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PRAA > SEC Filings for PRAA > Form 10-Q on 7-Nov-2012All Recent SEC Filings

Show all filings for PORTFOLIO RECOVERY ASSOCIATES INC

Form 10-Q for PORTFOLIO RECOVERY ASSOCIATES INC


7-Nov-2012

Quarterly Report


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

Cautionary Statements Pursuant to Safe Harbor Provisions of the Private Securities Litigation Reform Act of 1995:

This report contains forward-looking statements within the meaning of the federal securities laws. These forward-looking statements involve risks, uncertainties and assumptions that, if they never materialize or prove incorrect, could cause our results to differ materially from those expressed or implied by such forward-looking statements. All statements, other than statements of historical fact, are forward-looking statements, including statements regarding overall trends, gross margin trends, operating cost trends, liquidity and capital needs and other statements of expectations, beliefs, future plans and strategies, anticipated events or trends, and similar expressions concerning matters that are not historical facts. The risks, uncertainties and assumptions referred to above may include the following:

a prolonged economic recovery or a deterioration in the economic or inflationary environment in the United States or the United Kingdom, including the interest rate environment, that may have an adverse effect on our collections, results of operations, revenue and stock price or on the stability of the financial system as a whole;

our ability to purchase defaulted consumer receivables at appropriate prices;

our ability to replace our defaulted consumer receivables with additional receivables portfolios;

our ability to obtain accurate and authentic account documents relating to accounts that we acquire and the possibility that documents that we provide could contain errors;

our ability to successfully acquire receivables of new asset types;

changes in the business practices of credit originators in terms of selling defaulted consumer receivables;

changes in government regulations that affect our ability to collect sufficient amounts on our defaulted consumer receivables;

changes in or interpretation of tax laws or adverse results of tax audits;

changes in bankruptcy or collection laws that could negatively affect our business, including by causing an increase in certain types of bankruptcy filings involving liquidations, which may cause our collections to decrease;

our ability to employ and retain qualified employees, especially collection personnel, and our senior management team;

our work force could become unionized in the future, which could adversely affect the stability of our production and increase our costs;

changes in the credit or capital markets, which affect our ability to borrow money or raise capital;

the degree and nature of our competition;

the possibility that we could incur goodwill impairment charges;

our ability to retain existing clients and obtain new clients for our fee-for-service businesses;

our ability to comply with regulations of the collection industry;

our ability to successfully operate and/or integrate new business acquisitions;


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our ability to maintain, renegotiate or replace our credit facility;

our ability to satisfy the restrictive covenants in our debt agreements;

our ability to manage risks associated with our international operations acquired on January 16, 2012;

the imposition of additional taxes on us;

changes in interest rates, which could reduce our net income, and the possibility that future hedging strategies may not be successful, which could adversely affect our results of operations and financial condition, as could our failure to comply with hedge accounting principles and interpretations;

the possibility that we could incur significant allowance charges on our finance receivables;

our ability to manage growth successfully;

the possibility that we could incur business or technology disruptions, or not adapt to technological advances;

the possibility that we or our industry could experience negative publicity or reputational attacks;

the sufficiency of our funds generated from operations, existing cash and available borrowings to finance our current operations; and

the risk factors listed from time to time in our filings with the SEC.

You should assume that the information appearing in this quarterly report is accurate only as of the date it was issued. Our business, financial condition, results of operations and prospects may have changed since that date.

For a discussion of the risks, uncertainties and assumptions that could affect our future events, developments or results, you should carefully review the following "Management's Discussion and Analysis of Financial Condition and Results of Operations," as well as the discussion of "Business" and "Risk Factors" described in our 2011 Annual Report on Form 10-K, filed on February 28, 2012.

Our forward-looking statements could be wrong in light of these and other risks, uncertainties and assumptions. The future events, developments or results described in this report could turn out to be materially different. We have no obligation to publicly update or revise our forward-looking statements after the date of this report and you should not expect us to do so.

Investors should also be aware that while we do, from time to time, communicate with securities analysts and others, we do not, by policy, selectively disclose to them any material nonpublic information or other confidential commercial information. Accordingly, stockholders should not assume that we agree with any statement or report issued by any analyst regardless of the content of the statement or report. We do not, by policy, confirm forecasts or projections issued by others. Thus, to the extent that reports issued by securities analysts contain any projections, forecasts or opinions, such reports are not our responsibility.

