The Thugs of Asset Acceptance

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

Company Overview

We have been purchasing and collecting defaulted or charged-off accounts receivable portfolios from consumer credit originators since the formation of our predecessor company in 1962.


Charged-off receivables are the unpaid obligations of individuals to credit originators, such as credit card issuers, consumer finance companies, healthcare providers, retail merchants, telecommunications and utility providers.

Since these receivables are delinquent or past due, we are able to purchase them at a substantial discount.

We purchase and collect charged-off consumer receivable portfolios for our own account as we believe this affords us the best opportunity to use long-term strategies to maximize our profits.

The prices we paid for charged-off accounts receivable portfolios (“paper”) had steadily increased from 2002 through mid 2007.

During the latter half of 2007, the prices we paid for comparable paper began to decline. This decline continued into 2008, but prices remain at elevated levels compared to historical low prices that existed from 2000 to 2002.

We believe the primary reason for the continued decline in pricing is largely a result of macro-economic factors resulting from the expectation of a decline in the consumers’ ability to repay their current obligations as well as their past due debts.

Macro-economic factors include reduced availability of credit, falling real estate values, higher food and energy prices, increased unemployment and other factors (“macro-economic factors”).

In addition, we believe that some competitors are experiencing their own liquidity crises as their ability to fund portfolio purchases has been reduced when compared to much of the time since our initial public offering in 2004.

We believe that increases in charged-off rates being experienced by major credit card issuers is leading to an increase in supply of receivables available for sale.


Reduced competition and increased supply may contribute to reduced pricing.

During the six months ended June 30, 2008, we invested $87.6 million (net of buybacks) in paper, with an aggregate face value of $2.5 billion, or 3.53% of face value.

In the six months ended June 30, 2007, we invested $73.8 million (net of buybacks through June 30, 2008) in paper, with an aggregate face amount of $1.9 billion, or 3.94% of face value.

Our debt purchasing metrics (dollars invested, face amount, average purchase price, types of paper and sources of paper) may vary significantly from quarter to quarter.

During the second quarter of 2008, our cash collections declined by $0.2 million from the year ago period to $95.2 million.

This is our first year over year decline in quarterly cash collections since we went public in 2004.

The second quarter 2008 decline in cash collections when compared to the same period of 2007 follows growth in cash collections during the first quarter of 2008 of 4.6% compared to the first quarter 2007 and growth for the full year 2007 of 8.9% when compared to the full year 2006.

We believe that the decline in cash collections is primarily a result of two factors.

First, a more difficult collection environment attributable to macro-economic factors is leading to reduced collection results on all vintages and types of paper. We expect this more difficult collections environment to continue and are addressing our collection tactics and operations to deal with the current economic environment.

Second, we believe our robust purchasing activity since the fourth quarter of 2006 has outpaced our staffing of account representatives to collect on this newly acquired paper which may be leading to reduced collection results particularly on older vintages of paper.


We are addressing what we believe to be a capacity constraint on collections by forwarding more accounts to our agency network for collection on our behalf.

We increased the volume of accounts being forwarded in the second quarter of 2008 and expect additional cash collections to be generated from this initiative in the second half of 2008.

The increased forwarding activities may result in lower productivity of our in-house collections staff, but improve overall collections. Over the long term, we expect to increase our in-house staffing to better align with our inventory of paper.

Net income for the six months ended June 30, 2008 was $8.9 million, a decline of 50.9% from $18.1 million for the six months ended June 30, 2007.


Contributing to our decline in net income was higher amortization of purchased receivables in determining purchased receivable revenues and increased interest expense that we incurred subsequent to the recapitalization transaction completed in July 2007.

Cash collections increased by $4.2 million or 2.2% to $195.5 million for the six months ended June 30, 2008 compared to $191.3 million for the six months ended June 30, 2007. Despite the $4.2 million increase in cash collections, purchased receivable revenues declined by $12.4 million because amortization increased by $16.5 million. Amortization of purchased receivables, the difference between cash collections and purchased receivable revenues, increased to 38.6% of cash collections for the six months ended June 30, 2008 versus 30.8% in the six months ended June 30, 2007.


ncluded in amortization of purchased receivables are net impairments of $5.4 million and $9.6 million for the six months ended June 30, 2008 and 2007, respectively.


The increased purchased receivables amortization rate is primarily a result of the elevating pricing environment that we have experienced over the last several years in addition to placing the first quarter of 2005 aggregate and all healthcare portfolios on the cost recovery method. As prices have risen, our expected collection multiple of purchase price has come down. Macro-economic factors negatively affecting consumers’ financial well-being is also a factor in the lower multiples of purchase price expected to be collected, even as pricing for paper falls. The lower multiple of purchase price expected to be collected generally results in a lower IRR to be assigned for revenue recognition purposes. When lower yields are assigned, a larger proportion of our cash collections are treated as purchased receivable amortization instead of purchase receivable revenues.

Average borrowings on our Amended New Credit Facilities in 2008 were $171.6 million for the six months ended June 30, 2008, but only $43.1 million for the six months ended June 30, 2007. The increased borrowings are primarily the result of the $150.0 million borrowed to fund the return of capital to shareholders in June and July of 2007. Additionally, we have borrowed to fund our purchase of paper since late 2006. As a result of these two factors, interest expense increased by $5.2 million to $6.6 million in the six months ended June 30, 2008 compared to $1.4 million in the six months ended June 30, 2007.

Total operating expenses were $99.8 million for the six months ended June 30, 2008 a decrease of $3.2 million from $103.0 million in the six months ended June 30, 2007. As a percentage of cash collections, operating expenses were 51.0% and 53.8% for the six months ended June 30, 2008 and 2007, respectively. Salaries and benefits, collections expense and occupancy costs declined compared to the six months ended June 30, 2007, by $0.7 million, $1.6 million and $0.7 million, respectively. Administrative expenses increased by $0.1 million to $5.6 million in the six months ended June 30, 2008 compared to $5.5 million in the six months ended June 30, 2007. Other operating expenses, including depreciation and amortization, restructuring charges and impairment of intangible assets decreased by $0.2 million in the six months ended June 30, 2008 compared to June 30, 2007. The reduced salaries and benefits costs reflect an increasing portion of our cash collections coming from outside attorneys and agencies. Our collections from third party relationships (attorneys and collection agencies) have increased to 28.9% of total cash collections for the six months ended June 30, 2008 from 24.4% for the six months ended June 30, 2007.

