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Executives

Noel Ryan – Director of Investor Relations

Nathaniel F. (Brad) Bradley IV - Chairman, President, Chief Executive Officer; Director

Rion B. Needs - Senior Vice President and Chief Operating Officer

Mark A. Redman - Chief Financial Officer

Analysts

Mark Hughes - SunTrust

Sameer Gokhale - Keefe, Bruyette & Woods

Hugh Miller - Sidoti & Company

Rich Shane - Jefferies & Co.

Ashley Hemphill - William Blair

Justin Hughes - Philadelphia Financial

David Nierenberg - Nierenberg Investments

Asset Acceptance Capital Corp. (AACC) Q1 2008 Earnings Call April 30, 2008 10:00 AM ET

Operator

Welcome to today’s Asset Acceptance Capital Corporation first quarter 2008 earnings results conference call. (Operator Instructions) At this time, for opening remarks and introductions, I would like to turn the call over to Noel Ryan, Director of Investor Relations.

Noel Ryan

Welcome to Asset Acceptance Capital’s first quarter 2008 earnings conference call. On the call today are Brad Bradley, our Chairman, President and CEO; Rion Needs, Senior Vice President and COO; Mark Redman, our Senior Vice President of Finance and CFO.

Earlier this morning, we announced the company’s first quarter 2008 financial results. If you have not yet received a copy of the press release, please contact Patrick Kane at 616-233-0500 and have one faxed to you. The release is also available on many news sites, or it can be viewed at our corporate website at assetacceptance.com.

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

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

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

There are number of factors, many of which are beyond the company’s control which can cause the actual results and outcomes to differ materially from those described in the forward-looking statements.

Risk factors, include among others, our ability to purchase charged-off consumer receivables at appropriate prices, our ability to continue to acquire charged-off receivables in sufficient amounts to operate efficiently and profitably, employee turnover, our ability to compete in the marketplace, acquiring charged-off receivables in industries that the company has little or no experience and the integration and operations of newly acquired businesses.

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

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

With that said, I would now like to turn the call over to Brad Bradley, CEO of Asset Acceptance.

Nathaniel F. (Brad) Bradley IV

During today’s call, I will provide high-level commentary on our first quarter 2008 financial performance, a review of current macro industry trends as we see them and finally, I will conclude with the discussion of the plans and objectives we have in place as we look ahead to the remainder of fiscal 2008.

Following my comments, Rion Needs, our Chief Operating Officer, will provide an operational status report. Mark Redman, our Chief Financial Officer, will then provide a summary of our first quarter 2008 financial results. At the conclusion of our prepared remarks, we will have a question-and-answer session.

Our first quarter performance was a solid start to 2008, highlighted by continued cash collections growth, improved expense management as a percentage of cash collections, and double-digit growth in adjusted EBITDA when compared to the prior-year period. Despite these achievements, first quarter 2008 profitability declined when compared to the year-ago period, principally due to higher amortization of purchased receivables and increased interest expense when compared to the first quarter 2007.

Following five consecutive quarters of strong purchasing, which began with Q4 ‘06, we were opportunistic but selective in our approach to purchasing delinquent receivable portfolios in the first quarter. Although purchasing was relatively low in Q1, we were pleased with the mix and the quality of our acquisitions and are confident that we will meet or exceed our fiscal year purchasing target. I will discuss our purchasing activity in more detail shortly.

Given our moderate purchasing activities during the quarter, we used excess cash flow to reduce our outstanding debt on the revolving line of credit by $27 million during the first quarter. This reduction in our debt outstanding combined with the updated financial covenants under our credit agreement provide us with the financial flexibility to further capitalize on an improving debt purchasing environment.

Looking ahead to the remainder of 2008, we are encouraged by the opportunities available, but are keenly aware of the challenges that exist in the current economic climate. We continue to place sustained focus on generating cash collections, leveraging our associate talent, improving operating efficiency and capitalizing on an increased supply of charged-off accounts receivable becoming available in the market.

I will now provide a summary and review of our financial performance for the first quarter ended March 31, 2008. First quarter 2008 cash collections grew 4.6% to $100.3 million compared to $95.9 million in the year-ago period. Marking the first quarter in the history of our company where we have reported $100 million in collections in a single quarter.

During the first quarter, cash collections growth was driven by several factors, foremost of which included increased contributions from the legal collection channel and increased collections from the agency forwarding channel.

While call center collections represented nearly half of all cash collections for the quarter, legal collections continued to increase as a percentage of total cash collections from 37.4% in the first quarter 2007 to 38.1% in the first quarter 2008. Total revenues declined 4.4% to $64.4 million in the first quarter 2008 compared to revenue of $67.3 million in the prior year period.

Operating expenses as a percentage of total cash collections declined to 50% in the first quarter 2008, the lowest level since the second quarter of 2004. Rion and Mark will discuss our operating strategies that led to the decline in operating expenses later on this call.

Net income for the first quarter 2008 declined 31.2% from the prior-year period to $6.8 million or $0.22 per fully diluted share. As previously alluded to, there were two primary factors, which contributed to a decline in first quarter profitability when compared to the prior-year period: one, an increase in the amortization rate to 36.4% versus 30.3% in the year-ago period; and two, the impact of interest expense resulting from increased levels of borrowing subsequent to last year’s recapitalization transaction.

