UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
WASHINGTON, D.C. 20549
_________________
FORM 10-K
| (Mark One) |
| X | ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the fiscal year ended December 31, 2004 or |
| TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934 |
| For the transition period from ___________to ___________ |
Commission File Number 000-26489
_________________
ENCORE CAPITAL GROUP, INC.
(Exact name of registrant as specified in its charter)
_________________
| Delaware (State or Other Jurisdiction of Incorporation or Organization) |
48-1090909 (I.R.S. Employer Identification No.) |
|
8875 Aero Drive, Suite 200, San Diego, CA |
92123 (Zip Code) |
(877) 445-4581
(Registrant’s Telephone Number, Including Area Code)
_________________
Securities registered pursuant to Section 12(b) of the Act: None
Securities registered pursuant to Section 12(g) of the Act:
Common Stock, $.01 Par Value Per Share
(Title of Class)
Indicate by check mark whether the registrant: (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes [X] No [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [ ]
Indicate by check mark whether the registrant is an accelerated filer (as defined in Rule 12b-2 of the Act). Yes [ X ] No [ ]
The aggregate market value of the voting stock held by non-affiliates of the registrant totaling 10,455,392 shares was $138,115,728 at June 30, 2004 based on the closing price of the Common Stock of $13.21 per share on such date, as reported by the Nasdaq National Market.
The number of shares of the registrant’s Common Stock outstanding at February 14, 2005 was 22,245,174.
Documents Incorporated by Reference
Portions of the registrant’s proxy statement in connection with its annual meeting of shareholder to be held in 2005, are incorporated by reference in Items 11, 12, 13, 14 of Part III of this Form 10-K
Table of Contents
PART I
Item 1 — Business
An Overview of Our Business
Nature of Business
Encore Capital Group, Inc. together with its subsidiaries (“Encore”) is a systems-driven purchaser and manager of charged-off consumer receivables portfolios. Encore acquires these portfolios at deep discounts from their face values using its proprietary valuation process that is based on the consumer attributes of the underlying accounts. Based upon the ongoing analysis of these accounts, we employ a dynamic mix of collection strategies to maximize our return on investment. The receivable portfolios we purchase consist primarily of unsecured, charged-off domestic consumer credit card receivables purchased from national financial institutions, major retail credit corporations, and resellers of such portfolios. Acquisitions of receivable portfolios are financed by operations and by borrowings from third parties.
We have been in the collection business for 51 years and started purchasing portfolios for our own account approximately 14 years ago. We purchase charged-off credit card receivables and, to a lesser extent, other consumer receivables, including auto loan deficiencies and general consumer loans. From our inception through December 31, 2004, we have invested over $387.3 million to acquire 8.9 million consumer accounts with a face value of approximately $16.2 billion.
We have established certain relationships with credit card issuers, other lenders and resellers that allow us to purchase portfolios directly through negotiated transactions, and we participate in the auction-style purchase processes that typify our industry. In addition, we enter into “forward flow” arrangements in which we agree to buy receivables that meet agreed upon parameters over the course of the contract term. Since mid-2000, we have purchased pools of consumer receivables from approximately forty credit originators and resellers.
We evaluate each portfolio for purchase using our proprietary valuation and underwriting processes developed by our in-house team of statisticians. Unlike many of our competitors, which we believe often base their purchase decisions primarily on numerous aggregated portfolio-level factors, including the lender/originator, the type of receivables to be purchased, or the number of collection agencies the accounts have been placed with previously, we base our purchase decisions primarily on our analysis of the specific accounts included in a portfolio. Based upon this analysis, we determine a value for each account, which we aggregate to produce a valuation of the entire portfolio. We believe this capability allows us to perform more accurate valuations of receivables portfolios. In addition, we have successfully applied this methodology to other types of receivables, such as auto loan deficiencies and consumer loans.
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After we purchase a portfolio, we continuously refine our analysis of the accounts to determine the best strategy for collection. As with our purchase decisions, our collection strategies are based on account level criteria. Our collection strategies include:
- outbound calling, driven by proprietary predictive software, by our own sizable collection workforce located at our two call centers;
- the use of a nationwide network of collection attorneys to pursue legal action where appropriate;
- the use of multiple third party collection agencies;
- direct mail campaigns coordinated by our in-house marketing group;
- the transfer of accounts to a credit card provider, generating a payment to us; and
- the sale of accounts where appropriate.
Investors wishing to obtain more information about Encore Capital Group, Inc. may access our Internet site (www.encorecapitalgroup.com) that allows access to relevant investor related information such as SEC filings, analyst coverage and earnings estimates, press releases, featured articles, an event calendar, and frequently asked questions.
