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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 September 30, 2011

 

¨	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: 000-50552

 

 

ASSET ACCEPTANCE CAPITAL CORP.

(Exact name of registrant as specified in its charter)

 

 

Delaware		80-0076779
(State or other jurisdiction of incorporation or organization)		(I.R.S.Employer Identification No.)

28405 Van Dyke Avenue

Warren, Michigan 48093

(Address of principal executive offices)

Registrant’s telephone number, including area code:

(586) 939-9600

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.

Yes þ                     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 (§232.405 of this chapter) during the preceding 12 months (or for shorter period that the registrant was required to submit and post such files).

Yes þ                     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.

 

Large accelerated filer		¨		Accelerated filer		þ
Non-accelerated filer		¨  (Do not check if a smaller reporting company)		Smaller reporting company		¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).

Yes ¨                     No þ

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

As of October 20, 2011, 30,684,552 shares of the registrant’s common stock were outstanding.

 

 

 

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ASSET ACCEPTANCE CAPITAL CORP.

Quarterly Report on Form 10-Q

TABLE OF CONTENTS

 

				Page
		PART I – Financial Information
Item 1.		Financial Statements (unaudited)			3
Item 2.		Management’s Discussion and Analysis of Financial Condition and Results of Operations			21
Item 3.		Quantitative and Qualitative Disclosures about Market Risk			47
Item 4.		Controls and Procedures			47
		PART II – Other Information
Item 1.		Legal Proceedings			47
Item 2.		Unregistered Sales of Equity Securities and Use of Proceeds			48
Item 6.		Exhibits			48
Signatures					49
Exhibits:		31.1 Rule 13a-14(a) Certification of Chief Executive Officer
		31.2 Rule 13a-14(a) Certification of Chief Financial Officer
		32.1 Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
		101.INS XBRL Instance Document
		101.SCH XBRL Taxonomy Extension Schema Document
		101.CAL XBRL Taxonomy Extension Calculation Linkbase Document
		101.LAB XBRL Taxonomy Extension Label Linkbase Document
		101.PRE XBRL Taxonomy Extension Presentation Linkbase Document

Quarterly Report on Form 10-Q

We file reports with the Securities and Exchange Commission (“SEC”), which we make available on our website, www.assetacceptance.com, free of charge. These reports include Annual Reports on Form 10-K, Quarterly Reports on Form 10-Q, Current Reports on Form 8-K and amendments to such reports, each of which is provided on our website as soon as reasonably practicable after we electronically file such materials with or furnish them to the SEC.

 

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PART I – FINANCIAL INFORMATION

Item 1. Financial Statements

ASSET ACCEPTANCE CAPITAL CORP.

Consolidated Statements of Financial Position

 

		September 30, 2011				December 31, 2010
		(Unaudited)
ASSETS
Cash		$	7,813,332			$	5,635,503
Purchased receivables, net			348,086,909				321,318,255
Income taxes receivable			351,350				3,760,731
Property and equipment, net			12,394,080				13,055,723
Goodwill			14,323,071				14,323,071
Other assets			5,741,177				5,680,237
Total assets		$	388,709,919			$	363,773,520
LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Accounts payable		$	2,844,040			$	2,958,214
Accrued liabilities			18,040,444				25,178,707
Income taxes payable			1,067,336				1,407,794
Notes payable			173,634,956				157,259,956
Capital lease obligations			137,232				202,479
Deferred tax liability, net			59,261,199				52,863,654
Total liabilities			254,985,207				239,870,804
Stockholders’ equity:
Preferred stock, $0.01 par value, 10,000,000 shares authorized; no shares issued and outstanding			—				—
Common stock, $0.01 par value, 100,000,000 shares authorized; issued shares – 33,334,281 and 33,248,915 at September 30, 2011 and December 31, 2010, respectively			333,343				332,489
Additional paid in capital			150,510,589				149,438,202
Retained earnings			24,953,092				17,138,085
Accumulated other comprehensive loss, net of tax			(640,057	)			(1,680,370	)
Common stock in treasury; at cost, 2,649,729 and 2,627,339 shares at September 30, 2011 and December 31, 2010, respectively			(41,432,255	)			(41,325,690	)
Total stockholders’ equity			133,724,712				123,902,716
Total liabilities and stockholders’ equity		$	388,709,919			$	363,773,520

See accompanying notes.

 

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ASSET ACCEPTANCE CAPITAL CORP.

Consolidated Statements of Operations

(Unaudited)

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Revenues
Purchased receivable revenues, net		$	56,294,567			$	47,323,277			$	160,756,730			$	149,036,697
Gain on sale of purchased receivables			—				532,694				—				857,542
Other revenues, net			318,965				611,847				943,210				1,043,094
Total revenues			56,613,532				48,467,818				161,699,940				150,937,333
Expenses
Salaries and benefits			16,943,855				18,452,516				51,702,960				56,618,137
Collections expense			26,089,521				23,278,032				73,828,877				70,543,422
Occupancy			1,465,568				1,722,573				4,302,259				5,171,854
Administrative			3,155,217				2,113,567				7,190,614				6,056,546
Restructuring charges			—				1,255,759				—				1,255,759
Depreciation and amortization			944,118				1,168,685				2,994,633				3,477,396
(Gain) loss on disposal of equipment and other assets			(92,075	)			(1,021	)			(86,182	)			4,522
Total operating expenses			48,506,204				47,990,111				139,933,161				143,127,636
Income from operations			8,107,328				477,707				21,766,779				7,809,697
Other income (expense)
Interest expense			(2,631,787	)			(2,997,391	)			(7,932,278	)			(8,514,493	)
Interest income			152				60				283				1,473
Other			476				14,862				(1,640	)			70,425
Income (loss) before income taxes			5,476,169				(2,504,762	)			13,833,144				(632,898	)
Income tax expense (benefit)			2,405,567				(6,751,024	)			6,018,137				(6,010,134	)
Net income		$	3,070,602			$	4,246,262			$	7,815,007			$	5,377,236
Weighted-average number of shares:
Basic			30,781,016				30,703,735				30,752,965				30,685,659
Diluted			30,843,313				30,741,207				30,834,889				30,753,953
Earnings per common share outstanding:
Basic		$	0.10			$	0.14			$	0.25			$	0.18
Diluted		$	0.10			$	0.14			$	0.25			$	0.17

See accompanying notes.

 

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ASSET ACCEPTANCE CAPITAL CORP.

Consolidated Statements of Cash Flows

(Unaudited)

 

		Nine months ended September 30,
		2011				2010
Cash flows from operating activities
Net income		$	7,815,007			$	5,377,236
Adjustments to reconcile net income to net cash provided by operating activities:
Depreciation and amortization			2,994,633				3,477,396
Amortization of deferred financing costs			1,062,123				931,396
Deferred income taxes			5,783,570				(2,645,451	)
Share-based compensation expense			1,073,241				972,500
Net reversal of purchased receivables impairments			(3,651,900	)			(1,618,489	)
Non-cash revenue			(129	)			(10,990	)
(Gain) loss on disposal of equipment and other assets			(86,182	)			57,946
Gain on sale of purchased receivables			—				(857,542	)
Impairment of assets			—				812,400
Changes in assets and liabilities:
(Increase) decrease in other assets			(862,185	)			37,367
(Decrease) increase in accounts payable and other accrued liabilities			(5,452,798	)			586,919
Increase (decrease) in income taxes payable, net			3,068,923				(3,490,089	)
Net cash provided by operating activities			11,744,303				3,630,599
Cash flows from investing activities
Investment in purchased receivables, net of buybacks			(133,906,306	)			(120,871,744	)
Principal collected on purchased receivables			110,789,681				104,883,111
Proceeds from sale of purchased receivables			—				1,375,736
Purchase of property and equipment			(2,491,159	)			(1,956,267	)
Payments made for asset acquisition			—				(793,750	)
Proceeds from sale of property and equipment			99,000				5,255
Net cash used in investing activities			(25,508,784	)			(17,357,659	)
Cash flows from financing activities
Borrowings under notes payable			113,200,000				98,300,000
Repayments of notes payable			(96,825,000	)			(83,387,558	)
Payment of deferred financing costs			(260,878	)			(775,808	)
Payments on capital lease obligations			(65,247	)			(55,706	)
Purchase of treasury shares			(106,565	)			(48,519	)
Net cash provided by financing activities			15,942,310				14,032,409
Net increase in cash			2,177,829				305,349
Cash at beginning of period			5,635,503				4,935,248
Cash at end of period		$	7,813,332			$	5,240,597
Supplemental disclosure of cash flow information
Cash paid for interest, net of capitalized interest		$	6,909,686			$	7,844,446
Net cash (received) paid for income taxes			(2,817,694	)			125,406
Non-cash investing and financing activities:
Change in fair value of interest rate swap liability			1,654,289				1,303,522
Change in unrealized loss on cash flow hedge, net of tax			(1,040,313	)			(765,187	)
Change in purchased receivable obligations			—				(2,399,832	)

See accompanying notes.

 

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ASSET ACCEPTANCE CAPITAL CORP.

NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1. Basis of Presentation

Nature of Operations

Asset Acceptance Capital Corp. (a Delaware corporation) and its subsidiaries (collectively referred to as the “Company”) are engaged in the purchase and collection of defaulted and charged-off accounts receivable portfolios. These receivables are acquired from consumer credit originators, primarily credit card issuers including private label card issuers, consumer finance companies, telecommunications and other utility providers, resellers and other holders of consumer debt. The Company may periodically sell receivables from these portfolios to unaffiliated third parties.

In addition, the Company finances the sales of consumer product retailers, referred to as finance contract receivables, and licenses a proprietary collection software application referred to as licensed software.

The accompanying unaudited interim financial statements of the Company have been prepared in accordance with Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission (“SEC”) and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States of America (“U.S. GAAP”). In the opinion of management, the accompanying unaudited consolidated financial statements contain all adjustments necessary for a fair presentation of the Company’s financial position as of September 30, 2011 and its results of operations for the three and nine months ended September 30, 2011 and 2010 and cash flows for the nine months ended September 30, 2011 and 2010. All adjustments were of a normal recurring nature. The operations of the Company for the three and nine months ended September 30, 2011 and 2010 may not be indicative of future results. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K for the year ended December 31, 2010.

Reporting Entity

The accompanying consolidated financial statements include the accounts of Asset Acceptance Capital Corp. (“AACC”) and all subsidiaries. All significant intercompany balances and transactions have been eliminated in consolidation. The Company currently has three operating segments, one for purchased receivables, one for finance contract receivables and one for licensed software. The finance contract receivables and licensed software operating segments are not material and therefore are not disclosed separately from the purchased receivables segment.

2. Summary of Significant Accounting Policies

Use of Estimates

The preparation of financial statements in conformity with U.S. GAAP requires management to make estimates and assumptions that affect the reported amounts of assets and liabilities and disclosure of contingent assets and liabilities at the date of the financial statements and the reported amounts of revenues and expenses during the reporting period. Significant items related to such estimates include the timing and amount of future cash collections on purchased receivables, deferred tax assets, goodwill and share-based compensation. Actual results could differ from those estimates making it reasonably possible that a significant change in these estimates could occur within one year.

Goodwill

Goodwill with an indefinite life is not amortized, instead, is reviewed annually to assess recoverability or more frequently if impairment indicators are present. Refer to Note 8, “Fair Value”, for additional information about the fair value of goodwill.

 

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Accrued Liabilities

The details of accrued liabilities were as follows:

 

		September 30, 2011				December 31, 2010
Accrued general and administrative expenses (1)		$	6,843,971			$	4,849,348
Accrued payroll, benefits and bonuses			6,581,419				6,007,874
Deferred rent			2,474,945				2,738,363
Fair value of derivative instruments			1,126,860				2,781,149
Accrued interest expense			328,160				367,974
Accrued restructuring charges (2)			335,157				2,594,245
Deferred revenue			218,116				287,127
Accrued contract termination costs (3)			—				5,280,000
Other accrued expenses			131,816				272,627
Total accrued liabilities		$	18,040,444			$	25,178,707

 

(1)

Included $2,500,000 and $1,250,000 related to a litigation contingency as of September 30, 2011 and December 31, 2010, respectively. See Note 7, “Contingencies” for more information.

(2)

Restructuring charges are related to costs associated with closing the Chicago, Illinois, Brooklyn Heights (“Cleveland”), Ohio and Deerfield Beach, Florida collection offices in 2010; refer to Note 9, “Restructuring Charges” for additional information.

(3)

The Company terminated a relationship with a third party service provider that resulted in a $5,280,000 accrual for reimbursement of court costs at December 31, 2010, which was paid in January 2011.

Revenue Recognition

The Company accounts for its investment in purchased receivables using the guidance provided in Financial Accounting Standards Board (“FASB”) Accounting Standard Codification (“ASC”) Subtopic 310-30, “Loans and Debt Securities Acquired with Deteriorated Credit Quality”, referred to herein as the “Interest Method”. Refer to Note 3, “Purchased Receivables and Revenue Recognition”, for additional discussion of the Company’s method of accounting for purchased receivables and recognizing revenue.

Concentrations of Risk

For the three and nine months ended September 30, 2011, the Company invested 58.1% and 57.9% (net of buybacks), respectively, in purchased receivables from its top three sellers. For the three and nine months ended September 30, 2010, the Company invested 82.7% and 71.4% (net of buybacks through September 30, 2011), respectively, in purchased receivables from its top three sellers. One seller was included in the top three in both of the three and nine month periods.

Seasonality

Collections tend to be seasonally higher in the first and second quarters of the year due to consumers’ receipt of tax refunds and other factors. Conversely, collections tend to be lower in the third and fourth quarters of the year due to consumers’ spending in connection with summer vacations, the holiday season and other factors. However, revenues remain relatively level, excluding the impact of impairments or impairment reversals, due to the application of the Interest Method of revenue recognition. In addition, the Company’s operating results may be affected by the timing of purchases of charged-off consumer receivables due to the costs associated with initiating collection activities. Consequently, income and margins may fluctuate from quarter to quarter.

Collections by Third Parties

The Company regularly utilizes unaffiliated domestic and international third parties, primarily attorneys and other contingent collection agencies, to collect certain account balances on behalf of the Company in exchange for a percentage of the balance collected, or for a fixed fee. The Company generally receives these collection proceeds net of collection fees; however, records collections on a gross basis. Fees paid to third parties, and the reimbursement of certain legal and other costs, are recorded as a component of collections expense. The percent of gross cash collections by third parties was 45.6% and 37.7% for the three months ended September 30, 2011 and 2010, respectively, and 42.6% and 34.9% for the nine months ended September 30, 2011 and 2010, respectively.

 

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Interest Expense

Interest expense includes interest on the Company’s credit facilities, unused facility fees, the ineffective portion of the change in fair value of the Company’s derivative financial instruments (refer to Note 5, “Derivative Financial Instruments and Risk Management”), interest payments made on the interest rate swap and amortization of deferred financing costs. Interest expense was as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Interest expense		$	2,277,748			$	2,643,350			$	6,870,155			$	7,583,097
Amortization of deferred financing costs			354,039				354,041				1,062,123				931,396
Total interest expense		$	2,631,787			$	2,997,391			$	7,932,278			$	8,514,493

Income Tax

Beginning in the first quarter of 2011, the Company changed its calculation of the interim income tax provision. Previously, the income tax provision was calculated using the effective tax rate based on actual operating results for the quarter. The Company now calculates an estimated annual effective tax rate for the year based on forecasted annual operating results, as prescribed by FASB ASC Subtopic 740 “Income Taxes”. The estimated annual effective tax rate is applied to the actual operating results for the quarter. In the event there is a significant or unusual item recognized in the quarterly operating results, the tax attributable to that item is separately calculated and included in the annual effective tax rate.

Earnings Per Share

Earnings per share reflect net income divided by the weighted-average number of shares outstanding. The following table provides a reconciliation between basic and diluted weighted-average shares outstanding:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Basic weighted-average shares outstanding			30,781,016				30,703,735				30,752,965				30,685,659
Dilutive weighted-average shares (1)			62,297				37,472				81,924				68,294
Diluted weighted-average shares outstanding			30,843,313				30,741,207				30,834,889				30,753,953

 

(1)

Includes the dilutive effect of outstanding stock options, deferred stock units and restricted shares (collectively the “Share-Based Awards”). Share-Based Awards that are contingent upon the attainment of performance goals are not included in dilutive weighted-average shares until the performance goals are achieved.

There were 1,128,569 and 1,095,130 outstanding Share-Based Awards that were not included within the dilutive weighted-average shares as their fair value or exercise price exceeded the market price of the Company’s common stock at September 30, 2011 and 2010, respectively, and therefore were considered anti-dilutive.

Comprehensive Income

Components of comprehensive income are changes in equity other than those resulting from investments by owners and distributions to owners. Net income is the primary component of comprehensive income. Currently, the Company’s only component of comprehensive income other than net income is the change in unrealized loss on derivatives qualifying as cash flow hedges, net of tax. The aggregate amount of changes to equity that have not yet been recognized in net income are reported in the equity section of the accompanying consolidated statements of financial position as “Accumulated other comprehensive loss, net of tax”.

