOCIATES, INC.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(unaudited)
Leases:
     The Company is party to various operating and capital leases with respect to its facilities and equipment. Please refer to the Company’s consolidated financial statements and notes thereto in the Company’s Annual Report on Form 10-K, as filed with the Securities and Exchange Commission for discussion of these leases.
Litigation:
     The Company is from time to time subject to routine litigation incidental to its business. The Company believes that the results of any pending legal proceedings will not have a material adverse effect on the financial condition, results of operations or liquidity of the Company.
12.11. Recent Accounting Pronouncements:
     On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB statement No. 123(R), “Share-Based Payment,” (“FASSFAS 123R”). FASSFAS 123R revises FASB statement No. 123, “Accounting for Stock-Based Compensation” (“FASSFAS 123”) and requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. In addition to revising FASSFAS 123, FASSFAS 123R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and amends FASB Statement No. 95, “Statement of Cash Flows.” FASSFAS 123R applies to all stock-based compensation transactions in which a company acquires services by (1) issuing its stock or other equity instruments, except through arrangements resulting from employee stock-ownership plans (ESOPs) or (2) incurring liabilities that are based on the company’s stock price. FASSFAS 123R is effective for annual periods that begin after June 15, 2005; however, early adoption is encouraged. The Company believeshas determined that all of its existing stock-based awards are equity instruments. The Company previously adopted FASSFAS 123 on January 1, 2002 and has been expensing equity based compensation since that time. Management believes theThe Company adopted SFAS 123R on January 1, 2006. The adoption of FASSFAS 123R will havehad no material impact on its financial statements.

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Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations.
Cautionary Statements Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995:
This report contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks, uncertainties and assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. All statements, other than statements of historical fact, are forward-looking statements, including statements regarding overall trends, gross margin trends, operating cost trends, liquidity and capital needs and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. The risks, uncertainties and assumptions referred to above may include the following:
 • 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;
 
 • our ability to employ and retain qualified employees, especially collection personnel;
 
 • changes in the credit or capital markets, which affect our ability to borrow money or raise capital to purchase or service defaulted consumer receivables;
 
 • the degree and nature of our competition;
 
 • our future ability to comply with the provisions of the Sarbanes-Oxley Act of 2002 and the rules and regulations promulgated thereunder;
 
 • our ability to successfully integrate IGS and RDS into our business operations;
 
 • our ability to secure sufficient levels of placements for our fee-for-service businesses;
 
 • the sufficiency of our funds generated from operations, existing cash and available borrowings to finance our current operations; and
 
 • the risk factors listed from time to time in our filings with the Securities and Exchange Commission.
     You should assume that the information appearing in this 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 “Risk Factors” beginning on page 33 and described in our Annual Report on Form 10-K, filed on March 3, 2006.
     Our forward-looking statements could be wrong in light of these and other risks, uncertainties and assumptions. The future events, developments or results described in this report could turn out to be materially different. We have no obligation to publicly update or revise our forward-looking statements after the date of this annual report and you should not expect us to do so.
     Investors should also be aware that while we do, from time to time, communicate with securities analysts and others, we do not, by policy, selectively disclose to them any material nonpublic information or other confidential commercial information. Accordingly, stockholders should not assume that we agree with any statement or report issued by any analyst regardless of the content of the statement or report. We do not, by policy, confirm forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.

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Results of Operations
     The following table sets forth certain operating data as a percentage of total revenue for the periods indicated:
                        
 For the Three Months For the Nine Months  For the Three Months 
 Ended September 30, Ended September 30,  Ended March 31, 
 2005 2004 2005 2004  2006 2005 
Revenues:  
Income recognized on finance receivables  90.6%  95.7%  91.6%  95.3%  86.8%  90.1%
Commissions  9.4%  4.3%  8.4%  4.7%  13.2%  9.9%
              
Total revenue  100.0%  100.0%  100.0%  100.0%  100.0%  100.0%
Operating expenses:  
Compensation and employee services  29.9%  32.4%  29.8%  32.9%  31.1%  30.4%
Outside legal and other fees and services  19.8%  18.9%  20.3%  18.4%  20.0%  20.0%
Communications  3.0%  3.0%  2.9%  3.3%  3.6%  3.0%
Rent and occupancy  1.5%  1.5%  1.4%  1.6%  1.2%  1.3%
Other operating expenses  2.2%  2.3%  2.1%  2.5%  2.4%  2.1%
Depreciation and amortization  3.4%  1.7%  3.0%  1.7%  2.7%  2.6%
              
Total operating expenses  59.8%  59.8%  59.5%  60.4%  61.0%  59.4%
              
Income from operations  40.2%  40.2%  40.5%  39.6%  39.0%  40.6%
Other income and (expense):  
Interest income  0.5%  0.3%  0.4%  0.1%  0.2%  0.3%
Interest expense  (0.2%)  (0.2%)  (0.2%)  (0.3%)  (0.4%)  (0.2%)
              
Income before income taxes  40.5%  40.3%  40.7%  39.5%  38.8%  40.7%
Provision for income taxes  15.6%  15.6%  15.7%  15.3%  15.1%  15.8%
              
Net income  24.9%  24.7%  25.0%  24.2%  23.7%  24.9%
              
     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 September 30, 2005March 31, 2006 Compared To Three Months Ended September 30, 2004March 31, 2005
Revenue
     Total revenue was $37.5$45.3 million for the three months ended September 30, 2005,March 31, 2006, an increase of $9.2$9.5 million or 32.5%26.5% compared to total revenue of $28.3$35.8 million for the three months ended September 30, 2004.March 31, 2005.
Income Recognized on Finance Receivables
     Income recognized on finance receivables was $34.0$39.4 million for the three months ended September 30, 2005,March 31, 2006, an increase of $6.9$7.2 million or 25.5%22.4% compared to income recognized on finance receivables of $27.1$32.2 million for the three months ended September 30, 2004.March 31, 2005. The majority of the increase was due to an increase in our cash collections on our owned defaulted consumer receivables to $47.5$58.5 million from $38.8$47.8 million, an increase of 22.4%. Our amortization rate, including the allowance charge, on our owned portfolio for the three months ended September 30, 2005March 31, 2006 was 28.4%32.7% while for the three months ended September 30, 2004March 31, 2005 it was 30.3%32.6%. During the three months ended September 30, 2005,March 31, 2006, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $445.3 million

18

$3.87 billion at a cost of $16.5$16.2 million. During the three months ended September 30, 2004,March 31, 2005, we acquired defaulted consumer receivable portfolios with an aggregate face value of $564.9$659.9 million at a cost of $10.8$17.8 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.

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     Income recognized on finance receivables is shown net of valuation allowances recognized under SOP 03-3, which requires that a valuation allowance be taken for decreases in expected cash flows. For the three months ended March 31, 2006 we recorded an allowance charge of $175,000. No allowance charge was recorded during the three months ended March 31, 2005.

