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AACC > SEC Filings for AACC > Form 10-Q on 29-Apr-2013All Recent SEC Filings

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Quarterly Report

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

The following discussion of the Company's financial condition and results of operations ("MD&A") should be read in conjunction with the condensed consolidated financial statements and notes to those statements included elsewhere in this report. Unless expressly noted to the contrary, all forward-looking statements in this MD&A relate to the Company on a stand-alone basis and are not reflective of any potential impact of the proposed Merger with Encore.

Company Overview

We have been purchasing and collecting charged-off accounts receivable portfolios ("paper") from consumer credit originators since the formation of our predecessor company in 1962. Charged-off receivables are the unpaid obligations of individuals to credit originators, such as credit card issuers including private label card issuers, consumer finance companies, telecommunications providers and utility providers. Since these receivables are delinquent or past due, we purchase them at a substantial discount. Since January 1, 2006, we have purchased 999 consumer debt portfolios, with an original charged-off face value of $33.5 billion for an aggregate purchase price of $1.1 billion, or 3.21% of face value, net of buybacks. We purchase and collect charged-off consumer receivables for our own account as we believe this affords us the best opportunity to use long-term strategies to maximize collections.

Macro-economic factors in the U.S. may have a significant impact on our operations, both positively and negatively. Factors such as reduced availability of credit for consumers, a depressed housing market, elevated unemployment rates, increased gasoline prices and other factors have a negative impact in recent years by making it more difficult to collect from consumers on the paper we acquire. Macro-economic factors have also had an impact on the availability of charged-off debt in the market and the prices at which it is available. Since 2011, we have observed increased competition for available paper and an overall reduction in the supply of paper, contributing to higher prices. We expect macro-economic trends to continue to impact portfolio acquisition and collection results.

Despite increases in pricing, our investment in purchased receivables was higher in the first quarter of 2013 as compared to the same period of 2012. We only purchase paper when we believe we can achieve an acceptable return and do not pursue purchases when we believe the expected collections do not support the purchase price. Compared to the prior year, pricing for paper in the first quarter of 2013 increased for all stages of paper. We deploy our capital within the stages of delinquency based upon availability and our perception of the relative value of the available debt. While we expect a continuation of recently observed trends regarding pricing in 2013, we expect to purchase paper in sufficient quantities to support our business.

Given that cash collections are typically highest six to 18 months from purchase, higher levels of recent purchasing contributed to increased collections during the first quarter of 2013. Collections were also positively impacted by recent positive trends in certain macro-economic factors, such as the unemployment rate, increased investment in the legal collections channel and improvements in collector productivity through continued utilization of our analytical tools to create customized collection strategies by account type.

Cash collections for the first quarter of $103.8 million were higher than total collections of $101.1 million for the same period of 2012, which previously marked the highest quarterly cash collections in our history. In addition, our operating expenses as a percentage of cash collections, referred to as cost to collect, improved to 45.3%, which was the lowest level since we became a public company in 2004. These improvements were driven by better collection strategies and analytics related to our purchased receivables, continuous review of operational strategies and savings realized from office closings.

Purchased receivable revenues were lower during the first quarter of 2013 compared to the same period in 2012. This decrease in revenue was primarily related to lower weighted-average yields, lower collections on fully amortized portfolios and higher impairments on purchased receivable portfolios in 2013 compared to impairment reversals in 2012. We recorded purchased receivables impairments of $0.2 million in 2013 compared to impairment reversals of $4.5 million during the same period last year.