Definitions:

"Allowance charges" refers to a reduction in income recognized on finance receivables on pools of finance receivables whose cash collection estimates are not received or projected to not be received.

"Amortization rate" refers to cash collections applied to principal on finance receivables as a percentage of total cash collections.

"Buybacks" refers to purchase price refunded by the seller due to the return of non-compliant accounts.

"Cash collections" refers to collections from customers on our owned portfolios.

"Cash receipts" refers to collections on our owned portfolios plus fee income.


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"Core" accounts or portfolios refer to accounts or portfolios that are defaulted consumer receivables and are not in a bankrupt status upon purchase. These accounts are aggregated separately from purchased bankruptcy accounts. Core accounts do not include the accounts we purchase in the United Kingdom.

"EBITDA" refers to earnings before interest, taxes, depreciation and amortization.

"Estimated remaining collections" refers to the sum of all future projected cash collections on our owned portfolios.

"Fee income" refers to revenues generated from our fee-for-service subsidiaries.

"Income recognized on finance receivables" refers to income derived from our owned debt portfolios.

"Income recognized on finance receivables, net" refers to income derived from our owned debt portfolios and is shown net of allowance charges.

"Net finance receivable balance" is recorded on our balance sheet and refers to the purchase price less principal amortization and net allowance charges.

"Principal amortization" refers to cash collections applied to principal on finance receivables.

"Purchase price" refers to the cash paid to a seller to acquire defaulted consumer receivables, plus certain capitalized costs, less buybacks.

"Purchased bankruptcy" accounts or portfolios refer to accounts or portfolios that are in bankruptcy when we purchase them and as such are purchased as a pool of bankrupt accounts.

"Total estimated collections" refers to the actual cash collections, including cash sales, plus estimated remaining collections.

"Total estimated collections to purchase price" refers to the total estimated collections divided by the purchase price.

Overview

The Company is a specialized financial and business services company. Our primary business is the purchase, collection and management of portfolios of defaulted consumer receivables. We also service receivables on behalf of clients on either a commission or transaction-fee basis as well as providing class action claims settlement recovery services and related payment processing to corporate clients.

The Company is headquartered in Norfolk, Virginia, and employs approximately 3,100 team members. The Company's shares of common stock are traded on the NASDAQ Global Select Market under the symbol "PRAA."

On January 16, 2012, the Company acquired 100% of the equity interest in MHH. Based in Kilmarnock, Scotland, MHH employs approximately 250 people and offers outsourced and contingent consumer debt recovery on behalf of banks, credit providers and debt purchasers, as well as distressed and dormant niche portfolio purchasing.

Earnings Summary

During the third quarter of 2012, net income attributable to the Company was $33.3 million, or $1.96 per diluted share, compared with $25.5 million, or $1.48 per diluted share, in the third quarter of 2011. Total revenue was $150.5 million in the third quarter of 2012, up 31.7% from the same quarter one year earlier. Revenues in the recently completed quarter consisted of $135.8 million in income recognized on finance receivables, net of allowance charges, and $14.8 million in fee income. Income recognized on finance receivables, net of allowance charges, increased $32.9 million, or 32.0%, over the same period in 2011, primarily as a result of a significant increase in cash collections. Cash collections were $229.1 million in the third quarter of 2012, up 25.7% or $46.9 million as compared to the third quarter of 2011. During the quarter, $1.6 million in net allowance charges were incurred, compared with $0.7 million in the comparable quarter of 2011. Our performance has been positively impacted by operational efficiencies surrounding the cash collections process, including the continued refinement of account scoring analytics as it relates to both legal and non-legal collection channels. Additionally, we have


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continued to develop our internal legal collection staff resources, which enables us to place accounts into that channel that otherwise would have been prohibitively expensive for legal action and to collect these accounts more efficiently and profitably.

