Portfolio Recovery Associates Q1 2008 Earnings Call Transcript

Apr.29.08 | About: PRA Group, (PRAA)

Portfolio Recovery Associates (NASDAQ:PRAA)

Q1 2008 Earnings Call

April 28, 2008 5:30 pm ET

Executives

Kevin P. Stevenson – Chief Financial Officer, Executive Vice President & Treasurer

Steven D. Fredrickson – Chairman of the Board, President & Chief Executive Officer

Jim Fike - Vice President of Finance and Accounting

Analysts

Bob Napoli – Piper Jaffray

Mark Hughes – Centrix

David Sharp – JMP Securities

John Neff – William Blair & Company, LLC

A. Hamagarn – Shaker Investments

Hugh Miller – Sidoti & Company

Sameer Gokhale – Keefe, Bruyette & Woods

Operator

Good day, ladies and gentlemen, and welcome to the first quarter 2008 Portfolio Recovery Associates, Inc. earnings conference call. My name is Erica and I will be your coordinator for today. (Operator Instructions) I would now like to turn the presentation over to one of your host for today’s call, Mr. Jim Fike, Vice President of Finance. Please proceed, Sir.

Jim Fike

Good afternoon and thank you for joining Portfolio Recovery Associates first quarter 2008 earnings call. Speaking to you, as usual, will be Steve Fredrickson, our Chairman, President & CEO, and Kevin Stevenson, our Chief Financial and Administrative Officer. Steve and Kevin will begin with prepared comments and then follow up with a question-and-answer period. Afterwards Steve will wrap up the call with some final thoughts. Before we begin, I’d like everyone to please take note of our Safe Harbor language. Statements on this call which are not historical including Portfolio Recovery Associates or management’s intentions, hopes, beliefs, expectations, representations, projections, plans, or predictions of the future, including with respect to the future of Portfolio’s performance, opportunities, future space and staffing requirements, future productivity of collectors, expansion of the RDS, IGS and Anchor receivables management businesses, and the future contribution of the RDS, IGS and the Anchor businesses to earnings are forward-looking statements. These forward-looking statements are based upon management’s beliefs, assumptions, and expectations of the company’s future operations and economic 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 may differ from those expressed or implied in any such forward-looking statements as a result of various factors, including the risk factors and other risks that are described from time-to-time in the company’s filings with the Securities & Exchange Commission, including but not limited to its annual reports on form 10K, its quarterly reports on form 10Q, and its current reports on form 8K filed with the Securities and Exchange Commission and available through the company’s website, which contain a more detailed discussion of the company’s business, including risks and uncertainties that may affect future results. Due to such uncertainties and risk, you’re cautioned not to place undue reliance on any forward-looking statements which speak only as of the date hereof.

The company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in the company’s expectations with regard thereto, or to reflect any change in events, conditions, or circumstance on which any such forward-looking statements are based in whole or in part.

Now, here’s Steve Fredrickson our Chief Executive Officer.

Steven Fredrickson

Thanks, Jim, and thank you all for attending Portfolio Recovery Associates first quarter 2008 earnings call. On today’s call, I’ll begin by covering the company’s results broadly, and then Kevin will take you through the financial results in detail. After the prepared comments, we’ll open up the call to Q & A.

Let me begin from 30,000 feet and then get down to the details. Our Q108 really tell two stories. The first is a bottom line performance that was obviously less than we would have preferred. The reasons are increased interest expense, largely related to Portfolio acquisitions, as well as an allowance charge that turned out to be unusual in magnitude.

I’ll discuss the interest expense in detail with you and Kevin will walk you through the allowances.

The second story of this quarter in contrast to the first is one of solid performance on the operating side. We generated record cash collections of $79.4 million dollars with productivity at all of our call centers, including our newest in Jackson, Tennessee, improving and on track with our expectations together with very strong purchasing activity. In fact, the first quarter brought with it one of the most positive buying environments we’ve seen in years; however, amidst a more difficult collection environment.

Related to the second story is the fact that we are in the final steps of documentation to once again increase our bank line. This time from $270 million to $340 million dollars while maintaining the same attractive borrowing terms. Pending the final closing, we are particularly pleased to have been able to extend our line in this very difficult credit market. This of course will increase our access to capital for additional Portfolio acquisitions. Our ability to continue to not only access the capital markets in these difficult times, but to do so in increasing amounts while maintaining very attractive borrowing terms is testimony to the quality of our operating strength and the strong relationships we’ve built with our bank group.

We feel this is a strong differentiating competitive advantage for PRA during turbulent times. Kevin will give you additional color on this in a bit.

Looking at the broad sweep of our first quarter performance, we are very optimistic about PRA’s future. As Kevin and I explain our result in detail, I think you’ll see why.

Now, let me begin a full review of Q1, beginning with our financial results. We continued making significant acquisitions of charged off debt in Q1, investing $95.4 million dollars. We produced owned Portfolio cash collections in the first quarter of $79.4 million dollars, up 18% from $67.3 million in the same period a year ago. In addition, we produced strong fee for service revenue $11.5 million dollars in the first quarter representing 34% year-over-year growth. Overall, we saw 19% increase in revenue to a record $64.1 million dollars. This led in part to record income from operations of $21.8 million dollars.

EPS was $.78 cents versus $.80 cents in the year ago quarter, a 2.5% decline. Net income fell 8% to $11.9 million in the first quarter, but we had fewer shares due to our 2007 stock buyback. Our net interest expense totaled $2.5 million dollars. This compares with a net credit of $100,000 in the same period a year ago, representing an after tax expense swing of $1.6 million or $0.10 cents of earnings per share impact. Finally, we realized productivity of $133.31 per hour paid for Q108, which includes the effect of aggressive staffing and lower hourly productivity at the Jackson call center together with normal seasonal factors. During the quarter, we added 48 net new collectors to our company-wide owned portfolio call center staff, inclusive of 50 new collectors in the Philippines, all added in the final weeks of the quarter.

