Encore Capital Group Inc (ECPG) 2007 Q1 法說會逐字稿

Good afternoon, ladies and gentlemen. Thank you for standing by. Welcome to the Encore Capital Group first-quarter 2007 earnings call. During today's presentation, all parties will be in a listen-only mode. Following the presentation, the conference will be open for questions. (OPERATOR INSTRUCTIONS). This conference is being recorded Tuesday, May 8, 2007.

I would now like to turn the conference over to Tony Rossi of the Financial Relations Board. Please go ahead, sir.

Thank you, operator. Good afternoon and welcome to Encore Capital Group's first-quarter 2007 conference call. With us today from management are Brandon Black, President and Chief Executive Officer, and Paul Grinberg, Chief Financial Officer. Management will discuss first-quarter results and will then open up the call to your questions.

Earlier today, Encore Capital Group filed its 10-Q for the quarter ended March 31, 2007. This is a complete report of Encore's results, and we encourage you to read it thoroughly as 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 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 SEC filings, including its Annual Report on Form 10-K for the year ended December 31, 2006.

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.

In addition, the presentation today also includes information concerning adjusted EBITDA and other non-GAAP financial measures. The Company believes that these non-GAAP financial measures provide useful information to both management and investors in evaluating the Company's operations. The presentation of this additional information should not be considered as alternatives to or more meaningful than the Company's results prepared in accordance with GAAP. The press release issued today contains a reconciliation of adjusted EBITDA to reported earnings under GAAP and a reconciliation of operating expenses excluding stock-based compensation expense, Ascension Capital operating expenses and costs related to the consideration of strategic alternatives to the GAAP measure total operating expenses.

You can access a copy of the earnings press release by visiting the Company's Investor Relations website at www.encorecapitalgroup.com. As a reminder, this conference call will be available for Internet replay for the next 30 days.

With that, I would now like to turn the call over to Brandon Black. Brandon?

Thank you, Tony, and good afternoon. The beginning of 2007 has been very positive for Encore. Our first-quarter collections performance was one of the strongest in the Company's history, and we saw increasing productivity from our key strategic investments in India and the legal channel. Additionally, after the quarter closed, we finalized a buyout of the remaining contingent interest on our legacy secured lending facility.

Gross collections, excluding sales, were at an all-time high for the Company, and we saw a 20% increase in earnings per share when compared to the first quarter of 2006. This strong performance was largely due to the realization of the benefits of the new operating initiatives that we began early in 2006 and the corresponding increases in IRRs, which are the direct result of higher collections on existing pools of receivables.

As we discussed on our last call, we began collecting across all balance ranges in India at the beginning of the year. Previously, the team in India was only collecting on balances less than $500. Early returns are positive. In the first quarter of 2007, we collected $2.2 million in India compared to $500,000 in the first quarter of 2006 and $4 million for the entire year. As a result of that strong performance, we expanded the workforce in India to over 200 people at the end of the first quarter.

Our legal collections in the first quarter were once again at an all-time high and continued to be our largest collection channel. The new legal initiatives that we began discussing last year continued to perform as expected and will generate significantly more collections on certain accounts we would have collected merely using traditional strategies.

During the quarter, we invested $45 million to buy approximately $2.5 billion in fixed value of debt. This is up from an investment of $27 million in the first quarter of 2006. Our purchases happened to be concentrated this quarter in credit card portfolios as this asset class exhibited the best value during the period.

Despite the increase in purchase levels year over year, our view of the industry remains unchanged. Pricing remains at elevated levels across all asset classes and competition for portfolio is fierce. We anticipate this trend will continue and believe future earnings growth and long-term success in the debt purchasing business will be driven by our ability to improve the yield on new portfolios through continued innovation, not by merely using traditional collection methods. Such innovation will require investments which may have a negative impact on earnings in the short term, but will position us well for the long-term success.

Turning to the negotiated buyout with our prior lender, I'm pleased to report that we reached an agreement that will eliminate all future contingent interest payments going forward. Yesterday, we made a lump sum payment of $16.9 million that satisfied all remaining obligations to the prior lender, a portion of which will be expensed in the second quarter. This buyout will be the final chapter in what ended up being a very expensive relationship for Encore. As mentioned in prior calls, this was the only practical financing source available to us at the time we entered into it. As a result of our success over the last few years, we currently have less expensive financing alternatives available and we continue to take steps to lower these costs. Paul will discuss this transaction, which is both [NTV] positive and EPS accretive over the long term, in more detail.

