SquareTwo Financial Corp - FORM 10-Q

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, DC 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 September 30, 2014

o 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: 333-170734

_____________________________________________

SquareTwo Financial Corporation

(Exact name of Registrant as Specified in Its Charter)

_____________________________________________



Delaware		84-1261849
(State or Other Jurisdiction of Incorporation or Organization)		(I.R.S. Employer Identification No.)
4340 South Monaco Street, Second Floor
Denver, Colorado		80237
(Address of Principal Executive Offices)		(Zip Code)

303-296-3345

(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 past 90 days. Yes x No o

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 (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes x No o

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 o		Accelerated filer o
Non-accelerated filer x (Do not check if a smaller reporting company)		Smaller reporting company o

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

As of November 13, 2014, 1,000 shares of the registrant’s common stock, par value $0.001 per share, were outstanding.

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TABLE OF CONTENTS



		Page
Part I	FINANCIAL INFORMATION
Item 1.	Condensed Consolidated Financial Statements (Unaudited).	1
Item 2.	Management's Discussion and Analysis of Financial Condition and Results of Operations.	32
Item 3.	Quantitative and Qualitative Disclosures About Market Risk.	56
Item 4.	Controls and Procedures.	56

Part II	OTHER INFORMATION
Item 1.	Legal Proceedings.	57
Item 1A.	Risk Factors.	57
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds.	57
Item 3.	Defaults Upon Senior Securities.	57
Item 4.	Mine Safety Disclosures.	57
Item 5.	Other Information.	57
Item 6.	Exhibits.	57

	Signatures	58

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PART I

Item 1. Condensed Consolidated Financial Statements.

SquareTwo Financial Corporation and Subsidiaries

Condensed Consolidated Balance Sheets

(unaudited, in thousands except share data)



	September 30, 2014			December 31, 2013
Assets
Cash and cash equivalents	$	15,912		$	9,379
Restricted cash	24,817			6,484
Receivables:
Trade, net of allowance for doubtful accounts of $15 and $221, respectively	2,278			1,986
Notes receivable	371			212
Taxes receivable	—			275
Purchased debt, net	236,607			274,357
Property and equipment, net	23,226			24,356
Goodwill and intangible assets	171,348			171,348
Other assets	8,654			10,007
Total assets	$	483,213		$	498,404
Liabilities and equity (deficiency)
Payables:
Accounts payable, trade	$	2,931		$	3,505
Payable from trust accounts	1,679			1,933
Taxes payable	605			748
Accrued interest and other liabilities	33,030			27,861
Deferred tax liability	11,248			9,936
Line of credit	148,636			145,269
Notes payable, net of discount	289,385			289,414
Obligations under capital lease agreements	2,747			2,744
Total liabilities	490,261			481,410
Commitments and contingencies (Note 9)
Equity (deficiency)
Common stock, par value $0.001 per share; 1,000 shares authorized, issued and outstanding	—			—
Additional paid-in capital	190,178			190,262
Accumulated deficit	(200,174		)	(176,354		)
Accumulated other comprehensive loss	(2,634		)	(1,347		)
Total SquareTwo (deficiency) equity	(12,630		)	12,561
Noncontrolling interest	5,582			4,433
Total (deficiency) equity	(7,048		)	16,994
Total liabilities and (deficiency) equity	$	483,213		$	498,404

See Notes to the Condensed Consolidated Financial Statements

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SquareTwo Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Operations

(unaudited, in thousands)



	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2014			2013			2014			2013
Revenues
Purchased debt revenue, net	$	56,985		$	84,293		$	195,313		$	263,939
Other revenue	14			230			42			621
Total revenues	56,999			84,523			195,355			264,560
Expenses
Purchased debt expense	31,643			44,266			101,310			134,901
Court costs, net	8,422			9,935			27,563			31,861
Other direct operating expense	4,061			3,083			11,871			9,175
Salaries and payroll taxes	7,766			7,142			22,853			21,147
General and administrative	3,549			3,330			11,130			10,778
Depreciation and amortization	1,738			2,103			5,086			6,014
Total operating expenses	57,179			69,859			179,813			213,876
Operating (loss) income	(180		)	14,664			15,542			50,684
Other expenses
Interest expense	11,049			11,392			33,133			34,775
Other expense	80			1,316			273			3,659
Total other expenses	11,129			12,708			33,406			38,434
(Loss) income before income taxes	(11,309		)	1,956			(17,864		)	12,250
Income tax expense	(1,699		)	(590		)	(4,807		)	(3,180		)
Net (loss) income	(13,008		)	1,366			(22,671		)	9,070
Less: Net income attributable to the noncontrolling interest	409			387			1,149			1,053
Net (loss) income attributable to SquareTwo	$	(13,417	)	$	979		$	(23,820	)	$	8,017

See Notes to the Condensed Consolidated Financial Statements

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SquareTwo Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Comprehensive (Loss) Income

(unaudited, in thousands)



	Three Months Ended					Nine Months Ended
	September 30,					September 30,
	2014			2013		2014			2013
Net (loss) income	$	(13,008	)	$	1,366	$	(22,671	)	$	9,070
Other comprehensive (loss) income, net of tax:
Currency translation adjustment	(1,351		)	507		(1,287		)	(622		)
Comprehensive (loss) income	(14,359		)	1,873		(23,958		)	8,448
Less: Comprehensive income attributable to the noncontrolling interest	409			387		1,149			1,053
Comprehensive (loss) income attributable to SquareTwo	$	(14,768	)	$	1,486	$	(25,107	)	$	7,395

See Notes to the Condensed Consolidated Financial Statements

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SquareTwo Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Changes in Equity (Deficiency)

(unaudited, in thousands)



	Common Stock		Additional Paid-In Capital			Accumulated Deficit			Accumulated Other Comprehensive Loss			Total SquareTwo Equity (Deficiency)			Noncontrolling Interest		Total Equity (Deficiency)
Balances, December 31, 2013	$	—	$	190,262		$	(176,354	)	$	(1,347	)	$	12,561		$	4,433	$	16,994
Net (loss) income	—		—			(23,820		)	—			(23,820		)	1,149		(22,671		)
Currency translation adjustment	—		—			—			(1,287		)	(1,287		)	—		(1,287		)
Distribution to Parent	—		(150		)	—			—			(150		)	—		(150		)
Stock option expense	—		66			—			—			66			—		66
Balances, September 30, 2014	$	—	$	190,178		$	(200,174	)	$	(2,634	)	$	(12,630	)	$	5,582	$	(7,048	)

See Notes to the Condensed Consolidated Financial Statements

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SquareTwo Financial Corporation and Subsidiaries

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)



	Nine Months Ended
	September 30,
	2014			2013
Operating activities
Net (loss) income	$	(22,671	)	$	9,070
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization	5,086			6,014
Amortization of loan origination fees and debt discount	2,202			2,482
Recovery of step-up in basis of purchased debt	—			107
Purchased debt valuation allowance charges (reversals)	808			(6,460		)
Stock option expense	66			99
Amortization of prepaid and other non-cash expenses	3,252			3,344
Deferred tax provision, net of valuation allowance	1,312			—
Changes in operating assets and liabilities:
Income tax payable/receivable	129			(2,656		)
Restricted cash	(18,333		)	(14,624		)
Other assets	(3,686		)	(4,016		)
Accounts payable and accrued liabilities	4,788			11,153
Net cash (used in) provided by operating activities	(27,047		)	4,513
Investing activities
Investment in purchased debt	(97,482		)	(230,995		)
Proceeds applied to purchased debt principal	133,720			188,749
Payments to branch offices related to asset purchase program	—			(297		)
Net (investment in) proceeds from notes receivable	(170		)	27
Investment in property and equipment, including internally developed software	(3,028		)	(3,800		)
Net cash provided by (used in) investing activities	33,040			(46,316		)
Financing activities
Repayments of investment by Parent	(150		)	—
Payments on notes payable, net	(568		)	(411		)
Proceeds from lines-of-credit	334,924			472,177
Payments on lines-of-credit	(331,557		)	(429,382		)
Origination fees on lines-of-credit	(257		)	(856		)
Payments on capital lease obligations	(1,279		)	(1,121		)
Net cash provided by financing activities	1,113			40,407
Increase (decrease) in cash and cash equivalents	7,106			(1,396		)
Impact of foreign currency translation on cash	(573		)	(542		)
Cash and cash equivalents at beginning of period	9,379			7,538
Cash and cash equivalents at end of period	$	15,912		$	5,600
Supplemental cash flow information
Cash paid for interest	$	22,561		$	24,049
Cash paid for income taxes	3,367			5,837
Property and equipment financed with capital leases and notes payable	1,282			2,066

See Notes to the Condensed Consolidated Financial Statements

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SquareTwo Financial Corporation and Subsidiaries

Notes to the Condensed Consolidated Financial Statements

(unaudited, in thousands except share amounts or otherwise indicated)

1. Organization and Basis of Presentation

SquareTwo Financial Corporation (together with its subsidiaries referred to herein as “SquareTwo,” "we," "our," "us," or the “Company”) is a Delaware corporation that was organized in February 1994 and is headquartered in Denver, Colorado. On August 5, 2005, CA Holding Inc. (“Parent”) acquired 100% of the outstanding stock of SquareTwo and its subsidiaries (the “Acquisition”). The accompanying consolidated financial statements reflect Parent’s basis in SquareTwo. SquareTwo’s subsidiaries purchase domestic and Canadian charged-off receivables (referred to herein as “purchased debt”).

The Company is a leading purchaser of charged-off consumer and commercial receivables in the accounts receivable management industry. Our primary business is the acquisition, management and collection of charged-off consumer and commercial accounts receivable that we purchase from financial institutions, finance and leasing companies, and other issuers in the U.S. and Canada. SquareTwo, excluding our Canadian operations and SquareTwo Financial Services Corporation, serves as a network of attorney based branch offices which pursue proceeds on debt owned by the Company for a fee. Each of our branch offices is independently owned, but has executed detailed agreements that provide the legal structure for the relationship with SquareTwo.

In addition to managing the branch office network, SquareTwo places certain of its accounts for collection through its subsidiary SquareTwo Financial Services Corporation. Until August 2014, SquareTwo Financial Services Corporation was legally known as SquareTwo Financial Commercial Funding Corporation. Along with its legal name change, this entity has registered to conduct its collection activities within the United States under the d/b/a name Fresh View Solutions.

Our Canadian subsidiaries exclusively purchase charged-off Canadian accounts. In Canada, we utilize internal collectors and third-party non-legal and legal collection firms which exclusively service our Canadian customers.

The accompanying unaudited condensed consolidated financial statements of the Company have been prepared in accordance with U.S. generally accepted accounting principles (“GAAP”) for interim financial information and with the instructions to Form 10-Q and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (“SEC”) and, therefore, do not include all information and disclosures required by GAAP for complete financial statements. In the opinion of the Company, however, the accompanying unaudited condensed consolidated financial statements contain all adjustments, consisting only of normal recurring adjustments, necessary for a fair presentation of the Company’s condensed consolidated balance sheet as of September 30, 2014, its condensed consolidated statements of operations and condensed consolidated statements of comprehensive (loss) income for the three and nine months ended September 30, 2014 and 2013, its condensed consolidated statements of changes in equity (deficiency) for the nine months ended September 30, 2014, and its condensed consolidated statements of cash flows for the nine months ended September 30, 2014 and 2013. The condensed consolidated statements of operations and condensed consolidated statements of comprehensive (loss) income of the Company for the three and nine months ended September 30, 2014 may not be indicative of future results. These unaudited condensed consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto for the year ended December 31, 2013 included in the Company’s most recent Annual Report on Form 10-K.

2. Summary of Significant Accounting Policies

Principles of Consolidation

The condensed consolidated financial statements of the Company are prepared in accordance with GAAP and include the accounts of SquareTwo and its subsidiaries. SquareTwo owns the following subsidiaries: ReFinance America, Ltd.; CACV of Colorado, LLC; CACH, LLC; Collect Air, LLC; Healthcare Funding Solutions, LLC; SquareTwo Financial Services Corporation (d/b/a/ Fresh View Solutions); Collect America of Canada, LLC, and certain other inactive entities not listed. Collect America of Canada, LLC has a wholly-owned subsidiary, SquareTwo Financial Canada Corporation, which has an 86% ownership interest in CCL Financial Inc. ("CCL"). CCL is a consolidated subsidiary of the Company. As previously disclosed, Parent owns 100% of the outstanding equity of SquareTwo and all other Parent investments are dormant. All material expenses incurred by Parent on SquareTwo’s behalf have been allocated to SquareTwo and are reflected in the condensed consolidated financial statements of SquareTwo. All significant intercompany transactions and balances have been eliminated in consolidation.

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SquareTwo has two reportable operating segments, as defined by the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification ("ASC") Topic 280, Segment Reporting (“ASC 280”): Domestic and Canada.

Accounting Estimates

Actual results could differ from those estimates. The Company's condensed consolidated financial statements are based on a number of significant estimates, including the collectability of purchased debt and the timing of such proceeds, impairment testing of goodwill and the branch office network indefinite-lived intangible asset, and accounting for income taxes. Due to the uncertainties inherent in the estimation process, it is at least reasonably possible that the Company's estimates in connection with these items could be materially revised within the near term.

Revenue Recognition from Purchased Debt

Purchased debt represents receivables that have been charged-off as uncollectible by the originating organization and that may or may not have been subject to previous collection efforts. Through its subsidiaries, the Company purchases the rights to the unrecovered balances owed by individual customers from various financial institutions at a substantial discount from face value and records the purchase at the Company's cost to acquire the portfolio.

We account for our purchased debt under the guidance of ASC Topic 310-30, "Loans and Debt Securities Acquired with Deteriorated Credit Quality" ("ASC 310-30"). Under ASC 310-30, static pools of purchased debt may be established and accounted for under either the interest method of accounting (referred to by us as "level yield") or the cost recovery method of accounting. These pools are aggregated based on certain common risk criteria. Each static pool is recorded at cost and is accounted for as a single unit for the recognition of income, reduction of carrying value and any valuation allowance. Once a static pool is established, individual accounts are not added to or removed from the pool. Purchased debt accounted for under our level yield method of accounting is pooled each quarter, whereas purchased debt accounted for under cost recovery is pooled by each individual purchase. The cost recovery method prescribed by ASC 310-30 is required when cash proceeds on a particular purchase cannot be reasonably predicted in timing or amount. Purchased debt accounted for under the cost recovery method is comprised of Canadian portfolios acquired prior to January 1, 2012, commercial, student loan, medical, and any other purchases in the U.S. or Canada for which we do not have the necessary experience to forecast the timing and amount of cash flows. For purchased debt that we believe we can reasonably forecast the timing and amount of our cash proceeds we utilize the level yield method.

Level Yield Method

Most of our purchased debt is accounted for under the level yield method of accounting. Under the level yield method of accounting, cash proceeds on each static pool are allocated to both revenue and to reduce the carrying value (the purchased debt, net line item on the condensed consolidated balance sheets) based on an estimated gross internal rate of return ("IRR") for that pool. We determine the applicable IRR for each static pool based on our estimate of the expected cash proceeds of that pool which is based on our estimated remaining proceeds ("ERP") for the static pool, and the rate of return required to reduce the carrying value of that pool to zero over its estimated life. Each pool's IRR is typically determined using an expected life of six to nine years. As described below, if cash proceeds for a pool deviate from the forecast in timing or amount, we adjust the carrying value of the pool or its IRR (which determines our future revenue recognition), as applicable.

Purchased debt portfolios with similar economic characteristics accounted for under the level yield method are accumulated into static pools on a quarterly basis. Cash proceeds on a pool that are greater than the revenue recognized in accordance with the established IRR will reduce the carrying value of the static pool (also referred to as "amortization" of the pool). Cash proceeds on a pool that are lower than the revenue recognized in accordance with the established IRR will increase the carrying value of the static pool as required by ASC 310-30.

The expected trends of each pool are analyzed at least quarterly. If these trends are different than the original estimates, certain adjustments may be required. Each quarter, we use our ERP to determine our estimate of future cash proceeds for each pool. We then use all factors available, such as the types of assets within the pool, our experience with those assets, the age of the pool, any recent fluctuations in our recovery rates from the various channels we collect from, and where that pool is in its own collection life cycle. We use these factors for each static pool to determine a range of future proceeds, which becomes smaller as we gain more experience with each static pool. We determine our best estimate of future proceeds within that range, which may be used for adjustments to our revenue recognition, or for our determination of allowance charges.

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Using our best estimate of future proceeds, if we estimate a reduction or delay in the receipt of the aggregate future cash proceeds on a pool, a valuation allowance may be recognized and the original IRR remains unchanged. The valuation allowance is determined to the extent that the present value (using the established IRR) of the revised future cash proceeds is less than the current carrying value of the pool. If we estimate an increase in the aggregate future cash proceeds or an acceleration of the timing of future cash proceeds on a pool, the IRR may be increased prospectively to reflect revised best estimates of those future cash proceeds over the remaining life of the pool. If there was a previous valuation allowance taken, reversal of the previously recognized valuation allowance occurs prior to any increases to the IRR. ASC 310-30 requires that each pool be evaluated independently and does not allow netting across pools. Thus, even in periods of increasing cash proceeds for our entire purchased debt portfolio, we may be required to record a valuation allowance. Allowance charges for purchased debt are included as adjustments to the purchased debt revenue, net line item in the condensed consolidated statements of operations.

Canadian purchases made on or after January 1, 2012 are being accounted for under the level yield method unless we are unable to reasonably forecast the timing and amount of cash proceeds. Purchases eligible for the level yield method are being accumulated into static pools on a quarterly basis separately from U.S. purchases.

