PRA Group Inc (PRAA) 2012 Q2 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the second-quarter 2012 Portfolio Recovery Associates Incorporated earnings conference call. My name is Melanie, and I will be your coordinator today. At this time, all participants are in a listen-only mode. We will accept your questions at the end of the conference. (Operator Instructions) As a reminder, today's meeting will be recorded. I would now like to turn the call over to Mr. Jim Fike. Please proceed.

Good afternoon. I am Jim Fike, Vice President of Finance and Accounting for Portfolio Recovery Associates. Thank you for joining our second-quarter 2012 earnings call. Speaking to you today will be Steve Fredrickson, our Chairman, President and Chief Executive Office; Kevin Stevenson our Chief Financial and Administrative Officer; and Neal Stern, our Executive Vice President, Chief Operations Officer of Owned Portfolios. We will begin with prepared comments and then follow up with a question-and-answer period.

Before we begin, I would like everyone to please take note of our safe harbor language. Statements on this call which are not historical, including Portfolio Recovery Associates, our managements' intentions, hopes, beliefs, expectations, representations, projections, plans or predictions of the future, including with respect to the future portfolio performance, opportunities, future revenue and earnings growth, future cash collection, 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 management's beliefs, assumptions, and expectations of the Company's future operations and economic performance, taking into account currently available information. These statements are the same as historical fact.

Forward-looking statements involve risks and uncertainties, some of which are not currently known to us. Actual events or results may differ from those expressed or implied in any such forward-looking statements as a result of various factors, including the risk factors and other risks that are described from time to time in the Company's filings with 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 Company's website, which contain a more detailed discussion of the Company's business, including risks and uncertainties that may affect future results.

Due to such uncertainties and risks, you are cautioned not to place undue reliance on any forward-looking statements which speak only as of the date hereof. The Company expressly disclaims any obligation or undertaking to release publicly any updates or revisions to any forward-looking statements contained herein, reflect any change in the Company'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 full or in part.

Now here is Steve Fredrickson.

Thanks, Jim, and thank you all for joining us.

Today, I am pleased to report record buying, cash collections, revenue, and net income for our PRA quarter. I'll have our Q2 2012 highlights in a moment. Then I will spend a few minutes on a mid-year update of each of our fee-for-service businesses. Next, Neal Stern will comment on our operational strategies. Kevin Stevenson will discuss our key financial results. Then we will open up the call to Q&A.

Our Q2 results continued our strong performance this year, demonstrating the strength of our business model, focused on diverse revenue and earnings from our bankruptcy, core, and fee businesses, as well as our strategy to insource collection.

Here are the highlights of our Q2 results. Cash collections, including those in the UK, were $232 million, up 32% from 2011. Domestic collections alone were $229.8 million, up 30% from a year ago. Revenue was up 29% year-over-year to $148 million. Net income increased 25% year-over-year to $32 million, translating into diluted earnings per share of $1.87, compared with $1.48 in the second quarter of 2011. Return on equity exceeded 20% in Q2, achieving the benchmark that we set as a long-term goal.

We acquired a record $1.48 billion of face value domestic finance receivables for $123 million in the second quarter. These receivables were at 105 defaulted debt portfolios from 12 different sellers. Pricing continues to be quite competitive, but steady relative to Q1 2012 in both the direct from issuer and resale markets. With regard to expanded legal collections from those who can but won't pay their debt, I am happy to report that we continue ahead of expectation to achieve both our 2 to 1 return and a 6 to 12 month recovery of court cost expenses. And we experienced a lower impact to earnings than expected by handily exceeding our internal projections for cash collections overall. Neal and Kevin will have more details in a moment.

In spite of our expanded investment in court costs, our net margin grew to 21.7% in Q2 from 18% in Q1 2012, and fell just slightly from 22.3% in Q2, 2011. We continued executing opportunistic stock purchases under our existing program during the second quarter. Through June 30, we have acquired a total of 331,449 shares at an average price of $68.56 per share, spending a total of $22.7 million of the $100 million total authorized by the Board. We will continue to monitor market conditions as we administer the remaining $77 million under the current program.