Before I move on to discuss these results in detail, I would like to look at the three key factors driving this performance. I spoke to you about these on our fourth quarter call and they remain relevant for Q1. First, the weakening economy and tighter environment have continued to create improved opportunity for debt buying with prices further improving and supply remaining strong. This is noteworthy for a Q1, which is typically a weaker buying season; however, we do view this as a difficult underwriting environment in which only those with the underwriting expertise to properly price this complex asset type as well as the seasoned collector base and experience to liquidate these types of accounts in line with underwriting estimates to say nothing of the crucial ability to fund purchases through access to sufficient low cost capital will prevail.

We feel shortcomings in one or more of these areas have helped to reduce the number of viable competitors in our industry and will continue to do so in the months ahead. While collections have become relatively more difficult in the weak environment, this is mitigated by an improved buying opportunity.

Second, productivity continued to be impacted in the first quarter primarily by the Jackson call center. Although we’ve seen significant improvement in Jackson over the past two quarters. The issue for those new to PRA is the center was called into heavy service during 2007 before it was fully staffed and trained due to the improved market conditions for default of debt. We believe this center is performing in line with our expectations.

Third, as I mentioned earlier, our higher borrowing cost together with our increased use of leverage have resulted in higher interest expense. Since newly acquired debt takes a little while to begin generating cash, the corresponding interest expense has continued to generate expense ahead of revenue and therefore had an outsized impact on our bottom line performance. We expect this impact to moderate over time as ramped up collections begin to offset increased interest cost.

Now, let’s discuss our operations in detail, beginning with our significant Q1 Portfolio purchases and overall market conditions. During the quarter, we acquired 69 Portfolios from 21 different sellers. The majority, about 95% of our first quarter purchase volume in terms of dollars invested was a combination of VISA, MasterCard, and private label credit card asset classes. The remainder came from pools of medical, utility, and installment loan accounts. The majority of the bankrupt accounts acquired during the quarter are included in the VISA, MasterCard, and auto categories. Bankrupt accounts accounted for about 30% of our purchase activity in terms of dollars invested. Our bankruptcy purchases in Q1 included a significant portion that were aged from their initial bankruptcy filing and as a result are already generating significant cash flows. These financial characteristics should create a relatively low ERC to purchase price ratio for these types of accounts; however, taking together with low collection costs and financial leverage, we look for attractive returns nonetheless.

During the quarter, about two-thirds of our purchases were the result of flow relationships; however, some of this was the result of short-term flow arrangements entered into during Q1 that also expired in the quarter. Market conditions continue to improve in the quarter with increasing supply and somewhat softening pricing.

Looking ahead, as I discussed earlier, the weakening economic is clearly driving the improved market conditions. As we’ve commented in the past, higher buying volume and more moderate pricing in periods of economic difficulty is a phenomenon we’ve observed in past cycles.

For those with the ability to accurately price portfolios in this difficult environment and then bring sufficient capital to the picture in order to purchase and collect these portfolios effectively over the long run, times like these can be attractive. Now that does not mean we are buying with abandon. In fact, we are underwriting new portfolios very conservatively factoring in a moderate near term collection slowdown, due to current economic conditions. In addition, we have raised the targeted hurdle for our investment IRRs and have continued to aggressively evolve our collection strategies in an attempt to best match our internal call center capacity with our most liquid accounts.

Now let’s move onto collections. On the owned portfolio collection front, Portfolio Recovery Associates collected a record $79.4 million dollars in the first quarter, up 18% from $67.3 million a year earlier. Offering a bit more granularity, call center collections were a record $46.7 million dollars, up 19% from the same quarter last year. Legal collections were 28% of total cash collections in Q108 at a record $21.9 million dollars. This compares with 31% and $20.8 million dollars in Q107, representing year-over-year growth of 5% in terms of dollars collected. Excluding bankruptcy collections, legal was 32% of collections in Q108 versus 35% in Q107. We are very focused on improving our year-over-year legal collection growth rates during 2008. We are not satisfied with the recent single-digit growth from that collection channel. Cash collections for our purchased bankrupt accounts were a record $10.8 million dollars, up 50% from Q107. Overall, as you know, we track productivity in terms of recoveries per hour paid. The core metric that measures the average amount of cash each collector brings in. This metric finished at $133.31 for the first thee months of 2008, compared with $135.77 for the full year 2007. Excluding the effect of trustee administered purchased bankruptcy collections, PRA’s Q108 productivity was $116.35 versus $123.10 for the full year 2007. When excluding legal and trustee administered purchase bankruptcy collections, productivity for Q108 was $79.05 per hour paid versus $79.26 for all of 2007.

On last quarter’s call, I was asked about the dilutive effect of our Jackson office. During Q407, Jackson diluted overall productivity by about 7%. During Q108, this dilution dropped by about 100 basis points to less than 6%; however, with a very modest impact of the Philippine operation, combined dilution was unchanged at 7%.

As we’ve been discussing for the past several quarters, we are working aggressively to address our year-over-year decline in productivity, including significant re-engineering initiatives in our call centers. We are working against the rapid staffing we did in 2007, as well as softening in the collection environment related to the current economic slowdown. During Q1, net domestic staffing was held relatively flat as we relied upon increase use of predictive dialers and enhanced account level work prioritization to improve productivity. With the addition of the 50 collection reps in the Philippines and considering the significant amount of bankrupt accounts that have been purchased over the last 12 months, we consider our workforce appropriately sized at the current time. During Q1, we saw productivity increases at all of our call centers, which you would normally expect in a seasonally stronger collection period. To illustrate this point, I’d like to introduce to you a new metric – core call center productivity. This figure looks only at hourly paid productivity by collection reps. It excludes not only legal and bankrupt collections, but also any unowned, inbound-generated collections or collections coming from external activities such as collection agencies. Using this metric, we saw consecutive quarterly productivity increase of 26% during the first quarter in Jackson, 9% in Hampton, 7.5% in Kansas, and 11% in Norfolk. On an absolute basis, Kansas remains our top call center. During the quarter, Jackson operated at about 64% of the Kansas standard, while Norfolk and Hampton were about 89%. Although some modest geographic disparities do exist in the various office portfolios, we seek to drive the productivity of all centers not only higher, but to a lower degree of dispersion between our best and worst performing centers.

