Encore Capital Group, Inc. — 2017 Form 10-K
Business context and reporting period. This annual report covers the fiscal year ended December 31, 2017; quarterly figures are included below where notable. Encore purchases defaulted consumer receivables at a discount and collects or services them, primarily in the United States and through Cabot in Europe. The company reports one segment: portfolio purchasing and recovery.
Financial performance
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $1,187.0 million | $1,029.3 million | +15.3% |
| Receivable portfolio revenue, net | $1,094.6 million | $946.6 million | +15.6% |
| Operating income | $324.5 million | $241.5 million | +34.4% |
| Operating margin | 27.3% | 23.5% | +3.8 percentage points |
| Net income attributable to Encore shareholders | $83.2 million | $76.6 million | +8.7% |
| Diluted EPS | $3.15 | $2.96 | +6.4% |
| Gross collections | $1,767.6 million | $1,685.6 million | +4.9% |
| Portfolio purchases | $1,058.2 million | $906.7 million | +16.7% |
Consolidated net income was $79.0 million versus $16.8 million. The difference from shareholder-attributable income reflects a substantial change in noncontrolling-interest attribution: a $4.3 million net loss attributable to noncontrolling interests in 2017 versus $59.8 million of net income in 2016. Adjusted EBITDA, a non-GAAP measure, was $406.6 million versus $315.6 million; adjusted diluted EPS was $4.01 versus $3.48.
Operating expenses rose 9.5% to $862.5 million. The filing reports interest expense of $204.2 million, compared with $198.4 million, and an effective tax rate of 39.7%, down from 66.6%. Cost-to-collect increased to 39.5% from 38.5%.
Fourth quarter: Revenue was $317.5 million and operating expenses were $253.2 million. Income attributable to Encore shareholders was $12.7 million, compared with $22.8 million in fourth-quarter 2016. The filing identifies $15.3 million of withdrawn Cabot IPO expenses during 2017, contributing to higher fourth-quarter costs.
Cash flow, debt and liquidity
- Cash provided by operating activities was $123.8 million, down from $130.3 million. Investing activities used $452.1 million, principally reflecting portfolio purchases; financing activities provided $378.2 million.
- Year-end cash and cash equivalents were $212.1 million, including $171.4 million held by foreign entities, most of which management considered indefinitely reinvested.
- Total debt was $3.447 billion, up from $2.806 billion. Management reported compliance with financing covenants and stated it expected liquidity to be sufficient for at least the next 12 months.
- At year-end, Encore’s revolving facility had $329.0 million outstanding and $212.7 million available; Cabot’s revolver had approximately $179.0 million outstanding and $219.5 million available. Availability is subject to borrowing-base and covenant restrictions.
- Contractual obligations included $3.268 billion of debt principal and $745.0 million of estimated interest payments. Portfolio purchase commitments totaled $525.6 million, mostly due within one year. The company also reported $253.3 million of preferred equity certificates, with payment tied to disposition of the noncontrolling interest.
Material changes and unusual items
- Portfolio revenue benefited from a $41.2 million net allowance reversal in 2017, including a $45.7 million reversal for certain European pools after improved collections. This compared with an $84.2 million net allowance charge in 2016, including approximately $94.0 million of charges on European pools.
- Encore recorded an $11.4 million allowance charge on U.S. portfolios, primarily on pools concentrated in Puerto Rico affected by hurricanes.
- Portfolio purchases increased, with $1.058 billion invested for portfolios with $10.1 billion face value, at an average purchase price of 10.5% of face value, versus 9.2% in 2016. European purchases rose substantially; U.S. deployment reflected the company’s stated disciplined purchasing approach.
- Cabot’s planned IPO was withdrawn in November 2017 amid unfavorable U.K. equity-market conditions. Related costs were $15.3 million in the non-GAAP reconciliation. Cabot acquired U.K. collection-services provider Wescot in November.
- Encore issued $150 million of 3.25% convertible notes due 2022 and $325 million of 5.625% senior secured notes in 2017; Cabot also added securitization financing. The 2017 convertible notes matured and were settled in November.
- The Tax Cuts and Jobs Act resulted in a provisional additional tax expense of $1.2 million. The company had not selected an accounting policy for GILTI tax at year-end.
Outlook, risks and contingencies
The filing provides no specific earnings or revenue guidance. Management said it expects to continue investing in U.S. operations, international businesses, analytics, compliance and digital collection channels. It anticipated continued purchasing opportunities in the U.K. and Spain but noted elevated U.K. portfolio pricing and expected cost-to-collect to fluctuate with seasonality, portfolio mix, acquisitions, investment needs and regulation.
- Collection and valuation risk: Results depend on consumers’ ability to pay, portfolio purchase availability and price, and the accuracy of projected future collections. Changes in collection estimates can produce allowance charges.
- Leverage and funding: Significant debt and variable interest rates create refinancing, covenant and cash-servicing risks; portfolio purchasing also requires substantial ongoing capital.
- Regulatory and legal exposure: The 2015 CFPB consent order remains in effect, and related state attorney general investigations could result in penalties, restitution or operational requirements. The filing says no material reserves were recorded for other legal matters; outcomes or loss estimates for some matters were not determinable.
- International, currency and policy risks: Brexit, foreign exchange movements, evolving U.K./EU data-protection rules and other regulatory changes may affect collections, costs and operations.
- Other disclosed exposures: Cybersecurity and data protection, litigation, third-party servicing, goodwill impairment, and tax uncertainties are identified risks. Goodwill was $929.0 million; the 2017 annual impairment test identified no impairment.
Most important facts for investors to verify
- Whether improved European collections persist and support the allowance reversals, and whether Puerto Rico-related collection impacts worsen.
- Portfolio-level estimated collections, actual liquidation performance and future allowance requirements, especially given 2017 purchase prices and the $2.891 billion portfolio carrying value.
- Debt maturities, borrowing-base availability, covenant headroom, interest-rate exposure and the company’s ability to fund portfolio purchases while servicing debt.
- Developments under the CFPB consent order and state investigations, including any new costs, remedies or operational restrictions.
- The quality and sustainability of reported earnings: distinguish GAAP results from adjusted EBITDA/EPS and account for IPO costs, allowance changes, tax effects and noncontrolling interests.