We experienced a small sequential decline in our fee income from our fee-for-service businesses. I would like now to give you a mid-year update on each business. Our largest fee-for-service business, PRA government services, had a difficult quarter as a result of lower-than-anticipated contingent fee revenue from sales tax and use tax auditing. We believe this is a timing issue as the processing of corrections from state agencies has been delayed. Government services hourly audit and revenue administration services performed well. Because we are seeing sales efforts continuing to build government services book of business, we are investing more in our sales force. We anticipate improved results in Q3 and Q4.

PCB had a solid cash flow quarter and has been increasing marketing and sales efforts. Several very large cases are 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. PCB's strength has traditionally been in maximizing revenues to clients, and the team is now building a marketing engine to bring that message to market in order to expand the client base.

At PRA location services, we're seeing automotive delinquencies at historically low levels. This translates into fewer placements from existing clients and intense competition in the industry to secure business. The result is pricing pressure. Although placements have been down significantly from last year, contributing to a year-over-year decline in revenue, overall results for location services improved as this business became more efficient. Meanwhile, automotive, finance companies are starting to make more sub-prime loans. In the future, we anticipate more delinquencies will lead to more volume in this sector.

Several competitors have recently merged in an effort to survive, and many are struggling to maintain viability. Location Services differentiates itself through technology, information, compliance, and operational excellence. We believe that Location Services is the most efficient vendor to clients, putting this business in a strong position when cyclicality moves in its favor.

In the UK, we continue to integrate local operations with PRA. We made significant progress on accounting, HR, and operational front. We are now producing improved results for our UK clients, as well as PRA, by increasing the productivity of our UK call center staff. As a result, our standings in most lead tables have increased nicely since we bought this business.

Our sales efforts in the UK have resulted in an increased level of placements from numerous lenders, while many of our UK debt buying clients have cut back or eliminated new placements of Mackenzie Hall's contingency operation. We had anticipated that this would occur over time, but frankly it has occurred more quickly than we thought. However, with our increased productivity, even with lower inventory, we have produced increasing levels of fee income. As we build our contingent work from financial services companies, we should be able to continue this growth. Our UK debt purchase activity in Q2 remained at very modest levels, $2.1 million in small and niche portfolios as we continue to analyze market opportunity.

We announced last week that we promoted Owen James to Mackenzie Hall's CEO role. Owen has experience working in large matrix organizations, as well as deep experience in the collections and finance industry in the UK. He is an ideal fit for this position, and I'm very pleased to have him in this role.

For the last 10 years, PRA has pursued a strategy of deliberate diversification into businesses outside of our historical roots in the purchase and collection of US-based charge-off debt. With each acquisition our internal startup, we've sought to maintain the common characteristics of data and analytics-rich businesses that can differentiate themselves from the competition through operational excellence.

Our Bankruptcy business is a great example of this strategy in action. Starting from a business plan in 2001 to operational reality in 2003, it has become our largest contributor of profits for each of the past several years. All of the acquired fee-for-service businesses are making progress along their 2012 business plans, and while we would certainly like to see more material earnings impact, each is providing positive cash flow for 2012.

The Location Services business paid for itself years ago. And each of our acquisitions and is performing to a cash-on-cash return in the mid-teens. We remain committed to our diversification strategy. The real story this quarter, however, is the exceptional performance of our debt purchase business, both core charge-offs and bankruptcy. Let's keep that in perspective.

Finally, before I turn the call over to Neal, here's an update on US legislative and regulatory activity. Although some state legislatures remain in session, none have enacted proposals with any material effect on our debt buying or collection business. This might be expected in a presidential election year. The pace of activity on Capital Hill has been noticeably slow while members devote more time and attention to reelection campaigns and the upcoming nominating conventions. As a result, we do not expect any significant new Federal laws to be enacted before new Congress is sworn in next January.