Finally, I would like to discuss the recent changes to our stockholder base and the anticipated changes to our Board of Directors. As mentioned in our press release on April 23, we view J.C. Flowers, FPK Capital and Red Mountain as strong partners in building long-term value for Encore and all of its stockholders. We developed a strong relationship with Red Mountain over the past year, and while our affiliation with J.C. Flowers and FPK Capital has been formed more recently, we look forward to building on their deep knowledge of the financial service industry and their global relationships. In our discussions with these stockholders, they have been enthusiastic about the future of the consumer debt recovery industry and supportive of our strategies to grow the business.

We expect representatives from J.C. Flowers, FPK Capital and Red Mountain to be invited to join the Board shortly after the closing of FPK's purchase, currently scheduled for later this week. At that time, Ray Fleming, Eric Kogan and Peter May are expected to step down from the Board, and we expect to add four new members. Peter, Ray and Eric have each been affiliated with the Company for more than a decade. Each of them has contributed a great deal, and I would like to thank them for their many contributions.

Also, as we announced last week, Carl Gregory has been appointed Chairman of the Board effective May 1, replacing Dick Mandell, who will remain a Director and will continue to serve as Chairman of the audit committee. I'm excited that both Carl and Dick are going to remain with the Company and work with the management team as we execute on our strategic vision.

With that, I would like to turn it over to Paul to review our results in more detail. Paul?

Thanks, Brandon. Let me begin with the results from our debt purchasing business. Gross collections in the first quarter of 2007 were $90.5 million, an increase of 3% over the $87.6 million in the first quarter of 2006. Within our collection channels, legal collections continued to grow, increasing to $39.7 million in the first quarter of 2007 versus $25.8 million in the first quarter of 2006. This represented a 54% year-over-year growth in legal collections and was 44% of our total collections in the quarter. As we have mentioned over the past several conference calls, we believe that this is a direct result of the new initiatives put in place during 2006. This marks the third quarter in a row where legal collections represented the largest component of collections.

Collection sites represented nearly 38% of total collections, amounting to $34 million in the quarter. Sales represented 8% of collections at $7.3 million, nearly flat with $7.1 million in the prior year. The remaining 10% of collections were primarily from outsourced collection agencies.

Our revenue from receivable portfolios in the quarter was $62.2 million, an increase of 8% over the $57.6 million in the same period of the prior year. This included a net reversal of allowance charges of $217,000, composed of allowance charges taken during the quarter of $1 million and reversals of prior allowances of $1.2 million.

Revenue recognized on receivable portfolios as a percentage of portfolio collections was 69% in the first quarter compared with 66% in the same period of the prior year and 69% in the fourth quarter of 2006. The increase in the revenue recognition rate year over year was due to improvements in IRRs associated with several of our pool groups. As we mentioned previously, we expected additional collections from our legal initiatives which ultimately would enable us to increase IRRs in those pool groups where we deployed these strategies. This expectation materialized this quarter. The increase in the revenue recognition rate was also due to higher purchases in Q4 2006 and Q1 2007 compared to Q4 2005 and Q1 2006.

Our revenue recognition rate is dependent on several factors, including the mix of collections coming from higher and lower multiple pool groups, seasonality, changes to IRRs resulting from increases in expected future collections, and the timing and volume of purchases. Since revenue on any pool group is relatively consistent from period to period, during periods of higher collections, like the first quarter, all else being equal, the revenue recognition rate will typically be lower than periods of lower collections like the fourth quarter. Additionally, revenue is generally at its highest in the period immediately following a purchase.

Moving on to Ascension, our outsourced bankruptcy servicing business, servicing fees for the quarter were $3.2 million, up 12% over the $2.8 million last year. While increasing year over year, Ascension's revenue for the first quarter, like previous quarters in 2006, continues to be impacted by the dropoff in bankruptcy filings following bankruptcy reform in the fourth quarter of 2005. We continue to see bankruptcy filings rise at a moderate pace and hope that bankruptcies will return to their pre-reform levels by the end of 2007.

From a pipeline perspective, we're seeing more interest from creditors, yet we believe Ascension's revenue for 2007 will continue to be impacted by lower placement n volumes. Please note that Ascension's revenue in the second quarter of 2007 will not be comparable on a year-over-year basis. In the second quarter of 2006, we recorded the revenue associated with a large spike in bankruptcy placements immediately prior to bankruptcy reform. This resulted in approximately $6.3 million in revenue in the second quarter of 2006. We expect our Q2 2007 revenue to be similar to what was achieved this quarter.

Ascension generated net loss in the first quarter of $930,000 versus a $2.1 million loss last year. Included in the loss for the first quarter of 2007 were approximately $750,000 in noncash amortization charges relating to the amortization of intangible and other assets established in connection with our purchase accounting for Ascension.

