Seeking Alpha
We cover over 5K calls/quarter
Profile| Send Message|
( followers)  

Portfolio Recovery Associates, Inc. (NASDAQ:PRAA)

Q3 2012 Earnings Call

October 30, 2012 5:30 p.m. EDT

Executives

Steve Fredrickson – Chairman, President and CEO

Kevin Stevenson – EVP, CFO and Chief Administrative Officer

Neal Stern – EVP, COO

Analysts

David Scharf – JMP Securities

Hugh Miller – Sidoti & Co.

Bob Napoli – William Blair & Co.

Mark Hughes – SunTrust Robinson Humphrey

[Edward Hemminger] – Jaca Investments

Justin Hughes – Philadelphia Financial

Operator

Good day, ladies and gentlemen, and welcome to Portfolio Recovery Associates' third quarter 2012 earnings conference call.

At this time all participants are in a listen-only mode. Later we'll conduct a question-and-answer session and instructions will follow at that time. [Operator Instructions]. As a reminder, today's conference may be recorded.

Speaking to you today will be Steve Fredrickson, PRA's Chairman, President and Chief Executive Officer; Kevin Stevenson, Chief Financial and Administrative Officer; and Neal Stern, Executive Vice President, Chief Operations Officer, Loan Portfolios. We will begin with prepared comments then follow up with a question-and-answer period.

Before we begin, I'd like everyone to please take note of PRA's Safe Harbor language. Statements on this call which are not historical, including Portfolio Recovery Associates' or management's intentions, hopes, beliefs, expectations, representations, projections, plans or predictions of the future, including with respect to PRA's future portfolio performance, opportunities, future revenue and earnings growth, future cash collections, future space and staffing requirements, future productivity of collectors, and future contributions of the subsidiaries to earnings are forward-looking statements. These forward-looking statements are based upon PRA management's beliefs and assumptions and expectations of the company's future operations and economic performance, taking into account currently available information. These statements are not statements of historical facts.

Forward-looking statements include risks and uncertainties, some of which are not currently known to PRA. Actual events or results may differ from those expressed or implied in any such forward-looking statements or as a result of various factors, including risk factors and other risks that are described from time to time in PRA's filings with the Securities and Exchange Commission, including but not limited to its annual reports on Form 10-K, its quarterly reports on Form 10-Q, and its current reports on Form 8-K filed with the Securities and Exchange Commission and available through the PRA's website, which contain a more detailed discussion of the company's business including risk and uncertainties that may affect future results.

Due to such uncertainties and risks, PRA cautions you not to place undue reliance on any forward-looking statements which speak only as of the date hereof. PRA expressly disclaims any obligations or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein to reflect any change in PRA's expectations with regard thereto or to reflect any change in events, conditions or circumstances on which any such forward-looking statements are based in whole or in part.

And now I would like to turn the floor over to Steve Fredrickson, PRA's Chairman, President and Chief Executive Officer. Sir, the floor is yours.

Steve Fredrickson

Good afternoon, and thank you all for joining us. Today we're pleased to report strong financial results for the third quarter. Our Q3 results continued the trend of exceptional performance this year, results that again demonstrated the strength of our business model focused on diverse revenue and earnings from our bankruptcy business, our core debt purchase and collections operations, and our business services subsidiaries. Let me begin with some comments on key highlights of our record Q3 results.

Cash collections, including those in the UK, were $229 million, up 26% from the third quarter of 2011. Revenue was up 32% year over year to a record $150.5 million. Net income increased 31% year over year to a record $33.3 million, translating into diluted earnings per share of $1.96 compared with $1.48 in the third quarter of 2011. Return on equity of 20.3% again exceeded our 20% benchmark in Q3.

We acquired $1 billion in face value of domestic finance receivables for a total purchase price of $94 million in the third quarter. These receivables were 95 defaulted debt portfolios from 12 different sellers. Pricing remains very competitive and has moved higher relative to the first half of 2012.

In the UK, our debt purchase activity remained modest but steadily increased with purchases of smaller and niche portfolios totaling 5.7 million pounds in purchase price during the quarter. We continue to focus on incrementally developing our portfolio of UK debt.

Our strategy to expand legal collections from those who can but won't pay their debt continues to be tracking better than anticipated. We are maintaining performance that will allow us to improve our expected two-to-one payback and the payback timeframe we anticipated. Although our legal collection expenses remain substantially above the same period last year, due to our significant buildup earlier this year, they dropped by 10% or about $2.8 million from Q2 2012. Our bankruptcy business continues to grow and comprised 40% of our total cash collections in the third quarter. In Q3, collections from purchased bankruptcy portfolios totaled $91.1 million, a 22% increase from a year ago.