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In addition to the decrease in cost to collect during 2013, as noted above, total operating expenses decreased by 2.8% compared to 2012. We have realized cost reductions related to our office closings, primarily in the form of reduced salaries and benefits and occupancy costs. However, these savings have been offset in part by increased forwarding fees paid to third parties for performing collection activities on our behalf. In addition, our cost to collect has been impacted in 2013 by increased investment in the legal collections channel. Court and process server costs for the first quarter of 2013 increased by 15.2% compared to 2012 due to a continuation of a strategy initiated in 2012 to allocate a greater number of accounts to the legal collections channel. These costs are expensed as incurred, while the collections are generally received in future periods. The increased allocation of accounts to the legal collections channel is expected to favorably impact collections over time, as gross liquidations are typically higher from legal channel collections than collections from the call center. Aside from the transaction costs and increased legal investment, We continually review our business and operations and look for opportunities to become more efficient.

We also achieved record Adjusted Earnings Before Interest Taxes Depreciation and Amortization ("Adjusted EBITDA") for the quarter of $56.5 million, which was driven by the improvements we achieved in collection performance and our cost structure. Although Adjusted EBITDA is not calculated in accordance with accounting principles generally accepted in the United States of America, it is used by analysts, investors and management as a measure of our performance. Refer to pages 45 and 46 for additional information regarding the calculation of Adjusted EBITDA.

Pending Merger Transaction

On March 6, 2013, we entered into a definitive agreement and plan of merger (the "Merger Agreement") with Encore Capital Group, Inc. ("Encore"), pursuant to which a wholly-owned subsidiary of Encore will merge with and into our company, with our company continuing as the surviving corporation and a wholly-owned subsidiary of Encore (the "Merger"). For terms of the Merger Agreement, including circumstances under which the Merger Agreement can be terminated and the ramifications of such a termination, as well as other terms and conditions, refer to the Merger Agreement filed as Exhibit 1.1 to our Current Report on Form 8-K with the United States Securities and Exchange Commission ("SEC") on March 11, 2013.

If the Merger is completed, each Company stockholder will be entitled to receive, at his, her or its election and subject to the terms of the Merger Agreement, either $6.50 in cash or 0.2162 validly issued, fully paid and nonassessable shares of Encore common stock, in each case without interest and less any applicable withholding taxes, for each share of Company common stock owned by such stockholder at the time of the Merger. Notwithstanding the foregoing, no more than 25% of the total shares of Company common stock outstanding immediately prior to the Merger will be exchanged for shares of Encore common stock and any shares elected to be exchanged for Encore common stock in excess of such 25% limitation will be subject to proration in accordance with the terms of the Merger Agreement.

Upon completion of the Merger, Encore will own all of our capital stock. As a result, we will no longer have our stock listed on the NASDAQ Global Select Stock Market ("NASDAQ") and will no longer be required to file periodic and other reports with the SEC with respect to Company common stock.

The parties' obligation to complete the transaction is subject to several conditions, including, among others, approval of the Merger by our stockholders as described in our preliminary proxy statement/prospectus included in the Registration Statement on Form S-4, file No. 333-187581, filed by Encore with the SEC on March 27, 2013 (the "proxy statement/prospectus"), the termination or expiration of all waiting periods under the Hart-Scott-Rodino Antitrust Improvements Act of 1976, as amended (the "HSR Act") and other customary conditions; however, the consummation of the Merger is not conditioned on the receipt of financing. Our company and Encore filed the required notification and report forms under the HSR Act with the Federal Trade Commission (the "FTC") and the Antitrust Division of the Department of Justice on March 20, 2013. On April 3, 2013, the FTC granted early termination of the applicable waiting period. We expect to incur and pay additional fees and expenses through calendar year 2013, including transaction fees amounting to approximately $1.85 million payable (only upon closing of the Merger) to our financial advisor. The parties to the Merger Agreement currently expect to complete the Merger in the second quarter of 2013, although neither our management nor Encore can assure completion by any particular date or that the Merger will be completed at all. Because the Merger is subject to a number of conditions, the exact timing of completion of the Merger cannot be determined at this time.

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Our Board of Directors, acting upon the unanimous recommendation of a special committee of the Board of Directors comprised solely of disinterested directors, unanimously approved and adopted the Merger Agreement and has recommended that our stockholders vote to approve the Merger Agreement. Our company, in the proxy statement/proxy, indicated its intention to call a special meeting of its stockholders at a still to be specified date to vote on the Merger Agreement.

