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Executives

Jeff Lambert – IR

Brad Bradley – Chairman, President, and CEO

Rion Needs – SVP and COO

Mark Redman – SVP of Finance, CFO, Secretary and Treasurer

Analysts

Mark Hughes – SunTrust

Hugh Miller – Sidoti & Company

John Neff – William Blair

Rich Shane – Jefferies & Co.

Justin Hughes – Philadelphia Financial

Asset Acceptance Capital Corp. (AACC) Q2 2008 Earnings Call Transcript August 5, 2008 10:00 AM ET

Operator

Good day everyone and welcome to today’s Asset Acceptance Capital's corporate second quarter 2008 earnings results conference call. As a reminder, today’s call is being recorded. At this time, I would like to turn the call over to Mr. Jeff Lambert on behalf of Asset Acceptance Capital. Please go ahead sir.

Jeff Lambert

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

Earlier this morning, we announced the company’s second quarter 2008 financial results. We also announced the appointment of Rion Needs as the President and CEO effective January 1, 2009, succeeding Brad Bradley who will retain his position as Chairman. If you have not yet received a copy of either of these press releases, please contact Patrick Kane at 616-233-0500 to have one faxed to you. The release is also available on many news sites, or it can be viewed on our corporate web site at www.assetacceptance.com.

Before I turn the call over to management to comment on our results, I would like to remind you that this conference call contains certain statements, including the company’s plans and expectations regarding its operating strategies, 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 purchase and pricing, collections and financial results such as revenues, expenses, income, earnings per share, capital expenditures, operating margins, financial position, expected results of operation and other financial items, as well as industry trends and observations.

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

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

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

Other risk factors exist, and new risk factors emerge from time to time that may cause actual results to differ materially from those contained in any forward-looking statements. Given these risks and uncertainties, investors should not place undue reliance on forwardlooking 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 forwardlooking statements in such sections are incorporated herein by reference. With that said, I would now like to turn the call over to Brad Bradley, Chairman, President, and CEO of Asset Acceptance. Brad?

Brad Bradley

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

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 second quarter 2008 financials. At the conclusion of our prepared remarks, we will have a question-and-answer session.

Our second quarter performance was challenging on both a revenue and net income perspective. However, there were a number of positive developments during the quarter including continued progress on operating expense management and record levels of purchasing. With the current economic slowdown, the overall supply of charge-offs from issuers continues to grow and challenges faced by some competitors had place downward pressure on demand. This dynamic resulted in a modestly improved pricing environment in the second quarter as we increased purchases to a record level of $65.3 million. At the same time, as consumers continue to face pressure from rising food and energy cost and the challenging job market, collections became more difficult in the quarter. In this environment, we focused our recovery efforts on accounts we deem most collectible while improving our operating expenses as a percentage of cash collections.

Looking ahead to the remainder of 2008, we are encouraged by the opportunities presented in the current economic climate particularly with regard to both the supply and pricing of charge-offs. We continue to concentrate on growing cash collections, leveraging our associate talent, more effectively optimizing our collection capacity, and improving operational efficiency.

I will now provide a review of our financial performance for the second quarter ended June 30, 2008. Second quarter 2008 cash collections dropped 0.03% to $95.2 million compared to $95.4 million in the year-ago period. Call center collections declined 6.1% to $42.2 million or 44.4% of total cash collections. Legal collections continued to increase in aggregate and as a percentage of total cash collections, rising 5.4% to $39.9 million and representing 41.9% of total cash collections in the second quarter 2008. Total revenues declined 14.3% to $56.5 million in the second quarter compared to revenue of $65.9 million in the prior year period.

Operating expenses as a percentage of total cash collections improved to 52.2% in the second quarter 2008 from 54.1% in the second quarter of 2007. Year to date, operating expenses were 51% of total cash collections, better by 280 basis points when compared to the first half of 2007.

Net income for the second quarter of 2008 decreased to $2.1 million or $0.07 per fully diluted share compared with net income of $8.3 million or $0.24 per fully diluted share in the prior year quarter. There were two primary factors which contributed to the decline in second quarter profitability: one, an increase in the amortization rate to 41% versus 31.3% in the second quarter 2007; and two, the impact of interest expense resulting from increased levels of borrowing subsequent to last year’s recapitalization transaction.

On the supply side, our purchasing increased substantially from the year ago period. The current macro environment resulted in improved supply based softening in the broad economy leading to increase charge-offs. The increase in charge-off availability coupled with lower demand resulted in attractive pricing and increased purchasing activity for the quarter. During the second quarter, we invested a record $65.3 million in 52 charged-off consumer receivable portfolios with an aggregate face value of $1.9 billion for a blended rate of 3.38% of face. During the same period last year, we invested $37.6 million to purchase consumer debt portfolios with a face value of $1.1 billion for a blended rate of 3.39% of face value. Although the blended rate is virtually the same, the mix and quality, are representative of a more favorable pricing environment. Included in these purchase totals were 31 portfolios with an aggregate face value of $308.3 million purchased at a cost of $19.7 million or 6.41% of face value, which were acquired through 12 forward flow contracts.

