Encore Capital Group, Inc. — FY 2016 Form 10-K
Reporting period: Fiscal year ended December 31, 2016. The filing also reports fourth-quarter results. Encore buys defaulted consumer receivables at a discount and collects them through U.S., U.K./European and smaller international operations. In 2016 it had one reportable segment, portfolio purchasing and recovery, after selling its tax-lien business.
Key financial results
| Metric | FY 2016 | FY 2015 |
|---|---|---|
| Total revenue | $1.029 billion | $1.130 billion |
| Net portfolio revenue | $946.6 million | $1.072 billion |
| Operating income / margin | $241.5 million / 23.5% | $282.3 million / 25.0% |
| Interest expense | $198.4 million | $186.6 million |
| Continuing-operations income, consolidated | $19.2 million | $70.8 million |
| Net income, consolidated | $16.8 million | $47.4 million |
| Net income attributable to Encore stockholders | $76.6 million | $45.1 million |
| Diluted EPS attributable to Encore stockholders | $2.96 | $1.69 |
| Gross collections | $1.686 billion | $1.701 billion |
| Operating cash flow | $130.3 million | $114.4 million |
| Cash and cash equivalents, year-end | $149.8 million | $124.0 million |
| Total debt, year-end | $2.806 billion | $2.944 billion |
| Portfolio investment, net, year-end | $2.383 billion | $2.441 billion |
The difference between consolidated net income and income attributable to Encore is substantially affected by noncontrolling interests. Investors should distinguish these measures; the filing reports a $59.8 million net loss attributable to noncontrolling interests in 2016.
Material changes and operating trends
- Revenue fell 8.9% year over year, primarily from European portfolio allowance charges and unfavorable foreign-currency translation, particularly the weaker British pound. Other revenue increased to $82.6 million, mainly from international portfolio-management fees.
- Encore recorded a net portfolio allowance charge of $84.2 million, compared with a $6.8 million net reversal in 2015. The third-quarter charge on certain European pools was approximately $94.0 million before offsets.
- Management extended the forecast horizon for certain European portfolios from 120 to 180 months. This raised estimated remaining collections by approximately $296.5 million as of September 30, 2016 and reduced allowance charges by about $13.2 million. The longer forecast reflects management’s expectation of slower, longer-duration collections under changing U.K. collection practices.
- Collections declined 0.9%. U.S. collections decreased, partly because of delays obtaining account documentation needed for legal collections; European and other-geography collections increased. Cost-to-collect improved to 38.5% from 39.2%.
- Portfolio purchases were $906.7 million, down from $1.024 billion. The 2016 portfolios had $9.8 billion face value and an average purchase price of 9.2% of face value, versus 8.0% in 2015. U.S. purchases increased amid improving pricing conditions; European purchases declined partly because 2015 included portfolios acquired with dlc.
- Operating cash flow rose, while investing cash use narrowed to $168.8 million, including $907.4 million of portfolio purchases, $659.3 million of collections applied to portfolio principal and $106.0 million of net Propel divestiture proceeds.
Debt, liquidity and capital
Year-end debt was $2.806 billion, including approximately $1.5 billion at Cabot. Cash was $149.8 million, of which $114.6 million was held by foreign entities and generally considered indefinitely reinvested. Encore reported $203.7 million available under its senior secured credit facilities and approximately $274.4 million available under Cabot’s revolving facility. The company said it was in compliance with debt covenants and believed liquidity was sufficient for operations and obligations for at least the next 12 months.
In December 2016, Encore amended its revolving and term facilities, with total potential capacity of approximately $1.2 billion including an accordion feature. Cabot issued $442.6 million of 7.50% notes due 2023, using most proceeds to redeem higher-coupon 2019 notes and repay revolver borrowings. Contractual obligations included $221.1 million of debt principal due within one year; the $115 million 3.0% convertible notes due November 2017 are also a material near-term maturity.
Outlook, risks and unusual items
- The filing provides no specific earnings guidance and says Encore generally does not make earnings projections. Management expects to continue investing in its core business, expand geographically and pursue adjacent services and asset classes. In early 2017, Encore and Cabot co-investor J.C. Flowers began exploring options related to a potential Cabot IPO.
- Management said U.S. portfolio prices were beginning to soften as charge-off supply was expected to increase. U.K. portfolio prices remained above historical levels; management expected continued purchasing opportunities in Europe and Spain, while noting elevated pricing and regulatory effects on returns.
- Important risks include inaccurate collection forecasts, higher-than-expected portfolio prices, regulatory restrictions or enforcement, litigation, foreign-exchange and interest-rate changes, and substantial indebtedness. U.K. regulatory changes have shifted collections toward affordable payment plans and longer collection periods, reducing near-term collections.
- The 2015 CFPB consent order remains subject to operational obligations, consumer redress and a civil penalty; ancillary state attorney general investigations are also noted. Encore recorded a one-time after-tax charge of approximately $43 million in 2015 and said it expected subsequent earnings impact to be immaterial. The filing also describes TCPA settlements and related 2016 expenses.
- The effective tax rate rose to 66.6% from 27.7%, chiefly due to a valuation allowance at a foreign subsidiary, nondeductible items and the mix of earnings by jurisdiction. Propel was sold on March 31, 2016; its results are reported as discontinued operations, including a 2016 after-tax loss of $2.4 million.
- Fourth-quarter 2016 revenue was $271.4 million and net income attributable to Encore stockholders was $22.8 million. The third quarter included a substantial portfolio allowance charge and a loss from continuing operations.
Investor verification points
- Review the assumptions behind the $5.840 billion estimated remaining collections, especially the European 180-month forecast, U.S. collections beyond 120 months and the additional estimated zero-basis collections identified in the fourth quarter.
- Track whether European collections and portfolio performance recover from the 2016 allowance charges, and whether the longer forecast produces realized cash rather than only later-period estimates.
- Verify liquidity and refinancing plans for 2017 maturities, the borrowing-base availability of credit facilities, and the cash-flow capacity to service debt and fund portfolio purchases.
- Monitor CFPB consent-order compliance, state investigations, TCPA matters, and changes to U.S. and U.K. debt-collection rules that may affect collection methods and timing.
- Assess the effects of foreign exchange, interest rates, high portfolio purchase prices, and the elevated 2016 effective tax rate on future earnings and cash generation.