Encore Capital Group, Inc. (ECPG) Q1 2012 Earnings Report, Transcript and Summary

Good day, and welcome to the Encore Capital Group's First Quarter 2012 Earnings Conference Call. [Operator Instructions] As a reminder, this conference call is being recorded. I would now like to turn the conference over to our host today, Mr. Adam Sragovicz, Director of Finance and Treasury. Please go ahead.

Thank you, Carolina. Good afternoon, thank you for joining Encore Capital Group's First Quarter 2012 Earnings Call. As a reminder, in order to see the slides we are presenting this afternoon, please be sure to log into the webcast on the Investors section of our website, www.encorecapital.com. With me on the call today are Brandon Black, our Chief -- our President and Chief Executive Officer; and Paul Grinberg, our Chief Financial Officer. We will begin with prepared remarks, together with a slide presentation and then follow with a question-and-answer period. Given a significant number of new items, we decided to utilize the slide presentation as part of this quarter's call, which will also be available on our website following the call. Please also note that all spoken references to first quarter or Q1 will refer to the first quarter of 2012, unless otherwise stated. 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 the 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-Q 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 financial measure contained in covenants used in our credit agreement in the evaluation of our operation and believes this measure is a useful indicator of our ability to generate cash collections in excess of operating expenses through the liquidation of our receivable portfolio. 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 costs 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 other risks. As a reminder, this conference call will also be available for replay on the Investor Relations 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 Chief Executive Officer.

