Oct 17, 2007
Executives
Julie Prozeller - Financial Dynamics Michael Parks - Chairman of the Board, Chief Executive Officer Edward J. Heffernan - Chief Financial Officer, Executive Vice President
Operator
Good afternoon. Welcome to the Alliance Data third quarter 2007 earnings conference call.
(Operator Instructions) It is now my pleasure to introduce your host, Ms. Julie Prozeller of Financial Dynamics.
Julie Prozeller
Thank you, Operator. By now you should have received a copy of the company’s third quarter 2007 earnings release.
If you haven’t, please call FD at 212-850-5608. On the call today we have Mike Parks, Chairman and Chief Executive Officer, and Ed Heffernan, Chief Financial Officer of Alliance Data.
Please note that due to the pending proposed transaction with an affiliate of the Blackstone Group, there will be no live question-and-answer session during the call. I would like to remind you that some of the comments made on today’s call may contain forward-looking statements.
These statements are subject to the risks and 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 would like to turn the call over to Mike Parks. Mike.
Mike Parks
Thanks, Julie. Good afternoon, everyone.
Thanks for joining us again. Today I’ll spend a few minutes reviewing the status of the acquisition by Blackstone and the highlights for the quarter and the full year, and then Ed will review our financials in more detail and discuss guidance.
Let’s get started. Let’s turn to the next slide, the acquisition status.
Things continue to move along as planned. First, we received shareholder approval during August.
Second, on the regulatory front, discussions with both the OCC and FDIC have been quite positive and there have been no red flags in the process. As such, we feel we are in good shape for a fourth quarter close.
I do want to take a minute to clarify a potential misunderstanding around the bank regulatory process though. Our merger agreement with Blackstone contemplated that we would have the necessary bank regulatory approvals by today, or we would begin restructuring our bank subsidiaries to facilitate the merger closing.
Based on the progress with the FDIC and OCC to date, we and Blackstone have agreed to continue working toward obtaining the bank regulatory approval and have deferred going down the restructuring path. If at some point we determine that it is no longer likely that we will receive bank regulatory approval, the company has the ability to notify Blackstone that the deferral has ended and the parties will pursue the bank restructuring.
To be clear, reaching the October 17th date without obtaining bank regulatory approvals is not a breach of the merger agreement and does not give any party an out. To keep it very simple, we are happy with the progress and path we are on to get the necessary approvals.
All right, moving on to the third item, as you will see our results for the quarter were exceptionally strong. Guidance was raised and our outlook for 2008 is very positive and finally, financing has been fully committed and capped and we recently completed our rating agency business.
Yesterday we announced the launch of a prepayment offer for our existing $500 million of senior notes. We are set to begin the marketing of the deal upon the receipt of our rating from the rating agencies and approval from regulatory agencies.
We remain on track to close in Q4 and as mentioned earlier, we will not be taking any Q&A, we will not be taking calls after today’s presentation, and all the way until the deal closes. We are in a very fluid process and we do not want to run the risk of providing anyone an advantage or, as importantly, a disadvantage.
So now let’s move on to the quarter. Next slide -- obviously we are very pleased to announce a record quarter, our largest quarter ever for revenue, EBITDA, and cash earnings per share.
This also marked our 26th consecutive quarter of delivering or exceeding on our plan. During the period, revenue reached $570 million, an increase of 14%, and adjusted EBITDA increased by 30% to $173 million.
For the first time, our cash earnings exceeded a dollar, up to $1.01, which was up 25%. Also, our operating cash flow, or operating EBITDA, was a record $182 million.
Now let’s take a look at a few of the highlights, turning first with our marketing service business in Canada. As you know, they manage our Air Miles reward program and they did an outstanding job this quarter, delivering another double-digit organic growth quarter in both revenue and EBITDA.
Also this quarter, we announced an expansion with one of our founding and top ten sponsors, Rona, Canada’s largest hardware, home renovation and gardening retailer. Now collectors can earn reward miles at their Réno-Dépôt big box stores in Quebec, which represents 20% of Rona’s big box properties.
We also signed a multi-year agreement to extend our relationship with the Katz Group of Canada for their Rexall/Pharmaplus pharmacies. They have over 200 locations where collectors can earn miles for merchandise purchases.
Nice work, guys. On to the next slide, our U.S.
marketing services business, Epsilon, turned in a tremendous performance this quarter. Top line grew in excess of 50% and EBITDA in excess of 70%.
While our growth in the U.S. is still very strong, we are also very excited by our international prospects.
Last month we announced an agreement with Tesco Stores Limited, U.K.’ s largest retailer.
