| PORTFOLIO RECOVERY ASSOCIATES INC Item 1A Risk Factors |
| To the extent not described elsewhere in this Annual Report, the following are risks related to our business |
| We may not be able to purchase defaulted consumer receivables at appropriate prices, and a decrease in our ability to purchase portfolios of receivables could adversely affect our ability to generate revenue If we are unable to purchase defaulted receivables from debt owners at appropriate prices, or one or more debt owners stop selling defaulted receivables to us, we could lose a potential source of income and our business may be harmed |
| The availability of receivables portfolios at prices which generate an appropriate return on our investment depends on a number of factors both within and outside of our control, including the following: • the continuation of current growth trends in the levels of consumer obligations; • sales of receivables portfolios by debt owners; and • competitive factors affecting potential purchasers and credit originators of receivables |
| Because of the length of time involved in collecting defaulted consumer receivables on acquired portfolios and the volatility in the timing of our collections, we may not be able to identify trends and make changes in our purchasing strategies in a timely manner |
| We may not be able to collect sufficient amounts on our defaulted consumer receivables to fund our operations Our business primarily consists of acquiring and servicing receivables that consumers have failed to pay and that the credit originator has deemed uncollectible and has generally charged-off |
| The debt owners generally make numerous attempts to recover on their defaulted consumer receivables, often using a combination of in-house recovery efforts and third-party collection agencies |
| These defaulted consumer receivables are difficult to collect and we may not collect a sufficient amount to cover our investment associated with purchasing the defaulted consumer receivables and the costs of running our business |
| 17 _________________________________________________________________ We experience high employee turnover rates and we may not be able to hire and retain enough sufficiently trained employees to support our operations The accounts receivables management industry is very labor intensive and, similar to other companies in our industry, we typically experience a high rate of employee turnover |
| Our annual turnover rate, excluding those employees that do not complete our six week training program, was 52prca in 2005 |
| We compete for qualified personnel with companies in our industry and in other industries |
| Our growth requires that we continually hire and train new collectors |
| A higher turnover rate among our collectors will increase our recruiting and training costs and limit the number of experienced collection personnel available to service our defaulted consumer receivables |
| If this were to occur, we would not be able to service our defaulted consumer receivables effectively and this would reduce our ability to continue our growth and operate profitability |
| We serve markets that are highly competitive, and we may be unable to compete with businesses that may have greater resources than we have We face competition in both of the markets we serve — owned portfolio and fee based accounts receivable management — from new and existing providers of outsourced receivables management services, including other purchasers of defaulted consumer receivables portfolios, third-party contingent fee collection agencies and debt owners that manage their own defaulted consumer receivables rather than outsourcing them |
| The accounts receivable management industry is highly fragmented and competitive, consisting of approximately 6cmam000 consumer and commercial agencies, most of which compete in the contingent fee business |
| We face bidding competition in our acquisition of defaulted consumer receivables and in our placement of fee based receivables, and we also compete on the basis of reputation, industry experience and performance |
| Some of our current competitors and possible new competitors may have substantially greater financial, personnel and other resources, greater adaptability to changing market needs, longer operating histories and more established relationships in our industry than we currently have |
| In the future, we may not have the resources or ability to compete successfully |
| As there are few significant barriers for entry to new providers of fee based receivables management services, there can be no assurance that additional competitors with greater resources than ours will not enter the market |
| Moreover, there can be no assurance that our existing or potential clients will continue to outsource their defaulted consumer receivables at recent levels or at all, or that we may continue to offer competitive bids for defaulted consumer receivables portfolios |
| If we are unable to develop and expand our business or adapt to changing market needs as well as our current or future competitors are able to do, we may experience reduced access to defaulted consumer receivables portfolios at appropriate prices and reduced profitability |
| We may not be successful at acquiring receivables of new asset types or in implementing a new pricing structure We may pursue the acquisition of receivables portfolios of asset types in which we have little current experience |
