ASSET ACCEPTANCE CAPITAL CORP - 10-Q Quarterly Report

UNITED STATES
SECURITIES AND EXCHANGE COMMISSION

Washington, DC 20549

FORM 10-Q

(Mark One)


x		QUARTERLY REPORT PURSUANT TO SECTION 13 or 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
		For the quarterly period ended September 30, 2004

o		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: 000-50552

Asset Acceptance Capital Corp.

(Exact name of registrant as specified in its charter)


Delaware		80-0076779
(State or other jurisdiction of incorporation or organization)		(I.R.S. Employer Identification No.)

6985 Miller Road
Warren, Michigan 48092
(Address of principal executive offices)

Registrant’s telephone number, including area code: (586) 939-9600

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 o

Indicate by check mark whether the Registrant is an accelerated filer (as defined in Rule 12b-2 of the Exchange Act).

Yes o No x

Indicate the number of shares outstanding of each of the issuer’s classes of common stock, as of the latest practicable date.

As of October 20, 2004, 37,225,275 shares of the Registrant’s common stock were outstanding.

PART I — FINANCIAL INFORMATION

Item 1. Financial Statements

ASSET ACCEPTANCE CAPITAL CORP.
Consolidated Statements of Financial Position
(Unaudited)


	September 30, 2004		December 31, 2003
ASSETS
Cash	$	11,519,955	$	5,498,836
Purchased receivables		200,853,658		183,719,667
Finance contract receivables, net		699,453		642,530
Property and equipment, net		7,348,336		7,970,570
Goodwill		6,339,574		6,339,574
Other assets		3,662,632		2,938,999

Total assets	$	230,423,608	$	207,110,176

LIABILITIES AND STOCKHOLDERS’ EQUITY
Liabilities:
Line of credit	$	—	$	72,950,000
Notes payable — related party		—		39,560,110
Deferred tax liability		34,075,127		11,905,768
Accounts payable and other liabilities		11,571,606		8,092,844
Capital lease obligations		262,115		218,765

Total liabilities		45,908,848		132,727,487

Stockholders’ equity:
Preferred stock, $0.01 par value, 10,000,000 shares authorized, no shares issued and outstanding		—		—
Common stock, $0.01 par value, 100,000,000 shares authorized; issued and outstanding shares — 37,225,275 at September 30, 2004 and 28,448,449 at December 31, 2003		372,253		284,484
Additional paid in capital		159,249,595		36,385,000
Retained earnings		24,892,912		37,713,205

Total equity		184,514,760		74,382,689

Total liabilities and equity	$	230,423,608	$	207,110,176

See accompanying notes.

ASSET ACCEPTANCE CAPITAL CORP.
Consolidated Statements of Income
(Unaudited)


	Three months ended September 30,						Nine months ended September 30,
	2004			2003			2004			2003
Revenues
Purchased receivable revenues	$	55,870,763		$	43,020,901		$	156,810,383		$	115,451,811
Finance contract revenues		127,967			122,472			442,600			437,998

Total revenues		55,998,730			43,143,373			157,252,983			115,889,809

Expenses
Salaries and benefits		16,240,718			12,846,772			94,124,074			37,229,116
Collections expense		15,671,416			13,437,229			40,750,626			32,703,443
Occupancy		1,509,896			1,129,155			4,328,048			3,096,293
Administrative		1,343,371			685,225			3,984,713			2,422,069
Depreciation		669,213			652,898			2,132,800			1,890,429
(Gain)/loss on disposal of equipment		(1,041	)		—			41,865			2,714

Total operating expense		35,433,573			28,751,279			145,362,126			77,344,064

Income from operations		20,565,157			14,392,094			11,890,857			38,545,745
Net interest expense		224,323			1,876,203			1,554,267			5,465,598
Other income		(414	)		(174,107	)		(25,372	)		(355,005	)

Income before income taxes		20,341,248			12,689,998			10,361,962			33,435,152
Income taxes		7,579,901			2,614,363			22,182,255			6,831,500

Net income (loss)	$	12,761,347		$	10,075,635		$	(11,820,293	)	$	26,603,652

Pro forma income tax expense				$	4,753,285		$	3,854,650		$	12,471,312

Pro forma net income				$	7,936,713		$	6,507,312		$	20,963,840

Weighted average number of shares :
Basic		37,225,275			28,448,449			36,104,148			28,448,449
Diluted		37,230,985			28,448,449			36,110,708			28,448,449
Earnings (loss) per common share outstanding:
Basic	$	0.34		$	0.35		$	(0.33	)	$	0.94
Diluted	$	0.34		$	0.35		$	(0.33	)	$	0.94
Proforma earnings per common share outstanding:
Basic				$	0.28		$	0.18		$	0.74
Diluted				$	0.28		$	0.18		$	0.74

See accompanying notes.

ASSET ACCEPTANCE CAPITAL CORP.
Consolidated Statements of Cash Flows
(Unaudited)


	Nine months ended September 30,
	2004			2003
Cash flows from operating activities
Net income (loss)	$	(11,820,293	)	$	26,603,652
Adjustments to reconcile net income (loss) to net cash provided by operating activities:
Depreciation		2,132,800			1,890,429
Deferred income taxes		22,169,359			6,830,588
Share-based compensation expense		26,824,957			—
Loss on disposal of equipment		41,865			2,714
Provision for losses on finance contracts		126,980			144,239
Changes in assets and liabilities:
Increase in other assets		(903,865	)		(829,841	)
Increase in accounts payable and other liabilities		3,478,762			4,458,836

Net cash provided by operating activities		42,050,565			39,100,617

Cash flows from investing activities
Investment in purchased receivables, net of buybacks		(59,911,516	)		(63,743,884	)
Principal collected on purchased receivables		42,777,525			28,379,281
Investment in finance contracts		(590,677	)		(700,132	)
Principal collected on finance contracts		406,775			407,049
Proceeds from sale of fixed assets		—			1,956
Purchase of fixed assets		(1,224,125	)		(2,240,374	)

Net cash used in investing activities		(18,542,018	)		(37,896,104	)

Cash flows from financing activities
Borrowings under line of credit		45,420,000			43,700,000
Repayment of line of credit		(118,370,000	)		(42,400,000	)
Borrowings from related party		—			1,779,363
Repayments to related party		(39,560,110	)		—
Repayment of capital lease obligations		(104,724	)		(59,400	)
Dividends and distributions paid		(1,000,000	)		(738,500	)
Additional assets contributed		50,406			—
Proceeds from initial public offering, net of costs		96,077,000			—

Net cash provided by (used in) financing activities		(17,487,428	)		2,281,463

Net increase in cash		6,021,119			3,485,976
Cash at beginning of period		5,498,836			2,280,861

Cash at end of period	$	11,519,955		$	5,766,837

Supplemental disclosure of cash flow information
Cash paid for interest	$	1,380,658		$	2,452,403
Cash paid for income taxes		91,746			—
Non-cash investing and financing activities:
Capital lease obligations incurred		148,075			173,530

See accompanying notes.

ASSET ACCEPTANCE CAPITAL CORP.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)

1. Summary of Significant Accounting Policies

Reporting Entity

Asset Acceptance Capital Corp. (the “Company”) commenced an initial public offering (“IPO”) of common stock on February 5, 2004. On February 4, 2004, a reorganization was completed in which all of the shares of capital stock of AAC Investors, Inc. and RBR Holding Corp. were contributed to Asset Acceptance Capital Corp. in exchange for all of the outstanding shares of common stock of Asset Acceptance Capital Corp. AAC Investors, Inc. and RBR Holding Corp. held a 60% and 40% ownership interest in Asset Acceptance Holdings LLC, respectively. The resulting consolidated entity includes Asset Acceptance Capital Corp., AAC Investors, Inc., RBR Holding Corp. and Asset Acceptance Holdings LLC and subsidiaries. Prior to this reorganization, Asset Acceptance Capital Corp. did not conduct any business and did not have any assets or liabilities, except as related to the IPO. This reorganization was recorded at cost. All periods presented have been restated to reflect this reorganization.

AAC Investors, Inc. was formed in September 2002 for the purpose of acquiring an interest in Asset Acceptance Holdings LLC and subsidiaries. Effective at the close of business on September 30, 2002, AAC Investors, Inc. completed the acquisition of 60% of Asset Acceptance Holdings LLC.

We have presented pro forma income taxes and pro forma net income assuming the consolidated entity had been a C corporation for all periods presented. Tax rates used for pro forma income taxes are equal to the rates that would have been in effect had we been required to report tax expense in such years.

The consolidated financial statements of the Company include Asset Acceptance Capital Corp., AAC Investors, Inc., RBR Holding Corp., and Asset Acceptance Holdings LLC and its wholly-owned subsidiaries, Asset Acceptance, LLC, Financial Credit, LLC, CFC Financial, LLC, Rx Acquisitions, LLC (formerly known as Med-Fi Acceptance, LLC), and Consumer Credit, LLC. The accompanying unaudited financial statements of the Company have been prepared in accordance with Rule 10-01 of Regulation S-X promulgated by the Securities and Exchange Commission and, therefore, do not include all information and footnotes necessary for a fair presentation of financial position, results of operations and cash flows in conformity with accounting principles generally accepted in the United States. In the opinion of the Company, however, the accompanying unaudited consolidated financial statements contain all adjustments necessary for a fair statement of the Company’s financial position as of September 30, 2004 and its results of operations for the three and nine month periods ended September 30, 2004 and 2003 and cash flows for the nine month periods ended September 30, 2004 and 2003. The results of operations of the Company for the three and nine month periods ended September 30, 2004 and 2003 may not be indicative of future results. These consolidated financial statements should be read in conjunction with the audited consolidated financial statements and notes thereto included in the Company’s Annual Report on Form 10-K filed for the year ended December 31, 2003.