The comparison of our results in the first quarter of 2013 against the same period in 2012 is impacted by costs associated with the pending Merger. We incurred approximately $1.9 million of Merger related costs during this quarter which are classified within other expense in our statement of operations. In addition, accrued payroll, benefits and bonuses were reduced by $0.3 million in the first quarter of 2013 as a result of the expected completion of the Merger. This resulted in a net impact to income before taxes of $1.6 million for the first quarter of 2013 as a result of the pending Merger.

Effects on the Company if the Merger is Not Completed

If the Merger Agreement is not adopted by our stockholders or if the merger is not completed for any other reason, our stockholders will not receive any payment for their shares of Company common stock in connection with the merger. Instead, we will remain an independent public company, and our common stock will continue to be quoted on NASDAQ. In addition, if the merger is not completed, we expect that management will operate our business in a manner similar to that in which it is being operated today and that our stockholders will continue to be subject to the same risks and opportunities to which they are currently subject, including, without limitation, risks related to the highly competitive industry in which our company operates and adverse economic conditions.

Furthermore, if the merger is not completed, and depending on the circumstances that would have caused the merger not to be completed, the price of our common stock may decline significantly. If that were to occur, it is uncertain when, if ever, the price of our common stock would return to the price at which it trades as of the date of this filing.

If the merger is not completed, our Board of Directors will continue to evaluate and review our business operations, properties, dividend policy and capitalization, among other things, make such changes as are deemed appropriate and continue to seek to identify strategic alternatives to enhance stockholder value. If the Merger Agreement is not adopted by our stockholders or if the merger is not completed for any other reason, there can be no assurance that any other transaction acceptable to our company will be offered or that our business, prospects or results of operation will not be adversely impacted.

In addition, we may be required, under certain circumstances, to either pay Encore a termination fee of $4.25 million or $7.4 million and, under certain circumstances, reimburse up to $2.0 million of Encore's merger related expenses. The payment of any termination fee and expense reimbursement could have an adverse effect on our company that is material to the results of its operations.

Forward-Looking Statements

This report contains forward-looking statements that involve risks and uncertainties and that are made in good faith pursuant to the "safe harbor" provisions of the Private Securities Litigation Reform Act of 1995. These statements include, without limitation, statements about future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as "may", "will", "should", "expect", "anticipate", "intend", "plan", "believe", "estimate", "potential" or "continue", the negative of these terms or other comparable terminology. These statements involve a number of risks and uncertainties. Actual events or results may differ materially from any forward-looking statement as a result of various factors, including those we discuss in our annual report on Form 10-K for the year ended December 31, 2012 in the section titled "Risk Factors", in our preliminary proxy statement/prospectus included in the Registration Statement on Form S-4, file No. 333-187581, filed by Encore with the SEC on March 27, 2013, elsewhere in this report and in other filings with the SEC that attempt to advise interested parties of certain risks and factors that may affect our business, which are available on the SEC's website at

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Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Readers are cautioned not to place undue reliance on these forward-looking statements, which are based on current expectations and reflect management's opinions only as of the date thereof. Our historic results should not be viewed as indicative of future performance. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations. Factors that could affect our results and cause them to materially differ from those contained in the forward-looking statements include, but are not limited to, the following:

the parties to the Merger Agreement may be unable to satisfy the conditions to the completion of the Merger and the pending Merger with Encore may not be completed, which could negatively impact the market price of AACC common stock and our financial condition and results of operation;

until the consummation of the Merger, the Merger Agreement with Encore restricts our ability to engage in certain actions, including, among others, purchases of portfolio accounts receivable and making capital expenditures;

failure to comply with government regulation;

