PRA Group - 10-K annual report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
______

FORM 10-K

Portfolio Recovery Associates, Inc.
———————
(Exact name of registrant as specified in its charter)

Registrant’s telephone number, including area code: (888) 772-7326

Securities registered pursuant to Section 12(b) of the Act: None

Securities registered pursuant to Section 12(g) of the Act:

Common Stock $0.01 par value per share
(Title of Class)

     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 and Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

YES   X      NO ______

     Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment of this Form 10-K.    X  

     The aggregate market value of the voting stock held by non-affiliates of the registrant as of March 10, 2003 was $93,734,200.

     The number of shares of the registrant’s Common Stock outstanding as of March 10, 2002 was 13,550,000.

     Documents incorporated by reference: Portions of the Proxy Statement for the Company’s 2003 Annual Meeting of Stockholders are incorporated by reference into Part III of this Form 10-K.

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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 the results of the Company (as hereinafter defined) 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, 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:

     •     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 the Company’s ability to collect sufficient amounts on its acquired or serviced receivables;

     •     the Company’s ability to employ and retain qualified employees, especially collection personnel;

     •     changes in the credit or capital markets, which affect the Company’s ability to borrow money or raise capital to purchase or service defaulted consumer receivables;

     •     the degree and nature of the Company’s competition; and

     •     the risk factors listed from time to time in the Company’s filings with the Securities and Exchange Commission.

PART I

Item 1. Business.

General

     Portfolio Recovery Associates, Inc., together with its subsidiaries (collectively, the “Company”), is a full-service provider of outsourced receivables management. The Company purchases, collects and manages portfolios of defaulted consumer receivables. Defaulted consumer receivables are the unpaid obligations of individuals to credit originators, including banks, credit unions, consumer and auto finance companies, retail merchants and other providers of goods and services. The defaulted consumer receivables the Company collects are in substantially all cases either purchased from the credit originator or are collected on behalf of clients on a commission fee basis.

     The Company uses the following terminology throughout its reports. “Cash Receipts” refers to all collections of cash, regardless of the source. “Cash Collections” refers to collections on the Company’s owned portfolios only, exclusive of commission income and sales of finance receivables. “Cash Sales of Finance Receivables” refers to the sales of the Company’s owned portfolios. “Commissions” refers to fee income generated from the Company’s wholly-owned contingent fee subsidiary. Prior to the Company’s initial public offering on November 8, 2002, the Company was organized as a limited liability company with all income taxes charged to the partners of the partnership. Pro forma adjustments have been made to show the impact of corporate taxes for all periods prior to the Company’s conversion to a corporation.

     The Company specializes in receivables that have been charged-off by the credit originator. Since the credit originator has unsuccessfully attempted to collect these receivables, the Company is able to purchase them at a substantial discount to their face value. Through December 31, 2002, the Company acquired 335 portfolios with a face value of $5.55 billion for $142.8 million, or 2.57% of face value, represented in more than 2.6 million

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customer accounts. The success of the Company depends on its ability to purchase portfolios of defaulted consumer receivables at appropriate valuations and to collect on those receivables effectively and efficiently. To date, the Company has consistently been able to collect at a rate of 2.5 to 3.0 times its purchase price for defaulted consumer receivables portfolios, as measured over a five-year period, which has enabled the Company to generate increasing profits and positive cash flow.

     The Company has achieved strong financial results since its formation, with cash collections growing from $5.0 million in 1997 to $79.3 million in 2002. Total revenue has grown from $2.8 million in 1997 to $55.8 million in 2002, a compound annual growth rate of 82%. Similarly, pro forma net income has grown from $130,000 in 1997 to $11.4 million in 2002. Excluding the impact of proceeds from occasional portfolio sales, cash collections have increased every quarter since the Company’s formation.

     The Company was initially formed as Portfolio Recovery Associates, L.L.C., a Delaware limited liability company, on March 20, 1996, by four members of senior management that continue to lead it. Prior to the formation of the Company, members of the management team played key roles in the development of a defaulted consumer receivables acquisition and divestiture operation for Household Recovery Services, a subsidiary of Household International. In connection with an initial public offering, which commenced on November 8, 2002, all of the membership units of Portfolio Recovery Associates, L.L.C. were exchanged, simultaneously with the effectiveness of the Company’s registration statement, for a single class of the common stock of Portfolio Recovery Associates, Inc., a new Delaware corporation formed on August 7, 2002. Accordingly, the members of Portfolio Recovery Associates, L.L.C. became the common stockholders of Portfolio Recovery Associates, Inc., which became the parent company of Portfolio Recovery Associates, L.L.C. and its subsidiaries.

     Due to this reorganization, all shares of common stock received in exchange for the membership interests of Portfolio Recovery Associates, L.L.C. and not registered in the Company’s initial public offering are deemed to have a new “holding period” for purposes of Rule 144 under the Securities Act of 1933, as amended, and therefore may not be sold before November 6, 2003 unless registered under the Securities Act of 1933, as amended, or sold under an available exemption from registration, as in an organized stock offering.

Competitive Strengths

Complete Outsourced Solution for Credit Originators

     The Company offers credit originators a complete outsourced solution to address their defaulted consumer receivables. Depending on a credit originator’s timing and needs, the Company can either purchase from the credit originator their defaulted consumer receivables, providing immediate cash to the credit originator, or service those receivables on their behalf for a commission fee based on a percentage of its collections. Furthermore, the Company can purchase or service receivables throughout the entire delinquency cycle, from receivables that have only been processed for collection internally by the credit originator to receivables that have been subject to multiple external collection efforts. This flexibility helps the Company meet the needs of credit originators and allows it to become a trusted resource. Furthermore, the Company’s strength across multiple transaction and asset types provides the opportunity to cross-sell its services to credit originators, building on successful engagements.

Disciplined and Proprietary Underwriting Process

     One of the key components of the Company’s growth has been its ability to price portfolio acquisitions at levels that have generated profitable returns on investment. To date, the Company has consistently been able to collect at a rate of 2.5 to 3.0 times its purchase price for defaulted consumer receivables portfolios, as measured over a five-year period, which has enabled the Company to generate increasing profits and cash flow. In order to price portfolios and forecast the targeted collection results for a portfolio, the Company uses two separate statistical models developed internally that are often supplemented with on-site due diligence of the credit originator’s collection process and loan files. As the Company collects on its portfolios, the results are input back into the models in an ongoing process which the Company believes increases their accuracy. Through December 31, 2002 the Company’s management team has acquired 335 portfolios with a face value of more than $5.55 billion.

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Ability to Hire, Develop and Retain Productive Collectors

     In an industry characterized by high turnover, the Company’s ability to hire, develop and retain effective collectors is a key to its continued growth and profitability. The Company has found that tenure is a primary driver of its collector effectiveness. The Company offers its collectors a competitive wage with the opportunity to receive unlimited incentive compensation based on performance, as well as an attractive benefits package, a comfortable working environment and the ability to work on a flexible schedule. The Company has a comprehensive six week training program for most new employees and provides continuing advanced classes conducted in its four training centers. Recognizing the demands of the job, the Company’s management has endeavored to create a professional and supportive environment for collectors. Furthermore, several large military bases and several telemarketing, customer service and reservation phone centers are located near the Company’s headquarters and regional offices in Virginia, providing access to a large pool of trained personnel. The Company has also found the Hutchinson, Kansas area to provide a sufficient potential workforce of trained personnel.

Established Systems and Infrastructure

     The Company has devoted significant effort to developing its systems, including statistical models, databases and reporting packages, to optimize its portfolio purchases and collection efforts. In addition, the Company’s technology infrastructure is flexible, secure, reliable and redundant to ensure the protection of its sensitive data and to ensure minimal exposure to systems failure or unauthorized access. The Company believes that its systems and infrastructure give it meaningful advantages over its competitors. The Company has developed financial models and systems for pricing portfolio acquisitions, managing the collections process and monitoring operating results. The Company performs a static pool analysis monthly on each of its portfolios, inputting actual results back into its acquisition models, to enhance their accuracy. The Company monitors collection results continuously, seeking to identify and resolve negative trends immediately. The Company’s comprehensive management reporting package is designed to fully inform the Company’s management team so that it may make timely operating decisions. This combination of hardware, software and proprietary modeling and systems has been developed by the Company’s management team through years of experience in this industry and the Company believes provides it with an important competitive advantage from the acquisition process all the way through collection operations.

