Nov 9, 2017
Executives
Karen Keyes - SVP, IR David Johnston - Group CEO Mark Grafton - CFO
Analysts
Kenric Tyghe - Raymond James
Operator
Good morning. My name is Lisa and I will be your conference operator today.
At this time, I’d like to welcome everyone to the Aimia Incorporated Third Quarter Results Conference Call. All lines have been placed on mute to prevent background noise.
After the speakers’ remarks there will be question-and-answer session. [Operator Instructions] Thank you.
Karen Keyes, Head of Investor Relations, you may begin your conference.
Karen Keyes
Thank you very much, Lisa. Good morning to all of you attending on the phone and the webcast this morning.
With me on the call today are David Johnston, our Chief Executive; Mark Crafton, our Chief Financial Officer; and Steve Leonard, our Vice President and Chief Accounting Officer. Before we get underway, I would like to remind everyone to review our forward-looking statements and the cautions and risk factors pertaining to the statements.
For those of you following along on the webcast, you should see these on screen in front of you now. For those of you accessing the presentation which can be download from the website.
These can be found on page three of the highlights presentation. I’d also like to point out the presentation refers to a number of non-GAAP metrics to help you better understand the results of the business.
The definitions of these metrics and the reconciliation to their most comparable GAAP metric can be found on pages four and five. We have also included a full income statement, which can be found on page six and a reconciliation of our return on invested capital metric which can be found on page seven.
We will be focusing our comments today on the numbers for the core business, which is the basis on which we issued our 2017 guidance earlier this year. For those of you looking to reference the reported numbers, these can be found slide eight.
And with that, I’ll hand over to David.
David Johnston
Thanks, Karen and thank you everyone for joining us this morning. I'm going to start with where we got to in the quarter against our key financial and strategic priorities.
Before handing over to Mark to take you through the detail of the quarter and where we expect to end the year. Performance of this quarter was solid, Aeroplan gross billings were up 3% and that drove a 1% increase in coalition gross billings on a constant currency basis.
The decrease in loyalty services largely reflecting disposals and gross to net accounting, took the overall numbers down 5% to $497 million. On a constant currency basis that was a 4% decline.
Lower OpEx contributed to adjusted EBITDA margin being up 250 basis points to 14.5%, and you all have seen reporting an increase in our full year margin guidance today. Last year's free cash flow had the benefit of a $50 million tax refund, which made for tough a comp on a reported basis.
Excluding this last year's free cash flow was around $39 million and we have limit around $60 million of cash in the quarter, partly supported by lower interest, OpEx and net redemptions, which took year-to-date free cash to around $100 million on pre-restructuring basis. That increased cash flow translated to a meaningful increase of free cash flow per share, which was $1.40 on a per share basis for the quarter and return on invested capital was 6.1%.
Last quarter we acknowledged that changing the market's long-term outlook on the value of the business would require us to make progress in three key areas. The ongoing business simplification and acceleration of our cost reduction plans, the identification, negotiation and execution of our new long-term strategic and commercial partnership that will lie at the heart of a future Aeroplan redemption offer and heightened attention around preserving strong cash and liquidity position of the company.
Those priorities along with delivering on guidance very much continue to drive our focus. We've made significant progress in streamlining the operating costs of the business in recent years.
Since 2015 we've reduced OpEx by 16%. Some of the savings have come from the exits of lower margin businesses with higher operating cost to absorb cash.
We've also continue to exit investments to sell assets that don't align to our longer term strategic direction or where we haven't seen acceptable long-term return and we'll continue to explore further action on this front. Operating expenses for the first nine months of 2017 were just north of $400 million, excluding share-based compensation and certain non-recurring items and were down 14% on last year.
A significant part of the declines related to the businesses we disposed off earlier this year and you'll obviously see that noncore element come down to zero in the 2018 financials. In our coalitions' business, we cut cost by 10% in 2017.
At Aeroplan operational efficiencies drove reduced headcount and lower real estate trust, while international coalitions we've reduced operating cost. Disposals and exits including Cardlytics, UK sale also contributed to lower costs.
