Form 10-Q
Table of Contents

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 


FORM 10-Q

 


(Mark One)

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

For the quarterly period ended September 30, 2007

OR

 

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

For the transition period from              to             .

COMMISSION FILE NUMBER: 000-26489

 


ENCORE CAPITAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 


 

Delaware   48-1090909

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

 

8875 Aero Drive, Suite 200

San Diego, California

  92123
(Address of principal executive offices)   (Zip code)

(877) 445 - 4581

(Registrant’s telephone number, including area code)

(Not Applicable)

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

 


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

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, or a non-accelerated filer. See definition of “accelerated filer and large accelerated filer” in Rule 12b-2 of the Exchange Act. (Check one):

Large accelerated filer  ¨    Accelerated filer  x    Non-accelerated filer  ¨

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

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

 

Class

 

Outstanding at October 15, 2007

Common Stock, $0.01 par value   22,987,810 shares

 



Table of Contents

ENCORE CAPITAL GROUP, INC.

INDEX TO FORM 10-Q

 

     Page

PART I – FINANCIAL INFORMATION

  

Item 1 – Condensed Consolidated Financial Statements (Unaudited)

   3

Condensed Consolidated Statements of Financial Condition

   3

Condensed Consolidated Statements of Operations

   4

Condensed Consolidated Statement of Stockholders’ Equity

   5

Condensed Consolidated Statements of Cash Flows

   6

Notes to Unaudited Condensed Consolidated Financial Statements

   8

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

   27

Supplemental Performance Data

   39

Liquidity and Capital Resources

   47

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

   50

Item 4 – Controls and Procedures

   50

PART II – OTHER INFORMATION

   51

Item 1 – Legal Proceedings

   51

Item 1A – Risk Factors

   52

Item 6 – Exhibits

   55

SIGNATURES

   56

 

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Table of Contents

PART I. FINANCIAL INFORMATION

Item 1. Consolidated Financial Statements

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Financial Condition

(In Thousands, Except Par Value Amounts)

 

     September 30,
2007
(Unaudited)
    December 31,
2006 (A)

Assets

    

Cash and cash equivalents

   $ 4,478     $ 10,791

Restricted cash

     3,137       4,660

Accounts receivable, net

     4,915       2,599

Investment in receivable portfolios, net

     348,818       300,348

Property and equipment, net

     4,650       5,249

Prepaid income tax

     5,031       3,727

Purchased servicing asset

     314       1,132

Forward flow asset

     18,399       27,566

Other assets

     26,200       21,903

Goodwill

     13,735       13,735

Identifiable intangible assets, net

     2,825       3,628
              

Total assets

   $ 432,502     $ 395,338
              

Liabilities and stockholders’ equity

    

Liabilities:

    

Accounts payable and accrued liabilities

   $ 18,823     $ 23,744

Accrued profit sharing arrangement

     —         6,869

Deferred tax liabilities, net

     10,862       10,667

Deferred revenue

     3,034       2,156

Purchased servicing obligation

     187       634

Debt

     232,948       200,132

Other liabilities

     606       —  
              

Total liabilities

     266,460       244,202
              

Commitments and contingencies

    

Stockholders’ equity:

    

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

     —         —  

Common stock, $.01 par value, 50,000 shares authorized, 22,988 shares and 22,781 shares issued and outstanding as of September 30, 2007 and December 31, 2006, respectively

     230       228

Additional paid-in capital

     71,698       66,532

Accumulated earnings

     94,127       83,933

Accumulated other comprehensive (loss) income

     (13 )     443
              

Total stockholders’ equity

     166,042       151,136
              

Total liabilities and stockholders’ equity

   $ 432,502     $ 395,338
              

(A) Derived from the audited consolidated financial statements as of December 31, 2006.

See accompanying notes to unaudited condensed consolidated financial statements.

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Operations

(In Thousands, Except Per Share Amounts)

(Unaudited)

 

     Three Months ended
September 30,
    Nine Months Ended
September 30,
 
     2007     2006     2007     2006  

Revenues

        

Revenue from receivable portfolios, net

   $ 59,415     $ 57,247     $ 185,589     $ 174,425  

Servicing fees and other related revenue

     3,276       3,350       9,705       12,585  
                                

Total revenues

     62,691       60,597       195,294       187,010  
                                

Operating expenses

        

Salaries and employee benefits

     17,138       15,773       50,388       48,358  

Stock-based compensation expense

     1,281       1,490       3,286       4,335  

Cost of legal collections

     20,868       12,545       59,649       36,767  

Other operating expenses

     4,987       5,308       16,970       17,409  

Collection agency commissions

     2,478       4,533       8,639       14,178  

General and administrative expenses

     4,462       4,388       12,965       11,421  

Depreciation and amortization

     833       964       2,541       2,892  
                                

Total operating expenses

     52,047       45,001       154,438       135,360  
                                

Income before other (expense) income and income taxes

     10,644       15,596       40,856       51,650  
                                

Other (expense) income

        

Interest expense

     (3,648 )     (2,920 )     (9,904 )     (9,286 )

Contingent interest expense

     —         (3,824 )     (4,123 )     (12,746 )

Pay-off of future contingent interest

     —         —         (11,733 )     —    

Other income

     79       45       153       379  
                                

Total other expense

     (3,569 )     (6,699 )     (25,607 )     (21,653 )
                                

Income before income taxes

     7,075       8,897       15,249       29,997  

Provision for income taxes

     (1,717 )     (3,689 )     (5,055 )     (12,616 )
                                

Net income

   $ 5,358     $ 5,208     $ 10,194     $ 17,381  
                                

Basic – Earnings per share computation:

        

Net income available to common stockholders

   $ 5,358     $ 5,208     $ 10,194     $ 17,381  
                                

Weighted average shares outstanding

     22,922       22,778       22,837       22,745  
                                

Earnings per share – Basic

   $ 0.23     $ 0.23     $ 0.45     $ 0.76  
                                

Diluted – Earnings per share computation:

        

Net income available to common stockholders

   $ 5,358     $ 5,208     $ 10,194     $ 17,381  
                                

Weighted average shares outstanding

     22,922       22,778       22,837       22,745  

Incremental shares from assumed conversion of stock awards

     551       605       583       644  
                                

Diluted weighted average shares outstanding

     23,473       23,383       23,420       23,389  
                                

Earnings per share – Diluted

   $ 0.23     $ 0.22     $ 0.44     $ 0.74  
                                

See accompanying notes to unaudited condensed consolidated financial statements.

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statement of Stockholders’ Equity

(Unaudited, In Thousands)

 

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

Balance at December 31, 2006

   22,781    $ 228    $ 66,532    $ 83,933    $ 443     $ 151,136    

Net income

   —        —        —        10,194      —         10,194     $ 10,194  

Other comprehensive income:

                  

unrealized gain on non-qualified deferred compensation plan assets

   —        —        —        —        150       150       150  

unrealized loss on cash flow hedge

   —        —        —        —        (606 )     (606 )     (606 )

Exercise of stock options

   201      2      342      —        —         344       —    

Vesting of share based awards

   6      —        —        —        —         —         —    

Stock-based compensation

   —        —        3,286      —        —         3,286       —    

Tax benefit related to stock option exercises

   —        —        122      —        —         122       —    

Tax benefit from convertible note interest expense

   —        —        1,416      —        —         1,416       —    
                                                  

Balance at September 30, 2007

   22,988    $ 230    $ 71,698    $ 94,127    $ (13 )   $ 166,042     $ 9,738  
                                                  

See accompanying notes to unaudited condensed consolidated financial statements.

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited, In Thousands)

 

     Nine Months Ended
September 30,
 
     2007     2006  

Operating activities

    

Gross collections

   $ 269,782     $ 242,583  

Less:

    

Amounts collected on behalf of third parties

     (368 )     (546 )

Amounts applied to principal on receivable portfolios

     (81,267 )     (66,937 )

Servicing fees

     89       51  

Operating expenses

     (146,071 )     (121,420 )

Interest payments

     (10,193 )     (9,634 )

Contingent interest payments

     (22,724 )     (17,975 )

Other income

     153       379  

Decrease in restricted cash

     1,523       848  

Income taxes

     (7,398 )     (842 )

Excess tax benefits from stock-based payment arrangements

     (683 )     (754 )
                

Net cash provided by operating activities

     2,843       25,753  
                

Investing activities

    

Purchases of receivable portfolios, net of forward flow allocation

     (125,224 )     (73,237 )

Collections applied to principal of receivable portfolios

     81,267       66,937  

Proceeds from put-backs and recalls of receivable portfolios

     2,097       2,691  

Purchases of property and equipment

     (1,139 )     (1,447 )
                

Net cash used in by investing activities

     (42,999 )     (5,056 )
                

Financing activities

    

Proceeds from notes payable and other borrowings

     53,000       23,500  

Repayment of notes payable and other borrowings

     (20,000 )     (35,641 )

Proceeds from exercise of common stock options

     344       146  

Excess tax benefits from stock-based payment arrangements

     683       754  

Repayment of capital lease obligations

     (184 )     (179 )
                

Net cash provided by (used in) financing activities

     33,843       (11,420 )
                

Net (decrease) increase in cash

     (6,313 )     9,277  

Cash and cash equivalents, beginning of period

     10,791       7,026  
                

Cash and cash equivalents, end of period

   $ 4,478     $ 16,303  
                

See accompanying notes to unaudited condensed consolidated financial statements.

 

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ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Cash Flows (cont.)

Reconciliation of Net Income to Net Cash Provided by Operating Activities

(Unaudited, In Thousands)

 

     Nine Months Ended
September 30,
 
     2007     2006  

Net income

   $ 10,194     $ 17,381  

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

    

Depreciation and amortization

     2,541       2,892  

Amortization of loan costs

     912       1,039  

Stock-based compensation expense

     3,286       4,335  

Tax benefit from convertible note interest expense

     1,416       1,351  

Tax benefit from stock option exercises

     122       863  

Deferred income tax expense

     195       4,266  

Excess tax benefits from stock-based payment arrangements

     (683 )     (754 )

Impairment on receivable portfolios, net

     2,558       668  

Changes in operating assets and liabilities

    

Decrease in restricted cash

     1,523       848  

Increase in other assets

     (6,708 )     (1,137 )

(Increase) decrease in prepaid income tax

     (1,304 )     4,915  

Decrease in accrued profit sharing arrangement

     (6,869 )     (5,230 )

Increase (decrease) in deferred revenue and purchased service obligation

     431       (2,325 )

(Decrease) in accounts payable and accrued liabilities

     (5,377 )     (3,359 )

Increase in other liabilities

     606       —    
                

Net cash provided by operating activities

   $ 2,843     $ 25,753  
                

See accompanying notes to unaudited condensed consolidated financial statements.

 

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ENCORE CAPITAL GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Encore Capital Group, Inc. (“Encore”), through its subsidiaries (the “Company”), is a systems-driven purchaser and manager of charged-off consumer receivable portfolios and, through its wholly owned subsidiary Ascension Capital Group, Inc. (“Ascension”), a provider of bankruptcy services to the finance industry. The Company acquires its receivable portfolios at deep discounts from their face values using its proprietary valuation process that is based on the consumer attributes of the underlying accounts. Based upon the Company’s ongoing analysis of these accounts, it employs a dynamic mix of collection strategies to maximize its return on investment. The receivable portfolios the Company purchases consist primarily of unsecured, charged-off domestic consumer credit card, auto deficiency, and telecom purchased from national financial institutions, major retail credit corporations, telecom companies, and resellers of such portfolios. Acquisitions of receivable portfolios are financed by operations and by borrowings from third parties. See Note 6 for further discussion of the Company’s debt.

Note 2: Summary of Significant Accounting Policies

Financial Statement Preparation

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

In the opinion of management, the unaudited financial information for the interim periods presented reflects all adjustments, consisting of only normal and recurring adjustments, necessary for a fair presentation of the Company’s consolidated results of operations, financial position and cash flows. These condensed consolidated financial statements should be read in conjunction with the consolidated financial statements included in the Company’s Annual Report on Form 10-K for the fiscal year ended December 31, 2006. Operating results for interim periods are not necessarily indicative of operating results for an entire fiscal year.

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

Principles of Consolidation

The Company’s condensed consolidated financial statements include the assets, liabilities and operating results of its majority-owned subsidiaries. The ownership and operating results relating to the minority holders of consolidated subsidiaries is reflected as minority interest and is not significant. All significant intercompany accounts and transactions have been eliminated. The Company does not have any investments in entities it believes are variable interest entities for which the Company is the primary beneficiary.

 

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Effects of New Accounting Pronouncement

On July 13, 2006, the Financial Accounting Standards Board issued Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”), which is effective for fiscal years beginning after December 15, 2006, and adopted by the Company effective January 1, 2007. FIN 48 establishes recognition and measurement thresholds that must be met before a tax benefit can be recognized in the financial statements. See Note 7 to the condensed consolidated financial statements for further discussion of the impact of FIN 48 on the Company’s financial statements.

New Accounting Pronouncements

In February 2007, the Financial Accounting Standards Board issued Statement No. 159, “Fair Value Option for Financial Assets and Liabilities – including an amendment of FASB Statement No. 115” (“SFAS No. 159”), which is effective for financial statements issued for fiscal years beginning after November 15, 2007. SFAS No. 159 permits entities to choose to measure many financial instruments and certain other items at fair value. The objective is to improve financial reporting by providing entities with the opportunity to mitigate volatility in reported earnings caused by measuring related assets and liabilities differently without having to apply complex hedge accounting provisions. The Company is currently analyzing the effects of the new standard and its potential impact on its financial statements, if any.

In September 2006, the Financial Accounting Standards Board issued Statement No. 157, “Fair Value Measurements” (“SFAS No. 157”), which is effective for financial statements issued for fiscal years beginning after November 15, 2007. SFAS No. 157 defines fair value, establishes a framework for measuring fair value, and expands disclosures about fair value measurements. The Company is currently analyzing the effects of the new standard and its potential impact on its financial statements, if any.

Note 3: Stock-Based Compensation

On January 1, 2006, the Company implemented Statement of Financial Accounting Standard No. 123R, “Share-Based Payment” (“SFAS No. 123R”), which is a revision of Statement of Financial Accounting Standard No. 123, “Accounting For Stock-Based Compensation” (“SFAS No. 123”), using the modified prospective approach. The adoption of SFAS No. 123R requires all stock-based compensation to be recognized in the consolidated financial statements at fair value.

On March 30, 2005, the Board of Directors of the Company adopted a new 2005 Stock Incentive Plan (“2005 Plan”) for Board members, employees, officers, and executives of, and consultants and advisors to the Company. The 2005 Plan provides for the granting of incentive stock options, nonqualified stock options, stock appreciation rights, restricted stock, performance shares, and performance-based awards to eligible individuals. Upon adoption, an aggregate of 1,500,000 shares of the Company’s common stock were available for awards under the 2005 Plan, plus ungranted shares of stock that were available for future awards under the 1999 Equity Participation Plan (“1999 Plan”). In addition, shares subject to options granted under either the 1999 Plan or the 2005 Plan that terminate or expire without being exercised are available for grant under the 2005 Plan. The benefits provided under these plans are share-based compensation subject to the provisions of SFAS No. 123R.

