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ECPG > SEC Filings for ECPG > Form 10-Q on 10-May-2013All Recent SEC Filings

Show all filings for ENCORE CAPITAL GROUP INC | Request a Trial to NEW EDGAR Online Pro

Form 10-Q for ENCORE CAPITAL GROUP INC


10-May-2013

Quarterly Report


Item 2 - Management's Discussion and Analysis of Financial Condition and Results of Operations

This Quarterly Report on Form 10-Q contains "forward-looking statements" within the meaning of the securities laws. The words "believe," "expect," "anticipate," "estimate," "project," "intend," "plan," "will," "may," and similar expressions often characterize forward-looking statements. These statements may include, but are not limited to, projections of collections, revenues, income or loss, estimates of capital expenditures, plans for future operations, products or services and financing needs or plans, as well as assumptions relating to these matters. Although we believe that the expectations reflected in these forward-looking statements are reasonable, we caution that these expectations or predictions may not prove to be correct or we may not achieve the financial results, savings or other benefits anticipated in the forward-looking statements. These forward-looking statements are necessarily estimates reflecting the best judgment of our senior management and involve a number of risks and uncertainties, some of which may be beyond our control or cannot be predicted or quantified, that could cause actual results to differ materially from those suggested by the forward-looking statements. Many factors, including but not limited to those set forth in our Annual Report on Form 10-K under "Part I, Item 1A. Risk Factors," could cause our actual results, performance, achievements or industry results to be very different from the results, performance, achievements or industry results expressed or implied by these forward-looking statements. Our business, financial condition or results of operations could also be materially and adversely affected by other factors besides those listed. Forward-looking statements speak only as of the date the statements were made. We do not undertake any obligation to update or revise any forward-looking statements to reflect new information or future events, or for any other reason, even if experience or future events make it clear that any expected results expressed or implied by these forward-looking statements will not be realized. In addition, it is generally our policy not to make any specific projections as to future earnings, and we do not endorse projections regarding future performance that may be made by third parties.

Our Business and Operating Segments

We are a leading provider of debt management and recovery solutions for consumers and property owners across a broad range of financial assets. We purchase portfolios of defaulted consumer receivables at deep discounts to face value and manage them by working with individuals as they repay their obligations and work toward financial recovery. Defaulted receivables are consumers' unpaid financial commitments to credit originators, including banks, credit unions, consumer finance companies, commercial retailers, auto finance companies, and telecommunication companies. Defaulted receivables may also include receivables subject to bankruptcy proceedings. In addition, through our subsidiary, Propel, we assist Texas property owners who are delinquent on their property taxes by paying these taxes on behalf of the property owners in exchange for payment agreements collateralized by tax liens on the property.

We conduct business through two operating segments: portfolio purchasing and recovery and tax lien transfer. The operating results from our tax lien transfer segment are immaterial to our total consolidated operating results. However, the total segment assets are significant as compared to our total consolidated assets. As a result, in accordance with authoritative guidance on segment reporting, our tax lien transfer segment is determined to be a reportable segment.

Portfolio purchasing and recovery

Our portfolio purchasing and recovery segment purchases receivables based on robust, account-level valuation methods and employs proprietary statistical and behavioral models across the full extent of our operations. These investments allow us to value portfolios accurately (and limit the risk of overpaying), avoid buying portfolios that are incompatible with our methods or goals and align the accounts we purchase with our operational channels to maximize future collections. As a result, we have been able to realize significant returns from the receivables we acquire. We maintain strong relationships with many of the largest credit and telecommunication providers in the United States and believe we possess one of the industry's best collection staff retention rates.

While seasonality does not have a material impact on our portfolio purchasing and recovery segment, collections are generally strongest in our first calendar quarter, slower in the second and third calendar quarters, and slowest in the fourth calendar quarter. Relatively higher collections in the first quarter could result in a lower cost-to-collect ratio compared to the other quarters, as our fixed costs would be constant and applied against a larger collection base. The seasonal impact on our business may be influenced by our purchasing levels, the types of portfolios we purchase, and our operating strategies.