 

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A summary of accumulated other comprehensive loss, net of tax was as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Opening balance		$	(1,034,532	)		$	(2,321,921	)		$	(1,680,370	)		$	(2,955,451	)
Change in unrealized loss on cash flow hedge			394,475				131,657				1,040,313				765,187
Ending balance		$	(640,057	)		$	(2,190,264	)		$	(640,057	)		$	(2,190,264	)

Fair Value of Financial Instruments

The fair value of financial instruments is estimated using available market information and other valuation methods. Refer to Note 8, “Fair Value” for more information.

Recently Issued Accounting Pronouncements

The following accounting pronouncements have been issued and are effective for the Company in or after fiscal year 2011.

In September 2011, the FASB issued guidance which permits an entity to make a qualitative assessment of whether it is more likely than not that a reporting unit’s fair value is less than its carrying value as a basis for determining whether it is necessary to perform the two-step goodwill impairment test. This guidance is effective for fiscal years beginning after December 15, 2011; however, early adoption is permitted. The adoption of this guidance is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

In June 2011, the FASB issued guidance that amends the reporting requirements for comprehensive income. The new requirements are intended to increase the prominence of other comprehensive income and its components. This guidance requires a reporting entity to present the total of comprehensive income, the components of net income, and the components of other comprehensive income either in a single continuous statement of comprehensive income or in two separate but consecutive statements. This update eliminates the option to present the components of other comprehensive income as part of the statement of changes in stockholders’ equity. This guidance is effective retroactively for interim and annual periods beginning after December 15, 2011. The adoption of this guidance is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

In May 2011, the FASB issued guidance that clarifies the requirements for measuring fair value and for disclosing information about fair value measurements, including a consistent meaning of the term “Fair Value”. This guidance is effective prospectively for interim and annual periods beginning on or after December 15, 2011. The adoption of this guidance is not expected to have a material impact on the Company’s financial position, results of operations or cash flows.

3. Purchased Receivables and Revenue Recognition

Purchased receivables are receivables that have been charged-off as uncollectible by the originating organization and many times have been subject to previous collection efforts. The Company acquires pools of homogenous accounts which are the rights to the unrecovered balances owed by individual debtors. Receivable portfolios are purchased at a substantial discount (generally more than 90%) from their face value due to a deterioration of credit quality since origination and are initially recorded at the Company’s acquisition cost, which equals fair value at the acquisition date. Financing for purchasing is provided by the Company’s cash generated from operations and from borrowings on the Company’s revolving credit facility.

The Company accounts for its investment in purchased receivables using the Interest Method when the Company has reasonable expectations of the timing and amount of cash flows expected to be collected. Pools purchased after 2004 may be aggregated into one or more static pools within each quarter, based on common risk characteristics and payer dynamics. Risk characteristics of purchased receivables are generally considered to be similar when purchased receivables are in the post charged-off collection cycle. The Company therefore aggregates most pools purchased within each quarter. Pools purchased before 2005 may not be aggregated. Each static pool, either aggregated or non-aggregated, retains its own identity and does not change over the remainder of its life. Each static pool is accounted for as a single unit for recognition of revenue, collections and impairments.

 

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Collections on each static pool are allocated to revenue and principal reduction based on an internal rate of return (“IRR”). The IRR is the rate of return that each static pool requires to amortize the cost or carrying value of the pool to zero over its estimated life. Each pool’s IRR is determined by estimating future cash flows, which are based on historical collection data for pools with similar characteristics and future work efforts. These estimates are influenced by both internal and external factors. Internal factors that may have an impact on estimated future cash flows include (a) revisions to initial and post-acquisition recovery scoring and modeling estimates, (b) collection strategies, (c) the components of a pool, including paper type and date since charge-off, and (d) changes in productivity related to turnover and tenure of the Company’s collection staff. External factors that may have an impact on estimated future cash flows include (a) overall market pricing for new purchases, (b) new laws or regulations relating to collection efforts or new interpretations of existing laws or regulations, and (c) the overall condition of the economy. The actual life of each pool may vary, but will generally range between 36 and 84 months depending on the expected collection period that can reasonably be predicted. Monthly cash flows greater than revenue recognized will reduce the carrying value of each static pool. Monthly cash flows lower than revenue recognized will increase the carrying value of each static pool, absent the impact of impairments.

Future estimated cash collections for each static pool are reviewed at least quarterly and compared to historical trends and operational data to determine whether the static pool is performing as expected. If current cash flow estimates are greater than the original estimate, the IRR may be increased prospectively to reflect the revised estimate of cash flows over the remaining life of the static pool. If current cash flow estimates are less than the original estimate, and the Company believes those estimates will not increase in future periods, the IRR remains unchanged and an impairment is recognized. If cash flow estimates increase in periods subsequent to recording an impairment, reversal of the previously recognized impairment is made prior to increasing the IRR.

Agreements to purchase receivables typically include general representations and warranties from the sellers covering account holder death, bankruptcy, fraud and settled or paid accounts prior to sale. These representations and warranties permit the return of certain ineligible accounts from the Company back to the seller. The general time frame to return accounts is within 90 to 180 days from the date of the purchase agreement. Proceeds from returns, also referred to as buybacks, are applied against the carrying value of the static pool.

The cost recovery method is used when collections on a particular portfolio cannot be reasonably predicted. When appropriate, the cost recovery method may be used for pools that previously had an IRR assigned to them. Under the cost recovery method, no revenue is recognized until the Company has fully collected the cost of the portfolio. As of September 30, 2011, the Company had seven unamortized pools on the cost recovery method with an aggregate carrying value of $259,762 or about 0.1% of the total carrying value of all purchased receivables. As of December 31, 2010, the Company had 14 unamortized pools on the cost recovery method with an aggregate carrying value of $962,461 or about 0.3% of the total carrying value of all purchased receivables.

Although not its usual business practice, the Company may periodically sell, on a non-recourse basis, all or a portion of a pool to unaffiliated parties. The Company does not retain any significant continuing involvement with these pools subsequent to sale. Proceeds from these sales are compared to the carrying value of the accounts and a gain or loss is recognized on the difference between proceeds received and the carrying value, which is included in “Gain on sale of purchased receivables” in the accompanying consolidated statements of operations. The agreements to sell receivables typically include general representations and warranties.

 

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Changes in purchased receivables portfolios were as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Beginning balance		$	340,935,454			$	325,380,271			$	321,318,255			$	319,772,006
Investment in purchased receivables, net of buybacks			38,294,778				41,147,638				133,906,306				118,471,912
Cost of sale of purchased receivables sold			—				(518,168	)			—				(518,194	)
Cash collections			(87,437,890	)			(78,860,926	)			(267,894,382	)			(252,290,329	)
Purchased receivable revenues, net			56,294,567				47,323,277				160,756,730				149,036,697
Ending balance		$	348,086,909			$	334,472,092			$	348,086,909			$	334,472,092

Accretable yield represents the amount of revenue the Company expects over the remaining life of existing portfolios. Nonaccretable yield represents the difference between the remaining expected cash collections and the total contractual obligation outstanding, or face value, of purchased receivables. Changes in accretable yield were as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Beginning balance (1)		$	459,858,029			$	476,393,073			$	427,464,854			$	466,199,721
Revenue recognized on purchased receivables, net			(56,294,567	)			(47,323,277	)			(160,756,730	)			(149,036,697	)
Additions due to purchases			38,370,211				45,672,943				163,223,278				131,943,037
Reclassifications from (to) nonaccretable yield			20,468,205				(18,026,345	)			32,470,476				7,610,333
Ending balance (1)		$	462,401,878			$	456,716,394			$	462,401,878			$	456,716,394

 

(1)	Accretable yields are a function of estimated remaining cash collections. Refer to Forward-Looking Statements on page 22 and Critical Accounting Policies on page 45 for further information regarding these estimates.

Cash collections include collections from fully amortized pools of which 100% of the collections were reported as revenue. Components of cash collections from fully amortized pools were as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Fully amortized before the end of their expected life		$	2,499,752			$	1,807,834			$	8,718,064			$	8,765,086
Fully amortized after the end of their expected life			7,759,421				7,032,236				23,885,174				21,806,022
Accounted under the cost recovery method			2,368,005				1,735,320				6,277,913				8,758,772
Total cash collections from fully amortized pools		$	12,627,178			$	10,575,390			$	38,881,151			$	39,329,880

Changes in purchased receivables portfolios under the cost recovery method were as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Beginning balance		$	278,780			$	1,118,049			$	962,461			$	2,271,595
Addition of portfolios			306,587				110,919				1,145,543				239,629
Buybacks, impairments and resale adjustments			(213	)			(519,803	)			(446	)			(528,228	)
Cash collections until fully amortized			(325,392	)			(255,855	)			(1,847,796	)			(1,529,686	)
Ending balance		$	259,762			$	453,310			$	259,762			$	453,310

During the three and nine months ended September 30, 2011, the Company recorded net impairment reversals of purchased receivables of $2,733,100 and $3,651,900, respectively. During the three and nine months ended September 30, 2010, the Company recorded net impairment reversals of $653,458 and $1,618,489, respectively. Impairment reversals increase revenue and the carrying value of purchased receivables in the period recorded.

 

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Changes in the purchased receivables valuation allowance were as follows:

 

		Three months ended September 30,								Nine months ended September 30,
		2011				2010				2011				2010
Beginning balance		$	71,753,600			$	96,494,500			$	87,323,300			$	104,416,455
Impairments			—				240,042				2,838,900				623,911
Reversal of impairments			(2,733,100	)			(893,500	)			(6,490,800	)			(2,242,400	)
Deductions (1)			(6,314,900	)			(3,718,842	)			(20,965,800	)			(10,675,766	)
Ending balance		$	62,705,600			$	92,122,200			$	62,705,600			$	92,122,200

 

(1)	Deductions represent historical impairments of purchased receivable portfolios that became fully amortized during the period and, therefore, the balance is removed from the valuation allowance since it can no longer be reversed.

4. Notes Payable

The Company’s amended credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, and a syndicate of lenders named therein, originated on June 5, 2007 (the “Credit Agreement”). Under the terms of the Credit Agreement, the Company has a five-year $100,000,000 revolving credit facility which expires in June 2012 (the “Revolving Credit Facility”) and a six-year $150,000,000 term loan facility which expires in June 2013 (the “Term Loan Facility” and, together with the Revolving Credit Facility, the “Credit Facilities”). The Credit Facilities bear interest at 200 to 250 basis points over the bank’s prime rate depending upon the Company’s liquidity, as defined in the Credit Agreement. Alternately, at the Company’s discretion, the Company may borrow by entering into one, two, three, six or twelve-month contracts based on the London Inter Bank Offer Rate (“LIBOR”) at rates between 300 to 350 basis points over the respective LIBOR, depending on the Company’s liquidity. The Company’s Revolving Credit Facility includes an accordion loan feature that allows it to request a $25,000,000 increase as well as sublimits for $10,000,000 of letters of credit and for $10,000,000 of swingline loans. The Credit Agreement is secured by a first priority lien on substantially all of the Company’s assets. The Credit Agreement also contains certain covenants and restrictions that the Company must comply with, which, as of September 30, 2011 were:

 

•

Leverage Ratio (as defined) cannot exceed (i) 1.5 to 1.0 at any time on or before December 30, 2011 or (ii) 1.25 to 1.0 at any time thereafter;

 

•

Ratio of Consolidated Total Liabilities to Consolidated Tangible Net Worth (as defined) cannot exceed (i) 2.5 to 1.0 at any time on or before December 30, 2011, (ii) 2.25 to 1.0 at any time on or after December 31, 2011 and on or before March 30, 2012, (iii) 2.0 to 1.0 at any time thereafter; and

 

•

Consolidated Tangible Net Worth (as defined) must equal or exceed $85,000,000 plus 50% of positive consolidated net income for three consecutive fiscal quarters ending December 31, 2007 and for each fiscal year ending thereafter, such amount to be added as of December 31, 2007 and as of the end of each such fiscal year thereafter.

The Credit Agreement contains a provision that requires the Company to repay Excess Cash Flow (as defined) to reduce the indebtedness outstanding under its Term Loan Facility. Excess Cash Flow may exist for a fiscal year if the Company generates cash from operations in excess of amounts reinvested in the business, primarily for purchasing receivables. The annual repayment of the Company’s Excess Cash Flow was first effective with the issuance of its audited consolidated financial statements for fiscal year 2008, and the Company made a required payment of $8,962,558 in March 2010 related to the results of operations for the year ended December 31, 2009. There was no Excess Cash Flow payment required in 2011 based on the results of operations for the year ended December 31, 2010. The Excess Cash Flow payment, if required, is due within 10 days of the issuance of the annual financial statements. The repayment provisions are:

 

•

50% of the Excess Cash Flow for such fiscal year if the Leverage Ratio was greater than 1.0 to 1.0 as of the end of such fiscal year;

 

•

25% of the Excess Cash Flow for such fiscal year if the Leverage Ratio was less than or equal to 1.0 to 1.0 but greater than 0.875 to 1.0 as of the end of such fiscal year; or

 

•

0% if the Leverage Ratio is less than or equal to 0.875 to 1.0 as of the end of such fiscal year.

 

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Commitment fees on the unused portion of the Revolving Credit Facility are paid quarterly, in arrears, and are calculated as an amount equal to a margin of 0.50% on the average amount available on the Revolving Credit Facility.

The Credit Agreement requires the Company to effectively cap, collar or exchange interest rates on a notional amount of at least 25% of the outstanding principal amount of the Term Loan Facility. Refer to Note 5, “Derivative Financial Instruments and Risk Management” for additional information.

The Company had $173,634,956 and $157,259,956 of borrowings outstanding on its Credit Facilities as of September 30, 2011 and December 31, 2010, respectively, of which $132,234,956 and $133,359,956 was outstanding on the Term Loan Facility, respectively, and $41,400,000 and $23,900,000 was outstanding on the Revolving Credit Facility, respectively. The Term Loan Facility requires quarterly repayments totaling $1,500,000 annually until March 2013 with the remaining balance due in June 2013.

In April 2011, the Company announced that it had engaged JPMorgan Securities to arrange funding of new senior secured credit facilities to replace its existing Credit Facilities. In May 2011, the Company decided to delay its pursuit of new credit facilities as it demonstrated continued improved operating performance. The Company expects to complete a refinancing transaction prior to the expiration of the Revolving Credit Facility in June 2012. During the three and nine months ended September 30, 2011, the Company incurred deferred financing costs related to pursuing the new credit facilities of $2,355 and $260,878, respectively. In May 2010, the Company entered into a Third Amendment to the Credit Agreement for which the Company incurred deferred financing costs of $775,808.

The Company was in compliance with all covenants of the Credit Agreement as of September 30, 2011.

5. Derivative Financial Instruments and Risk Management

Risk Management

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-rate debt and their impact on earnings and cash flows. The Company does not utilize derivative financial instruments with a level of complexity or with a risk greater than the exposure to be managed nor does it enter into or hold derivatives for trading or speculative purposes. The Company periodically reviews the creditworthiness of the swap counterparty to assess the counterparty’s ability to honor its obligation. Counterparty default would further expose the Company to fluctuations in variable interest rates.

The Company records derivative financial instruments at fair value. Refer to Note 8, “Fair Value” for additional information.

Derivative Financial Instruments

In September 2007, the Company entered into an amortizing interest rate swap agreement whereby, on a quarterly basis, it swaps variable rates under its Term Loan Facility for fixed rates. At inception and for the first year, the notional amount of the swap was $125,000,000. Every year thereafter, on the anniversary of the swap agreement the notional amount decreases by $25,000,000. As of September 30, 2011, the notional amount was $25,000,000. This swap agreement expires on September 13, 2012.

During September 2011, the Company acquired an interest rate cap, expiring in November 2011, to mitigate the risk on the remaining amount of the principal required to be covered under the terms of the Credit Agreement. The fair value of the interest rate cap was not material at September 30, 2011.

The interest rate swap is designated and qualifies as a cash flow hedge. The effective portion of the gain or loss is reported as a component of Accumulated Other Comprehensive Income (“AOCI”) in the accompanying consolidated financial statements. The effective portion is recognized in income as interest expense in the period in which the related hedged cash flow is recorded in interest expense. To the extent the hedging relationship is not effective, the ineffective portion of the change in fair value of the derivative is recorded in interest expense in the period incurred. Derivatives that receive designated hedge accounting treatment are evaluated for effectiveness at the time that they are designated as well as throughout the hedging period.

 

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Changes in fair value are recorded as an adjustment to AOCI, net of tax. Amounts in AOCI will be reclassified into earnings under certain situations; for example, if the occurrence of the transaction is no longer probable or no longer qualifies for hedge accounting. In these situations, all or a portion of the transaction would be ineffective. The Company does not expect to reclassify any material amount currently included in AOCI into earnings due to ineffectiveness within the next twelve months.

As of September 30, 2011, the Company did not have any fair value hedges.