a decrease in collections if changes in or enforcement of debt collection laws impair our ability to collect, including any unknown ramifications from the Dodd-Frank Wall Street Reform and Consumer Protection Act;

our ability to purchase charged-off receivable portfolios on acceptable terms and in sufficient amounts;

instability in the financial markets and continued economic weakness or recession impacting our ability to acquire and collect on charged-off receivable portfolios and our operating results;

our ability to maintain existing, and to secure additional financing on acceptable terms;

changes in relationships with third parties collecting on our behalf;

ongoing risks of litigation in connection with the pending Merger and litigation in our litigious industry, including individual and class actions under consumer credit, collections and other laws;

concentration of a significant portion of our portfolio purchases during any period with a small number of sellers;

our ability to substantiate our application of tax rules against examinations and challenges made by tax authorities;

our ability to collect sufficient amounts from our purchases of charged-off receivable portfolios;

our ability to diversify beyond collecting on our purchased receivables portfolios into ancillary lines of business;

a decrease in collections as a result of negative attention or news regarding the debt collection industry and debtors' willingness to pay the debt we acquire;

our ability to respond to technology downtime and changes in technology to remain competitive;

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our ability to make reasonable estimates of the timing and amount of future cash receipts and assumptions underlying the calculation of the net impairment charges or IRR increases for purposes of recording purchased receivable revenues;

the costs, uncertainties and other effects of legal and administrative proceedings impacting our ability to collect on judgments in our favor;

our ability to successfully hire, train, integrate into our collections operations and retain in-house account representatives; and

other unanticipated events and conditions that may hinder our ability to compete.

Results of Operations

The following table sets forth selected statement of operations data expressed
as a percentage of total revenues and as a percentage of cash collections for
the periods indicated:

                                         Percent of Total Revenues                    Percent of Cash Collections
                                       Three Months Ended March 31,                  Three Months Ended March  31,
                                       2013                    2012                  2013                     2012
Purchased receivable
revenues, net                               99.7 %                  99.6 %                53.0 %                   60.9 %
Other revenues, net                          0.3                     0.4                   0.2                      0.2

Total revenues                             100.0                   100.0                  53.2                     61.1

Salaries and benefits                       25.8                    26.4                  13.7                     16.2
Collections expense                         51.0                    44.2                  27.1                     27.0
Occupancy                                    2.4                     2.3                   1.3                      1.4
Administrative                               3.9                     3.0                   2.1                      1.8
Depreciation and amortization                1.8                     2.2                   1.0                      1.3
Restructuring charges                        0.2                     0.1                   0.1                      0.1
Loss on disposal of equipment
and other assets                             0.0                     0.0                   0.0                      0.0

Total operating expenses                    85.1                    78.2                  45.3                     47.8

Income from operations                      14.9                    21.8                   7.9                     13.3
Other income (expense)
Merger transaction expense                  (3.5 )                   0.0                  (1.9 )                    0.0
Interest expense                            (8.9 )                  (8.6 )                (4.7 )                   (5.3 )
Interest income                              0.0                     0.0                   0.0                      0.0
Other                                        0.0                     0.1                   0.0                      0.1

Income before income taxes                   2.5                    13.3                   1.3                      8.1
Income tax expense                           1.8                     4.5                   0.9                      2.7

Net income                                   0.7 %                   8.8 %                 0.4 %                    5.4 %

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Three Months Ended March 31, 2013 Compared To Three Months Ended March 31, 2012


We generate substantially all of our revenue from our main line of business, the purchase and collection of charged-off consumer receivables. We refer to revenue generated from this line of business as purchased receivable revenues. Purchased receivable revenues are the difference between cash collections and amortization of purchased receivables.

