XNAS:ECPG Encore Capital Group Inc Quarterly Report 10-Q Filing - 3/31/2012

Effective Date 3/31/2012

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Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

(Mark One)

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

For the quarterly period ended March 31, 2012

OR

 

¨ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from             to            .

COMMISSION FILE NUMBER: 000-26489

ENCORE CAPITAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

Delaware   48-1090909

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

3111 Camino Del Rio North, Suite 1300

San Diego, California

  92108
(Address of principal executive offices)   (Zip code)

(877) 445 - 4581

(Registrant’s telephone number, including area code)

(Not Applicable)

(Former name, former address and former fiscal year, if changed since last report)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the last 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant 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 during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).     Yes  x    No  ¨

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 ¨    Accelerated filer x    Non-accelerated filer ¨    Smaller reporting company ¨

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

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

 

Class

 

Outstanding at April 16, 2012

Common Stock, $0.01 par value   24,695,920 shares

 

 

 


Table of Contents

ENCORE CAPITAL GROUP, INC.

INDEX TO FORM 10-Q

 

    Page  

PART I – FINANCIAL INFORMATION

    1   

Item 1— Condensed Consolidated Financial Statements (Unaudited)

    1   

Condensed Consolidated Statements of Financial Condition

    1   

Condensed Consolidated Statements of Comprehensive Income

    2   

Condensed Consolidated Statements of Stockholders’ Equity

    3   

Condensed Consolidated Statements of Cash Flows

    4   

Notes to Condensed Consolidated Financial Statements (Unaudited)

    5   

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

    17   

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

    31   

Item 4 – Controls and Procedures

    31   

PART II – OTHER INFORMATION

    32   

Item 1 – Legal Proceedings

    32   

Item 1A – Risk Factors

    32   

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

    32   

Item 5 – Other Information

    32   

Item 6 – Exhibits

    33   

SIGNATURES

    34   


Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Condensed Consolidated Financial Statements (Unaudited)

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Financial Condition

(In Thousands, Except Par Value Amounts)

(Unaudited)

 

     March 31,
2012
    December 31,
2011
 
Assets     

Cash and cash equivalents

   $ 15,446      $ 8,047   

Accounts receivable, net

     3,615        3,265   

Investment in receivable portfolios, net

     741,580        716,454   

Deferred court costs, net

     39,839        38,506   

Property and equipment, net

     19,603        17,796   

Other assets

     11,842        11,968   

Goodwill

     6,047        15,985   

Identifiable intangible assets, net

     —          462   
  

 

 

   

 

 

 

Total assets

   $ 837,972      $ 812,483   
  

 

 

   

 

 

 
Liabilities and stockholders’ equity     

Liabilities:

    

Accounts payable and accrued liabilities

   $ 31,161      $ 29,628   

Income tax payable

     2,078        —     

Deferred tax liabilities, net

     16,333        15,709   

Debt

     398,246        388,950   

Other liabilities

     5,297        6,661   
  

 

 

   

 

 

 

Total liabilities

     453,115        440,948   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity:

    

Convertible preferred stock, $.01 par value, 5,000 shares authorized, no shares issued and outstanding

     —          —     

Common stock, $.01 par value, 50,000 shares authorized, 24,696 shares and 24,520 shares issued and outstanding as of March 31, 2012 and December 31, 2011, respectively

     247        245   

Additional paid-in capital

     124,638        123,406   

Accumulated earnings

     261,258        249,852   

Accumulated other comprehensive loss

     (1,286     (1,968
  

 

 

   

 

 

 

Total stockholders’ equity

     384,857        371,535   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 837,972      $ 812,483   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements

 

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Table of Contents

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Comprehensive Income

(In Thousands, Except Per Share Amounts)

(Unaudited)

 

     Three Months Ended
March 31,
 
     2012     2011  

Revenues

    

Revenue from receivable portfolios, net

   $ 126,405      $ 105,326   

Servicing fees and other related revenue

     3,817        4,977   
  

 

 

   

 

 

 

Total revenues

     130,222        110,303   
  

 

 

   

 

 

 

Operating expenses

    

Salaries and employee benefits (excluding stock-based compensation expense)

     23,109        19,040   

Stock-based compensation expense

     2,266        1,765   

Cost of legal collections

     38,635        36,509   

Other operating expenses

     12,411        10,096   

Collection agency commissions

     3,959        3,914   

General and administrative expenses

     14,132        10,169   

Depreciation and amortization

     1,363        1,053   

Impairment charge for goodwill and identifiable intangible assets

     10,349        —     
  

 

 

   

 

 

 

Total operating expenses

     106,224        82,546   
  

 

 

   

 

 

 

Income from operations

     23,998        27,757   
  

 

 

   

 

 

 

Other (expense) income

    

Interest expense

     (5,515     (5,593

Other income

     267        116   
  

 

 

   

 

 

 

Total other expenses

     (5,248     (5,477
  

 

 

   

 

 

 

Income before income taxes

     18,750        22,280   

Provision for income taxes

     (7,344     (8,601
  

 

 

   

 

 

 

Net income

   $ 11,406      $ 13,679   
  

 

 

   

 

 

 

Weighted average shares outstanding:

    

Basic

     24,779        24,260   

Diluted

     25,740        25,451   

Earnings per share:

    

Basic

   $ 0.46      $ 0.56   

Diluted

   $ 0.44      $ 0.54   

Other comprehensive income:

    

Unrealized gain on derivative instruments

   $ 1,122      $ 836   

Income tax provision related to unrealized gain on derivative instruments

     (440     (329
  

 

 

   

 

 

 

Other comprehensive income, net of tax

     682        507   
  

 

 

   

 

 

 

Comprehensive income

   $ 12,088      $ 14,186   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements

 

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Table of Contents

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited, In Thousands)

 

     Common Stock      Additional
Paid-In
    Accumulated      Accumulated
Other
Comprehensive
    Total  
   Shares      Par      Capital     Earnings      (Loss) Income     Equity  

Balance at December 31, 2011

     24,520       $ 245       $ 123,406      $ 249,852       $ (1,968   $ 371,535   

Net income

     —           —           —          11,406         —          11,406   

Other comprehensive income:

               

Unrealized gain on derivative instruments, net of tax

     —           —           —          —           682        682   

Exercise of stock options and issuance of share-based awards, net of shares withheld for employee taxes

     176         2         (2,018     —           —          (2,016

Stock-based compensation

     —           —           2,266        —           —          2,266   

Tax benefit related to stock-based compensation

     —           —           984        —           —          984   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Balance at March 31, 2012

     24,696       $ 247       $ 124,638      $ 261,258       $ (1,286   $ 384,857   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited, In Thousands)

 

     Three Months Ended
March 31,
 
     2012     2011  

Operating activities:

    

Net income

   $ 11,406      $ 13,679   

Adjustments to reconcile net income to net cash provided by operating activities:

    

Depreciation and amortization

     1,363        1,053   

Impairment charge for goodwill and identifiable intangible assets

     10,349        —     

Amortization of loan costs

     466        440   

Stock-based compensation expense

     2,266        1,765   

Deferred income tax expense (benefit)

     623        (58

Excess tax benefit from stock-based payment arrangements

     (1,067     (1,343

Provision for allowances on receivable portfolios, net

     373        5,498   

Changes in operating assets and liabilities

    

Other assets

     (326     (1,819

Deferred court costs

     (1,333     (2,128

Prepaid income tax and income taxes payable

     2,130        8,437   

Accounts payable, accrued liabilities and other liabilities

     853        (450
  

 

 

   

 

 

 

Net cash provided by operating activities

     27,103        25,074   
  

 

 

   

 

 

 

Investing activities:

    

Purchases of receivable portfolios

     (130,463     (90,675

Collections applied to investment in receivable portfolios, net

     104,230        80,211   

Proceeds from put-backs of receivable portfolios

     734        900   

Purchases of property and equipment

     (1,555     (630
  

 

 

   

 

 

 

Net cash used in investing activities

     (27,054     (10,194
  

 

 

   

 

 

 

Financing activities:

    

Payment of loan costs

     —          (734

Proceeds from senior secured notes

     —          25,000   

Proceeds from revolving credit facility

     43,500        19,000   

Repayment of revolving credit facility

     (34,500     (46,000

Proceeds from exercise of stock options

     1,061        297   

Taxes paid related to net share settlement of equity awards

     (2,093     (1,439

Excess tax benefit from stock-based payment arrangements

     1,067        1,343   

Repayment of capital lease obligations

     (1,685     (877
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     7,350        (3,410
  

 

 

   

 

 

 

Net increase in cash and cash equivalents

     7,399        11,470   

Cash and cash equivalents, beginning of period

     8,047        10,905   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 15,446      $ 22,375   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid for interest

   $ 5,119      $ 5,002   

Cash paid for income taxes

     4,075        166   

Supplemental schedule of non-cash investing and financing activities:

    

Fixed assets acquired through capital lease

     1,564        371   

See accompanying notes to condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

Note 1: Ownership, Description of Business and Summary of Significant Accounting Policies

Encore Capital Group, Inc. (“Encore”), through its subsidiaries (collectively, the “Company”), is a leader in consumer debt buying and recovery. The Company purchases portfolios of defaulted consumer receivables and manages them by partnering with individuals as they repay their obligations and work toward financial recovery. Defaulted receivables are consumers’ unpaid financial commitments to credit originators, including banks, credit unions, consumer finance companies, commercial retailers, auto finance companies, and telecommunication companies, which the Company purchases at deep discounts. Defaulted receivables also include receivables subject to bankruptcy proceedings, or consumer bankruptcy receivables.

The Company purchases receivables based on robust, account-level valuation methods and employs a suite of proprietary statistical and behavioral models across the full extent of its operations. These investments allow the Company to value portfolios accurately (and limit the risk of overpaying), avoid buying portfolios that are incompatible with its methods or goals and precisely align the accounts it purchases with its operational channels to maximize future collections. As a result, the Company has been able to realize significant returns from the receivables it acquires. The Company maintains strong relationships with many of the largest credit providers in the United States, and possesses one of the industry’s best collection staff retention rates.

The Company expands upon the insights created during its purchasing process when building account collection strategies. The Company’s proprietary consumer-level collectability analysis is the primary determinant of whether an account is actively serviced post-purchase. Throughout the Company’s ownership period, it continuously refines this analysis to determine the most effective collection strategy to pursue for each account. After the Company’s preliminary analysis, it seeks to collect on only a fraction of the accounts it purchases, through one or more of its collection channels. The channel identification process is analogous to a funneling system where the Company first differentiates those consumers who are not able to pay, from those who are able to pay. Consumers who the Company believes are financially incapable of making any payments, are facing extenuating circumstances or hardships (such as medical issues), are serving in the military, or are currently receiving social security as their only means of financial sustenance are excluded from the next step of its collection process and are designated as inactive. The remaining pool of accounts in the funnel then receives further evaluation. At that point, the Company analyzes and determines a consumer’s willingness to pay. Based on that analysis, the Company will pursue collections through letters and/or phone calls to its consumers. Despite its efforts to reach consumers and work out a settlement option, only a small number of consumers who are contacted choose to engage with the Company. Those who do are often offered deep discounts on their obligations, or are presented with payment plans that are better suited to meet their daily cash flow needs. The majority of contacted consumers, however, ignore both the Company’s calls and letters, and therefore the Company must then make the difficult decision to pursue collections through legal means.

In addition, the Company provides bankruptcy support services to some of the largest companies in the financial services industry through its wholly owned subsidiary, Ascension Capital Group, Inc. (“Ascension”). Leveraging a proprietary software platform dedicated to bankruptcy servicing, Ascension’s operational platform integrates lenders, trustees, and consumers across the bankruptcy lifecycle. As discussed in Note 13 “Goodwill and Identifiable Intangible Assets,” on May 7, 2012, the Company’s Board of Directors (the “Board”) approved a plan to sell Ascension. At this time, the Company has reached an agreement in principle to sell Ascension to a third party.

Financial Statement Preparation

The accompanying interim condensed consolidated financial statements have been prepared by Encore, without audit, in accordance with the instructions to the Quarterly Report on Form 10-Q, and Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission and, therefore, do not include all information and footnotes necessary for a fair presentation of its consolidated financial position, results of operations and cash flows in accordance with accounting principles generally accepted in the United States.

In the opinion of management, the unaudited financial information for the interim periods presented reflects all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the Company’s consolidated financial position, results of operations, and cash flows. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2011. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year.

 

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Table of Contents

The preparation of financial statements in conformity with accounting principles generally accepted in the United States requires management to make estimates and assumptions that affect the reported amounts and the disclosure of contingent amounts in the Company’s financial statements and the accompanying notes. Actual results could materially differ from those estimates.

Basis of Consolidation

Encore is a Delaware holding company whose principal assets are its investments in various wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated in consolidation.

Reclassification

Certain reclassifications have been made to the condensed consolidated financial statements to conform to the current year’s presentation.