Commissions
     Commissions were $6.0 million for the three months ended March 31, 2006, an increase of $2.5 million or 71.4% compared to commissions of $3.5 million for the three months ended September 30, 2005, an increase of $2.3 million or 191.7% compared to commissions of $1.2 million for the three months ended September 30, 2004.March 31, 2005. Commissions increased as a result of the additionsaddition of our IGS fee-for-service business and our RDS government processing and collection business, as well as a slightan increase in revenue generated by our Anchor contingent fee business compared to the prior year period.
Operating Expenses
     Total operating expenses were $22.4$27.7 million for the three months ended September 30, 2005,March 31, 2006, an increase of $5.5$6.5 million or 32.5%30.7% compared to total operating expenses of $16.9$21.2 million for the three months ended September 30, 2004.March 31, 2005. Total operating expenses, including compensation and employee services expenses, were 44.0%42.9% of cash receipts excluding sales for the three months ended September 30, 2005March 31, 2006 compared to 42.2%41.4% for the same period in 2004.2005.
Compensation and Employee Services
     Compensation and employee services expenses were $11.2$14.1 million for the three months ended September 30, 2005,March 31, 2006, an increase of $2.0$3.2 million or 21.7%29.4% compared to compensation and employee services expenses of $9.2$10.9 million for the three months ended September 30, 2004.March 31, 2005. Compensation and employee services expenses increased as total employees grew to 1,0051,158 at September 30, 2005March 31, 2006 from 891978 at September 30, 2004.March 31, 2005. Compensation and employee services expenses as a percentage of cash receipts excluding sales decreasedincreased to 22.0%21.9% for the three months ended September 30, 2005March 31, 2006 from 22.9%21.2% of cash receipts excluding sales for the same period in 20042005 as a result of increased collector productivityheadcount and a shift in portfolio mix.
Outside Legal and Other Fees and Services
     Outside legal and other fees and services expenses were $7.4$9.1 million for the three months ended September 30, 2005,March 31, 2006, an increase of $2.1$1.9 million or 39.6%26.4% compared to outside legal and other fees and services expenses of $5.3$7.2 million for the three months ended September 30, 2004.March 31, 2005. Of the $2.1$1.9 million increase, $0.4 million was attributable to agency fees mainly incurred by our IGS subsidiary and $0.4 million was attributable to increases in other fees and services. The remaining $1.3$1.5 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 us 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 represented 32.4%27.3% of total cash receipts for the three months ended September 30, 2005March 31, 2006 compared to 29.7%27.4% for the three months ended September 30, 2004.March 31, 2005. Total legal expenses for the three months ended September 30, 2005March 31, 2006 were 34.5%36.2% of legal cash collections compared to 36.8%34.4% for the three months ended September 30, 2004.March 31, 2005. Legal fees and costs increased from $4.4$4.8 million for the three months ended September 30, 2004March 31, 2005 to $5.7$6.4 million, or an increase of 29.5%33.3%, for the three months ended September 30, 2005.
Communications
     Communications expenses were $1,116,000 for the three months ended September 30, 2005, an increase of $276,000 or 32.9% compared to communications expenses of $840,000 for the three months ended September 30, 2004. The increase was attributable to a growth in mailings which increased by $293,000 offset by a slight decrease in telephone expenses of $17,000.March 31, 2006.

2019

 

Communications
     Communications expenses were $1.6 million for the three months ended March 31, 2006, an increase of $500,000 or 45.5% compared to communications expenses of $1.1 million for the three months ended March 31, 2005. 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. Telephone expenses were responsible for 13.1% of this increase, while the remaining 86.9% was attributable to higher mailing expenses.
Rent and Occupancy
     Rent and occupancy expenses were $555,000$561,000 for the three months ended September 30, 2005,March 31, 2006, an increase of $120,000$85,000 or 27.6%17.9% compared to rent and occupancy expenses of $435,000$476,000 for the three months ended September 30, 2004.March 31, 2005. Our new IGS facility and our RDS facilityfacilities accounted for $75,000 and $17,000$69,000 of the increase, respectively.increase. The remaining increase was attributable to rent escalations at our Norfolk locations as well as increased utility charges generally.
Other Operating Expenses
     Other operating expenses were $834,000$1,076,000 for the three months ended September 30, 2005,March 31, 2006, an increase of $185,000$323,000 or 28.5%42.9% compared to other operating expenses of $649,000$753,000 for the three months ended September 30, 2004.March 31, 2005. The increase was due to changes in travel expenses, advertising and marketing, miscellaneous expenses, hiring expenses, repairs and maintenance, travel and taxes, feesmeals, hiring expenses, and licenses. Travelmiscellaneous expenses. Repairs and maintenance expenses increased by $63,000, advertising$48,000, travel and marketingmeals expenses increased by $37,000$105,000, hiring expenses increased by $70,000, and taxes, miscellaneous expenses increased by $26,000, repairs and maintenance increased by $24,000, hiring expenses increased by $22,000 and fees and licenses increased by $13,000.$100,000.
Depreciation and Amortization
     Depreciation and amortization expenses were $1,289,000$1,253,000 for the three months ended September 30, 2005,March 31, 2006, an increase of $801,000$312,000 or 164.1%33.2% compared to depreciation expenses of $488,000$941,000 for the three months ended September 30, 2004.March 31, 2005. The increase was attributable to the depreciation and amortization of the acquired assets of IGS and Alatax and the continued capital expenditures on equipment, software and computers related to our growth and systems upgrades. The amortization of the IGS and Alatax intangible assets accounted for $445,000 and $207,000 of the increase, respectively. The remaining increase of $149,000 resulted from continued capital expenditures on equipment, software and computers.
Interest Income
     Interest income was $188,000 for the three months ended September 30, 2005, an increase of $111,000 compared to interest income of $77,000 for the three months ended September 30, 2004. This increase is the result of the investment of larger balances in higher yielding auction rate certificates and tax exempt money market accounts during the three months ended September 30, 2005.
Interest Expense
     Interest expense was $59,000 for the three months ended September 30, 2005, a decrease of $10,000 compared to interest expense of $69,000 for the three months ended September 30, 2004. The decrease is due to lower balances on our long-term debt and obligations under capital leases.
Nine Months Ended September 30, 2005 Compared To Nine Months Ended September 30, 2004
Revenue
     Total revenue was $109.2 million for the nine months ended September 30, 2005, an increase of $27.5 million or 33.7% compared to total revenue of $81.7 million for the nine months ended September 30, 2004.
Income Recognized on Finance Receivables
     Income recognized on finance receivables was $100.1 million for the nine months ended September 30, 2005, an increase of $22.2 million or 28.5% compared to income recognized on finance receivables of $77.9 million for the nine months ended September 30, 2004. The majority of the increase was due to an increase in our cash collections

