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UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549

_________________

FORM 10-Q

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

For the quarterly period ended March 31, 2005

OR

[   ]    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)

(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 is an accelerated filer (as defined in Rule 12b-2 of the Act)

Yes [X] No [    ]                      

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

ENCORE CAPITAL GROUP, INC.INDEX
TO FORM 10-Q

PART I. FINANCIAL INFORMATION
Item 1. Consolidated Financial Statements

ENCORE CAPITAL GROUP, INC.
Condensed Consolidated Statements of Financial Condition
(In Thousands, Except Par Value Amounts)

(A)     Derived from the audited consolidated financial statements as of December 31, 2004

See accompanying notes to condensed consolidated financial statements

2

ENCORE CAPITAL GROUP, INC.
Condensed Consolidated Statements of Operations
(In Thousands, Except Per Share Amounts)
(Unaudited)

See accompanying notes to condensed consolidated financial statements

3

ENCORE CAPITAL GROUP, INC.
Condensed Consolidated Statement of Stockholders’ Equity
(Unaudited, In Thousands)

See accompanying notes to condensed consolidated financial statements

4

ENCORE CAPITAL GROUP, INC.
Condensed Consolidated Statements of Cash Flows
(Unaudited, In Thousands)

See accompanying notes to condensed consolidated financial statements

5

ENCORE CAPITAL GROUP, INC.
Condensed Consolidated Statements of Cash Flows (cont.) Reconciliation
of Net Income to Net Cash Provided by Operating Activities
(Unaudited, In Thousands)

See accompanying notes to condensed consolidated financial statements

6

ENCORE CAPITAL GROUP, INC.
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

Note 1: Ownership and Description of Business

Encore Capital Group, Inc. together with its subsidiaries (“Encore”) is a systems-driven purchaser and manager of charged-off consumer receivable portfolios. Encore acquires these portfolios at deep discounts from their face values using its proprietary valuation process that is based on the consumer attributes of the underlying accounts. Based upon Encore’s ongoing analysis of these accounts, it employs a dynamic mix of collection strategies to maximize its return on investment. The receivable portfolios Encore purchases consist primarily of unsecured, charged-off domestic consumer credit receivables purchased from national financial institutions, major retail credit corporations, and resellers of such portfolios. Acquisitions of receivable portfolios are financed by operations and by borrowings from third parties (see Note 6).

Encore is a Delaware holding company whose principal assets are its investments in various wholly-owned subsidiaries (collectively the “Company”).

Note 2: Summary of Significant Accounting Policies

Significant Accounting Policies
Please refer to the Company’s annual report on Form 10-K as of and for the year ended December 31, 2004 for a summary of the Company’s significant accounting policies.

Basis of Presentation
The accompanying unaudited interim condensed consolidated financial statements of the Company have been prepared in accordance with Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America. In the Company’s opinion, however, the accompanying unaudited interim condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary to present fairly the Company’s consolidated financial position as of March 31, 2005, and its consolidated results of operations and cash flows for the three months ended March 31, 2005 and 2004. The unaudited interim condensed consolidated results of operations of the Company for the three months ended March 31, 2005 may not be indicative of future results. These unaudited interim condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s annual report on Form 10-K as of and for the year ended December 31, 2004 filed with the Securities and Exchange Commission on March 3, 2005.

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Investments in marketable securities represents investments in auction rate debt securities, which are afforded the highest ratings by nationally recognized rating firms. The carrying amounts reported on the consolidated statements of financial condition for investments in marketable securities approximate their fair value.

Certain amounts included in the accompanying prior periods’ consolidated financial statements have been reclassified to conform to the current period presentation.

New Accounting Pronouncements
In December 2003, the AICPA issued Statement of Position 03-03 (“SOP 03-03”), “Accounting for Certain Debt Securities Acquired in a Transfer.” SOP 03-03 is effective for fiscal years beginning after December 15, 2004, and accordingly, the Company has adopted the provisions of this SOP in the quarter ended March 31, 2005. The implementation of SOP 03-03 is discussed in Note 4.

