Encore Capital Group Inc (ECPG) 2011 Q4 法說會逐字稿

Good day, ladies and gentlemen, and welcome to the Encore Capital Group announces Fourth Quarter and Full Year 2011 Financial Results Call. At this time, all participants are in a listen-only mode. Later, we will conduct a question and answer session and instructions will follow at that time. (Operator Instructions) As a reminder, this conference call is being recorded. I would now like to introduce your host for today's conference, Mr. Adam Sragovicz. Please go ahead.

Thank you, Patrick. Good afternoon and welcome to Encore Capital Group's fourth quarter and full year 2011 earnings call. With me on the call today are Brandon Black, our President and Chief Executive Officer and Paul Grinberg, our Executive Vice President and Chief Financial Officer. Brandon and Paul will make prepared remarks and then follow it with a question and answer period.

Before we begin, we have a few housekeeping items to take care of. Throughout this conference call, we will use forward-looking statements including predictions, expectations, estimates, or other information that might be considered forward looking. While these forward-looking statements represent our current judgment, these statements are also subject to risks and uncertainties that may cause actual results to differ materially from statements being made today. As a result, we caution you against placing undue reliance on these forward-looking statements, which speak only as of the date they are made. We will also use rounding and abbreviations in our conference call for the sake of brevity. For more detailed numbers and explanations, please refer to our Form 10-K that was filed today with the SEC.

We will also be referencing both GAAP and non-GAAP financial results. We believe certain non-GAAP financial measures provide useful information about our business. However, the presentation of this additional information should not be considered an alternative to or more meaningful than our results prepared in accordance with GAAP.

Management utilizes adjusted EBITDA, which is similar to a financial measure contained in covenants used in our credit agreement in the evaluation of our operations and believes this measure is a useful indicator of our ability to generate cash collection in excess of operating expenses through the liquidation of our receivable portfolios.

We included information concerning adjusted operating expenses excluding stock-based compensation expense and bankruptcy servicing operating expenses in order to facilitate a comparison of approximate cash cost to cash collections for the debt purchasing business in the periods presented.

Once again, please be sure to see our 10-K, 10-Q and other SEC filings including a press release issued as an exhibit to our current report on Form 8-K filed today for a more complete discussion of these factors and risks.

As a reminder, this conference call will also be available for replay on the Investors section of our website, and we also plan to post the prepared remarks following the conclusion of this call.

With that, let me turn the call over to Brandon Black, our President and Chief Executive Officer.

Thank you, Adam, and good afternoon everyone. I appreciate you joining us for a discussion of Encore's results for the fourth quarter and full year 2011.

Before beginning, I would like to recognize and thank Encore's 2,200 employees for a fantastic quarter and a record year. Our results are a direct reflection of their collective effort and I appreciate all of their hard work.

Throughout 2011, the Company was able to produce consistently strong results with contributions coming from all of our collection channels. We have achieved these results while investing in areas we believe will provide long-term strategic advantages and build upon our industry-leading debt purchasing and recovery platform. Our deliberate and disciplined approach to portfolio underwriting and management led to record earnings, collection and operating cash flow for the fourth quarter and the year.

Cash collections for the quarter were $186 million, which is a 25% increase over the fourth quarter of 2010. Looking at consumer behavior, we saw payer rates and payment sizes remain consistent as compared to prior periods. These strong collections were the result of our ability to identify and engage with those consumers with the greatest likelihood of recovery, even in the seasonally weak collection period.

When compared to the same period last year, our overall cost to collect in the fourth quarter decreased 30 basis points to 44.1%. This decrease reflects savings from various operational strategies which were partially offset by investments in our internal legal initiative, the ramp up of our new operating site in Costa Rica, and additional spending required to manage the changing regulatory and legislative environment.

The success of our business has allowed us to increase both our domestic and international headcounts. We are pleased that we have continued to hire here in the United States during a time of economic uncertainty from many in the domestic labor force. At the end of the fourth quarter, our US operations employed 800 people, up 17% from the end of last year. Similarly, the total number of employees in India increased by 18% to 1,400 at the end of 2011. During 2011, we added incremental office space in both San Diego and India where we can accommodate an additional 450 employees.