Fee income increased from $11.4 million in the third quarter of 2011 to $14.8 million in the third quarter of 2012 primarily due to the acquisition of MHH in the first quarter of 2012 and an increase in revenue generated by our PRA Government Services ("PRA GS") business, offset by a decline in revenue generated by our PRA Location Services ("PLS") business. The decline from PLS is due primarily to the adverse impact of the economic slowdown on automobile financing and related collateral recovery activities.

A summary of how our income was generated during the three months ended September 30, 2012 and 2011 is as follows:

                                                For the Three Months Ended
                                                       September 30,
        ($ in thousands)                          2012                2011
        Cash collections                      $     229,052        $  182,168
        Amortization of finance receivables         (91,735 )         (78,552 )
        Allowance charges                            (1,563 )            (741 )

        Finance receivable income                   135,754           102,875
        Fee income                                   14,765            11,401

        Total revenue                         $     150,519        $  114,276

Operating expenses were $93.5 million in the third quarter of 2012, up 32.8% over the third quarter of 2011, due primarily to increases in compensation expense, legal collection costs, legal collection fees and outside fees and services. Compensation expense increased primarily as a result of larger staff sizes, including the acquisition of MHH on January 16, 2012. Compensation and employee services expenses increased as total employees grew 23.9% to 3,103 as of September 30, 2012, from 2,504 as of September 30, 2011. Legal collection costs were $15.8 million for the three months ended September 30, 2012 compared to $9.7 million for the three months ended September 30, 2011, an increase of $6.1 million or 62.9%. This increase was the result of an increased portfolio size as well as a refinement of our internal scoring methodology that expanded our account selections for legal action. This strategy to expand the accounts brought into the legal collection process resulted in significant initial expenses, which may drive additional future cash collections and revenue. Legal collection fees increased from $6.0 million in the third quarter of 2011 to $8.6 million in the third quarter of 2012, an increase of $2.6 million or 43.3%. This increase was the result of an increase in cash collections from outside attorneys from $27.2 million in the three months ended September 30, 2011 to $39.9 million for the three months ended September 30, 2012, an increase of $12.7 million or 46.7%. Outside fees and services increased primarily as a result of legal related expenses as well as increases in costs related to software development.

Results of Operations

The results of operations include the financial results of Portfolio Recovery Associates, Inc. and all of our subsidiaries, all of which are in the receivables management business. Under the guidance of the FASB ASC Topic 280 "Segment Reporting" ("ASC 280"), we have determined that we have several operating segments that meet the aggregation criteria of ASC 280, and therefore, we have one reportable segment, accounts receivable management, based on similarities among the operating units including homogeneity of services, service delivery methods and use of technology.


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The following table sets forth certain operating data as a percentage of total revenues for the periods indicated:

                                              For the Three Months                For the Nine Months
                                               Ended September 30,                Ended September 30,
                                              2012              2011             2012              2011
Revenues:
Income recognized on finance
receivables, net                                 90.2 %           90.0 %            89.5 %           87.8 %
Fee income                                        9.8 %           10.0 %            10.5 %           12.2 %

Total revenues                                  100.0 %          100.0 %           100.0 %          100.0 %
Operating expenses:
Compensation and employee services               27.5 %           29.3 %            28.2 %           30.1 %
Legal collection fees                             5.7 %            5.2 %             5.8 %            5.2 %
Legal collection costs                           10.5 %            8.5 %            13.2 %            8.5 %
Agent fees                                        1.0 %            1.4 %             1.0 %            1.8 %
Outside fees and services                         6.7 %            5.4 %             4.9 %            4.0 %
Communication expenses                            4.5 %            5.1 %             5.0 %            5.2 %
Rent and occupancy                                1.2 %            1.3 %             1.2 %            1.3 %
Depreciation and amortization                     2.4 %            2.8 %             2.5 %            2.9 %
Other operating expenses                          2.5 %            2.5 %             2.7 %            2.7 %

Total operating expenses                         62.0 %           61.5 %            64.5 %           61.7 %
Gain on sale of property                          0.0 %            0.0 %             0.0 %            0.3 %


Income from operations                           38.0 %           38.5 %            35.5 %           38.6 %
Other income and (expense):
Interest income                                   0.0 %            0.0 %             0.0 %            0.0 %
Interest expense                                 (1.5 %)          (2.2 %)           (1.6 %)          (2.4 %)

