Bread Financial Holdings, Inc. (BFH) Q3 2016 Earnings Report, Transcript and Summary

Good morning, and welcome to the Alliance Data Third Quarter 2016 Earnings Conference Call. At this time, all parties will have been placed on a listen-only mode. Following today’s presentation, the floor will be open for your questions. [Operator Instructions] It is now my pleasure to introduce your host, Mr. Eddie Sebor of FTI Consulting. Sir, the floor is yours.

Thank you, operator. By now you should have received a copy of the company’s third quarter 2016 earnings release. If you haven’t, please call FTI Consulting at 212-850-5721. On the call today, we have Ed Heffernan, President and Chief Executive Officer of Alliance Data; Charles Horn, Chief Financial Officer of Alliance Data; and Bryan Kennedy, Chief Executive Officer of Epsilon/Conversant. Before we begin, I’d 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 will provide useful information for investors. Reconciliation of those measures to GAAP will be posted on the Investor Relations website at www.alliancedata.com. With that, I would like to turn the call over to Ed Heffernan. Ed?

Great. Thanks, Eddie. Joining me today is Charles Horn, our always prolific CFO; and Bryan Kennedy, as mentioned, President of Epsilon/Conversant. Charles will go first and update you on the quarterly results and then Bryan will discuss Epsilon/Conversant specifically, and then I’ll wrap up with a third quarter look, and a full year outlook as well as sort of our initial brief discussion as we look into 2017. So, Charles, take it away.

Thanks, Ed. It was a terrific third-quarter with double-digit growth in all profitability measures. LoyaltyOne and Card Services came in better than expected for the third quarter, while Epsilon/Conversant lagged a bit on the top line growth expectations, but executed the important turn in adjusted EBITDA, which was flat for the third quarter after being down in the first and second quarters. As a result of Q3’s strong performance we are raising annual guidance for the second time this year, increasing revenue from $7.15 billion to $7.2 billion and core EPS from $16.85 to $16.90. We did not pass through the full $0.32 [beat] to third quarter core EPS guidance because a large portion is timing related, whereby some earnings were pulled forward out of Q4 to Q3. In particular, for AIR MILES we expect redemption activity to moderate in Q4 after a run in Q3. Basically collectors were getting ahead of the upcoming expiry date. And for Card Services, our principal loss rates came in 20 basis points better than guidance in Q3. We expect to give that back in Q4 which will prompt some reserve build. Lastly I expect tax rates to tick up a bit in Q4. Turning to the repurchase program, we have acquired approximately 3.3 million shares under our repurchase program year-to-date, and have approximately 300 million of our board authorization left in 2016. You will notice from this slide that we are making a big change in our shareholders return philosophy with our board of directors declaring a quarterly dividend yielding 1% with a record date of November 3. Going forward we expect to use the balance of share repurchases and dividends to return capital to investors. Ed will talk about this some later in the presentation. Let us flip over to page 4 and talk about LoyaltyOne. As previously mentioned, LoyaltyOne exceeded expectations for the third quarter as revenue and adjusted EBITDA increased 28% and 14% respectively. Brand loyalty came in as planned with revenue up 5%. AIR MILES revenue greatly exceeded expectations increasing 43% from the third quarter of 2015 due to elevated redemption activity. As you can see from this slide, foreign exchange rates had a normal impact to the quarter. AIR MILES issued increased 6% in the third quarter rebounding from a 3% decline in the second quarter, and is on track for about 3% growth for the full year. AIR MILES redeemed increased 74% compared to the third quarter of 2015 as we saw a spike in activity in front of the 12/31 expiration date. Although expiry was introduced almost five years ago, this was the first quarter of elevated redemption activity related to it. We expect that some of the activity is just a pull forward from Q4 to Q3 and that activity will abate somewhat in Q4, a matter of timing. Now the answer to the question everyone now will be asking me is what does this mean for the accounting assumptions around the AIR MILES program. The answer is it is too early to know. We need to see if the elevated activity continues through Q4 and we need to evaluate which collector is redeeming as the break adjustment resume, certain collectors will redeem and certain collectors will not redeem. Only this second group really impacts breakage estimates. Fast forward to the end of the year, if we determine that a breakage adjustment is needed, keep in mind that the accounting assumptions for the program are not evaluated in isolation. Rather several other factors and accounting assumptions such as cost to mile, [Indiscernible] residual et cetera will also need to be evaluated. These potentially mitigate the impact of lowering breakage rates. Moving to BrandLoyalty, we recently signed supermarket chain, Lowes Foods, whereby we will manage promotional campaign in 75 Lowes Foods stores in North Carolina, South Carolina and Virginia. Overall we are making solid progress in the US. Let us move to Epsilon and Bryan Kennedy.

