Rewards Network Q4 2007 Earnings Call Transcript

Mar.12.08 | About: Rewards Network (DINE)

Rewards Network Inc. (IRN)

Q4 2007 Earnings Call

March 12, 2008 10:00 am ET

Executives

Ron Blake - President and Chief Executive Officer

Chris Locke - Senior Vice President and Chief Financial Officer

Analysts

Bob Renck - R.L. Renck & Company

Operator

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

Evan Makela

Thank you Rosa. 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 fourth quarter and full year 2007 results as issued over the newswires earlier 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 on 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 expectation 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 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 quarterly and annual reports on Form 10-Q and 10-K filed with the Securities and Exchange Commission. We undertake no obligation to, and expressly disclaim any such 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 will turn the call over to Chris Locke.

Christopher Locketopher Locke

Thanks Evan. The revenue and earnings results for 2007 are reflective of a year of investment and progress towards our longstanding goal of achievement profitable sustainable growth. In today’s call I intend to focus on certain accounts in our balance sheet because we believe that changes in the balance sheet demonstrate the true impact of our progress during the most recent period rather than the income statement. Our income statement follows the lead of our balance sheet and even more specifically, it follows changes -- the changes in our dining credit portfolio.

A few words first about how we do the dining credits portfolio. Net asset on our balance sheet represents the cost of dining credits that we have purchased from merchants and that our members will utilize in future periods. In other words, it’s the future value of our cost of sales. The future sales to be realized from this asset are approximately 1.75 times the value of the dining credits portfolio on the balance sheet. As this balance changes so too will our future dining credit sales.

To understand our performance in 2007 we should look back to the first quarter of 2005 and review the changes we made to the business since then and both the short and long-term impacts of those changes on our financial performance. At the end of the first quarter of 2005, the net dining credits portfolio totaled $142 million. Our total merchant count was over 10,300 and our cash reserves totaled approximately $11 million. While sales had been at or near record highs so were losses against the portfolio. We wanted to address those losses and improve the risk profile of the deals that made up the dining credits portfolio.

So throughout 2005 and 2006 we focused on two key initiatives. Our first priority was implementing new dining credit pricing, due diligence and risk assessment policies and procedures. Our second priority was to develop a value and needs based selling approach and rebuild our sales team so that we could better explain our value proposition and attract the quality of merchants that we wanted in our programs.

The impact of our new due diligence and risk assessment procedures became evident in both our merchant count and our dining credits net asset balance. Both of these metrics decreased steadily throughout 2005 and 2006. As a result of these new policies we not only avoided doing business with unattractive merchants but also lost some merchants that we otherwise would have wanted to keep, but that did not agree to our new pricing structure. As a result our net dining credits portfolio balance hit a low in December of 2006 at a value of $76 million. That’s just over half the value of the March 2005 portfolio.

At the beginning of 2007 our merchant count had decreased to 8,300 from a high of 10,500 in early 2005. The impact of our new pricing and risk assessment policies on our dining credits portfolio and merchant count was compounded by the changes we were making within our sales organization. In 2000 -- mid 2005 to 2006 we developed and implemented a value in needs based selling approach. In addition after assessing the quality of the sales organization, we reduced the size of the sales force from a high of over 150 reps in 2005 to a low of 80 reps during the second quarter of 2006. By the end of 2006, we rebuilt a newly trained sales -- the newly trained and certified sales team to over 140 reps. With fewer reps on the street during this time frame we did not sell as many deals as we have in the past, which also contributed to a decline in the dining credits portfolio and merchant count.

The implication of a decreasing dining credits portfolio is the significant growth in cash reserves. In the 2005 and 2006 timeframe we were not redeploying our cash back into the portfolio at the same rate we were collecting against it. At the time we decided to hold onto cash rather than redeploy it back into deals that didn’t meet our risk in due diligence criteria. In December 2006 our cash reserves totaled $85 million.