Total forwarding fees paid on cash collections from these third party relationships have increased to $16.6 million from $13.7 million in the six months ended June 30, 2008 versus the six months ended June 30, 2007. The remaining expenses included in collections expense declined by $4.5 million during the same period. The $4.5 million decline in the six months ended June 30, 2008 primarily reflected reduced legal collection costs. These savings were realized from a combination of reduced in-house collections, better expense management and our efforts to better match legal cash collections with legal collection expenses. Occupancy expenses declined by $0.7 million in the six months ended June 30, 2008 versus the six months ended June 30, 2007 resulting primarily from the consolidation of two call centers during 2007.

We adopted SFAS No. 157 as of January 1, 2008. According to FASB Staff Position No. FAS 157-2, the application of SFAS 157 to certain non-financial assets and liabilities is deferred to fiscal years beginning after November 15, 2008. Our goodwill and other intangible assets are measured at fair value on a recurring basis for impairment assessment. The deferral of SFAS 157 applies to these items. Adoption of SFAS 157 did not have a material impact on our consolidated statements of financial position, income or cash flows. We have chosen not to adopt SFAS No. 159, “Fair Value Option”.

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Forward-Looking Statements

This report contains forward-looking statements that involve risks and uncertainties and that are made in good faith pursuant to the “safe harbor” provisions of the Private Securities Litigation Reform Act of 1995.


These statements include, without limitation, statements about future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as “may”, “will”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate”, “potential” or “continue”, the negative of these terms or other comparable terminology.


These statements involve a number of risks and uncertainties.

Actual events or results may differ materially from any forward-looking statement as a result of various factors, including those we discuss in our annual report on Form 10-K for the year ended December 31, 2007 in the section titled “Risk Factors” and elsewhere in this report.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements.

Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations.

Factors that could affect our results and cause them to materially differ from those contained in the forward-looking statements include the following:

 

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

 

  •   our ability to recover sufficient amounts on our charged-off receivable portfolios;
 

 

  •   our ability to hire and retain qualified personnel;
 

 

  •   a decrease in collections if bankruptcy filings increase or if bankruptcy laws or other debt collection laws change;
 
 

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

 our ability to make reasonable estimates of the timing and amount of future cash receipts and values and assumptions underlying the calculation of the net impairment charges for purposes of recording purchased receivable revenues in accordance with Accounting Standards Executive Committee Statement of Position 03-3 as well as the Accounting Standards Executive Committee Practice Bulletin 6;
 

 

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

 

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

 

  •   the loss of any of our executive officers or other key personnel;
 

 

  •   the costs, uncertainties and other effects of legal and administrative proceedings;
 

 

  •   our ability to effectively manage excess capacity, reduce workforce or close remote call center locations;
 

 

  •   the temporary or permanent loss of our computer or telecommunications systems, as well as our ability to respond to changes in technology and increased competition;
 

 

  •   changes in our overall performance based upon significant macroeconomic conditions;
 

 

  •   changes in interest rates could adversely affect earnings or cash flows;
 

 

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

 

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

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Collections Expense.

Collections expense was $23.1 million for the three months ended June 30, 2008, a decrease of $0.6 million, or 2.4%, compared to collections expense of $23.7 million for the three months ended June 30, 2007.

Collections expense was 24.3% of cash collections during the three months ended June 30, 2008 compared with 24.8% for the same period in 2007. The collections expense decreased primarily due to a $2.0 million decline in legal collections costs, excluding legal forwarding fees.

These savings were realized from a combination of reduced in-house collections and better expense management.

This decrease was partially offset by increased forwarding fees of $1.1 million paid on cash collections from third parties relationships (attorneys and collection agencies) as a result of an increase in our collections from third parties relationships to 29.0% of total cash collections for the three months ended June 30, 2008, from 24.9% for the three months ended June 30, 2007.

In addition to these increased forwarding fees, there was a net $0.3 million increase in mailing and other data provider costs.

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Occupancy.

Occupancy expense was $1.9 million for the three months ended June 30, 2008, a decrease of $0.4 million, or 16.4%, compared to occupancy expense of $2.3 million for the three months ended June 30, 2007. Occupancy expense was 2.0% of cash collections for the three months ended June 30, 2008 compared with 2.4% for the same period in 2007. Occupancy expense decreased primarily due to the consolidation of two call centers during 2007.

Administrative.

Administrative expenses decreased to $3.0 million for the three months ended June 30, 2008, from $3.3 million for the three months ended June 30, 2007, reflecting a $0.3 million, or 10.1%, decrease. Administrative expenses were 3.1% of cash collections during the three months ended June 30, 2008 compared with 3.4% for the same period in 2007. Administrative expenses for the quarter ended June 30, 2007 include $0.5 million in share-based compensation expense relating to an amendment to our Stock Incentive Plan to add an anti-dilution provision.



Restructuring Charges.

There were no restructuring charges for the three months ended June 30, 2008. Pre-tax restructuring charges were $0.3 million for the three months ended June 30, 2007 as a result of our plans to close our White Marsh, Maryland and Wixom, Michigan offices during 2007. Charges were primarily related to associate one-time termination benefits and changes to the service life of certain long-lived assets.

Depreciation and Amortization. Depreciation and amortization expense was $0.9 million for the three months ended June 30, 2008, a decrease of $0.2 million or 14.6% compared to depreciation and amortization expense of $1.1 million for the three months ended June 30, 2007. Depreciation and amortization expense was 1.0% of cash collections during the three months ended June 30, 2008 compared with 1.1% for the same period in 2007.