Cost Recovery Method

Treatment of cash proceeds under the cost recovery method differs from treatment under the level yield method. Under the cost recovery method, as cash proceeds, excluding court cost recoveries, less collection fees paid are received, they directly reduce the carrying value of the purchased debt. For every dollar recorded as a fee paid to the branch offices or third party collection firms, there is a corresponding dollar recorded as revenue in the purchased debt revenue, net line item in the condensed consolidated statements of operations (i.e. the expense and revenue amounts are equal). Once the purchase's carrying value has been reduced to zero, all cash proceeds, excluding court cost recoveries, are recorded as revenues. Court cost recoveries received for purchased debt accounted for under the cost recovery method of accounting are netted against court cost expenditures in the court costs, net line item in the condensed consolidated statements of operations. As compared to the level yield method of accounting, the cost recovery method of accounting generally results in a more rapid reduction in the carrying value of purchased debt and slower recognition of revenue with respect thereto.

We assess our purchased debt accounted for under the cost recovery method at least annually, or more frequently if necessary, to determine if a valuation allowance is necessary. If the carrying value of a purchase is greater than our best estimate of future cash proceeds, excluding court cost recoveries, net of the fees expected to be paid for collections on that purchase, we record a valuation allowance for the difference. In the instance that our best estimate of future cash proceeds, excluding court cost recoveries, increases for a cost recovery purchase that had a valuation allowance previously recorded, we may reverse a portion or the entire valuation allowance, as estimates indicate. Similar to our process to determine our revenue recognition, or allowance charges for our level yield pools as described above, we use all factors available, and our ERP to determine our best estimate of future cash proceeds for our purchased debt accounted for under the cost recovery method.

Reclassifications

Certain reclassifications have been made to prior year amounts in order to conform to the current year presentation. The Company has revised the presentation of its condensed consolidated statement of operations for all the periods presented to provide improved visibility and comparability with the current year presentation.

Recently Issued Accounting Pronouncements

In May 2014, the FASB and the IASB issued ASU No. 2014-09, "Revenue from Contracts with Customers." ASU No. 2014-09 is a comprehensive new revenue recognition standard that supersedes virtually all existing revenue guidance under US GAAP and IFRS. The standard’s core principle is that a company will recognize revenue when it transfers promised goods or services to customers in an amount that reflects the consideration to which the company expects to be entitled in exchange for those goods or services. In doing so, companies will need to use more judgment and make more estimates than under current guidance. The Company will be required to apply the standard retrospectively in the first quarter of 2017. The Company is in the process of determining the impact this standard may have on its financial statements.

In June 2014, the FASB issued ASU No. 2014-12, "Compensation-Stock Compensation (Topic 718): Accounting for Share-Based Payments When the Terms of an Award Provide That a Performance Target Could Be Achieved after the Requisite Service Period.” ASU No. 2014-12 provides explicit guidance regarding share-based payments where the performance target could be achieved post-termination of employment and will be effective for the Company in the first quarter of 2016. As the

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Company, at times, issues these types of compensation arrangements, when applicable, this guidance will be used. ASU No. 2014-12 does not have an impact on the Company's consolidated financial statements at this time.

In August 2014, the FASB issued ASU No. 2014-15, "Presentation of Financial Statements-Going Concern (Subtopic 205-40).” ASU No. 2014-15 provides guidance about management's responsibility to evaluate whether there is substantial doubt about an entity's ability to continue as a going concern and to provide related footnote disclosures. This update will be effective for the Company for the annual period ending after December 15, 2016.

3. Purchased Debt

The following tables show the changes in purchased debt, net for the periods presented:



	Three Months Ended
	Level Yield						Cost Recovery						Totals
	September 30,						September 30,						September 30,
	2014			2013			2014			2013			2014			2013
Balance at beginning of period	$	236,860		$	266,529		$	16,860		$	23,041		$	253,720		$	289,570
Purchases	27,326			71,915			2,340			1,829			29,666			73,744
Valuation allowance (charges) reversals	(872		)	2,709			(459		)	—			(1,331		)	2,709
Proceeds applied to purchased debt principal	(41,932		)	(61,568		)	(2,888		)	(4,491		)	(44,820		)	(66,059		)
Other(1)	(625		)	279			(3		)	18			(628		)	297
Balance at end of period	$	220,757		$	279,864		$	15,850		$	20,397		$	236,607		$	300,261



	Nine Months Ended
	Level Yield						Cost Recovery						Totals
	September 30,						September 30,						September 30,
	2014			2013			2014			2013			2014			2013
Balance at beginning of period	$	254,419		$	230,773		$	19,938		$	20,909		$	274,357		$	251,682
Purchases	91,688			215,010			5,794			15,985			97,482			230,995
Valuation allowance (charges) reversals	(349		)	9,330			(459		)	(2,870		)	(808		)	6,460
Proceeds applied to purchased debt principal	(124,308		)	(174,839		)	(9,412		)	(13,910		)	(133,720		)	(188,749		)
Other(1)	(693		)	(410		)	(11		)	283			(704		)	(127		)
Balance at end of period	$	220,757		$	279,864		$	15,850		$	20,397		$	236,607		$	300,261

(1) Other includes impacts of the Company’s currency translation, branch office asset purchase program (discontinued), and recovery of step-up in basis on purchased debt.

The following tables show the relationship of purchased debt proceeds to gross revenue recognized and proceeds applied to principal for the periods presented:



	Three Months Ended
	Level Yield				Cost Recovery				Totals
	September 30,				September 30,				September 30,
	2014		2013		2014		2013		2014		2013
Proceeds	$	90,251	$	129,835	$	11,850	$	15,458	$	102,101	$	145,293
Less:
Gross revenue recognized	48,319		68,267		8,650		10,618		56,969		78,885
Cost recovery court cost recoveries(1)	—		—		312		349		312		349
Proceeds applied to purchased debt principal	41,932		61,568		2,888		4,491		44,820		66,059
	$	—	$	—	$	—	$	—	$	—	$	—

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	Nine Months Ended
	Level Yield				Cost Recovery				Totals
	September 30,				September 30,				September 30,
	2014		2013		2014		2013		2014		2013
Proceeds	$	288,903	$	390,781	$	37,342	$	48,367	$	326,245	$	439,148
Less:
Gross revenue recognized	164,595		215,942		26,982		33,373		191,577		249,315
Cost recovery court cost recoveries(1)	—		—		948		1,084		948		1,084
Proceeds applied to purchased debt principal	124,308		174,839		9,412		13,910		133,720		188,749
	$	—	$	—	$	—	$	—	$	—	$	—

(1) Cost recovery court cost recoveries are recorded as a contra expense in the court costs, net line item in the condensed consolidated statements of operations.

The following tables reconcile gross revenue recognized to purchased debt revenues, net for the periods presented:



	Three Months Ended
	Level Yield					Cost Recovery						Totals
	September 30,					September 30,						September 30,
	2014			2013		2014			2013			2014			2013
Gross revenue recognized	$	48,319		$	68,267	$	8,650		$	10,618		$	56,969		$	78,885
Purchased debt royalties	1,128			2,535		251			225			1,379			2,760
Valuation allowance (charges) reversals	(872		)	2,709		(459		)	—			(1,331		)	2,709
Other(1)	—			—		(32		)	(61		)	(32		)	(61		)
Purchased debt revenue, net	$	48,575		$	73,511	$	8,410		$	10,782		$	56,985		$	84,293



	Nine Months Ended
	Level Yield					Cost Recovery						Totals
	September 30,					September 30,						September 30,
	2014			2013		2014			2013			2014			2013
Gross revenue recognized	$	164,595		$	215,942	$	26,982		$	33,373		$	191,577		$	249,315
Purchased debt royalties	3,932			7,460		733			931			4,665			8,391
Valuation allowance (charges) reversals	(349		)	9,330		(459		)	(2,870		)	(808		)	6,460
Other(1)	—			—		(121		)	(227		)	(121		)	(227		)
Purchased debt revenue, net	$	168,178		$	232,732	$	27,135		$	31,207		$	195,313		$	263,939

(1) Other items relate to certain profit sharing items that reduce the Company’s revenue recorded on purchased debt, the branch office asset purchase program (discontinued), and recovery of step-up in basis.

The following tables show the detail of the Company’s purchases for the periods presented:



	Three Months Ended
	Level Yield						Cost Recovery						Totals
	September 30,						September 30,						September 30,
	2014			2013			2014			2013			2014			2013
Purchase price	$	27,326		$	71,915		$	2,340		$	1,829		$	29,666		$	73,744
Face value	287,531			626,377			54,584			38,718			342,115			665,095
% of face	9.5		%	11.5		%	4.3		%	4.7		%	8.7		%	11.1		%

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	Nine Months Ended
	Level Yield						Cost Recovery						Totals
	September 30,						September 30,						September 30,
	2014			2013			2014			2013			2014			2013
Purchase price	$	91,688		$	215,010		$	5,794		$	15,985		$	97,482		$	230,995
Face value	758,735			2,206,924			144,984			302,558			903,719			2,509,482
% of face	12.1		%	9.7		%	4.0		%	5.3		%	10.8		%	9.2		%

Accretable yield represents the difference between the ERP of our purchased debt accounted for under the level yield method and the carrying value of those assets. The ERP is used in determining our revenue recognition, and adjustments to our revenue recognition, for our purchased debt accounted for under the level yield method, which is described in further detail in Note 2.

During the three months ended September 30, 2014, the Company purchased $287.5 million in face value debt that qualified for the level yield method of accounting for a purchase price of $27.3 million. The ERP expected at acquisition for these level yield portfolios amounted to $42.2 million. The accretable yield for these purchases was $14.9 million, or the ERP of $42.2 million less the purchase price of $27.3 million.

During the nine months ended September 30, 2014, the Company purchased $758.7 million in face value debt that qualified for the level yield method of accounting for a purchase price of $91.7 million. The ERP expected at acquisition amounted to $135.9 million. The accretable yield for these purchases was $44.3 million, or the ERP of $135.9 million less the purchase price of $91.7 million.

The following table represents the quarterly change in accretable yield for the periods presented:



	2014			2013
Balance at December 31, prior year	$	523,006		$	596,849
Impact from revenue recognized on purchased debt, net	(61,085		)	(75,024		)
Additions from current purchases	13,150			62,109
Reclassifications to accretable yield, including foreign currency translation	13,555			10,475
Balance at March 31,	$	488,626		$	594,409
Impact from revenue recognized on purchased debt, net	(55,714		)	(79,272		)
Additions from current purchases	16,241			72,278
Reclassifications to accretable yield, including foreign currency translation	(10,751		)	12,639
Balance at June 30,	$	438,402		$	600,054
Impact from revenue recognized on purchased debt, net	(47,448		)	(70,976		)
Additions from current purchases	14,866			48,161
Reclassifications to accretable yield, including foreign currency translation	(1,031		)	(5,317		)
Balance at September 30,	$	404,789		$	571,922

The following tables show the changes in the valuation allowance for the Company’s purchased debt during the periods presented:



	Three Months Ended
	Level Yield					Cost Recovery				Totals
	September 30,					September 30,				September 30,
	2014		2013			2014		2013		2014		2013
Balance at beginning of period	$	125,561	$	129,981		$	17,584	$	16,584	$	143,145	$	146,565
Valuation allowance charges (reversals)	872		(2,709		)	459		—		1,331		(2,709		)
Balance at end of period	$	126,433	$	127,272		$	18,043	$	16,584	$	144,476	$	143,856

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	Nine Months Ended
	Level Yield					Cost Recovery				Totals
	September 30,					September 30,				September 30,
	2014		2013			2014		2013		2014		2013
Balance at beginning of period	$	126,084	$	136,602		$	17,584	$	13,714	$	143,668	$	150,316
Valuation allowance charges (reversals)	349		(9,330		)	459		2,870		808		(6,460		)
Balance at end of period	$	126,433	$	127,272		$	18,043	$	16,584	$	144,476	$	143,856

4. Goodwill and Other Intangibles

Indefinite lived intangible assets consist of goodwill and the value of the Company’s branch offices and were identified as part of purchase accounting at the date of the Acquisition. The Company tests its indefinite lived intangibles annually for impairment unless there is a triggering event during an interim period that would necessitate testing.

We have two operating segments: Domestic and Canada. In accordance with FASB ASC Topic 350, Intangibles-Goodwill and Other (“ASC 350”), we have deemed our operating segments to be reporting units for the purpose of testing goodwill for impairment.

The following is a summary of intangibles:



	September 30, 2014		December 31, 2013
Goodwill	$	146,458	$	146,458
Branch office intangible	24,890		24,890
Total intangible assets	$	171,348	$	171,348

5. Notes Payable and Other Borrowings

Line of Credit

The following is a listing of the Company’s outstanding line of credit borrowings, balances, and interest rates under the revolving credit facility:



	September 30, 2014					December 31, 2013
Type of Debt	Weighted Average Interest Rate(1)		Balance		Maturity	Weighted Average Interest Rate(1)		Balance		Maturity
Line of Credit US	4.8	%	$	148,636	April 2016	4.9	%	$	145,269	April 2016
Line of Credit Canada	5.8	%	—		April 2016	5.8	%	—		April 2016
Total Line of Credit			$	148,636				$	145,269

(1) Weighted average interest rates exclude the impact of amortization of fees associated with the origination of these instruments.

The remaining unamortized costs of the facility were $1,228 and $1,673 at September 30, 2014 and December 31, 2013, respectively, and are included in the other assets line on the condensed consolidated balance sheets. These costs are amortized on a straight-line basis over the remaining term of the facility. The Company had accrued interest on its lines of credit of $106 and $122 at September 30, 2014 and December 31, 2013, respectively, which are included in the accrued interest and other liabilities line item on the condensed consolidated balance sheets.

At September 30, 2014, our availability under the line of credit facility was $59.6 million based on our borrowing base calculation.

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Notes Payable

The following is a listing of the Company’s outstanding notes payable borrowings, balances, and interest rates:



	September 30, 2014					December 31, 2013
Type of Debt	Weighted Average Interest Rate(1)		Balance		Maturity	Weighted Average Interest Rate(1)		Balance		Maturity
Senior Second Lien Notes, net of $1,811 and $2,350 unamortized discount	11.625	%	$	288,189	April 2017	11.625	%	$	287,650	April 2017
Other Notes Payable	5.7	%	1,196		2015 - 2021	5.5	%	1,764		2015 - 2021
Total Notes Payable			$	289,385				$	289,414

(1) Weighted average interest rates exclude the impact of the amortization of fees associated with the origination of these instruments.

The remaining unamortized costs of the Senior Second Lien Notes were $3,224 and $4,185 at September 30, 2014 and December 31, 2013, respectively, and are included in the other assets line on the condensed consolidated balance sheets. These costs are amortized on a straight-line basis over the term of the notes.

The Company had accrued interest on its Senior Second Lien Notes payable of $16,856 and $8,428 at September 30, 2014 and December 31, 2013, respectively, which is included in the accrued interest and other liabilities line item on the condensed consolidated balance sheets.

Covenants

The senior revolving credit facility, as amended, and the Senior Second Lien Notes have certain covenants and restrictions, as is customary for such facilities, with which the Company must comply. As of September 30, 2014, the Company was in compliance with all covenants and restrictions of the revolving credit facility and Senior Second Lien Notes.

Subsequent to September 30, 2014, SquareTwo amended its Loan Agreement to decrease the Minimum Adjusted EBITDA Covenant. Further information regarding the amendment is disclosed in Note 12.

Letters of Credit

The Company had outstanding letters of credit totaling $492 at September 30, 2014 and December 31, 2013. At September 30, 2014 letters of credit totaling $492 had not been drawn on and remained outstanding. The letters of credit have been issued to provide support in connection with our licensing applications.

6. Stockholder's Equity (Deficiency)

Common Stock

As of September 30, 2014 and December 31, 2013, the Company is authorized to issue 1,000 shares, all of which are reserved as common stock, with 1,000 shares outstanding with a par value of $0.001 per share. There are no other equity shares outstanding that would take preference over the common stock in the instance that the Company pays dividends or liquidates. The outstanding shares are voting common stock and are owned 100% by Parent.

Non-Controlling Interest

The Company holds a controlling interest of approximately 86% in its Canadian subsidiary, CCL. The portions of net income and comprehensive income attributable to the non-controlling interest in CCL are shown on our condensed consolidated statements of operations and condensed consolidated statements of comprehensive (loss) income.

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Accumulated Other Comprehensive Loss

During the nine months ended September 30, 2014 and 2013, accumulated other comprehensive loss included currency translation adjustments resulting from converting transactions and balances related to our Canada segment's operations from Canadian dollars to U.S. dollars. The following is a summary of the changes in accumulated other comprehensive loss during the nine months ended September 30, 2014 and 2013:



Accumulated Other Comprehensive Loss	Currency Translation Adjustment			Total Accumulated Other Comprehensive Loss
Balance, December 31, 2013	$	(1,347	)	$	(1,347	)
Other comprehensive loss, net of tax of $0	(1,287		)	(1,287		)
Balance, September 30, 2014	$	(2,634	)	$	(2,634	)



Accumulated Other Comprehensive Loss	Currency Translation Adjustment			Total Accumulated Other Comprehensive Loss
Balance, December 31, 2012	$	(111	)	$	(111	)
Other comprehensive loss, net of tax of $0	(622		)	(622		)
Balance, September 30, 2013	$	(733	)	$	(733	)

7. Fair Value of Financial Instruments

ASC 820, "Fair Value Measurements and Disclosures", defines fair value based on the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC 820 establishes a fair value hierarchy that prioritizes observable and unobservable inputs used to measure fair value. The fair value hierarchy consists of three broad levels, which are described below:

· Level 1-Quoted prices (unadjusted) in active markets for identical assets or liabilities that the reporting entity can access at the measurement date.