Turning to expenses, our total operating expenses for the first quarter of 2007 were $49.8 million compared with $44.7 million in the same period last year. Our operating expenses in the first quarter of 2007 included stock-based compensation expense of approximately $800,000; operating expenses of $4.1 million for Ascension, which is a fee-based business; and $100,000 in costs related to our previous consideration of strategic alternatives. Excluding these items, our operating expenses as a percentage of collections were 49% in the first quarter of 2007 compared to 44% in the first quarter of last year. This increase is primarily attributable to the increase in legal costs associated with our newer initiatives.

Our total interest expense was $6.2 million in the first quarter of 2007 compared to $8 million in the same period last year. The contingent interest component of interest expense was $3.2 million in the first quarter of 2007 compared with $4.7 million in the same period last year. As Brandon mentioned, after the quarter closed, we reached an agreement with our previous secured lender to buy out all future contingent interest payments for a lump sum payment of approximately $16.9 million. As a result, beginning in May, we will no longer be incurring contingent interest expense in our financial statements.

The difference between the buyout payment and the amount accrued as a liability for profit sharing on our balance sheet will result in a one-time expense in the second quarter. We estimate that this expense will be approximately $11.7 million. We expect the net after-tax impact of the buyout to be negative by approximately $0.30 per share and will in all likelihood cause our overall second-quarter reported results to be negative. However, from a net present value perspective, this transaction is favorable for the Company and will improve the third and fourth quarter's results by approximately $0.06 and $0.05 per share after tax, respectively, due to the elimination of contingent interest expense.

Similarly, 2008 and beyond will see some EPS improvement from the elimination of any future contingent interest. And over the long term, this transaction is expected to be EPS accretive.

Concurrently with this buyout, we have amended our current credit facility to exclude the P&L impact of the buyout from the calculations of our financial covenants. As Brandon mentioned, we're happy to put this expensive financing facility behind us. Since we've put it in place in December 2000, we have paid more than $120 million in contingent interest, which has resulted in a significant drag on our profitability.

As it relates to stated interest expense, we expect to realize some improvement in our weighted average interest rate. In the first quarter, our weighted average interest rate on our line of credit was 7.4%. After the quarter closed, we entered into two separate interest rate swap agreements to effectively manage interest rates by establishing a set level of fixed rates. The first agreement is for a notional amount of $25 million, has a term of three years and a fixed interest rate of 4.99%. The second agreement is for a notional amount of $25 million, has a term of four years and a fixed rate of 5.01%.

We will continue to pay our credit spread of between 1.75% and 2.25% in addition to this fixed rate. Thus, we have effectively set approximately half of our line of credit interest at 7% for the next several years. This is currently below the prime rate of 8.25% and LIBOR plus our credit spread, totaling 7.32%.

Our tax expense in the quarter was $3.9 million. Our effective tax rate was 40.8% compared to 40.7% in the prior year. This rate is in line with the 40% to 41% range we expect in the future. Our fully diluted earnings per share were $0.24 in the first quarter of 2007 compared to $0.20 in the same period last year.

Our adjusted EBITDA was $45.9 million in the first quarter of 2007, which reflects net income before interest, taxes, depreciation and amortization, stock-based compensation and portfolio amortization. This was down slightly compared to the $47.8 million in the first quarter of 2006, primarily due to a shift in collection mix to the legal channel, which currently has higher upfront costs and an unusually high volume of collections from the mail channel in the 2006 quarter, which is a relatively low-cost channel. We continue to believe that this metric demonstrates our ability to profitably liquidate portfolio and generates strong cash flows.

Before I turn it back to Brandon, I would like to point out two new disclosures that we have included in our 10-Q that we filed today. In our supplemental performance data, we have included a table which shows the expected amortization of our current investment in receivable portfolios for the remainder of 2007 and for each calendar year thereafter. We've also included a table that shows our current projection of estimated remaining collections by purchase year for the remainder of 2007 and for each calendar year thereafter. Both of these tables have been provided in an effort to be more transparent regarding our collection assumptions on existing portfolio and the timing of amortization related to these portfolios.

We believe that with this additional information, analysts and investors will be able to more accurately model our business by being able to calculate aggregate portfolio IRRs by year of purchase, and with that, the corresponding revenue. Coupled with assumptions for new purchases, investors should be better able to forecast our debt purchasing business' revenue recognition.

When reviewing these disclosures, please keep in mind that our collection curves reflect a 72-month forecast and this will have an impact on the amortization in collections in the latter part of the collection curves. For example, for the 2005 vintage, the estimated remaining collections declined from $16.4 million in 2011 to less than $200,000 in 2012. Over time, we will continue to update our estimated remaining collections, which could change the amount of timing of collections from any particular vintage.

