Bread Financial Holdings, Inc. (BFH) Q3 2018 Earnings Report, Transcript and Summary

Good morning, and welcome to the Alliance Data Third Quarter 2018 Earnings Conference Call. At this time all parties have been placed on a listen-only mode. Following today’s presentation, the floor will be opened for your questions. [Operator Instructions] In order to view the company’s presentation on their website, please remember to turn off your pop-up blocker on your computer. It is now my pleasure to introduce your host, Ms. Vikki Nakhla of Advisory Partners. Madam the floor is yours.

Thank you, operator. By now, you should have received a copy of the company’s third quarter 2018 earnings release. If you haven’t, please call Advisory Partners at (212) 750-5800. On the call today, we have Ed Heffernan, President and Chief Executive Officer of Alliance Data; and Charles Horn, Chief Financial Officer of Alliance Data. Before we begin, I would like to remind you that some of the comments made on today’s call and some of the responses to your questions may contain forward-looking statements. These statements are subject to the risks and the uncertainties described in the company’s earnings release and other filings with the SEC. Alliance Data has no obligation to update the information presented on the call. Also on today’s call, our speakers will reference certain non-GAAP financial measures, which we believe will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at alliancedata.com. With that, I would like to turn the call over to Ed Heffernan. Ed?

Thanks, Vikki. With me today as always is Charles Horn, our CFO. He’ll update you on the third quarter results and then I will update everyone on our 2018 outlook, talk a little bit about some of the things we have going on and initial thoughts about 2019. We’ll try to get through this and have plenty of time for Q&A. So, Charles?

Thanks, Ed. Pro-forma revenue increased 5% to $2 billion for the third quarter of 2018, led by strong performances at LoyaltyOne and Card Services. EPS increased 28% to $5.39 for the third quarter of 2018, while core EPS increased 17% to $6.26, both aided by lower effective tax rate. That flips in the fourth quarter as we expect a 24% core effective tax rate compared to 14% in the fourth quarter of 2017. Turning to capital deployment, we spent approximately $103 million in share repurchases during the third quarter while dropping our corporate leverage ratio to 2.4x compared to our covenant of 3.5x. Year-to-date we have repurchased slightly over 1 million shares or about 2% of outstanding shares. Cash flow will continue to be used – continue to support share repurchases in our quarterly dividend but will also be used to reduce our corporate leverage ratio to 2.2x or lower by year end. Let’s turn to a recent hot topic which is CECL, the new accounting standard impacting loan loss reserving. The new accounting standard uses the life of the loan methodology to determine expected credit losses. The life of the loan approach is widely viewed as replacing the loss emergence period creating the potential for estimates to cover a longer loss horizon. We are in the early stages for implementation of the standard but the preliminary thought is at that the life of the credit card loan will be less than 12 months of coverage we currently reserve. Key in the determination of the allowance is the ability to provide reasonable and supportable forecast over the life of the loan. Again because we expect the life of credit card loan to be reasonably short, we believe our current forecasting process would cover that period as opposed to those with mortgage or auto loans, which have significantly longer life. In summary, we do not expect the new accounting standard to have any impact to our months coverage. Let’s go to next page and talk about the segments. Starting with LoyaltyOne pro forma revenue increased 8% to $329 million. Breaking down the quarter, AIR MILES’ pro forma revenue decreased 6% from the third quarter of 2017 primarily due to a lower burn rate, that’s the number of miles redeemed and a weaker Canadian dollar. AIR MILES issued increased 3% compared to the third quarter of 2017, benefiting from increased promotional activity by the Bank of Montreal. BrandLoyalty’s revenue increased 29% from the third quarter of 2017 and we expect continued strong growth in the fourth quarter. Turning to Epsilon, revenue decreased 4% to $538 million. Similar to the first half of 2018, combined revenue for our agency and side-based offerings were down double-digits. However, through strong expense management and the favorable shift in revenue mix, we maintained the same level of adjusted EBITDA as of third quarter 2017. Lastly, Card Services revenue increased 10% to $1.16 billion, consistent with the growth in average card receivables, while adjusted EBITDA net increased 4% to $414.3 million. Net loss rates improved sequentially by 50 basis points as the recovery rate improved from high single digits in the first quarter to slightly over 18% in the third quarter. The third quarter reserve rate decreased slightly to 6.5% due to expectations of further improvements in the net principal loss rate in the fourth quarter. The delinquency rate remains slightly elevated primarily due to a slowing growth rate in card receivables, essentially what we call growth map. With that I will turn it over to Ed.