Company wide at quarter end, our owned portfolio collector headcount was 1,106, up about 5% from the end of Q4. As it relates to staffing, please remember that a significant amount of our recent buying was related to pools of bankrupt accounts, which require relatively low levels of staff to handle. Please also note that our bankruptcy staff is not included in the collector headcount numbers I just shared with you.

Now let’s turn to PRA’s fee for service business, IGS, Anchor, and IDS, which performed quite nicely in Q1. During the quarter, these fee for service businesses saw revenue increases 34% from the same period a year earlier to $11.5 million dollars. They continue to grow, offering us not only incremental revenue and income, but also diversity in our earnings. IGS performed especially well during Q1, as the world of delinquent automobile receivables moved in our favor. Anchor showed modest improvement during Q1 on both the top and bottom line and although RDS showed moderate revenue growth, profitability was negatively affected by year-over-year increase in expenses. In total, the fee businesses grew net operating income strongly when compared to the same period a year earlier.

Now let me turn to our capital structure, which was a key issue in the quarter as I mentioned at the outset. As we’ve discussed repeatedly in the past, during 2007 we changed our balance sheet substantially. We made the decision to aggressively lower our weighted average cost of capital as we reduced our equity account via share repurchase program and special dividends. Then, over the past 12 months, we added approximately $217 million dollars of relatively low cost debt as we concluded our capital restructuring and purchased significant amounts of charged off portfolios, as much in the past 15 months as in the three and a half years prior to that. In Q108, as was the case in Q407, while the borrowing cost associated with these purchases created immediate expenses, the assets we purchased did not immediately begin generating substantial collections. That’s because it takes some time for the debt collection on any new portfolio to get up and running and to begin generating revenue. As these assets mature and begin throwing off more significant cash and revenue, we believe the financial results generated by our strategy will become more compelling.

Finishing up with our results, during the quarter we produced return on equity of 19.5%. Shareholder’s equity totaled $248 million dollars at quarter’s end, and our debt levels while increased remained relatively modest and less than our equity account. With that, let me turn the call over to PRA’s Chief Financial and Administrative Officer to take you through the financials. Kevin?

Kevin Stevenson

Thank you, Steve. Our first quarter 2008 performance continued to be very focused on a long term. Borrowing costs and allowance charges limited our year-over-year growth in net income during the quarter combining to reduce EPS by $.21 cents.

Net income in the quarter fell 8% to $11.9 million collars, while EPS declined 2.5%. Total revenue for the quarter was a record $64.1 million dollars, which represents growth of 19% from the same period a year ago.

Operating income grew just over 5% to a record $21.9 million dollars, while interest expense grew from a net credit one year ago to $2.5 million in Q1.

Our average interest cost on the acquisition line during the quarter was 5.23%. Breaking our first quarter revenue down into three components, once again the majority of total revenue or $52.6 million dollars came from income recognized by finance receivables. This is revenue generated by owned debt portfolios.

Income on finance receivables is derived from the $79.4 million dollars in cash collections recorded during the quarter which represent an 18% increase over Q107. First quarter cash collections were reduced by an amortization rate, including allowance charge of 33.7%. This amortization rate compares with 32.5% in Q107 and our full year 2007 rate 29.6%. During the quarter, PRA record allowance charges totaling $2.8 million dollars. If this is higher than you’ve seen from the past from PRA, I’d like to take a few minutes to walk through these charges and provide a bit more granularity. First remember that effective January 1, 2005, PRA began booking revenue under the guidance of SOP03-3. Prior to SOP03-3, we used the guidance of practice bulletin 6. As it related to allowances, the key difference between these two pronouncements is that SOP03-3 removed the company’s ability to reduce the yield on a pool once it is set. Furthermore, if a pool experiences better than expected results, in the yield, it’s a correspondingly moved up, that increased yield becomes a new baseline that cannot be subsequently reduced. The guidance of practice bulletin 6 allowed companies to move the yield up or down in order to amortize the pool at the end of its expected economic life. SOP03-3 prohibits lowering that yield, even if that current yield is significantly higher than that originally set. The only mechanism companies are afforded to ensure that a deal amortizes in its expected economic life is that of allowances. Allowances are taken so that the then current yield amortizes a pool of accounts during its expected economic life. Specifics – of the nearly $2.8 million dollars in allowances taken in Q108, approximately 247,000 was attributable to older pools, those from Q104 and back. These deals currently bear very high yield, in excess of 300%. When yields are this high, any negative variance in cash collections, even of a relatively modest size, can create the need for allowances. All in all, these pools are collecting well in an excess of original underwritten expectations. So the reserves are really more function of its high yield environment coupled with some weakness in current cash collections rather than mis-pricing or underperformance relative to original expectations.

Approximately $1 million dollars of the current paid allowance was attributable to higher yielding bankruptcy pools. While the yields on these bankrupt pools are not nearly s high as the pools referenced previously, the yields are currently in excess of their original book yields. From a financial investment perspective, these are very good deals, which should produce financial results that exceed their expectations. The allowances are simply related to the fact that our collection curve shape is somewhat different than expected. The early period of overperformance actually had a larger component of acceleration as compared to what we refer to as a betterment. To put it another way, we collected more than expected early in the life of these deals. When we sat down to analyze how much of that over collection was acceleration, which is a timing issue only, and how much was true betterment, we did not attribute enough to acceleration. These deals were mostly completed fairly soon after we began our bankruptcy buying operation. Our level of sophistication and understanding of bankruptcy curve shape as well as our analysis of what is acceleration and what is a true betterment has been refined over time.

