Good morning, and welcome to the Alliance Data Third Quarter 2017 Earnings Conference Call. At this time, all parties have been placed in a listen-only-mode. Following today's presentation, the floor will be open for your questions. [Operator Instructions] In order to view the company's presentation on their website, please remember to turn off the pop-up blocker on your computer. It is now my pleasure to introduce your host, Mr. Edward 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 2017 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; 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 www.alliancedata.com. With that, I'd like to turn the call over to Ed Heffernan. Ed?

Great. Thanks Eddie and welcome everyone. As usual, joining me today is Charles Horn, our CFO. And he's going to kick it off with an update on third quarter results, and then I'll jump in with full year expectations, and then provide the next layer of detail to our 2018 guidance. Charles?

Thanks Ed. Revenue for the third quarter increased 1% to $1.9 billion, soft against our mid-single digit expectations, primarily due to hurricanes Harvey and Irma negatively impacting the growth shields at Card Services, which knocked off about three points of growth. Core EPS increased 13% to $5.35 for the third quarter 2017, better than our expectations, primarily driven by lower loss rates of Card Services and a lower tax rate, a result of initiatives implemented during 2017. Excluding the improvement and the effective tax rate, core EPS increased approximately 9% for the third quarter. Adjusted EBITDA net increased 7%, benefiting from the better-than-expected loss rate at Card Services. During the quarter, we reduced our corporate debt by approximately $180 million to $6.2 billion. That brings our corporate leverage ratio down to about 2.8x as of September 30, 2017 versus our covenant of 3.5x, leaving us with over $2 billion in available liquidity. Let's slip to the next slide and talk about LoyaltyOne. As expected, the third quarter was tough for LoyaltyOne, with revenue decreasing 20% to $305 million and adjusted EBITDA decreasing 26% to $61 million. Fortunately, the future looks brighter for this segment. Breaking it down by major business. AIR MILES revenue decreased 28% to $185 million for the third quarter of 2017, driven by a 43% decline in AIR MILES reward miles redeemed. This drop in revenue was consistent with our expectations as we pulled in the burn rate, which are miles redeemed divided by miles issued from 129% last year to 80% this year. 80% is our target, really, moving forward. Importantly, the negative draw over from the elevated redemption rate is gone entering the fourth quarter of 2017. AIR MILES issued was down 7% year-over-year. Normal spend is on track, but we have seen less promotional…

Great. Thanks Charles. Slide 9, full year 2017 outlook on a consolidated basis, we're going to reiterate guidance of $7.8 billion in revs and $18.10 in core EPS. Obviously, on the rev side, the hurricanes hit us, as Charles said for about $40 million in Q3. We expect another $40 million in Q4. So it is about a $80 million on the top. Despite that, we are going to maintain the $7.8 billion guidance for the year. In terms of earnings per share, despite the big beat in this quarter, we are keeping it the same for now. If you flow through the impact of the hurricanes all the way down, we expect that to be about a $0.25 headwind between Q3 and Q4. We think we can play through that primarily because – as Charles mentioned, our loss rates are actually coming in a little bit better than anticipated even after the impact of the hurricane. So for now, we're going to use that as sort of our cushion to make sure we can play to the hurricane and hit the $18.10. So what does it all mean? It means that the slingshot that we've been talking about it seems forever is finally on track. The delinquency wedge is closing this month, which we're all looking forward to, and we expect Q4 to have our delinquencies finally anniversaried, and that means good news for next year. As Charles also mentioned, growth losses, which were up 75 basis points in the first half of the year, we thought they'd be up about 30 in the third quarter and flat in the fourth quarter, actually came in slightly better in the third quarter, and were, in fact, flat in the third quarter versus prior year even after factoring out the hurricane.…

Thank you. [Operator Instructions] Our first question comes from the line of Dan Perlin of RBC Capital Markets.