We experienced a small sequential decline in fee income from our business services subsidiaries. PRA Government Services had a slightly better financial performance in Q3 year over year and better performance in Q2 2012 as we slowly built new sales. Next quarter's results should be better still, benefiting from the usual seasonal strength in this market during Q4.

We also made progress at PRA Location Services versus Q2 2012, even though we are continuing to see automotive delinquencies at historically low levels. Competition remains intense in this market as remaining competitors fight for market share.

Although CCB saw Q3 improvement in performance versus a year ago, we saw a sequential decline in fee revenue. As we mentioned last quarter, CCB has been significantly increasing marketing and sales expense efforts in an attempt to capitalize on several very large cases in the pipeline, including the recently announced Visa MasterCard class action settlement. The team is focusing on adding clients that are potential recipients of these large claims.

In the UK, we continued to make progress on our integration plans. Our UK leadership team has been strengthened by the addition of new executives heading up compliance and legal operations. While fee income from financial institutions and service providers is up, overall fee income fell slightly due to an expected reduction in placement levels from UK debt-buying clients. As our performance levels continue to improve, new client business and greater allocations from existing clients have contributed to increased levels of contingent placements from financial institutions and service providers for three quarters in a row. We expect these volumes to continue to grow and have a positive effect on overall fee revenue.

Finally, regarding our share repurchase program, we made no purchases during Q3, but we continue to monitor market conditions for the program's remaining $77 million.

Next, Kevin Stevenson will elaborate on our financial results, then Neal Stern will have an update on operations. I'll have some closing comments before opening this call to your questions. Kevin?

Kevin Stevenson

Great. Thanks, Steve.

Please note the comparison I'm about to make are between Q3 2012 and Q3 2011 unless otherwise noted. Also recall that our UK business was acquired in 2012 and therefore the results of operations are included in our 2012 but not our 2011 financial statements. Let's begin with our income statement.

Our Q3 revenue of $150.5 million was comprised of $135.7 million in net finance receivables or NFR revenues and $14.8 million in fee revenues. Finance receivable revenue for the quarter was comprised of $90.2 million in core portfolio revenue net of an allowance charge of $700,000 and $45.5 million in bankruptcy portfolio net of an allowance charge of $863,000. Together, these allowance charges amount to less than two-tenths of 1% of the company's total net finance receivable balance at the end of Q3. Net core portfolio revenue increased 37% while net bankruptcy portfolio revenue increased 24%. Finance receivable revenue from our UK operation is included in the core figures I just provided.

Fee revenue of $14.8 million increased 30% and accounted for 10% of the company's revenue. Fee revenue from our UK operations drove the increase.

Operating expenses for the quarter increased on pace with our revenue growth at a rate of 33%. Operating expenses included an $8.8 million increase in legal collection expenses related to our expanded focus on legal collections as well as the inclusion of the UK business in our 2012 financial results. We continue to anticipate court and document costs of $14 million for the fourth quarter, down from $15.8 million in Q3.

Operating income was $57.1 million compared with $43.8 million, an increase of 30%. Operating margin was 38% for the quarter, roughly consistent with the third quarter of 2011 despite the increase in legal collection expenses. Sequentially, operating margin improved from 37% to 38%. Our net income margin was consistent with prior periods at 22%.

Moving on to the balance sheet, cash balances ended the quarter at $31 million. During the quarter we invested $103 million in defaulted debt portfolios. Investment activity was comprised of $62 million in core consumer debt purchases, including investments made in the UK and $41 million of bankruptcy portfolio purchases.

The NFR balance increased to $974 million, up from $919 million. The NFR balance is the amount of unamortized purchase price of acquired debt portfolios recorded on our balance sheet. Principal amortization of finance receivables including net allowance charges as a percentage of cash collections was 40.7% in Q3 2012, compared with 43.5% in Q3 2011.

Our debt-to-equity ratio at quarter-end stood at 37%, down from 46%. The debt-to-equity ratio including net deferred tax liabilities was 65%. The balance in our line of credit was $250 million at September, leaving availability under the line of $114 million, subject to normal collateral and borrowing provisions.

Cash income tax payments for the first nine months of 2012 were $71.5 million, up from $19.1 million during the first nine months of 2011 and $89,000 for the first nine months of 2010. The net deferred tax liability at September 30, 2012 was $186.5 million, down from $192.3 million at September 30, 2011. As a reminder, income taxes are fully expensed as income is earned.

Finally, let me throw out some details on cash collections. Cash collections were $229 million for the quarter, up 26%. Core portfolio collections, including $3.5 million from our UK business, were $138 million or up 28%. This increase was led by growth in legal collections, which increased 50%. Bankruptcy portfolio collections were $91 million, up 22%. Cash collections increased 29% for the first nine months of 2012 compared with the first nine months of 2011.