The following table summarizes the fair value of derivative instruments:

 

		September 30, 2011						December 31, 2010
		Financial Position Location		Fair Value				Financial Position Location		Fair Value
Derivatives designated as hedging instruments
Interest rate swap		Accrued liabilities		$	1,126,860			Accrued liabilities		$	2,781,149
Total derivatives designated as hedging instruments				$	1,126,860					$	2,781,149

The following tables summarize the impact of derivatives designated as hedging instruments:

 

Derivative		Amount of Gain or (Loss) Recognized in AOCI (Effective Portion)								Location of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)		Amount of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)								Location of Gain or (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)		Amount of Gain or (Loss) Recognized in Income  (Ineffective Portion and Amount Excluded from Effectiveness Testing)
		Three Months Ended September 30,										Three Months Ended September 30,										Three Months  Ended September 30,
		2011				2010						2011				2010						2011				2010
Interest rate swap		$	69,528			$	(340,468	)		Interest expense		$	(544,663	)		$	(800,487	)		Interest Expense		$	(6,821	)		$	948
Total		$	69,528			$	(340,468	)		Total		$	(544,663	)		$	(800,487	)		Total		$	(6,821	)		$	948

 

Derivative		Amount of Gain or (Loss) Recognized in AOCI (Effective Portion)								Location of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)		Amount of Gain or (Loss) Reclassified from AOCI into Income (Effective Portion)								Location of Gain or (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)		Amount of Gain or (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
		Nine Months Ended September 30,										Nine Months Ended September 30,										Nine Months  Ended September 30,
		2011				2010						2011				2010						2011				2010
Interest rate swap		$	(60,359	)		$	(1,259,606	)		Interest expense		$	(1,714,648	)		$	(2,563,128	)		Interest Expense		$	(6,694	)		$	2,186
Total		$	(60,359	)		$	(1,259,606	)		Total		$	(1,714,648	)		$	(2,563,128	)		Total		$	(6,694	)		$	2,186

6. Share-Based Compensation

The Company adopted a stock incentive plan (the “Stock Incentive Plan”) during February 2004 that authorizes the use of stock options, stock appreciation rights, restricted stock grants and units, performance share awards and annual incentive awards to eligible key associates, non-associate directors and consultants. The Company reserved 3,700,000 shares of common stock for issuance in conjunction with share-based awards to be granted under the plan of which 1,932,016 shares remain available to be granted as of September 30, 2011. The purpose of the plan is (i) to promote the best interests of the Company and its stockholders by encouraging associates and other participants to acquire an ownership interest in the Company, thus aligning their interests with those of stockholders and (ii) to enhance the ability of the Company to attract and retain qualified associates, non-associate directors and consultants. No participant may be granted options during any one fiscal year to purchase more than 500,000 shares of common stock.

 

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Based on historical experience, the Company uses an annual forfeiture rate of 15% for associate grants. Grants made to non-associate directors vest immediately and, therefore, have no associated forfeitures.

Share-based compensation expense and related tax benefits were as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Share-based compensation expense		$	289,581			$	274,056			$	1,073,241			$	972,500
Income tax benefits			127,849				102,831				466,860				379,275

The Company’s share-based compensation arrangements are described below.

Stock Options

The Company utilizes the Whaley Quadratic approximation model, an intrinsic value method, to calculate the fair value of stock awards on the date of grant using the assumptions noted in the following table. Changes to the subjective input assumptions can result in different fair market value estimates. With regard to the Company’s assumptions stated below, the expected volatility is based on the historical volatility of the Company’s stock and management’s estimate of the volatility over the contractual term of the options. The expected term of the options is based on management’s estimate of the period of time for which the options are expected to be outstanding. The risk-free rate is derived from the five-year U.S. Treasury yield curve on the date of grant.

The following table summarizes the assumptions used to determine the fair value of stock options granted:

 

Options issue year:		2011				2010
Expected volatility			59.90-63.99	%			57.20-59.90	%
Expected dividends			0.00	%			0.00	%
Expected term			4 Years				4 Years
Risk-free rate			1.89-2.25	%			2.20-2.42	%

As of September 30, 2011, the Company had options outstanding for 1,139,438 shares of its common stock under the Stock Incentive Plan. These options have been granted to key associates and non-associate 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 grant and have contractual terms ranging from seven to ten years. The options granted to key associates generally vest between one and five years from the grant date whereas the options granted to non-associate directors generally vest immediately. The fair value of stock options is expensed on a straight-line basis over the vesting period.

The related compensation expense was as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Salaries and benefits (1)		$	80,742			$	100,953			$	293,835			$	298,856
Administrative expenses (2)			—				—				79,232				147,297
Total		$	80,742			$	100,953			$	373,067			$	446,153

 

(1)	Salaries and benefits include amounts for associates.

(2)	Administrative expenses include amounts for non-associate directors.

The following table summarizes all stock option transactions from January 1, 2011 through September 30, 2011:

 

		Options Outstanding				Weighted-Average Exercise Price				Weighted-Average Remaining Contractual Term				Aggregate Intrinsic Value
										(In years)
Beginning balance			1,012,063			$	11.09
Granted			137,500				5.18
Forfeited or expired			(10,125	)			9.28
Outstanding at September 30, 2011			1,139,438				10.39				5.24			$	—
Exercisable at September 30, 2011			867,340			$	12.02				5.15			$	—

 

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The weighted-average grant date fair value of options granted during the nine months ended September 30, 2011 and 2010 was $2.49 and $3.17, respectively.

As of September 30, 2011, there was $659,754 of total unrecognized compensation expense related to nonvested stock options granted under the Stock Incentive Plan, which includes $596,577 for options expected to vest and $63,177 for options not expected to vest. Unrecognized compensation expense for options expected to vest is expected to be recognized over a weighted-average period of 2.06 years.

Deferred Stock Units

As of September 30, 2011, the Company had granted 71,079 deferred stock units (“DSUs”) to non-associate directors under the Company’s Stock Incentive Plan. DSUs represent the Company’s obligation to deliver one share of common stock for each unit at a later date elected by the holder, such as when his or her board service ends. DSUs vest immediately upon grant and are not subject to forfeiture. DSUs do not have voting rights but would receive common stock dividend equivalents in the form of additional DSUs. The value of each DSU is equal to the market price of the Company’s stock at the date of grant.

The fair value of the DSUs granted is expensed immediately to correspond with the vesting schedule, and is included in “Administrative expenses” in the accompanying consolidated statements of operations. The related expense for the three months ended September 30, 2011 and 2010 was $18,744 and $24,994, respectively. The related expense for the nine months ended September 30, 2011 and 2010 was $62,494 and $74,983, respectively.

The following table summarizes all DSU related transactions from January 1, 2011 through September 30, 2011:

 

		DSUs				Weighted-Average Grant-Date Fair Value
Beginning balance			58,437			$	7.41
Granted			12,642				4.98
Shares issued			(9,507	)			5.92
Ending balance			61,572			$	7.13

There was no unrecognized compensation expense for nonvested DSUs as of September 30, 2011.

Restricted Shares and Restricted Share Units

The Company grants restricted shares and restricted share units (restricted shares and restricted share units are referred to as “RSUs”) to key associates and non-associate directors under the Stock Incentive Plan. Each RSU is equal to one share of the Company’s common stock. The value of RSUs is equal to the market price of the Company’s stock at the date of grant.

RSUs granted to associates generally vest over two to four years, based on service or performance conditions. RSUs granted to non-associate directors generally vest when the non-associate director terminates board service. At September 30, 2011, 45,557 of the RSUs granted to associates will vest contingent on the attainment of performance conditions. When RSUs vest, participants have the option of selling a portion of vested shares to the Company in order to cover payroll tax obligations. The Company expects to repurchase approximately 23,000 shares for RSUs that are expected to vest during the next twelve months.

The fair value of RSUs granted to associates is expensed on a straight-line basis over the vesting period based on the number of RSUs expected to vest. The fair value of RSUs granted to non-associate directors is expensed immediately. For RSUs with performance conditions, if those conditions are not expected to be met, the compensation expense previously recognized is reversed.

 

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Compensation expense for RSUs, net of reversals, was as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Salaries and benefits (1)		$	190,095			$	148,110			$	584,586			$	348,144
Administrative expenses (2)			—				—				53,094				103,221
Total		$	190,095			$	148,110			$	637,680			$	451,365

 

(1)	Salaries and benefits include amounts for associates.

(2)	Administrative expenses include amounts for non-associate directors.

The Company issues shares of common stock for RSUs as they vest. The following table summarizes all RSU related transactions from January 1, 2011 through September 30, 2011:

 

		Nonvested RSUs				Weighted-Average Grant-Date Fair Value
Beginning balance			238,762			$	7.52
Granted			239,913				5.51
Vested and issued			(75,859	)			7.67
Forfeited			(65,526	)			8.87
Ending balance			337,290			$	5.80

As of September 30, 2011, there was $1,163,213 of total unrecognized compensation expense related to nonvested RSUs, which includes $1,012,234 for RSUs expected to vest and $150,979 for RSUs not expected to vest. Unrecognized compensation expense for RSUs expected to vest is expected to be recognized over a weighted-average period of 2.81 years.

7. Contingencies

Litigation Contingencies

The Company is involved in certain legal matters that management considers incidental to its business. The Company recognizes liabilities for contingencies and commitments when a loss is probable and estimable. The Company recognizes expense for defense costs when incurred. The Company does not expect these routine legal matters, either individually or in the aggregate, to have a material adverse effect on the Company’s financial position, results of operations, or cash flows.

As previously reported, the Federal Trade Commission (“FTC”) commenced an investigation into the Company’s debt collection practices under the Fair Credit Reporting Act, the Fair Debt Collection Practices Act and the Federal Trade Commission Act. The Company and its counsel continue to seek to resolve the matter and the Company believes it is nearing a final resolution. Although no assurances can be given as to the timing or terms of a final resolution, the Company believes it would include a consent decree that will, among other things, require additional disclosures to consumers and a monetary penalty. At September 30, 2011, the Company had an accrual of $2,500,000, which represented the best estimate of the amount of loss associated with the matter. The amount of the accrual was increased from $1,250,000 during the three months ended September 30, 2011. The final amount the Company may pay to resolve the matter could be more than the amount accrued.

8. Fair Value

The Company groups assets and liabilities at fair value in three levels, based on the markets in which the assets and liabilities are traded and the reliability of the assumptions used to determine fair value. These levels are:

 

 

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Disclosure of the estimated fair value of financial instruments often requires the use of estimates. The Company uses the following methods and assumptions to estimate the fair value of financial instruments:

 

						Fair Value Measurements at Reporting Date Using
		Total Recorded Fair Value at September 30, 2011				Quoted Prices in Active Markets for Identical Assets (Level 1)				Significant Other Observable Inputs (Level 2)				Significant Unobservable Inputs (Level 3)
Interest rate swap liability		$	1,126,860				—			$	1,126,860				—

The fair value of the interest rate swap represents the amount the Company would pay to terminate or otherwise settle the contract at the financial position date, taking into consideration current unearned gains and losses. The fair value was determined using a market approach, and is based on the three-month LIBOR curve for the remaining term of the swap agreement.

There were no transfers between the levels of valuation during the three and nine months ended September 30, 2011. The Company’s policy for recording transfers between levels is to reflect those transfers at the end of the reporting period. Refer to Note 5, “Derivative Financial Instruments and Risk Management”, for additional information about the fair value of the interest rate swap.

Goodwill

Goodwill is assessed annually for impairment using fair value measurement techniques. Goodwill impairment, if applicable, is determined using a two-step test. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its book value, including goodwill. If the fair value of the reporting unit exceeds its book value, goodwill is considered not impaired and the second step of the impairment test is unnecessary. If the book value of the reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the book value. If the book value of the reporting unit’s goodwill exceeds the implied fair value, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if it had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit. Events that could, in the future, result in impairment include, but are not limited to, sharply declining cash collections or a significant negative shift in the risk inherent in the reporting unit.

The estimate of fair value of the Company’s goodwill is determined using various valuation techniques including market capitalization, which is a Level 1 input, and an analysis of discounted cash flows, which includes Level 3 inputs. A discounted cash flow analysis requires various judgmental assumptions including assumptions about future cash collections, revenues, cash flows, growth rates and discount rates. The Company bases these assumptions on its budget and long-term plans. Discount rate assumptions are based on an assessment of the risk inherent in the reporting unit.

At the time of the most recent annual goodwill impairment test, November 1, 2010, market capitalization was substantially higher than book value and goodwill was not considered impaired. However, because market capitalization was less than book value during certain extended periods throughout 2011, the Company performed an interim step one analysis to further assess the fair value of goodwill of the Company’s single reporting unit. The Company prepared a discounted cash flow analysis, which resulted in fair value in excess of book value. The Company also prepared a market analysis to substantiate the value derived from the discounted cash flow analysis, which also resulted in fair value in excess of book value. The results of the fair value calculations indicate goodwill was not impaired. In addition, the Company believes that a reasonable potential buyer would offer a control premium for the business that would adequately cover the difference between the market valuation and book value. The Company performed a calculation of an implied control premium of the business, which supported the difference between the market valuation and book value. Based on the fair value calculations and the control premium reconciliation, the Company believes there was no impairment of Goodwill at September 30, 2011.

 

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The following disclosures pertain to the fair value of certain assets and liabilities, which are not measured at fair value in the accompanying consolidated financial statements.

Purchased Receivables

The Company’s purchased receivables had carrying values of $348,086,909 and $321,318,255 at September 30, 2011 and December 31, 2010, respectively. The Company computes the fair value of purchased receivables by discounting total estimated future cash flows generated by its forecasting model using a weighted-average cost of capital. The fair value of purchased receivables was approximately $400,000,000 and $360,000,000 at September 30, 2011 and December 31, 2010, respectively.

Credit Facilities

The Company’s Credit Facilities had carrying amounts of $173,634,956 and $157,259,956 as of September 30, 2011 and December 31, 2010, respectively. The fair value of the Credit Facilities approximated carrying value at both September 30, 2011 and December 31, 2010, respectively. The Company computed the fair value of its Credit Facilities based on quoted market prices.

9. Restructuring Charges

On July 29, 2010, the Company announced its commitment to no longer purchase and collect healthcare accounts receivable. Subsequently, the Company sold its healthcare accounts to a third party, closed its Deerfield Beach, Florida office and dissolved its Premium Asset Recovery Corporation (“PARC”) subsidiary. In addition, on October 4, 2010 and December 30, 2010, respectively, the Company announced plans to close its call center operations in the Chicago, Illinois and Cleveland, Ohio offices.

During the three months ended September 30, 2010, the Company recorded restructuring charges of $1,255,759. These charges included employee termination benefits, contract termination costs, write-off of furniture and equipment that would no longer be used, impairment of intangible assets and other exit costs. In addition, the Company sold its healthcare receivables for $1,045,050 and recognized a gain on the sale of $526,883 during the three months ended September 30, 2010. The gain on the sale of healthcare receivables is included in “Gain on sale of purchased receivables” in the accompanying consolidated statements of operations. The Company recognized total restructuring charges of $4,224,899 during the year ended December 31, 2010.

The components of restructuring charges were as follows:

 

		Three Months Ended September 30, 2010
Impairment of intangible assets		$	812,400
Operating lease charge			186,990
Employee termination benefits			186,057
Write-off of furniture and equipment			53,424
Other exit costs			16,888
Total restructuring charges		$	1,255,759

The restructuring liability as of September 30, 2011 was $335,157. The changes in the liability balance during the nine months ended September 30, 2011 were as follows:

 

		Employee Termination Benefits				Contract Termination Costs				Fixed Assets and Other				Total
Restructuring liability as of January 1, 2011		$	1,025,429			$	1,145,762			$	423,054			$	2,594,245
Payments			(912,866	)			(1,156,853	)			(31,164	)			(2,100,883	)
Adjustments to furniture and equipment			—				—				(158,205	)			(158,205	)
Other adjustments			—				11,091				(11,091	)			—
Restructuring liability as of September 30, 2011		$	112,563			$	—			$	222,594			$	335,157

 

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The restructuring activities are expected to be completed during 2011. There were no restructuring charges during the three and nine months ended September 30, 2011.

10. Income Taxes

The Company recorded income tax expense of $2,405,567 and income tax benefits of $6,751,024 for the three months ended September 30, 2011 and 2010, respectively, and income tax expense of $6,018,137 and income tax benefits of $6,010,134 for the nine months ended September 30, 2011 and 2010, respectively. The 2011 provision for income tax reflects a forecasted annualized effective income tax rate of 43.5%, which varied from the U.S. federal statutory rate due to state income taxes and non-deductible permanent differences, primarily the FTC accrual.

The effective income tax rate for the three and nine months ended September 30, 2010 was positively impacted by the PARC restructuring actions which provided a net income tax benefit of approximately $5,500,000. The benefit was the result of a worthless stock deduction for the investment in PARC and the tax recognition of a write-off of intercompany advances, partially offset by a valuation allowance related to PARC deferred tax assets.

As of September 30, 2011, the Company had a gross unrecognized tax benefit of $1,075,368 that, if recognized, would result in a net tax benefit of approximately $700,000, which would have a positive impact on net income and the effective tax rate. During the three and nine months ended September 30, 2011, there were no material changes to the unrecognized tax benefit. Since January 1, 2009, the Company has accrued interest related to unrecognized tax benefits of approximately $221,000, which has been classified as income tax expense in the accompanying consolidated financial statements.

The federal income tax returns of the Company for the years 2008 through 2010 are subject to examination by the IRS, generally for three years after the latter of their extended due date or when they are filed. The state income tax returns of the Company are subject to examination by the state taxing authorities, for various periods generally up to four years. The Company is currently under examination by the IRS for tax years 2008 through 2010. The Company does not anticipate a significant impact to its tax positions as a result of this examination.