Strong Relationships with Major Credit Originators

     The Company has done business with most of the top 25 consumer lenders in the United States. The Company maintains an extensive marketing effort and its senior management team is in contact with known and prospective credit originators. The Company believes that it has earned a reputation as a reliable purchaser of defaulted consumer receivables portfolios and as responsible collectors. Further, from the perspective of the selling credit originator, the failure to close on a negotiated sale of a portfolio consumes valuable time and expense and can have an adverse effect on pricing when the portfolio is re-marketed. The Company has never failed to close on a transaction. Similarly, if a credit originator sells a portfolio to a group that violates industry standard collecting practices, it can taint the reputation of the credit originator. The Company goes to great lengths to collect from consumers in a responsible, professional and lawful manner. The Company believes its strong relationships with major credit originators provide it with access to quality opportunities for portfolio purchases and contingent fee collection placements.

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Experienced Management Team

     The Company has an experienced management team with considerable expertise in the accounts receivable management industry. The Company was formed in March 1996 by four members of senior management that continue to lead it. Prior to the Company’s formation, the founders played key roles in the development and management of a consumer receivables acquisition and divestiture operation of Household Recovery Services, a subsidiary of Household International. As the Company has grown, its founders have expanded the management team with a group of successful, seasoned executives.

Risks Related to the Company’s Business

     To the extent not described elsewhere in this Annual Report, the following are risks related to the Company’s business.

The Company may not be able to collect sufficient amounts on its defaulted consumer receivables to fund its operations

     The Company’s business consists of acquiring and servicing receivables that consumers have failed to pay and that the credit originator has deemed uncollectible and has charged-off. The credit originators 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 the Company may not collect a sufficient amount to cover its investment associated with purchasing the defaulted consumer receivables and the costs of running its business.

The Company’s contingent fee collections operations have a limited operating history

     The Company’s contingent fee collections operations commenced in March 2001. These operations are in the early stages of development. Accordingly, these operations have a very limited operating history and their prospects must be considered in light of the risks and uncertainties facing early-stage companies. As of December 31, 2002, the Company has entered into contingent fee collection arrangements with 9 credit originators. Although the Company is currently generating positive operating income for its contingent fee collections operations, the Company’s limited operating history makes prediction of future results difficult.

The Company may not be able to purchase defaulted consumer receivables at appropriate prices, and a decrease in its ability to purchase portfolios of receivables could adversely affect its ability to generate revenue

     If one or more credit originators stops selling defaulted receivables to the Company and it is otherwise unable to purchase defaulted receivables from credit originators at appropriate prices, the Company could lose a potential source of income and its business may be harmed.

     The availability of receivables portfolios at prices which generate an appropriate return on the Company’s investment depends on a number of factors both within and outside of its control, including the following:

     •     the continuation of current growth trends in the levels of consumer obligations;

     •     sales of receivables portfolios by credit originators; 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 the Company’s collections, the Company may not be able to identify trends and make changes in its purchasing strategies in a timely manner.

     The Company is currently party to one “forward flow contract.” A forward flow contract is an arrangement in which the Company agrees to purchase defaulted consumer receivables based on specific parameters from a third-party supplier on a periodic basis at a set price over a specified time period. To the extent that the Company

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is unable to renew or replace the purchased volume represented by its forward flow contract once it expires, it could lose a potential source of income and its business may be harmed.

The Company experiences high employee turnover rates and it may not be able to hire and retain enough sufficiently trained employees to support its operations

     The accounts receivables management industry is very labor intensive and, similar to other companies in the Company’s industry, the Company typically experiences a high rate of employee turnover. The Company’s annual turnover rate, excluding those employees that do not complete its six week training program, was 34%. The Company competes for qualified personnel with companies in its industry and in other industries. The Company’s growth requires that it continually hire and train new collectors. A higher turnover rate among its collectors will increase the Company’s recruiting and training costs and limit the number of experienced collection personnel available to service its defaulted consumer receivables. If this were to occur, the Company would not be able to service its defaulted consumer receivables effectively and this would reduce its ability to continue its growth and operate profitability.

The Company serves markets that are highly competitive, and it may be unable to compete with businesses that may have greater resources than it has

     The Company faces competition in both of the markets it serves — owned portfolio and contingent fee 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 credit originators that manage their own defaulted consumer receivables rather than outsourcing them. The accounts receivable management industry is highly fragmented and competitive, consisting of approximately 6,000 consumer and commercial agencies, most of which compete in the contingent fee business.

     The Company faces bidding competition in its acquisition of defaulted consumer receivables and in its placement of contingent fee receivables, and the Company also competes on the basis of reputation, industry experience and performance. Some of the Company’s 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 its industry than it currently has. In the future, the Company may not have the resources or ability to compete successfully. As there are few significant barriers for entry to new providers of contingent fee receivables management services, there can be no assurance that additional competitors with greater resources than the Company’s will not enter its market. Moreover, there can be no assurance that the Company’s existing or potential clients will continue to outsource their defaulted consumer receivables at recent levels or at all, or that it may continue to offer competitive bids for defaulted consumer receivables portfolios. If the Company is unable to develop and expand its business or adapt to changing market needs as well as its current or future competitors are able to do, the Company may experience reduced access to defaulted consumer receivables portfolios at appropriate prices and reduced profitability.

The Company may not be successful at acquiring receivables of new asset types or in implementing a new pricing structure

     The Company may pursue the acquisition of receivables portfolios of asset types in which it has little current experience. The Company may not be successful in completing any acquisitions of receivables of these asset types and its limited experience in these asset types may impair its ability to collect on these receivables. This may cause the Company to pay too much for these receivables and consequently it may not generate a profit from these receivables portfolio acquisitions.

     In addition, the Company may in the future provide a service to clients in which clients will place defaulted consumer receivables with it 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. The Company may not be successful in determining and implementing the appropriate pricing for this pricing structure, which may cause it to be unable to generate a profit from this business.

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The Company’s collections may decrease if bankruptcy filings increase

     During times of economic recession, the amount of defaulted consumer receivables generally increases, which contributes to an increase in the amount of personal bankruptcy filings. Under certain bankruptcy filings a debtor’s assets are sold to repay credit originators, but since the defaulted consumer receivables the Company services are generally unsecured it often would not be able to collect on those receivables. The Company cannot insure that its collection experience would not decline with an increase in bankruptcy filings. If the Company’s actual collection experience with respect to a defaulted consumer receivables portfolio is significantly lower than it projected when it purchased the portfolio, the Company’s financial condition and results of operations could deteriorate.

The Company may make acquisitions that prove unsuccessful or strain or divert its resources

     The Company intends to consider acquisitions of other companies in its industry that could complement its business, including the acquisition of entities offering greater access and expertise in other asset types and markets that the Company does not currently serve. The Company has little experience in completing acquisitions of other businesses, and it may not be able to successfully complete an acquisition. If the Company does acquire other businesses, it may not be able to successfully integrate these businesses with its own and the Company may be unable to maintain its standards, controls and policies. Further, acquisitions may place additional constraints on the Company’s resources by diverting the attention of its management from other business concerns. Through acquisitions, the Company may enter markets in which it has no or limited experience. Moreover, any acquisition may result in a potentially dilutive issuance of equity securities, the incurrence of additional debt and amortization of expenses related intangible assets, all of which could reduce the Company’s profitability and harm its business.

The Company may not be able to continually replace its defaulted consumer receivables with additional receivables portfolios sufficient to operate efficiently and profitably

     To operate profitably, the Company must continually acquire and service a sufficient amount of defaulted consumer receivables to generate revenue that exceeds its expenses. Fixed costs such as salaries and lease or other facility costs constitute a significant portion of the Company’s overhead and, if it does not continually replace the defaulted consumer receivables portfolios the Company services with additional portfolios, it may have to reduce the number of its collection personnel. The Company would then have to rehire collection staff as it obtains additional defaulted consumer receivables portfolios. These practices could lead to:

     •     low employee morale;

     •     fewer experienced employees;

     •     higher training costs;

     •     disruptions in the Company’s operations;

     •     loss of efficiency; and

     •     excess costs associated with unused space in the Company’s facilities.

