BREAD FINANCIAL HOLDINGS, INC. annual report, FY2010

Filing identity and period

Important mismatch: The request identifies Bread Financial Holdings, Inc., but the supplied filing is Alliance Data Systems Corporation’s Form 10-K for the fiscal year ended December 31, 2010. This summary reflects the supplied filing, not a Bread Financial filing. Although the request refers to 2010 Q4, the filing reports full-year results and provides unaudited fourth-quarter figures.

Business context

Alliance Data provided loyalty programs, data-driven marketing and private-label and co-brand credit-card services through LoyaltyOne, Epsilon, and Private Label Services and Credit. In July 2010, it acquired Equifax’s Direct Marketing Services and Database Marketing divisions (DMS) for $117 million. The company reorganized its segments during 2010; prior-year segment data was restated to match the new presentation.

Financial performance

Amounts below are in U.S. dollars; “billion” and “million” are used for readability.

At year-end, cash and cash equivalents were $139.1 million; total assets were $8.272 billion, total liabilities $8.249 billion, and stockholders’ equity just $23.1 million. Credit-card receivables, net, were $4.838 billion, including a $518.1 million loan-loss allowance. Debt balances included $3.660 billion of asset-backed securities, $859.1 million of certificates of deposit, and $1.870 billion of long-term and other debt (including current maturities). The company reported $300 million drawn on its $750 million revolving credit facility, with $450 million available, and said it was in compliance with financial covenants.

Fourth quarter 2010

Unaudited Q4 revenue was $755.7 million, operating income $140.6 million, income from continuing operations $48.6 million, and net income $46.7 million. Diluted net EPS was $0.84. Compared with Q4 2009, revenue increased from $545.9 million and operating income from $132.0 million; net income increased from $40.6 million.

Material changes versus prior year

• Effective January 1, 2010, new accounting rules required consolidation of the WFN and WFC credit-card securitization trusts. On adoption, the company recorded approximately $3.4 billion of additional assets, including about $0.5 billion in loan-loss reserves, $3.7 billion of additional liabilities, and a $0.4 billion reduction in equity. Revenue presentation shifted from securitization income to finance charges and related expenses; securitization funding and cash flows were presented differently. Consequently, reported year-over-year revenue, expenses, debt, receivables, and cash-flow comparisons are not directly comparable without adjustments.
• On a conformed basis, Private Label Services and Credit revenue rose 10.4%, and adjusted EBITDA rose 15.5% after adjusting the comparison for securitization funding costs. Average credit-card receivables increased 15.3%, while credit sales rose 10.1%.
• Epsilon revenue grew 19.3% and adjusted EBITDA 18.8%, with DMS contributing $26.8 million of 2010 revenue. LoyaltyOne revenue grew 11.8% in reported dollars, helped by a stronger Canadian dollar, while adjusted EBITDA rose 1.9%.
• Credit quality improved from 2009: net charge-offs were 8.9% of average receivables versus 9.3%, and delinquency was 5.4% versus 6.1% at year-end. The charge-off rate remained above the 7.3% reported for 2008.
• Net interest expense rose to $318.3 million from $144.8 million, including $155.1 million of securitization funding costs presented as expense following consolidation.

Outlook, risks, and unusual items

• Management forecast high-single-digit consolidated revenue growth and double-digit adjusted EBITDA and net income per share growth in 2011. Epsilon was expected to deliver double-digit revenue and EBITDA growth; Private Label Services and Credit, high-single-digit revenue and double-digit EBITDA growth; LoyaltyOne, low-single-digit overall growth, partly reflecting international expansion costs.
• For 2011, management expected AIR MILES issuance growth in the mid-single digits, Private Label ending receivables growth of 4%–5%, and a net charge-off rate of approximately 8.3%. It also expected DMS to be accretive to earnings in 2011.
• Management said internally generated funds and other liquidity sources should meet requirements for at least 12 months. However, $1.7 billion of asset-backed securities debt was due within 12 months, and conduit facilities and other funding commitments required renewal. The filing identifies securitization-market access and refinancing as material risks.
• Private Label Services and Credit faces unsecured consumer-credit, delinquency, charge-off, and portfolio-underwriting risks. Regulatory changes, including the CARD Act, late-fee rules, and Dodd-Frank implementation, could affect product terms, revenue, and compliance costs. A 100-basis-point change in the estimated incurred loan-loss rate could change the allowance and provision by about $50 million.
• Other material exposures include customer concentration (the ten largest clients accounted for 49.5% of revenue; Bank of Montreal alone 12.4%), consumer-data privacy and cybersecurity, Canadian-dollar movements, and AIR MILES breakage and reward costs. A 10% increase in redemption costs was estimated to reduce pretax income by $40.9 million.
• The company reported a roughly $56 million net gain from the BMO AIR MILES liability assumption, recognized through redemption revenue over time; the related timing difference was expected to reduce redemption revenue by about $10 million in the first half of 2011. A $1.9 million after-tax loss related to the discontinued VENUE credit program was recorded in 2010. Routine claims and lawsuits were disclosed; management did not expect them to have a material adverse effect.
• The company repurchased approximately 2.5 million shares for $148.7 million in 2010 and authorized up to $400 million of additional repurchases through December 31, 2011, subject to debt restrictions. It did not anticipate cash dividends.

Investor verification priorities

1. Confirm the issuer and filing: the supplied 10-K is for Alliance Data Systems Corporation, not Bread Financial Holdings, Inc.
2. Reconcile 2010 and 2009 results on a consistent basis for the securitization-trust consolidation, especially revenue, loan-loss expense, interest expense, cash flow, and debt.
3. Review 2011 asset-backed debt maturities, conduit-facility renewal terms, securitization capacity, and compliance with credit-agreement covenants.
4. Track credit-card delinquency, net charge-offs, allowance adequacy, receivables growth, and expected credit losses against management’s outlook.
5. Assess customer concentration and the status and renewal terms of major client agreements, including Bank of Montreal and key private-label programs.
6. Evaluate AIR MILES redemption assumptions, deferred revenue, reward-cost exposure, and the expected 2011 revenue timing impact.
7. Consider that DMS was excluded from the company’s 2010 internal-control assessment; management planned to include it in 2011.