Rewards Network Inc. Q3 2008 Earnings Call Transcript

| About: Rewards Network (DINE)

Rewards Network Inc. (DINE) Q3 2008 Earnings Call October 22, 2008 10:00 AM ET


Evan Makela – Corporate Counsel

Ronald L. Blake – President, Chief Executive Officer

Christopher J. Locke – Senior Vice President, Chief Financial Officer


Gary Prestopino – Barrington Research


Good morning ladies and gentlemen and welcome to the third quarter earnings conference call. (Operator Instructions) I will now turn the call over to Mr. Evan Makela. Mr. Makela, you may begin.

Evan Makela

Thank you Kim. Welcome and thank you for joining us today. With me are Ron Blake, President and Chief Executive Officer and Chris Locke, Senior Vice President and Chief Financial Officer. During today’s call, Chris Locke will review our third quarter 2008 results as issued over the newswires early this morning. Ron will follow with his comments and we’ll have time at the end for your questions.

I will point out that statements made in this conference call that are not strictly historical are forward-looking statements and are made pursuant to the safe harbor provisions of the Private Securities Litigation Reform Act of 1995. These statements are based on management’s current expectations or beliefs and are subject to risks, trends and uncertainties. Actual results, performance or achievements may differ materially from those expressed or implied by these statements due to changes in economic, business, competitive, technological and/or regulatory factors and other factors affecting Rewards Network.

A description of the factors that could cause actual results to differ materially from those included in the forward-looking statements and that among others should be considered in evaluating our outlook can be found in the company’s most recent annual report on Form 10-K filed with the Securities and Exchange Commission. We undertake no obligation to and expressly disclaim any obligation to update or revise any forward-looking statements to reflect changed assumptions, the occurrence of anticipated or unanticipated events, changes to future results over time or otherwise, except where required by law.

Now I’ll turn the call over to Chris Locke.

Christopher J. Locke

Thanks Evan. The results of the third quarter reflect our continued efforts to achieve sales growth while managing risks in the Dining Credits portfolio, maintain member engagement while reducing the cost of member awards and marketing, and aggressively manage operating expenses. We ended the third quarter with 9,755 total merchants, 522 higher than the prior year.

The higher number of merchants contributed to the 9% increase in sales in the third quarter over the prior year to a total of $62.4 million. Overall merchant count decreased slightly as compared to the second quarter of 2008. Dining Credits merchants decreased by 3% between quarters, while marketing services merchants increased to almost completely offset the loss.

While we have consistently pointed to growth in our dining credit merchants account and the Dining Credits portfolio as critical to overall revenue growth, we previously indicated that we had adjusted our risk assessment approach within the Dining Credits program to insure that the portfolio was appropriately conservative given the ongoing economic and credit issues facing both restaurants and consumers, as well as to conserve cash to insure that we could retire the convertible debt that was put to us earlier this month.

We began this process during the fourth quarter of 2007 and have not strayed from this approach. The impact of our policy and risk assessment changes is evident in the year-over-year comparison of the Dining Credits portfolio in terms of size and usage period. The net Dining Credits portfolio at the end of Q3 2008 was $82 million, significantly lower than at the end of Q3 2007 when it reached $92 million. However, the net portfolio usage period in Q3 ’08 was 7.5 months as compared to 9.7 months at the end of Q3 ’07, a 23% decrease.

In addition, at Q3 ’08 there were 4% more Dining Credits program merchants on the program as compared to the prior period. In addition to lowering the risks we have taken with merchants by actively managing our Dining Credits portfolio, we have also driven increases in both merchants and revenues. We intend to continue this conservative approach during the ongoing climate of economic and credit uncertainty. The steps that we have taken to manage risks in the Dining Credits portfolio have contributed to increases in total sales and cash flow.

While these are positive results, we are mindful that a shorter usage period for Dining Credits means that we must more frequently renew our Dining Credits merchants. The decrease in dining credit merchant count as compared to the prior quarter is due in part to the need to renew deals more frequently, which not only is a strain on sales resources but also results in merchants completing the program quicker than in the past.

We are focusing our sales resources to address this challenge as we seek to continue to grow our merchant count and Dining Credits portfolio. In addition, while we have lowered our overall exposure by reducing the usage period of the Dining Credits portfolio, we do continue to see merchants exit the program due to cash flow issues and store closures. As a result, the balance sheet allowance for Dining Credits at the end of the third quarter was 22.2% of the gross asset, providing higher reserves against the gross Dining Credits asset than in any other period.

