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Portfolio Recovery Associates Inc. (NASDAQ:PRAA)

Q3 2007 Earnings Call

October 29, 2007 5:30 pm ET

Executives

Jim Fike - VP of Finance

Steve Fredrickson - Chairman, President and CEO

Kevin Stevenson - CFO

Analysts

Robert Napoli

Mark Hughes

John Neff

Edward Hemmelgarn

Audrey Snell

Sameer Gokhale

David Scharf

David Post

Craig Hoagland

Operator

Good day, ladies and gentlemen. And welcome to the ThirdQuarter 2007 Portfolio Recovery Associates Inc. Earnings Call. My name is[Shanik] and I will be your operator for today. At this time, all participantsare on a listen-only mode. We will conduct a question-and-answer sessiontowards the end of this conference. (Operator Instructions)

I would now like to turn the call over to Mr. Jim Fike, VicePresident of Finance. Pleased proceed.

Jim Fike

Good afternoon. And thank you for joining Portfolio RecoveryAssociates third-quarter 2007 earnings call. Speaking to you as usual will beSteve Fredrickson, our Chairman, President and CEO, and Kevin Stevenson, ourChief Financial and Administrative Officer. Steve and Kevin will begin withprepared comments and then follow up with a question-and-answer period.Afterwards, Steve will wrap up the call with some final thoughts. Before webegin I’d like everyone to please hear a note of safe harbor language.

Statements on this call which are not historical, includingPortfolio Recovery Associates or Management's intentions, hopes, beliefs,expectations, representations, projections, plans, or predictions of thefuture, including, with respect to the future of Portfolio's performance,opportunities, future space and staffing requirements, future productivity ofcollectors, expansion of the RDS, IGS and Anchor Receivables Managementbusinesses, and future contribution of the RDS, IGS and Anchor businesses toearnings are forward-looking statements.

These forward-looking statements are based upon Management'sbeliefs, assumptions, and expectations of the Company's future operations andeconomic performance, taking into account currently available information.These statements are not statements of historical fact.

Forward-looking statements involve risks and uncertainties,some of which are not currently known to us. Actual events or results maydiffer from those expressed or implied in any such forward-looking statementsas a result of various factors, including the risk factors and other risks thatare described from time to time in the Company's filings with the Securitiesand Exchange Commission, including, but not limited to, its annual reports onForm 10-K, its quarterly reports on Form 10-Q, and its current reports on Form8-K filed with the Securities and Exchange Commission and available through theCompany's website, which contain a more detailed discussion of the Company'sbusiness, including risks and uncertainties, that may affect future results.Due to such uncertainties and risks, you are cautioned not to place unduereliance on any forward-looking statements which speak only as of the date hereof.

The Company expressly disclaims any obligation orundertaking to release publicly any updates or revisions to any forward-lookingstatements contained herein to reflect any change in the Company's expectationswith regard there to or to reflect any change in events, conditions, orcircumstances on which any such forward-looking statements are based in wholeor in part.

Now, here is Steve Fredrickson, our Chief Executive Officer.

Steve Fredrickson

Thanks, Jim. And thank you all for attending PortfolioRecovery Associates' third quarter 2007 earnings call. On today's call, I’llbegin by covering the Company's results broadly, and then Kevin will take youthrough the financial results in detail. After our prepared comments, we willopen up the call to Q&A.

To begin let me say flatly that this was not the quarter wewere shooting for, it’s important to recognize, however, that the core businessof Portfolio Recovery Associates remains strong and growing and the outlook forthe future is as bright as ever.

The reality is, several factors came together in the thirdquarter to limit the earnings growth we were able to generate compared with theyear ago quarter. Let me be specific, one interest expense stemming from bothour third quarter debt purchasing activity as well as our one million sharestock buy-back, which we completed in the third quarter, drove incremental netinterest expense of $1.1 million or $0.04 a share net of taxes.

Two, we took a higher than normal allowance charge of $1.2million or $0.05 a share, again net of taxes, against certain pools of debt.Taken together, these first two factors accounted for $0.09 a share of netincome.

Three, sharply increased staffing to accommodate significantincreases in debt purchasing hurt near term productivity.

Capacity expansion always has this effect, and we have takensteps to bring these new collectors up to speed more quickly. We’ll discussthese three factors in more detail, as Kevin and I go through the quarter. ButI wanted to provide this context for you upfront.

Now in terms of our performance in the third quarter, wecontinued making significant acquisitions of charged-off debt in Q3, investing$57.4 million. Year-to-date purchases now total more than a $160 million, aheadof any prior full year total in our history.

We produced owned portfolio cash collections of $65.2million up 9% from $59.7 million in the same period one year ago. Q3 cashcollections were also up slightly from Q2 2007, despite seasonal weakness.

In addition, we produce strong fee-for-service revenue $8.5million in the third quarter representing 39% year-over-year growth. Overall,we saw a 14% increase in revenue to a strong $54.6 $million. Net income grew 4%to $11.7 million for the reasons I mentioned earlier. Per share earnings were$0.75 on a diluted basis.

Finally, we have realized productivity of $142.26 per hourpaid which includes the effect of aggressive staffing and lower hourlyproductivity at our new Jackson Tennessee call center as well as normalseasonal factors. All told, we had more than a 178 owned portfolio collectorsin Jackson atquarter's end, up from just a 132 at the end of Q2.

Let me now walk through our performance in detail, startingwith a very strong $57.4 million in portfolio acquisitions. Overall, weacquired 59 portfolios from 23 different sellers including several newrelationships for us. The majority about 76% of our third quarter purchasevolume, in terms of dollars invested was a combination of Visa Visa/MasterCardand private label credit card asset classes. The remainder came from pools ofauto-related receivables, both secured and unsecured, medical, utility, andinstallment loan accounts.