 

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In accordance with SFAS No. 123R, compensation expense is recognized only for those shares expected to vest, with estimated forfeitures based on the Company’s historical experience and future expectations. For the nine months ended September 30, 2007, $3.3 million was recognized as stock-based compensation expense.

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

Stock Options

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

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

The expected life of options granted, expected volatility, and forfeitures are based on data specific to each employee class under the assumptions that different classes of employees can act differently because of title, rank, number of options granted, and other like characteristics. For the purposes of this analysis, these classes include: (i) officers (as defined under Section 16 of the Securities Exchange Act of 1934) and (ii) all others receiving options. The assumptions below are used by the Company to determine the fair value of stock-based awards.

Expected Life. The expected life of options granted represents the period of time for which the options are expected to be outstanding. The Company retained an independent third party to perform valuation procedures in order to determine the expected life of the options, which took into account the percentage of option exercises, the percentage of options that expire unexercised, and the percentage of options outstanding. The Company used this valuation to determine the expected life of the options, which are 5.2 years for officers and 4.7 years for all others.

Expected Volatility. The expected volatility is based on the historical volatility of the Company’s common stock over the estimated expected life of the options, which is 5.2 years for officers and 4.7 years for all others.

Risk-Free Interest Rate. The risk-free interest rate is derived from the U.S. Treasury yield curve in effect at the date of grant.

 

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Dividends. The Company does not currently anticipate paying any cash dividends on its common stock. Consequently, the Company uses an expected dividend yield of zero in the Black-Scholes option valuation model.

Forfeitures. SFAS No. 123R requires the Company to estimate forfeitures at the time of grant and revise those estimates in subsequent periods if actual forfeitures differ from those estimates. To determine an expected forfeiture rate, the Company examined the historical employee turnover rate over the prior five years as a proxy for forfeitures. Based on the internal analysis, the expected forfeiture rates were determined to be 10.6% of options granted to officers and 11.5% of options granted to all others.

The fair value of options granted is estimated at the date of grant using a Black-Scholes option-pricing model with the following weighted-average assumptions:

 

    

Nine Months

Ended
September 30,

2007

   

Nine Months

Ended
September 30,
2006

 

Weighted average fair value of options granted

   $ 6.82     $ 5.33  

Risk free interest rate

     4.49 %     4.83 %

Dividend yield

     0.0 %     0.0 %

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

     70.69 %     44.38 %

Weighted-average expected life of options

     5 Years       3 Years  

Unrecognized compensation cost related to stock options as of September 30, 2007 was $5.1 million. The weighted-average remaining expense period, based on the unamortized value of these outstanding stock options was approximately 2.5 years. The fair value of options vested for the nine months ended September 30, 2007 and 2006 was $3.4 million and $4.3 million, respectively.

A summary of the Company’s stock option activity and related information is as follows for the nine months ended September 30, 2007:

 

     Number of
Shares
    Option Price Per
Share
   Weighted-Average
Exercise Price
  

Aggregate
Intrinsic
Value

(in thousands)

Outstanding at December 31, 2006

   2,535,018     $ 0.35 - $20.30    $ 10.25   

Granted

   330,000       10.92 - 11.30      11.03   

Cancelled/forfeited

   (503,451 )     16.17 - 20.30      17.93   

Exercised

   (200,499 )     0.35 - 12.01      1.72   
                      

Outstanding at September 30, 2007

   2,161,068     $ 0.35 -$20.09    $ 9.37    $ 8,684
                      

Exercisable at September 30, 2007

   1,450,908     $ 0.35 - $20.09    $ 7.49    $ 8,390
                      

The total intrinsic value of options exercised during the nine months ended September 30, 2007 and 2006 was $1.7 million and $2.0 million, respectively. As of September 30, 2007, the weighted-average remaining contractual life of options outstanding and options exercisable was 6.80 years and 5.79 years, respectively.

 

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The following table summarizes outstanding and exercisable options as of September 30, 2007:

 

     Options Outstanding    Options Exercisable
Exercise Prices   

Number

Outstanding

  

Weighted-Average
Exercise

Price

  

Weighted-Average
Remaining

Life

  

Number

Outstanding

  

Weighted-Average
Exercise

Price

$0.35 -$0.52    449,832    $ 0.50    4.92    449,832    $ 0.50
1.00    199,004      1.00    3.46    199,004      1.00
1.30    65,832      1.30    5.33    65,832      1.30
2.95    37,500      2.95    5.56    37,500      2.95
4.50    833      4.50    5.60    833      4.50
10.60    42,000      10.60    8.68    8,400      10.60
10.92    234,500      10.92    9.90    —        —  
11.00    150,001      11.00    6.08    150,001      11.00
11.30    95,500      11.30    9.32    —        —  
11.94    75,000      11.94    8.90    15,000      11.94
12.01    66,666      12.01    6.08    66,666      12.01
14.59    7,700      14.59    8.58    2,100      14.59
15.42    300,000      15.42    7.59    200,000      15.42
16.17    81,500      16.17    6.52    81,500      16.17
16.19    200,200      16.19    8.09    67,572      16.19
16.93    10,000      16.93    6.59    10,000      16.93
17.83    35,000      17.83    7.70    23,334      17.83
18.02    50,000      18.02    7.84    33,334      18.02
20.09    60,000      20.09    7.34    40,000      20.09
                              
$0.35 - $20.09    2,161,068    $ 9.37    6.80    1,450,908    $ 7.49
                              

Restricted Stock Units

Under the Company’s 2005 Plan, certain employees and directors are eligible to receive restricted stock units. In accordance with SFAS 123R, the fair value of restricted stock units is equal to the closing sale price of the Company’s common stock on the date of issuance. The total number of restricted stock awards expected to vest is adjusted by estimated forfeiture rates, which were determined to be 10.6% of awards granted to officers and 11.5% of awards granted to all others. As of September 30, 2007, 154,150 of the non-vested shares are expected to vest over approximately three to five years based on certain performance goals (“Performance Shares”). The fair value of the Performance Shares is expensed over the expected vesting period based on our forfeiture assumptions. If performance goals are not expected to be met, the compensation expense previously recognized would be reversed. No reversals of compensation expense related to the Performance Shares have been made as of September 30, 2007. The remaining 406,850 non-vested shares are not performance based, and will vest, and are being expensed over approximately two to three years of continuous service.

Restricted stock units activity and related information is as follows for the nine months ended September 30, 2007:

 

Restricted Stock Units

   Non-Vested
Shares
    Weighted-
Average
Grant Date
Fair Value

Beginning of period, December 31, 2006

   47,700     $ 16.19

Awarded

   532,600     $ 11.42

Released

   (6,000 )   $ 11.90

Cancelled/forfeited

   (13,300 )   $ 15.38
            

End of period, September 30, 2007

   561,000     $ 11.72
            

 

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Unrecognized compensation cost related to restricted stock units as of September 30, 2007 was $4.2 million. The weighted-average remaining expense period, based on the unamortized value of these outstanding restricted stock units was approximately 4.7 years.

The Financial Accounting Standards Board issued Statement No. 128, “Earnings per Share” (“SFAS No. 128”), which requires companies to disclose the number of stock options that have the potential to dilute basic earnings per share in the future, but which were not included in the computation of diluted earnings per share, because to do so would have been anti-dilutive in the periods presented. Employee stock options to purchase approximately 1,123,000 and 1,049,000 shares of common stock during the three months and nine months ended September 30, 2007, respectively, and employee stock options to purchase approximately 1,337,000 and 1,289,000 shares of common stock during the three months and nine months ended September 30, 2006, respectively, were outstanding but not included in the computation of diluted earnings per common share because the effect on diluted earnings per share would be anti-dilutive.

Note 4: Investment in Receivable Portfolios, Net

In accordance with the provisions of AICPA Statement of Position 03-03, “Accounting for Certain Debt Securities in a Transfer” (“SOP 03-03”), discrete receivable portfolio purchases during a quarter are aggregated into pools based on common risk characteristics. Once a static pool is established, the portfolios are permanently assigned to the pool. The discount (i.e., the difference between the cost of each static pool and the related aggregate contractual receivable balance) is not recorded because the Company expects to collect a relatively small percentage of each static pool’s contractual receivable balance. As a result, receivable portfolios are recorded at cost at the time of acquisition. All portfolios with common risk characteristics purchased prior to the adoption of SOP 03-03 in the first quarter of 2005 were aggregated by quarter of purchase.

In compliance with SOP 03-03, the Company accounts for its investments in consumer receivable portfolios using either the interest method or the cost recovery method. The interest method applies an effective interest rate, or internal rate of return (“IRR”), to the cost basis of the pool, which is to remain unchanged throughout the life of the pool unless there is an increase in subsequent expected cash flows. Subsequent increases in cash flows expected to be collected are generally recognized prospectively through an upward adjustment of the pool’s effective interest rate over its remaining life. Subsequent decreases in expected cash flows do not change the effective interest rate, but are recognized as an impairment of the cost basis of the pool, and are reflected in the consolidated statements of operations as a reduction in revenue with a corresponding valuation allowance offsetting the investment in receivable portfolios in the consolidated statements of financial condition.

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

 

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If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, the Company accounts for such portfolios on the cost recovery method (“Cost Recovery Portfolios”). The accounts in these portfolios have different risk characteristics than those included in other portfolios acquired during the same quarter, or the necessary information was not available to estimate future cash flows and, accordingly, they were not aggregated with other portfolios. Under the cost recovery method of accounting, no income is recognized until the purchase price of a Cost Recovery Portfolio has been fully recovered. As of September 30, 2007, there were six portfolios accounted for using the cost recovery method, consisting of $1.9 million in net book value of investment in receivable portfolios, representing all of the healthcare portfolios that the Company had acquired. In September 2007, the Company decided to exit its healthcare purchasing and collection activities. The Company is in the process of either selling these healthcare portfolios or placing the underlying accounts with external agencies for collections. Since the Company is no longer actively working on these accounts, it has placed them on cost recovery. The $1.9 million net book value, which has been reduced by a $1.4 million impairment charge, reflects the value that the Company expects to realize in a sale or through the collection activities of the external agencies.

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

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

 

     Nine Months Ended September 30, 2007  
     Estimate of
Zero Basis
Cash Flows
    Accretable
Yield
    Total  

Beginning balance at December 31, 2006

   $ 38,967     $ 417,981     $ 456,948  

Revenue recognized, net

     (5,108 )     (57,045 )     (62,153 )

(Reductions) additions on existing portfolios

     (3,956 )     20,438       16,482  

Additions for current purchases

     —         52,980       52,980  
                        

Balance at March 31, 2007

   $ 29,903     $ 434,354     $ 464,257  

Revenue recognized, net

     (4,047 )     (59,974 )     (64,021 )

Additions on existing portfolios

     4,442       39,959       44,401  

Additions for current purchases

     —         58,837       58,837  
                        

Balance at June 30, 2007

   $ 30,298     $ 473,176     $ 503,474  

Revenue recognized, net

     (3,316 )     (56,099 )     (59,415 )

Reductions on existing portfolios

     (2,613 )     (6,907 )     (9,520 )

Additions for current purchases

     —         58,936       58,936  
                        

Balance at September 30, 2007

   $ 24,369     $ 469,106     $ 493,475  
                        

 

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     Nine Months Ended September 30, 2006  
     Estimate of
Zero Basis
Cash Flows
    Accretable
Yield
    Total  

Beginning balance at December 31, 2005

   $ 57,116     $ 360,961     $ 418,077  

Revenue recognized, net

     (6,507 )     (51,067 )     (57,574 )

(Reductions) additions on existing portfolios

     (6,615 )     7,175       560  

Additions for current purchases

     —         28,708       28,708  
                        

Balance at March 31, 2006

   $ 43,994     $ 345,777     $ 389,771  

Revenue recognized, net

     (6,734 )     (52,870 )     (59,604 )

Additions on existing portfolios

     19,961       7,326       27,287  

Additions for 12 month curve extension

     —         86,020       86,020  

Additions for current purchases

     —         22,950       22,950  
                        

Balance at June 30, 2006

   $ 57,221     $ 409,203     $ 466,424  

Revenue recognized, net

     (6,150 )     (51,097 )     (57,247 )

(Reductions) additions on existing portfolios

     (2,084 )     13,722       11,638  

Additions for current purchases

     —         36,189       36,189  
                        

Balance at September 30, 2006

   $ 48,987     $ 408,017     $ 457,004  
                        

During the three months ended September 30, 2007, the Company purchased receivable portfolios with a face value of $1.3 billion for $47.9 million, or a purchase cost of 3.7% of face value. The estimated future collections at acquisition for these portfolios amounted to $108.1 million. During the nine months ended September 30, 2007, the Company purchased receivable portfolios with a face value of $5.1 billion for $134.4 million, or a purchase cost of 2.6% of face value. The estimated collections at acquisition for these portfolios amounted to $304.1 million.

All collections realized after the net book value of a portfolio has been fully recovered (“Zero Basis Portfolios”) are recorded as revenue (“Zero Basis Revenue”). During the three months ended September 30, 2007 and 2006, approximately $3.1 million and $5.9 million, respectively, was recognized as revenue on portfolios for which the related cost basis has been fully recovered. During the nine months ended September 30, 2007 and 2006, approximately $11.8 million and $18.4 million, respectively, was recognized as revenue on portfolios for which the related cost basis has been fully recovered.

During the quarter ended June 30, 2007, the Company revised the model it uses to value portfolio for the first six months of ownership. Effective April 1, 2007, this model was updated to extend future projected collections from 54 or 60 months to 72 months. This change was made as a result of the Company’s increased confidence in its ability to forecast future cash collections to 72 months. This change did not result in a significant change in forecasted collections or revenue.

During the quarter ended June 30, 2006, the Company revised the forecasting methodology it uses to value portfolio after the first six months of ownership, by extending the collection forecast from 60 months to 72 months. Extending the collection forecast from 60 months to 72 months resulted in an increase in the aggregate total estimated remaining collections for the receivable portfolios by $86.0 million, or 13.6% as of June 30, 2006.

 

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The following table summarizes the changes in the net balance of the investment in receivable portfolios during the nine months ended September 30, 2007 (in thousands, except percentages):

 

     For the Nine Months Ended September 30, 2007  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 300,348     $ —       $ —       $ 300,348  

Purchases of receivable portfolios

     134,392       —         —         134,392  

Transfer of healthcare receivables

     (3,241 )     3,241       —         —    

Gross collections1

     (256,943 )     —         (11,754 )     (268,697 )

Put-backs and recalls2

     (2,097 )     —         —         (2,097 )

Revenue recognized1

     175,676       —         11,754       187,430  

Impairment, net

     (1,167 )     —         —         (1,167 )

Write-down of healthcare receivables

     —         (1,391 )     —         (1,391 )
                                

Balance, end of period

   $ 346,968     $ 1,850     $ —       $ 348,818  
                                

Revenue as a percentage of collections

     67.9 %     0.0 %     100.0 %     68.8 %
                                

1

Gross collections and revenue related to the retained interest are not included in these tables. Zero basis collections and revenue related to the retained interest (which was fully amortized in the second quarter of 2004) were $0.7 million and $1.0 million for the nine months ended September 30, 2007 and 2006, respectively.

2

Represents accounts that are returned to or recalled by the seller in accordance with the respective purchase agreement.

