Encore Capital Group, Inc. — Q1 2018 Form 10-Q
Reporting period: Three months ended March 31, 2018. Unaudited consolidated results; comparisons are with Q1 2017 unless stated otherwise. Encore is an international specialty finance company that purchases defaulted consumer receivables and provides debt recovery and related services, including through its European subsidiary Cabot.
Key financial results
| Metric | Q1 2018 | Q1 2017 |
|---|---|---|
| Total revenues | $317.0 million | $269.8 million |
| Revenues adjusted for net portfolio allowances | $326.8 million | $271.9 million |
| Operating income | $88.5 million | $75.8 million |
| Operating margin on adjusted revenues | 27.1% | 27.9% |
| Net income | $23.7 million | $15.0 million |
| Net income attributable to Encore shareholders | $21.8 million | $22.1 million |
| Diluted EPS attributable to Encore shareholders | $0.83 | $0.85 |
| Interest expense | $57.5 million | $49.2 million |
| Operating cash flow | $1.0 million | $27.2 million |
| Cash used in investing activities | $84.5 million | $49.0 million |
- Portfolio revenue was $281.0 million, up 12.5%; other revenue was $36.0 million, up from $20.0 million, mainly reflecting fee-based services added through acquisitions.
- Gross collections rose 10.9% to $489.1 million. Portfolio purchases were $276.8 million, up 26.6%, for portfolios with $1.8 billion face value; average purchase cost was 15.4% of face value versus 13.2% a year earlier.
- Operating expenses increased 21.5% to $238.3 million. The operating margin on adjusted revenues narrowed 0.8 percentage points. Cost-to-collect increased to 38.5% from 37.8%, including higher U.S. legal spending and capacity investments.
- Tax expense declined to $9.5 million from $12.1 million; the effective tax rate was 28.5% versus 44.3%, primarily reflecting the U.S. corporate tax-rate reduction under the Tax Cuts and Jobs Act.
Balance sheet, debt and liquidity
- At March 31, 2018, cash and cash equivalents were $217.1 million; investment in receivable portfolios, net, was $3.024 billion; total assets were $4.642 billion.
- Debt, net, was $3.607 billion, up from $3.447 billion at year-end 2017. Debt includes multiple facilities and notes, including convertible notes and Cabot borrowings.
- Encore had $237.5 million available under its revolving credit facility after borrowing-base and covenant limits, excluding $99.7 million of remaining accordion capacity. Cabot had approximately $194.6 million available under its revolving facility.
- The company reported compliance with financing covenants and said it believed liquidity was sufficient to fund operations for at least the next 12 months. Of cash, $187.8 million was held outside the U.S.; $26.1 million was collected on behalf of clients and remained payable to them.
- Operating cash flow fell sharply year over year, with the filing citing changes in operating assets and liabilities, including lower cash contribution from payables and accrued liabilities. Portfolio investment continued to be funded with operating cash and borrowings.
Material changes, outlook and risks
- Growth in adjusted revenues reflected increased European portfolio activity and favorable foreign-currency translation, particularly the weaker U.S. dollar against the British pound. U.S. revenue was comparatively flat, while Europe grew substantially.
- Management described rising U.S. charged-off account supply and softening prices, particularly for fresh portfolios, as potential purchasing opportunities. It noted U.K. portfolio pricing remained elevated and anticipated additional opportunities in Spain, while cautioning that competitive pricing and collection performance affect returns.
- Management does not generally provide specific earnings projections. It expects cost-to-collect to fluctuate with seasonality, portfolio mix, acquisitions, foreign exchange, investment in operations and regulatory changes. U.S. collections are generally strongest in Q1; Cabot’s collections tend to be stronger in Q2 and Q3.
- After quarter-end, Encore signed agreements to acquire the remaining interests in Janus Holdings and Cabot Holdings, making them wholly owned. Consideration was £175.5 million (approximately $238.2 million) plus up to 4,999,947 Encore shares; closing was expected in Q2 or Q3 2018, subject to approvals and other conditions.
- Unusual items included a $2.3 million gain from a reduction in acquisition-related contingent consideration and $3.0 million of costs related to assessing options for a potential Cabot IPO. These items were excluded from management’s non-GAAP adjusted measures; adjusted diluted EPS was $0.98 versus $0.95.
- The company faces ongoing consumer-collection litigation and regulatory risks, including claims under debt-collection, consumer-protection and related laws. It reported no material developments in previously disclosed proceedings and no material legal reserves beyond reserves for the CFPB Consent Order and related state regulatory matters; some exposures could not yet be estimated.
- Portfolio values and expected collections rely on proprietary forecasts and significant estimates. Management reported no interim goodwill impairment trigger during the quarter, but adverse operating or market changes could lead to future impairment. The company was also evaluating the effects of new accounting standards for credit losses and leases.
Important facts for investors to verify
- Whether portfolio collections and forecast cash flows support the carrying value of the $3.024 billion receivable portfolio and the estimated $7.077 billion of remaining gross collections.
- How the 26.6% increase in portfolio purchases translates into realized returns, particularly as purchase prices and collection costs change.
- Reasons for the substantial decline in operating cash flow and whether working-capital movements reverse in subsequent periods.
- Debt maturities, floating-rate exposure, refinancing needs and continued compliance with leverage and interest-coverage covenants.
- Completion, final consideration and integration impacts of the planned purchase of the remaining Cabot interests, alongside ongoing legal and regulatory developments.