· Level 2-Inputs other than quoted prices included in Level 1, that are observable for the asset or liability, either directly or indirectly, such as quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; or other inputs that are observable or can be corroborated by observable market data.

· Level 3-Unobservable inputs that are supported by little, if any, market activity and that are significant to the fair value of the assets and liabilities. This includes certain pricing models, discounted cash flow methodologies and similar techniques that use significant unobservable inputs.

Purchased Debt Receivables

The Company initially records purchased debt receivables at cost. Purchased debt receivables, for which a valuation allowance has not been recorded, are subsequently recorded net of amortization under the interest method or the cost recovery method as discussed previously in Note 2. If a valuation allowance is required for a level yield pool, the Company records that portion of the total purchased debt balance by discounting the future cash flows generated by its proprietary forecasting model using the IRR as a discount rate. Valuation allowances for cost recovery pools are determined using the Company's proprietary forecasting model cash flows, which are undiscounted.

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Estimated Fair Value

The following tables display the carrying value and estimated fair value of the Company's financial instruments held in accordance with ASC 820-10-50-2E at September 30, 2014 and December 31, 2013:



	September 30, 2014
	Carrying amounts		Estimated fair value		Level 1		Level 2		Level 3
Purchased debt(1)	$	236,607	$	569,074	$	—	$	—	$	569,074
Line of credit(2)	148,636		148,636		—		148,636		—
Senior Second Lien Notes, net of $1,811 unamortized discount(3)	288,189		302,689		302,689		—		—
Other Notes Payable(4)	1,196		1,196		—		1,196		—



	December 31, 2013
	Carrying amounts		Estimated fair value		Level 1		Level 2		Level 3
Purchased debt(1)	$	274,357	$	658,676	$	—	$	—	$	658,676
Line of credit(2)	145,269		145,269		—		145,269		—
Senior Second Lien Notes, net of $2,350 unamortized discount(3)	287,650		295,987		295,987		—		—
Other Notes Payable(4)	1,764		1,764		—		1,764		—

(1) The Company's estimated fair value of purchased debt has been determined using our consolidated ERP discounted using a rate that approximates our weighted average cost of capital. Our ERP expectations are based on historical data as well as assumptions about future collection rates and customer behavior. The estimated fair value of purchased debt should not be construed to represent the underlying value of the Company.

(2) The Company has both a domestic and Canadian revolving credit facility. These instruments contain variable borrowing rates that are based in part on observed available market interest rates. As a result, the Company believes the carrying values of these instruments approximate fair value.

(3) The fair value of our Senior Second Lien Notes is based on recently observed available market trading metrics.

(4) We estimated the fair value of these notes to approximate carrying value, as the applicable interest rates of the notes approximate those of our other current borrowings, which are based in part on observable market rates.

The carrying values of cash and cash equivalents, accounts receivable and payable, accrued expenses, and notes receivable are considered to approximate fair value due to the short-term nature of these instruments.

8. Income Taxes

For financial statement reporting purposes, the Company is treated as a stand-alone entity, and therefore all components of the provision for, or benefit from income taxes as well as the deferred tax assets and liabilities recognized herein reflect only the financial results and position of SquareTwo. For income tax purposes, the Company is included in the consolidated return of Parent. Parent files income tax returns in the U.S. federal jurisdiction, and various state and foreign jurisdictions. Parent's U.S. federal income tax returns were last examined for the tax year ended December 31, 2004, and Parent potentially remains subject to examination for all tax years ended on or after December 31, 2009.

For the three and nine months ended September 30, 2014 the combined state, federal and Canadian tax expense from operations was $1.7 million and $4.8 million, respectively. These amounts are primarily comprised of foreign taxes on Canadian operations based on an effective tax rate of approximately 26.5% as well as $0.2 million and $1.4 million expense, respectively, related to those earnings in the U.S. Any tax benefits related to pretax losses generated by the Company’s ongoing U.S. operations during 2014 have been fully offset by a corresponding increase in the valuation allowance as the Company remains in a full valuation allowance position at September 30, 2014.

While virtually all U.S. tax expense associated with foreign earnings can be offset by the Company’s net operating losses or foreign tax credits available in the U.S., the $0.2 million and $1.4 million recognized during the three and nine months ended September 30, 2014, respectively, relates specifically to withholding taxes on the amount of the earnings that would be applicable upon a future distribution. Therefore, to the extent the earnings deemed distributed are not actually repatriated to the U.S., the withholding tax liability will not be paid.

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9. Commitments and Contingencies

Litigation

From time to time the Company is a defendant in ordinary routine litigation alleging violations of applicable state and federal laws by the Company or the branch offices acting on its behalf that is incidental to our business. These suits may include actions which may purport to be on behalf of a class of consumers. While the litigation and regulatory environment is challenging and continually changing, for the Company, our branch offices and our industry, in our opinion, such matters will not individually, or in the aggregate, result in a materially adverse effect on the Company's financial position, results of operations or cash flows. Management believes the range of reasonably possible loss for outstanding claims is between zero and $1.5 million. The Company accrues for loss contingencies as they become probable and estimable.

10. Segment Information

In its operation of the business, the chief operating decision maker ("CODM"), our Chief Executive Officer, reviews certain financial information, including segment statements of profitability prepared on a basis not consistent with GAAP. The segment information within this note is reported on that basis. The CODM evaluates this information in deciding how to allocate resources and in assessing performance. The Company has two reportable operating segments: Canada operations and Domestic operations, which have been determined based on the way our Board of Directors, the CODM, and our Senior Leadership Team review the Company's strategy and performance.

The accounting policies of our two segments are the same as those described in the summary of significant accounting policies in Note 2. Canadian purchases made on or after January 1, 2012 are being accounted for under the level yield method unless we are unable to reasonably forecast the timing and amount of cash proceeds. Purchases eligible for the level yield method are accumulated into static pools on a quarterly basis separately from U.S. purchases.

The following tables present the Company's operating segment results for the three and nine months ended September 30, 2014 and September 30, 2013:

Cash Proceeds on Purchased Debt:



	Three Months Ended September 30,				Nine Months Ended September 30,
Cash Proceeds on Purchased Debt	2014		2013		2014		2013
Domestic	$	91,035	$	133,265	$	293,373	$	402,311
Canada	11,066		12,028		32,872		36,837
Consolidated	$	102,101	$	145,293	$	326,245	$	439,148

Total Revenues:



	Three Months Ended September 30,				Nine Months Ended September 30,
Total Revenues	2014		2013		2014		2013
Domestic	$	50,004	$	77,394	$	175,208	$	242,428
Canada	6,995		7,129		20,147		22,132
Consolidated	$	56,999	$	84,523	$	195,355	$	264,560

Adjusted EBITDA:



	Three Months Ended September 30,				Nine Months Ended September 30,
Adjusted EBITDA(1)	2014		2013		2014		2013
Domestic	$	39,742	$	71,800	$	131,945	$	212,772
Canada	8,054		8,940		23,853		25,696
Consolidated	$	47,796	$	80,740	$	155,798	$	238,468

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(1) Segment Adjusted EBITDA is calculated consistently with the methodology used to report the Company's consolidated Adjusted EBITDA, except with regard to the costs of certain overhead items that may benefit both operating segments. The costs of these overhead items are included in the calculation of Domestic Adjusted EBITDA, but have not been allocated to Canada. This treatment of certain overhead costs is consistent with CODM review.

Segment net income or loss is not presented herein, which is consistent with the CODM's review of segment information. The table below reconciles consolidated net (loss) income to consolidated Adjusted EBITDA:



Reconciliation of Net (loss) Income to Adjusted EBITDA ($ in thousands)	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
Net (loss) income	$	(13,008	)	$	1,366		$	(22,671	)	$	9,070
Interest expense	11,049			11,392			33,133			34,775
Interest income	(44		)	(38		)	(101		)	(74		)
Income tax expense	1,699			590			4,807			3,180
Depreciation and amortization	1,738			2,103			5,086			6,014
EBITDA	1,434			15,413			20,254			52,965
Adjustments related to purchased debt accounting
Proceeds applied to purchased debt principal(1)	44,820			66,059			133,720			188,749
Amortization of step-up of carrying value(2)	—			—			—			107
Purchased debt valuation allowance charges (reversals)(3)	1,331			(2,709		)	808			(6,460		)
Certain other or non-cash expenses
Stock option expense(4)	17			32			66			99
Other(5)	194			1,945			950			3,008
Adjusted EBITDA	$	47,796		$	80,740		$	155,798		$	238,468

(1) Cash proceeds applied to purchased debt principal rather than recorded as revenue.

(2) Non-cash amortization of a step-up in the carrying value of certain purchased debt assets related to purchase accounting adjustments resulting from the 2005 acquisition of the Company by Parent.

(3) Represents non-cash valuation allowance charges (reversals) on purchased debt.

(4) Represents the non-cash expense related to option grants of Parent’s equity granted to certain employees, directors and branch office owners.

(5) Consistent with the covenant calculations within our revolving credit facility, other includes branch office note reserves, lease breakup costs, certain consulting fees, management fees paid to KRG, certain transaction expenses, recruiting expense, severance expense, and certain non-recurring items.

The table below reconciles net cash provided by operating activities to Adjusted EBITDA:



Reconciliation of Cash Flow from Operations to Adjusted EBITDA ($ in thousands)	Nine Months Ended September 30,
	2014			2013
Net cash (used in) provided by operating activities	$	(27,047	)	$	4,513
Proceeds applied to purchased debt principal(1)	133,720			188,749
Interest expense to be paid in cash(2)	30,931			32,293
Interest income	(101		)	(74		)
Amortization of prepaid and other non-cash expenses	(3,252		)	(3,344		)
Changes in operating assets and liabilities and deferred taxes:
Restricted cash(3)	18,333			14,624
Other operating assets and liabilities and deferred taxes(4)	(2,543		)	(4,481		)
Income tax expense	4,807			3,180
Other(5)	950			3,008
Adjusted EBITDA	$	155,798		$	238,468

(1) Cash proceeds applied to purchased debt principal are shown in the investing activities section of the condensed consolidated statements of cash flows.

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(2) Represents interest expense, excluding non-cash amortization of loan origination fees and debt discount.

(3) Represents the change in restricted cash balances for the period due to the timing of payments on our lines of credit and semi-annual interest payments on our Senior Second Lien Notes.

(4) The amount represents timing differences due to the recognition of certain expenses and revenue items on a cash versus accrual basis.

Segment assets were as follows as of September 30, 2014 and December 31, 2013:



Total Assets	September 30, 2014		December 31, 2013
Domestic	$	451,651	$	474,175
Canada	31,562		24,229
Consolidated	$	483,213	$	498,404

Long-lived assets, excluding financial instruments and deferred taxes, of our Canada segment were not material at September 30, 2014 or December 31, 2013.

11. Supplemental Guarantor Information

The payment obligations under the Senior Second Lien Notes (see Note 5) are fully and unconditionally guaranteed, jointly and severally, on a senior secured basis by substantially all of SquareTwo Financial Corporation’s (the “Borrower”) 100% owned existing and future domestic subsidiaries (“Guarantor Subsidiaries”). The Senior Second Lien Notes are not guaranteed by Parent.

The consolidating financial information presented below reflects information regarding the Borrower, the issuer of the Senior Second Lien Notes, the Guarantor Subsidiaries, and all other subsidiaries of the Borrower (“Non-Guarantor Subsidiaries”). This basis of presentation is not intended to present the financial condition, results of operations or cash flows of the Company, the Borrower, the Guarantor Subsidiaries or the Non-Guarantor Subsidiaries for any purpose other than to comply with the specific requirements for subsidiary guarantor reporting. The consolidating information is prepared in accordance with the same accounting policies as are applied to the Company’s condensed consolidated financial statements except for accounting for income taxes of the Guarantor Subsidiaries, which is reflected entirely in the Borrower’s financial statements as all material Guarantor Subsidiaries are disregarded entities for tax purposes and are combined with the Borrower in the consolidated income tax return of Parent.

The presentation of the Borrower’s financial statements represents the equity method of accounting for the Guarantor and Non-Guarantor Subsidiaries. The results of operations of the Guarantor and Non-Guarantor Subsidiaries reflects certain expense allocations from the Borrower, which are made in relation to the intercompany balances and the intercompany usage of the Borrower’s assets.

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Condensed Consolidating Balance Sheets



	September 30, 2014
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total
Assets
Cash and cash equivalents	$	187		$	1,031		$	14,694		$	—		$	15,912
Restricted cash	16,516			8,301			—			—			24,817
Receivables:
Trade, net of allowance for doubtful accounts	1,271			35			972			—			2,278
Notes receivable	170			—			201			—			371
Purchased debt, net	—			221,674			14,933			—			236,607
Property and equipment, net	22,985			74			167			—			23,226
Goodwill and intangible assets	170,779			—			569			—			171,348
Other assets	6,584			1,227			843			—			8,654
Investment in subsidiaries	260,131			—			—			(260,131		)	—
Total assets	$	478,623		$	232,342		$	32,379		$	(260,131	)	$	483,213
Liabilities and equity (deficiency)
Payables:
Accounts payable, trade	$	2,768		$	123		$	40		$	—		$	2,931
Payable from trust accounts	1,530			61			88			—			1,679
Payable to Borrower	—			349,644			2,137			(351,781		)	—
Taxes payable	388			—			217			—			605
Accrued interest and other liabilities	31,909			281			840			—			33,030
Deferred tax liability (asset)	11,256			—			(8		)	—			11,248
Line of credit	148,636			—			—			—			148,636
Notes payable, net of discount	289,385			—			—			—			289,385
Obligations under capital lease agreements	2,747			—			—			—			2,747
Total liabilities	488,619			350,109			3,314			(351,781		)	490,261
Equity (deficiency)
Common stock	—			—			—			—			—
Additional paid-in capital	190,178			1,527			1			(1,528		)	190,178
(Accumulated deficit) retained earnings	(200,174		)	(119,294		)	26,116			93,178			(200,174		)
Accumulated other comprehensive loss	—			—			(2,634		)	—			(2,634		)
Total (deficiency) equity before noncontrolling interest	(9,996		)	(117,767		)	23,483			91,650			(12,630		)
Noncontrolling interest	—			—			5,582			—			5,582
Total (deficiency) equity	(9,996		)	(117,767		)	29,065			91,650			(7,048		)
Total liabilities and (deficiency) equity	$	478,623		$	232,342		$	32,379		$	(260,131	)	$	483,213

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	December 31, 2013
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total
Assets
Cash and cash equivalents	$	—		$	—		$	9,379		$	—		$	9,379
Restricted cash	(647		)	7,131			—			—			6,484
Receivables:
Trade, net of allowance for doubtful accounts	1,113			9			864			—			1,986
Notes receivable	—			—			212			—			212
Taxes receivable	—			—			275			—			275
Purchased debt, net	—			261,714			12,643			—			274,357
Property and equipment, net	24,092			53			211			—			24,356
Goodwill and intangible assets	170,779			—			569			—			171,348
Other assets	8,023			1,119			865			—			10,007
Investment in subsidiaries	290,938			—			—			(290,938		)	—
Total assets	$	494,298		$	270,026		$	25,018		$	(290,938	)	$	498,404
Liabilities and equity (deficiency)
Payables:
Accounts payable, trade	$	3,507		$	39		$	(41	)	$	—		$	3,505
Payable from trust accounts	1,807			61			65			—			1,933
Payable to Borrower	—			367,463			337			(367,800		)	—
Taxes payable	748			—			—			—			748
Accrued interest and other liabilities	26,957			210			694			—			27,861
Deferred tax liability (asset)	9,944			—			(8		)	—			9,936
Line of credit	145,269			—			—			—			145,269
Notes payable, net of discount	289,414			—			—			—			289,414
Obligations under capital lease agreements	2,744			—			—			—			2,744
Total liabilities	480,390			367,773			1,047			(367,800		)	481,410
Equity (deficiency)
Common stock	—			—			—			—			—
Additional paid-in capital	190,262			1,052			1			(1,053		)	190,262
(Accumulated deficit) retained earnings	(176,354		)	(98,799		)	20,884			77,915			(176,354		)
Accumulated other comprehensive loss	—			—			(1,347		)	—			(1,347		)
Total equity (deficiency) before noncontrolling interest	13,908			(97,747		)	19,538			76,862			12,561
Noncontrolling interest	—			—			4,433			—			4,433
Total equity (deficiency)	13,908			(97,747		)	23,971			76,862			16,994
Total liabilities and equity (deficiency)	$	494,298		$	270,026		$	25,018		$	(290,938	)	$	498,404

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Condensed Consolidating Statements of Operations



	Three Months Ended September 30, 2014
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Total
Revenues
Purchased debt revenue, net	$	1,471		$	48,531		$	6,983		$	—	$	56,985
Other revenue	1			1			12			—		14
Total revenues	1,472			48,532			6,995			—		56,999
Expenses
Purchased debt expense	—			29,106			2,537			—		31,643
Court costs, net	—			8,324			98			—		8,422
Other direct operating expense	—			3,987			74			—		4,061
Salaries and payroll taxes	1,232			6,368			166			—		7,766
General and administrative	103			2,727			719			—		3,549
Depreciation and amortization	554			1,173			11			—		1,738
Total operating expenses	1,889			51,685			3,605			—		57,179
Operating (loss) income	(417		)	(3,153		)	3,390			—		(180		)
Other expenses
Interest expense	1,856			9,193			—			—		11,049
Other expense (income)	117			—			(37		)	—		80
Total other expenses	1,973			9,193			(37		)	—		11,129
(Loss) income before income taxes	(2,390		)	(12,346		)	3,427			—		(11,309		)
Income tax expense	(622		)	—			(1,077		)	—		(1,699		)
Loss from subsidiaries	(10,405		)	—			—			10,405		—
Net (loss) income	(13,417		)	(12,346		)	2,350			10,405		(13,008		)
Less: Net income attributable to the noncontrolling interest	—			—			409			—		409
Net (loss) income attributable to SquareTwo	$	(13,417	)	$	(12,346	)	$	1,941		$	10,405	$	(13,417	)

