Good morning, and welcome to the Alliance Data Fourth Quarter and Full Year 2018 Earnings Conference Call. [Operator Instructions] In order to view the company's presentation on their website, please remember to turn off your pop-up blockers on your computer. It is now my pleasure to introduce your host for today, Ms. Vicky Nakhla of AdvisIRy Partners. Madam, the floor is yours.

Thank you, operator. By now, you should have received a copy of the company's fourth quarter and full year 2018 earnings release. If you haven't, please call AdvisIRy 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 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. Reconciliations 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?

All right. Thanks, Vicky, and good morning, everyone. Joining me today, as always, is Charles Horn, our CFO. He's going to update you first on the full year results. I'll wrap up '18 and then we'll shift over to '19 with our guidance and our thoughts. We'll keep this relatively brief, so that we'll have plenty of time for Q&A. So Charles?

Thanks, Ed. Pro forma revenue increased 5% to $8.1 billion, adjusted EBITDA net increased 7% to $2.1 billion and core EPS increased 17% to $22.72 for full year 2018. Revenue came in short of our initial guidance. Conversely, our core EPS achieved the midpoint for the year. EPS increased 24% to $17.49 for full year 2018, aided by a lower effective tax rate, approximately 27% in 2017 compared to approximately 21% in 2018. We were active during 2018 transitioning Card Services toward more attractive clients and verticals. We sold $1.2 billion of held-for-sale receivables during 2018 and ended 2018 with $1.95 billion in held-for-sale receivables, with the goal of selling the majority of the balance early in 2019. From an accounting perspective, held-for-sale receivables are removed from card receivables and the related allowance for loan loss. They also no longer impact delinquency or principal loss rates. In addition, provision for loan loss expense is no longer recognized after the reclassification to held-for-sale but, rather, the market value of these receivables is continuously adjusted through a charge recorded in operating expenses. The mark-to-market charges on held-for-sale receivables were over $100 million in 2018. Optically, the different classification makes provision expense look low and operating expenses look high. During 2018, we spent $443 million on share repurchases and $125 million on dividends. In addition, we reduced our corporate debt by $342 million during the year, lowering our corporate leverage ratio from 2.7x to 2.3x, well below our covenant of 3.5x. Turning into the segments on the next page. Starting with LoyaltyOne, pro forma revenue increased 4% to $1.4 billion. AIR MILES pro forma revenue decreased 3% versus the prior year, primarily due to lower redemptions. AIR MILES issued were flat for the year, as we saw a pullback in promotional activity by our sponsors in the fourth quarter. BrandLoyalty's revenue increased double digits for the year, but product mix and higher-than-expected expenses kept adjusted EBITDA essentially flat. Epsilon's revenue decreased 4% to $2.2 billion, while adjusted EBITDA was $475 million, consistent with last year. The decline in revenue was primarily due to double-digit declines in our agency and site-based product offerings. Despite the top line decrease, we were able to maintain adjusted EBITDA due to expense control and a positive shift in product mix. Lastly, Card Services revenue increased 10% to $4.6 billion, while adjusted EBITDA net increased 11% to $1.5 billion. Average receivables increased 8%, while active card receivables increased a robust 23% for 2018. Net loss rates were 6.1%, essentially the same as the prior year, aided by an improving recovery rate. The reserve rate at year-end was 6.1% on reservable receivables, down slightly as a rate from 2017 due to improving loss trends. The delinquency rate remains elevated due to a slowing growth rate in cards receivables, what in the industry we call primarily growth math. I will now turn it back to Ed.

Great. Thanks, Charles. If you'll turn to the slide entitled 2018 Full Year. A bit of this is repetitive, but just to hit the key bullet points. For the non-card segments, which would be the Epsilon and LoyaltyOne parts of the company. Again, with Epsilon about $2.2 billion in revs and $475 million on the EBITDA side. It is a business that has a mix of growing and stable as well as declining products. And primarily on the declining side, the agency and the traditional site-based display offerings are in decline. but the margin itself continues to improve as we're shifting to the more tech-based solutions. On the LoyaltyOne side, again, that consist of 2 primary businesses: one, the AIR MILES business based out of Canada; as well as our BrandLoyalty business based out of the Netherlands. Combined, we call that LoyaltyOne. They did $1.4 billion in pro forma revenue and a little over $0.25 billion in adjusted EBITDA. BrandLoyalty, which, again, does a lot of the shorter-term grocery loyalty programs across the world, the revenue was up double digits, and AIR MILES revenue was down slightly. On the EBITDA side, essentially flat with the prior year. Really, the nice step-up in revenue from BrandLoyalty was largely offset by higher expenses. AIR MILES, the issuance, which is a key metric because it's essentially how we get paid, was effectively flat with prior year, primarily because in the fourth quarter, a number of programs were kicked by our sponsors into the earlier part of '19. So that's more of a timing issue. But that's sort of a wrap-up on the non-card segments. Let's turn now to the full year discussion of Card Services, which had a good year. The revenue of $4.6 billion in adjusted EBITDA, again, it's a term we…