The following table summarizes the change in the valuation allowance for investment in receivable portfolios during the nine months ended September 30, 2007 (in thousands):

 

     Valuation
Allowance
 

Balance at December 31, 2006

   $ 4,522  

Provision for impairment losses

     1,008  

Reversal of prior impairment

     (1,225 )
        

Balance at March 31, 2007

   $ 4,305  

Provision for impairment losses

     1,408  

Reversal of prior impairment

     (2,454 )
        

Balance at June 30, 2007

   $ 3,259  

Provision for impairment losses

     3,215  

Write-down of healthcare receivables

     1,391  

Reversal of prior impairment

     (785 )
        

Balance at September 30, 2007

   $ 7,080  
        

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

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007    2006    2007    2006

Collection sites

   $ 30,571    $ 28,449    $ 97,082    $ 103,310

Legal collections

     42,546      30,204      126,706      85,040

Sales

     4,992      4,094      20,261      13,188

Collection agencies

     6,894      12,409      23,397      39,324

Other

     627      625      2,336      1,721
                           

Gross collections for the period

   $ 85,630    $ 75,781    $ 269,782    $ 242,583
                           

 

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Note 5: Other Assets

Other assets consist of the following (in thousands):

 

     September 30,
2007
   December 31,
2006

Debt issuance costs

   $ 3,401    $ 4,272

Deferred court costs, net

     17,004      10,934

Deferred compensation assets

     3,262      4,256

Prepaid employment agreement

     611      1,111

Other

     1,922      1,330
             
   $ 26,200    $ 21,903
             

Note 6: Debt

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

 

     September 30,
2007
   December 31,
2006

Convertible Senior Notes

   $ 100,000    $ 100,000

Revolving Credit Facility

     132,669      99,669

Capital Lease Obligations

     279      463
             
   $ 232,948    $ 200,132
             

Convertible Senior Notes

In 2005, the Company issued $100.0 million of 3.375% convertible senior notes due September 19, 2010 (the “Convertible Notes”). Interest on the Convertible Notes is payable semi-annually, in arrears, on March 19 and September 19 of each year. The Convertible Notes rank equally with the Company’s existing and future senior indebtedness and are senior to the Company’s potential future subordinated indebtedness. Prior to the implementation of the net-share settlement feature discussed below, the Convertible Notes were convertible, prior to maturity, subject to certain conditions described below, into shares of the Company’s common stock at an initial conversion rate of 44.7678 per $1,000 principal amount of notes, which represented an initial conversion price of approximately $22.34 per share, subject to adjustment. As of September 30, 2007, the Company is making the required interest payments on the Convertible Notes and no other changes in the balance or structure of the Convertible Notes has occurred.

In October 2005, the Company obtained stockholder approval of a net-share settlement feature that allows the Company to settle conversion of the Convertible Notes through a combination of cash and stock. Based on the provisions of Emerging Issues Task Force No. 90-19, “Convertible Bonds with Issuer Option to Settle for Cash upon Conversion” (“EITF 90-19”) and Emerging Issues Task Force No. 00-19, “Accounting for Derivative Financial Instruments Indexed to, and Potentially Settled In, a Company’s Own Stock” (“EITF 00-19”), the net-settlement feature is accounted for as convertible debt and is not subject to the provisions of Statement of Financial Accounting Standards No. 133, “Accounting for Derivative Instruments and Hedging Activities” (“SFAS No. 133”). As a result of the net-settlement feature, the Company will be able to substantially reduce the number of shares issuable in the event of conversion of the Convertible Notes by repaying principal in cash instead of issuing shares of common stock for that amount. Additionally, the Company will not be required to include the underlying shares of common stock in the calculation of the Company’s diluted weighted average shares outstanding for earnings per share until the Company’s common stock price exceeds $22.34.

 

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The aggregate underwriting commissions and other debt issuance costs incurred with respect to the issuance of the Convertible Notes were $3.4 million, which have been capitalized as debt issuance costs on the Company’s consolidated statements of financial condition and are being amortized using the effective interest rate method over the term of the Convertible Notes.

The Convertible Notes also contain a restricted convertibility feature that does not affect the conversion price of the Convertible Notes but, instead, places restrictions on a holder’s ability to convert their Convertible Notes into shares of the Company’s common stock. A holder may convert the Convertible Notes prior to March 19, 2010 only if one or more of the following conditions are satisfied:

 

   

the average of the trading prices of the Convertible Notes for any five consecutive trading day period is less than 103% of the average of the conversion values of the Convertible Notes during that period;

 

   

the Company makes certain significant distributions to holders of the Company’s common stock;

 

   

the Company enters into specified corporate transactions; or

 

   

the Company’s common stock ceases to be approved for listing on the NASDAQ National Market and is not listed for trading on a U.S. national securities exchange or any similar U.S. system of automated securities price dissemination.

Holders may also surrender their Convertible Notes for conversion anytime on or after March 19, 2010 until the close of business on the trading day immediately preceding September 19, 2010, regardless of whether any of the foregoing conditions have been satisfied. Upon the satisfaction of any of the foregoing conditions on the last day of a reporting period, or during the twelve months prior to September 19, 2010, the Company would write off to expense all remaining unamortized debt issuance costs in that period.

If the Convertible Notes are converted in connection with certain fundamental changes that occur prior to March 19, 2010, the Company may be obligated to pay an additional make-whole premium with respect to the Convertible Notes converted.

Convertible Notes Hedge Strategy. Concurrent with the sale of the Convertible Notes, the Company purchased call options to purchase from the counterparties an aggregate of 4,476,780 shares of the Company’s common stock at a price of $22.34 per share. The cost of the call options totaled $27.4 million. The Company also sold warrants to the same counterparties to purchase from the Company an aggregate of 3,984,334 shares of the Company’s common stock at a price of $29.04 per share and received net proceeds from the sale of these warrants of $11.6 million. Taken together, the call option and warrant agreements have the effect of increasing the effective conversion price of the Convertible Notes to $29.04 per share. The call options and warrants must be settled in net shares, except in connection with certain termination events, in which case they would be settled in cash based on the fair market value of the instruments. On the date of settlement, if the market price per share of the Company’s common stock is above $29.04 per share, the Company will be required to deliver shares of its common stock representing the value of the call options and warrants in excess of $29.04 per share.

 

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The warrants have a strike price of $29.04 and are generally exercisable at anytime. The Company issued and sold the warrants in a transaction exempt from the registration requirements of the Securities Act of 1933, as amended, because the offer and sale did not involve a public offering. There were no underwriting commissions or discounts in connection with the sale of the warrants. In accordance with EITF No. 00-19 and Statement of Financial Accounting Standards No. 150, “Accounting for Certain Financial Instruments with Characteristics of both Liabilities and Equity,” the Company recorded the net call options and warrants as a reduction in additional paid in capital as of December 31, 2005, and will not recognize subsequent changes in fair value of the call options and warrants in its consolidated financial statements.

Revolving Credit Facility

During 2005, the Company entered into a three-year revolving credit facility (“Revolving Credit Facility”), to be used for the purposes of purchasing receivable portfolios and for general working capital needs. This Revolving Credit Facility has been amended several times to meet the needs of the Company, and is due to expire in May 2010.

On February 27, 2007, the Company amended the Revolving Credit Facility to allow for the Company to buy back up to $50 million of a combination of its common stock and Convertible Notes, subject to compliance with certain covenants and available borrowing capacity. The entire $50 million may be used to repurchase common stock, but only $25 million may be used to repurchase the Convertible Notes. This amendment also reset the Company’s minimum net worth threshold.

Effective May 7, 2007, the Company amended the facility in connection with an agreement reached with the lender under the Company’s Secured Financing Facility. This amendment allows the Company to exclude the expense associated with a one-time payment of $16.9 million in connection with its termination of all future obligations under its Secured Financing Facility as further discussed below.

Effective October 19, 2007, the Company amended the facility to change the definition of “change of control” to exclude from that definition acquisitions of stock by Red Mountain Capital Partners LLC (“Red Mountain”), JCF FPK I LP (“JCF FPK”) and their respective affiliates. The amendment was entered into in contemplation of a shareholders’ agreement between Red Mountain affiliates and JCF FPK.

Other provisions of the amended Revolving Credit Facility remain unchanged following the most recent amendment, and include:

 

   

Interest at a floating rate equal to, at the Company’s option, either: (a) reserve adjusted LIBOR plus a spread that ranges from 175 to 225 basis points, depending on the Company’s leverage; or (b) the higher of the federal funds rate then in effect plus a spread of 50 basis points or the prime rate then in effect.

 

   

An aggregate revolving commitment of $200.0 million (with an expansion feature to $250.0 million), subject to borrowing base availability, with $5.0 million sub-limits for swingline loans and letters of credit.

 

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A borrowing base provides for an 85.0% initial advance rate for the purchase of qualified receivable portfolios. The borrowing base reduces for each qualifying portfolio by 3% per month beginning after the third complete month subsequent to the initial purchase. The aggregate borrowing base is equal to the lesser of (a) the sum of all of the borrowing bases of all qualified receivable portfolios under this facility, as defined above, or (b) 95% of the net book value of all receivable portfolios acquired on or after January 1, 2005.

 

   

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

 

   

Events of default, which upon occurrence, may permit the lenders to terminate the Revolving Credit Facility and declare all amounts outstanding to be immediately due and payable.

 

   

Collateralization of all assets of the Company.

As September 30, 2007, of the $200.0 million commitment, the outstanding balance on the Revolving Credit Facility was $132.7 million, which bore a weighted average interest rate of 7.43%. The aggregate borrowing base was $200.0 million, of which $67.3 million was available for future borrowings.

Secured Financing Facility

The Company repaid in full the principal balance of the secured financing facility (“Secured Financing Facility”) at the end of 2006 and will make no further borrowings under that facility. Prior to May 7, 2007, the Company and the lender shared the residual collections, net of servicing fees paid to the Company. The residual collections paid to the lender were classified as contingent interest (“Contingent Interest”).

On May 7, 2007, the Company entered into an agreement with the lender under its Secured Financing Facility to eliminate all future Contingent Interest payments, for a one-time payment of $16.9 million. This agreement released the lender’s security interests in the remaining receivables originally financed under the Secured Financing Facility. This payment, less $5.2 million accrued on the Company’s balance sheet ($11.7 million, or $6.9 million after the effect of income taxes), is included in total other expense in the statement of operations for the nine months ended September 30, 2007. The charge reduced earnings per share by approximately $0.30 for the nine months ended September 30, 2007. Subsequent to the second quarter of 2007, the Company no longer recorded any Contingent Interest expense under the Secured Financing Facility.

The following table summarizes interest expense associated with the Secured Financing Facility for the periods presented (in thousands):

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007    2006    2007    2006

Stated interest

   $ —      $ 380    $ —      $ 1,277

Contingent interest

     —        3,824      4,123      12,746

Pay-off of contingent interest

     —        —        11,733      —  
                           

Total interest expense

   $ —      $ 4,204    $ 15,856    $ 14,023
                           

 

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Derivative Instruments

On April 11, 2007, the Company entered into two separate interest rate swap agreements intended to more effectively manage interest rates by establishing a set level of fixed rates associated with a portion of the borrowings under its Revolving Credit Facility. The first agreement is for a notional amount of $25 million, a term of three years and a fixed interest rate of 4.99%. The second agreement is for a notional amount of $25 million, a term of four years and a fixed interest rate of 5.01%. Giving effect to these hedges, the interest rate the Company will pay on $50 million of the outstanding balance under the Revolving Credit Facility will be the fixed interest rates mentioned above plus the required credit spread, which ranges from 175 to 225 basis points.

SFAS No. 133 “Accounting for Derivative Instruments and Hedge Activities, as amended” (“SFAS133”), requires that the derivatives be recorded on the balance sheet as either an asset or liability measured at its fair value. Changes in the derivatives fair value must be recorded to earnings unless specific hedge accounting criteria has been met and the hedge is designated as an effective hedge. When these criteria are met, the change in fair value is recorded as other comprehensive income. From the inception of the hedging program, the Company has concluded that the criteria have been met and the hedges have been classified as effective cash flow hedges. Accordingly, for the three and nine months ended September 30, 2007, the Company has recorded the change in fair value as other comprehensive income. As of September 30, 2007, the fair value of the hedges represented a liability of $0.6 million and is included in other liabilities and accumulated other comprehensive loss.

Capital Lease Obligations

The Company has capital lease obligations for certain computer equipment. These lease obligations require monthly payments aggregating approximately $21,000 through November 2008 and have implicit interest rates ranging from 2.9% to 3.1%. Capital lease obligations outstanding as of September 30, 2007, and September 30, 2006 were $0.3 million, and $0.5 million, respectively.

Note 7: Income Taxes

The Company recorded an income tax expense of $1.7 million, reflecting an effective rate of 24.3% of pretax income for the three months ended September 30, 2007. The effective tax rate for the three months ended September 30, 2007, consists primarily of a provision for Federal income taxes of 32.6% (which is net of a benefit for State taxes of 2.4%), a provision for State taxes of 6.8%, a provision for the effect of permanent book versus tax differences of 0.1%, and a benefit of 15.2% relating to State taxes. The 15.2% benefit is primarily due to a new effective State tax rate resulting from the receipt of a favorable ruling from a State tax authority

 

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granting the Company the right to a more favorable filing methodology, a net beneficial adjustment to the State and Federal tax payables resulting from the completion of the Company’s 1999 – 2006 State tax returns, a beneficial adjustment to the Company’s deferred taxes and the recognition of the benefit of certain State net operating losses generated in 2006. For the three months ended September 30, 2006, the Company recorded an income tax provision of $3.7 million, reflecting an effective rate of 41.5% of pretax income. The effective tax rate for the three months ended September 30, 2006, consists primarily of a provision for Federal income taxes of 31.9% (which is net of a benefit for State taxes of 3.1%), a provision for State taxes of 8.8%, and the effect of permanent book versus tax differences of 0.8%.

The Company recorded an income tax provision of $5.1 million, reflecting an effective rate of 33.1% of pretax income for the nine months ended September 30, 2007. The effective tax rate for the nine months ended September 30, 2007, consists primarily of a provision for Federal income taxes of 32.6% (which is net of a benefit for State taxes of 2.4%), a provision for State taxes of 6.8%, a provision for the effect of permanent book versus tax differences of 0.1%, and a benefit of 6.4% relating to State taxes. The 6.4% benefit is primarily due to a new effective State tax rate resulting from the receipt of a favorable ruling from a State tax authority granting the Company the right to a more favorable filing methodology, a net beneficial adjustment to the State and Federal tax payables resulting from the completion of the Company’s 1999-2006 State tax returns, a beneficial adjustment to the Company’s deferred taxes and the recognition of the benefit of certain State net operating losses generated in 2006. For the nine months ended September 30, 2006, the Company recorded an income tax provision of $12.6 million, reflecting an effective rate of 42.1% of pretax income. The effective tax rate for the nine months ended September 30, 2006, consists primarily of a provision for Federal income taxes of 31.9% (which is net of a benefit for State taxes of 3.1%), a provision for State taxes of 8.8%, the effect of permanent book versus tax differences of 0.2% and the effect of an anticipated adjustment related to an Internal Revenue tax audit of the Company’s 2003 income tax return of 1.2%, which the Company concluded during the three months ended September 30, 2006, was probable.

