Encore Capital Group Inc (ECPG) 2005 Q2 法說會逐字稿

Good afternoon, ladies and gentlemen, and welcome to the Encore Capital Group second-quarter 2005 conference call. At this time, all participants or 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 today, Thursday, August 4 of 2005. I would now like to turn the conference over to Tony Rossi of the Financial Relations Board. Please go ahead.

Good afternoon. We would like to welcome everybody to Encore Capital Group's second-quarter 2005 conference call. With us today from management are Carl Gregory, Vice Chairman and Chief Executive Officer; Brandon Black, President and Chief Operating Officer; and Paul Grinberg, Chief Financial Officer. Management will discuss second-quarter results and we will then open up the call to your questions.

Earlier today, Encore Capital Group filed its 10-Q for the quarter ended June 30, 2005. This is a 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 would like to note that certain statements in this conference call constitute forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995. Such statements involve 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 annual report on Form 10-K for the year ended December 31, 2004, filed with the SEC. Forward-looking statements speak only as of the date the statement was made. The Company will not undertake an 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?

Thank you, Tony, and good afternoon. We are exceptionally pleased with our second-quarter performance, in which we generated the highest level of collections revenue and earnings per share in the history of the Company. Particularly notable is that all of our key metrics improved over the first quarter, which is typically our strongest quarter of the year.

We continue to be guided by three core principles. First, leveraging our intellectual capital to discover hidden value and new ways through our proprietary technology and analytics expertise. Second, maintaining discipline, that is our commitment to buying right and collecting well. And third, embracing change to maximize profits through new markets, new ideas, and new approaches. As a result of our continued focus on these principles and the outstanding performance of our employees in San Diego and Phoenix, we see the following second-quarter results compared to the second quarter of 2004.

Net income was up 45% to $8.1 million. Earnings per fully-diluted share rose 42% to $0.34. Revenue increased 23% to $53.8 million, and collections increased 23% to $70.4 million.

A primary driver of our better-than-expected results in the quarter was our deeper penetration of more seasoned portfolios. This enabled us to continue to grow the profitability of existing debt portfolios, while simultaneously focusing on new growth opportunities. For example, even excluding the $3 million in collections associated with the Jefferson Capital portfolio, we collected more in the second quarter than in the typically stronger first quarter.

Of course, the most significant event of the second quarter was the transaction with Jefferson Capital, which brought Encore a large portfolio, a five-year forward-flow agreement and a seasoned staff to collect upon these accounts. In our view, the purchasing market remains extremely competitive, with prices remaining at a very high level. Against this backdrop, the Jefferson Capital transaction is strategically very beneficial.

In particular, we have largely satisfied our debt portfolio acquisition goals for 2005. Multiyear forward-flow components of the agreement provides us with approximately $55 million per month in fresh credit card charge-off at a fixed price. As such, we have locked in a material and meaningful portion of our future product supply on terms we consider attractive, including the ability to monitor the credit quality of each delivery of accounts.

Through this transaction, we believe we have at least partially insulated the Company from the irrationality and unpredictability of the debt purchasing market, the single biggest variable undermining the level of profitability of companies within the debt purchasing industry.

I would also like to mention that the integration of our new facility and collection team in St. Cloud, Minnesota is proceeding smoothly. We are very pleased with the superb quality of personnel we have added. They are seasoned, high-quality professionals. Additionally, there has been no interruption in their historical productivity and we have retained almost 100% of the employees since the announcement 60 days ago. We believe that as these employees are fully integrated into Encore's disciplined debt collection methodologies, they will become an important part of our team going forward.

With that as an overview, Paul will now take you through the financials in more detail. Paul?

Thanks, Carl. As Carl indicated, gross collections in the second quarter of 2005 were $70.4 million, an increase of 23% from gross collections of $57.4 million in the second quarter of 2004. This increase was primarily driven by our external legal and contingent agency outsourcing channels. These channels are used when our proprietary analytics suggest that the consumer's likeliness to pay would be greater using these channels versus a more traditional strategy.

In addition, all of the collections from the Jefferson Capital purchase are included in the contingent agency channel. Once their collectors become our employees in September, a portion of these collections will be added to our collection sites.

