10-K 1 d268614d10k.htm FORM 10-K Form 10-K
Table of Contents

 

 

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-K

 

 

(Mark One)

x ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the fiscal year ended December 31, 2011 or

TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from                      to                     .

COMMISSION FILE NUMBER: 000-26489

 

 

ENCORE CAPITAL GROUP, INC.

(Exact name of registrant as specified in its charter)

 

 

 

Delaware   48-1090909

(State or other jurisdiction of

incorporation or organization)

 

(IRS Employer

Identification No.)

3111 Camino Del Rio North, Suite 1300 San Diego, California   92108
(Address of principal executive offices)   (Zip code)

(877) 445-4581

(Registrant’s telephone number, including area code)

 

 

Securities registered pursuant to Section 12(b) of the Act:

 

Title of Each Class

 

Name of Each Exchange on Which Registered

Common Stock, $.01 Par Value Per Share

  The NASDAQ Stock Market LLC

Securities registered pursuant to Section 12(g) of the Act: None

Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act.    Yes  ¨    No  x

Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Act.    Yes  ¨    No  x

Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days.    Yes  x    No  ¨

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).    Yes  x    No  ¨

Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K.    ¨

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

Large accelerated filer    ¨

   Accelerated filer    x    Non-accelerated filer    ¨    Smaller reporting company    ¨

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Act).    Yes  ¨    No  x

The aggregate market value of the voting stock held by non-affiliates of the registrant totaling 16,317,228 shares was approximately $501,265,244 at June 30, 2011, based on the closing price of the common stock of $30.72 per share on such date, as reported by the NASDAQ Global Select Market.

The number of shares of our Common Stock outstanding at February 1, 2012, was 24,521,576.

Documents Incorporated by Reference

Portions of the registrant’s proxy statement in connection with its annual meeting of stockholders to be held in 2012 are incorporated by reference in Items 10, 11, 12, 13, and 14 of Part III of this Annual Report on Form 10-K for the fiscal year ended December 31, 2011.

 

 

 


Table of Contents

TABLE OF CONTENTS

 

     Page  

PART I

     1   

Item 1—Business

     1   

Item 1A—Risk Factors

     8   

Item 1B—Unresolved Staff Comments

     16   

Item 2—Properties

     16   

Item 3—Legal Proceedings

     16   

Item 4—Mine Safety Disclosures

     17   

PART II

     18   

Item  5—Market for the Registrant’s Common Equity Securities, Related Stockholder Matters and Issuer Purchases of Equity Securities

     18   

Item 6—Selected Financial Data

     20   

Item  7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

     22   

Item 7A—Quantitative and Qualitative Disclosures about Market Risk

     47   

Item 8—Financial Statements and Supplementary Data

     48   

Item 9—Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

     48   

Item 9A—Controls and Procedures

     48   

Item 9B—Other Information

     51   

PART III

     51   

Item 10—Directors, Executive Officers and Corporate Governance

     51   

Item 11—Executive Compensation

     51   

Item  12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

     51   

Item 13—Certain Relationships and Related Transactions, and Director Independence

     51   

Item 14—Principal Accountant Fees and Services

     51   

PART IV

     52   

Item 15—Exhibits and Financial Statement Schedules

     52   

SIGNATURES

     58   


Table of Contents

PART I

Item 1—Business

An Overview of Our Business

Nature of Our Business

We are a leader in consumer debt buying and recovery. We purchase portfolios of defaulted consumer receivables at deep discounts to face value and use a variety of operational channels to maximize our collections from these portfolios. We manage our receivables by partnering with individuals as they repay their obligations and work toward financial recovery. Defaulted receivables are consumers’ unpaid financial commitments to credit originators, including banks, credit unions, consumer finance companies, commercial retailers, auto finance companies, and telecommunication companies, and may also include receivables subject to bankruptcy proceedings, or consumer bankruptcy receivables.

Four competitive, strategic advantages underpin our success and drive our future growth:

 

   

The sophisticated and widespread use of analytics (Analytic Strength)

 

   

Broad investments in data and behavioral science (Consumer Intelligence)

 

   

Significant cost advantages based on our operations in India, as well as our enterprise-wide, account-level cost database (Cost Leadership)

 

   

A demonstrated commitment to conduct business ethically and in ways that support our consumers’ financial recovery (Principled Intent)

Although we have enabled over two million consumers to retire a portion of their outstanding debt since 2007, one of the industry’s most formidable challenges is that many distressed consumers will never make a payment, much less retire their total debt obligation. In fact, at the peak of the collection cycle, we generate payments from fewer than one percent of our accounts every month. To address these challenges, we evaluate portfolios of receivables that are available for purchase using robust, account-level valuation methods, and we employ a suite of proprietary statistical and behavioral models across the full extent of our operations. We believe these business practices contribute to our ability to value portfolios accurately, avoid buying portfolios that are incompatible with our methods or goals, and align the accounts we purchase with our operational channels to maximize future collections. We also have one of the industry’s largest distressed consumer databases containing information regarding approximately 25 million consumer accounts. We believe that our specialized knowledge, along with our investments in data and analytic tools, have enabled us to realize significant returns from the receivables we have acquired. From inception through December 31, 2011, we have invested approximately $2.1 billion to acquire 40.1 million consumer accounts with a face value of approximately $66.4 billion. We maintain strong relationships with many of the largest credit providers in the United States, and believe that we possess one of the industry’s best collection staff retention rates.

While seasonality does not have a material impact on our business, collections are generally strongest in our first calendar quarter, slower in the second and third calendar quarters, and slowest in the fourth calendar quarter. Relatively higher collections in the first quarter could result in a lower cost-to-collect ratio compared to the fourth quarter, as our fixed costs would be constant and applied against a larger collection base. The seasonal impact on our business may be influenced by our purchasing levels, the types of portfolios we purchase, and our operating strategies.

In addition, we provide bankruptcy support services to some of the largest companies in the financial services industry through our wholly owned subsidiary, Ascension Capital Group, Inc. (“Ascension”). Leveraging a proprietary software platform dedicated to bankruptcy servicing, Ascension’s operational platform integrates lenders, trustees, and consumers across the bankruptcy lifecycle.

 

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Investors wishing to obtain more information about us may access our Internet site (http://www.encorecapital.com). The site provides access to relevant investor related information, such as Securities and Exchange Commission (“SEC”) filings, press releases, featured articles, an event calendar, and frequently asked questions. SEC filings are available on the website as soon as reasonably practicable after being filed with, or furnished to, the SEC. The content of the Internet site is not incorporated by reference into this Annual Report on Form 10-K. Any materials that we filed with the SEC may also be read and copied at the SEC’s Public Reference Room at 100 F Street, N.E., Washington, D.C. 20549. The public may obtain information on the operation of the Public Reference Room by calling the SEC at 1-800-SEC-0330. The SEC maintains an Internet site that contains reports, proxy and information statements, and other information regarding issuers that file electronically with the SEC (http://www.sec.gov).

Our Competitive Advantages

Analytic Strength. We believe that success in our business depends on the ability to establish and maintain an information advantage. Leveraging an industry-leading distressed consumer database, our in-house team of statisticians, business analysts, and software programmers have developed, and continually enhance, proprietary behavioral and valuation models, custom software applications, and other business tools that guide our portfolio purchases. Moreover, our collection channels are informed by powerful statistical models specific to each collection activity, and each year we deploy significant capital to purchase credit bureau and customized consumer data that describe demographic, account level, and macroeconomic factors related to credit, savings, and payment behavior.

Consumer Intelligence. At the core of our analytic approach is a focus on understanding, measuring, and predicting distressed consumer behavior. In this effort, we apply tools and methods borrowed from statistics, psychology, economics, and management science across the full extent of our business. During portfolio valuation, we use an internally-developed and proprietary family of statistical models that determines the likelihood and expected amount of payment for each consumer within a portfolio. Subsequently, the expectations for each account are aggregated to arrive at a portfolio-level liquidation solution and a valuation for the entire portfolio is determined. During collections, we apply our “willingness-capability” framework, which allows us to match our collection approach to an individual consumer’s payment behavior.

Cost Leadership. Cost efficiency is central to our collection and purchasing strategies. We experience considerable cost advantages, stemming from our operations in India, our enterprise-wide, activity-level cost database, and the development and implementation of operational models that enhance profitability. We believe that we are the only company in our industry with a successful, late-stage collection platform in India. This cost-saving, first-mover advantage helps to reduce our call center variable cost-to-collect.

Principled Intent. We strive to treat consumers with respect, compassion, and integrity. From discounts and payment plans to hardship solutions, we partner with our consumers as they attempt to return to financial health. We are committed to dialogue that is honorable and constructive, and hope to play an important and positive role in our consumers’ lives.

Our Strategy

We have implemented a business strategy that emphasizes the following elements:

Extend our knowledge about distressed consumers. We believe our investments in data, analytic tools, and expertise related to both general and distressed consumers provide us with a competitive advantage. In addition to rigorous data collection practices that take advantage of our unique relationship with distressed consumers, our consumer intelligence program focuses on segmentation, marketing communications, and original research conducted in partnership with experts from both industry and academia. We believe this work will continue to bolster our operational success while fueling our efforts to understand the actions and motivations of our consumer base.

 

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Realize the full strength of our operations in India. We believe that our operations in India will be critical for both our future collections strategy as well as our future growth. Our call center has expanded considerably over the past few years, and we anticipate that this growth will continue. Our attrition rate for experienced account managers in India is approximately 40% per year in an industry where 100% attrition is not uncommon. Moreover, we have expanded our talented work force in India beyond call center operations and are now developing software, managing portions of our IT infrastructure, handling complex analytics, supporting our bankruptcy servicing teams, and processing a large portion of our back-office needs in India. As portfolio prices fluctuate and the complexity of our industry continues to increase, we expect that our operations in India will continue to provide a significant competitive advantage.

Safeguard and promote financial health and literacy. We believe that our interests, and those of the financial institutions from which we purchase portfolios, are closely aligned with the interests of government agencies seeking to protect consumer rights. Accordingly, we expect to continue investing in infrastructure and processes that support consumer advocacy and financial literacy, while promoting an appropriate balance between corporate and consumer responsibility.

Consider growth opportunities in adjacent businesses and new geographies. We may consider acquisitions of complementary companies in order to expand into new geographic markets or new types of defaulted consumer receivables, add capacity to our current business lines, or leverage our knowledge of the distressed consumer. We believe that our existing underwriting and collection processes can be extended to a variety of charged-off consumer receivables. These capabilities may allow us to develop and provide complementary products or services to specified distressed consumer segments.

Acquisition of Receivables

We provide sellers of delinquent receivables liquidity and immediate value through the purchase of charged-off consumer receivables. We believe that we are an appealing partner for these sellers given our financial strength, focus on principled intent, and track record of financial success.

Identify purchase opportunities. We maintain relationships with some of the largest credit grantors and sellers of charged-off consumer receivables in the United States. We identify purchase opportunities and secure, where possible, exclusive negotiation rights. We believe that we are a valued partner for primary issuers and sellers from whom we purchase portfolios, and our ability to secure exclusive negotiation rights is typically a result of our strong relationships and our scale of purchasing. Receivable portfolios are sold either through a general auction, where the seller requests bids from market participants or through an exclusive negotiation where the seller and buyer negotiate the sale privately. The sale transaction can be either for a one-time spot purchase or for a “forward flow” contract. A “forward flow” contract is a commitment to purchase receivables over a duration that is typically three to twelve months with specifically defined volume, frequency, and pricing. Typically, these contracts have provisions that allow for early termination or price re-negotiation should the underlying quality of the portfolio deteriorate over time or if any particular month’s delivery is materially different than the original portfolio used to price the forward flow contract. We generally attempt to secure forward flow contracts for receivables because a consistent volume of receivables over a set duration can allow us more precision in forecasting and planning our operational needs.

Evaluate purchase opportunities using account level analytics. Once a portfolio of interest is identified, we obtain detailed information regarding the portfolio’s accounts, including certain information regarding the consumers themselves. We then purchase additional information for the consumers whose accounts we are contemplating purchasing, including credit, savings, or payment behavior. Our internal modeling team then analyzes this information to determine the expected value of each potential new consumer. Our collection expectations are based on these demographic data, account characteristics, and economic variables, which we use to predict a consumer’s willingness and ability to repay its debt. The expected value of collections for each account is aggregated to calculate an overall value for the portfolio. Additional adjustments are made to account

 

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for qualitative factors that may impact the payment behavior of our consumers (such as prior collection activities, or the underwriting approaches of the seller), and servicing related adjustments to ensure our valuations are aligned with our operations.

Formal approval process. Once we have determined the value of the portfolio and have completed our qualitative diligence, we present the purchase opportunity to our investment committee, which either sets the maximum purchase price for the portfolio based on corporate Internal Rate of Return (“IRR”) objectives or declines to bid. Members of the investment committee include our CEO, CFO, other members of our senior management team, and experts, as needed.

We believe long-term success is best pursued by combining a diverse sourcing approach with an account-level scoring methodology and a disciplined evaluation process.

Collection Approach

We expand and build upon the insight developed during our purchase process when developing our account collection strategies for portfolios we have acquired. Our proprietary consumer-level collectability analysis is the primary determinant of whether an account is actively serviced post-purchase. Generally, we pursue collection activities on only a fraction of the accounts we purchase, through one or more of our collection channels. The channel identification process is analogous to a decision tree where we first differentiate those consumers who we believe are unable to pay from those who we believe are able to pay. Consumers who we believe are financially incapable of making any payments, or are facing extenuating circumstances or hardships that would prevent them from making payments are excluded from our collection process. It is our practice to assess each consumer’s willingness to pay through analytics, phone calls and/or letters. Despite our efforts to reach consumers and work out a settlement option, only a small number of consumers who we contact choose to engage with us. Those who do are often offered discounts on their obligations, or are presented with payments plans that are intended to suit their needs. However, the majority of consumers we contact ignore our calls and our letters and we must then make the decision about whether to pursue collections through legal means. During 2011, we called approximately 11.1 million unique consumers, of which 2.3 million, or 21%, made contact with us. Similarly, during the same time period, we mailed 9.7 million consumers, of which 2.4% engaged with us. Throughout our ownership period, we periodically refine our collection approach to determine the most effective collection strategy to pursue for each account. These strategies consist of:

 

   

Inactive. We strive to use our financial resources judiciously and efficiently by not deploying resources on accounts where the prospects of collection are remote. For example, for accounts where we believe that the consumer is currently unemployed, overburdened by debt, incarcerated, or deceased, no collection method of any sort is assigned.

 

   

Direct Mail. We develop innovative, low cost mail campaigns offering consumers appropriate discounts to encourage settlement of their accounts.

 

   

Call Centers. We maintain domestic collection call centers in San Diego, California, Phoenix, Arizona, and St. Cloud, Minnesota and international call centers in Gurgaon, India and Costa Rica (opened in January 2012). Call centers generally consist of multiple collection departments. Account managers supervised by group managers are trained and divided into specialty teams. Account managers use a friendly, but firm, approach to further assess our consumers’ willingness and capacity to pay. They attempt to work with consumers to evaluate sources and means of repayment to achieve a full or negotiated lump sum settlement or develop payment programs customized to the individual’s ability to pay. In cases where a payment plan is developed, account managers encourage consumers to pay through automatic payment arrangements. During our new hire training period, we educate account managers to understand and apply applicable laws and policies that are relevant in the account manager’s daily collection activities. Our ongoing training and monitoring efforts help ensure compliance with applicable laws and policies by account managers.

 

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Skip Tracing. If a consumer’s phone number proves inaccurate when an account manager calls an account, or if current contact information for a consumer is not available at the time of account purchase, then the account is automatically routed to our skip tracing process. We currently use a number of different skip tracing companies to provide phone numbers and addresses.

 

   

Legal Action. We generally refer accounts for legal action where the consumer has not responded to our direct mail efforts or our calls and it appears the consumer is able, but unwilling, to pay his or her obligations. When we decide to refer an account for legal action, we hire attorneys in-house or we retain law firms that specialize in collection matters in the states where we intend to pursue collections. Prior to engaging a collection firm, we evaluate the firm’s operations, financial condition, and experience, among other key criteria. We rely on the law firms’ expertise with respect to applicable debt collection laws to evaluate the accounts we refer to them and to make the decision about whether or not to pursue collection litigation. The law firms we have hired may also attempt to communicate with the consumers in an attempt to collect their debts prior to initiating litigation. We pay the law firms a contingency fee based on amounts they collect on our behalf.

 

   

Third Party Collection Agencies. We selectively employ a strategy that uses collection agencies. Collection agencies receive a contingency fee for each dollar collected. Generally, we use these agencies on accounts when we believe they can liquidate better or less expensively than we can or to supplement capacity in our internal call centers. We also use agencies to initially provide us a way to scale quickly when large purchases are made and as a challenge to our internal call center collection teams. Prior to engaging a collection agency, we evaluate, among other things, those aspects of the agency’s business that we believe are relevant to its performance and compliance with consumer credit laws and regulations.

 

   

Account Balance Transfer. We may transfer to our credit card partners accounts for which this approach offers the highest opportunity for success. The credit card partners may offer the consumer the opportunity to establish new credit and to transfer the balance onto a new credit card. If the account is transferred, we receive an agreed-upon payment. We did not transfer any accounts pursuant to this program in 2011.

 

   

Sale. We do not resell accounts to third parties in the ordinary course of our business. If we have an occasional instance when we do resell accounts, we only do so when we can provide the purchaser with documentation evidencing the amount owed on the account and clear title of ownership.

Corporate Compliance and Legal Oversight

Our corporate compliance and legal oversight functions are divided between our legal and financial compliance departments. Our legal department manages regulatory compliance, litigation, corporate transactions, and compliance with our internal ethics policy, while our financial compliance department manages our Sarbanes Oxley 404 compliance, internal audit, and Legal Outsourcing audit initiatives.

