Encore Capital Group Inc (ECPG) 2004 Q3 法說會逐字稿

Good afternoon ladies and gentlemen and welcome to the Encore Capital Group third-quarter 2004 conference call. At this time all participants are in a listen-only mode. Following today's presentation instructions will be given for the question and answer session. (OPERATOR INSTRUCTIONS) As a reminder this conference is being recorded Thursday, October 28, 2004. I'd now like to turn the conference over Ms. Moira Conlon with the Financial Relations Board. Please go ahead, man.

Good afternoon and thank you operator. We'd like to welcome everybody today to Encore Capital Group's third-quarter conference call. Today's web cast is being accompanied by a slide presentation which is available at www.EncoreCapitalGroup.com on the event calendar under the investor's page. With us today from management are Carl Gregory, Vice Chairman and Chief Executive Officer; Barry Barkley, Chief Financial Officer; and Brandon Black, President and Chief Operating Officer. Management will discuss the third-quarter results & Company developments and will then open the call up to your questions.

Earlier today Encore Capital Group filed its 10-Q for the third quarter. This is the complete report of Encore's results and I encourage you to read it thoroughly because it contains a great deal of useful information.

Before we begin, I'd like to refer you to slide 2 which is referenced to forward-looking statements. I would also like to note that certain statements in this conference call and slide show constitute forward-looking statements within the meeting of the Private Securities Litigation Reform Act of 1995. Such statements involves risks, uncertainties and other factors which may cause actual results, performance or achievements of the Company and its subsidiaries to be materially different from any financial results, performance or achievements expressed or implied by such forward-looking statements.

For a discussion of these factors, we refer you to the Company's quarterly report on Form 10-Q and to the Company's annual report on Form 10K for the year ended December 31st, 2003, filed with the SEC. forward-looking statements speak only as of the date the statement was made. The Company will not undertake and specifically declines any obligation to publicly release the results of any revision to forward-looking statements to reflect events or circumstances after the date of such statements or to reflect the occurrence of anticipated or unanticipated events whether as a result of new information, future events or for any other reason.

With that, I would now like to turn the call over to Carl Gregory. Carl?

Good afternoon. Encore continues to perform well achieving strong operating and financial results in the third quarter. In addition, we made some important organizational changes to strengthen our senior management and continued to exercise discipline in a purchasing of receivable portfolios.

Tuesday, the Board of Directors made 3 important organizational changes which are shown on Slide 2 ensuring that we will have the management talent necessary to capitalize on the opportunities we see ahead. Our Board of Directors elected Richard Mandell to the post of Chairman of the Board. Dick has been a Director of Encore since 2001 and will continue to serve as Chairman of the Audit Committee. Dick is a CPA, a graduate of Wharton with a background in accounting as well as investment banking. He currently serves on the Board to 2 other public companies. His experience and business acumen will be especially valuable as we continue to grow the Company.

Eric Kogan, who has been Chairman will continue to serve as the Director. Our board also elected Brandon Black, President and Chief Operating Officer of the Company. Brandon has been Executive Vice President and Chief Operating Officer for the past 5 years and has done a superb job. Brandon is the architect of many of the analytical procedures and collection processes that distinguish Encore's approach to the business. His intelligence, analytical ability and drive for success have been instrumental in Encore's success and in his new role will be key factors as we continue to build the business.

I will continue to serve as Chief Executive Officer and will become Vice Chairman working closely with Brandon to manage the Company. This change will strengthen our ability to pursue strategic opportunities as we develop them.

In addition, we have previously announced that Paul Grinberg has joined Encore as Senior Vice President of Finance. Paul is an important new member of the senior management team and continues our tradition of investing in experienced, talented people who can make immediate and lasting contributions to Encore's success. Paul has a terrific background. He is a CPA, has his MBA from Colombia and has substantial experience in accounting, finance and mergers and acquisitions. He will not only strengthen our finance and accounting group but also purchasing where his contacts and insights will be immediately helpful.

These additions and changes demonstrate the Board's commitment to serving the stockholders' best interest by recruiting and promoting the strongest possible people to manage the Company's business. The future holds different challenges and opportunities in the past. These changes are part of our efforts to be certain that we are as prepared for the future as we have been for the past.

Turning now to the quarter's results on Slide 3. Once again they were very good. Compared with the third quarter of 2003, collections were up 22 percent; revenue had an increase at 57.5 percent; pre-tax operating cash flow was up 82.1 percent; net income was up 89.5 percent; and earnings per fully diluted share came in at 25 cents, 66.7 percent higher than the same quarter last year. This continues the strong performance we experienced during the first 2 quarters of this year and is attributable to both our disciplined approach to purchasing and our multifaceted approach to collecting.

