Filing identity and reporting period
Important identity discrepancy: The supplied filing is Alliance Data Systems Corporation’s Form 10-K for the fiscal year ended December 31, 2017—not a filing for Bread Financial Holdings, Inc. This summary reflects the filing text provided.
Alliance Data provided data-driven marketing and loyalty services and private-label/co-brand credit cards through LoyaltyOne, Epsilon and Card Services. Card Services generated 54% of 2017 revenue; Epsilon 29%; LoyaltyOne 17%.
Financial and operating results
| Metric | 2017 | 2016 | Change |
|---|---|---|---|
| Total revenue | $7,719.4 million | $7,138.1 million | Up 8% |
| Operating income | $1,645.5 million | $1,265.5 million | Up 30% |
| Net income | $788.7 million | $517.6 million | Up 52% |
| Diluted EPS | $14.10 | $7.34 | Up 92% |
| Adjusted EBITDA, net (non-GAAP) | $1,936.5 million | $1,880.0 million | Up 3% |
| Cash from operating activities | $2,609.6 million | $2,114.4 million | Up $495.2 million |
Calculated operating margin was approximately 21.3%, versus 17.7% in 2016; calculated net margin was approximately 10.2%, versus 7.3%. Revenue growth was led by Card Services finance charges and receivables growth. Epsilon revenue increased 5%, while LoyaltyOne revenue declined 3% and its adjusted EBITDA, net declined 17%.
- Finance charges, net rose 15% to $4,171.9 million, primarily as average card and loan receivables grew 15% to $16,185.5 million.
- Provision for loan losses increased 21% to $1,140.1 million. The net charge-off rate rose to 6.0% from 5.1%; delinquency was 5.1% at year-end, up from 4.8%.
- Interest expense, net rose 32% to $564.4 million, reflecting higher borrowings and rates. Management estimated a 1% rate change would alter annual interest expense by about $112 million.
- Investing cash outflow was $4,288.5 million, largely reflecting $3,600.2 million of receivables growth, the Signet acquisition and capital spending. Financing cash inflow was $4,004.9 million. Year-end cash and cash equivalents were $4,190.0 million.
Debt and liquidity
At December 31, 2017, balance-sheet amounts included $6,079.6 million of long-term and other debt, $8,807.3 million of non-recourse securitization borrowings, and $10,930.9 million of deposits. These funding categories are not interchangeable; securitization debt is non-recourse to the general credit of the company. The company reported $1,097.4 million available on its revolving credit facility, a total leverage ratio of 2.7x against a 3.5x covenant maximum, and compliance with debt covenants. It stated that available liquidity should meet needs for at least 12 months.
The credit card banks were reported as well capitalized. Their year-end Common Equity Tier 1 ratios were 13.5% for Comenity Bank and 14.0% for Comenity Capital Bank. Cash held by regulated subsidiaries may be constrained from being distributed to the parent.
Material changes and unusual items
- The 2017 Tax Reform reduced the effective tax rate to 27.0% from 38.2% and benefited net income by approximately $64.9 million, principally from remeasurement of U.S. deferred taxes.
- Card Services acquired Signet credit card receivables and related operations for approximately $945.6 million in October 2017, including roughly 250 employees; a long-term card and marketing agreement accompanied the deal. The company recorded a $7.9 million bargain-purchase gain.
- The company sold two card and loan portfolios for preliminary cash consideration of approximately $797.7 million and recorded $23.3 million of gains. Receivables held for sale were $1,026.3 million at year-end.
- It repurchased approximately 2.3 million shares for $553.7 million and paid $115.5 million in dividends during 2017. The board authorized up to $1.0 billion of repurchases through July 31, 2018, with $446.3 million remaining at year-end.
- A 2016 change in AIR MILES breakage estimate from 26% to 20% reduced 2016 redemption revenue by $284.5 million. In 2017, the estimated life of a mile was shortened from 42 to 38 months, increasing revenue by approximately $20 million.
- The company adopted ASC 606 on January 1, 2018. It expected certain AIR MILES redemption revenue and related costs to each decline by approximately $350 million in 2018 due to net presentation, with no expected impact on net income or adjusted EBITDA.
- After year-end, the company gave notice that it intended to redeem $500 million of 6.375% notes due 2020 at par on April 2, 2018, conditioned on borrowing the required funds under its revolving facility.
Outlook, commentary and principal risks
For 2018, management expected moderate AIR MILES growth; double-digit BrandLoyalty revenue and adjusted EBITDA growth; mid-single-digit Epsilon growth; and double-digit Card Services revenue and adjusted EBITDA, net growth. It forecast 15% growth in card and loan receivables, stable gross yields, and flat delinquencies and net charge-offs for the year. Management cautioned that charge-offs could be elevated in the first quarter due to hurricane effects and a transition toward in-house collections. It also planned to invest some tax savings in deposit funding, digital CRM and new technology.
- Credit performance: Rising charge-offs and delinquencies, economic weakness, hurricane-related effects, portfolio acquisitions and collection recoveries could reduce earnings. A 100-basis-point change in estimated incurred loan losses would change the allowance by approximately $177 million.
- Funding and interest rates: The business depends on deposits and asset-backed securitizations. Conduit capacity was $4.5 billion, of which $3.8 billion was drawn; facilities matured from January through December 2019. Market disruption, renewal risk, securitization triggers or higher rates could constrain funding or profitability.
- Client and program concentration: The ten largest clients generated 33% of consolidated revenue. Bank of Montreal represented 21% of LoyaltyOne revenue; L Brands and affiliates represented 16% of Card Services revenue. Contract renewals and client losses are material sensitivities.
- Loyalty estimates and costs: AIR MILES revenue depends on estimates of breakage and mile life; higher redemptions or reward costs could hurt results. A 10% increase in redemption costs would have reduced 2017 pre-tax income by $34.2 million.
- Regulation, privacy and operations: The company cited CFPB and bank regulation, data-protection requirements including GDPR effective May 2018, cybersecurity, data-center continuity, foreign exchange, competition and acquisition integration as risks. The banks’ 2015 FDIC consent-order restitution obligations had been satisfied by year-end 2016.
Auditors issued unqualified opinions on the financial statements and internal control over financial reporting. Management also concluded disclosure controls and financial reporting controls were effective as of December 31, 2017. The filing states that ordinary-course legal claims were not expected to have a material effect.
Key facts investors should verify
- Confirm the issuer and ticker: the filing identifies Alliance Data Systems Corporation (NYSE: ADS), not Bread Financial Holdings, Inc.
- Assess whether worsening card-credit metrics continue: net charge-offs, delinquency, loan-loss provision and allowance adequacy.
- Review the maturity, renewal and pricing risks of securitization conduits, deposits and corporate debt, including available revolver capacity and covenant headroom.
- Separate recurring earnings growth from the $64.9 million tax benefit and the effect of 2016 AIR MILES breakage changes; assess non-GAAP adjusted EBITDA alongside GAAP results.
- Monitor delivery of 2018 segment outlook and the expected ASC 606 presentation change, particularly BrandLoyalty campaign timing and Card Services credit trends.
- Verify completion and funding of the planned 2020 notes redemption, and the sustainability of dividends and repurchases given leverage and funding needs.