Interest Income.
Interest income was $6,778 for the three months ended June 30, 2008, a decrease of $199,619 compared to $206,397 for the three months ended June 30, 2007.

Interest Expense. Interest expense was $3.3 million for the three months ended June 30, 2008, an increase of $2.2 million compared to interest expense of $1.1 million for the three months ended June 30, 2007. Interest expense was 3.4% of cash collections during the three months ended June 30, 2008 compared with 1.2% for the same period in 2007. The increase in interest expense was due to increased average borrowings during the three months ended June 30, 2008 compared to the same period in 2007. Average borrowings during the quarter ended June 30, 2008 reflect the new $150.0 million Term Loan Facility that was funded on June 12, 2007 to finance our stock repurchases and special one-time cash dividend.

Income Taxes.

Income tax expense of $1.4 million reflects a federal tax rate of 35.5% and a state tax rate of 4.8% (net of federal tax benefit) for the three months ended June 30, 2008. For the three months ended June 30, 2007, income tax expense was $5.0 million and reflected a federal tax rate of 35.2% and state tax rate of 2.5% (net of federal tax benefit). The 2.3% increase in the state rate was due to changing apportionment percentages among the various states. Income tax expense decreased $3.6 million, or 71.3% from income tax expense of $5.0 million for the three months ended June 30, 2007. The decrease in tax expense was due to a decrease in pre-tax financial statement income, which was $3.6 million for the three months ended June 30, 2008, compared to $13.3 million for the same period in 2007.

Six Months Ended June 30, 2008 Compared To Six Months Ended June 30, 2007

Revenue

Total revenues were $120.8 million for the six months ended June 30, 2008, a decrease of $12.3 million, or 9.3%, from total revenues of $133.2 million for the six months ended June 30, 2007. Purchased receivable revenues were $119.9 million for the six months ended June 30, 2008, a decrease of $12.4 million, or 9.3%, from the six months ended June 30, 2007 amount of $132.3 million. Purchased receivable revenues reflect an amortization rate, or the difference between cash collections and revenue, of 38.6%, an increase of 7.8%, from the amortization rate of 30.8% for the six months ended June 30, 2007. The increased amortization rate is primarily due to lower average internal rates of return assigned to recent years’ purchases as well as placing the first quarter of 2005 aggregate and all healthcare portfolios on the cost recovery method. Purchased receivable revenues reflect net impairments recognized during the six months ended June 30, 2008 and 2007 of $5.4 million and $9.6 million, respectively. Cash collections on charged-off consumer receivables increased 2.2% to $195.5 million for the six months ended June 30, 2008 from $191.3 million for the same period in 2007. Cash collections for the six months ended June 30, 2008 and 2007 include collections from fully amortized portfolios of $42.5 million and $40.3 million, respectively, of which 100% were reported as revenue.

During the six months ended June 30, 2008, we acquired charged-off consumer receivable portfolios with an aggregate face value of $2.5 billion at a cost of $87.6 million, or 3.53% of face value, net of buybacks. Included in these purchase totals were 66 portfolios with an aggregate face value of $514.8 million at a cost of $30.8 million, or 5.98% of face value, which were acquired through 12 forward flow contracts. Revenues on portfolios purchased from our top three sellers during vintage years 1997 through 2008 were $32.6 million and $36.6 million during the six months ended June 30, 2008, and 2007, respectively, with the same sellers included in the top three in both six-month periods. During the six months ended June 30, 2007, we acquired charged-off consumer receivable portfolios with an aggregate face value of $1.9 billion at a cost of $73.8 million, or 3.94% of face value (adjusted for buybacks through June 30, 2008). Included in these purchase totals were 34 portfolios with an aggregated face value of $148.1 million at a cost of $7.7 million, or 5.18% of face value (adjusted for buybacks through June 30, 2008), which were acquired through eight forward flow contracts. From period to period we may buy charged-off receivables of varying age, types and cost. As a result, the cost of our purchases, as a percent of face value, may fluctuate from one period to the next.

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Operating Expenses

Total operating expenses were $99.8 million for the six months ended June 30, 2008, a decrease of $3.2 million, or 3.1%, compared to total operating expenses of $103.0 million for the six months ended June 30, 2007. Total operating expenses were 51.0% of cash collections for the six months ended June 30, 2008, compared with 53.8% for the same period in 2007. The decrease as a percent of cash collections was due to decreases in collections expense, salaries and benefits and occupancy, and was partially offset by an increase in administrative expense. Operating expenses are traditionally measured in relation to revenues. However, we measure operating expenses in relation to cash collections. We believe this is appropriate because of varying amortization rates, which is the difference between cash collections and revenues recognized, from period to period, due to seasonality of collections and other factors that can distort the analysis of operating expenses when measured against revenues. Additionally, we believe that the majority of our operating expenses are variable in relation to cash collections.

Salaries and Benefits.

Salaries and benefits expense were $42.7 million for the six months ended June 30, 2008, a decrease of $0.7 million, or 1.7%, compared to salaries and benefits expense of $43.4 million for the six months ended June 30, 2007. Salaries and benefits expense were 21.8% of cash collections for the six months ended June 30, 2008, compared with 22.7% for the same period in 2007. Salaries and benefits expense decreased primarily because an increasing portion of our cash collections came from outside attorneys and agencies for the six months ended June 30, 2008 compared to the same period in 2007. The decrease was partially offset by an increase in equity compensation expense.

Since going public in 2004, we had granted equity compensation only to certain key associates and non-associate directors. During 2007, we began issuing equity awards to a broader group of management associates and expanded the use of performance conditions relating to some equity grants for senior executives. We recognized $0.3 million and a reversal of $0.1 million for shares not expected to vest in salary and benefit expenses for the six months ended June 30, 2008 and 2007, respectively, as it related to stock-based compensation awards granted to associates. As of June 30, 2008, there was $3.3 million of total unrecognized compensation expense related to nonvested awards of which $2.1 million was expected to vest over a weighted average period of 2.90 years. As of June 30, 2007, there was $0.3 million total unrecognized compensation expense related to nonvested awards, which was expected to vest over a weighted average period of 3.63 years.

