Encore Capital Group, Inc. — 2013 Form 10-K
Business context and reporting period. This is the annual report for the fiscal year ended December 31, 2013, not a standalone fourth-quarter filing. Encore buys and collects defaulted consumer receivables and finances delinquent property taxes through its Propel tax-lien business. During 2013 it completed the AACC merger, acquired control of U.K.-based Cabot, and acquired a majority interest in Refinancia, operating in Colombia and Peru. Cabot and AACC results are included only from their respective acquisition dates; Refinancia’s results were immaterial. The filing reports two segments: portfolio purchasing and recovery, and tax liens.
Financial performance and key metrics
| Metric | 2013 | 2012 |
|---|---|---|
| Total revenue | $773.4 million | $556.8 million |
| Operating income | $198.4 million; 25.6% margin | $155.1 million; 27.9% margin |
| Income from continuing operations | $75.5 million | $78.6 million |
| Net income attributable to Encore shareholders | $75.3 million | $69.5 million |
| Diluted EPS, continuing operations / net | $2.94 / $2.87 | $3.04 / $2.69 |
| Gross collections | $1,279.5 million | $948.1 million |
| Net cash from operating activities | $74.8 million | $98.5 million |
| Cash and cash equivalents, year-end | $126.2 million | $17.5 million |
| Total debt, year-end | $1,850.4 million | $706.0 million |
Revenue from receivable portfolios was $744.9 million, up 36.6%; total revenue grew 38.9%. Encore purchased $1.205 billion of portfolios, including portfolios acquired with AACC and Cabot, and recorded a $12.2 million net portfolio allowance reversal. Total operating expenses rose 43.1% to $575.0 million, faster than revenue; operating margin therefore declined. Interest expense increased to $73.3 million from $25.6 million, principally reflecting Cabot and acquisition-related borrowings. The effective tax rate was 37.6%, versus 39.7%.
For the three months ended December 31, 2013, quarterly revenue was $237.1 million, gross collections were $351.3 million, operating expenses were $168.5 million, income from continuing operations was $23.6 million, net income was $22.2 million, and diluted EPS from net income was $0.82. The filing notes U.S. collections are generally slowest in the fourth quarter, while U.K. collection patterns differ.
Material changes versus the prior comparable period
- Revenue and collections increased substantially, mainly from a larger portfolio base and the AACC and Cabot acquisitions; U.S. portfolio revenue also benefited from higher yields on certain pools.
- Portfolio purchases more than doubled to $1.205 billion from $562.3 million. The filing attributes the unusually low 2013 average purchase price as a percentage of face value (1.4%, versus 3.0%) partly to AACC accounts with little or no expected collection value included in the merger portfolio.
- Operating costs rose with acquisitions, higher staffing, expansion of the internal legal channel, and integration and technology spending. Adjusted cost per dollar collected was 39.1%, down from 40.0%, with lower U.K. costs offsetting a slight increase in U.S. costs.
- Operating cash flow decreased by $23.7 million despite higher earnings; the company cites, among other items, $66.8 million of income-tax payments. Investing cash outflow was $217.2 million, while financing provided $246.0 million.
- Year-end assets increased to $2.685 billion from $1.171 billion, including portfolio investments of $1.590 billion and goodwill of $504.2 million. Debt rose substantially following acquisitions and related financing.
Liquidity, debt, and capital
At December 31, 2013, cash was $126.2 million. Encore reported $496.6 million drawn and $257.9 million available under its then-existing revolving and term credit facility; Cabot had £85.0 million available under its revolver; Propel had $47.7 million available under its Texas facility and $81.7 million under its Wells Fargo facility. Management stated it expected sufficient liquidity for at least the next 12 months, citing operating cash flow, cash, capital-market access, and facility availability. The filing says the company was in compliance with financing covenants.
Debt includes $846.7 million at the Cabot variable-interest entity, whose creditors have no recourse to Encore, as well as convertible notes, secured borrowings, tax-lien facilities, and preferred equity certificates. After year-end, Encore amended its credit agreement on February 25, 2014: the facilities provide $692.6 million of revolving capacity, $153.8 million of term loans, and an accordion allowing up to $250 million of additional revolver capacity. In February 2014, Cabot acquired Marlin for approximately £295 million (about $481 million), financed partly with revolving-credit borrowing and senior secured bridge facilities. These post-year-end events materially affect the financing and leverage picture.
Encore had no specific earnings guidance in the filing and stated it generally does not make specific future earnings projections. It said U.S. portfolio prices remained elevated amid constrained supply and expected elevated pricing to persist for some time. It expected U.K. portfolio supply to increase, while noting prices remained above historical levels. Management expects collection costs to fluctuate with seasonality, operating investments, regulation, and collection-channel mix. No cash dividends had been paid, and the company did not intend to pay them in the foreseeable future.
Risks, contingencies, and unusual items
- Collections and portfolio valuation: Results depend on projected future collections; inaccurate models or weaker-than-expected recoveries could reduce revenue or cause portfolio allowance charges. Portfolio supply is constrained and purchase prices are elevated, increasing competition and the risk of overpaying.
- Leverage and liquidity: Debt increased sharply, variable-rate borrowings expose earnings to rate changes, and debt agreements impose covenants. The filing reports $1.9 billion of long-term indebtedness in its risk discussion and highlights refinancing, servicing, and covenant risks.
- Regulation and litigation: Debt collection is subject to extensive U.S. and international regulation, including CFPB supervision and anticipated U.K. regulatory changes. The company disclosed ongoing consumer-protection litigation and investigations; it had no material litigation reserves at year-end, stating some exposures were immaterial or could not yet be estimated. A revised national class settlement in the Brent/Franklin/Vassalle matters was subject to final court approval, with a settlement fund of about $5.2 million and a possible cap of $5.7 million.
- Acquisitions and integration: Integration of AACC and Cabot, and the subsequent Marlin acquisition, entail execution, cost, staffing, and systems risks. Management did not include Cabot in its 2013 internal-control assessment because of acquisition timing; it planned to monitor and test Cabot’s systems in 2014. The auditor’s opinion on Encore’s controls likewise excluded Cabot.
- Other notable items: The company recorded a $3.6 million loss on termination of an acquisition-related foreign-exchange collar, described as economically offset by a lower estimated Cabot purchase price. Discontinued operations recorded a $1.7 million net loss in 2013, including legacy Ascension claims and lease costs. The period’s $12.2 million portfolio allowance reversal benefited reported portfolio revenue. The filing also describes an $83.0 million gross uncertain tax benefit, primarily related to AACC; recognition would produce an estimated $13.5 million net tax benefit.
Important facts for investors to verify
- Reconcile reported 2013 earnings and margins with acquisition timing, the portfolio allowance reversal, and the non-GAAP adjustments for acquisition and integration costs.
- Review expected collections and carrying values for U.S. and U.K. portfolios, especially assumptions behind recently acquired pools and the reported $3.990 billion of estimated remaining gross collections.
- Assess pro forma leverage, interest expense, bridge-facility terms, and liquidity after the Marlin acquisition and February 2014 credit-agreement amendment.
- Track CFPB and U.K. regulatory developments, pending litigation, and the AACC-related uncertain tax position and audit outcome.
- Evaluate Cabot’s results and control environment: it contributed $95.5 million of 2013 revenue after acquisition, but was excluded from the year-end internal-control assessment.