As we have said before, we believe the use of customer level analytics to drive purchasing and collections is a key distinguishing characteristic of Encore.

On the purchasing front, we invested $21 million in new portfolios during the quarter, up 10 percent from the prior year's quarters purchases of $19 million. Our average purchase price for the quarter was 2.91 percent which was down slightly from last year's 3.02 percent. This was not as much as we had hoped to invest but appropriate given the high prices for much of the available supply.

Year-to-date, our purchases have been $57 million or about $7 million less than last year's first 3 quarters. For the year-to-date, approximately 48 percent of our purchases have been non-credit card, compared with just 6 percent last year for the same period. We will have more to say about purchasing in a minute but the purchasing discipline and analytical approach we've always taken are more important now than ever before.

To discuss the numbers in detail I will now turn the call over to Barry.

Thanks, Carl. As Carl indicated and as shown on Slide 5, gross collections in the third quarter of 2004 increased by 10.8 million or 22 percent to 59.9 million as compared to the 49.1 million collected in the same quarter of the prior year. Driving this growth were increases of 6.1 million in creditcard collections and 5.3 million in other asset categories.

As you can see on Slide 6, we also experienced a further increase in productivity during this quarter as average monthly collections per total employee increased by 18.6 percent to $27,300 from 23,000 in the prior year's quarter. This reflects the 22 percent increase in gross collections while total employees increased only about 3 percent. As you know we consider this an important metric to monitor.

In looking at collections by channel on Slide 7, we see that the $10.8 million increase quarter-over-quarter reflects a $10 million increase in the external legal collection channel and a $4.6 million increase in our new contingent agency channel. This increase in total collections was achieved despite reducing sales by $3.3 million.

Looking now at the next slide, the strong revenue growth reflects 2 trends that are the direct results of our conservative revenue recognition strategy. The first trend is the substantial growth in zero basis income from 5.1 million in the third quarter of 2003, to 10.7 million earned this quarter. To refresh your memory, zero basis reflects -- represents collections on those portfolios where the carrying value or adjusted cost basis has been entirely amortized.

The second trend is the increase in the revenue recognition percentage for our accrual basis portfolios. This results from our policy of conservatively estimating multiples on each new portfolio and then letting performance dictate increases and future expectations. Under this methodology but later in the ownership period, the adjustment is made the larger the affect it can have on future quarters. Our third-quarter results show this impact.

We implemented our remaining value model in the fourth quarter of 2003 which increased future collections, expectations and substantial proportions to the relatively small book values.

As you can see from the chart on Slide 9, those portfolios purchased prior to the introduction of our remaining value model had a third-quarter revenue recognition rate of 81 percent. While that may seem high, the life to date accretion rate is only 67 percent. You can also see that our lifetime revenue recognition on portfolio bought in the past year is 51 percent and will only be adjusted as question (ph) experience dictates.

We believe our accounting practices which have typically resulted in lower revenue recognition rates earlier in the life of a portfolio and higher rates later in the portfolio's life position us very well to the implementation of SOP-2003-03.

Turning now to Page 10, total operating expenses increased by 8.8 million to 28.3 million in the third quarter of 2004. As a percent of gross collections they increased from 39.7 in the third quarter of 2003 to 47.3 percent in a third quarter of 2004. There are 2 contributing factors that I would like to discuss.

The first factor it that the mix of our collections changed between the third quarters of 2004 and 2003. Sales, which is one of our lowest cost channels were down by 3.3 million. We were able to offset that decrease by increasing our throughput from our legal and contingent outsourcing channels which generated an additional 14.6 million in collections. The net impact was an increase in our cost per dollar collected.

The second factor is that the increase in cost that are for the most part not volume related. These include expenses for the implementation of our S3 Sarbanes-Oxley and an increase and health-care costs.

Our earnings continue to be impacted by the contingent interest feature of our Legacy funding facility. Slide 12 shows that the 20 cents per share of contingent interest expense was deducted before arriving at the 25 cents per share that we reported. We would reiterate our guidance that the 2005 and 2006 contingent interest expense will be approximately 60 percent and 30 percent respectively of the 2004 amount.

Finally on Slide 13, pre-tax cash flow grew by 82.1 percent to 12.1 million in the third quarter of 2004, from the 6.6 million generated during the prior year's quarter.

I will now turn the call back to Carl.

Thanks. As Barry mentioned, one of the primary metrics we follow is the monthly collections per average employee. Two other metrics that we also believe are quite important are shown on Slide 14. The first calculates how fast we are turning over our inventory and the second, how long it would take to fully amortized our existing portfolio at the current collections rate.