Thank you, Adam, and good afternoon. I appreciate you joining us today to discuss Encore's first quarter results and review the meaningful corporate developments. It's my hope that you'll take away 3 key points from this call: first, Encore delivered strong financial performance and record results in the quarter; second, we continue to improve and evolve our operating model to maximize returns and adjust to the constantly changing regulatory environment; and third, the meaningful corporate developments that we're announcing today are a testament to our commitment to expanding our business by leveraging our core competencies to drive future growth and shareholder value. I'm speaking with you today from the headquarters of Propel in San Antonio, Texas, and I'm thrilled to welcome the Propel employees to the Encore team. Paul is in our headquarters in San Diego, so please excuse any pauses during the question-and-answer period. This has been an important period and time for our company. And before getting started, I want to recognize and express my appreciation for our 2,600 employees around the world, whose dedication, hard work and perseverance helped make this quarter so successful. Our core business delivered strong results in the quarter. Collections reached an all-time high of $231 million, which is a 21% increase over the first quarter of 2011. We were able to produce these collections while continuing to expand our operating margin. During the quarter, our overall cost to collect decreased to 160 basis points to 38.4%. This is a significant accomplishment because these results include the continued investment that we are making in our internal legal initiative and our new operating site in Costa Rica. The growth in collections and improvement in cost to collect led to earnings per share of $0.69 was adjusted for the noncash charges related to Ascension. Adjusted EBITDA was $143 million, up from $116 million in the same period of 2011. During the quarter, we successfully deployed $130 million on new portfolios, which is a $40 million or 44% increase compared to the prior year. It was a record first quarter for purchases, and we completed 64 transactions from 12 different sellers. Our analytical discipline, increasing cost advantage and strong capital position drove our purchasing success. Over the past few years, you've heard us discuss the possibility of industry consolidation. And in the fourth quarter, we started to see an increase in portfolio purchase opportunities from competitors. In fact, we spent almost $50 million on these types of transaction in the fourth quarter. It's our belief that a key factor in a competitor's decision to sell is the challenge of competing with companies with meaningful operating and cost advantages. We are positioned to acquire these secondary market portfolios for 3 primary reasons: First, we have significant experience purchasing accounts and secondary markets. Our largest single purchase was from a competitor, and we have been a major proven player in the resell market throughout our history. Second, our consumer-centric model allows us to accurately evaluate portfolios, independent of the owner or originator of the portfolio. Third, as I mentioned before, Encore enjoys important cost and cost of capital advantages. These secondary market opportunities have continued into 2012. Specifically, we are the successful bidder on 9 separate portfolios of consumer loan and credit card receivables from one seller. The total face value is $3.3 billion, and we expect to close these transactions in mid-May at a combined price greater than $100 million. Some of you may have seen and FTC announced earlier today granting early termination to Encore. That announcement was related to the purchase of these portfolios. When added to other purchasing commitments in place, this large acquisition will push our second quarter purchases to over $200 million. That means our combined purchases for the fourth quarter of 2011 and the first quarter of 2012 -- first 2 quarters of 2012 will approach $500 million. Successfully negotiating and integrating these large complicated deals is no simple task. Each part of our organization has to pull together to ensure success, and I want to thank those individuals and teams who have worked so hard to make it happen. From analyzing and evaluating millions of accounts, to on-boarding dozens of new agencies and partners, our deep and talented teams have proven once again how truly capable they are. To be successful in our business, several key components are necessary. These include a robust consumer evaluation process and servicing platform, cost-efficient, highly-effective operating sites, access to reasonably priced capital and the ability to navigate through a complex and changing regulatory environment. We believe that an increasing number of our competitors will find it difficult to effectively compete across all of these dimensions and will ultimately exit the business, providing new opportunities for Encore. While our core businesses flourished, our extension bankruptcy servicing business has faced significant headwinds. Bankruptcy volumes have dropped year-over-year, which has led to a decline in subsidiaries' profitability. Also, in the first quarter, Ascension's large client put their business out for bid, and we see significantly lower quotes than what we could reasonably offer. Given that, we decided to seek strategic alternatives for the business. In February, we began exclusive negotiations with the company that has deep experience in the bankruptcy space, and we agreed to an agreement principle to sell the business to them. There's no question this is the best solution for Ascension's client and employees, who will now have the opportunity to flourish in a new environment. Paul will discuss the details of this transaction and its impact on current and future periods. For some time now, we've been focused on identifying complementary opportunities to our core business. In fact, over the past 24 months, we've explored both geographic and asset class diversification, including dozens of potential acquisitions. We have been focused on identifying an opportunity where we could add value to our analytical expertise, cost-effective operating platform and knowledge and understanding of the distressed consumer. These broad and patient efforts enabled us to form a deep knowledge of many adjacent industries and geographies, and ultimately, we decided to pursue an acquisition of the tax lien industry. This asset class is a natural extension of our core business, where success is driven by analytical rigor and efficient operating platform and consumer level underwriting and marketing. It gives us the flexibility to deploy significant amounts of capital at very strong merchant risk-adjusted returns. Our estimate of the total size in tax lien market is between $7 billion and $10 billion of capital deployment on an annual basis. Yesterday, we closed on the acquisition of Propel Financial Services, the company we approached towards the end of 2011. Propel helps home owners who are delinquent on their property taxes. On behalf of the consumer, they purchase the obligation from the municipality at par and work with the homeowner to create a payment plan that allows them to pay off the balance on reasonable terms. In this industry, which is presently unique to Texas, the transaction's referred to as a tax lien transfer. With the tax lien transfer model, homeowners opt-in and engage with companies like Propel to help them pay off the delinquent taxes. This is a win for municipalities because they receive the funds they need during a difficult economic times in their budgets, and it's a win for consumers because they can satisfy their obligations over time at a lower interest rate and fee structure than what the government charges. As the market leader, Propel is a strong brand and enjoys very high customer satisfaction. Propel grew significantly over the last few years, and we believe that we can accelerate its growth in 2012 and beyond by leveraging Encore's analytical, operational and marketing resource. The acquisition will be accretive to earnings in 2012, will strengthen our position as the leading consumer debt management platform and will create meaningful shareholder value. Paul will give you more information on the transaction, and we will tell you about Propel and the tax lien space in more detail on our annual investor day in New York on June 6. We are thrilled to be associated with such a high-quality group of management and employees and look forward to working with the Propel team to drive significant results in the coming years. Before I turn the call over to Paul, I want to highlight some of the things we are seeing on the regulatory front. While the industry continues to receive a significant amount of attention, we have become more adept at helping legislators and regulators understand both our company and our industry. Unfortunately, there's a significant amount of misinformation or information that has taken out of context. For example, there's been a lot written about the number of complaints that are made about the collection industry. Unfortunately, the raw numbers are never put into context. When we had the opportunity, we're able to show that the vast majority of consumers actually do not have a problem with the collection process. In fact, only 1/2 of 1% of consumers ever register a concern about their treatment. The industry has recently been provided access to the underlying Federal Trade Commission 2011 complaint data. And despite our size, complaints directed at Encore represent less than 1% of the total complaints collected. That number represents a remarkably small fraction when measured against the tens of millions of consumer interactions we had during the relevant period. And that makes sense given the emphasis we placed on treating consumers honestly and with respect. These and other facts are regularly used when we speak with legislators and generally have a positive impact on the dialogue. In the first quarter, we engaged with legislators in several states, and we're able to work with them to modify legislation, in ways that makes sense for consumers and the industry, or in some cases, see the bills pulled or defeated altogether. At the federal level, we have continued the dialogue with the CFPB and expect that to continue as they define their engagement level with the collections industry. Finally, we have proactively reached out to a group of Attorneys General and are working closely with them to address any remaining concerns. These conversations have been very constructive, and we hope this sets the stage for a positive resolution. Overall, our legislative and regulatory efforts are becoming more comprehensive, more sophisticated and more strategic to Encore. We believe that they will position us well in ethical, responsible company and the distressed consumer receivable space and allow us to stay engaged in an evolving legislative and regulatory landscape. With that, I will turn the call over to Paul, who will discuss our financial results in more detail. Paul?