| We may not be successful in completing any acquisitions of receivables of these asset types and our limited experience in these asset types may impair our ability to collect on these receivables |
| This may cause us to pay too much for these receivables and consequently, we may not generate a profit from these receivables portfolio acquisitions |
| In addition, we may in the future provide a service to debt owners in which debt owners will place consumer receivables with us for a specific period of time for a flat fee |
| This fee may be based on the number of collectors assigned to the collection of these receivables, the amount of receivables placed or other bases |
| We may not be successful in determining and implementing the appropriate pricing for this pricing structure, which may cause us to be unable to generate a profit from this business |
| Our collections may decrease if certain types of bankruptcy filings involving liquidations increase Various economic trends may contribute to an increase in the amount of personal bankruptcy filings |
| Under certain bankruptcy filings a debtor’s assets may be sold to repay creditors, but since the defaulted consumer receivables we service are generally unsecured we often would not be able to collect on those receivables |
| We cannot ensure that our collection experience would not decline with an increase in personal bankruptcy filings or a change in bankruptcy regulations or practices |
| If our actual collection experience with respect to a defaulted 18 _________________________________________________________________ bankrupt consumer receivables portfolio is significantly lower than we projected when we purchased the portfolio, our financial condition and results of operations could deteriorate |
| We may make acquisitions that prove unsuccessful or strain or divert our resources We intend to consider acquisitions of other companies in our industry that could complement our business, including the acquisition of entities offering greater access and expertise in other asset types and markets that are related but that we do not currently serve |
| We have little experience in completing acquisitions of other businesses |
| If we do acquire other businesses, we may not be able to successfully integrate these businesses with our own and we may be unable to maintain our standards, controls and policies |
| Further, acquisitions may place additional constraints on our resources by diverting the attention of our management from other business concerns |
| Through acquisitions, we may enter markets in which we have no or limited experience |
| Moreover, any acquisition may result in a potentially dilutive issuance of equity securities, the incurrence of additional debt and amortization expenses of related intangible assets, all of which could reduce our profitability and harm our business |
| The loss of IGS customers could negatively affect our operations On October 1, 2004 we acquired substantially all of the assets of IGS Nevada, Inc |
| for consideration of dlra14 million |
| A significant portion of the valuation was tied to existing client relationships |
| Our customers, in general, may terminate their relationship with us on 90 days’ prior notice |
| In the event a customer or customers terminate or significantly cut back any relationship with us, it could reduce our profitability and harm our business and could potentially give rise to an impairment charge related to an intangible asset specifically ascribed to existing client relationships |
| We may not be able to continually replace our defaulted consumer receivables with additional receivables portfolios sufficient to operate efficiently and profitably To operate profitably, we must continually acquire and service a sufficient amount of defaulted consumer receivables to generate revenue that exceeds our expenses |
| Fixed costs such as salaries and lease or other facility costs constitute a significant portion of our overhead and, if we do not continually replace the defaulted consumer receivables portfolios we service with additional portfolios, we may have to reduce the number of our collection personnel |
| We would then have to rehire collection staff as we obtain additional defaulted consumer receivables portfolios |
| These practices could lead to: • low employee morale; • fewer experienced employees; • higher training costs; • disruptions in our operations; • loss of efficiency; and • excess costs associated with unused space in our facilities |
| Furthermore, heightened regulation of the credit card and consumer lending industry or changing credit origination strategies may result in decreased availability of credit to consumers, potentially leading to a future reduction in defaulted consumer receivables available for purchase from debt owners |
| We cannot predict how our ability to identify and purchase receivables and the quality of those receivables would be affected if there is a shift in consumer lending practices, whether caused by changes in the regulations or accounting practices applicable to debt owners, a sustained economic downturn or otherwise |
| 19 _________________________________________________________________ We may not be able to manage our growth effectively We have expanded significantly since our formation and we intend to maintain our growth focus |