The following table summarizes our purchased receivable revenues including cash collections and amortization:

                                                                                               Percent of Cash  Collections
                                               Three Months Ended March 31,                    Three Months Ended March 31,
($ in millions)                       2013        2012       Change          Change             2013                  2012
Cash collections                     $ 103.8     $ 101.1     $   2.7               2.6 %            100.0 %               100.0 %
Purchased receivable amortization       48.8        39.5         9.3              23.5               47.0                  39.1
Purchased receivable revenues, net      55.0        61.6        (6.6 )           (10.7 )             53.0                  60.9

The 2.6% increase in cash collections during the first quarter of 2013 was a result of increased levels of purchasing, improvements in account representative productivity, enhanced analytics used to customize collection strategies by account type and increased investment in the legal collections channel. Refer to the "Cash Collections" tables on page 39 for additional information on collections by channel. Improved account representative productivity was due, in part, to recent enhancements to inventory and channel management strategies, which has also led to a reduction in the number of in-house associates. The increase in total collections was driven by a $7.9 million, or 18.6%, increase in legal channel collections, partially offset by collections which were $5.2 million, or 8.9%, lower in the call center channel. Although the overall collection environment remained challenging, we saw some improvement in general macro-economic factors, which improved debtors' ability to repay their obligations. We have also increased levels of purchasing in each of the past two annual periods. Generally, collections are strongest on portfolios six months to 18 months after purchase, therefore, these increases have had a positive impact on current collections. Cash collections included collections from fully amortized portfolios of $10.8 million and $12.7 million for the first quarter of 2013 and 2012, respectively, of which 100% was reported as revenue. Fully amortized portfolios are generally composed of older accounts and collections on these portfolios decline over time, absent any specific strategies to increase these collections on newer portfolios that become fully amortized.

The amortization rate of 47.0% for the first quarter of 2013 was 790 basis points higher than the amortization rate of 39.1% for the same period of 2012. The increase in the amortization rate was a result of lower weighted-average yields and collections on fully amortized portfolios, and impairments in 2013 compared to impairment reversals in 2012. During the first quarter of 2013, we increased yields on twelve portfolios from the 2008 through 2012 vintages, which results in a higher percentage of cash collections being applied to purchased receivable revenue and less to amortization. This compares to the first quarter of 2012, when we increased yields on ten portfolios. Increases in assigned yields are generally a result of increases in expected future collections. We recognized impairments of $0.2 million during the first quarter of 2013, compared to impairment reversals of $4.5 million during the same period of 2012. The impairment in 2013 was recognized on one portfolio from the 2007 vintage. In 2012, the impairment reversals were the result of increased expectations for future collections on certain portfolios from the 2005 through 2009 vintages. Refer to "Supplemental Performance Data" on Page 34 for a summary of purchased receivable revenues and amortization rates by year of purchase ("vintage") and an analysis of the components of collections and amortization.

Revenues on portfolios purchased from our top three sellers were $21.3 million and $24.0 million during the quarter ended March 31, 2013 and 2012, respectively. Two of the top three sellers were the same in both periods.

Investments in Purchased Receivables

We generate revenue from our investments in portfolios of charged-off consumer accounts receivable. Ongoing investments in purchased receivables are critical to continued generation of revenues. The time since charge off, paper types, and other account characteristics of our purchased receivables vary from period to period. As a result,

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the cost of our purchases, as a percent of face value, may fluctuate from one period to the next. In addition, the amount of paper we purchase in a period may be limited by market factors beyond our control (most importantly, the price, volume and mix of paper offered for sale in a period) and the restrictions on Company actions under the terms of the Merger Agreement which apply until the earlier of consummation of the Merger or termination of the Merger Agreement. Total purchases consisted of the following:

                                                          Three Months Ended March 31,
($ in millions, net of buybacks)                2013          2012          Change         Change
Acquisitions of purchased receivables, at
cost                                           $  27.1       $  21.1       $    6.0           28.1 %
Acquisitions of purchased receivables, at
face value                                     $ 431.6       $ 803.2       $ (371.6 )        (46.3 %)
Percentage of face value                          6.27 %        2.63 %
Percentage of forward flow purchases, at
. . .
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