     Furthermore, heightened regulation of the credit card and consumer lending industry may result in decreased availability of credit to consumers, potentially leading to a future reduction in defaulted consumer receivables available for purchase from credit originators. The Company cannot predict how its 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 credit originators, a sustained economic downturn or otherwise.

The Company may not be able to manage its growth effectively

     The Company has expanded significantly since its formation and intends to maintain its growth focus. However, the Company’s growth will place additional demands on its resources and the Company cannot insure

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that it will be able to manage its growth effectively. In order to successfully manage its growth, the Company may need to:

     •     expand and enhance its administrative infrastructure;

     •     continue to improve its management, financial and information systems and controls; and

     •     recruit, train, manage and retain its employees effectively.

     Continued growth could place a strain on the Company’s management, operations and financial resources. The Company cannot insure that its infrastructure, facilities and personnel will be adequate to support its future operations or to effectively adapt to future growth. If the Company cannot manage its growth effectively, its results of operations may be adversely affected.

The Company’s operations could suffer from telecommunications or technology downtime or increased costs

     The Company’s success depends in large part on sophisticated telecommunications and computer systems. The temporary or permanent loss of its computer and telecommunications equipment and software systems, through casualty or operating malfunction, could disrupt the Company’s operations. In the normal course of its business, the Company must record and process significant amounts of data quickly and accurately to access, maintain and expand the databases it uses for its collection activities. Any failure of the Company’s information systems or software and its backup systems would interrupt its business operations and harm its business. The Company’s headquarters is 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, the Company’s 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 its profitability or disrupt its operations and harm the Company’s business.

The Company may not be able to successfully anticipate, manage or adopt technological advances within its industry

     The Company’s business relies on computer and telecommunications technologies and its ability to integrate these technologies into its business is essential to the Company’s competitive position and its success. Computer and telecommunications technologies are evolving rapidly and are characterized by short product life cycles. The Company may not be successful in anticipating, managing or adopting technological changes on a timely basis.

     While the Company believes that its existing information systems are sufficient to meet its current demands and continued expansion, the Company’s future growth may require additional investment in these systems. The Company depends on having the capital resources necessary to invest in new technologies to acquire and service defaulted consumer receivables. The Company cannot insure that adequate capital resources will be available to it at the appropriate time.

The Company’s senior management team is important to its continued success and the loss of one or more members of senior management could negatively affect the Company’s operations

     The loss of the services of one or more of the Company’s executive officers or key employees could disrupt its operations. The Company has employment agreements with Steve Fredrickson, its president, chief executive officer and chairman of its board of directors, Kevin Stevenson, the Company’s senior vice president and chief financial officer, and most of its 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 the Company cannot insure that the non-compete provisions will be enforceable. The Company’s success depends on the continued service and performance of its executive officers, and it cannot guarantee that it will be able to retain those individuals. The loss of the services of Mr. Fredrickson, Mr. Stevenson or one or more of the Company’s other executive officers could seriously impair its ability to continue

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to acquire or collect on defaulted consumer receivables and to manage and expand its business. The Company maintains key man life insurance on Steve Fredrickson.

The Company’s ability to recover and enforce its defaulted consumer receivables may be limited under federal and state laws

     Federal and state laws may limit the Company’s ability to recover and enforce its defaulted consumer receivables regardless of any act or omission on its part. Some laws and regulations applicable to credit card issuers may preclude the Company from collecting on defaulted consumer receivables it purchases if the credit card issuer previously failed to comply with applicable law in generating or servicing those receivables. Collection laws and regulations also directly apply to the Company’s 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 card receivables. Any new laws, rules or regulations that may be adopted, as well as existing consumer protection and privacy protection laws, may adversely affect the Company’s ability to collect on its defaulted consumer receivables and may harm its 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 the Company’s defaulted consumer receivables. Although the Company cannot predict if or how any future legislation would impact its business, its failure to comply with any current or future laws or regulations applicable to it could limit its ability to collect on its defaulted consumer receivables, which could reduce its profitability and harm the Company’s business.

The Company utilizes the interest method of revenue recognition for determining its 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

     The Company utilizes the interest method to determine income recognized on finance receivables. Under this method, each static pool of receivables it acquires is modeled upon its projected cash flows. A yield is then established which, when applied to the outstanding balance 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 differences are noted, the yield is adjusted prospectively to reflect the revised estimate of cash flows. If the accuracy of the modeling process deteriorates or there is a decline in anticipated cash flows, the Company would suffer reductions in future revenues or a decline in the carrying value of its receivables portfolios, which in either case would result in lower earnings in future periods and could negatively impact the Company’s stock price.

Portfolio Acquisitions

     The Company’s portfolio of defaulted consumer receivables includes a diverse set of accounts that can be segmented by asset type, age and size of account, level of previous collection efforts and geography. To identify attractive buying opportunities, the Company maintains an extensive marketing effort with its senior officers contacting known and prospective sellers of defaulted consumer receivables. The Company acquires receivables of Visa®, MasterCard® and Discover® credit cards, private label credit cards, installment loans, lines of credit, deficiency balances of various types and legal judgments, all from a variety of credit originators. These credit originators include major banks, credit unions, consumer finance companies, telecommunication providers, retailers and auto finance companies. In addition, the Company exhibits at trade shows, advertises in a variety of trade publications and attends industry events in an effort to develop account purchase opportunities. The Company also maintains active relationships with brokers of defaulted consumer receivables. The following chart categorizes the Company’s owned portfolios as of December 31, 2002 into the major asset types represented.

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     The Company has acquired portfolios at various price levels, depending on the age of the portfolio, its geographic distribution, its historical experience with a certain asset type or credit originator and similar factors. A typical defaulted consumer receivables portfolio ranges from $5.0 to $75.0 million in face value and contains defaulted consumer receivables from diverse geographic locations with average initial individual account balances of $1,000 to $7,000.

     The age of a defaulted consumer receivables portfolio (i.e., the time since an account has been charged-off) is an important factor in determining the maximum price at which the Company will purchase a receivables portfolio. Generally, there is an inverse relationship between the age of a portfolio and the price that the Company will purchase the portfolio. This relationship is due to the fact that older receivables typically are more difficult to collect. The accounts receivables management industry places receivables into categories depending on the number of collection agencies that have previously attempted to collect on the receivables. Fresh accounts are typically past due 120 to 270 days and charged-off by the credit originator that are either being sold prior to any post-charge-off collection activity or are placed with a third-party for the first time. These accounts typically sell for the highest purchase price. Primary accounts are typically 180 to 270 days post charge-off, have been previously placed with one contingent fee servicer and receive a lower purchase price. Secondary and tertiary accounts are typically more than 360 days post charge-off, have been placed with two or three contingent fee servicers and receive even lower purchase prices. As shown in the following chart, as of December 31, 2002 a majority of the Company’s portfolios are secondary and tertiary accounts but it purchases or services accounts at any point in the delinquency cycle.

     The Company also reviews the geographic distribution of accounts within a portfolio because it has found that certain states have more debtor-friendly laws than others and, therefore, are less desirable from a collectibility perspective. In addition, economic factors and bankruptcy trends vary regionally and are factored into the Company’s maximum purchase price equation. As the following chart illustrates, as of December 31, 2002 the Company’s overall portfolio of defaulted consumer receivables is generally balanced geographically.

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Purchasing Process

     The Company acquires portfolios from credit originators through both an auction and a negotiated sale process. In an auction process, the credit originator will assemble a portfolio of receivables and seek purchase prices from specifically invited potential purchasers. In a privately negotiated sale process, the credit originator will contact known, reputable purchasers directly and negotiate the terms of sale. On a limited basis, the Company also acquires accounts in forward flow contracts. The Company currently has one such contract. Under a forward flow contract, the Company agrees to purchase defaulted consumer receivables from a credit originator on a periodic basis, at a set percentage of face value of the receivables over a specified time period. These agreements typically have a provision requiring that the attributes of the receivables to be sold will not significantly change each month and that the credit originator’s efforts to collect these receivables will not change. If this provision is not provided for, the contract will allow for the early termination of the forward flow contract by the purchaser. Forward flow contracts are a consistent source of defaulted consumer receivables for accounts receivables management providers and provide the credit originators with a reliable source of revenue and a professional resolution of defaulted consumer receivables.