The Consumer Financial Protection Bureau continues to increase the pace of its activities and grow into its intended role. During the second quarter, CFPB review public comments for a ruling defining supervision and examination authority over large market participants and certain non-bank financial markets, including debt collectors. We expect to be included among the non-bank large market participants when the CFPB ruling is issued this fall. The CFPB's director recently described its role as "helping honest debt collectors do their jobs responsibly while seeing that the rest are either rehabilitated or run out of business once and for all." Naturally, we endorse that goal.

To summarize, this was a record quarter for PRA resulting in exceptionally strong results at midyear. I want to publicly thank our employees who have worked so hard to deliver such extraordinary results for shareholders. We have an exceptional team that is putting even more room between us and our competitors. And we look forward to sustaining our Q2 growth and success for all of 2012.

Now let me turn the call over to Neal Stern.

Thanks, Steve.

Continuing Steve's commentary on a record quarter, I am pleased to report that PRA collected more than $2 million US payments in a single quarter for the first time in our Company's history. This milestone represented a 30% increase over Q2 2011. It is a strong testament to our staff's ability to find workable solutions to the financial difficulties that many US consumers continue to manage. As was the case in the first quarter, our average payment size was consistent with Q2 2011, reversing the declining trend we have experienced for the last several years. We expect our average payment size to remain stable or increase and remain coupled with a four-year running trend of double-digit increases in the number of monthly payments. The result, cash collections will continue to be strong.

In Q2, our strong performance was again driven by significant increases in collections from our purchase bankruptcy portfolio and from our legal channel and benefited from continued seasonal strength this quarter. Purchase bankruptcy portfolio collections increased $23.6 million, or 35% over the second quarter of 2011, while legal collections increased $23.5 million, or 54%. External legal collections were 52% higher and internal legal collections were up 58%. Internal legal collections accounted for 38% of our total legal collections, compared with 37% in the same quarter last year. This strong legal collections performance continues to be above what we expected from the incremental increase in court costs invested over the prior two quarters.

Cash collections resulting from our incremental increase in Q1 court costs are now more than 30% above our internal expectations. Collections from Q2 investments finished almost 10% ahead of our expectations. But even with these six months of performance results to examine, it is still difficult to assess whether or not these incremental cash collections represent acceleration or actual improvement in our longer-term cash collections. So we are now attributing at least some small percentage of that strong performance to an underlying improvement and have updated our models accordingly.

Our investment in court costs and Q3 will be similar to or slightly less than our Q2 legal expenses, and will likely be lower yet in the fourth quarter as we begin to prepare for the Q1 2013 tax season. Again, it is our expectation that we will deliver 200% plus ROI on these incremental court costs and recoup our costs within 6 to 12 months after making the investment.

I want to reiterate that these changes have not altered our philosophy about how and when to pursue legal collections. We will continue to only file lawsuits on the minority of accounts where we have attempted to collect in our call centers, identified an asset, and have not been able to compel the account holder to pay. In other words won't pays, not can't pays. This philosophy currently limits the population of accounts selected for legal treatment to less than 7% of our inventory, a figure that remains well below many others in our industry.

Turning now to our call centers, cash collections were also strong in the second quarter, although they were down sequentially from Q1, which is generally our seasonally strongest quarter for call-center collections. Call-center collections were up by 10% over Q2 of last year. Total paid hours in our US call centers were up by 15% over the prior year. These additional hours normally dampen collector productivity, but increased efficiencies negated most of that impact and allowed us to finish within 5% of the productivity results from Q2 of last year. As a reminder, Q3 and Q4 are both seasonally weaker than Q1 and Q2 with the most pronounced effects seen in Q4. We would expect normal seasonal trends this year, even with the added legal investments we have been making.

