BREAD FINANCIAL HOLDINGS, INC. quarterly report, Q2 FY2010

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Filing summary

Entity and period discrepancy: The request identifies Bread Financial Holdings, Inc., but the supplied filing is Alliance Data Systems Corporation’s unaudited Form 10-Q for the quarter ended June 30, 2010. The summary below reflects the filing provided, not Bread Financial.

Business context and reporting period

Alliance Data reported three segments: LoyaltyOne (AIR MILES), Epsilon (data-driven marketing), and Private Label Services and Credit. The filing covers the three and six months ended June 30, 2010, compared with the same periods in 2009. Beginning January 1, 2010, new accounting rules required consolidation of the company’s credit-card securitization trusts, substantially changing presentation of assets, debt, revenue, expenses, and cash flows; reported year-over-year comparisons are therefore not directly comparable without the company’s “conformed” adjustments.

Financial performance and position

  • Second-quarter revenue: $669.7 million, up 46.4%. Net income was $47.3 million versus $29.4 million; diluted EPS was $0.83 versus $0.51. Operating income was $160.4 million versus $80.6 million.
  • First-half revenue: $1.333 billion, up 42.3%. Net income was $94.0 million versus $57.3 million; diluted EPS was $1.67 versus $0.96. Operating income was $318.6 million versus $182.2 million.
  • Adjusted EBITDA (non-GAAP): $207.2 million for Q2, up 69.2%, with a 30.9% margin versus 26.8%. First-half adjusted EBITDA was $410.2 million, up 49.6%, with a 30.8% margin versus 29.3%. These comparisons are affected by the accounting change and should be read alongside the company’s reconciliation and conformed segment results.
  • Cash flow: First-half operating cash flow was $446.5 million versus $213.1 million; investing activities provided $184.9 million versus using $249.4 million; financing activities used $674.3 million versus $8.1 million. Capital expenditures were $31.5 million. Cash and cash equivalents were $250.3 million at June 30, compared with $213.4 million at year-end; adoption of the new accounting rules contributed a separately reported $81.6 million cash effect.
  • Credit quality: First-half net charge-offs were $234.7 million versus $197.5 million, while the annualized charge-off rate declined to 9.2% from 9.4%. Total delinquency was 5.4% of principal receivables at June 30, versus 6.1% at year-end. The allowance for loan loss was $526.8 million, including a large adoption-related addition.
  • Debt and liquidity: At June 30, long-term and other debt was $1.814 billion, certificates of deposit totaled $1.099 billion, and asset-backed securities debt was $3.353 billion. The company reported $250 million available under its $750 million revolving credit facility and compliance with financial covenants. Much of the securitization debt is non-recourse to the company; trust assets are restricted to trust obligations. Management said available funding sources were expected to meet needs for at least 12 months.
  • Equity: Stockholders’ equity was $34.8 million, down from $272.8 million at year-end, principally reflecting the $0.4 billion reduction recorded upon adoption of the consolidation rules. Total liabilities were $8.012 billion.

Material changes versus the prior comparable period

  • Trust consolidation replaced securitization income with finance charges and loan-loss provision, added asset-backed debt and credit-card receivables to the balance sheet, and moved securitization cash flows to financing activities. Management reported an adoption-related increase of about $3.4 billion in assets, $3.7 billion in liabilities, and a $0.4 billion decrease in equity.
  • On the company’s conformed presentation, Q2 Private Label Services and Credit revenue grew 16.2%; first-half growth was 11.5%. Portfolio growth, higher credit sales, and improved credit losses supported results. Epsilon’s database/digital business grew, while its Q2 adjusted EBITDA margin declined to 22.8% from 24.7%.
  • LoyaltyOne’s reported revenue benefited materially from a stronger Canadian dollar. Management cited lower AIR MILES redemption margins and higher campaign costs as pressures on local-currency adjusted EBITDA.
  • First-half adjusted EBITDA increased across all three segments, though Private Label Services and Credit’s reported margin declined year over year. Differences in accounting presentation make the filing’s conformed comparisons especially relevant.

Outlook, commentary, and risks

  • Management expected double-digit consolidated revenue growth in Q3 2010, with potential double-digit revenue growth in each segment. It expected positive double-digit adjusted EBITDA growth in Private Label Services and Credit and Epsilon, but a decline at LoyaltyOne, partly due to deferred-revenue run-off and changes in AIR MILES sponsor mix.
  • Management expected AIR MILES issuance growth of approximately 5% in 2010, with potential upside if grocery-sector promotions increased. It described credit losses as improving and funding costs as trending downward.
  • The company suspended a planned $1 card processing fee after final CARD Act late-fee rules proved less onerous than initially expected. It estimated that the timing gap and absence of the fee could reduce 2010 diluted EPS by about $0.30. Revised late-fee terms and minimum payments were planned for later in 2010.
  • The July 1 acquisition of Equifax’s Direct Marketing Services division cost approximately $117 million; management did not expect a material 2010 earnings benefit and expected it to be accretive in 2011. The company also disclosed a potential additional investment of up to $15 million in a Brazilian loyalty-program initiative, dependent on the initial phase and rollout.
  • Funding risk remains: some securitization commitments are short-term and subject to renewal, and the filing cautions that renewal on similar terms—or at all—is not assured. The company also identified uncertainty around the Dodd-Frank Act’s effects on financial institutions, consumer regulation, and securitization markets.
  • The filing states that ordinary-course legal claims were not expected to have a material adverse effect. Management concluded disclosure controls were effective and reported no material quarterly change in internal control over financial reporting.

Most important facts for investors to verify

  • Confirm the intended issuer: the provided filing is for Alliance Data Systems Corporation, not Bread Financial Holdings, Inc.
  • Assess performance using the filing’s conformed comparisons and non-GAAP reconciliations, given the 2010 securitization-consolidation accounting change.
  • Review credit losses, delinquency trends, allowance adequacy, and the impact of card-pricing and CARD Act changes.
  • Verify renewal and availability of securitization facilities, upcoming maturities, covenant compliance, and liquidity after the post-quarter refinancing.
  • Track whether the projected Q3 growth, LoyaltyOne outlook, and expected 2011 contribution from the Equifax DMS acquisition materialized.