     In a typical sale transaction, a credit originator distributes a computer disk or data tape containing 10 to 15 basic data fields on each receivables account in the portfolio offered for sale. Such fields typically include the consumer’s name, address, outstanding balance, date of charge-off, date of last payment and the date the account was opened. The Company performs its initial due diligence on the portfolio by electronically cross-checking the data fields on the computer disk or data tape against the accounts in its owned portfolios and against national demographic and credit databases. The Company compiles a variety of portfolio level reports examining all demographic data available.

     In order to determine a maximum purchase price for a portfolio, the Company uses computer models developed internally that often are supplemented with on-site due diligence of the credit originator’s collection operation and/or a review of their loan origination files, collection notes and work processes. The Company analyzes the portfolio using its proprietary multiple regression model, which analyzes the broad characteristics of the portfolio by comparing it to portfolios the Company has previously acquired to determine collectibility at fixed periods in the future. In addition, the Company analyzes the portfolio using an adjustment model, which uses an appropriate cash flow model depending upon whether it is a purchase of fresh, primary, secondary or

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tertiary accounts. Then, adjustments can be made to the cash flow model to compensate for demographic attributes supported by detailed analysis of demographic data. This process yields the Company’s quantitative purchasing analysis used to help price transactions and prioritize collection work efforts subsequent to purchase. With respect to prospective forward flow contracts and other long-term relationships, in addition to the procedures outlined above, the Company may obtain a representative test portfolio to evaluate and compare the characteristics of the portfolio to the assumptions the Company developed in its purchasing analysis.

     The Company’s due diligence and portfolio review results in a comprehensive analysis of the proposed portfolio. This analysis compares defaulted consumer receivables in the prospective portfolio with the Company’s collection history in similar portfolios. The Company then summarizes all anticipated cash collections and associated direct expenses and project a collectibility value expressed both in dollars and liquidation percentage and a detailed expense projection over the portfolio’s estimated five-year economic life. The Company uses the total projected collectibility value to determine an appropriate purchase price.

     The Company maintains detailed static pool analysis on each portfolio that it has acquired, capturing all demographic data and revenue and expense items for further analysis. The Company uses the static pool analysis to refine the underwriting models that it uses to price future portfolio purchases. The results of the static pool analysis are input back into the Company’s models, increasing the accuracy of the models as the data set increases with every portfolio purchase and each day’s collection efforts.

     The quantitative and qualitative data derived in the Company’s due diligence is evaluated together with its knowledge of the current defaulted consumer receivables market and any subjective factors that management may know about the portfolio or the credit originator. A portfolio acquisition approval memorandum is prepared for each prospective portfolio before a purchase price is submitted to a credit originator. This approval memorandum, which outlines the portfolio’s anticipated collectibility and purchase structure, is distributed to members of the Company’s investment committee. The approval by the committee sets a maximum purchase price for the portfolio.

     Once a portfolio purchase has been approved by the Company’s investment committee and the terms of the sale have been agreed to with the credit originator, the acquisition is documented in an agreement that contains customary terms and conditions. Provisions are incorporated for bankrupt, disputed, fraudulent or deceased accounts and typically, the credit originator either agrees to repurchase these accounts or replace them with acceptable replacement accounts within certain time frames.

Collection Operations

     The Company’s work flow management system places, recalls and prioritizes accounts in collectors’ work queues, based on the Company’s analyses of its accounts and other demographic, credit and prior work collection attributes. The Company uses this process to focus its work effort on those consumers most likely to pay on their accounts and to rotate to other collectors the non-paying accounts from which other collectors have been unsuccessful in receiving payment. The majority of the Company’s collections occur as a result of telephone contact with consumers.

     The collectibility forecast for a newly acquired portfolio will determine collection strategy. For example, the Company will obtain credit reports for the most collectible accounts and those accounts will be sent immediately to collectors’ work queues. Less collectible accounts will be set aside as house accounts to be collected using a predictive dialer or other passive, low cost methods.

     When a collector establishes contact with a consumer, the account information is placed automatically in the collector’s work queue. The Company’s computer system allows each collector to view all the scanned documents relating to the consumer’s account, which typically includes the original account application and payment checks. A typical collector work queue may include 650 to 1,000 accounts, depending on the skill level of the collector. The work queue is depleted and replenished automatically by the Company’s computerized work flow system.

     On the initial contact call, the consumer is given a standardized presentation regarding the benefits of resolving his or her account with the Company. Emphasis is placed on determining the reason for the consumer’s default in order to better assess the consumer’s situation and create a plan for repayment. The collector is

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incentivized to have the consumer pay the full balance of the account. If the collector cannot obtain payment of the full balance, the collector will suggest a three to four month payment plan or a reduced lump-sum settlement. If the consumer elects to utilize an installment plan, the Company has developed a system to make monthly withdrawals from a consumer’s bank account. Furthermore, the Company will settle the consumer’s obligations for less than the full balance, and each collector is authorized to make settlements above a threshold percentage or with the authorization of senior management.

     If a collector is unable to establish contact with a consumer based on information received, the collector must undertake skip tracing procedures to develop important account information. Skip tracing is the process of developing new phone, address, job or asset information on a consumer. Each collector does his or her own skip tracing using a number of computer applications available at his or her workstation, as well as a series of automated skip tracing procedures implemented by the Company on a regular basis.

     Accounts for which the consumer is not cooperative and for which the Company can establish a garnishable job or attachable asset are reviewed for legal action. Depending on the balance of the defaulted consumer receivable and the applicable state collection laws, the Company determines whether to commence legal action to collect on the receivable. The legal process can take an extended period of time, but it also generates cash collections that likely would not have been realized otherwise.

     The Company’s legal recovery department oversees and coordinates an independent nationwide collections attorney network which is responsible for the preparation and filing of judicial collection proceedings in multiple jurisdictions, determining the suit criteria, coordinating sales of property and instituting wage garnishments to satisfy judgments. This network consists of approximately 70 independent law firms who work on a contingent fee basis. The Company’s legal department also processes proofs of claims for recovery on receivables which are included in consumer bankruptcies filed under Chapter 13 of the U.S. Bankruptcy Code, and submits claims against estates in cases involving deceased debtors having assets at the time of death. Legal cash collections currently constitute approximately 20% of the Company’s total collections. As the Company’s portfolio matures, a larger number of accounts will be directed to its legal recovery department for judicial collection; consequently, the Company anticipates that legal cash collections will grow commensurately and comprise a larger percentage of its total cash collections.

Contingent Fee Collections Operations

     In order to provide credit originators with alternative collection solutions and to capitalize on common competencies between a contingent fee collections operation and an acquired receivables portfolio business, the Company commenced its third-party contingent fee collections operations in March 2001. In a contingent fee arrangement, clients typically place defaulted receivables with an outsourced provider once they have been deemed non-collectible. The clients then pay the third-party agency a commission fee based upon the amount actually collected from the consumer. A contingent fee placement of defaulted consumer receivables is usually for a fixed time frame, typically four to six months, or as long as nine months or more if there have been previous collection efforts. At the end of this fixed period, the third-party agency will return the uncollected defaulted consumer receivables to the client, which may then place the defaulted consumer receivables with another collection agency or sell the portfolio receivables.

     The determination of the commission fee to be paid for third-party collections is generally based upon the potential collectibility of the defaulted consumer receivables being assigned for placement. For example, if there has been no prior third-party collection activity with respect to the defaulted consumer receivables, the commission fee would be lower than if there had been one or more previous collection agencies attempting to collect on the receivables. The earlier the placement of defaulted consumer receivables in the collection process, the higher the probability of receiving a cash collection and, therefore, the lower the cost to collect and the lower the commission fee. Other factors, such as the location of the consumers, the size of the defaulted consumer receivables and the clients’ collection procedures and work standards also contribute to establishing a commission fee.

     Once a defaulted consumer receivable has been placed with the Company, the collection process operates in a slightly different manner than with its portfolio acquisition business. Servicing time limitations imposed by the Company’s clients requires a greater emphasis on immediate settlements and larger down payments, compared to

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much longer term repayment plans common with the Company’s owned portfolios of defaulted consumer receivables. In addition, work standards are often dictated by the Company’s clients. While the Company’s contingent fee collections operations utilize their own collectors and collection system, the Company has been able to leverage the portfolio acquisition business’ infrastructure, existing facilities and skill set of its management team to provide support for this business operation. The leveraged competencies of the portfolio acquisition business include its sophisticated technology systems and training techniques.