With a steadily decreasing merchant count and dining credits portfolio throughout 2005 and 2006 sales decreases follow. We ended 2006 with sales of $253 million. We entered 2007 with the lowest dining credits balance in recent years, but with the fully staffed and trained sales force ready grow both our total merchant count and our dining credits portfolio and put our cash back to work.

In the first quarter of 2007 the dining credits portfolio grew for the first time in many quarters. In each of the following quarters including the fourth quarter we saw growth in both the dining credits portfolio and the total merchant count. We ended 2007 with the net dining credits portfolio totaling $95 million. A 24% increase over the end of the prior year. We ended 2007 with a total merchant count of 9542, a significant increase over the prior year.

Throughout 2007 the sales team executed on our plan of redeploying our cash into the dining credits portfolio all the while at hearing to our pricing risk assessment policies. In addition our needs based selling approach resulted in steady gains in our marketing services merchant count. We are encouraged by our accomplishments in increasing these two metrics throughout 2007 and feel that the ending dining credits portfolio and total merchant count at December 31, 2007 positions us well in 2008.

Now, let’s talk about our uses of cash in 2007. During 2007 we utilized $49 million of cash. Our primary uses of cash were as follows. Approximately $27 million of cash was used to fund the dining credits portfolio. Approximately $8.1 million of cash was used for capital expenditures. The largest investment in this area was the development of our new member website platform. Approximately $9.3 million of cash was used to make the first payment of legal fees and settlement payments related to the Bistro Executive Lawsuit. The Company is obligated to paying additional $3.2 million related to this matter in 2008 and $3.1 million in 2009.

Finally approximately $14 million of cash was used to repurchase $15 million of our subordinate convertible debt. As you all know $55 million of subordinated convertible debentures may be put to us for payment in full in October 2008. In looking at our uses of cash for 2008 we believe we will be able to address this obligation but are currently evaluating other financing and capital structure alternatives to enhance our liquidity.

Now, let’s discuss the income statement. Our fourth quarter sales of $58 million was slightly down as compared to the prior year and higher than the prior quarter, which marks our third consecutive quarter of sales growth. The progress we have seen in our revenues throughout 2007 is reflective of the steadily growing Dining Credits portfolio and merchant count that I discussed earlier. The issue of more significance in analyzing our sales during the fourth quarter as compared to prior quarters is the average revenue we realized on a per merchant basis. As compared to the prior year sales were flat but merchant count was up over a 11%.

When we think that a double digit increase in merchants would drive a comparative increase in sales but it did not in the fourth quarter; pulled as a result of actions we took in some activity outside of our control. This decline in average revenue per merchant in the fourth quarter can be attributed to a decrease of member dining activity as well as our actions to help our dining credits merchants more effectively manage their cash flows.

Net revenues for the fourth quarter were also flat as compared to the prior year at $17 million. A favorable variance in member benefits was offset by an increase in our provision for losses. The provision for losses was higher than the fourth quarter of 2006 as a result of the continued growth in the dining credits portfolio. Because our reserve methodology calls for reserve to be placed on new dining credits when they are purchased, the provision expense increases as the dining credits portfolio grows. In addition the fourth quarter provision for losses was impacted by approximately $796,000 related to the RCR loan notes program which the Company discontinued effect of January 2008. The decision to discontinue this product line was made after we gained some experience in this type of product. Ultimately we decided to focus on our core marketing credits and marketing services programs.

Operating expenses for the fourth quarter of 2007 declined 64.8% as compared to the fourth quarter of 2006, largely due to litigation expense related to the Bistro Executive lawsuit settlement in the prior period. Absent the impact of the litigation expense and adjustments that I would describe in a moment the fourth quarter operating expenses decreased 600,000 over the prior year, increased -- I’m sorry increased 600,000 over the prior year due to investment in our sales force and related selling expenses.

