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Asset Acceptance Capital Corp. (AACC)

Q4 2008 Earnings Call Transcript

February 19, 2009 10:00 am ET

Executives

Jeff Tryka – IR, Lambert, Edwards & Associates

Rion Needs – President & CEO

Mark Redman – SVP, CFO, Secretary & Treasurer

Analysts

Hugh Miller – Sidoti

Sameer Gokhale – Keefe, Bruyette & Woods

Mark Hughes – SunTrust Bank

Rick Shane – Jefferies & Co.

Justin Hughes – Philadelphia Financial

Operator

Good morning and welcome to Asset Acceptance Capital Corp Q4 2008 conference call. All participants will be in a listen-only mode until question-and-answer session of this conference call. This call is being recorded at the request of Asset Acceptance. If anyone has any objections, you may disconnect at this time. I would now like to introduce Mr. Jeff Tryka, on behalf of Asset Acceptance Capital Corp. Mr. Tryka, you may proceed.

Jeff Tryka

Good morning and welcome to Asset Acceptance Capital’s fourth quarter and year-end 2008 conference call. On the call today are Rion Needs, our President and CEO; and Mark Redman, our Senior Vice President of Finance and CFO.

Earlier this morning, we announced the company’s fourth quarter and year-end financial results. If you did not get a copy of this press release, please contact Amanda Passage at 616-233-0500 to have one sent to you. This release is available on many news sites, or it can be viewed on our corporate website at www.assetacceptance.com.

Before I turn the call over to management to comment on our results, I would like to remind you that this conference call contains certain statements, including the company’s plans and expectations regarding its operating strategies, charged-off receivables and costs, which are forward-looking statements and are made pursuant to the Safe Harbor provision of the Securities Litigation Reform Act of 1995.

These forward-looking statements reflect the company’s views at the time such statements are made with respect to the company’s future plans, objectives, events, portfolio purchases and pricing, collections and financial results such as revenues, expenses, income, earnings per share, capital expenditures, operating margins, financial position, expected results of operation and other financial items, as well as industry trends and observations.

In addition, words such as estimate, expect, intend, should, could, will, and variations of such words and similar expressions are intended to identify forward-looking statements. These statements are not guarantees of future performance and involve certain risks, uncertainties and assumptions that are difficult to predict with regard to timing, extent, likelihood and degree of occurrence.

There are a number of factors, many of which are beyond the company’s control, which could cause actual results and outcomes to differ materially from those described in the forward-looking statements. Risk factors include, among others, our ability to purchase charged-off consumer receivables at appropriate prices, our ability to continue to acquire charged-off receivables in sufficient amounts to operate efficiently and profitably, employee turnover, our ability to compete in the marketplace, acquiring charged-off receivables in industries that the company has little or no experience, and the integration and operations of newly acquired businesses.

Other risk factors exist and new risk factors emerge from time to time that may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forward-looking statements as a prediction of actual results.

Furthermore, the company expressly disclaims any obligation to update, amend or clarify forward-looking statements. In addition to the foregoing, several risk factors are discussed in the company’s most recently filed Annual Report on Form 10-K and other SEC filings, in each case under the title Risk Factors or captions similar thereto and those discussions regarding risk factors as well as the discussion of forward-looking statements in such sections are incorporated herein by reference.

With that said, I would like to now turn the call over to Rion Needs, President, and CEO of Asset Acceptance. Rion?

Rion Needs

Thank you, Jeff. Good morning and welcome to our fourth quarter 2008 conference call. During today’s call, I will provide a high-level commentary on our fourth quarter and year-end financial performance, a review of our purchasing in the quarter, as well as the current collections environment, and current macro industry trends as we see them.

Following my initial comments, Mark Redman, our Chief Financial Officer, will then provide a summary of the fourth quarter and year-end 2008 financials. After our discussion of results, we will introduce our new econometric model and review how that model is shaping our current strategy including our plans for purchasing and collection. At the conclusion of our prepared remarks, we will have a question-and-answer session.

So turning to the fourth quarter and year-end 2008 performance, during the fourth quarter, we continued to face a number of challenges in light of the current economic environment, which resulted in 11.6% contraction in total revenues to $55 million.

Despite the lower revenues, we continued our focus on expense management which enabled us to post net income of $3.8 million or $0.12 per fully diluted share, compared with net income of $4 million or $0.13 per share a year ago. We generated total revenues for the full year 2008 of $234.2 million. Net income for the full year 2008 was $15.7 million or $0.51 for a fully diluted share.

As the current recession deepened during the quarter, the overall supply of charge-offs from issuers continued to expand, while overall demand remained soft given the reduced availability of credit within the industry. Consequently, the pricing environment in the fourth quarter showed modest improvement. But, as we will discuss shortly, we believe that supply and pricing will present even more attractive opportunities in the second half of 2009 and into 2010. Given these expectations, our purchases remained at lower levels as we invested $32.2 million in the quarter for a total of $155.2 million for the year.

In the fourth quarter, the collection’s environment was hampered by consumers facing falling home values, declining availability of credit, and increased levels of unemployment. In the face of these challenges, we continued working to maximize our collection efforts while tightly controlling our operating expenses as a percentage of cash collections.

Looking forward, we are encouraged by the opportunities presented in the current economic climate, but also recognize the challenges to our collections in this environment. We will continue to focus on growing cash collections, leveraging our associate talent, maximizing our collection capacity, and improving our operational efficiency.

We also intend to exercise patience and prudence in portfolio purchases as we seek to optimize future cash collections relative to portfolio pricing. I will now provide some comments on the current macro-environment as well as an update on several key operational initiatives that remain top priorities for our team in 2009. As a baseline, many economists believe we our in the midst of the worst recession in the post-war period.