In December 2004, the Financial Accounting Standards Board (“FASB”) issued SFAS No. 123 (revised 2004) (SFAS No. 123R) “Share – Based Payment,” which is a revision of SFAS No. 123. SFAS No. 123R requires fair value accounting for transactions in which an entity exchanges its equity instruments for goods and services. It also addresses transactions in which an entity incurs liabilities in exchange for goods and services that are based on the fair value of the entity’s equity instruments or that may be settled by the issuance of those equity instruments. This statement focuses primarily on accounting for transactions in which an entity obtains employee services in share-based payment transactions. In April 2005, the Securities and Exchange Commission (“SEC”) delayed the effective date of SFAS No. 123R. The new required implementation date for SFAS No. 123R for the Company is January 1, 2006, and accordingly, the Company expects to adopt the provisions of this pronouncement during the first quarter of 2006. For periods prior to implementation, we have retained our accounting for stock based employee compensation under APB No. 25 and have only adopted the pro forma disclosure requirements of SFAS No. 123. We expect that the adoption of SFAS No. 123R will reduce our reported net income and earnings per share. The effect of adopting this statement on our historical consolidated statements of operations is reflected on a proforma basis in the “Stock-Based Compensation” section contained in Note 3.

Note 3: Stock-Based Compensation

The 1999 Equity Participation Plan (“1999 Plan”), as amended, reserved up to 3,300,000 shares for grant to employees, directors and consultants. Pursuant to the 1999 Plan, the Company may grant options at a price in excess of 85.0% of the fair market value on the date of the grant and for a term not to exceed ten years. Options generally vest ratably over a three-year period unless otherwise determined by the Compensation Committee of the Board of Directors.

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On March 30, 2005, the Board of Directors of the Company adopted a new 2005 Stock Incentive Plan (the “2005 Plan”) for Board members, employees, officers, and executives of, and consultants and advisors to, the Company. The 2005 Plan was effective as of the date approved by the Board, and was approved by the Company’s stockholders at the annual meeting on May 3, 2005. The 2005 Plan provides for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, performance shares, and performance-based awards to eligible individuals. An aggregate of 1,500,000 shares of the Company’s common stock are available for awards under the 2005 Plan, plus ungranted shares of Stock that were available for future awards under the 1999 Plan as of the date of adoption of the 2005 Plan. In addition, shares subject to options granted under either the 1999 Plan or the 2005 Plan that terminate or expire without being exercised are again made available for grant under the 2005 Plan.

The following table summarizes outstanding and exercisable options at March 31, 2005:

A summary of the Company’s stock option activity and related information is as follows:

The Company has elected to follow Accounting Principles Board Opinion No. 25 (“APB No. 25”), Accounting for Stock Issued to Employees, and related interpretations in accounting for its employee stock options rather than the alternative fair value accounting provided for under SFAS No. 123, Accounting and Disclosure for Stock-Based Compensation. The Company has also adopted the pro forma disclosure requirements of SFAS No. 148, Accounting for Stock-Based Compensation—Transition and Disclosure an amendment of FASB Statement No. 123. In accordance with APB No. 25, compensation cost relating to stock options granted by the Company is measured as the excess, if any, of the market price of the Company’s stock at the date of grant over the exercise price of the stock options. This expense is recognized over the vesting period of the stock options.

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As required by SFAS No. 148 and SFAS No. 123, the Company provides pro forma net income and pro forma net income per common share disclosures for stock-based awards made during the periods presented as if the fair-value-based method defined in SFAS No. 123 had been applied.

The fair value for options granted during each of the periods presented was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:

The Black-Scholes option-pricing model was developed for use in estimating the fair value of traded options, which have no vesting restrictions and are fully transferable. Option valuation models require the input of highly subjective assumptions including the expected stock price volatility. Because the Company’s employee stock options have characteristics significantly different from those of traded options, and because changes in the subjective input assumptions can materially affect the fair value estimate, in management’s opinion, the existing models do not provide a reliable single measure of the fair value of its employee stock options.

For purposes of pro forma disclosures, the estimated fair value of the options is amortized to expense over the options’ vesting period. The Company’s pro forma information is as follows (in thousands, except per share amounts):

10

In connection with the Company’s management succession plan, which is described under the heading “Executive Officers and Compensation,” in the Company’s proxy statement filed on April 5, 2005, the vesting provisions of option grants on September 11, 2002 to three executive officers have been revised by the Compensation Committee of the Company’s Board of Directors as follows: Under the revised vesting dates, 50% of the options to purchase 208,333 shares at an exercise price of $0.51 per share granted to each of two of the executive officers vested on May 3, 2005, and the remaining 50% will vest no later than May 3, 2006. One of these officers retired on May 3, 2005 as an employee of the Company, but was elected as a director of the Company at the Company’s annual meeting on the same date. One-third of the option to purchase 208,333 shares granted at an exercise price of $0.51 per share to the other executive officer vested on May 3, 2005; an additional one-third will vest no later than on May 3, 2006; and the final one-third will vest no later than September 11, 2007. Under the revised vesting provisions, vesting may be accelerated upon the occurrence of an equity event as specified in the respective option agreements. As of March 31, 2005, none of these options were exercisable. The Compensation Committee of the Board of Directors has reviewed the succession plan and the new vesting provisions of the option grants and has determined that the changes associated with these options are not considered a modification that renews or increases the life of the option grant and thus does not result in a new measurement of compensation cost.