The legal department is responsible for interpreting and administering our Standards of Business Conduct (the “Standards”), which apply to all of our directors, officers, and employees and outlines our commitment to a culture of professionalism and ethical behavior. The Standards promote honest and ethical conduct, including the ethical handling of actual or apparent conflicts of interest between personal and professional relationships, compliance with applicable laws, rules and regulations, and full and fair disclosure in reports that we file with, or submit to, the SEC and in other public communications made by us. As described in the Standards, we have also established a toll-free Accounting and Fraud Hotline to allow directors, officers, and employees to report any detected or suspected fraud, misappropriations, or other fiscal irregularities, any good faith concern about our accounting and/or auditing practices, or any other violations of the Standards.

Beyond written policies, one of our core internal goals is the adherence to principled intent as it pertains to all consumer interactions. We believe that it is in our shareholders, and our employees’ best interest to treat all consumers with the highest standards of integrity. Specifically, we have strict policies and a code of ethics, which

 

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guide all dealings with our consumers. To reinforce existing written policies, we have established a number of quality assurance procedures. Through our Quality Assurance program, our Fair Debt Collection Practices Act (“FDCPA”) training for new account managers, our FDCPA recertification program for continuing account managers, and our Consumer Support Services department, we take significant steps to ensure compliance with applicable laws and regulations and seek to promote consumer satisfaction. Our Quality Assurance team aims to enhance the skills of account managers and to drive compliance initiatives through active call monitoring, account manager coaching and mentoring, and the tracking and distribution of company-wide best practices. Finally, our Consumer Support Services department works directly with consumers to seek to resolve incoming consumer inquiries and to respond to consumer disputes as they may arise.

Information Technology

Technical Infrastructure. Our internal network has been configured to be redundant in all critical functions, at all sites. This backup system has been implemented within the local area network switches, the data center network, and includes our redundant Multiprotocol Label Switching (MPLS) networks. We have the capability to handle high transaction volume in our server network architecture, which can be scaled seamlessly with our future growth plans.

Predictive Dialer Technology. Our upgraded predictive dialer technology continues to accommodate the ongoing expansion of our call centers. The technology allows additional call volume capacity and greater efficiency through shorter wait times and an increase in the number of live contacts. We believe this technology helps maximize account manager productivity and further optimizes the yield on our portfolio purchases. We also believe that the use of predictive dialing technology helps us to ensure compliance with certain applicable federal and state laws that restrict the time, place, and manner in which debt collectors can call consumers.

Computer Hardware. We use a robust computer platform to perform our daily operations, including the collection efforts of our global workforce. Because our custom software applications are integrated within our database server environment, we are able to process transaction loads with speed and efficiency. The computer platform offers us reliability and expansion opportunities. Furthermore, this hardware incorporates state of the art data security protection. We back up our data daily, and store copies at a secured off-site location. We also mirror our production data to a remote location to give us full protection in the event of the loss of our primary data center. To ensure the integrity and reliability of our computer platform we periodically engage outside auditors specializing in information technology to examine both our operating systems and disaster recovery plans.

Process Control. To ensure that our entire infrastructure continues to operate efficiently and securely we have developed a strong process and control environment. These controls govern all areas of the enterprise from physical security and virtual security, change management, data protection and segregation of duties.

Ability to Attract and Retain Employees

Of crucial importance to our success is the recruitment and retention of our key employees, account managers, and executive management team. In addition to offering attractive compensation structures for account managers, we may offer employee programs that promote personal and professional goals, such as leadership and skills training, tuition assistance in support of continued education, and wellness initiatives. Our wellness initiatives earned us the distinction as San Diego’s Healthiest Company, Large Company category, in 2011, and in India, we were selected as one of “India’s Best Companies to Work For” by India’s Great Place to Work Institute. We believe that these tangible benefits, combined with intangible differentiators, such as a diverse employee base and the prospect of living and working in an extremely temperate climate where our Corporate Headquarters is located, all contribute to a sustainable competitive advantage with respect to recruitment and retention.

 

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Competition

The consumer credit recovery industry is highly competitive and fragmented. We compete with a wide range of collection companies, financial services companies, and a number of well-funded entrants with limited experience in our industry. We also compete with traditional contingency collection agencies and in-house recovery departments. Competitive pressures affect the availability and pricing of receivable portfolios, as well as the availability and cost of qualified recovery personnel. In addition, some of our competitors may have signed forward flow contracts under which originating institutions have agreed to transfer charged-off receivables to them in the future, which could restrict those originating institutions from selling receivables to us. We believe some of our major competitors, which include companies that focus primarily on the purchase of charged-off receivable portfolios, have continued to diversify into third-party agency collections and into offering credit card and other financial services as part of their recovery strategy.

When purchasing receivables, we compete primarily on the basis of the price paid for receivable portfolios, the ease of negotiating and closing the prospective portfolio purchases with us, including our ability to obtain funding and our reputation with respect to the quality of services that we provide. We believe that our ability to compete effectively in this market is also dependent upon, among other things, our relationships with originators and sellers of charged-off consumer receivables, and our ability to provide quality collection strategies in compliance with applicable collections laws.

Government Regulation

In a number of states we must maintain licenses to perform debt recovery services and must satisfy related bonding requirements. It is our policy to comply with all material licensing and bonding requirements. Our failure to comply with existing licensing requirements, changing interpretations of existing requirements, or adoption of new licensing requirements, could restrict our ability to collect in states, subject us to increased regulation, increase our costs, or adversely affect our ability to collect our receivables.

Federal and state statutes establish specific guidelines and procedures which debt collectors must follow when collecting consumer receivables. The FDCPA and comparable state statutes establish specific guidelines and procedures which debt collectors must follow when communicating with consumers, including the time, place and manner of the communications. It is our policy to comply with the provisions of the FDCPA and comparable state statutes in all of our recovery activities. Our failure to comply with these laws could have a material adverse effect on us if they apply to some or all of our recovery activities. Alongside the FDCPA, the federal laws that apply to our business (in addition to the regulations that relate to these laws) include the following:

 

•    Truth-In-Lending Act

 

•    Credit CARD Act

•    Fair Credit Billing Act

 

•    Gramm-Leach-Bliley Act

•    Equal Credit Opportunity Act

 

•    Servicemembers’ Civil Relief Act

•    Fair Credit Reporting Act

•    Electronic Funds Transfer Act

•    U.S. Bankruptcy Code

•    Telephone Consumer Protection Act

 

•    Health Insurance Portability and Accountability Act

•    Dodd-Frank Wall Street Reform and Consumer Protection Act

•    Wire Act

 
 
 

State laws, among other things, may also limit the interest rate and the fees that a credit originator may impose on our consumers, and limit the time in which we may file legal actions to enforce consumer accounts.

The relationship between a consumer and a credit card issuer is extensively regulated by federal and state consumer protection and related laws and regulations. While we do not issue credit cards, these laws affect some of our operations because the majority of our receivables originate through credit card transactions. The laws and regulations applicable to credit card issuers, among other things, impose disclosure requirements when a credit

 

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card account is advertised, when it is applied for and when it is opened, at the end of monthly billing cycles and at year-end. Federal law requires, among other things, that credit card issuers disclose to consumers the interest rates; fees, grace periods, and balance calculation methods associated with their credit card accounts. Some laws prohibit discriminatory practices in connection with the extension of credit. If the originating institution fails to comply with applicable statutes, rules, and regulations, it could create claims and rights for the consumers that would reduce or eliminate their obligations related to those receivables. When we acquire receivables, we generally require the originating institution to contractually indemnify us against losses caused by its failure to comply with applicable statutes, rules and regulations relating to the receivables before they are sold to us.

Federal statutes further provide that, in some cases, consumers cannot be held liable for, or their liability is limited with respect to, charges to their credit card accounts that resulted from unauthorized use of their credit cards. These laws, among others, may give consumers a legal cause of action against us, or may limit our ability to recover amounts owing with respect to the receivables, whether or not we committed any wrongful act or omission in connection with the account.

State and federal laws concerning identity theft, privacy, data security, the use of automated dialing equipment and other laws related to consumers and consumer protection, as well as laws applicable to specific types of debt, impose requirements or restrictions on collection methods or our ability to enforce and recover certain of our receivables.

The laws described above, among others, as well as any new or changed laws, rules or regulations, may adversely affect our ability to recover amounts owing with respect to our receivables.

Employees

We are a Delaware corporation incorporated in 1999. As of December 31, 2011, we had approximately 2,200 employees. None of our employees is represented by a labor union. We believe that our relations with our employees are good.

Item 1A—Risk Factors

There are certain risks and uncertainties in our business that could cause our actual results to differ materially from those anticipated. We urge you to read these risk factors carefully in connection with evaluating our business and in connection with the forward-looking statements and other information contained in this Annual Report on Form 10-K. Any of the risks described herein could materially affect our business, financial condition or future results and the actual outcome of matters as to which forward-looking statements are made. The list of risks is not intended to be exhaustive and the order in which the risks appear is not intended as an indication of their relative weight or importance. Additional risks and uncertainties not currently known to us, or that we currently deem to be immaterial, also may materially adversely affect our business, financial condition and/or future results.

Risk Factors

We are exposed to risks associated with worldwide financial markets and the global economy.

As a result of the continuing global economic downturn, individual consumers are experiencing high unemployment, a lack of credit availability and depressed real estate values. This in turn places continued financial pressure on the consumer, which may reduce our ability to collect on our purchased consumer receivable portfolios and may adversely affect the value of our consumer receivable portfolios. Further, increased financial pressures on the distressed consumer may result in additional regulatory restrictions on our operations and increased litigation filed against us. We cannot predict the likely duration or severity of the current disruption in financial markets and adverse economic conditions and the effects they may have on our business, financial condition, and results of operations.

 

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Our operating results may fluctuate significantly in the future.

Our operating results will likely vary in the future due to a variety of factors that could affect our revenues and operating expenses. We expect that our operating expenses as a percentage of collections will fluctuate in the future as we expand into new markets, increase our business development efforts, hire additional personnel, and incur increased insurance and regulatory compliance costs. In addition, our operating results have fluctuated and may continue to fluctuate as a result of the factors described below and elsewhere in this Annual Report on Form 10-K for the fiscal year ended December 31, 2011:

 

   

the timing and amount of collections on our receivable portfolios, including the effects of seasonality and economic conditions;

 

   

any charge to earnings resulting from an allowance against the carrying value of our receivable portfolios;

 

   

increases in operating expenses associated with the growth or change of our operations;

 

   

the cost of credit to finance our purchases of receivable portfolios; and

 

   

the timing and terms of our purchases of receivable portfolios.

Due, in part, to fluctuating prices for receivable portfolios, there has been considerable variation in our purchasing volume from quarter to quarter and we expect that to continue. The volume of our portfolio purchases will be limited when prices are high, and may or may not increase when portfolio pricing is more favorable to us. We believe our ability to collect on receivable portfolios may be negatively impacted because of current economic conditions, and this may require us to increase our projected return hurdles in calculating prices we are willing to pay for individual portfolios. An increase in portfolio return hurdles may decrease the volume of portfolios we are successful in purchasing. Because we recognize revenue on the basis of projected collections on purchased portfolios, we may experience variations in quarterly revenue and earnings due to the timing of portfolio purchases.

We may not be able to purchase receivables at favorable prices or terms, or at all.

Our ability to continue to operate profitably depends upon the continued availability of receivable portfolios that meet our purchasing standards and are cost-effective based upon projected collections exceeding our costs. Our profitability also depends on our actual collections on accounts meeting or exceeding our projected collections. We do not know how long portfolios will be available for purchase on terms acceptable to us, or at all.

The availability of receivable portfolios at favorable prices and on favorable terms depends on a number of factors, including:

 

   

continued high levels of default in consumer debt;

 

   

continued sale of receivable portfolios by originating institutions and portfolio resellers at sufficient volumes and prevailing price levels;

 

   

our ability to develop and maintain long-term relationships with key major credit originators and portfolio resellers;

 

   

our ability to obtain adequate data from credit originators or portfolio resellers to appropriately evaluate the collectability of, and estimate the value of, portfolios;

 

   

changes in laws and regulations governing consumer lending, bankruptcy and collections; and

 

   

potential availability of government funding to competing purchasers for the acquisition of account portfolios under various programs intended to serve as an economic stimulus.

 

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In addition, because of the length of time involved in collecting charged-off consumer receivables on acquired portfolios and the volatility in the timing of our collections, we may not be able to identify trends and make changes in our purchasing strategies in a timely manner. Ultimately, if we are unable to continually purchase and collect on a sufficient volume of receivables to generate cash collections that exceed our costs, our business will be materially and adversely affected.

We may experience losses on portfolios consisting of new types of receivables due to our lack of collection experience with these receivables.

We continually look for opportunities to expand the classes of assets that make up the portfolios we acquire. Therefore, we may acquire portfolios consisting of assets with which we have little or no collection experience. Our lack of experience with new types of receivables may cause us to pay too much for these receivable portfolios, which may substantially hinder our ability to generate profits from such portfolios. Further, our existing methods of collections may prove ineffective for such new receivables, and we may not be able to collect on these portfolios. Our inexperience may have a material adverse effect on our results of operations.

We may purchase receivable portfolios that contain unprofitable accounts and we may not be able to collect sufficient amounts to recover our costs and to fund our operations.

We acquire and service receivables that the obligors have failed to pay and the sellers have deemed uncollectible and written off. The originating institutions generally make numerous attempts to recover on their nonperforming receivables, often using a combination of their in-house collection and legal departments, as well as third-party collection agencies. In order to operate profitably over the long term, we must continually purchase and collect on a sufficient volume of receivables to generate revenue that exceeds our costs. These receivables are difficult to collect, and we may not be successful in collecting amounts sufficient to cover the costs associated with purchasing the receivables and funding our operations. If we are not able to collect on these receivables or collect sufficient amounts to cover our costs, this may materially and adversely affect our results of operations.

Sellers may deliver portfolios that contain accounts which do not meet our account collection criteria.

In the normal course of our portfolio acquisitions, some receivables may be included in the portfolios that fail to conform to the terms of the purchase agreements and we may seek to return these receivables to the sellers for payment or replacement. However, sellers may not be able to meet their obligations to us. Accounts that we are unable to return to sellers may yield no return. If sellers deliver portfolios containing too many accounts that do not conform to the terms of the purchase agreements, we may be unable to collect a sufficient amount and the portfolio purchase could be unprofitable, which would have an adverse effect on our cash flows. If cash flows from operations are less than anticipated, our ability to satisfy our debt obligations and purchase new portfolios may be materially and adversely affected. If we are not able to satisfy our debt obligations and purchase new portfolios, this may materially and adversely affect our results of operations.

A significant portion of our portfolio purchases during any period may be concentrated with a small number of sellers.

We expect that a significant percentage of our portfolio purchases for any given fiscal year may be concentrated with a few large sellers, some of which also may involve forward flow arrangements. We cannot be certain that any of our significant sellers will continue to sell charged-off receivables to us on terms or in quantities acceptable to us, or that we would be able to replace such purchases with purchases from other sellers.

A significant decrease in the volume of purchases available from any of our principal sellers on terms acceptable to us would force us to seek alternative sources of charged-off receivables. We may be unable to find alternative sources from which to purchase charged-off receivables, and even if we could successfully replace such purchases, the search could take time, the receivables could be of lower quality, cost more, or both, any of which could materially adversely affect our financial performance.

 

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The statistical models we use to project remaining cash flows from our receivable portfolios may prove to be inaccurate and, if so, our financial results may be adversely impacted.

We use our internally developed Unified Collection Score, or UCS model, and Behavioral Liquidation Score, or BLS model, to project the remaining cash flows from our receivable portfolios. Our UCS and BLS models consider known data about our consumers’ accounts, including, among other things, our collection experience and changes in external consumer factors, in addition to all data known when we acquired the accounts. However, we may not be able to achieve the collections forecasted by our UCS and BLS models. If we are not able to achieve these levels of forecasted collection, our revenues will be reduced or we may be required to record an allowance charge, which may materially and adversely impact our results of operations.

We may incur allowance charges based on the authoritative guidance for loans and debt securities acquired with deteriorated credit quality.

We account for our portfolio revenue in accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality. The authoritative guidance limits the revenue that may be accrued to the excess of the estimate of expected future cash flows over a portfolio’s initial cost of accounts receivable acquired, requires that the excess of the contractual cash flows over expected cash flows not be recognized as an adjustment of revenue, expense, or on the balance sheet, and freezes the IRR originally estimated when the accounts receivable are purchased for subsequent allowance testing. Rather than lower the estimated IRR if the expected future cash flow estimates are decreased, the carrying value of our receivable portfolios would be written down to maintain the then-current IRR. Increases in expected future cash flows would be recognized prospectively through an upward adjustment of the IRR over a portfolio’s remaining life. Any increased yield then becomes the new benchmark for allowance testing. Since the authoritative guidance does not permit yields to be lowered, there is an increased probability of our having to incur allowance charges in the future, which would negatively impact our results of operations.

If our goodwill or amortizable intangible assets become impaired we may be required to record a significant charge to earnings.

We carry approximately $16.0 million in goodwill and approximately $0.5 million in amortizable intangible assets on our balance sheet. Under authoritative guidance, we review our goodwill for potential impairment at least annually, and review our amortizable intangible assets for impairment whenever events or changes in circumstances indicate that the carrying value may not be recoverable. Factors that may indicate that the carrying value of our goodwill or amortizable intangible assets may not be recoverable include adverse changes in estimated future cash flows, growth rates and discount rates. We may be required to record a significant charge in our financial statements during the period in which any impairment of our goodwill or amortizable intangible assets is determined, which could negatively impact our results of operations.

Our business of enforcing the collection of purchased receivables is subject to extensive statutory and regulatory oversight, which has increased and may continue to increase.

Laws relating to debt collections directly apply to our business. Our failure or the failure of third party agencies and attorneys or the originators of our receivables to comply with existing or new laws, rules or regulations could limit our ability to recover on receivables or cause us to pay damages to the original consumers, which could reduce our revenues and harm our business.

We sometimes purchase accounts in asset classes that are subject to industry-specific restrictions that limit the collection methods that we can use on those accounts. Our inability to collect sufficient amounts from these accounts through available collections methods could materially and adversely affect our results of operations.