Note 2: Earnings per Share

Basic earnings per share is calculated by dividing net earnings available to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted earnings per share is calculated on the basis of the weighted average number of shares of common stock plus the effect of dilutive potential common shares outstanding during the period using the treasury stock method. Dilutive potential common shares include outstanding stock options and restricted stock units.

The components of basic and diluted earnings per share are as follows (in thousands, except earnings per share):

 

     Three Months Ended
March 31,
 
     2012      2011  

Net income available for common shareholders (A)

   $ 11,406       $ 13,679   
  

 

 

    

 

 

 

Weighted average outstanding shares of common stock (B)

     24,779         24,260   

Dilutive effect of stock-based awards

     961         1,191   
  

 

 

    

 

 

 

Common stock and common stock equivalents (C)

     25,740         25,451   
  

 

 

    

 

 

 

Earnings per share:

     

Basic (A/B)

   $ 0.46       $ 0.56   

Diluted (A/C)

   $ 0.44       $ 0.54   

Employee stock options to purchase approximately 209,000 and 39,000 shares of common stock were outstanding during the three months ended March 31, 2012 and 2011, respectively, but not included in the computation of diluted earnings per common share because the effect on diluted earnings per share would be anti-dilutive.

Note 3: Fair Value Measurements

The Company accounts for certain assets and liabilities at fair value. The authoritative guidance for fair value measurements defines fair value as the price that would be received upon sale of an asset or the price paid to transfer a liability, in an orderly transaction between market participants at the measurement date (i.e. the “exit price”). The guidance utilizes a fair value hierarchy that prioritizes the inputs used in valuation techniques to measure fair value into three broad levels. The following is a brief description of each level:

 

   

Level 1: Observable inputs such as quoted prices (unadjusted) in active markets for identical assets or liabilities.

 

   

Level 2: Inputs other than quoted prices that are observable for the asset or liability, either directly or indirectly. These include quoted prices for similar assets or liabilities in active markets and quoted prices for identical or similar assets or liabilities in markets that are not active.

 

   

Level 3: Unobservable inputs that reflect the reporting entity’s own assumptions.

 

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Table of Contents

Financial assets and liabilities measured at fair value on a recurring basis are summarized below (in thousands):

 

,0000000 ,0000000 ,0000000 ,0000000
     Fair Value Measurements as of March 31, 2012  
     Level 1      Level 2     Level 3      Total  

Assets

          

Foreign currency exchange contracts

   $ —         $ 85      $ —         $ 85   

Liabilities

          

Interest rate swap agreements

     —           (1,225     —           (1,225

Foreign currency exchange contracts

     —           (956     —           (956

 

0000000000 0000000000 0000000000 0000000000
     Fair Value Measurements as of December 31, 2011  
     Level 1      Level 2     Level 3      Total  

Assets

          

Foreign currency exchange contracts

   $ —         $ 168      $ —         $ 168   

Liabilities

          

Interest rate swap agreements

     —           (1,014     —           (1,014

Foreign currency exchange contracts

     —           (2,371     —           (2,371

Fair values of derivative instruments included in Level 2 are estimated using industry standard valuation models. These models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign currency exchange rates, and forward and spot prices for currencies. As of March 31, 2012, the Company did not have any financial instruments carried at fair value that required Level 3 measurement.

Financial instruments not required to be carried at fair value

Borrowings under the Company’s revolving credit facility are carried at historical cost, adjusted for additional borrowings less principal repayments, which approximates fair value. For investment in receivable portfolios, there is no active market or observable inputs for the fair value estimation. The Company does not consider it practical to attempt to estimate the fair value of such financial instruments due to the excessive costs that would be incurred in doing so.

Note 4: Derivatives and Hedging Instruments

The Company uses derivative instruments to manage risks related to interest rates and foreign currency. The Company’s outstanding interest rate swap contracts and foreign currency exchange contracts qualify for hedge accounting treatment under the authoritative guidance for derivatives and hedging.

Interest Rate Swaps

The Company may periodically enter into derivative financial instruments, typically interest rate swap agreements, to reduce its exposure to fluctuations in interest rates on variable interest rate debt and their impact on earnings and cash flows. As of March 31, 2012, the Company had six interest rate swap agreements outstanding with a total notional amount of $150.0 million. Under the swap agreements, the Company receives floating interest rate payments based on one-month reserve-adjusted LIBOR and makes interest payments based on fixed interest rates. The Company intends to continue electing the one-month reserve-adjusted LIBOR as the benchmark interest rate on the debt being hedged through its term. No credit spread was hedged. The Company designates its interest rate swap instruments as cash flow hedges.

The authoritative accounting guidance requires companies to recognize derivative instruments as either an asset or liability measured at fair value in the statement of financial position. The effective portion of the change in fair value of the derivative instrument is recorded in other comprehensive income (“OCI”). The ineffective portion of the change in fair value of the derivative instrument, if any, is recognized in interest expense in the period of change. From the inception of the hedging program, the Company has determined that the hedging instruments are highly effective.

Foreign Currency Exchange Contracts

The Company has operations in India, which exposes the Company to foreign currency exchange rate fluctuations due to transactions denominated in Indian rupees, such as employee salaries and rent expenditures. To mitigate this risk, the Company enters into derivative financial instruments, principally forward contracts, which are designated as cash flow hedges, to mitigate fluctuations in the cash payments of future forecasted transactions in Indian rupees for up to 36 months. The Company adjusts the level and use of derivatives as soon as practicable after learning that an exposure has changed, and the Company reviews all exposures and derivative positions on an ongoing basis.

 

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Gains and losses on cash flow hedges are recorded in accumulated other comprehensive income (loss) until the hedged transaction is recorded in the consolidated financial statements. Once the underlying transaction is recorded in the consolidated financial statements, the Company reclassifies the accumulated other comprehensive income or loss on the derivative into earnings. If all or a portion of the forecasted transaction was cancelled, this would render all or a portion of the cash flow hedge ineffective and the Company would reclassify the ineffective portion of the hedge into earnings. The Company generally does not experience ineffectiveness of the hedge relationship and the accompanying consolidated financial statements do not include any such gains or losses.

As of March 31, 2012, the total notional amount of the forward contracts to buy Indian rupees in exchange for U.S. dollars was $32.0 million. All outstanding contracts qualified for hedge accounting treatment as of March 31, 2012. The Company estimates that approximately $0.7 million of net derivative loss included in OCI will be reclassified into earnings within the next 12 months. No gains or losses were reclassified from OCI into earnings as a result of forecasted transactions that failed to occur during the three months ended March 31, 2012 and 2011.

The Company does not enter into derivative instruments for trading or speculative purposes.

The following table summarizes the fair value of derivative instruments as recorded in the Company’s consolidated statements of financial position (in thousands):

 

     March 31, 2012     December 31, 2011  
   Balance Sheet
Location
     Fair Value     Balance Sheet
Location
     Fair Value  

Derivatives designated as hedging instruments:

          

Interest rate swaps

     Other liabilities       $ (1,225     Other liabilities       $ (1,014

Foreign currency exchange contracts

     Other assets         85        Other assets         168   

Foreign currency exchange contracts

     Other liabilities         (956     Other liabilities         (2,371

The following tables summarize the effects of derivatives in cash flow hedging relationships on the Company’s statements of comprehensive income during the three months ended March 31, 2012 and 2011 (in thousands):

 

     Gain or (Loss)
Recognized in OCI-
Effective Portion
     Location of Gain
or (Loss)
Reclassified from
OCI into

Income - Effective
Portion
   Gain or (Loss)
Reclassified
from OCI into
Income -Effective
Portion
     Location of
Gain or (Loss)
Recognized -
Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing
   Amount of
Gain or (Loss)
Recognized -
Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing
     Three Months Ended
March 31,
          Three Months Ended
March 31,
          Three Months Ended
March 31,
     2012      2011           2012      2011           2012    2011

Interest rate swaps

     $  (211)         $506       Interest expense      $—           $—         Other (expense)
income
   $—      $—  

Foreign currency exchange contracts

     903           355       Salaries and
employee
benefits
     (116)         73       Other (expense)

income

   —      —  

Foreign currency exchange contracts

     297           65       General and
administrative
expenses
     (16)         18       Other (expense)
income
   —      —  

Note 5: Stock-Based Compensation

On March 9, 2009, the Board approved an amendment and restatement of the 2005 Stock Incentive Plan (“2005 Plan”), which was originally adopted on March 30, 2005, for Board members, employees, officers, and executives of, and consultants and advisors to, the Company. The amendment and restatement of the 2005 Plan increased by 2,000,000 shares the maximum number of shares of the Company’s common stock that may be issued or be subject to awards under the plan, established a new 10-year term for the plan and made certain other amendments. The 2005 Plan amendment was approved by the Company’s stockholders on June 9, 2009. The 2005 Plan provides for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, restricted stock units, and performance-based awards to eligible individuals. As amended, the 2005 Plan allows the granting of an aggregate of 3,500,000 shares of the Company’s common stock for awards, plus the number of shares of stock that were available for future awards under the prior 1999 Equity Participation Plan (“1999 Plan”). In addition, shares subject to options granted under either the 1999 Plan or the 2005 Plan that terminate or expire without being exercised will become available for grant under the 2005 Plan. The benefit provided under these plans is compensation subject to authoritative guidance for stock-based compensation.

 

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In accordance with authoritative guidance for stock-based compensation, compensation expense is recognized only for those shares expected to vest, based on the Company’s historical experience and future expectations. Total compensation expense during the three months ended March 31, 2012 and 2011 was $2.3 million and $1.8 million, respectively.

The Company’s stock-based compensation arrangements are described below:

Stock Options

The 2005 Plan permits the granting of stock options to certain employees and directors of the Company. Option awards are generally granted with an exercise price equal to the market price of the Company’s stock at the date of issuance. They generally vest over three to five years of continuous service, and have ten-year contractual terms.

The Company uses the Black-Scholes option-pricing model to determine the fair-value of stock-based awards. All options are amortized ratably over the requisite service periods of the awards, which are generally the vesting periods.

The fair value for options granted was estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions (there were no options granted for the three months ended March 31, 2012):

 

     Three Months Ended March 31,  
     2012      2011  

Weighted average fair value of options granted

   $ —         $ 13.26   

Risk free interest rate

     —           2.0

Dividend yield

     —           0.0

Volatility factor of the expected market price of the Company’s common stock

     —           61

Weighted-average expected life of options

     —           5 Years   

Unrecognized compensation cost related to stock options as of March 31, 2012, was $2.1 million. The weighted-average remaining expense period, based on the unamortized value of these outstanding stock options, was approximately 1.6 years.

A summary of the Company’s stock option activity as of March 31, 2012, and changes during the three months ended, is presented below:

 

     Number of
Shares
    Option Price
Per Share
     Weighted Average
Exercise Price
     Aggregate
Intrinsic
Value
(in thousands)
 

Outstanding at December 31, 2011

     2,182,940      $  0.51 – $24.65       $ 13.00      

Granted

     —                 —        

Cancelled/forfeited

     —                 —        

Exercised

     (55,867     0.51 – 16.19         3.79      
  

 

 

   

 

 

    

 

 

    

Outstanding at March 31, 2012

     2,127,073      $ 0.51 – $24.65       $ 13.24       $ 20,238   
  

 

 

   

 

 

    

 

 

    

Exercisable at March 31, 2012

     1,432,745      $ 0.51 – $24.65       $ 12.21       $ 14,959   
  

 

 

   

 

 

    

 

 

    

The total intrinsic value of options exercised during the three months ended March 31, 2012 and 2011 was $1.1 million and $1.2 million, respectively. As of March 31, 2012, the weighted-average remaining contractual life of options outstanding and options exercisable was 5.6 years and 4.5 years, respectively.

Non-Vested Shares

Under the Company’s 2005 Plan, Board members, employees, officers and executives of, and consultants and advisors to, the Company are eligible to receive restricted stock units and restricted stock awards. In accordance with the authoritative guidance, the fair value of these non-vested shares is equal to the closing sale price of the Company’s common stock on the date of issuance. The total number of these awards expected to vest is adjusted by estimated forfeiture rates. As of March 31, 2012, 18,830 of the non-vested shares are expected to vest over approximately one to two years based on certain performance goals (“Performance-Based Awards”). The fair value of the Performance-Based Awards is expensed over the expected vesting period, net of estimated forfeitures. If performance goals are not expected to be met, the compensation expense previously recognized would be reversed. No reversals of compensation expense related to the Performance-Based Awards have been made as of March 31, 2012. The remaining 350,611 non-vested shares are not performance-based, and will vest over approximately one to three years of continuous service.

 

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A summary of the status of the Company’s restricted stock units and restricted stock awards as of March 31, 2012, and changes during the three months ended, is presented below:

 

     Non-Vested
Shares
    Weighted Average
Grant Date
Fair Value

Non-vested at December 31, 2011

     589,117      $19.22

Awarded

     17,681      $23.38

Vested

     (231,918   $16.92

Cancelled/forfeited

     (5,439   $22.85
  

 

 

   

Non-vested at March 31, 2012

     369,441      $20.81
  

 

 

   

Unrecognized compensation expense related to non-vested shares as of March 31, 2012, was $4.8 million. The weighted-average remaining expense period, based on the unamortized value of these outstanding non-vested shares, was approximately 1.7 years. The fair value of restricted stock units and restricted stock awards vested during the three months ended March 31, 2012 and 2011 was $5.3 million and $4.7 million, respectively.