Nature of Operations

The Company is a leading purchaser and collector of charged-off consumer receivables in the United States. These receivables are acquired from consumer credit originators, primarily credit card issuers, consumer finance companies, retail merchants and telecommunications and other utility providers as well as from resellers and other holders of consumer debt. As part of the collection process, the Company occasionally sells receivables from these portfolios to unaffiliated companies.

The Company also finances the sales of consumer product retailers located primarily in Michigan and Florida.

Purchased Receivables Portfolios and Revenue Recognition

Purchased receivables are receivables that have been charged-off as uncollectible by the originating organization and typically have been subject to previous collection efforts. The Company acquires the rights to the unrecovered balances owed by individual debtors through such purchases. The receivables portfolios are purchased at a substantial discount (usually discounted 95% to 98%) from their face amounts and are initially recorded at the Company’s cost to acquire the portfolio. Financing for the purchases is primarily provided by the Company’s line of credit and cash from operations.

The Company accounts for its investment in purchased receivables using the guidance provided by the Accounting Standards Executive Committee Practice Bulletin 6, “Amortization of Discounts on Certain Acquired Loans.” The Company purchases pools of homogenous accounts receivable (static pool) and records each pool at its acquisition cost. Each static pool retains its own identity and does not change. Each pool is accounted for as a single unit for recognition of revenue, principal payments and impairment. Collections on each static pool are allocated to revenue and principal reduction based on the estimated internal rate of return (“IRR”). The IRR is the rate of return that each static pool requires to amortize the cost or carrying value of the pool to zero over its estimated life. Each pool’s IRR is determined by estimating future cash flows, which are based on historical collection data for pools with similar characteristics (paper type). Based on historical cash collections, each pool is given an expected life of 60 months. The actual life of each pool may vary, but each pool generally amortizes between 50 and 60 months. Monthly cash flows greater than revenue recognized will reduce the carrying value of each static pool and monthly cash flows lower than revenue recognized will increase the carrying value of the static pool. Each pool is reviewed monthly and compared to historical cash flows, by paper type, to determine whether each pool is performing as expected. If a pool is not performing as expected, the IRR is adjusted either up or down so that the carrying value of the pool amortizes close to its expected life.

The cost recovery method prescribed by Practice Bulletin 6 is used when collections on a particular portfolio cannot be reasonably predicted. Under the cost recovery method, no revenue is recognized until we have fully collected the cost of the portfolio. As of September 30, 2004, the Company had 46 pools on the cost recovery method with an aggregate carrying value of $3.1 million or about 1.5% of the total carrying value of all purchased receivables.

In the event that cash collected would be inadequate to amortize the carrying value, an impairment charge would be taken with a corresponding write-off of the receivable balance. Accordingly, a reserve for impairment is not maintained for purchased receivables.

The agreements to purchase receivables typically include general representations and warranties from the sellers covering account holder death, bankruptcy, age of account and settled or disputed accounts prior to sale. The representation and warranty period permits the return of certain accounts from the Company back to the seller. The general time frame to return accounts is within 60 to 365 days. Returns are applied against the carrying value of the static pool.

Periodically the Company will sell, on a non-recourse basis, all or a portion of a pool to third parties. The Company does not have any significant continuing involvement with the sold pools subsequent to sale. Proceeds of these sales are generally compared to the carrying value of the accounts; a gain or loss is recognized on the difference between proceeds received and carrying value.

Changes in purchased receivables portfolios for the three and nine months ended September 30, 2004 and 2003 were as follows:


	Three Months ended September 30,						Nine Months ended September 30,
	2004			2003			2004			2003
Beginning balance	$	197,503,693		$	147,464,897		$	183,719,667		$	133,336,581
Investment in purchased receivables, net of buybacks		14,305,024			26,838,216			59,911,516			63,743,884
Cash collections		(66,825,822	)		(48,622,829	)		(199,587,908	)		(143,831,091	)
Purchased receivable revenues		55,870,763			43,020,901			156,810,383			115,451,811

Ending balance	$	200,853,658		$	168,701,185		$	200,853,658		$	168,701,185

Finance Contract Receivables

Finance contract revenues are recognized based on the accretion of the discount at which these contracts are financed over their respective terms. Unearned discounts on finance contract receivables were approximately $432,000 and $417,000 at September 30, 2004 and December 31, 2003, respectively. The fair value of finance contract receivables does not materially differ from their book value. Interest is recognized over the life of the contract. An allowance for doubtful accounts is established for estimated losses on accounts for which collection has been delayed or is in doubt. The allowance for doubtful accounts, which is netted against finance contract receivables on the consolidated statements of financial position, was approximately $99,000 and $106,000 at September 30, 2004 and December 31, 2003, respectively.

Collections from Third Parties

The Company regularly utilizes unaffiliated third parties, primarily attorneys and other contingent collection agencies, to collect certain account balances on behalf of the Company in exchange for a percentage of balances collected by the third party. The Company records the gross proceeds received by the unaffiliated third parties as cash collections. The Company includes the reimbursement of certain legal and other costs as cash collections. The Company records the percentage of the gross collections paid to the third parties as a component of collection expense. The percent of gross collections from such third party relationships were 24% and 21% for the three months ended September 30, 2004 and 2003, and 21% and 17% for the nine months ended September 30, 2004 and 2003, respectively.

Initial Public Offering

The Company received net proceeds of $96.1 million from the IPO of 7,000,000 shares of common stock which were used to eliminate the related party debt of $40.0 million, reduce the line of credit by $37.7 million and pay withholding taxes on behalf of the share appreciation rights holders in the amount of $18.4 million.

Share Appreciation Rights Compensation Charge

As previously announced in the Company’s Registration Statement on Form S-1 and the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and further described on Form 10-Q for the three months ended March 31, 2004, the Company recognized a compensation charge (including related payroll taxes) of $45.7 million ($28.7 million net of income taxes) during the first quarter of 2004 for its share appreciation rights plan. The share appreciation rights plan, adopted by Asset Acceptance Holdings LLC during 2002, granted participants the right to share in the appreciation of the value of Asset Acceptance Holdings LLC. The benefit earned was based on certain financial objectives and vested 100% upon completion of the IPO. There were 1,200,638 share appreciation rights outstanding at the time of the IPO.

Deferred Tax Charge

As previously announced in the Company’s Registration Statement on Form S-1 and the Company’s Annual Report on Form 10-K for the year ended December 31, 2003 and further described on Form 10-Q for the three months ended March 31, 2004, the Company recognized a deferred tax charge of $19.3 million during the first quarter of 2004 related to deferred taxes of RBR Holding Corp. RBR Holding Corp. was previously taxed as an S corporation under the Internal Revenue Code. The shareholders of RBR Holding Corp. included their respective shares of taxable income or loss in their individual tax returns and therefore no income tax expense was recognized on the financial statements of the Company. As a result of the reorganization completed on February 4, 2004, RBR Holding Corp. became a wholly-owned subsidiary of Asset Acceptance Capital Corp. and could no longer be taxed as an S corporation. The provision for deferred income taxes results from temporary differences between the financial statement carrying amounts and tax basis of assets and liabilities using enacted tax rates.

2. Related-Party Transactions

On October 1, 2002, the Company borrowed $35.0 million from its shareholders. Interest on the notes of 10% per annum, compounded on June 30 and December 31 of each year. The Company recognized $433,536 and $2,728,641 of interest expense on these notes for the nine months ended September 30, 2004 and 2003, respectively. The Company owed the related parties $39,560,110 as of December 31, 2003. These notes were paid in full during February 2004.

3. Line of Credit

The Company has a $100.0 million line of credit with a syndicate of commercial lenders that originated on September 30, 2002 and was amended most recently on February 11, 2004. The line of credit is collateralized by all assets of the Company and expires May 31, 2007. Interest is at prime, or depending on the Company’s liquidity, at 25 basis points over prime, or alternatively, at rates between 200 and 275 basis points over the 30, 60, or 90 day LIBOR rate. Additionally, the company pays an annual commitment fee of 0.375% on the unused portion of the line of credit. The outstanding balance was $72,950,000 at December 31, 2003. There was no outstanding balance at September 30, 2004. The line of credit facility has certain covenants and restrictions with which the Company must comply, including:

• Funds borrowed can be used to purchase portfolios of charged-off receivables and for general corporate purposes.

• Leverage ratio (as defined in the line of credit agreement) cannot exceed 1.5 to 1.0.

• Debt to total capitalization ratio (as defined in the line of credit agreement) cannot exceed 1.25 to 1.0.

The Company’s management believes it is in compliance with all terms of its line of credit agreement as of September 30, 2004.