Thanks, good morning, guys. So I had a question around card, in particular, around the operating expense. So – and it relates to where you are in the build-out of your in-house recoveries. So was up, I guess, 16% or so year-on-year, but as a percentage of AR, it was only modestly up year-on-year. It was really was up sequentially, but modestly. So I'm trying to understand how we should be mapping that out over the next several quarters. And where are you in the process of actually bringing those people and to build up the in-house recovery?

Yes, so there's two things I'd point you, Dan. First is the gross yield decline year-over-year makes the percent growth look a bit higher, the 16% you referred to. If you had basically the same gross yields year-over-year, you'd see it flat-flat. As a percentage of AR, it moved a nominal amount. We said, going back to the last quarter, we expected our operating expenses to be better this year, 40 to 50 basis points. I think that's still on track. We would tell you we're still in the process of adding collectors. And we'll staff them up over the remaining of Q4. I would still expect the OpEx leveraging in Q4 to be better year-over-year. That said, we're still very much on trend to that guidance we gave last quarter of about 40 to 50 basis points improvement on an annual basis.

Okay. But just to be clear, the absolute dollar of OpEx expense was up 16%. And you're saying you're expecting that to stay at these levels or playing out throughout the – I would imagine that's where you're capturing the incremental cost of this recovery business, correct?

That'd be correct as well. But let's say we hadn't had the influence of the hurricanes affecting our gross yields, the revenue growth would have been up 15% to 16%. So you have to basically influence the fact that you take a whack on your gross yields is not influencing your OpEx.

Okay. The other question I had is, can you just help me understand why the 15 basis point improvement in gross losses as a result of the hurricanes? I mean, I think I caught it, but I'm sure someone will ask, and I just want to make sure I'm clear on that.

It just means for affected person within that FEMA designated zone, that account is frozen from migration to the delinquency trends to loss if they're in that affected area. So if they were in to 150 days past due and they were affected, it would just mean that's going to freeze and that would not have rolled into the charge off after 180 days.

Okay.

Yes. So essentially, you get hit pretty hard – or actually harder on your lack of earnings in terms of the revenue, but you are getting a slight benefit in terms of – for a couple of months of putting those accounts – or suspending those accounts from rolling to losses. The net result is going to be about a $0.25 hit Q3, Q4 combined.

Yes. Okay. And then if I could sneak in one just quickly on Epsilon. You mentioned a pullback in digital growth. I'm wondering what do you think is driving that for you guys. And then secondly, you said onboarding new clients, I think, is going to help drive a big part of reacceleration there. And I'm just wondering what's happening, really, in the underlying core business. And then why is this – why are we seeing this shift? Thanks.

I'd say, Dan, we think the core is still very strong. Occasionally, you get some timing differentials when new programs are coming onboard. I think that's the biggest thing we're looking at. We'd expect it to bounce back in Q4. We just had a little bit of a timing with fewer new programs launched in Q3 than what we've been doing before. But like I said, I think that will bounce back in Q4.

Okay. And then the onboarding as sort of rate of change of new clients versus core, it's just proportionate to the new clients signed, I guess, is what you're saying in terms of how we're mapping up growth.

We would tell you the backlog is still strong. Occasionally, it just shifts as to which quarters till when the program is going to onboard. And I would say, we said a little bit lower in Q3.

Okay. Thank you, guys.

Thanks.

Our next question comes from the line of Sanjay Sakhrani of KBW.

Thanks, good morning. Charles and Ed, I guess, you guys mentioned the couple of different numbers on the impacts from the hurricanes. But I wanted to make sure I got the total because when I look at Slide 3, it talks about a three percentage point headwind related to the hurricanes. Is that the consolidated number, which would be, like, closer to $60 million on revenues?

That is the consolidated number. And again, it's rounded to three. It was about $40 million impact to card and a $40 million to total. It's about 2.6% so around…

Okay, I got it. All right, and I guess, my second question is a little bit higher level on Epsilon. It seems like – and it may be related to the question before, but just seems like that, that business unit is supposed to produce higher – high single-digit revenues. And that's what Ed sort of talked about in terms of multi-year view. I guess, when we look at all the variability in that business, I mean, is that still the case? Do you still think, Ed, that's it's a high single-digit top line grower? Or is there to be going some variability over the course of the next couple of years?