All right. Thanks Charles. Epsilon’s revenue increased to $543 million for the third quarter, up 2% compared to the third quarter of 2015. Importantly, adjusted EBITDA came in at $135 million, which was flat compared to prior year after two straight quarters of decline. So to give you an update on our business, let me first discuss the EBITDA results. Our most critical focus at Epsilon for the last several quarters has been to alter the long-term trajectory of the cost structure required to support our business. And a big part of that has been the ramp up of the investment in our India operations to fuel the global staffing model. I am pleased that adjusted EBITDA after a Q1 decline of 22%, followed by a Q2 decline of 9% has leveled off flat in Q3, even while still carrying substantial duplicative costs. While it has taken perhaps a quarter or two longer than we originally anticipated, I think on the cost front we can safely say that our strategy is working and we expect to see that trend continue to play out positively in Q4. So let us turn briefly to the revenue picture and a breakdown of the offerings within the Epsilon segment. I will start with agency media and services, roughly 25% of the total business. These offerings produced $138 million of revenue for the quarter, a decline of 5% versus prior year. At the beginning of the year this business line was one of our concern areas and our objective was quite simply to lower the drag that it was placing on overall growth rates. We have made steady progress with each sequential quarter from a decline of 23% in Q1 to a decline of 15% in Q2 and in this quarter as you can see we have now narrowed that drag to a mid-single-digit decline. Two key drivers fueled this. First after a slow first half Epsilon’s agency offering has generated a number of new wins, beginning to fuel back half growth, such as the agency of record win we announced this quarter with Del Monte Foods. Second we have been working to pivot Conversant’s agency media offering away from a commoditized offering with a dependence on large holding company agencies. We have got a sound plan in place and we are progressing each quarter. Specifically we are shifting towards an emphasis on more direct client relationships, on midsized agencies and on a data-driven digital media offering fuelled by our unique assets and scale. An essential part of this plan involves the consolidation of all of our digital media onto what we call our core platform, which is the engine that fuels Conversant’s data-rich, high-growth CRM business. And over the next two quarters we will have substantially migrated the agency business to this core platform. What that does for us is important. It increases the quality and granularity of the audiences we can offer to our clients and it enhances our ability to deliver the metrics that clients are looking for. So we are on a good track to continue the transition of this business. Let us turn to the digital and technology platform’s business, the other 75% of our revenue. We grew to $405 million of revenue for the quarter, up 5% over the third quarter of 2015. Performance here was lower than expected driven by two key offerings that I will outline; one on the negative side and one on the positive side. First the negative, our Epsilon technology platform business consisting specifically of loyalty and data-based solutions was soft for the quarter dampening an otherwise healthy growth for this category. This technology platform area in particular has been the focal point of the cost initiatives I described earlier as we have worked to correct this historic issue of being able to produce nice top line growth without demonstrating equal or better profitability growth. Consequentially at the same time as we have been pulling back to focus internally on reining in costs we are seeing some external market conditions spike up that include price pressure and increased competitive forces and in turn we missed some top line growth opportunities. Although it is critical to get to the cost side of this equation first, now that we are beginning to see it play out, we should be in a better position to return our focus on growth as we move through 2017. On the positive side, the second driver for the quarter here was Conversant’s CRM business, which continues to perform very well. This offering was up over 50% compared to prior year and really lead the growth for this overall category again. We continue to see strong demand with both new client wins and ongoing cross-sell into Epsilon’s client portfolio, and as of this quarter we have closed 36 year-to-date wins and a book of business that already exceeds our 2015 book by over 25% in potential value. In summary, if you look in aggregate we have put together so far for Epsilon/Conversant, in hasn't been quite what we had hoped for, but we have gotten some critical things done and are moving in the right direction. We addressed the cost structure within Epsilon, where the demand by our clients for hot skills wasn't matching up with a market willing to let us pass on those costs. And while we might have lost some momentum on the growth front due to that this was the right priority for our business. And we focused on the ongoing transformation at Conversant, while driving successfully the growth of our CRM business. We are happy with the progress there and really that is phase one that we are now wrapping up. Phase two will be our focus as we enter and move through 2017, completing the agency [pivot] at Conversant, expanding our CRM offering, putting our shoulder back into raising the growth profile of our database and loyalty business. We are well poised for that with our deep, unique assets and an excellent global team to service our clients. All right. Back over to you Charles.

Thanks Bryan. Let us flip over to Page 6 and talk about Card Services. Card Services had a better than expected quarter with revenue up 26% and adjusted EBITDA net up 14% compared to the third quarter of 2015. Now what really drove the over-performance and there is really several things that I would point to. First gross yields came in at 26.8%, 60 basis points better than original guidance and within 10 basis points of last year. Essentially the cardholder friendly changes we made in mid-2015 have burned in and the related compression has dissipated. Second, we continue to drive operating expenses leveraging with operating expenses as a percentage of average card receivables dropping 30 basis points compared to the third quarter of 2015. Third, principal loss rates were 20 basis points better than guidance of 4.7% and trends in delinquency rates are moving consistent with our principal loss rate forecast for 2016. Looking forward we believe the [Indiscernible] Q3 loss rate guidance is due to timing from seasonality and that we will give it back in Q4. Conversely we did see credit sale slow during the quarter. While we increased tender share with our brands by approximately 150 basis points during the third quarter, softness at several of our core brands dropped credit sales growth in our core to 3%, down from 7% growth in the first half of 2016. We expect that softness to continue into the fourth quarter. Counterbalancing, we have had a terrific year with new signings; The Children’s Place, Ulta Beauty, and Williams-Sonoma to name a few. Two of these brands have launched and we are seeing early and very encouraging results as we welcome new card members to the programs. We have seen healthy applications in the first few weeks thanks to our new [Frictionless] mobile credit acquisition capability, which reduces the times to apply by 25% and reduces abandonment rates more than five times. Turning back to our solid loss performance we have a good view into the rest of the year, and expect that we will track in line with full year expectations. We also expect as vintages mature, we will see delinquencies normalize around the middle of 2017 with losses normalizing thereafter. Ed will talk about this a bit later. With that I will turn it over to Ed.