During the first quarter, the amortization rate on purchased receivables continued to rise as portfolios acquired in recent years amid an elevated pricing environment comprise a larger portion of total cash collections. Notably, higher prices result in lower expected multiples of purchase price to be collected and therefore, lower yields for revenue recognition. The reduced yields result in a lower portion of cash collected being recognized as purchased receivable revenues. Mark will discuss revenue and amortization in more detail shortly.

The second factor contributing to our lower profitability involved increased levels of borrowings and the resulting interest expense. The increased borrowings are primarily the result of the $150 million borrowed in 2007 to fund the return of capital to shareholders in June and July of 2007.

Secondly, we have also borrowed to fund our purchase of paper since late 2006. As a result of these two factors, interest expense increased by $3 million to $3.3 million in the first quarter 2008, compared to $0.3 million in the three months ended March 31, 2007.

Several factors contributed to our modest investment in purchased receivables during the first quarter when compared to the year-ago period, including our belief that the pricing environment may continue to improve from current levels, our bias toward the most attractive deals available in the market, as well as our reduced purchasing activity for two weeks while we saw the temporary waiver for our credit agreement covenant violation.

During the first quarter, we invested $22.3 million in 47 charged-off consumer receivable portfolios with aggregate face value of $548.5 million for a blended rate of 4.07% of face value. Included in these purchase totals, were 35 portfolios with an aggregate face value of $206.8 million purchased at a cost of $11.1 million, or 5.35% of face value, which were acquired through 11 forward flow contracts.

Now, I’ll discuss key industry trends and observations. Early into 2008, the U.S. economy continues to show signs of slowing. Record high energy prices, food inflation, real estate deflation, lackluster employment figures and a weak dollar remain key factors, which may lend themselves to increasing the supply of charged-off consumer receivables as we look ahead to the remainder of the year. Consumer credit delinquencies in the fourth quarter of 2007 reached our highest level since 1992 according to the American Bankers Association’s Consumer Credit Delinquency report released in April 2008.

Other data from the ABA and the Federal Reserve Board suggest increasing delinquency rates on credit cards to approximately 4.5% up from prior quarters in 2007. Although, these underlying fundamentals may have a positive impact on the supply of charged-off receivables for sale in the coming quarters, a net positive for debt buyers is also probable that disposable income, which in the past may have been used to pay down consumer debt, may not be as readily available resulting in a potential hurdle to collections growth over the near term.

As we have noted on prior occasions, collections tend to be seasonally higher in the first and second quarters of the year due to consumer’s receipt of tax refunds and other factors. This year, the Federal government has begun to send out a total of $150 billion to low and middle-income households as part of a larger fiscal stimulus package.

However, according to a recent booking institute survey, because a record number of Americans are currently behind on their mortgage payments, auto leases, utility expenses and medical bills, less than 20% on the tax rebates are expected to be spent in the real economy and instead are expected to be used to pay outstanding loans and expenses.

Overall, the pricing environment continues to improve in the first quarter 2008 following a trend toward more favorable pricing, which began during the second half of 2007. Nevertheless, we believe prices remain at elevated levels relative to the comparatively lower prices that existed from 2000 to 2002.

However, given macro concerns at a liquidity crisis, resulting expectation of a decline in the consumer’s ability to repay their current obligations, certain issuers may be inclined to sell more portfolios at lower prices in coming quarters. In addition, we believe that some competitors are experiencing their own liquidity crisis as their ability to fund portfolio purchases has been reduced in recent periods.

Furthermore, we believe increases in charged-off rates being experienced by major credit card issuers is also leading to an increase in the supply of receivables available for sale. Therefore, we expect purchasing conditions to improve as the year progresses bolstered by an improving supply environment and continued downward pressure on portfolio prices.

With that, I will now turn the call over to Rion Needs, our Chief Operating Officer for a detailed update on the operations of our business.

Rion B. Needs

Today, I will give you an update on several key operational initiatives, which I touched on for the first time last quarter, which remain top priorities for our team, as we look ahead the remainder of 2008. Exiting 2007, our senior leadership team continues to focus on how best to leverage the people process and tools available to us to generate increased efficiency, operational excellence and continuous improvement throughout our organization.

During the first quarter, our ongoing efforts translated into the addition of key personnel, measurable improvements in cost rationalization, improved collection and expense forecasting, enhanced inventory management and capacity planning, and further progress towards our implementation and adoption of advanced tool and technologies designed to increase our ability to leverage our competitive advantages in the marketplace.

These efforts resulted in improving our cost to collect to 50% for the quarter. However, due to the deferral of some of the legal collection expenses and seasonality of our collections, we anticipate giving back some of those gains over the balance of the year.

As most of you are aware, legal collections have continued to grow as a percentage of our overall collections mix in recent quarters, finding new more efficient ways of utilizing the legal channel to collect on an ever increasing volume of purchased receivables has never been more critical.

So when Diane Kondrat, a 16-year veteran of Asset Acceptance and VP of our Legal Collections Department announced last year her intention to retire in the summer of 2008, our team set out to identify a suitable replacement that could help lead the legal collection department during the next stage of transition and process reengineering.