4. Property and Equipment

Property and equipment, having estimated useful lives ranging from three to ten years consisted of the following:


	September 30,			December 31,
	2004			2003
Computers and software	$	7,338,295		$	6,641,311
Furniture and fixtures		5,644,831			5,284,614
Leasehold improvements		705,091			689,043
Equipment under capital lease		453,856			397,908
Automobiles		133,325			133,325

Total property and equipment, cost		14,275,398			13,146,201
Less accumulated depreciation		(6,927,062	)		(5,175,631	)

Net property and equipment	$	7,348,336		$	7,970,570

5. Stock Based Compensation

Effective January 1, 2004, the Company adopted the fair value recognition provisions of FAS 123, “Accounting for Stock-Based Compensation,” prospectively to all employee awards granted, modified, or settled after January 1, 2004.

The Company adopted a stock incentive plan during February 2004 that authorizes the use of stock options, stock appreciation rights, restricted stock grants and units, performance share awards and annual incentive awards to key employees, primarily management. The Company has reserved 3,700,000 shares of common stock for issuance in conjunction with all options and other stock-based awards to be granted under the plan. The purpose of the plan is (1) to promote the best interests of the Company and its shareholders by encouraging employees to acquire an ownership interest in the Company, thus identifying their interests with those of shareholders and (2) to enhance the ability of the Company to attract and retain qualified employees, consultants and non-employee directors. No participant may be granted options during any one fiscal year to purchase more than 500,000 shares of Common Stock.

Stock Options

As of September 30, 2004, the Company had issued options to purchase 83,050 shares of its common stock under the plan. These options have been granted to non-employee directors of the Company. Options granted under the Stock Incentive Plan generally vest 50% after one year from the grant date and 100% after two years from the grant date, however when directors accept options in lieu of cash compensation, the options vest immediately. The related expense of $172,559 for the nine months ended September 30, 2004 is included in administrative expenses. The following summarizes all stock option related transactions from January 1, 2004 through September 30, 2004.


			Weighted
			Average
	Options		Exercise
	Outstanding		Price
January 1, 2004		—		—
Granted		83,050	$	16.62
Cancelled		—		—

September 30, 2004		83,050	$	16.62

The following options information is as of September 30, 2004:


					Weighted-
					Average		Weighted-				Weighted-
	Fair Value				Remaining		Average				Average
Exercise	of Option		Number		Contractual		Exercise		Number		Exercise
Price	Granted		Outstanding		Life		Price		Exercisable		Price
$15.00	$	4.84		45,000		9.35	$	15.00		—		—
$18.50	$	5.90		30,000		9.42	$	18.50		—		—
$19.48	$	6.57		3,850		9.63	$	19.48		3,850	$	19.48
$17.85	$	5.84		4,200		9.88	$	17.85		4,200	$	17.85

Total				83,050		9.41	$	16.62		8,050	$	18.63

The Company utilizes the Black-Scholes option-pricing model to calculate the value of the stock options when granted. This model was developed to estimate the fair value of traded options, which have

different characteristics than employee stock options. In addition, changes to the subjective input assumptions can result in materially different fair market value estimates. The Black-Scholes model may not necessarily provide a reliable single measure of the fair value of employee stock options. The fair value of each option was based on the following assumptions:


Options issue year:	2004
Weighted average fair value of options granted	$	5.35
Expected Volatility		30.00	%
Risk-free interest rate		2.98%-3.93	%
Expected dividend yield		0.00	%
Expected life	5 Years

Share Appreciation Rights

In 2002, Asset Acceptance Holdings LLC adopted a share appreciation rights plan for certain key employees. The purpose of the plan was to further the long-term stability and financial success of the Company, as participants in the plan had the potential to share in the appreciation of the value of Asset Acceptance Holdings LLC. Benefits were earned by participants based on certain financial objectives.

In connection with the consummation of the Company’s IPO in February 2004, the Company exercised its right to vest 100% of the share appreciation rights held by the participants in the plan which resulted in payment of $18.4 million dollars for the applicable withholding taxes due by the participants and the issuance of 1,776,826 unregistered shares of the Company’s common stock to the participants. As a result, the Company recognized a compensation charge including employer payroll taxes of $45.7 million ($28.7 million net of tax) during the first quarter of 2004 for its share appreciation rights plan.

6. Litigation Contingencies

The Company is involved in certain legal matters that management considers incidental to its business. Management has evaluated pending and threatened litigation against the Company as of September 30, 2004 and does not believe exposure to be material.

7. Income Taxes

Income taxes for the nine months ended September 30, 2004 included: (1) a deferred tax charge of $19.3 million resulting from RBR Holding Corp. losing its S corporation tax status after becoming a wholly-owned subsidiary of Asset Acceptance Capital Corp. during the first quarter of 2004 and (2) a tax benefit of $17.0 million from the vesting of 1,200,638 share appreciation rights related to Asset Acceptance Holdings LLC’s 2002 share appreciation rights plan.

Income taxes for the nine months ended September 30, 2004 (excluding the deferred tax charge related to RBR Holding Corp. and the tax benefit related to the vesting of the share appreciation rights) reflected income tax expense on only 60% of pretax income for the period January 1, 2004 through February 4, 2004, as RBR Holding Corp. (40% owner of Asset Acceptance Holdings LLC) was taxed as a S corporation under the Internal Revenue Code and therefore taxable income was included on the shareholders’ individual tax returns. Income taxes during the period February 5, 2004 through September 30, 2004 reflected income tax expense on 100% of pretax income as RBR Holding Corp. became a wholly-owned subsidiary of Asset Acceptance Capital Corp. as part of the reorganization that occurred on February 4, 2004 related to the IPO. Income taxes for the nine month period ended September 30, 2003 of $6.8 million reflected income tax expense on only 60% of pretax income as RBR Holding Corp. was taxed as an S corporation under the Internal Revenue Code and therefore taxable income was included on the shareholders’ individual tax returns.

Components of income tax expense are set forth below:


	Three months ended September 30				Nine months ended September 30,
	2004		2003		2004		2003
Income taxes consist of:
State actual	$	4,708	$	912	$	12,895	$	912
Federal deferred — net		7,127,341		2,454,076		20,926,642		6,434,930
State deferred — net		447,852		159,375		1,242,718		395,658

Total	$	7,579,901	$	2,614,363	$	22,182,255	$	6,831,500

Tax expense differs from the application of statutory rates to pretax income. The reconciliation of income tax expense and the statutory rates is set forth below:


	Three months ended September 30,					Nine months ended September 30,
	2004		2003			2004			2003
Federal taxes at statutory rate	$	7,127,341	$	4,314,599		$	3,635,681		$	11,369,992
S corporation benefit — federal		—		(1,860,523	)		(825,193	)		(4,935,062	)
S corporation benefit — state		—		(120,387	)		(51,869	)		(319,328	)
Deferred tax charge — federal		—		—			18,116,154			—
Deferred tax charge — state		—		—			1,190,490			—
State income taxes, net of federal tax benefit		452,560		280,674			116,992			715,898

Effective income taxes	$	7,579,901	$	2,614,363		$	22,182,255		$	6,831,500

Item 2. Management’s Discussion and Analysis of Financial Condition and Results of Operations

Third Quarter 2004 Overview

We have been purchasing and collecting defaulted or charged-off accounts receivable portfolios from consumer credit originators since the formation of our predecessor company in 1962. Charged-off receivables are the unpaid obligations of individuals to credit originators, such as credit card issuers, consumer finance companies, retail merchants and utility providers. Since these receivables are delinquent or past due, we are able to purchase them at a substantial discount. Unlike many of our competitors, we purchase and collect charged-off consumer receivable portfolios for our own account as we believe this affords us the best opportunity to use long-term strategies to maximize our profits. We currently do not collect on a commission or contingent fee basis.

For the third quarter of 2004, cash collections increased 37.4% to $66.8 million. Revenues for the third quarter of 2004 were $56.0 million, a 29.8% increase over the prior year. Net income was $12.8 million for the third quarter of 2004, an increase of $2.7 million over the prior year. On a pro forma basis, net income in the third quarter was $12.8 million, an increase of $4.8 million over the prior year.

For the third quarter of 2004, we invested $16.1 million in charged-off consumer receivable portfolios, with an aggregate face value of $642.1 million, for a blended rate of 2.50% of face value. For the first three quarters, the Company has acquired $3.2 billion of charged-off consumer receivable portfolios with an aggregate face value of $62.0 million for blended rate of 1.95% of the face value.

We began preparing for our fourth quarter move to a new corporate headquarters located in Warren, Michigan. The new building lease has a term of 120 months and will commence December 2004. The lease has future contractual cash obligations of $26.0 million over 10 years. Additionally, we expect to invest $4.0 to $4.5 million in capital expenditures related to our new corporate headquarters.

We believe that pricing for charged-off consumer receivables is cyclical. Current pricing continues to be competitive, but we are determined to remain disciplined and purchase portfolios only when we believe we can achieve acceptable returns.

Forward Looking Statements

Certain statements made in this Report could be construed to be forward-looking statements within the meaning given in the Securities Exchange Act of 1934. These statements include, without limitation, statements about future events or our future financial performance. In some cases, forward-looking statements can be identified by terminology such as “may”, “will”, “should”, “expect”, “anticipate”, “intend”, “plan”, “believe”, “estimate”, “potential” or “continue”, the negative of these terms or other comparable terminology. In addition, we, or persons acting on our behalf, may from time to time publish or communicate other items that could also be construed to be forward looking statements. Statements of this sort are or will be based on our estimates, assumptions and projections, and are subject to risks and uncertainties, including those specifically listed below that could cause actual results to differ materially from those included in the forward looking statements.