Approximately $850,000 dollars of the current period allowance was related to the Q105 pool that we’ve discussed before. We believe that this allowance is more attributable to a mis-pricing of a large deal in Q105 as compared to some mechanical distribution problem or some economic impact.

We have taken significant steps in terms of writing down estimated remaining collections. To date, we’ve taken allowances equal to $2.3 million dollars related to the Q105 pool primarily associated with one purchase transaction within that quarter, which has an associated $4.5 million dollar purchase price.

Lastly, we took approximately $700,000 dollars of allowances on two pools from 2006 that were otherwise more normal in nature. The pricing environment in 2006 was challenging leaving little room for underwriting or operational error. In Q108, we saw some weakness in these pools. Given the economy we face, we wanted to take aggressive action and hopefully set these pools on a correct course by taking these allowances now.

We’ll be sure to keep you apprised of the performance of these particular pools as time moves on.

As I’ve remarked repeatedly, I think it’s realistic to assume that some modest percentage of any debt buyers amortization will always be allowance charges. SOP03-3 simply creates an environment that supports this. Based on the directive to increase yields on overperforming transactions and the prohibition at lowering yields once they’re increased. Further, given the relatively tougher collection environment and facing any economic downturn, we feel it is imperative to take an appropriately large allowance expense at the first sign of serious weakness. If such a move proves to be too conservative down the road, one can always reverse the allowance, but by delaying the allowance charge, one only increases the risk of an even greater charge in the future, an event that needs to be avoided or at least minimized through conservative implementation.

During the first quarter, cash collected in fully amortized pools was $6.3 million dollars, down from $7.6 million dollars in Q107, but up sequentially from $5.3 million dollars in Q407. In referring to fully amortized pools, I mean purchase pools, with no remaining basis on our balance sheet. Eliminating these pools from our amortization calculation gives us a core amortization rate for Q1 of 36.6% identical to the 36.6% we saw in the first quarter of 2007. We continue to believe that the byproduct of SOP03-3, the quantity of zero basis cash collections should gradually decline over time, due primarily to the fact that under the guidance of SOP03-3 we aggregate all similar paper types required in a quarter in order to calculate revenue. These larger groupings allow us to forecast more accurately generally keeping a purchased finance receivable asset on our books for a longer period of time than we have historically.

During the quarter, commissions and fees generated by our fee for service businesses, Anchor, IGS, and RDS, sold $11.5 million dollars. This compares with $8.5 million in a year ago quarter. The third component of total revenue or cash sales of finance receivables was once again zero for the quarter, as it has been in every quarter since our IPO in late 2002. On the operating expense side, we experienced an increase of approximately $4.4 million dollars, when compared with Q407. This primarily came from the compensation line item, as well as the outside fees line item and communication costs, as we dramatically increased certain mailings in an effort to take advantage of the tax season. The compensation line item grew commensurate with our rapidly expanding workforce, while the outside fees were mostly in IGS impact relating to agent repossessions. As we were able to achieve improvements in productivity, we should be able to put downward pressure on the compensation in relation to revenue and cash collections. In fact, we are moving forward in a couple of interesting areas in terms of efficiency of our operations. First, we are continuing to invest in technology and strategy, as we’ve mentioned before, to help out existing collectors move more debt through the system. In this regard, we’ve changed our predictive dialer and account calling strategies in Q1, helping us to work 40% more discreet accounts and 17% more accounts per hours in March of 2008 than in December of 2007. Second, as we described last quarter, during Q1, we began an experiment using call center agents based on the Philippines. This experiment began with 25 reps in mid-March and is now at 50 reps. We will continue at this level until we have a better indication about the kind of productivity we can expect from this workforce.

Operating margins during Q1 were 34.1% compared with 33.9% in Q407 and 38.2% in Q107. This compares with full year 2007 operating margin of 36.8%. Without the margin dilution caused by the fee business, the operating margin would have been about 37.9% in Q1. As we’ve stated repeatedly in the past, we will make further investments in professional and collector staff throughout 2008 to assure we have the talent on hand to best exploit the many long-term opportunities we see. I’d like to help you understand some of this margin compression a bit further, case in point, there is a component of the IGS business that generates zero operating margin. There are certain fees that we simply pass through to the clients. Fees, where we take the risk of payment and as such under accounting guidance we book both as 100% revenue and 100% expense. This one component alone was approximately 100 basis points dilutive to the overall PRA margin Q108.

Operating expense to cash receipts, as I mentioned before, is perhaps a more insightful efficiency ratio since variations in purchase price amortization rates caused our revenue ratios to fluctuate, regardless of true operating efficiency levels. Operating expenses as a function of cash receipts during Q108 were 46% compared with 44% in Q107. This was driven by the same factors previously mentioned in my discussion of operating margin. While an interesting metric, please understand we are not running our business solely focused on operating margin. We feel that earnings efficiency ratios such as return on equity, return on invested capital, and growth in earnings are more important to the long-term healthy of the company should we need to invest in people, data, services or other items that drive up our expense ratios in an effort to improve ROE, ROIC, and earnings growth over the long term, that’s what we’ll do. We will remain keenly focused on operating expenses in 2008. We will not cut corners that could impact our long-term cash generation; however, I will tell you that we will continue working to address the decline in operating margin that occurred in 2007.

