Edgar Filing: ENCORE CAPITAL GROUP INC

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

FORM 10-Q

(Mark One)

x	QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended June 30, 2013

¨	TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from to .

COMMISSION FILE NUMBER: 000-26489

ENCORE CAPITAL GROUP, INC.

(Exact name of registrant as specified in its charter)


Delaware		48-1090909
(State or other jurisdiction of incorporation or organization)		(IRS Employer Identification No.)

3111 Camino Del Rio North, Suite 1300 San Diego, California		92108
(Address of principal executive offices)		(Zip code)

(877) 445 - 4581

(Registrant’s telephone number, including area code)

(Not Applicable)

(Former name, former address and former fiscal year, if changed since last report)

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 90 days. Yes x No ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer ¨ Accelerated filer x Non-accelerated filer ¨ Smaller reporting company ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act). Yes ¨ No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.


Class				Outstanding at July 29, 2013
Common Stock, $0.01 par value				25,252,071 shares

ENCORE CAPITAL GROUP, INC.

INDEX TO FORM 10-Q


	Page
PART I – FINANCIAL INFORMATION		3

Item 1— Condensed Consolidated Financial Statements (Unaudited)		3

Condensed Consolidated Statements of Financial Condition		3

Condensed Consolidated Statements of Comprehensive Income		4

Condensed Consolidated Statements of Stockholders’ Equity		5

Condensed Consolidated Statements of Cash Flows		6

Notes to Condensed Consolidated Financial Statements (Unaudited)		7

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations		27

Item 3 – Quantitative and Qualitative Disclosures About Market Risk		48

Item 4 – Controls and Procedures		48

PART II – OTHER INFORMATION		49

Item 1 – Legal Proceedings		49

Item 1A – Risk Factors		49

Item 2 – Unregistered Sales of Equity Securities and Use of Proceeds		58

Item 6 – Exhibits		59

SIGNATURES		61

PART I – FINANCIAL INFORMATION

Item 1 – Condensed Consolidated Financial Statements (Unaudited)

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Financial Condition

(In Thousands, Except Par Value Amounts)

(Unaudited)


	June 30, 2013		December 31, 2012
Assets
Cash and cash equivalents	$	222,171	$	17,510
Investment in receivable portfolios, net		1,096,698		873,119
Deferred court costs, net		40,056		35,407
Receivables secured by property tax liens, net		198,065		135,100
Property and equipment, net		36,788		23,223
Other assets		91,881		31,535
Goodwill		119,788		55,446

Total assets	$	1,805,447	$	1,171,340

Liabilities and stockholders’ equity
Liabilities:
Accounts payable and accrued liabilities	$	76,846	$	45,450
Deferred tax liabilities, net		104,303		8,236
Debt		1,107,659		706,036
Other liabilities		6,269		5,802

Total liabilities		1,295,077		765,524

Commitments and contingencies
Stockholders’ equity:
Convertible preferred stock, $.01 par value, 5,000 shares authorized, no shares issued and outstanding		—		—
Common stock, $.01 par value, 50,000 shares authorized, 25,252 shares and 23,191 shares issued and outstanding as of June 30, 2013 and December 31, 2012, respectively		253		232
Additional paid-in capital		163,753		88,029
Accumulated earnings		349,789		319,329
Accumulated other comprehensive loss		(3,425)		(1,774)

Total stockholders’ equity		510,370		405,816

Total liabilities and stockholders’ equity	$	1,805,447	$	1,171,340

See accompanying notes to condensed consolidated financial statements

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Comprehensive Income

(In Thousands, Except Per Share Amounts)

(Unaudited)


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Revenues
Revenue from receivable portfolios, net	$	152,024	$	138,731	$	292,707	$	265,136
Other revenue		380		183		681		188
Interest income – tax lien business		5,051		2,982		9,766		2,982
Interest expense – tax lien business		(1,334)		(650)		(2,447)		(650)

Net interest income – tax lien business		3,717		2,332		7,319		2,332

Total revenues		156,121		141,246		300,707		267,656


Operating expenses
Salaries and employee benefits		32,969		25,190		61,801		47,494
Cost of legal collections		44,483		41,024		86,741		79,659
Other operating expenses		13,797		12,427		27,062		24,025
Collection agency commissions		5,230		4,166		8,559		8,125
General and administrative expenses		27,601		18,582		43,943		32,240
Depreciation and amortization		2,158		1,420		4,004		2,660

Total operating expenses		126,238		102,809		232,110		194,203

Income from operations		29,883		38,437		68,597		73,453


Other (expense) income
Interest expense		(7,482)		(6,497)		(14,336)		(12,012)
Other (expense) income		(4,122)		(106)		(3,963)		161

Total other expense		(11,604)		(6,603)		(18,299)		(11,851)

Income from continuing operations before income taxes		18,279		31,834		50,298		61,602
Provision for income taxes		(7,267)		(12,846)		(19,838)		(24,506)

Income from continuing operations		11,012		18,988		30,460		37,096
Loss from discontinued operations, net of tax		—		(2,392)		—		(9,094)

Net income	$	11,012	$	16,596	$	30,460	$	28,002


Weighted average shares outstanding:
Basic		23,966		24,919		23,707		24,850
Diluted		24,855		25,825		24,652		25,822
Basic earnings (loss) per share from:
Continuing operations	$	0.46	$	0.76	$	1.28	$	1.49
Discontinued operations	$	—	$	(0.09)	$	—	$	(0.36)

Net basic earnings per share	$	0.46	$	0.67	$	1.28	$	1.13


Diluted earnings (loss) per share from:
Continuing operations	$	0.44	$	0.74	$	1.24	$	1.44
Discontinued operations	$	—	$	(0.10)	$	—	$	(0.36)

Net diluted earnings per share	$	0.44	$	0.64	$	1.24	$	1.08


Other comprehensive loss:
Unrealized loss on derivative instruments, net of tax		(1,574)		(1,790)		(954)		(1,108)
Unrealized loss on foreign currency translation, net of tax		(583)		—		(697)		—

Other comprehensive loss, net of tax		(2,157)		(1,790)		(1,651)		(1,108)

Comprehensive income	$	8,855	$	14,806	$	28,809	$	26,894

See accompanying notes to condensed consolidated financial statements

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited, In Thousands)


	Common Stock				Additional Paid-In		Accumulated		Accumulated Other Comprehensive		Total Equity
	Shares		Par		Capital		Earnings		Loss		Total Equity
Balance at December 31, 2012		23,191	$	232	$	88,029	$	319,329	$	(1,774)	$	405,816
Net income		—		—		—		30,460		—		30,460
Unrealized loss on derivative instruments, net of tax		—		—		—		—		(954)		(954)
Unrealized loss on foreign currency translation adjustments, net of tax		—		—		—		—		(697)		(697)
Exercise of stock options and issuance of share-based awards, net of shares withheld for employee taxes		413		4		(6,065)		—		—		(6,061)
Repurchase of common stock		(24)		—		(729)		—		—		(729)
Issuance of common stock		1,672		17		62,335		—		—		62,352
Stock-based compensation		—		—		5,180		—		—		5,180
Issuance of convertible notes		—		—		26,850		—		—		26,850
Purchase of convertible hedge		—		—		(15,750)		—		—		(15,750)
Tax benefit related to stock-based compensation		—		—		3,749		—		—		3,749
Tax benefit related to convertible notes, net		—		—		154		—		—		154

Balance at June 30, 2013		25,252	$	253	$	163,753	$	349,789	$	(3,425)	$	510,370

See accompanying notes to condensed consolidated financial statements

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited, In Thousands)


	Six Months Ended June 30,
	2013		2012
Operating activities:
Net income	$	30,460	$	28,002
Adjustments to reconcile net income to net cash provided by operating activities
Depreciation and amortization		4,004		2,660
Impairment charge for goodwill and identifiable intangible assets		—		10,400
Amortization of loan costs and premium on receivables secured by tax liens		3,550		1,210
Stock-based compensation expense		5,180		4,805
Recognized loss on termination of derivative contract		3,630		—
Deferred income taxes		(3,297)		89
Excess tax benefit from stock-based payment arrangements		(3,848)		(1,689)
Loss on sale of discontinued operations		—		2,416
Reversal for allowances on receivable portfolios, net		(4,680)		(789)
Changes in operating assets and liabilities, net of effects of acquisition
Other assets		(8,502)		298
Deferred court costs		1,492		(1,664)
Prepaid income tax and income taxes payable		(19,559)		(6,455)
Accounts payable, accrued liabilities and other liabilities		2,821		5,322

Net cash provided by operating activities		11,251		44,605


Investing activities:
Cash paid for acquisition, net of cash acquired		(293,329)		(185,990)
Purchases of receivable portfolios		(100,650)		(361,446)
Collections applied to investment in receivable portfolios		260,531		207,205
Proceeds from put-backs of receivable portfolios		2,454		1,625
Originations and purchases of receivables secured by tax liens		(87,961)		(14,072)
Collections applied to receivables secured by tax liens		27,097		7,467
Payment on termination of derivative contract		(3,630)		—
Purchases of property and equipment		(5,335)		(2,595)
Purchases of intangible assets		(1,900)		—

Net cash used in investing activities		(202,723)		(347,806)


Financing activities:
Payment of loan costs		(11,846)		(1,619)
Repayment of senior secured notes		(6,250)		—
Proceeds from credit facilities		514,065		383,399
Repayment of credit facilities		(228,175)		(70,500)
Proceeds from issuance of convertible senior notes		150,000		—
Payment of convertible hedge transactions		(15,750)		—
Repurchase of common stock		(729)		—
Proceeds from exercise of stock options		2,359		2,583
Taxes paid related to net share settlement of equity awards		(8,420)		(2,177)
Excess tax benefit from stock-based payment arrangements		3,848		1,689
Repayment of capital lease obligations		(2,969)		(3,207)

Net cash provided by financing activities		396,133		310,168

Net increase in cash and cash equivalents		204,661		6,967
Cash and cash equivalents, beginning of period		17,510		8,047

Cash and cash equivalents, end of period	$	222,171	$	15,014


Supplemental disclosures of cash flow information:
Cash paid for interest	$	12,537	$	11,075
Cash paid for income taxes		40,513		23,108
Supplemental schedule of non-cash investing and financing activities:
Fixed assets acquired through capital lease		1,189		2,779

See accompanying notes to condensed consolidated financial statements

ENCORE CAPITAL GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1: Ownership, Description of Business and Summary of Significant Accounting Policies

Encore Capital Group, Inc. (“Encore”), through its subsidiaries (collectively, the “Company”), is a leading provider of debt management and recovery solutions for consumers and property owners across a broad range of financial assets. The Company purchases portfolios of defaulted consumer receivables at deep discounts to face value and manages them by working with individuals as they repay their obligations and work toward financial recovery. Defaulted receivables are consumers’ unpaid financial commitments to credit originators, including banks, credit unions, consumer finance companies, commercial retailers, and telecommunication companies. Defaulted receivables may also include receivables subject to bankruptcy proceedings. In addition, through Encore’s subsidiary, Propel Financial Services, LLC (“Propel”), the Company assists Texas property owners who are delinquent on their property taxes by paying these taxes on behalf of the property owners in exchange for payment agreements collateralized by the existing tax liens on the property, and acquires tax lien certificates directly from taxing authorities outside of Texas.

Portfolio purchasing and recovery

The Company purchases receivables based on robust, account-level valuation methods and employs a suite of proprietary statistical and behavioral models across the full extent of its operations. These investments allow the Company to value portfolios accurately (and limit the risk of overpaying), avoid buying portfolios that are incompatible with its methods or goals and precisely align the accounts it purchases with its operational channels to maximize future collections. As a result, the Company has been able to realize significant returns from the receivables it acquires. The Company maintains strong relationships with many of the largest credit and telecommunication providers in the United States, and possesses one of the industry’s best collection staff retention rates.

The Company uses insights discovered during its purchasing process to build account collection strategies. The Company’s proprietary consumer-level collectability analysis is the primary determinant of whether an account will be actively serviced post-purchase. The Company continuously refines this analysis to determine the most effective collection strategy to pursue for each account it owns. After the Company’s preliminary analysis, it seeks to collect on only a fraction of the accounts it purchases, through one or more of its collection channels. The channel identification process is analogous to a funneling system, where the Company first differentiates those consumers who it believes are not able to pay from those who are able to pay. Consumers who the Company believes are financially incapable of making any payments, facing extenuating circumstances or hardships (such as medical issues), serving in the military, or currently receiving social security as their only source of income are excluded from the next step of its collection process and are designated as inactive. The remaining pool of accounts in the funnel then receives further evaluation. At that point, the Company analyzes and determines a consumer’s perceived willingness to pay. Based on that analysis, the Company will pursue collections through letters and/or phone calls to its consumers. Despite its efforts to reach consumers and work out a settlement option, only a small number of consumers who are contacted choose to engage with the Company. Those who do are often offered deep discounts on their obligations, or are presented with payment plans that are better suited to meet their daily cash flow needs. The majority of contacted consumers, however, ignore both the Company’s calls and letters, and therefore the Company must then make the difficult decision whether or not to pursue collections through legal means.

Tax Lien Business

Propel’s principal activities are the acquisition and servicing of residential and commercial tax liens secured by a lien on the underlying real property. This lien takes priority over most other liens. By funding tax liens, Propel provides state and local taxing authorities and governments with much needed tax revenue. To the extent permitted by local law, Propel works with property owners to structure affordable payment plans designed to allow them to keep their property while paying their tax obligation over time. Propel maintains a foreclosure rate of less than one-half of one percent.