Sure. So we're over on Page 8, and I thought we'd talk through some of the key performance indicators for the year. I think it's important to start with normalized average receivables for the simple fact it includes our held-for-sale receivables. And that's a relevant metric because, really, we continue to earn revenue and incur expenses on held-for-sale receivables until sold. So really, in evaluating gross yield, operating expense leveraging, you have to consider the held-for-sale receivables, which were about $1.95 billion at year-end. Our gross yields were down slightly, about 30 bps, and that's primarily due to vintage mix. What that means is more of our receivables growth are coming from younger vintages, and it takes a younger vintage about 3 to 4 years to really hit a run rate gross yield. Operating expenses, we actually were good on the leveraging there. They were up about 10 basis points year-over-year, even though the chart shows 70 bps, as we talked about before, about 60 bps is due to the mark-to-market adjustment to carrying value for the held-for-sale receivables. Lastly, the delinquency rate, which we talked about a little bit before, continues to be elevated on a year-over-year basis, primarily due to the slowing growth rate in card receivables. That pressure should moderate as card receivables growth reaccelerates. And we're anticipating that will be more in the third quarter, back half of 2019. With that, I'll now turn it back over to Ed.

Okay. So I'm on Slide 9, Card Services, the average receivables growth. This is what we use here to sort of gauge, are we heading in the right direction as we pivot the card business itself. And if you look at the active clients, those are the brands that we're counting on to drive the longer-term growth of the business. It's masked quite a bit by the fact that we did, as we've talked about, discontinue our relationship with a number of brands. And if we turn back to the active clients, you'll see is a very healthy year for growth, up over 20%. That's nice. What probably is more important is what does that mean for the future. And you'll see to the far right that roughly 1/3 of the growth coming from these newer vintages in the healthier, probably more exciting verticals that we've been talking about, and that's up 200% from the prior year. So what's it all mean? What's it all mean is that the 2015 to '18 groups of clients that we signed represented roughly $4 billion of the portfolio in '18. And when those things are fully ramped up, because many of them are in these early stages, that's going to be roughly $11 billion to $12 billion. So there's a lot runway there with these signings. We mentioned the various verticals that we're excited about, names such as IKEA and Wyndham and Academy Sports and Penn Gaming. But also in there are some of the earlier signings, such as the Wayfairs and the Ulta Beauty and the Signet Jewelery (sic) [ Signet Jewelers ], Williams-Sonoma, Diamonds International, Build.com, Viking Cruises. As you can see, a lot of different verticals from what we've been known for, for the first probably 15, 18 years of…

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

I guess, I've got one multi-question on card and one on Epsilon. On card, could you just walk us through this noise on the delinquencies and sort of why you're confident it'll improve over the course of the year? And then as far as, like, the provisioning is concerned into 2019, I know it's probably going to be a headwind from the growth, but any cadence associated with that, Charles, would be helpful. And then as far as the profile of the customer of these new partners that are growing -- that you're growing with, has that changed in any way, like the demographic profile? Because it used to be that this customer that you'd get would have a secondary income or additional income that they wouldn't have -- that they wouldn't sort of notate and that they'd have a very good credit quality profile. Is it sort of consistent with the same in low lines?

You want to start off from the delinquency?

Sure. I'll take the easier one first. And then I'll give the hard one to Charles. But in terms of the type of customer we're seeing in the newer verticals, no, I don't think the quality is any different. In fact, since we have the right to maintain a certain level of quality within the overall portfolio, Sanjay, we can obviously adjust the knobs as necessary to sort of track to that goal of roughly 6%. So I would say, the only big thing that has shifted -- when you -- when the vast majority, when 90%-plus are -- of our cardholder base are women, I don't see that changing a lot. But what we are seeing, obviously, as we're moving into the wayfair.coms and in some of the pure e-comm plays is, as you might expect, is you're going to begin to skew down more into the millennials, and you're beginning to see with the Ulta Beauty and stuff like that, the Gen Zs or the iGens. And so for those types of clients, we're getting them in the door a little bit younger. And so you would adjust your credit lines accordingly.