Note 6: Investment in Receivable Portfolios, Net

In accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality, discrete receivable portfolio purchases during a quarter are aggregated into pools based on common risk characteristics. Once a static pool is established, the portfolios are permanently assigned to the pool. The discount (i.e., the difference between the cost of each static pool and the related aggregate contractual receivable balance) is not recorded because the Company expects to collect a relatively small percentage of each static pool’s contractual receivable balance. As a result, receivable portfolios are recorded at cost at the time of acquisition. The purchase cost of the portfolios includes certain fees paid to third parties incurred in connection with the direct acquisition of the receivable portfolios.

In compliance with the authoritative guidance, the Company accounts for its investments in consumer receivable portfolios using either the interest method or the cost recovery method. The interest method applies an internal rate of return (“IRR”) to the cost basis of the pool, which remains unchanged throughout the life of the pool, unless there is an increase in subsequent expected cash flows. Subsequent increases in expected cash flows are generally recognized prospectively through an upward adjustment of the pool’s IRR over its remaining life. Subsequent decreases in expected cash flows do not change the IRR, but are recognized as an allowance to the cost basis of the pool, and are reflected in the consolidated statements of comprehensive income as a reduction in revenue, with a corresponding valuation allowance, offsetting the investment in receivable portfolios in the consolidated statements of financial condition.

The Company utilizes its proprietary forecasting models to continuously evaluate the economic life of each pool. The collection forecast of each pool is generally estimated to be between 84 to 96 months based on the expected collection period of each pool. The Company often experiences collections beyond the 84 to 96 month collection forecast. As of March 31, 2012, the total estimated remaining collections beyond the 84 to 96 month collection forecast was $104.2 million.

The Company accounts for each static pool as a unit for the economic life of the pool (similar to one loan) for recognition of revenue from receivable portfolios, for collections applied to the cost basis of receivable portfolios and for provision for loss or allowance. Revenue from receivable portfolios is accrued based on each pool’s IRR applied to each pool’s adjusted cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances.

If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, the Company accounts for such portfolios on the cost recovery method as Cost Recovery Portfolios. The accounts in these portfolios have different risk characteristics than those included in other portfolios acquired during the same quarter, or the necessary information was not available to estimate future cash flows and, accordingly, they were not aggregated with other portfolios. Under the cost recovery method of accounting, no income is recognized until the purchase price of a Cost Recovery Portfolio has been fully recovered.

Accretable yield represents the amount of revenue the Company expects to generate over the remaining life of its existing investment in receivable portfolios based on estimated future cash flows. Total accretable yield is the difference between future estimated collections and the current carrying value of a portfolio. All estimated cash flows on portfolios where the cost basis has been fully recovered are classified as zero basis cash flows.

 

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The following table summarizes the Company’s accretable yield and an estimate of zero basis future cash flows at the beginning and end of the period presented (in thousands):

 

     Accretable
Yield
    Estimate of
Zero Basis
Cash Flows
    Total  

Balance at December 31, 2011

   $ 821,527      $ 32,676      $ 854,203   

Revenue recognized, net

     (119,340     (7,065     (126,405

Net additions to existing portfolios(1)

     131,039        3,608        134,647   

Additions for current purchases(1)

     119,533        —          119,533   
  

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

   $ 952,759      $ 29,219      $ 981,978   
  

 

 

   

 

 

   

 

 

 

 

(1) 

Estimated remaining collections include anticipated collections beyond the 84 to 96 month collection forecast.

 

     Accretable
Yield
    Estimate of
Zero Basis
Cash Flows
    Total  

Balance at December 31, 2010

   $ 739,785      $ 4,274      $ 744,059   

Revenue recognized, net

     (101,709     (3,617     (105,326

Net additions to existing portfolios

     18,715        2,948        21,663   

Additions for current purchases

     93,098        —          93,098   
  

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

   $ 749,889      $ 3,605      $ 753,494   
  

 

 

   

 

 

   

 

 

 

During the three months ended March 31, 2012, the Company purchased receivable portfolios with a face value of $2.9 billion for $130.5 million, or a purchase cost of 4.5% of face value. The estimated future collections at acquisition for these portfolios amounted to $235.9 million. During the three months ended March 31, 2011, the Company purchased receivable portfolios with a face value of $2.9 billion for $90.7 million, or a purchase cost of 3.1% of face value. The estimated future collections at acquisition for these portfolios amounted to $178.4 million.

All collections realized after the net book value of a portfolio has been fully recovered (“Zero Basis Portfolios”) are recorded as revenue (“Zero Basis Revenue”). During the three months ended March 31, 2012 and 2011, approximately $6.0 million and $3.0 million, respectively, were recognized as revenue on portfolios for which the related cost basis has been fully recovered.

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

 

     Three Months Ended March 31, 2012  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 716,454      $ —        $ —        $ 716,454   

Purchases of receivable portfolios

     130,463        —          —          130,463   

Gross collections(1)

     (223,943     —          (7,065     (231,008

Put-backs and recalls(2)

     (734     —          —          (734

Revenue recognized

     120,746        —          6,032        126,778   

(Portfolio allowances) portfolio allowance reversals, net

     (1,406     —          1,033        (373
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 741,580      $ —        $ —        $ 741,580   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections(3)

     53.9     0.0     85.4     54.9
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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     Three Months Ended March 31, 2011  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 644,753      $ —        $ —        $ 644,753   

Purchases of receivable portfolios

     90,675        —          —          90,675   

Gross collections(1)

     (187,417     —          (3,617     (191,034

Put-backs and recalls(2)

     (900     —          —          (900

Revenue recognized

     107,804        —          3,020        110,824   

(Portfolio allowances) portfolio allowance reversals, net

     (6,095     —          597        (5,498
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $  648,820      $  —     $     $  648,820   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections(3)

     57.5     0.0     83.5     58.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

Put-backs represent accounts that are returned to the seller in accordance with the respective purchase agreement (“Put-Backs”). Recalls represent accounts that are recalled by the seller in accordance with the respective purchase agreement (“Recalls”).

(3) 

Revenue as a percentage of collections excludes the effects of net portfolio allowances or net portfolio allowance reversals.

The following table summarizes the change in the valuation allowance for investment in receivable portfolios during the periods presented (in thousands):

 

     Valuation Allowance  
     Three Months Ended March 31,  
     2012     2011  

Balance at beginning of period

   $ 109,494      $ 98,671   

Provision for portfolio allowances

     1,759        6,095   

Reversal of prior allowance

     (1,386     (597
  

 

 

   

 

 

 

Balance at end of period

   $ 109,867      $ 104,169   
  

 

 

   

 

 

 

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

 

     Three Months Ended March 31,  
     2012      2011  

Collection sites

   $ 109,870       $ 88,541   

Legal collections

     109,572         88,488   

Collection agencies

     11,586         13,990   

Other

     —           54   
  

 

 

    

 

 

 
   $ 231,028       $ 191,073   
  

 

 

    

 

 

 

Note 7: Deferred Court Costs, Net

The Company contracts with a nationwide network of attorneys that specialize in collection matters. The Company generally refers charged-off accounts to its contracted attorneys when it believes the related debtor has sufficient assets to repay the indebtedness and has, to date, been unwilling to pay. In connection with the Company’s agreement with the contracted attorneys, it advances certain out-of-pocket court costs (“Deferred Court Costs”). The Company capitalizes Deferred Court Costs in its consolidated financial statements and provides a reserve for those costs that it believes will ultimately be uncollectible. The Company determines the reserve based on its analysis of court costs that have been advanced and those that have been recovered. Deferred Court Costs not recovered within three years of placement are fully written-off. Collections received from these debtors are first applied against related court costs with the balance applied to the debtors’ account.

Deferred Court Costs for the three-year deferral period consist of the following as of the dates presented (in thousands):

 

     March 31,
2012
    December 31,
2011
 

Court costs advanced

   $ 231,055      $ 228,977   

Court costs recovered

     (61,929     (60,017

Court costs reserve

     (129,287     (130,454
  

 

 

   

 

 

 
   $ 39,839      $ 38,506   
  

 

 

   

 

 

 

 

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Note 8: Other Assets

Other assets consist of the following (in thousands):

 

     March 31,
2012
     December 31,
2011
 

Debt issuance costs, net of amortization

   $ 3,827       $ 4,293   

Prepaid expenses

     5,500         5,232   

Security deposit—India building lease

     1,630         1,482   

Deferred compensation assets

     748         722   

Prepaid income tax

     —           53   

Other

     137         186   
  

 

 

    

 

 

 
   $ 11,842       $ 11,968   
  

 

 

    

 

 

 

Deferred compensation assets represent monies held in a trust associated with the Company’s deferred compensation plan.

Note 9: Debt

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

 

     March 31,
2012
     December 31,
2011
 

Revolving credit facility

     $314,000         $305,000   

Senior secured notes

     75,000         75,000   

Capital lease obligations and other

     9,246         8,950   
  

 

 

    

 

 

 
     $398,246         $388,950   
  

 

 

    

 

 

 

Revolving Credit Facility

On April 10 and May 8, 2012, Encore entered into amendments to its revolving credit facility. The amendments added new lenders, appointed a new administrative agent, changed the borrowing base advance rate, increased the aggregate revolving loan commitment by $145.0 million, from $410.5 million to $555.5 million, and reset the accordion feature by an additional $100.0 million, resulting in a maximum of $655.5 million that can be borrowed under the facility. Additionally, the May 8, 2012 amendment approved the acquisition discussed in Note 14 “Subsequent Event.”

Loan fees and other loan costs associated with the above amendments amounted to approximately $0.7 million. These costs will be included in other assets in the Company’s consolidated statements of financial condition and amortized over the remaining term of the facility.

Provisions of the amended revolving credit facility include:

 

   

Interest at a floating rate equal to, at the Company’s option, either: (1) reserve adjusted LIBOR, plus a spread that ranges from 350 to 400 basis points, depending on the Company’s leverage; or (2) Alternate Base Rate (“ABR”), plus a spread that ranges from 250 to 300 basis points, depending on the Company’s leverage. ABR, as defined in the agreement, means the highest of (i) the rate of interest publicly announced by JPMorgan Chase Bank as its prime rate in effect at its principal office in New York City, (ii) the federal funds effective rate from time to time, plus 0.5% and (iii) reserved adjusted LIBOR for a one month interest period on the applicable date, plus 1.0%;

 

   

$10.0 million sub-limits for swingline loans and letters of credit;

 

   

A borrowing base equal to (1) the lesser of (i) 30% - 35% (depending, as defined in the amendment, on the Company’s trailing 12-month cost per dollar collected) of eligible estimated remaining collections, initially set at 33%, and (ii) the product of the net book value of all receivable portfolios acquired on or after January 1, 2005 multiplied by 95%, minus (2) the aggregate principal amount outstanding of the senior secured notes;

 

   

Restrictions and covenants, which limit, among other things, the payment of dividends and the incurrence of additional indebtedness and liens;

 

   

Repurchases of up to $50.0 million of Encore’s common stock, subject to compliance with certain covenants and available borrowing capacity;

 

   

A change of control definition, which excludes acquisitions of stock by Red Mountain Capital Partners LLC, JCF FPK I LP and their respective affiliates of up to 50% of the outstanding shares of Encore’s voting stock;

 

   

Events of default which, upon occurrence, may permit the lenders to terminate the revolving credit facility and declare all amounts outstanding to be immediately due and payable;

 

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An annual capital expenditure maximum of $12.5 million;

 

   

An annual rental expense maximum of $12.5 million;

 

   

An outstanding capital lease maximum of $12.5 million;

 

   

An acquisition limit of $100.0 million; and

 

   

Collateralization by all assets of the Company, other than the assets of Propel (as defined in Note 14 “Subsequent Event”).

At March 31, 2012, the outstanding balance on the revolving credit facility was $314.0 million, which bore a weighted average interest rate of 4.15% for the three months ended March 31, 2012. As discussed above, on April 10 and May 8, 2012, Encore entered into amendments to its revolving credit facility thereby increasing the aggregate revolving loan commitment by $145.0 million.

Subject to compliance with the revolving credit facility, Encore is authorized by its Board to repurchase up to $50.0 million of its common stock.

Senior Secured Notes

As of March 31, 2012, Encore had $75.0 million in senior secured notes with certain affiliates of Prudential Capital Group. Twenty five million dollars of the senior secured notes bear an annual interest rate of 7.375% and mature in 2018. These notes require quarterly interest only payments through May 2013. Beginning in May 2013, the notes require a quarterly payment of interest plus $1.25 million of principal. The remaining fifty million dollars of the senior secured notes bear an annual interest rate of 7.75% and mature in 2017 with principal amortization beginning in December 2012. These notes require quarterly interest only payments through December 2012. Beginning in December 2012, the notes require a quarterly payment of interest plus $2.5 million of principal.

