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PRAA > SEC Filings for PRAA > Form 10-Q on 6-Aug-2014All Recent SEC Filings

Show all filings for PORTFOLIO RECOVERY ASSOCIATES INC

Form 10-Q for PORTFOLIO RECOVERY ASSOCIATES INC


6-Aug-2014

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 Europe, including the interest rate environment, 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;

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

our ability to integrate the Aktiv business;

our ability to manage risks associated with our international operations, which risks will increase as a result of the Aktiv acquisition;

our ability to recognize the anticipated synergies and benefits of the Aktiv acquisition;

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;

our ability to collect sufficient amounts on our defaulted consumer receivables;

changes in tax laws regarding earnings of our subsidiaries located outside of the United States;

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;

changes in state or federal laws or the administrative practices of various bankruptcy courts, which may impact our ability to collect on our defaulted receivables;

our ability to collect and enforce our finance receivables may be limited under federal and state laws;

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;

the degree, nature, and resources of our competition;

the possibility that we could incur goodwill or other intangible asset impairment charges;

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

our ability to comply with existing and new regulations of the collection industry, the failure of which could result in penalties, fines, litigation, damage to our reputation or the suspension or termination of our ability to conduct our business;

changes in governmental laws and regulations which could increase our costs and liabilities or impact our operations;

our ability to adjust to debt collection and debt buying regulations that may be promulgated by the Consumer Financial Protection Bureau ("CFPB") and the regulatory and enforcement activities of the CFPB;

the possibility that new business acquisitions prove unsuccessful or strain or divert our resources;

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;

the possibility that compliance with foreign and U.S. laws and regulations that apply to our international operations could increase our cost of doing business in international jurisdictions;

the imposition of additional taxes on us;

changes in interest or exchange 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 loss contingency accruals may not be adequate to cover actual losses;

our ability to manage growth successfully;

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

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

the risk factors listed from time to time in our filings with the Securities and Exchange Commission (the "SEC").


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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 2013 Annual Report on Form 10-K, filed on February 28, 2014.
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. Except as required by law, we assume 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
We use the following terminology throughout this document:
"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 on our owned portfolios.

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

"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. Unless otherwise noted, Core accounts do not include the accounts we purchase in the United Kingdom.

"Estimated remaining collections" or "ERC" 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 businesses.

"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/reversals.

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

"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.

"Purchase price multiple" refers to the total estimated collections on owned debt portfolios divided by purchase price.

"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.

Overview
The Company is a 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 and provide class action claims settlement recovery services and related payment processing to corporate clients. Our industry is highly regulated under various federal laws, including the Fair Debt Collection Practices Act, Fair Credit Reporting Act, Dodd-Frank Wall Street Reform and Consumer Protection Act, Telephone Consumer Protection Act and other federal and state laws. We are subject to inspections, examinations, supervision by regulators in each state in which we are licensed, and also by the CFPB. The CFPB is expected to adopt additional rules that will affect our industry, and has sought feedback on a wide range of debt collection issues. The Company has provided its input and feedback with written comments and through a number of meetings with CFPB staff. The Company is currently engaged in discussions with the CFPB with a view toward


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adopting certain practices or controls in the conduct of its business. There can be no assurance that new industry regulations or the outcome of these discussions would not have an adverse effect on our business.

On August 4, 2014, the Office of the Comptroller of the Currency ("OCC") issued risk guidance detailing the principles they expect financial institutions to follow in connection with the sale of consumer debt. The Company is currently in the process of evaluating the impact that this guidance may have on its business, if any.
The Company is headquartered in Norfolk, Virginia, and employs approximately 3,567 team members. The Company's shares of common stock are traded on the NASDAQ Global Select Market under the symbol "PRAA."

On July 16, 2014, the Company, through a wholly owned subsidiary, completed the purchase of the outstanding equity of Aktiv, a Norway-based company specializing in the acquisition and servicing of non-performing consumer loans throughout Europe and in Canada, for a purchase price of approximately $872.6 million, and assumed approximately $431.3 million of Aktiv's corporate debt, resulting in an acquisition of estimated total enterprise value of $1.3 billion. The Company financed the acquisition with cash of $217.7 million, $169.9 million in financing from an affiliate of the seller, and $485.0 million from the Company's domestic, revolving credit facility.

A publicly traded company from 1997 until early 2012 (traded on the Oslo Stock Exchange under the symbol "AIK"), Aktiv has developed a mixed in-house and outsourced collection strategy. It maintains in-house servicing platforms in eight markets, and owns portfolios in fifteen markets. Aktiv has more than 20 years of experience and data in a wide variety of consumer asset classes, across an extensive geographic background. Aktiv has acquired more than 2,000 portfolios, with a face value of more than $38 billion. In 2013, Aktiv collected $318 million on its portfolios and purchased $248 million in new portfolios, up from $222 million in 2012. Aktiv's total assets were approximately $900 million at December 31, 2013.

