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, 2012

OR

 

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

For the transition period from              to              .

COMMISSION FILE NUMBER: 000-26489

 

 

ENCORE CAPITAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   48-1090909

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

3111 Camino Del Rio North, Suite 1300

San Diego, California

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

(877) 445 - 4581

(Registrant’s telephone number, including area code)

(Not Applicable)

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

 

 

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

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

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

 

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

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

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

 

Class

   Outstanding at October 16, 2012

Common Stock, $0.01 par value

   25,002,062 shares

 

 

 


Table of Contents

ENCORE CAPITAL GROUP, INC.

INDEX TO FORM 10-Q

 

     Page  

PART I – FINANCIAL INFORMATION

     1   

Item 1— Condensed Consolidated Financial Statements (Unaudited)

     1   

Condensed Consolidated Statements of Financial Condition

     1   

Condensed Consolidated Statements of Comprehensive Income

     2   

Condensed Consolidated Statements of Stockholders’ Equity

     3   

Condensed Consolidated Statements of Cash Flows

     4   

Notes to Condensed Consolidated Financial Statements (Unaudited)

     5   

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

     23   

Item 3 – Quantitative and Qualitative Disclosures About Market Risk

     41   

Item 4 – Controls and Procedures

     41   

PART II – OTHER INFORMATION

     42   

Item 1 – Legal Proceedings

     42   

Item 1A – Risk Factors

     42   

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

     43   

Item 6 – Exhibits

     44   

SIGNATURES

     45   


Table of Contents

PART I – FINANCIAL INFORMATION

Item 1 – Condensed Consolidated Financial Statements (Unaudited)

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Financial Condition

(In Thousands, Except Par Value Amounts)

(Unaudited)

 

     September 30,
2012
    December 31,
2011
 
Assets     

Cash and cash equivalents

   $ 19,263      $ 8,047   

Accounts receivable, net

     2,471        3,265   

Investment in receivable portfolios, net

     811,620        716,454   

Deferred court costs, net

     37,561        38,506   

Property tax payment agreements receivable, net

     135,190        —     

Interest receivable

     4,180        —     

Property and equipment, net

     19,771        17,796   

Other assets

     23,068        11,968   

Goodwill

     55,446        15,985   

Identifiable intangible assets, net

     515        462   
  

 

 

   

 

 

 

Total assets

   $ 1,109,085      $ 812,483   
  

 

 

   

 

 

 
Liabilities and stockholders’ equity     

Liabilities:

    

Accounts payable and accrued liabilities

   $ 43,108      $ 29,628   

Deferred tax liabilities, net

     17,532        15,709   

Debt

     615,131        388,950   

Other liabilities

     2,132        6,661   
  

 

 

   

 

 

 

Total liabilities

     677,903        440,948   
  

 

 

   

 

 

 

Commitments and contingencies

    

Stockholders’ equity:

    

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

     —          —     

Common stock, $.01 par value, 50,000 shares authorized, 25,002 shares and 24,520 shares issued and outstanding as of September 30, 2012 and December 31, 2011, respectively

     250        245   

Additional paid-in capital

     133,005        123,406   

Accumulated earnings

     299,162        249,852   

Accumulated other comprehensive loss

     (1,235     (1,968
  

 

 

   

 

 

 

Total stockholders’ equity

     431,182        371,535   
  

 

 

   

 

 

 

Total liabilities and stockholders’ equity

   $ 1,109,085      $ 812,483   
  

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements

 

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Table of Contents

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Comprehensive Income

(In Thousands, Except Per Share Amounts)

(Unaudited)

 

     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Revenues

        

Revenue from receivable portfolios, net

   $ 140,682      $ 115,843      $ 405,818      $ 332,262   

Tax lien transfer

        

Interest income

     5,585        —          8,567        —     

Interest expense

     (1,475     —          (2,125     —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Net interest income

     4,110        —          6,442        —     
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     144,792        115,843        412,260        332,262   
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Salaries and employee benefits

     25,397        20,087        72,891        57,458   

Cost of legal collections

     43,544        40,169        123,203        117,364   

Other operating expenses

     14,829        9,904        38,854        26,944   

Collection agency commissions

     4,227        3,264        12,352        10,774   

General and administrative expenses

     14,091        10,704        46,331        29,471   

Depreciation and amortization

     1,533        1,054        4,193        2,916   
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     103,621        85,182        297,824        244,927   
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     41,171        30,661        114,436        87,335   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) income

        

Interest expense

     (7,012     (5,175     (19,024     (16,137

Other income (expense)

     1,036        (342     1,385        (182
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     (5,976     (5,517     (17,639     (16,319
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     35,195        25,144        96,797        71,016   

Provision for income taxes

     (13,887     (9,834     (38,393     (27,658
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     21,308        15,310        58,404        43,358   

Income (loss) from discontinued operations, net of tax

     —          60        (9,094     466   
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 21,308      $ 15,370      $ 49,310      $ 43,824   
  

 

 

   

 

 

   

 

 

   

 

 

 

Weighted average shares outstanding:

        

Basic

     25,071        24,638        24,930        24,493   

Diluted

     26,047        25,604        25,920        25,636   

Basic earnings (loss) per share from:

        

Continuing operations

   $ 0.85      $ 0.62      $ 2.34      $ 1.77   

Discontinued operations

   $ 0.00      $ 0.00      $ (0.36   $ 0.02   

Net basic earnings per share

   $ 0.85      $ 0.62      $ 1.98      $ 1.79   

Diluted earnings (loss) per share from:

        

Continuing operations

   $ 0.82      $ 0.60      $ 2.25      $ 1.69   

Discontinued operations

   $ 0.00      $ 0.00      $ (0.36   $ 0.02   

Net diluted earnings per share

   $ 0.82      $ 0.60      $ 1.90      $ 1.71   

Other comprehensive gain (loss):

        

Unrealized gain (loss) on derivative instruments

     3,027        (2,042     1,205        (2,094

Income tax (provision) benefit related to unrealized gain (loss) on derivative instruments

     (1,186     796        (472     819   
  

 

 

   

 

 

   

 

 

   

 

 

 

Other comprehensive gain (loss), net of tax

     1,841        (1,246     733        (1,275
  

 

 

   

 

 

   

 

 

   

 

 

 

Comprehensive income

   $ 23,149      $ 14,124      $ 50,043      $ 42,549   
  

 

 

   

 

 

   

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements

 

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Table of Contents

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Stockholders’ Equity

(Unaudited, In Thousands)

 

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

Balance at December 31, 2011

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

Net income

     —           —           —          49,310         —          49,310   

Unrealized gain on derivative instruments, net of tax

     —           —           —          —           733        733   

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

     482         5         (618     —           —          (613

Stock-based compensation

     —           —           6,710        —           —          6,710   

Tax benefit related to stock-based compensation

     —           —           3,507        —           —          3,507   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

Balance at September 30, 2012

     25,002       $ 250       $ 133,005      $ 299,162       $ (1,235   $ 431,182   
  

 

 

    

 

 

    

 

 

   

 

 

    

 

 

   

 

 

 

See accompanying notes to condensed consolidated financial statements

 

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Table of Contents

ENCORE CAPITAL GROUP, INC.

Condensed Consolidated Statements of Cash Flows

(Unaudited, In Thousands)

 

     Nine Months Ended
September 30,
 
     2012     2011  

Operating activities:

    

Net income

   $ 49,310      $ 43,824   

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

    

Depreciation and amortization

     4,193        2,916   

Impairment charge for goodwill and identifiable intangible assets

     10,400        —     

Amortization of loan costs and premium on property tax payment agreements receivable

     2,091        1,367   

Stock-based compensation expense

     6,710        5,980   

Income tax provision in excess of (less than) income tax payments

     1,823        (1,472

Excess tax benefit from stock-based payment arrangements

     (3,600     (4,904

Loss on sale of discontinued operations

     2,416        —     

(Reversal) provision for allowances on receivable portfolios, net

     (1,506     8,109   

Changes in operating assets and liabilities, net of effects of acquisition

    

Other assets

     (20     1,944   

Deferred court costs

     945        (3,968

Prepaid income tax and income taxes payable

     (8,407     3,423   

Accounts payable, accrued liabilities and other liabilities

     1,798        1,012   
  

 

 

   

 

 

 

Net cash provided by operating activities

     66,153        58,231   
  

 

 

   

 

 

 

Investing activities:

    

Cash paid for acquisition, net of cash acquired

     (186,731     —     

Purchases of receivable portfolios

     (408,757     (250,107

Collections applied to investment in receivable portfolios, net

     313,205        234,726   

Proceeds from put-backs of receivable portfolios

     1,892        2,343   

Originations of property tax payment agreements receivable

     (22,912     —     

Collections applied to property tax payment agreements receivable, net

     24,967        —     

Purchases of property and equipment

     (3,665     (3,458
  

 

 

   

 

 

 

Net cash used in investing activities

     (282,001     (16,496
  

 

 

   

 

 

 

Financing activities:

    

Payment of loan costs

     (1,832     (835

Proceeds from senior secured notes

     —          25,000   

Proceeds from revolving credit facilities

     390,399        61,000   

Repayment of revolving credit facilities

     (163,048     (127,000

Proceeds from exercise of stock options

     5,181        1,287   

Taxes paid related to net share settlement of equity awards

     (2,287     (3,476

Excess tax benefit from stock-based payment arrangements

     3,600        4,904   

Repayment of capital lease obligations

     (4,949     (2,848
  

 

 

   

 

 

 

Net cash provided by (used in) financing activities

     227,064        (41,968
  

 

 

   

 

 

 

Net increase (decrease) in cash and cash equivalents

     11,216        (233

Cash and cash equivalents, beginning of period

     8,047        10,905   
  

 

 

   

 

 

 

Cash and cash equivalents, end of period

   $ 19,263      $ 10,672   
  

 

 

   

 

 

 

Supplemental disclosures of cash flow information:

    

Cash paid for interest

   $ 18,634      $ 14,591   

Cash paid for income taxes

     36,840        24,860   

Supplemental schedule of non-cash investing and financing activities:

    

Fixed assets acquired through capital lease

     2,817        2,434   

See accompanying notes to condensed consolidated financial statements

 

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ENCORE CAPITAL GROUP, INC.