Thank you, Brandon. As Brandon discussed, we had a very strong first quarter. Rather than going through the results in as much detail as I normally do, I will just focus on some of the highlights for the quarter and take the rest of the time to provide more detail about the 3 transactions, which Brandon mentioned. In this section, any reference to the prior year should be construed as a quarter-to-quarter comparison, unless I mention otherwise. Collections grew 21% to $231 million; adjusted EBITDA grew 23% to $143 million; and earnings per share, excluding the impact of the Ascension transaction, grew 28% to a record $0.69. On the operations front, despite the continued investment and initiatives, like internal legal and our new site in Costa Rica, our cost to collect was the lowest in the company's history at 38.4%, down from 40%. We are excited about the increased leverage, but I want to reiterate that our goal is to maximize dollars collected less dollars spent, not the ratio of dollars spent to dollars collected. As such, where we can generate incremental collections, we will do so, even when it may entail a higher average cost to collect. I also want to mention that as a result of the seasonality of our business, our cost to collect is generally the lowest during the first quarter and highest in the fourth quarter. The quarter's strong cash generation enabled us to deploy $130 million for purchases, while only increasing our debt by $9 million. After reflecting the impact of the recent amendments to our credit facility, at the end of the quarter, we had nearly $180 million of available borrowing capacity. This availability enabled us to complete the Propel acquisition, and we'll facility the large portfolio purchases that Brandon mentioned, without the need to raise expensive equity or other debt financing. One of the metrics we monitor closely is our estimated remaining collections or ERC. At March 31, ERC was just over $1.7 billion. We believe that our ERC, which reflects the estimated remaining value of our existing portfolio, is conservatively stated because of our cautious approach to setting initial curves and our practice of only increasing future expectations after sustained period of over-performance. Taking a closer look at our collections by channel, our call centers contributed 47.6% of total collections or $110 million for the quarter, as compared to $88.5 million in 2011. Legal channel collections grew to $110 million in the quarter compared to $88.5 million last year, and accounted for 47.4% of total collections. The remaining 5% of collections came primarily from collection agencies. Direct costs per $1 collected in our call centers declined to 5.9% for the quarter, from 7.6% in 2011. This improvement is largely the result of collections growth from our operations center in India, which increased 40.7% from $42.3 million in 2011, to $59.5 million in 2012. India represented 54.2% of total call center collections during the quarter. Cost to collect in the legal channel in 2012 was 35.3%, down meaningfully from 41.3% in 2011. The decline was largely 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 use this strategy. Moving on, revenue from receivable portfolios in the quarter was $126.4 million, an increase of 20% over the $105.3 million in 2011. As a percentage of collections and excluding the effects of allowances, the revenue recognition rate was 54.9% in the first quarter, slightly lower than the 58% in the first quarter of 2011. During the quarter, we've spent $373,000 in net allowance charges compared to $5.5 million in 2011. Looking at the breakdown by pool, we had $1.1 million of allowances in the 2006 vintage, $78,000 of allowances in the 2005 vintage and $209,000 in the 2007 vintage. These allowances were offset by $1 million in reversals. We had no allowance charges for the 2009, '10, '11 or '12 vintages in the quarter, as has been the case since we acquired these portfolios. This quarter, we outperformed our forecasted collection curves by 20%. The income tax provision in the first quarter was $7.3 million, reflecting an overall tax rate of 39.2% as compared to 38.6% in the same period in 2011. Turning to Ascension, our fee-based bankruptcy servicing business, revenue fell by 29%, from $4.9 million in the prior year, to $3.8 million. And cash operating costs were $4.5 million compared to $4.3 million in the prior year. Earnings per share for the quarter was impacted by our decision to transition Ascension to new owners. During the first quarter, we recorded a one-time noncash impairment charge of $10.3 million, associated with Ascension's goodwill and intangible assets. This reduced after-tax earnings by $0.25. Earnings per share were also impacted by Ascension's loss in the quarter and by the transaction costs associated with the Propel acquisition. We have an agreement in principle with the new owner and expect the transaction to be completed by the end of May. As part of the transition, Ascension's new owner will invest in new technology and apply the bankruptcy servicing expertise necessary for Ascension to compete more effectively, and we have agreed to cover normal operating losses in the first year of ownership. If the business grows and becomes profitable, we will be paid an earnout equal to 30% to 40% of Ascension's EBITDA for the first 5 years after closing. In the second quarter, we expect to accrue an estimate for Ascension's loss sharing and related matters of approximately $0.10 per share, and incur approximately $0.12 per share in Propel deal costs, which are expensed in accordance with GAAP. Beginning in the second quarter, we will treat Ascension as a discontinued operation. Turning to the acquisition of Propel and the large acquisition of 9 portfolios, we will fund these transactions through availability on our existing credit facility, cash-on-hand and a new $160 million syndicated loan facility led by Texas Capital Bank, which will be maintained at the Propel subsidiary level. This new 3-year revolving credit facility bears interest at LIBOR, plus a spread that ranges from 300 to 375 basis points, has a $40 million accordion feature and had $122 million drawn at closing. We welcome our new financing partners to Encore and look forward to working with them to grow our tax lien transfer business. Over the last few years, we focused our business on developing more insights into the financially stressed consumer, improving our marketing efforts and operational model through analytical rigor and building a superior, cost-effective operating platform. These have all led to record cash flows, strengthened our balance sheet with record low leverage and as I mentioned earlier, allowed us to build up a reservoir of value reflected in ERC. Together with the new Propel revolving credit facility, this enabled us to fund the Propel acquisition and will allow us to fund the 9 portfolio acquisitions without the need for raising more expensive debt financing or equity. The purchase price for Propel of $187 million would largely be allocated to Propel's tax lien transfer portfolio, with the balance going to goodwill and other intangibles is subject to a formal valuation analysis. A recurring question of what you had on our earnings calls has been whether we would deploy the excess capital we've been building to buy back stock or pay a dividend. We've maintained that we believe we can use that capital both in our core business and to diversify into other asset classes or geographies, and that those types of investments would yield a better return to our shareholders than a buyback or dividend. We believe that the 2 transactions we announced today demonstrate our ability to deploy our capital in a prudent manner and in ways which will provide sustainable growth for our company and create shareholder value. In anticipation of these transactions, we've made some changes to our credit facility. The most substance over these changes included increasing the size of the facility from $410 million to $555 million and reloading the accordion to $100 million, bringing the total facility to $655 million. We also increased our advanced rate from 30% of ERC to 33% of ERC, reflecting a significant reduction in our cost to collect since we put the facility in place. Despite the increased leverage resulting from these transactions, we are still well within the financial covenants established in our credit facility. While our leverage ratio has increased, it is still more than $315 million below our maximum threshold, and we believe that using excess capacity to fund strong growth opportunities like Propel will improve return on equity. As we continue to generate strong cash collections from our core business, we expect our leverage will decline. Also, as a result of the 9 portfolio purchases, which we will close later this month, we expect that purchases in Q3 will be significantly lower than historical purchase levels. This will also serve to reduce our leverage. As Brandon mentioned, excluding deal costs, we expect the Propel acquisition to be immediately accretive and expect solid performance from the large portfolio purchases. However, we will be making investments in Propel that will drive future growth and profitability and will also be making investments in legal operations as part of the portfolio acquisitions. Accordingly, we will be providing additional information and guidance at our investor day on June 6, and to assist you in updating your financial models' front. With that, I will turn it over briefly to Brandon, before opening up the call for questions. Brandon?