Collection seasonality with respect to our portfolio purchasing and recovery segment can also impact our revenue recognition rate. Generally, revenue for each pool group declines steadily over time, whereas collections can fluctuate from quarter to quarter based on seasonality, as described above. In quarters with lower collections (e.g., the fourth calendar quarter), revenue as a percentage of collections can be higher than in quarters with higher collections (e.g., the first calendar quarter).

In addition, seasonality could have an impact on the relative level of quarterly earnings. In quarters with stronger collections, total costs are higher as a result of the additional efforts required to generate those collections. Since revenue for each pool group declines steadily over time, in quarters with stronger collections and higher costs (e.g., the first calendar quarter), all else being equal, earnings could be lower than in quarters with slower collections and lower costs (e.g., the fourth calendar quarter). Additionally, in quarters where a greater percentage of collections come from our legal and agency outsourcing channels, cost to collect will be higher than if there were more collections from our internal collection sites.


Table of Contents

Tax lien transfer

Our tax lien transfer segment focuses on the property tax financing industry. Our principal activity is originating and servicing property tax lien transfers in the state of Texas. With the property owner's consent, we pay the property owner's delinquent property taxes directly to the taxing authority, which then transfers its tax lien to us. We then enter into a payment agreement with the property owner, creating an affordable payment plan. Revenue from our tax lien transfer segment comprised 2% of total consolidated revenues for the three months ended March 31, 2013. Operating income from our tax lien transfer segment comprised 1% of our total consolidated operating income for the three months ended March 31, 2013.

Merger Agreement

On March 6, 2013, we and our wholly owned subsidiary, Pinnacle Sub, Inc. ("Merger Sub"), entered into an agreement and plan of merger (the "Merger Agreement") with AACC, another leading provider of debt management and recovery solutions. Pursuant to the Merger Agreement, Merger Sub will merge with and into AACC, and AACC will continue as the surviving corporation and will become our wholly owned subsidiary. The Merger Agreement has been approved by our board of directors and by the board of directors of AACC.

The transaction is expected to close in the second quarter of 2013, and is subject to, among other items, customary closing conditions and regulatory approvals. Information regarding this transaction is set forth on our Registration Statement on Form S-4, as amended, initially filed with the SEC on March 27, 2013.

We will account for the merger using the acquisition method of accounting. Under the acquisition method of accounting, the assets and liabilities of AACC will be recorded as of the closing date of the merger, at their respective fair values, and consolidated with our assets and liabilities. The results of operations of AACC will be consolidated with our results of operations beginning on the closing date of the merger.

Discontinued Operations

On May 16, 2012, we completed the sale of substantially all of the assets and certain of the liabilities of our bankruptcy servicing subsidiary Ascension Capital Group, Inc. ("Ascension"). Accordingly, Ascension's results of operations are reflected as discontinued operations in our condensed consolidated statements of comprehensive income.

Purchases and Collections

Purchases by Type

The following table summarizes the types of charged-off consumer receivable
portfolios we purchased for the periods presented (in thousands):



                                   Three Months Ended March 31,
                                   2013                   2012
                Credit card   $       43,414        $        107,935
                Telecom               15,357                  22,528

                              $       58,771        $        130,463

During the three months ended March 31, 2013, we invested $58.8 million to acquire charged-off credit card and telecom portfolios, with face values aggregating $1.6 billion, for an average purchase price of 3.6% of face value. This is a $71.7 million decrease, or 55.0%, in the amount invested, compared with the $130.5 million invested during the three months ended March 31, 2012, to acquire charged-off credit card portfolios with a face value aggregating $2.9 billion, for an average purchase price of 4.5% of face value.

Average purchase price, as a percentage of face value, varies from period to period depending on, among other things, the quality of the accounts purchased and the length of time from charge off to the time we purchase the portfolios.