In the fourth quarter, we experienced significant increases in market volatility and massive programs by the US Treasury and Federal Reserve to aid banks (inaudible) credit markets. Despite injections of hundreds of billions of dollars into the banking system, little has changed as banks continue to hold cash and consumers and companies find access to need of credit becoming increasingly difficult. The recession is deepening as consumers reduce spending and increase savings, and businesses look to cut cost or forego investments.

Unemployment rose substantially in the fourth quarter with news of job cuts by major companies breaking on a weekly or even daily basis. As consumers face falling home values, rising worries over job prospects and falling cash flow, the collections environment has become even more challenging. These pressures on consumers inhibit their ability to use excess cash to pay down outstanding debt, making our work that much harder.

Overall, the pricing environment continued to show modest improvements in the fourth quarter of 2008. However, based on our analysis of current economic trend, we continue to believe that the overall economic picture may worsen before it eventually improves, presenting further downward pressure on pricing over the next several quarters. Given our view, we are being selective in our purchasing, opting to keep a good supply of dry powder for the opportunities that lie ahead.

In 2008, our portfolio purchases were $155.2 million representing face value of $3.8 billion, compared with purchases of $159.5 million representing face value of $5.2 billion in 2007. The reduction in our level of purchases is consistent with our desire to be more selective in light of the current market. I’ll come back to that after Mark’s comments.

The average blended price for our portfolio investments increased in 2008 to 4.05% from 3.26% in the prior year as a result of our purchase of overall higher quality paper in 2008. Overall, we are pleased with our level of debt purchasing in 2008, particularly in light of our pricing and collections expectation over the coming quarters. We expect to take advantage of the increasing supply of charged-off debt and resulting lower prices, but our approach will remain disciplined as economic conditions evolve.

Let me now turn to a review of our operations during the quarter. In the fourth quarter, we continue to work on our overall capacity utilization and inventory management to generate improved results going forward. We remain focused on achieving a high level of operational discipline throughout the organization as we seek to control cost within the current marketplace challenges. The focus has begun to bear fruit as our operating expenses were significantly reduced in the fourth quarter. Total operating expenses were reduced 12.3 % to $46 million from $52.4 in the fourth quarter of 2007.

Operating expenses as a percentage of cash collections in the quarter improved by 360 basis points compared to last year. Given the capacity constraints we’ve mentioned on previous calls, we continue to rely on outside partners in our collection efforts. Capacity planning and productivity remained key priorities for all of us on the management team, particularly as we seek to properly allocate the human capital necessary to collect on our significant inventory of charged-off receivables.

As we mentioned in previous quarters, we continue to work to better align our existing collection staff with our account inventory. And as a result, we anticipate that the elevated volume of accounts directed toward the agency forwarding channel will continue. As a result, we will likely see account representative productivity remain at lower levels over the coming quarters. However, and this is important, we believe this approach will generate increased cash collections on our portfolios. We remain confident that we’re on the correct path, but it will take some time and effort to arrive at the optimal balance of internal and outsourced collection efforts.

As we’ve emphasized in prior quarters, our senior team is focused on creating a highly engaged and skilled workforce that will allow us to capitalize on current and future market opportunities. Since assuming my role as CEO at the beginning of the year, I have traveled to most of our offices to meet with a large number of our associates to present my vision of the future and listen to their concerns.

I’ve been impressed with the quality of our people but I recognized that we have more work ahead of us to achieve our goal of becoming the employer of choice in our industry. We continue to work aggressively to improve our level of training, systems, and career development options for all of our associates. And we believe the investments we make in these areas will provide returns in the form of higher retention and increased productivity over the long term.

With that, I’ll hand the call over to Mark for a detailed review of our fourth quarter and year-end financial results.

Mark Redman

Thank you, Rion. This morning, I’ll review our fourth quarter 2008 and year-end financial results and metrics, provide a discussion on revenue recognition, and finally I will end with our liquidity and capital structure.

Starting with an overview of our financial results. In the fourth quarter, total cash collections declined 6.5% to $83.3 million compared with cash collections of $89.1 million in the fourth quarter of 2007. For the full year, cash collections fell 0.4% to $369.6 million from $371.2 million in 2007.

During the fourth quarter, we generated total revenues of $55 million, down 11.6% from $62.2 million in the same quarter of 2007. Full year revenue fell 5.6% to $234.2 million from $248 million a year ago. I will go into more detail on revenue shortly.

Total operating expenses improved 12.2% to $46 million in the fourth quarter of 2008 compared to total operating expenses of $52.4 million in the year-ago period. Total operating expenses were 55.2% of cash collections in the current quarter compared with 58.8% in the same period of 2007.

For the full year, operating expenses were reduced 5.6% to $195.8 million reflecting improvement in a majority of the areas compared to the year-ago period. The improvement in operating expenses was a bright spot in our 2008 performance. However, given the macroeconomic environment, we don’t expect to repeat that improvement in 2009.

In the fourth quarter, salaries and benefits decreased $200,000 or 1% to $19.3 million compared to $19.5 million in the year-ago period. For 2008, salaries and benefits were $82.8 million, a reduction of $100,000 from 2007 levels.

Collections per account representative declined 20.9% to $34,994 in the fourth quarter of 2008 compared with collections per account representative of $44,235 in the year-ago period. For the full year, collections per account representative fell 10.3% to $173,209 from $193,000 last year. We believe the drop in productivity was primarily the result of an increasingly more difficult collections environment.