21

on our owned defaulted consumer receivables to $144.1 million from $112.8 million, an increase of 27.8%. Our amortization rate on our owned portfolio for the nine months ended September 30, 2005 was 30.6% while for the nine months ended September 30, 2004 it was 30.9%. During the nine months ended September 30, 2005, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $2.47 billion at a cost of $57.3 million. During the nine months ended September 30, 2004, we acquired defaulted consumer receivable portfolios with an aggregate face value of $2.67 billion at a cost of $38.7 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.
Commissions
     Commissions were $9.1 million for the nine months ended September 30, 2005, an increase of $5.3 million or 139.5% compared to commissions of $3.8 million for the nine months ended September 30, 2004. Commissions increased as a result of the addition of our IGS fee-for-service business and our RDS government processing and collection business, as well as a slight increase in revenue generated by our Anchor contingent fee business compared to the prior year period.
Operating Expenses
     Total operating expenses were $65.0 million for the nine months ended September 30, 2005, an increase of $15.7 million or 31.9% compared to total operating expenses of $49.3 million for the nine months ended September 30, 2004. Total operating expenses, including compensation and employee services expenses, were 42.4% of cash receipts excluding sales for the nine months ended September 30, 2005 compared with 42.3% for the same period in 2004.
Compensation and Employee Services
     Compensation and employee services expenses were $32.5 million for the nine months ended September 30, 2005, an increase of $5.6 million or 20.8% compared to compensation and employee services expenses of $26.9 million for the nine months ended September 30, 2004. Compensation and employee services expenses increased as total employees grew to 1,005 at September 30, 2005 from 891 at September 30, 2004. Compensation and employee services expenses as a percentage of cash receipts excluding sales decreased to 21.2% for the nine months ended September 30, 2005 from 23.1% of cash receipts excluding sales for the same period in 2004 as a result of increased collector productivity and a shift in portfolio mix.
Outside Legal and Other Fees and Services
     Outside legal and other fees and services expenses were $22.2 million for the nine months ended September 30, 2005, an increase of $7.2 million or 48.0% compared to outside legal and other fees and services expenses of $15.0 million for the nine months ended September 30, 2004. Of the $7.2 million increase, $1.9 million was attributable to agency fees mainly incurred by our IGS subsidiary, $0.9 million was attributable to increases in other fees and services and $0.1 million was attributable to increases in accounting and professional fees. This was offset by a decrease of $0.5 million as a result of capitalized acquisition fees that were expensed in the quarter ended June 30, 2004 as a result of a review of our accounting. The remaining $4.8 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 us referring to the legal suit process previously unsuccessfully liquidated accounts that have an identified means of repayment but that are nearing their legal statute of limitations. Legal cash collections represented 30.7% of total cash receipts for the nine months ended September 30, 2005, compared to 28.3% for the nine months ended September 30, 2004. Total legal expenses for the nine months ended September 30, 2005 were 34.6% of legal cash collections compared to 34.8% for the nine months ended September 30, 2004. Legal fees and costs increased from $11.5 million for the nine months ended September 30, 2004 to $16.3 million, or an increase of 41.7%, for the nine months ended September 30, 2005.

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Communications
     Communications expenses were $3.2 million for the nine months ended September 30, 2005, an increase of $0.5 million or 18.5% compared to communications expenses of $2.7 million for the nine months ended September 30, 2004. The increase was attributable to growth in mailings and higher telephone expenses incurred to collect on a greater number of defaulted consumer receivables owned and serviced. Mailings were responsible for 92.1% of this increase, while the remaining 7.9% is attributable to higher telephone expenses.
Rent and Occupancy
     Rent and occupancy expenses were $1.5 million for the nine months ended September 30, 2005, an increase of $0.2 million or 15.4% compared to rent and occupancy expenses of $1.3 million for the nine months ended September 30, 2004. Our new IGS facility and RDS facility accounted for $166,000 and $17,000 of the increase, respectively, while the remaining increase was attributable to rent escalations at our Norfolk locations as well as increased utility charges generally.
Other Operating Expenses
     Other operating expenses were $2,316,000 for the nine months ended September 30, 2005, an increase of $288,000 million or 14.2% compared to other operating expenses of $2,028,000 for the nine months ended September 30, 2004. The increase was due mainly to changes in taxes, fees and licenses, travel and meals, advertising and marketing, insurance, hiring expenses, dues and subscriptions and repairs and maintenance. Taxes, fees and licenses increased by $120,000, travel and meals increased by $63,000, advertising and marketing increased by $57,000, insurance expenses increased by $42,000 and hiring expenses increased by $26,000. These increases were offset by a decrease in dues and subscriptions of $15,000 and a decrease in repairs and maintenance of $5,000.
Depreciation and Amortization
     Depreciation and amortization expenses were $3.3 million for the nine months ended September 30, 2005, an increase of $1.9 million or 135.7% compared to depreciation expenses of $1.4 million for the nine months ended September 30, 2004. The increase was attributable to the depreciation and amortization of the acquired assets of IGS and RDS and the continued capital expenditures on equipment, software and computers related to our growth and systems upgrades. The amortization of the IGS and RDS intangible assets accounted for $1.3 million and $0.2 million$122,000 of the increase, respectively.increase. The remaining increase of $0.4 million$190,000 resulted from continuednew capital expenditures on equipment, software and computers.
Interest Income
     Interest income was $476,000$73,000 for the ninethree months ended September 30, 2005, an increaseMarch 31, 2006, a decrease of $370,000$23,000 compared to interest income of $106,000$96,000 for the ninethree months ended September 30, 2004.March 31, 2005. This increasedecrease is the result of the investment of largerreduced cash balances in higher yielding auction rate certificates and tax exempt money market accounts during the nine months ended September 30,2006 quarter versus the same period in 2005.
Interest Expense
     Interest expense was $186,000$168,000 for the ninethree months ended September 30, 2005, a decreaseMarch 31, 2006, an increase of $20,000 or 9.7%$104,000 compared to interest expense of $206,000$64,000 for the ninethree months ended September 30, 2004.March 31, 2005. The decreaseincrease is due to lower balancesan outstanding balance on our long-term debt and obligations under capital leases.revolving line of credit during the quarter versus no outstanding line of credit balances in the comparative period in 2005.

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Supplemental Performance Data
Owned Portfolio Performance:
The following table shows our portfolio buying activity by year, setting forth, among other things, the purchase price, unamortized purchase price (finance receivables, net), actual cash collections and estimated remaining cash collections as of September 30, 2005.March 31, 2006.
($ in thousands)
                                 
