Encore Capital Group Inc (ECPG) 2007 Q2 法說會逐字稿

Good evening, ladies and gentlemen, and thank you for standing by. Welcome to the Encore Capital Group second quarter 2007 earnings conference 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 today, August 8, 2007. I would now like to turn the conference over to [Erin Cox], Financial Relations. Please go ahead, ma'am.

Thank you, Operator. Good afternoon and welcome to Encore Capital Group's second 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 second quarter results and will then open up the call to your questions.

Earlier today, Encore Capital Group filed its a 10-Q for the quarter ended June 30, 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 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 SEC filings, including its annual report on Form 10-K for the year ended December 31st, 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 these non-GAAP financial measures provide useful information to both management and investors in evaluating the Company's operations. This presentation of this additional information cannot be considered as an alternative 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 measured 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 like to turn the call over to Brandon Black. Brandon.

Thank you, Erin, and good afternoon.

During the second quarter we continued to follow the long-term operating plans that we have been sharing with you over the past year. Our operating results this quarter are directly attributable to these strategic decisions made more than a year ago, which are now having a positive impact on our collections and revenue.

These decisions are focused on optimizing value of our receivable portfolio over the collection life, irrespective of the impact they will have on our near-term quarterly earnings. We believe that this approach will maximize earnings for our stockholders and will solidify Encore's position as a leader in the increasingly competitive debt purchasing industry. Specifically, our second quarter collections performance benefited from the investments we've been making in our legal channel and in India. These initiatives of the drivers behind the sequential increase in collections despite the second quarter usually being seasonally slower than the first quarter.

During the second quarter, we collected $2.5 million in India compared to $950,000 in the second quarter of 2006, and $4 million for all of 2006. We have expanded the workforce in India to over 280 employees up from 160 in the same period last year.

Our legal collections in the second quarter were once again at an all-time high and continue to be our largest collection channel. The new legal initiatives that we began discussing last year continues to perform as expected and will generate significantly more collections on certain accounts than we would have collected merely using traditional strategies. As we have mentioned in the past, for accounts that are appropriate for the strategy we estimate that we will not collect more than three times what we would have achieved otherwise.

While these strategies are highly additive to our total collections, they have caused some increases in our cost per dollar collected while they ramp up. As we've stated previously, excluding the impact of sales we continue to expect our cost per dollar collected to start trending down on a year-over-year basis, beginning in the fourth quarter of 2007.

In addition, we continue to look for meaningful ways to reduce our expenses, which will make us more competitive when bidding on portfolios.

Looking at purchases we invested $41 million during the quarter to buy approximately $1.3 billion in fixed value of debt. This is up from an investment of $21 million in the second quarter of 2006. Similar to the first quarter, our purchases were more concentrated in credit card portfolios. Again this asset class exhibited best value during the period. As in the last few quarters, our ability to deploy capital has been positively influenced by the incremental liquidation, created with our newer initiatives, and has given us a competitive advantage while needing.

Despite our doubling of purchases year-over-year, our view of the industry remains generally unchanged. While we have seen some easing in portfolio pricing for certain alternative asset classes, specifically telecom where servicing costs are likely affecting the underlying economics, it is the exception of the rule. We anticipate this trend of elevated pricing will continue, which will put a premium on our ability to find new and innovative ways of increasing yield on purchases, combined with a relentless pursuit of managing costs.

And as we've said in the past our focus is on driving increasing levels of cash flow, which should allow us to increase profitability despite the higher prices for portfolios. Our goal is to maximize dollars collected, let dollars spent on net present value basis, not to manage to or minimize the ratio of dollars spent to dollars collected at any given period.

While we continue to operate the business as efficiently as possible and actively look for ways to drive down costs, we will pursue liquidation strategies that will generate incremental collections, even if they have a higher cost than our existing strategies if we believe they will increase our total cash generation over the life of the portfolio.

With respect to Ascension Capital, our outsource bankruptcy servicing business, new funds are increasing albeit at a continued slow pace. The executives now in charge of business development are ramping up their sales efforts and we continue to rightsize the business to deal with the lower placement volumes resulting from bankruptcy reform.