| However, our growth will place additional demands on our resources and we cannot ensure that we will be able to manage our growth effectively |
| In order to successfully manage our growth, we may need to: • expand and enhance our administrative infrastructure; • continue to improve our management, financial and information systems and controls; and • recruit, train, manage and retain our employees effectively |
| Continued growth could place a strain on our management, operations and financial resources |
| We cannot ensure that our infrastructure, facilities and personnel will be adequate to support our future operations or to effectively adapt to future growth |
| If we cannot manage our growth effectively, our results of operations may be adversely affected |
| Our operations could suffer from telecommunications or technology downtime or increased costs Our success depends in large part on sophisticated telecommunications and computer systems |
| The temporary or permanent loss of our computer and telecommunications equipment and software systems, through casualty or operating malfunction, could disrupt our operations |
| In the normal course of our business, we must record and process significant amounts of data quickly and accurately to access, maintain and expand the databases we use for our collection activities |
| Any failure of our information systems or software and our backup systems would interrupt our business operations and harm our business |
| Our headquarters are located in a region that is susceptible to hurricane damage, which may increase the risk of disruption of information systems and telephone service for sustained periods |
| Further, our business depends heavily on services provided by various local and long distance telephone companies |
| A significant increase in telephone service costs or any significant interruption in telephone services could reduce our profitability or disrupt our operations and harm our business |
| We may not be able to successfully anticipate, manage or adopt technological advances within our industry Our business relies on computer and telecommunications technologies and our ability to integrate these technologies into our business is essential to our competitive position and our success |
| Computer and telecommunications technologies are evolving rapidly and are characterized by short product life cycles |
| We may not be successful in anticipating, managing or adopting technological changes on a timely basis |
| While we believe that our existing information systems are sufficient to meet our current demands and continued expansion, our future growth may require additional investment in these systems |
| We depend on having the capital resources necessary to invest in new technologies to acquire and service defaulted consumer receivables |
| We cannot ensure that adequate capital resources will be available to us at the appropriate time |
| Our senior management team is important to our continued success and the loss of one or more members of senior management could negatively affect our operations The loss of the services of one or more of our key executive officers or key employees could disrupt our operations |
| We have employment agreements with Steve Fredrickson, our president, chief executive officer and chairman of our board of directors, Kevin Stevenson, our executive vice president and chief financial and administrative officer, Craig Grube, our executive vice president of portfolio acquisitions, and most of our other senior executives |
| The current agreements contain non-compete provisions that survive termination of employment |
| However, these agreements do not and will not assure the continued services of these officers and we cannot ensure that the non-compete provisions will be enforceable |
| Our success depends on the continued service and performance of our key executive officers, and we cannot guarantee that we will be able to retain those individuals |
| Fredrickson, Mr |
| Stevenson, Mr |
| Grube or other key executive officers could seriously impair our ability to continue to acquire or collect on defaulted consumer receivables and 20 _________________________________________________________________ to manage and expand our business |
| Under one of our credit agreements, if both Mr |
| Fredrickson and Mr |
| Stevenson cease to be president and chief financial and administrative officer, respectively, it would constitute a default |
| We maintain key man life insurance on Mr |
| Our ability to recover and enforce our defaulted consumer receivables may be limited under federal and state laws Federal and state laws may limit our ability to recover and enforce our defaulted consumer receivables regardless of any act or omission on our part |
| Some laws and regulations applicable to credit issuers may preclude us from collecting on defaulted consumer receivables we purchase if the credit issuer previously failed to comply with applicable laws in generating or servicing those receivables |
| Collection laws and regulations also directly apply to our business |
| Additional consumer protection and privacy protection laws may be enacted that would impose additional requirements on the enforcement of and collection on consumer credit receivables |