11. Subsequent Event

On November 1, 2011, the Company announced its plan to close its San Antonio, Texas collections office. The Company will incur approximately $700,000 in restructuring charges in conjunction with this action. Those charges include employee termination benefits of approximately $100,000, contract termination costs of approximately $400,000 for the remaining lease payments, net of potential sub-lease, write-off of furniture and equipment of approximately $100,000 and other exit costs of approximately $100,000. The termination benefits, contract termination costs and other exit costs will require the outlay of cash of approximately $600,000, while the write-off of furniture and equipment represents non-cash charges. The actions to close the office are expected to be substantially complete by June 30, 2012. These estimated restructuring charges were not recorded in the accompanying consolidated financial statements as of September 30, 2011.

 

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

Company Overview

We have been purchasing and collecting charged-off accounts receivable portfolios (“paper”) from consumer credit originators since the formation of our predecessor company in 1962. Charged-off receivables are the unpaid obligations of individuals to credit originators, such as credit card issuers including private label card issuers, consumer finance companies, telecommunications and utility providers. Since these receivables are delinquent or past due, we purchase them at a substantial discount. Since January 1, 2001, we purchased 1,270 consumer debt portfolios, with an original charged-off face value of $46.0 billion for an aggregate purchase price of $1.2 billion, or 2.71% of face value, net of buybacks. We purchase and collect charged-off consumer receivable portfolios for our own account as we believe this affords us the best opportunity to use long-term strategies to maximize our profits.

Macro-economic factors have impacted our results of operations both positively and negatively in recent years. Factors such as reduced availability of credit for consumers, a depressed housing market, elevated unemployment rates and other factors have had a negative impact on us by making it more difficult to collect from consumers on the paper we have acquired. We have observed recent positive trends in some of these indicators. For example, the nine-month average unemployment rate of 9.0% as of September 30, 2011 is lower than the average unemployment rate for all of 2010 and 2009. Conversely, while the supply of paper increased and prices dropped during 2009 and 2010, we have recently been observing increased competition for available paper and, depending on credit originator, the supply may be decreasing which contributes to higher pricing. These factors are most prevalent on newer stage paper. We expect these trends will continue to fluctuate based on further macro-economic shifts.

Collections for the first nine months of 2011 were significantly higher than the same period of 2010, primarily driven by higher levels of purchasing in 2011 and 2010 as compared to 2009. Collections are typically highest six to 18 months from purchase, therefore, these higher levels of purchasing have contributed to increased collections. Collections were also positively impacted by an increase in collector productivity and improved analytical tools used to create customized collection strategies. As a result, we grew collections for the year and in the current quarter even though we closed three collection offices in 2010 and have not been purchasing or collecting healthcare receivables since the third quarter of 2010.

Purchased receivable revenues for 2011 were also significantly higher than last year. This increase in revenue is primarily related to better collection strategy and analytics, higher average carrying balances of purchased receivables and increases in net impairment reversals, partially offset by a $0.4 million decrease in zero basis collections (collections on fully amortized portfolios) which are accounted for as revenue in the period collected. These fully amortized portfolios are generally at least five years old, and become more difficult to collect as they continue to age. Estimated future collections on most of our amortizing pools continued to improve throughout 2011, which lead us to increase yields on 11 portfolios during the first nine months of 2011 compared to five pools in the same period of 2010, and record net reversals of purchased receivables impairments of $3.7 million compared to $1.6 million during the same period last year.

Operating expenses during 2011 were favorable compared to the same period of 2010, primarily as a result of the actions we took in 2010 to restructure our operations. The following is a summary of the significant actions we took in 2010:

 

•

Exited the purchase and collection of healthcare receivables – During 2010, we exited the healthcare accounts receivable purchase and collection activities conducted by our former Premium Asset Recovery Corporation (“PARC”) subsidiary and sold substantially all of our healthcare receivables to a third party. Because of the sale, we will forego future collections on these accounts. The historical impact of these collections was as follows:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
($ in thousands)		2011				2010				2011				2010
Collections from non-healthcare receivables		$	87,437.9			$	78,799.5			$	267,894.4			$	248,918.7
Collections from healthcare receivables			—				61.4				—				3,371.6
Total collections		$	87,437.9			$	78,860.9			$	267,894.4			$	252,290.3

 

•

Closed collection offices – In connection with ceasing the purchase and collection of healthcare receivables, we closed our Deerfield Beach office and dissolved our PARC subsidiary. In addition, we closed our Chicago and Cleveland call center collection operations and shifted their inventory of receivables to other collection channels. These office closures significantly reduced our account representative headcount, our call center footprint, removed redundancy and simplified our infrastructure needs.

 

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•

Terminated third party agency relationship – We incurred a charge of $5.3 million resulting from the termination for performance of a relationship with a third party service provider. The charge related to a cash payment to reimburse the third party for court costs incurred on our behalf that they would otherwise have recovered through commissions in subsequent periods.

 

•

Acquisition — In July, we completed the purchase of substantially all of the assets of BSI eSolutions, LLC (“BSI”), a software vendor, including the collection software it developed, which we had been implementing to replace our legacy collection platform. We made the acquisition to protect our investment in the software acquired and to enhance our ability to successfully complete implementation. In addition, we believe this acquisition allows us to further enhance our collection platform in an efficient and cost effective manner.

The table below shows the statement of operations impact of the actions taken in the third quarter of 2010 to exit the healthcare accounts receivable purchase and collection activities conducted by PARC, dissolve the PARC subsidiary and close the Deerfield Beach collection office. These actions include a gain on sale of healthcare receivables, restructuring charges and an income tax benefit. The income tax benefit includes a worthless stock deduction for the investment in PARC and the tax recognition of a write-off of intercompany advances, partially offset by a valuation allowance related to PARC deferred tax assets. The gain on sale of receivables and restructuring charges are not considered non-recurring, infrequent or unusual items. However, we believe this information is useful to identify the impact of charges recorded in 2010.

The statement of operations impact of the PARC actions was, as follows:

 

		Three Months Ended September 30, 2010												Nine Months Ended September 30, 2010
($ in millions, except earnings per share)		Statement  of Operations				PARC Impact				Adjusted Statement  of Operations				Statement  of Operations				PARC Impact				Adjusted Statement  of Operations
Total revenue (1)		$	48.5			$	0.5			$	48.0			$	150.9			$	0.5			$	150.4
Operating expenses (2)			48.0				1.2				46.8				143.1				1.2				141.9
Income (loss) from operations			0.5				(0.7	)			1.2				7.8				(0.7	)			8.5
Other expense			(3.0	)			—				(3.0	)			(8.4	)			—				(8.4	)
(Loss) income before income taxes			(2.5	)			(0.7	)			(1.8	)			(0.6	)			(0.7	)			0.1
Income tax benefit			(6.7	)			(5.5	)			(1.2	)			(6.0	)			(5.5	)			(0.5	)
Net income (loss)		$	4.2			$	4.8			$	(0.6	)		$	5.4			$	4.8			$	0.6
Fully diluted earnings per share		$	0.14			$	0.16			$	(0.02	)		$	0.17			$	0.16			$	0.01

 

(1)	Impact includes an adjustment for the gain on sale of healthcare receivables.

(2)	Impact includes an adjustment for restructuring charges, including a non-cash impairment of trademark and trade names of $0.8 million.

In November 2011, we announced our plan to close our San Antonio, Texas collections office. We expect to incur approximately $0.7 million in restructuring charges related to this action. Restructuring charges include employee termination costs of approximately $0.1 million, contract termination costs of approximately $0.4 million for the remaining lease payments, net of potential sub-lease, write-off of furniture and equipment of approximately $0.1 million and other exit costs of approximately $0.1 million. The termination benefits, contract termination costs and other exit costs will require the outlay of cash of approximately $0.6 million. The charges related to these actions will be recognized through the second quarter of 2012.

The closing of this office is expected to favorably impact our financial results by approximately $2.5 million annually.

 

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Forward-Looking Statements

This report contains forward-looking statements that involve risks and uncertainties and that are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995. These statements include, without limitation, statements about future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as “may”, “will”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate”, “potential” or “continue”, the negative of these terms or other comparable terminology. These statements involve a number of risks and uncertainties. Actual events or results may differ materially from any forward-looking statement as a result of various factors, including those we discuss in our annual report on Form 10-K for the year ended December 31, 2010 in the section titled “Risk Factors” and elsewhere in this report.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations. Factors that could affect our results and cause them to materially differ from those contained in the forward-looking statements include the following:

 

•

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

 

•

failure to comply with government regulation, including our ability to successfully conclude the on-going FTC matter;

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

•

instability in the financial markets and continued economic weakness limiting our ability to access capital and to acquire and collect on charged-off receivable portfolios;

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

•

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

 

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•

our ability to acquire and to collect on charged-off receivable portfolios in industries in which we have little or no experience;

 

•

any significant and unanticipated changes in circumstances leading to goodwill impairment could adversely impact earnings and reduce our net worth; and

 

•

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

 

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Results of Operations

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

 

		Percent of Total Revenues																Percent of Cash Collections
		Three Months Ended September 30,								Nine Months Ended September 30,								Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010				2011				2010				2011				2010
Revenues
Purchased receivable revenues, net			99.4	%			97.6	%			99.4	%			98.7	%			64.4	%			60.0	%			60.0	%			59.1	%
Gain on sale of purchased receivables			0.0				1.1				0.0				0.6				0.0				0.7				0.0				0.3
Other revenues, net			0.6				1.3				0.6				0.7				0.4				0.8				0.4				0.4
Total revenues			100.0				100.0				100.0				100.0				64.8				61.5				60.4				59.8
Expenses
Salaries and benefits			29.9				38.1				32.0				37.5				19.4				23.4				19.3				22.4
Collections expense			46.1				48.0				45.7				46.8				29.8				29.5				27.5				28.0
Occupancy			2.6				3.5				2.7				3.4				1.7				2.2				1.6				2.0
Administrative			5.6				4.4				4.4				4.0				3.6				2.7				2.7				2.4
Restructuring charges			0.0				2.6				0.0				0.8				0.0				1.6				0.0				0.5
Depreciation and amortization			1.7				2.4				1.8				2.3				1.1				1.5				1.1				1.4
(Gain) loss on disposal of equipment and other assets			(0.2	)			0.0				(0.1	)			0.0				(0.1	)			0.0				0.0				0.0
Total operating expenses			85.7				99.0				86.5				94.8				55.5				60.9				52.2				56.7
Income from operations			14.3				1.0				13.5				5.2				9.3				0.6				8.2				3.1
Other income (expense)
Interest expense			(4.6	)			(6.2	)			(4.9	)			(5.6	)			(3.0	)			(3.8	)			(3.0	)			(3.4	)
Interest income			0.0				0.0				0.0				0.0				0.0				0.0				0.0				0.0
Other			0.0				0.0				0.0				0.0				0.0				0.0				0.0				0.0
Income (loss) before income taxes			9.7				(5.2	)			8.6				(0.4	)			6.3				(3.2	)			5.2				(0.3	)
Income tax expense (benefit)			4.3				(14.0	)			3.8				(4.0	)			2.8				(8.6	)			2.3				(2.4	)
Net income			5.4	%			8.8	%			4.8	%			3.6	%			3.5	%			5.4	%			2.9	%			2.1	%

Three Months Ended September 30, 2011 Compared To Three Months Ended September 30, 2010

Revenue

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

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

 

		Three Months Ended September 30,																Percentage of Cash  Collections Three Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Cash collections		$	87.4			$	78.9			$	8.5				10.9	%			100.0	%			100.0	%
Purchased receivable amortization			(31.1	)			(31.6	)			0.5				1.3				(35.6	)			(40.0	)
Purchased receivable revenues, net		$	56.3			$	47.3			$	9.0				19.0	%			64.4	%			60.0	%

The 10.9% increase in cash collections during the third quarter was a result of a combination of higher levels of recent purchasing, improved use of analytical tools and continued improvement in the utilization of our proprietary collection platform, which provided efficiencies that helped improve collector productivity, particularly in our legal channel. We invested 12.4% more in purchased receivables for all of 2010 than we did in the same period of 2009 and 22.7% more through the first six months of 2011 compared to the same period of 2010. Generally, collections are strongest on portfolios six to 18 months after purchase, therefore, these increases have had a positive impact on current collections. Cash collections included collections from fully amortized portfolios of $12.6 million and $10.6 million for the third quarter of 2011 and 2010, respectively, of which 100% was reported as revenue. The increase in these collections was a result of shifts in work strategy and discount offers on older accounts.

 

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The amortization rate of 35.6% for the three months ended September 30, 2011 was 440 basis points lower than the amortization rate of 40.0% for the same period of 2010. The decline in the current quarter was a result of higher average yields, higher net impairment reversals and higher zero basis collections. During the quarter, we increased yields on six portfolios, from the 2006 through 2009 vintages, as a result of improvements in future expected collections. We have also increased yields on multiple portfolios since the third quarter of last year, which results in a higher percentage of cash collections being applied to purchased receivable revenue and less to amortization. We recognized $2.7 million of impairment reversals in the third quarter of 2011 compared to net impairment reversals of $0.7 million in the third quarter of 2010. These impairment reversals were also a result of increased expectations for future collections on certain portfolios from the 2005 through 2007 vintages. Zero basis collections, or fully amortized collections, were $2.1 million higher this quarter than in the same period of 2010 and increased as a percent of total collections to 14.4% from 13.4%. Higher zero basis collections reduce the amortization rate since they are recorded as revenue in the period collected. Refer to “Supplemental Performance Data” on Page 33 for a summary of purchased receivable revenues and amortization rates by year of purchase (“vintage”) and an analysis of the components of collections and amortization on Page 34.

Revenues on portfolios purchased from our top three sellers were $22.3 million and $20.0 million during the quarter ended September 30, 2011 and 2010, respectively. Two of the three sellers were the same in both three-month periods.

Investments in Purchased Receivables

We generate revenue from our investment in portfolios of charged-off consumer accounts receivable. Ongoing investments in purchased receivables are critical to continued generation of cash collections and related revenues. From period to period, we may buy charged-off receivables of varying ages, types and demographics from an often-changing mix of sellers. As a result, the cost of our purchases, as a percent of face value, may fluctuate from one period to the next. In addition, the amount of paper we purchase in a period may be limited by market factors beyond our control, most importantly, the price, volume and mix of paper offered for sale in a period. Total purchases consisted of the following:

 

		Three Months Ended September 30,
($ in millions, net of buybacks)		2011				2010				Change				Percentage Change
Acquisitions of purchased receivables, at cost		$	38.5			$	41.1			$	(2.6	)			(6.5	)%
Acquisitions of purchased receivables, at face value		$	1,321.5			$	1,172.1			$	149.4				12.7	%
Percentage of face value			2.91	%			3.51	%

Our investment in purchased receivables, measured at cost, decreased in the third quarter of 2011 as compared to the same period of 2010, as a result of lower availability of paper at attractive pricing. However, we acquired more paper as measured by face value because of a lower average cost of these purchases. The lower average cost was a result of purchasing a higher percentage of older paper versus more recently charged-off receivables. For instance, purchases of older tertiary paper in the third quarter of 2011 represented over half of total purchases, whereas, purchases of newer secondary paper in the third quarter of 2010 represented over half of total purchases. As a result of fluctuations in the mix of purchases of receivables, the cost of our purchases, as a percent of face value, fluctuate from one period to the next and are not always indicative of our estimates of total return.

Investments under Forward Flow Contracts

Forward flow contracts commit a debt seller to sell a steady flow of charged-off receivables to us, and commit us to purchase receivables for a fixed percentage of the face value. Forward flow contracts may be attractive to us because they provide operational advantages from the consistent amount and type of accounts acquired.

 

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Forward flow purchases consisted of the following:

 

		Three Months Ended September 30,
($ in millions, net of buybacks)		2011				2010				Change				Percentage Change
Forward flow purchases, at cost		$	13.8			$	17.0			$	(3.2	)			(18.7	)%
Forward flow purchases, at face value		$	349.2			$	317.8			$	31.4				9.9	%
Percentage of face value			3.96	%			5.35	%
Percentage of forward flow purchases, at cost of total purchasing			35.9	%			41.3	%
Percentage of forward flow purchases, at face value of total purchasing			26.4	%			27.1	%

Investments in forward flow contracts, measured at cost, were lower in the third quarter of 2011 than the same period of 2010, and represented a lower percentage of total purchases. The decrease in the average cost of these purchases was primarily a result of purchasing a higher percentage of older paper versus more recently charged off receivables. For instance, purchases of secondary and tertiary paper represented over half our forward flow purchases in the third quarter of 2011 compared to less than 10% in 2010. Purchases from forward flows in 2011 included 24 portfolios from 11 forward flow contracts. Purchases from forward flows in 2010 included 27 portfolios from nine forward flow contracts.

Operating Expenses

Operating expenses are traditionally measured in relation to revenues. However, we measure operating expenses in relation to cash collections. We believe this is appropriate because amortization rates, the difference between cash collections and revenues recognized, vary from period to period. Amortization rates vary due to seasonality of collections, impairments, impairment reversals and other factors and can distort the analysis of operating expenses when measured against revenues. Additionally, we believe the majority of our operating expenses are variable in relation to cash collections.

