Encore Capital Group, Inc. — Q2 2018 Form 10-Q
Business context and reporting period. Unaudited results cover the three and six months ended June 30, 2018, compared with the same periods in 2017. Encore buys discounted defaulted consumer receivables and collects or services them across the United States, Europe and other markets. Cabot is its largest international subsidiary.
Financial performance and condition
- Q2 revenue: $332.1 million, up 17.7%; including net portfolio allowance reversals, adjusted revenue was $349.7 million, up 20.2%. Portfolio revenue was $292.7 million and other revenue was $39.5 million.
- Q2 earnings: Operating income was $103.4 million versus $80.6 million; operating margin on adjusted revenue was 29.6% versus 27.7%. Net income was $27.0 million, and income attributable to Encore shareholders was $26.3 million versus $20.3 million. Diluted EPS was $1.00 versus $0.77.
- First-half revenue and earnings: Adjusted revenue was $676.5 million, up 20.2%. Operating income was $191.9 million versus $156.4 million; operating margin was 28.4% versus 27.8%. Net income was $50.7 million and shareholder-attributable income was $48.1 million versus $42.4 million. Diluted EPS was $1.82 versus $1.61.
- Non-GAAP measures: Adjusted EBITDA was $119.7 million in Q2 versus $94.4 million, and $223.3 million for the first half versus $180.3 million. Adjusted diluted EPS was $1.33 in Q2 versus $0.87, and $2.31 for the first half versus $1.82. These measures exclude specified items and should be considered alongside GAAP results.
- Cash flow: First-half operating cash flow was $97.6 million versus $71.3 million. Investing used $240.9 million, including $633.0 million of portfolio purchases, partly offset by $415.2 million of collections applied to portfolio principal. Financing provided $121.0 million. Cash declined by $22.2 million before an $8.3 million adverse exchange-rate effect, ending at $181.7 million.
- Debt and liquidity: Debt, net, was $3.53 billion at June 30, up from $3.45 billion at year-end 2017. Cash was $181.7 million, including $22.7 million collected for clients; $150.6 million was held outside the U.S. Encore reported $243.5 million of availability under its revolving facility and Cabot reported approximately $145.7 million. The company said it was compliant with financing covenants and had sufficient liquidity for at least 12 months.
- Portfolio investment: First-half portfolio purchases were $636.3 million, up 36.8%, for portfolios with $4.7 billion face value. Gross collections rose 11.1% to $985.2 million. Receivable portfolios carried at $3.08 billion; estimated remaining gross collections were $7.22 billion, based on management forecasts.
Material changes versus the prior comparable period
- Growth reflected higher portfolio purchasing and collections, particularly in Europe, increased fee-based income following the Wescot acquisition, and favorable foreign-currency translation. Europe adjusted revenue for the first half rose to $275.1 million from $172.7 million.
- Operating expenses rose 17.1% in Q2 and 19.2% in the first half, driven by Wescot, expanded U.S. collection capacity, marketing and mailing initiatives, and currency translation. Despite higher expenses, operating margin improved.
- Interest expense increased to $60.5 million in Q2 from $50.5 million and to $118.0 million in the first half from $99.7 million, reflecting higher debt balances and currency effects, partly offset by Cabot refinancing.
- The effective tax rate fell to 29.5% in Q2 from 41.5% and to 29.1% for the first half from 42.8%, primarily reflecting the U.S. corporate tax-rate reduction under the Tax Cuts and Jobs Act.
- Q2 comprehensive income attributable to Encore shareholders was a loss of $9.1 million, despite positive net income, largely due to foreign-currency translation losses.
Outlook, commentary, risks and unusual items
- Outlook: The filing provides no specific earnings guidance; management states it generally does not issue earnings projections. Management expects positive operating cash flow and says available cash and borrowing capacity support liquidity for at least the next 12 months. It expects cost-to-collect to fluctuate with seasonality, portfolio mix, acquisitions, foreign exchange, operating initiatives and regulation.
- Market commentary: Management described increasing U.S. charge-off volumes and fresh-portfolio supply, with pricing beginning to soften after several years of elevated levels. U.K. portfolio prices remained above historical averages, and management cited continued purchasing opportunities in the U.K. and Spain.
- Cabot transaction after quarter-end: On July 24, 2018, Encore acquired the remaining Cabot interests, making Cabot wholly owned. Consideration comprised £178.5 million (approximately $234.1 million) in cash and 4,906,482 Encore shares. The filing treats this as an equity transaction, with no purchase-accounting adjustments.
- Other subsequent financing: On July 20, Encore issued $172.5 million of 4.5% exchangeable senior notes due 2023. Cabot also exchanged certain 2020 and 2021 notes for 2023 notes and issued £34.5 million of additional 2023 notes.
- Unusual derivative loss: A currency forward entered into for the Cabot transaction generated a $6.6 million Q2 loss recognized in other expense; it settled August 3 at a total loss of $9.3 million, which the company said was substantially offset by a lower final U.S.-dollar cash consideration.
- Collection and regulatory risks: Results depend on forecast collections, portfolio valuations and the ability to collect through legal and other channels. The company faces consumer-protection litigation and regulatory scrutiny, including under debt-collection laws. It reported no material legal reserves other than reserves related to the CFPB Consent Order and ancillary state regulatory matters; other exposures were immaterial or not yet estimable.
- Additional watch items: Foreign exchange movements, floating-rate debt, leverage and refinancing requirements, changes in collection regulation, and management estimates of future portfolio cash flows. Management noted that a 100-basis-point change in portfolio valuation cost-to-collect and discount-rate assumptions could change estimated portfolio fair value by approximately $55.1 million for U.S. portfolios and $71.3 million for European portfolios.
Most important facts for investors to verify
- Whether collection performance and portfolio cash-flow forecasts support the $3.08 billion carrying value and $7.22 billion estimated remaining collections.
- The economics and funding impact of acquiring the remaining Cabot interests, including the cash consideration, share issuance and subsequent debt transactions.
- Debt-service capacity, covenant headroom and available borrowing capacity after the Cabot transaction and subsequent note issuance.
- How much reported growth reflects recurring collections and fee income versus allowance reversals, acquisition contributions and favorable currency translation.
- Developments in CFPB and other regulatory matters, and any resulting changes to reserves, collection practices or costs.