Collections Expense.

Collections expense was $45.2 million for the six months ended June 30, 2008, a decrease of $1.6 million, or 3.3%, compared to collections expense of $46.8 million for the six months ended June 30, 2007. Collections expense was 23.1% of cash collections during the six months ended June 30, 2008 compared with 24.5% for the same period in 2007. The collections expense decreased primarily due to a $4.5 million decline in legal collections costs, excluding legal forwarding fees, and other data provider costs. These savings were realized from a combination of reduced in-house collections, better expense management and our efforts to better match legal cash collections with legal collection expenses. This decrease was partially offset by increased forwarding fees of $2.9 million paid on cash collections from third parties relationships (attorneys and collection agencies) as a result of an increase in our collections from third parties relationships to 28.9% of total cash collections for the six months ended June 30, 2008, from 24.4% for the six months ended June 30, 2007.

Occupancy.

Occupancy expense was $3.9 million for the six months ended June 30, 2008, a decrease of $0.7 million, or 17.0%, compared to occupancy expense of $4.6 million for the six months ended June 30, 2007. Occupancy expense was 2.0% of cash collections for the six months ended June 30, 2008 compared with 2.4% for the same period in 2007. Occupancy expense decreased primarily due to the consolidation of two call centers during 2007.

Administrative.

Administrative expenses increased to $5.6 million for the six months ended June 30, 2008, from $5.5 million for the six months ended June 30, 2007, reflecting a $0.1 million, or 2.3%, increase. Administrative expenses were 2.9% of cash collections during the six months ended June 30, 2008 and 2007, respectively.

Restructuring Charges.

There were no restructuring charges for the six months ended June 30, 2008. Pre-tax restructuring charges were $0.5 million for the six months ended June 30, 2007 as a result of our plans to close our White Marsh, Maryland and Wixom, Michigan offices during 2007. Charges were primarily related to associate one-time termination benefits and changes to the service life of certain long-lived assets.


Depreciation and Amortization.

Depreciation and amortization expense was $1.9 million for the six months ended June 30, 2008, a decrease of $0.3 million or 10.1% compared to depreciation and amortization expense of $2.2 million for the six months ended June 30, 2007. Depreciation and amortization expense was 1.0% of cash collections during the six months ended June 30, 2008 compared with 1.1% for the same period in 2007.

Impairment of Intangible Assets.

Impairment of intangible assets was $0.4 million for the six months ended June 30, 2008 as we decided to discontinue the medical contingent collection business. As a result, we recognized an impairment charge of the net carrying balance of intangible assets for customer contracts and relationships associated with the contingent collection business.

Interest Income. Interest income was $30,029 for the six months ended June 30, 2008, a decrease of $192,095 compared to $222,124 for the six months ended June 30, 2007.

Interest Expense.

Interest expense was $6.6 million for the six months ended June 30, 2008, an increase of $5.2 million compared to interest expense of $1.4 million for the six months ended June 30, 2007. Interest expense was 3.4% of cash collections during the six months ended June 30, 2008 compared with 0.7% for the same period in 2007. The increase in interest expense was due to increased average borrowings during the six months ended June 30, 2008 compared to the same period in 2007. Average borrowings during the quarter ended June 30, 2008 reflect the new $150.0 million Term Loan Facility that was funded on June 12, 2007 to finance our recapitalization and special one-time cash dividend. Interest expense also includes the amortization of capitalized bank fees of $0.3 million and $0.4 million for the six months ended June 30, 2008 and 2007, respectively.

Income Taxes.

Income tax expense of $5.6 million reflects a federal tax rate of 35.3% and a state tax rate of 3.3% (net of federal tax benefit) for the six months ended June 30, 2008. For the six months ended June 30, 2007, income tax expense was $10.9 million and reflected a federal tax rate of 35.2% and state tax rate of 2.4% (net of federal tax benefit including utilitization of state net operating losses). Income tax expense decreased $5.3 million, or 48.6% from income tax expense of $10.9 million for the six months ended June 30, 2007. The decrease in tax expense was due to a decrease in pre-tax financial statement income, which was $14.5 million for the six months ended June 30, 2008, compared to $29.0 million for the same period in 2007.

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Seasonality

The success of our business depends on our ability to collect on our purchased portfolios of charged-off consumer receivables. Collections within portfolios tend to be seasonally higher in the first and second quarters of the year due to consumers’ receipt of tax refunds and other factors. Conversely, collections within portfolios tend to be lower in the third and fourth quarters of the year due to consumers’ spending in connection with summer vacations, the holiday season and other factors. However, revenue recognized is relatively level, excluding the impact of impairments, due to the application of the provisions prescribed by SOP 03-3. In addition, our operating results may be affected to a lesser extent by the timing of purchases of charged-off consumer receivables due to the initial costs associated with purchasing and integrating these receivables into our system. Consequently, income and margins may fluctuate from quarter to quarter.


 Ratio of Consolidated Total Liabilities to Consolidated Tangible Net Worth cannot exceed (i) 3.0 to 1.0 at any time on or before September 29, 2008, (ii) 2.75 to 1.0 at any time on or after September 30, 2008 and on or before December 30, 2008, (iii) 2.5 to 1.0 at any time on or after December 31, 2008 and on or before December 30, 2009, (iv) 2.25 to 1.0 at any time on or after December 31, 2009 and on or before December 30, 2010, (v) 2.0 to 1.0 at any time on or after December 31, 2010 and on or before December 30, 2011 or (vi) 1.5 to 1.0 to any time thereafter; and
 

 

  •   Consolidated Tangible Net Worth must equal or exceed $80.0 million plus 50% of positive consolidated net income for three consecutive fiscal quarters ending December 31, 2007 and for each fiscal year ending thereafter, such amount to be added as of December 31, 2007 and as of the end of each such fiscal year thereafter.
 