Thanks, Paul. Encore's first quarter performance demonstrate that we are uniquely able to continue to succeed in an ever-changing business, economic and regulatory environment. Our continued focus on our core expertise around distressed consumers, strong operational capacity and legislative and regulatory expertise will help us drive future success. We are pleased to have found an opportunity to further leverage our analytics and experience with distressed consumer in our acquisition of Propel. Our strong team, disciplined approach and growing capital availability are all great news for Encore employees and shareholders. We thank you for listening, and we look forward to seeing you on our investor day in June. Operator, please open up the line for questions.

[Operator Instructions] And we have a question from the line of David Scharf with JMP Securities.

A few things, just starting on the purchase environment, I know you've provided a little commentary on Q3 being below normal. Just kind of wondering, are there any unique staffing issues related to the amount of paper you're taking on in just a 5-month period? Should there be any kind of unusual spinoff costs that might kind of depress margins a little bit in the next couple of quarters? Or is this all in kind of the regular course of business?

David, in anticipation of this transaction, we started expanding our staffing notably in India and had the good fortune of being able to adjust the work efforts for some of our employees there from lower yielding accounts onto the new portfolios. So we don't actually expect there would be a significant change, although there was certainly some staffing requirements. We also had the ability to work with the seller, who has generally had an outsource model to allow accounts from agencies for a period of time, so we recall them. But that's -- again, that's why I think we do well, and I think our team is poised to bring on this large set of portfolios on top of the prior 2 quarters in an expeditious fashion without any meaningful disruption.

Okay, that's helpful. And then turning to productivity, particularly legal. It was a dramatic decline, especially given the investments you're making. Should we interpret the -- setting aside seasonality, should we interpret this big decline in cost to collect any macro or consumer-driven factors? Or would you attribute this all to just operational improvement efficiencies?

If you go back, we made the decision 5 or 6 years ago, to really ramp up the investment in legal and those consumers who we thought could pay, but weren't engaging with us. And back then, it was more expensive. But as time has gone on, we've been able to build models that allow us to refine that process over and over. And so we think it's just 6 -- 5 or 6 years of learning. And each time around that we go around the annual process, we get better and better in what we do. So we don't think it's a macro effect. It's just really this long embedded duration of significant investment that's allowed us to bring the cost down.

Okay. So no need to kind of jump the gun and concluding anything about the consumer...

David, just I want to clarify that the internal legal costs are not included in the cost to collect for the legal operations. So they're just -- they're separated. They're disclosed in the Q separately, but they're not part of that cost to collect.