The senior secured notes are guaranteed in full by certain of Encore’s subsidiaries and are collateralized by all assets of the Company. The senior secured notes may be accelerated and become automatically and immediately due and payable upon certain events of default, including certain events related to insolvency, bankruptcy or liquidation. Additionally, the senior secured notes may be accelerated at the election of the holder or holders of a majority in principal amount of the senior secured notes upon certain events of default by the Company, including the breach of affirmative covenants regarding guarantors, collateral, most favored lender treatment or minimum revolving credit facility commitment or the breach of any negative covenant. If the Company prepays the senior secured notes at any time for any reason, payment will be at the higher of par or the present value of the remaining scheduled payments of principal and interest on the portion being prepaid. The discount rate used to determine the present value is 50 basis points over the then current Treasury Rate corresponding to the remaining average life. The covenants are substantially similar to those in the revolving credit facility. Prudential Capital Group and the administrative agent for the lenders of the revolving credit facility have an intercreditor agreement related to collateral, actionable default, powers and duties and remedies, among other topics.

Capital Lease Obligations

The Company has capital lease obligations primarily for certain computer equipment. As of March 31, 2012, the Company’s combined obligations for these computer equipment leases were approximately $8.3 million. These lease obligations require monthly or quarterly payments through July 2016 and have implicit interest rates that range from zero to approximately 7.7%.

Note 10: Income Taxes

The Company recorded an income tax provision of $7.3 million, reflecting an effective rate of 39.2% of pretax income during the three months ended March 31, 2012. The effective tax rate for the three months ended March 31, 2012 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%) and a blended provision for state taxes of 6.5%.

The Company recorded an income tax provision of $8.6 million, reflecting an effective rate of 38.6% of pretax income during the three months ended March 31, 2011. The effective tax rate for the three months ended March 31, 2011 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.7%, and a net benefit for the permanent book versus tax differences of 0.8%.

The Company’s subsidiary in India was operating under a tax holiday through March 31, 2011, at which time the tax holiday expired. If there had been no tax holiday for the quarter ended March 31, 2011, the Company would have expensed an additional $0.6 million in income taxes. The Company’s subsidiary in Costa Rica is operating under a 100% tax holiday for the next eight years and a 50% tax holiday for the following four years. The impact of the tax holiday in Costa Rica for the three months ended March 31, 2012 was immaterial.

 

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Table of Contents

As of March 31, 2012, the Company had a gross unrecognized tax benefit of $1.9 million that, if recognized, would result in a net tax benefit of approximately $1.2 million and would have a positive effect on the Company’s effective tax rate. During the three months ended March 31, 2012, there were no material changes to the unrecognized tax benefit.

During the three months ended March 31, 2012, the Company did not provide for the United States income taxes or foreign withholding taxes on the quarterly undistributed earnings from continuing operations of its subsidiary operating outside of the United States. Undistributed earnings of the subsidiary during the three months ended March 31, 2012 and 2011, were approximately $2.4 million and $1.9 million, respectively. Such undistributed earnings are considered permanently reinvested.

Note 11: Purchase Concentrations

The following table summarizes purchases by seller sorted by total aggregate cost (in thousands, except percentages):

 

     Three Months Ended
March  31, 2012
 
   Cost     %  

Seller 1

   $ 39,789        30.5

Seller 2

     27,792        21.3

Seller 3

     15,335        11.8

Seller 4

     13,642        10.5

Seller 5

     7,864        6.0

Other sellers

     26,041        19.9
  

 

 

   

 

 

 
   $ 130,463        100.0

Adjustments(1)

     (60  
  

 

 

   

Purchases, net

   $ 130,403     
  

 

 

   

 

(1) 

Adjusted for Put-backs and Recalls.

Note 12: Commitments and Contingencies

Litigation

The Company is involved in disputes and legal actions from time to time in the ordinary course of business. The Company, along with others in its industry, is routinely subject to legal actions based on the Fair Debt Collection Practices Act (“FDCPA”), comparable state statutes, the Telephone Consumer Protection Act (“TCPA”), state and federal unfair competition statutes and common law causes of action. The violations of law alleged in these actions often include claims that the Company lacks specified licenses to conduct its business, attempts to collect debts on which the statute of limitations has run, has made inaccurate assertions of fact in support of its collection actions and /or has acted improperly in connection with its efforts to contact consumers. These cases are frequently styled as supposed class actions. In addition, from time to time, the Company is subject to litigation and other actions by governmental bodies, including formal and informal investigations relating to its collection activities by the Federal Trade Commission, state attorneys general and other governmental bodies, with which the Company cooperates.

There has been no material development in any of the legal proceedings disclosed in the Company’s Annual Report on Form 10-K for the year ended December 31, 2011.

In certain legal proceedings, the Company may have recourse to insurance or third party contractual indemnities to cover all or portions of its litigation expenses, judgments or settlements. In accordance with authoritative guidance, the Company records loss contingencies in its financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated with no best estimate in the range, the Company records the minimum estimated liability. The Company continuously assesses the potential liability related to the Company’s pending litigation and revises its estimates when additional information becomes available. The Company’s legal costs are recorded to expense as incurred.

Purchase Commitments

In the normal course of business, the Company enters into forward flow purchase agreements and other purchase commitment agreements. As of March 31, 2012, the Company has entered into agreements to purchase receivable portfolios with a face value of approximately $3.3 billion for a purchase price of approximately $142.2 million. The Company has no purchase commitments extending past one year.

 

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Table of Contents

Note 13: Goodwill and Identifiable Intangible Assets

In accordance with authoritative guidance, goodwill is tested at the reporting unit level annually for impairment and in interim periods if certain events occur indicating the fair value of a reporting unit may be below its carrying value.

The Company has two reporting units that carry goodwill: portfolio purchasing and recovery and bankruptcy servicing. Annual testing is performed on October 1st for the portfolio purchasing and recovery reporting unit and on August 31st for the bankruptcy servicing reporting unit.

During the first quarter of 2012, the Company’s subsidiary, Ascension (which is determined to be the bankruptcy servicing reporting unit for the purpose of goodwill impairment testing), experienced uncertainty surrounding a material client’s contract renewal. The client agreed to renew the contract, provided that Ascension enters into an agreement with a specified third party to make or facilitate the technology improvements required by the client. On May 7, 2012, the Board approved a plan to sell Ascension. At this time, the Company has reached an agreement in principle to sell Ascension to the third party. As part of the sale, Ascension’s new owner will invest in new technology and apply the bankruptcy servicing expertise necessary for Ascension to compete more effectively, and the Company has agreed to cover normal operating losses in the first year of ownership. If the business grows and becomes profitable, the Company will be paid an earn-out equal to 30 to 40% of Ascension’s EBITDA for the first five years after closing. In connection with the preparation of its financial statements and based, in part, on these developments, the Company performed an interim goodwill impairment test for Ascension as of March 31, 2012. The goodwill impairment test is a two-step process. First, the Company estimated the fair value of Ascension by considering the proposed selling price to the potential buyer. The result of this analysis indicated that Ascension’s carrying value exceeded its fair value. Therefore, the Company measured the amount of impairment charge by comparing the implied fair value of the goodwill with the carrying value of that goodwill. Based on the proposed selling price, the Company concluded that the entire goodwill balance of $9.9 million for Ascension was impaired as of March 31, 2012. Additionally, the Company wrote-off the remaining identifiable intangible assets of approximately $0.4 million at Ascension. Beginning in the second quarter of 2012, and regardless of whether the sale discussed above is completed, Ascension will be treated as a discontinued operation.

As a result, the Company recognized a pre-tax impairment charge for goodwill and identifiable intangible assets of $10.3 million, or $0.25 per diluted share, after the effect of income taxes during the three months ended March 31, 2012.

The Company’s acquired intangible assets are summarized as follows (in thousands):

 

     As of March 31, 2012      As of December 31, 2011  
     Gross
Carrying
    Amount    
     Accumulated
    Amortization    
     Net
Carrying
    Amount    
     Gross
Carrying
    Amount    
     Accumulated
    Amortization    
    Net
Carrying
    Amount    
 

Intangible assets subject to amortization:

                

Customer relationships and other

   $ —         $ —         $ —         $ 6,000       $ (5,538   $ 462   

Intangible assets not subject to amortization:

  

Goodwill – portfolio purchasing and recovery

         $ 6,047            $ 6,047   

Goodwill – bankruptcy servicing

        —                9,938   
        

 

 

         

 

 

 

Total goodwill

         $ 6,047            $ 15,985   
        

 

 

         

 

 

 

Note 14: Subsequent Event

On May 8, 2012, the Company acquired all of the outstanding equity of Propel Financial Services, LLC, and certain of its affiliates (“Propel”) for $186.8 million in cash. Propel provides property tax solutions to customers in the state of Texas by paying real estate taxes on behalf of owners of real property in Texas in exchange for notes collateralized by tax liens on the property. The Company financed the acquisition through a new $160.0 million syndicated loan facility (the “Propel Facility”), the Company’s existing revolving credit facility and cash on hand. The Propel Facility will be used to fund a portion of the purchase price and to fund future growth at Propel. The Propel Facility has a three year term and includes the following key provisions:

 

   

Interest at Propel’s option, at either: (1) LIBOR, plus a spread that ranges from 300 to 375 basis points, depending on Propel’s leverage; or (2) Prime, plus a spread that ranges from 0 to 75 basis points, depending on Propel’s leverage;

 

   

A borrowing base of 90% of the face value of the tax lien collateralized notes;

 

   

Interest payable monthly; principal and interest due at maturity; and

 

   

A $40.0 million accordion feature.

The Propel Facility is collateralized by the tax lien collateralized notes and requires Propel to maintain various financial covenants, including a minimum interest coverage ratio and a maximum cash flow leverage ratio.

 

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

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of the securities laws. The words “believe,” “expect,” “anticipate,” “estimate,” “project,” “intend,” “plan,” “will,” “may” and similar expressions often characterize forward-looking statements. These statements may include, but are not limited to, projections of collections, revenues, income or loss, estimates of capital expenditures, plans for future operations, products or services and financing needs or plans, as well as assumptions relating to these matters. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we caution that these expectations or predictions may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control or cannot be predicted or quantified, that could cause actual results to differ materially from those suggested by the forward-looking statements. Many factors, including but not limited to those set forth in this Quarterly Report on Form 10-Q under “Part II, Item 1A. Risk Factors” and in our Annual Report on Form 10-K under “Part I, Item 1A. Risk Factors,” could cause our actual results, performance, achievements or industry results to be very different from the results, performance, achievements or industry results expressed or implied by these forward-looking statements. Our business, financial condition or results of operations could also be materially and adversely affected by other factors besides those listed. Forward-looking statements speak only as of the date the statements were made. We do not undertake any obligation to update or revise any forward-looking statements to reflect new information or future events, or for any other reason, even if experience or future events make it clear that any expected results expressed or implied by these forward-looking statements will not be realized. In addition, it is generally our policy not to make any specific projections as to future earnings, and we do not endorse projections regarding future performance that may be made by third parties.

Introduction

We are a leader in consumer debt buying and recovery. We purchase portfolios of defaulted consumer receivables at deep discounts to face value based on robust, account-level valuation methods, and employ a suite of proprietary statistical and behavioral models when building account collection strategies. We use a variety of operational channels to maximize our collections from the portfolios that we purchase, including seeking to partner with individuals as they repay their obligations and work toward financial recovery. In addition, we provide bankruptcy support services to some of the largest companies in the financial services industry through our wholly owned subsidiary, Ascension. On May 7, 2012, our Board of Directors (the “Board”) approved a plan to sell Ascension. At this time, we have reached an agreement in principle to sell Ascension to a third party. See Note 13 “Goodwill and Identifiable Intangible Assets” to our unaudited condensed consolidated financial statements for a further discussion.

While seasonality does not have a material impact on our business, collections are generally strongest in our first calendar quarter, slower in the second and third calendar quarters, and slowest in the fourth calendar quarter. Relatively higher collections in the first quarter could result in a lower cost-to-collect ratio compared to the other quarters, as our fixed costs would be constant and applied against a larger collection base. The seasonal impact on our business may be influenced by our purchasing levels, the types of portfolios we purchase, and our operating strategies.

Collection seasonality can also impact our revenue recognition rate. Generally, revenue for each pool group declines steadily over time, whereas collections can fluctuate from quarter to quarter based on seasonality, as described above. In quarters with lower collections (like the fourth calendar quarter), revenue as a percentage of collections can be higher than in quarters with higher collections (like the first calendar quarter).

In addition, seasonality could have an impact on the relative level of quarterly earnings. In quarters with stronger collections, total costs are higher, as a result of the additional efforts required to generate those collections. Since revenue for each pool group declines steadily over time, in quarters with stronger collections and higher costs (like the first calendar quarter), all else being equal, earnings could be lower than in quarters with slower collections and lower costs (like the fourth calendar quarter). Additionally, in quarters where a greater percentage of collections come from our legal and agency outsourcing channels, cost to collect will be higher than if there were more collections from our internal collection sites.