In May, we announced an acceleration of our plans for further operational efficiencies, which will lead to a 10% headcount reduction by year-end. Corporate cost will come down for Q4, 2017 in the back of the progress that we've already made and the impact will be more significant in 2018 as we eliminate roles in area such finance and HR.
Other roles will be moved to the divisions. A significant cost transformation is also expected in loyalty services over the next 12 to 18 months, where we continue to transition clients of legacy product.
As we do that, we're able to take cost down getting the right technology solutions in place to make that happen has driven some increased expense in 2017. Optimizing the rest of the cost base in 2018 will also be important to establish a better competitive positioning and a significant market segment going forward.
With respect to the Aeroplan program there are two key factors that will shape the future design and economics of the program. Reframing our partnerships and keeping our members engaged.
In the meantime, clearly it's critical that our member to engage in the program in order to support gross billings. And in the quarter members gave us confidence in their continued passion for the program and through our Moments Worth Millions contest.
Over a five week period, members shared more than 75,000 of their personal travels stories made possible with Aeroplan. The contest generated 85 million impressions and made us a trending item on Twitter in mid-September.
Members made it clear to us that Aeroplan is a key ingredient to staying close to family and friends. Member education was also an important focus for us, creating a video to help members understand how the program could evolve, which has now been viewed just under a 1 million times.
These engagement opportunities give us data demonstrated that members love the program are happy to engage with so far largely appear to be carrying on as usual with over 2.5 years to run until our transition from the current Air Canada agreement. And while the news earlier in the year meant that net promoter score took an understandable hit, we've started to regain this quarter.
Our efforts to keep members as up to-date as possible across all of our channels are working well. Interestingly, members who have redeemed since May announcement have subsequently begun rebuilding their balances and have accumulated their rates comparable to the same period a year before.
And this has been especially true among chair members. Member activity and accumulation were up as were Aeroplan gross billings number Mark is going to come back for the detail on that in a few moments.
Q3 redemption levels continue to be broadly in line with our range of expectations, but miles redeemed in the quarter up just under 5%. This is up on a 2% increase last quarter, but compared to a 4% increase in Q3 last year.
Redemptions have also grown together with increased Air Canada capacity that has come on-stream this year, with more international destinations and we’ve seeing more miles redeemed per order. All this in particular saw increased activity partly length of the successful Marriott campaign that ran over the summer.
But redemption expenses being well below the level that we saw in midnight and are historic highs. There’s of course always potential for elevated redemptions in our current context and we continue to monitor this closely especially as we approach Q1, which is typically the quarter in which we see seasonally higher redemption levels.
We continue to see some increases in non-air rewards from less engaged members and those with lower balances. Unit cost was lower in the quarter and that partially offset the increased volume.
Slide 18 illustrates how these activities shape up when we look at our cost of rewards for the nine months of 2017. Overall the cumulative increase in expense over the last year is running at around $21 million on a total spend of over $630 million were around 3% higher than at the same time last year, and 9% of that incremental expense was incurred in Q3.
The work we’re doing to streamline the business, and reduced OpEx is compensating for higher redemption expense and is resulting in solid operating cash generation. Combined the discipline around CapEx and lower interest we generated around $52 million of free cash flow after severance payments of around $8 million.
The sale of the Canadian Air Miles trademark at the end of August, as well as higher retained cash due to lower dividend also added the cash balances. At the start of Q4 which is our most cash generative quarter, we closed the $670 million of cash in investments.
At these levels we’re now back to where they were in the first half of 2016 before we repaid $200 million of the 2017 notes. Over $300 million is set aside in the redemption reserve for Aeroplan, with total reserves currently at over $500 million.
Available cash above the required reserves stands at around $150 million with undrawn room available as well on our credit facility and our next debt maturity not until May of 2018. On the basis of our current guidance, we’d expect add to cash balances in the fourth quarter.
So to sum up progress on our key priorities is driving to a liner more efficient business, attempted to cash generation and liquidity with a focus on urgency and reframing our strategic and commercial partnerships for enterprise. The build of our cash balances gives us more flexibility through this period of transition.
