Bread Financial Holdings, Inc. (BFH) Q4 2011 Earnings Report, Transcript and Summary

Good afternoon and welcome to the Alliance Data Fourth Quarter and Full Year 2011 Earnings Conference Call. At this time all parties have been placed on a listen-only-mode. Following today’s presentation, the floor will be opened for your questions. (Operator Instructions) In order to view the company’s presentation on their website, please remember to turn off the pop-up blocker on your computer. It is now my pleasure to introduce your host Ms. Julie Prozeller, of FTI Consulting. Ma’am the floor is yours.

Thank you, operator. By now you should have received a copy of the Company's fourth quarter and year-end 2011 earnings release. If you haven’t, please call FTI Consulting at 212-850-5721. On the call today we have Ed Heffernan, President and Chief Executive Officer and Charles Horn, Chief Financial Officer of Alliance Data. Before we begin, I’d like to remind you that some of the comments made on today's call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and the uncertainties described in the Company’s earnings release and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call. Also on today’s call our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. A reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.alliancedata.com. With that, I’d like to turn the call over to Ed Heffernan. Ed?

Thanks, Julie, and welcome. We are aware it is earnings season and everyone is pressed for time, so we will be respectful of your time. This morning and also hopefully we give everyone a very good start to the day as we talk about our record 2011 earnings, which came in nicely ahead of our expectations and also drove our decision to come out of the gate raising 2012 numbers. It does look like its going to be a superb year in 2012 thus far. With that being said, let’s get right at it. I will turn it over to Charles Horn, our CFO. He just finished his cup of coffee and he is ready to go.

Thanks, Ed. It was a great quarter to end another record year. We will start by looking at the fourth quarter. Our revenue increased 12%, to $848 million. Our EPS increased 33% to $1.12 per share. A very meaningful core EPS number increased 9% to a $1.70, beating the company’s guidance of a $1.46. If we exclude the year-over-year build in phantom shares, which you see on the slide. Our core EPS increased 17% year-over-year. And Adjusted EBITDA, net of funding costs increased 21% to $194 million. You routinely hear us talk about phantom shares, and many of you asked why do we point them out? The simple answer is because we never have to economically settle them. They come into our share count due to accounting reasons, but nothing else. So if you look at the slides, you can see our phantom shares added 4 million and 2. 8 million shares respectively to our diluted share count for the fourth quarter and full year 2011. As a result, it create a drag on core EPS of $0.12 for the fourth quarter and $0.39 for the full year 2011. Summarizing for the year, we achieved double-digit growth in our numbers. Revenue up 14%, EPS of 57%, Adjusted EBITDA, net of our funding cost up 35% and core EPS up 30%, a remarkable year. Let’s flip to the next page and talk about LoyaltyOne. LoyaltyOne came in consistent with our expectations for the quarter as we had anticipated an unfavorable exchange rate environment and lower collector redemptions as a result of active program management. For the quarter, revenue was down $10 million or 4% due to $2 million negative impact from exchange rates and a $9 million decrease in redemption revenue. The decrease in redemption revenue was due to a conscious…

Great. Thanks, Charles. I’m on the slide, 2012 trends and expectations and I think it would be helpful if we step back just for a second and talk about the assumptions inherent in these expectations. First, sort of a general couple of statements on the overall macro environment. I don’t think its anything stretching, but its essentially saying that we expect continued tepid growth in the macro economy, call it 2% real GDP. We do expect modest job creation. However, not enough to really make a dent in the elevated unemployment level and we expect the continuation of low interest rates. So, those are sort of the assumptions underpinning our expectations for the year. They seem fairly reasonable from what we’re seeing out there. And then, more specifically, let’s talk about our sandbox. In our sandbox we’re really focused on the $400 billion of annual spend in the marketing space that has continued it’s long-term shift towards direct data-intensive targeted marketing in a way from sort of the general marketing that characterize the industry a couple of decades ago. And the important thing here is the market is in fact growing in these direct data-intensive channels. And in fact, the aspects in which we compete the organic growth rate in these markets itself is about 7% growth. So, it’s a very, very attractive market. As we all know, it’s a lot easier to grow when the overall market is growing. So, we’ve – we focused our energy on this space, this subsection of the $400 billion that is in fact growing very nicely. And it’s important because it does cover all three of ADS’s businesses. So whether it’s a one-off type program like a Hilton-honors over at Epsilon or a large coalition program as in Canada or a one-off loyalty…

(Operator Instructions) Your first question comes from Jim Kissane with Credit Suisse.

Thanks guys, and great job. Charles, can you sketch out the P&L impact from the AIR MILES cash or instant redemptions and maybe some of the expectation around what portion of the AIR MILES will be instantly redeemed versus collected or saved for future use? Just trying to get a sense of what the future redemption rates will be an impact on the P&L? Thanks.