In response to the global economic downturn, or otherwise, additional consumer protection or privacy laws, rules and regulations may be enacted that impose additional restrictions on the collection of receivables. Such

 

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new laws, rules and regulations and the enforcement of them or increased enforcement of existing consumer protection or privacy laws, rules and regulations may materially and adversely affect our ability to collect on our receivables, which could materially and adversely affect our business and results of operations.

Our results of operations may be materially and adversely affected if bankruptcy filings increase or if bankruptcy or other debt collection laws change.

Our business model may be uniquely vulnerable to an economic recession, which typically results in an increase in the amount of defaulted consumer receivables, thereby contributing to an increase in the amount of personal bankruptcy filings. Under certain bankruptcy filings, a consumer’s assets are sold to repay credit originators, with priority given to holders of secured debt. Since the defaulted consumer receivables we purchase are generally unsecured, we often are not able to collect on those receivables. In addition, since we purchase receivables that may have been delinquent for a long period of time, this may be an indication that many of the consumers from whom we collect will be unable to service their debts going forward and are more likely to file for bankruptcy in an economic recession. We cannot be certain that our collection experience would not decline with an increase in bankruptcy filings. If our actual collection experience with respect to a defaulted consumer receivable portfolio is significantly lower than we projected when we purchased the portfolio, our results of operations could be materially and adversely affected.

Failure to comply with government regulation could result in the suspension or termination of our ability to conduct business, may require the payment of significant fines and penalties, or require other significant expenditures.

The collections industry is heavily regulated under various federal, state, and local laws, rules and regulations. Many states and several cities require that we be licensed as a debt collection company. The Federal Trade Commission, state attorneys general and other regulatory bodies have the authority to investigate a variety of matters, including consumer complaints against debt collection companies, and to recommend enforcement actions and seek monetary penalties. If we, or our third party collection agencies or law firms fail to comply with applicable laws, rules and regulations, including, but not limited to, identity theft, privacy, data security, the use of automated dialing equipment, laws related to consumer protection, debt collection, and laws applicable to specific types of debt, it could result in the suspension or termination of our ability to conduct collection operations, which would materially adversely affect us. Further, our ability to collect our receivables may be impacted by state laws, which require that certain types of account documentation be in our possession prior to the institution of any collection activities. In addition, new federal, state or local laws or regulations, or changes in the ways these rules or laws are interpreted or enforced, could limit our activities in the future and/or significantly increase the cost of regulatory compliance.

We are dependent upon third parties to service more than half of our consumer receivable portfolios.

We use outside collection services to collect a substantial portion of our receivables. We are dependent upon the efforts of third-party collection agencies and attorneys to service and collect our consumer receivables. Any failure by our third-party collection agencies and attorneys to perform collection services for us adequately or remit such collections to us could materially reduce our revenue and our profitability. In addition, if one or more of those third-party collection agencies or attorneys were to cease operations abruptly, or to become insolvent, such cessation or insolvency could materially reduce our revenue and profitability. Our revenue and profitability could also be materially adversely affected if we were not able to secure replacement third party collection agencies or attorneys or promptly transfer account information to our new third party collection agencies, attorneys or in-house in the event our agreements with our third-party collection agencies and attorneys were terminated. Our revenue and profitability could also be materially adversely affected if our third-party collection agencies or attorneys fail to perform their obligations adequately, or if our relationships with such third-party collection agencies and attorneys otherwise change adversely.

 

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Increases in costs associated with our collections through collection litigation can materially raise our costs associated with our collection strategies and the individual lawsuits brought against consumers to collect on judgments in our favor.

We hire in-house counsel and contract with a nationwide network of attorneys that specialize in collection matters. In connection with collection litigation, we advance certain out-of-pocket court costs, or Deferred Court Costs. Deferred Court Costs represent amounts we believe we will recover from our consumers, in addition to the amounts owed on our consumers’ accounts that we expect to collect. These court costs may be difficult or impossible to collect, and we may not be successful in collecting amounts sufficient to cover the amounts deferred in our financial statements. If we are not able to recover these court costs, this may materially and adversely affect our results of operations.

Further, we have substantial collection activity through our legal channel and as a consequence, increases in Deferred Court Costs, increases in costs related to counterclaims and an increase in other court costs, may increase our costs in collecting on these accounts, which may have a material adverse effect on our results of operations.

Our network of third party agencies and attorneys may not utilize amounts collected on our behalf or amounts we advance for court costs in the manner for which they were intended.

In the normal course of operations our third party collection agencies and attorneys collect funds on our behalf. These third parties may fail to remit amounts owed to us in a timely manner or at all. Additionally, we advance court costs to our third party attorneys which are intended for their use in filing lawsuits on our behalf. These third party attorneys may misuse some or all of the funds we advance to them. Our ability to recoup our funds may be diminished if these third parties become insolvent or enter into bankruptcy proceedings.

A significant portion of our collections relies upon our success in individual lawsuits brought against consumers and our ability to collect on judgments in our favor.

We generate a significant portion of our revenue by collecting on judgments that are granted by courts in lawsuits filed against consumers. A decrease in the willingness of courts to grant such judgments, a change in the requirements for filing such cases or obtaining such judgments, or a decrease in our ability to collect on such judgments could have a material and adverse effect on our results of operations. As we increase our use of the legal channel for collections, our short-term margins may decrease as a result of an increase in upfront court costs and costs related to counter claims. We may not be able to collect on certain aged accounts because of applicable statutes of limitations and we may be subject to adverse effects of regulatory changes. Further, courts in certain jurisdictions require that a copy of the account statements or applications be attached to the pleadings in order to obtain a judgment against consumers. If we are unable to produce those account documents, because the account documents have not been provided by the account’s seller or otherwise, these courts could deny our claims.

We are subject to ongoing risks of litigation, including individual and class action lawsuits, under consumer credit, consumer protection, theft, privacy, collections, and other laws, and may be subject to awards of substantial damages.

We operate in an extremely litigious climate and currently are, and may in the future be, named as defendants in litigation, including individual and class action lawsuits under consumer credit, consumer protection, theft, privacy, data security, automated dialing equipment, debt collections and other laws. Many of these cases present novel issues on which there is no clear legal precedent, which increases the difficulty in predicting both the potential outcomes and costs of defending these cases. We currently are, and may in the future be, subject to regulatory investigations, inquiries, litigation, and other actions by the Federal Trade Commission, state attorneys general or other governmental bodies relating to our activities. The litigation and

 

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regulatory actions in which we are currently engaged or which we may become subject to involve potential compensatory or punitive damage claims, fines, sanctions or injunctive relief that, if granted, could require us to pay damages or make other expenditures in amounts that could have a material adverse effect on our financial position and negatively impact results of operations. We have recorded loss contingencies in our financial statements only for matters on which losses are probable and can be reasonably estimated. Our assessments of these matters involve significant judgments, and may change from time to time. Actual losses incurred by us in connection with judgments or settlements of these matters may be more than our associated reserves. Furthermore, defending lawsuits and responding to governmental inquiries or investigations, regardless of their merit, could be costly and divert management’s attention from the operation of our business. All of these factors could have a material adverse effect on our business, financial condition, and results of operations.

Negative publicity associated with litigation, governmental investigations, regulatory actions, and other public statements could damage our reputation.

From time to time there are negative news stories about our industry or company, especially with respect to alleged conduct in collecting debt from customers. Such stories may follow the announcements of litigation or regulatory actions involving us or others in our industry. Negative publicity about our alleged or actual debt collection practices or about the debt collection industry generally could adversely impact our stock price and our ability to retain and attract customers and employees.

We may make acquisitions that prove unsuccessful or strain or divert our resources.

From time to time, we consider acquisitions of other companies that could complement our business, including the acquisition of entities in diverse geographic regions and entities offering greater access to businesses and markets that we do not currently serve. We may not be able to successfully acquire other businesses or, if we do, the acquisition may be unprofitable. If we do acquire one or more businesses, we may not successfully operate the businesses acquired, or may not successfully integrate such businesses with our own, which may result in our inability to maintain our goals, objectives, standards, controls, policies, culture, or profitability. In addition, through acquisitions, we may enter markets in which we have limited or no experience. The occurrence of one or more of these events may place additional constraints on our resources such as diverting the attention of our management from other business concerns, which may materially adversely affect our operations and financial condition. Moreover, any acquisition may result in a potentially dilutive issuance of equity securities, incurrence of additional debt, and amortization of identifiable intangible assets, all of which could reduce our profitability.

We are dependent on our management team for the adoption and implementation of our strategies and the loss of its services could have a material adverse effect on our business.

Our management team has considerable experience in finance, banking, consumer collections, and other industries. We believe that the expertise of our executives obtained by managing businesses across numerous other industries has been critical to the enhancement of our operations. Our management team has created a culture of new ideas and progressive thinking, coupled with increased use of technology and statistical analysis. The loss of the services of one or more of our key executive officers could disrupt our operations and seriously impair our ability to continue to acquire or collect on portfolios of charged-off consumer receivables and to manage and expand our business. Our success depends on the continued service and performance of our management team, and we may not be able to retain such individuals.

Regulatory, political, and economic conditions in India expose us to risk, including loss of business.

A significant element of our business strategy is to continue to develop and expand offshore operations in India. While wage costs in India are significantly lower than in the U.S. and other industrialized countries for comparably skilled workers, wages in India are increasing at a faster rate than in the U.S., and we experience

 

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higher employee turnover in our operations in India than is typical in our U.S. locations. The continuation of these trends could result in the loss of the cost savings we sought to achieve by establishing a portion of our collection operations in India. In the past, India has experienced significant inflation and shortages of readily available foreign currency for exchange and has been subject to civil unrest. We may be adversely affected by changes in inflation, exchange rate fluctuations, interest rates, tax provisions, social stability or other political, economic or diplomatic developments in or affecting India in the future. In addition, the infrastructure of the economy in India is relatively poor. Further, the Indian government is significantly involved in and exerts considerable influence over its economy through its complicated tax code and pervasive bureaucracy. In the recent past, the Indian government has provided significant tax incentives and relaxed certain regulatory restrictions in order to encourage foreign investment in certain sectors of the economy, including the technology industry. Changes in the business or regulatory climate of India could have a material and adverse effect on our business, results of operations and financial condition.

We may not be able to manage our growth effectively, including the expansion of our operations in India, and our newly established operations in Costa Rica.

We have expanded significantly in recent years. However, future growth will place additional demands on our resources, and we cannot be sure that we will be able to manage our growth effectively. Continued growth could place a strain on our management, operations, and financial resources. Our infrastructure, facilities, and personnel may not be adequate to support our future operations or to effectively adapt to future growth. To support our growth and improve our operations, we continue to make investments in infrastructure, facilities and personnel in our operations in the U.S., India and Costa Rica; however, these additional investments may not be successful or our investments may not produce profitable results. If we cannot manage our growth effectively, our results of operations may be materially and adversely affected.

If our technology and telecommunications systems were to fail, or if we are not able to successfully anticipate, invest in, or adopt technological advances within our industry, it could have an adverse effect on our operations.

Our success depends in large part on sophisticated computer and telecommunications systems. The temporary or permanent loss of our computer and telecommunications equipment and software systems, through casualty, operating malfunction, software virus, or service provider failure, could disrupt our operations. In the normal course of our business, we must record and process significant amounts of data quickly and accurately to properly bid on prospective acquisitions of receivable portfolios and to access, maintain and expand the databases we use for our collection activities. Any simultaneous failure of our information systems and their backup systems would interrupt our business operations.

In addition, our business relies on computer and telecommunications technologies, and our ability to integrate new technologies into our business is essential to our competitive position and our success. We may not be successful in anticipating, investing in, or adopting technological changes in a timely basis. Computer and telecommunications technologies are evolving rapidly and are characterized by short product life cycles.

We continue to make significant modifications to our information systems to ensure that they continue to meet our current and foreseeable demands and continued expansion, and our future growth may require additional investment in these systems. These system modifications may exceed our cost or time estimates for completion or may be unsuccessful. If we cannot update our information systems effectively, our results of operations may be materially and adversely affected.

We may not be able to adequately protect the intellectual property rights upon which we rely and, as a result, any lack of protection may materially diminish our competitive advantage.

We rely on proprietary software programs and valuation and collection processes and techniques, and we believe that these assets provide us with a competitive advantage. We consider our proprietary software,

 

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processes, and techniques to be trade secrets, but they are not protected by patent or registered copyright. We may not be able to protect our technology and data resources adequately, which may materially diminish our competitive advantage.

Item 1B—Unresolved Staff Comments

None.

Item 2—Properties

Our corporate headquarters and primary operations facility are located in approximately 87,900 square feet in two separate leased locations in San Diego, California.

We lease a facility for our call center located in Phoenix, Arizona with approximately 33,000 square feet of space and a facility for our call center located in St. Cloud, Minnesota with approximately 46,000 square feet of space.

Our leased Ascension facility is located in Arlington, Texas and is approximately 28,600 square feet. This facility serves as our bankruptcy servicing center.

We also lease a facility in Gurgaon, India. The facility in India has approximately 111,500 square feet of space and can accommodate approximately 1,850 employees. Our facility in India serves as a call center, bankruptcy servicing center, and administrative offices.

In addition, we entered into a lease that became effective in January 2012 to occupy approximately 20,900 square feet of space in Costa Rica. This facility can accommodate approximately 200 employees. This facility serves as an additional call center.

We believe that our current leased facilities are generally well maintained and in good operating condition. We believe that these facilities are suitable and sufficient for our operational needs. Our policy is to improve, replace, and supplement the facilities as considered appropriate to meet the needs of the individual operations.

Item 3—Legal Proceedings

We are involved in disputes and legal actions from time to time in the ordinary course of business. We, along with others in our industry, are routinely subject to legal actions based on the Fair Debt Collection Practices Act (“FDCPA”) comparable state statutes, the Telephone Consumer Protection Act (“TCPA”), state and federal unfair competition statutes, and common law causes of action. The violations of law alleged in these actions often include claims that we lack specified licenses to conduct our business, attempt to collect debts on which the statute of limitations has run, have made inaccurate assertions of fact in support of our collection actions and/or have acted improperly in connection with our efforts to contact consumers. These cases are frequently styled as supposed class actions. In addition, from time to time, we are subject to litigation and other actions by governmental bodies, including formal and informal investigations relating to our collection activities by the Federal Trade Commission, state attorneys general and other governmental bodies, with which we cooperate.

On May 19, 2008, an action captioned Brent v. Midland Credit Management, Inc et. al was filed in the United States District Court for the Northern District of Ohio Western Division, in which the plaintiff filed a class action counter-claim against two of our subsidiaries (the “Midland Defendants”). The complaint alleged

 

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that the Midland Defendants’ business practices violated consumers’ rights under the FDCPA and the Ohio Consumer Sales Practices Act. The plaintiff sought actual and statutory damages for the class of Ohio residents, plus attorney’s fees and costs of class notice and class administration. On August 12, 2011, the court issued an order granting final approval to the parties agreed upon settlement of this lawsuit, as well as two other pending lawsuits in the Northern District of Ohio entitled Franklin v. Midland Funding LLC and Vassalle v. Midland Funding LLC, on a national class basis, and dismissed the cases against the Midland Defendants with prejudice. That order has been appealed by certain objectors to the settlement, which appeals remain pending.

On November 2, 2010 and December 17, 2010 two national class actions entitled Robinson v. Midland Funding LLC and Tovar v. Midland Credit Management, respectively, were filed in the United States District Court for the Southern District of California. The complaints allege that our subsidiaries violated the TCPA by calling consumers’ cellular phones without their prior express consent. The complaints seek monetary damages under the TCPA, injunctive relief, and other relief, including attorney fees. On May 10, 2011 and May 11, 2011 two class actions entitled Scardina v. Midland Credit Management, Inc. Midland Funding LLC and Encore Capital Group, Inc. and Martin v. Midland Funding, LLC, respectively, were filed in the United States District Court for the Northern District of Illinois. The complaints allege on behalf of a putative class of Illinois consumers that our subsidiaries violated the TCPA by calling consumers’ cellular phones without their prior express consent. The complaints seek monetary damages under the TCPA, injunctive relief, and other relief, including attorney fees. On July 28, 2011, we filed a motion to transfer the Scardina and Martin cases to the United States District Court for the Southern District of California to be consolidated with the Tovar and Robinson cases. On October 11, 2011, the United States Judicial Panel on Multidistrict Litigation granted our motion to transfer.

In certain legal proceedings, we may have recourse to insurance or third party contractual indemnities to cover all or portions of our litigation expenses, judgments, or settlements. In accordance with authoritative guidance, we record loss contingencies in our financial statements only for matters in which losses are probable and can be reasonably estimated. Where a range of loss can be reasonably estimated with no best estimate in the range, we record the minimum estimated liability. We continuously assess the potential liability related to our pending litigation and revise our estimates when additional information becomes available. Our legal costs are recorded to expense as incurred.

Item 4—Mine Safety Disclosures

Not applicable.

 

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PART II

Item 5—Market for the Registrant’s Common Equity, Related Stockholder Matters and Issuer Purchase of Equity Securities

Our common stock is traded on the NASDAQ Global Select Market under the symbol “ECPG.”

The high and low sales prices of our common stock, as reported by NASDAQ Global Select Market for each quarter during our two most recent fiscal years, are reported below:

 

     Market Price  
     High      Low  

Fiscal Year 2011

     

First Quarter

   $ 27.67       $ 21.65   

Second Quarter

     33.16         23.85   

Third Quarter

     31.78         18.96   

Fourth Quarter

     28.50         19.40   

Fiscal Year 2010

     

First Quarter

     18.66         14.65   

Second Quarter

     24.09         16.50   

Third Quarter

     22.92         17.50   

Fourth Quarter

     23.67         16.70   

The closing price of our common stock on February 1, 2012, was $24.27 per share and there were 15 stockholders of record. Because many of our shares of common stock are held by brokers and other institutions on behalf of stockholders, we are unable to estimate the total number of stockholders represented by these stockholders of record.

The following Performance Graph and related information shall not be deemed “soliciting material” or “filed” with the SEC, nor shall such information be incorporated by reference into any future filing under the Securities Act of 1933 or Securities Exchange Act of 1934, each as amended, except to the extent that we specifically incorporate it by reference into such filing.