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	Three Months Ended September 30, 2013
	Borrower			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Total
Revenues
Purchased debt revenue, net	$	2,855		$	74,481	$	6,957		$	—		$	84,293
Other revenue	57			1		172			—			230
Total revenues	2,912			74,482		7,129			—			84,523
Expenses
Purchased debt expense	—			41,491		2,775			—			44,266
Court costs, net	—			9,797		138			—			9,935
Other direct operating expense	1			3,041		41			—			3,083
Salaries and payroll taxes	1,205			5,844		93			—			7,142
General and administrative	696			1,893		741			—			3,330
Depreciation and amortization	1,142			949		12			—			2,103
Total operating expenses	3,044			63,015		3,800			—			69,859
Operating (loss) income	(132		)	11,467		3,329			—			14,664
Other expenses
Interest expense	1,192			10,200		—			—			11,392
Other expense (income)	116			1,228		(28		)	—			1,316
Total other expenses	1,308			11,428		(28		)	—			12,708
(Loss) income before income taxes	(1,440		)	39		3,357			—			1,956
Income tax benefit (expense)	551			—		(1,141		)	—			(590		)
Income from subsidiaries	1,868			—		—			(1,868		)	—
Net income	979			39		2,216			(1,868		)	1,366
Less: Net income attributable to the noncontrolling interest	—			—		387			—			387
Net income attributable to SquareTwo	$	979		$	39	$	1,829		$	(1,868	)	$	979

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	Nine Months Ended September 30, 2014
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Total
Revenues
Purchased debt revenue, net	$	4,926		$	170,267		$	20,120		$	—	$	195,313
Other revenue	8			7			27			—		42
Total revenues	4,934			170,274			20,147			—		195,355
Expenses
Purchased debt expense	—			93,657			7,653			—		101,310
Court costs, net	—			27,293			270			—		27,563
Other direct operating expenses	4			11,729			138			—		11,871
Salaries and payroll taxes	3,828			18,505			520			—		22,853
General and administrative	1,089			7,776			2,265			—		11,130
Depreciation and amortization	1,656			3,397			33			—		5,086
Total operating expenses	6,577			162,357			10,879			—		179,813
Operating (loss) income	(1,643		)	7,917			9,268			—		15,542
Other expenses
Interest expense	4,721			28,412			—			—		33,133
Other expense (income)	366			—			(93		)	—		273
Total other expenses	5,087			28,412			(93		)	—		33,406
(Loss) income before income taxes	(6,730		)	(20,495		)	9,361			—		(17,864		)
Income tax expense	(1,827		)	—			(2,980		)	—		(4,807		)
Loss from subsidiaries	(15,263		)	—			—			15,263		—
Net (loss) income	(23,820		)	(20,495		)	6,381			15,263		(22,671		)
Less: Net income attributable to the noncontrolling interest	—			—			1,149			—		1,149
Net (loss) income attributable to SquareTwo	$	(23,820	)	$	(20,495	)	$	5,232		$	15,263	$	(23,820	)

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	Nine Months Ended September 30, 2013
	Borrower			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Total
Revenues
Purchased debt revenue, net	$	8,585		$	233,709	$	21,645		$	—		$	263,939
Other revenue	128			6		487			—			621
Total revenues	8,713			233,715		22,132			—			264,560
Expenses
Purchased debt expense	—			126,736		8,165			—			134,901
Court costs, net	—			31,381		480			—			31,861
Other direct operating expenses	4			9,045		126			—			9,175
Salaries and payroll taxes	3,712			16,981		454			—			21,147
General and administrative	2,913			5,082		2,783			—			10,778
Depreciation and amortization	3,427			2,549		38			—			6,014
Total operating expenses	10,056			191,774		12,046			—			213,876
Operating (loss) income	(1,343		)	41,941		10,086			—			50,684
Other expenses
Interest expense	4,028			30,747		—			—			34,775
Other expense	315			1,228		2,116			—			3,659
Total other expenses	4,343			31,975		2,116			—			38,434
(Loss) income before income taxes	(5,686		)	9,966		7,970			—			12,250
Income tax expense	(412		)	—		(2,768		)	—			(3,180		)
Income from subsidiaries	14,115			—		—			(14,115		)	—
Net income	8,017			9,966		5,202			(14,115		)	9,070
Less: Net income attributable to the noncontrolling interest	—			—		1,053			—			1,053
Net income attributable to SquareTwo	$	8,017		$	9,966	$	4,149		$	(14,115	)	$	8,017

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Condensed Consolidating Statements of Comprehensive (Loss) Income



	Three Months Ended September 30, 2014
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Total
Net (loss) income	$	(13,417	)	$	(12,346	)	$	2,350		$	10,405	$	(13,008	)
Other comprehensive loss, net of tax:
Currency translation adjustment	—			—			(1,351		)	—		(1,351		)
Comprehensive (loss) income	(13,417		)	(12,346		)	999			10,405		(14,359		)
Less: Comprehensive income attributable to the noncontrolling interest	—			—			409			—		409
Comprehensive (loss) income attributable to SquareTwo	$	(13,417	)	$	(12,346	)	$	590		$	10,405	$	(14,768	)

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	Three Months Ended September 30, 2013
	Borrower		Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Total
Net income	$	979	$	39	$	2,216	$	(1,868	)	$	1,366
Other comprehensive income, net of tax:
Currency translation adjustment	—		—		507		—			507
Comprehensive income	979		39		2,723		(1,868		)	1,873
Less: Comprehensive income attributable to the noncontrolling interest	—		—		387		—			387
Comprehensive income attributable to SquareTwo	$	979	$	39	$	2,336	$	(1,868	)	$	1,486

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	Nine Months Ended September 30, 2014
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Total
Net (loss) income	$	(23,820	)	$	(20,495	)	$	6,381		$	15,263	$	(22,671	)
Other comprehensive loss, net of tax:
Currency translation adjustment	—			—			(1,287		)	—		(1,287		)
Comprehensive (loss) income	(23,820		)	(20,495		)	5,094			15,263		(23,958		)
Less: Comprehensive income attributable to the noncontrolling interest	—			—			1,149			—		1,149
Comprehensive (loss) income attributable to SquareTwo	$	(23,820	)	$	(20,495	)	$	3,945		$	15,263	$	(25,107	)

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	Nine Months Ended September 30, 2013
	Borrower		Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Total
Net income	$	8,017	$	9,966	$	5,202		$	(14,115	)	$	9,070
Other comprehensive loss, net of tax:
Currency translation adjustment	—		—		(622		)	—			(622		)
Comprehensive income	8,017		9,966		4,580			(14,115		)	8,448
Less: Comprehensive income attributable to the noncontrolling interest	—		—		1,053			—			1,053
Comprehensive income attributable to SquareTwo	$	8,017	$	9,966	$	3,527		$	(14,115	)	$	7,395

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Condensed Consolidating Statements of Cash Flows



	Nine Months Ended September 30, 2014
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total
Operating activities
Net (loss) income	$	(23,820	)	$	(20,495	)	$	6,381		$	15,263		$	(22,671	)
Adjustments to reconcile net (loss) income to net cash (used in) provided by operating activities:
Depreciation and amortization	1,656			3,397			33			—			5,086
Amortization of loan origination fees and debt discount	2,202			—			—			—			2,202
Purchased debt valuation allowance charges	—			808			—			—			808
Stock option expense	41			25			—			—			66
Amortization of prepaid and other non-cash expenses	2,725			508			19			—			3,252
Deferred tax provision, net of valuation allowance	1,312			—			—			—			1,312
Loss from subsidiaries	15,263			—			—			(15,263		)	—
Changes in operating assets and liabilities:
Income tax payable/receivable	(360		)	—			489			—			129
Restricted cash	(17,163		)	(1,170		)	—			—			(18,333		)
Other assets	(2,900		)	(2,443		)	1,657			—			(3,686		)
Accounts payable and accrued liabilities	4,330			155			303			—			4,788
Net cash (used in) provided by operating activities	(16,714		)	(19,215		)	8,882			—			(27,047		)
Investing activities
Investment in purchased debt	—			(81,840		)	(15,642		)	—			(97,482		)
Proceeds applied to purchased debt principal	—			121,072			12,648			—			133,720
Net investments in notes receivable	(170		)	—			—			—			(170		)
Investment in subsidiaries	18,951			—			—			(18,951		)	—
Investment in property and equipment, including internally developed software	(2,993		)	(35		)	—			—			(3,028		)
Net cash provided by (used in) investing activities	15,788			39,197			(2,994		)	(18,951		)	33,040
Financing activities
Repayments of investment by Parent, net	(150		)	(18,951		)	—			18,951			(150		)
Payments on notes payable, net	(568		)	—			—			—			(568		)
Proceeds from lines-of-credit	334,924			—			—			—			334,924
Payments on lines-of-credit	(331,557		)	—			—			—			(331,557		)
Origination fees on lines-of-credit	(257		)	—			—			—			(257		)
Payments on capital lease obligations	(1,279		)	—			—			—			(1,279		)
Net cash provided by (used in) financing activities	1,113			(18,951		)	—			18,951			1,113
Increase in cash and cash equivalents	187			1,031			5,888			—			7,106
Impact of foreign currency translation on cash	—			—			(573		)	—			(573		)
Cash and cash equivalents at beginning of period	—			—			9,379			—			9,379
Cash and cash equivalents at end of period	$	187		$	1,031		$	14,694		$	—		$	15,912
Supplemental cash flow information
Cash paid for interest	$	22,561		$	—		$	—		$	—		$	22,561
Cash paid for income taxes	875			—			2,492			—			3,367
Property and equipment financed with capital leases and notes payable	1,282			—			—			—			1,282

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	Nine Months Ended September 30, 2013
	Borrower			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Total
Operating activities
Net income	$	8,017		$	9,966		$	5,202		$	(14,115	)	$	9,070
Adjustments to reconcile net income to net cash (used in) provided by operating activities:
Depreciation and amortization	3,427			2,549			38			—			6,014
Amortization of loan origination fees and debt discount	2,482			—			—			—			2,482
Recovery of step-up in basis of purchased debt	107			—			—			—			107
Purchased debt valuation allowance reversals	—			(6,442		)	(18		)	—			(6,460		)
Stock option expense	63			36			—			—			99
Amortization of prepaid and other non-cash expenses	2,763			298			283			—			3,344
Income from subsidiaries	(14,115		)	—			—			14,115			—
Changes in operating assets and liabilities:
Income tax payable/receivable	(106		)	—			(2,550		)	—			(2,656		)
Restricted cash	(14,914		)	290			—			—			(14,624		)
Other assets	(2,881		)	4,610			(5,745		)	—			(4,016		)
Accounts payable and accrued liabilities	10,977			(673		)	849			—			11,153
Net cash (used in) provided by operating activities	(4,180		)	10,634			(1,941		)	—			4,513
Investing activities
Investment in purchased debt	—			(216,533		)	(14,462		)	—			(230,995		)
Proceeds applied to purchased debt principal	—			173,742			15,007			—			188,749
Payments to branch offices related to asset purchase program	—			(297		)	—			—			(297		)
Net proceeds from notes receivable	27			—			—						27
Investment in subsidiaries	(32,454		)	—			—			32,454			—
Investment in property and equipment including internally developed software	(3,800		)	—			—			—			(3,800		)
Net cash (used in) provided by investing activities	(36,227		)	(43,088		)	545			32,454			(46,316		)
Financing activities
Proceeds from investment by Parent, net	—			32,454			—			(32,454		)	—
Payments on notes payable, net	(411		)	—			—			—			(411		)
Proceeds from lines-of-credit	472,177			—			—			—			472,177
Payments on lines-of-credit	(429,382		)	—			—			—			(429,382		)
Origination fees on lines-of-credit	(856		)	—			—			—			(856		)
Payments on capital lease obligations	(1,121		)	—			—			—			(1,121		)
Net cash provided by financing activities	40,407			32,454			—			(32,454		)	40,407
Decrease in cash and cash equivalents	—			—			(1,396		)	—			(1,396		)
Impact of foreign currency translation on cash	—			—			(542		)	—			(542		)
Cash and cash equivalents at beginning of period	—			—			7,538			—			7,538
Cash and cash equivalents at end of period	$	—		$	—		$	5,600		$	—		$	5,600
Supplemental cash flow information
Cash paid for interest	$	23,464		$	585		$	—		$	—		$	24,049
Cash paid for income tax	155			—			5,682			—			5,837
Property and equipment financed with capital leases and notes payable	2,066			—			—			—			2,066

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12. Subsequent Events

Loan Amendment

On November 11, 2014, SquareTwo Financial Corporation, together with certain of its domestic and Canadian subsidiaries, entered into Amendment No. 6 to its Loan Agreement ("Amendment No. 6") for the senior revolving credit facility. Pursuant to the terms of Amendment No. 6, the Minimum Adjusted EBITDA Covenant was decreased from $200 million to $165 million for a rolling four fiscal quarter basis beginning with the fiscal quarter ending December 31, 2014. The remaining terms of the Loan Agreement were not impacted by Amendment No. 6.

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

Some of the information in this Quarterly Report on Form 10-Q includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended, and Section 21E of the Securities Exchange Act of 1934, as amended. All statements other than statements of historical facts included in this Quarterly Report on Form 10-Q, including, without limitation, certain statements under “Management’s Discussion and Analysis of Financial Condition and Results of Operations,” may constitute forward-looking statements. In some cases you can identify these “forward-looking statements” by words like “may,” "will," “should,” “expect,” “intend,” “estimate,” “anticipate,” "plan," "foresee," “predict,” “believe,” “potential” or “continue” or, in each case, the negative or other variations or similar expressions. All forward-looking statements reflect our current beliefs and assumptions with respect to our future results, business plans and prospects, and are based on information currently available to us. Accordingly, these statements are subject to significant risks and uncertainties and our actual results, business plans and prospects could differ significantly from those expressed in, or implied by, these statements. Factors that could cause or contribute to such differences include, but are not limited to, those described under “Risk Factors” in our most recent Annual Report on Form 10-K (File No. 333- 170734). We undertake no obligation to update publicly or publicly revise any forward-looking statement, whether as a result of new information or otherwise.

Unless otherwise indicated, the terms (i) “SquareTwo,” “we,” “our,” “us” and the “Company” refer to SquareTwo Financial Corporation and all of its restricted subsidiaries on a consolidated basis, (ii) “SquareTwo Financial Corporation” refers to SquareTwo Financial Corporation and not to its parent company or any of its subsidiaries, and (iii) “Parent” refers to CA Holding, Inc. and not to any of its subsidiaries. You should read this discussion and analysis in conjunction with the condensed consolidated financial statements and notes that appear elsewhere in this Quarterly Report on Form 10-Q. Our financial information may not be indicative of our future performance and does not necessarily reflect what our financial condition and results of operations would have been had we operated as an independent, stand-alone entity during all periods presented.

Our Company

We are a leading purchaser of charged-off consumer and commercial receivables in the accounts receivable management industry. Our primary business is the acquisition, management and collection of charged-off consumer and commercial accounts receivable that we purchase from financial institutions, finance and leasing companies, and other issuers in the U.S. and Canada. We believe that we are one of the largest purchasers of "fresh" charged-off credit card and consumer loan receivables in the U.S. Fresh charged-off credit card and consumer loan receivables are generally 180-210 days past due at the time of sale and typically have not been subject to previous collection attempts by a third-party collection agency. The act of charging off an account is an action required by banking regulations and is an accounting action that does not release the obligor on the account from his/her responsibility to pay amounts due on the account. Because the credit issuer was unable to collect the charged-off receivables that we purchase, we are able to acquire these portfolios at a substantial discount to their face value.

Our business model leverages our analytical expertise, technology platform, operational experience and our network of branch offices, to purchase and then manage the recovery of charged-off receivables. Our focus throughout the recovery process is on the customer and helping the customer resolve their outstanding financial commitments, ensuring that those customers who demonstrate a significant ability to pay their validly incurred contractual obligations actually satisfy their obligations. In accordance with the Fair Square Promise, we are dedicated to treating customers fairly and ethically and maintaining stringent compliance standards, which we believe in turn allows us to liquidate more effectively. From 1999, our first full year of purchasing debt, to September 30, 2014, we have invested approximately $2.6 billion in the acquisition of charged-off receivables, representing over $37.6 billion in face value of accounts. The combination of our historical and future recovery efforts is expected to result in cumulative gross cash proceeds of approximately 2.1x our invested capital.

Based on our proprietary analytical models, which utilize historical and current account level data, as well as economic, pricing and collection trends, we expect that our U.S. owned charged-off receivables as of September 30, 2014 of $7.8 billion (active face value) will generate approximately $617.4 million in estimated remaining proceeds ("ERP") over the next nine years. In addition, we expect our Canadian owned charged-off receivables of $1.4 billion (active face value) to generate approximately $63.7 million in additional ERP. Therefore, the total ERP for both our U.S. and Canadian owned charged-off receivables was $681.1 million as of September 30, 2014. These expectations are based on historical data as well as assumptions about future collection rates, account sales activity and consumer behavior. We cannot guarantee that we will achieve such proceeds.