In addition to identifying an individual capable of overseeing operations for the entire legal department, we also wanted to identify candidate who could act as a cross functional resource to help lead change throughout our organization with an emphasis on process redesign and reengineering. With this criteria in mind, our team elected to hire Darin Herring as Vice President of Legal Collections, effective April 01, 2008.

During his 19-year career at American Express, Darin held numerous positions in finance, reengineering and corporate services business unit. Most recently as Vice President, Global Commercial Card and Services for American Express. In that role, Darin is responsible for the development of the new line of business providing source to settle products from the large and middle-market commercial card customers.

Prior to that role, Darin served as the Vice President and Regional Leader of Global Reengineering in Six Sigma. Darin’s responsibilities included identifying, planning and executing reengineering projects across American Express. Some of those projects included call center optimization, evaluation and implementation of global systems and credit card operations optimization.

By hiring Darin well ahead of Diane’s planned departure, we are managing toward a seamless succession process which will position us to continue to execute on our existing legal collections strategy, deliver on our collection platform implementation and accelerate our reengineering agenda. We welcome Darin to the team and look forward to leveraging his expertise.

Turning to our results, account rep productivity on a full-time equivalent basis increased slightly in the first quarter when compared to the prior year period. This level of productivity maintains the strong growth we have experienced over the past two years.

As Brad mentioned, our significant investment in debt portfolios over the last six quarters and the current advantageous purchasing environment will result in continued expansion of our available inventory. With that expansion, we are continuing to refine our inventory management and capacity planning to ensure that we can take advantage of the strong purchasing environment with a high confidence of liquidating those purchases in line with expected ROIs.

In order to accomplish that, we will continue to build and deepen our outsource relationships to create volume and elasticity in all our collection channels. Inventory and channel management remain key areas of focus for our team over the near term, particularly as we seek to properly allocate human resources necessary to collect on our substantial inventory of charged-off receivables.

As we seek to better align our existing collections infrastructure with anticipated increase in our account inventory, we anticipate that an increased volume of accounts will likely be directed towards legal and agency forwarding channels going forward. The net affect of this intentional shift of accounts away from our internal resources will, in all likelihood, result in a slowing of our historical productivity growth we’ve enjoyed over the past two years. We believe this approach will allow us to more effectively balance our total resource capacity and increase overall collections in the long-term while increasing our flexibility and scalability.

I will provide you with further updates on the progress we are making in this area in the coming quarters. As before, our leadership team is committed to creating a highly engaged and skilled workforce that will allow us to capitalize on existing and future market opportunities. One of the more recent personnel development initiatives, which we began in late 2007 and completed during the first quarter, involved the development of unique career paths for each of our associates.

This initiative is designed to help associates develop individual career plans and implement defined development plans to meet their current aspirations. Equipped with data from the career pathing initiative, we are filing a talent management system, which will assist us in future personnel development and succession planning. We believe this effort will prove valuable over time particularly as we seek to identify, develop, and retain leaders throughout our organizations.

Another key area of focus during the first quarter was our continued effort toward the implementation of work flow and process redesign initiatives to help improve the consistency and cost effectiveness of our business processes in line with our stated operational objective.

During the first quarter, one of our primary process-related initiatives was the development and implementation of an enhanced revenue and expense forecasting model for the legal collections operation. In conjunction with this model, we’ve entered into an external relationship that allows us to continue our expanded and accelerated legal process while being able to match expenses and revenues more closely.

In addition, we continue to move forward with the collections initiative which has enabled us to improve account segmentation, improve our ability to collect on high-value, higher-quality accounts in our inventory, with focus on improved inventory management and account prioritization. In 2008, we will continue to enhance our predictive modeling and segmentation capabilities in each of our collection channels to maximize collections and the associated margin.

As I discussed last quarter, another area of strategic focus for our senior leadership team is around the implementation of advanced tools and technologies to help us become increasingly efficient and competitive in the marketplace. At present, we continue to move forward with the adoption of our next generation collections platform which is designed to assist our teams in prioritizing accounts, improving workforce strategies and inventory management and alignment of our collections goals.

Over time, we anticipate this platform will help expedite our access to mission critical information and improve our analytics capabilities, while also increasing the interoperability of the existing systems, thereby allowing for better productivity and more effective communications throughout our organization. At this stage, we anticipate the first phase of the rollout to occur in the second quarter 2008 with the remaining implementation phases reaching completion by early 2009.

With that, I’ll hand the call over to Mark, who is going to take us through the first quarter financial results.

Mark A. Redman

I’ll review our first quarter 2008 financial results and metrics provide a discussion on revenue recognition, and finally, I will end with our liquidity and capital structure.

Starting with the overview of the financial results, in the first quarter, total cash collections increased 4.6% to $100.3 million compared with cash collections of $95.9 million in the first quarter of 2007.

Traditional call center collections for the first quarter declined 1.6% from the year-ago period to $47.5 million, representing 47.4% of total cash collections for the quarter compared to 50.4% of total cash collections in the prior-year period.

Legal collections grew 6.4% versus the prior year first quarter to $38.2 million representing 38.1% of total cash collections versus 37.4% of cash collections in the year-ago period.