Great. All right. If everyone could be on Slide 8, it say third-quarter and full year outlook. It has a bunch of colored dots on it to make it easy to follow, and this is the commentary I will give on the quarter and full year, then we will go into a couple of other items and then 2017. And from a consolidated level, third quarter revenue of $1.9 billion, up 19% and earnings per share of $4.74, up 20%. Obviously this was the largest quarter we have ever had in our history, and needless to say very, very pleased at how strong a quarter it was especially in this environment of low growth for the economy. Obviously compared to guidance we exceeded guidance by a lot, and I did want to break out our thinking in terms of how much to pass through and not pass through. We decided to sort of break it up into three pieces. Clearly some of it was timing. Our loss rate in Q3 was lower than expected but we expect the loss rate in Q4 to be to get that back and as a result, if you want to call $0.15 or $0.30 sort of that timing issue between quarters for loss rates that is just how it goes. So we don't expect to recapture that additional $0.15. The second is yes, we are following through some of the over-performance into higher guidance. We have raised guidance twice this year and that is what hopefully we will continue to do as is our practice. And then finally the third is, a little bit of – we need a little bit more flexibility in Q4, specifically as it relates to our AIR MILES business in Canada. As Charles talked about, we are now approaching the first time in the program’s history where we are looking at actually expiring miles from – I think it was 1992 through 2011. So you have got 20 years about to expire. Now everyone has been informed of this five years ago and has been informed since then. However, we did not know exactly what the behavior was going to be as we are approaching the final end date here, and as a result what we found is there is volumes that have picked up fairly dramatically in terms of people wanting to look at redeeming their miles, and as a result what we found is that it did drive a big spike in redemption activity, which does drive a little bit of profit through to the bottom line as redemptions go up higher than anticipated and that is what you saw in Q3. However, what we want to do is we want to make sure that the consumer is having a good experience and it has been challenging. We are putting therefore many millions of dollars into customer care. We have hired a ton of folks to work the phones on the redemption side. Up in Canada we have got management taking phone calls on the floor and as a result we want to make sure that the millions that we are putting into this customer experience effort gives – that is where we want to have the flexibility in terms of some of the excess from the Q3 over-performance. And so will we need it all? Don’t know, but it is better to be prudent. It is better that you have a good experience up there because frankly we are getting flooded with folks trying to get this stuff in and our job is to make sure that we don't damage the brand. So bear with us through the rest of the year. We think we are in very good shape, but we do want to have a little bit of flexibility here to make sure we can bulk up those resources as needed. So, we are raising annual guidance to 11% growth in top line or $7.2 billion and core EPS of $16.90 or 12%. Again I'm reminded of the beginning of the year when we started out and there were lots and lots of concern about the ability to continue to be a growth company in the face of normalizing credit conditions followed by frankly a very soft Q1 with only about 5% growth. We knew the engine was going to pick up eventually. It did so starting in Q2. There were then concerns about whether that can continue forward. Hopefully this has finally put that thing to bed. And what you have is you are beginning to see what this model can do and what this model can do is double-digit, top line double-digit earnings growth, while also absorbing almost 10 percentage points of the growth rate from normalizing in losses. Said differently, if we are guiding to 12%, in the environment that wouldn't have normalizing, we would have done over 20%. So that is what the model can do. We are very happy with it. And finally on the share repurchase side, I think we have done around 700 million so far, and corporate leverage ratio remains quite manageable at less than 3x. Again Charles hates when I use – when I round up or round down, but in general, you got about $5 billion of debt, you have got a little under a couple of billion of EBITDA, and again the EBITDA is measured for our covenants and indentures across the entire enterprise. So you are talking well under 3x and that we feel is a very manageable level. So we are good there, and then for the first time since we have started the company we are in fact establishing a quarterly dividend at 1%, and that is to provide sort of a more balanced return to shareholders. So you are going to see both dividends and you are going to see share repurchases. We are a growth company and that is something that frankly I have debated for years and years and years. The tide certainly has swung in favor of let us do a combo platter of both dividend and share repurchase. That is what we are doing. And being a growth company, one of the nice things is you have a dividend that is going to grow quite nicely in the coming years as we continue to grow at a rapid clip. So it is sort of a nice thing to have out there, and it is also not significant enough to our cash flow that it hampers our flexibility when it comes to either buybacks or M&A or additional growth in our card business. Speaking of which, let us go to our card business, another heck of a quarter portfolio growth, over 20% for both the quarter and the full year. And that is great news for me. What I am more pleased with frankly is the fact that our tender share, which again is defined as the amount of sales at a retailer that flow through our card versus other forms of payments. Basically it means that more and more of the dollars that are being spent at retailers are flowing through our card, and that either means that we are bringing on more and more folks. Perhaps they are folks with lesser credit quality. That has always been a question out there, and as we look at it we continue to see that is not the case, and in fact that 85% of the additional tender share or growth that is coming on our cards are coming from accounts that have been with us for three years or more. So it means that the personalized data-driven marketing stuff, so to speak, works. We have had tender share gains of between 150 basis points and 180 basis points. What does that mean? It basically means if the retailer is doing a couple of points of sales growth while we are going to do somewhere between 5 to 8 points higher than that. That is how important this tender share growth is and that is why it is so important especially coming from those nice mature accounts. Gross yields, Charles talked about, again that was a huge concern of folks at the beginning of the year when year-over-year we saw yields down over 200 basis points. We felt comfortable that that was going to clean itself up as the year of progressed, and sure enough by Q2 it was only down 80 and Q3 we are almost back to flat, so that is one big concern that we can check the box on. Finally delinquency rates and principal loss rates are tracking around the 50 basis points for the full year. We talked about our Q3 loss rate was below sort of our guidance of almost a year ago, and Q4 loss rate will make up the difference, but overall you are going to slosh around and come in right around where we want it to be for the year. The other huge thing that sort of got lost this year was the fact that this was by far the best year in our history in terms of signing high quality clients. And it was by far the biggest vintage we have ever signed, vintage meaning that most of these folks are starting from scratch. We have ramped them up over the process of three