 Unamortized Percentage Actual Cash Total Estimated Unamortized Percentage Actual Cash Total Estimated
 Purchase Price of Purchase Price Collections Estimated Total Estimated Collections to Purchase Price of Purchase Price Collections Estimated Total Estimated Collections to
Purchase Purchase Balance at Remaining Unamortized Including Cash Remaining Total Estimated Collections to Purchase Price Purchase Balance at Remaining Unamortized Including Cash Remaining Total Estimated Collections to Purchase Price
Period Price(1) September 30, 2005(2) at September 30, 2005(3) Sales Collections(4) Collections(5) Purchase Price(6) Adjusted(7) Price(1) March 31, 2006(2) at March 31, 2006(3) Sales Collections(4) Collections(5) Purchase Price(6) Adjusted(7)
1996 $3,080 $0  0% $9,419 $99 $9,518  309%  309% $3,080 $0  0% $9,552 $71 $9,623  312%  312%
1997 $7,685 $0  0% $23,113 $403 $23,516  306%  306% $7,685 $0  0% $23,486 $255 $23,741  309%  309%
1998 $11,089 $0  0% $32,549 $1,020 $33,569  303%  303% $11,089 $0  0% $33,396 $533 $33,929  306%  306%
1999 $18,898 $105  1% $56,994 $2,854 $59,848  317%  317% $18,898 $0  0% $58,851 $1,799 $60,650  321%  321%
2000 $25,015 $553  2% $85,741 $7,738 $93,479  374%  374% $25,015 $0  0% $90,380 $5,032 $95,412  381%  381%
2001 $33,470 $2,113  6% $119,947 $25,571 $145,518  435%  435% $33,468 $1,235  4% $129,587 $18,486 $148,073  442%  442%
2002 $42,279 $6,888  16% $112,486 $37,880 $150,366  356%  356% $42,277 $4,673  11% $126,467 $26,851 $153,318  363%  363%
2003 $61,482 $20,454  33% $114,969 $73,932 $188,901  307%  307% $61,466 $13,374  22% $139,324 $55,473 $194,797  317%  317%
2004 $59,965 $34,051  57% $54,105 $91,121 $145,226  242%  255% $59,355 $24,026  40% $75,793 $74,223 $150,016  253%  260%
2005 YTD $57,582 $53,082  92% $9,445 $109,416 $118,861  206%  224%
2005 $146,312 $130,784  89% $36,928 $266,011 $302,939  207%  224%
YTD 2006 $16,240 $15,755  97% $732 $29,574 $30,306  187%  231%
 
(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 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.
 
(7) Total estimated collections to purchase price adjusted refers to the total estimated collections divided by the purchase price after removing the impact of purchased bankrupt accounts as well as other purchased pools that had established some level of payment stream after charge-off (we refer to these as “paying” or “semi-performing” pools).

2421

 

     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 nine monthsquarters ended September 30, 2005March 31, 2006 and 2004.2005. 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 GRAPH)(PORTFOLIO PURCHASE GRAPH)
     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
                               
                                     Cash Collections By Year, By Year of Purchase 
($ in thousands)($ in thousands)  ($ in thousands) 
Purchase Purchase Cash Collection Period Purchase Cash Collection Period YTD   
Period Price 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 YTD Total Price 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 Total 
1996 $3,080 $548 $2,484 $1,890 $1,348 $1,025 $730 $496 $398 $285 $153 $9,357  $3,080 $548 $2,484 $1,890 $1,348 $1,025 $730 $496 $398 $285 $210 $77 $9,491 
1997 7,685 — 2,507 5,215 4,069 3,347 2,630 1,829 1,324 1,022 690 $22,633  7,685 — 2,507 5,215 4,069 3,347 2,630 1,829 1,324 1,022 860 192 $22,995 
1998 11,089 — — 3,776 6,807 6,398 5,152 3,948 2,797 2,200 1,416 $32,494  11,089 — — 3,776 6,807 6,398 5,152 3,948 2,797 2,200 1,811 463 $33,352 
1999 18,898 — — — 5,138 13,069 12,090 9,598 7,336 5,615 3,455 $56,301  18,898 — — — 5,138 13,069 12,090 9,598 7,336 5,615 4,352 960 $58,158 
2000 25,015 — — — — 6,894 19,498 19,478 16,628 14,098 8,683 $85,279  25,015 — — — — 6,894 19,498 19,478 16,628 14,098 10,924 2,398 $89,918 
2001 33,470 — — — — — 13,048 28,831 28,003 26,717 17,857 $114,456  33,468 — — — — — 13,048 28,831 28,003 26,717 22,639 4,859 $124,097 
2002 42,279 — — — — — — 15,073 36,258 35,742 25,401 $112,475  42,277 — — — — — — 15,073 36,258 35,742 32,497 6,885 $126,455 
2003 61,482 — — — — — — — 24,308 49,706 40,955 $114,970  61,466 — — — — — — — 24,308 49,706 52,640 12,670 $139,324 
2004 59,965 — — — — — — — — 18,019 36,080 $54,100  59,355 — — — — — — — — 18,019 46,475 11,294 $75,788 
2005 YTD 57,582 — — — — — — — — — 9,445 $9,445 
2005 146,312 — — — — — — — — — 18,968 17,960 $36,928 
YTD 2006 16,240 — — — — — — — — — — 732 $732 
Total $320,545 $548 $4,991 $10,881 $17,362 $30,733 $53,148 $79,253 $117,052 $153,404 $144,136 $611,508  $424,887 $548 $4,991 $10,881 $17,362 $30,733 $53,148 $79,253 $117,052 $153,404 $191,376 $58,490 $717,238 

2522

 

     When we acquire a new pool of finance receivables, our estimates typically result in a 72 —- - 84 month projection of cash collections. The following chart shows our historical cash collections (including cash sales of finance receivables) in relation to the aggregate of the total estimated collection projections made at the time of each respective pool purchase, adjusted for buybacks.
(ACTUAL CASH COLLECTIONS AND CASH SALES VS. ORIGINAL PROJECTIONS GRAPH)(HISTORICAL CASH COLLECTION CHART)
Owned Portfolio Personnel Performance:
     We measure the productivity of each collector each month, breaking results into groups of similarly tenured collectors. The following three tables display various productivity measures that we track.
Collector by Tenure
                                                
Collector FTE at: 12/31/01 12/31/02 12/31/03 12/31/04 09/30/04 09/30/05 12/31/02 12/31/03 12/31/04 12/31/05 03/31/05 03/31/06 
One year +1
 151 210 241 298 300 324  210 241 298 327 319 331 
Less than one year2
 218 223 338 349 342 268  223 338 349 364 345 360 
Total2
 369 433 579 647 642 592  433 579 647 691 664 691 
 
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 Tenure1
                                                
Average performance YTD 12/31/01 12/31/02 12/31/03 12/31/04 09/30/04 09/30/05 12/31/02 12/31/03 12/31/04 12/31/05 03/31/05 03/31/06
One year +2
 $15,205 $16,927 $18,158 $17,129 $17,497 $16,833  $16,927 $18,158 $17,129 $16,694 $17,846 $19,287 
Less than one year3
 $7,740 $8,689 $8,303 $9,363 $9,740 $8,931  $8,689 $8,303 $9,363 $8,491 $9,363 $10,056 
 
1 Cash collection numbers include only accounts assigned to collectors. Significant cash collections do occur on “unassigned” accounts.
 
2 Calculated using average YTD monthly cash collections of all collectors with one year or more of tenure.
 
3 Calculated using weighted average YTD monthly cash collections of all collectors with less than one year of tenure, including those in training.
YTD Cash Collections per Hour Paid1
                                                
Average performance YTD 12/31/01 12/31/02 12/31/03 12/31/04 09/30/04 09/30/05 12/31/02 12/31/03 12/31/04 12/31/05 03/31/05 03/31/06
Total cash collections $77.20 $96.37 $108.27 $117.59 $117.85 $136.18  $96.37 $108.27 $117.59 $133.39 $135.62 $151.60 
Non-legal cash collections $66.87 $77.72 $80.10 $82.06 $83.32 $91.79  $77.72 $80.10 $82.06 $89.25 $95.71 $105.97 
 
1 Cash collections (assigned and unassigned) divided by total hours paid (including holiday, vacation and sick time) to all collectors (including those in training).

