Encore Capital Group, Inc. — Q3 2014 Form 10-Q
Reporting period: Three and nine months ended September 30, 2014. Financial statements are unaudited. Encore is an international specialty finance company purchasing defaulted consumer receivables and financing delinquent property taxes through tax liens.
Key financial results
| Metric | Q3 2014 | Q3 2013 | Nine months 2014 | Nine months 2013 |
|---|---|---|---|---|
| Total revenue | $273.3 million | $235.6 million | $796.2 million | $536.3 million |
| Operating income | $84.3 million | $61.1 million | $231.1 million | $129.7 million |
| Operating margin | 30.9% | 26.0% | 29.0% | 24.2% |
| Net income attributable to Encore stockholders | $30.3 million | $21.9 million | $77.1 million | $52.3 million |
| Diluted EPS | $1.11 | $0.81 | $2.79 | $2.05 |
Revenue from receivable portfolios was $251.8 million in Q3 and $737.6 million for the nine-month period. Interest expense was $43.5 million and $124.7 million, respectively. Effective tax rates were 25.2% for Q3 and 33.9% year to date; the Q3 rate included a $4.3 million tax benefit from a favorable settlement.
Balance sheet, liquidity, and cash flow
- At September 30, 2014, cash and equivalents were $115.4 million; total assets were $3.72 billion; debt was $2.79 billion; and total equity was $600.1 million. At December 31, 2013, cash was $126.2 million and debt was $1.85 billion.
- For the first nine months of 2014, operating cash flow was $98.8 million, investing cash flow was negative $704.2 million, and financing cash flow was positive $593.1 million. Cash declined by $12.4 million before exchange-rate effects.
- Investing cash use included $495.5 million for acquisitions and $666.5 million for receivable portfolio purchases, partly offset by $488.1 million of collections applied to portfolio principal.
- Management reported compliance with financing covenants and believed available cash, operating cash flow, capital-market access, and credit-facility capacity would cover operations for at least 12 months. Encore reported $263.6 million available under its principal credit facility, excluding its accordion; additional availability was reported under Cabot and Propel facilities.
Material changes and business developments
- Revenue increased 16.0% in Q3 and 48.5% for the nine-month period year over year. Encore attributed growth principally to acquired businesses and larger portfolio balances, alongside improved collections on certain existing portfolios.
- Comparisons are materially affected by acquisitions: the 2013 periods included AACC and Cabot only from their respective closing dates; 2014 included Marlin from February, Grove from April, and Atlantic from August. Atlantic contributed $10.7 million of revenue and $2.6 million of net income after its acquisition through quarter-end.
- Debt and interest expense rose substantially, principally reflecting acquisition financing and the expanded debt structure. Goodwill increased to $921.5 million from $504.2 million, including goodwill from recent acquisitions.
- Gross collections were $407.2 million in Q3, up 7.3%, and $1.21 billion for nine months, up 30.7%. Receivable portfolio investment was $2.07 billion at quarter-end, versus $1.59 billion at year-end 2013.
- Encore repurchased 400,000 shares for approximately $16.8 million under a $50 million authorization. It issued $161 million of 2.875% convertible notes due 2021; Propel completed a $134 million tax-lien securitization with 1.44% notes due 2029.
Outlook, risks, and unusual items
- Encore gave no specific earnings guidance and stated it generally does not make specific future earnings projections. Management expects portfolio purchase prices to remain elevated, citing limited U.S. supply and continued demand; it expected U.K. debt supply to increase, while prices remained above historical averages.
- Management said Q3’s extension of U.S. portfolio collection forecasts from 84 or 96 months to 120 months did not materially increase quarterly pool yields or revenue. Portfolio valuation and future collections depend on forecasts and assumptions; a 100-basis-point change in specified valuation inputs could change estimated U.S. and U.K. portfolio fair values by approximately $44.1 million and $34.3 million, respectively.
- Regulatory exposure is significant. Encore disclosed ongoing discussions with the CFPB concerning business practices or controls. In the U.K., Cabot held interim FCA permission and was preparing for full authorization; changes to FCA requirements and proposed debt-claim procedures could raise costs or constrain collections.
- The company faces ordinary-course consumer collection litigation and regulatory matters, including claims involving collection practices and consumer-protection laws. It reported no material legal reserves and said some exposure could not yet be estimated.
- Other notable items include acquisition and integration costs, preliminary acquisition accounting subject to valuation changes, foreign-currency translation losses, and a favorable tax settlement. The filing reported $88.1 million of commitments to purchase receivable portfolios with approximately $0.6 billion face value.
Investor verification priorities
- Separate organic operating trends from acquisition contributions, especially Marlin, Grove, Atlantic, Cabot, and AACC-related comparability effects.
- Track collections, portfolio purchase prices, forecast accuracy, allowance reversals, and the assumptions behind estimated remaining collections.
- Assess leverage, cash interest burden, refinancing and covenant capacity, and debt associated with subsidiaries and securitizations.
- Monitor CFPB engagement, Cabot’s FCA authorization process, evolving collection rules, and potential litigation or regulatory outcomes.
- Review final purchase-price allocations and goodwill/intangible valuations for recent acquisitions, as well as the effect of the tax settlement and other nonrecurring items on reported earnings.