years, and when fully ramped up they should be adding north of $2 billion of portfolio growth. And if you look at the clients Boscovs, Hot Topic, Forever 21, The Children’s Place, Bed Bath & Beyond, Williams-Sonoma, Century 21, and Ulta Beauty you are talking about by far the best vintage in terms of size and quality that we’ve ever had which suggest the market is still quite robust. Alright, let’s go onto the next page talk a little bit about Epsilon and Conversant as Bryan talked about. I would say if there was something that was bit of a disappointment so far this year it would have to be our top line at Epsilon frankly. We were hoping that we could pull off the cost restructuring in the whole India initiative well at the same time not losing any momentum on the revenue side, I think our appetite was a bit too large on that one, so the revenue growth is still choppy it was down 2% in Q1, was up 5% in Q2, is up 2% in Q3 that’s not our model, that’s not what we’re shooting for, we want to get into a very solid mid single digit growth run rate on top line and actually have a very consistent flow through with some leverage to the bottom line. And in order to do that as Bryan talked about, we needed to completely revamp our cost structure essentially trying to mitigation the cost of the high skills with perhaps potentially some better leverage on the labor side and that was the whole India initiative where we have our office today and are very happy with all that things ramping up. So, from I guess a longer term perspective, from my perspective, from Bryan’s perspective we believe we have a cost structure fixed and you can see that it’s beginning to actually show results with your EBITDA year-over-year going from a minus 22% decline to minus 9% to flat and I expect this going up 5% in Q4 and then we exit the year and hopefully put this thing behind us. We will have the cost structure in shape so that we can now go after the top line knowing what our costs are. So, it’s been a long process and somewhat painful at times but nonetheless we’re done with it. We turn now to LoyaltyOne which comprises our European based BrandLoyalty business, what can you say there, they’re continuing to track double digit growth in revenue and adjust the EBITDA for the year, it seems to be a machine the Canadian rollout has been very successful and we’re looking at $45 million or so in revs just from that and it’s only a year or so old and then we had a big announcement of our first client in the United States and that rollout is beginning to takeoff and with that hopefully we will have many more announcements moving on from there. Obviously, with the US being 10x the size of Canada, the opportunity there is quite large. Looking at AIR MILES which is our Canadian royalty business, we are seeing double digit growth in revenue some of that driven by the extra redemption activity that's flowing through, but we are seeing mid single digit growth in EBITDA as well. So, the program itself is vibrant, it’s robust, it’s still growing. It is far from sun setting that's for sure. And probably the only cautionary we have there is we are working very hard to make sure that the brand does not get scarred with some of the drama around the expiration of 20 years worth of miles. It's happening it's going to happen. It's one and done for us financially. We don't think there is much risk there. However, we are being very cautious in terms of making sure we put as many resources as we can against this thing from people etcetera, etcetera to make sure that the consumer experience is as good as possible even though it is a little bit crazy right now. So that's where we are and let's now talk about the 2017 outlook again at a very high level. As we usually do this time of the year we give a base case and the base case is plus 10 plus 10. We expect also nicely growing cash flow, free cash flow to go along with that which you will tend to get with our type of business model. So that's the base. It doesn't assume any meaningful share repurchases, any meaningful M&A. And it also factors in what we believe is the final drag from the card services, loss rate, normalization. So again, you are talking we expect to grow double-double despite absorbing another 10 points potential earnings growth that's going towards this normalization process. And right now from what we are seeing it looks pretty good out there. The consumer looks good. And we expect another solid year of double digit growth. So we started 2016 with a lot of folk skeptical that we could in fact hit double-double and in fact we are doing quite a bit above that despite absorbing this drag. We expect a similar rollout in 2017 and hopefully people now feel comfortable that this is the type of model that can absorb this type of normalization. On LoyaltyOne what are the big things we are trying to do with BrandLoyalty continue what they are doing. It's pretty straight forward especially in North America let's keep going. There is a lot of wood to chop out there. So that's what we are going to be doing. In AIR MILES, we expect to have a solid 2017 that being said, I do believe that we are going to get dinged a little bit on our brand in terms of this whole expiry process even though it will be over by the end of the year and will be on a very simple quarterly basis and you won’t have the type of noise or drama. The fact is we are going to have to think hard about are we going to have to do something to make sure that our customers still feel well and respected and that they are getting value of the program. So we are going to watch very closely what the behavior is, what the reaction is and we are going to try to mitigate anything that comes out that somewhat negative On Epsilon, Bryan talked about what we have done this year. Its critical next year that Conversant continue exceptional growth in its CRM business, this is the data driven business where we ingest skew level information from various clients. We then match up that type of behavior to unique Ids associated with folks out there and reach out to them with very targeted messaging that business has been growing rapidly 30%-40%-50% something like that, over 40%. And it's a big business. It's getting bigger and bigger. We are growing somewhere between $80 million and $100 million a year of revenue. And we expect that to be a big engine going forward. What sort of lost in that is the whole agency piece of Conversant which again is when it's the old value click business where we use to provide inventory to the big holding companies on [indiscernible] that of course has gone the way of the rotary dial phone and what we are now doing is we have made the decision that this is absolutely a business that can be pivoted towards CRM-light or for those clients who don't need the full heavy duty CRM. It is just a list activation type program where we are reaching out very quickly for sale that's coming up in two days. This is a perfect way of doing it. So we think we have got a solution there that could also help feed eventually into the big CRM business. On the core, Epsilon core we need to convert this new cost structure quite frankly into revenue growth. It's time to get going on this thing. We have got the cost structure that we want. We know how to price the deals now. And we expect to get some movement here on card services. It's going to be a little bit different in 2017. The focus will be laser like on existing organic growth and making sure there is huge book that we signed in 2016 has a very strong start up. So, we will probably be a little bit less on just looking for bulk out there in the marketplace that is big portfolios to purchase. We are looking more on taking our bread and butter which is these great names that have never had a program starting them from scratch, nurturing them and getting them moving and grooving. And we expect that allows us to keep the types of returns that is unique in the marketplace. So that's what we are focused on. Also the less of a focus on pure bulk relates to the fact that some of these big files that are out there frankly the