Market Overview

While there has been improvement in macroeconomic indicators during the last three months, a broad economic recovery has yet to fully materialize for the U.S. consumer. Slow job growth, uncertainty over state and federal taxes and limited credit availability continue to challenge U.S. consumers, as demonstrated by weak consumer spending and volatile but rising consumer confidence levels. Within the credit card space, delinquency levels have improved at a rate that may indicate a fundamental improvement in consumer financial strength. However, related measures, like personal bankruptcies and home foreclosures, remain elevated and indicate continued near-term pressure on the average consumer.

 

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Despite this macroeconomic uncertainty through the first quarter of 2012, most of our internal collection metrics were consistent with, or better than, what we observed during the same periods in 2010 and 2011. To illustrate, payer rates and average payment size, adjusted for changes in the mix of settlements-in-full versus payment plans, remained consistent. As compared to prior years, more of our consumers continue to opt to settle their debt obligations through payment plans as opposed to one-time settlements. Settlements made through payment plans impact our recoveries in two ways. First, the delay in cash flows from payments received over extended time periods may result in a provision for portfolio allowance. When a long-term payment stream (as compared to a one-time payment of the same amount) is discounted using a pool group’s internal rate of return, or IRR, the net present value is lower. In other words, despite the absolute value of total cash received being identical in both scenarios, accounting for the timing of cash flows in a payment plan yields a lower net present value, which, in turn, can result in a provision for portfolio allowance. Second, payment plans inherently contain the possibility of consumers failing to complete all scheduled payments, which we term a “broken payer.”

The rate at which consumers are honoring their obligations and completing their payment plans has continued to increase over the last 12 months. We believe this is the result of two factors: our commitment to partner effectively with consumers during their recovery process and the strength of our analytic platform, which allows us to make accurate and timely decisions about how best to maximize our portfolio returns. Nevertheless, payment plans may still produce broken payers that fail to fulfill all scheduled payments. When this happens, we are often successful in getting the consumer back on plan, but this is not always the case, and in those instances where we are unable to do so, we may experience a shortfall in recoveries as compared to our initial forecasts. Please refer to “Management’s Discussion and Analysis – Revenue” below for a more detailed explanation of the provision for portfolio allowances.

Purchases and Collections

Purchases by Type

The following table summarizes the types of charged-off consumer receivables portfolios we purchased for the periods presented (in thousands):

 

     Three Months Ended March 31,  
     2012      2011  

Credit card

   $ 107,935       $ 87,991   

Telecom

     22,528         1,236   

Consumer bankruptcy receivables(1)

     —           1,448   
  

 

 

    

 

 

 
   $ 130,463       $ 90,675   
  

 

 

    

 

 

 

 

(1) 

Represents portfolio receivables subject to Chapter 13 and Chapter 7 bankruptcy proceedings acquired from issuers.

During the three months ended March 31, 2012, we invested $130.5 million to acquire charged-off credit card and telecom portfolios, with face values aggregating $2.9 billion, for an average purchase price of 4.5% of face value. This is a $39.8 million increase, or 43.9%, in the amount invested, compared with the $90.7 million invested during the three months ended March 31, 2011, to acquire charged-off credit card portfolios with a face value aggregating $2.9 billion, for an average purchase price of 3.1% of face value.

Average purchase price, as a percentage of face value, varies from period to period depending on, among other things, the quality of the accounts purchased and the length of time from charge off to the time we purchase the portfolios.

Collections by Channel

During the three months ended March 31, 2012 and 2011, we utilized numerous business channels for the collection of charged-off credit card receivables and other charged-off receivables. The following table summarizes gross collections by collection channel (in thousands):

 

     Three Months Ended March 31,  
     2012      2011  

Collection sites

   $ 109,870       $ 88,541   

Legal collections

     109,572         88,488   

Collection agencies

     11,586         13,990   

Other

     —           54   
  

 

 

    

 

 

 
   $ 231,028       $ 191,073   
  

 

 

    

 

 

 

Gross collections increased $39.9 million, or 20.9%, to $231.0 million during the three months ended March 31, 2012, from $191.1 million during the three months ended March 31, 2011.

 

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Results of Operations

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

 

     Three Months Ended March 31,  
     2012     2011  

Revenues

        

Revenue from receivable portfolios, net

   $ 126,405        97.1   $ 105,326        95.5

Servicing fees and related revenue

     3,817        2.9     4,977        4.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     130,222        100.0     110,303        100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Salaries and employee benefits (excluding stock-based compensation expense)

     23,109        17.8     19,040        17.3

Stock-based compensation expense

     2,266        1.7     1,765        1.6

Cost of legal collections

     38,635        29.7     36,509        33.1

Other operating expenses

     12,411        9.5     10,096        9.1

Collection agency commissions

     3,959        3.0     3,914        3.5

General and administrative expenses

     14,132        10.9     10,169        9.2

Depreciation and amortization

     1,363        1.0     1,053        1.0

Impairment charge for goodwill and identifiable intangible assets

     10,349        8.0     —          0.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     106,224        81.6     82,546        74.8
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     23,998        18.4     27,757        25.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) income

        

Interest expense

     (5,515     (4.2 )%      (5,593     (5.1 )% 

Other income

     267        0.2     116        0.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     (5,248     (4.0 )%      (5,477     (5.0 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     18,750        14.4     22,280        20.2

Provision for income taxes

     (7,344     (5.6 )%      (8,601     (7.8 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 11,406        8.8   $ 13,679        12.4
  

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per diluted share

   $ 0.44 (1)      $ 0.54     

 

(1) 

Includes a $0.25 effect related to a one-time, non-cash charge of $10.3 million ($6.3 million after the effects of income taxes) associated with the impairment of Ascension’s goodwill and identifiable intangible assets.

Comparison of Results of Operations

Revenue

Our revenue consists primarily of portfolio revenue and bankruptcy servicing revenue. Portfolio revenue consists of accretion revenue and zero basis revenue. Accretion revenue represents revenue derived from pools (quarterly groupings of purchased receivable portfolios) with a cost basis that has not been fully amortized. Revenue from pools with a remaining unamortized cost basis is accrued based on each pool’s effective interest rate applied to each pool’s remaining unamortized cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances. The effective interest rate is the internal rate of return derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool. All collections realized after the net book value of a portfolio has been fully recovered, or Zero Basis Portfolios, are recorded as revenue, or Zero Basis Revenue. We account for our investment in receivable portfolios utilizing the interest method in accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality. Servicing fee revenue is revenue primarily associated with bankruptcy servicing fees earned from Ascension, a provider of bankruptcy services to the finance industry.

 

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The following tables summarize collections, revenue, end of period receivable balance and other related supplemental data, by year of purchase (in thousands, except percentages):

 

     Three Months Ended March 31, 2012      As of
March 31, 2012
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
     Net
(Portfolio
Allowance)
Reversal
     Revenue
% of Total
Revenue
     Unamortized
Balances
     Monthly
IRR
 

ZBA(4)

   $ 7,065       $ 6,032         85.4%       $ 1,033         4.8%       $ —           —     

2005

     3,431         1,319         38.4%         (78)         1.0%         6,114         5.7%   

2006

     3,769         2,505         66.5%         (1,119)         2.0%         15,010         5.1%   

2007

     5,050         2,737         54.2%         (209)         2.2%         15,960         5.1%   

2008

     17,313         9,045         52.2%         —           7.1%         49,979         5.4%   

2009

     32,578         20,738         63.7%         —           16.3%         76,589         8.0%   

2010

     63,996         37,098         58.0%         —           29.3%         164,036         6.7%   

2011

     85,220         41,924         49.2%         —           33.1%         291,099         4.9%   

2012

     12,586         5,380         42.7%         —           4.2%         122,793         3.5%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 231,008       $ 126,778         54.9%       $ (373)         100.0%       $ 741,580         5.4%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

     Three Months Ended March 31, 2011      As of
March 31, 2011
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
     Net
(Portfolio
Allowance)
Reversal
     Revenue
% of Total
Revenue
     Unamortized
Balances
     Monthly
IRR
 

ZBA(4)

   $ 3,617       $ 3,020         83.5%       $ 597         2.7%       $ —           —     

2004

     1,103         180         16.3%         —           0.2%         242         6.6%   

2005

     5,471         2,741         50.1%         (603)         2.5%         13,983         5.6%   

2006

     5,313         4,145         78.0%         (2,481)         3.7%         25,241         5.1%   

2007

     13,458         8,718         64.8%         (1,463)         7.9%         31,936         7.4%   

2008

     26,425         14,981         56.7%         (1,548)         13.5%         86,797         5.2%   

2009

     49,666         29,310         59.0%         —           26.4%         127,439         6.8%   

2010

     77,719         43,119         55.5%         —           38.9%         276,479         4.8%   

2011

     8,262         4,610         55.8%         —           4.2%         86,703         3.6%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 191,034       $ 110,824         58.0%       $ (5,498)         100.0%       $ 648,820         5.2%   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

Gross revenue excludes the effects of net portfolio allowances or net portfolio allowance reversals.

(3) 

Revenue recognition rate excludes the effects of net portfolio allowances or net portfolio allowance reversals.

(4) 

ZBA revenue typically has a 100% revenue recognition rate. However, collections on ZBA pool groups where a valuation allowance remains must first be recorded as an allowance reversal until the allowance for that pool group is zero. Once the valuation allowance is reversed, the revenue recognition rate will become 100%.

Total revenues were $130.2 million during the three months ended March 31, 2012, an increase of $19.9 million, or 18.1%, compared to total revenues of $110.3 million during the three months ended March 31, 2011. Portfolio revenue was $126.4 million during the three months ended March 31, 2012, an increase of $21.1 million, or 20.0%, compared to portfolio revenue of $105.3 million during the three months ended March 31, 2011. The increase in portfolio revenue during the three months ended March 31, 2012 was primarily the result of lower net portfolio allowance provision and additional accretion revenue associated with a higher portfolio balance during the three months ended March 31, 2012 compared to the three months ended March 31, 2011. During the three months ended March 31, 2012, we recorded a net portfolio allowance provision of $0.4 million, compared to a net portfolio allowance provision of $5.5 million in the same period of the prior year.

Revenue associated with bankruptcy servicing fees earned from Ascension was $3.8 million during the three months ended March 31, 2012, a decrease of $1.1 million, or 23.3%, compared to revenue of $4.9 million during the three months ended March 31, 2011.

Operating Expenses

Total operating expenses were $106.2 million during the three months ended March 31, 2012, an increase of $23.7 million, or 28.7%, compared to total operating expenses of $82.5 million during the three months ended March 31, 2011.

 

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Operating expenses are explained in more detail as follows:

Salaries and employee benefits

Total salaries and employee benefits increased $4.1 million, or 21.4%, to $23.1 million during the three months ended March 31, 2012, from $19.0 million during the three months ended March 31, 2011. The increase was primarily the result of increases in headcount and related compensation expense to support our growth. Salaries and employee benefits related to our internal legal channel were approximately $1.3 million and $0.3 million for the three months ended March 31, 2012 and 2011, respectively.

Stock-based compensation expense

Stock-based compensation increased $0.5 million, or 28.4%, to $2.3 million during the three months ended March 31, 2012, from $1.8 million during the three months ended March 31, 2011. This increase was primarily attributable to higher fair value of equity awards granted in recent periods.

Cost of legal collections

The cost of legal collections increased $2.1 million, or 5.8%, to $38.6 million during the three months ended March 31, 2012, compared to $36.5 million during the three months ended March 31, 2011. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in the cost of legal collections was primarily the result of an increase of $21.1 million, or 23.8%, in gross collections through our legal channel. Gross legal collections were $109.6 million during the three months ended March 31, 2012, up from $88.5 million collected during the three months ended March 31, 2011. The cost of legal collections decreased as a percentage of gross collections through this channel to 35.3% during the three months ended March 31, 2012 from 41.3% during the same period in the prior year. This decrease was primarily due to an improvement in our court cost recovery rate and a decrease in the commission rate we pay our contracted attorneys.

The following table summarizes our legal collection channel performance and related direct costs (in thousands, except percentages):

 

     Three Months Ended March 31,  
     2012     2011  

Collections(1)

   $ 109,572        100.0   $ 88,488        100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Court costs advanced

   $ 22,116        20.2   $ 23,299        26.3

Court costs deferred

     (11,627     (10.6 )%      (11,591     (13.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Court cost expense(2)

     10,489        9.6     11,708        13.2

Other(3)

     579        0.5     494        0.6

Commissions

     27,567        25.2     24,307        27.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Total costs

   $ 38,635        35.3   $ 36,509        41.3
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Collections include approximately $2.9 million and less than $0.1 million from our internal legal channel for the three months ended March 31, 2012 and 2011, respectively.