The Company adopted the provisions of FIN 48 on January 1, 2007. During the quarter ended September 30, 2007, the Company filed certain amended State tax returns that generated refund claims in the amount of $0.9 million. However, due to the uncertainty of realizing such refunds, the Company has fully reserved the expected benefit, resulting in no impact to the Company’s financial statements. A reconciliation of the beginning and ending amount of unrecognized tax benefits through September 30, 2007 is as follows:

 

    

Amount

(in thousands)

 

Balance at December 31, 2006

   $ —    

Additions based on tax positions related to the current year

     885  

Reductions for tax positions related to the current year

     (885 )
        

Balance at September 30, 2007

   $ —    
        

 

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Note 8: Purchase Concentrations

The following table summarizes the concentration of the Company’s purchases by seller sorted by total aggregate costs for the nine months ended September 30, 2007 and 2006, adjusted for put-backs, account recalls and replacements (in thousands, except percentages):

 

     Concentration of Initial Purchase Cost by Seller  
     For the Nine Months Ended  
     September 30, 2007     September 30, 2006  
     Cost     %     Cost     %  

Seller 1

   $ 45,997     34.2 %   $ 36,009     44.6 %

Seller 2

     16,208     12.1 %     —       0.0 %

Seller 3

     12,078     9.0 %     3,622     4.5 %

Seller 4

     6,939     5.2 %     —       0.0 %

Seller 5

     6,283     4.7 %     —       0.0 %

Seller 6

     5,560     4.1 %     —       0.0 %

Seller 7

     5,196     3.9 %     —       0.0 %

Seller 8

     4,865     3.6 %     —       0.0 %

Seller 9

     3,955     2.9 %     6,256     7.8 %

Seller 10

     3,921     2.9 %     —       0.0 %

Other

     23,390     17.4 %     34,800     43.1 %
                            
   $ 134,392     100.0 %   $ 80,687     100.0 %

Adjustments1

     (762 )       (1,294 )  
                    

Purchases, net

   $ 133,630       $ 79,393    
                    

1

Adjusted for put-backs, account recalls and replacements.

Note 9: Commitments and Contingencies

Litigation

On October 18, 2004, Timothy W. Moser, a former officer of the Company, filed an action in the United States District Court for the Southern District of California against the Company, and certain individuals, including several of the Company’s officers and directors. On February 14, 2005, the Company was served with an amended complaint in this action alleging defamation, intentional interference with contractual relations, breach of contract, breach of the covenant of good faith and fair dealing, intentional and negligent infliction of emotional distress and civil conspiracy arising out of certain statements in the Company’s Registration Statement on Form S-1 originally filed in September 2003 and alleged to be included in the Company’s Registration Statement on Form S-3 originally filed in May 2004. The amended complaint seeks injunctive relief, economic and punitive damages in an unspecified amount plus an award of profits allegedly earned by the defendants and alleged co-conspirators as a result of the alleged conduct, in addition to attorney’s fees and costs. On May 2, 2006, the court denied the Company’s special motion to strike pursuant to California’s anti-SLAPP statute, denied in part and granted in part the Company’s motion to dismiss, denied a variety of ex parte motions and applications filed by the plaintiff and denied the plaintiff’s motion for leave to conduct discovery or file supplemental briefing. The court granted the plaintiff 30 days in which to further amend his complaint, and on June 1, 2006, the plaintiff filed a second amended complaint in which he amended his claim for negligent infliction of emotional distress. On May 25, 2006, the

 

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Company filed a notice of appeal of the court’s order denying the anti-SLAPP motion, which is pending. On June 16, 2006, the Company filed a motion to stay the case pending the outcome of the appeal. This motion was granted on March 27, 2007. On April 9, 2007, the plaintiff filed a motion requesting an accelerated early neutral evaluation conference, which the court denied on April 16, 2007. Management of the Company believes the claims are without merit and intends to vigorously defend the action. Although the outcome of this matter cannot be predicted with certainty, management does not currently believe that this matter will have a material adverse effect on the Company’s consolidated financial position or results of operations.

On September 7, 2005, Mr. Moser filed a related action in the United States District Court for the Southern District of California against Triarc Companies, Inc. (“Triarc”), which at the time, was a significant stockholder of the Company, alleging intentional interference with contractual relations and intentional infliction of emotional distress. The case arises out of the same statements made or alleged to have been made in the Company’s Registration Statements mentioned above. On January 7, 2006, Triarc was served with an amended complaint seeking injunctive relief, an order directing Triarc to issue a statement of retraction or correction of the allegedly false statements, economic and punitive damages in an unspecified amount and attorney’s fees and costs. Triarc tendered the defense of this action to the Company, and the Company accepted the defense and will indemnify Triarc, pursuant to the indemnification provisions of the Registration Rights Agreements dated as of October 31, 2000 and February 21, 2002, and the Underwriting Agreements dated September 25, 2004 and January 20, 2005 to which Triarc is a party. Although the outcome of this matter cannot be predicted with certainty, management does not currently believe that this matter will have a material adverse effect on the Company’s consolidated financial position or results of operations.

On February 9, 2007, the Company’s wholly-owned subsidiary, Midland Credit Management, Inc. (“Midland”), entered into a definitive joint stipulation of settlement and release (the “Settlement Agreement”) with the lead plaintiff in a proposed class action on behalf of herself and all others similarly situated, to settle litigation filed against Midland in the San Diego County Superior Court, relating to claims under the California Labor Code. Pursuant to the Settlement Agreement, the claims brought in the class action against Midland would be settled for a maximum total payment (if all settlement class members submit valid claims) of $1.1 million. Of this amount, approximately $85,000 represents unpaid bonus overtime compensation alleged to be owed to the approximately 400 members of the class over a 4-year period, including employer taxes and statutory interest on such amounts. The balance represents a negotiated settlement of penalties allegedly owed to the class members under California law for the failure to pay the unpaid bonus overtime compensation, plaintiff’s attorney’s fees, and the costs of administering the settlement. The Settlement received final court approval on June 7, 2007. The final settlement payment amount, reflecting actual claims submitted, was $0.9 million. Accordingly, to reflect the actual settlement, during the three months ended June 30, 2007, the Company reversed $0.2 million of the amount accrued for this matter.

Claims based on the Fair Debt Collection Practices Act (“FDCPA”) and comparable state statutes may result in class action lawsuits, which can be material to the Company due to the remedies available under these statutes, including punitive damages. A number of

 

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cases styled as class actions have been filed against the Company. To date, a class has been certified in two of these cases. Several of these cases present novel issues on which there is no legal precedent. As a result, the Company is unable to predict the range of possible outcomes. There are a number of other lawsuits, claims and counterclaims pending or threatened against the Company. In general, these lawsuits, claims or counterclaims have arisen in the ordinary course of business and involve claims for actual damages arising from alleged misconduct or improper reporting of credit information by the Company or its employees or agents. Although litigation is inherently uncertain, based on past experience, established reserves, the information currently available and the possible availability of insurance and/or indemnification in some cases, management of the Company does not believe that the currently pending and threatened litigation or claims will have a material adverse effect on the Company’s consolidated financial position or results of operations. However, future events or circumstances, currently unknown to management, will determine whether the resolution of pending or threatened litigation or claims will ultimately have a material effect on the Company’s consolidated financial position, liquidity or results of operations in any future reporting periods.

Purchase Commitments

In June 2005, the Company entered into a forward flow agreement to purchase a minimum of $3.0 billion in face value of credit card charge-offs over a five-year period at a fixed price. As of September 30, 2007, future minimum purchase commitments under this agreement are as follows (in thousands):

 

2007    2008    2009    2010    Total
$8,246    $ 32,982    $ 32,982    $ 16,491    $ 90,701
                             

The purchase commitment above assumes that the remaining commitment as of September 30, 2007 will be incurred ratably over the remaining term of such agreement.

Note 10: Securities Repurchase Program

On February 27, 2007, the Company’s board of directors authorized a securities repurchase program under which the Company may buy back up to $50 million of a combination of its common stock and Convertible Notes. The entire $50 million may be used to repurchase common stock, but only $25 million may be used to repurchase the Convertible Notes. The purchases may be made from time to time in the open market or through privately negotiated transactions and will be dependent upon various business and financial considerations. Securities repurchases are subject to compliance with applicable legal requirements and other factors. As of September 30, 2007, the Company has not repurchased any of its common stock or its Convertible Notes under this program.

Note 11: Cost Savings Initiatives

In September 2007, the Company announced certain cost savings initiatives aimed at reducing its overall operating expenses (the “Plan”). As part of the Plan, the Company has reduced its workforce by 115 people and will exit from its healthcare purchasing and collection activities. The reduction in workforce comprised 70 people at the Company’s call center in Phoenix, Arizona, 30 at its bankruptcy servicing center in Arlington, Texas and 15 at its corporate headquarters in San Diego, California.

 

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As of September 30, 2007, the Company estimates that the costs associated with exiting its healthcare purchasing and collection activities will be approximately $1.7 million, including a charge of $1.4 million related to a loss on the anticipated sale of its healthcare receivable portfolios, which has been recognized as an impairment charge against the Company’s revenue, and $0.3 million of salaries and benefits, primarily severance payments for its healthcare purchasing and collection employees. Pursuant to SFAS No. 146, “Accounting for Costs Associated with Exit or Disposal Activities” (“SFAS No 146”), the $0.3 million of salaries and benefits has been recognized and is included in salaries and employee benefits.

Pursuant to SFAS No. 146, the Company recorded a one-time charge of approximately $1.4 million in the third quarter of 2007 related to its reduction in workforce, including the severance cost of $0.3 million for the healthcare purchasing and collection employees discussed above. This one-time charge, primarily severance, is included in salaries and employee benefits.

The following table summarizes the components related to the cost savings initiatives associated with the Plan through September 30, 2007, (in thousands):

 

    

Cost Recognized

Through
September 30, 2007

  

Cost Incurred

Through
September 30, 2007

   

Accrual

As of
September 30, 2007

Write-down of healthcare receivables

   $ 1,391      —       $ 1,391

Employee separation costs

     1,196      —         1,196

Other

     235      (28 )     207
                     

Total Costs

   $ 2,822    $ (28 )   $ 2,794
                     

The Company expects the Plan to be fully executed by the end of 2007.

 

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

This information should be read in conjunction with the condensed consolidated financial statements and the notes thereto included in Item 1 of Part I of this Quarterly Report on Form 10-Q and the audited consolidated financial statements and notes thereto and Management’s Discussion and Analysis of Financial Condition and Results of Operations for the year ended December 31, 2006 contained in our 2006 Annual Report on Form 10-K. The Form 10-K contains a general description of our industry and a discussion of recent trends affecting the industry. Certain statements herein may constitute “forward-looking statements” under the Private Securities Litigation Reform Act of 1995 (the “Reform Act”), for which we claim the protection of the safe harbor of the Reform Act. See “Part II, Item 1A—Risk Factors” for more discussion on our forward-looking statements.

Introduction

We are a systems-driven purchaser and manager of charged-off consumer receivable portfolios and a provider of bankruptcy services to the finance industry. We acquire receivable portfolios at deep discounts from their face values using our proprietary valuation process that is based on the consumer attributes of the underlying accounts. Based upon the ongoing analysis of these accounts, we employ a dynamic mix of collection strategies to maximize our return on investment.

Cost Savings Initiatives

In September 2007, we announced certain cost savings initiatives aimed at reducing our overall operating expenses. These initiatives included reducing our workforce by 115 people and announcing that we will exit from our healthcare purchasing and collection activities. The reduction in workforce comprised 70 people at our call center in Phoenix, Arizona, 30 at our bankruptcy servicing center in Arlington, Texas and 15 at our corporate headquarters in San Diego, California.

As of September 30, 2007, we estimate that the costs associated with exiting our healthcare purchasing and collection activities will be approximately $1.7 million, including a charge of $1.4 million related to a loss on the anticipated sale of our healthcare receivable portfolios and $0.3 million of salaries and benefits, primarily severance payments, for our healthcare purchasing and collection employees.

We recorded a one-time charge of approximately $1.4 million in the third quarter of 2007 related to our reduction in workforce, including the severance cost of $0.3 million for our healthcare purchasing and collection employees discussed above. This one-time charge is composed primarily of severance payments for our former employees.

Purchases and Collections

Purchases by Paper Type

The following tables summarize the types of charged-off consumer receivable portfolios we purchased for the three and nine months ended September 30, 2007 and 2006 (in thousands):

 

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007    2006    2007    2006

Credit card

   $ 40,971    $ 12,078    $ 121,232    $ 37,995

Other

     6,898      20,256      13,160      42,692
                           
   $ 47,869    $ 32,334    $ 134,392    $ 80,687
                           

 

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During the three months ended September 30, 2007, we invested $47.9 million for portfolios with face values aggregating $1.3 billion for an average purchase price of 3.7% of face value. This is a $15.6 million increase, or 48.0%, in the amount invested, compared with the $32.3 million invested during the three months ended September 30, 2006, to acquire portfolios with a face value aggregating $1.1 billion for an average purchase price of 3.0% of face value.

During the nine months ended September 30, 2007, we invested $134.4 million for portfolios with face values aggregating $5.1 billion for an average purchase price of 2.6% of face value. This is a $53.7 million increase, or 66.6%, in the amount invested, compared with the $80.7 million invested during the nine months ended September 30, 2006, to acquire portfolios with a face value aggregating $2.2 billion for an average purchase price of 3.6% of face value.

During the twelve months ended September 30, 2007, we invested $198.0 million for portfolios with face values aggregating $6.6 billion for an average purchase price of 3.0% of face value. This is a $77.4 million increase, or 64.1%, in the amount invested, compared with the $120.6 million invested during the twelve months ended September 30, 2006, to acquire portfolios with a face value aggregating $3.6 billion for an average purchase price of 3.4% of face value.

Collections by Channel

During the three and nine months ended September 30, 2007 and 2006, we utilized several business channels for the collection of charged-off credit card receivables and other charged-off receivables. The following tables summarize gross collections by collection channel (in thousands):

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007    2006    2007    2006

Collection sites

   $ 30,571    $ 28,449    $ 97,082    $ 103,310

Legal collections

     42,546      30,204      126,706      85,040

Collection agencies

     6,894      12,409      23,397      39,324

Sales

     4,992      4,094      20,261      13,188

Other

     627      625      2,336      1,721
                           

Gross collections for the period

   $ 85,630    $ 75,781    $ 269,782    $ 242,583
                           

Gross collections increased $9.8 million, or 13.0%, to $85.6 million during the three months ended September 30, 2007, from $75.8 million during the three months ended September 30, 2006.

Gross collections increased $27.2 million, or 11.2%, to $269.8 million during the nine months ended September 30, 2007, from $242.6 million during the nine months ended September 30, 2006.