Now, I’ll discuss key industry trends and observations as we enter the second half of 2008. As we move into the second half of 2008, the US economy continues to show signs of sluggishness. Reduced availability of credit, falling real estate values, higher food and energy prices, and increased unemployment 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. Credit card delinquencies in the first quarter of 2008 continue to rise according to Federal Reserve Board statistics of the largest 100 commercials banks on a non-seasonally adjusted basis. The delinquency rate on credit cards increase for the third straight quarter to 4.79%. We believe increases in delinquency rate experienced by major credit card issuers will also lead to an increase in supply of receivables available for sale. Although these underlying fundamentals may have a positive impact on the supply charged-off receivables for sale in the coming quarters, a net positive for debt buyers, we are also seeing downward pressure on disposable income which in the past might have been used to pay down outstanding credit. The result is a more challenging collections environment illustrated by the slowing in our cash collections reported in the second quarter 2008 when compared to the prior year period.

Furthermore, we believe that our robust purchasing activities over the last several quarters has contributed to our slowing of cash collections because purchasing has outpaced our staffing of account representatives to collect on this newly acquired paper. As indicated last quarter, we are addressing this issue by forwarding more accounts to our agency network per collection on our behalf. Ryan will discuss the initiatives surrounding our capacity management in more detail shortly.

As we noted in our first quarter call, the impact of the $150 billion fiscal stimulus package on our collection’s performance was likely to be minimal. As consumers began receiving cash rebates in amidst of significant food and energy cost inflation, the overall effect of the stimulus on consumer spending turned out to be muted as it appears consumers funnel the large proportion of those rebates into purchases of basic necessities. We believe that the stimulus checks had very little direct impact on our collections during the second quarter.

Overall, the pricing environment continue to show modest improvements in the second quarter of 2008, although the rate of decline in pricing slowed from what we saw on the fourth quarter 2007 and the first quarter of 2008. However, we continue to believe that prices remain at elevated levels compared with the lower prices that existed in the 2000 to 2002 time period.

Given macro concerns regarding levels of consumer liquidity and the expectation of a decline in consumers’ ability to repay their current obligations, certain issuers may be inclined to sell more portfolios to improve their cash position, thus increasing the overall supply of available portfolios in coming quarters. In addition, we continue to believe that some competitors are experiencing their own liquidity issues resulting in a reduction in their ability to fund portfolio purchases. We are pleased with our level of debt purchasing in the second quarter and through the first six months of the year. The supply side of the business continues to improve as charged-off rise in response to more difficult economic times. We continue to be opportunistic but selective in our approach to purchasing charge-off debt and quite frankly, we have been looking forward to this type of purchasing environment.

We expect to capitalize on the robust supply of charge-off debt as we execute on our proven collection strategy over the next several years while adjusting our collection tactics and operation to address today’s more difficult collection environment.

Finally, let me say a few words about the leadership transition we announced this morning. After almost three decades in this business and a lot of hard work in building our company, the time has come for me to step back and allow a new leader to take the reign at Asset Acceptance. As we announced in the release, I will move to the nonexecutive chairman role and Rion Needs will become President and CEO effective January 1, 2009. The board and I have the greatest confidence in Rion given his significant experience in leading transformations at American Express as well as the leadership he has shown in implementing new programs, technologies, and strategies here at Asset since joining us a little over a year ago. I will remain as Chairman of the Board and will continue to share my experience and guidance with Rion in the senior leadership team as they strive to take AACC to new heights. On a personal note, it has been an honor and extremely rewarding to lead Asset Acceptance as we have grown from a staff of 10 to more than 1600 employees, transition to a public company, achieved revenues in excess of $250 million, and become a leader in the accounts receivable management industry. We have accomplished a lot in 29 years. I also believe there is significant opportunity in the future. The time is right for this transition, but more importantly Rion is the right person to take us to the next level.

With that, I’d like to turn it over to our current COO and future President and CEO, Rion Needs.

Rion Needs

Thank you, Brad, and thank you for your kind words. Before I begin my formal comments I’d like to share with you what an honor it is to have been selected to become the new President and CEO of Asset Acceptance. With my past experience in finance operations and business transformation, I feel I have a lot to contribute to my new role and I am excited to hit the ground running. Over the last year, I have seen our operations first hand and know where we are successful and know where we need to focus. The leadership team and I are committed to the success of our company in realizing our vision of returning value to our creditor of economy. Brad you’re certainly leaving me with big shoes to fill but rest assured I will do my best to live up to those expectations.

Today, I will provide an update on several key operational initiatives which I touched on last quarter that remained top priorities for our team, as we look ahead to the remainder of 2008. During the second quarter, our senior leadership team continues to focus on how best to leverage the people processes and tools available to us to generate increased efficiency, operational excellence and continuous improvement throughout our organization. We continue to work on our overall capacity utilization and inventory management to generate improved results.