Right, right. Okay, and then lastly and then I'll get back in queue. Can you give us a little better feel for -- I know you're going to discuss Propel in more detail in the investor day, but just how these tax liens ultimately liquidate, how we ought to think about the average life of the collections on these or the workout schedules, how it relates to your core credit card receivables, and in what kind of typical purchase prices they're acquired at?

So I'll handle a part of it and I'll let Paul sort of talk about the accounting differences. But generally, the assets are acquired at par. So unlike our core business is where you're paying sort of 10 cents on the dollar. You're paying largely 100 cents on the dollar. And that's because ultimately, these liens are sort of super secured, meaning that if you're thinking about that waterfall, who gets paid first, these liens go above even the first mortgage holder. That's why it's highly liquid and also highly secured. And the way they're originated, as you buy the par from the municipality and then you ultimately get that, their right as a tax lien holder. The duration, Paul, correct me if I'm wrong, is around 3 years and the accounting is slightly different. I'll let Paul work through that.

Yes, that's right, it's about between 3 and 4 years. And effectively, they're acquired at par and then accrue an interest rate, and so the earnings are the interest that's accrued on the investment. And so the curves are flatter than our typical curves are in the core business because we're acquiring it at par and just generating a return on that investment.

And our next question is from the line of Bob Napoli with William Blair.

Question, I guess, first on -- what was the size of the 9 portfolios, the dollar amount, did you give that one? I know you said over 100, but how much over 100?

We did not give the numbers, so we're just going to go with over 100.

Okay. I guess, I mean the -- obviously, that transaction was well publicized, and there was discussion about very aggressive price expectations from the seller. Can you comment? I mean, how can you give us comfort that you were -- that the multiple you paid, the pricing you paid was reasonable? It's a big chunk of business to take on, so it's a concentration of risk from one seller. So how did you go through the pricing, and are the rumor -- I mean, the discussion of pricing in the market, are you saying that -- was that right or wrong or -- maybe give us some color on that and the returns you expect on that business? Because obviously, it was very competitive.

Well, I don't know how a competitive it was or wasn't. What I can say is the whole portfolio wasn't sold. And so what we're buying is a portion of the portfolio that meets our return thresholds. I don't know what the other parts the portfolio did or didn't trade for. What I do know is that, as I mentioned in the call, our underwriting model is perfectly suited for this kind of opportunity. The -- our ability to evaluate the collectability at the individual consumer level allows us to look at portfolios that comes from issuers in the resale market. We'll ultimately -- we don't care who owned the right before us or who underwrote it. We care whether that individual consumer can recover and repay us over time. And the greatest testament to that, I think, is if you look at our history in being profitable on 95% of your deals, I'm not sure if there's a better answer than that one, they take our operating model, our history from the fact we only bought a portion of the portfolio that met our return thresholds, should give you the confidence, and I won't comment on what other people think about it.

Do you -- I mean, do you expect the similar returns on this paper as any other paper you've been buying in the market?

Absolutely.

Okay. The -- and then on the acquisition of Propel. Interesting business, and I've looked at tax lien businesses off and on for a long time. And typically, there's been a decent amount of regulatory risk that's been associated with the tax lien industry, at least in some markets at some times. How did you get comfortable with this business from that perspective? And it's in one state, did you have discussions with regulators in the state of Texas, or I mean how did you go get comfortable with the acquisition of Propel? And was it a competitive bid?

It was not a competitive bid. It was a company that we approached. And quite frankly, we view it as having very little regulatory risk in the sense that this is a government debt. And so unless they have a challenge with their own math, you don't run it yourself in the issue of kind of its underlying data could. In this particular product, the consumer chooses the auctions. There was an auction process, and the consumer gets better terms and conditions that would otherwise. The industry in Texas was legislated into existence about 70 years ago. It was amended about 20 years ago with some different changes. So we actually believe this model is the absolute right model for consumers. We think it comes with very little regulatory or headline risks, certainly compared to our core business. And we spend a lot of time getting comfortable with that, but we really think it's an excellent product and one that consumers need.

Okay. And then the purchase price, was that -- was there book value or is that -- was it -- what was the book value of Propel? Or is the $187 million, is that all intangible?

It's not all intangible. As I mentioned, a large portion of that will be allocated to the portfolio and the rest will be goodwill and intangibles. And obviously, over time, we'll be disclosing more details on what that is.

And just last question, what's the yield on that? What kind of yield do you get on the tax lien business? What's the interest rate on the loan to the consumer?

So we're not giving that number. You could think about it in sort of the mid-teens.

And our next question is from the line of Mark Hughes with SunTrust.

What does the revenue and margin and cash collection profile of the Propel business look like? If you take your current run rate or in the last 12 months or something, just so we can get a sense of how will it look on your income statement.

Mark, we'll be providing more information about the detailed specifics on Propel when we -- some historical data when we do our 8-K filing, which will include 2011 financial data for Propel. So we'll be doing that. We'll be filing our 8-K within 75 days or so of the closing of the acquisition. So we'll provide more information then. And obviously, as we close out our Q2 earnings, and it's part of that, we'll be providing additional data then.