The following table summarizes the significant components of our operating expenses:

 

		Three Months Ended September 30,																Percentage of Cash  Collections Three Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Salaries and benefits		$	16.9			$	18.5			$	(1.6	)			(8.2	)%			19.4	%			23.4	%
Collections expense			26.1				23.3				2.8				12.1				29.8				29.5
Administrative			3.2				2.1				1.1				49.3				3.6				2.7
Restructuring charges			—				1.3				(1.3	)			(100.0	)			—				1.6
Occupancy and other			2.3				2.8				(0.5	)			(19.8	)			2.7				3.7
Total operating expenses		$	48.5			$	48.0			$	0.5				1.1	%			55.5	%			60.9	%

Salaries and Benefits. The following table summarizes the significant components of our salaries and benefits expense:

 

		Three Months Ended September 30,																Percentage of Cash  Collections Three Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Compensation—revenue generating		$	9.0			$	11.2			$	(2.2	)			(19.2	)%			10.3	%			14.2	%
Compensation—administrative			4.5				4.1				0.4				8.6				5.1				5.2
Benefits and other			3.4				3.2				0.2				8.9				4.0				4.0
Total salaries and benefits		$	16.9			$	18.5			$	(1.6	)			(8.2	)%			19.4	%			23.4	%

Compensation for our revenue generating departments was lower in 2011 due to lower average headcount for in-house account representatives, partially offset by increased variable compensation resulting from increased collector productivity. We significantly reduced headcount for our collection operations in the second half of 2010 in connection with the restructuring actions to close three collection offices and transfer the inventory of purchased receivables of those offices to other collection channels. During the third quarter of 2011, we had an average of 648 in-house account representatives, including supervisors, compared to 807 in the same period of 2010. Higher compensation for our administrative departments was related to the addition of new associates from the BSI acquisition in July 2010 and the expectation of higher performance based incentive compensation for management. Benefits and other were slightly higher in 2011, primarily as a result of higher expenses for our self-insured medical programs and the reinstatement of our 401(k) plan match, which were partially offset by a decline in the number of associates.

 

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Collections Expense. The following table summarizes the significant components of collections expense:

 

		Three Months Ended September 30,																Percentage of Cash  Collections Three Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Forwarding fees		$	11.8			$	10.6			$	1.2				11.2	%			13.5	%			13.5	%
Court and process server costs			8.6				6.6				2.0				31.2				9.9				8.3
Lettering campaign and telecommunications costs			3.7				3.6				0.1				2.0				4.2				4.6
Data provider costs			1.2				1.3				(0.1	)			(6.1	)			1.4				1.6
Other			0.8				1.2				(0.4	)			(36.7	)			0.8				1.5
Total collections expense		$	26.1			$	23.3			$	2.8				12.1	%			29.8	%			29.5	%

Forwarding fees include fees paid to third parties to collect on our behalf including our agency firm in India. These fees increased in the third quarter of 2011 compared to the same period in 2010 because of higher cash collections generated by third parties, primarily driven by continued increases in non-legal accounts allocated to our agencies. The amount of accounts we forward to agencies has increased in recent quarters in response to the reduction in internal collector headcount as part of the 2010 restructuring actions and other inventory and channel management strategies. Collections generated by third parties were $39.9 million and $29.7 million, or 45.6% and 37.7% of cash collections for the third quarter of 2011 and 2010, respectively. Rates paid to forwarding agencies vary based on the age and type of paper we outsource. We offset a portion of the increase related to agency volume by reducing negotiated rates with domestic agencies. Rates also vary based on the mix of work performed by our agency firm in India, which is generally at a lower rate than on collections we outsource domestically. For the third quarter of 2011, 5.9% of our collections were through this agency compared to 4.3% in 2010.

Court and process server costs increased in the third quarter of 2011 from the same period in 2010 as a result of higher legal activity during the period driven by higher purchasing. The legal collection process requires an up-front investment in court costs and other fees, which we expense as incurred. There generally is a considerable delay before we generate collections on the accounts in the legal process. This delay can cause a change in related expenses that is disproportionate to the change in legal collections.

As a result of our improved analytical capabilities and continuous review of operational strategies, we were able to more effectively utilize variable collection activities, such as lettering campaigns and use of data provider services. The increase in these expenses during the quarter relates to the timing of investments in purchased receivables. Generally, these costs are higher in the first six months after purchase of a portfolio as we begin collection activities. We were also able to favorably renegotiate the terms of certain telecommunications contracts, which partially offset the increase in volume related expenses.

Administrative. Administrative expense during the quarter increased to $3.2 million in 2011 from $2.1 in 2010. The increase was related to a charge during the quarter of $1.25 million to increase the accrual for estimated settlement of the FTC matter, partially offset by a reduction in outside consulting fees.

Restructuring Charges. Restructuring charges were $1.3 million in the third quarter of 2010, which were a result of exiting our healthcare receivable purchase and collection activities and closing the Deerfield Beach, Florida office.

Income Taxes. We recognized income tax expense of $2.4 million and income tax benefits of $6.8 million for the three months ended September 30, 2011 and 2010, respectively. The third quarter 2011 tax expense reflects an effective tax rate of 43.9% based on a forecasted annualized effective tax rate of 43.5%. For the third quarter of 2010, the effective tax rate was 269.5%, which was significantly higher than the U.S. federal statutory rate as a result of tax benefits recognized for dissolving our PARC subsidiary. The current year variance from the statutory rate is attributable to a permanent difference for the accrual to settle the FTC matter and state income taxes, which have increased in recent periods. The overall increase in income tax expense was also driven by the increase in pre-tax income, which was $5.5 million for 2011 compared to a pre-tax loss of $2.5 million for the same period of 2010.

 

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Nine Months Ended September 30, 2011 Compared To Nine Months Ended September 30, 2010

Revenue

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

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

 

		Nine Months Ended September 30,																Percentage of Cash  Collections Nine Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Cash collections		$	267.9			$	252.3			$	15.6				6.2	%			100.0	%			100.0	%
Purchased receivable amortization			(107.1	)			(103.3	)			(3.8	)			(3.8	)			(40.0	)			(40.9	)
Purchased receivable revenues, net		$	160.8			$	149.0			$	11.8				7.9	%			60.0	%			59.1	%

The 6.2% increase in cash collections during the first nine months of 2011 was a result of a combination of higher levels of recent purchasing, improved use of analytical tools and the continued improvement in the utilization of our proprietary collection platform, which provided efficiencies that helped improve collector productivity, particularly in our legal channel. We invested 12.4% more in purchased receivables for all of 2010 than we did in the same period of 2009 and 22.7% more through the first six months of 2011 compared to the same period of 2010. Generally, collections are strongest on portfolios six to 18 months after purchase, therefore, these increases are having a positive impact on current collections. Cash collections included collections from fully amortized portfolios of $38.9 million and $39.3 million for 2011 and 2010, respectively, of which 100% was reported as revenue.

The amortization rate of 40.0% for the nine months ended September 30, 2011 was 90 basis points lower than the amortization rate of 40.9% for the same period of 2010. The decline for the period was a result of higher net impairment reversals offset by slightly lower zero basis collections. During the year, we increased the assigned yields on 11 portfolios and recognized $3.7 million of net impairment reversals compared to $1.6 million of net impairment reversals last year. These yield increases and net impairment reversals were a result of increased expectations for future collections on certain portfolios from the 2005 through 2010 vintages. Zero basis, or fully amortized collections, declined as a percentage of total collections to 14.5% in 2011 from 15.6% in 2010. Lower zero basis collections increase the amortization rate since they are recorded as revenue in the period collected. Refer to “Supplemental Performance Data” on Page 33 for a summary of purchased receivable revenues and amortization rates by year of purchase (“vintage”) and an analysis of the components of collections and amortization on Page 34.

Revenues on portfolios purchased from our top three sellers were $64.5 million and $57.6 million during the nine months ended September 30, 2011 and 2010, respectively. The top three sellers were the same in both nine-month periods.

Investments in Purchased Receivables

We generate revenue from our investment in portfolios of charged-off consumer accounts receivable. Ongoing investments in purchased receivables are critical to continued generation of cash collections and related revenues. From period to period, we may buy charged-off receivables of varying ages, types and demographics from an often-changing mix of sellers. In addition, the amount of paper we purchase in a period may be limited by market factors beyond our control, most importantly, the price, volume and mix of paper offered for sale in a period. As a result, the cost of our purchases, as a percent of face value, may fluctuate from one period to the next.

 

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Total purchases consisted of the following:

 

		Nine Months Ended September 30,
($ in millions, net of buybacks)		2011				2010				Change				Percentage Change
Acquisitions of purchased receivables, at cost		$	134.3			$	119.2			$	15.1				12.7	%
Acquisitions of purchased receivables, at face value		$	4,150.2			$	3,485.8			$	664.4				19.1	%
Percentage of face value			3.24	%			3.42	%

Our investment in purchased receivables increased in 2011 compared to the prior year while the average cost of those purchases decreased. The decline in the average cost was a result of purchasing a higher percentage of older paper. For instance, purchases of fresh paper in 2011 represented less than 5% of total purchases compared to approximately 20% of total purchases in the same period in 2010. As a result of these fluctuations in the mix of purchases of receivables, the cost of our purchases, as a percent of face value, fluctuate from one period to the next and are not always indicative of our estimates of total return.

Investments under Forward Flow Contracts

Forward flow contracts commit a debt seller to sell a steady flow of charged-off receivables to us, and commit us to purchase receivables for a fixed percentage of the face value. Forward flow contracts may be attractive to us because they provide operational advantages from the consistent amount and type of accounts acquired. Forward flow purchases consisted of the following:

 

		Nine Months Ended September 30,
($ in millions, net of buybacks)		2011				2010				Change				Percentage Change
Forward flow purchases, at cost		$	48.4			$	47.4			$	1.0				2.0	%
Forward flow purchases, at face value		$	1,156.5			$	1,066.5			$	90.0				8.4	%
Percentage of face value			4.18	%			4.45	%
Percentage of forward flow purchases, at cost of total purchasing			36.0	%			39.8	%
Percentage of forward flow purchases, at face value of total purchasing			27.9	%			30.6	%

Investments in forward flow contracts were higher in 2011 than in the same period in 2010, but represented a smaller percentage of total purchases. The decrease in the average cost of these purchases was a result of purchasing a higher percentage of older paper. For instance, purchases of primary paper represented almost half of our forward flow purchases in 2011, whereas purchases of newer fresh paper represented almost half of our forward flow purchases in 2010. Purchases from forward flows in 2011 included 81 portfolios from 22 forward flow contracts. Purchases from forward flows in 2010 included 70 portfolios from 11 forward flow contracts.

Operating Expenses

Operating expenses are traditionally measured in relation to revenues. However, we measure operating expenses in relation to cash collections. We believe this is appropriate because amortization rates, the difference between cash collections and revenues recognized, vary from period to period. Amortization rates vary due to seasonality of collections, impairments, impairment reversals and other factors and can distort the analysis of operating expenses when measured against revenues. Additionally, we believe the majority of our operating expenses are variable in relation to cash collections.

 

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The following table summarizes the significant components of our operating expenses:

 

		Nine Months Ended September 30,																Percentage of Cash  Collections Nine Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Salaries and benefits		$	51.7			$	56.6			$	(4.9	)			(8.7	)%			19.3	%			22.4	%
Collections expense			73.8				70.5				3.3				4.7				27.5				28.0
Occupancy			4.3				5.2				(0.9	)			(16.8	)			1.6				2.0
Administrative			7.2				6.1				1.1				18.7				2.7				2.4
Restructuring charges			—				1.3				(1.3	)			(100.0	)			—				0.5
Other			2.9				3.4				(0.5	)			(13.9	)			1.1				1.4
Total operating expenses		$	139.9			$	143.1			$	(3.2	)			(2.2	)%			52.2	%			56.7	%

Salaries and Benefits. The following table summarizes the significant components of our salaries and benefits expense:

 

		Nine Months Ended September 30,																Percentage of Cash  Collections Nine Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Compensation—revenue generating		$	28.4			$	34.5			$	(6.1	)			(17.5	)%			10.6	%			13.6	%
Compensation—administrative			13.5				12.0				1.5				12.5				5.1				4.8
Benefits and other			9.8				10.1				(0.3	)			(3.9	)			3.6				4.0
Total salaries and benefits		$	51.7			$	56.6			$	(4.9	)			(8.7	)%			19.3	%			22.4	%

Compensation for our revenue generating departments was lower in 2011 due to lower average headcount for in-house account representatives, partially offset by increased variable compensation resulting from increased collector productivity. We significantly reduced headcount for our collection operations starting in the second half of 2010 in connection with the restructuring actions to close three collection offices and transfer the inventory of purchased receivables of those offices to other collection channels. During 2011 we had an average of 682 in-house account representatives, including supervisors, compared to 926 in the same period of 2010. Higher compensation for our administrative departments in 2011 was a result of the addition of new associates from the BSI acquisition in July 2010 and the expectation of higher performance based incentive compensation for management. Benefits and other were slightly lower in 2011, primarily as a result of a decline in the number of associates, offset in part by higher expenses for our self-insured medical programs and the reinstatement of our 401(k) plan match in the third quarter.

Collections Expense. The following table summarizes the significant components of collections expense:

 

		Nine Months Ended September 30,																Percentage of Cash  Collections Nine Months Ended September 30,
($ in millions)		2011				2010				Change				Percentage Change				2011				2010
Forwarding fees		$	33.8			$	30.7			$	3.1				10.1	%			12.6	%			12.2	%
Court and process server costs			21.9				19.4				2.5				13.0				8.2				7.7
Lettering campaign and telecommunications costs			11.3				12.0				(0.7	)			(5.7	)			4.2				4.8
Data provider costs			3.7				4.5				(0.8	)			(19.5	)			1.4				1.8
Other			3.1				3.9				(0.8	)			(19.7	)			1.1				1.5
Total collections expense		$	73.8			$	70.5			$	3.3				4.7	%			27.5	%			28.0	%

Forwarding fees include fees paid to third parties to collect on our behalf including our agency firm in India. These fees increased in 2011 compared to the same period in 2010 because of higher cash collections generated by third parties, primarily driven by continued increases in non-legal accounts allocated to our agencies. The amount of accounts we forward to agencies has increased in recent quarters in response to the reduction in internal collector headcount as part of the 2010 restructuring actions and other inventory and channel management strategies. Collections generated by third parties were $114.2 million and $87.9 million, or 42.6% and 34.9% of cash collections, for 2011 and 2010, respectively. Rates paid to forwarding agencies vary based on the age and type of paper we outsource. We offset a portion of the increase related to agency volume by reducing negotiated rates on collections by domestic agencies. Rates also vary based on the mix of work performed by our agency firm in India, which is generally at a lower rate than on collections we outsource domestically. During 2011, 5.7% of our collections were through this agency compared to 3.7% in 2010.

 

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Court and process server costs increased in 2011 from the same period in 2010 as a result of higher legal activity during the period driven by higher purchasing. The legal collection process requires an up-front investment in court costs and other fees, which we expense as incurred. There generally is a considerable delay before we generate collections on the accounts in the legal process. This delay can cause a change in related expenses that is disproportionate to the change in legal collections.

As a result of our improved analytical capabilities and continuous review of operational strategies, we were able to more effectively utilize variable collection activities, such as lettering campaigns, and use of data provider services, resulting in reductions in the related expenses. Generally, these costs are higher in the first six months after purchase of a portfolio as we begin collection activities. We were also able to favorably renegotiate the terms of certain telecommunications contracts, which helped reduce the volume related expenses.

Occupancy. Occupancy expense declined to $4.3 million in 2011 from $5.2 million in 2010 as a result of the restructuring actions to close three collection offices during the second half of 2010.

Administrative. Administrative expense increased to $7.2 million in 2011 from $6.1 in 2010. The increase was related to a charge during the third quarter of $1.25 million to increase the accrual for settlement of the FTC matter, partially offset by a reduction in outside consulting fees.

Restructuring Charges. Restructuring charges were $1.3 million for 2010 as a result of exiting our healthcare receivable purchase and collection activities and closing our Deerfield Beach, Florida office.

Income Taxes. We recognized income tax expense of $6.0 million and income tax benefits of $6.0 million for the nine months ended September 30, 2011 and 2010, respectively. The 2011 tax expense reflects a forecasted annualized effective tax rate of 43.5%. For 2010, the effective tax rate was 949.6%, which was significantly higher than the U.S. federal statutory rate as a result of tax benefits recognized for dissolving our PARC subsidiary. The current year variance from the statutory rate is attributable to a permanent difference for the accrual to settle the FTC matter and state income taxes, which have increased in recent periods. The overall increase in income tax expense was also driven by the increase in the pre-tax income, which was $13.8 million for 2011 compared to a pre-tax loss of $0.6 million for the same period of 2010.