As Slide 15 shows, the turnover rate is calculated by dividing the sum of the beginning receivables balance and the annualized purchases by the annualized collections. As you can see, we are turning over our inventory about 1.5 times per year. The months to amortize collections is the receivables inventory at a point in time divided by the amortization rate. The resulting quotient is the total collections required to fully amortize the balance of the existing portfolio. When this number is divided by the average monthly collections, the result is the number of months required to amortize the portfolio. In our case 15 months.

By monitoring these 3 metrics, we ensure that we're not just collecting at an increasing rate but also penetrating the portfolios adequately.

Now Brandon is going to talk a bit about how we continually push the penetration model.

Thanks, Carl. Much of the focus on our business right now is on the rising prices and its impact on collection returns. The underlying assumption is that collections will be static and only prices will rise. I would like to take a minute to challenge that assumption.

As we have stated on many occasions, one of the core aspects of our strategy is challenging the conventional wisdom that persists in the debt collection industry. We believe that our commitment to innovation has allowed us to create historical returns in excess of our core business model and will mitigate some of the anticipated margin compression by improving the performance of existing and new portfolios. This innovation may take the form of creating new revenue channels or uniquely using those common to the industry.

Our most recent innovation is an example of the latter, specifically the development of a targeted agency outsourcing program. In contrast to the typical outsourcing cycle that moves static pools of accounts from agency to agency on a prescribed rotation, we are using our analytics to determine those individual accounts that cannot be profitably collected through our internal processes and are placing them with outside partners to generate incremental returns.

In general, as we said before, we expect about 80 percent of the accounts we purchased to pay us nothing during our ownership period. Recognizing that as a huge opportunity, we started a business development team late in 2003 to pursue new strategies for penetrating that large pool of accounts. Some areas of focus for us were low balances, accounts with no contact information and accounts beyond their legal statutes.

In the third quarter of 2004, collections from this channel amounted to $4.6 million, up from nothing in 2003. We believe much of these collections are incremental to our champion strategy and that channel will grow in 2005 and beyond. We are continually pursuing profitable liquidation strategy that will leverage our talented and deep management team. We believe our account level analytics will continue to unlock additional value on our portfolios and this approach should keep improving liquidation of our entire portfolio and provide flexibility to buy in the future.

Thanks, Brandon. Much has been said about the purchasing market over the last 9 months or so and I want to add a couple of personal thoughts and observations. Our better-known competitors and we would probably agree that too many deals are selling at prices not supported by the fundamental economics of the business. Our business is complicated and success only begins with buying the right portfolio at the right price. Ultimately success can only be realized by collecting well at a reasonable expense ratio.

The profitable returns generated by Encore, our public competitors and some of our larger private competitors over the last couple of years have been quite visible and have attracted a large amount of investment capital into the industry, contributing to a significant rise in the rise of the price of portfolios. In our view, a large portion of this money has flowed into companies whose business model is based on activity rather than a multi-disciplined approach to purchasing and collecting.

Interestingly, some of these activity based firms may be paying these higher than appropriate prices even though in our opinion, the underlying value of the portfolios they are buying measured in terms of ultimate collectibility has been degrading because the sellers have become much more sophisticated in choosing what to sell. Without the type of solid analytics we employ its difficult if not impossible to detect changes in portfolio quality before purchasing the accounts. By the time the purchaser realizes there's a quality issue, it may be too late.

Consequently it seems possible that over time many of these companies will fail to generate the returns they anticipated, reducing their access to capital and potentially requiring them to sell their remaining portfolios and exit the market. If and when this occurs, the results-oriented companies, such as Encore, will be in a strategically advantageous position to capitalize on such an event. Until the market stabilizes, we believe it's more important than ever to maintain discipline in purchasing in order to balance future profits growth and collections growth.

Before concluding, I'd like to remind everyone about the new accounting rule that will be implemented in the first quarter of 2005. We believe Encore is well-positioned for the adoption of SOP-0303. As Barry has indicated, we believe that our revenue recognition and amortization have been both appropriate and conservative. We don't anticipate any material impact from the implementation of the new rules.

Encore has a strong balance sheet, management resources and analytical skills to succeed in the challenging markets ahead. We believe the future is full of opportunity although it may be different than the past. We strongly believe that the market's natural weeding out process will ensure a return to prices supported by fundamental economics of the business. We are prepared to capitalize on those opportunities that are appropriate.

Now at this time, we would be happy to answer your questions.