frothiness in the market is such that it's just not attracted to us so we are going to be very disciplined about it than here before we will do it again. Nonetheless we expect very solid growth in cards and we did not forget talking about the final stage normalization in credit quality which should take place this year. I did want to mention very quickly I have seen a couple of commentaries out there about the 2015 vintage and loosening credit and everything else so let me make it very clear. We did not loosen credit at all in any of our vintages. What happens however, as you get further and further away from coming back from the great recession is that the clients that you signed and the cardholder that sign up will tend to skew more towards the lower end of our acceptable range. But we did not lower standards at all. But what you have is more folks coming from the lower end of that acceptable range and it's not being balanced out at the higher end. So as we moved into 2016, in the 2016 vintage you will see that we did in fact tried to balance that out a little bit better and so we did tweak the credit quality to be a little bit higher and that should balance out nicely. So I wanted to make sure that no one misunderstood that piece of it. Okay. I appreciate everyone's patience. Let's go to the outlook with the fabulous chart that we have here. It says delinquency and the net loss rates and Charles and I and the folks at Card Services have spent I don't know how much time trying to figure out the easiest way to communicate and to provide comfort that this is not a runaway train and that in fact this is a normal process that needs to take place after a long period of abnormally low losses following the great recession. And we have been through every single possible scenario and have come up with probably the easiest way for people to view this and this is how we run our business frankly, which is you look at delinquency rates. So in account that delinquent need to flow through 180 days of being delinquent before it actually writes-off and that the write-off results in a charge to the P&L statement. And that means that you have a nice view into what the ultimate loss rate will be. Delinquency rates have been the best predictor that there is in the card business and in our business for sure with 90% correlation over many, many, many years and so you will see from the first chart here, then in 2016 we saw our delinquency rates go from 42 to 47 and you saw our corresponding move on the loss rate side. We expect 2017 to be around a 5% and stabilize out there going into 2018 as well. How did we come up with this stuff? We just completed, we go through a portfolio by portfolio over 155 clients vintage by vintage in each portfolio, take a look at the aging and then we lay out what we believe the delinquency flows will be. This is what we are going to use. We will update this every month. We will provide this in our monthly release and this is really the best metric that we know that really captures everything. So if you start seeing these delinquency rates starts striking higher then chances are you are going to see losses as well. Alright, let's go to our final page I believe, second or final page which is the 2000 outlook what we are calling closing the wedge. This is a very simple concept. What you are looking at here are delinquency curves as fascinating as they are, let's spend a couple of seconds on it and what you will see here is it's by month. What you will also see is how the curves look very similar and how they go up and down which means there is a great deal of seasonality to delinquencies and so for example when we released our recent monthly data and it showed a 5% or something on delinquencies and I got a couple of folks saying, oh my gosh, your delinquencies are going a bit seasonality. October, which we haven't released yet, you are going to be in low fives and then November, December, you are going to start dipping into the fours. That’s just the way the cycle works. So again this is the best way to look at things and if you look at the orange line if you can see it that’s 2016, it shows how it is above the red line by about 50 basis points which was 2015 and fairly consistently so. And that’s right the good predictor of your loss rate. As we go into 2017, this is the critical point. 2017 is the dotted blue line. You will see that we will enter 2017 we believe around that 50 or 60 basis point spread versus last year and then the whole bet comes down to does this gap start to narrow. Does the wedge close? If in fact the wedge closes, over the next couple of quarters and starts to narrow then you just know by definition that the eventual losses that are spit out based on those delinquencies will normalize as well. So what this essentially says is the normalization process is nearing its end, we get into Q1 we get through Q2, Q2 which starts to narrow and by the end of Q3, you are basically on top of where we were this year, which means the losses that come out after that are going to be flat to this year. And what does that all mean, it means earnings accelerate from the low double digits to the 20 plus that you are used to. So get used to the wedge. That's what we are going to be talking about. And it also takes a lot of the noise out of the system and the idea of talking about delinquency flows up and down and master trust and growth losses and net losses and total losses and everything else frankly the noise level it's hard to really get the message out there and so this is how we run our business if the wedge doesn't close, then we have another year that we got to fight through this thing in 2018. We do not believe that's the case, but we are trying to be as transparent as possible. Alright finishing up on summary, over the past 15 years, this company has had revenue growth of 16% a year for 15 years. Core EPS has been up 26% each year for 15 years. As we look at 2016 and 2017, because of the normalization and loss rates which essentially means look the great recession washed a bunch of stuff out, you had sort of pristine credit only coming out of the recession and that’s beginning to normalize now as people have repaired their credit and we’ve a more normal consumer mix in our portfolio. It’s nothing to get worked up about, it just means things are returning to a level that we had anticipated. But, the normalization process has knocked 10 points of our earnings growth and brought it from the 20s into the 12% we’re looking at for 2016. Nonetheless despite this normalization effort you have a model that sufficiently diversified and business is cycling at different times where we can absorb this hit and still grow double-digit as we have this year top and bottom in double-digit in 2017 and then back to the 20% after the wedge closes. At the end of the day I’ll finish finally and say that I think the narrative for this company frankly has been lost this year in terms of the ways that has been out in the marketplace. We expect to regain the narrative and we will be talking more and more about the strategic positioning of this company why we believe financially even in a normalization period we’re double-double when the wedge closes we go back to 20%, but there is a reason for that and the reason for that is all our businesses are benefitting from the secular trends that we’re seeing whereby data and unique data is being used to gain insights to then provide marketing and creative that are then turned into personalized one-to-one communications to our client’s customers and that’s through the various digital channels where we have unique IDs on individuals around the world. And that’s a secular trend we expect to continue, it’s certainly not going away and it’s something that we are very excited about across all our businesses and as a result our time as long as the wedge is closing and we’re on track for our double-double we will be spending more time trying to explain what really makes the model unique and has been so successful for 15 years. So that’s it, I’m going to wrap it up and turn over to Q&A. Operator.