Throughout 2007 and 2008, we focused on implementing changes to our websites, our e-mail marketing and member awards structures to drive increased revenues and improved member engagement in a more cost effective way. Our e-mail marketing initiatives have resulted in overall marketing expense decreases of $775,000 for the quarter and $2.4 million year-to-date. While our marketing expenses have decreased, we continue to see increases in total revenues, total qualified transactions, and active members between periods.

Since the beginning of 2008, our member rewards structure began providing our highest levels of benefits to members who provide us permission to send marketing to their e-mail addresses, who dine frequently and who provide feedback regarding their dining experiences. These changes have had the dual impact of significantly decreasing the cost of member benefits while improving revenues and member engagement.

As compared to the prior year, the cost of our member benefits decreased $800,000 for the quarter and $4.9 million year-to-date. Year-to-date we have driven increases in qualified transactions, active members and overall revenues while lowering marketing and member benefit expense a total of $7.3 million.

Finally, we are focused on tight management of our operating expenses. Operating expenses for the third quarter totaled $16.5 million or 26.5% of sales as compared to $16.3 million or 28.5% of sales in the prior year. Year-to-date operating expenses totaled $50.1 million or 26.8% of sales as compared to $51.5 million or 30.8% of sales in the prior year after adjusting the prior year for the reversal of litigation expense.

We are focused on creating and maintaining operating leverage through disciplined expense management. The net impact of our efforts has resulted in continued progress towards our long stated goal of profitable, sustainable growth. Diluted EPS for the third quarter of 2008 totaled $0.05 as compared to $0.04 in the prior year, which included approximately $0.02 of interest income in the prior year period.

Diluted year-to-date EPS totaled $0.17 as compared to $0.23 in the prior year. The prior year included a $0.26 per share favorable adjustment related to the reversal of litigation expense. Excluding this adjustment, year-to-date diluted EPS was $0.20 higher in the prior year.

Now let’s move on to cash flow. Through the third quarter of 2008 the company expended approximately $105 million of new Dining Credits, invested $3.6 million in capital expenditures and repurchased approximately $40 million of our convertible subordinated debt out of cash reserves and operating cash flow. We ended the third quarter with a cash balance of

$18.5 million and during October, 2008 we retired the remaining $14.8 million of convertible debt out of our cash reserves.

On August 11, 2008 we amended our senior secured revolving credit facility with RBS Business Capital. Under the facility, RBS has committed to provide $25 million and has agreed to seek and obtain an additional commitment of $15 million from one or more other financial institutions. As of September 30, 2008 we had no borrowings against the facility and were in compliance with all financial covenants.

During October, 2008 we retired our convertible debt without a draw on the facility. We expect to utilize the facility going forward to fund our working capital needs and we believe the facility provides adequate liquidity. With that, I’d like to turn the call over to Ron.

Ronald L. Blake

Thanks Chris. Good morning everybody. Our results for the third quarter were consistent with the first half of 2008. We continued year-over-year growth in sales as well as continued operating profitability. Achieving these results in the current economic environment is a reflection of the steps we began to take over a year ago. We prepared our business by anticipating and managing risks in the Dining Credits portfolio, reducing operating expenses, taking advantage of the operating leverage in the business.

We’ve shifted our focus to Internet and e-mail marketing and implemented changes in our member benefit expense structure, which has led to reduced marketing expenses and the cost of member benefits, while we experienced an increase in sales. The positive impact of our disciplined approach is reflected in the results we’re reporting today, including our strong cash flows, our ability to buy back our convertible debt from cash on hand, our debt free position and our significant increase in profitability.

We continue to be very disciplined with respect to our Dining Credits portfolio, staying with our conservative approach to buying Dining Credits that we began implementing about a year ago. In maintaining the shortened usage period for Dining Credits we implemented in December of 2007, we have seen increased sales year-over-year with allied increase in our net Dining Credit portfolio, which means that we’ve not increased the amount of capital we have at risk in the current environment.

We continue to adhere to these policies and procedures and manage the risk in our Dining Credits portfolio in a prudent and cautious manner. In addition, we have maintained our focus on managing our operating expenses, which is important in maintaining our profitability in these very challenging times. Our ability to reduce operating expenses while growing sales demonstrates the operating leverage in our business.