Okay, let’s move to Slide 6, LoyaltyOne, we’ll start with Q3. As Charles walked you through, we had a good quarter in terms of growth in both pro forma revenue and adjusted EBITDA for the second consecutive quarter. The key metrics here in AIR MILES program is the miles issued as you could see from the chart. Ever since we have got the unfavorable ruling out of parliament back in 2016, it’s been a tough road back and we have been making good progress and turn the corner as we moved into the second quarter, and it’s since continued into Q3 and we expect that in Q4. So that’s a good indicator of not only the health of the program but the way the accounting is done with the deferral of the revenue, it means that we’re getting decent visibility on a go forward basis. Our BrandLoyalty, which stumbled last year came back strongly by Q2 of this year, experienced double-digit growth in both revenue and adjusted EBITDA for the second consecutive quarter, so we feel that, that program is back on track. So the outlook for the remainder of the year is solid, pro forma revenue and adjusted EBITDA to finish the year and we expect continued positive growth in AIR MILES issued. Turning to Epsilon, Q3 revenue was down 4% compared to down 5% in the first half. It’s still soft, and it’s still below expectations. We do have a number of businesses, so we have a mix of businesses that are growing, mixes of businesses that are stable and some product offerings that are declining. The biggest areas of challenge right now are the agency and site-based display, the old ValueClick platforms, and we had a number of client bankruptcies that during the year. The outlook we expect to be soft, down 3% to 5% for the year. We do however note that a lot of that is in the lower margin areas and strong expense control keeps adjusted EBITDA approximately flat with last year that means our EBITDA margin, we expect to expand by about 100 basis points this year. Okay, Card Services, Q3, probably the biggest item in Q3 was the fact that the new signings continue to be exceptionally strong at the same time we are aggressively implementing our strategy to diversify away from, what really has been the backbone of cards for 20 years, which is the mall-based specialty apparel sector and you will notice that the Bon-Ton portfolio, which is one of our largest clients and went into liquidation. We have moved that out of our portfolio and into held-for-sale for the eventual migration off to a third party as it winds down. Getting back to the new signings, what you’ll find is that as part of our ongoing process to find the verticals where the growth opportunities are greatest, you’ll find that we continue, as we started in 2015 to find verticals where the demand for our product is quite strong. And so the signings of IKEA in home decor, Wyndham and hospitality; Academy Sports, Floor & Decor, then we have some essentially pure e-com plays. Again, very much outside of what our traditional new signings would have been years ago. But again this continues the process of really reacting to where the consumer is going today. And fortunately we’re finding that the retailers in those spaces are quite interested in the product itself. Probably the biggest thing for this year is the fact that over the years, we’ve talked about signing $0.5 billion vintage, then $1 billion, then it was $2 billion for a number of years. This year is going to be the first year where we are looking at close to a $4 billion vintage signing. What does that mean? It essentially means signing clients who will, over a period of 2.5 to three years spool up and add as much as $4 billion of receivables to the portfolio. So it’s a massive year in terms of these signings. We have announced roughly $2 billion, and we have signed but not yet announced an additional $2 billion. So you’ll see them either announced at the very end or towards probably December or either first quarter of next year. But in total, a very, very large signing year, which makes this pivot that we’re talking about happen that much faster. Also of note is 100% of this has been what we call away from our traditional mall-based specialty apparel. So again, the portfolio is flipping very, very quickly. If you were to look at our active client base, credit sales were double digit; receivable gross, 17%, but highlighting the fact that the one area that is a drag on cards is the fact that there were a number of discontinued programs, whether it’s liquidation or bankruptcies. And those tend to reduce – those will reduce reported sales and receivables. And so you sort of have a tale of two worlds. You have the up and coming newer verticals or verticals that traditionally weren’t the mall-based specialty apparel that are doing quite well, and they’re becoming an increasingly larger part of our portfolio. Okay. Credit quality continues to improve. As Charles mentioned, from a guidance perspective, we sort of started the year and set the high six-s for the first quarter, then mid six-s and high five-s, then mid five-s and we’ve been dead-on as Q1 come in at 6.7 and 6.4, and Q3 came in at 5.9, we’re right on track for mid-five-s for Q4. What’s behind is what gives us comfort that we can get there? It really is, is nothing more than we’re seeing stability on the growth side, but the other driver that we’ve been waiting for has been on the recovery side. When you’re recovering almost 20% of your losses, that’s an important piece, and as a lot of you know, we went to a number of quarters where we moved that whole process from third parties to in-house. And that caused sufficient noise and turmoil in the numbers where the recovery rate had to dip down really in the single digits. Third quarter was the first quarter in quite some time where it actually was slightly above prior year and fourth quarter looks to be very strong. So it was an investment that we made, a decision that we made, caused some pain earlier, but it is working out right now. So if you were to sum up where we are in Card Services, you sort of have one negative and three positives. The one negative is, again, more of a macro issue of our traditional verticals, mall-based specialty apparel. Certainly, are stressed and that caused some dampening and a drag on growth. Against that, we’ve got actually four positives, very solid financial performance; second, the strongest year of wins ever and a very strong robust pipeline; third, the wins are in stronger verticals; and fourth, credit quality continues to improve as recovery – that process is complete. Turning to the receivables growth for Q3, we had reported growth of 10%. Again, that’s sort of masks what really is going on, which is the active client growth of 17%. And again, as we pivot towards the healthier verticals, what we see here and I think the big message is that the