Until January 1, 2006, the Company will continue to account for all of its stock options in accordance with APB No.25 with appropriate disclosure of pro forma net income and earnings per share determined as if the fair value based method had been applied in measuring compensation cost. On January 1, 2006, the Company will adopt the provisions of SFAS No.123R, which will result in the recording of compensation expense in its consolidated statement of operations for the unvested option grants based on the fair value of the respective options at the date of grant.

Note 4: Investment in Receivable Portfolios, Net

Prior to January 1, 2005, the Company accounted for its investment in receivable portfolios utilizing the interest method under the provisions of the AICPA’s Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans.” Commencing January 1, 2005 the Company began accounting for its investment in receivable portfolios utilizing the interest method in accordance with the provisions of the AICPA’s Statement of Position 03-03 (“SOP 03-03”), “Accounting for Certain Debt Securities Acquired in a Transfer.” SOP 03-03 addresses accounting for differences between initial estimated cash flows expected to be collected from purchased receivables, or “pools,” and subsequent changes to those estimated cash flows. SOP 03-03 limits the revenue that may be accreted (also known as accretable yield) to the excess of the Company’s estimate of undiscounted cash flows expected at acquisition to be collected over the Company’s initial investment in the pool. The effective interest rate applied to the cost basis of the pool would remain level, or “static” throughout its life unless there was an increase in subsequent expected cash flows. Subsequent increases in cash flows expected to be collected generally would be recognized prospectively through an upward adjustment of the pool’s effective interest rate over its remaining life. Subsequent decreases in expected cash flows would not change the effective interest rate, but would be recognized as an impairment of the cost basis of the pool, and would appear in the consolidated statement of operations with a corresponding valuation allowance offsetting the investment in receivables portfolios in the consolidated statement of financial condition.

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In accordance with SOP 03-03, static pools are established on a quarterly basis with accounts having common risk characteristics. Discrete receivable portfolio purchases during a quarter are aggregated into pools based on these common risk characteristics. Once a static pool is established, the receivables 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. Upon adoption of SOP 03-03, all portfolios with common risk characteristics purchased prior to the adoption of SOP 03-03 were aggregated by quarter of purchase.

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 principal of receivable portfolios and for provision for loss or impairment. Revenue from receivable portfolios is accrued based on each pool’s effective interest rate 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 impairments. The effective interest rate is the internal rate of return as derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool.

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. 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 current period (in thousands):

During the three months ended March 31, 2005, the Company purchased receivable portfolios with a face value of $530.0 million for $19.5 million, or a purchase cost of 3.68% of face value. The estimated remaining collections associated with these receivable portfolios as of March 31, 2005 was $41.5 million.

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 March 31, 2005 and 2004, approximately $10.4 million and $12.3 million, respectively, was recognized as revenue pertaining to collections on portfolios for which the related net book value has been fully recovered.

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If the amount and timing of future cash collections on a pool of receivable portfolios are not reasonably estimable, the Company accounts for such portfolios on the cost recovery method (“Cost Recovery Portfolios”). No revenue is accreted on Cost Recovery Portfolios. All collections are applied 100% to recover the remaining cost basis of the portfolio and thereafter are recognized as revenue. At March 31, 2005, no portfolios were accounted for using the cost recovery method. No provision for impairment losses was recorded during the three months ended March 2005 and 2004.

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

¹ Gross collections and revenue related to the retained interest are not included in these tables. Zero basis collections and revenue related to the retained interest (which was fully amortized in the second quarter of 2004) were $0.5 million during the three months ended March 31, 2005. During the three months ended March 31, 2004, gross collections and revenue were $1.1 million and less than $0.1 million, respectively.

² For accrual basis portfolios, the weighted average annualized effective interest rate is the accrual rate utilized in recognizing revenue on our accrual basis portfolios. This rate represents the monthly internal rate of return, which has been annualized utilizing the simple interest method. The monthly internal rate of return is determined based on the timing and amounts of actual cash received to date and the anticipated future cash flow projections for each pool.

