Encore Capital Group, Inc. — Q2 2014 Form 10-Q
Reporting period: Three and six months ended June 30, 2014. Amounts are in U.S. dollars; financial figures are in millions unless noted. Encore buys and collects defaulted consumer receivables and finances delinquent property-tax obligations through its Propel business.
Financial performance
| Metric | Q2 2014 | Q2 2013 | Six months 2014 | Six months 2013 |
|---|---|---|---|---|
| Total revenue | $269.2 | $156.1 | $522.9 | $300.7 |
| Operating income | $78.5 | $29.9 | $146.8 | $68.6 |
| Operating margin | 29.2% | 19.1% | 28.1% | 22.8% |
| Net income | $21.4 | $11.0 | $40.2 | $30.5 |
| Net income attributable to Encore shareholders | $23.6 | $11.0 | $46.7 | $30.5 |
| Diluted EPS | $0.86 | $0.44 | $1.68 | $1.24 |
| Operating cash flow | Not presented separately | Not presented separately | $37.6 | $11.3 |
Q2 revenue comprised $248.2 million from receivable portfolios, $14.1 million of other revenue, and $6.8 million of net interest income. Gross collections were $409.3 million, up 47.0%; six-month collections were $806.0 million, up 46.9%. These collection figures are not revenue.
For the six months, investing activities used $493.9 million, principally for acquisitions and portfolio purchases; financing activities provided $457.8 million. Cash and cash equivalents were $123.4 million at June 30, versus $126.2 million at December 31, 2013.
Balance sheet, debt and liquidity
- Total assets were $3.593 billion, including $1.988 billion of net receivable portfolios and $879.9 million of goodwill. Total liabilities were $2.979 billion.
- Reported debt was $2.716 billion, up from $1.850 billion at year-end. The reported balance includes preferred equity certificates and other financing obligations; convertible notes are presented net of discount. Interest expense was $43.2 million in Q2 and $81.2 million for the six months, compared with $7.5 million and $14.3 million, respectively, in 2013.
- At June 30, the Encore credit facility had $423.9 million outstanding, $418.6 million of stated borrowing capacity and $391.8 million of borrowing-base availability, excluding its accordion. Cabot had approximately $63.3 million available under its revolving facility. Propel reported $167.7 million and $100.7 million available under its two facilities.
- Management said the company was in compliance with financing covenants and believed available cash, operating cash flow, capital-market access and facility capacity were sufficient for at least the next 12 months. The filing does not provide a specific earnings or revenue forecast.
Changes versus the prior period
- Revenue grew 72.4% in Q2 and 73.9% for the six months; operating income grew 162.7% and 113.9%, respectively. Comparisons are not like-for-like: 2014 includes Cabot, acquired July 2013, Marlin from February 2014, and Grove from April 2014; 2013 did not include Cabot and included AACC only from its June 2013 closing.
- Management attributed higher portfolio revenue primarily to a larger portfolio base from acquisitions and stronger performance on certain existing pools, partly offset by lower yields on newer pools. Cabot contributed $73.4 million of revenue in Q2 and $135.9 million for the six months.
- Operating expenses rose 51.1% in Q2 and 62.1% for the six months, including higher staffing, integration and acquisition-related costs, and increased depreciation. U.S. portfolio-business cost per dollar collected rose to 40.4% in Q2 from 37.8%; total portfolio-business cost per dollar collected was 37.9% versus 37.8%.
- Higher interest expense reflected the enlarged debt base following acquisitions and financing activity. Q2 net income attributable to Encore exceeded consolidated net income because losses were allocated to noncontrolling interests.
Acquisitions, outlook, risks and unusual items
- Cabot acquired Marlin in February for approximately $274.1 million in cash and assumed approximately $246.5 million of Marlin senior secured notes. The preliminary allocation included $328.1 million of goodwill and remained subject to final valuation. Marlin-related acquisition and integration costs were approximately $9.8 million for the six months.
- Encore acquired a controlling 68.2% interest in Grove on April 1. Propel acquired a tax-lien portfolio and other assets in a transaction valued at approximately $43 million in May.
- After quarter-end, Encore acquired Atlantic Credit & Finance on August 6 for approximately $70 million in cash and paid a further $126.1 million to retire certain Atlantic obligations. It also amended its credit documents on August 1. These are subsequent events, not June 30 balances.
- On May 6, Propel issued $134 million of 1.44% securitized notes backed by Texas tax liens; the notes are non-recourse to the general assets of the securitization entity. Encore issued $161 million of 2.875% convertible notes due 2021 in March. A $50 million share-repurchase program was authorized in April; 400,000 shares were repurchased for $16.8 million during Q2.
- Management reported elevated U.S. portfolio prices, which it associated with reduced supply and continued buyer demand, and expected pricing to remain elevated for some time. It also noted regulatory pressure and issuer audits. Collection results are seasonal; management described U.S. collections as generally strongest in Q1 and U.K. collections as generally strongest in Q2 and Q3.
- Debt-collection operations face litigation and regulatory risks, including allegations involving licensing, time-barred debts, consumer communications and collection practices. The company reported no material litigation reserves at June 30; some exposures were immaterial or not estimable. It also disclosed an $88.2 million gross unrecognized tax benefit, primarily related to AACC tax revenue recognition; recognition would result in an estimated $18.7 million net tax benefit.
- Portfolio carrying values and expected collections depend on management forecasts and assumptions. The filing reports estimated remaining collections of $4.899 billion and notes sensitivity of estimated portfolio fair value to cost-to-collect and discount-rate assumptions. No formal specific earnings guidance was provided; management stated it generally does not make specific earnings projections.
Important facts for investors to verify
- How much of reported growth and profitability is attributable to acquisitions versus performance of the pre-existing business, and whether acquired operations meet expected collection and synergy assumptions.
- Whether portfolio collection forecasts, yields and allowances remain supportable as purchase prices stay elevated; monitor actual collections against estimates and cost per dollar collected.
- Debt, interest burden, facility availability and covenant headroom after the Atlantic acquisition and subsequent credit amendments; distinguish recourse borrowings from debt secured only by specific assets.
- Developments in debt-collection regulation, issuer audits, litigation and the unresolved AACC tax position, including any change in potential exposure.
- Integration progress and final purchase-price allocations for Marlin and Grove, and the financial impact of Atlantic, which was acquired after quarter-end.