Okay. How much of -- or how applicable is this business to other markets? Because obviously, in Texas, it sounds like it's pretty idiosyncratic for that state. Is it legal elsewhere? Is the hope to make it -- make legislative changes so it is something you can spread to other states?

Well we actually think about this acquisition as the entry into the tax lien market. We're doing it through, we think, it's one of the best platforms you could find. The actual product they work on today is exclusive to Texas, although, we believe that it's got the opportunity to go more broadly. But the company, we think about this as a 28-state, $10 billion market that we're sort of starting, getting a toe-hold in Texas. But we expect that, over time, to grow either by expansion of this product or by outright tax lien acquisitions over the next few years.

Yes, were they capital constrained in Texas? Were there still attractive investments they could have made it if they had more capital?

Well what I will say is the combined penetration of all the participants in the space is less than 20%. And so we think there's a significant amount of opportunity that can penetrate this consumer base. Just quite frankly, there isn't anybody who has a delinquent tax lien that shouldn't take this product. Just given the rate and fee structure of the -- what they'll get through the governmental entities. And our job is to help them with the analytics and the marketing to really grow and penetrate that other 80%. But we think there's significant growth opportunities just in Texas.

Right. Paul, you mentioned some good puts and takes here in terms of outlook, we've obviously got accretion from Propel and selling off Ascension and these portfolio purchases. You also mentioned investments in legal. Can you give us some body language on how does that shake out relative to -- you've been going along at a pretty good clip in terms of growth, EPS in the last year in the low 20s, this is obviously better than that. What can you tell us about how this all impacts the bottom line?

I think we've always said that our goal is to continue growing the business at rates where we've been growing at historically. And I think this will be one of the things that will be part of that growth.

Right. Now you're putting a lot of capital to work. One would hope if you do put that amount of capital that it would make the business grow faster. Would we be -- would that be too optimistic?

Well, I think since we've said this will be accretive to earnings, so we'll clearly grow faster than had we not done it.

[Operator Instructions] And our next question is from the line of Adam Letson with Piper Jaffray.

Just quickly to make sure I heard correctly, the Propel deal closed yesterday. And then, Paul, if you could walk through just the deal charges again, and then potentially kind of what you think the magnitude of accretion is.

Yes, we haven't shared what the magnitude of accretion is. So there's nothing there. In this quarter, there was about $0.01 of deal cost, which I didn't mention. But there was about $0.01 of deal cost in Q1. For Q2, we expect to have about $0.12 in deal cost.

And it did close yesterday.

Great. Just one quick follow-up on the pricing environment. Clearly, the purchases you made this quarter were a bit more expensive than last year. Purchasing the large portfolio, next quarter, is there -- if you can just give a little bit more color as to kind of how the pricing is working out relative to this quarter, that'd be helpful.

So it's our belief that the pricing continues to bend off slightly quarter-to-quarter, although, the advancements in pricing have slowed down pretty meaningfully from what was occurring in 2011. So we see pricing going up a little bit. And I just think our ability to purchase is a function of both the gross liquidation we're able to give, which we think is industry-leading. But now with our cost down where they are, that just allows us to be significantly more competitive than many of the people we compete with. And that's what we built the company for. So while we see a little bit of price increases, we've been able to moderate that with improvements in our operating platform.

And our next question is from the line of Hugh Miller with Sidoti.

Had a question, you guys have referenced kind of a mid-teens interest rate for the Propel business. I was wondering, is that the rate that the government's charging or that's the rate that you guys would be receiving after you've taken on the business?

The government actually charges a higher rate than that. So that would be our rate.

Okay. And as you look at that business and the returns on invested capital relative to the debt buying business, how do they compare?

On a risk-adjusted basis, we think they compare very favorably with our core business.

Okay. So one could say though that you view the Propel business as a lower risk business. Correct?

That's correct.

Okay. So risk adjusted is the same -- all right, that makes sense. And I guess as you -- as I look at the productivity, you guys referenced obviously some of the improvements you've made in productivity on the legal side. But it's also look like cash collections per hour paid, it was up materially on a year-over-year basis as well, in the north of 20%. I was wondering if you could talk about the drivers of that, and if it's primarily seasoning of some of the collectors, or have you noticed any difference in average payment size on a year-over-year basis?

So we think a big part of it is the seasoning of the account managers, especially in India, as we highlighted going back a couple of years now that as we bring on significant number of new employees, it takes them about a year to get up to curve. And Manu, if you have seen him over there, he's done a fantastic job of growing that workforce, and that's a big part of it. I also think we're getting better on the marketing direct mail side, which drove significant returns in the quarter. So it's a combination of those 2.

Okay. And any color you can provide on the average payment size? Is that -- any trends you're noticing their relative to last year in the first quarter?

Yes, we've seen a pretty flat average payment size for the last few years and no discernible trends in the first quarter.