The bankrupt accounts acquired during the quarter areincluded in the Visa/MasterCard in auto-categories. Bankrupt accounts accountedfor about 18% of our purchase activity this quarter in terms of dollarsinvested. Market conditions continue to slightly improve levels in the quarterwith a solid amounts supply in steady to softening pricing. We continue to seeless of what we would consider to be irrational pricing during the thirdquarter. Most competition appeared to be less aggressive than recent priorquarters.

During the quarter, we continued purchasing under anextension of our older, fresh forward flow, which represented about 14 % of theperiod's purchases. This flow is set to continue through November of 2007. Oursecond newer flow of prime paper represented about 16% of our buying volume interms of dollars invested during Q3. This flow runs through March of 2008.

Now onto collections, as I mentioned earlier on the ownedportfolio collection front portfolio recovery associates recovered $65.2million in the third quarter up 9% from $59.7 million a year earlier. Offeringa bit more granularity, call centre collections were $37.4 million up 15% fromthe same quarter last year and representing faster growth than the 11%year-over-year rate of Q2.

Call centre collections are the first to show an impact fromour more recent debt purchases and at this point are the primary drivers of ourcash collection growth. Legal collections were 33% of total cash collections inQ3 2007 at $21.4 million compared with $19.6 million in Q3 of 2006 representingyear-over-year growth of 9%. This modest increase is as a result of thecontinued significance investment we made over the last several years inpursuing lawsuits on appropriate accounts. I do feel as though we have moreroom to be increasingly aggressive with our legal strategy.

Cash collections for our purchased bankrupt accounts were$6.3 million down 15% from Q3 2006 but up slightly from Q2 2007. Bankruptcycash collections over the past couple of quarters have slowed in stock contrastto the period of exceptional growth we experienced earlier. This change is theresult of our moderate bankruptcy buying since the change in the bankruptcylaws in late 2005 and is inline with our projections.

As you know, we track productivity in terms of recoveriesper hour paid. The core metric that measures the average amount of cash eachcollector brings in. This metric finished at the $142.26 for the first ninemonths of 2007 compared with a $146.03 for all of 2006.

Excluding the effect of trustee-administered purchasedbankruptcy collections, PRA's 2007 productivity through the end of Q3 was a$129.35. This compares with $132.15 for all of 2006.

We have taken steps to address this flattening productivityincluding several significant reengineering initiatives in our call centers.These initiatives are focused on productivity and employee retention althoughin the short-term they may causes to turn over more highly tenured employees,whose productivity is considered unacceptability low.

Over all we have changed the way we handle in bound calls inan effort to allow our core collection employees to focus more intensely on Qmanagement. We also have adjusted our incentive pay program to more tightlyalign with tenure based collector goals as oppose to a more static tenure blindapproach.

This will permit less tenured employees more opportunity. Asa result of these changes we created a new inbound call unit staff withapproximately 70 employees. The staff of this inbound group will be included inour productivity and staffing numbers. This new group is been located adjacentto our Anchor Receivables Management operation, and in some cases using seatsthat Anchor had held historically, as a net result we have freed upapproximately 75 seats in our primary Norfolk call center that can be used fornew hires.

This combined with the first 20 new seats coming online fromour Kansas expansion will permit us tomoderate new hires in Jacksonduring Q4. Our new call center in Jackson Tennessee, continue its substantialgrowth. We ended the quarter there with about a 178 owned portfolio collectors,in a staff of 11 IGS skip tracers. This is more than 1250% staffing growth overthe past six months, and has made it more difficult to pull up overallproductivity there, especially when you consider the seasonal factors we facein Q3.

Nonetheless our new call center manager is having a verypositive impact on the Jacksoncenter. After finishing his training during July and early August he was ableto focus this center in late August and September, with the result being recordproductivity during September. Even while adding many new employees, Jackson increasedproductivity from about 30% of our top center standard to about 40% inSeptember.

Our Norfolkcenter also improved during the quarter on a relative basis. Overall atquarter’s end our owned portfolio collector head count was 973, up 7% from theend of Q2, and up 21% since the beginning of the year.

Now let’s turn to our three fee-for-service businesses, IGS,Anchor and RDS. During the third quarter our fee-for-service businesses sawrevenue increased 40% from the same period a year earlier to $8.5 million. IGScontinues to shine in terms of revenue and profit growth, increasing both fromthe prior quarter and year-over-year. Wecontinue to grow placement inventory and are very pleased with the performanceof the business.

Anchor continued to operate at fairly modest scale, withboth revenue and operating income declining slightly from the prior quarter,but with improvement on a year-over-year basis. We continue to operate this businesswith the mandate of appropriate profit and risk, which is limiting our abilityto strongly grow the business right now. We see no improvement in the pricingenvironment of the contingency collection business at this point.

RDS increased revenue modestly on a sequential basis, whilegrowing strongly year-over-year. Income was down somewhat on year-over-yearbasis, as we made staffing investments to support the growth of several newproduct offerings.

During the quarter RDS acquired most of the assets of aLouisiana-based insurance premium tax administration company, the Palmer Group,in a mostly cash acquisition. Although revenues from this purchase arerelatively modest, they still given us over 100 new clients in the state of Louisiana, as well asdesirable expertise in the insurance premium tax administration business.

We think this kind of smaller tuck-in acquisition is veryexciting, and could help us accelerate the growth in our fee business as weexpand our client base, service offerings, and our geographic footprint morerapidly than we could through internal marketing efforts alone.

Lastly, I would like to address our capital structure.During the quarter, we completed our previously announced share repurchaseplan, buying back the remaining 900,000 shares under our original 1 millionshare authorization. We acquired these shares during the quarter at an averageprice of $50.41. As a result together with our $57.4 million in portfolioacquisitions, PRA ended Q 3 with $100 million of debt on our balance sheet.

Once again, we produced return on equity for the quarter inexcess of 20%. With $223 million of shareholders' equity and relatively modestdebt at quarter end, combined with strong profitability and cash flow, PRA hassignificant resources to permit the continued levering of our balance sheet.