Other collections, including agency forwarding, bankruptcy and probate, increased 24.9% on a year-over-year basis to $14.6 million accounting for the remaining 14.5% of cash collections during the first quarter 2008 compared to 12.2% of total cash collections in the first quarter of 2007. The growth in other collections continue to be driven primarily by increases in agency forwarding collections; that is, collections from third-party collection agencies working accounts on our behalf.

We generated total revenues of $64.4 million in the first quarter 2008, down 4.4% from $67.3 million in the same quarter of 2007. I will go into more detail on the revenue shortly.

Total operating expenses declined 2.3% to $50.1 million in the first quarter 2008 compared to total operating expenses of $51.3 million in the year-ago period. Total operating expenses were 50.0% of cash collections in the first quarter 2008 compared with 53.4% in the same period of 2007.

The year-over-year variances in operating expenses when measured as a percentage of cash collections were driven primarily by decreased salaries and benefits expense, collection expense and occupancy costs.

Salaries and benefits decreased 2.3% to $21.9 million compared to $22.4 million in the year-ago period. The reduced salaries and benefits costs reflect an increasing portion of our cash collections coming from outside attorneys and agencies.

While discussing salaries and benefits expense, let’s move to account representative statistics for a moment, starting with productivity. Collections per account representative increased slightly to $53,908 in the first quarter 2008 compared with collections per account representative of $53,629 in the year-ago period.

For the first quarter 2008, we had an average of 901 account representatives on our team on a full-time equivalent basis of which 495 or 54.9% of the total, had one year or more of experience compared to 623 account reps or 67.6% of the total in the first quarter of 2007.

During the first quarter 2008, collections expense declined 4.2% to $22.1 million compared to $23.1 million in the prior-year period. Fees paid to contingent collectors, both agencies and attorneys, increased by $1.8 million in the first quarter of 2008, versus the first quarter of last year. Our collections from these third-party relationships increased to 28.9% of cash collections in the first quarter versus 23.9% in last year’s first quarter.

The remaining expenses included in collections expense declined by $2.8 million in the first quarter of 2008, compared to the same quarter last year. The $2.8 million declined on the remaining collections expense is principally due to reduced mailing, data provider and legal costs.

Occupancy costs declined 17.6% in the first quarter of 2008 to $1.9 million compared to the year-ago period. Occupancy costs declined as a result of the closing of our call centers in White Marsh, Maryland and Wixom, Michigan during the second half of 2007.

Administrative expenses increased 20.6% to $2.7 million in the first quarter 2008, compared to $2.2 million in the prior-year period, the increased results primarily from additional fees incurred through outside advisors and consultants.

As Brad has already discussed, largely as a result of the recapitalization last summer, we’ve recognized $3 million of increased interest expense during the first quarter 2008. Average filings on our credit facility in the first quarter of 2008 were $173.5 million compared to $8 million in the first quarter of 2007. Company reported net income in the first quarter of 2008 of $6.8 million or $0.22 per share compared to net income of $9.9 million or $0.28 per share in the first quarter 2007.

Next, I will discuss revenue, impairments, and portfolio amortization. As stated earlier, our first quarter purchased receivables revenue, our primary source of revenue, decreased 4.6% to $63.7 million compared to $66.8 million in the year-ago period.

The amortization rate for the difference between cash collections and revenue increased from 30.3% in the first quarter of 2007 to 36.4% in the first quarter of 2008. The increase in the amortization rate meant that we recognized $7.5 million more in purchased receivables amortization in the first quarter of 2008 when compared to first quarter of 2007.

The factor most significantly impacting amortization rates is the multiple of purchase price collected on our purchased receivables. Amortization rates on purchased receivables continue to rise, as the portfolios acquired in the recent years in an elevated pricing environment comprise a larger proportion of total cash collections.

Higher prices result in lower expected multiples of purchase price to be collected and therefore lower yields for revenue recognition. The reduced yields result in a lower proportion of cash collected being recognized as purchased receivables revenue.

Net impairments for the quarter were $400,000, down from a net impairment charge of $4.5 million in the first quarter of 2007. The net impairments consist of $1.8 million in impairments and $1.4 million in impairment reversals. As you will recall, net impairment charges are in effect amortization and therefore reduced revenue and the carrying value of the purchased receivables.

Collections on zero basis pools, or fully amortized pools, increased 20.5% to $22.3 million in the first quarter 2008 versus $18.5 million in the first quarter of 2007. Factoring out zero basis collection, the core amortization rate for the first quarter 2008 was 46.8% versus 37.6% in the first quarter 2007.

Cash flow generation remains consistent and strong. We disclose adjusted EBITDA on our quarterly earnings releases because it is an important measure we use to gauge the operational success of the business. It is a measure of the cash generated by the company that is available to purchased receivables, pay down debt, pay income taxes or return to shareholders among other uses.

For the first quarter of 2008, adjusted EBITDA increased by 12.9% to $52.1 million when compared to the first quarter 2007. Please refer to the table in this morning’s press release and on the attachment for the Form 8-K filed this morning, reconciling GAAP net income to adjusted EBITDA.

Now, turning to our balance sheet, as of March 31, our cash and equivalents balance was $12.8 million compared to $10.5 million a year ago. The carrying value of purchased receivables on March 31, 2008 was $330.1 million up from $308 million at March 31 of 2007. As of March 31 2008, we had $15 million outstanding on our $100 million revolving line of credit after paying $27 million since the end of 2007.