One of our most noteworthy accomplishments during the fourth quarter was in the area of purchasing. We successfully deployed $137 million during the quarter, making it the largest purchasing quarter in the Company's history. Our purchases consisted of 67 individual transactions from 15 unique sellers.

Completing that many transactions isn't an easy task and it requires precise coordination between our business development, information technology, accounting, finance, and valuation teams. Each group did their job flawlessly in the fourth quarter and they have positioned us well going into 2012.

The majority of our purchases or $117 million went toward the purchase of credit card and consumer loan portfolios. The balance of nearly $20 million was spent on telecommunication receivables. As we mentioned previously, we continue to deploy capital in those asset classes which we believe will yield the strongest returns. Telecommunications is one such asset class where the efficiency of our collection platform enables us to apply effort to small balanced accounts at a cost that is lower than many of our competitors.

Total purchase for the year was $387 million. This is a $25 million increase compared to 2010 and is in line with the guidance that we provided in June at our annual shareholder meeting and investor day.

From a market perspective, portfolio pricing trends remain consistent with moderate year-over-year increases across all types and ages of portfolios. Despite those increases, we have been able to find mismatches between portfolio returns and market clearing prices and will continue to capitalize on these.

Following up on the strategic initiatives we announced in June, our internal legal and near short call center projects are progressing nicely. Within our internal legal channel, we are now operational in five states and are planning to add five additional states in 2012. Our collections are tracking the plan and we are continuing to customize the underlying technology platform, which should give us substantial leverage in the future.

We are also pleased to report that we have completed the build out of our operating site in Costa Rica, hired and trained our first account managers and started collection efforts last week. Our extraordinary team worked tirelessly over the past few months to get that operational in time for the seasonally strong first quarter.

Also of note during the fourth quarter, Encore announced a launch of the Consumer Credit Research Institute or CCRI. The CCRI is a research organization dedicated to better understanding financially distressed consumers' decisions, choices, and activities. This work represents an industry first effort by Encore to differentiate and describe an important and often neglected consumer segment. By partnering with leading universities, non-profit organizations, and governmental agencies, we hope the CCRI will advance thinking in the areas of public policy, financial education, and business operations. Encore's relationship to low and middle income American consumers provides a unique perspective on household consumption and saving behavior and the CCRI's research will increase knowledge about consumers with whom we work.

Increasingly, developments like our Consumer Bill of Rights and the CCRI are allowing Encore to have differentiated discussions with regulators and legislatures. 2012 is likely to be another year of public focus on the finance industry and our goal is to be one of the leaders that help shape the dialogue about the industry's future. Our proactive efforts to engage in conversations with federal and state regulators and legislators have begun to pay off and we expect to increase those efforts in 2012.

A recent example of the benefits from this approach occurred last month here in California with Senate Bill 890, which is designed to protect the rights of consumers whose accounts are acquired by debt collectors. The current language in the bill is very different from the initial draft and is a direct result of collaborative negotiations between Encore, the bill's sponsor, the Attorney General office, and other industry representatives. In fact, members of our Government Relations team were in touch with the authors, working with language changes in the final hours before its submission to the floor. It is this kind of partnership that will allow thoughtful regulation to be enacted around the collection industry. We appreciate the partnership and expect to continue working with the Attorney General's office and the senator's staff as the bill moves to the assembly.

Finally, before turning the call over to Paul, I would like to highlight two changes to our board of directors. First, Norman Sorenson was appointed to the board back in December. Norman is the retiring chairman of Principal International, the International Asset Management and Accumulation division of the Principal Financial Group. Previously, he was a senior executive at AIG and held a number of senior international marketing and general management positions at Citigroup and American Express. Moreover, Norman is a director at Sara Lee Corporation. Norman has significant experience developing and nurturing consumer financial services products around the world. He will bring valuable perspective to the management team and the board and we believe Encore will benefit from his deep experience in corporate governance.

