Encore Capital Group, Inc. — Q1 2017 Form 10-Q
Business context and period. Encore is an international specialty finance company that buys defaulted consumer receivables and collects or services them. The filing covers the unaudited three months ended March 31, 2017, compared with Q1 2016. The company reported one segment: portfolio purchasing and recovery. Propel, its former tax-lien business, was sold in March 2016 and is presented as discontinued operations.
Key financial results
| Metric | Q1 2017 | Q1 2016 / prior date |
|---|---|---|
| Total revenue | $271.9 million | $289.0 million |
| Revenue from receivable portfolios, net | $252.0 million | $270.1 million |
| Income from operations | $75.8 million; 27.9% of revenue | $83.5 million; 28.9% |
| Income from continuing operations | $15.2 million consolidated; $22.3 million attributable to Encore | $29.8 million consolidated; $28.9 million attributable to Encore |
| Net income attributable to Encore | $22.1 million; diluted EPS $0.85 | $25.7 million; diluted EPS $0.99 |
| Operating cash flow | $27.2 million | $31.9 million |
| Cash and cash equivalents | $159.9 million at March 31 | $149.8 million at December 31, 2016 |
| Total assets | $3.765 billion at March 31 | $3.670 billion at December 31, 2016 |
| Total debt | $2.871 billion at March 31 | $2.806 billion at December 31, 2016 |
Consolidated net income was $15.0 million, versus $26.6 million a year earlier; the difference from Encore-attributable net income reflects losses attributable to noncontrolling interests in Q1 2017. The effective tax rate rose to 44.3% from 25.4%. Interest expense was $49.2 million, down from $50.7 million. Overall cost-to-collect was 37.8%, broadly flat versus 37.7%.
Gross collections were $440.9 million, down 1.6%. The company invested $218.7 million in receivable portfolios, compared with $256.8 million in Q1 2016; purchased portfolios had $1.7 billion face value at 13.2% of face value, versus $3.5 billion at 7.2% a year earlier. Management said lower deployment bought a similar level of estimated gross collections, and the estimated collections-to-purchase-price multiple on credit-card purchases increased to 2.0 from 1.7.
Liquidity, debt and cash flow
- Operating activities provided $27.2 million. Investing activities used $49.0 million, mainly reflecting portfolio purchases, net of collections applied to portfolio principal. Financing activities provided $28.3 million.
- Cash increased to $159.9 million. Of this, $30.0 million was held by U.S. entities and $129.9 million by foreign entities; most foreign cash was considered indefinitely reinvested and could incur material tax effects if repatriated.
- At quarter-end, Encore had $533.0 million drawn on its revolving credit facility and $268.7 million of stated availability, subject to borrowing-base and covenant limits. Its term loan balance was $118.6 million. Cabot had $66.9 million drawn and approximately $245.8 million available under its revolving facility.
- Q1 financing included issuance of $150.0 million of 3.25% convertible notes due 2022; net proceeds were approximately $145.3 million. The company used about $60.4 million to repurchase $50.0 million principal of 3.0% notes due 2017. Remaining 2017 convertible-note principal was $65.0 million and matures November 27, 2017.
- Management stated that the company was in compliance with financing covenants and expected liquidity, including cash flows and credit availability, to fund operations and debt payments for at least the next 12 months. No specific earnings guidance was provided.
Material changes and management commentary
- Revenue fell 5.9% year over year, with portfolio revenue down 6.7%. Management attributed the decline to the reduced European portfolio balance following a large Q3 2016 allowance charge and unfavorable foreign-currency translation, particularly the weaker British pound.
- Operating expenses declined 4.6%, to $196.1 million, but operating income and operating margin also decreased. Lower legal-collection costs and stock compensation were partly offset by increased collection-agency commissions.
- Collections in the U.S. were affected by delays in receiving account documentation needed to initiate legal collections. Management reported improvement from the second half of 2016 and expected most delayed collections to shift into 2017. European collections were also affected by currency translation.
- Other income was $0.6 million, versus $7.1 million, primarily because Q1 2016 included a $5.4 million gain on foreign-exchange contracts. The higher Q1 2017 tax rate reflected, among other factors, a change in U.K. tax law limiting interest deductibility; management cautioned that quarterly tax rates may fluctuate.
- Management described U.S. fresh-portfolio pricing as beginning to soften amid expected supply growth. It said U.K. portfolio prices remained elevated, while identifying potential purchasing and servicing opportunities in Spain and other European markets.
- Encore and its Cabot co-investor began exploring options for a potential Cabot IPO. This was exploratory; the filing did not provide a timetable or outcome.
Risks, contingencies and unusual items
- Portfolio valuation depends on proprietary cash-collection forecasts and assumptions. In 2016, Encore recorded approximately $94 million of allowance charges on certain European pools and extended forecasts for selected European portfolios from 120 to 180 months. The filing reports $136.3 million of portfolio valuation allowances at March 31, 2017.
- At quarter-end, the estimated fair value of receivable portfolios was approximately $2.370 billion, compared with a $2.436 billion carrying value. The filing estimates that a 100-basis-point change in specified cost-to-collect and discount-rate assumptions would change the fair value of U.S. and European portfolios by approximately $45.3 million and $53.7 million, respectively.
- The business is exposed to foreign-exchange movements, variable interest rates, collection performance, consumer-protection regulation and litigation. The filing noted the U.K.’s formal initiation of the Brexit process and said its financial, trade and legal effects remained uncertain.
- Encore is routinely subject to debt-collection lawsuits and regulatory inquiries. It reported no material new developments in proceedings disclosed in its 2016 Form 10-K; apart from previously described CFPB/state-regulatory and TCPA-related reserves, it reported no material legal reserves. Outcomes or exposures may be difficult to estimate.
- Purchase commitments at March 31 covered portfolios with approximately $2.4 billion face value and an approximately $288.6 million purchase price. Goodwill was $796.4 million; management reported no Q1 event requiring an interim impairment test, but adverse operating or market developments could lead to a future impairment.
- The Q1 2017 discontinued-operations loss was $0.2 million, reflecting a final purchase-price true-up related to the Propel sale. The company also recorded an approximately $0.8 million loss on repurchasing part of its 2017 convertible notes.
Most important facts for investors to verify
- Whether delayed U.S. legal collections were recovered as management expected, and how collections and portfolio performance develop across regions and vintages.
- Whether European cash-flow forecasts and valuation assumptions remain supportable, including the longer collection horizon applied to selected portfolios.
- Debt maturities, borrowing-base availability, covenant headroom and the company’s ability to refinance or repay the remaining 2017 convertible notes.
- The drivers and sustainability of the higher effective tax rate, including U.K. interest-deductibility rules and earnings mix by jurisdiction.
- Developments in CFPB, state regulatory, TCPA and other legal matters, as well as the evolving U.K. regulatory and Brexit environment.
- Any decision or material developments concerning a potential Cabot IPO; the filing provides no confirmed transaction or timing.