(OPERATOR INSTRUCTIONS) Joe Chumbler from Stephens Inc.

Thanks. Good afternoon everyone. Just start off a question on the amortization rate. If I back out the contingency fee, collections, does that get close to about 30 percent for the quarter?

I'm not sure what bearing that has.

The contingent fee collections aren't a revenue source in terms of a different business. It's actually contingent firms working our accounts we own as a company. Unlike for example, you might be thinking about PRA (ph) who has a contingent business. This isn't a contingent business.

But you guys received cash collections via outsource collectors and that was reported in your cash collections number, right?

That is correct.

And you're calculating your amortization rate based off of revenue that you recognized?

Revenue recognized on all collections regardless of source.

Yes. Because the contingent agency accounts are spread throughout all of the portfolios.

So I guess my question is did that lower your amortization rate in the quarter since it included these contingency -- outsourced contingency fee collections?

No, I don't think it had any affect at all because a dollar collected is a dollar collected for revenue recognitions at this point.

Let me try a different angle. On the second-quarter call you had indicated that your amortization rate would be increasing?

Yes.

It came down fairly dramatically sequentially. Why is that?

Do you have any other further questions, sir?

Wait a minute. We haven't answered his question.

I apologize.

I'm not quite clear what you're driving act. I think on the slide on page 9 the difference between the Q3 revenue percentage in 1 or 100 percent is the amortization rate. What that slide does is it shows that on the zero basis portfolio is essentially they were almost entirely revenues. The accrual basis portfolios are in 2 buckets; those that we've acquired in the last year on which the amortization rate was about 40.2 percent and all of the other ones where we -- and that is the impact of the adjustments that we had taken that created a very large revenue recognition rate during this period of time because they were close to the end of their life. As a result, more dollars were attributed. But if you look at the far right hand column, you can see that the 81.2 amortization rate on a life-to-date basis is 66.9 percent. The amortization rate on a lifetime basis for those portfolios is 33.1 percent.

What 2 numbers are you using? So you are saying it went down from what to what?

Was your amortization rate about 22 percent in the quarter?

It was 27.3 percent.

Let me just go back over the numbers and follow-up with you later.

That would be fine. We would welcome your call.

My next question is just what do you need to do to achieve your reduction in contingency interest expense over the next couple of years?

It will naturally decline as we continue to collect on the portfolios because it's specific to the portfolios that were financed using the Cargill debt. So in the normal course of our collection activities, we will pay off the remaining principal under the individual note and then as the collections from the individual portfolios decline over time so will the contingent interest.

Is there a certain level of purchasing you need to maintain to maintain a certain mix in your finance receivable?

No, it simply is -- a catch to the portfolio is that we purchased using it prior to 12-31 of this year. So it's not tied, not linked to anything else.

Thanks guys.

Sure.

Charles Trafton with America's Growth Capital.

Carl, where is the zero basis coming from? Is that coming from the portfolios purchased 5 of more years ago since you are assumed 5 years life or is some of that some of our more recent vintage since you have moved up the timer period a little bit recently?

If you go to our model and what we talked about last quarter you will see that on portfolios that were 2 years out we had achieved the 2.7 multiple on most of our collection. The majority at these portfolios are in years 3, 4, and prior. Most of them are in years 3 and 4. There is actually some in years -- we bought 2 years ago. It really represents those portfolios that we collected much more rapidly that we thought and by the time we implemented our adjustments in the fourth quarter of last year, there just wasn't any basis left.

Those 80 portfolios will be a static pool in the sense that they will continue to decline as a group and as we employ our revised question methodology, we may have 1 or 2, but we shouldn't have large numbers of portfolios during this group. The way to look at that pool is a static pool that will decline over time.

Largely though, those portfolios were purchased in 2001 and 2002. Does that help?

Mostly '01 and '02. Yes.

There were some in 2003, Charles. I guess the point is they're relatively recent purchases.

Some portfolios you bought in '03, you've already collected the 5 year's worth?

We've already collected what we originally projected.

Right. Did you talk about -- somebody asked earlier about amortization rates in the future. Should that fluctuate much in the next 2 or 3 quarters as you go into '05?

I guess I would encourage you to look at the slide on page 9 and the answer is different in each of those buckets. The zero basis income for those 80 portfolios will have no amortization obviously and that will continue to erode over time. The portfolios that we've acquired in the last year essentially have an amortization rate of about 40 percent and over the life of that pool that will increase slightly unless we -- as you recall, we revalue portfolios after 6 months. And if after 6 months of experience the date that we learned about the customers and what we experienced in our collection channels causes to increase the forecast, we will.