Additionally, John Oros resigned his position on the board effective February 7th. John joined our board shortly after J. C. Flowers made their investment in Encore back in 2007. Since then, John has been a dedicated, insightful board member who has partnered with the management team to help shape the strategic direction of the Company and helped us navigate through this difficult economic cycle. His presence will be missed. But we understand the decision to leave now that J. C. Flowers has sold the majority of their investment.

With that, I will turn it over to Paul, who will discuss our financial results in more detail. Paul?

Thank you, Brandon. As Brandon discussed, we had a very strong 2011. Collections reached an all-time high for a fourth quarter and the continued advancements in our operating platform give us confidence in our ability to expand on the operating leverage created over the past few years. We generated earnings of $0.67 per fully diluted share during the quarter, an increase of 20% over the fourth quarter of 2010.

For 2011, we generated earnings of $2.37 per share, an increase of 22% over 2010. Adjusted EBITDA, which represents the cash we generate that is available for future purchases, capital expenditures, debt service and taxes was $105 million in the fourth quarter, an increase of 25% compared to the fourth quarter of 2010. This strong cash flow allowed us to fund a significant portion of our portfolio acquisitions during the quarter. In fact, our debt levels at year end increased by only $3.7 million from the prior year, despite purchases of over $380 million. As a result of our strong financial performance, we have kept borrowing costs at the lowest rate tier possible under the terms of our credit facility.

Our overall cost to collect decreased 150 basis points to 42.2% in 2011, down significantly from 43.7% in 2010. We achieved these results even as we made investments to expand our internal legal channel and launched our new operations center in Costa Rica.

As I mentioned previously, our goal is to maximize dollars collected less dollars spent, not minimize the ratio of dollars spent to dollars collected. And where we can generate incremental collections, we will do so even when it may entail a slightly higher cost to collect. Overall, we expect our cost to collect to continually improve, but it will fluctuate from quarter to quarter based on seasonality, the level of our investment in new operating initiatives, as well as ongoing legal costs.

In 2012, we expect to invest $0.20 and $0.05 per share respectively in our internal legal platform and near shore site in Costa Rica. We anticipate that these investments will contribute positively to our long-term financial performance.

Due primarily to the large purchasing volume and the strong performance of portfolios purchased over the last couple of years, our estimated remaining collections or ERC at December 31st increased by $182 million over the prior year to approximately $1.6 billion.

As we've discussed previously, we believe that our ERC, which reflects the estimated remaining value of our existing portfolios, is conservatively stated because of our cautious approach to setting initial curves and our practice of only increasing future expectations after a sustained period of over performance.

As mentioned at the beginning of the call, fourth quarter collections were very strong at $186 million, up 25% from $149 million for the fourth quarter of 2010. Our call centers contributed 43% of total collections or $80 million as compared to $69 million in 2010. Direct cost per dollar collected in our call centers declined to 7.4% for the fourth quarter of 2011 from 9.6% in 2010. For the full year, collections were $761 million, up 26% from 2010's $605 million.

Just to put these numbers in context, in 2011 we collected over twice as much as we collected in 2007. We believe that this was noteworthy given that this growth took place during a period when the industry was in turmoil and the macroeconomic environment was extremely challenging. This improvement is largely the result of enhancements in our analytical models, which allow us to focus our efforts on those consumers who we believe have the ability and are most likely to pay and the growth of our operation center in India.

In the fourth quarter of 2011, India accounted for 52% of total call center collections as compared to 46% in the fourth quarter of 2010. Legal channel collections grew to $96 million in the fourth quarter, compared to $70 million in 2010 and accounted for 52% of total collections. Cost to collect in the legal channel for the fourth quarter of 2011 was 41.4%, down from 42.4% in the fourth quarter of 2010. For the full year, legal collections grew to $377 million compared to $267 million in 2010 and accounted for 50% of total collections.

We are often asked about the increasing contribution from our legal channel. The growth in legal channel collections is primarily attributable to the continued refinement of our analytic capabilities and increased ability to predict consumer behavior, which has allowed us to become more precise about when to pursue litigation. It is not the result of expanded volumes of new accounts going through this channel. In fact, we have not increased the volume of placements in the legal channel for the last two years and are not expecting to in 2012.

