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

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

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

Thanks, Ed. Pro-forma revenue increased 5% to $2 billion for the third quarter of 2018, led by strong performances at LoyaltyOne and Card Services. EPS increased 28% to $5.39 for the third quarter of 2018, while core EPS increased 17% to $6.26, both aided by lower effective tax rate. That flips in the fourth quarter as we expect a 24% core effective tax rate compared to 14% in the fourth quarter of 2017. Turning to capital deployment, we spent approximately $103 million in share repurchases during the third quarter while dropping our corporate leverage ratio to 2.4x compared to our covenant of 3.5x. Year-to-date we have repurchased slightly over 1 million shares or about 2% of outstanding shares. Cash flow will continue to be used – continue to support share repurchases in our quarterly dividend but will also be used to reduce our corporate leverage ratio to 2.2x or lower by year end. Let’s turn to a recent hot topic which is CECL, the new accounting standard impacting loan loss reserving. The new accounting standard uses the life of the loan methodology to determine expected credit losses. The life of the loan approach is widely viewed as replacing the loss emergence period creating the potential for estimates to cover a longer loss horizon. We are in the early stages for implementation of the standard but the preliminary thought is at that the life of the credit card loan will be less than 12 months of coverage we currently reserve. Key in the determination of the allowance is the ability to provide reasonable and supportable forecast over the life of the loan. Again because we expect the life of credit card loan to be reasonably short, we believe our current forecasting process would cover that period as opposed to those with…

Okay, let’s move to Slide 6, LoyaltyOne, we’ll start with Q3. As Charles walked you through, we had a good quarter in terms of growth in both pro forma revenue and adjusted EBITDA for the second consecutive quarter. The key metrics here in AIR MILES program is the miles issued as you could see from the chart. Ever since we have got the unfavorable ruling out of parliament back in 2016, it’s been a tough road back and we have been making good progress and turn the corner as we moved into the second quarter, and it’s since continued into Q3 and we expect that in Q4. So that’s a good indicator of not only the health of the program but the way the accounting is done with the deferral of the revenue, it means that we’re getting decent visibility on a go forward basis. Our BrandLoyalty, which stumbled last year came back strongly by Q2 of this year, experienced double-digit growth in both revenue and adjusted EBITDA for the second consecutive quarter, so we feel that, that program is back on track. So the outlook for the remainder of the year is solid, pro forma revenue and adjusted EBITDA to finish the year and we expect continued positive growth in AIR MILES issued. Turning to Epsilon, Q3 revenue was down 4% compared to down 5% in the first half. It’s still soft, and it’s still below expectations. We do have a number of businesses, so we have a mix of businesses that are growing, mixes of businesses that are stable and some product offerings that are declining. The biggest areas of challenge right now are the agency and site-based display, the old ValueClick platforms, and we had a number of client bankruptcies that during the year. The outlook we…

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

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

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

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

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

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

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

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

All right. Great. Thank you.

Your next question comes from Darrin Peller of Wolfe Research.

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

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

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

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

Okay. All right guys. Thanks very much.

Your next question comes from Andrew Jeffrey of SunTrust.

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

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

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

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

Great. Thank you.

Yep.

Your next question comes from Bob Napoli of William Blair.

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

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

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

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

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

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

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

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

Great. Thank you.

Your next question comes from David Togut of Evercore ISI.

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

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

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

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

Understood. Thank you very much.

Thanks.

Your next question comes from Jason Deleeuw of Piper Jaffray.

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

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

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

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

Great. Thank you very much.

Your next question comes from Tim Willi of Wells Fargo.

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

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

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

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

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

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

Good morning guys. How are you today?

Doing great.

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

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

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

Thank you, guys.

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

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