Encore Capital Group, Inc. — FY 2018 Form 10-K
Reporting period: Fiscal year ended December 31, 2018. This is an annual filing, not a standalone Q4 filing; quarterly Q4 figures are noted below. Amounts are U.S. dollars unless stated otherwise.
Business context
Encore is a specialty finance company that purchases defaulted consumer receivables and collects them, and provides debt-servicing services. Its principal operations are MCM in the United States and Cabot in Europe; Latin America and Asia-Pacific operations were not significant to consolidated results.
In July 2018, Encore acquired the remaining interests in Cabot, making it wholly owned. Consideration was approximately $414.7 million, comprising $234.1 million cash and $180.6 million in Encore shares. The transaction also included acquisition of Cabot preferred equity certificates.
Financial and operating results
| Metric | FY 2018 | FY 2017 | Change |
|---|---|---|---|
| Total revenues, GAAP | $1,320.6 million | $1,145.8 million | +15.3% |
| Net portfolio allowance reversals | $41.5 million | $41.2 million | — |
| Revenue adjusted for allowance reversals | $1,362.0 million | $1,187.0 million | +14.7% |
| Operating income | $405.3 million | $324.5 million | +24.9% |
| Net income attributable to Encore stockholders | $115.9 million | $83.2 million | +39.2% |
| Diluted EPS | $4.06 | $3.15 | +28.9% |
| Gross collections | $1,967.6 million | $1,767.6 million | +11.3% |
| Portfolio purchases, at cost | $1,131.9 million | $1,058.2 million | +7.0% |
Operating margin was approximately 29.8% of revenue adjusted for allowance reversals, versus 27.3% in 2017. Overall cost-to-collect improved to 37.9% from 39.5%. Portfolio purchases represented 13.3% of face value in 2018, compared with 10.5% in 2017; the filing attributes the higher rate partly to greater purchases of fresh portfolios.
Q4 2018 gross collections were $483.6 million; revenue adjusted for allowance reversals was $348.7 million; operating expenses were $232.8 million; and net income attributable to Encore stockholders was $47.0 million, or diluted EPS of $1.50.
Cash flow and liquidity: Operating cash flow was $186.8 million, compared with $123.8 million in 2017. Investing activities used $397.5 million, primarily reflecting portfolio purchases; financing activities provided $166.4 million. Cash and equivalents were $157.4 million at year-end, down from $212.1 million.
Debt: Total debt, net, was $3.49 billion at year-end, versus $3.45 billion in 2017. Reported total assets were $4.63 billion and total liabilities $3.81 billion. Available capacity under Encore’s revolving credit facility was $177.5 million, and Cabot’s facility had approximately $192.4 million available. The company stated it was in compliance with debt covenants and expected sufficient liquidity for at least the next 12 months.
Changes versus the prior year
- Collections and adjusted revenue increased, supported by higher purchasing volume, collection-capacity expansion and liquidation initiatives, as well as favorable currency translation.
- Operating expenses rose 10.9% to $956.7 million, primarily from added collection capacity, acquisitions, Cabot transaction costs and currency effects. Interest expense increased 17.6% to $240.0 million, reflecting higher debt balances, rates and refinancing costs; Cabot preferred-equity interest expense ceased after the buyout.
- Net income attributable to Encore rose more than GAAP net income because the 2018 purchase eliminated noncontrolling interests in Cabot and changed the allocation of earnings to Encore shareholders.
- Cash flow from operations improved, while cash balances declined. Portfolio investment rose and the receivables portfolio carrying value increased to $3.14 billion from $2.89 billion.
Outlook, risks and unusual items
- Outlook: Management said it expected to deploy a higher proportion of capital in the U.S. in 2019, based on anticipated attractive conditions, and to be more selective in Europe. The filing provides no specific earnings or revenue guidance. Management expected sufficient liquidity for at least 12 months.
- Tax item: Following IRS approval of a revenue-reporting tax accounting method change in early 2019, management expected a potentially material, one-time tax provision benefit in 2019, subject to standard IRS audit procedures.
- Acquisition and derivative item: A foreign-exchange forward contract related to the Cabot transaction generated a $9.3 million loss, substantially offset by a reduction in the transaction’s final U.S.-dollar cash consideration. The Cabot transaction’s direct and incremental costs were $8.6 million.
- Regulatory and legal exposure: Encore remained subject to a CFPB consent order entered in 2015, scheduled to terminate in September 2020, and related state attorney general investigations. The company disclosed ongoing litigation and regulatory matters but reported no material legal reserves at year-end and believed outcomes would not materially affect the business, based on then-current knowledge.
- Key business risks: Collection forecasts and portfolio valuations may prove inaccurate; purchase prices and competition may pressure returns; the business depends on legal collections and third-party agencies; and substantial debt creates refinancing, interest-rate and covenant risks. Other significant uncertainties include evolving U.S. and U.K. consumer-protection and data-privacy rules, Brexit, currency movements, cybersecurity, and adoption of the expected-credit-loss accounting standard, which the company said could significantly affect portfolio income measurement.
Important facts for investors to verify
- Whether collections and realized returns on recent purchase vintages support the company’s estimated remaining collections and portfolio valuations.
- Debt maturities, borrowing-base availability, interest-rate exposure and compliance with financial covenants as portfolio purchases continue.
- The ultimate effects of Cabot’s full consolidation on earnings, cash flow, financing costs and share dilution.
- Developments under the CFPB consent order, related investigations and consumer-collection litigation, including any changes to collection practices or reserves.
- The amount and timing of the expected 2019 tax benefit, and the implementation impact of new lease and credit-loss accounting standards.