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The Company historically has purchased portfolios of charged-off unsecured consumer credit cards and relatively few portfolios of charged-off unsecured consumer loans. During 2001, the Company resumed purchasing charged-off unsecured consumer loans, in 2002 it began purchasing auto loan deficiencies, and in 2004 it began purchasing charged-off consumer telecom receivables. The Company purchased $8.9 million of non-credit card loans during the three months ended March 31, 2004, but did not purchase any non-credit card loans during the three months ended March 31, 2005. Gross collections related to all portfolios of charged-off unsecured consumer loans, auto loan deficiencies and telecom receivables amounted to $6.7 million and $3.1 million for the three months ended March 31, 2005 and 2004, respectively.

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

During the first quarter of 2004, the Company discontinued its business of rewritten consumer notes and sold its portfolio of rewritten notes. The notes, which were related to accounts throughout the Company’s portfolios, were sold for $4.0 million. The cash proceeds of $2.9 million from accruing portfolios and $1.1 million from zero basis portfolios were treated as additional portfolio collections for revenue recognition purposes. This is consistent with the Company’s historical accounting for collections from the rewritten notes.

Note 5: Property and Equipment

Property and equipment consist of the following as of the dates presented (in thousands):

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Note 6: Notes Payable and Other Borrowings

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

Secured Financing Facility
On December 31, 2004, the Company’s $75.0 million secured financing facility (the “Secured Financing Facility”) expired. The Secured Financing Facility was entered into on December 20, 2000 by MRC Receivables Corporation, a wholly owned bankruptcy-remote, special-purpose entity, to finance the purchase of receivable portfolios. The facility generally provided for a 90.0% advance rate with respect to each qualified receivable portfolio purchased. Interest accrues at the prime rate plus 3.0% per annum and is payable weekly. The interest rate reduces by 1.0% on outstanding amounts in excess of $25.0 million. Notes issued under the facility are collateralized by the charged-off receivables that are purchased with the proceeds from this financing arrangement. Each note has a maturity date not to exceed 27 months after the borrowing date. Once the notes are repaid and the Company has been repaid its investment, the Company and the lender share the residual cash flows from the receivable portfolios, net of servicing fees. The sharing in residual cash flows continues for the entire economic life of the receivable portfolios financed using this facility, and therefore will extend substantially beyond the expiration date of the Secured Financing Facility. The Company was required to give the lender the opportunity to fund all of its purchases of charged-off credit card receivables with advances on the Secured Financing Facility through December 31, 2004. Most purchases during the fourth quarter of 2004 were financed under an amendment to the Secured Financing Facility that provides for a cap, as defined, on the total amount of interest owed to the lender for such borrowings.

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The following table summarizes interest expense associated with the Secured Financing Facility for the periods presented (in thousands, except percentages):

¹ The weighted average effective interest rate is interest expense applied to the weighted average outstanding balance on all debt during the period and annualized based on a simple interest method. The calculation of this rate also includes contingent interest expense associated with loans whose principal has been repaid.

The Secured Financing Facility had a balance of $46.0 million as of March 31, 2005 and was collateralized by certain charged-off receivable portfolios with an aggregate carrying amount of $98.1 million at that time. The assets pledged under this financing facility, together with their associated cash flows, would not be available to satisfy claims of general creditors of the Company.

Revolving Credit Facility
On June 30, 2004, the Company entered into a $75.0 million, three-year revolving credit facility (the “Revolving Credit Facility”) to be utilized for the purposes of purchasing portfolio receivables and for working capital needs. Interest rates on borrowings under this facility are, at the Company’s option, at the lender’s prime rate or at Eurodollar plus a current margin of 2.50%. The applicable margin is adjusted quarterly based on a pricing grid that takes into account certain financial covenants related to the Company’s consolidated financial condition and results of operations. The Revolving Credit Facility provides for an 85.0% initial advance rate with respect to each qualified receivable portfolio financed, or available drawings equal to 85.0% of any portfolio purchased that was not financed. The balance outstanding under the Revolving Credit Facility must not exceed an amount determined under a “borrowing base” formula. The eligible borrowing base of each portfolio financed under this facility is calculated by applying a three percentage point reduction to the 85.0% initial advance rate each month, commencing after the first three complete months of ownership of the portfolio. The aggregate borrowing base is the sum of all of the borrowing bases of all portfolios financed under this facility. The Revolving Credit Facility is secured by a security interest in all assets of the Company, except for those assets in which the Secured Financing Facility lender has a first priority security interest.