We’ll provide an e-mail communications and campaign management platform, as well as professional services to their online business, Tesco.com. Additionally, we will help them in developing highly targeted campaigns to acquire and retain customers and increase sales through upselling and cross-selling opportunities.
Also, just last week, we announced an agreement with EachNet, a joint venture with U.S.-based e-Bay and Shanghai-based TOM Online. EachNet is an online auctioneer in China founded in 1999 and has a database of 30 million customers throughout Mainland China.
We’ll provide both e-mail marketing technology, professional services to help them manage their complex communications, and create timely and relevant marketing campaigns. We are equally proud of our ability to deliver what we promised and as a result, we’ve received high marks from our client.
In a recent survey conducted by Gardner, 100% of Epsilon clients would recommend Epsilon to their colleagues. Great quarter, team.
Now let’s turn over to the next slide and our private label group. Once again, an outstanding quarter.
They delivered strong double-digit growth despite a difficult economic environment, as you know. Unlike many other providers whose business models are those of a finance company, our focus is on helping our clients increase sales and create long-term loyal consumer relationships.
The most recent testament to our strategy is the renewal and expansion of our Williams-Sonoma agreement. We announced last month a launch of the new private label card program for their West Elm brand, and extended our contract to provide services of The Pottery Barn brand.
West Elm offers high quality furniture and home accessories through their catalogue, website and retail store locations. We signed a solid book of new business so far this year.
We’ve announced six transactions against our typical four to five deals we expect each year. We may even sneak another one in before the year is out.
Our pipeline is strong and we see it carrying us well into 2008. Once again, a very nice quarter.
Thanks to the card group. Let’s turn to the next slide, if you will, for the full year outlook.
Looking at the fourth quarter, based on our over-performance in the first nine months of this year, we are upgrading guidance to at least $3.70. We expect strong, double-digit growth to continue from Air Miles, Epsilon, and our private label business, which positions us very nicely for the year.
These businesses represent 85% of all of our revenue and nearly all of our EBITDA. We have strong momentum for the remainder of this year and through 2008.
We’ve had some significant client wins and fully expect this to continue. Our renewals and expansions with key clients are solid, further providing us with a highly visible and predictable year.
I want to congratulate our management team and associates on an outstanding quarter and thanks for remaining committed and focused amidst the many distractions we’ve had over the last few months as we work toward our close. Great work, everybody.
Ed, will you take a dive into the financials?
Edward J. Heffernan
Thanks, Mike. Before we get into the results, let’s just do a quick walk-through of the one-time or non-cash items this quarter.
As you might expect, these were related to getting things ready for the buy-out. EBITDA and cash EPS excluded the usual non-cash stock comp charge of about $11 million.
Additionally, it excludes about $6 million in accelerated stock comp charges related to certain departing executives; $6 million in merger costs, and a one-time non-cash charge of $40 million related to the write-down of assets in our utility business. The write-down decision was made due to the continuing cost overruns in our utility business and the flat revenue forecast for 2008.
As such, this review resulted in an impairment and we took the one-time non-cash charge in Q3. All right, let’s talk a little bit about the quarter.
I would say probably six key takeaways from the quarter. The first one being this was our 26th consecutive quarter, that is from the IPO all the way to today, where the company has met or exceeded expectations.
Second, this was also our best quarter in our history, with record revenues, EBITDA, and cash EPS. From a purely cash flow perspective, also our best as operating EBITDA, a good proxy for operating cash flow, came in at $182 million, up over 30% from last year.
Third, double-digit top line growth came from our big three engines -- that is, loyalty Air Miles in Canada, Epsilon or U.S. Marketing, and private label.
Of special interest is that each of these engines grew at a double-digit pace on both top line and EBITDA. Great growth with great balance.
Fourth, the big three accounted for all of the growth and produced 85% of all revenues and virtually all our cash flow. This bodes extremely well for future growth.
The remaining 15% of the business was flat. Fifth, EBITDA margin hit a record 30%, up 400 basis points from last year, as loyalty, Epsilon and private label achieved huge gains from leveraging operations.
And finally, cash flow growth has continued to accelerate as EBITDA’s year-over-year growth has moved from 19% in Q1 to 30% in Q3, with similar acceleration in operating EBITDA. So overall, we thought it was a great quarter and as importantly, there has been absolutely no sign of any “bleed-up” from sub-prime troubles in the economy.
Onward and upward, so let’s hit the segments. Next slide.
As we say, let’s go from worse to first -- the transaction services segment houses private label, utility services, and our traditional merchant acquiring bank card business. Top line was stagnant, despite a respectable 6% growth in statements generated, which drives both private label and utility services.
