BREAD FINANCIAL HOLDINGS, INC. annual report, FY2019

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Business context and reporting period

Alliance Data Systems Corporation (now associated with the Bread Financial name in the request metadata) filed this Form 10-K for the fiscal year ended December 31, 2019. The filing reports annual results, not a standalone Q4 report. Its continuing businesses were LoyaltyOne, including AIR MILES and BrandLoyalty, and Card Services, primarily private-label and co-brand credit cards. Epsilon was classified as discontinued operations and sold on July 1, 2019.

Financial performance and position

  • Revenue: $5.58 billion, down 2% from $5.67 billion in 2018. Card Services generated $4.55 billion; LoyaltyOne generated $1.03 billion.
  • Profit: Operating income was $1.31 billion, down 26%; income from continuing operations was $572.6 million, down 39%. Net income was $278.0 million versus $963.1 million, with the 2019 result including a $294.6 million loss from discontinued operations. Operating margin was approximately 23.4% versus 31.0% in 2018; continuing-operations net margin was approximately 10.3% versus 16.7%.
  • Credit performance: Provision for loan losses rose 17% to $1.19 billion. Net charge-off rate was 6.1%, unchanged from 2018; delinquency was 5.8% of principal receivables at year-end, versus 5.7%. The allowance for loan loss was $1.17 billion.
  • Cash flow: Operating cash flow was $1.22 billion, down from $2.75 billion. Investing activities provided $2.86 billion, largely reflecting $4.41 billion of Epsilon-sale proceeds; financing activities used $4.09 billion. Cash and cash equivalents were $3.87 billion at year-end.
  • Debt and funding: Long-term and other debt, including current maturities, was $2.85 billion; non-recourse securitization borrowings were $7.28 billion; deposits were $12.15 billion. The company had no revolver borrowings and $750 million available under its revolving facility. Its credit-agreement leverage ratio was 1.6x, below the 3.5x maximum covenant.
  • Other metrics: Net credit card and loan receivables were $18.29 billion. Adjusted EBITDA, net, a non-GAAP measure, was $1.27 billion, down 21%. Dividends paid were $2.52 per share ($127.4 million); repurchases totaled $976.1 million.

Material changes versus the prior comparable period

  • Revenue slipped modestly, while operating income and continuing-operations earnings fell substantially. Higher loan-loss provision, portfolio valuation adjustments, funding costs, restructuring charges and debt-extinguishment costs contributed to the decline.
  • Card Services adjusted EBITDA, net declined 25% to $1.12 billion; LoyaltyOne declined 4% to $244.5 million. Corporate/Other improved to a $92.9 million adjusted EBITDA, net loss from $140.8 million.
  • The Epsilon sale brought $4.4 billion in cash proceeds. The company used sale proceeds in part to redeem $1.9 billion of senior notes and repay $500 million on its revolving facility; it later issued $850 million of 4.750% notes due 2024 and prepaid term debt.
  • Credit card and loan receivables, net, increased from $16.82 billion to $18.29 billion, while cash from operating activities fell sharply. The year-end balance sheet also reflected Epsilon’s removal from continuing operations.

Outlook, commentary, risks and unusual items

  • Management said 2019 results did not meet original expectations and cited cost-saving initiatives, including $118.1 million of restructuring and other charges, which it did not expect to recur in 2020. The filing gives no specific earnings or revenue guidance.
  • Management stated that available internal funds and other liquidity sources should meet working-capital, capital-expenditure and other business needs for at least 12 months. It expected capital expenditures to remain below 3% of annual revenue and, subject to board approval and other constraints, expected to continue quarterly dividends.
  • CECL was adopted January 1, 2020 and increased the allowance for loan loss by $644 million, recorded as a cumulative adjustment to retained earnings, net of tax. The filing warns that expected-loss estimates and economic conditions could create further allowance volatility.
  • Customer concentration is material: the ten largest clients represented 44% of consolidated revenue in 2019. One large-client contract, representing about 3% of revenue, ran through September 2020 and was not expected to renew. L Brands and affiliates represented about 11% of consolidated revenue.
  • Key risks include consumer credit deterioration, access to securitization and deposit funding, interest-rate exposure, client losses, AIR MILES redemptions and breakage estimates, foreign-exchange movements, regulation and privacy requirements, cybersecurity, and COVID-19-related disruption identified as a forward-looking risk.
  • The company recorded an Epsilon-sale pre-tax gain of $512.2 million but an after-tax loss on the sale of $252.1 million. It also accrued a $32.9 million net-of-tax contingency for its indemnification of Publicis related to a DOJ investigation involving Epsilon marketing practices; the ultimate exposure was uncertain.
  • BrandLoyalty goodwill fair value exceeded carrying value by less than 10%, leaving limited disclosed headroom. The annual impairment test found no impairment.

Most important facts for investors to verify

  1. Review the detailed notes on the $644 million CECL transition and its effects on capital, retained earnings and future loan-loss expense.
  2. Assess credit trends beyond the reported 6.1% net charge-off rate, including delinquency, portfolio mix, receivables held for sale and allowance assumptions.
  3. Confirm the status and financial impact of the expected non-renewal of the client contract representing approximately 3% of revenue.
  4. Track the DOJ investigation and Epsilon indemnification exposure, and whether the recorded contingency changes.
  5. Verify ongoing access, cost and maturity profile of deposits and securitization funding, along with debt-covenant headroom and the company’s ability to sustain dividends and repurchases.