Income before income taxes                       36.5 %           36.3 %            33.9 %           36.2 %
Provision for income taxes                       14.4 %           14.1 %            13.3 %           14.5 %

Net income                                       22.1 %           22.2 %            20.6 %           21.7 %
Adjustment for (loss)/income
attributable to redeemable
noncontrolling interest                          (0.1 %)          (0.3 %)           (0.1 %)           0.1 %


Net income attributable to Portfolio
Recovery Associates, Inc.                        22.2 %           22.5 %            20.7 %           21.6 %

Three Months Ended September 30, 2012 Compared To Three Months Ended September 30, 2011

Revenues

Total revenues were $150.5 million for the three months ended September 30, 2012, an increase of $36.2 million, or 31.7%, compared to total revenues of $114.3 million for the three months ended September 30, 2011.

Income Recognized on Finance Receivables, net

Income recognized on finance receivables, net was $135.8 million for the three months ended September 30, 2012, an increase of $32.9 million, or 32.0%, compared to income recognized on finance receivables, net of $102.9 million for the three months ended September 30, 2011. The increase was primarily due to an increase in cash collections on our finance receivables to $229.1 million for the three months ended September 30, 2012, from $182.2 million for the three months ended September 30, 2011, an increase of $46.9 million or 25.7%. During the three months ended September 30, 2012, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $1.3 billion at a cost of $102.9 million. During the three months ended September 30, 2011, we acquired defaulted consumer receivable portfolios with an aggregate face value of $5.7 billion at a cost of $122.1 million. In any period, we acquire defaulted consumer receivables that can vary dramatically in their age, type and ultimate collectability. We may pay significantly different purchase rates for purchased receivables within any period as a result of this quality fluctuation. In addition, market forces can drive pricing rates up or down in any period, irrespective of other quality fluctuations. As a result, the average purchase rate paid for any given period can fluctuate dramatically based on our particular buying activity in that period. However, regardless of the average purchase price and for similar time frames, we intend to target a similar internal rate of return, after direct expenses, in pricing our portfolio acquisitions; therefore, the absolute rate paid is not necessarily relevant to the estimated profitability of a period's buying.

Income recognized on finance receivables, net is shown net of changes in valuation allowances recognized under FASB ASC Topic 310-30 "Loans and Debt Securities Acquired with Deteriorated Credit Quality" ("ASC 310-30"), which requires that a valuation allowance be recorded for significant decreases in expected cash flows or a


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change in timing of cash flows which would otherwise require a reduction in the stated yield on a pool of accounts. For the three months ended September 30, 2012, we recorded net allowance charges of $1.6 million, of which $0.9 million related to purchased bankruptcy portfolios primarily purchased in 2007 and 2008, $1.9 million related to Core portfolios primarily purchased in 2006 and 2007. This was offset by an allowance reversal of $1.1 million on Core portfolios purchased in 2005, and a $0.1 million reversal on purchased bankruptcy portfolios. In any given period, we may be required to record valuation allowances due to pools of receivables underperforming our expectations. Factors that may contribute to the recording of valuation allowances may include both internal as well as external factors. External factors which may have an impact on the collectability, and subsequently to the overall profitability, of purchased pools of defaulted consumer receivables include: new laws or regulations relating to collections, new interpretations of existing laws or regulations, and the overall condition of the economy. Internal factors which may have an impact on the collectability, and subsequently the overall profitability, of purchased pools of defaulted consumer receivables would include: necessary revisions to initial and post-acquisition scoring and modeling estimates, non-optimal operational activities (relating to the collection and movement of accounts on both our collection floor and external channels), and decreases in productivity related to turnover of our collection staff.

Fee Income

Fee income increased from $11.4 million in the third quarter of 2011 to $14.8 million in the third quarter of 2012 primarily due to the acquisition of MHH in the first quarter of 2012 and an increase in revenue generated by our PRA GS business, offset by a decline in revenue generated by our PLS business. The decline from PLS is due primarily to the adverse impact of the economic slowdown on automobile financing and related collateral recovery activities.