Meaningful increases in the prices for portfolios offered for sale directly from credit issuers continued into the first quarter 2013 especially for fresh portfolios. Fresh portfolios are portfolios that are generally transacted within six months of the consumer's account being charged-off by the financial institution. We believe this price increase is due to a reduction in the supply of charged-off accounts and continued demand in the marketplace. We believe that the reduction in supply is partially due to shifts in underwriting standards by financial institutions which have resulted in lower volumes of charged-off accounts. We expect that pricing will remain at these elevated levels for a period of time. We believe that pricing will not decline until buyers who have paid prices that are too high recognize that they are unable to realize a profit. Should pricing trends continue in this manner, we expect to continue to adjust our purchasing strategies away from fresh portfolios, and toward portfolios in alternative asset classes or aged portfolios, where pricing is not as elevated and where we believe that our operational model allows us to maintain acceptable profit margins. Additionally, as discussed above, we entered into an agreement to purchase AACC, another leading provider of debt management and recovery solutions, including their investment in receivable portfolios. We expect this transaction to close in the second or third quarter of 2013 and for this transaction to account for a significant portion of our 2013 purchases.


Table of Contents

Collections by Channel

We utilized numerous business channels for the collection of charged-off credit
card receivables and other charged-off receivables. The following table
summarizes gross collections by collection channel in the respective periods (in
thousands):



                                       Three Months Ended March 31,
                                        2013                   2012
            Collection sites      $       126,562        $       109,870
            Legal collections             122,273                109,572
            Collection agencies            21,335                 11,586

                                  $       270,170        $       231,028

Gross collections increased $39.1 million, or 16.9%, to $270.2 million during the three months ended March 31, 2013, from $231.0 million during the three months ended March 31, 2012.

Results of Operations

Results of operations in dollars and as a percentage of total revenue were as
follows (in thousands, except per share amounts and percentages):



                                                          Three Months Ended March 31,
                                                       2013                           2012
Revenues
Revenue from receivable portfolios, net     $  140,683          97.5%       $ 126,405         100.0%
Net interest income - tax lien transfer          3,602           2.5%              -            0.0%

Total revenues                                 144,285         100.0%         126,405         100.0%

Operating expenses
Salaries and employee benefits                  28,832          20.0%          22,304          17.6%
Cost of legal collections                       42,258          29.3%          38,635          30.6%
Other operating expenses                        13,265           9.2%          11,598           9.2%
Collection agency commissions                    3,329           2.3%           3,959           3.1%
General and administrative expenses             16,342          11.3%          13,658          10.8%
Depreciation and amortization                    1,846           1.3%           1,240           1.0%

Total operating expenses                       105,872          73.4%          91,394          72.3%

Income from operations                          38,413          26.6%          35,011          27.7%

Other (expense) income
Interest expense                                (6,854)        (4.7)%          (5,515)        (4.4)%
Other income                                       460           0.3%             272           0.2%

Total other expense                             (6,394)        (4.4)%          (5,243)        (4.2)%

Income from continuing operations before
income taxes                                    32,019          22.2%          29,768          23.5%
Provision for income taxes                     (12,571)        (8.7)%         (11,660)        (9.2)%

Income from continuing operations               19,448          13.5%          18,108          14.3%
Loss from discontinued operations, net
of tax                                              -            0.0%          (6,702)        (5.3)%

Net income                                  $   19,448          13.5%       $  11,406           9.0%

Non-GAAP Disclosure

In addition to the financial information prepared in conformity with Generally Accepted Accounting Principles ("GAAP"), we provide certain historical non-GAAP financial information. Management believes that the presentation of such non-GAAP financial information is meaningful and useful in understanding the activities and business metrics of our operations. Management believes that these non-GAAP financial measures reflect an additional way of viewing aspects of our business that, when viewed with our GAAP results, provide a more complete understanding of factors and trends affecting our business.