We need to be realistic around the speed that we can move with potential partners in the context of our current agreement to influx for the next 2.5 years. Come out with what’s the nature of the industry also means that members aren’t able to and they can’t plan their travel that far in advance either we don’t intent to take anything for granted.
We’re focused on billing solutions in place well in advance to 2020 and meet the needs of our members, shareholders and other stakeholders. So let me hand it over to Mark now to take you through the Q3 results including some of the detail and the Aeroplan trends and our guidance for 2017.
Mark Grafton
Thanks, David and good morning to all of you on the call today. So let me take you to the overview on slide 22.
Total gross billings were down around 5% on a core basis for the quarter, the constant currency decline was 4% with currency being a less meaningful factor than it has been in prior quarters at around $6 million compared to $20 million last year. In American coalitions gross billings were up 1% with the $8 million of gross to net impact moderating solid Aeroplan growth.
In international coalitions an operational highlight was a good take off we saw in the first quarter as daily mail issuance with more linking of active member accounts than we had expected. As we’ve seen in the past with new partners like eBay, customers who link their accounts tend to be more engaged in the program.
However, overall coalition issuance was not as strong as last year when combined with lower gross billings in our analytics business so international coalitions billings down 9% on a constant currency basis. In Global Loyalty Solutions underlying sales with existing clients were up with the decline mainly due to a $10 million impact from the divestiture of the rewards fulfillment business in New Zealand in May.
Platform based sales and related services now account for over fifth of sales in this division. So let me take you through some of the detail now starting with Aeroplan on slide 24.
Gross billings at Aeroplan were up 3% for the quarter against a strong comp last year. Similar to last quarter, a highly successful Marriott Hotel conversion campaign, increased Air Canada issuance on the back of higher capacity and the growth in the active card base were the main contributed.
Miles issued were up 2% and burn earn was 86%. Financial cards accounted for around two thirds of Aeroplan gross billings in Q3 and overall issuance fee was stable in the quarter with few promotional miles issued compared to last year where we had significant new card campaign activity.
The issuance was underpinned by healthy spend on financial cards by the end of September, spend levels were above last year and above the levels we saw prior to Air Canada announcement in May. That was true for both CIBC and TD, as well as across new and tenured members.
The waiting of new card acquisition campaigns for the first half of 2017 and lower attrition compared to last year drove the 5% growth in actives cards in the first half of the year, which rose to 3% in Q3 against the tough comp. Let’s jump now to slide 27.
There were three main moving parts in the international coalitions division this quarter. The first is in our coalitions business, net issuance was down 7% largely as a result of Sainsbury’s campaigns and the home based exit at the end of 2016, which was only particularly offset by new daily mail issuance.
While the Middle East program saw a few promotional miles issued in the quarter. Shopper analytics reflected decline exit last year and finally although currency impact is less than the weaker pound accounts for just under a third of the decline in Q3.
As expected, third quarter issuances at Sainsbury’s was down on last year with base issuance broadly stable and the change attributable to lower bonusing activity. As in previous years we expect the fourth quarter to be the highest for overall points issuance albeit we don't expect to meet the same level we had in Q4 last year.
The launch of the Collect for Christmas campaign pictures here along with a good take up in the Swipe and Win campaign held over the October 6 to 8 weekend is expected to drive the solid Q4 performance you see here. Moving to slide 31, as you can see on the chart, most of the 15% increase in adjusted EBITDA in the quarter came from Aeroplan, where adjusted EBITDA was up $10 million, gross billings were up and OpEx was lower.
The consolidation of our Toronto office real estate last year was part of the driver here along with composition cost coming down as we reduce headcount. We also had a $2 million benefit from the reversal of a migration provision put in place in 2013 related to our financial cards.
Lower gross billings across the business and international coalitions meant we did not see as much benefit of the operational efficiency that meant to coming through and the sale of the Canadian Air Miles trademark meant we only have two months of contribution from that business. In GLS and corporate, we had a $1.5 million impact from expensing of development cost in our loyalty platforms, which we're previously capitalized.