The following graph compares the total cumulative stockholder return on our common stock for the period from December 29, 2006 through December 31, 2011, with the cumulative total return of (a) the NASDAQ Index and (b) Asset Acceptance Capital Corp., Asta Funding, Inc. and Portfolio Recovery Associates, Inc., which we believe are comparable companies. The comparison assumes that $100 was invested on December 29, 2006, in our common stock and in each of the comparison indices.

 

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LOGO

 

     12/2006      12/2007      12/2008      12/2009      12/2010      12/2011  

Encore Capital Group, Inc.

   $ 100.00       $ 76.83       $ 57.14       $ 138.10       $ 186.11       $ 168.73   

NASDAQ Composite

     100.00         110.26         65.65         95.19         112.10         110.81   

Peer Group

     100.00         81.76         44.86         62.71         91.45         80.27   

Dividend Policy

As a public company, we have never declared or paid dividends on our common stock. However, the declaration, payment and amount of future dividends, if any, is subject to the discretion of our board of directors, which may review our dividend policy from time to time in light of the then existing relevant facts and circumstances. Under the terms of our revolving credit facility, we are permitted to declare and pay dividends in an amount not to exceed, during any fiscal year, 20% of our audited consolidated net income for the then most recently completed fiscal year, so long as no default or unmatured default under the facility has occurred and is continuing or would arise as a result of the dividend payment. We may also be subject to additional dividend restrictions under future financing facilities.

 

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Item 6—Selected Financial Data

This table presents selected historical financial data of Encore Capital Group, Inc. and its consolidated subsidiaries. This information should be carefully considered in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The selected data in this section are not intended to replace the consolidated financial statements. The selected financial data (except for “Selected Operating Data”) in the table below, as of December 31, 2009, 2008, and 2007 and for the years ended December 31, 2008 and 2007, were derived from our audited consolidated financial statements not included in this Annual Report on Form 10-K. The selected financial data as of December 31, 2011, and 2010 and for the years ended December 31, 2011, 2010, and 2009, were derived from our audited consolidated financial statements included elsewhere in this Annual Report on Form 10-K. The Selected Operating Data were derived from our books and records (in thousands, except per share and personnel data):

 

     As of and For The Year Ended December 31,  
     2011     2010     2009     2008     2007  

Revenues

          

Revenue from receivable portfolios, net(1)

   $ 448,714      $ 364,294      $ 299,732      $ 240,802      $ 241,402   

Servicing fees and related revenue(2)

     18,657        17,014        16,687        15,087        12,609   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     467,371        381,308        316,419        255,889        254,011   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

          

Salaries and employee benefits

     81,509        65,767        58,025        58,120        64,153   

Stock-based compensation expense

     7,709        6,010        4,384        3,564        4,287   

Cost of legal collections

     157,050        121,085        112,570        96,187        78,636   

Other operating expenses

     39,776        36,387        26,013        23,652        21,533   

Collection agency commissions

     14,162        20,385        19,278        13,118        12,411   

General and administrative expenses

     41,730        31,444        26,920        19,445        17,478   

Depreciation and amortization

     4,661        3,199        2,592        2,814        3,351   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     346,597        284,277        249,782        216,900        201,849   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     120,774        97,031        66,637        38,989        52,162   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) income

          

Interest expense

     (21,116     (19,349     (16,160     (20,572     (34,504

Other (expense) income

     (394     316        3,266        5,129        1,071   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     (21,510     (19,033     (12,894     (15,443     (33,433
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     99,264        77,998        53,743        23,546        18,729   

Provision for income taxes

     (38,306     (28,946     (20,696     (9,700     (6,498
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 60,958      $ 49,052      $ 33,047      $ 13,846      $ 12,231   
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Earnings per share:

          

Basic

   $ 2.48      $ 2.05      $ 1.42      $ 0.60      $ 0.53   

Diluted

   $ 2.37      $ 1.95      $ 1.37      $ 0.59      $ 0.52   

Weighted-average shares outstanding:

          

Basic

     24,572        23,897        23,215        23,046        22,876   

Diluted

     25,690        25,091        24,082        23,577        23,386   

 

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     As of and For The Year Ended December 31,  
     2011     2010     2009     2008     2007  

Cash flow data:

          

Cash flows provided by (used in):

          

Operating activities

   $ 84,579      $ 75,475      $ 76,519      $ 63,071      $ 19,610   

Investing activities

     (88,088     (142,807     (79,171     (107,252     (95,059

Financing activities

     651        69,849        699        45,846        73,334   

Selected operating data:

          

Purchases of receivable portfolios, at cost(3)

   $ 386,850      $ 361,957      $ 256,632      $ 230,278      $ 208,953   

Gross collections for the period

     761,158        604,609        487,792        398,633        355,193   

Consolidated statements of financial condition data:

          

Cash and cash equivalents

   $ 8,047      $ 10,905      $ 8,388      $ 10,341      $ 8,676   

Investment in receivable portfolios, net

     716,454        644,753        526,877        461,346        392,209   

Total assets

     812,483        736,468        595,159        549,079        483,011   

Total debt

     388,950        385,264        303,075        303,655        256,223   

Total liabilities

     440,948        433,771        352,068        345,653        295,576   

Total stockholders’ equity

     371,535        302,697        243,091        203,426        187,435   

 

(1) 

Includes net allowance charges of $10.8 million, $22.2 million, $19.3 million, $41.4 million and $11.2 million for the years ended December 31, 2011, 2010, 2009, 2008, and 2007, respectively.

(2) 

Includes $18.6 million, $16.9 million, $16.7 million, $15.0 million and $12.5 million in revenue from Ascension for the years ended December 31, 2011, 2010, 2009, 2008, and 2007, respectively.

(3) 

Purchase price includes a $10.3 million, $5.6 million and $11.7 million allocation of our forward flow asset for 2009, 2008 and 2007, respectively. In July 2008, we ceased forward flow purchases from Jefferson Capital Systems, LLC (“Jefferson Capital”) due to an alleged breach by Jefferson Capital and its parent, CompuCredit Corporation, of certain agreements. In September 2009, we settled our dispute with Jefferson Capital. As part of the settlement, we purchased a receivable portfolio and applied the remaining forward flow asset to that purchase.

 

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Item 7—Management’s Discussion and Analysis of Financial Condition and Results of Operations

This Annual Report on Form 10-K contains “forward-looking statements” within the meaning of the securities laws. The words “believe,” “expect,” “anticipate,” “estimate,” “project,” “intend,” “plan,” “will,” “may” and similar expressions often characterize forward-looking statements. These statements may include, but are not limited to, projections of collections, revenues, income or loss, estimates of capital expenditures, plans for future operations, products or services and financing needs or plans, as well as assumptions relating to these matters. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we caution that these expectations or predictions may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control or cannot be predicted or quantified, that could cause actual results to differ materially from those suggested by the forward-looking statements. Many factors, including but not limited to those set forth in this Annual Report on Form 10-K under “Part I, Item 1A. Risk Factors,” could cause our actual results, performance, achievements or industry results to be very different from the results, performance or achievements expressed or implied by these forward-looking statements. Our business, financial condition or results of operations could also be materially and adversely affected by other factors besides those listed. Forward-looking statements speak only as of the date the statements were made. We do not undertake any obligation to update or revise any forward-looking statements to reflect new information or future events, or for any other reason, even if experience or future events make it clear that any expected results expressed or implied by these forward-looking statements will not be realized. In addition, it is generally our policy not to make any specific projections as to future earnings, and we do not endorse projections regarding future performance that may be made by third parties.

Introduction

We are a leader in consumer debt buying and recovery. We purchase portfolios of defaulted consumer receivables at deep discounts to face value based on robust, account-level valuation methods, and employ a suite of proprietary statistical and behavioral models when building account collection strategies. We use a variety of operational channels to maximize our collections from the portfolios that we purchase, including seeking to partner with individuals as they repay their obligations and work toward financial recovery. In addition, we provide bankruptcy support services to some of the largest companies in the financial services industry through our wholly owned subsidiary, Ascension Capital Group, Inc. (“Ascension”).

While seasonality does not have a material impact on our business, collections are generally strongest in our first calendar quarter, slower in the second and third calendar quarters, and slowest in the fourth calendar quarter. Relatively higher collections in the first quarter could result in a lower cost-to-collect ratio compared to the other quarters, as our fixed costs would be constant and applied against a larger collection base. The seasonal impact on our business may be influenced by our purchasing levels, the types of portfolios we purchase, and our operating strategies.

Collection seasonality can also impact our revenue recognition rate. Generally, revenue for each pool group declines steadily over time, whereas collections can fluctuate from quarter to quarter based on seasonality, as described above. In quarters with lower collections (like the fourth calendar quarter), revenue as a percentage of collections can be higher than in quarters with higher collections (like the first calendar quarter).

In addition, seasonality could have an impact on the relative level of quarterly earnings. In quarters with stronger collections, total costs are higher, as a result of the additional efforts required to generate those collections. Since revenue for each pool group declines steadily over time, in quarters with stronger collections and higher costs (like the first calendar quarter), all else being equal, earnings could be lower than in quarters with slower collections and lower costs (like the fourth calendar quarter). Additionally, in quarters where a greater percentage of collections come from our legal and agency outsourcing channels, cost to collect will be higher than if there were more collections from our internal collection sites.

 

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Market Overview

While there has been improvement in macroeconomic indicators during the last twelve months, a broad economic recovery has yet to fully materialize for the U.S. consumer. Minimal job growth, uncertainty over state and federal taxes, and limited credit availability continue to challenge U.S. consumers, as demonstrated by weak consumer spending and volatile but rising consumer confidence levels. Within the credit card space, delinquency levels have improved at a rate that may indicate a fundamental improvement in consumer financial strength. However, related measures, like personal bankruptcies and home foreclosures, remain elevated and indicate continued near-term pressure on the average consumer.

Despite this macroeconomic uncertainty through the fourth quarter of 2011, most of our internal collection metrics were consistent with, or better than, what we observed during the same periods in 2009 and 2010. To illustrate, payer rates and average payment size, adjusted for changes in the mix of settlements-in-full versus payment plans, remained consistent. As compared to prior years, more of our consumers continue to opt to settle their debt obligations through payment plans as opposed to one-time settlements. Settlements made through payment plans impact our recoveries in two ways. First, the delay in cash flows from payments received over extended time periods may result in a provision for portfolio allowance. When a long-term payment stream (as compared to a one-time payment of the same amount) is discounted using a pool group’s internal rate of return, or IRR, the net present value is lower. In other words, despite the absolute value of total cash received being identical in both scenarios, accounting for the timing of cash flows in a payment plan yields a lower net present value which, in turn, can result in a provision for portfolio allowance. Second, payment plans inherently contain the possibility of consumers failing to complete all scheduled payments, which we term a “broken payer.”

The rate at which consumers are honoring their obligations and completing their payment plans has continued to increase over the last 12 months. We believe this is the result of two factors: our commitment to partner effectively with consumers during their recovery process and the strength of our analytic platform, which allows us to make accurate and timely decisions about how best to maximize our portfolio returns. Nevertheless, payment plans may still produce broken payers that fail to fulfill all scheduled payments. When this happens, we are often successful in getting the consumer back on plan, but this is not always the case, and in those instances where we are unable to do so, we may experience a shortfall in recoveries as compared to our initial forecasts. Please refer to “Management’s Discussion and Analysis – Revenue” below for a more detailed explanation of the provision for portfolio allowances.

Throughout the credit crisis, we strategically invested in receivable portfolios as credit card charge-offs increased to historic levels and we believe that some of our competitors were (i) caught owning receivables with low yields as a result of purchasing certain portfolios at elevated pricing levels between 2005 and 2008 and (ii) faced with constrained access to capital to fund portfolio purchases due to depressed capital markets. These dynamics resulted in a supply-demand gap that dramatically reduced pricing of available portfolios, beginning in early 2009. For example, prices for freshly charged-off assets (i.e., receivables sold within thirty days of charge-off by the credit issuers) declined from a range of 8% – 13% in 2008 to a range of 5% – 9% in 2009 and early 2010. Similar price reductions were apparent across a broad range of defaulted consumer receivable asset classes (including credit cards and other consumer loans), balance ranges, and ages. After such a dramatic decline, pricing increased beginning in mid-2010 and has continued to increase throughout 2011. We continue to exercise discipline in portfolio acquisitions, only purchasing those portfolios which meet our internal rate of return hurdle rates. In response to the price declines in 2009 and early 2010, some issuers opted not to sell all of their receivable portfolios and instead, pursued internal liquidation strategies or partnered with third party agencies. We believe that as pricing increases, these issuers will sell a greater percentage of their charged-off portfolios.

 

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Purchases and Collections

Purchases by Type

The following table summarizes the types of charged-off consumer receivable portfolios we purchased during the periods presented (in thousands):

 

     Year Ended December 31,  
     2011      2010      2009  

Credit card

   $ 346,324       $ 341,910       $ 256,632   

Telecom

     38,882         7,842         —     

Consumer bankruptcy receivables(1)

     1,644         12,205         —     
  

 

 

    

 

 

    

 

 

 
   $ 386,850       $ 361,957       $ 256,632   
  

 

 

    

 

 

    

 

 

 

 

(1) 

Represents portfolio receivables subject to Chapter 13 and Chapter 7 bankruptcy proceedings acquired from issuers.

During the year ended December 31, 2011, we invested $386.9 million for portfolios, primarily for charged-off credit card, telecom, and bankruptcy portfolios, with face values aggregating $11.7 billion for an average purchase price of 3.3% of face value. This is a $24.9 million increase, or 6.9%, in the amount invested, compared with the $362.0 million invested during the year ended December 31, 2010, to acquire portfolios, primarily consisting of charged-off credit card, bankruptcy, and telecom portfolios, with a face value aggregating $10.9 billion for an average purchase price of 3.3% of face value. Included in our 2010 purchases was a $45.6 million, one-time, large portfolio purchase from one seller in December 2010.

During the year ended December 31, 2010, we invested $362.0 million for portfolios, primarily for charged-off credit card, bankruptcy and telecom portfolios, with face values aggregating $10.9 billion for an average purchase price of 3.3% of face value. This is a $105.4 million increase, or 41.0%, in the amount invested, compared with the $256.6 million invested during the year ended December 31, 2009, to acquire portfolios, primarily consisting of charged-off credit card portfolios, with a face value aggregating $6.5 billion for an average purchase price of 4.0% of face value. Included in our 2010 purchases was a $45.6 million, one-time, large portfolio purchase from one seller in December 2010.

Average purchase price, as a percentage of face value, varies from period to period depending on, among other things, the quality of the accounts purchased and the length of time from charge-off to the time we purchase the portfolios.

Collections by Channel

During 2011, 2010 and 2009, we utilized numerous business channels for the collection of charged-off credit card receivables and other charged-off receivables. The following table summarizes gross collections by collection channel (in thousands):

 

     Year Ended December 31,  
   2011      2010      2009  

Legal collections

   $ 377,455       $ 266,762       $ 232,667   

Collection sites

     335,992         268,205         185,789   

Collection agencies

     47,657         68,042         62,653   

Other

     54         1,600         6,683   
  

 

 

    

 

 

    

 

 

 
   $ 761,158       $ 604,609       $ 487,792   
  

 

 

    

 

 

    

 

 

 

Gross collections increased $156.6 million, or 25.9%, to $761.2 million during the year ended December 31, 2011, from $604.6 million during the year ended December 31, 2010, primarily due to increased portfolio purchases in the current and prior years.

 

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Gross collections increased $116.8 million, or 23.9%, to $604.6 million during the year ended December 31, 2010, from $487.8 million during the year ended December 31, 2009, primarily due to increased portfolio purchases in the current and prior years.

Results of Operations

Results of operations, in dollars and as a percentage of total revenue, were as follows (in thousands, except percentages):

 

     Year Ended December 31,  
     2011     2010     2009  

Revenues

            

Revenue from receivable portfolios, net

   $ 448,714        96.0   $ 364,294        95.5   $ 299,732        94.7

Servicing fees and related revenue

     18,657        4.0     17,014        4.5     16,687        5.3
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total revenues

     467,371        100.0     381,308        100.0     316,419        100.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Operating expenses

            

Salaries and employee benefits

     81,509        17.5     65,767        17.2     58,025        18.4

Stock-based compensation expense

     7,709        1.7     6,010        1.6     4,384        1.4

Cost of legal collections

     157,050        33.6     121,085        31.8     112,570        35.6

Other operating expenses

     39,776        8.5     36,387        9.5     26,013        8.2

Collection agency commissions

     14,162        3.0     20,385        5.4     19,278        6.1

General and administrative expenses

     41,730        8.9     31,444        8.2     26,920        8.5

Depreciation and amortization

     4,661        1.0     3,199        0.8     2,592        0.8
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total operating expenses

     346,597        74.2     284,277        74.5     249,782        79.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income from operations

     120,774        25.8     97,031        25.5     66,637        21.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Other (expense) income

            

Interest expense

     (21,116     (4.5 )%      (19,349     (5.1 )%      (16,160     (5.1 )% 

Other (expense) income

     (394     (0.1 )%      316        0.1     3,266        1.0
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total other expense

     (21,510     (4.6 )%      (19,033     (5.0 )%      (12,894     (4.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Income before income taxes

     99,264        21.2     77,998        20.5     53,743        16.9

Provision for income taxes

     (38,306     (8.2 )%      (28,946     (7.6 )%      (20,696     (6.5 )% 
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Net income

   $ 60,958        13.0   $ 49,052        12.9   $ 33,047        10.4
  

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Comparison of Results of Operations

Year Ended December 31, 2011 Compared to Year Ended December 31, 2010

Revenues

Our revenues consist primarily of portfolio revenue and bankruptcy servicing revenue. Portfolio revenue consists of accretion revenue and zero basis revenue. Accretion revenue represents revenue derived from pools (quarterly groupings of purchased receivable portfolios) with a cost basis that has not been fully amortized. Revenue from pools with a remaining unamortized cost basis is accrued based on each pool’s effective interest rate applied to each pool’s remaining unamortized cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances. The effective interest rate is the internal rate of return derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool. All collections realized after the net book value of a portfolio has been fully recovered, or zero basis portfolios, are recorded as revenue, or zero basis revenue or allowance reversal if applicable. We account for our investment in receivable portfolios utilizing the interest method in accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality. Servicing fee

 

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revenue is revenue primarily associated with bankruptcy servicing fees earned from our Ascension subsidiary, a provider of bankruptcy services to the finance industry.