Yes, it's a fair question. I mean, I think the one thing we've learned over the last couple of years is this variability is certainly by quarter. The big 25% of Epsilon, that's a tech platform was really our big concern because that was, as we said, melting pretty quickly last year. That's fully turned and we expect that to contribute positively next year. And so I really do think the long-term growth rate, Sanjay, of Epsilon has to be up around that 7%. And it's a question of how do we get from the sort of 5%. We're running this year, year-to-date, up to the 7%. And hopefully, with the technology piece turning, that should give us a decent shot next year to get pretty close. But my goal, quite frankly, is that, that's going to be not really a mid-single-digit. That needs to be a high single-digit top line growth business.

I got just one more on credit quality because I figured I should ask this, and I appreciate all the color that you guys provided related to it. But I guess, with credit now sort of outperforming even relative to your expectation, the concern in the market has been there might be some contagion with the consumer, like there's something wrong with the consumers' health. It seems like given that credit is doing relative better than your expected range and this is a range that you provided a couple of years ago, the state of the consumer is relatively stable. That – would you concur with that view? Or do you feel like the health of the consumer is a little bit weaker than when you first gave that guidance?

No, no. I – there's no question in our minds. And we do, if not twice a week, at least, weekly calls with the folks on the front line doing the actual collections. And these are thousands of people and we ask, what are the trends? What are you hearing? Are you hearing any sort of hesitancy? Are you hearing some of the noise that's coming out? And it's been rock solid with – there's no issues out there. If anything, I'd say, things are actually a little bit better. And obviously, we're seeing it in our own loss rates. But no, we're not hearing anything. And it sort of goes back – it's playing out pretty much the way we said, as you mentioned, a couple of years ago that we're just normalizing back to where we were before the Great Recession and then it stops. And it's stable thereafter.

Right, thank you.

Our next question comes from the line of Darrin Peller of Barclays.

Thanks guys. Just a first question on the growth of receivables guidance. I know you're mid-teens for next year, including Signet. I guess, that's a more of a high single-digit organic growth rate. It seems like your – is it strategically you're managing to a mid-teens all in growth just to really balance the business now? It's a bigger picture question, Ed, around the mix of business between the card business versus the others. Or is it more that the organic growth of the purchase volume has become more of a mid- to high-single-digit grower, and so that's just the new world we live in now?

If I can say yes and yes, I think that would probably cover it. But I think it's sort of a combo platter. They earn off exactly what you just said, which is, we think, 15% growth for us is roughly a nice comfortable growth rate given the amount of business that's flowing in to the top of the funnel and to your point, factoring in, which we didn't have several years ago, some attrition on the bottom of the funnel as some of our longstanding clients are having difficulty making the transition into the new, whatever the new is. And so we're not getting quite the growth we got from the core of five years ago. But what we're getting is we're getting more coming in, in terms of people shifting the marketing dollars to the data-driven business, which is Private Label. So it kind of watches against each other. And I would say, 15% is a good number. Could it flex up to a couple of points higher than that if core retail comes back? For sure. But I think 15% is a safe bet and that's sort of our strategic plan for the next three to five years.

Okay. And so just to remind us, the e-com – or the digital element of your business, I know you've talked about it before, I mean, that's obviously one of the bigger drivers. What is the metrics you've provided around that, again, if you don't mind repeating?

Well, what we said on the last call, Darrin, is that the credit sales through online are basically outside of bricks-and-mortar over a third of our credit sales. That number can jump up to north of 40% in the fourth quarter as you get the holiday spend. That's really the metric we've been focusing on. It's the traditional bricks-and-mortar or about 85% in store, 15% online. And we have over a third of our credit sales online. So that's really the ability for us to capture the data, identify you, track you online and give you a relevant target it off and it gives us the ability to do that.