Our balance sheet remains strong during the quarter, despite significant purchases of new portfolios and subsequent draws on our line of credit. Cash balances increased slightly to $16.8 million at the end of the first quarter. Rounding out the balance sheet, we had $477.8 million dollars in finance receivables, $25.3 million dollars in property, equipment, and other assets, $18.6 million in goodwill, and $4.7 million dollars in intangible assets all related to our business acquisitions. During 2008, we are incurring intangible amortization expense of approximately $350,000 a quarter. We have about $217 million dollars of short and long-term debt and obligations in our capital leases, with total liabilities both long and short-term of $295 million dollars. The majority of this debt is at $217 million dollars outstanding under our line of credit. In March 31st, 2008, shareholder’s equity totaled $248 million dollars.

As we’ve mentioned repeatedly, the current buying environment is favorable for those with the expertise to accurately underwrite, the ability to effectively collect, and the capital to make it all a reality. PRA believes it brings all three to the table. In regards to the latter, capital, we’ve reached an agreement in principle with our bank group to extend our line of credit by $70 million dollars, from $270 million to $340 million, on virtually identical terms to our existing line. This would be accomplished by adding a new bank to our existing three bank group. This deal when completed would also include a refreshed three-year term.

We are very focused on the long-term growth of PRA. Although we’re very interested in driving all the key metrics that measure our progress, we will not substitute short-term goals for long-term grows. At the same time, I also want to make it clear that a long-term view will not be used as an excuse for poor short-term execution. We are closely watching productivity and operating costs and believe we have opportunities for improvement in both during 2008.

With that, I’ve completed my prepared comment. I’d like to open the call up to Q&A. Steve and I will both be available to answer your questions. Operator?

Question-and-Answer Session

Operator

Ladies and gentlemen, (Operator instructions) Our first question comes from the line of Bob Napoli from Piper Jaffray. Please proceed.

Bob Napoli – Piper Jaffray

I was hoping to dig in a little bit more on the allowance that you guys took in the quarter on some of the different pieces and the way you lay it out is, I mean, it’s kind of like you’re suggesting it’s a one-time item. I don’t think you’re doing that fully, because there’s some write-offs you’ve had pretty much each quarter. This one is obviously much higher, but I’m just wondering if you could dig in a little bit more, the $1 million from the higher yielding bankruptcy pools and the 2006 is what I’ve been most concerned about and why you think this allowance level would be abnormal versus future levels.

Kevin Stevenson

Well, Bob, again, you’ve got to assume some level of allowances are going to be booked binding debt buyer. You know, if you want to talk a little bit more about these deals, again, I think I laid it out. The bankruptcy deals was really a curve shaped issue. We just collected a lot more than we expected a lot earlier than we expected. I just kind of went through the whole genesis of that and with the 2006 deals, again, we just saw some weakness in Q1 and facing the economic environment, you know, really isn’t the time to become super optimistic on that stuff and we just thought that we should be allowance now. I think I laid it out clearly, but if you have more questions, I can maybe get more precise on it.

Bob Napoli – Piper Jaffray

Maybe just a question on the competitive environment then. Have you seen significant competitors pull back from the market for whatever reason, competitive or performance reason, over the last three to six months?

Steven Fredrickson

I don’t think anybody in particular advertises why they are or aren’t in the market at any given time, Bob. It’s our perception though that the demand side of the market is a little softer than we would anticipate given what’s going on from a pricing standpoint and I guess given kind of anecdotal evidence, that would be our take, that capital and performance is an issue.

Operator

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

Mark Hughes – Centrix

Can you share your expectations for collections for the portfolios you’ve acquired this quarter, kind of the collections multiple or the BK and the non-BK pieces?

Steven Fredrickson

We’re going to be following our queue very shortly. Let me see if I can grab that during the call here, but I’m going to guess within a day or so we’ll be following that queue for you and you’ll have that data to chew on.

Mark Hughes – Centrix

How much would you say prices have declined on same type of paper from a similar seller? What kind of range would you say in terms of pricing?

Steven Fredrickson

We typically try to stay away from giving you guys the ranges. I think your channel checks are probably as accurate as anything. We’re talking about multiple variables changing over time, even when you’re talking about a single seller from period to period, but I would say that if you look at prices relative to a year or 18 months ago, certainly the pricing declines would probably be in the 10 to 30% range, depending on a lot of moving pieces.

Operator

Our next question comes from the line of Rick Shane from Jeffries. Please proceed.

Richard Shane – Jeffries & Company

First, I just want to make sure that I understand some of the disclosure correctly. When I look back to what you’ve disclosed, you said that in 2006 you bought 139 transactions. Is that equivalent to the pools that you’re talking about?

Steven Fredrickson

Yeah, whenever we talk about a finite number of deals, I guess we’ve used the term deals or pools interchangeably.

Richard Shane – Jeffries & Company

So based on that, the average pool size for 2006 was about $800,000 dollars by my calculation. That would suggest that the magnitude of write-down on these two pools is pretty significant. I mean roughly half. Is that the right way to look at it?

Kevin Stevenson

When we talk about deals or portfolios, we’re talking about a purchase transaction from a seller. Pools though, as I mention in my talk of SOP03-3, aggregate different deals by quarter. So those allowances from 2006 would have been on aggregated quarterly deals.

Richard Shane – Jeffries & Company

That makes more sense, certainly. Can you give us an idea of how much the write-downs were, the magnitude of your carrying value? I mean allowances.

Steven Fredrickson

I don’t have the original purchase amount in those pools. I think Mr. Fike is working on that right now.

Richard Shane – Jeffries & Company

Okay, maybe you can answer it later in the call. My understanding is that in terms of the bankruptcy paper, it is much more efficient collect and much more predictable in terms of collections?

Steven Fredrickson

Yeah, the bankruptcy paper again is we don’t use collectors to collect it. The trustees do that for us once we purchase it and get all the paperwork filed.

Richard Shane – Jeffries & Company

I guess what I’m trying to understand here is really what’s the value at? I mean is it just a pure financial transaction?

