Encore Capital Group, Inc. — Q2 2011 Form 10-Q
Reporting period: Quarter and six months ended June 30, 2011. The company buys and collects defaulted consumer receivables and provides bankruptcy servicing. Financial amounts below are in millions unless otherwise stated.
Financial performance and position
| Metric | Q2 2011 | Q2 2010 | Six months 2011 | Six months 2010 |
|---|---|---|---|---|
| Total revenue | $115.8 | $96.2 | $226.1 | $183.6 |
| Operating income | $29.6 | $23.4 | $57.4 | $45.1 |
| Operating margin | 25.6% | 24.4% | 25.4% | 24.6% |
| Net income | $14.8 | $11.7 | $28.5 | $22.6 |
| Diluted EPS | $0.58 | $0.47 | $1.11 | $0.91 |
| Net margin | 12.8% | 12.2% | 12.6% | 12.3% |
- Q2 revenue grew 20.4% and net income 26.0% year over year; six-month revenue grew 23.2% and net income 26.0%. Portfolio revenue accounted for most revenue growth, primarily from a larger portfolio balance.
- Gross collections were $195.1 in Q2, up 24.4%, and $386.2 for six months, up 29.6%. Six-month portfolio purchases were $184.4 for receivables with $5.9 billion face value, at an average 3.1% of face value.
- Operating costs rose 18.5% in Q2 and 21.9% for six months. Legal collection costs increased with legal-channel collections and litigation spending; legal costs were 41.5% of legal collections in Q2 versus 45.9% a year earlier. Total cost per dollar collected declined to 40.9% in Q2 and 40.4% for six months.
- Interest expense was $5.4 in Q2 and $11.0 for six months. Effective tax rates increased to 39.1% and 38.9%, respectively, principally because India’s tax holiday expired March 31, 2011.
- At June 30, cash was $14.7; net receivable portfolios were $657.8; total assets were $763.0; debt was $378.2; and stockholders’ equity was $337.3. Debt comprised $295.0 under the revolving facility, $75.0 in senior secured notes, and $8.2 of capital leases and other obligations.
- Six-month operating cash flow was $31.7, compared with $34.8 in 2010. Investing cash use was $21.0 versus $52.3; financing cash use was $7.0, compared with $19.5 of financing cash provided in 2010. Cash increased $3.8 to $14.7.
- The revolving facility totaled $410.5; borrowing-base availability was $54.6 at quarter-end. Management stated it was in covenant compliance and expected liquidity to cover operations for at least 12 months.
Material changes and management commentary
- Purchases increased 11.8% for the first half compared with 2010. Management said receivable pricing had begun to rise from 2009–early 2010 lows but remained favorable relative to 2005–2008.
- Management reported payer rates and average payment size were broadly consistent with 2009 and 2010, while consumers increasingly chose payment plans. Plans may delay collections, reduce present value, and result in broken payers and portfolio allowance charges.
- Six-month net portfolio allowance provision was $6.5, down from $10.7 in 2010. Management attributed provisions to collection shortfalls in certain pool groups, particularly 2005–2008 vintages, despite aggregate collections exceeding forecasts.
- The company issued an additional $25.0 of 7.375% senior secured notes due 2018 and expanded revolving commitments by $50.0 to $410.5; proceeds were primarily used to reduce revolver borrowings. Six interest-rate swaps had $150.0 aggregate notional, and Indian-rupee forward contracts had $20.5 notional.
Outlook, risks and contingencies
- No specific earnings guidance is provided; the company says it generally does not make specific earnings projections. Management cited a slow and uncertain consumer recovery, elevated unemployment and bankruptcies, and limited credit availability.
- Key risks include uncertainty in collection forecasts and portfolio valuations, consumer weakness, purchase pricing and availability, seller concentration, seasonality, and reliance on third-party agencies and attorneys. The company cautions that actual results may differ materially from forward-looking statements.
- Debt collection regulation and litigation are significant risks. Minnesota filed a state complaint seeking penalties, disgorgement, injunctive relief and fees; Texas filed a petition with similar requested relief. The company said it would vigorously defend both. Oregon and New York authorities had issued investigative demands or subpoenas.
- A national-class settlement covering Brent, Franklin and Vassalle was preliminarily approved; following a July 11, 2011 final approval hearing, the court’s decision was pending. The filing does not provide a clear settlement amount.
- At June 30, the company had commitments to purchase receivables with approximately $2.6 billion face value for about $70.0; it did not expect to cancel them. Deferred court costs, net, were $36.1, supported by a $122.9 reserve against $214.0 of costs advanced.
- Management said no material change occurred in disclosed foreign-currency or interest-rate market risks. Disclosure controls were deemed effective, with no material quarterly change in internal control over financial reporting.
Investor verification priorities
- Assess whether growth in collections and portfolio revenue is sustainable and whether expected cash flows support the $657.8 portfolio carrying value and reported accretable yield.
- Track portfolio allowances, especially performance of 2005–2008 vintages, payment-plan completion, and the impact of consumers’ weaker financial condition.
- Monitor the Minnesota and Texas matters, the Ohio class settlement approval and any related financial exposure; the filing records contingencies only when losses are probable and reasonably estimable.
- Confirm borrowing-base availability, facility covenants, interest costs and liquidity needs as portfolio purchases continue.
- Review the recoverability of deferred court costs and effects of higher legal-channel activity, regulatory actions and collection compliance requirements.