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This financing arrangement does not require the Company to share residual collections with the lender. During the third and fourth quarters of 2004, the Company was limited to drawing under the Revolving Credit Facility for purchases of non-credit card portfolios, and upon expiration of the Company’s Secured Financing Facility on December 31, 2004, the Company was permitted to fund all types of portfolio purchases, including credit card receivables with the Revolving Credit Facility. The Revolving Credit Facility provides for a $5.0 million letter of credit sub-facility and requires, under certain circumstances, permanent reductions in the outstanding balance and overall availability of the facility. The Revolving Credit Facility may be repaid without penalty. The Revolving Credit Facility contains substantial restrictive financial covenants, including but not limited to, financial ratios and limitations on acquisitions, dispositions, merger, dissolution, payment of dividends, indebtedness and capital expenditures. There was no balance on the Revolving Credit Facility as of March 31, 2005.

Secured Financing
On July 25, 2003, through Midland Funding NCC-1 Corporation, a wholly owned subsidiary, the Company entered into a $1.8 million secured financing arrangement (the “Secured Financing”). This financing was repaid in full on June 30, 2004. The Secured Financing provided for a 75.0% advance rate with respect to four purchased receivable portfolios of charged-off unsecured consumer loans and auto loan deficiencies. Interest accrued at 15.0% and was payable weekly. This financing arrangement did not require the Company to share residual collections with the lender.

Secured Note
On October 1, 2003, the Company entered into a loan for the purchase of certain equipment (“Secured Note”) in the amount of $0.3 million with a term of 36 months. This note is secured by the equipment, carries an interest rate of 7.24%, and had a balance of $0.1 million as of March 31, 2005.

Note 7: Income Taxes

The Company recorded an income tax provision of $5.1 million for the three months ended March 31, 2005 and $3.9 million for the three months ended March 31, 2004. The provision for income tax expense reflects tax expense at an effective rate of 40.4% for the three months ended March 31, 2005 and an effective rate of 39.5% for the three months ended March 31, 2004. For the three months ended March 31, 2005, this consists primarily of a provision for Federal income taxes of 31.9% (which is net of a benefit for state taxes of 3.1%), a provision for state taxes of 8.8%, and the effect of permanent book versus tax differences of 0.3%. For the three months ended March 31, 2004, this consists primarily of a provision for Federal income taxes of 31.3% (which is net of a benefit for state taxes of 2.7%), a provision for state taxes of 8.0%, and the effect of permanent book versus tax differences of 0.2%.

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Note 8: Commitments and Contingencies

Litigation
On October 18, 2004, Timothy W. Moser, a former officer of the Company, filed an action in the United States District Court for the Southern District of California against the Company, and certain individuals, including several of the Company’s officers and directors. On February 14, 2005 the Company was served with an amended complaint in this action alleging defamation, intentional interference with contractual relations, breach of contract, breach of the covenant of good faith and fair dealing, intentional and negligent infliction of emotional distress and civil conspiracy arising out of certain statements in the Company’s Registration Statement on Form S-1 originally filed in September 2003 and alleged to be included in the Company’s Registration Statement on Form S-3 originally filed in May 2004. The amended complaint seeks injunctive relief, economic and punitive damages in an unspecified amount plus an award of profits allegedly earned by the defendants and alleged co-conspirators as a result of the alleged conduct, in addition to attorney’s fees and costs. The Company believes the claims are without merit and will vigorously defend the action. Although the outcome of this matter cannot be predicted with certainty, management does not currently believe that this matter will have a material adverse effect on the Company’s consolidated financial position or results of operations.

The Fair Debt Collection Practices Act (“FDCPA”) and comparable state statutes may result in class action lawsuits, which can be material to the Company due to the remedies available under these statutes, including punitive damages. The Company has recently experienced an increase in the volume of such claims, which we believe reflects the trend in our industry. Management is aware of 13 cases styled as class actions that have been filed against the Company. To date, no class has been certified in any of these cases. The Company believes that these cases are without merit and intends to vigorously defend them. However, several of these cases present novel issues on which there is no legal precedent. As a result, the Company is unable to predict the range of possible outcomes.

There are a number of other lawsuits or claims pending or threatened against the Company. In general, these lawsuits or claims have arisen in the ordinary course of business and involve claims for actual damages arising from alleged misconduct or improper reporting of credit information by the Company or its employees. Although litigation is inherently uncertain, based on past experience, the information currently available, and the possible availability of insurance and/or indemnification from originating institutions in some cases, management of the Company does not believe that the currently pending and threatened litigation or claims will have a material adverse effect on the Company’s consolidated financial position or results of operations. However, future events or circumstances, currently unknown to management, will determine whether the resolution of pending or threatened litigation or claims will ultimately have a material effect on the Company’s consolidated financial position or results of operations in any future reporting periods.