Total headcount at Ascension has declined to nearly 150 people from 190 a year ago. This has reduced Ascension's quarterly cash breakeven level to approximately $3.2 million in revenue, down from $3.8 million a year ago.

Before Paul discusses the financial results in more detail, I'd like to provide some additional thoughts on all the recent headlines surrounding the subprime mortgage turmoil, credit crunches, and the like.

As the headlines suggest and we concur, we continue to see the consumer coming under pressure and expect favorable long-term growth prospects in the distressed consumer debt market. We believe the major strategic investments we have made over the past few years should allow us to take advantage of these opportunities. The timing and the magnitude of the opportunities still remain to be seen but we are very encouraged by recent success and the prospects on the horizon.

We also now have the benefit of our association with J.C. Flowers and Red Mountain. Our four new Board members are actively involved and have already begun to work on the Company's behalf, making introductions to key leaders in the financial services industry that can potentially open up new purchasing opportunities. We are pleased to have them as part of the team.

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

Thanks, Brandon.

Before discussing the results for the quarter, I wanted to highlight some additional disclosures that were incorporated into the 10-Q which was filed today. This quarter, we added more detail in our supplemental performance data on our cost as a percentage of collections from our legal and agency outsourcing channels.

We believe this information will provide investors with additional insights, particularly as it relates to our court costs. I will talk about these in more detail during my discussion of operating expenses.

In addition to the new disclosures made in the first quarter on future gross collection expectations by vintage and year for our estimated remaining collections, we will look to provide new information that will make our business more transparent to the investment community. After investors and analysts have had a chance to review these new disclosures, we will be available to answer any of your questions.

Turning to the results for the quarter, our fully diluted loss per share was $0.04 compared to earnings per share of $0.32 in the same period last year. This quarter's results included the impact of a $0.30 per share after-tax charge related to the agreement reached with our previous lender to pay off all future contingent interest payments. Without this onetime charge, we would have earned $0.26 per share.

As we mentioned in our last earnings call, we reached an agreement with our previous secured lender to buy up all future contingent interest payments for a lump sum payment of approximately $16.9 million. As a result, beginning in May we no longer incurred contingent interest expense in our financial statements.

This is the final chapter of what was a very expensive relationship for Encore. For the past few years, our results have been skewed by this burdensome arrangement. In total, we paid more than $120 million in contingent interests under this financing arrangement.

Going forward, our results will be more comparable to our competitors, and the focus can shift from the differences caused by financing choices to net liquidation, which is the true measure of success in this business.

Adjusted EBITDA for the quarter was $47.1 million, which reflects net income before interest, taxes, depreciation and amortization, stock-based compensation and portfolio amortization. This was up 10% compared to the $42.8 million in the second quarter of 2006. We continue to believe that this metric demonstrates our ability to profitably liquidate portfolio and generate strong cash flows.

Gross collections in the second quarter of 2007 were $93.6 million, an increase of 18% over the $79.2 million in the second quarter of 2006. Excluding the large portfolio sale in the fourth quarter of 2006, which was related to purchases financed by our previous secured lender, this was the highest level of collections we have achieved as a company.

Within our collection channels, legal collections continue to grow increasing to $44.4 million, compared to $29.1 million in the second quarter of 2006. This represented a 53% year-over-year growth and was 47% of our total collections in the quarter. As we've mentioned over the past several conference calls, we believe that this is a direct result of the new initiatives put in place during 2006.

Collection sites represented nearly 35% of total collections, amounting to $32.5 million in the quarter. Sales represented 9% of collections at $8 million. I would like to elaborate a little more on our treatment of sale proceeds and revenue recognition.

As we've stated previously, we treat sales as collections, not as revenue. As such whether the collections come from sales or any other channel in a given period, this does not have a direct impact on revenue other than as it relates to the timing of cash flows and the resulting IRR assigned to any given pool of receivables purchased.

Thus, $1 of sales is accounted for the same way as $1 collected from our legal channel, from our agency channel, or from our internal sites and revenue is recognized on that $1, based on the revenue recognition rate for the pool group it was collected from. As I have mentioned in prior calls we sell accounts opportunistically, when we receive more for the sale in the open market than the net present value of our expected remaining cash flows.