Let me now turn the call over to Neal Stern.

Neal Stern

Thanks, Kevin. In Q3, our operational results continued the trends that had been in place over the last several quarters. The number of payments we received was up materially over the prior year. Our average payment size remained essentially flat from a year ago, but just as in Q2, we again collected more than $2 million in the quarter. Call center productivity held steady in spite of the year-over-year staffing increases. Our legal collection performance exceeded our expectations and in the UK we continued to strengthen operations. Let me expand on these trends.

The number of payments collected represented a 25% increase over the same quarter in the prior year excluding payments collected in our UK operation. The overwhelming majority, almost 90% of these payments are from customers that have made prior payments to us. This is an important indicator that the payment plans we're setting up with our customers are reasonable. It speaks to our account representatives' ability to find workable solutions to the financial difficulties that many consumers deal with.

Call center cash collections were strong in Q3, finishing 8% higher than the same quarter in the prior year excluding UK collections. Call center cash collections were down sequentially from Q2, which is consistent with the seasonality we've experienced in prior years. Total domestic call center paid hours were up by 16% in Q3 over the prior year. Added hours normally dampen collector productivity, but PRA's increased efficiencies helped to offset much of that effect, allowing us to finish within 2% of the productivity results from Q3 of last year.

Q3 legal collections increased by 50% over the same quarter last year. External legal collections finished 46% higher and internal legal collections were up 56%. Internal legal collections accounted for 39% of our total legal collections. We remain focused on growing our percentage of internal legal collections in the coming quarters while retaining the external firms that are helping to drive our strong results.

Performance from our legal collections channel remained above our internal expectations and continued to benefit from the incremental court costs invested over the prior three quarters. Cash collections from our Q1 incremental investment in court costs are now 27% over our internal expectations. Collections from our Q2 court costs are 11% ahead of expectations, and our Q3 investment in court costs finished the quarter 3% ahead of expectations.

As a reminder, our expectations were to recoup our investments within six to 12 months and to deliver a 200-plus percent return on investment. With nine months of performance results to examine, we can now say with confidence that our incremental recoveries represent an improvement to our longer-term cash collections and are not merely an acceleration of cash collections.

Our models have been and will continue to be updated to accurately reflect that opportunity. Going forward, our investment in court costs are likely to moderate slightly from those in Q3. However, we expect these expenses as a percentage of legal recoveries to diminish over the next year.

Again we continue to only file lawsuits on the minority of accounts where we've attempted to collect in our call centers, identified an asset, and have not been able to compel the account holder to pay. This philosophy is one that we are proud of and currently constrains the population of core accounts selected for legal treatment to approximately 5% of our inventory.

Finally, our work in the UK in Q3 produced positive intangible results for the near term in the area of collector productivity. New calling strategies, incentive compensation structures and scheduling techniques have been implemented. Our work toward producing benefits from improved account scoring and segmentation also progressed but will not yield meaningful results until the second or third quarter of next year. These developments are underscored by a strong emphasis on compliance and internal control in the UK. PRA's philosophy of not outsourcing collection activity or reselling accounts is also being adopted in the UK.

And now, some final thoughts from Steve.

Steve Fredrickson

Thanks, Neal. Before I turn the call over to your questions, a brief comment on last week's consumer financial protection bureau announcement.

As expected, PRA is among the approximately 175 large market participants in debt buying and collection who will be subject to CFPB supervision and examination authority. PRA supports the CFPB's goal of protecting consumers behind on their bills from abuse or harassment. For more than 16 years we've maintained a strong culture of compliance with consumer protection laws, helping millions of customers find an affordable repayment plan that meets their needs within their household budgets and on their time schedule. We're prepared to be included in the CFPB's oversight beginning in January 2013.

Next month we celebrate the 10th anniversary of our IPO. Since going public in 2002 with $13 per share, PRA has generated nearly eight-fold increase for PRAA shareholders, with our stock currently trading above $100 per share. In spite of the economic malaise gripping our country, PRA is performing at record levels, advancing this month to the top 25 of Forbes' Best Small Companies in America for 2012.

I'm particularly proud of the 3,000 jobs we support across the company, which provide good wages and strong benefits, up from less than 600 jobs in 2002. I'm proud of our business mission to provide capital to financial institutions for their distressed loans, to work with customers to fairly and flexibly resolve their outstanding accounts in a compliance-driven environment, and to provide best-in-class results to our business services clients.

PRA stands ready for the challenges of the next ten years and the ten after that, with a management that is second to none, with employees whose professionalism and zeal to excel is demonstrated for our shareholders and customers everyday.