Yes. And I would say that we're also beginning to see, Darrin, the core retailers. We're working pretty hard with them to increase the ease of their – of the online experience as well as bringing on the wafers of the world, the overstocks of the world, sort of the pure e-commerce players. And you'll continue to see that shift. My guess is – from an online credit sales perspective, my guess is we'll be at 50% in a couple of years.

Okay. That's helpful, guys. So just a quick follow-up, Charles. The delinquency trends you guys are guiding towards for the fourth quarter and into 2018, what is the impact of Signet on that in terms of – in other words, organically, without that would – I mean, I think delinquencies are still improving year-over-year and the wedge is getting close, but what are – where would we have been, I guess, organically?

We'd put it this way, Darrin, is the improvement is not definitive on us onboarding Signet. I mean, we're looking basically – yes. If we're looking to Q4, we would tell you putting Signet on the side line, we feel good gross losses will be down year-over-year in Q4. And that's going to be driven by the natural improvement you're seeing on delinquencies in that wedge.

Okay, all right. That’s great to hear guys. Thank you.

Our next question comes from the line of Ramsey El-Assal of Jefferies.

Hi, guys. Thanks for taking my questions. Can you take a step back on the hurricane and just help us think through what percentage of your business is generated in those impacted geographies?

We estimate that it's up to 15% of our accounts were within the Florida affected area and the Houston and Texas affected area. That doesn't mean that all of them would have gone into this program, but it's up to 15% of our accounts were affected.

Okay. So yes, essentially what you have is you put them into various buckets. And FEMA provides us with the areas that are hit the hardest. And that's probably about a two month tight hit, so you get the tail end at Q3. You get the beginning of Q4. But by November, December, we expect things to look pretty normal across the board. And we've got check this thing with what happened during Katrina, obviously, very different, but that's sort of – it's the same blueprint.

And basically, there's no kind of intelligence behind in the sense they just give zip codes, and any account associated with that zip code gets the special treatment.

No.

Okay. I wanted to ask about the Equifax situation and whether that has – you anticipate any impact from that. It feels like not as many people are freezing their credits as maybe was anticipated initially, whether that would impact you at all regardless because you have a different underwriting procedure. Just wanted to get your comments on that.

Yes, it's a great question. And I think it's top of everyone's mind. For sure, you heard an awful lot of stuff, bad stuff that came out of it and one of the things had to do with how can we protect the consumer or the consumer can freeze their accounts, et cetera, et cetera, that's going to lead to a lot lower level of account openings, both online and within the bricks-and-mortar stores for us. And we watch it pretty closely, and to your point, what started off as a potentially significant item and dwindled pretty quickly. We estimate that it's probably, at most, it will affect new account openings by about 1%. I mean it’s we’re just not seeing it happen. And even in some cases where they may freeze at Equifax, they're not freezing at the other bureaus, which we also use. So it remains to be seen a year or two from now, whether everyone gets on the bandwagon. But right now, it's really a nonevent from that perspective.

Are there any dependencies on Equifax in terms of data you require for underwriting that have – you've had to find another solution? Or is it really just kind of business as usual?

For us, it's pretty much business as usual. We'll go to other folks as we need them. But in terms of data availability that we need, I mean, that – it's there, it's available, and it's business as usual. It doesn't change the fact that a lot of sensitive information has gotten out there. But from our business perspective, it really hasn't changed procedures.

Great, thanks so much for taking my questions.

Sure.

Our next question comes from the line of Andrew Jeffrey of SunTrust.

Hi, good morning guys, thanks for taking the question. I guess a couple questions about loyalty. First would be in BrandLoyalty. Just trying to understand, sort of similar to Epsilon, how do you think about sort of your installed base of customers in terms of their growth. You mentioned some new signings and initiatives next year that will probably drive growth. But can you talk a little bit about same-store sales in BrandLoyalty, if that's the right way to think about the business and what those trends look like?