Our Strengths
Empirically Based and Technology-Driven Business Processes. We have assembled a team of statisticians, business analysts and software programmers that have developed and continually enhance proprietary valuation models, software and other business systems that guide our portfolio purchases and collection efforts. Our information technology department has developed and continually updates sophisticated software that manages the movement of data, accounts and information throughout the company. These proprietary systems give us the flexibility, speed and control to capitalize on business opportunities.
Account-Based Portfolio Valuation. We analyze each account within a portfolio presented to us for purchase to determine the likelihood and expected amount of payment. We utilize an internally developed valuation process based on a set of proprietary statistical models that predict behavior at the consumer level. Individual consumer characteristics are weighted according to the models, the expectations for each account are then aggregated to arrive at a portfolio-level liquidation assessment and a valuation for the entire portfolio is made. Our valuations are derived in large part from information accumulated on approximately 6.4 million accounts acquired since mid-2000, supplemented by external data purchased from data providers.
Dynamic Collections Approach. Over the past three years, we have dramatically reduced our dependence on general outbound calling by expanding our collection strategies. Moreover, because the status of individual debtors changes continually, once each quarter we re-analyze all of our accounts with refreshed external data, which we supplement with information gleaned from our own collection efforts. We change our collection method for each account accordingly.
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Experienced Management Team. Our management team has considerable experience in financial, banking, consumer and other industries, as well as the collections industry. We believe that the expertise of our executives obtained by managing in other industries has been critical to the enhancement of our operations. Our management team has created a culture of new ideas and progressive thinking, coupled with the increased use of technology and statistical analysis.
Our Strategy
To enhance our position in the industry, we have implemented a business strategy that emphasizes the following elements:
Implement and Refine New and Existing Collection Channels. We continually refine our collection processes, and evaluate new collection strategies, such as strategic outsourcing, to further supplement our traditional call center approach. We believe that our multiple and dynamic approach to collections increases our opportunity to achieve enhanced returns on our investments.
Leverage Expertise in New Markets. We believe that our internally developed underwriting and collection processes can be extended to a variety of charged-off consumer receivables in addition to charged-off credit card receivables. We intend to continue to leverage our valuation, underwriting and collection processes to other charged-off receivables markets, including auto loan deficiencies and general consumer loans. To date, our purchases of auto loan deficiencies and general consumer loans have performed to expectations.
Continue to Build Our Data Management and Analysis Capabilities. We are continually improving our technology platform and our pricing, underwriting and collection processes through software development, statistical analysis and experience.
Consider Complementary Acquisitions. We intend to actively pursue acquisitions of complimentary companies to expand into new markets, add capacity in our current business, or leverage our knowledge of the distressed consumer.
Acquisition of Receivables
Typically, receivables portfolios are offered for sale through a general auction, “forward-flow” contract or direct negotiation. A “forward-flow” contract is a commitment to purchase a defined volume of accounts from a seller for a period of typically 3 to 12 months. We believe long-term success is achieved by combining a diverse sourcing approach with an account level scoring methodology and a disciplined evaluation process.
Identify purchase opportunities. We employ a team of sales professionals who maintain relationships with the largest credit grantors in the United States. Their role is to identify purchase opportunities and secure, if possible, exclusive negotiation rights for Encore.
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Analyze paper- account level analytics. Once a portfolio acquisition is identified, our internal modeling team analyzes information provided by the seller and other external sources, if appropriate, to determine the expected value of each potential new customer. The expected value of each individual consumer is aggregated into a total portfolio value.
Maintain purchasing discipline. We continue to see increased levels of capital entering the purchase market. This has caused a general increase in portfolio pricing. It is our belief that many of these new entrants will ultimately have difficulty generating adequate returns, given the increase in portfolio pricing, and will ultimately leave the market. We believe that this should relieve some of the recent pricing pressures. During the period of escalating pricing, we will continue to remain focused on making purchasing decisions based on sound quantitative and qualitative analysis.
Collection Strategies
We expand upon the insights created during our purchasing process when building account management strategies. Our proprietary consumer level collectability analysis is the primary determinant of whether an account is actively worked post-purchase. Throughout our ownership period, we continuously refine this analysis to determine the most effective collection strategy to pursue for each account. These strategies consist of:
- Call Centers. We maintain inbound and outbound collection call centers in San Diego and Phoenix. Our collections department is divided into groups each consisting of three collection managers supervising approximately 36 collectors. Collectors are trained to use a friendly, but firm approach to assess the willingness of the customer to pay. They attempt to work with customers to evaluate sources and means of repayment to achieve a full or negotiated lump sum settlement or develop payment programs customized to the individual's ability to pay. In some cases, collectors advise the debtors of alternative sources of financing to pay off their debt, such as a home equity line of credit. In cases where a payment plan is developed, collectors encourage debtors to pay through automatic payment arrangements.
