Business context and reporting period
Encore Capital Group, Inc. is an international specialty finance company that purchases and collects defaulted consumer receivables and provides debt-servicing services. Its principal operations are Midland Credit Management in the U.S. and Cabot in Europe. This unaudited Form 10-Q covers the quarter and six months ended June 30, 2019; comparisons are with the corresponding 2018 periods. Amounts below are in U.S. dollars unless stated otherwise.
Financial performance and position
| Metric | Q2 2019 | Q2 2018 | Six months 2019 | Six months 2018 |
|---|---|---|---|---|
| Total revenue | $344.8m | $332.1m | $690.5m | $649.1m |
| Revenue adjusted for net portfolio allowances | $346.9m | $349.7m | $694.0m | $676.5m |
| Operating income | $113.7m | $103.4m | $224.8m | $191.9m |
| Operating margin on adjusted revenue | 32.8% | 29.6% | 32.4% | 28.4% |
| Net income attributable to Encore shareholders | $36.7m | $26.3m | $85.9m | $48.1m |
| Diluted EPS | $1.17 | $1.00 | $2.74 | $1.82 |
| Interest expense | $63.9m | $60.5m | $118.9m | $118.0m |
For the six months, net cash from operations was $108.8m, investing cash outflow was $115.7m, and financing cash inflow was $27.6m. Cash and cash equivalents were $168.6m at June 30, 2019, including $24.2m collected for third-party clients. Receivable portfolio investment was $3.225bn.
Total debt, net of debt issuance costs, was $3.530bn, versus $3.491bn at December 31, 2018. The company reported $496.0m drawn on its U.S. revolving facility and $160.8m available under it; Cabot had $291.4m drawn and approximately $197.5m available under its revolving facility. Encore stated it was in material compliance with financing covenants. Stockholders’ equity was $900.5m.
Material changes versus prior comparable periods
- Q2 revenue adjusted for net portfolio allowances declined 0.8%; for the first half it increased 2.6%. Portfolio revenue rose 6.8% in Q2 and 8.7% for the half, which management attributed to collection improvements. Net allowance reversals were substantially lower: $2.1m in Q2 versus $17.6m and $3.4m for the half versus $27.4m.
- Operating expenses fell 5.3% in Q2 and 3.2% for the half. Lower other operating and general and administrative expenses contributed, partly offset by increased salaries and collection-agency commissions.
- Gross collections increased 3.8% in Q2 to $514.9m and 4.4% for the half to $1.029bn. Portfolio purchases decreased 32.5% in Q2 to $242.7m and 20.6% for the half to $505.0m; management cited a more selective purchasing approach in Europe and a plan to reduce European debt leverage.
- Operating cash flow rose to $108.8m from $97.6m for the half, while investing outflow narrowed from $240.9m to $115.7m, principally reflecting lower portfolio purchases.
- The first-half effective tax rate was 15.2%, compared with 29.1%, including a $9.1m benefit from an IRS-approved tax accounting method change. Q2 effective tax rates were 24.2% and 29.5%, respectively.
Outlook, commentary, risks and unusual items
- No specific earnings guidance was provided; the company says it generally does not make specific earnings projections. Management expects sufficient liquidity to fund operations for at least the next 12 months, subject to portfolio and business acquisition needs.
- Management cited favorable U.S. portfolio supply and pricing conditions, while noting elevated European pricing and currency headwinds. The stronger U.S. dollar reduced reported international revenue; the pound weakened 5.9% year over year in Q2 and 6.4% for the half.
- In June, Cabot issued approximately $452m of euro-denominated floating-rate senior secured notes due 2024, using proceeds and cash to redeem existing notes. Approximately $9.0m of related refinancing fees was recorded as interest expense.
- Adoption of the new lease standard in January 2019 added operating lease right-of-use assets of approximately $95.954m and operating lease liabilities of $109.518m at quarter-end; management said adoption did not materially affect operations, cash flows, or covenant compliance.
- The company expects the new credit-loss standard, effective for it in 2020, to significantly change accounting for receivable portfolios; implementation was ongoing. All Mexican portfolios were transferred to cost-recovery accounting because collection timing was not reasonably estimable amid changing political and economic conditions.
- Risks include consumer-debt collection regulation and litigation, portfolio collection estimates, interest and foreign-exchange movements, and Brexit-related economic and currency uncertainty. The CFPB proposed debt-collection rules in May 2019; final rules were anticipated in late 2019 or early 2020. The company reported no material legal reserves and no material developments in previously disclosed proceedings.
- Management reported effective disclosure controls and no material change in internal control over financial reporting during the quarter.
Important facts for investors to verify
- Whether collection performance and forecast portfolio cash flows support the carrying value of receivables; the company’s fair-value estimates use significant Level 3 assumptions.
- How the lower allowance reversals and more selective portfolio purchases affect revenue, collections, and returns in subsequent periods.
- Debt maturities, refinancing costs, facility availability, covenant headroom, and exposure to floating interest rates and foreign currencies.
- The durability of reported earnings growth excluding the $9.1m tax-method-change benefit and other non-GAAP adjustments.
- Developments in CFPB rulemaking, collection-related litigation, Brexit, and implementation of the expected-credit-loss accounting standard.