 

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Supplemental Performance Data

The following tables and analysis show select data related to our purchased portfolios including purchase price, account volume and mix, historical collections, cumulative and estimated remaining collections, productivity and certain other data that we believe is important to understanding our business. Total estimated collections as a percentage of purchase price provides a view of how acquired portfolios, generally disclosed by vintage year, have performed as compared to initial purchase price. This percentage reflects how well we expect our paper to perform, regardless of the underlying mix. Also included is a summary of our purchased receivable revenues by year of purchase, which provides additional vintage detail of collections, net impairments or reversals and zero basis collections.

The primary factor in determining purchased receivable revenue is the IRR assigned to the carrying value of portfolios. When carrying balances go down or assigned IRRs are lower than historical levels, revenue will generally be lower. When carrying balances increase or assigned IRRs go up, revenue will generally be higher. Purchased receivables revenue also depends on the amount of impairments or impairment reversals recognized. When collections fall short of expectations or future expectations decline, impairments may be recognized in order to write-down a portfolio’s balance to reflect lower estimated total collections. When collections exceed expectations or the future forecast improves we may reverse previously recognized impairments or increase assigned IRRs when there are no previous impairments to reverse. Zero basis collections are collections on portfolios that no longer have a carrying balance and therefore do not generate revenue by applying an assigned IRR. Collections on these portfolios are recognized as purchased receivables revenue in the period collected.

Portfolio Performance

The following table summarizes our historical portfolio purchase price and cash collections on an annual vintage basis by year of purchase:

 

($ in thousands) Year of Purchase		Number  of Portfolios				Purchase Price (1)				Cash Collections				Estimated Remaining Collections  (2,3)				Total Estimated Collections				Total Estimated Collections as a Percentage of Purchase Price
2003			76			$	87,147			$	450,414			$	—			$	450,414				517	%
2004			106				86,536				277,982				946				278,928				322
2005			104				100,746				216,452				8,237				224,689				223
2006			154				142,230				323,745				30,213				353,958				249
2007			158				169,327				277,500				57,246				334,746				198
2008			164				153,518				225,806				87,906				313,712				204
2009			123				120,916				163,826				153,053				316,879				262
2010			122				135,966				93,957				198,472				292,429				215
2011(4)			107				134,262				23,784				274,416				298,200				222
Total			1,114			$	1,130,648			$	2,053,466			$	810,489			$	2,863,955				253	%

 

(1)	Purchase price refers to the cash paid to a seller to acquire a portfolio less buybacks.

(2)	Estimated remaining collections are based in part on historical cash collections. Refer to Forward-Looking Statements on page 22 and Critical Accounting Policies on page 45 for further information regarding these estimates.

(3)

Estimated remaining collections refers to the sum of all future projected cash collections on our owned portfolios using up to an 84 month collection forecast from the date of purchase. Collections are often received after a portfolio reaches the end of its expected 84 month amortization period; however, these collections are not included in the estimated remaining collections table. Estimated remaining collections for pools on the cost recovery method for revenue recognition purposes are equal to the carrying value. There are no estimated remaining collections for pools on the cost recovery method that are fully amortized.

(4)	Includes nine months of activity through September 30, 2011.

 

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The following table summarizes our quarterly portfolio purchasing since January 1, 2009:

 

($ in thousands) Quarter of Purchase		Number  of Portfolios				Purchase Price (1)				Face Value
Q1 2009			31			$	21,753			$	736,846
Q2 2009			22				19,628				716,008
Q3 2009			33				36,912				1,585,047
Q4 2009			37				42,623				1,378,195
Q1 2010			28				29,615				818,620
Q2 2010			41				48,424				1,495,045
Q3 2010			34				41,142				1,172,119
Q4 2010			19				16,785				297,232
Q1 2011			37				46,379				1,227,838
Q2 2011			39				49,403				1,600,822
Q3 2011			31				38,480				1,321,492
Total			352			$	391,144			$	12,349,264

 

(1)	Purchase price refers to the cash paid to a seller to acquire a portfolio less buybacks.

The following table summarizes the remaining unamortized balances of our purchased receivables portfolios by year of purchase:

 

($ in thousands) Year of Purchase		Unamortized Balance				Purchase Price (1)				Unamortized Balance as a Percentage of Purchase Price				Unamortized Balance as a Percentage of Total
2003		$	—			$	87,147				0.0	%			0.0	%
2004			349				86,536				0.4				0.1
2005			2,614				100,746				2.6				0.7
2006			10,336				142,230				7.3				3.0
2007			25,034				169,327				14.8				7.2
2008			35,455				153,518				23.1				10.2
2009			51,786				120,916				42.8				14.9
2010			93,594				135,966				68.8				26.9
2011(2)			128,919				134,262				96.0				37.0
Total		$	348,087			$	1,130,648				30.8	%			100.0	%

 

(1)	Purchase price refers to the cash paid to a seller to acquire a portfolio less buybacks.

(2)	Includes nine months of activity through September 30, 2011.

 

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The following table summarizes purchased receivable revenues and amortization rates by year of purchase:

 

		Three months ended September 30, 2011
Year of Purchase		Collections				Revenue				Amortization Rate (1)				Monthly Yield (2)				Net Impairments (Reversals)				Zero Basis Collections
2005 and prior		$	12,851,763			$	12,121,177				N/M				N/M			$	(1,228,100	)		$	10,282,392
2006			6,458,530				4,176,153				35.3	%			11.27	%			(1,155,000	)			634,018
2007			8,804,890				4,353,546				50.6				5.14				(350,000	)			250,263
2008			11,593,862				6,374,200				45.0				5.45				—				1,448,771
2009			16,156,896				9,550,306				40.9				5.67				—				11,734
2010			18,249,572				9,280,467				49.1				3.11				—				—
2011			13,322,377				10,438,718				21.6				3.26				—				—
Totals		$	87,437,890			$	56,294,567				35.6	%			5.42	%		$	(2,733,100	)		$	12,627,178

 

		Three months ended September 30, 2010
Year of Purchase		Collections				Revenue				Amortization Rate (1)				Monthly Yield (2)				Net Impairments (Reversals)				Zero Basis Collections
2004 and prior		$	11,434,838			$	10,052,273				N/M				N/M			$	120,942			$	8,794,343
2005			2,940,541				2,022,671				31.2	%			12.58	%			(514,400	)			645,031
2006			7,661,203				4,602,803				39.9				6.84				(260,000	)			800,988
2007			11,043,083				5,894,024				46.6				4.02				—				318,613
2008			14,650,321				6,553,089				55.3				3.30				—				16,415
2009			19,690,261				10,728,208				45.5				3.94				—				—
2010			11,440,679				7,470,209				34.7				2.77				—				—
Totals		$	78,860,926			$	47,323,277				40.0	%			4.79	%		$	(653,458	)		$	10,575,390

 

		Nine months ended September 30, 2011
Year of Purchase		Collections				Revenue				Amortization Rate (1)				Monthly Yield (2)				Net Impairments (Reversals)				Zero Basis Collections
2005 and prior		$	41,869,974			$	37,104,776				N/M				N/M			$	(3,367,100	)		$	31,083,506
2006			20,279,215				12,713,065				37.3	%			9.61	%			(2,705,800	)			2,109,765
2007			29,072,113				13,449,001				53.7				4.49				117,000				863,639
2008			37,871,244				19,602,641				48.2				4.84				—				4,812,507
2009			54,729,671				29,209,017				46.6				5.04				2,304,000				11,734
2010			60,288,455				30,236,967				49.8				3.06				—				—
2011			23,783,710				18,441,263				22.5				3.30				—				—
Totals		$	267,894,382			$	160,756,730				40.0	%			5.33	%		$	(3,651,900	)		$	38,881,151

 

		Nine months ended September 30, 2010
Year of Purchase		Collections				Revenue				Amortization Rate (1)				Monthly Yield (2)				Net Impairments (Reversals)				Zero Basis Collections
2004 and prior		$	41,640,745			$	35,665,226				N/M				N/M			$	258,711			$	30,279,570
2005			12,194,237				7,510,169				38.4	%			12.20	%			(1,668,200	)			2,548,443
2006			29,280,864				16,460,687				43.8				6.80				(209,000	)			3,455,446
2007			39,139,208				20,415,995				47.8				4.10				—				2,056,216
2008			49,656,047				22,895,100				53.9				3.37				—				228,077
2009			62,999,170				34,128,022				45.8				3.76				—				762,128
2010			17,380,058				11,961,498				31.2				2.77				—				—
Totals		$	252,290,329			$	149,036,697				40.9	%			5.16	%		$	(1,618,489	)		$	39,329,880

 

(1)	“N/M” indicates that the calculated percentage is not meaningful.

(2)	The monthly yield is the weighted-average yield determined by dividing purchased receivable revenues recognized in the period by the average of the beginning monthly carrying values of the purchased receivables for the period presented.

 

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Core Amortization

The table below shows components of revenue from purchased receivables, the amortization rate and the core amortization rate. We use the core amortization rate to monitor performance of pools with remaining balances, and to determine if impairments, impairment reversals, or yield increases should be recorded. Core amortization trends may identify over or under performance compared to forecasts for pools with remaining balances.

The following factors contributed to the change in amortization rates from the prior year:

 

•

total amortization remained relatively flat during the third quarter compared to the same period in 2010 while total amortization as a percentage of collections decreased. The decrease is primarily attributable to the increase in purchased receivable impairment reversals and higher collections from fully amortized pools. Total amortization was higher while the amortization rate declined for the first nine months of 2011 compared to the same period in 2010. The decline in the amortization rate was the result of higher net impairment reversals offset in part by slightly lower zero basis collections. Portfolio balances that amortize too slowly in relation to current or expected collections may lead to impairments. If portfolio balances amortize too quickly and we expect collections to continue to exceed expectations, previously recognized impairments may be reversed, or if there are no impairments to reverse, assigned yields may increase;

 

•

amortization of receivable balances increased in both the third quarter and first nine months of 2011 as compared to the same periods of 2010. The increases are a result of higher average balances of purchased receivables and higher collections on amortizing pools;

 

•

higher zero basis collections in the third quarter of 2011 compared to the same period in 2010, reduced the amortization rate because 100% of these collections are recorded as revenue and do not contribute towards portfolio amortization. The nine month period in 2011 had lower zero basis collections compared to the same period in 2010, which increased the amortization rate; and

 

•

net impairment reversals are recorded as a reduction to amortization, and decrease the amortization rate, while net impairments have the opposite effect. Higher net impairment reversals for the three and nine month periods of 2011 decreased total amortization and the amortization rate compared to the prior year periods.

 

($ in millions)		Three Months  Ended September 30,								Nine Months  Ended September 30,
		2011				2010				2011				2010
Cash collections:
Collections on amortizing pools		$	74.8			$	68.3			$	229.0			$	213.0
Zero basis collections			12.6				10.6				38.9				39.3
Total collections		$	87.4			$	78.9			$	267.9			$	252.3
Amortization:
Amortization of receivables balances		$	33.5			$	32.0			$	109.0			$	103.4
Reversals of impairments			(2.7	)			(0.9	)			(6.5	)			(2.2	)
Impairments			—				0.2				2.8				0.6
Cost recovery amortization			0.3				0.3				1.8				1.5
Total amortization		$	31.1			$	31.6			$	107.1			$	103.3
Purchased receivable revenues, net		$	56.3			$	47.3			$	160.8			$	149.0
Amortization rate			35.6	%			40.0	%			40.0	%			40.9	%
Core amortization rate (1)			41.6	%			46.2	%			46.8	%			48.5	%

 

(1)	The core amortization rate is calculated as total amortization divided by collections on non-fully amortized portfolios.

 

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Account Representative Tenure and Productivity

We measure in-house call center account representative tenure by two major categories, those with less than one year of experience and those with one or more years of experience. The following tables display the experience of our account representatives and off-shore account representatives:

In-House Account Representatives, including Supervisors, by Experience

 

		Three months ended September  30,								Nine months ended September  30,								Year ended December 31,
		2011				2010				2011				2010				2010				2009
One year or more (1)			348				502				383				535				516				587
Less than one year (2)			300				305				299				391				365				422
Total			648				807				682				926				881				1,009

 

(1)	Based on number of average in-house call center Full Time Equivalent (“FTE”) account representatives and supervisors with one or more years of service.

(2)	Based on number of average in-house call center FTE account representatives and supervisors with less than one year of service, including new associates in training.

Off-Shore Account Representatives (1)

 

		Three months ended September  30,								Nine months ended September  30,								Years ended December 31,
		2011				2010				2011				2010				2010				2009(2)
Number of account representatives			250				250				250				211				227				17

 

(1)	Based on number of average off-shore account representatives staffed by a third party agency measured on a per seat basis.

(2)	Includes activity beginning in November 2009 averaged over the 12-month period.

The following table displays our account representative productivity:

Overall Account Representative Collection Averages

 

		Three months ended September  30,								Nine months ended September  30,								Years ended December 31,
		2011				2010(1)				2011				2010(1)				2010				2009
Overall collection averages		$	42,135			$	41,217			$	134,237			$	121,933			$	164,206			$	156,391

 

(1)	Prior year amounts were adjusted to remove supervisors from the collection average which is consistent with the current presentation. Supervisors do not have collection goals; therefore, we believe this presentation better represents our collection averages.

In-house account representative average collections per FTE increased for the three and nine months ended September 30, 2011 by 2.2% and 10.1%, respectively, compared to the prior year periods. Account representative productivity improved as a result of a 12.4% increase in purchasing in 2010 as compared to 2009, coupled with a more effective training program, better utilization of our standardized collection methodology, targeted lettering and dialing strategies and improved analytical models and tools, including improved channel management strategies. Account representative productivity is generally lower in the third and fourth quarters compared to the first and second quarters as a result of the seasonality of our cash collections.

 

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Cash Collections

The following tables provide further detailed vintage collection analysis on an annual and a cumulative basis:

Historical Collections (1)

 

($ in thousands)   Year of		Purchase				Years Ended December 31,																																								Nine Months Ended September 30,
Purchase		Price (2)				2001				2002				2003				2004				2005				2006				2007				2008				2009				2010				2011
Pre-2001						$	53,438			$	47,874			$	39,973			$	32,262			$	26,349			$	19,898			$	14,564			$	10,283			$	7,200			$	5,167			$	3,647
2001		$	43,029				17,630				50,327				50,967				45,713				39,865				30,472				21,714				13,351				8,738				5,610				3,858
2002			72,255				—				22,339				70,813				72,024				67,649				55,373				39,839				24,529				15,957				11,367				7,379
2003			87,147				—				—				36,067				94,564				94,234				79,423				58,359				38,408				23,842				15,774				9,743
2004			86,536				—				—				—				23,365				68,354				62,673				48,093				32,276				21,082				13,731				8,408
2005			100,746				—				—				—				—				23,459				60,280				50,811				35,638				22,726				14,703				8,835
2006			142,230				—				—				—				—				—				32,751				101,529				79,953				53,239				35,994				20,279
2007			169,327				—				—				—				—				—				—				36,269				93,183				69,891				49,085				29,072
2008			153,518				—				—				—				—				—				—				—				41,957				83,430				62,548				37,871
2009			120,916				—				—				—				—				—				—				—				—				27,926				81,170				54,730
2010			135,966				—				—				—				—				—				—				—				—				—				33,669				60,288
2011			134,262				—				—				—				—				—				—				—				—				—				—				23,784
Total						$	71,068			$	120,540			$	197,820			$	267,928			$	319,910			$	340,870			$	371,178			$	369,578			$	334,031			$	328,818			$	267,894

Cumulative Collections (1)

 

($ in thousands)   Year of		Purchase				Total Through December 31,																																								Total Through September 30,
Purchase		Price (2)				2001				2002				2003				2004				2005				2006				2007				2008				2009				2010				2011
2001		$	43,029			$	17,630			$	67,957			$	118,924			$	164,637			$	204,502			$	234,974			$	256,688			$	270,039			$	278,777			$	284,387			$	288,245
2002			72,255				—				22,339				93,152				165,176				232,825				288,198				328,037				352,566				368,523				379,890				387,269
2003			87,147				—				—				36,067				130,631				224,865				304,288				362,647				401,055				424,897				440,671				450,414
2004			86,536				—				—				—				23,365				91,719				154,392				202,485				234,761				255,843				269,574				277,982
2005			100,746				—				—				—				—				23,459				83,739				134,550				170,188				192,914				207,617				216,452
2006			142,230				—				—				—				—				—				32,751				134,280				214,233				267,472				303,466				323,745
2007			169,327				—				—				—				—				—				—				36,269				129,452				199,343				248,428				277,500
2008			153,518				—				—				—				—				—				—				—				41,957				125,387				187,935				225,806
2009			120,916				—				—				—				—				—				—				—				—				27,926				109,096				163,826
2010			135,966				—				—				—				—				—				—				—				—				—				33,669				93,957
2011			134,262				—				—				—				—				—				—				—				—				—				—				23,784
Cumulative Collections as Percentage of Purchase Price (1)
Year of		Purchase Price (2)				Total Through December 31,																																								Total Through September 30,
Purchase						2001				2002				2003				2004				2005				2006				2007				2008				2009				2010				2011
2001		$	43,029				41	%			158	%			276	%			383	%			475	%			546	%			597	%			628	%			648	%			661	%			670	%
2002			72,255				—				31				129				229				322				399				454				488				510				526				536
2003			87,147				—				—				41				150				258				349				416				460				488				506				517
2004			86,536				—				—				—				27				106				178				234				271				296				312				321
2005			100,746				—				—				—				—				23				83				134				169				191				206				215
2006			142,230				—				—				—				—				—				23				94				151				188				213				228
2007			169,327				—				—				—				—				—				—				21				76				118				147				164
2008			153,518				—				—				—				—				—				—				—				27				82				122				147
2009			120,916				—				—				—				—				—				—				—				—				23				90				135
2010			135,966				—				—				—				—				—				—				—				—				—				25				69
2011			134,262				—				—				—				—				—				—				—				—				—				—				18

 

(1)	Does not include proceeds from sales of receivables.

