Business context and reporting period
Portfolio Recovery Associates, Inc. (PRA Group) purchases, collects and manages defaulted consumer receivables, and provides receivables servicing and claims-settlement services. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2013; comparisons are with the corresponding 2012 periods. Dollar amounts below are in millions unless stated otherwise. Per-share and share data reflect the three-for-one stock split.
Financial performance and position
| Metric | Q3 2013 | Q3 2012 | Change |
|---|---|---|---|
| Total revenue | $197.8 | $150.5 | +31.4% |
| Operating income | $79.5 | $57.1 | +39.2% |
| Operating margin | 40.2% | 37.9% | +2.3 percentage points |
| Net income attributable to PRA | $47.3 | $33.3 | +42% |
| Diluted EPS | $0.93 | $0.65 | +43% |
| Cash collections on owned portfolios | $291.7 | $229.1 | +27.3% |
| Fee income | $26.3 | $14.8 | +78% |
For the nine months ended September 30, revenue was $550.3 million, up 25.5%; operating income was $219.2 million, up 40.4%; net income attributable to PRA was $129.5 million, up 42.7%; and diluted EPS was $2.54 versus $1.77. Net income margin for the nine-month period was 23.8%, compared with 20.6%.
Operating cash flow for the nine months was $172.1 million, versus $93.7 million. Investing activities used $187.4 million, mainly reflecting $546.2 million of receivables purchases, partly offset by $368.7 million of principal collections. Financing activities provided $91.2 million. Cash increased to $108.7 million from $32.7 million at December 31, 2012.
At September 30, 2013, finance receivables, net, were $1.257 billion, up from $1.079 billion at year-end. Total assets were $1.548 billion and total liabilities were $721.0 million. Borrowings were $452.2 million, including a $196.3 million term loan, $0.2 million equipment loan and convertible notes carried net of discount at $255.8 million. The company reported $435.5 million of undrawn revolving credit availability, subject to borrowing-base and covenant limits. Its reported debt-to-equity ratio was 55.4%, compared with 37.4% in the prior-year comparison.
Material changes and unusual items
- Portfolio purchases rose: during the first nine months, PRA paid $557.3 million for portfolios with $6.83 billion face value, compared with $339.4 million for $4.25 billion face value in 2012. Estimated remaining collections (ERC) reached $2.672 billion, up 25% year over year.
- Cash collections and finance-receivable income increased substantially. Management attributed performance to higher collections and operational improvements, including account scoring and expanded internal legal collections. Nine-month operating expenses grew 17.2%, slower than revenue growth.
- Q3 included a $6.4 million non-cash goodwill impairment, eliminating all goodwill assigned to PRA Location Services (PLS), whose reporting unit had revenue and profitability declines, recent losses and the loss of a significant client. PLS-related intangible assets were fully amortized.
- Fee income growth was driven largely by Claims Compensation Bureau revenue related to a single case; this was partly offset by lower fee income at Mackenzie Hall and PLS.
- In August, PRA issued $287.5 million of 3.00% convertible senior notes due 2020. Net proceeds were approximately $279 million; $174 million repaid revolver borrowings and $50 million funded share repurchases. The initial conversion price was approximately $65.72 per share. Notes were not convertible as of September 30, 2013, because conversion conditions had not been met.
- PRA repurchased 1.203 million shares for $58.5 million during the first nine months. The board-authorized repurchase program had approximately $18.8 million remaining at quarter-end.
- PRA exercised its option to acquire the remaining 19% interest in CCB for approximately $4.5 million; the transaction closed October 31, 2013, after the reporting date.
Outlook, risks and contingencies
No specific earnings or revenue guidance was provided. Management said operating cash generation, portfolio collections, cash on hand and available credit were expected to fund operations, planned capital expenditures, forward-flow commitments and normal-course portfolio purchases over the next 12 months. Higher-than-normal portfolio purchases or acquisitions could require additional financing. Estimated future principal collections on finance receivables were $442.0 million for the 12 months ending September 30, 2014; these are estimates, not a guarantee of collections.
Key risks include the accuracy and timing of proprietary collection forecasts and ERC, portfolio pricing and competition, consumer and regulatory conditions, collection-law changes, hiring and retention of collectors, and interest-rate and foreign-exchange movements. PRA had no interest-rate or currency hedges in place. Management estimated that a 200-basis-point rate increase would have raised quarterly interest expense by $1.4 million at the Q3 2013 average variable-rate borrowing level.
The IRS is challenging PRA’s cost-recovery tax method and treatment of unused credit-line fees for tax years 2005–2007; PRA is contesting the deficiency in Tax Court. An adverse outcome could require taxes, interest and possibly penalties and could require additional financing. PRA also faces consolidated Telephone Consumer Protection Act litigation and an ongoing matter involving a preliminary injunction restricting certain calls to California cellular numbers. Management said pending proceedings were not expected to have a material adverse impact based on current knowledge, but acknowledged that outcomes could be material. The filing reports no material legal proceeding commenced during the quarter.
PRA stated it was in compliance with financing covenants at September 30, 2013. The credit facility is secured by substantially all company assets and includes leverage, borrowing-base, net-worth and other restrictions. The convertible notes add potential cash requirements for repurchases after a fundamental change or cash settlement of conversions.
Important facts for investors to verify
- Whether portfolio collection performance and ERC estimates remain on track, particularly as purchasing volume and the finance-receivable balance expand.
- How much Q3 and year-to-date earnings growth is repeatable given the single-case contribution to fee income and the PLS impairment.
- Whether expanded legal-collection activity produces sufficient future collections to justify its associated upfront costs.
- Updates on the IRS tax dispute and TCPA litigation, including any changes to estimated exposure or operational restrictions.
- Debt-service capacity, covenant headroom, variable-rate exposure and possible cash or dilution effects of the convertible notes.
- The impact of the post-quarter CCB buyout and the sustainability of fee-for-service business results.