PRA Group, Inc. (Portfolio Recovery Associates) — Q2 2011 Form 10-Q
Business context and reporting period
Quarter ended June 30, 2011; filed August 5, 2011. PRA primarily purchases and collects charged-off consumer receivables, including bankruptcy accounts, and also provides location, government receivables, and class-action claims services. The company reports one segment: receivables management. Financial statement amounts below are in U.S. dollars; income statement and cash-flow figures are in millions unless noted.
Financial results and key metrics
| Metric | Q2 2011 | Q2 2010 | Change |
|---|---|---|---|
| Total revenue | $114.8 million | $93.0 million | +23.4% |
| Finance-receivable income, net | $100.3 million | $76.9 million | +30.4% |
| Fee income | $14.5 million | $16.1 million | -9.9% |
| Operating expenses | $70.4 million | $58.7 million | +19.9% |
| Income from operations | $45.5 million | $34.3 million | +32.6% |
| Net income attributable to PRA | $25.6 million | $19.5 million | +31.0% |
| Diluted EPS | $1.48 | $1.14 | +29.8% |
| Operating margin | 39.7% | 36.9% | +2.8 percentage points |
| Net margin | 22.3% | 21.0% | +1.3 percentage points |
- First half 2011: Revenue was $226.6 million, up 28.5%; operating income was $88.2 million, up 45.2%; net income attributable to PRA was $48.7 million, up 41.9%; diluted EPS was $2.83 versus $2.06.
- Collections and portfolios: Q2 owned-portfolio cash collections increased 37.3% to $176.3 million; first-half collections rose 38.5% to $343.0 million. Net finance receivables were $879.5 million at June 30, up from $831.3 million at year-end 2010. Estimated remaining collections were $1.816 billion, 12.7% above June 2010.
- Allowance: Q2 net allowance charges were $2.3 million, versus $6.3 million a year earlier; first-half charges were $6.3 million, versus $13.2 million. The ending allowance was $82.7 million, up from $64.4 million at June 2010.
- Cash flow and liquidity: First-half operating cash flow was $87.0 million versus $67.3 million. Investing activities used $50.6 million, including $194.9 million of receivables purchases and $146.7 million of collections applied to principal. Financing activities used $52.0 million, primarily reflecting net line-of-credit repayments. Cash fell to $25.5 million from $41.1 million at December 31, 2010.
- Debt and equity: Line-of-credit borrowings were $250.0 million, including a $50 million fixed-rate loan; total facility availability was $157.5 million. Long-term debt was $1.9 million. Stockholders’ equity was $542.4 million. PRA reported compliance with all credit covenants at June 30.
Material changes and management commentary
- Growth in collections and finance-receivable income drove the revenue increase; management cited improved dialer technology, account-scoring analytics, and expanded internal legal-collection capacity. Cash collections per collector hour also improved year over year.
- Operating expenses increased 20%, led by compensation, legal fees and costs, and communications. Legal collection fees and costs together rose to $15.8 million from $10.6 million as the portfolio grew and more accounts were referred for legal action. Operating expenses as a share of cash receipts improved to 36.9% from 40.6%.
- Fee income declined, principally due to weakness in PRA Location Services amid the economic slowdown; government-services revenue partly offset the decline. First-half fee income also benefited from CCB and government-services growth.
- First-half portfolio purchases cost $197.4 million for receivables with $2.90 billion face value, compared with $189.4 million for $3.56 billion face value in the prior-year period. Management noted competitive pricing and changes in bankruptcy/Core portfolio mix can affect expected returns; bankruptcy accounts may produce delayed collections.
- A $1.2 million gain from selling land adjacent to the Norfolk headquarters increased Q2 and first-half operating income. The effective tax rate was 40.4% in Q2 and the first half, versus 38.8% and 38.9%, respectively, in 2010.
Outlook, risks, and contingencies
- No formal earnings or revenue guidance was provided. Management said operating cash flows, cash on hand, and available credit were expected to fund operations, planned capital spending, approximately $160.5 million of forward-flow purchases, and additional portfolio buying over the next 12 months.
- Key risks include collection performance and economic conditions; availability and pricing of receivables; regulatory or legal changes; staffing and collection productivity; competition; funding access and covenant compliance; and the accuracy of cash-flow estimates and valuation allowances.
- The IRS dispute concerns the company’s cost-recovery method for tax revenue recognition and treatment of unused credit-facility fees. The IRS expanded its audit to include 2008 and 2009. PRA believes its positions are supportable, but an adverse outcome could require tax and interest payments and possibly additional financing; the filing does not state a clear estimated exposure.
- Five putative class actions allege violations of the Telephone Consumer Protection Act concerning calls to cellular phones without prior express consent. The company intends to defend them; potential losses cannot currently be estimated. Missouri’s appeal of a dismissed enforcement action remained pending after the Court of Appeals affirmed dismissal.
- The CCB minority holder’s put right begins in March 2012; maximum consideration for the 38% interest is $22.8 million. Forward-flow purchase commitments and the CCB interest are included in contractual obligations.
- Variable-rate borrowings expose PRA to interest-rate risk. Management estimated an immediate 200-basis-point increase would have raised Q2 interest expense by approximately $1.1 million.
Most important facts for investors to verify
- Whether the sharp increase in collections is sustainable and supported by realized portfolio performance, especially as purchase pricing and the bankruptcy/Core mix change.
- How future cash-flow estimates, allowance charges, and the $82.7 million finance-receivable allowance evolve relative to actual collections.
- Availability and cost of credit, covenant headroom, and funding capacity for committed and additional portfolio purchases.
- Developments in the IRS examination and TCPA and Missouri litigation, including any eventual quantification of potential exposure.
- Whether lower fee income and rising legal, communications, and personnel costs affect margins in subsequent periods.