Business context and reporting period
This unaudited Form 10-Q covers the quarter and six months ended June 30, 2011. The filing identifies the registrant as Alliance Data Systems Corporation—not Bread Financial Holdings, Inc.; confirm that this is the intended filing. Its businesses are LoyaltyOne (AIR MILES), Epsilon (marketing services), and Private Label Services and Credit.
Financial performance and position
- Second quarter: Revenue was $740.5 million, up 10.6% year over year; operating income was $191.8 million, up 19.6%; net income was $69.0 million, up 45.9%. Diluted EPS was $1.19 versus $0.83. Adjusted EBITDA, a non-GAAP measure, was $238.9 million, up 15.3%; its reported margin was 32.3% versus 30.9%.
- First half: Revenue was $1.481 billion, up 11.1%; operating income was $403.7 million, up 26.7%; net income was $155.4 million, up 65.4%. Diluted EPS was $2.74 versus $1.67. Adjusted EBITDA was $495.3 million, up 20.8%; reported margin was 33.4% versus 30.8%.
- Revenue drivers: First-half Epsilon revenue rose 30.7%, including contributions from acquisitions and organic growth; Private Label Services and Credit revenue rose 5.4%; LoyaltyOne revenue rose 7.6%, partly reflecting a stronger Canadian dollar.
- Credit quality: First-half net charge-off rate improved to 7.5% from 9.2% a year earlier; second-quarter rate was 7.2% versus 9.0%. Delinquencies were 4.5% of principal receivables at June 30, compared with 5.4% at December 31, 2010. The allowance for loan loss was $461.0 million, down from $518.1 million at year-end.
- Cash flow: First-half operating cash flow was $406.9 million, versus $446.5 million. Investing activities used $276.4 million, largely including the Aspen acquisition; financing activities used $37.8 million. Cash and cash equivalents were $232.8 million at June 30, up from $139.1 million at December 31.
- Debt and liquidity: Debt balances comprised $827.7 million of certificates of deposit, $3.307 billion of asset-backed securities, and $2.362 billion of long-term and other debt. The company had $176.5 million of availability under its revolving facility and reported $3.3 billion of available liquidity at bank subsidiaries. It was in covenant compliance; its core-debt-to-adjusted-EBITDA ratio was 2.5 versus a 3.50 covenant limit. Securitized assets and associated debt are subject to restrictions and limited recourse.
Material changes and notable items
- On May 31, 2011, the company acquired Aspen Marketing Holdings for $358.2 million net of acquired cash. Preliminary purchase accounting included $232.0 million of goodwill and $140.0 million of intangible assets; the goodwill is not tax deductible. Aspen results are included in Epsilon from the acquisition date.
- The company entered a new credit agreement in May, with a $792.5 million term loan and a $792.5 million revolving facility, and terminated prior facilities. It repaid $250 million of Series B notes at scheduled maturity. It also repurchased 1.5 million shares for $116.7 million in the first half; $211.4 million remained available under the repurchase authorization at June 30.
- Revenue growth outpaced cost growth in the first half, while lower loan-loss provision and reduced net interest expense supported profit growth. The company attributed lower provision partly to improved credit performance and lower average receivables; higher cardholder payment rates also restrained receivables growth.
Outlook, commentary, and risks
- Management expected AIR MILES issuance growth to be in the mid-single digits and redemption growth to remain in the low single digits for the rest of 2011. It expected credit-quality metrics to continue improving and stated that liquidity sources should meet operating and capital needs for at least 12 months. Capital expenditures were not expected to exceed approximately 3% of annual revenue.
- Management described Epsilon’s outlook as strong, citing client wins, expanded services, and acquisitions. It noted that LoyaltyOne’s adjusted EBITDA was pressured by runoff of amortized revenue, while Epsilon margins were affected by acquisition-related revenue mix.
- Funding remains exposed to renewal risk: some securitization commitments are short-term, and renewal on similar terms or at all is not assured. An asset-performance-triggered early amortization event could restrict additional securitization funding. The company reported that such an event was not considered reasonably likely.
- An unauthorized entry into Epsilon’s email system exposed some client customer names and/or email addresses in March 2011. The company said no associated personal information was at risk and did not expect significant costs or a material financial impact.
- Aspen’s approximately $140 million tax net operating loss carryforward was not recognized because its availability depends on whether a prior merger qualifies as a tax-free reorganization. The filing also notes ordinary-course claims and lawsuits, which the company did not expect to have a material adverse effect.
Important facts for investors to verify
- Confirm the issuer identity: the supplied filing is for Alliance Data Systems Corporation, not Bread Financial Holdings, Inc.
- Review the sustainability of credit-quality improvements, allowance adequacy, and the effect of continued high customer payment rates on receivables and finance-charge revenue.
- Assess refinancing and renewal exposure for securitization facilities, including maturities and the availability and terms of future funding.
- Evaluate Aspen’s integration, contribution to Epsilon growth and margins, final purchase accounting, and the contingent tax-loss benefit.
- Track AIR MILES issuance, redemption, deferred revenue, and sponsor contract changes, particularly changes that could affect the timing of revenue recognition.
- Consider that adjusted EBITDA and its margin are non-GAAP measures; compare them with GAAP earnings and operating cash flow.