The Amended New Credit Agreement contains a provision that requires us to repay Excess Cash Flow, as defined, to reduce the indebtedness outstanding under our Amended New Credit Agreement. The annual repayment of our Excess Cash Flow is effective with the issuance of our audited consolidated financial statements for fiscal year 2008. The repayment provisions are:

 

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

 

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

 

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

Commitment fees on the unused portion of the New Revolving Credit Facility are paid quarterly, in arrears, and are calculated as an amount equal to a margin of 0.25% to 0.50%, depending on our liquidity, on the average amount available on the New Revolving Credit Facility.

The Amended New Credit Agreement requires us to effectively cap, collar or exchange interest rates on a notional amount of at least 25% of the outstanding principal amount of the Term Loan.

We had $189.5 million principal balance outstanding on our Amended New Credit Facilities at June 30, 2008. We have an interest rate swap agreement that hedges a portion of the interest rate expense on the Term Loan Facility. We believe we are in compliance with all terms of the Amended New Credit Agreement as of June 30, 2008.

Cash Flows

For the six months ended June 30, 2008, we invested $85.0 million in purchased receivables, net of buybacks, funded by a combination of internal cash flow and the Revolving Credit Facility. Our cash balance decreased from $10.5 million at December 31, 2007 to $9.2 million as of June 30, 2008.

Our operating activities provided cash of $20.2 million and $32.7 million for the six months ended June 30, 2008 and 2007, respectively. Cash provided by operating activities for the six months ended June 30, 2008 and 2007 was generated primarily from net income earned through cash collections as adjusted for the timing of payments in income taxes payable, accounts payable and accrued liabilities as of June 30, 2008 and 2007 compared to December 31, 2007 and 2006, respectively.

Investing activities used cash of $19.1 million and $24.2 million for the six months ended June 30, 2008 and 2007, respectively. Cash used by investing activities was primarily due to acquisitions of purchased receivables, net of cash collections applied to principal.

Financing activities used cash of $2.4 million and provided cash of $66.2 million for the six months ended June 30, 2008 and 2007, respectively. Cash used by financing activities for the six months ended June of 2008 was primarily due to repayments on our Revolving Credit Facility and Term Loan Facility of $58.8 million net of borrowings under the Revolving Credit Facility of $57.0 million. In addition, cash used by financing activities for the six months ended June of 2008 was due to payment of credit facility charges of $0.7 million associated with the amendment of the New Credit Agreement. Cash provided by financing activities for the first six months of 2007 was primarily due to borrowings of




$199.0 million under our New Credit Facilities and former credit agreement to fund the recapitalization transactions ($150.0 million) and investments in purchased receivables ($49.0 million). Cash used in financing activities include repayments of $54.0 million on our former credit agreement and capital lease obligations as well as payments of $75.0 million for our repurchase of 4,000,000 shares in accordance with the Recapitalization Plan. Also, the Company exercised its right to buy its shares from former employees for $15.00 per share, or $0.7 million.

We believe that cash generated from operations combined with borrowing available under our Amended New Credit Facilities, will be sufficient to fund our operations for the next twelve months, although no assurance can be given in this regard. In the future, if we need additional capital for investment in purchased receivables, working capital or to grow our business or acquire other businesses, we may seek to sell additional equity or debt securities or we may seek to increase the availability under our Revolving Credit Facility.

Future Contractual Cash Obligations

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Off-Balance Sheet Arrangements

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

Critical Accounting Policies

We utilize the interest method of accounting for our purchased receivables because we believe that the amounts and timing of cash collections for our purchased receivables can be reasonably estimated. This belief is predicated on our historical results and our knowledge of the industry. The interest method is prescribed by the Accounting Standards Executive Committee Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”).

We adopted the provisions of SOP 03-3 in January 2005 and apply SOP 03-3 to purchased receivables acquired after December 31, 2004. The provisions of SOP 03-3 that relate to decreases in expected cash flows amend previously followed guidance, the Accounting Standards Executive Committee Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans”, for consistent treatment and apply prospectively to purchased receivables acquired before January 1, 2005. We purchase pools of homogenous accounts receivable and record each pool at its acquisition cost. Pools purchased after 2004 may be aggregated into one or more static pools within each quarter, based on common risk characteristics. Risk characteristics of purchased receivables are assumed to be similar since purchased receivables are usually in the late stages of the post charged-off collection cycle. We therefore aggregate most pools purchased within each quarter. Pools purchased before 2005 may not be aggregated with other pool purchases. Each static pool, either aggregated or non-aggregated, retains its own identity and does not change over the remainder of its life. Each static pool is accounted for as a single unit for recognition of revenue, principal payments and impairments.

Each static pool of receivables is statistically modeled to determine its projected cash flows based on historical cash collections for pools with similar characteristics. An internal rate of return (“IRR”) is calculated for each static pool of receivables based on the projected cash flows. The IRR is applied to the remaining balance of each static pool of accounts to determine the revenue recognized. Each static pool is analyzed at least quarterly to assess the actual performance compared to the expected performance. To the extent there are differences in actual performance versus expected performance, the IRR is adjusted prospectively to reflect the revised estimate of cash flows over the remaining life of the static pool. Effective January 2005, under SOP 03-3, if the revised cash flow estimates are less than the original estimates, the IRR remains unchanged and an impairment is recognized. If cash flow estimates increase subsequent to recording an impairment, reversal of the previously recognized impairment is made prior to any increases to the IRR.

The cost recovery method prescribed by SOP 03-3 is used when collections on a particular portfolio cannot be reasonably predicted. Under the cost recovery method, no revenue is recognized until we have fully collected the cost of the portfolio.