Competition

     The Company faces competition in both of the markets it serves — owned portfolio and contingent fee 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 credit originators that manage their own defaulted consumer receivables rather than outsourcing them. The accounts receivable management industry (owned portfolio and contingent fee) is highly fragmented and competitive, consisting of approximately 6,000 consumer and commercial agencies. The Company estimates that more than 90% of these agencies compete in the contingent fee market. There are few significant barriers for entry to new providers of contingent fee receivables management services and, consequently, the number of agencies serving the contingent fee market may continue to grow. Greater capital needs and the need for portfolio evaluation expertise sufficient to price portfolios effectively constitute significant barriers for entry to new providers of owned portfolio receivables management services.

     The Company faces bidding competition in its acquisition of defaulted consumer receivables and in obtaining placement of contingent fee receivables. The Company also competes on the basis of reputation, industry experience and performance. Among the positive factors which the Company believes influence its ability to compete effectively in this market are its ability to bid on portfolios at appropriate prices, its reputation from previous transactions regarding its ability to close transactions in a timely fashion, its relationships with originators of defaulted consumer receivables, its team of well-trained collectors who provide quality customer service and compliance with applicable collections laws, its ability to collect on various asset types and its ability to provide both purchased and contingent fee solutions to credit originators. Among the negative factors which the Company believes could influence its ability to compete effectively in this market are that some of its 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 its industry than the Company currently has.

Information Technology

Technology Operating Systems and Server Platform

     The scalability of the Company’s systems provides it with a technology system that is flexible, secure, reliable and redundant to ensure the protection of its sensitive data. The Company utilizes Intel-based servers running industry standard open systems coupled with Microsoft Windows 2000 and NT Server operating systems. In addition, the Company utilizes a blend of purchased and proprietary software systems tailored to the needs of its business. These systems are designed to eliminate inefficiencies in the Company’s collections, continue to meet business objectives in a changing environment and meet compliance obligations with regulatory entities. The Company believes that its combination of purchased and proprietary software packages provide collections automation that is superior to its competitors.

Network Technology

     To provide delivery of the Company’s applications, it utilizes Intel-based workstations across its entire business operations. The environment is configured to provide speeds of 100 megabytes to the desktops of its collections and administration staff. The Company’s one gigabyte server network architecture supports high-speed data transport. The Company’s network system is designed to be scalable and meet expansion and inter-building bandwidth and quality of service demands.

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Database Systems

     The ability to access and utilize data is essential to the Company being able to operate nationwide in a cost-effective manner. The Company’s centralized computer-based information systems support the core processing functions of its business under a set of integrated databases and are designed to be both replicable and scalable to accommodate its internal growth. This integrated approach helps to assure that consistent sources are processed efficiently. The Company uses these systems for portfolio and client management, skip tracing, check taking, financial and management accounting, reporting, and planning and analysis. The systems also support the Company’s consumers, including on-line access to account information, account status and payment entry. The Company uses a combination of Microsoft, Oracle and Cache database software to manage its portfolios, financial, customer and sales data, and the Company believes these systems will be sufficient for its needs for the foreseeable future. The Company’s contingent fee collections operations database incorporates an integrated and proprietary predictive dialing platform used with its predictive dialer discussed below.

Redundancy, System Backup, Security and Disaster Recovery

     The Company’s data centers provide the infrastructure for innovative collection services and uninterrupted support of hardware and server management, server co-location and an all-inclusive server administration for its business. The Company believes its facilities and operations include sufficient redundancy, file back-up and security to ensure minimal exposure to systems failure or unauthorized access. The preparations in this area include the use of call centers in Virginia and in Kansas in order to help provide redundancy for data and processes should one site be completely disabled. The Company has a comprehensive disaster recovery plan covering its business that is tested on a periodic basis. The combination of the Company’s locally distributed call control systems provides enterprise-wide call and data distribution between its call centers for efficient portfolio collection and business operations. In addition to real-time replication of data between the sites, incremental backups of both software and databases are performed on a daily basis and a full system backup is performed weekly. Backup data tapes are stored at an offsite location along with copies of schedules and production control procedures, procedures for recovery using an off-site data center, documentation and other critical information necessary for recovery and continued operation. The Company’s Virginia headquarters has two separate power and telecommunications feeds, uninterruptible power supply and a diesel-generator power plant, that provide a level of redundancy should a power outage or interruption occur. The Company also employs rigorous physical and electronic security to protect its data. The Company’s call centers have restricted card key access and appropriate additional physical security measures. Electronic protections include data encryption, firewalls and multi-level access controls.

Plasma Displays for Real Time Data Utilization

     The Company utilizes plasma displays at its main facility to aid in recovery of portfolios. The displays provide real-time business-critical information to the Company’s collection personnel for efficient collection efforts such as telephone, production, employee status, goal trending, training and corporate information.

Dialer Technology

     The Noble Systems Predictive Dialer ensures that the Company’s collection staff focuses on certain defaulted consumer receivables according to the Company’s specifications. The Company’s predictive dialer takes account of all campaign and dialing parameters and is able to constantly adjust its dialing pace to match changes in campaign conditions and provide the lowest possible wait times.

Employees

     The Company employed 581 persons on a full-time basis, including 425 collectors on its owned portfolios and an additional 47 collectors working in its contingent fee collections operations, as of December 31, 2002. None of the Company’s employees are represented by a union or covered by a collective bargaining agreement. The Company believes that its relations with its employees are good.

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Hiring

     The Company recognizes that its collectors are critical to the success of its business as a majority of the Company’s collection efforts occur as a result of telephone contact with consumers. The Company has found that the tenure and productivity of its collectors are directly related. Therefore, attracting, hiring, training, retaining and motivating its collection personnel is a major focus for the Company. The Company pays its collectors competitive wages and offers employees a full benefits program which includes comprehensive medical coverage, short and long term disability, life insurance, dental and vision coverage, an employee assistance program, supplemental indemnity, cancer, hospitalization, accident insurance, a flexible spending account and a matching 401(k) program. In addition to a base wage, the Company provides collectors with the opportunity to receive unlimited compensation through an incentive compensation program that pays bonuses above a set monthly base, based upon each collector’s collection results. This program is designed to ensure that employees are paid based not only on performance, but also on consistency. The Company believes that these practices have enabled it to achieve an annual post-training turnover rate of 34%.

     A large number of telemarketing, customer-service and reservation phone centers are located near the Company’s Virginia headquarters. The Company believes that it offers a higher base wage than many local employers and therefore has access to a large number of trained personnel. In addition, there are approximately 100,000 active-duty military personnel in the area. The Company employs numerous military spouses and retirees and find them to be excellent employees. The Company has also found the Hutchinson, Kansas area to provide a large potential workforce of trained personnel.

Training

     The Company provides a comprehensive six-week training program for all new owned portfolio collectors. The first three weeks of the training program is comprised of lectures to learn collection techniques, state and federal collection laws, systems, negotiation skills, skip tracing and telephone use. These sessions are then followed by an additional three weeks of practical experience conducting live calls with additional managerial supervision in order to provide employees with confidence and guidance while still contributing to the Company’s profitability. Each trainee must successfully pass a comprehensive examination before being assigned to the collection floor. In addition, the Company conducts continuing advanced classes in its four training centers. The Company’s technology and systems allow it to monitor individual employees and then offer additional training in areas of deficiency to increase productivity. In addition to the Company’s in-house training, many of its collectors have taken certification courses offered through the American Collectors Association.

Legal

Legal Recovery Department

     An important component of the Company’s collections effort involves its legal recovery department and the judicial collection of accounts of customers who have the ability, but not the willingness, to resolve their obligations. The Company’s legal recovery department oversees and coordinates an independent nationwide attorney network which is responsible for the preparation and filing of judicial collection proceedings in multiple jurisdictions, determining the suit criteria, coordinating sales of property and instituting wage garnishments to satisfy judgments. This nationwide collections attorney network consists of approximately 70 independent law firms. The Company’s legal recovery department also submits claims against estates in cases involving deceased debtors having assets at the time of death, and processes proofs of claims for recovery on accounts which are included in consumer bankruptcies filed under Chapter 13 of the U.S. Bankruptcy Code. Recent proposed amendments to federal bankruptcy laws, if passed, will very likely have an impact upon the Company’s operations. The amendments, which, among other things, establish income criteria for the filing of a Chapter 7 bankruptcy petition, are expected to cause more debtors to file bankruptcy petitions under Chapter 13, rather than Chapter 7 of the U.S. Bankruptcy Code. Consequently, the Company expects that fewer debtors will be able to have their obligations completely discharged in Chapter 7 bankruptcy actions, and will instead enter into the payment plans required by Chapter 13. The Company expects that this will enable it to generate recoveries from a larger number of bankrupt debtors through the filing of proofs of claims with bankruptcy trustees.