For the fourth quarter 2008, we had an average of 1,003 account representatives on our team on a full-time equivalent basis, an increase of 114 from an average of 889 account reps in the fourth quarter of 2007, also on a full-time equivalent basis.

During the current quarter, collections expense declined $5.3 million or 20.1% to $21.1 million compared to $26.4 million in the prior-year period. For the full year, collections expense decreased 9.5% to $90 million compared to $99.4 million in 2007. The improvement was driven by a $15.1 million decline in variable costs associated with lower data provider cost, better expense management, and our efforts to better match legal collection with legal collection expenses.

The $15.1 million decrease was partially offset by an increase in forwarding fees of $5.7 million paid on cash collections from third party relationships, that is attorneys and collection agencies. As a result of an increase in our collections from third party relationships, the 30.9% of total cash collections for the 2008 year from 26.8% for 2007.

Occupancy cost declined $200,000 or 10.3% in the fourth quarter 2008 to $1.9 million compared to the year-ago period. For 2008, occupancy costs were reduced 15.4% to $7.7 million compared with $9.1 million in 2007, due primarily to the consolidation of two of our call centers in 2007. Administrative expenses decreased 11.9% to $2.4 million in the fourth quarter 2008 compared to $2.7 million in the prior year period. For the full year, administrative expenses remained flat compared to 2007 at $10.5 million.

Interest expense was $3.1 million during the fourth quarter of 2008, down from $3.4 million in the fourth quarter of 2007. Interest expense for the full year was $13 million, an increase of $4.9 million from 2007. The higher interest expense was largely as a result of higher average borrowings during the year. Average borrowings were higher in 2008 and in 2007, primarily because of the borrowings under the $150 million term loan were outstanding for 12 months in 2008 compared to approximately seven months in 2007.

The company reported net income of $3.8 million or $0.12 per share in the 2008 fourth quarter compared with net income of $4 million or $0.13 per share in the fourth quarter of 2007. For the year, the company reported net income of $15.7 million or $0.51 per share versus net income of $20.4 million or $0.63 per share last year.

Next, I will detail revenue impairments and portfolio amortization. Fourth quarter purchase receivables revenues, our primary source of revenue, decreased 10.6% to $54.9 million compared with $61.4 million in the year-ago period. For the full year, purchase receivables revenue fell 5.2% to $232.9 million from $245.7 million in 2007. Net impairments for the quarter were $4.6 million versus a net impairment charge of $900,000 in the fourth quarter of 2007. Impairments for the full year amounted to $13 million compared to $24.4 million in the prior year.

In the fourth quarter, the most significant impairment which was $1.9 million came from the Q1 ’06 aggregate pool. The remaining net impairments of $2.7 million came from approximately 30 pools with a little more than half of those pools having been acquired in 2004. We continue to closely monitor our actual collection performance in relation to our revenue models. Because of the macroeconomic environment that has led to a degradation in collections, we remain cautious with regard to impairments and yields given the current environment.

The amortization rate or the difference between cash collections and revenue increased from 31.2% in the fourth quarter 2007 to 34.2% in the fourth quarter of 2008. For the full-year, the amortization rate increased to 37% from 33.8%. The increased amortization rate is primarily due to lower average internal rates of return assigned to recent year’s purchases as well as pricing [ph] first quarter of 2005 aggregate in all healthcare portfolios on cost recovery methods.

Collections on zero-basis pools or fully amortized pools decreased 13.3% to $17.7 million in the fourth quarter of 2008 versus $20.4 million in the fourth quarter last year. Collections on zero-basis pools for the full year decreased 4.2% to $78.6 million compared to $82 million in 2007.

Despite the increasingly difficult collections environment, cash flow generation in 2008 remained consistently strong. As we have discussed in the past, we disclose our adjusted EBITDA in our quarterly earnings releases because it is an important measure we use to gauge the operational success of the business. It is a measure of the cash generated by the company that is available to purchase receivables, paid down debt, pay income taxes, or return to our shareholders, among other uses.

The cash generated by our business has been the primary source of funding for purchases in 2008 as we invest $155.2 million in purchased receivables even as we reduced the outstanding debt on our credit facilities by $9.7 million.

For the fourth quarter 2008, adjusted EBITDA increased by 1.2% to $38.9 million when compared to the fourth quarter of 2007. For the full-year, adjusted EBITDA increased 5.8% to $179.7 million from $169.8 million in 2007. Please refer to the table in the press release and on the attachment to the Form 8-K filed this morning reconciling GAAP net income to adjusted EBITDA.

Turning to our balance sheet, as of December 31, 2008, our cash and equivalents balance was $6 million compared to $10.5 million at December 31, 2007. The carrying value of purchased receivables as of December 31, 2008 was $361.8 million, up from $346.2 million at December 31, 2007.

Also as of December 31, 2008, we had outstanding borrowings of $181.6 million on our amended credit facility, a decrease of $9.7 million compared to the balance at the end of 2007. Borrowings on our $100 million revolver at the end of the third quarter were $33.8 million, leaving capacity on the current facility of $66.2 million. However, our capacity was further limited by our debt covenants. I estimate that the capacity under the most restrictive debt covenant as of December 31, 2008 was approximately $28 million.

With that overview, I will turn the call back over to Rion to discuss our strategic outlook for 2009.

Rion Needs

Thanks, Mark, appreciate that. We’d like to now actually talk to you about our 2009 economic outlook and really introduce our new Econometric Scenario Projection or ESP model that has really helped shape our view of that outlook.

Beginning in the second half of 2008, we began to see a dynamic change in the economic forces that affect our industry. The collapse of the credit markets and subsequent contraction had majorly impacted consumers’ borrowing capacity, which in turn is driving increases in the supply and decreased pricing. This presents both challenges and opportunities for us. To better understand how to maximize the opportunities and manage the challenges, we created an econometric model to assist us in our ability to project future trends in our business. This model uses leading indicators that could forecast key business metrics into the near future.