clients that we’ve signed since 2015, so the newer vintages, are already 25% of the portfolio, up from 14% of the portfolio last year. And in fact, they’re growing 19% year-over-year. And that’s the area we’re going to be really focused on. Now against that, you’ve got these discontinued programs, which primarily would be the bankruptcy of Gander Mountain and a partial quarter of Bon-Ton. And so overall, the pivot and what we’re trying to do seems to be picking up speed. Same deal on credit sales. Again, some of folks were concerned about, "Oh my gosh. We’re not seeing much credit sales growth." A lot of that is nothing more than when you go into bankruptcy and liquidation, you don’t have credit sales. So the active clients again were up double digit. And again, the newer vintages are representing about a quarter of our credit sales and are growing quite rapidly. Alright, let’s go to outlook. It will be Slide 11. Active client receivables growth, we expect to continue in the mid-teens. Nonstrategic clients, now what does that all mean? Nonstrategic clients is nothing more than saying, those clients that are in liquidation, that have gone bankrupt or in decline due to M&A. In other words, if you are on the other side of M&A, you’re acquired, you don’t tend to have that type of growth that you had in the past. They will be aggressively removed from the portfolio. And what this essentially means is reported growth will slow and then recover as we move throughout 2019, while at the same time active client growth remains very strong throughout. This frees up capital and makes room for a record new vintage. And frankly, we can’t really help the clients at this point who are in liquidation and bankruptcy. Our model, which drives loyalty and incremental sales, really isn’t effective if the client is bankrupt, liquidating or sold off. So strategically I don’t think we’re doing a disservice to ourselves or to client. And also rather than having a slow bleed over the next two years, we’re moving these files aggressively out of our active programs. We’ve got over half done so far, and we’ll get the final piece done in Q4. So this is not something that’s going to linger around. This is a very, very big piece of our strategic focus. New signings we talked about are on track for $4 billion vintage. And then we talked about the 15 to 18 signings already a quarter of the portfolio. We want them to be at 50% in two years. So there’s a lot of numbers floating around. What does it really mean? If you look at the signings over the past several years, and you look at our portfolio today, the portfolio today only reflects about $4.5 billion of the spool up of these vintages. When these vintages are fully spooled up over the next couple of years, they will be a total of $11 billion. So we’re not even halfway there in terms of what the existing signed clients will spool up to be, which gives us a lot of confidence in what we’re doing today. Credit quality, I think we’ve beaten that one forever, but we are at our long term annual growth rate of right around that 6%. I know it’s been a bumpy ride getting there, but the loss rate in Q1 was high 6s and in Q4, we’re coming right in, in the mid-5s. And if you think about it, all the noise and delinquencies and everything else aside. It really the differences in entirely to do with the recovery rates. The recovery rates were 50 points headwind in Q1, they’re going to be a 65 basis point tailwind in the end of the year. And so the entire difference between Q1 and Q4 was all due to the ramp up in recovery rates. And since we’re fully ramped up, that means that we have a very strong view towards where we believe things will be as we go into next year. All right, turning to Slide 12, we added sort of what is our long-term trend, where do we like to be? Loss rates for 2017 and 2018 are right around that 6% level and as much chatter as there is out there. You’ll see the pre-Great Recession, we’re right around that 6%. And right now, we’re back to where we were pre-Great Recession. So this is where we like to run the portfolio in that we think provides us with a very strong return and, at the same time, provides our clients with a good tender share flowing through the cards. If we turn to the next slide, which is the average card receivables and the track record. Over the past seven years, you will see that the portfolio has grown, on average, 20% a year for the past seven years. And to put that in perspective, if you were to look at the most common proxy used out there, that would be the revolving debt numbers. Revolving debt has moved from about $840 billion to a bit north of $1 trillion. That’s about a 3% growth rate over the last seven years. So clearly, we’re growing quite a bit faster than the industry. But at the same time, our return on equity continues to be well above industry levels at 30%-plus. So it’s a faster growing model and a more profitable model, and that’s what we expect out of cards going forward as well. All right. Let’s take a breather, we move to Slide 17 and talk about strategic objectives. There are four primary objectives that we have either executed or in the process of executing or will execute. And this is sort of flow into next year as well. The biggest one was to move the recovery process in-house. Again, it was done during a time of rising overall loss rates as credit normalized, so it really – you couldn’t have had a worse time to have to do it. But I’m glad we did and got it behind us. And it allowed us to move from a headwind in Q1 to a tailwind in the second half and well into 2019. If you look at – so we’re going to give that a green check. If you look at the next thing, we talked about aggressively pruning the portfolio of non-strategic clients. Again, those are clients that are going to be in liquidation, bankruptcy or on the other side of M&A. And to be sure, we are fully supporting the remaining core clients. And support will be including all of everything that we’ve done in the past, everything on the account acquisition side. We’re building new tools that are pretty exciting in terms of things like in-store acquisition away from the point of sale, so like iPads. EC. You’re just going to swipe your license. We’re going to be focusing on payment and security. But we’re primarily known for engagement and rewards, and having realtime capabilities and the always-on, one-button approach is really what we’re all about. Again, we’re driving insight, loyalty and customer experience, which, in the end, lift and drive sales of loyalty for our clients, and that’s not going to change. In addition to aggressively moving out those clients that have been considered nonstrategic, we are pivoting the portfolio towards strong high growth verticals. And as I mentioned before, less than half of what we have already signed is reflected in the portfolio today. The pipeline looks as healthy today as it did two, three years ago. And we expect to maintain a model and improve visibility. The model for cards, long term, continues to be mid-teens receivable growth, a targeted loss rate approximately 6% in that range and, most importantly, as you move different levers of OpEx and losses and revenue and all that other stuff, is we want to make sure we grow, but we grow with a return on equity target of greater than 30%. That’s the model, and that’s what we expect to execute on. All right. 