Management believes that the presentation of these measures provides investors with greater transparency and facilitates comparison of operating results across a broad spectrum of companies with varying capital structures, compensation strategies, derivative instruments, and amortization methods, which provide a more complete understanding of our financial performance, competitive position, and prospects for the future. Readers should consider the information in addition to, but not instead of, our financial statements prepared in accordance with GAAP. This non-GAAP financial information may be determined or calculated differently by other companies, limiting the usefulness of these measures for comparative purposes.


Table of Contents

Adjusted Income from Continuing Operations Per Share. Management believes that investors regularly rely on non-GAAP adjusted earnings and adjusted earnings per share, to assess operating performance, in order to highlight trends in our business that may not otherwise be apparent when relying on financial measures calculated in accordance with GAAP. Adjusted income from continuing operations excludes non-cash interest and issuance cost amortization, relating to our convertible notes, and acquisition related expenses, net of tax. The following table provides a reconciliation between income from continuing operations and diluted income from continuing operations per share calculated in accordance with GAAP to adjusted income from continuing operations and adjusted income from continuing operations per share, respectively (in thousands, except per share data):

                                                          Three Months Ended March 31,
                                                   2013                                   2012
                                                        Per Diluted                            Per Diluted
                                         $                 Share                $                 Share
GAAP income from continuing
operations, as reported              $  19,448        $         0.80        $  18,108        $         0.70
Adjustments:
Convertible notes non-cash
interest and issuance cost
amortization, net of tax                   673                  0.03               -                     -
Acquisition related expenses,
net of tax                                 775                  0.03               -                     -

Adjusted income from continuing
operations                           $  20,896        $         0.86        $  18,108        $         0.70

Adjusted EBITDA. Management utilizes adjusted EBITDA (defined as net income before interest, taxes, depreciation and amortization, stock-based compensation expenses, portfolio amortization, and acquisition related expenses), which is materially similar to a financial measure contained in covenants used in our credit agreement, in the evaluation of our operations and believes that this measure is a useful indicator of our ability to generate cash collections in excess of operating expenses through the liquidation of our receivable portfolios (in thousands):

                                                             Three Months Ended March 31,
                                                              2013                   2012
GAAP net income, as reported                            $        19,448        $        11,406
Adjustments:
Loss from discontinued operations, net of tax                        -                   6,702
Interest expense                                                  6,854                  5,515
Provision for income taxes                                       12,571                 11,660
Depreciation and amortization                                     1,846                  1,240
Amount applied to principal on receivable portfolios            129,487                104,603
Stock-based compensation expense                                  3,001                  2,266
Acquisition related expenses                                      1,276                    489

Adjusted EBITDA                                         $       174,483        $       143,881

Adjusted operating expenses. We have included information concerning adjusted operating expenses, excluding stock-based compensation expense, tax lien transfer segment operating expenses, and acquisition related expenses, in order to facilitate a comparison of approximate cash costs to cash collections for the portfolio purchasing and recovery business in the periods presented. (in thousands):

                                                           Three Months Ended March 31,
                                                           2013                    2012
GAAP total operating expenses, as reported           $        105,872         $       91,394
Adjustments:
Stock-based compensation expense                               (3,001)                (2,266)
Tax lien transfer segment operating expenses                   (3,022)                    -
Acquisition related expenses                                   (1,276)                  (489)

Adjusted operating expenses for the portfolio
purchasing and recovery business                     $         98,573         $       88,639


Table of Contents

Comparison of Results of Operations

Revenues

Our revenues consist primarily of portfolio revenue and interest income net of related interest expense from property tax payment agreements receivable.