Our model indicates that due to current economic factors, supply will continue to grow, pricing will continue to decrease, as well as liquidation rates into 2010. As a result, we have undertaken a strategy to slow our purchasing in the first half of 2009, as I mentioned earlier, to free up capital to purchase at more advantageous prices in the second half of 2009 and into 2010. Should major economic factors such as unemployment deteriorate faster than current forecast, that window could be extended.

Now, I’d like to take you through some of the output from our model and how that has shaped our strategic view. If you look at the liquidation performance on the upper graph, we have scaled that monthly liquidation rate proportionally to the pricing curves so that you can more easily see the relationship of the general curves associated with both liquidation and pricing, but the curve and the shape of the curve itself is accurate.

Historically, our debtors were relatively unaffected by macroeconomic events. From 2002 to 2006, very little change in monthly liquidation rate occurred. From 2007 to the first half of 2008, we saw significant increase in liquidation rates, which we believe were driven by the housing boom and expansion of credit markets. From the second half of 2008 to present, we have seen significant decrease of liquidation rates due to the housing bust, contraction in credit markets, increased unemployment, and deteriorating consumer confidence about the future. Our model indicates that with these economic pressures, we can expect to see continued deterioration of liquidation rates as indicated on the blue line through 2010.

From a pricing perspective, the model indicates that charged-off receivables or debt available for purchase in the market has steadily grown from 2006 to present due to the expansion of credit markets. Our model indicates that this supply will significantly grow through 2010 due to recessionary factors in the market, coupled with consumer credit contraction.

As a result of deteriorating liquidation rates, capacity constraints in outside agencies, reduced competitive forces due to the exit of some debt buyers from the industry and liquidity constraints of remaining buyers, as well as increasing supply and economic pressure on sellers, pricing will continue to decline through 2010.

As a result of our modeling, we have adjusted our purchasing strategy to temporarily slow down our purchasing in favor of building cash reserves to take advantage of pricing that will continue to improve and allow for superior margins as liquidation rates improve.

We are often asked why we just don’t buy heavily now at prices not seen since 2004. Unfortunately, debt portfolios lose value over time and delays in collections in the early stages of ownership are not significantly recaptured in later stages.

Let's turn the page and focus really on the purchasing dynamics associated with the market and how that impacts our multiples. The dynamic of increasing supply and declining pricing have the potential to significantly improve collection multiples in the future despite declining liquidation rates. We believe this potential will be realized most effectively by slowing purchasing in the near-term to buy when pricing reaches the bottom and liquidation rates begin to recover.

In the past, concerns have been expressed over the current borrowing capacity, our current borrowing capacity, and the lack of activity in expanding our facility. We currently have the ability to renegotiate our credit agreement and that would allow us to tap the full value of our facility and expand it. However, as indicated on the slide, given the current credit environment, that would result in significant erosion of both short-term and long-term margins. Repricing our agreement in today’s market would result in more than doubling our current interest rate, not only on future borrowings but on the entire outstanding base.

Given the considerable premium we would pay for this action, coupled with the fact that we believe the most advantageous pricing in collection environment are still in front of us, we will continue to be selective in our purchasing in the short-term. We also believe that the credit markets will normalize as a precursor to economic recovery, allowing us to expand our facility prior to the improvement in liquidation rates and hitting the bottom of the pricing decline. This will free up capital to take full advantage of what we believe will be the most advantageous environment in the future.

Our new ESP model is rooted in a rigorous statistical analysis. Through extensive research, we have identified macroeconomic indicators that over time have the ability to reliably forecast our key business drivers, such as pricing, liquidation rates, and supply. All of these indicators have a correlation coefficient of at least 0.79 with a statistical significance of greater than 99%. We believe that we have developed a tool that creates significant value in assets should now provide a significant detail regarding the underlying detail of the model.

Based on our model indicating that supply will continue to grow and prices decline through 2010, coupled with the irrational credit markets today, we believe that prudent strategies and slow purchasing in the near-term to build cash reserves to take advantage of what promises to be a better pricing market at the end of 2009 and 2010.

In the meantime, we are committed to our focus on improving operational excellence and improving our cost to collect to offset deterioration and liquidation rates. We will continue to aggressively assess the credit markets and take advantage of the first available opportunity to expand our credit facility at rates that will increase margins. Using our model, we will continue to adjust our strategy based on changes and the leading economic indicators that drive our business to ensure the long-term success of our company.

With that, we’d like to turn it over to the operator now to open up the lines for question-and-answers.

Question-and-Answer Session

Operator

(Operator instructions) And the first question comes from the line of Hugh Miller from Sidoti. Please proceed.

Hugh Miller – Sidoti

Good morning.

Rion Needs

Good morning, Hugh.

Hugh Miller – Sidoti

I was wondering if – this is a housekeeping question. Can you guys say whether or not there were any compensation accrual reversals in the fourth quarter? Obviously, the FTEs were up, but the comp was down. I was wondering if that had any impact in the compensation for the fourth quarter.

Mark Redman

Hugh, there weren’t any significant compensation reversals in the fourth quarter.

Hugh Miller – Sidoti

Okay. And looking on a sequential basis in the fourth quarter, there was about $2.5 million decline in the collection expense. In the past, you guys have talked about that you had experienced some cost deferrals that you were able to have and also some operating synergies that improved the expense line item. I was wondering if you can maybe talk to us about the sequential decline and maybe give us a sense of what percentage may have been more of a cost-deferral factor and what may have been operational synergies.