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

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

Encore Capital Group, Inc. (“Encore”), through its subsidiaries (collectively, the “Company”), is a leading provider of debt management and recovery solutions for consumers and property owners across a broad range of assets. The Company purchases portfolios of defaulted consumer receivables and manages them by partnering with individuals as they repay their obligations and work toward financial recovery. Defaulted receivables are consumers’ unpaid financial commitments to credit originators, including banks, credit unions, consumer finance companies, commercial retailers, auto finance companies, and telecommunication companies, which the Company purchases at deep discounts. Defaulted receivables may also include receivables subject to bankruptcy proceedings, or consumer bankruptcy receivables. In addition, through its subsidiary, Propel Financial Services, LLC (“Propel”), the Company assists Texas property owners who are delinquent on their property taxes by paying these taxes on behalf of the property owners in exchange for payment agreements collateralized by tax liens on the property.

Portfolio purchasing and recovery

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

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

Tax lien transfer

Propel’s principal activity is originating and servicing property tax lien transfers in the state of Texas. With the property owner’s consent, Propel pays the property owner’s delinquent property taxes directly to the taxing authority, which then transfers its tax lien to Propel. Propel then enters into a payment agreement with the property owner creating an affordable payment plan. Tax lien transfers provide the local taxing authorities with much needed tax revenue and property owners with an alternative method to paying their property tax bills in one lump sum. Tax lien transfers typically carry a lower interest rate and fee structure than what the local taxing authority would charge. Based in San Antonio, Texas, Propel is the largest tax lien transfer company in Texas.

Financial Statement Preparation

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

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

 

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

Basis of Consolidation

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

On May 8, 2012, the Company completed its acquisition of Propel, BNC Retax, LLC, RioProp Ventures, LLC, and certain related affiliates (collectively, the “Propel Entities”). The condensed consolidated statements of comprehensive income for the three and nine months ended September 30, 2012 include the results of operations of the Propel Entities since the date of acquisition. For additional acquisition related information relating to the Propel Entities, please refer to the Company’s Current Report on Form 8-K filed with the SEC on July 24, 2012.

Reclassification

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

Note 2: Discontinued Operations

On May 16, 2012, the Company completed the sale of substantially all of the assets and certain of the liabilities of its bankruptcy servicing subsidiary Ascension Capital Group, Inc. (“Ascension”) to a subsidiary of American InfoSource, L.P. (“AIS”). As part of the sale, the Company agreed to fund certain, agreed-upon operating losses in the first year of AIS’ ownership of the Ascension business, not to exceed $4.0 million. If the Ascension business becomes profitable under AIS’ ownership, the Company will be paid an earn-out equal to 30 to 40% of Ascension’s EBITDA for the first five years commencing May 16, 2012. The Company received no proceeds from the sale. Additionally, the Company recognized the entire $4.0 million loss contingency during the second quarter of 2012.

The Company performed an interim goodwill impairment test for Ascension as of March 31, 2012 and concluded that the entire goodwill balance relating to Ascension of $9.9 million was impaired. Additionally, the Company wrote-off the remaining identifiable intangible assets of approximately $0.4 million relating to Ascension as of March 31, 2012.

Ascension’s operations are presented as discontinued operations for the three and nine months ended September 30, 2012 and 2011, in the Company’s consolidated statements of comprehensive income. The following table presents the revenue and components of discontinued operations, net of tax (in thousands):

 

     Three Months  Ended
September 30,
    Nine Months Ended
September 30,
 
     2012      2011     2012     2011  

Revenue

   $ —         $ 4,716      $ 5,704      $ 14,409   
  

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations before income taxes

   $ —         $ 94      $ (11,942   $ 763   

Income tax (expense) benefit

     —           (34     4,678        (297
  

 

 

    

 

 

   

 

 

   

 

 

 

Income (loss) from discontinued operations

     —           60        (7,264     466   
  

 

 

    

 

 

   

 

 

   

 

 

 

Loss on sale of discontinued operations, before income taxes

     —           —          (2,416     —     

Income tax benefit

     —           —          586        —     
  

 

 

    

 

 

   

 

 

   

 

 

 

Loss on sale of discontinued operations

     —           —          (1,830     —     
  

 

 

    

 

 

   

 

 

   

 

 

 

Total income (loss) from discontinued operations

   $ —         $ 60      $ (9,094   $ 466   
  

 

 

    

 

 

   

 

 

   

 

 

 

 

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Note 3: Business Combination

On May 8, 2012, the Company acquired all of the outstanding equity interests of the Propel Entities (the “Propel Acquisition”) for $186.8 million in cash. The Propel Acquisition is being accounted for using the acquisition method of accounting and, accordingly, the tangible and intangible assets acquired and liabilities assumed were recorded at their estimated fair values as of the date of the acquisition.

The Company has completed an independent valuation study and determined the fair value of the assets acquired and the liabilities assumed from the Propel Entities. Fair value measurements have been applied based on assumptions that market participants would use in the pricing of the respective assets and liabilities.

The components of the purchase price allocation for the Propel Entities are as follows (in thousands):

 

Purchase price:

  

Cash paid at acquisition

   $ 186,814   

Purchase price adjustment

     741   
  

 

 

 

Total purchase price

   $ 187,555   
  

 

 

 

Allocation of purchase price:

  

Cash

   $ 824   

Accounts receivable

     1,049   

Interest receivable

     3,679   

Property tax payment agreements receivable

     132,978   

Fixed assets

     461   

Other assets

     860   

Liabilities assumed

     (2,265

Identifiable intangible assets

     570   

Goodwill

     49,399   
  

 

 

 

Total net assets acquired

   $ 187,555   
  

 

 

 

The following summary presents unaudited pro forma consolidated results of operations for the three and nine months ended September 30, 2012 and 2011 as if the Propel Acquisition had occurred on January 1, 2012 and 2011, respectively. The following unaudited pro forma financial information does not necessarily reflect the actual results that would have occurred had the Company and the Propel Entities been combined during the periods presented, nor is it necessarily indicative of the future results of operations of the combined companies (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Consolidated pro forma revenue

   $ 144,792       $ 120,189       $ 418,767       $ 344,466   

Consolidated pro forma income from continuing operations

     21,308         16,336         62,016         45,462   

Note 4: Earnings per Share

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

 

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012     2011  

Income from continuing operations

   $ 21,308       $ 15,310       $ 58,404      $ 43,358   

Income (loss) from discontinued operations, net of tax

     —           60         (9,094     466   
  

 

 

    

 

 

    

 

 

   

 

 

 

Net income available for common stockholders

   $ 21,308       $ 15,370       $ 49,310      $ 43,824   
  

 

 

    

 

 

    

 

 

   

 

 

 

Weighted average common shares outstanding – basic

     25,071         24,638         24,930        24,493   

Dilutive effect of stock-based awards

     976         966         990        1,143   
  

 

 

    

 

 

    

 

 

   

 

 

 

Weighted average common shares outstanding – diluted

     26,047         25,604         25,920        25,636   
  

 

 

    

 

 

    

 

 

   

 

 

 

Basic earnings (loss) per share from:

          

Continuing operations

   $ 0.85       $ 0.62       $ 2.34      $ 1.77   

Discontinued operations

   $ 0.00       $ 0.00       $ (0.36   $ 0.02   

Net basic earnings per share

   $ 0.85       $ 0.62       $ 1.98      $ 1.79   

Diluted earnings (loss) per share from:

          

Continuing operations

   $ 0.82       $ 0.60       $ 2.25      $ 1.69   

Discontinued operations

   $ 0.00       $ 0.00       $ (0.36   $ 0.02   

Net diluted earnings per share

   $ 0.82       $ 0.60       $ 1.90      $ 1.71   

Employee stock options to purchase approximately 210,000 and 335,000 shares of common stock during the three and nine months ended September 30, 2012, respectively, and employee stock options to purchase approximately 209,000 and 153,000 shares of common stock during the three and nine months ended September 30, 2011, respectively, were outstanding but not included in the computation of diluted earnings per share because the effect on diluted earnings per share would be anti-dilutive.

Note 5: Fair Value Measurements

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

 

   

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

 

   

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

 

   

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

Financial instruments required to be carried at fair value

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

 

     Fair Value Measurements as of September 30, 2012  
     Level 1      Level 2     Level 3      Total  

Assets

          

Foreign currency exchange contracts

   $ —         $ 46      $ —         $ 46   

Liabilities

          

Interest rate swap agreements

     —           (1,023     —           (1,023

Foreign currency exchange contracts

     —           (1,035     —           (1,035

 

8


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

Assets

          

Foreign currency exchange contracts

   $ —         $ 168      $ —         $ 168   

Liabilities

          

Interest rate swap agreements

     —           (1,014     —           (1,014

Foreign currency exchange contracts

     —           (2,371     —           (2,371

Fair values of derivative instruments included in Level 2 are estimated using industry standard valuation models. These models project future cash flows and discount the future amounts to a present value using market-based observable inputs including interest rate curves, foreign currency exchange rates, and forward and spot prices for currencies.

Financial instruments not required to be carried at fair value

The Company records its investment in receivable portfolios at cost, which represents a significant discount from the contractual receivable balances due. The Company computes the fair value of its investment in receivable portfolios by discounting the estimated future cash flows, generated by its proprietary forecasting models, using an estimated market participant discount rate. Using this method, the fair value of investment in receivable portfolios was approximately $1.2 billion and $1.0 billion as of September 30, 2012 and December 31, 2011, respectively. A 100 basis point fluctuation in the discount rate used would result in an increase or decrease in the fair value by approximately $20.0 million as of September 30, 2012. This fair value calculation does not represent, and should not be construed to represent, the underlying value of the Company or the amount which could be realized if its investment in receivable portfolios were sold. The carrying value of the investment in receivable portfolios was $811.6 million and $716.5 million as of September 30, 2012 and December 31, 2011, respectively.

The Company capitalizes deferred court costs and provides a reserve for those costs that it believes will ultimately be uncollectible. The carrying value of net deferred court costs approximates fair value.