Although we believe that the expectations reflected in the forward-looking statements are reasonable, we cannot guarantee future results, levels of activity, performance or achievements. Except as required by law, we undertake no obligation to update publicly any forward-looking statements for any reason after the date of this report to conform these statements to actual results or to changes in our expectations. Factors that could affect our results and cause them to materially differ from those contained in the forward-looking statements include the following:

• our ability to purchase charged-off receivable portfolios on acceptable terms and in sufficient amounts;

• our ability to maintain existing, and secure additional financing on acceptable terms;

• our ability to recover sufficient amounts on our charged-off receivable portfolios;

• our ability to make reasonable estimates of the timing and amount of future cash receipts for purposes of recording purchased receivable revenues in accordance with Accounting Standards Executive Committee Practice Bulletin 6 (PB6);

• our ability to integrate acquired portfolios or businesses into our company;

• our ability to hire and retain qualified personnel;

• a decrease in collections if bankruptcy filings increase or if bankruptcy laws or other debt collection laws change;

• changes in, or failure to comply with, governmental regulations;

• the costs, uncertainties and other effects of legal and administrative proceedings (which may include legal proceedings arising out of purchases of portfolios or companies for which seller indemnification is not available);

• our ability to respond to changes in technology and increased competition; and

• other unanticipated events and conditions that may hinder our ability to compete.

Significant Events During the Nine Months Ended September 30, 2004

Reorganization and Initial Public Offering

We completed a reorganization on February 4, 2004 and commenced an initial public offering (“IPO”) of common stock on February 5, 2004. The reorganization was completed pursuant to which all of the shares of capital stock of AAC Investors, Inc. and RBR Holding Corp., which hold 60% and 40% of the ownership interests in Asset Acceptance Holdings LLC, respectively, were contributed to Asset Acceptance Capital Corp. in exchange for all of the outstanding shares of common stock of Asset Acceptance Capital Corp. The resulting consolidated entity includes Asset Acceptance Capital Corp., AAC Investors, Inc., RBR Holding Corp. and Asset Acceptance Holdings LLC and its subsidiaries. Prior to this reorganization, Asset Acceptance Capital Corp. did not conduct any business and did not have any assets or liabilities, except as related to the IPO.

We received net proceeds of $96.1 million from the IPO of 7,000,000 shares of common stock which were used to eliminate related party debt of $40.0 million, reduce the line of credit by $37.7 million and pay withholding taxes on behalf of share appreciation rights (“SAR”) holders in the amount of $18.4 million.

Share Appreciation Rights Compensation Charge

We recognized a compensation charge of $45.0 million and $0.7 million of related payroll taxes ($28.7 million net of income taxes) during the first quarter of 2004 for the vesting of share appreciation rights. The share appreciation rights plan, adopted by Asset Acceptance Holdings LLC during 2002, granted participants the right to share in the appreciation of the value of Asset Acceptance Holdings LLC. The benefit earned was based on certain financial objectives and vested 100% upon completion of the IPO. There were 1,200,638 share appreciation rights outstanding at the time of the IPO.

Deferred Tax Charge

We recognized a deferred tax charge of $19.3 million during the first quarter of 2004 related to deferred taxes of RBR Holding Corp. Prior to the reorganization completed on February 4, 2004, RBR Holding Corp. was taxed as an S corporation under the Internal Revenue Code and the shareholders of RBR

Holding Corp. included their respective shares of taxable income or loss in their individual tax returns. As a result of the reorganization, RBR Holding Corp. became a wholly-owned subsidiary of Asset Acceptance Capital Corp. and could no longer be taxed as an S corporation. Deferred income taxes were recognized in the first quarter of 2004 for the cumulative effect of all prior periods that RBR Holding Corp. was an S corporation.

Results of Operations

The following table sets forth selected statement of income data expressed as a percentage of total revenues for the periods indicated.


	Three Months Ended						Nine Months Ended
	September 30,						September 30,
	2004			2003			2004			2003
Revenues
Purchased receivable revenues		99.8	%		99.7	%		99.7	%		99.6	%
Finance contract revenues		0.2			0.3			0.3			0.4

Total revenues		100.0			100.0			100.0			100.0

Expenses
Salaries and benefits		29.0			29.8			59.9			32.1
Collections expense		28.0			31.1			25.9			28.2
Occupancy		2.7			2.6			2.7			2.7
Administrative		2.4			1.6			2.5			2.1
Depreciation		1.2			1.5			1.4			1.6
Loss on disposal of equipment		0.0			0.0			0.0			0.0

Total operating expense		63.3			66.6			92.4			66.7

Income from operations		36.7			33.4			7.6			33.3
Net interest expense		0.4			4.4			1.0			4.7
Other expense (income)		0.0			(0.4	)		0.0			(0.3	)

Income before income taxes		36.3			29.4			6.6			28.9
Income taxes		13.5			6.0			14.1			5.9

Net income (loss)		22.8	%		23.4	%		(7.5	)%		23.0	%

Pro forma income tax expense (1)					11.0	%		2.5	%		10.8	%

Pro forma net income (1)					18.4	%		4.1	%		18.1	%

(1)

For comparison purposes we have presented pro forma net income which is net income adjusted for pro forma income taxes assuming all entities had been a C corporation for all periods presented.

Three Months Ended September 30, 2004 Compared To Three Months Ended September 30, 2003

Revenue

Total revenues were $56.0 million for the three months ended September 30, 2004, an increase of $12.9 million or 29.8% over total revenues of $43.1 million for the three months ended September 30, 2003. Purchased receivable revenues were $55.9 million for the three months ended September 30, 2004, an increase of $12.9 million or 29.9% over the three months ended September 30, 2003 amount of $43.0 million. The increase in revenue was due primarily to an increase in the average outstanding balance of purchased receivables.

Cash collections on charged-off consumer receivables increased 37.4% to $66.8 million for the three months ended September 30, 2004 from $48.6 million for the same period in 2003. Cash collections for the three months ended September 30, 2004 and 2003 include collections from fully amortized portfolios of $8.6 million and $3.3 million, respectively. The increase in collections was primarily due to an increased number of consumer receivables portfolios, the refinement and application of various collection strategies and improvements in collector efficiency.

During the three months ended September 30, 2004, we acquired charged-off consumer receivables portfolios with an aggregate face value amount of $642.1 million at a cost of $16.1 million. Included in these purchase totals were ten portfolios acquired through four forward flow contracts with an aggregate face value of $72.4 million at a cost of $2.0 million. Forward flow contracts commit a debt seller to sell us receivable portfolios over a specified period of time in the future. During the three months ended September 30, 2003, we acquired charged-off consumer receivables portfolios with an aggregate face value of $1.3 billion at a cost of $25.8 million, net of buybacks.

Operating Expenses

Total operating expenses were $35.4 million for the three months ended September 30, 2004, an increase of $6.6 million or 23.2% compared to total operating expenses of $28.8 million for the three months ended September 30, 2003. Total operating expenses were 53.0% of cash collections for the three months ended September 30, 2004 compared with 59.1% for the same period in 2003. The improvement in operating expenses as a percent of cash collections was primarily due to strong collections, resulting from increased collector efficiency, the application of successful collection strategies and a focus on expense reduction.

Salaries and Benefits. Salary and benefit expenses were $16.2 million for the three months ended September 30, 2004, an increase of $3.4 million or 26.4% compared to salary and benefit expenses of $12.8 million for the three months ended September 30, 2003. The increase was primarily due to an increase in total employees which grew to 1,618 at September 30, 2004 from 1,475 at September 30, 2003, in response to the growth in the number of portfolios of charged-off consumer receivables owned by the Company. As a percentage of cash collections, salary and benefit expenses decreased to 24.3% of cash collections for the three months ended September 30, 2004 from 26.4% of cash collections for the same period in 2003. The decrease as a percent of cash collections was primarily due to increased collector efficiency. Traditional call center collections per employee increased to $40,224 for the three months ended September 30, 2004 compared to $33,077 for the same period in 2003. The average headcount for this class of employees increased to 910 in the third quarter of 2004 from 847 in the same period of 2003 calculated on a full-time equivalent basis.

Collections Expense. Collections expense increased to $15.7 million for the three months ended September 30, 2004, reflecting an increase of $2.3 million or 16.6% over $13.4 million for the three months ended September 30, 2003. The increase was primarily attributable to the increased number of accounts on which we were collecting. Collections expense decreased to 23.5% of cash collections for the three months ended September 30, 2004 from 27.6% of cash collections for the three months ended September 30, 2003. This decrease was primarily due to decreases in amounts spent for postage and letters, credit reports and legal expenses, as a percentage of cash collections, as we continuously improve and refine our collection strategies.

Occupancy. Occupancy expense was $1.5 million for the three months ended September 30, 2004, an increase of $0.4 million or 33.7% over occupancy expense of $1.1 million for the three months ended September 30, 2003. The increase was primarily attributable to the relocation of our Florida office to Riverview, Florida in January 2004, the relocation of our Phoenix, Arizona office and the addition of our Chicago, Illinois office in September 2003.

Administrative. Administrative expenses increased to $1.3 million for the three months ended September 30, 2004 from $0.7 million for the three months ended September 30, 2003, reflecting a $0.6

million or 96.0% increase. The increase in administrative expenses was principally a result of the increased number of accounts being processed as well as additional expenses related to being an SEC registrant.