Last quarter, we discussed the capacity constraints we are facing in core collections and the need to increase our overall capacity. In order to optimize our capacity, we completed a comprehensive review of our existing inventory and aligned it with our available resources to ensure optimal collections at the most advantageous margins. As indicated, we lack sufficient internal resources to liquidate our existing portfolio at expected range requiring us to expand our overall capacity. Due to the ongoing pressure of acquiring and retaining skilled collectors and the associated lead time to train and develop those resources, we elected to immediately expand our external relationships providing the greatest speed to market in increasing our capacity.

Although at present, we are significantly below our optimal internal capacity, the marketplace has the necessary resources to quickly bring our capacity level where we needed to be. Maintaining a robust and effective internal or external partner network is a critical component of our overall capacity management process that in the future will allow us to efficiently manage the fluctuations in our inventory level.

However, in the long term, we will continue to balance the internal and external utilization rate through the effective management of account representative retention and recruiting. As a result of our outside agency network expansion, other collections consisting of primarily agency collections rose to $13.1 million or 13.7% of total cash collections. With the placements made in the first half of the year and scheduled placements coinciding with our purchasing forecast for the balance of the year, we anticipate other collections will continue its growth while we continue to build our internal capacity allowing us to meet collection expectations.

Unfortunately, a combination of the economic environment and the lead time necessary to transfer these accounts through our external partners and begin robust collections contributed to some of the impairments we experienced in the second quarter. We believe that rightsizing our capacity will have a positive impact on avoiding impairments in the future. It’s important to note that our expectations for margins on external collections are in line with our internal collections target and that we have identified external partners with the skills and expertise to successfully execute the strategy.

In June, our strategy met our initial expectations for collection on the initial wave of accounts that were outsourced. Still, we will have more telling and challenging goals in the months to come. During the quarter, account representative productivity on the fulltime equivalent basis declined 7.9% when compared to the prior year period.

This reduction in productivity was also expected as we indicated in our first quarter call as we rationalized our portfolios in shifted accountable way from the call center to the agency forwarding channel having the anticipated impact reducing productivity in the call center representative. Capacity planning and productivity remained key areas of focus for a team over the near term, particularly as we seek to properly align or properly allocate the human resources necessary to collect on our substantial inventory of charged-off receivable

As we work to better align our existing collection staff with our account inventory, we anticipate in the short term that the elevated volume of accounts directed for the agency forwarding channel will continue. As a result, we will likely see further negative impact on our account represented productivity metric over the coming quarters. However, we believe this approach will generate increased cash collection on our portfolio. I will provide you with further updates on the progress we are making in this area in the coming month and quarters. We are on the correct path but it will take some time and effort to get there.

As before, our senior team is committed to creating a highly engaged and skilled workforce that will allow us to capitalize on existing and future market opportunities. We continue to work aggressively to improve the level of training at greater system and career development options for all our associates. We are actively engaged in leadership development initiative that we believe will reduce turnover and increase retention of our associates.

Ultimately, our goal is to become the employer of choice in our industry and the markets we operate in, understanding that the investment we make in human capital will paid dividends through expanded capacity, productivity, and efficiency but we will not just go out and hire people on mass to artificially solve our capacity problem as this could have a substantial negative impact on results. We must improve our training and retentions while simultaneously leveraging other partners and resources to optimize collections on our portfolios.

We continue to move forward on a broad set of initiatives geared toward improving our processes and associated quality. As mentioned last quarter, we have created a reengineering organization that will identify, evaluate, and implement projects across the enterprise. As we previously discussed, one of those initiatives was aimed at better matching our legal collections and associated expenses. That program is operating as designed and is significantly contributing to our cost to collect improvement – the cost to collect improvement we are experiencing and will continue to pay dividends as a program continues to ramp up.

As I outlined in previous quarters, another area of strategic focus where the entire senior leadership team surrounds the implementation of advanced tools and technologies to help us become increasingly efficient and competitive in the marketplace. During the second quarter, we implemented the first phase of our platform conversion. The new platform will effectively eliminate our legacy system, replacing it with a new state-of-the-art Windows-based collection system. The new system includes enhanced capabilities and data management and data mining to increase the effectiveness of our collections representatives. It is also a much simpler and intuitive system that reduces training requirement and increases productivity which we anticipate will have a positive impact on employee retention. We will continue to face implementation of new platforms throughout the company over the next year based on these successes.

With that, I will hand the call over to Mark for a detailed review of our second quarter financial results.

Mark Redman

Thanks, Rion. This morning, I will review our second quarter 2008 financial results and metrics, provide a discussion on impairments and revenue recognition, and finally I will end with our liquidity and capital structure.

Starting with an overview of the financial results, in the second quarter, total cash collections declined $200,000 or 0.3% to $95.2 million compared with cash collections of $95.4 million in the second quarter of 2007.

Traditional call center collections for the second quarter decreased 6.1% from the year-ago period to $42.2 million, representing 44.4% of total cash collections for the quarter compared to 47.1% of total cash collections in the prior-year period.

Legal collections grew 5.4% versus the prior year second quarter to $39.9 million, representing 41.9% of total cash collections versus 39.7% of cash collections in the year-ago period.