Importantly, as we have communicated consistently in thepast, we believe the Company will have substantial opportunities in the futureto invest in distressed assets or acquire companies to further diversify ourbusiness. In fact, as Kevin will discuss with you shortly, we've reached anagreement with our bank group to further increase our credit line providingeven greater resources to make such investments.

With that, let me turn the call over to PRA's ChiefFinancial and Administrator Officer to take you through the financials. Kevin?

Kevin Stevenson

Thank you, Steve. Our third-quarter 2007 performance showedsolid financial results in all areas. However, as Steve mentioned our netincome growth was disappointing. I'll be providing additional insight about therevenue and expense perspective.

Net income in the quarter grew 4% to $11.7 million. Totalrevenue for the quarter was $54.6 million, which represents growth of 14% fromthe same period a year ago.

Breaking our second-quarter revenue down into its threecomponents, once again, the majority of total revenue or $46.4 million camefrom income recognized on finance receivables. This is revenue generated by ourowned debt portfolios.

Income on finance receivables is derived from the $65.2million in cash collections we recorded during the quarter, which represents a9% increase over Q3 2006. Third-quarter cash collections were reduced by anamortization rate, including a net allowance charge of 29.2%. This amortizationrate compares with 28.2% in Q2 2007 and 30% in Q3 2006, and our full year 2006rate of 38.9%. Year-to-date 2007 amortization is now at 30%.

As you saw in our press release, we incurred a total of $1.2million in net allowance charges during the quarter, representing about 6% ofall amortization realized during the quarter. These charges are associated withvarious different pools and represent adjustments to better reflect actualversus previously forecasted future collections. To rewind more color on theallowances approximately $200,000 comes from when I referred to as older, highyield deals.

These are pools, it has result of continued consistent overperformance had yields increased in many cases substantially. When we experiencea period of more modest cash collections, these high yield deals even thoughall they are performing at levels far in access of original expectations, mayneed [ambition] reserved to fully amortized the remaining carrying balance overtheir expected economic life. That was the case this quarter.

We took 480,000 allowances on several high yieldingbankruptcy deals. Deposit performed well in access of expectations andtherefore had experienced yield increases in the past. Once these high yields,any deterioration in performance can require allowance to set them back ontrack that was the case here.

Finally, we took a 500,000 allowance on a more normal olderdeal, where we experienced some degradation in performance during Q3. Although,we believe it might out of the question that this performance can be improvedin Q4 and in the future at this point the proper course of the action will takethe allowance.

We're not pleased to set higher than normal allowances. I dothink it's realistic to assume that some modest percentage of any debt buyers'amortization will always set the allowance charges. SOP 03-3 simply creates anenvironment to support this. Based on the directive to increase yield on overperforming transactions and a provision on lowering yields once they'reincreased.

Nonetheless, we will continue in an effort to minimizeallowances. During the third quarter cash collected on fully amortized poolswas $5.6 million down from $7.4 million in Q3 2006. In referring to fullyamortized pools, I mean, purchased pools with no remaining basis on our balancesheet with zero basis assets. Eliminating those pools from our amortizationcalculation gives us a core amortization rate for Q3 of 32% versus 34.3% in thethird quarter of 2006 and 35.3% for all of 2006.

We continue to believe it is a byproduct of SOP 03-3 ineffect since January 1st, 2005. The quantity of zero basis cash collectionsshould gradually decline overtime and this quarter's trend is indicative ofthat. It should be remembered that as a result of SOP 03-3 we aggregate allsimilar paper types acquired in the quarter in order to calculate revenue.These larger groupings allow us to forecast more accurately, generally keepingthe purchase finance receivable asset on our books for a longer period of timethan we have historically, which in turn drive the lower average portfolioamortization rate over the long-term.

During the quarter, commissions and fees generated by ourfee-for-service businesses, Anchor, IGS, and RDS totaled $8.5 million. Thiscompares with $6.1 million in the year-ago quarter and represents a sequentialincrease from Q2, 2007.

The third component of total revenue, cash sales of financereceivables, was once again zero for the quarter. During the quarter, weretained all of our purchases for our internal collection efforts, as we havein every quarter since our IPO in late 2002.

On the expense side, we have experienced an increase ofapproximately $1.6 million when compared with Q2, 2007. This primarily camefrom the compensation line as well as outside fees. The compensation line itemsgrew commensurate with our rapidly expanding workforce, while the outside feesare mostly in IGS impact relating to agent repossessions. As we are able toachieve improvements and productivity, we should be able to put down ourpressure on the compensation line in relation to revenue and cash collection,as we have done historically.

Operating margins during Q3 were 35.8% compared with 38.8%in Q2 2007, 38% in Q3 2006, and 38.2% for all of 2006. As we have statedrepeatedly in the past, we will make further investments in professional andcollector staff throughout 2007 to assure we have the talent on hand to bestexploit the money long-term opportunities we see.

During 2005 and 2006, the fee businesses caused ouroperating margin to be about 450 basis points lower than it would have beenwithout them. During Q3, we continue to run any narrowed compression of about400 basis points. As we have stated, we see real promise in these fee businesses,great synergy with other PRA activities and believe we will be able to continueto expand our margins and income substantially over the years.

Operating expense to cash receipts is the perhaps moreinsightful efficiency ratio as variations in purchase price amortization ratescause our revenue ratio to fluctuate regardless of true operating efficiencylevels. Operating expenses as a function of cash receipts, excluding sales,have narrowed steadily from 54% in 1999 to 43% in 2004 and 2005 and 45% in 2006.This ration is 47.6% for Q3 up from Q3 2006 of 45.1%. This was driven by thesame factors previously mentioned in my discussion of operating margin.

While an interesting metric, please understand we are notrunning our business solely focused on operating margins. We feel that earningsefficiency ratios, such as return on equity, return on investor capital, andgrowth, and earnings are much more important for long term health of thecompany. Should we need to invest in people, data, services or other items thedrive up or expense ratios in order to improve ROE, ROIC, and earnings growthover the long term, that is what we will do.