Leases
The Company leases office facilities and equipment in Phoenix, Arizona and in San Diego, California. The leases are structured as operating leases, and the Company incurred related rent expense in the amounts of $0.5 million and $0.3 million during the three months ended March 31, 2005 and 2004, respectively.

The Company leases certain property and equipment through capital leases. These long-term leases are non-cancelable and expire on varying dates through 2008. At March 31, 2005 and December 31, 2004, the cost of assets under capital leases was $0.3 million. The related accumulated amortization as of March 31, 2005 and as of December 31, 2004 was $0.2 million. Amortization of assets under capital leases is included in depreciation and amortization expense.

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Employee Benefit Plans
The Company maintains a 401(k) Salary Deferral Plan (the “Plan”) whereby eligible employees voluntarily may contribute up to a maximum percentage of compensation, as specified in the Internal Revenue Code. The Company may match a percentage of employee contributions at its discretion. Employer matching contributions and administrative costs relating to the Plan totaled $0.2 million and $0.3 million for the three months ended March 31, 2005 and 2004, respectively.

Effective March 1, 2002, the Company adopted a non-qualified deferred compensation plan for its senior management. This plan permits deferral of a portion of compensation until a specified period of time. As of March 31, 2005, the plan assets were $2.9 million and plan liabilities were $2.8 million. As of December 31, 2004, the plan assets and plan liabilities were each $2.4 million. These amounts are included in the Company’s consolidated statements of financial condition in accrued liabilities and other assets. The use of plan assets is legally restricted to distributions to participants or to creditors in the event of bankruptcy.

Employment and Severance Agreements
In March 2002, the Company entered into employment agreements with two of its executive officers. These agreements generally provide for one-year terms with automatic renewals, base compensation aggregating approximately $0.7 million per year, plus incentive compensation, as defined in the respective agreements, and non-competition provisions. The agreements provide for severance payments over periods between one year and one and a half years upon termination without cause, as defined in the respective agreements. These executive officers are currently in negotiations with the Compensation Committee of the Board of Directors regarding certain changes to their respective agreements consistent with the Company’s management succession plan adopted by the Board of Directors. In September 2004, the Company entered into an agreement with another executive officer that provides for severance payments of up to twelve months’ base salary in the event of termination without Cause, due to death or disability or following a Change of Control or upon resignation for Good Reason, as those terms are defined in the agreement.

Self Insured Health Benefits
Effective June 1, 2003, the Company established a self-insured health benefits plan for its employees. This plan is administered by a third party, and has stop loss provisions insuring losses beyond $40,000 per employee per year, and $1.6 million per year in the aggregate, subject to adjustment as defined. The Company recorded a reserve for unpaid claims in the amount of $0.4 million in accrued liabilities in the Company’s consolidated statements of financial condition as of March 31, 2005 and December 31, 2004. These amounts represent the Company’s estimate of incurred but not reported claims from the inception of the plan at June 1, 2003 to the end of each respective period.

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Self Insured Workers Compensation Plan
Effective November 1, 2003, the Company established a self-insured workers compensation plan for its employees. This plan is administered by a third party, and has stop loss provisions insuring losses beyond $350,000 per employee per occurrence, and $1.3 million per year in the aggregate, subject to adjustment as defined. As of March 31, 2005 and December 31, 2004, the Company recorded a reserve for unpaid claims in the amount of $0.6 million in accrued liabilities in the Company’s consolidated statements of financial condition. This amount represents the Company’s estimate of incurred but not reported claims from the inception of the plan at November 1, 2003 to the end of each respective period.

Purchase Concentrations
The following table summarizes the concentration of our purchases by seller by year sorted by total aggregate costs for the three month periods presented, adjusted for put-backs, account recalls and replacements (in thousands, except percentages):

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

This “Management’s Discussion and Analysis of Financial Condition and Results of Operations” should be read in conjunction with “Management’s Discussion and Analysis of Financial Condition and Results of Operations” in the Annual Report on Form 10-K of Encore Capital Group, Inc. as of and for the year ended December 31, 2004, as filed with the Securities and Exchange Commission. The Form 10-K contains a general description of our industry and a discussion of recent trends affecting that industry. Certain statements under this caption may constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”). Forward-looking statements involve risks, uncertainties and other factors that may cause our actual results, performance, or achievements to be materially different from any future results, performance or achievements express or implied by such forward-looking statements. The Company claims the protection of the safe harbor of the reform act for forward-looking statements. (See Part II — Other Information for more information regarding forward looking statements.)