The following tables summarize collections, revenue, end of period receivable balance and other related supplemental data, by year of purchase (in thousands, except percentages):

 

     Year Ended December 31, 2011     As of
December 31, 2011
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA

   $ 20,609       $ 16,171         78.5   $ 4,448        3.5   $ —           —     

2004

     1,462         196         13.4     102        0.0     —           —     

2005

     18,276         8,492         46.5     771        1.9     8,304         5.7

2006

     18,294         13,958         76.3     (7,160     3.0     17,394         5.1

2007

     38,654         23,578         61.0     (4,564     5.1     18,483         5.1

2008

     87,083         49,985         57.4     (4,420     10.9     58,249         5.4

2009

     164,358         105,080         63.9     —          22.9     88,436         8.0

2010

     288,679         169,588         58.7     —          36.9     190,948         6.5

2011

     123,596         72,489         58.6     —          15.8     334,640         4.2
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 761,011       $ 459,537         60.4   $ (10,823     100.0   $ 716,454         5.5
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 
     Year Ended December 31, 2010     As of
December 31, 2010
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA

   $ 10,590       $ 9,689         91.5   $ 901        2.5   $ —           —     

2002

     417         —           0.0     417        0.0     —           —     

2003

     3,215         759         23.6     1,829        0.2     —           —     

2004

     7,799         2,822         36.2     1,553        0.7     1,166         6.6

2005

     27,034         16,301         60.3     (2,750     4.2     17,315         5.6

2006

     26,185         21,592         82.5     (9,605     5.6     28,890         5.1

2007

     70,569         44,689         63.3     (4,527     11.6     38,302         7.5

2008

     126,496         78,579         62.1     (10,027     20.3     99,802         5.1

2009

     206,360         135,096         65.5     —          35.0     147,830         6.4

2010

     125,729         76,976         61.2     —          19.9     311,448         4.2
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 604,394       $ 386,503         63.9   $ (22,209     100.0   $ 644,753         5.1
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

Gross revenue excludes the effects of net portfolio allowance or net portfolio allowance reversals.

(3) 

Revenue recognition rate excludes the effects of net portfolio allowance or net portfolio allowance reversals.

Total revenues were $467.4 million for the year ended December 31, 2011, an increase of $86.1 million, or 22.6%, compared to total revenues of $381.3 million for the year ended December 31, 2010. Portfolio revenue was $448.7 million for the year ended December 31, 2011, an increase of $84.4 million, or 23.2%, compared to portfolio revenue of $364.3 million for the year ended December 31, 2010. The increase in portfolio revenue for the year ended December 31, 2011 was primarily the result of additional accretion revenue associated with a higher portfolio balance and lower net portfolio allowance provision during the year ended December 31, 2011, compared to the year ended December 31, 2010. During the year ended December 31, 2011, we recorded a net portfolio allowance provision of $10.8 million, compared to a net portfolio allowance provision of $22.2 million in the prior year. The portfolio allowances for the years ended December 31, 2011 and 2010 were largely due to a

 

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shortfall in collections in certain pool groups against our forecast. While our total collections exceeded our forecast, there is often variability at the pool group level between our actual collections and our forecasted collections, primarily our 2006 through 2008 vintage portfolios. This is the result of several factors, including pressures on our consumers due to a weakened economy, changes in internal operating strategies, shifts in consumer payment patterns, and the inherent challenge of forecasting collections at the pool group level.

Revenue associated with bankruptcy servicing fees was $18.6 million for the year ended December 31, 2011, an increase of $1.7 million, or 9.9%, compared to revenue of $16.9 million for the year ended December 31, 2010.

Operating Expenses

Total operating expenses were $346.6 million for the year ended December 31, 2011, an increase of $62.3 million, or 21.9%, compared to total operating expenses of $284.3 million for the year ended December 31, 2010.

Operating expenses are explained in more detail as follows:

Salaries and employee benefits

Total salaries and employee benefits increased $15.7 million, or 23.9%, to $81.5 million during the year ended December 31, 2011, from $65.8 million during the year ended December 31, 2010. The increase was primarily the result of increased headcount to support our growth. Salaries and employee benefits related to our internal legal channel were approximately $2.6 million and $0.1 million for the years ended December 31, 2011 and 2010, respectively.

Stock-based compensation expenses

Stock-based compensation increased $1.7 million, or 28.3%, to $7.7 million during the year ended December 31, 2011, from $6.0 million during the year ended December 31, 2010. This increase was primarily attributable to the higher fair value of equity awards granted in recent periods due to an increase in our stock price.

Cost of legal collections

The cost of legal collections increased $36.0 million, or 29.7%, to $157.1 million during year ended December 31, 2011, compared to $121.1 million during the year ended December 31, 2010. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in the cost of legal collections was primarily the result of an increase of $26.8 million in contingent fees paid to our network of attorneys related to an increase of $110.7 million, or 41.5%, in gross collections through our legal channel, in addition to an increase of $9.5 million in upfront litigation costs expensed during the period. Gross legal collections amounted to $377.5 million during the year ended December 31, 2011, up from $266.8 million collected during the year ended December 31, 2010. The cost of legal collections decreased as a percent of gross collections through this channel to 41.6% during the year ended December 31, 2011, from 45.4% during the year ended December 31, 2010, as a result of improvements in our ability to more accurately and consistently identify those consumers with the financial means to repay their obligations.

 

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The following table summarizes our legal collection channel performance and related direct costs (in thousands, except percentages):

 

     Year Ended December 31,  
     2011     2010  

Collections(1)

   $ 377,455        100.0   $ 266,762        100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Court costs advanced

   $ 95,672        25.4   $ 74,758        28.0

Court costs deferred

     (43,664     (11.6 )%      (32,247     (12.1 )% 
  

 

 

   

 

 

   

 

 

   

 

 

 

Court cost expense(2)

     52,008        13.8     42,511        15.9

Other(3)

     2,029        0.5     2,403        0.9

Commissions

     103,013        27.3     76,171        28.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs

   $ 157,050        41.6   $ 121,085        45.4
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Collections include approximately $2.3 million from our internal legal channel for the year ended December 31, 2011. We had no collections through our internal legal channel during the year ended December 31, 2010.

(2) 

In connection with our agreement with contracted attorneys, we advance certain out-of-pocket court costs. We capitalize these costs in our consolidated financial statements and provide a reserve and corresponding court cost expense for the costs that we believe will be ultimately uncollectible. This amount includes changes in our anticipated recovery rate of court costs expensed. This amount also includes court costs expensed through our internal legal channel of approximately $1.7 million for the year ended December 31, 2011. We did not incur court costs through our internal legal channel during the year ended December 31, 2010.

(3) 

Other costs consist of costs related to counter claims and legal network subscription fees.

Other operating expenses

Other operating expenses increased $3.4 million, or 9.3%, to $39.8 million during the year ended December 31, 2011, from $36.4 million during the year ended December 31, 2010. The increase was primarily the result of an increase of $1.0 million in direct mail campaign expenses, an increase of $0.8 million in telephone expenses, an increase of $0.5 million in recruiting expenses, and a net increase in various other operating expenses of $1.1 million, all to support our growth.

Collection agency commissions

During the year ended December 31, 2011, we incurred $14.2 million in commissions to third party collection agencies, or 29.7% of the related gross collections of $47.7 million, compared to $20.4 million in commissions, or 30.0% of the related gross collections of $68.0 million during the year ended December 31, 2010. The decline in commissions and collections in this channel is part of our strategy to place more accounts internally to reduce our overall cost to collect. The decrease in the net commission rate as a percentage of the related gross collections was primarily due to the mix of accounts placed with the agencies. Commissions, as a percentage of collections through this channel, vary from period to period depending on, among other things, the time from charge-off of the accounts placed with an agency. Generally, freshly charged-off accounts have a lower commission rate than accounts that have been charged off for a longer period of time.

General and administrative expenses

General and administrative expenses increased $10.3 million, or 32.7%, to $41.7 million during the year ended December 31, 2011, from $31.4 million during the year ended December 31, 2010. The increase was primarily the result of an increase of $3.8 million in litigation and corporate legal expenses associated with governmental investigations or inquiries and litigation, an increase of $1.3 million in building rent, an increase of $0.9 million in consulting fees, an increase of $0.9 million in system maintenance costs and a net increase in other general and administrative expenses of $3.4 million, primarily to support our growth.

 

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Depreciation and amortization

Depreciation and amortization expense increased $1.5 million, or 45.7%, to $4.7 million during the year ended December 31, 2011, from $3.2 million during the year ended December 31, 2010. The increase was primarily due to increased depreciation expenses resulted from our acquisition of fixed assets in the current and prior years.

Cost per Dollar Collected

The following table summarizes our cost per dollar collected (in thousands, except percentages):

 

    Year Ended December 31,  
    2011     2010  
    Collections     Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
    Collections     Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
 

Legal networks(1)

  $ 377,455      $ 157,050 (1)      41.6     20.6   $ 266,762      $ 121,085 (1)      45.4     20.0

Collection sites(2)

    335,992        25,112        7.5     3.3     268,205        24,312        9.1     4.0

Collection agencies

    47,657        14,162        29.7     1.9     68,042        20,385        30.0     3.4

Other

    54        —          —          —          1,600        —          —          —     

Other indirect costs(3)

    —          124,533        —          16.4     —          98,157        —          16.3
 

 

 

   

 

 

     

 

 

   

 

 

   

 

 

     

 

 

 

Total

  $ 761,158      $ 320,857 (4)        42.2   $ 604,609      $ 263,939 (4)        43.7
 

 

 

   

 

 

     

 

 

   

 

 

   

 

 

     

 

 

 

 

(1) 

Collections include approximately $2.3 million from our internal legal channel for the year ended December 31, 2011. Court costs expensed through our internal legal channel were approximately $1.7 million for the year ended December 31, 2011. We had no collections and did not incur any court costs through our internal legal channel during the year ended December 31, 2010.

(2) 

Cost in collection sites represents only account managers and their supervisors’ salaries, variable compensation, and employee benefits.

(3) 

Other indirect costs represent non-collection site salaries and employee benefits, general and administrative expenses, other operating expenses and depreciation and amortization. Included in other indirect costs were costs related to our internal legal channel of approximately $3.8 million and $0.3 million for the years ended December 31, 2011 and 2010, respectively.

(4) 

Represents all operating expenses, excluding stock-based compensation expense and bankruptcy servicing operating expenses. We include this information in order to facilitate a comparison of approximate cash costs to cash collections for the debt purchasing business in the periods presented. Refer to the items for reconciliation of operating expenses, excluding stock-based compensation expense and bankruptcy servicing operating expenses, to generally accepted accounting practices (“GAAP”) total operating expenses in the table below.

During the year ended December 31, 2011, cost per dollar collected decreased by 150 basis points to 42.2% of gross collections from 43.7% of gross collections during the year ended December 31, 2010. This decrease was primarily due to several factors, including:

 

   

The costs from our collection sites, including account managers and their supervisors’ salaries, variable compensation and employee benefits, as a percentage of total collections, decreased to 3.3% during the year ended December 31, 2011, from 4.0% during the year ended December 31, 2010 and, as a percentage of our site collections, decreased to 7.5% during the year ended December 31, 2011, from 9.1% during the year ended December 31, 2010. The decrease was primarily due to the continued growth of our collection workforce in India.

 

   

Collection agency commissions, as a percentage of total collections, decreased to 1.9% during the year ended December 31, 2011, from 3.4% during the year ended December 31, 2010. The decrease in the percentage of commissions to total collections was due to our strategy to place more accounts internally, resulting in a significant decline in collections through this channel. Commissions as a percentage of channel collections declined to 29.7% during the year ended December 31, 2011, as compared to 30.0% during the prior year due to the mix of accounts placed in this channel.

 

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The decrease was slightly offset by:

 

   

An increase in cost of legal collections, as a percent of total collections, to 20.6% during the year ended December 31, 2011, from 20.0% during the year ended December 31, 2010. The increase in the cost of legal collections to total collections was due to collections in our legal channel growing at a rate faster than total collections. Cost per dollar collected in this channel declined to 41.6% during the year ended December 31, 2011, from 45.4% during the prior year. This decrease was primarily the result of improvements in our ability to more accurately and consistently identify those consumers with the financial means to repay their obligations (see “Cost of legal collections” section above for details).

The following table presents the items for reconciliation of operating expenses, excluding stock-based compensation expense and bankruptcy servicing operating expenses to GAAP total operating expenses (in thousands):

 

     Years Ended December 31,  
     2011     2010  

GAAP total operating expenses, as reported

   $ 346,597      $ 284,277   

Stock-based compensation expense

     (7,709     (6,010

Bankruptcy servicing operating expenses

     (18,031     (14,328

Expansion in offshore operations

To support our growth and improve our operations, we continue to make investments offshore. In January 2012, we opened our first near-shore operations center in Costa Rica. Our operations in Costa Rica will allow us to better serve our Spanish-speaking consumers and will add important strategic capacity and strength to our worldwide operations. Until we are fully operational in our Costa Rica site, we expect that our overall variable cost to collect will increase and our overall account manager productivity will decline. However, once we are staffed to optimal levels, we expect that this expansion will have a positive long-term impact on both our overall cost to collect and our productivity.

Interest expense

The following table summarizes our interest expense (in thousands, except percentages):

 

     Year Ended December 31,  
     2011      2010      $ Change     % Change  

Stated interest on debt obligations

   $ 19,283       $ 15,667       $ 3,616        23.1

Amortization of loan fees and other loan costs

     1,833         1,669         164        9.7

Amortization of debt discount—convertible notes

     —           2,013         (2,013     (100.0 )% 
  

 

 

    

 

 

    

 

 

   

Total interest expense

   $ 21,116       $ 19,349       $ 1,767        9.1
  

 

 

    

 

 

    

 

 

   

Stated interest on debt obligations increased $3.6 million to $19.3 million during the year ended December 31, 2011, compared to the prior year. This increase was primarily due to higher interest rates on our senior secured notes, offset by lower outstanding loan balances under our revolving credit facility.

Other income and expense

During the year ended December 31, 2011, we incurred other expense of $0.4 million. This expense was primarily attributable to our revaluation of foreign currency monetary assets and liabilities held by our India subsidiary. During the year ended December 31, 2010, total other income was $0.3 million. This was primarily the result of a $0.3 million gain recognized in connection with the early termination of a contract.

 

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Provision for income taxes

During the year ended December 31, 2011, we recorded an income tax provision of $38.3 million, reflecting an effective rate of 38.6% of pretax income. The effective tax rate for the year ended December 31, 2011 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.5%, and a benefit for the effect of permanent book versus tax differences of 0.6%.

During the year ended December 31, 2010, we recorded an income tax provision of $28.9 million, reflecting an effective rate of 37.1% of pretax income. The effective tax rate for the year ended December 31, 2010 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.7%, a 0.6% beneficial adjustment to federal taxes payable as a result of state tax true ups, and a benefit for the effect of permanent book versus tax differences of 1.7%.

Year Ended December 31, 2010 Compared to Year Ended December 31, 2009

Revenues

Our revenues consist primarily of portfolio revenue and bankruptcy servicing revenue. Portfolio revenue consists of accretion revenue and zero basis revenue. Accretion revenue represents revenue derived from pools (quarterly groupings of purchased receivable portfolios) with a cost basis that has not been fully amortized. Revenue from pools with a remaining unamortized cost basis is accrued based on each pool’s effective interest rate applied to each pool’s remaining unamortized cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances. The effective interest rate is the internal rate of return derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool. All collections realized after the net book value of a portfolio has been fully recovered, or zero basis portfolios, are recorded as revenue, or zero basis revenue or allowance reversal if applicable. We account for our investment in receivable portfolios utilizing the interest method in accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality. Servicing fee revenue is revenue primarily associated with bankruptcy servicing fees earned from our Ascension subsidiary, a provider of bankruptcy services to the finance industry.

The following tables summarize collections, revenue, end of period receivable balance and other related supplemental data, by year of purchase (in thousands, except percentages):

 

     Year Ended December 31, 2010     As of
December 31, 2010
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA

   $ 10,590       $ 9,689         91.5   $ 901        2.5   $ —           —     

2002

     417         —           0.0     417        0.0     —           —     

2003

     3,215         759         23.6     1,829        0.2     —           —     

2004

     7,799         2,822         36.2     1,553        0.7     1,166         6.6

2005

     27,034         16,301         60.3     (2,750     4.2     17,315         5.6

2006

     26,185         21,592         82.5     (9,605     5.6     28,890         5.1

2007

     70,569         44,689         63.3     (4,527     11.6     38,302         7.5

2008

     126,496         78,579         62.1     (10,027     20.3     99,802         5.1

2009

     206,360         135,096         65.5     —          35.0     147,830         6.4

2010

     125,729         76,976         61.2     —          19.9     311,448         4.2
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 604,394       $ 386,503         63.9   $ (22,209     100.0   $ 644,753         5.1
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

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Table of Contents
     Year Ended December 31, 2009     As of
December 31, 2009
 
     Collections(1)      Gross
Revenue(2)
     Revenue
Recognition
Rate(3)
    Net
Reversal

(Portfolio
Allowance)
    Revenue
% of Total
Revenue
    Unamortized
Balances
     Monthly
IRR
 

ZBA

   $ 8,927       $ 8,927         100.0   $ —          2.8   $ —           —     

2002

     2,831         903         31.9     1,254        0.3     —           —     

2003

     8,021         5,932         74.0     59        1.9     629         31.4

2004

     11,363         6,922         60.9     (629     2.1     4,600         8.1

2005

     41,948         26,332         62.8     (2,192     8.2     30,804         5.6

2006

     44,554         31,864         71.5     (4,622     10.0     44,030         5.1

2007

     111,116         64,045         57.6     (6,357     20.1     68,739         5.8

2008

     162,846         112,657         69.2     (6,823     35.3     157,807         5.0

2009

     95,852         61,460         64.1     —          19.3     220,268         4.4
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

Total

   $ 487,458       $ 319,042         65.5   $ (19,310     100.0   $ 526,877         5.0
  

 

 

    

 

 

    

 

 

   

 

 

   

 

 

   

 

 

    

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

Gross revenue excludes the effects of net portfolio allowance or net portfolio allowance reversals.