In addition to operating margin expansion, we expect fromour fee-for-service business overtime, we will remain keenly focused onoperating expenses in 2007, as much as ever. However, we will not cut cornersthat could impact long term cash generation.

For example, in terms of our investment facilities we arenow occupying the entire new 35,000 sq, ft. administrative and executive centrein Norfolk, Virginia, as we've discussed in priorquarters. During the third quarter, part of our IT and accounting functionsalso began to occupy the space.

In the our Kansas call centre expansion, which will give uscapacity for about 205 collectors, had its second phase completed in Q3, andshould be totally complete during Q4. This will permit us to add up to 20 newreps there during Q4 and an additional 25 to 30 in early 2008.

Our balance sheet remained strong during the quarter, despitesignificant purchase of new portfolios and substantial activity with thecompletion of our share repurchase plan. Cash balances declined slightly to$14.5 million at the end of the quarter.

Running at the balance sheet, we had $326.5 million infinance receivables $22.3 million in property equipment and other assets. $18.6million in goodwill and $5.4 million in intangible assets all related to ourbusiness acquisitions.

During 2007, we are incurring intangible amortizationexpenses of approximately $500,000 per quarter. We have about $100.1 million ofshort and long-term debt and obligations under capital leases. With totalliabilities, both long and short-term of $164 million. The majority of thisdebt is the $100 outstanding under our line of credits. At September 30, 2007,shareholders equity totaled $223.2 million.

As mentioned earlier during Q3 we moved forward towardscompleting the previously announced capital structure optimization program. Andas a result, we completed our 1 million share repurchase program, as theCompany bought back 900,000 shares of common stock in Q3, in open markettransactions at an average price of $50.41 per share.

To recap our entire program we have now repurchased 1million shares of stock, at a total price of $50.6 million for an average priceof $50.56 per share.

As you saw in our press release, we recently reached anagreement with our bank group to increase the size of our credit line to $270million, up from $150 million, under terms similar to our prior facility. Wetook this step because we want to be in a position to capitalize on attractivedebt and/or company purchase opportunities that may present themselves. Webelieve the current market is just the sort of environment that can respondthese very attractive situations.

In summary, we are focused on a long-term growth of PRA,while we are interested in driving all the key metrics that measure ourprogress, we will not substitute short-term goals for long-term goals.

Q3 is an example of just this approach. Those with along-term view should know that we’re setting strategy based on a multi yearview of our operations and opportunities.

With that I have completed my prepared comments I would liketo open the call up to Q&A. Steve and I will both be available to answeryour questions. Operator?

Question-and-AnswerSession

Operator

Thank you. (Operator instructions) You have a question fromthe line of Robert Napoli. Please proceed.

Robert Napoli

Thank you. Good afternoon. Kevin, question for you, though Kevinprobably, I guess on the charges that you talked in the quarter, and what kindof confidence do you have that they are in fact abnormal hits this quarters?Didn’t say one should expect something on a quarterly basis? We have seen smallhits out of you, obviously this was much bigger. But what is your confidencethat level that this is an abnormal level? And why are you confident in that,if you are?

Kevin Stevenson

Well, what I was getting at is that it’s certainly abnormalcompared to our past and we booked anywhere from as low as about $90,000 aquarter up to about $450,000 last year. So, I kind of standby my commentssaying that really any small percentage of really any debt buyers, amortizationis going to come from reserves or impairments. So, we are always going tostayed focused on doing our best to limit this things I think that again the $1million been about double the largest impairment thus so far to date, but Ithink still within that normal band that one might expect.

Robert Napoli

Okay.

Kevin Stevenson

Hope that answers your question, or didn’t it?

Robert Napoli

No, I guess it's helpful. Let me think about it. Talkingabout return on equity: you guys focus on ROE certainly makes a lot of sense,but what is your confidence level that you can maintain at least 20% ROE guyshave been generating? I mean, you have been done it without leverage, but nowyou are using some leverage in generating their 20 ROE, I mean would you guysbe -- are you confident with 20 ROE? Would you be disappointed if it’s belowthat level?

Steve Fredrickson

Well Bob, as we said, we are trying to focus on severaldifferent metrics which we feel are important for long-term. We don’t giveguidance and so I don’t want to be evasive, but I also want to stay consistentwith our policy there. We are certainly running the company in such a way as tocreate good solid ROE for a long time to come.

Robert Napoli

Okay. And on the expense line: I think Kevin talked aboutbeing able to bring that compensation number as a percentage of revenue, orcash collections, back. Putting downward pressure on that, I mean, what kind ofa target level? How much downward pressure do you think you can put on that,and right now? In order to, I guess, with the rapid growth in collections,would it be prudent to think about that number maybe going up, before it goesdown, as you had collectors?

Kevin Stevenson

Yeah, I didn’t try giving the feel for that was going on,but certainly if you look at Jackson, those guys are very new, yet coming upprepared nicely; but its going to take time to hit those guys to be asproductive as reps who have been here awhile. And that's really the point of mycomment, is that we've just ramped up so aggressively in the near term that,again be rest assured, our focus is watching the stuff daily and trying to getthese guys to curb as fast as possible in terms of productivity.

Robert Napoli

Can you give any specific metrics on the new facility onproductivity trend?

Kevin Stevenson

We did comment about one of the things that we do on amonthly basis and that is to examine really core cash collections per hourpaid, at each one of the call centers, and we also always look at thoserelative to the top producing center. And we saw very good movement from the Tennessee office,especially during September, and hope that that's the beginning of a trend inshowing that, especially since the manager that took over there just severalmonths ago is having the impact that we hoped for, and he is moving that centeralong.

Robert Napoli

Thanks, and just one last question: I missed the number yougave the collections from fully amortized pools?

Steve Fredrickson

Do you have exact numbers here? Right, they are $5.6million.