Your first question comes from the line of Ashish Sabadra with Deutsche Bank.

Good morning, thanks, solid beat. My question was around Epsilon, so Ed you talked about it being choppy and you’re taking all the right measure on the cost structure. My question was can you also talk about the demand environment and the competitive environment is there anything going on there which has caused the softness in the technology, revenues that moderated quite a bit from 15% to 5%?

Sure, I’ll take that question. I think, I mean that’s something that we look at pretty carefully there is no question that there are lot of companies that are playing in this space and have entered the space from the big Google and Facebook of the world that provide solutions to SAS players to the big agency holding companies that are scrambling to put together technology and data solution. Now, we stand back and look at it and we think that it’s still a very vibrant market, we have a particular focus which is to bring our data driven solutions together with technology and creative and deliver those in kind of a client intimate ways. So, we’re looking for the segment of the market where clients really value a services rich sort of deliver that’s not going to be the model that the entire market will chase after, but we think that there is plenty for us. So, I think for Epsilon at this point this is a bit more of a scenario where our win rate has slowed a bit that perhaps is because you’ve been more picky and cautious with all of the focus on costs. And then, if you look at our existing client base, we’ve seen a bit of a pullback in some of our large clients again perhaps that’s a loss of focus that something that we better workout as we move through 2017, we certainly will have a much more intense focus on growth as we roll into the year. So, a couple of factors out there but I don’t think major drivers for this market.

Thanks for that color Bryan, very helpful. Second question Charles was on the delinquencies, on the slide 11 you talk about – the slide talks about delinquencies going up 30 basis point in 2017 that’s lower than the expectations for the charge off increased by 50 basis point, I was wondering if you can provide some more color there and how much confidence do you have in the delinquencies only go up 30 basis point?

It’s one of those I would say we’ve pretty good confidence in what we have here Ashish, you can see as Ed talked about we built this up portfolio to portfolio, we do expect as you look at the gap on page 12 would be most pronouncing the first two quarters then narrowing in the third and fourth quarter. Going back to what Ed talked about if you look in the Trust which is not a great illustration but it’s a little bit of a sample. You could see the 2015 vintage went quickly to loss, the 2016 vintage is going much slower it takes about two years for an account to get what we comment to and less risky. So that 2015 will be flowing through by the middle of 2017 and that’s why you will see that wedge close quite appreciably. So, I would say right now that obviously we’re looking for the 12 months, more than 12 months, we turn the portfolio every six months. So we can get pretty good visibility to it and we can make changes to the portfolio as necessary to track to the numbers we are looking for.

Yes. I mean the way I look at it is just math, if you are going to be up your 50 basis points it's kind of what we are talking about at the beginning of the year and then the gap starts to narrow and then you are running in the back half at almost flat to where you are. By definition you are not going to be up your 50 or 60 basis points because of the math.

Okay. That's very helpful. Thanks for that color. And maybe the last question on the – if I based on the fiscal year 2016 guidance if I back into the fourth quarter number that implies a softness like the revenue moderate to 8% growth for fourth quarter. Is that just conservatism or are there puts and takes there that we need to be aware of?

It primarily goes back to what we talked about with LoyaltyOne and AIR MILES where we had a big ramp in revenue in Q3. We think some of that is pull forward out of Q4. So we already expect that the AIR MILES revenue to drop in Q4 and that's really what you are seeing sequentially.

Okay. That's helpful. Congrats once again on the solid quarter. Thanks.

Thank you.

Your next question comes from the line of Wayne Johnson with Raymond James.

Hi, yes good morning. Ed I was hoping that we could touch base a little bit on the card services and the four growth components namely same-stores sales growth, tender share, new account wins and then portfolio purchases. In the past you parsed that out when we asked about it and I was hoping you could do the same again as we look forward into 2017?