Revenue recognized as a percentage of collections was 76% in the quarter, the same percentage as last year. Consistent with our recent experience, this percentage reflects the deeper penetration of our more seasoned portfolios. Included in revenue for the second quarter was $9.2 million of zero basis revenue.

Our total operating expenses for the second quarter were $31.9 million, compared with $25.4 million last year. As a percentage of collections, operating expenses were only slightly higher than the second quarter of 2004, increasing from 44% to 45%.

Our total interest expense was $8.4 million in the second quarter, compared to $9 million last year. The contingent interest portion was approximately 21% lower than it was in the same quarter last year. Due to the stronger than expected collections from older portfolios, which still require contingent interest payments to the provider of our previous credit facility, our total contingent interest has been higher than we expected it to be this year. However, we still expect to see a decline in contingent interest in future quarters, with the degree of decline dependent upon the ultimate liquidation of our older portfolios.

Our current estimate of after-tax contingent interest expense for the remainder of 2005 is approximately $0.25 per fully-diluted share.

Although the Jefferson Capital transaction provided us with a significant amount of new debt to collect upon, we continue to be opportunistic in our approach to the traditional purchasing market, with a strict focus on the portfolios available with the most attractive terms. In addition to the portfolio purchase from Jefferson Capital, we spent $25.3 million to purchase $874 million in face value of credit card and automobile deficiency portfolios during the second quarter of 2005. I should note that we took our first delivery of fresh charge-offs pursuant to the new forward-flow agreement during July.

Before I conclude, I would like to cover a few details regarding the Jefferson Capital transaction. There were some minor adjustments to the portfolio we purchased from Jefferson Capital which resulted in the total face value we acquired now rounding down to $2.8 billion, rather than rounding up to the $2.9 billion we initially reported.

With regard to the forward-flow agreement, you will notice in our 10-Q that our total commitment covers $3 billion over the next five years. However, our agreement with Jefferson Capital obligates them to offer us 100% of their fresh charge-offs, and based on their current projections, we expect this amount to be closer to $3.25 billion over the five-year period.

We have also completed our preliminary allocation of the $142.9 million purchase price for the transaction. $95.7 million has been allocated to the initial portfolio we received, based upon our estimate of future collections from this portfolio. $42.2 million has been allocated to the value of the forward-flow agreement, which reflects the present value of the difference between our required future payments and the value we assign to the forward-flow portfolios. Essentially, this amount is the upfront portion of the total consideration to be paid for the forward-flow assets and will be spread evenly over the entire $3.25 billion of future forward-flow deliveries, taking into account the time value of money. It is not an option payment for the right to purchase the accounts.

The remaining $5 million has been allocated to goodwill, which relates to the agreement to offer employment to the 120 employees at Jefferson Capital upon completion of the three-month transition period.

The final allocation of the purchase price is pending completion of an external valuation study of the assets we acquired and we will provide updates on any meaningful changes that occur. Given our current allocation, we reaffirm our guidance for 2005 earnings per share of $1.25 to $1.33.

I would now like to turn the call over to Brandon, who will provide some closing remarks. Brandon?

Thanks, Paul. As we have witnessed over the past few years, the operating environment for the debt collection industry has changed significantly, in large part due to the rising prices in the purchasing market. We believe that this change may be a permanent shift.

he reality of this industry is that it is in constant flux, whether relating to pricing for portfolios, regulatory changes, new asset classes, new collection channels, changing consumer trends, just to name a few. As a result, our continued focus is to constantly refine our operating strategy and develop entirely new ways to address emerging challenges.

We believe we are well prepared to meet the expectations for growth ahead. With the expanding credit facility we have put in place with JP Morgan Chase, which is now 200 million plus an accordion feature for another 25 million, we have ample financial resources to take advantage of new growth opportunities as we find them. We are particularly pleased that we received such a strong response to the syndication of our new credit facility that has allowed us to reduce our interest rate margins and negotiate covenants that are more favorable to the Company.

On a final note, we believe a key element in our ability to effectively address the constant change in the industry is the composition of our management team. Our leadership team is comprised of a well-balanced mix of backgrounds and industry experience. This enables us to approach market challenges creatively and to consider a much broader range of business opportunities.