Operating expenses in the quarter included a $1.6 million pretax benefit arising from the reversal of litigation expense related to the Bistro Executive settlement while operating expenses for the fourth quarter of 2006 reflected a 29.4 million settlement expense. Full year revenues totaled $225 million which was 11% lower than the prior year. As I discussed earlier we entered 2007 with the lowest dining credits portfolio balance in recent history and a significantly lower merchant count in the prior year. While we were successful in growing the dining credits portfolio and total merchant count throughout 2007, we were unable to offset the impact on revenues of starting the year at these low levels.

Net revenues for the full year were $64.5 million 21% lower than the prior year. Net revenues were negatively impacted both by the decrease in sales as well as a $6.8 million increase in the provision for losses as a result of growth in our dining credits portfolio throughout the year.

Operating expenses for the full year totaled $56 million as compared to $106 million for the prior year. As with the quarterly results the full year results were significantly impacted by the Bistro Litigation settlement. Excluding litigation and related expenses 2007 operating expenses were 115,000 lower than the prior year as a $2.6 million increase in sales commissions and expenses was offset by a $3.5 million decrease in salaries and benefits to the lower headcount and management compensation.

Fully diluted EPS for the fourth quarter totaled $0.02, while fully diluted EPS for the full year totaled $0.26. When EPS is adjusted for the impact of the Bistro Litigation accrue reversals you will find operating EPS results that are at or slightly below breakeven for both the quarter and the full year.

With that I would like to turn the call over to Ron.

Ron Blake

Thanks Chris. Good morning everyone. We are encouraged by the progress we made throughout 2007 with respect to rolling the dining credits portfolio, our merchant count and improving the productivity of our sales force. We believe we are well positioned for 2008 even in the face of an uncertain economic environment.

We used a portion of our cash in 2007 to grow the dining credits portfolio and the merchant count and also to invest in our website platform. We launched a new website for our Rewards Network Cashback members in early 2008. This new website is already available for a few of our partners and we plan to continue to roll out our new website to partners throughout this year. You can see the new website for yourself by visiting www.rewardsnetwork.com and we encourage you to do so.

In addition to a great new look, the website offers better presentation of information on our restaurants including menus, maps and driving directions and even more of the ratings and comments that we receive from members. By providing the information that members want when they consider their dining option our websites are used to reinforce the value of being a member and encourage our engagement in our programs. We believe our websites are a powerful tool to influence member dining decisions to the benefit of our members and our restaurants.

One sign of member engagement is the surveys that some of our members complete after they dine at our restaurants. We’ve recently reached a significant milestone when we received survey number 1 million. Restaurants know that they must listen to our customers to improve their business. The ratings and comments that we gather from members through surveys add great value by providing restaurants with information they really can’t get anywhere else. Restaurants want this feedback and so do members.

Many consumers want to read reviews from other diners when they are deciding where to dine. Our member ratings and comments are particularly useful because they come from members who have actually dined at our restaurants. Another powerful way to influence member engagement is with the benefits we provide members for dining at our restaurants. During 2007 we worked on restructuring member benefits. We launched these changes for most partners at the beginning of 2008. The restructuring is designed to provide incentives to members to become more engaged in our programs. In addition to reducing expenses associated with member benefits and doing a better job of linking benefits to member engagement these changes offer our most engaged members added incentives for completing surveys and provide a framework to boost engagement with all members.

On the sales side of our business we are pleased with the productivity of our sales force during 2007. Our productive sales force drove our growth in restaurants in the dining credits portfolio. In addition, we have pursued new opportunities to work with large multi-unit restaurants. For example we recently entered into a large deal with about 200 corporate owned Baja Fresh and La Salsa restaurants. This partnership has strengthened our offerings in the fast casual segment of the restaurant market and continues to demonstrate that we can provide valuable services to multi-unit operators.

Overall the restaurant market is receptive to the marketing, access to capital, business intelligence, member feedback and frequent dining programs provided by our products. While we are pleased with our progress we are not satisfied with simply relying on our current products and we continue to look for ways to make our programs more attractive to members and merchants.