In the U.S. we primarily utilize our branch offices, which provide nationwide coverage. These offices use eAGLE, an integrated account management system that we have developed and maintain, to liquidate accounts. Each of our branch offices

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has an executed detailed agreement that provides the legal structure for the relationship with SquareTwo, including their right to use eAGLE. Also, while we continue to utilize specialized legal collection firms in the U.S. for a small portion of our older legal accounts, we currently place all non-legal and legal consumer accounts exclusively within our network of branch offices and employ a small number of collectors focused on commercial collections.

During the quarter ended September 30, 2014, the Company continued to expand its asset recovery options by launching plans to open new locations in the fourth quarter of 2014 dedicated to consumer collections. As part of these changes, SquareTwo Financial Commercial Funding Corporation’s legal name was changed to SquareTwo Financial Services Corporation, and it registered the d/b/a name Fresh View Solutions. The financial results for the three and nine months ended September 30, 2014 were not impacted materially by the ongoing efforts to expand our asset recovery options, and Fresh View Solutions’ consumer collections did not commence until after September 30, 2014.

In Canada, we utilize internal collectors and third-party non-legal and legal collection firms which exclusively service our Canadian customers.

Our Branch Offices

Collection efforts on our U.S. purchased debt are generally handled by our branch offices. Under the terms of our contractual arrangements, our offices license our proprietary technology and perform recovery work on our behalf in accordance with our required policies. We are under no obligation to provide accounts to any branch office. We pay our offices a fee, which varies based upon their performance against our return assumptions and is subject to adjustment based upon the performance against our operational requirements. These include providing a positive customer experience within the context of the collections industry and conformance with legal and regulatory requirements. We allocate accounts to our offices based on capacity, geographic coverage, their performance against our return expectations, and adherence to the aforementioned operational requirements.

We believe that our competitive account placement model and our variable fee structure are critical to our performance as they motivate each office to optimize its efforts on its allocated accounts, while at the same time providing for tight focus on both compliance with applicable laws and regulations and a positive customer experience. We believe that our law firm model promotes the highest ethical standards in the industry as our branch offices maintain both SquareTwo’s commitment to the Fair Square Promise which embodies our stringent compliance standards as well as the obligations imposed by membership in the bar associations of the respective states in which their attorneys are licensed to practice law. In addition to these compliance and collections benefits, we believe that law firms generally provide a more professional environment than traditional call centers, helping our offices to more effectively attract and retain quality collectors. Additionally, SquareTwo provides branch offices with training and comprehensive business and operational support to ensure that their relationship with our customers reflects our desire to help customers resolve their financial obligations in a respectful manner.

Underwriting and Purchasing

The success of our business depends heavily on our ability to find charged-off receivables for purchase, evaluate these assets accurately and acquire them at the appropriate pricing. We have a dedicated Business Development team that generates portfolio acquisition opportunities in the markets in which we operate and works with our Decision Science team to prepare pricing models and perform account-level analysis. Historically, we have purchased charged-off receivables from seven of the ten largest U.S. credit card issuers, as well as from super-regional and regional banks and other issuers of credit. Potential purchasing opportunities are reviewed in detail by our Decision Science department, which is responsible for preparing forecasted cash flows from each purchase based on our proprietary statistical models and our experience with similar purchases. These models and related assumptions are reviewed by our investment committee, which includes members of our senior leadership team and representatives from each key business function, to determine the appropriate purchase price for the available portfolios. We target purchases that meet return thresholds determined by our investment committee. In times of increased pricing in the market, we may accept a lower return, while still maintaining our yield-based purchasing strategy. In addition to the credit card and consumer loan business, we are actively engaged in the development of business opportunities in purchasing other forms of charged-off domestic and Canadian financial obligations.

Sources of Revenue and Expense

Sources of Revenue

Our primary sources of revenue are revenues recognized on our portfolio base of purchased debt assets which are driven by cash proceeds from voluntary, non-legal collections, legal collections, court cost recoveries, sales, recourse and

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bankruptcy. Generally, we earn royalties from our branch offices ranging from 2% to 4% of each dollar collected in the non-legal channels for the use of our proprietary collection platform, eAGLE.

Expenses

Purchased Debt Expense

Purchased debt expense represents the direct costs of collections related to our purchased debt. The majority of our direct expenses represent the fees that we pay to our branch offices based on their collections on our purchased debt. The fee we pay to our branch offices varies depending on the age and type of purchased debt and certain network performance targets and other operational factors. In Canada, purchased debt expense includes the cost of our internal collectors as well as fees paid to outside agencies with whom we place certain accounts.

Court Costs, Net

Court costs represent court costs and related fees on accounts placed for legal action. Court costs are expensed as incurred and are reduced by court cost recoveries for purchased debt accounted for under the cost recovery method. Court cost recoveries for purchased debt accounted for under the level yield method are included in level yield proceeds which drive purchased debt revenue, net. We estimate that we recover in excess of one-third of all court costs expended.

Other Direct Operating Expense

Other direct operating expense represents other costs of collections, primarily on purchased debt. Included in other direct operating expense is direct legal compliance and certain other operating and branch office costs. Additionally, other direct operating expense includes the amounts paid to our commercial debt collectors employed by Fresh View Solutions.

Costs to Collect

We consider our true costs to collect on our purchased debt accounts to include purchased debt expense, gross court costs, and other direct operating expense. We measure our costs to collect in relation to total collections rather than revenue due to the timing differences between revenue and expense recognition for GAAP purposes.

Salaries and Payroll Taxes

Salaries and payroll taxes include employment-related expenses, including salaries, wages, bonuses, insurance, payroll taxes and benefits.

General and Administrative

General and administrative expenses consist of rent, utilities, marketing, information technology, property and other miscellaneous taxes, office, travel and entertainment, accounting and payroll services, consulting fees, licenses, and general insurance.

Depreciation and Amortization

We incur depreciation related to our property and equipment. We incur amortization on the value of our internally developed proprietary collection platform eAGLE, which is used by our branch offices.

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Results of Operations

We have two reportable operating segments, as defined by the Financial Accounting Standards Board's ("FASB") Accounting Standards Codification Topic 280, Segment Reporting ("ASC 280"): Domestic and Canada.

A reporting segment's operating results are regularly reviewed by the Company's Chief Operating Decision Maker ("CODM"), our Chief Executive Officer, to make decisions about resources to be allocated to the segment and assess its performance. Consistent with how the Board of Directors, the CODM, and the leadership team review the Company's results, the following discussion and analysis is primarily around consolidated results. Segment specific information reviewed by the CODM and Company directors is discussed later in this section under the heading "Segment Performance Summary".

Three and Nine Months Ended September 30, 2014 Compared to Three and Nine Months Ended September 30, 2013

Purchasing Activity

The following table summarizes the purchasing activity for the three and nine months ended September 30, 2014 compared to the three and nine months ended September 30, 2013:



	Three Months Ended											Nine Months Ended
Purchasing Activity ($ in thousands)	September 30,											September 30,
Purchasing Activity ($ in thousands)	2014			2013			$ Variance			% Variance		2014			2013			$ Variance			% Variance
Credit Card/Consumer Loan - Fresh(1)
Face Value	$	135,678		$	483,252		$	(347,574	)	(71.9	)%	$	557,270		$	1,412,689		$	(855,419	)	(60.6	)%
Price	20,355			64,322			(43,967		)	(68.4	)%	81,409			174,596			(93,187		)	(53.4	)%
Price (%)	15.0		%	13.3		%						14.6		%	12.4		%
Credit Card/Consumer Loan - Non-Fresh(1)
Face Value	151,853			143,125			8,728			6.1	%	201,465			794,235			(592,770		)	(74.6	)%
Price	6,971			7,593			(622		)	(8.2	)%	10,279			40,414			(30,135		)	(74.6	)%
Price (%)	4.6		%	5.3		%						5.1		%	5.1		%
Other(2)
Face Value	54,584			38,718			15,866			41.0	%	144,984			302,558			(157,574		)	(52.1	)%
Price	2,340			1,829			511			27.9	%	5,794			15,985			(10,191		)	(63.8	)%
Price (%)	4.3		%	4.7		%						4.0		%	5.3		%
Purchased Debt - Total
Face Value	$	342,115		$	665,095		$	(322,980	)	(48.6	)%	$	903,719		$	2,509,482		$	(1,605,763	)	(64.0	)%
Price	29,666			73,744			(44,078		)	(59.8	)%	97,482			230,995			(133,513		)	(57.8	)%
Price (%)	8.7		%	11.1		%						10.8		%	9.2		%

(1) Includes both Domestic and Canadian purchases.

(2) Other includes commercial, student loan, medical, and other purchased debt assets.

Credit Card/Consumer Loan - Fresh

Credit card and consumer loan - fresh purchases were $135.7 million of face value receivables at a price of $20.4 million during the three months ended September 30, 2014, compared to $483.3 million of face value receivables at a price of $64.3 million during the three months ended September 30, 2013, a decrease of 71.9% in face value and 68.4% in capital deployed. During the nine months ended September 30, 2014 credit card and consumer loan - fresh purchases were $557.3 million of face value at a price of $81.4 million compared to $1.4 billion of face value at a price of $174.6 million during nine months ended September 30, 2013, a decrease of 60.6% in face value and 53.4% in capital deployed. We generally attribute the decrease in purchasing to decreased supply from certain financial institutions resulting from their anticipation and implementation of expected rules to be promulgated by the Consumer Financial Protection Bureau ("CFPB"). While regulations continue to be better understood by the industry, thereby providing, improved clarity and direction, many banks remain almost entirely focused on enhancing internal activities to ensure they have their respective processes in order before they will reenter the market.

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During the three and nine months ended September 30, 2014, we accepted lower returns on certain purchases relative to prior years. Refer to the Supplemental Performance Data for further information regarding purchases made during the three and nine months ended September 30, 2014.

Credit Card/Consumer Loan - Non-Fresh

Credit card and consumer loan - non-fresh purchases consist of charged-off receivables that have been worked by an external agency or other party external to the originating financial institution. Credit card and consumer loan - non-fresh purchases were $151.9 million of face value receivables at a price of $7.0 million during the three months ended September 30, 2014, compared to $143.1 million of face value receivables at a price of $7.6 million during the three months ended September 30, 2013, an increase of 6.1% in face value and a decrease of 8.2% in capital deployed. Our average price for credit card/consumer loan - non-fresh purchases decreased from 5.3% to 4.6% for the three months ended September 30, 2014. There was an increase in credit card/consumer loan - non-fresh Canadian purchasing during the three months ended September 30, 2014, as discussed in further detail in the Segment Performance Summary. During the nine months ended September 30, 2014 credit card and consumer loan - non-fresh purchases were $201.5 million of face value at a price of $10.3 million compared to $794.2 million of face value at a price of $40.4 million during the nine months ended September 30, 2013, a decrease of 74.6% in face value and a decrease of 74.6% in capital deployed. These decreases were due to a reduction in the supply of charged-off receivables similar to credit card/consumer loan - fresh.

Other

Other purchases consist of commercial, student loan, and other various asset classes. Other purchases were $54.6 million in face value at a price of $2.3 million during the three months ended September 30, 2014, compared to $38.7 million in face value at a price of $1.8 million during the three months ended September 30, 2013, an increase of 41.0% in face value and 27.9% in capital deployed primarily related to commercial purchases.

Other purchases were $145.0 million in face value at a price of $5.8 million during the nine months ended September 30, 2014, compared to $302.6 million in face value at a price of $16.0 million during the nine months ended September 30, 2013, a decrease of 52.1% in face value and 63.8% in capital deployed. These decreases were driven by a decrease in face value and capital deployed for commercial purchases as well as no student loan and medical purchases during the nine months ended September 30, 2014. The commercial purchase decreases were the result of reduction in the supply of charged-off receivables and increased competition in the market, similar to credit card/consumer loan - fresh. In addition, the Company is no longer actively pursuing purchases of medical accounts and has not purchased any medical portfolios since the first quarter of 2013.

Cash Proceeds on Purchased Debt

A key driver to our performance, and one of the primary metrics monitored by our management team, is cash proceeds received from our purchased debt. This measurement, and our focus on cash proceeds, is important because proceeds drive our business operations. Included in cash proceeds are voluntary non-legal collections, legal collections, the reimbursement of court costs, sales of accounts, returns of non-conforming accounts (which we refer to as recourse), and bankruptcy.

The following table summarizes the cash proceeds activity for the three and nine months ended September 30, 2014 compared to the three and nine months ended September 30, 2013:



	Three Months Ended									Nine Months Ended
	September 30,									September 30,
Cash Proceeds ($ in thousands)	2014		2013		$ Variance			% Variance		2014		2013		$ Variance			% Variance
Credit card/consumer loan collections
Voluntary, non-legal collections	$	44,278	$	79,629	$	(35,351	)	(44.4	)%	$	147,189	$	243,634	$	(96,445	)	(39.6	)%
Legal collections	51,058		54,986		(3,928		)	(7.1	)%	158,321		161,991		(3,670		)	(2.3	)%
Other collections(1)	5,172		6,514		(1,342		)	(20.6	)%	15,419		17,866		(2,447		)	(13.7	)%
Total collections	100,508		141,129		(40,621		)	(28.8	)%	320,929		423,491		(102,562		)	(24.2	)%
Sales, recourse & bankruptcy proceeds	1,593		4,164		(2,571		)	(61.7	)%	5,316		15,657		(10,341		)	(66.0	)%
Total cash proceeds on purchased debt	$	102,101	$	145,293	$	(43,192	)	(29.7	)%	$	326,245	$	439,148	$	(112,903	)	(25.7	)%

(1) Other includes collections and court cost recoveries on commercial, student loan, medical, and other accounts.

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Credit Card/Consumer Loan Collections

Voluntary, Non-legal Collections

Credit card and consumer loan voluntary, non-legal collections were $44.3 million during the three months ended September 30, 2014 compared to $79.6 million during the three months ended September 30, 2013, a decrease of 44.4%. During the nine months ended September 30, 2014 credit card and consumer loan voluntary, non-legal collections were $147.2 million compared to $243.6 million during the nine months ended September 30, 2013, a decrease of 39.6%. These decreases were driven primarily by lower face value of purchases during late 2013 and 2014 and therefore less inventory in the voluntary, non-legal channel. Credit card/consumer loan non-legal collections represented 43.4% and 54.8% of total cash proceeds on purchased debt during three months ended September 30, 2014 and 2013, respectively and 45.1% and 55.5% of total cash proceeds on purchased debt during the nine months ended September 30, 2014 and 2013, respectively.

Legal Collections

Credit card and consumer loan legal collections were $51.1 million during the three months ended September 30, 2014 compared to $55.0 million during the three months ended September 30, 2013, a decrease of 7.1%. Credit card and consumer loan legal collections were $158.3 million during the nine months ended September 30, 2014 compared to $162.0 million during the nine months ended September 30, 2013, a decrease of 2.3%. Legal collections were largely unaffected by the lower purchases over the last year due to the time lag between when portfolios are acquired versus when legal action, our strategy of last resort, is commenced. Credit card/consumer loan legal collections represented 50.0% and 37.8% of total cash proceeds on purchased debt during three months ended September 30, 2014 and 2013, respectively and 48.5% and 36.9% of total cash proceeds on purchased debt during the nine months ended September 30, 2014 and 2013, respectively.

Other Collections

Other collections were $5.2 million during the three months ended September 30, 2014 compared to $6.5 million during the three months ended September 30, 2013, a decrease of 20.6%, which is primarily attributable to a decrease in commercial collections based on the timing of commercial purchases. Other collections were $15.4 million during the nine months ended September 30, 2014 compared to $17.9 million during the nine months ended September 30, 2013, a decrease of 13.7%, which is primarily related to lower medical and student loan collections with commercial collections staying relatively consistent with prior year.

Sales, Recourse, and Bankruptcy Proceeds

Sales, recourse, and bankruptcy proceeds were $1.6 million during the three months ended September 30, 2014 compared to $4.2 million during the three months ended September 30, 2013. Sales, recourse, and bankruptcy proceeds were $5.3 million during the nine months ended September 30, 2014 compared to $15.7 million during the nine months ended September 30, 2013. The decrease is directly attributable to a shift in the Company's strategy away from account re-sales. Concurrent with the shift away from account re-sales, the Company made operational improvements to enhance internal bankruptcy processing capabilities.

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Consolidated Results

The following table summarizes the results of our operations for the three months ended September 30, 2014 compared to the three months ended September 30, 2013:



	Three Months Ended
	September 30,
Consolidated Results ($ in thousands)	2014			2013			$ Variance			% Variance
Revenues
Purchased debt revenue, net	$	56,985		$	84,293		$	(27,308	)	(32.4	)%
Other revenue	14			230			(216		)	(93.9	)%
Total revenues	56,999			84,523			(27,524		)	(32.6	)%
Expenses
Purchased debt expense	31,643			44,266			(12,623		)	(28.5	)%
Court costs, net	8,422			9,935			(1,513		)	(15.2	)%
Other direct operating expense	4,061			3,083			978			31.7	%
Salaries and payroll taxes	7,766			7,142			624			8.7	%
General and administrative	3,549			3,330			219			6.6	%
Depreciation and amortization	1,738			2,103			(365		)	(17.4	)%
Total operating expenses	57,179			69,859			(12,680		)	(18.2	)%
Operating (loss) income	(180		)	14,664			(14,844		)	(101.2	)%
Other expenses
Interest expense	11,049			11,392			(343		)	(3.0	)%
Other expense	80			1,316			(1,236		)	(93.9	)%
Total other expenses	11,129			12,708			(1,579		)	(12.4	)%
(Loss) income before income taxes	(11,309		)	1,956			(13,265		)	(1)
Income tax expense	(1,699		)	(590		)	(1,109		)	(188.0	)%
Net (loss) income	$	(13,008	)	$	1,366		$	(14,374	)	(1)

(1) Not meaningful.

