Encore Capital Group, Inc. — Q3 2013 Form 10-Q
Reporting period: Quarter and nine months ended September 30, 2013. Amounts are in U.S. dollars; financial statement amounts are generally in millions unless stated otherwise.
Business context
Encore purchases and collects defaulted consumer receivables, operates a U.K. debt-management business through Cabot, and provides property-tax lien financing through Propel. The period included two major acquisitions: AACC, completed June 13, and a 50.1% interest in Janus Holdings, parent of Cabot, completed July 1. Their results are included only from the respective closing dates, so reported year-over-year comparisons are not fully like-for-like.
Key financial metrics
| Metric | Q3 2013 | Q3 2012 | Nine months 2013 | Nine months 2012 |
|---|---|---|---|---|
| Total revenue | $235.6 | $145.2 | $536.3 | $412.9 |
| Operating income | $61.1 | $41.6 | $129.7 | $115.1 |
| Operating margin | 26.0% | 28.6% | 24.2% | 27.9% |
| Income from continuing operations attributable to Encore | $22.2 | $21.3 | $52.7 | $58.4 |
| Net income attributable to Encore | $21.9 | $21.3 | $52.3 | $49.3 |
| Diluted EPS, continuing operations | $0.82 | $0.82 | $2.06 | $2.25 |
| Net cash from operating activities | Not presented for quarter | Not presented for quarter | $39.9 | $66.2 |
Q3 revenue rose 62.2%, while Encore-attributable net income increased about 2.7%; higher operating costs and interest expense reduced margins and pretax income. Nine-month revenue rose 29.9%, but continuing income attributable to Encore fell about 9.8%, reflecting higher operating and financing costs. Nine-month net income attributable to Encore increased 6.2%, partly because the prior-year period included a larger discontinued-operations loss.
- Collections: $379.7 in Q3 and $928.2 for nine months, up 54.4% and 29.4%, respectively, year over year.
- Portfolio investment: $1,595.6 at September 30, versus $873.1 at December 31, 2012. Nine-month portfolio purchases were $1,099.7, including portfolios acquired with AACC and Cabot.
- Cash and debt: Cash and equivalents were $110.2 at September 30, versus $17.5 at year-end 2012. Debt was $1,806.7, versus $706.0; debt includes acquired Cabot financing and preferred equity certificates classified as debt.
- Balance sheet: Total assets were $2,591.0 and stockholders’ equity $548.0 at September 30. Cabot VIE assets of $1,067.0 are restricted to settling VIE obligations; its $864.4 of liabilities are nonrecourse to Encore.
- Liquidity: Encore reported $104.1 available under its revolving facility; Propel reported $28.7 available on its tax-lien transfer facility and $73.0 on its tax-lien certificate facility. Cabot had £85.0 available under its revolving facility. Management said liquidity was sufficient for at least the next 12 months.
Material changes and notable items
- AACC and Cabot added scale and portfolio revenue, but also increased staffing, general and administrative costs, depreciation, and debt. Q3 interest expense rose to $29.2 from $7.0; nine-month expense rose to $43.5 from $19.0.
- Q3 operating expenses increased 68.3% to $174.4, faster than revenue. Management attributed the increase principally to acquisitions and growth; acquisition-related legal, advisory, integration, and other costs were also reported.
- Operating cash flow declined to $39.9 for the nine months, from $66.2. The filing cites income-tax payments of $54.5 as a significant cash use. Investing cash outflow was $214.4, including acquisition spending; financing cash inflow was $264.7.
- Management reported elevated U.S. portfolio prices and constrained supply, partly linked to underwriting changes and issuer audits. It said pricing could remain elevated. The U.K. market had increased supply but prices above historical averages.
- Acquisition purchase-price allocations remained preliminary, with final valuation work expected by Q2 2014. Goodwill was $489.5 at September 30; impairment could result in a significant earnings charge.
- The filing records a $3.6 loss on termination of a foreign-exchange collar in Q2, partly offset by a lower estimated Cabot purchase price. A $0.3 after-tax loss from discontinued operations was recorded in Q3, related to the previously sold Ascension business.
Outlook, risks, and contingencies
- Management expected AACC’s combined operations to reach Encore’s lower cost-to-collect within roughly two to three quarters; successful integration without disrupting business relationships is a key condition.
- Management expected to pursue Cabot growth using Encore’s analytics and operating platform, while Cabot would continue as a standalone business. These are forward-looking expectations, not guarantees.
- Risks include elevated portfolio acquisition prices and limited supply, collection forecast and valuation uncertainty, integration execution, regulatory and consumer-protection compliance, foreign exchange and interest-rate exposure, and potential goodwill or intangible-asset impairment.
- Encore reported compliance with financing covenants. It disclosed routine debt-collection litigation and AACC merger-related shareholder suits; a settlement was preliminarily approved, subject to final court approval, with plaintiffs’ counsel able to seek up to $550,000 in fees and costs. The company reported no material litigation reserves.
- Forward-flow and other purchase commitments covered portfolios with approximately $562.8 face value for an estimated $58.5 purchase price, with no commitments beyond December 2014. The filing states that management generally does not issue specific earnings projections.
Investor verification priorities
- Review acquisition-adjusted performance: reported 2013 results include AACC and Cabot only after closing, and the purchase-price allocations were not final.
- Assess debt service, refinancing and covenant capacity, including Cabot’s high-coupon secured notes and the $190.3 of preferred equity certificates classified as debt.
- Test the assumptions behind portfolio cash-flow estimates, yields, allowances and the $4,022.0 of estimated remaining collections; these are forecasts, not guaranteed collections.
- Track integration progress, cost-to-collect trends, collector productivity, and whether expected synergies materialize.
- Monitor portfolio pricing and availability, consumer-collection regulation and litigation, goodwill impairment indicators, and the timing and outcome of the merger-related settlement.