- Legal Action. We generally outsource those accounts where it appears the debtor is able, but is unwilling to pay. We utilize lawyers that specialize in collection matters, paying them a contingency fee on amounts collected. This process is managed by our Legal Outsourcing Department. Prior to sending accounts to a law firm, a specialized internal group of collectors, "Recovery Collectors," communicates to the debtor our intention to have a lawyer evaluate the suitability of the account for litigation if payment arrangements cannot be established.
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- Third Party Collection Agencies. In 2004, we employed a strategy that uses contingency collection agencies, which receive a contingency fee for each dollar collected, to pursue accounts that generally have low liquidation expectations, such as, accounts with small balances or with limited consumer contact information.
- Direct Mail. We have an in-house marketing team that develops innovative mail campaigns. The mail campaigns generally offer debtors targeted discounts on their balance owed to encourage settlement of their accounts and provide us with a low cost recovery method. This allows us to actively penetrate the segment of the portfolio that would not qualify for our outbound calling or legal action strategies.
- Sale. We believe our ability to purchase large portfolios enables us to sell a portion to buyers at a premium price. In addition, we sell, on a forward flow basis, all accounts in which the debtor has filed for protection under Chapter 13 of the United States Bankruptcy Code. Furthermore, we periodically sell accounts after we have determined that additional recovery efforts are not warranted.
- Account Balance Transfer. We may transfer to our credit card partner accounts for which this approach offers the highest opportunity for success. The credit card partner may offer the debtor the opportunity to establish new credit and transfer the balance on a credit card. If the account is transferred we receive an agreed-upon payment.
- Skip Tracing. If a debtor's phone number proves inaccurate when a collector calls an account, or if current contact information for a debtor is not available at the time of account purchase, then the account is automatically routed to our database skip tracing process. We currently use eight different companies to provide phone numbers and addresses. We are able to process large volumes of accounts in a relatively short period of time.
- Inactive. For accounts where the prospects of collection seem remote - for example, the debtor is currently unemployed, overburdened by debt, incarcerated, or deceased - no collection method of any sort is assigned at that time. We use our collection resources wisely and efficiently by not deploying resources on accounts where the prospects of collection are remote.
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Competition
The consumer credit recovery industry is highly competitive and fragmented. We compete with a wide range of collection companies, financial services companies, and an increasing number of well funded new entrants with limited experience in our industry. We also compete with traditional contingency agencies and in-house recovery departments. Competitive pressures affect the availability and pricing of receivables portfolios, as well as the availability and cost of qualified recovery personnel. In addition, some of our competitors may have signed forward flow contracts under which originating institutions have agreed to transfer charged-off receivables to them in the future, which could restrict those originating institutions from selling receivables to us. We believe some of our major competitors, which include companies that focus primarily on the purchase of charged-off receivables portfolios, have continued
to diversify into third party agency collections and into offering credit card and other financial services as part of their recovery strategy.
When purchasing receivables, we compete primarily on the basis of the price paid for receivables portfolios, our ability to be a reliable funder of prospective portfolio purchases, and the quality of services that we provide. There continues to be consolidation of issuers of credit cards, which have been a principal source of receivable purchases. This consolidation has limited the sellers in the market and has correspondingly given the remaining sellers increasing market strength in establishing the price and terms of the sale of credit card accounts.
Government Regulation
In a number of states we must maintain licenses to perform debt recovery services and must satisfy related bonding requirements. We believe that we have satisfied all material licensing and bonding requirements, and are in compliance with all material government regulations.
The Fair Debt Collection Practices Act (“FDCPA”) and comparable state statutes establish specific guidelines and procedures, which debt collectors must follow when communicating with customers, including the time, place and manner of the communications. It is our policy to comply with the provisions of the FDCPA and comparable state statutes in all of our recovery activities, even though we may not be specifically subject to these laws. Our failure to comply with these laws could have a material adverse effect on us if they apply to some or all of our recovery activities. In addition to the FDCPA, significant federal laws applicable to our business include the following:
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Additionally, there may be comparable statutes in those states in which customers reside or in which the originating institutions are located. State laws may also limit the interest rate and the fees that a credit card issuer may impose on its customers, and also limit the time in which we may file legal actions to enforce consumer accounts.