The fair value of property tax payment agreements receivable is estimated by discounting the future cash flows of the portfolio using a discount rate equivalent to the current rate at which similar property tax payment agreements receivable would be originated. The carrying value of property tax payment agreements receivable approximates fair value. Additionally, the carrying value of interest receivable approximates fair value.

Borrowings under the Company’s revolving credit facilities are carried at historical cost, adjusted for additional borrowings less principal repayments, which approximates fair value.

Note 6: Derivatives and Hedging Instruments

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

Interest Rate Swaps

The Company may periodically enter into derivative financial instruments, typically interest rate swap agreements, to reduce its exposure to fluctuations in interest rates on variable interest rate debt and their impact on earnings and cash flows. As of September 30, 2012, the Company had six interest rate swap agreements outstanding with a total notional amount of $150.0 million. Under the swap agreements, the Company receives floating interest rate payments based on one-month reserve-adjusted LIBOR and makes interest payments based on fixed interest rates. The Company intends to continue electing the one-month reserve-adjusted LIBOR as the benchmark interest rate on the debt being hedged through its term. No credit spread was hedged. The Company designates its interest rate swap instruments as cash flow hedges.

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

Foreign Currency Exchange Contracts

The Company has operations in India, which exposes the Company to foreign currency exchange rate fluctuations due to transactions denominated in Indian rupees, such as employee salaries and rent expenditures. To mitigate this risk, the Company enters into derivative financial instruments, principally forward contracts, which are designated as cash flow hedges, to mitigate fluctuations

 

9


Table of Contents

in the cash payments of future forecasted transactions in Indian rupees for up to 36 months. The Company adjusts the level and use of derivatives as soon as practicable after learning that an exposure has changed. The Company reviews all exposures and derivative positions on an ongoing basis.

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

As of September 30, 2012, the total notional amount of the forward contracts to buy Indian rupees in exchange for U.S. dollars was $41.6 million. All outstanding contracts qualified for hedge accounting treatment as of September 30, 2012. The Company estimates that approximately $0.6 million of net derivative loss included in OCI will be reclassified into earnings within the next 12 months. No gains or losses were reclassified from OCI into earnings as a result of forecasted transactions that failed to occur during the three and nine months ended September 30, 2012 and 2011.

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

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

 

     September 30, 2012     December 31, 2011  
   Balance Sheet
Location
     Fair Value     Balance Sheet
Location
     Fair Value  

Derivatives designated as hedging instruments:

          

Interest rate swaps

     Other liabilities       $ (1,023     Other liabilities       $ (1,014

Foreign currency exchange contracts

     Other assets         46        Other assets         168   

Foreign currency exchange contracts

     Other liabilities         (1,035     Other liabilities         (2,371

The following tables summarize the effects of derivatives in cash flow hedging relationships on the Company’s statements of comprehensive income during the periods presented (in thousands):

 

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

Income - Effective
Portion
   Gain or (Loss)
Reclassified
from OCI into
Income - Effective
Portion
     Location of
Gain or (Loss)
Recognized -
Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing
  Amount of
Gain or (Loss)
Recognized -
Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing
 
     Three Months Ended
September 30,
         Three Months Ended
September 30,
         Three Months Ended
September 30,
 
     2012      2011          2012     2011          2012      2011  

Interest rate swaps

   $ 62       $ (795   Interest expense    $ —        $ —         Other (expense)
income
  $ —         $ —     

Foreign currency exchange contracts

     2,131         (984   Salaries and
employee
benefits
     (389     27       Other (expense)
income
    —           —     

Foreign currency exchange contracts

     377         (230   General and
administrative
expenses
     (69     6       Other (expense)
income
    —           —     

 

10


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

Income - Effective
Portion
   Gain or (Loss)
Reclassified
from OCI into
Income - Effective
Portion
     Location of
Gain or (Loss)
Recognized -
Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing
   Amount of
Gain or (Loss)
Recognized -
Ineffective
Portion and
Amount
Excluded from
Effectiveness
Testing
 
     Nine Months Ended
September 30,
         Nine Months Ended
September 30,
          Nine Months Ended
September 30,
 
     2012     2011          2012     2011           2012      2011  

Interest rate swaps

   $ (9   $ (1,361   Interest expense    $ —        $ —         Other (expense)
income
   $ —         $ —     

Foreign currency exchange contracts

     (69     (387   Salaries and
employee
benefits
     (946     194       Other (expense)
income
     —           —     

Foreign currency exchange contracts

     173        (108   General and
administrative
expenses
     (164     44       Other (expense)
income
     —           —     

Note 7: Stock-Based Compensation

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

In accordance with authoritative guidance for stock-based compensation, compensation expense is recognized only for those shares expected to vest, based on the Company’s historical experience and future expectations. Total stock-based compensation expense during the three months ended September 30, 2012 and 2011 was $1.9 million and $2.4 million, respectively. Total stock-based compensation expense during the nine months ended September 30, 2012 and 2011 was $6.7 million and $6.0 million, respectively.

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

Stock Options

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

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

 

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

 

     Nine Months Ended September 30,  
     2012     2011  

Weighted average fair value of options granted

   $ 11.77      $ 13.26   

Risk free interest rate

     0.89     2.0

Dividend yield

     0.0     0.0

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

     63     61

Weighted-average expected life of options

     5 Years        5 Years   

Unrecognized compensation cost related to stock options as of September 30, 2012, was $2.5 million. The weighted-average remaining expense period, based on the unamortized value of these outstanding stock options, was approximately 1.9 years.

A summary of the Company’s stock option activity as of September 30, 2012, and changes during the nine months then ended, is presented below:

 

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

Outstanding at December 31, 2011

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

Granted

     193,500        22.17        22.17      

Cancelled/forfeited

     —                 —        

Exercised

     (322,443     0.51 – 20.09         4.52      
  

 

 

   

 

 

    

 

 

    

Outstanding at September 30, 2012

     2,053,997      $ 1.30 – $24.65       $ 15.19       $ 26,837   
  

 

 

   

 

 

    

 

 

    

Exercisable at September 30, 2012

     1,644,169      $ 1.30 – $24.65       $ 13.49       $ 24,282   
  

 

 

   

 

 

    

 

 

    

The total intrinsic value of options exercised during the nine months ended September 30, 2012 and 2011 was $7.5 million and $10.2 million, respectively. As of September 30, 2012, the weighted-average remaining contractual life of options outstanding and options exercisable was 5.82 years and 5.09 years, respectively.

Non-Vested Shares

Under the Company’s 2005 Plan, Board members, employees, officers and executives of, and consultants and advisors to the Company are eligible to receive restricted stock units and restricted stock awards. In accordance with the authoritative guidance, the fair value of these non-vested shares is equal to the closing sale price of the Company’s common stock on the date of issuance. The total number of these awards expected to vest is adjusted by estimated forfeiture rates. As of September 30, 2012, 16,437 of the non-vested shares are expected to vest over approximately one year based on certain performance goals (“Performance-Based Awards”). The fair value of the Performance-Based Awards is expensed over the expected vesting period, net of estimated forfeitures. If performance goals are not expected to be met, the compensation expense previously recognized would be reversed. No reversals of compensation expense related to the Performance-Based Awards have been made as of September 30, 2012. The remaining 740,773 non-vested shares are not performance-based, and will vest over approximately one to three years of continuous service.

A summary of the status of the Company’s restricted stock units and restricted stock awards as of September 30, 2012, and changes during the nine months then ended, is presented below:

 

     Non-Vested
Shares
    Weighted Average
Grant Date
Fair Value
 

Non-vested at December 31, 2011

     589,117      $ 19.22   

Awarded

     462,291      $ 24.45   

Vested

     (251,785   $ 16.50   

Cancelled/forfeited

     (42,413   $ 22.26   
  

 

 

   

Non-vested at September 30, 2012

     757,210      $ 23.15   
  

 

 

   

Unrecognized compensation expense related to non-vested shares as of September 30, 2012, was $10.3 million. The weighted-average remaining expense period, based on the unamortized value of these outstanding non-vested shares, was approximately 2.2 years. The fair value of restricted stock units and restricted stock awards vested during the nine months ended September 30, 2012 and 2011 was $5.8 million and $6.0 million, respectively.

 

12


Table of Contents

Note 8: Investment in Receivable Portfolios, Net

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

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

The Company utilizes its proprietary forecasting models to continuously evaluate the economic life of each pool. The collection forecast of each pool is generally estimated to be between 84 to 96 months based on the expected collection period of each pool. The Company often experiences collections beyond the 84 to 96 month collection forecast. As of September 30, 2012, the total estimated remaining collections beyond the 84 to 96 month collection forecast was $103.4 million.

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

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

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

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

 

     Accretable
Yield
    Estimate of
Zero Basis
Cash Flows
    Total  

Balance at December 31, 2011

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

Revenue recognized, net

     (119,340     (7,065     (126,405

Net additions to existing portfolios(1)

     131,039        3,608        134,647   

Additions for current purchases(1)

     119,533        —          119,533   
  

 

 

   

 

 

   

 

 

 

Balance at March 31, 2012

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

 

 

   

 

 

   

 

 

 

Revenue recognized, net

     (131,624     (7,107     (138,731

Net additions to existing portfolios(1)

     77,473        13,738        91,211   

Additions for current purchases(1)

     178,332        —          178,332   
  

 

 

   

 

 

   

 

 

 

Balance at June 30, 2012

   $ 1,076,940      $ 35,850      $ 1,112,790   

Revenue recognized, net

     (134,294     (6,387     (140,681

Net additions to existing portfolios(1)

     71,729        (2,041     69,688   

Additions for current purchases(1)

     36,387        —          36,387   
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2012

   $ 1,050,762      $ 27,422      $ 1,078,184   
  

 

 

   

 

 

   

 

 

 

 

(1) 

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

 

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Table of Contents
     Accretable
Yield
    Estimate of
Zero Basis
Cash Flows
    Total  

Balance at December 31, 2010

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

Revenue recognized, net

     (101,709     (3,617     (105,326

Net additions to existing portfolios

     18,715        2,948        21,663   

Additions for current purchases

     93,098        —          93,098   
  

 

 

   

 

 

   

 

 

 

Balance at March 31, 2011

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

Revenue recognized, net

     (106,961     (4,132     (111,093

Net additions to existing portfolios

     15,575        3,900        19,475   

Additions for current purchases

     95,532        —          95,532   
  

 

 

   

 

 

   

 

 

 

Balance at June 30, 2011

   $ 754,035      $ 3,373      $ 757,408   

Revenue recognized, net

     (110,215     (5,628     (115,843

Net additions to existing portfolios

     82,505        32,491        114,996   

Additions for current purchases

     59,434        —          59,434   
  

 

 

   

 

 

   

 

 

 

Balance at September 30, 2011

   $ 785,759      $ 30,236      $ 815,995   
  

 

 

   

 

 

   

 

 

 

During the three months ended September 30, 2012, the Company purchased receivable portfolios with a face value of $1.1 billion for $47.3 million, or a purchase cost of 4.5% of face value. The estimated future collections at acquisition for these portfolios amounted to $80.4 million. During the nine months ended September 30, 2012, the Company purchased receivable portfolios with a face value of $10.0 billion for $408.8 million, or a purchase cost of 4.1% of face value. The estimated future collections at acquisition for these portfolios amounted to $717.3 million.

