Alliance Data Systems Corporation — Q3 2019 Form 10-Q
Entity note: The supplied filing is for Alliance Data Systems Corporation (NYSE: ADS), not Bread Financial Holdings, Inc. It covers the quarter and nine months ended September 30, 2019; financial statements are unaudited. Epsilon is presented as discontinued operations and was sold on July 1, 2019.
Business context and reporting period
After the Epsilon sale, the continuing business reported two segments: LoyaltyOne, including AIR MILES and BrandLoyalty, and Card Services, which provides private-label and co-brand credit card services. Q3 2018 comparisons include Epsilon in discontinued operations, so continuing-operations comparisons are not fully like-for-like with the former company structure.
Key financial metrics
| Metric | Q3 2019 | Q3 2018 | Nine months 2019 | Nine months 2018 |
|---|---|---|---|---|
| Total revenue | $1,437.6 million | $1,423.1 million | $4,120.3 million | $4,202.0 million |
| Operating income | $304.2 million | $479.8 million | $998.4 million | $1,248.7 million |
| Continuing-operations income | $121.6 million | $288.7 million | $442.2 million | $692.4 million |
| Net income (loss), including discontinued operations | $(107.6) million | $296.5 million | $180.5 million | $678.2 million |
| Adjusted EBITDA, net (non-GAAP) | $367.3 million | $438.9 million | $993.5 million | $1,151.2 million |
| Operating cash flow | Not provided for quarter | Not provided for quarter | $1,530.2 million | $2,025.4 million |
Q3 revenue rose 1%, while operating income fell 37% and continuing-operations income fell 58%. The operating margin was approximately 21.2%, versus 33.7% a year earlier. Nine-month revenue declined 2%, operating income 20%, and continuing-operations income 36%. Adjusted EBITDA, net declined 16% for the quarter and 14% for the nine months; this is a non-GAAP measure.
- Revenue drivers: Q3 finance charges, net increased 3% to $1,235.8 million, supported by higher normalized average receivables; finance charge yield was flat year over year. LoyaltyOne revenue fell 6%, while Card Services revenue rose 3%. For the nine months, finance charges were nearly flat, while services and redemption revenue declined.
- Credit costs and asset quality: Q3 provision for loan losses increased 51% to $297.3 million; nine-month provision decreased 5% to $806.8 million. Principal net charge-offs were $242.8 million in Q3 and $769.6 million year to date; rates were 5.6% and 6.0%, respectively, compared with 5.9% and 6.3% in the prior-year periods. Delinquencies of 31 days or more rose to 5.9% of principal receivables from 5.7% at December 31, 2018.
- Cash and liquidity: Cash and cash equivalents were $4,512.5 million at September 30, 2019, versus $3,817.4 million at year-end 2018. Cash, cash equivalents and restricted cash totaled $5,051.7 million. Cash flow from operations was $1,530.2 million; investing provided $3,650.5 million, principally reflecting Epsilon sale proceeds, and financing used $4,096.1 million. The cash flow statement combines discontinued and continuing operations.
- Debt and deposits: Long-term and other debt was $2,846.1 million carrying value, and non-recourse securitization borrowings were $6,894.4 million; $2,040.9 million of the latter was current. Deposits totaled $12,528.9 million. The revolving facility had $1,072.4 million available and no outstanding balance. The company reported compliance with financial covenants and a 1.44-to-1 leverage ratio against a 3.5-to-1 maximum.
- Capital returns: The company repurchased approximately 6.3 million shares for $975.9 million during the nine months, including a $750 million tender offer, and had $347.8 million remaining under its repurchase authorization. It paid $97.4 million in dividends and dividend equivalents.
Material changes, outlook, and risks
- Epsilon divestiture: The July 1 sale generated $4,369.6 million of cash proceeds in investing activities and a $512.2 million pretax accounting gain. The company also reported an after-tax loss on sale of $252.1 million, including transaction costs and tax effects; discontinued-operations loss was $229.2 million in Q3 and $261.7 million year to date. These items materially affected reported net income.
- Debt restructuring: Sale proceeds funded repayment of $1.9 billion of senior notes and a mandatory $500 million revolving-credit repayment. The company recorded a $71.9 million extinguishment loss. It also repaid the BrandLoyalty credit facility in September.
- Restructuring: Charges were $54.9 million in Q3 and $85.1 million year to date, including LoyaltyOne asset impairments and workforce actions. In October, management estimated an additional $15–$20 million of Card Services restructuring charges, with actions expected to be completed in Q4 2019; further LoyaltyOne charges remained possible.
- Management outlook: No specific earnings or revenue guidance is provided in the supplied filing text. Management said internal funds and other liquidity sources were expected to cover working capital, capital expenditures and other business needs for at least the next 12 months.
- Key risks and contingencies: The company indemnified Epsilon’s buyer for losses related to an ongoing DOJ investigation of third-party marketing practices; the duration, outcome and possible loss could not be estimated. Management expected adoption of the new expected-credit-loss accounting standard to significantly increase the loan-loss allowance, but could not yet estimate the impact. The annual goodwill impairment assessment was not complete, and management cited events, particularly in Q3, that could negatively affect reporting-unit fair values. The proposed merger of Comenity Bank into Comenity Capital Bank remained subject to regulatory approval.
Important facts for investors to verify
- Confirm the filing entity: this 10-Q is Alliance Data Systems Corporation, not Bread Financial Holdings, Inc.
- Review the Epsilon sale’s final purchase-price adjustments, tax consequences, and continuing indemnity exposure; a $40.1 million receivable for post-closing adjustments was collected in October 2019.
- Track credit quality, especially rising delinquency levels, loan-loss provisions, portfolio valuation adjustments, and the expected CECL allowance impact.
- Assess post-divestiture earnings and segment trends, including the decline in Card Services adjusted EBITDA, LoyaltyOne foreign-exchange exposure, and planned restructuring costs.
- Monitor liquidity and funding markets, including deposit costs, securitization access and maturities, and the use of remaining share-repurchase authorization.