We recently added another exceptional executive with the hiring of Ron Eckhardt, who will serve in the newly created position of Executive Vice President and General Manager. Ron joins us following a 20-year career running a number of different businesses for Hewlett-Packard. The strong leadership and organizational skills that Ron developed at HP make him well-suited to manage our core debt collection process. His addition will allow other members of our management team to increase our focus on pursuing our long-term growth strategies, such as expanding into faster growing areas of the debt collection market and exploring acquisitions of complementary businesses.

In summary, we have never been more optimistic about the future of Encore. Our debt collection business is performing very well. We have locked in the necessary fuel to continue building this business with the Jefferson Capital transaction. We continue to add to our base of intellectual capital with seasoned executives that stimulate our ability to innovate. We have a strong pipeline of opportunities to expand into new segments of debt collection market, either organically or through acquisitions. And we have sufficient access to capital to invest in our growth strategy.

The collective impact of these factors makes us highly confident in our ability to increase value for our shareholders over the coming years. Now we will be happy to answer your questions. Operator, please open up the call.

(OPERATOR INSTRUCTIONS) Joe Chumbler, Stephens Inc.

Brandon, could you just give us your outlook for the non-card debt segment, maybe for the industry in general and for Encore, in terms of supply and deal flow?

Sure. We continue to see an increasing amount of portfolio being offered through, I guess I would call it, two primary sources, telecom and automobile deficiencies. So we are excited about the supply of raw materials. We are seeing pricing pressure in those segments like we see in the credit card business, but we believe we're starting to see a greater and greater flow of assets coming through those particular two markets. And hopefully, as they open up, we will see other things happen. But we are seeing nice movement.

So in your closing comments, when you talked about the challenges for the industry, were you referring more to the credit card class?

No, I think I am referring to in general the fact that pricing is up across the board. The amount of capital that has come in -- we believe here that it is more prudent to be proactive and deal with the fact that there may be a permanent shift in pricing. And I think there may be some people who are hoping that pricing turns around very quickly and we just don't see that happening.

And then what about just supply channels in general? Are you concerned that M&A in the banking industry is going to limit the number of sellers down the road at some point?

Obviously, there are deals being announced. There was one announced today. We don't see any slowing down of supply, maybe some concentration, which, quite frankly, positions us well because the larger the organizations become, I think they will tend to sell to the larger, more established, well-entrenched companies which we consider to be one of the few.

Okay. And then just on the agency commission line, it looked like it ticked up a little bit year-over-year and sequentially. Anything going on there?

No. As Paul mentioned, we continue to find opportunity in that channel, as our analytics prove out that there are assets we would not normally collect from that we are able to collect through that channel, so that is one natural growth. But the biggest jump in the quarter was the fact that we are accounting for all of the Jefferson Capital collections in that line item, so all the collections and the expenses associated with Jefferson Capital are in that channel.

Once those collectors from Jefferson Capital become our employees in September, the portion of their collections from their employees will be included in our sites rather than in the agency's. So there will be a flip beginning in the third quarter.

Okay, I missed that. Thank you.

Charles Trafton, America's Growth Capital.

In that CompuCredit 10-Q today, they had listed the payment for the forward flow of 67 million, I believe. Can you just tell us how that -- what is constituted in that 67 million and how you will account for it over time? I think earlier you talked about capitalizing part of the purchase price.

Sure. What I had mentioned is that we have allocated $42.2 million of the purchase price --

42.2?

42.2, which is different than the number that CompuCredit disclosed in their filing this morning. We determined that number to be the present value of the difference between our required payments under the forward flow and the value that we have assigned to the forward flow.

We assigned the value to the forward flow in a manner similar to how we assign value to any portfolio that we purchase, so we took the difference between our required payments and the ultimate value, discounted that back and came up with $42.2 million, which is the asset that is on our balance sheet that relates to this forward flow.

That asset will be allocated to each of the forward flow payments that we make over the course of the next five years on a pro rata basis, other than the fact that we will be taking into account the time value of money so the earlier allocations will be more heavily weighted than the later allocations.