Propel’s receivables secured by property tax liens include tax lien transfers (“TLTs”) and tax lien certificates (“TLCs”). With TLTs, property owners choose to transfer their tax liens to Propel in order to pay their tax lien obligations over time and at a lower interest rate than is being assessed by the tax authority. TLTs provide property owners with repayment plans that are both affordable and flexible when compared with other payment options. Propel also purchases TLCs directly from taxing authorities, securing rights to future property tax payments, interest and penalties. In most cases, TLCs continue to be serviced by the taxing authority. When the taxing authority is paid, it repays the Company the outstanding balance of the lien plus interest, which is negotiated at the time of the purchase.

Financial Statement Preparation and Presentation

The accompanying interim condensed consolidated financial statements have been prepared by Encore, without audit, in accordance with the instructions to the Quarterly Report on Form 10-Q, and Rule 10-01 of Regulation S-X promulgated by the U.S. Securities and Exchange Commission (the “SEC”) and, therefore, do not include all information and footnotes necessary for a fair presentation of its consolidated financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States.

In the opinion of management, the unaudited financial information for the interim periods presented reflects all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the Company’s consolidated financial position, results of operations, and cash flows. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2012. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year.

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in the Company’s financial statements and the accompanying notes. Actual results could materially differ from those estimates.

Basis of Consolidation

Encore is a Delaware holding company whose principal assets are its investments in various wholly-owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

On July 1, 2013, the Company completed its acquisition (the “Cabot Acquisition”) of 50.1% of the equity interest in Janus Holdings Luxembourg S.a.r.l. (“Janus Holdings”), the indirect holding company of U.K. and Ireland based Cabot Credit Management Limited (“Cabot”), from an affiliate of J.C. Flowers & Co. LLC (“J.C. Flowers”). Through its acquisition of Janus Holdings the Company’s equity ownership of Cabot currently amounts to 41.7%, after reflecting the ownership of Cabot’s management team. Encore’s equity interest will automatically increase to approximately 42.8% by June 2014, following the redemption or conversion of certain Bridge Preferred Equity Certificates. The Company holds a controlling interest in Janus Holdings and will consolidate the financial results and financial position of the consolidated group. The Company’s condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2013 do not include the results of operations of Janus Holdings, because the Cabot Acquisition was not completed until July 1, 2013. For additional information relating to the Cabot Acquisition, please refer to the Company’s Current Report on Form 8-K filed with the SEC on May 30, 2013 and July 8, 2013.

On June 13, 2013, the Company completed its merger (the “AACC Merger”) with Asset Acceptance Capital Corp. (“AACC”). The condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2013 include the results of operations of AACC only since the closing date of the AACC Merger. For additional information relating to the AACC Merger, please refer to the Company’s Current Reports on Form 8-K filed with the SEC on March 6, 2013 and June 17, 2013.

On May 8, 2012, the Company completed its acquisition of Propel, BNC Retax, LLC, RioProp Ventures, LLC, and certain related affiliates (collectively, the “Propel Entities”). The condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2012 include the results of operations of Propel only since the closing date of the acquisition. For additional acquisition related information relating to the Propel Entities, please refer to the Company’s Current Report on Form 8-K filed with the SEC on July 24, 2012.

Reclassifications

Certain immaterial amounts in the 2012 consolidated financial statements have been reclassified to conform to the 2013 presentation.

Note 2: Discontinued Operations

On May 16, 2012, the Company completed the sale of substantially all of the assets and certain of the liabilities of its bankruptcy servicing subsidiary, Ascension Capital Group, Inc. (“Ascension”), to a subsidiary of American InfoSource, L.P. (“AIS”). As part of the sale, the Company agreed to fund certain agreed-upon operating losses in the first year of AIS’ ownership of the Ascension business, not to exceed $4.0 million. If the Ascension business becomes profitable under AIS’ ownership, the Company will be paid an earn-out equal to 40% of Ascension’s EBITDA for the first five years commencing May 16, 2012. The Company received no proceeds from the sale and recognized the entire $4.0 million loss contingency during the second quarter of 2012. Additionally, the Company did not receive any earn-out from AIS during the first year subsequent to the sale.

The Company performed an interim goodwill impairment test for Ascension as of March 31, 2012 and concluded that the entire goodwill balance relating to Ascension of $9.9 million was impaired. Additionally, the Company wrote-off the remaining identifiable intangible assets of approximately $0.4 million relating to Ascension as of March 31, 2012.

Ascension’s operations are presented as discontinued operations for the three and six months ended June 30, 2012, in the Company’s condensed consolidated statements of comprehensive income. The following table presents the revenue and components of discontinued operations, net of tax (in thousands):


	Three Months Ended June 30, 2012		Six Months Ended June 30, 2012
Revenue	$	1,892	$	5,704

Loss from discontinued operations before income taxes	$	(924)	$	(11,942	)
Income tax benefit		362		4,678

Loss from discontinued operations		(562)		(7,264	)

Loss on sale of discontinued operations, before income taxes		(2,416)		(2,416	)
Income tax benefit		586		586

Loss on sale of discontinued operations		(1,830)		(1,830	)

Total loss from discontinued operations	$	(2,392)	$	(9,094	)

Note 3: Business Combinations

Cabot Acquisition

On July 1, 2013, the Company completed its acquisition of 50.1% of the equity interest in Janus Holdings, the indirect holding company of Cabot, from J.C. Flowers. See Note 17 “Subsequent Events” for information regarding the Cabot Acquisition.

AACC Merger

On June 13, 2013, the Company completed the merger with AACC, another leading provider of debt management and recovery solutions in the United States. The purchase price consisted of $150.8 million in cash consideration and 1.7 million shares of Encore common stock valued at $37.30 per share. In addition, the Company paid off approximately $165.7 million of AACC debt on the closing date of the AACC Merger.

The AACC Merger was accounted for using the acquisition method of accounting and, accordingly, the tangible and intangible assets acquired and liabilities assumed were recorded at their estimated fair values as of the date of the merger. Fair value measurements have been applied based on assumptions that market participants would use in the pricing of the respective assets and liabilities. As of the date of this Quarterly Report on Form 10-Q, the Company is still finalizing the allocation of the purchase price. The initial purchase price allocation presented below was based on the preliminary assessment of assets acquired and liabilities assumed, which is subject to change based on the final valuation study that is expected to be completed in 2013.

The components of the preliminary purchase price allocation for the AACC Merger are as follows (in thousands):


Purchase price:
Cash paid at acquisition	$	316,485
Stock consideration		62,352

Total purchase price	$	378,837

Allocation of purchase price:
Cash	$	23,156
Investment in receivable portfolios		381,233
Deferred court costs		6,141
Property plant and equipment		11,003
Other assets		16,004
Liabilities assumed		(128,541)
Identifiable intangible assets		1,490
Goodwill		68,351

Total net assets acquired	$	378,837

The entire goodwill of $68.4 million related to AACC was assigned to the Company’s portfolio purchasing reporting unit and is not deductible for income tax purposes. The goodwill recognized is primarily attributable to expected synergies when combining AACC with the Company.

The amount of revenue and net income included in the Company’s condensed consolidated statement of comprehensive income for the three months ended June 30, 2013 related to AACC was $10.0 million and $0.9 million, respectively.

The following summary presents unaudited pro forma consolidated results of operations for the three and six months ended June 30, 2013 and 2012 as if the AACC Merger had occurred on January 1, 2012. The following unaudited pro forma financial information does not necessarily reflect the actual results that would have occurred had the Company and AACC been combined during the periods presented, nor is it necessarily indicative of the future results of operations of the combined companies (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Consolidated pro forma revenue	$	194,764	$	196,474	$	390,052	$	381,443
Consolidated pro forma income from continuing operations		14,733		22,644		35,996		46,514

Note 4: Earnings per Share

Basic earnings per share is calculated by dividing net earnings available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is calculated on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options, restricted stock, and the dilutive effect of the convertible senior notes.

The components of basic and diluted earnings per share are as follows (in thousands, except earnings per share):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Income from continuing operations	$	11,012	$	18,988	$	30,460	$	37,096
Loss from discontinued operations, net of tax		—		(2,392)		—		(9,094)

Net income available for common stockholders	$	11,012	$	16,596	$	30,460	$	28,002

Weighted average common shares outstanding – basic		23,966		24,919		23,707		24,850
Dilutive effect of stock-based awards		849		906		945		972
Dilutive effect of convertible senior notes		40		—		—		—

Weighted average common shares outstanding – diluted		24,855		25,825		24,652		25,822

Basic earnings (loss) per share from:
Continuing operations	$	0.46	$	0.76	$	1.28	$	1.49
Discontinued operations	$	—	$	(0.09)	$	—	$	(0.36)

Net basic earnings per share	$	0.46	$	0.67	$	1.28	$	1.13

Diluted earnings (loss) per share from:
Continuing operations	$	0.44	$	0.74	$	1.24	$	1.44
Discontinued operations	$	—	$	(0.10)	$	—	$	(0.36)

Net diluted earnings per share	$	0.44	$	0.64	$	1.24	$	1.08

No anti-dilutive employee stock options were outstanding during the three and six months ended June 30, 2013. Employee stock options to purchase approximately 391,900 and 300,400 shares of common stock during the three and six months ended June 30, 2012, respectively, were outstanding but not included in the computation of diluted earnings per share because the effect on diluted earnings per share would be anti-dilutive.

The dilutive effect of the Company’s convertible senior notes was approximately 40,000 shares for the three months ended June 30, 2013. The effect of the convertible senior notes was anti-dilutive for the six months ended June 30, 2013. See Note 11 “Debt” for additional details.

Warrants to purchase approximately 3.6 million shares of the Company’s common stock were outstanding at June 30, 2013 but were not included in the computation of diluted earnings per share because the warrants’ exercise price of $44.1875 was greater than the average share price of the Company’s common stock during the three and six months ended June 30, 2013; therefore, the effect of the warrants was anti-dilutive for those periods.

Note 5: Fair Value Measurements

The authoritative guidance for fair value measurements defines fair value as the price that would be received upon sale of an asset or the price paid to transfer a liability, in an orderly transaction between market participants at the measurement date (i.e., the “exit price”). The guidance utilizes a fair value hierarchy that prioritizes the inputs used in valuation techniques to measure fair value into three broad levels. The following is a brief description of each level:

•

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

•

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

•

Level 3: Unobservable inputs, including inputs that reflect the reporting entity’s own assumptions.

Financial instruments required to be carried at fair value

Financial assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):


	Fair Value Measurements as of June 30, 2013
	Level 1		Level 2		Level 3		Total
Liabilities
Interest rate swap agreements	$	—	$	(271)	$	—	$	(271)
Foreign currency exchange contracts		—		(4,056)		—		(4,056)


	Fair Value Measurements as of December 31, 2012
	Level 1		Level 2		Level 3		Total
Liabilities
Interest rate swap agreements	$	—	$	(645)	$	—	$	(645)
Foreign currency exchange contracts		—		(2,010)		—		(2,010)

Fair values of derivative instruments included in Level 2 are estimated using industry standard valuation models. These models project future cash flows and discount the future amounts to a present value using market-based observable inputs, including interest rate curves, foreign currency exchange rates, and forward and spot prices for currencies.

Financial instruments not required to be carried at fair value

The Company records its investment in receivable portfolios at cost, which represents a significant discount from the contractual receivable balances due. The Company computes the fair value of its investment in receivable portfolios by discounting the estimated future cash flows, generated by its proprietary forecasting models, using an estimated market participant cost to collect of approximately 48.0% and discount rate of approximately 12.0%. Using this method, the fair value of investment in receivable portfolios approximates book value as of June 30, 2013 and December 31, 2012, respectively. A 100 basis point fluctuation in the cost to collect and discount rate used would result in an increase or decrease in the fair value by approximately $21.6 million and $20.7 million, respectively, as of June 30, 2013. This fair value calculation does not represent, and should not be construed to represent, the underlying value of the Company or the amount which could be realized if its investment in receivable portfolios were sold. The carrying value of the investment in receivable portfolios was $1.1 billion and $873.1 million as of June 30, 2013 and December 31, 2012, respectively.

The Company capitalizes deferred court costs and provides a reserve for those costs that it believes will ultimately be uncollectible. The carrying value of net deferred court costs approximates fair value.

The fair value of receivables secured by property tax liens is estimated as follows: for tax lien transfer receivables, the fair value is estimated by discounting the future cash flows of the portfolio using a discount rate equivalent to the current rate at which similar portfolios would be originated and; for tax lien certificates receivables, the fair value is estimated by discounting the expected future cash flows of the portfolio using a discount rate equivalent to the interest rate expected when acquiring these certificates. The carrying value of receivables secured by property tax liens approximates fair value. Additionally, the carrying value of interest receivable approximates fair value.

The Company’s senior secured notes and borrowings under its revolving credit and term loan facilities are carried at historical costs, adjusted for additional borrowings less principal repayments, which approximate fair value.

The Company’s convertible senior notes are carried at historical cost, adjusted for debt discount. The carrying value of the convertible senior notes was $265.0 million, net of debt discount of $41.2 million, and $115.0 million, net of debt discount of $14.4 million as of June 30, 2013 and December 31, 2012, respectively. The fair value estimate for these convertible senior notes incorporates quoted market prices, which was approximately $286.1 million and $128.3 million as of June 30, 2013 and December 31, 2012, respectively.

Note 6: Derivatives and Hedging Instruments

The Company uses derivative instruments to manage risks related to interest rates and foreign currency. The Company’s outstanding interest rate swap contracts and foreign currency exchange contracts qualify for hedge accounting treatment under the authoritative guidance for derivatives and hedging.