Finally the work we're getting now the simplification of the business and new Aeroplan partnerships is driving higher professional fees in corporate more than offsetting operational efficiencies and lower share based compensation in the quarter. Adjusted EBITDA on a reported basis includes the restructuring cost which were around $11 million with around three quarters of those expenses incurred Americas Coalitions in corporate areas, which will drive benefit over the coming quarter.
Excluding those, the core business contributed around $72 million, represented a margin of around 14.5%, which was up 250 basis points on last year. Moving on the free cash flow now starting on slide 35, we converted over 80% of adjusted EBITDA into cash in the quarter.
On a normalized basis delivering close to $60 million of free cash broadly in line with the $40 million to $60 million range we've seen in the second and third quarters of 2015 and 2016. The major adjustment to get to the normalized number was the $7.6 million of severance we paid in the quarter, while 2016 has also been adjusted for the $50 million tax rate currently received in the third quarter last year.
Excluding these, cash from operating activities was up $16 million. Cost of rewards and direct costs were down due to lower redemptions outside Aeroplan and we play lower taxes and interest in the quarter.
Net interest paid was down $10 million impart due to the repayments of the 2017 bonds and impart due to the phrasing of interest payments resulting from the early repayments of the 2018 bonds using the revolving credit facility. The lower debt was at a lower effective interest rate for the quarter, although we will see some upward pressure on the interest rate on our outstanding debt from Q3 as a result of credit rating downgrades in August.
And finally looking at the increase over last year on a normalized basis, lower capital expenditures were an important contributor down $5 million to $11 million in the quarter, partly as a result of the expensing of previously capitalized costs. Given we have already touched on most of the relevant changes in the balance sheet let me jump straight to slide 39 to cover the puts and takes that arriving in our guidance for 2017.
Our cash positive free cash flow will be slightly different than we expected, with lower gross billings, so we continue to expect the booked change $220 million for the full year before accounting for the additional $10 million interest expense and financing costs incurred as a result of repaying the 2018 bonds. And restructuring cash costs of between $20 million and $25 million.
At the time we set our guidance we included around $45 million of gross billings related to the reward fulfillment business in New Zealand, and the Canadian Air Miles trademark for full year 2017, compared to the $21 million both businesses contributed up to their respected disposals. Combined with a delayed start on daily mail issuance the $24 million headwind against our overall gross billings number makes it likely that our gross billings will land below the $2.1 billion we had guided to you previously and we are now guiding to a range of between $2 billion and $2.1 billion.
This has however been account to balance by a better performance on adjusted EBITDA margin as a result of lower OpEx. Despite the loss of the adjusted EBITDA associated with the Air Miles trademark, a favorable unit cost at Aeroplan, lower shared based compensation and operation efficiencies have helped us here and we now expect adjusted EBITDA margin to in around 13%, compared to the 12% we guided to at the beginning of the year.
Redemptions outside Aeroplan have been lower than expected. We also reduced our guidance for CapEx earlier in the year, from our initial range of $50 million to $60 million and still expect this to be between $45 million and $50 million in 2017.
Our gross billings guidance takes into account our latest view on holiday spent and bonusing at Aeroplan and Nectar, which typically drive the fourth quarter waiting of gross billings. Our current view is that Q4 will likely land lower than last year.
While attrition to-date has remained broadly unchanged, we cloud see some cycling of financing cost due to strong acquisitions last year. In the UK, weekly consumer spending and our expectation that Christmas bonusing Sainsbury’s is unlikely to match last year’s strong performance, means Nectar gross billings could fall below last year.
As ever a fair proportion of our free cash flow will come from Q4. Aeroplan redemption expense will be a key determinant of how we’ll end the year, but the early OpEx savings of $9 million we are achieving will flow through the free cash flow and we expect to land this Q4 free cash flow above a $120 million on the basis of our guidance.
As we’re focus on the key priority that David has talked about, we need to issue day-to-day execution in an environment that will likely continue to evolve. Monitoring the key metrics in our businesses carefully means we are able to respond to anything unexpected and to ensure we can deliver solid performance a quarter at a time.
And with that let me hand you back to David to complete our comments today.