Right, and they will be amortized over the life of the forward-flow agreement?

Those will be treated as we treat all of our portfolio. It will be added to the basis of the portfolio and it will run through our accretion model.

So, you've mentioned there was no option premium paid to them. Explain how the pricing on the forward flow will change in the future. Will you get credit for what you have already paid them today?

There is a fixed price that we're required to pay in the future, and for accounting purposes we will allocate a portion of this $42.2 million to that fixed price. Some of the fixed price plus the allocation of the $42.2 million will be, in total, treated as a purchase like any other purchase and will run through our accretion model.

So for purchase price multiple purposes, you will include the 42?

That is correct.

Okay. Did you have any impairments in the quarter vis-a-vis the new SOP?

We did not.

Are you aggregating all of your pools today?

We are aggregating all the pools with common risk characteristics, and in this quarter, all of the purchases have been aggregated in one quarterly pool.

Why not raise the guidance considering you beat this quarter's guidance so meaningfully?

We have always been conservative as a Company. We just made a very large transaction that we are integrating into our core business, and we felt like it was prudent to let that happen and make sure we have got everything where we want it to be before we re-examine the guidance range, and right now (indiscernible) to say that range is what we're comfortable with.

You mentioned earlier that you had taken your first delivery relative to the forward flow in June. I missed the date.

July.

In July? Okay, and collections from your collection sites were down the year-over-year, although legal and agency collections were up. Do you have lower productivity with your on-site collectors or is there higher productivity and just fewer of them?

It is the latter. It is higher productivity and fewer of them. We continue to be able to get more through our existing workforce and so we haven't had to add -- and, quite frankly, we've shrunk a few people, but once the Jefferson Capital employees come on board, that will increase the collector workforce by about 15, 20%

And are you getting better margins on the third-party collections that you're farming out to other agencies? How is pricing on that stuff -- like commissions?

It is really not comparable, because the assets that go through that channel don't look like the assets we would collect through our core collection channels. These are specifically targeted. And again, some of the categories, to give you an idea, are low balance accounts, low scoring accounts, skip accounts. And so the margins vary based on the product type, and it's very hard to compare it across to our collections sites because we are working our -- the accounts that seem to be most collectible to our collection site and less collectible accounts generally go through the agency cycle.

I just mean on your same-store basis, is the agency a higher margin channel for you than it was a year ago, vis-a-vis commission payments?

It is. It is higher, and it is for a reason that agency channel actually originated out of a big deal we did in December of 2003, and we left a portion of the accounts at the agency at the time. All of the accounts we left were payers, so the effective cost back then was in the low to mid-20s, and it has now normalized in the $0.40 range.

Okay, thank you.

I just wanted to add one other comment, just to clarify what I said a minute ago. There was a portion of the Jefferson Capital assets that were acquired which are bankrupt and deceased assets. We have ascribed very little value to those assets and we have included them in a separate pool for accounting purposes. So there were in fact two pools this quarter, one which includes the Jefferson Capital assets and all of our other purchases, other than these bankrupts and deceased accounts. The second pool includes the bankrupt and deceased accounts, for which we have allocated very little value.

Right. Okay, got it.

Dan Fannon, Jefferies & Co.

Thanks for taking my question. The forward-flow agreement is locked in at a set price, at least that's what was reported when you first announced it. Can you give us any color about whether there's any changes at those prices that have already been negotiated for the future periods, like two to three years out?

What we can say is that it is at a fixed price and it is not variable throughout the life.

Okay. On the conference call, you also stated that the collector that you acquired up in that Jefferson Capital facility works accounts differently than you do in your own sites. Can you elaborate on that for us?

Sure. Historically, the team up in St. Cloud had worked accounts in a manner similar to an agency where they are working them for a finite period of time, and then accounts would move from that site to a third-party agency and then potentially back. So what you had was a different operating model, where they were working accounts, again, almost exactly like an agency.

And do you see you being able to transfer other accounts that were worked in your San Diego or Phoenix collection sites being moved there or using that technique in other areas in which you hadn't before?