The remaining 9% of collections were primarily from outsourced collection agencies. While agency collections have decreased to $7.7 million from $14 million in the prior year, there's more of a function of the mix of paper we have been placing with the agencies and the natural transition of much of the Jefferson Capital bulk portfolio to our internal sites.

Our revenue from receivable portfolios in the quarter was $64 million, an increase of 7% over the $59.6 million in the same period of the prior year. This included a net reversal of allowance charges of $1 million composed of allowance charges taken during the quarter of $1.4 million, and reversals of prior allowances of $2.4 million.

Revenue recognized on receivable portfolios as a percentage of portfolio collections was 68% in the second quarter compared with 75% in the same period of the prior year. The decrease in the revenue recognition rate year-over-year was due to a higher percentage of collections from more recently purchased portfolios that have lower collection multiples assigned to them, as well as a higher level of collections in the second quarter of 2007, as compared to the prior year.

Further explanation of the variance in revenue recognition is detailed in the MD&A section of our 10-Q.

Turning to expenses, our total operating expenses were $52.6 million compared with $45.7 million in the same period last year. Included in operating expenses, stock-based compensation expense of approximately $1.2 million operating expenses of $4 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 expenses as a percentage of collections were 50.5% compared to 49.5% in the second quarter of last year. This increase is primarily attributable to the increase in legal costs associated with our newer initiatives. In particular you can see in the new disclosure in our 10-Q damaging previously that court cost expenses have increased to $8 million is quarter compared to $3.6 million in the second quarter of last year, as a result of the significant growth in the number of accounts that have been placed through our legal channel. If court cost expenses had remained constant, our cost per dollar collected would have been closer to 46%.

Moving on to Ascension, our outsourced bankruptcy servicing business, servicing fees for the quarter was $3.2 million, down 48% from the $6.2 million last year. This decrease is primarily attributable to the onetime spike in bankruptcy placements, leading up to bankruptcy reform in 2005, which were recognized in revenue during the second quarter of 2006.

Ascension generated a net loss in the second quarter of $830,000 versus a profit of $1.3 million last year. Included in the loss were approximately $710,000 and non-cash amortization charges relating to intangible and other assets established in connection with our purchase accounting. This compared to a $930,000 in the first quarter of 2007, a period that was not skewed by the increase of revenue relating to bankruptcy reform.

While we continue to see bankruptcy filings increase at a moderate pace we believe Ascension revenue for 2007 will continue to be impacted by lower placement volumes.

Finally a financial note this quarter. Our weighted average interest rate on our line of credit was 7.35% for the quarter, which reflected the positive effect of the two separate interest rate swap agreements we entered into during the quarter totaling $50 million. These agreements effectively manage our interest rates by establishing a set level of fixed rates closer to 7% or $50 million of outstanding debt.

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

Thanks, Paul.

As I've said previously we are excited about the future of Encore and are encouraged by the results being generated by our new collections initiatives. Our investments over the past year or so underscore our commitment to making decisions that will create the most value for our stockholders over time, rather than what will produce the highest short-term earnings.

Looking at this business over the long-term allows for the variability in purchasing and the investment in new liquidation strategy to be more completely evaluated. Given the long-term nature of this business and our belief that investors would benefit from a deeper appreciation of our Company and the dynamics surrounding the accounting for our debt purchasing business we have decided to shift much of our investor communications strategy toward a comprehensive annual review of our operations rather than quarterly updates that place undue focus on short-term trends.

This year at our annual meeting of stockholders, which is expected to take place on October 30th in San Diego, we plan to provide a very deep review of the industry, our strategy and the prospects for growth. Investors and analysts will be given the opportunity to interact with the senior management team and our Board of Directors to better gain a perspective of the Company and its goals.

We believe this expanded yearly communication approach better suits our multiyear operating strategy and will help cultivate a strong long-term focused stockholder base. We encourage all stockholders and analysts to attend the meeting.

Consistent with this new approach, we will no longer be hosting quarterly earnings calls. We will, however, continue to issue press releases along with our quarterly filings. Our goal will be to provide our investors with increasing levels of insight and transparency into the business. Of course we'll continue to be available to answer questions about the publicly reported information in our filings and will abide by all Regulation FD standards for disseminating information.