Yeah, it’s a good question. The way, it's a little different from same-store, but kind of the similar concept, which is the number of programs that a specific chain will launch in any given year. See you may have a large grocer in Germany that if we can get them to do two programs a year, that would be great, right? We're running 220, 230 programs a year, so it is a bunch. And so we make our money, essentially, when whoever it may be decides to run one of these three month promo, heavy-promo programs. So it could be either an existing grocer pulls up to do three programs in a year or we get a new grocer who only wants to do one program a year. So it's really hard to do a same-store sales. But in general, we know sort of the total number of programs we need to launch in a given year to drive what has historically been a double-digit top and bottom growth engine for us. What we're seeing, as we move into World Cup and everything next year, is the European side of the business, which is the bulk of it tends to crank it up quite a bit for these things, less so in North America. And that is, in fact, what we're hearing from some of our big clients over Germany, in France, in Italy, et cetera. We also – with the launch, we're always looking for new product for these promotions. And having the exclusivity with the Disney brands over there, I think, will provide an additional incentive for the grocers to roll it up. So there's really two drivers that we think will help the return to double-digit growth next year. And then the big wild card, Andrew, we're not baking it in, but if we can get someone big in the U.S. onboard, that's your upside. And so we've got a couple small programs that have launched in the U.S. Can we get one of the big guys to sign up, to try guys to sign up, to try to differentiate themselves a little bit, especially given all the turmoil in the grocer market here in the States? Don't know yet.

Got you. That's helpful. And then just as a follow-up on AIR MILES. There's been clearly some disruption in the U.S. grocery market. I know you talked about promotions in Canada and the desire – the intent to grow with GDP. Can you just comment on sort of the health and vibrancy of the grocery channel generally and whether or not that's something that you think is affecting AIR MILES?

Sure, yeah I think the reason for the drop-off in promo activity is, to your point, it's all grocer. And so we need to make sure that the other verticals are running and gunning, so that we can get this whole machine back up and going again. I mean, we're getting there. And it's frustrating in the sense of it hasn't fully turned yet. But the collector activation rates are pretty much back where they were. We haven't lost any sponsors. We're seeing weakness, to your point, on the promotional side from the grocers. But with the new deal with Bank of Montreal, which is a very large, while it is the largest sponsor, we expect to really reenergize that card program there. So hopefully, the game plan is we're going to get more out of the financial services vertical than we had in the past and that should help hedge against continued softness on the promo side.

Thank you.

Our next question comes from the line of Tim Willi of Wells Fargo.

Thank you and good morning. I have two questions around Private Label that, I guess, might be a little bit more intermediate term in nature. But just given the discussion around the operating leverage and the improvements that you've quantified, Charles, is there like sort of a permanent sort of target we should think about on the operating expenses relative to receivables on an ongoing basis once you sort of gets that peak, I guess, leverage point, that this is sort of where the ratio goes to and probably stays there if we keep it at a sort of a mid-teens portfolio growth? Anything we should think about?

Yeah. I’d hate to say anything is permanent, but I'd tell you what we would target is about 20 basis points improvement per year, and that's expressed as a percentage of average AR. Obviously, growth imbalances influences it. There are certain programs that influence it. But I think that's a very reasonable target. It's about 20 basis points per year.

My other question was about the digital side and referencing about 1/3 of credit sales and maybe, over time, that goes to half. Are you seeing anything around delinquencies or customer service related to the consumers that are heavy digital? Just sort of curious about shift over time impacts. Anything positive or negative for the operation on serving those retailers and their customers?

Tim, we'd tell you not really anything that we've seen different between the interactions online versus bricks-and-mortar. We know with online, we need to drive different service products. That's just the ability to minimize shopping cart abandonment, the ability to capture. You make it very simple if you make a transaction. But in terms of loss performance, delinquency performance, so forth, there's really no differences.