Robert Napoli

Thank you.

Operator

Your next question comes from the line of Mark Hughes.Please proceed.

Mark Hughes

Thank you very much. What is the FTE equivalent fulltimeequivalent in the quarter for collectors?

Steve Fredrickson

I've got that somewhere.

Mark Hughes

I think total number 973 just trying to curious what the FTEwas?

Steve Fredrickson

FTEs were 872.

Mark Hughes

And that will be what you report in the Q?

Kevin Stevenson

Yes.

Mark Hughes

Okay.

Steve Fredrickson

Which one is right number there [one or two?]

Kevin Stevenson

Yes 872, that's correct.

Mark Hughes

Okay. Thank you very much.

Operator

Your next question comes from the line of John Neff. Pleaseproceed.

John Neff

Hi. Thank you I was just wondering if you could just breakout the gross impairment charge and recoveries to get to that net 1.2 million?Could you net out anything.

Kevin Stevenson

I got it. No, that was gross that we didn’t net outanything, there is no recovery.

John Neff

No recovery. Okay, and top to say but would you attributethe charge in the quarter to productivity decline thing as were back at,roughly 2005 levels and I know typically sort of model out current productivitylevels. When you’re making a purchase?

Kevin Stevenson

So your question is: What I attribute, any of that reserve,to productivity issues?

John Neff

Yes.

Kevin Stevenson

Or, I guess corresponding with staffing issues. That's hard,that’s a tough one I think from the accounting perspective, we simply view cashcollections and we look at the flow. And as I talked about, two of the threedeals were very high yielding deals and any kind of weakness. So I suppose onecould make the argument that it could be impacted by either staffing orproductivity issues. That's the case and hopefully we will be back on track ina few quarters. And will be able to recover that. But right now, we decided totake the allowance as it sets.

John Neff

Okay. And then I was just wondering if you can give us alittle bit of an update on the purchasing environment: both on the supply andon the demand side?

Kevin Stevenson

As we commented, we felt that the environment continues tomove slightly in a debt purchaser’s favor. We continued to see good flow ofportfolios; we also felt that pricing was steady to slightly softer. We continuedto believe we’re buying at slightly better long-term yields than we had beenpreviously.

John Neff

And, I just want to make sure that I heard this right, Kevindid you say 75% from credit cards in terms of purchasing in the quarter.

Kevin Stevenson

Yes, 76% was combination of Visa MasterCard and privatelabel credit card and that’s in terms of investment amount.

John Neff

You had mentioned that it has been closer to that 90% level,and you mentioned medical purchasing in you prepared comments, any elaborationthere. And also can you elaborate on the step-up here after kind of yourtailing down for a while, looks like bankruptcy stepped up as well?

Steve Fredrickson

Yeah, on the medical side, I would say that we continue tomake some modest progress in our program there. Our feeling is that pricing inthe medical environment is getting a little bit more rational, we felt thatpricing had been kind of crazy in the prior year, year and half and it seems asthough it’s leveling out a bit, more meeting what we believe is, realisticlevel.

So, we are doing a little bit more there and then on thebankruptcy side, we are simply seeing a little bit more flow of product, reallyspecially as you see portfolio's growth somewhat, and filings increasedsomewhat from the very low level that they had been following that 2005 changein law.

John Neff

Are you buying pre-reformed law or post-reformed law?

Steve Fredrickson

It would continue to be a combination of the two, althoughas time goes on we are buying more and more post-amendment filings.

John Neff

Okay. It looks encouraging, and then, you gave the collectorheadcount, Kevin, but it is 978, but what would that headcount be? And if youadd in the first line supervisors as well, the number I am taking out of thesecond quarter, was 1051.

Steve Fredrickson

Right yes, that will be 1144.

John Neff

1144. And last question, do you anticipate doing anyoutsourcing of collections, at least temporarily, while given the purchasingand the ramp in the productivity, the current sort of softening inproductivity? Thank you.

Steve Fredrickson

We have done, and continue to do, small amount of outsourceof collection work. We continue to look at kind of experiments and projectsthat would allow us to work various segments of our portfolio in an outsourcescenario.

So, that’s something that we continue to evaluate on anongoing basis. Just to provide a little bit of clarity, we were not looking atthat in lieu of building our own capacity at this point. We are looking at itsimply as a supplemental collection channel.

Operator

Your next question comes from the line of Edward Hemmelgarn.Please proceed.

Edward Hemmelgarn

Yeah, just a couple of questions here, one, could you talk alittle bit about, you mentioned an inbound call centre that you said how doesthat work?

Steve Fredrickson

Previously an inbound call would be made, it would travel toone of our call centers, and be distributed automatically to any givencollector in any given call centre.

We had changed that call routing, so that all inboundtraffic is being received by a dedicated group of collectors. And we are tryingto deal with those inbound calls in a kind of [sync] uniform manner, as opposedto distributing them across the floor.

Edward Hemmelgarn

Well, I guess it’s much of a thing: How does an inbound calloriginate? I am just curious, it doesn’t strike me as people are typicallycalling you if they owe you money.

Steve Fredrickson

No, only about 10% of our call volume is inbound, so it isnot a huge piece of our volume. However, when someone is calling a debtcollector, generally you've got a higher propensity that that call is going tobe a payer then in outbound call and so you want it, make sure you treating itwith a very high quality experience. And so, we're focusing on making sure thatwe are creating that high quality experience in capturing as many of thedollars as possible through those inbound call.

Edward Hemmelgarn

That they are calling and after you'd made a prior contactof that?

Steve Fredrickson

That's right. Either through an outbound call through alater or in some cases they may be calling off of a credit line or somethinglike that.