The relationship between a customer and a credit card issuer is extensively regulated by federal and state consumer protection and related laws and regulations. While we are not a credit card issuer, these laws affect some of our operations because the majority of our receivables were originated through credit card transactions. The laws and regulations applicable to credit card issuers, among other things, impose disclosure requirements when a credit card account is advertised, when it is applied for and when it is opened, at the end of monthly billing cycles, and at year-end. Federal law requires, among other things, that credit card issuers disclose to consumers the interest rates, fees, grace periods, and balance calculation methods associated with their credit card accounts. Some laws prohibit discriminatory practices in connection with the extension of credit. If the originating institution fails to comply with applicable statutes, rules, and regulations, it could create claims and rights for the customers that would reduce or eliminate their obligations under their receivables, and have a possible material adverse effect on us. When we acquire receivables, we generally require the originating institution to contractually indemnify us against losses caused by its failure to comply with applicable statutes, rules, and regulations relating to the receivables before they are sold to us.
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Federal statutes further provide that, in some cases, consumers cannot be held liable for, or their liability is limited with respect to, charges to the credit card account that were a result of an unauthorized use of the credit card. These laws, among others, may give consumers a legal cause of action against us, or may limit our liability to recover amounts owing with respect to the receivables, whether or not we committed any wrongful act or omission in connection with the account.
Recently enacted state and federal laws concerning identity theft, privacy, the use of automated dialing equipment and other laws related to debtors and consumer protection impose requirements or restrictions on collection methods or our ability to enforce and recover certain debts. These requirements or restrictions could adversely affect our ability to enforce the receivables.
The laws described above, among others, as well as any new laws, rules or regulations, may adversely affect our ability to recover amounts owing with respect to the receivables.
Employees
As of December 31, 2004, we had 705 employees. None of our employees are represented by a labor union. We believe that our relations with our employees are good.
Item 2 – Properties
We service our customers from two facilities. Our larger facility is located in Phoenix, Arizona. We lease the Phoenix facility, which is approximately 62,000 square feet, for a current monthly amount of $28,000. This lease expires in 2008. We also lease a 51,000 square foot facility in San Diego, California, which contains additional collection operations and also serves as our corporate headquarters. The lease on this facility commenced in October 2004, has an initial term of 10.5 years with two renewable 5-year options at approximately fair market value, and provides for escalating monthly payments ranging from $62,900 to $94,500.
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Table of Contents
Item 3 — Legal Proceedings
On October 18, 2004, Timothy W. Moser, a former officer of the Company, filed an action in the United States District Court for the Southern District of California against us, and certain individuals, including several of our officers and directors. On February 14, 2005, we were served with an amended complaint in this action alleging defamation, intentional interference with contractual relations, breach of contract, breach of the covenant of good faith and fair dealing, intentional and negligent infliction of emotional distress and civil conspiracy arising out of certain statements in our Registration Statement on Form S-1 originally filed in September 2003 and alleged to be included in our Registration Statement on Form S-3 originally filed in May 2004. The amended complaint seeks injunctive relief, economic and punitive damages in an unspecified amount plus an award of profits allegedly earned by the defendants and alleged co-conspirators as a result of the alleged conduct, in addition to attorney’s fees and costs. We believe the claims are without merit and will vigorously defend the action. Although the outcome of this matter cannot be predicted with certainty, we do not believe currently that this matter will have a material adverse effect on our consolidated financial position or results of operations.
The FDCPA and comparable state statutes may result in class action lawsuits, which can be material to our business due to the remedies available under these statutes, including punitive damages. We have recently experienced an increase in the volume of such claims, which we believe reflects the trend in our industry. We are aware of approximately 10 cases styled as class actions that have been filed against the Company, although we have not been served in all of these cases. To date, no class has been certified in any of these cases. We believe that these cases are without merit and intend to vigorously defend them. However, several of these cases present novel issues on which there is no legal precedent. As a result, we are unable to predict the range of possible outcomes.
There are a number of other lawsuits or claims pending or threatened against us. In general, these lawsuits or claims have arisen in the ordinary course of business and involve claims for actual damages arising from alleged misconduct or improper reporting of credit information by us or our employees. Although litigation is inherently uncertain, based on past experience, the information currently available, and the possible availability of insurance and/or indemnification from originating institutions in some cases, we do not believe that the currently pending and threatened litigation or claims will have a material adverse effect on the our consolidated financial position or results of operations. However, future events or circumstances, currently unknown to us, will determine whether the resolution of pending or threatened litigation or claims will ultimately have a material effect on our consolidated financial position or results of operations in any future reporting periods.
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Table of Contents
Item 4 – Submission of Matters to a Vote of Securities Holders
None.