This acquisition provided us entry into thirteen new markets, providing us additional geographical diversity in portfolio purchasing and collection. Aktiv's Chief Executive Officer and his executive team and the more than 400 Aktiv employees joined our workforce upon the closing of the transaction.

We anticipate total transaction costs of approximately $15 million. During the first and second quarters of 2014, we incurred approximately $4.4 million and $4.1 million, respectively, of the total estimated transaction costs of $15 million. Additionally, we recorded an unrealized foreign currency transaction loss as a result of us entering into foreign currency exchange rate forward contracts during the second quarter of 2014 to acquire 518 million Euros in anticipation of closing the acquisition of Aktiv. As a result of the strengthening U.S. dollar relative to the Euro as of June 30, 2014 relative to the period during which the contracts were entered into, an unrealized loss of $6.2 million on the forward contracts was recognized during the quarter. A corresponding liability was recorded and included in Accrued Expenses and Other Liabilities as of June 30, 2014. In the third quarter of 2014, we recorded an additional $2.0 million foreign currency transaction loss upon the settlement of these foreign currency exchange rate forward contracts.

Our total borrowings are approximately $1.5 billion after closing the Aktiv acquisition, compared to the Company's total borrowings of $448.8 million at June 30, 2014.
Earnings Summary
During the second quarter of 2014, net income attributable to the Company was $37.5 million, or $0.74 per diluted share, compared with $43.6 million, or $0.85 per diluted share, in the second quarter of 2013. Total revenue was $197.3 million in the second quarter of 2014, up 7.9% from the second quarter of 2013. Revenues in the second quarter of 2014 consisted of $182.5 million in income recognized on finance receivables, net, and $14.8 million in fee income. Income recognized on finance receivables, net, in the second quarter of 2014 increased $13.9 million, or 8.3%, over the second quarter of 2013, primarily as a result of an increase in cash collections. Cash collections, which drives our finance receivable income, were $319.3 million in the second quarter of 2014, up 7.7%, or $22.9 million, as compared to the second quarter of 2013. During the second quarter of 2014, we incurred $2.3 million in net allowance reversals, compared with $1.2 million of net allowance reversals in the second quarter of 2013. 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 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.


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Fee income increased to $14.8 million in the second quarter of 2014 from $14.4 million in the second quarter of 2013, primarily due to higher fee income generated by Claims Compensation Bureau, LLC ("CCB") and PRA Government Services, LLC ("PGS"). This was partially offset by lower fee income generated in the second quarter of 2014 by Mackenzie Hall Holdings, Limited ("PRA UK"), PRA Location Services ("PLS") and Bankruptcy Services when compared to the second quarter of 2013.
A summary of how our income was generated during the three months ended June 30, 2014 and 2013 is as follows:

                                       For the Three Months Ended June 30,
($ in thousands)                           2014                   2013
Cash collections                    $        319,274       $        296,397
Amortization of finance receivables         (139,055 )             (129,012 )
Net allowance reversals                        2,299                  1,185
Finance receivable income                    182,518                168,570
Fee income                                    14,825                 14,391
Total revenue                       $        197,343       $        182,961

Operating expenses were $124.9 million in the second quarter of 2014, up 14.4% over the second quarter of 2013, due primarily to increases in compensation expense, legal collection costs, outside fees and services and other operating expenses. Compensation expense increased primarily as a result of larger staff sizes, increases in incentive compensation paid as a result of collector performance and normal pay increases. Compensation and employee services expenses increased as total employees grew 6.1% to 3,567 as of June 30, 2014, from 3,362 as of June 30, 2013. Legal collection costs increased from $22.7 million in the second quarter of 2013 to $25.4 million in the second quarter of 2014, an increase of $2.7 million, or 11.9%. This increase was the result of our continued expansion of the accounts brought into the legal collection process. Outside fees and services expenses increased $3.5 million, or 40.7%, which was mainly attributable to the $4.1 million of transaction costs incurred in the second quarter of 2014 related to the Aktiv acquisition. Other operating expenses increased from $5.7 million in the second quarter of 2013 to $7.7 million in the second quarter of 2014, an increase of $2.0 million, or 35.1%. Of the $2.0 million increase, $0.6 million was due to an increase in provision for doubtful accounts, $0.6 million was due to an increase in taxes, fees and licenses, $0.3 million was due to an increase in general office expenses and $0.3 million was due to an increase in accrued estimated contingent payments related to a previous acquisition. None of the remaining $0.2 million increase was attributable to any significant identifiable items.
During the three months ended June 30, 2014, we acquired defaulted consumer receivables portfolios with an aggregate face value amount of $966.9 million at a cost of $109.2 million. During the three months ended June 30, 2013, we acquired defaulted consumer receivable portfolios with an aggregate face value of $3.19 billion at a cost of $200.5 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.


