Business context and reporting period
Encore Capital Group, Inc. is an international specialty finance company that buys defaulted consumer receivables and collects them through internal, legal, and agency channels. This unaudited Form 10-Q covers the quarter and nine months ended September 30, 2016. Following the March 2016 sale of Propel, the company reported one segment: portfolio purchasing and recovery.
Financial performance and liquidity
| Metric | Q3 2016 | Q3 2015 | Nine months 2016 | Nine months 2015 |
|---|---|---|---|---|
| Total revenue | $179.4 million | $278.9 million | $757.9 million | $839.4 million |
| Operating income (loss) | $(21.2) million | $30.7 million | $154.1 million | $197.9 million |
| Net income (loss), consolidated | $(51.9) million | $(9.4) million | $5.5 million | $45.8 million |
| Net income (loss) attributable to Encore shareholders | $(1.5) million | $(11.0) million | $53.8 million | $46.1 million |
| Diluted EPS attributable to Encore | $(0.06) | $(0.43) | $2.08 | $1.71 |
| Operating margin | (11.8)% | 11.0% | 20.3% | 23.6% |
Q3 consolidated net loss included a $50.4 million loss attributable to noncontrolling interests; accordingly, the loss attributable to Encore shareholders was substantially smaller. Q3 adjusted income from continuing operations was $3.6 million, or $0.14 per diluted share, versus $32.2 million, or $1.21, a year earlier. Adjusted EBITDA, a non-GAAP measure, was $245.5 million for Q3 and $811.4 million year to date.
- Cash and cash equivalents were $157.7 million at September 30, 2016, versus $124.0 million at December 31, 2015. Total assets were $3.71 billion and total liabilities were $3.09 billion.
- Total debt was $2.85 billion, down from $2.94 billion at year-end 2015. Interest expense was $48.6 million in Q3 and $149.9 million year to date.
- Cash from operating activities was $85.3 million for the nine months; investing activities used $91.6 million and financing activities provided $13.7 million. Portfolio purchases were $712.7 million, partially offset by $507.6 million of collections applied to portfolio principal and $106.0 million of net Propel divestiture proceeds.
- Encore’s secured credit facilities had $175.6 million of available capacity, subject to borrowing-base and covenant limits, plus up to $195.0 million of remaining accordion capacity. Cabot’s facility had approximately $145.5 million available before its subsequent amendment.
Material changes versus prior periods
- Q3 portfolio revenue fell 39.9% to $159.5 million, chiefly reflecting a $94.0 million allowance charge on European portfolios and unfavorable foreign-exchange translation. Total Q3 revenue declined 35.7%; nine-month revenue declined 9.7%.
- The European portfolio allowance reflected delays or shortfalls in near-term collections. The company extended collection forecasts for certain European portfolios from 120 to 180 months, increasing estimated remaining collections by about $296.5 million and reducing the allowance charge by approximately $13.2 million. The allowance charge is a significant estimate-dependent item.
- Q3 gross collections decreased 3.5% to $407.0 million, mainly because of lower U.S. legal collections amid temporary delays in receiving account media from issuers, and currency effects in Europe. Nine-month collections were nearly flat at $1.29 billion.
- Q3 operating expenses fell 19.2% to $200.6 million, but remained above revenue. The comparison included $55.9 million of prior-year settlement and related administrative expenses in G&A; excluding specified acquisition, restructuring, and settlement items, Q3 G&A declined modestly.
- Q3 included an additional $11.3 million reserve for U.K. court costs after a reduction in the estimated recovery rate. The court-cost reserve was $331.7 million at September 30.
- Propel was sold for $144.4 million cash consideration; net proceeds after cash divested were $106.0 million. The sale removed the tax-lien business from continuing operations.
Outlook, risks, contingencies, and unusual items
- Management stated it does not generally provide specific earnings projections. It expects U.S. legal-channel placements to increase as temporary issuer-media delays ease, and expects European collections to shift over time toward longer payment plans and a longer collection curve.
- Management expected Q4 tax expense to exceed a normally expected level by approximately $10 million, reflecting the estimated annual tax rate and the mix of losses in lower-tax jurisdictions and income in the United States.
- Regulatory uncertainty remains material. The CFPB was developing debt-collection rules and examining industry practices; the company said final rules’ effects could not yet be predicted. U.K. FCA requirements, including affordability assessments, were changing collection patterns. GDPR requirements were scheduled to apply in 2018.
- Brexit-related uncertainty and British-pound volatility could adversely affect reported results and financial condition. The company reported substantial foreign-currency translation losses in other comprehensive income and uses derivatives to manage some currency exposures.
- Litigation and regulatory matters include TCPA settlements and previously disclosed CFPB and state regulatory matters. The company recorded an additional $2.4 million TCPA settlement-fund reserve in September. Other than specified reserves, it reported no material legal reserves; some exposures could not yet be estimated.
- After quarter-end, Cabot issued £350 million of 7.50% senior secured notes due 2023, using proceeds to redeem its 10.375% 2019 notes and repay part of its revolving borrowings. Cabot also increased its revolving facility commitment to £250 million and reduced its stated margin to LIBOR/EURIBOR plus 3.25%.
- The company reported compliance with debt covenants and stated it believed liquidity was sufficient for at least the next 12 months. It also noted that much of its foreign-held cash was indefinitely reinvested and could incur material tax effects if repatriated.
Important facts for investors to verify
- Whether European portfolio collection performance supports the revised 180-month forecasts and the estimated $296.5 million increase in remaining collections; monitor further allowance activity.
- Whether U.S. legal placements recover as expected after issuer-media delays, and whether collections and cost-to-collect improve.
- The sustainability of earnings after separating portfolio performance from large allowances, foreign-exchange gains, tax effects, and noncontrolling-interest allocations.
- Debt maturity, refinancing, interest-rate, covenant, and borrowing-base capacity after Cabot’s post-quarter-end note and facility transactions.
- Potential effects of CFPB and FCA actions, litigation and settlement costs, Brexit and currency movements, and changes to court-cost recovery estimates.