And on the delinquency, Sanjay, you know quite well when AR growth decelerates, it pressures delinquency trends. You have less receivables going into your current bucket. And then when you get back to a point where AR growth is accelerating, it gives you some benefits on your delinquency trends. Based upon the profile we see now, I think you'll still see pressure on delinquency rates until you start moving into the growth periods of Q3, Q4. And I'd say, the same will be true of your provisioning. Most of that will be more back-half weighted. Again, as you saw, we expect receivables to be down Q1, Q2, accelerate in Q3, Q4, with quite a bit of growth, based on the timing we see now, in fourth quarter. So I'd expect it to be your largest quarter in terms of provisioning expense.

And I think on the delinquency side, Charles, check me if I'm wrong here, but we should see the year-over-year spread begin to narrow, like, very soon. So, probably next release.

Hope so. And then on Epsilon, I know you guys are limited to what you can say. But could you just characterize if you're reasonably pleased with the bids and if you envision a total or partial sale?

Well, I've got counsel sort of hanging over here. But no, I think we've probably said all we can. I mean, clearly, if you're going into -- if you're selecting final bids, final round for bidders, you're not displeased with what you're seeing. So I think I'll probably have to stop there.

And your next question comes from the line of Darrin Peller with Wolfe Research.

Let me just start off. I understand the rationale around the restructuring on the card side, obviously. Just, can you give us a little more of an idea when do you expect the held-for-sale portfolios could actually get sold? And then thinking about the freed-up capital there, should we consider that being invested in growth receivables? Should we think about portfolio acquisitions? Is there even anything out there?

So I'll start with the held-for-sale. You saw there, we sold $1.2 billion during the course of the year. We ended the year at $1.95 billion. A chunk of that is to -- relates to one bankrupt retailer that's in liquidation we're working on. I think that one could get done in the first quarter. And then I think a lot of it can be addressed first half of 2020. It's just some of it may take a little bit longer. What was the second one?

In terms of, are there...

Just the freed-up capital plans.

Yes. I mean, clearly, if we're expecting the -- both active and reported to hit that 15% growth rate by year-end, clearly, we're deploying that capital back into the business. A lot of it will be, obviously, to fund the continued ramp-up of the '15 to '18 vintages. However, to your point, Darrin, there are a handful of files that are not likely to attract the attention of the big banks, but very nicely in our wheelhouse in terms of size. And I think you can expect to see a combo platter from us in terms of both the organic vintage ramp-ups as well as a handful of these smaller portfolios coming in.

Okay. And just one follow-up. When we think of the pro forma entity for the restructuring for Epsilon, I mean, we have a large card business now and we'll have, obviously, the LoyaltyOne business. So when we think about that, I mean, is the LoyaltyOne business still going to operate as a standalone business underneath the Alliance Data umbrella? Does it make sense to keep it? Does it makes sense to -- I just -- I never really saw a ton of synergy between that and the card business, so I'd just be curious of your thoughts there.

Yes. No, it's a fair comment. I think -- I guess, the easiest way to explain it is we've got a lot of balls in the air right now, and so we're taking things one step at a time. You've got -- sort of what can we say has been completed in terms of the overall strategic plan. We've completed sort of the necessary divestitures of those brands that we talked about in the card business. And we've set the card business up now, in my opinion, to have a very strong run for several years. We also have determined that there's a lot of value in Epsilon that we can unlock, and so that's sort of #2 on the list. Obviously, there are further discussions going on about what else could we do in terms of continuing to focus and clean up the narrative on a go-forward basis. Are there other assets that may or may not fit? And at this point, we're getting around to that. But right now, cards was first; Epsilon, second. And that's sort of what we're focused on right now.

And your next question comes from Ramsey El-Assal with Barclays.

I'm going to try again on Epsilon. Can you share any details on potential timing? Is this something that we should expect prior to the next earnings call, somewhat imminently, in terms of some resolution there on Epsilon?

I guess, we can keep trying to answer the question the same way. But I guess, the best way to think of it is talk to your banker friends. And when someone says they're going into the final round, you can take from that how long it usually takes from final around to when a potential announcement could come out, and we're likely to be on that track. So that's about as much of a nonanswer as I can give you.