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Results of Operations
The results of operations include the financial results of the Company and all
of our subsidiaries. The following table sets forth certain operating data as a
percentage of total revenues for the periods indicated:
                                     For the Three Months Ended June 30,       For the Six Months Ended June 30,
                                          2014                  2013               2014                 2013
Revenues:
Income recognized on finance
receivables, net                             92.5 %                 92.1 %            92.1 %                91.7 %
Fee income                                    7.5 %                  7.9 %             7.9 %                 8.3 %
Total revenues                              100.0 %                100.0 %           100.0 %               100.0 %
Operating expenses:
Compensation and employee services           26.6 %                 26.3 %            26.5 %                26.4 %
Legal collection fees                         5.8 %                  5.8 %             5.7 %                 6.0 %
Legal collection costs                       12.9 %                 12.4 %            13.3 %                12.3 %
Agent fees                                    0.7 %                  0.7 %             0.7 %                 0.8 %
Outside fees and services                     6.1 %                  4.7 %             5.9 %                 4.6 %
Communication expenses                        4.0 %                  3.6 %             4.4 %                 4.2 %
Rent and occupancy                            1.1 %                  1.0 %             1.1 %                 1.0 %
Depreciation and amortization                 2.1 %                  1.9 %             2.1 %                 2.0 %
Other operating expenses                      3.9 %                  3.1 %             3.5 %                 3.2 %
Total operating expenses                     63.2 %                 59.5 %            63.2 %                60.5 %
Income from operations                       36.8 %                 40.4 %            36.8 %                39.5 %
Other expense:
Interest expense                              2.6 %                  1.6 %             2.5 %                 1.6 %
Other expense                                 3.2 %                    - %             1.6 %                   - %
Income before income taxes                   31.1 %                 38.8 %            32.7 %                38.0 %
Provision for income taxes                   12.0 %                 15.0 %            12.7 %                14.8 %
Net income                                   19.0 %                 23.7 %            20.0 %                23.2 %
Adjustment for loss attributable
to redeemable noncontrolling
interest                                        - %                  0.1 %               - %                 0.1 %
Net income attributable to
Portfolio Recovery Associates,
Inc.                                         19.0 %                 23.8 %            20.0 %                23.3 %

Three Months Ended June 30, 2014 Compared To Three Months Ended June 30, 2013 Revenues
Total revenues were $197.3 million for the three months ended June 30, 2014, an increase of $14.3 million, or 7.8%, compared to total revenues of $183.0 million for the three months ended June 30, 2013. Income Recognized on Finance Receivables, net Income recognized on finance receivables, net was $182.5 million for the three months ended June 30, 2014, an increase of $13.9 million, or 8.2%, compared to income recognized on finance receivables, net of $168.6 million for the three months ended June 30, 2013. The increase was primarily due to an increase in cash collections on our finance receivables to $319.3 million for the three months ended June 30, 2014, from $296.4 million for the three months ended June 30, 2013, an increase of $22.9 million, or 7.7%. Our finance receivables amortization rate, including net allowance charges, was 42.8% for the three months ended June 30, 2014 compared to 43.1% for the three months ended June 30, 2013.
Accretable yield represents the amount of income recognized on finance receivables the Company can expect to generate over the remaining life of its existing portfolios based on estimated future cash flows as of the balance sheet date. Additions represent the original expected accretable yield, on portfolios purchased during the period, to be earned by the Company based on its proprietary buying models. Net reclassifications from nonaccretable difference to accretable yield primarily result from the Company's increase in its estimate of future cash flows. Increases in future cash flows may occur as portfolios age and actual cash collections exceed those originally expected. If those cash flows are determined to be incremental to the portfolio's original forecast, future projections of cash flows are generally increased resulting in higher expected revenue and hence increases in accretable yield. During the three months ended June 30, 2014 and 2013, the Company reclassified amounts from nonaccretable difference to accretable yield due primarily to increased cash collection forecasts relating to pools acquired from 2009-2013. When


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applicable, net reclassifications to nonaccretable difference from accretable yield result from the Company's decrease in its estimates of future cash flows and allowance charges that exceed the Company's increase in its estimate of future cash flows.
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 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 June 30, 2014, we recorded net allowance reversals of $2.3 million. On our Core portfolios, we recorded net allowance reversals of $3.3 million on portfolios purchased between 2005 and 2008, offset by net allowance charges of $0.9 million on portfolios purchased in 2010 and 2011. On our purchased bankruptcy portfolios, we recorded net allowance reversals of $0.4 million on portfolios primarily purchased in 2007 and 2008 offset by a net allowance charge of $0.5 million on Canadian portfolios purchased in 2014. For the three months ended June 30, 2013, we recorded net allowance reversals of $1.2 million, of which a charge of $0.6 million related to purchased bankruptcy portfolios primarily purchased in 2008, offset by reversals of $1.8 million related to Core portfolios purchased between 2005 and 2008.
In any given period, we may be required to record valuation allowances due to pools of receivables underperforming our previous 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 . . .

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