(3) 

Revenue recognition rate excludes the effects of net portfolio allowance or net portfolio allowance reversals.

Total revenues were $381.3 million for the year ended December 31, 2010, an increase of $64.9 million, or 20.5%, compared to total revenues of $316.4 million for the year ended December 31, 2009. Portfolio revenue was $364.3 million for the year ended December 31, 2010, an increase of $64.6 million, or 21.5%, compared to portfolio revenue of $299.7 million for the year ended December 31, 2009. The increase in portfolio revenue for the year ended December 31, 2010, was primarily the result of additional accretion revenue associated with a higher portfolio balance during the year ended December 31, 2010 compared to the year ended December 31, 2009. During the year ended December 31, 2010, we recorded a net portfolio allowance provision of $22.2 million, compared to a net portfolio allowance provision of $19.3 million in the prior year. The portfolio allowances for the years ended December 31, 2010 and 2009 were largely due to a shortfall in collections in certain pool groups against our forecast. While our total collections exceeded our forecast, there is often variability at the pool group level between our actual collections and our forecasted collections, primarily our 2006 through 2008 vintage portfolios. This is the result of several factors, including pressures on our consumers due to a weakened economy, changes in internal operating strategies, shifts in consumer payment patterns, and the inherent challenge of forecasting collections at the pool group level.

Revenue associated with bankruptcy servicing fees was $16.9 million for the year ended December 31, 2010, an increase of $0.2 million, or 1.9%, compared to revenue of $16.7 million for the year ended December 31, 2009.

Operating Expenses

Total operating expenses were $284.3 million for the year ended December 31, 2010, an increase of $34.5 million, or 13.8%, compared to total operating expenses of $249.8 million for the year ended December 31, 2009.

Operating expenses are explained in more detail as follows:

Salaries and employee benefits

Total salaries and employee benefits increased $7.8 million, or 13.3%, to $65.8 million during the year ended December 31, 2010, from $58.0 million during the year ended December 31, 2009. The increase was primarily the result of an additional $9.4 million in payroll related expenses due to increased headcount to support our growth, offset by a $1.6 million decrease in our self-insured health care costs due to our successful wellness programs and to fewer catastrophic claims compared to the prior year.

 

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Stock-based compensation expenses

Stock-based compensation increased $1.6 million, or 37.1%, to $6.0 million during the year ended December 31, 2010, from $4.4 million during the year ended December 31, 2009. This increase was primarily attributable to awards granted to our senior management team in the year ended December 31, 2010 and the higher fair value of equity awards granted in recent periods due to an increase in our stock price.

Cost of legal collections

The cost of legal collections increased $8.5 million, or 7.6%, to $121.1 million during the year ended December 31, 2010, compared to $112.6 million during the year ended December 31, 2009. These costs represent contingent fees paid to our nationwide network of attorneys and costs of litigation. The increase in the cost of legal collections was primarily the result of an increase in commissions paid on increased collections through our legal channel, partially offset by a decrease in court cost expense. For the year ended December 31, 2010, we paid commissions of $76.2 million, or 28.6%, on legal collections of $266.8 million, compared to commissions of $66.5 million, or 28.6%, on legal collections of $232.7 million for the year ended December 31, 2009. Court cost expense decreased to $42.5 million for the year ended December 31, 2010, compared to $43.6 million for the year ended December 31, 2009. This decrease was due to the effect of our change in accounting estimate of deferred court costs effective October 1, 2010, which reduced our court cost expense by $2.8 million. This decrease was offset by additional expense related to the increase of $10.7 million in court costs advanced in the year ended December 31, 2010, compared to the year ended December 31, 2009. Accordingly, court cost expense decreased to 15.9% as a percent of legal collections for the year ended December 31, 2010, compared to 18.7% of legal collections for the year ended December 31, 2009. As a result, the cost of legal collections, as a percent of gross collections through this channel, decreased to 45.4% for the year ended December 31, 2010 from 48.4% for the year ended December 31, 2009.

The following table summarizes our legal collection channel performance and related direct costs (in thousands, except percentages):

 

     Year Ended December 31,  
     2010     2009  

Collections

   $ 266,762        100.0   $ 232,667        100.0
  

 

 

   

 

 

   

 

 

   

 

 

 

Court costs advanced

   $ 74,758        28.0   $ 64,047        27.5

Court costs deferred

     (32,247     (12.1 )%      (22,169     (9.5 )% 

Deferred court costs reversal(1)

     —          0.0     1,714        0.7
  

 

 

   

 

 

   

 

 

   

 

 

 

Court cost expense(2)

     42,511        15.9     43,592        18.7

Other(3)

     2,403        0.9     2,444        1.1

Commissions

     76,171        28.6     66,534        28.6
  

 

 

   

 

 

   

 

 

   

 

 

 

Total Costs

   $ 121,085        45.4   $ 112,570        48.4
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Primarily related to our settled arbitration with Jefferson Capital Systems, LLC (“Jefferson Capital”) in September 2009. As part of the settlement with Jefferson Capital, we returned accounts that were subject to Jefferson Capital’s settlement with the Federal Trade Commission. A portion of those accounts were in our legal channel and, when these were returned, resulted in the reversal of court costs previously deferred.

(2) 

In connection with our agreement with contracted attorneys, we advance certain out-of-pocket court costs. We capitalize these costs in our consolidated financial statements and provide a reserve and corresponding court cost expense for the costs that we believe will be ultimately uncollectible. This amount includes changes in our anticipated recovery rate of court costs expensed.

(3) 

Other costs consist of costs related to counter claims and legal network subscription fees.

Other operating expenses

Other operating expenses increased $10.4 million, or 39.9%, to $36.4 million during the year ended December 31, 2010, from $26.0 million during the year ended December 31, 2009. The increase was primarily the result of an increase of $2.6 million in direct mail campaign expenses, an increase of $1.7 million in media-

 

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Table of Contents

related expenses, an increase of $1.9 million in telephone expenses, an increase of $1.1 million in telephone number tracing expenses and a net increase in various other operating expenses of $3.1 million, all to support our growth.

Collection agency commissions

During the year ended December 31, 2010, we incurred $20.4 million in commissions to third party collection agencies, or 30.0% of the related gross collections of $68.0 million, compared to $19.3 million in commissions, or 30.8% of the related gross collections of $62.7 million during the year ended December 31, 2009. The decrease in the net commission rate as a percentage of the related gross collections was primarily due to the mix of accounts placed with the agencies. Commissions, as a percentage of collections through this channel, vary from period to period depending on, among other things, the time from charge-off of the accounts placed with an agency. Generally, freshly charged-off accounts have a lower commission rate than accounts that have been charged off for a longer period of time. During the year ended December 31, 2010, we collected more freshly charged-off accounts with our agencies as compared to the prior year.

General and administrative expenses

General and administrative expenses increased $4.5 million, or 16.8%, to $31.4 million during the year ended December 31, 2010, from $26.9 million during the year ended December 31, 2009. The increase was primarily the result of an increase of $4.1 million in legal settlements, an increase of $1.4 million in system maintenance costs, an increase of $0.4 million in consulting fees, and a net increase in other general and administrative expenses of $3.8 million. The increase was offset by a decrease of $5.2 million in corporate legal expenses due to incurring significant legal expenses in 2009 in connection with our settled arbitration with Jefferson Capital.

Depreciation and amortization

Depreciation and amortization expense increased $0.6 million, or 23.4%, to $3.2 million during the year ended December 31, 2010, from $2.6 million during the year ended December 31, 2009. The increase was primarily due to increased depreciation expenses resulted from our acquisition of fixed assets in the current and prior years.

Cost per Dollar Collected

The following table summarizes our cost per dollar collected (in thousands, except percentages):

 

    Year Ended December 31,  
    2010     2009  
    Collections     Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
    Collections      Cost     Cost Per
Channel
Dollar
Collected
    Cost Per
Total
Dollar
Collected
 

Collection sites

  $ 268,205      $ 24,312 (1)      9.1     4.0   $ 185,789       $ 22,536 (1)      12.1     4.6

Legal networks

    266,762        121,085        45.4     20.0     232,667         112,570        48.4     23.1

Collection agencies

    68,042        20,385        30.0     3.4     62,653         19,278        30.8     4.0

Other

    1,600        —          —          —          6,683         —          —          —     

Other indirect costs(2)

    —          98,157        —          16.3     —           77,796        —          15.9
 

 

 

   

 

 

     

 

 

   

 

 

    

 

 

     

 

 

 

Total

  $ 604,609      $ 263,939 (3)        43.7   $ 487,792       $ 232,180 (3)        47.6
 

 

 

   

 

 

       

 

 

    

 

 

     

 

 

 

 

(1) 

Represents only account managers and their supervisors’ salaries, variable compensation and employee benefits.

(2) 

Other indirect costs represent non-collection site salaries and employee benefits, general and administrative expenses, other operating expenses, and depreciation and amortization.

 

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Table of Contents
(3) 

Represents all operating expenses excluding stock-based compensation expense and bankruptcy servicing operating expenses. We include this information in order to facilitate a comparison of approximate cash costs to cash collections for the debt purchasing business in the periods presented. Refer to the items for reconciliation of operating expenses, excluding stock-based compensation expense and bankruptcy servicing operating expenses to GAAP total operating expenses in the table below.

During the year ended December 31, 2010, cost per dollar collected decreased by 390 basis points to 43.7% of gross collections from 47.6% of gross collections during the year ended December 31, 2009. This decrease was primarily due to several factors, including:

 

   

The cost from our collection sites, which includes account manager salaries, variable compensation and employee benefits, as a percentage of total collections, decreased to 4.0% for the year ended December 31, 2010, from 4.6% for the year ended December 31, 2009 and, as a percentage of our site collections, decreased to 9.1% for the year ended December 31, 2010, from 12.1% for the year ended December 31, 2009. The decrease was primarily due to the growth of our collection workforce in India.

 

   

The cost of legal collections as a percent of total collections decreased to 20.0% for the year ended December 31, 2010, from 23.1% for the year ended December 31, 2009 and, as a percentage of legal collections, decreased to 45.4% in the year ended December 31, 2010, from 48.4% for the year ended December 31, 2009. The decreases were primarily due to the effect of our change in accounting estimate of deferred court costs effective October 1, 2010, which reduced our court cost expense by $2.8 million. Additionally, as we refine our analytics and increase our ability to model consumer behavior, we have been able to be more precise about where to use the legal channel, which has enabled us to reduce our cost expenditure without negatively impacting collections.

 

   

The cost of collection agency commissions, as a percentage of total collections, decreased to 3.4% for the year ended December 31, 2010, from 4.0% for the year ended December 30, 2009. The cost in collection agency commissions, as a percentage of channel collections, decreased to 30.0% for the year ended December 31, 2010, from 30.8% for the year ended December 31, 2009. This decrease was the result of a change in the mix of accounts placed into this channel. Freshly charged-off accounts have a lower commission rate than accounts that have been charged-off for a longer period of time. During the year ended December 31, 2010, we collected more freshly charged-off accounts with our agencies as compared to the prior year.

The decrease in cost per dollar collected was partially offset by an increase in other costs not directly attributable to specific channel collections (other indirect costs), as a percentage of total collections, from 15.9% for the year ended December 31, 2009, to 16.3% for the year ended December 31, 2010. These costs include non-collection site salaries and employee benefits, general and administrative expenses, other operating expenses and depreciation and amortization. The dollar increase and the increase in cost per dollar collected were due to several factors, including increases in corporate settlements and increases in headcount and general and administrative expenses to support our growth.

The following table presents the items for reconciliation of operating expenses, excluding stock-based compensation expense and bankruptcy servicing operating expenses to GAAP total operating expenses (in thousands):

 

     Years Ended December 31,  
           2010                 2009        

GAAP total operating expenses, as reported

   $ 284,277      $ 249,782   

Stock-based compensation expense

     (6,010     (4,384

Bankruptcy servicing operating expenses

     (14,328     (13,218

 

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Table of Contents

Interest expense

The following table summarizes our interest expense (in thousands, except percentages):

 

     Year Ended December 31,  
     2010      2009      $ Change     % Change  

Stated interest on debt obligations

   $ 15,667       $ 12,080       $ 3,587        29.7

Amortization of loan fees and other loan costs

     1,669         1,179         490        41.6

Amortization of debt discount—convertible notes

     2,013         2,901         (888     (30.6 )% 
  

 

 

    

 

 

    

 

 

   

Total interest expense

   $ 19,349       $ 16,160       $ 3,189        19.7
  

 

 

    

 

 

    

 

 

   

Stated interest on debt obligations increased $3.6 million during the year ended December 31, 2010, compared to the prior year, primarily due to higher interest rates and increases in amounts borrowed under our revolving credit facility to fund our purchases of receivable portfolios and for general working capital needs.

Other income and expense

During the year ended December 31, 2010, total other income was $0.3 million, compared to a total other expense of less than $0.1 million for the year ended December 31, 2009. The other income of $0.3 million during the year ended December 31, 2010 was primarily attributable to a $0.3 million gain recognized in connection with the early termination of a contract.

Provision for income taxes

During the year ended December 31, 2010, we recorded an income tax provision of $28.9 million, reflecting an effective rate of 37.1% of pretax income. The effective tax rate for the year ended December 31, 2010 primarily consisted of a provision for federal income taxes of 32.7% (which is net of a benefit for state taxes of 2.3%), a blended provision for state taxes of 6.7%, a 0.6% beneficial adjustment to federal taxes payable as a result of state tax true ups and a benefit for the effect of permanent book versus tax differences of 1.7%.

During the year ended December 31, 2009, we recorded an income tax provision of $20.7 million, reflecting an effective rate of 38.5% of pretax income. The effective tax rate for the year ended December 31, 2009 primarily consisted of a provision for federal income taxes of 32.4% (which is net of a benefit for state taxes of 2.6%), a blended provision for state taxes of 7.3%, a 1.0% beneficial adjustment to federal taxes payable as a result of state tax rate changes and a benefit for the effect of permanent book versus tax differences of 0.2%.

 

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Table of Contents

Supplemental Performance Data

Cumulative Collections to Purchase Price Multiple

The following table summarizes our purchases and related gross collections by year of purchase (in thousands, except multiples):

 

Year of
Purchase

  Purchase
Price(1)
    Cumulative Collections through December 31, 2011  
    <2005     2005     2006     2007     2008     2009     2010     2011     Total(2)     CCM(3)  

<2005

  $ 385,471 (4)    $ 749,791      $ 224,620      $ 164,211      $ 85,333      $ 45,893      $ 27,708      $ 19,986      $ 15,180      $ 1,332,722        3.5   

2005

    192,585        —          66,491        129,809        109,078        67,346        42,387        27,210        18,651        460,972        2.4   

2006

    141,027        —          —          42,354        92,265        70,743        44,553        26,201        18,306        294,422        2.1   

2007

    204,098        —          —          —          68,048        145,272        111,117        70,572        44,035        439,044        2.2   

2008

    227,863        —          —          —          —          69,049        165,164        127,799        87,850        449,862        2.0   

2009

    253,368        —          —          —          —          —          96,529        206,773        164,605        467,907        1.8   

2010

    358,800        —          —          —          —          —          —          125,853        288,788        414,641        1.2   

2011

    385,748        —          —          —          —          —          —          —          123,596        123,596        0.3   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

Total

  $ 2,148,960      $ 749,791      $ 291,111      $ 336,374      $ 354,724      $ 398,303      $ 487,458      $ 604,394      $ 761,011      $ 3,983,166        1.9   
 

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Adjusted for put-backs, account recalls, and purchase price rescissions. Put-backs represent accounts that are returned to the seller in accordance with the respective purchase agreement (“Put-Backs”). Recalls represents accounts that are recalled by the seller in accordance with the respective purchase agreement (“Recalls”).

(2) 

Cumulative collections from inception through December 31, 2011, excluding collections on behalf of others.

(3) 

Cumulative Collections Multiple (“CCM”) through December 31, 2011– collections as a multiple of purchase price.

(4) 

From inception through December 31, 2004.

Total Estimated Collections to Purchase Price Multiple

The following table summarizes our purchases, resulting historical gross collections, and estimated remaining gross collections, by year of purchase (in thousands, except multiples):

 

     Purchase  Price(1)     Historical
Collections(2)
     Estimated
Remaining
Collections
     Total Estimated
Gross Collections
     Total Estimated Gross
Collections to
Purchase Price
 

<2005

   $ 385,471 (3)    $ 1,332,722       $ 2,857       $ 1,335,579         3.5   

2005

     192,585        460,972         12,715         473,687         2.5   

2006

     141,027        294,422         30,124         324,546         2.3   

2007

     204,098        439,044         60,355         499,399         2.4   

2008

     227,863        449,862         119,308         569,170         2.5   

2009

     253,368        467,907         224,749         692,656         2.7   

2010

     358,800        414,641         467,057         881,698         2.5   

2011

     385,748        123,596         653,492         777,088         2.0   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 2,148,960      $ 3,983,166       $ 1,570,657       $ 5,553,823         2.6   
  

 

 

   

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Adjusted for Put-Backs, Recalls, and purchase price rescissions.

(2) 

Cumulative collections from inception through December 31, 2011, excluding collections on behalf of others.

(3) 

From inception through December 31, 2004.