Interest Rate Swaps

The Company may periodically enter into derivative financial instruments, typically interest rate swap agreements, to reduce its exposure to fluctuations in interest rates on variable interest rate debt and their impact on earnings and cash flows. As of June 30, 2013, the Company had three interest rate swap agreements outstanding with a total notional amount of $75.0 million. Under the swap agreements, the Company receives floating interest rate payments based on one-month reserve-adjusted LIBOR and makes interest payments based on fixed interest rates. The Company intends to continue electing the one-month reserve-adjusted LIBOR as the benchmark interest rate on the debt being hedged through its term. No credit spread was hedged. The Company designates its interest rate swap instruments as cash flow hedges.

The authoritative accounting guidance requires companies to recognize derivative instruments as either an asset or liability measured at fair value in the statement of financial position. The effective portion of the change in fair value of the derivative instrument is recorded in other comprehensive income (“OCI”). The ineffective portion of the change in fair value of the derivative instrument, if any, is recognized in interest expense in the period of change. From the inception of the hedging program, the Company has determined that the hedging instruments are highly effective.

Foreign Currency Exchange Contracts

The Company has operations in India, which exposes the Company to foreign currency exchange rate fluctuations due to transactions denominated in Indian rupees, such as employee salaries and rent expenditures. To mitigate this risk, the Company enters into derivative financial instruments, principally forward contracts, which are designated as cash flow hedges, to mitigate fluctuations in the cash payments of future forecasted transactions in Indian rupees for up to 36 months. The Company adjusts the level and use of derivatives as soon as practicable after learning that an exposure has changed, and the Company reviews all exposures and derivative positions on an ongoing basis.

Gains and losses on cash flow hedges are recorded in OCI until the hedged transaction is recorded in the consolidated financial statements. Once the underlying transaction is recorded in the consolidated financial statements, the Company reclassifies the OCI on the derivative into earnings. If all or a portion of the forecasted transaction was cancelled, this would render all or a portion of the cash flow hedge ineffective and the Company would reclassify the ineffective portion of the hedge into earnings. The Company generally does not experience ineffectiveness of the hedge relationship and the accompanying consolidated financial statements do not include any such gains or losses.

As of June 30, 2013, the total notional amount of the forward contracts to buy Indian rupees in exchange for U.S. dollars was $46.4 million. All outstanding contracts qualified for hedge accounting treatment as of June 30, 2013. The Company estimates that approximately $1.9 million of net derivative loss included in OCI will be reclassified into earnings within the next 12 months. No gains or losses were reclassified from OCI into earnings as a result of forecasted transactions that failed to occur during the three and six months ended June 30, 2013 and 2012.

The Company may periodically enter into other foreign currency exchange contracts to mitigate its risk that cash flows and earnings will be adversely affected by foreign currency exchange rate fluctuations. In anticipation of the Cabot Acquisition, as discussed in Note 17, “Subsequent Events,” on June 7, 2013, the Company entered into a European style zero-cost collar foreign exchange contract with a notional amount of £132.1 million (approximately $206.0 million), which was equal to the anticipated purchase price for the Cabot Acquisition. The collar was set to expire on August 13, 2013, which was the anticipated date of closing of the Cabot Acquisition. The collar was used to offset the risk of changes in the foreign exchange rate relating to the purchase price for the Company’s interest in Janus Holdings. The Company did not apply hedge accounting on this foreign exchange contract. Due to the early closing of the Cabot Acquisition, the foreign exchange contract was terminated on June 28, 2013 at a loss of $3.6 million, which was recorded as other expenses in the Company’s condensed consolidated statements of income for the three and six months ended June 30, 2013. This foreign exchange loss was offset by a decrease in the estimated purchase price of approximately $4.3 million during the same period of time.

The Company does not enter into derivative instruments for trading or speculative purposes.

The following table summarizes the fair value of derivative instruments as recorded in the Company’s condensed consolidated statements of financial condition (in thousands):

June 30, 2013

December 31, 2012

Balance Sheet
Location

Fair Value

Balance Sheet
Location

Fair Value

Derivatives designated as hedging instruments:

Interest rate swaps

Other liabilities

(271)

Other liabilities

(645)

Foreign currency exchange contracts

Other liabilities

(4,056)

Other liabilities

(2,010)

The following tables summarize the effects of derivatives in cash flow hedging relationships in the Company’s statements of comprehensive income during the periods presented (in thousands):


	Gain or (Loss) Recognized in OCI- Effective Portion				Location of Gain or (Loss) Reclassified from OCI into Income - Effective Portion	Gain or (Loss) Reclassified from OCI into Income - Effective Portion				Location of Gain or (Loss) Recognized - Ineffective Portion and Amount Excluded from Effectiveness Testing	Amount of Gain or (Loss) Recognized - Ineffective Portion and Amount Excluded from Effectiveness Testing
	Three Months Ended June 30,					Three Months Ended June 30,					Three Months Ended June 30,
	2013		2012			2013		2012			2013		2012
Interest rate swaps	$	151	$	140	Interest expense	$	—	$	—	Other (expense) income	$	—	$	—
Foreign currency exchange contracts		(2,540)		(3,120)	Salaries and employee benefits		(219)		(442)	Other (expense) income		—		—
Foreign currency exchange contracts		(531)		(510)	General and administrative expenses		(44)		(78)	Other (expense) income		—		—


	Gain or (Loss) Recognized in OCI- Effective Portion				Location of Gain or (Loss) Reclassified from OCI into Income - Effective Portion	Gain or (Loss) Reclassified from OCI into Income - Effective Portion				Location of Gain or (Loss) Recognized - Ineffective Portion and Amount Excluded from Effectiveness Testing	Amount of Gain or (Loss) Recognized - Ineffective Portion and Amount Excluded from Effectiveness Testing
	Six Months Ended June 30,					Six Months Ended June 30,					Six Months Ended June 30,
	2013		2012			2013		2012			2013		2012
Interest rate swaps	$	374	$	(71)	Interest expense	$	—	$	—	Other (expense) income	$	—	$	—
Foreign currency exchange contracts		(1,938)		(2,200)	Salaries and employee benefits		(268)		(557)	Other (expense) income		—		—
Foreign currency exchange contracts		(428)		(204)	General and administrative expenses		(52)		(95)	Other (expense) income		—		—

Note 7: Investment in Receivable Portfolios, Net

In accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality, discrete receivable portfolio purchases during a quarter are aggregated into pools based on common risk characteristics. Once a static pool is established, the portfolios are permanently assigned to the pool. The discount (i.e., the difference between the cost of each static pool and the related aggregate contractual receivable balance) is not recorded because the Company expects to collect a relatively small percentage of each static pool’s contractual receivable balance. As a result, receivable portfolios are recorded at cost at the time of acquisition. The purchase cost of the portfolios includes certain fees paid to third parties incurred in connection with the direct acquisition of the receivable portfolios.

In compliance with the authoritative guidance, the Company accounts for its investments in consumer receivable portfolios using either the interest method or the cost recovery method. The interest method applies an internal rate of return (“IRR”) to the cost

basis of the pool, which remains unchanged throughout the life of the pool, unless there is an increase in subsequent expected cash flows. Subsequent increases in expected cash flows are generally recognized prospectively through an upward adjustment of the pool’s IRR over its remaining life. Subsequent decreases in expected cash flows do not change the IRR, but are recognized as an allowance to the cost basis of the pool, and are reflected in the consolidated statements of comprehensive income as a reduction in revenue, with a corresponding valuation allowance, offsetting the investment in receivable portfolios in the consolidated statements of financial condition.

The Company utilizes its proprietary forecasting models to continuously evaluate the economic life of each pool. The collection forecast of each pool is generally estimated to be between 84 to 96 months based on the expected collection period of each pool. The Company often experiences collections beyond the 84 to 96 month collection forecast. As of June 30, 2013, the total estimated remaining collections beyond the 84 to 96 month collection forecast, which are not included in the calculation of the Company’s IRRs, were $147.1 million.

The Company accounts for each static pool as a unit for the economic life of the pool (similar to one loan) for recognition of revenue from receivable portfolios, for collections applied to the cost basis of receivable portfolios, and for provision for loss or allowance. Revenue from receivable portfolios is accrued based on each pool’s IRR applied to each pool’s adjusted cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances.

If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, the Company accounts for such portfolios on the cost recovery method as Cost Recovery Portfolios. The accounts in these portfolios have different risk characteristics than those included in other portfolios acquired during the same quarter, or the necessary information was not available to estimate future cash flows and, accordingly, they were not aggregated with other portfolios. Under the cost recovery method of accounting, no income is recognized until the purchase price of a Cost Recovery Portfolio has been fully recovered.

Accretable yield represents the amount of revenue the Company expects to generate over the remaining life of its existing investment in receivable portfolios based on estimated future cash flows. Total accretable yield is the difference between future estimated collections and the current carrying value of a portfolio. All estimated cash flows on portfolios where the cost basis has been fully recovered are classified as zero basis cash flows.

The following table summarizes the Company’s accretable yield and an estimate of zero basis future cash flows at the beginning and end of the period presented (in thousands):


	Accretable Yield		Estimate of Zero Basis Cash Flows		Total
Balance at December 31, 2012	$	984,944	$	17,366	$	1,002,310
Revenue recognized, net		(135,072)		(5,611)		(140,683)
Net additions to existing portfolios⁽¹⁾		173,634		7,061		180,695
Additions for current purchases⁽¹⁾		66,808		—		66,808

Balance at March 31, 2013	$	1,090,314	$	18,816	$	1,109,130

Revenue recognized, net		(144,186)		(7,838)		(152,024)
Net additions to existing portfolios⁽¹⁾		30,458		10,784		41,242
Additions for current purchases^{(1), (2)}		645,865		—		645,865

Balance at June 30, 2013	$	1,622,451	$	21,762	$	1,644,213


	Accretable Yield		Estimate of Zero Basis Cash Flows		Total
Balance at December 31, 2011	$	821,527	$	32,676	$	854,203
Revenue recognized, net		(119,340)		(7,065)		(126,405)
Net additions to existing portfolios⁽¹⁾		131,039		3,608		134,647
Additions for current purchases⁽¹⁾		119,533		—		119,533

Balance at March 31, 2012	$	952,759	$	29,219	$	981,978

Revenue recognized, net		(131,624)		(7,107)		(138,731)
Net additions to existing portfolios⁽¹⁾		77,473		13,738		91,211
Additions for current purchases⁽¹⁾		178,332		—		178,332

Balance at June 30, 2012	$	1,076,940	$	35,850	$	1,112,790

⁽¹⁾	Estimated remaining collections and accretable yield include anticipated collections beyond the 84 to 96 month collection forecast.

⁽²⁾	Includes $381.2 million of portfolios acquired in connection with the AACC Merger discussed in Note 3 “Business Combinations.”

During the three months ended June 30, 2013, the Company purchased receivable portfolios with a face value of $68.9 billion for $423.1 million, or a purchase cost of 0.6% of face value. Included in this amount is the purchase of investment receivables related to AACC of $381.2 million with a face value of $68.2 billion or a purchase cost of 0.6% of face value. Excluding the AACC receivables, the Company purchased receivable portfolios during the quarter with a face value of $0.7 billion for $41.9 million, or a purchase cost of 5.8% of face value. The lower purchase rate for the AACC portfolio is due to the Company’s purchase of AACC which included all portfolios owned, including accounts that have no value. No value accounts would typically not be included in a portfolio purchase transaction, as the sellers would remove them from the sale file. The estimated future collections at acquisition for all portfolios purchased during the quarter amounted to $1.0 billion.

During the six months ended June 30, 2013, the Company purchased receivable portfolios with a face value of $70.5 billion for $481.9 million, or a purchase cost of 0.7% of face value. Included in this amount is the purchase of investment receivables related to AACC of $381.2 million with a face value of $68.2 billion, or a purchase cost of 0.6% of face value. Excluding the AACC purchase, the Company purchased receivable portfolios during the six months ended June 30, 2013, with a face value of $2.3 billion for $100.7 million, or a purchase cost of 4.4% of face value. The lower purchase rate for the AACC portfolio is due to the Company’s purchase of AACC which included all portfolios owned, including accounts that have no value. No value accounts would typically not be included in a portfolio purchase transaction, as the sellers would remove them from the sale file. The estimated future collections at acquisition for all portfolios purchased during the six months ended June 30, 2013, amounted to $1.1 billion.

During the three months ended June 30, 2012, the Company purchased receivable portfolios with a face value of $6.0 billion for $231.0 million, or a purchase cost of 3.8% of face value. The estimated future collections at acquisition for these portfolios amounted to $407.4 million. During the six months ended June 30, 2012, the Company purchased receivable portfolios with a face value of $8.9 billion for $361.4 million, or a purchase cost of 4.0% of face value. The estimated future collections at acquisition for these portfolios amounted to $643.6 million.

All collections realized after the net book value of a portfolio has been fully recovered (“Zero Basis Portfolios”) are recorded as revenue (“Zero Basis Revenue”). During the three months ended June 30, 2013 and 2012, Zero Basis Revenue was approximately $4.7 million and $6.1 million, respectively. During the six months ended June 30, 2013 and 2012, Zero Basis Revenue was approximately $9.4 million and $12.2 million, respectively.