Operating Expenses

Total operating expenses were $93.5 million for the three months ended September 30, 2012, an increase of $23.1 million or 32.8% compared to total operating expenses of $70.4 million for the three months ended September 30, 2011. Total operating expenses were 38.3% of cash receipts for the three months ended September 30, 2012 compared to 36.4% for the same period in 2011.

Compensation and Employee Services

Compensation and employee services expenses were $41.3 million for the three months ended September 30, 2012, an increase of $7.8 million, or 23.3%, compared to compensation and employee services expenses of $33.5 million for the three months ended September 30, 2011. Compensation expense increased primarily as a result of larger staff sizes, including the addition of new employees as a result of the acquisition of MHH on January 16, 2012. Compensation and employee services expenses increased as total employees grew 23.9% to 3,103 as of September 30, 2012, from 2,504 as of September 30, 2011. Compensation and employee services expenses as a percentage of cash receipts decreased to 17.0% for the three months ended September 30, 2012, from 17.3% of cash receipts for the same period in 2011.

Legal Collection Fees

Legal collection fees represent contingent fees incurred for the cash collections generated by our independent third party attorney network. Legal collection fees were $8.6 million for the three months ended September 30, 2012, an increase of $2.6 million, or 43.3%, compared to legal collection fees of $6.0 million for the three months ended September 30, 2011. This increase was the result of an increase in cash collections from outside attorneys from $27.2 million in the three months ended September 30, 2011 to $39.9 million for the three months ended September 30, 2012, an increase of $12.7 million or 46.7%. Legal collection fees for the three months ended September 30, 2012 were 3.5% of cash receipts, compared to 3.1% for the three months ended September 30, 2011.


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Legal Collection Costs

Legal collection costs consist of costs paid to courts where a lawsuit is filed and the cost of documents received from sellers of defaulted consumer receivables. Legal collection costs were $15.8 million for the three months ended September 30, 2012, an increase of $6.1 million, or 62.9%, compared to legal collection costs of $9.7 million for the three months ended September 30, 2011. This increase was the result of an increased portfolio size as well as a refinement of our internal scoring methodology that expanded our account selections for legal action. This strategy to expand the accounts brought into the legal collection process resulted in significant initial expenses, which may drive additional future cash collections and revenue. These legal collection costs represent 6.5% and 4.4% of cash receipts for the three month periods ended September 30, 2012 and 2011, respectively.

Agent Fees

Agent fees primarily represent costs paid to repossession agents to repossess vehicles. Agent fees were $1.5 million for the three months ended September 30, 2012, a decrease of $0.1 million, or 6.3%, compared to agent fees of $1.6 million for the three months ended September 30, 2011. The decrease was primarily due to a decline in agent fees related to reduced business activity associated with PLS.

Outside Fees and Services

Outside fees and services expenses were $10.1 million for the three months ended September 30, 2012, an increase of $3.9 million or 62.9% compared to outside fees and services expenses of $6.2 million for the three months ended September 30, 2011. Of the $3.9 million increase, $3.3 million increase was attributable to an increase in legal reserve accruals and corporate legal expenses and the remaining $0.6 million increase was mainly attributable to other outside fees and services including increases in non-capitalized software development costs.

Communication Expenses

Communication expenses were $6.8 million for the three months ended September 30, 2012, an increase of $0.9 million, or 15.3%, compared to communications expenses of $5.9 million for the three months ended September 30, 2011. The increase was primarily due to additional postage expense resulting from an increase in special letter campaigns. The remaining increase was attributable to higher telephone expenses driven by a greater number of finance receivables to work, as well as an expansion of our telephone system and a resulting increase in the number of collection calls made. Expenses related to customer mailings were responsible for 66.7% or $0.6 million of this increase, while the remaining 33.3% or $0.3 million was attributable to increased call volumes and other telephone related charges.

Rent and Occupancy

Rent and occupancy expenses were $1.8 million for the three months ended September 30, 2012, an increase of $0.3 million, or 20.0%, compared to rent and occupancy expenses of $1.5 million for the three months ended September 30, 2011. The increase was primarily due to the additional space leased for our Birmingham call center operations, the addition of our MHH foreign operations as well as increased utility charges.

Depreciation and Amortization

Depreciation and amortization expenses were $3.6 million for the three months . . .

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