PART II
Item 5 — Market for the Registrant’s Common Equity Securities
and Related Stockholder Matters
Our common stock is traded on the Nasdaq Stock Market’s National Market under the symbol “ECPG.” Prior to July 21, 2003, our stock traded on the OTC Electronic Bulletin Board under the symbol “ECPG.OB” (and before February 2002, it traded under the symbol “MCMC.OB”).
The high and low closing sales prices of the common stock, as reported by Nasdaq Stock Market’s National Market and the OTC Electronic Bulletin Board for each quarter during our two most recent fiscal years are reported below:
| Market Price | |||||||||
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| High | Low | ||||||||
| Fiscal Year 2003 | |||||||||
| First Quarter | $ | 1.60 | $ | 1.05 | |||||
| Second Quarter | $ | 9.70 | $ | 1.60 | |||||
| Third Quarter | $ | 14.40 | $ | 8.99 | |||||
| Fourth Quarter | $ | 15.10 | $ | 11.85 | |||||
| Fiscal Year 2004 | |||||||||
| First Quarter | $ | 17.35 | $ | 13.82 | |||||
| Second Quarter | $ | 18.00 | $ | 12.81 | |||||
| Third Quarter | $ | 19.88 | $ | 13.30 | |||||
| Fourth Quarter | $ | 26.73 | $ | 17.83 | |||||
The closing price of our common stock on March 1, 2005 was $20.30 per share and there were 106 holders of record, including 81 NASD registered broker/dealers that held 9,338,396 shares on behalf of their clients.
Dividend Policy
As a public company, we have never declared or paid dividends on our common stock. However, the declaration, payment and amount of future dividends, if any, is subject to the discretion of our board of directors, which may review our dividend policy from time to time in light of the then existing relevant facts and circumstances. Under the terms of our $75.0 million Revolving Credit Facility, we are permitted to declare and pay dividends in an amount not to exceed, during any fiscal year, 20% of our audited consolidated net income for the then most recently completed fiscal year, so long as no default or unmatured default under the facility has occurred and is continuing or would arise as the result of the dividend payment. The Secured Financing Facility requires us to meet and maintain certain financial covenant and other requirements; if we fail to meet those requirements, our ability to make
dividend payments is restricted. We may also be subject to additional dividend restrictions under future financing facilities.
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Table of Contents
Item 6 — Selected Consolidated Financial Data
This table presents selected historical financial data of Encore. This information should be carefully considered in conjunction with the consolidated financial statements and notes thereto appearing elsewhere in this report. The selected data in this section are not intended to replace the consolidated financial statements. The selected financial data (except for “Selected Operating Data” in the table below), as of December 31, 2002, 2001, and 2000 and for the years ended December 31, 2001 and 2000, were derived from our audited consolidated financial statements not included in this report. The Selected Operating Data are derived from the books and records of Encore.
The selected historical financial data, except for Selected Operating Data, as of December 31, 2004 and 2003 and for the years ended December 31, 2004, 2003 and 2002, were derived from our audited consolidated financial statements included elsewhere in this report. (In thousands, except per share, percentages, and personnel data):
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| 2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||
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| Revenue from receivables portfolios¹ | $ | 175,296 | $ | 115,575 | $ | 80,961 | $ | 32,581 | $ | 15,434 | |||||||
| Revenue from retained interest | 2,487 | 307 | 5,707 | 9,806 | 11,679 | ||||||||||||
| Servicing fees and related revenue | 692 | 1,620 | 3,712 | 5,458 | 9,447 | ||||||||||||
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| Total revenues | 178,475 | 117,502 | 90,380 | 47,845 | 36,560 | ||||||||||||
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| Operating expenses | |||||||||||||||||
| Salaries and employee benefits | 47,193 | 39,286 | 35,137 | 27,428 | 23,423 | ||||||||||||
| Other operating expenses | 13,645 | 11,335 | 7,934 | 5,708 | 6,211 | ||||||||||||
| Cost of legal collections | 28,202 | 15,827 | 11,028 | 5,457 | 129 | ||||||||||||
| Collection agency commissions | 4,786 | - | - | - | - | ||||||||||||
| General and administrative expenses | 9,212 | 6,509 | 6,314 | 5,750 | 5,458 | ||||||||||||
| Restructuring charges | - | - | - | - | 1,388 | ||||||||||||
| Provision for portfolio losses | - | - | 1,049 | - | 20,886 | ||||||||||||
| Depreciation and amortization | 1,951 | 2,023 | 2,453 | 2,481 | 2,154 | ||||||||||||
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| Total operating expenses | 104,989 | 74,980 | 63,915 | 46,824 | 59,649 | ||||||||||||
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| Income (loss) before interest, | |||||||||||||||||