(2) 

In connection with our agreement with contracted attorneys, we advance certain out-of-pocket court costs. We capitalize these costs in our consolidated financial statements and provide a reserve and corresponding court cost expense for the costs that we believe will be ultimately uncollectible. This amount includes changes in our anticipated recovery rate of court costs expensed. This amount also includes court costs expensed through our internal legal channel of approximately $1.2 million and less than $0.1 million for the three months ended March 31, 2012 and 2011, respectively.

(3) 

Other costs consist of costs related to counter claims and legal network subscription fees.

Other operating expenses

Other operating expenses increased $2.3 million, or 22.9%, to $12.4 million during the three months ended March 31, 2012, from $10.1 million during the three months ended March 31, 2011. The increase was primarily the result of an increase of $1.5 million in direct mail campaign expenses, an increase of $0.5 million in media-related expenses, and a net increase in various other operating expenses of $0.3 million, all to support our growth.

Collection agency commissions

During the three months ended March 31, 2012, we incurred $4.0 million in commissions to third party collection agencies, or 34.2%, of the related gross collections of $11.6 million, compared to $3.9 million in commissions, or 28.0%, of the related gross collections of $14.0 million, during the three months ended March 31, 2011. The increase in the net commission rate as a percentage of the related gross collections was primarily due to the mix of accounts placed with the agencies. Commissions, as a percentage of collections through this channel, vary from period to period depending on, among other things, the time from charge-off of the accounts placed with an agency. Generally, freshly charged-off accounts and consumer bankruptcy receivable accounts have a lower commission rate than consumer credit card receivable accounts and accounts that have been charged off for a longer period of time.

 

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General and administrative expenses

General and administrative expenses increased $3.9 million, or 39.0%, to $14.1 million during the three months ended March 31, 2012, from $10.2 million during the three months ended March 31, 2011. The increase was primarily the result of an increase of $1.6 million in costs related to legal settlements, an increase of $0.4 million in corporate legal expenses, an increase of $0.4 million in building rent and an increase in other general and administrative expenses of $1.5 million. During the three months ended March 31, 2012, we incurred approximately $0.5 million in acquisition related expenses.

Depreciation and amortization

Depreciation and amortization expense increased $0.3 million, or 29.4%, to $1.4 million during the three months ended March 31, 2012, from $1.1 million during the three months ended March 31, 2011. The increase was primarily related to increased depreciation expenses resulted from our acquisition of fixed assets in recent periods.

Impairment charge for goodwill and identifiable intangible assets

During the three months ended March 31, 2012, we recorded $10.3 million in impairment charges for goodwill and identifiable intangible assets related to our bankruptcy servicing reporting unit, Ascension. This impairment charge was a result of our interim impairment testing performed at Ascension as of March 31, 2012. During the first quarter of 2012, Ascension experienced uncertainty surrounding a material client’s contract renewal. The client agreed to renew the contract, provided that Ascension enters into an agreement with a specified third party to make or facilitate the technology improvements required by the client. On May 7, 2012, our Board approved a plan to sell Ascension. At this time, we have reached an agreement in principle to sell Ascension to the third party. As part of the sale, Ascension’s new owner will invest in new technology and apply the bankruptcy servicing expertise necessary for Ascension to compete more effectively, and we have agreed to cover normal operating losses in the first year of ownership. If the business grows and becomes profitable, we will be paid an earn-out equal to 30 to 40% of Ascension’s EBITDA for the first five years after closing. In connection with the preparation of our financial statements and based, in part, on these developments, we performed an interim goodwill impairment test for Ascension and concluded that the entire goodwill balance of $9.9 million for Ascension was impaired as of March 31, 2012. Additionally, we wrote-off the remaining identifiable intangible assets of approximately $0.4 million. Beginning in the second quarter of 2012, and regardless of whether the sale discussed above is completed, Ascension will be treated as a discontinued operation.

As a result, we recognized a pre-tax impairment charge for goodwill and identifiable intangible assets of $10.3 million, or $0.25 per diluted share, after the effect of income taxes during the three months ended March 31, 2012. See footnote 13 “Goodwill and Identifiable Intangible Assets” in our unaudited condensed consolidated financial statements for further details. We did not record any goodwill impairment charges in the three months ended March 31, 2011.

Cost per Dollar Collected

The following table summarizes our cost per dollar collected (in thousands, except percentages):

 

     Three Months Ended March 31,  
     2012     2011  
     Collections      Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
    Collections      Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
 

Collection sites

   $ 109,870       $ 6,476 (1)      5.9     2.8   $ 88,541       $ 6,709 (1)      7.6     3.5

Legal networks(2)

     109,572         38,635        35.3     16.7     88,488         36,509        41.3     19.1

Collection agency outsourcing

     11,586         3,959        34.2     1.7     13,990         3,914        28.0     2.0

Other collections

     —           —          —          —          54         —          —          —     

Other indirect costs(3)

     —           39,569        —          17.2     —           29,330        —          15.4
  

 

 

    

 

 

     

 

 

   

 

 

    

 

 

     

 

 

 

Total

   $ 231,028       $ 88,639 (4)        38.4   $ 191,073       $ 76,462 (4)        40.0
  

 

 

    

 

 

     

 

 

   

 

 

    

 

 

     

 

 

 

 

(1) 

Cost in collection sites represents only Account Managers and their supervisors’ salaries, variable compensation, and employee benefits.

(2) 

Collections include approximately $2.9 million and less than $0.1 million from our internal legal channel for the three months ended March 31, 2012 and 2011, respectively. Court costs expensed through our internal legal channel were approximately $1.2 million and less than $0.1 million for the three months ended March 31, 2012 and 2011, respectively.

(3) 

Other indirect costs represent non-collection site salaries and employee benefits, general and administrative expenses, other operating expenses and depreciation and amortization. Included in other indirect costs were costs related to our internal legal channel of approximately $1.8 million and $0.4 million for the three months ended March 31, 2012 and 2011, respectively.

(4) 

Represents all operating expenses, excluding stock-based compensation expense, bankruptcy servicing operating expenses, and acquisition related expenses. We include this information in order to facilitate a comparison of approximate cash costs to cash collections for the debt purchasing business in the periods presented. Refer to the items for reconciliation of operating expenses, excluding stock-based compensation expense, bankruptcy servicing operating expenses, and acquisition related expenses to generally accepted accounting practices (“GAAP”) total operating expenses in the table below.

 

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The following table presents the items for reconciliation of operating expenses, excluding stock-based compensation expense, bankruptcy servicing expenses, and acquisition related expenses to GAAP total operating expenses (in thousands):

 

     Three Months Ended March 31,  
     2012     2011  

GAAP total operating expenses, as reported

   $ 106,224      $ 82,546   

Stock-based compensation expense

     (2,266     (1,765

Bankruptcy servicing expenses

     (14,830     (4,319

Acquisition related expenses

     (489     —     

During the three months ended March 31, 2012, cost per dollar collected decreased by 160 basis points to 38.4% of gross collections, from 40.0% of gross collections during the three months ended March 31, 2011. This decrease was primarily due to cost improvement across all of our channels as follows:

 

   

The cost from our collection sites, which includes Account Manager salaries, variable compensation and employee benefits, as a percentage of total collections, decreased to 2.8% during the three months ended March 31, 2012, from 3.5% during the three months ended March 31, 2011 and, as a percentage of our site collections, decreased to 5.9% from 7.6%. The decreases were primarily due to the continued growth of our collection workforce in India and improvements in our consumer insights, where we can more effectively determine which consumers have the ability to pay and how to best engage with them.

 

   

The cost of legal collections as a percentage of total collections decreased to 16.7% during the three months ended March 31, 2012, from 19.1% during the three months ended March 31, 2011 and, as a percentage of legal collections, decreased to 35.3% from 41.3%. The decreases were primarily due to an improvement in our court cost recovery rate and a decrease in the commission rate we pay our contracted attorneys.

 

   

Collection agency commissions, as a percentage of total collections, decreased to 1.7% during the three months ended March 31, 2012, from 2.0% during the same period in the prior year. The decrease was due to our continued effort in shifting collections from third party agencies to our collection sites. Our collection agency commission rate increased to 34.2% during the three months ended March 31, 2012, from 28.0% during the same period in the prior year. The increase in our commission rate was a result of change in the mix of accounts placed into this channel. Generally, freshly charged-off accounts and consumer bankruptcy receivable accounts have a lower commission rate than consumer credit card receivable accounts and accounts that have been charged off for a longer period of time.

The decrease in cost per dollar collected was partially offset by an increase in other costs not directly attributable to specific channel collections (other indirect costs), as a percentage of total collections, from 15.4% for the three months ended March 31, 2012, to 17.2% for the three months ended March 31, 2011. These costs include non-collection site salaries and employee benefits, general and administrative expenses, other operating expenses and depreciation and amortization. The dollar increase and the increase in cost per dollar collected were due to several factors, including increases in corporate settlements and increases in headcount and general and administrative expenses, to support our growth.

Interest Expense

Interest expense remained consistent during the three months ended March 31, 2012 and 2011. The following table summarizes our interest expense (in thousands, except percentages):

 

     Three Months Ended March 31,  
     2012      2011      $ Change     % Change  

Stated interest on debt obligations

   $ 5,049       $ 5,153       $ (104     (2.0 %) 

Amortization of loan fees and other loan costs

     466         440         26        5.9
  

 

 

    

 

 

    

 

 

   

Total interest expense

   $ 5,515       $ 5,593       $ (78     (1.4 %) 
  

 

 

    

 

 

    

 

 

   

Provision for Income Taxes

During the three months ended March 31, 2012, we recorded an income tax provision of $7.3 million, reflecting an effective rate of 39.2% of pretax income. The effective tax rate for the three months ended March 31, 2012 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%) and provision for state taxes of 6.5%.

During the three months ended March 31, 2011, we recorded an income tax provision of $8.6 million, reflecting an effective rate of 38.6% of pretax income. The effective tax rate for the three months ended March 31, 2011 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a provision for state taxes of 6.7%, and a net benefit of permanent book versus tax differences of 0.8%.

 

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Table of Contents

The increase in our overall effective tax rate from March 31, 2011 to March 31, 2012 was primarily attributable to an increase in the effective tax rate in India. Our operations in India benefited from a tax holiday, which expired on March 31, 2011. Our subsidiary in Costa Rica is operating under a 100% tax holiday for the next eight years and a 50% tax holiday for the following four years. The impact of the tax holiday in Costa Rica for the three months ended March 31, 2012 was immaterial.

 

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Table of Contents

Supplemental Performance Data

Cumulative Collections to Purchase Price Multiple

The following table summarizes our purchases and related gross collections by year of purchase (in thousands, except multiples):

 

Year of Purchase

   Purchase
Price(1)
    Cumulative Collections through March 31, 2012  
     <2006      2006      2007      2008      2009      2010      2011      2012      Total(2)      CCM(3)  

<2005

   $ 385,471 (4)    $ 974,411       $ 164,211       $ 85,333       $ 45,893       $ 27,708       $ 19,986       $ 15,180       $ 3,006       $ 1,335,728         3.5   

2005

     192,585        66,491         129,809         109,078         67,346         42,387         27,210         18,651         3,636         464,608         2.4   

2006

     141,027        —           42,354         92,265         70,743         44,553         26,201         18,306         3,771         298,193         2.1   

2007

     204,096        —           —           68,048         145,272         111,117         70,572         44,035         8,694         447,738         2.2   

2008

     227,862        —           —           —           69,049         165,164         127,799         87,850         17,456         467,318         2.1   

2009

     253,362        —           —           —           —           96,529         206,773         164,605         32,634         500,541         2.0   

2010

     358,786        —           —           —           —           —           125,853         288,788         64,005         478,646         1.3   

2011

     385,502        —           —           —           —           —           —           123,596         85,220         208,816         0.5   

2012

     129,998        —           —           —           —           —           —           —           12,586         12,586         0.1   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,278,689      $ 1,040,902       $ 336,374       $ 354,724       $ 398,303       $ 487,458       $ 604,394       $ 761,011       $ 231,008       $ 4,214,174         1.8   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Adjusted for put-backs, account recalls, and purchase price rescissions. Put-backs represent accounts that are returned to the seller in accordance with the respective purchase agreement (“Put-Backs”). Recalls represents accounts that are recalled by the seller in accordance with the respective purchase agreement (“Recalls”).

(2) 

Cumulative collections from inception through March 31, 2012, excluding collections on behalf of others.

(3) 

Cumulative Collections Multiple (“CCM”) through March 31, 2012 – collections as a multiple of purchase price.

(4) 

From inception through December 31, 2004.

