Encore Capital Group, Inc. — Q1 2013 Form 10-Q
Period and business: Three months ended March 31, 2013; comparisons are with Q1 2012 unless stated otherwise. Encore purchases and collects defaulted consumer receivables and, through Propel, originates Texas property-tax lien payment agreements. The unaudited interim statements should be read with the company’s 2012 Form 10-K.
Financial performance and position
Amounts below are USD millions, except per-share data and percentages.
- Revenue: Total revenue was $144.3, up 14.1%. Receivable-portfolio revenue was $140.7, up 11.3%; tax-lien net interest income contributed $3.6.
- Profit and margins: Operating income was $38.4, up from $35.0; operating margin was 26.6%, versus 27.7%. Continuing-operations income was $19.4, up from $18.1, with a 13.5% margin versus 14.3%. Net income was $19.4 versus $11.4, as Q1 2012 included a $6.7 after-tax discontinued-operations loss. Diluted EPS was $0.80 versus $0.44; continuing-operations diluted EPS was $0.80 versus $0.70.
- Non-GAAP measures: Adjusted diluted income per share was $0.86 versus $0.70. Adjusted EBITDA was $174.5 versus $143.9; this measure includes the amount applied to receivable-portfolio principal and is not comparable to GAAP operating cash flow.
- Cash flow: Operating cash flow was $23.7, down from $27.1. Investing activities provided $54.7 versus using $27.1, reflecting portfolio collections exceeding purchases, partly offset by $27.4 of Propel originations. Financing used $66.0, primarily for revolving-debt repayments. Cash increased $12.4 to $29.9.
- Assets and liquidity: Total assets were $1,132.5 at March 31, down from $1,171.3 at year-end. Net receivable portfolios were $801.5, down from $873.1; property-tax agreements receivable were $153.6, up from $135.1. Management said available cash, operating cash flow and credit facilities were sufficient for at least the next 12 months.
- Debt: Reported debt, net of convertible-note discount, was $646.0, down from $706.0 at December 31. Cash was $29.9; stockholders’ equity was $426.9. The company reported compliance with financing covenants. Its existing credit facility commitment was $595.0; a May 9, 2013 amendment increased commitments to $812.5, with a further accordion allowing maximum borrowing of $975.0.
- Other metrics: Gross collections rose 16.9% to $270.2. Adjusted portfolio-business operating expenses per dollar collected improved to 36.5% from 38.4% (non-GAAP). The effective income-tax rate was 39.3%, compared with 39.2%.
Material changes and management commentary
- Portfolio revenue growth reflected collections outperforming prior cash projections and resulting increases to certain portfolio internal rates of return; the company also recorded a $1.0 portfolio-allowance reversal, versus a $0.4 provision in Q1 2012.
- Portfolio purchases fell 55.0% to $58.8, despite purchasing $1.6 billion face value of receivables. The average purchase price declined to 3.6% of face value from 4.5%. Management said market prices, especially for fresh portfolios, remained elevated due to reduced supply and sustained buyer demand; it expected elevated pricing to persist and said it could shift toward aged portfolios or alternative asset classes.
- Operating expenses rose 15.8% to $105.9. Salaries and benefits increased with headcount, business growth and Propel; general and administrative costs included acquisition and IT expenses. Interest expense rose 24.3% to $6.9, including convertible-note discount and loan-cost amortization.
- Management cited first-quarter seasonality: collections are generally strongest in Q1 and slowest in Q4. Collector productivity measures declined during international call-center expansion; management described this as a short-term ramp-up effect and expected productivity to recover as employees gained experience.
- The company agreed to acquire Asset Acceptance Capital Corp. (AACC) on March 6. Consideration per AACC share is an election of $6.50 cash or 0.2162 Encore shares, subject to a 25% cap on stock elections and proration. The filing anticipated closing in Q2 2013 in its merger disclosure; MD&A also referred to Q2 or Q3. The transaction remained subject to customary conditions and regulatory approvals. Encore expected to fund the cash portion with cash and borrowings, potentially borrowing up to $381.7 under its revolver.
- After quarter-end, Encore announced a CEO transition: Kenneth Vecchione was appointed to replace J. Brandon Black, effective April 8, 2013. On May 9, credit and senior-note amendments expanded financing capacity and permitted the AACC merger.
Risks, contingencies and unusual items
- Merger risks include failure to close, integration and retention challenges, unanticipated costs, increased debt and the possibility that anticipated benefits are not realized. Shareholder suits seeking to block or rescind the AACC transaction were disclosed; damages were unspecified.
- The Sixth Circuit reversed approval of a nationwide settlement in the Brent/Franklin/Vassalle consumer class litigation and remanded the matter for further proceedings. Encore reported no material litigation reserves, noting some exposures were immaterial or not yet estimable. The company also described routine consumer-collection litigation risks under federal and state laws.
- Receivable-portfolio values depend on estimated future collections and discount rates. The company estimated $1.2 billion fair value for portfolios carried at $801.5 million; a 100-basis-point discount-rate change would alter estimated fair value by approximately $20.0 million. This fair value is not a sale value or valuation of the company.
- Management changed the court-cost deferral period prospectively from three to five years beginning January 2013, citing recoveries beyond three years. Net deferred court costs were $35.4 million, against $304.2 million advanced and a $162.5 million reserve.
- Property-tax receivables were $153.6 million, including $20.7 million more than 90 days past due. The company reported no historical losses, relied on lien priority and underwriting, and recorded no allowance; actual recoveries remain subject to credit and property-value risks.
- Interest-rate and Indian-rupee exposure is partly hedged. The filing reported $125.0 million notional interest-rate swaps and $41.6 million notional currency forwards. Management does not provide specific earnings projections and cautioned that forward-looking expectations may not be achieved.
Key facts investors should verify
- Whether AACC closed on the anticipated timeline, the final cash/stock mix, total financing used, integration costs and realized benefits.
- Whether elevated portfolio purchase prices and constrained supply affect future purchase volumes, returns and collection forecasts.
- Trends in portfolio collections, allowance revisions, estimated remaining collections and the sensitivity of fair-value assumptions.
- Revolver availability, borrowing-base limits, debt service and covenant compliance after the May 2013 amendments and any merger borrowing.
- Developments in the consumer class litigation and AACC shareholder suits, as well as potential costs not currently estimable.
- Recovery experience for deferred court costs under the extended five-year period and delinquency/loss performance of Propel’s tax-lien portfolio.