Other collections, including agency forwarding, bankruptcy and probate, increased 3.8% on a year-over-year basis to $13.1 million, accounting for the remaining 13.7% of cash collections during the second quarter 2008 compared to 13.2% of total cash collections in the second quarter of 2007. The growth in other collections continues to be driven primarily by increases in agency forwarding collections; that is, cash collections from third-party collection agencies working accounts on our behalf.

During the second quarter, we generated total revenues of $56.5 million, down 14.3% from $65.9 million in the same quarter of 2007. I will go into more detail on revenue shortly.

Total operating expenses improved 3.9% to $49.7 million in the second quarter of 2008 compared to total operating expenses of $51.7 million in the year-ago period. Total operating expenses were 52.2% of cash collections in the second quarter of 2008 compared with 54.1% in the same period of 2007.

We saw across the border improvements in operating expenses compared to the year-ago period. Salaries and benefits improved $300,000 or 1% to $20.7 million compared to $21 million in the year-ago period. Reduced salaries and benefits costs reflected increasing portion of our cash collections coming from outside agencies and attorneys.

While discussing salaries and benefits expense, let’s move to account representative statistics for a moment, starting with productivity. Collections per account representative declined 7.9% to $45,538 in the second quarter of 2008 compared with collections per account representative of $49,458 in the year-ago period. We believe the drop in productivity was the result of the capacity planning and strategic outsourcing that Rion previously mentioned combined with the more difficult collections environment.

For the second quarter 2008, we had an average of 939 account representatives on our team on a full-time equivalent basis, of which 496 or 52.8% of the total had one year or more of experience compared to 584 account reps or 62.8% of the total in the second quarter of 2007. During the second quarter of 2008, collections expense fell $600,000 or 2.4% to $23.1 million compared to $23.7 million in the prior year period. Fees paid to contingent collectors, both agencies and attorneys, increased by $1.1 million in the second quarter of 2008 versus the second quarter of last year. Our collections from these third party relationships increased to 29% of total cash collections in the second quarter versus 24.9% in last year’s second quarter. The remaining expenses included in the collections expense declined by $1.7 million in the second quarter of 2008 compared to the same quarter last year. We had a $2 million decline in legal costs excluding legal foreign fees in the second quarter compared to the year-ago quarter. That was offset by a net $300,000 increase in mailing and other data provider costs.

Occupancy costs declined $400,000 or 16.4% in the second quarter 2008 to $1.9 million compared to the year-ago period. Occupancy costs decline primarily to the closing our call centers in White Marsh, Maryland and Wixom, Michigan during the second half of 2007.

Administrative expenses decreased $300,000 or 10.1% to $3 million from the second quarter of 2008 compared to $3.3 million in the prior-year period. In the year-ago period, we recognized an extra $500,000 share-based compensation charge related to the expanded anti-dilution provisions of our equity based compensation plans.

Interest expense was $3.3 million during the second quarter of 2008 up from $1.1 million dollars in the second quarter of 2007, largely as a result of the recapitalization last summer, and increase borrowings to purchase paper. Average borrowings on our credit facility in the second quarter were $178.8 million dollar compared $56.7 million in the second quarter of 2007. Company reported net income in the second quarter of 2008 of $2.1 million or $0.07 per share compared with net income of $8.3 or $0.24 per share in the second quarter of 2007.

Next, I will discuss revenue, impairments, and portfolio amortization. Second quarter purchase receivables revenue, our primary source of revenue, decreased 14.2% to $56.2 million compared to $65.5 million in the year-ago period.

Net impairments for the quarter were $5 million versus a net impairment charge of $5.1 million in the second quarter of 2007. As you will recall, net impairment charges are in effect amortization and therefore reduced revenue and the carrying value of purchased receivables.

The amortization rate for the difference between cash collections and revenue increased from 31.3% in the second quarter of 2007 to 41% in the second quarter of 2008. This increase in the amortization rate resulted in a lower proportion of cash collection being recognized as revenue during the current quarter. In fact, the impact of the 9.7% higher amortization rate on pretax income was $9.1 million.

Let me turn for a moment to the amortization in the impairments taken in the second quarter, but first a couple of big-picture thought. First, as we discussed on previous earnings call, the biggest factor impacting amortization rate is the multiple of purchase price collected on our purchase receivable. Multiple has come in recent years as a result of the elevated pricing environment which is less the higher overall amortization rate. Secondly, impairments are not always indicative of poor overall performance on the pool or in our overall collection. In fact, overall collections can meet or exceed expectation but we can still recognize the impairment when the collections don’t come in sufficient amount from the right pool.

And to the details for quarter, it is important to note that $4.5 million of the impairment came from two aggregate portfolios acquired in 2005 and 2006 which about to perform the original expectation. Due to stronger performance on this pool, yields were previously increased to reflect the higher overall expectations. During the quarter, we saw decline in actual collection results from expected collection, due in part, we believe, to macro-economic factors and capacity issue. The impairment on each aggregate portfolio, that is the Q4 ‘05 and Q1 ‘06 portfolio, is approximately $2.5 million. The Q4 ‘05 aggregate pool originally had a monthly yield assign of approximately 4% and overtime it has been raised to approximately 5.5%. The Q1 ‘06 aggregate pool was initially assigned a yield under 3% monthly but has been raised to over 6%.