Purchased Debt Revenue, Net

Purchased debt revenue, net was $57.0 million during the three months ended September 30, 2014 compared to $84.3 million during the three months ended September 30, 2013, a decrease of $27.3 million or 32.4%. This change was predominantly driven by a $19.9 million decrease in gross revenue on level yield assets. Increased purchase prices led to lower return expectations on certain 2013 and 2014 purchases, which resulted in a lower overall weighted average IRR. Also impacting gross revenue on purchased debt was a decrease in the average carrying value of level yield purchased debt assets from $273.2 million to $228.8 million. Gross revenue on cost recovery assets decreased $2.0 million which was in line with the decrease in cost recovery proceeds due to an older base of existing assets accounted for under the cost recovery method of accounting.

Also contributing to the overall decrease in purchased debt revenue, net was a decrease in net valuation allowance reversals which directly impact purchased debt revenue. During the three months ended September 30, 2014, we recorded $1.3 million net expense for non-cash valuation allowances compared to $2.7 million in reversals of non-cash valuation allowances during the three months ended September 30, 2013.

In addition, purchased debt royalties decreased $1.4 million, which was in line with the decrease in non-legal collections.

Purchased Debt Expense

Purchased debt expense was $31.6 million during the three months ended September 30, 2014 compared to $44.3 million during the three months ended September 30, 2013. Purchased debt expense decreased 28.5%, which was primarily attributable to a decrease of 28.8% in total collections on purchased debt.

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Court Costs, Net

Court costs, net were $8.4 million during the three months ended September 30, 2014, compared to $9.9 million during the three months ended September 30, 2013. Court costs are expensed as incurred; however, partial recovery of these costs occurs over several periods. We estimate that we recover in excess of one-third of all court costs expended.

Other Direct Operating Expense

Other direct operating expense was $4.1 million during the three months ended September 30, 2014, which represented an increase of $1.0 million from the three months ended September 30, 2013. This increase was attributable to certain branch office, legal, and operational expenses, including ongoing investments in operational improvements.

Costs to Collect

We refer to the costs directly related to the collection of purchased debt as our "costs to collect", which includes purchased debt expense, gross court costs, and other direct operating expense. We measure our costs to collect in relation to total collections rather than revenue due to the timing differences between revenue and expense recognition for GAAP purposes. For the purpose of this metric, we use gross court costs in the numerator because court cost recoveries are included in total collections.

The following table summarizes our costs to collect and our costs to collect excluding court costs as a % of total collections for the three months ended September 30, 2014 compared to the three months ended September 30, 2013:



	Three Months Ended
	September 30,
Costs to Collect ($ in thousands)	2014		2013		$ Variance			% Variance
Total collections	100,508		141,129		$	(40,621	)	(28.8	)%

Costs to collect(1)	44,435		57,633		(13,198		)	(22.9	)%
Costs to collect as a % of collections	44.2	%	40.8	%

Costs to collect excluding court costs	35,704		47,349		(11,645		)	(24.6	)%
Costs to collect excluding court costs as a % of collections	35.5	%	33.6	%

(1) Excludes court cost recoveries of $0.3 million and $0.3 million, respectively, to arrive at gross court costs.

The increase in costs to collect was partially due to the mix of legal collections as a % of total proceeds having increased from 37.8% during the three months ended September 30, 2013 to 50.0% during the three months ended September 30, 2014, as well as an increase in court costs and other direct operating expenses. Excluding court costs, costs to collect were slightly higher due to the change in mix of legal collections and an increase in other direct operating expenses.

Other Expense

Other expense recognized during the three months ended September 30, 2013 was primarily related to a prepayment in satisfaction of all future obligations of a residual interest arrangement with a former lender. Previous payments under this lending arrangement were recorded in interest expense.

Income Tax Expense

For the three months ended September 30, 2014 the combined state, federal and Canadian tax expense from operations was $1.7 million compared to income tax expense of $0.6 million for the same period in 2013. The increase was attributable to foreign taxes, U.S. taxes on foreign earnings as well as miscellaneous U.S. state income taxes. Any tax benefit related to pretax losses generated by the Company’s U.S. operations during the three months ended September 30, 2014 has been fully offset by a corresponding increase in the valuation allowance as the Company remains in a full valuation allowance position.

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The following table summarizes the results of our operations for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013:



	Nine Months Ended
	September 30,
Consolidated Results ($ in thousands)	2014			2013			$ Variance			% Variance
Revenues
Purchased debt revenue, net	$	195,313		$	263,939		$	(68,626	)	(26.0	)%
Other revenue	42			621			(579		)	(93.2	)%
Total revenues	195,355			264,560			(69,205		)	(26.2	)%
Expenses
Purchased debt expense	101,310			134,901			(33,591		)	(24.9	)%
Court costs, net	27,563			31,861			(4,298		)	(13.5	)%
Other direct operating expense	11,871			9,175			2,696			29.4	%
Salaries and payroll taxes	22,853			21,147			1,706			8.1	%
General and administrative	11,130			10,778			352			3.3	%
Depreciation and amortization	5,086			6,014			(928		)	(15.4	)%
Total operating expenses	179,813			213,876			(34,063		)	(15.9	)%
Operating (loss) income	15,542			50,684			(35,142		)	(69.3	)%
Other expenses
Interest expense	33,133			34,775			(1,642		)	(4.7	)%
Other expense	273			3,659			(3,386		)	(92.5	)%
Total other expenses	33,406			38,434			(5,028		)	(13.1	)%
(Loss) income before income taxes	(17,864		)	12,250			(30,114		)	(1)
Income tax expense	(4,807		)	(3,180		)	(1,627		)	(51.2	)%
Net (loss) income	$	(22,671	)	$	9,070		$	(31,741	)	(1)

(1) Not meaningful.

Purchased Debt Revenue, Net

Purchased debt revenue, net was $195.3 million during the nine months ended September 30, 2014 compared to $263.9 million during the nine months ended September 30, 2013, a decrease of $68.6 million or 26.0%. This change was predominantly driven by a $51.3 million decrease in gross revenue on level yield assets. Increased purchase prices led to lower return expectations on certain 2013 and 2014 purchases, which resulted in a lower overall weighted average IRR. Gross revenue on cost recovery assets decreased $6.4 million which was in line with the decrease in cost recovery proceeds due to an older base of existing assets accounted for under the cost recovery method of accounting.

During the nine months ended September 30, 2014, we recorded $0.8 million in net expense for non-cash valuation allowances compared to $6.5 million in net reversals of non-cash valuation allowances during the nine months ended September 30, 2013. In addition, purchased debt royalties decreased $3.7 million, which was in line with the decrease in non-legal collections.

Purchased Debt Expense

Purchased debt expense was $101.3 million during the nine months ended September 30, 2014 compared to $134.9 million during the nine months ended September 30, 2013. Purchased debt expense decreased 24.9%, which was primarily attributable to a decrease of 24.2% in total collections on purchased debt.

Court Costs, Net

Court costs, net were $27.6 million during the nine months ended September 30, 2014, compared to $31.9 million during the nine months ended September 30, 2013. Court costs are expensed as incurred; however, partial recovery of these costs occurs over several periods. We estimate that we recover in excess of one-third of all court costs expended.

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Other Direct Operating Expense

Other direct operating expense was $11.9 million during the nine months ended September 30, 2014, which represented an increase of $2.7 million from the nine months ended September 30, 2013. This increase was attributable to certain branch office, legal, and operational expenses, including ongoing investments in operational improvements. As part of the operational improvements, SquareTwo assumed certain operating costs during the second quarter of 2013 which were previously paid for by the branch offices.

Costs to Collect

The following table summarizes our costs to collect and our costs to collect excluding court costs as a % of total collections for the nine months ended September 30, 2014 compared to the nine months ended September 30, 2013:



	Nine Months Ended
	September 30,
Costs to Collect ($ in thousands)	2014		2013		$ Variance			% Variance
Total collections	320,929		423,491		$	(102,562	)	(24.2	)%

Costs to collect(1)	141,689		177,021		(35,332		)	(20.0	)%
Costs to collect as a % of collections	44.1	%	41.8	%

Costs to collect excluding court costs	113,181		144,076		(30,895		)	(21.4	)%
Costs to collect excluding court costs as a % of collections	35.3	%	34.0	%

(1) Excludes court cost recoveries of $0.9 million and $1.1 million, respectively, to arrive at gross court costs.

The increase in costs to collect was partially due to the mix of legal collections as a % of total proceeds having increased from 36.9% during the nine months ended September 30, 2013 to 48.5% during the nine months ended September 30, 2014, as well as an increase in court costs and other direct operating expenses. Excluding court costs, costs to collect were slightly higher due to the change in mix of legal collections and an increase in other direct operating expenses.

Other Expense

Other expense recognized during the nine months ended September 30, 2013 consisted of $1.5 million related to the harmonized sales tax (“HST”) assessment in Canada. In addition, we prepaid and satisfied all future obligations under a residual interest arrangement with a former lender. Previous payments under this lending arrangement were recorded as interest expense.

Income Tax Expense

Income tax expense was $4.8 million for the nine months ended September 30, 2014 compared to income tax expense of $3.2 million for the same period in 2013. The increase was primarily attributable to a $1.4 million expense recognized in the U.S. related to Canadian earnings. While virtually all U.S. tax expense associated with foreign earnings can be offset by the Company’s net operating losses or foreign tax credits available in the U.S., the $1.4 million expense relates specifically to withholding taxes on the amount of Canadian earnings deemed distributed for income tax purposes. Therefore, no additional tax expense will be recognized in the future upon an actual repatriation of cash up to the amount of earnings recognized in 2014.

The remainder of the expense was almost entirely attributable to the Canadian operations based on an effective tax rate of approximately 26.5% as any tax expense or benefit attributable to the pre-tax income or loss in the U.S. was entirely offset by a corresponding change in the valuation allowance.

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Adjusted EBITDA

Adjusted EBITDA is calculated as income before interest, taxes, depreciation and amortization (including amortization of the carrying value on our purchased debt), as adjusted by several items. Adjusted EBITDA generally represents cash proceeds on our owned charged-off receivables plus the contributions of our other business activities less operating expenses (other than non-cash expenses, such as depreciation and amortization) as adjusted. Adjusted EBITDA, which is a non-GAAP financial measure, should not be considered an alternative to, or more meaningful than, net income prepared on a GAAP basis. We present Adjusted EBITDA because we consider it to be an important supplemental measure of our performance. We believe Adjusted EBITDA is representative of our cash flow generation that can be used to purchase charged-off receivables, pay down or service debt, pay income taxes, and for other uses. We believe that Adjusted EBITDA is frequently used by investors and other interested parties in the evaluation of companies in our industry. In addition, the instruments governing our indebtedness use Adjusted EBITDA to measure our compliance with certain covenants and, in certain circumstances, our ability to make certain borrowings. The following table summarizes our Adjusted EBITDA for the three and nine months ended September 30, 2014 compared to the three and nine months ended September 30, 2013:



	Three Months Ended									Nine Months Ended
	September 30,									September 30,
Adjusted EBITDA ($ in thousands)	2014		2013		$ Variance			% Variance		2014		2013		$ Variance			% Variance
Voluntary, non-legal collections	$	44,278	$	79,629	$	(35,351	)	(44.4	)%	$	147,189	$	243,634	$	(96,445	)	(39.6	)%
Legal collections	51,058		54,986		(3,928		)	(7.1	)%	158,321		161,991		(3,670		)	(2.3	)%
Other collections(1)	5,172		6,514		(1,342		)	(20.6	)%	15,419		17,866		(2,447		)	(13.7	)%
Sales, recourse & bankruptcy proceeds	1,593		4,164		(2,571		)	(61.7	)%	5,316		15,657		(10,341		)	(66.0	)%
Contribution of other business activities(2)	1,393		2,990		(1,597		)	(53.4	)%	4,707		9,012		(4,305		)	(47.8	)%
Total inflows	103,494		148,283		(44,789		)	(30.2	)%	330,952		448,160		(117,208		)	(26.2	)%

Purchased debt expense	31,643		44,266		(12,623		)	(28.5	)%	101,310		134,901		(33,591		)	(24.9	)%
Court costs, net	8,422		9,935		(1,513		)	(15.2	)%	27,563		31,861		(4,298		)	(13.5	)%
Other direct operating expense	4,061		3,083		978			31.7	%	11,871		9,175		2,696			29.4	%
Salaries, general and administrative expenses	11,315		10,472		843			8.1	%	33,983		31,925		2,058			6.4	%
Other(3)	468		535		(67		)	(12.5	)%	1,443		3,708		(2,265		)	(61.1	)%
Total outflows	55,909		68,291		(12,382		)	(18.1	)%	176,170		211,570		(35,400		)	(16.7	)%
Adjustments(4)	211		748		(537		)	(71.8	)%	1,016		1,878		(862		)	(45.9	)%
Adjusted EBITDA	$	47,796	$	80,740	$	(32,944	)	(40.8	)%	$	155,798	$	238,468	$	(82,670	)	(34.7	)%

(1) Other includes collections and court cost recoveries on commercial, student loan, medical, and other accounts.

(2) Includes royalties on purchased debt and other revenue.

(3) Represents certain other items consistent with our debt covenant calculation.

(4) Consistent with the covenant calculations within our revolving credit facility, adjustments include the non-cash expense related to option grants of Parent’s equity granted to our employees, directors and branch office owners, branch office note reserves, lease breakup costs, certain consulting fees, management fees paid to KRG, certain transaction expenses, recruiting expense, severance expense, and certain non-recurring items.

The table above represents cash generated by collecting debt, selling debt and other business activities, less operating and other cash expenses, resulting in Adjusted EBITDA. The table below reconciles net income to EBITDA and adjusts for certain purchasing items and other non-cash items to reconcile to Adjusted EBITDA:

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	Three Months Ended											Nine Months Ended
Reconciliation of Net (Loss) Income to Adjusted EBITDA ($ in thousands)	September 30,											September 30,
	2014			2013			$ Variance			% Variance		2014			2013			$ Variance			% Variance
Net (loss) income	$	(13,008	)	$	1,366		$	(14,374	)	(6)		$	(22,671	)	$	9,070		$	(31,741	)	(6)
Interest expense	11,049			11,392			(343		)	(3.0	)%	33,133			34,775			(1,642		)	(4.7	)%
Interest income	(44		)	(38		)	(6		)	(15.8	)%	(101		)	(74		)	(27		)	(36.5	)%
Income tax expense	1,699			590			1,109			188.0	%	4,807			3,180			1,627			51.2	%
Depreciation and amortization	1,738			2,103			(365		)	(17.4	)%	5,086			6,014			(928		)	(15.4	)%
EBITDA	1,434			15,413			(13,979		)	(90.7	)%	20,254			52,965			(32,711		)	(61.8	)%
Adjustments related to purchased debt accounting
Proceeds applied to purchased debt principal(1)	44,820			66,059			(21,239		)	(32.2	)%	133,720			188,749			(55,029		)	(29.2	)%
Amortization of step-up of carrying value(2)	—			—			—			—		—			107			(107		)	(100.0	)%
Purchased debt valuation allowance charges (reversals)(3)	1,331			(2,709		)	4,040			(6)		808			(6,460		)	7,268			(6)
Certain other or non-cash expenses
Stock option expense(4)	17			32			(15		)	(46.9	)%	66			99			(33		)	(33.3	)%
Other(5)	194			1,945			(1,751		)	(90.0	)%	950			3,008			(2,058		)	(68.4	)%
Adjusted EBITDA	$	47,796		$	80,740		$	(32,944	)	(40.8	)%	$	155,798		$	238,468		$	(82,670	)	(34.7	)%

(1) Cash proceeds applied to purchased debt principal rather than recorded as revenue.

(2) Non-cash amortization of a step-up in the carrying value of certain purchased debt assets related to purchase accounting adjustments resulting from the 2005 acquisition of the Company by Parent.

(3) Represents non-cash valuation allowance charges (reversals) on purchased debt.

(4) Represents the non-cash expense related to option grants of Parent’s equity granted to certain employees, directors and branch office owners.

(6) Not meaningful.

The table below reconciles net cash used in operating activities to Adjusted EBITDA:



	Nine Months Ended
Reconciliation of Cash Flow from Operations to Adjusted EBITDA ($ in thousands)	September 30,
	2014			2013			$ Variance			% Variance
Net cash (used in) provided by operating activities	$	(27,047	)	$	4,513		$	(31,560	)	(6)
Proceeds applied to purchased debt principal(1)	133,720			188,749			(55,029		)	(29.2	)%
Interest expense to be paid in cash(2)	30,931			32,293			(1,362		)	(4.2	)%
Interest income	(101		)	(74		)	(27		)	(36.5	)%
Amortization of prepaid and other non-cash expenses	(3,252		)	(3,344		)	92			2.8	%
Changes in operating assets and liabilities and deferred taxes:
Restricted cash(3)	18,333			14,624			3,709			25.4	%
Other operating assets and liabilities and deferred taxes(4)	(2,543		)	(4,481		)	1,938			43.2	%
Income tax expense	4,807			3,180			1,627			51.2	%
Other(5)	950			3,008			(2,058		)	(68.4	)%
Adjusted EBITDA	$	155,798		$	238,468		$	(82,670	)	(34.7	)%

(1) Cash proceeds applied to purchased debt principal are shown in the investing activities section of the condensed consolidated statements of cash flows.

(2) Represents interest expense, excluding non-cash amortization of loan origination fees and debt discount.

(3) Represents the change in restricted cash balances for the period due to the timing of payments on our lines of credit and semi-annual interest payments on our Senior Second Lien Notes.

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(4) The amount represents timing differences due to the recognition of certain expenses and revenue items on a cash versus accrual basis.