Now, operator, we'll open up our call to your questions.

Question-and-Answer Session

Operator

Thank you, sir. [Operator Instructions].

Our first question comes from the line of David Scharf with JMP Securities. Please go ahead, your line is open.

David Scharf – JMP Securities

Thanks for taking my questions. Steve, I'm wondering if you can give us a little more help in how to think about the trends in yields going forward. And specifically I'm looking at the press release and, you know, the first quote in here that says, as the US economy slowly recovers, more consumers are paying down their debt, resulting in strong arrear collections. You've been very careful during this prolonged recession and slow recovery to kind of dampen any enthusiasm that there's really a material improvement in consumer health and payment patterns. But the combination of that comment in the press release along with what looked like higher revenue recognition this quarter and increased collection multiples, should we read anything about your expectations for overall consumer payment patterns next year?

Neal Stern

This is Neal. I guess the thing that stands out to me, and we've commented on this in the past, is the stickiness of the people who are making monthly payments to us. I commented in my script that it's important for us to find payment plans that work for consumers, but the stickiness of those payers has impressed me over time, and I think that's a good sign for us going forward.

David Scharf – JMP Securities

Okay. And you're referring to the comment that 90% of your payments were sort of --

Neal Stern

Yup. I think a year ago when I talked about this metric last year, it was about 85% of our payments were coming from people that previously made payments. And so that has ticked up modestly. But the fact that it is that sticky, and if you contemplate the kind of accounts that we're buying and the delinquency stage and whatnot, I think it's a very impressive stat.

David Scharf – JMP Securities

Got it. But we shouldn't read too much into perhaps your assessment of more the macro outlook. Is that correct?

Neal Stern

I don’t know that it speaks anything more broadly in terms of the health of the consumer. But it speaks to the fact that we're doing a nice job of getting people on payment plants that work for them. And that obviously has an impact on the tail of our curves. We've talked for a long time about the payments that were one-time lump sum settlements being converted in the monthly payers, and that taking the [tails] out a bit further, and I think that's been evidenced over time since we made that comment originally back in, whatever, late 2008, early 2009.

Steve Fredrickson

I think it also speaks to the quality of the work that's being done on the accounts, and ultimately it helps us hold expenses down as we get a lot of these reoccurring payments and we avoid having a customer talk repeatedly to an agent when that's not required. Clearly it's to our advantage from an expense perspective.

David Scharf – JMP Securities

Okay. Just two other quick questions. One, on court costs, I think on the last call you guided to about $16 million to $18 million this quarter. It looked like it came in at the low end or maybe just slightly below that, it's $15.8 million. I have written down that three months ago you suggested $14 million for the quarter. Is that still a reasonable number?

Kevin Stevenson

Yes.

David Scharf – JMP Securities

Okay, good. And --

Kevin Stevenson

-- very precisely, we're usually in the ballpark. Give me a little cushion there.

David Scharf – JMP Securities

Yeah, I just wanted to get a sense whether or not coming in the low end in the third quarter suggested maybe fourth quarter would be even lower, [that sign].

And then lastly, in the UK, we know there's some kind of regulatory wait-and-see right now on continuous payment of sortie in overall kind of collection regs that the OFT is supposed to rule on imminently. Do you sense that some regulatory uncertainty might be why there were some lower debt placements this past quarter? It sounded like there was less use of third-party contingency agents.

Steve Fredrickson

I think the issue that we're seeing there is that previously, when the company was acquired, we had a strong concentration of contingency work from other debt buyers, and we've had a number of those debt buyers decide that they simply didn't want to do business with the UK operation because it was now owned by another debt buyer. That's not the case with all of our debt buyer clients but with some large ones. And I think that's more the situation that we've seen. Our placements, as we commented, our placements direct with financial institutions have been growing steadily. So it's a trend we expect to continue to see.

David Scharf – JMP Securities

Okay. And I missed the first couple of minutes of the call. Did you provide a figure for how much of the $94 million of capital deployed came out of the UK?

Kevin Stevenson

How much of what?

David Scharf – JMP Securities

I'm sorry, how much of the debt purchasing was in the UK this past quarter.

Kevin Stevenson

5.7 million pounds.

Steve Fredrickson

Yup.

Kevin Stevenson

5.7 million pounds, David.

David Scharf – JMP Securities

Okay.

Kevin Stevenson

That's what -- was that $9 million?

David Scharf – JMP Securities

So, about 10% of your purchasing.

Steve Fredrickson

And again, the $94 million was domestic purchases.

David Scharf – JMP Securities

Oh okay. Got it. Okay. Thanks very much.

Steve Fredrickson

You bet.