In the second quarter, we saw a decline in the performance of these portfolios in large part due to the increasing difficult collections environment brought about by the weakening economic conditions which may reduce collection results in all vintages of paper.

We believe the performance in the second quarter was further affected by capacity issues which Rion discussed earlier that may be impacting collection result on older vintages of paper as our capacity constrain the account representatives work more recently acquired portfolio. Given the current collection environment, we are being cautious when we assign yields to new pool consider adjusting yield of first when recognizing impairments and reversals. I was pointing out that we would proactively to recognize impairments on two aggregate pools, the Q4 ‘05 and Q1 ‘06, now, in the hopes of heading off potential of larger impairments in the future. Outside of these two specific portfolios, giving rise to impairment charges, our net impairments were nominal.

After recognizing relatively minor net impairments in each of the last two quarters after improving our cash collection forecast modeling in Q3 of 2007, some may be surprised by the level of impairments recognized by us this quarter. First, as I just said, we moved the aggressively to recognize impairments on the two aggregate portfolios given the current collection environment in the recent trend in collection performance on these pools. Of the capacity planning that Rion has outlined, may result in reversing the current performance trend. It will take sometime for that planning to be in full swing and therefore we believe it was prudent to move quickly and decisively to recognize these impairments.

Second, our cash collection forecasting models are based on historical trends. As I said before to the extensive actual results vary negatively and timing or amount from the historical pattern, we are at risk for recognizing impairment. That being said, I continue to have confidence in overall cash collection modeling in the improvements that we made last year. However, we continue to refine the model and seek ways to more accurately forecast cash collection.

Collections on zero basis pools, or fully amortized pools, decreased 7.1% to $20.3 million in the second quarter of 2008 versus $21.8 million from the second quarter last year. Factoring out zero basis collection, the core amortization rate for the second quarter 2008 was 52.1% versus 41.1% in the prior year quarter.

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

For the second quarter of 2008, adjusted EBITDA increased by 3.3% to $46.7 million when compared to the second quarter of 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.

Turning to our balance sheet, as of June 30, 2008 our cash and equivalents balance was $9.2 million compared to $10.5 million at December 31, 2007. The carrying value of purchased receivables as of June 30, 2008 was $355.6 million, up slightly from $346.2 million at December 31, 2007. As of June 30, 2008, we had drawn $41 million on our $100 million line of credit, a decline of $1 million compared to the balance at the end of the fourth quarter.

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

Question-and-Answer Session

Operator

Thank you. (Operator instructions) Our first question comes from Mark Hughes with SunTrust.

Mark Hughes – SunTrust

Thank you very. To what extent did not transition the more agency collections hurt your performance in the quarter. I think you’ve alluded to it. Did you try to calculate any rough numbers?

Brad Bradley

Mark, actually you witnessed so much the movement. It was the end of capacity of our existing recourse [ph] level that caused us not to get as much cash collections as we had hoped. We just hit the saturation point and then the lead time to push it out. So we didn’t specifically quantify what that number was.

Mark Hughes – SunTrust

Okay. What has been the trend lately as you’ve pursued these agreements – the commissions that you’re paying, I think, you said that the profitability on these collections was comparable to your norm. How have the commission rates been in this kind of alter [ph] market, tough collections, how much are these agencies charging?

Brad Bradley

Yes. They are holding steady right now. We aren’t seeing inflation but there clearly is pressure as new charge-offs are hitting the market. We are seeing some discussions and pressure but he haven’t seen anything flow through in our current agreements that is causing that. And obviously, there is a wide spectrum in the cost associated with those fees depending upon the type of paper. If you are pushing out past ad [ph] versus fresh paper, there are different pieces associated with it relative to the amount of work that needs to be applied to each of those paper values. So it’s a wide average and we are not seeing it dramatically change.

Mark Hughes – SunTrust

Do you feel like the capacity out there is constrained to do this kind of work?

Brad Bradley

Right now, we’re not. And that is one of things that we really focused on as we rationalized our existing network. We brought on to new resource, a new partners, and we really focused to place better volumes of more predictable placements and higher paper values to really lock in the partners that we are using and ensure that we get our fair share of that capacity. So right now, we are not seeing of that. That is why we are monitoring closely to make sure we don’t become impinged by more volume in the system.

Mark Hughes – SunTrust

And finally, any thoughts in terms of your outlook for amortization in the next few quarters?