Portfolio revenue consists of accretion revenue and zero basis revenue. Accretion revenue represents revenue derived from pools (quarterly groupings of purchased receivable portfolios) with a cost basis that has not been fully amortized. Revenue from pools with a remaining unamortized cost basis is accrued based on each pool's effective interest rate applied to each pool's remaining unamortized cost basis. The cost basis of each pool is increased by revenue earned and decreased by gross collections and portfolio allowances. The effective interest rate is the IRR derived from the timing and amounts of actual cash received and anticipated future cash flow projections for each pool. All collections realized after the net book value of a portfolio has been fully recovered, or Zero Basis Portfolios, are recorded as revenue, or Zero Basis Revenue. We account for our investment in receivable portfolios utilizing the interest method in accordance with the authoritative guidance for loans and debt securities acquired with deteriorated credit quality. Interest income, net of related interest expense represents net interest income on property tax payment agreements receivable.

The following tables summarize collections, revenue, end of period receivable balance and other related supplemental data, by year of purchase from our portfolio purchasing and recovery segment (in thousands, except percentages):

                                                                                                                            As of
                                         Three Months Ended March 31, 2013                                             March 31, 2013
                                                                            Net
                                                   Revenue          Portfolio Allowance          Revenue
                                  Gross          Recognition             Reversal              % of  Total        Unamortized       Monthly
          Collections(1)       Revenue (2)         Rate(3)              (Allowance)              Revenue           Balances           IRR
ZBA(4)   $          5,611     $       4,662              83.1 %      $               949                3.4 %    $          -             -
2005                2,251               233              10.4 %                       10                0.2 %              108           5.3 %
2006                2,503             1,140              45.5 %                     (459 )              0.8 %            6,415           5.1 %
2007                3,378             1,554              46.0 %                      343                1.1 %            8,966           5.1 %
2008               12,114             7,031              58.0 %                      163                5.0 %           29,395           7.1 %
2009               23,232            14,695              63.3 %                       -                10.5 %           38,683          10.9 %
2010               45,224            28,392              62.8 %                       -                20.3 %           87,624           9.5 %
2011               67,236            36,348              54.1 %                       -                26.0 %          164,466           6.5 %
2012              104,172            43,295              41.6 %                       -                31.0 %          409,360           3.1 %
2013                4,449             2,327              52.3 %                       -                 1.7 %           56,508           3.8 %

Total    $        270,170     $     139,677              51.7 %      $             1,006              100.0 %    $     801,525           5.1 %


                                                                                                                            As of
                                         Three Months Ended March 31, 2012                                             March 31, 2012
                                                                            Net
                                                   Revenue          Portfolio Allowance          Revenue
                                  Gross          Recognition             Reversal              % of Total         Unamortized       Monthly
          Collections(1)       Revenue(2)          Rate(3)              (Allowance)              Revenue           Balances           IRR
ZBA(4)   $          7,065     $       6,032              85.4 %      $             1,033                4.8 %    $          -             -
2005                3,431             1,319              38.4 %                      (78 )              1.0 %            6,114           5.7 %
2006                3,769             2,505              66.5 %                   (1,119 )              2.0 %           15,010           5.1 %
2007                5,050             2,737              54.2 %                     (209 )              2.2 %           15,960           5.1 %
2008               17,313             9,045              52.2 %                       -                 7.1 %           49,979           5.4 %
2009               32,578            20,738              63.7 %                       -                16.3 %           76,589           8.0 %
2010               63,996            37,098              58.0 %                       -                29.3 %          164,036           6.7 %
2011               85,220            41,924              49.2 %                       -                33.1 %          291,099           4.9 %
2012               12,586             5,380              42.7 %                       -                 4.2 %          122,793           3.5 %

Total    $        231,008     $     126,778              54.9 %      $              (373 )            100.0 %    $     741,580           5.4 %

(1) Does not include amounts collected on behalf of others.

(2) Gross revenue excludes the effects of net portfolio allowances or net portfolio allowance reversals.

(3) Revenue recognition rate excludes the effects of net portfolio allowances or net portfolio allowance reversals.

(4) ZBA revenue typically has a 100% revenue recognition rate. However, collections on ZBA pool groups where a valuation allowance remains must first be recorded as an allowance reversal until the allowance for that pool group is zero. Once the valuation allowance is reversed, the revenue recognition rate will become 100%.

. . .

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