With that overview, I will turn the call over to the operator to begin the question-and-answer session.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from Mark Hughes - SunTrust.

Mark Hughes - SunTrust

You had that nice drop in collections expense and I think you talked about the shift in strategy more towards outsourced services. How much of that decline sequentially was from cutting, say, upfront spending on the legal channel versus savings that will be more sustainable going forward?

Rion B. Needs

Mark, on that one, the lion’s share of it was in the legal expense, which is partially a deferral and part of it was our ability to actually reforecast, the forecasting model that we developed for both revenues and expenses we’re much more accurate now being able to tie those two together, which has increased our ability to have a lower expense base and increased debt collections associated with them. So part of it is just the deferral, which you will see come through in the balance of the year, and about half of it is due to a greater efficiencies in our forecasting.

Mark Hughes - SunTrust

Now once you get caught up and you are fully ramped up with these external relationships, relative to last year, should the cost structure be similar? I think you’ve mentioned at one point, you might see a little drop in productivity because of the more outsourcing or increased outsourcing. What should we think about in terms of the costs, again once you get this fully up and running?

Rion B. Needs

On a marginal basis, we expect that the outsource on traditional call centers will actually improve slightly, and then on legal, it will actually improve pretty significantly because we are able to more closely tie the expenses and the revenues with that relationship. So, we in the past, we’ve discussed the fact that on the legal channel, we have to incur the legal expenses well in advance of the associated revenues, which leaves us this timing gap, with the relationship we now have, we’ll actually be able to compress those two together.

Mark A. Redman

And Mark, I would add to that too, we are always trying to find smarter, better, more efficient ways of operating the business and I think we are focused on that. The drop from 53% to 50% is more than we expect to be able to accomplish in a year-over-year basis, but we are focused on trying to continually make improvements in our operations.

Mark Hughes - SunTrust

You have got a nice pick up in the agency forwarding collections, third-party collections. Are you placing accounts with the third parties that you had previously not worked that would just be sitting in inventory so to speak or these accounts that you would have worked internally, but now you are just shifting them to the external service here?

Rion B. Needs

No. For the first quarter, it’s predominantly accounts that were lower on our prioritization, so, were not being worked as aggressively as the balance of our inventory. Moving forward as I alluded to we will be shifting and looking to move more because the volume that we have today to get greater penetration around our total inventory out to agency forwarding.

Operator

Your next question comes from Sameer Gokhale - Keefe, Bruyette & Woods.

Sameer Gokhale - Keefe, Bruyette & Woods

Mark on the table where you show the monthly yield for the ‘08 purchases in Q1. It looks like the monthly yield is 1.38% compared to 2.5% for purchases made in ‘07. Given that it seems like in recent months, pricing seems to have improved on a year-over-year basis, the decline in the yield, is that more indicative of like a mix shift and something going on there or maybe something else. Can you just provide some commentary on that please?

Mark A. Redman

Well, Sameer, I also compare it to the yields that we assigned on 2000 in purchases in the first quarter of 2007 which was 1.5% versus the 1.4%. So, I don’t see it as a dramatic change in yields being assigned. We want to start and make sure that we are starting at yields that we are comfortable with assigning. And if we over time are able to outperform those yields then we will raise them and that’s what you are seeing that’s happened on the 2007 pool. A year ago, their average yield, as I just said, it was about 1.5%, now it’s 2.5%. So, we are beginning to gradually raise yields there.

Sameer Gokhale - Keefe, Bruyette & Woods

In terms of the mix again of one plus year and less than one plus year collectors in Q1 of ‘08 versus Q1 of ‘07, can you just go over those numbers again please?

Mark A. Redman

The total account representatives this year is 901, 495 with more than a year, 406 with less than a year. A year ago, there was a total of 921 with 623 more than a year and 298 less than a year.

Sameer Gokhale - Keefe, Bruyette & Woods

We look at this quarter’s numbers and clearly there have been some strides made in terms of the operating efficiencies and the outlook going forward. You expect pricing to be continuing to improve going forward, is this the inflection point that investors should be looking for in terms of earnings going forward?

I know, you don’t provide specific guidance but, in a general sense, is this the inflection point that you think you have reached at this point or is it still out a few more quarters, just some commentary would be terrific.

Mark A. Redman

I believe there is a mix of positive and negative news. Right now, obviously some of the operational improvements are positive. The pricing is a positive. However, there is uncertainty over the collection environment. And I think everyone is taking up a wait and see position and I am not going to try to predict for investors when they should begin investing. Yes, there’s a mix of good and bad. Now, if we saw these decreasing prices with a continuing good collection environment, obviously I would probably be more positive than I would be right now.

Operator

Your next question comes from Hugh Miller - Sidoti & Company.

Hugh Miller - Sidoti & Company

If I heard correctly you were saying that roughly half of the reduction in the collection expense was with regards to a deferment and half of it was just greater forecasting efficiency. Is that correct?

Rion Needs

Yes, roughly, those are just directional. We haven’t actually quantified the exact contribution to each of those.

Hugh Miller - Sidoti & Company

And can you help me explain what’s driving the reduction in cost relative to the deferment? You mentioned just greater forecasting efficiencies, but what exactly is driving that cost reduction?