Yeah, I think, the thing to remember, this is sort to use the buzzword, the omni-channel approach of whether it's bricks or clicks. What you're basically looking at is the same customer. And five, six years ago, you would say that she would shop 8 to 10 trips a year. And those would be to the mall. Now she's shopping like a dozen times a year, some more trips, but only two to the mall and the other 10 are "trips online." So it's the same customer. It's just that they're shopping differently.

Great, that’s all I had. Thanks very much.

And we do one more.

Our next question comes from the line of Bob Napoli of William Blair.

Good morning, thank you for squeezing me in. One question on credit first and then an Epsilon question. Just the improvement in credit in the month of September, Charles, is that a move to the heavy increase in held-for-sale? I mean, there was a pretty significant increase in held-for-sale in the quarter. And when do you expect to sell those receivables? Are they essentially marked to where you expect to sell them at this point?

So think about it this way. It didn't influence our loss rates, really, at all for the quarter. The shift you saw that is put in held-for-sale is a vertical that's really just not a core vertical for us. It's pretty small. We're going to look to divest it. It is at the carrying value, which would be par amount than the anticipated losses, so there is no assumed gain or anything associated with it. It's something we'd probably look to try to get off our books toward the end of this year, early next year. But really, it goes back to something that Ed said before, is with the growth we're generating and now assume that coming onboard, we can look at different verticals and this is one we tested for several years, really, not a great vertical for us. It's really time for us to basically do a little bit of cathartic process to the file and get rid of the things that we don't want to focus on. And so that shift to held-for-sale, that's exactly that small vertical that we're just decided not to pursue.

And the improvement in September then was driven by – it was a monthly data.

It is performance of the overall portfolio, plus we did have some sales in the market, which we already had contracts in place. So just like we saw in June, we saw a little bit of improvement in recovery rate. We saw the same thing in September. So it's a combination of natural trends, a little bit of sale of previously charged-off paper that really drove the improvement.

Yes, gross losses themselves are actually running flat or better than last year, which, is about a quarter ahead of when we thought that would happen. And then you throw in some of the third-party sales on the paper that we had hanging out there from the beginning of the year. That's what drove it.

Okay and Signet, you said you think it's going to be a little over $1 billion now coming onboard.?

Yes.

Okay. And then just as it relates to Epsilon because that's – and I know you talked a bit about that. But the slowdown was obviously disappointing to you and below to us. But the CRM business and the auto – I mean, that business has been 30% grower. And it seems like having spent time with the management team there that seemed very optimistic about high levels of growth for that business. Is the visibility not as high? Is it not as predictable? And how lumpy – and are the opportunities in that very high-margin business, do you expect to see that? I mean, sounds like you're talking down the expected growth of that piece of the business.

We break it down it two ways. We'd say auto is still doing fine. That's really not showing the revenue growth. We did see the CRM drop. The digital overall drop a little bit in Q3. We think it's still going to be a grower long term. That's going to be 25%, 35% grower. We think it's really unique business. What you're always going to have are little bumps on the road where you're just not onboarding the same number of new clients during the given quarter or where an existing client pulls back a little bit during the quarter. And we saw that with a couple of clients. So we think it's, again, transitory. We think it's got a good top line. We think it's still a very unique business. It's going to grow into the future. So we don't think it's one where we're going to dial back the overall growth rate for Epsilon. We think it's going to be one of the drivers of Epsilon's growth rate in the future.

And just as it relates to Epsilon, obviously, I mean, how much of the Epsilon is tied to the secular growth – the positive secular growth trends within the marketing versus the agency? And as they see, the traditional agencies, obviously, are very much struggling when – and I kind of view Epsilon as being – having tailwinds from secular trends but what portions do and don’t. How do you do that.

25% agency like and 75% is getting the tailwinds.

All right. Thank you. Appreciated.

All right. Thank you, everyone. We'll talk to you next quarter. Bye-bye.

Thank you ladies and gentlemen. This does conclude today’s conference call you may now disconnect and have a wonderful day.