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Corporate Legal Department

     The Company’s corporate legal department manages general corporate legal matters, including litigation management, contract and document preparation and review, regulatory and statutory compliance, obtaining and maintaining multi-state licensing, bonding and insurance, and dispute and complaint resolution. As a part of its compliance functions, the Company’s corporate legal department also assists with training the Company’s staff. The Company provides employees with extensive training on the Fair Debt Collection Practices Act and other relevant laws and regulations. The Company’s corporate legal department distributes guidelines and procedures for collection personnel to follow when communicating with a customer, customer’s agents, attorneys and other parties during its recovery efforts. In addition, the Company’s corporate legal department regularly researches, and provides collection personnel and the training department with summaries and updates of changes in federal and state statutes and relevant case law, so that they are aware of new laws and judicial interpretations of applicable requirements and laws when tracing or collecting an account.

Regulation

     Federal and state statutes establish specific guidelines and procedures which debt collectors must follow when collecting consumer accounts. It is the Company’s policy to comply with the provisions of all applicable federal laws and comparable state statutes in all of its recovery activities, even in circumstances in which it may not be specifically subject to these laws. The Company’s failure to comply with these laws could have a material adverse effect on it in the event and to the extent that they apply to some or all of the Company’s recovery activities. Federal and state consumer protection, privacy and related laws and regulations extensively regulate the relationship between debt collectors and debtors, and the relationship between customers and credit card issuers. Significant federal laws and regulations applicable to the Company’s business as a debt collector include the following:

     •     Fair Debt Collection Practices Act. This act imposes certain obligations and restrictions on the practices of debt collectors, including specific restrictions regarding communications with consumer customers, including the time, place and manner of the communications. This act also gives consumers certain rights, including the right to dispute the validity of their obligations.

     •     Fair Credit Reporting Act. This act places certain requirements on credit information providers regarding verification of the accuracy of information provided to credit reporting agencies and investigating consumer disputes concerning the accuracy of such information. The Company provides information concerning its accounts to the three major credit reporting agencies, and it is the Company’s practice to correctly report this information and to investigate credit reporting disputes.

     •     Gramm-Leach-Bliley Act. This act requires that certain financial institutions, including collection agencies, develop policies to protect the privacy of consumers’ private financial information and provide notices to consumers advising them of their privacy policies. This act also requires that if private personal information concerning a consumer is shared with another unrelated institution, the consumer must be given an opportunity to opt out of having such information shared. Since the Company does not share consumer information with non-related entities, except as required by law, or except as needed to collect on the receivables, its consumers are not entitled to any opt-out rights under this act. This act is enforced by the Federal Trade Commission, which has retained exclusive jurisdiction over its enforcement, and does not afford a private cause of action to consumers who may wish to pursue legal action against a financial institution for violations of this act.

     •     Electronic Funds Transfer Act. This act regulates the use of the Automated Clearing House (“ACH”) system to make electronic funds transfers. All ACH transactions must comply with the rules of the National Automated Check Clearing House Association (“NACHA”) and Uniform Commercial Code § 3-402. This act, the NACHA regulations and the Uniform Commercial Code give the consumer, among other things, certain privacy rights with respect to the transactions, the right to stop payments on a pre-approved fund transfer, and the right to receive certain documentation of the transaction. This act also gives consumers a right to sue institutions which cause financial damages as a result of their failure to comply with its provisions.

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     •     Telephone Consumer Protection Act. In the process of collecting accounts, the Company uses automated predictive dialers to place calls to consumers. This act and similar state laws place certain restrictions on telemarketers and users of automated dialing equipment who place telephone calls to consumers.

     •     U.S. Bankruptcy Code. In order to prevent any collection activity with bankrupt debtors by creditors and collection agencies, the U.S. Bankruptcy Code provides for an automatic stay, which prohibits certain contacts with consumers after the filing of bankruptcy petitions.

     Additionally, there are in some states statutes and regulations comparable to and in some cases more stringent than the above federal laws, and specific licensing requirements which affect the Company’s operations. State laws may also limit credit account interest rates and the fees, as well as limit the time frame in which judicial actions may be initiated to enforce the collection of consumer accounts.

     Although the Company is not a credit originator, some of these laws directed toward credit originators may occasionally affect its operations because its receivables were originated through credit transactions, such as the following laws, which apply principally to credit originators:

     •     Truth in Lending Act;

     •     Fair Credit Billing Act; and

     •     Equal Credit Opportunity Act.

     Federal laws which regulate credit originators require, among other things, that credit card issuers disclose to consumers the interest rates, fees, grace periods, and balance calculation methods associated with their credit card accounts. Consumers are entitled under current laws to have payments and credits applied to their accounts promptly, to receive prescribed notices, and to require billing errors to be resolved promptly. Some laws prohibit discriminatory practices in connection with the extension of credit. Federal statutes further provide that, in some cases, consumers cannot be held liable for, or their liability is limited with respect to, charges to the credit card account that were a result of an unauthorized use of the credit card. These laws, among others, may give consumers a legal cause of action against the Company, or may limit the Company’s ability to recover amounts owing with respect to the receivables, whether or not it committed any wrongful act or omission in connection with the account. If the credit originator fails to comply with applicable statutes, rules and regulations, it could create claims and rights for consumers that could reduce or eliminate their obligations to repay the account, and have a possible material adverse effect on the Company. Accordingly, when the Company acquires defaulted consumer receivables, it contractually requires credit originators to indemnify it against any losses caused by their failure to comply with applicable statutes, rules and regulations relating to the receivables before they are sold to the Company.

     The U.S. Congress and several states are currently in the process of enacting legislation concerning identity theft. Additional consumer protection and privacy protection laws may be enacted that would impose additional requirements on the enforcement of and recovery on consumer credit card or installment accounts. Any new laws, rules or regulations that may be adopted, as well as existing consumer protection and privacy protection laws, may adversely affect the Company’s ability to recover the receivables. In addition, the Company’s failure to comply with these requirements could adversely affect its ability to enforce the receivables.

     The Company cannot insure that some of the receivables were not established as a result of identity theft or unauthorized use of a credit card and, accordingly, the Company could not recover the amount of the defaulted consumer receivables. As a purchaser of defaulted consumer receivables, the Company may acquire receivables subject to legitimate defenses on the part of the consumer. The Company’s account purchase contracts allow it to return to the credit originators certain defaulted consumer receivables that may not be collectible, due to these and other circumstances. Upon return, the credit originators are required to replace the receivables with similar receivables or repurchase the receivables. These provisions limit to some extent the Company’s losses on such accounts.

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Item 2. Properties.

     The Company’s principal executive offices and primary operations facility are located in approximately 40,000 square feet of leased space in Norfolk, Virginia and the Company rents two administrative facilities in Virginia Beach, Virginia that are each approximately 2,500 square feet. The Company’s Norfolk and Virginia Beach, Virginia facilities can currently accommodate approximately 550 employees. The Company owns a two-acre parcel of land across from its headquarters which it developed into a parking lot for use by its employees. In addition, the Company owns an approximately 15,000 square foot facility in Hutchinson, Kansas that can currently accommodate approximately 100 employees. The Company has also leased an additional facility located in approximately 21,000 square feet of leased space in Hampton, Virginia to accommodate approximately 285 additional employees. This new office opened with approximately 65 collectors (72 employees) on March 3, 2003. About one-half of those employees transferred from the Company’s Norfolk office. The Company does not consider any specific leased or owned facility to be material to its operations. The Company believes that equally suitable alternative facilities are available in all areas where it currently does business.

Item 3. Legal Proceedings.

     From time to time, the Company is involved in various legal proceedings which are incidental to the ordinary course of its business. The Company regularly initiates lawsuits against consumers and is occasionally countersued by them in such actions. Also, consumers occasionally initiate litigation against the Company, in which they allege that it has violated a state or federal law in the process of collecting on their account. The Company does not believe that these routine matters represent a substantial volume of its accounts or that, individually or in the aggregate, they are material to its business or financial condition.