2018 overall company guidance revenue, obviously, with some weakness in Epsilon and with the pruning that we’re doing in cards. That is going to put pressure on our top line. And so we’re going to be moving top line to a little under $8 billion and pro forma at about $8.2 billion. And we that that will not influence our EBITDA. And as a result, we see no issue with maintaining our overall guidance that we gave a year ago of $22.50 to $23 a share or roughly between 16% and 19%. Just to put it in perspective, year-to-date, we’re up 20%. So with three months to go, I think we feel pretty good about being nicely in that range. All right. Two-part strategic effort. This is what we’ve been working on over the last year or so, and let’s unveil as much as we can at this point. So it has two pieces. The first piece relates to the card group. And the second piece relates to the non-card group. In the card group, we will be, again, aggressively continuing our effort to reposition the portfolio into the strongest, highest growth verticals. This is not something that’s new. We started this back in 2015. And again, the receivables in our portfolio, only about $4.5 of the $11 billion signed are reflected in the portfolio today. So we’ve got quite a bit more that we know is coming onboard. The pipeline for new business remains exceptionally strong. So while you have sort of across current of mall-based specialty apparel feeling stressed as people are moving to a different way of shopping in different verticals. On the other side, you are seeing new verticals that frankly we’re never really interested in our product, basically all saying the same thing, which is tell me about my customer. I’ve got to know more about my customer and that gets down to the ability to extract at skew level information and use it for insight at marketing. So if I were to put a net against it, I would say the net macro flow into the new verticals is outweighing the stress that we’re seeing on the mall-based specialty apparel. So we will expect to continue to see very large vintages being signed and as a result we feel comfortable taking the position of reaping the mandate off, so to speak and aggressively prune those clients in liquidation, bankruptcy or in the other side of M&A. we’ve done about 50% so far, we’ll take care of the rest in the fourth quarter, it will eliminate the drag over the next couple years, give us a nice clean start, freeze up some regulatory capital. And I think one of the big things that gave us increasing comfort in doing this now as oppose to later or observing this drain over the next two years, as the team has done a super job of making sure that we are now at the point of saying, we have no renewal risk in 2019, which is a very big plus going into the New Year. All right, high level objectives, card receivables, we would expect to exit 2019 north of $20 billion. We would expect to exit 2020 north of $24 billion. Those are our guidepost for the next couple of years. How do we get there? Well, it’s actually pretty simple, we just simply added the remaining piece of those signed in 2015 to 2018 that are not in the portfolio today. Recall about $4.5 billion is in the portfolio today. However, the way they’re spooling up with 90% growth, they’re going to get from $4.5 billion to about $11 billion. You simply add that additional $6 billion, and there you have it. So what we’ve done is we’ve taken that as sort of a very conservative tack, and we basically said that, that means that any new clients sign in 2019 and 2020 merely offset unknown future client attrition. We have no idea whether there’ll be any or whether there’ll be some, but this seems to be a fairly conservative way of taking care of it. So I think these are good numbers, that’s what where our plan is driving towards. Credit quality, 2017, 2018 we know we’re going to be right around that 6% loss rate, which is our long-term target. We have a similar target going forward, assuming there’s no major macro shock out there. And again, while so many people focus on it, the rate is important, but our focus is on return on equity. And our ROE target remains greater than 30%. So in summary, stronger client base, high growth and high profitability. All right. Let’s get into strategic efforts in the non-card space. We have taken a good year or so to get to this point. And let me just go through it. We believe that the current stock price does not reflect the intrinsic value of our business, period. We are evaluating which assets could thrive under a different steward, while also unlocking the value for stockholders. We will have a crystallized game plan of what and how before year-end and communicate this path at this time. Overall, it should be noted, this will be an aggressive and significant effort. In 2019 – for 2019, more specific guidance will be provided on the fourth quarter earnings call, obviously due to the upcoming major non-card strategic announcements. You should have a pretty good idea on cards, where we we’re heading; but non-cards, we’re going to wait until we make the announcement. We believe that executing on both parts of our strategic plan will result in a much more focused and unique model, a model that can sustain strong double-digit growth, a model generating significant and growing cash flow and a configuration that unlocks significant value for investors. So I do want to make sure that I’m crystal clear on this thing. Regarding our upcoming announcement for non-cards, make no mistake. We will be moving very aggressively on this and that it will be significant in size. This is not going to be minor surgery. Our board and management are in full agreement as to the needed actions. And frankly, we like what we’re seeing from a market demand perspective. Our board review and debate phase, which took all of a year, is now over. There is no more debate, so you can expect a detailed announcement comfortably before year-end. We just need a few weeks more to dot the Is and cross the Ts. Between this and card’s aggressive approach, we expect to have a very nice model as we move forward, while at the same time unlocking significant value for shareholders and creating the new Alliance for the next decade. With that, I’ll stop and take questions.