This decision comes at the right time for Encore as collections are at an all-time high for the Company in the second quarter and we now have 18 months of experience with our new legal initiative and our India call center. The communication strategy was well thought out and carefully reviewed by both our senior management team and the Board of Directors.

As we continue to evolve our investor communications strategy, we welcome your feedback and look forward to the continued growth of the Company.

With that, we would be happy to answer any questions you may have. Operator, please open the line up for questions.

(OPERATOR INSTRUCTIONS). Dan Fannon with Jefferies & Company.

In talking about the market and pricing, there obviously has been conflicting reports or connotations associated with the market from some of your peers in terms of pricing getting better. Can you talk about what you mentioned in terms of telecom and that asset class and then also in terms of supply, if you have seen a meaningful change in that either in the second quarter or post to queue as you guys have been in the market?

Sure. So I would separate the market into kind of three chunks. There is the direct from the issuer portfolios. In that environment we see no change in the pricing dynamics. Pricing continues to be high and very competitive.

There's the alternative asset classes which I would lump in there, automobile deficiencies and telecom and consumer loans. In that pocket I would say the one area we have seen a decent decline in pricing is in telecom where you've got a concentration of relatively low balance accounts that we think underlying cost to collect is much higher than what historically would have been the average for companies that just bought credit cards. As that plays out, we think pricing will continue to come down there. But we don't see much change in the automobile receivable market or the consumer loan market.

Then, in the resale market, I think you'll see potentially a little bit of a mixed bag, some places that are very competitive where things can get broken up into little pieces. But in large bulk sales, we are probably seeing some slight decline but nothing noticeable.

On the volume front, we saw good volume in the second quarter. Third quarter is still pretty new and a lot of the sales happened in the back half of the quarter so it'd be tough for me to comment there.

Thank you. I'm sorry, am I still on the call because I got disconnected before.

You're on.

That's helpful in terms of the market and then if you talk about the cost structure here. When you guys obviously are seeing the benefit in terms of collections on the legal side but the rate and ramp of the expenses is also pretty dramatic. At what point should we expect some leveling off there? You mentioned fourth quarter. Is there upfront costs associated with this business or is it just the anniversary of some of the changes you've made. Basically are you going to start to see some margin expansion in the near term?

Our discussion around the fourth quarter is really talking about where the run rates and the legal, new legal initiatives is about equal so you don't have this kind of large upfront costs on a year-over-year basis. So all discussion or other where we spent $8 million in court costs rather than $3.6 million to show to the magnitude of the intermodal investment we are making. All of that expense is for collections that will happen in the future.

So we spent in this quarter. We get collections in the future. By the fourth quarter those differences will start to moderate and we will start to see costs (inaudible) collected come down.

Then lastly here, just any update on your buyback program and where that stands in your stance towards being active in the market at these levels?

I think we may have mentioned it on the last call. There is a buyback committee. We obviously did not buy any stock in the second quarter. I think the Board is always looking to balance uses of capital; and for example in the second quarter we did the large buyout with the secured lender so we are looking to make sure we have enough capital to do what we need to run the business and are constantly making those trade-offs.

Jack Sherck with SunTrust.

I was just curious. Did you enter any new [forward flow] agreements during the quarter?

We did not.

Then I also noticed that, in terms of -- I realize it is not an exact science and I haven't had a chance to look through your Q yet -- but just in terms of the purchasing if it was about the same in terms of dollars as in the previous quarter; except I noticed the blended rate picked up about $0.03 versus about [1 6]. Were you guys buying more fresh or primary paper or was there any other driver to that?

Jack, I would encourage you not to do that calculation. It's a -- the only reason I said that, it's a very easily misleading number. We could have bought a lot of portfolio in the first quarter at 10 basis points, some old stuff that would bring the average down. So I wouldn't try to draw any conclusions there.

We buy across the age spectrum. This quarter we will have bought very -- we will buy fresh assets from our Jefferson Capital deal, and we will buy age assets. I wouldn't look at trends in the cost per dollar at face.

Hugh Miller with Sidoti & Co.

