Encore Capital Group, Inc. — Q2 2022 Form 10-Q
Reporting period: Unaudited quarter and six months ended June 30, 2022. Encore purchases and collects defaulted consumer receivables, primarily in the United States and Europe, and provides debt-servicing services, principally in Europe. Financial amounts below are in U.S. dollars.
Key financial metrics
| Metric | Q2 2022 | Q2 2021 | Six months 2022 | Six months 2021 |
|---|---|---|---|---|
| Total revenue | $356.9 million | $427.7 million | $856.6 million | $844.6 million |
| Income from operations | $118.9 million | $174.3 million | $384.0 million | $342.6 million |
| Net income attributable to Encore | $60.4 million | $96.5 million | $236.2 million | $191.1 million |
| Diluted EPS | $2.29 | $3.07 | $8.77 | $6.04 |
| Operating margin | 33.3% | 40.7% | 44.8% | 40.6% |
- Cash flow, six months: Operating cash flow was $98.5 million versus $149.0 million; investing cash flow was $35.1 million versus $240.7 million; financing used $155.6 million versus $369.6 million. Cash and cash equivalents ended at $154.3 million, down from $189.6 million at year-end 2021.
- Balance sheet at June 30: Receivable portfolios, net, were $3.04 billion; total assets were $4.46 billion; reported borrowings were $2.79 billion, down from $3.00 billion at December 31, 2021. Stockholders’ equity was $1.23 billion.
- Debt and liquidity: Available capacity under the Global Senior Facility, after applicable covenant limits, was $575.5 million. Encore reported material compliance with financing covenants. The facility was amended in March 2022, upsized to $1.14 billion and extended to September 2026. Cash includes $19.2 million collected for clients; $135.9 million was held by foreign entities, most of which management considers indefinitely reinvested.
Material changes versus comparable periods
- Q2 revenue fell 16.6% and net income attributable to Encore fell 37.4% year over year. For the first half, revenue rose 1.4% and net income attributable to Encore rose 23.6%.
- Q2 debt-purchasing revenue declined 16.0%; servicing revenue declined 25.8%. Six-month debt-purchasing revenue increased 3.3%, while servicing revenue declined 22.7%.
- Collections from purchased receivables were down 18.7% in Q2 and 16.6% for the six months. Management attributed the comparison partly to unusually high prior-year collections associated with pandemic-era consumer behavior and to lower purchasing volumes in recent periods.
- Recoveries exceeded forecast by $9.9 million in Q2 and $56.3 million in the first half. Updated lifetime collection forecasts added $15.2 million and $136.1 million, respectively, to recoveries revenue. This contrasted with negative forecast revisions in the prior-year periods.
- Q2 operating margin contracted as revenue fell faster than operating expenses. First-half operating margin improved. Interest expense declined 16.1% in Q2 and 20.9% for the six months, mainly reflecting lower average debt balances, refinancing and foreign-exchange effects.
- A stronger U.S. dollar, particularly against the British pound, reduced reported international revenue and contributed to a $59.8 million Q2 foreign-currency translation loss in other comprehensive income. Goodwill also declined by $73.6 million from year-end, primarily due to currency translation; no interim goodwill impairment assessment was required.
Outlook, risks and unusual items
- The company does not provide specific earnings projections and states that it does not endorse third-party projections. Management expects positive operating cash flows and says liquidity is sufficient for at least the next twelve months, subject to collection timing, portfolio purchases and access to financing.
- Management described U.S. portfolio supply as beginning to increase, with purchases still below pre-pandemic levels; it believes pricing plateaued in Q2. European supply remained below pre-pandemic levels and pricing was more competitive. Forward-flow purchase agreements had estimated minimum aggregate purchase commitments of approximately $488.1 million; management expects actual purchases to be significantly greater.
- Collection and portfolio valuations rely on estimates of future recoveries and are sensitive to collection performance, consumer behavior, operating execution, regulation and macroeconomic conditions. Management cautions actual results may differ materially from estimates. The $7.56 billion estimated remaining gross collections figure is a model-based estimate, not a guarantee.
- Interest-rate and foreign-exchange exposures remain relevant. Encore held interest-rate caps and cross-currency swaps; the filing expects approximately $4.0 million of net derivative gains and $6.3 million of net derivative losses, respectively, to be reclassified from accumulated other comprehensive income into earnings over the next 12 months.
- Debt-collection operations face litigation and regulatory risks, including claims under consumer-protection and debt-collection laws. No material legal reserves were recorded and no material developments in previously disclosed proceedings were reported. The filing also identifies difficulty recruiting and retaining employees, including possible wage-cost inflation, as a risk.
- Control weakness: Disclosure controls were deemed ineffective at June 30 because of a material weakness in internal control over financial reporting previously disclosed in the 2021 Form 10-K. Remediation was underway, with completion expected no later than December 31, 2022, subject to successful operation and testing of controls.
- During the first half, Encore paid $221.2 million to settle the $150.0 million 2022 convertible notes at maturity; the $71.2 million excess over principal was recorded in equity. The company repurchased $50.7 million of common stock in the first half, with $128.1 million remaining under the repurchase program at June 30.
Important facts for investors to verify
- Whether collection outperformance and upward lifetime recovery revisions persist, and how much of earnings depends on forecast changes rather than recurring portfolio accretion.
- Whether portfolio purchases and collection trends recover, especially in the U.S. and Europe, and how competitive pricing affects expected returns.
- Liquidity, debt maturities, variable-rate borrowing costs, covenant headroom and the use of cash for portfolio purchases, note repayments and share repurchases.
- Progress and testing evidence for remediation of the material weakness in internal controls by the stated year-end target.
- Developments in consumer-protection litigation and regulation, labor availability and wage costs, and foreign-exchange effects on reported results and equity.