Encore Capital Group, Inc. — Q1 2012 Form 10-Q
Business context and reporting period
Unaudited results cover the three months ended March 31, 2012, compared with the same period in 2011. Encore buys defaulted consumer receivables and collects through its own sites, legal networks and third-party agencies; it also provided bankruptcy servicing through Ascension. Amounts below are in U.S. dollars.
Financial performance and position
- Revenue: $130.2 million, up 18.1%. Portfolio revenue rose 20.0% to $126.4 million; servicing fees and related revenue fell 23.3% to $3.8 million.
- Profit: Operating income was $24.0 million versus $27.8 million; net income was $11.4 million versus $13.7 million. Diluted EPS was $0.44 versus $0.54. Results included a $10.3 million pretax, noncash impairment charge ($6.3 million after tax, or $0.25 per diluted share).
- Margins: Operating margin was 18.4%, down from 25.2%; net margin was 8.8%, down from 12.4%. The impairment was a significant contributor to the decline. Total operating expenses increased 28.7% to $106.2 million.
- Collections and portfolio investment: Gross collections increased 20.9% to $231.0 million. Encore purchased $130.5 million of portfolios with $2.9 billion face value, at 4.5% of face value, compared with $90.7 million at 3.1% a year earlier. Net investment in receivable portfolios was $741.6 million at quarter-end.
- Cash flow: Operating cash flow was $27.1 million versus $25.1 million. Investing cash outflow was $27.1 million versus $10.2 million, reflecting increased portfolio purchases; financing cash flow was positive $7.4 million versus outflow of $3.4 million. Cash ended at $15.4 million, up from $8.0 million at year-end.
- Debt and liquidity: Total debt was $398.2 million at March 31, including $314.0 million drawn on the revolver, $75.0 million of senior secured notes and $9.2 million of capital leases and other obligations. Total liabilities were $453.1 million and stockholders’ equity was $384.9 million. Management said the company was in covenant compliance and expected sufficient liquidity for at least 12 months.
Material changes versus prior year
- Revenue and collections grew, while net income and EPS declined. The $10.3 million impairment was new in Q1 2012; without it, reported diluted EPS would have been higher by $0.25, according to the filing.
- Portfolio purchases rose 43.9%, while the average purchase price increased from 3.1% to 4.5% of face value. Net portfolio allowance provision fell to $0.4 million from $5.5 million, supporting portfolio revenue growth.
- Cost per dollar collected, a company-reported operating measure, improved to 38.4% from 40.0%. Legal collection costs fell as a share of legal collections, while general and administrative expense rose 39.0%, partly due to legal settlements and growth-related costs.
- Ascension servicing revenue decreased to $3.8 million from $4.9 million. Its goodwill and remaining identifiable intangible assets were written off, reducing reported goodwill to $6.0 million from $16.0 million.
Outlook, commentary, risks and unusual items
- No specific earnings guidance: Encore said it generally does not make specific earnings projections. Management described Q1 collections as seasonally strong, with collections typically slower in Q2 and Q3 and slowest in Q4.
- Management said internal collection metrics were consistent with or better than prior-year periods. More consumers were using payment plans; delayed payments and “broken payers” can reduce the present value or ultimate recovery of expected collections. Management also cited continuing consumer economic pressures and elevated bankruptcies and foreclosures.
- Ascension: On May 7, 2012, the Board approved a plan to sell Ascension, and Encore reported an agreement in principle with a third party. Encore agreed to cover normal operating losses in the first year after closing; if the business grows and becomes profitable, Encore may receive 30%–40% of EBITDA for five years. Ascension was to be treated as a discontinued operation beginning in Q2 2012 whether or not the sale closes.
- Acquisition and financing after quarter-end: On May 8, Encore acquired Propel Financial Services for $186.8 million in cash, financed with a new $160.0 million three-year facility, the existing revolver and cash. The Propel facility is secured by tax-lien collateralized notes and has financial covenants. Amendments increased the revolver commitment from $410.5 million to $555.5 million, with a further $100 million accordion, for potential capacity of $655.5 million.
- At March 31, Encore had commitments to purchase receivable portfolios with approximately $3.3 billion face value for about $142.2 million, with no commitments extending beyond one year. This is in addition to ordinary portfolio valuation and collection uncertainty.
- Encore routinely faces consumer-collection litigation, including alleged violations of debt-collection, telephone-contact and consumer-protection laws, and may face class actions or government investigations. The filing reported no material development in previously disclosed proceedings. Actual litigation losses may differ from recorded estimates.
- Interest-rate and foreign-exchange exposures are hedged in part with swaps and forward contracts; management reported no material change in market-risk disclosures. The filing identifies no off-balance-sheet arrangements.
Important facts for investors to verify
- Whether the proposed Ascension sale closed, the final terms, first-year loss support and any resulting earn-out.
- Propel’s subsequent operating results, acquisition accounting, facility utilization and covenant headroom, and the impact of the acquisition on consolidated leverage and liquidity.
- Whether portfolio collections and forecast recoveries support carrying values and estimated remaining collections, including the effect of payment-plan performance and broken payers.
- The sustainability of improved collection costs and the drivers of rising overhead, legal settlements and purchase prices.
- Developments in litigation, regulatory inquiries, portfolio purchase commitments and compliance with financing covenants.