Encore Capital Group, Inc. — Q2 2016 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2016. Encore purchases defaulted consumer receivables and collects on them across the U.S. and international markets. Following the March 31 sale of Propel, its tax-lien business, the company reports one segment: portfolio purchasing and recovery. Figures below are in U.S. dollars; financial statement amounts are unaudited.
Key financial metrics
| Metric | Q2 2016 | Q2 2015 | Six months 2016 | Six months 2015 |
|---|---|---|---|---|
| Total revenue | $289.4 million | $282.7 million | $578.5 million | $560.4 million |
| Operating income | $91.7 million | $84.3 million | $175.3 million | $167.2 million |
| Operating margin | 31.7% | 29.8% | 30.3% | 29.8% |
| Net income attributable to Encore shareholders | $29.6 million | $27.7 million | $55.3 million | $57.1 million |
| Diluted EPS attributable to Encore | $1.14 | $1.03 | $2.14 | $2.11 |
Q2 continuing-operations income attributable to Encore was $29.6 million, compared with $26.0 million in Q2 2015; Q2 2016 had no discontinued-operations income. For the six-month period, continuing-operations income attributable to Encore was $58.5 million versus $53.5 million, while discontinued operations recorded a $3.2 million after-tax loss, including the Propel sale loss.
- Cash flow: Six-month operating cash flow was $49.1 million, versus $47.4 million a year earlier. Investing cash flow was negative $53.0 million and financing cash flow negative $11.2 million. Portfolio purchases totaled $517.7 million in cash; collections applied to portfolio principal were $351.2 million. Period-end cash was $139.0 million.
- Balance sheet and debt: At June 30, total assets were $3.77 billion, total debt $2.85 billion, and equity $628.4 million. Debt was down from $2.94 billion at December 31, 2015. Debt includes $212.7 million of preferred equity certificates. Cash was $139.0 million.
- Liquidity: Encore’s credit facilities had $193.7 million of availability, subject to borrowing-base and covenant limits, plus $195.0 million of remaining accordion capacity. Cabot’s facility had approximately $139.3 million available. Management said liquidity was sufficient for at least the next 12 months and reported compliance with debt covenants.
- Portfolio metrics: Net investment in receivable portfolios was $2.47 billion. Six-month gross collections were $881.9 million, up 2.3% year over year; portfolio purchases were $489.9 million, down 9.9%. Estimated remaining gross collections were $5.54 billion; these are forecasts, not guaranteed proceeds.
Material changes versus comparable periods
- Q2 revenue rose 2.4% and operating income rose 8.8%; shareholder-attributable net income rose 7.0%. Six-month revenue increased 3.2%, but shareholder-attributable net income declined 3.2%, mainly reflecting the discontinued-operations loss from Propel.
- Q2 portfolio revenue declined 1.1%, while other revenue increased to $22.0 million from $12.4 million, primarily from international contingent-fee income. Six-month portfolio revenue increased 0.6% and other revenue rose to $40.9 million from $26.0 million.
- Operating expenses were nearly flat in Q2 and increased 2.5% for the six-month period. Higher international staffing and operating costs were partly offset by lower legal-collection costs. Interest expense rose 9.4% in Q2 and 14.4% year to date, primarily due to higher average European debt and Baycorp, acquired in 2015.
- Overall cost per dollar collected improved to 36.9% in Q2 from 37.6%, and to 37.3% for six months from 38.1%, primarily reflecting improved U.S. costs.
- The March 2016 Propel divestiture generated $106.0 million of net cash proceeds after cash divested; the transaction removed the tax-lien segment and its assets and liabilities from the balance sheet. Goodwill also declined, including foreign-currency translation effects.
Outlook, commentary, risks and unusual items
- The filing provides no specific earnings guidance. Management expects continued positive operating cash flow and says existing cash, capital-market access, and facility availability should fund operations for at least 12 months; future cash needs depend partly on portfolio and business acquisitions.
- Management describes U.S. portfolio supply as potentially increasing as charge-offs rise, with fresh-portfolio pricing beginning to soften. U.K. portfolio prices remain above historical levels. The company expects European legal-collection investment to increase costs, with potential collections accruing over a longer period.
- Cabot’s FCA authorization and consumer-protection requirements have lengthened payment plans and reduced near-term collections; management expects a longer collection curve. The CFPB’s proposed rulemaking and examinations could affect collection practices and costs. The eventual effect of proposed or evolving rules is not yet clear.
- The U.K. Brexit vote has increased uncertainty and currency volatility. A weaker pound may reduce reported international results and could adversely affect the company; the ultimate economic, trade, and regulatory effects remain uncertain. The EU General Data Protection Regulation is scheduled to apply from 2018.
- Foreign-exchange movements materially affected comprehensive income: six-month foreign-currency translation loss was $34.4 million after tax. The company also recognized $7.4 million of pre-tax gains on non-hedge-designated currency forwards for the first half.
- Portfolio revenue depends on estimates of future collections and pool yields; underperformance can trigger allowance charges. The company reported $4.7 million of net portfolio allowance reversals for the first half, versus $7.2 million in 2015.
- Receivable-purchase commitments at June 30 covered approximately $1.2 billion face value for an estimated $195.5 million purchase price. The filing notes ordinary-course litigation and regulatory matters; apart from CFPB and ancillary state matters discussed in its prior annual report, Encore reported no material legal reserves. The Brent class-action settlement appeal was affirmed on July 7, 2016; the settlement fund had already been paid.
Important facts for investors to verify
- Whether collections, portfolio performance, and allowance assumptions support the $5.54 billion estimated remaining collections forecast, particularly for Cabot and newer international portfolios.
- How FCA, CFPB, data-protection, and potential U.K. debt-collection rule changes affect collection timing, litigation activity, compliance costs, and portfolio valuations.
- Encore’s leverage, covenant headroom, facility availability, and refinancing needs, including the $60.0 million term-loan tranche maturing in February 2017 and the $6.3 million tranche maturing in November 2017.
- The impact of Brexit and sterling volatility on reported results, cash flows, and the value of international operations.
- The final Propel divestiture adjustments and any developments in the CFPB or state regulatory matters for which the filing does not give a clear quantified exposure.