 

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Results of Operations

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

 

     Three Months Ended September 30,  
     2007     2006  

Revenue

        

Revenue from receivable portfolios, net

   $ 59,415     94.8 %   $ 57,247     94.5 %

Servicing fees and other related revenue

     3,276     5.2 %     3,350     5.5 %
                            

Total revenue

     62,691     100.0 %     60,597     100.0 %
                            

Operating expenses

        

Salaries and employee benefits

     17,138     27.3 %     15,773     26.0 %

Stock-based compensation expense

     1,281     2.0 %     1,490     2.5 %

Cost of legal collections

     20,868     33.3 %     12,545     20.7 %

Other operating expenses

     4,987     8.0 %     5,308     8.7 %

Collection agency commissions

     2,478     4.0 %     4,533     7.5 %

General and administrative expenses

     4,462     7.1 %     4,388     7.3 %

Depreciation and amortization

     833     1.3 %     964     1.6 %
                            

Total operating expenses

     52,047     83.0 %     45,001     74.3 %
                            

Income before other (expense) income and income taxes

     10,644     17.0 %     15,596     25.7 %
                            

Other (expense) income

        

Interest expense

     (3,648 )   (5.8 )%     (2,920 )   (4.8 )%

Contingent interest expense

     —       —         (3,824 )   (6.3 )%

Pay-off of future contingent interest

     —       —         —       —    

Other income

     79     0.1 %     45     0.1 %
                            

Total other expense

     (3,569 )   (5.7 )%     (6,699 )   (11.0 )%
                            

Income before income taxes

     7,075     11.3 %     8,897     14.7 %

Provision for income taxes

     (1,717 )   (2.7 )%     (3,689 )   (6.1 )%
                            

Net income

   $ 5,358     8.6 %   $ 5,208     8.6 %
                            
     Nine Months Ended September 30,  
     2007     2006  

Revenue

        

Revenue from receivable portfolios, net

   $ 185,589     95.0 %   $ 174,425     93.3 %

Servicing fees and other related revenue

     9,705     5.0 %     12,585     6.7 %
                            

Total revenue

     195,294     100.0 %     187,010     100.0 %
                            

Operating expenses

        

Salaries and employee benefits

     50,388     25.8 %     48,358     25.9 %

Stock-based compensation expense

     3,286     1.7 %     4,335     2.3 %

Cost of legal collections

     59,649     30.6 %     36,767     19.7 %

Other operating expenses

     16,970     8.7 %     17,409     9.3 %

Collection agency commissions

     8,639     4.4 %     14,178     7.6 %

General and administrative expenses

     12,965     6.6 %     11,421     6.1 %

Depreciation and amortization

     2,541     1.3 %     2,892     1.5 %
                            

Total operating expenses

     154,438     79.1 %     135,360     72.4 %
                            

Income before other (expense) income and income taxes

     40,856     20.9 %     51,650     27.6 %
                            

Other (expense) income

        

Interest expense

     (9,904 )   (5.1 )%     (9,286 )   (5.0 )%

Contingent interest expense

     (4,123 )   (2.1 )%     (12,746 )   (6.8 )%

Pay-off of future contingent interest

     (11,733 )   (6.0 )%     —       —    

Other income

     153     0.1 %     379     0.2 %
                            

Total other expense

     (25,607 )   (13.1 )%     (21,653 )   (11.6 )%
                            

Income before income taxes

     15,249     7.8 %     29,997     16.1 %

Provision for income taxes

     (5,055 )   (2.6 )%     (12,616 )   (6.8 )%
                            

Net income

   $ 10,194     5.2 %   $ 17,381     9.3 %
                            

 

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Comparison of Results of Operations

Revenue

Our revenue consists primarily of portfolio revenue and bankruptcy servicing revenue. Portfolio revenue is comprised of accretion revenue and zero basis revenue. Accretion revenue represents revenue derived from pools (quarterly groupings of purchased receivable portfolios) with a cost basis that has not been fully amortized. Revenue from pools with a remaining unamortized cost basis is accrued based on each pool’s effective interest rate applied to each pool’s remaining unamortized cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and impairments. The effective interest rate is the internal rate of return derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool. All collections realized after the net book value of a portfolio has been fully recovered (“Zero Basis Portfolios”) are recorded as revenue (“Zero Basis Revenue”). We account for our investment in receivable portfolios utilizing the interest method in accordance with the provisions of the AICPA’s Statement of Position 03-03, “Accounting for Certain Debt Securities Acquired in a Transfer” (“SOP 03-03”). Servicing fee revenue is revenue primarily associated with bankruptcy servicing fees earned from our subsidiary, Ascension Capital Group, Inc. (“Ascension”), a provider of bankruptcy services to the finance industry.

 

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

 

    

For the Three Months Ended

September 30, 2007

   

As of

September 30, 2007

 
     Collections1   

Net

Revenue

   Revenue
Recognition
Rate
    % of Total
Revenue
    Net
(Impairment)
Reversal
    Unamortized
Balance
   IRR  

ZBA2

   $ 3,316    $ 3,316    100.0 %   5.6 %   $ —       $ —      100.0 %

2002

     2,140      1,759    82.2 %   3.0 %     (368 )     2,649    25.7 %

2003

     5,717      4,920    86.1 %   8.3 %     (834 )     5,958    30.6 %

2004

     7,863      5,063    64.4 %   8.5 %     (1,131 )     24,311    8.0 %

2005

     25,373      15,925    62.8 %   26.8 %     (1,362 )     96,531    5.6 %

2006

     22,096      15,299    69.2 %   25.7 %     30       102,959    4.7 %

2007

     19,023      13,133    69.0 %   22.1 %     (156 )     116,410    4.2 %
                                               

Total

   $ 85,528    $ 59,415    69.5 %   100.0 %   $ (3,821 )   $ 348,818    5.6 %
                                               

 

   

For the Three Months Ended

September 30, 2006

   

As of

September 30, 2006

 
    Collections1   

Net

Revenue

   Revenue
Recognition
Rate
    % of Total
Revenue
    Net
(Impairment)
Reversal
    Unamortized
Balance
   IRR  

ZBA2

  $ 6,150    $ 6,150    100.0 %   10.7 %   $ —       $ —      100.0 %

2001

    181      39    21.5 %   0.1 %     —         —      19.4 %

2002

    4,986      3,803    76.3 %   6.6 %     (419 )     6,246    20.0 %

2003

    11,230      9,921    88.3 %   17.3 %     —         13,866    22.6 %

2004

    12,707      9,584    75.4 %   16.7 %     (201 )     38,413    7.8 %

2005

    28,180      20,327    72.1 %   35.5 %     (194 )     136,709    4.8 %

2006

    12,152      7,423    61.1 %   13.0 %     —         71,490    4.1 %
                                              

Total

  $ 75,586    $ 57,247    75.7 %   100.0 %   $ (814 )   $ 266,724    6.3 %
                                              
   

For the Nine Months Ended

September 30, 2007

   

As of

September 30, 2007

 
    Collections1    Net
Revenue
   Revenue
Recognition
Rate
    % of Total
Revenue
    Net
(Impairment)
Reversal
    Unamortized
Balance
   IRR  

ZBA2

  $ 12,471    $ 12,471    100.0 %   6.7 %   $ —       $ —      100.0 %

2002

    8,338      7,424    89.0 %   4.1 %     (36 )     2,649    25.7 %

2003

    22,013      19,075    86.6 %   10.3 %     (936 )     5,958    30.6 %

2004

    28,199      19,392    68.8 %   10.4 %     (1,381 )     24,311    8.0 %

2005

    86,447      55,560    64.3 %   29.9 %     760       96,531    5.6 %

2006

    71,320      48,261    67.7 %   26.0 %     (809 )     102,959    4.7 %

2007

    40,626      23,406    57.6 %   12.6 %     (156 )     116,410    4.2 %
                                              

Total

  $ 269,414    $ 185,589    68.9 %   100.0 %   $ (2,558 )   $ 348,818    5.6 %
                                              
   

For the Nine Months Ended

September 30, 2006

   

As of

September 30, 2006

 
    Collections1    Net
Revenue
   Revenue
Recognition
Rate
    % of Total
Revenue
    Net
(Impairment)
Reversal
    Unamortized
Balance
   IRR  

ZBA2

  $ 19,390    $ 19,390    100.0 %   11.1 %   $ —       $ —      100.0 %

2001

    2,766      1,263    45.7 %   0.7 %     135       —      19.4 %

2002

    18,037      14,078    78.1 %   8.1 %     (306 )     6,246    20.0 %

2003

    39,288      33,500    85.3 %   19.2 %     175       13,866    22.6 %

2004

    40,733      28,507    70.0 %   16.3 %     (201 )     38,413    7.8 %

2005

    100,206      64,777    64.6 %   37.1 %     (471 )     136,709    4.8 %

2006

    21,616      12,910    59.7 %   7.40 %     —         71,490    4.1 %
                                              

Total

  $ 242,036    $ 174,425    72.1 %   100.0 %   $ (668 )   $ 266,724    6.3 %
                                              

1

Does not include amounts collected on behalf of others.

2

Gross collections and revenue related to the retained interest are included in these tables.

 

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Total revenue was $62.7 million for the three months ended September 30, 2007, an increase of $2.1 million, or 3.5%, compared to total revenue of $60.6 million for the three months ended September 30, 2006. Revenue, excluding Ascension’s bankruptcy servicing fees of $3.3 million, increased $2.2 million, or 3.8%, to $59.4 million. The increase in portfolio revenue was primarily the result of additional accretion revenue associated with higher purchasing volumes in the first nine months of 2007 compared to the same period in 2006 and increased accretion revenue related to new operating initiatives. The increase in revenue was partially offset by a greater portion of our revenues coming from our 2004 to 2006 portfolio purchases that have lower effective accretion rates than our 2003 and prior purchases, due to a more competitive pricing environment since 2004, a charge of $1.4 million related to a loss on the anticipated sale of our healthcare receivable portfolios and the recording of a larger impairment provision on certain of our portfolios during the quarter. During the three months ended September 30, 2007, we recorded a net impairment provision of $2.4 million compared to a net impairment provision of $0.8 million during the same period in the prior year.

Total revenue was $195.3 million for the nine months ended September 30, 2007, an increase of $8.3 million, or 4.4%, compared to total revenue of $187.0 million for the nine months ended September 30, 2006. Revenue, excluding Ascension’s bankruptcy servicing fees of $9.7 million, increased $11.2 million, or 6.4%, to $185.6 million. The increase in portfolio revenue was primarily the result of additional accretion revenue associated with higher purchasing volumes in the first nine months of 2007 compared to the same period in 2006, increased accretion revenue associated with extending our collection forecast in the second quarter of 2006 from 60 months to 72 months and increased accretion revenue related to new operating initiatives. The increase in revenue was partially offset by a greater portion of our revenues coming from our 2004 to 2006 portfolio purchases that have lower effective accretion rates than our 2003 and prior purchases, due to a more competitive pricing environment since 2004, a charge of $1.4 million related to a loss on the anticipated sale of our healthcare receivable portfolios and the recording a larger impairment provision on certain of our portfolios during the nine month period. During the nine months ended September 30, 2007, we recorded a net impairment provision of $1.2 million compared to a net impairment provision of $0.7 million during the same period in the prior year.

Revenue associated with bankruptcy servicing fees earned from Ascension, a provider of bankruptcy services to the finance industry, was $3.3 million for the three months ended September 30, 2007, a decrease of $0.1 million, or 2.2%, compared to revenue of $3.4 million for the three months ended September 30, 2006. Revenue associated with bankruptcy servicing fees earned from Ascension, was $9.7 million for the nine months ended September 30, 2007, a decrease of $2.8 million, or 23.3%, compared to revenue of $12.5 million for the nine months ended September 30, 2006. The decrease in Ascension revenue for the nine months ended September 30, 2007, is due to the high volume of bankruptcy placements in October 2005 just prior to the effective date of the Bankruptcy Reform Act (the “Act”). Consistent with our revenue recognition policy, the revenue associated with the significant number of Chapter 7 bankruptcy placements in October 2005 was recognized during the nine months ended September 30, 2006. Although bankruptcy placements have not returned to the levels experienced prior to the Act, they have increased from the low levels experienced in late 2005 and early 2006.

 

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Operating Expenses

Total operating expenses were $52.0 million for the three months ended September 30, 2007, an increase of $7.0 million, or 15.7%, compared to total operating expenses of $45.0 million for the three months ended September 30, 2006. Excluding $1.4 million severance and other costs associated with our cost savings initiatives, operating expenses were $50.6 million, an increase of $5.6 million, or 12.5%, compared to total operating expenses of $45.0 million for the three months ended September 30, 2006.

Total operating expenses were $154.4 million for the nine months ended September 30, 2007, an increase of $19.0 million, or 14.1%, compared to total operating expenses of $135.4 million for the nine months ended September 30, 2006. Excluding $1.4 million severance and other costs associated with our cost savings initiatives, operating expenses were $153.0 million, an increase of $17.6 million, or 13.0%, compared to total operating expenses of $135.4 million for the nine months ended September 30, 2006.

Operating expenses are explained in more detail as follows:

Salaries and employee benefits

Total salaries and employee benefits increased by $1.3 million, or 8.7%, to $17.1 million during the three months ended September 30, 2007, from $15.8 million during the three months ended September 30, 2006. This increase was primarily due to an increase of $1.4 million in severance and other costs associated with the reduction in our workforce and the decision to exit our healthcare purchasing and collection activities and an increase of $0.4 million related to insurance and other health benefit costs, offset by a $0.5 million reduction in salaries and wages and related costs due to reductions in headcount.

Total salaries and employee benefits increased by $2.0 million, or 4.2%, to $50.4 million during the nine months ended September 30, 2007, from $48.4 million during the nine months ended September 30, 2006. This increase was primarily due to an increase of $1.4 million in severance and other costs associated with the reduction in our workforce and the decision to exit our healthcare purchasing and collection activities, $0.5 million in other severance costs, and an increase of $0.3 million related to insurance and other health benefits, offset by a net $0.2 million reduction in salaries and wages and related costs.

Stock-based compensation expenses

Stock-based compensation expense decreased $0.2 million, or 14.0%, to $1.3 million, for the three months ended September 30, 2007, compared to $1.5 million for the three months ended September 30, 2006. This decrease was primarily the result of a reduction in expense of $0.5 million due to actual versus estimated forfeiture adjustments of certain stock options, offset by additional expense of $0.1 million associated with a modification of certain stock options and $0.1 million associated with the issuance of new equity grants.

Stock-based compensation expense decreased $1.0 million, or 24.2%, to $3.3 million, for the nine months ended September 30, 2007, compared to $4.3 million for the nine months ended September 30, 2006. This decrease was primarily the result of the reduction of approximately $1.1 million of expenses related to changes in assumptions used in calculating stock-based compensation for the nine months ended September 30, 2007 compared to September 30, 2006, and a reduction in expense of $0.5 million due to actual versus

 

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estimated forfeiture adjustments of certain stock options, offset by additional expense of $0.1 million associated with a modification of certain stock options and $0.5 million associated with new equity grants issued during the nine months ended September 30, 2007.

Statement of Financial Accounting Standards No. 123R, “Share-Based Payment,” requires us to analyze our assumptions used in valuing stock-based compensation and revise and implement new assumptions on an annual basis. The primary revision made in our 2007 assumptions was to use approximately five years to calculate the expected volatility and forfeitures rather than three years, which was used in 2006. See Note 3 to the condensed consolidated financial statements for a further discussion of stock-based compensation.