Introduction

We are a systems-driven purchaser and manager of charged-off consumer receivables portfolios. We acquire these portfolios at deep discounts from their face values using our proprietary valuation process that is based on the consumer attributes of the underlying accounts. Based upon the ongoing analysis of these accounts, we employ a dynamic mix of collection strategies to maximize our return on investment.

Overview
Our business and financial results improved during the three months ended March 31, 2005 as compared to the three months ended March 31, 2004. Highlights for the three months ended March 31, 2005 as compared to the three months ended March 31, 2004 are as follows:

• Gross collections increased $1.9 million or 2.9% to $65.9 million¹
• Revenues increased $8.1 million or 19.1% to $50.5 million
• Net income increased $1.4 million or 23.9% to $7.5 million

During the quarter ended March 31, 2005 we continued to improve our financial position. Our stockholders’ equity was $104.5 million as of March 31, 2005, an increase of $8.5 million from the $96.0 million in stockholders’ equity as of December 31, 2004. Moreover, our operating performance during the quarter resulted in unrestricted cash and marketable securities of $31.1 million as of March 31, 2005 after repaying $22.5 million in principal on our debt facilities and purchasing $19.5 million in receivables portfolios (only $2.1 million of such purchases were financed).

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Purchasing Market Outlook
In general, the increased competition in the purchasing market results in portfolio purchases at higher prices than we have paid historically, which reduces the profitability of our business. Although we believe that our consumer level analytics and multi-disciplined approach to purchasing allows us to determine the most attractive portfolios to purchase, the current portfolio purchasing market remains challenging and we may not be able to meet our purchase goals on a consistent basis quarter-to-quarter.

Results of Operations

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

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Three Months Ended March 31, 2005 Compared to Three Months Ended March 31, 2004

Revenue

Total revenue was $50.5 million for the three months ended March 31, 2005, an increase of $8.1 million or 19.1% compared to total revenue of $42.4 million for the three months ended March 31, 2004. The increase in revenue was primarily the result of increased receivable portfolio purchases and higher internal rates of return applied to some portfolios as a result of increases in future expected cash flows. During the twelve months prior to March 31, 2005, we invested $105.6 million for portfolios with face values aggregating $3.2 billion for an average purchase price of 3.3% of face value. This is a $17.4 million, or 19.7% increase in the amount invested compared with the $88.3 million invested during the twelve months prior to March 31, 2004 to acquire portfolios with a face value aggregating $3.5 billion for an average purchase price of 2.5% of face value. Gross collections on our investment in receivables portfolios increased $1.9 million or 2.9% to $65.9 million during the three months ended March 31, 2005 from $64.0 million during the three months ended March 31, 2004. Revenue as a percentage of collections for the three months ended March 31, 2005 was 76.6% compared to 66.2% for the three months ended March 31, 2004. For additional information on revenue see the Supplemental Performance Data.

Operating Expenses

Total operating expenses were $30.3 million for the three months ended March 31, 2005, an increase of $7.0 million or 29.9% compared to total operating expenses of $23.3 million for the three months ended March 31, 2004.

Salaries and employee benefits
Total salaries and benefits increased by $1.0 million or 8.4% to $12.6 million during the three months ended March 31, 2005 from $11.6 million during the three months ended March 31, 2004. The increase was the result of a $0.2 million or 2.3% increase in salaries and wages; a $0.4 million or 13.2% increase in account manager incentive compensation resulting from our strong operating performance; a $0.2 million or 34.0% increase in healthcare costs as a result of increased health benefits provided to our employees, rising healthcare costs and an increase in the number of employees participating in our health plan; and a $0.3 million or 26.5% increase in payroll taxes and severance payments. Total salaries and benefits as a percentage of gross collections during the three months ended March 31, 2005 were 19.1% compared to 18.2% for the three months ended March 31, 2004. During the three months ended March 31, 2005 we had 701 average employees whose monthly gross collections were $31,300 per month. During the three months ended March 31, 2004 we had 729 average employees whose monthly gross collections were $29,300 per month.

Other operating expenses
Other operating expenses increased $1.2 million, or 35.7%, to $4.6 million during the three months ended March 31, 2005 from $3.4 million during the three months ended March 31, 2004. The increase during the three months ended March 31, 2005 primarily reflects increases in the volume of direct mail campaigns and costs associated with recruiting employees and temporary services. The cost of direct mail campaigns increased 52.3% or $0.8 million to $2.2 million during the three months ended March 31, 2005 compared to $1.5 million during the three months ended March 31, 2004. The costs of employee recruiting and temporary services increased $0.2 million or 202.0%.