Depreciation. Depreciation expense was $0.7 million for the three months ended September 30, 2004, and 2003, respectively. Capital expenditures for 2004 and 2003 were required to support the increased number of accounts serviced by us, and the purchase of furniture and technology equipment in our new and expanded facilities.

Net Interest Expense

Net interest expense was $0.2 million for the three months ended September 30, 2004, a decrease of $1.7 million or 88.0% compared to net interest expense of $1.9 million for the three months ended September 30, 2003. During February 2004, the Company paid in full a related party debt of $40.0 million which resulted in a reduction in interest expense of $0.9 million during the three months ended September 30, 2004 from the same prior year period. In addition, average borrowings on our line of credit decreased to $4.9 million for the three months ended September 30, 2004 from $68.6 million for the same period in 2003. The reduction in our average borrowings was due to payment of $37.7 million of debt from the proceeds of the IPO and cash generated from operations which was used to pay down debt. Net interest expense included the amortization of capitalized bank fees of $71,138 and $76,499 for the three months ended September 30, 2004 and 2003, respectively.

Income Taxes

Income tax expense was $7.6 million for the three months ended September 30, 2004, an increase of $5.0 million or 189.9% over income tax expense of $2.6 million for the three months ended September 30, 2003. The increase is primarily due to increased income and taxes related to RBR Holding Corp. For the three months ended September 30, 2004 taxes were incurred on 100% of pretax income as RBR Holding Corp. became a wholly-owned subsidiary of Asset Acceptance Capital Corp. on February 4, 2004, as part of the reorganization related to our IPO. Income taxes for the three month period ended September 30, 2003 reflected income tax expense on only 60% of pretax income, as RBR Holding Corp. was taxed as an S corporation under the Internal Revenue Code and therefore taxable income was included on the shareholders’ individual tax returns.

Nine Months Ended September 30, 2004 Compared To Nine Months Ended September 30, 2003

Revenue

Total revenues were $157.3 million for the nine months ended September 30, 2004, an increase of $41.4 million or 35.7% over total revenues of $115.9 million for the nine months ended September 30, 2003. Purchased receivable revenues were $156.8 million for the nine months ended September 30, 2004, an increase of $41.3 million or 35.8% over the nine months ended September 30, 2003 amount of $115.5 million. The increase in revenue was due primarily to an increase in the average outstanding balance of purchased receivables.

Cash collections on charged-off consumer receivables increased 38.8% to $199.6 million for the nine months ended September 30, 2004 from $143.8 million for the same period in 2003. Cash collections for the nine months ended September 30, 2004 and 2003 include collections from fully amortized portfolios of $21.2 million and $8.4 million, respectively. The increase in collections was primarily due to an increased number of consumer receivables portfolios, the refinement and application of various collection strategies and improvements in collector efficiency.

During the nine months ended September 30, 2004, we acquired charged-off consumer receivables portfolios with an aggregate face value amount of $3.2 billion at a cost of $62.0 million. Included in these purchase totals were 20 portfolios with an aggregate face value of $208.3 million at a cost of $6.1 million acquired through four forward flow contracts. During the nine months ended September 30, 2003, we

acquired charged-off consumer receivables portfolios with an aggregate face value of $2.7 billion at a cost of $63.4 million, net of buybacks.

Operating Expenses

Total operating expenses were $145.4 million for the nine months ended September 30, 2004, an increase of $68.1 million or 87.9% compared to total operating expenses of $77.3 million for the nine months ended September 30, 2003. Total operating expenses were 72.8% of cash collections for the nine months ended September 30, 2004 compared with 53.8% for the same period in 2003. Operating expenses include a $45.0 million compensation charge and a $0.7 million payroll tax charge related to the vesting of the outstanding share appreciation rights. Excluding the share appreciation rights and related payroll tax charge, total operating expenses were $99.7 million for the nine months ended September 30, 2004, an increase of $22.4 million or 28.9% over the prior year. Excluding the share appreciation rights charge and related payroll taxes, operating expenses decreased to 49.9% of cash collections for the nine months ended September 30, 2004 from 53.8% of cash collections for the same nine month period in 2003. The improvement in operating expenses as a percent of cash collections was primarily due to strong collections, resulting from increased collector efficiency, along with the application of successful collection strategies and a focus on expense reduction.

Salaries and Benefits. Salary and benefit expenses were $94.1 million for the nine months ended September 30, 2004, an increase of $56.9 million or 152.8% compared to salary and benefit expenses of $37.2 million for the nine months ended September 30, 2003. Salary and benefit expenses increased primarily due to a $45.7 million charge related to the vesting of the outstanding share appreciation rights and related payroll taxes. We believe that 2004 salary and benefit expenses, excluding the share appreciation rights charge of $45.7 million, provides a better measure of financial performance as it is more consistent between 2004 and 2003. As such, we have included this non-GAAP measure below.

Excluding the share appreciation rights charge and related payroll taxes, salary and benefit expenses were $48.5 million for the nine months ended September 30, 2004, an increase of $11.3 million or 30.1% compared to 2003. The increase over the prior year was primarily due to an increase in total employees which grew to 1,618 at September 30, 2004 from 1,475 at September 30, 2003, in response to the growth in the number of portfolios of charged-off consumer receivables owned by us. As a percentage of cash collections, salary and benefit expenses, excluding the $45.7 million share appreciation rights charge, decreased to 24.3% of cash collections for the nine months ended September 30, 2004 from 25.9% of cash collections for the same period in 2003. The decrease as a percent of cash collections was primarily due to increased collector efficiency and improved collection strategies. Traditional call center collections per employee increased to $129,486 for the nine months ended September 30, 2004 compared to $114,047 for the same period in 2003. Average headcount for this class of employees increased to 897 for the first nine months of 2004 from 779 during the same period in 2003 calculated on a full-time equivalent basis.

Collections Expense. Collections expense increased to $40.8 million for the nine months ended September 30, 2004, reflecting an increase of $8.1 million or 24.6% over $32.7 million for the nine months ended September 30, 2003. The increase was primarily attributable to the increased number of accounts on which we were collecting. Collections expense decreased to 20.4% of cash collections for the nine months ended September 30, 2004 from 22.7% of cash collections for the nine months ended September 30, 2003. This decrease was primarily due to decreases in amounts spent for postage and letters, credit reports and legal expenses, as a percentage of cash collections, as we continuously improve and refine our collection strategies.

Occupancy. Occupancy expense was $4.3 million for the nine months ended September 30, 2004, an increase of $1.2 million or 39.8% over occupancy expense of $3.1 million for the nine months ended September 30, 2003. The increase was primarily attributable to the relocation of our Florida office to Riverview, Florida in January 2004, the relocation of our Phoenix, Arizona office and the addition of our Chicago, Illinois office in September 2003.

Administrative. Administrative expenses increased to $4.0 million for the nine months ended September 30, 2004 from $2.4 million for the nine months ended September 30, 2003, reflecting a $1.6

million or 64.5% increase. The increase in administrative expenses was principally a result of the increased number of accounts being processed as well as additional expenses related to being an SEC registrant.

Depreciation. Depreciation expense was $2.1 million for the nine months ended September 30, 2004, an increase of $0.2 million or 12.8% over depreciation expense of $1.9 million for the nine months ended September 30, 2003. The increase was due to capital expenditures during 2004 and 2003, which were required to support the increased number of accounts serviced by us, and the purchase of furniture and technology equipment in our new and expanded facilities.

Net Interest Expense

Net interest expense was $1.6 million for the nine months ended September 30, 2004 reflecting a decrease of $3.9 million or 71.6% compared to net interest expense of $5.5 million for the nine months ended September 30, 2003. During February 2004, the company paid in full a related party debt of $40.0 million which resulted in a reduction in interest expense of $2.3 million during the nine months ended September 30, 2004 from the same prior year period. Additionally, the decrease in interest expense was due to lower average borrowings on our line of credit, which decreased to $21.5 million for the nine months ended September 30, 2004 from $67.3 million for the same period in 2003. The reduction in our average borrowings was due to repayment of $37.7 million of debt from the proceeds of the IPO and cash generated from operations which was used to pay down debt. Net interest expense included the amortization of capitalized bank fees of $212,302 and $226,859 for the nine months ended September 30, 2004 and 2003, respectively.

Income Taxes

Income taxes of $22.2 million for the nine months ended September 30, 2004 included (1) a deferred tax charge of $19.3 million resulting from RBR Holding Corp. losing its S corporation tax status after becoming a wholly-owned subsidiary of Asset Acceptance Capital Corp. during the first quarter of 2004 and (2) a tax benefit of $17.0 million from the vesting of 1,200,638 share appreciation rights related to Asset Acceptance Holdings LLC’s 2002 share appreciation rights plan.

Income taxes for the nine months ended September 30, 2004 (excluding the deferred tax charge related to RBR Holding Corp. and the vesting of the share appreciation rights) reflected income tax expense on only 60% of pretax income for the period January 1, 2004 through February 4, 2004, as RBR Holding Corp. (40% owner of Asset Acceptance Holdings LLC) was taxed as a S corporation under the Internal Revenue Code and therefore taxable income was included on the shareholders’ individual tax returns. Income taxes during the period February 5, 2004 through September 30, 2004 reflected income tax expense on 100% of pretax income as RBR Holding Corp. became a wholly-owned subsidiary of Asset Acceptance Capital Corp. as part of the reorganization that occurred on February 4, 2004 related to our IPO. Income taxes for the nine month period ended September 30, 2003 of $6.8 million reflected income tax expense on only 60% of pretax income as RBR Holding Corp. was taxed as an S corporation under the Internal Revenue Code and therefore taxable income was included on the shareholders’ individual tax returns.