Okay. And you guys also referenced in the third quarter that you'd anticipate seeing kind of the less-than-normal buying activity if you guys to swallow the deal activity in the first half of the year. Can you just -- can you give us a sense on how meaningful that reduction is probably likely to be? [Audio Gap]

On our forecast for purchasing for the year.

And our next question is from the line of Mark Hughes with SunTrust. Please go ahead.

Paul, just so I understand. Could you walk me through how the cash flow works on -- you make an investment, say, $100 in the tax lien business. It sounds like you're buying it at par, you're then charging the consumer 15% interest rate. I presume you're recognizing that as revenue. Could you give me just a little more detail, you spent $100, how does it come back to you with a good return?

Through Propel, we would enter into something similar to an amortizing loan with a consumer where, say, if we lent $100 and it paid, as using your example here, 15%. And if it was a 5-year term, there would be a monthly payment that they would pay every month, which includes both principal and interest and it would amortize the loan in the example over that 5 years. And there are no prepayment penalties, so while the terms are typically longer, the average life is 3 to 4 years because there are prepayments.

And do you always buy it at par?

Yes.

And so whatever the losses may be are just factored into the interest rate that you charge?

Historically, there have been no losses.

Right, so everybody pays?

That's correct.

It's the big daddy gov is backing you up, right? Okay, well that's -- can you say what Propel -- their revenue growth in 2011, what it was over 2010. Historically, what kind of cyclical impact of this business? Are cities more likely to -- I don't know whether they persuade or are happier to have you step in or more consumers are delinquent in bad economies, and so therefore when we -- if we do get in a recovery, that could have some influence on the business. Could you -- again, what was the growth last year and what kind of cyclicality does the business have?

I'll address the cyclicality. I actually believe this has been a growing market over -- if you go back through time, we think any reduction, any one geography will be offset by growth in the new geographies. So it's our belief we'll continue to do that. We also think that this consumer-friendly product of having the consumer ultimately choose it rather than having imposed on them is a better solution. And we think more and more localities will come around to believing that this is a better product than holding on themselves or selling it in some way. If you think about what fund's most municipal budgets, it's the taxes on real estate. And so we think if anything there'd be more people selling given the shortfall in many budgets, not fewer.

How do your analytics help in this case? Is it determining whether you accept the consumers if they choose this? Is it a underwriting process where you accept or reject or your interest rate adjusts depending on the individual? How does that work?

I think you described it largely. I think it's understanding the population of consumers who are eligible, if you define a set of people and creating offers and opportunities for them at the individual level. And what we bring to the table is the ability to really understand and analyze that consumer rather than just a property. And so it's in the combination of consumer analytics and the real estate knowledge that Propel has is one advantage. The second is our deep ability to think about how they market to these consumers. And then we think our servicing platform will be able to help them in building other avenues in areas like telemarketing where not much is done today. So there's a broad number of areas, and we'll go through all of the synergies as we see them when we get to the June meeting.

And we have a follow-up question from the line of Bob Napoli with William Blair.

On the legal side, the reduction in the fees that you paid to the attorneys, how is that sustained -- I guess, is that sustainable? I mean you had a pretty big drop in legal costs. The costs that we see this quarter, as a percentage of the legal collections, is that sustainable? A pretty big drop percentage-wise. I'm trying to understand how that happened and if it's sustainable?

Yes, so, I mean a lot of it happened because of what Brandon described, which is being more sophisticated around which consumers we use this strategy with. And so, it is sustainable, but I'll say one thing though, that if we're able to identify another group of consumers where we can spend a little more and generate incremental collection dollars, we will do that. So our goal isn't to minimize the cost per dollar collection, it's to maximize with dollars -- collection of dollars spent. So based upon the pool that we collected from this quarter, clearly, it's sustainable. But we keep identifying new pools of consumers. And so, there may be increases in the future, depending upon whether we can generate incremental dollars or not.

So the decrease in the commission rate, is that -- I mean, is that happening across the industry or is it because you're giving so much volume to the attorneys?

This is less about the actual commission rate. It's more around -- our cost are both the commissions we pay the law firms as well as the unsuccessful use of court costs, and we see here today, maybe for reduction in the, I call them, wasted court costs over time.

Okay, interesting. And then in portfolio purchases, I kind of missed what you said about third quarter purchases.

I said that they will be lower than our -- significantly lower than what we typically spend in the third quarter, as we digest the significant volume of purchases we've had in Q4, Q1, and what we're anticipating in Q2.

Are you seeing less -- I mean obviously you're significant competitor has signed their portfolio, you're buying a part of it. Are you seeing any new players -- private equity-backed players or anything? I mean there's been pretty big, I guess, mergers of the industry into a handful of, say, larger players. And are there new players coming up? Are there less bidders now for portfolios than you've seen over the last 10 years?