Finally our work in the UK continued to produce encouraging results as we share best practices between our US and UK call centers. UK collector productivity has been favorably impacted by these changes and we continued to make slow but steady progress in building a platform in the UK in which we can leverage some of the scoring and account segmentation strategies that have made such a significant impact on our domestic performance over the last several years.

Now let me turn the call over to Kevin Stevenson for our key financial results. Kevin?

Thanks, Neil. Hopefully, you have had an opportunity to review our earnings results that were released earlier today. I am going to run through the key items and plan to leave additional time for Q&A. I would note the comparisons I am about to make are between second-quarter 2012 and second- quarter 2011, unless otherwise noted.

Total revenues grew 29% to $147.9 million, up from $114.8 million. Revenue was comprised of $132.6 million in net finance receivables, or NFR revenues, and $15.3 million in fee revenues. The $132.6 million in finance receivable revenue for the quarter included $88.3 million in core portfolio revenue, including an allowance reversal of $260,000 and $43.1 million in bankruptcy portfolio revenue, net of an allowance charge of $2.5 million.

Net core portfolio revenues increased 35%, while net bankruptcy portfolio revenues increased 23%. Fee revenue of $15.3 million increased 6% and accounted for 10% of the Company's overall revenue. Fee revenue from our UK operation offset a year-over-year decline in fee revenue from our domestic fee-for-service subsidiaries.

During the quarter, we generated approximately $1.1 million dollars in finance receivable revenue from our UK operation and approximately $3.4 million in fee revenue. Operating expenses for the quarter increased 32%. Operating expenses were impacted by a planned $8.3 million increase in legal costs related to our expanded focus on legal collections. Operating expenses were also impacted by a $7.7 million increase in compensation and employee services expenses, as well as other expense increases primarily related to growth in collection activities. We continue to anticipate court and document costs of $16 million to $18 million for the third quarter, and then $14 million in the fourth quarter.

Operating income was $54.6 million, compared with $45.5 million, or a 20% increase. Our operating margin was 36.9% for the quarter, down from 39.7%. The decrease can be attributed in large part to the increased legal collection expenses associated with the Company's longer-term focus on driving additional collections from the legal channel. Net income of $32 million was up 25% from $25.6 million. The net margins for the quarter was 21.7%, down slightly from 22.3%. Diluted earnings per share advanced to $1.87, compared with $1.48, or a 26% increase.

Moving on to the balance sheet, cash balances ended the quarter at $43 million. During the quarter, we invested $125 million in defaulted debt portfolios. This represented $1.5 billion in face value and included $53.5 million of bankrupt paper and $71.5 million of core charged-off paper, including investments made by our UK operation. The NFR balance increased to $967 million, up from $880 million. The NFR balance is the amount of unamortized purchase price of acquired debt portfolios recorded our balance sheet. The NFR revenue and amortization calculation this quarter resulted in 42% of cash collections being applied to principal. This is relatively consistent with the percentage in the year-earlier period. The percentage does not include the impact of allowance charges.

Our debt-to-equity ratio at quarter end stood at 46%, consistent with the prior-year. Our debt-to-equity ratio including net deferred tax liabilities was 76%. As a reminder, in April, we increased our line of credit facility by $51 million to a total of $458.5 million. Existing lenders provided $41 million of the increase, while $10 million was provided by a new lender. The balance on the line of credit was $292 million at June 30, leaving availability under the line of $166.5 million subject to borrowing base and debt covenants.

As Steve mentioned, our Board of Directors previously authorized during the first quarter, the implementation of a share repurchase program of up to $100 million of our common stock. To date, we have repurchased 331,449 shares at an average price of $68.56 per share. Our strong operating cash flows provides us with flexibility to opportunistically use this program to enhance shareholder value and take advantage of market displacements should they develop. And our credit facility provides us with ample funding for portfolio purchases and other business opportunities. Overall, our balance sheet remains strong.