Edward Hemmelgarn

Okay. Thanks. Second you've also said that you've beenadding to your collector based very nicely this last year, it has lag growsignificantly your increases in dollars at least to spend on non-bankruptcydebt, which is up about a 150% or something last couple of years. Can you givemore on the exact numbers through the latest purchases of this flip? But asyour number of collectors are in near a much. Do you think that you, that thereis an opportunity to continue to significantly increase the collectors, I mean,as that your leaving something there on the table, if you had more materialcollectors you would be able to be collecting substantially more than you arereally now?

Steve Fredrickson

Well, I think that there is room for cash collectionimprovement, as our productivity comes up, however, you don't want to staff up.You don't want to double your staff. If your staff is in a certain areacollecting it has the productivity you are going to have issues down the roadin that situation. So, we're simply, for at least a short period of time,living with the lower productivity, but I think the other concept that you havegot to focus on, in the numbers that you threw out, is not just the dollars ofinvestment, but also the multiples that we think are associated with those. Socertainly, as time goes on, and as purchase multiples in different periodsbecome evident, it's also clear that a dollar of investment in one perioddoesn't necessitate the same level of collectors as another. And so, we'retrying to staff appropriately for the amount of cash collections that we see ineach trench and at this point, we think, we're staffed appropriately if we seecollection results are multiple start to expand we may rethink our staffingmodels.

Edward Hemmelgarn

Okay, thanks.

Operator

Your next question comes from Audrey Snell. Please proceed

Audrey Snell

Few questions gentlemen, do you expect seasonal slowness inthe fourth quarter of this year?

Steve Fredrickson

Well, the seasonality in the collection business Audrey, Ithink is it just a fact and generally cash collections all things been equaltend to peak in Q1 continue to some degree in Q2 and then fall sequentially inQ3 and Q4 strictly from a seasonality standpoint.

Audrey Snell

Okay. So, we should factor that and also how much of yourresults would you attribute to a slowing economy?

Steve Fredrickson

Well, we've spent a fair amount of time going through ourpayment data trying to make sure that we understand that specific issue and aswe look at really wide variety of data from all of our annual trenches ofpurchasing. We are not seeing significant differences in how papers liquidatingfor us payment sizes, continue to look good, the amount of payment falls thatwe take continue to look good. Our settlement rates are steady. We get someanecdotal evidence that the consumers are certainly as difficult as ever, ifnot more so to collect from, but thus far our payment data is looking prettysteady.

Audrey Snell

And yet Kevin alluded to the impairments impart being causedby the backing off some of the yields and formally increasing yield pools. So,I am curious about that whether that's function of perhaps the age of theportfolios or something else?

Kevin Stevenson

Again, John Neff actually also asked: Do I think it'srelated to short staffing or productivity issues? And I kind of said: “Well, ifit does, it will be released”. But actually, one of these pools that Imentioned with $200,000 reserve against, you'd actually seen one of thoseearlier with some reserves on those some quarters ago. So, just to give you a quickinsight of that particular deal, it's got almost of 600% yield on it.

So, I mean, these yields are just the kind of legacy dealsthat had accrued these large yields on, and any weakness in cash flow. So,we'll see how it goes in Q1, Q2 with those deals. But I don't know if thatanswered your question? But I don't know that again, from accounting aspect, weare looking at these things they are just incredible home run deals and we justwere a little bit off on cash projections.

Audrey Snell

So, the comps are getting harder on the older deals thatwere stars? So, are we to conclude then that really it's a blocking andtackling question, and just getting some of these productivity measuresimproved and simultaneously expanding in additional direction?

Steve Fredrickson

That would be our perspective. We feel that thisproductivity challenge continues to be an issue for us. We think we're movingit in the right direction based on data that we've gotten through September.But it certainly continues to be as you put it a blocking and tackling issue,this is all about managing and motivating your people and increasing theirability to collect per hour paid.

Audrey Snell

One last question, Kevin: Why increase the line of creditsignificantly at this point? Are you proactively anticipating a lot ofcharge-off paper coming into the market in fourth quarter or perhaps firstquarter of next year? Given the credit issues we’ve seen in the general market,or has it something to do with perhaps an acquisition or something else couldyou elaborate a little bit?

Kevin Stevenson

Yeah. That’s right. I try to in my script, and it might, Iam bearing there little bit, but that was really the goal, the goal is that weneed to make sure we’re prepared to take advantage of anything in thisparticular environment that might deal to us. So, in either of those two casesso, you should be buying, continue to be robust.

I want to make sure that at least from my standpoint, thecredit facility is there to let Craig and all the other guys, who buy debt dothat. Or if they attractively price tuck in acquisition as Steve put itearlier. Should present itself, I want to make sure there is capital there forthat as well.

Audrey Snell

Partly is the same question, will you consider using some ofthose proceeds for additional repurchase authorization?

Steve Fredrickson

I mean, we are never going to preclude any action, Audrey,but at this point in time as evidenced by our lack of communication in thatdirection that’s not something that the boards authorized.

Audrey Snell

Okay. Thank you.

Operator

Your next question comes from the line of Sameer Gokhale.Please proceed.

Sameer Gokhale

Hi, good evening. I just had a question about the, I thinkthere is some comments about the collector turnover and I wanted to talk aboutthose within the context of the productivity improvements. I think you all hadmention on the call that you are trying to put in some more policies were theremight be some more turnover among the season collectors?

Steve Fredrickson

Right.

Sameer Gokhale

I was wondering how we should think about that relative tothe overall productivity improvement that you’re expecting?

Steve Fredrickson

Certainly. It is I guess not a completely evidence issue,when we talk about tenured productivity, but as we have a long commented ourmost tenured people tend to be our most productive. We have long operated undera collection concept of account ownership in most of our collection processesand as such, a tenured collection representative will build a book a business,build a book of performing accounts overtime and generally as their skill setbuilds, their book of business also builds and they are paid for the dollarscollect. So, they get paid a residual I guess you could call it, on whatthey've done in the past as well as dollars if they are bringing in, freshdollars they are bringing in each month.