You know, Jim at this point we really don’t know how much will transition into this new instant reward option, my guess would be over the next five years it could be as much as 40% of points issued goes into it. The difference is with the instant reward option, it’s not going to be more profitable, the EBITDA percentage will be about the same. But what is likely going to do, it just accelerate [forward] revenue and EBITDA for the simple fact that you’re going to have a shorter life. We estimate right now that the instant reward option will play about 12-month life versus our existing program, which has a 42-month life. So, I think the profitability will be equivalent. It will come through gross margin versus breakage, but it will just likely come through quicker as the programs ramps up due to the shorter life of the points.

Sponsors will be paying more per mile, is that the case?

No. The cost to the sponsor will be the same. It just comes down to reward option value.

Okay.

So like with any traditional program, like in the U.S, if you take cash versus a product, you get less equivalent cash value. So, it’s the same concept. The costs of the products are redeemed and so it’s little bit cheaper to maintain a gross margin, which equates to what you normally would make on your EBITDA margin.

Okay. And you obviously did some things in the fourth quarter to push down the redemption rate, should we expect the redemption rate maybe absent for instant reward option to remain lower than where it’s been in the past?

We try to keep the existing program with the burn rate of somewhere around 69% to 73%. That’s the range we’ll like to see it operate. Last year and fourth quarter of ’10, it was little bit rich. So, what we do is we actively controlled the program via the options that you can redeem for the pricing of the option to try to keep it in the band as we move up toward that ultimate redemption rate of 72%.

Okay. And then just last question, I know we’re running out of time, but the incremental investments related to going to more regions with the Dotz program in 2012, what’s the impact this year on the numbers?

Yeah, it’s -- again, we’re going to double the number of regions we’re going to go in. I don’t think it’s a material number, it’s a few million probably for an extra couple of regions, but given where we think the over performance is going to come in the company that’s already been factored in. So think of it is, we’ll take a little bit off the table in terms of over performance and pour it into a faster spool up there the same way on our funding side for Private Label. Jim as you know in the past we’ve tended to trade-off a little bit of over performance there to lock in longer term visibility by locking in long-term fixed rate funding.

Great job, thanks.

Your next question comes from Darrin Peller with Barclays Capital.

Hey, thanks guys. So let me just start-off, if you don’t mind with Epsilon. The trends have obviously been pretty strong over the past couple of quarters and we are now seeing mid single-digits high organic growth in the business added on by the recent deal, but can you just maybe give us some color on expectations for 2012, maybe even beyond just the actual growth rate. Maybe – can you give us a little color on the actual trends? What is the actual – what is the demand by your customers really that’s driving this kind of growth, and how sustainable is that?

Yeah, as we look into 2012, obviously we think the Epsilon model is high single-digits on the top line for sure. Will it reach 10%? I don’t know, but it’s very robust. What we’re seeing is the biggest demand is coming from the very large database builds and those are driven by the Global 1000 essentially saying; hey look, I’ve got 20 different brands, they’re all in a different system, I need someone who can pull it altogether and then also I need sort of the demographic, psychographic information to be added to it. Oh, by the way I need to have someone who has a clue about the campaigns and how they should look and what distribution channels they should use. So the bottom line Darrin, is if our bet is right at Epsilon, which right now it looks like its heading in our favor, that there will be a – the biggest demand at Epsilon will be coming from the Global 1000 basically sitting there saying; I want to expand my relationship with Epsilon because I’m sick of dealing with 20 different providers out there. And as a result with Epsilon, you’re seeing almost two-thirds of the new growth that Epsilon is actually coming from existing clients making bigger commitments along the food chain there.

Got it. Moving more internationally as well as though? I know there is existing clients taking their business from domestic operations and moving it out, overseas perhaps?

Yeah, I mean that’s part of it, so for example; when you see us launch a big Global 1000, you can be sure that if someone is in an other country and logging into that clients website and signing up for whatever it maybe, and providing information that engine will flow into Epsilon for sure.

All right, if I can shift over for a minute to the credit book, Private Label. The reserve rate now, your allowance is about 200 basis points higher than your charge-off ratio which is one of the bigger cushions in terms of safety and reserving that we’ve seen versus most of the banks, just seems kind of high. I guess, just questions, should we expect further momentum down on that number, assuming charge-off to stay flat or even improve more?

Well Darrin, the way I would look at it, we ended the year with a -- for the full-year charge-off rate is 6.9%, we’ve got it towards 6.3% for 2012. What I would anticipate is that 60, 70 basis points if it manifests will come through to the bottom line, so the reserve will drop.

Good. So, you still have more leverage there as well. And a last question on Private Label and I’ll turn it back into the queue, on the transaction side; can you just explain the drop in the merchant fees. I think you said there was 19% drop in some of the merchant fees or the merchant related revenue whereas I know volume was up.