The following tables summarize the changes in the balance of the investment in receivable portfolios during the following periods (in thousands, except percentages):


	Three Months Ended June 30, 2013
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	801,525	$	—	$	—	$	801,525
Purchases of receivable portfolios⁽¹⁾		423,113		—		—		423,113
Transfer of portfolios		(6,649)		6,649		—		—
Gross collections⁽²⁾		(269,710)		(842)		(7,836)		(278,388)
Put-backs and recalls		(1,543)		(31)		(2)		(1,576)
Revenue recognized		143,607		—		4,743		148,350
Portfolio allowances reversals, net		579		—		3,095		3,674

Balance, end of period	$	1,090,922	$	5,776	$	—	$	1,096,698

Revenue as a percentage of collections⁽³⁾		53.2%		0.0%		60.5%		53.3%


	Three Months Ended June 30, 2012
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	741,580	$	—	$	—	$	741,580
Purchases of receivable portfolios⁽¹⁾		230,983		—		—		230,983
Gross collections⁽²⁾		(233,437)		—		(7,107)		(240,544)
Put-backs and recalls		(891)		—		—		(891)
Revenue recognized		131,443		—		6,126		137,569
Portfolio allowances reversals, net		181		—		981		1,162

Balance, end of period	$	869,859	$	—	$	—	$	869,859

Revenue as a percentage of collections⁽³⁾		56.3%		0.0%		86.2%		57.2%


	Six Months Ended June 30, 2013
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	873,119	$	—	$	—	$	873,119
Purchases of receivable portfolios⁽¹⁾		481,884		—		—		481,884
Transfer of portfolios		(6,649)		6,649		—		—
Gross collections⁽²⁾		(534,269)		(842)		(13,447)		(548,558)
Put-backs and recalls		(2,421)		(31)		(2)		(2,454)
Revenue recognized		278,622		—		9,405		288,027
Portfolio allowances reversals, net		636		—		4,044		4,680

Balance, end of period	$	1,090,922	$	5,776	$	—	$	1,096,698

Revenue as a percentage of collections⁽³⁾		52.2%		0.0%		69.9%		52.5%


	Six Months Ended June 30, 2012
	Accrual Basis Portfolios		Cost Recovery Portfolios		Zero Basis Portfolios		Total
Balance, beginning of period	$	716,454	$	—	$	—	$	716,454
Purchases of receivable portfolios⁽¹⁾		361,446		—		—		361,446
Gross collections⁽²⁾		(457,380)		—		(14,172)		(471,552)
Put-backs and recalls		(1,625)		—		—		(1,625)
Revenue recognized		252,189		—		12,158		264,347
(Portfolio allowances) portfolio allowance reversals, net		(1,225)		—		2,014		789

Balance, end of period	$	869,859	$	—	$	—	$	869,859

Revenue as a percentage of collections⁽³⁾		55.1%		0.0%		85.8%		56.1%

⁽¹⁾	Purchases of portfolio receivables for the three and six month periods ended June 30, 2013 include $381.2 million acquired in connection with the AACC Merger discussed in Note 3 “Business Combinations.”

⁽²⁾	Does not include amounts collected on behalf of others.

⁽³⁾	Revenue as a percentage of collections excludes the effects of net portfolio allowances or net portfolio allowance reversals.

The following table summarizes the change in the valuation allowance for investment in receivable portfolios during the periods presented (in thousands):


	Valuation Allowance
	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Balance at beginning of period	$	104,267	$	109,867	$	105,273	$	109,494
Provision for portfolio allowances		—		2,116		479		3,875
Reversal of prior allowances		(3,674)		(3,278)		(5,159)		(4,664)

Balance at end of period	$	100,593	$	108,705	$	100,593	$	108,705

The Company currently utilizes various business channels for the collection of its receivables. The following table summarizes the total collections by collection channel (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Legal collections	$	133,682	$	114,876	$	255,955	$	224,448
Collection sites		116,853		111,641		243,415		221,511
Collection agencies ⁽¹⁾		27,853		14,043		49,188		25,629

	$	278,388	$	240,560	$	548,558	$	471,588

⁽¹⁾	Collections through our collection agency channel include accounts subject to bankruptcy filings collected by others.

Note 8: Receivables Secured by Property Tax Liens, Net

The Company’s receivables secured by property tax liens include TLTs and TLCs. Repayment of the tax liens is generally dependent on the property owner but can also come through payments from other lien holders or foreclosure on the properties. The Company evaluates the entire portfolio of tax liens for impairment. The primary factor the Company uses to evaluate each receivable is the lien to value ratio, which is typically less than 15% and rarely exceeds 25%. The Company has not experienced any losses on receivables secured by property tax liens in its portfolio. In addition, management believes, based on the fact that the tax liens that collateralize the TLTs and TLCs are in a priority position over most other liens on the properties, that it will not experience any material losses on the ultimate collection of these receivables. Therefore, no allowance has been provided for as of June 30, 2013.

The following table presents the Company’s aging analysis of receivables secured by tax liens as of June 30, 2013 and December 31, 2012 (in thousands):


	June 30, 2013		December 31, 2012
Current	$	123,196	$	101,052
31-60 days past due		10,238		10,175
61-90 days past due		4,956		1,982
> 90 days past due		20,673		21,891

Tax lien transfer		159,063		135,100

Tax lien certificates		39,002		—

	$	198,065	$	135,100

Note 9: Deferred Court Costs, Net

The Company contracts with a nationwide network of attorneys that specialize in collection matters. The Company generally refers charged-off accounts to its contracted attorneys when it believes the related consumer has sufficient assets to repay the indebtedness and has, to date, been unwilling to pay. In connection with the Company’s agreement with the contracted attorneys, it advances certain out-of-pocket court costs (“Deferred Court Costs”). The Company capitalizes Deferred Court Costs in its consolidated financial statements and provides a reserve for those costs that it believes will ultimately be uncollectible. The Company determines the reserve based on its analysis of court costs that have been advanced and those that have been recovered. Historically, the Company wrote off Deferred Court Costs not recovered within three years of placement. However, as a result of a history of court cost recoveries beyond three years, the Company has determined that court costs are recovered over a longer period of time. As a result, on a prospective basis, the Company began increasing its deferral period from three years to five years in January 2013. Collections received from these debtors are first applied against related court costs with the balance applied to the debtors’ account.

Deferred Court Costs consist of the following as of the dates presented (in thousands):


	June 30, 2013		December 31, 2012
Court costs advanced	$	334,760	$	279,314
Court costs recovered		(118,610)		(94,827)
Court costs reserve		(176,094)		(149,080)

	$	40,056	$	35,407

A roll forward of the Company’s court cost reserve is as follows (in thousands):


	Court Cost Reserve
	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Balance at beginning of period	$	(162,500)	$	(129,287)	$	(149,080)	$	(130,454)
Provision for court costs		(13,594)		(12,789)		(27,014)		(25,133)
Write-off of reserve after the deferral period		—		9,296		—		22,807

Balance at end of period	$	(176,094)	$	(132,780)	$	(176,094)	$	(132,780)

Note 10: Other Assets

Other assets consist of the following (in thousands):


	June 30, 2013		December 31, 2012
Debt issuance costs, net of amortization	$	24,816	$	14,397
Prepaid income taxes		21,699		—
Service fee receivable		13,896		—
Prepaid expenses		12,486		6,399
Interest receivable		6,597		4,042
Identifiable intangible assets, net		3,834		487
Security deposit—India building leases		2,696		1,696
Recoverable legal fees		2,223		1,521
Other		3,634		2,993

	$	91,881	$	31,535

Note 11: Debt

The Company is obligated under borrowings, as follows (in thousands):


	June 30, 2013		December 31, 2012
Revolving credit facility	$	446,000	$	258,000
Term loan facility		194,875		148,125
Propel TLT facility		132,042		117,601
Propel TLC facility		36,699		—
Senior secured notes		66,250		72,500
Convertible notes		265,000		115,000
Less: Debt discount		(41,233)		(14,442)
Capital lease obligations		8,026		9,252

	$	1,107,659	$	706,036

Revolving Credit Facility and Term Loan Facility

The Company’s Amended and Restated Credit Agreement (the “Credit Agreement”) originally included a term loan facility tranche of $150.0 million and a revolving credit facility tranche of $425.0 million for a total commitment of $575.0 million (the “Credit Facility”). The maturities of both facilities are five years, expiring in November 2017, except with respect to a $50.0 million subtranche of the term loan facility, which has a three-year maturity, expiring in November 2015. The Credit Agreement includes several financial institutions and lenders and is led by an administrative agent. The Credit Agreement contained an accordion feature that allowed the Company to request an increase in the facility of up to $200.0 million by obtaining one or more commitments from existing or prospective lenders with the consent of the administrative agent. The Company exercised $20.0 million of the original $200.0 million accordion feature in December 2012, increasing the amount of the revolving credit facility from $425.0 million to $445.0 million. On May 9, 2013, the Company entered into an amendment to its Credit Facility, restating the Credit Agreement in its entirety (the “Restated Credit Agreement”) and increasing the aggregate loan commitment by $217.5 million, from $595.0 million to $812.5 million, and resetting the accordion feature. The $217.5 million exercise included a $168.9 million increase to the revolving credit facility tranche, increasing the aggregate revolving loan commitment to $613.9 million, and a $48.6 million term loan facility tranche, with a six-month maturity, expiring November 2013, increasing the term loan facility tranche to $198.6 million. Currently the accordion feature would allow the Company to increase the facility by an additional $162.5 million. Including the remaining accordion feature, the maximum amount that can be borrowed under the Credit Facility is $975.0 million.

The Restated Credit Agreement also allowed for the AACC Merger, included a basket to allow for investments in unrestricted subsidiaries and increased the subordinated debt basket to $300.0 million.

On May 29, 2013, the Company entered into an amendment to the Restated Credit Agreement which, among other things, allowed the Company to consummate the Cabot Acquisition. See Note 17 “Subsequent Events” for more information on the Cabot Acquisition.

Provisions of the Restated Credit Agreement include, but are not limited to:

•

A revolving loan of $613.9 million, interest at a floating rate equal to, at the Company’s option, either: (1) reserve adjusted London Interbank Offered Rate (“LIBOR”), plus a spread that ranges from, depending on the Company’s cash flow leverage ratio, 250 to 300 basis points; or (2) Alternate Base Rate, plus a spread that ranges from, depending on the Company’s cash flow leverage ratio, 150 to 200 basis points. “Alternate Base Rate,” as defined in the agreement, means the highest of (i) the per annum rate which the administrative agent publicly announces from time to time as its prime lending rate, as in effect from time to time, (ii) the federal funds effective rate from time to time, plus 0.5% and (iii) reserved adjusted LIBOR determined on a daily basis for a one month interest period, plus 1.0%;

•

A $100.0 million five-year term loan, interest at a floating rate equal to, at the Company’s option, either: (1) reserve adjusted LIBOR, plus a spread that ranges from 250 to 300 basis points, depending on the Company’s cash flow leverage ratio; or (2) Alternate Base Rate, plus a spread that ranges from 150 to 200 basis points, depending on the Company’s cash flow leverage ratio. Principal amortizes $1.3 million in 2012, $5.0 million in 2013, $5.6 million in 2014, $8.1 million in 2015, $10.0 million in 2016, and $5.0 million in 2017 with the remaining principal due at the end of the term;

•

A $50.0 million three-year term loan, interest at a floating rate equal to, at the Company’s option, either: (1) reserve adjusted LIBOR, plus a spread that ranges from 200 to 250 basis points, depending on the Company’s cash flow leverage ratio; or (2) Alternate Base Rate, plus a spread that ranges from 100 to 150 basis points, depending on the Company’s cash flow leverage ratio. Principal amortizes $0.6 million in 2012, $2.5 million in 2013, $2.8 million in 2014, $2.8 million in 2015 with the remaining principal due at the end of the term;

•

A $48.6 million six-month term loan, interest at a floating rate equal to, at the Company’s option, either: (1) reserve adjusted LIBOR, plus a spread that ranges from 250 to 300 basis points, depending on the Company’s cash flow leverage ratio; or (2) Alternate Base Rate, plus a spread that ranges from 150 to 200 basis points, depending on the Company’s cash flow leverage ratio. Principal amortizes in six equal monthly installments;

•

A borrowing base equal to (1) the lesser of (i) (a) 55% of eligible estimated remaining collections for consumer receivables subject to bankruptcy proceedings, provided that the amount described in this clause (i)(a) may not exceed 35% of the amount described in clauses (i)(a) and (i)(b), plus (b) 30%—35% (depending on the Company’s trailing 12-month cost per dollar collected) of all other eligible estimated remaining collections, initially set at 33%, and (ii) the product of the net book value of all receivable portfolios acquired on or after January 1, 2005 multiplied by 95%, minus (2) (x) the aggregate principal amount outstanding of the Prudential senior secured notes plus (y) the aggregate principal amount outstanding under the term loans;

•

The allowance of additional unsecured indebtedness not to exceed $300.0 million;

•

Restrictions and covenants, which limit the payment of dividends and the incurrence of additional indebtedness and liens, among other limitations;

•

Repurchases of up to $50.0 million of Encore’s common stock, subject to compliance with certain covenants and available borrowing capacity. The Company has repurchased approximately $50.0 million common stock during the fourth quarter of 2012 and in January 2013;

•

A change of control definition, which excludes acquisitions of stock by Red Mountain Capital Partners LLC, JCF FPK LLP and their respective affiliates of up to 50% of the outstanding shares of Encore’s voting stock;

•

Events of default which, upon occurrence, may permit the lenders to terminate the facility and declare all amounts outstanding to be immediately due and payable;

•

An annual capital expenditure limit of $20.0 million;

•

An annual rental expense limit of $15.0 million;

•

An outstanding capital lease limit of $20.0 million;

•

An acquisition limit of $100.0 million; and

•

Collateralization by all assets of the Company, other than the assets of the Propel Entities or any foreign or unrestricted subsidiaries.

At June 30, 2013, the outstanding balance on the Credit Facility was $640.9 million, which bore a weighted average interest rate of 3.17% and 4.11% for the six months ended June 30, 2013 and 2012, respectively.

Propel Tax Lien Transfer Facility

The Company, through Propel, has a $160.0 million syndicated loan facility (the “Propel TLT Facility”). The Propel TLT Facility was used in part to fund a portion of the Propel Acquisition and to fund future growth at Propel.