 

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Table of Contents

Estimated Remaining Gross Collections by Year of Purchase

The following table summarizes our estimated remaining gross collections by year of purchase (in thousands):

 

     Estimated Remaining Gross Collections by Year of Purchase  
     2012      2013      2014      2015      2016      2017      2018      Total  

<2005(1)

   $ 1,328       $ 1,002       $ 527       $ —         $ —         $ —         $ —         $ 2,857   

2005

     10,503         2,212         —           —           —           —           —           12,715   

2006

     16,496         11,323         2,305         —           —           —           —           30,124   

2007

     28,237         17,169         8,534         2,753         1,955         1,707         —           60,355   

2008

     54,215         32,966         18,565         10,258         3,304         —           —           119,308   

2009

     104,886         61,041         34,244         16,704         7,867         7         —           224,749   

2010

     192,176         122,039         74,628         43,817         24,351         10,033         13         467,057   

2011

     223,286         186,761         107,651         65,777         38,917         22,008         9,092         653,492   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total

   $ 631,127       $ 434,513       $ 246,454       $ 139,309       $ 76,394       $ 33,755       $ 9,105       $ 1,570,657   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

Estimated remaining collections for Zero Basis Portfolios can extend beyond our collection forecasts.

Unamortized Balances of Portfolios

The following table summarizes the remaining unamortized balances of our purchased receivable portfolios by year of purchase (in thousands, except percentages):

 

     Unamortized
Balance as of
December 31, 2011
     Purchase
Price(1)
     Unamortized
Balance as a
Percentage of
Purchase Price
    Unamortized
Balance as a
Percentage
of Total
 

2005

   $ 8,304       $ 192,585         4.3     1.2

2006

     17,394         141,027         12.3     2.4

2007

     18,483         204,098         9.1     2.6

2008

     58,249         227,863         25.6     8.1

2009

     88,436         253,368         34.9     12.3

2010

     190,948         358,800         53.2     26.7

2011

     334,640         385,748         86.8     46.7
  

 

 

    

 

 

    

 

 

   

 

 

 

Total

   $ 716,454       $ 1,763,489         40.6     100.0
  

 

 

    

 

 

    

 

 

   

 

 

 

 

(1) 

Purchase price refers to the cash paid to a seller to acquire a portfolio less Put-Backs, plus an allocation of our forward flow asset (if applicable), and less the purchase price for accounts that were sold at the time of purchase to another debt purchaser.

Changes in the Investment in Receivable Portfolios

Revenue related to our investment in receivable portfolios comprises two groups. First, revenue from those portfolios that have a remaining book value and are accounted for on the accrual basis (“Accrual Basis Portfolios”), and second, revenue from those portfolios that have fully recovered their book value Zero Basis Portfolios and, therefore, every dollar of gross collections is recorded entirely as Zero Basis Revenue. If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, we account for such portfolios on the cost recovery method (“Cost Recovery Portfolios”). No revenue is recognized on Cost Recovery Portfolios until the cost basis has been fully recovered, at which time they become Zero Basis Portfolios.

 

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The following tables summarize the changes in the balance of the investment in receivable portfolios and the proportion of revenue recognized as a percentage of collections (in thousands, except percentages):

 

     Year Ended December 31, 2011  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 644,753      $ —        $ —        $ 644,753   

Purchases of receivable portfolios

     386,850        —          —          386,850   

Gross collections(1)

     (740,402     —          (20,609     (761,011

Put-backs and recalls

     (2,843     —          (9     (2,852

Revenue recognized

     443,367        —          16,170        459,537   

(Portfolio allowances) portfolio allowance reversals, net

     (15,271     —          4,448        (10,823
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 716,454      $ —        $ —        $ 716,454   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections(2)

     59.9     0.0     78.5     60.4
  

 

 

   

 

 

   

 

 

   

 

 

 
     Year Ended December 31, 2010  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 526,366      $ 511      $ —        $ 526,877   

Purchases of receivable portfolios

     361,957        —          —          361,957   

Gross collections(1)

     (593,749     (55     (10,590     (604,394

Put-backs and recalls

     (3,981     —          —          (3,981

Revenue recognized

     376,814        —          9,689        386,503   

(Portfolio allowances) portfolio allowance reversals, net

     (22,654     (456     901        (22,209
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 644,753      $ —        $ —        $ 644,753   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections(2)

     63.5     0.0     91.5     63.9
  

 

 

   

 

 

   

 

 

   

 

 

 
     Year Ended December 31, 2009  
     Accrual Basis
Portfolios
    Cost Recovery
Portfolios
    Zero Basis
Portfolios
    Total  

Balance, beginning of period

   $ 460,598      $ 748      $ —        $ 461,346   

Purchases of receivable portfolios

     256,632        —          —          256,632   

Gross collections(1)

     (478,253     (237     (8,968     (487,458

Put-backs and recalls

     (3,371     —          (4     (3,375

Revenue recognized

     310,116        —          8,926        319,042   

(Portfolio allowances) portfolio allowance reversals, net

     (19,356     —          46        (19,310
  

 

 

   

 

 

   

 

 

   

 

 

 

Balance, end of period

   $ 526,366      $ 511      $ —        $ 526,877   
  

 

 

   

 

 

   

 

 

   

 

 

 

Revenue as a percentage of collections(2)

     64.8     0.0     99.5     65.4
  

 

 

   

 

 

   

 

 

   

 

 

 

 

(1) 

Does not include amounts collected on behalf of others.

(2) 

Revenue as a percentage of collections excludes the effects of net portfolio allowance or net portfolio allowance reversals.

 

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Table of Contents

As of December 31, 2011, we had $716.5 million in investment in receivable portfolios. This balance will be amortized based upon current projections of cash collections in excess of revenue applied to the principal balance. The estimated amortization of the investment in receivable portfolio balance is as follows (in thousands):

 

Year Ended December 31,

   Amortization  

2012

   $ 246,105   

2013

     205,498   

2014

     117,750   

2015

     72,901   

2016

     43,415   

2017

     22,951   

2018

     7,834   
  

 

 

 

Total

   $ 716,454   
  

 

 

 

Collections by Channel

We utilize numerous business channels for the collection of charged-off credit cards and other receivables. The following table summarizes the gross collections by collection channel (in thousands):

 

     Year Ended December 31,  
   2011      2010      2009  

Legal collections

   $ 377,455       $ 266,762       $ 232,667   

Collection sites

     335,992         268,205         185,789   

Collection agencies

     47,657         68,042         62,653   

Other

     54         1,600         6,683   
  

 

 

    

 

 

    

 

 

 
   $ 761,158       $ 604,609       $ 487,792   
  

 

 

    

 

 

    

 

 

 

Legal Outsourcing Costs as a Percentage of Gross Collections by Year of Collection

The following table summarizes our legal outsourcing court cost expense and commissions as a percentage of gross collections by year of collection:

 

     Collection Year  

Placement Year

   2003     2004     2005     2006     2007     2008     2009     2010     2011     Cumulative
Average
 

2003

     41.7     39.2     35.2     33.4     31.0     32.0     32.9     33.2     31.3     36.7

2004

     —          41.7     39.8     35.7     32.4     32.8     33.2     34.6     32.2     37.7

2005

     —          —          46.1     40.6     32.6     32.1     32.3     34.0     32.5     38.2

2006

     —          —          —          54.9     41.0     32.8     30.5     33.5     32.7     39.9

2007

     —          —          —          —          64.8     43.5     31.3     32.2     32.5     43.1

2008

     —          —          —          —          —          69.7     43.0     33.1     31.4     43.6

2009

     —          —          —          —          —          —          69.7     41.4     31.1     44.2

2010

     —          —          —          —          —          —          —          72.5     39.1     48.1

2011

     —          —          —          —          —          —          —          —          64.5     64.5

 

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Table of Contents

Headcount by Function by Site

The following table summarizes our headcount by function by site:

 

     Headcount as of December 31,  
     2011      2010      2009  
     U.S.      India      U.S.      India      U.S.      India  

General & Administrative

     468         334         378         233         345         170   

Account Manager

     223         1,005         217         909         223         665   

Bankruptcy Specialist

     104         87         83         71         64         56   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 
     795         1,426         678         1,213         632         891   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Gross Collections by Account Manager

The following table summarizes our collection performance by account manager (in thousands, except headcount):

 

     Year Ended December 31,  
     2011      2010      2009  

Gross collections—collection sites

   $ 335,992       $ 268,205       $ 185,789   

Average active account managers

     1,186         1,040         678   

Collections per average active account manager

   $ 283.3       $ 257.9       $ 274.0   

Gross Collections per Hour Paid

The following table summarizes our gross collections per hour paid to account managers (in thousands, except gross collections per hour paid):

 

     Year Ended December 31,  
     2011      2010      2009  

Gross collections—collection sites

   $ 335,992       $ 268,205       $ 185,789   

Total hours paid

     2,243         1,960         1,242   

Collections per hour paid

   $ 149.8       $ 136.8       $ 149.6   

Collection Sites Direct Cost per Dollar Collected

The following table summarizes our gross collections in collection sites and the related direct cost (in thousands, except percentages):

 

     Year Ended December 31,  
     2011     2010     2009  

Gross collections—collection sites

   $ 335,992      $ 268,205      $ 185,789   

Direct costs(1)

   $ 25,112      $ 24,312      $ 22,536   

Cost per dollar collected

     7.5     9.1     12.1

 

(1) 

Represent account managers and their supervisors’ salaries, variable compensation, and employee benefits.

 

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Table of Contents

Salaries and Employee Benefits by Function

The following table summarizes our salaries and employee benefits by function (excluding stock-based compensation) (in thousands):

 

     Year Ended December 31,  
     2011      2010      2009  

Portfolio purchasing and recovery activities

        

Collection site salaries and employee benefits(1)

   $ 25,112       $ 24,312       $ 22,536   

Non-collection site salaries and employee benefits

     44,984         33,755         27,667   
  

 

 

    

 

 

    

 

 

 

Subtotal

     70,096         58,067         50,203   

Bankruptcy services

     11,413         7,700         7,822   
  

 

 

    

 

 

    

 

 

 
   $ 81,509       $ 65,767       $ 58,025   
  

 

 

    

 

 

    

 

 

 

 

(1) 

Represent account managers and their supervisors’ salaries, variable compensation, and employee benefits.

Purchases by Quarter

The following table summarizes the purchases we made by quarter, and the respective purchase prices (in thousands):

 

Quarter

   # of
Accounts
     Face Value      Purchase
Price
     Forward  Flow
Allocation(1)
 

Q1 2008

     647       $ 1,199,703       $ 47,902       $ 2,926   

Q2 2008

     676         1,801,902         52,492         2,635   

Q3 2008

     795         1,830,292         66,107         —     

Q4 2008

     1,084         1,729,568         63,777         —     

Q1 2009

     505         1,341,660         55,913         —     

Q2 2009

     719         1,944,158         82,033         —     

Q3 2009

     1,515         2,173,562         77,734         10,302   

Q4 2009

     519         1,017,998         40,952         —     

Q1 2010

     839         2,112,332         81,632         —     

Q2 2010

     1,002         2,245,713         83,336         —     

Q3 2010

     1,101         2,616,678         77,889         —     

Q4 2010

     1,206         3,882,646         119,100         —     

Q1 2011

     1,243         2,895,805         90,675         —     

Q2 2011

     1,477         2,998,564         93,701         —     

Q3 2011

     1,633         2,025,024         65,731         —     

Q4 2011

     2,776         3,782,595         136,743         —     

 

(1) 

Allocation of the forward flow asset to the cost basis of receivable portfolio purchases. In July 2008, we ceased forward flow purchases from Jefferson Capital due to an alleged breach by Jefferson Capital and its parent, CompuCredit Corporation, of certain agreements. In September 2009, we settled our dispute with Jefferson Capital.

Liquidity and Capital Resources

Overview

Historically, we have met our cash requirements by utilizing our cash flows from operations, bank borrowings, and equity offerings. Our primary cash requirements have included the purchase of receivable portfolios, operational expenses, and the payment of interest and principal on bank borrowings and tax payments.

 

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The following table summarizes our cash flows by category for the periods presented (in thousands):

 

     Year Ended December 31,  
     2011     2010     2009  

Net cash provided by operating activities

   $ 84,579      $ 75,475      $ 76,519   

Net cash used in investing activities

     (88,088     (142,807     (79,171

Net cash provided by financing activities

     651        69,849        699   

On February 11, 2011, we increased the amount available for borrowing under our revolving credit facility from $360.5 million to $410.5 million by exercising $50.0 million of our $100.0 million accordion feature. As of December 31, 2011, the aggregate revolving loan commitment and borrowing base availability under our revolving credit facility were $105.5 million and $91.2 million, respectively.

On February 10, 2011, we issued an additional $25.0 million in senior secured notes to certain affiliates of Prudential Capital Group through an amended and restated note purchase agreement. The notes bear an annual interest rate of 7.375% and mature in 2018 with principal amortization beginning in May 2013. The proceeds from the notes were primarily used to reduce aggregate outstanding borrowings under our revolving credit facility. See Note 8 “Debt” to our consolidated financial statements for a further discussion of our debt.

Currently, all of our portfolio purchases are funded with cash from operations and borrowings under our revolving credit facility.

Operating Cash Flows

Net cash provided by operating activities was $84.6 million, $75.5 million and $76.5 million for the years ended December 31, 2011, 2010, and 2009, respectively.

Cash provided by operating activities for the year ended December 31, 2011, is primarily related to net income of $61.0 million and $10.8 million in a non-cash add back related to the net portfolio allowance provision of our receivable portfolios. Cash provided by operating activities for the year ended December 31, 2010, is primarily related to net income of $49.1 million and $22.2 million in a non-cash add back related to the net portfolio allowance provision of our receivable portfolios. Cash provided by operating activities for the year ended December 31, 2009, is primarily related to net income of $33.0 million, $19.3 million in a non-cash add back related to the net portfolio allowance provision of our receivable portfolios and an $11.2 million increase in income taxes payable.

Investing Cash Flows

Net cash used in investing activities was $88.1 million, $142.8 million, and $79.2 million for the years ended December 31, 2011, 2010, and 2009, respectively.

The cash flows used in investing activities for the year ended December 31, 2011, are primarily related to receivable portfolio purchases of $386.9 million, offset by gross collection proceeds applied to the principal of our receivable portfolios in the amount of $301.5 million. The cash flows used in investing activities for the year ended December 31, 2010, are primarily related to receivable portfolio purchases of $362.0 million, offset by gross collection proceeds applied to the principal of our receivable portfolios in the amount of $217.9 million. The cash flows used in investing activities for the year ended December 31, 2009, are primarily related to receivable portfolio purchases of $246.3 million ($256.6 million of gross purchases less our forward flow allocation of $10.3 million), offset by gross collection proceeds applied to the principal of our receivable portfolios in the amount of $168.4 million.

Capital expenditures for fixed assets acquired with internal cash flow were $5.6 million, $2.7 million, and $4.6 million for the years ended December 31, 2011, 2010 and 2009, respectively.

 

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Financing Cash Flows

Net cash provided by financing activities was $0.7 million, $69.8 million and $0.7 million for the years ended December 31, 2011, 2010, and 2009, respectively.

The cash provided by financing activities during the year ended December 31, 2011, reflects $121.0 million in borrowings under our revolving credit facility and $25.0 million in proceeds from the issuance of our senior secured notes, offset by $143.0 million in repayments of amounts outstanding under our revolving credit facility. The cash provided by financing activities during the year ended December 31, 2010, reflects $125.5 million in borrowings under our revolving credit facility and $50.0 million in proceeds from the issuance of our senior secured notes, offset by $58.5 million in repayments of amounts outstanding under our revolving credit facility and $42.9 million in repayments of the remaining balance of our convertible notes that matured on September 20, 2010. The cash provided by financing activities during the year ended December 31, 2009, reflects $68.5 million in repayments of amounts outstanding under our revolving credit facility and $22.3 million in repurchase of our outstanding convertible notes, offset by $90.5 million in borrowings under our revolving credit facility.

Future Contractual Cash Obligations

The following table summarizes our future contractual cash obligations as of December 31, 2011 (in thousands):

 

     Payment Due By Period  

Contractual Obligations

   Total      Less Than
1 Year
     1 – 3 Years      3 – 5 Years      More
Than
5 Years
 

Revolving credit facility

   $ 305,000       $ —         $ 305,000       $ —         $ —     

Senior secured notes

     75,000         2,500         28,750         30,000         13,750   

Estimated interest payments(1)

     61,956         26,454         31,041         4,086         375   

Purchase commitments on receivable portfolios

     151,043         151,043         —           —           —     

Lease obligations

     44,763         11,246         15,092         10,244         8,181   

Employee agreements

     331         331         —           —           —     
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

Total contractual cash obligations

   $ 638,093       $ 191,574       $ 379,883       $ 44,330       $ 22,306   
  

 

 

    

 

 

    

 

 

    

 

 

    

 

 

 

 

(1) 

We calculated estimated interest payments for long-term debt as follows: for the senior secured notes, we calculated interest based on the applicable rates and payment dates. For our revolving credit facility, we calculated the interest for the hedged portion using fixed interest rates plus the required spread. For the remaining balance, which is subject to a variable interest rate, we estimated the debt balance and interest rates based on our determination of the most likely scenario. We expect to settle such interest payments with cash flows from operating activities.

We are in compliance with all covenants under our financing arrangements and, excluding the effects of the one-time payment of $16.9 million to eliminate all future contingent interest payments in the second quarter of 2007 (this payment, less amounts accrued on our balance sheet, resulted in a charge in our statement of operations of $6.9 million after the effect of income taxes) and the effects of the adoption of a new accounting principal related to our convertible notes, we have achieved 40 consecutive quarters of positive net income. We believe that we have sufficient liquidity to fund our operations for at least the next twelve months, given our expectation of continued positive cash flows from operations, our cash and cash equivalents of $8.0 million as of December 31, 2011, our access to the capital markets and availability under our revolving credit facility, which expires in December 2013.

Off-Balance Sheet Arrangements

We do not have any off-balance sheet arrangements as defined by Item 303(a)(4) of Regulation S-K.

 

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Critical Accounting Policies

Investment in Receivable Portfolios and Related Revenue. As permitted by the authoritative guidance for loans and debt securities acquired with deteriorated credit quality, static pools are established on a quarterly basis with accounts purchased during the quarter that have common risk characteristics. Discrete receivable portfolio purchases during a quarter are aggregated into pools based on these common risk characteristics. Once a static pool is established, the portfolios are permanently assigned to the pool. The discount (i.e., the difference between the cost of each static pool and the related aggregate contractual receivable balance) is not recorded because we expect to collect a relatively small percentage of each static pool’s contractual receivable balance. As a result, receivable portfolios are recorded at cost at the time of acquisition. The purchase cost of the portfolios includes certain fees paid to third parties incurred in connection with the direct acquisition of the receivable portfolios.