Yeah, I mean, I’ll jump in on that. A lot of that has to do with the programs that we’re striking with, either on the renewals or on the new accounts which essentially is, we're in partnership with the merchants creating if you want to call it, a structure whereby there is a pool of money based on sales that will both parties has agreed will go directly towards promoting increased usage in the card. So the big struggle that Private Label has always had and won't go away in the near future is, unlike bank card, Visa, MasterCard which is jamming your mailbox with gazillion offers, our cost per acquisition is very, very low, its through the store most likely, point of sale. But what's behind all that is a critical need for the store associates to be familiar with the card, the offer, the rewards program, the loyalty attached to it. And therefore given the turnover in retail associates at the store which is huge, there’s a huge amount of training that needs to take place. So we think its better to spend our dollars helping that part of the training as opposed and to give up some of the merchant fee in return. So essentially funding is a rebate that’s being used to fund that training.

Okay. That’s very helpful, thanks. All right, thanks guys. Good quarter.

Your next question comes from Carter Malloy with Stephens, Inc.

Hey guys, congratulations again. Some great wins and growth in the Private Label program, so I almost hate to ask, but can you comment on, is there more there, what you see in the pipeline and competition for those portfolios?

Sure, I’ll jump in on that, its -- I think Carter, if you looked at last year, we signed, 6, 7 whatever the number is, that was probably our best year, in a number of years and then from a qualitative perspective the names that we signed the Pier-1 and the Marathon’s and whatever. I mean, these are good quality names that I think will endure and growth in our file going forward. As I look into 2012 and ’13 there are a couple of trends that are of interest. One is; it all gets back to all this micro targeted marketing and everything else. The Private Label business again with the closed-loop network provides SKU level information, which is so critical to merchants these days and you can’t get that with general purpose bank cards. So there is a renewed interest from what we’ve seen on behalf of a lot of retailers out there to find a way to mine information so they know more about the client and they can market to their existing customers and acquire new customers, and Private Label is a perfect platform for that, so there’s additional interest in that. The other is, a really interesting trend that’s going on separate than that, and that is there is an awful lot of turmoil that what I would call, the large players and the big portfolios that are out there that, really fly above our radar screen, but you’ve got, Private Label is now back quote-unquote in as a great asset to hold, so its been moved from bad banks to good banks. You’ve got a very significant acquisition of one of the major players out there in the Private Label business that will sell some confusion. So there’s a lot of turmoil from what we’re seeing out there, as a result there are certain clients who in the past have gone with the larger players primarily, because they don’t want to give up the touch points, the customer care and a lot of the marketing that we require to come onboard with us. What we’re finding is that is now becoming a reasonable request given what they have experienced through the great recession from a service quality perspective. So we are going to try to make some hay, I would be very surprised if you did not see a couple of nice portfolio wins, takeaways, in addition to our more traditional new retail start-ups.

Okay, thanks for the color on that. And then another question on the Canadian loyalty side, you have roughly 1,200 basis points of safety net there, but what are your expectations around the impact of expirations driving up redemption rates there and how is your outlook over the next, say, two to five years?

It’s a situation where the expiration really doesn’t affect that curve very much. The expiration or the time stamping nearly makes the miles we have already deemed to get from an accounting perspective to go away, it just provide certainty. In terms of the way we keep the tracking toward 72% is through exactly what Ed has talked about for years. You pull levers to keep the burn rates within a reasonable range, 69% to 72%. Then you know it’s going to mature to about at a pace of about 1% per year, and then you keep tapping the breaks until it slows at the 72%. So your point has lot of head room between the current redemption rate and the ultimate redemption rate and you just moderate your redemption levels, your burn rate to keep it achieving that ultimate redemption rate.

And said another -- put in highly technical terms probably. There hasn’t been any freak out.

All right. It’s helpful. Thanks guys.

Your next question comes from David Scharf with JMP.

Hi, good morning. I am going to stay on the same topic because I want to make sure I can understand really just from a – more of a consumer perspective how this transition works. First of all when you talk about rolling out instant rewards in March, is this about just a handful of sponsors or you have got some significant client concentration or one or two very large sponsors behind this drive to move towards instant rewards and what’s the real timeframe for when this is all rolled out to your top guys?

It won’t take pretty much the full-year David. So you will get a couple of big guys that come in the second quarter, some in the third quarter, some in the fourth. So it’s going to rollout by region. Obviously it affects your supermarkets, people like that. Any type of retailer benefits the most because you’ve a point of sale. You come and swipe your card, you get the instant liquidity option. So I would say it’s going to roll in over the course of the year. We will not have too much Brazilian impacts 2012, but it really sets us up in 13, 14, and 15.