Supplemental Performance Data

Portfolio Performance

The following table summarizes our historical portfolio purchase price and cash collections on an annual vintage basis since 1990 through September 30, 2004.


					Cash Collections		Collections as a
	Number of		Purchase		Including Cash		Percentage of
Purchase Period	Portfolios		Price(1)		Sales(2)		Purchase Price(2)
(Dollars in thousands)
1990		9	$	638	$	3,095		485	%
1991		12		280		1,449		518
1992		29		309		2,847		921
1993		30		790		7,745		980
1994		36		1,427		6,750		473
1995		53		1,519		7,617		501
1996		46		3,844		16,381		426
1997		45		4,345		26,531		611
1998		61		16,412		72,132		440
1999		51		12,926		49,394		382
2000		49		20,599		89,098		433
2001		62		43,136		155,345		360
2002		94		72,304		148,574		205
2003		76		87,605		107,216		122
2004 (3)		82		62,015		12,617		20

(1)		Purchase price refers to the cash paid to a seller to acquire a portfolio less the purchase price refunded by a seller due to the return of non-compliant accounts (also referred to as buybacks) less the purchase price for accounts that were sold at the time of purchase to another debt purchaser.

(2)		For purposes of this table, cash collections include selected cash sales that were entered into subsequent to purchase. Cash sales, however, exclude the sale of portfolios which occurred at the time of purchase.

(3)		Includes only nine months of activity through September 30, 2004.

Cash Collections

The following tables provide further detailed vintage collection analysis on an annual and a cumulative basis.

Historical Collections (1)


Purchase	Purchase		Year Ended December 31,																						Nine Months ended September 30,
Period	Price (2)		1993		1994		1995		1996		1997		1998		1999		2000		2001		2002		2003		2004
(Dollars in thousands)
Pre-1993			$	1,394	$	1,156	$	910	$	766	$	517	$	354	$	276	$	244	$	201	$	127	$	148	$	95
1993	$	790		526		1,911		1,630		1,022		768		480		373		311		236		175		175		88
1994		1,427		—		345		1,763		1,430		1,005		647		457		357		258		176		188		89
1995		1,519		—		—		388		1,566		1,659		1,118		786		708		472		343		278		182
1996		3,844		—		—		—		827		3,764		3,085		2,601		2,098		1,440		1,041		816		555
1997		4,345		—		—		—		—		1,682		4,919		5,573		5,017		3,563		2,681		1,784		1,202
1998		16,412		—		—		—		—		—		4,835		15,220		15,045		12,962		11,021		7,987		4,485
1999		12,926		—		—		—		—		—		—		3,761		11,331		10,862		9,750		8,278		5,166
2000		20,599		—		—		—		—		—		—		—		8,895		23,444		22,559		20,318		13,418
2001		43,136		—		—		—		—		—		—		—		—		17,630		50,327		50,967		35,537
2002		72,304		—		—		—		—		—		—		—		—		—		22,340		70,813		55,005
2003		87,605		—		—		—		—		—		—		—		—		—		—		36,067		71,149
2004		62,015		—		—		—		—		—		—		—		—		—		—		—		12,617

Total			$	1,920	$	3,412	$	4,691	$	5,611	$	9,395	$	15,438	$	29,047	$	44,006	$	71,068	$	120,540	$	197,819	$	199,588

Cumulative Collections (1)


Purchase	Purchase		Total Through December 31,																						Total Through September 30,
Period	Price (2)		1993		1994		1995		1996		1997		1998		1999		2000		2001		2002		2003		2004
(Dollars in thousands)
1993	$	790	$	526	$	2,437	$	4,067	$	5,089	$	5,857	$	6,337	$	6,710	$	7,021	$	7,257	$	7,432	$	7,607	$	7,695
1994		1,427		—		345		2,108		3,538		4,543		5,190		5,647		6,004		6,262		6,438		6,626		6,715
1995		1,519		—		—		388		1,954		3,613		4,731		5,517		6,225		6,697		7,040		7,318		7,500
1996		3,844		—		—		—		827		4,591		7,676		10,277		12,375		13,815		14,856		15,672		16,227
1997		4,345		—		—		—		—		1,682		6,601		12,174		17,191		20,754		23,435		25,219		26,421
1998		16,412		—		—		—		—		—		4,835		20,055		35,100		48,062		59,083		67,070		71,555
1999		12,926		—		—		—		—		—		—		3,761		15,092		25,954		35,704		43,982		49,148
2000		20,599		—		—		—		—		—		—		—		8,895		32,339		54,898		75,216		88,634
2001		43,136		—		—		—		—		—		—		—		—		17,630		67,957		118,924		154,461
2002		72,304		—		—		—		—		—		—		—		—		—		22,340		93,153		148,158
2003		87,605		—		—		—		—		—		—		—		—		—		—		36,067		107,216
2004		62,015		—		—		—		—		—		—		—		—		—		—		—		12,617

Cumulative Collections as Percentage of Purchase Price (1)


Purchase	Purchase		Total Through December 31,																																	Total Through September 30,
Period	Price (2)		1993			1994			1995			1996			1997			1998			1999			2000			2001			2002			2003			2004
1993	$	790		67	%		308	%		515	%		644	%		741	%		802	%		849	%		889	%		919	%		941	%		963	%		974	%
1994		1,427		—			24			148			248			318			364			396			421			439			451			464			471
1995		1,519		—			—			26			129			238			311			363			410			441			463			482			494
1996		3,844		—			—			—			22			119			200			267			322			359			386			408			422
1997		4,345		—			—			—			—			39			152			280			396			478			539			580			608
1998		16,412		—			—			—			—			—			29			122			214			293			360			409			436
1999		12,926		—			—			—			—			—			—			29			117			201			276			340			380
2000		20,599		—			—			—			—			—			—			—			43			157			266			365			430
2001		43,136		—			—			—			—			—			—			—			—			41			158			276			358
2002		72,304		—			—			—			—			—			—			—			—			—			31			129			205
2003		87,605		—			—			—			—			—			—			—			—			—			—			40			122
2004		62,015		—			—			—			—			—			—			—			—			—			—			—			20

(1)		Does not include proceeds from sales of any receivables.

(2)		Purchase price refers to the cash paid to a seller to acquire a portfolio less the purchase price refunded by a seller due to the return of non-compliant accounts (also referred to as buybacks) less the purchase price for accounts that were sold at the time of purchase to another debt purchaser.

Seasonality

Our business depends on our ability to collect on our purchased portfolios of charged-off consumer receivables. Collections within portfolios tend to be seasonally higher in the first and second quarters of the year due to consumers’ receipt of tax refunds and other factors. Conversely, collections within portfolios tend to be lower in the third and fourth quarters of the year due to consumers’ spending in connection with summer vacations, the holiday season and other factors. Our historical growth in purchased portfolios and in our resultant quarterly cash collections has helped to minimize the effect of seasonal cash collections. Operating expenses are seasonally higher during the first and second quarters of the year due to expenses necessary to process the increase in cash collections. However, revenue recognized is relatively consistent due to the application of the interest method for revenue recognition. In addition, our operating results may be affected to a lesser extent by the timing of purchases of charged-off consumer receivables due to the initial costs associated with purchasing and integrating these receivables into our system. Consequently, income and margins may fluctuate quarter to quarter.

Below is a chart that illustrates our quarterly collections for years 2000 through September 2004.

(PERFORMANCE GRAPH)


Cash Collections
Quarter	2000		2001		2002		2003		2004
First	$	10,095,735	$	15,592,577	$	27,297,721	$	44,017,730	$	65,196,055
Second		10,669,184		17,661,537		30,475,078		51,190,533		67,566,031
Third		11,076,359		17,766,800		29,337,914		48,622,829		66,825,822
Fourth		12,164,526		20,046,733		33,429,419		53,988,333		—

We monitor asset types for our portfolios because different asset types have different performance characteristics. The following chart categorizes our purchased receivables portfolios, as of September 30, 2004, into the major asset types represented:


	Face Value of
	Charged-off					No. of
Asset Type	Receivables		%			Accounts		%
Visa®/MasterCard®/Discover®	$	8,354,115,638		46.7	%		3,809,860		23.3	%
Private Label Credit Cards		2,511,712,059		14.1			3,612,612		22.1
Health Club		1,269,920,687		7.1			1,329,881		8.1
Auto Deficiency		1,240,060,146		6.9			207,147		1.3
Telecommunications/Utility/Gas		1,166,454,458		6.5			2,697,476		16.5
Installment loans		754,095,427		4.2			221,761		1.3
Other (1)		2,582,668,979		14.5			4,496,529		27.4

Total	$	17,879,027,394		100.0	%		16,375,266		100.0	%

(1)

“Other” includes charged-off receivables of several debt types, including student loan, mobile home deficiency and retail mail order. This includes the purchase of a single portfolio in June 2002 with a face value of $1.2 billion at a cost of $1.2 million (or 0.1% of face value) and consisting of approximately 3.8 million accounts.