The Propel TLT Facility has a three-year term and includes the following key provisions:

•

Interest at Propel’s option, at either: (1) LIBOR, plus a spread that ranges from 300 to 375 basis points, depending on Propel’s cash flow leverage ratio; or (2) Prime Rate, which is defined in the agreement as the rate of interest per annum equal to the sum of (a) the interest rate quoted in the “Money Rates” section of The Wall Street Journal from time to time and designated as the “Prime Rate” plus (b) the Prime Rate Margin, which is a spread that ranges from 0 to 75 basis points, depending on Propel’s cash flow leverage ratio;

•

A borrowing base of 90% of the face value of the tax lien collateralized payment arrangements;

•

Interest payable monthly; principal and interest due at maturity;

•

Restrictions and covenants, which limit, among other things, the payment of dividends and the incurrence of additional indebtedness and liens;

•

Events of default which, upon occurrence, may permit the lender to terminate the Propel TLT Facility and declare all amounts outstanding to be immediately due and payable; and

•

A $40.0 million accordion feature.

The Propel TLT Facility is primarily collateralized by the TLT tax liens and requires Propel to maintain various financial covenants, including a minimum interest coverage ratio and a maximum cash flow leverage ratio.

At June 30, 2013, the outstanding balance on the Propel TLT Facility was $132.0 million and, for the six months ended June 30, 2013 and 2012, bore a weighted average interest rate of 3.53% and 3.54%, respectively.

Propel Tax Lien Certificate Facility

On May 9, 2013, the Company, through subsidiaries of Propel, entered into a $100.0 million revolving credit facility (the “Propel TLC Facility”). The Propel TLC Facility is used to purchase TLCs from taxing authorities.

The Propel TLC Facility has a four-year term and includes the following key provisions:

—

During the first two years of the four-year term, the committed amount can be drawn on a revolving basis. During the following two years, no additional draws are permitted, and all proceeds from the TLCs are used to repay any amounts outstanding under the facility. After the four-year period ends, if any amounts are still outstanding, an alternate interest rate applies until all amounts owed are repaid;

—

Prior to the expiration of the four-year term, interest at a per annum floating rate equal to LIBOR plus a spread of 325 basis points;

—

Following the expiration of the four-year term or upon the occurrence of an event of default, interest at 400 basis points plus the greater of (i) a per annum floating rate equal to LIBOR plus a spread of 325 basis points, or (ii) Prime Rate, which is defined in the agreement as the rate most recently announced by the lender at its branch in San Francisco, California, from time to time as its prime commercial rate for United States dollar-denominated loans made in the United States;

—

Proceeds from the TLCs are applied to pay interest, principal and other obligations incurred in connection with the Propel TLC Facility on a monthly basis as defined in the agreement;

—

Special purpose entity covenants designed to protect the bankruptcy-remoteness of the borrowers and additional restrictions and covenants, which limit, among other things, the payment of certain dividends, the occurrence of additional indebtedness and liens and use of the collections proceeds from the TLCs; and

—

Events of default which, upon occurrence, may permit the lender to terminate the Propel TLC Facility and declare all amounts outstanding to be immediately due and payable.

The Propel TLC Facility is collateralized by the TLCs acquired under the Propel TLC Facility. At June 30, 2013, the outstanding balance on the Propel TLC Facility was $36.7 million and, for the three months ended June 30, 2013, bore a weighted average interest rate of 5.17%.

Senior Secured Notes

In 2010 and 2011 Encore entered into an aggregate of $75.0 million in senior secured notes with certain affiliates of Prudential Capital Group (the “Senior Secured Notes”). $25.0 million dollars of the Senior Secured Notes bear an annual interest rate of 7.375% and mature in 2018. Beginning in May 2013, these notes require a quarterly payment of interest plus $1.25 million of principal. Prior to May 2013, these notes required quarterly interest payments only. The remaining $50.0 million of Senior Secured Notes bear an

annual interest rate of 7.75%, mature in 2017 and require quarterly principal amortization payments of $2.5 million. Prior to December 2012, these notes required quarterly interest payments only. As of June 30, 2013 $66.3 million is outstanding under these obligations.

The Senior Secured Notes are guaranteed in full by certain of Encore’s subsidiaries. Similar to, and pari passu with, the Credit Facility, the Senior Secured Notes are also collateralized by all assets of the Company, other than the assets of the Propel Entities and any foreign and unrestricted subsidiaries. The Senior Secured Notes may be accelerated and become automatically and immediately due and payable upon certain events of default, including certain events related to insolvency, bankruptcy, or liquidation. Additionally, the Senior Secured Notes may be accelerated at the election of the holder or holders of a majority in principal amount of the Senior Secured Notes upon certain events of default by Encore, including the breach of affirmative covenants regarding guarantors, collateral, most favored lender treatment or minimum revolving credit facility commitment or the breach of any negative covenant. If Encore prepays the Senior Secured Notes at any time for any reason, payment will be at the higher of par or the present value of the remaining scheduled payments of principal and interest on the portion being prepaid. The discount rate used to determine the present value is 50 basis points over the then current Treasury Rate corresponding to the remaining average life of the senior secured notes. The covenants are substantially similar to those in the Restated Credit Agreement. Prudential Capital Group and the administrative agent for the lenders of the Restated Credit Agreement have an intercreditor agreement related to their pro rata rights to the collateral, actionable default, powers and duties and remedies, among other topics. The terms of the Senior Secured Notes were amended and restated on May 9, 2013 in connection with the Restated Credit Agreement in order to properly align certain provisions between the two agreements.

Convertible Senior Notes

2012 Convertible Senior Notes

On November 27, 2012, Encore sold $100.0 million in aggregate principal amount of 3.0% convertible senior notes due November 27, 2017 in a private placement transaction. On December 6, 2012, the initial purchasers exercised, in full, their option to purchase an additional $15.0 million of the convertible senior notes, which resulted in an aggregate principal amount of $115.0 million of the convertible senior notes outstanding (collectively, the “2012 Convertible Notes”). Interest on the 2012 Convertible Notes is payable semi-annually, in arrears, on May 27 and November 27 of each year, beginning on May 27, 2013. The 2012 Convertible Notes are the Company’s general unsecured obligations. The 2012 Convertible Notes will be convertible into cash up to the aggregate principal amount of the 2012 Convertible Notes to be converted and the Company will pay or deliver, as the case may be, cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election, in respect of the remainder, if any, of the Company’s conversion obligation in excess of the aggregate principal amount of the 2012 Convertible Notes being converted. The 2012 Convertible Notes will be convertible at an initial conversion rate of 31.6832 shares of the Company’s common stock per $1,000 principal amount of 2012 Convertible Notes, subject to adjustment upon certain events, which is equivalent to an initial conversion price of approximately $31.56 per share of the Company’s common stock. As of June 30, 2013, none of the conditions allowing holders of the 2012 Convertible Notes to convert their notes had occurred.

In accordance with authoritative guidance related to derivatives and hedging and earnings per share calculation, only the conversion spread of the 2012 Convertible Notes is included in the diluted earnings per share calculation, if dilutive. Under such method, the settlement of the conversion spread has a dilutive effect when the average share price of the Company’s common stock during any quarter exceeds $31.56. The average share price of the Company’s common stock for the three months ended June 30, 2013 exceeded $31.56, however, the dilutive effect from the 2012 Convertible Notes was immaterial. See Note 4 “Earnings per Share” for additional information.

Concurrent with the pricing of the 2012 Convertible Notes, the Company entered into privately negotiated convertible note hedge transactions (together, the “Convertible Note Hedge Transactions”) with certain counterparties. The Convertible Note Hedge Transactions, collectively cover, subject to customary anti-dilution adjustments, the number of shares of the Company’s common stock underlying the 2012 Convertible Notes, as described below. Concurrently with entering into the Convertible Note Hedge Transactions, the Company also entered into separate, privately negotiated warrant transactions (together, the “Warrant Transactions”) with the same counterparties, whereby the Company sold to the counterparties warrants to purchase, collectively, subject to customary anti-dilution adjustments, up to the same number of shares of the Company’s common stock as in the Convertible Note Hedge Transactions. Subject to certain conditions, the Company may settle the warrants in cash or on a net-share basis.

The Convertible Note Hedge Transactions are expected generally to reduce the potential dilution and/or offset the potential cash payments the Company is required to make in excess of the principal amount upon conversion of the 2012 Convertible Notes in the event that the market price per share of the Company’s common stock, is greater than the strike price of the Convertible Note Hedge Transactions, which initially corresponds to the conversion price of the 2012 Convertible Notes and is subject to anti-dilution adjustments. If, however, the market price per share of the Company’s common stock, as measured under the terms of the Warrant Transactions, exceeds the strike price of the warrants, there would nevertheless be dilution to the extent that such market price exceeds the strike price of the warrants, unless the Company elects, subject to certain conditions, to settle the Warrant Transactions in cash. The strike price of the Warrant Transactions will initially be $44.1875 per share of the Company’s common stock and is subject to certain adjustments under the terms of the Warrant Transactions. Taken together, the Convertible Note Hedge Transactions and the Warrant Transactions have the effect of increasing the effective conversion price of the 2012 Convertible Notes to $44.1875 per share.

The Convertible Note Hedge Transactions and the Warrant Transactions are separate transactions, in each case, entered into by the Company with certain counterparties, and are not part of the terms of the 2012 Convertible Notes and will not affect any holder’s rights under the 2012 Convertible Notes. Holders of the 2012 Convertible Notes will not have any rights with respect to the Convertible Note Hedge Transactions or the Warrant Transactions. In accordance with authoritative guidance, as of December 31, 2012, the Company recorded the net cost of the Convertible Note Hedge Transactions and the Warrant Transactions as a reduction in additional paid in capital, and will not recognize subsequent changes in fair value of these financial instruments in its consolidated financial statements.

The net proceeds from the sale of the 2012 Convertible Notes were approximately $111.1 million, after deducting estimated fees and expenses. The Company used approximately $11.5 million of the net proceeds to pay the cost of the Convertible Note Hedge Transactions, taking into account the proceeds to the Company of the Warrant Transactions; approximately $25.0 million of the net proceeds to repurchase shares of the Company’s common stock; approximately $61.5 million of the net proceeds to repay borrowings under the Credit Agreement; and the balance of the net proceeds for general corporate purposes.

The Company determined that the fair value of the 2012 Convertible Notes at the date of issuance was approximately $100.3 million, and designated the residual value of approximately $14.7 million as the equity component. Additionally, the Company allocated approximately $3.3 million of the $3.8 million original 2012 Convertible Notes issuance cost as debt issuance cost and the remaining $0.5 million as equity issuance cost.

2013 Convertible Senior Notes

On June 24, 2013, Encore sold $150.0 million in aggregate principal amount of 3.00% convertible senior notes due July 1, 2020 in a private placement transaction (the “2013 Convertible Notes”). The 2013 Convertible Notes are general unsecured obligations of the Company. Interest on the 2013 Convertible Notes is payable semi-annually, in arrears, on January 1 and July 1 of each year, beginning on January 1, 2014. Prior to January 1, 2020, the 2013 Convertible Notes will be convertible only during specified periods, if certain conditions are met. On or after January 1, 2020, the 2013 Convertible Notes will be convertible regardless of these conditions. Upon conversion, holders will receive cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election. The conversion rate for the 2013 Convertible Notes is 21.8718 shares per $1,000 principal amount, which is equivalent to an initial conversion price of approximately $45.72 per share of common stock. As of June 30, 2013, none of the conditions allowing holders of the 2013 Convertible Notes to convert their notes had occurred.

As noted above, upon conversion, holders of the Company’s 2013 Convertible Notes will receive cash, shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election. However, the Company’s current intent is to settle conversions through combination settlement (i.e., convertible into cash up to the aggregate principal amount, and shares of the Company’s common stock or a combination of cash and shares of the Company’s common stock, at the Company’s election, for the remainder). As a result and in accordance with authoritative guidance related to derivatives and hedging and earnings per share, only the conversion spread is included in the diluted earnings per share calculation, if dilutive. Under such method, the settlement of the conversion spread has a dilutive effect when the average share price of the Company’s common stock during any quarter exceeds $45.72.

In connection with the pricing of the 2013 Convertible Notes, the Company entered into privately negotiated capped call transactions (the “Capped Call Transactions”) with one or more of the initial purchasers (or their affiliates) and one or more other financial institutions (the “Option Counterparties”). The Capped Call Transactions cover, collectively, the number of shares of the Company’s common stock underlying the 2013 Convertible Notes, subject to anti-dilution adjustments substantially similar to those applicable to the 2013 Convertible Notes. The cost of the Capped Call Transactions was approximately $15.8 million. In accordance with authoritative guidance, as of June 30, 2013, the Company recorded the net cost of the Capped Call Transactions as a reduction in additional paid in capital, and will not recognize subsequent changes in fair value of these financial instruments in its consolidated financial statements.

The Capped Call Transactions are expected generally to reduce the potential dilution and/or offset the cash payments the Company is required to make in excess of the principal amount upon conversion of the 2013 Convertible Notes in the event that the market price of the Company’s common stock is greater than the strike price of the Capped Call Transactions (which initially corresponds to the initial conversion price of the 2013 Convertible Notes and is subject to certain adjustments under the terms of the Capped Call Transactions), with such reduction and/or offset subject to a cap based on the cap price of the Capped Call Transactions. The cap price of the capped call transactions is $61.5475 per share, and is subject to certain adjustments under the terms of the Capped Call Transactions.

The Capped Call Transactions are separate transactions, in each case, entered into by the Company with the Option Counterparties, and are not part of the terms of the 2013 Convertible Notes and will not affect any holder’s rights under the 2013 Convertible Notes. Holders of the 2013 Convertible Notes do not have any rights with respect to the Capped Call Transactions.