During the three months ended September 30, 2011, the Company purchased receivable portfolios with a face value of $2.0 billion for $65.7 million, or a purchase cost of 3.2% of face value. The estimated future collections at acquisition for these portfolios amounted to $121.0 million. During the nine months ended September 30, 2011, the Company purchased receivable portfolios with a face value of $7.9 billion for $250.1 million, or a purchase cost of 3.2% of face value. The estimated future collections at acquisition for these portfolios amounted to $485.3 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, 2012 and 2011, Zero Basis Revenue was approximately $5.5 million and $4.2 million, respectively. During the nine months ended September 30, 2012 and 2011, Zero Basis Revenue was approximately $17.6 million and $10.1 million, respectively.

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

 

     Three Months Ended September 30, 2012  
     Accrual Basis
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 869,859      $ —        $ 869,859   

Purchases of receivable portfolios

     47,311        —          47,311   

Gross collections(1)

     (239,577     (6,388     (245,965

Put-backs and recalls(2)

     (267     —          (267

Revenue recognized

     134,496        5,469        139,965   

(Portfolio allowances) portfolio allowance reversals, net

     (202     919        717   
  

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 811,620      $ —        $ 811,620   
  

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections (3)

     56.1     85.6     56.9
  

 

 

   

 

 

   

 

 

 

 

     Three Months Ended September 30, 2011  
     Accrual Basis
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 657,783      $ —        $ 657,783   

Purchases of receivable portfolios

     65,731        —          65,731   

Gross collections(1)

     (183,406     (5,624     (189,030

Put-backs and recalls(2)

     (641     (4     (645

Revenue recognized

     113,275        4,173        117,448   

(Portfolio allowances) portfolio allowance reversals, net

     (3,060     1,455        (1,605
  

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 649,682      $ —        $ 649,682   
  

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections (3)

     61.8     74.2     62.1
  

 

 

   

 

 

   

 

 

 

 

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Table of Contents
     Nine Months Ended September 30, 2012  
     Accrual Basis
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 716,454      $ —        $ 716,454   

Purchases of receivable portfolios

     408,757        —          408,757   

Gross collections(1)

     (696,957     (20,560     (717,517

Put-backs and recalls(2)

     (1,892     —          (1,892

Revenue recognized

     386,685        17,627        404,312   

(Portfolio allowances) portfolio allowance reversals, net

     (1,427     2,933        1,506   
  

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 811,620      $ —        $ 811,620   
  

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections (3)

     55.5     85.7     56.3
  

 

 

   

 

 

   

 

 

 

 

     Nine Months Ended September 30, 2011  
     Accrual Basis
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 644,753      $ —        $ 644,753   

Purchases of receivable portfolios

     250,107        —          250,107   

Gross collections(1)

     (561,724     (13,373     (575,097

Put-backs and recalls(2)

     (2,339     (4     (2,343

Revenue recognized

     330,264        10,107        340,371   

(Portfolio allowances) portfolio allowance reversals, net

     (11,379     3,270        (8,109
  

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 649,682      $ —        $ 649,682   
  

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections (3)

     58.8     75.6     59.2
  

 

 

   

 

 

   

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

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

(3) 

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

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

 

     Valuation Allowance  
     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Balance at beginning of period

   $ 108,705      $ 105,175      $ 109,494      $ 98,671   

Provision for portfolio allowances

     1,616        4,753        5,491        13,401   

Reversal of prior allowances

     (2,333     (3,148     (6,997     (5,292
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ 107,988      $ 106,780      $ 107,988      $ 106,780   
  

 

 

   

 

 

   

 

 

   

 

 

 

 

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Legal collections

   $ 111,334       $ 94,932       $ 335,782       $ 281,504   

Collection sites

     116,928         83,301         338,439         256,418   

Collection agencies

     17,715         10,825         43,344         37,236   

Other

     —           —           —           54   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 245,977       $ 189,058       $ 717,565       $ 575,212   
  

 

 

    

 

 

    

 

 

    

 

 

 

Note 9: Property Tax Payment Agreements Receivable, Net

The Company’s portfolio of property tax payment agreements receivable primarily consists of payment agreements collateralized by tax liens on residential and commercial properties in the state of Texas. The tax liens are in a priority position to most other liens on the properties, including those that existed at the time the tax lien was transferred from the respective taxing authority to the Company. Repayment of residential and commercial property tax payment agreements receivable is generally dependent on the property owner. However, repayment may ultimately come through payments from other lien holders or foreclosure on the properties. Risk of loss is mitigated by the Company’s internal underwriting policies, including its policy relating to the amount of taxes it will pay relative to the value of the property. The Company will generally not originate a tax lien transfer if this percentage is in excess of 25% and, in most cases, this percentage is below 15%.

The Company evaluates the entire portfolio of property tax payment agreements receivable for impairment. The primary credit quality indicator the Company uses to evaluate its portfolio is lien to value ratio. The Company has not experienced any losses on the property tax payment agreements receivable in its portfolio. In addition, management believes, based on the fact that the tax liens that collateralize the payment agreements are in a priority position over most other liens on the properties, that it will not experience any material losses on the ultimate collection of its property tax payment agreements receivable. Therefore, no allowance has been provided for as of September 30, 2012.

The following table presents the Company’s aging analysis of property tax payment agreements receivable as of September 30, 2012. These amounts do not include the related deferred origination fees or premiums on purchased property tax payment agreements receivable (in thousands):

 

     Current      30-59 Days
Past Due
     60-89 Days
Past Due
     >90 Days
Past Due
     Total  

Property tax payment agreements receivable

   $ 103,856       $ 4,021       $ 8,610       $ 21,729       $ 138,216   

Note 10: Deferred Court Costs, Net

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

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

 

     September 30,
2012
    December 31,
2011
 

Court costs advanced

   $ 252,150      $ 228,977   

Court costs recovered

     (74,082     (60,017

Court costs reserve

     (140,507     (130,454
  

 

 

   

 

 

 
   $ 37,561      $ 38,506   
  

 

 

   

 

 

 

 

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A roll forward of the Company’s court cost reserve is as follows (in thousands):

 

     Court Cost Reserve  
     Three Months Ended
September 30,
    Nine Months Ended
September 30,
 
     2012     2011     2012     2011  

Balance at beginning of period

   $ (132,780   $ (122,920   $ (130,454   $ (113,239

Provision for court costs

     (13,378     (14,126     (37,536     (41,063

Write-off of reserve after the 36th month

     5,651        9,694        27,483        26,950   
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance at end of period

   $ (140,507   $ (127,352   $ (140,507   $ (127,352
  

 

 

   

 

 

   

 

 

   

 

 

 

Note 11: Other Assets

Other assets consist of the following (in thousands):

 

     September 30,
2012
     December 31,
2011
 

Prepaid income tax

   $ 8,460       $ 53   

Debt issuance costs, net of amortization

     4,371         4,293   

Prepaid expenses

     4,607         5,232   

Security deposit—India building lease

     1,631         1,482   

Deferred compensation assets

     735         722   

Recoverable legal fees

     1,092         —     

Real estate owned

     441         —     

Other

     1,731         186   
  

 

 

    

 

 

 
   $ 23,068       $ 11,968   
  

 

 

    

 

 

 

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

Note 12: Debt

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

 

     September 30,
2012
     December 31,
2011
 

Revolving credit facility

   $ 410,000       $ 305,000   

Propel facility

     122,351         —     

Senior secured notes

     75,000         75,000   

Capital lease obligations and other

     7,780         8,950   
  

 

 

    

 

 

 
   $ 615,131       $ 388,950   
  

 

 

    

 

 

 

Revolving Credit Facility

On April 10 and May 8, 2012, Encore entered into amendments to its revolving credit facility. The amendments added new lenders, appointed a new administrative agent, changed the borrowing base advance rate and the method for its calculation, increased the aggregate revolving loan commitment by $145.0 million, from $410.5 million to $555.5 million, and reset the accordion feature by an additional $100.0 million, resulting in a maximum of $655.5 million that can be borrowed under the facility. Additionally, the May 8, 2012 amendment approved the Propel Acquisition discussed in Note 3 “Business Combination.”

Loan fees and other loan costs associated with the above amendments amounted to approximately $0.9 million. These costs were included in other assets in the Company’s consolidated statements of financial condition and will be amortized over the remaining term of the facility.

Provisions of the amended revolving credit facility include:

 

   

Interest at a floating rate equal to, at the Company’s option, either: (1) reserve adjusted LIBOR, plus a spread that ranges from 350 to 400 basis points, depending on the Company’s cash flow leverage ratio; or (2) Alternate Base Rate (“ABR”),

 

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plus a spread that ranges from 250 to 300 basis points, depending on the Company’s cash flow leverage ratio. ABR, as defined in the agreement, means the highest of (i) the rate of interest publicly announced by SunTrust Bank as its prime rate in effect at its principal office in Atlanta, Georgia, (ii) the federal funds effective rate from time to time, plus 0.5% and (iii) reserved adjusted LIBOR for a one month interest period on the applicable date, plus 1.0%;

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

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

 

   

An annual capital expenditure limit of $12.5 million;

 

   

An annual rental expense limit of $12.5 million;

 

   

An outstanding capital lease limit of $12.5 million;

 

   

An acquisition limit of $100.0 million; and

 

   

Collateralization by all assets of the Company, other than the assets of the Propel Entities.