[Operator Instructions] And your first question comes from Sanjay Sakhrani of KBW.

Thanks. Good morning. Maybe first on this strategic repositioning or realignment. Ed, just to be clear, by the end of the year, we’ll get details on how you move forward versus a specific sale? I guess, what I’m asking is, are you shopping the businesses now? And also secondly, as far as the card businesses are concerned, is the sale of those – of that business being contemplated as well?

On the card side, we’re looking – the big focus on the card side will be on, if you want to call it moving out the sale, moving to held-for-sale just as accounts that are liquidation, bankrupt or on the receiving side of M&A. So you should think of that more as pruning and cleaning up the files that are just going to be a drag for the next couple of years. And look, regarding the non-cards side of it, again, the decisions have been made. We are in the process of getting all the information where it needs to be. And so the announcement that you’re going to see shortly will just be clear in terms, of which assets we’re talking about. And we would expect that we would move very quickly on that.

Okay. And then as far as the pruning is concerned in the Card Services business, maybe Charles, can you just talk about what kind of core or what’s going to be removed further in the fourth quarter as far as size? I think my math gets me to a little under $1 billion that would be moved aside. And I guess, then, how comfortable are you guys that going forward, the core portfolio, what’s left is not going to experience any additional bumps or hits, again.

Sure. So you could see in the third quarter, we added to the held-for-sale were about $1.7 billion at this point. The biggest piece was Bon-Ton, which was one of our biggest – I think, it was our second biggest program went into Chapter 7 bankruptcy. In the fourth quarter, I think there’ll be another one or two that we’ll look to add based upon the various criteria that Ed gave you before. I don’t know if it’s going to be as much as $1 billion, but it could be. And I think it will position us quite well. As Ed talked about, the renewal risk for 2019 is done. I think we’ll be in very good shape after the one or two additional programs in the fourth quarter that we evaluate, and we look to divest.

And I think that as we said, the view towards where we want to exit next year, that’s all based on what we’ve already signed. So there’s no spec in there. There’s no renewal risk in there. And what we’re basically saying is if there’s another client that comes along that goes into bankruptcy or liquidation, we’re just counting on offsetting that with anything new that we signed over the next two years. So I think it’s a fairly conservative plan.

And just one final one, sorry, just on the charge-off rate for next year. I know ROE is important and there’s a lot of noise in the rate if you’re divesting or moving aside portfolios. But you’re expecting 6% for next year despite the denominator pressure?

We expect to be around the 6% level, approximately 6% level this year and approximately 6% last year. So yes, six, plus or minus. We do believe that, that’s where we’re heading. And a lot of that, Sanjay, is nothing – is we think nothing more than if there is some pressure coming from the growth map, which you’re going to see is that’s going to be nicely offset through much of the year with nothing more than the anniversary of the higher recovery rates.