(6) Not meaningful.

Segment Performance Summary

We have two reportable segments in accordance with the GAAP criteria for segment reporting: Domestic and Canada. A reporting segment's operating results are regularly reviewed by the CODM to make decisions about resources to be allocated to the segment and assess its performance. The segment operating results discussed in this section are presented on a basis consistent with our current management reporting being reviewed by our Board of Directors and the CODM.

Domestic Performance Summary

The following table presents selected financial data for our Domestic operating segment for the following periods:



Domestic Segment Performance Summary	Three Months Ended											Nine Months Ended
Domestic Segment Performance Summary	September 30,											September 30,
($ in thousands)	2014			2013			$ Variance			% Variance		2014			2013			$ Variance			% Variance
Purchases - face value	$	184,475		$	598,506		$	(414,031	)	(69.2	)%	$	665,222		$	2,323,982		$	(1,658,760	)	(71.4	)%
Purchases - price	21,570			69,309			(47,739		)	(68.9	)%	81,839			216,533			(134,694		)	(62.2	)%
Purchases - price (%)	11.7		%	11.6		%						12.3		%	9.3		%
Cash proceeds on purchased debt	91,035			133,265			(42,230		)	(31.7	)%	293,373			402,311			(108,938		)	(27.1	)%
Total revenues	50,004			77,394			(27,390		)	(35.4	)%	175,208			242,428			(67,220		)	(27.7	)%
Adjusted EBITDA(1)	39,742			71,800			(32,058		)	(44.6	)%	131,945			212,772			(80,827		)	(38.0	)%

Purchases

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Total domestic purchases decreased $414.0 million or 69.2% in face value and $47.7 million or 68.9% in capital deployed. Credit card/consumer loan - fresh debt purchases decreased $345.2 million in face value and $43.7 million in capital deployed. In addition, credit card/consumer loan - non-fresh debt purchases decreased $84.7 million in face value and $4.5 million in capital deployed. We generally attribute the decrease in purchasing to decreased supply from certain financial institutions resulting from their anticipation and implementation of expected rules to be promulgated by the CFPB. While regulations continue to be better understood by the industry, thereby providing, improved clarity and direction, many banks remain almost entirely focused on enhancing internal activities to ensure they have their respective processes in order before they will reenter the market.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Total domestic purchases decreased $1.7 billion or 71.4% in face value and $134.7 million or 62.2% in capital deployed. Credit card/consumer loan - fresh debt decreased $840.6 million in face value and $91.6 million in capital deployed. In addition, credit card/consumer loan - non-fresh debt decreased $660.6 million in face value and $32.9 million in capital deployed and purchases of commercial accounts decreased $124.9 million in face value and $6.0 million in capital deployed. We generally attribute the decrease in purchasing to decreased supply from certain financial institutions resulting from their anticipation and implementation of expected rules to be promulgated by the CFPB. While regulations continue to be better understood by the industry, thereby providing, improved clarity and direction, many banks remain almost entirely focused on enhancing internal activities to ensure they have their respective processes in order before they will reenter the market.

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Cash Proceeds

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Domestic cash proceeds on purchased debt decreased $42.2 million or 31.7%. The largest driver was a decrease of $34.1 million or 49.5% in credit card and consumer loan voluntary, non-legal collections, due to lower face value of purchases in late 2013 and 2014 and therefore less inventory in the voluntary, non-legal channel. In addition, sales decreased $3.5 million due to a shift in the Company's strategy away from account re-sales.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Domestic cash proceeds on purchased debt decreased $108.9 million or 27.1%. The largest driver was a decrease of $92.0 million or 43.6% in credit card and consumer loan voluntary, non-legal collections, due to lower face value of purchases in late 2013 and 2014 and therefore less inventory in the voluntary, non-legal channel. In addition, sales decreased $12.6 million due to a shift in the Company's strategy away from account re-sales.

Total Revenues

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Total revenues attributable to our Domestic segment decreased $27.4 million or 35.4%. Gross revenue on level yield assets decreased by $21.0 million. Increased purchase prices led to lower return expectations on certain 2013 and 2014 purchases, which resulted in a lower overall weighted average IRR. In addition, gross revenue on cost recovery assets decreased $0.9 million, which was in line with the decrease in cost recovery proceeds. During the three months ended September 30, 2014, we recorded $1.3 million net expense for non-cash valuation allowances compared to $2.7 million in reversals of non-cash valuation allowances during the three months ended September 30, 2013. The remaining difference was a $1.4 million decrease in purchased debt royalties, which was in line with the decrease in domestic voluntary, non-legal collections.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Total revenues attributable to our Domestic segment decreased $67.2 million or 27.7%. Gross revenue on level yield assets decreased by $53.1 million. Increased purchase prices led to lower return expectations on certain 2013 and 2014 purchases, which resulted in a lower overall weighted average IRR. In addition, gross revenue on cost recovery assets decreased $3.1 million, which was in line with the decrease in cost recovery proceeds. During the nine months ended September 30, 2014, we recorded $0.8 million in net expense for non-cash valuation allowances compared to $6.5 million in net reversals of non-cash valuation allowances during the nine months ended September 30, 2013. The remaining difference was a $3.7 million decrease in purchased debt royalties, which was in line with the decrease in domestic voluntary, non-legal collections.

Adjusted EBITDA

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Domestic Adjusted EBITDA decreased $32.1 million or 44.6%. This was due primarily to a decrease in cash proceeds on purchased debt of $42.2 million, which resulted in a partially offsetting $12.9 million decrease in costs to collect.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Domestic Adjusted EBITDA decreased $80.8 million or 38.0%. This was due primarily to a decrease in cash proceeds on purchased debt of $108.9 million, which resulted in a partially offsetting $34.5 million decrease in costs to collect.

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Canada Performance Summary

The following table presents selected financial data for our Canada operating segment for the following periods:



Canada Segment Performance Summary	Three Months Ended											Nine Months Ended
Canada Segment Performance Summary	September 30,											September 30,
($ in thousands)	2014			2013			$ Variance			% Variance		2014			2013			$ Variance			% Variance
Purchases - face value	$	157,640		$	66,589		$	91,051		136.7	%	$	238,497		$	185,500		$	52,997		28.6	%
Purchases - price	8,096			4,435			3,661			82.5	%	15,643			14,462			1,181			8.2	%
Purchases - price (%)	5.1		%	6.7		%						6.6		%	7.8		%
Cash proceeds on purchased debt	11,066			12,028			(962		)	(8.0	)%	32,872			36,837			(3,965		)	(10.8	)%
Total revenues	6,995			7,129			(134		)	(1.9	)%	20,147			22,132			(1,985		)	(9.0	)%
Adjusted EBITDA(1)	8,054			8,940			(886		)	(9.9	)%	23,853			25,696			(1,843		)	(7.2	)%

Purchases

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Purchases by our Canada segment increased $91.1 million in face value and $3.7 million in capital deployed due to greater acquisition opportunities in the quarter in credit card/consumer loan - non-fresh that met our return criteria.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Purchases by our Canada segment increased slightly with an additional $53.0 million in face value and $1.2 million in capital deployed for the nine months ended September 30, 2014.

Cash Proceeds

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Canada cash proceeds on purchased debt decreased $1.0 million or 8.0%, primarily driven by a decrease in voluntary, non-legal collections, due to lower face value of purchases in late 2013 and 2014 and therefore less inventory in the voluntary, non-legal channel.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Canada cash proceeds on purchased debt decreased $4.0 million or 10.8%, primarily driven by a decrease in voluntary, non-legal collections, due to lower face value of purchases in late 2013 and 2014 and therefore less inventory in the voluntary, non-legal channel.

Total Revenues

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Total revenues from our Canada segment were $7.0 million, which was relatively consistent with total revenues in the corresponding period in 2013.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Total revenues from our Canada segment decreased $2.0 million or 9.0%. The decrease was due primarily to a $3.3 million decrease in gross revenue on cost recovery assets, which was in line with the decrease in cost recovery proceeds and our cost recovery asset base, as we started placing our Canadian asset purchases on level yield accounting in January 2012. The decrease in gross revenues on cost recovery assets was partially offset by a $1.8 million increase in level yield revenue.

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Adjusted EBITDA

Three months ended September 30, 2014 compared with three months ended September 30, 2013

Adjusted EBITDA decreased $0.9 million or 9.9%. Cash proceeds on purchased debt decreased $1.0 million, which resulted in an offsetting $0.3 million decrease in costs to collect.

Nine months ended September 30, 2014 compared with nine months ended September 30, 2013

Adjusted EBITDA decreased $1.8 million or 7.2%. Cash proceeds on purchased debt decreased $4.0 million, which resulted in an offsetting $0.8 million decrease in costs to collect. In addition, during the nine months ended September 30, 2013 there was a $1.5 million one time harmonized sales tax payment in Canada.

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Supplemental Performance Data

Our Owned Portfolios

As of September 30, 2014, our active owned charged-off receivables in the U.S. and Canada totaled $9.2 billion in face value and consisted of approximately 2.3 million accounts. We believe that these accounts will represent a significant base of cash flows for us over the next nine years. The following table sets forth summary information on our active owned charged-off receivables as of September 30, 2014.



Account Type	# of Active Accts (in thousands)	Avg. Bal. per Acct.		Active Face Value ($ in millions)		Active Face Value (% of Total)		Capital Deployed(1) ($ in millions)		Capital Deployed(1) (% of Total)
Credit Card/Consumer Loan - Fresh	1,436	$	3,986	$	5,724	62.4	%	$	2,077	81.3	%
Credit Card/Consumer Loan - Non-Fresh	733	3,267		2,395		26.1	%	343		13.4	%
Other(2)	106	9,972		1,057		11.5	%	134		5.2	%
Total/Average	2,275	$	4,033	$	9,176	100.0	%	$	2,554	100.0	%

(1) Capital Deployed is an aggregate life-to-date total by account type. It is a representation of resource allocation and includes active and inactive accounts.

(2) Other includes commercial, student loan, medical and other purchased debt assets.

Owned Portfolio Performance

The following tables show certain data related to our purchased debt portfolios. These tables describe purchase price, cash proceeds received to date, estimated remaining cash proceeds, and related gross return on investment.

The gross ROIs for 2007 and 2008 shown below are lower in comparison to most of our historical multiples. These lower ROIs were generally caused by increased market pricing and an overall deterioration in the macroeconomic environment. The gross ROIs for 2013 and 2014 purchases are also lower in comparison to most of our historical returns, primarily due to lower supply that has resulted in increased market competition and rising prices.

U.S. Purchased Debt Portfolio as of September 30, 2014 ($ in thousands)



Purchase Period	Purchase Price(1)		Valuation Allowance (2)			Purchased Debt, net Carrying Value(3)		% of Carrying Value Unamortized(4)		Actual Proceeds Life to Date		Estimated Remaining Proceeds		Total Estimated Proceeds(5)		Gross ROI(6)
2006 and prior	$	896,340	$	(4,235	)	$	1,797	—	%	$	2,102,662	$	4,918	$	2,107,580	2.35x
2007	236,005		(58,282		)	3,523		1	%	349,677		4,696		354,373		1.50x
2008	226,030		(67,808		)	6,340		3	%	337,476		11,255		348,731		1.54x
2009	105,157		(699		)	2,574		2	%	210,208		13,867		224,075		2.13x
2010	164,117		(1,975		)	1,339		1	%	390,138		49,002		439,140		2.68x
2011	244,959		(3,071		)	9,462		4	%	528,009		95,599		623,608		2.55x
2012	246,011		(4,026		)	34,303		14	%	409,374		135,936		545,310		2.22x
2013	240,595		(4,380		)	105,547		44	%	217,674		209,249		426,923		1.77x
2014	81,839		—			57,924		71	%	28,283		92,882		121,165		1.48x
Total	$	2,441,053	$	(144,476	)	$	222,809			$	4,573,501	$	617,404	$	5,190,905	2.13x

(1) Purchase price represents cost of each purchase.

(2) Valuation allowance represents the total valuation allowance on our purchased debt, net of reversals.

(3) Portfolio carrying value represents the net book value of our purchased debt portfolios excluding the impact of the branch office asset purchase program (discontinued).

(4) Percentage of carrying value unamortized represents the carrying value divided by the purchase price.

(5) Total estimated proceeds represent actual proceeds life to date plus the estimated remaining proceeds.

(6) Gross ROI represents the total estimated proceeds divided by purchase price.

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Canada Purchased Debt Portfolio as of September 30, 2014 (U.S. dollars in thousands)



Purchase Period	Purchase Price(1)		Valuation Allowance		Purchased Debt, net Carrying Value		% of Carrying Value Unamortized		Actual Proceeds Life to Date(1)		Estimated Remaining Proceeds(2)		Total Estimated Proceeds		Gross ROI
2006 and prior	$	5,885	$	—	$	—	—	%	$	9,418	$	35	$	9,453	1.61x
2007	7,889		—		—		—	%	14,879		176		15,055		1.91x
2008	6,282		—		—		—	%	9,457		246		9,703		1.54x
2009	3,350		—		—		—	%	9,249		711		9,960		2.97x
2010	7,706		—		—		—	%	28,493		3,435		31,928		4.14x
2011	22,745		—		106		—	%	57,006		7,538		64,544		2.84x
2012	26,746		—		1,002		4	%	46,454		9,840		56,294		2.10x
2013	17,515		—		3,542		20	%	20,998		17,056		38,054		2.17x
2014	15,643		—		10,283		66	%	7,132		24,697		31,829		2.03x
Total	$	113,761	$	—	$	14,933			$	203,086	$	63,734	$	266,820	2.35x

(1) Converted to U.S. dollars using average historical exchange rates effective in the month of activity.

(2) Converted to U.S. dollars using the exchange rate as of September 30, 2014.

Consolidated Purchased Debt Portfolio as of September 30, 2014 (U.S. dollars in thousands)



Purchase Period	Purchase Price(1)		Valuation Allowance			Purchased Debt, net Carrying Value(3)		% of Carrying Value Unamortized		Actual Proceeds Life to Date(1)		Estimated Remaining Proceeds(2)		Total Estimated Proceeds		Gross ROI
2006 and prior	$	902,225	$	(4,235	)	$	1,797	—	%	$	2,112,080	$	4,953	$	2,117,033	2.35x
2007	243,894		(58,282		)	3,523		1	%	364,556		4,872		369,428		1.51x
2008	232,312		(67,808		)	6,340		3	%	346,933		11,501		358,434		1.54x
2009	108,507		(699		)	2,574		2	%	219,457		14,578		234,035		2.16x
2010	171,823		(1,975		)	1,339		1	%	418,631		52,437		471,068		2.74x
2011	267,704		(3,071		)	9,568		4	%	585,015		103,137		688,152		2.57x
2012	272,757		(4,026		)	35,305		13	%	455,828		145,776		601,604		2.21x
2013	258,110		(4,380		)	109,089		42	%	238,672		226,305		464,977		1.80x
2014	97,482		—			68,207		70	%	35,415		117,579		152,994		1.57x
Total	$	2,554,814	$	(144,476	)	$	237,742			$	4,776,587	$	681,138	$	5,457,725	2.14x

(1) Canadian amounts converted to U.S. dollars using average historical exchange rates effective in the month of activity.

(2) Canadian amounts converted to U.S. dollars using the exchange rate as of September 30, 2014.

(3) Portfolio carrying value represents the net book value of our purchased debt portfolios excluding the impact of the branch office asset purchase program (discontinued).

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Estimated Remaining Proceeds

Based on our proprietary models and analytics, we have developed detailed cash flow forecasts for our charged-off receivables. As outlined in the tables below, we anticipate that our U.S. owned charged-off receivables as of September 30, 2014 will generate a total of approximately $617.4 million of gross cash proceeds over the next nine years. Our ERP expectations are based on historical data as well as assumptions about future collection rates and consumer behavior and are subject to a variety of factors that are beyond our control, and we cannot guarantee that we will achieve these results.

U.S. Purchased Debt Calendar Year Estimated Remaining Proceeds by Year of Purchase ($ in thousands)



Purchase Year	2014			2015			2016			2017			2018			2019			2020			2021 and thereafter			Total
2006 and prior(1)	$	1,097		$	2,287		$	1,065		$	368		$	87		$	14		$	—		$	—		$	4,918
2007	1,258			3,009			429			—			—			—			—			—			4,696
2008	2,350			6,681			1,969			255			—			—			—			—			11,255
2009	1,740			5,833			3,943			2,007			344			—			—			—			13,867
2010	5,401			17,513			12,706			8,472			4,221			689			—			—			49,002
2011	11,359			31,261			21,351			15,730			10,349			4,891			658			—			95,599
2012	17,712			47,519			26,201			17,827			13,196			8,683			4,060			738			135,936
2013	25,592			79,505			43,377			22,831			15,896			11,105			7,200			3,743			209,249
2014	8,285			32,013			20,901			11,959			6,713			4,329			3,165			5,517			92,882
Total	$74,794			$225,621			$131,942			$79,449			$50,806			$29,711			$15,083			$9,998			$617,404
Cumulative Percent	12.1		%	48.7		%	70.0		%	82.9		%	91.1		%	95.9		%	98.4		%	100.0		%

U.S. Purchased Debt Rolling Twelve Months Estimated Remaining Proceeds by Year of Purchase ($ in thousands)



Purchase Year	0 - 12 Months			13 - 24 Months			25 - 36 Months			37 - 48 Months			49 - 60 Months			61 - 72 Months			73 - 84 Months			85 - 108 Months			Total
2006 and prior(1)	$	2,949		$	1,320		$	492		$	133		$	24		$	—		$	—		$	—		$	4,918
2007	3,819			875			2			—			—			—			—			—			4,696
2008	7,862			2,878			514			1			—			—			—			—			11,255
2009	6,284			4,428			2,491			663			1			—			—			—			13,867
2010	19,039			13,817			9,517			5,284			1,341			4			—			—			49,002
2011	36,337			22,861			17,072			11,705			6,255			1,364			5			—			95,599
2012	56,320			29,696			19,214			14,364			9,807			5,215			1,110			210			135,936
2013	89,470			50,875			26,191			17,243			12,114			8,182			4,250			924			209,249
2014	32,993			24,090			13,666			7,765			4,741			3,390			2,652			3,585			92,882
Total	$255,073			$150,840			$89,159			$57,158			$34,283			$18,155			$8,017			$4,719			$617,404
Cumulative Percent	41.3		%	65.7		%	80.2		%	89.4		%	95.0		%	97.9		%	99.2		%	100.0		%

(1) Represents estimated remaining proceeds for purchased debt acquired during the years 2004-2006.

