Alliance Data Systems Corporation (ADSC) — Form 10-Q summary
Registrant clarification: The supplied filing is for Alliance Data Systems Corporation, not Bread Financial Holdings, Inc. It covers the quarter ended September 30, 2010 and was signed November 9, 2010. Financial statements are unaudited.
Business context and reporting period
ADSC reported three segments: LoyaltyOne (AIR MILES), Epsilon (data-driven marketing) and Private Label Services and Credit (retail credit-card programs). In January 2010, the company began consolidating its credit-card securitization trusts under new accounting rules. That change materially altered the presentation of assets, liabilities, revenue, expenses and cash flows, making reported comparisons with 2009 not directly comparable.
Financial performance and position
Amounts below are in millions of U.S. dollars except per-share data.
| Metric | Q3 2010 | Q3 2009 | First nine months 2010 | First nine months 2009 |
|---|---|---|---|---|
| Revenue | $702.4 | $481.4 | $2,035.7 | $1,418.4 |
| Operating income | $170.0 | $93.5 | $488.6 | $275.7 |
| Income from continuing operations | $53.1 | $45.3 | $147.0 | $116.8 |
| Net income | $53.1 | $45.8 | $147.0 | $103.1 |
| Diluted net income per share | $0.96 | $0.83 | $2.63 | $1.78 |
| Adjusted EBITDA (non-GAAP) | $218.9 | $140.2 | $629.1 | $414.4 |
| Adjusted EBITDA margin | 31.2% | 29.1% | 30.9% | 29.2% |
| Net cash from operating activities | Not provided for quarter | Not provided for quarter | $693.5 | $306.1 |
- Reported Q3 revenue rose 45.9% and adjusted EBITDA rose 56.2%. For Private Label Services and Credit, management’s accounting-adjusted comparison showed Q3 revenue growth of 16.0% and adjusted EBITDA growth of 40.0%; reported segment growth is inflated by the accounting change.
- Q3 segment results varied: Private Label Services and Credit adjusted EBITDA was $143.9 million, up 112.1% as reported; Epsilon was $44.1 million, up 25.3%; LoyaltyOne was $46.5 million, down 12.6%.
- For the first nine months, reported revenue rose 43.5% and adjusted EBITDA rose 51.8%. Management’s adjusted comparison for Private Label Services and Credit showed revenue growth of 13.0% and adjusted EBITDA growth of 30.4%.
- Credit-card principal charge-offs were 8.3% of average receivables in Q3, versus 9.4% a year earlier; the nine-month rate was 8.9%, versus 9.4%. Delinquencies were 6.1% of principal receivables at September 30, unchanged from December 31, 2009, though management said the September rate was 10–20 basis points above normal seasonality.
- At September 30, cash and cash equivalents were $391.2 million; total assets were $8.13 billion, total liabilities $8.08 billion and stockholders’ equity $45.8 million. Equity was $272.8 million at year-end 2009; the January accounting adoption reduced equity by about $0.4 billion.
- Debt included $1.93 billion of long-term and other borrowings before current classification, $966.8 million of certificates of deposit and $3.36 billion of asset-backed securities owed to securitization investors. Of the asset-backed securities, $885.5 million was current. The company had $380 million available under its $750 million revolving facility and reported compliance with financial covenants.
- Nine-month investing cash flow was positive $164.2 million, including a $273.9 million cash inflow from changes in credit-card receivables and $117.0 million paid for the DMS acquisition. Financing activities used $759.3 million; ending cash was $391.2 million, versus $449.6 million at September 30, 2009.
Material changes, outlook and risks
- Securitization accounting: Consolidation added about $3.4 billion of assets and $3.7 billion of liabilities at adoption. Securitization income was replaced by finance charges and loan-loss provision; trust funding costs are now shown as interest expense. Securitization cash flows are classified as financing activities, rather than as sales-related operating or investing flows. Trust creditors generally have no recourse to ADSC’s general credit.
- Acquisition and capital allocation: ADSC acquired Equifax’s Direct Marketing Services and Database Marketing divisions for $117 million on July 1, 2010. Management said the deal was not expected to materially benefit 2010 earnings but expected it to be accretive in 2011. A new share-repurchase authorization allows purchases of up to $400 million through December 31, 2011, subject to credit-agreement restrictions; $76.7 million was spent on repurchases in the first nine months.
- Guidance: Management expected double-digit consolidated revenue and adjusted EBITDA growth in Q4. It forecast positive revenue and adjusted EBITDA growth for Private Label Services and Credit and Epsilon; for LoyaltyOne, positive revenue growth but lower adjusted EBITDA. Epsilon was expected to grow revenue and adjusted EBITDA about 20% in Q4 year over year. Q4 average credit-card receivables were expected to be flat year over year, and loan-loss provision was expected to rise seasonally and exceed charge-offs.
- Management commentary and risks: AIR MILES issuance fell 3.9% in Q3 amid reduced grocery promotions and sluggish Canadian consumer spending. Management cited deferred-revenue runoff, sponsor mix and economic conditions as risks to LoyaltyOne revenue and margins; it expected the timing-related negative effect to moderate by mid-2011. The Brazilian loyalty initiative could require up to $15 million of further investment, contingent on initial performance and rollout timing.
- Management said it believed available operating cash and other liquidity sources would meet needs for at least 12 months, while noting securitization and conduit commitments can be short-term and may not renew on similar terms or at all. New Federal Reserve late-fee rules took effect in August 2010; revised minimum payments and fee structures were scheduled for billing cycles beginning November 2010. The company did not expect new FDIC securitization safe-harbor rules to adversely affect its program but said market participants were still evaluating them.
- The filing reported no material change in previously disclosed risk factors. Ordinary-course claims and lawsuits were not believed likely to have a material adverse effect. Management concluded disclosure controls were effective as of September 30, 2010.
Important facts for investors to verify
- Use management’s accounting-adjusted comparisons when assessing growth, and verify the effects of trust consolidation on revenue, credit costs, debt and cash-flow classifications.
- Track credit performance, including charge-offs, delinquencies, seasonal receivable growth and the allowance for loan losses; the allowance was $514.3 million at quarter-end.
- Review upcoming asset-backed note maturities and conduit renewals, available revolver capacity, covenant headroom and the refinancing risk identified by management.
- Assess whether the $400 million repurchase program is consistent with liquidity needs and debt restrictions, and monitor the expected 2011 contribution from DMS.
- Monitor AIR MILES issuance, redemption and deferred-revenue trends, sponsor mix, the projected Q4 segment outlook, and any further funding needs for the Brazilian program.