Managing expenses will continue to be a focus going forward. We’re constantly assessing our business in light of the changing economic circumstances and we will continue to make changes as necessary to take into account development that impact our business. We’re well aware of the current state of the credit markets. We have heard that firms engaged in restaurant financing are pulling back or exiting altogether from certain geographic markets.

These developments present an opportunity for us to help merchants meet their need for capital with our Dining Credits program, but we must approach this cautiously. We understand that we must adhere to our risk assessment and credit analysis policies to successfully address the opportunity we now have with merchants.

Another opportunity created by the current environment is with our numbers. Diners are seeking value in times like these and we believe our programs provide compelling value to our members, which rewards we provide for dining at our restaurants such as airline miles, college savings rewards points or our cashback savings rewards.

We continue to make changes in our programs that align our interests with the interests of our members and our merchants. We have seen traffic to our new websites increase 50% over the last year, a positive sign that members are taking advantage of our pre-designed websites, engaging in our programs and receiving the marketing that we do for our merchants.

The third quarter continued to demonstrate positive results from our restructuring of member benefits to increase engagement. For example, in the month – in each month third quarter our members completed over 120,000 surveys of their dining experience. That’s over 360,000 for the quarter and a 25% increase over the second quarter. We continue to develop new ways to engage members because more engagement from our members makes the program more valuable to our merchants.

We see a lot of challenges to the restaurant industry today. The current economic environment presents many challenges for our business, but as we work to address the needs of restaurants, we also see opportunities. In 2007 we believed we needed to prepare our business for a difficult economic environment. We took several steps with that in mind.

We became more conservative in our Dining Credit purchases to manage the risk in our Dining Credits portfolio. We reduced operating expenses. We implemented changes in our marketing and our member benefit structure that resulted in reduced costs while sales increased. And we focused on the value we provide to our merchants and our members.

We’re encouraged that in the face of the challenges affecting the restaurant industry, our preparation for these times has resulted in another quarter of profitable sales growth. We’re also pleased that our strong cash flows enabled us to repurchase our convertible debt out of cash reserves. We continue to be positive about the opportunities we see in the marketplace and believe that our programs are attractive to both diners and merchants, even in these challenging times.

We remain focused on execution as we continue to pursue our goal of sustainable, profitable growth. We thank you for your time this morning and we would like to take your questions.

Question-and-Answer Session


Thank you. (Operator Instructions) Your first question comes from Gary Prestopino – Barrington Research.

Gary Prestopino – Barrington Research

A couple of housekeeping questions, Chris, can you give me the component, the numbers for interest and other income and interest expense and financing costs? Do you have them handy?

Christopher J. Locke

Yes I can give you the breakdown between interest expense and interest income. For the quarter it was $446 of interest expense and $229 of interest income.

Gary Prestopino – Barrington Research

Just another housekeeping question, what was your D&A for the quarter? Depreciation and amortization?

Christopher J. Locke

$4.2 million.

Gary Prestopino – Barrington Research

Just a couple of other questions, non-housekeeping. This amended facility with RBS when you said for working capital, can you use that facility for the Dining Credits portfolio?

Christopher J. Locke


Gary Prestopino – Barrington Research

In terms of what’s going on in the restaurant industry right now, I mean all we’re hearing is doom and gloom, could you see you taking that months to consume Dining Credits down from 7.5 days as we go forward just more of a tightening of the credit parameters? Is that something that you’re entertaining?

Ronald L. Blake

I think in a very realistic fashion we’re assessing all the same information that you’re seeing in the marketplace. We have implemented a number of changes, including risk based pricing to the portfolio which gives us some comfort about the kinds of deals that we’re doing. But yes we are looking and have tightened up on the amount that we were willing to purchase especially for, I would say, the lower rated credits but Chris add to that?

Christopher J. Locke

No that’s right on Gary. We are obviously watching very closely what’s going on in the market. We have a significant amount of data on the dining industry and we’re adjusting real time in terms of what we feel is appropriate risk given the credit profile, the restaurant, the sale trends that we’re seeing and their performance on the program. We – I think it is safe to say that we will become more conservative.

Gary Prestopino – Barrington Research

In terms of given that we’re reading that dining out is – the growth is slowing and/or declining, is your sales force now seeing more high quality restaurants that probably wouldn’t have entertained using your program now at least amenable to talking with you because we’re seeing sluggishness on the dining level?