Finally, let me turn to some other data. The return to equity was 20.3% in the quarter, up from 19.2%, and as such, surpassed our long disclosed goal of 20%. Cash collections increased 32% to $232 million in the quarter. Cash collected on fully amortized pools was $7.5 million, compared to $10.1 million.

And with that, we have completed our prepared comments. We would like to open the call up to Q&A. Operator?

(Operator Instructions) Our first question comes from the line of Hugh Miller with Sidoti. Go ahead.

I guess one question I had was with regards to some of the mark ups you guys took in the quarter on the '09, '10 and '11 traditional vintages. Obviously, collections were very strong in the quarter. But I was just wondering, as you look at where they stand now, relative to the underwriting process you did when you bought the paper, I guess are they starting to come more in line with how you were looking at them at the beginning, the accounting versus the underwriting forecasts?

To tell you the truth, Hugh, at this point from an accounting perspective, we are running off of revised curves. So generally what we will do, just for, I know you know this, but just for the group's satisfaction, we will get every quarter updated projections from Neal Stern and the operations bunch, and then we will also get new projections from the acquisitions group. So we are tracking to those numbers. But certainly we continue to perform substantially better than underwritten.

Yes, I'm just wondering, how conservative do feel as though these new numbers are? Just because you have always done a great job of forecasting, but when I look at it relative to some peers, it is just that they are heading to be a bit higher. I'm just looking to get a sense of the level of conservativeness?

Well Hugh, I get this question a lot and I think that every quarter, I say the same thing. We feel like we are in a good spot right now, and we will have to let the numbers in the next couple of quarters guide us. But I think we continue to get -- I guess maybe in general terms, we continue to get increasing percentages of projections from everyone basically that provides us projections. So I think we are in a good spot right now.

Okay. I guess as you look out on the competitive landscape, you gave us a little bit of color there. But I continue to hear about the potential for some other competitors to potentially exit the business. Do you foresee an environment where we could possibly see pricing come down in the next year or two? Or do you think best-case scenario is that it just stays relative to where it is, steady?

I think it would probably be optimistic to look for declining prices. I would say that it's probably more likely that even if people exited, we would continue to see a fair amount of competition in the market and pricing would remain relatively steady. But I guess that is all going to be dependent on the magnitude of the supply that would be coming out and what happens on the competitive front.

Okay. And as I look at the blended interest rate that you guys had in the quarter, it came in a bit lower than what I was looking for, obviously despite the strong purchasing. Was that quarter's purchases fairly backend loaded? Or was there anything unusual in this particular quarter?

Maybe if you look at our financials, we had a fixed rate tranche of $50 million that rolled into our floating base. So that probably had the delta you are looking at. I think that interest rate was 6.7%, 6.8% on that $50 million tranche.

So that should be then floating going forward?

Yes. It's a normal floating with LIBOR.

Okay, that is probably the difference there. The other thing I noticed there was the stock-based comp, in the first half of the year, you made a quick comment about it. It just tends to be running substantially higher. Is there any particular reason why it is accruing at that rate, and we see a drop-off from the first half levels as we think about that in the second half of the year?

We definitely made an adjustment to that the long-term [incentive] program. That is what you are seeing this quarter. And it just depends on the performance of stock and all of our computations for all the components of LTI.

Okay, and last question I had was with regards to, you made some commentary about getting some decisions in the CFPB about who they may include as a large participant. Do you guys anticipate that they will ratchet up that threshold and oversee far fewer participants? Or any thoughts there?

Well we are certainly rooting for as many people to be participating in this as possible. Some of the early commentary that the CFPB has put out, in writing, suggested that the number could be fairly low. And we would guess, I think estimates were closer to 200 participants. So we will wait and see what that number ultimately is. But naturally, we are hoping that it is fairly expansive.

Okay thank you.

Our next question comes from the line of Bob Napoli with William Blair. Go ahead.