Operator

Thank you. Our next question comes from the line of Hugh Miller with Sidoti & Co. Please go ahead, your line is open.

Hugh Miller – Sidoti & Co.

Thank you very much for taking my questions. Just want to start I guess with one housekeeping question. I was wondering if you could provide us with the fee-based business margin dilution from the quarter.

Steve Fredrickson

I don’t have that in my script this quarter, Hugh.

Hugh Miller – Sidoti & Co.

Yeah, you didn't put in last either. I was wondering -- I just find it something that is actually helpful. That's something you might be able to circle around with.

Steve Fredrickson

Okay. Yeah, I just again didn't include it -- you're right, didn't include it last quarter either. Sorry about that.

Hugh Miller – Sidoti & Co.

Right. Yes. So anyway, I'd certainly like to get it if possible.

Another question, just about, you know, it looks like you added 40 collectors this quarter and I think various news agencies had reported that you guys are active on the hiring front and looking to add 250 collectors. But is that -- should we read into anything with that with regards to anticipation of purchasing activity in the fourth quarter and into 2013?

Neal Stern

We usually ramp our hiring in the fourth quarter. We want people trained and ready to go by Q1, which is seasonally our strongest, when we've got the tax returns and whatnot. And we want those people trained and ready to go.

Hugh Miller – Sidoti & Co.

Okay. Okay. And I guess if you could expand a little bit on the dynamics for the quarter. I mean you mentioned how competition kind of heated up a bit relative to the first half, and obviously deployment of capital was a touch lower than what we've seen in the past, but yet you were placing the 2012 vintage, the new purchases on the books, at a higher multiple relative to where they were as of the second quarter. Just trying to wrap my head around that kind of scenario and if you could provide color, it would be great.

Steve Fredrickson

Yeah. I mean we did see deal volume slip this quarter. There was a very large seller that had some very large sales toward the end of Q2 and we didn't see that same type of activity in Q3. So overall there was a pretty measurable drop-off in the overall deal volume that we observed. So we feel as though we got our fair share of what was out there. But as we commented, it was competitive and on slightly offered volume than what you've seen previously.

Hugh Miller – Sidoti & Co.

Okay. And are you getting an indication of an expectation that volumes are likely to remain at these levels, or do you think it's kind of a short-term phenomenon?

Steve Fredrickson

It's difficult to say. There are some sellers who I think have been stepping back, getting their house in order from a regulatory perspective, making sure that their sales process was in good shape with the regulators. And so we may see a little more volume come on from those people as they get comfortable with that. We're also continuing to see some activity with large portfolios of resale in the market. And so when those hit, they can be a real shot in the arm to purchase volume for us. So we continue to watch those closely.

Hugh Miller – Sidoti & Co.

Okay. And one other housekeeping question I had was that I think I caught that you said that call center collections per hour paid were down 2% on a year-over-year basis relative to an increase, 16% increase in hours paid. Is that correct?

Neal Stern

Yeah, that's just -- that's taking out the inbound calls and all the rest. No legal and no inbound calls from our call centers.

Hugh Miller – Sidoti & Co.

Right. Did you provide that data as well on just total cash collections per hour paid as well? I didn't catch it.

Kevin Stevenson

It'll be in the Q.

Hugh Miller – Sidoti & Co.

Okay. Thank you.

Operator

Thank you. Our next question comes from the line of Bob Napoli with William Blair & Co. Please go ahead, your line is open.

Bob Napoli – William Blair & Co.

Hi, everybody. Good afternoon.

Steve Fredrickson

Hi there.

Bob Napoli – William Blair & Co.

Just on the UK, so you purchased about $9 million, 5.7 million pounds this quarter. What was that last quarter? I think it was a couple of million less than that.

Kevin Stevenson

That's right --

Bob Napoli – William Blair & Co.

Are you getting any more comfort with that market? I mean, are you going to see a gradual increase in purchases from that -- from the UK?

Steve Fredrickson

All things being equal, we would hope to, Bob. Again, we're looking at that as a very incremental process for us, and we want to take our time and make sure that we understand exactly what we're doing. So it'll be a slow process forward for us.

Bob Napoli – William Blair & Co.

Okay. But it's become a bit material at $9 million, up from $7 million. I mean, do you have -- what kind of feel do you have through nine months of running that business, sorry? How are you feeling about the margins and profitability about that business versus the US business?

Steve Fredrickson

Let's say we're still getting our arms around our analytics. Neal had made some commentary that things that we take for granted in the US, some of our scoring and segmentation, we're still a couple of quarters out to really be able to employ that fully. So it is still an integration and learning process. So far so good, but again we're trying to -- we're trying to obtain reasonable sample and move our buying process forward, but at the same time we're trying to be careful at the same time.