So we're seeing meaningfully fewer bidders when you contrast it over history. In the near term, I think what you're saying is it's getting harder and harder and harder for the small- and medium-sized companies to compete just because they don't have the access to capital or the operating platform or the analytics or the technology. Our belief is every time the industry will consolidate into a few significant meaningful players, and it will be hard for a private equity leg firm to come into business and make it work.

And then just last question on the tax lien business, I mean it sounds like the metrics that you put out, it sounds awful attractive, 0 losses, 15 mid-teens yields and it still -- it improves the lot of the consumer. Sounds like a great business. What is the competitive environment like? And it seems like a kind of business that would attract a lot of competition. What is the barrier to entry? What does your company do that builds a barrier to competition? What is unique about Propel?

It's unique in many ways. One, it's clearly the market leader and it's one that has 3 -- have sort of branched in a couple of different directions. It's got one set of offices that has storefronts that address populations in a more face-to-face interaction. It's got direct marketing arm. It's now got 5 years worth of history. It isn't just something you come in to start sending letters around the people. I think getting access to capital is challenging as well. So we think the history that they have, the fact that they've been able to build multiple distribution channels for the product, the fact that they've been dedicated and thinking about it in an analytic lens and then our access to capital is what's going to keep it from having a lot of people come in. There are competitors in this space. There's more than a handful. But Propel has just driven a better model, and that's why we approached them late last year. We thought that they were the best-in-class and we'd be able to really take advantage of it.

And then we have a follow-up from the line of David Scharf with JMP Securities.

Two things. One on the purchasing side, obviously we heard about the Q3 reduction as you front-end loaded so much buying with these large acquisitions. I don't know if you purposely omitted Q4, but should we see a return to normal, say, by the end of the year? Or do we kind of consider this to be sort of 2012's budget pretty much nailed down by June?

As Paul alluded to, we have more distinct guidance, but we expect the majority of the pause could be through the third quarter and then a higher level of purchasing in the fourth quarter. We'll try to give you more specific detail in June.

Okay, that's actually helpful. And then just a couple of follow-ons on the tax lien. I've heard you mentioned no losses. Is there a -- it's a super secured lien, is there actually a foreclosure element to this type of product that you have to outsource, just kind of at a little bit of a loss to kind of grasp the concept of 0% losses on these assets.

It starts with positive selection from the consumer. Again, the consumer opts in to get that -- you are able to segment the whole universe of people into those who positively select in versus not. Ultimately, if it's not paid by the consumer, the next likely party to pay it is the first mortgage holder who oftentimes -- or the vast majority of times, will pay off the delinquent tax liens that rolled into their obligation. And about 1%, I've said 1% of the cases, there is a foreclosure element to it.

It's about half -- less than half of a percent of foreclosure instance.

And we have a follow-up question from the line of Hugh Miller with Sidoti.

Actually, you guys delved into the questions I had about the competitive environment and the differentiations between Propel and other companies. Just I guess, 2 quick follow-ups, is just one, you talked about how the penetration rate within Texas is extremely low at this point. But is it still somewhat competitive that everyone is kind of chasing after the same pool group of assets to the consumers to do business with. And the other question is just if you talked about expansion into other states as a possibility, would that be done via an acquisition of another firm or do you feel as though the knowledge that Propel has here could then be used organically to grow into other states?

So the first question, the universe of people that you can market this product is finite. It's published by the state. And so, you do have each group deciding of that population who they're willing to target, based on their risk tolerance. We think we're able to broaden that universe with our consumer level analytics. And then if we think a lot of it is education in the marketing angle and that's what we're going to focus on. But we think there is finite -- we can't create an increment of people and what our job is going to be to figure out how to partner with the team down here to penetrate the 80% that's not been penetrated. In terms of our growth strategy, we think about the team down here is being repeatedly used to drive into other geographies. It doesn't mean we won't add industry expertise or geographic expertise. But our platform will be the Propel platform.

And our next question is a follow-up from the line of Mark Hughes with SunTrust.

The company has been in business for 5 years. Is there any potential for some kind of tail risk or there's still some early loans that are still in the books, haven't been repaid that, again, 0-loss number is a very good number. Is there some reason to think that -- decent life, but not too long of a life of the company might not reflect some additional risks.

So the answer is, we believe, no. The part of the reason why we haven't talked about it thus far is we probably -- we hope to get details in the June 6 meeting, but I appreciate the questions. The LTV of many of these loans, if you ever think about it that way is, the underwriting is about 5%. So you're talking about just a dramatic difference between the value of the property and the actual lien amount. And so even the older vintages, we think are the most valuable ones, those are the consumers who have been paying for 5 years. So in the sense that so when you get late in the tail, some of you were the most committed, you're probably most at risk early on when somebody takes on the transfer. But ultimately, doesn't start paying right out of the gate. So we don't believe there's any tail risk.

This concludes the Q&A portion of today's conference call. Thank you for your participation in the Encore Capital Group's First Quarter 2012 Earnings Conference Call. This does conclude the program, and you may now disconnect. Thank you, and have a wonderful day.