Cost of legal collections

The cost of legal collections increased $8.4 million, or 66.4%, to $20.9 million during the three months ended September 30, 2007, as compared to $12.5 million during the three months ended September 30, 2006. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in contingent fees was primarily the result of an increase of $12.3 million, or 40.9%, in gross collections through our legal channel. Gross legal collections increased to $42.5 million during the three months ended September 30, 2007, from $30.2 million collected during the three months ended September 30, 2006. Cost of legal collections increased as a percent of gross collections through this channel to 49.0% during the three months ended September 30, 2007, from 41.5% during the three months ended September 30, 2006, primarily as a result of the payment of upfront court costs associated with our pursuit of legal collections and changes in our expected recovery rate on court costs spent.

The cost of legal collections increased $22.8 million, or 62.2%, to $59.6 million during the nine months ended September 30, 2007, as compared to $36.8 million during the nine months ended September 30, 2006. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in contingent fees was primarily the result of an increase of $41.7 million, or 49.0%, in gross collections through our legal channel. Gross legal collections increased to $126.7 million during the nine months ended September 30, 2007, from $85.0 million collected during the nine months ended September 30, 2006. Cost of legal collections increased as a percent of gross collections through this channel to 47.1% during the nine months ended September 30, 2007, from 43.2% during the nine months ended September 30, 2006, primarily as a result of the payment of upfront court costs associated with our pursuit of legal collections and changes in our expected recovery rate on court costs spent.

Other operating expenses

Other operating expenses decreased $0.3 million, or 6.1%, to $5.0 million during the three months ended September 30, 2007, from $5.3 million during the three months ended September 30, 2006. The decrease was primarily the result of a decrease in Ascension’s legal expense, a decrease in the amortization of deferred revenue, a decrease in recruiting expenses, and a decrease in other costs related to operations, offset by an increase in the number of direct mail campaigns for our receivable portfolios. Ascension’s legal

 

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expense decreased $0.3 million, or 36.9%, to $0.5 million during the three months ended September 30, 2007. Amortization of deferred revenue decreased $0.2 million, or 51.3%, to $0.2 million during the three months ended September 30, 2007. Recruiting costs decreased $0.2 million, or 59.2%, to $0.1 million during the three months ended September 30, 2007. Other costs related to operations such as telephone and credit report notification decreased $0.4 million, or 28.6%, to $1.2 million during the three months ended September 30, 2007. The cost of direct mail campaigns increased $0.8 million, or 52.0%, to $2.4 million during the three months ended September 30, 2007, compared to $1.6 million during the three months ended September 30, 2006.

Other operating expenses decreased $0.4 million, or 2.5%, to $17.0 million during the nine months ended September 30, 2007, from $17.4 million during the nine months ended September 30, 2006. The decrease was primarily the result of a decrease in Ascension’s legal expense, a decrease in the amortization of deferred revenue, and a decrease in recruiting expenses, offset by an increase in the number of direct mail campaigns for our receivable portfolios. Ascension’s legal expense decreased $0.9 million, or 41.7%, to $1.2 million during the nine months ended September 30, 2007. Amortization of deferred revenue decreased $0.7 million, or 46.9%, to $0.8 million during the nine months ended September 30, 2007. Recruiting costs decreased $0.7 million, or 58.5%, to $0.5 million during the nine months ended September 30, 2007. The cost of direct mail campaigns increased $1.9 million, or 33.0%, to $7.6 million during the nine months ended September 30, 2007, compared to $5.7 million during the nine months ended September 30, 2006.

Collection agency commissions

During the three months ended September 30, 2007, we incurred $2.5 million in commissions to third party collection agencies, or 35.9% of the related gross collections of $6.9 million, compared to $4.5 million in commissions, or 36.5% of the related gross collections of $12.4 million during the three months ended September 30, 2006. The decrease in commissions is consistent with the decrease in collections through this channel. The decrease in the commission rate as a percentage of the related gross collections is primarily the result of the mix of accounts placed with the agencies. Commissions as a percentage of collections in this channel vary from period to period depending on, among other things, the time from charge-off of the accounts placed with an agency, as freshly charged-off accounts have a lower commission rate than accounts that have been charged off for a long period of time.

During the nine months ended September 30, 2007, we paid $8.6 million in commissions to third party collection agencies, or 36.9% of the related gross collections of $23.4 million, compared to $14.2 million in commissions, or 36.1% of the related gross collections of $39.3 million during the nine months ended September 30, 2006. The decrease in commissions is consistent with the decrease in collections through this channel. The increase in the commission rate as a percentage of the related gross collections is primarily the result of the mix of accounts placed with the agencies.

General and administrative expenses

General and administrative expenses increased $0.1 million, or 1.7%, to $4.5 million during the three months ended September 30, 2007, from $4.4 million during the three months ended September 30, 2006. The increase in general and administrative expenses was

 

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primarily the result of an increase of $0.8 million in general corporate expenses offset by costs associated with our strategic alternatives process incurred during the three months ended September 30, 2006, of $0.7 million.

General and administrative expenses increased $1.6 million, or 13.5%, to $13.0 million during the nine months ended September 30, 2007, from $11.4 million during the nine months ended September 30, 2006. The increase was primarily the result of approximately $0.6 million of increased accounting and consulting service fees related to the filing of our 1999-2005 State tax returns, $0.6 million of increased building rent, and a $0.9 million net increase in general corporate expenses, offset by $0.5 million decrease in costs associated with the strategic alternatives process.

Depreciation and amortization

Depreciation and amortization expense decreased $0.2 million, or 13.2%, to $0.8 million during the three months ended September 30, 2007, from $1.0 million during the three months ended September 30, 2006. Depreciation expense remained consistent at $0.6 million during the three months ended September 30, 2007 and 2006. Amortization expense relating to intangible assets purchased from Ascension was $0.3 million for the three months ended September 30, 2007, compared to $0.4 million for the three months ended September 30, 2006.

Depreciation and amortization expense decreased $0.4 million, or 12.1%, to $2.5 million during the nine months ended September 30, 2007, from $2.9 million during the nine months ended September 30, 2006. Depreciation expense remained consistent at $1.7 million during the nine months ended September 30, 2007 and 2006. Amortization expense relating to intangible assets acquired in conjunction with the acquisition of Ascension was $0.8 million for the nine months ended September 30, 2007, compared to $1.2 million for the nine months ended September 30, 2006.

Interest expense

Total interest expense decreased $3.1 million, or 45.9%, to $3.6 million during the three months ended September 30, 2007, from $6.7 million during the three months ended September 30, 2006.

Total interest expense increased $3.8 million, or 16.9%, to $25.8 million during the nine months ended September 30, 2007 from $22.0 million during the nine months ended September 30, 2006.

The following table summarizes our total interest expense (in thousands, except percentages):

 

     For the Three Months Ended September 30,  
     2007    2006    $ Change     % Change  

Stated interest on debt obligations

   $ 3,277    $ 2,491    $ 786     31.6 %

Amortization of loan fees and other loan costs

     371      429      (58 )   (13.5 )%

Contingent interest expense

     —        3,824      (3,824 )   (100.0 )%
                        

Total interest expense

   $ 3,648    $ 6,744    $ (3,096 )   (45.9 )%
                        
     For the Nine Months Ended September 30,  
     2007    2006    $ Change     % Change  

Stated interest on debt obligations

   $ 8,752    $ 7,820    $ 932     11.9 %

Amortization of loan fees and other loan costs

     1,152      1,466      (314 )   (21.4 )%

Contingent interest expense

     4,123      12,746      (8,623 )   (67.7 )%

Pay-off of future contingent interest

     11,733      —        11,733     —    
                        

Total interest expense

   $ 25,760    $ 22,032    $ 3,728     16.9 %
                        

 

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As of December 31, 2004, we no longer made borrowings under our Secured Financing Facility. As of December 31, 2006, we repaid in full the principal balance of our Secured Financing Facility. Prior to May 7, 2007, we shared with the lender the residual collections on purchases made under this facility, net of servicing fees paid to us. The residual collections paid to the lender were classified as contingent interest.

On May 7, 2007, we entered into an agreement with the lender under our Secured Financing Facility to eliminate all future contingent interest payments, for a one-time payment of $16.9 million. This agreement released the lender’s security interests in the remaining receivables originally financed under the Secured Financing Facility. This payment, less $5.2 million accrued on our balance sheet ($11.7 million, or $6.9 million after the effect of income taxes), is included in total other expense in our statement of operations for the nine months ended September 30, 2007. The charge reduced earnings per share by approximately $0.30 for the nine months ended September 30, 2007. Subsequent to the second quarter of 2007, we no longer recorded any contingent interest expense under the Secured Financing Facility in our statements of operations.

During 2005, we entered into a three-year revolving credit facility (“Revolving Credit Facility”), to be used for the purposes of purchasing receivable portfolios and for general working capital needs. This Revolving Credit Facility has been amended several times to meet the needs of the Company, and is due to expire in May 2010. We have financed portfolio purchases subsequent to December 31, 2004, using our Revolving Credit Facility, which does not require the sharing of residual collections with the lender. See Note 6 to the consolidated financial statements for a further discussion on our Revolving Credit Facility.

Other income and expense

Total other income remained consistent, at less than $0.1 million during the three months ended September 30, 2007 and 2006.

Total other income decreased $0.2 million, or 59.6%, to $0.2 million during the nine months ended September 30, 2007, from $0.4 million during the nine months ended September 30, 2006. The decrease in other income was primarily attributable to additional expenses associated with our non-qualified employee benefit plan.

Provision for income taxes

During the three months ending September 30, 2007, we recorded an income tax expense of $1.7 million, reflecting an effective rate of 24.3% of pretax income. Our effective tax rate for the three months ended September 30, 2007, differed from the Federal statutory rate primarily due to the net effect of State taxes, the effect of permanent book versus tax differences, and the beneficial effect of a new effective State tax rate. The new State tax rate was a result of the receipt of a favorable ruling from a State tax authority granting

 

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us the right to a favorable filing methodology, and the recognition of the benefit of certain net operating losses generated in 2006. This new effective State tax rate resulted in a beneficial adjustment to our deferred taxes. For the three months ended September 30, 2006, we recorded an income tax provision of $3.7 million, reflecting an effective rate of 41.5% of pretax income. Our effective tax rate for the three months ended September 30, 2006, differed from the Federal statutory rate primarily due to the net effect of State taxes.

During the nine months ended September 30, 2007, we recorded an income tax provision of $5.1 million, reflecting an effective rate of 33.1% of pretax income. Our effective tax rate for the nine months ended September 30, 2007, differed from the Federal statutory rate primarily due to the net effect of State taxes, a new effective State tax rate, and the recognition of the benefit of certain State net operating losses generated in 2006. This new effective State tax rate resulted in a beneficial adjustment to our deferred taxes. For the nine months ended September 30, 2006, we recorded an income tax provision of $12.6 million, reflecting an effective rate of 42.1% of pretax income. Our effective tax rate for the nine months ended September 30, 2006, differed from the Federal statutory rate primarily due to the net effect of State taxes, and an adjustment for a 2003 tax audit. The decrease in our effective tax rate was the result of the changing mix of permanent book versus tax differences relative to taxable income. See Note 7 to the consolidated financial statements for a further discussion of income taxes.

During the third quarter of 2007, we filed certain amended State tax returns that generated refund claims in the amount of $0.9 million. Due to the uncertainty of realizing related refunds, we placed a reserve against the refunds in accordance with the Interpretation No. 48, “Accounting for Uncertainty in Income Taxes” (“FIN 48”) issued by the Financial Accounting Standards Board. See Note 7 to the consolidated financial statements for a further discussion of the impact of FIN 48 on our financial statements.

 

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Supplemental Performance Data

Cumulative Collections to Purchase Price Multiple

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

 

     Cumulative Collections through September 30, 2007
    

Purchase

Price1

    <2001    2001    2002    2003    2004    2005    2006    2007    Total2    CCM3

<1999

   $ 41,117 4   $ 88,629    $ 22,545    $ 15,007    $ 7,546    $ 4,202    $ 2,042    $ 1,513    $ 830    $ 142,314    3.5

1999

     48,712       29,163      19,174      16,259      11,508      8,654      5,157      3,513      1,576      95,004    2.0

2000

     6,153       5,489      7,172      4,542      4,377      2,293      1,323      1,007      472      26,675    4.3

2001

     38,186       —        21,197      54,184      33,072      28,551      20,622      14,521      4,657      176,804    4.6

2002

     61,501       —        —        48,322      70,227      62,282      45,699      33,694      12,171      272,395    4.4

2003

     88,534       —        —        —        59,038      86,958      69,932      55,131      22,053      293,112    3.3

2004

     101,349       —        —        —        —        39,400      79,845      54,832      28,199      202,276    2.0

2005

     192,882       —        —        —        —        —        66,491      129,809      87,511      283,811    1.5

2006

     142,136       —        —        —        —        —        —        42,354      71,320      113,674    0.8

2007

     133,631       —        —        —        —        —        —        —        40,626      40,626    0.3
                                                                           

Total

   $ 854,201     $ 123,281    $ 70,088    $ 138,314    $ 185,768    $ 232,340    $ 291,111    $ 336,374    $ 269,415    $ 1,646,691    1.9
                                                                           

1 Adjusted for put-backs, account recalls, purchase price rescissions, and the impact of an acquisition in 2000.
2 Cumulative collections from inception through September 30, 2007.
3 Cumulative Collections Multiple (“CCM”) – collections to date as a multiple of purchase price.
4 From inception to December 31, 1998.

Total Estimated Collections to Purchase Price Multiple

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

 

   

Purchase

Price1

   

Historical

Gross

Collections2

 

Estimated
Remaining
Gross

Collections3

 

Total
Estimated
Gross

Collections

 

Total Estimated Gross

Collections to
Purchase Price

<1999

  $ 41,117 4   $ 142,314   $ 867   $ 143,181   3.5

1999

    48,712       95,004     2,190     97,194   2.0

2000

    6,153       26,675     623     27,298   4.4

2001

    38,186       176,804     10,463     187,267   4.9

2002

    61,501       272,395     16,548     288,943   4.7

2003

    88,534       293,112     34,244     327,356   3.7

2004

    101,349       202,276     60,137     262,413   2.6

2005

    192,882       283,811     209,752     493,563   2.6

2006

    142,136       113,674     238,831     352,505   2.5

20075

    133,631       40,626     268,638     309,264   2.3
                             

Total

  $ 854,201     $ 1,646,691   $ 842,293   $ 2,488,984   2.9
                             

1

Adjusted for put-backs, account recalls, purchase price rescissions, and the impact of an acquisition in 2000.

2

Cumulative collections from inception through September 30, 2007.

3

Includes $1.9 million in expected collections for the healthcare portfolios in cost recovery.

4

From inception to December 31, 1998.

5

As of April 1, 2007, initial collection forecasts for portfolio purchases were extended from 54 or 60 months to 72 months.

 

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Estimated Remaining Gross Collections by Year of Purchase

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

 

     Estimated Remaining Gross Collections by Year of Purchase
     20071,2    2008    2009    2010    2011    2012    2013    Total

<1999

   $ 164    $ 479    $ 224    $ —      $ —      $ —      $ —      $ 867

1999

     390      1,209      591      —        —        —        —        2,190

2000

     106      336      181      —        —        —        —        623

2001

     1,231      4,703      3,144      1,280      105      —        —        10,463

2002

     3,281      10,016      2,315      905      31      —        —        16,548

2003

     5,519      20,110      8,615      —        —        —        —        34,244

2004

     7,737      25,814      17,645      8,941      —        —        —        60,137

2005

     24,482      83,265      51,319      35,821      14,722      125      18      209,752

2006

     20,468      74,174      53,426      41,602      33,020      16,141      —        238,831

2007

     16,830      77,570      66,369      46,389      32,602      22,636      6,242      268,638
                                                       

Total

   $ 80,208    $ 297,676    $ 203,829    $ 134,938    $ 80,480    $ 38,902    $ 6,260    $ 842,293
                                                       

1

2007 amount consists of three months data, from October 1, 2007 to December 31, 2007.

