Encore Capital Group, Inc. — Q3 2011 Form 10-Q
Business context and reporting period
Encore purchases defaulted consumer receivables at discounts and collects through internal sites, attorneys and third-party agencies; it also provides bankruptcy servicing. This unaudited report covers the quarter and nine months ended September 30, 2011, with comparisons to 2010.
Financial performance and liquidity
| Metric | Q3 2011 | Q3 2010 | Nine months 2011 | Nine months 2010 |
|---|---|---|---|---|
| Total revenue | $120.6m | $98.0m | $346.7m | $281.5m |
| Operating income | $30.8m | $23.7m | $88.1m | $68.8m |
| Net income | $15.4m | $12.3m | $43.8m | $34.9m |
| Diluted EPS | $0.60 | $0.49 | $1.71 | $1.39 |
| Operating margin | 25.5% | 24.2% | 25.4% | 24.5% |
| Net margin | 12.7% | 12.5% | 12.6% | 12.4% |
- Receivable-portfolio revenue was $115.8m in Q3 and $332.3m year to date; servicing revenue was $4.7m and $14.4m, respectively.
- Gross collections rose 20.1% to $189.1m in Q3 and 26.3% to $575.2m year to date. Portfolio purchases were $65.7m in Q3 and $250.1m year to date; nine-month purchases were 3.0% higher than in 2010.
- For the first nine months, operating cash flow was $58.2m, investing cash outflow $16.5m and financing cash outflow $42.0m. Cash at September 30 was $10.7m.
- Total debt was $344.2m, down from $385.3m at December 31, 2010. Debt comprised $261.0m under the revolving facility, $75.0m in senior secured notes and $8.2m in capital leases and other obligations. The revolver’s Q3 weighted-average rate was 4.29%.
- The $410.5m revolving facility had $149.5m of unused commitment and $103.7m of borrowing-base availability. Stockholders’ equity was $353.9m; total assets were $747.4m.
Changes versus prior comparable periods
- Q3 revenue increased 23.1%, operating income 29.8% and net income 25.1% year over year. For nine months, revenue increased 23.1%, operating income 28.0% and net income 25.6%.
- Higher portfolio revenue reflected a larger portfolio balance and lower net portfolio allowance provisions: $1.6m in Q3 versus $6.1m, and $8.1m year to date versus $16.8m.
- Nine-month cost per dollar collected improved to 41.5% from 43.4%; Q3 was essentially flat at 43.8% versus 43.9%. Legal-channel collections grew materially, while third-party agency collections declined as Encore shifted placements toward internal channels.
- Debt fell despite issuance of $25m in additional notes, as revolving borrowings were repaid. Interest expense increased 12.5% year to date, mainly due to higher stated interest on debt.
Outlook, commentary, risks and contingencies
- Management gave no specific earnings forecast and said it generally does not make specific future earnings projections. It believes liquidity is sufficient for at least 12 months, based on expected operating cash flow, cash, capital-market access and revolver availability. It cited approximately $100m of borrowing-base capacity for purchases and potential acquisitions.
- Management reported collection metrics generally consistent with or better than 2009–2010, while noting persistent consumer economic pressure. Portfolio prices had risen through 2011; the company said it would maintain purchase discipline and acquire portfolios only when expected returns meet internal hurdles.
- Seasonality affects collections, cost-to-collect and quarterly earnings; collections are generally strongest in Q1 and slowest in Q4. Payment plans can delay cash flows and increase the risk of broken payment plans and portfolio allowances. Management identified forecast variability, especially in 2006–2008 portfolios.
- The India tax holiday expired March 31, 2011, contributing to higher effective tax rates: 39.1% in Q3 2011 versus 35.0% in Q3 2010, and 38.9% year to date versus 36.3%.
- Key exposures include consumer weakness and bankruptcy, uncertain portfolio availability and collections estimates, seller concentration, regulatory changes and litigation. The filing describes FDCPA/TCPA class actions, including appeals of an approved Ohio settlement; TCPA cases transferred for consolidation; and a Texas Attorney General matter with a settlement in principle that includes a proposed penalty, costs and consumer credits. A North Carolina investigation was also disclosed. Legal expense was expected to remain elevated near term.
- At September 30, receivable purchase commitments covered approximately $3.0bn face value for an estimated $102.4m purchase price; the company said it did not then expect to cancel them. No purchase commitments extended beyond one year. The company reported compliance with financing covenants and effective disclosure controls.
Important facts for investors to verify
- Whether portfolio cash-flow forecasts and allowance assumptions remain consistent with realized collections, particularly for older vintages and payment-plan accounts.
- Actual borrowing-base availability and covenant headroom, since unused revolver commitment exceeded borrowing-base availability.
- Progress and financial impact of the Texas proposed settlement, Ohio settlement appeals, TCPA litigation and North Carolina inquiry.
- Whether rising portfolio purchase prices and the scheduled $102.4m commitments generate returns meeting management’s investment hurdles.
- Whether the higher tax rate, elevated legal costs and seasonal collection patterns affect subsequent-period earnings and margins.