Bob Napoli – William Blair & Co.

Is everything you're buying out of the UK or are you looking at other countries as well? Can we [utilize] other countries out of that market?

Steve Fredrickson

Everything is in the UK.

Bob Napoli – William Blair & Co.

Okay. On the competitive environment in the US, I did miss the upfront, I think you said. Are you saying that -- I mean, are you seeing less players but those -- the competitors that are left, yourselves, on core, bigger players, asset --

Steve Fredrickson

Yeah, I think that's a proper characterization. We don’t see net new players. It just seems as though the existing larger players are, you know, it's hard to tell exactly who, but there are some people that are bidding more aggressively than we saw at least in the first half of the year.

Bob Napoli – William Blair & Co.

Okay. And the, I mean, the IRS, any update there? I mean, you gave, Kevin, some good color on what's going on with your deferred tax liability. Is there -- I mean, I think you had expected that you were going to be going to court by the end of '12, but we haven't heard anything.

Kevin Stevenson

That's correct. Right on all fronts. I figured we would be in court by December and that's probably not going to be the case. So, not really any updates for you at this time.

Bob Napoli – William Blair & Co.

And has caused -- is it just the aging of your portfolio that's causing you to have higher, you know, the increase in the tax payments?

Kevin Stevenson

Yeah, exactly. And it's what we've been talking about for so long, is that this cost recovery method for tax is simply a timing difference. And I think Neal Stern put it best the other day, was it's all about the steepness of the increases. So, to the extent that you're increasing your portfolio investments, so if you look at our buying from '06 to '07 to '08, you'll see pretty steep ramp there in buying, and then there was also a steep ramp in the organization at the same time. So that tends to add to the deferral as you're laying on all these deals and in the cost recovery method.

And then as that thing all kind of catches up together, you end up in a situation where you end up paying $70 million in a year in taxes. So that's kind of the mechanics behind it.

Bob Napoli – William Blair & Co.

Okay. And just any other thoughts on other asset classes or countries at this point in time strategically, looking out the next few years?

Steve Fredrickson

Well, first, on asset classes, we continue to both buy and review a wide variety of asset classes. I really can't think of an unsecured consumer asset class short of medical that we're not actively taking a look at right now. As it relates to other countries, we have an active business development team and we're looking at any number of opportunities at any given point in time. But nothing is current or pending at this point.

Bob Napoli – William Blair & Co.

Any other thoughts on the M&A front domestically or otherwise? I mean, you're obviously in the UK with an acquisition, so I guess if you're looking at other countries, you'd be looking at potential acquisitions. But any other thoughts on acquisitions on businesses related to your core business?

Steve Fredrickson

No, other than letting you know that we're continuing to keep our eyes open, we don't have anything to talk about.

Bob Napoli – William Blair & Co.

Did you buy any new asset classes this quarter or this year that you've been testing?

Steve Fredrickson

Net new? No. I mean we've been buying a wide variety of asset classes for many years including the deficiency balances, telcom paper, you name it, even a period, as you know, when we bought medical papers. So I can't think of an asset class that we haven't been active in, in the past, and we continue to keep our eyes open in the future.

Bob Napoli – William Blair & Co.

But you haven't been comfortable enough with those classes to make it a material part of your business? Is that --

Steve Fredrickson

No. We buy auto deficiency balances almost on a quarterly basis, we buy telcom paper. It's all a matter of value. So we are not uncomfortable buying any of those asset classes. We just don't see compelling enough opportunities and large enough size to move the needle at this point.

Bob Napoli – William Blair & Co.

Thank you.

Steve Fredrickson

You bet.

Operator

Thank you, sir. Our next question comes from Mark Hughes with SunTrust. Go ahead, your line is open.

Mark Hughes – SunTrust Robinson Humphrey

Thank you very much. Any distinction you can make about the supply and the competitive dynamics in BK versus the non-BK?

Steve Fredrickson

They're both competitive markets. I think that we're seeing very similar dynamics between the two. There have always been, just in sheer number, less competitors on the bankruptcy side, although they tend to be I think overall better financed. But we're continuing to see strong competition in both segments. And actually we're bidding to very similar IRRs in both businesses.

Mark Hughes – SunTrust Robinson Humphrey

You might have touched on this, but in this quarter, it seems like share buybacks would have been a natural. You generated very good free cash and didn't spend it all on purchases -- for all your purchases. Why not buy back more shares?

Steve Fredrickson

It was a discussion that we have with the Board on an ongoing basis, and for a variety of reasons, we just decided to [sit back] this quarter. So again it's a discussion we're having on an ongoing basis and one we'll make a decision on kind of quarter by quarter.