At September 30, 2012, the outstanding balance on the revolving credit facility was $410.0 million, which bore a weighted average interest rate of 4.16% and 4.13% for the three and nine months ended September 30, 2012, respectively. As discussed above, on April 10 and May 8, 2012, Encore entered into amendments to its revolving credit facility, thereby increasing the aggregate revolving loan commitment by $145.0 million.

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

Propel Facility

In connection with the Propel Acquisition, as discussed in Note 3 “Business Combination,” the Company entered into a new $160.0 million syndicated loan facility (the “Propel Facility”). The Company financed the Propel Acquisition using the Propel Facility, Encore’s existing revolving credit facility, and cash on hand. In addition to funding a portion of the Propel Acquisition, the Propel Facility will be used to fund future growth at Propel.

Loan fees and other loan costs associated with the Propel Facility amounted to approximately $0.7 million. These costs are included in other assets in the Company’s consolidated statements of financial condition and are amortized over the term of the Propel Facility.

The Propel Facility has a three-year term and includes the following key provisions:

 

   

Interest at Propel’s option, at either: (1) LIBOR, plus a spread that ranges from 300 to 375 basis points, depending on Propel’s cash flow leverage ratio; or (2) Prime Rate, which is defined in the agreement as the rate of interest per annum equal to the sum of (a) the interest rate quoted in the “Money Rates” section of The Wall Street Journal from time to time and designated as the “Prime Rate” plus (b) the Prime Rate Margin, which is a spread that ranges from 0 to 75 basis points, depending on Propel’s cash flow leverage ratio;

 

   

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

 

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Interest payable monthly; principal and interest due at maturity;

 

   

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 lender to terminate the Propel Facility and declare all amounts outstanding to be immediately due and payable; and

 

   

A $40.0 million accordion feature.

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

At September 30, 2012, the outstanding balance on the Propel Facility was $122.4 million, which bore a weighted average interest rate of 3.54% and 3.56% for the three months ended September 30, 2012 and the period from acquisition (May 8, 2012) through September 30, 2012, respectively.

Senior Secured Notes

As of September 30, 2012, Encore had $75.0 million in senior secured notes with certain affiliates of Prudential Capital Group. Twenty five million dollars of the senior secured notes bear an annual interest rate of 7.375% and mature in 2018. These notes require quarterly interest only payments through May 2013. Beginning in May 2013, the notes require a quarterly payment of interest plus $1.25 million of principal. The remaining $50.0 million of the senior secured notes bear an annual interest rate of 7.75% and mature in 2017 with principal amortization beginning in December 2012. These notes require quarterly interest only payments through December 2012. Beginning in December 2012, the notes require a quarterly payment of interest plus $2.5 million of principal.

The senior secured notes are guaranteed in full by certain of Encore’s subsidiaries. Similar to the revolving credit facility, the senior secured notes are also collateralized by all assets of the Company, other than the assets of the Propel Entities. The senior secured notes may be accelerated and become automatically and immediately due and payable upon certain events of default, including certain events related to insolvency, bankruptcy or liquidation. Additionally, the senior secured notes may be accelerated at the election of the holder or holders of a majority in principal amount of the senior secured notes upon certain events of default by Encore, including the breach of affirmative covenants regarding guarantors, collateral, most favored lender treatment or minimum revolving credit facility commitment or the breach of any negative covenant. If Encore prepays the senior secured notes at any time for any reason, payment will be at the higher of par or the present value of the remaining scheduled payments of principal and interest on the portion being prepaid. The discount rate used to determine the present value is 50 basis points over the then current Treasury Rate corresponding to the remaining average life of the senior secured notes. The covenants are substantially similar to those in the revolving credit facility. Prudential Capital Group and the administrative agent for the lenders of the revolving credit facility have an intercreditor agreement related to pro rata rights to the collateral, actionable default, powers and duties and remedies, among other topics. Certain terms of the senior secured notes were amended on May 8, 2012, to provide for the change in administrative and collateral agent, the Propel Acquisition, and the addition of the Propel Facility.

Capital Lease Obligations

The Company has capital lease obligations primarily for certain computer equipment. As of September 30, 2012, the Company’s combined obligations for these computer equipment leases were approximately $7.5 million. These lease obligations require monthly or quarterly payments through July 2016 and have implicit interest rates that range from zero to approximately 7.7%.

Note 13: Income Taxes

During the three months ended September 30, 2012, the Company recorded an income tax provision of $13.9 million, reflecting an effective rate of 39.5% of pretax income from continuing operations. The effective tax rate for the three months ended September 30, 2012 consisted primarily of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.5%, and a provision due to permanent book versus tax differences of 0.3%.

During the three months ended September 30, 2011, the Company recorded an income tax provision of $9.8 million, reflecting an effective rate of 39.1% of pretax income from continuing operations. The effective tax rate for the three months ended September 30, 2011 consisted primarily of a provision for federal income taxes of 32.8% (which is net of a benefit for state taxes of 2.2%), a blended provision for state taxes of 6.2%, and a net provision for permanent book versus tax differences of 0.1%.

During the nine months ended September 30, 2012, the Company recorded an income tax provision of $38.4 million, reflecting an effective rate of 39.7% of pretax income from continuing operations. The effective tax rate for the nine months ended September 30, 2012, consisted primarily of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a provision for state taxes of 6.5%, and a provision due to permanent book versus tax differences of 0.5%.

 

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During the nine months ended September 30, 2011, the Company recorded an income tax provision of $27.7 million, reflecting an effective rate of 38.9% of pretax income from continuing operations. The effective tax rate for the nine months ended September 30, 2011, consisted primarily of a provision for federal income taxes of 32.8% (which is net of a benefit for state taxes of 2.2%), a provision for state taxes of 6.2%, and a benefit for permanent book versus tax differences of 0.1%.

The Company’s subsidiary in Costa Rica is operating under a 100% tax holiday for the next eight years and a 50% tax holiday for the subsequent four years. The impact of the tax holiday in Costa Rica for the three and nine months ended September 30, 2012 was immaterial.

As of September 30, 2012, the Company had a gross unrecognized tax benefit of $1.5 million that, if recognized, would result in a net tax benefit of approximately $0.9 million and would have a positive effect on the Company’s effective tax rate. During the three and nine months ended September 30, 2012, there was a reduction in the gross unrecognized tax benefit of $0.4 million.

During the three and nine months ended September 30, 2012, the Company did not provide for United States income taxes or foreign withholding taxes on the quarterly undistributed earnings from continuing operations of its subsidiaries operating outside of the United States. Undistributed earnings of these subsidiaries during the three and nine months ended September 30, 2012, were approximately $2.1 million and $5.8 million, respectively. Such undistributed earnings are considered permanently reinvested.

Note 14: Purchase Concentrations

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

 

     Nine Months Ended
September 30, 2012
 
   Cost     %  

Seller 1

   $ 130,592        31.9

Seller 2

     81,843        20.0

Seller 3

     59,527        14.6

Seller 4

     30,469        7.5

Seller 5

     30,418        7.4

Other sellers

     75,908        18.6
  

 

 

   

 

 

 
   $ 408,757        100.0

Adjustments(1)

     (334  
  

 

 

   

Purchases, net

   $ 408,423     
  

 

 

   

 

(1) 

Adjusted for Put-backs and Recalls.

Note 15: Commitments and Contingencies

Litigation

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

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

In certain legal proceedings, the Company may have recourse to insurance or third party contractual indemnities to cover all or portions of its litigation expenses, judgments, or settlements. In accordance with authoritative guidance, the Company records loss contingencies in its financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated with no best estimate in the range, the Company records the minimum estimated liability. The Company continuously assesses the potential liability related to the Company’s pending litigation and revises its estimates when additional information becomes available. As of September 30, 2012, the Company has no material reserves for litigation. Additionally, based on the current status of litigation matters, either the estimate of exposure is immaterial to the Company’s financial statements or an estimate cannot yet be determined. The Company’s legal costs are recorded to expense as incurred.

 

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Purchase Commitments

In the normal course of business, the Company enters into forward flow purchase agreements and other purchase commitment agreements. As of September 30, 2012, the Company has entered into agreements to purchase receivable portfolios with a face value of approximately $861.4 million for a purchase price of approximately $46.7 million. The Company has no purchase commitments extending past one year.

Note 16: Segment Information

The Company conducts business through two operating segments: portfolio purchasing and recovery and tax lien transfer. The Company’s management relies on internal management reporting processes that provide segment revenue, segment operating income, and segment asset information in order to make financial decisions and allocate resources. The operating results from the Company’s tax lien transfer segment are immaterial to the Company’s total consolidated operating results. However, total assets from this segment are significant as compared to the Company’s total consolidated assets. As a result, in accordance with authoritative guidance on segment reporting, the Company’s tax lien transfer segment is determined to be a reportable segment.

Segment operating income includes income from operations before depreciation, amortization of intangible assets, and stock-based compensation expense. The following table provides a reconciliation of revenue and segment operating income by reportable segment to consolidated results and was derived from the segment’s internal financial information as used for corporate management purposes (in thousands):

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Revenues:

           

Portfolio purchasing and recovery

   $ 140,682       $ 115,843       $ 405,818       $ 332,262   

Tax lien transfer (1)

     4,110         —           6,442         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 144,792       $ 115,843       $ 412,260       $ 332,262   
  

 

 

    

 

 

    

 

 

    

 

 

 

Operating income:

           

Portfolio purchasing and recovery

   $ 42,554       $ 34,120       $ 122,465       $ 96,231   

Tax lien transfer (1)

     2,055         —           2,874         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
     44,609         34,120         125,339         96,231   

Depreciation and amortization

     1,533         1,054         4,193         2,916   

Stock-based compensation

     1,905         2,405         6,710         5,980   

Other expense

     5,976         5,517         17,639         16,319   
  

 

 

    

 

 

    

 

 

    

 

 

 

Income from continuing operations before income taxes

   $ 35,195       $ 25,144       $ 96,797       $ 71,016   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Nine months ended September 30, 2012 data for the tax lien transfer segment only includes the period from May 8, 2012 (date of acquisition) through September 30, 2012.