| Any new laws, rules or regulations that may be adopted, as well as existing consumer protection and privacy protection laws, may adversely affect our ability to collect on our defaulted consumer receivables and may harm our business |
| In addition, federal and state governmental bodies are considering, and may consider in the future, other legislative proposals that would regulate the collection of our defaulted consumer receivables |
| Additionally, the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “Bankruptcy Act”) is expected to temporarily disrupt our historical bankruptcy collection curves, making it more difficult to accurately price bankrupt accounts created after October 17, 2005, the effective date of the Bankruptcy Act |
| Further, new tax law changes such as Internal Revenue Code Section 6050P (requiring 1099-C returns to be filed on discharge of indebtedness in excess of dlra600dtta00) could negatively impact our ability to collect or cause us to incur additional expenses |
| Although we cannot predict if or how any future legislation would impact our business, our failure to comply with any current or future laws or regulations applicable to us could limit our ability to collect on our defaulted consumer receivables, which could reduce our profitability and harm our business |
| Our ability to recover on portfolios of bankrupt consumer receivables may be impacted by changes in federal laws or the change in administrative practices of the various bankruptcy courts We recover on consumer receivables that have filed for bankruptcy protection under available US bankruptcy legislation |
| We recover on consumer receivables that have filed for bankruptcy protection after we acquired them, and we also purchase accounts that are currently in bankruptcy proceedings |
| The Bankruptcy Act may affect the process in which the various bankruptcy courts administer bankruptcy plans as well as our ability to recover on bankrupt consumer receivables |
| We utilize the interest method of revenue recognition for determining our income recognized on finance receivables, which is based on an analysis of projected cash flows that may prove to be less than anticipated and could lead to reductions in future revenues or impairment charges We utilize the interest method to determine income recognized on finance receivables |
| Under this method, static pools of receivables we acquire are modeled upon their projected cash flows |
| A yield is then established which, when applied to the unamortized purchase price of the receivables, results in the recognition of income at a constant yield relative to the remaining balance in the pool of defaulted consumer receivables |
| Each static pool is analyzed monthly to assess the actual performance compared to that expected by the model |
| If the accuracy of the modeling process deteriorates or there is a decline in anticipated cash flows, we would suffer reductions in future revenues or a decline in the carrying value of our receivables portfolios or impairment charges, which in any case would result in lower earnings in future periods and could negatively impact our stock price |
| We may be required to incur impairment charges as a result of the application of American Institute of Certified Public Accountants Statement of Position 03-3 In October 2003, the American Institute of Certified Public Accountants (“AICPA”) issued Statement of Position (“SOP”) 03-3, “Accounting for Loans or Certain Securities Acquired in a Transfer |
| ” The SOP provides guidance on accounting for differences between contractual and expected cash flows from an investor’s initial investment in loans or debt securities acquired in a transfer if those differences are attributable, at least in part, to credit quality |
| The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004 and amends Practice Bulletin 6 which remains in effect for loans acquired prior to the SOP effective date |
| The SOP 21 _________________________________________________________________ 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, expense, or on the balance sheet |
| The SOP initially freezes the internal rate of return, referred to as IRR, originally estimated when the accounts receivable are purchased for subsequent impairment testing |
| Rather than lower the estimated IRR if the original collection estimates are not received, effective January 1, 2005, the carrying value of a portfolio will be written down to maintain the then-current IRR The SOP also amends Practice Bulletin 6 in a similar manner and applies to all loans acquired prior to January 1, 2005 |
| Increases in expected future cash flows can be recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining life |
| Any increased yield then becomes the new benchmark for impairment testing |
| 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 upward and downward as appropriate under that guidance |
| However, since the new SOP guidance does not permit yields to be lowered, under either the revised Practice Bulletin 6 or SOP 03-3, it will increase the probability of us having to incur impairment charges in the future, which could reduce our profitability in a given period and could negatively impact our stock price |
| We incur increased costs as a result of enacted and proposed changes in laws and regulations Enacted and proposed changes in the laws and regulations affecting public companies, including the provisions of the Sarbanes-Oxley Act of 2002 and rules proposed by the SEC and by the NASDAQ Stock Market, have resulted in increased costs to us as we implement their requirements |