All right. Great. Thank you.

Your next question comes from Darrin Peller of Wolfe Research.

All right guys. Thank you. So I mean it sounds like you’re going to be freeing up a pretty decent amount of capital from moving those non-core loans more aggressively, and I just want to understand, I mean, would that be applied to just other receivables growth in some of the better areas you’re talking about? Or would it be should we consider some for debt pay down? And then so when you think of the $4 billion, which is obviously a much bigger number than we expected of loans signed this year or the vintages, just what’s the underlying growth in credit to that? I guess, are there portfolio acquisitions included in that, that we haven’t seen announced yet?

I have not seen any portfolio acquisitions announced in that $4 billion. And in fact, there aren’t any. There are obviously a handful of files that are out there that we’ll take closer look on – look at. Clearly, freeing up additional capital from troubled clients and pouring it into potentially a portfolio acquisition would make all the sense in the world. The guidance that we’ve given you on the norms, however, do not contemplate any portfolio acquisitions.

Okay. All right. Thanks. And then when you think of the Epsilon businesses, I know you mentioned a decline in the agency side, which we have been seeing. How was the growth of the other non-agency side of the business overall?

I’ll put it this way. The biggest growth drivers for the Epsilon business has been in the auto vertical as well as the Conversant CRM. They’re still growing. They haven’t grown in quite the same pace as last year and part goes to what Ed talked about, which is the various class going into bankruptcy. We had some big clients within Conversant CRM to file bankruptcy, this put a little bit of a drag. We continue to onboard new programs quite aggressively in CRM, they’re going to be very good. But CRM works a little bit like credit card vintage. A new client in year one is going to be much smaller than a client who spent four, five years. So really with the Conversant side of it, we’ve been playing through the bankruptcies with auto, it’s really coming down to went to a big clients run the programs that they’re doing well, they run fewer programs and so it’s a little bit of a timing issue to get there. But overall, the two growth drivers are still in place, technology is very stable. We came into the year looking for stable growth within the technology business, and that’s what we’re seeing. The two big drags that been, again continue to be agency and obviously the old ValueClick, which is the site-based, not the CRM where we directly target to. Those have been drags, but are getting to a point where they’re much smaller and I think at some point, the drag will abate.

Okay. All right guys. Thanks very much.

Your next question comes from Andrew Jeffrey of SunTrust.

Hi good morning guys. Thanks for taking the question. I understand and appreciate, Ed, that the strategic repositioning is a work in progress. I just wonder from a high level conceptual standpoint, is Alliance Data sort of for the next decade going to be best thought of as a pure play technology-enabled Private Label services business? I mean, from a high level, can we start to think about the company looking like that?

I would probably broaden it a little bit more to say more of a payment solutions, Andrew only because I’m not sure the card moniker is something that is going to be relevant three, four years from now. It will be considered sort of yesterday’s news. But effectively, you’re essentially, everyone will have, if you want to call it virtual cards on their phone and different payment options and multichannel marketing and all that other stuff. So at the end of the day, I think it’s fair to say that Alliance Data 2.0 will be a combo of both the financial services that we provide today as well as the technology behind those programs, which allows us to understand the customer better than anyone else out there to the use of data and use that information to drive incremental activity at that client, whether it’s on the card or separate from the card. And so yes. I mean, I would say at a very high level, it’s sort of a combo platter of financial and technology that are going to be wrapped together and entwined.

Okay. And with regard to these in new clients you’re signing, can you talk a little bit about the demographics? It sounds like perhaps you think the ultimate cardholder or virtual cardholder as maybe is perhaps a better customer than the traditional mall-based retail customer? And does that imply the potential for faster or higher than GDP sustained same-store sales growth?

Yes. It’s a great question. The cardholder itself isn’t changing, right? It’s really the retailer itself. So in the “old days of all of five or six years ago”, you had same- store sales growth at the core retailers growing 3%, 4% a year. We pick up tender share, and that gives us the first seven points, six, seven points of growth in the portfolio. Today, you’re not seeing any growth. In fact, you may be seeing negative growth at the retailer. So as a result, you don’t have that sort of existing growth driver that you used to have. So it’s not really the cardholder, it’s more of the client. So as we shift into areas where the clients themselves are growing quite dramatically, then we’re going to pick up more and more cardholders as the client grow. So it really is more of the health of the client and how the client is doing because that will allow us to – we will typically get 30%, 35%, 40% sometimes of all sales flowing through our cards. And if you can get that with a client that’s growing, obviously, that rising tide lifts all ships, right?

Great. Thank you.

Yep.

Your next question comes from Bob Napoli of William Blair.