I was wondering if you could add a little color on the year-over-year collection growth through the call center. Obviously legal channel looks like it's up dramatically but that the call center on a year-over-year basis was down just slightly. Can you add some color there?

We have been building a lot of our investments to the point of improving yield has been to build collections through some of the alternative channels, not just through our call center. So our focus actually has been on the legal channel and some other areas and just supporting our call centers over time. It's not an area we are making a huge investment in right now because we believe we are optimally penetrating there that incremental collections will come from areas other than making outbound phone calls.

Also I think for the first time in a while, I noticed the purchase price (inaudible) collections as a percentage of the purchase price had increased for the portfolio. I noticed you have some strong collections in the second quarter for the 2006 and 2007 vintages. But I was wondering if you could add some color there with what you guys are seeing from those two vintages in the collections and why they may be so strong?

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(OPERATOR INSTRUCTIONS). Dan [Weiskopf] with UBS.

I'm just curious what your thought is on not having conference calls on a quarterly basis? Some of the investor relations problem is educating people on this business which is clearly very complicated about the terms of accounting and perception. Can you talk about that, please?

Sure. So I think as we think about it, it is our view after discussing with our Board and just internally that the quarterly calls don't provide a deep enough view into what is really happening in this business. I mean if you look at what has transpired -- at least with our Company -- over the past year we have been pretty clear about we thought was going to happen.

It happened and yet there still was a lot of penalty along the way and we (inaudible) the function of a lack of detailed knowledge. So as we talked about it we felt like it was a very good strategy. It is actually a strategy that had been deployed very successfully at one of our Board member's company and they have done incredibly well, where you really focused on somebody who is trying to understand this business and want to own it in 2010 not in the first quarter of 2008. And we felt that was the best way to go about doing it.

So that means you are not going to be giving guidance on a quarterly basis and people can have varying views on the quarter and you are not going to make any comments on the quarterly results?

I think what we would say is, we've never really given guidance in terms of what to expect quarter to quarter. And we think that so much of the business is tied to what we purchase that it's just not enough clarity there. What we have done is we have given you, I think, a good deal of insights into what we think is going to happen with our business looking out by giving you where we think collections come from in revenue over the life of the portfolios. So we've given we hope the key input to anybody around what we think is going to happen with this business in the Q.

Jack Sherck with SunTrust.

I may have missed it but do you have any impairment charges related to SOP 03-3 during the quarter?

Yes. During the quarter we had a net reversal of an impairment of $1 million, which represents reversals of $2.4 million, offset by allowance charges of $1.4 million.

[Rick Biggs] with (inaudible) Capital.

Nice quarter and I definitely appreciate pulling the quarterly conference call a game out of effect and moving to a longer-term view. (multiple speakers)

I guess the only -- that wasn't really a question. The question I had was I haven't dug all the way though the Q. You are making it too tough on us analysts here at the end of earnings season. But was wondering if the collections, you're expected multiple on your purchases, say, this last few months was different than prior periods?

The multiple on the 2007 vintage moved from 2.2 to 2.3. You know there was 2.2 last quarter and it's 2.3 this quarter. 2006 went from 2.2 at the end of Q4 to 2.4 at the end of Q1 to 2.5 at the end of this quarter and 2004 moved from 2.5 to 2.6.

And without seeing -- if you're not seen prices dropped certainly not drop anything dramatically this last quarter over the first quarter, why would the collections multiple pick up? Is that just again a reflection of the new strategies paying off?

It is and it's also a function of us getting more comfort with the strategies and what we think they will contribute over the long-term and so now we got a year-and-a-half worth of history. Got a pretty good sense of as accounts now go into that strategy what our liquidation will be and a high degree of confidence so it's time with the strategy and then it's just the gross application of getting (inaudible) of what we're buying.

There are no further questions in the queue. I will turn it back to management for any closing remarks.

Thanks, everybody, for joining the call today and we look forward to speaking with you at our annual meeting of stockholders in October.

Thank you. That does conclude today's conference call. If you'd like to listen to a replay of today's call, please dial 303-590-3000 or 800-405-2236. Enter the passcode 11094310 followed by the pound sign. Once again that is 303-590-3000 or 800-405-2236. Enter the passcode 11094310 followed by the pound sign.

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