Mark Redman

I’ll go the tagline that we use from time to time that we don’t give guidance but certainly amortization rates have come up in recent quarters and frankly, over the last several years, they’ve been generally increasing. When we look at the source of our collections now, the majority of our collections are coming from the period of time of a higher priced environment. So beginning as early as 2003 but certainly as 2004 when prices began to rise up through the middle of 2007, so with the higher prices, we are expecting a lower multiples on the purchases. Unfortunately, like I said, the majority of our collections are coming from that time period now. Hopefully over time, with the improved pricing environment that we’ve seen since the middle of 2007 and continue to see and hopefully we continue to see for as long as possible. At some point in time, I would expect that we’ll see some improvement in the (inaudible) amortization rate. Offsetting that unfortunately is difficult collection environment too, so there are so many different factors that can impact that amortization rate. But when a greater proportion of our collections are coming from the lower priced portfolios and the multiples of purchased price go up, because of that or because of improving collection environment, we’ll begin to see better lower amortization rates.

Mark Hughes – SunTrust

That is helpful, thank you.

Operator

Our next question comes from Hugh Miller from Sidoti & Company.

Hugh Miller – Sidoti & Company

Hi, good morning.

Brad Bradley

Good morning, Hugh.

Hugh Miller – Sidoti & Company

We are just wondering – some of your peers had mentioned that they were seeing a little bit of a shift in payments in full to payment plans. I was wondering if that was something that you guys were experiencing as well.

Brad Bradley

Yes, we absolutely are. In these economic times, we obviously continue to lead, we are seeking payment in full but more work to payment plans constructively to assist debtors in resolving their outstanding debt in difficult times. So we are seeing a shift in that.

Hugh Miller – Sidoti & Company

Is it more than just a shift in the duration of payments received and not necessarily a shift in the overall amount of collections or are you seeing adjustment there as well?

Brad Bradley

Can you say that again?

Hugh Miller – Sidoti & Company

I was just wondering if it’s just a shift in the timing or if you are noticing just a reduction in overall collections as well?

Brad Bradley

No. Right now, we are just seeing it in timing, just really putting it more into the payment plans and elongating some of those payment plans.

Hugh Miller – Sidoti & Company

Okay. I was wondering if you could give a little color on the types of receivables that have impacted the ’05 and ’06 payments, were they telecom or credit card, or what they may be?

Brad Bradley

First of all, these are both aggregate pools, so they would include the vast majority of all of our purchases in each of those quarters. I don’t have the exact portfolio that make up the aggregate pools at my fingertips. But my recollection is that they are largely –or majority of the pools are made up by traditional type paper, the credit cards as opposed to any sort of a non-traditional paper that's like we saw in the Q1 ‘05 through Q3 ‘05 timeframe that is well documented the difficulties of our telecom. I mean, these are actually good performing pools and we’re very pleased with the overall performance. Unfortunately it slowed a little bit in this quarter and we thought it was prudent to recognize these impairments.

Hugh Miller – Sidoti & Company

Thank you for the color there and just looking at the expense trend, obviously, you guys are trying to improve expenses as relation to collections and did see an uptick on sequential basis. Obviously, some of that may be driven by just the timing of collections and so on. But I was wondering what the goal is really on a longer term basis to really get that down to – for the overall expenses in relation to collections?

Brad Bradley

Yes. Definitely, the timing of collections in the second quarter is what spiked that up a little bit from the first quarter. But, from a target – we haven’t set a specific target but clearly we want to be clearly south of 50% to collect, and obviously down to the most efficient level that we can be without negatively impacting our collection. So we believe we still have significant room and with the implementation of our new platform, we believe that is going to pave the way to making some significant improvements as well.

Hugh Miller – Sidoti & Company

Okay. Have you guys given any consideration to possibly implementing the offshore collection, some of your peers have started and looked into?

Brad Bradley

We have. We utilize today actually with some of our third-party partners, offshore resources. We have taken a little bit of a look into some of the offshore facilities from a proprietary or joint venture perspective as well to hold on to that. I might have actually a lot of experience in my former work in developing offshore capabilities, in fact started in 1994 in India, and so we will continue to place emphasis and effort there. But some of that, the labor arbitrage is definitely growing up very quickly. Over the last six years, seven years of my experience, they have actually been increasing wage inflation at a clerical level to the tune of about 13% to 16% annually, so that gap in labor arbitrage is evaporating fairly quickly but it is still a viable mechanism for us, a channel and we will be exploring that more aggressively.

Hugh Miller – Sidoti & Company

Okay. Great color there and just I guess as the last question. You guys have mentioned in the past and given us just a little bit more color on the pricing environment, what you’re seeing. You did mention that pricing did improve during the quarter but may be at a slower pace but had alluded to that pricing is obviously much higher than it was on the last cycle back in 2000-2002. Can you give us your thoughts on whether or not you anticipate that we could actually see pricing head that low or is that really more of a distant possibility? Any color there would be great.

Mark Redman

Sure. I think the way that the purchasing market, the purchasing industry has evolved in recent years that pricing at the 2000-2002 levels is probably more of a distant possibility than an expectation. Having said that, we’re in a market right now where the pricing is attractive and I believe that there is room for further contraction in pricing as more supply continues to come into the purchasing channels. Certainly, the collection environment is challenging right now but collection should hold their own as we continue to execute on our long-term business model and when the economy improves, we’re going to be in a position where we have invested in attractively priced portfolios and really stock piled inventory and based on our long-term strategies, I would expect collections despite with an improving economy. So pricing is attractive. I think there is room for further improvement as far as decreases in pricing and we’re going to continue to be selective and opportunistic as we do our diligence on all the portfolios that become available to us.