We actually see something potentially different, which is we have been impressed with the group up there and have made the decision to give them access to all of our accounts rather than just a small number of accounts through the Jefferson Capital transaction. So they will actually be blended in and look like our other two call centers, so that we will have three call centers working through a core process. We will continue to use some external agencies, who are really performing at excellent levels, to work some of the fresher assets through this transaction. But the team in St. Cloud will be converted closer to look like what we do today.

Okay, great. Thanks.

James O'Brien, Brean Murray.

I was wondering X the Jefferson purchase, can you give us maybe a split of what that was between credit card and automobile?

I think we are trying to get away from giving specific guidance or information around the breakout of our portfolios. And so I would rather not answer that.

Okay, fair enough. What about the credit card, though? Was it a mix or was it fresher paper? Can you give us a little there or no?

We have made several transactions that spanned across the whole delinquency range, so we bought some reasonably fresher paper and then some older paper.

Okay, getting back to your JP Morgan relationship, do you see perhaps going forward that situations such as that allows you to get bigger and have more financial wherewithal, and that will help you separate yourselves from the pack a little bit more in terms of when you go into a competitive bidding process and you are leaving other people perhaps behind who don't have that financial wherewithal?

We certainly believe that as the industry continues to be more competitive, that those competitors who can not only deal with the larger banks -- as was mentioned earlier, we think we will be in a position to write large checks to increasingly large companies, that our access to capital will be a distinguishing feature of the Company, and only those select firms who have that access, we believe will be successful in the long run.

Okay. And then just lastly here, turning back to the cash collections and obviously it was very strong, aside from your debt analytics and whatnot, what about from a macro level? Is this 5% unemployment environment we are in and a decent job creation environment, does that play into it at all or the type of paper you buy, those types of economic variables don't really matter when it comes to collecting?

We believe it is probably more the latter, that the consumers we are dealing with generally do not have a direct correlation to average consumer statistics. However, saying that, we have yet to find any repository of data that would allow us to do that correlation. So we believe in good times and in bad times you've got individuals who are in their own personal recession and it is tough to correlate macro economic variables to those individuals.

Okay, great. And then just one last one for you. You said you are still seeing deal flow but that the large purchases have set you up comfortably for the remainder of the year. But in looking, is there any other forward-flow contract maybe you are looking at and are they reasonably priced or that is not the case?

Rather than giving specific guidance of what we're looking at, I would say that we continue to see high prices and we haven't had the luxury of being able to be very selective in which portfolios we would buy. And our analytics put us in a position where we think we can understand value at a deeper level than many of our competitors.

Okay, fair enough. Thanks so much.

Frank DeSantis, Copper Beech Capital.

Great quarter. I would echo what Charlie Trafton said about the guidance, though. I think you are totally lowballing the numbers. In the Q, you break out the pro forma numbers for including the Jefferson transaction as if it were there for the whole time. You come up with like a six-month number of $0.82 versus the 66 that you reported. Does that include any sort of implicit cost of debt that you took down to make transaction? I mean, is the Company earning at a run rate now of $0.41 a quarter?

That number includes Jefferson Capital expenses and it includes allocation of certain CompuCredit expenses and it includes -- it includes a lot of things that will not be there for us when we have that portfolio. So that just looks at them as a separate business and what would have happened had we acquired that business at the beginning of the year.

So it is really not an apples-to-apples comparison with what it will look like as part of Encore, because we will not have those expenses, and we won't replicate them with -- we will have our own expenses.

I'm struggling to see with what is implicit in your second half guidance how you can't meaningfully beat that, but we can go on from there.

Also, on the estimated remaining collections that you have in the Q, since the purchase volume is 140, I presume that that includes the Jefferson transaction in there.

Yes.

So if we want to compare what happened to the estimated remaining collections, 1Q to 2Q, is there any kind of guidance you can give with regard to how much influence there was with the Jefferson acquisition?

It was that the Jefferson Capital transaction had was that we made a decision to continue to be conservative about continue to be conservative about estimated remaining collections until we can digest this portfolio. We did not materially increase future collections and we're going to let the portfolio go for another quarter or so. And that will then give us more visibility to how it impacts the collections under our legacy portfolio.