     The Company is not a party to any material legal proceedings and it is unaware of any contemplated material actions against it.

Item 4. Submission of Matters to a Vote of Securityholders.

     No matters were submitted to a vote of securityholders during the fourth quarter of the fiscal year covered by this report.

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PART II

Item 5. Market for Registrant’s Common Equity and Related Stockholder Matters.

Price Range of Common Stock

     The Company’s common stock (“Common Stock”) began trading on the Nasdaq National Market under the symbol “PRAA” on November 8, 2002. The following table sets forth the high and low sales price for the Common Stock for the fourth quarter of 2002 from November 8, 2002.

     As of March 3, 2003, there were approximately 16 holders of record of the Common Stock. Based on information provided by the Company’s transfer agent and registrar, the Company believes that there are approximately 2,300 beneficial owners of the Common Stock.

Restricted Shares and Shares Subject to Lock-up

     Approximately 9,035,000 shares of common stock of the Company are “restricted,” shares, which means they were not subject to a registration statement filed with the Securities and Exchange Commission. The holders of 8,985,000 of these shares agreed to a 180-day “lock-up” with respect to such shares. The “lock-up” period with respect to these shares expires on May 6, 2003; however, notwithstanding the expiration of the 180-day “lock-up” period, none of these restricted shares may be sold until they have been registered under the Securities Act or under an available exemption from registration, such as provided by Rule 144 promulgated under the Securities Act. In connection with the reorganization of the Company from a limited liability company, the one-year holding period required for Rule 144 will not expire until November 6, 2003

Dividend Policy

     The Company’s board of directors sets its dividend policy. The Company currently intends to retain all available funds and any future earnings for use in the operation and expansion of its business, but the Company may determine in the future to declare or pay cash dividends on its common stock. Any future determination as to the declaration and payment of dividends will be at the discretion of the Company’s board of directors and will depend on then existing conditions, including the Company’s financial condition, results of operations, contractual restrictions, capital requirements, business prospects and other factors that the Company’s board of directors may consider relevant.

Use of Proceeds of Initial Public Offering

     The effective date of the Company’s registration statement (Registration No. 333- 99225) filed on Form S-1 relating to its initial public offering of Common Stock was November 6, 2002. In its initial public offering, the Company sold 3,470,000 shares of Common Stock at a price of $13.00 per share and PRA Investments, L.L.C., the selling stockholder, sold 1,015,000 shares of Common Stock at a price of $13.00 per share. The Company’s initial public offering was managed on behalf of the underwriters by William Blair & Company and U.S. Bancorp Piper Jaffray. The offering commenced on November 8, 2002 and closed on November 14, 2002. Gross proceeds to the Company from its initial public offering totaled $45.1 million. Underwriting discounts of $3.2 million were charged to the Company and deducted from the net proceeds remitted to the Company. None of the expenses incurred in the Company’s initial public offering were direct or indirect payments to its directors, officers, general partners or their associates, to persons owning 10% or more of any class of the Company’s equity securities or to its affiliates. Of the $41.9 million raised, $29.0 million has been used for repayment of outstanding indebtedness. In addition, the Company has utilized $1.6 million for offering related expenses such as accountant fees, attorney fees and SEC and Nasdaq filing fees. A further $2.5 million of proceeds has been

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used to purchase defaulted consumer receivables portfolios. The Company intends to use the remaining $8.8 million for working capital and general corporate purposes, including acquisitions of additional defaulted consumer receivables portfolios or potential possible acquisitions of complementary business, technologies or products.

     The occurrence of unforeseen events, opportunities or changed business conditions, however, could cause the Company to use the net proceeds of its initial public offering in a manner other than as described above.

Item 6. Selected Financial Data.

     The following selected financial data should be read in conjunction with the audited financial statements.

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Item 7. Management’s Discussion and Analysis of Financial Condition and Results of Operations.

Results of Operations

     The following table sets forth certain operating data in dollars and as a percentage of total revenue for the years ended December 31, 2002, 2001 and 2000:

Year Ended December 31, 2002 Compared to Year Ended December 31, 2001

Revenue

     Total revenue was $55.8 million for the year ended December 31, 2002, an increase of $23.5 million or 72.8% compared to total revenue of $32.3 million for the year ended December 31, 2001.

Income Recognized on Finance Receivables

     Income recognized on finance receivables was $53.8 million for the year ended December 31, 2002, an increase of $22.6 million or 72.4% compared to income recognized on finance receivables of $31.2 million for the year ended December 31, 2002. The majority of the increase was due to an increase in the Company’s cash collections on its owned defaulted consumer receivables to $79.3 million from $53.1 million, an increase of 49.3%. In the second half of 2001 and continuing throughout 2002, the Company has experienced an acceleration of the increase in its collector productivity resulting in an acceleration of its performance in cash collections compared to projections. This performance has led to lower amortization rates as the Company’s projected multiple of cash collections to purchase price has increased. The Company’s amortization rate on owned portfolios for the year ended December 31, 2001 was 41.2% while for the year ended December 31, 2002 it was 32.1%. During the year ended December 31, 2002, the Company acquired defaulted consumer receivables portfolios with an aggregate face value amount of $2.0 billion at a cost of $42.4 million. During the year ended December 31, 2001, the Company acquired defaulted consumer receivable portfolios with an aggregate face value

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of $1.6 billion at a cost of $33 million (inclusive of purchases subsequently sold). The Company’s relative cost of acquiring defaulted consumer receivable portfolios increased from 2.1% of face value for the year ended December 31, 2001 to 2.2% of face value for the year ended December 31, 2002.

Commissions

     Commissions were $1.9 million for the year ended December 31, 2002, an increase of $1.7 million or 850.0% compared to commissions of $215,000 for the year ended December 31, 2001. Commissions increased as business volume increased substantially in the Company’s contingent fee collection business as a result of increased account placements.

Net gain on cash sales of defaulted consumer receivables

     Net gain on cash sales of defaulted consumer receivables were $100,000 for the year ended December 31, 2002, a decrease of $801,000 or 88.9% compared to net gain on cash sales of defaulted consumer receivables of $901,000 for the year ended December 31, 2001. During September 2001, the Company purchased $4.4 million of defaulted consumer receivables that were immediately sold to a buying entity. A net gain of $369,000 was recognized on this back to back purchase-sale transaction. The remaining change is the result of twelve small sales in 2001 versus one sale in 2002.

Operating Expenses

     Total operating expenses were $34.9 million for the year ended December 31, 2002, an increase of $11.3 million or 47.9% compared to total operating expenses of $23.6 million for the year ended December 31, 2001. Total operating expenses, including compensation expenses, were 44.0% of cash collections for the year ended December 31, 2002 compared with 44.4% for the same period in 2001.

Compensation

     Compensation expenses were $21.7 million for the year ended December 31, 2002, an increase of $6.1 million or 39.1% compared to compensation expenses of $15.6 million for the year ended December 31, 2001. Compensation expenses increased as total employees grew from 501 at December 31, 2001 to 581 at December 31, 2002. Additionally, existing employees received normal salary increases and increased bonuses. Compensation expenses as a percentage of cash collections decreased to 27.4% for the year ended December 31, 2002 from 29.3% of cash collections for the same period in 2001, as a result of increasing employee productivity.

Legal, Accounting and Outside Fees and Services

     Legal, accounting and outside fees and services expenses were $8.1 million for the year ended December 31, 2002, an increase of $4.5 million or 125.0% compared to legal, accounting and outside fees and services expenses of $3.6 million for the year ended December 31, 2001. 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 the Company experienced in its portfolio of defaulted consumer receivables, and a portfolio management strategy shift implemented in mid 2002. This strategy resulted in the Company 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.

Communications

     Communications expenses were $1.9 million for the year ended December 31, 2002, an increase of $270,000 or 18.8% compared to communications expenses of $1.6 million for the year ended December 31, 2001. 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 69.4% of this increase, while the remaining 30.6% was attributable to a higher number of phone calls.

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Rent and Occupancy

     Rent and occupancy expenses were $799,000 for the year ended December 31, 2002, an increase of $87,000 or 12.2% compared to rent and occupancy expenses of $712,000 for the year ended December 31, 2001. The increase was attributable to increased leased space related to a storage facility, an off-site administrative and mail handling site and contractual increases in annual rental rates. The new storage facility accounted for $7,300 of the increase and the administrative/mail site accounted for $19,000 of the increase. The remaining increase was attributable to contractual increases in annual rental rates.