Rion Needs

There’s two things. One of them is we’ve implemented predictive modeling that’s helping us identify higher probable success with accounts that move into the legal channel. So therefore, we are getting a higher recovery rate associated with those accounts moving in.

And two is the reforecasting capability that we have today has made less to look at what the desired collection rate is and when do we need to incur those expenses. So, we are able to smooth those out more than we’ve done in the past.

So because on a legal channel, you are paying well in advance six to eight months on average in advance for the collections because of the lead time of filing the case, going through the courts and then getting to a garnishment or a collection, that timing in the past has caused us to push more on the expense base and therefore create more lumpy results. Whereas now we are able to actually smooth those out, which has dropped some of our projected costs when we need to spend in the current period.

Hugh Miller - Sidoti & Company

But that would be more of a deferment, the actual cost reduction is just more in your ability to see that the right accounts have a better success rate, correct?

Rion Needs

That’s correct.

Hugh Miller - Sidoti & Company

Can you talk a little about the purchases in the quarter and possibly give us some sense as to what percentage was made after the resolution of the debt covenant issues?

Nathaniel F. (Brad) Bradley IV

Yes. I’ll talk about the purchasing in the quarter. I’m not sure I can provide you with the numbers that occurred post the resolution. Hugh, that’s really not usual for purchasing to be inconsistent on a quarter-to-quarter basis and we’ve certainly seen that historically in the debt purchasing market. If the market continues to improve, we are seeing improvements in supply that are apparent in the increasing delinquency and charged-off rates and there is a lot of supply that has yet to reach the market.

We are adhering to a more selective, more opportunistic approach. We want to seek out and close on the best deals that are available in the marketplace. With the improved pricing, we feel as if we are getting more for our money. We are seeing some good quality deal flow in the first quarter and even during the month of April. And as I mentioned in my prepared comments, we fully expect and are confident that we are going to hit our purchasing objectives by the end of the year.

Hugh Miller - Sidoti & Company

And I believe on the last quarter, you had given a little bit of insight as to what you may have been seeing on a year-over-year basis with regards to pricing just in a broader range, but can you give us a sense from the first quarter, what types of pricing you were seeing relative to the year prior? And possibly also and just some thoughts on where you think the potential for the decline may be?

Nathaniel F. (Brad) Bradley IV

I talked to Deb about what we are seeing in terms of pricing reductions and I am not sure these are actually year-over-year percentages, but we’ve seen prices move as much as 25% to 40% on portfolios and where it’s going to bottom out is certainly yet to be seen and I would be reluctant to make any predictions on that.

Hugh Miller - Sidoti & Company

The season collectors figures that you have put out there, obviously, noticing just a little bit of a decline there and the percentage that are one year plus. Can you talk a little bit about what may be driving that turnover? Is it possibly because of the challenging collection environment and whether or not you anticipate that over time that will impact possibly the productivity levels on a go-forward basis?

Rion B. Needs

We really don’t try and talk about the turnover on an individual quarter basis. We will talk about on an annual basis in our 10-K. However, as Mark alluded to our occupancy improvement, we did have a significant shift between our Wixom office and Maryland office that we closed last year that would have been open this time, and not open for this time a year ago and closed this year. So that had an impact on those. We don’t specifically talk about the quarter.

Hugh Miller - Sidoti & Company

Any color you might be able to give us on the impairment on the ‘04 vintage and then also the reversals for the ‘03 and the prior vintages there.

Mark A. Redman

I can give you a little of color. The reversals are on a couple of our more significant portfolio purchases from those vintages that we’ve had, obviously, mixed collection results on, and have recently become more confident in our ability to reverse some of the impairments that we have taken on those pools than we have been. The 2004 vintage impairments, I believe continue to result from the lack of aggregation of those pools, just typical volatility that exist when pools are being accounted for on a standalone basis.

Hugh Miller - Sidoti & Company

And on the ‘04?

Mark A. Redman

That last comment about the volatility was the ‘04.

Operator

Your next question comes from Rich Shane - Jefferies & Co.

Rich Shane - Jefferies & Co.

You mentioned your purchasing targets for 2008 and that you still feel confident that you will achieve them. Can you give us some range to what your targets are for 2008? Is it up, down, flat to 2007?

Nathaniel F. (Brad) Bradley IV

I am sorry Rick, but that’s just not something that we are prepared to disclose. We would consider that guidance and we just don’t give guidance.

Rich Shane - Jefferies & Co.

Going forward, if those targets change, will you at least let us know that throughout the year?

Nathaniel F. (Brad) Bradley IV

I think that that falls into the same category.

Rich Shane - Jefferies & Co.

In terms of what’s going on with the revolving facility, how much capacity do you officially have left and as you were working through the covenant issues, were there any changes that were made in terms of advanced rates or anything that we should be thinking about?

Mark A. Redman

The changes in the covenants that were made were to give us a little bit more room on the covenant. So, instead of being at a for example, a 2.5 total liabilities to tangible network covenant requirement, right now, we are at a 3-to-1 ratio.

Probably, what I would consider the only negative implication from the issue was the fact that we increased our borrowing rates by 25 basis points. So, the spread increased by 25 basis points. In terms of capacity, as of March 31, there was probably $50 million, little more than $50 million of bulk capacity to borrow on the most restrictive of the various covenants.