| other income, and income taxes | 73,486 | 42,522 | 26,465 | 1,021 | (23,089 | ) | |||||||||||
| Interest expense | (35,330 | ) | (20,479 | ) | (18,592 | ) | (10,945 | ) | (7,829 | ) | |||||||
| Other income (expense), net | 690 | 7,380 | ² | 213 | 208 | (69 | ) | ||||||||||
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| Income (loss) before income taxes | 38,846 | 29,423 | 8,086 | (9,716 | ) | (30,987 | ) | ||||||||||
| (Provision for) benefit from income taxes | (15,670 | ) | (11,003 | ) | 5,703 | ³ | (1,149 | ) | 7,257 | ||||||||
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| Net income (loss) | 23,176 | 18,420 | 13,789 | (10,865 | ) | (23,730 | ) | ||||||||||
| Preferred stock dividends | - | (374 | ) | (440 | ) | - | - | ||||||||||
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| Net Income (loss) available | |||||||||||||||||
| to common stockholders | $ | 23,176 | $ | 18,046 | $ | 13,349 | $ | (10,865 | ) | $ | (23,730 | ) | |||||
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As Of And For The Years Ended December 31, | ||||||||||||||||
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| 2004 | 2003 | 2002 | 2001 | 2000 | |||||||||||||
| Earnings (loss) per common share: | |||||||||||||||||
| Basic | $ | 1.05 | $ | 1.65 | $ | 1.82 | $ | (1.52 | ) | $ | (3.20 | ) | |||||
| Diluted | $ | 0.99 | $ | 0.88 | $ | 0.84 | $ | (1.52 | ) | $ | (3.20 | ) | |||||
| Weighted-average shares outstanding: | |||||||||||||||||
| Basic | 22,072 | 10,965 | 7,339 | 7,161 | 7,421 | ||||||||||||
| Diluted | 23,481 | 20,873 | 16,459 | 7,161 | 7,421 | ||||||||||||
| Cash flow data: | |||||||||||||||||
| Cash flows provided by (used in): | |||||||||||||||||
| Operating | $ | 36,412 | $ | 33,971 | $ | 24,690 | $ | 8,853 | $ | (15,831 | ) | ||||||
| Investing | $ | (50,157 | ) | (19,472 | ) | (11,158 | ) | (21,773 | ) | 12,399 | |||||||
| Financing | $ | 24,864 | 23,361 | (14,192 | ) | 13,444 | 3,968 | ||||||||||
| Selected operating data: | |||||||||||||||||
| Purchases of receivables portfolios, at cost | $ | 103,374 | $ | 89,834 | $ | 62,525 | $ | 39,030 | $ | 6,911 | 4 | ||||||
| Gross collections for the period | $ | 234,676 | $ | 190,519 | $ | 148,808 | $ | 83,051 | $ | 66,117 | |||||||
| Average active employees for the period | 728 | 679 | 573 | 538 | 554 | ||||||||||||
| Gross collections per average active | |||||||||||||||||
| employee for the period | $ | 322 | $ | 281 | $ | 260 | $ | 154 | $ | 119 | |||||||
| Consolidated statements | |||||||||||||||||
| of financial condition data: | |||||||||||||||||
| Cash | $ | 49,731 | $ | 38,612 | $ | 752 | $ | 1,412 | $ | 888 | |||||||
| Restricted cash | 3,432 | 842 | 3,105 | 3,053 | 2,468 | ||||||||||||
| Investment in receivables portfolios | 137,963 | 89,136 | 64,168 | 47,001 | 25,969 | ||||||||||||
| Investment in retained interest | - | 1,231 | 8,256 | 17,926 | 31,616 | ||||||||||||
| Total assets | 201,142 | 138,285 | 89,974 | 77,711 | 71,101 | ||||||||||||
| Accrued profit sharing arrangement | 20,881 | 12,749 | 11,180 | 2,378 | - | ||||||||||||
| Total debt | 66,828 | 41,638 | 48,033 | 70,451 | 55,503 | ||||||||||||
| Total liabilities | 105,127 | 66,914 | 70,432 | 80,069 | 61,022 | ||||||||||||
| Total stockholders’ equity (deficit) | 96,015 | 71,371 | 19,542 | (2,358 | ) | 10,079 | |||||||||||
| 1Includes gains from whole portfolio sales totaling $0.3 million and $0.7 million for the years ended December 31, 2003 and 2002, respectively. |
| 2Reflects a non-recurring net pre-tax gain totaling $7.2 million, recognized in the first quarter of 2003 upon settlement of a lawsuit against the seller of certain accounts. This resulted in an after tax net gain of $4.4 million or $0.21 per share on a fully diluted basis. |
| 3Reflects a benefit totaling $9.9 million or $0.60 per share on a fully diluted basis, recognized in 2002 resulting from our reinstatement of our net deferred tax asset. |
| 4Includes $2.0 million in receivables portfolios purchased as part of an acquisition. |
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Item 7 - Management's Discussion and Analysis of Financial Condition and Results of Operations
Overview
Our business and financial results improved significantly during the year ended December 31, 2004 as compared to prior years. Highlights for the year ended December 31, 2004 as compared to the year ended December 31, 2003 are as follows:
- Gross collections increased 23.2% to $234.7 million
- Revenues increased 51.9% to $178.5 million
- Net income increased 25.8% to $23.2 million
We attribute these improvements to stronger collections, especially of seasoned portfolios, disciplined purchasing and our multiple collection strategies. We believe that the markets for unsecured charged-off consumer debt are becoming more competitive. This has increased and, we believe, will continue to increase the pricing of portfolios. We are continuing to diversify our acquisition of portfolios into other categories that are somewhat less competitive.