Collection agency commissions
These expenses are commissions we pay to third party collection agencies. During the three months ended March 31, 2005 we paid $2.0 million in commissions to third party collection agencies or 36.6% of the related gross collections of $5.5 million compared to $0.7 million in commissions or 32.6% of the related gross collections of $2.1 million during the three months ended March 31, 2004. Commissions as a percentage of collections in this channel may change from period to period depending on, among other things, the time from charge-off of the accounts placed with the agency (freshly charged-off accounts have a lower commission rate).

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Cost of legal collections
The cost of legal collections increased $2.9 million or 51.9% to $8.4 million during the three months ended March 31, 2005 as compared to $5.5 million during the three months ended March 31, 2004. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in the cost of legal collections was primarily the result of a $7.0 million or 49.7% increase in gross collections through our legal channel, for total gross collections of $21.2 million during the three months ended March 31, 2005 compared to $14.2 million collected during the three months ended March 31, 2004. Cost of legal collections increased as a percent of gross collections through this channel to 39.4% during the three months ended March 31, 2005 from 38.9% during the three months ended March 31, 2004.

Other general and administrative expenses
Other general and administrative expenses increased $0.5 million, or 30.5% to $2.2 million during the three months ended March 31, 2005 from $1.7 million during the three months ended March 31, 2004. The increase is a result of a $0.2 million or 72.7% increase in rent expense due to the relocation of our San Diego operations to a larger facility, and a $0.2 million or 78.3% increase in legal and accounting fees due to the increased costs of financial compliance and increased litigation defense costs.

Depreciation and amortization
Depreciation expense remained relatively consistent at $0.5 million and $0.4 million during the three months ended March 31, 2005 and 2004, respectively.

Interest expense

Interest expense decreased $1.2 million or 12.9% to $8.1 million during the three months ended March 31, 2005 from $9.3 million during the three months ended March 31, 2004. The following table summarizes our interest expense (in thousands):

¹ The weighted average effective interest rate is interest expense applied to the weighted average outstanding balance on all debt during the period and annualized based on a simple interest method. The calculation of this rate also includes contingent interest expense associated with loans whose principal has been repaid.

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The decrease in interest expense is due to a decrease in contingent interest recorded under the terms of our Secured Financing Facility. The Secured Financing Facility expired on December 31, 2004, and therefore, no new borrowings were made under this facility. Under the terms of our Secured Financing Facility, once we repay the lender for the notes associated with each purchased portfolio and collect sufficient amounts to recoup our initial cash investment in each purchased portfolio, we then share the residual collections (“Contingent Interest”) from the receivable portfolios, net of our servicing fees, with the lender. The sharing in residual cash flows and the recording of Contingent Interest expense will continue for the entire economic life of the receivable portfolios financed using the Secured Financing Facility, which will extend substantially beyond the expiration date of this facility. We make estimates with respect to the timing and amount of collections of future cash flows from these receivable portfolios. Based on these estimates, we record a portion of the estimated future profit sharing obligation as Contingent Interest Expense (See Note 6 to the unaudited interim condensed consolidated financial statements for more discussion on our Secured Financing Facility and Contingent Interest).

Since the inception of the Secured Financing Facility on December 20, 2000, we have borrowed $230.1 million under the facility, representing $257.5 million in receivable portfolio purchases. As of March 31, 2005, $46.0 million in principal remained outstanding with $19.6 million accrued for Contingent Interest.

Financing of future portfolio purchases will utilize our Revolving Credit Facility, which does not require the sharing of residual collections with the lender (See Note 6 to the unaudited interim condensed consolidated financial statements for more discussion of our Revolving Credit Facility).

Other income and expense

During the three months ended March 31, 2005 total other income was $0.4 million, compared to $0.2 million during the three months ended March 31, 2004 primarily as a result of higher interest income.

Provision for income taxes

During the three months ended March 31, 2005, we recorded an income tax provision of $5.1 million, reflecting an effective rate of 40.4% of pretax income. For the three months ended March 31, 2004, we recorded an income tax provision of $3.9 million, reflecting an effective rate of 39.5% of pretax income. The increase in our effective tax rate was the result of increases in federal and state taxes applicable to us as a result of higher taxable income, the changing mix of state taxability and related apportionment factors, and the effect of permanent book versus tax differences (See Note 7 to the unaudited interim condensed consolidated financial statements for more discussion of income taxes).

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Supplemental Performance Data

Cumulative Collections to Purchase Price Multiple
The following table summarizes our purchases and related resulting gross collections per year of purchase (in thousands, except multiples):