David Johnston
Okay, thanks. So, as we think about how we’ll end 2017 and enter 2018, there are a few things that obviously paying close attention to and were another quarter of data is going to helpful.
Redemption passenger Aeroplan is the most obvious, a low redemption expenses is up overall, our members our continuing to engage in fairly normal patterns, but it’s something that we are going to continue to watch. The shape of the active financial card basis and other retention and spend will be important considerations as we enter 2018 with new card acquisition activity expected to be second half weighted.
We are also paying close attention to the weakness we are seeing outside of Aeroplan, certainly the fourth quarter is always the strongest for Nectar so that’s going to be another important event. On the other hand this -- there are a few things that we are very encouraged by Aeroplan members particularly our best customers have continued to engage and to reengage after successful redemption.
They have thus far been willing to give us time recognizing that we have the best value proposition in the market and access to our Canada capacity until at least 2020. We continue to see healthy spend per card and there is a strong group of core customers that are clearly committed to their current choice into Aeroplan.
And we are really encouraged by the passion and constructive conversions with member and partners around the future shape of Aimia. With all of that said we continue to progress with a high degree of urgency against our three priorities.
Identifying and negotiating new partnerships, our focus on simplifying the business and strengthening our cash reserves to give us flexibility to face into any challenges. And with that I will turn it over to you for your questions.
Operator
[Operator Instruction] And our first question comes from the line of Kenric Tyghe from Raymond James. Your line is open.
Kenric Tyghe
Thank you. Good morning, David.
David with respect to question on being realistic on new partners and the like how should we interpret that is that a function not of a decrease to frequency or change in tone of the discussion, but rather these discussions do have long tail on them. And is that the messaging on that?
And then the second part of the question would be a follow-up with respect to your divestitures and some sort of color around, how close you think we are to being there, there being some indication of how much more there is to go outside of any sort of big [indiscernible]? How many more of the smaller divestitures there might be to go, to look and get to sort of a core and a base that we can look at as being a stable base in the core business?
David Johnston
Okay, yes thanks, Kenric. Look on the first question, it’s the latter part the way you framed it, it is just I think a natural dynamic of the nature of these discussions.
We are in discussions, we’ve had more discussions now than we’ve had in August, and our sense of urgency remains unchanged. And again, I reemphasize the purchasing power of our members, with $200 billion unredeemed miles and something like $700 million in tickets spend last year.
But we’re two and half years away from when those agreements will take place. I understand a desire from all of our stakeholders, whether that’s members, partners or shareholders to get news on that as soon as possible.
But at this point, all I’d say is that we’re working with a high degree of urgency in that direction, and look forward to sharing more detail with you as soon as we can. On the divestitures question, I mean, I’m not sure I can identify all you now when are we there, but I can give you some insight into to how our sales management and the Board are -- view that question in terms of what might we divest and what might we not.
We’ve talked previously about return on invested capital being the key metric, it remains a key metric for how we look at the returns of individual businesses. But obviously, when you’re considering divestiture, you need to consider a broader range of metrics than just ROIC.
So, we continue to do that, but I don’t know that I can sort of try and give any further in ultimately what might be in and what might out.
Kenric Tyghe
Fair enough, thank you. And then my second question is, can you help me reconcile the performance at Amex with your comments on a highly engaged, high value member and a reengaged high value member.
We’re looking at sort of two years plus now of underperformance within that base. And I’m trying to understand or get to the core of what is going on within that Amex space, it just doesn’t seem to be responding as you would expect it would, given who Amex banks and who that Amex card member is by way of income demographic or other.
Could you speak to the performance in Amex, recognizing obviously the strength of within your Visa portfolio as a positive, but certainly the drag in Amex, and a continued drag is something that flags?
David Johnston
Look I think the key answer is kind of answer in the question, which is what we see is strong growth within the TD and CIBC portfolios. And that is reflective of the quality of the marketing job that we’ve done with our partners, as well as the strength of the business.
I don’t know that I’d go too much further into the performance of Amex on a standalone basis. Yes, it’s something that we continue to work with more, but look more broadly across, what I wouldn’t do is take the performance of Amex when I think about the premium segment, because the growth in TD and CIBC also reflects strong performance within the premium and demographic.