Thank you and good morning. I guess, Ed, I mean it sounds like you’re strongly leaning towards selling both the Epsilon and the loyalty businesses. And if that were to be the case if you sold either one of those two, I would assume you’re going to channel that capital back into a substantial share buyback, or what is the thought on the segments and the capital from the distribution?

Yes. As I mentioned obviously, we’re not at the point right now, where we’re going to specifically identify, which of the assets other than saying it’s going to be significant, and it’s going to be within non-cards. Obviously, we see what’s going on outside in the marketplace. We think there is a huge opportunity to unlock some value here. We’ll have the announcement come out in the next several weeks. We expect to move quickly. And yes, we would expect to have a considerable amount of capital or cash flow available to us, assuming everything goes well, and we take care of these things. There are going to be some big numbers. And they would come in, and we would have a – there’s a few things you can do with it just like the free cash flow coming off the business. You can reduce debt, you can do buybacks, you can do special dividends, you could do acquisitions. You should assume that we will fall into one if not more of those buckets.

Thank you. And then Charles, on CECL, what are your plans? What is the – what is Alliance Data’s accounting strategy going to be on CECL? How is that going to affect the reported numbers?

Like what we talked about Bob, earlier, we really don’t think it’s going to have much of an impact on us. We currently reserve at about 12 months’ forward coverage. If you look at the life of our balances, it seems to run six, seven months. So, we don’t see anything that would put up a pressure in terms of how we currently reserve. So, 12 months feels pretty reasonable, I could actually present a scenario, where it could go a little bit lower. but I think right now, we sit here and say we feel very comfortable. We will not have to increase our months’ coverage going forward.

All right. And last question, just on – to be clear, on the end of 2019, $20 billion of receivables, does that compare to the balance sheet receivables of $17.4 billion, the reported balance sheet receivables excluding the held-for-sale, and that’s an end of period number?

It would be an end of period number. So, whatever number we exit the year at, that would be excluding anything sold or held-for-sale. So the – what we would call our active file.

And that’s what we would see on the balance sheet, is that the same comparable number? Because there’s a number of different receivables that you report monthly versus the balance sheet and includes some other things.

I would be – it would be an end of period 2019 balance sheet number compared to your end of period 2018 balance sheet number.

Great. Thank you.

Your next question comes from David Togut of Evercore ISI.

Thanks. Good morning. As you moved towards the strategic alignment, and become more of a payment solutions company. Do you anticipate being able to use your data and analytics capability to move well beyond Private Label and co-brand, let’s say, to more traditional Visa and MasterCard issuers help them with, let’s say marketing to their customer base? Is there a broader flexibility of your analytics, in other words?

Yes. It’s a great question, David. I think for sure, obviously, the big engine that’s going to continue to drive the bus will be Private Label. But to the extent, there are co-brand programs out there, we can clearly use the similar type of technology to certainly help any type of on-us transactions. If the co-brand issued by a certain retailer, obviously, any transaction, that retailer would be part of sort of the family that we’ve talked about in terms of SKU-level information. A little less so once they do their shopping outside of the co-brand, but there’s a lot of interesting things we can do with that data as well in terms of understanding the lifestyle and tendencies of those customers. So, we would not limit ourselves to just the Private Label space. We wouldn’t limit ourselves just to general purpose cards, although from – right now, from a financial perspective, where we’re steering clear of most of the co-brands, because of the competitive pressures in the marketplace. But we would like to be viewed as a larger payment options provider than just Private Label.

Understood. Then as a quick follow-up on the credit side, you expect hurricane Michael to be a significant credit event, the way the hurricanes last fall were to your book of business.

Yes. At this point, it’s a little bit too early to tell. but we don’t expect it to be nearly the size of last time, that’s why we’re sticking with our loss guidance. Again, we’ve done, frankly, a pretty poor job of communicating delinquency flows in and out of the bucket. So, there may be some noise in there. But from a loss perspective, we feel good about the guidance that we’ve provided.

Understood. Thank you very much.

Thanks.

Your next question comes from Jason Deleeuw of Piper Jaffray.

Good morning. Thanks for taking the question. Just last quarter, there was a talk about the in-house capabilities that have been built up in Card Services and the data and the marketing side. Is Card Services now at a point, where it can kind of stand on its loan – on its own with those capabilities or with these strategic changes that will be coming, I mean, is there going to have to be, I guess, depends on what happens. But I guess, I’m just trying to figure out; does Card Services have enough of the capability on its own or will it need outside help still?