Before we open up the call for questions, I would like to turn it over to Brandon for some additional remarks. Brandon?

Thanks, Paul. We are excited about the future of Encore Capital Group. With each quarter, we're seeing more evidence that our investments in India and the legal channel were prudent and will ultimately have very positive impact on our profitability. Due to our success in these initiatives, we're starting to see more opportunities to buy portfolios that meet our hurdle rates, which makes us optimistic about both revenue and earnings growth in future years.

While we are reiterating our view that this year is the second year in a two-year investment period, we expect our cost per dollar collected as a percentage of collections to begin trending down on a year-over-year basis toward the end of 2007.

Other investments in areas such as healthcare receivables and bankruptcy servicing have been slower to materialize, but we continue to feel that these areas will be meaningful businesses for us in the future. These investments underscore our commitment to managing with a long-term focus and making decisions based on what will create the most value for stockholders over time rather than what will produce the highest short-term earnings. Our buyout of the remaining contingent interest is another example of our approach to capitalize on transactions and investment opportunities that will yield positive net present value payoffs for the Company.

In closing, we believe we are pursuing the appropriate strategies for maintaining a sustainable, competitive advantage in the evolving distressed consumer debt industry. The execution of these strategies is proceeding well and tracking according to our expectations. As time passes, we believe the results of our efforts will become more pronounced and will create significant value for our stockholders in the years to come.

We would now be happy to answer any questions you have. Operator, we're ready for the first question.

(OPERATOR INSTRUCTIONS). Mark Hughes, SunTrust Capital.

Brandon, you had suggested you expect the cost per dollar collected to trend down by the end of this year. Is that to say the percentage of costs to gross collections year over year ought to be improving?

That is correct, Mark.

How about the type of paper that you are acquiring? Any differences in terms of the freshness of the paper? Is it similar to your historical mix, or have you shifted the focus at all?

It's a good question. Every quarter, it varies. We have one consistent type of portfolio, which is the Jefferson Capital forward flow, which is fresh paper. Other than that, we are opportunistic and we buy across other asset classes and age. So it will vary quarter to quarter. This one happened to be concentrated in credit card portfolios, but that is not a shift in strategy; it's more taking advantage of where we thought the greatest amount of value was.

Refresh me again on how much was Jefferson Capital in the quarter.

Paul is looking at it.

In the quarter, it was $17 million.

You had discussed in the last conference call that you would be capitalizing some expenses. Is that something that you are going to keep us up to date on? Or is that disclosed in the Q?

Mark, this is Paul. We have done that for the last several years, since we've started with our legal strategy. So it's not something new that we started. We just went into a little more detail over the last couple of calls because it's becoming a larger portion of our collections. But we do disclose the amount that is capitalized in the other asset footnote in the 10-Q, and it's not a change in what we have done historically.

Brian Hagler, Kennedy Capital.

Just wanted to get a little bit more detail on the payoff of the contingent debt. What was the remaining maturity on that if you would not have paid it off?

There was no practical maturity. We owed the prior lender a percentage of collections in perpetuity. So as long as we collected on portfolios that were underwritten in the window where they lent us the money, we owed them a contingent interest piece. So it would go out for years.

So is it safe to assume, based on some of the details that Paul provided, that the payback period on this transaction is about a year and a half to two years, using the $0.06 and $0.05 numbers for third and fourth quarter?

It will obviously trend down over time. It is probably not an unrealistic window to think about. But it won't be at that -- it won't be $0.11 over two quarters. It will come down over time. But that is probably a fair period of time. On a cash basis, it is slightly different because cash was actually higher than what is in the P&L. So cash will pay back faster.

And then finally, I guess there's no mention or comments on the buyback, and it doesn't appear that maybe there was any. Did the payoff for this contingent interest preclude that, or can you comment on potential buybacks?

Sure. I think in the last call, we were asked the question -- we've got a buyback committee that is looking in any given period of time at all the possible uses of capital for the Company and making a determination -- is that the right time to buy the stock back? We did not make any purchases in the quarter, but that doesn't mean that we won't in the next quarter; it's just there's a constant discussion about what are the opportunities in front of the Company and when do we want to take advantage of the opportunity.

So the payoff of this contingent interest really didn't have anything to do with the buyback strategy this quarter?

It did not. It was a use of capital, but it wasn't a factor one way or the other.

(OPERATOR INSTRUCTIONS). I show no further questions at this time. I would like to turn the call back over to management for any closing remarks.

Thank you, everybody. We will speak to you at the next conference call.

Thank you. Ladies and gentlemen, this concludes the Encore Capital Group first-quarter 2007 earnings call. You may now disconnect.