Sure I would be happy to Wayne, I think one of the areas that is of concern is the fact that our client base although the consumer right is doing quite well and is holding up the economy what we are not seeing is we are not seeing that translate into a lot of good growth at our clients. What we are seeing that our clients probably overall is actually they are same-stores sales Wayne have been down 1% to 2%. And that's not new news to anyone, but soft good apparel high end home furnishings, jewelry stuff like that you are just not seeing the consumer spend there. The consumer spending it on autos and things like that which of course benefits our auto business, but so the same-stores sales are probably minus 1, minus 2, and as a result with the tender share gains we can get probably plus 5, plus 6 and sales growth from the core whereas before we used to do plus 10 when the clients were doing plus 3. So you have sort of down shifted a little bit in terms of expectations from the core. We still expect to get somewhere between 5% and 8% point above same-stores sales of the clients but right now we are seeing softness. I know the NRF came out and suggested we are going to have a pretty decent holiday, hopefully that is the case. But again that's sort of down shifted. Sort of mitigating that for us has been the fact that the vintage that we did sign for 2016 frankly was well north of what's going to be a 2 billion add to the file. The big growth chains like in [indiscernible] and forever 21s of the world those are going to do quite well. The other ones are very large clients [Williamson] owners of the world. They are beyond of the world. They are going to be good size files and so I would say that weakness on the core client base itself is going to be mitigated by the ramp up on the organic side from the big 2016 vintage. As we look at big portfolio purchases in 2017 frankly, we don't see much out there that is hugely attractive if we do something it will have to be some very strict hurdles rates we are not going to dilute the business. We want to see our yields hold up very firmly through 2017. So, we may sacrifice a bit of growth on the portfolio to maintain more robust yields and a better use of capital. So look for 2017 to reflect a little less robust growth from the core due to the core itself the retailers being sort of sub-par growth on their sales but we do expect the tender share gain and very strong 2016 contribution.

I appreciate that response. That's very helpful. And just a quick follow up if I may so on the tender share gain can you just talk little bit about where, what the tender share is for matured retail customer or customer you have had three or four or so. What's that wallet share versus a new client when they are brought on board and what's driving that cadence?

Sure, fair question. Essentially when for those of you not all that familiar with wallet share it's essentially right the percentage of the retailer sales that flow through our card. The first answer to where it is when we start the program I can even do that without rounding. It's at zero. And then over the course of three years we will probably get it to around 30% or so of all sales at that retail flow through our card. And then, the real fun stuff kicks in that the longer we have our client, the more skew level information we have on the customers of that client which means the more precise the targeting is when we do all of our targeting to the clients through all the different channels that whether it's point of sale or whether it's through all the various digital channels using Conversant. And we actually have a number of clients who are over 50%. And what we are finding is a huge chunk of the incremental pickup for us Wayne is through the online channels, these retailers are using online very effectively and our online sales are probably close to 40% of total card sales versus the retailers which are maybe 20%. So you can expect to see the slow creep from 30% tend to share up to as much as 50% over a period of ten years.

Great, thank you.

Your next question comes from line of Andrew Jeffrey with Sun Trust.

Hi guys. I appreciate you taking the questions this morning. Just a question with regard to the wedge add which I think is a great way to frame up your expectations. When you talk about normalization just cause that -- would you say that as the credit cycle progressed and you saw the 2015 vintage sort of evolve that underwriting tightened a little bit and that's why you are so sure that as there is vintages season that the loss rates will moderate or is there something else at work? I am just trying to get a little granularity on your confidence level there and what’s driving in?

Yes, Charles can take care, but the bigger thing is that the losses, in the great recession you flushed out more than you normally would in a more typical recession and as a result what was left over who was left standing meant that you had a lot of like super prime coming into the file which is not really our bread and butter. We are much more in the sort of mid to upper prime type range and what's happened over the course of the number of years the recession is in the rare view mirror, you are having more and more folks who have repaired their credit, who are back in the market, who have jobs again, who are working and they tend to flow into the file and as a result what you saw was it's less about losses going up is more about losses are beginning to conform more to sort of the type of consumer that we cater to. So that’s sort of the big, sort of misperception out there of – we’re not shooting for 4% loss rate that’s not how we optimize a file. When you’re talking to folks that we want and the people who visit the stores, our loss rate we believe is optimized at a higher level and those are the folks that have been flowing in specific to your question, yes, when we saw the 2015 vintage and we saw that we were kind of, it’s looks like a lot of the prime folks who are at the high end of the pool, there are few of those and more folks who still matter credit card carrier but it was a little bit lower in the overall pecking order. They tended to dominate a little bit more and we needed to tighten up a little bit.

Not a lot I can add to it, this is purely mix. A higher percentage of applications in the early part of coming out of the recession are high quality individuals, super prime because you basically burned a lot of the market. As they start to repair their credit four or five years thereafter they start applying for credit hitting the bottom end of it and writing quite seriously. So, you have a mix shift that you can adjust if it gets beyond a certain spectrum and that’s what we did. 2015 move to little bit, quicker than what we thought it would so we tightened up little bit in 2016 to keep a track into the numbers we want.

Okay, thanks. And just as a quick followup can you just talk a little bit about how you view Amazon with regard to its impact on your client same store sales recognizing the tender share may get some of the impact?

Yes, whether it’s Amazon or the whole online Amazon affect, what it essentially done is two things. First, it has made shoppers much more educated when it comes to where they can get the best price. So whereas before you had folks who has a little bit hit or miss, now everyone has got their phone, everyone is comparing prices and as a result that’s what putting a lot of pressure on our clients which is really on the pricing side and so that’s why the margins have been so tough at our clients. Obviously, the whole online space makes it a lot more convenient for people to work, I do think the retailers in our space are coming back strongly with their online offerings and will make a nice dent on that side of it. But Andrew, I really from what we’re seeing it’s the pricing side of it, it is your Amazon has educated the consumer to such a degree that the consumer, no one pays full price anymore and as a result your sales are suffering as much from pricing declines as from just unit declines. So that's what the retailers are struggling with is what is the new model. What we are trying to do is obviously this flows very nicely into how we run our business which is you can't just have $200 million marketing budget and go out and splash it around to everyone. You need to be much more precise, much more effective with how you market to folks down to one-one-one level. So this impact has been driving quite a bit of thinking on the part of retailers to change what has been for decades their way of going about marketing and moving towards the unique data driven personalized approach we do.