In really digging into our productivity in an attempt tomake sure we understood exactly what’s going on in the floor, we made thedetermination that we had some level of experienced people who had build thatbook of business so to speak, but who had backed off in current production. Andwithout changing the world in which they live from a compensation standpoint,we've simply tried to tweak the goal environment so that they need tocompliment that existing book a business with a constant fresh dollarcollections or new money collections.

And if we have experienced people that have this existingbase of business, that for whatever reason are not up for producing new moneyin acceptable level, then perhaps its time that the employment of those folksis reexamined. So, that's what we are going through now. We don't want to getinto a situation where we are simply paying people for what they did yesterday.We need people driving in cash collections from portfolios today.

Sameer Gokhale

Okay, so its net, net an improvement in productivity offsetpartly by this impact, from may be higher turnover on the season collectors. Isthat fair to say?

Steve Fredrickson

Well the changes were made during the quarter and so, Idon't think you saw a great deal of impact. I would say that our comment ismore related to what may happen in the future. So, if you see our one year pluscollection numbers bounce around a little bit, it may very well be thatsituation.

Sameer Gokhale

Okay and then the other thing I just want to clarity is thetax rate. I was wondering, it seems like this quarter the tax rate was at 36.7%compared to kind of the roughly averaging of the mid 38% range. Going forward,should we expect the lower tax rate on the quarterly basis or how should wethink about that from a modeling standpoint?

Steve Fredrickson

No, this is our Q3, which is the time we follow-up our taxreturns. We get our annual true up after the quarter. So that's really what yousaw there.

Sameer Gokhale

Okay and then do you have the dollar amounts for the averagepayment size, I think you had said last quarter that it was a little bit under$80 or so. Is it roughly about the same number this quarter or maybe slightlybelow that?

This is I think when you were talking about the collectionstrength on your portfolios in the health of the consumer?

Steve Fredrickson

Right, just give me one second. Actually our average as wewould call it pure payment was trending up slightly during this quarter.

Sameer Gokhale

Okay. That’s helpful thank you.

Operator

You have a question from the line of David Scharf. Pleaseproceed

David Scharf

Hi good afternoon. Just a couple of quick follow-ups. Norfolk I didn’t catch itI know the productivity was flat last quarter which was among the biggersurprises how did that perform in the third quarter?

Steve Fredrickson

Our productivity there I did comment was on a relative basismoving up so we feel like some of the changes that we were making are doing theright thing to that Norfolk's staff. The Norfolkstaff also being our most tenured is going to be the sight that I think has gotthe most impact to the change in the collection policies and collectionpractices. So it will be very interesting I think over the next couple ofquarter to see how Norfolkproductivity tracks.

David Scharf

Okay. Switching to purchasing you have commented on theoverall environment just curious you’ve got two flow deals that account for apretty big chunk of purchasing these last few quarters and one of them ofcourse expires next month. As you look at the supply environment have youalready entered into any other material flow deals to kind of plug that wholeor do you see more general spot selling on the market. Is that any cause forconcern in terms of the volumes we should think about modeling?

Steve Fredrickson

I would say given what we have seen in the supply side ofthe market, we are not concerned about the flow deal we pricing this quarter.

David Scharf

Okay. And obviously after all these years I am not going to,not can even attempt to get any I'll say guidance side of view, but is it safeto say that the fourth quarter is typically seasonally very strong in terms oflot of banks purging accounts in that at least directionally we on to belooking it probably a larger number than we saw in the third quarter?

Steve Fredrickson

Ahead we are right up until the last part of your question.I’ll just say that generically we have typically seen good activity in Q4 andyears past. And given everything that’s been going on in the financial sector,I think it’s reasonable to anticipate that we continue to see pretty decentvolume of Portfolio’s for sale in the fourth quarter.

David Scharf

Okay. And then just lastly I wanted to make sure, I heardcorrectly, productivity year-to-date it looks like at least measured in termsof collections per hour paid is off about I guess 3.5% versus the prior year.If you’re seeing pretty constant payment metrics in terms of settlement ratesin payments sizes in the like is 3.5% would you characterize that as entirelyrelated to the aggressive staffing at Jackson or is their anything else thatyou could point your finger at.

Steve Fredrickson

There is nothing else I can point my finger at, howeverwhile we don’t believe that the underlying economy if that’s what your gettingat gives us big swings on the collection front given the fact that we collectfrom this charge-off customers, that are so deeply delinquent. We do think thatall things been equal it’s a little bit easier to collect in a better economicenvironment than a worse. And so, part of it maybe some economic impact there.But again it is not evident enough for us at this point to be able to extractthat from at least the data we look at.

David Scharf

Okay. And just lastly, given how labor intensive it is, istheir any discernible change in the overall wage environment over the lastcouple quarters or year.

Steve Fredrickson

No at the collector level we feel like its pretty muchsteady as she goes.

David Scharf

Okay. Got you, thank you.

Operator

You have a question from the line of [Michael Tanbon].Please proceed

David Post

Hi this is actually [David Post]. Can you give us themonthly cash collections by tenure for the third quarter?

Steve Fredrickson

Actually we’ll give you a heads-up on that one, because ofthese reengineering efforts that we have put forth. We are no longer obviouslygoing to be collecting the same way that we have in the past, and so thatparticular metric is going to kind of an apples and oranges situation, and sowe won't publish it on go forward basis?

David Post

Okay. Because my follow-up is going to be and I guess I willadjust it with the older data up until this quarter. If I look at the one yearor ten year collectors relative to the less seasoned collectors, the ratio ofthe one year tier collection to the less seasoned in second quarter was 240%,the previous quarter was 246%, and the [newer] if you look back in '05 and '06,it was about a 180% or 190%. So, at least relative to the less seasonedcollectors, the last two to three quarters the more seasoned collectors appearto be doing quit a much better job. So, I am wondering why is the focus on themore seasoned collectors as oppose to the less seasoned collectors.

