Encore Capital Group, Inc. — Q2 2012 Form 10-Q
Reporting period: Three and six months ended June 30, 2012. Unaudited consolidated results. Amounts below are in millions of dollars except per-share data. Encore purchases and collects defaulted consumer receivables; following its May 8 acquisition of Propel, it also finances Texas property-tax delinquencies through tax-lien-backed payment agreements. Propel results are included only from the acquisition date.
Key financial results
| Metric | Q2 2012 | Q2 2011 | Six months 2012 | Six months 2011 |
|---|---|---|---|---|
| Total revenue | $141.1 | $111.1 | $267.5 | $216.4 |
| Operating income | $38.3 | $29.6 | $73.3 | $56.7 |
| Operating margin | 27.1% | 26.6% | 27.4% | 26.2% |
| Continuing-operations income | $19.0 | $14.8 | $37.1 | $28.0 |
| Net income | $16.6 | $14.8 | $28.0 | $28.5 |
| Diluted EPS, continuing operations | $0.74 | $0.58 | $1.44 | $1.09 |
| Net diluted EPS | $0.64 | $0.58 | $1.08 | $1.11 |
- Q2 portfolio revenue was $138.7, up 24.9%; Propel added $2.3 of net interest income. Six-month portfolio revenue rose 22.5%. Management attributed portfolio growth chiefly to a larger portfolio balance.
- Q2 operating expenses grew 26.1% to $102.8; six-month expenses rose 21.6% to $194.2. For the first half, general and administrative expense increased $13.5, including acquisition-related accounting and consulting costs and higher legal-settlement costs.
- Q2 net income included a $2.4 after-tax discontinued-operations loss; the six-month loss was $9.1. Continuing-operations income grew, but the discontinued-operations charge left first-half net income slightly below 2011.
Cash flow, balance sheet and debt
- First-half operating cash flow was $44.6, versus $31.7 a year earlier. Investing used $347.8, including $361.4 of receivable-portfolio purchases and $186.0 net cash paid for Propel, partly offset by $207.2 of collections applied to portfolio principal. Financing provided $310.2. Cash ended June 30 at $15.0.
- Total assets were $1,167.9, including $869.9 in net receivable portfolios and $139.4 in net property-tax payment agreements receivable. Total liabilities were $764.3; stockholders’ equity was $403.6.
- Total debt was $702.3, up from $389.0 at year-end 2011. Components included $490.0 drawn on the revolving facility, $127.9 on Propel’s facility, $75.0 of senior secured notes, and $9.4 of capital leases and other obligations. The revolving facility’s total commitment was increased to $555.5, with an additional accordion feature; actual availability is subject to borrowing-base and covenant provisions. Management reported compliance with financing covenants and said liquidity was sufficient for at least 12 months.
Material changes, outlook and risks
- Propel acquisition: Encore acquired the Propel entities for an estimated total purchase price of $187.5, funded with cash, existing borrowings and a new $160.0 facility. The purchase-price allocation was preliminary; the filing anticipated completing reconciliation in Q3 2012. Propel reported $202.5 of segment assets at June 30. Its Texas property-tax receivables had $21.7 more than 90 days past due; the company recorded no allowance, citing lien priority and underwriting, and reported no historical losses.
- Ascension sale and impairment: Encore sold its bankruptcy-servicing subsidiary’s assets on May 16 with no sale proceeds. It recognized a $4.0 maximum first-year operating-loss contingency, impaired $9.9 of goodwill and wrote off about $0.4 of intangible assets. Encore may receive an earn-out of 30%–40% of Ascension EBITDA over five years if performance conditions are met.
- Collections and portfolio estimates: Gross collections rose 23.3% in Q2 and 22.1% in the first half. Management said most internal collection metrics were consistent with or better than 2010 and 2011 despite a slow, uncertain consumer recovery. More consumers were using payment plans; delays can reduce present value and consumers may fail to complete scheduled payments. Forecast collections and portfolio revenue depend on estimates, and actual results may differ. The company cited seasonality in collections and earnings.
- Portfolio investment: First-half receivable purchases rose to $361.4 from $184.4, at an average purchase price of 4.0% of face value versus 3.1%. Purchases were concentrated: the largest seller accounted for 36.1% of first-half purchases, and the top three for 70.3%. One purchase exceeding $100 million occurred in the period.
- Legal and regulatory exposure: The company faces ordinary-course consumer collection litigation and governmental inquiries, including claims under debt-collection, telephone-contact and consumer-protection laws. It reported no material developments in previously disclosed proceedings. It had agreements to purchase portfolios with about $58.6 of committed purchase price, with no commitments extending beyond one year.
- Outlook: Encore gave no specific earnings guidance and stated it generally does not make earnings projections. Management noted macroeconomic uncertainty, including slow job growth, constrained credit availability and volatile consumer confidence. Interest-rate and foreign-currency risk disclosures were said to be materially unchanged; derivatives hedge certain exposures, not for trading.
Important facts for investors to verify
- Whether the Propel acquisition’s final purchase-price allocation, integration costs and portfolio performance differ materially from preliminary estimates.
- Whether receivable-portfolio cash-flow forecasts, allowance reversals and purchase returns support the reported carrying values and expected collections.
- How collection costs, legal-channel efficiency, payment-plan completion rates and seasonal patterns affect margins and cash generation.
- Available borrowing capacity under the revolving facility after borrowing-base tests, covenant restrictions and the significant increase in debt.
- The development of collection-related litigation, the $4.0 Ascension loss contingency and any earn-out payments or proceeds.
- The quality and aging of Propel’s tax-lien receivables, particularly past-due balances, and the basis for recording no allowance.