2

Includes $1.9 million in expected collections for the healthcare portfolios in cost recovery.

Unamortized Balances of Portfolios

The following table summarizes the remaining unamortized balances of our purchased receivable portfolios by year of purchase as of September 30, 2007 (in thousands, except percentages):

 

   

Unamortized

Balance as of

September 30,
20071

 

Purchase

Price2

 

Unamortized

Balance as a

Percentage of
Purchase Price

   

Unamortized

Balance as a

Percentage of Total

 

2002

  $ 2,649   $ 61,501   4.3 %   0.7 %

2003

    5,958     88,534   6.7 %   1.7 %

2004

    24,311     101,349   24.0 %   7.0 %

2005

    96,531     188,993   51.1 %   27.7 %

2006

    102,959     140,366   73.4 %   29.5 %

2007

    116,410     133,190   87.4 %   33.4 %
                       

Totals

  $ 348,818   $ 713,933   48.9 %   100.0 %
                       

1

Includes $1.9 million for the healthcare portfolios in cost recovery.

2

Purchase price refers to the cash paid to a seller to acquire a portfolio less the purchase price refunded by a seller due to the return of non-compliant accounts (also defined as put-backs) less the purchase price for accounts that were sold at the time of purchase to another debt purchaser.

Collections by Channel

During the three and nine months ended September 30, 2007 and 2006, we utilized several business channels for the collection of charged-off credit card receivables and other charged-off receivables. The following tables summarize gross collections by collection channel (in thousands):

 

     Three Months Ended September 30,    Nine Months Ended September 30,
     2007    2006    2007    2006

Collection sites

   $ 30,571    $ 28,449    $ 97,082    $ 103,310

Legal collections

     42,546      30,204      126,706      85,040

Collection agencies

     6,894      12,409      23,397      39,324

Sales

     4,992      4,094      20,261      13,188

Other

     627      625      2,336      1,721
                           

Gross collections for the period

   $ 85,630    $ 75,781    $ 269,782    $ 242,583
                           

 

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Table of Contents

External Collection Channels and Related Direct Costs

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

 

     Legal Collections     Collection Agencies  
     Three Months Ended September 30,     Three Months Ended September 30,  
     2007     2006     2007     2006  

Collections

   $ 42,546    100.0 %   $ 30,204    100.0 %   $ 6,894    100.0 %   $ 12,409    100.0 %

Commissions

     12,392    29.1 %     8,838    29.3 %     2,478    35.9 %     4,533    36.5 %

Court cost expense1

     8,195    19.3 %     3,674    12.2 %     —      —         —      —    

Other2

     281    0.6 %     33    0.1 %     —      —         —      —    
                                                    

Total Costs

   $ 20,868    49.0 %   $ 12,545    41.5 %   $ 2,478    35.9 %   $ 4,533    36.5 %
                                                    
     Legal Collections     Collection Agencies  
     Nine Months Ended September 30,     Nine Months Ended September 30,  
     2007     2006     2007     2006  

Collections

   $ 126,706    100.0 %   $ 85,040    100.0 %   $ 23,397    100.0 %   $ 39,324    100.0 %

Commissions

     37,240    29.4 %     26,464    31.1 %     8,639    36.9 %     14,178    36.1 %

Court cost expense1

     21,757    17.2 %     10,219    12.0 %     —      —         —      —    

Other2

     652    0.5 %     84    0.1 %     —      —         —      —    
                                                    

Total Costs

   $ 59,649    47.1 %   $ 36,767    43.2 %   $ 8,639    36.9 %   $ 14,178    36.1 %
                                                    

1

In connection with our agreement with contracted attorneys, we advance certain out-of-pocket court costs. We capitalize these costs in our consolidated financial statements and provide a reserve and corresponding court cost expense for the costs that we believe will be ultimately uncollectible. This amount includes changes in our anticipated recovery rate of court costs expensed.

2

Other costs consist primarily of costs related to counter claims.

 

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Table of Contents

Legal Outsourcing Collections and Related Costs

The following tables summarize our legal outsourcing collection channel performance and related direct costs (in thousands, except percentages):

 

     Gross Collections by Year of Collection1  

Placement Year

   2003     2004     2005     2006     20072     Total
Collections
 
2003    $ 10,750     $ 27,192     $ 17,212     $ 9,566     $ 4,501     $ 69,221  
2004      —       $ 23,455     $ 37,674     $ 21,676     $ 9,962     $ 92,767  
2005      —         —       $ 21,694     $ 40,762     $ 18,335     $ 80,791  
2006      —         —         —       $ 39,395     $ 66,623     $ 106,018  
20072      —         —         —         —       $ 23,548     $ 23,548  

1       Includes collections for accounts placed in our legal channel beginning January 1, 2003. We continue to collect on accounts placed in this channel prior to that date.

2       2007 amount consists of nine months data, from January 1, 2007, to September 30, 2007.

          

         

     Court Cost Expense by Year of Collection1  

Placement Year

  

2003

    2004     2005     2006     20072     Total Court
Costs
 
2003    $ 908     $ 2,046     $ 571     $ 300     $ 119     $ 3,944  
2004      —       $ 2,509     $ 2,937     $ 1,087     $ 324     $ 6,857  
2005      —         —       $ 3,271     $ 4,426     $ 713     $ 8,410  
2006      —         —         —       $ 10,158     $ 9,290     $ 19,448  
20072      —         —         —         —       $ 9,529     $ 9,529  

1       Includes court cost expense for accounts placed in our legal channel beginning January 1, 2003. We continue to incur court cost expense on accounts placed in this channel prior to this date.

2       2007 amount consists of nine months data, from January 1, 2007, to September 30, 2007.

          

         

     Commissions by Year of Collection1  

Placement Year

   2003     2004     2005     2006     20072     Total
Commissions
 
2003    $ 3,574     $ 8,606     $ 5,496     $ 2,898     $ 1,279     $ 21,853  
2004      —       $ 7,273     $ 12,060     $ 6,653     $ 2,916     $ 28,902  
2005      —         —       $ 6,725     $ 12,108     $ 5,291     $ 24,124  
2006      —         —         —       $ 11,451     $ 19,150     $ 30,601  
20072      —         —         —         —       $ 6,684     $ 6,684  

1       Includes commissions for accounts placed in our legal channel beginning January 1, 2003. We continue to incur commissions on collections for accounts placed in this channel prior to that date.

2       2007 amount consists of nine months data, from January 1, 2007, to September 30, 2007.

          

         

     Court Cost Expense and Commissions
as a Percentage of Gross Collections by Year of Collection
 

Placement Year

   2003     2004     2005     2006     20071     Cumulative
Average
 
2003      41.7 %     39.2 %     35.2 %     33.4 %     31.1 %     37.3 %
2004      —         41.7 %     39.8 %     35.7 %     32.5 %     38.7 %
2005      —         —         46.1 %     40.6 %     32.7 %     40.3 %
2006      —         —         —         54.9 %     42.7 %     47.2 %
20071      —         —         —         —         68.8 %     68.8 %

1       2007 amount consists of nine months data, from January 1, 2007, to September 30, 2007.

         

     Lawsuits Filed by Year1  

Placement Year2

   2003     2004     2005     2006     20073     Total Sued  

2003

     23       29       5       2       —         59  

2004

     —         59       39       11       1       110  

2005

     —         —         76       46       2       124  

2006

     —         —         —         205       93       298  

20073

     —         —         —         —         209       209  
                                                

Total Sued

     23       88       120       264       305       800  
                                                

1       Represents the year the account was placed into litigation.

2       Represents the year the account was placed into our legal channel.

3       2007 amount consists of nine months data, from January 1, 2007, to September 30, 2007.

         

         

         

 

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Table of Contents

Changes in Investment in Receivable Portfolios

Revenue related to our investment in receivable portfolios consists of two components. First, revenue from those portfolios that have a remaining book value and are accounted for on the accrual basis (“Accrual Basis Portfolios”), and second, revenue from those portfolios that have fully recovered their cost basis, for which every dollar of gross collections is recorded as Zero Basis Revenue (“Zero Basis Portfolios”).

If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, we account for such portfolios on the cost recovery method (“Cost Recovery Portfolios”). The accounts in these portfolios have different risk characteristics than those included in other portfolios acquired during the same quarter, or the necessary information was not available to estimate future cash flows and, accordingly, they were not aggregated with other portfolios. Under the cost recovery method of accounting, no income is recognized until the purchase price of a Cost Recovery Portfolio has been fully recovered. As of September 30, 2007, there were six portfolios accounted for using the cost recovery method, consisting of $1.9 million in net book value of investment in receivable portfolios and representing all of the healthcare portfolios that we have acquired.

In September 2007, we decided that we would exit our healthcare purchasing and collection activities because we had not achieved our profitability targets in this asset class. We are in the process of either selling our healthcare portfolios or placing the underlying accounts with external agencies for collections. Since we are no longer actively working these accounts, we have placed them on cost recovery. The $1.9 million net book value, which has been reduced by a $1.4 million impairment charge reflects the value that we expect to realize in a sale or through the collection activities of the external agencies.

 

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Table of Contents

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

     For the Three Months Ended September 30, 2007  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 327,586     $ —       $ —       $ 327,586  

Purchases of receivable portfolios

     47,869       —         —         47,869  

Transfer of healthcare receivables

     (3,241 )     3,241       —         —    

Gross collections1

     (82,213 )     —         (3,090 )     (85,303 )

Put-backs and recalls2

     (523 )     —         —         (523 )

Revenue recognized1

     59,920       —         3,090       63,010  

Impairment, net

     (2,430 )     —         —         (2,430 )

Write-down of healthcare receivables

     —         (1,391 )     —         (1,391 )
                                

Balance, end of period

   $ 346,968     $ 1,850     $ —       $ 348,818  
                                

Revenue as a percentage of collections

     69.9 %     0.0 %     100.0 %     69.4 %
                                
     For the Three Months Ended September 30, 2006  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 250,445     $ 2,992     $ —       $ 253,437  

Purchases of receivable portfolios

     32,334       —         —         32,334  

Gross collections1

     (68,929 )     (507 )     (5,866 )     (75,302 )

Put-backs and recalls2

     (707 )     —         —         (707 )

Revenue recognized1

     51,910       —         5,866       57,776  

Impairment, net

     (814 )     —         —         (814 )
                                

Balance, end of period

   $ 264,239     $ 2,485     $ —       $ 266,724  
                                

Revenue as a percentage of collections

     74.1 %     0.0 %     100.0 %     75.6 %
                                
     For the Nine Months Ended September 30, 2007  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 300,348     $ —       $ —       $ 300,348  

Purchases of receivable portfolios

     134,392       —         —         134,392  

Transfer of healthcare receivables

     (3,241 )     3,241       —         —    

Gross collections1

     (256,943 )     —         (11,754 )     (268,697 )

Put-backs and recalls2

     (2,097 )     —         —         (2,097 )

Revenue recognized1

     175,676       —         11,754       187,430  

Impairment, net

     (1,167 )     —         —         (1,167 )

Write-down of healthcare receivables

     —         (1,391 )     —         (1,391 )
                                

Balance, end of period

   $ 346,968     $ 1,850     $ —       $ 348,818  
                                

Revenue as a percentage of collections

     67.9 %     0.0 %     100.0 %     68.8 %
                                

 

     For the Nine Months Ended September 30, 2006  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 255,299     $ 1,034     $ —       $ 256,333  

Purchases of receivable portfolios

     77,064       3,623       —         80,687  

Gross collections1

     (220,469 )     (2,172 )     (18,382 )     (241,023 )

Put-backs and recalls2

     (2,689 )     —         (2 )     (2,691 )

Revenue recognized1

     155,702       —         18,384       174,086  

Impairments, net

     (668 )     —         —         (668 )
                                

Balance, end of period

   $ 264,239     $ 2,485     $ —       $ 266,724  
                                

Revenue as a percentage of collections

     70.3 %     0.0 %     100.0 %     72.0 %
                                

1

For accrual basis portfolios, the weighted average annualized effective interest rate is the accrual rate utilized in recognizing revenue on our Accrual Basis Portfolios. This rate represents the monthly internal rate of return, which has been annualized utilizing the simple interest method. The monthly internal rate of return is determined based on the timing and amounts of actual cash received to date and the anticipated future cash flow projections for each pool.

2

Represents accounts that are returned to or recalled by the seller in accordance with the respective purchase agreement.

 

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Table of Contents

As of September 30, 2007, we had $349.0 million in investment in receivable portfolios. This balance will be amortized based upon current projections of cash collections in excess of revenue applied to the principal balance. The estimated amortization of the investment in receivable portfolio balance is as follows (in thousands):

 

For the Years Ended December 31,

   Amortization

20071

   $ 19,574

2008

     99,838

2009

     80,683

2010

     65,726

2011

     48,515

2012

     28,970

2013

     5,512
      

Total

   $ 348,818
      

1

2007 amount consists of three months data from October 1, 2007 to December 31, 2007.

Analysis of Changes in Revenue

The following tables analyze the components of the increase in revenue from our receivable portfolios for the three and nine months ended September 30, 2007, compared to the three and nine months ended September 30, 2006 (in thousands, except percentages):

 

     For The Three Months Ended September 30,  

Variance Component

   2007     2006     Change    

Revenue

Variance

 

Average portfolio balance

   $ 331,113     $ 254,993     $ 76,120     $ 15,251  

Weighted average effective interest rate1

     67.8 %     80.2 %     (12.4 )%     (10,249 )

Zero basis revenue

   $ 3,090     $ 5,866         (2,776 )

Retained interest revenue

   $ 226     $ 284         (58 )
              

Total variance

         $ 2,168  
              

 

     For The Nine Months Ended September 30,  

Variance Component

   2007     2006     Change     Revenue
Variance
 

Average portfolio balance

   $ 314,481     $ 252,163     $ 62,318     $ 38,313  

Weighted average effective interest rate1

     73.4 %     82.0 %     (8.6 )%     (20,230 )

Zero basis revenue

   $ 11,754     $ 18,384         (6,630 )

Retained interest revenue

   $ 718     $ 1,007         (289 )
              

Total variance

         $ 11,164  
              

1

For Accrual Basis Portfolios, the weighted average annualized effective interest rate is the accrual rate utilized in recognizing revenue on our accrual basis portfolios. This rate represents the monthly internal rate of return, which has been annualized utilizing the simple interest method. The monthly internal rate of return is determined based on the timing and amounts of actual cash received to date and the anticipated future cash flow projections for each pool.