Kevin Stevenson

It’s really a bit of both. It is, number one, we think a more complicated underwriting transaction. There is an awful lot of data that’s involved and getting both the timing and the magnitude of the cash flow’s right is a lot of science and something that we think is difficult to get correct. Also, you need to have a very efficient processing staff and we have spent a considerable amount of time and money building a highly automated process to keep our operating costs there as low as possible. So even though the operating costs are low, if you’ve got a sizeable advantage over your competitors in operating costs on the bankruptcy side, you’ve got that much more of a pricing advantage.

Richard Shane – Jeffries & Company

I apologize. I’m not sure I necessarily understand what the processors do and I realized I’ve asked a lot of questions, but if you could understand that so we could get some sense. I mean the first part makes sense to me. You’ve got to price these things correctly, but it almost sounds like once you make that decision, I mean I could dumb luck into the same price that you do not knowing anything. Help us understand how the processors really add value.

Steven Fredrickson

In essence, you really need to do one of two things when you buy these pools. If the chapter 13 filings have already been made and if a proof of claim has already been filed, you need to file a joint notice of transfer to get those accounts in effect in your name. If that hasn’t been done, you need to file the original proof of claim. You also need to make sure that the accounts you’re buying live up to the terms you negotiated in your contract. You need to check on the dividend rates and that these plans are indeed valid plans and to be able to communicate with the bankruptcy courts and do all of that kind of processing work very quickly, very accurately and at low cost is definitely a process.

Kevin Stevenson

Mr. Fife passed me a sheet of paper, the original purchase price on those deals was $54,756,000 dollars.

Operator

Our next question comes from the line of David Sharp from JMP Securities. Please proceed.

David Sharp – JMP Securities

Steve, can you talk a little more specifically about what your assessment is of what might be going on in the legal channel. Obviously, your own centers, we’re seeing this is kind of a fifth quarter in a row sequentially where your growth rate of collections is accelerated. You know, BK is obviously quite a bit, that’s…the purchase activity, but besides the obviously deceleration in legal, operationally what do you think is going on out there and do you sense that the industry as a whole is experiencing the same thing with their attorney networks?

Steven Fredrickson

I do believe it’s a little bit of the latter. I think that there, at least from what I’ve heard, there’s some challenges on the legal collection side. I don’t know, David, it might be partially because it’s a more exploited channel than it once was and so there’s a little bit of competition that’s starting to show up there. I know in our case, we also have to some degree some new placement issues. I don’t think we were necessarily as aggressive in getting out new placements during some time periods as we could have been and we’re trying to make sure that we’re doing that on a current and go-forward basis.

David Sharp – JMP Securities

Is there anything that ultimately leads to more of a pay-for-performance commission rate on legal outsourcing?

Steven Fredrickson

Well, first and foremost, to a great degree, it is pay-for-performance, because these are all contingent fee collection shops; however, I think like a lot of people, I think most enlightened users of services like that are probably looking at inventory control or placement volumes and performance payments to try to not only spur behavior but really continuing to do it for you. So certainly we’re in that camp.

David Sharp – JMP Securities

Trying to reconcile some of these collection numbers. It looks like your own call centers or actually the combination of your own call centers and legal. So ex-BK as it looks like your cash collections were up 14% and it looks like your collector FTs were probably up in the mid-teens as well, yet your productivity ex-BKs was down 17% and I would have thought that sort of productivity would have to be so much flat for a certain increase in headcount to result in a corresponding increase in collections.

Kevin Stevenson

I think you’re asking a question that might be higher level math than we can do on the fly here, David.

David Sharp – JMP Securities

What was the collector FTs?

Steven Fredrickson

We only gave headcount thus far. We had 1,106 on the headcount for 3-31.

David Sharp – JMP Securities

And I heard you mention that you thought that was an appropriate level for the balance of the year?

Steven Fredrickson

No, from where we stand today.

David Sharp – JMP Securities

Lastly, I know this is difficult, it kind of leads into the realm of guidance, but trying to get a sense for how to think about BK liquidations, how they would trend throughout the year. Close to $11 million in the first quarter. I would assume that is not the type of seasonality for a lot of these particularly.

Steven Fredrickson

Typically, in bankruptcy, someone is either performing under a plan or not performing under a plan and the plan typically doesn’t take into account seasonality. Now the extent people are more flushed because of tax returns in Q1 and so we see less bankruptcy plans fall out and miss payments. Maybe that could have some impact, but I would tend to think there’s less seasonality to the bankruptcy payments, all things being equal.

Kevin Stevenson

David, did you say you though collector headcount was flat Q-over-Q? Is that what you were looking for, Q107 to A108?

David Sharp – JMP Securities

No, I was looking at collector FTEs being up perhaps in the mid to high teens year-over-year.

Steven Fredrickson

David, the headcount was up 30%, Q107 to Q108, and the FTEs I feel comfortable saying it’s going to be up about 30% as well. That would seem to play into a little more what you’re asking, I believe.

David Sharp – JMP Securities

That’s very helpful. Thank you.

Operator

Our next question comes from the line of John Neff from William Blair. Please proceed.

John Neff – William Blair & Company, LLC

A million dollar impairment on the bankruptcy pools, could you just tell me what vintage year were those purchased, 04 or 05 or 05 06?

Kevin Stevenson

I put in there, I said it happened very early in our bankruptcy buying evolution, so that would have been really the 05, just 05.

John Neff – William Blair & Company, LLC

Anything unique or different about the one Q05 purchase, the $4.5 million portfolio that’s giving you some problems. Was it a different type or a different seller?

Kevin Stevenson

Yes, it’s not an asset class that we were experience with, but it was a non-VISA MasterCard asset class and was a little more out there and we knew it was. It’s actually a deal that we spent a lot of time underwriting. We even did on-site due diligence on this particular deal and we didn’t get it right.

John Neff – William Blair & Company, LLC

Then, and you don’t have to tell me that it doesn’t mean anything in terms of price, because I know that, but blended rate was high this quarter, 6.4%. Last quarter it was 2.8% and last quarter of the BK purchasing I think was 61% of total purchasing. About a third this quarter. So what does imply? Are you seeing more value at the fresher end of the charge-off spectrum.