Additionally, assets are allocated to operating segments for management review. As of September 30, 2012, total segment assets were $914.8 million and $194.3 million for the portfolio purchasing and recovery segment and tax lien transfer segment, respectively.

Note 17: Goodwill and Identifiable Intangible Assets

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

As discussed in Note 2, “Discontinued Operations,” on May 16, 2012, the Company completed the sale of substantially all of the assets and certain liabilities of Ascension to AIS.

In connection with the preparation of its financial statements and based, in part, on the anticipated disposition of Ascension, the Company performed an interim goodwill impairment test for Ascension as of March 31, 2012 and concluded that Ascension’s entire goodwill balance of $9.9 million was impaired. Additionally, the Company wrote-off Ascension’s remaining identifiable intangible assets of approximately $0.4 million as of March 31, 2012.

As of September 30, 2012, the Company has two reporting units that carry goodwill: portfolio purchasing and recovery and tax lien transfer. Annual testing is performed as of October 1st for the portfolio purchasing and recovery reporting unit and as of April 1st for the tax lien transfer reporting unit.

 

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

 

     As of September 30, 2012      As of December 31, 2011  
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net Carrying
Amount
     Gross
Carrying
Amount
     Accumulated
Amortization
    Net Carrying
Amount
 

Intangible assets subject to amortization:

               

Customer relationships

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

Trade name and other

     570         (55     515         —           —          —     
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Total intangible assets subject to amortization

   $ 570       $ (55   $ 515       $ 6,000       $ (5,538   $ 462   
  

 

 

    

 

 

   

 

 

    

 

 

    

 

 

   

 

 

 

Intangible assets not subject to amortization:

               

Goodwill – portfolio purchasing and recovery

        $ 6,047            $ 6,047   

Goodwill – tax lien transfer

          49,399              —     

Goodwill – bankruptcy servicing

          —                9,938   
       

 

 

         

 

 

 

Total goodwill

        $ 55,446            $ 15,985   
       

 

 

         

 

 

 

 

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

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

Our Business and Operating Segments

We are a leading provider of debt management and recovery solutions for consumers and property owners across a broad range of assets. We purchase portfolios of defaulted consumer receivables and manage them by partnering with individuals as they repay their obligations and work toward financial recovery. In addition, through our subsidiary Propel Financial Services, LLC (“Propel”), we assist Texas property owners who are delinquent on their property taxes by paying these taxes on behalf of the property owners in exchange for payment agreements collateralized by tax liens on the property.

We conduct business through two operating segments: portfolio purchasing and recovery and tax lien transfer. The operating results from our tax lien transfer segment are immaterial to our total consolidated operating results. However, the total segment assets are significant as compared to our total consolidated assets. As a result, in accordance with authoritative guidance on segment reporting, our tax lien transfer segment is determined to be a reportable segment.

Portfolio purchasing and recovery

Our portfolio purchasing and recovery segment purchases receivables based on robust, account-level valuation methods and employs a suite of proprietary statistical and behavioral models across the full extent of our operations. These investments allow us to value portfolios accurately (and limit the risk of overpaying), avoid buying portfolios that are incompatible with our methods or goals and precisely align the accounts we purchase with our operational channels to maximize future collections. As a result, we have been able to realize significant returns from the receivables we acquire. We maintain strong relationships with many of the largest credit and telecommunication providers in the United States, and possess one of the industry’s best collection staff retention rates.

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

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

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

 

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Tax lien transfer

Our tax lien transfer segment focuses on the property tax financing industry. Our principal activity is originating and servicing property tax lien transfers in the state of Texas. With the property owner’s consent, we pay the property owner’s delinquent property taxes directly to the taxing authority, which then transfers its tax lien to us. We then enter into a payment agreement with the property owner creating an affordable payment plan. Revenue from our tax lien transfer segment for the period May 8, 2012 (date of acquisition) through September 30, 2012, comprised 3% and 2% of total consolidated revenues for the three and nine months ended September 30, 2012, respectively. Operating income from our tax lien transfer segment for the period May 8, 2012 (date of acquisition) through September 30, 2012, comprised 5% and 2% of our total consolidated operating income for the three and nine months ended September 30, 2012, respectively.

Discontinued Operations

On May 16, 2012, we completed the sale of substantially all of the assets and certain of the liabilities of our bankruptcy servicing subsidiary Ascension Capital Group, Inc. (“Ascension”). Accordingly, Ascension’s results of operations are reflected as discontinued operations in our condensed consolidated statements of comprehensive income.

Portfolio Purchasing and Recovery Market Overview

While there has been improvement in macroeconomic indicators during the last three months, a broad economic recovery has yet to fully materialize for the U.S. consumer. Slow job growth, uncertainty over state and federal taxes, and limited credit availability continue to challenge U.S. consumers, as demonstrated by weak consumer spending and volatile but rising consumer confidence levels.

Despite this macroeconomic uncertainty through the third quarter of 2012, most of our internal collection metrics were consistent with, or better than, what we observed during the same periods in 2010 and 2011. To illustrate, payer rates, adjusted for changes in the mix of settlements-in-full versus payment plans, remained consistent. As compared to prior years, more of our consumers continue to opt to settle their debt obligations through payment plans as opposed to one-time settlements. Settlements made through payment plans impact our recoveries in two ways. First, the delay in cash flows from payments received over extended time periods may result in a provision for portfolio allowance. When a long-term payment stream (as compared to a one-time payment of the same amount) is discounted using a pool group’s internal rate of return, or IRR, the net present value is lower. In other words, despite the absolute value of total cash received being identical in both scenarios, accounting for the timing of cash flows in a payment plan yields a lower net present value, which, in turn, can result in a provision for portfolio allowance. Despite this, as a result of our cautious approach to setting initial pool groups’ internal rates of return, we have experienced no provisions for portfolio allowances for the 2009 – 2012 pool groups. Second, payment plans inherently contain the possibility of consumers failing to complete all scheduled payments, which we term a “broken payer.”

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

We have recently seen a meaningful increase in the prices for portfolios directly from credit issuers, especially for fresh portfolios. These are portfolios that are generally transacted within 6 months of the consumer’s account being charged-off by the financial institution. We believe this pricing increase is due to a reduction in supply of charged-off accounts and constant demand in the marketplace. Given shifts in underwriting standards by financial institutions resulting in the lower volumes of charged-off accounts, we expect that the pricing will remain at these elevated levels for a period of time. We believe that this will reverse itself when buyers of these portfolios are unable to realize a profit after paying elevated prices. We do not expect the current supply environment to have a material impact on our portfolio purchases for 2012, as we fulfilled much of our planned 2012 portfolio acquisition in the first half of the year, when pricing was more favorable. However, our ability to purchase additional portfolios in 2013 at favorable prices may be adversely impacted unless this trend is reversed in the near term. Should pricing trends continue in this manner, we expect to adjust our purchasing strategies away from fresh portfolios, and towards portfolios in alternative asset classes or with higher aging, where our operational model allows us to continue to be profitable.

 

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Purchases and Collections

Purchases by Type

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Credit card

   $ 28,547       $ 52,821       $ 338,776       $ 229,069   

Telecom

     18,764         12,910         69,981         19,394   

Consumer bankruptcy(1)

     —           —           —           1,644   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 47,311       $ 65,731       $ 408,757       $ 250,107   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

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

During the three months ended September 30, 2012, we invested $47.3 million in receivable portfolios, primarily for charged-off credit card portfolios with face values aggregating $1.1 billion, for an average purchase price of 4.5% of the face value of the purchased receivables. This is an $18.4 million decrease, or 28.0%, in the amount invested, compared to the $65.7 million invested during the three months ended September 30, 2011, to acquire receivable portfolios, primarily consisting of charged-off credit card portfolios, with a face value aggregating $2.0 billion for an average purchase price of 3.2% of the face value of the purchased receivables.

During the nine months ended September 30, 2012, we invested $408.8 million in receivable portfolios, primarily for charged-off credit card portfolios with face values aggregating $10.0 billion, for an average purchase price of 4.1% of the face value of the purchased receivables. This is a $158.7 million increase, or 63.5%, in the amount invested, compared to the $250.1 million invested during the nine months ended September 30, 2011, to acquire receivable portfolios, primarily consisting of charged-off credit card portfolios, with a face value aggregating $7.9 billion for an average purchase price of 3.2% of the face value of the purchased receivables. Included in our portfolio purchases for the nine months ended September 30, 2012, is a single, one-time purchase of more than $100.0 million.

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

Collections by Channel

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

 

     Three Months Ended
September 30,
     Nine Months Ended
September 30,
 
     2012      2011      2012      2011  

Legal collections

   $ 111,334       $ 94,932       $ 335,782       $ 281,504   

Collection sites

     116,928         83,301         338,439         256,418   

Collection agencies

     17,715         10,825         43,344         37,236   

Other

     —           —           —           54   
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 245,977       $ 189,058       $ 717,565       $ 575,212   
  

 

 

    

 

 

    

 

 

    

 

 

 

Gross collections increased $56.9 million, or 30.1%, to $246.0 million during the three months ended September 30, 2012, from $189.1 million during the three months ended September 30, 2011. Gross collections increased $142.4 million, or 24.8%, to $717.6 million during the nine months ended September 30, 2012, from $575.2 million during the nine months ended September 30, 2011.