2623

 

     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 on a quarterly basis. The difference between cash collections and income recognized is referred to as payments applied to principal. It is also referred to as amortization. This amortization is the portion of cash collections that is used to recover the cost of the portfolio investment represented on the balance sheet.
(CASH COLLECTIONS VS. INCOME RECOGNIZED ON FINANCE RECEIVABLES GRAPH)(CASH COLLECTIONS CHART)
 
(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. 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. Due to our historical quarterly increases in cash collections, our growth has partially masked the impact of this seasonality.
(QUARTERLY CASH COLLECTIONS GRAPH)(QUARTERLY CASH COLLECTION CHART)
 
(1) Includes cash collections on finance receivables only. Excludes commission fees and cash proceeds from sales of defaulted consumer receivables.

2724

 

     The following table shows the changes in finance receivables, including the amounts paid to acquire new portfolios.
        
                 Three Months Three Months 
 Three Months Three Months Nine Months Nine Months  Ended Ended 
 Ended Ended Ended Ended  March 31, March 31, 
 September 30, September 30, September 30, September 30,  2006 2005 
 2005 2004 2005 2004  
Balance at beginning of period $114,837,794 $96,270,285 $105,188,906 $92,568,557  $193,644,670 $105,188,906 
 
Acquisitions of finance receivables, net of buybacks(1)
 15,916,690 10,821,842 56,133,504 37,626,129  15,318,806 17,735,629 
 
Cash collections applied to principal(2)
  (13,508,013)  (11,780,396)  (44,075,939)  (34,882,955)
         
Cash collections applied to principal on finance receivables(2)
  (19,116,097)  (15,580,134)
      
Balance at end of period $117,246,471 $95,311,731 $117,246,471 $95,311,731  $189,847,379 $107,344,401 
              
 
Estimated Remaining Collections (“ERC”) (3)
 $350,034,361 $286,735,182 $350,034,361 $286,735,182  $478,308,322 $313,855,339 
              
 
(1) Agreements to purchase receivables typically include general representations and warranties from the sellers covering account holders’ death or bankruptcy and accounts settled or disputed prior to sale. The seller can replace or repurchase these accounts. We refer to repurchased accounts as buybacks. We also capitalize certain acquisition related costs.
 
(2) Cash collections applied to principal (also referred to as amortization) on finance receivables consists of cash collections less income recognized on finance receivables.
 
(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 tables categorize our owned portfolios as of September 30, 2005March 31, 2006 into the major asset types and account types represented, respectively:
                                
 Life to Date Purchased Face Face    Life to Date Purchased Face   
 No. of Value of Defaulted Consumer    No. of Value of Defaulted Consumer   
Asset Type Accounts % Receivables(1) %  Accounts % Receivables(1) % 
Visa/MasterCard/Discover 3,020,916  42.0% $8,207,589,273  60.4% 4,702,806  49.7% $14,326,384,476  70.6%
Consumer Finance 2,678,808  37.3% 2,263,817,413  16.7% 2,928,309  31.0% 2,548,075,027  12.5%
Private Label Credit Cards 1,290,516  17.9% 1,922,291,731  14.1% 1,610,499  17.0% 2,129,500,771  10.5%
Auto Deficiency 201,266  2.8% 1,196,982,207  8.8% 215,596  2.3% 1,301,757,641  6.4%
                  
 
   
Total:
 7,191,506  100.0% $13,590,680,624  100.0% 9,457,210  100.0% $20,305,717,915  100.0%
                  
 
(1) The Life“Life to Date Purchased Face Value of Defaulted Consumer ReceivablesReceivables” represents the original face amount purchased from sellers and has not been decremented by any adjustments including payments and buybacks.buybacks (“buybacks” are defined as purchase price refunded by the seller due to the return of non-compliant accounts).

2825

 

     As shown in theThe following chart shows details of our life to date buying activity as of September 30, 2005 a majority of our portfolios are secondaryMarch 31, 2006. We actively seek to purchase both bankrupt and tertiary accounts but we purchase or servicenon-bankrupt accounts at any point in the delinquency cycle.cycle
                                
 Life to Date Purchased Face    Life to Date Purchased Face   
 Value of Defaulted Consumer    Value of Defaulted Consumer   
Account Type No. of Accounts % Receivables(1) %  No. of Accounts % Receivables(1) % 
Fresh 189,359  2.6% 608,813,763  4.5% 201,476  2.1% $ 645,897,478  3.2%
Primary 1,022,245  14.2% 2,479,969,219  18.2% 1,062,969  11.2% 2,592,961,243  12.8%
Secondary 1,733,493  24.1% 3,284,819,130  24.2% 1,903,013  20.1% 3,767,365,777  18.6%
Tertiary 2,753,729  38.3% 3,206,092,051  23.6% 2,930,313  31.0% 3,568,911,720  17.6%
BK Trustees 1,506,912  15.9% 5,681,196,172  28.0%
Other 1,492,680  20.8% 4,010,986,461  29.5% 1,852,527  19.7% 4,049,385,525  19.8%
                  
Total:
 7,191,506  100.0% $13,590,680,624  100.0% 9,457,210  100.0% $20,305,717,915  100.0%
                  
 
(1) The Life“Life to Date Purchased Face Value of Defaulted Consumer ReceivablesReceivables” represents the original face amount purchased from sellers and has not been decremented by any adjustments including payments and buybacks.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. These facts are considered in our pricing analysis. In addition, historical payment patterns due to economic factors and bankruptcy trends vary regionally and are also factored into our maximum purchase price equation.
     The following chart sets forth our overall life to date portfolio of defaulted consumer receivables geographically as of September 30, 2005:March 31, 2006:
                                        