Rion Needs

Sure. So, from a cost-deferral perspective, we talked previously about matching a more accurate basis our expenses and revenues, our collections associated with the legal stream. And so, we were able to do that through third-party relationship that we had entered into. That has had the favorable impact on our expense improvement, cost to collect improvement, in addition to the fact that we went through reduction in force. Actually, it was in October – September, October we saw the economy turning down pretty aggressively. We went to restructure a number of our groups and that reduction in force was predominantly driven by leadership positions, where we increased spending control on the minor sites from a leadership perspective.

The decline in collections have obviously been relative to the economic impact in the fourth quarter where we saw that the largest impact, specifically in October/November, where we saw the most dramatic declines in those collections. We continue to stay focused on operational efficiencies. And as I mentioned in my remarks, to make sure that we’ve got our capacity aligned and how we think about liquidating because we also know that we are better at liquidating our own portfolios than third-party agencies, but we also recognize and believe that inventory in-house where we don’t have complete capacity would reduce the total collection. So, we are balancing those two off with each other, but we continue to focus on retention and we’ve made marked improvements in 2008 in retention numbers, which has also allowed us, as indicated in our press release to increase our headcounts by 111 collectors.

Hugh Miller – Sidoti

Okay. And I guess if you – you mentioned that you went through the reduction in force in September/October. I guess, yet the – on a sequential basis, you guys added about 37 FTEs during the quarter. I guess can you talk about the dynamic there and what may have occurred?

Rion Needs

Sure. So, the difference there is that the net add of 37 came from an increase in our collector base and the REF, the reduction of force, came out of our management base. So, we basically reduced overhead and increased revenue-producing positions.

Hugh Miller – Sidoti

Okay. And then, I was wondering if you could talk a little bit about the underlying characteristics of the receivables that you’re seeing right now for sale that you’re buying and whether or not you’re seeing possibly an improvement in those characteristics, excluding obviously any adjustments you’ve made with your expectation for collections from the economy. But just looking at the underlying characteristics, FICO scores and so on of the receivables you’re buying, and whether or not that’s actually improved over the past year or two.

Rion Needs

Yes. That’s a great a question. One of the problems that you have with the FICO scores and with Lexus scores and extreme [ph] scores, all of the metrics that we utilize is they are a snapshot in time and the problem is the economy is evolving very, very rapidly. So, what we buy today and hold may change very rapidly in the future, so they’re hard to use as (inaudible). What I can tell you is that the paper that we’re purchasing today is of, in general, higher quality because we’re seeing it much earlier.

So, we’re seeing tertiary paper actually on the markets for sale in about half the time of what we used to see just because of the capacity constraints in the agency community where sellers no longer have the same opportunity to sit out at the agencies and try and collect on it, as well as their pressure to continue to drive improved revenues. So, we often talk about the indifference point of sellers. The reality is most of them, I believe, have indifference point that is the future cash flows associated with agency placement versus the price in the current market for sale. And the realities with declining liquidation rates in today’s environment, their future cash flows continue to diminish especially with the capacity constraint. And as a result, they are pushing to sell much more rapidly because of the growing wave behind them, which we indicated in the model.

Hugh Miller – Sidoti

Okay. I guess just as a follow up, the point I was driving at was that the type of person that’s getting charged off in this particular market, whether or not they may be even more likely to pay at some point in the future relative to someone who was charged off in an actual thriving economy.

Rion Needs

Sure. So, if I think about it into the future periods, that’s absolutely the case. We’re getting new entrants into the debt environment today that have historically not been here. So, the problem is, if we think about the cycle of all this, right, that went bad or has been going bad really since the middle of 2008 when the upheaval in the markets occurred; and so, it’s still relatively fresh and we’re not seeing those new entrants in the tertiary paper. We are seeing it in the prime paper, where those new entrants are starting to make their way into. We expect to see them in that big wave that we’re forecasting out into 2009 and 2010.

In that supply base, we’re going to see those new entrants and I believe that they will behave very differently than our traditional debtor. From a standpoint, they’ve never been there, they want to get out of there and they’re going to want to rectify their financial situation, so they can move their life forward and get back into the houses foreclosed on and just improve their general life, but they have a conclusively different psychology than our traditional debtor.

Hugh Miller – Sidoti

Okay. Great color there. I guess just one last question, I’ll get back in the queue. In the past, you guys have talked about, I guess, from a numerical standpoint, about pricing trends that you’re seeing on the receivable side and you did mention that you saw a modest improvement in the fourth quarter. I was wondering maybe if you could give us a sense on a year-over-year basis as to maybe a range that you’re seeing in the pricing that’s declined from the end of last year.

Rion Needs

On a year-over-year for equivalent paper?

Hugh Miller – Sidoti

Yes.

Mark Redman

It’s going to vary between types of paper and classes of paper. I mean, some classes such as the non-traditional classes have really fallen off quite a bit, more so than the traditional asset classes. The traditional asset classes –

Hugh Miller – Sidoti

Maybe focusing more on your traditional credit card.

Rion Needs

Yes. Just trying to run some numbers real quick that we have here, for trying to get exact as we can, we have seen probably in the range of approximately 50% year-over-year for comparable paper from where we were.

Hugh Miller – Sidoti

Okay. Thank you very much.

Operator

And the next question comes from the line of Sameer Gokhale from Keefe, Bruyette & Woods. Please proceed.

Sameer Gokhale – Keefe, Bruyette & Woods

Hi. Thanks and good morning. Just a quick comment, as far as the slides go, I don’t know if they were emailed out or not, I caught a quick glimpse of a couple of them on the webcast, but I don’t think they’re on your website just yet. If they could be out there sometime soon, it’d be helpful to take another look at all those slides in some more detail.