Total Estimated Collections to Purchase Price Multiple

The following table summarizes our purchases, resulting historical gross collections, and estimated remaining gross collections by year of purchase (in thousands, except multiples):

 

     Purchase  Price(1)     Historical
Collections(2)
     Estimated
Remaining
Collections(4)
     Total Estimated
Gross Collections
     Total Estimated Gross
Collections to
Purchase Price

<2005

   $ 385,471 (3)    $ 1,335,728       $ 3,233       $ 1,338,961       3.5

2005

     192,585        464,608         15,407         480,015       2.5

2006

     141,027        298,193         27,905         326,098       2.3

2007

     204,096        447,738         54,889         502,627       2.5

2008

     227,862        467,318         108,209         575,527       2.5

2009

     253,362        500,541         219,133         719,674       2.8

2010

     358,786        478,646         441,986         920,632       2.6

2011

     385,502        208,816         615,386         824,202       2.1

2012

     129,998        12,586         237,410         249,996       1.9
  

 

 

   

 

 

    

 

 

    

 

 

    

Total

   $ 2,278,689      $ 4,214,174       $ 1,723,558       $ 5,937,732       2.6
  

 

 

   

 

 

    

 

 

    

 

 

    

 

(1) 

Adjusted for Put-Backs, Recalls, and purchase price rescissions.

(2) 

Cumulative collections from inception through March 31, 2012, excluding collections on behalf of others.

(3) 

From inception through December 31, 2004.

(4) 

Estimated remaining collections include anticipated collections beyond our 84 to 96 month collection forecast.

 

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Table of Contents

Estimated Remaining Gross Collections by Year of Purchase

The following table summarizes our estimated remaining gross collections by year of purchase (in thousands):

 

     Estimated Remaining Gross Collections by Year of Purchase(1)  
     2012      2013      2014      2015      2016      2017      2018      2019      2020      2021      2022      Total  
<2005    $ 1,355       $ 1,082       $ 565       $ 202       $ 29       $       $       $       $       $       $       $ 3,233   
2005      6,848         4,530         3,008         1,021                                                                 15,407   
2006      11,323         11,322         3,090         1,509         661                                                         27,905   
2007      20,039         17,262         8,495         4,290         3,107         1,304         275         117                                 54,889   
2008      37,015         32,476         18,323         10,047         5,433         3,503         1,412                                         108,209   
2009      70,226         62,601         37,273         19,169         15,613         7,678         4,686         1,887                                 219,133   
2010      128,786         121,466         78,643         47,060         26,668         18,136         10,810         7,183         3,234                         441,986   
2011      174,284         175,493         100,611         62,780         40,116         25,751         17,119         9,630         6,847         2,755                 615,386   
2012      50,657         70,105         46,770         28,432         17,848         10,733         6,342         3,031         1,906         1,030         556         237,410   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
   $  500,533       $  496,337       $  296,778       $  174,510       $  109,475       $  67,105       $  40,644       $  21,848       $  11,987       $  3,785       $  556       $  1,723,558   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Estimated remaining collections include anticipated collections beyond our 84 to 96 month collection forecast.

Unamortized Balances of Portfolios

The following table summarizes the remaining unamortized balances of our purchased receivable portfolios by year of purchase (in thousands, except percentages):

 

     Unamortized
Balance as of
March 31, 2012
     Purchase
Price(1)
     Unamortized
Balance as a
Percentage of
Purchase Price
    Unamortized
Balance as a
Percentage
of Total
 

2005

   $ 6,114       $ 192,585         3.2     0.8

2006

     15,010         141,027         10.6     2.0

2007

     15,960         204,096         7.8     2.2

2008

     49,979         227,862         21.9     6.7

2009

     76,589         253,362         30.2     10.3

2010

     164,036         358,786         45.7     22.1

2011

     291,099         385,502         75.5     39.3

2012

     122,793         129,998         94.5     16.6
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 741,580       $ 1,893,218         39.2     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) 

Purchase price refers to the cash paid to a seller to acquire a portfolio less Put-Backs, plus an allocation of our forward flow asset (if applicable), and less the purchase price for accounts that were sold at the time of purchase to another debt purchaser.

Changes in the Investment in Receivable Portfolios

Revenue related to our investment in receivable portfolios comprises two groups. First, revenue from those portfolios that have a remaining book value and are accounted for on the accrual basis (“Accrual Basis Portfolios”), and second, revenue from those portfolios that have fully recovered their book value Zero Basis Portfolios and, therefore, every dollar of gross collections is recorded entirely as Zero Basis Revenue. If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, we account for such portfolios on the cost recovery method (“Cost Recovery Portfolios”). No revenue is recognized on Cost Recovery Portfolios until the cost basis has been fully recovered, at which time they become Zero Basis Portfolios.

 

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Table of Contents

The following tables summarize the changes in the balance of the investment in receivable portfolios and the proportion of revenue recognized as a percentage of collections (in thousands, except percentages):

 

     Three Months Ended March 31, 2012  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 716,454      $ —        $ —        $ 716,454   

Purchases of receivable portfolios

     130,463        —          —          130,463   

Gross collections(1)

     (223,943     —          (7,065     (231,008

Put-backs and recalls

     (734     —          —          (734

Revenue recognized

     120,746        —          6,032        126,778   

(Portfolio allowances) portfolio allowance reversals, net

     (1,406     —          1,033        (373
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 741,580      $ —        $ —        $ 741,580   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections (2)

     53.9     0.0     85.4     54.9
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Three Months Ended March 31, 2011  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 644,753      $ —        $ —        $ 644,753   

Purchases of receivable portfolios

     90,675        —          —          90,675   

Gross collections(1)

     (187,417     —          (3,617     (191,034

Put-backs and recalls

     (900     —          —          (900

Revenue recognized

     107,804        —          3,020        110,824   

(Portfolio allowances) portfolio allowance reversals, net

     (6,095     —          597        (5,498
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 648,820      $ —        $ —        $ 648,820   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections (2)

     57.5     0.0     83.5     58.0
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

Revenue as a percentage of collections excludes the effects of net portfolio allowance or net portfolio allowance reversals.

As of March 31, 2012, we had $741.6 million in investment in receivable portfolios. This balance will be amortized based upon current projections of cash collections in excess of revenue applied to the principal balance. The estimated amortization of the investment in receivable portfolio balance is as follows (in thousands):

 

Year Ended December 31,                            

   Amortization  

2012(1)

     $194,312   

2013

     224,522   

2014

     136,118   

2015

     84,668   

2016

     54,504   

2017

     32,805   

2018

     14,079   

2019

     572   
  

 

 

 

Total

     $741,580   
  

 

 

 

 

(1) 

2012 amount consists of nine months data from April 1, 2012 to December 31, 2012.

 

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Table of Contents

Collections by Channel

We utilize numerous business channels for the collection of charged-off credit cards and other receivables. The following table summarizes the gross collections by collection channel (in thousands):

 

     Three Months Ended March 31,  
     2012      2011  

Collection sites

   $ 109,870       $ 88,541   

Legal collections

     109,572         88,488   

Collection agencies

     11,586         13,990   

Other

     —           54   
  

 

 

    

 

 

 
   $ 231,028       $ 191,073   
  

 

 

    

 

 

 

Legal Outsourcing Costs as a Percentage of Gross Collections by Year of Collection

The following table summarizes our legal outsourcing court cost expense and commissions as a percentage of gross collections by year of collection:

 

     Collection Year  

Placement

Year

   2003     2004     2005     2006     2007     2008     2009     2010     2011     2012     Cumulative
Average
 

2003

     41.7     39.2     35.2     33.4     31.0     32.0     32.9     33.2     31.3     32.4     36.9

2004

     —          41.7     39.8     35.7     32.4     32.8     33.2     34.6     32.2     33.9     38.1

2005

     —          —          46.1     40.6     32.6     32.1     32.3     34.0     32.5     32.3     38.6

2006

     —          —          —          54.9     41.0     32.8     30.5     33.5     32.7     31.9     39.9

2007

     —          —          —          —          64.8     43.5     31.3     32.2     32.5     31.6     42.8

2008

     —          —          —          —          —          69.7     43.0     33.1     31.4     29.9     43.0

2009

     —          —          —          —          —          —          69.7     41.4     31.1     28.6     43.4

2010

     —          —          —          —          —          —          —          72.5     39.1     29.5     46.0

2011

     —          —          —          —          —          —          —          —          64.5     41.7     56.2

2012

     —          —          —          —          —          —          —          —          —          74.4     74.4

Headcount by Function by Site

The following table summarizes our headcount by function by site:

 

     Headcount as of March 31,  
     2012      2011  
     Domestic      International      Domestic      International  

General & Administrative

     473             367             394             265       

Account Manager

     213             1,165             230             958       

Bankruptcy Specialist

     94             83             102             100       
  

 

 

    

 

 

    

 

 

    

 

 

 
     780             1,615             726             1,323       
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross Collections by Account Manager

The following table summarizes our collection performance by Account Manager (in thousands, except headcount):

 

     Three Months Ended March 31,  
     2012      2011  

Gross collections—collection sites

     $ 109,870         $ 88,541   

Average active Account Managers

     1,239         1,142   

Collections per average active Account Manager

     $ 88.7         $ 77.5   

 

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Table of Contents

Gross Collections per Hour Paid

The following table summarizes our gross collections per hour paid to Account Managers (in thousands, except gross collections per hour paid):

 

     Three Months Ended March 31,  
     2012      2011  

Gross collections—collection sites

     $ 109,870         $ 88,541   

Total hours paid

     532         525   

Collections per hour paid

     $ 206.5         $ 168.6   

Collection Sites Direct Cost per Dollar Collected

The following table summarizes our gross collections in collection sites and the related direct cost (in thousands, except percentages):

 

     Three Months Ended March 31,  
     2012      2011  

Gross collections—collection sites

     $ 109,870         $ 88,541   

Direct cost(1)

     $ 6,476         $ 6,709   

Cost per dollar collected

     5.9%         7.6%   

 

(1) 

Represent Account Managers and their supervisors’ salaries, variable compensation, and employee benefits.

Salaries and Employee Benefits by Function

The following table summarizes our salaries and employee benefits by function (excluding stock-based compensation) (in thousands):

 

     Three Months Ended March 31,  
     2012      2011  

Portfolio purchasing and recovery activities

     

Collection site salaries and employee benefits(1)

   $ 6,476       $ 6,709   

Non-collection site salaries and employee benefits

     13,562         9,799   
  

 

 

    

 

 

 

Subtotal

     20,038         16,508   

Bankruptcy services

     3,071         2,532   
  

 

 

    

 

 

 
   $ 23,109       $ 19,040   
  

 

 

    

 

 

 

 

(1) 

Represent Account Managers and their supervisors’ salaries, variable compensation, and employee benefits.

Purchases by Quarter

The following table summarizes the purchases we made by quarter, and the respective purchase prices (in thousands):

 

Quarter                                 

   # of
Accounts
     Face Value      Purchase
Price
     Forward  Flow
Allocation(1)
 

Q1 2009

     505           $ 1,341,660       $ 55,913       $ —     

Q2 2009

     719             1,944,158         82,033         —     

Q3 2009

     1,515             2,173,562         77,734         10,302   

Q4 2009

     519             1,017,998         40,952         —     

Q1 2010

     839             2,112,332         81,632         —     

Q2 2010

     1,002             2,245,713         83,336         —     

Q3 2010

     1,101             2,616,678         77,889         —     

Q4 2010

     1,206             3,882,646         119,100         —     

Q1 2011

     1,243             2,895,805         90,675         —     

Q2 2011

     1,477             2,998,564         93,701         —     

Q3 2011

     1,633             2,025,024         65,731         —     

Q4 2011

     2,776             3,782,595         136,743         —     

Q1 2012

     2,132             2,902,409         130,463         —     

 

(1) 

Allocation of the forward flow asset to the cost basis of receivable portfolio purchases. In July 2008, we ceased forward flow purchases from Jefferson Capital Systems, LLC (“Jefferson Capital”) due to an alleged breach by Jefferson Capital and its parent, CompuCredit Corporation, of certain agreements. In September 2009, we settled our dispute with Jefferson Capital.

 

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Table of Contents

Liquidity and Capital Resources

Overview

Historically, we have met our cash requirements by utilizing our cash flows from operations, bank borrowings, and equity offerings. Our primary cash requirements have included the purchase of receivable portfolios, operating expenses, and the payment of interest and principal on bank borrowings and tax payments.

The following table summarizes our cash flows by category for the periods presented (in thousands):

 

     Three Months Ended March 31,  
     2012     2011  

Net cash provided by operating activities

   $ 27,103      $ 25,074   

Net cash used in investing activities

     (27,054     (10,194

Net cash provided by (used in) financing activities

     7,350        (3,410

On April 10 and May 8, 2012, we entered into amendments to our revolving credit facility. The amendments added new lenders, appointed a new administrative agent, changed the borrowing base advance rate, increased the aggregate revolving loan commitment by $145.0 million, from $410.5 million to $555.5 million, and reset the accordion feature by an additional $100.0 million, resulting in a maximum of $655.5 million that can be borrowed under the facility.

Currently, all of our portfolio purchases are funded with cash from operations and borrowings under our revolving credit facility. See Note 9 “Debt” to our unaudited condensed consolidated financial statements for a further discussion of our debt.

Operating Cash Flows

Net cash provided by operating activities was $27.1 million and $25.1 million during the three months ended March 31, 2012 and 2011, respectively.