Statement growth was offset by the expected ongoing attrition in our non-core merchant acquiring bank card business, as well as some softness in utility. EBITDA bounced back from Q2 but still remained below prior year.
Similar to Q2, the segment was burdened by about $5 million in extra costs from ramping up our collection staff and client services teams for private label. The results of this spending shows up in the huge performance in the credit segment as credit losses, yield and portfolio growth all came in strongly.
So overall, the money was well-spent. Our inter-company transfer prices are established at the beginning of each year and these additional collections and client services costs were not included in the transfer price assumption.
Simply put, for now transaction services eats it while credit services gets [the benny]. Utility services was the source of the remaining shortfall as client ramp-ups continued to lag budget.
The outlook, we expect relatively flat year-over-year growth in Q4 EBITDA, despite the inter-company drag. Next up, credit services -- another great quarter as revenue grew 12% and EBITDA a robust 33%.
Let’s go ahead and walk through the key drivers; leading off, portfolio growth was a solid 8% as new programs ramped up and existing programs continue to drive market share. Solid growth in the portfolio plus a rock solid earnings from yield and fees drove growth into the double digits.
Credit sales, however, were poor at a mere 1% growth. While credit sales growth was generally poor across the board, our big catalog clients seemed to bear the brunt of it, specifically the recent large increase in postal rates certainly caused a drop off in books mailed and hence sales.
Other folks have mentioned tough comps from prior year, the weather, et cetera, et cetera -- we really can’t comment on that. All we can say is fortunately, it didn’t dent our earnings whatsoever.
Funding rates remained flat to last year. Our funding book matches fixed rate assets, our cards, with fixed rate liabilities via long-term fixed rate asset-backed bonds.
This long-term approach has enabled us to keep our funding rate flat this year versus last year versus the year before and we believe this will hold true in 2008 as well -- all good news. Also, from a liquidity perspective, we have recently renewed all maturing conduit vehicles and have already pre-funded our maturing $600 million in asset-backed notes.
We’ll now have the luxury of hitting the markets with new notes at our own discretion. And finally, credit losses came in just a bit under 6% for the quarter, while delinquencies came in a bit over 5%, both excellent numbers.
Losses have now normalized versus abnormally low levels previously due to the bankruptcy reform bill, and based on delinquency levels, especially in the early stage buckets, the 30-60-90 days, we remain very comfortable with our credit loss profile being quite stable -- call it around the 6% level. We have seen no evidence to suggest any negative “bleed-up” from the macro sub-prime issues that are out there in the market.
So as such, our outlook for 2008 in credit services remains quite positive. All right, and finally, the big dog, marketing services, which includes both our Canadian loyalty business and Epsilon, also called our U.S.
marketing footprint. First in Canada, grew double-digit organically, both top and bottom line.
Strong pricing power, deeper financial commitments from existing sponsors, the ramp-up of new sponsors, and the “network effect” from our households frequenting more and more sponsors, all drove growth. Despite having 70% of all the households in the entire country active in our program, the trends continue to suggest solid double-digit organic growth for the foreseeable future.
Firm revenue per mile in combination with a favorable cost per mile rate and leverage of our existing infrastructure were likely all key drivers in our 500 basis point increase in marketing services gross margin year over year. Next, U.S., our Epsilon group, which grew both top and bottom lines well in excess of 50% year over year; while U.S.
growth remains very strong, the international arena continues to hold additional promise. As Mike talked about, the signing of Tesco, a $92 billion retailer and one of the largest in Europe, gives us a great solid cornerstone client for that region.
Equally important is our recent signing of EachNet, or e-Bay’s joint venture in China. U.S., Europe and Asia-Pacific all offer great growth vehicles for the future as more and more marketing dollars are being redirected away from traditional media channels and into our transactional-based one-to-one marketing offerings.
In sum, the company continues its migration towards a purely value-added, transactional-based marketing firm. Whether it’s a coalition program like the one in Canada, or here in the States with City’s Thank you program, or a one-off program like the Hilton reward program, or a program that offers a credit component, such as Fortune Officer, Pottery Barn’s private label programs, it’s all based on the same principal, and that is that past transactions are the best predictor of future behavior.
The ability to link past history to a specific consumer allows for an unbeatable model to micro-target consumers and product huge ROIs versus traditional marketing channels. We think it’s a winner today and for many years to come.
Okay, a couple of items on the balance sheet. First, in Canada, deferred revenue increased a whopping $66 million from last quarter and $126 million from this time last year, more than double our normal rate.
