ENCORE CAPITAL GROUP INC quarterly report, Q3 FY2018

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Encore Capital Group, Inc. — Q3 2018 Form 10-Q

Reporting period: Three and nine months ended September 30, 2018. Encore purchases and collects defaulted consumer receivables and provides debt-servicing services, primarily through Midland in the U.S. and Cabot in Europe.

Financial performance

  • Q3 revenue: $332.7 million, up 15.9% year over year; revenue adjusted for net portfolio allowance reversals was $336.8 million, up 9.8%. Portfolio revenue rose 11.9% to $295.4 million; other revenue increased to $37.4 million from $23.1 million, mainly reflecting fee-based services including Wescot.
  • Q3 earnings: Operating income was $97.5 million, down 6.1%, and operating margin on adjusted revenue was 29.0%, versus 33.9%. Consolidated net income was $13.0 million; income attributable to Encore shareholders was $20.7 million, down from $28.2 million. Diluted EPS was $0.69 versus $1.05. Adjusted EBITDA, a non-GAAP measure, was $120.3 million versus $124.2 million.
  • Nine-month results: Adjusted revenue was $1.013 billion, up 16.5%; operating income was $289.4 million, up 11.2%. Encore-attributable net income was $68.9 million versus $70.5 million, and diluted EPS was $2.49 versus $2.68. Adjusted EBITDA was $343.6 million versus $304.5 million.
  • Collections and portfolios: Gross collections grew 12.6% to $498.8 million in Q3 and 11.6% to $1.484 billion for nine months. Portfolio purchases were $248.7 million in Q3 and $885.0 million for nine months. The September 30 portfolio carrying value was $3.109 billion; estimated remaining gross collections were $7.221 billion.
  • Cash flow: Nine-month operating cash flow was $120.0 million, versus $81.7 million. Investing used $326.1 million, principally reflecting portfolio purchases net of collections applied to principal. Financing provided $204.9 million. Cash declined to $204.6 million from $212.1 million at year-end 2017.
  • Debt and liquidity: Debt, net, was $3.561 billion, up from $3.447 billion at December 31, 2017. Revolver availability was $178.1 million at Encore and approximately $100.5 million at Cabot; the company reported compliance with debt covenants. Management said liquidity was sufficient for at least 12 months. Of cash, $171.9 million was held outside the U.S.; $26.2 million was collected for clients and remained payable to them.

Material changes and unusual items

  • On July 24, Encore acquired the remaining Cabot interests, making Cabot wholly owned. Stated total consideration was approximately $414.7 million, including $234.1 million cash and $180.6 million in stock; the transaction also involved acquisition of outstanding preferred equity certificates.
  • Operating expenses rose 17.9% in Q3, faster than adjusted revenue, reflecting Wescot and Cabot-related costs and expanded U.S. collection capacity. Interest expense increased to $65.1 million from $52.8 million, including higher borrowings, rates and financing costs.
  • The company recorded a $9.3 million loss on a foreign-exchange forward contract entered into for the Cabot transaction; management said this was substantially offset by a lower final U.S.-dollar cash purchase price. Nine-month results also included $6.6 million of Cabot refinancing fees and approximately $2.5 million of bridge-loan commitment fees.
  • Q3’s effective tax rate was 56.5%, including approximately $5.0 million of discrete charges for foreign deferred tax assets and nondeductible Cabot transaction costs. The nine-month effective rate was 37.1%.
  • Net portfolio allowance reversals were $4.0 million in Q3 versus $19.6 million a year earlier; management attributed the current-period reversals largely to improved collections on certain European portfolios. Cost-to-collect improved to 36.0% in Q3 from 38.4%.

Outlook, risks and contingencies

  • Encore does not provide specific earnings projections and cautions that actual results may differ materially from forward-looking statements. Management cited continued portfolio investment and international growth as strategic priorities and expects liquidity to cover at least the next 12 months.
  • Management described increasing U.S. supply of charged-off and fresh portfolios, with some easing in U.S. portfolio prices; it expects U.K. prices to remain elevated. Returns depend on purchase pricing, collection performance, operating costs and portfolio cash-flow estimates.
  • Key exposures include changing debt-collection laws and regulation, litigation and regulatory proceedings, foreign exchange, floating interest rates, and the ability to meet financing covenants. The filing reports reserves related to the CFPB Consent Order and ancillary state matters, but does not provide a clear reserve amount here. Other material legal reserves were not recorded; certain exposures could not yet be estimated.
  • Receivable valuation relies on forecasts and significant judgment; a 100-basis-point increase in specified cost-to-collect and discount-rate assumptions would reduce estimated portfolio fair value by approximately $133 million in aggregate. The company said adoption of the expected-credit-loss standard could significantly affect portfolio income measurement. It planned to adopt the new lease standard in 2019.
  • Subsequent financing actions included an October amendment extending the Cabot securitization facility to 2023 and a November amendment increasing Cabot’s revolving facility by £90 million, extending most maturities to 2022 and reducing the margin on those tranches.

Key facts for investors to verify

  • Whether higher collections and portfolio purchases translate into durable cash generation and returns, particularly for newer U.S. and European vintages.
  • The sustainability of operating-cost trends, margin pressure, and Q3’s gap between adjusted revenue growth and operating-income growth.
  • Debt levels, interest-rate sensitivity, covenant headroom, upcoming maturities and the effect of the Cabot transaction and subsequent facility amendments.
  • The assumptions underlying estimated remaining collections, portfolio allowances and the potential impact of the expected-credit-loss accounting standard.
  • Developments in CFPB, state and other legal or regulatory matters, and the effect of discrete tax items and foreign-held cash on available liquidity.