Okay. And when -- when you think about kind of managing to the same gross margin level, I mean, I think most of the loyalty world out there is no longer really operating on a breakage model. They have instant rewards. I mean when you look at other instant reward programs in the industry and even when you look at Dotz, which is not a breakage model. Should we ultimately think about, I mean, there is always going to be some level of breakage. People die and in case of AIR MILES, people probably leave Canada, but how long does it take when you look at other programs. There is a sort of 95% redemption kind of program ultimately and does that mean you have to basically raise the number of miles constantly that people have to accumulate it they want to redeem instantly because it seems like if the sponsor is not paying more, the consumer has to.

Yeah. It’s -- we do think it will have a bifurcated collector base. And what we are seeing is that was a very strong push from both sponsors and collectors to offer up something less than a week’s vacation down in Disney Land or something like that and have something more on the instant side. So to your point you will have almost a barbell where you’re going to have one end, which is driven by the more instant rewards where profit is driven by pricing and gross margin and really no breakage. And then you will still have a fairly significant group which could be 50%, 60% who are in fact aspirational, and as a result they do want to spend their time saving up for the family vacation or the big reward down the road. So you are going to have two types of collectors and not much in the middle.

And is there any data out there, I mean, as you do market research and what the impact is of ultimately raising the number of miles, your points you have to accumulate to take advantage of an instant award. I mean -- for the sponsors, the sponsors obviously want this because the consumers do. The sponsors have any say and kind of how much you ultimately are raising, the effective price really on the consumers. Do they just pretty much assume that at least in Canada, it’s the only game in town so these people are still going to want to accumulate?

(Indiscernible) through before we do it. The second piece of it is as a consumer you are accustomed to a discount when you’re dealing with cash option versus a product option, it’s same in the US. When we do that you have a grace credit card, if you want cash you get 20% less once you get if you did product. So it’s a mindset that’s pervasive throughout any coalition program or any loyalty program for that matter. But if you take cash you’re going to take a little bit of a discount or haircut off of it. So that’s just pretty common nature and it’s pretty well accepted.

Thanks very much.

Your last question comes from Sanjay Sakhrani with KBW.

Thank you. Hey Charles, we talked about this before, but just in terms of the receivables growth you guys are expecting this year, but could you just talk about what kind of impact that has on the P&L as far as pluses and minuses are concerned. And then – I’m not sure if I’ve missed this, but just the interest expense was a lot better than what we expected, could you just talk about that a little bit? Thanks.

All right. So if we break down the seven signings, we had four of them actually come with miles attached, two closed in ’11, which we will get a full benefit pretty much in ’12. Now the two files that we’ve closed within 2012, Pier 1 and Bon-Ton where you get the AR coming through, you don’t get a lot of earnings boost within 2012. Much – most of the earnings will come through in 2013, 2014. The reason basically be when you acquire portfolio, you fair value it, so your purchase accounting will soak up any embedded income that come from it. So the key takeaway would be most of the programs we add in 2011 will be ramping in ’12. Pier 1 and Bon-Ton units are closed in second, third quarter will not provide a lot to ’12 because of the way the accounting works. The most of the benefit will come in ’14 and ’15 – I’m sorry, ’13 and ’14.

And that the growth expectation that you guys alluded to at the begin – in your prepared remarks, that doesn’t include any potential wins that you may have, right?

Correct.

Okay, great. And just that interest expense plan?

This is corporate?

Yeah. Was there anything specific there?

You know Sanjay, I can’t think of anything. I will look at it and call you back. It didn’t hit my radar screen as to what you’re looking at.

Okay. Fair enough. And final question maybe just on Dotz, I think you guys, Ed kind of touched on it earlier on, but just – what’s the timeline where it becomes a significant earnings?

Yeah. Well, it depends how fast if we keep accelerating it, there are eight regions that essentially cover the marketplace with a 190 million people in Brazil. There is about 70 million to 90 million that we will consider in our sweet spot, so to middle-class type consumers and 90% plus of them are in those eight regions. So we should have six regions done by the end of ’12. We should have all eight regions done by the end of ’13. So in terms of the earnings power, I think what you will see is something fairly significant start flowing in ’14 for sure. Maybe we can accelerate that a little bit sooner, but the beauty is because there is no big trust account down there that the cash coming in is in fact used as working capital. And therefore can fund a lot of the expansion and so the only thing you take is a little bit more on your P&L. So, look our goal is like everything else. The coalition program works best when you have the largest number of folks and the largest number of sponsors. And so our goal is essentially to charge 100% to get this stuff up and running and get the network in place and then after that hopefully it just becomes a nice cash flow machine for us.

Okay, great. Thank you.

Okay, that’s it. We will let everyone get back to work. Thank you very much for your time. Bye.

This does conclude today’s conference call. You may now disconnect.