 

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Table of Contents

Purchases by Quarter

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

 

Quarter

   # of
Accounts
   Face Value    Purchase
Price
   Forward Flow
Allocation2

Q1 2004

   400    $ 786,398    $ 17,248    $ —  

Q2 2004

   296      758,877      19,031      —  

Q3 2004

   365      721,237      20,967      —  

Q4 2004

   530      1,195,090      46,128      —  

Q1 2005

   513      530,047      19,523      —  

Q2 20051

   2,773      3,675,277      121,939      —  

Q3 2005

   434      381,508      14,151      2,330

Q4 2005

   1,568      1,326,216      39,941      1,935

Q1 2006

   673      558,574      27,091      2,403

Q2 2006

   837      594,190      21,262      2,118

Q3 2006

   1,469      1,081,892      32,334      2,939

Q4 2006

   814      1,439,826      63,600      3,184

Q1 2007

   1,434      2,510,347      45,386      3,539

Q2 2007

   1,042      1,341,148      41,137      2,949

Q3 2007

   659      1,281,468      47,869      2,680

1

Purchase price for Q2 2005 includes a $0.9 million cost adjustment associated with the finalization of the Jefferson Capital purchase price allocation.

2

Allocation of the forward flow asset to the cost basis of receivable portfolio purchases.

Purchases by Paper Type

The following tables summarize the types of charged-off consumer receivable portfolios we purchased for the three and nine months ended September 30, 2007 and 2006 (in thousands):

 

     Three Months Ended
September 30,
   Nine Months Ended
September 30,
     2007    2006    2007    2006

Credit card

   $ 40,971    $ 12,078    $ 121,232    $ 37,995

Other

     6,898      20,256      13,160      42,692
                           
   $ 47,869    $ 32,334    $ 134,392    $ 80,687
                           

 

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Table of Contents

Liquidity and Capital Resources

Overview

Historically, we have met our cash requirements by utilizing our cash flows from operations, bank borrowings and equity offerings. Our primary cash requirements have included the purchase of receivable portfolios, operational expenses, the payment of interest and the repayment of principal on bank borrowings and tax payments. Our strong operating performance has resulted in an increase in stockholders’ equity to $166.0 million as of September 30, 2007, from $151.1 million as of December 31, 2006.

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

 

     Nine Months ended September 30,  
     2007     2006  

Net cash provided by operating activities

   $ 2,843     $ 25,753  

Net cash used in investing activities

     (42,999 )     (5,056 )

Net cash provided by (used in) financing activities

     33,843       (11,420 )

On December 31, 2004, our Secured Financing Facility expired. All of our portfolio purchases are now funded with cash or financed under our $200.0 million Revolving Credit Facility. Unlike our Secured Financing Facility, our Revolving Credit Facility does not require us to share with the lender the residual collections on the portfolios financed. See Note 6 to the consolidated financial statements for a further discussion on our Revolving Credit Facility, Secured Financing Facility and Contingent Interest.

On May 7, 2007, we entered into an agreement with the lender under our Secured Financing Facility to eliminate all future Contingent Interest payments, for the one-time payment of $16.9 million. As a result, beginning in May 2007, we are no longer obligated to make future Contingent Interest payments under this facility.

Operating Cash Flows

Net cash provided by operating activities was $2.8 million for the nine months ended September 30, 2007, compared to $25.8 million in net cash provided by operating activities for the nine months ended September 30, 2006. The reduction in net cash provided by operating activities was primarily due to an increase of $24.7 million in cash basis operating expenses, a $4.7 million increase in Contingent Interest payments, an increase of $14.3 million in amounts applied to principal on receivable portfolios, and an increase of $6.6 million in income tax payments, offset by an increase of $27.2 million in gross collections. The increase in operating expenses was primarily related to an increase in the payment of upfront court costs

Interest payments were $32.9 million for the nine months ended September 30, 2007, compared to $27.6 million for the nine months ended September 30, 2006. The increase in interest expense was due to the one-time Contingent Interest payment discussed above, offset by the elimination of Contingent Interest payments subsequent to May 2007. Gross collections for the nine months ended September 30, 2007, grew $27.2 million, or 11.2%, to $269.8 million, from $242.6 million for the nine months ended September 30, 2006.

 

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Table of Contents

Investing Cash Flows

Net cash used in investing activities was $43.0 million for the nine months ended September 30, 2007, compared to $5.1 million net cash provided by investing activities for the nine months ended September 30, 2006.

The cash flows used in investing activities for the nine months ended September 30, 2007 are primarily related to cash receivable portfolio purchases of $125.2 million ($134.4 million of gross purchases less our forward flow allocation of $9.2 million), offset by gross collection proceeds applied to the principal of our receivable portfolios in the amount of $81.3 million. The cash flows used in investing activities for the nine months ended September 30, 2006 are primarily related to cash receivable portfolio purchases of $73.2 million ($80.7 million of gross purchases less our forward flow allocation of $7.5 million), offset by gross collection proceeds applied to the principal of our receivable portfolios in the amount of $66.9 million.

Capital expenditures for fixed assets acquired with internal cash flows were $1.1 million and $1.4 million for the nine months ended September 30, 2007 and 2006, respectively.

Financing Cash Flows

Net cash provided by (used in) financing activities was $33.8 million and $(11.4) million for the nine months ended September 30, 2007 and 2006, respectively.

The cash provided by financing activities during the nine months ended September 30, 2007 reflects $53.0 million in borrowings, offset by $20.0 million in repayments under our Revolving Credit Facility. The cash provided by financing activities during the nine months ended September 30, 2006, reflects $35.6 million in repayments of notes payable and amounts outstanding under our line of credit and other borrowings, offset by $23.5 million in borrowings under our Revolving Credit Facility. The increase in borrowings for the nine months ended September 30, 2007 was directly related to the increase in receivable portfolio purchases discussed above.

Future Contractual Cash Obligations

The following table summarizes our future contractual cash obligations as of September 30, 2007 (in thousands):

 

     Payments Due by Period
     Total    Less Than
1 Year
  

1 – 3

Years

   3 – 5
Years
  

More
Than

5 Years

Capital lease obligations

   $ 279    $ 250    $ 29    $ —      $ —  

Operating leases

     9,320      1,832      2,549      2,124      2,815

Employment agreements

     289      289      —        —        —  

Revolving Credit Facility

     132,669      —        132,669      —        —  

Contractual interest on derivative instruments

     7,706      2,500      4,478      728      —  

3.375% Convertible Senior Notes

     100,000      —        100,000      —        —  

Contractual interest on 3.375% Convertible Senior Notes

     10,125      3,375      6,750      —        —  

Portfolio forward flow agreement

     90,701      32,982      57,719      —        —  
                                  

Total contractual cash obligations

   $ 351,089    $ 41,228    $ 304,194    $ 2,852    $ 2,815
                                  

 

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Our Revolving Credit Facility has a remaining term of 2.7 years and to the extent that a balance is outstanding on our Revolving Credit Facility, it would be due in May 2010. Interest on the Revolving Credit Facility is variable and is not included in this table. The outstanding balance on our Revolving Credit Facility as of September 30, 2007, was $132.7 million. The portfolio forward flow agreement represents estimated payments under our five-year portfolio purchase forward flow agreement entered into on September 7, 2005. For additional information on our debt, see Note 6 to the consolidated financial statements. Also, for additional information on purchase commitments see Note 9 to the consolidated financial statements.

We are in compliance with all covenants under our financing arrangements and, excluding the effects of the one-time payment of $16.9 million to eliminate all future Contingent Interest payments in the second quarter of 2007 (this payment, less amounts accrued on our balance sheet, resulted in a charge to our statement of operations of $6.9 million after the effect of income taxes), we have achieved twenty-three consecutive quarters of positive net income. We believe that we have sufficient liquidity to fund our operations for at least the next twelve months, given our expectation of continued positive cash flows from operations, our cash and cash equivalents of $4.5 million as of September 30, 2007, and $67.3 million in borrowing capacity and borrowing base availability under our Revolving Credit Facility as of September 30, 2007.

Off Balance Sheet Arrangements

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

 

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Item 3. Quantitative and Qualitative Disclosures about Market Risk

For quantitative and qualitative disclosures about market risk affecting Encore, see Item 7A, “Quantitative and Qualitative Disclosures About Market Risk,” of our Annual Report on Form 10-K for the fiscal year ended December 31, 2006, which is incorporated herein by reference. Our exposure to market risk has not changed materially since December 31, 2006.

Item 4. Controls and Procedures

Evaluation of Disclosure Controls and Procedures

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

Based on their most recent evaluation, as of the end of the period covered by this Quarterly Report on Form 10-Q, our Chief Executive Officer and Chief Financial Officer have concluded our disclosure controls and procedures, as defined in Rules 13a-15(e) and 15d-15(e) of the Securities Exchange Act of 1934 (“Exchange Act”), as amended, are effective.

Changes in Internal Control over Financial Reporting

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

 

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PART II—OTHER INFORMATION

Item 1. Legal Proceedings

On October 18, 2004, Timothy W. Moser, one of our former officers, filed an action in the United States District Court for the Southern District of California against us, and certain individuals, including several of our officers and directors. On February 14, 2005, we were served with an amended complaint in this action alleging defamation, intentional interference with contractual relations, breach of contract, breach of the covenant of good faith and fair dealing, intentional and negligent infliction of emotional distress and civil conspiracy arising out of certain statements in our Registration Statement on Form S-1 originally filed in September 2003 and alleged to be included in our Registration Statement on Form S-3 originally filed in May 2004. The amended complaint seeks injunctive relief, economic and punitive damages in an unspecified amount plus an award of profits allegedly earned by the defendants and alleged co-conspirators as a result of the alleged conduct, in addition to attorney’s fees and costs. On May 2, 2006, the court denied our special motion to strike pursuant to California’s anti-SLAPP statute, denied in part and granted in part our motion to dismiss, denied a variety of ex parte motions and applications filed by the plaintiff and denied the plaintiff’s motion for leave to conduct discovery or file supplemental briefing. The court granted the plaintiff 30 days in which to further amend his complaint, and on September 1, 2006, the plaintiff filed a second amended complaint in which he amended his claim for negligent infliction of emotional distress. On May 25, 2006, we filed a notice of appeal of the court’s order denying the anti-SLAPP motion, which is pending. On September 16, 2006, we filed a motion to stay the case pending the outcome of the appeal. This motion was granted on March 27, 2007. On April 9, 2007, the plaintiff filed a motion requesting an accelerated early neutral evaluation conference, which the court denied on April 16, 2007. Our management believes the claims are without merit and intends to vigorously defend the action. Although the outcome of this matter cannot be predicted with certainty, management does not currently believe that this matter will have a material adverse effect on our consolidated financial position or results of operations.

On September 7, 2005, Mr. Moser filed a related action in the United States District Court for the Southern District of California against Triarc Companies, Inc. (“Triarc”), which at the time, was a significant stockholder of ours, alleging intentional interference with contractual relations and intentional infliction of emotional distress. The case arises out of the same statements made or alleged to have been made in our Registration Statements mentioned above. On January 7, 2006, Triarc was served with an amended complaint seeking injunctive relief, an order directing Triarc to issue a statement of retraction or correction of the allegedly false statements, economic and punitive damages in an unspecified amount and attorney’s fees and costs. Triarc tendered the defense of this action to us, and we accepted the defense and will indemnify Triarc, pursuant to the indemnification provisions of the Registration Rights Agreements dated as of October 31, 2000 and February 21, 2002, and the Underwriting Agreements dated September 25, 2004 and January 20, 2005 to which Triarc is a party. Although the outcome of this matter cannot be predicted with certainty, management does not currently believe that this matter will have a material adverse effect on our consolidated financial position or results of operations.

 

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Claims based on the Fair Debt Collection Practices Act (“FDCPA”) and comparable state statutes may result in class action lawsuits, which can be material to us due to the remedies available under these statutes, including punitive damages. A number of cases styled as class actions have been filed against us. To date, a class has been certified in two of these cases. Several of these cases present novel issues on which there is no legal precedent. As a result, we are unable to predict the range of possible outcomes. There are a number of other lawsuits or claims pending or threatened against us. In general, these lawsuits, claims and counterclaims have arisen in the ordinary course of business and involve claims for actual damages arising from alleged misconduct or improper reporting of credit information by our employees or us. Although litigation is inherently uncertain, based on past experience, established reserves, the information currently available and the possible availability of insurance and/or indemnification from originating institutions in some cases, our management does not believe that the currently pending and threatened litigation or claims will have a material adverse effect on our consolidated financial position or results of operations. However, future events or circumstances, currently unknown to management, will determine whether the resolution of pending or threatened litigation or claims will ultimately have a material effect on our consolidated financial position, liquidity or results of operations in any future reporting periods.

Item 1A. Risk Factors

This Quarterly Report on Form 10-Q contains “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933, as amended (the “Securities Act”), and Section 21E of the Securities Exchange Act of 1934, as amended (the “Exchange Act”), which we believe are subject to certain safe harbors. Many statements, other than statements of historical facts, included or incorporated into this Quarterly Report on Form 10- Q are forward-looking statements. The words “believe,” “expect,” “anticipate,” “estimate,” “project,” “intend,” “plan,” “will,” “may,” and similar expressions often characterize forward-looking statements. These statements may include, but are not limited to, projections of collections, revenues, income or loss, estimates of capital expenditures, plans for future operations, products or services, and financing needs or plans, as well as assumptions relating to these matters. In particular, these statements may be found, among other places, under the “Management’s Discussion and Analysis of Financial Condition and Results of Operations” and “Risk Factors” sections.

Although we believe that the expectations reflected in these forward-looking statements are reasonable, we caution you that these expectations or predictions may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control or cannot be predicted or quantified, that could cause actual results to differ materially from those suggested by the forward-looking statements. Many factors, including but not limited to those set forth below, could cause our actual results, performance, achievements, or industry results to be very different from the results, performance or achievements expressed or implied by these forward-looking statements. Our business, financial condition or results of operations could also be materially and adversely affected by other factors besides those listed. These factors include, but are not limited to, the following:

 

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Our quarterly operating results may fluctuate and cause the prices of our common stock and convertible notes to decrease;

 

 

We may not be able to purchase receivables at sufficiently favorable prices or terms, or at all;

 

 

We may not be successful in acquiring and collecting on portfolios consisting of new types of receivables;

 

 

We may not be able to collect sufficient amounts on our receivable portfolios to recover our costs and fund our operations;

 

 

We may purchase portfolios that contain unprofitable accounts;

 

 

The statistical model we use to project remaining cash flows from our receivable portfolios may prove to be inaccurate, which could result in reduced revenues or the recording of an impairment charge if we do not achieve the collections forecasted by our model;

 

 

Our industry is highly competitive, and we may be unable to continue to compete successfully with businesses that may have greater resources than we have;

 

 

Our failure to purchase sufficient quantities of receivable portfolios may necessitate workforce reductions, which may harm our business;

 

 

A significant portion of our portfolio purchases during any period may be concentrated with a small number of sellers;

 

 

We may be unable to meet our future liquidity requirements;

 

 

We may not be able to continue to satisfy the restrictive covenants in our debt agreements;

 

 

We use estimates in our revenue recognition, and our earnings will be reduced if actual results are less than estimated;

 

 

We may incur impairment charges based on the provisions of American Institute of Certified Public Accountants Statement of Position 03-03;

 

 

Government regulation may limit our ability to recover and enforce the collection of receivables;

 

 

Failure to comply with government regulation could result in the suspension or termination of our ability to conduct business;