The net proceeds from the sale of the 2013 Convertible Notes were approximately $144.9 million, after deducting the initial purchasers’ discounts and commissions and the estimated offering expenses payable by the Company. The Company used approximately $15.8 million of the net proceeds from this offering to pay the cost of the Capped Call Transactions and used the remainder of the net proceeds from this offering to pay a portion of the purchase price for the Cabot Acquisition and for general corporate purposes.

The Company determined that the fair value of the 2013 Convertible Notes at the date of issuance was approximately $122.0 million, and designated the residual value of approximately $28.0 million as the equity component. Additionally, the Company allocated approximately $4.3 million of the $5.3 million original 2013 Convertible Notes issuance cost as debt issuance cost and the remaining $1.0 million as equity issuance cost.

On July 18, 2013, the initial purchasers exercised, in full, their option to purchase an additional $22.5 million of the 2013 Convertible Notes, which resulted in an aggregate principal amount of $172.5 million of the 2013 Convertible Notes outstanding. Refer to Note 17 “Subsequent Events” for more information about the additional notes.

Authoritative guidance related to debt with conversion and other options requires that, for convertible debt instruments that may be settled fully or partially in cash upon conversion, issuers must separately account for the liability and equity components in a manner that will reflect the entity’s nonconvertible debt borrowing rate when interest cost is recognized in subsequent periods. Additionally, debt issuance costs are required to be allocated in proportion to the allocation of the liability and equity components and accounted for as debt issuance costs and equity issuance costs, respectively.

The balances of the liability and equity components of all of the convertible notes outstanding were as follows (in thousands):


	June 30, 2013		December 31, 2012
Liability component—principal amount	$	265,000	$	115,000
Unamortized debt discount		(41,233)		(14,442)

Liability component—net carrying amount	$	223,767	$	100,558

Equity component	$	42,748	$	14,702

The debt discount is being amortized into interest expense over the remaining life of the convertible notes using the effective interest rates, which are 6.0 % and 6.35% for the 2012 and 2013 Convertible Notes, respectively.

Interest expense related to the convertible notes was as follows (in thousands):


	Three Months Ended June 30, 2013		Six Months Ended June 30, 2013
Interest expense – stated coupon rate	$	948	$	1,806
Interest expense – amortization of debt discount		710		1,317

Total interest expense – convertible notes	$	1,658	$	3,123

The Company is in compliance with all covenants under its financing arrangements.

Capital Lease Obligations

The Company has capital lease obligations primarily for computer equipment. As of June 30, 2013, the Company’s combined obligations for these equipment leases were approximately $8.0 million. These lease obligations require monthly or quarterly payments through May 2018 and have implicit interest rates that range from zero to approximately 7.7 %.

Note 12: Income Taxes

During the three months ended June 30, 2013, the Company recorded an income tax provision of $7.3 million, reflecting an effective rate of 39.8% of pretax income from continuing operations. The effective tax rate for the three months ended June 30, 2013 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.6%, and a provision due to permanent book and tax difference of 0.5%.

During the three months ended June 30, 2012, the Company recorded an income tax provision of $12.8 million, reflecting an effective rate of 40.4% of pretax income from continuing operations. The effective tax rate for the three months ended June 30, 2012 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.5%, and a provision due to the true-up of certain state and federal tax accounts of 1.2%.

During the six months ended June 30, 2013, the Company recorded an income tax provision of $19.8 million, reflecting an effective rate of 39.4 % of pretax income from continuing operations. The effective tax rate for the six months ended June 30, 2013 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.6% and a provision due to permanent book and tax difference of 0.1%.

During the six months ended June 30, 2012, the Company recorded an income tax provision of $24.5 million, reflecting an effective rate of 39.8% of pretax income from continuing operations. The effective tax rate for the six months ended June 30, 2012, primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a provision for state taxes of 6.5%, and a provision due to the true-up of certain state and federal tax accounts of 0.6%.

The Company’s subsidiary in Costa Rica is operating under a 100% tax holiday through December 31, 2018 and a 50% tax holiday for the subsequent four years. The impact of the tax holiday in Costa Rica for the three and six months ended June 30, 2013 was immaterial.

As of June 30, 2013, the Company had a gross unrecognized tax benefit of $15.4 million that, if recognized, would result in a net tax benefit of approximately $14.5 million and would have a positive effect on the Company’s effective tax rate. During the three and six months ended June 30, 2013, there was an increase in the gross unrecognized tax benefit of $12.7 million as a result of the AACC Merger as discussed in Note 3 “Business Combinations.”

During the three and six months ended June 30, 2013, the Company did not provide for United States income taxes or foreign withholding taxes on the quarterly undistributed earnings from continuing operations of its subsidiaries operating outside of the United States. Undistributed earnings of these subsidiaries during the three and six months ended June 30, 2013, were approximately $1.5 million and $3.2 million, respectively. Such undistributed earnings are considered permanently reinvested.

Note 13: Purchase Concentrations

The following table summarizes purchases by seller sorted by total aggregate cost (in thousands, except percentages):


	Six Months Ended June 30, 2013
	Cost		%
Portfolios acquired in AACC Merger	$	381,233		79.1%
Seller 1		18,791		3.9%
Seller 2		14,904		3.1%
Seller 3		13,064		2.7%
Seller 4		11,813		2.5%
Other sellers		42,079		8.7%

Total purchases	$	481,884		100.0%

Note 14: Commitments and Contingencies

Litigation

The Company is involved in disputes and legal actions from time to time in the ordinary course of business. The Company, along with others in its industry, is routinely subject to legal actions based on the Fair Debt Collection Practices Act (“FDCPA”), comparable state statutes, the Telephone Consumer Protection Act (“TCPA”), state and federal unfair competition statutes, and common law causes of action. The violations of law alleged in these actions often include claims that the Company lacks specified licenses to conduct its business, attempts to collect debts on which the statute of limitations has run, has made inaccurate assertions of fact in support of its collection actions, and/or has acted improperly in connection with its efforts to contact consumers. These cases are frequently styled as supposed class actions.

On March 8, 2013, March 19, 2013 and March 20, 2013, three actions entitled Shell v. Asset Acceptance Capital Corp., et. al., Neumann v. Asset Acceptance Capital Corp., et. al., and Jaluka v. Asset Acceptance Capital Corp. et. al., respectively, were filed in the Macomb County Circuit Court of the State of Michigan. On April 19, 2013, a fourth action entitled Dix v. Asset Acceptance Capital Corp. et al was filed in the Court of Chancery of the State of Delaware. These actions were brought by purported stockholders of AACC, against the Company, AACC, and certain other named entities and individuals, and allege, among other things, that the Company has aided and abetted AACC’s directors in breaching their fiduciary duties of care, loyalty and candor or disclosure owed to AACC stockholders. Plaintiffs in the actions sought, among other things, injunctive relief prohibiting consummation of the proposed acquisition, or rescission of the proposed acquisition (in the event the transaction has already been consummated), as well as costs and disbursements, including reasonable attorneys’ and experts’ fees, and other equitable or injunctive relief as the court may deem just and proper. The plaintiffs did not specify the dollar amount of damages sought in each action. On June 2, 2013, AACC entered into a Memorandum of Understanding (the “MOU”) with the plaintiffs in the Michigan actions and Delaware action that sets forth the parties’ agreement in principle for settlement. As explained in the MOU, without admitting any wrongdoing, AACC agreed to make certain additional disclosures related to the proposed merger, and to enter into a stipulation of settlement providing for the certification of a class, for settlement purposes only, that includes certain persons or entities who held shares of AACC common stock and the release of all asserted claims. Once the stipulation of settlement is approved by the Michigan court, which has yet to and may not occur, the attorneys for the class members intend to seek an award of attorneys’ fees and costs incurred in a total amount not to exceed $550,000, which the defendants have agreed to not oppose.

Except as described above and in the Company’s Quarterly Report on Form 10-Q for the quarter ended March 31, 2013, there have been no material developments in any of the legal proceedings disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2012.

In certain legal proceedings, the Company may have recourse to insurance or third party contractual indemnities to cover all or portions of its litigation expenses, judgments, or settlements. In accordance with authoritative guidance, the Company records loss contingencies in its financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated with no best estimate in the range, the Company records the minimum estimated liability. The Company continuously assesses the potential liability related to the Company’s pending litigation and revises its estimates when additional information becomes available. As of June 30, 2013, the Company has no material reserves for litigation. Additionally, based on the current status of litigation matters, either the estimate of exposure is immaterial to the Company’s financial statements or an estimate cannot yet be determined. The Company’s legal costs are recorded to expense as incurred.

Purchase Commitments

In the normal course of business, the Company enters into forward flow purchase agreements and other purchase commitment agreements. As of June 30, 2013, the Company has entered into agreements to purchase receivable portfolios with a face value of approximately $435.8 million for a purchase price of approximately $35.5 million. The Company has no purchase commitments beyond December 2014.

Note 15: Segment Information

The Company conducts business through two operating segments: portfolio purchasing and recovery and tax lien business. The Company’s management relies on internal management reporting processes that provide segment revenue, segment operating income, and segment asset information in order to make financial decisions and allocate resources. The operating results from the Company’s tax lien business segment are immaterial to the Company’s total consolidated operating results. However, total assets from this segment are significant as compared to the Company’s total consolidated assets. As a result, in accordance with authoritative guidance on segment reporting, the Company’s tax lien business segment is determined to be a reportable segment.

Segment operating income includes income from operations before depreciation, amortization of intangible assets, and stock-based compensation expense. The following table provides a reconciliation of revenue and segment operating income by reportable segment to consolidated results and was derived from the segments’ internal financial information as used for corporate management purposes (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Revenues:
Portfolio purchasing and recovery	$	152,091	$	138,733	$	292,774	$	265,143
Tax lien business		4,030		2,513		7,933		2,513

	$	156,121	$	141,246	$	300,707	$	267,656

Operating income:
Portfolio purchasing and recovery	$	33,478	$	41,396	$	76,158	$	79,918
Tax lien business		742		1,000		1,623		1,000

		34,220		42,396		77,781		80,918
Depreciation and amortization		(2,158)		(1,420)		(4,004)		(2,660)
Stock-based compensation		(2,179)		(2,539)		(5,180)		(4,805)
Other expense		(11,604)		(6,603)		(18,299)		(11,851)

Income from continuing operations before income taxes	$	18,279	$	31,834	$	50,298	$	61,602

Additionally, assets are allocated to operating segments for management review. As of June 30, 2013, total segment assets were $1.5 billion and $256.4 million for the portfolio purchasing and recovery segment and tax lien business segment, respectively.

Note 16: Goodwill and Identifiable Intangible Assets

In accordance with authoritative guidance, goodwill is tested at the reporting unit level annually for impairment and in interim periods if certain events occur that indicate the fair value of a reporting unit may be below its carrying value.

As of June 30, 2013, the Company has two reporting units that carry goodwill: portfolio purchasing and recovery and tax lien business. Annual testing is performed as of October 1^st for the portfolio purchasing and recovery reporting unit and as of April 1^st for the tax lien business reporting unit.

The Company’s acquired intangible assets are summarized as follows (in thousands):


	As of June 30, 2013						As of December 31, 2012
	Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount		Gross Carrying Amount		Accumulated Amortization		Net Carrying Amount
Intangible assets subject to amortization:
Trade name and other	$	2,060	$	(126)	$	1,934	$	570	$	(83)	$	487
Intangible assets not subject to amortization:
Goodwill – portfolio purchasing and recovery					$	74,398					$	6,047
Goodwill – tax lien business						45,390						49,399
Other intangibles						1,900						—

					$	121,688					$	55,446

The changes in carrying amount of goodwill by reporting unit for the six months ended June 30, 2013 are as follows (in thousands):


	Portfolio Purchasing and Recovery		Tax Lien business
Balance, December 31, 2012	$	6,047	$	49,399
Goodwill acquired		68,351		—
Goodwill adjustment⁽¹⁾		—		(4,009)

Balance, June 30, 2013	$	74,398	$	45,390

⁽¹⁾

As a result of its final valuation study related to the Company’s acquisition of Propel, during the three months ended March 31, 2013, the Company made an adjustment to the initial purchase price allocation, increasing receivables secured by tax liens and decreasing goodwill by approximately $4.0 million.

Note 17: Subsequent Events

Cabot Acquisition

On July 1, 2013, the Company acquired 50.1% of the equity interest in Janus Holdings, the indirect holding company of Cabot, from J.C. Flowers, for £115.1 million (approximately $174.6 million). The remaining 49.9% of Janus Holdings is held by a fund advised by J.C. Flowers & Co., LLC. The Company has the option to purchase the remaining interest in Janus Holdings during the period from the fourth anniversary to the sixth anniversary of the closing. Through its acquisition of Janus Holdings the Company’s equity ownership of Cabot currently amounts to 41.7%, after reflecting the ownership of Cabot’s management team. Encore’s equity interest will automatically increase to approximately 42.8% by June 2014, following the redemption or conversion of certain Bridge Preferred Equity Certificates. For additional information relating to the Cabot Acquisition, please refer to the Company’s Current Reports on Form 8-K filed with the SEC on May 30, 2013 and July 8, 2013.

The Company will account for this acquisition using the acquisition method of accounting and, accordingly, the tangible and intangible assets acquired and liabilities assumed will be recorded at their estimated fair values as of the date of the Cabot Acquisition. The results of operations of Janus Holdings will be consolidated with those of the Company beginning on July 1, 2013. As of the date of this Quarterly Report on Form 10-Q, the Company has not completed its preliminary purchase price allocation for the Cabot Acquisition because the Company has not had sufficient time to complete the allocation.