Rion Needs

Sameer, they should be available via the webcast replay.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. That’s terrific. And then, one of the questions I had was your commentary on the number of FTEs that you gave, but what – could you share with us your retention rate for the full-year of ’08 compared to ’07. And I know you’ve taken some steps to try to improve selective retention, but do you think that’s now – specifically, if you look at even from Q3 to Q4, if you look at the increase in FTEs, is that a function of the weakening of the economy and that’s why the retention rate has improved? I mean, can you provide just some color there incrementally?

Rion Needs

Yes. I don’t have the exact numbers, but just generally, I know where we were trending, so I’ll give you the basic numbers. I think that it was actually around 22% to 23% in 2007 and that is now 39% in 2008, and that’s all in. One of the problems with productivity in RRS retention and one of the reasons why we haven’t been disclosing that is that it’s not very comparable in the market. We find that a lot of our competitors, as well as ourselves, calculate that differently. Ours is all in. So, total number of people, day one you’re hired to how many people left, it’s that simple. We don’t discount for 90 days and we didn’t make it through training, and any of that; so that’s why our numbers are often lower than our competitors.

Sameer Gokhale – Keefe, Bruyette & Woods

So, then given that your purchases – I think you’d said that you want to just you’d cut back or maybe just monitor those pretty carefully until, say, the second half of 2009 because you think that prices could be lower even then. Do you anticipate having further reductions in your headcount until you ramp up purchases again or should we expect the number of FTEs to continue to increase? Because I think you’d also mentioned that you’re using more third-party collectors, so I’m just curious how those dynamics – we should think about those dynamics.

Rion Needs

Yes, absolutely, Sameer. It’s a great question. Also, to answer the second part of your first question is that, no, we don’t think the increases or any retention is driven specifically by the economic factors during that period. We have put a lot of effort and focus on becoming an employer of choice and on our leadership development, so those initiatives are very improved now in that improved retention. To your question, no, we will not be cutting back on hiring, because we are using third parties, they are not as efficient as we are. We want to bring that paper in as fast as we can, but as we’ve discussed on previous calls, with high attrition rates, it doesn’t make any sense to be bringing them in and let them go. So, we had to stabilize that. As we stabilize, you’re going to see us continue to bring on additional collectors and turning back on the placements with outside agencies.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay, that’s helpful. And then, so to Mark's comments about expecting a similar improvement in the OpEx [ph] collections in ’09, I’m assuming that we shouldn’t expect an improvement in that ratio of the same order of magnitude in ’09. Is that right?

Mark Redman

Certainly, that’s correct. I mean, we are, as we said, trying to continue very effective cost management strategies, but frankly, the macroeconomic environment is very difficult and it’s taking greater efforts to bring the same sorts of dollars through the door. So, on one hand, we’ll be trying to improve certain areas, but probably on the other hand, there’ll be other costs that we’ll increase because telephone calls, maybe letters, and some of the other types of collection tools that we use won’t be as effective as they were in the not too distant past.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. And then just a couple of other ones, in terms of the impairment charges, Mark, what I was curious about is the impairment charges you’d mentioned on the ’06 and ’04 pools, are those now – at this point, are those more a function of changing the timing of your collections? In other words, maybe your collections expectations are more front-end loaded and because of the weak economy, you pushed out the curve of collections and that’s why you have the impairment charges or are you actually reducing expected multiples on your portfolios at this point?

Mark Redman

On the pools that we took specific impairments on, I would say that we’re reducing our expectations for life. I mean, both pools are a couple of years to a few years old and there’s just not as much life left in them. So, just based upon the economic environment, we’re looking at reducing collections pretty much over the remainder of the life.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. And then, just a last question was I briefly looked at the slide where you showed the new model that you’re using. I mean, how much are you incorporating the use of that model into your, I think, it was for pricing. Because if I look at the R-squared and not to get too much into the statistics, I don’t know what the adjusted R-squared is, but assuming the same thing with 63%, I mean that suggests that the explanatory power of the model explains 63% of the changes in pricing relative to the variables. So, there’s a big margin for error there. I mean, are you using that to a great extent in your pricing models at this point or is that just one measure you use amongst others to determine your pricing and how you think about purchases?

Rion Needs

That is correct. We use it as one of many indicators. And because of that volatility, we believe it’s a better predictor over a longer period and not for a snapshot view. So, as a result, it’s in combination with the rest of our purchasing program.

Sameer Gokhale – Keefe, Bruyette & Woods

Okay. That’s helpful. Thank you.

Operator

And the next question comes from the line of Mark Hughes from SunTrust Bank. Please proceed.

Mark Hughes – SunTrust Bank

Thank you very much. Could you comment on collections through the quarter, and then perhaps what you’ve seen in January so far?

Rion Needs

Yes. Collections during the quarter – October was difficult in relation to November and December. Once November and December were done, October felt pretty good. So, November and December were much more difficult than we saw in October. Typically, we don’t give into our quarter guidance, but I don’t see any harm in saying really the trend that we saw in November and December continued into January. We did see some of the normal seasonal increase that we would at the beginning of the year, but the collection environment is still very difficult.

Mark Hughes – SunTrust Bank

Right. And also keeping in mind you don’t give guidance, any thoughts or anything you could suggest about amortization? It was obviously up in 2008. What should we think about 2009?