The age of a charged-off consumer receivables portfolio, or the time since an account has been charged-off, is an important factor in determining the value at which we will offer to purchase a receivables portfolio. Generally, there is an inverse relationship between the age of a portfolio and the price at which we will purchase the portfolio. This relationship is due to the fact that older receivables are typically more difficult to collect. The accounts receivable management industry places receivables into the following categories depending on the number of collection agencies that have previously attempted to collect on the receivables:

• Fresh accounts are typically 120 to 270 days past due, have been charged-off by the credit originator and are either being sold prior to any post charge-off collection activity or are placed with a third party for the first time. These accounts typically sell for the highest purchase price.

• Primary accounts are typically 270 to 360 days past due, have been previously placed with one third party collector and typically receive a lower purchase price.

• Secondary and tertiary accounts are typically more than 360 days past due, have been placed with two or three third party collectors and receive even lower purchase prices.

We specialize in the primary, secondary and tertiary markets but we will purchase accounts at any point in the delinquency cycle. We deploy our capital within these markets based upon the relative values of the available debt portfolios.

The following chart categorizes our purchased receivables portfolios, as of September 30, 2004, into the major account types represented:


	Face Value of
	Charged-off					No. of
Account Type	Receivables		%			Accounts		%
Fresh	$	1,023,449,269		5.7	%		378,002		2.3	%
Primary		3,445,187,495		19.3			2,264,203		13.8
Secondary		3,090,065,830		17.3			2,001,613		12.2
Tertiary(1)		9,354,895,328		52.3			11,218,150		68.5
Other		965,429,472		5.4			513,298		3.2

Total	$	17,879,027,394		100.0	%		16,375,266		100.0	%

(1)

This includes the purchase of a single portfolio in June 2002 with a face value of $1.2 billion at a cost of $1.2 million (or 0.1% of face value), and consisting of approximately 3.8 million accounts.

We also review the geographic distribution of accounts within a portfolio because collection laws differ from state to state. The following chart illustrates, as of September 30, 2004, our purchased receivables portfolios based on geographic location of debtor:


	Face Value of
	Charged-off					No. of
Geographic Location	Receivables		%			Accounts		%
Texas(1)	$	2,343,320,905		13.1	%		1,924,727		11.8	%
California		1,772,487,411		9.9			1,711,424		10.4
Florida(1)		1,693,757,787		9.5			1,173,949		7.2
Michigan(1)		1,393,654,018		7.8			1,590,793		9.7
New York		1,064,149,983		5.9			856,925		5.2
Ohio(1)		1,035,394,129		5.8			1,093,776		6.7
Illinois(1)		825,438,179		4.6			1,060,901		6.5
Pennsylvania		537,032,419		3.0			456,750		2.8
North Carolina		463,424,181		2.6			371,159		2.3
Georgia		449,221,218		2.5			376,296		2.3
New Jersey(1)		353,473,833		2.0			297,886		1.8
Other(2)		5,947,673,331		33.3			5,460,680		33.3

Total	$	17,879,027,394		100.0	%		16,375,266		100.0	%

(1)		Collection site located in this state.

(2)		Each state included in “Other” represents under 2.0% individually of the face value of total charged-off consumer receivables.

Liquidity and Capital Resources

Historically, our primary sources of cash have been from operations and bank borrowings. However, during the first quarter of 2004 we completed our IPO and used $77.7 million of the proceeds to reduce our outstanding debt. We have traditionally used cash for acquisitions of purchased receivables, repayment of bank borrowings, purchasing property and equipment and working capital to support growth.

Borrowings

We maintain a $100.0 million line of credit, secured by a first priority lien on all of our assets, that expires in May 2007 and bears interest at prime or 25 basis points over prime depending upon our liquidity as defined in the credit agreement. Alternately, at our discretion, we may borrow by entering into 30, 60 or 90 day LIBOR contracts at rates between 200 to 275 basis points over the respective LIBOR rates, depending on our liquidity. As of September 30, 2004, we did not have any borrowings on our line of credit, however we anticipate using our line of credit to fund operations when necessary. The line of credit has certain covenants and restrictions which we believe we are in compliance with as of September 30, 2004. During February 2004, we used $37.7 million of the proceeds from the IPO to reduce the outstanding amount on our line of credit.

At December 31, 2003, the Company had a note payable outstanding to a related party totaling $39.6 million including principal and accrued interest. During February 2004, we used $40.0 million of the proceeds from the IPO to pay our related party debt in full.

Cash Flows

The majority of our purchases have been funded with internal cash flow. For the nine months ended September 30, 2004, we invested $59.9 million in purchased receivables, net of buybacks, while our balance under our line of credit decreased $73.0 million (including the payment of $37.7 million from the proceeds of the IPO).

Our operating activities provided cash of $42.1 million and $39.1 million for the nine months ended September 30, 2004 and 2003, respectively. Cash provided by operating activities for the nine months ended September 30, 2004 includes the use of cash of $19.0 million for payment of withholding taxes and employer taxes related to the share appreciation rights. Excluding this use of cash, cash provided by operating activities would have been $61.1 million. Cash provided by operating activities for the nine months ended September 30, 2003 of $39.1 million was generated primarily from net income earned through cash collections.

Investing activities used cash of $18.5 million and $37.9 million for the nine months ended September 30, 2004 and 2003, respectively. For both periods the cash used for investing purposes was primarily due to acquisitions of purchased receivables, net of cash collections applied to principal.

Financing activities used cash of $17.5 million for the nine months ended September 30, 2004 and provided cash of $2.3 million for the same period in 2003. In 2004, cash used by financing activities was primarily due to repayments on our line of credit, net of borrowings, and the repayment of our related party notes payable. The total reduction in debts was partially offset by proceeds from our IPO. In 2003, the cash provided by financing activities was primarily due to borrowing on our line of credit, net of repayments.

Cash paid for interest was $1.4 million and $2.5 million for the nine months ended September 30, 2004 and 2003, respectively. Cash paid for interest consisted of $1.0 million for the line of credit and $0.4 million paid for the related party debt for the nine months ended September 30, 2004 and consisted of $2.5 million for the line of credit for the nine months ended September 30, 2003.

We believe that borrowing available under our line of credit, combined with cash generated from operations, should be sufficient to fund our operations for the next 12 months, although no assurance can be given in this regard. In the future, if we need additional capital for investment in purchased receivables, working capital or to grow our business or acquire other businesses, we may seek to sell equity (which may be dilutive of existing positions) or debt securities or secure additional availability under our line of credit.

New Corporate Headquarters

We plan on relocating to our new corporate headquarters in Warren, Michigan during the fourth quarter of 2004. Our new headquarters will be in a 200,000 square foot building that provides sufficient room for growth, accommodating up to 1,400 employees. Currently we have 535 employees occupying 70,000 square feet at our corporate headquarters. The lease was entered into in October 2003 and will commence December 2004 with an annual base rent expense of approximately $2.6 million compared to approximately $600,000 for our existing headquarters. We expect operating net costs for the new building to be less than the approximately $7.50 per square foot that we pay now because newer buildings require less maintenance and we will receive abatements of most real and personal property taxes due to the building’s location in a Renaissance Zone. Michigan Single Business taxes are also abated to the extent our business activities are located in the Renaissance Zone. The tax abatements will expire in 2012 with a three year phase out period beginning in 2009. Additionally, we expect to invest $4.0 to $4.5 million in capital expenditures of which most will be incurred during the fourth quarter of 2004. It is possible that some of the capital expenditures may be reimbursed based on certain contingent events.

Future Contractual Cash Obligations

The following table summarizes our future contractual cash obligations as of September 30, 2004:


	Year ending December 31,
	2004		2005		2006		2007 (2)		2008		Thereafter
Capital lease obligations	$	37,496	$	129,176	$	83,545	$	11,899	$	—	$	—
Operating leases (1)		968,626		5,057,970		5,665,154		5,414,746		4,502,118		17,655,858
Employment agreements		283,750		976,250		500,000		—		—		—

Total	$	1,289,872	$	6,163,396	$	6,248,699	$	5,426,645	$	4,502,118	$	17,655,858

(1)		On October 31, 2003, we entered into a lease for a new headquarters site in Warren, Michigan. The lease term is 120 months and will commence December 2004. This lease has future contractual cash obligations of $26.0 million.

(2)		To the extent that a balance is outstanding on our line of credit, it would be due in 2007. There was no outstanding balance on our line of credit at September 30, 2004.

Critical Accounting Policies

We believe that the amounts and timing of cash collections for our purchased receivables can be reasonably estimated and therefore, we utilize the interest method of accounting for our purchased receivables prescribed by the Accounting Standards Executive Committee Practice Bulletin 6 (PB 6). This belief is predicated on our historical results and our knowledge of the industry. Each static pool of receivables is statistically modeled to determine its projected cash flows based on historical cash

collections for pools with similar characteristics. An internal rate of return (“IRR”) is calculated for each static pool of receivables based on the projected cash flows and applied to the balance of the static pool. The resulting revenue recognized is based on the IRR applied to the remaining balance of each static pool of accounts. Each static pool is analyzed monthly to assess the actual performance compared to the expected performance. To the extent there are differences in actual performance versus expected performance, the IRR is adjusted prospectively to reflect the revised estimate of cash flows over the remaining life of the static pool.