Mark Hughes – SunTrust Robinson Humphrey

How should we think about the legal spending? Last year in your fourth quarter call you introduced the strategy that seemingly has worked out quite well. Are you settled in terms of the approach you're going to take in Q1? Is that -- should we assume that legal expenses ought to grow more consistent with the collection there? Or are you considering a follow-on strategy maybe but not similar amounts? How are you thinking about that?

Neal Stern

So I think we're predicting over the shorter term that legal costs will be in line with where we just were, maybe slightly below that. We have the big increase in Q1 of this year because we had changed our models and we had contemplated a different ROI threshold, and we've moved through all of that volume and things should be steady. That said, we look to refresh all of our models all the time. And if we ever find a pocket of accounts or our models have meaningful changes in their variables and it changes the population, we'll act accordingly.

Steve Fredrickson

I think what you'd see from us in the future would likely be something that was less dramatic than that you experienced a year ago. But the bottom line is, should we see pockets of collection that need extra expense to get to them, we're more than prepared to bite the bullet and do that to increase our collection rates, as long as we see good positive ROI.

Mark Hughes – SunTrust Robinson Humphrey

And just one final question, just thinking about your language you've used in terms of talking about supply. If you take out the large seller that helped 2Q, you look at the underlying trends, I guess you might say, how would you characterize the supply or the amount that was offered in Q3 versus Q2?

Steve Fredrickson

I mean it's a fairly dynamic market, but I think our view is that it was a fairly healthy offering, although again we missed -- we did miss similar volume to that offered in late Q2 which ended up in a decent delta, again given that one seller in that large transaction.

Mark Hughes – SunTrust Robinson Humphrey

Okay. Thank you for that.

Operator

Thank you. Our next question in queue comes from [Edward Hemminger] with Jaca Investments. Please go ahead, your line is open.

[Edward Hemminger] – Jaca Investments

Yeah, I just got a couple of questions. The outside fees and services was up a lot in the quarter of the expense. What was that? And do you expect that to continue at that rate?

Kevin Stevenson

Yeah. That line item again showed there's a bunch of things in that line item that you might imagine that falls in the outside fees and services, anywhere from the stuff you'd normally expect to things that we call corporate legal. And so one of the things that this quarter you probably was an increase in accruals for litigation, because every quarter we're required to take a look at all the lawsuits against us and [check] what's going on, so we upped the accrual a little bit. So I don’t think that's going to be a recurring number for you.

[Edward Hemminger] – Jaca Investments

Okay. In terms of looking at the portfolios that you purchased this quarter, they tended to be quite a little bit higher purchase prices at multiple of the face value. Is that -- should we make anything of that, I mean, in terms of, you know, are they, you know, for example, for the cores, just newer paper than some of the times in years past when you've gotten much more of a discount? And the same for the bankruptcy, I mean is that stuff just collecting faster?

Steve Fredrickson

Yeah, I think we're seeing a combination of things. We are seeing good liquidity on the paper that's being offered, but we are buying fresher paper overall both on the bankruptcy and on the core front. It's also combined on the core side kind of an absence this quarter of much meaningful older purchases, and those older purchases with sometimes very low purchase rates can pull down that overall pretty significantly. So that didn’t occur this quarter and that led to the observed average price that you were talking about.

[Edward Hemminger] – Jaca Investments

It seemed like during the downturn there wasn't nearly the amount of paper entering the market that was obviously being written off. So I'm a little puzzled by the fact that you're not seeing more kind of older paper. Does it not exist or are banks just kind of continuing to hold that off the market? And for what reason?

Steve Fredrickson

Well, we spent in excess of $90 million this quarter. There wasn't, as you know, there was a dearth of supply. So I think I need to at least clarify that point first. It's difficult to tell exactly what's happening with the older portfolio that you talked about that wasn't sold during the downturn, and again, various banks have various strategies for that paper and will ultimately make their decision on it, although we would anticipate that the vast majority at some point in time will release that paper into the market.

For instance, we did see that type of warehouse paper sale occur at the end of Q2, and it resulted in a big tick-up in claim. It didn’t happen this quarter. I think a lot of banks are looking at Q3 and didn't see a need to do anything dramatic. They're trying to figure out what their strategy is going to be here for yearend in Q4, and so maybe we'll see a tick-up in volume. I think that's all we can say from our perspective at this point.

[Edward Hemminger] – Jaca Investments

Okay. And then the other question I've got is, where, if you're not including the purchase price in your, you know, the data you gave for the UK portfolio. I mean, as you said, the $9 million wasn't in the $94 million. Where do we also though find the data about these purchase portfolios? Are you not -- and where would the, for example, the cash collection in total show up at?

Kevin Stevenson

So, yeah, I think you're asking about, will there be a supplemental data section at some point for the UK?