Rion Needs

Yes. The amortization rate has, I think, been up for at least two or three years in a row now, maybe longer, and it doesn’t seem like it can keep going up by a lot. We’ve done some things in 2008 that caused some increases in amortization rates. I mean, I think about the increased level of pools that we’re put on for cost recovery in late 2007 or the beginning of 2008 that certainly impacted the amortization rate. I think of, as I mentioned in my prepared comments, the level of caution that we’re using on initial yield assignments and yield increases for that matter, we’ve been very cautious in raising yields in 2007, particularly in the back-end of 2007 and throughout 2008, because of the whole financial mess that exists in the economy.

And I feel very good that we started that when we did because things have really continued to get worse with unemployment and other matters out there. A lot depends on what happens with the economy. If it continues to get worse, amortization could potentially creep up. On the other hand, if the stimulus plan works and things start to turn quickly, it could get better. The amortization could reduce but that’s not really what our expectation is. We do expect 2009 to continue to be difficult. And amortization rates, therefore, we do not expect them to have – see a big decline in them.

Mark Hughes – SunTrust Bank

All right. And then, without giving anything away on the model, were there any one or two factors that really jumped out as being most important in terms of determining collectability?

Rion Needs

Yes, that’s a great question. We looked at a wide range in series [ph]. I think probably we don’t want to give out any details, Mark, on that. But the thing I think was interesting is we found what most people think to be a counterintuitive as some of the major drivers in the industry. And like I mentioned in the conversation, our debtor base is different, and there is a resiliency towards normal economic shift and change, but we’ve been able to pinpoint where those happened, why they happened and how to really project them into the future.

Mark Hughes – SunTrust Bank

Okay, thank you.

Operator

And the next question comes from the line of Rick Shane from Jefferies. Please proceed.

Rick Shane – Jefferies & Co.

Hey, guys. Thanks for taking my question this morning. First question, what is the estimated remaining collection on the portfolio at this point, just so we can plug that into our model?

Mark Redman

Let me see if I cut that here, Rick. It’s approximately about $900 million right now, just around $900 million.

Rick Shane – Jefferies & Co.

Okay, great. That’s helpful. Thank you. Looking back at the queue from last quarter, it basically indicated that you had about $30 million to $31 million of forward flow purchases that you were required to make during the fourth quarter. Were there any purchases above and beyond the forward flow and – well, I’ll just leave it there for now.

Mark Redman

I think the purchasing that we made in the fourth quarter was pretty much limited to the forward flow.

Rick Shane – Jefferies & Co.

Okay. And it’s an important question just as we serve a dial in our models, and the reason being that you guys are giving a pretty cautious outlook in terms of what, purchasing volumes is going to look like over the next couple of quarters based on your decision to effectively weigh things out a little bit. Is it fair to assume that you won’t be making significant incremental purchases in excess of forward flow again? And so, we could really – because it looks to me like you have about $5 million or $6 million of remaining forward flow. We could really see the purchase volume go down substantially even from Q4 levels at this point.

Rion Needs

Our expectation is that we will look at forward flow carefully but we’re also looking at stock purchases carefully, and when we filed the 10-K probably in the next 10 days or so, you’ll see that we have increased (inaudible) and it’s under forward flows from the $5 million or so that you sight that we had at the end of the third quarter. So it will be less dramatic that this.

Rick Shane – Jefferies & Co.

Got it. Is it true to say given your view on things that pricing is going to decline going forward that you’re less interested in forward flows because that’s a good strategy when pricings rising. It gives you some certainty and helps you lock in pricing. But, frankly, if pricings decline, do you really want to be out there in the stock market?

Mark Redman

Yes, it’s a great question. I think it’s one that we grapple with frequently. We’ve been trying to influence the market to do more (inaudible) seeing the declining pricing environment. But the reality is that the sellers drive that, right? And so, as long as we have competitors willing to bid on longer range forward flow which makes it hard to overly influence them. What we are seeing is that they’re starting to become a shift now in the sellers plot or mind process. What we’re seeing is 12 months forward flows are now moving to nine, nine are moving to six, and six are moving to three. And three is really are just currently ball sales [ph] from my perspective, and we’re seeing more and more of that as it starts to enter now into our discussion, so we want to be in a declining pricing market in the ball and do everything we can but we’re limited to what’s available out in the market.

Rick Shane – Jefferies & Co.

Got it. And realistically, you guys effectively backing away from the stock market in the fourth quarter probably does impact the overall marking and seller sentiment. Related to pricing power, given what is going on in the industry, what pricing power do you have as you were working with third party collectors? Is that something where we could see the economics improve? Do you have negotiating power there?

Rion Needs

We do have significant negotiating power. The difficulty we have in those relationships with outside agencies is that in the declining liquidation market, they only start with $0.30 to $0.50 of a dollar, right? Permanent expense base to work with so they have even less ability to put significant resource against over pool. So what happens in a declining liquidation market is that they’re looking to increase their fees to allow them to turn it to profit because they’re spending more time, just like we are, trying to collect every dollar which is driving out their cost to quad ratio. But we have negotiating power. We leverage that. But right now, it’s a counter cyclical move.

Rick Shane – Jefferies & Co.

Got it. And one last question. Thank you guys for answering so many. You’ve obviously spent a lot of time and presumably a fair amount of money developing this ESP model. You use it in the context of pricing, are you now going back in revaluing your existing portfolio using the ESP inputs? And is that something we should look for going forward because presumably if you’re saying that your collections are going to deteriorate going forward, that has to have an impact on the existing pools. How are you incorporating that logic.