Okay. Thanks a lot. Appreciate it.

Your next question comes from line of Brett Huff with Stephens.

Good morning guys. Thanks for taking my question. First question on Epsilon, you talked a little bit about sort of some of the things you going through and I think you said you needed to kind of refocus on some of those big clients that they have pulled back their spending and maybe there is loss of focus as you’re reducing cost. Can you talk about how that might compare to any structural changes that you see because you mentioned it wasn't structural, but I just want to make sure I understand that point that you made?

Yes, sure Brett, I mean, I think from the perspective of existing client relationships obviously you got to do an excellent job of serving clients, walking the halls, bringing solutions to them that really meet the needs that they have. And I mean, we strongly believe that that demand for full service kind of strategic support is still rich in the marketplace. There are certainly alternatives with software as a solution kind of offerings that will allow client to maybe do something in-house. Over the long haul our bet is that the kind of skills required to really make that work and to drive results are difficult to create within a client's organization. So, I think from a market perspective having watched us for 20 years I don't see that that's going to change radically. So that's kind of the focus point for our business. In terms of whether there is something structural that goes well beyond that again we will watch that quarter to quarter but we really believe strongly and this is coming from the voice of the clients that we serve and the global 1000 CMO that we are targeting that needed there in the marketplace and those are the skills that they don't have in-house. The focus issue for us and really they’re using famous foundation and places, the change we did see is scenario where the kinds of skills that you need to service those relationships aren't always matched up with the client’s willingness to continue more for those as cost of living goes up etcetera. So that's really the driver behind our shift on the cost structure.

Great, that's helpful, thank you. And just second follow-up question on card. Ed, I think you mentioned more folks in organic growth less buying portfolios I think you have also in the past said that there are couple of programs you are going to non-renew, I want to know the status of those were in your commentary of focusing on organic growth and if there is any knock-on effects from that non-renewal, should we expect more of that overtime from some of those clients or does that moderate?

So, in the first quarter we did put the two portfolios to help our sale knowing that we were not going to renew them at the end of 2016. We would expect those two programs to be gone from ADS by the end of 2016. If you look at the average card receivables we gave you, we excluded already. So we are not considering that in the growth rate. So I don't think it's going to have any meaningful effect going into 2017 especially to Ed's point given that very strong 2016 vintage we signed to replace it.

Okay. That's all I need. Thanks guys.

And our final question will come from the line of Robert Mattson with Dougherty & Company.

Thanks for taking my call and congratulations on the quarter. Ed quick question. The dividend and for long time I guess the preference was to not protect [indiscernible]. I guess a little thought here is this, you curiously book up your cash flow in the three buckets M&A, funding the receivables and then share returns. Will this strictly come out of the share returns or will this be incremental and obviously we see this as maybe pulling little out of M&A, a little out of funding and then also you mentioned about it growing, should we also be thinking this as some of the payout ratio and should grow more or less with those?

So on the first one Robert I would say this adds to fourth option that we can flex based on what we see in the market. It could flex against M&A, it could flex against buyback. So it's really just fourth item we can consider on our capital allocation strategy.

Okay. And I guess going on to Epsilon on a little bit different angle. Let's talk about the current customers. If you look out in the space there is a lot of vendors particularly in the technology side versus Derby, which is one of your partners. They are seeing opportunities to gain share, they’re seeing lot of activities, lot of activities on the digital transformations and the data driven marketing. Opportunity spend against share could you elaborate a little bit more Bryan I guess on kind of activity you can do to bring the growth rate higher and make them more durable to get around away from this choppiness. It would seem to me that the growth rate should be able to get higher give rate of market strength and desires where most thing down this path?

Yes, I mean no question there right now given all of the options in the space it's kind of a complicated decision process for our clients to navigate in terms of thinking through all of those options and then selecting the right choice. I mean, part of what we have done historically is position ourselves is kind of a trusted adviser that has the ability to really help a client navigate those decisions and then actually drive outcomes from their investments. That's a different position than a lot of the other providers including some of our partners who are little more focused on a software sale with less accountability and responsibility to really drive results. So part of what we need to do better I think is kind of double down on that bet in terms of educating our clients. And then focusing carefully on the players that really value this sort of services that we bring to the table and not frankly chasing everything. The other side of it from our perspective is when you look at the assets that Conversant brings to the table from a digital execution perspective, from the ability to really have pristine cross device capabilities and then incredible ability to reach consumers. When you put that together with our big technology platforms including harmony and database and loyalty platforms you start to really see I think some significant differentiation in terms of what we do versus the rest of the marketplace. We have frankly not put our shoulder significantly into that effort. It’s part of what we are working on right now in fact we have several key pilots with clients that being to put those capabilities together on a more integrated way and I think that's going to be a key effort for us as we move through 2017, that will start to drive part of what you are asking about.

Okay and I guess this is final question, going back to the delinquency trajectories, if we were to look at the ability to meet that wedge, missing the wedge would that be, is anything intrinsic to your portfolio or this be largely a broader macro event?

This is the portfolio by portfolio roll up, so again we go through all 155 portfolios every vintage in it and we will see where they are and life of the account and how the curves are looking and then we project out. So it does not assume any huge improvement on the macro side at all.

Okay, great, thanks a lot.

Okay. So I think that's it. Thank you for all your time and we will talk you next time. Bye, bye.

Thank you. That concludes today’s conference call, you may now disconnect.