So there was an increase in the quarter. It was generally just the increase in overperformance in the quarter and that we have not increased expectations going forward, until we get comfortable that this large portfolio won't have any kind of negative impact on our collections.

So we can impute back then, if we know what first quarter ending estimated collections were and we know what you collected?

You can.

Good. And then in the cash collections that you had this quarter, were there any sales?

Yes, there were approximately $7.4 million of sales.

I'm sorry -- that is about in line with past quarters, isn't it?

Over the last couple of years, it has ranged from the low 3s as high as 9. So I don't know what the average is for the last couple years, but it has ranged from as low as 3.3 to as high as 9.

And then the last question, what are the critical assumptions that you have to make in order to get the MPV (ph) calculation for purposes of determining the 42 million that was allocated to the forward-flow agreement? Is it just as simple as estimating the collections or is it more than that?

It is pretty much as simple as -- not that it is simple, but projecting what we anticipate the future collections are from the forward flows and determining what our acquired payment is and the difference between the value from projecting the collections and the required payment, that comes up with the value.

Okay, great quarter.

Justin Hughes, Philadelphia Financial (ph).

A lot of them have been answered, but I wanted to ask on the 7.5 million that you sold this quarter, was any of that (indiscernible) from the Jefferson portfolio?

No.

Okay. And on your guidance for the second half this year, I agree it looks extremely conservative. If you hit the numbers you're talking about, it is giving the appearance that the Jefferson deal is dilutive, because you are pointing towards down second half numbers. I just don't see how it is possible with almost doubling the size of the receivables. But in the second half guidance, do you expect to sell any of the Jefferson portfolio and how much?

We would not give any specific guidance on what we would sell there. The only thing I would make to your first comment and the reason we are conservative and I think we are well-positioned is there is a larger kind of trend at play where you do have some exceptionally strong performing portfolios that are running off over time being replaced by portfolios that are profitable but not at the same levels. And so even as we add assets, you have to temper your expectations, understanding what happens to the legacy portfolios.

And I think the other thing that we did mention is that the valuation we have done on the Jefferson Capital portfolio is preliminary and we will have an external valuation firm perform a valuation, and the ultimate valuation could have an impact on earnings during the remainder of the year. So until we get that completed, we did not feel it was appropriate to change our guidance.

Okay. And how should we look at portfolio sales in the second half? Should we look at it to be 10% of corrections or should look at it being roughly 7 million a quarter?

It is very hard to pick a number. Quite frankly, we're very opportunistic in what we sell. For example, in the second quarter, we actually sold a good portion of accounts that we had owned for awhile that were in a skip Q (ph) status, where someone was willing to pay us more than we thought it was worth. That opportunity may go away, and so it is hard to say here is exactly what we will sell in the quarter. We're very opportunistic where we think we can sell a portfolio that has more value to somebody else than we have expected value in our forecast.

And then on the profitability on the flow agreement, you are projecting that the portfolio you have purchased already is going to collect 2.1 times what you paid for it. Should we expect a similar type of correction multiple on the forward-flow agreement if we were to add together what you have already paid for that agreement plus what you are going to be paying when the portfolio comes on? Should we look for a similar multiple?

Again, rather than giving you a specific multiple, I think you should continue to expect us to be conservative when assigning initial multiples, and as we get more comfortable with the collection curve, if performance dictates it, we will increase that multiple.

Okay. And then last question on the existing Jefferson portfolio, where we are we at in the cycle on that portfolio? Are collections still accelerating, are they flat, are they decelerating?

Again, without giving you the curve, what I will tell you is the portfolio we bought had a mix of assets that ranged from stuff that charged off as recently as May of 2005 and goes back several years. So it is going to be a combination of the strategy we employ that will get there, but we think there is a tremendous amount of collection to be had in the near term for that portfolio.

You can't tell us on a weighted average basis if that is accelerating or decelerating?

No.

Thank you.

There are no further questions at this time. Please continue.

I'd like to thank everybody for joining us today and we look forward to speaking with you again next quarter.

Ladies and gentlemen, this concludes the Encore Capital Group's second-quarter 2005 conference call. You may now disconnect.