Thank you, and I missed some of your opening comments, so I apologize if you did discuss this in more depth. I guess I would like a little bit more color on your strategy in the UK and how it is progressing. I know you have taken best practices over there, and you say, I've heard that you have improved productivity. But at what point do you -- how much work do you need to do over there before you start to look to grow that business? Do you have a TRA'd yet or what else needs to be done?

I think that we feel good about where the business is and what we are really waiting on in terms of increasing investment is how our portfolios are performing and just getting comfortable with the market dynamic there. And that is just a matter of quarter by quarter.

And so this may be -- you may watch the business for a year or so? Obviously with the results you are driving, there is no hurry to ramp that business up. But will it take, say a year of watching portfolios perform before you get more comfortable with growing that business more quickly?

It all depends on the type of performance that we see. Overtime Bob and we will just follow that carefully. But again, the move to the UK was a long-term move for us, and we will go about this at an even pace.

Is your one big competitor that suggested they would be out of the market for a quarter or so, are they out of the market?

It is difficult for us to establish exactly who is in the market and for how much. And so I would say at this point it is difficult to tell.

Your allowance of $89 million of your reserves, what are your thoughts around that reserve over the next several years? Do you think you will recover a meaningful portion of that reserve or not?

I'm sorry, a total allowance number. I didn't know what numbers you are looking at. So again, here we are. We have reversed off $260,000. It is actually interesting. A couple of deals, I will give you a little bit of insight. A couple of older deals from '05 and '07, had reversed off all of their allowance last quarter. Of course, we didn't do anything in regard to yield there. But again, second quarter, and again these couple deals came in so strong that we did actually increase the interest rate, the yield on one of those deals. So there is some evidence that some of those vintages, again '05 and '07 especially, are showing some signs of reversing allowances and a couple of them for the first time ever. And then in a couple of cases expanding yield. So we are going to be very cautious though, Bob. When you have a deal that has got an allowance on it, the last thing you want to do is reverse it off and rebook it. So we're trying to be careful about that.

Thanks. Congratulations on a nice job.

Our next question comes from the line of Mark Hughes with SunTrust.

The collections in the quarter, any stab you can make at how much contribution you got from the extra legal expending or expenditures that you have done through the first six months?

When you think about the legal curve, we just talk about getting our money back within 6 to 12 months. So we spent an incremental $14 million or so in the Q, and you can imagine how that comes back over that 6 to 12 month time period. We are really not in the meaty part of the curve. So these first six months are still very early in terms of what we would realize from that spend.

So you would say it was a small, maybe a few points of total collections?

Yes, right.

Okay. Kevin, the 2010 vintage to the earlier discussion, has actually, the collections increased year-over-year, which is very unusual. Anything happening there? Any strange steps you have taken to target that 2010 paper? Or is that just indicative of good collections overall?

We just wanted you to take a victory lap on your prediction early on that 2010 was going to be a great year for us. But no seriously, this question came up last quarter and I gave you credit for identifying that early on. But that tranche is definitely performing very well. There's nothing Neal did out of the ordinary on that tranche. And we're continuing to move those projections upward.

Okay, great. And then one more question. The payables and accrued liabilities. I cannot remember whether you've made a comment on this in Q1, but the dampening cash flow, what is going on there and does that reverse at some point?

What number are you looking at?

Out of the cash flow. Your -- I think it is payables and accrued liabilities. It has been a negative for you for the six months on cash flow statements. Looking at negative $19.7 million, if I'm reading this properly.

Right that is a negative number, right. We're certainly looking at additional accruals there.

I think a lot of that happened in Q1. So I was just curious if there was anything unusual or whether that is just a timing issue that that ought to reverse.

Right, so you can tell by our delay here it is probably nothing unusual that hit our radar screens. So we can tear that apart take a look at it, but nothing unusual coming to mind on that.

Okay. All right. Thank you. Good quarter.

Thank you.

Ladies and gentlemen, that does conclude the time that we have available for questions. We would like to thank you for your participation in today's conference. That does conclude the presentation. You may disconnect. Have a wonderful day.