Hugh Miller – Sidoti & Company

Okay. Thank you so much and I guess one just final question; I’ll head back into queue after that. You guys have mentioned obviously that you have initiatives there to try and bolster the account rep productivity through training and career development and so on. Any commentary you can give there on what you’re seeing from those efforts and what time period you might anticipate that you would then start to increase your staffing levels. Obviously right now, you’re using the outsourced capacity there but when you might look to start to ramp up internally.

Brad Bradley

It's a great question. What are we trying do is, really there is two pieces there associated with it. One is retention and we obviously want to improve retention rate before we go out and try to bring on significant incremental staff, right. Because from margin perspective, if we are churning those over at a very rapid rate, then we are just adding to our cost base and not increasing our collections or productivity associated with it. So we want to get that right, which we’ve targeted a number of issues around employer of choice, around leadership development, and all that which we are seeing pay dividends now. We are seeing modest increases in our retention rate through the first half of the year. We’ve got a lot of focus and energy on that. We expect to start ramping up those internal resources as we continue to improve retention, so that is targeted really for the back half of this year. We would hope to get that markedly improved.

And the second is productivity. In productivity will obviously come as we retain people on a longer term basis. But it also comes specifically from our initiatives around our platform conversion. And so that is targeted to be completed over the next year and that is when we start or believe we will start to see really significant uptick in productivity.

Hugh Miller – Sidoti & Company

And so will it be likely that you guys possibly could be increasing headcount with more of an emphasis as we head into 2009?

Brad Bradley

Yes.

Hugh Miller – Sidoti & Company

Okay. Great, thank you.

Operator

John Neff from William Blair has our next question.

John Neff – William Blair

Hi, thanks. And first, congratulations to Brad and to Rion.

Brad Bradley

Thanks, John.

Rion Needs

Thanks, John.

John Neff – William Blair

Probably a question for Mark, in the adjusted EBITDA calculation, can you explain change to balance of purchased receivables?

Mark Redman

Sure. That is the amortization, impairment, and revenue compared with the other item that's called – non-cash revenue, I think, is what we call it.

John Neff – William Blair

Okay. Adjusted EBITDA year to date is up 8%, free cash flow year to date is down 52%. Which do you think is a better performance gauge?

Mark Redman

We have always looked at the adjusted EBITDA because it gives us a idea of what we are able to reinvest in paper really, whereas the free cash flow I think as you referred to it number already has the cost of the paper taken out.

John Neff – William Blair

Correct. I was just looking at it from the standpoint of cash numbers plus CapEx.

Mark Redman

Plus CapEx. They’re both healthy numbers as they were able to reinvest the paper. The metric we've always used I think is the adjusted EBITDA number.

John Neff – William Blair

It’s the number of you can reinvest in portfolios?

Mark Redman

Yes and you’re right. It does fix the asset acquisitions need to come out of there also. As I stated, we also have to pay income taxes and service debt from all of that, but we’ve always targeted the adjusted EBITDA number as the key metric for us to look at.

John Neff – William Blair

Can you give us an update, what portfolios are on cost recovery besides healthcare? (inaudible) – for example, are the 2007 and 2008 to date, are those purchases all on cost recovery or are they still typically on interest method?

Mark Redman

No. They are typically – 2007-2008 calls typically on an interest method other than the healthcare portfolios.

John Neff – William Blair

Okay.

Mark Redman

There are probably some other minor smaller purchases that we’ve made that we don’t have a reasonable basis to estimate collections that were also beyond full cost recovery basis but nothing significant. At the current time, the most other significant portfolio that's on full cost recovery is the Q1 ‘05 aggregate pool.

John Neff – William Blair

Q1 ’05. Okay. All in I guess, if we were to look at your NFR balance, for example, what percentage of that roughly would be on cost recovery?

Mark Redman

I think it is in the 6%, 7%, 8% range. It is a disclosure in our 10-Q. So we will try to look that up and find it for you.

John Neff – William Blair

Okay. You said about the use of agency collections, just from a long-term perspective, do you want to use – see more of your overall cash collection mix coming from outsourced collection and also can you give us a sense for what sort of order of magnitude do you look to increase your capacity of AVN [ph] 2009 or beyond?

Mark Redman

It is a great question, John. From a balance perspective, we always want to have a robust external network. From this standpoint, we always want to be able to be opportunistic in purchasing levels and to be able to acquire paper that we know we can liquidate by having a strong network that we can go to without having to try and ramp up resources on a short-term basis. But we want to get that to an optimal mix that we’re not at today. So our goal would be to get that more that into an 80/20 type of situation where we can take the fluctuations in the market place and pricing and supply of paper, and take those fluctuations with the external partnerships. From a ramp up perspective, we would like to – again a lot of it has to do with what our purchasing forecast is going to be. But right now as we look at our purchasing, I would tell you we want to add probably to the tune – to get that 80/20. Right now, it is probably about 500 reps or so.