 Life to Date Purchased Face    Life to Date Purchased Face Original Purchase Price of  
 No. of Value of Defaulted Consumer    No. of Value of Defaulted Consumer Defaulted Consumer  
Geographic Distribution Accounts % Receivables(1) %  Accounts % Receivables(1) % Receivables(2) %
Texas 1,768,334  25% $2,023,025,922  15% 1,928,985  20% $2,502,462,654  12% $53,372,962  12%
California 657,402  9% 1,621,207,876  12% 902,229  10% 2,468,096,397  12% 46,802,949  11%
Florida 477,211  6% 1,392,213,806  10% 706,564  7% 2,068,148,804  10% 41,269,141  10%
New York 317,546  4% 926,030,502  7% 554,235  6% 1,481,961,856  7% 31,587,865  7%
Pennsylvania 185,073  3% 490,043,746  4% 265,711  3% 734,652,739  4% 17,295,622  4%
North Carolina 185,359  3% 467,090,073  3%
Illinois 229,827  3% 415,225,097  3% 316,499  3% 682,486,441  3% 14,777,713  3%
Ohio 220,354  3% 401,697,368  3% 310,767  3% 678,192,732  3% 14,380,007  3%
North Carolina 248,594  3% 611,407,125  3% 14,421,246  3%
New Jersey 128,329  2% 386,783,549  3% 196,852  2% 597,582,635  3% 13,750,657  3%
Georgia 158,996  2% 364,695,344  3% 235,569  2% 555,736,835  3% 14,197,450  3%
Michigan 269,159  3% 519,422,044  3% 12,089,778  3%
Massachusetts 151,768  2% 333,667,992  2% 207,434  2% 481,781,593  2% 9,272,465  2%
Michigan 195,549  3% 322,024,182  2%
South Carolina 123,995  2% 283,648,663  2%
Virginia 170,141  2% 382,285,080  2% 9,090,184  2%
Missouri 255,972  4% 254,718,792  2% 289,934  3% 378,587,614  2% 7,938,115  2%
Virginia 107,673  1% 236,687,615  2%
Arizona 136,105  1% 364,563,053  2% 7,277,520  2%
Tennessee 103,600  1% 233,376,115  2% 149,952  2% 360,245,736  2% 8,960,899  2%
Other(2)
 1,924,518  27% 3,438,543,982  25%
         
Other(3)
 2,568,480  28% 5,438,104,577  27% 115,082,068  28%
   
Total:
 7,191,506  100% $13,590,680,624  100% 9,457,210  100% $20,305,717,915  100% $431,566,641  100%
           
 
(1) The Life“Life to Date Purchased Face Value of Defaulted Consumer ReceivablesReceivables” represents the original face amount purchased from sellers and has not been decremented by any adjustments including payments and buybacks.buybacks (“buybacks” are defined as purchase price refunded by the seller due to the return of non-compliant accounts).

26

(2)The “Original Purchase Price” represents the cash paid to sellers to acquire portfolios of defaulted consumer receivables.
(3) Each state included in “Other” represents less than 2% of the face value of total defaulted consumer receivables.

29

Liquidity and Capital Resources
     Historically, our primary sources of cash have been cash flows from operations, bank borrowings and equity offerings. Cash has been used for acquisitions of finance receivables, corporate acquisitions, repayments of bank borrowings, purchases of property and equipment and working capital to support our growth.
     We believe that funds generated from operations, together with existing cash and available borrowings under our credit agreement will be sufficient to finance our current operations, planned capital expenditure requirements, and internal growth at least through the next twelve months. However, we could require additional debt or equity financing if we were to make any 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 $48.0$17.0 million and $36.1$14.9 million for the ninethree months ended September 30,March 31, 2006 and 2005, and 2004, respectively. In these periods, cash from operations was generated primarily from net income earned through cash collections and commissions received for the period which increased from $19.7$8.9 million for the ninethree months ended September 30, 2004March 31, 2005 to $27.3$10.7 million for the ninethree months ended September 30, 2005.March 31, 2006. The remaining increase was due to changes in other accounts related to our operating activities.
     Our investing activities usedprovided cash of $6.2$2.7 million and $25.7$21.0 million during the ninethree months ended September 30,March 31, 2006 and 2005, and 2004, respectively. Cash used in investing activities is primarily driven by acquisitions of defaulted consumer receivables, net of cash collections applied to principal on finance receivables and purchases of auction rate certificates. Cash provided by investing activities is primarily driven by the sale of auction rate certificates. In addition, in July 2005, we purchased the assets of Alatax, Inc. for $15.0 million in cash (net of acquisition costs and cash received).
     Our financing activities used cash of $12.4 million and provided cash of $1.1$0.7 million and $481,000 during the ninethree months ended September 30,March 31, 2006 and 2005, and 2004, respectively. Cash used in financing activities is primarily driven by payments on our revolving lines of credit, long term debt and capital lease obligations. Cash is provided by proceeds from debt financing, and stock option exercises.
     Cash received for interestexercises and income was $476,000 and $106,000 for the nine months ended September 30, 2005 and 2004, respectively. The interest income received was the result in the investment in auction rate certificates and other high quality investments.tax benefits from share based compensation.
     Cash paid for interest expenses was $186,000$201,000 and $206,000$64,000 for the ninethree months ended September 30,March 31, 2006 and 2005, and 2004, respectively. The interest expenses were paid for our revolving lines of credit, capital lease obligations and other long-term debt.
     We maintainOn November 29, 2005, we entered into a $25.0 millionLoan and Security Agreement for a revolving line of credit jointly offered by Bank of America, N. A. and Wachovia Bank, National Association. The agreement is a revolving line of credit in an amount equal to the lesser of $75,000,000 or twenty percent of our estimated remaining collections of all its eligible asset pools. The new line of credit replaces our previous $25,000,000 credit facility with RBC Centura Bank, (“RBC”) pursuant to an agreement entered intowhich was terminated (without having any borrowings under the line in 2005) on November 28, 2003 and amended on November 22, 2004. The2005. Borrowings under the new revolving credit facility bearsbear interest at a spreadfloating rate equal to the LIBOR Market Index Rate plus 1.75% and expires on November 29, 2008. The loan is collateralized by substantially all of 2.50% over LIBORour tangible and extends through November 28, 2006.intangible assets. The agreement provides for:
 • restrictions on monthly borrowings are limited to 20% of Estimated Remaining Collections;
 
 • a funded debt coverageto EBITDA ratio of at least 8.0less than 1.0 to 1.0 calculated on a rolling twelve-month average;
 
 • a debt to tangible net worth ratio of less than 0.40 to 1.00;
•net income per quarter of at least $1.00, calculated on a consolidated basis;100% of prior quarter tangible net worth plus 25% of cumulative positive net income since the end of such fiscal quarter, plus 100% of the net proceeds from any equity offering; and
 
 • restrictions on change of control.

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     This facility had no amounts outstanding at September 30, 2005.
In accordanceMarch 31, 2006. As of March 31, 2006 we are in compliance with all of the credit agreement, we obtained approval from the lender prior to the RDS acquisition.covenants of this agreement.