Application of PB 6 requires the use of estimates to calculate a projected IRR for each pool. These estimates are based on historical cash collections. If future cash collections are materially different in amount or timing than projected cash collections, earnings could be affected either positively or negatively. Higher collection amounts or cash collections that occur sooner than projected cash collections will have a favorable impact on IRR and revenues. Lower collection amounts or cash collections that occur later than projected cash collections will have an unfavorable impact on IRR and revenues. For the nine months ended September 30, 2004, every 20 basis point change in the average IRR for all pools would have affected year-to-date revenue by approximately $3.4 million or 2.2%. A full percentage point change (100 basis points) in the average IRR for all pools would have affected year-to-date revenue by approximately $17.7 million or 11.3%.

New Accounting Pronouncements

In December 2003, the Accounting Standards Executive Committee issued Statement of Position 03-3, “Accounting for Certain Loans of Debt Securities Acquired in a Transfer”. This Statement of Position (“SOP”) addresses accounting for differences between contractual cash flows and cash flows expected to be collected from an investor’s initial investment in loans or debt if those differences are attributable, at least in part, to credit quality. Increases in expected cash flows should be recognized prospectively through adjustment of IRR while decreases in expected cash flows should be recognized as impairment. This treatment differs form our current guidance, Practice Bulletin 6 (PB 6).

Under both the guidance of PB 6 and SOP 03-3, when expected cash flows are higher than prior projections, the increase in expected cash flows results in an increase in the IRR and therefore, the effect of the cash flow increase is recognized as increased revenue prospectively over the remaining life of the affected pool. However, when expected cash flows are lower than prior projections, SOP 03-3 requires that the expected decrease be recognized as an impairment by decreasing the carrying value of the affected pool (rather than lower the IRR) so that the pool will amortize over its expected life using the original IRR. Under our current guidance (PB 6), a decrease in expected cash flows results in a reduction of the IRR and therefore, the effect of the cash flow reduction is recognized as lower revenue prospectively over the remaining life of the affected pool.

Beginning with the adoption of SOP 03-3 in January 2005, when expected cash flows are lower than originally projected, an immediate impairment will be recognized. However, under SOP 03-3 the IRR is not lowered and therefore, more revenue will be recognized over the remaining life of the pool than would be recognized under PB 6. The amount of revenue recognized over the approximate 60 month life of each pool is identical under both PB 6 and SOP 03-3.

The SOP is effective for loans acquired in fiscal years beginning after December 15, 2004 and should be applied prospectively to loans acquired on or before December 15, 2004 as it applies to decreases in expected cash flows.

Item 3. Quantitative and Qualitative Disclosures about Market Risk

Our exposure to market risk relates to the interest rate risk with our variable line of credit. As of September 30, 2004 we did not have any borrowings against our variable line of credit. The average borrowings on the variable line of credit were $21.5 million and $67.3 million for the nine months ended September 30, 2004 and 2003, respectively. Assuming a 200 basis point increase in interest rates on our variable rate debt, interest expense would have increased approximately $306,000 and $409,000 for the nine months ended September 30, 2004 and 2003, respectively. The estimated increases in interest expense are based on the portion of our variable interest debt that is not offset by interest rate swap agreements and assumes no changes in the volume or composition of the debt.

Item 4. Controls and Procedures

With respect to 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 pursuant to Rule 13a-15 of the Securities Exchange Act of 1934. Based upon that evaluation, our Chief Executive Officer and our Chief Financial Officer concluded that our disclosure controls and procedures are effective to cause material information required to be disclosed by us in the reports that we file or submit under the Securities Exchange Act of 1934 to be recorded, processed, summarized and reported within the time periods specified in the Commission’s rules and forms. There have been no changes in our internal controls over financial reporting that have materially affected, or are reasonably likely to materially affect, the registrant’s internal controls over financial reporting.

PART II — OTHER INFORMATION

Item 1. Legal Proceedings.

In the ordinary course of our business, we are involved in numerous legal proceedings. We regularly initiate collection lawsuits, using both our in-house attorneys and our network of third party law firms, against consumers and are occasionally countersued by them in such actions. Also, consumers occasionally initiate litigation against us, in which they allege that we have violated a federal or state law in the process of collecting on their account. It is not unusual for us to be named in a class action lawsuit relating to these allegations, with these lawsuits routinely settling for immaterial amounts. Currently, we are not named in any class action lawsuits in which an underlying class has been certified. However, as of October 22, 2004, we are named in seven class action lawsuits in which the underlying classes have not been certified. We do not believe that these ordinary course matters, individually or in the aggregate, are material to our business or financial condition. However, there can be no assurance that a class action lawsuit would not, if decided against us, have a material and adverse effect on our financial condition.

We are not a party to any material legal proceedings. However, we expect to continue to initiate collection lawsuits as part of the ordinary course of our business (resulting occasionally in countersuits against us) and we may, from time to time, become a party to various other legal proceedings arising in the ordinary course of our business.

Item 2. Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities

The Company’s non-management directors have the right to receive a quarterly fee in the amount of $5,000. In lieu of the cash fee, the non-management directors who are eligible to receive options under our 2004 stock incentive plan have the right to receive immediately vested options to purchase shares of our common stock in an amount equal to three times the cash compensation. These options were issued in private placements in reliance on the exemption from registration contained in Section 4(2) of the Securities Act of 1933, as amended. Each option entitles the holder to purchase one share of our common stock at the exercise price shown below. Pursuant to this program, the following options have been issued to the non-management directors:


Director¹	Option Grant Date	Number of Options		Exercise Price
Jennifer L. Adams	May 19, 2004		770		19.48
Terrence L. Daniels	May 19, 2004		770		19.48
Donald Haider	May 19, 2004		770		19.48
Anthony Ignaczak	May 19, 2004		770		19.48
H. Eugene Lockhart	May 19, 2004		770		19.48
Jennifer L. Adams	September 1, 2004		840		17.85
Terrence L. Daniels	September 1, 2004		840		17.85
Donald Haider	September 1, 2004		840		17.85
Anthony Ignaczak	September 1, 2004		840		17.85
H. Eugene Lockhart	September 1, 2004		840		17.85

¹ Messrs. Daniels and Ignaczak assigned their options granted on May 19, 2004 to Quad-C Management, Inc.

31.1		Rule 13a-14(a) Certification of Chief Executive Officer.

31.2		Rule 13a-14(a) Certification of Chief Financial Officer.

32.1		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer.


	ASSET ACCEPTANCE CAPITAL CORP.
Date: October 29, 2004	By:	/s/ Nathaniel F. Bradley IV
		Nathaniel F. Bradley IV
		President and Chief Executive Officer (Principal Executive Officer)



Date: October 29, 2004	By:	/s/ Mark A. Redman
		Mark A. Redman
		Vice President — Finance and Chief Financial Officer (Principal Financial and Accounting Officer)


Exhibit No.		Description
31.1		Rule 13a-14(a) Certification of Chief Executive Officer

31.2		Rule 13a-14(a) Certification of Chief Financial Officer

32		Section 1350 Certification of Chief Executive Officer and Chief Financial Officer

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		Page
Part I	Financial Information		3

Item 1.	Consolidated Financial Statements (unaudited)		3
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		13
Item 3.	Quantitative and Qualitative Disclosures about Market Risk		26
Item 4.	Controls and Procedures		26

Part II	Other Information		27

Item 1.	Legal Proceedings		27
Item 2.	Changes in Securities, Use of Proceeds and Issuer Purchases of Equity Securities		27
Item 6.	Exhibits and Reports on Form 8-K		28

Signatures			29

Rule 13a-14(a) Certification of CEO
Rule 13a-14(a) Certification of CFO
Section 1350 Certification of CEO and CFO

	•		Funds borrowed can be used to purchase portfolios of charged-off receivables and for general corporate purposes.

	•		Leverage ratio (as defined in the line of credit agreement) cannot exceed 1.5 to 1.0.

	•		Debt to total capitalization ratio (as defined in the line of credit agreement) cannot exceed 1.25 to 1.0.

	•		our ability to purchase charged-off receivable portfolios on acceptable terms and in sufficient amounts;

	•		our ability to maintain existing, and secure additional financing on acceptable terms;

	•		our ability to recover sufficient amounts on our charged-off receivable portfolios;

	•		our ability to make reasonable estimates of the timing and amount of future cash receipts for purposes of recording purchased receivable revenues in accordance with Accounting Standards Executive Committee Practice Bulletin 6 (PB6);

	•		our ability to integrate acquired portfolios or businesses into our company;

	•		our ability to hire and retain qualified personnel;

	•		a decrease in collections if bankruptcy filings increase or if bankruptcy laws or other debt collection laws change;

	•		changes in, or failure to comply with, governmental regulations;

	•		the costs, uncertainties and other effects of legal and administrative proceedings (which may include legal proceedings arising out of purchases of portfolios or companies for which seller indemnification is not available);

	•		our ability to respond to changes in technology and increased competition; and

	•		other unanticipated events and conditions that may hinder our ability to compete.

	•		Fresh accounts are typically 120 to 270 days past due, have been charged-off by the credit originator and are either being sold prior to any post charge-off collection activity or are placed with a third party for the first time. These accounts typically sell for the highest purchase price.

	•		Primary accounts are typically 270 to 360 days past due, have been previously placed with one third party collector and typically receive a lower purchase price.

	•		Secondary and tertiary accounts are typically more than 360 days past due, have been placed with two or three third party collectors and receive even lower purchase prices.