Kevin Stevenson

Yeah, you know, it implies I guess what really happened is we ended up buying less old paper than we typically do. One of the things that we’ve witnessed particularly over the last three months or so is there’s not a lot going on in the deep discount end of the market, the retrade market or, as we would refer to it as the warehouse market. I don’t know specifically why, maybe prices have declined to the point where people are just saying – you know what, for this price I’m not going to move it out, but typically we do some volume in that lower price market and that brings your average price down. We didn’t do much of that this quarter if you point out a fair amount of money in the bankruptcy arena, which cash flowing deals is a very high purchase rate, and it’s just how the blunt came out.

John Neff – William Blair & Company, LLC

Kevin, collectors and supervisors, I want to make sure I’ve got the apples to apples one. It was $12.40 last quarter?

Kevin Stevenson

Right. It’s $13.05 this quarter.

John Neff – William Blair & Company, LLC

Even with the impairment charge or revenue was better than I was looking for. So what really hurt you was the expenses and you mentioned the expense, the competition up in line with headcount growth, I’m assuming that the growth going forward will be less than what…this will be kind of the high water mark from a year-over-year perspective if the employee count starts to increase more incrementally from here.

Steven Fredrickson

My comment on that would it obviously depends on the buying environment. So should buying be robust, you know we’re going to be adding people most likely. I would say it also depends on the productivity enhancements I mentioned in my script. So make sure you factor those potentials in there.

Kevin Stevenson

Our operation guys do believe though we’ve got some opportunities and we are focused on a number of initiatives. So we’re really looking at expenses at this point, John.

John Neff – William Blair & Company, LLC

Philippines, I realize it’s too early to get a productivity read, but number one, are those folks actively collecting at this point and, number two, you said I think it was 25 collectors in March and now it’s 50. Was that a planned? Is 50 sort of the target get-to number?

Steven Fredrickson

John, it was just a phase thing. So 25 was phase one followed almost immediately by the second 25. The first 25 collected for a week and a half or so during March. So there was very little impact and the second 25 came on right as March closed and we’re just holding at 50 while we try to get a read on how productive these folks can be.

John Neff – William Blair & Company, LLC

You mentioned RDS higher cost. Is that investment spending? When might you predict RDS sort of starts to hit its stride from an operating leverage perspective? Kind of like you talked a little over a year ago, I think about last year being a big year for IGS. And Kevin, sort of along this line, I didn’t get it down – the total operating margin drag from fee for services.

Steven Fredrickson

Yeah, on RDS, it is investment, particularly in some new product lines. We are hiring people and in some cases doing work prior to producing revenue. So hopefully we’ve got it right and good profitable revenue will be generated from that work, but time will tell and in the meantime we are very aware of what we’re doing there as far as affecting the overall finances of PRA and we’re watching it closely.

Kevin Stevenson

A million dollar impairment on the bankruptcy pools, could you just tell me what vintage year were those purchased, 04 or 05 or 05 06?

Kevin Stevenson

John, operating margins were 34.1%. Without the subs, they were 37.9. So that’s still pretty close to that 40 basis points.

Operator

Our next question comes from the line of A. Hamagarn from Shaker Investments. Please proceed.

A. Hamagarn – Shaker Investments

One quick question, on the bankruptcy purchases that you had on the fourth quarter, can you give us a little idea of when you think it may ramp and peak out?

Steven Fredrickson

Yeah, I mean as we described at the time, it’s cash flowing paper. It’s having impact immediately. You’ll be able to take a look at our filings I think and through a combination of pace and estimated remaining collections, you know, get somewhat of a feel for what the curve shape there is going to be. Without stepping over the line and starting to give guidance on this item or that item, I really do believe you’re going to be able to drill down on it once you get those additional financial statistics in our 10Q.

A. Hamagarn – Shaker Investments

To put it in other ways, at this point in time, do you expect it to have similar collection characteristics similar to what your prior bankruptcy collections.

Steven Fredrickson

We’ve had a variety of performance from the bankruptcy vintages. So I would say that it will perform online we anticipate it would roughly perform online with some of those years where we had lower multiple bankruptcy buying. So if you take a look at those, you might be able to get closer to the curve shape than not.

A. Hamagarn – Shaker Investments

Do you expect your collectors that you’re hiring now in the Philippines to ramp in terms of productivity at the same speed that you might be expecting them to ramp in the United States?

Steven Fredrickson

Well, I’ll tell you what, the reason we’re calling this an experiment is because we really don’t know what to expect. We were hopeful. We like the quality that we’re getting so far as it relates to our phone calls and the talk-offs that we’re hearing. The initial results look fine, but it is very much an experiment, we’re isolating it to these 50 reps, so that if it does not work out, we don’t have a big unwind expense and we are just closely and carefully watching this and every month we’ll know a little bit more.

Operator

Our next question comes the line of Hugh Miller from Sidoti & Company. Please proceed.

Hugh Miller – Sidoti & Company

I was wondering, is it possible for us to get Neal Sturns thoughts on what he sees right now as he’s been there for a few months in areas that he sees for improvement with regards to call center collection and productivity levels?

Steven Fredrickson

If he was here, I’d drag him in and make him talk to you. He’s not, but I’ll tell you what, we will give careful consideration to giving him some time on the next call.

Hugh Miller – Sidoti & Company

You guys have mentioned that you see or are planning on improving the legal collections. Can you give us a few examples on initiatives?

Kevin Stevenson

One just simply relates to inventory, making sure that we are getting the appropriate amount of appropriate accounts out in a timely basis to our attorneys. The second thing that we’re doing is the continued expansion of our in-house legal effort where our own employees or attorneys that are on more of a salary retainer are filing suits on our behalf as opposed to using contingent fee attorneys and this would relate mostly to smaller balance accounts, let’s say less than $200,000 balances. The other things we’re doing are trying to as we talked earlier based on the other question, driving performance through the use of financial incentives as well as inventory placement level incentives.