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Historical Proceeds

The following table demonstrates our ability to realize continuing cash flow streams on our purchased debt, showing our cash proceeds by year, and year of purchase.

U.S. Period of Proceeds ($ in thousands)



Purchase Year	2006 & Prior(2)		2007		2008		2009		2010		2011		2012		2013		2014		Total
2006 & Prior(1)	$	1,329,748	$	338,808	$	180,830	$	96,778	$	61,165	$	40,410	$	26,238	$	18,207	$	10,478	$	2,102,662
2007	—		98,929		111,049		54,363		34,500		21,178		14,424		9,919		5,315		349,677
2008	—		—		98,025		88,017		65,471		38,416		24,983		15,024		7,540		337,476
2009	—		—		—		49,074		71,698		41,300		27,948		13,681		6,507		210,208
2010	—		—		—		—		90,429		130,132		94,374		53,213		21,990		390,138
2011	—		—		—		—		—		163,304		196,236		120,068		48,401		528,009
2012	—		—		—		—		—		—		176,605		163,096		69,673		409,374
2013	—		—		—		—		—		—		—		122,488		95,186		217,674
2014	—		—		—		—		—		—		—		—		28,283		28,283
Total	$	1,329,748	$	437,737	$	389,904	$	288,232	$	323,263	$	434,740	$	560,808	$	515,696	$	293,373	$	4,573,501

(1) Represents purchase vintage years 1998-2006.

(2) Represents proceeds from purchased debt during the years 1998-2006.

The following chart represents our historical proceeds on owned debt by quarter, with collections shown in black and sales, recourse & bankruptcy proceeds in gray.

Quarterly Cash Proceeds ($ in millions)

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Liquidity and Capital Resources

Working Capital

Our primary sources of working capital are cash flows from operations, excess cash balances and bank borrowings. Our working capital levels fluctuate throughout the year based on purchasing volumes and are generally positively affected by first and second quarter collections each year when we historically tend to have higher collections. Generally, these higher first and second quarter collections are driven by tax refunds, patterns of seasonal employment, and the impact of reductions in consumer spending following the holiday season. We use our working capital to purchase charged-off receivables, service our indebtedness, and fund our operations to generate long-term growth.

Under our current borrowing structure, our lines of credit are managed separately within our domestic and Canadian operations. Our domestic operation sweeps all cash proceeds obtained to pay down our domestic line of credit daily. As a result, we maintain minimal domestic cash balances on hand, excluding our restricted cash. Domestically and in Canada, we borrow from our line of credit only as needed to reduce overall interest costs on our outstanding borrowings. Our line of credit, in total for both domestic and Canadian operations, is subject to a borrowing base and is described further in our condensed consolidated financial statements. To the extent our Canadian cash flow exceeds the cash flow needs of our Canadian operation including purchasing new assets, the excess Canadian cash flow, after paying down the Canadian line of credit to zero, is held in our Canadian bank accounts or used to pay down our domestic line of credit.

The Company from time to time enters into forward flow purchase agreements with various debt sellers to purchase specified amounts of debt for designated prices. These contracts typically cover a year or less and can generally be canceled by the Company at its discretion with 30-60 days’ notice. At September 30, 2014, the Company did not have any significant non-cancelable forward flow purchase agreements.

Based on our current level of operations, we have ample liquidity to fund our operations through the next twelve months. Our purchasing volumes and proceeds in any period fluctuate based on pricing and other macro-economic factors. We view our liquidity as our availability to borrow on our domestic and Canadian line of credit, plus our domestic and Canadian non-restricted cash balances, which primarily includes excess Canadian cash on hand. As of September 30, 2014, our total availability under our line of credit was $59.6 million based on our borrowing base calculation, and our non-restricted cash balances were $15.9 million, resulting in liquidity as of September 30, 2014 of $75.5 million.

Cash Flows

Our primary sources of liquidity are cash proceeds from purchased debt, cash from operations, excess cash balances, and borrowings on our senior revolving credit facility. Our primary uses of liquidity are to purchase additional charged-off receivables, fund operating expenses, and service our indebtedness. Our total indebtedness, net of discount, at September 30, 2014 and December 31, 2013 was $440.8 million and $437.4 million, respectively, including obligations under capital leases. Our ability to service our debt and to fund planned purchases of charged-off receivables will depend on our ability to generate cash proceeds in the future, which, to a certain extent, is subject to general economic, financial, competitive, legislative, regulatory and other factors beyond our control.

The following table provides a summary of the components of cash flow for the nine months ended September 30, 2014 and 2013:



	Nine Months Ended
	September 30,
$ in thousands	2014			2013
Net cash (used in) provided by operating activities	$	(27,047	)	$	4,513
Net cash provided by (used in) investing activities	33,040			(46,316		)
Net cash provided by financing activities	1,113			40,407
Increase (decrease) in cash and cash equivalents (1)	$	7,106		$	(1,396	)

(1) Before the impact of foreign currency translation on cash of $(573) and $(542), respectively.

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Operating Activities

Cash generated from operations is dependent upon our ability to generate proceeds on our purchased debt. Many factors, including the economy and our branch offices' ability to maintain low collector turnover and adequate liquidation rates, are essential to our ability to generate cash proceeds. Fluctuations in these factors that cause volatility in our business could have a material impact on our expected future cash flows. Proceeds on purchased debt recorded as revenue are included in the operating activities, while proceeds recorded as amortization of purchased debt principal are included in the investing activities. See the reconciliation of cash flow from operations to Adjusted EBITDA in the Results of Operations section herein.

Our operating activities used net cash of $27.0 million and provided $4.5 million during the nine months ended September 30, 2014 and 2013, respectively, resulting in a net increase in cash used in operating activities of $31.6 million. The increase in cash used was primarily due to a $57.7 million decrease in gross revenue recognized on purchased debt assets. This was partially offset by a corresponding decrease in costs to collect including court costs of $35.3 million. The remaining change in net cash provided by operating activities was due to normal changes in operating assets and liabilities.

Investing Activities

Our investing activities provided net cash of $33.0 million and used $46.3 million during the nine months ended September 30, 2014 and 2013, respectively. Cash used in investing activities is primarily driven by investments in charged-off receivables offset by cash proceeds applied to the carrying value of our purchased debt. The increase in cash provided by investing activities of $79.4 million was due primarily to a $133.5 million decrease in investments in purchased debt, partially offset by a $55.0 million decrease in cash proceeds recorded as a reduction of our purchased debt carrying value.

Financing Activities

Financing activities provided net cash of $1.1 million and $40.4 million during the nine months ended September 30, 2014 and 2013, respectively. Financing activities are primarily driven by purchasing volume (which drives our incremental borrowing), payments on our revolving credit facility, capital lease obligations, and payments of origination fees on our revolving line of credit. Cash is provided by draws on our revolving credit facility and proceeds are used to pay down the revolving credit facility. The increase in cash used by financing activities of $39.3 million was due to a decrease of $137.3 million in draws on our revolving credit facility used to fund purchases and overhead costs. Lower purchasing resulted in lower collections which led to a $97.8 million decrease in payments on our revolving credit facility.

Long-term Financing

Senior Revolving Credit Facility and Senior Second Lien Notes

As of September 30, 2014, there were no material changes to the Company's revolving credit facility or its Senior Second Lien Notes from the information previously disclosed except for additional draws and repayments on the revolving credit facility. The balance of the outstanding line of credit under the revolving facility was $148.6 million and $145.3 million at September 30, 2014 and December 31, 2013, respectively; a decrease of $3.4 million. At September 30, 2014, our availability under the line of credit was $59.6 million based on our borrowing base calculation.

Subsequent to September 30, 2014, the Company entered into Amendment No. 6 to its Loan Agreement, ("Amendment No. 6") for the senior revolving credit facility, which decreased the Minimum Adjusted EBITDA Covenant from $200 million to $165 million for a rolling four fiscal quarter basis beginning with the fiscal quarter ending December 31, 2014.

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Company Debt Outstanding as a Multiple of TTM Adjusted EBITDA

We believe the metric of debt outstanding as a multiple of TTM Adjusted EBITDA is representative of the Company's business model operating leverage. The ratio increased from 1.5x at September 30, 2013 to 2.0x at September 30, 2014 as a result of a 28.4% decrease in our TTM Adjusted EBITDA and a 5.7% decrease in our total debt. Adjusted EBITDA declined primarily due to lower cash proceeds on purchased debt.

Covenants

The senior revolving credit facility and the Senior Second Lien Notes have certain covenants and restrictions, as is customary for such facilities, with which the Company must comply. Some of the financial covenants under the revolving credit facility include: minimum Adjusted EBITDA, capital expenditures limits, and maximum operating lease obligations. The minimum Adjusted EBITDA covenant, as defined in detail in the revolving credit facility agreement is $200 million for each of the trailing twelve month periods following the fiscal quarter ending March 31, 2012. The maximum capital expenditures covenant for any fiscal year, as further described in the revolving credit facility agreement, is $8 million and is subject to provisions set forth in the agreement. Maximum aggregate rent expense and certain other operating lease obligations, excluding a certain operating lease, are $3 million in any fiscal year.

As of September 30, 2014, the Company was in compliance with all covenants and restrictions of the revolving credit facility and Senior Second Lien Notes.

As noted above, the Minimum Adjusted EBITDA Covenant was decreased from $200 million to $165 million for a rolling four fiscal quarter basis beginning with the fiscal quarter ending December 31, 2014.

Capital Leases

We had outstanding capital lease obligations relating to computer and office equipment of $2.0 million and software agreements of $0.8 million as of September 30, 2014.

Related Party Loans

During 2001, we entered into two promissory notes with two individuals related to a co-founder and member of our Board of Directors, P. Scott Lowery. The notes were issued to repurchase common stock of SquareTwo held by these related parties. These notes bear interest at a fixed rate of 8.0% and require us to make monthly principal and interest payments of less than $0.1 million. As of September 30, 2014, these notes had outstanding balances of $0.4 million and $0.3 million, respectively. The notes mature on January 15, 2016, and August 15, 2021, respectively.

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Off-Balance Sheet Arrangements

As of September 30, 2014, we did not have any off balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.

Critical Accounting Policies

The preparation of financial statements and related disclosures in conformity with GAAP and our discussion and analysis of our financial condition and results of operations require our management to make judgments, assumptions and estimates that affect the amounts reported in our condensed consolidated financial statements and accompanying notes. We base our estimates on historical experience and on various other assumptions we believe to be reasonable under the circumstances, the results of which form the basis for making judgments about the carrying values of assets and liabilities. Actual results may differ from these estimates and such differences may be material.

Management believes our critical accounting policies and estimates are those related to revenue recognition, accounting estimates, valuation of acquired intangibles and goodwill and income taxes. Management believes these policies to be critical because they are both important to the portrayal of our financial condition and results, and they require management to make judgments and estimates about matters that are inherently uncertain.

Revenue

We account for our purchased debt under the guidance of ASC Topic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality” (“ASC 310-30”). Under ASC 310-30, static pools of purchased debt, aggregated based on certain common risk criteria, can be accounted for under either the interest method of accounting or the cost recovery method of accounting. Revenue recognition under ASC 310-30 is based in part on life-to-date performance of our static pools as well as our forecasts of future proceeds on those pools, which reflect our judgments and various assumptions and estimates made quarterly. See accounting for income recognized on purchased debt discussed in detail in "Management's Discussion and Analysis of Financial Condition and Results of Operations" as well as Note 2 to the condensed consolidated financial statements.

Accounting Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the amounts reported in the financial statements and the accompanying notes. Actual results could differ from those estimates. Our condensed consolidated financial statements are based on a number of significant estimates, including the collectability of purchased debt and the timing of such proceeds. Due to the uncertainties inherent in the estimation process, it is at least reasonably possible that our estimates in connection with these items could be materially revised within the near term.

Goodwill and Intangible Assets

Goodwill represents the cost of acquired businesses in excess of the fair value assigned to the net tangible and identifiable intangible assets acquired. As prescribed by ASC Topic 350, "Intangibles-Goodwill and Other", goodwill is not amortized. We review goodwill for impairment annually, or more frequently, if indicators of possible impairment arise. Potential impairment is indicated when the book value of a reporting unit, including goodwill, exceeds its fair value. Significant judgments are required to estimate the fair value of reporting units and intangible assets including estimating future cash flows, and determining appropriate discount rates, growth rates, and other assumptions. If potential impairment exists, the fair value of the reporting unit is compared to the fair value of its assets and liabilities, excluding goodwill, to estimate the implied value of the reporting unit's goodwill. An impairment loss is recognized for any excess of the book value of the reporting unit's goodwill over the implied fair value.

In connection with the Acquisition, certain intangible assets were identified. The branch office intangible, with a value of $24.9 million, was deemed to have an indefinite life and, therefore, is not being amortized. We perform an impairment test annually, or more frequently, if events or changes in circumstances indicate impairment of intangible assets. Our judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of our businesses, market conditions and other factors.

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Income Taxes

The Company uses the liability method of accounting for income taxes in accordance with the authoritative guidance for income taxes. When the Company prepares its consolidated financial statements, it estimates income taxes based on the various jurisdictions where it conducts business. This requires the Company to estimate current tax exposure and to assess temporary differences that result from differing treatments of certain items for tax and accounting purposes. Deferred income taxes are recognized based on the difference between the financial statements and income tax bases of assets and liabilities using the enacted tax rates in effect for the year in which the differences are expected to reverse. The Company then assesses the likelihood that deferred tax assets will be realized. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. When the Company establishes a valuation allowance or increases this allowance in an accounting period, it records a corresponding tax expense in the consolidated statements of operations. The Company includes interest and penalties related to the income taxes within its provision for income taxes. See Note 8 for additional discussion of income taxes.

Management must make significant judgments to determine the provision for income taxes, deferred tax assets and liabilities, and any valuation allowance to be recorded against the deferred tax assets.

Item 3. Quantitative and Qualitative Disclosure About Market Risk.

Market Risk

We are exposed to various types of market risk in the normal course of business, including the impact of interest rate changes, foreign currency exchange rate fluctuations, changes in corporate tax rates, and inflation. From time to time, we employ risk management strategies that may include the use of derivatives, such as interest rate swap agreements. We do not enter into derivatives for trading purposes.

For additional discussion of market risks affecting SquareTwo Financial, see "Quantitative and Qualitative Disclosure About Market Risk" in our Annual Report on Form 10-K. Our exposure to market risk has not changed materially since the filing of our most recent Annual Report on Form 10-K.

Item 4. Controls and Procedures.

Under the supervision and with the participation of our management, including the Chief Executive Officer and Chief Financial Officer, we have evaluated the effectiveness of our disclosure controls and procedures (as such term is defined in Rules 13a-15(e) and 15d-15(e) under the Securities Exchange Act of 1934) as of the end of the period covered by this report. Based on that evaluation, the Chief Executive Officer and Chief Financial Officer have concluded that these disclosure controls and procedures were effective as of the end of the period covered by this report. There were no changes in our internal control over financial reporting during the three months ended September 30, 2014 that have materially affected, or are reasonably likely to materially affect, our internal control over financial reporting.

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PART II

Item 1. Legal Proceedings.

Item 1A. Risk Factors.

In addition to the other information set forth in this report, you should carefully consider the factors discussed in the section entitled "Risk Factors" in our most recent Annual Report on Form 10-K.

There have been no material changes to risk factors previously disclosed in our most recent Annual Report on Form 10-K.

Item 2. Unregistered Sales of Equity Securities and Use of Proceeds.

None.

Item 3. Defaults Upon Senior Securities.

None.

Item 4. Mine Safety Disclosures.

Not applicable.

Item 5. Other Information.

None.

Item 6. Exhibits.



Exhibit No.	Description

31.1	Certification of Principal Executive Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002

31.2	Certification of Principal Financial Officer pursuant to Section 302 of the Sarbanes Oxley Act of 2002

32.1	Certification of Principal Executive Officer and Principal Financial Officer pursuant to Section 906 of the Sarbanes Oxley Act of 2002

101.INS	XBRL Instance Document

101.SCH	XBRL Taxonomy Extension Schema Document

101.CAL	XBRL Taxonomy Extension Calculation Linkbase Document

101.LAB	XBRL Taxonomy Extension Label Linkbase Document

101.PRE	XBRL Taxonomy Extension Presentation Linkbase Document

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.



	SQUARETWO FINANCIAL CORPORATION

November 13, 2014	By:	/s/ Paul A. Larkins
	Name:	Paul A. Larkins
	Title:	Chief Executive Officer
		(Principal Executive Officer)

November 13, 2014	By:	/s/ John D. Lowe
	Name:	John D. Lowe
	Title:	Senior Vice President and Chief Financial Officer
		(Principal Financial and Accounting Officer)

Attached files

SquareTwo Financial Corp Reports

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