Okay. And if the end state of the entity here, let's just say that you hive off Epsilon and that, potentially, LoyaltyOne is to follow. I mean, at some point, does it make sense to change your corporate structure from this ILC structure? I mean, would that not unlock quite a bit of trapped capital that could be put to work? I was just curious about your philosophy of kind of the long-term maintenance of that ILC corporate structure.

That would certainly be a possibility.

Your next question comes from the line of Dominick Gabriele with Oppenheimer.

Just as you continue to develop your relationships with the card partners and their needs, many of these partners are seeing more sales online -- on the online channel. Can you talk about how the -- how ADS' capabilities in a post-Epsilon world can continue to help your partners drive sales through the online channel? And also what did Wayfair see in ADS and your capabilities that some new prospective partners in the card business may also gravitate towards?

Sure, and it's a good question. I think, obviously, we've had the capabilities for quite some time to do omnichannel-type transactions, whether it's bricks-and-mortar or catalog, online, whatever it is. To us, they all flow into the central bucket. You're absolutely right. We're seeing -- even with traditional bricks-and-mortar, you're seeing a larger and larger footprint on the online space. You're seeing, at times, our online sales representing 40% of our overall sales volume. So it is an enormous piece of our business today. What we're trying to do on the online side is continue to develop those tools that will make it, if you want to call it, an effortless transaction on behalf of anyone who shops online. We've all been in that position where you've got the screen pops up and then you get all these fields to fill in, and it takes you forever. And so the abandonment rate is huge. People just get frustrated with that. So what we do is you have your card and you have your number and your ability to get in there and sort of that one button, one-push-type transaction, which is so critical to closing the sale, that type of technology, we have rolled out or are in the process of rolling out across all of our clients. Additionally, the ability to understand who is shopping online and offer right then and there a personalized-type discount or reward point or something that we get them to, what we call, a trigger marketing to make that one extra purchase that they normally wouldn't have done is critical. And so to sort of answer your question of what do we do that others don't, it really comes down to, again, understanding who the customer is, whether online or in the store, and proactively offering up a very, very focused offer that could trigger that one incremental purchase that they otherwise wouldn't have made. And so our whole business is driven off of driving incremental sales as opposed to saving money from the client on interchange or something like that. And so the data itself and how we use the data won't change, whether Epsilon is part of the overall ADS or outside of ADS. It'll either be a service arrangement or, frankly, we've built a 500-person division within cards itself over the years of folks, whether data scientists or marketing experts, to help drive that. So, that's sort of the special sauce.

Right. And then just one more, if I can. Can you just talk about the average balance size that you have currently versus where this average balance size could go when you keep moving away from specialty retail? And that -- how much do you think that piece of the loan growth story in '19 and '20 is attributed to that?

I don't have that off the top of my head. I can get that for you once we go offline. I just don't have that number.

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

Ed, maybe I'm not sure if you could answer this or not, but I'll try. With Epsilon, would you -- with the company, would ADS not sell Epsilon if they didn't get offers that were within -- had a valuation that added significant value to shareholders on the -- with the capital deployment you would make? Are you committed to selling this? Or if you got the bids that were insufficient, would you pull back?

I think that there's no question there is a floor. And it's got to be above the floor, for sure. And so we wouldn't be moving to final rounds with bidders, unless we felt comfortable we're heading in the right direction.

Okay. And then just on -- I think last quarter, you had put out kind of a 2020 receivables number. Just first of all, are the new assets generating the same returns that you've generated historically? Are they a little bit lower? I mean, 30% ROE is wonderful. But as we try to think about earnings growth into 2020, yes, as you're -- you build the portfolio, how should we think about the returns relative to the historical levels that ADS has delivered?

Yes. I mean, I think, look, we're pretty -- there's a lot of deals that we walk away from, obviously. And what we're trying to do is keeping the pricing discipline where it has been in the past. And so far, as long as -- frankly, as long as we stay within, I keep calling it, our sandbox, we seem to be maintaining that level of ROE hurdles that we've had in the past. Now clearly, when you're taking a very mature portfolio that's been around for 15 years, not really growing, it's throwing off a lot of cash and profit. But longer term, obviously, it's not the healthiest. But those are being divested. And you're spinning up the newer brands, which take a little bit of time before they can actually generate those types of returns, right? I mean, it's the nature of these vintages. So -- but steady-state, no, we -- we're keeping the same discipline we've seen before. And frankly, the people who are looking for the special sauce that we're -- that we offer, they're pretty focused on how are you going to drive that incremental sales and prove it to me. And as a result, I think we're -- we should be in good shape on the ROEs.