We have significantly improved our financial position as a result of our recent operating performance and our successful follow-on public offering of 3.0 million shares of our common stock in the fourth quarter of 2003. Our stockholders’ equity was $96.0 million as of December 31, 2004, an increase of $76.5 million from the $19.5 million in stockholders’ equity as of December 31, 2002. Moreover, our improved operating cash flow combined with the net proceeds of $30.1 million from our follow-on public offering resulted in an unrestricted cash balance of $49.7 million dollars as of December 31, 2004 and have allowed us to repay significant amounts of principal on our debt facilities during the past three years. We repaid $53.3 million, $85.5 million and $79.7 million in principal during the years ended December 31, 2004, 2003 and 2002, respectively.
Our strong financial condition and sound operating performance have also allowed us to obtain a new $75.0 million Revolving Credit Facility. Unlike our previous facility, the new Revolving Credit Facility does not require us to share with the lender the residual collections on the portfolios financed. In addition, this facility carries a lower base rate of interest. Accordingly, as we replace borrowings under our old facility with our new facility, our interest costs should decline.
Purchasing Market Outlook
In general, the increased competition in the purchase market results in an increasing number of deals at prices which are reducing the profitability of our business. This is a complicated business and success only begins by purchasing portfolios at the right price. It also requires collecting well at a reasonable expense ratio.
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Recently, our industry has attracted a large amount of investment capital. With this inflow of capital, we have seen a significant increase in the pricing of portfolios to levels that we believe will generate marginally acceptable returns on investment. As an example, despite bidding significantly more for an annual forward flow arrangement that we had maintained for several years, we were out bid for the 2005 contract and have been replacing this contract with individual porfolio purchases. We expect that over time, many recent entrants to the market, whose business model may be based on less than a multi-disciplined approach to purchasing and collecting, will not generate the returns they anticipated. This may then reduce their ability to access capital and potentially may require them to sell their remaining portfolios and exit the market. If and when this occurs, we believe that prices should return to justifiable levels. We believe that our multi-disciplined approach to purchasing places us in a strategically advantageous position to capitalize on such an event.