Cabot 2013 Senior Secured Notes

On August 2, 2013, Cabot Financial (Luxembourg) S.A. (the “Issuer”), a subsidiary of the Company, sold £100 million U.K. pounds sterling in aggregate principal amount of 8.375% Senior Secured Notes due 2020 (the “Cabot Notes”). The Cabot Notes are fully and unconditionally guaranteed on a senior secured basis by the following subsidiaries of the Company: Cabot Credit Management Limited, Cabot Financial Limited, and all material subsidiaries of Cabot Financial Limited (other than the Issuer). Refer to the Company’s Current Report on Form 8-K filed with the SEC on August 6, 2013 for more information about the Cabot Notes.

2013 Convertible Notes

On June 24, 2013, Encore sold $150.0 million in aggregate principal amount of 3.00% 2013 Convertible Notes due July 1, 2020 in a private placement transaction. On July 18, 2013, the initial purchasers exercised, in full, their option to purchase an additional $22.5 million in aggregate principal amount of the 2013 Convertible Notes, which resulted in an aggregate principal amount of $172.5 million of the 2013 Convertible Notes. The additional notes have the same terms as the 2013 Convertible Notes. The Company also entered into capped call transactions that have the same terms as those associated with the 2013 Convertible Notes. Refer to Note 11 “Debt” for more information on the Company’s 2013 Convertible Notes.

Item 2 – Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the securities laws. The words “believe,” “expect,” “anticipate,” “estimate,” “project,” “intend,” “plan,” “will,” “may,” and similar expressions often characterize forward-looking statements. These statements may include, but are not limited to, projections of collections, revenues, income or loss, estimates of capital expenditures, plans for future operations, products or services and financing needs or plans, as well as assumptions relating to these matters. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we caution that these expectations or predictions may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control or cannot be predicted or quantified, that could cause actual results to differ materially from those suggested by the forward-looking statements. Many factors, including but not limited to those set forth in our Annual Report on Form 10-K under “Part I, Item 1A. Risk Factors” and those set forth in this Quarterly Report on Form 10-Q under “Part II, Item 1A – Risk Factors,” could cause our actual results, performance, achievements or industry results to be very different from the results, performance, achievements or industry results expressed or implied by these forward-looking statements. Our business, financial condition or results of operations could also be materially and adversely affected by other factors besides those listed. Forward-looking statements speak only as of the date the statements were made. We do not undertake any obligation to update or revise any forward-looking statements to reflect new information or future events, or for any other reason, even if experience or future events make it clear that any expected results expressed or implied by these forward-looking statements will not be realized. In addition, it is generally our policy not to make any specific projections as to future earnings, and we do not endorse projections regarding future performance that may be made by third parties.

Our Business and Operating Segments

We are a leading provider of debt management and recovery solutions for consumers and property owners across a broad range of financial assets. We purchase portfolios of defaulted consumer receivables at deep discounts to face value and manage them by working with individuals as they repay their obligations and work toward financial recovery. Defaulted receivables are consumers’ unpaid financial commitments to credit originators, including banks, credit unions, consumer finance companies, commercial retailers, and telecommunication companies. Defaulted receivables may also include receivables subject to bankruptcy proceedings. In addition, through our subsidiary, Propel, we assist Texas property owners who are delinquent on their property taxes by paying these taxes on behalf of the property owners in exchange for payment agreements collateralized by tax liens on the property, as well as purchase tax lien certificates directly from taxing authorities.

We conduct business through two operating segments: portfolio purchasing and recovery and tax lien business. The operating results from our tax lien business segment are immaterial to our total consolidated operating results. However, the total segment assets are significant as compared to our total consolidated assets. As a result, in accordance with authoritative guidance on segment reporting, our tax lien business segment is determined to be a reportable segment.

Our long-term growth strategy involves growing our core portfolio purchasing and recovery business, expanding into new asset classes, and expanding into new geographies.

Portfolio purchasing and recovery

Our portfolio purchasing and recovery segment purchases receivables based on robust, account-level valuation methods and employs proprietary statistical and behavioral models across the full extent of our operations. These investments allow us to value portfolios accurately (and limit the risk of overpaying), avoid buying portfolios that are incompatible with our methods or goals and align the accounts we purchase with our operational channels to maximize future collections. As a result, we have been able to realize significant returns from the receivables we acquire. We maintain strong relationships with many of the largest credit and telecommunication providers in the United States and believe we possess one of the industry’s best collection staff retention rates.

While seasonality does not have a material impact on our portfolio purchasing and recovery segment, collections are generally strongest in our first calendar quarter, slower in the second and third calendar quarters, and slowest in the fourth calendar quarter. Relatively higher collections in the first quarter could result in a lower cost-to-collect ratio compared to the other quarters, as our fixed costs would be constant and applied against a larger collection base. The seasonal impact on our business may be influenced by our purchasing levels, the types of portfolios we purchase, and our operating strategies.

Collection seasonality with respect to our portfolio purchasing and recovery segment can also affect our revenue recognition rate. Generally, revenue for each pool group declines steadily over time, whereas collections can fluctuate from quarter to quarter based on seasonality, as described above. In quarters with lower collections (e.g., the fourth calendar quarter), revenue as a percentage of collections can be higher than in quarters with higher collections (e.g., the first calendar quarter).

In addition, seasonality could have an impact on the relative level of quarterly earnings. In quarters with stronger collections, total costs are higher as a result of the additional efforts required to generate those collections. Since revenue for each pool group declines steadily over time, in quarters with higher collections and higher costs (e.g., the first calendar quarter), all else being equal,

earnings could be lower than in quarters with slower collections and lower costs (e.g., the fourth calendar quarter). Additionally, in quarters where a greater percentage of collections come from our legal and agency outsourcing channels, cost to collect will be higher than if there were more collections from our internal collection sites.

Tax lien business

Our tax lien business segment focuses on the property tax financing industry. Our principal activity is originating and servicing property tax lien transfers in the state of Texas and investing in tax lien certificates in other states. For tax lien transfers, with the property owner’s consent, we pay the property owner’s delinquent property taxes directly to the taxing authority, which then transfers its tax lien to us. This lien takes priority over most other liens. By funding tax liens, we provide state and local taxing authorities and governments with much needed tax revenue. To the extent permitted by law, we then enter into a payment agreement with the property owner, creating an affordable payment plan designed to permit the property owner to keep his or her property. For tax lien certificates, we purchase the tax lien certificates directly from taxing authorities, securing rights to future property tax payments, interest and penalties. Tax lien certificates we invest in are collateralized by the underlying property, and in most cases, continue to be serviced by the taxing authority. When the taxing authority is paid, it repays us the outstanding balance of the lien plus interest, which is negotiated at the time of the purchase. Revenue from our tax lien business segment comprised 3% of total consolidated revenues for the three and six months ended June 30, 2013. Operating income from our tax lien business segment comprised 2% of our total consolidated operating income for the three and six months ended June 30, 2013.

Cabot Acquisition

On July 1, 2013, we completed the purchase (the “Cabot Acquisition”) of 50.1% of the equity interest in Janus Holdings Luxembourg S.a.r.l. (“Janus Holdings”), the indirect holding company of U.K. and Ireland based Cabot Credit Management Limited (“Cabot”), from an affiliate of J.C. Flowers & Co. LLC (“J.C. Flowers”). Through our acquisition of Janus Holdings our equity ownership of Cabot currently amounts to 41.7%, after reflecting the ownership of Cabot’s management team. Our equity interest will automatically increase to approximately 42.8% by June 2014, following the redemption or conversion of certain Bridge Preferred Equity Certificates. Cabot is a market leader in debt management in the United Kingdom and Ireland specializing in higher balance, “semi-performing” (i.e., paying) accounts. We expect that the acquisition will provide Cabot with access to more capital, which will enable Cabot to purchase additional debt and expand into other asset categories. In addition, the acquisition provides synergy opportunities through Cabot’s ability to leverage our analytic capabilities and efficient operating platform. Our initial focus will be to help Cabot expand into the large secondary and tertiary markets by leveraging our analytical insights in these markets and utilizing our workforce in India, during the day, when this site is dormant. The acquisition also enables us to deploy capital globally in a market that we believe has strong growth potential. Cabot will continue to be a stand-alone entity. It will retain its current staff and brand and continue to be run as its own company. The condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2013 do not include the results of operations of Janus Holdings because the Cabot Acquisition was not completed until July 1, 2013. The results of operations of Janus Holdings will be consolidated within our portfolio purchasing and recovery business in future periods. For additional information relating to the Cabot Acquisition, please refer to the Company’s Current Reports on Form 8-K filed with the Securities and Exchange Commission (the “SEC”) on May 30, 2013 and July 8, 2013.

AACC Merger

On June 13, 2013, we completed our merger with Asset Acceptance Capital Corp. (“AACC”), another leading provider of debt management and recovery solutions in the United States (the “AACC Merger”). We believe that our operating and cost advantages will improve the profitability of AACC’s investments and that the AACC Merger also provides us with valuable operations capabilities and synergy opportunities. We expect our combined organization to operate at our lower cost-to-collect within the next three to four quarters. However, the success of the merger will depend on our ability to successfully integrate AACC’s business with our business in a cost-effective manner that does not disrupt the existing business relationships of either company. See “Item 1A – Risk Factors” for more information. The condensed consolidated statements of comprehensive income for the three and six months ended June 30, 2013 include the results of operations of AACC only since the closing date of the AACC Merger. For additional information relating to the AACC Merger, please refer to our Current Reports on Form 8-K filed with the SEC on March 6, 2013 and June 17, 2013.

In January 2012, Asset Acceptance, LLC, a subsidiary of AACC, entered into a consent decree with the Federal Trade Commission (“FTC”). The consent decree ended an FTC investigation into Asset Acceptance, LLC’s compliance with the Federal Trade Commission Act, Fair Debt Collection Practices Act and Fair Credit Reporting Act. As part of the consent decree, Asset Acceptance, LLC agreed to undertake certain consumer protection practices, including, among other things, furnishing additional disclosures when collecting debt past the statute of limitations, and paid a civil penalty of $2,500,000. These practices continue to apply to the portfolios we purchased as a result of the AACC Merger. We do not expect compliance with the consent decree to have a material effect on our business.

Purchases and Collections

Portfolio Pricing and Supply

Meaningful increases in the prices for portfolios offered for sale directly from credit issuers continued into the second quarter of 2013, especially for fresh portfolios. Fresh portfolios are portfolios that are generally transacted within six months of the consumer’s account being charged-off by the financial institution. We believe this price increase is due to a reduction in the supply of charged-off accounts and continued demand in the marketplace. We believe that the reduction in supply is partially due to shifts in underwriting standards by financial institutions, which have resulted in lower volumes of charged-off accounts. We believe that this reduction in supply is also the result of certain financial institutions temporarily halting their sales of charged-off accounts while they conduct audits of debt management and recovery companies, including Encore. We expect that pricing will remain at these elevated levels for

some period of time. We believe that pricing will not decline until buyers who have paid prices that are too high recognize that they are unable to realize a profit or until the financial institutions complete their audits of debt management and recovery companies and resume selling their charged-off accounts in greater volumes than current levels. Should pricing trends continue in this manner, we expect to continue to adjust our purchasing strategies away from fresh portfolios, and toward portfolios in alternative asset classes or aged portfolios, where pricing is not as elevated and where we believe that our operational model allows us to maintain acceptable profit margins. Additionally, the AACC Merger accounted for a significant portion of our 2013 forecasted purchases and, as a result, we slowed our purchasing efforts in the second quarter of 2013 as compared to the second quarter of 2012 and expect to slow our purchases in the third quarter of 2013 as compared to the third quarter of 2012.

Portfolio Demand

We believe that smaller competitors are being driven out of the portfolio purchasing market because of the high cost to operate due to regulatory pressure and because the issuers are being more selective with buyers in the marketplace, resulting in consolidation within the portfolio purchasing and recovery industry.

Purchases by Type

The following table summarizes the types of charged-off consumer receivable portfolios we purchased for the periods presented (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Credit card⁽¹⁾	$	380,423	$	202,294	$	423,837	$	310,229
Consumer bankruptcy receivables⁽¹⁾⁽²⁾		39,897		—		39,897		—
Telecom		2,793		28,689		18,150		51,217

	$	423,113	$	230,983	$	481,884	$	361,446

⁽¹⁾	Purchases of consumer portfolio receivables for the three and six month periods ended June 30, 2013 include $381.2 million acquired in connection with the AACC Merger ($345.5 million for credit card and $35.7 million for consumer bankruptcy receivables).

⁽²⁾	Represents portfolio receivables subject to Chapter 13 and Chapter 7 bankruptcy proceedings acquired from issuers and resellers.

During the three months ended June 30, 2013, we invested $423.1million to acquire charged-off credit card, telecom and consumer bankruptcy portfolios, with face values aggregating $68.9 billion, for an average purchase price of 0.6% of face value. This is a $192.1 million increase, or 83.2%, in the amount invested, compared with the $231.0 million invested during the three months ended June 30, 2012, to acquire charged-off credit card and telecom portfolios with a face value aggregating $6.0 billion, for an average purchase price of 3.8% of face value. Purchases of charged-off credit card, telecom and consumer bankruptcy portfolios include $381.2 million acquired in conjunction with the AACC Merger. The period-over-period increase in purchases and decrease in the percentage of face value is related to the purchase of these portfolios.

During the six months ended June 30, 2013, we invested $481.9 million to acquire charged-off credit card, telecom and consumer bankruptcy portfolios, with face values aggregating $70.5 billion, for an average purchase price of 0.7% of face value. This is a $120.4 million increase, or 33.3%, in the amount invested, compared with the $360.4 million invested during the six months ended June 30, 2012, to acquire charged-off portfolios with a face value aggregating $8.9 billion, for an average purchase price of 4.0% of face value. Purchases of charged-off credit card, telecom and consumer bankruptcy portfolios include $381.2 million of portfolio acquired in conjunction with the AACC Merger. The increase in purchases and decrease in the percentage of face value is related to this purchase.