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     As of September 30, 2005March 31, 2006 there are fourthree loans outstanding. On February 9, 2001, we entered into a commercial loan agreement in the amount of $107,000 in order to purchase equipment for our Norfolk, Virginia location. This loan bears interest at a fixed rate of 7.9% and maturesmatured on February 1, 2006. On February 20, 2002, one of our subsidiaries entered into an additional arrangement for a $500,000 commercial loan in order to finance construction of a parking lot at our Norfolk, Virginia location. This loan bears interest at a fixed rate of 6.47% and matures on September 1, 2007. On May 1, 2003, we entered into a commercial loan agreement in the amount of $975,000 to finance equipment purchases for our Hampton, Virginia location. This loan bears interest at a fixed rate of 4.25% and matures on May 1, 2008. On January 9, 2004, we entered into a commercial loan agreement in the amount of $750,000 to finance equipment purchases at our newly leased Norfolk facility. This loan bears interest at a fixed rate of 4.45% and matures on January 1, 2009. The loans are collateralized by the related asset and require us to maintain net worth greater than $20 million and a cash flow coverage ratio of at least 1.5 to 1.0 calculated on a rolling twelve-month average.
Contractual Obligations
Our contractual obligations as of September 30, 2005March 31, 2006 are as follows:follows:
                                        
Payments due by period
 Less More Payments due by period 
Obligations than 1 1 — 3 4 — 5 than 5
Contractual Total year years years years
 Less More 
 than 1 1 - 3 4 - 5 than 5 
Contractual Obligations Total year years years years 
Operating Leases $13,110,890 $1,779,978 $3,587,045 $3,522,949 $4,220,918  $12,257,491 $1,818,964 $3,614,629 $3,226,343 $3,597,555 
Long-Term Debt 1,356,156 513,267 786,990 55,899 —  1,108,074 502,417 591,682 13,975 — 
Capital Lease Obligations 460,406 169,085 268,528 22,793 —  367,382 150,330 217,052 — — 
Purchase Commitments(1)
 8,402,611 5,975,752 2,314,359 112,500 —  91,382,332 91,120,980 216,352 45,000 — 
Employment Agreements 3,871,884 1,854,023 2,017,861 — —  12,166,938 4,504,180 7,662,758 — — 
    
Total $27,201,947 $10,292,105 $8,974,783 $3,714,141 $4,220,918  $117,282,217 $98,096,871 $12,302,473 $3,285,318 $3,597,555 
    
 
(1) Of thisThe Purchase Commitments’ amount $4,000,000includes the maximum amount to be purchased under forward flow contracts for the purchase of charged-off consumer debt in the amount of $75 million. In addition, $2 million represents the potential payout we may incur as additional purchase price in association with the acquisition of the assets of IGS Nevada, Inc. The earn out provisions are defined in the asset purchase agreement.agreement dated October 1, 2004 between the owners of IGS Nevada, Inc. and Portfolio Recovery Associates, Inc.
Off Balance Sheet Arrangements
     We do not have any off balance sheet arrangements as defined by Regulation S-K 303(a)(4) promulgated under the Securities Exchange Act of 1934.
Recent Accounting Pronouncements
     In October 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-3, “Accounting for Loans or Certain Securities Acquired in a Transfer.” This SOP proposes guidance on accounting for differences between contractual and expected cash flows from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality. This SOP is effective for loans acquired in fiscal years beginning after December 15, 2004. Accordingly, we adopted SOP 03-3 on January 1, 2005. The SOP limits the revenue that may be accrued to the excess of the estimate of expected future cash flows over a portfolio’s initial cost of accounts receivable acquired. The SOP requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue or expense or on the balance sheet. The SOP freezes the internal rate of return, referred to as IRR, originally estimated when the accounts receivable are purchased for subsequent impairment testing. Rather than lower the estimated IRR if the original collection estimates are not received or projected to be received, the carrying value of a portfolio is written down to maintain the original IRR. Increases in actual, or expected future cash flows are recognized prospectively through adjustment of the IRR over a portfolio’s remaining life. The SOP provides that previously issued annual financial statements would not need to be restated. Historically, as we have applied the guidance of Practice Bulletin 6, we have moved yields both upward and downward as appropriate under that guidance. However, since the new SOP guidance does not permit yields to be lowered, it will increase the probability of impairment charges in the future.

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On December 16, 2004, the Financial Accounting Standards Board (“FASB”) issued FASB statement No. 123(R), “Share-Based Payment,” (“FASSFAS 123R”). FASSFAS 123R revises FASB statement No. 123, “Accounting for Stock-Based Compensation” (“FASSFAS 123”) and requires companies to expense the fair value of employee stock options and other forms of stock-based compensation. In addition to revising FASSFAS 123, FASSFAS 123R supersedes Accounting Principles Board Opinion No. 25, “Accounting for Stock Issued to Employees” and amends FASB Statement No. 95, “Statement of Cash Flows.” FASSFAS 123R applies to all stock-based compensation transactions in which a company acquires services by (1) issuing its stock or other equity instruments, except through arrangements resulting from employee stock-ownership plans (ESOPs) or (2) incurring liabilities that are based on the company’s stock price. FASSFAS 123R is effective for annual periods that begin after June 15, 2005; however, early adoption is encouraged. We believehave determined that all of our existing stock-based awards are equity instruments. We previously adopted FASSFAS 123 on January 1, 2002 and have been expensing equity based compensation since that time.

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We believe theadopted SFAS 123R on January 1, 2006. The adoption of FASSFAS 123R will havehad no material impact on our financial statements.
Critical Accounting Policies
     The preparation of financial statements and related disclosures in conformity with U.S. generally accepted accounting principles and our discussion and analysis of our financial condition and results of operations require our management to make judgments, assumptions, and estimates that affect the amounts reported in our consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and such differences may be material.
     Management believes our critical accounting policies and estimates are those related to revenue recognition, valuation of acquired intangibles and goodwill and income taxes. Management believes these policies to be critical because they are both important to the portrayal of our financial condition and results, and they require management to make judgments and estimates about matters that are inherently uncertain. Our senior management has reviewed these critical accounting policies and related disclosures with the Audit Committee of our Board of Directors.
Revenue Recognition
     We acquire accounts that have experienced deterioration of credit quality between origination and our acquisition of the accounts. The amount paid for an account reflects our determination that it is probable we will be unable to collect all amounts due according to the account’s contractual terms. At acquisition, we review each account to determine whether there is evidence of deterioration of credit quality since origination and if it is probable that we will be unable to collect all amounts due according to the account’s contractual terms. If both conditions exist, we determine whether each such account is to be accounted for individually or whether such accounts will be assembled into pools based on common risk characteristics. We consider expected prepayments and estimate the amount and timing of undiscounted expected principal, interest and other cash flows for each acquired portfolio and subsequently aggregated pools of accounts. We determine the excess of the pool’s scheduled contractual principal and contractual interest payments over all cash flows expected at acquisition as an amount that should not be accreted (nonaccretable difference) based on our proprietary acquisition models. The remaining amount, representing the excess of the account’s cash flows expected to be collected over the amount paid, is accreted into income recognized on finance receivables over the remaining life of the account or pool (accretable yield).
     Prior to January 1, 2005, we accounted for our investment in finance receivables using the interest method under the guidance of Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans.” Effective January 1, 2005, we adopted and began to account for our investment in finance receivables using the interest method under the guidance of AICPA SOP 03-3, “Accounting for Loans or Certain Securities Acquired in a Transfer.” For loans

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acquired in fiscal years beginning prior to December 15, 2004, Practice Bulletin 6 is still effective; however, Practice Bulletin 6 was amended by SOP 03-3 as described further in this note. For loans acquired in fiscal years beginning after December 15, 2004, SOP 03-3 is effective. Under the guidance of SOP 03-3 (and the amended Practice Bulletin 6), static pools of accounts are established. These pools are aggregated based on certain common risk criteria. Each static pool is recorded at cost, which includes certain direct costs of acquisition paid to third parties, and is accounted for as a single unit for the recognition of income, principal payments and loss provision. Once a static pool is established for a quarter, individual receivable accounts are not added to the pool (unless replaced by the seller) or removed from the pool (unless sold or returned to the seller). SOP 03-3 (and the amended Practice Bulletin 6) requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue or expense or on the balance sheet. The SOP initially freezes the internal rate of return, referred to as IRR, estimated when the accounts receivable are purchased as the basis for subsequent impairment testing. Significant increases in 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