Rich Shane - Jefferies & Co.

I am still confused by the temporary deferral of the legal expenses. Is what you are saying that as you have gained confidence in your modeling of legal collections, that you are more comfortable matching legal expenses to those collections and so, even though you incurred those expenses from a cash perspective, you are just going to smooth out how you actually recognize them through the P&L or you are saying that you are actually not making some of those investments right now and deferring it and what will cause you to get back into it if it’s the latter?

Rion B. Needs

It’s actually the latter. Is that we actually did defer some expenses that we historically were forecasting to make, while we developed or refined our forecasting capabilities. So, some of those expenses were literally, we just postponed the activity into the back part of the year.

Rich Shane - Jefferies & Co.

And there was no change in terms of the recognition policy on legal expenses?

Rion B. Needs

No.

Operator

Your next question comes from Ashley Hemphill - William Blair.

Ashley Hemphill - William Blair

We’ve talked a lot about the pricing environment and your expectation for prices to continue to decline and I was just wondering if you could give us an idea given the $63 million purchased in the fourth quarter, what that indicates for the leaser buying in the first quarter. Was that an indictment that maybe the portfolios you purchased in the fourth quarter were at higher prices than you expect to purchase in the future or were the supply demand dynamics more favorable at the end of the year or just maybe some color there?

Nathaniel F. (Brad) Bradley IV

Well, again Ashley, the purchasing opportunities can be somewhat lumpy and we have had a record quarter in the fourth quarter 2007. We are very pleased with the portfolios that we invested in the fourth quarter that did not have a bearing on our thought processes for investing in the first quarter of 2008.

We are obviously active in the market on a daily basis and doing the best that we can to try to monitor what the thresholds may be in any given portfolio, any given debt sale that we are participating in. And we just believe that prices are going to continue to come down. We are very happy with the portfolios that we invested in, in the first quarter of 2008. We feel as if we received good value for our investments.

We are working the relationships that we have with debt sellers. We are monitoring the activity of the debt sellers and making sure that we understand the strategies that they may be implementing in this market as they look at how they can get the best recoveries on their bad debt portfolios.

So, I wouldn’t read too much into the fact that we had a record purchasing quarter followed up by a moderate purchasing quarter. Again, it’s not unusual to see that type of inconsistency. We are trying to make the best investments that we possibly can during this time of improving pricing and improving supply. And our MO is certainly to grow our purchasing, to grow our company and to grow our earnings and we are trying to do that in the smartest possible way.

Ashley Hemphill - William Blair

I know you talked about the stimulus checks coming out. I am wondering if you did any focused marketing or any efforts made to collect some of that money as it comes in?

Rion B. Needs

We absolutely have. We had timed some of our letter activity to go out in conjunction with receipt of those stimulus packages and we are using talk ops and we’ve incorporated language into our talk ops that help identify that opportunity with our debtors to resolve some of these past issues. So, we anticipate getting our fair share of that opportunity.

Ashley Hemphill - William Blair

Mark, can you give me a little more information on the impairment of intangible assets? What is that from exactly?

Rion B. Needs

What happened in the first quarter is with our acquisition of PARC, our medical debt collection arm; we had made the decision in the first quarter to cease our operations around contingency collection.

We have a robust purchasing environment in the medical field as well as the physicianal field and given the mix of our inventory, right now we felt that we were better suited to deploy our resource against our own inventory and future inventory that we could acquire rather than pursue collections on behalf of hospitals and other entities.

So, we made that decision to exit that business, and as a result, we had a intangible asset on the books, reflective of customer relationships at the time of the acquisition. And so, per accounting requirements, we wrote that intangible asset off.

Ashley Hemphill - William Blair

So any clarification in terms of what exactly went wrong with that acquisition? Was it just ill-timed?

Rion B. Needs

No. There was no issue or impairment associated with the acquisition. It was purely a decision to cease that activity which was contingent collections which during the acquisition, a portion of the purchase price was ascribed to those customer relationships and therefore, capitalized on the books as an intangible asset and our decision to cease that activity accounting, our regulations required us to write that off.

There is nothing related to the value and/or performance of the acquisition. It purely is a decision to refocus those energies to what we believe will be a higher margin business or a higher margin opportunity with our resource.

Operator

You have a follow-up question from Mark Hughes - SunTrust.

Mark Hughes - SunTrust

In terms of the legal activity, am I right in understanding that the pace of lawsuits and your pursuit of debtors has not slowed in this transition; it’s just the timing of the expense recognition that has changed. Is that right?

Rion B. Needs

Well, in the first quarter, actually, some of the deferral of that expense was really a slowdown in suits that were referred into the system for collection. That’s what the deferral really represents. But, no, on a going forward basis, we are not slowing that activity at all.

In fact as you can tell from the growth rate, what we talked about in looking at shifting to outsource partners, we anticipate that that volume will keep at that pace and continue to grow. So, it was just a momentary slowdown, if you want to call it that associated with our ability to improve our predicted modeling and also our forecasting of the revenues and expenses.

Operator

Your next question comes from Justin Hughes - Philadelphia Financial.