Application of the interest method of accounting requires the use of estimates, primarily estimated remaining collections, to calculate a projected IRR for each pool. These estimates are primarily based on historical cash collections. If future cash collections are materially different in amount or timing than the remaining collections estimate, earnings could be affected, either positively or negatively. Higher collection amounts or cash collections that occur sooner than projected will have a favorable impact on yields and revenues. Lower collection amounts or cash collections that occur later than projected will have an unfavorable impact and may result in an impairment being recorded.

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Item 3. Quantitative and Qualitative Disclosures about Market Risk 

Our exposure to market risk relates to the interest rate risk with our Amended New Credit Facilities. We may periodically enter into interest rate swap agreements to modify the interest rate exposure associated with our outstanding debt. The outstanding borrowings on our Amended New Credit Facilities were $189.5 million and $191.3 million as of June 30, 2008 and December 31, 2007, respectively. In September 2007, we entered into an amortizing interest rate swap agreement whereby, on a quarterly basis, we swap variable rates equal to three-month LIBOR for fixed rates on the notional amount of $125 million. Every year thereafter, on the anniversary of the swap agreement the notional amount will decrease by $25 million. The outstanding unhedged borrowings on our Amended New Credit Facilities were $64.5 million as of June 30, 2008, consisting of $41.0 million outstanding on the Revolving Credit Facility and $23.5 million outstanding on the term loan facility. Interest rates on unhedged borrowings may be based on the Prime rate or LIBOR, at our discretion. Assuming a 200 basis point increase in interest rates, interest expense would have increased approximately $0.4 million on the unhedged borrowings for the six months ended June 30, 2008.

The hedged borrowings on our Amended New Credit Facilities were $125.0 million at June 30, 2008. For the six months ended June 30, 2008, the swap was determined to be highly effective in hedging against fluctuations in variable interest rates associated with the underlying debt. Interest rates have decreased since we entered into our swap agreement, reducing the fair value and resulting in a liability balance. Additional declines in interest rates will further reduce the fair value, while increasing interest rates will increase the fair value. As of June 30, 2008, the Company does not have any fair value hedges.

Interest rate fluctuations do not have a material impact on interest income.



Item 4. Controls and Procedures 

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

There have been no changes in our internal controls over financial reporting that occurred during our fiscal quarter ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.



The age of a charged-off consumer receivables portfolio, or the time since an account has been charged-off, is an important factor in determining the price at which we will offer to purchase a receivables portfolio. Generally, there is an inverse relationship between the age of a portfolio and the price at which we will purchase the portfolio. This relationship is due to the fact that older receivables are typically more difficult to collect. The accounts receivable management industry places receivables into the following categories depending on the number of collection agencies that have previously attempted to collect on the receivables and the age of the receivables:

 

  •   Fresh accounts are typically 120 to 270 days past due, have been charged-off by the credit originator and are either being sold prior to any post charged-off collection activity or are placed with a third party collector for the first time. These accounts typically sell for the highest purchase price.
 

 

  •   Primary accounts are typically 270 to 360 days past due, have been previously placed with one-third party collector and typically receive a lower purchase price.
 

 

  •   Secondary and tertiary accounts are typically more than 360 days past due, have been placed with two or three third party collectors and receive even lower purchase prices.
 

We specialize in the primary, secondary and tertiary markets, but we will purchase accounts at any point in the delinquency cycle. We deploy our capital within these markets based upon the relative values of the available debt portfolios.



Liquidity and Capital Resources

Historically, our primary sources of cash have been from operations and bank borrowings. We have traditionally used cash for acquisitions of purchased receivables, repayment of bank borrowings, purchasing property and equipment and working capital to support growth. During the six months ended June 30, 2008, we had repayments of $58.8 million to reduce our outstanding Revolving Credit Facility and Term Loan Facility balances while having $57.0 million in borrowings against our Revolving Credit Facility. In addition, we entered into a new agreement with a third party collecting on our behalf. Under this agreement, we will receive a total cash advance of $7.0 million through November 2009. We received $2.5 million in the first half of 2008, and incurred approximately $2.4 million in court cost expenses, which were offset with a portion of the cash advance. A liability equal to the unused cash advance is included in accrued liabilities on the consolidated statements of financial position. The agreement contains performance conditions for both parties and we may be required to refund a portion of the cash advance in certain situations.

Borrowings

We maintain a credit agreement with JPMorgan Chase Bank, N.A., as administrative agent, and a syndicate of lenders named therein, that originated on June 5, 2007 and was amended on March 10, 2008. Under the terms of the Amended New Credit Agreement, we have a five-year $100 million Revolving Credit Facility and a six-year $150 million Term Loan Facility. The Amended New Credit Facilities bear interest at prime or up to 125 basis points over prime depending upon our liquidity, as defined in the Amended New Credit Agreement. Alternately, at our discretion, we may borrow by entering into one, two, three, six or twelve-month LIBOR contracts at rates between 150 to 250 basis points over the respective LIBOR rates, depending on our liquidity. Our Revolving Credit Facility includes an accordion loan feature that allows us to request a $25.0 million increase as well as sublimits for $10.0 million of letters of credit and for $10.0 million of swingline loans. The Amended New Credit Agreement is secured by a first priority lien on all of our assets. The Amended New Credit Agreement also contains certain covenants and restrictions that we must comply with, which as of June 30, 2008 were:

 

  •   Leverage Ratio (as defined) cannot exceed (i) 1.25 to 1.0 at any time on or before June 29, 2009, (ii) 1.125 to 1.0 at any time on or after June 30, 2009 and on or before December 30, 2010 or (iii) 1.0 to 1.0 at any time thereafter;
 
Ratio of Consolidated Total Liabilities to Consolidated Tangible Net Worth cannot exceed (i) 3.0 to 1.0 at any time on or before September 29, 2008, (ii) 2.75 to 1.0 at any time on or after September 30, 2008 and on or before December 30, 2008, (iii) 2.5 to 1.0 at any time on or after December 31, 2008 and on or before December 30, 2009, (iv) 2.25 to 1.0 at any time on or after December 31, 2009 and on or before December 30, 2010, (v) 2.0 to 1.0 at any time on or after December 31, 2010 and on or before December 30, 2011 or (vi) 1.5 to 1.0 to any time thereafter; and
 

 

  •   Consolidated Tangible Net Worth must equal or exceed $80.0 million plus 50% of positive consolidated net income for three consecutive fiscal quarters ending December 31, 2007 and for each fiscal year ending thereafter, such amount to be added as of December 31, 2007 and as of the end of each such fiscal year thereafter.
 