Ronald L. Blake

Gary, a couple of comments for that, first off in terms of overall trends in the dining industry probably two big ones at least to note and then I’ll comment on the quality of the restaurants. We see people trading down to lower entrée prices and thus lower cost restaurants. From what we hear back from the feedback we get from our merchants and their assessment of their business, they are clearly seeing a decline in purchase of like bottles of wine and desserts, even though they may still be having reasonable traffic into their restaurants.

And I think thirdly yes I think the market, because of the overall economic environment and the credit markets in particular we are seeing restaurants spend in the past probably didn’t need the type of program, marketing, feedback and capital that we can provide that we’re beginning to talk to. I would emphasize in that though the fact that they may have been higher end restaurants, the same due diligence, the same credit review and the same conservative approach that we’ve talked about we will take with them.

Gary Prestopino – Barrington Research

Yes, I wasn’t really talking about maybe higher end restaurants but you know there’s like in Chicago there’s very popular restaurants here that are going to draw crowds no matter what.

Ronald L. Blake

And we are seeing interest from a variety of restaurants that we haven’t in the past.


At this time I show no further questions. We have a follow-up question from Gary Prestopino – Barrington Research.

Gary Prestopino – Barrington Research

Just a quick question and just to refresh my memory, it looks like as I look at my income statement here, it looks like continuously for the last couple of quarters the cost of marketing credits has somewhat outstripped the growth in sales – sale growth. Could you just explain why that’s happening? Is that just the function of some of the deals you’re striking or am I totally off base there?

Christopher J. Locke

No that’s right on Gary. When we price a Dining Credits deal, as we’ve lowered the usage period which again has gone from upwards of over 10 or 11 months, six or seven quarters ago, down to 7.5 this quarter, typically the discount that we pay for those meals in advance gets smaller because of the fact that we’re buying less and so over the last three or four quarters as the usage period has gone down, you’ve seen the cost of sales go up. So since we’re buying less credits, we pay a smaller discount. That’s typically how the pricing works.

Ronald L. Blake

Gary I’d also add that we have been working on this for the last several months. We have done some restructuring of incentives in the sales force relative to getting higher ratio which would be a lower cost of sales. So it’s a subject that we are very focused on and while we are where we are at the moment, our expectation is that we’re going to continue to focus on improving it as we go forward.

Gary Prestopino – Barrington Research

Yes it looks like the net write-offs have been trending down, too, continuously. You know, it was at $4.7 million and I guess in the first quarter is that right? Or am I wrong there?

Christopher J. Locke

No you’re right. The first quarter however had a true up in terms of a write-off policy that we implemented at the beginning of 2007 which basically not delayed but we put in a 12 month period in which certain deals would be evaluated by our collections group and then written off. That’s just a write-off number as opposed to the reserve number. Our reserve number, our reserve policy never changed. So that’s – I believe it was 95% of that $4.7 million was fully reserved for when it was written off.

So after that first quarter you start to see a little bit more consistent trend in terms of write-offs.

Gary Prestopino – Barrington Research

According to what my data I have here it was about $3.2 million in Q2. Is that right?

Christopher J. Locke

Yes, it’s $2.7.

Gary Prestopino – Barrington Research

Could we expect that I guess Q4 is usually one of your seasonally strongest quarters. Given what’s gone on in the market here, is that expectation relevant in what we’re looking at?

Ronald L. Blake

I think we’re really more on a day-to-day basis here at the moment. The economics and the psychology in the market right now are such that we’ll have to wait and see. You are right seasonally. The fourth quarter is usually a better one. But I think we’re in truly unique times right now and I think we’re going to stay more neutral and wait and see at this point.


At this time I show no further questions.

Christopher J. Locke

Okay. Well, thank you everyone for joining us.

Ronald L. Blake

Yes. Let me add one thing here. We thank everybody for coming today. At the end of the day we believe that we’ve done an awful lot to prepare the business for some difficult times. As I said to Gary at the end there it’s very difficult at this point to forecast what and how things are going to play out over the next six or eight months. But we are going to remain cautious, focused on our costs and just as importantly on the quality of the Dining Credits portfolio. And while there may be more opportunity out there, we well recognize there’s more risk and we are going to manage it appropriately.

So I thank everybody for today. We look forward to talking to you with year end results.


Thank you ladies and gentlemen. This concludes today’s conference. Thank you for participating. You may all disconnect.

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