| These rules have made it more difficult or more costly for us to obtain certain types of insurance, including director and officer liability insurance, and we have been forced to accept reduced policy limits and coverage or incur substantially higher costs to obtain the same or similar coverage |
| The impact of these events could also make it more difficult for us to attract and retain qualified persons to serve on our board of directors, our board committees or as executive officers |
| We are presently evaluating and monitoring developments with respect to new and proposed rules and cannot predict or estimate the amount of the additional costs we will incur or the timing of such costs |
| The future impact on us of Section 404 of the Sarbanes-Oxley Act of 2002 relating to financial controls is unclear at this time As directed by Section 404 of the Sarbanes-Oxley Act of 2002, the SEC adopted rules requiring public companies to include a report by management on the company’s internal control over financial reporting in our annual reports on Form 10-K This report is required to contain an assessment by management of the effectiveness of such company’s internal controls over financial reporting |
| In addition, the public accounting firm auditing a public company’s financial statements must attest to and report on management’s assessment of the effectiveness of the company’s internal controls over financial reporting |
| As is the case with many public companies, at this time the long-term impact of Section 404 on us is unclear |
| In the future, if we are unable to comply with the requirements of Section 404 in a timely manner, it could result in an adverse reaction in the financial markets due to a loss of confidence in the reliability of our internal controls over financial reporting, which could cause the market price of our common stock to decline and make it more difficult for us to finance our operations |
| The market price of our shares of common stock could fluctuate significantly Wide fluctuations in the trading price or volume of our shares of common stock could be caused by many factors, including factors relating to our company or to investor perception of our company (including changes in financial estimates and recommendations by research analysts), but also factors relating to (or relating to investor perception of) the accounts receivable management industry or the economy in general |
| Our certificate of incorporation, by-laws and Delaware law contain provisions that may prevent or delay a change of control or that may otherwise be in the best interest of our stockholders Our certificate of incorporation and by-laws contain provisions that may make it more difficult, expensive or otherwise discourage a tender offer or a change in control or takeover attempt by a third-party, even if such a transaction would be beneficial to our stockholders |
| The existence of these provisions may have a negative impact on the price of our common stock by discouraging third-party investors from purchasing our common stock |
| In particular, our certificate of incorporation and by-laws include provisions that: 22 _________________________________________________________________ • classify our board of directors into three groups, each of which, after an initial transition period, will serve for staggered three-year terms; • permit a majority of the stockholders to remove our directors only for cause; • permit our directors, and not our stockholders, to fill vacancies on our board of directors; • require stockholders to give us advance notice to nominate candidates for election to our board of directors or to make stockholder proposals at a stockholders’ meeting; • permit a special meeting of our stockholders be called only by approval of a majority of the directors, the chairman of the board of directors, the chief executive officer, the president or the written request of holders owning at least 30prca of our common stock; • permit our board of directors to issue, without approval of our stockholders, preferred stock with such terms as our board of directors may determine; • permit the authorized number of directors to be changed only by a resolution of the board of directors; and • require the vote of the holders of a majority of our voting shares for stockholder amendments to our by-laws |
| In addition, we are subject to Section 203 of the Delaware General Corporation Law which provides certain restrictions on business combinations between us and any party acquiring a 15prca or greater interest in our voting stock other than in a transaction approved by our board of directors and, in certain cases, by our stockholders |
| These provisions of our certificate of incorporation and by-laws and Delaware law could delay or prevent a change in control, even if our stockholders support such proposals |
| Moreover, these provisions could diminish the opportunities for stockholders to participate in certain tender offers, including tender offers at prices above the then-current market value of our common stock, and may also inhibit increases in the trading price of our common stock that could result from takeover attempts or speculation |