Justin Hughes - Philadelphia Financial

I wanted to talk about the zero basis revenue that you brought in. I think it was a record level this quarter and I know you lengthened your curves last year, should we continue to see that go up or will the lengthened curve different modeling, will that start to trend down at some point?

Mark A. Redman

Well, once again, I am not going to give you too much projections there in accordance with our policy not to give guidance. But the items that impact the zero basis collections, obviously, I think, as we have extended lives, you would expect to have less zero basis collections because we have pools that are going to collect for seven years. We had a five-year accounting life on it. Obviously, you had two years of zero basis collections. Now if we have a seven-year life on it, you have no zero basis collections.

Another item impacting zero basis collections would be aggregation. So without aggregation, you have more pools that are going to amortize before their expected for life, and we started aggregating our pools in 2005. So, as you get further out from the 2004 and prior year’s pools, we will have more of our pools on a aggregated basis, and so I think that will generate less zero basis collections than you would have if you weren’t aggregating. So there is some factors that I think are tending to push for lower zero basis collections than we would have had otherwise.

Justin Hughes - Philadelphia Financial

So, before when you were doing the five-year forecast, you were really almost building in two years of zero, now you are doing seven years at seven years, theoretically if you are 100% accurate, there will be zero basis.

Mark A. Redman

Correct.

Justin Hughes - Philadelphia Financial

There has been a lot of headlines about the arbitration process, and I think state of California is suing the National Arbitration Forum, one that you have used in the past. Can you give us some color there and also of your $38 million of legal collections. How much of that is actually from courts and how much of it is from arbitration?

Rion B. Needs

Yes. I don’t have those numbers on me as to what the split would be between arbitration. All I can say in general, we don’t engage in arbitration nearly as much as our normal collection process.

As to the actual changes in California law or statutes or the suits that’s pending there, we don’t have any impact associated with that more constantly assessing the changing legal environment across all of the states and we monitor that on a regular basis and enact strategies to ensure it doesn’t have a negative impact on us. But right now at this point, there is nothing that’s currently that we are involved in that’s making us change our strategies or rethink the way that we are processing our work.

Justin Hughes - Philadelphia Financial

There is no way that the state or any other state could actually come after you, right? They would just go after the arbitration firm?

Rion B. Needs

Yes. Again, without detail about it, I think, to provide you with a legal opinion that I am clearly not justified giving you.

Operator

Your final question comes from David Nierenberg - Nierenberg Investments.

David Nierenberg - Nierenberg Investments

Rion, judging by the sheer number of questions about the change in legal expense, let me try to ask what I hope might be a concluding clarifying question.

I am going to come all the way back to the first time you characterized that because people seems to be having trouble understanding how much of the savings in the first quarter is merely a deferral which will pop up later in the year, and how much could be characterized as a more permanent and on-going savings from lessons learnt about efficiency.

What I think I heard you say was that you would roughly attribute that 50% of the savings to deferral and 50% to more permanent efficiency. Is that correct?

Rion B. Needs

Yes, in general. That is it. And then combined with that is also this external relationship that we entered into, that will allow us to continue the accelerated and the expanded legal process, but more closely match our expenses and revenues than we’ve done historically, which will have also compensating impact.

David Nierenberg - Nierenberg Investments

Mark, in your last quarterly call, you were good enough to give us a mid-quarter glimpse into whether or not you have continued after the end of the December quarter, continued reducing your indebtedness. And I wonder if you would be good enough now that today is the last day of April, if you could tell us if you have continued working down your notes payable balance since March 31 and if so to what level?

Mark A. Redman

David, I am going to decline to do that. I think that the situation and the reason for doing that in the first quarter was a special circumstance surrounding the debt covenant violation and the need just to let investors understand, where we stood as of that point in time with respect to the debt obligation and in coordination with the whole thing.

If you have spent enough time, you could back in and understand where we were in relation to the debt covenants and that the actual amount that we had paid down we were really back in compliance with the covenants, although having violated it as of December 31.

David Nierenberg - Nierenberg Investments

What I am really driving at is this, Mark, if you think about the total valuation of the company on an enterprise basis combining market cap and indebtedness minus cash, it looks to me that between 12/31 and 3/31, the company has managed during that one brief quarter to reduce net indebtedness from $181 to a $151 which is a change of $30 million which maintaining a constant total enterprise values suggest that the equity value has organically grown by $1 per share in that quarter alone. So congratulations.

Operator

That does conclude our question-and-answer session.

Nathaniel F. (Brad) Bradley IV

In summary, we are pleased with the progress we made during the first quarter. We did a good job of continuing to grow cash collections through increased use of our legal and third-party collections channels. We effectively managed our operating cost as a percentage of cash collections and we continue to generate strong cash flows from operations, all while remaining profitable in an uncertain macro economic climate.

In addition, we continue to rollout a series of processed reengineering, and IS-related initiatives designed to increase the efficiency and the competitiveness of our people in the marketplace over the long term. Overall, it was a productive quarter and a good start to the year and we remain grateful for the support of our associates, investors, and partners, each of whom remain central to our future success.

That concludes our conference call today. Thank you for joining us. We look forward to speaking with you during our second quarter 2008 conference call. Good day.

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Source: Asset Acceptance Capital Corp. Q1 2008 Earnings Call Transcript
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