[Edward Hemminger] – Jaca Investments

Yes.

Kevin Stevenson

If that's the question, yeah, at some point we'll put that together for you. And down the road you're going to end up with, when it becomes meaningful, you'll end up with a section just like we'd give you for the domestic. You should see one just like it for the UK and probably would be listed in pounds.

[Edward Hemminger] – Jaca Investments

Okay. Is it -- I mean, are you just including that, I guess the net income recognized on finance receivables from the UK collections, is that just being included in fee income along with any fees that they're getting --

Kevin Stevenson

Okay. Yeah, I got your question. So, remember, those guys over there do two things just like we do. We have fee for service and we also have NFR revenues. So their NFR revenue rolls into our NFR revenue. Their commissions and fees roll into our commissions and fees, again on US-based GAAP and converted for pound to US dollars.

[Edward Hemminger] – Jaca Investments

Okay. But it's -- so, I guess, until you then disclose the detailed info about the UK, we're not going to be able to reconcile the tables with --

Kevin Stevenson

Sure. Yeah, you directly reconcile it, all I got to do is take what we show on the cash flow statement and on the income statement and compare it to the supplemental data section and they'll be out of balance. And that'll be -- the amount of the out of balance will be the UK operations.

[Edward Hemminger] – Jaca Investments

Okay. Great. Thanks.

Kevin Stevenson

Yeah.

Operator

Thank you, sir. Next question comes from Justin Hughes with Philadelphia Financial. Please go ahead, your line is open.

Justin Hughes – Philadelphia Financial

Good afternoon. Just a kind of a follow-up on Mark Hughes' question about the cash flow. I believe in 2007 you paid a special dividend and here you guys are, your EPS is up I think 36% year over year, and despite that, your debt to equity ratio is down 20% year over year. If you just got your debt to equity ratio back to where it was a year ago, it looks like you should pay a $5 special before tax rates go up. Have you thought about that analysis?

Steve Fredrickson

Yeah. It's something that we've discussed. The use of capital clearly is a significant focus here. And what we're trying to balance are a number of market opportunities including these large portfolios that we've talked about for a while and doing something that is more long-impacting earnings per share, like share repurchase or something that's more of a one-time benefit like the special dividend. So those are all things that we discuss at the Board level.

Justin Hughes – Philadelphia Financial

Okay. Thank you.

Operator

Thank you, sir. [Operator Instructions]. Our next phone question comes from Hugh Miller with Sidoti & Co. Please go ahead, your line is open.

Hugh Miller – Sidoti & Co.

Just wanted to quickly follow up on one other question with the dynamics of the purchasing in the quarter. So, obviously you guys had mentioned that pricing has increased relative to the first half of the year in the third quarter. Why was the third quarter purchases for traditional receivables put on the books at a higher multiple then?

Neal Stern

In purchase price, kind of -- we're talking about two different things maybe here --

Steve Fredrickson

Yeah. I think my comments weren't related to the multiple. Mine were related to the purchase rate.

Neal Stern

Right.

Steve Fredrickson

Which that what I understood the question to be.

Neal Stern

So, but to follow up on your question, Hugh, our process is unchanged, so, as we talked before, we get curves from the buying guys and we ask them to give us curves that they think are highly achievable and we put those on the books at that point and we start watching results in the upcoming quarters. So that process really hasn't changed.

Hugh Miller – Sidoti & Co.

I understand that. But I mean, so what you're telling me is that the general pricing of receivables has increased somewhat relative to the first half of the year, correct?

Neal Stern

Right.

Hugh Miller – Sidoti & Co.

And yet you're putting the third quarter '12 -- or the 2012 vintage is now on the books I think at 2.30 multiples and at 2.24 for the traditional 2012, the second quarter. So, is there -- is it just a change in maybe composition of what you've been buying this quarter relative to the past that gives you a little bit more confidence that relative to that higher pricing you're still going to be able to collect a greater multiple?

Steve Fredrickson

I think that's part of it. We're also trying to make a general market commentary about pricing as opposed to specifically about the pools that we acquired in any period. So, pricing being up on a second half versus first half of the year is more of a macro observation.

Hugh Miller – Sidoti & Co.

Got you. Okay. Thank you very much.

Steve Fredrickson

You bet.

Operator

Thank you, sir. And that does conclude our time for questions. We thank you for your questions. Again, ladies and gentlemen, this also does conclude today's program. Thank you for your participation, and have a wonderful day. Attendees, you may disconnect at this time.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: transcripts@seekingalpha.com. Thank you!

Source: Recovery Portfolio Associates' CEO Discusses Q3 2012 Results - Earnings Call Transcript
This Transcript
All Transcripts