 

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Results of Operations

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

 

     Three Months Ended September 30,  
     2012     2011  

Revenues

        

Revenue from receivable portfolios, net

   $ 140,682        97.2   $ 115,843        100.0

Net interest income — tax lien transfer

     4,110        2.8     —          0.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     144,792        100.0     115,843        100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Salaries and employee benefits

     25,397        17.5     20,087        17.3

Cost of legal collections

     43,544        30.1     40,169        34.7

Other operating expenses

     14,829        10.3     9,904        8.5

Collection agency commissions

     4,227        2.9     3,264        2.8

General and administrative expenses

     14,091        9.7     10,704        9.3

Depreciation and amortization

     1,533        1.1     1,054        0.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     103,621        71.6     85,182        73.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     41,171        28.4     30,661        26.5
  

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) income

        

Interest expense

     (7,012     (4.8 )%      (5,175     (4.5 )% 

Other income

     1,036        0.7     (342     (0.3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     (5,976     (4.1 )%      (5,517     (4.8 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     35,195        24.3     25,144        21.7

Provision for income taxes

     (13,887     (9.6 )%      (9,834     (8.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     21,308        14.7     15,310        13.2

Income (loss) from discontinued operations, net of tax

     —          0.0     60        0.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 21,308        14.7   $ 15,370        13.3
  

 

 

   

 

 

   

 

 

   

 

 

 

 

     Nine Months Ended September 30,  
     2012     2011  

Revenues

        

Revenue from receivable portfolios, net

   $ 405,818        98.4   $ 332,262        100.0

Net interest income – tax lien transfer

     6,442        1.6     —          0.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     412,260        100.0     332,262        100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

        

Salaries and employee benefits

     72,891        17.7     57,458        17.3

Cost of legal collections

     123,203        29.9     117,364        35.3

Other operating expenses

     38,854        9.4     26,944        8.1

Collection agency commissions

     12,352        3.0     10,774        3.2

General and administrative expenses

     46,331        11.2     29,471        8.9

Depreciation and amortization

     4,193        1.0     2,916        0.9
  

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     297,824        72.2     244,927        73.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     114,436        27.8     87,335        26.3
  

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) income

        

Interest expense

     (19,024     (4.6 )%      (16,137     (4.8 )% 

Other income

     1,385        0.3     (182     (0.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     (17,639     (4.3 )%      (16,319     (4.9 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations before income taxes

     96,797        23.5     71,016        21.4

Provision for income taxes

     (38,393     (9.3 )%      (27,658     (8.3 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Income from continuing operations

     58,404        14.2     43,358        13.1

(Loss) income from discontinued operations, net of tax

     (9,094     (2.2 )%      466        0.1
  

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 49,310        12.0   $ 43,824        13.2
  

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Results of Operations

Revenues

Our revenues consist primarily of portfolio revenue and interest income net of related interest expense from property tax payment agreements receivable.

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

 

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

 

     Three Months Ended September 30, 2012     As of
September 30, 2012
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA(4)

   $ 6,388       $ 5,469         85.6   $ 919        3.9   $ —           —     

2005

     2,767         760         27.5     135        0.4     3,127         5.8

2006

     2,884         1,811         62.8     (998     1.3     10,798         5.1

2007

     3,873         2,045         52.8     (247     1.6     11,974         5.1

2008

     13,881         7,478         53.9     908        5.3     36,946         6.1

2009

     25,881         16,506         63.8     —          11.8     54,724         9.0

2010

     52,328         32,612         62.3     —          23.3     120,327         8.1

2011

     71,657         40,800         56.9     —          29.2     221,790         5.6

2012

     66,306         32,484         49.0     —          23.2     351,934         3.1
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 245,965       $ 139,965         56.9   $ 717        100.0   $ 811,620         5.1
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

     Three Months Ended September 30, 2011     As of
September 30, 2011
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA(4)

   $ 5,624       $ 4,173         74.2   $ 1,455        3.6   $ —           —     

2005

     4,172         1,912         45.8     1,313        1.6     10,103         5.7

2006

     4,197         3,278         78.1     (1,571     2.8     20,172         5.1

2007

     8,235         4,452         54.1     (1,680     3.8     21,241         5.1

2008

     19,779         11,660         59.0     (1,122     9.9     66,224         5.4

2009

     37,895         25,372         67.0     —          21.6     98,187         7.9

2010

     69,460         43,196         62.2     —          36.8     213,962         6.2

2011

     39,668         23,405         59.0     —          19.9     219,793         3.9
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 189,030       $ 117,448         62.1   $ (1,605     100.0   $ 649,682         5.5
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

     Nine Months Ended September 30, 2012     As of
September 30, 2012
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA(4)

   $ 20,560       $ 17,627         85.7   $ 2,933        4.4   $ —           —     

2005

     9,403         3,116         33.1     1,110        0.7     3,127         5.8

2006

     10,059         6,457         64.2     (2,993     1.6     10,798         5.1

2007

     13,498         7,143         52.9     (123     1.7     11,974         5.1

2008

     46,761         24,955         53.4     579        6.2     36,946         6.1

2009

     88,278         54,592         61.8     —          13.5     54,724         9.0

2010

     175,093         104,705         59.8     —          25.9     120,327         8.1

2011

     237,268         125,248         52.8     —          31.0     221,790         5.6

2012

     116,597         60,469         51.9     —          15.0     351,934         3.1
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 717,517       $ 404,312         56.3   $ 1,506        100.0   $ 811,620         5.1
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     Nine Months Ended September 30, 2011     As of
September 30, 2011
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA(4)

   $ 13,373       $ 10,107         75.6   $ 3,270        3.0   $ —           —     

2004

     1,462         196         13.4     102        0.1     —           0.0

2005

     14,723         6,854         46.6     656        2.0     10,103         5.7

2006

     14,558         11,097         76.2     (5,257     3.3     20,172         5.1

2007

     33,863         20,503         60.5     (3,524     5.9     21,241         5.1

2008

     69,964         39,773         56.8     (3,356     11.7     66,224         5.4

2009

     131,668         82,108         62.4     —          24.1     98,187         7.9

2010

     225,450         129,187         57.3     —          38.0     213,962         6.2

2011

     70,036         40,546         57.9     —          11.9     219,793         3.9
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 575,097       $ 340,371         59.2   $ (8,109     100.0   $ 649,682         5.5
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

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

(3) 

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

(4) 

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

Total revenues were $144.8 million during the three months ended September 30, 2012, an increase of $29.0 million, or 25.0%, compared to total revenues of $115.8 million during the three months ended September 30, 2011. Total revenues were $412.3 million during the nine months ended September 30, 2012, an increase of $80.0 million, or 24.1%, compared to total revenues of $332.3 million during the nine months ended September 30, 2011.

Revenue from our portfolio purchasing and recovery segment was $140.7 million during the three months ended September 30, 2012, an increase of $24.9 million, or 21.4%, compared to revenue of $115.8 million during the three months ended September 30, 2011. Portfolio revenue was $405.8 million during the nine months ended September 30, 2012, an increase of $73.5 million, or 22.1%, compared to portfolio revenue of $332.3 million during the nine months ended September 30, 2011. The increase in portfolio revenue during the three and nine months ended September 30, 2012 was primarily the result of additional accretion revenue associated with a higher portfolio balance during the three and nine months ended September 30, 2012 compared to the same periods of the prior year. During the three months ended September 30, 2012, we recorded a net portfolio allowance reversal of $0.7 million, compared to a net portfolio allowance provision of $1.6 million during the three months ended September 30, 2011. During the nine months ended September 30, 2012, we recorded a net portfolio allowance reversal of $1.5 million, compared to a net portfolio allowance provision of $8.1 million during the nine months ended September 30, 2011.

Net interest income from our tax lien transfer segment was $4.1 million and $6.4 million for the three months ended September 30, 2012 and the period from acquisition (May 8, 2012) through September 30, 2012, respectively.

Operating Expenses

Total operating expenses were $103.6 million during the three months ended September 30, 2012, an increase of $18.4 million, or 21.6%, compared to total operating expenses of $85.2 million during the three months ended September 30, 2011.

Total operating expenses were $297.8 million during the nine months ended September 30, 2012, an increase of $52.9 million, or 21.6%, compared to total operating expenses of $244.9 million during the nine months ended September 30, 2011.

Operating expenses are explained in more detail as follows:

Salaries and employee benefits

Salaries and employee benefits increased $5.3 million, or 26.4%, to $25.4 million during the three months ended September 30, 2012, from $20.1 million during the three months ended September 30, 2011. The increase was primarily the result of increases in headcount and related compensation expense to support the growth in our portfolio purchasing and recovery business and the acquisition of Propel Financial Services, LLC, BNC Retax, LLC, RioProp Ventures, LLC, and certain related affiliates (collectively, the “Propel Entities”). The increase was offset by a decrease in stock-based compensation expense of $0.5 million primarily due to the impact of the acceleration of certain equity awards during the three months ended September 30, 2011. Salaries and employee benefits related to our internal legal channel were approximately $1.8 million and $0.7 million for the three months ended September 30, 2012 and 2011, respectively.

Salaries and employee benefits, increased $15.4 million, or 26.9%, to $72.9 million during the nine months ended September 30, 2012, from $57.5 million during the nine months ended September 30, 2011. The increase was primarily the result of increases in headcount and related compensation expense to support our growth, and an increase of $0.7 million in stock-based compensation expense primarily due to higher fair value of equity awards granted in recent periods. Salaries and employee benefits related to our internal legal channel were approximately $4.7 million and $1.5 million for the nine months ended September 30, 2012 and 2011, respectively.

 

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Salaries and employee benefits broken down between the reportable segments are as follows (in thousands):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2012      2011      2012      2011  

Salaries and employee benefits:

           

Portfolio purchasing and recovery

   $ 24,304       $ 20,087       $ 71,110       $ 57,458   

Tax lien transfer(1)

     1,093         —           1,781         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 25,397       $ 20,087       $ 72,891       $ 57,458   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Nine months ended September 30, 2012 data for the tax lien transfer segment only includes the period from May 8, 2012 (date of acquisition) through September 30, 2012.

Cost of legal collections – Portfolio purchasing and recovery

The cost of legal collections increased $3.3 million, or 8.4%, to $43.5 million during the three months ended September 30, 2012, compared to $40.2 million during the three months ended September 30, 2011. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in the cost of legal collections was partially the result of a net increase of $1.4 million in contingent fees paid to our network of attorneys related to an increase of $16.4 million, or 17.3%, in gross collections, offset by a reduction in commission rates. Gross legal collections amounted to $111.3 million during the three months ended September 30, 2012, up from $94.9 million collected during the three months ended September 30, 2011. The increase was also attributable to an increase of $1.7 million in upfront litigation costs expensed during the period. The cost of legal collections decreased as a percent of gross collections through this channel to 39.1% during the three months ended September 30, 2012, from 42.3% during the three months ended September 30, 2011, primarily due to an improvement in our court cost recovery rate and a decrease in the commission rate we pay our contracted attorneys.