In compliance with the authoritative guidance, we account for our investments in consumer receivable portfolios using either the interest method or the cost recovery method. The interest method applies an internal rate of return (“IRR”), to the cost basis of the pool, which remains unchanged throughout the life of the pool, unless there is an increase in subsequent expected cash flows. Subsequent increases in expected cash flows are generally recognized prospectively through an upward adjustment of the pool’s IRR over its remaining life. Subsequent decreases in expected cash flows do not change the IRR, but are recognized as an allowance to the cost basis of the pool, and are reflected in the consolidated statements of income as a reduction in revenue, with a corresponding valuation allowance, offsetting the investment in receivable portfolios in the consolidated statements of financial condition.

We account for each static pool as a unit for the economic life of the pool (similar to one loan) for recognition of revenue from receivable portfolios, for collections applied to the cost basis of receivable portfolios and for provision for loss or allowance. Revenue from receivable portfolios is accrued based on each pool’s IRR applied to each pool’s adjusted cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances.

If the amount and timing of future cash collections on a pool of receivables are not reasonably estimable, we account for such portfolios on the cost recovery method as cost recovery portfolios. The accounts in these portfolios have different risk characteristics than those included in other portfolios acquired during the same quarter, or the necessary information was not available to estimate future cash flows and, accordingly, they were not aggregated with other portfolios. Under the cost recovery method of accounting, no income is recognized until the purchase price of a cost recovery portfolio has been fully recovered.

Deferred Revenue. We provide bankruptcy administration services primarily to holders of motor vehicle and real estate secured loans, on which the consumer has filed for Chapter 7 or 13 bankruptcy protection. These services are provided subject to the terms of long-term contracts. Such contracts generally have initial terms of one or two years and automatically renew annually. Fees for the bankruptcy administration services are charged on a ‘per referred’ account basis and generally consist of an upfront fee at the time of account referral. This upfront fee is typically coupled with either an ongoing monthly service fee per referred account or service specific fees based on a predetermined fee schedule. The servicing deliverable for Chapter 7 accounts is focused on the completion of the entire bankruptcy process resulting in the most favorable possible conclusion for the customer. As a result, revenue is deferred and not recognized until the bankruptcy case is closed (dismissal/discharge). Due to practical limitations and constraints, a historical average life of eight months is used rather than actual closure dates. Therefore, the total financial consideration (less efforts applied to litigation for client contracts without a separate litigation fee schedule) is recognized seven months after a referred account is activated. Chapter 13 bankruptcy proceedings, also known as reorganizations, are generally designed to restructure an individual’s debts and allow him or her to propose a repayment plan detailing how he or she is going to pay back his or her debts over the plan period. The responsibility of Ascension is to ensure that the client’s claim is recognized by the court to the maximum benefit of the client, and to monitor and/or collect the consumer payments throughout the confirmed bankruptcy plan term. The average duration period for Chapter 13 bankruptcy placements is 33 months. Given the nature and duration of a Chapter 13 proceeding, the monthly servicing deliverable provided relative to a Chapter 13 referred account is

 

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considered “delivered” each month and revenue is recognized ratably, including any upfront fees we received over time as the services are provided. The litigation deliverable is an as incurred event, with revenue recognized based on the historical percentage of accounts litigated over the average duration of an account. Any billings in excess of the ratable revenue will be deferred. The average duration period for Chapter 7 and 13 bankruptcy placements is reviewed periodically for changes. We include deferred revenue in “Other liabilities” in our Consolidated Statements of Financial Condition.

Deferred Court Costs. We contract with a nationwide network of attorneys that specialize in collection matters. We generally refer charged-off accounts to our contracted attorneys when we believe the related consumer has sufficient assets to repay the indebtedness and has, to date, been unwilling to pay. In connection with our agreements with our contracted attorneys, we advance certain out-of-pocket court costs, or Deferred Court Costs. We capitalize these costs in the consolidated financial statements and provide a reserve for those costs that we believe will ultimately be uncollectible. We determine the reserve based on our analysis of court costs that have been advanced and recovered, or that we anticipate recovering. Deferred Court Costs not recovered within three years of placement are fully written off.

Derivative Instruments and Hedging Activities. We use derivative instruments to manage risks related to interest rates and foreign currency. Our interest rate swap contracts and foreign currency exchange contracts qualify for hedge accounting treatment under the authoritative guidance for derivatives and hedging.

The authoritative guidance for derivatives and hedging requires that qualifying derivative instruments be recorded on the balance sheet as either an asset or liability measured at its fair value. The effective portion of the change in fair value of the derivative is recorded in other comprehensive income. The ineffective portion of the change in fair value of the derivatives, if any, is recognized in earnings in the period of change. See Note 3 “Derivatives and Hedging Instruments” to our consolidated financial statements for further discussion of our derivative instruments.

Goodwill and Other Intangible Assets. In accordance with authoritative guidance on goodwill and other intangible assets, we perform annual impairment analyses to assess the recoverability of the goodwill at each reporting unit. Application of the goodwill impairment test requires judgment, including the identification of reporting units, assigning assets and liabilities to reporting units, assigning goodwill to reporting units, and determining the fair value of each reporting unit. Effective July 1, 2011, we adopted the amended standard for goodwill impairment testing. The amended standard allows companies to first assess qualitative factors to determine whether it is necessary to perform the two-step quantitative goodwill impairment test. The qualitative factors include economic environment, business climate, market capitalization, operating performance, competition, and other factors.

If quantitative analyses are required, we apply various valuation techniques to measure the fair value of each reporting unit. Significant judgments are required to estimate the fair value of reporting units including estimating future cash flows, and determining appropriate discount rates, growth rates, and other assumptions. We will perform additional impairment testing if events occur or circumstances change between annual tests, that would more likely than not, reduce the fair value of the reporting unit below its carrying value.

Intangible assets with estimable useful lives are required to be amortized over their respective estimated useful lives and reviewed for impairment whenever events or changes in circumstances indicate that the carrying amount may not be recoverable. An impairment evaluation is based on an undiscounted cash flow analysis. We assess potential impairments to intangible assets when there is evidence that events or changes in circumstances indicate that the carrying amount of an asset or asset group may not be recovered. Our judgments regarding the existence of impairment indicators and future cash flows related to intangible assets are based on operational performance of our businesses, market conditions and other factors.

 

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Stock-Based Compensation. We record compensation costs related to our stock-based awards which include stock options, restricted stock awards and restricted stock units. We measure stock-based compensation cost at the grant date based on the fair value of the award. Compensation cost for service-based awards is recognized ratably over the applicable vesting period. Compensation cost for performance-based awards is reassessed each period and recognized based upon the probability that the performance targets will be achieved. The amount of stock-based compensation expense recognized during a period is based on the portion of the awards that are ultimately expected to vest. The total expense recognized over the vesting period will only be for those awards that ultimately vest.

Income Taxes. We use the liability method of accounting for income taxes. When we prepare the consolidated financial statements, we estimate our income taxes based on the various jurisdictions where we conduct business. This requires us to estimate our current tax exposure and to assess temporary differences that result from differing treatments of certain items for tax and accounting purposes. Deferred income taxes are recognized based on the differences between the financial statement and income tax bases of assets and liabilities using enacted tax rates in effect for the year in which the differences are expected to reverse. We then assess the likelihood that our deferred tax assets will be realized. Valuation allowances are established, when necessary, to reduce deferred tax assets to the amount expected to be realized. When we establish a valuation allowance or increase this allowance in an accounting period, we record a corresponding tax expense in our statement of income. When we reduce our valuation allowance in an accounting period, we record a corresponding tax benefit in our statement of income. We include interest and penalties related to income taxes within our provision for income taxes. See Note 10 “Income Taxes” to our consolidated financial statements for further discussion of income taxes.

Use of Estimates. We have made significant estimates with respect to the rate of return established to recognize accretion revenue on our receivable portfolios and with respect to the provision for allowances of receivable portfolios. In connection with these estimates, we have made significant estimates with respect to the timing and amount of collections of future cash flows from receivable portfolios owned.

Significant estimates have also been made with respect to Ascension’s service revenue, the ability to realize our net deferred court costs, intangible assets, net deferred tax assets and tax reserve, stock-based compensation, and the potential liabilities with respect to our health benefit plans.

Item 7A—Quantitative and Qualitative Disclosures About Market Risk

We are exposed to economic risks from foreign currency exchange rates and interest rates. A portion of these risks is hedged, but the risks may impact our financial statements.

Foreign Currency. We have operations in India, which expose us to foreign currency exchange rate fluctuations due to transactions denominated in Indian rupees, such as employee salaries and rent expenditures. We continuously evaluate and manage our foreign currency risk through the use of derivative financial instruments, including foreign currency forward contracts with financial counterparties where practicable. Such derivative instruments are viewed as risk management tools and are not used for speculative or trading purposes. As of December 31, 2011, we had 44 outstanding foreign currency forward contracts that hedge our risk of foreign currency exchange against the Indian rupee. Each contract settles monthly with a notional amount ranging from an United States dollar equivalent of $0.2 million to $1.4 million. The contracts hedge the forecasted monthly cash settlements resulting from the expenses incurred by our operations in India. We have not experienced any hedge ineffectiveness since the inception of the hedging program; a hypothetical change in the foreign exchange rate against the Indian rupee would not have a material impact on our consolidated statement of income.

 

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In addition, we are exposed to foreign currency risk that arises from the revaluation of monetary assets and liabilities held by our subsidiary in India that are not denominated in our functional currency. We may hedge currency exposures associated with certain assets and liabilities denominated in nonfunctional currencies and certain anticipated nonfunctional currency transactions. We could experience unanticipated gains or losses on anticipated foreign currency cash flows.

Interest Rate. As of December 31, 2011, we had total variable-interest-bearing borrowings of $305.0 million outstanding under our revolving credit facility, thus subjecting us to interest rate risk. We manage our interest rate risk through the use of derivative financial instruments, including interest rate swap contracts with financial counterparties. Such derivative instruments are viewed as risk management tools and are not used for speculative or trading purposes. We entered into several receive-floating pay-fixed interest rate swaps to hedge against potential changes in cash flows on our outstanding variable-interest-bearing debt. The receive variable leg of the swaps and the variable rate paid on the underlying debt bear the same rate of interest, excluding the credit spread, and reset and pay interest on the same dates. As of December 31, 2011, we have six interest rate swap contracts with financial counterparties with a total notional amount of $150.0 million. The contracts bear fixed annual interest rates ranging from 0.765% to 1.00%.

From the inception of the hedging program, the swaps have been determined to be highly effective. A hypothetical change in the interest rates would not have an impact on our interest expense on the $150.0 million hedged portion of our variable-interest-bearing debt. The remaining $150.5 million of our revolving credit facility is subject to the risk of interest rate fluctuations. If the market interest rates for our variable rate agreements increase 10%, interest expense on such outstanding debt would increase by approximately $0.7 million, on an annualized basis. Conversely, if the market interest rates decreased an average of 10%, our interest expense on such outstanding debt would decrease by $0.7 million.

Our analysis and methods used to assess and mitigate the risks discussed above should not be considered projections of future risks.

Item 8—Financial Statements and Supplementary Data

Our consolidated financial statements, the notes thereto and the Report of BDO USA, LLP, our Independent Registered Public Accounting Firm, are included in this Annual Report on Form 10-K on pages F-1 through F-28.

Item 9—Changes in and Disagreements With Accountants on Accounting and Financial Disclosure

None.

Item 9A—Controls and Procedures

Evaluation of Disclosure Controls and Procedures

As of the end of the period covered by this report, we carried out an evaluation, under the supervision and with the participation of our management, including our Chief Executive Officer and Chief Financial Officer, of the effectiveness of the design and operation of our disclosure controls and procedures, as defined in Exchange Act Rule 13a-15(e) and 15d-15(e). Based upon that evaluation, our Chief Executive Officer and Chief Financial Officer concluded that, as of the end of the period covered by this Annual Report on Form 10-K, our disclosure controls and procedures are effective in enabling us to record, process, summarize and report information required to be included in our periodic SEC filings within the required time period.

 

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Management’s Report on Internal Control over Financial Reporting

The Company’s management, including our Chief Executive Officer and Chief Financial Officer, is responsible for establishing and maintaining adequate internal control over financial reporting (as such term is defined in Exchange Act Rule 13a-15(f) and 15d-15(f)) for Encore Capital Group, Inc. and its subsidiaries (the “Company”). The Company’s internal control system was designed to provide reasonable assurance to the Company’s management and Board of Directors regarding the preparation and fair presentation of published consolidated financial statements in accordance with accounting principles generally accepted in the United States of America.

Because of its inherent limitations, a system of internal control over financial reporting can provide only reasonable assurance and may not prevent or detect misstatements. Further, because of changing conditions, effectiveness of internal control over financial reporting may vary over time. The Company’s processes contain self-monitoring mechanisms and actions are taken to correct deficiencies as they are identified.

Management has assessed the effectiveness of Encore’s internal control over financial reporting as of December 31, 2011, based on the criteria for effective internal control described in Internal Control—Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission. Based on its assessment, management concluded that the Company’s internal control over financial reporting was effective as of December 31, 2011.

BDO USA, LLP, the independent registered public accounting firm that audited the consolidated financial statements included in this Annual Report on Form 10-K, was engaged to attest to and report on the effectiveness of Encore’s internal control over financial reporting as of December 31, 2011, as stated in its report below.

 

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Report of Independent Registered Public Accounting Firm

Board of Directors and Stockholders

Encore Capital Group, Inc.

San Diego, California

We have audited Encore Capital Group, Inc.’s internal control over financial reporting as of December 31, 2011, based on criteria established in Internal Control - Integrated Framework issued by the Committee of Sponsoring Organizations of the Treadway Commission (the COSO criteria). Encore Capital Group, Inc.’s management is responsible for maintaining effective internal control over financial reporting and for its assessment of the effectiveness of internal control over financial reporting, included in the accompanying Management’s Report on Internal Control Over Financial Reporting. Our responsibility is to express an opinion on the company’s internal control over financial reporting based on our audit.

We conducted our audit in accordance with the standards of the Public Company Accounting Oversight Board (United States). Those standards require that we plan and perform the audit to obtain reasonable assurance about whether effective internal control over financial reporting was maintained in all material respects. Our audit included obtaining an understanding of internal control over financial reporting, assessing the risk that a material weakness exists, and testing and evaluating the design and operating effectiveness of internal control based on the assessed risk. Our audit also included performing such other procedures as we considered necessary in the circumstances. We believe that our audit provides a reasonable basis for our opinion.

A company’s internal control over financial reporting is a process designed to provide reasonable assurance regarding the reliability of financial reporting and the preparation of financial statements for external purposes in accordance with generally accepted accounting principles. A company’s internal control over financial reporting includes those policies and procedures that (1) pertain to the maintenance of records that, in reasonable detail, accurately and fairly reflect the transactions and dispositions of the assets of the company; (2) provide reasonable assurance that transactions are recorded as necessary to permit preparation of financial statements in accordance with generally accepted accounting principles, and that receipts and expenditures of the company are being made only in accordance with authorizations of management and directors of the company; and (3) provide reasonable assurance regarding prevention or timely detection of unauthorized acquisition, use, or disposition of the company’s assets that could have a material effect on the financial statements.

Because of its inherent limitations, internal control over financial reporting may not prevent or detect misstatements. Also, projections of any evaluation of effectiveness to future periods are subject to the risk that controls may become inadequate because of changes in conditions, or that the degree of compliance with the policies or procedures may deteriorate.

In our opinion, Encore Capital Group, Inc. maintained, in all material respects, effective internal control over financial reporting as of December 31, 2011, based on the COSO criteria.

We also have audited, in accordance with the standards of the Public Company Accounting Oversight Board (United States), the consolidated statements of financial condition of Encore Capital Group, Inc. as of December 31, 2011 and 2010, and the related consolidated statements of income, stockholders’ equity and comprehensive income, and cash flows for each of the three years in the period ended December 31, 2011 and our report dated February 9, 2012, expressed an unqualified opinion thereon.

/s/ BDO USA, LLP

San Diego, California

February 9, 2012

 

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Changes in Internal Control over Financial Reporting

There was no change in internal control over financial reporting (as such term is defined in Exchange Act Rules 13a-15(f) and 15d-15(f)), during our fourth fiscal quarter that has materially affected, or is reasonably likely to materially affect, our internal control over financial reporting.

Item 9B—Other Information

None.

PART III

Item 10—Directors, Executive Officers and Corporate Governance

The information under the captions “Election of Directors,” “Executive Officers” and “Section 16(a) Beneficial Ownership Reporting Compliance,” appearing in the 2012 Proxy Statement to be filed no later than April 29, 2012, is hereby incorporated by reference.

Item 11—Executive Compensation

The information under the caption “Executive Compensation and Other Information,” appearing in the 2012 Proxy Statement to be filed no later than April 29, 2012, is hereby incorporated by reference.

Item 12—Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters

The information under the captions “Security Ownership of Principal Stockholders and Management” and “Equity Compensation Plan Information,” appearing in the 2012 Proxy Statement to be filed no later than April 29, 2012, is hereby incorporated by reference.

Item 13—Certain Relationships and Related Transactions, and Director Independence

The information under the captions “Certain Relationships and Related Transactions” and “Election of Directors—Corporate Governance—Director Independence,” appearing in the 2012 Proxy Statement to be filed no later than April  29, 2012, is hereby incorporated by reference.

Item 14—Principal Accounting Fees and Services

The information under the caption “Independent Registered Public Accounting Firm,” appearing in the 2012 Proxy Statement to be filed no later than April 29, 2012, is hereby incorporated by reference.

 

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PART IV

Item 15—Exhibits and Financial Statement Schedules

(a) Financial Statements.

The following consolidated financial statements of Encore Capital Group, Inc. are filed as part of this annual report on Form 10-K:

 

Report of Independent Registered Public Accounting Firm

     F-1   

Consolid