Cash provided by operating activities during the three months ended March 31, 2012, was primarily related to net income of $11.4 million and a $10.3 million non-cash add back related to impairment charges for goodwill and identifiable intangible assets related to Ascension, our bankruptcy servicing reporting unit. Cash provided by operating activities during the three months ended March 31, 2011, was primarily attributable to net income of $13.7 million and $5.5 million in a non-cash add back related to the net provision for allowance on our receivable portfolios.

Investing Cash Flows

Net cash used in investing activities was $27.1 million and $10.2 million during the three months ended March 31, 2012 and 2011, respectively.

The cash flows used in investing activities during the three months ended March 31, 2012, were primarily related to receivable portfolio purchases of $130.5 million, offset by gross collection proceeds applied to the principal of our receivable portfolios in the amount of $104.2 million. The cash flows used in investing activities during the three months ended March 31, 2011, were primarily related to receivable portfolio purchases of $90.7 million, offset by gross collection proceeds applied to the principal of our receivable portfolios in the amount of $80.2 million.

Capital expenditures for fixed assets acquired with internal cash flow were $1.6 million and $0.6 million for three months ended March 31, 2012 and 2011, respectively.

Financing Cash Flows

Net cash provided by financing activities was $7.4 million during the three months ended March 31, 2012, and net cash used in financing activities was $3.4 million during the three months ended March 31, 2011.

The cash provided by financing activities during the three months ended March 31, 2012, reflects $43.5 million in borrowings under our revolving credit facility, offset by $34.5 million in repayments of amounts outstanding under our revolving credit facility. The cash used in financing activities during the three months ended March 31, 2011, reflects $46.0 million in repayments of amounts outstanding under our revolving credit facility, offset by $19.0 million in borrowings under our revolving credit facility and $25.0 million in borrowings under our senior secured notes.

We are in compliance with all covenants under our financing arrangements. We believe that we have sufficient liquidity to fund our operations for at least the next twelve months, given our expectation of continued positive cash flows from operations, our cash and cash equivalents of $15.4 million as of March 31, 2012, our access to the capital markets and availability under our revolving credit facility, which expires in December 2013.

 

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Table of Contents

Off Balance Sheet Arrangements

We do not have any off balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.

Item 3. Quantitative and Qualitative Disclosures About Market Risk

Foreign Currency. At March 31, 2012, there had not been a material change in any of the foreign currency risk information disclosed in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Interest Rate. At March 31, 2012, there had not been a material change in the interest rate risk information disclosed in Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

We maintain disclosure controls and procedures that are designed to ensure that information required to be disclosed in our periodic reports filed or submitted under the Securities Exchange Act of 1934, as amended (the “Exchange Act”), is recorded, processed, summarized and reported within the time periods specified in the rules and forms of the Securities and Exchange Commission (the “SEC”) and that such information is accumulated and communicated to our management, including our principal executive officer and principal financial officer, as appropriate, to allow timely decisions regarding required disclosure. In designing and evaluating the disclosure controls and procedures, our management recognizes that any controls and procedures, no matter how well designed and operated, can provide only reasonable assurance of achieving the desired control objectives and accordingly, management is required to apply its judgment in evaluating the cost-benefit relationship of possible controls and procedures.

Based on their most recent evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Exchange Act are effective.

Changes in Internal Control over Financial Reporting

There was no change in our internal control over financial reporting during the most recent fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

 

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Table of Contents

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

We are involved in disputes and legal actions from time to time in the ordinary course of business. We, along with others in our industry, are routinely subject to legal actions based on the FDCPA, comparable state statutes, the TCPA, state and federal unfair competition statutes, and common law causes of action. The violations of law alleged in these actions often include claims that we lack specified licenses to conduct our business, attempt to collect debts on which the statute of limitations has run, have made inaccurate assertions of fact in support of our collection actions and/or have acted improperly in connection with our efforts to contact consumers. These cases are frequently styled as supposed class actions. In addition, from time to time, we are subject to litigation and other actions by governmental bodies, including formal and informal investigations relating to our collection activities by the Federal Trade Commission, state attorneys general and other governmental bodies, with which we cooperate.

There has been no material development in any of the legal proceedings disclosed in our Annual Report on Form 10-K for the year ended December 31, 2011.

In certain legal proceedings, we may have recourse to insurance or third party contractual indemnities to cover all or portions of our litigation expenses, judgments, or settlements. In accordance with authoritative guidance, we record loss contingencies in our financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated with no best estimate in the range, we record the minimum estimated liability. We continuously assess the potential liability related to our pending litigation and revise our estimates when additional information becomes available. Our legal costs are recorded to expense as incurred.

Item 1A—Risk Factors

There are certain risks and uncertainties in our business that could cause our actual results to differ materially from those anticipated. We urge you to carefully consider the specific risk factors listed under Part I, Item 1A of our 2011 Annual Report on Form 10-K filed on February 9, 2012 (incorporated by reference herein), together with all other information included or incorporated in our reports filed with the SEC. Any such risks may materialize, and additional risks not known to us, or that we now deem immaterial, may arise. In such event, our business, financial condition, results of operations or prospects could be materially adversely affected. If that occurs, the market price of our common stock could fall, and you could lose all or part of your investment.

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

Our revolving credit facility contains restrictions and covenants, which limit, among other things, the payment of dividends.

In addition, in connection with, and upon closing of, the transaction described in Note 14 “Subsequent Event” above, the Company entered into an agreement with Mr. John P. Nelson to issue and sell to him common stock of the Company for an aggregate purchase price of $350,000. These shares have not been registered and are being issued pursuant to an exemption under Section 4(2) of the Securities Act of 1933, as amended.

Item 5—Other Information

On May 8, 2012, the Company acquired all of the outstanding equity of Propel Financial Services, LLC, and certain of its affiliates (“Propel”) for $186.8 million in cash pursuant to a Securities Purchase Agreement by and among Propel Acquisition LLC (a wholly-owned subsidiary of the Company) and the sellers name therein (the “Agreement”). Propel provides property tax solutions to customers in the state of Texas by paying real estate taxes on behalf of owners of real property in Texas in exchange for notes collateralized by tax liens on the property. The Company financed the acquisition through (i) a new $160.0 million syndicated loan facility (the “Propel Facility”) dated May 8, 2012 by and among Propel, Texas Capital Bank, National Association as Administrative Agent, and the certain banks named therein, (ii) the Company’s existing revolving credit facility and (iii) cash on hand. The Propel Facility will be used to fund a portion of the purchase price and to fund future growth at Propel. The Propel Facility has a three year term and includes the following key provisions:

 

   

Interest at Propel’s option, at either: (1) LIBOR, plus a spread that ranges from 300 to 375 basis points, depending on Propel’s leverage; or (2) Prime, plus a spread that ranges from 0 to 75 basis points, depending on Propel’s leverage;

 

   

A borrowing base of 90% of the face value of the tax lien collateralized notes;

 

   

Interest payable monthly;

 

   

Principal and interest due at maturity; and

 

   

A $40.0 million accordion feature.

The Propel Facility is collateralized by the tax lien collateralized notes and requires Propel to maintain various financial covenants, including a minimum interest coverage ratio and a maximum cash flow leverage ratio.

On May 8, 2012, the Company also agreed to sell to Mr. John P. Nelson 14,849 shares of its common stock in a private placement at a 5 day average of the market closing prices ending on May 7, 2012. The shares sold will not be registered under the Securities Act of 1933 (the “Act”) and will be issued and sold in reliance upon the exemption from registration contained in Section 4(2) of the Act and Rule 506 promulgated thereunder.

 

32


Table of Contents

Item 6. Exhibits

 

  2.1    Securities Purchase Agreement, dated as of May 8, 2012, by and among Propel Acquisition LLC and McCombs Family Partners, Ltd., JHBC Holdings, LLC and Texas Tax Loans, LLC (filed herewith).
  4.1    Amendment No. 1, dated as of May 8, 2012, to Amended and Restated Senior Secured Note Purchase Agreement, dated as of February 10, 2011, by and among the Company, The Prudential Insurance Company of America, Pruco Life Insurance Company, Prudential Retirement Insurance and Annuity Company and Prudential Annuities Life Assurance Corporation, and SunTrust Bank as collateral agent and administrative agent (filed herewith).
10.1    Amendment No. 4, dated as of April 10, 2012, to Credit Agreement, dated as of February 8, 2010, by and among the Company, the financial institutions listed on the signature pages thereto, and JPMorgan Chase Bank, N.A. as collateral agent and administrative agent (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 16, 2012).
10.2    Amendment No. 5, dated as of May 8, 2012, to Credit Agreement, dated as of February 8, 2010, by and among the Company, the financial institutions listed on the signature pages thereto, and SunTrust Bank as collateral agent and administrative agent (filed herewith).
10.3    Credit Facility Loan Agreement, dated as of May 8, 2012, by and among Texas Capital Bank, National Association, as administrative agent, certain banks and Propel Financial Services, LLC (filed herewith).
10.4    Guaranty Agreement dated as of May 8, 2012, with respect to the Credit Facility Loan Agreement, dated as of May 8, 2012 (filed herewith).
10.5    Form of Restricted Stock Award Grant Notice and Agreement (filed herewith).
31.1    Certification of the Principal Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 (filed herewith).
31.2    Certification of the Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 (filed herewith).
32.1    Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).
101    The following financial information from the Encore Capital Group, Inc. Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Statements of Financial Condition; (ii) Condensed Consolidated Statements of Comprehensive Income; (iii) Condensed Consolidated Statements of Stockholders’ Equity; (iv) Condensed Consolidated Statements of Cash Flows; and (v) the Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.*

* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

 

33


Table of Contents

SIGNATURES

Pursuant to the requirements 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.

 

ENCORE CAPITAL GROUP, INC.
By:   /s/ Paul Grinberg
  Paul Grinberg
  Executive Vice President,
  Chief Financial Officer and Treasurer

Date: May 9, 2012

 

34


Table of Contents

EXHIBIT INDEX

 

  2.1    Securities Purchase Agreement, dated as of May 8, 2012, by and among Propel Acquisition LLC and McCombs Family Partners, Ltd., JHBC Holdings, LLC and Texas Tax Loans, LLC (filed herewith).
  4.1    Amendment No. 1, dated as of May 8, 2012, to Amended and Restated Senior Secured Note Purchase Agreement, dated as of February 10, 2011, by and among the Company, The Prudential Insurance Company of America, Pruco Life Insurance Company, Prudential Retirement Insurance and Annuity Company and Prudential Annuities Life Assurance Corporation, and SunTrust Bank as collateral agent and administrative agent (filed herewith).
10.1    Amendment No. 4, dated as of April 10, 2012, to Credit Agreement, dated as of February 8, 2010, by and among the Company, the financial institutions listed on the signature pages thereto, and JPMorgan Chase Bank, N.A. as collateral agent and administrative agent (incorporated by reference to Exhibit 10.1 to the Company’s Current Report on Form 8-K filed on April 16, 2012).
10.2    Amendment No. 5, dated as of May 8, 2012, to Credit Agreement, dated as of February 8, 2010, by and among the Company, the financial institutions listed on the signature pages thereto, and SunTrust Bank as collateral agent and administrative agent (filed herewith).
10.3    Credit Facility Loan Agreement, dated as of May 8, 2012, by and among Texas Capital Bank, National Association, as administrative agent, certain banks and Propel Financial Services, LLC (filed herewith).
10.4    Guaranty Agreement dated as of May 8, 2012, with respect to the Credit Facility Loan Agreement, dated as of May 8, 2012 (filed herewith).
10.5    Form of Restricted Stock Award Grant Notice and Agreement (filed herewith).
31.1    Certification of the Principal Executive Officer pursuant to Rule 13a-14(a) or 15d-14(a) under the Securities Exchange Act of 1934 (filed herewith).
31.2    Certification of the Principal Financial Officer pursuant to Rule 13a-14(a) under the Securities Exchange Act of 1934 (filed herewith).
32.1    Certifications of Chief Executive Officer and Chief Financial Officer pursuant to 18 U.S.C. Section 1350, as adopted pursuant to Section 906 of the Sarbanes-Oxley Act of 2002 (furnished herewith).
101    The following financial information from the Encore Capital Group, Inc. Quarterly Report on Form 10-Q for the quarter ended March 31, 2012 formatted in eXtensible Business Reporting Language (XBRL): (i) Condensed Consolidated Statements of Financial Condition; (ii) Condensed Consolidated Statements of Comprehensive Income; (iii) Condensed Consolidated Statements of Stockholders’ Equity; (iv) Condensed Consolidated Statements of Cash Flows; and (v) the Notes to Condensed Consolidated Financial Statements, tagged as blocks of text.*

* Pursuant to Rule 406T of Regulation S-T, the Interactive Data Files on Exhibit 101 hereto are deemed not filed or part of a registration statement or prospectus for purposes of Sections 11 or 12 of the Securities Act of 1933, as amended, are deemed not filed for purposes of Section 18 of the Securities and Exchange Act of 1934, as amended, and otherwise are not subject to liability under those sections.

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