Average purchase price, as a percentage of face value, varies from period to period depending on, among other things, the quality of the accounts purchased and the length of time from charge off to the time we purchase the portfolios. The low purchase rate for the three and six month periods ending June 30, 2013 is related to the portfolio acquired in connection with the AACC Merger. This low rate is a result of us acquiring the entire portfolio of AACC, which included accounts for which we ascribed low or no value.

Collections by Channel

We utilized numerous business channels for the collection of charged-off credit card receivables and other charged-off receivables. The following table summarizes gross collections by collection channel in the respective periods (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
Legal collections	$	133,682	$	114,876	$	255,955	$	224,448
Collection sites		116,853		111,641		243,415		221,511
Collection agencies ⁽¹⁾		27,853		14,043		49,188		25,629

	$	278,388	$	240,560	$	548,558	$	471,588

⁽¹⁾	Collections through our collection agency channel include accounts subject to bankruptcy filings collected by others.

Gross collections increased $37.8 million, or 15.7%, to $278.4 million during the three months ended June 30, 2013, from $240.6 million during the three months ended June 30, 2012. Gross collections increased $77.0 million, or 16.3%, to $548.6 million during the six months ended June 30, 2013, from $471.6 million during the six months ended June 30, 2012.

Results of Operations

Results of operations in dollars and as a percentage of total revenue were as follows (in thousands, except per share amounts and percentages):


	Three Months Ended June 30,
	2013						2012
Revenues
Revenue from receivable portfolios, net		$	152,024		97.4	%		$	138,731		98.2	%
Service fee income			380		0.2	%			183		0.1	%
Net interest income —tax lien business			3,717		2.4	%			2,332		1.7	%

Total revenues			156,121		100.0	%			141,246		100.0	%

Operating expenses
Salaries and employee benefits			32,969		21.1	%			25,190		17.8	%
Cost of legal collections			44,483		28.5	%			41,024		29.0	%
Other operating expenses			13,797		8.9	%			12,427		8.8	%
Collection agency commissions			5,230		3.3	%			4,166		3.0	%
General and administrative expenses			27,601		17.7	%			18,582		13.2	%
Depreciation and amortization			2,158		1.4	%			1,420		1.0	%

Total operating expenses			126,238		80.9	%			102,809		72.8	%

Income from operations			29,883		19.1	%			38,437		27.2	%

Other (expense) income
Interest expense			(7,482	)	(4.8	)%			(6,497	)	(4.6	)%
Other expense			(4,122	)	(2.6	)%			(106	)	(0.1	)%

Total other expense			(11,604	)	(7.4	)%			(6,603	)	(4.7	)%

Income from continuing operations before income taxes			18,279		11.7	%			31,834		22.5	%
Provision for income taxes			(7,267	)	(4.6	)%			(12,846	)	(9.1	)%

Income from continuing operations			11,012		7.1	%			18,988		13.4	%
Loss from discontinued operations, net of tax			—		0.0	%			(2,392	)	(1.7	)%

Net income		$	11,012		7.1	%		$	16,596		11.7	%


	Six Months Ended June 30,
	2013						2012
Revenues
Revenue from receivable portfolios, net		$	292,707		97.4	%		$	265,136		99.1	%
Service fee income			681		0.2	%			188		0.1	%
Net interest income – tax lien business			7,319		2.4	%			2,332		0.8	%

Total revenues			300,707		100.0	%			267,656		100.0	%

Operating expenses
Salaries and employee benefits			61,801		20.6	%			47,494		17.7	%
Cost of legal collections			86,741		28.8	%			79,659		29.8	%
Other operating expenses			27,062		9.0	%			24,025		9.0	%
Collection agency commissions			8,559		2.9	%			8,125		3.0	%



	Six Months Ended June 30,
	2013						2012
General and administrative expenses			43,943		14.6	%			32,240		12.1	%
Depreciation and amortization			4,004		1.3	%			2,660		1.0	%

Total operating expenses			232,110		77.2	%			194,203		72.6	%

Income from operations			68,597		22.8	%			73,453		27.4	%

Other (expense) income
Interest expense			(14,336	)	(4.8	)%			(12,012	)	(4.5	)%
Other (expense)income			(3,963	)	(1.3	)%			161		0.1	%

Total other expense			(18,299	)	(6.1	)%			(11,851	)	(4.4	)%

Income from continuing operations before income taxes			50,298		16.7	%			61,602		23.0	%
Provision for income taxes			(19,838	)	(6.6	)%			(24,506	)	(9.1	)%

Income from continuing operations			30,460		10.1	%			37,096		13.9	%
Loss from discontinued operations, net of tax			—		0.0	%			(9,094	)	(3.4	)%

Net income		$	30,460		10.1	%		$	28,002		10.5	%

Non-GAAP Disclosure

In addition to the financial information prepared in conformity with Generally Accepted Accounting Principles (“GAAP”), we provide certain historical non-GAAP financial information. Management believes that the presentation of such non-GAAP financial information is meaningful and useful in understanding the activities and business metrics of our operations. Management believes that these non-GAAP financial measures reflect an additional way of viewing aspects of our business that, when viewed with our GAAP results, provide a more complete understanding of factors and trends affecting our business.

Management believes that the presentation of these measures provides investors with greater transparency and facilitates comparison of operating results across a broad spectrum of companies with varying capital structures, compensation strategies, derivative instruments, and amortization methods, which provide a more complete understanding of our financial performance, competitive position, and prospects for the future. Readers should consider the information in addition to, but not instead of, our financial statements prepared in accordance with GAAP. This non-GAAP financial information may be determined or calculated differently by other companies, limiting the usefulness of these measures for comparative purposes.

Adjusted Income from Continuing Operations Per Share. Management believes that investors regularly rely on non-GAAP adjusted income and adjusted income per share, to assess operating performance, in order to highlight trends in our business that may not otherwise be apparent when relying on financial measures calculated in accordance with GAAP. Adjusted income from continuing operations excludes non-cash interest and issuance cost amortization relating to our convertible notes, one-time charges, and acquisition and integration related expenses, all net of tax. The following table provides a reconciliation between income from continuing operations and diluted income from continuing operations per share calculated in accordance with GAAP to adjusted income from continuing operations and adjusted income from continuing operations per share, respectively (in thousands, except per share data):


	Three Months Ended June 30,								Six Months Ended June 30,
	2013				2012				2013				2012

	$		Per Diluted Share		$		Per Diluted Share		$		Per Diluted Share		$		Per Diluted Share
GAAP net income from continuing operations, as reported	$	11,012	$	0.44	$	18,988	$	0.74	$	30,460	$	1.24	$	37,096	$	1.44
Adjustment:
Convertible notes non-cash interest and issuance cost amortization, net of tax		529	$	0.02		—		—		1,000	$	0.04		—		—
Acquisition related legal and advisory fees, net of tax		4,205	$	0.17		2,251	$	0.09		4,980	$	0.20		2,567	$	0.10
Acquisition related integration and severance costs, and consulting fees, net of tax		3,304	$	0.13		—		—		3,304	$	0.13		—		—
Acquisition related other expenses, net of tax		2,198	$	0.09		—		—		2,198	$	0.09		—		—

Adjusted income from continuing operations	$	21,248	$	0.85	$	21,239	$	0.83	$	41,942	$	1.70	$	39,663	$	1.54

Adjusted EBITDA. Management utilizes adjusted EBITDA (defined as net income before interest, taxes, depreciation and amortization, stock-based compensation expenses, portfolio amortization, one-time charges, and acquisition related expenses), which is materially similar to a financial measure contained in covenants used in our revolving credit and term loan facility, in the evaluation of our operations and believes that this measure is a useful indicator of our ability to generate cash collections in excess of operating expenses through the liquidation of our receivable portfolios (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
GAAP net income, as reported	$	11,012	$	16,596	$	30,460	$	28,002
Adjustments:
Loss from discontinued operations, net of tax		—		2,392		—		9,094
Interest expense		7,482		6,497		14,336		12,012
Provision for income taxes		7,267		12,846		19,838		24,506
Depreciation and amortization		2,158		1,420		4,004		2,660
Amount applied to principal on receivable portfolios		131,044		101,813		260,531		206,416
Stock-based compensation expense		2,179		2,539		5,180		4,805
Acquisition related legal and advisory fees		6,948		3,774		8,224		4,263
Acquisition related integration and severance costs, and consulting fees		5,455		—		5,455		—
Acquisition related other expenses		3,630		—		3,630		—

Adjusted EBITDA	$	177,175	$	147,877	$	351,658	$	291,758

Adjusted operating expenses. We have included information concerning adjusted operating expenses, excluding stock-based compensation expense, tax lien business segment operating expenses, one-time charges, and acquisition and integration related operating expenses, in order to facilitate a comparison of approximate cash costs to cash collections for the portfolio purchasing and recovery business in the periods presented (in thousands):


	Three Months Ended June 30,				Six Months Ended June 30,
	2013		2012		2013		2012
GAAP total operating expenses, as reported	$	126,238	$	102,809	$	232,110	$	194,203
Adjustments:
Stock-based compensation expense		(2,179)		(2,539)		(5,180)		(4,805)
Tax lien business segment operating expenses		(3,504)		(1,513)		(6,526)		(1,513)
Acquisition related legal and advisory fees		(6,948)		(3,774)		(8,224)		(4,263)
Acquisition related integration and severance costs, and consulting fees		(5,455)		—		(5,455)		—

Adjusted operating expenses	$	108,152	$	94,983	$	206,725	$	183,622

Comparison of Results of Operations

Revenues

Our revenues consist primarily of portfolio revenue and interest income net of related interest expense from receivables secured by property tax liens.

Portfolio revenue consists of accretion revenue and zero basis revenue. Accretion revenue represents revenue derived from pools (quarterly groupings of purchased receivable portfolios) with a cost basis that has not been fully amortized. Revenue from pools with a remaining unamortized cost basis is accrued based on each pool’s effective interest rate applied to each pool’s remaining unamortized cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances. The effective interest rate is the Internal Rate of Return (“IRR”) derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool. All collections realized after the net book value of a portfolio has been fully recovered, or Zero Basis Portfolios, are recorded as revenue, or Zero Basis Revenue. We account for our investment in

receivable portfolios utilizing the interest method in accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality. Interest income, net of related interest expense represents net interest income on receivables secured by property lien taxes.

The following tables summarize collections, revenue, end of period receivable balance and other related supplemental data, by year of purchase from our portfolio purchasing and recovery segment (in thousands, except percentages):


	Three Months Ended June 30, 2013																As of June 30, 2013

	Collections⁽¹⁾			Gross Revenue⁽²⁾			Revenue Recognition Rate⁽³⁾			Net Portfolio Allowance Reversal				Revenue % of Total Revenue			Unamortized Balances			Monthly IRR
ZBA⁽⁴⁾		$	7,836		$	4,743		60.5	%		$	3,095			3.2	%		$	—			100	.0
2005			114			6		5.3	%			—			0.0	%			—			5.7	%
2006			2,518			902		35.8	%			57			0.6	%			4,856			5.1	%
2007			3,270			1,400		42.8	%			237			0.9	%			7,333			5.5	%
2008			11,525			6,415		55.7	%			285			4.3	%			24,565			7.6	%
2009			21,698			13,684		63.1	%			—			9.2	%			30,658			12.7	%
2010			42,374			26,205		61.8	%			—			17.7	%			71,433			10.6	%
2011			60,511			34,535		57.1	%			—			23.3	%			138,462			7.4	%
2012			93,093			42,142		45.3	%			—			28.4	%			357,596			3.6	%
2013			35,449			18,318		51.7	%			—			12.4	%			461,795			4.2	%

Total		$	278,388		$	148,350		53.3	%		$	3,674			100.0	%		$	1,096,698			5.1	%


	Three Months Ended June 30, 2012																As of June 30, 2012

	Collections⁽¹⁾			Gross Revenue⁽²⁾			Revenue Recognition Rate⁽³⁾			Net Reversal (Portfolio Allowance)				Revenue % of Total Revenue			Unamortized Balances			Monthly IRR
ZBA⁽⁴⁾		$	7,107		$	6,126		86.2	%		$	981			4.5	%		$	—			—
2005			3,205			1,037		32.4	%			1,053			0.8	%			5,000			5.7	%
2006			3,406			2,141		62.9	%			(876	)		1.6	%			12,869			5.1	%
2007			4,575			2,361		51.6	%			333			1.7	%			14,079			5.1	%
2008			15,567			8,432		54.2	%			(329	)		6.1	%			42,512			6.0	%
2009			29,819			17,348		58.2	%			—			12.6	%			64,115			8.0	%
2010			58,769			34,995		59.5	%			—			25.4	%			140,057			7.5	%
2011			80,391			42,524		52.9	%			—			30.9	%			252,702			5.1	%
2012			37,705			22,605		60.0	%			—			16.4	%			338,525			3.0	%

Total		$	240,544		$	137,569		57.2	%		$	1,162			100.0	%		$	869,859			5.4	%


	Six Months Ended June 30, 2013																As of June 30, 2013

	Collections⁽¹⁾			Gross Revenue⁽²⁾			Revenue Recognition Rate⁽³⁾			Net Reversal (Portfolio Allowance)				Revenue % of Total Revenue			Unamortized Balances			Monthly IRR
ZBA⁽⁴⁾		$	13,448		$	9,405		69.9	%		$	4044			3.3	%		$	—			—
2005			2,364			239		10.1	%			10			0.1	%			—			5.7	%
2006			5,021			2,042		40.7	%			(402	)		0.7	%			4,856			5.1	%
2007			6,648			2,954		44.4	%			580			1.0	%			7,333			5.5	%
2008			23,639			13,446		56.9	%			448			4.7	%			24,565		<

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