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receivables is accrued quarterly based on each static pool’s effective IRR. Quarterly cash flows greater than the interest accrual will reduce the carrying value of the static pool. Likewise, cash flows that are less than the accrual will accrete the carrying balance. The IRR is estimated and periodically recalculated based on the timing and amount of anticipated cash flows using our proprietary collection models. A pool can become fully amortized (zero carrying balance on the balance sheet) while still generating cash collections. In this case, all cash collections are recognized as revenue when received. Additionally, we use the cost recovery method when collections on a particular pool of accounts cannot be reasonably predicted. Under the cost recovery method, no revenue is recognized until we have fully collected the cost of the portfolio, or until such time that we consider the collections to be probable and estimable and begin to recognize income based on the interest method as described above.
     We establish valuation allowances for all acquired accounts subject to SOP 03-3 to reflect only those losses incurred after acquisition (that is, the present value of cash flows initially expected at acquisition that are no longer expected to be collected). Valuation allowances are established only subsequent to acquisition of the accounts. At September 30, 2005,March 31, 2006, we had noa $375,000 valuation allowance on our finance receivables. Prior to January 1, 2005, in the event that estimated future cash collections would be inadequate to amortize the carrying balance, an impairment charge would be taken with a corresponding write-off of the receivable balance.
     We utilize the provisions of Emerging Issues Task Force 99-19, “Reporting Revenue Gross as a Principal versus Net as an Agent” (“EITF 99-19”) to commission revenue from our contingent fee, skip-tracing and government processing and collection subsidiaries. EITF 99-19 requires an analysis to be completed to determine if certain revenues should be reported gross or reported net of their related operating expense. This analysis includes an assessment of who retains inventory/credit risk, who controls vendor selection, who establishes pricing and who remains the primary obligor on the transaction. Each of these factors was considered to determine the correct method of recognizing revenue from our subsidiaries.
     For our contingent fee subsidiary, revenue is recognized at the time customer (debtor) funds are collected. The portfolios are owned by the clients and the collection effort is outsourced to our subsidiary under a commission fee arrangement. The clients retain control and ownership of the accounts we service. These revenues are reported on a net basis and are included in the line item “Commissions.”
     Our skip tracing subsidiary utilizes gross reporting under this EITF. We generate revenue by working an account and successfully locating a customer for our client. An “investigative fees”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 Legallegal and Other Feesother fees and Services”services” for these pass-through items.

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     Our government processing and collection business’ssubsidiary utilizes both gross and net reporting under this EITF. RDS’s primary source of income is derived from servicing taxing authorities in several different ways: processing all of their tax payments and tax forms, collecting delinquent taxes, identifying taxes that are not being paid and auditing tax payments. The processing and collection pieces are standard commission based billings.billings or fee for service transactions and are included in the line item “Commissions.” When RDS conducts an audit, there are two components. The first is a charge for the hours incurred on conducting the audit. This charge is for hours worked. This charge is up-charged from theworked and includes a profit margin above our actual costs incurred.cost. The gross billing is a component of Commissions“Commissions” and the expense is included in compensation.“Compensation and Employee Services.” The second item is for expenses incurred while conducting the audit. Most jurisdictions will reimburse RDS for direct expenses incurred for the audit including such items as travel and meals. The billed amounts are included in Commissions“Commissions” and the expense component is included in their appropriate expense category, generally other“Other operating expenses.”
     We account for our gain on cash sales of finance receivables under Statement of Financial Accounting Standards (“SFAS”) No. 140, “Accounting��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.

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     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; (2) we estimate the fair value of those reporting units to which the goodwill relates; and (3) we determine the book value of those reporting units. If the estimated fair value of reporting units with allocated goodwill is determined to be less than their book value, we are required to estimate the fair value of all identifiable assets and liabilities of those reporting units in a manner similar to a purchase price allocation for an acquired business. This requires independent valuation of certain unrecognized assets. Once this process is complete, the amount of goodwill impairment, if any, can be determined.
     We believe as of September 30, 2005March 31, 2006, there was no impairment of goodwill. 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.
     Effective with our 2002 tax filings, we adopted the cost recovery method of income recognition for tax purposes. We believe cost recovery to be an acceptable method for companies in the bad debt purchasing industry and results in the reduction of current taxable income as, for tax purposes, collections on finance receivables are applied first to principle to reduce the finance receivables to zero before any income is recognized.

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     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 net 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.

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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. As of September 30, 2005,March 31, 2006, we had no variable rate debt outstanding on our revolving credit lines. Currently, we have no variable rate debt outstanding. A 10% change in future interest rates on the variable rate credit line would not lead to a material decrease in future earnings assuming all other factors remained constant.
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, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions or thatand 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 September 30, 2005,March 31, 2006, 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 September 30, 2005March 31, 2006 that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

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PART II. OTHER INFORMATION
Item 6. Exhibits1. 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 Reportsare occasionally countersued by them in such actions. Also, consumers occasionally initiate litigation against us, in which they allege that we have violated a state or federal law in the process of collecting on an account. We do not believe that these routine matters represent a substantial volume of our accounts or that, individually or in the aggregate, they are material to our business or financial condition. We are not a party to any material legal proceedings and we are unaware of any contemplated material actions against us.
Item 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 8-K.10-K filed on March 3, 2006, together with all other information included or incorporated in our reports filed with the Securities and Exchange Commission. 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.
Item 3. Defaults Upon Senior Securities
None.
Item 4. Submission of Matters to a Vote of the Security Holders
None.
Item 5. Other Information
None.
Item 6. Exhibits
 (a) Exhibits.
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.
(b)Reports on Form 8-K.
Filed July 19, 2005, entry into a material definitive agreement approving the increase in compensation of its lead outside director.
Filed July 26, 2005, issuance of a quarterly earnings press release for the three months ended June 30, 2005.
Filed August 2, 2005, entry into a material definitive agreement with Alatax, Inc. and its stockholders regarding the acquisition of the assets of Alatax, Inc..

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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: October 31, 2005April 28, 2006 By: /s/ Steven D. Fredrickson
Steven D. Fredrickson 
Chief Executive Officer, President and
Chairman of the Board of Directors
(Principal Executive Officer) 
     
   Steven D. Fredrickson
Chief Executive Officer, President and Chairman of the Board of Directors
(Principal Executive Officer)
Date: October 31, 2005April 28, 2006 By: /s/ Kevin P. Stevenson
  
  Kevin P. Stevenson
  
  Chief Financial and Administrative Officer, Executive Vice President,
Treasurer and Assistant Secretary
(Principal (Principal Financial and Accounting Officer)

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