What’s it mean? Well, it suggests that these revenues and profits have been earned but not yet flowed through the P&L for accounting purposes.
This will drive exceptional growth in our Canadian business going forward. Second, our net debt, which has always excluded CDs, improved by $150 million in the quarter and our key covenant metric, which is core debt to LTM operating EBITDA, improved from 1.8 times last quarter to 1.5 times currently -- very, very strong.
Okay, everyone’s favorite, let’s talk a little bit about guidance. Next slide -- again, things are going up.
We are looking at another strong finish to another strong year. We are raising guidance again.
Revenues, we’re looking at around $2.3 billion, up about 15%; adjusted EBITDA of about $640 million, up about 24%. Not on this slide is our cash flow metric, which would be operating EBITDA.
That’s probably going to be running around $675 million to $680 million, and then finally cash EPS of $3.70 a share, as we close in on about 20%. Let’s not forget that this year, we actually had to play through about $0.25 of grow over related to the abnormally low losses last year, so our normalized growth rate is getting close to 30%.
In terms of how we walked up the guidance over the past year or so, we walked it up as we’ve looked at how the businesses are doing in this macro environment, lots of concerns out there. What we are seeing is not affecting our business whatsoever.
I think back in October on our Q3 call, we had $3.50 a share, and then we moved from there to $3.55 to $3.60 to $3.65 and now to at least $3.70 a share, so clearly we are feeling pretty comfortable with the remainder of the year and going into 2008. Let’s move on to free cash flow, which includes both operating EBITDA of at least 670 to 680, somewhere in there, less CapEx and interest and taxes of about $350 million.
Essentially it’s about 317 minimum, probably it will be a little bit above that or a little bit under $4 per share of pure free cash flow. Going back, again our original guidance was more to the tune of $3.70 and we are going to come in probably a bit north of $3.90 per share, so again, everything seems to be heading in the right direction for the remainder of the year and for 2008.
Finishing up with the last two slides, the leverage we are getting continues to be exceptional. We have been growing our EBITDA margin from the mid-teens back in 2000 and we are getting closer and closer to 30% this year, so overall we are seeing tremendous leverage in the business.
We expect that to continue on a go-forward basis. And then finally, probably one of our favorite charts is how things have been going.
Obviously the growth rate has been exceptional over the last several years, but as importantly to that, it’s been very consistent and I think those are the two key themes of our model of double-digit organic growth plus some over-performance, some moderate acquisitions, and keeping things very visible and consistent has been the hallmark since day one of our model. Obviously we’ve been very pleased with it and before I turn it over to Mike, a couple of thoughts.
Now that we are most likely winding up our public run, first, this has been now 26 quarters in a row since our IPO of over-performance and it’s something we are very proud of and hopefully it provided some ongoing comfort to our large shareholders, that they could count on us in good or bad times, when the environment itself is difficult, we tend to be able to play through. Second, we look back now almost seven years when we went public at $12 a share and we’ll be taking out at just under $82, nearly a 600% return versus 20% for the market over that same period and again, a proud record and a special thanks to our shareholders and our sell-side analysts who believed our model, even though it wasn’t simple but it was in fact unique and it certainly did deliver.
And finally, we started as an LBO 10 years ago, got us down to investment grade while growing enormously. We view the deal with Blackstone as a good opportunity to continue and improve upon our unique model.
So thanks for all the support from both the shareholder base and also from the key sell-side analysts -- you all know who you are, so Mike and I say thanks on behalf of the rest of Alliance. It’s been fun but we think Alliance Data, act II, perhaps called the return, will be even more exciting.
So bye for now and I’ll kick it over to Mike.
Mike Parks
Thanks, Ed and my thanks as well to everyone. I appreciate the support, as Ed said, as well for the long-term shareholders.
I appreciate your guidance as well. Having never led a public company before, I have certainly learned a lot over the six-plus, almost seven years.
I’ve enjoyed our many discussions regarding shareholder return methodology and your guidance there and at the end of the day, I trust that everyone has been highly satisfied or will be highly satisfied with their returns on Alliance Data. And if the opportunity presents itself again, I look forward to working with many of you again.
Also, as Ed said, it helps to have a strong business model. It also helps to have it married in the right market and the right growth characteristics and we think we are in the sweet spot of that.
But even more importantly, the right people to execute passionately and deliver what they promise, and we certainly have that and it’s my sincere thanks for all of our folks, our entire management team and our associates. Thanks to everyone, and with that said, I hope everybody has a great week.
Bye for now.
Operator
Thank you, everyone. This concludes today’s conference call.
You may disconnect your lines at this time and please have a wonderful day.