The Amended New Credit Agreement contains a provision that requires us to repay Excess Cash Flow, as defined, to reduce the indebtedness outstanding under our Amended New Credit Agreement. The annual repayment of our Excess Cash Flow is effective with the issuance of our audited consolidated financial statements for fiscal year 2008. The repayment provisions are:

 

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

 

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

 

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

Commitment fees on the unused portion of the New Revolving Credit Facility are paid quarterly, in arrears, and are calculated as an amount equal to a margin of 0.25% to 0.50%, depending on our liquidity, on the average amount available on the New Revolving Credit Facility.

The Amended New Credit Agreement requires us to effectively cap, collar or exchange interest rates on a notional amount of at least 25% of the outstanding principal amount of the Term Loan.

We had $189.5 million principal balance outstanding on our Amended New Credit Facilities at June 30, 2008. We have an interest rate swap agreement that hedges a portion of the interest rate expense on the Term Loan Facility. We believe we are in compliance with all terms of the Amended New Credit Agreement as of June 30, 2008.

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Cash Flows

For the six months ended June 30, 2008, we invested $85.0 million in purchased receivables, net of buybacks, funded by a combination of internal cash flow and the Revolving Credit Facility. Our cash balance decreased from $10.5 million at December 31, 2007 to $9.2 million as of June 30, 2008.

Our operating activities provided cash of $20.2 million and $32.7 million for the six months ended June 30, 2008 and 2007, respectively. Cash provided by operating activities for the six months ended June 30, 2008 and 2007 was generated primarily from net income earned through cash collections as adjusted for the timing of payments in income taxes payable, accounts payable and accrued liabilities as of June 30, 2008 and 2007 compared to December 31, 2007 and 2006, respectively.

Investing activities used cash of $19.1 million and $24.2 million for the six months ended June 30, 2008 and 2007, respectively. Cash used by investing activities was primarily due to acquisitions of purchased receivables, net of cash collections applied to principal.

Financing activities used cash of $2.4 million and provided cash of $66.2 million for the six months ended June 30, 2008 and 2007, respectively. Cash used by financing activities for the six months ended June of 2008 was primarily due to repayments on our Revolving Credit Facility and Term Loan Facility of $58.8 million net of borrowings under the Revolving Credit Facility of $57.0 million. In addition, cash used by financing activities for the six months ended June of 2008 was due to payment of credit facility charges of $0.7 million associated with the amendment of the New Credit Agreement. Cash provided by financing activities for the first six months of 2007 was primarily due to borrowings of $199.0 million under our New Credit Facilities and former credit agreement to fund the recapitalization transactions ($150.0 million) and investments in purchased receivables ($49.0 million). Cash used in financing activities include repayments of $54.0 million on our former credit agreement and capital lease obligations as well as payments of $75.0 million for our repurchase of 4,000,000 shares in accordance with the Recapitalization Plan. Also, the Company exercised its right to buy its shares from former employees for $15.00 per share, or $0.7 million.

We believe that cash generated from operations combined with borrowing available under our Amended New Credit Facilities, will be sufficient to fund our operations for the next twelve months, although no assurance can be given in this regard. In the future, if we need additional capital for investment in purchased receivables, working capital or to grow our business or acquire other businesses, we may seek to sell additional equity or debt securities or we may seek to increase the availability under our Revolving Credit Facility.


Critical Accounting Policies

We utilize the interest method of accounting for our purchased receivables because we believe that the amounts and timing of cash collections for our purchased receivables can be reasonably estimated. This belief is predicated on our historical results and our knowledge of the industry. The interest method is prescribed by the Accounting Standards Executive Committee Statement of Position 03-3, “Accounting for Certain Loans or Debt Securities Acquired in a Transfer” (“SOP 03-3”).

We adopted the provisions of SOP 03-3 in January 2005 and apply SOP 03-3 to purchased receivables acquired after December 31, 2004. The provisions of SOP 03-3 that relate to decreases in expected cash flows amend previously followed guidance, the Accounting Standards Executive Committee Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans”, for consistent treatment and apply prospectively to purchased receivables acquired before January 1, 2005. We purchase pools of homogenous accounts receivable and record each pool at its acquisition cost. Pools purchased after 2004 may be aggregated into one or more static pools within each quarter, based on common risk characteristics. Risk characteristics of purchased receivables are assumed to be similar since purchased receivables are usually in the late stages of the post charged-off collection cycle. We therefore aggregate most pools purchased within each quarter. Pools purchased before 2005 may not be aggregated with other pool purchases. Each static pool, either aggregated or non-aggregated, retains its own identity and does not change over the remainder of its life. Each static pool is accounted for as a single unit for recognition of revenue, principal payments and impairments.

Each static pool of receivables is statistically modeled to determine its projected cash flows based on historical cash collections for pools with similar characteristics. An internal rate of return (“IRR”) is calculated for each static pool of receivables based on the projected cash flows. The IRR is applied to the remaining balance of each static pool of accounts to determine the revenue recognized. Each static pool is analyzed at least quarterly to assess the actual performance compared to the expected performance. To the extent there are differences in actual performance versus expected performance, the IRR is adjusted prospectively to reflect the revised estimate of cash flows over the remaining life of the static pool. Effective January 2005, under SOP 03-3, if the revised cash flow estimates are less than the original estimates, the IRR remains unchanged and an impairment is recognized. If cash flow estimates increase subsequent to recording an impairment, reversal of the previously recognized impairment is made prior to any increases to the IRR.