The cost of legal collections increased $5.8 million, or 5.0%, to $123.2 million during the nine months ended September 30, 2012, compared to $117.4 million during the nine months ended September 30, 2011. The increase in the cost of legal collections was primarily the result of an increase of $6.0 million in contingent fees paid to our network of attorneys related to an increase of $54.3 million, or 19.3%, in gross collections, offset by a reduction in commission rates. Gross legal collections amounted to $335.8 million during the nine months ended September 30, 2012, up from $281.5 million collected during the nine months ended September 30, 2011. The cost of legal collections decreased as a percent of gross collections through this channel to 36.7% during the nine months ended September 30, 2012, from 41.7% during the nine months ended September 30, 2011, primarily due to an improvement in our court cost recovery rate and a decrease in the commission rate we pay our contracted attorneys.

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

 

     Three Months Ended September 30,     Nine Months Ended September 30,  
     2012     2011     2012     2011  

Collections(1)

   $ 111,334        100.0   $ 94,932        100.0   $ 335,782        100.0   $ 281,504        100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Court costs advanced

     23,059        20.7     23,367        24.6     68,280        20.3     71,019        25.2

Court costs deferred

     (7,416     (6.6 )%      (9,468     (10.0 )%      (29,989     (8.9 )%      (32,096     (11.4 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Court cost expense(2)

     15,643        14.1     13,899        14.6     38,291        11.4     38,923        13.8

Other(3)

     686        0.6     445        0.5     1,857        0.6     1,360        0.5

Commissions

     27,215        24.4     25,825        27.2     83,055        24.7     77,081        27.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs

   $ 43,544        39.1   $ 40,169        42.3   $ 123,203        36.7   $ 117,364        41.7
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Includes collections from our internal legal channel of approximately $5.1 million and $0.7 million for the three months ended September 30, 2012 and 2011, respectively; and approximately $12.3 million and $0.9 million for the nine months ended September 30, 2012 and 2011, respectively.

(2) 

In connection with our agreement with contracted attorneys, we advance certain out-of-pocket court costs. We capitalize these costs in our consolidated financial statements and provide a reserve and corresponding court cost expense for the costs that we believe will be ultimately uncollectible. This amount includes changes in our anticipated recovery rate of court costs expensed. This amount also includes court costs expensed through our internal legal channel of approximately $1.7 million and $0.5 million for the three months ended September 30, 2012 and 2011, respectively; and approximately $4.4 million and $0.8 million for the nine months ended September 30, 2012 and 2011, respectively.

(3) 

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

 

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Other operating expenses

Other operating expenses increased $4.9 million, or 49.7%, to $14.8 million during the three months ended September 30, 2012, from $9.9 million during the three months ended September 30, 2011. The increase was primarily the result of an increase of $2.6 million in direct mail campaign expenses, an increase of $0.5 million in telephone expenses, an increase of $0.5 million in media-related expenses, and a net increase in various other operating expenses of $1.3 million, primarily to support our growth.

Other operating expenses increased $11.9 million, or 44.2%, to $38.8 million during the nine months ended September 30, 2012, from $26.9 million during the nine months ended September 30, 2011. The increase was primarily the result of an increase of $5.3 million in direct mail campaign expenses, an increase of $1.5 million in media-related expenses, an increase of $0.9 million in telephone expenses, an increase of $0.7 million in recruiting expenses, an increase of $0.7 million in advertising expenses related to the Propel Entities, and a net increase in various other operating expenses of $2.8 million, primarily to support our growth.

Other operating expenses broken down between the reportable segments are as follows (in thousands):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2012      2011      2012      2011  

Other operating expenses:

           

Portfolio purchasing and recovery

   $ 14,339       $ 9,904       $ 37,794       $ 26,944   

Tax lien transfer(1)

     490         —           1,060         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 14,829       $ 9,904       $ 38,854       $ 26,944   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Nine months ended September 30, 2012 data for the tax lien transfer segment only includes the period from May 8, 2012 (date of acquisition) through September 30, 2012.

Collection agency commissions – Portfolio purchasing and recovery

During the three months ended September 30, 2012, we incurred $4.2 million in commissions to third party collection agencies, or 23.9% of the related gross collections of $17.7 million, compared to $3.3 million in commissions, or 30.2%, of the related gross collections of $10.8 million, during the three months ended September 30, 2011. During the quarter ended June 30, 2012, we acquired a large portfolio from a competitor where most of the customer’s accounts had been placed with third party collection agencies. We have slowly transitioned these accounts from collection agencies to our internal operating sites. Until such transition is complete, there may be an increase in agency collections and related commissions. During the three months ended September 30, 2012, we experienced an increased in such collections and commissions. During the same period, the commission rate decrease as compared to the prior year as a result of the lower commission rates negotiated with the agencies where these accounts had been placed as compared to the average rates paid to other third party collection agencies.

During the nine months ended September 30, 2012, we incurred $12.4 million in commissions to third party collection agencies, or 28.5%, of the related gross collections of $43.3 million, compared to $10.8 million in commissions, or 28.9%, of the related gross collections of $37.2 million, during the nine months ended September 30, 2011. As discussed above, the increase in collections and commissions and decrease in commission rate as a percentage of the related gross collections were primarily due to the accounts placed with third party collection agencies related to our large portfolio purchase in the second quarter of 2012.

General and administrative expenses

General and administrative expenses increased $3.4 million, or 31.6%, to $14.1 million during the three months ended September 30, 2012, from $10.7 million during the three months ended September 30, 2011. The increase was primarily the result of increased corporate legal expenses and general and administrative costs associated with Propel of $0.5 million.

General and administrative expenses increased $16.8 million, or 57.2%, to $46.3 million during the nine months ended September 30, 2012, from $29.5 million during the nine months ended September 30, 2011. The increase was primarily the result of $4.3 million in legal, accounting and consulting fees attributable to the Propel Acquisition, an increase of $3.3 million in costs related to legal settlements, an increase of $3.6 million in corporate legal expenses, an increase of $0.8 million in building rent, general and administrative costs associated with Propel of $0.7 million, and a net increase in other general and administrative expenses of $4.1 million.

General and administrative expenses broken down between the reportable segments are as follows (in thousands):

 

     Three Months Ended September 30,      Nine Months Ended September 30,  
     2012      2011      2012      2011  

General and administrative expenses:

           

Portfolio purchasing and recovery

   $ 13,619       $ 10,704       $ 45,604       $ 29,471   

Tax lien transfer(1)

     472         —           727         —     
  

 

 

    

 

 

    

 

 

    

 

 

 
   $ 14,091       $ 10,704       $ 46,331       $ 29,471   
  

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Nine months ended September 30, 2012 data for the tax lien transfer segment only includes the period from May 8, 2012 (date of acquisition) through September 30, 2012.

 

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Depreciation and amortization

Depreciation and amortization expense increased $0.4 million, or 45.4%, to $1.5 million during the three months ended September 30, 2012, from $1.1 million during the three months ended September 30, 2011. Depreciation and amortization expense increased $1.3 million, or 43.8%, to $4.2 million during the nine months ended September 30, 2012, from $2.9 million during the nine months ended September 30, 2012. The increases during the three and nine months ended September 30, 2012 were primarily related to increased depreciation expenses resulting from our acquisition of fixed assets in recent periods.

Cost per Dollar Collected – Portfolio purchasing and recovery

The following tables summarize our cost per dollar collected (in thousands, except percentages):

 

     Three Months Ended September 30,  
     2012     2011  
     Collections      Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
    Collections      Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
 

Legal networks(1)

   $ 111,334       $ 43,544        39.1     17.7   $ 94,932       $ 40,169        42.3     21.3

Collection sites

     116,928         6,944 (2)      5.9     2.8     83,301         6,035 (2)      7.2     3.2

Collection agency outsourcing

     17,715         4,227        23.9     1.7     10,825         3,264        30.2     1.7

Other indirect costs(3)

     —           44,946        —          18.3     —           33,309        —          17.6
  

 

 

    

 

 

     

 

 

   

 

 

    

 

 

     

 

 

 

Total

   $ 245,977       $ 99,661 (4)        40.5   $ 189,058       $ 82,777 (4)        43.8
  

 

 

    

 

 

     

 

 

   

 

 

    

 

 

     

 

 

 

 

     Nine Months Ended September 30,  
     2012     2011  
     Collections      Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
    Collections      Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
 

Legal networks(1)

   $ 335,782       $ 123,203        36.7     17.2   $ 281,504       $ 117,364        41.7     20.4

Collection sites

     338,439         20,096 (2)      5.9     2.8     256,418         19,272 (2)      7.5     3.3

Collection agency outsourcing

     43,344         12,352        28.5     1.7     37,236         10,774        28.9     1.9

Other

     —           —          —          —          54         —          —          —     

Other indirect costs(3)

     —           131,895        —          18.4     —           91,537        —          15.9
  

 

 

    

 

 

     

 

 

   

 

 

    

 

 

     

 

 

 

Total

   $ 717,565       $ 287,546 (4)        40.1   $ 575,212       $ 238,947 (4)        41.5
  

 

 

    

 

 

     

 

 

   

 

 

    

 

 

     

 

 

 

 

(1) 

Collections include collections from our internal legal channel of approximately $5.1 million and $0.7 million for the three months ended September 30, 2012 and 2011, respectively; and approximately $12.3 million and $0.9 million for the nine months ended September 30, 2012 and 2011, respectively. Court costs expensed through our internal legal channel were approximately $1.7 million and $0.5 million for the three months ended September 30, 2012 and 2011, respectively; and approximately $4.4 million and $0.8 million for the nine months ended September 30, 2012 and 2011, respectively.

(2) 

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

(3) 

Other indirect costs represent non-collection salaries and employee benefits, Internal Legal department salaries, and employee benefits, general and administrative expenses, other operating expenses, and depreciation and amortization. Included in other indirect costs were costs related to our internal legal channel of approximately $2.7 million and $1.1 million for the three months ended September 30, 2012 and 2011, respectively; approximately $6.8 million and $2.2 million for the nine months ended September 30, 2012 and 2011, respectively.