Encore Capital Group, Inc. — Q2 2013 Form 10-Q
Reporting period: Three and six months ended June 30, 2013. Financial statements are unaudited. Amounts below are in millions of U.S. dollars, except per-share data and percentages.
Business context and period events
Encore buys and collects defaulted consumer receivables and, through Propel, finances delinquent property taxes secured by tax liens. The June 13 acquisition of Asset Acceptance Capital Corp. (AACC) is included in results only from its closing date. The July 1 acquisition of a controlling interest in U.K.- and Ireland-based Cabot occurred after quarter-end and is not included in Q2 results.
Financial performance
| Metric | Q2 2013 | Q2 2012 | Six months 2013 | Six months 2012 |
|---|---|---|---|---|
| Total revenue | $156.1 | $141.2 | $300.7 | $267.7 |
| Operating income | $29.9 | $38.4 | $68.6 | $73.5 |
| Net income | $11.0 | $16.6 | $30.5 | $28.0 |
| Diluted EPS | $0.44 | $0.64 | $1.24 | $1.08 |
| Net cash from operating activities | — | — | $11.3 | $44.6 |
Revenue from receivable portfolios was $152.0 million in Q2 and $292.7 million for the first half. Q2 revenue rose 10.5%, but operating income fell 22.3%; operating margin declined to 19.1% from 27.2%. Continuing-operations income was $11.0 million for Q2, down from $19.0 million, and $30.5 million for the half, down from $37.1 million. Prior-year net income included discontinued-operation losses of $2.4 million for Q2 and $9.1 million for the half. Management’s non-GAAP adjusted diluted EPS was $0.85 versus $0.83 in Q2 and $1.70 versus $1.54 for the half; it excludes specified acquisition and financing-related items.
Gross collections increased 15.7% to $278.4 million in Q2 and 16.3% to $548.6 million for the half. The company reported adjusted cost per dollar collected of 38.8% for Q2 versus 39.5%, and 37.7% for the half versus 38.9%. Adjusted EBITDA was $177.2 million for Q2 versus $147.9 million and $351.7 million for the half versus $291.8 million; these are non-GAAP measures.
Balance sheet, debt and liquidity
- At June 30, cash was $222.2 million, total assets $1.805 billion, receivable portfolios net $1.097 billion, and tax-lien receivables net $198.1 million.
- Reported debt was $1.108 billion, up from $706.0 million at December 31, 2012; stockholders’ equity was $510.4 million. The company reported compliance with its financing covenants.
- Six-month investing cash outflow was $202.7 million, including $293.3 million paid for AACC net of cash acquired; financing cash inflow was $396.1 million. Operating cash flow was $11.3 million, versus $44.6 million, with the filing citing, among other factors, $40.5 million of income taxes paid.
- Management said available cash, expected operating cash flows, capital-market access and credit-facility availability were sufficient for at least the next 12 months. Approximately $174.6 million of June 30 cash was used to fund the July 1 Cabot acquisition.
Material changes and unusual items
- AACC’s purchase price was approximately $378.8 million, including cash and stock consideration; Encore also repaid approximately $165.7 million of AACC debt at closing. The initial allocation included $68.4 million of goodwill and remained preliminary.
- Encore completed the Cabot transaction after quarter-end for approximately $174.6 million, acquiring 50.1% of Janus Holdings; its effective equity ownership of Cabot was 41.7%, with a stated expected increase to approximately 42.8% by June 2014. The company planned to consolidate Cabot from July 1.
- Q2 and first-half expenses included $3.6 million from terminating a foreign-exchange collar related to Cabot; the filing says a roughly $4.3 million reduction in estimated purchase price offset that loss.
- Encore issued $150 million of 3.0% convertible notes due 2020 in June; purchasers exercised an option for a further $22.5 million in July. The June issuance was partly used to fund Cabot and included a $15.8 million capped-call cost.
- Portfolio purchases were $481.9 million for the first half, including $381.2 million of AACC portfolios. Excluding AACC, purchases were $100.7 million, versus $361.4 million in the prior-year half.
Outlook, commentary and risks
- Encore does not provide specific earnings projections and cautions that forward-looking statements are uncertain. Management expected elevated prices for fresh charged-off portfolios to persist for some time, citing reduced supply and continued demand; it said purchasing could shift toward aged portfolios or alternative asset classes. It also expected to slow purchases in Q3 versus the prior year following AACC.
- Management expected the combined company to reach Encore’s lower cost-to-collect within three to four quarters, while warning that integration could disrupt operations, relationships or employee retention and that anticipated savings may not be achieved.
- Portfolio collections and revenue depend on estimates of future cash flows and collection timing. The filing reports a $100.6 million portfolio valuation allowance and estimates $147.1 million of collections beyond the usual 84–96-month forecast, excluded from IRR calculations.
- Key exposures include elevated portfolio prices and supply constraints, regulatory and consumer-collection litigation risk, acquisition integration and international expansion, currency and interest-rate movements, and substantial secured and convertible debt. The company disclosed no material litigation reserves. AACC shareholder suits had a proposed settlement subject to court approval; contemplated plaintiffs’ fees and costs were capped at $550,000.
- The company said Propel had experienced no losses on its tax-lien portfolio and maintained a foreclosure rate below 0.5%; these are management-reported historical observations, not guarantees of future performance.
Most important facts for investors to verify
- Whether AACC integration delivers the anticipated cost savings, and whether the final purchase-price allocation or integration costs differ materially from preliminary estimates.
- Whether collections and cash-flow forecasts support portfolio carrying values, revenue accretion and the valuation allowance, including assumptions for collections beyond the standard forecast period.
- How the Cabot acquisition and subsequent financing affect debt, interest expense, cash availability, covenant headroom and future consolidated results.
- Whether portfolio pricing and supply trends, and the planned change in purchasing mix, preserve expected returns and collection performance.
- Developments in regulatory scrutiny, consumer-collection litigation and the AACC shareholder settlement, together with dilution and cash-settlement exposure under convertible notes and related instruments.