During 2008 we intend to explore changes to our marketing services product line to spur both revenue and merchant growth. Also during 2008 we intend to address the majority of our convertible debt issue or the maturity of our convertible debt issue by assessing and revising our capital structure based on our needs and the constraints of the credit markets. We intend to continue to grow the dining credits portfolio in accordance with our risk assessment policies and we plan to continue to invest in technology that more effectively markets are merchants to our member base in order to increase member engagement and activity in our programs.

We thank you for your time this morning and we will now take questions.

Question-and-Answer Session

Operator

Our first question comes from Bob Renck from R.L. Renck & Company. Please go ahead.

Bob Renck - R.L. Renck & Company

Yes. Good morning Ron.

Ron Blake

Good morning Bob.

Bob Renck - R.L. Renck & Company

I have got a couple of questions. I guess my memory is getting vague but it’s been a couple of years since you’ve been CEO and I think one of the questions that I asked you at the time in our first discussion was, if we were sitting here at three to five years from now how would you like to be measured? What would you deem to be successful? I am not going to come back and play roistered with you and give you what you said, but sitting where we are today in March 2008, if we are sitting here two years from now, how would you define success for you as the CEO of Rewards?

Ron Blake

Well, I think we have all set out to do one thing which is to have sustainable, predictable earnings growth and over the last two and a half, three years, I think we have resided all of the changes that we put in place that we think sets a good foundation to produce that as we go forward and I think that’s the one thing that, the businesses had challenges with over the last several years and I think that’s the measure of success that we are looking for.

Bob Renck - R.L. Renck & Company

Can you kind of put it in terms of let’s say return on invested capital or --?

Ron Blake

Well, as you know Bob we all make earnings forecast but obviously the result to date haven’t been at the cost of capital and we certainly need to see those returns improve.

Bob Renck - R.L. Renck & Company

Okay and a question for Chris. I think you’ve alluded to or discussed the fact that you got these -- you got about $55 million or they are about Sikoko is coming due in October. Can you -- and I realize that this was not something that at least Chris was involved with and I am not even sure that you were involved with at the time when that deal was done, but can you -- you have talked about potential changes in capital structure, can you give us a range of options?

Christopher Locke

Hey Bob, it’s Chris.

Bob Renck - R.L. Renck & Company

Yeah.

Christopher Locke

Well can’t -- I don’t think I can run through everything that we are looking at but obviously the maturity of these converts is probably with the largest issue facing the Company. On the face of our balance sheet we have the liquidity to be able to retire them although that wouldn’t be a lot of operating capital for us.

Bob Renck - R.L. Renck & Company

Right.

Christopher Locke

It’s a project that we are very obviously very aware of and have been working on for some time and working through a range of options in the capital markets to address this.

Bob Renck - R.L. Renck & Company

Well, would that include sale of stock.

Christopher Locke

We are evaluating it above all the options that are available to us. So, I can’t get much more specific than that.

Bob Renck - R.L. Renck & Company

Okay.

Ron Blake

Bob, you are right. The convertibles sold a couple of years before this management team was put in place.

Bob Renck - R.L. Renck & Company

Right.

Ron Blake

And I think it was originally five years to the first part which is in October of 2008.

Bob Renck - R.L. Renck & Company

Right and at the time I reflected to your CFO is the stupidest idea I’d ever heard of considering the fact that you had an ability to finance, so I’m just not sure. I think the risks outweighed the rewards. Is there any chance of going back to a secured credit line the way you had with Brown Brothers Harriman in chase before?

Ron Blake

Bob we really are looking at all the options and right now its premature to give any specifics. If that’s a possibility probably but there are a lot of other options on the table that we want to get through first.

Bob Renck - R.L. Renck & Company

Okay. Alright thank you.

Ron Blake

Thanks Bob.

Christopher Locke

Thanks Bob.

Operator

And there are no further questions at this time.

Ron Blake

Well we thank everybody for taking time today and we look forward to talking with you about first quarter results.

Operator

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

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