Steve Fredrickson

Again, it's really a focus on new money production and thething that you can't separate out in those macro statistics is how productivean individual is in the new money category versus their existing book ofbusiness. Now, we have experienced reps who are incredible negotiators, and whoproduce a very high amount of new money each month and they add that to theirexisting book of business, and as a result they are very well paid.

However, we have other very tenured people, who have a veryhigh base of existing money, who bring in very little new money, in factsignificantly less new money than someone who may have three, four, five monthsof tenure. And though, that sub-segment of the tenured reps, is really what weare really trying to deal with. This is by no means an issue with all ourexperienced people. Most of our experienced people remain our most productive,but there are pockets there that we feel grew significant enough that we neededto make some changes.

David Post

Okay. So, are you essentially with the more seasoned people,is there going to be change in the commission system so it's kind of a tailingcommission, so once you've been making a collections on this particular accountfor certain period of time, you get a smaller and smaller percentage and that'show they are intended to raise new money?

Steve Fredrickson

It's more of a new money requirement; as opposed to tailingthings off on the older book of business.

David Post

Okay. Quote obvious, thank you

Steve Fredrickson

Just a quick comment, although no one asked about it, wethink the other positive with this new system is that it will give a newer repthat is producing high amounts of new money. More reason to stick around andbecome tenured, and it will help us reduce some of the turnover thathistorically we had run into in months say three through nine. We think it'sgoing to be productive for us.

David Post

When you do let go various more seasoned collectors, whatwill happen to those accounts that were assigned to them previously, where dothey go?

Steve Fredrickson

Well they are just simply maintained, those furthermost partwe're talking about legal money which is no longer being handle by that repwhich the dollars will come in regardless and then the other is what we call adirect cheque base and those are cheques that are on file and they simply getmoved over to a customer service unit that make sure those cheques allliquidate out overtime and if they don't or need to reset. They'll get a call,so we don't lose that money at all.

David Post

But there will be a lower commissions or lower expenseassociated with that account, right?

Steve Fredrickson

That's true. Yes.

David Post

Okay, thank you.

Operator

You have a question from the line of Craig Hoagland. Pleaseproceed.

Craig Hoagland

Hi, I was just wondering on going back to the allowance, howmechanistic is the process of determining that amount? Is it just strictcompletely mathematically driven or is there a judgment involved as you lookback on these?

Steve Fredrickson

So, the question is how mechanical is it versus how muchjudgment?

Craig Hoagland

Yeah.

Steve Fredrickson

So, what happened actually is that actually, gentleman herein the room Jim Fike, who read the opening few pages. Actually, we'll start offthat process entire income recognition process and then he looks at it. Andthen it gets moved over to me to do a sign-off and review. So the answer is, itis mechanical once the cash collection projection is set. But that it so butthere is judgment used in terms of where do we think the cash collections aregoing and what has cause them to be kind of where they are at.

Craig Hoagland

Okay. So that cash collection forecast is refreshedperiodically.

Steve Fredrickson

Right.

Craig Hoagland

And that's the judgment call.

Steve Fredrickson

What will happen is, we've got the original curves and we'vegot the curves that are adjusted overtime. And what we're basically doing isjust trying to do some curve fitting, trying to look at where those data pointsactually have fallen and what their trend lines tell us. In some cases, we willgo back to the acquisitions group and say, hey, what you guys seem here, wherethese accounts on the floor, are they pocketed somewhere, they shouldn't be.So, there are situations, in fact, the larger reserve that I talked about, thatwas one where we were looking at where the accounts are, whose working and whatqueues they are in. So, we really kind of dive into them in some cases on avery, very detailed level.

Craig Hoagland

Okay. So, it's not just a simple thing, we thought we getthis much correction and we got less than that?

Steve Fredrickson

Right, yeah, no, its not, if that easy I can close lotquicker, lot quicker.

Craig Hoagland

Okay. My other question is, how quick when you buy a, likelast couple of quarters, you've done a lot of buying. What's the lag betweenwhen you buy things and when they are fully integrated into your collectionsprocess?

Steve Fredrickson

I think when they full integrated.

Craig Hoagland

When they are being addressed with the full effort of yourcollections team?

Steve Fredrickson

Good question, and it definitely can be impacted by volumes,there will be times where literally, we will be backed up loading andconverting accounts and in those cases, we could have something that gets movedout from a perfect scenario by may be 30 days or so. There will be othersituations where we will plan when we do our purchase that a collectionactivity is going to be ramped somewhat and we will price accordingly. So thoseaccounts may be treated slightly differently than we would in a differentscenario but again we try to price for situations like that.

Craig Hoagland

What was the range of time, I mean, is it from within a weekof making a purchase to several months later, or what is the range?

Steve Fredrickson

No, generally, we have got accounts in converted, loaded,and lettered within a couple of weeks of the purchase. Again, if we're reallybusy and it's a low priority portfolio. You could get pushed out some what fromthat.

Craig Hoagland

Okay. Thank you very much.

Steve Fredrickson

Thanks.

Operator

There are no further questions. I would like to turn thecall over to Mr. Steven Fredrickson for closure remarks. Please proceed.

Steve Fredrickson

Thank you, operator. First I would like to thank all of youfor participating in our conference call. Before we go, I would like toreiterate a few key points about our third quarter.

As Kevin and I discussed, interest expense from both oursubstantial debt purchasing activity and stock buyback, a higher than normalimpairment charge, and sharply increased staffing combined to holdback earningsgrowth from the levels we had hoped to achieve. However, the core business ofPortfolio Recovery Associates remains strong growing and the outlook for thefuture is as bright as ever.

In the context of the long-term, we continue investing inour businesses, adding expertise, capacity, and capabilities as we develop evermore effective methods of underwriting in collecting. Thanks again for yourtime and attention. We look forward to speaking with you again next quarter.

Operator

Thank you for your participate on today's conference. Thisconcludes the presentation. You may now disconnect. Good day.

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Source: Portfolio Recovery Associates Q3 2007 Earnings Call Transcript
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