Last question, real quick. On the $22 guidance for next year, and I understand there's a lot of moving pieces that are going to change that as we move through the year, but does that include share buybacks?

It does not.

Your next question comes from the line of Dan Salmon with BMO Capital Markets.

This is William on for Dan. Just following up on Epsilon with a more fundamental-oriented question. You called out agency and site-based displays obviously being weak. But I was wondering if you'd go into more detail about areas of strength and which offerings are showing the most promise right now.

The way I'd break it down is Technology Platform, which you remember, is really the older part of Epsilon, has -- was very stable this year after being down the prior year. The 2 big drivers last year really were the auto vertical and the CRM -- Conversant CRM. We did not see the same level of growth this year with those 2 growth drivers as we did the prior year. But we still see building backlogs. We still see a big runway for them to develop. But even with our 2 bigger growth drivers, they didn't really produce as much in '18 as what we thought they could.

Yes. I mean, the big growth drivers going forward would be the CRM engine, the more traditional tech platforms, which are building the big loyalty in CRM databases and then the auto as well.

Your next question is from the line of Andrew Jeffrey with SunTrust.

With regard to the ongoing discussions around Epsilon, and I wonder if you can just comment on sort of how broadly, or from a high level, you're thinking about the pieces of that business that historically have been important to driving the value in card and whether or not -- or how you contemplate the sustainability of your ROE and the value prop, which we, I think, understand so well in the context of selling the entirety of Epsilon perhaps. Just how intertwined are those businesses?

Yes. It's a great question, Andrew and, obviously, something that we gave a great deal of thought to of -- by "unlocking" the value with Epsilon, are you, in fact, going to hurt the offering in cards? And so what we've done is a number of things. First out of the gate, as I mentioned, over the last several years, we've built up a, what I would call, mini Epsilon within cards itself. So you've got a 500-person dedicated division of marketing and data scientists who, you could say, normally would be over at Epsilon. But since cards was so big, we built it in cards. So that won't suffer. It's more on the technology side. So all of our brands in cards use the Epsilon platform for the various reward and loyalty programs. That will continue to be the case. It will be a service level agreement -- service agreement between the 2 entities. Additionally, these brands would use the various digital channels, whether it's Conversant or whether it's the digital e-mail platforms. Again, those would be direct service agreements with Epsilon. And then finally, a lot of the demographics, psychographic data that is housed within Epsilon, again, would be a service agreement between the 2 entities. So to put it as succinctly as I can, which is always difficult, Andrew, it would be the people-based stuff, we think, is all taken care of in-house within cards. The technology and the data that we need from Epsilon, we are carving out very specific contracts and agreements between the 2 entities. So the goal is not to have anything that disrupts what we offer to the client set.

Okay. That's helpful. And then Ed, I just wonder, I think becoming a pure play or closer to a pure-play in value-added Card Services makes a ton of sense for Alliance shareholders. Are you -- but is there a question about where we are in the cycle as you get more of a -- as you become more of a pure play in a credit business?

Yes. I mean, I think that's a lot of the stuff, right, that has sort of hit valuations of the financial sector and consumer finance companies. And all we can do is, frankly, what worked best for us -- should a recession approach in the next couple of years, what worked best for us in the Great Recession if -- because you were around, was the fact that we actually grew. We basically did not pull in during the Great Recession. In fact, we expanded and actually grew the portfolio and took advantage of the environment to, frankly, get some really nice clients with very good ROEs over the longer term. And my guess is we are positioning the company right now, if you think about it, as we deleverage and take advantage of what we believe are very attractive valuations out there for us. I don't see us doing anything differently. So we're going to play through in terms of right now, times are good. And so we're going to continue to sign and to grow to the extent there's some types of recession in the road. When you're making the returns that we're making, losses from a recession, you're probably talking 1 point, maybe 1.5 points at most, which still leaves a ton of profit flowing from the card business. So we would follow the exact same game plan as before and deploy as much, if not more, capital towards growth if there's a downturn. All right. Okay. Thank you, everyone. Appreciate it, and we look forward to our next call. Bye.

Thank you again for joining today's call. This does conclude today's conference. You may now disconnect.