John Neff – William Blair

About 500.

Brad Bradley

So a significant amount.

John Neff – William Blair

Yes.

Brad Bradley

We have a lot of opportunity, John.

John Neff – William Blair

Yes. That certainly is a statement for what you expect from the purchasing level, 500 over one year or two years?

Brad Bradley

Probably a year or two and that is why we want to do it in a very controlled fashion, again, so that we can maintain productivity. And with the retention rates that the industry has, we are obviously trying to improve that dramatically but we want to control that growth rate which is why we want to leverage the external partners because it gives us the highest degree of efficiency while maximizing the opportunity.

John Neff – William Blair

Great. And Mark, quick housekeeping, I just missed the mix of collectors one-plus year and less than one year.

Mark Redman

To answer your other question about the carrying value under full-cost recovery, it is about $17.8 million or 5% of the carrying value as of June 30. The housekeeping, we had during the second quarter an average of 939 total FTEs, 496 for greater than year, 443 for less than a year.

John Neff – William Blair

Thank you very much.

Mark Redman

You’re welcome.

Operator

Our next question comes from Rich Shane from Jefferies & Co.

Rich Shane – Jefferies & Co.

Guys, thanks for taking my questions. A couple of things here. You’d mentioned that you didn’t really think that there was any impact from the tax stimulus checks. Did you do anything tactically to take advantage of this? One of your competitors had mentioned that they basically saw collection enhancement of about one-plus percent by my calculations related to very targeted mailings by zip codes related to timing of tax stimulus checks. Did you do anything similar to that?

Rion Needs

We did and we didn’t – when Mark made that comment, we didn’t say or Brad may – we didn’t say that there were no impact. We do not have it at the level we were expecting when the original stimulus was announced. I mean, we just saw a drop off from what our original expectations, so we did see some impact and, yes, we had a number of targeted focuses. We did zip code sorts based on when the stimulus checks were being mailed out by the IRF. We dropped the number of letter campaigns, specifically targeted both language and timing around maximizing our opportunities. We built call pools, dialing pools around the same timing in the letters, so that we reinforced with call volume right after letters hit, associated with them. So we had a very robust plan around capturing that opportunity and we did see some improvement. It just was not nearly to the volume we expected to be able to capture based on the change in the overall economic environment as they got released.

Rich Shane – Jefferies & Co.

Got it. That’s very helpful. Thank you for clarifying that. Second question is when you’d made the comment that basically there was collections pressure during the quarter related to capacity issues and when we look at the purchase volumes over the last three quarters, there was a spike in the fourth quarter though was not unusual, was in line with fourth quarter of '07. Q1 of this year was actually very much a trough in terms of purchase volume and then you did see an increase in Q2. I’m curious what created the bottleneck, was it the Q2 purchasing volumes and did you see this coming strategically? How did you get in the situation where you basically apparently bought too much in context of your ability to process the loan volume or the paper volume?

Rion Needs

Yes, this was a historical problem that predated even the fourth quarter or this year. As we discovered it and identified it near the end of last year, we recognized as you look at our historical purchasing from 2006 forward, our traditional call center because the capacity issue is in our traditional call center environment, it is not in our legal environment. So, you actually have to breakdown those numbers as far as collection reps between those two channels. What you find is that we had basically a deteriorating number of collectors with an ever escalating inventory base. As so, it was something that we actually brought forward from the past that we resolved. And then obviously, the spike in the second quarter is going to add some additional weight behind that, that we’ve already factored in through our placement strategy and our work with our outside network.

Rich Shane – Jefferies & Co.

Great. Rion, thank you very much, appreciate the answers.

Operator

Our next question comes from Justin Hughes with Philadelphia Financial.

Justin Hughes – Philadelphia Financial

Thanks for taking my question. I am just curious on our debt capacity. Earlier this year, you were paying down a lot of debt and generating cash. Now you are taking the debt back up and using cash. What is maximum leverage? Because I have in my notes your maximum leverage was 1.25 to equity but you’re above that now.

Mark Redman

The constraining factor should be the consolidated indebtedness as defined to adjusted EBIDTA which I think we are closer to 1.07 on that metric right now. So there is a little bit north of 30 million of capacity as of June 30.

Operator

Thank you. And that is all the time we have for questions today. At this time, I’d like to turn conference over to Mr. Brad Bradley. Please go ahead, sir.

Brad Bradley

Thank you, operator. In summary, we are pleased with the progress we made during the second quarter in spite of the challenging market conditions and difficult collections environment. We move to improve our overall capacity management 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 roll out a series of processed reengineering and systems-related initiatives designed to increase the efficiency and the competitiveness of our people in the marketplace over the long term. Overall, it was a challenging quarter but full of operational bright spots. We remain grateful for the support and commitment of our employees, 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 third quarter 2008 conference call. Good day.

Operator

This concludes today’s presentation. Thank you for your participation and have a wonderful day.

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