Other Operating Expenses

     Other operating expenses were $1.4 million for the year ended December 31, 2002, an increase of $171,000 or 13.2% compared to other operating expenses of $1.3 million for the year ended December 31, 2001. The increase was due to increases in taxes, fees and licenses, travel and meals and miscellaneous expenses. Taxes, fees and licenses increased by $81,000, travel and meals increased $94,000 and miscellaneous expenses decreased by $4,000.

Depreciation

     Depreciation expenses were $940,000 for the year ended December 31, 2002, an increase of $263,000 or 38.8% compared to depreciation expenses of $677,000 for the year ended December 31, 2001. The increase was attributable to continued capital expenditures on equipment, software, and computers related to our continued growth.

Interest Income

     Interest income was $22,000 for the year ended December 31, 2002, a decrease of $42,000 or 65.6% compared to interest income of $64,000 for the year ended December 31, 2001. This decrease occurred due to a drop in our yields during the fourth quarter of 2001. As a result of the yield decrease, the Company terminated the treasury repurchase agreement in favor of earning fee offset credit with our bank.

Interest Expense

     Interest expense was $2.4 million for the year ended December 31, 2002, a decrease of $335,000 or 12.0% compared to interest expense of $2.8 million for the year ended December 31, 2001. This decrease primarily as a result of the payoff of all outstanding revolving debt with the proceeds from the Company’s initial public offering.

Year Ended December 31, 2001 Compared to Year Ended December 31, 2000

Revenue

     Total revenue was $32.3 million for the year ended December 31, 2001, an increase of $13.0 million or 67.4% compared to total revenue of $19.3 for the year ended December 31, 2000.

Income Recognized on Finance Receivables

     Income recognized on finance receivables was $31.2 million for the year ended December 31, 2001, an increase of $12.2 million or 64.2% compared to income recognized on finance receivables of $19.0 million for the year ended December 31, 2000. The increase was due to an increase in the Company’s cash collections on its owned defaulted consumer receivables portfolios to $53.4 million from $30.7 million, an increase of 74.0%. During the year ended December 31, 2001, the Company acquired defaulted consumer receivables portfolios with an aggregate face value amount of $1.6 billion at a cost of $33 million. During the year ended December 31, 2000, the Company acquired defaulted consumer receivable portfolios with an aggregate face value of $1.0 billion at a cost of $24.7 million.

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Commissions

     Commissions were $214,000 for the year ended December 31, 2001, an increase of $214,000 compared to zero for the year ended December 31, 2000. The increase is a result of the commencement of the Company’s contingent fee collections operations in March 2001.

Net Gain on Cash Sales of Defaulted Consumer Receivables

     Net gain on cash sales of defaulted consumer receivables was $901,000 for the year ended December 31, 2001, an increase of $558,000 or 162.7% compared to net gain on cash sales of defaulted consumer receivables of $343,000 for the year ended December 31, 2000. This increase is the result of increased sale activity. In 2000 the Company sold $13.6 million in face value at an average price of 4.3% whereas in 2001 the Company sold $151.5 million in face value at an average price of 3.8%. The percentage increase in face value sold from 2000 to 2001 was significantly more than the percentage increase in recognized net gain on cash sales of defaulted consumer receivables. This is simply because the Company had a much higher basis in the receivables sold in 2001 compared with those sold in 2000.

Expenses

     Total operating expenses were $23.6 million for the year ended December 31, 2001, an increase of $8.6 million or 57.3% compared to total operating expenses of $15.0 million for the year ended December 31, 2000. Total operating expenses, including compensation expenses, were 44.2% of cash collections in 2001 compared to 48.9% in 2000.

Compensation

     Compensation expenses were $15.6 million for the year ended December 31, 2001, an increase of $5.7 million or 57.6% compared to compensation expenses of $9.9 million for the year ended December 31, 2000. Compensation expenses increased as total employees grew from 370 at December 31, 2000 to 501 at December 31, 2001. This increase reflects the continued staffing of both the Company’s Virginia and Kansas facilities and the commencement of its contingent fee collections operations in March 2001. The additional employees were required to collect on the Company’s growing portfolio of acquired pools of defaulted consumer receivables. Compensation expenses decreased to 29.3% of cash collections in 2001 from 32.2% of cash collections in 2000. Staffing at the Company’s Virginia facility was responsible for 51.2% of this increase, staffing at the Company’s Kansas facility was responsible for 19.8% of this increase and staffing for the Company’s contingent collections operations was responsible for the remaining 29% of this increase.

Legal, Accounting and Outside Fees and Services

     Legal, accounting and outside fees and services expenses were $3.6 million for the year ended December 31, 2001, an increase of $1.0 million or 38.5% compared to legal, accounting and outside fees and services expenses of $2.6 million for the year ended December 31, 2000. The increase was primarily attributable to the increased number of accounts referred to independent attorneys for collection.

Communications

     Communications expenses were $1.6 million for the year ended December 31, 2001, an increase of $774,000 or 88.9% compared to communications expenses of $871,000 for the year ended December 31, 2000. The increase was primarily a result of higher postage due to mailings required under the Gramm-Leach-Bliley Act, and a higher number of phone calls made to collect on a greater number of receivables owned and serviced. Mailings were responsible for 62.9% of this increase while the remaining 37.1% is attributable to a higher number of phone calls.

Rent and Occupancy

     Rent and occupancy expenses were $712,000 for the year ended December 31, 2001, an increase of $109,000 or 18.1% compared to rent and occupancy expenses of $603,000 for the year ended December 31, 2000. The

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increase was primarily a result of the first full year of occupancy of the Company’s Kansas facility, which opened in July 2000.

Other Operating Expenses

     Other operating expenses were $1.3 million for the year ended December 31, 2001, an increase of $613,000 or 94.0% compared to other operating expenses of $652,000 for the year ended December 31, 2000. Significant components of the other operating expenses include taxes, fees and licenses, hiring expenses and travel and meals, all of which are related to the Company’s contingent fee collections operations and the continued expansion of the Company’s workforce throughout 2001. Taxes, fees and licenses were responsible for 26.9% of this increase, travel and meals were responsible for 16.9% of this increase, hiring expenses were responsible for 19.6% of this increase and miscellaneous expenses were responsible for the remaining 36.6% of this increase.

Depreciation

     Depreciation expenses were $677,000 for the year ended December 31, 2001, an increase of $240,000 or 54.9% compared to depreciation expenses of $437,000 for the year ended December 31, 2000. The increase was attributable to increased capital expenditures during late 2000 and 2001, especially in connection with the acquisition of technology for the Company’s contingent fee collection operations.

Interest Income

     Interest income was $65,000 for the year ended December 31, 2001, a decrease of $29,000 or 30.9% compared to interest income of $94,000 for the year ended December 31, 2000. This decrease occurred due to the significant drop in the Company’s yields during the fourth quarter of 2001. The Company’s average cash balance changed from $2.7 million in 2000 to $4.3 million in 2001.

Interest Expenses

     Interest expenses were $2.8 million for the year ended December 31, 2001, an increase of $922,000 or 49.6% compared to interest expenses of $1.9 million for the year ended December 31, 2000. This increase was a result of increased borrowings to finance the growth in acquisitions of defaulted consumer receivable portfolios during 2001. During 2001, the Company made additional investments in defaulted consumer receivable portfolios of $33.4 million. To finance these acquisitions of defaulted consumer receivable portfolios, the Company’s borrowings increased during 2001. The Company had average monthly borrowings of $25.6 million during 2001, compared to average monthly borrowings of $15.5 million during 2000.

Loss on Extinguishment of Debt

     Loss on extinguishment of debt was $424,000 for the year ended December 31, 2001, an increase of $424,000 compared to none for the year ended December 31, 2000. The increase was due to the early extinguishment of debt under two of the Company’s previous line of credit agreements in 2001, for which the Company expensed $232,000 of remaining unamortized debt acquisition costs and $192,000 for the extinguishment of a contingent interest provision.

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Supplemental Performance Data

Owned Portfolio Performance:

     The following table groups the Company’s portfolio buying activity by year, showing the purchase price, actual cash collections and estimated remaining cash collections.

($ in thousands)