The cost recovery method prescribed by SOP 03-3 is used when collections on a particular portfolio cannot be reasonably predicted. Under the cost recovery method, no revenue is recognized until we have fully collected the cost of the portfolio.

Application of the interest method of accounting requires the use of estimates, primarily estimated remaining collections, to calculate a projected IRR for each pool. These estimates are primarily based on historical cash collections. If future cash collections are materially different in amount or timing than the remaining collections estimate, earnings could be affected, either positively or negatively. Higher collection amounts or cash collections that occur sooner than projected will have a favorable impact on yields and revenues. Lower collection amounts or cash collections that occur later than projected will have an unfavorable impact and may result in an impairment being recorded.

 

Item 3. Quantitative and Qualitative Disclosures about Market Risk 

Our exposure to market risk relates to the interest rate risk with our Amended New Credit Facilities. We may periodically enter into interest rate swap agreements to modify the interest rate exposure associated with our outstanding debt. The outstanding borrowings on our Amended New Credit Facilities were $189.5 million and $191.3 million as of June 30, 2008 and December 31, 2007, respectively. In September 2007, we entered into an amortizing interest rate swap agreement whereby, on a quarterly basis, we swap variable rates equal to three-month LIBOR for fixed rates on the notional amount of $125 million. Every year thereafter, on the anniversary of the swap agreement the notional amount will decrease by $25 million. The outstanding unhedged borrowings on our Amended New Credit Facilities were $64.5 million as of June 30, 2008, consisting of $41.0 million outstanding on the Revolving Credit Facility and $23.5 million outstanding on the term loan facility. Interest rates on unhedged borrowings may be based on the Prime rate or LIBOR, at our discretion. Assuming a 200 basis point increase in interest rates, interest expense would have increased approximately $0.4 million on the unhedged borrowings for the six months ended June 30, 2008.

The hedged borrowings on our Amended New Credit Facilities were $125.0 million at June 30, 2008. For the six months ended June 30, 2008, the swap was determined to be highly effective in hedging against fluctuations in variable interest rates associated with the underlying debt. Interest rates have decreased since we entered into our swap agreement, reducing the fair value and resulting in a liability balance. Additional declines in interest rates will further reduce the fair value, while increasing interest rates will increase the fair value. As of June 30, 2008, the Company does not have any fair value hedges.

Interest rate fluctuations do not have a material impact on interest income.


Item 4. Controls and Procedures  

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

There have been no changes in our internal controls over financial reporting that occurred during our fiscal quarter ended June 30, 2008 that have materially affected, or are reasonably likely to materially affect, our internal controls over financial reporting.

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PART II - OTHER INFORMATION

 

Item 1. Legal Proceedings 

In the ordinary course of our business, we are involved in numerous legal proceedings.

We regularly initiate collection lawsuits, using both our in-house attorneys and our network of third party law firms, against consumers and are occasionally countersued by them in such actions.

Also, consumers initiate litigation against us, in which they allege that we have violated a federal or state law in the process of collecting on their account.

It is not unusual for us to be named in a class action lawsuit relating to these allegations, with these lawsuits routinely settling for immaterial amounts.


We do not believe that these ordinary course matters, individually or in the aggregate, are material to our business or financial condition. However, there can be no assurance that a class action lawsuit would not, if decided against us, have a material and adverse effect on our financial condition.

We are not a party to any material legal proceedings. However, we expect to continue to initiate collection lawsuits as a part of the ordinary course of our business (resulting occasionally in countersuits against us) and we may, from time to time, become a party to various other legal proceedings arising in the ordinary course of business.

 

Item 4. Submission of Matters to a Vote of Security Holders 

The annual meeting of the shareholders of the Company was held on May 21, 2008. The results of the voting were as follows:

1. The following individuals were elected as directors for a three-year term:

 

     
Director
    Votes for
    Votes Withheld
 
Terrence D. Daniels
    25,382,122    1,845,150
William F. Pickard
    25,431,877    1,795,395

The following is a list of the other directors whose term of office continues beyond the annual shareholder meeting:

Jennifer Adams

Nathaniel F. Bradley IV

Donald Haider

Anthony R. Ignaczak

William I Jacobs

H. Eugene Lockhart

2. The ratification of Grant Thornton LLP as the Company’s independent registered public accounting firm for the fiscal year ending December 31, 2008:

 

     
Votes for
    Votes Against
    Votes abstained
 
27,178,100    21,491    27,681

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Item 6. Exhibits 

 

   
Exhibit

Number
   Description
 
10.1
   First Amendment to the Lease Agreement dated as of April 11, 2008, between Asset Acceptance, LLC and Northpoint Atrium Office Building, Ltd. (Incorporated by reference to Exhibit 10.1 included in the Current Report on Form 8-K filed on May 6, 2008)
 
31.1*
   Rule 13a-14(a) Certification of Chief Executive Officer
 
31.2*
   Rule 13a-14(a) Certification of Chief Financial Officer
 
32.1*
   Section 1350 Certification of Chief Executive Officer and Chief Financial Officer
 
* Filed herewith 


SIGNATURES

Pursuant to the requirements of Section 13 or 15(d) of the Securities Exchange Act of 1934, the Registrant has duly caused this Report to be signed on its behalf by the undersigned, thereunto duly authorized on August 5, 2008.

 

     
   ASSET ACCEPTANCE CAPITAL CORP.
   
Date: August 5, 2008   By:   /s/ Nathaniel F. Bradley IV
 
      Nathaniel F. Bradley IV
      Chairman of the Board, President and

Chief Executive Officer
 
      (Principal Executive Officer)
   
Date: August 5, 2008   By:   /s/ Mark A. Redman
 
      Mark A. Redman
      Senior Vice President – Finance and

Chief Financial Officer
 
      (Principal Financial and Accounting Officer)

 

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[nydeemarie]

Any costs mentioned for compliance with the Identity Theft Red Flag rule?? 

I don't see it mentioned here...   Wonder why...