I'd like to reiterate that our long-stated preference is to work with our consumers to negotiate a mutually-acceptable payment plan, which is tailored to their personal financial situation. These plans almost always involve substantial discounts from what is owed to us. We not only believe that this is the right thing to do for our consumers but it is the right thing to do for our business.

Another impact of our refined placement strategy is a lower overall cost to collect. Cost to collect in the legal channel in 2011 was 41.6%, down meaningfully from 45.4% in 2010. We also incurred approximately $1.6 million in costs this quarter associated with the build out of our internal legal platform.

Finally, 6% of collections came from third-party collection agencies. We expect collections from this channel to continue to decline as we shift more of our work to our internal call centers at a lower overall cost to collect. Consistent with our stated practice and in keeping with our Consumer Bill of Rights, we had no portfolio sales in the fourth quarter.

Moving on, revenue from receivable portfolios in the fourth quarter was $116 million, an increase of 22% over the $96 million in 2010. As a percentage of collections and excluding the effects of allowances, the revenue recognition rate was 64% as compared to 68% in the fourth quarter of 2010. For the full year, revenue from receivable portfolios was $449 million, an increase of 23% over $364 million in 2010.

Our revenue recognition rate is attributable to our cautious approach to setting initial IRRs and our policy of increasing them gradually after periods of over performance. For example, as a result of sustained over performance, we have slowly increased the multiples on the 2009 and 2010 vintages over time to 2.7 and 2.5 times respectively, up from 2.4 and 2.1 times respectively.

Another byproduct of the accounting method we use is that revenue does not fluctuate from quarter to quarter in line with collections. Other than the impact of new purchases and allowance charges, revenue is relatively consistent from quarter to quarter. So when periods with seasonally strong collections, the additional costs incurred to generate those collections may result in lower earnings than in periods with seasonally weaker collections, when collection costs are lower. Accordingly, earnings are typically lower in the seasonally strong first quarter and higher in the fourth quarter.

During the fourth quarter of 2011, we expensed $2.7 million in net allowance charges compared to $5.4 million in the comparable period of 2010. Looking at the breakdown by year, we had $100,000 of allowances in the 2005 vintage, $1.9 million in the 2006 vintage, $1 million in the 2007 vintage, and $1.3 million in the 2008 vintage. These allowances were offset by $1.6 million in reversals. We had no allowance charges for the 2009, 2010, or 2011 vintages in the quarter as has been the case since we acquired these portfolios. This quarter we over performed our forecasted collection curves by 16%.

As many of you know, we account for the business on a quarterly pool basis, not in an overall level. When pools underperform, we take allowance charges, which are reflected as an immediate reduction in revenue. We measure underperformance against the current yield that is assigned to a pool, not its original expectation. This pool-by-pool level accounting treatment leads inevitably to non-cash allowance charges in certain periods, even when we are over performing a pool's initial expectations. In contrast, when pools over perform that over performance is not reflected immediately. Once we have evidence of sustained over performance in a pool, we will increase that pool's yield.

Unlike allowance charges, which are realized immediately, this increased yield will be reflected as increased revenue in the current and in future quarters. Consistent with this practice, as a result of continued over performance in certain pool groups, primarily in the 2009, 2010, and 2011 vintages, we increased yields in those pool groups this quarter.

Turning to Ascension, our fee-based bankruptcy servicing business, revenue in the fourth quarter rose by 5% from the prior year to $4.2 million. As we discussed last quarter, performance from servicing one large new client was below our expectations and we have parted ways with that client. This separation will have a negative financial impact on the next few quarters at Ascension but it was the right long-term business decision.

Shifting now to expenses, our total operating expenses from the fourth quarter were $88 million, up from $72 million in the fourth quarter of 2010. For the full year, our total operating expenses were $347 million, up from $284 million in 2010. Included in operating expenses for the fourth quarter of 2011 were stock-based compensation expenses of approximately $1.7 million and Ascension operating expenses of $4.4 million.

The income tax provision for the fourth quarter and full year was $10 million and $38 million respectively. This reflects an overall tax rate of 37.7% for the quarter and 38.6% for the full year as compared to 39% for the quarter and 37.1% for the full year in 2010.