Kenric Tyghe
Thank you.
Operator
[Operator instructions] Our next question comes from the line of Sean Noel [ph] from FCM. Your line is open.
Unidentified Analyst
Hey, guys. I’m curious if you have a target internally of where you can get non-airline redemptions for Aeroplan, perhaps now that you’re less concerned about protecting the Air Canada relationship?
David Johnston
Well, look, if you think about the long-term strategy for the business, what we’ve said is, we’re multi-airline program today, with Air Canada and Star we want to be a multi-airline program in future. And that may include Air Canada, as they and we’ve both said or they’ve said that we’ve access to tickets after 2020, but obviously only to be a broader airline set there.
So, Air is going to continue to be at the core of what we do. But I think, we have the opportunity to continue to develop Aeroplan into a broader travel platform.
If you think about -- we see Aeroplan as a travel companion if you think about the next trip that you’ve got to book, you’ve got to sold for more than just what flight you get, you got to think about rental, you got to think about hotel, and that’s the journey that we are on with the business. You will continue to see further development in that area, but obviously even over the last year or so you’ve seen the addition of Avis as a key partner in car rental, and we've talked on the call about some of the promotional activity with Marriott this year.
So net-net we are keen to broaden out the travel offering beyond there although that's not to say that air would remain an important component, I wouldn't at this point put a number on the mix.
Unidentified Analyst
Okay, interesting. So then Global Loyalty clearly not generating a great rise for shareholders.
Do you think it's just a question of like changing the pricing model or do you think you can cut OpEx there, or I'm just trying to understand how you bring that business to drive an acceptable return?
David Johnston
Yes, it’s a fair question. And I'm for sure we are not there yet, I think that the journey that we’ve been on with that business has really been focused on developing a market leading product set and converting our clients from legacy technology, which is tended to be higher costs onto a small number of global platforms.
That we're now well down that path and that is reflected I’d internally in our success in winning new clients, as well as broadening out the range of services that we offer with existing clients. And it's reflected and we talked about this before externally and things like Forester Report, which identified us as the top player in both enterprise and SaaS within loyalty.
So, job one was to deliver a market leading product set, that helps us winning the market, but at a sustainable level of client margin. But we also said on the call that I think there is more -- we are not fully there, but we are now at a special level maturity that I do want to take a harder look at some of the other areas of operating expense in that business over the next 18 months.
And that's where the focus will be as we layout our internal plans for the business in 2018 and 2019.
Unidentified Analyst
Okay, great. That makes a lot of sense.
And then, is there any reason that it wouldn’t make sense to take Aeroplan and put it into a joint venture with Air Canada potentially or some other airline coalition kind of similar to -- and then effectively be like a Canadian PLM structure or I'm just trying to think about like sort of outside of bringing in other partners like are there other creative things that you're looking at?
David Johnston
Look, I understand that it's tempting to speculate, I am pretty sure there is a lot of interesting models out there I don't think I can speculate too much on that right now. My focus is what we talked about where the Aeroplan program was a strong multiline airline program and we’ve got to get new partners in place after 2020, we got to take cost out of the business and we’ve got to strengthen the balance sheet.
So, that's where management focus is right now. You could be right, there could be other models and structures out there, but we're focused on delivering on our priorities right now.
Unidentified Analyst
Okay, thanks guys. I thought the quarter was great, and I know you're working hard.
So appreciate it.
David Johnston
Thank you.
Operator
[Operator Instructions] We have no further questions in queue. I'll turn back to the presenters.
David Johnston
Okay, well thank you very much everyone for making the time and to be with us today. I will just finish by again restating the priorities we’ve moved with urgency on establishing new commercial partnerships on taking costs out of the business and on strengthening the balance sheet.
Balance sheet this quarter has $670 million of cash on the balance sheet right now, but we continue to work on those priorities. Thanks again for your time, and I am sure I’ll catch-up with any of you over the next few weeks.
Operator
This concludes today's conference call. You may now disconnect.