Results of Operations
Results of operations in dollars and as a percentage of net revenue were as follows (in thousands, except percentages):
| 2004 | 2003 | 2002 | ||||||||||||||||||
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| Revenues | ||||||||||||||||||||
| Revenue from receivables portfolios | $ | 175,296 | 98.2 | % | $ | 115,575 | 98.4 | % | $ | 80,961 | 89.6 | % | ||||||||
| Revenue from retained interest | 2,487 | 1.4 | % | 307 | 0.2 | % | 5,707 | 6.3 | % | |||||||||||
| Servicing fees and related revenue | 692 | 0.4 | % | 1,620 | 1.4 | % | 3,712 | 4.1 | % | |||||||||||
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| Total revenues | 178,475 | 100.0 | % | 117,502 | 100.0 | % | 90,380 | 100.0 | % | |||||||||||
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| Operating expenses | ||||||||||||||||||||
| Salaries and employee benefits | 47,193 | 26.4 | % | 39,286 | 33.4 | % | 35,137 | 38.8 | % | |||||||||||
| Other operating expenses | 13,645 | 7.6 | % | 11,335 | 9.6 | % | 7,934 | 8.8 | % | |||||||||||
| Cost of legal collections | 28,202 | 15.8 | % | 15,827 | 13.5 | % | 11,028 | 12.2 | % | |||||||||||
| Collection agency commissions | 4,786 | 2.7 | % | - | 0.0 | % | - | 0.0 | % | |||||||||||
| General and administrative expenses | 9,212 | 5.2 | % | 6,509 | 5.5 | % | 6,314 | 7.0 | % | |||||||||||
| Provision for portfolio losses | - | 0.0 | % | - | 0.0 | % | 1,049 | 1.2 | % | |||||||||||
| Depreciation and amortization | 1,951 | 1.1 | % | 2,023 | 1.7 | % | 2,453 | 2.7 | % | |||||||||||
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| Total operating expenses | 104,989 | 58.8 | % | 74,980 | 63.7 | % | 63,915 | 70.7 | % | |||||||||||
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| Income before interest, | ||||||||||||||||||||
| other income, and income taxes | 73,486 | 41.2 | % | 42,522 | 36.2 | % | 26,465 | 29.3 | % | |||||||||||
| Interest expense | (35,330 | ) | (19.8 | %) |
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(20,479 | ) |
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(18,592 | ) | (20.6 | %) | ||||||
| Other income | 690 | 0.4 | % | 7,380 | 6.3 | % | 213 | 0.2 | % | |||||||||||
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| Income before income taxes | 38,846 | 21.8 | % | 29,423 | 25.1 | % | 8,086 | 8.9 | % | |||||||||||
| (Provision for) benefit from income taxes | (15,670 | ) | (8.8 | %) | (11,003 | ) | (9.4 | %) | 5,703 | 6.3 | % | |||||||||
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| Net income | $ | 23,176 | 13.0 | % | $ | 18,420 | 15.7 | % | $ | 13,789 | 15.3 | % | ||||||||
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Year Ended December 31, 2004 Compared to Year Ended December 31, 2003
Revenue
Total revenue was $178.5 million for the year ended December 31, 2004, an increase of $61.0 million or 51.9% compared to total revenue of $117.5 million for the year ended December 31, 2003. The increase in revenue was primarily the result of increased receivables portfolios purchases and increased gross collections during the year. During the year ended December 31, 2004, we invested $103.4 million for portfolios with face values aggregating $3.5 billion for an average purchase price of 2.99% of face value. This is a $13.6 million, or 15.1% increase compared with the $89.8 million invested during the year ended December 31, 2003 to acquire portfolios with a face value aggregating $3.3 billion for an average purchase price of 2.73% of face value. Gross collections on our investment in receivable portfolios increased $49.7 million, or 27.8% to $228.7 million during the year ended December 31, 2004 from $179.0 million during the year ended December 31, 2003. The weighted average annualized effective interest rate on our accrual basis portfolios was 138.7% for the year ended December 31, 2004 compared to 140.5% for the year ended December 31, 2003. The revenue as a percentage of collections for the year ended December 31, 2004 was 76.7% compared to 64.6% for the year ended December 31, 2003. For additional information on revenue see the Supplemental Performance Data.
Operating Expenses
Total operating expenses were $105.0 million for the year ended December 31, 2004, an increase of $30.0 million or 40.0% compared to total operating expenses of $75.0 million for the year ended December 31, 2003.
Salaries and employee benefits
Total salaries and benefits increased by $7.9 million or 20.1% to $47.2 million during the year ended December 31, 2004 from $39.3 million during the year ended December 31, 2003. The increase was the result of a $4.1 million or 14.0% increase in salaries, wages and payroll taxes reflecting an increase in the number of our employees; a $2.5 million or 31.8% increase in incentive compensation resulting from our strong operating performance; and $1.1 million or 64.5% increase in healthcare costs as a result of increased health benefits provided to our employees, rising healthcare costs and an increase in the number of employees participating in our health plan. Total salaries and benefits as a percentage of gross collections during the year ended December 31, 2004 were 20.1% compared to 20.6% for the year ended December 31, 2003.
Other operating expenses
Other operating expenses increased $2.3 million, or 20.4%, to $13.6 million during the year ended December 31, 2004 from $11.3 million during the year ended December 31, 2003. The increase during the year ended December 31, 2004 reflects volume-driven increases in the cost of direct mail campaigns and in skip tracing costs. The cost of direct mail campaigns increased 11.8% or $0.6 million to $5.3 million during the year ended December 31, 2004 compared to $4.7 million during the year ended December 31, 2003. Skip tracing, credit reporting and scoring costs increased $1.3 million, or 41.5% to $4.6 million during the year ended December 31, 2004 compared to $3.3 million during the year ended December 31, 2003.
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