Finally, our fully diluted earnings per share during the fourth quarter were $0.67, a 20% increase compared to quarterly earnings per share of $0.56 in the same period last year. For the full year, our fully diluted earnings per share increased 22% to $2.37 from $1.95 in 2010.

Before turning the call back over to Brandon for some final remarks, I wanted to ask you to please mark your calendars for our annual meeting with shareholders and investor day, which will be held in New York on Wednesday, June 6th. More details will follow in the coming weeks.

With that, I will turn it back to Brandon before opening up the call for questions. Brandon?

Thank you, Paul. Encore's fourth quarter and full year performance were highlighted by record-setting cash collections and our continued deployment of capital at strong returns. Our proactive approach to engaging regulators and our new operating initiatives are paving the way for stable growth in an uncertain and changing macroeconomic environment. Encore's key differentiators were at work in the fourth quarter and we expect that they will continue to be key drivers in the growth of cash flows and year-over-year earnings.

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

(Operator Instructions) Hugh Miller from Sidoti.

I had I guess a housekeeping question. First to start off one with regards to the tax rate. I guess coming in a bit lighter than I think what you guys have been talking about previously was kind of wondering what was driving the rate and how we should be thinking about that as we head into 2012?

The rate in 2012 will be about 39%, Hugh, and from quarter to quarter it does vary based upon timing and differences between permanent and non-permanent tax adjustments. So it's really, from quarter to quarter, it's going to vary but for the year it should be about 39%.

Okay, great. Looks like I guess within the headcount for the offshore call center in India on an end-of-period basis you actually had a decline from the end of period of the third quarter. Was wondering I guess if you can talk a bit about that and how we should be thinking about headcount in 2012?

Yes, I think if anything, it's a timing of hiring classes more than anything else. You should expect continued growth of headcount in India in 2012.

Okay, so just a matter of maybe attrition and the timing of when you guys would be doing more hiring?

That's right. Someone could have got hired the last day of the third quarter and started their work in the fourth quarter. I don't have the exact numbers in front of you, but I don't think it signals any trend. You should just expect continued growth into 2012.

Okay. Have attrition rates kind of varied at all? I know we talked a bit about that at the beginning of the year, but have those trends changed at all over the course of 2011 in offshore?

They have not. We have consistent year-over-year attrition almost identical 2010 and 2011.

Okay. The other thing I guess on the collections, zero-based collections exceptionally strong in the fourth quarter on both an absolute basis and as a percentage of collections. Wanted I guess get the sense of kind what's driving that? You know is it a function of just you being so conservative and not moving up the yields or improvements in the models or adjustments to strategies? Any color there?

There are a couple things, Hugh. One is, as you mentioned, the conservatism which has led to certain pool groups going ZBA. There's also -- we did have pool group in 2007 which performed exceptionally well and actually fully amortized recently. That's generated an increase in the ZBA collections and so we -- we would expect that trend to continue because of that pool group now being included in ZBA collections.

Okay. And I realize that you typically, during the analyst day, give us a purchasing goal for the year with a tangible figure. But as you look out at the trends that you're seeing, you commented a bit about pricing and areas there. But are you guys anticipating that you will show growth in 2012 on the purchasing front relative to 2011?

Certainly our goal was to grow purchasing and our target to give more definitive guidance will be around the investor day as well. I plan -- (inaudible) our plan will be to disclose our targets at the June 6 meeting.

Okay. The last question I had was just if you could talk to us about you did give us color about working with legislation in order to draft stuff that's thoughtful. I guess as you're seeing commentary from the CFPB, I was wondering if you could just give us a sense of your expectations about working with them and what changes you could foresee coming to the business down the pike?

We've had a lot of conversations with the CFPB. It's not led to any clear goals on their part. Most of it is them asking us questions and us answering it in a constructive way. I believe the collection industry will be an industry that they spend time and focus on at some point in 2012 and which I can't give you any specificity other than I think they're having a very open and constructive dialogue with industry leaders and I hope our input will be factored in as they think about any changes.

Thank you.

Mike Grondahl from Piper Jaffray.