Rion Needs

All right. That’s a great question, Rick. It’s a very complicated question from the standpoint in revaluing your pool. Because of the SOP, we don’t have the ability to actually change yields downward. So if you believe that yields are changing downward, then basically take in the form of an impairment which is a mathematical calculation based on those future projections to cash flow. I mean, you take those when you trip the threshold. So it’s not something we can actually go back and say, we now have reduced expectations. If we had increased expectations, obviously, we increase the yield throughout the pool or we think those future cash flows will be. There is a limit to what we can do with that from a revaluing perspective but we have not yet integrated the ESP model into our revenue recognition process. That will be a step that we will undertake here as we move forward.

Rick Shane – Jefferies & Co.

Great, guys and thank you very much. I appreciate not only you guys taking all these questions but also, I think, what is a very imbalance outlook on what’s going in the market right now. Thank you.

Rion Needs

Thanks, Rick.

Operator

And the next question comes from the line of Justin Hughes from Philadelphia Financial. Please proceed.

Justin Hughes – Philadelphia Financial

Good morning. Most of my questions have been answered but I have a couple of follow ups. First of all, you said you’ve got pricing, it was down about 50% year-over-year but when I look at the estimated monthly yield on your ’08 pool versus the ’07 pool, that indicating the yield down 23%, so it looks – well, maybe your pricing is down 50%, the expected collection must be down somewhere between 60% to 70%. Does that make sense?

Mark Redman

A couple of thoughts about that. Liquidation rates have fallen typically. Also, though our expected collections start more conservatively and we build on them over time. So 2008 would have some natural conservatism built into the ERC in relation to 2007 pools because we only have between 12 months and 24 months of experience on the 2007 pools.

Justin Hughes – Philadelphia Financial

Okay. And then my second on the zero basis collection until about the middle of ’08 they’re still trending up slightly year-over-year; and then the last two quarters they’ve been down year-over-year. Should we expect that to continue downward?

Mark Redman

I think given the macroeconomic environment, absolutely. If the economy was improving or at least stable, be it improving but if we were looking at stable economic environment over the timeframe that we’re doing a comparison to, then not necessarily.

Justin Hughes – Philadelphia Financial

Okay. I thought it would be more related to how old and how much are your portfolios were in older pools. Which should I think is more related to the macro-environment though?

Mark Redman

There’s a mix of things and then we don’t have a tremendous increase in pools coming out from underneath amortization to make that very – by itself significantly.

Justin Hughes – Philadelphia Financial

Okay. And then my last question is, you’re strategy has build up cash here for the first half of the year in order to saw the pricing in the second half, and you mentioned you had $20 million of debt capacity at the end of ’08. What’s your targeted – just to go into the second half of ’08 with it, to accelerate things.

Mark Redman

We don’t – I don’t think we’d like to give specific guidance with respect to that. Obviously, we want to build up as much capacity as possible. A little will depend on what opportunities that we do see in the first half of the year now. And we’ve indicated pretty clearly, we expect reduced levels of collections or on that collection. But the purchasing in the first half of the year, we’ve got some internal targets but we’re not going to share those publicly and we do expect to have more dry powder when we go to the second half of the year to increase those assuming our models indicate that we should be increasing at that time.

Justin Hughes – Philadelphia Financial

Okay. So let’s say, we’ll have to have a material drop off from purchasing in the first half which goes for purchasing $32 million, $30 million a quarter now, and in the last six months your debt was down by $8 million. It sounds like you’re asking a meaningfully below $30 million to really build up a (inaudible) for second half of the year. Is that fair?

Mark Redman

A lot of factors go into that but you could come to that conclusion.

Rion Needs

You could give us a range for your materiality.

Justin Hughes – Philadelphia Financial

I’m assuming you want something closer to $100 million to go out and purchase with.

Rion Needs

Yes, we want to be near to that.

Mark Redman

Don’t forget about cash flow though, Justin. As we indicated, we invested a $155 million this year essentially out of cash flow.

Justin Hughes – Philadelphia Financial

Okay. What part of increase capacity being increased in the debt line, is that an option?

Mark Redman

That’s an option and as Rion talked about we got to think very carefully about the timing of that. We’ve been monitoring the credit markets for a long time now, and they’ve continued to deteriorate, from our perspective, it become more expensive. We’d like to go in but we don’t want to go in at any cost.

Rion Needs

Yes, what was this – Harley Davidson issue, the subordinate debt that they run at 15%.

Justin Hughes – Philadelphia Financial

Wow. Okay. Thank you.

Rion Needs

Yes.

Operator

Thank you, ladies and gentlemen. I would now like to turn the call back over to Mr. Rion Needs, CEO. Please proceed.

Rion Needs

Thank you, operator. In summary, we’ve made this progress in 2008 even in the face of a volatile and deteriorating market condition and an increasingly difficult collections environment. We continue to make headway on the initiatives we outlined for you moving to optimize our overall capacity management with increased use of our network, of outside collections channels, managing our operating costs in absolute dollars and as a percentage of cash collections. And we continue to generate strong cash flows from operations, all while remaining profitable in a weak macroeconomic climate. As we outlined in our strategy discussion, we face strong headwinds in 2009 but we believe we have a strategic vision that will allow us to remain disciplined in our portfolio investments to maximize collections relative to purchase price, leading to enhance returns on our investments. Overall, it was a challenging quarter, but it was also pleasing to see the initial positive results for many of our initiatives we put forth in 2008. We are also guardedly optimistic about 2009, as we believe, we have the strategy in placed to enable us to weather these difficult economic conditions. We remain grateful for the support and commitment of our employees, investors and partners, which of whom will remain central to our future success. Thank you for your time and have a great day.

Operator

And this concludes the presentation for today. Ladies and gentlemen, you may now disconnect. Have a wonderful day.

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Source: Asset Acceptance Capital Corp. Q4 2008 Earnings Call Transcript
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