Yes. Now, it’s a good question. We’ve looked at obviously, a lot of this stuff. Fortunately, several years ago, because the retail vertical is so large for us, you’ve heard me talk about building up this mini-Epsilon within cards or sort of 500 of data scientists and analytics and marketing specialists. So from a perspective of what’s already in place within cards, that’s already there. From a technology perspective, regardless of where we wind up on this realignment, we will continue to have the various cousins involved in the card business. So for example, providing the technology that drives the loyalty platforms of all of our businesses, whether those assets are within the mothership or sort of outside as a cousin, it’s a pretty straightforward deal, but we will absolutely need to rely on the cousins, for example, the loyalty platform, for example, on the Conversant side, we think that’s going to be a critical new account acquisition tool for us to go out there in the marketplace and source new growth for our customers. So, there will be a number of technology items that will continue to go back and forth between the different divisions, whether some of those assets are within the company or some are out, it’s pretty straightforward in terms of what the services are.

Thanks for that. And then there has been a lot of pivoting and strategic change already across the three businesses and some of the businesses are much further along and been more successful than that than some of the others or at least areas of the others. I guess, why is now the right time to do the strategic change and maybe unlock value by separating some of the pieces of the business? Why is now the right time? Why not wait a little bit longer till some of these other businesses benefit from the changes you’ve already put in place?

Yes. I mean, it’s a fair question. It’s one of those, how long do you wait. And I think we’ve had these discussions with the board for well over a year now. So this started up north of the year ago, probably 1.5 years ago. And if I go back 20 years, there’s always a time when one of our engines, people are saying, this thing should be spun out or sold or done something with. And as we approach the end of this year, what we’re essentially seeing is that there seems to be huge demand out there in the marketplace for some of our assets. And frankly, we’re seeing that these assets are not really getting value as part of Alliance and that they’re overwhelmed by the sheer size of some of the other businesses. And so you put that, those two pieces together of outside demand is quite strong for these sort of scarce assets, along with we’re certainly not getting credit for it. So it just seems like an appropriate time to do something.

Great. Thank you very much.

Your next question comes from Tim Willi of Wells Fargo.

I just had a few questions, One is just sort of clarifying something around the credit loss expectation. I apologize if I missed this earlier. So for 2019, your guidance is essentially a loss rate of six that would essentially be what you’re expecting for 2018, correct?

Our guidance is around six so that I don’t get nailed on if it’s six-point something, something, something. So we’ll be in the ballpark and the ZIP Code, whatever you want to call it, the 6-ish range, in 2017, 2018, 2019, that’s sort of what we target. And whether it’s 6.25% or 5.9% or something like that, I can’t really say. But it will be close enough that it won’t change the numbers.

Okay, great. And then my follow-up, I guess, just sort of going to the company after all these events that you’re going to discuss, I guess, in the next month or two. When you look at Private Label, I guess, and payment solutions, I guess, I’m thinking about like the talent acquisition side, if there’s any way to think about, hey, we want to hire the best payment sort of dynamic space, bit challenging to get the people to the caliber that we want to move forward given where the equity has been and the noise around the company, and if you can really streamline this like you’re talking about, is there actually an HR aspect here, a talent aspect that you think also benefits the ongoing company?

Yes. It certainly doesn’t hurt. But I think we have thousands of people throughout the organization that are in, what we call, the hot skill areas. And we have not had any major issues recruiting folks from that area. Again, 98% of the company is outside of Silicon Valley, where you hear a lot of those pressures. And so hubs that we’ve developed over the years, whether it’s Chicago or Dallas or Boston, New York, Columbus, places like that, we have a pretty strong rapid and pretty strong presence in those areas. So I think that should put us in good stead from a talent acquisition perspective.

Okay, great. That’s all I have. Thanks very much.

And our final question comes from Larry Berlin of First Analysis.

Good morning guys. How are you today?

Doing great.

Someone have to ask that question, right? On the portfolio and so forth, no discussion on interest rates so far. What percentage of your borrowings are fixed versus floating? And then what assumptions are you making or consider that going forward for the interest rates in the U.S. these days?

Yes. You’d have to break it down between Card Services and at the corporate level. With Card Services, we tend to keep around 60% to 70% of the borrowings fixed, which should either be termed asset-backed securities and/or CDs, the variable would be on the conduits primarily or any money market demand accounts. That could change, Larry, as we move more to a consumer direct program out of our small bank in Utah. We could be doing more savings accounts and so forth that could influence it, but that’s kind of where we tend to stay. At the corporate level, we’re probably at about $2 billion of fixed-rate debt, the rest is variable. But I can think you just call me and we can sync up your models.

Yes, I would say overall, a gradual rising interest rate environment is not hugely beneficial, but slightly beneficial to us at this point.

Thank you, guys.

Okay. All right, thanks, everyone. We’ll be updating everyone later on the strategic realignment, and so stay tuned. Thank you.

This concludes today’s conference call. You may now disconnect.