And the final group is 100 portfolios that are currently at about a 19 percent amortization and that will continue to drift down but it will be a fairly high bucket, a fairly low amortization rate, I'm sorry. If you look at it in those -- we will continue to report out these traunches each quarter which should help you begin to forecast what you think our earnings will be.

And legal channel was up again a lot this quarter, is that going to be your best performing channel for the foreseeable future?

It's certainly an important channel at 30 percent of our collections and it will continue to represent a large part of our total. I don't know that it will grow to be much greater than 30 percent of the total going forward.

Okay. Thanks.

Rick Shane with Jefferies & Co.

Three questions. Actually just two because one has been answered already. What was the increase in revenue from the retained interest during the quarter -- that was up fairly sharply?

In April of this year we fully amortized the remaining balance of the retained interest on our balance sheet and consequently thereafter every dollar we collect on that is zero basis income.

It's just coming through a zero basis. That's helpful. The other question was from that slide on page 9 that you referred to, that's excluding any portfolios that are on our cost recovery basis at this point?

Yes. We only have one portfolio that has a book value of about $4,000 right now so it will be essentially -- we're essentially over, through all of the cost recovery portfolios.

That was it. All my other questions have been asked and answered.

Justin Hughes with Philadelphia Financial.

Good afternoon. You gave us some really clear guidance on what will happen with the contingency interest payment in '05 and obviously that's a direct result of collections. What are your collection assumptions to get to that reduction in contingency for '05?

Justin, we just elected consistently not to give guidance with respect to collections or revenue or profits looking out.

I'm not asking for guidance. I'm just wondering what was used to make those assumptions?

I'm not sure I can answer the question without giving guidance.

My next question is you guys are timely enough to get your Q out before the call -- one of the few companies that does, and when I --

Thank you for noticing.

And you moved your call up by a couple of weeks too.

That's right.

But when I look at your 2004 pools, to date you've collected 26 million and when I compare that to your '03 pool at the same time that had collected 59 million -- so it's down over 50 percent when I compare those 2 data points. Is that a fair assessment of how much more competitive the pricing is in '04?

I think one of the things you have to do is remember that in the first group, the older group, last year's group, we had a higher sales component. That's a meaningful number. I think that makes a big difference.

So in the '03 pool you sold more portfolios off?

More portions of the portfolio.

Generally when we sell portfolio, we sell at the time of purchase which is where the greatest opportunity to get a spread on what you paid. So most of the sales for example the 3.3 million in reduction in sales in this quarter would have been in the prior year would have been on new portfolios.

You've given the more competitive pricing environment, how much -- could you quantify for us how much lower your expectations are for returns because even if you're going to get the same collections at a higher price, it's going to be a lower return.

You're right, I think one of the challenges has been, as I tried to indicate, we don't want to drive collections by sacrificing profits. So the real skill here we think is balancing both of those things. It is a more competitive market. We expect to see lumpiness in the purchasing side of our business. And what we're purchasing is a raw material that drives both collections and revenue in the future. It's possible we could see lumpiness in revenues and collections in the future also.

The other thing, we tried to get across and it might not have been clear and what I said was, one of the things we're spending an equal amount of time working on is improving the return and not expecting to only collect a certain amount of dollars. Over time as these channels prove out, I think we'll see better returns than were expected but ultimately our goal is to maximize that penetration to hopefully offset some of that price increase.

Last question. One of the advantages you guys have is that you have a flow agreement that historically accounted for about -- I think it's about 35 percent of your purchases. How much did that account for this quarter and how long is that agreement in place or is there something that's kind of always open for negotiation?

That agreement actually expires at the end of this year although we've had that agreement several years and it has expired previously. And we've always renewed it when it did expire. So I can't predict what will happen when it expires at the end of this year. We would certainly sit down and see if we can make a financially feasible deal with the seller.

How much did that account for in the quarter for your -- of the 21 million in purchases?

Around 30 percent.

Around 30 percent. Thank you very much.

(OPERATOR INSTRUCTIONS) At this time we have no further questions. I'd like to turn the conference back over for any concluding comments.

Thank you all for tuning in to our conference call. As I said, we've had a fine third quarter and particularly with the changes in our management, we're very excited about our talent and our ability to capitalize on some opportunities that we see in the future. So tune in for the next one in about 3 months.

Ladies and gentlemen, this concludes the Encore Capital Group third-quarter 2004 conference call. If you'd like to listen to the replay of today's conference, please dial in at 303-590-3000 and you will need to enter the access code of 11013486, followed by the pound sign. Once again, thank you for participating in today's conference. At this time you may now disconnect.