(2)	Purchase price refers to the cash paid to a seller to acquire a portfolio less buybacks.

 

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Seasonality

The success of our business depends on our ability to collect on our purchased portfolios of charged-off consumer receivables. Collections tend to be seasonally higher in the first and second quarters of the year due to consumers’ receipt of tax refunds and other factors. Conversely, collections tend to be lower in the third and fourth quarters of the year due to consumers’ spending in connection with summer vacations, the holiday season and other factors. These fluctuations are also impacted by the timing and volume of purchases. However, revenue recognized is relatively level, excluding the impact of impairments or impairment reversals, due to the application of the provisions prescribed by the Interest Method of accounting. In addition, our operating results may be affected by the timing of purchases of charged-off consumer receivables due to the costs associated with initiating collection activities. Consequently, income and margins may fluctuate from quarter to quarter.

The following table illustrates our quarterly cash collections:

Cash Collections

 

Quarter		2011								2010								2009								2008								2007
		Amount				%(1)				Amount				%				Amount				%				Amount				%				Amount				%
First		$	91,284,934				N/M	%		$	89,215,330				27.1	%		$	94,116,937				28.2	%		$	100,264,281				27.1	%		$	95,853,350				25.8	%
Second			89,171,558				N/M				84,214,073				25.6				87,293,577				26.1				95,192,743				25.8				95,432,021				25.7
Third			87,437,890				N/M				78,860,926				24.0				77,832,357				23.3				90,775,528				24.6				90,748,442				24.5
Fourth			—				—				76,528,161				23.3				74,787,726				22.4				83,345,578				22.5				89,144,650				24.0
Total cash collections		$	267,894,382				100.0	%		$	328,818,490				100.0	%		$	334,030,597				100.0	%		$	369,578,130				100.0	%		$	371,178,463				100.0	%

 

(1)	“N/M” indicates that the calculated percentage for quarterly collections is not meaningful compared to prior years.

We segregate our collection operations into two primary channels, call center collections and legal collections. Our call center collections include our in-house call center operations and third party collection agencies, including an agency in India. Our legal collections include our in-house legal operations and call centers, bankruptcy and probate teams and our legal forwarding network. The following table illustrates cash collections and percentages by source:

 

		Three months ended September 30,																Nine months ended September 30,
		2011								2010								2011								2010
		Amount				%				Amount				%				Amount				%				Amount				%
Call center collections		$	48,177,986				55.1	%		$	43,715,130				55.4	%		$	148,241,162				55.3	%		$	139,670,154				55.4	%
Legal collections			39,259,904				44.9				35,145,796				44.6				119,653,220				44.7				112,620,175				44.6
Total cash collections		$	87,437,890				100.0	%		$	78,860,926				100.0	%		$	267,894,382				100.0	%		$	252,290,329				100.0	%

The average payment size of collections grew 11.6% to $172 during the third quarter of 2011 when compared to the same period in 2010. This increase reflects the net impact of an 8.9% and a 15.2% increase in the size of average call center collection payments and legal payments, respectively. The increase in call center payment size was a result of collections on paper with higher average balances coupled with more effective training programs, better utilization of our standardized collection methodology, targeted lettering and dialing strategies and improved analytical models and tools. The overall increase in the size of payments from the legal channel was influenced by improvements in our in-house dialing and lettering strategies as well as increases in our average garnishment payments.

 

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The following table categorizes our purchased receivables portfolios acquired since January 1, 2001 by major asset type:

 

($ and accounts in thousands) Asset Type		Face Value of Charged-off Receivables(1)				%				No. of Accounts				%
General Purpose Credit Cards		$	24,169,603				52.5	%			9,341				26.8	%
Private Label Credit Cards			7,112,875				15.5				8,725				25.0
Telecommunications/Utility/Gas			3,156,679				6.9				7,998				23.0
Installment Loans			2,466,518				5.4				413				1.2
Healthcare			2,465,023				5.3				4,101				11.8
Health Club			1,445,929				3.1				1,145				3.3
Auto Deficiency			1,040,021				2.3				183				0.5
Other (2)			4,132,736				9.0				2,925				8.4
Total		$	45,989,384				100.0	%			34,831				100.0	%

 

(1)

Face value of charged-off receivables represents the cumulative amount of purchases net of buybacks. The amounts in this table are not adjusted for payments received, settlements or additional accrued interest that occur after purchase. This table also excludes the purchase of a single portfolio in June 2002 with a face value of $1.2 billion at a cost of $1.2 million (or 0.1% of face value), consisting of approximately 3.8 million accounts, which would have been included in “Other”.

(2)	“Other” includes charged-off receivables of several debt types, including student loan, mobile home deficiency and retail mail order.

The age of a charged-off consumer receivables portfolio, the time since an account has been charged-off by the credit originator and the number of times a portfolio has been placed with third parties for collection purposes are important factors in determining the price at which we will offer to purchase a portfolio and the collection strategies we employ. Generally, there is an inverse relationship between the age of a portfolio and the price at which we will purchase it. This relationship is due to the fact that older receivables are typically more difficult to collect. The consumer debt collection industry places receivables into the fresh, primary, secondary or tertiary categories depending on the age and number of third parties that have previously attempted to collect on the receivables. We will purchase accounts at any point in the delinquency cycle. We deploy our capital within these delinquency stages based upon the relative values of the available debt portfolios.

The following table categorizes our purchased receivables portfolios acquired since January 1, 2001 by major account type:

 

($ and accounts in thousands) Delinquency Stage		Face Value of Charged-off Receivables(1)				%				No. of Accounts				%
Fresh		$	2,993,587				6.5	%			1,618				4.7	%
Primary			5,671,975				12.3				5,097				14.6
Secondary			12,178,323				26.5				9,302				26.7
Tertiary			25,145,499				54.7				18,814				54.0
Total		$	45,989,384				100.0	%			34,831				100.0	%

 

(1)

Face value of charged-off receivables represents the cumulative amount of purchases net of buybacks. The amounts in this table are not adjusted for payments received, settlements or additional accrued interest that occur after purchase. This table also excludes the purchase of a single portfolio in June 2002 with a face value of $1.2 billion at a cost of $1.2 million (or 0.1% of face value), consisting of approximately 3.8 million accounts, which would have been included in “Tertiary”.

 

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We also review the geographic distribution of accounts within a portfolio because collection laws differ from state to state and therefore may impact collectability. In addition, economic factors vary regionally and are factored into our purchasing analysis. The following table illustrates our purchased receivables portfolios acquired since January 1, 2001 based on geographic location of the debtor:

 

($ and accounts in thousands) Geographic Location		Face Value of Charged-off Receivables(1)				%				No. of Accounts				%
Texas		$	6,197,822				13.5	%			5,478				15.7	%
California			5,941,201				12.9				4,047				11.6
Florida			4,838,757				10.5				2,637				7.6
New York			2,801,437				6.1				1,536				4.4
Michigan			2,287,830				5.0				2,581				7.4
Ohio			1,926,298				4.2				2,302				6.6
Illinois			1,820,172				4.0				1,802				5.2
Pennsylvania			1,627,277				3.5				1,087				3.1
New Jersey			1,521,433				3.3				1,218				3.5
North Carolina			1,373,894				3.0				824				2.4
Georgia			1,307,019				2.8				958				2.7
Arizona			956,674				2.1				657				1.9
Other (2)			13,389,570				29.1				9,704				27.9
Total		$	45,989,384				100.0	%			34,831				100.0	%

 

(1)

Face value of charged-off receivables represents the cumulative amount of purchases net of buybacks. The amounts in this table are not adjusted for payments received, settlements or additional accrued interest that occur after purchase. This table also excludes the purchase of a single portfolio in June 2002 with a face value of $1.2 billion at a cost of $1.2 million (or 0.1% of face value), consisting of approximately 3.8 million accounts.

(2)	Each state included in “Other” represents less than 2.0% of the face value of total charged-off receivables.

Liquidity and Capital Resources

Historically, our primary sources of cash have been from operations and bank borrowings. We have traditionally used cash for acquisitions of purchased receivables, repayment of bank borrowings, purchasing property and equipment and working capital to support growth. We believe that cash generated from operations combined with borrowings currently available under our credit facilities, will be sufficient to fund our operations for the next twelve months, although no assurance can be given in this regard. If we need additional capital for investment in purchased receivables, working capital to grow our business or acquire other businesses, we may seek to sell additional equity or debt securities, increase the availability on, or replace, our existing credit facilities.

Borrowings

We maintain an amended credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, and a syndicate of lenders named therein, that originated on June 5, 2007 (the “Credit Agreement”). Under the terms of the Credit Agreement, we have a five-year $100.0 million revolving credit facility which expires in June 2012 (the “Revolving Credit Facility”), which may be limited by financial covenants, and a six-year $150.0 million term loan facility which expires in June 2013 (the “Term Loan Facility” and together with the Revolving Credit Facility, the “Credit Facilities”). The Credit Facilities bear interest at 200 to 250 basis points over the bank’s prime rate depending upon our liquidity, as defined in the Credit Agreement. Alternately, at our discretion, we may borrow by entering into one, two, three, six or twelve-month London Inter Bank Offer Rate (“LIBOR”) contracts at rates between 300 to 350 basis points over the respective LIBOR rates, depending on our liquidity. Our Revolving Credit Facility includes an accordion loan feature that allows us to request a $25.0 million increase as well as sublimits for $10.0 million of letters of credit and for $10.0 million of swingline loans. The Credit Agreement is secured by a first priority lien on substantially all of our assets. The Credit Agreement also contains certain covenants and restrictions that we must comply with, which as of September 30, 2011 were:

 

•

Leverage Ratio (as defined) cannot exceed (i) 1.5 to 1.0 at any time on or before December 30, 2011 or (ii) 1.25 to 1.0 at any time thereafter;

 

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•

Ratio of Consolidated Total Liabilities to Consolidated Tangible Net Worth (as defined) cannot exceed (i) 2.5 to 1.0 at any time on or before December 30, 2011, (ii) 2.25 to 1.0 at any time on or after December 31, 2011 and on or before March 30, 2012 (iii) 2.0 to 1.0 at any time thereafter; and

 

•

Consolidated Tangible Net Worth (as defined) must equal or exceed $85.0 million plus 50% of positive consolidated net income for three consecutive fiscal quarters ending December 31, 2007 and for each fiscal year ending thereafter, such amount to be added as of December 31, 2007 and as of the end of each such fiscal year thereafter.

The financial covenants may restrict our ability to borrow against the Revolving Credit Facility. At September 30, 2011, total available borrowings on our Revolving Credit Facility were $58.6 million, which were not limited by the financial covenants. However, borrowing levels in future periods may be restricted by our financial covenants. In addition, our borrowing capacity may be reduced under the terms of the financial covenants if we experience declines in cash collections or increases in operating expenses that are not offset by a reduction in outstanding borrowings.

The Credit Agreement contains a provision that requires us to repay Excess Cash Flow (as defined) to reduce the indebtedness outstanding under our Term Loan Facility. Excess cash flow may exist for a fiscal year if we generate cash from operations in excess of amounts reinvested in our business, primarily for purchasing receivables. The Excess Cash Flow repayment provisions are:

 

•

50% of the Excess Cash Flow for such fiscal year if the Leverage Ratio was greater than 1.0 to 1.0 as of the end of such fiscal year;

 

•

25% of the Excess Cash Flow for such fiscal year if the Leverage Ratio was less than or equal to 1.0 to 1.0 but greater than 0.875 to 1.0 as of the end of such fiscal year; or

 

•

0% if the Leverage Ratio is less than or equal to 0.875 to 1.0 as of the end of such fiscal year.

Based on the Excess Cash Flow provisions for fiscal 2009, we made a required prepayment of $9.0 million on the Term Loan Facility during the first quarter of 2010. There was no excess cash flow payment required in 2011 based on the results of operations for fiscal 2010. Payment of the Excess Cash Flow in 2010 did not reduce our total borrowing capacity under the Revolving Credit Facility.

Commitment fees on the unused portion of the Revolving Credit Facility are paid quarterly, in arrears, and are calculated as an amount equal to a margin of 0.50% on the average amount available on the Revolving Credit Facility.

The Credit Agreement requires us to effectively cap, collar or exchange interest rates on a notional amount of at least 25% of the outstanding principal amount of the Term Loan Facility. At September 30, 2011, we had an interest rate swap and an interest rate cap that hedge the required portion of the interest on the Term Loan Facility. Refer to Note 5 of the consolidated financial statements, “Derivative Financial Instruments and Risk Management” for additional information.

We had $173.6 million and $157.3 million of borrowings outstanding on our Credit Facilities at September 30, 2011 and December 31, 2010, respectively, of which $132.2 million and $133.4 million was outstanding on the Term Loan Facility and $41.4 million and $23.9 million was outstanding on the Revolving Credit Facility. The Term Loan Facility requires quarterly repayments totaling $1.5 million annually until expiration. The increase in total outstanding borrowings in 2011 was a result of the increased investments in purchased receivables portfolios and timing of payments for operating expenses.

In April 2011, we announced that we had engaged JPMorgan Securities to arrange funding of new senior secured credit facilities to replace our existing Credit Facilities. In May 2011, we decided to delay our pursuit of new credit facilities as we demonstrated continued improved operating performance. We expect to complete a refinancing transaction prior to the expiration of the Revolving Credit Facility in June 2012.

We were in compliance with all covenants of the Credit Agreement as of September 30, 2011.

 

 

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Cash Flows

The majority of our cash flow requirements are for purchases of receivables and payment of operating expenses. Historically, these items have been funded with internal cash flow and with borrowings against our Revolving Credit Facility. For the nine months ended September 30, 2011, we invested $133.9 million in purchased receivables, net of buybacks, which was $13.0 million higher than the same period of 2010. These purchases were primarily funded by higher collections and higher net borrowings on our revolving credit facility. Our cash balance increased from $5.6 million at December 31, 2010 to $7.8 million as of September 30, 2011. At September 30, 2011, we had the ability to increase the borrowings on our Revolving Credit Facility by $58.6 million.

Our operating activities provided cash of $11.7 million and $3.6 million for the nine months ended September 30, 2011 and 2010, respectively. Cash provided by operating activities for these periods was generated primarily from operating income earned through cash collections as adjusted for non-cash items and the timing of payments of income taxes, accounts payable and accrued liabilities. Cash provided by operations was negatively impacted in 2011 by the payment of a contract settlement fee accrued at December 31, 2010. We rely on cash generated from our operating activities and from the principal collected on our purchased receivables, included as a component of investing activities, to allow us to fund operations and re-invest in purchased receivables.

Investing activities used cash of $25.5 million and $17.4 million for the nine months ended September 30, 2011 and 2010, respectively. The change in investing cash flows was primarily the result of a $13.0 million increase in investment in purchased receivable portfolios during the first nine months of 2011 compared to the same period of 2010. This increase was offset in part by higher principal collected on purchased receivables, which is a function of higher cash collections. We believe that we have sufficient capacity in our Credit Facilities when combined with anticipated cash flows from operations to fund investment in purchased receivables at or above historical levels.

Financing activities provided cash of $15.9 million and $14.0 million for the nine months ended September 30, 2011 and 2010, respectively. The increase in cash provided by financing activities in 2011 was driven by a $1.5 million increase in net borrowings on our credit facilities for the first nine months of 2011 from the same period last year. Cash provided by financing activities will increase in future periods to the extent we use net borrowings to fund purchases of paper or operations.

Adjusted EBITDA

We define Adjusted Earnings Before Interest Taxes Depreciation and Amortization (“Adjusted EBITDA”) as net income plus (a) the provision for income taxes, (b) interest expense, net, (c) depreciation and amortization, (d) share-based compensation, (e) gain or loss on sale of assets, net, (f) non-cash restructuring charges and impairment of assets, (g) purchased receivables amortization, and (h) in accordance with our Credit Facilities, certain FTC related charges. Adjusted EBITDA is not a measure of liquidity calculated in accordance with accounting principles generally accepted in the United States of America (“U.S. GAAP”), and should not be considered an alternative to, or more meaningful than, net income prepared on a U.S. GAAP basis. Adjusted EBITDA does not purport to represent cash flow provided by, or used in, operating activities as defined by U.S. GAAP, which is presented in our statements of cash flows. In addition, Adjusted EBITDA is not necessarily comparable to similarly titled measures reported by other companies.

We believe Adjusted EBITDA is useful to an investor in evaluating our operating performance for the following reasons:

 

•

Adjusted EBITDA is widely used by investors to measure a company’s operating performance without regard to items such as interest income, taxes, depreciation and amortization including purchased receivables amortization, and share-based compensation, which can vary substantially from company to company depending upon accounting methods and the book value of assets, capital structure and the method by which assets were acquired; and

 

•

analysts and investors use Adjusted EBITDA as a supplemental measure to evaluate the overall operating performance of companies in our industry.