Could you maybe just give a little bit greater description of the competitive environment, kind of what you're seeing there today and maybe what your expectations are for the first six months of 2012? Maybe specifically as it relates to fresh credit card paper? Then also just kind of your early take on how your telecom initiative is going. It looks like it got up to be about 10% of purchases by the end of the year.

Sure, Mike. I think on the competitive side what we do see is we don't see a lot of new entrants or any new entrants in the space. If anything, I believe 2012 may be a year where we see some shrinking of competition. To be successful in our industry today, you've got to have an advantage somewhere whether that's an information advantage, an operating advantage, operating cost advantage or a cost of funds advantage. If you think about the smaller middle market firm, it's just going to be difficult for them to obtain any of those. As the environment gets more competitive, we think the larger companies are best positioned to take advantage of whatever portfolio may become available whether that'll be fresh or otherwise.

So I expect 2012 is actually a year of net decrease in demand. You'll see more of the large players acquiring the volume that's available just because we have scale. We have lower operating costs and we have lower cost of capital. Again, I think that would apply to fresh portfolio or aged portfolio. I don't think you'll see much change there.

On the telecom front, we signaled that obviously in June we've been investing in this asset class now for many years. We've accelerated our purchasing in the fourth quarter, which is just more a function of the [cooperation] of some new relationships but continue to believe it's an asset class that many can't compete in. Some may try and not actually appreciate the cash flow dynamics or the cost dynamics. But we think over the long haul, this is an asset class that we're uniquely positioned to buy the vast majority of what gets sold.

Got you, thanks. Then just lastly for Paul, was the $1.6 million in kind of internal legal channel investment, was that really the only kind of unique investment or charge in the quarter, Paul, that we should back out or think about?

That was the most meaningful one in the quarter as it relates to comparisons from Q4 of 2011 to Q4 of 2010. There are obviously some smaller ones but that was the most meaningful one.

Okay, thanks a lot.

(Operator Instructions) Edward Hemmelgarn from Shaker Investments.

You mentioned, Paul, you think the and Brandon that you think there may be less competition next year, do you have any thoughts that anyone -- there may be any portfolios available for sale from the existing collectors that somebody may go out of business or something?

We would expect there to be supplier portfolio from anyone who's an established player where maybe their inability to deploy capital gets -- their ability to deploy capital gets constrained, we would expect them to consider selling their portfolio. We've seen some of that. We've participated in some of that and that's what gives us the confidence that that's likely to continue throughout the year.

Okay, thanks.

Thank you.

Hugh Miller from Sidoti.

Just had one follow question more an overview, I know that you guys have considered geographic expansion as a part of your strategy longer term. Was wondering could you talk to us just a little bit about the nuance differences in kind of looking at the UK and Australia relative to the US and how that differs?

Well, it continues to be something that we believe is part of Encore's destiny. We see all the transactions that are perspective transactions. We certainly haven't found one yet that meets our financial and operational goals. But we think ultimately over time that we'll do something. The differences are largely around the walls that govern the collection industry and how you go about collecting in those environments. We've spent now it feels two or three years studying that and think we have a pretty handle on what that would look like. We think we can leverage our India call center in either geography so it's just making sure we get aligned transaction which would produce the right financial returns and be the right entry point for us. We expect that to happen I guess at some point in our history.

Okay. Is the underwriting substantially different? You were talking about just from a collections standpoint and different laws and those types of things. Do you see kind of the modeling of the underwriting being dramatically different than the way that you go about underwriting here in the US?

I think we would continue to do a consumer-based underwriting -- we'd say underwriting approach. What differs is the data that's available at the time of purchase. So you'd have to customize your models to adjust for the data that's available. But we would still take the exact same approach. We'd build -- likely build unique models for those geographies and as a result, would probably want to, if we were to enter one of them, likely acquire an established large debt purchaser, which would give us all the history we need to build the models.

Okay, thank you. Appreciate it.

Thank you.

We currently show no other questions in queue.

Thank you, everybody, for your time today and look forward to speaking with you at the first quarter earnings release.

Ladies and gentlemen, thank you for participating in today's program. This concludes the program. You may all disconnect.