BREAD FINANCIAL HOLDINGS, INC. annual report, FY2012

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Filing summary

Entity and period: The supplied filing is Alliance Data Systems Corporation’s Form 10-K for the fiscal year ended December 31, 2012, filed February 28, 2013. It is not a filing under the name Bread Financial Holdings, Inc. The filing also provides unaudited fourth-quarter results.

Business context and reporting period

Alliance Data provided data-driven marketing and loyalty services through LoyaltyOne, Epsilon, and Private Label Services and Credit. Its credit-card business funded and serviced private-label and co-branded retail card receivables; LoyaltyOne operated Canada’s AIR MILES program. Unless noted, amounts below are U.S. dollars.

Key financial metrics

  • Full-year revenue: $3.641 billion, up 14.8% from $3.173 billion in 2011.
  • Profitability: Operating income was $974.4 million, up 19.9%; net income was $422.3 million, up 33.9%. Diluted EPS was $6.58, versus $5.45. Adjusted EBITDA, a non-GAAP measure, was $1.192 billion, up 18.1%; adjusted EBITDA margin rose to 32.7% from 31.8%.
  • Fourth quarter: Revenue was $971.8 million and net income was $83.7 million, compared with $847.5 million and $65.9 million, respectively, in fourth-quarter 2011. Diluted EPS was $1.27 versus $1.11.
  • Cash flow: Operating cash flow was $1.134 billion; investing activities used $2.671 billion; financing activities provided $2.209 billion. Capital expenditures were $116.5 million.
  • Liquidity and balance sheet: Cash and equivalents were $893.4 million; total assets were $12.000 billion and stockholders’ equity $528.5 million. The company reported $915.7 million available under its revolving credit facility and no revolver borrowings. Its total leverage ratio under the credit agreement was 2.3x, against a 3.5x maximum.
  • Debt and funding: At year-end, asset-backed securities debt was $4.131 billion, long-term and other debt was $2.855 billion, and deposits were $2.228 billion. The $805 million convertible notes due August 2013 were a near-term maturity. The company said it expected available liquidity to cover needs for at least 12 months, including repayment of those notes.
  • Credit portfolio: Net credit-card receivables were $6.968 billion, with an allowance for loan losses of $482.0 million. Average receivables were $5.928 billion; credit sales were $12.524 billion. Delinquencies were 4.0% of principal receivables at year-end, down from 4.4%; the annual principal net charge-off rate improved to 4.8% from 6.9%.

Material changes versus 2011

  • Private Label Services and Credit revenue grew 16.3% to $1.732 billion and adjusted EBITDA grew 21.4% to $823.2 million. Growth reflected higher credit sales and average receivables, portfolio acquisitions, and improved credit quality.
  • Epsilon revenue grew 17.6% to $996.2 million and adjusted EBITDA rose 13.7% to $222.3 million, largely reflecting the Aspen acquisition in 2011 and HMI in November 2012. Its adjusted EBITDA margin fell to 22.3% from 23.1%, partly due to revenue mix and growth-related spending.
  • LoyaltyOne revenue and adjusted EBITDA each increased 8.8%, to $919.0 million and $236.1 million. AIR MILES redemptions rose 11.2%; issuance increased 5.7%. A weaker Canadian dollar reduced revenue by $10.9 million and adjusted EBITDA by $3.1 million.
  • The company acquired HMI for approximately $451.8 million net of acquired cash, Advecor for $12.2 million net of acquired cash, and four credit-card portfolios for approximately $780 million in total. These transactions contributed to substantial investing cash outflows and higher receivables, goodwill, and intangible assets.
  • Cash and equivalents increased from $216.2 million to $893.4 million, while total liabilities rose from $8.804 billion to $11.472 billion. The company issued $500 million of 6.375% senior notes due 2020 and $400 million of 5.250% senior notes due 2017.

Outlook, commentary, risks, and unusual items

  • AIR MILES estimate change: The estimated breakage rate was reduced from 28% to 27% at year-end. Management said this would reduce deferred breakage by approximately $59 million and lower pretax earnings by $28.4 million in 2013, $19.2 million in 2014, $9.9 million in 2015, and $1.5 million in 2016; it expected expense reductions and higher product margins to offset the impact.
  • Spending and expansion: Management expected capital expenditures to remain at or below approximately 3% of annual revenue for the foreseeable future. It planned to expand the dotz loyalty program into five additional Brazilian markets during 2013 and anticipated more AIR MILES Cash redemption sponsors, subject to sponsors’ point-of-sale changes. No consolidated revenue or earnings guidance is provided in the supplied filing text.
  • Concentration and execution: The ten largest clients generated 46.5% of consolidated revenue; Bank of Montreal alone represented 10.5%. The General Motors Epsilon contract was due to expire in 2013, subject to an optional one-year renewal. Acquisition integration and acquired or new credit programs could add execution and credit-loss risks.
  • Funding, debt, and rate exposure: The business relies substantially on securitizations and deposit funding; some conduit commitments were short-term and subject to renewal. Approximately $1.5 billion of asset-backed securities debt was due within 12 months. Management warned that disruption to securitization markets could constrain receivables funding. A 1 percentage-point interest-rate increase was estimated to reduce 2012 pretax income by $12.3 million.
  • Other material risks: Consumer-credit losses, AIR MILES redemption costs and breakage estimates, Canadian-dollar movements, privacy and data-security incidents, and changing consumer-finance and securitization regulation could affect results. A 10% increase in AIR MILES redemption costs would have reduced 2012 pretax income by $43.9 million.
  • Audit and controls: Deloitte issued unqualified opinions on the financial statements and internal control over financial reporting. The 2012 internal-control assessment excluded HMI and Advecor because of acquisition timing; management said it planned to include them in its 2013 evaluation. Ordinary-course legal claims were reported as not expected to have a material effect.

Most important facts for investors to verify

  • Confirm the filing identity: the document is Alliance Data Systems Corporation’s 2012 10-K, not a Bread Financial Holdings, Inc. filing.
  • Review the $805 million convertible-note repayment due in August 2013, subsequent refinancing or repayment, and the terms and renewal status of securitization and conduit funding.
  • Track credit-card receivables growth, allowance adequacy, delinquencies, charge-offs, and acquired portfolio performance; note that 2012 charge-off rates exclude purchased-portfolio losses under GAAP.
  • Assess client concentration and contract renewals, particularly Bank of Montreal and the then-upcoming General Motors renewal.
  • Monitor the AIR MILES breakage estimate, redemption costs, and the forecast earnings effects disclosed for 2013–2016.
  • Separate acquisition-driven growth from organic growth and evaluate HMI integration, Epsilon margins, and the control assessment’s exclusion of acquired businesses.