Our management uses Adjusted EBITDA:

 

•

for planning purposes, including in the preparation of our internal annual operating budget and periodic forecasts;

 

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•

in communications with the Board of Directors, stockholders, analysts and investors concerning our financial performance;

 

•

as a significant factor in determining bonuses under management’s annual incentive compensation program; and

 

•

as a measure of operating performance for the financial covenants in our Credit Agreement, because it provides information related to our ability to provide cash flows for investments in purchased receivables, capital expenditures, acquisitions and working capital requirements.

The following table reconciles net income, the most directly comparable U.S. GAAP measure, to Adjusted EBITDA:

 

		Three Months Ended September 30,								Nine Months Ended September 30,
		2011				2010				2011				2010
Net income		$	3,070,602			$	4,246,262			$	7,815,007			$	5,377,236
Adjustments:
Income tax expense (benefit)			2,405,567				(6,751,024	)			6,018,137				(6,010,134	)
Interest expense, net			2,631,635				2,997,331				7,931,995				8,513,020
Depreciation and amortization			944,118				1,168,685				2,994,633				3,477,396
Share-based compensation			289,581				274,056				1,073,241				972,500
Gain on sale of assets, net			(92,075	)			(480,291	)			(86,182	)			(799,596	)
Impairment of assets			—				812,400				—				812,400
Purchased receivables amortization			31,143,323				31,537,649				107,137,652				103,253,632
FTC related charges			1,354,633				84,452				1,597,560				303,589
Adjusted EBITDA		$	41,747,384			$	33,889,520			$	134,482,043			$	115,900,043

Collections and operating expenses, net of the adjustment items, are the primary drivers of Adjusted EBITDA. During the third quarter of 2011, Adjusted EBITDA was $7.9 million, or 23.2%, higher than the same period of 2010. This increase was a result of an increase in cash collections of $8.6 million offset by a decrease in operating expenses of $0.4 million related to the restructuring charges discussed above. Excluding those charges, Adjusted EBITDA for the third quarter would have been higher than 2010 by $7.5 million, or 21.8%. During the first nine months of 2011, Adjusted EBITDA was $18.6 million, or 16.0%, higher than in the same period of 2010. This increase was a result of an increase in cash collections of $15.6 million combined with a decrease in applicable operating expenses of $3.1 million. For 2010, applicable operating expenses included $0.4 million related to the restructuring actions discussed above. Excluding those charges, Adjusted EBITDA for the first nine months of 2011 would have been higher than 2010 by $18.2 million, or 15.6%.

Future Contractual Cash Obligations

The following table summarizes our future contractual cash obligations as of September 30, 2011:

 

		Years Ending December 31,
		2011				2012				2013				2014				2015				Thereafter
Operating lease obligations		$	1,101,177			$	4,241,368			$	4,242,985			$	4,261,212			$	3,857,759			$	1,555,114
Capital lease obligations			18,805				112,828				23,242				—				—				—
Purchase obligations			757,146				2,367,523				1,717,523				853,548				799,548				145,960
Forward flow obligations (1)			3,265,650				5,007,000				—				—				—				—
Revolving credit (2)			—				41,400,000				—				—				—				—
Term loan (3)			375,000				1,500,000				130,359,956				—				—				—
Contractual interest on derivative instruments			313,128				946,267				—				—				—				—
Total (4)		$	5,830,906			$	55,574,986			$	136,343,706			$	5,114,760			$	4,657,307			$	1,701,074

 

(1)	We have four forward flow contracts that have terms beyond September 30, 2011 with the last contract expiring in July 2012.

(2)	To the extent that a balance is outstanding on our Revolving Credit Facility, it would be due in June 2012 or earlier as defined in the Credit Agreement. Interest on our Revolving Credit Facility is not included within the amount outstanding as of September 30, 2011.

 

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(3)	To the extent that a balance is outstanding on our Term Loan Facility, it would be due in June 2013. The variable interest is not included within the amount outstanding as of September 30, 2011.

(4)	We have a liability of $1.1 million relating to uncertain tax positions, which has been excluded from the table above because the amount and fiscal year of the payment cannot be reliably estimated.

Off-Balance Sheet Arrangements

We currently do not have any off-balance sheet arrangements.

Critical Accounting Policies

Revenue Recognition

We generally account for our revenues from collections on purchased receivables by using the Interest Method in accordance with U.S. GAAP, which requires making reasonable estimates of the timing and amount of future cash collections. Application of the Interest Method requires the use of estimates, primarily estimated remaining collections, to calculate a projected IRR for each pool. These estimates are based on historical cash collections, anticipated work effort and payer dynamics. If future cash collections are materially different in amount or timing from the remaining collections estimate, earnings could be affected, either positively or negatively. The estimates of remaining collections are sensitive to the inputs used and the performance of each pool. Performance is dependent on macro-economic factors and the specific demographic makeup of the debtors in the pool. Higher collection amounts or cash collections that occur sooner than projected will have a favorable impact on impairments, impairment reversals or increases in yields and revenues. Lower collection amounts or cash collections that occur later than projected will have an unfavorable impact and may result in impairment of receivables balances. Impairments of purchased receivables put pressure on the financial covenants in our Credit Facilities.

We use the cost recovery method when collections on a particular portfolio cannot be reasonably predicted. The cost recovery method may be used for pools that previously had an IRR assigned. Under the cost recovery method, no revenue is recognized until we have fully collected the pool’s balance.

We adopted the Interest Method in January 2005 and apply it to purchased receivables acquired after December 31, 2004. The provisions of the Interest Method that relate to decreases in expected cash flows amend previously followed guidance for consistent treatment and apply prospectively to purchased receivables acquired before January 1, 2005. We purchase pools of homogenous accounts receivable and record each pool at its acquisition cost. Pools purchased after 2004 may be aggregated into one or more static pools within each quarter, based on common risk characteristics. Risk characteristics of purchased receivables are assumed to be similar since purchased receivables are usually in the late stages of the post charged-off collection cycle. We therefore aggregate most pools purchased within each quarter. Pools purchased before 2005 may not be aggregated with other pools. Each static pool, either aggregated or non-aggregated, retains its own identity and does not change over the remainder of its life. Each static pool is accounted for as a single unit for recognition of revenue, principal payments and impairments.

Each static pool of receivables is statistically modeled to determine its projected cash flows based on historical cash collections for pools with similar characteristics. An IRR is calculated for each static pool of receivables based on projected cash flows. The IRR is applied to the remaining balance of each static pool to determine the revenue recognized. Each static pool is analyzed at least quarterly to assess the actual performance compared to expected performance. This review includes an assessment of the actual results of cash collections, the work effort used and expected to be used in future periods, the components of the static pool including type of paper, the average age of purchased receivables, certain demographics and other factors that help us understand how a pool may perform in future periods. Generally, to the extent the differences in actual performance versus expected performance are favorable and the results of the review of pool demographics is also favorable, the IRR is adjusted prospectively to reflect the revised estimate of cash flows over the remaining life of the static pool. If the review of actual performance results in revised cash flow estimates that are less than the original estimates, and if the results of the review lead us to believe the decline in performance is not temporary, the IRR remains unchanged and an impairment is recognized. If cash flow estimates increase in periods subsequent to recording an impairment, reversal of the previously recognized impairment is made prior to any increases to the IRR.

These periodic reviews, and any adjustments or impairments, are discussed with our Audit Committee.

 

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Goodwill

We periodically review the carrying value of intangible assets not subject to amortization, including goodwill, to determine whether an impairment may exist. U.S. GAAP requires that goodwill and certain intangible assets not subject to amortization be assessed annually for impairment using fair value measurement techniques.

Goodwill impairment is determined using a two-step test. The first step of the goodwill impairment test is used to identify potential impairment by comparing the fair value of a reporting unit with its book value, including goodwill. If the fair value of the reporting unit exceeds its book value, goodwill is considered not impaired and the second step of the impairment test is unnecessary. If the book value of the reporting unit exceeds its fair value, the second step of the goodwill impairment test is performed to measure the amount of impairment loss, if any. The second step of the goodwill impairment test compares the implied fair value of the reporting unit’s goodwill with the book value. If the book value of the reporting unit’s goodwill exceeds the implied fair value of that goodwill, an impairment loss is recognized in an amount equal to that excess. The implied fair value of goodwill is determined in the same manner as the amount of goodwill recognized in a business combination. That is, the fair value of the reporting unit is allocated to all of the assets and liabilities of that unit as if the reporting unit had been acquired in a business combination and the fair value of the reporting unit was the purchase price paid to acquire the reporting unit.

At the time of the most recent annual goodwill impairment test, November 1, 2010, market capitalization was 31.1% higher than book value and goodwill was not considered impaired. However, because market capitalization was less than book value during certain extended periods throughout 2011, we performed an interim step one analysis to assess the fair value of our single reporting unit. The estimate of fair value of our goodwill reporting unit, the purchased receivables operating segment, is determined using various valuation techniques including market capitalization, which is a Level 1 input, and an analysis of discounted cash flows, which includes Level 3 inputs. We performed a discounted cash flow analysis which resulted in fair value in excess of book value by 3.1%, which indicated goodwill was not impaired. A discounted cash flow analysis requires various judgmental assumptions including assumptions about future cash collections, revenues, cash flows, growth rates, and discount rates which we base on our budget and long-term plans. Discount rate assumptions are based on an assessment of the risk inherent in the reporting unit, which we calculated to be 17.5%. A discount rate of 19.6% was used in the prior year for a similar discounted cash flow analysis. The decrease in the discount rate in the current period was a result of decreases in the risk free rate and the beta rate, offset in part by increases in risk premiums. A 25 basis point increase in the discount rate or a decrease in cash flow of approximately $600 thousand in each year of the analysis would have resulted in an excess of book value over fair value.

In order to corroborate the discounted cash flow results, we also prepared a market analysis to calculate the fair value of our reporting unit. This market analysis took into consideration the fair value of our assets and liabilities utilizing our own assessment, and publicly available industry information, on sale multiples. This analysis also resulted in fair value in excess of book value and in excess of the results of the discounted cash flow analysis, which provided additional step one support that indicated goodwill was not impaired. In addition, we believe that a reasonable potential buyer would offer a control premium for our business that would adequately cover the difference between our market valuation and book value. We performed a calculation of an implied control premium of our business, which supported the difference between the market valuation and book value. Based on the fair value calculations and the control premium reconciliation, we believe there was no impairment of Goodwill at September 30, 2011.

The assessment of fair value of goodwill will change in future periods based on a mix of the results of operations, changes in forecasted profitability and cash flows, assumptions used in our fair value models and other market factors that may change the risk inherent in the reporting unit, most importantly factors impacting our cost of equity and the regulatory environment. We will continue to monitor these factors and related changes, which may require us to prepare an interim analysis prior to the next required annual assessment. At September 30, 2011, the carrying value of goodwill was $14.3 million. If there is an impairment in future periods, it is likely all or portion of the carrying value of goodwill would be recorded as an impairment of assets in the consolidated statements of operations. This charge would be a non-cash event, and therefore as such, would not have a material impact on our business, operations or ability to borrow on our Credit Facilities. In addition, the non-cash charge would not impact the covenants in our Credit Facilities or other contractual commitments.

Income Taxes

We record a tax provision for the anticipated tax consequences of the results of operations. The provision for income taxes is computed using the asset and liability method, under which deferred tax assets and liabilities are recognized for the expected future tax consequences of temporary differences between the financial reporting and tax basis of assets and liabilities, and for operating losses and tax credit carry-forwards. Deferred tax assets and liabilities are measured using the enacted tax rates and laws that will be in effect when the differences are expected to be reversed.

We believe it is more likely than not that forecasted income, including income that may be generated as a result of certain tax planning strategies, together with the tax effects of the deferred tax liabilities, will be sufficient to recover deferred tax assets fully. In the event that all or part of the deferred tax assets are determined not to be realizable in the future, a valuation allowance would be established and charged to earnings in the period such determination is made. Similarly, if we subsequently realize deferred tax assets that were previously determined to be unrealizable, the respective valuation allowance would be reversed, resulting in a positive adjustment to earnings in the period such determination is made. In addition, the calculation of tax liabilities involves significant judgment in estimating the impact of uncertainties in

 

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the application of complex tax laws. Resolution of these uncertainties in a manner inconsistent with our expectations could have a material impact on our results of operations and financial position. We account for uncertain tax positions using a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return.

Recently Issued Accounting Pronouncements

Refer to Note 2, “Summary of Significant Accounting Policies” of the accompanying consolidated financial statements for further information.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk relates to the interest rate risk with our Credit Facilities. Accordingly, we may periodically enter into interest rate swap agreements for non-trading purposes to mitigate the interest rate exposure associated with our outstanding debt. The outstanding borrowings on our Credit Facilities were $173.6 million and $157.3 million as of September 30, 2011 and December 31, 2010, respectively. In September 2007, we entered into an amortizing interest rate swap agreement whereby, on a quarterly basis, we swap variable rates equal to three-month LIBOR for fixed rates on the notional amount of $125.0 million. Every year thereafter, on the anniversary of the swap agreement the notional amount decreases by $25.0 million. The outstanding unhedged borrowings on our Credit Facilities were $139.6 million as of September 30, 2011. During September 2011, the Company acquired an interest rate cap, expiring in November 2011, to mitigate the risk on the remaining amount of the principal required to be covered under the terms of the Credit Agreement. Interest rates on unhedged borrowings may be based on the prime rate or LIBOR, at our discretion. Assuming a 200 basis point increase in interest rates on the unhedged borrowings, interest expense would have increased approximately $1.7 million and $1.3 million for the nine months ended September 30, 2011 and 2010, respectively.

The swap was determined to be highly effective in hedging against fluctuations in variable interest rates associated with the underlying debt since we entered into the agreement. Interest rates have decreased since we entered into our swap agreement, reducing the fair value and resulting in a liability balance. Additional declines in interest rates will further reduce the fair value, while increasing interest rates will increase the fair value.

Item 4. Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective at the reasonable assurance level to cause material information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 to be recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms.

There have been no changes in our internal controls over financial reporting that occurred during the three months ended September 30, 2011 that have materially affected, or are reasonably likely to materially affect, our controls over financial reporting.

PART II—OTHER INFORMATION

Item 1. Legal Proceedings

In the ordinary course of business, we are involved in numerous legal proceedings. We regularly initiate collection lawsuits against consumers and are occasionally countersued by them in such actions. Also, consumers occasionally initiate litigation against us, in which they allege that we have violated a federal or state law in the process of collecting on their account. It is not unusual for us to be named in a class action lawsuit relating to these allegations, with these lawsuits routinely settling for immaterial amounts. We do not believe that these ordinary course matters, individually or in the aggregate, are material to our business or financial condition. However, there can be no assurance that a class action lawsuit would not, if decided against us, have a material adverse effect on our financial condition.

 

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As previously reported, the FTC commenced an investigation into our debt collection practices under the Fair Credit Reporting Act, the Fair Debt Collection Practices Act and the Federal Trade Commission Act. The Company and its counsel continue to seek to resolve this matter and we believe it is nearing a final resolution. Although no assurances can be given as to the timing or terms of a final resolution, we believe it would include a consent decree that will, among other things, require additional disclosures to consumers and a monetary penalty. We do not believe that the resolution of this matter will have a material adverse effect on our business.

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

Company’s Repurchases of Its Common Stock

The following table provides information about the Company’s common stock repurchases during the third quarter of 2011:

 

Month		Total Number of Shares Purchased				Average Price Paid per Share				Total Number of Shares  Purchased as Part of Publicly Announced Plans or Programs				Maximum Number of Shares that May Yet Be Purchased Under the Plans or Programs
July (1)			1,310			$	4.94				—				—
August (1)			10,759				4.50				—				—
September			—				—				—				—
Total			12,069			$	4.55				—				—

 

(1)	The shares were withheld for tax obligations in connection with the vesting of restricted share units. The shares were withheld at the fair market value on the vesting date of the restricted share units.

We did not sell any equity securities during the third quarter of 2011 that were not registered under the Securities Act.

Item 6. Exhibits

 

Exhibit Number		Description
31.1*		Rule 13a-14(a) Certification of Chief Executive Officer
31.2*		Rule 13a-14(a) Certification of Chief Financial Officer
32.1*		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
101.INS		XBRL Instance Document
101.SCH		XBRL Taxonomy Extension Schema Document
101.CAL		XBRL Taxonomy Extension Calculation Linkbase Document
101.LAB		XBRL Taxonomy Extension Label Linkbase Document
101.PRE		XBRL Taxonomy Extension Presentation Linkbase Document

 

*	Filed herewith

 

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SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on November 2, 2011.

 

				ASSET ACCEPTANCE CAPITAL CORP.
Date: November 2, 2011				By:		/s/ RION B. NEEDS
						Rion B. Needs
						President and Chief Executive Officer
						(Principal Executive Officer)

 

Date: November 2, 2011				By:		/s/ REID E. SIMPSON
						Reid E. Simpson
						Senior Vice President—Finance and
						Chief Financial Officer (Principal Financial and Accounting Officer)

 

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