Hugh Miller – Sidoti & Company

Can you talk a little about the initiatives on the cost side. You mentioned that you do see opportunities for improvements. Any color on that area would be great.

Steven Fredrickson

Sure. We are looking very carefully at cause and effect in cost. We’ve done a lot of work as it relates to trying to optimize our letter sends, looking at how productive each letter that we send is looking at letter send by account type and by account score. Again, trying to find the optimal type of accounts and frequency of letters to send. We’re also combining research like that with calls. So when do we call, when do we letter, do we make a dialer call versus a manual call? What kind of letter do we send? And we’ve been working to try to optimize a number of pieces like that. We’re also looking at expenses like credit bureau. Making sure that we are pulling this data and using it effectively. We run very large expenses and it relates to credit bureaus and letters and if we can trim some of that expense and not only not lose any recoveries, but by shaping the accounts that we’re spending that money on, actually drive up our recoveries, we could stand to get kind of a double kick, which would be great.

Hugh Miller – Sidoti & Company

With regards to the operating expenses, can you give us a sense as to any type of range you anticipate would be a realistic expectation in 08 and whether or not you would anticipate that might peak this year and you’ll have some efficiency gains in 09?

Kevin Stevenson

Hugh, I’m not going to go down the guidance path, but just to say I put my last couple scripts, Steve and I are watching expenses on a daily basis and that’s all I can tell you. We are trying to, in fact, I’ve put in my script that we’re working hard trying to reverse some of the margin slip that you saw in 07.

Hugh Miller – Sidoti & Company

Do you happen to have a feel of the Philippines cost. As you’ve said, you made some hiring. The very end of the quarter obviously wasn’t really much of a revenue generator, but the impact from that imitative from an EPS standpoint for the quarter?

Kevin Stevenson

From an EPS, it would be tiny. The hit to productivity, you know, it diluted productivity by a little less than one percent. I think it was a tiny impact.

Hugh Miller – Sidoti & Company

Okay, great. Thank you.

Kevin Stevenson

We will try as we did this time to give you a little bit more granularity as to the impact of the various centers’ performance to overall productivity and certainly as we get our full quarter results from the Philippines in Q2, we’ll give you color on that.

Operator

Our last question comes from the line of Sameer Gokhale from KBW. Please proceed.

Sameer Gokhale – Keefe, Bruyette & Woods

I know you talked about the productivity data that you’d be sharing at some point, but one thing I wasn’t sure about is some of the new metric that you discussed, the core cost of center productivity, did you provide the details in terms of year-over-year comps or sequential comps?

Kevin Stevenson

Part of the reason why we’re doing that, Sameer, is we changed that significant operating process in September of last year and as a result all of the inbound traffic on unowned accounts, which is considerable, is not showing up in collector numbers. It’s showing up in this inbound unit, which we are stripping off. We manage it separately and it really doesn’t have anything to do with necessarily the productivity of those collectors we’re trying to measure. So that doesn’t give us much history to go back upon. So we’ll just start building it with you and let you know how we’re doing on a sequential basis and obviously we’ll give you look-back data when we start getting year-over-year comparables.

Sameer Gokhale – Keefe, Bruyette & Woods

You give us a lot of detail on a quarterly basis about the different factors affecting earnings and operating expenses and revenues, but just to look at kind of the growth in the balance sheet asset, the year-over-year growth and the purchase receivable asset on the balance sheet, and given the high level of purchasing, that growth has been very rapid. Like I think Q407 was 81% growth in purchase receivables, before that it was 54%, and the quarter before that was 46%. When you look at EPS numbers this quarter, if you strip out the impairment charge and even the interest expense, it’s like year-over-year basis it’s like a 20% of EPS growth. So I know there are many different factors that you guys discussed, but your view, at what point in time will this rapid increase in purchase receivables going to manifest itself in kind of more robust, for lack of a better word, earnings growth projection?

Kevin Stevenson

Part of it has to do with what the future looks like. So if we shut off buying tomorrow, you would see a more profound bottom line impact than if we continue to ramp things up and grow that asset and the borrowing costs and the kind of front end loaded cost that are associated with some of these acquisitions. So it will be dependent upon the future pace of buying, but obviously we’re well aware the same phenomenon that you have and we fully expect at a point in time where the investments that we’re making are going benefit and the wiseness become apparent. So we’re still confident of our strategy.

Sameer Gokhale – Keefe, Bruyette & Woods

Do you guys have any expectations for the tax rebate checks, the incentives, and how that might help you on the collection front in the second quarter?

Kevin Stevenson

Well, we’re spending some money to get our fair share, let’s put it that way. We’ve got series of mailings that have been carefully timed to hit at the same time that the checks hit. So, as you know, those are just going out. I don’t have any actual results for you, but again, we’re trying to be creative and we’re trying to get our fair share of those. So we’ll have something concrete to talk about three months from now.

Operator

There are no further questions. I would now like to turn the call back over to Steve Fredrickson for closing remarks. Proceed, sir.

Steven Fredrickson

Thank you, operator. First I’d like to thank all of you for participating in our conference call. Before we go, I’d like to reiterate a few key points about our first quarter. As I mentioned at the outset of the call, PRA’s first quarter is best viewed as two stories. One has to do with increased interest expense and allowance charges, which together hindered our bottom line numbers; however, the second story which has to do with our core skills in debt purchasing and collection was very positive. This leads us to the conclusion that the outlook for PRA’s future today is as bright as ever. Thanks again for your time and attention. We look forward to speaking with you again next quarter.

Operator

Thank you for your participation in today’s conference. This concludes our presentation. You may now disconnect. Have a good day.

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