Encore Capital Group, Inc. — Q2 2017 Form 10-Q
Reporting period: Three and six months ended June 30, 2017. Unaudited; amounts below are in U.S. dollars unless stated otherwise. Encore purchases and services defaulted consumer receivables. Its sole reportable segment is portfolio purchasing and recovery.
Key financial results
| Metric | Q2 2017 | Q2 2016 | First half 2017 | First half 2016 |
|---|---|---|---|---|
| Total revenue | $290.9 million | $289.4 million | $562.9 million | $578.5 million |
| Operating income | $80.6 million | $91.7 million | $156.4 million | $175.3 million |
| Net income attributable to Encore stockholders | $20.3 million | $29.6 million | $42.4 million | $55.3 million |
| Diluted EPS | $0.77 | $1.14 | $1.61 | $2.14 |
| Operating margin | 27.7% | 31.7% | 27.8% | 30.3% |
- Q2 net receivable-portfolio revenue was $272.2 million, up 1.8%; other revenue was $18.7 million, down from $22.0 million. First-half total revenue fell 2.7%.
- Q2 operating expenses rose 6.4% to $210.3 million. Legal collection costs, agency commissions and G&A increased; legal costs were higher in the U.S. as placements in that channel increased.
- First-half net cash from operations was $71.3 million, versus $49.1 million. Investing used $115.1 million, including $464.5 million of portfolio purchases partly offset by $371.3 million of collections applied to portfolio principal. Financing provided $35.8 million.
- At June 30, cash was $146.6 million; total debt was $2.964 billion, compared with $2.806 billion at December 31, 2016. Total assets were $3.919 billion and total equity was $541.7 million.
- Encore’s revolving credit facility had $539.0 million drawn and $262.7 million available, subject to borrowing-base and covenant limits. Cabot’s facility had $81.2 million drawn and approximately $243.6 million available. The company reported compliance with financing covenants.
Changes, outlook and material items
- Q2 operating income declined 12.2% and stockholder net income declined 31.5% year over year, despite slightly higher revenue. First-half stockholder net income fell 23.4%. The filing attributes revenue pressure mainly to foreign-exchange effects and the reduced European portfolio balance following 2016 allowance charges; expense growth also compressed margins.
- Collections increased 2.8% in Q2 to $446.2 million and 0.6% in the first half to $887.0 million. The company reported improved European collections and reversed $9.5 million of prior portfolio allowances in Q2, partly offset by a $0.7 million provision, for a net $8.8 million reversal.
- Portfolio purchases were $246.4 million in Q2, up 5.7%, but $465.1 million for the first half, down 5.1%. Management described U.S. pricing as softening as supply increased, while U.K. portfolio prices remained above historical averages. It emphasized disciplined purchasing and expected continued opportunities in Europe; these are qualitative comments, not earnings guidance.
- Management stated it does not generally issue specific earnings projections. It believed liquidity, expected operating cash flows, cash and credit availability were sufficient for operations and debt payments for at least the next 12 months. Future cash needs depend in part on portfolio and business acquisitions.
- Encore and its Cabot co-investor were exploring a potential Cabot IPO. Any IPO-related deconsolidation could materially change reported assets, liabilities, liquidity and capital resources; no completed transaction or definitive terms are provided here.
- Notable items include a $2.8 million gain from reversing contingent consideration in Q2, partly offset in adjusted-performance presentations by other excluded items; issuance of $150 million of 3.25% convertible notes due 2022 and repurchase of $50 million principal of 2017 notes; and an effective tax rate of 41.5% in Q2 and 42.8% for the first half. Management cited U.K. tax-law changes affecting interest deductibility.
- Risks include debt-collection regulation and litigation, potential changes to CFPB communications and disclosure rules, Brexit uncertainty, foreign exchange, interest rates, and the judgment-sensitive forecasts of portfolio collections. The filing reports no material change to the risk factors in the 2016 Form 10-K. It identifies existing CFPB/state regulatory and TCPA-related reserves, but says other material legal loss estimates are either immaterial or not yet determinable.
Most important facts for investors to verify
- Whether collection performance and portfolio cash-flow forecasts support the carrying value of receivables; portfolio fair value is Level 3 and depends on significant assumptions.
- Whether higher U.S. legal-collection costs and overall cost-to-collect—40.3% in Q2 versus 36.9% a year earlier—are temporary or persist.
- Debt maturities, facility availability, covenant headroom and the effect of floating rates; the filing identifies certain credit-facility commitments and term-loan tranches maturing in November 2017.
- Any developments in the potential Cabot IPO, regulatory proceedings, CFPB rulemaking, and material litigation or settlement exposures.
- The impact of currency movements and the higher effective tax rate on future reported earnings.